-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VJEGhVKBmconJoTSBQX/vd2J745zkfa2vUYDuyWZPS1b4mGSoFuGVSpJwFb8cafm fVaq3nQqwqBJCZYY6RIjXg== 0000950134-99-007404.txt : 19990816 0000950134-99-007404.hdr.sgml : 19990816 ACCESSION NUMBER: 0000950134-99-007404 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VALERO ENERGY CORP/TX CENTRAL INDEX KEY: 0001035002 STANDARD INDUSTRIAL CLASSIFICATION: PETROLEUM REFINING [2911] IRS NUMBER: 741828067 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-13175 FILM NUMBER: 99689708 BUSINESS ADDRESS: STREET 1: ONE VALERO PLACE CITY: SAN ANTONIO STATE: TX ZIP: 78212 BUSINESS PHONE: 2103702000 MAIL ADDRESS: STREET 1: ONE VALERO PLACE CITY: SAN ANTONIO STATE: TX ZIP: 78230 10-Q 1 FORM 10-Q FOR QUARTER ENDED JUNE 30, 1999 1 =============================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to _____________ Commission file number 1-13175 VALERO ENERGY CORPORATION (Exact name of registrant as specified in its charter) Delaware 74-1828067 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) One Valero Place San Antonio, Texas (Address of principal executive offices) 78212 (Zip Code) (210) 370-2000 (Registrant's telephone number, including area code) --------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- --------- Indicated below is the number of shares outstanding of the registrant's only class of common stock, as of August 1, 1999.
Number of Shares Title of Class Outstanding -------------- ----------- Common Stock, $.01 Par Value 56,241,188
=============================================================================== 2 VALERO ENERGY CORPORATION AND SUBSIDIARIES INDEX
Page ---- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets - June 30, 1999 and December 31, 1998..................................... 3 Consolidated Statements of Income - For the Three Months Ended and Six Months Ended June 30, 1999 and 1998............................................................. 4 Consolidated Statements of Cash Flows - For the Six Months Ended June 30, 1999 and 1998.............................................................................. 5 Notes to Consolidated Financial Statements............................................................ 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................................. 12 Item 3. Quantitative and Qualitative Disclosures About Market Risk....................................... 24 PART II. OTHER INFORMATION................................................................................. 27 Item 1. Legal Proceedings................................................................................ 27 Item 4. Submission of Matters to a Vote of Security Holders.............................................. 27 Item 6. Exhibits and Reports on Form 8-K................................................................. 27 SIGNATURE................................................................................................... 28
2 3 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS VALERO ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (THOUSANDS OF DOLLARS)
June 30, 1999 December 31, (Unaudited) 1998 ------------- -------------- ASSETS CURRENT ASSETS: Cash and temporary cash investments ................................ $ 5,804 $ 11,199 Receivables, less allowance for doubtful accounts of $1,600 (1999) and $1,150 (1998) .................................. 302,428 283,456 Inventories ........................................................ 329,612 316,405 Current deferred income tax assets ................................. 79,946 4,851 Prepaid expenses and other ......................................... 20,359 23,799 ----------- ----------- 738,149 639,710 ----------- ----------- PROPERTY, PLANT AND EQUIPMENT - including construction in progress of $147,467 (1999) and $179,136 (1998), at cost ....................................... 2,628,453 2,572,190 Less: Accumulated depreciation .................................. 655,578 612,847 ----------- ----------- 1,972,875 1,959,343 ----------- ----------- DEFERRED CHARGES AND OTHER ASSETS .................................... 158,960 126,611 ----------- ----------- $ 2,869,984 $ 2,725,664 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Short-term debt .................................................... $ 31,000 $ 160,000 Accounts payable ................................................... 422,022 283,183 Accrued expenses ................................................... 60,139 54,561 ----------- ----------- 513,161 497,744 ----------- ----------- LONG-TERM DEBT ....................................................... 916,104 822,335 ----------- ----------- DEFERRED INCOME TAXES ................................................ 271,606 210,389 ----------- ----------- DEFERRED CREDITS AND OTHER LIABILITIES ............................... 112,989 109,909 ----------- ----------- COMMON STOCKHOLDERS' EQUITY: Common stock, $.01 par value - 150,000,000 shares authorized; issued 56,314,798 (1999 and 1998) shares ......................... 563 563 Additional paid-in capital ......................................... 1,100,615 1,112,726 Accumulated deficit ................................................ (42,419) (17,618) Treasury stock, 99,353 (1999) and 378,130 (1998) shares, at cost ... (2,635) (10,384) ----------- ----------- 1,056,124 1,085,287 ----------- ----------- $ 2,869,984 $ 2,725,664 =========== ===========
See Notes to Consolidated Financial Statements. 3 4 VALERO ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED)
Three Months Ended Six Months Ended June 30, June 30, ------------------------------- ------------------------------- 1999 1998 1999 1998 ----------- ----------- ----------- ----------- OPERATING REVENUES .................................. $ 1,824,450 $ 1,448,104 $ 3,161,553 $ 2,810,463 ----------- ----------- ----------- ----------- COSTS AND EXPENSES: Cost of sales and operating expenses .............. 1,808,653 1,346,460 3,096,000 2,638,729 Write-down of inventories to market value ......... -- -- -- 37,673 Selling and administrative expenses ............... 14,540 18,585 32,728 35,915 Depreciation expense .............................. 21,990 18,735 45,038 36,239 ----------- ----------- ----------- ----------- Total ........................................... 1,845,183 1,383,780 3,173,766 2,748,556 ----------- ----------- ----------- ----------- OPERATING INCOME (LOSS) ............................. (20,733) 64,324 (12,213) 61,907 OTHER INCOME, NET ................................... 1,066 482 987 437 INTEREST AND DEBT EXPENSE: Incurred .......................................... (16,013) (8,292) (30,301) (15,868) Capitalized ....................................... 1,495 1,125 3,326 1,879 ----------- ----------- ----------- ----------- INCOME (LOSS) BEFORE INCOME TAXES ................... (34,185) 57,639 (38,201) 48,355 INCOME TAX EXPENSE (BENEFIT) ........................ (12,100) 17,700 (13,400) 14,300 ----------- ----------- ----------- ----------- NET INCOME (LOSS) ................................... $ (22,085) $ 39,939 $ (24,801) $ 34,055 =========== =========== =========== =========== EARNINGS (LOSS) PER SHARE OF COMMON STOCK ........... $ (.39) $ .71 $ (.44) $ .61 Weighted average common shares outstanding (in thousands) ...................................... 56,162 56,201 56,109 56,175 EARNINGS (LOSS) PER SHARE OF COMMON STOCK - ASSUMING DILUTION ................................. $ (.39) $ .70 $ (.44) $ .59 Weighted average common shares outstanding - assuming dilution (in thousands) ................ 56,162 57,353 56,109 57,319 DIVIDENDS PER SHARE OF COMMON STOCK ................. $ .08 $ .08 $ .16 $ .16
See Notes to Consolidated Financial Statements. 4 5 VALERO ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (THOUSANDS OF DOLLARS) (UNAUDITED)
Six Months Ended June 30, --------------------------- 1999 1998 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) ............................................. $ (24,801) $ 34,055 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation expense ...................................... 45,038 36,239 Amortization of deferred charges and other, net ........... 26,090 18,733 Write-down of inventories to market value ................. -- 37,673 Changes in current assets and current liabilities ......... 114,472 13,453 Deferred income tax expense (benefit) ..................... (13,800) 3,000 Changes in deferred items and other, net .................. 880 (460) --------- --------- Net cash provided by operating activities ............... 147,879 142,693 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Capital expenditures .......................................... (58,270) (68,942) Deferred turnaround and catalyst costs ........................ (52,763) (39,886) Earn-out payment in connection with Basis acquisition ......... -- (10,325) Other, net .................................................... (127) 857 --------- --------- Net cash used in investing activities ....................... (111,160) (118,296) --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Increase (decrease) in short-term debt, net ................... (129,000) 3,000 Long-term borrowings .......................................... 592,794 103,741 Long-term debt reduction ...................................... (501,000) (125,000) Common stock dividends ........................................ (8,978) (8,986) Issuance of common stock ...................................... 4,696 933 Purchase of treasury stock .................................... (626) (1,442) --------- --------- Net cash used in financing activities ....................... (42,114) (27,754) --------- --------- NET DECREASE IN CASH AND TEMPORARY CASH INVESTMENTS .............................................. (5,395) (3,357) CASH AND TEMPORARY CASH INVESTMENTS AT BEGINNING OF PERIOD ........................................... 11,199 9,935 --------- --------- CASH AND TEMPORARY CASH INVESTMENTS AT END OF PERIOD ................................................. $ 5,804 $ 6,578 ========= =========
See Notes to Consolidated Financial Statements. 5 6 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION The consolidated financial statements included herein have been prepared by Valero Energy Corporation ("Valero") and subsidiaries (collectively referred to as the "Company"), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). However, all adjustments have been made to the accompanying financial statements which are, in the opinion of the Company's management, necessary for a fair presentation of the Company's results for the periods presented. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented herein not misleading. Certain prior period amounts have been reclassified for comparative purposes. 2. ACQUISITION OF PAULSBORO REFINERY On September 16, 1998, the Company and Mobil Oil Corporation ("Mobil") entered into an asset sale and purchase agreement for the acquisition by the Company of substantially all of the assets and the assumption of certain liabilities related to Mobil's 155,000 barrel-per-day ("BPD") refinery in Paulsboro, New Jersey ("Paulsboro Refinery"). The acquisition was accounted for using the purchase method of accounting and the purchase price was allocated to the assets acquired and liabilities assumed based on estimated fair values, pending the completion of an independent appraisal. Pursuant to the purchase method of accounting, the accompanying Consolidated Statements of Income for the three months ended and six months ended June 30, 1998 do not include the results of operations of the Paulsboro Refinery. Pursuant to the asset sale and purchase agreement, Mobil is entitled to receive payments in any of the five years following the acquisition if certain average refining margins during any of such years exceed a specified level. Any payments under this earn-out arrangement, which will be determined in September of each year beginning in 1999, are limited to $20 million in any year and $50 million in the aggregate. In connection with the acquisition of the Paulsboro Refinery, Mobil agreed to indemnify the Company for certain environmental matters and conditions existing on or prior to the acquisition and the Company agreed to assume Mobil's environmental liabilities, with certain limited exceptions (including "superfund" liability for off-site waste disposal). Mobil's indemnities and the periods of indemnification include (i) third party environmental claims for a period of five years, (ii) governmental fines and/or penalties for a period of five years, (iii) required remediation of known environmental conditions for a period of five years, subject to a cumulative deductible, (iv) required remediation of unknown environmental conditions for a period of seven years, subject to a sharing arrangement with a cap on the Company's obligation and subject to a cumulative deductible, and (v) certain capital expenditures required by a governmental entity for a three-year period, to the extent required to cure a breach of certain representations of Mobil concerning compliance with environmental laws, subject to a specified deductible. The Company's assumed liabilities include remediation obligations to the New Jersey Department of Environmental Protection. These remediation obligations relate primarily to clean-up costs associated with groundwater contamination, landfill closure and post-closure monitoring costs, and tank farm spill prevention costs. As of June 30, 1999, the 6 7 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Company has recorded approximately $20 million in Accrued Expenses and Deferred Credits and Other Liabilities representing its best estimate of costs to be borne by the Company related to these remediation obligations. The majority of such costs are expected to be incurred in relatively level amounts over the next 20 years. The following unaudited pro forma financial information of the Company for the six months ended June 30, 1998 assumes that the acquisition of the Paulsboro Refinery occurred at the beginning of such period. Such pro forma information is not necessarily indicative of the results of future operations. (Dollars in thousands, except per share amounts.) Operating revenues............................................................. $3,329,658 Operating income............................................................... 97,373 Net income..................................................................... 49,490 Earnings per common share...................................................... .88 Earnings per common share - assuming dilution.................................. .86
3. INVENTORIES Refinery feedstocks and refined products and blendstocks are carried at the lower of cost or market, with the cost of feedstocks purchased for processing and produced products determined under the last-in, first-out ("LIFO") method of inventory pricing, and the cost of feedstocks and products purchased for resale determined under the weighted average cost method. During the first quarter of 1999, LIFO inventory quantities were reduced causing prior year LIFO costs, which were lower than current year replacement costs, to be charged to cost of sales. This LIFO liquidation resulted in a decrease in cost of sales of $10.5 million and a decrease in the net loss of $6.8 million, or $.12 per share, for the first six months of 1999. At June 30, 1999, the replacement cost of the Company's LIFO inventories exceeded their LIFO carrying values by approximately $92 million. Materials and supplies are carried principally at weighted average cost not in excess of market. Inventories as of June 30, 1999 and December 31, 1998 were as follows (in thousands):
June 30, December 31, 1999 1998 --------- ------------ Refinery feedstocks .................... $ 67,881 $ 80,036 Refined products and blendstocks ....... 200,743 174,125 Materials and supplies ................. 60,988 62,244 --------- --------- $ 329,612 $ 316,405 ========= =========
7 8 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 4. STATEMENTS OF CASH FLOWS In order to determine net cash provided by operating activities, net income (loss) has been adjusted by, among other things, changes in current assets and current liabilities. The changes in the Company's current assets and current liabilities are shown in the following table as an (increase)/decrease in current assets and an increase/(decrease) in current liabilities (in thousands). These amounts exclude, among other things, a $37.7 million noncash write-down of inventory to market value in the first quarter of 1998 and changes in cash and temporary cash investments, current deferred income tax assets and short-term debt.
Six Months Ended June 30, -------------------------- 1999 1998 --------- -------- Receivables, net .................. $ (18,966) $ 43,672 Inventories ....................... (14,080) 4,757 Prepaid expenses and other ........ 3,440 3,107 Accounts payable .................. 138,500 (21,157) Accrued expenses .................. 5,578 (16,926) --------- -------- Total .......................... $ 114,472 $ 13,453 ========= ========
Cash flows related to interest and income taxes were as follows (in thousands):
Six Months Ended June 30, ------------------------ 1999 1998 -------- -------- Interest paid (net of amount capitalized) ........ $ 20,536 $ 13,390 Income tax refunds received ...................... 7,505 9,000 Income taxes paid ................................ 531 5,282
Noncash investing activities for the six months ended June 30, 1998 included various adjustments to property, plant and equipment and certain current assets and current liabilities resulting from the completion of an independent appraisal performed in connection with the May 1997 acquisition of Basis Petroleum, Inc. ("Basis") and the allocation of the Basis purchase price to the assets acquired and liabilities assumed. 5. LONG-TERM DEBT In March 1999, the Company completed a public offering of $300 million principal amount of 7 3/8% notes which are due on March 15, 2006. The notes were issued under the Company's $600 million universal shelf registration statement which was previously declared effective by the SEC on June 30, 1998. Net proceeds from the financing of approximately $297.5 million were used to pay down borrowings under the Company's revolving bank credit facility. Also in March 1999, the Company refinanced $25 million of its Series 1998 taxable, variable rate Waste Disposal Revenue Bonds with tax-exempt bonds. These Series 1999 tax-exempt bonds have a fixed interest rate of 5.7% and mature on April 1, 2032. 8 9 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) 6. EARNINGS PER SHARE The computation of basic and diluted per-share amounts, as required by the Financial Accounting Standards Board's ("FASB") Statement of Financial Accounting Standards ("SFAS") No. 128, is as follows (dollars and shares in thousands, except per share amounts):
Three Months Ended June 30, ----------------------------------------------------------------- 1999 1998 ----------------------------- ---------------------------- Per- Per- Net Share Net Share (Loss) Shares Amt. Income Shares Amt. ------ ------ ---- ------ ------ ---- Net income (loss)......................... $(22,085) $ 39,939 ======== ======== BASIC EARNINGS PER SHARE: Net income (loss) available to common stockholders..................... $(22,085) 56,162 $(.39) $ 39,939 56,201 $ .71 ===== ===== EFFECT OF DILUTIVE SECURITIES: Stock options............................. -- -- -- 1,038 Performance awards........................ -- -- -- 114 -------- -------- -------- ------ DILUTED EARNINGS PER SHARE: Net income (loss) available to common stockholders plus assumed conversions................ $(22,085) 56,162 $(.39) $ 39,939 57,353 $ .70 ======== ======= ===== ======== ====== =====
Six Months Ended June 30, ------------------------------------------------------------------ 1999 1998 ----------------------------- ----------------------------- Per- Per- Net Share Net Share (Loss) Shares Amt. Income Shares Amt. ------ ------ ---- ------ ------ ---- Net income (loss)......................... $(24,801) $ 34,055 ======== ======== BASIC EARNINGS PER SHARE: Net income (loss) available to common stockholders..................... $(24,801) 56,109 $(.44) $34,055 56,175 $ .61 ===== ===== EFFECT OF DILUTIVE SECURITIES: Stock options............................. -- -- -- 1,034 Performance awards........................ -- -- -- 110 -------- -------- -------- ------ DILUTED EARNINGS PER SHARE: Net income (loss) available to common stockholders plus assumed conversions................ $(24,801) 56,109 $(.44) $ 34,055 57,319 $ .59 ======== ======= ===== ======== ====== =====
9 10 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) Because the Company reported a net loss for the three months and six months ended June 30, 1999, various stock options and performance awards which were granted to employees in connection with the Company's stock compensation plans and were outstanding during such periods were not included in the computation of diluted earnings per share because the effect would have been antidilutive. At June 30, 1999, options to purchase approximately 6.4 million common shares and performance awards totaling approximately 317,000 common shares were outstanding. 7. NEW ACCOUNTING PRONOUNCEMENTS In March 1998, the American Institute of Certified Public Accountants ("AICPA") issued Statement of Position ("SOP") No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." This SOP provides guidance for determining when to capitalize or expense costs incurred to develop or obtain internal-use software. This statement became effective for the Company's financial statements beginning January 1, 1999, with its requirements applied to costs incurred on or after such date. The adoption of this SOP did not have a material effect on the Company's consolidated financial statements. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. The statement requires that changes in a derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement, and requires that a company must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. As issued, this statement was to become effective for the Company's financial statements beginning January 1, 2000. However, in June 1999, the FASB issued SFAS No. 137 which delayed for one year the effective date of SFAS No. 133. As a result, SFAS No. 133 will become effective for the Company's financial statements beginning January 1, 2001 and is not allowed to be applied retroactively to financial statements of prior periods. At such effective date, SFAS No. 133 must be applied to (i) all freestanding derivative instruments and (ii) all embedded derivative instruments required by the statement to be separated from their host contracts (or, at the Company's election, only those derivatives embedded in hybrid instruments issued, acquired or substantively modified on or after January 1, 1998 or January 1, 1999). The Company is currently evaluating the impact on its financial statements of adopting this statement. Adoption of this statement could result in increased volatility in the Company's earnings and other comprehensive income. 8. LITIGATION AND CONTINGENCIES Prior to July 31, 1997, Valero was a wholly owned subsidiary of Valero Energy Corporation ("Energy"). Energy was engaged in both the refining and marketing business and the natural gas related services business. On July 31, 1997, Energy spun off Valero to Energy's stockholders and merged its remaining natural gas related services business with a wholly owned subsidiary of PG&E Corporation ("PG&E") (the "Restructuring"). Energy and certain of its natural gas related subsidiaries, as well as the Company, have been sued by Teco Pipeline Company ("Teco") regarding the operation of the 340-mile 10 11 VALERO ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED) West Texas pipeline in which a subsidiary of Energy holds a 50% undivided interest. In 1985, a subsidiary of Energy sold a 50% undivided interest in the pipeline and entered into a joint venture through an ownership agreement and an operating agreement, each dated February 28, 1985, with the purchaser of the interest. In 1988, Teco succeeded to that purchaser's 50% interest. A subsidiary of Energy has at all times been the operator of the pipeline. Notwithstanding the written ownership and operating agreements, the plaintiff alleges that a separate, unwritten partnership agreement exists, and that the defendants have exercised improper dominion over such alleged partnership's affairs. The plaintiff also alleges that the defendants acted in bad faith by negatively affecting the economics of the joint venture in order to provide financial advantages to facilities or entities owned by the defendants and by allegedly usurping for the defendants' own benefit certain opportunities available to the joint venture. The plaintiff asserts causes of action for breach of fiduciary duty, fraud, tortious interference with business relationships, professional malpractice and other claims, and seeks unquantified actual and punitive damages. Energy's motion to compel arbitration was denied, but Energy has filed an appeal. Energy has also filed a counterclaim alleging that the plaintiff breached its own obligations to the joint venture and jeopardized the economic and operational viability of the pipeline by its actions. Energy is seeking unquantified actual and punitive damages. Although PG&E previously acquired Teco and now owns both Teco and Energy, PG&E's Teco acquisition agreement purports to assign the benefit or detriment of this lawsuit to the former shareholders of Teco. Pursuant to the agreement by which the Company was spun off to Energy's stockholders in connection with the Restructuring, the Company has agreed to indemnify Energy with respect to this lawsuit to the extent of 50% of the amount of any final judgment or settlement amount not in excess of $30 million, and 100% of that part of any final judgment or settlement amount in excess of $30 million. The Company is also a party to additional claims and legal proceedings arising in the ordinary course of business. The Company believes it is unlikely that the final outcome of any of the claims or proceedings to which the Company is a party would have a material adverse effect on the Company's financial statements; however, due to the inherent uncertainty of litigation, the range of possible loss, if any, cannot be estimated with a reasonable degree of precision and there can be no assurance that the resolution of any particular claim or proceeding would not have an adverse effect on the Company's results of operations for the interim period in which such resolution occurred. 9. SUBSEQUENT EVENTS On July 29, 1999, the Company's Board of Directors declared a regular quarterly cash dividend of $.08 per common share payable September 8, 1999, to holders of record at the close of business on August 11, 1999. 11 12 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS SECOND QUARTER 1999 COMPARED TO SECOND QUARTER 1998 FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended June 30, ------------------------------------------------------------------ Change ------------------------ 1999 1998 (1) Amount % ------------ ------------ ---------- ----- Operating revenues ........................... $ 1,824,450 $ 1,448,104 $ 376,346 26% Cost of sales ................................ (1,680,888) (1,234,326) (446,562) (36) Operating costs: Cash (fixed and variable) ................ (115,098) (102,818) (12,280) (12) Depreciation and amortization ............ (33,738) (27,504) (6,234) (23) Selling and administrative expenses (including related depreciation expense) ............ (15,459) (19,132) 3,673 19 ------------ ------------ ---------- Total operating income (loss) ........ $ (20,733) $ 64,324 $ (85,057) (132) ============ ============ ========== Other income, net ............................ $ 1,066 $ 482 $ 584 121 Interest and debt expense, net ............... $ (14,518) $ (7,167) $ (7,351) (103) Income tax (expense) benefit ................. $ 12,100 $ (17,700) $ 29,800 168 Net income (loss) ............................ $ (22,085) $ 39,939 $ (62,024) (155) Earnings (loss) per share of common stock - assuming dilution ........................ $ (.39) $ .70 $ (1.09) (156) Earnings before interest, taxes, depreciation and amortization ("EBITDA") .............. $ 15,129 $ 93,299 $ (78,170) (84) Ratio of EBITDA to interest incurred ......... .9x 11.3x (10.4)x (92)
- --------- (1) Excludes the operations of the Paulsboro Refinery which commenced September 17, 1998. 12 13 OPERATING HIGHLIGHTS
Three Months Ended June 30, ----------------------------------------------- Change --------------------- 1999 1998 (1) Amount % ------- ------- ------- ------- Sales volumes (Mbbls per day) .................... 1,037 873 164 19% Throughput volumes (Mbbls per day) ............... 716(2) 550 166 30 Average throughput margin per barrel ............. $ 2.20 $ 4.27 $ (2.07) (48) Operating costs per barrel: Cash (fixed and variable) .................... $ 1.76 $ 2.05 $ (.29) (14) Depreciation and amortization ................ .52 .55 (.03) (5) ------- ------- ------- Total operating costs per barrel ......... $ 2.28 $ 2.60 $ (.32) (12) ======= ======= ======= Charges: Crude oils: Sour ..................................... 43% 29% 14% 48% Heavy sweet .............................. 16 26 (10) (38) Light sweet .............................. 9 13 (4) (31) ------- ------- ------- Total crude oils ..................... 68 68 -- -- High-sulfur residual fuel oil ("resid") ...... 3 11 (8) (73) Low-sulfur resid ............................. 7 1 6 600 Other feedstocks and blendstocks ............. 22 20 2 10 ------- ------- ------- Total charges ............................ 100% 100% -- % -- ======= ======= ======= Yields: Gasolines and blendstocks .................... 53% 54% (1)% (2)% Distillates .................................. 28 28 -- -- Petrochemicals ............................... 4 4 -- -- Lubes and asphalts ........................... 3 -- 3 -- Other products ............................... 12 14 (2) (14) ------- ------- ------- Total yields ............................. 100% 100% -- % -- ======= ======= =======
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS (U.S. GULF COAST) (DOLLARS PER BARREL)
Three Months Ended June 30, ----------------------------------------------- Change ------------------ 1999 1998 Amount % --------- --------- -------- ---- Feedstocks: West Texas Intermediate ("WTI") crude oil ......... $ 17.63 $ 14.65 $ 2.98 20% WTI less sour crude oil (Arab medium) (3) ......... $ 2.85 $ 3.92 $ (1.07) (27) WTI less heavy sweet crude oil (Cabinda) (3) ...... $ 1.29 $ .94 $ .35 37 WTI less high-sulfur resid (Singapore) (3) ........ $ 2.36 $ 1.33 $ 1.03 77 Products: Conventional 87 gasoline less WTI ................. $ 2.85 $ 4.75 $ (1.90) (40) No. 2 fuel oil less WTI ........................... $ (.62) $ 1.76 $ (2.38) (135) Propylene less WTI ................................ $ (1.90) $ 1.47 $ (3.37) (229)
- --------- (1) Excludes the operations of the Paulsboro Refinery which commenced September 17, 1998. (2) Includes 177 Mbbls per day related to the Paulsboro Refinery. (3) Excludes $.25 to $.50 per barrel for other delivery-related costs into the Company's refineries. 13 14 The Company reported a net loss for the second quarter of 1999 of $22.1 million, or $.39 per share, compared to net income of $40.0 million, or $.70 per share, for the second quarter of 1998. The decline in second quarter results was due primarily to exceptionally weak refining industry fundamentals in the 1999 period which resulted in the lowest refining margins in over 15 years, and, to a lesser extent, to increased interest expense. Partially offsetting the decreases in income resulting from these factors were significant reductions in cash operating costs (excluding the effect of the Paulsboro Refinery which was acquired in September 1998) and selling and administrative expenses resulting from the Company's comprehensive cost reduction efforts. Operating revenues increased $376.3 million, or 26%, to $1.8 billion during the second quarter of 1999 compared to the same period in 1998 due to a 19% increase in average daily sales volumes and a $1.10, or 6%, increase in the average sales price per barrel. The increase in sales volumes was due to additional volumes attributable to the acquisition of the Paulsboro Refinery. The increase in sales prices was attributable primarily to markedly higher crude oil prices resulting from a decision by OPEC in March 1999 to reduce crude oil production. However, refined product prices did not increase as much as crude oil prices due to above-average refined product inventory levels. Inventories continued to be at above-average levels due to high refinery utilization rates, higher gasoline imports and weak distillate demand. Operating income decreased $85.1 million during the second quarter of 1999 compared to the second quarter of 1998 resulting in an operating loss in the 1999 period of $20.7 million. This decrease in operating income was due primarily to an approximate $70 million decrease in total throughput margins. Also contributing to the decrease in operating income was the inclusion in the 1999 quarter of approximately $31 million of operating costs attributable to the Paulsboro Refinery. Partially offsetting these decreases was an approximate $13 million decrease in operating costs for all refineries exclusive of the Paulsboro Refinery, as well as an approximate $4 million decrease in selling and administrative expenses (including related depreciation expense), resulting mainly from a Company-wide effort to reduce costs. Total throughput margins were negatively affected, both in total and on a per-barrel basis, by (i) significantly lower gasoline and distillate margins (average distillate margins were negative in the 1999 second quarter) resulting primarily from the change in crude oil prices noted above in the discussion of operating revenues, and (ii) lower petrochemical margins resulting from continuing depressed demand for petrochemical feedstocks due to the Asian economic crisis. Total throughput margins were also negatively affected by an approximate $19 million decrease in benefits from the Company's price risk management program, including an approximate $7 million decrease in results from trading activities. Partially offsetting the effects of the above factors was a positive contribution to total throughput margins from the Paulsboro Refinery. The above-noted decrease in operating costs for all refineries exclusive of the Paulsboro Refinery was due to a $16 million decrease in cash operating expenses resulting mainly from lower maintenance, fuel and other costs, partially offset by a $3 million increase in depreciation expense and amortization of deferred turnaround and catalyst costs. Net interest and debt expense increased $7.4 million to $14.5 million during the second quarter of 1999 compared to the same period in 1998 due primarily to an increase in borrowings resulting from the acquisition of the Paulsboro Refinery. Income taxes decreased $29.8 million, from a $17.7 million expense during the second quarter of 1998 to a $12.1 million benefit during the second quarter of 1999, due primarily to the decrease in pre-tax income. 14 15 YEAR-TO-DATE 1999 COMPARED TO YEAR-TO-DATE 1998 FINANCIAL HIGHLIGHTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
Six Months Ended June 30, ---------------------------------------------------------------------- Change ---------------------------- 1999 1998 (1) Amount % ------------ ------------ ---------- -------- Operating revenues .................................... $ 3,161,553 $ 2,810,463 $ 351,090 12% Cost of sales ......................................... (2,835,848) (2,422,102) (413,746) (17) Operating costs: Cash (fixed and variable) ......................... (234,540) (199,582) (34,958) (18) Depreciation and amortization ..................... (68,865) (52,443) (16,422) (31) Selling and administrative expenses (including related depreciation expense) ..................... (34,513) (36,756) 2,243 6 ------------ ------------ ---------- Operating income (loss), before inventory write-down ........................................ (12,213) 99,580 (111,793) (112) Write-down of inventories to market value ............. -- (37,673) 37,673 100 ------------ ------------ ---------- Total operating income (loss) ..................... $ (12,213) $ 61,907 $ (74,120) (120) ============ ============ ========== Other income, net ..................................... $ 987 $ 437 $ 550 126 Interest and debt expense, net ........................ $ (26,975) $ (13,989) $ (12,986) (93) Income tax (expense) benefit .......................... $ 13,400 $ (14,300) $ 27,700 194 Net income (loss) ..................................... $ (24,801) $ 34,055 $ (58,856) (173) Earnings (loss) per share of common stock - assuming dilution ................................. $ (.44) $ .59 $ (1.03) (175) Earnings before interest, taxes, depreciation and amortization ("EBITDA") ....................... $ 60,240 $ 154,057(2) $ (93,817) (61) Ratio of EBITDA to interest incurred .................. 2.0x 9.7x (7.7)x (79)
- --------- (1) Excludes the operations of the Paulsboro Refinery which commenced September 17, 1998. (2) Excludes the $37.7 million pre-tax write-down of inventories to market value. 15 16 OPERATING HIGHLIGHTS
Six Months Ended June 30, ----------------------------------------------------------- Change ------------------------- 1999 1998 (1) Amount % ------- -------- ------- ------- Sales volumes (Mbbls per day) .................... 1,043 845 198 23% Throughput volumes (Mbbls per day) ............... 707(2) 539 168 31 Average throughput margin per barrel ............. $ 2.54 $ 3.98(3) $ (1.44) (36) Operating costs per barrel: Cash (fixed and variable) .................... $ 1.83 $ 2.05 $ (.22) (11) Depreciation and amortization ................ .54 .54 -- -- ------- ------- ------- Total operating costs per barrel ......... $ 2.37 $ 2.59 $ (.22) (8) ======= ======= ======= Charges: Crude oils: Sour ..................................... 47% 31% 16% 52% Heavy sweet .............................. 14 21 (7) (33) Light sweet .............................. 10 13 (3) (23) ------- ------- ------- Total crude oils ..................... 71 65 6 9 High-sulfur resid ............................ 3 11 (8) (73) Low-sulfur resid ............................. 6 3 3 100 Other feedstocks and blendstocks ............. 20 21 (1) (5) ------- ------- ------- Total charges ............................ 100% 100% -- % -- ======= ======= ======= Yields: Gasolines and blendstocks .................... 52% 54% (2)% (4) Distillates .................................. 29 28 1 4 Petrochemicals ............................... 4 4 -- -- Lubes and asphalts ........................... 3 -- 3 -- Other products ............................... 12 14 (2) (14) ------- ------- ------- Total yields ............................. 100% 100% -- % -- ======= ======= =======
AVERAGE MARKET REFERENCE PRICES AND DIFFERENTIALS (U.S. GULF COAST) (DOLLARS PER BARREL)
Six Months Ended June 30, ------------------------------------------------- Change -------------------- 1999 1998 Amount % --------- --------- -------- ------ Feedstocks: WTI crude oil ..................................... $ 15.34 $ 15.30 $ .04 -- % WTI less sour crude oil (Arab medium) (4) ......... $ 2.95 $ 3.58 $ (.63) (18) WTI less heavy sweet crude oil (Cabinda) (4) ...... $ 1.13 $ 1.29 $ (.16) (12) WTI less high-sulfur resid (Singapore) (4) ........ $ 1.68 $ 2.59 $ (.91) (35) Products: Conventional 87 gasoline less WTI ................. $ 2.26 $ 3.78 $ (1.52) (40) No. 2 fuel oil less WTI ........................... $ (.16) $ 1.77 $ (1.93) (109) Propylene less WTI ................................ $ (1.10) $ 2.68 $ (3.78) (141)
- --------- (1) Excludes the operations of the Paulsboro Refinery which commenced September 17, 1998. (2) Includes 175 Mbbls per day related to the Paulsboro Refinery. (3) Excludes a $.39 per barrel reduction resulting from the effect of the $37.7 million pre-tax write-down of inventories to market value. (4) Excludes $.25 to $.50 per barrel for other delivery-related costs into the Company's refineries. 16 17 The Company reported a net loss for the first six months of 1999 of $24.8 million, or $.44 per share, compared to net income of $34.1 million, or $.59 per share, for the first six months of 1998. The results for the 1998 period were reduced by a $37.7 million ($23.9 million after-tax) write-down in the carrying amount of the Company's refinery inventories resulting from a significant decline in feedstock and refined product prices during the 1998 first quarter. Excluding the effect of the 1998 inventory write-down, results for the first six months of 1999 were significantly below 1998 levels for the same period due primarily to extremely weak refining industry fundamentals in the 1999 period, the effect of significant downtime at the Company's Corpus Christi refinery in early 1999 due to a major maintenance turnaround and expansion of the heavy oil cracker and related units, and increased interest expense. Partially offsetting the decreases in income resulting from these factors were significant reductions in cash operating costs (excluding the effect of the Paulsboro Refinery which was acquired in September 1998) and selling and administrative expenses resulting from the Company's comprehensive cost reduction efforts, increased benefits from the Company's price risk management activities, and a benefit to income related to a permanent reduction in LIFO inventories during the first quarter of 1999 (see Note 3 of Notes to Consolidated Financial Statements). Operating revenues increased $351.1 million, or 12%, to $3.2 billion during the first six months of 1999 compared to the same period in 1998 due to a 23% increase in average daily sales volumes, partially offset by a $1.62, or 9%, decrease in the average sales price per barrel. The increase in sales volumes was due primarily to additional volumes attributable to the September 1998 acquisition of the Paulsboro Refinery, while the decrease in sales prices was due to the industry's high level of refined product inventories which resulted in depressed refined product prices. Excluding the effect of the $37.7 million inventory write-down in the first six months of 1998 described above, operating income decreased $111.8 million during the first six months of 1999 compared to the same period in 1998 resulting in an operating loss in the 1999 period of $12.2 million. This decrease in operating income was due primarily to an approximate $63 million decrease in total throughput margins, approximately $66 million of operating costs attributable to the Paulsboro Refinery in the 1999 period, and a $9 million increase in depreciation expense and amortization of deferred turnaround and catalyst costs for all refineries exclusive of the Paulsboro Refinery. Partially offsetting these decreases was an approximate $24 million reduction in cash operating costs for all refineries exclusive of the Paulsboro Refinery resulting mainly from lower maintenance and fuel costs as well as other cost-reduction efforts, and an approximate $2 million decrease in selling and administrative expenses (including related depreciation expense) due mainly to Company-wide cost reduction initiatives. Total throughput margins were negatively affected, both in total and on a per-barrel basis, by (i) significantly lower gasoline and distillate margins resulting primarily from the depressed refined product prices noted above and higher crude oil prices attributable to OPEC production cuts announced in March 1999, (ii) a decrease in feedstock discounts relative to WTI, and (iii) lower petrochemical margins resulting from continuing depressed demand for petrochemical feedstocks due to the Asian economic crisis. The negative effect on throughput margins resulting from the changes in gasoline and distillate margins and feedstock discounts was partially offset by a positive contribution from the Paulsboro Refinery in the 1999 period, an approximate $15 million increase in benefits from the Company's price risk management program, including an approximate $6 million increase in gains from trading activities, and a $10.5 million benefit resulting from the liquidation of LIFO inventories in the 1999 period. Net interest and debt expense increased $13.0 million, or 93%, to $27.0 million during the first six months of 1999 compared to the same period in 1998 due primarily to an increase in borrowings resulting from the acquisition of the Paulsboro Refinery in September 1998. 17 18 Income taxes decreased $27.7 million, from a $14.3 million expense during the first six months of 1998 to a $13.4 million benefit during the same period in 1999, due primarily to a decrease in pre-tax income. OUTLOOK Thus far in the third quarter of 1999, gasoline margins have improved significantly from second quarter levels, rising above average historical levels, and are in excess of third quarter 1998 margins. This improvement has been due to a decline in gasoline inventories resulting from strong demand and a moderation of refinery utilization rates and European imports. Heating oil margins, although still below historical averages and third quarter 1998 levels, have recovered substantially from the negative margins in the 1999 second quarter and are approaching third quarter 1998 margins due to declining inventories resulting from reduced production. If these trends continue, and combined with anticipated benefits from the Company's cost-cutting initiatives begun earlier in 1999, earnings for the third quarter of 1999 should be significantly higher than earnings reported for the third quarter of 1998. LIQUIDITY AND CAPITAL RESOURCES Net cash provided by operating activities was $147.9 million during the first six months of 1999, a $5.2 million increase compared to the same period in 1998. The net cash provided by operating activities for the 1999 period was achieved primarily through a $114.5 million decrease in the amount of cash utilized for working capital purposes, as detailed in Note 4 of Notes to Consolidated Financial Statements. In the first six months of 1999, both accounts receivable and accounts payable increased due to a significant increase in commodity prices from December 31, 1998 to June 30, 1999. Combined with concerted efforts by the Company during such period to collect accounts receivable, which helped reduce the increase in receivables resulting from higher commodity prices, the Company realized a net decrease in cash utilized for working capital purposes. Included in the changes in current assets and current liabilities for the 1998 period was a decrease in both accounts receivable and accounts payable due primarily to a reduction in commodity prices from December 31, 1997 to June 30, 1998. During the first six months of 1999, cash provided by operating activities, proceeds from the issuance of the 7 3/8% notes described in Note 5 of Notes to Consolidated Financial Statements (approximately $298 million) and a portion of existing cash balances were utilized to reduce bank borrowings, fund capital expenditures and deferred turnaround and catalyst costs, and pay common stock dividends. The Company currently maintains an unsecured $835 million revolving bank credit and letter of credit facility that matures in November 2002 and is available for general corporate purposes including working capital needs and letters of credit. Borrowings under this facility bear interest at either LIBOR plus a margin, a base rate or a money market rate. The Company is also charged various fees and expenses in connection with this facility, including a facility fee and various letter of credit fees. The interest rate and fees under the credit facility are subject to adjustment based upon the credit ratings assigned to the Company's long-term debt. The credit facility includes certain restrictive covenants including a coverage ratio, a capitalization ratio, and a minimum net worth test. As of June 30, 1999, outstanding borrowings and letters of credit under this committed bank credit and letter of credit facility totaled approximately $295 million. The Company also has uncommitted short-term bank credit facilities under which amounts up to $130 million may be borrowed, along with uncommitted bank letter of credit facilities totaling $285 million. As of June 30, 1999, $31 million was outstanding under the short-term bank credit facilities, and letters of credit totaling approximately $48 million were outstanding under the uncommitted letter of credit facilities. As of June 30, 1999, the Company's debt to capitalization ratio was 47.3%. 18 19 During the first six months of 1999, the Company reduced its exposure to increases in interest rates and increased its financial flexibility by (i) issuing $300 million of seven-year 7 3/8% notes under its $600 million shelf registration statement and using the net proceeds to reduce variable rate bank borrowings and (ii) refinancing $25 million of its taxable, variable rate industrial revenue bonds with tax-exempt 5.7% fixed rate bonds. See Note 5 of Notes to Consolidated Financial Statements. As described in Note 2 of Notes to Consolidated Financial Statements, Mobil is entitled to receive payments from the Company in any of the five years following the Company's September 1998 acquisition of the Paulsboro Refinery if certain average refining margins during any of such years exceed a specified level. Based on margin levels since the acquisition date, no earn-out payments are currently anticipated to be made to Mobil in 1999. During the first six months of 1999, the Company expended approximately $111 million for capital investments, including capital expenditures of $58 million and deferred turnaround and catalyst costs of $53 million. The deferred turnaround and catalyst costs related primarily to (i) a major maintenance turnaround of the heavy oil cracker and related units at the Corpus Christi refinery in the first quarter, (ii) a catalyst change for the Corpus Christi hydrodesulfurization unit in the second quarter, and (iii) a turnaround and catalyst change of the Texas City Residfiner also in the second quarter. For total year 1999, the Company currently expects to incur approximately $175 million for capital investments, including approximately $110 million for capital expenditures and approximately $65 million for deferred turnaround and catalyst costs. The capital expenditure estimate includes approximately $20 million for computer system projects and approximately $10 million for projects related to environmental control and protection. On July 29, 1999, the Company's Board of Directors declared a regular quarterly cash dividend of $.08 per common share payable September 8, 1999, to holders of record at the close of business on August 11, 1999. The Company believes it has sufficient funds from operations, and to the extent necessary, from the public and private capital markets and bank markets, to fund its ongoing operating requirements. The Company expects that, to the extent necessary, it can raise additional funds from time to time through equity or debt financings; however, except for borrowings under bank credit agreements or offerings under its universal shelf registration statement that may occur from time to time, the Company has no other specific financing plans. NEW ACCOUNTING PRONOUNCEMENTS As discussed in Note 7 of Notes to Consolidated Financial Statements, various new financial accounting pronouncements have been issued by the AICPA and FASB which either became effective for the Company's financial statements beginning in 1999 or become effective in 2001. Except for SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," for which the impact has not yet been determined, the adoption of these statements has not had a material effect on the Company's consolidated financial statements. 19 20 YEAR 2000 READINESS DISCLOSURE BACKGROUND The transition to January 1, 2000 poses problems for almost all users of information technology ("IT"). These potential problems result from the fact that many computer programs created in the past were programmed to identify calendar dates with only the last two digits of the year. As a result, such programs are unable to distinguish between the year 1900 and the year 2000, potentially resulting in miscalculations, malfunctions or failures of such programs. In addition to its potential effect on computer systems, the century date change may also result in malfunctions or failures of non-IT equipment which contain embedded systems with date-sensitive functions. These potential consequences are generally referred to as the "Year 2000" problem. STATE OF READINESS In 1996, in order to improve business processes, reduce costs, integrate business information, improve access to such information, and provide flexibility for ongoing business changes, the Company began the implementation of new client/server based systems which will run substantially all of the Company's principal business software applications. These new systems have been represented as Year 2000 compliant by their respective manufacturers and were substantially implemented by the end of 1998. In order to verify the Year 2000 compliance of the above noted systems, and address the Year 2000 problem with respect to other IT systems and non-IT embedded systems, the Company has developed a compliance plan with respect to those systems and services that are deemed to be critical to the Company's operations and safety of its employees. This plan is divided into the following sections, which represent major business areas that are potentially affected by the Year 2000 problem: Business Systems (includes IT hardware, software and network systems serving the Company's corporate, refining, marketing and supply areas); Plant Facilities (includes non-IT embedded systems such as process control systems and the physical equipment and facilities at the Company's refineries); and Office Facilities/Aviation (includes telephone, security and environmental systems and office equipment at the Company's office facilities and aviation-related equipment and software). Implementation of the Company's Year 2000 compliance plan is led by a Management Oversight Committee, which includes members of executive management, and Year 2000 coordinators for each of the business areas described above. The compliance plan is monitored weekly by the business area coordinators and progress reported monthly to the Management Oversight Committee. The compliance plan includes the following phases and scheduled completion dates:
Scheduled Compliance Plan Phase Completion Date - ---------------------------------------------------------------------------------------- --------------- o Form internal Year 2000 organizations, both at the corporate and refinery level, to pursue relevant action plans. Completed o Inventory affected systems and services for all business areas and prioritize the importance of each particular system to the Company and its operations as either high, medium, or low priority. Completed (1) o Assess the compliance of inventoried items by contacting the vendor or manufacturer to determine whether the system is Year 2000 compliant. Completed (1) o Develop action plans to remediate (fix, replace, or discard) each of the non-compliant high and medium priority items (those items believed by the Company to have a risk involving the safety of individuals,
20 21 significant damage to equipment, the environment, or communications, or a significant loss of revenues). Completed (1) o Remediate the non-compliant high and medium priority items by implementing the plans developed above. 8/31/99 (2) o Validate Year 2000 compliance by testing, wherever possible, all high and medium priority items. 8/31/99 (2) o Develop contingency plans for (i) the most critical high-priority items, even if validated as compliant, and (ii) all high and medium priority items that cannot be tested. 9/30/99 (3)
- --------- (1) Although the Company-wide inventory, assessment and planning phases have been completed, other non- compliant items may be discovered during the remediation and testing phases. (2) The Company currently expects the remediation and testing phases to be substantially complete for each of its major business areas by August 31, 1999. Items for which remediation and/or testing is not expected to be complete by such date are anticipated to be remediated and/or tested prior to December 31, 1999. (3) The Company currently expects that each of its major business areas will have substantially completed its contingency plans by September 30, 1999. Plans remaining uncompleted at such date will be finalized, and completed plans will be refined, during the 1999 fourth quarter. The Company currently anticipates that completion of its Year 2000 compliance plan will be performed primarily by Company personnel. However, in certain cases, outside contractors or consultants have been engaged to assist in the Company's Year 2000 efforts and may be required in the future. Presently, no significant IT projects have been delayed due to the implementation of the Company's Year 2000 compliance plan. The following table indicates, as of August 5, 1999, the status of the Company's progress in completing the remediation and testing phases of its compliance plan. The "Remediated" percentages reported below represent the estimated percentage of total inventoried items (high, medium and low priority items for Business Systems and Office Facilities/Aviation, and high and medium priority items for Plant Facilities) that are now remediated. For Business Systems, the "Tested" percentage represents the percentage of total inventoried items that are now tested. However, for Office Facilities/Aviation and Plant Facilities, not all inventoried items will be tested due to various factors. Therefore, for these areas, the "Tested" percentage represents a percentage of items to be tested.
Remediated Tested ---------- ------ Business Systems........................................................... 96% 87% Office Facilities/Aviation................................................. 94 (1) 100 Plant Facilities........................................................... 99 96
- --------- (1) Declined from 96% as disclosed in the Company's first quarter 1999 Form 10-Q due to the inclusion of additional inventoried items which were not included in the prior disclosure. In addition to the major business areas described above, the Company's External Service Providers (third-party relationships material to the Company's operations, including (i) service providers for the Company's Business Systems, Plant Facilities and Office Facilities/Aviation described above, (ii) "supply" relationships such as major suppliers of refinery feedstocks, (iii) "marketing" relationships such as major customers and pricing services, and (iv) "logistics" relationships such as pipelines, terminals, ships, barges and storage facilities) could equally be affected by the Year 2000 problem, which in turn could have an impact on the Company's business. For that reason, Year 2000 compliance of the External Service Providers 21 22 which the Company believes to be critical is also being assessed as part of the Company's Year 2000 compliance plan. Over 70 Year 2000 questionnaires have been sent to External Service Providers deemed to be critical. Additionally, approximately 700 questionnaires have been sent to External Service Providers classified as either high or low priority. As of August 5, 1999, responses have been received for approximately 66% of the total questionnaires sent (78% of critical service providers). The percentage of questionnaires received for critical service providers declined from 83% as reported in the Company's first quarter 1999 Form 10-Q due to a re-prioritization of External Service Providers during the 1999 second quarter. A risk assessment of the responses is expected to be completed by August 31, 1999 for all critical and high priority External Service Providers, and contingency plans are expected to be developed for all critical External Service Providers by September 30, 1999. Contingency plans may also be developed for certain External Service Providers not deemed to be critical depending upon their priority and level of risk. COSTS Total external costs incurred to date in connection with the completion of the Company's Year 2000 compliance plan are approximately $1 million. The estimated total external costs to complete the Company's Year 2000 compliance plan are currently estimated to be approximately $4 million. The Company does not separately track internal costs, principally consisting of payroll and related costs for its information systems group and certain other employees, incurred in connection with its Year 2000 compliance efforts. The above amounts do not include costs associated with the implementation of the new client/server based systems described under "State of Readiness." RISKS The scheduled completion dates and costs of compliance noted above are the current best estimates of the Company's management and are believed to be reasonably accurate. In the event unanticipated problems are encountered which cause the compliance plan to fall behind schedule, the Company may need to devote more resources to completing the plan and additional costs may be incurred. If the Company were not able to satisfactorily complete its Year 2000 compliance plan, including identifying and resolving problems encountered by the Company's External Service Providers, potential consequences could include, among other things, unit downtime at or damage to the Company's refineries, delays in transporting refinery feedstocks and refined products, impairment of relationships with significant suppliers or customers, loss of accounting data or delays in processing such data, and loss of or delays in internal and external communications. The occurrence of any or all of the above could result in a material adverse effect on the Company's results of operations, liquidity or financial condition. Although the Company currently believes that it will satisfactorily complete its Year 2000 compliance plan as described above prior to January 1, 2000, there can be no assurance that the plan will be completed by such time or that the Year 2000 problem will not adversely affect the Company and its business. CONTINGENCY PLANS During the second quarter of 1999, the Company made substantial progress in developing Year 2000 contingency plans for its Business Systems, Plant Facilities and Office Facilities/Aviation business areas, as well as for various key corporate departments and certain critical External Service Providers. These plans consist of documenting established plans of action to be followed in the event certain assumed Year 2000 disruption scenarios occur during the period January 1-15, 2000 and are designed to accomplish the following objectives: (i) continue critical Company business operations; (ii) minimize the decisions and effort required to continue business operations; (iii) minimize dependence on any one person to continue business operations; 22 23 (iv) minimize the risks to the Company in terms of diminished cash flow, income, assets or customer relations; and (v) establish lines of communication to be followed while the plans are in action. As discussed above, the Company currently anticipates that contingency planning will be substantially complete by September 30, 1999. YEAR 2000 INFORMATION AND READINESS DISCLOSURE ACT To the maximum extent permitted by applicable law, the above information is being designated as a "Year 2000 Readiness Disclosure" pursuant to the "Year 2000 Information and Readiness Disclosure Act" which was signed into law on October 19, 1998. FORWARD-LOOKING STATEMENTS The foregoing discussion contains certain estimates, predictions, projections and other "forward-looking statements" (within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934) that involve various risks and uncertainties. While these forward-looking statements, and any assumptions upon which they are based, are made in good faith and reflect the Company's current judgment regarding the direction of its business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions, or other future performance suggested herein. Some important factors (but not necessarily all factors) that could affect the Company's sales volumes, growth strategies, future profitability and operating results, or that otherwise could cause actual results to differ materially from those expressed in any forward-looking statement include the following: renewal or satisfactory replacement of the Company's feedstock arrangements as well as market, political or other forces generally affecting the pricing and availability of refinery feedstocks and refined products; accidents or other unscheduled shutdowns affecting the Company's, its suppliers' or its customers' pipelines, plants, machinery or equipment; excess industry capacity; competition from products and services offered by other energy enterprises; changes in the cost or availability of third-party vessels, pipelines and other means of transporting feedstocks and products; cancellation of or failure to implement planned capital projects and realize the various assumptions and benefits projected for such projects; the failure to avoid or correct a material Year 2000 problem, including internal problems or problems encountered by third parties; state and federal environmental, economic, safety and other policies and regulations, any changes therein, and any legal or regulatory delays or other factors beyond the Company's control; weather conditions affecting the Company's operations or the areas in which the Company's products are marketed; rulings, judgments, or settlements in litigation or other legal matters, including unexpected environmental remediation costs in excess of any reserves; the introduction or enactment of federal or state legislation which may adversely affect the Company's business or operations; and changes in the credit ratings assigned to the Company's debt securities and trade credit. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the foregoing. The Company undertakes no obligation to publicly release the result of any revisions to any such forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. 23 24 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK COMMODITY PRICE RISK The Company is exposed to market risks related to the volatility of crude oil and refined product prices, as well as volatility in the price of natural gas used in the Company's refining operations. In order to reduce the risks of these price fluctuations, the Company uses derivative commodity instruments to hedge certain refinery feedstock and refined product inventories to reduce the impact of adverse price changes on these inventories before the conversion of the feedstock to finished products and ultimate sale. The Company also uses derivative commodity instruments to hedge the price risk of anticipated transactions. Such transactions include anticipated feedstock, product and natural gas purchases, and product sales. These instruments are used to lock in purchase or sales prices or components of refining operating margins, including feedstock discounts, crack spreads (i.e., the difference between the price of crude oil and conventional gasoline or heating oil) and premium product differentials. In addition, the Company uses derivative commodity instruments for trading purposes using its fundamental and technical analysis of market conditions to earn additional revenues. The types of instruments used in the Company's hedging and trading activities described above include price swaps, options, and futures contracts. The Company's positions in derivative commodity instruments are monitored and managed on a daily basis by a risk control group to ensure compliance with the Company's stated risk management policy which has been approved by the Company's Board of Directors. The following table provides information about the Company's derivative commodity instruments, which mature in 1999, held to hedge refining inventories as of June 30, 1999 (dollars in thousands, except per barrel amounts). Volumes shown for swaps represent notional volumes which are used to calculate amounts due under the agreements.
Fixed Price ------------------------------ Payor Receiver --------- ----------- Swaps: Notional volumes (Mbbls)............................. -- 600 Weighted average pay price (per bbl)................. -- $ .26 Weighted average receive price (per bbl)............. -- $ .37 Fair value........................................... -- $ 68 Futures: Volumes (Mbbls)...................................... 2,679 8,645 Weighted average price (per bbl)..................... $ 18.62 $ 19.95 Contract amount...................................... $ 49,879 $ 172,428 Fair value........................................... $ 52,948 $ 182,242
24 25 The following table provides information about the Company's derivative commodity instruments held to hedge anticipated feedstock and product purchases, product sales and refining margins as of June 30, 1999 and which mature in 1999 or 2000 (dollars in thousands, except amounts per barrel).
Mature in 1999 Mature in 2000 ---------------------- ---------------------- Fixed Price Fixed Price ---------------------- ---------------------- Payor Receiver Payor Receiver ------- --------- ------- --------- Futures: Volumes (Mbbls) ......................... 14 5 250 402 Weighted average price (per bbl) ........ $ 19.89 $ 19.24 $ 18.39 $ 18.20 Contract amount ......................... $ 279 $ 96 $ 4,598 $ 7,316 Fair value .............................. $ 299 $ 103 $ 5,035 $ 8,160
In addition to the above, as of June 30, 1999, the Company was the fixed price payor under certain swap contracts held to hedge anticipated purchases of refinery feedstocks and refined products that mature in 2002 with notional volumes totaling approximately 7.5 million barrels, a weighted average pay price of $20.11 per barrel, a weighted average receive price of $17.72 per barrel, and a net unrecognized fair value of approximately $5 million. The following table provides information about the Company's derivative commodity instruments held or issued for trading purposes as of June 30, 1999 and which mature in 1999 or 2000 (dollars in thousands, except amounts per barrel or per million British thermal units ("MMBtu")). Volumes shown for swaps represent notional volumes which are used to calculate amounts due under the agreements.
Mature in 1999 Mature in 2000 -------------------------- --------------------------- Fixed Price Fixed Price -------------------------- --------------------------- Payor Receiver Payor Receiver --------- -------- --------- --------- Swaps: Notional volumes (Mbbls) ..................... 17,250 15,775 13,650 14,025 Weighted average pay price (per bbl) ......... $ 1.97 $ 1.64 $ 1.89 $ 1.82 Weighted average receive price (per bbl) ..... $ 1.89 $ 1.96 $ 1.78 $ 2.17 Fair value ................................... $ (1,393) $ 5,034 $ (1,481) $ 5,005 Notional volumes (MMBtus) .................... 620 620 -- -- Weighted average pay price (per MMBtu) ....... $ 2.13 $ 1.31 -- -- Weighted average receive price (per MMBtu) ... $ 1.31 $ 2.32 -- -- Fair value ................................... $ (504) $ 622 -- -- Options: Volumes (Mbbls) .............................. 1,500 2,400 -- -- Weighted average strike price (per bbl) ...... $ 17.59 $ 11.59 -- -- Contract amount .............................. $ 544 $ 515 -- -- Fair value ................................... $ 1,674 $ 1,674 -- -- Futures: Volumes (Mbbls) .............................. 21,369 21,314 6,387 6,447 Weighted average price (per bbl) ............. $ 17.19 $ 17.12 $ 15.22 $ 14.91 Contract amount .............................. $ 367,241 $364,919 $ 97,237 $ 96,131 Fair value ................................... $ 415,242 $409,009 $ 115,800 $116,921
25 26 INTEREST RATE RISK The Company's primary market risk exposure for changes in interest rates relates to the Company's long-term debt obligations. The Company manages its exposure to changing interest rates principally through the use of a combination of fixed and floating rate debt and currently does not use derivative financial instruments to manage such risk. See Management's Discussion and Analysis of Financial Condition and Results of Operations Liquidity and Capital Resources for a discussion of various initiatives undertaken by the Company in the first six months of 1999 to reduce its exposure to increases in interest rates and increase its financial flexibility. 26 27 PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. On November 25, 1998, the Texas Natural Resources Conservation Commission ("TNRCC") initiated an enforcement action against the Company's Corpus Christi refinery alleging violations of state and federal air regulations and proposed an Agreed Order settlement of $226,050. The TNRCC alleged that nitrous oxide emission monitors were not installed in two utility boiler stacks and certain record keeping and monitoring deficiencies. The Company challenged the allegations and on June 16, 1999 a final settlement was reached with the TNRCC for $111,000 in penalties. All deficiencies noted by the TNRCC have been corrected. On June 11, 1999, the TNRCC notified the Company of its commencement of proceedings against the Company's Texas City refinery concerning certain record keeping deficiencies and alleged emissions exceedances which occurred prior to the Company's acquisition of the refinery. Corrective action was immediately taken and all contested matters have been resolved. Settlement negotiations are ongoing with the TNRCC and the Company expects that the penalties imposed will be less than $150,000. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. The Company's annual meeting of stockholders was held April 29, 1999. Matters voted on at the meeting and the results thereof were (i) a proposal to elect three Class II directors to serve until 2002: Ronald K. Calgaard (approved with 50,578,078 affirmative votes, and 146,872 abstentions), William E. Greehey (approved with 50,567,965 affirmative votes, and 156,985 abstentions), and Susan Kaufman Purcell (approved with 50,577,287 affirmative votes, and 147,663 abstentions); and (ii) a proposal to ratify the appointment of Arthur Andersen LLP as independent public accountants (approved with 50,687,560 affirmative votes, 20,259 negative votes, and 17,131 abstentions). Directors whose term of office continued after the meeting were: Edward C. Benninger, Robert G. Dettmer, Ruben M. Escobedo, James L. Johnson and Lowell H. Lebermann. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. *+10.18 Employment Agreement dated March 25, 1999, effective as of April 29, 1999 between Valero Energy Corporation and William E. Greehey. **27.1 Financial Data Schedule (reporting financial information as of and for the six months ended June 30, 1999). - -------------------------- * Filed herewith + Identifies a management contract or compensatory plan or arrangement required to be filed as an exhibit hereto pursuant to Item 6(a) of Form 10-Q. ** The Financial Data Schedule shall not be deemed "filed" for purposes of Section 11 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, and is included as an exhibit only to the electronic filing of this Form 10-Q in accordance with Item 601(c) of Regulation S-K and Section 401 of Regulation S-T. (b) Reports on Form 8-K. The Company did not file any Current Reports on Form 8-K during the quarter ended June 30, 1999. 27 28 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. VALERO ENERGY CORPORATION (Registrant) By: /s/ John D. Gibbons ----------------------------------- John D. Gibbons Chief Financial Officer, Vice President - Finance (Duly Authorized Officer and Principal Financial and Accounting Officer) Date: August 13, 1999 28 29 EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION ------- ----------- *+10.18 Employment Agreement dated March 25, 1999, effective as of April 29, 1999 between Valero Energy Corporation and William E. Greehey. **27.1 Financial Data Schedule (reporting financial information as of and for the six months ended June 30, 1999).
- -------------------------- * Filed herewith + Identifies a management contract or compensatory plan or arrangement required to be filed as an exhibit hereto pursuant to Item 6(a) of Form 10-Q. ** The Financial Data Schedule shall not be deemed "filed" for purposes of Section 11 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, and is included as an exhibit only to the electronic filing of this Form 10-Q in accordance with Item 601(c) of Regulation S-K and Section 401 of Regulation S-T. EX-10.18 2 EMPLOYMENT AGREEMENT - WILLIAM E. GREEHEY 1 EXHIBIT 10.18 EMPLOYMENT AGREEMENT This Employment Agreement ("Agreement"), between Valero Energy Corporation, a Delaware corporation ("Valero"), and William E. Greehey, a resident of San Antonio, Texas, ("Mr. Greehey") is executed effective as of the 25th day of March 1999 ("Effective Date"). Valero and Mr. Greehey are sometimes referred to herein individually as a "Party," and collectively as the "Parties." The Parties hereby agree as follows: 1. Employment. Valero hereby employs Mr. Greehey, and Mr. Greehey hereby accepts employment with Valero, subject to the terms and conditions set forth in this Agreement. 2. Term. Subject to the provisions for termination of employment as provided in Section 9(a), this Agreement shall be in effect beginning on the Effective Date and ending on July 31, 2001 ("Initial Period"). If Mr. Greehey notifies Valero at least ninety (90) calendar days prior to the end of the Initial Period of his intention to extend this Agreement, then this Agreement shall be extended on a month-to-month basis ("Extension Period"). Mr. Greehey may terminate this Agreement within the Extension Period by giving Valero ninety (90) calendar days written notice of termination. 3. Compensation. Mr. Greehey's compensation during his employment under the terms of this Agreement and prior to his retirement shall be as follows: (a) Base Salary. Valero shall pay to Mr. Greehey a base salary (the "Base Salary") of Nine Hundred Thousand Dollars ($900,000) per year. In addition, the Board of Directors of Valero shall in good faith consider granting annual increases to the Base Salary based upon such factors as Mr. Greehey's performance and the growth and profitability of Valero, but it shall have no obligation to grant any such increases in compensation; provided that, based upon the same such factors, the Board of Directors of Valero may thereafter reduce the Base Salary to an amount that is not below the amount first set forth above in this Paragraph 3(a). The Base Salary, as from time to time so increased or subsequently decreased, shall be payable in equal, semi-monthly installments on the 15th day and last day of each month or at such other times and in such installments as may be agreed between Valero and Mr. Greehey. All payments shall be subject to the deduction of payroll taxes, income tax withholdings, and similar deductions and withholdings as required by law. (b) Bonus. In addition to the Base Salary, Mr. Greehey shall be eligible to receive bonus compensation in such amounts and at such times as the Board of Directors of Valero shall from time to time determine. In the year of his retirement, Mr. Greehey shall be eligible to receive a pro-rata share of bonus compensation in such amount as the Board of Directors of Valero shall determine at the customary time annual bonuses are determined and paid to executive officers of Valero. (c) Stock Option Grant. On the Effective Date, Mr. Greehey shall receive a nonqualified stock option grant (each an "Option") to purchase 860,000 shares of $.01 par 2 value common stock of Valero ("Common Stock"), with an exercise price per share equal to the fair market value of the Common Stock on the Effective Date. Fifty percent (50%) of the options shall vest on the first anniversary of the Effective Date and the remaining 50% shall vest on the second anniversary of the Effective Date, and the options shall have a total term of ten years from the Effective Date. These vesting periods shall not be modified by the accelerated vesting provisions set forth in Paragraph 7(f). (d) Performance Share Award. On the Effective Date, Mr. Greehey shall receive an award of 150,000 Performance Shares under Valero's Executive Stock Incentive Plan. Fifty percent (50%) of the Performance Shares shall vest on the first anniversary of the Effective Date and the remaining 50% shall vest on the second anniversary of the Effective Date. The Performance Shares shall be available to be earned on each vesting date pursuant to established performance criteria set forth in the award agreement to be entered into between Mr. Greehey and Valero. 4. Expenses and Benefits. During his employment, Mr. Greehey is authorized to incur reasonable expenses in connection with the business of Valero, including expenses for entertainment, travel and similar matters. Valero will reimburse Mr. Greehey for such expenses upon presentation by Mr. Greehey of such accounts and records as Valero may from time to time reasonably require. Valero also agrees to provide Mr. Greehey with the following benefits during employment: (a) Insurance. Permanent life insurance in accordance with Paragraph 7(g) in addition to any life insurance under Valero's normal benefit plans. (b) Employee Benefit Plans. Participation in any employee benefit plans now existing or hereafter adopted by Valero for its executives or other officers and employees. (c) Club Memberships. Valero shall reimburse Mr. Greehey for all monthly dues and fees for Mr. Greehey's present country club memberships and for any expenses incurred by Mr. Greehey in connection with such club memberships in representing Valero's interests. (d) Vacations. Mr. Greehey shall be entitled (in addition to the usual Valero holidays) to a paid vacation for a period in each calendar year not exceeding five weeks. (e) Working Facilities. Mr. Greehey shall be furnished by Valero with an office, secretarial help and other facilities and services, including but not limited to, full use of Valero's mail and communication facilities and services reasonably suitable to his position and reasonably necessary for the performance of his duties under this Agreement. (f) Tax Planning. Mr. Greehey will be furnished tax planning services by an independent certified public accounting firm of the type furnished to executive officers of Valero. (g) Other. Such other items as Valero shall from time to time consider necessary or appropriate to assist Mr. Greehey in or to provide incentives or compensation for the performance of his duties under this Agreement. 3 5. Positions and Duties. Mr. Greehey is employed as Chief Executive Officer of Valero and for no additional compensation shall, subject to his being elected or re-elected as a director by Valero's stockholders, serve at the discretion of the Board as its Chairman of the Board. In addition, if requested to do so, Mr. Greehey shall serve as the chief executive officer or as a member of the Board of Directors, or both, of any subsidiary or affiliate of Valero. Such duties shall be performed at Valero's principal place of business in San Antonio, Texas. 6. Extent of Service. Mr. Greehey shall, during his employment under the terms of this Agreement, devote substantially all of his working time, attention, energies and business efforts to his duties as an employee of Valero and to the business of Valero generally, and shall not, during the term of this Agreement, engage in any other business activity whatsoever, whether or not such business activity is pursued for gain, profit or other pecuniary advantage; however, this Paragraph 6 shall not be construed to prevent Mr. Greehey from serving as a member of the board of directors of other companies, or from investing his personal, private assets as a passive investor in such form or manner as will not require any active services on the part of Mr. Greehey in the management or operation of the affairs of the companies, partnerships, or other business entities in which any such passive investments are made. 7. Retirement. Notwithstanding the term and notice provisions of Paragraph 2, Mr. Greehey may retire at any time as Chief Executive Officer of Valero under the terms of this Agreement by giving Valero written notice of his intention to retire ninety (90) days in advance of the designated retirement date. Upon retirement, and provided that Valero has not terminated Mr. Greehey for cause pursuant to Paragraph 9(a), Mr. Greehey shall no longer be employed by Valero, but he shall have the following rights and obligations: (a) Continuation as Chairman. Subject to his being elected or re-elected as a director by Valero's stockholders, Mr. Greehey agrees to continue serving at the discretion of the Board as Chairman of the Board of Valero for two years following his effective date of retirement; (b) Duties. As Chairman of the Board of Valero, Mr. Greehey shall perform such duties as are reasonably required by a person holding such position. However, it is agreed and understood that Mr. Greehey shall not be obligated to devote any particular amount of time to the affairs of Valero over and above that which he determines is necessary to perform his duties as a director, and will be free to pursue other business interests provided the pursuit thereof does not violate any fiduciary duty owed to Valero in Mr. Greehey's capacity as Chairman of the Board or violate the provisions of Paragraphs 11 or 12; (c) Compensation. Mr. Greehey shall be paid for serving as Chairman of the Board for such two-year period an amount per annum equal to one-half of the Base Salary being paid to Mr. Greehey at the time of his retirement, which shall be payable in semi-monthly installments; (d) Working Facilities. Valero shall provide Mr. Greehey with off-site office facilities and secretarial and other office services reasonably commensurate with 4 Mr. Greehey's position as retired Chief Executive Officer of Valero. The office facilities and secretarial and other services to be provided to Mr. Greehey following his retirement shall continue until December 31, 2005. (e) Annual Physical Examination. Valero shall pay for an annual physical examination for Mr. Greehey for the remainder of his life. (f) Vesting and Option Exercise Periods. Upon retirement, Mr. Greehey's stock options, stock appreciation rights, restricted stock grants, performance share awards, and any other similar stock or long-term incentive rights or benefits previously granted to Mr. Greehey, which have not fully vested, shall immediately fully vest, except for any unvested stock options granted to Mr. Greehey pursuant to Paragraph 3(c). Mr. Greehey shall have the right to exercise any vested stock options or other similar stock or long-term incentive rights or benefits that have an option or exercise feature for the full remaining term thereof. Any outstanding performance share awards shall be deemed to have been earned at the target level for the full term and shares of Valero Common Stock representing such awards deemed earned at the target level shall promptly be issued to Mr. Greehey. (g) Retirement Benefits and Supplemental Retirement Benefits. Mr. Greehey shall be entitled to all retirement benefits provided under the Valero Energy Corporation Pension Plan ("Pension Plan") and Supplemental Executive Retirement Plan ("SERP"), with the following supplemental benefits: (i) retiree medical coverage consistent with coverage amounts and/or deductibles and costs as provided to other Valero retirees; (ii) paid up permanent life insurance, in addition to life insurance included in Valero's normal retirement benefit plans, with cash value of at least $300,000; (iii) a total of eight "points" under the SERP to be added to his years of credited service, or his age, or divided between both in such proportion that total eight, as he elects at the time of his retirement (the amount per month equal to the difference between Mr. Greehey's normal monthly retirement benefit under the Pension Plan and the SERP with the eight added points shall constitute a supplemental monthly retirement payment, payable at the time each payment is made under the Pension Plan; and for purposes of calculating Mr. Greehey's monthly retirement benefits, service shall be deemed continuous from August 19, 1963 through the date of retirement pursuant to this Agreement); and (iv) payments under any other employee benefit plan(s), which are due as a result of separation of service. Mr. Greehey shall not be entitled to participate in nor receive the benefits of any special "window" retirement or early retirement program, if any, that may from time to time be offered to other employees of Valero. 5 8. Death and Disability. (a) Death. (i) If during the term of Mr. Greehey's employment under this Agreement and prior to the date of retirement Mr. Greehey dies, then in addition to all other employee benefits to which Mr. Greehey's estate, spouse or other beneficiaries may be entitled, Valero shall pay in equal semi-monthly installments to the beneficiary designated by Mr. Greehey, or his estate if no such beneficiary has been designated in writing to Valero, the Base Salary that Mr. Greehey would have received if he had remained employed to the end of the Initial Period or, if his employment has been extended pursuant to Paragraph 2, to the end of the Extension Period. (ii) If during the term of Mr. Greehey's service as Chairman of the Board pursuant to Paragraph 7(a) Mr. Greehey dies, then in addition to all other benefits to which Mr. Greehey's estate, spouse or other beneficiaries may be entitled, Valero shall pay in equal semi-monthly installments to the beneficiary designated by Mr. Greehey, or his estate if no such beneficiary has been designated in writing to Valero, the compensation provided for in Paragraph 7(c) that Mr. Greehey would have received if he had continued to serve as Chairman of the Board for the remainder of the two-year period following the end effective date of his retirement. (b) Disability. (i) If during the term of Mr. Greehey's employment under this Agreement he becomes unable to perform his duties as Chief Executive Officer as a result of illness or physical injury as defined in Valero's Long Term Disability Plan, Mr. Greehey shall be deemed to have retired and be entitled to the benefits described in Paragraph 7(d), (e), (f) and (g). (ii) If following his retirement as Chief Executive Officer, Mr. Greehey is not elected or re-elected as a director by Valero's stockholders or becomes unable to perform his duties as Chairman of the Board, as determined by a majority of the other Directors, Mr. Greehey's obligations under Paragraph 7(a) and (b) shall cease; however, Mr. Greehey shall be entitled to the balance of the remaining two years' compensation for serving as Chairman of the Board, as defined in Paragraph 7 (c), payable in semi-monthly installments. 9. Termination by Valero. Valero shall have the right to terminate Mr. Greehey's employment as hereinafter provided. (a) Termination for Cause. Valero shall have the right to terminate Mr. Greehey's employment under this Agreement for cause. As used herein, "cause" shall mean and be strictly limited to: (i) Mr. Greehey's conviction of a crime constituting a felony under federal or state law or involving moral turpitude; 6 (ii) an illegal act or acts that were intended to and did defraud Valero; or (iii) the willful refusal by Mr. Greehey to fulfill responsibilities under this Agreement after written notice of such willful refusal from the Board and the failure to correct such refusal within 30 days from the date such notice is given. If Valero terminates this Agreement pursuant to the provisions of this Paragraph 9(a): (i) all compensation or other benefits due Mr. Greehey pursuant to Paragraphs 3 and 4, or 7(c), as the case may be, shall be paid by Valero to Mr. Greehey to the date of such termination; and (ii) all supplemental and additional benefits and rights granted to Mr. Greehey at retirement by Paragraph 7 shall be automatically revoked and become null and void; and, upon such payment by Valero of the amounts required under subparagraph (i), all obligations of Valero to Mr. Greehey shall be totally and completely satisfied, and Valero shall have no further obligations of any type to Mr. Greehey pursuant to this Agreement. (b) Termination other than for Cause. Valero shall have the right to terminate Mr. Greehey's employment as Chief Executive Officer under this Agreement without cause, and Mr. Greehey's employment under this Agreement shall be deemed terminated upon the giving of ninety (90) days written notice to such effect by Valero to Mr. Greehey. A termination of employment other than as a result of death, retirement, disability, or in accordance with Paragraph 9(a) shall be deemed a termination without cause. In the event of termination without cause: (i) Valero shall pay Mr. Greehey in cash a lump sum amount equal to the product of Mr. Greehey's semi-monthly Base Salary being paid to Mr. Greehey at the date of such termination multiplied by the number of semi-monthly pay periods remaining to the end of the Initial Period (or successive monthly period if employment has been extended pursuant to Paragraph 2), plus an amount equal to the highest annual bonus paid to Mr. Greehey during the five years preceding the time of such termination. Such amount shall be paid within five business days of termination; (ii) Mr. Greehey shall receive all the payments and benefits to which he is entitled pursuant to Paragraph 7(f) and (g); but shall not be entitled to receive any further payments or benefits under Paragraph 7 after the date of such termination, including any payment under 7(c). (c) Termination as Chairman of the Board. If for any reason Mr. Greehey is removed by a majority of the other Directors as Chairman of the Board after his retirement as Chief Executive Officer, other than as a result of death or disability or for cause, he shall receive the balance of the remaining two years' compensation for serving as Chairman of the Board as defined in Paragraph 7(c), payable in semi-monthly installments. 10. Executive Severance Agreement. In the event Mr. Greehey receives any cash 7 payments under that certain Executive Severance Agreement dated December 15, 1982 between Valero and Mr. Greehey, Valero shall be entitled to credit any cash payments that are made to Mr. Greehey pursuant to his Executive Severance Agreement against any cash payments that it is obligated to make under this Agreement. Valero agrees that if remuneration or benefits of any form paid to Mr. Greehey by Valero during or after his employment with Valero are excess parachute payments as defined in Section 280G of the Internal Revenue Code of 1986, as amended ("Code"), and are subject to the 20% excise tax imposed by Section 4999 of the Code, Valero shall pay Mr. Greehey a bonus no later than seven days prior to the earliest of the due date for the excise tax return or initial estimated payment, in an amount equal to the excise tax payable as a result of the excess parachute payment and any additional federal income taxes (including any additional excise taxes) payable by him as a result of the bonus, assuming that he will be subject to federal income taxes at the highest individual marginal rate. It is the intention of the Parties that the bonus be "grossed up" so that the bonus contains sufficient funds to pay the excise and all additional federal income taxes due as a result of the bonus payment so that Mr. Greehey will suffer no detriment from the excise tax payable as a result of the excess golden parachute payments. 11. Disclosure of Confidential Information. Except to the extent absolutely required in the performance of his duties and obligations to Valero as expressly authorized herein, or by prior written consent of a duly authorized officer or director of Valero, Mr. Greehey will not, directly or indirectly, at any time during his employment with Valero, or at any time subsequent to the termination thereof, for any reason whatsoever, with or without cause, breach the confidence reposed in him by Valero by using, disseminating, disclosing, divulging or in any manner whatsoever disclosing or permitting to be divulged or disclosed in any manner to any person, firm, corporation, association or other business entity, trade secrets, secret methods or "Confidential Information" of Valero, nor will Mr. Greehey lecture on or publish articles concerning any trade secrets, secret methods or "Confidential Information" of Valero. As used herein, the term "Confidential Information" means any and all information concerning Valero's products, processes, sources of supply, and services, including information relating to research, development, inventions, manufacture, purchasing, accounting, engineering, marketing, merchandising, or the selling of any product or products to any customers of Valero, disclosed to Mr. Greehey or known by Mr. Greehey as a consequence of or through his employment by Valero (or any parent, subsidiary or affiliated corporations of Valero) including, but not necessarily limited to, any person, firm, corporation, association or other business entity with which Valero has any type of agency agreement, or any shareholders, directors, or officers of any such person, firm, corporation, association or other business entity, if such information is not generally known in any industry in which Valero is or may become engaged during the term of this Agreement. On termination of employment with Valero, all documents, records, notebooks, or similar repositories of or containing Confidential Information, including all copies of any documents, records, notebooks, or similar repositories of or containing Confidential Information, then in Mr. Greehey's possession or in the possession of any third party under the control of Mr. Greehey or pursuant to any agreement with Mr. Greehey, whether prepared by Mr. Greehey or any other person, firm, corporation, association or other business entity, will be delivered to Valero by Mr. Greehey. 12. Noncompetition. Mr. Greehey recognizes and understands that in performing the responsibilities of his employment, he will occupy a position of fiduciary trust and confidence, pursuant to which he will develop and acquire experience and knowledge with respect to Valero's 8 business. It is the expressed intent and agreement of Mr. Greehey and Valero that such knowledge and experience shall be used exclusively in the furtherance of the interests of Valero and not in any manner which would be detrimental to Valero's interests. Mr. Greehey further understands and agrees that Valero conducts its business within a specialized market segment throughout the United States, and that it would be detrimental to the interests of Valero if Mr. Greehey used the knowledge and experience which he currently possesses or which he acquires pursuant to his employment hereunder for the purpose of directly or indirectly competing with Valero or for the purpose of aiding other persons or entities in so competing with Valero. In consideration for the benefits herein, Mr. Greehey therefore agrees that so long as he is employed by Valero and for a period of the greater of (i) two years after termination of Mr. Greehey's employment, or (ii) as long as he is receiving any payments under Paragraph 7(c), unless he first secures the written consent of Valero, Mr. Greehey will not directly or indirectly invest, engage or participate in any entity in direct or indirect competition with Valero's business or contract to do so, other than investments in amounts aggregating less than 1% in any securities of any company that is obligated under the 1934 Act to file periodic reports pursuant to Section 13 thereunder. In the event that the provisions of this Paragraph 12 should ever be deemed to exceed the time or geographic limitations permitted by applicable laws, then such provisions shall be reformed to the maximum time or geographic limitations permitted by applicable law. 13. Insurance. Valero may, in its sole and absolute discretion, at any time after the Effective Date, apply for and procure, as owner and for its own benefit, insurance on the life of Mr. Greehey, in such amounts and in such forms as Valero may choose. Unless otherwise agreed by Valero, Mr. Greehey shall have no interest whatsoever in any such policy or policies, but Mr. Greehey shall, at Valero's request, submit to such medical examinations, supply such information, and execute and deliver such documents as may be required by the insurance company or companies to which Valero has applied for such insurance. 14. Acknowledgment of Mr. Greehey. Mr. Greehey hereby acknowledges that his execution of this Agreement is given in consideration of the following, any of which Mr. Greehey acknowledges is adequate consideration: (i) Valero's employment of Mr. Greehey under the terms and conditions contained herein; and (ii) The termination by Valero of any previous employment agreement between Valero and Mr. Greehey. 15. Notice. Any notice, request, reply, instruction, or other communication provided or permitted in this Agreement must be given in writing and may be served by depositing same in the United States mail in certified or registered form, postage prepaid, addressed to the Party to be notified with return receipt requested, or by delivering the notice in person to such Party. Unless actual receipt is required by any provision of this Agreement, notice deposited in the United States mail in the manner herein prescribed shall be effective on dispatch. For purposes of notice, the address of Mr. Greehey, his spouse, any purported donee or transferee or any administrator, executor or legal representative of Mr. Greehey or his estate, as the case may be, shall be as follows: 9 The address of Valero shall be: Valero Energy Corporation One Valero Place P.O. Box 500 San Antonio, Texas 78212-3186 (78292-0500) Attention: General Counsel Valero and Mr. Greehey shall have the right from time to time and at any time to change their respective addresses and shall have the right to specify as their respective addresses any other address by giving at least ten days written notice to the other Party as provided hereby. 16. Termination of other Employment Agreements. On the Effective Date, all other prior employment agreements between the Parties in effect on the Effective Date shall terminate and forever be from the date null, void and of no further force or effect whatsoever, and any and all such agreements shall be superseded in their entirety by this Agreement. 17. Litigation. In the event litigation shall be brought by either Party to enforce or interpret any provision contained in this Agreement the following provisions shall apply: (a) if Mr. Greehey brings such an action, and it is not established by clear and convincing evidence that Mr. Greehey has no meritorious bases for such action, Valero shall pay all of Mr. Greehey's and Valero's legal fees incurred in connection with such litigation; (b) in the event Valero brings such an action, and it is not established by clear and convincing evidence that Mr. Greehey has no meritorious defenses to such action, Valero shall pay all of Mr. Greehey's and Valero's legal fees incurred in connection with such litigation; and (c) any claim by Valero of a right to terminate this Agreement pursuant to Paragraph 9(a) which is subjected to litigation must be established by Valero by clear and convincing evidence. 18. Controlling Law. The execution, validity, interpretation, and performance of this Agreement shall be determined and governed by the laws of the State of Texas. 19. Additional Instruments. Valero and Mr. Greehey shall execute and deliver any and all additional instruments and agreements which may be necessary or proper to carry out this Agreement. 20. Entire Agreement. This Agreement contains the entire agreement of the Parties. This Agreement may not be changed orally but only by an agreement in writing signed by the Party against whom enforcement of any waiver, change, modification, extension or discharge is sought. 21. Separability. If any provision of the Agreement is rendered or declared illegal or 10 unenforceable by reason of any existing or subsequently enacted legislation or by decree of a court of last resort, Valero and Mr. Greehey shall promptly meet and negotiate substitute provisions for those rendered and declared illegal or unenforceable, and all the remaining provisions of this Agreement shall remain in full force and effect. 22. Effect of Agreement. This Agreement shall be binding upon Mr. Greehey and his heirs, executors, legal representatives, successors and assigns, and Valero and its legal representatives, successors and assigns. 23. Execution. This Agreement may be executed in multiple counterparts each of which shall be deemed an original and all of which shall constitute one instrument. 24. Waiver of Breach. The waiver by Valero of a breach of any provision of the Agreement by Mr. Greehey shall not operate or be construed as a waiver by Valero of any subsequent breach by Mr. Greehey. The waiver by Mr. Greehey of a breach of any provision of the Agreement by Valero shall not operate or be construed as a waiver by Mr. Greehey of any subsequent breach by Valero. 11 IN WITNESS WHEREOF, the Parties have executed this Agreement as of the Effective Date. /s/ William E. Greehey ------------------------------------- WILLIAM E. GREEHEY VALERO ENERGY CORPORATION By: /s/ Keith D. Booke --------------------------------- Keith D. Booke, Vice President-Administration and Human Resources EX-27.1 3 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE CONSOLIDATED BALANCE SHEET AS OF JUNE 30, 1999 AND THE CONSOLIDATED STATEMENT OF INCOME FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 6-MOS DEC-31-1999 JAN-01-1999 JUN-30-1999 5,804 0 304,028 1,600 329,612 738,149 2,628,453 655,578 2,869,984 513,161 916,104 0 0 563 1,055,561 2,869,984 3,161,553 3,161,553 3,173,766 3,173,766 0 0 26,975 (38,201) (13,400) (24,801) 0 0 0 (24,801) (.44) (.44)
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