Initial Public Offering (IPO): Registration Statement (General Form) — Form S-1
Filing Table of Contents
Document/Exhibit Description Pages Size
1: S-1 Registration Statement (General Form) 141 822K
2: EX-2.1 Agreement & Plan of Merger 43 282K
3: EX-2.2 Agreement & Plan of Distribution 24 154K
4: EX-2.3 Tax Sharing Agreement 31 102K
5: EX-2.4 Employee Benefits Agreement 26 97K
6: EX-2.5 Interim Services Agreement 12 53K
7: EX-3.1 Restated Certificate of Incorporation 12 64K
8: EX-3.2 By-Laws 14 63K
9: EX-4.1 Rights Agreement 64 187K
10: EX-4.2 Credit Agreement 134 393K
11: EX-5 Opinion of Morris, Nichols, Arsht & Tunnell 3 15K
12: EX-10.1 Incentive Bonus Plan 6 24K
21: EX-10.10 Incentive Bonus Agreement 12 35K
22: EX-10.11 Schedule of Incentive Bonus Agreements 1 8K
23: EX-10.12 Management Stability Agreement 18 44K
24: EX-10.13 Schedule of Management Stability Agreements 1 8K
13: EX-10.2 Stock Incentive Plan 19 91K
14: EX-10.3 Stock Option Plan 17 81K
15: EX-10.4 Restricted Stock Plan for Non-Employee Directors 13 68K
16: EX-10.5 Non-Employee Director Stock Option Plan 9 47K
17: EX-10.6 Executive Severance Agreement 5 24K
18: EX-10.7 Schedule of Executive Severance Agreements 1 8K
19: EX-10.8 Indemnity Agreement 5 27K
20: EX-10.9 Schedule of Indemnity Agreements 1 9K
25: EX-11.1 Computation of Earnings Per Share 2± 12K
26: EX-21.1 List of Subsidiaries 1 9K
27: EX-23.1 Consent of Arthur Andersen LLP Re: Registrant 1 9K
28: EX-23.2 Consent of Arthur Andersen LLP Re: Basis Petroleum 1 9K
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 13, 1997.
REGISTRATION NO. 333-
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM S-1
REGISTRATION STATEMENT
UNDER THE SECURITIES ACT OF 1933
----------------
VALERO REFINING AND MARKETING COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
----------------
DELAWARE 2911 74-1828067
(STATE OR OTHER (PRIMARY STANDARD (I.R.S. EMPLOYER
JURISDICTION OF INDUSTRIAL CLASSIFICATION IDENTIFICATION NO.)
INCORPORATION OR CODE NUMBER)
ORGANIZATION)
530 MCCULLOUGH AVENUE
SAN ANTONIO, TEXAS 98215
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
----------------
RAND C. SCHMIDT
530 MCCULLOUGH AVENUE
SAN ANTONIO, TEXAS 98215
(210) 246-2000
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
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WITH A COPY TO:
EDWARD D. HERLIHY, ESQ.
WACHTELL, LIPTON, ROSEN & KATZ
51 WEST 52ND STREET
NEW YORK, NEW YORK 10019
(212) 403-1000
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective and all other
conditions to the Merger of PG&E Acquisition Corporation with and into Valero
Energy Corporation pursuant to the Agreement and Plan of Merger dated as of
January 31, 1997, have been satisfied or waived.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]
If this form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]
If this form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]
CALCULATION OF REGISTRATION FEE
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PROPOSED
PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT MAXIMUM AGGREGATE AMOUNT OF
SECURITIES TO BE TO BE OFFERING PRICE OFFERING REGISTRATION
REGISTERED REGISTERED(1) PER UNIT(2) PRICE(2) FEE(2)
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Common Stock, par value
$.01 per share......... 57,000,000 $26.26 $1,496,820,000 $453,581.81
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Preferred Share Purchase
Rights(3).............. 57,000,000 -- -- None
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Total................... $453,581.81
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(1) Estimated maximum amount which may be issued.
(2) The registration fee for the securities registered hereby has been
calculated pursuant to Rule 457(f)(2) under the Securities Act and is
based upon the book value of the Common Stock computed as of March 31,
1997 as adjusted for the acquisition of Basis Petroleum, Inc.
(3) Rights initially are carried and traded with the Common Stock. The value
attributable to the Rights, if any, is reflected in the market price of
the Common Stock.
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS
REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH
SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT
SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID
SECTION 8(A), MAY DETERMINE.
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PROSPECTUS
VALERO REFINING AND MARKETING COMPANY
(TO BE RENAMED "VALERO ENERGY CORPORATION")
COMMON STOCK
Valero Energy Corporation (Valero) proposes to spin off Valero Refining and
Marketing Company (New Valero) to our stockholders, and to merge Valero, which
at that time will consist only of Valero's remaining natural gas related serv-
ices business, with a wholly owned subsidiary of PG&E Corp.
The Board of Directors of Valero is recommending that you vote in favor of a
tax-free spinoff and merger that, if accomplished, will result in the following
changes:
NEW VALERO WILL:
. continue to own and operate Valero's refining and marketing business, in-
cluding the business of Basis Petroleum, Inc. recently acquired by Valero
and expected to be contributed to New Valero prior to the spinoff, as de-
scribed herein.
VALERO WILL:
. continue to own and operate only Valero's natural gas related services
business;
. prior to the spinoff, receive a dividend from New Valero of $210 million;
and
. be owned by PG&E Corp.
FOR EACH SHARE OF VALERO COMMON STOCK YOU OWN ON THE RECORD DATE FOR THE
SPINOFF, YOU WILL RECEIVE:
. one share of New Valero common stock; and
. a portion of a share of PG&E common stock. This is explained more fully
in the Proxy Statement-Prospectus. You will receive cash in lieu of frac-
tional shares.
These transactions will occur only if the Valero stockholders approve the spin-
off and the merger and the parties either meet or waive the other conditions
described in the Proxy Statement-Prospectus.
WE URGE YOU TO READ THE PROXY STATEMENT-PROSPECTUS AND THIS DOCUMENT CAREFULLY
SINCE EACH CONTAINS INFORMATION THAT IS IMPORTANT TO YOU. ALSO, PAY PARTICULAR
ATTENTION TO THE "RISK FACTORS" BEGINNING ON PAGE 16.
Immediately after the spinoff and merger, New Valero will change its name to
"Valero Energy Corporation." We expect that New Valero's common stock will
trade on the New York Stock Exchange under the symbol "VLO."
---------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES REGULA-
TORS HAVE APPROVED THE NEW VALERO COMMON STOCK TO BE ISSUED OR DETERMINED IF
THIS DOCUMENT IS ACCURATE OR ADEQUATE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
WE MAILED THIS DOCUMENT TO OUR STOCKHOLDERS ON OR ABOUT MAY 14, 1997.
PROSPECTUS
TABLE OF CONTENTS
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PAGE
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QUESTIONS AND ANSWERS ABOUT THE SPINOFF OF NEW VALERO COMMON STOCK......... 1
SUMMARY OF CERTAIN INFORMATION............................................. 2
NEW VALERO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL
STATEMENTS................................................................ 4
Balance Sheet............................................................ 4
Income Statement......................................................... 4
Natural Gas Business Historical.......................................... 5
Historical Consolidated Financial Statements............................. 5
VALERO UNAUDITED PRO FORMA CONDENSED INCOME STATEMENTS..................... 10
SUMMARY SELECTED HISTORICAL FINANCIAL INFORMATION.......................... 12
WHERE STOCKHOLDERS CAN FIND MORE INFORMATION............................... 13
INTRODUCTION............................................................... 14
RISK FACTORS............................................................... 16
No Operating History as an Independent Company........................... 16
No Prior Market for New Valero Common Stock.............................. 16
New Valero Dividend Policy............................................... 17
Certain Anti-takeover Effects............................................ 17
Certain Federal Income Tax Considerations................................ 17
Basis Acquisition........................................................ 17
Indemnification.......................................................... 18
Effect of Economic and Other Conditions on Operating Margins............. 18
Effect of Political and Regulatory Factors on New Valero's Operations.... 18
Operating Hazards........................................................ 18
Commodity Pricing and Demand............................................. 19
Feedstock Supply......................................................... 19
Competition.............................................................. 19
Environmental Matters.................................................... 20
THE DISTRIBUTION........................................................... 20
Background and Reasons for the Distribution.............................. 20
Manner of Effecting the Distribution..................................... 21
Certain Federal Income Tax Considerations................................ 21
Listing and Trading of New Valero Common Stock........................... 22
REGULATORY MATTERS......................................................... 22
AGREEMENTS BETWEEN VALERO AND NEW VALERO................................... 22
Distribution Agreement................................................... 23
Tax Sharing Agreement.................................................... 26
Employee Benefits Agreement.............................................. 26
Interim Services Agreement............................................... 28
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS..................................................... 30
Overview................................................................. 30
The Proposed Transactions................................................ 30
Change in Segment Reporting.............................................. 30
Acquisition of VNGP, L.P................................................. 31
ii
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Results of Operations.................................................... 32
1996 Compared to 1995................................................... 33
Consolidated Results................................................... 33
Segment Results........................................................ 33
Refining Business..................................................... 33
Natural Gas Business.................................................. 35
1995 Compared to 1994................................................... 36
Consolidated Results................................................... 36
Segment Results........................................................ 37
Refining Business..................................................... 37
Natural Gas Business.................................................. 38
Other................................................................. 38
Basis Petroleum......................................................... 38
Outlook................................................................. 42
Refining Business...................................................... 42
Liquidity and Capital Resources.......................................... 43
Current Structure....................................................... 43
BUSINESS AND PROPERTIES.................................................... 46
Overview................................................................. 46
Strategy................................................................. 46
Refining Operations...................................................... 46
Sales.................................................................... 47
Feedstock Supply......................................................... 48
Acquisition of Basis Petroleum........................................... 48
Factors Affecting Operating Results...................................... 50
Competition.............................................................. 51
Environmental Matters.................................................... 51
Employees................................................................ 51
Properties............................................................... 52
Litigation............................................................... 52
DESCRIPTION OF CERTAIN NEW VALERO INDEBTEDNESS............................. 54
MANAGEMENT................................................................. 56
Directors of New Valero.................................................. 56
Audit Committee.......................................................... 57
Compensation Committee................................................... 57
Executive Committee...................................................... 58
Compensation of Directors................................................ 58
Executive Officers of New Valero......................................... 59
EXECUTIVE COMPENSATION..................................................... 60
Stock Option Grants and Related Information.............................. 61
Retirement Benefits...................................................... 63
Description of Executive Bonus, Stock Incentive and Stock Option Plans... 65
Description of Thrift Plan............................................... 65
Description of Other Benefit Plans....................................... 66
Arrangements with Certain Officers and Directors......................... 66
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION................ 67
TRANSACTIONS WITH MANAGEMENT............................................... 68
iii
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............ 69
DESCRIPTION OF NEW VALERO CAPITAL STOCK................................... 71
Authorized Capital Stock................................................ 71
New Valero Common Stock................................................. 71
New Valero Preferred Stock.............................................. 71
New Valero Purchase Rights.............................................. 71
ANTI-TAKEOVER EFFECTS OF CERTAIN PROVISIONS............................... 74
Limitations on Changes in Board Composition and Other Actions by Stock-
holders................................................................ 74
Preferred and Common Stock.............................................. 75
Amendment of Certain Provisions of the New Valero Certificate and New
Valero By-laws......................................................... 75
Rights.................................................................. 76
Management Stability Agreements; Other Severance Arrangements........... 76
Business Combinations................................................... 76
Statutory Provisions.................................................... 76
VALIDITY OF SECURITIES.................................................... 77
EXPERTS................................................................... 77
STOCKHOLDER PROPOSALS..................................................... 77
INDEX OF DEFINED TERMS.................................................... 78
INDEX TO FINANCIAL INFORMATION............................................ F-1
iv
QUESTIONS AND ANSWERS ABOUT THE SPINOFF OF
NEW VALERO COMMON STOCK
Q. WHEN WILL THE SPINOFF OCCUR?
A: If the Valero stockholders approve the spinoff and merger and the other
conditions are satisfied, the parties will complete the transactions as
soon as possible. Currently, the parties anticipate completing the spinoff
and the merger in the third quarter of 1997, subject to regulatory approv-
al.
Q. WHAT BUSINESS WILL NEW VALERO OWN?
A. After the spinoff, New Valero will continue to own the refining and market-
ing business currently owned by New Valero and, indirectly, by Valero. New
Valero will also own the business of Basis Petroleum, Inc. (Basis). Please
read the information on New Valero's business and the associated risks be-
ginning on pages 46 and 16.
Q. WHAT WILL I RECEIVE IN THE SPINOFF?
A. For every share of Valero common stock you own, you will receive one share
of New Valero common stock. You should receive your New Valero common stock
certificates within several weeks after the completion of the transactions.
Q. WILL NEW VALERO PAY DIVIDENDS?
A. The New Valero Board of Directors, in its sole discretion, will declare the
future payment and amount of dividends, if any. The decision to declare a
dividend will depend upon the financial condition, capital requirements and
earnings of New Valero, and such other factors that the New Valero Board of
Directors determines to be relevant. Following the spinoff, the New Valero
Board of Directors will consider declaring a quarterly cash dividend with
respect to the New Valero common stock.
Q. DO I HAVE TO PAY TAXES ON THE RECEIPT OF NEW VALERO COMMON STOCK?
A. No. Valero has received an opinion of counsel that the spinoff of New
Valero common stock will be tax free to Valero stockholders for United
States federal income tax purposes. Valero expects to receive, at the time
of the spinoff and merger, an additional opinion of counsel confirming this
treatment. These opinions are not binding on the Internal Revenue Service.
To review certain tax consequences of the spinoff and merger in greater de-
tail, see pages 17 and 21.
Q. WHERE WILL I BE ABLE TO TRADE THE SHARES OF NEW VALERO COMMON STOCK?
A. We are applying to list the shares of New Valero common stock on the New
York Stock Exchange.
Q. WHAT HAPPENS TO MY EXISTING VALERO STOCK?
A. PG&E Corp., through an exchange agent, will send you written instructions
for exchanging your existing Valero common stock for shares of PG&E Corp.
common stock and a cash payment in lieu of any fractional share.
Q. WHAT DO I NEED TO DO NOW?
A. Just mail your signed proxy card in the enclosed return envelope as soon as
possible, so that your shares may be represented at the annual meeting at
which the transactions will be considered. Valero stockholders should NOT
send in their stock certificates at this time. If you continue to hold your
Valero shares at the time of the spinoff, you will automatically receive
your New Valero shares. After the merger, you will receive instructions for
exchanging your Valero stock certificates for PG&E Corp. stock and cash, as
described in the Proxy Statement-Prospectus.
1
SUMMARY OF CERTAIN INFORMATION
This summary highlights selected information from this document. It may not
contain all of the information that is important to you. To better understand
the transactions and for a more complete description of the legal terms of the
spinoff and the merger, you should read carefully this entire document, the
Proxy Statement-Prospectus, and other documents referred to therein and in this
summary.
THE SPINOFF
If you have questions about If you have questions about the
Valero, New Valero or your mailing or receipt of your New
stockholdings in either company Valero stock certificates please
please contact: contact:
Valero Energy Corporation 530 Harris Trust and Savings Bank P.O.
530 McCullough Avenue P.O. Box A3504
San Antonio, Texas 78215 Chicago, Illinois 60690-3504
Attn: Investor Relations Proxy Services
(210) 246-2099 (312) 461-6001
THE SPINOFF AND MERGER
PG&E Corp. and Valero have agreed that PG&E Corp. will acquire Valero's natu-
ral gas and natural gas liquids related services business, power marketing
business and related risk management business, which we refer to as the "Natu-
ral Gas Business." In order to separate the Natural Gas Business from Valero's
other businesses, which we refer to as the "Refining Business," Valero will
transfer certain assets and related liabilities of the Refining Business from
Valero and subsidiaries of Valero that engage primarily in the Natural Gas
Business to subsidiaries that engage primarily in the Refining Business and
will transfer certain assets and related liabilities of the Natural Gas Busi-
ness from subsidiaries that engage primarily in the Refining Business to sub-
sidiaries that engage primarily in the Natural Gas Business. Immediately prior
to the merger, New Valero will pay a cash dividend to Valero, and Valero will
distribute (as a dividend) the shares of New Valero to Valero's stockholders.
Immediately after the spinoff, a subsidiary of PG&E Corp. will be merged into
Valero, common stockholders of Valero will receive common stock of PG&E Corp.
and cash in lieu of fractional shares in exchange for their Valero stock cer-
tificates and Valero will become a wholly owned subsidiary of PG&E Corp.
As a result of these transactions, former stockholders of Valero will own (i)
the same proportional interest in the Refining Business, through their owner-
ship of New Valero common stock, as immediately prior to the transactions and
(ii) an indirect interest in the Natural Gas Business through their ownership
of PG&E Corp. common stock.
Immediately after the spinoff and merger, New Valero will change its name to
"Valero Energy Corporation."
RELATIONSHIP BETWEEN VALERO AND NEW VALERO AFTER THE SPINOFF AND MERGER
After the spinoff, Valero and New Valero will be separate companies. Valero
and New Valero will enter into agreements to help in the separation and transi-
tion of the Natural Gas Business and the Refining Business. The agreements deal
with many operational issues, including:
. the separation of the Natural Gas Business from the Refining Business;
. transitional services to be provided by each of Valero and New Valero
to the other from the effective time of the merger until December 31,
1998; and
. the allocation of certain tax, employee benefits and other liabili-
ties between Valero and New Valero.
2
Under these agreements, Valero and New Valero will agree to compensate each
other after the spinoff for certain losses, damages, claims and liabilities re-
sulting from various actions. Each of Valero and New Valero will also provide
the other, in exchange for certain fees, with various services following the
merger including financial, regulatory, information, tax, computer, administra-
tive and other services. Additionally, Valero and New Valero will each agree to
indemnify the other from and against certain tax liabilities. Detailed informa-
tion about these agreements can be found in the section titled "Agreements Be-
tween Valero and New Valero."
RISK FACTORS
Stockholders should carefully review the matters discussed under the section
titled "Risk Factors."
3
NEW VALERO
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
On April 22, 1997, Valero entered into a stock purchase agreement with Salo-
mon Inc (Salomon) to acquire Basis, a wholly owned subsidiary of Salomon (the
Basis Acquisition), and on May 1, 1997, Valero acquired Basis. The Basis Acqui-
sition will be accounted for by New Valero under the purchase method of ac-
counting, and, as a result, pro forma adjustments are reflected in the accompa-
nying unaudited pro forma condensed combined financial statements (Pro Forma
Financial Statements) to reflect, among other things:
. a preliminary allocation of Valero's purchase cost among the assets
acquired and liabilities assumed;
. the elimination of operating results and shutdown costs for operations of
Basis which were discontinued prior to the Basis Acquisition; and
. the elimination of the effect from the sale of certain assets by Basis
prior to the Basis Acquisition.
The assets acquired and liabilities assumed by Valero as a result of the Ba-
sis Acquisition will become part of the Refining Business. The accompanying Pro
Forma Financial Statements show the effects on the financial position and re-
sults of operations of New Valero of both the Basis Acquisition and the pro-
posed spinoff and merger. For more information concerning the Basis Acquisi-
tion, see "Business and Properties--Acquisition of Basis Petroleum" and "Man-
agement's Discussion and Analysis of Financial Condition and Results of Opera-
tions--Results of Operations--Basis Petroleum."
BALANCE SHEET
The accompanying unaudited pro forma condensed combined balance sheet at De-
cember 31, 1996 presents the combined financial position of New Valero assuming
the Basis Acquisition and the spinoff and merger had occurred on that date.
This balance sheet has been derived from the historical balance sheet of Valero
adjusted for:
. the effects of the Basis Acquisition;
. the divestiture of the Natural Gas Business;
. the $210,000,000 dividend to Valero;
. the refunding of industrial revenue bonds; and
. an adjustment to the par value of the shares of New Valero (the
Recapitalization).
INCOME STATEMENT
The accompanying unaudited pro forma condensed combined statement of income
for the year ended December 31, 1996 presents the combined results of opera-
tions of New Valero assuming the Basis Acquisition and the spinoff and merger
had occurred on January 1, 1996. This statement of income has been derived from
the historical statement of income of Valero adjusted for:
. the effects of the Basis Acquisition;
. the elimination of operating results and shutdown costs for operations of
Basis which were discontinued prior to the Basis Acquisition;
. the elimination of the effect from the sale of certain assets by Basis
prior to the Basis Acquisition; and
. the divestiture of the Natural Gas Business as contemplated by the
Distribution Agreement.
4
NATURAL GAS BUSINESS HISTORICAL
The "Natural Gas Business Historical" column in the unaudited pro forma con-
densed combined balance sheet represents the combined historical assets and li-
abilities directly attributable to the Natural Gas Business plus a portion of
certain corporate assets and liabilities allocated to the Natural Gas Business
based upon methods deemed reasonable by Valero's management. Included in such
corporate assets and liabilities allocated to the Natural Gas Business is a
portion of the corporate debt of Valero allocated to the Natural Gas Business
based on the ratio of the Natural Gas Business' net assets, excluding the
amounts of intercompany notes receivable or payable with corporate entities, to
Valero's consolidated net assets. The "Natural Gas Business Historical" column
in the unaudited pro forma condensed combined statement of income represents
the combined historical results of operations of the Natural Gas Business plus
the effects on results of operations of the allocation of corporate assets and
liabilities noted above. No general corporate overhead has been allocated to
the discontinued operations. Interest expense related to corporate debt has
been allocated to the Natural Gas Business based on the net asset ratios noted
above.
HISTORICAL CONSOLIDATED FINANCIAL STATEMENTS
The Pro Forma Financial Statements should be read in conjunction with the
historical consolidated financial statements and the related notes of Valero
and Basis which are included beginning on pages F-2 and F-33 of this Prospec-
tus. The Pro Forma Financial Statements are not necessarily indicative of the
financial position that actually would have been obtained or the results that
actually would have occurred if the Basis Acquisition and the spinoff and
merger had been consummated as of December 31, 1996 or January 1, 1996. The Pro
Forma Financial Statements are also not necessarily indicative of the financial
position or results which may be attained in the future. The pro forma adjust-
ments, as described in the Notes to Pro Forma Condensed Combined Financial
Statements, are based upon available information and upon certain assumptions
that management believes are reasonable.
5
NEW VALERO
PRO FORMA CONDENSED COMBINED BALANCE SHEET
DECEMBER 31, 1996
(THOUSANDS OF DOLLARS)
(UNAUDITED)
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BASIS ACQUISITION
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NEW
VALERO NATURAL GAS TRANSACTIONS VALERO
VALERO PRO FORMA PRO FORMA BUSINESS PRO FORMA PRO FORMA
HISTORICAL HISTORICAL ADJUSTMENTS COMBINED HISTORICAL ADJUSTMENTS COMBINED
ASSETS ---------- ---------- ----------- ---------- ----------- ------------ ----------
$ (233,683)(a) $ 9,990 (A)
(150,000)(b) 1,396 (B)
CURRENT ASSETS.......... $ 888,169 $ 906,529 65,328 (b) $1,476,343 $ (556,065) (1,150)(D) $ 930,514
PROPERTY, PLANT AND
EQUIPMENT, NET......... 2,079,079 817,967 (540,868)(b) 2,356,178 (850,245) -- 1,505,933
(7,865)(a)
8,000 (b) (1,994)(B)
DEFERRED CHARGES AND
OTHER ASSETS........... 167,526 9,448 10,640 (b) 187,749 (44,618) (1,852)(C) 139,285
---------- ---------- ---------- ---------- ----------- -------- ----------
$3,134,774 $1,733,944 $ (848,448) $4,020,270 $(1,450,928) $ 6,390 $2,575,732
========== ========== ========== ========== =========== ======== ==========
LIABILITIES AND
STOCKHOLDERS' EQUITY
CURRENT LIABILITIES, ex-
cluding short-term debt
and current $(122,807) (a)
maturities of long-term
debt................... $ 720,813 $ 673,145 (38,992) (b) $1,232,159 $ (524,892) $ (4,194)(C) $ 703,073
---------- ---------- ---------- ---------- ----------- -------- ----------
TOTAL DEBT:
Short-term............. 82,000 -- -- 82,000 (82,000) -- --
Current maturities..... 72,341 -- -- 72,341 (72,341) -- --
219,990 (A)
3,955 (B)
Long-term maturities... 868,300 -- 254,150 (b) 1,122,450 (431,428) (338,372)(C) 576,595
Notes payable to affil-
iates................. -- 618,438 (618,438)(c) -- -- -- --
---------- ---------- ---------- ---------- ----------- -------- ----------
1,022,641 618,438 (364,288) 1,276,791 (585,769) (114,427) 576,595
---------- ---------- ---------- ---------- ----------- -------- ----------
DEFERRED INCOME TAXES
AND OTHER DEFERRED
CREDITS AND OTHER
LIABILITIES............ 314,345 69,171 (69,171)(a) 314,345 (59,580) (686)(B) 254,079
---------- ---------- ---------- ---------- ----------- -------- ----------
REDEEMABLE PREFERRED
STOCK, SERIES A........ 1,150 -- -- 1,150 -- (1,150)(D) --
---------- ---------- ---------- ---------- ----------- -------- ----------
(49,570)(a) (210,000)(A)
618,438 (c) (3,867)(B)
STOCKHOLDERS' EQUITY.... 1,075,825 373,190 (822,058)(b) 1,195,825 (280,687) 340,714 (C) 1,041,985
---------- ---------- ---------- ---------- ----------- -------- ----------
$3,134,774 $1,733,944 $ (848,448) $4,020,270 $(1,450,928) $ 6,390 $2,575,732
========== ========== ========== ========== =========== ======== ==========
See Notes to Pro Forma Condensed Combined Financial Statements.
6
NEW VALERO
PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
FOR THE YEAR ENDED DECEMBER 31, 1996
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
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BASIS ACQUISITION
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NEW
VALERO NATURAL GAS TRANSACTIONS VALERO
VALERO PRO FORMA PRO FORMA BUSINESS PRO FORMA PRO FORMA
HISTORICAL HISTORICAL ADJUSTMENTS COMBINED HISTORICAL ADJUSTMENTS COMBINED
---------- ---------- ----------- ----------- ----------- ------------ -----------
OPERATING $ (200,565)(g)
REVENUES............... $4,990,681 $9,504,844 (1,936,506)(d) $12,358,454 $(2,257,605) $ 24,777 (E) $10,125,626
---------- ---------- ----------- ----------- ----------- -------- -----------
COSTS AND EXPENSES: (1,918,229)(d)
12,032 (e)
Cost of sales and oper-
ating (7,460)(f) 24,777 (E)
expenses............... 4,606,320 9,565,499 (245,066)(g) 12,013,096 (2,050,785) 1,792 (F) 9,988,880
Selling and administra-
tive
expenses............... 81,665 36,141 (3,316)(d) 114,490 (50,381) 44 (F) 64,153
(1,396)(d)
(1,493)(g)
Depreciation expense.... 101,787 46,510 (34,063)(h) 111,345 (46,465) (1,404)(F) 63,476
---------- ---------- ----------- ----------- ----------- -------- -----------
Total................. 4,789,772 9,648,150 (2,198,991) 12,238,931 (2,147,631) 25,209 10,116,509
---------- ---------- ----------- ----------- ----------- -------- -----------
OPERATING INCOME
(LOSS)................. 200,909 (143,306) 61,920 119,523 (109,974) (432) 9,117
LOSS ON INVESTMENT IN
PROESA JOINT VENTURE... (19,549) -- -- (19,549) -- -- (19,549)
REVERSAL OF ACQUISITION
EXPENSE
ACCRUAL................ 18,698 -- -- 18,698 (18,698) -- --
OTHER INCOME 2,282 (e)
(EXPENSE), NET......... 8,820 82,030 (82,030)(g) 11,102 (1,001) -- 10,101
(12,207)(I)
30,628 (H)
INTEREST AND DEBT
EXPENSE, NET........... (95,177) (39,172) 28,594 (i) (105,755) 56,655 5,207 (G) (25,472)
---------- ---------- ----------- ----------- ----------- -------- -----------
INCOME (LOSS) BEFORE IN-
COME TAXES............. 113,701 (100,448) 10,766 24,019 (73,018) 23,196 (25,803)
INCOME TAX EXPENSE (BEN-
EFIT).................. 41,000 (34,782) 3,393 (j) 9,611 (26,289) 8,119 (J) (8,559)
---------- ---------- ----------- ----------- ----------- -------- -----------
NET INCOME (LOSS)....... 72,701 (65,666) 7,373 14,408 (46,729) 15,077 (17,244)
Less: preferred stock
dividend requirements.. 11,327 -- -- 11,327 (10,781) (546)(G) --
---------- ---------- ----------- ----------- ----------- -------- -----------
NET INCOME (LOSS)
APPLICABLE TO
COMMON STOCK........... $ 61,374 $ (65,666) $ 7,373 $ 3,081 $ (35,948) $ 15,623 $ (17,244)
========== ========== =========== =========== =========== ======== ===========
EARNINGS (LOSS) PER
SHARE OF COMMON STOCK.. $ 1.40 $ .07 $ (.32)
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING
(in thousands)......... 43,926 47,356 54,371
See Notes to Pro Forma Condensed Combined Financial Statements.
7
NEW VALERO
NOTES TO PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
PRO FORMA ADJUSTMENTS RELATED TO BASIS ACQUISITION
(a)To reflect assets and liabilities to be retained by Salomon as follows (in
millions):
[Download Table]
Current assets.................................................... $ 234
Deferred charges and other assets................................. 8
Current liabilities............................................... (123)
Deferred income taxes............................................. (69)
-----
$ 50
=====
(b) To reflect the issuance of $254 million of debt (including the incurrence
of $8 million of debt issuance costs) under a new $835 million revolving
credit facility with a group of banks, the issuance of $120 million of
equity, and the receipt of $150 million pursuant to an inventory purchase
agreement whereby New Valero intends to sell a portion of its base
inventory to a third party, the proceeds of which are used to fund the
acquisition of all of the common stock of Basis. Also reflected are
adjustments to certain of Basis's historical assets and liabilities to
reflect the estimated fair values of the assets acquired and liabilities
assumed, as follows (in millions):
Increase in current assets........................................ $ 65
Decrease in property, plant and
equipment, net................................................... (541)
Increase in deferred charges and other assets..................... 11
Decrease in current liabilities................................... 39
-----
Excess of historical cost over purchase price of Basis assets ac-
quired and liabilities assumed................................... $(426)
=====
(c) To reflect the cancellation of the note payable by Basis to its parent,
Salomon.
(d) To reflect the elimination of income associated with Basis's investment in
a crude gathering business, which is being retained by Salomon, and to
reverse the elimination of sales made by Basis to the crude gathering
business.
(e) To reflect costs associated with the $150 million inventory purchase
agreement and the reclassification of certain income from Cost of Sales to
Other Income.
(f) To reflect the elimination of income relating to certain 1996 inventory
adjustments and derivative transactions resulting from the adjustment to
fair value of the assets acquired and liabilities assumed as of the date of
the acquisition, and to reduce turnaround expenses to conform to New
Valero's method of accounting.
(g) To reflect the elimination of operating losses and shutdown costs
associated with operations discontinued during 1995 and 1996, and to
eliminate the gain recorded on the sale of certain assets during 1996. Had
the operating results and shutdown costs for operations of Basis which were
discontinued prior to the Basis Acquisition and the effect from the sale of
certain assets by Basis prior to the Basis Acquisition not been eliminated
in the accompanying unaudited pro forma condensed combined financial
statements, operating income would have decreased by $46 million, other
income (expense), net would have benefited by $82 million, income (loss)
before income taxes would have benefited by $36 million and net income
(loss) would have benefited by $23 million.
(h) To reverse historical depreciation expense and record depreciation expense
on the portion of the acquisition cost allocated to property, plant and
equipment.
(i) To reflect the elimination of $45 million of interest expense on the note
payable by Basis to Salomon and to reflect interest expense on the debt
issued to partially fund the acquisition. A 1/8% change in the variable
interest rate associated with such debt would have a $.3 million effect on
interest expense.
(j) To reflect the tax effect of the pro forma pre-tax income adjustments
related to the Basis Acquisition.
PRO FORMA ADJUSTMENTS RELATED TO THE TRANSACTIONS
(A) To reflect the payment of a $210 million cash dividend to Valero and bank
borrowings required to fund such dividend and an increase in operating cash
balances to a $10 million level.
(B) In connection with the refunding of the $98.5 million of Industrial Revenue
Bonds (IRBs) of New Valero, to reflect borrowings to fund the payment of $1
million of debt issuance costs associated with the new refunding IRBs and a
$3 million premium paid in
8
NEW VALERO
NOTES TO PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
connection with the redemption of the existing IRBs, a $3 million write-off
of unamortized debt costs related to the existing IRBs, and a $2.1 million
reduction in income taxes associated with such write-off and the redemption
premium.
(C) To reduce the historical corporate debt allocated to New Valero to reflect
the assumption of all such corporate debt by Valero in accordance with the
Distribution Agreement.
(D) To reflect the redemption of the remaining shares of mandatorily
redeemable preferred stock.
(E) To reverse the elimination of sales made by New Valero to Valero.
(F) To adjust historical costs and expenses to reflect the allocation of
corporate assets and liabilities between Valero and New Valero in
accordance with the Distribution Agreement.
(G) To reduce interest expense and preferred stock dividends resulting from
the refunding and reissuance of the IRBs of New Valero and the redemption
of the mandatorily redeemable preferred stock, respectively. A 1/8% change
in the variable interest rate associated with the IRBs of New Valero would
have a $.1 million effect on interest expense.
(H) To eliminate historical interest expense on corporate debt allocated to
New Valero resulting from the assumption of all such debt by Valero in
accordance with the Distribution Agreement.
(I) To reflect interest expense on borrowings under the new bank credit line
of New Valero. A 1/8% change in the variable interest rate associated with
such borrowings under the new bank credit line would have a $.2 million
effect on interest expense.
(J) To reflect the tax effect of the pro forma pre-tax income adjustments
related to the Transactions.
9
VALERO
UNAUDITED PRO FORMA CONDENSED INCOME STATEMENTS
The accompanying unaudited pro forma condensed income statements for the
years ended December 31, 1995 and 1994 show the effects on the reported results
of operations of Valero assuming the proposed spinoff and merger are
consummated and, as a result, the results of operations of the natural gas
business are presented as discontinued operations. These income statements are
presented on a pro forma basis pending the occurrence of the event that would
establish the measurement date for treatment of the natural gas business as
discontinued operations, namely approval by Valero stockholders.
The "Natural Gas Business Historical" columns in the unaudited pro forma
condensed statements of income represent the historical results of operations
of the Natural Gas Business plus the effects on results of operations of the
allocation of certain corporate assets and liabilities to the Natural Gas
Business based upon methods deemed reasonable by Valero's management. Interest
expense related to corporate debt has been allocated to the Natural Gas
Business based on the average of the beginning-of-year and end-of-year ratios
of the Natural Gas Business' net assets, exclusive of intercompany notes
receivable or payable, to Valero's consolidated net assets.
In addition, in calculating earnings per share, preferred stock dividends
have been allocated entirely to the discontinued operations of the natural gas
business since the convertible preferred stock proceeds were used to fund the
repurchase of the publicly held units of Valero Natural Gas Partners, L.P.
The unaudited pro forma condensed income statements should be read in
conjunction with the historical consolidated financial statements and the notes
related thereto of Valero which are included beginning on page F-2 of this
Prospectus. The unaudited pro forma condensed income statements are not
necessarily indicative of the results that actually would have occurred if the
spinoff and merger had been consummated as of the beginning of each year
presented, or the results which may be attained in the future.
10
VALERO
PRO FORMA CONDENSED STATEMENTS OF INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
[Enlarge/Download Table]
YEAR ENDED DECEMBER 31, 1995 YEAR ENDED DECEMBER 31, 1994
----------------------------------- ----------------------------------
NATURAL GAS NATURAL GAS
VALERO BUSINESS VALERO VALERO BUSINESS VALERO
HISTORICAL HISTORICAL PRO FORMA HISTORICAL HISTORICAL PRO FORMA
---------- ----------- ---------- ---------- ----------- ----------
OPERATING REVENUES...... $3,197,872 $(1,425,234) $1,772,638 $1,837,440 $(746,943) $1,090,497
---------- ----------- ---------- ---------- --------- ----------
COSTS AND EXPENSES:
Cost of sales and
operating expenses.... 2,830,636 (1,270,312) 1,560,324 1,561,225 (613,569) 947,656
Selling and
administrative
expenses.............. 78,120 (46,728) 31,392 66,258 (42,075) 24,183
Depreciation expense... 100,325 (43,158) 57,167 84,032 (28,985) 55,047
---------- ----------- ---------- ---------- --------- ----------
Total................ 3,009,081 (1,360,198) 1,648,883 1,711,515 (684,629) 1,026,886
---------- ----------- ---------- ---------- --------- ----------
OPERATING INCOME
(LOSS)................. 188,791 (65,036) 123,755 125,925 (62,314) 63,611
EQUITY IN EARNINGS OF
VALERO NATURAL GAS
PARTNERS, L.P. ........ -- -- -- (10,698) 10,698 --
PROVISION FOR
ACQUISITION
EXPENSE ACCRUAL........ (2,506) 2,506 -- (16,192) 16,192 --
OTHER INCOME (EXPENSE),
NET.................... 10,075 (4,199) 5,876 5,868 (1,966) 3,902
INTEREST AND DEBT
EXPENSE, NET........... (101,222) 60,287 (40,935) (76,921) 38,211 (38,710)
---------- ----------- ---------- ---------- --------- ----------
INCOME (LOSS) FROM
CONTINUING OPERATIONS
BEFORE INCOME TAXES.... 95,138 (6,442) 88,696 27,982 821 28,803
INCOME TAX EXPENSE
(BENEFIT).............. 35,300 (4,846) 30,454 10,700 (408) 10,292
---------- ----------- ---------- ---------- --------- ----------
INCOME (LOSS) FROM
CONTINUING OPERATIONS.. 59,838 (1,596) 58,242 17,282 1,229 18,511
INCOME (LOSS) FROM
DISCONTINUED
OPERATIONS, NET OF
TAX.................... -- 1,596 1,596 -- (1,229) (1,229)
---------- ----------- ---------- ---------- --------- ----------
NET INCOME (LOSS)....... 59,838 -- 59,838 17,282 -- 17,282
Less: preferred stock
dividend
requirements.......... 11,818 -- 11,818 9,490 -- 9,490
---------- ----------- ---------- ---------- --------- ----------
NET INCOME (LOSS)
APPLICABLE TO COMMON
STOCK.................. $ 48,020 $ -- $ 48,020 $ 7,792 $ -- $ 7,792
========== =========== ========== ========== ========= ==========
EARNINGS (LOSS) PER
SHARE OF COMMON STOCK:
Continuing
Operations............ $ 1.33 $ .43
Discontinued
Operations............ (.23) (.25)
---------- ----------
Total................ $ 1.10 $ .18
========== ==========
WEIGHTED AVERAGE COMMON
SHARES OUTSTANDING (in
thousands)............. 43,652 43,370
11
SUMMARY SELECTED HISTORICAL FINANCIAL INFORMATION
The following table sets forth Summary Selected Historical Financial Informa-
tion for Valero. For financial reporting purposes under federal securities
laws, New Valero will be a "successor registrant" to Valero. As a result, the
historical financial information set forth below and elsewhere in this Prospec-
tus is the historical financial information of Valero and includes the results
of operations and financial position of the Natural Gas Business. Accordingly,
the historical information presented below is not indicative of the results of
operations or financial position that would have been obtained if New Valero
had been an independent company during the periods shown or of New Valero's fu-
ture performance as an independent company. It is important that you read the
section titled "New Valero Unaudited Pro Forma Condensed Combined Financial
Statements" for reference to what New Valero's financial position and results
of operations might have been had New Valero been operated as an independent
company.
The financial data set forth below has been derived from the consolidated fi-
nancial statements of Valero. The data should be read in conjunction with "Man-
agement's Discussion and Analysis of Financial Condition and Results of Opera-
tions" and the consolidated financial statements of Valero and the notes
thereto included elsewhere in this Prospectus. The selected financial data set
forth below for the year ended December 31, 1996 is derived from Valero's con-
solidated financial statements. The selected financial data for the years ended
prior to December 31, 1996 is derived from the selected financial data con-
tained in Valero's Annual Report on Form 10-K for the year ended December 31,
1995 except as noted below.
The following summaries are in thousands of dollars except for per share
amounts:
[Enlarge/Download Table]
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
1996 1995 1994(A) 1993 1992
---------- ---------- ---------- ---------- ----------
OPERATING REVENUES..... $4,990,681 $3,197,872(b) $1,837,440 $1,222,239 $1,234,618
OPERATING INCOME....... $ 200,909 $ 188,791 $ 125,925 $ 75,504 $ 134,030
EQUITY IN EARNINGS
(LOSSES) OF AND INCOME
FROM VALERO NATURAL
GAS PARTNERS, L.P..... $ -- $ -- $ (10,698) $ 23,693 $ 26,360
NET INCOME............. $ 72,701 $ 59,838 $ 17,282(c) $ 36,424 $ 83,919
Less: Preferred stock
dividend
requirements........ 11,327 11,818 9,490 1,262 1,475
---------- ---------- ---------- ---------- ----------
NET INCOME APPLICABLE
TO COMMON STOCK....... $ 61,374 $ 48,020 $ 7,792(c) $ 35,162 $ 82,444
========== ========== ========== ========== ==========
EARNINGS PER SHARE OF
COMMON STOCK.......... $ 1.40 $ 1.10 $ .18(c) $ .82 $ 1.94
TOTAL ASSETS........... $3,134,774(c) $2,861,880(c) $2,816,558(c) $1,764,437 $1,759,100
LONG-TERM OBLIGATIONS
AND REDEEMABLE
PREFERRED STOCK....... $ 869,450 $1,042,541 $1,034,470 $ 499,421 $ 497,308
COMMON STOCK AND OTHER
STOCKHOLDERS' EQUITY.. $1,075,825(c) $1,024,213(c) $1,002,880(c) $ 842,297 $ 820,758
DIVIDENDS PER SHARE OF
COMMON STOCK.......... $ .52 $ .52 $ .52 $ .46 $ .42
--------
(a) Reflects the consolidation of Valero Natural Gas Partners, L.P. together
with its consolidated subsidiaries as of May 31, 1994.
(b) Revised to include revenues from certain refining and marketing trading ac-
tivities previously classified as a reduction of cost of sales.
(c) Restated to reflect the effects of a prior period adjustment resulting in a
charge to 1994 income for an acquisition expense accrual originally charged
to property, plant and equipment. See "Restatement of Financial Informa-
tion" in Note 1 of Valero Energy Corporation and Subsidiaries Notes to Con-
solidated Financial Statements.
12
WHERE STOCKHOLDERS CAN FIND MORE INFORMATION
Valero files (and New Valero will file) annual, quarterly and special re-
ports, proxy statements and other information with the Securities and Exchange
Commission (SEC). You may read and copy any reports, statements or other in-
formation that Valero or New Valero files at the SEC's public reference rooms
in Washington, D.C., New York, New York and Chicago, Illinois. Please call the
SEC at 1-800-SEC-0330 for further information on the public reference rooms.
Valero's and New Valero's SEC filings are also available to the public from
commercial document retrieval services and at the web site maintained by the
SEC at "http://www.sec.gov."
New Valero has filed with the SEC a Registration Statement on Form S-1 (the
New Valero Registration Statement) under the Securities Act of 1933, as amend-
ed, relating to the shares of New Valero common stock to be issued pursuant to
the spinoff. This Prospectus, which forms a part of the New Valero Registra-
tion Statement, does not contain all of the information in the New Valero Reg-
istration Statement and the related exhibits and schedules. Statements in this
Prospectus as to the contents of any contract, agreement or other document are
summaries only and are not necessarily complete. For complete information as
to these matters, refer to the applicable exhibit or schedule to the New
Valero Registration Statement. The New Valero Registration Statement and the
related exhibits filed by New Valero may be inspected at the public reference
facilities of the SEC listed above.
The principal office of New Valero is located at 530 McCullough Avenue, San
Antonio, Texas 78215 (telephone: (210) 246-2000).
Questions concerning Valero, New Valero, the Distribution (as defined here-
in) or the Merger (as defined herein) should be directed to the Investor Rela-
tions Department, Valero Energy Corporation, P.O. Box 500, San Antonio, Texas
78292-0500 (telephone: (210) 246-2099) or Harris Trust and Savings Bank, P.O.
Box A3504, Chicago, Illinois 60690-3504, Attn: Proxy Services (telephone:
(312) 461-6001).
----------------
NO PERSON IS AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE
ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS,
AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST
NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED.
13
INTRODUCTION
This Prospectus (the "Prospectus") is being furnished to stockholders of
Valero Energy Corporation, a Delaware corporation ("Valero"), in connection
with the contemplated pro rata distribution (the "Distribution") to Valero
stockholders of shares of common stock, par value $0.01 per share ("New Valero
Common Stock"), of Valero Refining and Marketing Company, a Delaware
corporation and wholly owned subsidiary of Valero ("New Valero"). The holders
of Valero common stock, par value $1.00 per share ("Valero Common Stock"),
will receive, at the time the Distribution is effected (the "Time of
Distribution"), one share of New Valero Common Stock, together with an
associated Valero preferred share purchase right (a "Right"), with respect to
each share of Valero Common Stock held by such holder on the record date for
the Distribution (the "Distribution Record Date") (references hereinafter to
New Valero Common Stock will be deemed to include a reference to the
associated Rights). The Distribution will result in 100% of the outstanding
shares of New Valero Common Stock being distributed to Valero stockholders on
a share-for-share basis. The Distribution is being effected by Valero in
connection with the acquisition by PG&E Corporation, a California corporation
("PG&E Corp."), of the Natural Gas Business, pursuant to a merger (the
"Merger") of a newly formed subsidiary of PG&E Corp. ("Merger Sub") with and
into Valero immediately following the Distribution. After the Merger, Valero
will be renamed "PG&E Gas Transmission, Texas, Co." and New Valero will be
renamed "Valero Energy Corporation."
Valero stockholders are being asked to vote on the Distribution and the
Merger but are not being asked to vote on any of the asset transfers or other
actions taken to facilitate the Distribution (the "Intercorporate
Reorganization") or on the acquisition (the "Basis Acquisition") of Basis
Petroleum, Inc. ("Basis"), a wholly owned subsidiary of Salomon Inc
("Salomon"). Although the Distribution will not be effected unless the Merger
is approved and about to occur, the Distribution is separate from the Merger
and the New Valero Common Stock to be received by holders of Valero Common
Stock in the Distribution will not constitute a part of the Merger
consideration. No consideration will be paid by Valero stockholders for the
shares of New Valero Common Stock to be received by them in the Distribution.
There is currently no public trading market for trading the shares of New
Valero Common Stock. New Valero intends to apply to list the New Valero Common
Stock on the New York Stock Exchange, Inc. (the "NYSE") where it is expected
to be traded under the symbol "VLO."
The Distribution has not yet been declared by the Valero Board of Directors
(the "Valero Board"), and, accordingly, the Distribution Record Date has not
yet been determined. The Distribution may be abandoned at any time prior to
the date of its effectiveness by the Valero Board in the event of the
termination of the Agreement and Plan of Merger, dated as of January 31, 1997
(as it may be amended, supplemented or otherwise modified from time to time,
the "Merger Agreement"), among Valero, PG&E Corp. and Merger Sub, which is
attached as Appendix A to the Proxy Statement-Prospectus which was mailed to
the stockholders of Valero together with this Prospectus (the "Proxy
Statement-Prospectus"). See "The Merger Agreement" in the Proxy Statement-
Prospectus.
The Distribution and the Merger (sometimes referred to herein collectively
as the "Transactions") are conditioned upon receipt of opinions of Wachtell,
Lipton, Rosen & Katz, special counsel to Valero and Orrick, Herrington &
Sutcliffe LLP, counsel to PG&E Corp. (together, the "Tax Opinions"), as to
certain income tax consequences of the Transactions. The opinion of Wachtell,
Lipton, Rosen & Katz is to be principally to the effect that, for federal
income tax purposes, the receipt of New Valero Common Stock in the
Distribution will be tax free to holders of Valero Common Stock and to Valero
and the receipt of PG&E Corp. common stock, no par value, ("PG&E Corp. Common
Stock") in the Merger also will be tax free. The opinion of Orrick, Herrington
& Sutcliffe LLP is to be principally to the effect that the receipt of PG&E
Corp. Common Stock in the Merger will be tax free for federal income tax
purposes. See "The Proposed Transactions--Material Federal Income Tax
Consequences" in the Proxy Statement-Prospectus.
14
The following terms will be used throughout this Prospectus:
"Natural Gas Business"........... the business involving natural gas and
natural gas liquids related services, power
marketing and risk management activities
which is being acquired by PG&E Corp.
pursuant to the Merger Agreement.
"Refining Business".............. the business involving the refining and
processing of petroleum and other
feedstocks and the marketing of various
fuels and other products which is owned and
operated by New Valero and is being spun
off immediately prior to the Merger. The
Refining Business will include the business
of Basis.
All of the agreements, instruments, understandings, assignments and other
arrangements, excluding the Merger Agreement, to be entered into in connection
with the transactions contemplated by the Agreement and Plan of Distribution
(the "Distribution Agreement"), including, without limitation, the Tax Sharing
Agreement among Valero, New Valero and PG&E Corp. (the "Tax Sharing
Agreement"), the Employee Benefits Agreement between Valero and New Valero
(the "Employee Benefits Agreement") and the Interim Services Agreement between
Valero and New Valero (the "Interim Services Agreement") are sometimes
referred to herein collectively as the "Ancillary Agreements."
15
RISK FACTORS
Stockholders should carefully consider and evaluate the following risk
factors together with the other information set forth in this Prospectus.
Stockholders should also be aware that this Prospectus includes certain
estimates, predictions, projections and other "forward-looking statements"
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 New Valero's current judgment regarding the direction of its
business, actual results will almost always vary, sometimes materially, from
any estimates, predictions, projections, assumptions, or other future
performance suggested herein. Some important factors (but not necessarily all
factors) that could affect New Valero'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: general economic conditions in the
areas served by the Refining Business; changes in commodity pricing and
demand; renewal or satisfactory replacement of New Valero's residual oil
feedstock arrangements as well as market, political or other forces generally
affecting the pricing and availability of residual oil feedstock and other
refinery feedstocks and refined products; 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; the acquisition of Basis
described herein and implementation of the cost reductions and operational
changes and realization of certain assumptions described in "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Results of Operations--Basis Petroleum"; execution of planned capital
projects; accidents or other unscheduled shutdowns affecting New Valero's, its
suppliers' or its customers' pipelines, plants, machinery or equipment;
weather conditions affecting New Valero's operations or the areas in which New
Valero's products are marketed; state and federal environmental, economic,
safety and other policies and regulations, any changes therein, legal or
regulatory delays or other factors beyond New Valero's control; adverse
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 legislation including tax
legislation, affecting the spinoff and the merger; adverse changes in the
credit ratings assigned to New Valero's debt securities and trade credit and
the other factors referred to herein under "Risk Factors." New Valero
undertakes no obligation to release publicly 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.
NO OPERATING HISTORY AS AN INDEPENDENT COMPANY
New Valero does not have an operating history as an independent public
company. While New Valero has been profitable as part of Valero, there is no
assurance that as a stand-alone company profits will continue at the same
level. The Refining Business has historically relied on Valero for various
financial and administrative services. After the Distribution, New Valero will
maintain its own lines of credit, banking relationships and administrative
functions.
NO PRIOR MARKET FOR NEW VALERO COMMON STOCK
There has been no prior trading market for New Valero Common Stock and there
can be no assurance as to the prices at which the New Valero Common Stock will
trade before or after the Time of Distribution. Until the New Valero Common
Stock is fully distributed and an orderly market develops, the prices at which
the New Valero Common Stock trades may fluctuate significantly. Prices for the
New Valero Common Stock will be determined in the trading markets and may be
influenced by many factors, including the depth and liquidity of the market
for New Valero Common Stock, investor perceptions of New Valero and the
prospects for its businesses, the amount of New Valero's reported earnings or
losses, New Valero's dividend policy and general economic and market
conditions. See "--New Valero Dividend Policy" and "The Distribution--Listing
and Trading of New Valero Common Stock."
16
NEW VALERO DIVIDEND POLICY
The decision to declare a dividend and the amount thereof, if any, will be
in the sole discretion of the New Valero Board of Directors (the "New Valero
Board"). Any future payment of dividends will depend upon the financial
condition, capital requirements and earnings of New Valero, and such other
factors that the New Valero Board may deem relevant. Following the
Distribution, the New Valero Board will consider declaring a quarterly cash
dividend with respect to the New Valero Common Stock. However, the New Valero
Board may change its policy on dividends at any time.
CERTAIN ANTI-TAKEOVER EFFECTS
The Restated Certificate of Incorporation of New Valero (the "New Valero
Certificate"), the By-laws of New Valero (the "New Valero By-laws"), the
Rights and the Delaware General Corporation Law (the "DGCL") contain several
provisions that could have the effect of delaying, deferring or preventing a
change of control of New Valero in a transaction not approved by the New
Valero Board. In addition, the New Valero Board has adopted certain other
programs, plans and agreements with its management and/or employees which may
make such a change of control more expensive. See "--Certain Federal Income
Tax Considerations" and "Anti-Takeover Effects of Certain Provisions."
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
As a condition to the Merger (and therefore, as a condition to the
Distribution as well), Valero and PG&E Corp. must receive Tax Opinions to the
effect that, for United States federal income tax purposes (i) the
Distribution will qualify as a transaction described in Section 355 of the
Internal Revenue Code of 1986, as amended (the "Code") and a "reorganization"
within the meaning of Section 368(a)(1)(D) of the Code and (ii) the Merger
will qualify as a "reorganization" within the meaning of Section 368(a)(1)(B)
of the Code. The Tax Opinions will be based, in part, on certain factual
representations and assumptions. PG&E Corp., Valero and New Valero have agreed
to certain restrictions on their future actions following the Distribution to
provide further assurance that the Transactions will qualify for tax-free
treatment. If the Distribution were taxable, then (i) corporate level income
taxes would be payable by the consolidated group of which Valero is the common
parent, based upon the amount by which the fair market value of the New Valero
Common Stock distributed in the Distribution exceeds Valero's basis therein
and (ii) each holder of Valero Common Stock who receives shares of New Valero
Common Stock in the Distribution would be treated as if such stockholder
received a taxable distribution, taxed as a dividend to the extent of such
stockholder's pro rata share of Valero's current and accumulated earnings and
profits. New Valero has agreed to indemnify Valero and PG&E Corp. for any
adverse corporate level income tax consequences resulting from the failure of
the Distribution and/or the Merger to qualify for tax-free treatment, except
that Valero will be liable to the extent that such failure is attributable to
actions of Valero following the Distribution that are inconsistent with the
contemplated tax treatment of the Distribution and the Merger. See "Agreements
Between Valero and New Valero--Tax Sharing Agreement." The potential corporate
level income tax liability which could arise from an acquisition of New Valero
for a period of time following the Distribution, together with the foregoing
indemnification arrangements, could have an anti-takeover effect with respect
to a potential acquisition of control of New Valero.
BASIS ACQUISITION
As is discussed more fully in "Business and Properties--Acquisition of Basis
Petroleum", "Business and Properties--Litigation" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Results of
Operations--Basis Petroleum," on April 22, 1997, Valero entered into a stock
purchase agreement to acquire Basis, and on May 1, 1997, pursuant to the terms
of the stock purchase agreement, Valero acquired Basis. Basis owns three
refineries located in Texas and Louisiana and conducts marketing operations.
Basis has recently completed a significant refinery upgrading project which
has not been fully reflected in its operating results; additionally, Basis has
incurred operating losses during the last several years. New Valero does not
have an operating history with respect to the Basis refineries. While New
Valero's Refining Business has been profitable, there is no assurance that,
following the Basis Acquisition, the combined entities will be profitable, or
will be able to achieve the cost savings and operational improvements
anticipated by New
17
Valero or that the projected prices of refinery feedstocks and refined
products assumed by New Valero in connection with the Basis Acquisition will
be realized. Additionally, although Valero and New Valero have conducted a due
diligence investigation of Basis prior to the closing of the purchase, the
scope of such investigation, particularly in light of the volume of
environmental, litigation and other matters to be investigated, has
necessarily been limited. The stock purchase agreement provides for
indemnification from the seller with respect to suits, actions, claims and
investigations pending at the time of the acquisition and for additional
indemnification, subject to certain terms, conditions and limitations, with
respect to other matters. However, there can be no assurance that other
material matters, not identified or fully investigated in due diligence, will
not subsequently be identified or that the matters heretofore identified will
not prove to be more significant than currently expected.
INDEMNIFICATION
From and after the effective time of the Merger (the "Effective Time"), New
Valero and its successors and assigns will indemnify, defend and hold harmless
Valero and PG&E Corp. from and against, and pay or reimburse Valero and PG&E
Corp. for certain losses arising from (i) certain New Valero assets and
liabilities relating to the Refining Business, (ii) with respect to
information provided by New Valero any untrue statement of a material fact
contained in any filings with the SEC or any omission to state in such filings
a material fact so as to make the statement not misleading, (iii) certain
guarantees made by Valero relating to the Refining Business and certain
specified indebtedness of New Valero, (iv) the transfer of certain real
property by warranty deeds, (v) any breach by New Valero of the Distribution
Agreement and (vi) the enforcement by Valero and PG&E Corp. of their rights to
be indemnified, defended and held harmless under the Distribution Agreement.
The amount of any loss or liability for which indemnification is provided will
be net of any amounts actually recovered by the indemnitee from third parties.
See "Agreements Between Valero and New Valero--Distribution Agreement."
EFFECT OF ECONOMIC AND OTHER CONDITIONS ON OPERATING MARGINS
New Valero conducts significant refining and marketing operations in the
state of Texas and the surrounding region, and significant marketing
operations in the northeastern, southeastern and midwestern United States.
Results of these operations will be significantly affected by changes in the
volumes of refined products sold and the prices received on those volumes.
These, in turn, are influenced by such factors as the general economic
condition of such regions, which affect the overall demand for gasoline and
other refined products, the actions taken by competitors, including both
pricing and the expansion and retirement of refining capacity in response to
market conditions and environmental and other regulations. Projections as to
the level of future earnings are dependent on New Valero's ability to produce
and sell the volumes of refined products and to achieve the margins on which
those projections are based.
EFFECT OF POLITICAL AND REGULATORY FACTORS ON NEW VALERO'S OPERATIONS
New Valero's ability to conduct refining and marketing operations is
dependent on the political and regulatory climate in the particular geographic
regions where its properties are located, as well as environmental regulations
issued by the state and federal governments, including particularly
regulations dealing with gasoline composition and characteristics. New
Valero's ability to negotiate and implement specific projects in a timely and
favorable manner may be impacted by political considerations unrelated to or
beyond the control of New Valero. Political constraints either in the form of
express legal requirements or general political pressure may limit the margins
otherwise available to New Valero. Possible political and regulatory actions
by governments may affect future results in unpredictable ways.
OPERATING HAZARDS
New Valero's refining and marketing operations are subject to various
hazards common to the industry, including explosions, fires, and
uncontrollable flows of oil and gas. They are also subject to the additional
hazards of loss from severe weather conditions.
18
COMMODITY PRICING AND DEMAND
New Valero's refining and marketing operating results are affected by the
relationship between refined product prices and residual fuel oil ("resid")
prices, which, in turn, are largely determined by market forces. The price of
resid is affected by the relationship between the growth in the demand for
fuel oil and other products (which increases crude oil demand, thereby
increasing the supply of resid when more crude oil is processed) and worldwide
additions to resid conversion capacity (which has the effect of reducing the
available supply of resid). The crude oil and refined products markets
typically experience periods of extreme price volatility and may vary based on
factors such as seasonal weather patterns, the national and regional economy,
market demand, regulatory changes, the price of resid and other feedstocks,
the ability of regional refiners and New Valero to provide a sufficient supply
of refined products and unexpected national and international events. During
such periods, disproportionate changes in the prices of refined products and
resid usually occur. Also, a substantial amount of New Valero's Refinery (as
defined herein) feedstocks and refined product production is purchased or sold
on the spot market or under short-term contracts at market sensitive prices.
Spot market prices for such feedstock and products are subject to volatile
trading patterns in the commodity futures markets, including among others, the
New York Mercantile Exchange, because of the factors mentioned above. Although
the futures markets provide some indication of feedstock and refined product
prices for the subsequent 12 to 18 months, prices in the futures markets are
subject to substantial changes in relatively short periods of time. The
potential impact of changing crude oil and refined product prices on New
Valero's results of operations is further affected by the fact that New Valero
generally buys its resid feedstock approximately 45 to 50 days prior to
processing it in the Refinery (as defined herein).
FEEDSTOCK SUPPLY
The predominant feedstock for the Refinery is resid produced at refineries
outside the United States. Most of the large refineries in the United States
are able to convert internally produced resid into higher value end-products.
Many overseas refineries, however, are less sophisticated, process a smaller
portion of resid internally, and therefore produce larger volumes of resid for
sale. As a result, New Valero acquires and expects to acquire most of its
resid in international markets. New Valero has entered into several term
agreements for the supply of approximately 58,000 barrels per day of resid
feedstocks at market-related prices which provide for approximately 70% of New
Valero's estimated resid feedstock requirements for 1997. These supply
agreements include an agreement with the Saudi Arabian Oil Company to provide
an average of 36,000 barrels per day of resid from its Ras Tanura, Saudi
Arabia, refinery through mid-1998. The Saudi Arabian Oil Company has advised
New Valero that it plans to begin operation of certain new resid conversion
units at the Ras Tanura refining complex in 1998. As a result, the production
of resid at Ras Tanura for export would be significantly reduced. A reduction
in resid production at Ras Tanura could adversely affect the price or
availability of resid feedstocks in the future. New Valero believes that if
any of its existing feedstock arrangements were interrupted or terminated,
supplies of resid could be obtained from other sources or on the open market;
however, New Valero could be required to incur higher feedstock costs or
substitute other types of resid, thereby producing less favorable operating
results. Over the past few years, demand for the type of resid feedstock now
processed at the Refinery has increased in relation to the availability of
supply. New Valero expects resid to continue to sell at a discount to crude
oil, but is unable to predict future relationships between the supply of and
demand for resid. Installation of additional refinery crude distillation and
upgrading facilities, as well as price volatility, international political
developments and other factors beyond the control of New Valero, are likely to
continue to play an important role in refining industry economics.
COMPETITION
The refining industry is highly competitive with respect to both supply and
markets. New Valero competes with numerous other companies for available
supplies of resid and other feedstocks and for outlets for its refined
products. Whereas New Valero obtains all of its resid feedstock from
unaffiliated sources, many of New Valero's competitors obtain a significant
portion of their feedstocks from company-owned production and are able to
dispose of refined products at their own retail outlets. Competitors that have
their own production or retail outlets
19
may be able to offset losses from refining operations with profits from
producing or retailing operations, and may be better positioned than New
Valero to withstand periods of depressed refining margins or feedstock
shortages. See "Business and Properties--Competition" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
ENVIRONMENTAL MATTERS
Like others in similar businesses, Valero is, and New Valero will be,
subject to extensive federal, state and local environmental laws and
regulations. Although New Valero's environmental policies and practices are
designed to ensure compliance with these laws and regulations, future
developments and increasingly stringent regulation could require New Valero to
make additional unforeseen expenditures relating to environmental matters. In
1996, capital expenditures for the Refining Business attributable to
compliance with environmental regulations were approximately $5 million and
are currently estimated to be $7 million for 1997 (exclusive of any
expenditures for Basis). Although the level of future expenditures for such
matters cannot be determined with absolute certainty, based on the facts
currently known to it, management does not believe that such costs are likely
to have a material effect on New Valero's financial position, results of
operations or liquidity. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and "Business and Properties--
Environmental Matters."
THE DISTRIBUTION
BACKGROUND AND REASONS FOR THE DISTRIBUTION
For the past several years, Valero's management has noted significant,
ongoing changes in the natural gas industry, as well as in the electric
utility industry. Valero recognized that these trends would change the terms
and conditions upon which it would be required to compete in the future.
Over a period of years continuing until November 1996, Valero management
engaged in discussions with prospective joint venture partners regarding
possible alliances, combinations, partnerships or joint venture transactions
involving its Natural Gas Business. However, Valero management was not
successful in arranging any such transaction on satisfactory terms. Over this
same period, merger and acquisition activity in the energy industry, as well
as the size and scope of announced transactions, increased markedly.
On November 21, 1996, Valero announced that the Valero Board had determined
to pursue strategic alternatives to further position its businesses for future
growth, including accelerating existing efforts to seek a strategic alliance
for Valero's Natural Gas Business and likely spinoff of its Refining Business.
The management and Valero Board concluded that such a transaction had the
greatest potential for enhancing the competitive position of the Natural Gas
Business, and thereby enhancing overall stockholder value, since Valero
stockholders would receive--on a tax-free basis--both common stock in a new
company (i.e., the Natural Gas Business combined with the acquiror's existing
business) that would have a stronger market position and stronger earnings
growth potential than Valero's Natural Gas Business on a stand-alone basis, as
well as separate common stock in the spun off company holding the Refining
Business. Valero also concluded that a separation of the Refining Business
from the Natural Gas Business would benefit the Refining Business by
permitting it to adopt a capitalization structure and strategies and
investment opportunities that best suited its needs, without concern for or
competition for capital from the Natural Gas Business.
On January 30, 1997, the Valero Board reviewed the terms of the Merger
Agreement, the Distribution Agreement, and the Ancillary Agreements,
determined that the Distribution and the Merger were in the best interests of
Valero and Valero's stockholders and approved the Merger Agreement, the
Distribution Agreement and the Ancillary Agreements.
The Valero Board believes that the Distribution and the Merger will
accomplish a number of important business objectives. The Distribution and
Merger will allow Valero's stockholders to retain an equity
20
participation in a stronger, more competitive natural gas business and to
realize a significant premium for Valero's existing Natural Gas Business. The
Valero Board also believes that the Distribution will permit Valero's
stockholders to continue their participation in the Refining Business in a
form designed to maximize its strengths and focus on its particular business
needs by adopting strategies and pursuing investment opportunities that are
appropriate to its business and operating needs without concern for or
competition for capital from the Natural Gas Business. The Distribution will
enable New Valero to have its own publicly traded equity security to finance
its own growth opportunities. By distributing the New Valero Common Stock to
Valero's stockholders, the Valero Board believes that there will be a greater
potential for increasing the long-term value of the investment of Valero's
stockholders in the Refining Business. The Valero Board believes that the
Distribution and Merger will enable investors to evaluate better the
performance, investment characteristics and the future prospects of the
Refining Business now conducted by Valero, enhancing the likelihood that it
will achieve appropriate market recognition of its performance and potential.
MANNER OF EFFECTING THE DISTRIBUTION
The Distribution is expected to be effected immediately prior to the
Effective Time. Immediately after the Time of Distribution, the New Valero
Common Stock will be delivered to the distribution agent (the "Distribution
Agent"). As soon as practicable thereafter, the Distribution Agent will begin
mailing share certificates for New Valero Common Stock to holders of Valero
Common Stock as of the close of business on the Distribution Record Date on
the basis of one share of New Valero Common Stock for every share of Valero
Common Stock held on the Distribution Record Date. Based on the number of
shares of Valero Common Stock issued and outstanding at May 2, 1997 and after
giving effect to the expected conversion of shares of Valero's $3.125
Convertible Preferred Stock (the "Convertible Preferred Stock"), the exercise
of certain Valero Options (as defined herein) and the issuance of 3,429,796
shares of Valero Common Stock to Salomon in connection with the Basis
Acquisition, approximately 56 million shares of New Valero Common Stock are
expected to be issued pursuant to the Distribution. All shares of New Valero
Common Stock will be fully paid, nonassessable and free of preemptive rights.
The New Valero Board is expected to adopt the New Valero Rights Agreement (as
defined herein) and declare a distribution of one Right for every outstanding
share of New Valero Common Stock, which Rights will be evidenced by the
outstanding certificates of New Valero Common Stock distributed in the
Distribution. Each Right, among other things, would allow stockholders to
purchase additional shares of New Valero Common Stock upon the occurrence of
certain takeover related events. See "Description of New Valero Capital
Stock--New Valero Purchase Rights."
Immediately following the Distribution, PG&E Corp., pursuant to the Merger,
will acquire the Natural Gas Business and each share of Valero Common Stock
will, at the Effective Time, be converted into a right to receive a fraction
of a share of PG&E Corp. Common Stock. Shares of Valero Common Stock owned by
PG&E Corp. or Valero and their wholly owned subsidiaries will not be so
converted. See "The Merger Agreement" in the Proxy Statement-Prospectus.
Following the Distribution, approximately 94 million shares of New Valero
Common Stock will remain authorized but unissued, of which approximately 4.8
million will be reserved for issuance pursuant to incentive compensation
awards and other employee stock plans.
NO HOLDER OF VALERO COMMON STOCK WILL BE REQUIRED TO PAY ANY CASH OR OTHER
CONSIDERATION FOR THE SHARES OF NEW VALERO COMMON STOCK TO BE RECEIVED IN THE
DISTRIBUTION OR TO SURRENDER OR EXCHANGE SHARES OF VALERO COMMON STOCK (OTHER
THAN IN REGARD TO THE EXCHANGE AS PART OF THE MERGER AS DESCRIBED IN THE PROXY
STATEMENT-PROSPECTUS) OR TO TAKE ANY OTHER ACTION IN ORDER TO RECEIVE NEW
VALERO COMMON STOCK.
CERTAIN FEDERAL INCOME TAX CONSIDERATIONS
For a discussion of the material United States federal income tax
consequences of the Transactions to Valero and Valero's stockholders, please
refer to "Material Federal Income Tax Consequences" in the Proxy Statement-
Prospectus. In addition to describing United States federal income tax
consequences of the Transactions, that
21
section of the Proxy Statement-Prospectus also discusses the President's
budget recommendations calling for new legislation which could have an effect
on the Transactions. If the proposed United States legislative initiatives are
enacted or pending prior to the Merger with an effective date provision that
could cause Valero to be subject to tax, the Tax Opinions may not be available
and as a result the Distribution and the Merger may not be consummated.
LISTING AND TRADING OF NEW VALERO COMMON STOCK
The New Valero Common Stock is expected to be listed on the NYSE, under the
symbol "VLO." There is currently no public trading market for New Valero
Common Stock. Prices at which New Valero Common Stock may trade prior to or
following the Distribution cannot be predicted. See "Risk Factors--No Prior
Market for New Valero Common Stock." A when-issued trading market is expected
to develop on or about the Distribution Record Date. The term "when-issued"
means that shares can be traded prior to the time certificates are actually
available or issued. Prices at which the shares of New Valero Common Stock may
trade on a when-issued basis or after the Distribution cannot be predicted.
As of the Distribution Record Date, New Valero expects to have approximately
6,300 stockholders of record, based upon the number of holders of record of
Valero Common Stock as of March 31, 1997. The Transfer Agent and Registrar for
the New Valero Common Stock will be Harris Trust and Savings Bank. As of April
30, 1997, approximately 4 million options to acquire shares of Valero Common
Stock were outstanding, of which, if outstanding at the Distribution,
approximately 3 million will be converted into options to acquire shares of
New Valero Common Stock in connection with the Distribution, were held by
current or former employees of New Valero.
Shares of New Valero Common Stock distributed to Valero stockholders in the
Distribution will be freely transferable, except for shares received by
persons who may be deemed to be "affiliates" of New Valero under the
Securities Act of 1933, as amended (the "Securities Act"). Persons who may be
deemed to be affiliates of New Valero generally include individuals or
entities that control, are controlled by, or are under common control with,
New Valero, and may include certain officers and directors of New Valero as
well as principal stockholders of New Valero, if any. Persons who are
affiliates of New Valero may sell their shares of New Valero Common Stock only
pursuant to an effective registration statement under the Securities Act or an
exemption from the registration requirements of the Securities Act, such as
the exemptions afforded by Section 4(2) of the Securities Act and Rule 144
thereunder.
REGULATORY MATTERS
Other than as described in the Proxy Statement-Prospectus, no material
United States federal or state regulatory approvals are required in connection
with the Distribution which have not been obtained. For a discussion of United
States regulatory approvals with respect to the Transactions, see "The Merger
Agreement--Certain Regulatory Matters" in the Proxy Statement-Prospectus.
AGREEMENTS BETWEEN VALERO AND NEW VALERO
For the purpose of effecting the Distribution and governing certain of the
relationships between Valero and New Valero after the Distribution, Valero and
New Valero have entered or will enter into the various agreements described
below. The Distribution Agreement, the material features of which are
summarized below, is attached as Appendix B to the Proxy Statement-Prospectus,
and the Ancillary Agreements, the material features of which are summarized
below, have been filed as exhibits to New Valero's Registration Statement on
Form S-1 (the "New Valero Registration Statement"). The following descriptions
do not purport to be complete and are qualified in their entirety by reference
to such agreements.
22
DISTRIBUTION AGREEMENT
Method of Effecting the Distribution. The Distribution Agreement provides
that, at the Time of Distribution, Valero will distribute all outstanding
shares of New Valero Common Stock to holders of record of Valero Common Stock
on the Distribution Record Date on the basis of one share of New Valero Common
Stock for each share of Valero Common Stock outstanding on the Distribution
Record Date. The Distribution will be made immediately prior to PG&E Corp.
acquiring Valero through the Merger.
Intercorporate Reorganization. Prior to or at the Time of Distribution,
Valero and New Valero will complete the Intercorporate Reorganization the
purpose and effect of which will be to facilitate the Merger by separating the
Natural Gas Business from the Refining Business. The assets retained by Valero
will consist principally of the assets that are used primarily in or held
primarily for use in or otherwise necessary for the operation, as presently
conducted, of the Natural Gas Business. The assets owned by New Valero will
consist principally of the assets that are used primarily in or held primarily
for use in or otherwise necessary for the operation, as presently conducted,
of the Refining Business.
The Distribution Agreement provides that Valero will transfer to New Valero
or to one of New Valero's subsidiaries all of Valero's right, title and
interest in certain Refining Business assets. New Valero will transfer to
Valero or a subsidiary of Valero (a "Retained Subsidiary"), all of New
Valero's right, title and interest in certain Natural Gas Business assets.
Valero or a Retained Subsidiary will assume and agree to pay, perform and
discharge in due course certain liabilities relating to or arising in
connection with the Natural Gas Business. New Valero or one of New Valero's
subsidiaries will assume and agree to pay, perform and discharge in due course
certain liabilities relating to or arising from the Refining Business,
Valero's filings with the SEC prior to the Time of Distribution, any breach or
alleged breach by any director or officer of Valero of the director's
fiduciary duties to Valero and its stockholders occurring at or prior to the
Effective Time, the MTBE plant in Mexico (as defined and described in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Results of Operations--1996 Compared to 1995"), and certain
assumed liabilities.
Repayment of Intercompany Indebtedness and Cash Dividend. Prior to the Time
of Distribution, Valero will redeem (or convert) the Convertible Preferred
Stock. The redemption, if any, of the Convertible Preferred Stock will be
funded by Valero with the proceeds of borrowings under the $835 million credit
facility (the "New Credit Facility") which New Valero will assume immediately
prior to the Distribution. Prior to the Time of Distribution, New Valero shall
pay a cash dividend (the "Cash Dividend") to Valero in an amount equal to
$210,000,000.
Valero and New Valero will (a) eliminate without payment the $212,450,000
net amount of the intercompany note owing from Valero to New Valero as of
December 31, 1996, (b) refrain from creating any obligations under such
intercompany note after December 31, 1996, except in the ordinary course of
business consistent with past practice or as contemplated by the Ancillary
Agreements and (c) satisfy by cash payment at the Time of Distribution the
full net amount of such note for the period from January 1, 1997 to the Time
of Distribution (which intercompany note will not reflect the assumption by
New Valero of liabilities related to the acquisition of Basis and redemption
of the Convertible Preferred Stock). Prior to the assumption by New Valero of
liabilities under the New Credit Facility, all liabilities under the New
Credit Facility that are unrelated to (i) Valero's acquisition of Basis or
(ii) the redemption of the Convertible Preferred Stock will be transferred to
certain uncommitted facilities of Valero or, to the extent capacity is not
available thereunder, be borne by Valero by a reduction in amounts owed by New
Valero (or an increase in amounts owed by Valero) under the intercompany note.
Valero Guarantees. Neither New Valero nor any of its subsidiaries (the "New
Valero Group") will increase its outstanding obligations in excess of the
aggregate amount of all obligations under certain guarantees of Valero (the
"Valero Guarantees") as of January 31, 1997, nor will New Valero or the New
Valero Group renew or enter into any additional obligations for which Valero
would act as guarantor unless such guarantee by its terms expires as to Valero
and its subsidiaries (the "Valero Group") without further liability at or
prior to
23
the Time of Distribution. New Valero will use its reasonable best efforts to
obtain any amendments to, or consents with respect to, the Valero Guarantees
that are necessary in order that Valero be released no later than the Time of
Distribution from any liability or obligation under the Valero Guarantees;
provided that if any such release has not been obtained by the Time of
Distribution, New Valero will: (i) provide Valero with a full indemnity with
respect thereto and (ii) continue to use its best efforts to obtain such
release as soon as practicable thereafter.
Use of Names, Trademarks, etc. Pursuant to the Distribution Agreement, from
and after the Time of Distribution, New Valero will have all rights, including
all intellectual property rights in and exclusive use of the trademarks, trade
names and service marks, the United States federal and Mexican registrations
and applications, the Internet domain registration and exclusive use of the
name "Valero," and any and all other designs, logos and slogans, related to
the names "Valero" and "Valero Energy Corporation" and the "Walking Flame"
service mark, and all other rights (whether tangible or intangible, statutory,
at common law or otherwise) in connection therewith, whether alone or in
combination with one or more other words or marks in connection therewith. As
promptly as practicable after the Effective Time, but in any event no later
than six months after the Effective Time, Valero will cease using the "Valero"
name and mark or service mark and the "Walking Flame" service mark.
Intercompany Arrangements. Certain agreements, contracts, arrangements and
commitments, between a member of the New Valero Group on the one hand, and
Valero or one of its subsidiaries on the other hand, which were entered into
prior to the closing date of the Transactions for the purchase or sale of
goods or services, will remain in effect as of and after the Time of
Distribution.
Non-Competition Covenants. From and after the Distribution until the second
anniversary of the closing date of the Transactions, New Valero will not, and
will cause its affiliates and subsidiaries not to, directly or indirectly,
within the geographic area in which such businesses are currently conducted by
the Valero Group (i) engage in marketing natural gas or marketing and trading
electric power (a "Competitive Business") (provided that nothing in the
Distribution Agreement will preclude New Valero from marketing surplus
electric power generated at its refineries), (ii) sell, assign or otherwise
transfer the trademarks, trade names, service marks, the use of the name
"Valero" or any and all other designs, logos and slogans, related to the names
"Valero" and "Valero Energy Corporation" and the "Walking Flame" service mark
to a Competitive Business, or (iii) invest in, as principal, partner or
stockholder (otherwise than through the ownership of less than 4% of the
outstanding voting securities of any corporation which are listed on a
national securities exchange or accepted for quotation on the over-the-counter
market), any person, partnership, firm, corporation or other business entity
which is engaged in a Competitive Business; provided, that New Valero will not
be precluded from acquiring (or, thereafter, from operating) a Competitive
Business if the operations constituting a Competitive Business are incidental
to a larger acquisition of a business or entity whose principal operations do
not constitute a Competitive Business.
Conditions to the Distribution. The obligations of Valero to consummate the
Distribution are subject to the fulfillment of each of the following
conditions: (i) each of the covenants and provisions in the Distribution
Agreement required to be performed or complied with on or before the Time of
Distribution having been performed and complied with; (ii) each condition to
the closing of the Merger Agreement, other than the condition as to the
consummation of the Distribution, having been fulfilled or waived by the party
for whose benefit such condition exists; (iii) the Boards of Directors of
Valero and PG&E Corp. being satisfied that Valero's surplus would be
sufficient to permit, without violation of Section 170 of the DGCL, the
Distribution and having given final approval of the Distribution; (iv) the New
Valero Common Stock having been approved for listing, upon notice of issuance,
on the NYSE; (v) the Distribution having been duly approved by the requisite
vote of the holders of Valero Common Stock; and (vi) the Intercorporate
Reorganization having been completed as contemplated by the terms of the
Distribution Agreement.
24
The condition to Valero's obligation to consummate the Distribution may be
waived in whole or part as may be agreed by Valero and PG&E Corp., and to the
extent permitted by applicable law.
Indemnification. Pursuant to the Distribution Agreement, from and after the
Effective Time, New Valero and its successors and assigns, on the one hand,
and Valero and its successors and assigns, on the other hand, will indemnify
each other for certain losses (defined in the Distribution Agreement as
"Indemnifiable Losses") arising from certain matters. Additionally, pursuant
to an Agreement and Consent, dated as of March 10, 1997 (the "Consent"),
executed in connection with the letter of intent relating to the Basis
Acquisition, New Valero has agreed to indemnify Valero and PG&E Corp. with
respect to certain matters regarding the Basis Acquisition.
Specifically, New Valero and its successors and assigns will indemnify,
defend and hold harmless the Valero Group from and against, and pay or
reimburse the Valero Group for, all Indemnifiable Losses, as incurred:
(i) relating to or arising from certain New Valero assets or liabilities
relating to the Refining Business (including the failure by New Valero to
pay, perform or otherwise discharge such liabilities in accordance with
their terms), whether such Indemnifiable Losses relate to or arise from
events, occurrences, actions, omissions, facts or circumstances occurring,
existing or asserted before, at or after the Time of Distribution;
(ii) arising from or based upon any untrue statement of a material fact
contained in any of the filings with the SEC, or any omission to state
therein a material fact required to be stated therein or necessary to make
the statements therein, in light of the circumstances under which they were
made, not misleading; but only in each case with respect to information
provided by Valero relating to the New Valero Group contained in or omitted
from such filings;
(iii) relating to the Valero Guarantees and Valero's guarantee of the
industrial revenue bonds ("IRBs");
(iv) relating to the transfer of certain real property by warranty deeds;
(v) relating to any breach or violation of the Distribution Agreement by
New Valero or, prior to the Time of Distribution, by Valero; any breach by
New Valero or, prior to the Time of Distribution, by Valero, of any of the
representations, warranties or covenants made in the Distribution
Agreement, or any inaccuracy or misrepresentation in the schedules thereto
or in any certificate or document delivered in accordance with the terms of
the Distribution Agreement;
(vi) incurred in connection with the enforcement by any member of the
Valero Group of its rights to be indemnified, defended and held harmless
under the Distribution Agreement; or
(vii) relating to or arising from the Basis Acquisition of the assets or
business being acquired, or from any breach of violation of the Consent by
New Valero (or prior to the Effective Time, Valero).
Valero and its successors and assigns will indemnify, defend and hold
harmless the New Valero Group for and against, and pay or reimburse the New
Valero Group for, all Indemnifiable Losses, as incurred:
(i) relating to or arising from certain Valero assets or liabilities
relating to the Natural Gas Business (including the failure by Valero to
pay, perform or otherwise discharge such liabilities in accordance with
their terms), whether such Indemnifiable Losses relate to or arise from
events, occurrences, actions, omissions, facts or circumstances occurring,
existing or asserted before, at or after the Time of Distribution;
(ii) arising from or based upon any untrue statement of a material fact
contained in any filings with the SEC, or any omission to state therein a
material fact required to be stated therein or necessary to make the
statements therein, in light of the circumstances under which they were
made, not misleading; but only in each case with respect to information
provided by PG&E Corp. relating to PG&E Corp. or any of its subsidiaries
contained in or omitted from such filings; or
(iii) incurred in connection with the enforcement by any member of the
New Valero Group of its rights to be indemnified, defended and held
harmless under the Distribution Agreement.
25
The amount of any Indemnifiable Losses or other liability for which
indemnification is provided under the Distribution Agreement will be net of
any amounts actually recovered by the indemnitee from third parties
(including, without limitation, amounts actually recovered under insurance
policies) with respect to such Indemnifiable Losses or other liability.
Modification or Amendment. The Distribution Agreement provides that Valero
and New Valero may modify or amend the Distribution Agreement only by written
agreement executed and delivered by duly authorized officers of Valero and New
Valero, and the written consent of PG&E Corp. thereto.
TAX SHARING AGREEMENT
Prior to the Transactions, Valero, New Valero and PG&E Corp. will enter into
the Tax Sharing Agreement, which will set forth each party's rights and
obligations with respect to payments and refunds, if any, of federal, state,
local or other taxes for periods before the Transactions. The Tax Sharing
Agreement will also address related matters, such as the filing of tax returns
and the conduct of audits and other tax proceedings.
In general, under the Tax Sharing Agreement, Valero and New Valero will each
be responsible for its allocable share of the federal, state and other taxes
incurred by the combined operations of Valero and New Valero prior to the
Distribution. Furthermore, New Valero will be responsible for any tax
liability resulting from the Transactions, including any tax arising as a
result of the failure of the Distribution to qualify as a transaction
described in Section 355 of the Code and/or as a "reorganization" under
Section 368 of the Code, or of the Merger to qualify as a "reorganization"
under Section 368 of the Code (a "Reorganization Tax"), except as follows:
pursuant to the Tax Sharing Agreement, Valero will be responsible for any
Reorganization Tax attributable to certain actions taken by Valero and/or PG&E
Corp. and for any tax liability resulting from the Transactions other than a
Reorganization Tax liability to the extent such tax liability is less than $3
million.
EMPLOYEE BENEFITS AGREEMENT
The discussion below summarizes the terms by which assets relating to, and
liabilities arising under, various benefit plans and programs presently
maintained by Valero will be allocated pursuant to the Employee Benefits
Agreement.
Employees. The Employee Benefits Agreement provides for the transfer of
employees between New Valero and Valero in connection with the Distribution.
Stock Options and SARs. The Employee Benefits Agreement provides that,
effective as of the Time of Distribution, each option to purchase Valero
Common Stock ("Valero Option") held by a current or former New Valero employee
will be converted into an option to acquire shares of New Valero Common Stock
and, in connection with the Merger, each Valero Option held by a current or
former employee of Valero will be converted into an option to acquire shares
of PG&E Corp. Common Stock, in each case in a manner that will provide
equivalent value to each Valero Option holder by preserving the aggregate
"spread" that existed prior to the Transactions between the per share value of
Valero Common Stock and the per share exercise price of the Valero Options
being converted. Each Valero stock appreciation right ("SAR") which is held by
a current or former New Valero employee and is outstanding at the Time of
Distribution will be replaced as of the Time of Distribution with a number of
New Valero SARs equal to the number of Valero SARs held by the holder
immediately before such replacement in a manner that will provide equivalent
value to each Valero SAR holder in the manner noted above.
The Employee Benefits Agreement sets forth the manner in which the Valero
Options of current and former employees of New Valero will be converted.
Pursuant to the Employee Benefits Agreement, the per share exercise price of
each New Valero option will be equal to the product of (i) the per share
exercise price of the Valero Option immediately prior to the conversion
multiplied by (ii) a fraction, the numerator of which is the Average Price (as
defined herein) of New Valero Common Stock and the denominator of which is the
Average Price of Valero Common Stock (the "Conversion Ratio"). The number of
shares of New Valero Common Stock
26
for which each New Valero option will be exercisable will be equal to the
product of the number of shares of Valero Common Stock for which the Valero
Option is exercisable immediately prior to the conversion multiplied by the
reciprocal of the Conversion Ratio. "Average Price" with respect to any stock
means the average of the daily closing prices per share of such stock on the
NYSE for the 15 consecutive full NYSE trading days ending on the trading day
before the Time of Distribution, in the case of New Valero Common Stock
trading on a "when-issued" basis. The Employee Benefits Agreement also sets
forth the manner in which Valero SARs held by current and former employees of
New Valero will be converted, which is similar to the manner noted above with
regard to Valero Options.
Pension Plan. The Employee Benefits Agreement provides that, effective as of
the Time of Distribution, New Valero will become the sponsor of the Pension
Plan (as defined herein), which shall subsequently be referred to as the "New
Valero Pension Plan." New Valero and the New Valero Pension Plan will
thereafter be solely responsible for (i) pension liabilities existing
immediately prior to the Time of Distribution to, or relating to, individuals
employed by Valero after the Distribution, which liabilities shall become
payable upon the retirement of such individuals, (ii) all liabilities to or
relating to former employees of Valero and New Valero and (iii) all
liabilities to or relating to current employees of New Valero.
Non-Employee Directors Pension Plan. The Employee Benefits Agreement
provides that, effective as of the Time of Distribution, New Valero shall
assume and become solely responsible for all liabilities existing under the
Non-Employee Director Pension Plan as of the Time of Distribution.
Thrift Plan. The Employee Benefits Agreement provides that, effective as of
the Time of Distribution, New Valero shall become the sponsor of Valero's
thrift plan (the "Valero Thrift Plan"), which shall subsequently be referred
to as the "New Valero Thrift Plan." Each current Valero employee participating
in the Valero Thrift Plan prior to the Distribution shall be entitled to
either (i) maintain his or her account in the New Valero Thrift Plan; (ii)
transfer the account balance to a qualified "Individual Retirement Account";
(iii) transfer the account balance to the PG&E Corp. thrift plan; or (iv)
receive a distribution of the account balance. (The transfers described in
clauses (ii) and (iii) are hereinafter referred to as "Thrift Plan
Transfers"). New Valero and the New Valero Thrift Plan shall be solely
responsible for all liabilities arising under the New Valero Thrift Plan after
the Time of Distribution to or with respect to current New Valero employees,
former employees of both Valero and New Valero, and Valero employees who
elected to maintain their account balances in the New Valero Thrift Plan.
Excess Thrift Plan. The Employee Benefits Agreement provides that, effective
as of the Time of Distribution, New Valero shall become the sponsor of
Valero's excess thrift plan (the "Valero Excess Thrift Plan") and shall
thereby assume all liabilities to or with respect to current and former
employees of both Valero and New Valero arising under such plan.
Supplemental Retirement Plans and Supplement Executive Retirement
Agreements. The Employee Benefits Agreement provides that, effective as of the
Time of the Distribution, New Valero shall become the sponsor of Valero's
supplemental retirement plan (the "Valero Supplemental Retirement Plan") and
Valero's Supplemental Executive Retirement Plan (the "SERP") and shall thereby
assume all liabilities with respect to current and former employees of both
Valero and New Valero under such plans. Such obligations of New Valero under
the SERP are substantially fully funded through investments held in a trust
established for the SERP (the "SERP Trust").
The Employee Benefits Agreement provides further that, effective as of the
Time of Distribution, New Valero shall be solely responsible for all
liabilities arising under certain supplemental executive retirement agreements
between Valero and former and current employees of both Valero and New Valero.
Other Post Employment Benefits. The Employee Benefits Agreement provides
that, effective as of the Time of Distribution, New Valero shall be solely
responsible for all liabilities to former employees of both Valero and New
Valero as well as current employees of New Valero arising under Valero's
health care and life insurance programs.
27
Deferred Compensation Plans. The Employee Benefits Agreement provides that,
effective as of the Time of Distribution, New Valero shall become the sponsor
of each of the two Valero deferred compensations plans, and shall thereby
assume all liabilities of Valero arising under such plans to or relating to
former and current employees of both Valero and New Valero.
Severance Pay. The Employee Benefits Agreement provides that, for the
purpose of any policy, plan program or agreement of Valero that provides for
severance benefits, no Valero employee shall be deemed to have experienced a
termination or severance of employment as a result of the Distribution.
VESOP. The Employee Benefits Agreement provides that, at a time sufficiently
in advance of the Time of Distribution to permit subsequent transactions
relating to the leveraged employees' stock ownership plan sponsored by Valero
(the "VESOP") (which are described in this paragraph) to occur prior to the
Time of Distribution, Valero shall direct the trustee of the VESOP to sell
Valero stock held in the VESOP suspense account in an amount sufficient to
repay all outstanding debt of the VESOP. Following such transaction, Valero
shall direct the trustee of the VESOP to allocate whatever stock remains in
the suspense account to the accounts of participants in the VESOP. Valero
shall subsequently terminate or merge the VESOP into the Valero Thrift Plan in
a transaction consistent with the requirements of Section 4.14(l) of the Code.
ESOP. The Employee Benefits Agreement provides that, prior to certain Thrift
Plan Transfers, Valero shall terminate or merge the non-leveraged employees'
stock ownership plan sponsored by Valero (the "ESOP") into the Valero Thrift
Plan in a transaction consistent with the requirements of Section 4.14(l) of
the Code.
Indemnification. The Employee Benefits Agreement provides that all
liabilities allocated pursuant to such Agreement shall be treated as
Indemnifiable Losses under the Distribution Agreement. As a result, each of
Valero and New Valero will indemnify, defend and hold harmless the other for
all liabilities allocated to the indemnifying party pursuant to the Employee
Benefits Agreement. For additional discussion of indemnification obligations
and procedures, see "--Distribution Agreement--Indemnification."
INTERIM SERVICES AGREEMENT
Term and Termination. The term of the Interim Services Agreement will
commence at the Effective Time and will end on December 31, 1998, except for
any particular service that is earlier canceled or for which the Interim
Services Agreement specifically provides for an earlier or later termination.
Payment. The Interim Services Agreement provides that certain fees, which
are detailed in an exhibit to the Interim Services Agreement, will be charged
for the services rendered by Valero and New Valero under the Interim Services
Agreement. The fees will be calculated at a percentage use, cost or other
basis depending on the services to be rendered.
Information Services. In consideration for certain fees, Valero will provide
various information services to New Valero. Such information services involve,
among other things, data processing services, computer maintenance for the
Valero system computer equipment, data storage, and access and instructions
with regard to the Valero system.
Financial and Regulatory Services. In consideration for certain fees, each
of Valero and New Valero will provide the other with various financial and
regulatory services. Such financial and regulatory services involve, among
other things, tax services, governmental compliance services and check
printing.
Administrative Services. In consideration for certain fees, Valero will
provide various administrative services to New Valero. Such administrative
services involve, among other things, San Antonio, Texas office space and
parking, security, telecommunications, mail, printing and document design and
records storage, and travel.
28
In consideration for certain fees, New Valero will provide various
administrative services to Valero. Such administrative services involve, among
other things, Houston, Texas office space, health care, payroll services and
accounts payable processing.
Liability and Indemnification. Neither Valero nor New Valero makes any
warranty, express or implied, with respect to the services to be provided by
Valero or New Valero with respect to the quality of performance of services
provided under the Interim Services Agreement. The liability of any performing
party ("Performing Party") with respect to the quality of performance of
services provided under the Interim Services Agreement is limited to the total
compensation for the services provided by the Performing Party under the
Interim Services Agreement and will not include any contingent liability. The
sole remedy (other than the amount of damages described in the foregoing
sentence) for the Performing Party's breach of the Interim Services Agreement
will be the termination of the Interim Services Agreement.
With respect to any service performed for the benefit of a receiving party
(the "Receiving Party"), the Receiving Party will indemnify, defend and hold
the Performing Party harmless from and against any and all claims (except for
certain excepted claims) incurred by or assessed against the Performing Party
in connection with (i) the performance of services by the Performing Party
under the Interim Services Agreement, (ii) the injury to or death of any
individual during the term of the Interim Services Agreement who is an
employee of the Receiving Party at the time of the occurrence which causes
such injury or death, or (iii) loss of or damage to any property of the
Receiving Party during the term of the Interim Services Agreement. With
respect to the services performed by the Performing Party, the Performing
Party will indemnify, defend and hold the Receiving Party harmless from and
against any and all claims incurred by or assessed against the Receiving Party
in connection with the gross negligence, willful misconduct, or fraud of, or
the imposition of punitive or exemplary damages against, the Performing Party
in the performance of services under the terms of the Interim Services
Agreement.
All indemnities set forth in the Interim Services Agreement extend to the
officers, directors, employees and affiliates of the party indemnified. Unless
the Interim Services Agreement expressly provides to the contrary, the
indemnities set forth therein apply regardless of whether the indemnified
party (or its employees, agents, contractors, successors or assigns) was a
contributing cause of the indemnified claim, expressly including indemnified
claims arising out of or resulting, in whole or part, from the indemnified
party's (or its employees', agents', contractors', successors' or assigns')
sole or concurrent negligence. However, the indemnities set forth in the
Interim Services Agreement do not extend to any part of an indemnified claim
that is the result of the gross negligence, willful misconduct or fraud of the
indemnified party or the result of the imposition of punitive or exemplary
damages on the indemnified party.
29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For financial reporting purposes, New Valero is a "successor registrant" to
Valero and, as such, all financial information included in this discussion and
in the historical financial statements beginning on page F-2 represent the
historical financial information of Valero. Therefore, references to the
"Company" in this discussion and in the related historical financial
statements are references to Valero, without giving effect to the Distribution
or the Merger.
OVERVIEW
The Company, a Delaware corporation incorporated in 1955, is a diversified
energy company engaged in the production, transportation and marketing of
environmentally clean fuels and products. The Company conducts its business
through two business segments: the Refining Business, which refines, processes
and markets various fuels and products, and the Natural Gas Business, which
owns and operates natural gas pipeline systems and natural gas processing
plants and markets natural gas and natural gas liquids (natural gas liquids
are sometimes referred to herein as "NGL").
THE PROPOSED TRANSACTIONS
On January 31, 1997, the Company announced that it had entered into the
Merger Agreement, pursuant to which Merger Sub will merge with and into the
Company, which immediately prior to the Merger will operate only the Natural
Gas Business. Prior to the Merger, the Company will (and will cause its
subsidiaries to) (i) transfer all assets and related liabilities of the
Refining Business that are not already owned by New Valero or its subsidiaries
to New Valero or its subsidiaries and (ii) transfer all assets and related
liabilities of the Natural Gas Business that are not already owned directly by
the Company or by one of the Company's subsidiaries involved in the Natural
Gas Business to the Company or one of such subsidiaries. Immediately prior to
the Merger, the Company will spin off New Valero to the Company's stockholders
in a tax-free distribution. Each holder of Valero Common Stock will receive
one share of New Valero Common Stock for each share of Valero Common Stock
owned immediately prior to the Distribution. In addition, prior to the
Distribution, New Valero will pay a dividend to the Company pursuant to the
terms of the Distribution Agreement. See "--Liquidity and Capital Resources"
and "Description of Certain New Valero Indebtedness."
The transactions described above are subject to, among other things,
approval by the Company's stockholders, receipt of the Tax Opinions of the
Company's and PG&E Corp.'s tax counsel regarding certain tax aspects of the
Transactions and certain regulatory approvals. See "Agreements Between Valero
and New Valero" and "The Merger Agreement--Conditions" in the Proxy Statement-
Prospectus. If the transactions described above are consummated, at the Time
of Distribution the only business that will be conducted by New Valero will be
the Refining Business.
CHANGE IN SEGMENT REPORTING
Prior to January 1, 1996, the Company reported three separate business
segments: (i) a natural gas segment, (ii) a natural gas liquids segment and
(iii) a refining segment. Due to the restructuring of the interstate natural
gas pipeline industry in 1993 through Federal Energy Regulatory Commission
("FERC") Order 636 and the resulting transformation of the United States
natural gas industry into a more market and customer-oriented environment, the
Company has recently integrated its natural gas and natural gas liquids
businesses. Effective January 1, 1996, in recognition of this integration, the
Company began to report its natural gas and natural gas liquids businesses as
one industry segment. The primary effect of this change on the Company's
segment disclosures was the elimination of volume, revenue and income amounts
related to natural gas fuel and shrinkage volumes sold to and transported for
the natural gas liquids segment by the natural gas segment. The Company's 1995
and 1994 financial and operating highlights for its Natural Gas Business which
follow under "--Results of Operations," and the discussion of the Company's
Natural Gas Business which follows under "--Results of
30
Operations--1995 Compared to 1994--Segment Results," have been revised from
that contained in the Company's Annual Report on Form 10-K for the year ended
December 31, 1995 to reflect this change in segment reporting.
ACQUISITION OF VNGP, L.P.
As described in Note 3 of Notes to Consolidated Financial Statements, the
merger of Valero Natural Gas Partners, L.P. ("VNGP, L.P." and together with
VNGP, L.P.'s consolidated subsidiaries, sometimes referred to herein as the
"Partnership") with the Company (the "VNGP Merger") was consummated on May 31,
1994. As a result of the VNGP Merger, VNGP, L.P. became a subsidiary of the
Company. The accompanying consolidated statements of income of the Company for
the years ended December 31, 1996, 1995 and 1994 reflect the Company's 100%
interest in the Partnership's operations after May 31, 1994 and its effective
equity interest of approximately 49% for all periods prior to and including
May 31, 1994. Because 1994 results of operations for the Natural Gas Business
are not comparable to subsequent and prior periods due to the VNGP Merger, the
discussion of this segment which follows under "--Results of Operations--1995
Compared to 1994--Segment Results" is based on pro forma operating results for
1994 that reflect the consolidation of the Partnership with the Company for
all of such year.
31
RESULTS OF OPERATIONS
The following are the Company's financial and operating highlights for each
of the three years in the period ended December 31, 1996. For 1995 and 1994,
operating revenues and operating income (loss) by segment and certain Natural
Gas Business operating statistics have been restated to conform to the 1996
presentation. As used throughout this Prospectus, "Mbbls" is an abbreviation
for "thousand barrels," "MMcf" is an abbreviation for "million cubic feet" and
"Mcf" is an abbreviation for "thousand cubic feet."The amounts in the
following table are in thousands of dollars, unless otherwise noted:
[Download Table]
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
OPERATING REVENUES:
Refining Business (1).................... $2,757,801 $1,950,657 $1,090,368
Natural Gas Business (2)................. 2,445,504 1,396,468 784,287
Other (2)................................ 123 126 42,639
Intersegment eliminations (2)............ (212,747) (149,379) (79,854)
---------- ---------- ----------
Total.................................. $4,990,681 $3,197,872 $1,837,440
========== ========== ==========
OPERATING INCOME (LOSS):
Refining Business........................ $ 110,046 $ 141,512 $ 78,660
Natural Gas Business (2)................. 132,178 83,180 61,944
Corporate general and administrative ex-
penses and other, net (2)............... (41,315) (35,901) (14,679)
---------- ---------- ----------
Total.................................. $ 200,909 $ 188,791 $ 125,925
========== ========== ==========
EQUITY IN EARNINGS (LOSSES) OF AND INCOME
FROM:
Valero Natural Gas Partners, L.P. (3).... $ -- $ -- $ (10,698)
Joint ventures........................... $ 3,899 $ 4,827 $ 2,437
LOSS ON INVESTMENT IN PROESA JOINT VEN-
TURE...................................... $ (19,549) $ -- $ --
(PROVISION FOR) REVERSAL OF ACQUISITION EX-
PENSE ACCRUAL (5)......................... $ 18,698 $ (2,506) $ (16,192)
OTHER INCOME, NET.......................... $ 4,921 $ 5,248 $ 3,431
INTEREST AND DEBT EXPENSE, NET............. $ (95,177) $ (101,222) $ (76,921)
NET INCOME (5)............................. $ 72,701 $ 59,838 $ 17,282
NET INCOME APPLICABLE TO VALERO COMMON
STOCK (5)................................. $ 61,374 $ 48,020 $ 7,792
EARNINGS PER SHARE OF VALERO COMMON STOCK
(5)....................................... $ 1.40 $ 1.10 $ .18
PRO FORMA OPERATING INCOME (LOSS) (4):
Refining Business........................ $ 110,046 $ 141,512 $ 78,660
Natural Gas Business..................... 132,178 83,180 69,769
Corporate general and administrative ex-
penses and other, net................... (41,315) (35,901) (22,486)
---------- ---------- ----------
Total.................................. $ 200,909 $ 188,791 $ 125,943
========== ========== ==========
OPERATING STATISTICS:
Refining Business:
Throughput volumes (Mbbls per day)..... 170 160 146
Average throughput margin per barrel... $ 5.29 $ 6.25 $ 5.36
Sales volumes (Mbbls per day) (1)...... 291 231 140
Natural Gas Business (4):
Gas volumes (MMcf per day):
Sales................................ 1,693 1,429 1,139
Transportation....................... 1,665 1,430 1,398
---------- ---------- ----------
Total gas volumes.................. 3,358 2,859 2,537
========== ========== ==========
Average gas sales margin per Mcf....... $ .146 $ .162 $ .184
Average gas transportation fee per
Mcf................................... $ .089 $ .094 $ .102
NGL plant production:
Production volumes (Mbbls per day)... 80.9 80.3 79.5
Average NGL market price per gallon.. $ .354 $ .258 $ .265
Average gas cost per Mcf............. $ 1.93 $ 1.40 $ 1.75
Average NGL margin per gallon........ $ .103 $ .080 $ .076
32
--------
(1) Revised for 1995 to include revenues and associated volumes related to
certain Refining Business trading activities previously classified as a
reduction of cost of sales.
(2) Reflects the consolidation of the Partnership commencing June 1, 1994.
(3) Represents the Company's approximate 49% effective equity interest in the
operations of the Partnership and interest income on certain capital lease
transactions with the Partnership for the period prior to June 1, 1994.
(4) Operating income (loss) presented herein for 1994 represents pro forma
amounts that reflect the consolidation of the Partnership with the Company
for all of such year. Operating statistics for the Natural Gas Business
segment for 1994 represent pro forma statistics that reflect such
consolidation.
(5) Restated for 1994 to reflect the effects of a prior period adjustment
resulting in a charge to income for an acquisition expense accrual
originally charged to property, plant and equipment. See "Restatement of
Financial Information" in Note 1 of Valero Energy Corporation and
Subsidiaries Notes to Consolidated Financial Statements.
1996 COMPARED TO 1995
CONSOLIDATED RESULTS
The Company reported net income of $72.7 million, or $1.40 per share, for
the year ended December 31, 1996 compared to $59.8 million, or $1.10 per
share, for the year ended December 31, 1995. For the fourth quarter of 1996,
net income was $18.8 million, or $.37 per share, compared to $12.9 million, or
$.23 per share, for the fourth quarter of 1995. Net income and earnings per
share increased during the 1996 fourth quarter and total year compared to the
same periods in 1995 due primarily to a significant increase in operating
income from the Company's Natural Gas Business, partially offset by a decrease
in Refining Business operating income and an increase in corporate expenses.
Lower net interest expense also contributed to the increase in net income and
earnings per share, partially offset by higher income taxes.
Operating revenues increased $1.8 billion, or 56%, to $5 billion during 1996
compared to 1995 due to an approximate $1 billion, or 75% increase in Natural
Gas Business revenues and an approximate $800 million, or 41% increase in
Refining Business revenues. Operating income increased $12.1 million, or 6%,
to $200.9 million during 1996 compared to 1995 due to a $49 million, or 59%
increase in Natural Gas Business operating income, partially offset by a $31.5
million, or 22% decrease in Refining Business operating income and a $5.4
million increase in corporate expenses resulting primarily from higher
employee-related and other costs. Changes in operating revenues and operating
income by business segment are explained below under "--Segment Results."
During the fourth quarter of 1996, the Company wrote off its investment in
its joint venture project to design, construct and operate a plant in Mexico
to produce methyl tertiary butyl ether ("MTBE") and accrued an estimate of
additional liabilities associated with such investment resulting in a loss of
$19.5 million (see Note 7 of Valero Energy Corporation and Subsidiaries Notes
to Consolidated Financial Statements). Also in the fourth quarter of 1996, the
Company recorded $16.6 million of income representing the reversal of the
excess portion of an accrual established in May 1994 to cover expected costs
related to the Company's acquisition of the publicly held units of VNGP, L.P.
Net interest and debt expense decreased $6 million to $95.2 million during
1996 compared to 1995 due primarily to a decrease in bank borrowings and
paydowns of certain outstanding nonbank debt, partially offset by the issuance
of medium-term notes ("Medium-Term Notes") in the first half of 1995. See "--
Liquidity and Capital Resources." Income tax expense increased $5.7 million in
1996 compared to 1995 due primarily to higher pre-tax income.
SEGMENT RESULTS
Refining Business
Operating revenues from the Company's Refining Business operations increased
$807.1 million, or 41%, to $2.8 billion during 1996 compared to 1995 due
primarily to a 26% increase in sales volumes and a 12% increase in the average
sales price per barrel. The increase in sales volumes was due primarily to
increased volumes from trading and rack marketing activities, and a 6%
increase in average daily throughput volumes resulting from various unit
improvements and enhancements made during 1995 and a reduced impact on
production due to unit
33
turnarounds which occurred in 1996 compared to 1995, partially offset by the
effects of two second quarter 1996 power outages at the Company's petroleum
refinery in Corpus Christi, Texas (the "Refinery"). The average sales price
per barrel increased due primarily to higher gasoline and distillate prices
which generally followed an increase in crude oil prices during 1996.
Operating income from Refining Business operations decreased $31.5 million,
or 22%, to $110 million during 1996 compared to 1995 due primarily to a
decrease in total throughput margins and higher operating expenses. The
decrease in total throughput margins was due primarily to lower oxygenate
margins resulting from higher butane feedstock costs, particularly in the
fourth quarter, lower margins on sales of petrochemical feedstocks, and
decreased results from price risk management activities. These decreases in
throughput margins were partially offset by the increase in throughput volumes
noted above, higher distillate margins, and an improvement in discounts on
purchases of resid feedstocks. Operating expenses increased due primarily to
costs associated with the Company's joint venture methanol plant which was
placed in service in late August 1995 and higher variable costs resulting from
increased throughput at the Refinery.
The Company has entered into various term feedstock supply agreements for
approximately 58,000 barrels per day of resid which are based on market prices
and extend through 1997, including an agreement with the Saudi Arabian Oil
Company for approximately 36,000 barrels per day which extends through mid-
1998. These agreements provide approximately 70% of the Refinery's estimated
daily resid feedstock requirements for 1997. The Company believes that if any
of its existing resid feedstock arrangements were interrupted or terminated,
supplies of resid could be obtained from other sources or on the open market.
However, because the demand for the type of resid feedstock now processed at
the Refinery has increased in relation to the availability of supply over the
past few years, if any such interruptions or terminations did occur, the
Company could be required to incur higher resid feedstock costs or substitute
other types of resid, thereby producing less favorable operating results. The
Company also has two agreements to supply feedstock for the Refinery's crude
unit; one with the Chinese state-owned oil company for approximately 22,000
barrels per day of sweet crude oil extending through June 1997, and one with a
domestic refiner for approximately 8,000 barrels per day of crude oil
extending through the end of 1997. The remainder of the Refinery's resid and
crude feedstocks are purchased at market-based prices under short-term
contracts. Production from the Company's joint venture methanol plant normally
provides all of the methanol feedstock presently required for the Refinery's
production of oxygenates (as defined herein) used in reformulated gasoline
("RFG").
In 1996, a maintenance turnaround and a catalyst change for the Refinery's
hydrodesulfurization unit (the "HDS Unit") were completed in July, a
turnaround of the Refinery's MTBE plant (the "MTBE Plant") was completed in
September during which its capacity was increased by approximately 1,500
barrels per day, and turnarounds of the Refinery's Hydrocracker (as defined
herein) and naphtha Reformer (as defined herein) units were completed in
December. In early December, an explosion occurred at the methanol plant as it
was being shut down for repairs. The Company's share of repair costs is
estimated to be $2.5 million, and the plant resumed operations in late
February 1997. In 1995, a maintenance turnaround and a catalyst change for the
HDS Unit and turnarounds of the Hydrocracker and naphtha Reformer units were
all completed in April of that year. The MTBE Plant was down for nine days in
January 1997 to replace a catalyst and the HOC unit was down for approximately
two weeks in the second quarter of 1997 for unscheduled maintenance. During
1997, the crude unit is scheduled for a maintenance turnaround in the second
quarter, and the HDS Unit is scheduled for a maintenance turnaround and
catalyst change in the fourth quarter.
The Company enters into various exchange-traded and over-the-counter
financial instrument contracts with third parties to manage price risk
associated with refining feedstock and fuel purchases, refined product
inventories and refining operating margins. Although such activities are
intended to limit the Company's exposure to loss during periods of declining
margins, such activities could tend to reduce the Company's participation in
rising margins. In 1996, refining throughput margins were reduced by $1.2
million as a result of hedging activities compared to a $12.8 million benefit
in 1995. The 1995 benefit resulted primarily from favorable price swap
contracts on methanol, since methanol prices dropped by over 70% during that
year. In 1996 and 1995, the Company was also able to reduce its operating
costs by $2.8 million and $1 million, respectively, as a result of hedges on
refining natural gas fuel requirements. See Note 1 under "Price Risk
Management Activities" and Note 6 of Valero Energy Corporation and
Subsidiaries Notes to Consolidated Financial Statements.
34
Natural Gas Business
Operating revenues from the Company's Natural Gas Business operations
increased $1 billion, or 75%, to $2.4 billion during 1996 compared to 1995 due
primarily to a 47% increase in average natural gas sales prices, an 18%
increase in natural gas sales volumes, primarily off-system sales, a 37%
increase in average NGL market prices, and a 28% increase in NGL sales
volumes. Natural gas sales prices and volumes were higher due to increased
demand for natural gas to replenish low industry-wide natural gas storage
inventories drawn down by extreme cold winter weather during the 1996 first
quarter and which remained below 1995 levels during all of 1996. Natural gas
demand also increased due to early cold weather during the 1996 fourth
quarter. NGL market prices increased as a result of historically low NGL
inventory levels, firm petrochemical and refining demand, and strong crude oil
and refined product prices. NGL sales volumes were higher due primarily to an
increase in NGL marketing activities.
Operating income from Natural Gas Business operations increased $49 million,
or 59%, to $132.2 million during 1996 compared to 1995 due primarily to higher
margins on NGL production, and, to a lesser extent, to increases in total gas
sales margins, natural gas transportation revenues and income from NGL trading
activities. Total margins on NGL production were higher due to the substantial
increase in average NGL market prices noted above and to an approximate $16
million increase in benefits from price risk management activities which
limited the increase in natural gas fuel and shrinkage costs. Total gas sales
margins increased due primarily to the increase in off-system sales volumes
noted above and to increased benefits from price risk management activities,
partially offset by an increase in fuel costs. Natural gas transportation
revenues were higher due to a 16% increase in transportation volumes resulting
from increased marketing activities, partially offset by a 5% decrease in
average transportation fees. NGL trading income increased due primarily to the
increase in NGL marketing activities noted above. NGL production volumes
increased slightly in 1996 compared to 1995 as production increases at various
plants resulting from the completion in 1995 and 1996 of certain operational
improvements and production enhancements generally offset the effects of the
sale of two of the Natural Gas Business's West Texas processing plants in
August 1995.
Demand for natural gas continues to be affected by the operation of various
nuclear and coal power plants in the Natural Gas Business's core service area.
At full operation, the South Texas Project nuclear plant in Bay City, Texas
and the Comanche Peak nuclear plant near Ft. Worth, Texas displace
approximately 650 MMcf per day and 600 MMcf per day of natural gas demand,
respectively. In addition, coal-fired electrical generation facilities owned
and operated by San Antonio City Public Service displace a portion of natural
gas demand.
The Natural Gas Business's gas sales and transportation businesses are based
primarily on competitive market conditions and contracts negotiated with
individual customers. The Natural Gas Business has been able to mitigate, to
some extent, the effect of competitive industry conditions by aggressive
marketing efforts to increase gas sales and transportation volumes,
particularly in its off-system marketing business with local distribution and
industrial companies throughout the United States, and by the flexible use of
its strategically located pipeline system. However, gas sales and
transportation margins remain under intense pressure as the natural gas
industry continues to adjust to deregulation and the customer-driven market
that has developed since FERC Order 636 was enacted.
Gas sales are also made, to a significantly lesser extent, to intrastate
customers under contracts with 20- to 30-year terms which originated in the
1960s and 1970s. These contracts provide for the sale of gas at its weighted
average cost ("WACOG"), plus a margin. In addition to the cost of gas
purchases, WACOG has included storage, gathering and other fixed costs,
including the amortization of deferred gas costs related to the settlement of
take-or-pay and related claims. As a result of contracts expiring in 1998, the
majority of storage costs previously included in WACOG (see Note 14 of Valero
Energy Corporation and Subsidiaries Notes to Consolidated Financial
Statements), will no longer be recovered through these gas sales rates.
The Natural Gas Business's NGL operations benefit from the strategic
location of its facilities in relation to natural gas supplies and markets,
particularly in South Texas which is a core supply area for the Natural Gas
35
Business's natural gas and NGL operations. Currently, approximately 93% of the
Natural Gas Business's NGL production comes from plants in South Texas and the
Texas Gulf Coast. The Natural Gas Business's NGL operations should benefit in
the longer term from the expected continued growth in demand for NGLs as
petrochemical feedstocks and in the production of MTBE. The demand for NGLs,
particularly natural gasoline, will continue to be affected seasonally,
however, by Environmental Protection Agency ("EPA") regulations limiting
gasoline volatility during the summer months.
The Natural Gas Business enters into various exchange-traded and over-the-
counter financial instrument contracts with third parties to manage price risk
associated with its natural gas storage, natural gas marketing and NGL
operations. Such activities are intended to manage price risk but may result
in gas, fuel and shrinkage costs either higher or lower than those that would
have been incurred absent such activities. In 1996 and 1995, total gas sales
margins benefitted from gas cost reductions of $23.4 million and $12 million,
respectively, resulting from price risk management activities. Of these
amounts, $12.6 million and $5.6 million, respectively, were recognized in the
1996 and 1995 fourth quarters. In addition, in 1996 and 1995, total margins on
NGL production benefitted from fuel and shrinkage cost reductions of $19.7
million and $4.1 million, respectively, resulting from price risk management
activities. For all such activities, an additional $16.6 million and
$3.8 million was deferred at December 31, 1996 and 1995, respectively, which
is recognized as a reduction to cost of sales in the subsequent year. See Note
1 under "Price Risk Management Activities" and Note 6 of Valero Energy
Corporation and Subsidiaries Notes to Consolidated Financial Statements.
1995 COMPARED TO 1994
CONSOLIDATED RESULTS
The Company reported net income of $59.8 million, or $1.10 per share, for
the year ended December 31, 1995 compared to $17.3 million, or $.18 per share,
for the year ended December 31, 1994. For the fourth quarter of 1995, net
income was $12.9 million, or $.23 per share, compared to net income of $3.9
million, or $.02 per share, for the fourth quarter of 1994. Net income and
earnings per share increased during 1995 compared to 1994 due primarily to a
significant increase in operating income from the Refining Business, improved
operating results from the Natural Gas Business, including the effect of the
VNGP Merger, and the nonrecurring recognition in expense in 1994 of an accrual
for loss contingencies recorded in connection with the VNGP Merger. The
increases in net income and earnings per share resulting from these factors
were partially offset by increases in corporate expenses, net interest expense
and income tax expense and the nonrecurring recognition in income in 1994 of
deferred management fees resulting from the VNGP Merger. The increase in
earnings per share was also partially offset by an increase in preferred stock
dividend requirements resulting from the issuance in March 1994 of 3.45
million shares of the Convertible Preferred Stock. See Note 9 of Valero Energy
Corporation and Subsidiaries Notes to Consolidated Financial Statements.
Operating revenues increased $1.4 billion, or 74%, to $3.2 billion during
1995 compared to 1994 due primarily to an increase in operating revenues from
Refining Business operations which is explained under "--Segment Results" and
the inclusion of operating revenues attributable to Partnership operations in
all of 1995 versus only the months of June through December in 1994. Other
operating revenues decreased $42.5 million due to the elimination of
management fee revenues received by the Company from the Partnership as a
result of the VNGP Merger.
Operating income increased $62.9 million, or 50%, to $188.8 million during
1995 compared to 1994 due primarily to an increase in operating income from
Refining Business operations and to the inclusion of Partnership operating
income in all of 1995 versus only the months of June through December in 1994.
Partially offsetting these increases in operating income was an increase in
corporate expenses, net, resulting primarily from the nonrecurring recognition
in income in 1994 of deferred management fees resulting from the VNGP Merger,
the allocation of corporate expenses to the Partnership in 1994 for the
periods prior to the VNGP Merger and an increase in compensation expense.
36
As a result of the VNGP Merger and the Company's change in the method of
accounting for its investment in the Partnership from the equity method to the
consolidation method, the Company did not report equity in earnings (losses) of
and income from the Partnership for 1995 and the months of June through
December 1994. See "--Segment Results" for a discussion of the Natural Gas
Business's operations, including 100% of the operations of the Partnership on a
pro forma basis for 1994. Equity in earnings of joint ventures increased
$2.4 million to $4.8 million for 1995 compared to 1994 due to an increase in
the Company's equity in earnings of Javelina Company ("Javelina"), a general
partnership that owns a refinery off-gas processing plant in Corpus Christi,
Texas. Javelina's earnings increased due primarily to higher product prices as
a result of strong product demand from the petrochemical industry, as well as
from lower feedstock costs.
Net interest and debt expense increased $24.3 million to $101.2 million
during 1995 compared to 1994 due primarily to the inclusion of Partnership
interest expense in all of 1995 versus only the months of June through December
in 1994, and to a lesser extent to the issuance of Medium-Term Notes in
December 1994 and the first half of 1995. Income tax expense increased $24.6
million to $35.3 million in 1995 compared to 1994 due primarily to higher pre-
tax income.
SEGMENT RESULTS
Refining Business
Operating revenues from Refining Business operations increased $860.3
million, or 79%, to $2 billion during 1995 compared to 1994 due primarily to a
65% increase in sales volumes and a 9% increase in the average sales price per
barrel. The increase in sales volumes was due primarily to higher purchases for
resale of conventional gasoline to supply rack customers as a result of the
Company's conversion of its Refinery operations to produce primarily RFG
beginning in the fourth quarter of 1994, a 10% increase in throughput volumes
resulting from various unit improvements completed during the latter part of
1994 and first half of 1995, and additional sales volumes in 1995 related to
increased fuel oil trading activities. The average sales price per barrel
increased due to higher refined product prices, including higher prices
received on sales of RFG and other higher-value products.
Operating income from Refining Business operations increased $62.8 million,
or 80%, to $141.5 million during 1995 compared to 1994 due primarily to an
increase in total throughput margins partially offset by an increase in
operating and other expenses. Total throughput margins increased due to higher
margins on sales of RFG, oxygenates and petrochemical feedstocks, the effects
of the unit improvements noted above, and the nonrecurrence of a turnaround of
the Refinery's heavy oil cracking complex completed during the latter part of
1994, net of the effect of unit turnarounds which occurred in 1995. The
increase in total throughput margins resulting from these factors was partially
offset by a decrease in conventional refined product margins ("crack spread")
resulting primarily from depressed gasoline markets in early 1995 attributable
to uncertainties pertaining to the general acceptance of RFG and oxygenates.
Costs for the Company's resid feedstocks increased in 1995 compared to 1994 due
to a continuing worldwide decrease in resid supplies resulting from the
addition of new refinery upgrading capacity and increased production of light
sweet crude oil in relation to heavy crude oil. However, the effect of such
increased resid costs on throughput margins was more than offset by a decrease
in other feedstock costs, including a $7.5 million increase in benefits from
price risk management activities, approximately $7 million of which was
attributable to fourth quarter operations. Although operating expenses
increased approximately 4% due primarily to higher costs resulting from
increased throughput, operating expenses per barrel decreased by approximately
5%. Selling and administrative expenses increased due to higher compensation
and other expenses, while depreciation expense increased approximately 4% due
to capital expenditures incurred during the latter part of 1994 and in 1995.
In 1995 and 1994, refining feedstock costs were reduced by $12.8 million and
$5.3 million, respectively, as a result of price risk management activities. In
addition, in 1995, the Company was able to reduce its operating costs by $1
million as a result of such activities. In 1994, the effect of such activities
on operating costs was not significant.
37
Natural Gas Business
Operating income from Natural Gas Business operations was $83.2 million for
1995 compared to pro forma operating income of $69.8 million for 1994. The
$13.4 million, or 19%, increase was due primarily to an increase in total gas
sales margins and other operating revenues, higher margins on NGL production,
a decrease in NGL transportation and fractionation costs, and a decrease in
operating, selling and administrative expenses. The increase in operating
income resulting from these factors was partially offset by decreases in
natural gas transportation revenues and NGL revenues from transportation and
fractionation of third-party plant production. Total gas sales margins
increased due to a 25% increase in gas sales volumes, reductions in gas costs
resulting from price risk management activities, and the nonrecurrence of
certain settlements relating to measurement and customer billing differences
which adversely affected 1994. The increase in total gas sales margins
resulting from these factors was partially offset by reduced volumetric gains
and lower unit margins due primarily to an increase in lower-margin spot and
off-system sales. Total margins on NGL production were higher due to a
decrease in fuel and shrinkage costs resulting from a 20% decrease in the
average cost of natural gas, which more than offset a 3% decrease in the
average NGL market price. Average natural gas costs decreased due to surplus
industry capacity and benefits from price risk management activities, while
average NGL prices decreased due to weak ethane prices resulting from above-
normal inventory levels. The decrease in operating, selling and administrative
expenses was due primarily to the nonrecurrence of certain adverse settlements
in 1994, including $6.8 million related to a settlement with the City of
Houston regarding a franchise fee dispute, partially offset by higher ad
valorem tax, maintenance and compensation expenses. The decrease in
transportation revenues was due primarily to an 8% decrease in average
transportation fees. NGL production volumes increased slightly in 1995
compared to 1994 as volume increases in 1995 resulting from the addition of
new natural gas supplies under processing agreements with natural gas
producers and operational improvements and production enhancements at certain
of the Natural Gas Business's NGL plants were mostly offset by volume
decreases resulting primarily from the sale of two of the Natural Gas
Business's West Texas processing plants in August 1995.
In 1995, total gas sales margins benefitted from gas cost reductions of $12
million resulting from price risk management activities, $5.6 million of which
was recognized in the fourth quarter, compared to $2.1 million in 1994 on a
pro forma basis. In addition, in 1995, total margins on NGL production
benefitted from fuel and shrinkage cost reductions of $4.1 million resulting
from price risk management activities. In 1994, the effect of such activities
on fuel and shrinkage costs was not significant. For all such activities, an
additional $3.8 million and $6.8 million was deferred at December 31, 1995 and
1994, respectively, which is recognized as a reduction to cost of sales in the
subsequent year.
Other
Pro forma corporate general and administrative expenses and other, net,
increased $13.4 million during 1995 compared to 1994 due primarily to the
nonrecurring recognition in income in 1994 of deferred management fees
resulting from the VNGP Merger, as noted above, and an increase in
compensation expense.
BASIS PETROLEUM
Valero has acquired (and will transfer to New Valero) Basis. Basis owns and
operates three petroleum refineries located in Texas and Louisiana and markets
refined products. New Valero believes that Salomon has invested approximately
$660 million in the Basis refineries for upgrading facilities and other
improvements since 1992. Most of these improvements were made at the two Texas
refineries. Although Basis recorded a small profit in 1994, Basis's audited
financial statements reflect that Basis incurred pre-tax losses of
approximately $91 million in 1995 and $100 million in 1996. However, New
Valero believes that the Basis refineries can be operated profitably due to
recently completed refinery upgrading projects, a reduction in depreciation
and amortization expense due to the acquisition cost of Basis being less than
its net book value, and a projected reduction in operating and overhead costs
expected to be achieved through certain changes to be implemented by New
Valero, as described below. New Valero believes that, assuming the realization
of the assumptions described below, the Basis refineries will be accretive to
New Valero's consolidated cash flow and earnings beginning in 1997.
38
The following table shows certain selected pro forma projected income
statement, balance sheet and cash flow information for New Valero, Basis, and
New Valero and Basis combined for the years ended December 31, 1997 and 1998.
Such selected pro forma projected financial information (i) assumes the
completion of certain refinery turnarounds, as described below, (ii) reflects
cash proceeds of approximately $150 million from an inventory purchase
agreement currently being negotiated, (iii) excludes certain marketing
operations of Basis which are expected to be discontinued, and (iv) includes a
preliminary allocation of the purchase price of Basis to the assets acquired
and liabilities assumed. The 1998 cash flow of Basis and New Valero and Basis
combined was reduced by $3.2 million representing a projected earn-out payment
for the period from May 1, 1997 through April 30, 1998. Operating income and
net income for 1998 were each reduced by approximately $.1 million
representing the effect of increased depreciation expense resulting from the
treatment of the earn-out payment as an additional cost of the acquisition.
The purchase accounting adjustments necessary to allocate the purchase price
of Basis remain subject to change and the depreciation and amortization
expense ultimately reflected in New Valero's financial statements may vary,
perhaps significantly, from the information presented herein.
NEW VALERO AND BASIS COMBINED
SELECTED PRO FORMA PROJECTED FINANCIAL INFORMATION
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
[Download Table]
AS OF OR FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------
1997 1998
------------------------- -------------------------
NEW VALERO BASIS COMBINED NEW VALERO BASIS COMBINED
---------- ----- -------- ---------- ----- --------
INCOME STATEMENT
INFORMATION:
Operating Income......... $ 133 $47 $ 180 $ 138 $88 $ 226
Interest expense, net.... 13 11 24 8 15 23
Income taxes............. 42 13 55 47 25 72
Income from continuing
operations.............. 78 24 102 86 47 133
Earnings per share of
common stock from
continuing operations... 1.53 -- 1.90 1.69 -- 2.44
BALANCE SHEET INFORMATION:
Working capital.......... 149 50 199 149 50 199
Property, plant and
equipment, net.......... 1,259 300 1,559 1,343 327 1,670
Deferred charges and
other assets............ 113 27 140 117 29 146
Long-term debt........... 251 229 480 245 197 442
Deferred income taxes and
other deferred credits
and other liabilities... 276 5 281 293 20 313
Stockholders' equity..... 994 143 1,137 1,070 190 1,260
CASH FLOW INFORMATION:
Depreciation expense..... 56 9 65 56 17 73
Amortization expense..... 36 3 39 30 13 43
Capital expenditures..... 85 36 121 60 80 140
Deferred turnaround and
catalyst costs.......... 18 12 30 29 16 45
39
The following table includes historical and projected operating statistics
for Basis, reflecting the feedstocks utilized and products produced by Basis
for 1995 and for the first nine months of 1996, and as projected following the
Basis Acquisition after giving effect to the operational improvements which
New Valero expects to implement. The information shown in the column
"Historical January-September 1996" reflects charges and yields prior to
completion of the Residfiner and ROSE units at the Texas City refinery.
BASIS REFINERY SYSTEM CHARGE AND YIELD SUMMARY (IN THOUSAND BARRELS PER
CALENDAR DAY)
[Download Table]
HISTORICAL
JANUARY-
HISTORICAL SEPTEMBER
1995 1996 PROJECTED
---------- ---------- ---------
FEEDSTOCKS:
Crude oil:
Medium sour................................... 94 146 159
Heavy sweet................................... 75 38 80
Light sweet................................... 66 78 61
--- --- ---
Total crude oil............................... 235 262 300
Vacuum gas oil.................................. 18 21 15
Other feedstocks................................ 4 10 14
--- --- ---
Total refinery feedstocks....................... 257 293 329
=== === ===
PRODUCTS:
Gasoline and components......................... 113 118 132
Distillates..................................... 91 98 129
Naphtha......................................... 4 16 36
Propylene/LPG................................... 16 14 20
Low-sulfur resid................................ 15 13 15
High-sulfur resid............................... 18 27 0
Other........................................... 0 8 1
--- --- ---
Total products.................................. 257 294 333
=== === ===
In preparing such projections, New Valero has made certain assumptions, both
with respect to general refining industry conditions and with respect to the
future operations of Basis in particular. Such projections and underlying
assumptions have been made in good faith and reflect New Valero's current
judgment regarding such matters. However, there can be no assurance that
actual results will not vary, perhaps significantly, from the future
performance suggested herein. See "Forward-Looking Statements." The following
principal assumptions have been made by New Valero in preparing the foregoing
projections:
Improved Refining Economics. If refining industry economics improve, New
Valero believes that the operating results of the Basis refineries should also
improve. New Valero has assumed that during 1997-1998, as well as subsequent
periods, there will be some improvement from depressed 1996 levels in general
refining economics and, accordingly, in the margins or "spreads" obtainable in
the market between key refined products, on the one hand, and high-quality
West Texas Intermediate crude oil ("WTI"), a key pricing benchmark, on the
other hand, as well as some improvement in the discounts to WTI obtainable for
key refinery feedstocks.
One nominal indicator of refining profitability is the "2-1-1 crack spread,"
which indicates profitability based upon the Gulf Coast prices received for
one barrel of conventional 87 octane unleaded gasoline and one barrel of No. 2
fuel oil, less the cost of two barrels of WTI. Since 1991, the average annual
2-1-1 crack spread
40
per barrel has varied from $2.19 to $3.91, and averaged $2.88 per barrel for
such six-year period. For 1996, the average 2-1-1 crack spread per barrel was
approximately $2.65. New Valero has assumed that for 1997-1998, the 2-1-1
crack spread will average about $2.68 per barrel in 1997 and about $2.73 per
barrel in 1998.
New Valero expects that medium sour crude oil and heavy sweet crude oil will
be the principal feedstocks utilized for the Basis refineries, and that
gasoline, gasoline blendstocks and distillates will constitute the principal
refined products to be produced at these refineries.
New Valero expects that, as a result of the increasing availability of
heavier and higher sulfur crude oils, the discounts between the Basis
refineries' principal feedstocks and WTI will improve. The table below
specifies (in per barrel amounts), for each of the two principal feedstocks
for the Basis refineries, the range of such discount over the past six years,
the average discount in 1996 and the average discount that New Valero has
assumed for 1997 and 1998.
FEEDSTOCK DIFFERENTIALS TO WTI (PER BARREL)*
[Download Table]
DISCOUNT TO WTI
---------------------------------------------
ASSUMED
RANGE OF DISCOUNT
DISCOUNT FOR THE AVERAGE DISCOUNT -----------
FEEDSTOCK PERIOD 1991-1996 IN 1996 1997 1998
--------- ---------------- ---------------- ----- -----
Medium sour crude....... $1.03-$2.04 $1.17 $1.42 $1.42
Heavy sweet crude....... $0.06-$1.09 $0.18 $0.29 $0.29
--------
* based on feedstocks delivered to the refinery, including duties.
New Valero also expects that the margins or "spreads" between the Basis
refineries' principal refined products and WTI will improve in the period
1997-1998. The following table sets forth (in per barrel amounts) the range of
the high and low spread (based on Platt's mean) over the past six years, the
average spread in 1996 and the assumed average spread for 1997-1998, for the
spread between regular unleaded 87 octane conventional gasoline, and No. 2
fuel oil, respectively, and WTI.
REFINED PRODUCT DIFFERENTIALS TO WTI (PER BARREL)
SPREAD BETWEEN REFINED PRODUCTS AND WTI
---------------------------------------------
ASSUMED
RANGE OF SPREAD SPREAD
FOR THE PERIOD AVERAGE SPREAD -----------
REFINED PRODUCT 1991-1996 IN 1996 1997 1998
--------------- ---------------- ---------------- ----- -----
Regular unleaded 87 oc-
tane conventional gaso-
line................... $2.87-$5.01 $2.87 $3.18 $3.20
No. 2 fuel oil.......... $1.40-$2.81 $2.43 $2.18 $2.25
Reduction of Operating Costs. The 1997 budget prepared by Basis reflects
approximately $140 million of refinery variable costs, approximately $177
million of refinery fixed costs and approximately $42 million of refinery
secondary costs and corporate overhead and selling, general and administrative
costs. Both New Valero and Basis have extensive refined product marketing
operations and market substantially more refined products than they produce.
New Valero has estimated that consolidation of Basis's corporate and refinery
support staff, including its selling, marketing, trading, transportation,
accounting and other functions, will result in net savings in personnel
related costs (including salaries, wages and employee benefit expense; rental
expenses; allocated overhead expense; and other employee-related costs) of
approximately $25 million annually.
41
Reconfiguration of Operations. Although Basis recently upgraded its
facilities through the addition of, among other things, a 75,000 barrel per
day ("BPD") resid hydrodesulfurization unit ("Residfiner") and a 40,000 BPD
solvent deasphalter ("ROSE Unit") at the Texas City, Texas refinery, such new
facilities were not placed in service until October 1996, and did not achieve
planned operating levels during 1996. New Valero believes that use of these
facilities has not yet been fully optimized. New Valero intends to modify the
slate of feedstocks processed at Basis's Texas refineries principally by
increasing the use of medium sour and heavy sweet crudes; New Valero believes
that this change in the feedstock slate will more efficiently utilize the
Residfiner and ROSE Units and produce a lesser amount of low-value resid and a
greater proportion of higher value gasoline and other premium products. New
Valero believes that it can also achieve more reliable and efficient operation
of other of Basis's refinery units, and intends to shut down certain marginal
and inefficient units. New Valero also believes that it can reduce offsite
storage and working capital requirements, and that it can achieve various
other efficiencies by coordinating the operation of the Basis refineries with
its existing refinery in Corpus Christi, Texas. In its projections, New Valero
has assumed that there would be a turnaround for the Texas City Residfiner and
cogeneration units in 1997 and for the Houston refinery in 1998.
Allocation of Purchase Price. The amounts shown above in the "New Valero and
Basis Combined Selected Pro Forma Projected Financial Information" table
include preliminary allocations of the purchase price of Basis to the assets
acquired and liabilities assumed based on estimated fair value. Further
allocations will be made based upon appraisal of such assets and liabilities.
Contingent Liabilities. Basis is a party to a substantial number of claims
and legal proceedings arising in the ordinary course of business, many of
which allege injuries resulting from exposures to asbestos, benzene and other
allegedly toxic and/or carcinogenic compounds. The stock purchase agreement
provides that Salomon will indemnify Valero, New Valero and Basis from loss,
cost, damage or expense attributable to all obligations, liabilities and
expenses related to suits, actions, claims and investigations pending as of
the closing date, and for additional indemnification, subject to certain
terms, conditions and limitations, with respect to other matters. The
foregoing projections assume that all losses, costs, damages and expenses
incurred by New Valero and Basis following the acquisition will not materially
exceed the amount of such indemnification and that all applicable
indemnification will be provided in accordance with such indemnification
agreement. See "Business and Properties--Litigation--Basis Litigation." The
foregoing projections also assume that capital expenditures and other costs of
environmental compliance at the Basis refineries will not materially exceed
certain amounts which New Valero has budgeted therefor and which it has
factored into its purchase offer for Basis. See "Business and Properties--
Environmental Matters."
OUTLOOK
Refining Business
Over the next few years, light product demand is expected to grow moderately
and refining capacity in the United States is expected to remain tight.
However, the ongoing restructuring of the refining industry to improve
performance as a result of poor margins experienced in recent years will
create an extremely competitive business environment. The Company entered into
several new feedstock arrangements in 1996 and will continue to explore
various opportunities, both domestically and abroad, to diversify its sources
of feedstock supply. The Company expects resid to continue to sell at a
discount to crude oil, but is unable to predict the amount of such discount or
future relationships between the supply of and demand for resid. Domestic
gasoline demand, which increased by 1%, 1.5% and 1.7% in 1996, 1995 and 1994,
respectively, is expected to continue to grow over the next several years due
to slowing gains in fuel efficiency for passenger cars, higher sales of light
trucks and sport-utility vehicles which average fewer miles per gallon than
passenger cars, higher speed limits and an increasing number of miles driven.
The demand for RFG increased in 1996 to over 30% of the total demand for
gasoline in the United States following the implementation of the California
Air Resources Board's "CARB II" gasoline program (gasoline that contains
between zero and 2.7% oxygen by weight is sometimes known as
42
"CARB II" gasoline), and may continue to increase if areas of the country
whose ozone emissions exceed permitted levels are permitted and elect to "opt
in" to the RFG program to reduce their emission levels. The demand for
oxygenates, including MTBE, is expected to increase due to the future need to
replace the octane displaced by the worldwide movement to reduce the use of
lead in gasoline, and to growing demand for oxygenated gasolines. Refinery
throughput volumes are expected to benefit from the full year effect of
various unit improvements and enhancements made during 1996 and no significant
unit turnarounds being scheduled in 1997. On January 31, 1997, the Company
announced that its Refining Business would be spun off to stockholders. See
"--The Proposed Transactions" and Note 2 of Valero Energy Corporation and
Subsidiaries Notes to Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
As described above, the Refining Business is expected to be spun off as a
separate company to the Company's stockholders. The Refining Business
currently obtains working capital financing from the Company pursuant to the
Company's new $835 million revolving bank credit and letter of credit facility
(which replaces a prior $300 million facility) and certain uncommitted short-
term bank credit lines and uncommitted bank letter of credit facilities
obtained by the Company as described under "--Current Structure." Such new
credit facility has been used to provide financing for the Basis Acquisition
and credit support for the reissue and refunding of the IRBs. At the Time of
Distribution the new credit facility will be assumed by New Valero and will
also be used for other general corporate purposes, including the issuance of
letters of credit and the funding of a dividend payable to Valero pursuant to
the terms of the Distribution Agreement. In addition, a $150 million inventory
purchase agreement is being arranged that is expected to be used to monetize a
portion of the Basis and/or New Valero inventories. Closing of the inventory
purchase agreement is expected to occur during the third quarter of 1997.
On April 16, 1997, the Industrial Development Corporation of the Port of
Corpus Christi issued $98.5 million principal amount of tax-exempt refunding
revenue bonds (the "Refunding Bonds"), in four series, the proceeds of which
were loaned to New Valero and deposited with a trustee so as to defease $90
million principal amount of 10 1/4% refunding revenue bonds and $8.5 million
principal amount of 10 5/8% revenue bonds issued on behalf of New Valero in
1987. The Series 1997A Refunding Bonds have a principal amount of $24.4
million and are due in 2027. The Series 1997B and 1997C Refunding Bonds each
have a principal amount of $32.8 million and mature in 2018. The Series 1997D
Refunding Bonds have a principal amount of $8.5 million and are due in 2009.
The Series 1997A, 1997B and 1997C Refunding Bonds are each subject to a
mandatory sinking fund beginning in 2010. The Refunding Bonds are supported by
an irrevocable, direct-pay letter of credit issued by Bank of Montreal under
the new credit facility described above. The letter of credit is scheduled to
expire April 15, 1998, but is expected to be renewed or replaced. In the event
that the Refunding Bonds were not supported by a qualifying letter of credit
or other qualifying credit enhancement, the Refunding Bonds would be subject
to mandatory tender or acceleration. The Refunding Bonds will initially accrue
interest at a floating rate determined weekly and initially set at 3.85% per
annum with respect to the Series 1997A, 1997B, 1997C Refunding Bonds and 3.95%
with respect to the Series 1997D Refunding Bonds, but such rate may be
converted from time to time at the election of New Valero to a daily, weekly
or commercial paper rate, or to a fixed rate.
The Company believes that New Valero, after the Time of Distribution, will
have 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.
Current Structure
Net cash provided by the Company's operating activities increased $120
million to $275.8 million in 1996 compared to 1995 due primarily to the
increase in income described under "--Results of Operations" and to the
changes in current assets and current liabilities detailed in Note 1 of Valero
Energy Corporation and Subsidiaries Notes to Consolidated Financial Statements
under "Statements of Cash Flows." Included in such changes was a substantial
increase in accounts payable in 1996 offset to a large extent by increases in
accounts
43
receivable and inventories. Accounts payable and accounts receivable increased
in 1996 due to higher commodity prices and increased purchase and sales
volumes of refined products, natural gas and NGLs. Refining inventories
increased in 1996 due to increased rack and wholesale marketing activities,
while Refining inventories decreased in 1995 resulting from a decrease in
volumes available under crude feedstock contracts, above-normal low-sulphur
heavy oil cracking complex (the "HOC") feedstock inventories at the end of
1994 in anticipation of a turnaround of the HDS Unit in the first quarter of
1995, and above-normal refined product inventories at the end of 1994
attributable to uncertainties related to the implementation of the new RFG
regulations. Prepaid and other expenses decreased in 1996 compared to an
increase in 1995 due to lower commodity deposits and deferrals, while accrued
interest decreased in 1996 compared to an increase in 1995 as a result of
timing differences on interest payments for certain nonbank debt. During 1996,
the Company utilized the cash provided by its operating activities, a portion
of its existing cash balances, proceeds from issuances of Valero Common Stock
related to the Company's employee benefit plans, and proceeds from
dispositions of various nonessential properties to fund capital expenditures
and deferred turnaround and catalyst costs, reduce bank debt, repay principal
on certain outstanding nonbank debt, pay common and preferred stock dividends,
and redeem a portion of its outstanding Cumulative Preferred Stock, $8.50
Series A.
The Company currently maintains an unsecured $835 million revolving bank
credit and letter of credit facility (which replaces a prior $300 million
facility) that 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 (inclusive of a facility fee), a Base
Rate or a competitive bid money market rate. The Company is also charged
various fees, including various letter of credit fees. As of December 31,
1996, the Company had approximately $273 million available under the prior
committed bank credit facility for additional borrowings and letters of
credit. The Company also has $190 million of uncommitted short-term bank
credit lines and $170 million of uncommitted bank letter of credit facilities,
of which $108 million and $129 million, respectively, were available as of
December 31, 1996 for additional borrowings and letters of credit. The Company
was in compliance with all covenants contained in its various debt facilities
as of December 31, 1996. See Notes 4 and 5 of Valero Energy Corporation and
Subsidiaries Notes to Consolidated Financial Statements.
In the first quarter of 1995, the SEC declared effective the Company's shelf
registration statement to offer up to $250 million principal amount of
additional debt securities, including Medium-Term Notes, $96.5 million of
which were issued in 1995. The net proceeds were used for general corporate
purposes, including the repayment of existing indebtedness, financing of
capital projects and additions to working capital. See Note 5 of Valero Energy
Corporation and Subsidiaries Notes to Consolidated Financial Statements. No
additional Medium-Term Notes have been issued since June 1995 and none are
expected to be issued in the future. The Company's ratio of earnings to fixed
charges, as computed based on rules promulgated by the SEC, was 1.98 for the
year ended December 31, 1996.
During 1996, the Company expended approximately $165 million for capital
investments, including capital expenditures and deferred turnaround and
catalyst costs. Of this amount, $93 million related to Refining Business
operations while $66 million related to Natural Gas Business operations.
Included in the Refining Business amount was $36 million for turnarounds of
the Refinery's HDS Unit, MTBE Plant, and Hydrocracker and naphtha Reformer
units. For 1997, the Company currently expects to incur approximately $175
million for capital expenditures and deferred turnaround and catalyst costs.
During 1996, the Company entered into a sublease agreement for unused space
in its corporate headquarters office complex. The sublease has a primary term
of 20 years, with the sublessee having an option to terminate the lease after
10 years. The sublessee is scheduled to occupy the premises in phases, with
full occupancy currently expected in 1997. The sublease reduced the Company's
rent expense in 1996 by $.5 million and is expected to reduce future rent
expense by approximately $2.1 million per year once fully occupied.
Dividends on Valero Common Stock are considered quarterly by the Valero
Board and may be paid only when approved by the Valero Board. The current
quarterly dividend rate on Valero Common Stock of $.13 per share has remained
unchanged since the fourth quarter of 1993. Because appropriate levels of
dividends are
44
determined by the Valero Board on the basis of earnings and cash flows, the
Company cannot assure the continuation of Valero Common Stock dividends at any
particular level. For information regarding dividends on New Valero Common
Stock, see "Risk Factors--New Valero Dividend Policy."
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 and as otherwise described herein, the Company has no
specific financing plans as of the date hereof.
The Refining Business has a concentration of customers in the oil refining
industry and spot and retail gasoline markets. The Natural Gas Business has a
concentration of customers in the natural gas transmission and distribution,
and refining and petrochemical industries. These concentrations of customers
may impact the Company's overall exposure to credit risk, either positively or
negatively, since the customers in each specific industry segment may be
similarly affected by changes in economic or other conditions. However, the
Company believes that its portfolio of accounts receivable is sufficiently
diversified to the extent necessary to minimize potential credit risk.
Historically, the Company has not had any significant problems collecting its
accounts receivable. The Company's accounts receivable are not collateralized.
The Company is subject to environmental regulation at the federal, state and
local levels. The Company's capital expenditures for environmental control and
protection for Refining Business operations totalled approximately $5 million
in 1996 and are expected to be approximately $7 million in 1997 (excluding any
expenditures for Basis). These amounts are exclusive of any amounts related to
constructed facilities for which the portion of expenditures relating to
environmental requirements is not determinable. Capital expenditures for
environmental control and protection for Natural Gas Business operations have
not been material to date and are not expected to be material in 1997. The
Refinery was completed in 1984 under more stringent environmental requirements
than many existing United States refineries, which are older and were built
before such environmental regulations were enacted. As a result, the Company
believes that it may be able to more easily comply with present and future
environmental legislation. Within the next several years, all United States
refineries must obtain federal operating permits under provisions of the Clean
Air Act Amendments of 1990 (the "Clean Air Act"). In addition, Clean Air Act
provisions will require many of the Natural Gas Business's gas processing
plants and gas pipeline facilities to obtain new operating permits. However,
the Clean Air Act is not expected to have any significant adverse impact on
the Company's operations and the Company does not anticipate that it will be
necessary to expend any material amounts in addition to those mentioned above
to comply with such legislation. The Company is not aware of any material
environmental remediation costs related to its operations. Accordingly, no
amount has been accrued for any contingent environmental liability.
In June 1996, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities," which
establishes new accounting and reporting standards for transfers and servicing
of financial assets and extinguishments of liabilities. The statement is
effective for transactions occurring after December 31, 1996. Based on
information currently known by the Company, this statement will not have a
material effect on the Company's consolidated financial statements.
45
BUSINESS AND PROPERTIES
Except for historical information, the matters discussed in this section are
forward-looking statements that involve risks and uncertainties, including
general economic, business and market conditions, costs or difficulties
related to the establishment of New Valero as an independent entity, increased
competitive pressure in the refining and marketing business and other risks
detailed throughout this Prospectus. These forward-looking statements
represent New Valero's judgment as of the filing date of the New Valero
Registration Statement of which this Prospectus is a part. New Valero
disclaims, however, any intent or obligation to update such statements.
OVERVIEW
New Valero was incorporated in Delaware in 1981. New Valero's principal
business is specialized refining; it owns the Refinery in Corpus Christi ,
Texas, and refines high-sulfur atmospheric resid oil and other refinery
feedstocks into refined products, primarily RFG and petrochemical feedstocks.
New Valero markets refined products principally in Texas and also in the
midwestern, northeastern and southeastern United States.
STRATEGY
Following the Distribution, New Valero expects that its ratio of debt-to-
total capitalization will be substantially reduced from Valero's current 49%
debt. New Valero's objective is to utilize this enhanced financial flexibility
to pursue acquisitions and strategic alliances, and to become a multi-facility
refiner. See "--Acquisition of Basis Petroleum."
New Valero also plans to continue to produce a high percentage of its
refined products as RFG, to focus significant marketing efforts on the RFG and
oxygenates markets and to further expand its product slate to pursue higher
margin products.
New Valero will seek to diversify further its feedstock supply position to
reduce reliance on any single supplier and to benefit from changing feedstock
supply patterns and pricing differentials. New Valero will also seek to
strengthen its marketing and trading operations, and to reduce its per-barrel
operating costs to further enhance operating results.
REFINING OPERATIONS
The Refinery processes high-sulphur atmospheric tower bottoms, a type of
resid, and other feedstocks into a product slate of higher value products,
principally RFG and middle distillates. The Refinery can produce approximately
171,500 barrels per day of refined products, with gasoline and gasoline-
related products comprising approximately 85% of the Refinery's production,
and middle distillates comprising the remainder. The Refinery can produce all
of its gasoline as RFG and all of its diesel fuel as low-sulfur diesel. The
Refinery has substantial flexibility to vary its mix of gasoline products to
meet changing market conditions. For additional information regarding the
Refining Business operating results for the three years ended December 31,
1996, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
The Refinery's principal operating units include the HDS Unit and the HOC.
The HDS Unit removes sulfur and metals from resid to improve the resid's
subsequent cracking characteristics. The HDS Unit has a capacity of
approximately 70,000 barrels per day. The HOC processes feedstock primarily
from the HDS Unit and has a capacity of approximately 74,000 barrels per day.
The Refinery's other significant units include a 36,000 barrel-per-day
"Hydrocracker" (which produces reformer feed naphtha from the Refinery's gas
oil and distillate streams), a 36,000 barrel-per-day continuous catalyst
regeneration "Reformer" (which produces "reformate," a low vapor pressure
high-octane gasoline blendstock, from the Refinery's naphtha streams), a
31,000 barrel-per-day reformate splitter (which separates a benzene
concentrate stream from reformate produced at the Reformer), a 30,000 barrel-
per-day crude unit, and a 24,000 barrel-per-day vacuum unit.
46
Also located at the Refinery are New Valero's MTBE Plant and MTBE/TAME Unit
(the "MTBE/TAME Unit"). The MTBE Plant can produce approximately 17,000
barrels per day of MTBE from butane and methanol feedstocks. MTBE is an
oxygen-rich, high-octane gasoline blendstock produced by reacting methanol and
isobutylene, and is used to manufacture oxygenated and reformulated gasolines.
New Valero can blend the MTBE produced at the Refinery into its own gasoline
production or sell the MTBE separately. The Refinery's MTBE/TAME Unit converts
streams produced by the HOC into MTBE and tertiary amyl methyl ether ("TAME").
TAME, like MTBE, is an oxygen-rich, high-octane gasoline blendstock. The MTBE
Plant and MTBE/TAME Unit enable New Valero to produce approximately 22,500
barrels per day of total oxygenates. Substantially all of the methanol
feedstocks required for the production of oxygenates at the Refinery can
normally be provided by a methanol plant in Clear Lake, Texas owned by a joint
venture between New Valero and Hoechst Celanese Chemical Group, Inc. (the
"Methanol Plant"). The Methanol Plant can produce approximately 13,000 barrels
per day of methanol.
In January 1997, New Valero placed into service a xylene fractionation
facility ("Xylene Unit") which recovers xylene from the Reformer's reformate
stream. The fractionated xylene may be sold into the petrochemical feedstock
market for use in the production of paraxylene. The Xylene Unit is designed to
recover a mixed xylene stream of approximately 6,500 barrels per day. The MTBE
Plant, the MTBE/TAME Unit, the Xylene Unit and related facilities diversify
New Valero's refining operations, enabling the Refining Business to pursue the
higher margin product markets.
In 1996, New Valero completed scheduled turnarounds on its HDS Unit,
Hydrocracker, Reformer, and MTBE Plant. The capacity of the MTBE Plant was
increased by approximately 1,500 barrels per day. During the second quarter of
1996, New Valero experienced unscheduled down time at the Refinery because of
two power outages. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations." The Refinery's other principal refining
units operated during 1996 without significant unscheduled down time. However,
the Methanol Plant suffered an explosion in early December 1996. There were no
injuries, but New Valero's share of repair costs is estimated to be $2.5
million. The Methanol Plant resumed operations in late February 1997. The MTBE
Plant was down for nine days in January 1997 to replace a catalyst and the HOC
Unit was down for approximately two weeks in the second quarter of 1997 for
unscheduled maintenance. During 1997, the HDS Unit is scheduled for a
maintenance turnaround and catalyst change in the fourth quarter. The crude
unit is scheduled to be down for approximately 14 days in the second quarter
of 1997 for a maintenance turnaround.
SALES
Set forth below is a summary of the Refining Business' refining and
marketing throughput volumes per day, average throughput margin per barrel and
sales volumes per day for the three years ended December 31, 1996. Average
throughput margin per barrel is computed by subtracting total direct product
cost of sales from product sales revenues and dividing the result by
throughput volumes.
[Download Table]
YEAR ENDED DECEMBER 31,
--------------------------
1996 1995 1994
------- ------- -------
Throughput volumes (Mbbls per day)............... 170 160 146
Average throughput margin per barrel............. $ 5.29 $ 6.25 $ 5.36
Sales volumes (Mbbls per day).................... 291 231(1) 140
--------
(1) Revised for 1995 to include sales volumes related to certain refining and
marketing trading activities previously classified as a reduction of cost
of sales.
New Valero sells refined products under term contracts as well as on a spot
and truck rack basis. A "truck rack sale" is a sale to a customer that
provides trucks to take delivery at loading facilities. In 1996, term, spot
and truck rack sales volumes accounted for approximately 35%, 49% and 16%,
respectively, of total gasoline and distillate sales. Sales of New Valero's
refined products under term contracts are made principally to large oil
companies. Spot sales of New Valero's refined products are made to large oil
companies and gasoline distributors. The principal purchasers of New Valero's
products from truck racks have been wholesalers and
47
jobbers in the eastern and midwestern United States. New Valero's products are
transported through common-carrier pipelines, barges and tankers.
Interconnects with common-carrier pipelines give the Refining Business the
flexibility to sell products to the northeastern, midwestern or southeastern
United States.
Approximately 50% of New Valero's RFG production is under contract to supply
wholesale gasoline marketers in Texas at market-related prices; another 17% of
New Valero's RFG production is under contract to gasoline marketers in the
northeast United States, which is currently the largest RFG market in the
United States. In 1996, New Valero also supplied approximately 1.5 million
barrels of CARB II gasoline in the West Coast markets in connection with the
commencement of the California Air Resources Board's gasoline program. See "--
Factors Affecting Operating Results."
FEEDSTOCK SUPPLY
The predominant feedstock for the Refinery is resid produced at refineries
outside the United States. Most of the large refineries in the United States
are able to convert internally produced resid into higher value end-products.
Many overseas refineries, however, are less sophisticated, process smaller
portion of resid internally, and, therefore, produce larger volumes of resid
for sale. As a result, New Valero acquires and expects to acquire most of its
resid in international markets. These supplies are loaded aboard chartered
vessels and are subject to the usual maritime hazards. New Valero maintains
insurance on its feedstock cargos.
The Refining Business has entered into several term agreements for the
supply of approximately 58,000 barrels per day of resid feedstocks at market-
related prices which provide for approximately 70% of New Valero's estimated
resid feedstock requirements for 1997. These supply agreements include an
agreement with the Saudi Arabian Oil Company to provide an average of 36,000
barrels per day of resid from its Ras Tanura refinery to New Valero through
mid-1998. New Valero believes that if any of its existing feedstock
arrangements were interrupted or terminated, supplies of resid could be
obtained from other sources or on the open market; however, the Refining
Business could be required to incur higher feedstock costs or substitute other
types of resid, thereby producing less favorable operating results. Over the
past few years, demand for the type of resid feedstock now processed at the
Refinery has increased in relation to the availability of supply. See "--
Factors Affecting Operating Results." New Valero also recently entered into
term contracts for the supply of crude oil feedstocks for the Refinery's crude
unit, including a contract for approximately 20,000 barrels per day of Daqing
sweet crude oil for the first six months of 1997, and a contract for
approximately 8,000 barrels per day of domestically produced crude extending
through 1997. The remainder of the Refinery's resid and crude feedstocks are
purchased at market-based prices under short-term contracts.
In connection with the Distribution, New Valero entered into several
contracts with its former affiliates, including a 10-year term contract under
which a former affiliate is to supply substantially all of the butane and
methanol feedstocks currently required to operate the MTBE Plant. New Valero
also entered into a 10-year term contract whereby another former affiliate
supplies at least one-half of the Methanol Plant's natural gas feedstock
requirements.
New Valero owns feedstock and product storage facilities with a capacity of
approximately 6.9 million barrels. Approximately 4.4 million barrels of
storage capacity are heated tanks for heavy feedstocks. New Valero also leases
fuel oil and refined product storage facilities in various locations,
including approximately 600,000 barrels of gasoline storage in the Houston,
Texas area. New Valero also owns dock facilities at the Refinery that can
unload simultaneously two 150,000 dead-weight ton capacity ships and can dock
larger crude carriers after partial unloading.
ACQUISITION OF BASIS PETROLEUM
On April 22, 1997 Valero and Salomon entered into a stock purchase agreement
pursuant to which Valero agreed, subject to certain terms and conditions, to
acquire the stock of Basis from Salomon for $285 million, plus approximately
$200 million for the value of inventories and other working capital. In
addition, the stock
48
purchase agreement provides for the seller to receive up to 10 additional
payments following each anniversary date of the closing of the acquisition.
These annual earn-out payments would be based on the difference between a
stated base refining "crack spread" and the theoretical spread computed using
actual average quoted prices, and calculated using a nominal average annual
throughput of 100 million barrels. These payments are limited to $35 million
in any year and $200 million in the aggregate. Any such participation
payments, if made, will be accounted for as an additional cost of the
acquisition of Basis by Valero and will be depreciated over the remaining
lives of the assets to which the additional cost is allocated. The purchase
price was paid, in part, with 3,429,796 shares of Valero Common Stock having a
fair market value of $120 million, with the remainder paid in cash. Valero has
assumed that approximately $150 million of the cash consideration can be
financed through an inventory purchase agreement which is expected to be
implemented in the third quarter of 1997; the remaining portion of the cash
consideration was borrowed under credit facilities. Prior to the Distribution,
Valero will transfer the stock of Basis to New Valero.
Basis owns and operates three petroleum refineries with a total crude oil
processing capacity of about 310,000 BPD, including a 160,000 BPD facility at
Texas City, Texas; an 85,000 barrel per day facility in Houston, Texas; and a
65,000 barrel per day facility in Krotz Springs, Louisiana. The three
refineries currently are projected to produce approximately 330,000 BPD of
refined products, including about 130,000 BPD of gasoline, about 130,000 BPD
of distillates and jet fuel, and approximately 20,000 BPD of chemical grade
propylene and LPGs.
The Texas City and Houston refineries are fully integrated merchant refining
facilities capable of receiving feedstocks and shipping refined products via
ocean-going tankers. In addition to crude oil and vacuum units, the Texas City
facility includes, among other processing units, a 48,000 BPD fluid catalytic
cracking unit ("FCC Unit") (which further processes gas oil feedstock from the
crude and vacuum units), a 22,000 BPD naphtha Reformer, a ROSE Unit (which
recovers deasphalted oil for feed to the FCC Unit from vacuum tower bottoms)
and a Residfiner (which improves the cracking characteristics of the residual
oil feed for the FCC Unit). The Texas City refinery was upgraded in the third
quarter of 1996 through the addition of the Residfiner and ROSE Units, as well
as sour crude oil conversion capacity, tankage and various other improvements.
The Houston facility includes a 61,000 BPD FCC Unit and a 17,000 BPD ROSE
Unit. The Krotz Springs, Louisiana facility includes a 30,000 BPD FCC Unit and
a 12,000 BPD Reformer. The Krotz Springs facility has access to the Colonial
Pipeline, a major interstate refined product pipeline. Basis is a merchant
refiner and markets refined products in approximately 155 markets in 36
states. Basis currently employs approximately 1,275 persons; the workforce is
not unionized.
The stock purchase agreement contains provisions whereby Salomon will
indemnify Valero, New Valero and Basis with respect to suits, actions, claims
and investigations pending at the time of the acquisition. Subject to certain
terms, conditions and limitations, Salomon will also provide indemnification
for certain other matters arising prior to the closing and Valero and New
Valero will provide indemnification for certain matters arising subsequent to
the closing. The closing documentation contains, among other things,
standstill provisions limiting sales of Valero or New Valero stock acquired by
Salomon, provisions granting to Valero certain rights of first refusal with
respect to sales of Valero or New Valero stock by Salomon and provisions
granting certain registration rights to Salomon if the Merger is not
consummated.
For certain historical pro forma financial information with respect to
Basis, see "New Valero Unaudited Pro Forma Condensed Combined Financial
Statements."
For a presentation of certain forward-looking information, including certain
projections and related assumptions, with respect to the Basis Acquisition,
see "Management's Discussion and Analysis of Financial Condition and Results
of Operations--Basis Petroleum."
49
FACTORS AFFECTING OPERATING RESULTS
The Refining Business' refining and marketing operating results are affected
by the relationship between refined product prices and resid prices, which in
turn are largely determined by market forces. The price of resid is affected
by the relationship between the growth in the demand for fuel oil and other
products (which increases crude oil demand, thereby increasing the supply of
resid when more crude oil is processed) and worldwide additions to resid
conversion capacity (which has the effect of reducing the available supply of
resid). The crude oil and refined products markets typically experience
periods of extreme price volatility. During such periods, disproportionate
changes in the prices of refined products and resid usually occur. The
potential impact of changing crude oil and refined product prices on New
Valero's results of operations is further affected by the fact that New Valero
generally buys its resid feedstock approximately 45 to 50 days prior to
processing it in the Refinery.
Because the Refinery is more complex than many conventional refineries and
is designed principally to process resid rather than crude oil, its operating
costs per barrel are generally higher than those of most conventional
refineries. But because resid usually sells at a large enough discount to
crude oil, New Valero has been generally able to recover its higher operating
costs and generate higher margins than many conventional refiners that use
crude oil as their principal feedstock. Moreover, through recent improvements
in technology, the Refinery has improved its ability to process different
types of feedstocks, including synthetic domestic heavy oil blends that have
been successfully processed in the HDS Unit.
The Saudi Arabian Oil Company has advised the Company that it plans to begin
operation of certain new resid conversion units in 1998 at the Ras Tanura
refining complex in Saudi Arabia. As a result, the production of resid at Ras
Tanura for export would be significantly reduced. The resid feedstock
purchased by New Valero from the Saudi Arabian Oil Company is produced at Ras
Tanura. Accordingly, a reduction in resid production at Ras Tanura could
adversely affect the price or availability of resid feedstocks in the future.
New Valero expects resid to continue to sell at a discount to crude oil, but
is unable to predict future relationships between the supply of and demand for
resid. Installation of additional refinery crude distillation and upgrading
facilities, price volatility, international political developments and other
factors beyond the control of New Valero are likely to continue to play an
important role in refining industry economics.
Because the Refinery is able to manufacture all of its gasoline as RFG and
can produce approximately 22,500 barrels per day of total oxygenates, certain
federal and state clean-fuels programs significantly affect the operations of
the Refining Business and the markets in which New Valero sells its refined
products. First, the EPA's oxygenated fuel program under the Clean Air Act
requires for certain winter months that areas designated nonattainment for
carbon monoxide use gasoline that contains a prescribed amount of clean
burning oxygenates./1/ Second, the EPA's RFG program under the Clean Air Act
is required in areas designated "extreme" or "severe" nonattainment for ozone.
In addition to these nonattainment areas, approximately 43 of the 87 areas
that were designated as "serious," "moderate," or "marginal" nonattainment for
ozone also "opted in" to the RFG program to decrease their emissions of
hydrocarbons and toxic pollutants./1/ In 1996, California adopted a statewide,
year-round program requiring the use of gasoline that meets more restrictive
emissions specifications than the federally mandated RFG. Under the California
gasoline program, areas not subject to either the federal oxygenated fuels
program or the federal RFG program may use CARB II gasoline so long as the
gasoline meets the California emissions standards.
--------
(1) "Oxygenates" are liquid hydrocarbon compounds containing oxygen. Gasoline
that contains oxygenates usually has lower carbon monoxide emissions than
conventional gasoline. The Clean Air Act and certain state laws require
oxygenated gasoline to have a minimum oxygen content of 2.7% by weight. As
of September 1996, only 31 of the original 42 areas designated as
nonattainment for carbon monoxide remain designated as nonattainment. As
areas have come into "attainment," they generally have left the oxygenated
fuels program. However, Minnesota elected to use oxygenated gasoline
statewide and year-round beginning in 1997, and other states are
considering similar requirements.
50
MTBE margins are affected by the price of the MTBE and its feedstocks,
methanol and butane, as well as the demand for RFG, oxygenated gasoline and
premium gasoline. The worldwide movement to reduce lead in gasoline is
expected to increase worldwide demand for oxygenates to replace the octane
provided by lead-based compounds. The general United States growth in gasoline
demand as well as additional "opt-ins" by certain areas into the EPA clean
fuels programs are expected to continue to grow the demand for MTBE.
COMPETITION
The refining industry is highly competitive with respect to both supply and
markets. New Valero competes with numerous other companies for available
supplies of resid and other feedstocks and for outlets for its refined
products. New Valero obtains all of its resid feedstock from unaffiliated
sources. Many of New Valero's competitors obtain a significant portion of
their feedstocks from company-owned production and are able to dispose of
refined products at their own retail outlets. New Valero does not have retail
gasoline operations. Competitors that have their own production or retail
outlets (and brand-name recognition) may be able to offset losses from
refining operations with profits from producing or retailing operations, and
may be better positioned than the Refining Business to withstand periods of
depressed refining margins or feedstock shortages.
Because the Refinery was completed in 1984, it was built under more
stringent environmental requirements than many existing refineries. The
Refinery currently meets EPA emissions standards requiring the use of "best
available control technology," and is located in an area currently designated
"attainment" for air quality. Accordingly, New Valero expects to be able to
comply with the Clean Air Act and future environmental legislation more easily
than older refineries, and will not be required to spend significant
additional capital for environmental compliance. In 1996, the Corpus Christi,
Texas, area was approved as a "flexible attainment region" ("FAR") by the EPA
and the Texas Natural Resource Conservation Commission ("TNRCC"). Under the
Clean Air Act, the FAR designation will allow local officials to design and
implement an ozone prevention strategy customized for the community. This
designation also prevents the EPA from designating the Corpus Christi area as
"nonattainment" for a five-year period while agreed-upon control strategies
are being initiated to reduce ozone formation. The FAR designation should
provide greater flexibility with respect to possible future expansion projects
at the Refinery.
New Valero produces enough oxygenates to blend all of its gasoline as RFG
and to sell additional quantities of oxygenates to third parties who require
oxygenates for blending. RFG generally sells at a premium over conventional
gasoline. Most of the United States refining industry uses the conventional
"3-2-1 crack spread" (which assumes the input of three parts of WTI and the
output of two parts gasoline and one part diesel) as an approximation for
gross margins; however, the Refinery produces predominately premium products
such as RFG and low-sulfur diesel and also produces a higher percentage of its
refined products as gasoline. Thus, New Valero's "85-15 clean fuels crack
spread" (85% RFG, 15% low-sulfur diesel) has provided a wider margin than the
typical crack spread experienced by a conventional refiner.
ENVIRONMENTAL MATTERS
New Valero's operations are subject to environmental regulation by federal,
state and local authorities, including the EPA and the TNRCC and the Texas
Railroad Commission. The regulatory requirements relate primarily to water and
storm water discharges, waste management and air pollution control measures.
In 1996, capital expenditures for the Refining Business attributable to
compliance with environmental regulations were approximately $5 million and
are currently estimated to be $7 million for 1997 (excluding any expenditures
for Basis). These amounts are exclusive of any amounts related to constructed
facilities for which the portion of expenditures relating to compliance with
environmental regulations is not determinable.
EMPLOYEES
As of the date of Distribution, New Valero is expected to have approximately
770 employees, not including employees of Basis.
51
PROPERTIES
New Valero's properties include the Refinery and related facilities all
located in Texas. See "Refining Operations," which includes detailed
information regarding properties of the Refining Business. New Valero believes
that its facilities are generally adequate for their respective operations,
and that its facilities are maintained in a good state of repair. Valero is
the lessee under a number of cancelable and noncancelable leases for certain
real properties, including the Xylene Plant and certain storage facilities.
See Note 14 of Valero Energy Corporation and Subsidiaries Notes to
Consolidated Financial Statements. As a result of the Basis Acquisition, the
properties of New Valero will also include the three Basis refineries
described under "--Acquisition of Basis Petroleum."
LITIGATION
Javelina Company Litigation. Valero Javelina Company owns a 20% general
partner interest in Javelina. Javelina has been named as a defendant in 11
lawsuits filed since 1993 in state district courts in Nueces County, and Duval
County, Texas. Nine of the suits include as defendants other companies that
own refineries or other industrial facilities in Nueces County. These suits
were brought by a number of plaintiffs who reside in neighborhoods near the
facilities. The plaintiffs claim injuries relating to alleged exposure to
toxic chemicals, and generally claim that the defendants were negligent,
grossly negligent and committed trespass. The plaintiffs claim personal injury
and property damages resulting from soil and ground water contamination and
air pollution allegedly caused by the operations of the defendants. The
plaintiffs seek an unspecified amount of actual and punitive damages. The
remaining two suits were brought by plaintiffs who either live or have
businesses near the Javelina plant. The plaintiffs in these suits allege
claims similar to those described above and seek unspecified actual and
punitive damages.
Teco Pipeline Company v. Valero Energy Corporation, et al., 215th State
District Court, Harris County, Texas (filed April 24, 1996). New Valero's
former parent company, Valero, and certain Valero subsidiaries have been sued
by Teco Pipeline Company ("Teco") regarding the operation of the 340-mile West
Texas pipeline in which a subsidiary of Valero holds a 50% undivided interest.
In 1985, a subsidiary of Valero 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 Valero 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, and other claims, and seeks unquantified actual and punitive
damages. Valero's motion to compel arbitration was denied, but has been
appealed. Valero has 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; Valero is seeking
unquantified actual and punitive damages. Pursuant to the Distribution
Agreement, New Valero has agreed to indemnify and hold harmless Valero to the
extent of (i) 50% of the amount of any final judgment or settlement amount not
in excess of $30 million, and (ii) 100% of that part of any final judgment or
settlement amount in excess of $30 million.
Other. New Valero is also a party to additional claims and legal proceedings
arising in the ordinary course of business. Except as noted, many of the
foregoing matters are in preliminary stages, involve complex issues of law and
fact and may proceed for protracted periods of time. Based upon a review of
the petitions in the above matters, New Valero believes that many of such
petitions contain questionable allegations and that there are numerous
meritorious defenses. New Valero believes it is unlikely that the final
outcome of any of the claims or proceedings to which New Valero is a party,
including those described above, would have a material adverse effect on New
Valero's financial statements; however, due to the inherent uncertainty of
litigation, the range of
52
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 New Valero's results
of operations for the interim period in which such resolution occurred.
Basis Litigation. Basis is a defendant in numerous lawsuits brought by
present or former employees of Basis, by employees of Basis' customers or
contractors, or by other persons based on negligence, gross negligence,
products liability, strict liability, breach of warranty and other theories of
recovery and claiming injuries, including wrongful death, resulting from
exposure to asbestos, benzene and other allegedly toxic or carcinogenic
compounds allegedly processed, used, manufactured, distributed or sold by
Basis or its predecessors. Approximately ten of the lawsuits involve class or
other actions involving numerous plaintiffs and defendants, while the
remaining actions have individual plaintiffs and involve only Basis or a
limited group of defendants. In most such cases, discovery is underway and
trial dates have not been set.
In addition to the foregoing matters, Basis is a defendant in a lawsuit,
Friends of the Earth, Inc. v. Phibro Energy USA, Inc., filed in the United
States District Court for the Southern District of Texas (filed June 1994),
alleging, among other things, that Basis has violated the terms of its
National Pollutant Discharge Elimination System permit for wastewater
discharge at its Houston, Texas refinery. Although the District Court granted
Basis a summary judgment, the United States Court of Appeals for the Fifth
Circuit reversed the summary judgment and remanded the case to the trial court
for further discovery. The case is currently stayed by mutual agreement
pending the decision of the United States Court of Appeals for the Fifth
Circuit in a similar case (Friends of the Earth v. Chevron Chemical Co., Inc.)
in which the lower court granted summary judgment dismissing the case for lack
of standing by the plaintiffs.
Basis is also a defendant in a lawsuit, Amoco Chemical Company, et al. v.
United States of America, et al., pending in the United States District Court
for the Southern District of Texas (served May 1996), which is a CERCLA cost
recovery action related to the Tex-Tin "superfund" site. Such site is not
owned by Basis, and Basis has advised New Valero that Basis has not disposed
of any material at the site. However, Basis has been identified as a
"generator defendant" with respect to such site, as the successor to the
previous refinery owner. Basis may potentially be named as a defendant or
"potentially responsible party" in other similar pending or threatened
superfund-related actions. Basis is also a defendant in City of Houston v.
Phibro Energy, USA, Inc., filed in the 11th Judicial District Court, Harris
County, Texas (filed December 20, 1995) involving alleged Texas Clean Air Act
violations related to allegedly excessive SO2 emissions. Agreement among the
various parties has been reached to settle the City of Houston action on terms
and conditions not material to Basis; however, such settlement is not yet
final.
Basis has also received TNRCC notices of violation ("NOV") and/or federal
Environmental Protection Agency ("EPA") NOVs or administrative orders with
respect to environmental matters at each of its three refineries, including an
April 10, 1997 notice of intention to file civil suit for alleged violations
of the New Source Performance Standards under the Clean Air Act at the Texas
City, Texas refinery. Certain of such notices and orders may need to be
addressed through operational and capital improvements, and may involve the
assessment of substantial monetary penalties.
Basis is also a plaintiff in a lawsuit, Phibro Energy USA, Inc. v. Belmont
Contractors, Inc. et al., pending in the 190th Judicial District Court, Harris
County, Texas (filed March 26, 1996) and alleging generally that through a
bribery and kickback scheme, defendants destroyed plaintiff's independent
bargaining position with respect to construction work performed by defendants,
creating causes of action for fraud, tortious interference with contract,
breach of fiduciary duty, breach of contract and negligent misrepresentation.
Defendant Belmont has previously asserted in a separate action against Basis
causes of action for breach of contract and quantum meruit and various
construction claims aggregating approximately $25 million; while Belmont's
original suit has been abated, these claims are expected to be asserted in the
Harris County litigation.
53
Basis is also a party to various other lawsuits arising in the ordinary
course of its business. The various lawsuits referred to herein seek actual
and punitive damages which, in many cases, are unspecified but which total
several hundreds of millions of dollars, together, in certain cases, with
demands for injunctive relief. In certain of the matters cited above,
including the cited TNRCC and EPA matters, Basis could potentially be
adversely affected through: required reductions in emissions or discharges;
required additions and improvements to refinery controls or other equipment;
required reductions in permit limits or refinery throughput; and/or fines and
penalties. Additionally, although Valero and New Valero have conducted a due
diligence investigation of Basis prior to the closing of the purchase, the
scope of such investigation, particularly in light of the volume of
environmental, litigation and other matters to be investigated, has
necessarily been limited. The stock purchase agreement provides for
indemnification from the seller with respect to suits, actions, claims and
investigations pending at the time of the acquisition and for additional
indemnification, subject to certain terms, conditions and limitations, with
respect to other matters. However, there can be no assurance that other
material matters, not identified or fully investigated in due diligence, will
not subsequently be identified or that the matters heretofore identified will
not prove to be more significant than currently expected.
Many of the lawsuits in which Basis is involved, including certain of those
mentioned above, are in preliminary stages, involve complex issues of law and
fact and may proceed for a protracted period of time. Based upon a preliminary
review of Basis' files in connection with its due diligence investigation of
Basis, and Basis' representations and warranties in the Basis purchase
agreement, New Valero believes that many of such petitions contain
questionable allegations and that there are numerous meritorious defenses
which Basis can raise. As noted above, Valero and New Valero have considered
the possible need for capital expenditures related to environmental matters in
developing their offer to purchase Basis. Particularly in light of the
indemnification provided to Valero, New Valero and Basis by Salomon pursuant
to the stock purchase agreement, New Valero believes it is unlikely that the
final outcome of any of the claims or proceedings to which Basis is a party at
the time of the closing of the purchase of Basis, including those described
above, would have a material adverse effect on New Valero's financial
statements; however, due to the inherent uncertainty of litigation, the range
of possible loss, if any, that may be sustained by Basis cannot be estimated
with a reasonable degree of precision and there can be no assurance that the
resolution of any particular claim or proceeding could not have an adverse
effect on Basis' and New Valero's results of operations for the interim period
in which such resolution occurred.
DESCRIPTION OF CERTAIN NEW VALERO INDEBTEDNESS
New Valero currently obtains working capital financing from Valero pursuant
to Valero's committed revolving credit and letter of credit facility and
certain short-term uncommitted bank lines and letter of credit facilities
maintained by Valero. Valero and New Valero have arranged an $835 million
committed revolving credit and letter of credit facility, which became
effective May 1, 1997. The new facility has provided financing for the Basis
Acquisition, credit support for the reissue and refunding of the Refunding
Bonds (hereafter defined), credit support for a planned issuance of $25
million of tax-exempt industrial revenue bonds for Basis, and will provide
financing for other general corporate purposes, including the issuance of
letters of credit, the funding of a $210 million dividend (as such amount may
be increased or decreased in connection with the repayment of the intercompany
note, see "Agreements Between Valero and New Valero") payable to Valero
immediately prior to the Distribution pursuant to the terms of the
Distribution Agreement, and, if necessary, up to $175 million for the
redemption of the Convertible Preferred Stock. Under the new $835 million
revolving credit and letter of credit facility, availability is limited to
$600 million ($775 million if necessary to fund redemption of the Convertible
Preferred Stock) prior to the Distribution. At the time of the Distribution,
the new credit facility will be assumed by New Valero and Valero would be
released from any obligations thereunder. In addition, a $150 million
inventory purchase agreement is being arranged that is expected to be used to
monetize a portion of the Basis and/or New Valero inventories. The bank credit
facility has (and inventory purchase agreement is expected to have) a term of
five years. The bank credit facility reduces by $150 million at the end of
each of the third and fourth years. In addition, the amount of the facility
would be reduced by the amount of cash proceeds realized from certain assets
sales and issuances of debt, and by 75% of the cash proceeds from certain
issuances of equity
54
securities. Borrowings under the new revolving bank credit facility will bear
interest annually at the rate of (i) LIBOR plus a margin, or (ii) a Base Rate,
or (iii) a money market rate determined by auction. In addition, various fees
and expenses, including a facility fee, a letter of credit issuance fee and a
fee based on letters of credit outstanding are payable under the facility. The
interest margins and fees described in this paragraph will fluctuate based
upon the credit ratings assigned from time to time to New Valero's long-term
debt. The credit facility contains various covenants that relate to or limit,
among other things, and subject to certain exceptions, liens, subsidiary debt,
investments, loans and advances, consolidations, mergers and transfers of
assets, transactions with affiliates and lease payments. The credit facility
also contains certain financial covenants, including a minimum fixed charge
coverage ratio, a maximum permitted debt-to-capitalization ratio, a minimum
net worth test and a requirement that the Company maintain certain interest
cap hedging facilities. The credit facility also limits the amount of certain
restricted payments, including dividends on, or repurchases of, common stock
of New Valero, to $22 million (or, under certain circumstances, $15 million)
during the period prior to April 30, 1998, and, during any 12-month period
ending April 30 in any subsequent year, to the sum of 25% (15% under certain
circumstances) of consolidated net income of New Valero for the four
consecutive fiscal quarters ending with the preceding March 31, plus such
portion of such $22 million (or, if applicable, $15 million) amount not
utilized in any prior period. Except for any unused portion of such $22
million (or $15 million) amount, amounts available to be paid but not paid in
any 12-month period may not be carried forward to the subsequent 12-month
period. The new credit facility is unsecured; however, following the
Distribution, each of the principal subsidiaries of New Valero will guaranty
the obligations of New Valero under the new credit facility. New Valero may
also obtain short-term uncommitted revolving credit or letter of credit
facilities, the lenders or issuers, amounts, terms and conditions of which
cannot currently be determined.
On April 16, 1997, the Industrial Development Corporation of the Port of
Corpus Christi issued $98.5 million principal amount of tax-exempt refunding
revenue bonds (the "Refunding Bonds"), in four series, the proceeds of which
were loaned to New Valero and deposited with a trustee so as to defease $90
million principal amount of 10 1/4% refunding revenue bonds and $8.5 million
principal amount of 10 5/8% revenue bonds issued on behalf of New Valero in
1987. The Series 1997A Refunding Bonds have a principal amount of $24.4
million and are due in 2027. The Series 1997B and 1997C Refunding Bonds each
have a principal amount of $32.8 million and mature in 2018. The Series 1997D
Refunding Bonds have a principal amount of $8.5 million and are due in 2009.
The Series 1997A, 1997B and 1997C Refunding Bonds are each subject to a
mandatory sinking fund beginning in 2010. The Refunding Bonds are supported by
an irrevocable, direct-pay letter of credit issued by Bank of Montreal under
the new credit facility described above. The letter of credit is scheduled to
expire April 15, 1998, but is expected to be renewed or replaced. In the event
that the Refunding Bonds were not supported by a qualifying letter of credit
or other qualifying credit enhancement, the Refunding Bonds would be subject
to mandatory tender or acceleration. The Refunding Bonds will initially accrue
interest at a floating rate determined weekly and initially set at 3.85% per
annum with respect to the Series 1997A, 1997B, 1997C Refunding Bonds and 3.95%
with respect to the Series 1997D Refunding Bonds, but such rate may be
converted from time to time at the election of New Valero to a daily, weekly
or commercial paper rate, or to a fixed rate.
55
MANAGEMENT
DIRECTORS OF NEW VALERO
Pursuant to the New Valero Certificate and the New Valero By-laws as
expected to be adopted prior to the Distribution, the business of New Valero
will be managed by or under the direction of the New Valero Board. The New
Valero Board will conduct its business through meetings of the New Valero
Board and its committees. Pursuant to the New Valero Certificate, the New
Valero Board has standing Audit, Compensation and Executive Committees. When
deemed necessary or advisable, the New Valero Board may also form from its
members a Nominating Committee to consider and recommend candidates for
election to the New Valero Board. The standing committees of the New Valero
Board are described below. The New Valero Certificate requires the New Valero
Board to be divided into Class I, Class II and Class III directors, with each
class serving a staggered three-year term. At the Time of Distribution, the
size of the New Valero Board is expected to be set at eight members and is
expected to be divided into two Class I, three Class II and three Class III
directors.
The following table sets forth information as to the individuals who will
serve as directors of New Valero following the Distribution, their class
membership and their original terms (the directors' ages are as of December
31, 1996). Initially, following the Distribution, the New Valero Board will
consist of the individuals who currently serve as directors of Valero (other
than Mr. Dudley, who will retire as of the annual meeting of stockholders as
described in the Proxy Statement-Prospectus). Mr. Greehey will serve as the
initial Chairman of the New Valero Board. All of the individuals that
currently serve as directors of Valero will cease to be directors of Valero as
of or prior to the Effective Time.
The New Valero By-laws provide that no individual may stand for election or
re-election as a director after having attained the age of 70 (except that, in
the case of individuals who served as directors of Valero prior to February
25, 1993, such age is 72).
[Enlarge/Download Table]
AGE
EXECUTIVE AS OF
OFFICER OR DECEMBER INITIAL
POSITION(S) HELD DIRECTOR OF 31, TERM DIRECTOR
NAME WITH VALERO VALERO SINCE 1996 EXPIRES CLASS
---- ----------------------------------- ------------ -------- ------- --------
Edward C. Benninger..... Director, President 1979 54 2000 III
Ronald K. Calgaard...... Director 1996 59 1999 II
Robert G. Dettmer....... Director 1991 65 2000 III
Ruben M. Escobedo....... Director 1994 59 1998 I
William E. Greehey...... Director, Chairman of the Board and 1979 60 1998 I
Chief Executive Officer
James L. Johnson........ Director 1991 69 2000 III
Lowell H. Lebermann..... Director 1986 57 1998 I
Susan Kaufman Purcell... Director 1994 54 1999 II
Mr. Benninger has served as a director of Valero since 1990. He was elected
President and Chief Financial Officer of Valero in 1996. He had served as
Executive Vice President of Valero since 1989, and previously served as Chief
Operating Officer of Valero Natural Gas Company from 1992 to 1995. He has
served in various other capacities with Valero since 1975. Mr. Benninger will
cease to be an officer of Valero as of or prior to the Effective Time.
Dr. Calgaard has been a director of Valero since 1996. He has served as
President of Trinity University, San Antonio, Texas since 1979. Dr. Calgaard
previously served as a director of Valero Natural Gas Company from 1987 until
1994.
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Mr. Dettmer was elected as a director of Valero in 1991. He retired from
PepsiCo, Inc. in 1996 after serving as Executive Vice President and Chief
Financial Officer since 1986.
Mr. Escobedo was elected as a director of Valero in 1994. He has been with
his own accounting firm, Ruben Escobedo & Company, CPAs, in San Antonio, Texas
since its formation in 1977. Mr. Escobedo also serves as a director of
Cullen/Frost Bankers, Inc. and previously served as a director of Valero
Natural Gas Company from 1989 to 1994.
Mr. Greehey has served as Chief Executive Officer and as a director of
Valero since 1979 and as Chairman of the Board since 1983. He retired from his
positions as President and Chief Executive Officer in June 1996 but resumed
his duties as Chief Executive Officer following the resignation of his
successor in November 1996. Mr. Greehey is also a director of Weatherford
Enterra, Inc. and Santa Fe Energy Resources, Inc. Mr. Greehey will cease to be
an officer of Valero as of or prior to the Effective Time.
Mr. Johnson has been a director of Valero since 1991. He previously served
as Chairman and Chief Executive Officer of GTE Corporation from 1988 to 1992,
and since 1992 has served as Chairman Emeritus. Mr. Johnson also serves as a
director of CellStar Corporation, FINOVA Group, Inc., Harte-Hanks
Communications, Inc., The Mutual Life Insurance Company of New York and Walter
Industries, Inc.
Mr. Lebermann was elected as a director of Valero in 1986, and previously
served on Valero's Board from 1979 to 1993. Mr. Lebermann has been President
of Centex Beverage, Inc., a beverage distributor in Austin, Texas, since 1981.
Mr. Lebermann is also a director of Station Casinos, Inc. and of Franklin
Federal Bankcorp, a Federal Savings Bank, Austin, Texas.
Dr. Purcell was elected as a director of Valero in 1994. She has served as
Vice President of the Americas Society in New York, New York since 1989 and is
also Vice President of the Council of the Americas. Dr. Purcell is a
consultant for several international and national firms and serves on the
boards of several mutual funds, including The Argentina Fund, The Latin
America Dollar Income Fund and Scudder World Income Opportunities Fund.
AUDIT COMMITTEE
The Audit Committee reviews and reports to the New Valero Board on various
auditing and accounting matters, including the quality and performance of New
Valero's internal and external accountants and auditors, the adequacy of its
financial controls, and the reliability of financial information reported to
the public. The Audit Committee also monitors New Valero's efforts to comply
with environmental laws and regulations. The initial members of the Audit
Committee are expected to be James L. Johnson (Chairman), Ruben M. Escobedo,
and Susan Kaufman Purcell.
COMPENSATION COMMITTEE
The Compensation Committee reviews and reports to the New Valero Board on
matters related to compensation strategies, policies and programs, including
certain personnel policies and policy controls; management development;
management succession; and benefit programs. The Compensation Committee also
approves and administers New Valero's stock option, executive stock incentive,
incentive bonus and other stock plans. The initial members of the Compensation
Committee are expected to be Lowell H. Lebermann (Chairman), Robert G. Dettmer
and James L. Johnson, none of whom is a current or former employee or officer
of Valero or New Valero.
There are no Compensation Committee interlocks. For the previous three
fiscal years, except for compensation arrangements disclosed herein, New
Valero has not participated in any contracts, loans, fees, awards or financial
interests, direct or indirect, with any committee member, nor is New Valero
aware of any means, directly or indirectly, by which a committee member could
receive a material benefit from New Valero or from its predecessor, Valero.
57
EXECUTIVE COMMITTEE
The Executive Committee exercises the power and authority of the New Valero
Board between meetings of the New Valero Board. Actions taken by the Executive
Committee do not require ratification by the New Valero Board. In the absence
of a Nominating Committee, the Executive Committee may also review possible
director candidates and recommend individuals for election as a director. The
initial members of the Executive Committee are expected to be Robert G.
Dettmer (Chairman), Ronald K. Calgaard, William E. Greehey and Lowell H.
Lebermann.
COMPENSATION OF DIRECTORS
Effective at the date of Distribution, non-employee directors will receive a
retainer fee of $18,000 per year, plus $1,000 for each New Valero Board and
committee meeting attended. Each director will also be reimbursed for expenses
of meeting attendance. Directors who are employees of New Valero will receive
no compensation (other than reimbursement of expenses) for serving as
directors.
New Valero has adopted a Restricted Stock Plan for Non-Employee Directors
("Director Plan") and a Non-Employee Director Stock Option Plan ("Director
Option Plan") to supplement the compensation paid to non-employee directors
and increase their identification with the interests of New Valero's
stockholders through ownership of New Valero Common Stock ("Director Stock").
Under the Director Plan, non-employee directors receive grants of Director
Stock that vest (become nonforfeitable) in three equal annual installments.
Such annual installments will usually vest on or about the date of New
Valero's annual meeting of stockholders. When all of the Director Stock
previously granted to a director is fully vested and the director is reelected
for an additional term, or his or her term of office otherwise continues after
such Director Stock is fully vested, another similar grant will be made. The
value of such subsequent grants will be equal to the value of the original
grant, adjusted to reflect subsequent changes in the consumer price index.
However, if a director is not eligible for reelection due to New Valero's
mandatory retirement policy or if a director does not intend to stand for
reelection, the grant would be reduced pro rata based on the number of years
remaining to the end of that director's term.
The Director Option Plan provides non-employee directors of New Valero
automatic annual grants of stock options for New Valero Common Stock. To the
extent necessary, the Director Option Plan is administered by the Compensation
Committee of the New Valero Board. The Director Option Plan provides that,
after the Time of Distribution, each new non-employee director joining the New
Valero Board will receive an initial grant of 5,000 options. On the date of
each New Valero annual meeting, each non-employee director (other than any new
non-employee directors receiving their initial grant of 5,000 options)
automatically receives a grant of 1,000 additional options. Options awarded
under the Director Option Plan will have an exercise price equal to the market
price of the New Valero Common Stock on the date of grant. The initial grant
of options to each non-employee director will vest in three equal annual
installments. Such annual installments will usually vest on or about the date
of New Valero's annual meeting of stockholders. The subsequent annual grants
of 1,000 options will vest fully six months following the date of grant. All
options will expire 10 years following the date of grant. Options vest and
remain exercisable in accordance with their original terms in the case of a
director retiring from the New Valero Board. In the event of a "Change of
Control" of New Valero, as defined in the Director Option Plan, all options
previously granted under the plan immediately become vested or exercisable
upon the date of the Change of Control. The Director Option Plan also provides
for adjustment in the number of options to prevent dilution or enlargement of
the benefits or potential benefits intended under the plan in the event the
Compensation Committee determines that any dividend or other distribution,
recapitalization, stock split, reverse stock split, reorganization, merger,
consolidation, split-up, spin-off, combination, repurchase, or exchange of
shares of New Valero or other similar corporate transaction or event affects
New Valero Common Stock.
The Director Plan and Director Option Plan will be approved by Valero, as
the sole stockholder of New Valero, prior to the Distribution.
58
Under the Retirement Plan for Non-Employee Directors ("Retirement Plan"),
non-employee directors become entitled to a retirement benefit upon completion
of five years of service (including prior service with Valero). The annual
benefit at retirement is equal to 10% of the highest annual cash retainer paid
to the director during his or her service on the New Valero Board (or Valero
Board), multiplied by the number of full and partial years of service (not to
exceed 10 years). Such benefit is then paid for a period equal to the shorter
of the director's number of years of service or the director's lifetime, but
in no event for longer than 10 years. The Retirement Plan provides no survivor
benefits and is an unfunded plan paid from the general assets of New Valero.
EXECUTIVE OFFICERS OF NEW VALERO
New Valero's senior management team (the "Executive Officers") consists
primarily of individuals currently responsible for the management of the
Refining Business as conducted by Valero. No family relationship exists among
any of the Executive Officers or directors of New Valero. There is no
arrangement or understanding between any Executive Officer and any other
person pursuant to which he was or is to be selected as an officer. All of
such individuals will resign from any positions they may hold with Valero and
its subsidiaries (other than New Valero and its subsidiaries) effective as of
the Time of Distribution.
[Enlarge/Download Table]
YEAR FIRST ELECTED
NEW VALERO OR APPOINTED AS AGE AS OF
POSITION AND OFFICER OR DIRECTOR DECEMBER 31,
NAME OFFICE HELD OF NEW VALERO 1996
---- ------------ ------------------- ------------
William E. Greehey...... Director, Chairman of the Board 1982 60
and Chief Executive Officer
Edward C. Benninger..... Director, President and Chief Financial Officer 1984 54
Stan L. McLelland....... Executive Vice President and General Counsel 1984 51
E. Baines Manning....... Executive Vice President 1986 56
George E. Kain.......... Senior Vice President 1994 60
John R. Gibbons......... Vice President Finance and Treasurer 1992 43
Gregory C. King......... Vice President 1997 36
Mr. Greehey: for biography, see "--Directors of New Valero."
Mr. Benninger: for biography, see "--Directors of New Valero."
Mr. McLelland was elected Executive Vice President and General Counsel of
Valero in 1989 and had served as Senior Vice President and General Counsel of
Valero since 1981.
Mr. Manning has served as Executive Vice President of New Valero since 1995
and has served in various other capacities with the Refining Business since
1986.
Mr. Kain has served as Senior Vice President of New Valero since 1994 and
has served in various other capacities with the Refining Business since 1982.
Mr. Gibbons was elected Vice President Finance of Valero in 1997; he had
served as Treasurer of Valero since 1992 and in various other capacities with
Valero since 1981.
Mr. King was elected Vice President of Valero in 1997 and has served as
Associate General Counsel since joining Valero in 1993. Prior to joining
Valero, Mr. King was a partner at the law firm of Bracewell & Patterson,
L.L.P., Houston, Texas, where he had been employed since 1985.
59
EXECUTIVE COMPENSATION
All direct and indirect remuneration of all Executive Officers and certain
other executives will be approved by the Compensation Committee and, in the
case of the Chief Executive Officer and President, by the New Valero Board. It
is anticipated that compensation for the Executive Officers and for other
executives will consist principally of base salary, an annual incentive bonus
opportunity and long-term stock-based incentive awards. The following tables
and narrative text discuss the compensation paid by Valero in 1996 to New
Valero's Chief Executive Officer and to the four other most highly compensated
executive officers of New Valero (the "Named Executive Officers") for services
rendered in all capacities to Valero for the last three years. Benefits under
health care, disability, term life insurance, vacation and other plans
available to employees generally are not included herein.
SUMMARY COMPENSATION TABLE (1994--1996)
[Enlarge/Download Table]
ANNUAL COMPENSATION LONG-TERM COMPENSATION
----------------------- --------------------------------
RESTRICTED SECURITIES
STOCK UNDERLYING ALL OTHER
BONUS AWARDS OPTIONS/ LTIP COMPENSATION
NAME AND POSITION(S) YEAR SALARY($) ($)(1) ($)(2) SARS(#) PAYOUTS(3) ($)(4)
-------------------- ---- --------- -------- ---------- ---------- ---------- ------------
William E. Greehey(5)... 1996 $497,337 $670,739 $1,545,362 5,000 $325,000 $928,949
Director, Chairman of 1995 684,540 560,000 431,250 0 0 73,007
the Board and Chief 1994 622,020 0 0 355,300 0 71,664
Executive Officer of
New Valero
F. Joseph Becraft(5).... 1996 $450,030 $ 0 $ 276,250 40,000 $271,138 $ 4,252
Director, President and 1995 266,680 180,000 421,875 120,000 0 4,252
Chief Executive Officer
of New Valero
Edward C. Benninger(5).. 1996 $357,180 $335,370 $ 497,500 25,000 $ 93,698 $ 28,541
Director and President 1995 342,600 210,000 189,750 0 0 27,016
of New Valero 1994 335,040 0 0 125,500 0 27,598
Stan L. McLelland....... 1996 $300,930 $111,812 $ 0 25,000 $ 70,200 $ 25,631
Executive Vice 1995 278,700 162,000 138,000 0 0 23,313
President and General 1994 262,380 0 0 82,600 0 23,836
Counsel of New Valero
E. Baines Manning....... 1996 $253,230 $122,989 $ 0 18,000 $ 58,500 $ 18,758
Executive Vice 1995 231,420 120,000 51,750 0 0 12,468
President of New Valero 1994 216,420 0 0 63,500 0 15,524
George E. Kain.......... 1996 $178,530 $ 55,922 $ 0 5,500 $ 0 $ 11,282
Director, Senior Vice 1995 175,020 72,011 34,250 0 0 9,974
President of New Valero 1994 161,020 0 0 20,911 0 11,002
--------
(1) In 1994, the Named Executive Officers received no bonuses. For 1995, the
Named Executive Officers received bonuses payable 70% in cash and 30% in
Valero Common Stock. For 1996, the Named Executive Officers received
bonuses payable 25% in cash and 75% in Valero Common Stock.
(2) For each Named Executive Officer, the number of restricted shares of
Valero Common Stock ("Restricted Stock") held at December 31, 1996, and
the value thereof, based on the closing market price of the Common Stock
at December 31, 1996, was as follows: Mr. Greehey: 62,073 shares--
$1,776,840; Mr. Benninger: 27,333 shares--$782,407; Mr. McLelland: 5,333
shares--$152,667; Mr. Manning: 2,000 shares--$57,250; and Mr. Kain: 1,333
shares--$38,157.13. Dividends are paid on the Restricted Stock at the same
rate as on unrestricted Valero Common Stock. The 1996 grants of Restricted
Stock to Messrs. Greehey and Benninger will vest upon completion of the
transaction contemplated by the Merger Agreement or, if such
60
transaction is not consummated, would vest in annual increments of 33 1/3%
beginning on the first anniversary of the grant date. Mr. Becraft did not
hold Restricted Stock at December 31, 1996.
(3) Long-Term Incentive Plan ("LTIP") payouts are the number of performance
share awards vested for 1996 multiplied by the market price per share on
the vesting date. For more information see the notes following the table
entitled "Long Term Incentive Plans--Awards in Last Fiscal Year."
(4) Amounts include Valero contributions pursuant to employee stock plans, and
that portion of interest accrued under Valero's Executive Deferred
Compensation Plan which is deemed to be at "above-market" rates under
applicable SEC rules. Messrs. Greehey, Becraft, Benninger, McLelland,
Manning and Kain were allocated $31,460, $10,973, $25,574, $21,074,
$18,758 and $11,282, respectively, as a result of Company contributions to
employee stock plans for 1996, and $9,066, $0, $2,967, $4,557, $0 and $0,
respectively, as a result of "above-market" allocations to the Valero
Executive Deferred Compensation Plan for 1996. Messrs. Becraft, Manning
and Kain do not participate in the Valero Executive Deferred Compensation
Plan. Amounts for Mr. Greehey also include executive insurance policy
premiums with respect to cash value life insurance (not split-dollar life
insurance) in the amount of $13,000 for 1994 and 1995 and $7,583 for 1996;
such amounts for 1996 also include (i) consulting fees ($141,667), Valero
Board fees ($29,833), SERP payments ($278,862) and the interest component
of deferred compensation plan payments ($27,648) made during the period
following his retirement and prior to his reemployment, and (ii) payments
made following his retirement for Valero Excess Thrift Plan balances
($339,617) and unused vacation ($63,213). Payments received during Mr.
Greehey's retirement directly from the Pension Plan (as defined herein)
are excluded.
(5) Mr. Becraft was employed by Valero beginning May 1, 1995, and was elected
President of Valero on January 1, 1996 and Chief Executive Officer of
Valero on June 30, 1996. Mr. Greehey resigned from his position as Chief
Executive Officer of Valero on June 30, 1996. Mr. Becraft resigned from
his positions as President and Chief Executive Officer of Valero on
November 20, 1996, whereupon Mr. Greehey was reappointed Chief Executive
Officer of Valero. At that time, the Board also elected Mr. Benninger
President of Valero.
STOCK OPTION GRANTS AND RELATED INFORMATION
The following table provides further information regarding the grants of
stock options with respect to Valero Common Stock to the Named Executive
Officers.
OPTION/SAR GRANTS IN THE LAST FISCAL YEAR
[Enlarge/Download Table]
NUMBER OF PERCENT OF
SECURITIES TOTAL
UNDERLYING OPTIONS/
OPTIONS/ SARS GRANTED MARKET
SARS TO EMPLOYEES EXERCISE OR PRICE AT GRANT DATE
GRANTED IN FISCAL BASE PRICE GRANT DATE EXPIRATION PRESENT VALUE
NAME (#)(1) YEAR ($/SH) ($/SH) DATE $ (2)
---- ---------- ------------ ----------- ---------- ---------- -------------
William E. Greehey...... 5,000 0.69% $25.3125 $25.3125 07/01/2006 $29,580
F. Joseph Becraft....... 40,000 5.56% 27.5625 27.5625 05/30/2006 259,440
Edward C. Benninger..... 25,000 3.47% 27.5625 27.5625 05/30/2006 162,150
Stan L. McLelland....... 25,000 3.47% 27.5625 27.5625 05/30/2006 162,150
E. Baines Manning....... 18,000 2.50% 27.5625 27.5625 05/30/2006 116,748
George E. Kain.......... 5,500 0.77% 27.5625 27.5625 05/30/2006 35,673
--------
(1) Options granted in 1996 vest (become exercisable and nonforfeitable) in
equal increments over a three-year period from the date of grant. In the
event of a change of control of Valero (including stockholder approval of
the Merger Agreement), such options would also become immediately
exercisable pursuant to provisions
61
of the Valero Executive Stock Incentive Plan (the "Valero ESIP") or of an
executive severance agreement. Under the terms of the Valero ESIP, the
exercise price and tax withholding obligations related to exercise may be
paid by delivery of already owned shares or by offset of the underlying
shares, subject to certain conditions.
(2) A variation of the Black-Scholes option pricing model was used to
determine grant date present value. This model is designed to value
publicly traded options. Options issued under Valero's option plans are
not freely traded, and the exercise of such options is subject to
substantial restrictions. Moreover, the Black-Scholes model does not give
effect to either risk of forfeiture or lack of transferability. The
estimated values under the Black-Scholes model are based on assumptions as
to variables such as interest rates, stock price volatility and future
dividend yield. The estimated grant date present values presented in this
table were calculated using an expected average option term of 3.32 years,
a risk-free rate of return of 6.41%, an average volatility rate of 25.4%
for the options expiring May 30, 2006 and of 25.17% for the options
expiring July 1, 2006 and a dividend yield of 1.88% for the options
expiring May 30, 2006 and 2.04% for the options expiring July 1, 2006. The
actual value of stock options could be zero; realization of any positive
value depends upon the actual future performance of the Valero Common
Stock, the continued employment of the option holder throughout the
vesting period and the timing of the exercise of the option. Accordingly,
the values set forth in this table may not be achieved.
The following table provides information regarding securities underlying
options exercisable with respect to Valero Common Stock at December 31, 1996,
and options exercised during 1996, for the Named Executive Officers:
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION/SAR VALUES
[Enlarge/Download Table]
VALUE OF UNEXERCISED
NUMBER OF SECURITIES IN-THE-MONEY
SHARES UNDERLYING UNEXERCISED OPTIONS/SARS AT
ACQUIRED VALUE OPTIONS/SARS AT FY-END(#) FY-END($)(1)
ON EXERCISE REALIZED ------------------------- -------------------------
NAME (#) ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- -------- ----------- ------------- ----------- -------------
William E. Greehey...... -- -- 510,184 5,000 $4,522,154 $ 15,625
F. Joseph Becraft....... -- -- 160,000 -- 1,167,500 --
Edward C. Benninger..... -- -- 62,472 133,833 364,587 1,031,800
Stan L. McLelland....... -- -- 47,857 96,266 328,157 682,762
E. Baines Manning....... -- -- 38,217 72,833 270,792 524,300
George E. Kain.......... -- -- 19,635 21,500 108,345 151,687
--------
(1) Represents the dollar value obtained by multiplying the number of
unexercised options/SARs by the difference between the stated exercise
price per share of the options/SARs and the average market price per share
of Valero Common Stock on December 31, 1996.
62
The following table provides information regarding long-term incentive
awards made to the Named Executive Officers during 1996:
LONG-TERM INCENTIVE PLANS--AWARDS IN LAST FISCAL YEAR (1)
[Enlarge/Download Table]
ESTIMATED FUTURE PAYOUTS
UNDER NON-STOCK PRICE-
BASED PLANS
--------------------------------
PERFORMANCE
NUMBER OF OR OTHER PERIOD
SHARES, UNITS UNTIL MATURATION THRESHOLD TARGET MAXIMUM
NAME OR OTHER RIGHTS OR PAYOUT (# SHARES) (# SHARES) (# SHARES)
---- --------------- ---------------- ---------- ---------- ----------
William E. Greehey...... 10,000 12/31/96 0 10,000 20,000
10,000 12/31/97 0 10,000 20,000
10,000 12/31/98 0 10,000 20,000
F. Joseph Becraft....... 3,634 12/31/96 0 3,634 7,268
3,633 12/31/97 0 3,633 7,266
3,633 12/31/98 0 3,633 7,266
Edward C. Benninger..... 2,884 12/31/96 0 2,884 5,768
2,883 12/31/97 0 2,883 5,766
2,883 12/31/98 0 2,883 5,766
Stan L. McLelland....... 2,160 12/31/96 0 2,160 4,320
2,160 12/31/97 0 2,160 4,320
2,160 12/31/98 0 2,160 4,320
E. Baines Manning....... 1,800 12/31/96 0 1,800 3,600
1,800 12/31/97 0 1,800 3,600
1,800 12/31/98 0 1,800 3,600
--------
(1) LTIP awards are grants of performance shares ("Performance Shares") made
under the Valero ESIP. Mr. Kain did not receive a LTIP award.
(2) Total shareholder return ("TSR") during a specified "performance period"
was established as the performance measure for determining what portion of
the 1996 Performance Share awards will vest. For purposes of the
Performance Share awards, TSR is measured by dividing the sum of (i) the
net change in the price of a share of Valero's Common Stock between the
beginning of the performance period and the end of the performance period,
and (ii) the total dividends paid on the Valero Common Stock during the
performance period, by (iii) the price of a share of Valero's Common Stock
at the beginning of the performance period. Each 1996 Performance Share
award is subject to vesting in three increments, based upon Valero's TSR
during overlapping three-year periods, with the first such three-year
period for the 1996 grants beginning January 1, 1994 and ending December
31, 1996. At the end of the three-year performance period, Valero's TSR is
compared to the TSR for each company in a target group of approximately 16
companies. Valero and the companies in the target group are then ranked by
quartile. At the end of each performance period, participants earn 0%,
50%, 100% or 150% of the initial grant amount for such period depending
upon whether Valero's TSR is in the last, 3rd, 2nd or 1st quartile of the
target group; 200% will be earned if Valero ranks highest in the group.
Amounts not earned in a given three-year period can be carried forward for
one additional three-year period and up to 100% of the carried amount can
still be earned, depending upon the quartile achieved for such subsequent
period.
RETIREMENT BENEFITS
At or prior to the Time of Distribution, New Valero will become the sponsor
of the Valero Pension Plan ("Pension Plan") and assume all obligations of
Valero with respect to (i) individuals who are retirees at the
63
time of Distribution and (ii) individuals who are or become employees of the
Refining Business. Substantially all employees of New Valero having one year
or more of service with New Valero and/or Valero will be eligible to
participate in the Pension Plan, which is a noncontributory, defined benefit
plan. Prior service with Valero will be fully credited in determining
retirement benefits payable under the Pension Plan upon retirement from New
Valero. The following table shows the estimated annual gross benefits payable
under the Pension Plan, the Valero Supplemental Pension Plan (the
"Supplemental Pension Plan") and SERP upon retirement at age 65, based upon
the assumed compensation levels and years of service indicated and assuming an
election to have payments continue for the benefit of the life of the
participant only.
ESTIMATED ANNUAL PENSION BENEFITS AT AGE 65
[Download Table]
YEARS OF SERVICE
COVERED --------------------------------------------
COMPENSATION 15 20 25 30 35
------------ -------- -------- -------- -------- --------
$ 200,000................... $ 55,000 $ 73,000 $ 92,000 $110,000 $128,000
300,000................... 84,000 112,000 141,000 169,000 197,000
400,000................... 114,000 151,000 189,000 227,000 265,000
500,000................... 143,000 190,000 238,000 286,000 333,000
600,000................... 172,000 229,000 287,000 344,000 401,000
700,000................... 201,000 268,000 336,000 403,000 470,000
800,000................... 231,000 307,000 384,000 461,000 538,000
900,000................... 260,000 346,000 433,000 520,000 606,000
1,000,000................... 289,000 385,000 482,000 578,000 674,000
1,100,000................... 289,000 385,000 482,000 578,000 674,000
1,200,000................... 348,000 463,000 579,000 695,000 811,000
1,300,000................... 377,000 502,000 628,000 754,000 879,000
In addition to the Pension Plan, Valero also maintains (and New Valero will
assume and become the sponsor of) a noncontributory, nonqualified Supplemental
Pension Plan which provides supplemental pension benefits to certain highly
compensated employees to the extent that the pension benefits otherwise
payable to such employees from the Pension Plan would exceed benefits
permitted under applicable regulations to be paid from a tax-qualified defined
benefits plan. Accrued contributions for the 1996 Pension Plan year were
approximately 5.5% of total covered compensation. No contributions were made
to the Supplemental Pension Plan. The Pension Plan (supplemented, as
necessary, by the Supplemental Pension Plan) provides a monthly pension at
normal retirement equal to 1.6% of the participant's average monthly
compensation (based upon the participant's base earnings during the 60
consecutive months of the participant's credited service affording the highest
such average) times the participant's years of credited service, plus .35%
times the product of the participant's years of credited service (maximum 35
years) multiplied by the excess of the participant's average monthly
compensation over the lesser of 1.25 times the monthly average (without
indexing) of the social security wage bases for the 35-year period ending with
the year the participant attains social security retirement age, or the
monthly average of the social security wage base in effect for the year that
the participant retires.
Valero also maintains (and New Valero will assume and become the sponsor of)
the SERP, a non-qualified plan providing additional pension benefits to
certain executive officers and employees. The obligations which will be
assumed by New Valero under the SERP are substantially fully funded through
investments held in the SERP Trust under which Frost National Bank of San
Antonio, N.A., serves as trustee. During 1996 contributions aggregating $9.2
million were made to the SERP Trust.
Compensation for purposes of the Valero Pension Plan and Supplemental
Pension Plan includes only salary as reported in the Summary Compensation
Table and excludes cash bonuses. For purposes of the SERP, the participant's
most highly compensated consecutive 36 months of service during the
participant's last 10 years of employment (rather than 60 months) are
considered, and bonuses are included. Accordingly, the amounts reported in the
Summary Compensation Table under the headings "Salary" and "Bonus" constitute
covered
64
compensation for purposes of the SERP. Pension benefits are not subject to any
deduction for social security or other offset amounts.
Credited years of service for the period ended December 31, 1996 for the
Named Executive Officers in the Summary Compensation Table are as follows: Mr.
Greehey--33 years; Mr. Becraft--6 years; Mr. Benninger--22 years; Mr.
McLelland--18 years; Mr. Manning--10 years; and Mr. Kain--17 years. The
credited service for Mr. Becraft and Mr. McLelland includes five years and two
years service, respectively, credited pursuant to the terms of his employment
by Valero and for which benefits are payable only from the SERP. See "--
Arrangements with Certain Officers and Directors."
DESCRIPTION OF EXECUTIVE BONUS, STOCK INCENTIVE AND STOCK OPTION PLANS
New Valero has adopted an executive incentive bonus plan (the "New Valero
Bonus Plan") under which Executive Officers will have the opportunity to earn
an annual incentive bonus based upon the position of the Executive Officer,
realization by New Valero of financial performance targets approved by the
Compensation Committee and a qualitative evaluation of the individual's
performance. Bonus targets for each eligible executive are expected to be
established based upon compensation levels for similar positions at a
comparator group of companies with which New Valero competes for executive
talent. However, the composition of such comparator group, individual bonus
targets, the quantitative performance factors upon which awards will be based,
individuals eligible to receive awards, evaluations of individual performance
and other matters relating to incentive bonus awards, including any
determination as to whether to pay such awards in cash, in New Valero Common
Stock, or in a combination of cash and stock, will be made by the Compensation
Committee in its discretion. No fixed number of shares of New Valero Common
Stock has been designated for awards under the Bonus Plan.
New Valero has adopted an executive stock incentive plan (the "New Valero
ESIP") authorizing the grant of various stock and stock-related awards to
Executive Officers and other key employees. Awards available under the New
Valero ESIP will include options to purchase shares of New Valero Common
Stock, stock appreciation rights ("SARs"), restricted stock, performance
awards and other stock-based awards. A total of 2,500,000 shares may be issued
under the New Valero ESIP, of which no more than 500,000 shares may be awarded
to any one individual in any year. In addition, New Valero has adopted a stock
option plan (the "New Valero Option Plan") under which an aggregate of
2,000,000 options to purchase New Valero Common Stock can be granted to all
employees and prospective employees of New Valero. In connection with the
Merger, New Valero has agreed that stock options previously granted by Valero
to Valero directors who became directors of New Valero, or to active or former
employees of New Valero, and which are outstanding at the time of Distribution
shall be converted into New Valero options having an initial value equal to
the value of such Valero options. New Valero expects that any such options
outstanding under Valero's Director Option Plan will be converted into options
under the New Valero Director Plan, that options outstanding under Valero's
ESIP will be converted into options under the New Valero ESIP, and that
options outstanding under Valero's other stock option plans would be converted
into options under the New Valero Option Plan. Any such option which, under
the Valero plans, is accompanied by an SAR would be accompanied by an SAR
under the New Valero plan.
Under the terms of the New Valero ESIP and the New Valero Option Plan, the
exercise price of the options granted will not be less than 100% of the fair
market value of the New Valero Common Stock at the date of grant. The exact
terms and conditions of stock options and other awards, including the vesting
provisions and expiration date of any option, would be determined by the
Compensation Committee.
The New Valero Bonus Plan, New Valero ESIP and New Valero Option Plan will
be approved by Valero, as sole stockholder of New Valero, prior to the
Distribution.
DESCRIPTION OF THRIFT PLAN
New Valero will assume and become the sponsor of the Valero Thrift Plan
which is an employee profit sharing plan. Participation in the New Valero
Thrift Plan will be voluntary and will be open to employees of
65
New Valero who were eligible to participate in Valero's Thrift Plan or who
become eligible to participate following the completion of three months of
continuous employment. Participating employees may make a base contribution
from 2% up to 8% of their annual base salary, depending upon months of
contributions by a participant. New Valero intends to make matching
contributions to the New Valero Thrift Plan, with New Valero's contribution
initially expected to aggregate 75% of employee base contributions.
Participants may also make a supplemental contribution to the New Valero
Thrift Plan of up to an additional 10% of their annual base salary which is
not matched by New Valero. In 1989, Valero established the VESOP which was a
leveraged employee stock ownership plan. The VESOP was terminated, debt
associated with the VESOP will be paid prior to the Distribution, and share
balances in employee accounts (excepting employees electing to receive a
distribution or transfer their balances into an individual retirement account)
were transferred to the Valero Thrift Plan.
DESCRIPTION OF OTHER BENEFIT PLANS
New Valero intends to assume and become the sponsor of two deferred
compensation plans previously established by Valero. Under the plans,
employees previously deferred receipt of a portion of their salaries, and are
entitled to receive such deferred amounts, plus interest credited in
accordance with such plans, upon retirement. Valero has previously obtained,
and will assign to New Valero or a trustee, life insurance policies covering
the plan participants, the proceeds of which fund a portion of the plan
obligations. In addition, New Valero intends to establish a non-qualified
trust to which it will further assign such policies in order to fund such
obligations.
New Valero also intends to adopt a flexible benefit plan (including
comprehensive health care, dental and vision care, life, dependent life,
survivor income and long-term disability coverages) which will be available on
the same terms and conditions to employees generally.
ARRANGEMENTS WITH CERTAIN OFFICERS AND DIRECTORS
Valero entered into an employment agreement with Mr. Greehey dated May 16,
1990 which expired on June 9, 1995. The agreement provided that Mr. Greehey
would be entitled to receive certain post-retirement benefits, including
office facilities and secretarial support until age 69, transfer of certain
club memberships, the vesting of previously granted stock option and
restricted stock grants, certain medical and life insurance benefits and the
right to certain supplemental amounts under the SERP. In November 1994, the
Valero Board approved resolutions continuing such post-retirement benefits,
notwithstanding the termination of such agreement. Effective upon Mr.
Greehey's retirement from his positions as President and Chief Executive
Officer in June 1996, the specified post-retirement, benefits were provided to
Mr. Greehey and he was requested to continue to serve as Chairman of the
Board. Valero and Mr. Greehey also entered into a consulting agreement
pursuant to which Mr. Greehey received compensation at the rate of $340,000
per annum for providing general advice and consulting services, as well as
management services for particular projects. Mr. Greehey was reemployed by
Valero on November 21, 1996, and the consulting agreement terminated at that
time. In order to clarify Mr. Greehey's continuing benefit arrangements, the
Valero Board determined that, following Mr. Greehey's ultimate retirement from
active employment, he will continue to be eligible to receive substantially
the same office and secretarial support, medical and life insurance benefits
and supplemental SERP benefits as were provided following his earlier
retirement.
Valero entered into agreements (the "Severance Agreements") with Messrs.
Greehey, Benninger, McLelland and Manning which provide certain payments and
other benefits in the event of their termination of employment under certain
circumstances. The Severance Agreements provide that if the executive leaves
Valero for any reason (other than death, disability or normal retirement)
within two years after a "change of control," the executive will receive a
lump sum cash payment equal to three times, in the cases of Messrs. Greehey
and McLelland, and two times, in the cases of Messrs. Benninger and Manning,
his highest compensation during any consecutive 12-month period in the prior
three years. The executive will also be entitled to accelerated exercise
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of stock options and SARs and accelerated vesting of restricted stock
previously granted. The Severance Agreements also provide for special
retirement benefits if the executive would have qualified for benefits under
the Pension Plan had he remained with Valero for the three-year period
following such termination, for continuance of life and health insurance
coverages and other fringe benefits for such three-year period and for
relocation assistance. Messrs. Greehey, Benninger, McLelland and Manning have
each executed a waiver and agreement with New Valero providing that (i) the
consummation of the transactions contemplated by the Merger Agreement will not
constitute a "change of control" for purposes of such Severance Agreements,
and (ii) New Valero will be deemed a successor of Valero for all purposes of
the Severance Agreements.
In connection with pursuing various strategic alternatives, including the
transactions contemplated by the Merger Agreement, Valero entered into
Management Stability Agreements ("Stability Agreements") and Incentive Bonus
Agreements ("Incentive Agreements") with various key executives, including
Messrs. Gibbons and King. These agreements were intended to assure the
continued availability of such executives in the event of certain transactions
culminating in a "change of control" of Valero and/or a divestiture of one of
Valero's principal businesses. Under the Stability Agreements, in the event an
executive's employment is terminated within two years after a change of
control or divestiture transaction has occurred, and termination is not
voluntary or the result of death, permanent disability, retirement or certain
other defined circumstances, the executive would be entitled to receive a lump
sum cash payment equal to the sum of (i) up to two times the highest annual
compensation paid to such executive during the prior three year period, plus
(ii) in certain cases an amount equal to the executive's average annual
incentive bonus over the prior three years; the continuation of life,
disability and health insurance coverages for two years; and, in certain
cases, relocation assistance. The executives would also be entitled to
accelerated vesting of all previously granted stock options, SARs and
restricted stock. Under the Incentive Agreements, if the executive continues
to be employed by Valero or New Valero and a merger or another qualifying
transaction is accomplished, the executive will be entitled to receive a cash
incentive bonus payment equal to up to one times the executive's highest
annual base salary during the prior three year period. In certain cases, all
of such incentive payment is payable at the closing of the transaction, and,
in certain cases, 60% of such payment is payable at closing and 40% is payable
six months following closing or, under certain circumstances, upon earlier
termination of employment. New Valero intends to assume the continuing
obligations of Valero under the Incentive Agreements to executives who are or
become employees of New Valero. New Valero also intends to enter into
management stability agreements with the same executive officers in
substantially the form of the Stability Agreements.
In connection with Mr. Greehey's then-pending retirement from Valero, in May
1996 the Compensation Committee of the Valero Board approved special
retirement arrangements applicable to Messrs. Benninger and McLelland. Under
these arrangements, upon their ultimate retirement, Messrs. Benninger and
McLelland would each receive eight supplemental retirement "points," to be
divided between age and credited service in such proportions as each shall
elect at the time of retirement. In addition, for the year in which he retires
each such executive will be entitled to a prorated executive incentive bonus
and tax preparation services. Each such executive would also be entitled to
accelerated vesting of all previously granted stock options and Restricted
Stock, and Mr. Benninger's existing club membership would be transferred to
him without cost.
COMPENSATION COMMITTEE INTERLOCKS
AND INSIDER PARTICIPATION
The Compensation Committee of the Valero Board is, and the Compensation
Committee of the New Valero Board will be, comprised exclusively of directors
who are not and have never been Valero or New Valero employees. No Valero or
New Valero Executive Officer serves on the Valero Compensation Committee, or
will serve on the New Valero Compensation Committee, or serves as a director
of another company for which any member of either Compensation Committee
serves as a director or executive officer.
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TRANSACTIONS WITH MANAGEMENT
Valero invested, through its wholly owned subsidiary Valero Coal Company
("Coal"), approximately $9.7 million in a program to drill coal seam gas wells
in New Mexico. In order to share the drilling and other risks inherent in this
project, various officers and employees of Valero and/or New Valero were
permitted to invest as general partners in a partnership to which Coal's
interest was assigned. The Valero Board determined in 1992 that this
transaction was fair to Valero. During 1992 and 1993, Messrs. Greehey,
Benninger, McLelland and Manning invested approximately $207,000, $52,000,
$156,000 and $104,000, respectively, to acquire interests of 2.0%, .50%, 1.5%
and 1.0%, respectively, in the project. No additional investments were made by
these executive officers during 1994 or 1996. During 1995, a company owned by
Mr. Manning purchased an additional .25% interest in the project from another
investor. During 1996, Messrs. Greehey, Benninger, McLelland and Manning
(including the company owned by Mr. Manning) received cash distributions of
$45,680, $11,420, $34,260 and $28,550, respectively, attributable to their
investments. Additionally, all investors in the project may be eligible to
utilize certain federal income tax credits applicable to the project. In
connection with the Distribution, Coal will become a wholly owned subsidiary
of New Valero.
Except as disclosed herein, no Executive Officer or director of New Valero
has been indebted to Valero or New Valero, or has acquired a material interest
in any transaction to which Valero or New Valero is a party, during the last
fiscal year.
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SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
All of the outstanding New Valero Common Stock is currently held by Valero.
To the best knowledge of New Valero, the following table sets forth projected
New Valero Common Stock ownership information with respect to each of the New
Valero directors, Named Executive Officers and all New Valero directors and
Executive Officers as a group and with respect to each person who is projected
to own 5% or more of the New Valero Common Stock immediately after the
Distribution. Such projections are based on the anticipated distribution of
one share of New Valero Common Stock for every one share of Valero Common
Stock beneficially owned by such parties as of the Distribution Record Date
(including shares of New Valero Common Stock held in the New Valero Thrift
Plan for accounts of the Executive Officers). Except with respect to Salomon,
ownership information of 5% holders is as of December 31, 1996 and is based
solely upon statements on Schedule 13G filed by such entity with the SEC with
respect to their ownership of Valero Common Stock as of such date. Ownership
information with respect to Salomon is based solely upon the shares of Valero
Common Stock issued in the Basis Acquisition. Ownership information for the
New Valero directors, Executive Officers and all New Valero directors and
Executive Officers as a group is based on each individual's estimated
ownership of Valero Common Stock as of March 30, 1997. Such information has
been furnished to New Valero by such persons and cannot be independently
verified by New Valero.
[Download Table]
SHARES
SHARES UNDER PROJECTED
NAME AND ADDRESS BENEFICIALLY EXERCISABLE PERCENT
OF BENEFICIAL OWNER (1)(2)(3) OWNED(4) OPTIONS(5) OF CLASS(2)
----------------------------- ------------ ----------- -----------
Franklin Resources, Inc.(6)............ 6,366,167 11.4%
777 Mariners Island Blvd.
San Mateo, CA 94404
Merrill Lynch & Co., Inc.(7)........... 4,160,610 7.4%
World Financial Center, North Tower
250 Vessey Street
New York, NY 10281
Frost National Bank of................. 4,027,492 7.2%
San Antonio, N.A.(8)
100 West Houston Street
San Antonio, TX 78205
Salomon Inc(9)......................... 3,429,796 6.1%
Seven World Trade Center
New York, NY 10048
The Capital Group Companies, Inc.(10).. 3,292,700 5.9%
75 State Street
Boston, MA 02109
Wellington Management Company(11)...... 2,841,946 5.1%
75 State Street
Boston, MA 02109
F. Joseph Becraft...................... 0 0 *
Edward C. Benninger.................... 114,247 75,139 *
Ronald K. Calgaard..................... 2,142 1,667 *
Robert G. Dettmer(12).................. 5,877 3,000 *
Ruben M. Escobedo(13).................. 3,094 3,000 *
William E. Greehey..................... 369,861 478,184 1.5%
James L. Johnson....................... 3,852 3,000 *
George E. Kain......................... 33,893 20,569 *
Lowell H. Lebermann.................... 2,244 3,000 *
E. Baines Manning...................... 47,959 43,750 *
Stan L. McLelland...................... 93,596 56,524 *
Susan Kaufman Purcell.................. 2,289 3,000 *
All Executive Officers and directors as
a group, including the persons named
above (14 persons)(14)................ 688,602 720,456 2.5%
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--------
* Indicates that the percentage of beneficial ownership does not exceed 1%
of the class.
(1) The business address for all beneficial owners listed above who are
directors or Executive Officers of New Valero is 530 McCullough Avenue,
San Antonio, Texas 78215.
(2) For directors and Executive Officers, the calculation for Percent of
Class includes shares listed under the captions "Shares Beneficially
Owned" and "Shares Under Exercisable Options."
(3) For directors and Executive Officers includes shares allocated pursuant
to various Valero employee stock plans available to Valero employees
generally (collectively, the "Employee Stock Plans"), as well as shares
granted under Valero's Restricted Stock Bonus and Incentive Stock Plan
(the "Restricted Stock Plan"), the Valero ESIP and Valero's Non-employee
Director Restricted Stock Plan. Except as otherwise noted, each person
named in the table, and each other executive officer, has sole power to
vote or direct the vote of all such shares beneficially owned by him or
her. Except as otherwise noted, each person named in the table, and each
other executive officer, has sole power to dispose or direct the
disposition of shares beneficially owned by him or her.
(4) Does not include shares that could be acquired under options, which
information is set forth in the second column.
(5) Includes shares subject to options that are exercisable within 60 days
from February 1, 1997. Such shares may not be voted unless the options
are exercised. Options that may become exercisable within such 60 day
period only in the event of a change of control of Valero are excluded.
None of the current directors or Executive Officers of New Valero holds
any right to acquire New Valero Common Stock except through exercise of
stock options or vesting of Performance Shares.
(6) Franklin Resources, Inc. has reported that it and certain of its
shareholders and subsidiaries have sole voting power with respect to
5,960,170 shares, shared voting power with respect to 459,997 shares and
shared dispositive power with respect to 6,366,167 shares.
(7) Merrill Lynch & Co., Inc. has reported that it has shared voting power
with respect to 4,160,610 shares while certain of its subsidiaries have
shared voting power and shared dispositive power with respect to up to
4,160,610 shares.
(8) Frost National Bank of San Antonio, N.A. has reported that it has shared
voting and dispositive power with respect to 4,027,492 shares in its
capacity as Trustee for the Valero Thrift Plan, ESOP, VESOP, Valero
Benefits Trust and SERP Trust.
(9) Salomon Inc acquired 3,429,796 shares on May 1, 1997, in connection with
the Basis Acquisition.
(10) The Capital Group Companies, Inc. has reported that it and certain
investment management subsidiaries have sole voting power with respect to
600 shares and sole dispositive power with respect to 3,292,700 shares.
One such subsidiary, Capital Research and Management Company, has also
reported that it has sole dispositive power with respect to 2,823,180 of
such shares.
(11) Wellington Management Company, LLP has reported that it has shared
dispositive power with respect to 2,841,946 shares and shared voting
power with respect to 126,099 shares. Its affiliate, Vanguard/Windsor
Fund, Inc., has reported shared dispositive power with respect to
2,688,100 of such shares.
(12) Includes shares held by spouse.
(13) Includes shares held by spouse and shares held in a trust.
(14) Certain officers of New Valero not designated as Executive Officers by
the New Valero Board do not perform the duties of Executive Officers and
are not classified as "Executive Officers" for purposes of this
Prospectus.
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DESCRIPTION OF NEW VALERO CAPITAL STOCK
The following description of certain material terms of New Valero capital
stock does not purport to be complete and is qualified in its entirety by
reference to the New Valero Certificate, the New Valero By-laws and the Rights
Agreement to be entered into by New Valero and Harris Trust and Savings Bank,
as rights agent (the "New Valero Rights Agreement"), as well as by applicable
statutory or other law.
AUTHORIZED CAPITAL STOCK
The total number of shares of all classes of stock that New Valero will have
authority to issue under the New Valero Certificate will be 170 million, of
which 150 million will be shares of New Valero Common Stock and 20 million
will be shares of $0.01 par value preferred stock ("New Valero Preferred
Stock"). No shares of New Valero Preferred Stock will be issued in connection
with the Distribution. All of the shares of New Valero Common Stock issued in
the Distribution will be validly issued, fully paid and nonassessable.
NEW VALERO COMMON STOCK
The holders of New Valero Common Stock will be entitled to one vote for each
share held of record on the applicable record date on all matters voted on by
stockholders, except with regard to the election of directors and except as
otherwise required by law or provided in any resolution adopted by the New
Valero Board with respect to any shares of New Valero Preferred Stock. The New
Valero Certificate does not provide for cumulative voting in the election of
directors or any preemptive rights to purchase or subscribe to any securities
of New Valero of any kind or class except as the New Valero Board in its
discretion may determine. Subject to any preferential rights of any
outstanding series of New Valero Preferred Stock created by the New Valero
Board from time to time, the holders of New Valero Common Stock on the
applicable record date will be entitled to such dividends as may be declared
from time to time by the New Valero Board from funds available therefor, and
upon liquidation will be entitled to receive pro rata all assets of New Valero
available for distribution to such holders. See "Risk Factors--New Valero
Dividend Policy" and "The Distribution--Manner of Effecting the Distribution."
The New Valero Certificate, New Valero By-laws and Rights Agreement contain
certain provisions which may have the effect of discouraging certain types of
transactions that involve an actual or threatened change of control of New
Valero. See "--New Valero Purchase Rights" and "Anti-Takeover Effects of
Certain Provisions."
NEW VALERO PREFERRED STOCK
The New Valero Board has the authority to issue shares of New Valero
preferred stock in one or more series and to fix, by resolution, the voting
powers, which may be full or limited or no voting powers, designations,
preferreds and relative, participating, optional or other special rights and
the qualifications, limitations or restrictions thereof, including liquidation
preferreds, dividend rates, conversion rights and redemption provisions of the
shares constituting any series, without any further vote or action by the
stockholders. Any shares of New Valero Preferred Stock so authorized and
issued could have priority over the New Valero Common Stock with respect to
dividend and/or liquidation rights.
NEW VALERO PURCHASE RIGHTS
The New Valero Board will declare a dividend distribution of one Right for
each outstanding share of New Valero Common Stock to be distributed to Valero
stockholders pursuant to the Distribution. Except as set forth below, each
Right will entitle the registered holder to purchase from New Valero one one-
hundredth of a share of New Valero Junior Participating Preferred Stock,
Series I, ("Junior Preferred Stock") at a price of $100 per one one-hundredth
of a share, subject to adjustment (the "Purchase Price"). The description and
terms of the Rights will be set forth in the New Valero Rights Agreement.
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Until the earlier to occur of (i) 10 days following a public announcement
that a person or group of affiliated or associated persons (an "Acquiring
Person") has acquired beneficial ownership of 15% or more of the outstanding
shares of New Valero Common Stock or (ii) 10 business days (or such later date
as may be determined by action of the New Valero Board prior to such time as
any person or group becomes an Acquiring Person) following the commencement
of, or announcement of an intention to make, a tender offer or exchange offer
the consummation of which would result in the beneficial ownership by a person
or group of 15% or more of such outstanding New Valero Common Stock (the
earlier of such dates being called the "Rights Separation Date").
The New Valero Rights Agreement provides that, until the Rights Separation
Date (or earlier redemption or expiration of the Rights), the Rights will be
transferred with and only with the New Valero Common Stock. As soon as
practicable following the Rights Separation Date, separate certificates
evidencing the Rights (the "Right Certificates") will be mailed to holders of
record of the New Valero Common Stock as of the close of business on the
Rights Separation Date and such separate Right Certificates alone will
evidence the Rights.
The Rights are not exercisable until the Rights Separation Date. The Rights
will expire on June 30, 2007 (the "Final Expiration Date"), unless the Final
Expiration Date is extended or unless the Rights are earlier redeemed or
exchanged by New Valero, in each case, as described below.
The Purchase Price payable, and the number of shares of Junior Preferred
Stock or other securities or property issuable, upon exercise of the Rights
will be subject to adjustment from time to time to prevent dilution (i) in the
event of a stock dividend on, or a subdivision, combination or
reclassification of, the shares of Junior Preferred Stock, (ii) upon the grant
to holders of shares of Junior Preferred Stock of certain rights or warrants
to subscribe for or purchase shares of Junior Preferred Stock at a price, or
securities convertible into shares of Junior Preferred Stock with a conversion
price, less than the then current market price of shares of Junior Preferred
Stock or (iii) upon the distribution to holders of shares of Junior Preferred
Stock of evidences of indebtedness or assets (excluding regular periodic cash
dividends paid out of earnings or retained earnings or dividends payable in
shares of Junior Preferred Stock or of subscription rights or warrants (other
than those referred to above).
The number of outstanding Rights and the number of one one-hundredths of a
share of Junior Preferred Stock issuable upon exercise of each Right are also
subject to adjustment in the event of a stock split of the New Valero Common
Stock or a stock dividend on the New Valero Common Stock payable in New Valero
Common Stock or subdivisions, consolidations or combinations of the New Valero
Common Stock occurring, in any such case, prior to the Rights Separation Date.
Shares of Junior Preferred Stock purchasable upon exercise of the Rights
will not be redeemable. Each share of Junior Preferred Stock will be entitled
to a minimum preferential quarterly dividend payment of $1 per share but will
be entitled to an aggregate dividend of 100 times the dividend declared per
share of New Valero Common Stock. In the event of liquidation, the holders of
shares of Junior Preferred Stock will be entitled to a minimum preferential
liquidation payment of $100 per share but will be entitled to an aggregate
payment of 100 times the payment made per share of New Valero Common Stock.
Each share of Junior Preferred Stock will have 100 votes, voting together with
the New Valero Common Stock. Finally, in the event of any merger,
consolidation or other transaction in which New Valero Common Stock is
exchanged, each share of Junior Preferred Stock will be entitled to receive
100 times the amount received per share of New Valero Common Stock. These
rights will be protected by customary antidilution provisions.
Because of the nature of the Junior Preferred Stock's dividend, liquidation
and voting rights, the value of the one one-hundredth interest in a share of
Junior Preferred Stock purchasable upon exercise of each Right should
approximate the value of one share of New Valero Common Stock.
In the event that after the Rights Separation Date, New Valero is acquired
in a merger or other business combination transaction, or if 50% or more of
its consolidated assets or earning power are sold, proper provision will be
made so that each holder of a Right will thereafter have the right to receive,
upon the exercise thereof at
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the then current exercise price of the Right, that number of shares of common
stock of the acquiring company which at the time of such transaction will have
a market value of two times the exercise price of the Right. In the event that
any person or group of affiliated or associated persons becomes the beneficial
owner of 15% or more of the outstanding New Valero Common Stock, proper
provision shall be made so that each holder of a Right, other than Rights
beneficially owned by the Acquiring Person (which will thereafter be void),
will thereafter have the right to receive upon exercise that number of shares
of New Valero Common Stock having a market value of two times the exercise
price of the Right.
At any time after the acquisition by a person or group of affiliated or
associated persons of beneficial ownership of 15% or more of the outstanding
New Valero Common Stock and prior to the acquisition by such person or group
of 50% or more of the outstanding New Valero Common Stock, the New Valero
Board may exchange the Rights (other than Rights owned by such person or group
which have become void), in whole or in part, at an exchange ratio of one
share of New Valero Common Stock, or one one-hundredth of a share of Junior
Preferred Stock (or of a share of a class or series of New Valero Preferred
Stock having equivalent rights, preferreds and privileges), per Right (subject
to adjustment).
With certain exceptions, no adjustment in the Purchase Price will be
required until cumulative adjustments require an adjustment of at least 1% in
such Purchase Price. No fractional shares of Junior Preferred Stock will be
issued (other than fractions which are integral multiples of one one-hundredth
of a share of Junior Preferred Stock, which may, at the election of New
Valero, be evidenced by depositary receipts) and in lieu thereof, an
adjustment in cash will be made based on the market price of shares of Junior
Preferred Stock on the last trading day prior to the date of exercise.
At any time prior to the acquisition by a person or group of affiliated or
associated persons of beneficial ownership of 15% or more of the outstanding
New Valero Common Stock, the New Valero Board may redeem the Rights in whole,
but not in part, at a price of $.01 per Right (the "Redemption Price"). The
redemption of the Rights may be made effective at such time on such basis and
with such conditions as the New Valero Board, in its sole discretion, may
establish. Immediately upon any redemption of the Rights, the right to
exercise the Rights will terminate and the only right of the holders of Rights
will be to receive the Redemption Price.
The terms of the Rights may be amended by the New Valero Board without the
consent of the holders of the Rights, including an amendment to lower certain
thresholds described above to not less than the greater of (i) the sum of
.001% and the largest percentage of the outstanding New Valero Common Stock
then known to New Valero to be beneficially owned by any person or group of
affiliated or associated persons and (ii) 10%, except that from and after such
time as any person becomes an Acquiring Person no such amendment may adversely
affect the interests of the holders of the Rights.
Until a Right is exercised, the holder thereof, as such, will have no rights
as a stockholder of New Valero, including, without limitation, the right to
vote or to receive dividends.
The Rights may have certain anti-takeover effects. The Rights will cause
substantial dilution to a person or group that attempts to acquire New Valero
on terms not approved by the New Valero Board, except pursuant to an offer
conditioned on a substantial number of Rights being acquired. The Rights
should not interfere with any merger or other business combination approved by
the New Valero Board since the Rights may be redeemed by New Valero at the
Redemption Price prior to the time that a person or group has acquired
beneficial ownership of 15% or more of the New Valero Common Stock.
The foregoing summary of certain terms of the Rights is qualified in its
entirety by reference to the New Valero Rights Agreement, a form of which is
filed as an exhibit to the New Valero Registration Statement.
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ANTI-TAKEOVER EFFECTS OF CERTAIN PROVISIONS
The New Valero Certificate, the New Valero By-laws, the New Valero Rights
Agreement and the DGCL contain certain provisions that could have the effect
of delaying, deferring or preventing a change in control of New Valero by
various means such as a tender offer or merger not approved by the New Valero
Board. These provisions are designed to enable the New Valero Board,
particularly in the initial years of New Valero's existence as an independent,
publicly owned company, to develop New Valero's business in a manner that will
foster its long-term growth without the potential disruption that might be
entailed by the threat of a takeover not deemed by the New Valero Board to be
in the best interests of New Valero and its stockholders.
The description set forth below is intended as a summary of these provisions
only and is qualified in its entirety by reference to such provisions. Copies
of the New Valero Certificate and the New Valero By-laws are filed as exhibits
to the New Valero Registration Statement, of which this Prospectus is a part.
LIMITATIONS ON CHANGES IN BOARD COMPOSITION AND OTHER ACTIONS BY STOCKHOLDERS
The New Valero By-laws provide that, except as otherwise fixed pursuant to
the provisions of the New Valero Certificate relating to the rights of the
holders of any class or series of stock having a preference over the New
Valero Common Stock as to dividends or upon liquidation to elect additional
directors under specified circumstances, the number of directors will be fixed
by the New Valero Board, but will consist of no less than five and no more
than 13 directors (initially the New Valero Board will be comprised of eight
directors). The New Valero Certificate requires the New Valero Board to be
divided into Class I, Class II and Class III directors, with each class
serving a staggered three-year term. At the Time of Distribution, the size of
the New Valero Board is expected to be set at eight members and is expected to
be divided into two Class I, three Class II and three Class III directors. As
a result, at least two annual meetings of stockholders may be required for
stockholders to change a majority of the directors, whether or not a majority
of New Valero's stockholders believes that such a change would be desirable.
See "Management--Directors of New Valero."
The New Valero Certificate provides that, subject to the rights of holders
of any series of New Valero Preferred Stock to elect additional directors
under specific circumstances, any director may be removed from office at any
time, but only for cause and only by the affirmative vote of the holders of at
least 60% of the voting power of the then outstanding voting stock of New
Valero. Consistent with the provisions of the DGCL, the New Valero By-laws
provide that any vacancy in the New Valero Board, including any vacancies
resulting from an increase in the number of directors, will be filled by a
majority of the directors then in office, although less than a quorum.
Under the New Valero By-laws, only individuals who are nominated by or at
the direction of the New Valero Board, or by a stockholder who has given
notice in accordance therewith, which requires notice not later than the close
of business on the 60th day nor earlier than the close of business on the 90th
day prior to the first anniversary of the preceding year's annual meeting
(provided, however, that in the event that the date of the annual meeting is
more than 30 days before or more than 60 days after such anniversary date,
notice by the stockholder to be timely must be delivered not earlier than the
close of business on the 90th day prior to such annual meeting and not later
than the close of business on the later of the 60th day prior to such annual
meeting or the 10th day following the day on which public announcement of the
date of such meeting is first made by New Valero), will be eligible for
election as directors at that meeting. The New Valero By-laws also establish
such advance notice procedure with regard to other matters which any
stockholder may desire to be brought before any meeting of stockholders. See
"Stockholder Proposals."
The DGCL provides that special meetings of stockholders may be called by the
board of directors or by such person or persons as may be authorized by a
corporation's certificate of incorporation or by-laws. The New Valero By-laws
provide that special meetings of New Valero's stockholders may be called only
by the Chief Executive Officer of New Valero or by a majority of the directors
which New Valero would have if there were no vacancies. The New Valero By-laws
provide that the notice of special meeting will include a statement of the
purpose or purposes for which the special meeting is called and that only such
business will be conducted at a special meeting as was brought before the
meeting pursuant to the notice of meeting.
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Under the DGCL, unless otherwise provided in the corporation's certificate
of incorporation, stockholders may take action without a meeting without prior
notice and without a vote, upon the written consent of stockholders having not
less than the minimum number of votes that would be necessary to authorize the
proposed action at a meeting at which all shares entitled to vote were present
and voted. The New Valero Certificate provides that action can be taken by
stockholders only at a meeting of stockholders and that stockholder action by
written consent is prohibited.
The provisions of the New Valero Certificate and the New Valero By-laws with
respect to the classification of directors, the advance notice requirements
for director nominations or other proposals of stockholders and the
limitations on the ability of stockholders to increase the size of the board,
remove directors, fill vacancies, and act by written consent, will have the
effect of making it more difficult for stockholders to change the composition
of the New Valero Board or otherwise to bring a matter before stockholders
without the New Valero Board's consent, and thus will reduce the vulnerability
of New Valero to an unsolicited takeover proposal.
PREFERRED AND COMMON STOCK
The New Valero Certificate authorizes the New Valero Board to establish one
or more series of New Valero Preferred Stock and to determine, with respect to
any series of New Valero Preferred Stock, the voting powers, full or limited,
or no voting powers, and such designations, preferreds and relative,
participating, optional or other special rights and such qualifications,
limitations or restrictions thereof as are stated in the resolutions of the
New Valero Board providing for such series. In addition, the New Valero
Certificate authorizes the New Valero Board to issue up to approximately 89
million additional shares of New Valero Common Stock after the Distribution
(in addition to shares reserved for outstanding options or other benefit
plans). The number of authorized but unissued shares will provide New Valero
with the ability to meet future capital needs and to provide shares for
possible acquisitions and stock dividends or stock splits.
New Valero believes that the New Valero Preferred Stock will provide New
Valero with increased flexibility in structuring possible future financings
and acquisitions, and in meeting other corporate needs that might arise.
Having such authorized shares available for issuance will allow New Valero to
issue shares of New Valero Preferred Stock without the expense and delay of a
special stockholders' meeting. The authorized and unissued shares of preferred
stock, as well as the authorized and unissued shares of New Valero Common
Stock, will be available for issuance without further action by stockholders,
unless such action is otherwise required by applicable law. Although the New
Valero Board has no intention at the present time of doing so, it could issue
a series of New Valero Preferred Stock that could, subject to certain
limitations imposed by the law, depending on the terms of such series, impede
the completion of a merger, tender offer or other takeover attempt. The New
Valero Board will make any determination to issue such shares based on its
judgment as to the best interests of New Valero and its then-existing
stockholders at the time of the issuance. The New Valero Board, in so acting,
could issue preferred stock having terms which could discourage an acquisition
attempt or other transaction that some, or a majority, of the stockholders
might believe to be in their best interests or in which stockholders might
receive a premium for their stock over the then market price of such stock.
AMENDMENT OF CERTAIN PROVISIONS OF THE NEW VALERO CERTIFICATE AND NEW VALERO
BY-LAWS
The DGCL provides that a Delaware corporation's certificate of incorporation
may be amended by the affirmative vote of a majority of the outstanding stock
entitled to vote thereon and a majority of the outstanding stock of each class
entitled to vote thereon as a class. Amendment of the provisions of the New
Valero Certificate relating to the inability of stockholders to act by written
consent, the removal of directors, the classification of the New Valero Board
and the ability of stockholders to amend the New Valero By-laws requires 80%
of the voting power of the then outstanding voting stock, voting together as a
single class. The New Valero Certificate and the New Valero By-laws provide
that the New Valero By-laws may be amended by the New Valero Board by a
majority vote of the New Valero Board or by the stockholders by a vote of at
least 80% of the voting stock of New Valero.
75
RIGHTS
The New Valero Rights Agreement to be adopted by the New Valero Board, as
described above, will permit disinterested stockholders to acquire shares of
New Valero Common Stock or common stock of an acquiring company at a
substantial discount in the event of certain described changes in control. See
"Description of New Valero Capital Stock--New Valero Purchase Rights."
MANAGEMENT STABILITY AGREEMENTS; OTHER SEVERANCE ARRANGEMENTS
New Valero has entered into certain Severance Agreements, Stability
Agreements and Incentive Agreements with its Executive Officers and other key
management employees providing severance compensation and continuation of
benefits in the event of termination following a change in control of New
Valero, with the amount of payments to be received being dependent upon the
voluntary or involuntary nature of such termination. See "Executive
Compensation--Arrangements With Certain Officers and Directors."
BUSINESS COMBINATIONS
The New Valero Certificate provides that certain "business combinations" (as
defined in the New Valero Certificate) must be approved by the holders of at
least 66 2/3% of the voting power of the shares of New Valero Common Stock not
owned by an "interested stockholder" (as defined in the New Valero Certificate,
the beneficial owner of 15% of the outstanding voting stock), unless the
business combination is approved by the "Continuing Directors" (as defined in
the New Valero Certificate) or meet certain requirements regarding price and
procedure.
STATUTORY PROVISIONS
New Valero is subject to Section 203 of the DGCL ("Section 203"), which may
make it more difficult for there to be a change in control of New Valero or for
New Valero to enter into certain business combinations than if New Valero were
not subject to such section.
Section 203 provides that, subject to certain exceptions specified therein, a
corporation shall not engage in any "business combination" with any "interested
stockholder" for a three-year period following the time that such stockholder
becomes an interested stockholder unless (i) prior to such time, the board of
directors of the corporation approved either the business combination or the
transaction which resulted in the stockholder becoming an interested
stockholder, (ii) upon consummation of the transaction which resulted in the
stockholder becoming an interested stockholder, the interested stockholder
owned at least 85% of the voting stock of the corporation outstanding at the
time the transaction commenced (excluding certain shares) or (iii) on or
subsequent to such time, the business combination is approved by the board of
directors of the corporation and by the affirmative vote of at least 66 2/3% of
the outstanding voting stock which is not owned by the interested stockholder.
Section 203 generally defines an "interested stockholder" to include (x) any
person that is the owner of 15% or more of the outstanding voting stock of the
corporation, or is an affiliate or associate of the corporation and was the
owner of 15% or more of the outstanding voting stock of the corporation at any
time within three years immediately prior to the relevant date and (y) the
affiliates and associates of any such person. Section 203 generally defines a
"business combination" to include (i) mergers and sales or other dispositions
of 10% or more of the assets of the corporation with or to an interested
stockholder, (ii) certain transactions resulting in the issuance or transfer to
the interested stockholder of any stock of the corporation or its subsidiaries,
(iii) certain transactions which would result in increasing the proportionate
share of the stock of the corporation or its subsidiaries owned by the
interested stockholder and (iv) receipt by the interested stockholder of the
benefit (except proportionately as a stockholder) of any loans, advances,
guarantees, pledges, or other financial benefits.
Under certain circumstances, Section 203 makes it more difficult for a person
who would be an "interested stockholder" to effect various business
combinations with a corporation for a three-year period, although the
certificate of incorporation or stockholder-adopted by-laws may exclude a
corporation from the restrictions imposed thereunder. Neither the New Valero
Certificate nor the New Valero By-laws exclude New Valero from the restrictions
imposed under Section 203. It is anticipated that the provisions of Section 203
may encourage
76
companies interested in acquiring New Valero to negotiate in advance with the
New Valero Board since the stockholder approval requirement would be avoided
if the New Valero Board approves, prior to the time the stockholder becomes an
interested stockholder, either the business combination or the transaction
which results in the stockholder becoming an interested stockholder.
VALIDITY OF SECURITIES
The validity of the shares of New Valero Common Stock and Rights to be
issued in connection with the Distribution will be passed upon for New Valero
by Morris, Nichols, Arsht & Tunnell.
EXPERTS
The consolidated financial statements of Valero as of December 31, 1996 and
1995 and for each of the three years in the period ended December 31, 1996,
included in this Prospectus have been audited by Arthur Andersen LLP,
independent public accountants, as set forth in their report with respect
thereto, and are included herein in reliance upon the authority of said firm
as experts in accounting and auditing in giving said reports.
The financial statements of Basis as of December 31, 1996 and 1995, and for
each of the years in the three-year period ended December 31, 1996, included
in this Prospectus, have been audited by Arthur Andersen LLP, independent
public accountants, as indicated in their report with respect thereto which is
included herein. The financial statements audited by Arthur Andersen LLP have
been included herein in reliance upon the authority of said firm as experts in
accounting and auditing in giving said reports.
The New Valero Board expects to appoint Arthur Andersen LLP as New Valero's
independent public accountants to audit New Valero's financial statements as
of and for the year ended December 31, 1997.
STOCKHOLDER PROPOSALS
Section 9 of the New Valero By-laws, filed as an exhibit to the New Valero
Registration Statement of which this Prospectus is a part, sets forth advance
notice requirements applicable to stockholders desiring to nominate candidates
for directors or to present a proposal or bring other business before an
annual meeting of stockholders of New Valero. In each case, the notice must be
given to the Corporate Secretary of New Valero whose address is 530
McCullough, San Antonio, Texas 78215. The New Valero 1998 Annual Meeting of
Stockholders is expected to be held on or around April 30, 1998. To be
considered, notice of any such nomination or proposal must be received between
January 30, 1998 and March 1, 1998. To be included in New Valero's proxy
statement and form of proxy for that meeting, any such nomination or proposal
must also comply in all respects with the rules and regulations of the SEC and
must be received by the Corporate Secretary of New Valero within the time
period specified therein.
77
INDEX OF DEFINED TERMS
[Download Table]
PAGE
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2-1-1 crack spread....................................................... 40
3-2-1 crack spread....................................................... 51
85-15 clean fuels crack spread........................................... 51
Acquiring Person......................................................... 72
Ancillary Agreements..................................................... 15
Average Price............................................................ 27
Basis.................................................................... 1, 14
Basis Acquisition........................................................ 4, 14
BPD...................................................................... 42
CARB II.................................................................. 42
Cash Dividend............................................................ 23
Clean Air Act............................................................ 45
Coal..................................................................... 68
Code..................................................................... 17
Company.................................................................. 30
Competitive Business..................................................... 24
Consent.................................................................. 25
Conversion Ratio......................................................... 26
Convertible Preferred Stock.............................................. 21
crack spread............................................................. 37
DGCL..................................................................... 17
Director Option Plan..................................................... 58
Director Plan............................................................ 58
Director Stock........................................................... 58
Distribution............................................................. 14
Distribution Agent....................................................... 21
Distribution Agreement................................................... 15
Distribution Record Date................................................. 14
Effective Time........................................................... 18
Employee Benefits Agreement.............................................. 15
Employee Stock Plans..................................................... 70
EPA...................................................................... 36, 53
ESOP..................................................................... 28
Executive Officers....................................................... 59
FAR...................................................................... 51
FCC Unit................................................................. 49
FERC..................................................................... 30
Final Expiration Date.................................................... 72
HDS Unit................................................................. 34
HOC...................................................................... 44
Hydrocracker............................................................. 46
Incentive Agreements..................................................... 67
Indemnifiable Losses..................................................... 25
Intercorporate Reorganization............................................ 14
Interim Services Agreement............................................... 15
IRBs..................................................................... 8, 25
Javelina................................................................. 37
Junior Preferred Stock................................................... 71
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LTIP..................................................................... 61
Medium-Term Notes........................................................ 33
Merger................................................................... 14
Merger Agreement......................................................... 14
Merger Sub............................................................... 14
Methanol Plant........................................................... 47
Mbbls.................................................................... 32
MMcf..................................................................... 32
Mcf...................................................................... 32
MTBE..................................................................... 33
MTBE Plant............................................................... 34
MTBE/TAME Unit........................................................... 47
Named Executive Officers................................................. 60
Natural Gas Business..................................................... 2, 15
New Credit Facility...................................................... 23
New Valero............................................................... i, 14
New Valero Board......................................................... 17
New Valero Bonus Plan.................................................... 65
New Valero By-laws....................................................... 17
New Valero Certificate................................................... 17
New Valero Common Stock.................................................. 14
New Valero ESIP.......................................................... 65
New Valero Group......................................................... 23
New Valero Option Plan................................................... 65
New Valero Pension Plan.................................................. 27
New Valero Preferred Stock............................................... 71
New Valero Registration Statement........................................ 13, 22
New Valero Rights Agreement.............................................. 71
New Valero Thrift Plan................................................... 27
NGL...................................................................... 30
NOV...................................................................... 53
NYSE..................................................................... 14
oxygenates............................................................... 50
Partnership.............................................................. 31
Pension Plan............................................................. 63
Performance Shares....................................................... 63
Performing Party......................................................... 29
PG&E Corp................................................................ 14
PG&E Corp. Common Stock.................................................. 14
Pro Forma Financial Statements........................................... 4
Prospectus............................................................... 14
Proxy Statement-Prospectus............................................... 14
Purchase Price........................................................... 71
Recapitalization......................................................... 4
Receiving Party.......................................................... 29
Redemption Price......................................................... 73
Refinery................................................................. 34
Refining Business........................................................ 2, 15
78
[Download Table]
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reformate................................................................ 46
Reformer................................................................. 46
Refunding Bonds.......................................................... 43
Reorganization Tax....................................................... 26
resid.................................................................... 19
Residfiner............................................................... 42
Restricted Stock......................................................... 60
Restricted Stock Plan.................................................... 70
Retained Subsidiary...................................................... 23
Retirement Plan.......................................................... 59
RFG...................................................................... 34
Right.................................................................... 14
Right Certificates....................................................... 72
Rights Separation Date................................................... 72
ROSE Unit................................................................ 42
Salomon.................................................................. 4, 14
SARs..................................................................... 26, 65
SEC...................................................................... 13
Section 203.............................................................. 76
Securities Act........................................................... 22
SERP..................................................................... 27
SERP Trust............................................................... 27
Severance Agreements..................................................... 66
Stability Agreements..................................................... 67
Supplemental Pension Plan................................................ 64
TAME..................................................................... 47
Tax Opinions............................................................. 14
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Tax Sharing Agreement..................................................... 15
Teco...................................................................... 52
Thrift Plan Transfers..................................................... 27
Time of Distribution...................................................... 14
TNRCC..................................................................... 51
Transactions.............................................................. 14
truck rack sale........................................................... 47
TSR....................................................................... 63
Valero.................................................................... i, 14
Valero Board.............................................................. 14
Valero Common Stock....................................................... 14
Valero Excess Thrift Plan................................................. 27
Valero ESIP............................................................... 62
Valero Group.............................................................. 23
Valero Guarantees......................................................... 23
Valero Option............................................................. 26
Valero Supplemental Retirement Plan....................................... 27
Valero Thrift Plan........................................................ 27
VESOP..................................................................... 28
VNGP, L.P. ............................................................... 31
VNGP Merger............................................................... 31
WACOG..................................................................... 35
WTI....................................................................... 40
when-issued............................................................... 27
Xylene Unit............................................................... 47
79
INDEX TO FINANCIAL INFORMATION
[Download Table]
Consolidated Financial Statements--Valero Energy Corporation:*
Report of Independent Public Accountants................................. F-2
Consolidated Balance Sheets.............................................. F-3
Consolidated Statements of Income........................................ F-4
Consolidated Statements of Common Stock and Other Stockholders' Equity... F-5
Consolidated Statements of Cash Flows.................................... F-6
Notes to Consolidated Financial Statements............................... F-7
Consolidated Financial Statements--Basis Petroleum, Inc.:
Report of Independent Public Accountants................................. F-33
Consolidated Balance Sheets.............................................. F-34
Consolidated Statements of Operations.................................... F-35
Consolidated Statements of Stockholders' Equity.......................... F-36
Consolidated Statements of Cash Flows.................................... F-37
Notes to Consolidated Financial Statements............................... F-38
--------
* For financial reporting purposes under the federal securities laws, New
Valero is a "successor registrant" to Valero. As a result, the historical
financial information included herein is the historical financial information
of Valero.
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of Valero Energy Corporation:
We have audited the accompanying consolidated balance sheets of Valero
Energy Corporation (a Delaware corporation) and subsidiaries as of December
31, 1996 and 1995, and the related consolidated statements of income, common
stock and other stockholders' equity and cash flows for each of the three
years in the period ended December 31, 1996. These financial statements are
the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
As explained in Note 1 to the financial statements, the Company has restated
its consolidated balance sheets as of December 31, 1996 and 1995, its
consolidated statements of common stock and other stockholders' equity for
each of the three years in the period ended December 31, 1996, and its
consolidated statements of income and cash flows for the year ended December
31, 1994, to change the accounting for a contingency which was recorded in
conjunction with the acquisition of Valero Natural Gas Partners, L.P. in May
of 1994.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Valero Energy Corporation
and subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the three years in the period
ended December 31, 1996, in conformity with generally accepted accounting
principles.
Arthur Andersen LLP
San Antonio, Texas
February 14, 1997 (except with
respect to the matters discussed
in Notes 1, 2 and 3, as to which
the date is May 9, 1997)
F-2
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(THOUSANDS OF DOLLARS)
[Enlarge/Download Table]
DECEMBER 31,
----------------------
1996 1995
---------- ----------
ASSETS
CURRENT ASSETS:
Cash and temporary cash investments.......................................... $ 19,847 $ 28,054
Cash held in debt service escrow............................................. 37,746 36,627
Receivables, less allowance for doubtful accounts of $1,624 (1996) and $1,193
(1995)...................................................................... 566,088 339,189
Inventories.................................................................. 212,134 140,822
Current deferred income tax assets........................................... 22,408 29,530
Prepaid expenses and other................................................... 29,946 47,321
---------- ----------
888,169 621,543
---------- ----------
PROPERTY, PLANT AND EQUIPMENT--including construction in progress of $45,824
(1996) and $37,472 (1995), at cost............................................ 2,787,431 2,682,694
Less: Accumulated depreciation............................................... 708,352 622,123
---------- ----------
2,079,079 2,060,571
---------- ----------
INVESTMENT IN AND ADVANCES TO JOINT VENTURES................................... 29,192 41,890
---------- ----------
DEFERRED CHARGES AND OTHER ASSETS.............................................. 138,334 137,876
---------- ----------
$3,134,774 $2,861,880
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Short-term debt.............................................................. $ 82,000 $ --
Current maturities of long-term debt......................................... 72,341 81,964
Accounts payable............................................................. 661,273 312,672
Accrued interest............................................................. 20,082 31,104
Other accrued expenses....................................................... 39,458 42,542
---------- ----------
875,154 468,282
---------- ----------
LONG-TERM DEBT, less current maturities........................................ 868,300 1,035,641
---------- ----------
DEFERRED INCOME TAXES.......................................................... 279,938 270,813
---------- ----------
DEFERRED CREDITS AND OTHER LIABILITIES......................................... 34,407 56,031
---------- ----------
REDEEMABLE PREFERRED STOCK, SERIES A, issued 1,150,000 shares, outstanding
11,500 (1996) and 69,000 (1995) shares........................................ 1,150 6,900
---------- ----------
COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY:
Preferred stock, $1 par value--20,000,000 shares authorized including
redeemable preferred shares:
$3.125 Convertible Preferred Stock, issued and outstanding 3,450,000
(1996 and 1995) shares ($172,500 aggregate involuntary liquidation value).. 3,450 3,450
Common stock, $1 par value--75,000,000 shares authorized; issued 44,185,513
(1996) and 43,739,380 (1995) shares......................................... 44,186 43,739
Additional paid-in capital................................................... 540,133 530,177
Unearned Valero Employees' Stock Ownership Plan Compensation................. (8,783) (11,318)
Retained earnings............................................................ 496,839 458,343
Treasury stock, -0- (1996) and 6,904 (1995) common shares, at cost........... -- (178)
---------- ----------
1,075,825 1,024,213
---------- ----------
$3,134,774 $2,861,880
========== ==========
See Notes to Consolidated Financial Statements.
F-3
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
[Download Table]
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
OPERATING REVENUES........................ $4,990,681 $3,197,872 $1,837,440
---------- ---------- ----------
COSTS AND EXPENSES:
Cost of sales and operating expenses.... 4,606,320 2,830,636 1,561,225
Selling and administrative expenses..... 81,665 78,120 66,258
Depreciation expense.................... 101,787 100,325 84,032
---------- ---------- ----------
Total................................. 4,789,772 3,009,081 1,711,515
---------- ---------- ----------
OPERATING INCOME.......................... 200,909 188,791 125,925
EQUITY IN EARNINGS (LOSSES) OF AND INCOME
FROM:
Valero Natural Gas Partners, L.P........ -- -- (10,698)
Joint ventures.......................... 3,899 4,827 2,437
LOSS ON INVESTMENT IN PROESA JOINT
VENTURE.................................. (19,549) -- --
(PROVISION FOR) REVERSAL OF ACQUISITION
EXPENSE ACCRUAL.......................... 18,698 (2,506) (16,192)
OTHER INCOME, NET......................... 4,921 5,248 3,431
INTEREST AND DEBT EXPENSE:
Incurred................................ (99,505) (105,921) (79,286)
Capitalized............................. 4,328 4,699 2,365
---------- ---------- ----------
INCOME BEFORE INCOME TAXES................ 113,701 95,138 27,982
INCOME TAX EXPENSE........................ 41,000 35,300 10,700
---------- ---------- ----------
NET INCOME................................ 72,701 59,838 17,282
Less: Preferred stock dividend
requirements........................... 11,327 11,818 9,490
---------- ---------- ----------
NET INCOME APPLICABLE TO COMMON STOCK..... $ 61,374 $ 48,020 $ 7,792
========== ========== ==========
EARNINGS PER SHARE OF COMMON STOCK........ $ 1.40 $ 1.10 $ .18
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
(in thousands)........................... 43,926 43,652 43,370
DIVIDENDS PER SHARE OF COMMON STOCK....... $ .52 $ .52 $ .52
See Notes to Consolidated Financial Statements.
F-4
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY
(THOUSANDS OF DOLLARS)
[Enlarge/Download Table]
CONVERTIBLE
PREFERRED NUMBER OF COMMON ADDITIONAL UNEARNED
STOCK COMMON STOCK PAID-IN VESOP RETAINED TREASURY
$1 PAR SHARES $1 PAR CAPITAL COMPENSATION EARNINGS STOCK
----------- ---------- ------- ---------- ------------ -------- --------
BALANCE, December 31,
1993................... $ -- 43,391,685 $43,392 $371,303 $(15,958) $446,931 $(3,371)
Net income.............. -- -- -- -- -- 17,282 --
Dividends on Series A
Preferred Stock........ -- -- -- -- -- (1,173) --
Dividends on Convertible
Preferred Stock........ -- -- -- -- -- (7,427) --
Dividends on Common
Stock.................. -- -- -- -- -- (22,554) --
Issuance of Convertible
Preferred Stock, net... 3,450 -- -- 164,428 -- -- --
Unearned Valero
Employees' Stock
Ownership Plan
compensation........... -- -- -- -- 2,252 -- --
Shares repurchased and
shares issued pursuant
to employee stock plans
and other.............. -- 72,184 72 882 -- -- 3,371
------ ---------- ------- -------- -------- -------- -------
BALANCE, December 31,
1994................... 3,450 43,463,869 43,464 536,613 (13,706) 433,059 --
Net income.............. -- -- -- -- -- 59,838 --
Dividends on Series A
Preferred Stock........ -- -- -- -- -- (1,075) --
Dividends on Convertible
Preferred Stock........ -- -- -- -- -- (10,781) --
Dividends on Common
Stock.................. -- -- -- -- -- (22,698) --
Unearned Valero
Employees' Stock
Ownership Plan
compensation........... -- -- -- -- 2,388 -- --
Deficiency payment tax
effect................. -- -- -- (9,106) -- -- --
Shares repurchased and
shares issued pursuant
to employee stock plans
and other.............. -- 275,511 275 2,670 -- -- (178)
------ ---------- ------- -------- -------- -------- -------
BALANCE, December 31,
1995................... 3,450 43,739,380 43,739 530,177 (11,318) 458,343 (178)
Net income.............. -- -- -- -- -- 72,701 --
Dividends on Series A
Preferred Stock........ -- -- -- -- -- (587) --
Dividends on Convertible
Preferred Stock........ -- -- -- -- -- (10,781) --
Dividends on Common
Stock.................. -- -- -- -- -- (22,837) --
Unearned Valero
Employees' Stock
Ownership Plan
compensation........... -- -- -- -- 2,535 -- --
Shares repurchased and
shares issued pursuant
to employee stock plans
and other.............. -- 446,133 447 9,956 -- -- 178
------ ---------- ------- -------- -------- -------- -------
BALANCE, December 31,
1996................... $3,450 44,185,513 $44,186 $540,133 $ (8,783) $496,839 $ --
====== ========== ======= ======== ======== ======== =======
See Notes to Consolidated Financial Statements.
F-5
VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(THOUSANDS OF DOLLARS)
[Download Table]
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................. $ 72,701 $ 59,838 $ 17,282
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense...................... 101,787 100,325 84,032
Loss on investment in Proesa joint
venture.................................. 19,549 -- --
Provision for (reversal of) acquisition
expense accrual.......................... (18,698) 2,506 16,192
Amortization of deferred charges and
other, net............................... 32,458 32,352 19,452
Changes in current assets and current
liabilities.............................. 50,232 (31,636) (95,597)
Deferred income tax expense............... 20,000 4,700 7,000
Equity in (earnings) losses in excess of
distributions:
Valero Natural Gas Partners, L.P. ...... -- -- 16,179
Joint ventures.......................... (3,899) (4,304) (2,437)
Changes in deferred items and other, net.. 1,671 (7,959) 6,008
--------- --------- ---------
Net cash provided by operating
activities............................. 275,801 155,822 68,111
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures........................ (128,453) (124,619) (80,738)
Deferred turnaround and catalyst costs...... (36,389) (35,590) (21,999)
Investment in and advances to joint
ventures, net.............................. 1,197 (2,018) (9,229)
Investment in Valero Natural Gas Partners,
L.P. ...................................... -- -- (124,264)
Assets leased to Valero Natural Gas
Partners, L.P. ............................ -- -- (1,886)
Distributions from Valero Natural Gas
Partners, L.P. ............................ -- -- 2,789
Dispositions of property, plant and
equipment.................................. 6,834 13,531 4,504
Other, net.................................. 637 70 898
--------- --------- ---------
Net cash used in investing activities..... (156,174) (148,626) (229,925)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in short-term debt, net............ 82,000 -- --
Long-term borrowings........................ 65,000 508,500 574,100
Long-term debt reduction.................... (240,229) (473,357) (509,385)
Increase in cash held in debt service escrow
for principal.............................. (1,875) (1,875) (22,768)
Common stock dividends...................... (22,837) (22,698) (22,554)
Preferred stock dividends................... (11,368) (11,856) (8,600)
Issuance of Convertible Preferred Stock,
net........................................ -- -- 167,878
Issuance of common stock.................... 11,225 6,129 4,178
Purchases of treasury stock................. (4,000) (4,445) (927)
Repurchase of Series A Preferred Stock...... (5,750) (5,750) (1,150)
--------- --------- ---------
Net cash provided by (used in) financing
activities............................... (127,834) (5,352) 180,772
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND TEMPORARY
CASH INVESTMENTS............................. (8,207) 1,844 18,958
CASH AND TEMPORARY CASH INVESTMENTS AT
BEGINNING OF PERIOD.......................... 28,054 26,210 7,252
--------- --------- ---------
CASH AND TEMPORARY CASH INVESTMENTS AT END OF
PERIOD....................................... $ 19,847 $ 28,054 $ 26,210
========= ========= =========
See Notes to Consolidated Financial Statements.
F-6
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Presentation
The accompanying consolidated financial statements include the accounts of
Valero Energy Corporation ("Energy") and subsidiaries (collectively referred
to herein as the "Company"). All significant intercompany transactions have
been eliminated in consolidation. Certain prior period amounts have been
reclassified for comparative purposes.
Energy conducts its refining and marketing operations through its wholly
owned subsidiary, Valero Refining and Marketing Company ("VRMC"), and VRMC's
operating subsidiaries (collectively referred to herein as "Refining"). Prior
to and including May 31, 1994, the Company accounted for its effective equity
interest of approximately 49% in Valero Natural Gas Partners, L.P. ("VNGP,
L.P.") and VNGP, L.P.'s consolidated subsidiaries, including Valero Management
Partnership, L.P. (the "Management Partnership") and various subsidiary
operating partnerships ("Subsidiary Operating Partnerships") (collectively
referred to herein as the "Partnership") using the equity method of
accounting. Effective May 31, 1994, the Company acquired through a merger the
remaining effective equity interest of approximately 51% in the Partnership
and changed the method of accounting for its investment in the Partnership to
the consolidation method (see Note 3).
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Revenue Recognition
Revenues generally are recorded when services have been provided or products
have been delivered. Changes in the fair value of financial instruments
related to trading activities are recognized in income currently. See "Price
Risk Management Activities" below.
Price Risk Management Activities
The Company enters into various exchange-traded and over-the-counter
financial instrument contracts with third parties to hedge the purchase costs
and sales prices of inventories, operating margins and certain anticipated
transactions. Such contracts are designated at inception as a hedge where
there is a direct relationship to the price risk associated with the Company's
inventories or future purchases and sales of commodities used in the Company's
operations. Hedges of inventories are accounted for under the deferral method
with gains and losses included in the carrying amounts of inventories and
ultimately recognized in cost of sales as those inventories are sold. Hedges
of anticipated transactions are also accounted for under the deferral method
with gains and losses on these transactions recognized in cost of sales when
the hedged transaction occurs. Gains and losses on early terminations of
financial instrument contracts designated as hedges are deferred and included
in cost of sales in the measurement of the hedged transaction. Certain of the
Company's hedging activities could tend to reduce the Company's participation
in rising margins but are intended to limit the Company's exposure to loss
during periods of declining margins.
The Company also enters into various exchange-traded and over-the-counter
financial instrument contracts with third parties for trading purposes.
Contracts entered into for trading purposes are accounted for under the fair
value method. Changes in the fair value of these contracts are recognized as
gains or losses in cost of sales currently and are recorded in the
Consolidated Balance Sheets in "Prepaid expenses and other" and "Accounts
payable" at fair value at the reporting date. The Company determines the fair
value of its exchange-traded contracts based on the settlement prices for open
contracts, which are established by the exchange on which the
F-7
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
instruments are traded. The fair value of the Company's over-the-counter
contracts is determined based on market-related indexes or by obtaining quotes
from brokers. See Note 6.
Inventories
The Company owns a specialized petroleum refinery (the "Refinery") in Corpus
Christi, Texas. Refinery feedstocks and refined products and blendstocks are
carried at the lower of cost or market, with the cost of feedstocks and
produced products determined primarily under the last-in, first-out ("LIFO")
method of inventory pricing and the cost of products purchased for resale
determined under the weighted average cost method. The excess of the
replacement cost of the Company's LIFO inventories over their LIFO values was
approximately $51 million at December 31, 1996. Natural gas in underground
storage, natural gas liquids ("NGLs") and materials and supplies are carried
principally at weighted average cost not in excess of market. Inventories as
of December 31, 1996 and 1995 were as follows (in thousands) (see Note 6):
[Download Table]
DECEMBER 31,
-----------------
1996 1995
-------- --------
Refinery feedstocks..................................... $ 42,744 $ 48,295
Refined products and blendstocks........................ 99,398 41,967
Natural gas in underground storage...................... 40,609 31,156
NGLs.................................................... 5,190 3,280
Materials and supplies.................................. 24,193 16,124
-------- --------
$212,134 $140,822
======== ========
Refinery feedstock and refined product and blendstock inventory volumes
totalled 7.4 million barrels ("MMbbls") and 6.2 MMbbls as of December 31, 1996
and 1995, respectively. Natural gas inventory volumes totalled approximately
10 billion cubic feet ("Bcf") and 11.7 Bcf as of December 31, 1996 and 1995,
respectively.
Prepaid Expenses and Other
Prepaid expenses and other as of December 31, 1996 and 1995 were as follows
(in thousands):
[Download Table]
DECEMBER 31,
---------------
1996 1995
------- -------
Commodity deposits and deferrals (see Note 6)............. $18,914 $34,553
Prepaid insurance......................................... 6,737 8,663
Prepaid benefits expense.................................. 2,794 2,187
Other..................................................... 1,501 1,918
------- -------
$29,946 $47,321
======= =======
Property, Plant and Equipment
Property additions and betterments include capitalized interest, and
acquisition and administrative costs allocable to construction and property
purchases.
The costs of minor property units (or components of property units), net of
salvage, retired or abandoned are charged or credited to accumulated
depreciation under the composite method of depreciation. Gains or losses on
sales or other dispositions of major units of property are credited or charged
to income.
F-8
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Major classes of property, plant and equipment as of December 31, 1996 and
1995 were as follows (in thousands):
[Download Table]
DECEMBER 31,
---------------------
1996 1995
---------- ----------
Refining and marketing--processing facilities...... $1,634,430 $1,596,832
Natural gas related services--transmission,
gathering, processing and storage facilities...... 988,234 945,408
Other.............................................. 118,943 102,982
Construction in progress........................... 45,824 37,472
---------- ----------
$2,787,431 $2,682,694
========== ==========
Provision for depreciation of property, plant and equipment is made
primarily on a straight-line basis over the estimated useful lives of the
depreciable facilities. During early 1996, a detailed study of the Company's
fixed asset lives was completed by a third-party consultant for the majority
of the Company's refining and marketing and natural gas related services
assets. As a result of such study, effective January 1, 1996, the Company
adjusted the weighted-average remaining lives of the assets subject to the
study, utilizing the composite method of depreciation, to better reflect the
estimated periods during which such assets are expected to remain in service.
The effect of this change in accounting estimate on depreciation expense for
1996 was insignificant. A summary of the principal rates used in computing the
annual provision for depreciation, primarily utilizing the composite method
and including estimated salvage values, is as follows:
[Download Table]
WEIGHTED
RANGE AVERAGE
--------- --------
Refining and marketing--processing facilities......... 3.6%-4.9% 4.4%
Natural gas related services--transmission, gathering,
processing and storage facilities.................... 4.3%-5.3% 4.7%
Other................................................. 6%-45% 25.3%
Deferred Charges
Deferred Gas Costs
Payments made or agreed to be made in connection with the settlement of
certain disputed contractual issues with natural gas suppliers are initially
deferred. The balance of deferred gas costs included in noncurrent other
assets was $26 million as of December 31, 1996. Such amount is expected to be
recovered over the next five years through natural gas sales rates charged to
certain customers.
Catalyst and Refinery Turnaround Costs
Catalyst costs are deferred when incurred and amortized over the estimated
useful life of that catalyst, normally one to three years. Refinery turnaround
costs are deferred when incurred and amortized over that period of time
estimated to lapse until the next turnaround occurs.
Other Deferred Charges
Other deferred charges consist of technological royalties and licenses,
contract costs, debt issuance costs, and certain other costs. Technological
royalties and licenses are amortized over the estimated useful life of each
particular related asset. Contract costs are amortized over the term of the
related contract. Debt issuance costs are amortized by the effective interest
method over the estimated life of each instrument or facility.
F-9
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Other Accrued Expenses
Other accrued expenses as of December 31, 1996 and 1995 were as follows (in
thousands):
[Download Table]
DECEMBER 31,
---------------
1996 1995
------- -------
Accrued taxes............................................. $19,633 $16,433
Other accrued employee benefit costs (see Note 13)........ 8,688 11,047
Current portion of accrued pension cost (see Note 13)..... 4,265 4,695
Accrued lease expense..................................... 3,006 4,566
Other..................................................... 3,866 5,801
------- -------
$39,458 $42,542
======= =======
Fair Value of Financial Instruments
The carrying amounts of the Company's financial instruments approximate fair
value, except for long-term debt and certain financial instruments used in
price risk management activities. See Notes 5 and 6.
Earnings Per Share
Earnings per share of common stock were computed, after recognition of
preferred stock dividend requirements, based on the weighted average number of
common shares outstanding during each year. For the years ended December 31,
1996, 1995 and 1994, the conversion of the Convertible Preferred Stock (see
Note 9) is not assumed since its effect would be antidilutive. Potentially
dilutive common stock equivalents were not material and therefore were also
not included in the computation. The weighted average number of common shares
outstanding for the years ended December 31, 1996, 1995 and 1994 was
43,926,026, 43,651,914 and 43,369,836, respectively.
Statements of Cash Flows
In order to determine net cash provided by operating activities, net income
has been adjusted by, among other things, changes in current assets and
current liabilities, excluding changes in cash and temporary cash investments,
cash held in debt service escrow for principal, current deferred income tax
assets, short-term debt and current maturities of long-term debt. Also
excluded are the Partnership's current assets and liabilities as of the
acquisition date (see Note 3). The changes in the Company's current assets and
current liabilities, excluding the items noted above, are shown in the
following table as an (increase) decrease in current assets and an increase
(decrease) in current liabilities. The Company's temporary cash investments
are highly liquid, low-risk debt instruments which have a maturity of three
months or less when acquired. (Dollars in thousands.)
[Download Table]
YEAR ENDED DECEMBER 31,
------------------------------
1996 1995 1994
--------- --------- --------
Cash held in debt service escrow for
interest................................. $ 756 $ 689 $(12,673)
Receivables, net.......................... (226,899) (106,916) (64,150)
Inventories............................... (71,312) 41,267 (21,785)
Prepaid expenses and other................ 17,375 (22,304) 142
Accounts payable.......................... 344,418 38,825 (4,295)
Accrued interest.......................... (11,022) 11,411 3,901
Other accrued expenses.................... (3,084) 5,392 3,263
--------- --------- --------
Total................................. $ 50,232 $ (31,636) $(95,597)
========= ========= ========
F-10
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table provides information related to cash interest and income
taxes paid by the Company for the periods indicated (in thousands):
[Download Table]
YEAR ENDED DECEMBER 31,
------------------------
1996 1995 1994
-------- ------- -------
Interest--net of amount capitalized of $4,328
(1996), $4,699 (1995) and $2,365 (1994)......... $105,519 $86,553 $72,023
Income taxes..................................... 19,043 23,935 3,931
Noncash investing activities for 1995 included the reclassification to
"Deferred charges and other assets" of $12.1 million of contract costs,
previously included in "Property, plant and equipment" on the Consolidated
Balance Sheets. Noncash investing activities for 1994 included the accrual of
the remaining $60 million payment made in 1995 for the Company's interest in a
methanol plant renovation project.
Accounting Changes
In June 1996, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," which establishes new accounting and reporting standards for
transfers and servicing of financial assets and extinguishments of
liabilities. The statement is effective for transactions occurring after
December 31, 1996. Based on information currently known by the Company, this
statement will not have a material effect on the Company's consolidated
financial statements.
SFAS No. 123, "Accounting for Stock-Based Compensation," issued by the FASB
in October 1995, encourages, but does not require companies to measure and
recognize in their financial statements a compensation cost for stock-based
employee compensation plans based on the "fair value" method of accounting set
forth in the statement. The Company has chosen to continue to account for its
employee stock compensation plans using the "intrinsic value" method of
accounting set forth in Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees," and related Interpretations.
Accordingly, compensation cost for stock options is measured as the excess, if
any, of the quoted market price of the Company's common stock at the date of
the grant over the amount an employee must pay to acquire the stock. See Note
13 for the pro forma effects on net income and earnings per share had
compensation cost for the Company's stock-based compensation plans been
determined consistent with SFAS No. 123.
Effective January 1, 1996, the Company adopted SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." This statement establishes accounting standards for the impairment of
long-lived assets, certain identifiable intangibles, and goodwill related to
assets to be held and used, and for long-lived assets and certain identifiable
intangibles to be disposed of. This statement is required to be applied
prospectively for assets to be held and used, while its initial application to
assets held for disposal is required to be reported as the cumulative effect
of a change in accounting principle. Since adoption, no impairment losses have
been recognized in the Company's consolidated financial statements. However,
see Note 7 for a discussion of the Company's write-off in the fourth quarter
of 1996 of its equity method investment in its Mexico joint venture project.
Restatement of Financial Information
The Company has restated its financial statements for the years ended
December 31, 1996, 1995 and 1994. This action was taken to change the
accounting for a contingency which was recorded in conjunction with the
acquisition of VNGP, L.P. in May of 1994. For a further discussion of the
nature of the contingency, see Note 3, "Acquisition of Valero Natural Gas
Partners, L.P."
As of the date of the acquisition of VNGP, L.P., the Company's management
believed that it was probable that a liability had been incurred resulting
from the acquisition. Although the specific amount of the contingency
F-11
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
could not be determined as of the date of the acquisition, the Company
believed that the liability would be within a range of amounts that could be
reasonably estimated as of that date. Accordingly, the Company recorded a
liability in the amount of $14.8 million, representing the minimum amount of
the range determined by management. The liability was originally recorded as a
cost of the acquisition. Since the contingency arose as a result of the
acquisition and represented an obligation of the Company rather than an
obligation of VNGP, L.P., the income statement for 1994 has been restated to
charge the acquisition contingency to expense, rather than property, plant,
and equipment, as of the date of the acquisition. As a result of this change,
the balances of property, plant, and equipment, deferred income taxes, and
retained earnings have been restated in the Consolidated Balance Sheets as of
December 31, 1996 and 1995. The impact of this change on the Consolidated
Statement of Income for the year ended December 31, 1994, is summarized below
(dollars in thousands):
[Download Table]
YEAR ENDED
DECEMBER 31, 1994
-----------------
AS AS
REPORTED RESTATED
-------- --------
Income before income taxes................................. $42,782 $27,982
Income tax expense......................................... 15,900 10,700
Net income................................................. 26,882 17,282
Net income applicable to common stock...................... 17,392 7,792
Earnings per share of common stock......................... .40 .18
2. SUBSEQUENT EVENTS
Acquisition of Basis Petroleum, Inc.
The Company and Salomon Inc ("Salomon") have entered into a stock purchase
agreement pursuant to which Valero has acquired the stock of Basis Petroleum,
Inc. ("Basis") from Salomon for $285 million, plus approximately $200 million
for inventories and other working capital. Basis owns and operates three
petroleum refineries located in Texas and Louisiana and markets refined
products. The three refineries have a total crude oil processing capacity of
about 310,000 barrels per day. The acquisition will be accounted for using the
purchase method of accounting. Therefore, the results of operations of Basis
will be included in the consolidated financial statements of the Company
commencing on May 1, 1997. The stock purchase agreement provides for Salomon
to receive up to 10 additional payments following each anniversary date of the
closing of the acquisition. These annual earn-out payments would be based on
the difference between a stated base refining "crack spread" and the
theoretical spread computed using actual average quoted prices, and calculated
using a nominal average annual throughput of 100 million barrels. These
payments are limited to $35 million in any year and $200 million in the
aggregate. Any such participation payments, if made, will be accounted for as
an additional cost of the acquisition of Basis by the Company and will be
depreciated over the remaining lives of the assets to which the additional
cost is allocated. The purchase price was paid, in part, with 3,429,796 shares
of Valero Common Stock having a fair market value of approximately $120
million, with the remainder paid in cash.
Proposed Restructuring
In November 1996, the Company publicly announced that its Board of Directors
had approved a management recommendation to pursue strategic alternatives
involving the Company's principal business activities. Such alternatives
included seeking a strategic alliance for the Company's natural gas related
services business and a spin-off of its petroleum refining and marketing
operations. In response to the Company's solicitation for indications of
interest, a number of companies submitted written proposals to engage in a
strategic alliance with the Company, and the Company invited a final group of
five companies to participate in a more extensive due diligence review. On
January 31, 1997, the Company announced that its Board of Directors had
approved an agreement and plan of merger with PG&E Corporation ("PG&E") to
combine the Company's
F-12
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
natural gas related services business with PG&E following the spin-off of the
Company's refining and marketing business to the Company's shareholders (the
"Restructuring"). Under the terms of the merger agreement, the Company's
natural gas related services business will be merged with a wholly owned
subsidiary of PG&E. PG&E will acquire the Company's natural gas related
services business for approximately $1.5 billion, plus adjustments for working
capital and other considerations. PG&E will issue $722.5 million of common
stock, subject to certain closing adjustments, in exchange for outstanding
shares of Energy's common stock, and will assume approximately $777.5 million
of net debt and other liabilities. Each Energy shareholder will receive a
fractional share of PG&E common stock (trading on the New York Stock Exchange
under the symbol "PCG") for each Energy share; the amount of PG&E stock to be
received will be based on the average price of the PG&E common stock during a
period preceding the closing of the transaction and the number of Energy shares
issued and outstanding at the time of the closing. Energy's shareholders will
also receive one share of the spun-off refining and marketing company for each
share of Energy common stock. The refining and marketing company will retain
the Valero Energy Corporation name and will apply to be listed on the New York
Stock Exchange. The refining and marketing company expects to aggressively
pursue acquisitions and strategic alliances in the refining and marketing
industry. The spin-off of the refining and marketing business and the merger
with PG&E are expected to be tax-free transactions. However, on February 6,
1997, President Clinton's budget recommendations to Congress called for new
legislation that, if enacted, may require Energy to pay federal income tax upon
the consummation of the Restructuring on the amount of gain equal to the excess
of the value of the refining and marketing company stock distributed to
Energy's stockholders over Energy's basis in such stock. The President's
proposal, which has not yet been introduced in Congress, would be effective for
distributions after the date of first committee action. On April 17, 1997, the
Chairs of the House Ways and Means Committee and Senate Finance Committee and
the ranking Democrat on the Finance Committee introduced similar legislation
which, however, would not apply to distributions made pursuant to a written
agreement which was binding on April 16, 1997 and at all times thereafter nor
to distributions announced publicly by that date. It is uncertain whether any
such legislation ultimately will be enacted or what the effective date may be.
PG&E Corp. and Valero believe it is likely that any legislation ultimately
enacted will provide an exemption for transactions like the Distribution and
the Merger for which definitive agreements were executed prior to February 6,
1997. However, if the proposal is enacted or pending prior to the Merger with
an effective date provision that could cause Valero to be so subject to tax,
the Tax Opinions described in the Proxy Statement-Prospectus may not be
available and as a result the Distribution and the Merger may not be
consummated. The Restructuring transactions are subject to approval by the
Company's shareholders, the Securities and Exchange Commission, and certain
regulatory agencies, and receipt of favorable tax opinions. The Company expects
to hold an annual meeting in June 1997 to consider the Restructuring
transactions; such transactions are expected to be completed by mid-1997.
However, there can be no assurance that the various approvals or opinions will
be given or that the conditions to consummating the transactions will be met.
3. ACQUISITION OF VALERO NATURAL GAS PARTNERS, L.P.
In March 1994, Energy issued Convertible Preferred Stock (see Note 9) to fund
the merger of VNGP, L.P. with a wholly owned subsidiary of Energy. On May 31,
1994, the holders of common units of limited partner interests ("Common Units")
of VNGP, L.P. approved the merger. Upon consummation of the merger, VNGP, L.P.
became a wholly owned subsidiary of Energy and the publicly traded Common Units
(the "Public Units") were converted into the right to receive cash in the
amount of $12.10 per Common Unit. The Company utilized $117.5 million of the
net proceeds from the Convertible Preferred Stock issuance to fund the
acquisition of the Public Units. The remaining net proceeds of $50.4 million
were used to reduce outstanding indebtedness under bank credit lines and to pay
expenses of the acquisition. As a result of the merger, all of the outstanding
Common Units are held by the Company.
The merger was accounted for as a purchase and the purchase price was
allocated to the assets acquired and liabilities assumed based on estimated
fair values resulting in part from an independent appraisal of the property,
F-13
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
plant and equipment of the Partnership. The consolidated statements of income
of the Company reflect the Company's effective equity interest of
approximately 49% in the Partnership's operations for periods prior to and
including May 31, 1994, and reflect 100% of the Partnership's operations for
all periods thereafter.
In conjunction with the acquisition of the Partnership by the Company, the
Company recorded in 1994 a $14.8 million loss representing the Company's
estimate of certain costs resulting from the acquisition of the Public Units
of VNGP, L.P. See Note 1 "--Restatement of Financial Information". The reserve
was established as a result of various claims and lawsuits filed against the
Company to block the merger or to increase the price offered by the Company
for the purchase of the outstanding Public Units, and the Company's
determination that it was probable that losses were expected from successful
assertion of claims relative to the acquisition. In late 1996, upon receipt by
the Company of a favorable ruling by the magistrate hearing the sole remaining
lawsuit related to the acquisition (as described in Note 15), the Company
reversed all remaining reserves pertaining to the acquisition.
The following unaudited pro forma financial information of Valero Energy
Corporation and subsidiaries assumes that the above described transactions
occurred for all of 1994. Such pro forma information is not necessarily
indicative of the results of future operations.
[Download Table]
YEAR ENDED
DECEMBER 31, 1994
-------------------------
(THOUSANDS OF DOLLARS,
EXCEPT PER SHARE AMOUNTS)
Operating revenues............................. $2,333,982
Operating income............................... 125,943
Net income..................................... 9,789
Net loss applicable to common stock............ (2,158)
Loss per share of common stock................. (.05)
Prior to the merger, the Company entered into transactions with the
Partnership commensurate with its status as the General Partner. The Company
charged the Partnership a management fee equal to the direct and indirect
costs incurred by it on behalf of the Partnership. In addition, the Company
purchased natural gas and NGLs from the Partnership and sold NGLs to the
Partnership. The Company paid the Partnership a fee for operating certain of
the Company's assets. Also, the Company and the Partnership entered into other
transactions, including certain leasing transactions.
The following table summarizes transactions between the Company and the
Partnership for the five months ended May 31, 1994 (in thousands):
[Download Table]
FIVE MONTHS
ENDED
MAY 31, 1994
------------
NGL purchases and services from the Partnership............... $36,536
Natural gas purchases from the Partnership.................... 9,672
Sales of NGLs and natural gas, and transportation and other
charges to the Partnership................................... 11,385
Management fees billed to the Partnership for direct and
indirect costs............................................... 34,299
Interest income from capital lease transactions............... 5,481
4. SHORT-TERM DEBT
Energy currently maintains nine separate short-term bank lines of credit
totalling $190 million, $82 million of which was outstanding at December 31,
1996 at a weighted average interest rate of 6.81%. Five of these lines are
cancellable on demand, and the others expire at various times in 1997. These
short-term lines bear interest at each respective bank's quoted money market
rate, have no commitment or other fees or compensating balance requirements
and are unsecured and unrestricted as to use.
F-14
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. LONG-TERM DEBT AND BANK CREDIT FACILITIES
Long-term debt balances as of December 31, 1996 and 1995 were as follows (in
thousands):
[Download Table]
DECEMBER 31,
-------------------
1996 1995
-------- ----------
Valero Refining and Marketing Company:
Industrial revenue bonds:
Marine terminal and pollution control revenue bonds,
Series 1987A bonds, 10 1/4%, due June 1, 2017.......... $ 90,000 $ 90,000
Marine terminal revenue bonds, Series 1987B bonds, 10
5/8%, due June 1, 2008................................. 8,500 8,500
Valero Energy Corporation:
$300 million revolving bank credit and letter of credit
facility, 6% at December 31, 1996, due November 1, 2000.. 25,000 120,000
10.58% Senior Notes, due December 30, 2000................ 140,343 187,714
9.14% VESOP Notes, due February 15, 1999 (see Note 13).... 5,083 6,819
Medium-Term Notes......................................... 228,500 228,500
Valero Management Partnership, L.P. First Mortgage Notes.... 443,215 476,072
-------- ----------
Total long-term debt...................................... 940,641 1,117,605
Less current maturities................................... 72,341 81,964
-------- ----------
$868,300 $1,035,641
======== ==========
Energy currently maintains an unsecured $835 million revolving bank credit
and letter of credit facility (which has replaced a prior $300 million
facility) that 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 (inclusive of a facility fee), base
rate or a competitive bid money market rate. The Company is also charged
various fees, including various letter of credit fees. As of December 31,
1996, Energy had approximately $273 million available under the prior bank
credit facility for additional borrowings and letters of credit. Energy also
has $170 million of uncommitted bank letter of credit facilities,
approximately $129 million of which were available as of December 31, 1996 for
additional letters of credit.
In 1992, Energy filed with the Securities and Exchange Commission (the
"Commission") a shelf registration statement which was used to offer $150
million principal amount of Medium-Term Notes, $132 million of which were
outstanding at December 31, 1996. In 1994, Energy filed another shelf
registration statement with the Commission to offer up to $250 million
principal amount of additional debt securities, including Medium-Term Notes,
$96.5 million of which were issued and outstanding at December 31, 1996. As of
December 31, 1996, Energy's outstanding Medium-Term Notes had a remaining
weighted average life of approximately 7.5 years and a weighted average
interest rate of approximately 8.3%. No Medium-Term Notes have been issued
since June 1995 and none are expected to be issued in the future.
The Management Partnership's First Mortgage Notes are currently comprised of
five remaining series due serially from 1997 through 2009, and are secured by
mortgages on and security interests in substantially all of the currently
existing and after-acquired property, plant and equipment of the Management
Partnership and each Subsidiary Operating Partnership and by the Management
Partnership's limited partner interest in each Subsidiary Operating
Partnership (the "Mortgaged Property"). As of December 31, 1996, the First
Mortgage Notes had a remaining weighted average life of approximately 5.5
years and a weighted average interest rate of 10.13% per annum. Interest on
the First Mortgage Notes is payable semiannually, but one-half of each
interest
F-15
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
payment and one-fourth of each annual principal payment are escrowed quarterly
in advance. At December 31, 1996, $37.7 million had been deposited with the
Mortgage Note Indenture trustee ("Trustee") in an escrow account. The amount
on deposit is classified as a current asset (cash held in debt service escrow)
and the liability to be paid off when the cash is released by the Trustee from
escrow is classified as a current liability.
The indenture of mortgage and deed of trust pursuant to which the First
Mortgage Notes were issued (the "Mortgage Note Indenture") contains covenants
prohibiting the Management Partnership and the Subsidiary Operating
Partnerships (collectively referred to herein as the "Operating Partnerships")
from incurring additional indebtedness, including any additional First
Mortgage Notes, other than (i) up to $50 million of indebtedness to be
incurred for working capital purposes (provided that for a period of 45
consecutive days during each 16 consecutive calendar month period no such
indebtedness will be permitted to be outstanding) and (ii) up to the amount of
any future capital improvements financed through the issuance of debt or
equity by VNGP, L.P. and the contribution of such amounts as additional equity
to the Management Partnership. The Mortgage Note Indenture also prohibits the
Operating Partnerships from (a) creating new indebtedness unless certain cash
flow to debt service requirements are met; (b) creating certain liens; or (c)
making cash distributions in any quarter in excess of the cash generated in
the prior quarter, less (i) capital expenditures during such prior quarter
(other than capital expenditures financed with certain permitted
indebtedness), (ii) an amount equal to one-half of the interest to be paid on
the First Mortgage Notes on the interest payment date occurring in or next
following such prior quarter and (iii) an amount equal to one-quarter of the
principal required to be paid on the First Mortgage Notes on the principal
payment date occurring in or next following such prior quarter, plus cash
which could have been distributed in any prior quarter but which was not
distributed. The Operating Partnerships are further prohibited from purchasing
or owning any securities of any person or making loans or capital
contributions to any person other than investments in the Subsidiary Operating
Partnerships, advances and contributions of up to $20 million per year and
$100 million in the aggregate to entities engaged in substantially similar
business activities as the Operating Partnerships, temporary investments in
certain marketable securities and certain other exceptions. The Mortgage Note
Indenture also prohibits the Operating Partnerships from consolidating with or
conveying, selling, leasing or otherwise disposing of all or any material
portion of their property, assets or business as an entirety to any other
person unless the surviving entity meets certain net worth requirements and
certain other conditions are met, or from selling or otherwise disposing of
any part of the Mortgaged Property, subject to certain exceptions.
The Company was in compliance with all covenants contained in its various
debt facilities as of December 31, 1996.
Based on long-term debt outstanding at December 31, 1996, maturities of
long-term debt, including sinking fund requirements and excluding borrowings
under bank credit facilities, for the years ending December 31, 1998 through
2001 are approximately $75 million, $73.2 million, $85.6 million and $94.5
million, respectively. Maturities of long-term debt under Energy's revolving
bank credit and letter of credit facility for the year ended December 31, 2000
are $25 million.
Based on the borrowing rates currently available to the Company for long-
term debt with similar terms and average maturities, the fair value of the
Company's long-term debt, including current maturities, was $1,039 million and
$1,275 million at December 31, 1996 and 1995, respectively.
6. PRICE RISK MANAGEMENT ACTIVITIES
Refining and Marketing Hedging Activities
The Company uses over-the-counter price swaps, options and futures to hedge
refinery feedstock purchases and refined product inventories in order to
reduce the impact of adverse price changes on these inventories before
F-16
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
the conversion of the feedstock to finished products and ultimate sale. Swaps,
options and futures contracts at the end of 1996 and 1995 had remaining terms
of less than one year. As of December 31, 1996 and 1995, 13% and 19%,
respectively, of the Company's refining inventory position was hedged. The
amount of deferred hedge losses included as an increase to refinery
inventories was $.8 million and $1 million as of December 31, 1996 and 1995,
respectively. The following is a summary of the contract amounts and range of
prices of the Company's contracts held or issued to hedge refining inventories
as of December 31, 1996 and 1995:
[Download Table]
1996 1995
--------------------------- ---------------------------
PAYOR RECEIVER PAYOR RECEIVER
------------- ------------- ------------- -------------
SWAPS:
Volumes (Mbbls)... 497 497 -- --
Price (per bbl)... $17.50-$17.57 $17.31-$17.38 -- --
OPTIONS:
Volumes (Mbbls)... -- -- -- 150
Price (per bbl)... -- -- -- $24.36-$24.78
FUTURES:
Volumes (Mbbls)... -- 981 250 1,327
Price (per bbl)... -- $24.87-$29.65 $22.71-$23.83 $17.57-$24.55
The Company also hedges anticipated transactions. Over-the-counter price
swaps, options and futures are used to hedge refining operating margins for
periods up to 12 months by locking in components of the margins, including the
resid discount, the conventional crack spread and the premium product
differentials. As of December 31, 1996 and 1995, less than 2% of the Company's
anticipated 1997 and 1996 refining margin, respectively, were hedged. There
were no significant explicit deferrals of hedging gains or losses related to
these anticipated transactions as of either year end. The following table is a
summary of the contract or notional amounts and range of prices of the
Company's contracts held or issued to hedge refining margins as of December
31, 1996 and 1995. Volumes shown for swaps represent notional volumes which
are used to calculate amounts due under the agreements and do not represent
volumes exchanged.
[Download Table]
1996 1995
--------------------------- -------------
PAYOR RECEIVER RECEIVER
------------- ------------- -------------
SWAPS:
Volumes (Mbbls).................. 6,000 28,300 525
Price (per bbl).................. $.53 -$4.90 $.74-$3.55 $34.23-$35.81
OPTIONS:
Volumes (Mbbls).................. 750 -- --
Price (per bbl).................. $25.00-$32.76 -- --
FUTURES:
Volumes (Mbbls).................. 1,312 1,410 14
Price (per bbl).................. $26.46-$30.87 $21.74-$30.39 $18.95-$19.50
Natural Gas Related Services Hedging Activities
The Company uses futures, price swaps and over-the-counter and exchange-
traded options to hedge gas storage. These financial instrument contracts run
for periods of up to three months. The Company also enters into basis swaps
for location differentials at fixed prices which generally extend for periods
up to three months. As of December 31, 1996 and 1995, 59% and 26%,
respectively, of the Company's natural gas inventory position was hedged. The
amount of deferred hedge gains (losses) included as a reduction (increase) of
natural gas inventories was $(7.8) million and $.9 million as of December 31,
1996 and 1995, respectively. The following is
F-17
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
a summary of the contract or notional amounts and range of prices of the
Company's contracts held or issued to hedge natural gas inventories as of
December 31, 1996 and 1995. Volumes shown for swaps and basis swaps represent
notional volumes which are used to calculate amounts due under the agreements
and do not represent volumes exchanged.
[Download Table]
1996 1995
----------------------- -----------------------
PAYOR RECEIVER PAYOR RECEIVER
----------- ----------- ----------- -----------
SWAPS:
Volumes (MMcf)............. 8,155 9,155 1,000 1,000
Price (per Mcf)............ $3.20-$4.37 $2.72-$4.25 $1.91 $2.87-$3.45
OPTIONS:
Volumes (MMcf)............. 33,290 33,850 12,000 23,000
Price (per Mcf)............ $2.20-$2.60 $2.50-$3.30 $1.90-$2.50 $1.90-$2.50
FUTURES:
Volumes (MMcf)............. 31,710 36,970 17,480 15,430
Price (per Mcf)............ $2.12-$4.57 $2.08-$4.37 $1.77-$3.45 $1.75-$3.45
BASIS SWAPS:
Volumes (MMcf)............. 2,000 4,096 500 2,120
Price (per Mcf)............ $(.16)-$.32 $(.60)-$.19 $.63 $.13-$.85
The Company also uses futures, price swaps and over-the-counter and
exchange-traded options to hedge certain anticipated transactions, including
anticipated natural gas purchase requirements for NGL plant shrinkage and
refining operations, natural gas liquids sales, and commitments to buy and
sell natural gas at fixed prices. These financial instrument contracts extend
through the year 2001. The Company also enters into basis swaps for location
differentials at fixed prices which extend through the year 2001. As of
December 31, 1996 and 1995, 12% and 29%, respectively, of the Company's
anticipated annual NGL plant shrinkage requirements, and 11% and 29%,
respectively, of Refining's anticipated annual natural gas requirements, were
hedged. Explicitly deferred gains from hedges of these anticipated
transactions of $24.4 million and $3.9 million, as of December 31, 1996 and
1995, respectively, will be recognized when the hedged transaction occurs. The
following table is a summary of the contract or notional amounts and range of
prices of the Company's contracts held or issued to hedge anticipated natural
gas purchase requirements for NGL plant shrinkage and refining operations,
natural gas purchase and sales commitments, and anticipated NGL production
volumes as of December 31, 1996 and 1995. Volumes shown for swaps and basis
swaps represent notional volumes which are used to calculate amounts due under
the agreements and do not represent volumes exchanged.
F-18
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
[Enlarge/Download Table]
TOTAL TOTAL
1996 1995
EXPECTED MATURITY DATE BALANCE BALANCE
------------------------------------------------------- --------------------------- -----------------------
1997 1998-2001
--------------------------- ---------------------------
PAYOR RECEIVER PAYOR RECEIVER PAYOR RECEIVER PAYOR RECEIVER
------------- ------------- ------------- ------------ ------------- ------------- ----------- -----------
SWAPS:
Volumes (MMcf).. 28,353 13,327 14,422 -- 42,775 13,327 55,277 26,111
Price (per
Mcf)........... $1.54-$4.55 $1.65-$4.25 $2.06 -- $1.54-$4.55 $1.65-$4.25 $1.31-$3.45 $1.71-$4.34
Volumes
(Mbbls)........ 3,080 980 -- -- 3,080 980 -- --
Price (per
bbl)........... $9.35-$28.77 $10.71-$20.37 -- -- $9.35-$28.77 $10.71-$20.37 -- --
OPTIONS:
Volumes (MMcf).. 26,565 21,195 -- -- 26,565 21,195 10,340 9,073
Price (per
Mcf)........... $1.66-$3.50 $1.61-$4.00 -- -- $1.66-$3.50 $1.61 -$4.00 $1.66-$3.25 $1.50-$2.45
Volumes
(Mbbls)........ 75 975 -- -- 75 975 -- --
Price (per
bbl)........... $17.43 $14.07-$16.80 -- -- $17.43 $14.07-$16.80 -- --
FUTURES:
Volumes (MMcf).. 90,810 82,200 740 -- 91,550 82,200 105,020 52,680
Price (per
Mcf)........... $1.72-$4.57 $1.75 -$4.56 $2.35 -$2.51 -- $1.72-$4.57 $1.75-$4.56 $1.50-$3.45 $1.50-$3.61
Volumes
(Mbbls)........ 1,223 1,803 -- -- 1,223 1,803 -- --
Price (per
bbl)........... $14.99-$28.81 $15.33-$27.62 -- -- $14.99-$28.81 $15.33-$27.62 -- --
BASIS SWAPS:
Volumes (MMcf).. 32,296 36,961 11,224 40,470 43,520 77,431 16,787 98,541
Price (per
Mcf)........... $(.66)-$.24 $(.32)-$.35 $(.52) -$(.06) $(.30)-$(.26) $(.66)-$.24 $(.32)-$.35 $.06-$1.06 $.03-$.85
The following table discloses the carrying amount and fair value of the
Company's refining, natural gas and NGL contracts held or issued for non-
trading purposes as of December 31, 1996 and 1995 (dollars in thousands):
[Download Table]
1996 1995
---------------------- ------------------------
ASSETS (LIABILITIES) ASSETS (LIABILITIES)
---------------------- ------------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
----------- ---------- ----------- -----------
Swaps...................... $ 7,184 $ 13,853 $ 98 $ 1,557
Options.................... 1,101 (2,638) (91) 429
Futures.................... 21,116 21,116 217 217
Basis Swaps................ -- 2,809 -- 5,823
---------- ---------- --------- -----------
Total.................... $ 29,401 $ 35,140 $ 224 $ 8,026
========== ========== ========= ===========
Trading Activities
The Company enters into transactions for trading purposes using its
fundamental and technical analysis of market conditions to earn additional
revenues. The types of instruments used include futures, price swaps, basis
swaps and over-the-counter and exchange-traded options. Except in limited
circumstances, these contracts run for periods of up to 12 months, with the
exception of basis swaps which extend through the year 2000. The following
table is a summary of the contract amounts and range of prices of the
Company's contracts held or issued for trading purposes as of December 31,
1996 and 1995:
F-19
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
[Enlarge/Download Table]
TOTAL TOTAL
1996 1995
EXPECTED MATURITY DATE BALANCE BALANCE
--------------------------------------------- ----------------------- ---------------------------
1997 1998-2000
------------------------ --------------------
PAYOR RECEIVER PAYOR RECEIVER PAYOR RECEIVER PAYOR RECEIVER
----------- ------------ ------- ------------ ----------- ----------- ------------- -------------
SWAPS:
Volumes (MMcf)....... 4,520 4,160 -- -- 4,520 4,160 23,430 24,950
Price (per Mcf)...... $3.25-$4.25 $3.15 -$4.25 -- -- $3.25-$4.25 $3.15-$4.25 $1.79-$3.44 $1.71-$3.44
Volumes (Mbbls)...... 400 400 -- -- 400 400 2,925 2,250
Price (per bbl)...... $4.25-$4.55 $4.20-$4.72 -- -- $4.25-$4.55 $4.20-$4.72 $1.80-$4.14 $2.40-$4.18
OPTIONS:
Volumes (MMcf)....... 15,000 15,310 -- -- 15,000 15,310 36,100 18,000
Price (per Mcf)...... $2.10-$5.20 $1.65-$5.20 -- -- $2.10-$5.20 $1.65-$5.20 $1.60-$3.25 $1.60-$2.40
Volumes (Mbbls)...... -- 275 -- -- -- 275 -- 150
Price (per bbl)...... -- $25.20 -- -- -- $25.20 -- $17.50-$19.00
FUTURES:
Volumes (MMcf)....... 39,420 41,390 -- -- 39,420 41,390 63,650 59,280
Price (per Mcf)...... $1.87-$4.50 $2.09-$4.58 -- -- $1.87-$4.50 $2.09-$4.58 $1.64-$3.44 $1.67-$3.67
Volumes (Mbbls)...... -- -- -- -- -- -- 100 450
Price (per bbl)...... -- -- -- -- -- -- $23.42-$23.44 $18.24-$19.00
BASIS SWAPS:
Volumes (MMcf)....... 27,000 30,460 11,850 27,275 38,850 57,735 11,620 42,000
Price (per Mcf)...... $(.32)-$.38 $(.32)-$.40 $(.10) $(.08)-$(.05) $(.32)-$.38 $(.32)-$.40 $.07-$.47 $.03-$.22
The following table discloses the fair values of contracts held or issued
for trading purposes and net gains (losses) from trading activities as of or
for the periods ended December 31, 1996 and 1995 (dollars in thousands):
[Download Table]
FAIR VALUE OF ASSETS (LIABILITIES)
---------------------------------------
AVERAGE ENDING NET GAINS (LOSSES)
------------------ ------------------- -------------------
1996 1995 1996 1995 1996 1995
-------- -------- --------- -------- --------- ---------
Swaps.......... $ (102) $ (329) $ (560) $ 245 $ 613 $ (2,143)
Options........ (93) 1,026 (1,047) 297 8,270 (3,273)
Futures........ 1,951 2,030 926 6,739 4,016 8,822
Basis Swaps.... 1,705 487 1,072 1,266 277 2,706
-------- -------- --------- -------- --------- ---------
Total........ $ 3,461 $ 3,214 $ 391 $ 8,547 $ 13,176 $ 6,112
======== ======== ========= ======== ========= =========
Market and Credit Risk
The Company's price risk management activities involve the receipt or
payment of fixed price commitments into the future. These transactions give
rise to market risk, the risk that future changes in market conditions may
make an instrument less valuable. The Company closely monitors and manages its
exposure to market risk on a daily basis in accordance with policies limiting
net open positions. Concentrations of customers in the refining and natural
gas industries may impact the Company's overall exposure to credit risk, in
that the customers in each specific industry may be similarly affected by
changes in economic or other conditions. The Company believes that its
counterparties will be able to satisfy their obligations under contracts.
7. INVESTMENTS
The Company currently owns a 35% interest in Productos Ecologicos, S.A. de
C.V. ("Proesa"), a Mexican corporation which is involved in a project (the
"Project") to design, construct and operate a plant in Mexico to produce
methyl tertiary butyl ether ("MTBE"). Proesa is also owned 10% by Dragados y
Construcciones, S.A., a Spanish construction company ("Dragados"), and 55% by
a corporation formed by a subsidiary of Banamex,
F-20
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Mexico's largest bank ("Banamex"), and Infomin, S.A. de C.V., a privately
owned Mexican corporation ("Infomin"). Beginning in December 1994, the Mexican
peso experienced substantial devaluation, interest rates in Mexico increased
significantly and Mexican economic conditions deteriorated. Because of these
factors, in January 1995 the Board of Directors of Energy determined that the
Company would suspend further investment in the Project pending the resolution
of certain key issues. During 1995 and continuing in 1996, the Project
participants engaged in negotiations among themselves and with potential
additional participants in an attempt to restructure the participants'
ownership interests in Proesa and arrange funding for the Project. To date,
financing on terms satisfactory to the participants has not been available.
During the fourth quarter of 1996, the Company determined that it is unlikely
that the Project can go forward. Accordingly, the Company wrote off its $16.5
million investment in Proesa and accrued a provision for additional
liabilities associated with such investment of $3 million.
8. REDEEMABLE PREFERRED STOCK
In December of 1996, Energy redeemed 57,500 shares ($5,750,000) of its
Cumulative Preferred Stock, $8.50 Series A ("Series A Preferred Stock"), at
$100 per share. The redemption of the remaining balance (11,500 shares or
$1,150,000) is expected to occur prior to December 1, 1997.
9. CONVERTIBLE PREFERRED STOCK
In March 1994, Energy issued 3,450,000 shares of its $3.125 convertible
preferred stock ("Convertible Preferred Stock") with a stated value of $50 per
share and received cash proceeds, net of underwriting discounts, of
approximately $168 million. Each share of Convertible Preferred Stock is
convertible at the option of the holder into shares of Energy common stock
("Common Stock") at an initial conversion price of $27.03. The Convertible
Preferred Stock may not be redeemed prior to June 1, 1997. Thereafter, the
Convertible Preferred Stock may be redeemed, in whole or in part at the option
of Energy, at a redemption price of $52.188 per share through May 31, 1998,
and at ratably declining prices thereafter, plus dividends accrued to the
redemption date.
10. PREFERENCE SHARE PURCHASE RIGHTS
On November 25, 1995, Energy made a dividend distribution of one Preference
Share Purchase Right ("Right") for each outstanding share of Common Stock,
replacing similar expiring rights distributed on November 25, 1985. Until
exercisable, the Rights are not transferable apart from Common Stock. Each
Right will entitle shareholders to buy one-hundredth (1/100) of a share of a
newly issued series of Junior Participating Serial Preference Stock, Series
III, at an exercise price of $75 per Right.
F-21
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
11. INDUSTRY SEGMENT INFORMATION
[Download Table]
YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------
(THOUSANDS OF DOLLARS)
Operating revenues:
Refining and marketing................... $2,757,801 $1,950,657 $1,090,368
Natural gas related services............. 2,445,504 1,396,468 784,287
Other.................................... 123 126 42,639
Intersegment eliminations................ (212,747) (149,379) (79,854)
---------- ---------- ----------
Total.................................. $4,990,681 $3,197,872 $1,837,440
========== ========== ==========
Operating income (loss):
Refining and marketing................... $ 110,046 $ 141,512 $ 78,660
Natural gas related services............. 132,178 83,180 61,944
Corporate general and administrative
expenses and other, net................. (41,315) (35,901) (14,679)
---------- ---------- ----------
Total.................................. 200,909 188,791 125,925
Equity in earnings (losses) of and income
from:
Valero Natural Gas Partners, L.P......... -- -- (10,698)
Joint ventures........................... 3,899 4,827 2,437
Loss on investment in Proesa joint
venture................................... (19,549) -- --
(Provision for) reversal of acquisition
expense accrual........................... 18,698 (2,506) (16,192)
Other income, net.......................... 4,921 5,248 3,431
Interest and debt expense, net............. (95,177) (101,222) (76,921)
---------- ---------- ----------
Income before income taxes................. $ 113,701 $ 95,138 $ 27,982
========== ========== ==========
Identifiable assets:
Refining and marketing................... $1,621,998 $1,524,065 $1,528,621
Natural gas related services............. 1,366,050 1,162,724 1,119,347
Other.................................... 145,248 150,141 149,688
Investment in and advances to joint
ventures................................ 29,192 41,890 41,162
Intersegment eliminations and
reclassifications....................... (27,714) (16,940) (22,260)
---------- ---------- ----------
Total.................................. $3,134,774 $2,861,880 $2,816,558
========== ========== ==========
Depreciation expense:
Refining and marketing................... $ 52,680 $ 55,032 $ 52,956
Natural gas related services............. 44,211 40,881 26,636
Other.................................... 4,896 4,412 4,440
---------- ---------- ----------
Total.................................. $ 101,787 $ 100,325 $ 84,032
========== ========== ==========
Capital additions:
Refining and marketing................... $ 56,673 $ 29,039 $ 119,748
Natural gas related services............. 65,671 33,489 18,860
Other.................................... 6,109 2,091 2,130
---------- ---------- ----------
Total.................................. $ 128,453 $ 64,619 $ 140,738
========== ========== ==========
The Company's core businesses are specialized refining and natural gas
related services. Effective January 1, 1996, the Company's natural gas and NGL
businesses were reported as one industry segment for financial
F-22
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
reporting purposes (described herein as "natural gas related services") in
recognition of the Company's increasing integration of these business
activities due to the restructuring of the interstate natural gas pipeline
industry in 1993 through FERC Order 636 and the resulting transformation of the
U.S. natural gas industry into a more market and customer-oriented environment.
The Company's ability to gather, transport, market and process natural gas,
among other things, are value-added services offered to producers and attract
additional quantities of gas to the Company's pipeline system and processing
plants through integrated business arrangements. Prior to 1996, the Company's
natural gas and NGL businesses were reported as separate industry segments. The
primary effect of this change on the Company's segment disclosures was the
elimination of volume, revenue and income amounts related to natural gas fuel
and shrinkage volumes sold to and transported for the natural gas liquids
segment by the natural gas segment. Amounts for 1995 and 1994 shown above have
been restated to conform to the 1996 presentation.
At its refinery in Corpus Christi, Refining converts high-sulfur atmospheric
residual oil into premium products, primarily reformulated gasoline ("RFG"),
and sells those products principally on a spot, truck rack and term contract
basis. Spot and term sales of Refining's products are made principally to
larger oil companies and gasoline distributors in the northeastern, midwestern
and southeastern United States. In 1996, the Company also began sales of "CARB"
gasoline into the West Coast market in connection with the startup of the
California Air Resources Board's statewide CARB gasoline program. This program
requires the use of gasoline which meets more restrictive air quality
specifications than the federally mandated RFG. The principal purchasers of
Refining's products from truck racks have been wholesalers and jobbers in the
eastern and midwestern United States. The Company's natural gas related
services business consists of: purchasing, gathering, processing, storing,
transporting and selling natural gas, principally to gas distribution
companies, electric utilities, pipeline companies and industrial customers;
transporting natural gas for producers, other pipelines and end users in North
America; extracting natural gas liquids, principally from natural gas
throughput of the Company's pipeline operations; fractionating, transporting
and selling natural gas liquids, principally to petrochemical plants,
refineries and domestic fuel distributors in the Corpus Christi and Mont
Belvieu (Houston) areas; and marketing electric power throughout the United
States. Intersegment revenue eliminations relate primarily to the refining and
marketing segment's purchases of feedstocks and fuel gas from the natural gas
related services segment. In 1996, the Company had no significant amount of
export sales and no significant foreign operations, and no single customer
accounted for more than 10% of the Company's operating revenues. The foregoing
segment information reflects the Company's effective equity interest of
approximately 49% in the Partnership's operations for periods prior to and
including May 31, 1994, and reflects 100% of the Partnership's operations
thereafter (see Note 3). Capital additions in 1994 include the accrual of the
remaining $60 million payment made in 1995 for the Company's interest in a
methanol plant renovation project.
12. INCOME TAXES
Components of income tax expense were as follows (in thousands):
[Download Table]
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
------- ------- -------
Current:
Federal......................................... $20,996 $29,674 $ 3,535
State........................................... 4 926 165
------- ------- -------
Total current................................. 21,000 30,600 3,700
Deferred:
Federal......................................... 20,000 4,700 7,000
------- ------- -------
Total income tax expense...................... $41,000 $35,300 $10,700
======= ======= =======
F-23
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Total income tax expense differs from the amount computed by applying the
statutory federal income tax rate to income before income taxes. The reasons
for these differences are as follows (in thousands):
[Download Table]
YEAR ENDED DECEMBER 31,
-----------------------
1996 1995 1994
------- ------- -------
Federal income tax expense at the statutory rate... $39,800 $33,300 $ 9,800
State income taxes, net of federal income tax
benefit........................................... -- 600 100
Other--net......................................... 1,200 1,400 800
------- ------- -------
Total income tax expense....................... $41,000 $35,300 $10,700
======= ======= =======
The tax effects of significant temporary differences representing deferred
income tax assets and liabilities are as follows (in thousands):
[Download Table]
DECEMBER 31,
--------------------
1996 1995
--------- ---------
Deferred income tax assets:
Tax credit carryforwards............................ $ 21,835 $ 33,001
Other............................................... 43,214 25,570
--------- ---------
Total deferred income tax assets.................. $ 65,049 $ 58,571
========= =========
Deferred income tax liabilities:
Depreciation........................................ $(291,315) $(262,700)
Other............................................... (31,264) (37,154)
--------- ---------
Total deferred income tax liabilities............. $(322,579) $(299,854)
========= =========
At December 31, 1996, the Company had an alternative minimum tax ("AMT")
credit carryforward of approximately $21.3 million which is available to
reduce future federal income tax liabilities. The AMT credit carryforward has
no expiration date. The Company has not recorded any valuation allowances
against deferred income tax assets as of December 31, 1996.
The Company's taxable years through 1992 are closed to adjustment by the
Internal Revenue Service. The Company believes that adequate provisions for
income taxes have been reflected in its consolidated financial statements.
F-24
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
13. EMPLOYEE BENEFIT PLANS
Pension and Other Employee Benefit Plans
The following table sets forth for the pension plans of the Company, the
funded status and amounts recognized in the Company's consolidated financial
statements at December 31, 1996 and 1995 (in thousands):
[Download Table]
DECEMBER 31,
----------------
1996 1995
------- -------
Actuarial present value of benefit obligations:
Accumulated benefit obligation, including vested benefits
of $76,448 (1996) and $65,420 (1995).................... $78,441 $66,085
======= =======
Projected benefit obligation for services rendered to
date...................................................... $99,435 $87,609
Plan assets at fair value.................................. 92,486 68,619
------- -------
Projected benefit obligation in excess of plan assets...... 6,949 18,990
Unrecognized net gain from past experience different from
that assumed.............................................. 5,700 2,335
Prior service cost not yet recognized in net periodic
pension cost.............................................. (5,305) (5,033)
Unrecognized net asset at beginning of year................ 1,341 1,483
Additional minimum liability accrual....................... -- 1,948
------- -------
Accrued pension cost..................................... $ 8,685 $19,723
======= =======
Net periodic pension cost for the years ended December 31, 1996, 1995 and
1994 included the following components (in thousands):
[Download Table]
YEAR ENDED DECEMBER 31,
---------------------------
1996 1995 1994
-------- -------- -------
Service cost--benefits earned during the
period...................................... $ 4,622 $ 3,465 $ 3,981
Interest cost on projected benefit
obligation.................................. 6,309 5,455 4,990
Actual (return) loss on plan assets.......... (12,424) (14,376) 1,820
Net amortization and deferral................ 6,651 9,637 (6,135)
-------- -------- -------
Net periodic pension cost.................. $ 5,158 $ 4,181 $ 4,656
======== ======== =======
Participation in the pension plan for employees of the Company commences
upon attaining age 21 and the completion of one year of continuous service. A
participant vests in plan benefits after 5 years of vesting service or upon
reaching normal retirement date. The pension plan provides a monthly pension
payable upon normal retirement of an amount equal to a set formula which is
based on the participant's 60 consecutive highest months of compensation
during the latest 10 years of credited service under the plan. The weighted-
average discount rate used in determining the actuarial present value of the
projected benefit obligation was 7.25% as of December 31, 1996 and 1995. The
rate of increase in future compensation levels used in determining the
projected benefit obligation as of December 31, 1996 and 1995 was 4% for
nonexempt personnel and 3% for exempt personnel. The expected long-term rate
of return on plan assets was 9.25% as of December 31, 1996 and 1995.
Contributions, when permitted, are actuarially determined in an amount
sufficient to fund the currently accruing benefits and amortize any prior
service cost over the expected life of the then current work force. The
Company also maintains a nonqualified Supplemental Executive Retirement Plan
("SERP") which provides additional pension benefits to the executive officers
and certain other employees of the Company. The Company's contributions to the
pension plan and SERP in 1996, 1995 and 1994 were approximately $14.2 million,
$4.3 million and $5 million, respectively, and are currently estimated to be
$4.3 million in 1997. The tables at the beginning of this note include amounts
related to the SERP.
F-25
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company is the sponsor of the Valero Energy Corporation Thrift Plan
("Thrift Plan") which is an employee profit sharing plan. Participation in the
Thrift Plan is voluntary and is open to employees of the Company who become
eligible to participate following the completion of three months of continuous
employment. Participating employees may make a base contribution from 2% up to
8% of their annual base salary, depending upon months of contributions by a
participant. Thrift Plan participants are automatically enrolled in the VESOP
(see below). The Company makes contributions to the Thrift Plan to the extent
employees' base contributions exceed the amount of the Company's contribution
to the VESOP for debt service. Prior to 1994, the Company matched 100% of the
employee contributions. In 1994, the Thrift Plan was amended to provide for a
total Company match in both the Thrift Plan and the VESOP aggregating 75% of
employee base contributions, with an additional contribution of up to 25%
subject to certain conditions. Participants may also make a supplemental
contribution to the Thrift Plan of up to an additional 10% of their annual
base salary which is not matched by the Company. There were no Company
contributions to the Thrift Plan in 1996 or 1995, while approximately $42,000
was contributed during 1994.
In 1989, the Company established the Valero Employees' Stock Ownership Plan
("VESOP") which is a leveraged employee stock ownership plan. Pursuant to a
private placement in 1989, the VESOP issued notes in the principal amount of
$15 million, maturing February 15, 1999 (the "VESOP Notes"). The net proceeds
from this private placement were used by the VESOP trustee to fund the
purchase of Common Stock. During 1991, the Company made an additional loan of
$8 million to the VESOP which was also used by the Trustee to purchase Common
Stock. This second VESOP loan matures on August 15, 2001. The number of shares
of Common Stock released at any semi-annual payment date is based on the
proportion of debt service paid during the year to remaining debt service for
that and all subsequent periods times the number of unreleased shares then
outstanding. As explained above, the Company's annual contribution to the
Thrift Plan is reduced by the Company's contribution to the VESOP for debt
service. During 1996, 1995 and 1994, the Company contributed $3,372,000,
$3,170,000 and $3,160,000, respectively, to the VESOP, comprised of $525,000,
$678,000 and $819,000, respectively, of interest on the VESOP Notes and
$3,072,000, $2,918,000 and $2,777,000, respectively, of compensation expense.
Compensation expense is based on the VESOP debt principal payments for the
portion of the VESOP established in 1989 and on the cost of the shares
allocated to participants for the portion of the VESOP established in 1991.
Dividends on VESOP shares of Common Stock are recorded as a reduction of
retained earnings. Dividends on allocated shares of Common Stock are paid to
participants. Dividends paid on unallocated shares were used to reduce the
Company's contributions to the VESOP during 1996, 1995 and 1994 by $225,000,
$426,000 and $436,000, respectively. VESOP shares of Common Stock are
considered outstanding for earnings per share computations. As of December 31,
1996 and 1995, the number of allocated shares were 1,052,454 and 940,470,
respectively, the number of committed-to-be-released shares were 62,918 and
62,918, respectively, and the number of suspense shares were 583,301 and
772,055, respectively.
The Company also provides certain health care and life insurance benefits
for retired employees, referred to herein as "postretirement benefits other
than pensions." Substantially all of the Company's employees may become
eligible for those benefits if, while still working for the Company, they
either reach normal retirement age or take early retirement. Health care
benefits are offered by the Company through a self-insured plan and a health
maintenance organization while life insurance benefits are provided through an
insurance company.
Effective January 1, 1993, the Company adopted SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions", which requires a
change in the Company's accounting for postretirement benefits other than
pensions from a pay-as-you-go basis to an accrual basis of accounting. The
Company is amortizing the transition obligation over 20 years, which is
greater than the average remaining service period until eligibility of active
plan participants. The Company continues to fund its postretirement benefits
other than pensions on a pay-as-you-go basis.
F-26
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table sets forth for the Company's postretirement benefits
other than pensions, the funded status and amounts recognized in the Company's
consolidated financial statements at December 31, 1996 and 1995 (in
thousands):
[Download Table]
DECEMBER 31,
------------------
1996 1995
-------- --------
Accumulated benefit obligation:
Retirees............................................... $ 11,930 $ 10,295
Fully eligible active plan participants................ 390 331
Other active plan participants......................... 17,571 13,504
-------- --------
Total accumulated benefit obligation................. 29,891 24,130
Unrecognized loss........................................ (4,498) (4,586)
Unrecognized prior service cost.......................... (3,909) --
Unrecognized transition obligation....................... (10,334) (10,987)
-------- --------
Accrued postretirement benefit cost.................... $ 11,150 $ 8,557
======== ========
Net periodic postretirement benefit cost for the years ended December 31,
1996, 1995 and 1994 included the following components (in thousands):
[Download Table]
DECEMBER 31,
--------------------
1996 1995 1994
------ ------ ------
Service cost--benefits attributed to service during
the period.......................................... $1,091 $ 860 $1,196
Interest cost on accumulated benefit obligation...... 1,716 1,769 1,686
Amortization of unrecognized transition obligation... 653 766 948
Amortization of prior service cost................... -- -- (84)
Amortization of unrecognized net loss................ 110 -- 75
------ ------ ------
Net periodic postretirement benefit cost........... $3,570 $3,395 $3,821
====== ====== ======
For measurement purposes, the assumed health care cost trend rate was 7% in
1996, decreasing gradually to 5.5% in 1998 and remaining level thereafter. The
health care cost trend rate assumption has a significant effect on the amount
of the obligation and periodic cost reported. An increase in the assumed
health care cost trend rate by 1% in each year would increase the accumulated
postretirement benefit obligation as of December 31, 1996 by $5.2 million and
the aggregate of the service and interest cost components of net periodic
postretirement benefit cost for the year then ended by $.7 million. The
weighted-average discount rate used in determining the accumulated
postretirement benefit obligation as of December 31, 1996 and 1995 was 7.25%.
Stock Option and Bonus Plans
As of December 31, 1996, the Company has various fixed and performance-based
stock compensation plans which are described below. The Company applies APB
Opinion No. 25 and related Interpretations in accounting for its plans.
Accordingly, no compensation cost has been recognized for its fixed stock
option plans. The compensation cost reflected in net income for its stock-
based compensation plans was $2.6 million and $1.7 million for 1996 and 1995,
respectively. Had compensation cost for the Company's stock-based compensation
plans been determined based on the fair value at the grant dates for 1996 and
1995 awards under those plans consistent with the method of SFAS No. 123, the
Company's net income and earnings per share for the years ended December 31,
1996 and 1995 would have been reduced to the pro forma amounts indicated
below:
F-27
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
[Download Table]
DECEMBER 31,
---------------
1996 1995
------- -------
Net Income..................................... As Reported $72,701 $59,838
Pro Forma $70,427 $58,373
Earnings per share............................. As Reported $ 1.40 $ 1.10
Pro Forma $ 1.35 $ 1.07
Because the SFAS No. 123 method of accounting has not been applied to awards
granted prior to January 1, 1995, the resulting pro forma compensation cost
may not be representative of that to be expected in future years.
The Company's Executive Stock Incentive Plan (the "ESIP") authorizes the
grant of various stock and stock-related awards to executive officers and
other key employees. Awards available under the ESIP include options to
purchase shares of Common Stock, stock appreciation rights ("SARs"),
restricted stock, performance awards and other stock-based awards. A total of
2,100,000 shares may be issued under the ESIP, of which no more than 750,000
shares may be issued as restricted stock. Under the ESIP, 110,500 options,
97,000 shares of restricted stock and 64,830 shares under performance awards
were granted during 1996, while 1,043,581 awards were available for grant as
of December 31, 1996. In addition to options available under the ESIP, the
Company also has three non-qualified stock option plans, Stock Option Plan No.
5, Stock Option Plan No. 4, and Stock Option Plan No. 3, collectively referred
to herein as the "Stock Option Plans," and a non-employee director stock
option plan. Awards under the Stock Option Plans are granted to key officers,
employees and prospective employees of the Company. As of December 31, 1996,
there were 46,705 and 48,000 shares available for grant under the Stock Option
Plans and non-employee director plan, respectively.
Under the terms of the ESIP, the Stock Option Plans and the non-employee
director plan, the exercise price of the options granted will not be less than
100%, 75%, or 100%, respectively, of the fair market value of Common Stock at
the date of grant. As of December 31, 1996, all outstanding options contain
exercise prices not less than fair market value at date of grant. Stock
options become exercisable pursuant to the individual written agreements
between the Company and the participants, generally either at the end of a
three-year period beginning on the date of grant or in three equal annual
installments beginning one year after the date of grant, with unexercised
options expiring ten years from the date of grant. A summary of the status of
the Company's stock option plans, including options granted under the ESIP,
the Stock Option Plans and the non-employee director plan, as of December 31,
1996, 1995, and 1994, and changes during the years then ended is presented in
the table below:
[Enlarge/Download Table]
1996 1995 1994
-------------------- -------------------- --------------------
WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- --------- --------- --------- --------- ---------
Outstanding at beginning
of year................ 3,928,267 $20.69 2,575,902 $21.51 1,261,624 $23.69
Granted................. 757,920 27.44 1,599,463 18.99 1,343,919 19.43
Exercised............... (418,117) 19.28 (171,604) 17.08 (7,555) 14.53
Forfeited............... (38,978) 22.17 (74,428) 21.12 (22,086) 21.90
Expired................. -- -- (1,066) 18.36 -- --
--------- --------- ---------
Outstanding at end of
year................... 4,229,092 22.02 3,928,267 20.69 2,575,902 21.51
========= ========= =========
Exercisable at end of
year................... 2,525,957 21.71 1,531,718 22.30 708,055 23.13
Weighted-average fair
value of options
granted................ $ 6.25 $ 4.50 N/A
F-28
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The following table summarizes information about stock options outstanding
under the ESIP, the Stock Option Plans and the non-employee director plan as
of December 31, 1996:
[Enlarge/Download Table]
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------- --------------------------
RANGE NUMBER WEIGHTED-AVG. NUMBER
OF OUTSTANDING REMAINING WEIGHTED-AVG. EXERCISABLE WEIGHTED-AVG.
EXERCISE PRICES AT 12/31/96 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/96 EXERCISE PRICE
--------------- ----------- ---------------- -------------- ----------- --------------
$14.52-$21.88........... 2,460,074 7.5 years $19.02 1,499,074 $19.17
$22.13-$29.75........... 1,769,018 7.4 26.20 1,026,883 25.41
--------- ---------
$14.52-$29.75........... 4,229,092 7.5 22.02 2,525,957 21.71
========= =========
The fair value of each option grant was estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1996 and 1995, respectively: risk-free interest
rates of 6.4 percent and 6.7 percent; expected dividend yields of 1.9 percent
and 2.8 percent; expected lives of 3.1 years and 3.2 years; and expected
volatility of 25.5 percent and 29.5 percent.
For each share of stock that can be purchased thereunder pursuant to a stock
option, Stock Option Plans No. 3 and 4 provide that a SAR may also be granted.
A SAR is a right to receive a cash payment equal to the difference between the
fair market value of Common Stock on the exercise date and the option price of
the stock to which the SAR is related. SARs under Stock Option Plans No. 3 and
4 are exercisable only upon the exercise of the related stock options. At the
end of each reporting period within the exercise period, the Company records
an adjustment to deferred compensation expense based on the difference between
the fair market value of Common Stock at the end of each reporting period and
the option price of the stock to which the SAR is related. As of December 31,
1996, 89,087 SARs were outstanding and exercisable, at a weighted-average
exercise price of $14.52 per share. During 1996, 21,316 SARs were exercised at
a weighted-average exercise price of $14.52 per share and 600 SARs were
forfeited.
The Company maintains a Restricted Stock Bonus and Incentive Stock Plan
("Bonus Plan") for certain key executives of the Company. Under the Bonus
Plan, 750,000 shares of Common Stock were reserved for issuance. As of
December 31, 1996, there were 6,927 shares available for award. No shares were
awarded under this plan in 1996, while 9,000 and 3,000 shares were awarded
under this plan during 1995 and 1994, respectively. The amount of Bonus Stock
and terms governing the removal of applicable restrictions, and the amount of
Incentive Stock and terms establishing predefined performance objectives and
periods, are established pursuant to individual written agreements between
Energy and each participant in the Bonus Plan.
14. LEASE AND OTHER COMMITMENTS
The Company has major long-term operating lease commitments in connection
with a gas storage facility, its corporate headquarters office complex and
various facilities and equipment used to store, transport and produce refinery
feedstocks and/or refined products. The gas storage facility lease has a
remaining primary term of three years, and, subject to certain conditions, one
eight-year optional renewal period during which the lease payments decrease by
one-half and one or more additional optional renewal periods of five years
each at fair market rentals. The corporate headquarters lease has a remaining
primary term of 15 years with five optional renewal periods of five years
each. In 1996, the Company entered into a sublease agreement for unused space
in its corporate headquarters office complex. The sublease has a primary term
of 20 years, with the sublessee having an option to terminate the lease after
10 years. The sublessee is occupying the premises in phases, with full
occupancy currently expected in 1997. The Company's long-term refinery
feedstock and refined product storage and transportation leases have remaining
primary terms of up to 5.3 years with optional renewal periods of up to 10
years and provide for various contingent payments based on throughput volumes
in excess of a base amount,
F-29
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
among other things. The Company also has other noncancelable operating leases
with remaining terms of up to 10 years for significant leases. The related
future minimum lease payments as of December 31, 1996, including amounts to be
received under the corporate headquarters office complex sublease, are as
follows (in thousands):
[Download Table]
OFFICE
COMPLEX
GAS ----------------
STORAGE PRIMARY
FACILITY LEASE SUBLEASE REFINING OTHER
-------- ------- -------- -------- ------
1997............................. $ 9,832 $ 4,570 $ (2,088) $ 6,028 $1,502
1998............................. 10,156 4,570 (2,088) 7,886 1,490
1999............................. 10,438 4,570 (2,088) 7,761 966
2000............................. 5,221 4,570 (2,088) 4,977 292
2001............................. -- 4,570 (2,088) 4,075 134
Remainder........................ -- 40,771 (9,971) 1,359 616
------- ------- -------- ------- ------
Total minimum lease payments..... $35,647 $63,621 $(20,411) $32,086 $5,000
======= ======= ======== ======= ======
The future minimum lease payments listed above exclude operating leases
having initial or remaining noncancelable lease terms of one year or less.
Consolidated rental expense under operating leases, excluding amounts paid in
connection with the gas storage facility and net of amounts related to the
office complex sublease, amounted to approximately $31,663,000, $29,313,000,
and $14,040,000 for 1996, 1995 and 1994 (including Partnership rents
commencing June 1, 1994), respectively, and includes various month-to-month
and other short-term rentals in addition to rents paid and accrued under long-
term lease commitments. For the period prior to the merger of VNGP, L.P. with
Energy, a portion of these amounts was charged to and reimbursed by the
Partnership for its proportionate use of the Company's corporate headquarters
office complex and for the use of certain other properties managed by the
Company for the period prior to such merger. Gas storage facility rentals paid
by the Partnership for the period prior to the VNGP, L.P. merger, and paid by
the Company for the period subsequent to the such merger, totalling
$10,438,000 per year for 1996, 1995 and 1994, were included in the cost of
gas.
The obligations of the Company under the gas storage facility lease include
its obligation to make scheduled lease payments and, in the event of a
declaration of default and acceleration of the lease obligation, to make
certain lump sum payments based on a stipulated loss value for the gas storage
facility less the fair market sales price or fair market rental value of the
gas storage facility. Under certain circumstances, a default by Energy or a
subsidiary of Energy under its credit facilities could result in a cross
default under the gas storage facility lease. The Company believes that it is
unlikely that such a default would result in actual acceleration of the gas
storage facility lease, and further believes that the occurrence of such event
would not have a material adverse effect on the Company.
15. LITIGATION AND CONTINGENCIES
City of Edinburg and Related Litigation. The Company and Southern Union
Company ("Southern Union") are defendants in a lawsuit brought by the City of
Edinburg, Texas (the "City") regarding certain ordinances of the City that
granted franchises to Rio Grande Valley Gas Company ("RGV") and its
predecessors allowing RGV to sell and distribute natural gas within the City.
RGV was formerly owned by Energy. On September 30, 1993, Energy sold the
common stock of RGV to Southern Union. The City alleges that the defendants
used RGV's facilities to sell or transport natural gas in Edinburg in
violation of the ordinances and franchises granted by the City, and that RGV
(now Southern Union) has not fully paid all franchise fees due the City. The
City also alleges that the defendants used the public property of the City
without compensating the City for such use, and alleges conspiracy and alter
ego claims involving all defendants. The City seeks alleged
F-30
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
actual damages of $50 million and unspecified punitive damages related to
amounts allegedly due under the RGV franchise, City ordinances and state law.
In addition, the City of Pharr, Texas, filed an intervention seeking
certification of a class, with itself as class representative, consisting of
all cities served by franchise by Southern Union. The court certified the
class and severed the claims of the City of Pharr and the class from the
original City of Edinburg lawsuit. The City of Pharr subsequently amended its
petition deleting all Valero entities as defendants. The original trial judge
was disqualified upon motion of the defendants (such disqualification was
upheld on appeal), and a new trial judge has been assigned to preside over
both the City of Edinburg and City of Pharr litigation. The City of Edinburg
lawsuit is scheduled for trial on August 11, 1997. In 1996, the South Texas
cities of Alton and Donna also independently intervened as plaintiffs in the
Edinburg lawsuit filed in the 92nd State District Court in Hidalgo County.
These lawsuits subsequently were severed from the Edinburg lawsuit. The claims
asserted by the cities of Alton and Donna are substantially similar to the
Edinburg litigation claims. Damages are not quantified. In connection with the
City of Edinburg lawsuit, Southern Union filed a cross-claim against Energy,
alleging, among other things, that Southern Union is entitled to
indemnification pursuant to the purchase agreement under which Energy sold RGV
to Southern Union. Southern Union also asserts claims related to a 1985
settlement among Energy, RGV and the Railroad Commission of Texas regarding
certain gas contract pricing terms. This pricing claim was recently severed
into a separate lawsuit. Southern Union's claims include, among other things,
damages for indemnification, breach of contract, negligent misrepresentation
and fraud. Three additional lawsuits were filed during December 1996 by
certain other municipalities in South Texas making allegations substantially
similar to those in the City of Edinburg litigation. In these three lawsuits,
the defendants are alleged to have excluded certain revenues from their
calculations of franchise taxes and are alleged to have provided unauthorized
gas transportation services to third parties. The plaintiffs seek actual and
exemplary, but as yet, unspecified, damages.
Teco Pipeline Company. Energy and certain of its subsidiaries have been sued
by Teco Pipeline Company ("Teco") regarding the operation of the Company's
340-mile West Texas pipeline. 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, and other claims, and seeks
unquantified actual and punitive damages. The Company's motion to compel
arbitration was denied, but has been appealed. The Company has 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. The Company is seeking unquantified actual and
punitive damages.
Sinco Pipeline Rupture Litigation. Approximately 15 lawsuits have been filed
against various pipeline owners and other parties, including the Company,
arising from the rupture of several pipelines and fire as a result of severe
flooding of the San Jacinto River in Harris County, Texas on October 20, 1994.
The Company is a defendant in 10 of these lawsuits. The plaintiffs are
property owners in surrounding areas who allege that the defendant pipeline
owners were negligent and grossly negligent in failing to bury the pipelines
at a proper depth to avoid rupture or explosion and in allowing the pipelines
to leak chemicals and hydrocarbons into the flooded area. The plaintiffs
assert claims for property damage, costs for medical monitoring, personal
injury and nuisance, and seek an unspecified amount of actual and punitive
damages.
F-31
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
J.M. Davidson, Inc. Energy and certain of its subsidiaries are defendants in
a lawsuit originally filed in January 1993. The lawsuit is based upon
construction work performed by the plaintiff at one of the Company's gas
processing plants in 1991 and 1992. The plaintiff alleges that it performed
work for the defendants for which it was not compensated. The plaintiff
asserts claims for fraud, quantum meruit, and numerous other tort claims. The
plaintiff seeks actual damages, on each of its causes of action, of
approximately $1.25 million, plus retainage, interest and attorneys fees, and
punitive damages of at least four times the amount of actual damages. No trial
date has been set.
The Long Trusts. On April 15, 1994, certain trusts named certain
subsidiaries of the Company as additional defendants (the "Valero Defendants")
to a lawsuit filed in 1989 by the trusts against a supplier with whom the
Valero Defendants have contractual relationships under gas purchase contracts.
In order to resolve certain potential disputes with respect to the gas
purchase contracts, the Valero Defendants agreed to bear a substantial portion
of any settlement or any nonappealable final judgment rendered against the
supplier. In January 1993, the District Court ruled in favor of the trusts'
motion for summary judgment against the supplier. Damages, if any, were not
determined. The trusts seek $50 million in damages from the Valero Defendants
as a result of the Valero Defendants' alleged interference between the trusts
and the supplier, plus punitive damages in excess of treble the amount of
actual damages proven at trial. The trusts also seek approximately $56 million
in take-or-pay damages from the supplier and $70 million as damages for the
supplier's failure to take the trusts' gas ratably. The Company believes that
the claims brought by the trusts have been significantly overstated, and that
the supplier and the Valero Defendants have a number of meritorious defenses
to the claims. No trial date has been set.
Mizel. A federal securities fraud lawsuit was filed against Energy and
certain of its subsidiaries by a former owner of limited partnership interests
of VNGP, L.P. The plaintiff alleges that the proxy statement used in
connection with the solicitation of votes for approval of the Merger of the
Company and VNGP, L.P. contained fraudulent misrepresentations. The plaintiff
also alleges breach of fiduciary duty in connection with the merger
transaction. The subject matter of this lawsuit was the subject matter of a
prior Delaware class action lawsuit which was settled prior to consummation of
the Merger. The Company believes that the plaintiff's claims have been settled
and released by the prior class action settlement. Pending in the district
court is a memorandum issued by the magistrate assigned to the case which
recommends approval of the Company's motion for summary judgment.
Javelina. Valero Javelina Company, a wholly owned subsidiary of Energy, owns
a 20% general partner interest in Javelina Company ("Javelina"), a general
partnership that owns a refinery off-gas processing plant in Corpus Christi.
Javelina has been named as a defendant in ten lawsuits filed since 1993 in
state district courts in Nueces County and Duval County, Texas. Eight of the
suits include as defendants other companies that own refineries or other
industrial facilities in Nueces County. These suits were brought by a number
of plaintiffs who reside in neighborhoods near the facilities. The plaintiffs
claim injuries relating to an alleged exposure to toxic chemicals, and
generally claim that the defendants were negligent, grossly negligent and
committed trespass. The plaintiffs claim personal injury and property damages
resulting from soil and ground water contamination and air pollution allegedly
caused by the operations of the defendants. The plaintiffs seek an unspecified
amount of actual and punitive damages. The remaining two suits were brought by
plaintiffs who either live or have businesses near the Javelina plant. The
plaintiffs in these suits allege claims similar to those described above and
seek unspecified actual and punitive damages.
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, including those described above, 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,
F-32
VALERO ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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.
16. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The results of operations by quarter for the years ended December 31, 1996
and 1995 were as follows (in thousands of dollars, except per share amounts):
[Download Table]
OPERATING OPERATING NET EARNINGS PER SHARE
REVENUES INCOME INCOME OF COMMON STOCK
---------- --------- ------- ------------------
1996--Quarter Ended:
March 31............... $1,110,098(a) $ 52,238 $19,914 $ .39
June 30................ 1,152,737 54,433 20,841 .41
September 30........... 1,123,527 40,025 13,146 .23
December 31............ 1,604,319 54,213 18,800 .37
---------- -------- ------- -----
Total................ $4,990,681 $200,909 $72,701 $1.40
========== ======== ======= =====
1995--Quarter Ended:
March 31............... $ 690,535 $ 28,667 $ 3,759 $ .02
June 30................ 775,822(b) 54,953 20,522 .40
September 30........... 803,670(b) 57,781 22,630 .45
December 31............ 927,845(b) 47,390 12,927 .23
---------- -------- ------- -----
Total................ $3,197,872(b) $188,791 $59,838 $1.10
========== ======== ======= =====
--------
(a) Revised from the amount shown in the Company's Form 10-Q for the three
months ended March 31, 1996 to include revenues from certain NGL trading
activities previously classified as a reduction of cost of sales.
(b) Revised to include revenues from certain refining and marketing trading
activities previously classified as a reduction of cost of sales.
F-33
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of Basis Petroleum, Inc.:
We have audited the accompanying consolidated balance sheets of Basis
Petroleum, Inc. (the Company) (a Texas corporation), and subsidiaries as of
December 31, 1996 and 1995, and the related consolidated statements of
operations, stockholder's equity and cash flows for each of the three years in
the period ended December 31, 1996. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
As discussed in Note 15 to the accompanying consolidated financial
statements, Salomon Inc (the Company's parent) has executed a letter of intent
with Valero Energy Corporation for the sale of all of the Company's
outstanding common stock at a price substantially less than the book value of
the Company's assets.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Basis
Petroleum, Inc., and subsidiaries as of December 31, 1996 and 1995, and the
results of their operations and their cash flows for each of the three years
in the period ended December 31, 1996, in conformity with generally accepted
accounting principles.
Arthur Andersen LLP
Houston, Texas
January 31, 1997 (except with respect to the matter discussed in Note 15, as
to which date is March 17, 1997)
F-34
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1995
(DOLLARS IN THOUSANDS)
[Download Table]
1996 1995
---------- ----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.................... $ 25,438 $ 11,518
Accounts receivable, unrelated parties, net
of allowance for doubtful accounts of
$1,566 in 1996 and 1995..................... 433,647 537,615
Accounts receivable, related parties......... 4,609 10,691
Market value of forward contracts............ 21,694 27,276
Inventories.................................. 357,283 347,355
Prepaid expenses and other current assets.... 5,181 5,119
Income tax benefit........................... 58,677 50,068
---------- ----------
Total current assets....................... 906,529 989,642
PROPERTY, PLANT AND EQUIPMENT, net............. 817,967 804,943
PARTNERSHIP INVESTMENTS........................ 7,448 --
OTHER ASSETS................................... 2,000 2,585
---------- ----------
Total assets............................... $1,733,944 $1,797,170
========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
CURRENT LIABILITIES:
Accounts payable, unrelated parties.......... $ 446,298 $ 568,097
Accounts payable, related parties............ 66,004 6,827
Working capital advance due to Salomon....... 93,438 246,638
Market value of forward contracts............ 16,481 31,667
Accrued liabilities.......................... 144,362 64,275
---------- ----------
Total current liabilities.................. 766,583 917,504
LONG-TERM DEBT DUE TO SALOMON ................. 525,000 525,000
DEFERRED INCOME TAXES.......................... 69,171 55,810
---------- ----------
Total liabilities.......................... 1,360,754 1,498,314
---------- ----------
COMMITMENTS AND CONTINGENCIES (Note 12)
STOCKHOLDER'S EQUITY:
Common stock, $.01 par value, 2,000 shares
authorized, 1,000 shares
issued and outstanding...................... -- --
Additional paid-in capital................... 543,069 403,069
Retained deficit............................. (169,879) (104,213)
---------- ----------
Total stockholder's equity................. 373,190 298,856
---------- ----------
Total liabilities and stockholder's
equity.................................... $1,733,944 $1,797,170
========== ==========
The accompanying notes are an integral part of these financial statements.
F-35
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS)
[Download Table]
1996 1995 1994
---------- ----------- ----------
REVENUES:
Unrelated parties....................... $9,163,205 $ 9,149,046 $7,223,599
Related parties......................... 341,639 882,747 572,706
---------- ----------- ----------
9,504,844 10,031,793 7,796,305
---------- ----------- ----------
COSTS AND EXPENSES:
Cost of sales, unrelated parties........ 9,127,451 9,167,502 6,910,158
Cost of sales, related parties.......... 416,048 848,776 770,112
General and administrative.............. 36,141 41,392 43,063
Depreciation and amortization........... 46,510 37,531 40,435
Provision for exiting petrochemicals
business............................... 22,000 -- --
---------- ----------- ----------
OPERATING INCOME (LOSS)................... (143,306) (63,408) 32,537
INTEREST EXPENSE, net..................... (39,172) (27,532) (18,560)
GAIN (LOSS) ON SALE OF ASSETS............. 82,030 (552) 6,617
---------- ----------- ----------
INCOME (LOSS) BEFORE INCOME TAXES AND
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE................................ (100,448) (91,492) 20,594
INCOME TAX (PROVISION) BENEFIT............ 34,782 33,894 (7,422)
---------- ----------- ----------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF
CHANGE IN ACCOUNTING PRINCIPLE........... (65,666) (57,598) 13,172
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE, net of income tax benefit of
$1,043................................... -- -- (1,936)
---------- ----------- ----------
NET INCOME (LOSS)......................... $ (65,666) $ (57,598) $ 11,236
========== =========== ==========
The accompanying notes are an integral part of these financial statements.
F-36
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS)
[Download Table]
ADDITIONAL TOTAL
COMMON PAID-IN RETAINED STOCKHOLDER'S
STOCK CAPITAL DEFICIT EQUITY
------ ---------- --------- -------------
BALANCE, January 1, 1994........... $ -- $403,069 $ (57,851) $345,218
NET INCOME......................... -- -- 11,236 11,236
----- -------- --------- --------
BALANCE, December 31, 1994......... -- 403,069 (46,615) 356,454
NET LOSS........................... -- -- (57,598) (57,598)
----- -------- --------- --------
BALANCE, December 31, 1995......... -- 403,069 (104,213) 298,856
CONVERSION OF DEBT TO EQUITY (Note
7)................................ -- 140,000 -- 140,000
NET LOSS........................... -- -- (65,666) (65,666)
----- -------- --------- --------
BALANCE, December 31, 1996......... $ -- $543,069 $(169,879) $373,190
===== ======== ========= ========
The accompanying notes are an integral part of these financial statements.
F-37
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(DOLLARS IN THOUSANDS)
[Download Table]
1996 1995 1994
-------- --------- --------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)............................. $(65,666) $(57,598) $ 11,236
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating ac-
tivities--
Depreciation and amortization............... 46,510 37,531 40,435
(Gain) loss on sale of assets............... (82,030) 147 (3,743)
Gain on termination of interest rate caps... -- (915) (2,902)
Provision for exiting petrochemical busi-
ness....................................... 22,000 -- --
Write-down of assets held for sale.......... -- 1,320 --
Deferred income taxes....................... 17,820 28,315 (13,420)
Market value of forward contracts, net...... (9,604) 5,818 13,957
Turnaround and other noncash charges........ 28,559 (19,693) 12,811
Base stock inventory reduction (Note 4)..... (23,940) -- --
Changes in operating assets and liabilities
(Note 3)................................... 96,095 (7,477) 1,346
-------- --------- --------
Net cash provided by (used in) operating
activities............................... 29,744 (12,552) 59,720
-------- --------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of--
Assets held for sale........................ -- 9,680 14,520
St. Rose refinery........................... -- -- 9,962
Drilling assets............................. -- -- 4,500
Other fixed assets.......................... 290 507 2,227
Equity investments.......................... -- 2,500 --
Proceeds from sale of crude oil gathering
business..................................... 82,446 -- --
Insurance proceeds from involuntary conversion
of assets.................................... -- 1,610 3,619
(Increase) decrease in--
Property, plant and equipment............... (77,876) (247,285) (120,138)
Partnership investments and other........... (7,484) (291) 8,614
-------- --------- --------
Net cash used in investing activities..... (2,624) (233,279) (76,696)
-------- --------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in long-term debt due to Salomon..... -- 175,000 25,000
Change in working capital advances due to
Salomon...................................... (13,200) 72,625 (12,965)
Interest rate caps and corridors, net......... -- 1,388 (722)
-------- --------- --------
Net cash provided by (used in) financing
activities............................... (13,200) 249,013 11,313
-------- --------- --------
NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS.................................... 13,920 3,182 (5,663)
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR.. 11,518 8,336 13,999
-------- --------- --------
CASH AND CASH EQUIVALENTS AT END OF YEAR........ $ 25,438 $ 11,518 $ 8,336
======== ========= ========
The accompanying notes are an integral part of these financial statements.
F-38
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
1. DESCRIPTION OF BUSINESS:
Basis Petroleum, Inc. (the Company), with headquarters in Houston, Texas is
a wholly owned subsidiary of Salomon Inc (Salomon). Effective April 1, 1996,
the Company changed its name from Phibro Energy USA, Inc., to Basis Petroleum,
Inc. The Company owns and operates three oil refineries in the U.S. Gulf Coast
area, with a combined design crude oil distillation capacity of approximately
310,000 barrels per day and additional throughputs of purchased feedstock of
approximately 39,000 barrels per day.
During the fourth quarter of 1996, the Company exited its petrochemical
manufacturing business resulting in a $22,000,000 nonrecurring charge to
pretax income.
On May 9, 1995, the Company established PEUSA Clearing, Inc., a wholly owned
subsidiary, for the purpose of clearing the Company's commodity futures
transactions on the New York Mercantile Exchange (NYMEX). Effective April 1,
1996, PEUSA Clearing, Inc., changed its name to Basis Clearing, Inc.
The Company's continued focus on its core oil refining business resulted in
the divestiture of certain assets in 1994. The Company sold its St. Rose,
Louisiana refinery, certain excess equipment purchased but not required to
complete its Residfiner/ROSE unit complex, the assets of Questor Drilling
Corp. and certain assets related to its Louisiana marine fuels and lubricants
business (see Note 14).
During 1996, the Company and Howell Corporation (Howell) contributed their
respective crude oil gathering, marketing and transportation activities to
form Genesis Energy, L.P. (Genesis). The accompanying consolidated statements
of operations include results of the Company's crude oil gathering, marketing
and transportation division which had revenues of $3,598,107,000,
$3,440,065,000 and $1,830,721,000, gross margin of $18,277,000, $23,154,000
and $16,702,000 and net income of $8,609,000, $9,127,000 and $2,783,000 for
the eleven months ended November 30, 1996, and the years ended December 31,
1995 and 1994, respectively. In December 1996, units in Genesis were sold to
the public. The Company recorded a pretax gain of approximately $82,100,000 as
a result of this public offering. The Company retained a 10.58 percent
minority interest in Genesis. The Company holds a 54 percent majority
ownership interest in Genesis Energy, L.L.C. Genesis Energy L.L.C. is the
general partner holding a 2 percent ownership interest in Genesis. The
Company's investments (included in partnership investments) in Genesis are
accounted for under the equity method of accounting as the Company has the
ability to exercise significant influence over the operations of Genesis. At
December 31, 1996, Genesis' current assets, total assets and total equity is
$410,603,000, $510,132,000 and $111,338,000, respectively.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. Intercompany balances and transactions have been
eliminated from the consolidated financial statements. The Company accounted
for certain partnership investments, which were less than majority-owned,
under the equity method of accounting. Certain prior-year amounts have been
reclassified to conform to the current-year presentation.
Use of Estimates
The preparation of these consolidated financial statements required the use
of certain estimates and assumptions by management in determining the
Company's assets, liabilities, revenues and expenses. Actual results could
differ from those estimates.
F-39
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
Cash and Cash Equivalents
The Company considers investments purchased with an original maturity of
three months or less to be cash equivalents. At December 31, 1996 and 1995,
cash equivalents include U.S. Treasury bills that are pledged at banks for the
benefit of the NYMEX to support any open trading positions held by the Company
and to provide for the Company's Guaranty Fund deposit as required of all
NYMEX clearing members. These amounts were $13,500,000 and $2,300,000,
respectively, at December 31, 1996 and $5,300,000 and $2,300,000,
respectively, at December 31, 1995. The Company has no other requirements for
compensating balances or restrictions on cash.
Inventories
All physical inventories held for sale are carried at market value.
Due to the nature of the Company's refining and marketing activities,
significant levels of physical inventories are required, as determined by the
Company, to ensure efficient and uninterrupted operation of the Company's
refining and marketing facilities. These minimum refining and marketing
inventories are not marked-to-market as inventories held for sale but are
carried at the lower of cost or market using the weighted average cost method.
During 1996, the Company reduced its minimum refining and marketing
inventories (see Note 4).
Warehouse materials and supplies, including chemicals and catalysts, are
carried at the lower of cost or market.
Financial Instruments
The Company routinely utilizes forward contracts, swaps, options and futures
contracts. Gains and losses on forward contracts, swaps, options and futures
contracts used to hedge future anticipated refinery production or future
contract purchases of unpriced domestic crude oil where firm commitments to
sell are required prior to establishment of the purchase price, are deferred
until the margin from the underlying risk element is recognized in accordance
with Statement of Financial Accounting Standards (SFAS) No. 80, "Accounting
for Futures Contracts." Unrecognized losses of $2,803,000 and unrecognized
gains of $7,806,000 were deferred on these contracts at December 31, 1996 and
1995, respectively.
The Company accounts for all transactions, other than hedges of anticipated
refinery production and unpriced domestic crude oil discussed above, under the
mark-to-market method of accounting. Under this methodology, forward
contracts, swaps, options and futures contracts are reflected at market value
and the resulting unrealized gains and losses are recognized currently in the
consolidated statements of income. The net gains and losses are determined on
a counterparty-by-counterparty basis, netted when a contractual right of
offset exists, and are reflected as either an asset or liability on the
consolidated balance sheets.
Property, Plant and Equipment
Property, plant and equipment is carried at cost. Depreciation of property,
plant and equipment is provided using the straight-line method over the
respective estimated useful lives, which range from three to 30 years. Routine
maintenance, repairs and replacement costs are charged against current
operations. Expenditures which materially increase values, change capacities
or extend useful lives are capitalized.
F-40
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
In most cases, maintenance routines, known as turnarounds, are performed on
the major refinery units every two to four years. The Company accrues for
turnaround expenditures by charging cost of sales for amounts estimated to be
sufficient to fully fund the cost of the turnaround on the date it commences.
The accrued liability for future turnaround expenditures was $41,731,000 and
$14,865,000 at December 31, 1996 and 1995, respectively.
The Company capitalizes interest costs on major projects that require more
than one year to complete. Interest capitalized in 1996, 1995 and 1994 was
$5,410,000, $11,991,000 and $2,875,000, respectively.
During 1995, the Company adopted SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."
SFAS No. 121 provides accounting guidance with regard to the impairment of
long-lived assets when circumstances exist that indicate the carrying value of
an asset may not be recoverable. SFAS No. 121 requires an impairment
adjustment if expected future cash flows, undiscounted and excluding interest,
are less than the asset carrying value. Measurement of an impairment
adjustment is then based on the difference between the carrying value of the
asset and its fair value. Management has concluded that, pursuant to this
standard, no impairment adjustment is warranted.
Income Taxes
The Company is included in the consolidated federal income tax return of
Salomon. State income tax returns are filed separately for each entity except
where combined or consolidated returns are required or elected to be filed.
The Company's federal income taxes are provided as if the Company filed its
income tax return separately from Salomon. If there is federal taxable income,
taxes are provided at the federal statutory rate reduced by allowable tax
credits. If there is a taxable loss, a tax benefit is provided at the federal
statutory rate without limitation of any loss deduction. The tax benefit is
increased by tax credits to the extent the credits may be utilized by the
Salomon consolidated group.
State income taxes are provided on the basis that state income tax returns
are filed separately for each entity. Tax benefits from losses are provided
only if the entities are assured that the losses may be utilized in the filing
of state income tax returns.
The Company accounts for income taxes using the liability method,
recognizing deferred tax assets and liabilities for the expected future tax
consequences of events that have been recognized in the financial statements
or tax returns. Under this method, deferred tax assets and liabilities are
determined based on differences between the tax bases of assets and
liabilities and their reported amounts in the financial statements using
statutory tax rates.
Postemployment Benefits
Effective January 1, 1994, the Company adopted SFAS No. 112, "Employers'
Accounting for Postemployment Benefits." SFAS No. 112 requires employers to
accrue the cost of postemployment benefits during the service periods of
eligible employees. The Company recorded, as the cumulative effect of a change
in accounting principle, a net charge to income of $1,936,000 (net of an
income tax benefit of $1,043,000) to reflect the present value at January 1,
1994, of expected future benefits to be provided by the Company to former or
inactive employees after employment but before retirement attributed to
employees' services prior to the January 1, 1994, adoption date. For 1994, the
increase in expense, excluding the one-time cumulative adjustment, was
approximately $450,000.
F-41
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
Accounting Pronouncements
In October 1996, the American Institute of Certified Public Accountants
issued Statement of Position No. 96-1, "Environmental Remediation
Liabilities," which establishes new accounting and reporting for the
recognition and disclosure of environmental remediation liabilities. The
provisions of the statement are effective for fiscal years beginning after
December 15, 1996. The impact of this new standard has not been fully
evaluated, although it is not expected to have a significant effect on the
Company's consolidated financial position or results of operations.
In June 1996, the Financial Accounting Standards Board issued SFAS No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities," which establishes new accounting and
reporting standards for transfers and servicing of financial assets and
extinguishment of liabilities. The statement is effective for transactions
occurring after December 31, 1996. The impact of the adoption of the new
standard is not expected to have a significant effect on the Company's
consolidated financial position or results of operations.
3. SUPPLEMENTAL CASH FLOW INFORMATION:
In order to determine net cash provided by operating activities, the
Company's net income (loss) has been adjusted by, among other things, changes
in operating assets and liabilities, excluding changes in cash and cash
equivalents. Those changes are shown as an (increase) decrease in operating
assets or an increase (decrease) in operating liabilities as follows (in
thousands):
[Download Table]
YEARS ENDED DECEMBER 31,
-----------------------------
1996 1995 1994
-------- -------- ---------
Accounts receivable...................... $110,050 $ 16,016 $(152,525)
Inventories.............................. 15,928 57,575 (77,454)
Prepaid expenses and other current
assets................................... (62) (1,339) --
Accounts payable......................... (62,622) 16,875 148,254
Accrued liabilities...................... 45,869 (38,755) 25,885
Income taxes............................. (13,068) (57,849) 57,186
-------- -------- ---------
Total................................ $ 96,095 $ (7,477) $ 1,346
======== ======== =========
Interest payments, net of amounts capitalized, were $36,690,000, $27,913,000
and $17,602,000 during 1996, 1995 and 1994, respectively. The Company received
payments from Salomon in the fourth quarter of 1996 of $43,536,000 related to
1995 federal income tax net operating losses. The Company made payments to
Salomon in the fourth quarter of 1995 of $13,712,000 related to 1994 federal
income tax net operating income. The Company received $17,421,000 from Salomon
in the fourth quarter of 1995 in payment of 1992 and 1993 New York state and
city income tax benefits net of federal income taxes. The Company received a
$38,737,000 payment from Salomon in the fourth quarter of 1994 for utilization
of 1993 federal income tax net operating losses.
Noncash charges included in operating activities primarily relate to the
Company's method of accounting for turnaround expenditures and the adoption of
SFAS No. 112 in 1994. Other noncash items include the conversion of
$140,000,000 of the Company's working capital debt to additional paid-in
capital in 1996. (See Note 7).
F-42
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
4. INVENTORIES:
At December 31, 1996 and 1995, inventories consisted of the following (in
thousands):
[Download Table]
1996 1995
-------- --------
Refining and marketing inventories, at market......... $191,554 $140,339
Minimum refining and marketing inventories, at lower
of cost or market.................................... 126,252 172,154
Store warehouse inventories, at lower of cost or mar-
ket.................................................. 39,477 34,862
-------- --------
Total inventories................................. $357,283 $347,355
======== ========
As of December 31, 1996 and 1995, the number of barrels included in minimum
refining and marketing inventories was 7,805,000 and 11,199,000, respectively,
with approximate market values of $212,384,000 and $233,396,000, respectively.
In April 1996, the Company reduced its estimate of required minimum refining
and marketing inventories by 3,034,000 barrels to more closely reflect current
operations. The reduction of minimum inventories contributed approximately
$24,000,000 to operating income.
5. PROPERTY, PLANT AND EQUIPMENT:
At December 31, 1996 and 1995, property, plant and equipment consisted of
the following (in thousands):
[Download Table]
1996 1995
--------- --------
Land and buildings.................. $ 24,584 $ 22,932
Refining and processing facilities.. 980,513 946,493
Other............................... 12,297 9,002
--------- --------
1,017,394 978,427
Less: Accumulated depreciation...... (199,427) (173,484)
--------- --------
Property, plant and equipment
net............................. $ 817,967 $804,943
========= ========
Depreciation expense was $46,501,000, $34,857,000 and $35,359,000 for the
years ended December 31, 1996, 1995 and 1994, respectively.
During 1994, the Company revised the estimated useful lives of certain fixed
assets to more closely reflect expected useful lives. The effect of this
change in accounting estimate resulted in an increase in the Company's income
before taxes and cumulative effect of change in accounting principle of
approximately $10,200,000 in 1994.
6. OTHER ASSETS:
At December 31, 1996 and 1995, other assets consisted of the following (in
thousands):
[Download Table]
1996 1995
------ ------
Interest rate cap and corridor premiums,
less
accumulated amortization................. $ 126 $ 732
Exchange seats, at cost................... 1,584 1,584
Long-term investments..................... 97 190
Other assets.............................. 193 79
------ ------
Total other assets................... $2,000 $2,585
====== ======
Amortization of other assets at December 31, 1996, 1995 and 1994, was
$9,000, $2,637,000 and $5,058,000, respectively.
F-43
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
7. DEBT:
The Company and Salomon have a treasury management agreement whereby Salomon
provides a working capital facility on an unsecured basis. This agreement
expires on the earlier of August 31, 1997, or when the Company ceases to be a
wholly owned subsidiary of Salomon. Outstanding working capital borrowings
totaled $93,438,000 and $246,638,000 at December 31, 1996 and 1995,
respectively. The Company also has an unsecured subordinated term note with
Salomon that allows borrowings up to $525,000,000. The outstanding balances
under this note were $525,000,000 at December 31, 1996 and 1995. At December
31, 1996 and 1995, both the Company's working capital facility and unsecured
subordinated debt had fair values that approximated their carrying amounts.
At December 31, 1996 and 1995, the Company's working capital borrowings from
Salomon carried a variable interest rate based on the blended Salomon short-
term borrowing rate which tracked the daily federal funds rate. At December
31, 1996 and 1995, the Company's subordinated term note with Salomon carried
an interest rate based on, at the option of the Company, the daily federal
funds rate or LIBOR. At various times during 1996 and 1995, the Company
effectively converted its subordinated term note to fixed interest rate debt
using interest rate hedges.
Interest charged at rates in accordance with the working capital funding
agreement and subordinated term note with Salomon averaged 6.74 percent during
1996, 6.56 percent during 1995 and 4.32 percent during 1994. The Company, as a
net borrower from Salomon during 1996, 1995 and 1994, incurred interest
expense of $42,546,000, $37,850,000 and $20,199,000, respectively.
Effective January 3,1996, Salomon increased its equity investment in the
Company by converting $140,000,000 of the Company's working capital debt to
additional paid-in capital.
Interest on the unsecured subordinated term note with Salomon is due and
payable quarterly through December 31, 1997. Thereafter, the Company is
obligated to satisfy the outstanding balance with 20 equal quarterly principal
payments plus accrued interest commencing March 31,1998. Aggregate maturities
of long-term debt in the next five years are as follows (in thousands):
[Download Table]
1997.............................................................. $ --
1998.............................................................. 105,000
1999.............................................................. 105,000
2000.............................................................. 105,000
2001.............................................................. 105,000
Thereafter........................................................ 105,000
--------
Total......................................................... $525,000
========
Should the Company cease to be a wholly owned subsidiary of Salomon, the
subordinated term note becomes due and payable within 30 days of such
occurrence.
F-44
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
8.EMPLOYEE BENEFIT PLANS:
401(k) Profit-Sharing Benefits
In order to encourage long-term savings and to provide additional funds for
retirement to its employees, the Company sponsors a profit-sharing and
retirement savings plan. Under this plan, the Company's matching contribution
is calculated as the lesser of 50 percent of each employee's annual pretax
contribution or 3 percent of each employee's total compensation. The Company
also makes a profit-sharing contribution of at least 3 percent of each
eligible employee's total compensation. The Company's costs relating to this
plan were $4,284,000, $4,142,000 and $3,822,000 in 1996, 1995 and 1994,
respectively.
Health Care Benefits
The Company also provides certain health care benefits for its active
employees. Such program is funded by a combination of Company and active
employee contributions. At December 31, 1996, there were 1,387 active
employees eligible for such benefits. Expenses recorded for these benefits
were $5,752,000, $5,581,000 and $8,935,000 in 1996, 1995 and 1994,
respectively.
Postretirement Benefits
Effective January 1, 1993, the Company adopted SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions." SFAS No. 106
requires employers to accrue the cost of retiree health care and other
postretirement benefits during the service periods of eligible employees. The
Company's projected obligation with respect to these benefits is $6,802,000
and $7,160,000 as of December 31, 1996 and 1995, respectively, related to such
benefits. Expenses recorded for these benefits were $299,000, $264,000 and
$377,000 in 1996, 1995 and 1994, respectively.
Postemployment Benefits
As described in Note 2, effective January 1,1994, the Company adopted SFAS
No. 112, "Employers' Accounting for Postemployment Benefits." SFAS No. 112
requires employers to accrue the cost of postemployment benefits during the
service periods of eligible employees. The Company's projected obligation with
respect to these benefits is $3,166,000 and $3,314,000 as of December 31, 1996
and 1995, respectively, related to such benefits. Expenses recorded for these
benefits were $420,000, $417,000 and $450,000 in 1996, 1995 and 1994,
respectively.
9. LEASES:
The Company leases certain land, dock facilities, storage tanks, office
space and other equipment. Land leases are for periods from one to 18 years.
Dock facility and tank storage leases are for periods from one to seven years.
The future minimum rental payments under all noncancelable operating leases as
of December 31, 1996, were as follows (in thousands):
[Download Table]
1997............................................. $23,845
1998............................................. 15,279
1999............................................. 13,827
2000............................................. 8,313
2001............................................. 4,245
Thereafter....................................... 17,114
-------
Total..................................... $82,623
=======
F-45
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
Total operating lease expense for the years ended December 31, 1996, 1995
and 1994, was $47,870,000, $47,792,000 and $39,365,000, respectively.
10. INCOME TAXES:
The components of the provision (benefit) for income taxes are as follows
(in thousands):
[Download Table]
YEARS ENDED DECEMBER 31
---------------------------
1996 1995 1994
-------- -------- -------
Current--
Federal........................................ $(48,831) $(43,220) $16,616
State and local................................ 439 356 271
-------- -------- -------
Total current............................... (48,392) (42,864) 16,887
-------- -------- -------
Deferred--
Federal, from operations ...................... 13,610 8,970 (9,465)
Federal, effect of accounting change........... -- -- (1,043)
-------- -------- -------
Total deferred.............................. 13,610 8,970 (10,508)
-------- -------- -------
Total provision (benefit)................... $(34,782) $(33,894) $ 6,379
======== ======== =======
The components of deferred income tax assets and liabilities at December 31,
1996 and 1995, are as follows (in thousands):
[Download Table]
1996 1995
-------- --------
Deferred income tax assets--
Inventories, principally due to different inventory
valuations for book and tax purposes..................... $ -- $ 16,077
Accounts receivable, principally due to allowance for
doubtful accounts........................................ 548 1,240
Accrued liabilities, primarily contingency reserves and
turnaround accrual....................................... 21,911 10,933
Capitalized interest on construction in progress.......... 232 413
Other assets (liabilities)................................ 2,358 954
Future lease deductions................................... 18,785 19,344
Less: valuation allowance................................. (18,785) (19,344)
-------- --------
Total deferred income tax assets, net.................. 25,049 29,617
-------- --------
Deferred income tax liabilities--
Property and equipment principally due to accelerated de-
preciation for tax purposes.............................. (69,428) (55,910)
Inventories, principally due to different inventory
valuations for book and tax purposes..................... (1,588) --
Other..................................................... -- (313)
-------- --------
Total deferred income tax liabilities.................. (71,016) (56,223)
-------- --------
Net deferred income tax liabilities....................... $(45,967) $(26,606)
======== ========
The Company has determined that it is more likely than not that some of its
deferred tax assets will not be realized; therefore, a valuation allowance has
been provided in 1996 and 1995.
F-46
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
A reconciliation of income taxes computed at the federal statutory tax rate
to income taxes computed at the Company's effective tax rate is as follows (in
thousands):
[Download Table]
YEARS ENDED DECEMBER 31,
---------------------------
1996 1995 1994
-------- --------- ------
Provision (benefit) for income taxes at the stat-
utory rate...................................... $(35,157) $ (32,022) $7,208
State and local taxes............................ 286 232 175
Reversal of overaccrual of federal income taxes.. -- (2,052) --
Other............................................ 89 (52) 39
-------- --------- ------
Provision (benefit) for income taxes......... (34,782) (33,894) 7,422
Tax effect of accounting change.................. -- -- (1,043)
-------- --------- ------
Provision (benefit) for income taxes after
tax
effect of accounting change................. $(34,782) $(33,894) $6,379
======== ========= ======
11. RELATED-PARTY TRANSACTIONS:
During 1996, 1995 and 1994, the Company's working capital requirements were
funded through a working capital agreement between the Company and Salomon
(see Note 7). To the extent the Company has temporarily available excess
funds, these amounts are remitted to Salomon.
The Company has related-party sales and purchases of crude oil and refined
products with a wholly owned subsidiary of Salomon transacted at prevailing
market prices which amounted to approximately $340,558,000 and $364,257,000,
respectively, for 1996, approximately $882,747,000 and $848,776,000,
respectively, for 1995, and approximately $572,706,000 and $770,112,000,
respectively, for 1994.
The Company had sales and purchases of crude oil with Genesis during
December 1996 amounting to $1,081,000 and $51,791,000, respectively. Included
in these amounts are purchases made under a one-year term contract beginning
in 1996 for purchases of 11,000 barrels of crude oil per day into the
Company's Krotz Springs, Louisiana refinery at market-based prices. The
Company has agreed to provide certain administrative and NYMEX transaction
clearing services to Genesis, but may terminate this agreement upon 90 days'
notice. Such costs are allocated based upon the percentage of the Company's
resources applied to Genesis' operations. The Company allocated $119,000 to
Genesis for December 1996 related to such services. At December 31, 1996, the
Company had a receivable balance of $4,609,000 and payable balance of
$61,946,000 with Genesis.
In addition, pursuant to a credit support agreement (Master Credit Support
Agreement), Salomon will provide Genesis with credit support in the form of
guarantees, up to prescribed limits that will decline over a period of three
years, in connection with the purchase, sale or exchange of crude oil in
transactions with third parties in the ordinary course of Genesis' business.
The cost of such credit support by Salomon will increase over the three-year
period from a below-market rate to a rate that may be higher than rates paid
to independent financial institutions for similar credit. In addition,
pursuant to the Master Credit Support Agreement, the Company will use its
reasonable best efforts to provide Genesis with, for a period of six months
ending May 31, 1997, a line of credit of up to $50,000,000, which amount
includes direct cash advances not to exceed $35,000,000, outstanding at any
one time and letters of credit that may be required in the ordinary course of
Genesis' business. Salomon and the Company will receive a security interest in
all of Genesis' receivables, inventories, general intangibles and cash to
secure obligations under the Master Credit Support Agreement.
F-47
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
Salomon agreed, subject to certain limitations, to contribute cash, if
necessary, to Genesis in return for subordinated partnership interests (APIs).
Solomon's obligation to purchase APIs may be assigned in certain circumstances
and is limited in any one quarter to an amount equal to the defined minimum
quarterly distribution payable to the unit holders of Genesis up to a maximum
amount outstanding at any one time equal to $17.6 million.
Sales, purchases and other transactions with affiliated companies, including
Genesis, in the opinion of management, are conducted under terms no more or
less favorable than those conducted with unaffiliated parties.
On September 12, 1995, the Company sold its equity investment in Patterson
Energy, Inc. (Patterson), to Salomon Brothers Inc (SBI) who, in turn, sold the
investment to a third party. As a result the Company transferred at market value
250,000 shares of Patterson stock to SBI for $2,500,000, resulting in a gain of
$625,000.
2. COMMITMENTS AND CONTINGENCIES:
The Company has contractual commitments (primarily forward contracts)
arising in the ordinary course of business. The consummation of these
commitments is not expected to have a material adverse effect on the Company's
financial position or results of operations.
The Company is subject to lawsuits in the normal course of business and
examination by tax and other regulatory authorities. Such matters presently
pending are not expected to have a material adverse effect on the Company's
financial position or results of operations.
As a result of the sale of certain tax benefits in 1983, the Company is
contingently liable at December 31, 1996, for up to $13,189,000 under a
standby letter of credit. This contingent liability would be payable only if
certain conditions were to exist with respect to property located at the Krotz
Springs, Louisiana refinery, which would result in a termination of the lease
underlying the tax benefit sale. The liability diminishes over time until the
year 2007 when it expires.
The Company is subject to various environmental laws and regulations.
Policies and procedures are in place to monitor compliance. The Company
continues to commit a significant portion of its capital budget to
environmental projects. The Company's management has made an assessment of its
potential environmental exposure and determined that such exposure is not
material to its financial position or results of operations.
The Company has several uncommitted lines of credit in place which are
provided by commercial banks on a stand-alone credit basis without support
from Salomon. Outstanding letters of credit under these lines totaled
$127,572,000, $19,175,000 and $74,415,000 at December 31, 1996, 1995 and 1994,
respectively.
The Company also is contingently liable for irrevocable letters of credit of
$5,000,000 available to satisfy margin and guarantee requirements of the
NYMEX.
In connection with the sale of the assets of Questor Drilling Corp. to
Patterson (see Note 14), the Company agreed to retain certain liabilities
relating to past, present or future controversy or litigation in connection
with the Company's ownership and/or operation of the assets acquired by
Patterson. The Company has agreed to indemnify Patterson against any losses,
liabilities and damages incurred by Patterson that may arise from any
liabilities retained by the Company. Management believes any such
indemnification will not have a material effect upon the financial position or
results of operations.
F-48
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
13. FINANCIAL INSTRUMENTS:
Market Risk
In order to hedge its exposure to market fluctuations, the Company enters
into various financial instruments with off-balance sheet risk, including
option contracts, swap agreements and interest rate caps and corridors. The
Company does not consider its commodity futures and forward contracts to be
financial instruments since these contracts either require or permit
settlement by the delivery of the underlying commodities.
The Company's objectives for entering into these financial instruments are
the following:
a. To hedge the rate risk of future increases in the Company's variable
interest rate obligations. The premiums paid for these instruments are
amortized over the life of the instrument.
b. To hedge the market risk of future anticipated refinery feedstock
charges and product yields. Any resulting gains and losses are deferred
until recognition of any gains or losses on the transactions being
hedged.
Gains and losses on financial instruments are recognized in cost of sales on
the accompanying consolidated statements of operations. Normally, any
contracts used to hedge market risk are relatively short-term in duration. As
of December 31, 1996, there were 11 contracts with terms beyond one year.
At December 31, 1996, the Company had written average price options on
24,000,000 barrels of crude oil with terms extending through December 31,
1997. These options obligate the Company to buy the committed barrels at
$18.50 per barrel. At December 31, 1996, the Company had purchased average
price options on 24,000,000 barrels of crude oil with terms extending through
December 31, 1997. These options obligate the Company to sell the first near
month committed barrels and buy the second near month barrels at market
prices.
Fair Value and Net Gains and Losses
Estimated fair values of financial instruments and the net gains and losses,
both recognized and deferred at December 31, 1996, 1995 and 1994, are as
follows (in thousands):
[Enlarge/Download Table]
1996 1995 1994
------------------------- ------------------------ --------------------------
NET NET NET
CARRYING FAIR GAINS CARRYING FAIR GAINS CARRYING FAIR GAINS
AMOUNT VALUE (LOSSES) AMOUNT VALUE (LOSSES) AMOUNT VALUE (LOSSES)
-------- ------- -------- -------- ------ -------- -------- ------- --------
Option contracts
written................ $-- $ -- $ -- $3,300 $5,983 $ (2,683) $2,433 $ 2,298 $ (135)
Swap agreements......... -- 10,417 10,417 -- 5,554 5,554 -- (2,717) (2,717)
Interest rate caps and
corridors.............. 127 127 -- 732 751 19 2,032 3,759 1,727
Loan guarantees......... -- -- -- -- -- -- -- 12,500 --
Quoted market prices are used in determining the fair value of financial
instruments held or issued for trading purposes. If quoted prices are not
available, fair values are estimated on the basis of pricing models or quoted
prices for financial instruments with similar characteristics.
F-49
BASIS PETROLEUM, INC.
(FORMERLY PHIBRO ENERGY USA, INC.)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996
Credit Risk
Credit risk represents the accounting loss that the Company would record if
counterparties of its financial transactions failed to perform pursuant to
contractual terms. Management of credit risk involves a number of
considerations, such as the financial profile of the counterparty, the value
of collateral held, if any, specific terms and duration of the contractual
agreement and the counterparty's sensitivity to political and macroeconomic
developments.
The Company has established various procedures to manage credit exposure,
including initial credit approval, credit limits, collateral requirements and
rights of offset. Letters of credit prepayments and guarantees are also
utilized to limit credit risk to ensure that management's established credit
criteria are met.
14. SALE OF ASSETS:
In January 1994, the Company sold its St. Rose refinery located in
Louisiana, which was the Company's smallest and least sophisticated refinery.
The proceeds from the sale of the refinery, including inventory, were
$9,962,000, resulting in a gain of $1,704,000.
During 1994, substantially all the excess equipment purchased but not
required to complete the Company's Residfiner/ROSE unit complex construction
project was sold for approximately $24,200,000, resulting in a gain of
$1,830,000.
In July 1994, the Company sold substantially all of its physical assets of
Questor Drilling Corp. to Patterson for $4,500,000 in cash and 250,000 shares
of Patterson common stock (see Notes 11 and 12). The resulting gain was
immaterial to the Company's results of operations. The Patterson shares
acquired were subject to certain transfer restrictions. In addition, the
Company held certain rights to require Patterson to register the shares and
otherwise guarantee the sale price of the shares.
In July 1994, the Company sold the assets of its Louisiana-based marine
fuels and lubricants business for approximately $1,600,000. The resulting loss
was immaterial to the Company's results of operations.
In 1995 and 1994, the Company terminated various interest rate caps and
corridors. The amount realized on termination exceeded the unamortized cost of
these instruments, resulting in gains of $915,000 and $2,902,000,
respectively.
15. SUBSEQUENT EVENT:
On March 17, 1997, Salomon announced that its Board of Directors had
approved a letter of intent to sell all of the outstanding common stock of
Basis to Valero Energy Corporation (Valero). Closing is expected in May 1997.
Proceeds to Salomon from the sale will include cash of $365 million, Valero
common stock of $120 million and participation payments. The participation
payments are based on a fixed notional throughput and the difference, if any,
between an average market crackspread and a base crackspread over each of the
next ten years. The sale is subject to negotiation of a final agreement and to
the satisfaction of other customary conditions.
Such letter of intent reflects a sales price substantially less than the
Company's net book value. The sales price reflects the fair value of the
Company as perceived by a buyer.
Valero will be adjusting the historical carrying values of the Company's
assets and liabilities under purchase accounting to reflect fair values as
determined by the sales price.
F-50
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
The following table sets forth the various expenses in connection with the
sale and distribution of the securities being registered, other than the
underwriting discounts and commissions. All amounts shown are estimates except
for the Securities and Exchange Commission registration fee.
[Download Table]
SEC Registration Fee.......................................... $ 453,581.81
NYSE Fees..................................................... 5,300
Transfer Agent and Registrar Fees............................. 20,000
Accounting Fees and Expenses.................................. 450,000
Legal Fees and Expenses....................................... 450,000
Printing, Engraving and Mailing Expenses...................... 225,000
Miscellaneous................................................. 5,000
-------------
Total....................................................... $1,608,881.81
=============
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
LIMITATION OF LIABILITY
As permitted by Section 102(b)(7) of the DGCL, the New Valero Certificate
provides that a director of New Valero will not be personally liable to New
Valero or its stockholders for monetary damages for breach of fiduciary duty
as a director, except for liability (i) for any breach of the director's duty
of loyalty to New Valero or its stockholders, (ii) for acts or omissions not
in good faith or which involve intentional misconduct or a knowing violation
of law, (iii) under Section 174 of Title 8 of the DGCL, which concerns
unlawful payments of dividends, stock purchases or redemptions, or (iv) for
any transaction from which the director derived an improper personal benefit.
While the New Valero Certificate provides directors with protection from
awards for monetary damages for breaches of their duty of care, it does not
eliminate such duty. Accordingly, the New Valero Certificate will have no
effect on the availability of equitable remedies such as an injunction or
rescission based on a director's breach of his or her duty of care. The
provisions of the New Valero Certificate described above apply to an officer
of New Valero only if he or she is a director of New Valero and is acting in
his or her capacity as director, and do not apply to officers of New Valero
who are not directors.
INDEMNIFICATION AND INSURANCE
The New Valero Certificate provides that New Valero will indemnify its
directors, officers, employees, agents, or any person who is or was serving at
the request of New Valero as a director, officer, employee or agent of another
corporation, partnership, joint venture, trust or other enterprise, to the
full extent permitted by the law of the State of Delaware.
Section 145 of the DGCL provides that a corporation may indemnify any person
who was or is a party or is threatened to be made a party to any threatened,
pending or completed action, suit or proceeding, whether civil, criminal or
investigative (other than an action by or in the right of the corporation) by
reason of the fact that he or she is or was a director, officer, employee or
agent of the corporation or is or was serving at the request of the
corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, against expenses
(including attorneys' fees), judgments, fines and amounts paid in settlement
actually and reasonably incurred by him or her in connection with such action,
suit or proceeding if he or she acted in good faith and in a manner he or she
reasonably believed to be in or not opposed to the best interests of
II-1
the corporation, and with respect to any criminal action or proceeding, had
not reasonable cause to believe his or her conduct was unlawful. Section 145
of the DGCL further provides that a corporation similarly may indemnify any
such person serving in any such capacity who was or is a party or is
threatened to be made by a party to any threatened, pending or completed
action or suit by or in the right of the corporation to procure a judgment in
its favor, against expenses actually and reasonably incurred in connection
with the defense or settlement of such action or suit if he or she acted in
good faith and in a manner he or she reasonably believed to be in or not
opposed to the best interest of the corporation and except that no
indemnification shall be made in respect of any claim, issue or matter as to
which such person shall have been adjudged to be liable to the corporation
unless and only to the extent that the Delaware Court of Chancery or such
other court in which such action or suit was brought shall determine upon
applications that, despite the adjudication of liability but in view of all
the circumstances of the case, such person is fairly and reasonably entitled
to indemnity for such expenses which the Court of Chancery or such other court
shall deem proper.
The New Valero By-laws provide that each director or officer of New Valero
who was or is made a party or is threatened to be made a party to or is
involved in any threatened, pending or completed action, suit or proceeding,
whether civil, criminal, administrative or investigative, by reason of the
fact that he, or a person of whom he is the legal representative, is or was a
director or officer of New Valero or is or was serving at the request of New
Valero as a director, officer, employee or agent of another corporation or of
a partnership, joint venture, trust or other enterprise, including service
with respect to employee benefit plans, whether the basis of such proceeding
is alleged action in an official capacity while serving as a director,
officer, employee or agent, will be indemnified and held harmless by New
Valero to the fullest extent authorized by the DGCL (but, in the case of any
amendment thereto, only to the extent that such amendment permits New Valero
to provide broader indemnification rights than the DGCL permitted New Valero
to provide prior to such amendment), against all expenses (including
attorneys' fees), judgments, fines and amounts paid in settlement actually and
reasonably incurred by such person in connection therewith and such
indemnification will continue as to a person who has ceased to be a director,
officer, employee or agent and will inure to the benefit of his heirs,
executors and administrators. The right to indemnification conferred in the
New Valero By-laws is a contract right and includes the right to be paid by
New Valero the expenses incurred in defending any such proceeding in advance
of its final disposition; provided, however, that, if the DGCL requires, the
payment of such expenses incurred by a director or officer in his capacity as
a director or officer (but not in any other capacity in which service was or
is rendered by such person while a director or officer, including, without
limitation, service with respect to an employee benefit plan) in advance of
the final disposition of a proceeding will be made only upon delivery to New
Valero of an undertaking, by or on behalf of such director or officer, to
repay all amounts so advanced if it will ultimately be determined that such
director or officer is not entitled to be indemnified under the applicable
provisions of the DGCL. New Valero may, by action of the New Valero Board or
as required pursuant to the New Valero Certificate, provide indemnification to
employees and agents of New Valero with the same scope and effect as the
foregoing indemnification of directors and officers.
As is permitted under Section 145 of the DGCL, New Valero also intends to
enter into individual indemnification agreements ("Indemnification
Agreements") with its officers and directors. Each Indemnification Agreement
will provide directors and officers with additional contractual assurance that
indemnification and advancement of expenses will be available to them
regardless of any amendments to or revocation of the indemnification
provisions of the New Valero By-laws. Each Indemnification Agreement provides
for indemnification of directors and officers against both stockholder
derivative claims and third-party claims. Sections 145(a) and 145(b) of the
DGCL, which grant corporations the power to indemnify directors and officers,
specifically authorize lesser indemnifications in connection with derivative
claims than in connection with third-party claims. The distinction is that
Section 145(a), concerning third-party claims, authorizes expenses and
judgments and amounts paid in settlement (as is provided in each
Indemnification Agreement), while Section 145(b), concerning derivative suits,
generally authorizes only indemnification of expenses. However, Section 145(f)
expressly provides that the indemnification and advancement of expenses
provided by or granted pursuant to the subsections of Section 145 shall not be
exclusive of any other rights to which those seeking indemnification or
advancement of expenses may be entitled under any agreement.
II-2
In connection with the Distribution, New Valero will assume all rights and
obligations of Valero with respect to an insurance policy that insures
directors and officers against certain liabilities.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
None.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Exhibits:
[Download Table]
EXHIBIT
NO. DESCRIPTION
------- -----------
2.1 Agreement and Plan of Merger, dated as of January 31, 1997, as
amended, by and among Valero Energy Corporation, PG&E Corporation,
and PG&E Acquisition Corporation. Valero Refining and Marketing
Company agrees to furnish supplementally a copy of any omitted
exhibit or schedule to the Commission upon request.
2.2 Form of Agreement and Plan of Distribution between Valero Energy
Corporation and Valero Refining and Marketing Company. Valero
Refining and Marketing Company agrees to furnish supplementally a
copy of any omitted exhibit or schedule to the Commission upon
request.
2.3 Form of Tax Sharing Agreement among Valero Energy Corporation,
Valero Refining and Marketing Company and PG&E Corporation. New
Valero agrees to furnish supplementally a copy of any omitted
exhibit or schedule to the Commission upon request.
2.4 Form of Employee Benefits Agreement between Valero Energy
Corporation and Valero Refining and Marketing Company. Valero
Refining and Marketing Company agrees to furnish supplementally a
copy of any omitted exhibit or schedule to the Commission upon
request.
2.5 Form of Interim Services Agreement between Valero Energy Corporation
and Valero Refining and Marketing Company. Valero Refining and
Marketing Company agrees to furnish supplementally a copy of any
omitted exhibit or schedule to the Commission upon request.
3.1 Amended and Restated Certificate of Incorporation of Valero Refining
and Marketing Company.
3.2 By-Laws of Valero Refining and Marketing Company.
4.1 Form of Rights Agreement between Valero Refining and Marketing
Company and Harris Trust and Savings Bank, as Rights Agent.
4.2 Form of Credit Agreement among Valero Refining and Marketing
Company, Morgan Guaranty Trust Company of New York, Bank of Montreal
and the banks and co-agents party thereto.
5 Opinion of Morris, Nichols, Arsht & Tunnell with respect to the
validity of the securities being offered.
10.1 Valero Refining and Marketing Company Executive Incentive Bonus
Plan, dated as of April 23, 1997.
10.2 Valero Refining and Marketing Company Executive Stock Incentive
Plan, dated as of April 23, 1997.
10.3 Valero Refining and Marketing Company Stock Option Plan, dated as of
April 23, 1997.
10.4 Valero Refining and Marketing Company Restricted Stock Plan for Non-
Employee Directors, dated as of April 23, 1997.
10.5 Valero Refining and Marketing Company Non-Employee Director Stock
Option Plan, dated as of April 23, 1997.
10.6 Executive Severance Agreement between Valero Energy Corporation and
William E. Greehey, dated December 15, 1982, as adopted and ratified
by Valero Refining and Marketing Company.
10.7 Schedule of Executive Severance Agreements.
10.8 Form of Indemnity Agreement between Valero Refining and Marketing
Company and William E. Greehey.
10.9 Schedule of Indemnity Agreements.
10.10 Form of Incentive Bonus Agreement between Valero Refining and
Marketing Company and Gregory C. King.
II-3
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EXHIBIT
NO. DESCRIPTION
------- -----------
10.11 Schedule of Incentive Bonus Agreements.
10.12 Form of Management Stability Agreement between Valero Refining and
Marketing Company and Gregory C. King.
10.13 Schedule of Management Stability Agreements.
11.1 Computation of Earnings Per Share.
21.1 List of subsidiaries of Valero Refining and Marketing Company.
23.1 Consent of Arthur Andersen LLP with respect to Registrant.
23.2 Consent of Arthur Andersen LLP with respect to Basis Petroleum.
23.3 Consent of Morris, Nichols, Arsht & Tunnell (included in Exhibit 5).
24.1 Powers of Attorney (included with signature page).
(b) All applicable required schedules are included in the Prospectus and
therefore are omitted from the following pages of this Registration Statement.
Copies of exhibits filed as a part of this Registration Statement may be
obtained by stockholders of record at a charge of $.15 per page, minimum $5.00
each request. Direct inquiries to Rand C. Schmidt, Corporate Secretary, Valero
Refining and Marketing Company, P.O. Box 500, San Antonio, Texas 78292.
Pursuant to paragraph 601(b)(4)(iii)(A) of Regulation S-K, the registrant
has omitted from the foregoing listing of exhibits, and hereby agrees to
furnish to the Securities and Exchange Commission, upon its request, copies of
certain instruments, each relating to long-term debt not exceeding 10% of the
total assets of the registrant and its subsidiaries on a consolidated basis.
ITEM 17. UNDERTAKING
The undersigned Registrant hereby undertakes:
(a)-(g) Not applicable.
(h) Insofar as indemnification for liabilities arising under the Act may
be permitted to directors, officers and controlling persons of the
Registrant pursuant to the provisions contained in the Certificate of
Incorporation and By-Laws of the Registrant and the laws of the State of
Delaware, or otherwise, the Registrant has been advised that in the opinion
of the Securities and Exchange Commission such indemnification is against
public policy as expressed in the Act and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other
than the payment by the Registrant of expenses incurred or paid by a
director, officer or controlling person of the Registrant in the successful
defense of any action, suit or proceeding) is asserted by such director,
officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question whether such indemnification by it is
against public policy as expressed in the Act and will be governed by the
final adjudication of such issue.
(i) Not applicable.
II-4
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized in the City of San Antonio, State of
Texas, on May 13, 1997.
Valero Refining and Marketing
Company
/s/ William E. Greehey
By: _________________________________
William E. Greehey Chairman of
the Board and Chief Executive
Officer
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes and appoints
William E. Greehey, Edward C. Benninger and Rand C. Schmidt, or either of
them, as his attorney-in-fact, with full power of substitution and
resubstitution, to sign and file on his behalf individually and in each such
capacity stated below any and all amendments and post-effective amendments to
this Registration Statement, as fully as such person could do in person,
hereby verifying and confirming all that said attorney-in-fact, or his
substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
SIGNATURES TITLE DATE
/s/ William E. Greehey Director, Chairman May 13, 1997
----------------------------------- of the Board and
William E. Greehey Chief Executive
Officer (Principal
Executive Officer)
/s/ Edward C. Benninger Director and May 13, 1997
----------------------------------- President
Edward C. Benninger (Principal
Accounting and
Financial Officer)
/s/ E. Baines Manning Director May 13, 1997
-----------------------------------
E. Baines Manning
/s/ Stan L. McLelland Director May 13, 1997
-----------------------------------
Stan L. McLelland
/s/ George E. Kain Director May 13, 1997
-----------------------------------
George E. Kain
/s/ Wayne D. Smithers Director May 13, 1997
-----------------------------------
Wayne D. Smithers
II-5
EXHIBIT INDEX
Exhibits required by S-K item 601:
[Download Table]
EXHIBIT
NO. DESCRIPTION
------- -----------
2.1 Agreement and Plan of Merger, dated as of January 31, 1997, as
amended, by and among Valero Energy Corporation, PG&E Corporation,
and PG&E Acquisition Corporation. Valero Refining and Marketing
Company agrees to furnish supplementally a copy of any omitted
exhibit or schedule to the Commission upon request.
2.2 Form of Agreement and Plan of Distribution between Valero Energy
Corporation and Valero Refining and Marketing Company. Valero
Refining and Marketing Company agrees to furnish supplementally a
copy of any omitted exhibit or schedule to the Commission upon
request.
2.3 Form of Tax Sharing Agreement among Valero Energy Corporation,
Valero Refining and Marketing Company and PG&E Corporation. New
Valero agrees to furnish supplementally a copy of any omitted
exhibit or schedule to the Commission upon request.
2.4 Form of Employee Benefits Agreement between Valero Energy
Corporation and Valero Refining and Marketing Company. Valero
Refining and Marketing Company agrees to furnish supplementally a
copy of any omitted exhibit or schedule to the Commission upon
request.
2.5 Form of Interim Services Agreement between Valero Energy Corporation
and Valero Refining and Marketing Company. Valero Refining and
Marketing Company agrees to furnish supplementally a copy of any
omitted exhibit or schedule to the Commission upon request.
3.1 Amended and Restated Certificate of Incorporation of Valero Refining
and Marketing Company.
3.2 By-Laws of Valero Refining and Marketing Company.
4.1 Form of Rights Agreement between Valero Refining and Marketing
Company and Harris Trust and Savings Bank, as Rights Agent.
4.2 Form of Credit Agreement among Valero Refining and Marketing
Company, Morgan Guaranty Trust Company of New York, Bank of Montreal
and the banks and co-agents party thereto.
5 Opinion of Morris, Nichols, Arsht & Tunnell with respect to the
validity of the securities being offered.
10.1 Valero Refining and Marketing Company Executive Incentive Bonus
Plan, dated as of April 23, 1997.
10.2 Valero Refining and Marketing Company Executive Stock Incentive
Plan, dated as of April 23, 1997.
10.3 Valero Refining and Marketing Company Stock Option Plan, dated as of
April 23, 1997.
10.4 Valero Refining and Marketing Company Restricted Stock Plan for Non-
Employee Directors, dated as of April 23, 1997.
10.5 Valero Refining and Marketing Company Non-Employee Director Stock
Option Plan, dated as of April 23, 1997.
10.6 Executive Severance Agreement between Valero Energy Corporation and
William E. Greehey, dated December 15, 1982, as adopted and ratified
by Valero Refining and Marketing Company.
10.7 Schedule of Executive Severance Agreements.
10.8 Form of Indemnity Agreement between Valero Refining and Marketing
Company and William E. Greehey.
10.9 Schedule of Indemnity Agreements.
10.10 Form of Incentive Bonus Agreement between Valero Refining and
Marketing Company and Gregory C. King.
10.11 Schedule of Incentive Bonus Agreements.
10.12 Form of Management Stability Agreement between Valero Refining and
Marketing Company and Gregory C. King.
10.13 Schedule of Management Stability Agreements.
11.1 Computation of Earnings Per Share.
21.1 List of subsidiaries of Valero Refining and Marketing Company.
[Download Table]
EXHIBIT
NO. DESCRIPTION
------- -----------
23.1 Consent of Arthur Andersen LLP with respect to Registrant.
23.2 Consent of Arthur Andersen LLP with respect to Basis Petroleum.
23.3 Consent of Morris, Nichols, Arsht & Tunnell (included in Exhibit 5).
24.1 Powers of Attorney (included with signature page).
(b) All applicable required schedules are included in the Prospectus and
therefore are omitted from the following pages of this Registration Statement.
Copies of exhibits filed as a part of this Registration Statement may be
obtained by stockholders of record at a charge of $.15 per page, minimum $5.00
each request. Direct inquiries to Rand C. Schmidt, Corporate Secretary, Valero
Refining and Marketing Company, P.O. Box 500, San Antonio, Texas 78292.
Pursuant to paragraph 601(b)(4)(iii)(A) of Regulation S-K, the registrant
has omitted from the foregoing listing of exhibits, and hereby agrees to
furnish to the Securities and Exchange Commission, upon its request, copies of
certain instruments, each relating to long-term debt not exceeding 10% of the
total assets of the registrant and its subsidiaries on a consolidated basis.
Dates Referenced Herein and Documents Incorporated by Reference
2 Subsequent Filings that Reference this Filing
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