PROSPECTUS SUPPLEMENT
(To Prospectus dated April 5, 2002) FILED PURSUANT TO RULE 424(b)(5)
REGISTRATION NO. 333-84820
REGISTRATION NO. 333-84820-01
REGISTRATION NO. 333-84820-02
$1,800,000,000
[VALERO ENERGY LOGO]
$300,000,000 6 1/8% NOTES DUE 2007
$750,000,000 6 7/8% NOTES DUE 2012
$750,000,000 7 1/2% NOTES DUE 2032
------------------------
Interest payable on April 15 and October 15
------------------------
WE MAY REDEEM ANY OR ALL OF THE 2007 NOTES, 2012 NOTES OR 2032 NOTES AT ANY TIME
AT THE REDEMPTION PRICE DESCRIBED HEREIN PLUS ACCRUED INTEREST.
------------------------
INVESTING IN THE NOTES INVOLVES RISKS. SEE "RISK FACTORS" BEGINNING ON PAGE 4
OF THE ACCOMPANYING PROSPECTUS.
------------------------
2007 NOTES - PRICE 99.809% AND ACCRUED INTEREST, IF ANY
2012 NOTES - PRICE 99.750% AND ACCRUED INTEREST, IF ANY
2032 NOTES - PRICE 99.140% AND ACCRUED INTEREST, IF ANY
------------------------
UNDERWRITING
DISCOUNTS AND PROCEEDS TO
PRICE TO PUBLIC COMMISSIONS COMPANY
--------------- ------------- ------------
Per 2007 Note.............................. 99.809% .600% 99.209%
Total...................................... $299,427,000 $1,800,000 $297,627,000
Per 2012 Note.............................. 99.750% .650% 99.100%
Total...................................... $748,125,000 $4,875,000 $743,250,000
Per 2032 Note.............................. 99.140% .875% 98.265%
Total...................................... $743,550,000 $6,562,500 $736,987,500
------------------------
The Securities and Exchange Commission and state securities regulators have not
approved or disapproved of these securities, or determined if this prospectus
supplement or the accompanying prospectus are truthful or complete. Any
representation to the contrary is a criminal offense.
The underwriters expect to deliver the notes to purchasers on April 15, 2002.
------------------------
JOINT BOOK-RUNNING MANAGERS
MORGAN STANLEY JPMORGAN
------------------------
BANC OF AMERICA LLC
BANC ONE CAPITAL MARKETS, INC.
BARCLAYS CAPITAL
BNP PARIBAS
FLEET SECURITIES, INC.
MIZUHO INTERNATIONAL PLC
RBC CAPITAL MARKETS
THE ROYAL BANK OF SCOTLAND
SCOTIA CAPITAL
SUNTRUST ROBINSON HUMPHREY
TD SECURITIES
TOKYO-MITSUBISHI INTERNATIONAL PLC
April 10, 2002
TABLE OF CONTENTS
PROSPECTUS SUPPLEMENT PAGE
--------------------- ----
Summary............................... S-3
Use of Proceeds....................... S-7
Capitalization........................ S-8
Unaudited Pro Forma Combined Financial
Statements.......................... S-10
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... S-13
Business.............................. S-27
Description of the Notes.............. S-39
Underwriting.......................... S-43
Legal Matters......................... S-44
Experts............................... S-44
Index to Financial Statements......... F-1
PROSPECTUS PAGE
---------- ----
About this Prospectus.................. 3
About Valero Energy Corporation........ 3
Risk Factors........................... 4
Cautionary Statement Concerning
Forward-Looking Statements........... 9
Use of Proceeds........................ 11
Ratio of Earnings to Fixed Charges..... 11
Description of Debt Securities......... 12
Description of Capital Stock........... 19
Description of Warrants................ 23
Plan of Distribution................... 23
Legal Matters.......................... 25
Experts................................ 25
Where You Can Find More Information.... 25
Information We Incorporate by
Reference............................ 25
You should rely only on the information contained in or incorporated into
this document. We have not authorized anyone to provide you with information
that is different from that contained in this document. This document is not an
offer to sell securities and is not soliciting an offer to buy securities in any
state where the offer or sale is not permitted. The information contained in
this document is accurate only as of the date hereof, regardless of the time of
delivery of this document or of any sale of securities.
S-2
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. As used in this prospectus supplement, the terms
"Valero" and "we" or "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.
VALERO ENERGY CORPORATION
Valero Energy Corporation is a Fortune 100 company based in San Antonio,
Texas with over 22,000 employees and total assets of almost $15 billion. One of
the top three U.S. refining companies in terms of refining capacity, Valero owns
and operates 11 refineries in the United States and one refinery in Canada with
a combined throughput capacity of about 1.9 million barrels per day (BPD).
Valero's refining network stretches from eastern Canada to the U.S. Gulf Coast
and West Coast. Valero produces premium, environmentally clean products, such as
reformulated gasoline, gasoline meeting the specifications of the California Air
Resources Board (CARB), CARB diesel fuel, low-sulfur diesel fuel and oxygenates.
Valero also produces a substantial slate of conventional gasoline, distillates,
jet fuel, asphalt and petrochemicals.
Valero is also a leading marketer of refined products. Valero markets
branded and unbranded refined products on a wholesale basis in 40 U.S. states
and Canada through an extensive bulk and rack marketing network. Valero also
markets refined products and convenience store merchandise through a network of
retail sites in the United States and Canada bearing the Diamond Shamrock(R),
Ultramar(R), Valero(R), Beacon(R) and Total(R) brand names.
Valero also has a logistics system that complements Valero's refining and
marketing assets in the U.S. Gulf Coast and Mid-Continent regions. Valero owns
about 73 percent of Valero L.P., a master limited partnership that owns and
operates crude oil pipelines, refined product pipelines and refined product
terminals in Texas, Oklahoma, New Mexico and Colorado. Units of Valero L.P. are
listed on the New York Stock Exchange under the symbol "VLI."
Valero was incorporated in Delaware in 1981 under the name Valero Refining
and Marketing Company as a wholly owned subsidiary of a corporation then known
as Valero Energy Corporation, and referred to in this prospectus supplement 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 to them 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 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.
Valero's principal executive offices are located at One Valero Place, San
Antonio, Texas, 78212, and its telephone number is (210) 370-2000. Its common
stock trades on the New York Stock Exchange under the symbol "VLO."
RECENT DEVELOPMENTS
Acquisition of Ultramar Diamond Shamrock Corporation. Effective December
31, 2001, Valero completed the acquisition of Ultramar Diamond Shamrock
Corporation (UDS), which is referred to in this prospectus supplement as the UDS
Acquisition. The consideration paid by Valero to UDS shareholders included
approximately $2.1 billion in cash and approximately 45.9 million shares of
Valero common stock. In connection with the acquisition, Valero assumed
approximately $2 billion of UDS debt.
S-3
Prior to the acquisition, UDS was an independent refiner and retailer of
refined products and convenience store merchandise in the central, southwest and
northeast regions of the United States and eastern Canada. UDS owned and
operated seven refineries with a combined throughput capacity of approximately
850,000 BPD. UDS marketed refined products and a broad range of convenience
store merchandise through a network of approximately 4,500 convenience stores in
the United States and eastern Canada.
As a condition to approval of the UDS Acquisition, the U.S. Federal Trade
Commission (FTC) is requiring Valero to sell UDS's 168,000 BPD Golden Eagle
Refinery located in the San Francisco Bay Area, its related wholesale marketing
business and 70 associated Beacon- and Ultramar-branded retail sites in Northern
California (collectively, the Golden Eagle Business). In February 2002, Valero
entered into an agreement to sell the Golden Eagle Business to Tesoro Refining
and Marketing Company for approximately $1.13 billion, subject to closing
adjustments and certain indemnifications. The sale is expected to close in April
2002, subject to regulatory approval. The FTC has approved a trustee to manage
the operations of these assets pending their sale to Tesoro.
Acquisition of Huntway Refining Company. Effective June 1, 2001, Valero
completed its acquisition of Huntway Refining Company. Huntway owned and
operated two California refineries at Benicia and Wilmington that produce
asphalt for use in road construction and repair, primarily in California and
Nevada. The facilities also produce smaller amounts of gas oil, naphtha and
kerosene. These facilities have been substantially integrated into Valero's
refinery systems at Benicia and Wilmington. The purchase price, net of cash
acquired, was approximately $76 million and included payment to Huntway's common
stockholders of $1.90 per share and amounts required to retire Huntway's
outstanding debt and satisfy payment obligations under outstanding stock
options.
Acquisition of El Paso Refinery and Related Product Logistics
Business. Effective June 1, 2001, Valero completed its acquisition of El Paso
Corporation's 115,000 BPD Corpus Christi, Texas refinery and related product
logistics business through capital lease agreements that have a term of 20 years
and require annual lease payments of $18.5 million for the first two years and
increased amounts thereafter. The agreements also give Valero an option to
purchase the facilities for approximately $294 million at the end of the second
year of the lease and for increasing amounts in each succeeding year through the
end of the lease term. As part of the acquisition, Valero also purchased
inventories for approximately $109 million. The refinery, which is located near
Valero's existing Corpus Christi Refinery, is a complex refinery that processes
heavy, high-sulfur crude oil into conventional gasoline, diesel, jet fuel and
other light products and petrochemicals. The product logistics facilities
consist of three intrastate common carrier pipelines and related terminal
facilities that enable refined products to be shipped from Corpus Christi to
markets in Houston, San Antonio, Victoria and the Rio Grande Valley.
SELECTED FINANCIAL DATA
The following table sets forth selected financial data for the five years
ended December 31, 2001. This information should be read in conjunction with
Valero's consolidated financial statements and related notes for the years ended
December 31, 2001, 2000 and 1999 included elsewhere in this prospectus
supplement. This selected financial data is derived from our consolidated
financial statements, which have been audited by Arthur Andersen LLP,
independent public accountants.
S-4
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
2001(A)(B) 2000(C) 1999 1998(D)(E) 1997(F)
----------- ----------- ---------- ---------- ----------
(IN THOUSANDS, EXCEPT FOR
RATIOS AND PER SHARE AMOUNTS)
Operating Revenues................ $14,988,339 $14,671,087 $7,961,168 $5,539,346 $5,756,220
Operating Income (Loss)........... $1,001,343 $ 610,979 $ 72,029 $ (48,347) $ 213,885
Income (Loss) From Continuing
Operations...................... $ 563,553 $ 339,120 $ 14,287 $ (47,291) $ 111,768
Loss From Discontinued Operations,
Net of Income Tax Benefit(g).... $ -- $ -- $ -- $ -- $ (15,672)
Net Income (Loss)................. $ 563,553 $ 339,120 $ 14,287 $ (47,291) $ 96,096
Less: Preferred stock dividend
requirements and redemption
premium...................... -- -- -- -- 4,592
----------- ----------- ---------- ---------- ----------
Net Income (Loss) Applicable to
Common Stock.................... $ 563,553 $ 339,120 $ 14,287 $ (47,291) $ 91,504
=========== =========== ========== ========== ==========
Earnings (Loss) Per Share of
Common Stock --Assuming
Dilution:
Continuing operations........ $ 8.83 $ 5.60 $ .25 $ (.84) $ 2.03
Discontinued operations...... -- -- -- -- (.29)
----------- ----------- ---------- ---------- ----------
Total...................... $ 8.83 $ 5.60 $ .25 $ (.84) $ 1.74
=========== =========== ========== ========== ==========
Ratio of Earnings to Fixed
Charges(h)...................... 7.3x 5.6x 1.3x -- 4.1x
Total Assets...................... $14,377,096 $ 4,307,704 $2,979,272 $2,725,664 $2,493,043
Long-Term Debt (less current
portion) and Capital Lease
Obligations..................... $2,805,247 $ 1,042,417 $ 785,472 $ 822,335 $ 430,183
Company-Obligated Preferred
Securities of Subsidiary
Trusts.......................... $ 372,500 $ 172,500 $ -- $ -- $ --
Stockholders' Equity.............. $4,202,563 $ 1,527,055 $1,084,769 $1,085,287 $1,158,841
------------
(a)Operating revenues, operating income, income from continuing operations, net
income, earnings per share and ratio of earnings to fixed charges exclude
amounts related to UDS, while total assets, long-term debt (less current
portion) and capital lease obligations, company-obligated preferred
securities of subsidiary trusts and stockholders' equity include amounts
related to UDS, which was acquired by Valero on December 31, 2001.
(b)Includes the operations of Huntway and the operations related to the El Paso
Corpus Christi refinery and related product logistics business beginning June
1, 2001.
(c)Includes the operations related to the Benicia Refinery and the related
distribution assets (Distribution Assets) beginning May 16, 2000 and the
operations related to the service stations included as part of the
acquisition from ExxonMobil (Service Stations) beginning June 16, 2000
(combined, the Benicia Acquisition).
(d)Includes the operations of the Paulsboro Refinery beginning September 17,
1998.
(e)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.
(f)Includes the operations of the Texas City, Houston and Krotz Springs
refineries beginning May 1, 1997.
(g)Reflects the results of the natural gas related services business of Old
Valero for periods prior to the July 31, 1997 Restructuring, which resulted
in the creation of Valero.
(h)Computed 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, one-third (the proportion deemed
representative of the interest factor) of rental expense and distributions on
preferred securities of a subsidiary trust which are deducted in the
determination of consolidated pre-tax income from continuing operations. For
the year ended December 31, 1998, earnings were insufficient to cover fixed
charges by $77.7 million. This deficiency was due primarily to the $170.9
million pre-tax charge to earnings to write down the carrying amount of
refinery inventories to market value described above in note (e). Excluding
the effect of the inventory write-down, the ratio of earnings to fixed
charges would have been 2.7x.
S-5
THE OFFERING
Notes Offered............................... $300,000,000 in principal amount of 6 1/8% Notes due
2007.
$750,000,000 in principal amount of 6 7/8% Notes due
2012.
$750,000,000 in principal amount of 7 1/2% Notes due
2032.
Maturity Date............................... 2007 Notes -- April 15, 2007
2012 Notes -- April 15, 2012
2032 Notes -- April 15, 2032
Interest Payment Dates...................... April 15 and October 15, beginning on October 15, 2002.
Interest will accrue from the issue date of the notes.
Ranking..................................... The notes are unsecured senior obligations of Valero and
will rank pari passu with all other unsecured senior
indebtedness of Valero.
Optional Redemption......................... We may redeem some or all of the notes at any time at
the redemption price described in the "Description of
the Notes" section under the heading "Optional
Redemption," plus accrued interest to the date of
redemption.
Covenants................................... The indenture governing the notes contains covenants
that, with certain exceptions, limit our ability and our
subsidiaries' ability to:
- incur debt secured by liens; and
- engage in sale/leaseback transactions.
For more details, see the section under the heading
"Description of Debt Securities -- Restrictive Cove-
nants in the Senior Indenture" in the accompanying
prospectus.
Use of Proceeds............................. We anticipate using the net proceeds of this offering to
repay all of the borrowings under our $1.5 billion
bridge loan facility and a portion of the borrowings
under our revolving bank credit facilities.
Risk Factors................................ You should carefully consider all information set forth
and incorporated by reference in this prospectus
supplement and, in particular, should carefully read the
section entitled "Risk Factors" in the accompanying
prospectus before purchasing any of the Notes.
S-6
USE OF PROCEEDS
We estimate that the proceeds (after deducting underwriting discounts and
commissions and estimated offering expenses) we will receive from this offering
will be approximately $1.78 billion.
The cash portion of the UDS Acquisition was funded with $1.5 billion in
borrowings under a bridge loan facility, which currently bears interest at a
rate of LIBOR plus 1% and matures on December 13, 2002, and approximately $555
million in borrowings under revolving bank credit facilities, which also
currently bear interest at a rate of LIBOR plus 1%. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources" for more information on these credit facilities.
We anticipate using the net proceeds of this offering to repay all of the
borrowings under the bridge loan facility and a portion of the borrowings under
the revolving bank credit facilities discussed above. Affiliates of the
underwriters are lenders under the bridge loan facility and the revolving bank
credit facilities. We will pay a portion of the proceeds of this offering to
these affiliates of the underwriters when we repay borrowings under the bridge
loan facility and the revolving bank credit facilities. See "Underwriting" for
further discussion.
S-7
CAPITALIZATION
The following table sets forth our capitalization (which includes our
consolidated subsidiaries) as of December 31, 2001 on an historical basis and as
adjusted to (i) reflect borrowings in January 2002 under the bridge loan and
revolving bank credit facilities for the purpose of paying the cash
consideration to UDS shareholders in connection with the UDS Acquisition, (ii)
reflect this offering and the application of the net proceeds from this offering
as described under "Use of Proceeds" and (iii) give effect to the sale of the
Golden Eagle Business and the application of the proceeds to pay down debt and
repurchase common stock, as described under "Unaudited Pro Forma Combined
Financial Statements." This table should be read in conjunction with our
historical consolidated financial statements beginning on page F-2 of this
prospectus supplement.
DECEMBER 31, 2001
---------------------------------------------
PRO FORMA PRO FORMA
HISTORICAL ADJUSTMENTS AS ADJUSTED
----------- ----------- -----------
(IN THOUSANDS)
Short-term debt:
Short-term bank credit facility.......................... $ 200,000 $ -- $ 200,000
Bank bridge loan facility, $1.5 billion.................. -- 1,500,000 (1) --
(1,500,000)(2)
Revolving bank credit facility, 364-day, $750 million.... -- 555,250 (1) --
(276,985)(2)
(278,265)(3)
----------- ----------- ----------
Total short-term debt............................. 200,000 -- 200,000
----------- ----------- ----------
Current portion of long-term debt.......................... 305,661 -- 305,661
----------- ----------- ----------
Payable to UDS shareholders................................ 2,055,250 (2,055,250)(1) --
----------- ----------- ----------
Long-term debt, less current portion....................... 2,517,398 (456,735)(3) 2,060,663
----------- ----------- ----------
Notes offered hereby....................................... -- 1,800,000 1,800,000
----------- ----------- ----------
Capital lease obligations.................................. 287,849 -- 287,849
----------- ----------- ----------
Company-obligated preferred securities of subsidiary
trusts................................................... 372,500 -- 372,500
----------- ----------- ----------
Minority interest in consolidated partnership.............. 115,608 -- 115,608
----------- ----------- ----------
Stockholders' equity:
Common stock, $0.01 par value; 300,000,000 shares
authorized; 108,198,992 shares issued.................. 1,082 -- 1,082
Additional paid-in capital............................... 3,468,550 -- 3,468,550
Retained earnings........................................ 864,421 -- 864,421
Accumulated other comprehensive income................... 18,126 -- 18,126
Treasury stock, at cost; 4,001,683 shares; 12,892,548
shares as adjusted for the repurchase of shares with
proceeds from the sale of the Golden Eagle Business.... (149,616) (400,000)(3) (549,616)
----------- ----------- ----------
Total stockholders' equity........................ 4,202,563 (400,000) 3,802,563
----------- ----------- ----------
Total capitalization.............................. $10,056,829 $(1,111,985) $8,944,844
=========== =========== ==========
------------
See notes on following page.
S-8
(1) To reflect the payment in January 2002 of the cash consideration to UDS
shareholders in connection with the UDS Acquisition, recorded as a payable
as of December 31, 2001, using borrowings of $1.5 billion under the bridge
loan facility and approximately $555.3 million under the revolving bank
credit facilities. For purposes of the capitalization table, we are assuming
the $555.3 million was borrowed under the 364-day revolving bank credit
facility.
(2) To reflect the anticipated use of the expected net proceeds of this offering
to repay all of the borrowings under the $1.5 billion bridge loan facility
and a portion of the borrowings under the revolving bank credit facilities.
(3) Assuming that the issuance of notes pursuant to this offering, as described
in note 2 above, has already occurred, this transaction reflects the
anticipated use of the expected proceeds from the sale of the Golden Eagle
Business to repay $735 million of bank borrowings and repurchase $400
million of our common stock at an assumed price per share of $44.99
(approximately 8.9 million shares). During December 2001, approximately $100
million of our common stock was repurchased as part of our plan to
repurchase a total of $500 million of our common stock using anticipated
proceeds from the sale of the Golden Eagle Business.
S-9
UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
On December 31, 2001, Valero completed the UDS Acquisition. As a condition
to regulatory approval of the UDS Acquisition, the FTC approved a consent decree
requiring Valero to divest the Golden Eagle Business. In February 2002, Valero
reached a definitive agreement to sell the Golden Eagle Business for
approximately $1.13 billion.
The following unaudited pro forma combined statement of income combines the
historical consolidated statements of income of Valero and UDS, giving effect to
the acquisition using the purchase method of accounting. The unaudited pro forma
combined statement of income assumes that:
-- the UDS Acquisition was effected on January 1, 2001;
-- Valero issued approximately 45.9 million shares of common stock and
paid approximately $2.1 billion of cash to UDS shareholders; and
-- the proceeds from the sale of the Golden Eagle Business are used to
pay down approximately $635 million of debt and repurchase $500
million of Valero common stock (approximately 11.1 million shares).
The unaudited pro forma combined statement of income does not reflect
anticipated synergies or costs and charges that may result from the acquisition.
For purposes of this unaudited pro forma combined statement of income, the
purchase price was allocated to the individual assets acquired and liabilities
assumed based on preliminary estimates of fair values, pending the completion of
an independent appraisal and other evaluations. The accounting policies of
Valero and UDS are substantially comparable. However, certain historical amounts
of UDS have been reclassified to conform the financial statement presentation of
the two companies.
This unaudited pro forma combined financial information should be read in
conjunction with the historical consolidated financial statements of Valero and
UDS included in this prospectus supplement beginning on page F-1. The pro forma
adjustments use estimates and assumptions based on currently available
information. Management believes that the estimates and assumptions are
reasonable, and that the significant effects of the acquisition are properly
reflected. However, this pro forma information is not intended to be indicative
of the historical results that would have been achieved had the companies always
been combined or the results of operations which may be achieved in the future.
S-10
VALERO ENERGY CORPORATION
UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 2001
(MILLIONS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
VALERO
VALERO UDS PRO FORMA AND UDS
HISTORICAL HISTORICAL ADJUSTMENTS COMBINED
---------- ---------- ----------- ---------
Operating revenues........................ $14,988.3 $16,860.0 $(2,020.6)(a) $26,681.2
(2,664.2)(b)
(482.3)(c)
--------- --------- --------- ---------
Costs and expenses:
Cost of sales and operating expenses.... 13,684.1 15,211.3 (1,759.9)(a) 23,989.0
(2,664.2)(b)
(482.3)(c)
Selling and administrative expenses..... 165.2 415.0 (15.3)(a) 546.5
(18.4)(d)
Goodwill amortization................... -- 20.0 (5.3)(a) --
(14.7)(e)
Depreciation expense.................... 137.7 232.8 (37.3)(a) 313.1
(20.1)(f)
--------- --------- --------- ---------
Total costs and expenses........ 13,987.0 15,879.1 (5,017.5) 24,848.6
--------- --------- --------- ---------
Operating income (loss)................... 1,001.3 980.9 (149.6) 1,832.6
Other income (expense), net............... (4.6) .5 (0.4)(a) (4.5)
Interest and debt expense:
Incurred................................ (99.1) (110.9) (137.4)(g) (307.0)
(3.0)(g)
42.5(h)
.9(h)
Capitalized............................. 10.6 4.8 -- 15.4
Distributions on preferred securities of
subsidiary trusts....................... (13.3) (17.2) -- (30.5)
Minority interest in net income of
consolidated partnership................ -- (9.4) -- (9.4)
--------- --------- --------- ---------
Income (loss) before income taxes......... 894.9 848.7 (247.0) 1,496.6
Income tax expense (benefit).............. 331.3 313.7 (82.9)(a) 549.1
(13.0)(i)
--------- --------- --------- ---------
Net income (loss)......................... $ 563.6 $ 535.0 $ (151.1) $ 947.5
========= ========= ========= =========
Earnings per share of common stock........ $ 9.28 $ 7.22 $ 9.92
Weighted average common shares
outstanding (in millions)............ 60.7 74.1 95.5(j)
Earnings per share of common
stock--assuming dilution................ $ 8.83 $ 7.08 $ 9.47
Weighted average common equivalent
shares outstanding (in millions)..... 63.8 75.5 100.1(j)
See Notes to Unaudited Pro Forma Combined Financial Statements.
S-11
VALERO ENERGY CORPORATION
NOTES TO UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME
(a)To exclude the results of operations related to the Golden Eagle Business
that are included in the UDS historical results, as the Golden Eagle Business
is assumed to have been sold as of January 1, 2001.
(b)To exclude excise taxes of $2,664.2 million (the amount remaining after
excluding the taxes eliminated as part of the Golden Eagle Business)
collected on behalf of governmental agencies associated with UDS' operations
from Operating Revenues and Cost of Sales to conform to Valero's accounting
policies.
(c)To eliminate intercompany sales of $482.3 million from Operating Revenues and
Cost of Sales.
(d)To eliminate certain UDS nonrecurring transaction costs of $18.4 million
directly attributable to the acquisition that were expensed by UDS.
(e)To reverse UDS' historical goodwill amortization.
(f)To record a $20.1 million decrease in UDS' depreciation expense based on the
preliminary purchase price allocation and estimated useful lives.
(g)To reflect interest expense of $137.4 million at a weighted average annual
interest rate of 6.6875% on borrowings of $2.1 billion required to fund the
UDS Acquisition and $3.0 million of amortization of related debt issuance
costs. A 1/8% change in the interest rate associated with these borrowings
would have a $2.6 million effect on interest expense for the year ended
December 31, 2001.
(h)To reflect a reduction in interest expense of $42.5 million and a $.9 million
reduction in amortization of related debt issuance costs resulting from the
assumed paydown of $635 million of debt with part of the proceeds from the
sale of the Golden Eagle Business. A 1/8% change in the interest rate
associated with this reduction in borrowings would have a $.8 million effect
on interest expense for the year ended December 31, 2001.
(i)To reflect the tax effect of the pro forma pre-tax income adjustments related
to the UDS Acquisition and adjust the effective tax rate to the rate that
would have been incurred by Valero with respect to the assets acquired.
(j)The weighted average shares used to compute pro forma earnings per share
reflect the issuance of 45.9 million shares to effect the acquisition,
reduced by 11.1 million shares repurchased with part of the proceeds from the
disposition of the Golden Eagle Business.
S-12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following selected review of the results of operations and financial
condition of Valero is taken from "Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations" in Valero's Form 10-K for the
year ended December 31, 2001. This selected review is not complete. For a more
complete review of the results of operations and financial condition of Valero
you should refer to "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" in Valero's Form 10-K for the year ended
December 31, 2001, which is incorporated herein by reference. The following
selected review of the results of operations and financial condition of Valero
should be read in conjunction with "Business" and our consolidated financial
statements included elsewhere in this prospectus supplement. All references to
Consolidated Balance Sheets, Consolidated Statements of Income and Notes to
Consolidated Financial Statements pertain to Valero's consolidated financial
statements and related notes for the year ended December 31, 2001 found on pages
F-2 through F-60. In the discussions that follow, all "per share" amounts assume
dilution.
ACQUISITION OF ULTRAMAR DIAMOND SHAMROCK CORPORATION
On December 31, 2001, Valero completed its acquisition of UDS (the UDS
Acquisition) after the Federal Trade Commission (FTC) approved a consent decree
on December 19 allowing the acquisition to be completed. In connection with the
UDS Acquisition, Valero issued approximately 45.9 million shares of common stock
and paid approximately $2.1 billion of cash to UDS shareholders. UDS was an
independent refiner and retailer of refined products and convenience store
merchandise in the central, southwest and northeast regions of the United States
and eastern Canada. UDS owned and operated seven refineries, including two in
Texas, two in California and one each in Oklahoma, Colorado, and Quebec, Canada,
with a combined throughput capacity of approximately 850,000 barrels per day.
UDS marketed refined products and a broad range of convenience store merchandise
through a network of approximately 4,500 convenience stores under the Diamond
Shamrock(R), Beacon(R), Ultramar(R), and Total(R) brand names in the United
States and eastern Canada. UDS's northeast retail operations also included the
marketing of refined products through 86 cardlocks, which are card- or
key-activated, self-service, unattended stations that allow commercial, trucking
and governmental fleets to buy gasoline and diesel fuel 24 hours a day, and a
retail home heating oil business that sells heating oil to approximately 250,000
households. As a condition for the regulatory approval of the acquisition, the
FTC's consent decree requires Valero to divest the 168,000 barrel-per-day Golden
Eagle Refinery located in the San Francisco Bay Area, the related wholesale
marketing business and 70 associated Beacon- and Ultramar-branded retail sites
located throughout Northern California (collectively, the Golden Eagle
Business). On February 4, 2002, Valero entered into a definitive agreement with
Tesoro Refining and Marketing Company (Tesoro), which was subsequently amended
on February 20, 2002, under which Tesoro will purchase the Golden Eagle Business
for approximately $1.13 billion, subject to closing adjustments and certain
indemnifications. The transaction is expected to close in April 2002, subject to
regulatory approval. See Notes 2, 3 and 27 of Notes to Consolidated Financial
Statements for additional information about the acquisition and the assets
required to be divested and their expected sale to Tesoro.
S-13
RESULTS OF OPERATIONS
2001 COMPARED TO 2000
FINANCIAL HIGHLIGHTS
YEAR ENDED DECEMBER 31,
-------------------------------------------
CHANGE
---------------
2001(A)(B) 2000(C) AMOUNT %
----------- ----------- -------- ----
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE
AMOUNTS)
Operating revenues.................................. $14,988,339 $14,671,087 $317,252 2%
Cost of sales....................................... (12,738,607) (13,076,849) 338,242 3
Operating costs:
Cash (fixed and variable)......................... (852,155) (682,742) (169,413) (25)
Depreciation and amortization..................... (222,411) (164,008) (58,403) (36)
Selling and administrative expenses (including
related depreciation expense)..................... (173,823) (136,509) (37,314) (27)
----------- ----------- --------
Total operating income.................... 1,001,343 610,979 390,364 64
Other income (expense), net......................... (4,613) 282 (4,895) --(d)
Interest and debt expense, net...................... (88,508) (76,245) (12,263) (16)
Distributions on preferred securities of subsidiary
trust............................................. (13,369) (6,796) (6,573) (97)
Income tax expense.................................. (331,300) (189,100) (142,200) (75)
----------- ----------- --------
Net income.......................................... $ 563,553 $ 339,120 $224,433 66
=========== =========== ========
Earnings per share of common stock--assuming
dilution.......................................... $ 8.83 $ 5.60 $ 3.23 58
Earnings before interest, taxes, depreciation and
amortization (EBITDA)(e).......................... $1,235,005 $ 785,744 $449,261 57
Ratio of EBITDA to interest incurred(e)............. 11.0x 8.7x 2.3x 26
------------
(a)Excludes amounts related to UDS which was acquired by Valero on December 31,
2001.
(b)Includes the operations of Huntway and the operations related to the El Paso
Corpus Christi refinery and related product logistics business beginning June
1, 2001.
(c)Includes the operations related to the Benicia Refinery and the related
distribution assets (Distribution Assets) beginning May 16, 2000 and the
operations related to the service stations included as part of the
acquisition from ExxonMobil (Service Stations) beginning June 16, 2000
(combined, the Benicia Acquisition).
(d)Percentage variance is greater than 100%.
(e)For purposes of this calculation, distributions on preferred securities of
subsidiary trust are included in interest incurred.
S-14
OPERATING HIGHLIGHTS
YEAR ENDED DECEMBER 31,
-----------------------------------
CHANGE
------------
2001(A)(B) 2000(C) AMOUNT %
---------- ------- ------ ---
Sales volumes (thousand barrels per day or MBPD)........ 1,355 1,142 213 19%
Throughput volumes (MBPD)............................... 1,001 857 144 17
Average throughput margin per barrel.................... $ 6.16 $ 5.08 $1.08 21
Operating costs per barrel:
Cash (fixed and variable)............................. $ 2.31 $ 2.18 $ .13 6
Depreciation and amortization......................... .61 .52 .09 17
------ ------ -----
Total operating costs per barrel.............. $ 2.92 $ 2.70 $ .22 8
====== ====== =====
Charges:
Crude oils:
Sour............................................... 62% 55% 7% 13
Heavy sweet........................................ 4 8 (4) (50)
Light sweet........................................ 7 8 (1) (13)
------ ------ -----
Total crude oils.............................. 73 71 2 3
High-sulfur residual fuel oil (resid)................. 4 4 -- --
Low-sulfur resid...................................... 4 3 1 33
Other feedstocks and blendstocks...................... 19 22 (3) (14)
------ ------ -----
Total charges................................. 100% 100% --% --
====== ====== =====
Yields:
Gasolines and blendstocks............................. 53% 53% --% --
Distillates........................................... 27 28 (1) (4)
Petrochemicals........................................ 3 3 -- --
Lubes and asphalts.................................... 4 3 1 33
Other products........................................ 13 13 -- --
------ ------ -----
Total yields.................................. 100% 100% --% --
====== ====== =====
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS
YEAR ENDED DECEMBER 31,
------------------------------
CHANGE
------------
2001 2000 AMOUNT %
------ ------ ------ ---
(DOLLARS PER BARREL)
Feedstocks (at U.S. Gulf Coast, except as noted):
West Texas Intermediate (WTI) crude oil(d)................ $25.93 $30.36 $(4.43) (15)%
WTI less sour crude oil(e)(f)............................. $ 5.01 $ 3.52 $1.49 42
WTI less Alaska North Slope (ANS) crude oil (U.S. West
Coast)(d).............................................. $ 2.69 $ 2.04 $ .65 32
WTI less sweet crude oil(g)()............................. $ (.23) $ (.49) $ .26 53
Products:
U.S. Gulf Coast:
Conventional 87 gasoline less WTI(d)................... $ 5.07 $ 4.66 $ .41 9
No. 2 fuel oil less WTI(d)............................. $ 3.01 $ 3.60 $(.59) (16)
Propylene less WTI(h).................................. $ (.83) $ 4.88 $(5.71) --(i)
U.S. East Coast:
Conventional 87 gasoline less WTI(d)................... $ 5.05 $ 5.62 $(.57) (10)
No. 2 fuel oil less WTI(d)............................. $ 3.83 $ 5.73 $(1.90) (33)
Lube oils less WTI(f)(j)............................... $26.83 $17.31 $9.52 55
U.S. West Coast:
CARB 87 gasoline less ANS(d)........................... $16.04 $14.74 $1.30 9
Low-sulfur diesel less ANS(d).......................... $ 9.05 $10.63 $(1.58) (15)
---------------
See notes on following page.
S-15
(a)Excludes amounts related to UDS which was acquired by Valero on December 31,
2001.
(b)Includes the operations of Huntway and the operations related to the El Paso
Corpus Christi refinery and related product logistics business beginning June
1, 2001.
(c)Includes the operations related to the Benicia Refinery and the Distribution
Assets beginning May 16, 2000 and the operations related to the Service
Stations beginning June 16, 2000.
(d)Based on posted prices from Platts, the energy information and market
services unit of The McGraw-Hill Companies.
(e)The market reference differential for sour crude oil is based on posted
prices for 50% Arab medium and 50% Arab light crude oils from Petroleum
Argus, a global independent source of oil and gas pricing information.
(f)The market reference differential for the 2000 period has been restated from
the amount reported in Valero's Form 10-K for the year ended December 31,
2000 to conform to the components used in the 2001 period.
(g)The market reference differential for sweet crude oil is based on Platts
posted prices for 50% light Louisiana sweet (LLS) and 50% Cusiana crude oils,
with LLS adjusted for backwardation.
(h)Based on posted prices from Chemical Marketing Associates, Inc. (CMAI), a
consulting service for the worldwide petrochemical, plastics, fibers and
chlor-alkali industries.
(i)Percentage variance is greater than 100%.
(j)Based on posted prices for ExxonMobil lube oils from ICIS-LOR, a pricing
information service for the petrochemical and oil markets.
General. Valero reported net income of $563.6 million, or $8.83 per share,
for the year ended December 31, 2001 compared to net income of $339.1 million,
or $5.60 per share, for the year ended December 31, 2000. For the fourth quarter
of 2001, Valero reported net income of $51.6 million, or $.82 per share,
compared to net income of $93.3 million, or $1.47 per share, for the fourth
quarter of 2000. The increase in total year results was due in part to the full
year contribution from the Benicia Acquisition which was completed in the second
quarter of 2000. Excluding the effect of the Benicia Acquisition, total year
results increased as a result of a substantial increase in throughput margins
due primarily to a significant improvement in sour crude oil discounts, higher
throughput volumes resulting largely from the acquisitions of the El Paso and
Huntway refineries in June 2001 and upgrades to the crude units at the Texas
City Refinery in February 2001, and an $8.8 million pre-tax, or $.09 per share
after-tax, benefit attributable to the acquisition of UDS inventories on
December 31, 2001 as discussed in Note 6 of Notes to Consolidated Financial
Statements. Partially offsetting the increase in throughput margins for Valero's
operations excluding Benicia were higher operating costs and selling and
administrative expenses, and an increase in income tax expense.
Results for the fourth quarter of 2001 declined from fourth quarter 2000
levels due primarily to a decrease in distillate and gasoline margins
attributable to exceptionally high margins experienced in the 2000 period and
higher industry-wide inventories in the 2001 period, and increases in operating
costs, depreciation expense and interest expense. Partially offsetting the
decrease in income resulting from these factors were higher throughput volumes
as described above, the processing of a larger percentage of sour crude oil, the
above-noted benefit attributable to the December 31, 2001 acquisition of UDS
inventories, and decreases in selling and administrative expenses and income tax
expense.
Operating Revenues. Operating revenues increased $317.3 million, or 2%, to
$15.0 billion during 2001 compared to 2000 due primarily to a 19% increase in
average daily sales volumes, offset to a large extent by a $4.81, or 14%,
decrease in the average sales price per barrel. The increase in average daily
sales volumes was due primarily to (i) the full year effect of volumes
attributable to the Benicia Acquisition, (ii) an increase in the sale of
feedstocks and products purchased for resale, and (iii) higher throughput
volumes resulting from the contribution of the El Paso and Huntway refineries
acquired in the second quarter of 2001 and capacity expansions at the Texas City
and other refineries during 2001. The decrease in average sales prices was due
primarily to lower refined product prices resulting from increased refined
product inventories industry-wide and a decrease in crude oil prices. The
increase in refined product inventory levels was attributable primarily to (i)
increased production and higher imports of gasoline which more than offset
improved demand, (ii) unusually low distillate inventories in 2000 and (iii) a
weakened economy following the terrorist attacks on September 11, 2001.
Operating Income. Operating income increased $390.4 million, or 64%, to
$1.0 billion during 2001 compared to 2000 due in part to the above-noted full
year contribution from the Benicia Acquisition which
S-16
resulted in an increase in operating income of approximately $67 million.
Excluding the effect of the Benicia Acquisition, operating income increased due
to an approximate $472 million increase in total throughput margins (operating
revenues less cost of sales), partially offset by an approximate $122 million
increase in operating costs (including an $80 million increase in cash operating
costs and a $42 million increase in depreciation and amortization expense), and
an approximate $27 million increase in selling and administrative expenses
(including related depreciation expense).
Total throughput margins, excluding the effect of the Benicia Acquisition,
increased due to (i) the effect of higher throughput volumes resulting from the
factors noted above in the discussion of operating revenues, including a
significant increase in the volume of Valero's sour crude oil charges during
2001 to take advantage of higher sour crude oil discounts discussed below, (ii)
higher per barrel feedstock discounts, particularly for sour crude oil resulting
primarily from an increase in supplies of heavier crude oil while demand for
sweeter crude oil increased to meet lower sulfur requirements for certain
refined products, (iii) higher lube oil margins resulting mainly from improved
market conditions, (iv) higher prices for No. 6 fuel oil and other heavy
products relative to crude oil prices, and (v) the pre-tax benefit attributable
to the December 31, 2001 acquisition of UDS inventories noted above under
"General." Partially offsetting the increases in total throughput margins
resulting from these factors were (i) lower distillate margins, when compared to
exceptionally high margins in 2000, due to strong demand and extremely low
industry inventory levels in 2000 resulting from cold weather and high natural
gas prices which caused power producers to switch to fuel oil to run their
plants, (ii) a significant decrease in margins for propylene and other
petrochemical feedstocks, to negative levels in 2001, due to slowing economic
activity throughout the world, and (iii) an increase in natural gas, hydrogen
and methanol feedstock costs relative to crude oil.
Cash operating costs were higher due primarily to the operations of the
Corpus Christi refinery and related product logistics business acquired from El
Paso in 2001 and increases in employee salaries, benefits and variable
compensation, maintenance costs, and ad valorem taxes, partially offset by
reduced refinery energy costs. Depreciation and amortization expense was higher
due primarily to an increase in turnaround and catalyst amortization and
increased depreciation expense resulting from the 2001 acquisition of the El
Paso facilities and capital expansion projects. Selling and administrative
expenses (including related depreciation expense) increased primarily as a
result of an increase in employee salaries, benefits and variable compensation,
and integration and early retirement costs incurred in 2001 in connection with
the UDS Acquisition. Partially offsetting these increases in selling and
administrative expenses was the nonrecurrence in 2001 of costs recorded in 2000
associated with certain litigation and other matters.
Other Income (Expense), Net. Other income (expense), net, decreased $4.9
million, from income of $.3 million during 2000 to expense of $4.6 million
during 2001, due to reduced results from Valero's 20% equity interest in the
Javelina off-gas processing plant in Corpus Christi attributable primarily to
higher natural gas feedstock costs and lower product prices resulting from a
weak petrochemical market. Partially offsetting the reduced results from the
Javelina plant were lower costs related to the agreement entered into by Valero
in September 1999 to sell a portion of its accounts receivable.
Net Interest and Debt Expense. Net interest and debt expense increased
$12.3 million, or 16%, to $88.5 million in 2001 compared to 2000 due primarily
to a full year of interest in 2001 on borrowings incurred to fund the Benicia
Acquisition, including interest on the senior notes issued in June 2000, and
interest recognized in connection with the capital lease obligations associated
with the June 1, 2001 El Paso acquisition, partially offset by a decrease in
bank borrowings resulting from Valero's strong earnings and cash flow.
Distributions on Preferred Securities of Subsidiary Trust. Distributions
on preferred securities of subsidiary trust increased from $6.8 million in 2000
to $13.4 million in 2001 due to a full year of distributions on the PEPS Units
issued in June 2000 in connection with funding the Benicia Acquisition. See
Notes 2 and 13 of Notes to Consolidated Financial Statements.
Income Tax Expense. Income tax expense increased from $189.1 million in
2000 to $331.3 million in 2001 due primarily to the significant increase in
pre-tax income. See Note 19 of Notes to Consolidated Financial Statements.
S-17
2000 COMPARED TO 1999
FINANCIAL HIGHLIGHTS
YEAR ENDED DECEMBER 31,
-----------------------------------------------
CHANGE
-----------------
2000(A) 1999 AMOUNT %
------------ ----------- ----------- ---
(DOLLARS IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
Operating revenues............................ $ 14,671,087 $ 7,961,168 $ 6,709,919 84%
Cost of sales................................. (13,076,849) (7,206,903) (5,869,946) (81)
Operating costs:
Cash (fixed and variable)................... (682,742) (473,787) (208,955) (44)
Depreciation and amortization............... (164,008) (135,764) (28,244) (21)
Selling and administrative expenses (including
related depreciation expense)............... (136,509) (72,685) (63,824) (88)
------------ ----------- -----------
Total operating income.............. 610,979 72,029 538,950 --(b)
Other income, net............................. 282 3,587 (3,305) (92)
Interest and debt expense, net................ (76,245) (55,429) (20,816) (38)
Distributions on preferred securities of
subsidiary trust............................ (6,796) -- (6,796) --(b)
Income tax expense............................ (189,100) (5,900) (183,200) --(b)
------------ ----------- -----------
Net income.................................... $ 339,120 $ 14,287 $ 324,833 --(b)
============ =========== ===========
Earnings per share of common stock--assuming
dilution.................................... $ 5.60 $ .25 $ 5.35 --(b)
Earnings before interest, taxes, depreciation
and amortization (EBITDA)(c)................ $ 785,744 $ 216,769 $ 568,975 --(b)
Ratio of EBITDA to interest incurred(c)....... 8.7x 3.5x 5.2x --(b)
------------
(a)Includes the operations related to the Benicia Refinery and the Distribution
Assets beginning May 16, 2000 and the operations related to the Service
Stations beginning June 16, 2000.
(b)Percentage variance is greater than 100%.
(c)For purposes of this calculation, distributions on preferred securities of
subsidiary trust are included in interest incurred.
S-18
OPERATING HIGHLIGHTS
YEAR ENDED DECEMBER 31,
---------------------------------
CHANGE
------------
2000(A) 1999 AMOUNT %
------- ------ ------ ---
Sales volumes (MBPD)..................................... 1,142 1,033 109 11%
Throughput volumes (MBPD)................................ 857(b) 712 145 20
Average throughput margin per barrel..................... $ 5.08 $ 2.90 $2.18 75
Operating costs per barrel:
Cash (fixed and variable).............................. $ 2.18 $ 1.83 $ .35 19
Depreciation and amortization.......................... .52 .52 -- --
------ ------ -----
Total operating costs per barrel............... $ 2.70 $ 2.35 $ .35 15
====== ====== =====
Charges:
Crude oils:
Sour................................................ 55% 48% 7% 15
Heavy sweet......................................... 8 12 (4) (33)
Light sweet......................................... 8 9 (1) (11)
------ ------ -----
Total crude oils............................... 71 69 2 3
High-sulfur resid...................................... 4 3 1 33
Low-sulfur resid....................................... 3 6 (3) (50)
Other feedstocks and blendstocks....................... 22 22 -- --
------ ------ -----
Total charges.................................. 100% 100% --% --
====== ====== =====
Yields:
Gasolines and blendstocks.............................. 53% 51% 2% 4
Distillates............................................ 28 29 (1) (3)
Petrochemicals......................................... 3 5 (2) (40)
Lubes and asphalts..................................... 3 3 -- --
Other products......................................... 13 12 1 8
------ ------ -----
Total yields................................... 100% 100% --% --
====== ====== =====
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS
YEAR ENDED DECEMBER 31,
--------------------------------
CHANGE
--------------
2000 1999 AMOUNT %
------ ------ ------ -----
(DOLLARS PER BARREL)
Feedstocks (at U.S. Gulf Coast, except as noted):
WTI crude oil(c)........................................ $30.36 $19.28 $11.08 57%
WTI less sour crude oil(d)(e)........................... $ 3.52 $ 2.40 $1.12 47
WTI less ANS (U.S. West Coast)(c)(f).................... $ 2.04 $ 1.55 $ .49 32
WTI less sweet crude oil(g)............................. $ (.49) $ (.06) $(.43) --(h)
Products:
U.S. Gulf Coast:
Conventional 87 gasoline less WTI(c)................. $ 4.66 $ 2.53 $2.13 84
No. 2 fuel oil less WTI(c)........................... $ 3.60 $ .33 $3.27 --(h)
Propylene less WTI(i)................................ $ 4.88 $ .93 $3.95 --(h)
U.S. East Coast:
Conventional 87 gasoline less WTI(c)................. $ 5.62 $ 3.47 $2.15 62
No. 2 fuel oil less WTI(c)........................... $ 5.73 $ 1.16 $4.57 --(h)
Lube oils less WTI(e)(j)............................. $17.31 $12.51 $4.80 38
U.S. West Coast(f):
CARB less ANS(c)..................................... $14.74 $12.13 $2.61 22
Low-sulfur diesel less ANS(c)........................ $10.63 $ 6.86 $3.77 55
---------------
See notes on following page.
S-19
(a)Includes the operations related to the Benicia Refinery and the Distribution
Assets beginning May 16, 2000 and the operations related to the Service
Stations beginning June 16, 2000.
(b)Includes 106 MBPD for 2000 related to the Benicia Refinery.
(c)Based on Platts posted prices.
(d)The market reference differential for sour crude oil is based on Petroleum
Argus posted prices for 50% Arab Medium and 50% Arab light crude oils.
(e)The market reference differentials for the 2000 and 1999 periods have been
restated from the amounts reported in Valero's Form 10-K for the year ended
December 31, 2000 to conform to the components used in the 2001 period.
(f)The market reference differentials for the U.S. West Coast are total year
differentials presented for informational purposes only. The comparison is
not relevant to Valero since the Benicia Acquisition did not occur until the
second quarter of 2000.
(g)The market reference differential for sweet crude oil is based on Platts
posted prices for 50% LLS and 50% Cusiana crude oils, with LLS adjusted for
backwardation.
(h)Percentage variance is greater than 100%.
(i)Based on CMAI posted prices.
(j)Based on ICIS-LOR posted prices for ExxonMobil lube oils.
General. Valero reported net income of $339.1 million, or $5.60 per share,
for the year ended December 31, 2000 compared to net income of $14.3 million, or
$.25 per share, for the year ended December 31, 1999. For the fourth quarter of
2000, Valero reported net income of $93.3 million, or $1.47 per share, compared
to net income of $16.5 million, or $.29 per share, for the fourth quarter of
1999. The substantial increase in full year results was due primarily to
dramatically improved refining industry fundamentals which resulted in a
significant increase in throughput margins, and the contribution from the
Benicia Acquisition ($1.80 per share) completed in the second quarter of 2000.
Also contributing to higher full year results was the effect in the first
quarter of 1999 of a major maintenance turnaround of the heavy oil cracker and
related units at the Corpus Christi Refinery, as well as certain unit expansions
implemented during that downtime, which both reduced results for 1999 and
increased results for 2000. Partially offsetting the increases in net income
resulting from these factors for Valero's operations excluding Benicia were
higher cash operating costs and selling and administrative expenses, an increase
in income tax expense, the effect of certain scheduled and unscheduled refinery
downtime experienced primarily during the 2000 second quarter, and the
nonrecurrence in 2000 of benefits to income in 1999 related to reductions in
LIFO inventories.
Results for the fourth quarter of 2000 increased from fourth quarter 1999
levels due primarily to the significant contribution from the Benicia
Acquisition ($.71 per share) and substantially higher throughput margins for
Valero's operations excluding Benicia resulting from exceptionally strong
refining industry fundamentals and higher throughput volumes in the 2000
quarter. Partially offsetting the increase in throughput margins for Valero's
operations excluding Benicia were increases in cash operating costs, including
substantially higher natural gas costs, selling and administrative expenses, and
income tax expense.
Operating Revenues. Operating revenues increased $6.7 billion, or 84%, to
$14.7 billion during 2000 compared to 1999 due to a $13.88, or 66%, increase in
the average sales price per barrel and an 11% increase in average daily sales
volumes. The increase in average sales prices was due primarily to significantly
higher refined product prices resulting from reduced refined product inventories
industry-wide and an increase in crude oil prices. The decline in refined
product inventory levels was attributable primarily to (i) lower crude oil
supplies resulting from the continued impact of OPEC's decision in March 1999 to
significantly reduce crude oil production, (ii) lower refinery utilization rates
in late 1999 and early 2000, (iii) reduced refinery production due to more
stringent fuel specifications in the U.S. and Europe that became effective in
2000, and (iv) improved demand for distillates. Average daily sales volumes
increased due primarily to additional volumes attributable to the Benicia
Acquisition.
Operating Income. Operating income increased $539 million, from $72
million in 1999 to $611 million in 2000, due in part to the contribution from
the Benicia Acquisition noted above. Excluding the effect of the Benicia
Acquisition, operating income increased due to an approximate $471 million
increase in total
S-20
throughput margins, partially offset by an approximate $99 million increase in
cash operating costs and an approximate $49 million increase in selling and
administrative expenses (including related depreciation expense).
Total throughput margins, excluding the effect of the Benicia Acquisition,
increased due to (i) significantly higher distillate margins resulting primarily
from strong demand and extremely low industry inventory levels, (ii) higher
gasoline margins resulting primarily from supply constraints and low industry
inventories, (iii) improved feedstock discounts for sour crude oil resulting
primarily from increases in sour crude oil production by OPEC and a shift in
demand from sour crude oil to sweet crude oil due to lower sulfur requirements
for certain refined products, (iv) higher RFG premiums and oxygenate margins due
to improved demand and the tightening of fuel specifications in the U.S. and
Europe noted above, (v) significantly higher lube oil margins resulting mainly
from improved market conditions, (vi) higher petrochemical margins resulting
from improved worldwide demand, particularly in Asia, and (vii) higher
throughput volumes. The strong demand for distillate noted above was
attributable mainly to cold weather and high natural gas prices. These high
natural gas prices caused various power producers to switch to fuel oil to run
their plants, which also served to further reduce distillate inventories.
Partially offsetting the increases in total throughput margins resulting from
the above factors were (i) lower prices for No. 6 fuel oil and other heavy
products relative to crude oil prices, (ii) an increase in sweet crude oil costs
to amounts in excess of WTI, (iii) the effect of scheduled and unscheduled
refinery downtime experienced primarily during the 2000 second quarter, (iv) a
decrease in gains from trading activities and (v) the nonrecurrence in 2000 of
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.
Cash operating costs were higher due primarily to higher fuel and
electricity costs attributable mainly to an increase in natural gas prices, an
increase in employee salaries, benefits and variable compensation, and higher
maintenance costs related primarily to certain unscheduled refinery downtime,
tank cleanings and lower than normal maintenance activities in 1999. Selling and
administrative expenses (including related depreciation expense) increased
primarily as a result of an increase in employee salaries, benefits, variable
compensation and other employee-related costs, and costs associated with
litigation and other matters.
Other Income, Net. Other income, net, decreased $3.3 million to $.3
million during 2000 compared to 1999 due primarily to increased costs in 2000
related to the agreement entered into by Valero in September 1999 to sell a
portion of its accounts receivable, partially offset by improved results of $2.6
million from Valero's 20% equity interest in the Javelina off-gas processing
plant in Corpus Christi. The increase in Javelina's results was attributable
primarily to significantly higher prices for natural gas liquids and increases
in prices for ethylene and other products, partially offset by significantly
higher natural gas feedstock costs.
Net Interest and Debt Expense. Net interest and debt expense increased
$20.8 million, or 38%, to $76.2 million during 2000 compared to 1999 due
primarily to increased borrowings to fund the Benicia Acquisition, including the
issuance of the senior notes in June 2000 and borrowings under Valero's bank
credit facilities (the effects of which are included in the $1.80 per share
contribution from the Benicia Acquisition noted above), partially offset by a
paydown of bank borrowings during 2000 resulting from Valero's strong earnings
and cash flow.
Income Tax Expense. Income tax expense increased from $5.9 million in 1999
to $189.1 million in 2000 due primarily to the significant increase in pre-tax
income. See Note 19 of Notes to Consolidated Financial Statements.
OUTLOOK
OVERVIEW
The economy continued to weaken throughout 2001 and the decline was
accelerated by the terrorist attacks on the U.S. on September 11, 2001.
Following September 11th, refined product demand declined, particularly for jet
fuel, and distillate and gasoline inventories started building. An unusually
mild winter, coupled with the weak economy, contributed to further weakening of
refined product demand, which resulted
S-21
in a further build-up of refined product inventories. To compensate for the
decreasing demand for crude oil, OPEC cut crude oil production, primarily sour
crudes, which has resulted in a significant narrowing of the sour crude discount
to WTI.
FIRST QUARTER 2002
Through February 2002, refining margins are 40 to 50 percent below refining
margins in the first quarter of 2001. Average gasoline margins remain well below
the exceptionally high levels seen during the first quarter of 2001, due
primarily to above-average inventory levels, which resulted from high production
levels, increased imports and the blending of various petrochemicals into the
gasoline pool. For example, through February 2002, average Gulf Coast gasoline
margins relative to WTI were approximately $2.45 per barrel, compared to average
first quarter 2001 margins of $5.76 per barrel. Through February 2002, average
West Coast gasoline margins relative to ANS were also weak due to high inventory
levels resulting from West Coast refineries maintaining relatively high
production rates. The West Coast gasoline margin has averaged $9.70 per barrel
through February 2002, well below average first quarter 2001 margins of $19.47
per barrel. Average distillate margins through February 2002 are much lower than
those seen in the first quarter of 2001 as a result of the mild winter and weak
economy as discussed above, and reduced demand for jet fuel (which is causing an
increase in distillate inventories). For example, average Gulf Coast distillate
margins relative to WTI have declined to $1.36 per barrel thus far in 2002
compared to average first quarter 2001 margins of $3.47 per barrel. Average
margins for other products, including lube oil and propylene, have also declined
thus far in 2002, primarily due to lower demand caused by the weak economy.
Retail fuel margins have also been under pressure in the first quarter of
2002 due to various factors, including significant discounting by major
retailers in an effort to capture market share and increased competition from
large discount marketers of gasoline.
With respect to feedstocks, the lower OPEC production of sour crude oils
discussed above has resulted in average discounts for sour crude oil narrowing
substantially in the first quarter of 2002 from the very strong first quarter
2001 levels. Sour crude oil discounts to WTI (defined as an average of Arab
Light and Arab Medium delivered to the U.S. Gulf Coast) averaged $2.28 per
barrel through February 2002 compared to $5.33 per barrel in the first quarter
2001.
Valero's refinery utilization rates for the first quarter of 2002 are
expected to be below historical levels due to heavy turnaround activity, various
unscheduled downtimes, and economic-based run cuts as a result of poor margins.
Based on current plans, Valero's crude oil run cuts are expected to amount to
approximately 23% of total crude capacity for the first quarter, inclusive of
turnarounds. During the first quarter of 2002, Valero will have six of its 12
refineries involved in major turnaround activities at various times and for
varying durations. Most of the refinery units scheduled to be down during these
turnarounds are conversion units, which are the primary gasoline making units in
a refinery. The six refineries in turnaround include the Corpus Christi,
Benicia, Three Rivers, McKee, Ardmore and Krotz Springs refineries. In addition,
the Texas City Refinery will undergo a major turnaround in April 2002.
As a result of the poor product margins experienced thus far in 2002, the
substantial narrowing of sour crude discounts due to OPEC production cuts, and
significantly lower refinery utilization rates, Valero currently expects to
incur a slight loss in the first quarter of 2002.
REMAINDER OF 2002 AND BEYOND
Industry Fundamentals
For the remainder of 2002, Valero anticipates, based on projected supply
and demand fundamentals, that refining margins should strengthen. Refinery
utilization rates have remained low throughout the first quarter of 2002. In
addition to Valero's heavy turnaround activity and announced run cuts described
above, industry consultants have indicated that first quarter refinery
turnarounds will be heavy throughout the industry, and other refiners have also
announced significant levels of economic-based run cuts this quarter, especially
of crude units. Considering these lower refinery utilization rates coupled with
lower OPEC crude oil production,
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inventories should decline from first quarter 2002 levels. In addition, the
economy is showing signs of recovery, with commodity prices rising,
manufacturing activity increasing, and consumer confidence improving. As the
economy continues its recovery, the supply and demand balance should tighten
leading to lower refined product inventories, improved margins and positive
earnings going forward.
In the four weeks ending March 1, 2002, gasoline demand was 490,000 BPD or
approximately 6% higher than the same period last year, due primarily to
relatively low pump prices and more consumers opting to drive rather than fly.
Gasoline demand is expected to further strengthen as the summer driving season
approaches, given the effect of low pump prices on demand, many consumers opting
to drive rather than fly this summer and the impact of the recovering economy on
consumer sentiment. It is also encouraging to note that, despite the high
inventory levels, days supply of gasoline is currently the same as last year.
However, gasoline margins will likely continue under pressure until excess
inventories are reduced.
Distillate demand is down 4.7% through February 2002 compared to the first
two months of 2001 due to the mild winter and weak economy as described above.
As a result, distillate inventories are approximately 20 million barrels above
normal. Distillate margins will remain weak until inventories are reduced to
more normal levels. Reduced distillate production due to economic-based run cuts
by the industry, and an improving economy, should help reduce excess
inventories.
Valero believes that beyond 2002, refined product margins will improve due
to continued tightening fuel specifications and improving economic conditions
throughout the world. Refined product supply and demand balances are expected to
tighten in the U.S., Europe and Asia from the combined effect of increasing
demand, more stringent gasoline specifications, and refinery closures (resulting
from increased capital requirements to meet the increasingly stringent fuel
specifications). In fact, the impact of these fundamental changes to the
industry is already being seen in the U.S. by the closure last year of the
85,000 barrel-per-day Blue Island Refinery in the Midwest and the recent
announcement of the closure later this year of another Midwest refinery that
produces 70,000 barrels per day of refined products. The impact of refinery
closures and the volumetric impact caused by tighter fuel specifications should
more than offset refinery capacity additions and the limited amount of new
refinery construction that is underway around the world.
New product pipeline projects, including the Centennial pipeline that
connects the Gulf Coast to the Midwest and the Longhorn pipeline that connects
the Gulf Coast to El Paso, Texas, will change the dynamics of regional refined
product pricing in the U.S. The increased refined product supply capability will
tend to mitigate the upside volatility of refined product margins in the Midwest
and in the West Texas/New Mexico markets, and should also improve the Gulf Coast
margins as more refined products are delivered away from the Gulf Coast region.
Certain higher-cost, inefficient refiners in the Midwest and in the West
Texas/New Mexico markets may be forced to shut down if they cannot reduce their
costs to remain competitive.
Over the next several years, Valero expects the production of heavy sour
crude will exceed that of light sweet crude by an increasing amount, which
should result in widening discounts for Valero's purchases of sour crude oils.
As the world economy strengthens, demand for crude oil is expected to increase.
As OPEC increases its crude oil production levels to meet this demand, the
incremental sour crude barrels that were taken off the market will be the first
barrels brought back to the market to meet increasing demand. Additionally, new
discoveries of sour and heavy reserves are rapidly coming to the market from
areas such as deepwater Gulf of Mexico, the former Soviet Union and Canada. In
some major regions such as the North Sea, light sweet crude production is
already declining. With demand for sweet and light crude oils continuing to be
strong due to the implementation in 2000 of lower sulfur requirements in
products and the increasing availability of sour crude oil versus sweet crude
oil, the price differential between sweet crude oil and sour crude oil should
increase. Beginning in 2004, the further tightening of fuel specifications will
also increase the demand for light, sweet crude, further contributing to wider
light sweet/heavy sour price differentials. Valero expects to recognize
significant benefits from its ability to meet current fuel specifications using
predominantly sour crude oil feedstocks as the supply of sour crude and the
demand for sweet crude continue to increase in the future. In addition, Valero
expects that an improving world economy would cause crude oil demand to improve
which would widen the sour crude discount, thereby significantly benefiting
Valero.
S-23
Capital Investments
During 2001, Valero added more than 900,000 barrels per day of throughput
capacity to its refining operations, acquired an extensive logistics business to
enhance its business operations and became one of the nation's largest
retailers, primarily through the UDS Acquisition on December 31, 2001.
Currently, Valero's primary focus is to capture the synergy opportunities that
the UDS Acquisition creates. Beyond 2002, Valero plans to implement projects to
increase the amount of heavy sour crude processed at the UDS refineries.
For 2002, Valero currently expects to incur approximately $1 billion for
capital investments, including approximately $840 million for capital
expenditures (approximately $165 million of which is for environmental projects)
and approximately $160 million for deferred turnaround and catalyst costs. The
capital expenditure estimate excludes approximately $100 million and $35
million, respectively, related to a delayed coker facility at the Texas City
Refinery and the planned expansion of the UDS headquarters facility for future
use as Valero's new corporate headquarters, which are being funded through
structured lease arrangements (see Notes 23 and 27 of Notes to Consolidated
Financial Statements). The capital expenditure estimate also excludes
anticipated expenditures related to the earn-out contingency agreements
described in Note 2 of Notes to Consolidated Financial Statements. The estimate
of deferred turnaround and catalyst costs includes the costs of major
maintenance turnarounds planned for the remainder of 2002 at the Corpus Christi,
Texas City and Paulsboro refineries, which are expected to enhance the
profitability of these refineries going forward.
As refining margins merit, Valero expects to continue making capital
investments at its refineries to enhance feedstock flexibility, meet low sulfur
gasoline and distillate requirements, meet other environmental requirements of
both the EPA and various state agencies, make improvements in throughput
capacity, and enhance the operational efficiency and mechanical reliability of
its operations. Typically, these capital improvements would be implemented
during scheduled maintenance turnarounds.
Valero also plans to continue its program of modernizing and upgrading its
convenience store network through its re-imaging program. Over the past several
years, UDS has re-imaged 130 sites. Valero plans to continue this program and is
currently evaluating the entire network of UDS convenience stores to determine
the appropriate branding, the number of sites and the timetable for upgrading
the network.
Industry Consolidation
Significant industry consolidation through mergers and acquisitions has
occurred in the past and is continuing. Valero expects that industry
consolidations will continue, providing Valero with possible additional
opportunities to expand its operations. Geographically, that growth will most
likely come in the Northeast, Mid-Continent and Gulf Coast regions. Valero is
well positioned to capitalize on further industry consolidation opportunities
and to benefit from these long-term industry trends.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operating activities increased $304.2 million to
$905.5 million during 2001 compared to 2000, due primarily to the significant
increase in net income discussed above under "Results of Operations," partially
offset by an increase in the amount of cash used to fund working capital. During
2001, approximately $1.1 billion of cash was generated from earnings,
approximately $181.1 million of which was used for other operating activities,
primarily working capital requirements. During 2001, there were significant
changes in individual components of working capital, as detailed in "Statements
of Cash Flows" in Note 16 of Notes to Consolidated Financial Statements.
Accounts payable decreased $237.6 million and accounts receivable decreased
$122.1 million primarily due to a decline in various commodity prices from
December 2000 to December 2001, partially offset by an increase in volumes
purchased and sold. Accounts payable also declined due to Valero's redelivery to
the U.S. Strategic Petroleum Reserve in 2001 of approximately one million
barrels of crude oil in settlement of a time exchange of crude oil entered into
in 2000. During 2001, cash provided by operating activities, issuances of common
stock in connection with Valero's benefit plans, and proceeds from the
disposition of property, plant and equipment were utilized to (i) fund capital
expenditures, deferred turnaround and catalyst costs and the earn-out
contingency payments to Salomon Inc
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and ExxonMobil described in Note 2 of Notes to Consolidated Financial
Statements, (ii) fund the acquisition of Huntway and inventories related to the
acquisition of El Paso's Corpus Christi refinery and related product logistics
business, (iii) repurchase shares of Valero common stock, and (iv) pay common
stock dividends.
Valero's cash flows from operations are primarily affected by the
relationship, or margins, between refined product prices and the prices for
crude oil and other feedstocks. Historically, refining margins have been
volatile, and they are likely to continue to be volatile in the future. Based on
results thus far in 2002 and margin estimates for the remainder of the year,
operating cash flows for 2002 are expected to be significantly below 2001
levels.
As discussed in Note 2 of Notes to Consolidated Financial Statements, the
$2.1 billion cash portion of the UDS Acquisition was financed with proceeds from
a $1.5 billion bridge loan facility and borrowings under two new $750 million
revolving bank credit facilities. The bridge loan facility, which is a
single-draw facility, has a one-year maturity. Proceeds from the required
disposition of the Golden Eagle Refinery and associated retail assets must be
used to pay down any amounts then outstanding under the bridge facility and
reduce commitments thereunder. The two revolving bank credit facilities provide
for commitments of $750 million for a five-year term and $750 million for a
364-day term, respectively, and replace Valero's previous $835 million revolving
bank credit and letter of credit facility. Borrowings under these facilities
bear interest at either the London interbank offered rate (LIBOR) plus a margin,
a base rate or a money market rate. The interest rate and fees under these
credit facilities are subject to adjustment based upon the credit ratings
assigned to Valero's long-term debt. The credit facilities include certain
restrictive covenants including a coverage ratio and a debt-to-capitalization
ratio. As of December 31, 2001, borrowings under the two revolving credit
facilities were $525 million, while letters of credit outstanding were
approximately $145 million. Valero also currently has an uncommitted short-term
bank credit facility, along with various uncommitted bank letter of credit
facilities. As of December 31, 2001, $200 million was outstanding under the
short-term bank credit facility, and letters of credit totaling approximately
$92 million were outstanding under the uncommitted letter of credit facilities.
As of December 31, 2001, Valero's committed revolving credit facilities
also consisted of a Canadian facility under which a Canadian subsidiary may
borrow, issue bankers' acceptances and obtain letters of credit in an aggregate
amount of Cdn. $200 million, and a U.S. facility under which Valero L.P. may
borrow up to $120 million, both of which were assumed in the UDS Acquisition.
Valero must pay annual fees on the total used and unused portion of these
revolving credit facilities. The interest rate under these facilities floats
based upon the prime rate, LIBOR or other floating interest rates, at Valero's
option. As of December 31, 2001, there were no amounts outstanding under the
Canadian facility and $16 million was outstanding under the Valero L.P.
facility.
As of December 31, 2001, Valero had outstanding $150 million principal
amount of 6 3/4% notes, under which a third party has an option to purchase the
notes under certain circumstances at par on December 15, 2002. If the third
party does not exercise its purchase option, Valero would be required to
repurchase the notes at par on December 15, 2002. Valero currently expects that
the third party will exercise its purchase option, in which case the term of the
notes would be extended to December 15, 2032.
The following table presents Valero's commercial bank commitments and the
amount of commitment expiration per period as of December 31, 2001 (in
thousands). Valero had no guarantees or standby repurchase obligations as of
December 31, 2001.
AMOUNT OF COMMITMENT EXPIRATION
PER PERIOD
TOTAL -------------------------------------------
AMOUNTS LESS THAN OVER 5
COMMERCIAL BANK COMMITMENTS COMMITTED 1 YEAR 1-3 YEARS 4-5 YEARS YEARS
--------------------------- ---------- ---------- --------- --------- ------
Lines of credit.............. $3,449,845 $2,579,845 $ -- $870,000 $--
Standby letters of credit.... 144,735 110,032 34,687 -- 16
As discussed in Note 5 of Notes to Consolidated Financial Statements,
Valero, through a wholly owned subsidiary, has an agreement, which matures in
September 2002, with a third party financial institution to sell,
S-25
on a revolving basis, up to $100 million of eligible trade accounts receivable.
Also, in connection with the UDS Acquisition, Valero assumed a $360 million
revolving accounts receivable sales facility, maturing in December 2002, whereby
Valero can sell, on an ongoing basis, eligible credit card and trade accounts
receivable through a wholly owned subsidiary to a third party financial
institution. Under these agreements, the subsidiaries sell an undivided
percentage ownership interest in the eligible receivables, without recourse, to
the third party financial institutions which maintain at all times a 3% equity
interest in their undivided interest in the receivables. Valero's retained
interest in these receivables is included in "Receivables, net" on the
Consolidated Balance Sheets and is recorded at fair value. Valero remains
responsible for servicing the transferred receivables and pays certain fees
related to its sale of receivables under these programs. During 2001, 2000 and
1999, the costs incurred by Valero related to its pre-existing program, which
are included in "Other income (expense), net" in the Consolidated Statements of
Income and exclude costs related to the program assumed in the UDS Acquisition,
were $2.3 million, $6.8 million and $1.6 million, respectively. As of December
31, 2001, the amount of eligible receivables sold to the third party financial
institutions under these programs was $373 million.
Under common stock repurchase programs approved by Valero's Board of
Directors, Valero repurchases shares of its common stock from time to time for
use in connection with its employee benefit plans and other general corporate
purposes. During 2001, Valero repurchased shares of its common stock under these
programs at a cost of $156.7 million. Through February 2002, Valero has
repurchased additional common shares under these programs at a cost of
approximately $6.4 million.
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. Through the third
quarter of 2001, Valero declared a dividend of $.08 per common share for each
quarter since the July 1997 Restructuring. On October 18, 2001, Valero's Board
of Directors approved an increase in Valero's regular quarterly cash dividend on
common stock from $.08 per common share to $.10 per common share.
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. With this offering, Valero is issuing $1.8
billion of notes with varying maturities under a $3.5 billion universal shelf
registration statement filed with the SEC during the first quarter of 2002. The
net proceeds of this offering are expected to be used to repay all of the
borrowings under the $1.5 billion bridge loan facility and a portion of the
borrowings under the revolving bank credit facilities. Valero expects that, to
the extent necessary, it can raise additional funds from time to time through
equity or other debt financings. However, there can be no assurances regarding
the availability of any future financings or whether such financings can be made
available on terms acceptable to Valero.
Valero's refining and marketing operations have a concentration of
customers in the petroleum 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.
S-26
BUSINESS
The following selected review of the business of Valero is taken from
"Items 1. & 2. Business & Properties" in Valero's Form 10-K for the year ended
December 31, 2001. This selected review is not complete. For a more complete
review of the business of Valero you should refer to "Items 1. & 2. Business &
Properties" in Valero's Form 10-K for the year ended December 31, 2001, which is
incorporated herein by reference.
Valero Energy Corporation is a Fortune 100 company based in San Antonio,
Texas with over 22,000 employees and total assets of almost $15 billion. One of
the top three U.S. refining companies in terms of refining capacity, Valero owns
and operates 11 refineries in the United States and one refinery in Canada with
a combined throughput capacity of about 1.9 million barrels per day (BPD).
Valero's refining network stretches from eastern Canada to the U.S. Gulf Coast
and West Coast. Valero produces premium, environmentally clean products, such as
reformulated gasoline (RFG), gasoline meeting the specifications of the
California Air Resources Board (CARB), CARB diesel fuel, low-sulfur diesel fuel
and oxygenates. Valero also produces a substantial slate of conventional
gasoline, distillates, jet fuel, asphalt and petrochemicals.
Valero is also a leading marketer of refined products. Valero markets
branded and unbranded refined products on a wholesale basis in 40 U.S. states
and Canada through an extensive bulk and rack marketing network. Valero also
markets refined products and convenience store merchandise through a network of
retail sites in the United States and Canada bearing the Diamond Shamrock(R),
Ultramar(R), Valero(R), Beacon(R) and Total(R) brand names.
Valero also has a logistics system that complements Valero's refining and
marketing assets in the U.S. Gulf Coast and Mid-Continent regions. Valero owns
about 73 percent of Valero L.P., a master limited partnership that owns and
operates crude oil pipelines, refined product pipelines and refined product
terminals in Texas, Oklahoma, New Mexico and Colorado. Units of Valero L.P. are
listed on the New York Stock Exchange under the symbol "VLI."
Valero was incorporated in Delaware in 1981 under the name Valero Refining
and Marketing Company as a wholly owned subsidiary of a corporation then known
as Valero Energy Corporation, and referred to in this prospectus supplement 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 to them 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 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.
Valero's principal executive offices are located at One Valero Place, San
Antonio, Texas, 78212, and its telephone number is (210) 370-2000. Its common
stock trades on the New York Stock Exchange under the symbol "VLO."
All references to Notes to Consolidated Financial Statements pertain to the
notes to Valero's consolidated financial statements for the year ended December
31, 2001 found on pages F-8 through F-60 of this prospectus supplement.
RECENT DEVELOPMENTS
Acquisition of Ultramar Diamond Shamrock Corporation. Effective December
31, 2001, Valero completed the merger of Ultramar Diamond Shamrock Corporation
(UDS) into Valero Energy Corporation, with Valero Energy Corporation as the
surviving corporation. We refer to this transaction as the UDS Acquisition.
Under the terms of the merger agreement dated May 6, 2001, each outstanding
share of UDS common stock, other than treasury shares (which were cancelled) and
shares in employee benefit plans (which were converted directly into Valero
common stock), was converted into the right to receive, at the shareholder's
election but subject to proration, either (i) cash, (ii) a number of shares of
Valero common stock, or (iii) a combination of cash and Valero stock, in each
case having a value equal to the sum of $27.50
S-27
and .614 shares of Valero common stock (valued at the average closing Valero
common stock price over a ten trading-day period ending three days prior to the
merger). Merger consideration paid by Valero to UDS shareholders included
approximately $2.1 billion in cash and approximately 45.9 million shares of
Valero common stock (based on an average Valero stock price of $35.78 during the
measurement period).
UDS was an independent refiner and retailer of refined products and
convenience store merchandise in the central, southwest and northeast regions of
the United States and eastern Canada. UDS owned and operated seven refineries,
including two in Texas, two in California and one each in Oklahoma, Colorado and
Quebec, Canada, with a combined throughput capacity of approximately 850,000
BPD. UDS marketed refined products and a broad range of convenience store
merchandise through a network of approximately 4,500 convenience stores in the
United States and eastern Canada under the brand names Diamond Shamrock(R),
Beacon(R), Ultramar(R) and Total(R). UDS's Northeast operations also included a
retail home heating oil business.
As a condition to approval of the UDS Acquisition, the U.S. Federal Trade
Commission (FTC) is requiring Valero to sell UDS's 168,000 BPD Golden Eagle
Refinery located in the San Francisco Bay Area, its related wholesale marketing
business and 70 associated Beacon- and Ultramar-branded retail sites in Northern
California (collectively, the Golden Eagle Business). In February 2002, Valero
entered into an agreement to sell the Golden Eagle Business to Tesoro Refining
and Marketing Company (Tesoro) for approximately $1.13 billion, subject to
closing adjustments and certain indemnifications. The sale is expected to close
in April 2002, subject to regulatory approval. The FTC has approved a trustee to
manage the operations of these assets pending their sale to Tesoro. See Notes 2,
3 and 27 of Notes to Consolidated Financial Statements.
Acquisition of Huntway Refining Company. Effective June 1, 2001, Valero
completed its acquisition of Huntway Refining Company. Huntway owned and
operated two California refineries at Benicia and Wilmington that produce
asphalt for use in road construction and repair, primarily in California and
Nevada. The facilities also produce smaller amounts of gas oil, naphtha and
kerosene. These facilities have been substantially integrated into Valero's
refinery systems at Benicia and Wilmington. The purchase price, net of cash
acquired, was approximately $76 million and included payment to Huntway's common
stockholders of $1.90 per share and amounts required to retire Huntway's
outstanding debt and satisfy payment obligations under outstanding stock
options.
Acquisition of El Paso Refinery and Related Product Logistics
Business. Effective June 1, 2001, Valero completed its acquisition of El Paso
Corporation's 115,000 BPD Corpus Christi, Texas refinery and related product
logistics business through capital lease agreements that have a term of 20 years
and require annual lease payments of $18.5 million for the first two years and
increased amounts thereafter. The agreements also give Valero an option to
purchase the facilities for approximately $294 million at the end of the second
year of the lease and for increasing amounts in each succeeding year through the
end of the lease term. As part of the acquisition, Valero also purchased
inventories for approximately $109 million. The refinery, which is located near
Valero's existing Corpus Christi Refinery, is a complex refinery that processes
heavy, high-sulfur crude oil into conventional gasoline, diesel, jet fuel and
other light products and petrochemicals. The product logistics facilities
consist of three intrastate common carrier pipelines and related terminal
facilities that enable refined products to be shipped from Corpus Christi to
markets in Houston, San Antonio, Victoria and the Rio Grande Valley.
VALERO'S OPERATIONS
Valero's primary reportable business segments are refining and retail.
Valero's refining segment includes refinery, wholesale marketing, product supply
and distribution, and transportation operations. The refining segment is
segregated geographically into the Gulf Coast, Mid-Continent, West Coast and
Northeast regions. Valero's retail segment includes company-operated convenience
stores, Canadian dealers/jobbers, truckstop facilities, cardlock and home
heating oil operations. The retail segment is also segregated geographically.
Valero's retail operations in the northeastern United States and eastern Canada
are referred to as the
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Northeast System, and Valero's remaining retail operations in the United States
are referred to as the US System. See Note 20 of Notes to Consolidated Financial
Statements for additional segment information.
REFINING, WHOLESALE MARKETING AND FEEDSTOCK SUPPLY
Refining
Valero's refining operations include 12 refineries with a combined total
throughput capacity of approximately 1.9 million BPD. The following table lists
the location of each of Valero's refineries and its respective feedstock
throughput capacity. The table excludes the Golden Eagle Refinery, which is
being sold.
THROUGHPUT
CAPACITY(a)
(BARRELS
REFINERY LOCATION PER DAY)
-------- -------- -----------
GULF COAST:
Corpus Christi............................ Texas 340,000
Texas City................................ Texas 240,000
Houston................................... Texas 135,000
Three Rivers.............................. Texas 98,000
Krotz Springs............................. Louisiana 85,000
---------
898,000
---------
WEST COAST:
Benicia................................... California 180,000
Wilmington................................ California 140,000
---------
320,000
---------
MID-CONTINENT:
McKee..................................... Texas 170,000
Ardmore................................... Oklahoma 85,000
Denver.................................... Colorado 27,000
---------
282,000
---------
NORTHEAST:
Quebec.................................... Quebec, Canada 205,000
Paulsboro................................. New Jersey 195,000
---------
400,000
---------
TOTAL....................................... 1,900,000
=========
------------
(a)Throughput capacity includes crude oil, intermediates and other feedstocks.
Total crude oil capacity is approximately 1,526,000 BPD.
Gasolines represent approximately 52 percent of Valero's refined product
slate, and distillates--such as home heating oil, diesel and jet fuel--represent
approximately 30 percent; asphalt, lubricants, petrochemicals and other heavy
products comprise the remaining 18 percent. Of the gasoline that Valero
produces, about 45 percent is produced as reformulated gasoline and CARB
gasoline, which sell at a premium over conventional grades of gasoline. Over 75
percent of Valero's distillate slate is CARB diesel, low-sulfur diesel and jet
fuel, which sell for a premium over high-sulfur heating oil.
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Gulf Coast
Valero's Gulf Coast refining region includes the Corpus Christi Refinery,
the Texas City Refinery, the Houston Refinery, the Three Rivers Refinery and the
Krotz Springs Refinery. The following table shows representative percentages of
the principal feedstock charges and product yields for the five refineries in
this region for 2002.
COMBINED GULF COAST REGION FEEDSTOCKS AND PRODUCTS
PROJECTED FOR 2002
PERCENTAGE
----------
Feedstocks:
sour crude................................................ 54 %
sweet crude............................................... 22 %
residual fuel oil......................................... 9 %
other feedstocks and blendstocks.......................... 15 %
Products:
gasoline & blendstocks.................................... 50 %
Distillates............................................... 30 %
Petrochemicals............................................ 5 %
lubes and asphalts........................................ 2 %
other products............................................ 13 %
Corpus Christi Refinery. The Corpus Christi Refinery is located along the
Corpus Christi Ship Channel on the Texas Gulf Coast. The refinery is composed of
two plants, Valero's flagship West Plant and the recently acquired East Plant.
The West Plant is a highly complex refinery that specializes in processing
primarily lower-cost sour crude oil and residual fuel oil (resid) into premium
products such as RFG and CARB gasoline. Valero has substantially integrated the
operations of the West Plant and the East Plant allowing for the transfer of
various feedstocks and blending components between the plants and the sharing of
resources. The refinery typically receives and delivers its feedstocks and
products by tanker and barge via deep-water docking facilities along the Corpus
Christi Ship Channel. In addition, the refinery has an eight-bay truck rack for
servicing local markets and uses the Colonial, Explorer and other major
pipelines--including its own pipelines--for distribution of its products.
Texas City Refinery. The Texas City Refinery is located approximately 40
miles southeast of Houston on the Texas City Ship Channel. As a result of
improvements Valero made to this refinery since its acquisition in 1997, the
Texas City Refinery processes primarily lower-cost sour crudes into a wide slate
of products. A 45,000 BPD delayed coking unit and related facilities are being
constructed at the refinery which are expected to be operational in early 2004.
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.
Houston Refinery. The Houston Refinery is located on the Houston Ship
Channel. The refinery typically receives its feedstocks via tanker at deep-water
docking facilities along the Houston Ship Channel. The refinery primarily
delivers its products through major product pipelines, including the Colonial,
Explorer and TEPPCO pipelines.
Three Rivers Refinery. The Three Rivers Refinery is located in South Texas
near Corpus Christi. The Three Rivers Refinery has access to crude oil from
foreign sources delivered to the Texas Gulf Coast at Corpus Christi as well as
crude oil from domestic sources through third-party pipelines. The Three Rivers
Refinery and the Corpus Christi Refinery are connected by a 70-mile pipeline
that can deliver 120,000 BPD of crude oil. Valero distributes refined products
produced at this refinery primarily through pipelines owned by Valero L.P.
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Krotz Springs Refinery. The Krotz Springs Refinery is located
approximately halfway between Baton Rouge and Lafayette, Louisiana on the
Atchafalaya River. The refinery's location provides access to upriver markets on
the Mississippi River, and its docking facilities along the Atchafalaya River
are sufficiently deep to allow barge access. The facility also uses the Colonial
pipeline to transport products to markets in the Southeast and Northeast.
West Coast
Valero's West Coast refining region includes the Benicia Refinery and the
Wilmington Refinery. The following table shows representative percentages of the
principal feedstock charges and product yields for the two refineries in this
region for 2002.
COMBINED WEST COAST REGION FEEDSTOCKS AND PRODUCTS
PROJECTED FOR 2002
PERCENTAGE
----------
Feedstocks:
sour crude................................................ 77%
sweet crude............................................... 0%
residual fuel oil......................................... 0%
other feedstocks and blendstocks.......................... 23%
Products:
gasoline & blendstocks.................................... 64%
distillates............................................... 23%
petrochemicals............................................ 0%
lubes and asphalts........................................ 2%
other products............................................ 11%
Benicia Refinery. The Benicia Refinery is located northeast of San
Francisco on the Carquinez Straits of San Francisco Bay. It is a highly complex
refinery that processes sour crude oils into a high percentage of premium
products, primarily CARB gasoline. The refinery can receive crude supplies via a
deep-water dock that can berth large crude carriers and a 20-inch crude pipeline
connected to a southern California crude delivery system. Most of the refinery's
products are distributed via the Kinder Morgan pipeline in California.
Wilmington Refinery. The Wilmington Refinery is located near Los Angeles,
California. The refinery processes a blend of lower-cost heavy and high-sulfur
crude oils. The refinery can produce all of its gasoline as CARB gasoline. The
refinery is connected by pipeline to marine terminals and associated dock
facilities that can move and store crude oil and other feedstocks. Refined
products are distributed via a third-party pipeline and terminals in southern
California, Nevada and Arizona.
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Mid-Continent
Valero's Mid-Continent refining region includes the McKee Refinery, the
Ardmore Refinery and the Denver Refinery. The following table shows
representative percentages of the principal feedstock charges and product yields
for the three refineries in this region for 2002.
COMBINED MID-CONTINENT REGION FEEDSTOCKS AND PRODUCTS
PROJECTED FOR 2002
PERCENTAGE
----------
Feedstocks:
sour crude................................................ 20%
sweet crude............................................... 75%
residual fuel oil......................................... 0%
other feedstocks and blendstocks.......................... 5%
Products:
gasoline & blendstocks.................................... 56%
distillates............................................... 29%
petrochemicals............................................ 3%
lubes and asphalts........................................ 7%
other products............................................ 5%
McKee Refinery. The McKee Refinery is located in the Texas panhandle. The
McKee Refinery has access to crude oil from Texas, Oklahoma, Kansas and Colorado
through crude oil pipelines owned or leased by Valero and through third-party
pipelines. The refinery also has access at Wichita Falls, Texas to third-party
pipelines that transport crude oil from the Texas Gulf Coast and West Texas oil
fields to the Mid-Continent region. The refinery distributes its products via
pipeline to markets in North Texas, New Mexico, Arizona, Colorado and Oklahoma.
Ardmore Refinery. The Ardmore Refinery is located in Ardmore, Oklahoma,
approximately 90 miles from Oklahoma City. Crude oil is delivered to the
refinery through Valero's crude oil gathering and trunkline systems, third-party
pipelines and trucking operations. Refined products are transported via
pipelines, rail cars and trucks.
Denver Refinery. The Denver Refinery is located outside Denver, Colorado.
Crude oil for the refinery is supplied by a third-party pipeline and by truck.
The refinery benefits from a refined product pipeline that runs to and from the
McKee Refinery, which enhances flexibility in operations at both refineries.
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Northeast
Valero's Northeast refining region includes the Quebec Refinery in Quebec,
Canada and the Paulsboro Refinery in New Jersey. The following table shows
representative percentages of the principal feedstock charges and product yields
for the two refineries in this region for 2002.
COMBINED NORTHEAST REGION FEEDSTOCKS AND PRODUCTS
PROJECTED FOR 2002
PERCENTAGE
----------
Feedstocks:
sour crude................................................ 66%
sweet crude............................................... 27%
residual fuel oil......................................... 0%
other feedstocks and blendstocks.......................... 7%
Products:
gasoline & blendstocks.................................... 41%
distillates............................................... 40%
petrochemicals............................................ 3%
lubes and asphalts........................................ 6%
other products............................................ 10%
Quebec Refinery. Valero's Quebec Refinery is located in Quebec, Canada on
the St. Lawrence River. The refinery receives crude oil by ship at its
deep-water dock on the St. Lawrence River and can receive year-round shipments
of crude oil from large crude oil tankers. Valero charters large crude oil
tankers that can navigate the St. Lawrence River year-round. The refinery's
production is transported primarily by unit trains to markets in Montreal and
New Brunswick, and by tankers and trucks to markets in Canada's Atlantic
provinces.
Paulsboro Refinery. The Paulsboro Refinery is located in Paulsboro, New
Jersey approximately 15 miles south of Philadelphia on the Delaware River. The
refinery processes primarily sour crudes into a wide slate of products including
gasoline, distillates, a variety of lube oil basestocks, asphalt and fuel oil.
Feedstocks and refined products are typically transported by tanker and barge
via refinery-owned dock facilities along the Delaware River, ExxonMobil's
product distribution system, an onsite truck rack and the Colonial pipeline,
which allows products to be sold into the New York Harbor market.
Wholesale Marketing
Valero is a leading wholesale marketer of branded and unbranded refined
products. Valero markets on a wholesale basis in 40 U.S. states and Canada
primarily through an extensive bulk and rack marketing network. Valero markets
branded refined products under the Diamond Shamrock(R), Ultramar(R), Valero(R),
Beacon(R), Total(R) and Exxon(R) brand names.
Valero's bulk gasoline and distillate sales are made to various oil
companies and gasoline distributors and are transported by pipeline, barges and
tankers. The principal purchasers of Valero's transportation fuels from terminal
truck racks are wholesalers, distributors, retailers and end users (such as
railroads, airlines and utilities) throughout the United States. Most of
Valero's refineries have access to deep-water transportation facilities, and all
interconnect with common-carrier pipeline systems allowing Valero to sell
products in most major geographic regions of the United States and eastern
Canada.
Valero also enters into refined product exchange and purchase agreements.
These agreements enable Valero to minimize transportation costs, optimize
refinery utilization, balance refined product availability, broaden geographic
distribution and sell to markets not connected to Valero's refined product
pipeline system. Exchange agreements provide for the delivery of refined
products to unaffiliated companies at Valero's and
S-33
third parties' terminals in exchange for delivery of a similar amount of refined
products to Valero by these unaffiliated companies at specified locations.
Purchase agreements involve Valero's purchase of refined products from third
parties with delivery occurring at specified locations. Most of these agreements
are long-standing arrangements. However, they generally can be terminated with
30 to 90 days notice. Valero does not anticipate an interruption in its ability
to exchange or purchase refined products in the near future.
Valero also sells a variety of other products produced at its refineries
including asphalt, lube base oils and commodity petrochemicals. These products
are transported via pipelines, barges, trucks and railcars. Valero produces and
markets approximately 57,000 BPD of asphalt to customers in the paving and
roofing industries. Valero is the second largest producer of asphalt in the
United States. Valero produces asphalt at eight refineries and markets asphalt
in 20 states from coast to coast through 11 company-owned or leased terminal
facilities.
Paraffinic lube base oils are produced at Valero's Paulsboro Refinery and
are sold to a variety of customers, including ExxonMobil under a long-term
agreement. ExxonMobil purchases approximately 50% of the refinery's production
with the balance sold to independent motor oil and industrial lubricant
customers.
Valero produces and markets a variety of commodity petrochemicals including
aromatic solvents (benzene, toluene, and xylene), refinery- and chemical-grade
propylene and anhydrous ammonia. Aromatic solvents and propylene are sold to
customers for further processing in the chemical industry for such products as
paints, plastics and adhesives. Ammonia, produced at Valero's McKee Refinery, is
sold to customers in the agriculture industry as fertilizer.
Approximately 10.6 percent of Valero's consolidated operating revenues for
the year ended December 31, 2001 were derived from ExxonMobil. Other than sales
to ExxonMobil, no single purchaser of Valero's products accounted for more than
10 percent of Valero's total operating revenues for 2001.
Feedstock Supply
Valero processes a wide slate of feedstocks including sour crude oils,
intermediates and resid, which can typically be purchased at a discount to West
Texas Intermediate, a benchmark crude oil. Sour crude oils represent
approximately 50 percent of Valero's present feedstock slate, sweet crudes
represent about 30 percent, and the remaining 20 percent is composed of
intermediates, resid and blendstocks.
Approximately 1,160,000 BPD, or 76 percent, of Valero's crude feedstock
requirements are purchased through term contracts. The remainder of Valero's
feedstock requirements are generally purchased on the spot market. The term
agreements include contracts to purchase feedstocks from various foreign
national oil companies (including feedstocks originating in Saudi Arabia,
Mexico, Iraq, Venezuela and Africa) and domestic integrated oil companies at
market-related prices. Valero also uses the futures market to manage the price
risk inherent in purchasing crude oil in advance of its delivery date and in
maintaining Valero's inventories.
Valero's U.S. network of crude oil pipelines and terminals allows Valero to
acquire crude oil from producing leases, domestic crude oil trading centers and
ships delivering cargoes of foreign and domestic crude oil. The network also
allows Valero to transport crude supplies to many of its U.S. refineries at a
competitive cost (compared to facilities that lack proprietary supply networks).
Valero's Quebec Refinery relies on foreign crude oil that is delivered to its
St. Lawrence River dock facility by ship.
Valero's cost to acquire feedstocks, and the price for which Valero
ultimately can sell refined products, depend on a number of factors beyond
Valero's control, including regional and global supply and demand for crude oil,
gasoline, diesel and other feedstocks and refined products. These in turn are
dependent upon, among other things, the availability of imports, the production
levels of domestic and foreign suppliers, competitive fuels, U.S. relationships
with foreign governments, political affairs and the extent of governmental
regulation.
S-34
VALERO L.P.
Valero also has a logistics system that complements the company's refining
and marketing business in the U.S. Gulf Coast and Mid-Continent regions. Valero
owns approximately 73 percent of Valero L.P., a master limited partnership that
owns approximately 782 miles of crude oil pipelines, 2,845 miles of refined
product pipelines and 11 refined product terminals. Valero assumed its ownership
interest in Valero L.P. (formerly known as "Shamrock Logistics, L.P.") upon
completion of the UDS Acquisition. Valero L.P.'s revenues for the year ended
December 31, 2001, were approximately $98.8 million.
Valero L.P. transports the majority of all refined products from Valero's
McKee, Three Rivers and Ardmore refineries to markets in the Mid-Continent,
Southwest and Mexico border regions of the United States. In addition, Valero
L.P.'s pipelines supply these three refineries with crude oil feedstocks and
provide access to Texas, Gulf Coast and foreign crude oil sources.
RETAIL
Valero is one of the largest independent retailers of refined products in
the central and southwest United States, with strong brand identification in a
12-state retail area, including Texas, California, Colorado, Oklahoma, and in
eastern Canada. Valero's US System sells gasoline and diesel fuel under the
brand names Diamond Shamrock(R), Valero(R), Beacon(R), Ultramar(R) and Total(R).
Valero has approximately 1,430 company-operated and five dealer-operated
convenience stores in its US System. Of the company-operated stores, about 770
are owned and 660 are leased. Company-operated stores are operated under a
variety of brand names including Corner Store(R), Ultramart(R) and Stop N Go(R).
For the year ended December 31, 2001, the total sales of refined products of UDS
and Valero through the US System's retail sites averaged approximately 164,000
BPD.
The company-operated convenience stores sell, in addition to gasoline and
diesel fuels, a wide variety of immediately consumable products such as snacks,
candy, beer, fast foods, cigarettes, fountain drinks and other beverages. Valero
has an ongoing program to modernize and upgrade the convenience stores it
operates. These efforts are focused primarily on improving the uniformity and
appearance of existing stores. Improvements generally include new exterior
signage, lighting and canopies, and interior store upgrades.
Valero's competitive retail position is supported by its proprietary credit
card program, which had approximately 691,000 active accounts as of December 31,
2001. Valero uses electronic point-of-sale (POS) credit card processing at
substantially all of its company- and dealer-operated stores. POS processing
reduces transaction time at the sales counter and lowers Valero's credit card
program costs.
In eastern Canada, Valero is a major supplier of refined products serving
Quebec, Ontario and the Atlantic provinces of Newfoundland, Nova Scotia, New
Brunswick and Prince Edward Island. For the year ended December 31, 2001, total
retail sales of refined products through the Northeast System averaged
approximately 72,800 BPD. Gasoline and diesel fuel are sold under the
Ultramar(R) brand through a network of 1,134 stores throughout eastern Canada.
As of December 31, 2001, UDS owned (or controlled under long-term leases) 529
stores and distributed gasoline to about 605 dealers and independent jobbers. In
addition, the Northeast System operates 86 cardlocks, which are card- or
key-activated, self-service, unattended stations that allow commercial, trucking
and governmental fleets to buy gasoline and diesel fuel 24 hours a day.
The Northeast System operations also include one of the largest home
heating oil businesses in North America. In 2001, UDS sold home heating oil
under the Ultramar(R) brand to approximately 250,000 households in eastern
Canada and the northeastern United States.
COMPETITION
The refining and marketing industry continues to be highly competitive.
Valero's competitors include well-capitalized and fully integrated major oil
companies and other independent refining and marketing entities that operate in
all of Valero's market areas. Many of Valero's competitors 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
S-35
competitors may have greater flexibility in responding to or absorbing market
changes occurring in one or more of such 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.
Financial returns in the refining and marketing industry depend largely on
refining margins and retail fuel margins, both of which fluctuate significantly.
Refining margins are frequently impacted by sharp changes in crude oil costs
which are not immediately reflected in product prices. Historically, refining
margins have been volatile, and they are likely to continue to be volatile in
the future. The retail sector has become increasingly competitive. Valero faces
fierce competition from the fully integrated major oil companies that have
increased their efforts to capture retail market share in recent years. Valero
also competes with large grocery stores and other general merchandisers (the
so-called "hypermarts") that often sell gasoline at aggressively competitive
prices in order to attract customers to their sites. Some specific factors that
may affect Valero's margins are discussed under "Risk Factors" in the
accompanying prospectus.
Most of Valero's refineries and supply and distribution networks are
strategically located in the markets Valero serves. For example, in Quebec,
Canada and in the adjacent Atlantic provinces, Valero is the largest independent
retailer of gasoline. The industry tends to be seasonal with increased demand
for gasoline during the summer driving season and, in the northeast regions,
increased demand for home heating oil during the winter months.
ENVIRONMENTAL MATTERS
The principal environmental risks associated with Valero's operations are
emissions into the air and releases into soil or groundwater. Valero's
operations 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 compositions of gasoline and diesel fuels. Valero's operations are subject
to environmental regulation by several federal, state and local authorities. The
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 (CERCLA), and the Solid Waste Disposal Act, as amended by the
Resource Conservation and Recovery Act (RCRA).
In February 2000, the U.S. Environmental Protection Agency (EPA) published
its "Tier II" gasoline standard pursuant to the Clean Air Act. The standard
requires the sulfur content in gasoline to be reduced from approximately 300
parts per million to 30 parts per million; the regulation will be phased in
between 2004 and 2006. In addition, the EPA's Tier II distillate standard
requires the sulfur content of diesel fuel sold to highway consumers to be
reduced from 500 parts per million to 15 parts per million, beginning in 2006.
(The American Petroleum Institute is challenging the EPA's distillate standard
in federal court.) Modifications will be required at each of Valero's refineries
as a result of the Tier II standards. Valero believes that capital expenditures,
not including costs for hydrogen facilities, of approximately $550 million will
be required for its refineries to meet the Tier II standards. (Valero expects to
refine this estimate throughout the phase-in of the Tier II standards.) Valero
began implementing the modifications in 2002 and expects modifications to be
complete in time for compliance with the effective dates of the gasoline and
distillate standards.
In 2000, the EPA issued to a majority of refiners operating in the United
States a series of information requests pursuant to Section 114 of the Clean Air
Act as part of an enforcement initiative. Valero received a Section 114
information request pertaining to all of its refineries owned at that time.
Valero completed its response to the request and has provided additional
clarification requested by the EPA. After Valero received its Section 114
information request, Valero acquired the Benicia Refinery and the Golden Eagle
Refinery, which were subject to Section 114 information requests received by the
prior owners of these refineries. Valero has not been named in any proceeding.
However, based in part upon announced settlements and evaluation of its relative
position, Valero expects to incur penalties and related expenses in connection
with its potential settlement of this enforcement initiative. Valero believes
that any potential settlement penalties and expenses will be immaterial to its
financial position. Valero believes that any potential settlement with the EPA
in this matter will require various capital improvements, which could be
material in the aggregate, or changes in operating parameters or both at some or
all of its refineries.
S-36
The presence of MTBE in some water supplies in California and other states,
resulting from gasoline leaks primarily from underground and aboveground storage
tanks, has led to public concern that MTBE has contaminated drinking water
supplies and thus poses a possible health risk. As a result of heightened public
concern, California passed initiatives to ban the use of MTBE as a gasoline
component in California by the end of 2002. In March 2002, however, the governor
of California issued an executive order postponing the ban for one year.
Accordingly, the California Air Resources Board's specifications for CARB Phase
III gasoline are not expected to become effective until the beginning of 2004.
Valero estimates that the cost for permitting and modification of its California
refineries to comply with CARB Phase III specifications and eliminate MTBE as a
gasoline component is approximately $50 million. Valero, like other producers of
MTBE, is subject to litigation or proceedings involving the manufacture or use
of MTBE. 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 believes that its
major non-California MTBE-producing facilities could be modified to produce
iso-octane for a capital investment of approximately $35 million.
The Houston/Galveston State Implementation Plan (SIP) was approved by the
EPA in October 2001. The SIP requires the Houston/Galveston area to reduce NOx
emissions by 75 percent from both stationary and mobile sources. The SIP will
require the area to demonstrate compliance with the Clean Air Act's ozone
standard by 2007. Valero's Texas City and Houston refineries are included within
the region affected by the SIP. To achieve compliance, Valero is required to
install advanced emission control technology at its Texas City and Houston
refineries by 2007, at a cost estimated by Valero to be approximately $50
million.
In 2001, Valero's capital expenditures attributable to compliance with
environmental regulations were approximately $34 million, and are currently
estimated to be $165 million for 2002 and $450 million for 2003. These estimates
for 2002 and 2003 do not include expenditures for the installation of a flue gas
scrubber at the Texas City Refinery (funded through a structured lease
arrangement), or any amounts related to constructed facilities for which the
portion of expenditures relating to compliance with environmental regulations is
not determinable.
Under various environmental laws, we may be liable, alone or with others,
for the release or threatened release of hazardous substances and petroleum or
its derivatives into the environment. The release of these materials can occur
at any of our facilities, including our refineries, pipelines, terminals or in
connection with the storage of fuel at our retail operations. We may be liable
for releases at facilities we own or lease that occur during or prior to our
ownership or operations, and we may also be liable for releases at other
facilities if our hazardous waste is transported to that site or if it migrates
from an owned or leased location. Based on current information we have reserved,
in the aggregate, $179.6 million for remediation liabilities. See Note 24 of
Notes to Consolidated Financial Statements.
Governmental regulations are complex, are subject to different
interpretations and are becoming increasingly more stringent. Development of new
facts or future regulatory initiatives could result in changes to expected
operating permits, additional remedial actions or increased capital
expenditures, operating costs or clean-up liabilities that cannot be assessed
with certainty at this time. In addition, because certain air emissions at
Valero's refineries have been grandfathered under particular environmental laws,
any major upgrades at any of its refineries could require potentially material
additional expenditures to comply with environmental laws and regulations.
EMPLOYEES
As of January 31, 2002, Valero had 22,452 employees, including salaried and
hourly employees, of which 19,012 were employed in the United States and 3,440
were employed in Canada.
PROPERTIES
Valero's principal properties are described above under the caption
"Valero's Operations." In addition, Valero owns feedstock and refined product
storage facilities in various locations. Valero believes that its properties and
facilities are generally adequate for its 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
S-37
properties, including the Corpus Christi Refinery East Plant and related product
logistics business which were acquired under capital lease agreements, the
Benicia Refinery dock facility, office facilities, retail facilities,
transportation equipment and various assets used to store, transport and produce
refinery feedstocks and/or refined products. See Note 23 of Notes to
Consolidated Financial Statements.
Valero's patents relating to its refining operations are not material to
Valero as a whole. The trademarks and tradenames under which Valero conducts its
retail and branded wholesale business--specifically Diamond Shamrock(R),
Ultramar(R), Valero(R), Beacon(R), Total(R), Exxon(R), Corner Store(R),
Ultramart(R), Stop N Go(R) and ValPar(TM)--and other trademarks employed in the
marketing of petroleum products are important to Valero's operations.
Valero currently has about 220 company-operated convenience stores and
supplies about 600 distributor-owned sites under a brand license agreement with
TotalFinaElf for use of the Total(R) brand name. The Total-branded sites are
located in Arkansas, Colorado, Iowa, Kansas, Minnesota, Missouri, Nebraska, New
Mexico, Oklahoma, South Dakota and Texas. Per the license agreement with
TotalFinaElf, Valero's rights to use the Total(R) brand will expire in Colorado
in 2002, and in other states in subsequent years through 2007. Valero believes
that it can successfully convert, when necessary, from the Total(R) brand to
another of Valero's proprietary brands without adversely impacting Valero's
operations.
S-38
DESCRIPTION OF THE NOTES
The following description of the particular terms of the notes offered
hereby (referred to in the accompanying prospectus as the debt securities)
supplements, and to the extent inconsistent therewith replaces, the description
of the general terms and provisions of the debt securities set forth in the
accompanying prospectus, to which we refer you. The following summary of the
notes is qualified in its entirety by reference to the indenture referred to in
the accompanying prospectus.
GENERAL
The 6 1/8% notes due 2007 (the 2007 notes) will constitute a separate
series of debt securities under the indenture, initially limited to $300 million
aggregate principal amount and will mature on April 15, 2007. The 6 7/8% notes
due 2012 (the 2012 notes) will constitute a separate series of debt securities
under the indenture, initially limited to $750 million aggregate principal
amount and will mature on April 15, 2012. The 7 1/2% notes due 2032 (the 2032
notes and, together with the 2007 notes and the 2012 notes, the notes) will
constitute a separate series of debt securities under the indenture, initially
limited to $750 million aggregate principal amount and will mature on April 15,
2032. Valero will issue the notes in fully registered book-entry form only,
without coupons, in denominations of $1,000 and integral multiples thereof. The
indenture does not limit the aggregate principal amount of debt securities that
may be issued thereunder, including the issuance of further notes that are
consolidated and fungible with and form a single series with the notes issued in
this offering, 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.
Each note will bear interest at the respective rates per annum shown on the
cover page of this prospectus supplement from April 15, 2002 or from the most
recent interest payment date to which interest has been paid or provided for,
payable semiannually on April 15 and October 15 of each year, commencing October
15, 2002, to the persons in whose names such notes are registered at the close
of business on the date fifteen days prior to such interest payment date.
Interest on the notes will be computed on the basis of a 360-day year consisting
of twelve 30-day months. If an interest payment date, redemption date or
maturity date of any note falls on a day that is not a business day, then
payment of principal, premium, if any, or interest will be made on the next
succeeding business day.
No interest will accrue on the amount so payable for the period from such
interest payment date, redemption date or maturity date, as the case may be, to
the date payment is made.
The notes will not be entitled to the benefit of any sinking fund.
The notes will be our unsecured senior obligations that will rank on a
parity with all for our other unsecured senior indebtedness from time to time
outstanding.
OPTIONAL REDEMPTION
Each series of notes is redeemable, in whole or in part, at any time, and
at our option, at a redemption price equal to the greater of:
-- 100% of the principal amount of the applicable series of notes then
outstanding, or
-- the sum of the present values of the remaining scheduled payments of
principal and interest thereon (not including any portion of such
payments of interest accrued as of the redemption date) discounted to
the redemption date on a semiannual basis (assuming a 360-day year
consisting of twelve 30-day months) at the adjusted treasury rate,
plus 25 basis points with respect to the 2007 notes, 30 basis points
with respect to the 2012 notes and 35 basis points with respect to
the 2032 notes, as calculated by an independent investment banker,
plus, in either of the above cases, accrued and unpaid interest thereon to the
redemption date.
S-39
"Adjusted treasury rate" means, with respect to any redemption date:
-- the yield, under the heading which represents the average for the
immediately preceding week, appearing in the most recently published
statistical release designated "H.15(519)" or any successor
publication which is published weekly by the Board of Governors of
the Federal Reserve System and which establishes yields on actively
traded United States Treasury securities adjusted to constant
maturity under the caption "Treasury Constant Maturities," for the
maturity corresponding to the comparable treasury issue (if no
maturity is within three months before or after the remaining life,
yields for the two published maturities most closely corresponding to
the comparable treasury issue shall be determined and the adjusted
treasury rate shall be interpolated or extrapolated from such yields
on a straight line basis, rounding to the nearest month); or
-- if such release (or any successor release) is not published during
the week preceding the calculation date or does not contain such
yields, the rate per annum equal to the semi-annual equivalent yield
to maturity of the comparable treasury issue, calculated using a
price for the comparable treasury issue (expressed as a percentage of
its principal amount) equal to the comparable treasury price for such
redemption date.
The adjusted treasury rate shall be calculated on the third business day
preceding the redemption date.
"Comparable treasury issue" means the United States Treasury security
selected by an independent investment banker as having a maturity comparable to
the remaining term of the 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 such notes (remaining life).
"Comparable treasury price" means, with respect to any redemption date, (1)
the average of five reference treasury dealer quotations for such redemption
date, after excluding the highest and lowest reference treasury dealer
quotations, or (2) if the independent investment banker obtains fewer than five
such reference treasury dealer quotations, the average of all such quotations.
"Independent investment banker" means one of the reference treasury dealers
appointed by us to act as the independent investment banker from time to time.
"Reference treasury dealer" means:
-- Morgan Stanley & Co. Incorporated and J.P. Morgan Securities Inc.,
and their respective successors; provided that, if any of the
foregoing ceases to be a primary U.S. Government securities dealer in
New York City (a primary treasury dealer), we will substitute another
primary treasury dealer; and
-- any other primary treasury dealer selected by us.
"Reference treasury dealer quotations" means, with respect to each
reference treasury dealer and any redemption date, the average, as determined by
the independent investment banker, 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 independent investment banker at 5:00
p.m., New York City time, on the third business day preceding such redemption
date.
We will mail a notice of redemption at least 30 days but not more than 60
days before the redemption date to each holder of notes to be redeemed. If we
elect to partially redeem the notes, the trustee will select in a fair and
appropriate manner the notes to be redeemed.
Unless we default in payment of the redemption price, on and after the
redemption date, interest will cease to accrue on the notes or portions thereof
called for redemption.
BOOK-ENTRY SYSTEM, FORM AND DELIVERY
Each series of the notes will be represented by one or more global
securities registered in the name of Cede & Co., the nominee of the Depository
Trust Company, as "depositary," and the provisions set forth
S-40
under "Description of Debt Securities--Form, Exchange, Registration and
Transfer" in the accompanying prospectus will apply to the notes.
The depositary is a limited-purpose trust company organized under New York
banking law, a "banking organization" within the meaning of New York banking
law, a member of the United States 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
Securities Exchange Act of 1934, as amended. The depositary holds securities
that its participants deposit with the depositary. The depositary also
facilitates the settlement among its participants of securities transactions,
such as transfers and pledges, in deposited securities through electronic
computerized book-entry changes in participants' accounts, thereby eliminating
the need for physical movement of securities certificates. Direct participants
include securities brokers and dealers, banks, trust companies, clearing
corporations and certain other organizations. The depositary is owned by a
number of its direct participants and by The New York Stock Exchange, Inc., the
American Stock Exchange, Inc., and the National Association of Securities
Dealers, Inc. Access to the depositary's system is also available to indirect
participants in the depositary such as securities brokers and dealers, banks and
trust companies that clear through, or maintain a custodial relationship with, a
direct participant, either directly or indirectly. The rules applicable to the
depositary and its participants are on file with the Securities and Exchange
Commission.
According to the depositary, the foregoing information with respect to the
depositary has been provided to the financial community for informational
purposes only and is not intended to serve as a representation, warranty or
contract modification of any kind.
Purchases of the notes under the depositary's system must be made by or
through direct participants, which will receive a credit for the notes on the
depositary's records. The beneficial ownership interest of each actual purchaser
of each note is in turn to be recorded on the direct and indirect participants'
respective records. Beneficial owners will not receive written confirmation from
the depositary of their purchase, but beneficial owners are expected to receive
written confirmations providing details of the transaction, as well as periodic
statements of their holdings, from the direct or indirect participant through
which the beneficial owner entered into the transaction. Transfers of ownership
interest in the notes are to be accomplished by entries made on the books of
participants acting on behalf of beneficial owners. Beneficial owners will not
receive certificates representing their ownership interest in notes except in
the event that use of the book-entry system for the notes is discontinued.
To facilitate subsequent transfers, all notes deposited with the depositary
by participants in the depositary will be registered in the name of the
depositary's nominee, Cede & Co., or such other nominee as may be requested by
an authorized representative of the depositary. The deposit of the notes with
the depositary and their registration in the name of Cede & Co. or such other
nominee effect no change in beneficial ownership. The depositary has no
knowledge of the actual beneficial owners of the notes; the depositary's records
reflect only the identity of the direct participants to whose accounts such
notes are credited, which may or may not be the beneficial owners. The
participants will remain responsible for keeping account of their holdings on
behalf of their customers.
Conveyance of notices and other communications by the depositary to direct
participants, by direct participants to indirect participants, and by direct
participants and indirect participants to beneficial owners will be governed by
arrangements among them, subject to any statutory or regulatory requirements as
may be in effect from time to time.
The laws of some states may require that certain persons take physical
delivery in definitive form of securities which they own. Consequently, those
persons may be prohibited from purchasing beneficial interest in the global
notes from any beneficial owner or otherwise.
So long as the depositary's nominee is the registered owner of the global
notes, such nominee for all purposes will be considered the sole owner or holder
of the notes under the indenture. Except as provided below, beneficial owners
will not be entitled to have any of the notes registered in their names, will
not receive
S-41
or be entitled to receive physical delivery of the notes in definitive form and
will not be considered the owners or holders thereof under the indenture.
Neither the depositary nor Cede & Co. will consent or vote with respect to
the notes. Under its usual procedures, the depositary mails an omnibus proxy to
Valero as soon as possible after the record date. The omnibus proxy assigns Cede
& Co.'s consenting or voting rights to those direct participants to whose
accounts the notes are credited on the record date (identified in a listing
attached to the omnibus proxy).
Payments of principal, interest and premium, if any, on the notes will be
made to Cede & Co. The depositary's practice is to credit direct participants'
accounts upon the depositary's receipt of funds and corresponding detail from
the trustee or Valero on the relevant payment date in accordance with their
respective holdings shown on the depositary's records. Payments by participants
to beneficial owners will be governed by standing instructions and customary
practices, as is the case with securities for the accounts of customers in
bearer form or registered in "street-name," and will be the responsibility of
each participant and not of the depositary, the underwriters, or Valero, subject
to any statutory or regulatory requirements as may be in effect from time to
time. Payment of principal, interest and premium, if any, to Cede & Co. is the
responsibility of Valero or the respective trustees. Disbursement of such
payments to direct participants is the responsibility of the depositary, and
disbursement of such payments to the beneficial owners of the notes is the
responsibility of direct and indirect participants in the depositary.
The depositary may discontinue providing its services as securities
depository with respect to the notes at any time by giving reasonable notice to
us. Under such circumstances and in the event that a successor securities
depository is not obtained, certificates for the notes are required to be
printed and delivered. In addition, we may decide to discontinue use of the
system of book-entry transfers through the depositary (or a successor securities
depository). In that event, certificates will be printed and delivered.
We will not have any responsibility or obligation to participants in the
depositary or the persons for whom they act as nominees with respect to the
accuracy of the records of the depositary, its nominee or any direct or indirect
participant with respect to any ownership interest in the notes, or with respect
to payments to or providing of notice for the direct participants, the indirect
participants or the beneficial owners of the notes.
The information contained herein under the caption "Description of
Notes--Book-Entry System, Form and Delivery" concerning the depositary and the
depositary's book-entry system has been obtained from sources that we believes
to be reliable. Neither Valero, the trustee nor the underwriters, dealers or
agents take responsibility for the accuracy or completeness thereof.
THE TRUSTEE
The trustee under the indenture is The Bank of New York, as trustee.
S-42
UNDERWRITING
Under the terms and subject to the conditions contained in an underwriting
agreement, dated the date of this prospectus supplement, the underwriters named
below have severally agreed to purchase, and we have agreed to sell to them,
severally, the respective principal amount of the notes set forth opposite their
respective names below:
PRINCIPAL AMOUNT PRINCIPAL AMOUNT PRINCIPAL AMOUNT
NAME OF 2007 NOTES OF 2012 NOTES OF 2032 NOTES
---- ---------------- ---------------- ----------------
Morgan Stanley & Co. Incorporated....... $105,000,000 $262,500,000 $262,500,000
J.P. Morgan Securities Inc. ............ 15,000,000 37,500,000 37,500,000
Banc of America Securities LLC.......... 15,000,000 37,500,000 37,500,000
Banc One Capital Markets, Inc........... 15,000,000 37,500,000 37,500,000
Barclays Capital Inc.................... 15,000,000 37,500,000 37,500,000
BNP Paribas Securities Corp............. 15,000,000 37,500,000 37,500,000
Fleet Securities, Inc................... 15,000,000 37,500,000 37,500,000
Mizuho International plc................ 15,000,000 37,500,000 37,500,000
RBC Dominion Securities Corporation..... 15,000,000 37,500,000 37,500,000
The Royal Bank of Scotland plc.......... 15,000,000 37,500,000 37,500,000
Scotia Capital (USA) Inc................ 15,000,000 37,500,000 37,500,000
SunTrust Capital Markets, Inc........... 15,000,000 37,500,000 37,500,000
TD Securities (USA) Inc................. 15,000,000 37,500,000 37,500,000
Tokyo-Mitsubishi International plc...... 15,000,000 37,500,000 37,500,000
------------ ------------ ------------
Total......................... $300,000,000 $750,000,000 $750,000,000
============ ============ ============
The underwriting agreement provides that the obligations of the several
underwriters to pay for and accept delivery of the notes is subject to, among
other things, the approval of certain legal matters by their counsel and certain
other conditions. The underwriters are obligated to take and pay for all of the
notes if any are taken.
The underwriters initially propose to offer part of the notes directly to
the public at the public offering price set forth on the cover page hereof and
part to certain dealers at a price that represents a concession not in excess of
..35% of the principal amount in the case of the 2007 notes, .40% of the
principal amount in the case of the 2012 notes and .50% of the principal amount
in the case of the 2032 notes. Any underwriter may allow, and any such dealers
may reallow, a concession to certain other dealers not to exceed .25% of the
principal amount in the case of the 2007 notes, .25% of the principal amount in
the case of the 2012 notes and .25% of the principal amount in the case of the
2032 notes. After the initial offering of the notes, the offering price and
other selling terms may from time to time be varied by the underwriters.
We have agreed to indemnify the several underwriters against certain
liabilities, including liabilities under the Securities Act of 1933, as amended,
or to contribute to payments the underwriters may be required to make because of
any of those liabilities.
We do not intend to apply for listing of the notes on a national securities
exchange, but have been advised by the underwriters that they intend to make a
market in the notes. The underwriters are not obligated, however, to do so and
may discontinue their market making at any time without notice. No assurance can
be given as to the liquidity of the trading market for the notes.
In order to facilitate the offering of the notes, the underwriters may
engage in transactions that stabilize, maintain or otherwise affect the prices
of the notes. Specifically, the underwriters may overallot in connection with
the offering, creating a short position in the notes for their own account. In
addition, to cover overallotments or to stabilize the price of the notes, the
underwriters may bid for, and purchase, the notes in the open market. Finally,
the underwriters may reclaim selling concessions allowed to an underwriter or a
dealer for distributing the notes in the offering, if they repurchase previously
distributed notes in transactions
S-43
to cover syndicate short positions, in stabilization transactions or otherwise.
Any of these activities may stabilize or maintain the market price for the notes
above independent market levels. The underwriters are not required to engage in
these activities and may end any of these activities at any time.
We estimate that our total expenses for this offering will be approximately
$880,000.
J.P. Morgan Securities Inc. (JPMorgan) will make the securities available
for distribution on the Internet through a proprietary Web site and/or a
third-party system operated by Market Axess Inc., an Internet-based
communications technology provider. Market Axess Inc. is providing the system as
a conduit for communications between JPMorgan and its customers and is not a
party to any transactions. Market Axess Inc., a registered broker-dealer, will
receive compensation from JPMorgan based on transactions JPMorgan conducts
through the system. JPMorgan will make the securities available to its customers
through the Internet distributions, whether made through a proprietary or
third-party system, on the same terms as distributions made through other
channels.
Certain of the underwriters and their respective affiliates have, from time
to time, performed various investment or commercial banking, financial advisory
and lending services for us in the ordinary course of business for which they
have received customary fees and expenses. Affiliates of the underwriters are
lenders under our bridge loan facility and our revolving bank credit facilities.
We will pay a portion of the net proceeds from this offering to these affiliates
of the underwriters when we repay borrowings under our bridge loan facility and
our revolving bank credit facilities. Under the Conduct Rules of the National
Association of Securities Dealers (NASD), special considerations apply to a
public offering of securities if more than 10% of the net proceeds thereof will
be paid to members or affiliates of members of the NASD participating in the
offering. Because we will pay more than 10% of the aggregate proceeds from this
offering to affiliates of the underwriters, this offering is being conducted
pursuant to Rule 2710(c)(8) of the NASD Conduct Rules.
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
The audited consolidated financial statements of Valero Energy Corporation
included in and incorporated by reference in this prospectus supplement and
elsewhere in the registration statement have been audited by Arthur Andersen
LLP, independent public accountants, as indicated in their reports with respect
thereto, and are included herein in reliance upon the authority of said firm as
experts in accounting and auditing in giving said reports.
The audited consolidated financial statements of Ultramar Diamond Shamrock
Corporation included in and incorporated by reference in this prospectus
supplement and elsewhere in the registration statement have been audited by
Arthur Andersen LLP, independent public accountants, as indicated in their
reports with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in accounting and auditing in giving said
reports.
On March 12, 2002, Valero's Board of Directors dismissed Arthur Andersen
LLP as the company's independent public accountants and appointed Ernst & Young
LLP as the company's independent public accountants for the fiscal year ending
December 31, 2002.
S-44
INDEX TO FINANCIAL STATEMENTS
PAGE
----
VALERO ENERGY CORPORATION AND SUBSIDIARIES
Report of Independent Public Accounts..................... F-2
Consolidated Balance Sheets as of December 31, 2001 and
2000................................................... F-3
Consolidated Statements of Income for the Years Ended
December 31, 2001, 2000 and 1999....................... F-4
Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 2001, 2000 and 1999........... F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999....................... F-6
Consolidated Statements of Comprehensive Income for the
Years Ended December 31, 2001, 2000 and 1999........... F-7
Notes to Consolidated Financial Statements................ F-8
ULTRAMAR DIAMOND SHAMROCK CORPORATION
Report of Independent Public Accountants.................. F-61
Consolidated Balance Sheets as of December 31, 2001 and
2000................................................... F-62
Consolidated Statements of Income for the Years Ended
December 31, 2001, 2000 and 1999....................... F-63
Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 2001, 2000 and 1999........... F-64
Consolidated Statements of Cash Flows for the Years Ended
December 31, 2001, 2000 and 1999....................... F-65
Consolidated Statements of Comprehensive Income for the
Years Ended December 31, 2001, 2000 and 1999........... F-66
Notes to Consolidated Financial Statements................ F-67
F-1
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,
2001 and 2000, and the related consolidated statements of income, stockholders'
equity, cash flows and comprehensive income for each of the three years in the
period ended December 31, 2001. 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 auditing standards generally
accepted in the United States. 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, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.
/s/ ARTHUR ANDERSEN LLP
San Antonio, Texas
March 5, 2002
F-2
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS, EXCEPT PAR VALUE)
DECEMBER 31,
------------------------
2001 2000
----------- ----------
ASSETS
Current assets:
Cash and temporary cash investments....................... $ 269,437 $ 14,596
Restricted cash........................................... 76,623 --
Receivables, net.......................................... 785,605 585,892
Inventories............................................... 1,453,106 539,882
Current deferred income tax assets........................ -- 105,817
Income taxes receivable................................... 132,226 --
Prepaid expenses and other current assets................. 92,510 38,880
Assets held for sale...................................... 1,303,637 --
----------- ----------
Total current assets............................... 4,113,144 1,285,067
----------- ----------
Property, plant and equipment, at cost...................... 8,197,841 3,481,117
Less accumulated depreciation............................... (937,386) (804,437)
----------- ----------
Property, plant and equipment, net........................ 7,260,455 2,676,680
----------- ----------
Goodwill.................................................... 2,210,473 --
Intangible assets, net...................................... 366,702 59,141
Deferred charges and other assets........................... 426,322 286,816
----------- ----------
Total assets....................................... $14,377,096 $4,307,704
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt and current portion of long-term debt..... $ 505,661 $ 27,000
Payable to UDS shareholders............................... 2,055,250 --
Accounts payable.......................................... 1,374,501 806,697
Accrued expenses.......................................... 413,902 104,473
Taxes other than income taxes............................. 320,208 72,589
Current deferred income tax liabilities................... 60,724 --
Income taxes payable...................................... -- 28,233
----------- ----------
Total current liabilities.......................... 4,730,246 1,038,992
----------- ----------
Long-term debt, less current portion........................ 2,517,398 1,042,417
----------- ----------
Capital lease obligations................................... 287,849 --
----------- ----------
Deferred income tax liabilities............................. 1,388,123 406,634
----------- ----------
Other long-term liabilities................................. 762,809 120,106
----------- ----------
Commitments and contingencies
Company-obligated preferred securities of subsidiary
trusts.................................................... 372,500 172,500
----------- ----------
Minority interest in consolidated partnership............... 115,608 --
----------- ----------
Stockholders' equity:
Common stock, $0.01 par value; 300,000,000 and 150,000,000
shares authorized at 2001 and 2000, respectively; issued
108,198,992 and 62,311,166 shares at 2001 and 2000,
respectively............................................ 1,082 623
Additional paid-in capital................................ 3,468,550 1,249,127
Treasury stock, at cost; 4,001,683 and 1,472,698 shares at
2001 and 2000, respectively............................. (149,616) (44,261)
Retained earnings......................................... 864,421 321,566
Accumulated other comprehensive income.................... 18,126 --
----------- ----------
Total stockholders' equity......................... 4,202,563 1,527,055
----------- ----------
Total liabilities and stockholders' equity......... $14,377,096 $4,307,704
=========== ==========
See Notes to Consolidated Financial Statements.
F-3
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
YEAR ENDED DECEMBER 31,
--------------------------------------
2001 2000 1999
----------- ----------- ----------
Operating revenues..................................... $14,988,339 $14,671,087 $7,961,168
----------- ----------- ----------
Costs and expenses:
Cost of sales and operating expenses................. 13,684,041 13,817,524 7,731,151
Selling and administrative expenses.................. 165,215 130,506 68,463
Depreciation expense................................. 137,740 112,078 89,525
----------- ----------- ----------
Total costs and expenses..................... 13,986,996 14,060,108 7,889,139
----------- ----------- ----------
Operating income....................................... 1,001,343 610,979 72,029
Other income (expense), net............................ (4,613) 282 3,587
Interest and debt expense:
Incurred............................................. (99,142) (83,678) (61,182)
Capitalized.......................................... 10,634 7,433 5,753
Distributions on preferred securities of subsidiary
trust................................................ (13,369) (6,796) --
----------- ----------- ----------
Income before income tax expense....................... 894,853 528,220 20,187
Income tax expense..................................... 331,300 189,100 5,900
----------- ----------- ----------
Net income............................................. $ 563,553 $ 339,120 $ 14,287
=========== =========== ==========
Earnings per share of common stock..................... $ 9.28 $ 5.79 $ 0.25
Weighted average common shares outstanding (in
thousands)........................................ 60,749 58,532 56,086
Earnings per share of common stock--assuming
dilution............................................. $ 8.83 $ 5.60 $ 0.25
Weighted average common equivalent shares outstanding
(in thousands).................................... 63,803 60,525 56,758
Dividends per share of common stock.................... $ 0.34 $ 0.32 $ 0.32
See Notes to Consolidated Financial Statements.
F-4
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(THOUSANDS OF DOLLARS)
RETAINED ACCUMULATED
NUMBER OF ADDITIONAL EARNINGS OTHER
COMMON COMMON PAID-IN (ACCUMULATED TREASURY COMPREHENSIVE
SHARES STOCK CAPITAL DEFICIT) STOCK INCOME
----------- ------ ---------- ------------ --------- -------------
BALANCE AS OF 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 AS OF DECEMBER 31,
1999......................... 56,331,166 563 1,092,348 (3,331) (4,811) --
Net income................... -- -- -- 339,120 -- --
Dividends on common stock.... -- -- (4,469) (14,223) -- --
Proceeds from common stock
offering, net.............. 5,980,000 60 166,693 -- -- --
Shares repurchased and shares
issued in connection with
employee stock plans and
other...................... -- -- 339 -- (39,450) --
Issuance costs of PEPS
Units...................... -- -- (5,784) -- -- --
----------- ------ ---------- -------- --------- -------
BALANCE AS OF DECEMBER 31,
2000......................... 62,311,166 623 1,249,127 321,566 (44,261) --
Net income................... -- -- -- 563,553 -- --
Dividends on common stock.... -- -- -- (20,698) -- --
Issuance of common stock in
connection with UDS
Acquisition................ 45,887,826 459 2,064,034 -- -- --
Fair value of replacement
stock options issued in
connection with UDS
Acquisition................ -- -- 120,075 -- -- --
Shares repurchased and shares
issued in connection with
employee stock plans and
other...................... -- -- 35,314 -- (105,355) --
Net gains on cash flow
hedges..................... -- -- -- -- -- 18,126
----------- ------ ---------- -------- --------- -------
BALANCE AS OF DECEMBER 31,
2001......................... 108,198,992 $1,082 $3,468,550 $864,421 $(149,616) $18,126
=========== ====== ========== ======== ========= =======
See Notes to Consolidated Financial Statements.
F-5
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
YEAR ENDED DECEMBER 31,
-------------------------------------
2001 2000 1999
----------- ----------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income........................................... $ 563,553 $ 339,120 $ 14,287
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense.............................. 137,740 112,078 89,525
Amortization of deferred charges and other, net... 114,614 60,978 49,498
Changes in current assets and current
liabilities..................................... (152,842) 3,492 293,822
Deferred income tax expense (benefit)............. 270,700 103,100 (9,400)
Changes in deferred charges and credits and other,
net............................................. (28,251) (17,466) (2,621)
----------- ----------- ---------
Net cash provided by operating activities.... 905,514 601,302 435,111
----------- ----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures................................. (393,561) (194,889) (100,594)
Deferred turnaround and catalyst costs............... (142,423) (107,495) (72,681)
UDS Acquisition, net of cash acquired................ (1,829,584) -- --
Advance to UDS in connection with UDS Acquisition.... (703,057) -- --
Purchase of inventories in connection with El Paso
Acquisition....................................... (108,779) -- --
Huntway Acquisition, net of cash acquired............ (75,782) -- --
Benicia Acquisition.................................. -- (889,730) --
Earn-out payments in connection with acquisitions.... (55,000) -- --
Proceeds from disposition of property, plant and
equipment......................................... 7,699 7 1,255
Investment in joint ventures and other, net.......... (1,393) (1,880) (148)
----------- ----------- ---------
Net cash used in investing activities........ (3,301,880) (1,193,987) (172,168)
----------- ----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Financing required to fund cash portion of UDS
Acquisition, net of issuance costs................ 2,052,553 -- --
Increase (decrease) in short-term debt, net.......... 173,000 27,000 (160,000)
Long-term debt borrowings, net of issuance costs..... 543,095 1,899,344 922,794
Long-term debt repayments............................ (18,500) (1,647,000) (961,000)
Proceeds from common stock offering, net............. -- 166,753 --
Issuance of common stock in connection with employee
benefit plans..................................... 78,434 17,365 15,620
Proceeds from offering of preferred securities of
subsidiary trust, net............................. -- 166,716 --
Common stock dividends............................... (20,698) (18,692) (17,931)
Purchase of treasury stock........................... (156,677) (64,292) (13,538)
----------- ----------- ---------
Net cash provided by (used in) financing
activities................................. 2,651,207 547,194 (214,055)
----------- ----------- ---------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY CASH
INVESTMENTS.......................................... 254,841 (45,491) 48,888
CASH AND TEMPORARY CASH INVESTMENTS AT BEGINNING OF
YEAR................................................. 14,596 60,087 11,199
----------- ----------- ---------
CASH AND TEMPORARY CASH INVESTMENTS AT END OF YEAR..... $ 269,437 $ 14,596 $ 60,087
=========== =========== =========
See Notes to Consolidated Financial Statements.
F-6
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(THOUSANDS OF DOLLARS)
YEAR ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
-------- -------- -------
Net income.................................................. $563,553 $339,120 $14,287
-------- -------- -------
Other comprehensive income, net of income tax expense
(benefit):
Net gain on derivative instruments designated and
qualifying as cash flow hedges:
Statement No. 133 transition adjustment, net of
income tax expense of $15,240..................... 28,304 -- --
Net loss arising during the period, net of income tax
benefit of $19,363................................ (35,960) -- --
Net loss reclassified into income, net of income tax
benefit of $13,883 (including $679 related to the
Statement No. 133 transition adjustment, net of
tax of $441)...................................... 25,782 -- --
-------- -------- -------
Net gains on cash flow hedges............................. 18,126 -- --
-------- -------- -------
Comprehensive income........................................ $581,679 $339,120 $14,287
======== ======== =======
See Notes to Consolidated Financial Statements.
F-7
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
Valero Energy Corporation (Valero) is an independent refining and marketing
company. Prior to the acquisition of Ultramar Diamond Shamrock Corporation (UDS)
on December 31, 2001, discussed further below, Valero owned and operated six
refineries in Texas, California, Louisiana and New Jersey with a combined
throughput capacity of over one million barrels per day. Valero produces
premium, environmentally clean products such as reformulated gasoline, gasoline
meeting specifications of the California Air Resources Board (CARB), low-sulfur
diesel and oxygenates. Valero also produces distillates, jet fuel and
petrochemicals. Valero markets its products through an extensive wholesale bulk
and rack marketing network, and through branded retail and other distributor
retail locations.
During 2001, Valero completed the following acquisitions:
-- June 1--Huntway Refining Company, which owned and operated two
California asphalt refineries (Huntway Acquisition);
-- June 1--El Paso Corporation's Corpus Christi, Texas refinery and
related product logistics business (El Paso Acquisition);
-- December 31--UDS, an independent refining and marketing company,
which owned and operated seven refineries and marketed its products
through approximately 4,500 company-operated and dealer-operated
convenience stores (UDS Acquisition).
These acquisitions, as described in Note 2, were accounted for using the
purchase method.
These consolidated financial statements include the accounts of Valero and
subsidiaries in which Valero has a controlling interest. Investments in 50% or
less owned entities are accounted for using the equity method of accounting.
Intercompany balances and transactions have been eliminated in consolidation.
As used in this report, the term Valero may refer to Valero Energy
Corporation, one or more of its consolidated subsidiaries, or all of them taken
as a whole.
USE OF ESTIMATES
The preparation of financial statements in conformity with United States
generally accepted accounting principles requires management to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those
estimates. On an ongoing basis, management reviews their estimates based on
currently available information. Changes in facts and circumstances may result
in revised estimates.
F-8
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
CASH AND TEMPORARY CASH INVESTMENTS
Valero's temporary cash investments are highly liquid, low-risk debt
instruments which have a maturity of three months or less when acquired. Cash
and temporary cash investments exclude cash that is not available to Valero due
to restrictions related to its use. Such amounts are segregated in the
Consolidated Balance Sheets in "Restricted cash."
INVENTORIES
Inventories are carried at the lower of cost or market. The cost of
refinery feedstocks purchased for processing and produced products are
determined under the last-in, first-out (LIFO) method. Valero uses the
dollar-value LIFO method with any increments valued based on average purchase
prices during the year. The cost of feedstocks and products purchased for resale
and the cost of materials, supplies and convenience store merchandise are
determined principally under the weighted-average cost method.
PROPERTY, PLANT AND EQUIPMENT
Additions to property, plant and equipment, including capitalized interest
and certain costs allocable to construction and property purchases, are recorded
at cost.
The costs of minor property units (or components of property units), net of
salvage value, 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 recorded in income.
Depreciation of property, plant and equipment, including amortization of
assets acquired under capital leases, is recorded primarily on a straight-line
basis over the estimated useful lives of the related facilities.
GOODWILL AND INTANGIBLE ASSETS
Goodwill represents the excess of cost (purchase price) over the fair value
of the net assets of businesses acquired. In accordance with Statement No. 142
issued by the Financial Accounting Standards Board (FASB), "Goodwill and Other
Intangible Assets," which will be effective for Valero's consolidated financial
statements commencing January 1, 2002, goodwill resulting from business
combinations completed after June 30, 2001 will not be amortized but instead
will be tested at least annually for impairment.
Intangible assets, which consist primarily of trade names, customer lists,
air emission credits, retail branding rights, royalties and licenses, and
franchise agreements, are recorded at cost and are amortized over their
estimated useful lives.
F-9
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DEFERRED CHARGES AND OTHER ASSETS
Refinery Turnaround Costs
Refinery turnaround costs which are incurred in connection with planned
major maintenance activities at Valero's refineries are deferred when incurred
and amortized on a straight-line basis over that period of time estimated to
lapse until the next turnaround occurs. The frequency of refinery turnarounds
varies with each operating unit; the weighted average amortization period for
the $134.6 million balance of deferred turnaround costs as of December 31, 2001
is 3.4 years. Refinery turnaround costs include, among other things, the cost to
repair, restore, refurbish or replace refinery equipment such as vessels, tanks,
reactors, piping, rotating equipment, instrumentation, electrical equipment,
heat exchangers and fired heaters.
Fixed-Bed Catalyst Costs
Fixed-bed catalyst costs represent the cost of catalyst that is not
continually regenerated, but is instead changed out at periodic intervals when
the quality of the catalyst has deteriorated to such an extent that the
effectiveness of that catalyst in performing its prescribed function has
deteriorated. Fixed-bed catalyst costs are deferred when incurred and amortized
on a straight-line basis over the estimated useful life of the specific
catalyst, normally one to three years depending on the catalyst and the
operating unit in which it is utilized.
Equity Investments
Valero accounts for its interest in investments in 50% or less owned
entities using the equity method of accounting. Valero's equity investments
include:
-- a 20% interest in the Javelina off-gas processing plant in Corpus
Christi, Texas,
-- a 50% interest in the Clear Lake, Texas methanol plant, and
-- a 50% interest in the Skelly-Belvieu natural gas liquids pipeline, an
equity interest that was acquired as part of the UDS Acquisition.
Other Noncurrent Assets
Other noncurrent assets include prefunded benefit costs, debt issuance
costs and various other costs.
TAXES OTHER THAN INCOME TAXES
Taxes other than income taxes includes liabilities for ad valorem taxes,
excise taxes and payroll taxes.
INCOME TAXES
Income taxes are accounted for under the asset and liability method. Under
this method, deferred tax assets and liabilities are recognized for the future
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred amounts are measured using enacted tax rates expected to apply
to taxable income in the year those temporary differences are expected to be
recovered or settled.
F-10
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOREIGN CURRENCY TRANSACTIONS
The functional currency of Valero's Canadian operations is the Canadian
dollar. The translation into U.S. dollars is performed for balance sheet
accounts using exchange rates in effect as of the balance sheet date and for
revenue and expense accounts using the weighted-average exchange rate during the
year. Adjustments resulting from this translation will be reported in other
comprehensive income.
REVENUE RECOGNITION
Revenues are recorded when title to products sold has been transferred or
when services have been provided.
PRODUCT SHIPPING AND HANDLING COSTS
Costs incurred for shipping and handling of products are included in "Cost
of sales and operating expenses" in the Consolidated Statements of Income.
IMPAIRMENT
Long-lived assets, including goodwill and intangible assets, are reviewed
for impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. The evaluation of recoverability is
performed using undiscounted estimated net cash flows generated by the related
assets. If an asset is deemed to be impaired, the amount of impairment is
determined as the amount by which the carrying value exceeds discounted
estimated net cash flows. Effective January 1, 2002, Valero adopted Statement
No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," as
described below in New Accounting Pronouncements.
ENVIRONMENTAL MATTERS
Liabilities for future remediation costs are recorded when environmental
assessments and/or remedial efforts are probable and the costs can be reasonably
estimated. Other than for assessments, the timing and magnitude of these
accruals are generally based on the completion of investigations or other
studies or a commitment to a formal plan of action. Environmental liabilities
are based on best estimates of probable undiscounted future costs using
currently available technology and applying current regulations, as well as
Valero's own internal environmental policies. The environmental liabilities have
not been reduced by possible recoveries from third parties.
PRICE RISK MANAGEMENT ACTIVITIES
Effective January 1, 2001, Valero adopted Statement of Financial Accounting
Standard No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended. Statement No. 133 establishes accounting and reporting
standards for derivative instruments and for hedging activities. It requires
that all derivative instruments be recorded in the balance sheet as either
assets or liabilities measured at their fair value. The Statement also requires
that changes in a derivative's fair value be recognized currently in income
unless specific hedge accounting criteria are met. Statement No. 133 allows
special hedge accounting for
F-11
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
derivative instruments designated and qualifying as a fair value hedge or a cash
flow hedge. Statement No. 133 provides that the gain or loss on a derivative
instrument designated and qualifying as a fair value hedge, as well as the
offsetting loss or gain on the hedged item attributable to the hedged risk, be
recognized currently in income in the same period. Statement No. 133 also
provides that the effective portion of the gain or loss on a derivative
instrument designated and qualifying as a cash flow hedge be reported outside
income as a component of other comprehensive income and be reclassified into
income in the same period or periods during which the hedged forecasted
transaction affects income. The remaining ineffective portion of the gain or
loss on the derivative instrument, if any, is recognized currently in income.
Statement No. 133 requires that a company formally document, designate, and
assess the effectiveness of transactions that receive hedge accounting.
Statement No. 133 is not to be applied retroactively to financial
statements of prior periods. The adoption of this Statement has not resulted in
any significant changes in Valero's business practices, including its hedging
and trading activities as described below; however, various systems
modifications have been required.
When Valero enters into a derivative instrument, the derivative is
designated as a fair value hedge, a cash flow hedge, an economic hedge or a
trading instrument. For those derivatives designated as fair value or cash flow
hedges, Valero formally documents the hedging relationship and its risk
management objective and strategy for undertaking the hedge.
Valero accounts for its hedging relationships designated and qualifying as
fair value hedges or cash flow hedges in accordance with the requirements of
Statement No. 133. For Valero's economic hedging relationships (hedges not
designated as fair value or cash flow hedges) and for derivative commodity
instruments entered into by Valero for trading purposes, the derivative
instrument is recorded at fair value and the gain or loss on the derivative
instrument is recognized currently in income.
Valero discontinues hedge accounting prospectively if (i) it is determined
that the derivative is no longer highly effective in offsetting changes in fair
value or cash flows attributable to the hedged risk, (ii) the derivative expires
or is sold, terminated, or exercised, or (iii) the derivative is no longer
designated as a hedging instrument. In any of these circumstances, Valero may
designate prospectively a new hedging relationship with a new hedging instrument
or, in the case of (i) or (iii), a different hedged item or hedged transaction.
When a cash flow hedge is discontinued, Valero continues to report the
related net derivative gain or loss in accumulated other comprehensive income
until the hedged forecasted transaction affects income, at which time the net
derivative gain or loss is reclassified into income. However, if it is probable
that the forecasted transaction will not occur either by the end of the
originally specified time period or within two months thereafter, Valero
reclassifies the related derivative gain or loss from accumulated other
comprehensive income into income immediately.
F-12
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of Valero's financial instruments approximate fair
value, except for certain long-term debt. See Note 10.
LEGAL FEES
Legal fees are expensed as incurred.
STOCK-BASED COMPENSATION
Valero 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 Valero's common stock at the
date of the grant over the amount an employee must pay to acquire the stock.
EARNINGS PER SHARE
Earnings per share of common stock is computed by dividing net income by
the weighted-average number of common shares outstanding for the year. Earnings
per share of common stock--assuming dilution reflects the potential dilution of
Valero's outstanding stock options and performance awards granted to employees
in connection with Valero's stock compensation plans.
FRANCHISE AGREEMENTS
In connection with the Benicia Acquisition described in Note 2, as a result
of ExxonMobil's requirement to withdraw the "Exxon" brand name from the San
Francisco Bay area and terminate the franchise right of dealers in this market
area to market Exxon-branded products, Valero introduced its own brand of retail
petroleum products in the San Francisco Bay area and entered into franchise
agreements with these dealers providing them the right to market products under
the new Valero brand. The activities under these franchise agreements consist of
petroleum product sales to these dealers through supply agreements that require
them to purchase petroleum products exclusively from Valero. Revenue from these
petroleum product sales is recorded when title transfers in accordance with
Valero's revenue recognition policy described above. Under the dealer supply
agreements, no initial franchise fees or continuing franchise fees are charged
and petroleum product sales are made at market prices. Recurring general,
selling and administrative costs related to these activities that are incurred
irrespective of the level of sales are expensed as incurred, while direct,
incremental costs incurred that are dependent on the level of sales are deferred
and recognized when the related revenue is recognized.
COMPREHENSIVE INCOME
Comprehensive income consists of net income and other gains and losses
affecting stockholders' equity that, under United States generally accepted
accounting principles, are excluded from net income, such as
F-13
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
foreign currency translation adjustments, minimum pension liability adjustments,
unrealized gains and losses on certain investments in debt and equity
securities, and gains and losses related to certain derivative instruments.
BUSINESS COMBINATIONS
Effective July 1, 2001, Valero adopted Statement No. 141, "Business
Combinations." All business combinations in the scope of Statement No. 141 are
to be accounted for using the purchase method. The provisions of Statement No.
141 apply to all business combinations initiated after June 30, 2001 and apply
to all business combinations accounted for using the purchase method for which
the date of acquisition is July 1, 2001 or later. As described in Note 2, the
UDS Acquisition was accounted for using the purchase method.
RECLASSIFICATIONS
Certain previously reported amounts have been reclassified to conform to
the 2001 presentation.
NEW ACCOUNTING PRONOUNCEMENTS
FASB Statement No. 144
In August 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." Statement No. 144, which
supersedes Statement No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of" and the accounting and
reporting provisions of APB Opinion No. 30, "Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions,"
establishes accounting standards for the impairment and disposal of long-lived
assets and criteria for determining when a long-lived asset is held for sale.
Statement No. 144 removes the requirement to allocate goodwill to long-lived
assets to be tested for impairment, requires that the depreciable life of a
long-lived asset to be abandoned be revised in accordance with APB Opinion No.
20, "Accounting Changes," provides that one accounting model be used for
long-lived assets to be disposed of by sale, whether previously held and used or
newly acquired, and broadens the presentation of discontinued operations to
include more disposal transactions. Statement No. 144 will be effective for
financial statements beginning January 1, 2002, with earlier application
encouraged. Valero does not expect the adoption of this statement to have a
material impact on its consolidated financial statements.
FASB Statement No. 143
In June 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations." Statement No. 143 requires entities to record the fair
value of a liability for an asset retirement obligation when an existing law or
contract requires that the obligation be settled. The statement requires that
the amount recorded as a liability be capitalized by increasing the carrying
amount of the related long-lived asset. Subsequent to initial measurement, the
liability is accreted to the ultimate amount anticipated to be paid, and is also
adjusted for revisions to the timing or amount of estimated cash flows. The
capitalized cost is depreciated over the useful life of the related asset. Upon
settlement of the liability, an entity either settles the
F-14
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
obligation for its recorded amount or incurs a gain or loss upon settlement.
Statement No. 143 will be effective for financial statements beginning January
1, 2003, with earlier application encouraged. Valero is currently evaluating the
impact on its consolidated financial statements of adopting this statement.
FASB Statement No. 142
In June 2001, the FASB issued Statement No. 142, "Goodwill and Other
Intangible Assets." This statement, which supersedes APB Opinion No. 17,
"Intangible Assets," provides that goodwill and other intangible assets that
have indefinite useful lives will not be amortized but instead will be tested at
least annually for impairment. Intangible assets that have finite useful lives
will continue to be amortized over their useful lives, but such lives will not
be limited to 40 years. Statement No. 142 provides specific guidance for testing
goodwill and other nonamortized intangible assets for impairment. Additionally,
the statement requires certain disclosures about goodwill and other intangible
assets subsequent to their acquisition, including changes in the carrying amount
of goodwill from period to period, the carrying amount of intangible assets by
major intangible asset class for those assets subject to amortization and for
those not subject to amortization, and the estimated intangible asset
amortization expense for the next five years. The provisions of this statement
must be applied in Valero's consolidated financial statements beginning January
1, 2002, except that any goodwill and other intangible assets acquired after
June 30, 2001 will be subject immediately to the amortization provisions of this
statement. Valero did not have goodwill prior to July 1, 2001 but did have
finite-lived intangible assets that will continue to be amortized and are
subject to this statement beginning January 1, 2002. Goodwill and other
intangible assets acquired in connection with the UDS Acquisition will be
accounted for in accordance with the provisions of this statement.
2. ACQUISITIONS
ULTRAMAR DIAMOND SHAMROCK CORPORATION
On December 31, 2001, Valero completed its acquisition of UDS. Under the
terms of the merger agreement, each outstanding share of UDS common stock, with
limited exceptions, was converted into the right to receive cash, Valero common
stock, or a combination of cash and Valero common stock at the shareholder's
election but subject to proration. Based on the exchange election results,
shareholders electing Valero common stock received, for each share of UDS common
stock, approximately 0.9265 shares of Valero common stock and $16.32 in cash.
Shareholders electing cash and non-electing shareholders received $49.47 in cash
for each UDS share. The average closing price of Valero common stock for the
10-day measurement period specified in the merger agreement was $35.78. As a
result, Valero issued 45,887,826 shares of Valero common stock and paid $2.1
billion of cash to UDS shareholders.
UDS was an independent refiner and retailer of refined products and
convenience store merchandise in the central, southwest and northeast regions of
the United States and eastern Canada. UDS owned and operated seven refineries in
Texas (2), California (2), Oklahoma, Colorado, and Quebec, Canada, with a
F-15
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
combined throughput capacity of approximately 850,000 barrels per day. UDS
marketed refined products and a broad range of convenience store merchandise
through a network of approximately 4,500 convenience stores under the Diamond
Shamrock(R), Ultramar(R), Beacon(R) and Total(R) brand names. UDS's operations,
primarily in Canada, also included the marketing of refined products through 86
cardlocks, which are card- or key-activated, self-service, unattended stations
that allow commercial, trucking and governmental fleets to buy gasoline and
diesel fuel 24 hours a day, and a retail home heating oil business that sells
heating oil to approximately 250,000 households. As a condition for the
regulatory approval of the acquisition, the Federal Trade Commission's (FTC)
consent degree requires Valero to divest the 168,000 barrel-per-day Golden Eagle
Refinery located in the San Francisco Bay Area, the related wholesale marketing
business, and 70 associated Beacon- and Ultramar-branded convenience stores
located throughout Northern California. See Note 3.
Reasons for UDS Acquisition
Valero's management believes that the UDS Acquisition provides a favorable
balance between refining and retail assets and provides to Valero the scale and
financial flexibility to pursue opportunities for continued profitable growth.
Valero's management believes the acquisition will result in Valero becoming a
stronger competitor in the domestic refining and marketing business, and expects
that Valero's financial performance will benefit from potential synergies,
subject to its ability to integrate the two companies successfully. However, the
financial results of the combined company will still remain influenced by
refining and retail margins which are volatile.
Financing of UDS Acquisition
Valero financed the $2.1 billion cash portion of the UDS Acquisition with
proceeds from a $1.5 billion bridge loan facility and borrowings under two new
$750 million revolving bank credit facilities. Valero finalized both the bridge
loan facility and the two revolving bank credit facilities prior to completing
the acquisition, with borrowings under these facilities made on January 7, 2002.
As of December 31, 2001, the cash consideration was recorded as a "Payable to
UDS shareholders" in the Consolidated Balance Sheet.
The bridge loan facility has a one-year maturity at variable interest
rates. Valero expects to repay the bridge loan facility with a combination of
proceeds from the disposition of certain assets, as described in Notes 3 and 27,
proceeds from capital market issuances of debt securities and cash flows from
operations. The two revolving bank credit facilities provide for commitments of
$750 million for a five-year term and $750 million for a 364-day term and,
subject to the commitment amounts and terms, provide for borrowings thereunder
to be made at various amounts, maturities and interest rates, at the option of
Valero. See Note 10 for additional details.
On December 31, 2001, prior to the closing of the UDS Acquisition, UDS
ceased borrowing under its commercial paper program that had previously been
used to fund certain of its ongoing operations. As a result, Valero borrowed
$703 million under its revolving bank credit facilities and uncommitted
short-term bank lines
F-16
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
and loaned that amount to UDS for its use in repaying all amounts outstanding
under the commercial paper program. Since the transaction occurred prior to the
closing of the UDS Acquisition, the funds borrowed are included in financing
activities and the loan to UDS is reflected as "Advance to UDS in connection
with UDS Acquisition" in the Consolidated Statement of Cash Flows.
HUNTWAY REFINING COMPANY
Effective June 1, 2001, Valero completed the acquisition of Huntway
Refining Company, a leading supplier of asphalt in California. Huntway owned and
operated two California refineries at Benicia and Wilmington, which primarily
process California crude oil to produce liquid asphalt for use in road
construction and repair, primarily in California and Nevada, as well as smaller
amounts of gas oil, naphtha, kerosene, distillate and bunker fuels. The purchase
price, net of Huntway's cash balance on the date of acquisition, was
approximately $76 million and included payment to Huntway's common stockholders
of $1.90 per share, as well as amounts required to retire Huntway's outstanding
debt and satisfy payment obligations under outstanding stock options.
EL PASO REFINERY AND RELATED PRODUCT LOGISTICS BUSINESS
Effective June 1, 2001, Valero completed the acquisition of El Paso
Corporation's Corpus Christi, Texas refinery and related product logistics
business through lease agreements entered into with certain wholly owned
subsidiaries of El Paso. The lease agreements, which are accounted for as
capital leases, are for a term of 20 years and require Valero to make annual
lease payments of $18.5 million for each of the first two years and increased
amounts thereafter. Valero has an option to purchase the facilities for
approximately $294 million at the end of the second year of the lease, and for
increasing amounts in each succeeding year through the end of the lease term.
The El Paso Corpus Christi refinery, which is located near Valero's
existing Corpus Christi refinery, is a highly complex refinery capable of
processing approximately 110,000 barrels per day of heavy, high-sulfur crude
oil. Approximately 70% of the refinery's production is light products, including
conventional gasoline, diesel fuel, jet fuel, petrochemicals, propane, butane
and light naphthas. In addition, the refinery produces multiple grades of
asphalt and petroleum coke. The product logistics facilities consist of three
intrastate common carrier refined product pipelines and related terminal
facilities that enable refined products to be shipped from Corpus Christi to
markets in Houston, San Antonio, Victoria, and the Rio Grande Valley.
As part of the acquisition, Valero also purchased inventories for
approximately $109 million and assumed certain environmental liabilities, which
are included in "Other long-term liabilities" in the Consolidated Balance Sheet.
The inventories were purchased with available cash and the property, plant and
equipment, net of assumed liabilities, were acquired through capital lease
obligations of approximately $286 million. As of December 31, 2001, the capital
lease assets were $318.7 million, net of accumulated amortization of $6.0
million.
F-17
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
PURCHASE PRICE ALLOCATIONS FOR ACQUISITIONS IN 2001
The UDS, Huntway and El Paso Acquisitions were accounted for using the
purchase method. The purchase price for each acquisition was allocated based on
the estimated fair values of the individual assets and liabilities at the date
of acquisition pending the completion of independent appraisals and other
evaluations. The excess of purchase price over the fair values of the net assets
acquired is recorded as goodwill. The operating results of the Huntway and El
Paso Acquisitions were included in the Consolidated Statement of Income
beginning June 1, 2001. The operating results of UDS will be included in the
Consolidated Statement of Income beginning January 1, 2002.
As of December 31, 2001, the preliminary purchase price allocations,
including transaction costs incurred for the acquisitions, were as follows (in
thousands):
UDS HUNTWAY EL PASO
----------- -------- ---------
Current assets, excluding assets held for sale.... $ 1,553,417 $34,102 $ 108,779
Assets held for sale.............................. 1,303,637 -- --
Property, plant and equipment..................... 3,873,605 57,776 324,665
Goodwill.......................................... 2,210,473 -- --
Intangible assets................................. 257,059 -- --
Deferred charges and other assets................. 100,010 263 --
Current liabilities, less current portion of
long-term debt and advance from Valero.......... (1,360,902) (12,021) (1,234)
Advance from Valero............................... (703,057) -- --
Long-term debt assumed, including current
portion......................................... (1,256,817) -- --
Capital lease obligations......................... -- -- (285,500)
Deferred income tax liabilities................... (805,610) (1,088) --
Other long-term liabilities....................... (578,536) (1,090) (37,931)
Minority interest in consolidated partnership..... (115,608) -- --
Company-obligated preferred stock of subsidiary
trust........................................... (200,000) -- --
----------- -------- ---------
Total purchase price.................... 4,277,671 77,942 108,779
Less unrestricted cash acquired................... (262,154) (2,160) --
----------- -------- ---------
Purchase price, excluding unrestricted
cash acquired......................... $ 4,015,517 $75,782 $ 108,779
=========== ======== =========
BENICIA ACQUISITION
During the second quarter of 2000, Valero completed the acquisition of
certain assets from ExxonMobil in the State of California. The assets and
related operations acquired by Valero are referred to as the Benicia Acquisition
and included:
-- the 165,000 barrel-per-day Benicia refinery located in the San
Francisco Bay area and all tangible assets used in the operations of
the refinery (Benicia Refinery);
F-18
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
-- 80 Exxon-branded California retail service stations (Service
Stations); and
-- branded supplier relationships with over 260 Exxon-branded service
stations (Distribution Assets).
The purchase price for the Benicia Acquisition was $895 million, plus
approximately $150 million for refinery inventories acquired in the transaction
(based on market prices at the time of closing) and certain costs incurred in
connection with the acquisition. The Benicia Acquisition was funded through a
$400 million senior notes offering, a $172.5 million offering of premium equity
participating security units (PEPS Units), a common stock offering totaling
approximately $174.2 million and borrowings under Valero's existing bank credit
facilities. See Notes 10, 13 and 14 for details regarding the senior notes, PEPS
Units, and common stock offerings, respectively. In addition, Valero entered
into a $155 million structured lease arrangement for the Service Stations and
the Benicia Refinery's dock facility. See Note 23.
The Service Stations included 10 company-operated service stations and
approximately 70 dealer-operated service stations subleased from Valero, all of
which are located in the San Francisco Bay area and have been rebranded to the
Valero brand. In July 2000, the dealers were offered an option to purchase at
fair value the service stations that they were leasing and enter into a new
fuels purchase agreement with Valero for a term of 15 years. In connection with
this option, these dealers purchased 49 service stations during 2001; there were
no service stations purchased during 2000. As a result, the value attributable
to the Service Stations was reduced by $72 million.
In connection with the Benicia Acquisition, Valero assumed all liabilities,
including environmental liabilities, of ExxonMobil related to the acquired
California assets with certain exceptions, including those exceptions enumerated
below. ExxonMobil retained liability for, and agreed to indemnify Valero for:
-- penalties assessed for violations relating to the Benicia Refinery
which were pending at the closing of the Benicia Acquisition,
-- lawsuits pending at closing,
-- personal injury or exposure, including asbestos exposure, suffered by
ExxonMobil employees, contractors or subcontractors prior to closing,
-- all costs associated with compliance with a variance issued in
connection with control of nitrogen oxides,
-- 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,
-- the capital costs incurred within five years of closing for specified
corrective action of groundwater and soil contamination,
-- all covered contamination at the Service Stations caused by
ExxonMobil or its lessees that is reflected in baseline reports
prepared prior to closing (provided that the indemnity for covered
contamination is for five years),
F-19
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
-- the repair or replacement of any underground storage tanks at the
Service Stations found to be leaking prior to closing, and
-- 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.
The Benicia Acquisition was accounted for using the purchase method. The
Consolidated Statements of Income include the results of operations related to
the Benicia Refinery and the Distribution Assets beginning May 16, 2000 and the
results of operations related to the Service Stations beginning June 16, 2000.
During the year following the Benicia Acquisition, independent appraisals and
other evaluations were completed and the final purchase price allocation was as
follows (in thousands):
Current assets.............................................. $186,471
Property, plant and equipment............................... 688,605
Intangible assets........................................... 35,000
Deferred charges and other assets........................... 3,705
Current liabilities......................................... (7,876)
Other long-term liabilities................................. (16,175)
--------
Final purchase price...................................... $889,730
========
PRO FORMA FINANCIAL INFORMATION
The following unaudited pro forma financial information assumes that the
UDS, Huntway and El Paso Acquisitions occurred at the beginning of 2001 and
2000, and that the Benicia Acquisition and the senior notes, PEPS Units and
common stock offerings occurred at the beginning of 2000 and 1999. The effect of
the UDS Acquisition included in this pro forma financial information assumes the
Golden Eagle Business, as described and defined in Note 3, was sold as of the
beginning of 2001 and 2000, approximately $625 million of proceeds were used to
pay down debt and approximately $500 million of proceeds were used to repurchase
11.1 million shares of common stock at $44.99 per share. This pro forma
information is not necessarily indicative of the results of future operations
(dollars in thousands, except per share amounts).
YEAR ENDED DECEMBER 31,
--------------------------------------
2001 2000 1999
----------- ----------- ----------
Operating revenues............................. $27,186,064 $29,816,574 $9,312,743
Operating income............................... 1,868,707 1,408,768 221,519
Net income..................................... 961,483 668,656 70,963
Earnings per share of common stock............. 10.07 6.94 1.14
Earnings per share of common stock--assuming
dilution..................................... 9.61 6.78 1.13
F-20
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
CONTINGENT EARN-OUT AGREEMENTS
In connection with Valero's acquisition of the Paulsboro Refinery in
September 1998, Mobil (now ExxonMobil) 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 due 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 payments were due for the years ended September 16, 1999
and 2000, and an earn-out amount of $20 million was paid for the year ended
September 16, 2001.
Also, in connection with Valero's acquisition of Basis Petroleum, Inc. from
Salomon Inc in May 1997, Salomon is entitled to receive payments in any of the
ten years following the acquisition if certain average refining margins during
the ten-year period exceed a specified level. Any payments due under this
earn-out arrangement, which are determined as of May 1 of each year, are limited
to $35 million in any year and $200 million in the aggregate. No earn-out
amounts were due for the years ended May 1, 1999 and 2000, and the earn-out
amount for the year ended May 1, 2001 was $35 million. Aggregate earn-out
payments through December 31, 2001 totaled $45.3 million.
Valero accounts for any payments under these arrangements as an additional
cost of the respective acquisition, which has been attributed to property, plant
and equipment and is being depreciated over the remaining lives of the assets to
which the additional cost is allocated.
3. ASSETS HELD FOR SALE
Assets held for sale include the amounts expected to be realized from the
dispositions of:
-- the Golden Eagle Business, based on the sale to Tesoro Refining and
Marketing Company (Tesoro) discussed in Note 27 and expected cash
flows from operations of the Golden Eagle Business from January 1,
2002 through the anticipated date of sale. Results of operations for
the Golden Eagle Business beginning January 1, 2002 will be excluded
from Valero's results of operations.
-- the operating assets of Diamond-Koch, L.P., also discussed in Note
27. Income (loss) from Valero's equity investment in Diamond-Koch
beginning January 1, 2002 will be excluded from Valero's results of
operations.
Assets held for sale is comprised of the following (dollars in thousands):
Golden Eagle Business....................................... $1,021,887
Diamond-Koch................................................ 281,750
----------
Assets held for sale...................................... $1,303,637
==========
F-21
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
GOLDEN EAGLE BUSINESS
In conjunction with the UDS Acquisition, the FTC approved a consent decree
requiring divestiture of certain UDS assets. Similar decrees were finalized with
the state of Oregon and California. Pursuant to the consent decrees, the assets
to be divested were required to be held separate from other Valero operations,
with the future operations of those assets overseen by an independent trustee
approved by the FTC. These assets and their related operations are referred to
as the Golden Eagle Business and include:
-- the 168,000 barrel-per-day Golden Eagle Refinery located in the San
Francisco Bay area and all tangible assets used in the operation of
the refinery including docks, tanks and pipelines;
-- the wholesale marketing business generally associated with the Golden
Eagle Refinery production, which includes primarily sales to
unbranded customers located in the northern half of California and
Reno, Nevada; and
-- 70 Beacon- and Ultramar-branded convenience stores located in
Northern California, including land, buildings, pump equipment,
underground storage tanks and various store equipment.
DIAMOND-KOCH
In the latter part of 2001, Koch Industries, Inc. and UDS, both 50%
partners in the Diamond-Koch, L.P. joint venture, decided to sell the four
operating assets of Diamond-Koch and began soliciting bids from interested
parties. The four operating assets include the following:
-- propane/propylene splitter facility and related distribution pipeline
and terminal;
-- hydrocarbon storage facilities;
-- natural gas liquids fractionator facility; and
-- natural gas liquids gathering and pipeline system.
See Note 27 for a discussion of the sale of certain of these Diamond-Koch assets
in 2002.
4. RESTRICTED CASH
Restricted cash includes cash held in trust related to change-in-control
payments to be made to UDS officers and key employees in connection with the UDS
Acquisition, and cash restricted for use for environmental remediation costs
related to the Alma Refinery that was shut down by UDS in 1999.
F-22
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. RECEIVABLES
Receivables consisted of the following (in thousands):
DECEMBER 31,
-------------------
2001 2000
-------- --------
Accounts receivable......................................... $720,812 $579,600
Notes receivable............................................ 66,862 --
Other....................................................... 9,270 11,904
-------- --------
796,944 591,504
Allowance for doubtful accounts............................. (11,339) (5,612)
-------- --------
Receivables, net.......................................... $785,605 $585,892
======== ========
The changes in allowance for doubtful accounts consisted of the following
(in thousands):
YEAR ENDED DECEMBER 31,
-------------------------
2001 2000 1999
------- ------ ------
Balance at beginning of year.............................. $ 5,612 $3,038 $1,150
Provision charged to expense............................ 2,040 2,920 2,000
Huntway Acquisition..................................... 615 -- --
UDS Acquisition......................................... 3,399 -- --
Accounts written off, net of recoveries................. (327) (346) (112)
------- ------ ------
Balance at end of year.................................... $11,339 $5,612 $3,038
======= ====== ======
In September 1999, Valero entered into a revolving accounts receivable
sales facility with a third party financial institution (Transferee) to sell, on
a revolving basis, up to $100 million of an undivided percentage ownership
interest in a designated pool of trade accounts receivable. At the inception of
the facility in 1999, proceeds of $100 million were received under this program
which were used to reduce indebtedness under Valero's bank credit facilities.
Under the facility, which matures in September of 2002, Valero retains the
residual interest in the designated pool of receivables. This retained interest,
which is included in "Receivables, net" in the Consolidated Balance Sheets, is
recorded at fair value. Due to (i) a short average collection cycle for such
receivables of less than one month, (ii) Valero's collection experience history,
and (iii) the composition of the designated pool of trade accounts receivable
that are part of this program, the fair value of Valero's retained interest
approximates the total amount of the designated pool of accounts receivable
reduced by the amount of accounts receivable sold to the Transferee under the
program.
Under this revolving accounts receivable sales facility, the Transferee has
no recourse to any other assets of Valero. Valero remains responsible for
servicing the transferred accounts receivable and pays certain fees to
F-23
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
the Transferee related to its sale of accounts receivable under this program.
The costs incurred by Valero related to this program, which are included in
"Other income (expense), net" in the Consolidated Statements of Income, were
$2.3 million, $6.8 million and $1.6 million for the years ended December 31,
2001, 2000 and 1999, respectively. Proceeds from collections under this
revolving accounts receivable sales facility of $1.8 billion and $2.9 billion
were reinvested in the program by the Transferee for the years ended December
31, 2001 and 2000, respectively. However, the Transferee's interest in Valero's
accounts receivable was never in excess of $100 million at any time under this
program. No accounts receivable included in this program were written off during
2001, 2000 or 1999.
As of December 31, 2001 and 2000, $178 million and $238 million,
respectively, of Valero's accounts receivable comprised the designated pool of
trade accounts receivable included in this program. Of these amounts, $100
million had been sold to the Transferee and the remaining amount was retained by
Valero.
In connection with the UDS Acquisition, Valero assumed a $360 million
revolving accounts receivable sales facility, whereby Valero can sell, on an
ongoing basis, eligible credit card and trade accounts receivable through a
wholly owned subsidiary to a third party financial institution. Valero's
retained interest in accounts receivable sold to the third party financial
institution is included in "Receivables, net" in the Consolidated Balance Sheet
as of December 31, 2001 and is recorded at fair value. Due to (i) a short
average collection cycle for such accounts receivable of less than three months,
(ii) collection experience history, and (iii) the composition of the designated
pool of credit card and trade accounts receivable that are part of this program,
the fair value of Valero's retained interest in these accounts receivable
approximates the eligible accounts receivable sold to the wholly owned
subsidiary less the amount of accounts receivable sold to the third party
financial institution. As of December 31, 2001, the amount of eligible accounts
receivable sold to the financial institution under this program was $273
million, against which a reserve for bad debts of $12.0 million was recorded in
"Accrued expenses" in the Consolidated Balance Sheets. This facility matures in
December 2002.
6. INVENTORIES
Inventories consisted of the following (in thousands):
DECEMBER 31,
---------------------
2001 2000
---------- --------
Refinery feedstocks......................................... $ 513,370 $142,522
Refined products and blendstocks............................ 727,836 332,441
Convenience store merchandise............................... 87,873 212
Materials and supplies...................................... 124,027 64,707
---------- --------
Inventories............................................... $1,453,106 $539,882
========== ========
F-24
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Refinery feedstock and refined product and blendstock inventory volumes
totaled 57.0 million barrels and 21.7 million barrels as of December 31, 2001
and 2000, respectively. The increase was primarily attributable to inventories
acquired in connection with the UDS Acquisition.
In determining the carrying value of Valero's inventories as of December
31, 2001, Valero recognized a net reduction in "Cost of sales and operating
expenses" of $8.8 million resulting from the effect of the valuation of
inventories acquired in the UDS Acquisition. This reduction in "Cost of sales
and operating expenses" was attributable to:
-- a $101.4 million reduction in cost of sales due to the valuation of
the 2001 LIFO inventory increment, resulting primarily from the
December 31, 2001 UDS Acquisition, under Valero's pricing methodology
of average purchase prices during the year (which were significantly
in excess of the December 31, 2001 prices at which the UDS
inventories were acquired), and
-- a $92.6 million increase in cost of sales resulting from the
write-down of LIFO inventories to market value as of December 31,
2001.
As a result of the inventory write-down, the replacement cost of LIFO
inventories approximates its carrying value as of December 31, 2001.
7. PROPERTY, PLANT AND EQUIPMENT
Major classes of property, plant and equipment, which includes capital
lease assets, consisted of the following (in thousands):
DECEMBER 31,
-----------------------
2001 2000
---------- ----------
Land........................................................ $ 453,516 $ 39,460
Crude oil processing facilities............................. 5,469,942 2,926,263
Butane processing facilities................................ 243,686 243,686
Pipeline and terminal facilities............................ 605,065 1,500
Retail facilities........................................... 573,942 5,312
Other....................................................... 325,226 106,451
Construction in progress.................................... 526,464 158,445
---------- ----------
Property, plant and equipment............................. $8,197,841 $3,481,117
========== ==========
F-25
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A summary of the principal rates used in computing the annual provision for
depreciation and amortization, primarily utilizing the composite method and
including estimated salvage values, is as follows:
WEIGHTED
RANGE AVERAGE
---------- --------
Crude oil processing facilities............................. 3.2%-5.1% 3.5%
Butane processing facilities................................ 3.3% 3.3%
Pipeline and terminal facilities............................ 2.7%-3.6% 2.7%
Retail facilities........................................... 6.0%-30.0% 8.8%
Other....................................................... 2.3%-50.0% 17.7%
8. INTANGIBLE ASSETS AND GOODWILL
Intangible assets consisted of the following (in thousands):
WEIGHTED
AVERAGE
REMAINING DECEMBER 31,
AMORTIZATION ------------------
(YEARS) 2001 2000
------------ -------- -------
Intangible assets subject to amortization:
Customer lists.................................. 15.0 $ 90,000 $ --
Air emission credits............................ 11.0 50,000 --
Retail branding rights.......................... 8.3 35,000 35,000
Pension benefits................................ 13.0 32,784 --
Royalties and licenses.......................... 16.4 32,310 31,740
Franchise agreements............................ 14.4 23,672 --
Trade names--U.S. retail operations............. 7.0 17,820 --
Non-compete agreements.......................... 3.8 394 --
Franchise licenses.............................. 8.0 355 --
-------- -------
Intangibles subject to amortization.......... 282,335 66,740
Intangible assets not subject to amortization:
Trade name--Canadian retail operations....... 97,920 --
-------- -------
Total intangible assets........................... 380,255 66,740
Accumulated amortization.......................... (13,553) (7,599)
-------- -------
Intangible assets, net....................... $366,702 $59,141
======== =======
F-26
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In connection with the Benicia Acquisition, Valero received 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. The value assigned to this
right was $35 million and is being amortized over the ten-year term of the
rights agreement.
The trade names, customer lists, air emission credits, non-compete
agreements, and franchise licenses, were acquired on December 31, 2001 in the
UDS Acquisition; therefore, no amortization expense was incurred for these
intangible assets in the Consolidated Statement of Income for the year ended
December 31, 2001.
Amortization expense on intangible assets held prior to the UDS Acquisition
was as follows (in thousands):
YEAR ENDED
DECEMBER 31,
---------------
2001 2000
------ ------
Retail branding rights...................................... $3,530 $2,056
Royalties and licenses...................................... 1,523 1,482
Franchise agreements........................................ 901 --
As of December 31, 2001, goodwill consisted of $2.2 billion resulting from
the UDS Acquisition, based on the preliminary purchase price allocation, none of
which will be deductible for tax purposes. No goodwill was recorded as of
December 31, 2000. Since the UDS Acquisition occurred on December 31, 2001 and
the independent appraisals have not been completed, goodwill by reportable
segments is not currently available.
9. ACCRUED EXPENSES
Accrued expenses consisted of the following (in thousands):
DECEMBER 31,
-------------------
2001 2000
-------- --------
Accrued employee benefit costs.............................. $147,607 $ 47,044
Change-in-control benefits.................................. 60,793 --
Accrued interest expense.................................... 42,364 11,204
Accrued environmental costs................................. 33,563 1,409
Accrued acquisition costs................................... 26,164 --
Derivative liabilities...................................... 20,580 --
Other....................................................... 82,831 44,816
-------- --------
Accrued expenses.......................................... $413,902 $104,473
======== ========
F-27
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
10. DEBT
Long-term debt balances, at stated values, consisted of the following (in
thousands):
DECEMBER 31,
-----------------------
MATURITY 2001 2000
-------- ---------- ----------
Industrial revenue bonds:
Tax-exempt Revenue Refunding Bonds:
Series 1997A, 5.45%........................... 2027 $ 24,400 $ 24,400
Series 1997B, 5.40%........................... 2018 32,800 32,800
Series 1997C, 5.40%........................... 2018 32,800 32,800
Series 1997D, 5.13%........................... 2009 8,500 8,500
Tax-exempt Waste Disposal Revenue Bonds:
Series 1997, 5.6%............................. 2031 25,000 25,000
Series 1998, 5.6%............................. 2032 25,000 25,000
Series 1999, 5.7%............................. 2032 25,000 25,000
Series 2001, 6.65%............................ 2032 18,500 --
Taxable Waste Disposal Revenue Bonds, Series
1998, 6.75% at December 31, 2000.............. -- -- 18,500
6 3/4% notes (callable or putable December 15,
2002)............................................ 2032 150,000 150,000
7 3/8% notes....................................... 2006 300,000 300,000
8 3/8% notes....................................... 2005 200,000 200,000
8 3/4% notes....................................... 2030 200,000 200,000
8.625% Guaranteed Notes............................ 2002 275,000 --
Medium-term Notes:
7.4% (average rate).............................. 2005 46,000 --
8.0%............................................. 2005 150,000 --
8.5% (average rate).............................. 2003 24,000 --
Debentures:
7.25% (non-callable)............................. 2010 25,000 --
7.65% (putable July 1, 2006)..................... 2026 100,000 --
8.00% (callable April 1, 2003)................... 2023 100,000 --
8.75% (non-callable)............................. 2015 75,000 --
Senior Notes:
6.75% (putable October 15, 2009; callable
thereafter)................................... 2037 100,000 --
7.20% (callable)................................. 2017 200,000 --
7.45% (callable)................................. 2097 100,000 --
$750 million revolving bank credit and letter of
credit facility.................................. 2006 525,000 --
Other.............................................. Various 59,803 --
Net unamortized premium (including fair market
value adjustments)............................... 1,256 417
---------- ----------
Total debt............................... 2,823,059 1,042,417
Less current portion, including unamortized premium
of $7,621........................................ (305,661) --
---------- ----------
Long-term debt, less current portion..... $2,517,398 $1,042,417
========== ==========
F-28
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Valero also has various uncommitted short-term bank credit facilities and
uncommitted bank letter of credit facilities. As of December 31, 2001, $200.0
million was outstanding under the short-term bank credit facilities with a
weighted-average interest rate of 3.5%. There was $92.2 million outstanding
under the letter of credit facilities as of December 31, 2001. These credit
facilities have no commitment or other fees, no compensating balance
requirements and are unsecured and unrestricted as to use.
As discussed in Note 2, the cash portion of the UDS Acquisition was
financed with the proceeds from a $1.5 billion bridge loan facility and
borrowings under two new $750 million revolving bank credit facilities. Because
borrowings under these facilities were not made until January 7, 2002, as of
December 31, 2001, the cash obligation was recorded as "Payable to UDS
shareholders" on the Consolidated Balance Sheet. The bridge loan facility, which
is a single-draw facility, has a one-year maturity. The two revolving bank
credit facilities provide for commitments of $750 million for a five-year term
and $750 million for a 364-day term, respectively, and replaced an $835 million
revolving bank credit and letter of credit facility. Borrowings under these
facilities bear interest at LIBOR plus a margin, a base rate or a money market
rate. Valero will also be charged various fees and expenses in connection with
these facilities, including facility fees and various letter of credit fees. The
interest rates and fees under these facilities are subject to adjustment based
upon the credit ratings assigned to Valero's long-term debt. These facilities
include certain restrictive covenants including a coverage ratio and a
debt-to-capitalization ratio. As of December 31, 2001, borrowings under these
committed facilities were $525.0 million, while letters of credit outstanding
were approximately $145 million.
Proceeds from the sale of the Golden Eagle Business, estimated to be $1.125
billion, must be used to pay down any amounts then outstanding under the bridge
facility. Thereafter, commitments under the bridge facility will be reduced by
that same amount.
On June 29, 2000, Valero issued to the public $200 million aggregate
principal amount of 8 3/8% notes which are due on June 15, 2005, and $200
million aggregate principal amount of 8 3/4% notes which are due on June 15,
2030. These notes were issued under Valero's $1.3 billion universal shelf
registration statement. The net proceeds received by Valero from this offering,
which were used in connection with funding the Benicia Acquisition, were
approximately $394 million, including an aggregate discount of approximately
$1.8 million related to the two issuances. Interest payments on the notes are
made semi-annually on June 15 and December 15 of each year. These notes are
unsecured and unsubordinated, rank equally with all of Valero's other unsecured
and unsubordinated debt, have no sinking fund requirements, and are redeemable
at any time, in whole or in part, at Valero's option.
In March 2001, the Gulf Coast Waste Disposal Authority issued and sold for
the benefit of Valero $18.5 million of new tax-exempt Waste Disposal Revenue
Bonds which have a fixed interest rate of 6.65% and mature on April 1, 2032. The
proceeds from the sale of these tax-exempt fixed-rate bonds were used to redeem
$18.5 million of Taxable Waste Disposal Revenue Bonds.
F-29
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In December 1997, Valero issued $150 million principal amount of 6 3/4%
notes for net proceeds of approximately $156.0 million. These notes are
unsecured and unsubordinated and rank equally with all of Valero's other
unsecured and unsubordinated debt. The notes were issued to the Valero
Pass-Through Asset Trust 1997-1 which funded the acquisition of the notes
through a private placement of $150 million principal amount of 6 3/4%
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,
Valero would be required to repurchase the notes at par on December 15, 2002.
In connection with the UDS Acquisition, Valero assumed the following debt
obligations, which were recorded at fair value:
-- 8.625% Guaranteed Notes;
-- Medium-term Notes;
-- Debentures;
-- Senior Notes
-- The 2017 Notes and the 2097 Notes may be redeemed at any time at
Valero's option, in whole or in part, at a redemption price equal
to the greater of: (a) 100% of the principal amount, or (b) the sum
of the present value of outstanding principal and interest thereon,
discounted at the U.S. Treasury Yield plus 20 basis points,
together with accrued interest, if any, to the date of redemption.
-- The 2037 Notes may be redeemed, in whole or in part, by the holders
on October 15, 2009, at a redemption price equal to 100% of the
principal plus accrued interest. After October 15, 2009, the 2037
Notes are redeemable at Valero's option in the same manner as the
2017 Notes and 2097 Notes.
-- Other debt obligations comprised of various notes payable.
Generally, the UDS debt obligations are unsecured with interest payable
semi-annually.
Valero also assumed from UDS the following committed revolving credit
facilities:
-- a Canadian facility under which a Canadian subsidiary, Canadian
Ultramar Company, may borrow, issue bankers' acceptances and obtain
letters of credit in an aggregate amount of Cdn. $200 million, and
-- a U.S. facility under which Valero L.P. (see Note 12) may borrow up
to $120 million.
Valero must pay annual fees on the total used and unused portions of these
revolving credit facilities. The interest rates under these facilities float
based upon the prime rate, LIBOR or other floating interest rates, at Valero's
option. As of December 31, 2001, there were no amounts outstanding under the
Canadian Facility, which expires in July 2002, and $16 million was outstanding
under the Valero L.P. Facility which expires in 2006.
F-30
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Valero also assumed UDS's uncommitted money market lines of credit which
provide additional uncommitted capacity of $35.0 million and Cdn. $195.0
million. As of December 31, 2001, there was Cdn. $6 million of letters of credit
outstanding on the Canadian line of credit.
As of December 31, 2001, Valero's debt-to-capitalization ratio (net of
cash) was 54.5%, an increase from 39.9% as of December 31, 2000 due to the UDS
Acquisition, partially offset by strong cash flows and net income in 2001. For
purposes of this computation, the "Payable to UDS shareholders" in the
Consolidated Balance Sheet as of December 31, 2001, the $200 million
company-obligated preferred securities of subsidiary trust assumed in the UDS
Acquisition, and 20% of the aggregate liquidation amount of trust preferred
securities issued as part of the PEPS Units were included as debt.
The aggregate stated maturities of long-term debt as of December 31, 2001
were as follows (in thousands):
2002........................................................ $ 298,041
2003........................................................ 28,801
2004........................................................ 557
2005........................................................ 396,601
2006........................................................ 841,647
Thereafter.................................................. 1,256,156
Unamortized premium......................................... 1,256
----------
Total............................................. $2,823,059
==========
As of December 31, 2001, debt assumed in the UDS Acquisition of $1.3
billion is recorded at fair value since the acquisition was completed on
December 31, 2001. Excluding debt assumed in the UDS Acquisition, the estimated
fair value of Valero's tax-exempt bonds and fixed-rate notes as of December 31,
2001 and 2000, was approximately $1,091.3 million and $1,051.1 million,
respectively, compared to a carrying amount of $1,041.2 million and $1,023.9
million, respectively. The fair values of these instruments were estimated based
on borrowing rates available to Valero for long-term debt with similar terms and
maturities. As of December 31, 2001, the carrying amount of Valero's revolving
bank credit facility approximated fair value due to its variable interest rate.
F-31
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
11. OTHER LONG-TERM LIABILITIES
Other long-term liabilities consisted of the following (in thousands):
DECEMBER 31,
-------------------
2001 2000
-------- --------
Employee benefit plan liabilities........................... $387,416 $ 65,616
Environmental liabilities................................... 125,887 17,574
Unfavorable lease obligations............................... 136,700 --
Captive insurance reserves.................................. 47,148 --
Other....................................................... 65,658 36,916
-------- --------
Other long-term liabilities....................... $762,809 $120,106
======== ========
12. MINORITY INTEREST IN CONSOLIDATED PARTNERSHIP
On April 16, 2001, Shamrock Logistics, L.P. (now Valero L.P.), a previously
wholly owned subsidiary of UDS, issued 5,175,000 limited partnership units in an
initial public offering at a price of $24.50 per unit. Proceeds from the
offering totaled $111.9 million, net of offering expenses of $14.9 million, and
were used to pay down debt of UDS. As a result of the UDS Acquisition, Valero
now owns approximately 73% of Valero L.P.
Valero L.P. is consolidated in Valero's Consolidated Balance Sheet. The
minority interest in consolidated partnership in the Consolidated Balance Sheet
represents the public unitholders' interest in Valero L.P.
13. COMPANY-OBLIGATED PREFERRED SECURITIES OF SUBSIDIARY TRUSTS
Company-obligated preferred securities of subsidiary trusts include:
-- $172.5 million of Premium Equity Participating Security Units (PEPS
Units) which are mandatorily redeemable, and
-- $200 million of Trust Originated Preferred Securities (TOPrS) which
are redeemable at Valero's option.
PREMIUM EQUITY PARTICIPATING SECURITY UNITS
On June 28, 2000, Valero issued $172.5 million of 7 3/4% PEPS Units in a
public offering (6,900,000 units at $25.00 per unit). The PEPS Units were issued
under Valero's $1.3 billion universal shelf registration. The net proceeds
received by Valero from this offering, which were used in connection with
funding the Benicia Acquisition, were approximately $167 million. Each PEPS Unit
consists of a purchase contract for shares of Valero common stock and a trust
preferred security.
F-32
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Each purchase contract obligates the holder to purchase from Valero on
August 18, 2003, for a price of $25.00 per contract, the following number of
shares of Valero common stock based on the average closing price of Valero's
common stock over the 20-day trading period ending on the third trading day
prior to August 18, 2003:
(i) .71531 shares if the average closing price equals or exceeds
$34.95;
(ii) a number of shares having a value equal to $25.00 if the average
closing price is less than $34.95 but greater than $29.125; and
(iii) .85837 shares if the average closing price is less than or equal
to $29.125.
The holder has the option to settle a purchase contract early for a price of
$25.00 in exchange for .71531 shares of Valero common stock.
Each trust preferred security represents an undivided interest in the
assets of VEC Trust I, a wholly owned subsidiary trust of Valero, has a stated
liquidation amount of $25.00 and matures on August 18, 2005. The trust preferred
security is pledged as collateral to secure the PEPS Unit holder's obligation to
purchase Valero common stock under the related purchase contract. VEC Trust I
pays a cash distribution on each trust preferred security at the annual rate of
7.75% of the $25.00 stated liquidation amount prior to August 18, 2003, and from
August 18, 2003 until August 18, 2005, at a reset rate that may be less than,
equal to or greater than this amount. The cash distribution payments are made
quarterly on February 18, May 18, August 18 and November 18 of each year, and
began August 18, 2000.
The assets of VEC Trust I consist solely of Valero senior deferrable notes
maturing on August 18, 2005. VEC Trust I's sole source of funds for
distributions on the trust preferred securities is the interest payments it
receives from Valero on the senior deferrable notes. Valero has the right to
defer interest on the senior deferrable notes until August 18, 2003, in which
case distributions on the trust preferred securities would also be deferred. Any
deferred distributions will accumulate and compound quarterly at the rate of
7.75% per year. Valero guarantees the payment of distributions on the trust
preferred securities to the extent interest is paid on the senior deferrable
notes. Distributions on the trust preferred securities, whether paid or
accumulated, are reflected in "Distributions on preferred securities of
subsidiary trust" in the Consolidated Statements of Income.
Prior to the issuance of shares of Valero common stock upon settlement of
the purchase contracts, the PEPS Units are reflected in Valero's earnings per
share of common stock assuming dilution calculations using the treasury stock
method. Consequently, the PEPS Units will have a dilutive effect on earnings per
share for reporting periods during which the average market price per share of
Valero common stock exceeds $34.95. For reporting periods during which the
average market price per share of Valero common stock is $34.95 or less, the
PEPS Units will have a dilutive effect on earnings per share only when that
average market price per share is above the average closing price for the 20-day
trading period ending on the third trading day prior to the end of the reporting
period.
F-33
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
TRUST ORIGINATED PREFERRED SECURITIES
On June 25, 1997, UDS Capital I (the Trust) issued $200 million of 8.32%
Trust Originated Preferred Securities (TOPrS) in an underwritten public offering
(8,000,000 units at $25.00 per unit). The TOPrS are redeemable on or after June
30, 2002 at the option of the Trust, in whole or in part, at a redemption price
of $25.00 per security. Distributions on the TOPrS are cumulative and payable
quarterly in arrears, on March 31, June 30, September 30 and December 31, if and
when the Trust has funds available for distribution, at the annual rate of 8.32%
of the liquidation amount of $25.00 per TOPrS.
As a result of the UDS Acquisition, the Trust is a wholly owned subsidiary
of Valero. Valero has guaranteed, on a subordinated basis, the dividend payments
due on the TOPrS if and when declared.
14. STOCKHOLDERS' EQUITY
AUTHORIZED SHARES
On September 27, 2001, Valero's stockholders approved an increase in the
number of authorized shares of common stock from 150 million shares to 300
million shares. Effective December 31, 2001, Valero's Restated Certificate of
Incorporation was amended to reflect the increase in the number of authorized
shares of Valero common stock.
Valero also has 20 million shares of Preferred Stock authorized with a par
value of $0.01 per share. As of December 31, 2001 and 2000, there were no
outstanding shares of Preferred Stock.
EXCHANGE OF UDS SHARES
In connection with the UDS Acquisition, Valero issued 45,887,826 shares of
Valero common stock and vested 5,836,933 employee stock options in the exchange,
which increased stockholders' equity by a total of approximately $2.2 billion.
COMMON STOCK OFFERING
On June 28, 2000, Valero issued to the public 5,980,000 shares of its
common stock at $29.125 per share. These shares were issued under Valero's $1.3
billion universal shelf registration statement. Valero received net proceeds of
approximately $167 million from this offering, which were used to fund the
Benicia Acquisition.
F-34
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
COMMON STOCK BUYBACK PROGRAMS
Under common stock repurchase programs approved by Valero's Board of
Directors, Valero repurchases shares of its common stock from time to time for
use in connection with its employee benefit plans and other general corporate
purposes. During the years ended December 31, 2001 and 2000, Valero repurchased
shares of its common stock under these programs at a cost of $156.7 million and
$64.3 million, respectively.
15. EARNINGS PER SHARE
The computation of earnings per share amounts is as follows (dollars and
shares in thousands, except per share amounts):
YEAR ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
-------- -------- -------
Earnings Per Share of Common Stock:
Net income applicable to common shares................ $563,553 $339,120 $14,287
======== ======== =======
Weighted-average common shares outstanding............ 60,749 58,532 56,086
======== ======== =======
Earnings per share of common stock.................... $ 9.28 $ 5.79 $ 0.25
======== ======== =======
Earnings Per Share of Common Stock--Assuming Dilution:
Net income available to common equivalent shares...... $563,553 $339,120 $14,287
======== ======== =======
Weighted-average common shares outstanding............ 60,749 58,532 56,086
Effect of dilutive securities:
Stock options....................................... 1,849 1,304 292
Performance awards and other benefit plans.......... 986 689 380
PEPS Units.......................................... 219 -- --
-------- -------- -------
Weighted-average common equivalent shares
outstanding......................................... 63,803 60,525 56,758
======== ======== =======
Earnings per share of common stock--assuming
dilution............................................ $ 8.83 $ 5.60 $ 0.25
======== ======== =======
F-35
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
16. STATEMENTS OF CASH FLOWS
In order to determine net cash provided by operating activities, net income
is adjusted by, among other things, changes in current assets and current
liabilities as follows (in thousands):
YEAR ENDED DECEMBER 31,
--------------------------------
2001 2000 1999
--------- --------- --------
Decrease (increase) in current assets:
Receivables, net................................. $ 122,132 $(213,350) $(89,086)
Inventories...................................... (66,532) (70,364) 8,747
Prepaid expenses and other current assets........ 5,943 (10,346) 10,265
Increase (decrease) in current liabilities:
Accounts payable................................. (237,587) 189,954 326,355
Accrued expenses................................. 33,127 49,758 14,649
Taxes other than income taxes.................... 6,915 21,570 22,464
Income taxes payable............................. (16,840) 36,270 428
--------- --------- --------
Changes in current assets and current
liabilities................................. $(152,842) $ 3,492 $293,822
========= ========= ========
The amounts shown above exclude changes in cash and temporary cash
investments, restricted cash, current deferred income tax assets and
liabilities, and short-term debt and current portion of long-term debt. Also
excluded from the table above are the current assets and current liabilities
acquired in connection with the Huntway, El Paso and UDS Acquisitions in 2001
and the Benicia Acquisition in 2000, which are reflected separately in the
Consolidated Statements of Cash Flows.
Cash flows related to interest paid and income taxes paid and received were
as follows (in thousands):
YEAR ENDED DECEMBER 31,
----------------------------
2001 2000 1999
-------- ------- -------
Interest paid (net of amount capitalized).............. $ 78,822 $71,789 $49,023
Income taxes paid...................................... 124,779 49,578 13,582
Income tax refunds received............................ 2,508 565 7,530
Noncash investing and financing activities for 2001 include:
-- the issuance of $2.1 billion of common stock and $120 million of
vested employee stock options as partial consideration for the UDS
Acquisition,
-- the recognition of capital lease obligations of approximately $286
million related to the El Paso Acquisition, and
F-36
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
-- various adjustments to property, plant and equipment and certain
current assets and current and noncurrent liabilities resulting from
the final purchase price allocation related to the Benicia
Acquisition.
Noncash investing and financing activities for the years ended December 31,
2000 and 1999 included various adjustments to property, plant and equipment and
certain current assets and current liabilities resulting from the preliminary
purchase price allocation related to the Benicia Acquisition and the final
purchase price allocation related to the acquisition of the Paulsboro Refinery,
respectively.
17. PRICE RISK MANAGEMENT ACTIVITIES
As discussed in Note 1, effective January 1, 2001, Valero adopted Statement
No. 133, "Accounting for Derivative Instruments and Hedging Activities," as
amended. Valero follows Statement No. 133 in accounting for derivative
instruments used in its price risk management activities.
COMMODITY PRICE RISK
Valero 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 its refining operations. To reduce the impact of this price volatility,
Valero uses derivative commodity instruments (swaps, futures and options) to
manage its exposure to:
-- changes in the fair value of a portion of its refinery feedstock and
refined product inventories and a portion of its unrecognized firm
commitments to purchase these inventories (fair value hedges);
-- changes in cash flows of certain forecasted transactions such as
forecasted feedstock and natural gas purchases, product sales and
refining operating margins (cash flow hedges); and
-- price volatility on a portion of its refined product inventories and
on certain forecasted feedstock and refined product purchases that
are not designated as either fair value or cash flow hedges (economic
hedges).
In addition, Valero uses derivative commodity instruments for trading purposes
using its fundamental and technical analysis of market conditions to earn
additional income.
Valero's positions in derivative commodity instruments are monitored and
managed on a daily basis by a risk control group to ensure compliance with
Valero's stated risk management policy which has been approved by Valero's Board
of Directors.
INTEREST RATE RISK
Valero is exposed to market risk for changes in interest rates related to
certain of its long-term debt obligations. Interest rate swap agreements are
used to manage a portion of the exposure to changing interest rates by
converting certain fixed-rate debt to floating rate. The gain or loss on the
interest rate swap agreements, which have been designated and have qualified as
fair value hedging instruments, and changes in the fair value of the related
hedged debt are recorded in interest expense.
F-37
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOREIGN CURRENCY RISK
Periodically, Valero may enter into short-term foreign exchange and
purchase contracts to manage its exposure to exchange rate fluctuations on the
trade payables of its Canadian operations that are denominated in U.S. dollars.
Under Statement No. 133, these contracts are not designated as hedging
instruments.
IMPACT OF ADOPTION
The impact of adopting Statement No. 133 as of January 1, 2001 was as
follows (debit (credit) in thousands):
Inventories................................................. $ 3,215
Deferred charges, deferred credits and other................ 42,865
Accounts payable............................................ (2,536)
Deferred income tax liabilities............................. (15,240)
Other comprehensive income, net of income tax expense....... (28,304)
CURRENT PERIOD DISCLOSURES
For the year ended December 31, 2001, the net loss recognized in income
representing the amount of hedge ineffectiveness was $3.4 million for fair value
hedges and $20.8 million for cash flow hedges. These amounts are included in
"Cost of sales and operating expenses" in the Consolidated Statements of Income.
Valero did not exclude any component of the derivative instruments' gain or loss
from the assessment of hedge effectiveness. No amounts were recognized in income
for hedged firm commitments no longer qualifying as fair value hedges.
For cash flow hedges, gains and losses currently reported in "Accumulated
other comprehensive income" in the Consolidated Statement of Comprehensive
Income will be reclassified into income when the forecasted feedstock or natural
gas purchase, product sale or refining operating margin affects income. The
estimated amount of existing net gain included in "Accumulated other
comprehensive income" as of December 31, 2001 that is expected to be
reclassified into income within the next 12 months is $18.1 million. As of
December 31, 2001, the maximum length of time over which Valero was hedging its
exposure to the variability in future cash flows for forecasted transactions was
15 months. For the year ended December 31, 2001, no amounts were reclassified
from "Accumulated other comprehensive income" into income as a result of the
discontinuance of cash flow hedge accounting.
MARKET AND CREDIT RISK
Valero'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. Valero closely monitors and manages its exposure to market risk
on a daily basis in accordance with policies approved by its Board of Directors.
Market risks are monitored by a risk control group to ensure compliance with
Valero's stated risk management policy. Concentrations of customers
F-38
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
in the refining industry may impact Valero's overall exposure to credit risk, in
that these customers may be similarly affected by changes in economic or other
conditions. Valero believes that its counterparties will be able to satisfy
their obligations under contracts.
18. PREFERRED SHARE PURCHASE RIGHTS
Each outstanding share of Valero's common stock is accompanied by one
Preferred Share Purchase Right (Right). With certain exceptions, each Right
entitles the registered holder to purchase from Valero one one-hundredth of a
share of Valero'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 (Acquiring Person) has acquired beneficial
ownership of 15% or more of the outstanding shares of Valero's common
stock,
(ii) 10 business days (or later date as may be determined by action
of Valero'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 Valero'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, Valero's Board of Directors may redeem
the Rights at a price of $0.01 per Right. The Rights will expire on June 30,
2007, unless extended or the Rights are earlier redeemed or exchanged by Valero.
If after the Rights Separation Date, Valero 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, Valero's Board
of Directors may exchange the Right (other than Rights owned by the
F-39
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 Valero 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 Valero on
terms not approved by Valero'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 Valero's
Board of Directors since the Rights may be redeemed by Valero prior to the time
that an Acquiring Person has acquired beneficial ownership of 15% or more of the
common stock.
19. INCOME TAXES
Components of income tax expense were as follows (in thousands):
YEAR ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
-------- -------- -------
Current:
Federal............................................. $ 56,221 $ 80,021 $14,896
State............................................... 4,379 5,979 404
-------- -------- -------
Total current.................................... 60,600 86,000 15,300
-------- -------- -------
Deferred:
Federal............................................. 246,579 102,076 (9,400)
State............................................... 24,121 1,024 --
-------- -------- -------
Total deferred................................... 270,700 103,100 (9,400)
-------- -------- -------
Income tax expense............................. $331,300 $189,100 $ 5,900
======== ======== =======
F-40
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following is a reconciliation of total income tax expense to income
taxes computed by applying the statutory federal income tax rate (35% for all
years presented) to income before income taxes (in thousands):
YEAR ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
-------- -------- -------
Federal income tax expense at the statutory rate...... $313,199 $184,877 $ 7,065
State income taxes, net of federal income tax
effect.............................................. 18,525 4,553 263
Research and experimentation tax credit............... (1,000) (3,022) --
Basis difference on disposition of investment......... -- -- (1,894)
Other, net............................................ 576 2,692 466
-------- -------- -------
Income tax expense.................................. $331,300 $189,100 $ 5,900
======== ======== =======
The tax effects of significant temporary differences representing deferred
income tax assets and liabilities are as follows (in thousands):
DECEMBER 31,
-----------------------
2001 2000
----------- ---------
Deferred income tax assets:
Tax credit carryforwards.................................. $ 92,633 $ 47,468
Net operating losses...................................... 21,760 --
Compensation and employee benefit liabilities............. 107,529 35,953
Inventories............................................... -- 54,870
Accrued liabilities....................................... 110,931 20,890
Other assets.............................................. 84,480 --
----------- ---------
Total deferred income tax assets....................... 417,333 159,181
Less: Valuation allowance................................. (23,988) --
----------- ---------
Net deferred income tax assets......................... 393,345 159,181
----------- ---------
Deferred income tax liabilities:
Turnarounds............................................... (96,986) (30,978)
Depreciation.............................................. (1,477,351) (413,689)
Equity investment in Diamond-Koch, L.P.................... (75,530) --
Inventories............................................... (55,106) --
Other..................................................... (137,219) (15,331)
----------- ---------
Total deferred income tax liabilities.................. (1,842,192) (459,998)
----------- ---------
Net deferred income tax liabilities......................... $(1,448,847) $(300,817)
=========== =========
F-41
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
As of December 31, 2001, Valero had the following U.S. federal and state
income tax credit and loss carryforwards (in thousands):
AMOUNT EXPIRATION
------- -----------------
Alternative minimum tax (AMT) credit.................... $64,085 Indefinite
U.S. federal and state income tax credits............... 12,284 2002 through 2014
Foreign tax credit...................................... 16,264 2006
U.S. federal net operating losses (NOL)................. 20,331 2011 through 2013
Canadian net operating losses (NOL)..................... 868 2007
Approximately $56 million of the AMT credit and all of the U.S. federal
income tax credits, foreign tax credit and U.S. federal NOL carryforwards are
subject to annual U.S. federal income tax limitations.
The realization of net deferred income tax assets recorded as of December
31, 2001 is dependent upon Valero's ability to generate future taxable income in
both the U.S. and Canada. Although realization is not assured, Valero believes
it is more likely than not that the net deferred income tax assets will be
realized. There was no valuation allowance recorded against net deferred income
tax assets as of December 31, 2000.
U.S. federal deferred income taxes or Canadian withholding taxes have not
been provided for on the undistributed earnings of Valero's Canadian
subsidiaries based on the determination that those earnings will be indefinitely
reinvested. As of December 31, 2001, the cumulative undistributed earnings of
these subsidiaries were approximately $106 million. If those earnings were not
considered indefinitely reinvested, U.S. federal deferred income taxes and
Canadian withholding taxes would have been provided after consideration of
foreign tax credits. However, determination of the amount of U.S. federal
deferred income taxes and Canadian withholding taxes is not practical.
Valero's separate taxable years through 1997 are closed to adjustment by
the Internal Revenue Service. UDS's separate tax years 1995 through 1997 are
currently under examination. Valero believes that adequate provisions for income
taxes have been reflected in the consolidated financial statements.
20. SEGMENT INFORMATION
Prior to the UDS Acquisition, Valero's operations consisted primarily of
six petroleum refineries, the products of which were marketed through an
extensive wholesale bulk and rack marketing network and through retail
operations in California. In applying the requirements of FASB Statement No.
131, "Disclosures about Segments of an Enterprise and Related Information,"
Valero's six refineries, each of which represents an operating segment as
defined by Statement No. 131, were aggregated for reporting purposes. As a
result, Valero had one reportable segment, which was the refining and marketing
of premium, environmentally clean products.
F-42
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Since the UDS Acquisition occurred on December 31, 2001, the results of
operations of UDS will be included with Valero's operations beginning January 1,
2002. Valero will have two reportable segments beginning January 1, 2002,
refining and retail. The refining segment will include refinery, wholesale
marketing, product supply and distribution, and transportation operations. The
retail segment will include company-operated convenience stores, Canadian
dealers/jobbers and truckstop facilities, cardlock and home heating oil
operations. Operations that are not included in either of the two reportable
segments will be included in the corporate category.
Valero's principal products include conventional, reformulated and CARB
gasolines, low-sulfur diesel, and oxygenates and other gasoline blendstocks.
Valero also produces a substantial slate of middle distillates, jet fuel and
petrochemicals, in addition to lube oils and asphalt. Operating revenues from
external customers for Valero's principal products for the years ended December
31, 2001, 2000 and 1999 were as follows (in thousands):
YEAR ENDED DECEMBER 31,
--------------------------------------
2001 2000 1999
----------- ----------- ----------
Gasolines and blendstocks...................... $ 8,442,540 $ 7,831,464 $4,381,112
Distillates.................................... 3,368,913 3,747,128 1,848,621
Petrochemicals................................. 301,904 386,909 258,850
Lubes and asphalts............................. 410,027 295,300 178,653
Other products and revenues.................... 2,464,955 2,410,286 1,293,932
----------- ----------- ----------
Consolidated operating revenues.............. $14,988,339 $14,671,087 $7,961,168
=========== =========== ==========
During the years ended December 31, 2001, 2000 and 1999, Valero had no
significant amount of export sales and no significant foreign operations. During
the years ended December 31, 2001, 2000 and 1999, approximately $1.6 billion
(10.6%), $1.7 billion (11.7%) and $1.2 billion (15.4%), respectively, of
Valero's consolidated operating revenues were derived from sales to ExxonMobil.
Long-lived assets include property, plant and equipment, intangible assets,
and certain long-lived assets included in deferred charges and other assets.
Goodwill by geographic area is not currently available and therefore is excluded
from the amounts below. Geographic information by country for long-lived assets
consisted of the following (in thousands):
DECEMBER 31,
-----------------------
2001 2000
---------- ----------
United States............................................... $6,798,904 $2,858,087
Canada...................................................... 1,024,393 --
---------- ----------
Consolidated long-lived assets............................ $7,823,297 $2,858,087
========== ==========
F-43
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Total assets by reportable segment are as follows (in thousands):
DECEMBER 31,
------------------------
2001 2000
----------- ----------
Refining.................................................... $10,342,980 $4,069,340
Retail...................................................... 1,165,430 42,568
Corporate................................................... 658,213 195,796
----------- ----------
Total reportable segments................................. 12,166,623 4,307,704
Goodwill.................................................... 2,210,473 --
----------- ----------
Total consolidated assets................................. $14,377,096 $4,307,704
=========== ==========
Since the UDS Acquisition occurred on December 31, 2001 and the independent
appraisals have not been completed, goodwill by reportable segment is not
currently available.
21. EMPLOYEE BENEFIT PLANS
PENSION PLANS AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
Valero's qualified pension plan, which is subject to the provisions of the
Employee Retirement Income Security Act of 1974, as amended (ERISA), is designed
to provide eligible employees with retirement income. Participation in the plan
commences upon the completion of one year of continuous service, and a
participant vests in plan benefits after five years of vesting service. Upon
becoming a participant, all service since date of hire is included in
determining vesting and credited service, except for individuals who became
employees of Valero as a result of an acquisition by Valero, for whom benefits
are determined by the terms of the acquisition agreement. Valero also provides
certain retirement benefits under a nonqualified plan, the Supplemental
Executive Retirement Plan (SERP), which is designed to provide additional
pension benefits to executive officers and certain other employees.
The qualified pension plan provides a monthly pension payable upon normal
retirement of an amount equal to a set formula which, prior to the UDS
Acquisition, was based on the participant's 60 consecutive highest months of
compensation during the latest 10 years of credited service under the plan.
Effective January 1, 2002, the pension benefit will be calculated based on the
highest three consecutive calendar years of the participant's total pay,
including overtime and bonuses. Any contributions to the plan are made by Valero
and contributions by participants are neither required nor permitted. Valero's
contributions 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. Valero's contributions to the
pension plan and SERP in 2001, 2000 and 1999 were approximately $18 million, $10
million and $7 million, respectively, and are currently estimated to be $32
million in 2002.
F-44
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In connection with the UDS Acquisition, Valero approved the establishment
of a supplement to the pension plan (the 2001 Voluntary Early Retirement Window)
which permitted certain employees to retire from employment during 2002. There
were 100 employees who accepted the 2001 Voluntary Early Retirement Window
option.
Valero also provides certain health care and life insurance benefits for
retired employees, referred to as postretirement benefits other than pensions.
Substantially all of Valero's employees may become eligible for these benefits
if, while still working for Valero, they either reach normal retirement age or
take early retirement. Health care benefits are offered by Valero through a
self-insured plan and a health maintenance organization while life insurance
benefits are provided through an insurance company. Valero funds its
postretirement benefits other than pensions on a pay-as-you-go basis.
Individuals who became Valero employees as a result of an acquisition by Valero
became eligible for other postretirement benefits under Valero's plan as
determined by terms of the acquisition agreement.
The changes in benefit obligation, changes in plan assets, funded status
and amounts recognized in Valero's Consolidated Balance Sheets for Valero's
pension plans, including the SERP, and other postretirement benefits are
summarized below (in thousands):
OTHER POSTRETIREMENT
PENSION BENEFITS BENEFITS
-------------------- --------------------
2001 2000 2001 2000
--------- -------- --------- --------
Change in Benefit Obligation:
Benefit obligation at beginning of
year................................... $ 188,309 $163,342 $ 62,718 $ 42,629
Service cost........................... 15,160 11,009 4,653 2,206
Interest cost.......................... 15,394 12,297 6,604 3,392
UDS Acquisition........................ 389,505 -- 98,280 --
Huntway Acquisition.................... -- -- 1,077 --
El Paso Acquisition.................... -- -- 5,531 --
Benicia Acquisition.................... -- 5,756 3,143 5,212
Participant contributions.............. -- -- 169 152
Plan amendments........................ 41,351 -- (26,720) --
2001 Voluntary Early Retirement
Window.............................. 2,465 -- 562 --
Benefits paid.......................... (6,843) (6,490) (2,409) (2,091)
Actuarial loss......................... 44,818 2,395 39,656 11,218
--------- -------- --------- --------
Benefit obligation at end of year........ $ 690,159 $188,309 $ 193,264 $ 62,718
F-45
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
OTHER POSTRETIREMENT
PENSION BENEFITS BENEFITS
-------------------- --------------------
2001 2000 2001 2000
--------- -------- --------- --------
========= ======== ========= ========
Change in Plan Assets:
Fair value of plan assets at beginning of
year................................... $ 182,260 $171,715 $ -- $ --
Actual return on plan assets........... (13,995) 7,032 -- --
Valero contributions................... 18,492 10,003 2,240 1,939
Participant contributions.............. -- -- 169 152
UDS Acquisition........................ 216,497 -- -- --
Benefits paid.......................... (6,843) (6,490) (2,409) (2,091)
--------- -------- --------- --------
Fair value of plan assets at end of
year................................... $ 396,411 $182,260 $ -- $ --
========= ======== ========= ========
Reconciliation of funded status:
Fair value of plan assets at end of
year................................... $ 396,411 $182,260 $ -- $ --
Less: Benefit obligation at end of
year................................... 690,159 188,309 193,264 62,718
--------- -------- --------- --------
Funded status at end of year............. (293,748) (6,049) (193,264) (62,718)
Unrecognized net loss (gain)........... 69,561 (5,085) 48,971 10,530
Unrecognized prior service cost........ 46,429 6,051 (21,953) 1,444
Unrecognized net transition obligation
(asset)............................. (563) (738) -- 3,754
--------- -------- --------- --------
Accrued benefit cost..................... $(178,321) $ (5,821) $(166,246) $(46,990)
========= ======== ========= ========
Amounts recognized in the Consolidated
Balance Sheets:
Prepaid benefit cost................... $ 21,345 $ 13,402 $ -- $ --
Intangible asset....................... 32,784 -- -- --
Accrued benefit liability.............. (232,450) (19,223) (166,246) (46,990)
--------- -------- --------- --------
Accrued benefit cost..................... $(178,321) $ (5,821) $(166,246) $(46,990)
========= ======== ========= ========
As of December 31, 2001, after incorporating the effect of the UDS
Acquisition, the projected benefit obligation, accumulated benefit obligation
and fair value of plan assets for pension plans with accumulated benefit
obligations in excess of plan assets was $620.1 million, $475.3 million and
$331.5 million, respectively. There was no unfunded accumulated benefit
obligation as of December 31, 2000.
F-46
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The components of net periodic benefit cost are summarized as follows (in
thousands):
OTHER POSTRETIREMENT
PENSION BENEFITS BENEFITS
------------------------------ -------------------------
2001 2000 1999 2001 2000 1999
-------- -------- -------- ------- ------ ------
Components of net periodic benefit
cost:
Service cost........................ $ 15,160 $ 11,009 $ 9,466 $ 4,653 $2,206 $2,047
Interest cost....................... 15,394 12,297 10,114 6,604 3,392 2,818
Expected return on plan assets...... (16,873) (15,704) (12,642) -- -- --
2001 Voluntary Early Retirement
Window........................... 2,465 -- -- 562 -- --
Amortization of:
Transition obligation............ (175) (175) (144) 317 317 317
Prior service cost............... 973 870 866 114 114 114
Net loss......................... 1,039 31 343 1,216 -- --
-------- -------- -------- ------- ------ ------
Net periodic benefit cost............. $ 17,983 $ 8,328 $ 8,003 $13,466 $6,029 $5,296
======== ======== ======== ======= ====== ======
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, 2001 and 2000 were as follows:
OTHER
PENSION POSTRETIREMENT
BENEFITS BENEFITS
----------- --------------
2001 2000 2001 2000
---- ---- ------ -----
Weighted average assumptions:
Discount rate......................................... 7.00% 7.50% 7.00% 7.50%
Expected long-term rate of return on plan assets...... 8.75% 9.25% -- --
Rate of compensation increase......................... 5.62% 5.00% -- --
Health care cost trend rate........................... -- -- 10.00% 5.00%
For the December 31, 2001 measurement, the health care cost trend rate is
assumed to decrease 1% per year from the 2001 rate of 10% to an ultimate rate of
5.5% in 2006 and beyond. For the December 31, 2000 measurement, the health care
cost trend rate was assumed to remain at five percent for all future years.
Assumed health care cost trend rates have a significant effect on the amounts
reported for health care plans. A one percentage-point change in assumed health
care cost trend rates would have the following effects on other postretirement
benefits (in thousands):
1% INCREASE 1% DECREASE
----------- -----------
Effect on total of service and interest cost components... $ 2,187 $ (1,790)
Effect on other postretirement benefit obligation......... 16,764 (13,943)
F-47
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
PROFIT-SHARING/SAVINGS PLANS
Valero is the sponsor of the Valero Energy Corporation Thrift Plan, which
is a qualified employee profit-sharing plan. Participation in the Thrift Plan is
voluntary and is open to Valero employees who become eligible to participate
upon the completion of one month of continuous service. This service may include
prior employment with other companies prior to individuals becoming employees of
Valero through an acquisition by Valero.
Prior to a plan change effective January 1, 2002 discussed below,
participating employees could contribute from 2% up to 8% of their total annual
compensation as basic contributions, with those participants making a basic
contribution of 8% allowed to make a supplemental contribution of up to 14% of
their total annual compensation. Participants may elect to make contributions on
a before-tax and/or after-tax basis, with federal income taxes on before-tax
contributions being deferred until a distribution is made to the participant.
Participants' basic contributions of up to 8% of their base annual compensation
were matched 75% by Valero, with an additional match of up to 25% subject to
certain conditions. Participants' basic contributions in excess of 8% of their
base annual compensation were not matched by Valero. In January 2001, the
compensation committee of Valero's Board of Directors approved an increase in
Valero's matching percentage from 75% to 100% for the 12-month period beginning
February 1, 2001.
Effective January 1, 2002, the Thrift Plan was amended to provide that
participants will be able to make a supplemental contribution of up to 22% of
their total annual compensation, and the maximum match by Valero will be 75% of
the participants' basic contributions based on the participants' total annual
compensation, including overtime and cash bonuses.
Valero's contributions to the Thrift Plan for the years ended December 31,
2001, 2000 and 1999 were $13.5 million, $8.2 million and $6.7 million,
respectively.
STOCK COMPENSATION PLANS
Valero has various fixed and performance-based stock compensation plans.
Valero's Executive Stock Incentive Plan (ESIP) 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 awards which vest upon the achievement of an objective
performance goal, and restricted stock which vests over a period determined by
Valero's compensation committee. As of December 31, 2001, a total of 2,459,098
shares of Valero common stock remain available to be awarded under the ESIP.
Valero also has
F-48
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
a non-qualified stock option plan under which awards are granted to key
officers, employees and prospective employees. A total of 646,283 shares of
Valero common stock remain available to be awarded under this plan. Valero also
maintains an Executive Incentive Bonus Plan, under which shares of Valero common
stock may be issued that provide bonus compensation to key employees based on
individual contributions to company profitability. Bonuses are payable either in
cash, Valero common stock, or both. Valero also has a non-employee director
stock option plan, under which 77,105 shares of Valero common stock remain
available to be awarded, and a non-employee director restricted stock plan,
under which 138,000 shares of Valero common stock remain available to be
awarded.
The number and weighted average grant-date fair value of shares of Valero
common stock granted under the above-noted plans (other than shares related to
stock options which are presented in a separate table below) during the years
ended December 31, 2001, 2000 and 1999 were as follows:
2001 2000 1999
-------------------- -------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES GRANT-DATE SHARES GRANT-DATE SHARES GRANT-DATE
GRANTED FAIR VALUE GRANTED FAIR VALUE GRANTED FAIR VALUE
------- ---------- ------- ---------- ------- ----------
ESIP:
Restricted stock....... 8,000 $37.52 17,619 $29.14 85,937 $19.57
Performance awards..... 132,400 34.13 146,100 21.81 225,500 21.31
Executive Incentive Bonus
Plan................... 251,624 36.72 134,362 21.81 -- --
Non-employee director
restricted stock
plan................... 1,932 37.79 1,608 28.00 4,190 21.48
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 Valero's common stock at the date of grant.
Stock options become exercisable pursuant to the individual written agreements
between Valero 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. Upon completion of the UDS
Acquisition, all vested UDS stock options held by employees and non-employee
directors of UDS were converted to Valero stock options which had a fair value
of $120 million.
F-49
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
A summary of the status of Valero's stock option plans, including stock
options granted under the ESIP, the stock option plan, which includes UDS stock
options converted to Valero stock options, the non-employee director stock
option plan and Old Valero's previously existing stock compensation plans is
presented in the table below.
NUMBER OF WEIGHTED AVERAGE
STOCK OPTIONS EXERCISE PRICE
------------- ----------------
Outstanding as of December 31, 1998................ 5,528,996 $21.01
Granted.......................................... 1,580,062 20.29
Exercised........................................ (17,806) 14.77
Forfeited........................................ (29,677) 23.41
----------
Outstanding as of December 31, 1999................ 7,061,575 20.86
Granted.......................................... 1,854,460 28.00
Exercised........................................ (1,215,573) 19.11
Forfeited........................................ (176,763) 22.58
----------
Outstanding as of December 31, 2000................ 7,523,699 22.86
Granted.......................................... 2,496,016 34.25
Exercised........................................ (828,178) 22.67
Forfeited........................................ (104,346) 22.04
Conversion of UDS stock options.................. 5,836,933 22.66
----------
Outstanding as of December 31, 2001................ 14,924,124 24.71
==========
Stock options exercisable at December 31:
1999............................................. 3,788,724 19.93
2000............................................. 4,212,683 21.10
2001............................................. 11,046,525 22.36
F-50
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table summarizes information about stock options outstanding
under the ESIP, the stock option plan and the non-employee director stock option
plan as of December 31, 2001:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------------- ----------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER LIFE EXERCISE NUMBER EXERCISE
EXERCISE PRICE OUTSTANDING IN YEARS PRICE EXERCISABLE PRICE
-------------- ----------- --------- -------- ----------- --------
$10.85-$14.10 708,221 2.34 $12.58 708,221 $12.58
$15.19-$19.92 2,255,859 6.13 17.52 2,053,956 17.52
$20.03-$24.91 6,588,386 6.76 22.48 6,562,690 22.48
$25.44-$29.88 1,812,906 8.13 27.93 650,530 27.81
$30.06-$34.91 2,817,968 8.83 33.31 580,010 31.67
$35.00-$39.78 717,912 6.31 37.13 483,246 36.70
$40.20-$49.05 22,872 9.27 45.97 7,872 48.07
---------- ----------
$10.85-$49.05 14,924,124 6.99 24.71 11,046,525 22.36
========== ==========
The weighted average fair value of stock options granted during the years
ended December 31, 2001, 2000 and 1999 was $11.60, $9.64 and $6.61 per stock
option, respectively. The fair value of each stock option grant was estimated on
the grant date using the Black-Scholes option-pricing model with the following
assumptions:
YEAR ENDED DECEMBER 31,
---------------------------------
2001 2000 1999
--------- --------- ---------
Risk free interest rate.............................. 4.4% 6.7% 5.5%
Expected life........................................ 3.1 years 3.1 years 3.2 years
Expected volatility.................................. 46.1% 42.8% 42.3%
Expected dividend yield.............................. 1.2% 1.1% 1.6%
Valero accounts for its employee stock compensation plans using the
intrinsic value method (see Note 1 under "STOCK-BASED COMPENSATION").
Accordingly, no compensation cost has been recognized for its fixed stock option
plans. The after-tax compensation cost reflected in net income for other
stock-based compensation plans for the years ended December 31, 2001, 2000 and
1999 was $11.9 million, $8.8 million and $4.0 million, respectively. Had
compensation cost for Valero's stock-based compensation plans been determined
based on the grant date fair value of awards for the years ended December 31,
2001, 2000 and
F-51
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1999 consistent with the method set forth in FASB Statement No. 123, Valero's
net income and earnings per share of common stock for the years ended December
31, 2001, 2000 and 1999 would have been reduced to the pro forma amounts
indicated below:
YEAR ENDED DECEMBER 31,
-----------------------------
2001 2000 1999
-------- -------- -------
Net income (in thousands):
As Reported......................................... $563,553 $339,120 $14,287
Pro Forma........................................... $554,082 $331,321 $ 7,869
Earnings per share of common stock:
As Reported......................................... $ 9.28 $ 5.79 $ 0.25
Pro Forma........................................... $ 9.12 $ 5.66 $ 0.14
Earnings per share of common stock--assuming dilution:
As Reported......................................... $ 8.83 $ 5.60 $ 0.25
Pro Forma........................................... $ 8.68 $ 5.47 $ 0.14
22. STRATEGIC PETROLEUM RESERVE CRUDE OIL
In September of 2000, the Department of Energy (DOE) announced its
intention to solicit offers for the time exchange of certain crude oil in the
U.S. Strategic Petroleum Reserve (SPR). In the fourth quarter of 2000, the DOE
approved a bid by Valero to receive one million barrels of crude oil under this
program. In November and December of 2000, Valero received a total of one
million barrels of crude oil in exchange for the obligation to redeliver
1,026,000 barrels of crude oil to the SPR during the third and fourth quarters
of 2001. Valero also entered into a derivative contract to lock in the cost of
the crude oil to be purchased and redelivered to the SPR in 2001. As of December
31, 2000, Valero's obligation to redeliver crude oil was recorded in "Accounts
Payable" in the Consolidated Balance Sheet at the fair market value of the crude
oil to be redelivered. Both the crude oil payable and the related derivative
contract were adjusted for changes in fair market value, with such adjustments
reflected in income. Valero redelivered the barrels to the SPR during the third
quarter of 2001.
23. LEASE AND OTHER COMMITMENTS
LEASES
Valero has long-term operating lease commitments in connection with land,
office facilities and equipment, retail facilities and equipment, transportation
equipment, dock facilities and various facilities and equipment used in the
storage, transportation and production of refinery feedstocks and refined
products. In addition, in connection with the UDS Acquisition, Valero assumed
various operating leases for convenience stores, transportation equipment,
office space and other assets with terms expiring at various dates through 2053.
F-52
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Included in the operating leases assumed in the UDS Acquisition were
various time charters for ocean-going tankers and coastal vessels which expire
on various dates through 2009. Two additional time charters will commence in mid
to late summer 2002 and will be accounted for as operating leases upon their
commencement. Certain of these charters include renewal options and escalation
clauses, which vary by charter. In addition, certain charters provide for the
payment of chartering fees which vary based on usage while others provide for
payments, in addition to established minimums, contingent upon usage.
Including the leases assumed in connection with the UDS Acquisition,
long-term leases for land have remaining primary terms of up to 22.7 years,
long-term leases for office facilities have remaining primary terms of up to 3.5
years and long-term leases for transportation equipment have remaining primary
terms of up to 8.2 years. Long-term leases for production equipment and
feedstock and refined product storage facilities and vessels have remaining
primary terms of up to 3.25 years and in certain cases provide for various
contingent payments based on, among other things, throughput volumes in excess
of a base amount. Long-term leases for convenience stores have remaining primary
terms of up to 52 years and provide, in certain cases, for the payment of
rentals that are wholly or partially contingent on sales volumes.
The following table reflects Valero's future minimum rental payments and
minimum rentals to be received under subleases for (i) operating leases having
initial or remaining noncancelable lease terms in excess of one year as of
December 31, 2001 and (ii) the capital leases related to the El Paso Acquisition
discussed in Note 2 (in thousands):
OPERATING CAPITAL
LEASES LEASES
--------- --------
2002........................................................ $152,199 $ 18,500
2003........................................................ 129,069 298,625
2004........................................................ 112,759 --
2005........................................................ 89,876 --
2006........................................................ 70,908 --
Remainder................................................... 189,206 --
-------- --------
Gross minimum rental payments............................. 744,017 317,125
Less minimum rentals to be received under subleases......... (29,174) --
-------- --------
Net minimum rental payments............................... $714,843 317,125
========
Less interest expense....................................... (29,276)
--------
Capital lease obligations................................. $287,849
========
Included in the table above are long-term operating lease commitments that
have been funded through structured lease arrangements with non-consolidated
third-party entities. These leases are for land, office
F-53
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
facilities and equipment, retail facilities and equipment, dock facilities,
transportation equipment, and various facilities and equipment used in the
production of refined products. These entities constructed or purchased the
related assets and then leased them to Valero. The assets held by these entities
were originally recorded at the cost of the assets constructed or purchased,
with such cost being funded through borrowings by these entities and equity
contributions equal to at least 3% of the asset cost. Each entity maintains at
all times a minimum equity equal to 3% of the related assets. No interest in
these entities is held by Valero, its affiliates or any related parties. All
agreements provided for initial commitment terms of either 5 or 7 years,
expiring at various times between August 2002 and September 2006. For each
lease, Valero has the option to purchase the leased assets at any time during
the lease term for a price that approximates fair value. After the initial lease
term, the leases may be extended by agreement of the parties. Alternatively,
Valero may arrange for the sale of the leased properties to one or more third
parties, in which case the leases provide for a maximum residual value guarantee
ranging from 82% to 85% of the appraised value of the leased properties at the
end of the lease term, as determined at the inception of the lease. As of
December 31, 2001, the value of these leased assets held by these entities was
approximately $513 million.
In addition to the above-noted structured lease arrangements, in August
2001, Valero entered into a $300 million structured lease arrangement to fund
the construction of a new 45,000 barrel-per-day delayed coker facility at its
Texas City Refinery. This structured lease has a lease term that expires in
August 2006 and will be accounted for as an operating lease upon completion of
construction of the coker facility. Valero has an option to purchase the leased
property at any time during the lease term for a price that approximates fair
value. After the initial lease term, Valero may renew the lease for up to two
additional one-year periods followed by one additional nine-month period,
subject to the lessor's approval, or Valero may arrange for the sale of the
leased property to a third party, in which case the lease provides for a maximum
residual value guarantee equal to approximately 82% of the property's
construction cost. The sale option can also be exercised at the end of any
renewal period. If Valero elects the sale option, the lessor has the right to
require Valero to extend the lease term for up to one additional year, in which
case the maximum residual value guarantee percentages will be reduced.
See Note 27 for information about an additional structured lease
arrangement entered into by Valero in February 2002.
Consolidated rental expense under operating leases for the years ended
December 31, 2001, 2000 and 1999 was approximately $92 million, $72 million and
$57 million, respectively. These amounts are included in the 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.
F-54
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
OTHER COMMITMENTS
In addition to commitments under operating leases, Valero has a commitment
under a product supply arrangement to pay a reservation fee of approximately $11
million annually through August 2002. Valero also has an obligation under
certain long-term hydrogen supply arrangements to make fixed minimum payments of
approximately $5 million annually, as well as other minimum payments which vary
based on certain natural gas reference prices. These arrangements, which were
entered into in 1999 for the purpose of securing a firm supply of hydrogen for
the Texas City Refinery, have remaining terms of approximately 14 years.
In connection with the UDS Acquisition, Valero assumed a commitment under a
product supply arrangement to pay a reservation fee of approximately $10 million
annually through June 2002. Valero also assumed long-term contracts for the
supply of hydrogen at the Wilmington Refinery and the Three Rivers Refinery,
which expire in 2011. These contracts have take-or-pay provisions requiring
monthly payments totaling approximately $2 million, which are adjusted
periodically based on certain market indices.
24. ENVIRONMENTAL MATTERS
Liabilities for future remediation costs are recorded when environmental
assessments and/or remedial efforts are probable and the costs can be reasonably
estimated. Other than for assessments, the timing and magnitude of these
accruals are generally based on the completion of investigations or other
studies or a commitment to a formal plan of action. Environmental liabilities
are based on best estimates of probable undiscounted future costs using
currently available technology and applying current regulations, as well as
Valero's own internal environmental policies.
In connection with the UDS Acquisition, Valero assumed all environmental
liabilities of UDS which are estimated at approximately $123 million. Valero's
assumed liabilities include remediation obligations and site restoration costs.
These environmental liabilities are included in "Other long-term liabilities" in
the Consolidated Balance Sheet as of December 31, 2001.
In connection with the El Paso Acquisition, Valero assumed all
environmental liabilities related to the facilities with certain exceptions. El
Paso retained liabilities for, and agreed to indemnify Valero against (a) all
environmental claims and costs related to offsite hazardous materials on or
under certain adjacent properties, and all claims and costs pertaining to
offsite environmental conditions arising under the requirements of an agreed
final judgment dated April 1, 1998 between the State of Texas and Coastal
Refining and Marketing, Inc. (a subsidiary of El Paso), (b) any environmental
claim or cost related to the transportation or offsite disposal of any hazardous
substance related to the facilities prior to June 1, 2001, (c) bodily injury and
property damage resulting from exposure to or contamination by hazardous
materials arising from El Paso's operation and use of the facilities prior to
June 1, 2001, and (d) environmental claims and costs relating to the presence of
hazardous materials resulting from El Paso's continued use of its assets that
are located at or
F-55
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
adjacent to the site of the facilities leased by Valero. El Paso also retained
liabilities for all third-party claims relating to or arising out of the
operation of the refinery prior to June 1, 2001 and for any pre-existing orders,
judgments or citations that El Paso failed to disclose prior to June 1, 2001.
Valero's assumed liabilities include certain environmental remediation
obligations relating primarily to soil and groundwater contamination at the
leased facilities. As of December 31, 2001, approximately $32 million has been
accrued in "Other long-term liabilities" representing an estimate of the costs
to be incurred in connection with Valero's assumption of these environmental
liabilities.
In 2000, the EPA issued to a majority of refiners operating in the United
States a series of information requests pursuant to Section 114 of the Clean Air
Act as part of an enforcement initiative. Valero received a Section 114
information request pertaining to all of its refineries owned at that time.
Valero completed its response to the request and has provided additional
clarification requested by the EPA. After Valero received its Section 114
information request, Valero acquired the Benicia Refinery and the Golden Eagle
Refinery, which were subject to Section 114 information requests received by the
prior owners of these refineries. Valero has not been named in any proceeding.
However, based in part upon announced settlements and evaluation of its relative
position, Valero expects to incur penalties and related expenses in connection
with its potential settlement of this enforcement initiative. Valero believes
that any potential settlement penalties and expenses will be immaterial to its
financial position. Valero believes that any potential settlement with the EPA
in this matter will require various capital improvements or changes in operating
parameters or both at some or all of Valero's refineries.
In connection with the Benicia Acquisition, Valero assumed all
environmental liabilities of ExxonMobil related to the acquired assets with
certain exceptions. Valero's assumed liabilities include remediation obligations
relating primarily to clean-up costs associated with refinery and terminal soil
and groundwater contamination. As of December 31, 2001, approximately $2 million
had been accrued in "Other long-term liabilities" in connection with Valero's
assumption of these environmental liabilities.
In connection with the acquisition of the Paulsboro Refinery, Mobil Oil
Corporation (now ExxonMobil) agreed to indemnify Valero for certain
environmental matters and conditions existing on or prior to the acquisition
date and Valero agreed to assume Mobil's environmental liabilities, with certain
limited exceptions. Certain of the environmental indemnities of ExxonMobil have
now expired. Indemnification for certain remediation obligations remains in
effect through 2003 for known conditions and 2005 for unknown conditions.
Valero's assumed liabilities include remediation obligations to the New Jersey
Department of Environmental Protection relating 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, 2001,
approximately $17 million is included in "Accrued expenses" and "Other long-term
liabilities" representing Valero's best estimate of its remaining costs to be
borne related to these remediation obligations. The majority of these costs are
expected to be incurred in relatively level amounts over the next 17 years.
F-56
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In connection with the acquisition of Basis Petroleum, Inc. from Salomon
Inc in 1997, Valero received $9.5 million from Salomon in settlement of certain
contingent environmental obligations previously assumed by Salomon, and recorded
an accrual for the amount received. As of December 31, 2001, approximately $5.6
million of this accrual remained outstanding.
Valero believes that it has adequately provided for its environmental
exposures with the accruals referred to above. These liabilities have not been
reduced by possible recoveries from third parties. Environmental liabilities are
difficult to assess and estimate due to unknown factors such as the magnitude of
possible contamination, the timing and extent of remediation, the determination
of Valero's liability in proportion to other parties, improvements in cleanup
technologies, and the extent to which environmental laws and regulations may
change in the future. Although environmental costs may have a significant impact
on results of operations for a single period, Valero believes that these costs
will not have a material adverse effect on its financial position.
25. LITIGATION AND CONTINGENCIES
UNOCAL
On January 22, 2002, Union Oil Company of California (Unocal) filed a
patent infringement lawsuit against Valero in California federal court. The
complaint seeks a 5.75 cents per gallon royalty on all reformulated gasoline
infringing on Unocal's feet393 and feet126 patents. These patents cover certain
compositions of cleaner-burning gasoline. The complaint seeks treble damages for
Valero's alleged willful infringement of Unocal's patents. In a previous
lawsuit, Unocal prevailed against five other major refiners involving its
feet393 patent. In August 2001, the FTC announced that it would begin an
antitrust investigation concerning Unocal's conduct with a joint industry
research group during the time that Unocal was prosecuting its patents at the
U.S. Patent and Trademark Office (PTO). The FTC could potentially issue an
injunction against Unocal's enforcement of its patents as a result of the FTC
investigation. In 2001, the PTO began a reexamination of Unocal's feet393
patent, and in January 2002, the PTO issued a notice of rejection of all claims
of the feet393 patent. Unocal has the opportunity to respond to the PTO's
action. In January 2002, the PTO reversed an earlier denial and began a
reexamination of Unocal's feet126 patent. Both reexaminations could affect the
scope and validity of the patents. Notwithstanding the judgment against the
other refiners in the previous litigation, Valero believes that it has several
strong defenses to Unocal's lawsuit, including those arising from Unocal's
misconduct, and Valero believes it will prevail in the lawsuit. However, due to
the inherent uncertainty of litigation, there can be no assurance that Valero
will prevail, and an adverse result could have a material adverse effect on
Valero's results of operations and financial position.
MTBE LITIGATION
Valero has been named as defendant in several cases alleging MTBE
contamination in groundwater in New York, Texas and California. Complaints in
the three New York cases--including those in Berisha and
F-57
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
O'Brien v. Amerada Hess Corporation, et al., Case No. MDL 1358, Master File C.A.
No. 1:00-1898 [SAS], United States District Court for the Southern District of
New York--allege that the gasoline suppliers produced and/or distributed
gasoline that is alleged to be defective because it contained MTBE. The four
Texas cases are based on the alleged discharge of gasoline into East Caddo Creek
in Hunt County, Texas on March 9, 2000 when a pipeline belonging to Explorer
Pipeline Company ruptured. Valero was named in City of Dallas v. Explorer
Pipeline Company, Inc., Valero Energy Corporation, et al., 160th State District
Court, Dallas County, Texas (filed May 14, 2001) and related private landowner
cases. The three California cases are primarily based on a product
liability/product defect theory. In the New York, Texas and California cases,
the plaintiffs generally seek individual, unquantified compensatory and punitive
damages and attorneys' fees. Valero believes it is unlikely that the final
outcome of any one of these claims or proceedings would have a material adverse
effect on its results of operations or financial position, but that an adverse
result in a majority of these cases could have a material adverse effect on
Valero's results of operations and financial position.
TECO PIPELINE COMPANY
Prior to July 31, 1997, Valero was a wholly owned subsidiary of a separate
corporation named at that time Valero Energy Corporation, or 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, together with certain of its natural gas related
subsidiaries, and Valero were sued by Teco Pipeline Company regarding the
operation of a 340-mile pipeline in West Texas in which a subsidiary of Old
Valero owned a 50% undivided interest and Teco owned a 50% undivided interest. A
subsidiary of Old Valero was the operator of the pipeline. The plaintiff
asserted that the defendants acted in bad faith and negatively affected the
economics of the pipeline in order to provide financial advantages to facilities
or entities owned by the defendants. Arbitration of the matter began in February
2001 and concluded in the fourth quarter of 2001. In December 2001, the
arbitration panel ruled against the plaintiffs, and this matter was closed.
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 position, results of operations
or liquidity; 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.
F-58
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
26. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Valero's results of operations by quarter for the years ended December 31,
2001 and 2000 were as follows (in thousands, except per share amounts):
2001 QUARTER ENDED(a)
------------------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 TOTAL
---------- ---------- ------------ ----------- -----------
Operating revenues......... $3,769,288 $4,499,108 $3,858,734 $2,861,209 $14,988,339
Operating income........... 237,059 464,283 188,340 111,662 1,001,344
Net income................. 136,082 274,863 101,013 51,595 563,553
Earnings per share of
common stock............. 2.23 4.50 1.66 0.86 9.28
Earnings per share of
common stock--assuming
dilution................. 2.13 4.23 1.58 0.82 8.83
2000 QUARTER ENDED(b)
------------------------------------------------------------------
MARCH 31 JUNE 30(B) SEPTEMBER 30 DECEMBER 31 TOTAL
---------- ---------- ------------ ----------- -----------
Operating revenues......... $2,928,617 $3,372,502 $4,248,831 $4,121,137 $14,671,087
Operating income........... 57,767 158,392 223,910 170,910 610,979
Net income................. 30,739 87,680 127,356 93,345 339,120
Earnings per share of
common stock............. 0.55 1.56 2.08 1.53 5.79
Earnings per share of
common stock--assuming
dilution................. 0.54 1.51 2.01 1.47 5.60
------------
(a)Includes the operations of the Huntway and El Paso Acquisitions beginning
June 1, 2001. Since the UDS Acquisition was completed on December 31, 2001,
its operations have not been included in these amounts.
(b)Includes the operations related to the Benicia Refinery and the Distribution
Assets beginning May 16, 2000 and the operations related to the Service
Stations beginning June 16, 2000.
27. SUBSEQUENT EVENTS
CASH DIVIDENDS AND DISTRIBUTIONS
On January 17, 2002, Valero's Board of Directors declared a regular
quarterly cash dividend of $0.10 per common share payable March 13, 2002, to
holders of record at the close of business on February 13, 2002.
F-59
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
On January 22, 2002, Valero L.P. declared a quarterly partnership
distribution of $0.60 per unit payable on February 14, 2002 to unitholders of
record on February 1, 2002. The total distribution is expected to be
approximately $12 million of which $3 million is payable to minority
unitholders.
SALES OF ASSETS
Diamond-Koch
On January 16, 2002, subsequent to the UDS Acquisition, Diamond-Koch
entered into a purchase and sale agreement with Enterprise Products Texas
Operating L.P. for the sale of the hydrocarbon storage facilities for $129.3
million, of which $64.7 million was distributed to Valero in January 2002. On
January 31, 2002, Diamond-Koch entered into an asset purchase and sale agreement
with Enterprise Products Operating L.P. for the sale of the propane/propylene
splitter facility and related distribution pipeline and terminal for $238.5
million, of which $119.3 million was distributed to Valero in February 2002. On
March 1, 2002, Diamond-Koch entered into an asset purchase and sale agreement
with Teppco Partners, L.P. for the sale of the natural gas liquids gathering and
pipeline system for $132.0 million, of which $66.0 million was distributed to
Valero in March 2002. Diamond-Koch is in the process of finalizing negotiations
with purchasers for the remaining assets and expects to complete the sale no
later than April 2002.
Golden Eagle Business
Pursuant to an agreement dated February 4, 2002, and subsequently amended
on February 20, 2002, Valero reached a definitive agreement with Tesoro to sell
the Golden Eagle Business for $1.125 billion, which includes an estimated $130
million for refinery feedstock and refined product inventories and is subject to
closing adjustments. The sales price includes the assumption by Tesoro of
various employee benefit and lease obligations, but excludes certain assets and
liabilities of the Golden Eagle Business that will be retained by Valero,
including accounts receivable, accounts payable, certain accrued liabilities and
income tax obligations. The sale is expected to close in April 2002, subject to
regulatory approval.
LEASE COMMITMENTS
In February 2002, Valero entered into a $170 million structured lease
arrangement to combine a portion of an existing structured lease assumed in the
UDS Acquisition related to the UDS headquarters facility with the funding of
planned construction to expand this facility for future use as Valero's new
corporate headquarters. The portion of the new arrangement related to the
existing UDS facility is being accounted for as an operating lease beginning in
February 2002, while the portion related to planned construction will be
accounted for as an operating lease upon completion of the construction. This
structured lease has a lease term that expires in February 2007 and provides for
up to two one-year renewal periods exercisable at Valero's option. If Valero
elects to renew the lease, Valero is required to provide cash collateral in an
amount equal to the residual value guarantee, which is currently estimated to be
approximately $146 million.
F-60
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 Ultramar
Diamond Shamrock Corporation (a Delaware corporation) and subsidiaries (the
Company) as of December 31, 2001 and 2000, and the related consolidated
statements of income, stockholders' equity, cash flows and comprehensive income
for each of the three years in the period ended December 31, 2001. 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 auditing standards generally
accepted in the United States. 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 Ultramar Diamond Shamrock
Corporation and subsidiaries as of December 31, 2001 and 2000, and the results
of its operations and its cash flows for each of the three years in the period
ended December 31, 2001 in conformity with accounting principles generally
accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
San Antonio, Texas
March 5, 2002
F-61
ULTRAMAR DIAMOND SHAMROCK CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
---------------------
2001 2000
--------- ---------
(IN MILLIONS,
EXCEPT SHARE DATA)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents (including $76.6 million of cash
held in trust as of December 31, 2001)................. $ 338.8 $ 197.1
Accounts and notes receivable, net........................ 324.2 700.5
Inventories............................................... 892.3 808.8
Prepaid expenses and other current assets................. 61.7 29.3
Income taxes receivable................................... 137.0 --
Current deferred income tax assets........................ 60.7 117.6
Asset held for sale....................................... 106.8 --
--------- ---------
TOTAL CURRENT ASSETS.............................. 1,921.5 1,853.3
--------- ---------
Property, plant and equipment............................... 5,458.0 5,136.0
Less accumulated depreciation and amortization.............. (1,707.9) (1,501.7)
--------- ---------
Property, plant and equipment, net........................ 3,750.1 3,634.3
Other assets, net........................................... 650.8 500.8
--------- ---------
TOTAL ASSETS........................................... $ 6,322.4 $ 5,988.4
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Advance from Valero Energy Corporation.................... $ 703.0 $ --
Current portion of long-term debt......................... 305.6 1.7
Accounts payable.......................................... 789.8 988.2
Accrued expenses and other current liabilities............ 285.1 203.9
Taxes other than income taxes............................. 230.8 289.8
Income taxes payable...................................... -- 59.3
--------- ---------
TOTAL CURRENT LIABILITIES......................... 2,314.3 1,542.9
--------- ---------
Long-term debt, less current portion........................ 966.9 1,659.8
--------- ---------
Other long-term liabilities................................. 362.5 366.3
--------- ---------
Deferred income tax liabilities............................. 613.4 394.1
--------- ---------
Commitments and contingencies
Minority interest in consolidated partnership............... 115.6 --
--------- ---------
Company-obligated preferred stock of subsidiary trust....... 200.0 200.0
--------- ---------
STOCKHOLDERS' EQUITY:
Common Stock, par value $0.01 per share:
250,000,000 shares authorized; 74,736,000 and
86,987,000 shares issued and outstanding as of
December 31, 2001 and 2000............................ 0.7 0.9
Additional paid-in capital................................ 940.0 1,516.9
Treasury stock, at cost; 1,099,026 shares and 51,795
shares as of December 31, 2001 and 2000................ (44.6) (1.2)
Grantor trust stock ownership program, at cost; no shares
and 3,583,000 shares as of December 31, 2001 and
2000................................................... -- (95.8)
Retained earnings......................................... 997.0 509.0
Accumulated other comprehensive loss...................... (143.4) (104.5)
--------- ---------
TOTAL STOCKHOLDERS' EQUITY............................. 1,749.7 1,825.3
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY............. $ 6,322.4 $ 5,988.4
========= =========
See accompanying notes to consolidated financial statements.
F-62
ULTRAMAR DIAMOND SHAMROCK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
--------------------------------------
2001 2000 1999
---------- ---------- ----------
(IN MILLIONS, EXCEPT PER SHARE DATA)
SALES AND OTHER REVENUES.................................. $16,860.0 $17,061.1 $13,939.3
--------- --------- ---------
COSTS AND EXPENSES:
Cost of products sold................................... 11,037.5 11,806.8 8,975.3
Operating expenses...................................... 1,263.7 1,092.8 994.5
Selling, general and administrative expenses............ 368.9 326.4 300.9
Taxes other than income taxes........................... 2,936.4 2,768.7 2,990.5
Depreciation and amortization........................... 277.8 253.1 240.8
Restructuring and other expenses, net................... (4.6) 1.2 8.2
--------- --------- ---------
TOTAL COSTS AND EXPENSES............................. 15,879.7 16,249.0 13,510.2
--------- --------- ---------
OPERATING INCOME.......................................... 980.3 812.1 429.1
Interest income......................................... 8.3 21.0 12.4
Interest expense, net................................... (119.2) (134.1) (141.5)
Equity income from joint ventures....................... 5.8 18.4 14.6
Minority interest in net income of consolidated
partnership.......................................... (9.4) -- --
--------- --------- ---------
INCOME BEFORE INCOME TAXES AND DIVIDENDS OF SUBSIDIARY
TRUST................................................... 865.8 717.4 314.6
Provision for income taxes.............................. (320.5) (262.8) (131.1)
Dividends on preferred stock of subsidiary trust........ (10.3) (10.3) (10.3)
--------- --------- ---------
NET INCOME................................................ $ 535.0 $ 444.3 $ 173.2
========= ========= =========
BASIC NET INCOME PER SHARE................................ $ 7.22 $ 5.12 $ 2.00
========= ========= =========
DILUTED NET INCOME PER SHARE.............................. $ 7.08 $ 5.11 $ 2.00
========= ========= =========
WEIGHTED AVERAGE NUMBER OF SHARES:
Basic................................................... 74.052 86.773 86.615
Diluted................................................. 75.537 87.002 86.742
See accompanying notes to consolidated financial statements.
F-63
ULTRAMAR DIAMOND SHAMROCK CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(IN MILLIONS)
GRANTOR
TRUST ACCUMULATED
ADDITIONAL STOCK OTHER TOTAL
COMMON PAID-IN TREASURY OWNERSHIP RETAINED COMPREHENSIVE STOCKHOLDERS'
STOCK CAPITAL STOCK PROGRAM EARNINGS LOSS EQUITY
------ ---------- -------- --------- -------- ------------- -------------
BALANCE AS OF JANUARY 1,
1999......................... $ 0.9 $1,512.7 $(100.1) $ -- $ 82.5 $(112.0) $1,384.0
Net income................... -- -- -- -- 173.2 -- 173.2
Issuance of Common Stock..... -- 3.6 (0.6) -- -- -- 3.0
Shares transferred to Grantor
Trust Stock Ownership
Program.................... -- -- 100.0 (100.0) -- -- --
Cash dividends............... -- -- -- -- (95.3) -- (95.3)
Other, net................... -- -- -- -- -- 28.4 28.4
----- -------- ------- ------- ------ ------- --------
BALANCE AS OF DECEMBER 31,
1999......................... 0.9 1,516.3 (0.7) (100.0) 160.4 (83.6) 1,493.3
Net income................... -- -- -- -- 444.3 -- 444.3
Issuance of restricted stock,
net of forfeitures......... -- 0.6 (0.5) 4.2 -- -- 4.3
Cash dividends............... -- -- -- -- (95.7) -- (95.7)
Other, net................... -- -- -- -- -- (20.9) (20.9)
----- -------- ------- ------- ------ ------- --------
BALANCE AS OF DECEMBER 31,
2000......................... 0.9 1,516.9 (1.2) (95.8) 509.0 (104.5) 1,825.3
Net income................... -- -- -- -- 535.0 -- 535.0
Issuance of restricted stock,
net of forfeitures......... -- (0.1) 0.6 5.9 -- -- 6.4
Exercise of stock options.... -- 22.8 38.9 89.9 -- -- 151.6
Shares purchased under Common
Stock buyback program...... -- -- (682.7) -- -- -- (682.7)
Retirement of Common Stock
held in treasury........... (0.2) (599.6) 599.8 -- -- -- --
Cash dividends............... -- -- -- -- (47.0) -- (47.0)
Other, net................... -- -- -- -- -- (38.9) (38.9)
----- -------- ------- ------- ------ ------- --------
BALANCE AS OF DECEMBER 31,
2001......................... $ 0.7 $ 940.0 $ (44.6) $ -- $997.0 $(143.4) $1,749.7
===== ======== ======= ======= ====== ======= ========
See accompanying notes to consolidated financial statements.
F-64
ULTRAMAR DIAMOND SHAMROCK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- --------- -------
(IN MILLIONS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 535.0 $ 444.3 $ 173.2
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization.......................... 277.8 253.1 240.8
Loss on derivative instruments......................... 3.1 -- --
Provision for losses on receivables.................... 16.6 21.4 9.2
Gain on sale of property, plant and equipment.......... (0.7) (1.4) (116.0)
Write-down of property, plant and equipment and
goodwill............................................. 1.2 5.2 131.4
Equity income from joint ventures...................... (5.8) (18.4) (14.6)
Minority interest in net income of consolidated
partnership.......................................... 9.4 -- --
Deferred income tax provision.......................... 252.8 97.3 72.4
Other, net............................................. 12.0 4.6 3.6
Changes in operating assets and liabilities, net of
acquisitions:
Decrease (increase) in accounts and notes
receivable........................................ 363.2 (104.1) (79.2)
Decrease (increase) in inventories................... (68.7) (109.9) 87.4
Decrease (increase) in prepaid expenses and other
current assets.................................... (3.7) (8.3) 13.1
Increase (decrease) in accounts payable, accrued
expenses and other current liabilities............ (379.0) 306.5 56.0
Decrease in other assets............................... 2.5 26.6 18.2
Increase (decrease) in other long-term liabilities..... 4.9 (20.1) (58.8)
-------- --------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES......... 1,020.6 896.8 536.7
-------- --------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures...................................... (426.2) (191.7) (167.6)
Acquisitions, net of cash acquired........................ (6.8) (21.0) (17.3)
Acquisition of Golden Eagle Refinery...................... (148.2) (807.7) --
Deferred refinery maintenance turnaround costs............ (109.9) (18.7) (33.9)
Proceeds from sales of property, plant and equipment...... 31.7 27.8 289.4
-------- --------- -------
NET CASH (USED IN) PROVIDED BY INVESTING
ACTIVITIES...................................... (659.4) (1,011.3) 70.6
-------- --------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Advance from Valero Energy Corporation.................... 703.0 -- --
Proceeds from bridge loan facility........................ 554.9 -- --
Net change in commercial paper and working capital
borrowings............................................. (320.6) 354.9 (371.4)
Repayment of long-term debt............................... (640.8) (41.5) (231.4)
Proceeds from the exercise of stock options............... 111.4 3.0 3.5
Shares purchased under Common Stock buyback program....... (682.7) -- --
Payment of cash dividends................................. (47.0) (95.7) (95.3)
Proceeds from sale of minority interest in consolidated
partnership............................................ 111.9 -- --
Payment of cash distributions to minority interest in
consolidated partnership............................... (5.7) -- --
-------- --------- -------
NET CASH (USED IN) PROVIDED BY FINANCING
ACTIVITIES...................................... (215.6) 220.7 (694.6)
-------- --------- -------
Effect of exchange rate changes on cash..................... (3.9) (1.9) 4.0
-------- --------- -------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ 141.7 104.3 (83.3)
CASH AND CASH EQUIVALENTS AS OF BEGINNING OF YEAR........... 197.1 92.8 176.1
-------- --------- -------
CASH AND CASH EQUIVALENTS AS OF END OF YEAR................. $ 338.8 $ 197.1 $ 92.8
======== ========= =======
See accompanying notes to consolidated financial statements.
F-65
ULTRAMAR DIAMOND SHAMROCK CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED
DECEMBER 31,
------------------------
2001 2000 1999
------ ------ ------
(IN MILLIONS)
NET INCOME.................................................. $535.0 $444.3 $173.2
------ ------ ------
Other comprehensive income (loss):
Foreign currency translation adjustment................... (36.8) (20.4) 29.7
------ ------ ------
Minimum pension liability adjustment, net of income tax
benefit................................................ (2.9) (0.5) (1.3)
------ ------ ------
Derivative instruments adjustments, net of income tax
expense (benefit):
Cumulative effect of accounting change, net of income
tax expense of $8.5 million........................... 13.3 -- --
Change in fair value of derivative instruments, net of
income tax benefit of $4.1 million.................... (6.3) -- --
Reclassification adjustment for gains included in net
income, net of income tax benefit of $4.0 million..... (6.2) -- --
------ ------ ------
Derivative instruments adjustment, net............... 0.8 -- --
------ ------ ------
COMPREHENSIVE INCOME........................................ $496.1 $423.4 $201.6
====== ====== ======
See accompanying notes to consolidated financial statements.
F-66
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2001, 2000 AND 1999
NOTE 1: BUSINESS DESCRIPTION AND ACQUISITION OF UDS BY VALERO ENERGY
CORPORATION
UDS' BUSINESS
Ultramar Diamond Shamrock Corporation (UDS) was an independent refiner and
retailer of refined products and convenience store merchandise in the central,
southwest and northeast regions of the United States and eastern Canada. UDS
owned and operated seven refineries located in Texas (2), California (2),
Oklahoma, Colorado and Quebec, Canada, and marketed its products through
approximately 4,500 company-operated and dealer-operated convenience stores and
86 unattended cardlock stations. In the northeast region of the United States
and in eastern Canada, UDS sold, on a retail basis, home heating oil to
approximately 250,000 households.
UDS' operations were affected by:
-- company-specific factors, primarily refinery utilization rates and
refinery maintenance turnarounds;
-- seasonal factors, such as the demand for refined products during the
summer driving season and heating oil during the winter season; and
-- industry factors, such as movements in and the level of crude oil
prices, the demand for and prices of refined products, industry supply
capacity, refinery maintenance turnarounds and availability of refined
product pipeline capacity.
ACQUISITION OF UDS BY VALERO ENERGY CORPORATION
On May 7, 2001, UDS announced that it had entered into an Agreement and
Plan of Merger (the acquisition agreement) with Valero Energy Corporation
(Valero) whereby UDS agreed to be acquired by Valero for total consideration of
approximately $4.3 billion. In September 2001, the board of directors and
shareholders of both UDS and Valero approved the acquisition and, on December
31, 2001, Valero completed its acquisition of UDS. Under the acquisition
agreement, UDS shareholders received, for each share of UDS common stock they
held, at their election, cash, Valero common stock or a combination of cash and
Valero common stock, having a value equal to the sum of $27.50 plus 0.614 shares
of Valero common stock (based on the average Valero common stock price over a
ten trading-day period ending three days prior to closing).
The average closing price of Valero common stock for the ten trading-day
period specified in the acquisition agreement was $35.78 per share. Based on the
exchange election results, UDS' shareholders electing Valero shares received,
for each share of UDS common stock, 0.9265 shares of Valero common stock and
$16.32 in cash. Shareholders electing cash and non-electing UDS shareholders
received $49.47 in cash for each share of UDS common stock. The acquisition was
accounted for by Valero using the purchase method.
As a condition of the acquisition, on December 19, 2001, the U.S. Federal
Trade Commission (FTC) approved a consent decree requiring divestiture of
certain UDS assets. Pursuant to the consent decree, the assets to be divested
were required to be put into a trust, with the future operations of those assets
managed by an independent trustee approved by the FTC. The assets and their
related operations are referred to as the Golden Eagle Refining and Marketing
Assets Business and include:
-- the 168,000 barrel-per-day Golden Eagle Refinery located in the San
Francisco Bay area and all tangible assets used in the operation of
the refinery including docks, tanks and pipelines;
-- the wholesale marketing business generally associated with the Golden
Eagle Refinery production, which includes primarily sales to unbranded
customers located in the northern half of California, Fresno and
north, and Reno, Nevada; and
-- 70 Beacon- and Ultramar-branded convenience stores located in Northern
California, including land, buildings, pump equipment, underground
storage tanks and various store equipment.
F-67
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Prior to the acquisition, Valero owned and operated six refineries,
including three in Texas and one each in Louisiana, New Jersey and California
with a combined throughput capacity of more than one million barrels per day.
Valero markets its gasoline, diesel and other refined products in 34 states
through a bulk and rack marketing network and, in California, through
approximately 350 retail locations.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION: These consolidated financial statements include the
accounts of UDS and its wholly-owned subsidiaries and majority-owned partnership
in which a controlling interest is held. Investments in 50% or less owned
companies and joint ventures are accounted for using the equity method of
accounting. All intercompany balances and transactions are eliminated in
consolidation. These consolidated financial statements have been prepared in
accordance with United States generally accepted accounting principles and
reflect UDS' historical cost basis and do not include any purchase price
adjustments that resulted from the acquisition of UDS by Valero.
USE OF ESTIMATES: The preparation of financial statements in accordance
with United States generally accepted accounting principles requires management
to make estimates and assumptions that affect the amounts reported in the
consolidated financial statements and accompanying notes. Actual results could
differ from those estimates. On an ongoing basis, management reviews their
estimates, including those related to restructurings, litigation, environmental
liabilities, and employee benefit obligations, based on currently available
information. Changes in facts and circumstances may result in revised estimates.
CASH AND CASH EQUIVALENTS: All highly liquid investments with an original
maturity of three months or less when purchased are considered to be cash
equivalents. Cash and cash equivalents include $76.6 million of cash held in
trust related to change-in-control payments to be made to UDS officers and key
employees in connection with the acquisition by Valero, and cash restricted for
use for environmental remediation costs.
INVENTORIES: Crude oil, other feedstock and refined product inventories
are valued at the lower of cost or market (net realizable value). Cost is
determined primarily on the last-in, first-out (LIFO) basis. Materials, supplies
and convenience store merchandise are valued at average cost, not in excess of
market value.
PROPERTY, PLANT AND EQUIPMENT: Additions to property, plant and equipment,
including capitalized interest, are recorded at cost. Depreciation is provided
principally using the straight-line method over the estimated useful lives of
the related assets. Assets recorded under capital leases and leasehold
improvements are amortized using the straight-line method over the shorter of
the lease term or the estimated useful life of the related asset.
GOODWILL: The excess of purchase price over the fair value of net assets
of businesses acquired (goodwill) was being amortized using the straight-line
method primarily over 15 to 20 years. Effective January 1, 2002, amortization of
goodwill will cease and the unamortized balance will be tested annually for
impairment. See the discussion of the Financial Accounting Standards Board's
(FASB) Statement No. 142 below regarding these required accounting changes.
IMPAIRMENT: Long-lived assets, including goodwill, are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. The evaluation of recoverability is
performed using undiscounted estimated net cash flows generated by the related
assets. If an asset is deemed to be impaired, the amount of impairment is
determined as the amount by which the net carrying value exceeds discounted
estimated net cash flows. Effective January 1, 2002, impairment accounting
requirements will change. See the discussion of FASB Statement No. 144 below
regarding the required accounting change.
REFINERY MAINTENANCE TURNAROUND COSTS: Refinery maintenance turnaround
costs are deferred when incurred and amortized over the period of time estimated
to lapse until the next turnaround occurs which is
F-68
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
typically three to four years. Deferred costs include, among other items, the
cost to repair, restore, refurbish or replace refinery equipment such as
vessels, tanks, reactors, piping, valves, electrical equipment and heat
exchangers.
COMPUTER SOFTWARE COSTS: Purchased computer software costs, and the direct
costs, both external and internal, associated with internally developed computer
software are capitalized at cost. The internal costs are limited to capitalized
interest and payroll costs of employees involved in the development. During 2001
and 2000, UDS capitalized $4.4 million and $14.7 million, respectively, of
external and internal software costs, primarily related to the new stand-alone
enterprise-wide information technology system implemented in February 2000 and
upgraded in September 2001. Amortization is provided using the straight-line
method over the estimated useful life of the related software, generally three
to seven years.
ENVIRONMENTAL REMEDIATION COSTS: Environmental remediation costs are
expensed and the related accrual established when site restoration and
environmental remediation and cleanup obligations are either known or considered
probable and can be reasonably estimated. Accrued liabilities are not discounted
to present value and are not reduced by possible recoveries from third parties.
Environmental costs include initial site surveys, costs for remediation and
restoration, including direct internal costs, and ongoing monitoring costs, as
well as fines, damages and other costs, when estimable. Adjustments to initial
estimates are recorded, from time to time, to reflect changing circumstances and
estimates based upon additional information developed in subsequent periods.
REVENUE RECOGNITION: Sales and other revenues are recognized when the
related goods are shipped and all significant obligations have been satisfied.
SHIPPING AND HANDLING FEES AND COSTS: The FASB's Emerging Issues Task
Force issued EITF Issue No. 00-10, "Accounting for Shipping and Handling Fees
and Costs" which addresses the income statement classification of amounts billed
to a customer for shipping and handling and the related costs incurred for
shipping and handling. The Task Force concluded that all amounts billed to a
customer in a sale transaction related to shipping and handling, if any,
represent revenues earned for the goods provided and should be classified as
revenue. The Task Force also concluded that the classification of shipping and
handling costs is an accounting policy that should be disclosed. Registrants
were required to apply the consensus guidance in the financial statements for
the fourth quarter of their fiscal year beginning after December 15, 1999. Upon
application of the consensus, comparative financial statements for prior periods
were reclassified to comply with the classification guidelines of this Issue.
During the fourth quarter of 2000, $30.5 million of freight costs was
reclassified which had been netted against sales and other revenues during 2000
to cost of products sold. No other reclassifications to prior years' statements
were necessary.
Shipping and handling fees and costs are classified in cost of products
sold. Such fees and costs relate to the transportation (via ship, train, truck
or pipeline) of crude oil and other feedstocks to the refineries and refined
products from the refineries to wholesale markets and company-operated and
dealer-operated convenience stores.
EXCISE TAXES: Federal excise and state motor fuel taxes collected on the
sale of products and remitted to governmental agencies are included in sales and
other revenues and in taxes other than income taxes. For the years ended
December 31, 2001, 2000 and 1999, excise taxes were $2,820.9 million, $2,664.5
million and $2,895.9 million, respectively.
INCOME TAXES: Income taxes are accounted for under the asset and liability
method. Under this method, deferred income tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
their respective income tax bases. Deferred amounts are measured using enacted
tax rates expected to apply to taxable income in the year those temporary
differences are expected to be recovered or settled.
F-69
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FOREIGN CURRENCY TRANSLATION: The functional currency of the Canadian
operations is the Canadian dollar. The translation into U.S. dollars is
performed for balance sheet accounts using exchange rates in effect as of the
balance sheet date and for revenue and expense accounts using the weighted
average exchange rate during the year. Adjustments resulting from this
translation are reported in other comprehensive income.
STOCK-BASED COMPENSATION: Stock-based compensation is accounted for using
the intrinsic value method. Accordingly, compensation cost for stock options is
measured as the excess, if any, of the quoted market price of UDS' common stock
at the date of grant over the amount an employee must pay to acquire the stock.
In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation," which clarified certain
issues from APB Opinion No. 25, "Accounting for Stock Issued to Employees."
Interpretation No. 44 clarified the definition of an employee for purposes of
applying Opinion No. 25, the criteria for determining whether a plan qualifies
as a noncompensatory plan, the accounting consequence of various modifications
to the terms of a previously fixed stock option or award, and the accounting for
an exchange of stock compensation awards in a business combination.
Interpretation No. 44 was effective July 1, 2000. UDS has reviewed the guidance
of this interpretation and believes that its accounting policies and the
disclosures in the consolidated financial statements are appropriate and
adequately address the requirements of Interpretation No. 44.
INCOME PER SHARE: The computation of basic income per share is based on
the weighted average number of common shares outstanding during the year.
Diluted income per share is based on the weighted average number of common
shares outstanding during the year and, to the extent dilutive, common stock
equivalents consisting of stock options, stock awards subject to restrictions
and stock appreciation rights.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES: Effective January 1, 2001,
UDS adopted FASB Statement No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended. This statement established accounting and
reporting standards for derivative instruments and for hedging activities. It
requires that all derivative instruments be recognized as either assets or
liabilities in the balance sheet and be measured at their fair value. The
statement requires that changes in the derivative instrument's fair value be
recognized currently in income unless specific hedge accounting criteria are
met.
The application of Statement No. 133, as amended, could increase volatility
in net income and other comprehensive income based on the level of derivative
instruments utilized and the extent of hedging activities, which are subject to
change from time to time based on management's decision as to the appropriate
strategies and overall risk exposure levels.
Interest rate swap agreements are used to manage the exposure to interest
rate risk on fixed-rate debt obligations. Under Statement No. 133, as amended,
these interest rate swap agreements are designated and documented as fair value
hedges of the related fixed-rate debt obligations. The net gain or loss arising
from marking to market the interest rate swap agreements, which have been
designated and have qualified as fair value hedging instruments, and the related
hedged debt are recorded in interest expense.
UDS operations utilize contracts that provide for the purchase of crude oil
and other feedstocks and for the sale of refined products. Certain of these
contracts meet the definition of a derivative instrument in accordance with
Statement No. 133, as amended. Management believes these contracts qualify for
the normal purchases and normal sales exception under Statement No. 133, as
amended, because they will be delivered in quantities expected to be used or
sold over a reasonable period of time in the normal course of business.
Accordingly, these contracts are designated as normal purchases and normal sales
contracts and are not required to be recorded as derivative instruments under
Statement No. 133, as amended.
Commodity futures and options contracts are used to procure a large portion
of UDS crude oil requirements and to hedge the exposure to crude oil, refined
product, and natural gas price volatility. Under
F-70
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Statement No. 133, as amended, these commodity futures contracts are not
designated as hedging instruments. Commodity price and spread swaps contracts
are used to manage the exposure to price volatility related to forecasted
purchases of crude oil, refined products and natural gas and sales of refined
products. Under Statement No. 133, as amended, certain commodity swaps are
designated and documented as cash flow hedges of forecasted purchases. Other
commodity swaps are not designated as hedging instruments. The net gain or loss
arising from marking to market the commodity futures and swaps contracts is
recorded in cost of products sold.
Periodically, UDS enters into short-term foreign exchange and purchase
contracts to manage the exposure to exchange rate fluctuations on the trade
payables of the Canadian operations that are denominated in U.S. dollars. Under
Statement No. 133, as amended, these contracts are not designated as hedging
instruments.
ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND
EXTINGUISHMENTS OF LIABILITIES: In September 2000, the FASB issued Statement
No. 140, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities, a replacement of FASB Statement No. 125."
Statement No. 140 revises the standards for accounting for securitizations and
other transfers of financial assets and collateral and requires certain
disclosures, but it carries over most of the provisions of Statement No. 125
without reconsideration. Except as otherwise provided, Statement No. 140 is
effective for transfers and servicing of financial assets and extinguishments of
liabilities occurring after March 31, 2001. The statement shall be applied
prospectively; earlier or retroactive application of this statement is not
permitted. UDS has reviewed the requirements of Statement No. 140 and believes
that the accounting policies and disclosures in the consolidated financial
statements are appropriate and adequately address the requirements of Statement
No. 140. There was no impact to UDS' financial position or results of operations
as a result of implementation of this statement.
RECLASSIFICATIONS: Certain previously reported amounts have been
reclassified to conform to the 2001 presentation.
NEW ACCOUNTING PRONOUNCEMENTS
FASB Statement No. 141
In June 2001, the FASB issued Statement No. 141, "Business Combinations."
Statement No. 141 addresses financial accounting and reporting for business
combinations and supersedes APB Opinion No. 16, "Business Combinations," and
Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased
Enterprises." All business combinations within the scope of Statement No. 141
are to be accounted for using the purchase method. The provisions of Statement
No. 141 apply to all business combinations initiated after June 30, 2001 and to
all business combinations accounted for using the purchase method for which the
date of acquisition is July 1, 2001 or later. Since UDS has not consummated a
business combination subsequent to June 30, 2001, there was no impact to its
financial position or results of operations as a result of implementation of
this statement.
FASB Statement No. 142
In June 2001, the FASB issued Statement No. 142, "Goodwill and Other
Intangible Assets." Statement No. 142 addresses financial accounting and
reporting for acquired goodwill and other intangible assets and supersedes APB
Opinion No. 17, "Intangible Assets." Statement No. 142 addresses how intangible
assets that are acquired individually or with a group of other assets (but not
those acquired in a business combination) should be accounted for in financial
statements upon their acquisition. This statement also addresses how goodwill
and other intangible assets should be accounted for after they have been
initially recognized in the financial statements. The provisions of Statement
No. 142 are required to be applied starting with fiscal years beginning after
December 15, 2001. This statement is required to be applied at the beginning of
an entity's
F-71
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
fiscal year and to be applied to all goodwill and other intangible assets
recognized in its financial statements at that date. The statement provides that
goodwill and other intangible assets that have indefinite useful lives will not
be amortized but instead will be tested at least annually for impairment.
Intangible assets that have finite useful lives will continue to be amortized
over their useful lives, but such lives will not be limited to 40 years.
Impairment losses for goodwill and indefinite-lived intangible assets that arise
due to the initial application of Statement No. 142 are to be reported as
resulting from a change in accounting principle. UDS has reviewed the
requirements of Statement No. 142, and the impact of adoption effective January
1, 2002 will result in the cessation of goodwill amortization beginning January
1, 2002, which amortization approximates $15.0 million annually. In addition,
UDS believes that future reported net income may be more volatile because
impairment losses related to goodwill are likely to occur irregularly and in
varying amounts.
FASB Statement No. 143
Also in June 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations." This statement establishes standards for accounting for
an obligation associated with the retirement of a tangible long-lived asset. An
asset retirement obligation should be recognized in the financial statements in
the period in which it meets the definition of a liability as defined in FASB
Concepts Statement No. 6, "Elements of Financial Statements." The amount of the
liability would initially be measured at fair value. Subsequent to initial
measurement, an entity would recognize changes in the amount of the liability
resulting from (a) the passage of time and (b) revisions to either the timing or
amount of estimated cash flows. Statement No. 143 also establishes standards for
accounting for the cost associated with an asset retirement obligation. It
requires that, upon initial recognition of a liability for an asset retirement
obligation, an entity capitalize that cost by recognizing an increase in the
carrying amount of the related long-lived asset. The capitalized asset
retirement cost would then be allocated to expense using a systematic and
rational method. Statement No. 143 will be effective for financial statements
issued for fiscal years beginning after June 15, 2002, with earlier application
encouraged. UDS is currently evaluating the impact of adopting this new
statement.
FASB Statement No. 144
In August 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." Statement No. 144 addresses
financial accounting and reporting for the impairment of long-lived assets and
for long-lived assets to be disposed of. This statement supersedes Statement No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," but retains Statement No. 121's fundamental
provisions for recognition and measurement of impairment of long-lived assets to
be held and used and measurement of long-lived assets to be disposed of by sale.
This statement also supersedes APB Opinion No. 30, "Reporting the Results of
Operations--Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions," for
the disposal of a segment of a business. Statement No. 144 does not apply to
goodwill or other intangible assets, the accounting and reporting of which is
addressed in newly issued Statement No. 142, "Goodwill and Other Intangible
Assets." The provisions of Statement No. 144 are effective for financial
statements for fiscal years beginning after December 15, 2001, and interim
periods within those fiscal years, with early application encouraged. UDS is
currently evaluating the impact of adopting this new statement.
NOTE 3: ACQUISITIONS
GOLDEN EAGLE REFINERY
On August 31, 2000, UDS acquired Tosco Corporation's 168,000 barrel-per-day
Avon Refinery (renamed the Golden Eagle Refinery) located in the San Francisco
bay area of California. The original purchase price of $806.8 million also
included crude oil, feedstock and refined product inventories and the assumption
of certain employee benefit liabilities. In addition, the terms of the purchase
and sale agreement
F-72
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
provided for additional consideration of up to $150.0 million over an eight-year
period if average annual West Coast refinery margins exceeded historical
averages. The purchase price was funded by a combination of proceeds from a
$350.0 million bridge loan, $250.0 million from the sale of accounts receivable
under the existing sales facility, and the remainder from commercial paper
borrowings and cash on hand. In October 2000, the bridge loan was refinanced
with commercial paper borrowings.
The acquisition was accounted for using the purchase method. The purchase
price was allocated based on the estimated fair values of the individual assets
and liabilities at the date of acquisition. During the subsequent year, it was
determined that the estimated fair values of inventories, accrued liabilities
and other long-term liabilities were understated and property, plant and
equipment was overstated. In addition, West Coast refinery margins exceeded
historical averages resulting in the full $150.0 million of contingent
consideration becoming due to Tosco Corporation. In accordance with the purchase
and sale agreement, the $150.0 million was paid to Tosco Corporation in November
2001.
The following table summarizes the revisions to the initial allocation of
purchase price:
FINAL INITIAL
ALLOCATION ALLOCATION ALLOCATION
AUGUST 31, DECEMBER 31, AUGUST 31,
2001 2000 2000
---------- ------------ ----------
(IN MILLIONS)
Inventories and other current assets.......... $179.8 $150.3 $150.3
Property, plant and equipment................. 642.0 646.0 650.0
Goodwill...................................... 205.3 33.4 28.6
Accrued expenses and other current
liabilities................................. (47.4) -- --
Other long-term liabilities................... (23.8) (22.0) (22.1)
------ ------ ------
Total purchase price................ $955.9 $807.7 $806.8
====== ====== ======
VALLEY SHAMROCK
On September 29, 2000, UDS purchased Valley Shamrock, Inc., in a purchase
business combination, for $16.2 million, which included the assumption of $6.2
million of debt. Valley Shamrock operates 23 convenience stores and two
wholesale facilities in the Rio Grande Valley of south Texas.
A summary of the purchase price allocation for Valley Shamrock is shown
below:
FINAL
ALLOCATION
-------------
(IN MILLIONS)
Working capital............................................. $ 0.7
Property, plant and equipment............................... 19.8
Goodwill.................................................... 2.6
Other assets................................................ 0.5
Long-term debt.............................................. (6.2)
Other long-term liabilities................................. (1.2)
-----
Total purchase price.............................. $16.2
=====
The operating results of these acquired businesses have been included in
the consolidated statements of income from the dates of acquisition.
F-73
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 4: RESTRUCTURING AND OTHER EXPENSES
Restructuring and other expenses consisted of the following:
YEARS ENDED
DECEMBER 31,
----------------------
2001 2000 1999
----- ----- ------
(IN MILLIONS)
Gain on sale of other property, plant and equipment......... $(0.7) $(1.4) $(31.2)
Write-down of property, plant and equipment................. -- 5.2 6.0
Loss on permanent closure of Alma Refinery.................. 1.2 -- 138.2
Gain on sale of Michigan convenience stores, pipelines and
terminals................................................. -- -- (97.6)
Transaction costs related to the proposed Diamond 66 joint
venture................................................... -- -- 11.0
Restructuring reserve reductions related to retail, refining
and pipeline operations................................... (5.1) (2.6) (18.2)
----- ----- ------
Restructuring and other expenses, net.................. $(4.6) $ 1.2 $ 8.2
===== ===== ======
ASSET SALES AND JOINT VENTURES
In March 2001, a $6.6 million gain on the sale of the Ardmore crude oil
gathering operations to Teppco Partners, L.P. was recognized and throughout
2001, net losses totaling $5.9 million primarily related to retail asset sales
and retirements were recognized. In December 2001, UDS recognized a loss of $1.2
million to write down the Alma Refinery salvage value.
In June 2000, a $5.2 million impairment write-down was recognized related
to certain pipelines and crude oil gathering operations in Colorado (carrying
value prior to writedown was $5.7 million). In June 1999, UDS recognized a $6.0
million impairment write-down related to certain pipelines and crude oil
gathering operations in Oklahoma and Kansas (carrying value prior to writedown
was $9.5 million).
In December 1999, UDS finalized the sale of the Michigan convenience
stores, pipelines and terminals, with a net carrying value of $124.6 million, to
Marathon Ashland Petroleum LLC and recognized a gain of $97.6 million. Upon
completion of the sale, the Alma Refinery was permanently closed and a loss of
$138.2 million was recognized, which included a $125.4 million impairment
write-down and $12.8 million of severance and closure costs. The impairment
write-down consisted of $100.4 million related to property, plant and equipment
(carrying value prior to write-down was $128.4 million), $22.0 million related
to goodwill and $3.0 million related to deferred refinery maintenance turnaround
costs.
Included in gain on sale of other property, plant and equipment of $31.2
million for the year ended December 31, 1999 is a $22.6 million gain related to
the sale or closure of 239 convenience stores including 162 of the
under-performing convenience stores identified in June 1998. The net carrying
value of the 239 convenience stores was $38.7 million, including goodwill. In
addition, UDS recognized a $2.2 million gain on the sale of an 8.33% interest in
the McKee to El Paso refined product pipeline and terminal to Phillips Petroleum
Company.
In March 1999, UDS terminated discussions with Phillips Petroleum Company
related to the formation of a proposed joint venture (Diamond 66). During the
first quarter of 1999, $11.0 million of transaction costs related to the
formation of Diamond 66 were expensed.
F-74
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
RESTRUCTURINGS
In June 1998, UDS adopted a three-year restructuring plan to reduce the
cost structure of its US retail system by eliminating employee positions to
improve operating efficiencies and to close and sell 316 under-performing
convenience stores. In addition, UDS restructured certain pipeline and terminal
operations and support infrastructure. Under the restructuring plan, the
convenience stores were to be operated until closed and management decided the
best sales alternative. Operating income before retail overhead expense
allocations for the 316 convenience stores for the six months ended June 30,
2001 and the years ended December 31, 2000 and 1999 was breakeven, $0.7 million
and $3.8 million, respectively, including the results for the sold stores
through the date of sale.
From July 1998 through June 2001, 286 convenience stores were sold or
closed, and 261 retail employees and 76 pipeline and terminal employees were
terminated. In addition, it was subsequently determined that the operations of
12 convenience stores could be improved and those stores would not be sold. The
remaining 18 under-performing convenience stores, which have not been sold, are
in the process of being disposed of and management does not anticipate incurring
additional expenses related to the disposal of those stores. Effective June 30,
2001, the three-year restructuring program was completed and the balance of the
various restructuring reserves was credited into income.
During 1999 and 2000, the market demand for convenience stores increased
significantly as both large and small operators sought to increase the number of
stores they operated. As a result, UDS was able to sell many of the
under-performing convenience stores, instead of closing them and selling the
underlying property as originally planned. Because UDS was able to sell these
properties as operating stores, a portion of the fuel system removal costs,
lease buyout costs and severance costs have not been incurred, and the
restructuring reserves were reduced accordingly during the six months ended June
30, 2001, and the years ended December 31, 2000 and 1999.
Changes in accrued restructuring reserves were as follows:
SEVERANCE AND LEASE BUYOUT FUEL SYSTEM
RELATED COSTS COSTS REMOVAL COSTS TOTAL
------------- ------------ ------------- ------
(IN MILLIONS)
Balance as of December 31,
1998......................... $ 19.0 $14.0 $ 16.1 $ 49.1
Payments..................... (12.8) (1.8) (2.7) (17.3)
Reserve reductions........... (1.1) (6.2) (10.9) (18.2)
------ ----- ------ ------
Balance as of December 31,
1999......................... 5.1 6.0 2.5 13.6
Payments..................... (2.4) (0.5) (0.5) (3.4)
Reserve reductions........... -- (1.6) (1.0) (2.6)
------ ----- ------ ------
Balance as of December 31,
2000......................... 2.7 3.9 1.0 7.6
Payments..................... (0.1) (2.0) (0.4) (2.5)
Reserve reductions........... (2.6) (1.9) (0.6) (5.1)
------ ----- ------ ------
Balance as of December 31,
2001......................... $ -- $ -- $ -- $ --
====== ===== ====== ======
F-75
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 5: ACCOUNTS AND NOTES RECEIVABLE
Accounts and notes receivable consisted of the following:
DECEMBER 31,
---------------
2001 2000
------ ------
(IN MILLIONS)
Accounts receivable......................................... $253.8 $393.0
Notes receivable............................................ 66.1 307.7
------ ------
Total..................................................... 319.9 700.7
Allowance for uncollectible accounts........................ (3.4) (5.3)
Other....................................................... 7.7 5.1
------ ------
Accounts and notes receivable, net........................ $324.2 $700.5
====== ======
The changes in allowance for uncollectible accounts consisted of the
following:
YEARS ENDED
DECEMBER 31,
----------------------
2001 2000 1999
----- ----- ------
(IN MILLIONS)
Balance as of beginning of year............................. $ 5.3 $ 3.4 $ 14.3
Provision charged to expense.............................. 0.4 3.4 0.4
Accounts written off, net of recoveries................... (2.3) (1.5) (11.3)
----- ----- ------
Balance as of end of year................................... $ 3.4 $ 5.3 $ 3.4
===== ===== ======
In March 1999, UDS arranged a $250.0 million revolving accounts receivable
sales facility. On March 1, 2001, the facility was increased $110.0 million to
$360.0 million. On an ongoing basis, UDS sells eligible accounts receivable to
Coyote Funding, L.L.C. (Coyote), a non-consolidated, wholly owned subsidiary.
Coyote sells a percentage ownership in these receivables, without recourse, to a
third party cooperative corporation. UDS' retained interest in receivables sold
to Coyote is included in notes receivable and is recorded at fair value. The
fair value of the retained interest in these receivables approximates the
eligible accounts receivable sold to Coyote less the amount of receivables sold
to the third party cooperative corporation.
As of December 31, 2001 and 2000, the outstanding amount of receivables
sold to the third party cooperative corporation was $273.0 million and $250.0
million, respectively. Discounts and net expenses associated with the sales of
receivables totaled $13.1 million, $10.9 million and $11.2 million and are
included in interest expense in the consolidated statements of income for the
years ended December 31, 2001, 2000 and 1999, respectively.
The cash flows related to this sales facility consisted of the following:
YEARS ENDED
DECEMBER 31,
-------------------
2001 2000
-------- --------
(IN MILLIONS)
Proceeds from the sales of receivables...................... $ 84.1 $ 313.0
Proceeds from collections under the facility................ 8,875.0 7,916.9
F-76
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Proceeds from the sales of receivables were used partially to fund the
share buyback program in 2001 (see Note 14: Stockholders' Equity) and partially
to fund the acquisition of the Golden Eagle Refinery in 2000. Proceeds from
collections under the sales facility were reinvested in the program by the third
party cooperative corporation. The third party cooperative corporation's
interest in UDS receivables was never in excess of $360.0 million and $250.0
million during the years ended December 31, 2001 and 2000, respectively.
Included in accrued expenses and other current liabilities is the allowance
for uncollectible accounts related to the accounts receivable sales facility.
The changes in this allowance for uncollectible accounts consisted of the
following:
YEARS ENDED
DECEMBER 31,
----------------------
2001 2000 1999
------ ------ ----
(IN MILLIONS)
Balance as of beginning of year............................. $ 11.0 $ 8.8 $ --
Provision charged to expense.............................. 16.2 18.0 8.8
Accounts written off, net of recoveries................... (15.3) (15.8) --
------ ------ ----
Balance as of end of year................................... $ 11.9 $ 11.0 $8.8
====== ====== ====
NOTE 6: INVENTORIES
Inventories consisted of the following:
DECEMBER 31,
---------------
2001 2000
------ ------
(IN MILLIONS)
Crude oil and other feedstocks.............................. $362.1 $279.1
Refined and other finished products......................... 376.2 380.2
Convenience store merchandise............................... 83.0 83.7
Materials and supplies...................................... 71.0 65.8
------ ------
Total inventories......................................... $892.3 $808.8
====== ======
The LIFO value of the crude oil and other feedstocks and refined and other
finished products inventories as of December 31, 2001 was based on an average
cost of $20.98 per barrel and the average market price was $24.31 per barrel.
The LIFO value of the crude oil and other feedstocks and refined and other
finished products inventories as of December 31, 2000 was based on an average
cost of $20.29 per barrel and the average market price was $36.05 per barrel. As
of December 31, 2001, replacement cost exceeded the LIFO cost of inventories by
$106.0 million.
F-77
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 7: PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following:
DECEMBER 31,
ESTIMATED ---------------------
USEFUL LIVES 2001 2000
------------ --------- ---------
(IN MILLIONS)
Land............................................. - $ 320.6 $ 291.7
Crude oil processing facilities.................. 15-30 years 3,245.0 3,103.5
Pipelines and terminals.......................... 15-30 years 594.7 564.6
Retail facilities................................ 5-30 years 886.0 844.6
Petrochemical processing facilities.............. 5-25 years 62.1 61.9
Other............................................ 3-10 years 118.0 92.0
Construction in progress......................... 231.6 177.7
--------- ---------
Total.......................................... 5,458.0 5,136.0
Accumulated depreciation and amortization........ (1,707.9) (1,501.7)
--------- ---------
Property, plant and equipment, net............. $ 3,750.1 $ 3,634.3
========= =========
F-78
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 8: OTHER ASSETS
Other assets consisted of the following:
DECEMBER 31,
---------------
2001 2000
------ ------
(IN MILLIONS)
Goodwill, net of accumulated amortization of $92.4 million
in 2001 and $74.3 million in 2000......................... $387.4 $235.8
Non-current notes receivable, net........................... 28.8 30.5
Refinery maintenance turnaround costs, net of accumulated
amortization of $71.4 million in 2001 and $64.7 million in
2000...................................................... 140.5 43.0
Equity investment in Diamond-Koch, L.P. .................... -- 109.3
Equity investment in Skelly-Belvieu Pipeline Company, LLC... 16.5 16.2
Other non-current assets.................................... 77.6 66.0
------ ------
Other assets, net......................................... $650.8 $500.8
====== ======
During the year ended December 31, 2001, goodwill increased $169.7 million
due primarily to the $150.0 million contingency payment paid to Tosco
Corporation relating to the acquisition of the Golden Eagle Refinery.
UDS has a 50% interest in Diamond-Koch, L.P., a joint venture with Koch
Industries, Inc., which includes each entity's petrochemical assets located at
Mont Belvieu, Texas. In the latter part of 2001, Koch Industries and UDS decided
to sell Diamond-Koch's four operating units and began soliciting bids from
interested parties. See Note 24: Subsequent Events for details regarding sales
that have been completed. As of December 31, 2001, the equity investment in
Diamond-Koch has been reclassified to asset held for sale in the consolidated
balance sheet. During the years ended December 31, 2001, 2000 and 1999, equity
income from Diamond-Koch totaled $2.3 million, $14.5 million and $10.7 million,
respectively. Also during the years ended December 31, 2001, 2000 and 1999,
distributions received from Diamond-Koch totaled $4.8 million, $19.2 million and
$10.9 million, respectively.
UDS has a 50% equity investment in Skelly-Belvieu Pipeline Company, LLC, a
partnership with Phillips Petroleum Company, which owns a natural gas pipeline
that transports refinery-grade propylene from UDS' McKee Refinery and Phillips'
Borger Refinery to Mont Belvieu, Texas. During the years ended December 31,
2001, 2000 and 1999, equity income from Skelly-Belvieu totaled $3.2 million,
$3.9 million and $3.9 million, respectively. Also during the years ended
December 31, 2001, 2000 and 1999, distributions received from Skelly-Belvieu
totaled $2.9 million, $4.7 million and $3.7 million, respectively.
NOTE 9: ADVANCE FROM VALERO ENERGY CORPORATION
On December 31, 2001, prior to the closing of the acquisition of UDS by
Valero, UDS ceased borrowing under its commercial paper program that was used to
fund its operations. As a result, Valero advanced to UDS $703.0 million to repay
all amounts outstanding under the commercial paper program.
F-79
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 10: LONG-TERM DEBT
Long-term debt consisted of the following:
DECEMBER 31,
-------------------
MATURITY 2001 2000
-------- -------- --------
(IN MILLIONS)
8.625% Guaranteed Notes............................... 2002 $ 282.6 $ 274.8
Medium-term Notes:
7.4% (average rate)................................. 2005 46.0 46.0
8.0%................................................ 2005 161.3 149.9
8.5% (average rate)................................. 2003 24.0 24.0
9.375%.............................................. 2001 -- 75.0
Debentures:
7.25% (non-callable)................................ 2010 25.0 25.0
7.65% (putable July 1, 2006)........................ 2026 100.0 100.0
8.00% (callable April 1, 2003)...................... 2023 98.8 100.0
8.75% (non-callable)................................ 2015 75.0 75.0
Total Senior Notes:
6.75% (putable October 15, 2009; callable
thereafter)...................................... 2037 100.0 100.0
7.20% (callable).................................... 2017 200.0 200.0
7.45% (callable).................................... 2097 100.0 100.0
Partnership Revolving Credit Facility................. 2006 16.0 --
Commercial Paper...................................... -- 354.3
Other................................................. Various 43.8 37.5
-------- --------
Total long-term debt................................ 1,272.5 1,661.5
Less current portion.................................. (305.6) (1.7)
-------- --------
Long-term debt, less current portion................ $ 966.9 $1,659.8
======== ========
Generally, UDS' outstanding debt is unsecured with interest payable
semi-annually.
In 1992, Ultramar Credit Corporation (UCC), a financing subsidiary, issued
the 8.625% Guaranteed Notes in a public offering and such notes are guaranteed
by UDS.
The 2017 Total Senior Notes and the 2097 Total Senior Notes may be redeemed
at any time at UDS' option, in whole or in part, at a redemption price equal to
the greater of: (a) 100% of the principal amount, or (b) the sum of the present
value of outstanding principal and interest thereon, discounted at the U.S.
Treasury Yield plus 20 basis points, together with accrued interest, if any, to
the date of redemption. The 2037 Total Senior Notes may be redeemed, in whole or
in part, by the holders on October 15, 2009, at a redemption price equal to 100%
of the principal plus accrued interest. After October 15, 2009, the 2037 Total
Senior Notes are redeemable at UDS' option in the same manner as the 2017 Total
Senior Notes and 2097 Total Senior Notes.
During the year ended December 31, 2001, UDS had the following debt
facilities available:
-- a $700.0 million U.S. revolving credit facility (U.S. Bank Facility)
along with a $700.0 million commercial paper program supported by the
U.S. Bank Facility;
-- a Cdn. $200.0 million revolving credit facility for Canadian Ultramar
Company (CUC), a Canadian subsidiary of UDS;
F-80
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
-- money market lines of credit with numerous financial institutions
which provided borrowing capacity of $470.0 million and Cdn. $195.0
million; and
-- a Partnership facility under which Shamrock Logistics, L.P. (now
Valero L.P.) may borrow up to $120.0 million (the Partnership
Revolving Credit Facility).
In order for Valero to finalize its financing arrangements related to the
acquisition of UDS on December 31, 2001, UDS was required to terminate its
$700.0 million U.S. Bank Facility and commercial paper program on December 31,
2001. In addition, the available borrowing capacity under the U.S. money market
lines of credit was reduced from $470.0 million to $35.0 million. The various
Canadian debt facilities were not impacted by the acquisition.
Borrowings under the money market lines are typically short-term and bear
interest at prevailing market rates as established by the financial
institutions. As of December 31, 2001 and 2000, there were no outstanding
borrowings under these money market lines.
The Revolving Credit Facilities require annual fees on the total used and
unused portion of the facilities. The interest rate under the Revolving Credit
Facilities is floating based upon the prime rate, the London interbank offered
rate or other floating interest rates, at UDS' option. Amounts outstanding under
the Canadian Facility and the Partnership Revolving Credit Facility are due in
2002 and 2006, respectively, upon expiration. Outstanding letters of credit
totaled $134.6 million and $145.8 million as of December 31, 2001 and 2000,
respectively.
The aggregate maturity of long-term debt as of December 31, 2001 was as
follows (in millions):
2002........................................................ $ 305.6
2003........................................................ 28.8
2004........................................................ 0.6
2005........................................................ 207.9
2006........................................................ 16.7
Thereafter.................................................. 712.9
--------
Total long-term debt...................................... $1,272.5
========
The Revolving Credit Facility and the indentures governing the various
notes contain restrictive covenants relating to UDS' financial condition,
operations and properties. Under these covenants, UDS and certain of its
subsidiaries are required to maintain, among other things, certain specified
consolidated interest coverage and debt-to-total capitalization ratios. Although
these covenants have the effect of limiting UDS' ability to pay dividends, it is
not anticipated that these limitations will affect its present ability to pay
dividends.
In order to manage interest costs on outstanding long-term debt, UDS
entered into various interest rate swap agreements (see Note 20: Financial
Instruments). The interest rate swap agreements modify the interest rate
characteristics of a portion of UDS' long-term debt from a fixed to a floating
rate. As of December 31, 2001 and 2000, the following interest rate swap
agreements were outstanding:
YEAR OF MATURITY
------------------------
FIXED TO FLOATING 2002 2005 2023
----------------- ------ ------ ------
Notional amount (in millions).............................. $200.0 $150.0 $100.0
Weighted average rate received............................. 6.23% 6.36% 6.93%
Weighted average rate paid in 2001......................... 4.16% 4.22% 4.42%
Weighted average rate paid in 2000......................... 6.22% 6.10% 6.47%
F-81
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Interest payments totaled $123.2 million, $122.5 million and $127.9 million
for the years ended December 31, 2001, 2000 and 1999, respectively.
NOTE 11: OTHER LONG-TERM LIABILITIES
Other long-term liabilities consisted of the following:
DECEMBER 31,
---------------
2001 2000
------ ------
(IN MILLIONS)
Employee benefit plan liabilities........................... $181.7 $150.1
Environmental liabilities................................... 78.5 100.0
Other....................................................... 102.3 116.2
------ ------
Other long-term liabilities............................... $362.5 $366.3
====== ======
NOTE 12: MINORITY INTEREST IN CONSOLIDATED PARTNERSHIP
On April 16, 2001, Shamrock Logistics, L.P. (renamed Valero L.P. on
December 31, 2001), previously a wholly owned partnership of UDS, issued 5.2
million limited partnership common units in an initial public offering at a
price of $24.50 per unit. Proceeds from the offering totaled $111.9 million, net
of offering expenses of $14.9 million, and were used to pay down debt.
Subsequent to the initial public offering, UDS owned approximately 74% of
Shamrock Logistics' ownership equity. The issuance of Shamrock Logistics' common
units was accounted for as a capital transaction in the consolidated financial
statements; thus no gain or loss was recognized in the consolidated statement of
income.
As a result of UDS' owning a majority of the ownership interest, Shamrock
Logistics is consolidated in UDS' consolidated financial statements. The
minority interest in consolidated partnership on the consolidated balance sheet
of $115.6 million represents the minority unitholders' investment in Shamrock
Logistics plus their share of the net income of Shamrock Logistics since April
16, 2001 less distributions paid to minority unitholders. The minority interest
in net income of consolidated partnership in the consolidated statement of
income of $9.4 million represents the minority unitholders' share of the net
income of Shamrock Logistics.
Shamrock Logistics declared quarterly partnership distributions as follows
(in millions, except per unit amounts):
DISTRIBUTION
TOTAL PAID TO
DISTRIBUTION DISTRIBUTION MINORITY
DATE DISTRIBUTION WAS PAID PER UNIT PAID UNITHOLDERS
-------------------------- ------------ ------------ ------------
August 14, 2001............................. $0.50 $ 9.8 $2.6
November 14, 2001........................... 0.60 11.7 3.1
NOTE 13: COMPANY-OBLIGATED PREFERRED STOCK OF SUBSIDIARY TRUST
On June 25, 1997, UDS Capital I (the Trust) issued 8,000,000 shares of
8.32% Trust Originated Preferred Securities (TOPrS), with a $25.00 liquidation
amount per security, in an underwritten public offering. Total proceeds from the
offering were $200.0 million. Holders of the TOPrS have limited voting rights
and are not entitled to vote to appoint, remove or replace, or to increase or
decrease the number of trustees, which voting rights are vested exclusively with
UDS.
The TOPrS are redeemable on or after June 30, 2002 at the option of the
Trust, in whole or in part, at a redemption price equal to $25.00 per security.
Distributions on the TOPrS are cumulative and payable
F-82
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
quarterly in arrears on March 31, June 30, September 30 and December 31 of each
year, if and when the Trust has funds available for distribution, at the annual
rate of 8.32% of the liquidation amount of $25.00 per TOPrS.
The Trust is a wholly-owned subsidiary trust and UDS has guaranteed, on a
subordinated basis, the dividend payments due on the TOPrS if and when declared.
NOTE 14: STOCKHOLDERS' EQUITY
GRANTOR TRUST STOCK OWNERSHIP PROGRAM
In November 1999, UDS created the Grantor Trust Stock Ownership Program
(GSOP) to which 3,740,000 shares of treasury stock were contributed. UDS
instructed the trustee to sell shares as necessary and to use the proceeds from
those sales and any dividends paid on those contributed shares, toward the
satisfaction of a portion of UDS' future obligations under certain compensation
and employee benefit plans. The shares held in trust were not considered
outstanding for income per share purposes until they were committed to be
released. During the years ended December 31, 2001 and 2000, 156,661 shares and
3,583,339 shares, respectively, were transferred directly to employees or
employee benefit plan participants in satisfaction of UDS' obligation to pay
compensation and benefits. The majority of shares transferred related to stock
option exercise activity. For financial reporting purposes, the GSOP was
consolidated with UDS and all dividends and interest transactions between the
GSOP and UDS were eliminated.
COMMON STOCK BUYBACK PROGRAM
On February 7, 2001, the Board of Directors of UDS approved a share buyback
program to repurchase $750.0 million of UDS common stock. As of December 31,
2001, 17,050,109 shares of common stock had been purchased at a total cost of
$682.7 million, including 7,050,109 shares at a price of $32.85 per share which
were held by TotalFinaElf since UDS acquired Total Petroleum (North America)
Ltd. in September 1997. In conjunction with the share buyback program, UDS
entered into an agreement to repurchase 10,000,000 shares under an accelerated
program with a financial institution at an initial cost of $323.3 million. In
May 2001, the accelerated stock buyback program was settled with an additional
payment of $126.3 million as a result of an increase in the UDS common stock
price.
In order to fund the share buyback program, UDS entered into a short-term
bridge loan agreement on February 7, 2001 with two banks that committed to lend
up to $750.0 million. Borrowings under the short-term bridge loan totaled $554.9
million. In May 2001, the outstanding balance of the bridge loan was paid off
with proceeds received from commercial paper borrowings and available cash.
INCENTIVE PLANS
UDS had adopted several Long-Term Incentive Plans (the LTIPs) which are
administered by the Compensation Committee of the Board of Directors (the
Committee). Under the terms of the LTIPs, the Committee could grant restricted
shares, stock options, stock appreciation rights and performance units to
officers and key employees. The vesting period for awards under the LTIPs was
established by the Committee at the time of grant. Restricted shares awarded
under the 1992 and 1996 LTIPs generally vested on the third anniversary of the
date of grant. Restricted shares granted under the 1987 and 1990 LTIPs vested
generally over a four-year period. Stock options could not be granted at less
than the fair market value of the common stock on the date of grant and could
not expire more than ten years from the date of grant. The majority of stock
options became exercisable 30%, 30% and 40% on the first, second and third
anniversaries of the date of grant.
During the year ended December 31, 2001, under the LTIPs, the Committee
granted 217,800 performance restricted shares, 10,814,610 performance units and
5,006 restricted shares to officers and certain key
F-83
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
employees. During the year ended December 31, 2000, under the LTIPs, the
Committee granted 148,800 performance restricted shares, 6,768,100 performance
units and 10,961 restricted shares to officers and certain key employees. The
performance restricted shares would vest if UDS achieved specific financial
objectives over a three-year performance period and the ultimate number of
performance restricted shares granted for a particular grant year could have
been increased up to 200% (i.e. 435,600 shares for the performance restricted
shares granted in 2001). The performance units, equal to $1 per unit, would vest
if UDS achieved specific financial objectives over a two-year performance period
and the ultimate number of performance units granted for a particular grant year
could have been increased up to 200% (i.e. 21,629,220 units for the 2001 grant).
The restricted shares vested on the second anniversary from the date of grant.
During the performance periods, a grantee could vote and receive dividends
on the performance restricted shares and the restricted shares. However, the
performance restricted shares and restricted shares were subject to transfer
restrictions and were all or partially forfeited if a grantee terminated. Upon
issuance of the performance restricted shares, unearned compensation cost
equivalent to the market value of the shares granted was charged to
stockholders' equity and was amortized to salary expense over the vesting period
as the performance objectives were achieved. The unamortized compensation cost
was adjusted periodically based on changes in the market value of the shares.
Any additional performance restricted shares earned in excess of the granted
shares were to be paid in cash and were accrued based on the market value of the
equivalent shares earned to date. Compensation expense for the performance units
was recognized over the vesting period as the performance objectives were
achieved.
During the years ended December 31, 2001 and 2000, UDS recognized
compensation expense of $23.7 million and $6.6 million, respectively, related to
performance restricted shares, performance units and restricted shares.
All of the LTIPs included a "change in control" provision under which all
granted and outstanding performance restricted shares, performance units and
restricted shares would vest upon a "change in control" as defined in the LTIP
agreements. In the case of the performance restricted shares and performance
units, the level of achievement for the performance objectives during the
remaining performance period was assumed to equal 100%. In addition, all
outstanding stock options vested and became 100% exercisable upon a "change in
control" as defined in the stock option agreements. A "change in control"
occurred when UDS was acquired by Valero on December 31, 2001 and all
outstanding stock options, performance restricted shares, performance units and
restricted shares became vested.
In addition to the above, UDS had previously entered into employment
agreements with its officers and certain key employees that provided for "change
in control" payments equivalent to three years of salary and bonus and
additional retirement benefits if the acquiring company did not retain the
services of such officers or key employees.
The consolidated financial statements do not reflect the acquisition of UDS
by Valero; thus the impact of the "change in control" provisions relating to the
LTIP agreements and the employment agreements have not been recognized in the
accompanying consolidated financial statements. In January 2002, subsequent to
the acquisition, Valero paid $90.1 million to the officers and certain key
employees of UDS pursuant to the change in control provisions of the LTIP
agreements and the employment agreements.
F-84
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Stock option transactions under the various LTIPs are summarized as follows:
NUMBER OF WEIGHTED AVERAGE
STOCK OPTIONS EXERCISE PRICE
------------- ----------------
Outstanding as of December 31, 1998................ 7,196,599 $27.67
Granted.......................................... 290,900 21.71
Canceled......................................... (597,199) 30.26
Exercised........................................ (157,339) 20.38
----------
Outstanding as of December 31, 1999................ 6,732,961 27.35
Granted.......................................... 1,115,987 23.32
Canceled......................................... (420,034) 28.70
Exercised........................................ (132,943) 19.32
----------
Outstanding as of December 31, 2000................ 7,295,971 26.80
Granted.......................................... 2,060,952 36.23
Canceled......................................... (38,687) 29.43
Exercised........................................ (5,159,478) 26.91
----------
Outstanding as of December 31, 2001................ 4,158,758 31.32
==========
Stock options exercisable as of December 31:
1999............................................. 3,941,934 26.92
2000............................................. 4,076,591 26.56
2001 (excluding the impact of the change in
control)...................................... 2,110,966 26.52
The above stock options had terms ranging from 5 to 10 years. As of
December 31, 2001, prior to the acquisition by Valero, there were 4,423,892
shares available for future issuance under the LTIPs. For the year ended
December 31, 2001, UDS recorded in stockholders' equity a $38.0 million non-cash
tax benefit resulting from the exercise of stock options.
Stock options outstanding and exercisable (exclusive of the impact of the
change in control) as of December 31, 2001 were as follows:
STOCK OPTIONS OUTSTANDING STOCK OPTIONS EXERCISABLE
------------------------------------------------- ------------------------------
WEIGHTED AVERAGE
RANGE OF NUMBER REMAINING LIFE WEIGHTED AVERAGE NUMBER WEIGHTED AVERAGE
EXERCISE PRICE OUTSTANDING IN YEARS EXERCISE PRICE EXERCISABLE EXERCISE PRICE
-------------- ----------- ---------------- ---------------- ----------- ----------------
$15.00-$19.49 66,620 0.8 $15.83 66,620 $15.83
$20.40-$24.88 780,160 6.2 23.31 780,160 23.31
$25.00-$29.90 666,158 3.6 27.00 666,158 27.00
$30.13-$34.63 2,172,611 5.9 32.29 567,011 31.09
$35.52-$38.93 66,176 2.5 36.89 31,017 36.29
$43.40-$44.35 14,544 2.5 43.67 -- --
$46.40-$49.90 166,044 5.6 48.99 -- --
$50.05-$55.58 226,445 5.6 51.44 -- --
--------- ---------
$15.00-$55.58 4,158,758 4.1 $31.32 2,110,966 $26.52
========= =========
F-85
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UDS accounts for its stock option plans using the intrinsic value method
and, accordingly, has not recognized compensation expense for stock options
granted, since the option price equaled the common stock price on the date of
grant. The weighted average fair value of stock options granted during the years
ended December 31, 2001, 2000 and 1999 was $7.00, $4.74 and $3.96 per option,
respectively. The fair value for these stock options was estimated at the
respective grant dates using the Black-Scholes option pricing model with the
following assumptions:
YEARS ENDED DECEMBER 31,
---------------------------------------
2001 2000 1999
----------- ----------- -----------
Risk free interest rate.................... 1.79%-5.05% 6.02%-6.79% 4.77%-6.02%
Expected life.............................. 4 years 4 years 4 years
Expected volatility........................ 28%-34% 24%-26% 24%-25%
Expected dividend yield.................... 3.70%-4.41% 4.00%-4.19% 3.70%-3.94%
Had UDS accounted for stock options granted in 2001, 2000 and 1999 using
the fair value method at the date of grant, additional compensation expense
would have been recorded and the pro forma effect would have been as follows:
YEARS ENDED
DECEMBER 31,
------------------------
2001 2000 1999
------ ------ ------
(IN MILLIONS, EXCEPT PER
SHARE DATA)
Pro forma net income....................................... $531.0 $440.7 $170.1
Pro forma net income per share:
Basic.................................................... $ 7.17 $ 5.08 $ 1.96
Diluted.................................................. $ 7.03 $ 5.07 $ 1.96
For purposes of the pro forma disclosures, the estimated fair value of
stock options is amortized to expense over the stock options' vesting periods.
The Committee adopted the 2001, 2000 and 1999 Annual Incentive Plans (AIP)
which provide for cash awards based on certain criteria to officers and certain
key employees. For the years ended December 31, 2001, 2000 and 1999, the related
AIP expense was $18.3 million, $11.3 million and $8.6 million, respectively.
Under the terms of the Non-Employee Director Equity Plan, non-employee
directors are granted restricted shares on the date elected to the Board of
Directors equal to at least 50% of the non-employee director's annual retainer.
Additional restricted shares are granted to the non-employee director every five
years following the initial date of grant. At each annual meeting, each
non-employee director is also granted stock options for 1,000 shares. The stock
options are fully exercisable at the following annual meeting. The stock options
expire ten years from the date of grant. During the year ended December 31,
2001, 18,000 stock options and 44,583 restricted share awards were granted.
During the year ended December 31, 2000, 20,000 stock options and 4,530
restricted share awards were granted. During the year ended December 31, 1999,
11,000 stock options and 2,502 restricted share awards were granted. As of
December 31, 2001, a total of 235,285 shares were available for future issuance
under this plan.
In 1993, the Committee adopted the Ultramar Corporation Stock Purchase Plan
and Dividend Reinvestment Plan which allows eligible holders of common stock to
use dividends to purchase common stock and to make optional cash payments to buy
additional shares of common stock. UDS had reserved a total of 2,000,000 shares
of common stock for issuance under this plan. As of December 31, 2001, a total
of 57,441 shares had been issued under the plan and 1,942,559 shares remain
available for future issuance.
F-86
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 15: COMPUTATION OF NET INCOME PER SHARE
Basic net income per share is calculated as net income divided by the
weighted average number of common shares outstanding. Diluted net income per
share assumes, when dilutive, issuance of the net incremental shares from stock
options and restricted shares. The following table reconciles the net income
amounts and share numbers used in the computation of net income per share.
YEARS ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------
BASIC NET INCOME PER SHARE:
Weighted average common shares outstanding (in
thousands)............................................ 74,052 86,773 86,615
======= ======= =======
Net income (in millions).............................. $ 535.0 $ 444.3 $ 173.2
======= ======= =======
Basic net income per share.............................. $ 7.22 $ 5.12 $ 2.00
======= ======= =======
DILUTED NET INCOME PER SHARE:
Weighted average common shares outstanding (in
thousands)............................................ 74,052 86,773 86,615
Net effect of dilutive stock options based on the
treasury stock method using the average market price
(in thousands)........................................ 1,485 229 127
------- ------- -------
Weighted average common equivalent shares (in
thousands)......................................... 75,537 87,002 86,742
======= ======= =======
Net income (in millions).............................. $ 535.0 $ 444.3 $ 173.2
======= ======= =======
Diluted net income per share............................ $ 7.08 $ 5.11 $ 2.00
======= ======= =======
NOTE 16: EMPLOYEE BENEFIT PLANS
UDS has several qualified, non-contributory defined benefit plans (the
Qualified Plans) covering substantially all salaried employees in the United
States and Canada, including certain plans subject to collective bargaining
agreements. These plans generally provide retirement benefits based on years of
service and compensation during specific periods. Officers and certain key
employees covered by these plans are also entitled to participate in various
unfunded supplemental executive retirement plans (Supplemental Plans) which
provide retirement benefits based on years of service and compensation,
including compensation not permitted to be taken into account under the
Qualified Plans. The Supplemental Plans and the Qualified Plans are collectively
referred to as the Pension Plans.
Under the Qualified Plans, UDS' policy is to fund normal cost plus the
amortization of the unfunded actuarial liability for costs arising from
qualifying service determined under the projected unit credit method. The
underlying pension plan assets include cash equivalents, fixed income securities
(primarily obligations of the U.S. government) and equity securities.
F-87
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The changes in benefit obligation, changes in plan assets and the weighted
average assumptions for the Pension Plans and other postretirement benefits are
as follows:
PENSION OTHER POSTRETIREMENT
BENEFITS BENEFITS
--------------- -------------------------
2001 2000 2001 2000
------ ------ ----------- -----------
(IN MILLIONS)
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation as of the beginning of year............ $292.0 $283.5 $ 81.1 $ 81.3
Service cost.......................................... 16.7 14.3 1.9 1.9
Interest cost......................................... 24.7 22.1 6.7 5.8
Plan participants' contributions...................... 0.3 0.3 -- --
Acquisitions.......................................... -- 20.3 -- 2.0
Actuarial loss (gain)................................. 75.5 (9.0) 15.5 (4.9)
Plan amendments....................................... 7.9 -- -- --
Foreign currency exchange rate changes................ -- -- (0.6) (0.3)
Termination benefits.................................. 1.8 -- -- --
Benefits paid......................................... (32.0) (39.5) (5.8) (4.7)
------ ------ ----------- -----------
Benefit obligation as of the end of year.................. 386.9 292.0 98.8 81.1
------ ------ ----------- -----------
CHANGE IN PLAN ASSETS:
Fair value of plan assets as of the beginning of year..... 245.8 261.9 -- --
Actual return on plan assets.......................... (4.0) (1.7) -- --
Employer contributions................................ 6.4 24.8 5.8 4.7
Plan participants' contributions...................... 0.3 0.3 -- --
Benefits paid......................................... (32.0) (39.5) (5.8) (4.7)
------ ------ ----------- -----------
Fair value of plan assets as of the end of year........... 216.5 245.8 -- --
------ ------ ----------- -----------
Funded status as of the end of year....................... (170.4) (46.2) (98.8) (81.1)
Unrecognized net actuarial loss (gain)................ 95.6 (4.2) (6.1) (22.1)
Unrecognized prior service cost....................... 25.2 20.3 (11.0) (12.2)
Unrecognized net transition obligation................ 0.1 0.2 -- --
------ ------ ----------- -----------
Accrued benefit cost...................................... $(49.5) $(29.9) $ (115.9) $ (115.4)
====== ====== =========== ===========
Amounts recognized in the consolidated balance sheets:
Prepaid benefit cost.................................. $ 1.9 $ 6.0 $ -- $ --
Intangible asset...................................... 12.7 -- -- --
Accrued benefit liability............................. (51.4) (35.9) (115.9) (115.4)
Additional minimum liability.......................... (20.5) (3.0) -- --
Accumulated other comprehensive loss.................. 7.8 3.0 -- --
------ ------ ----------- -----------
Net amount recognized at end of year...................... $(49.5) $(29.9) $ (115.9) $ (115.4)
====== ====== =========== ===========
WEIGHTED AVERAGE ASSUMPTIONS:
Discount rate......................................... 7.00% 7.75% 7.00% 7.75%
Expected return on plan assets........................ 8.75% 9.50% N/A N/A
Rate of compensation increase......................... 5.00% 4.50% 4.25%-5.00% 4.25%-4.50%
Health care cost trend on covered charges............. N/A N/A 7.6% 6.4%
In connection with the acquisition of the Golden Eagle Refinery and Valley
Shamrock, Inc. in 2000, UDS assumed liabilities totaling $22.3 million related
to certain employee pension and other postretirement benefit obligations.
F-88
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The projected benefit obligation, accumulated benefit obligation and fair
value of plan assets for the Pension Plans with accumulated benefit obligations
in excess of plan assets consisted of the following:
DECEMBER 31,
--------------
2001 2000
------ -----
(IN MILLIONS)
Projected benefit obligation................................ $366.1 $28.4
Accumulated benefit obligation.............................. 261.3 21.7
Fair value of plan assets................................... 197.4 9.6
The components of net periodic benefit cost are summarized as follows:
OTHER POSTRETIREMENT
PENSION BENEFITS BENEFITS
------------------------ ---------------------
2001 2000 1999 2001 2000 1999
------ ------ ------ ----- ----- -----
(IN MILLIONS)
COMPONENTS OF NET PERIODIC BENEFIT COST:
Service cost................................. $ 16.7 $ 14.3 $ 16.1 $ 1.9 $ 1.9 $ 2.1
Interest cost................................ 24.7 22.1 22.5 6.7 5.8 5.9
Expected return on plan assets............... (21.8) (22.5) (21.8) -- -- --
Amortization of:
Transition obligation...................... 0.1 0.1 0.1 -- -- --
Prior service cost......................... 2.9 2.4 2.4 (1.2) (1.2) (1.2)
Actuarial loss (gain)...................... 0.1 0.1 1.5 (0.4) (1.2) (0.6)
Termination charge......................... -- -- 6.4 -- -- --
Curtailment gain........................... -- -- (1.2) -- -- --
Settlement charge (gain)................... -- (0.6) 0.2 -- -- --
------ ------ ------ ----- ----- -----
Net periodic benefit cost.................... $ 22.7 $ 15.9 $ 26.2 $ 7.0 $ 5.3 $ 6.2
====== ====== ====== ===== ===== =====
In connection with the acquisition of UDS by Valero, UDS implemented an
early retirement program whereby certain UDS employees (47 years old or older)
were eligible to receive additional credits (8 years of combined service or age)
under the Pension Plan. As a result, 75 UDS employees elected to retire early
under this program.
UDS also maintains retirement plans for certain collective bargaining
groups (the Bargaining Unit Plans). The Bargaining Unit Plans generally provide
benefits that are based on the union member's monthly base pay during the five
years prior to retirement.
UDS maintains several defined contribution retirement plans for
substantially all eligible employees in the United States and Canada.
Contributions to the plans are generally determined as a percentage of each
eligible employee's salary. Contributions to these plans amounted to $8.2
million, $6.3 million and $6.0 million during the years ended December 31, 2001,
2000 and 1999, respectively.
UDS sponsors unfunded defined benefit postretirement plans, which provide
health care and life insurance benefits to retirees who satisfy certain age and
service requirements. In addition, pursuant to the terms of a distribution
agreement between Diamond Shamrock, Inc. (subsequently merged into UDS) and
Maxus, Diamond Shamrock, Inc.'s parent company prior to its 1987 spin-off, UDS
also shares in the cost of providing similar benefits to former employees of
Maxus.
F-89
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Generally, the health care plans pay a stated percentage of most medical
expenses reduced for any deductibles, payments made by government programs and
other group coverage. The cost of providing these benefits is shared with
retirees.
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A 1% change in assumed health care
cost trend rates would have the following effects:
1% INCREASE 1% DECREASE
----------- -----------
(IN MILLIONS)
Effect on total of service and interest cost components... $0.4 $(0.3)
Effect on postretirement benefit obligation............... 7.1 (6.0)
NOTE 17: INCOME TAXES
Income before income taxes and dividends of subsidiary trust consisted of
the following:
YEARS ENDED
DECEMBER 31,
------------------------
2001 2000 1999
------ ------ ------
(IN MILLIONS)
United States.............................................. $652.8 $505.9 $264.9
Canada..................................................... 213.0 211.5 49.7
------ ------ ------
Total.................................................... $865.8 $717.4 $314.6
====== ====== ======
Provision for income taxes consisted of the following:
YEARS ENDED
DECEMBER 31,
------------------------
2001 2000 1999
------ ------ ------
(IN MILLIONS)
Current:
U.S. federal............................................. $ 31.6 $ 55.7 $ 6.9
U.S. state............................................... 2.2 4.4 (1.4)
Canada................................................... 33.9 105.4 53.2
------ ------ ------
Total current......................................... 67.7 165.5 58.7
------ ------ ------
Deferred:
U.S. federal............................................. 196.2 106.4 96.0
U.S. state............................................... 19.9 12.3 10.1
Canada................................................... 36.7 (21.4) (33.7)
------ ------ ------
Total deferred........................................ 252.8 97.3 72.4
------ ------ ------
Provision for income taxes................................. $320.5 $262.8 $131.1
====== ====== ======
Deferred income taxes arise from temporary differences between the income
tax basis of assets and liabilities and their reported amounts in the
consolidated financial statements.
F-90
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The components of deferred income tax liabilities and assets consisted of
the following:
DECEMBER 31,
-----------------
2001 2000
------- -------
(IN MILLIONS)
Deferred income tax liabilities:
Excess of book basis over tax basis of:
Property, plant and equipment.......................... $(587.9) $(518.9)
Equity investment in Diamond-Koch, L.P................. (9.7) (9.3)
Excess of tax basis over book basis of leasing
arrangements........................................... (70.5) (70.8)
Deferred refinery maintenance turnaround costs............ (63.3) (36.5)
LIFO inventory............................................ (16.4) --
------- -------
Total deferred income tax liabilities.................. (747.8) (635.5)
------- -------
Deferred income tax assets:
LIFO inventory............................................ -- 36.3
Accrued expenses and other long-term liabilities.......... 110.8 131.6
U.S. federal and state income tax credit carryforwards.... 84.2 147.6
Canadian tax benefit on unrealized foreign exchange
adjustment............................................. 2.3 3.7
Net operating loss carryforwards.......................... 21.8 40.9
Other..................................................... -- 7.3
------- -------
Total deferred income tax assets....................... 219.1 367.4
Less valuation allowance.................................. (24.0) (8.4)
------- -------
Net deferred income tax assets......................... 195.1 359.0
------- -------
Net deferred income tax liabilities.................. $(552.7) $(276.5)
======= =======
As of December 31, 2001, U.S. federal and state and Canadian income tax
credit and loss carryforwards were as follows:
AMOUNT EXPIRATION
------------- ----------
(IN MILLIONS)
U.S. federal and state income tax credits.......... $12.2 2002 through 2014
Alternative minimum tax (AMT) credits.............. 55.7 Indefinitely
Foreign tax credits................................ 16.3 2006
U.S. federal net operating losses (NOL)............ 20.3 2011 through 2013
Canadian net operating losses...................... 0.9 2007
Included in the above are $1.1 million of income tax credit carryforwards,
$16.9 million of AMT credit carryforwards and $20.3 million of NOL carryforwards
acquired from Total Petroleum (North America), Ltd., which are subject to annual
U.S. federal income tax limitations.
UDS has established a valuation allowance for certain deferred income tax
assets, primarily state NOLs and foreign tax credit carryforwards, which may not
be realized in future periods. The realization of net deferred income tax assets
recorded as of December 31, 2001 is dependent upon UDS' ability to generate
future taxable income in both the U.S. and Canada. Although realization is not
assured, management believes it is more likely than not that the net deferred
income tax assets will be realized.
F-91
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
UDS has not provided any U.S. federal deferred income taxes or Canadian
withholding taxes on the undistributed earnings of its Canadian subsidiaries
based on the determination that those earnings will be indefinitely reinvested.
As of December 31, 2001, the cumulative undistributed earnings of these
subsidiaries were approximately $105.9 million. If those earnings were not
considered indefinitely reinvested, U.S. federal deferred income taxes and
Canadian withholding taxes would have been provided after consideration of
foreign tax credits. However, determination of the amount of U.S. federal
deferred income taxes and Canadian withholding taxes is not practical.
The differences between the effective income tax rate and the U.S. federal
statutory rate is reconciled as follows:
YEARS ENDED
DECEMBER 31,
--------------------
2001 2000 1999
---- ---- ----
U.S. federal statutory rate................................. 35.0% 35.0% 35.0%
Effect of foreign operations................................ (0.5) 1.4 0.6
U.S. state income taxes, net of U.S. federal taxes.......... 1.7 1.5 2.5
Non-deductible goodwill amortization and impairment
charge.................................................... 0.5 0.8 5.6
Other....................................................... 0.3 (2.1) (2.0)
---- ---- ----
Effective income tax rate................................. 37.0% 36.6% 41.7%
==== ==== ====
Income taxes paid, net of refunds, for the years ended December 31, 2001,
2000 and 1999 amounted to $189.7 million, $144.7 million and $22.1 million,
respectively.
In December 2000, UDS settled an appeal with the Internal Revenue Service
related to tax issues for the years 1988 through 1994. The appeal pertained to
the IRS's decision to not allow certain income tax deductions taken during those
years. All issues were resolved favorably and a tax refund was received of $12.5
million plus interest of $6.1 million, or $0.19 per share.
NOTE 18: ENVIRONMENTAL MATTERS
The operations of UDS are subject to environmental laws and regulations
adopted by various federal, state and local governmental authorities in the
jurisdictions in which it operates. Although management believes the operations
are in general compliance with applicable environmental regulations, risks of
additional costs and liabilities are inherent in petroleum refining and retail
marketing operations, and there can be no assurance that significant costs and
liabilities will not be incurred. Moreover, it is possible that other
developments, such as increasingly stringent environmental laws, regulations and
enforcement policies thereunder, and claims for damages to property or persons
resulting from the operations, could result in substantial costs and
liabilities. Accordingly, UDS has adopted policies, practices and procedures in
the areas of pollution control, product safety, occupational health and the
production, handling, storage, use and disposal of hazardous materials to
prevent material environmental or other damage, and to limit the financial
liability which could result from those events. However, some risk of
environmental or other damage is inherent in the refining and marketing
business, as it is with other companies engaged in similar businesses.
UDS has been designated as a potentially responsible party by the U.S.
Environmental Protection Agency (the EPA) under the Comprehensive Environmental
Response, Compensation, and Liability Act of 1980, and by certain states under
applicable state laws, with respect to the cleanup of hazardous substances at
several sites. In each instance, other potentially responsible parties also have
been so designated. UDS has accrued liabilities for environmental remediation
obligations at these sites, as well as estimated site restoration costs to be
incurred in the future.
F-92
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The balances of and changes in accruals for environmental matters which are
principally included in other long-term liabilities consisted of the following:
YEARS ENDED
DECEMBER 31,
------------------------
2001 2000 1999
------ ------ ------
(IN MILLIONS)
Balance as of the beginning of year........................ $152.7 $171.0 $219.4
Additions to accrual..................................... 8.1 13.2 4.1
Reductions from accrual.................................. (2.1) (4.6) (20.6)
Payments................................................. (36.0) (26.9) (31.9)
------ ------ ------
Balance as of the end of year.............................. $122.7 $152.7 $171.0
====== ====== ======
During the year ended December 31, 2001 and 2000, environmental liabilities
were increased for various refinery and retail environmental remediation
projects including California MTBE issues. During the year ended December 31,
1999, based on the annual review of environmental liabilities, it was determined
that certain liabilities were overstated as the required cleanup obligation was
less than originally estimated. Accordingly, environmental liabilities were
reduced by $20.6 million.
The accruals noted above represent UDS' best estimate of the costs which
will be incurred over an extended period for restoration and environmental
remediation at various sites. However, environmental exposures are difficult to
assess and estimate due to unknown factors such as the magnitude of possible
contamination, the timing and extent of remediation, the determination of UDS'
liability in proportion to other parties, improvements in cleanup technologies
and the extent to which environmental laws and regulations may change in the
future. Although environmental costs may have a significant impact on results of
operations for any single period, UDS believes that these costs will not have a
material adverse effect on its financial position. The liabilities reflected
above have not been reduced by possible recoveries from third parties and
projected cash expenditures have not been discounted.
NOTE 19: COMMITMENTS AND CONTINGENCIES
UDS leases convenience stores, office space, refinery equipment and other
assets under operating leases with terms expiring at various dates through 2053.
Certain leases contain renewal options and escalation clauses and require the
payment of property taxes, insurance and maintenance costs. These provisions
vary by lease. Certain convenience store leases provide for the payment of
rentals based solely on sales volume while others provide for payments, in
addition to any established minimums, contingent upon the achievement of
specified levels of sales volumes.
As of December 31, 2001, UDS had various time charters for ocean-going
tankers and coastal vessels which expire on various dates through 2009. Two
additional time charters will commence in mid to late summer 2002. Certain of
these charters include renewal options and escalation clauses, which vary by
charter. In addition, certain time charters provide for the payment of
chartering fees which vary based on usage while others provide for payments, in
addition to established minimums, contingent upon usage.
F-93
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Future minimum rental payments applicable to non-cancelable operating
leases and time charters as of December 31, 2001 are as follows (in millions):
2002........................................................ $106.2
2003........................................................ 89.5
2004........................................................ 80.9
2005........................................................ 78.3
2006........................................................ 67.7
Thereafter.................................................. 166.1
------
Gross minimum lease payments.............................. 588.7
Less future minimum sublease rental income.................. (21.1)
------
Net future minimum lease payments......................... $567.6
======
Rental expense, net of sublease rental income, for all operating leases
consisted of the following:
YEARS ENDED
DECEMBER 31,
-----------------------
2001 2000 1999
------ ----- ------
(IN MILLIONS)
Minimum rental expense...................................... $ 71.7 $75.3 $ 90.3
Contingent rental expense................................... 12.0 10.9 8.5
------ ----- ------
Gross rental expense...................................... 83.7 86.2 98.8
Less sublease rental income................................. (10.0) (9.8) (10.6)
------ ----- ------
Net rental expense........................................ $ 73.7 $76.4 $ 88.2
====== ===== ======
Charges to cost of products sold for marine freight time charters totaled
$54.6 million, $61.9 million and $44.9 million for the years ended December 31,
2001, 2000 and 1999, respectively.
To accommodate UDS' convenience store construction program, UDS has three
long-term operating lease arrangements which are summarized below:
FACILITY AMOUNT DRAWN AT
AMOUNT DECEMBER 31, 2001 EXPIRATION
-------- ----------------- -------------
(IN MILLIONS)
Total Lease.......................... $ 65.0 $ 18.5 August 2002
Jamestown Lease...................... 76.2 76.2 July 2003
Brazos Lease......................... 186.8 186.8 December 2003
------ ------
$328.0 $281.5
====== ======
These lease arrangements have been used to construct or purchase
convenience stores and to construct the headquarters in San Antonio, Texas.
After their respective non-cancelable lease terms, the leases may be extended by
agreement of the parties, or UDS may purchase or arrange for the sale of the
convenience stores or the corporate headquarters. If UDS were unable to extend
the lease or arrange for the sale of the properties to a third party at the
respective expiration dates of the leases, the amount necessary to purchase the
properties under the leases as of December 31, 2001 would be approximately
$271.8 million. As of December 31, 2001, UDS has available capacity under the
Total lease of $46.5 million.
F-94
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In conjunction with the construction of a high-pressure gas oil
hydrotreater at the Wilmington Refinery, UDS entered into a long-term contract
for the supply of hydrogen, which expires in 2011. UDS also entered into a
long-term contract for the supply of hydrogen to the Three Rivers Refinery,
which expires in 2011. In conjunction with the acquisition of the Golden Eagle
Refinery, a long-term contract for the supply of hydrogen was assumed, which
expires in 2009. All three of the hydrogen contracts have take-or-pay provisions
requiring monthly payments totaling approximately $2.9 million, which are
adjusted periodically based on certain market indices. UDS also has a commitment
under a product supply arrangement to pay a reservation fee of approximately
$10.4 million annually through June 2002.
Also in conjunction with the acquisition of the Golden Eagle Refinery, UDS
assumed an operating lease for the MTBE facility located at the refinery, which
expires in 2010. At the time of the acquisition, governmental regulations
required that the use of MTBE blended gasolines be phased out by 2004. The
Golden Eagle Refinery is completing various capital projects which will allow it
to phase out MTBE effective December 31, 2002. Accordingly, a lease termination
obligation for the MTBE facility lease of $36.1 million was accrued as part of
the allocation of the purchase price. The lease termination obligation is
included in accrued expenses and other current liabilities in the consolidated
balance sheet as of December 31, 2001.
Pursuant to the terms of various agreements, UDS has agreed to indemnify
the former owners of Ultramar, Inc. (UI) and CUC and certain of their affiliates
for any claims or liabilities arising out of, among other things, refining and
retail activities and litigation related to the operations of UI and CUC prior
to their acquisition by UDS in 1992.
UDS is also a party to additional claims and legal proceedings arising in
the ordinary course of business. UDS 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 position, results of operations or
liquidity; 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 UDS' results of operations,
financial position or liquidity.
NOTE 20: FINANCIAL INSTRUMENTS
Financial instruments consisted of the following:
DECEMBER 31,
---------------------------------------------
2001 2000
--------------------- ---------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
--------- --------- --------- ---------
(IN MILLIONS)
Cash and cash equivalents................ $ 338.8 $ 338.8 $ 197.1 $ 197.1
Non-current notes receivable............. 28.8 28.8 30.5 30.5
Advance from Valero Energy Corporation... (703.0) (703.0) -- --
Long-term debt, including current
portion................................ (1,272.5) (1,257.0) (1,661.5) (1,674.0)
Interest rate swap agreements:
Receivable position.................... 19.1 19.1 -- 1.8
Payable position....................... (1.3) (1.3) -- --
Commodity contracts:
Asset position......................... 14.2 14.2 5.4 29.2
Liability position..................... (20.6) (20.6) (8.3) (10.2)
F-95
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Cash and cash equivalents as of December 31, 2001 and 2000 include $204.9
million and $126.6 million, respectively, of investments in marketable
securities with maturities of less than three months. The investments are held
to maturity and are stated at amortized cost, which approximates fair market
value.
The aggregate carrying amount of non-current notes receivable approximated
fair value as determined based on the discounted cash flow method.
The fair value of the fixed rate debt as of December 31, 2001 and 2000 was
$1,219.5 million and $1,306.2 million, respectively (carrying amounts of
$1,235.0 million and $1,293.7 million, respectively) and was estimated based on
the quoted market price of similar debt instruments. The carrying amounts of the
borrowings under the revolving credit agreements and money market facilities
approximate fair value because these obligations generally bear interest at
floating rates.
The fair value of interest rate swap agreements is determined based on the
differences between the contract rate of interest and the rates currently quoted
for agreements of similar terms and maturities.
The fair value of commodity futures and options contracts is based on
quoted market prices. The fair value of commodity price and spread swap
contracts is determined based on the differences between the contract rate of
the swap and quoted market prices for contracts of similar terms.
UDS is subject to the market risk associated with changes in the market
price of the underlying crude oil and refined products; however, these changes
in values are generally offset by changes in the sales price of the related
refined products.
UDS is exposed to credit risk in the event of nonperformance by the
counterparties in all interest rate swap agreements, price swap contracts and
foreign exchange contracts. Generally, UDS does not anticipate nonperformance by
any of the counterparties; however to the extent nonperformance is expected, a
provision to reduce the amount due from the counterparty is recorded. The amount
of this exposure is generally the unrealized gains or losses on those contracts.
Other financial instruments, which potentially subject UDS to credit risk,
consist principally of accounts receivable. Concentration of credit risk with
respect to accounts receivable is limited due to the large number of customers
comprising the customer base and their dispersion across different geographic
areas. As of December 31, 2001 and 2000, UDS had no significant concentrations
of credit risk.
NOTE 21: DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
UDS is exposed to various market risks, including changes in interest
rates, commodity prices related to crude oil, refined products and natural gas
and foreign currency rates. To manage or reduce these market risks, interest
rate swaps, commodity contracts and foreign exchange and purchase contracts are
used.
Interest rate swap agreements are used to manage the exposure to interest
rate risk on fixed-rate debt obligations.
Commodity futures and options contracts are used to procure a large portion
of the crude oil requirements of the refineries and to hedge the exposure to
crude oil, refined product, and natural gas price volatility. Commodity price
and spread swap contracts are used to manage the exposure to price volatility
related to forecasted purchases of crude oil, refined products and natural gas
and sales of refined products.
The impact of adopting Statement No. 133, as amended, on January 1, 2001
was to record derivative assets of $25.6 million, derivative liabilities of
$16.1 million and a cumulative effect adjustment to other comprehensive income
of $13.3 million, net of income tax expense.
F-96
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Derivative assets and liabilities consisted of the following as of December
31, 2001:
DERIVATIVE DERIVATIVE
ASSETS LIABILITIES
---------- -----------
(IN MILLIONS)
Derivative instruments designated as:
Fair value hedge.......................................... $19.1 $ 1.3
Cash flow hedge........................................... 1.3 --
Not designated............................................ 12.9 20.6
Included in other comprehensive income as of December 31, 2001 are $0.8
million of gains associated with the cash flow hedge, which will be reclassified
into income during June 2002 when the forecasted transactions impact income.
For the year ended December 31, 2001, there was no net gain or loss
recognized in the consolidated statement of income related to hedge
ineffectiveness for fair value hedges or cash flow hedges, and no component of
the derivative instruments' gain or loss from the assessment of hedge
effectiveness was excluded. No amounts were recognized in income for hedged firm
commitments no longer qualifying as fair value hedges.
The above transactions are non-cash items which were excluded from the
consolidated statement of cash flows for the year ended December 31, 2001.
NOTE 22: BUSINESS SEGMENTS AND GEOGRAPHIC INFORMATION
UDS has three reportable segments: Refining, Retail and Petrochemical/NGL.
The Refining segment includes refinery, wholesale, product supply and
distribution, and transportation operations. The Retail segment includes
company-operated convenience stores, Canadian dealers/jobbers, cardlock and home
heating oil operations. The Petrochemical/NGL segment includes income from
Nitromite fertilizer, NGL marketing and certain NGL pipeline operations. Equity
income from joint ventures is not included in operating income. Operations that
are not included in any of the three reportable segments are included in the
corporate category and consist primarily of corporate office expenditures.
The reportable segments are strategic business units that offer different
products and services. They are managed separately as each business requires
unique technology and marketing strategies. Performance is evaluated based on
operating income and EBITDA which is defined as operating income plus
depreciation and amortization and equity income from joint ventures less gain
(plus loss) on sale of property, plant and equipment. EBITDA is a measure used
for internal analysis and in presentations to analysts, investors and lenders.
The calculation of EBITDA is not based on United States generally accepted
accounting principles and should not be considered as an alternative to net
income or cash flows from operating activities (which are determined in
accordance with U.S. GAAP). This measure may not be comparable to similarly
titled measures used by other entities as other entities may not calculate
EBITDA in the same manner. Intersegment sales are generally derived from
transactions made at prevailing market rates.
F-97
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Total expenditures include capital expenditures, acquisition costs of
refining and retail operations, net of cash acquired, and deferred refinery
maintenance turnaround costs.
PETROCHEMICAL/
REFINING RETAIL NGL CORPORATE TOTAL
--------- -------- -------------- --------- ---------
(IN MILLIONS)
YEAR ENDED DECEMBER 31, 2001:
Sales and other revenues
from external
customers.............. $10,382.6 $6,356.8 $120.6 $ -- $16,860.0
Intersegment sales....... 3,015.7 -- -- -- 3,015.7
EBITDA................... 1,245.3 180.7 5.3 (166.9) 1,264.4
Depreciation and
amortization........... 190.8 74.3 -- 12.7 277.8
Operating income
(loss)................. 1,060.2 100.2 (0.2) (179.9) 980.3
Total assets............. 4,393.9 1,190.1 150.6 587.8 6,322.4
Total expenditures....... 575.6 105.1 -- 10.4 691.1
YEAR ENDED DECEMBER 31, 2000:
Sales and other revenues
from external
customers.............. 10,273.3 6,625.1 162.7 -- 17,061.1
Intersegment sales....... 3,375.9 -- 1.4 -- 3,377.3
EBITDA................... 1,022.0 172.7 21.4 (128.7) 1,087.4
Depreciation and
amortization........... 170.6 70.2 0.9 11.4 253.1
Operating income
(loss)................. 846.3 104.5 2.1 (140.8) 812.1
Total assets............. 4,295.4 1,270.7 117.8 304.5 5,988.4
Total expenditures....... 913.7 94.6 -- 30.8 1,039.1
YEAR ENDED DECEMBER 31, 1999:
Sales and other revenues
from external
customers.............. 7,921.0 5,883.2 135.1 -- 13,939.3
Intersegment sales....... 2,683.7 8.1 -- -- 2,691.8
EBITDA................... 615.8 202.0 19.5 (137.4) 699.9
Depreciation and
amortization........... 168.2 67.8 1.4 3.4 240.8
Operating income
(loss)................. 358.6 202.5 3.5 (135.5) 429.1
Total assets............. 3,326.5 1,220.2 148.2 241.1 4,936.0
Total expenditures....... 109.2 62.2 0.1 47.3 218.8
F-98
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following summarizes the reconciliation of reportable segment sales and
other revenues, operating income, and assets to consolidated sales and other
revenues, operating income and total assets:
YEARS ENDED DECEMBER 31,
---------------------------------
2001 2000 1999
--------- --------- ---------
(IN MILLIONS)
SALES AND OTHER REVENUES:
Total sales for reportable segments................. $19,875.7 $20,438.4 $16,631.1
Elimination of intersegment sales................... (3,015.7) (3,377.3) (2,691.8)
--------- --------- ---------
Consolidated sales and other revenues............. $16,860.0 $17,061.1 $13,939.3
========= ========= =========
OPERATING INCOME:
Total operating income for reportable segments...... $ 1,160.2 $ 952.9 $ 564.6
Other unallocated expenses.......................... (179.9) (140.8) (135.5)
--------- --------- ---------
Consolidated operating income..................... $ 980.3 $ 812.1 $ 429.1
========= ========= =========
DECEMBER 31,
-------------------
2001 2000
-------- --------
(IN MILLIONS)
TOTAL ASSETS:
Total assets for reportable segments........................ $5,734.6 $5,683.9
Other unallocated assets.................................... 587.8 304.5
-------- --------
Consolidated total assets................................. $6,322.4 $5,988.4
======== ========
Sales and other revenues from external customers by reportable segment by
refined product were as follows:
YEARS ENDED DECEMBER 31,
---------------------------------
2001 2000 1999
--------- --------- ---------
(IN MILLIONS)
REFINING:
Gasoline and blendstocks.......................... $ 5,934.1 $ 5,168.5 $ 4,987.7
Distillates (diesel, jet fuel, heating oil,
etc.).......................................... 3,336.0 3,922.3 2,278.5
Petrochemicals.................................... 430.7 486.4 319.1
Asphalt and lubes................................. 453.9 457.0 270.0
Other............................................. 227.9 239.1 65.7
--------- --------- ---------
10,382.6 10,273.3 7,921.0
--------- --------- ---------
RETAIL:
Fuel sales (gasoline and diesel).................. 4,817.8 5,073.9 4,472.7
Merchandise sales................................. 1,487.6 1,505.0 1,186.9
Home heating oil.................................. 51.4 46.2 223.6
--------- --------- ---------
6,356.8 6,625.1 5,883.2
PETROCHEMICAL/NGL................................... 120.6 162.7 135.1
--------- --------- ---------
Total sales and other revenues from external
customers......................................... $16,860.0 $17,061.1 $13,939.3
========= ========= =========
F-99
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Geographic information by country for sales and other revenues from
external customers based on location of customer consisted of the following:
YEARS ENDED DECEMBER 31,
---------------------------------
2001 2000 1999
--------- --------- ---------
(IN MILLIONS)
United States....................................... $13,247.3 $13,006.2 $11,140.2
Canada.............................................. 3,607.5 4,054.9 2,799.1
Italy............................................... 5.2 -- --
--------- --------- ---------
Consolidated sales and other revenues............. $16,860.0 $17,061.1 $13,939.3
========= ========= =========
Long-lived assets include property, plant and equipment, goodwill and
refinery maintenance turnaround costs, net of related accumulated depreciation
and amortization. Geographic information by country for long-lived assets
consisted of the following:
DECEMBER 31,
-------------------
2001 2000
-------- --------
(IN MILLIONS)
United States............................................... $3,735.0 $3,424.4
Canada...................................................... 543.0 488.7
-------- --------
Consolidated long-lived assets............................ $4,278.0 $3,913.1
======== ========
NOTE 23: QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
2001 QUARTERS
-----------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
-------- -------- -------- -------- ---------
(IN MILLIONS, EXCEPT PER SHARE DATA)
Sales and other revenues.................. $4,214.1 $5,105.6 $4,019.9 $3,520.4 $16,860.0
Cost of products sold and operating
expenses................................ 3,122.5 3,748.5 2,823.4 2,606.8 12,301.2
Operating income.......................... 254.5 464.6 252.1 9.1 980.3
Net income (loss)......................... 136.7 266.4 149.0 (17.1) 535.0
Net income (loss) per share:
Basic................................... $ 1.77 $ 3.72 $ 2.04 $ (0.23) $ 7.22
Diluted................................. $ 1.73 $ 3.63 $ 2.00 $ (0.23) $ 7.08
Weighted average number of shares:
Basic................................... 77.440 71.619 73.129 74.065 74.052
Diluted................................. 78.883 73.410 74.616 75.349 75.537
In March 2001, the No. 3 crude oil unit of the Golden Eagle Refinery was
restarted which increased the refinery's capability to process more crude oil
and increased the production of California Air Resource Board gasoline and
diesel fuel. Refining operating costs were higher in the first and second
quarters of 2001 due to higher fuel gas and electricity costs, which began
increasing in 2000 as a result of higher crude oil and natural gas prices.
During the third and fourth quarter of 2001, natural gas prices declined to more
normal levels.
Net income per share for the second quarter of 2001 increased due to higher
refining margins, especially on the West Coast. Net income per share also
increased as a result of a decrease in the number of outstanding
F-100
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
shares of common stock as a result of the shares repurchased under the share
buyback program (see Note 14: Stockholders' Equity).
During the fourth quarter of 2001, the refinery margins at all of UDS'
refineries decreased significantly, due to declining demand and increased
industry-wide inventory levels which negatively impacted wholesale and retail
refined product prices. Also during the fourth quarter of 2001, significant
refinery maintenance turnaround work began at both West Coast refineries and at
the McKee Refinery, reducing production and income. UDS also incurred $14.2
million of costs associated with the acquisition of UDS by Valero.
2000 QUARTERS
-----------------------------------------------------
FIRST SECOND THIRD FOURTH TOTAL
-------- -------- -------- -------- ---------
(IN MILLIONS, EXCEPT PER SHARE DATA)
Sales and other revenues.................. $3,645.4 $4,009.5 $4,527.9 $4,878.3 $17,061.1
Cost of products sold and operating
expenses................................ 2,698.8 2,952.2 3,417.6 3,831.0 12,899.6
Operating income.......................... 139.1 236.7 240.0 196.3 812.1
Net income................................ 69.1 128.5 127.6 119.1 444.3
Net income per share:
Basic................................... $ 0.80 $ 1.48 $ 1.47 $ 1.37 $ 5.12
Diluted................................. $ 0.80 $ 1.47 $ 1.47 $ 1.37 $ 5.11
Weighted average number of shares:
Basic................................... 86.713 86.767 86.794 86.816 86.773
Diluted................................. 86.814 87.024 87.003 87.205 87.002
On August 31, 2000, UDS acquired the Golden Eagle Refinery from Tosco
Corporation and on September 29, 2000, UDS purchased Valley Shamrock, which
resulted in increased net income in the third and fourth quarters of 2000.
In December 2000, UDS settled an appeal with the IRS related to tax issues
for the years 1988 through 1994. The appeal was resolved favorably and a tax
refund was received of $12.5 million plus interest of $6.1 million, or $0.19 per
basic share.
NOTE 24: SUBSEQUENT EVENTS
DIAMOND-KOCH, L.P.
In the latter part of 2001, Koch Industries, Inc. and UDS, both 50%
partners in the Diamond-Koch, L.P. joint venture, decided to sell the four
operating assets of Diamond-Koch and began soliciting bids from interested
parties. As of December 31, 2001, the equity investment in Diamond-Koch has been
reclassified to asset held for sale in the consolidated balance sheet.
The four operating assets include the following:
- propane/propylene splitter facility and related distribution pipeline
and terminal;
- hydrocarbon storage facilities;
- natural gas liquids fractionator facility; and
- natural gas liquids gathering and pipeline system.
On January 16, 2002, Diamond-Koch entered into a purchase and sale
agreement with Enterprise Products Texas Operating L.P. for the sale of the
hydrocarbon storage facilities for $129.3 million, of which $64.7 million was
distributed to UDS in January 2002.
F-101
ULTRAMAR DIAMOND SHAMROCK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
On January 31, 2002, Diamond-Koch entered into an asset purchase and sale
agreement with Enterprise Products Operating L.P. for the sale of the
propane/propylene splitter facility and related distribution pipeline and
terminal for $238.5 million, of which $119.3 million was distributed to UDS in
February 2002.
On March 1, 2002, Diamond-Koch entered into a purchase and sale agreement
with Teppco Partners, L.P. for the sale of the natural gas liquids gathering and
pipeline system for $132.0 million, of which $66.0 million was distributed to
UDS in March 2002.
Diamond-Koch is in the process of finalizing negotiations with purchasers
for the remaining two assets and expects to complete those sales no later than
April 2002.
SALE AND PURCHASE AGREEMENT WITH TESORO
In conjunction with the acquisition of UDS by Valero, the consent decree,
approved by the FTC in December 2001, required Valero to divest of certain UDS
assets. In February 2002, Ultramar, Inc. (now a subsidiary of Valero) and Tesoro
Refining and Marketing Company (Tesoro) entered into a sale and purchase
agreement whereby Tesoro will acquire the Golden Eagle Refinery and associated
wholesale marketing operation in Northern California and the network of 70
convenience stores located in the northern half of California. The total
purchase price of $1.1 billion includes an estimated $130.0 million for the
crude oil and refined product inventories and the assumption of various employee
benefit and lease obligations, but excludes other working capital items.
VALERO L.P.
On January 22, 2002, Valero L.P. declared a quarterly partnership
distribution of $0.60 per unit payable on February 14, 2002 to unitholders of
record on February 1, 2002. The total distribution is expected to be
approximately $11.8 million of which $3.1 million is payable to minority
unitholders.
CONTINGENCY
In January 2002, Union Oil Company of California (Unocal) filed a patent
infringement lawsuit against Valero (in its capacity as the surviving entity in
the merger of UDS into Valero) in California federal court. The complaint seeks
a 5.75 cents per gallon royalty on all reformulated gasoline infringing on
Unocal's feet393 and feet126 patents. These patents cover certain compositions
of cleaner-burning gasoline. The complaint seeks treble damages for Valero's and
UDS' alleged willful infringement of Unocal's patents. In a previous lawsuit,
Unocal prevailed against five other major petroleum refiners involving the
feet393 patent. In August 2001, the FTC announced that it would begin an
antitrust investigation concerning Unocal's conduct with a joint industry
research group during the time that Unocal was prosecuting its patent at the
U.S. Patent and Trademark Office (PTO). The FTC could potentially issue an
injunction against Unocal's enforcement of its patents as a result of the
investigation. In 2001, the PTO began a reexamination of Unocal's feet393
patent, and in January 2002, the PTO issued a notice of rejection of all claims
of the feet393 patent. Unocal has the opportunity to respond to the PTO's
action. Also in January 2002, the PTO reversed an earlier denial and began a
reexamination of Unocal's feet126 patent. Both reexaminations could affect the
scope and validity of the patents. Notwithstanding the judgement against the
other petroleum refiners in the previous litigation, UDS believes that it has
several strong defenses to Unocal's lawsuit, including those arising from
Unocal's misconduct, and UDS believes that it will prevail in the lawsuit.
However, due to the inherent uncertainty of litigation, there can be no
assurance that UDS would prevail and an adverse result could have a material
adverse effect on UDS' results of operations and financial position.
F-102
PROSPECTUS
$3,500,000,000
(VALERO ENERGY 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
We will provide the specific THE OFFERING
terms of the securities in one We may offer from time to time
or more supplements to this - Senior debt securities
prospectus. You should read - Subordinated debt securities
this prospectus and the - Common stock
related prospectus supplement - Preferred stock
carefully before you invest in - Warrants
our securities. This
prospectus may not be used to We will provide the specific terms of the securities in
offer and sell our securities supplements to this prospectus. Our common stock is listed
unless accompanied by a on the New York Stock Exchange under the symbol "VLO."
prospectus supplement.
INVESTING IN THE SECURITIES INVOLVES RISKS. SEE "RISK
FACTORS" BEGINNING ON PAGE 4.
---------------------
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 April 5, 2002.
TABLE OF CONTENTS
About This Prospectus....................................... 3
About Valero Energy Corporation............................. 3
Risk Factors................................................ 4
Cautionary Statement Concerning Forward-Looking
Statements................................................ 9
Use of Proceeds............................................. 11
Ratio of Earnings To Fixed Charges.......................... 11
Description of Debt Securities.............................. 12
Description of Capital Stock................................ 19
Description of Warrants..................................... 23
Plan of Distribution........................................ 23
Legal Matters............................................... 25
Experts..................................................... 25
Where You Can Find More Information......................... 25
Information We Incorporate by Reference..................... 25
---------------------
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
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 III and
VEC Trust IV, 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 $3,500,000,000. 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. Effective
December 31, 2001, we acquired Ultramar Diamond Shamrock Corporation, or UDS. In
connection with the acquisition of UDS, we issued 45.9 million shares of common
stock, paid $2.1 billion of cash to UDS stockholders and assumed approximately
$2 billion of UDS debt. As of January 1, 2002, we owned and operated eleven
refineries in the United States and one refinery in Canada with a combined
throughput capacity of approximately 1.9 million barrels per day. This excludes
the Golden Eagle Refinery acquired from UDS, which is under contract to be sold
for approximately $1.13 billion to comply with Federal Trade Commission
requirements in connection with our acquisition of UDS.
We produce premium, environmentally clean products such as reformulated
gasoline, gasoline meeting the specifications of the California Air Resources
Board, or CARB gasoline, CARB diesel fuel, low sulfur diesel fuel and
oxygenates. We also produce a substantial slate of conventional gasoline,
distillates, jet fuel, asphalt and petrochemicals. We market refined products
through approximately 4,500 retail sites in the United States and Canada,
branded as Diamond Shamrock(R), Ultramar(R), Valero(R), Beacon(R) and Total(R).
We also market refined products on a wholesale basis through a bulk and rack
marketing network in 40 U.S. states and Canada.
We have a logistics system that complements our refining and marketing
assets in the southwestern and central United States. We own approximately 73
percent of Valero L.P., a master limited partnership which owns and operates
crude oil pipelines, refined product pipelines and refined product terminals in
Texas, Oklahoma, New Mexico and Colorado. Units of Valero L.P. are listed on the
New York Stock Exchange under the "VLI" symbol.
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
stockholders, 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.
3
RISK FACTORS
You should carefully consider the following matters, in addition to the
other information we have provided in this prospectus, the accompanying
prospectus supplement and the documents we incorporate by reference, before
reaching a decision regarding an investment in our securities.
OUR FINANCIAL RESULTS ARE AFFECTED BY VOLATILE REFINING MARGINS.
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. Actual earnings on a fully diluted
basis for 2001 were $8.83 per share. In our annual report on Form 10-K for the
year ended December 31, 2001 filed with the SEC on March 14, 2002, we indicated
at that time that we expected to incur a slight loss for the first quarter of
2002. This estimate speaks only as of the date it was made and will vary in the
future depending on refining margins and market conditions. See "Cautionary
Statement Concerning Forward-Looking Statements."
WE MAY BE UNABLE TO SUCCESSFULLY INTEGRATE UDS'S OPERATIONS.
The difficulties of combining our operations with those of UDS include:
- the necessity of coordinating geographically separate organizations
- integrating personnel with diverse business backgrounds
The process of integrating operations could cause an interruption of, or
loss of momentum in, the activities of one or more of our businesses and the
loss of key personnel. The diversion of management's attention and any delays or
difficulties encountered in connection with the integration of the two
companies' operations could have an adverse effect on our business, results of
operations or financial condition, including by delaying the time at which
synergies such as cost savings can be realized and reducing management time and
effort available for other business matters and strategic opportunities.
OUR LEVERAGE MAY LIMIT OUR FINANCIAL FLEXIBILITY.
As of December 31, 2001, after giving effect to the acquisition of UDS, we
would have had total debt of approximately $5.4 billion (including capital lease
obligations), trust preferred securities in an aggregate liquidation amount of
$372.5 million, and stockholders' equity of approximately $4.2 billion,
resulting in a total debt to total capital ratio of 54.5%, as more fully
described in our annual report on Form 10-K for the year ended December 31, 2001
incorporated by reference herein. We may also incur additional indebtedness in
the future, including in connection with acquisitions, although our ability to
do so will be restricted by existing bank credit facilities. 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
- 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
4
- we may be at a competitive disadvantage to our competitors that are less
leveraged
- 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. Such refinancing might not be possible and additional
financing might not be available on commercially acceptable terms or at all.
Our bank credit facility imposes financial and other restrictions on us.
Covenants contained in the credit facility and relating to certain of our other
indebtedness limit, among other things, the incurrence of funded indebtedness by
us and our subsidiaries and require maintenance of a minimum coverage ratio and
a maximum debt-to-capitalization ratio. 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, we might not 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.
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, the Tier II gasoline and distillate standards and the
Maximum Available Control Technology rule (MACT II rule) under the Clean Air
Act, the level of future expenditures required for environmental matters could
increase in the future. In addition, any major upgrades in any of our refineries
could require material additional expenditures to comply with environmental laws
and regulations.
In February 2000, the Environmental Protection Agency's "Tier II" gasoline
standard was published in final form under the Clean Air Act. The standard
requires the sulfur content in gasoline to be reduced from approximately 300
parts per million to 30 parts per million. The regulation will be phased in
beginning in 2004. In addition, the EPA finalized its Tier II distillate
standard to reduce the sulfur content of diesel fuel sold to highway consumers
by 97%, from 500 parts per million to 15 parts per million, beginning June 1,
2006. We have determined that modifications will be required at each of our
refineries as a result of the Tier II standards. Based on preliminary estimates,
we believe that the new Tier II specifications will require approximately $550
million in capital expenditures for our refineries to comply, excluding the cost
to install hydrogen production facilities. We expect all modifications to be
complete in time for compliance with the effective dates of the gasoline and
distillate standards.
DISRUPTION OF OUR ABILITY TO OBTAIN CRUDE OIL COULD ADVERSELY AFFECT OUR
OPERATIONS.
Over 75% of our total crude oil feedstock requirements are purchased
through term crude oil feedstock contracts totaling approximately 1,160,000 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 companies and various domestic integrated oil
companies. In particular, a significant portion of our feedstock requirements
are satisfied 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, it is possible that we would be unable to
find alternative sources of supply. If we are unable to
5
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, including reduced sales volumes of refined products or reduced margins
as a result of higher crude oil costs.
COMPETITORS WHO PRODUCE THEIR OWN SUPPLY OF FEEDSTOCKS, WHO HAVE MORE 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. Many of our competitors, however, obtain a significant portion of
their feedstocks from company-owned production and some have more extensive
retail outlets than we do. 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.
As a result of the merger with UDS, we have increased our presence in 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 SIGNIFICANT INTERRUPTION IN ONE OR MORE OF OUR REFINERIES COULD ADVERSELY
AFFECT OUR BUSINESS.
With the acquisition of UDS, our refining activities will be conducted at
twelve major refineries in Texas, Louisiana, New Jersey, California, Oklahoma,
Colorado and Quebec, Canada. 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.
If any refinery were to experience an interruption in operations, earnings
therefrom could be materially adversely affected, including as a result of lost
production and repair costs.
WE MAY BE UNABLE TO COMPETE SUCCESSFULLY WITH OTHER COMPANIES IN THE RETAIL
SECTOR.
The retail sector has become increasingly competitive. We face strong
competition from the fully integrated major oil companies that have increased
their efforts to capture retail market share in recent years. We also compete
with large grocery stores and other general merchandisers (the so-called
"hypermarts") that often sell gasoline at aggressively competitive prices in
order to attract customers to their sites. A number of our competitors also have
materially greater financial and other resources than we possess. The actions of
our competitors could lead to lower prices and reduced margins, which could have
a material adverse effect on our financial position.
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. We may not be able to maintain or obtain insurance of the type
and amount we desire at reasonable rates. As a result of market conditions,
premiums and deductibles for certain of our insurance policies have
6
increased substantially, and could escalate further. In some instances, certain
insurance could become unavailable or available only for reduced amounts of
coverage. For example, insurance carriers are now requiring broad exclusions for
losses due to war risk and terrorist acts. If we were to incur a significant
liability for which we were not fully insured, it could have a material adverse
effect on our financial position.
THE BANNING OF THE USE OF MTBE COULD ADVERSELY AFFECT US.
The presence of MTBE in some water supplies in California and other states,
resulting from gasoline leaks primarily from underground and aboveground storage
tanks, has led to public concern that MTBE has contaminated drinking water
supplies and thus poses a possible health risk. As a result of heightened public
concern, California passed initiatives to ban the use of MTBE as a gasoline
component in California by the end of 2002. In March 2002, however, the governor
of California issued an executive order postponing the ban for one year.
Accordingly, the California Air Resources Board's specifications for CARB Phase
III gasoline are not expected to become effective until the beginning of 2004.
We estimate that the cost for permitting and modification of our California
refineries to comply with CARB Phase III specifications and eliminate MTBE as a
gasoline component is approximately $50 million. We, like other producers of
MTBE, are subject to litigation or proceedings involving the manufacture or use
of MTBE that could adversely affect us. 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, we believe that our major non-California MTBE-producing facilities could
be modified to produce iso-octane for a capital investment of approximately $35
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.
WE MAY NOT BE SUCCESSFUL IN CONTINUING TO GROW THROUGH ACQUISITIONS, AND ANY
FURTHER ACQUISITIONS MAY REQUIRE US TO OBTAIN ADDITIONAL FINANCING OR COULD
RESULT IN DILUTION.
A substantial portion of our growth over the last several years has been
attributed to acquisitions. The ability to continue to grow through acquisitions
will be dependent on a number of factors, including our ability to
- identify acceptable acquisition candidates
- consummate acquisitions on favorable terms
- successfully integrate acquired businesses
- obtain financing to support our growth
We may not be successful in continuing to grow through acquisitions. 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 stockholders.
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.
7
A PATENT DISPUTE WITH UNOCAL COULD ADVERSELY AFFECT US.
Union Oil Company of California has filed a patent infringement lawsuit
against Valero in California federal court. The complaint seeks a 5.75 cent per
gallon royalty on all reformulated gasoline infringing on Unocal patents that
cover certain compositions of cleaner-burning gasoline. The complaint seeks
treble damages for Valero's alleged willful infringement of Unocal's patents. In
a previous lawsuit involving one of its patents, Unocal prevailed against five
other major refiners. In August 2001, the FTC announced that it would begin an
antitrust investigation concerning Unocal's conduct with a joint industry
research group during the time that Unocal was prosecuting its patents at the
U.S. Patent and Trademark Office, or the PTO. In 2001, the PTO began a
reexamination of one of Unocal's patents, and in January 2002, the PTO issued a
notice of rejection of all claims of the patent. Unocal has the opportunity to
respond to the PTO's action. In January 2002, the PTO reversed an earlier denial
and began a reexamination of another of Unocal's patents. Both reexaminations
could affect the scope and validity of the patents. Due to the inherent
uncertainty of litigation, there can be no assurance that Valero will prevail in
the lawsuit, and an adverse result could have a material adverse effect on
Valero's results of operations and financial position.
8
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS
This prospectus and the accompanying prospectus supplement, including the
information we incorporate by reference, contain certain estimates, predictions,
projections, assumptions 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 Valero's current judgment regarding the direction
of its business, actual results will almost always vary, sometimes materially,
from any estimates, predictions, projections, assumptions, or other future
performance suggested in this report. 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 effect of Valero's recently completed acquisition of UDS on Valero's
business, results of operations and financial condition
- future refining margins, including gasoline and heating oil margins
- future retail margins, including gasoline, diesel fuel, home heating oil
and convenience store merchandise margins
- expectations regarding feedstock costs, including crude oil discounts,
and operating costs
- anticipated levels of crude oil and refined product inventories
- Valero's anticipated level of capital investments, including deferred
turnaround and catalyst costs and capital expenditures for environmental
and other purposes, and the effect of these capital investments on
Valero's results of operations
- anticipated trends in the supply of and demand for crude oil feedstocks
and refined products in the United States, Canada and elsewhere
- expectations regarding environmental and other regulatory initiatives
- the effect of general economic and other conditions on refining and
retail industry fundamentals
Valero's forward-looking statements are based on its beliefs and
assumptions derived from information available at the time the statements are
made. Differences between actual results and any future performance suggested in
these forward-looking statements could result from a variety of factors,
including but not limited to those described under the heading "Risk Factors"
and the following:
- acts of terrorism aimed at either Valero's facilities or other facilities
that could impair Valero's ability to produce and ship refined products
or receive foreign feedstocks
- political conditions in crude oil producing regions, including the Middle
East
- the domestic and foreign supplies of refined products such as gasoline,
diesel fuel, 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 on and to maintain crude 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
9
- the level of foreign imports
- accidents or other unscheduled shutdowns affecting Valero's refineries,
machinery, pipelines or equipment, or those of Valero's suppliers or
customers
- changes in the cost or availability of transportation for feedstocks and
refined products
- the price, availability and acceptance of alternative fuels and
alternative-fuel vehicles
- 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 or
regulatory matters, including unexpected environmental remediation costs
in excess of any reserves or insurance coverage
- the introduction or enactment of federal or state legislation which may
adversely affect Valero's business or operations
- changes in the credit ratings assigned to Valero's debt securities and
trade credit
- changes in the value of the Canadian dollar relative to the U.S. dollar
- overall economic conditions
- other economic, business, competitive and/or regulatory factors that may
affect Valero's business generally as described in our filings with the
SEC
Any one of these factors, or a combination of these factors, could
materially affect Valero's future results of operations and whether any
forward-looking statements ultimately prove to be accurate. Valero's
forward-looking statements are not guarantees of future performance, and actual
results and future performance may differ materially from those suggested in any
forward-looking statement. Valero does not intend to update these statements
unless it is required by the securities laws to do so.
All subsequent written and oral forward-looking statements attributable to
Valero or persons acting on its behalf are expressly qualified in their entirety
by the foregoing. Valero undertakes no obligation to publicly release the result
of any revisions to any such forward-looking statements that may be made to
reflect events or circumstances after the date of this report or to reflect the
occurrence of unanticipated events.
10
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
- permanent financing of bridge facilities used to make acquisitions
- acquisitions
- working capital
- capital expenditures
- repayment or refinancing of debt or other corporate obligations
- repurchases and redemptions of securities
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:
YEAR ENDED DECEMBER 31,
--------------------------------
2001 2000 1999 1998 1997
---- ---- ---- ---- ----
Ratio of earnings to fixed charges.................... 7.3x 5.6x 1.3x -- 4.1x
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, one-third (the proportion deemed representative of the interest
factor) of rental expense and distributions on preferred securities of a
subsidiary trust which are deducted in the determination of consolidated pretax
income from continuing operations. For the year ended December 31, 1998, our
earnings were insufficient to cover fixed charges by $77.7 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 2.7x.
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 preference
securities outstanding with respect to continuing operations for any period
presented, other than preferred securities of a subsidiary trust. As a result,
the ratio of earnings to combined fixed charges and preference dividends is the
same as the ratio of earnings to fixed charges.
11
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 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 we or any of our 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.
We are organized as a holding company that owns subsidiary companies. Our
subsidiary companies conduct substantially all of our business. The holding
company structure results in two principal risks:
- Our subsidiaries may be restricted by contractual provisions or
applicable laws from providing us the cash that we need 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
12
- 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
- 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
We have 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:
- we are the continuing corporation, or
- if we are not the continuing corporation, the successor is organized and
existing under the laws of any United States jurisdiction and assumes all
of our 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
13
- 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 us
- 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.
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
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- 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
- 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
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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.
BOOK-ENTRY AND SETTLEMENT
We 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 we 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. As of February
28, 2002, The Bank of New York serves as trustee:
- for our senior unsecured notes aggregating $1.2 billion
- for pollution control bonds previously issued on our behalf aggregating
$6.4 million
- in connection with our premium equity participating security units
aggregating $172.5 million
- in connection with our trust originated preferred securities aggregating
$200 million
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
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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 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
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- 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
- 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.
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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.
"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:
- 300,000,000 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 Computershare Investor Services, LLC, as
successor rights agent to Harris Trust and Savings Bank, 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."
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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.
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
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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.
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
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- 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
- 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
- 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
Computershare Investor Services, LLC, 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.
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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
- 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
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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 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.
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LEGAL MATTERS
Mr. Jay D. Browning, Esq., Vice President and Corporate Secretary of
Valero, will issue opinions about the legality of the offered securities for us.
Mr. Browning is our employee and at February 28, 2002, beneficially owned
approximately 8,106 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 27,845 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.
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, 2001 and our current reports on Form 8-K/A filed March 18, 2002 have been
audited by Arthur Andersen LLP, independent public accountants, as indicated in
their reports 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 reports.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current 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, 2001
- 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
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- our current report on Form 8-K dated December 31, 2001 and filed with the
SEC on January 11, 2002
- our current report on Form 8-K dated March 12, 2002 and filed with the
SEC on March 14, 2002
- our current report on Form 8-K/A dated December 31, 2001 and filed with
the SEC on March 18, 2002 (the "Initial Form 8-K/A"), which amends our
current report on Form 8-K dated December 31, 2001 and filed with the SEC
on January 11, 2002
- our current report on Form 8-K/A dated December 31, 2001 and filed with
the SEC on March 18, 2002, which amends the Initial Form 8-K/A
- our current report on Form 8-K/A dated March 12, 2002 and filed with the
SEC on April 3, 2002, which amends our current report on Form 8-K dated
March 12, 2002 and filed with the SEC on March 14, 2002.
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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(VALERO LOGO)