Filed Pursuant to Rule 424(b)(1)
Registration No. 333-89978
Registration No. 333-89978-01
PROSPECTUS SUPPLEMENT
(To Prospectus dated June 17, 2002)
(VALERO LP LOGO)
5,750,000 COMMON UNITS
REPRESENTING LIMITED PARTNER INTERESTS
--------------------------------------------------------------------------------
We are offering to sell up to 5,750,000 common units representing limited
partner interests in Valero L.P. Our common units are listed on the New York
Stock Exchange under the symbol "VLI." The last reported sale price of our
common units on the New York Stock Exchange on March 12, 2003 was $36.75 per
unit.
Investing in the common units involves risk. "Risk Factors" begin on page S-19
of this prospectus supplement and on page 4 of the accompanying prospectus.
PER COMMON UNIT TOTAL
--------------- ------------
Public offering price....................................... $36.75 $211,312,500
Underwriting Discount....................................... $ 1.56 $ 8,970,000
Proceeds to Valero L.P. (before expenses)................... $35.19 $202,342,500
We have granted the underwriters a 30-day option to purchase up to 862,500
common units on the same terms and conditions as set forth above to cover
over-allotments, if any.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS
PROSPECTUS SUPPLEMENT OR THE ACCOMPANYING PROSPECTUS IS TRUTHFUL OR COMPLETE.
ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
Lehman Brothers, on behalf of the underwriters, expects to deliver the common
units on or about March 18, 2003.
--------------------------------------------------------------------------------
LEHMAN BROTHERS
GOLDMAN, SACHS & CO.
MORGAN STANLEY
SALOMON SMITH BARNEY
UBS WARBURG
CREDIT SUISSE FIRST BOSTON
RBC CAPITAL MARKETS
SANDERS MORRIS HARRIS
MARCH 12, 2003
[Map showing assets proposed to be contributed to Valero Logistics as well
as Valero Logistics' current asset portfolio including its refined product
pipelines, crude oil pipelines, natural gas liquid pipelines, hydrogen pipeline,
refined product terminals and crude oil storage facilities in Colorado, Kansas,
New Mexico, Oklahoma, Texas and California as well as the Valero Energy
refineries interconnected with the Valero Logistics pipelines.]
This document is in two parts. The first part is this prospectus
supplement, which describes the specific terms of this common unit offering. The
second part is the accompanying prospectus, which gives more general
information, some of which may not apply to this common unit offering. If the
description of the common unit offering varies between the prospectus supplement
and the accompanying prospectus, you should rely on the information in the
prospectus supplement. The sections captioned "Where You Can Find More
Information" and "Validity of the Securities" in the accompanying prospectus are
superseded in their entirety by the similarly titled sections included in this
prospectus supplement.
You should rely only on the information contained or incorporated by
reference in this prospectus supplement and the accompanying prospectus. We have
not authorized anyone to provide you with additional or different information.
If anyone provides you with additional, different or inconsistent information,
you should not rely on it. We are offering to sell the common units, and seeking
offers to buy the common units, only in jurisdictions where offers and sales are
permitted. You should not assume that the information we have included in this
prospectus supplement or the accompanying prospectus is accurate as of any date
other than the dates shown in these documents or that any information we have
incorporated by reference is accurate as of any date other than the date of the
document incorporated by reference. Our business, financial condition, results
of operations and prospects may have changed since that date.
TABLE OF CONTENTS
PAGE
----
PROSPECTUS SUPPLEMENT
Where You Can Find More Information... ii
Summary............................... S-1
Risk Factors.......................... S-19
The Transactions...................... S-23
Use of Proceeds....................... S-34
Capitalization........................ S-35
Price Range of Common Units and
Distributions....................... S-36
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... S-37
Business.............................. S-54
Tax Considerations.................... S-67
Underwriting.......................... S-68
Notice to Canadian Residents.......... S-71
Validity of the Securities............ S-72
Experts............................... S-72
Index to Financial Statements......... F-1
PAGE
----
PROSPECTUS
About Valero L.P. and Valero Logistics
Operations.......................... 1
About this Prospectus................. 1
Where You Can Find More Information... 1
Forward-Looking Statements............ 3
Risk Factors.......................... 4
Use of Proceeds....................... 16
Ratio of Earnings to Fixed Charges.... 16
Description of Common Units........... 17
Cash Distributions.................... 18
Description of Debt Securities........ 25
Book Entry, Delivery and Form......... 35
Tax Considerations.................... 37
Investment in Us by Employee Benefit
Plans............................... 51
Plan of Distribution.................. 52
Validity of the Securities............ 53
Experts............................... 53
Change in Independent Public
Accountants......................... 53
i
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement with the SEC under the Securities
Act of 1933 that registers the common units offered by this prospectus
supplement. The registration statement, including the attached exhibits,
contains additional relevant information about us. The rules and regulations of
the SEC allow us to omit some information included in the registration statement
from this prospectus supplement.
In addition, we file annual, quarterly and other reports and other
information with the SEC. You may read and copy any document we file at the
SEC's public reference room at 450 Fifth Street, N.W., Washington, D.C. 20549.
Please call the SEC at 1-800-SEC-0330 for further information on the operation
of the SEC's public reference room. Our SEC filings are also available at the
SEC's website at http://www.sec.gov.
The SEC allows us to "incorporate by reference" the information we have
filed with the SEC. This means that we can disclose important information to you
without actually including the specific information in this prospectus
supplement by referring you to another document filed separately with the SEC.
The information incorporated by reference is an important part of this
prospectus supplement. Information that we file later with the SEC will
automatically update and may replace information in this prospectus supplement
and information previously filed with the SEC.
We incorporate by reference the documents listed below that we have
previously filed with the SEC. They contain important information about us, our
financial condition and results of operations.
- Valero L.P.'s Annual Report on Form 10-K for the year ended December 31,
2002;
- the description of our common units contained in our registration
statement on Form 8-A, filed on March 30, 2001; and
- any future filings made with the SEC under Sections 13(a), 13(c), 14 or
15(d) of the Securities Exchange Act of 1934 subsequent to the date of
this prospectus supplement and until all of the securities offered by
this prospectus have been sold.
You may obtain any of the documents incorporated by reference in this
document through us or from the SEC through the SEC's website at the address
provided above. Documents incorporated by reference are available from us
without charge, excluding any exhibits to those documents, unless the exhibit is
specifically incorporated by reference in this document, by requesting them in
writing or by telephone from us at the address below. You may also obtain these
documents through our website at www.valerolp.com.
Investor Relations
Valero L.P.
One Valero Place
San Antonio, Texas 78212
Telephone: (210) 370-2000
ii
SUMMARY
The summary highlights information contained elsewhere in this prospectus
supplement and the accompanying prospectus. It does not contain all of the
information that you should consider before making an investment decision. You
should read the entire prospectus supplement and the accompanying prospectus
carefully, including the historical financial statements and notes to those
financial statements included in this prospectus supplement. Please read "Risk
Factors" beginning on page S-19 of this prospectus supplement and beginning on
page 4 of the accompanying prospectus for more information about important risks
that you should consider before buying our common units. Unless the context
otherwise indicates, the information presented in this prospectus supplement
assumes that the underwriters do not exercise their over-allotment option. In
this prospectus supplement, unless the context otherwise indicates, the terms
"Valero L.P." and "we," "us," "our" and similar terms mean Valero L.P., together
with our operating subsidiary, Valero Logistics Operations, L.P. The term
"Valero Energy" means, depending on the context, Valero Energy Corporation, one
or more of its consolidated subsidiaries, or all of them taken as a whole, but
excluding Valero L.P. and its operating subsidiary.
VALERO L.P.
We are a publicly traded Delaware limited partnership formed in 1999. We
were originally formed under the name of "Shamrock Logistics, L.P.," and changed
our name to "Valero L.P." effective January 1, 2002, upon completion of Valero
Energy Corporation's acquisition of Ultramar Diamond Shamrock Corporation on
December 31, 2001. In April 2001, we completed our initial public offering of
5,175,000 common units. Valero Energy, a Delaware corporation, currently owns an
aggregate 71.6% limited partner interest in us. Our operations are controlled
and managed by our general partner, an indirect wholly owned subsidiary of
Valero Energy. We own and operate most of the crude oil and refined product
pipeline, terminalling and storage assets located in Texas, Oklahoma, New Mexico
and Colorado that support Valero Energy's McKee, Three Rivers and Ardmore
refineries. We transport crude oil and other feedstocks to these refineries and
transport refined products from these refineries to our terminals or to
interconnections with third party pipelines for further distribution to Valero
Energy's company-operated convenience stores or wholesale customers located in
Texas, Oklahoma, Colorado, New Mexico, Arizona and other mid-continent states.
Our pipeline, terminalling and storage assets consist of:
- approximately 783 miles of crude oil pipelines, including approximately
31 miles jointly owned with third parties, and five major crude oil
storage facilities with a total storage capacity of approximately 3.3
million barrels;
- approximately 2,846 miles of refined product pipelines, including
approximately 1,996 miles jointly owned with third parties, and twelve
refined product terminals (including one asphalt terminal), one of which
is jointly owned, with a total storage capacity of approximately 3.2
million barrels; and
- a 25-mile crude hydrogen pipeline connected to Valero Energy's Texas City
refinery.
We generate revenues by charging tariffs for transporting crude oil and
refined products through our pipelines and by charging a fee for use of our
terminals. We do not own any of the crude oil or refined products transported
through our pipelines, and we do not engage in the trading of crude oil or
refined products. As a result, we are not directly exposed to any risks
associated with fluctuating commodity prices, although these risks indirectly
influence our activities and results of operations.
During the year ended December 31, 2002, we transported an average of
348,023 barrels per day through our crude oil pipelines and an average of
295,456 barrels per day through our refined product pipelines and handled an
average of 175,559 barrels per day in our refined product terminals. Our
revenues for the year ended December 31, 2002 were approximately $118.5 million,
a 20% increase from our revenues for the year ended December 31, 2001 of
approximately $98.8 million. Operating income for the year ended December 31,
2002 was approximately $57.2 million, a 23% increase from our operating income
for the year ended December 31, 2001 of approximately $46.5 million.
S-1
Concurrently with this offering, Valero Logistics is offering $250 million
of senior notes in a private placement to institutional investors. With $134.1
million of the proceeds from the private placement, we will redeem 3,809,750
common units from Valero Energy, which will reduce Valero Energy's aggregate
ownership interest in us to 49.5%. We will use the remainder of these proceeds,
together with the net proceeds from this offering and borrowings under Valero
Logistics' bank credit facility, to pay for the contribution to us by Valero
Energy of 58 crude oil and intermediate feedstock storage tanks for $200 million
and three refined product pipeline systems in South Texas for $150 million. The
discussions in this prospectus supplement of our business as of the date hereof
do not include the assets to be contributed to us. Please read "-- Summary of
the Transactions" beginning on page S-4, "The Transactions" beginning on page
S-23 and "Use of Proceeds" on page S-34 of this prospectus supplement.
BUSINESS STRATEGIES
The primary objective of our business strategies is to increase our cash
available for distribution to unitholders. We intend to achieve this primary
objective by:
- sustaining high levels of volumes in our pipelines, terminalling and
storage assets;
- increasing volumes in our existing pipelines and shifting volumes to
higher tariff pipelines;
- increasing our pipeline and terminal capacity through expansions and new
construction;
- pursuing selective strategic and accretive acquisitions that complement
our existing asset base; and
- continuing to improve our operating efficiency.
COMPETITIVE STRENGTHS
We believe we are well positioned to successfully execute our business
strategies due to the following competitive strengths:
- Our pipelines provide the principal access to and from Valero Energy's
McKee, Three Rivers and Ardmore refineries located near Amarillo, Texas,
Corpus Christi, Texas and Ardmore, Oklahoma, respectively.
- Our refined product pipelines serve Valero Energy's marketing operations
in the southwestern and Rocky Mountain regions of the United States.
These operations are concentrated in fast-growing metropolitan areas in
the states of Texas, Colorado, New Mexico, Arizona and other
mid-continent states.
- We believe our pipeline, terminalling and storage assets are modern,
efficient and well maintained, with 50% of our pipeline ownership mileage
having been built since 1990.
- Our pipelines have available capacity that provides us the opportunity to
increase volumes and cash available for distribution to unitholders from
existing assets.
- Our revolving credit facility, coupled with our ability to issue new
partnership units, provides us with financial flexibility to pursue
expansion and acquisition opportunities.
OUR RELATIONSHIP WITH VALERO ENERGY
Our operations are strategically located within Valero Energy's refining
and marketing supply chain for Texas, Oklahoma, Colorado, New Mexico, Arizona
and other mid-continent states of the United States, but we do not own or
operate any refining or marketing operations. Valero Energy is dependent upon us
to provide transportation services that support the refining and marketing
operations in the markets served by Valero Energy's McKee, Three Rivers and
Ardmore refineries. At the same time, we are dependent on the continued use of
our pipelines, terminals and storage facilities by Valero Energy and the ability
of Valero Energy's refineries to maintain their production of refined products.
Valero Energy accounted for 99% of our revenues for the years ended December 31,
2001 and 2002. Although we intend to pursue third party business
S-2
as opportunities may arise, we expect to continue to derive most of our revenues
from Valero Energy for the foreseeable future. Valero Energy has advised us that
it currently does not intend to close or dispose of the refineries currently
served by our pipelines, terminals and storage assets (McKee, Three Rivers and
Ardmore) or any of the refineries that will be served by our pipelines,
terminals and storage assets upon the closing of the crude oil tank contribution
and the South Texas pipeline contribution (Corpus Christi and Texas City, Texas
and Benicia, California) or to cause any changes that would have a material
adverse effect on these refineries' operations.
Description of Valero Energy's Business. Valero Energy is one of the top
three U.S. refining companies in terms of refining capacity. Valero Energy
acquired Ultramar Diamond Shamrock Corporation on December 31, 2001, and now
owns and operates 12 refineries, three of which are served by our pipelines and
terminals:
- the McKee refinery, which has a current total capacity to process 170,000
barrels per day of crude oil and other feedstocks, making it the largest
refinery located between the Texas Gulf Coast and the West Coast;
- the Three Rivers refinery, which has a current total capacity to process
98,000 barrels per day of crude oil and other feedstocks; and
- the Ardmore refinery, which has a current total capacity to process
85,000 barrels per day of crude oil and other feedstocks.
Valero Energy markets the refined products produced by these three
refineries primarily in Texas, Oklahoma, Colorado, New Mexico, Arizona and other
mid-continent states through a network of company-operated and dealer-operated
convenience stores, as well as through other wholesale and spot market sales and
exchange agreements.
Our Pipelines and Terminals Usage Agreement with Valero Energy. In
connection with our initial public offering and as a result of Valero Energy's
acquisition of Ultramar Diamond Shamrock, Valero Energy has generally agreed to
transport, until April 1, 2008, at least 75% of the aggregate volumes of crude
oil shipped to, and at least 75% of the aggregate volumes of refined products
shipped from, the McKee, Three Rivers and Ardmore refineries in our crude oil
pipelines and refined product pipelines, respectively, and to use our refined
product terminals for terminalling services for at least 50% of the refined
products shipped from these refineries. For the year ended December 31, 2002,
Valero Energy used our pipelines to transport 97% of its crude oil and other
feedstocks shipped to, and 80% of the refined products shipped from, the McKee,
Three Rivers and Ardmore refineries, and used our terminalling services for 59%
of all refined products shipped from these refineries. In addition, Valero
Energy has agreed, until April 1, 2008, to remain the shipper for its crude oil
and other feedstocks and refined products transported in our pipelines, and not
to challenge our tariff rates for the transportation of crude oil and refined
products.
Valero Energy's obligation to use our pipelines and terminals will be
suspended if Valero Energy ceases to own the refineries, if material changes in
market conditions occur that have a material adverse effect on Valero Energy or
if we are unable to handle the volumes due to operational difficulties with our
pipelines or terminals.
In connection with the crude oil tank contribution and South Texas pipeline
contribution, together referred to as the contributions, we will enter into
additional handling and throughput agreements with Valero Energy. Please read
"The Transactions" beginning on page S-23 of this prospectus supplement.
Valero Energy owns Valero L.P.'s general partner. Valero Energy owns and
controls Riverwalk Logistics, L.P., which serves as our general partner with a
2% general partner interest. Currently, Valero Energy also indirectly owns an
aggregate 71.6% limited partner interest in us. At the closing of this common
unit offering and following our redemption of 3,809,750 of its common units,
Valero Energy's indirect aggregate interest in us will decrease to 49.5%, which
includes its 2% general partner interest. Please read "-- Summary of the
Transactions" below.
S-3
As a result of Valero Energy's ownership of our general partner, conflicts
of interest are inherent in our relationship with Valero Energy. Please read
"Risk Factors -- Risks Inherent in Our Business -- Valero Energy and its
affiliates have conflicts of interest and limited fiduciary responsibilities,
which may permit them to favor their own interests to the detriment of our
security holders" on page 10 of the accompanying prospectus.
Omnibus Agreement. At the closing of our initial public offering, we
entered into an omnibus agreement with Valero Energy that governs potential
competition between us and Valero Energy. Valero Energy has agreed, for so long
as it controls our general partner, not to engage in, whether by acquisition or
otherwise, the business of transporting crude oil and other feedstocks or
refined products, including petrochemicals, or operating crude oil storage or
refined product terminalling assets in the United States. This restriction does
not apply to:
- any business retained by Ultramar Diamond Shamrock (and now part of
Valero Energy) at the closing of our initial public offering or any
business owned by Valero Energy at the date of its acquisition of
Ultramar Diamond Shamrock on December 31, 2001;
- any business with a fair market value of less than $10 million;
- any business acquired by Valero Energy in the future that constitutes
less than 50% of the fair market value of a larger acquisition, provided
that we have been offered and declined the opportunity to purchase this
business; or
- any newly constructed pipeline, terminalling or storage assets that we
have not offered to purchase within one year of construction at fair
market value.
Also under the Omnibus Agreement, Valero Energy has agreed to indemnify us
for environmental liabilities related to assets transferred to us in connection
with our initial public offering that arose prior to April 16, 2001 and are
discovered within 10 years after April 16, 2001 (excluding liabilities resulting
from any changes in law after April 16, 2001).
SUMMARY OF THE TRANSACTIONS
GENERAL
Immediately upon the closing of the common unit offering and subject to the
conditions described below:
- Valero Energy will contribute the 58 crude oil and intermediate feedstock
storage tank assets, as described below, to Valero Logistics for $200
million in cash;
- Valero Energy will contribute the South Texas refined product pipelines
and terminals, as described below, to Valero Logistics for $150 million
in cash;
- Valero Logistics will issue $250 million aggregate principal amount of
senior notes, guaranteed by us, in a private placement to institutional
investors;
- Valero Logistics will borrow approximately $34.3 million under its
revolving credit facility;
- we will redeem 3,809,750 common units from Valero Energy for
approximately $134.1 million; and
- we will amend our partnership agreement as described below.
S-4
The following table sets forth an estimated breakdown of the sources and
uses of the funds to be used in these transactions:
AMOUNTS
-------------
(IN MILLIONS)
SOURCES OF FUNDS:
Valero L.P. common unit offering(1)....................... $211.3
Valero Logistics senior notes offering(1)................. 249.3
Borrowings under Valero Logistics' revolving credit
facility............................................... 34.3
Valero L.P.'s net general partner capital
contribution(2)........................................ 1.5
------
$496.4
======
USES OF FUNDS:
Crude oil tank contribution............................... $200.0
South Texas pipeline contribution......................... 150.0
Redemption of common units from Valero Energy............. 134.1
Estimated transaction expenses (including underwriting
discounts and commissions)............................. 12.3
------
$496.4
======
---------------
(1) Before deducting underwriting discounts and commissions and other
transaction expenses.
(2) Reflects the general partner's capital contribution to maintain its 2%
general partner interest in us upon the issuance of common units in this
offering, reduced by the amount paid to the general partner in redemption of
a portion of its general partner interest concurrently with the redemption
of common units from Valero Energy.
CRUDE OIL TANK CONTRIBUTION
We have entered into two contribution agreements with Valero Energy
pursuant to which, upon closing of this common unit offering and the private
placement of senior notes and upon satisfaction of customary closing conditions,
Valero Energy will contribute 58 crude oil and intermediate feedstock storage
tanks and related assets to us for $200 million in cash.
The tank assets consist of all of the tank shells, foundations, tank
valves, tank gauges, pressure equipment, temperature equipment, corrosion
protection, leak detection, tank lighting and related equipment and
appurtenances associated with the specified crude oil tanks and intermediate
feedstock tanks located at Valero Energy's:
- West plant of the Corpus Christi refinery in Corpus Christi, Texas, which
has a current total capacity to process 225,000 barrels per day of crude
oil and other feedstocks;
- Texas City refinery in Texas City, Texas, which has a current total
capacity to process 243,000 barrels per day of crude oil and other
feedstocks; and
- Benicia refinery in Benicia, California, which has a current total
capacity to process 180,000 barrels per day of crude oil and other
feedstocks.
The Corpus Christi refinery consists of two plants, the West plant and the East
plant, with a combined total capacity to process 340,000 barrels per day of
crude oil and other feedstocks. Since June 1, 2001 (the date Valero Energy began
operating the East plant), Valero Energy has operated both plants as one
refinery. Unless otherwise indicated, references to the Corpus Christi refinery
include both the West and the East plants.
The 58 crude oil and intermediate feedstock storage tanks at these
refineries have approximately 11.0 million barrels of storage capacity in the
aggregate. Valero Energy will agree to pay Valero Logistics a fee, for an
initial period of ten years, for 100% of specified feedstocks delivered to each
of the West plant of the Corpus Christi refinery, the Texas City refinery and
the Benicia refinery and to use Valero Logistics for
S-5
handling all deliveries to these refineries as long as Valero Logistics is able
to provide the handling and throughput services.
For a more detailed discussion of the crude oil tank contribution, please
read "The Transactions -- Crude Oil Tank Contribution" beginning on page S-23 of
this prospectus supplement.
SOUTH TEXAS PIPELINE CONTRIBUTION
We have entered into a contribution agreement with Valero Energy pursuant
to which, upon closing of this common unit offering and the private placement of
senior notes and upon satisfaction of customary closing conditions, Valero
Energy will contribute the South Texas pipeline system, comprised of the Houston
pipeline system, the San Antonio pipeline system and the Valley pipeline system
and related terminalling assets, to us for $150 million in cash. The three
pipeline systems that make up the South Texas pipeline assets are intrastate
common carrier refined product pipelines that connect Valero Energy's Corpus
Christi and Three Rivers refineries to the Houston, San Antonio and Rio Grande
Valley, Texas markets.
In connection with the South Texas pipeline contribution, Valero Energy
will commit, for an initial period of seven years with respect to gasoline,
distillate and raffinate only, to transport in our pipelines certain percentages
of refined product production and to use our terminals for certain percentages
of throughput in our pipelines.
For a more detailed discussion of the South Texas pipeline contribution,
please read "The Transactions -- South Texas Pipeline Contribution" beginning on
page S-26 of this prospectus supplement.
PRIVATE PLACEMENT OF SENIOR NOTES
Concurrently with this offering, Valero Logistics is offering $250 million
in aggregate principal amount of senior notes in a private placement. The senior
notes are being offered only to qualified institutional investors in reliance on
Rule 144A under the Securities Act and to non-U.S. persons in offshore
transactions pursuant to Regulation S under the Securities Act. The senior notes
will be unsecured and guaranteed by us. This prospectus supplement and the
accompanying prospectus shall not be deemed to be an offer to sell or a
solicitation of an offer to buy any senior notes offered in the private
placement. There is no assurance that this private placement will be completed
or, if it is completed, that it will be completed for the amount contemplated.
The private placement is conditioned upon the consummation of this common unit
offering, and this common unit offering is conditioned upon the consummation of
the private placement.
REDEMPTION OF COMMON UNITS OWNED BY VALERO ENERGY AND AMENDMENT TO PARTNERSHIP
AGREEMENT
Common Unit Redemption. Immediately following the closing of the
offerings, we will redeem from Valero Energy 3,809,750 common units for
approximately $134.1 million, which will reduce Valero Energy's aggregate
ownership interest in us to 49.5%. We will redeem the common units for $35.19
per unit, which is equal to the net proceeds per unit we receive in this public
offering of common units before expenses. Immediately following the redemption,
we will cancel the common units redeemed from Valero Energy. We will also redeem
the corresponding portion of Valero Energy's general partner interest so that it
maintains its 2% general partner interest.
Amendment to Partnership Agreement. Immediately upon closing of the
offerings, we will amend our partnership agreement to provide that our general
partner may be removed by the vote of the holders of at least 58% of our
outstanding common units and subordinated units, excluding the common units and
subordinated units held by affiliates of our general partner. We will also amend
our partnership agreement to provide that the election of a successor general
partner upon any such removal be approved by the holders of a majority of the
common units, excluding the common units held by affiliates of our general
partner.
For a more detailed discussion of the common unit redemption and
partnership agreement amendment, please read "The Transactions -- Redemption of
Common Units Owned by Valero Energy and Amendment to Partnership Agreement"
beginning on page S-33 of this prospectus supplement.
S-6
CONFLICTS COMMITTEE APPROVAL
The conflicts committee of the board of directors of Valero GP, LLC, the
general partner of our general partner, approved the contributions based in part
on an opinion from its independent financial advisor that the consideration to
be paid by us pursuant to the transaction agreements related to each of the
contributions is fair from a financial point of view to us and our public
unitholders. The conflicts committee also concluded that the pricing mechanism
in this common unit offering would produce a fair price for the redemption.
RECENT DEVELOPMENTS
FINANCIAL OUTLOOK AND EXPECTED CASH AVAILABLE FOR DISTRIBUTION
Due to a combination of circumstances in the first two months of 2003,
Valero Energy reduced its production at several of its refineries, including the
McKee, Three Rivers and Ardmore refineries, by as much as 15%, for economic
reasons. The primary reason for the reduction was the unfavorable impact the oil
workers' strike in Venezuela had on crude oil and other feedstock supplies in
the market, which caused sweet crude oil and other feedstock processing
economics to be unfavorable. The oil workers' strike in Venezuela has reduced
the amount of Venezuelan crude oil received by the Three Rivers refinery under
its purchase agreement with PDVSA, the national oil company of Venezuela. In
addition, beginning in mid-March of 2003, a 20-day plant-wide maintenance
turnaround of the Ardmore refinery will lower pipeline throughputs related to
that refinery.
As a result of Valero Energy's reduction in refinery production during the
first quarter of 2003, throughput in our pipelines and terminals in the first
quarter of 2003 is expected to be lower than throughput levels in the fourth
quarter of 2002 and comparable to throughput levels in the first quarter of
2002. Accordingly, net income per unit applicable to our limited partners for
the first quarter of 2003 is expected to be in the range of $0.55 per unit,
which compares to $0.50 per unit in the first quarter of 2002 and $0.74 per unit
in the fourth quarter of 2002. Based on the net income expected to be generated
during the first quarter of 2003, we expect to have sufficient cash available
for distribution to distribute $0.70 per unit for the first quarter of 2003.
More recently however, a combination of strong refining and marketing
fundamentals and increased crude oil availability have improved conditions
substantially from earlier this year. If these improved conditions continue, we
expect average pipeline and terminal throughput levels for the remainder of 2003
to return to average historical levels.
Management expects that the contributions, the redemption and the
adjustment to terminalling fees discussed below will result in an increase in
cash available for distribution that we believe will be sufficient to enable
management to make a recommendation to the board of directors to increase the
quarterly distribution to $0.75 per unit commencing with the distribution with
respect to the second quarter of 2003. However, any increase in the cash
distribution to unitholders must be approved by the board of directors based on
the actual amount of cash available for distribution at the time. Management's
expectations with respect to cash available for distribution and distribution
levels are based on the following assumptions:
- We will consummate this common unit offering and Valero Logistics will
issue $250 million aggregate principal amount of senior notes and will
borrow $34.3 million under its revolving credit facility;
- Average daily throughput volumes for 2003 in the tank assets will be 7%
higher than average daily throughput volumes for those assets in 2002 due
to higher refining margins and no turnarounds at the related refineries;
- Average daily throughput volumes for 2003 in the South Texas pipelines
and terminals will be 4% higher than average daily throughput volumes for
those assets in 2002 as a result of the October 2002 expansion of the
Corpus Christi to Houston refined product pipeline;
- The tariffs and terminalling fees charged for use of these assets will be
at least those set forth in the contractual arrangements with Valero
Energy;
S-7
- Annual operating expenses related to the crude oil tank contribution will
be equal to the $4.2 million in fees that we have agreed to pay Valero
Energy plus $6.3 million of additional expenses, including maintenance
capital expenditures;
- Annual operating and general and administrative expenses related to the
South Texas pipeline contribution will be approximately $2 million less
than those for the year ended December 31, 2002 mainly as a result of the
exclusion of volumetric gains and losses and allocation of overhead;
- Average daily throughput volumes in, and annual operating expenses
related to, our existing assets will be substantially similar to those
for the year ended December 31, 2002; and
- Our business will not be materially adversely affected by refinery
shutdowns, labor disturbances, general economic conditions, terrorist
actions, environmental releases, changes in laws, accidents or similar
factors.
While management believes these assumptions are reasonable in light of
management's current beliefs concerning future events, these assumptions are
inherently uncertain and are subject to significant business, economic,
regulatory and competitive risks and uncertainties that could cause actual
results to differ materially from those management anticipates. If our
assumptions are not realized, then actual cash available for distribution could
be insufficient to enable us to increase our distribution. Consequently, any
statements about cash available for distribution or distribution levels should
not be regarded as a representation by us or the underwriters that we will have
sufficient cash available for distribution to make these distributions or that
we will increase our current distribution levels to unitholders.
ADJUSTMENT TO TERMINALLING FEES
In conjunction with the contributions, we reviewed our existing pipeline
tariff rates and terminalling fees, including the additive blending fee that we
charge for blending additives into gasoline and diesel fuel. Based on this
review, we have reached agreement with Valero Energy, effective January 1, 2003,
to increase the additive blending fee that we charge for blending additives into
gasoline and diesel fuel at our 12 currently owned refined product terminals to
$0.12 per barrel for the remaining term of the pipelines and terminals usage
agreement. Assuming that this additional additive blending fee had been in
effect during the year ended December 31, 2002, and assuming no change in the
number of barrels of refined product that we blended, we would have generated an
additional $1.5 million in operating income.
ACQUISITION OF THE TELFER ASPHALT TERMINAL
In January 2003, we purchased an asphalt terminal in Pittsburg, California
from Telfer Oil Company for $15.0 million. The asphalt terminal assets include
two storage tanks with a combined storage capacity of 350,000 barrels, six
5,000-barrel polymer modified asphalt tanks, a truck rack, rail facilities and
various other tanks and equipment. In conjunction with the Telfer acquisition,
we entered into a six-year terminal storage and throughput agreement with Valero
Energy. The agreement includes an exclusive lease by Valero Energy of the
asphalt storage tanks and related equipment for a monthly fee per barrel of
storage capacity, Valero Energy's right to move asphalt through the terminal for
a per barrel throughput fee with a guaranteed minimum annual throughput of
280,000 barrels, and Valero Energy's reimbursement to us of related costs,
including utilities.
RATING AGENCY ACTION
On March 6, 2003 Moody's Investors Service downgraded Valero Logistics'
6.875% senior notes due 2012 from Baa2 to Baa3, with a stable outlook. The
downgrade was prompted by Moody's downgrade of the ratings of Valero Energy's
debt from Baa2 to Baa3 on the same date. Moody's stated that the ratings of
Valero Logistics were tied to Valero Energy's ratings because of Valero Energy's
ownership interest in and control of us and Valero Logistics, the strong
operational links between Valero Energy and Valero Logistics and the reliance of
Valero Logistics on Valero Energy for over 90% of its revenues. On March 7,
2003, Standard and Poor's affirmed the debt rating of the 6.875% senior notes at
BBB, with a negative outlook.
S-8
AMENDED REVOLVING CREDIT FACILITY
Valero Logistics has entered into an amended revolving credit facility for
up to $175 million with JPMorgan Chase Bank and other lenders. The amended
revolving credit facility is currently scheduled to expire January 15, 2006.
Upon completion of this common unit offering and the related transactions, we
expect to have approximately $34.3 million outstanding under the credit
facility.
Borrowings under the credit facility may be used for working capital and
general partnership purposes. The credit facility also allows Valero Logistics
to issue letters of credit for an aggregate amount of $75 million.
For a more detailed description of Valero Logistics' amended revolving
credit facility, please read "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources"
beginning on page S-46 of this prospectus supplement.
S-9
PARTNERSHIP STRUCTURE AND MANAGEMENT
Valero Energy owns and controls Riverwalk Logistics, our general partner.
Valero Energy also currently indirectly owns an aggregate 73.64% ownership
interest in us.
- Riverwalk Logistics, our general partner and an indirect wholly owned
subsidiary of Valero Energy, currently owns and will own after this
common unit offering, a 2% general partner interest in us and the
incentive distribution rights pursuant to our amended partnership
agreement;
- UDS Logistics, the sole limited partner of Riverwalk Logistics and an
indirect wholly owned subsidiary of Valero Energy, currently owns an
aggregate 71.27% limited partner interest in us and will own an aggregate
47.16% limited partner interest in us after the closing of the redemption
transaction and this common unit offering;
- Valero GP, LLC, an indirect wholly owned subsidiary of Valero Energy, is
the general partner of Riverwalk Logistics and currently owns a 0.37%
limited partner interest in us and will own a 0.34% limited partner
interest in us after the closing of the redemption transaction and this
common unit offering. Valero GP, LLC performs all management and
operating functions for us; and
- We currently own and will continue to own, a 99.99% limited partner
interest in Valero Logistics and 100% of Valero GP, Inc., which is the
sole general partner of Valero Logistics with a 0.01% general partner
interest. Valero GP, Inc. performs all management and operating functions
for Valero Logistics.
The chart on the following page depicts our organization and ownership
structure after giving effect to the redemption transaction and this common unit
offering.
S-10
(CHART)
---------------
(1) Valero GP, LLC does not have voting rights with respect to these 73,319
common units.
(2) Valero Logistics Operations, L.P. owns a 50% interest in Skelly-Belvieu
Pipeline Company, L.L.C. The remaining 50% interest is owned by
ConocoPhillips.
S-11
THE OFFERING
Common units offered by Valero
L.P........................... 5,750,000 common units
Units to be outstanding after
this common unit offering and
the redemption of common
units......................... 11,624,822 common units
9,599,322 subordinated units
Use of proceeds............... We will receive net proceeds from this common
unit offering of approximately $202.3 million,
or approximately $232.7 million if the
underwriters' over-allotment option is
exercised in full. We plan to use net proceeds
from this common unit offering, together with
the proceeds of the private placement of senior
notes by Valero Logistics and the borrowings
under the amended revolving credit facility, to
fund the:
- crude oil tank contribution;
- South Texas pipeline contribution; and
- redemption of common units from Valero
Energy.
The proceeds from any exercise of the
underwriters' over-allotment option will be
used to pay off borrowings under the revolving
credit facility or for working capital and
general partnership purposes.
Distribution policy........... Under our partnership agreement, we must
distribute all of our cash on hand as of the
end of each quarter, less reserves established
by our general partner. We refer to this cash
as "available cash," and we define its meaning
in our partnership agreement.
On February 14, 2003, we paid a quarterly cash
distribution for the fourth quarter of 2002 of
$0.70 per unit or $2.80 per unit on an
annualized basis.
When quarterly cash distributions exceed $0.60
per unit in any quarter, our general partner
receives a higher percentage of the cash
distributed in excess of that amount, in
increasing percentages up to 50% if the
quarterly cash distributions exceed $0.90 per
unit. For a description of our cash
distribution policy, please read "Cash
Distributions" in the accompanying prospectus.
Subordination period.......... The subordination period will end once we meet
the financial tests in the partnership
agreement, but it generally cannot end before
March 31, 2006. There is no provision in our
partnership agreement for early conversion of a
portion of the subordinated units.
When the subordination period ends, all
subordinated units will convert into common
units on a one-for-one basis, and the common
units will no longer be entitled to arrearages.
Estimated ratio of taxable
income to distributions....... We estimate that if you own the common units
you purchase in this common unit offering
through the record date for the distribution
with respect to the fourth calendar quarter of
2005,
S-12
you will be allocated, on a cumulative basis,
an amount of federal taxable income for the
period 2003 through 2005 that will be less than
20% of the cash distributed to you with respect
to that period. Please read "Tax
Considerations" beginning on page S-67 of this
prospectus supplement for the basis of this
estimate.
Risk factors.................. An investment in our common units involves
risks. Please read "Risk Factors" beginning on
page S-19 of this prospectus supplement and
page 4 of the accompanying prospectus.
New York Stock Exchange
symbol........................ VLI
S-13
SUMMARY FINANCIAL AND OPERATING DATA
The following table provides selected financial data that was derived from
our audited financial statements, as well as selected operating data. This data
does not include any results from the contributions, nor does it give effect to
the redemption transaction or the related financings associated with these
transactions. The following table should be read together with, and is qualified
in its entirety by reference to, the historical financial statements and the
accompanying notes included elsewhere in this prospectus supplement. The table
should be read together with "Management's Discussion and Analysis of Financial
Condition and Results of Operations." In addition, please read "Valero South
Texas Pipelines and Terminals Business Financial Statements" beginning on page
F-31. Financial data for the crude oil tank contribution is unavailable as these
assets have historically not been accounted for separately and have not been
operated as an autonomous business unit. Please read "The Transactions"
beginning on page S-23 for more information on the contributions.
Prior to July 1, 2000, our pipeline, terminalling and storage assets were
owned and operated by Ultramar Diamond Shamrock Corporation (now part of Valero
Energy), and such assets serviced Ultramar Diamond Shamrock's McKee and Three
Rivers refineries located in Texas, and the Ardmore refinery located in
Oklahoma. These assets and their related operations were referred to as the
Ultramar Diamond Shamrock Logistics Business. Effective July 1, 2000, Ultramar
Diamond Shamrock transferred the Ultramar Diamond Shamrock Logistics Business,
along with certain liabilities, to Shamrock Logistics Operations, L.P. (now
Valero Logistics Operations, L.P.), a wholly owned subsidiary of Shamrock
Logistics, L.P. (now Valero L.P.). We were wholly owned by Ultramar Diamond
Shamrock. Data in the following table prior to the July 1, 2000 transfer is
indicated as "Predecessor" and data subsequent thereto is indicated as
"Successor." On April 16, 2001, we closed on our initial public offering of
common units, which represented 26.4% of our outstanding partnership interests.
On May 7, 2001, Valero Energy announced that it had entered into an
Agreement and Plan of Merger with Ultramar Diamond Shamrock whereby Ultramar
Diamond Shamrock agreed to be acquired by Valero Energy for total consideration
of approximately $4.3 billion and the assumption of approximately $2.0 billion
of debt. The acquisition of Ultramar Diamond Shamrock by Valero Energy became
effective on December 31, 2001. This acquisition included the acquisition of
Ultramar Diamond Shamrock's majority ownership interest in us. Our consolidated
balance sheet as of December 31, 2001 was not adjusted to fair value due to the
significant level of public ownership interest in us. Effective January 1, 2002,
we changed our name to Valero L.P., and Shamrock Logistics Operations changed
its name to Valero Logistics.
On February 1, 2002, we acquired the Wichita Falls Business from Valero
Energy for $64 million.
The selected financial data and operating data for the years ended December
31, 1998 and 1999, and for the six months ended June 30, 2000, reflect the
operations of the Ultramar Diamond Shamrock Logistics Business (the predecessor
to Valero Logistics) as if it had existed as a single separate entity from
Ultramar Diamond Shamrock. The transfer of the Ultramar Diamond Shamrock
Logistics Business to Valero Logistics represented a reorganization of entities
under common control and was recorded at historical cost. The selected financial
data and operating data for the six months ended December 31, 2000, and for the
years ended December 31, 2001 and 2002, represent the consolidated operations of
Valero L.P. and Valero Logistics. The selected financial data as of December 31,
2001, includes the acquisition of the Wichita Falls Business because we and the
Wichita Falls Business came under the common control of Valero Energy commencing
on December 31, 2001, and thus, represented a reorganization of entities under
common control. The selected financial data and operating data for the year
ended December 31, 2002, reflects the operations of the Wichita Falls Business
for the entire year.
S-14
PREDECESSOR SUCCESSOR
-------------------------------- ----------------------------------
YEARS ENDED SIX MONTHS SIX MONTHS YEARS ENDED
DECEMBER 31, ENDED ENDED DECEMBER 31,
------------------- JUNE 30, DECEMBER 31, -------------------
1998 1999 2000 2000 2001 2002
-------- -------- ---------- ------------ -------- --------
(IN THOUSANDS, EXCEPT PER UNIT DATA AND BARREL/DAY INFORMATION)
STATEMENT OF INCOME DATA:
Revenues(1)...................... $ 97,883 $109,773 $ 44,503 $ 47,550 $ 98,827 $118,458
Costs and expenses:
Operating expenses............. 32,179 29,013 17,912 15,593 33,583 37,838
General and administrative
expenses.................... 4,552 4,698 2,590 2,549 5,349 6,950
Depreciation and
amortization................ 12,451 12,318 6,336 5,924 13,390 16,440
-------- -------- -------- -------- -------- --------
Total costs and expenses.... 49,182 46,029 26,838 24,066 52,322 61,228
Gain on sale of property, plant
and equipment(2)............ 7,005 2,478 -- -- -- --
-------- -------- -------- -------- -------- --------
Operating income................. 55,706 66,222 17,665 23,484 46,505 57,230
Equity income from Skelly-Belvieu
Pipeline Company............... 3,896 3,874 1,926 1,951 3,179 3,188
Interest expense, net............ (796) (777) (433) (4,748) (3,811) (4,880)
-------- -------- -------- -------- -------- --------
Income before income tax expense
(benefit)...................... 58,806 69,319 19,158 20,687 45,873 55,538
Income tax expense
(benefit)(3)................... 22,517 26,521 (30,812) -- -- 395
-------- -------- -------- -------- -------- --------
Net income....................... $ 36,289 $ 42,798 $ 49,970 $ 20,687 $ 45,873 $ 55,143
======== ======== ======== ======== ======== ========
Basic and diluted net income per
unit applicable to limited
partners(4).................... $ 1.82 $ 2.72
======== ========
Cash distributions per unit
applicable to limited
partners....................... $ 1.70 $ 2.75
======== ========
OTHER FINANCIAL DATA:
EBITDA(5)........................ $ 72,053 $ 82,414 $ 25,927 $ 31,359 $ 63,074 $ 76,858
Distributable cash flow(5)....... 62,258 77,841 25,091 26,393 56,172 68,437
Distributions from Skelly-Belvieu
Pipeline Company............... 3,692 4,238 2,306 2,352 2,874 3,590
Net cash provided by operating
activities..................... 48,642 54,054 20,247 1,870 77,132 77,656
Net cash provided by (used in)
investing activities........... 14,703 2,787 (4,505) (1,736) (17,926) (80,607)
Net cash provided by (used in)
financing activities........... (63,345) (56,841) (15,742) (133) (51,414) 28,688
Maintenance capital
expenditures................... 2,345 2,060 1,699 619 2,786 3,943
Expansion capital expenditures... 9,952 7,313 3,186 1,518 4,340 1,761
Acquisitions..................... -- -- -- -- 10,800 75,000
Total capital expenditures....... 12,297 9,373 4,885 2,137 17,926 80,704
OPERATING DATA (barrels/day):
Crude oil pipeline throughput.... 265,243 280,041 294,037 295,524 303,811 348,023
Refined product pipeline
throughput..................... 268,064 297,397 312,759 306,877 308,047 295,456
Refined product terminal
throughput..................... 144,093 161,340 168,433 162,904 176,771 175,559
S-15
PREDECESSOR SUCCESSOR
------------------- ------------------------------
DECEMBER 31, DECEMBER 31,
------------------- ------------------------------
1998 1999 2000 2001 2002
-------- -------- -------- -------- --------
(IN THOUSANDS)
BALANCE SHEET DATA:
Property, plant and equipment, net............ $297,121 $284,954 $280,017 $349,012 $349,276
Total assets.................................. 321,002 308,214 329,484 387,070 415,508
Long-term debt, including current portion and
debt due to parent.......................... 11,455 11,102 118,360 26,122 109,658
Partners' equity/net parent investment(6)..... 268,497 254,807 204,838 342,166 293,895
---------------
(1) Effective January 1, 2000, the Ultramar Diamond Shamrock Logistics Business
(predecessor) filed revised tariff rates on many of its crude oil and
refined product pipelines to reflect the total cost of the pipeline, the
current throughput capacity, the current throughput utilization and other
market conditions. Prior to 1999, the Ultramar Diamond Shamrock Logistics
Business did not charge a separate terminalling fee for terminalling
services at its refined product terminals. These costs were charged back to
the related refinery. Beginning January 1, 1999, the Ultramar Diamond
Shamrock Logistics Business began charging a separate terminalling fee at
its refined product terminals. If the revised tariff rates and the
terminalling fee had been implemented effective January 1, 1998, revenues
would have been as follows for the years presented. The revised tariff rates
and terminalling fee were in effect throughout the years ended December 31,
2000, 2001 and 2002.
YEARS ENDED
DECEMBER 31,
-------------------
1998 1999
-------- --------
(IN THOUSANDS)
Revenues -- historical...................................... $ 97,883 $109,773
-------- --------
Decrease in tariff revenues............................... (17,067) (21,892)
Increase in terminalling revenues......................... 1,649 --
-------- --------
Net decrease.............................................. (15,418) (21,892)
-------- --------
Revenues -- as adjusted..................................... $ 82,465 $ 87,881
======== ========
(2) In March 1998, the Ultramar Diamond Shamrock Logistics Business recognized a
gain on the sale of a 25% interest in the McKee to El Paso refined product
pipeline and the El Paso refined product terminal to ConocoPhillips
(previously Phillips Petroleum Company). In August 1999, the Ultramar
Diamond Shamrock Logistics Business recognized a gain on the sale of an
additional 8.33% interest in the McKee to El Paso refined product pipeline
and terminal to ConocoPhillips.
(3) Effective July 1, 2000, Ultramar Diamond Shamrock transferred the Ultramar
Diamond Shamrock Logistics Business (predecessor) to Valero Logistics. As a
limited partnership, Valero Logistics is not subject to federal or state
income taxes. Due to this change in tax status, the deferred income tax
liability of $38,217,000 as of June 30, 2000 was written off in the
statement of income of the Ultramar Diamond Shamrock Logistics Business for
the six months ended June 30, 2000. The resulting income tax benefit of
$30,812,000 for the six months ended June 30, 2000, includes the write-off
of the deferred income tax liability less the provision for income tax
expense of $7,405,000 for the six months ended June 30, 2000. The income tax
expense for periods prior to July 1, 2000 was based on the effective income
tax rate for the Ultramar Diamond Shamrock Logistics Business of 38%. The
effective income tax rate exceeds the U.S. federal statutory income tax rate
due to state income taxes.
Income tax expense for the year ended December 31, 2002 represents income
tax expense incurred by the Wichita Falls Business during the month ended
January 31, 2002, prior to the acquisition of the Wichita Falls Business by
us on February 1, 2002.
(4) Net income per unit applicable to limited partners is computed by dividing
net income applicable to limited partners, after deduction of the general
partner's 2% interest and incentive distributions, by the
S-16
weighted average number of limited partnership units outstanding for each
class of unitholder. Basic and diluted net income per unit applicable to
limited partners is the same. Net income per unit applicable to limited
partners for the periods prior to April 16, 2001 is not shown as units had
not been issued.
FOR THE PERIOD
APRIL 16, 2001
THROUGH
DECEMBER 31, YEAR ENDED
2001 DECEMBER 31, 2002
---------------- -----------------
(IN THOUSANDS)
Net income.............................................. $ 45,873 $ 55,143
Less net income applicable to the period from January 1,
2001 through April 15, 2001........................... (10,126) --
Less net income applicable to the Wichita Falls Business
for the month ended January 31, 2002.................. -- (650)
Less net income applicable to general partner's
interest, including incentive distributions........... (715) (2,187)
----------- -----------
Net income applicable to limited partners' interest..... $ 35,032 $ 52,306
=========== ===========
Basic and diluted net income per unit applicable to
limited partners...................................... $ 1.82 $ 2.72
=========== ===========
Weighted average number of units outstanding, basic and
diluted............................................... 19,198,644 19,250,867
=========== ===========
(5) The following is a reconciliation of income before income tax expense
(benefit) to EBITDA and distributable cash flow. Beginning July 1, 2000, the
impact of volumetric expansions, contractions and measurement discrepancies
in the pipelines has been borne by the shippers in our pipelines and is
therefore not reflected in operating expenses subsequent to July 1, 2000.
The effect of volumetric expansions, contractions and measurement
discrepancies in the pipelines was a net reduction to income before income
tax expense (benefit).
PREDECESSOR SUCCESSOR
------------------------------ --------------------------------
YEARS ENDED SIX MONTHS SIX MONTHS YEARS ENDED
DECEMBER 31, ENDED ENDED DECEMBER 31,
----------------- JUNE 30, DECEMBER 31, -----------------
1998 1999 2000 2000 2001 2002
------- ------- ---------- ------------ ------- -------
(IN THOUSANDS)
Income before income tax expense
(benefit)...................... $58,806 $69,319 $19,158 $20,687 $45,873 $55,538
Plus interest expense, net..... 796 777 433 4,748 3,811 4,880
Plus depreciation and
amortization................ 12,451 12,318 6,336 5,924 13,390 16,440
------- ------- ------- ------- ------- -------
EBITDA........................... 72,053 82,414 25,927 31,359 63,074 76,858
Less equity income from Skelly-
Belvieu Pipeline Company.... (3,896) (3,874) (1,926) (1,951) (3,179) (3,188)
Less interest expense, net..... (796) (777) (433) (4,748) (3,811) (4,880)
Less maintenance capital
expenditures................ (2,345) (2,060) (1,699) (619) (2,786) (3,943)
Less gain on sale of property,
plant and equipment and
equipment................... (7,005) (2,478) -- -- -- --
Plus distributions from Skelly-
Belvieu Pipeline Company.... 3,692 4,238 2,306 2,352 2,874 3,590
Plus impact of volumetric
variances................... 555 378 916 -- -- --
------- ------- ------- ------- ------- -------
Distributable cash flow.......... $62,258 $77,841 $25,091 $26,393 $56,172 $68,437
======= ======= ======= ======= ======= =======
S-17
(6) The partners' equity amount as of December 31, 2001 includes $50,631,000 of
net parent investment resulting from our acquisition of the Wichita Falls
Business on February 1, 2002, which represented a transfer between entities
under common control and therefore required a restatement of our December
31, 2001 consolidated balance sheet to include the Wichita Falls Business as
if it had been combined with us as of December 31, 2001. Upon execution of
the acquisition on February 1, 2002, partners' equity/net parent investment
was reduced by $51,281,000.
S-18
RISK FACTORS
You should read carefully the discussion of the material risks relating to
our business under the caption "Risk Factors" beginning on page 4 of the
accompanying prospectus along with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" beginning on page S-37 of this
prospectus supplement. In addition, please read carefully the following risks
relating to our business and the contributions:
WE WILL DEPEND ON VALERO ENERGY FOR SUBSTANTIALLY ALL OF THE CRUDE OIL AND
REFINED PRODUCT THROUGHPUT TO BE HANDLED BY THE TANK ASSETS AND SOUTH TEXAS
PIPELINES AND TERMINALS, AND IF THERE IS ANY REDUCTION IN THIS THROUGHPUT, WE
MAY NOT REALIZE THE ANTICIPATED BENEFITS OF THE CONTRIBUTIONS AND THEREFORE OUR
ABILITY TO MAKE CASH DISTRIBUTIONS TO OUR UNITHOLDERS MAY BE ADVERSELY AFFECTED.
Because of the geographic location of the tank assets and South Texas
pipelines and terminals, which serve Valero Energy's Corpus Christi, Three
Rivers, Texas City and Benicia refineries, we depend upon Valero Energy to
provide substantially all of the throughput for these assets. If Valero Energy
were to decrease the throughput of crude oil and/or refined products in these
assets for any reason, including as a result of reduced refinery utilization, we
may not realize the expected benefits of the contributions. In any of these
circumstances, we would have great difficulty in finding other sources of
throughput. Because our operating costs are primarily fixed, a reduction in
throughput would result in not only a reduction of revenues but a decline in net
income and cash flow of similar or greater magnitude, which would reduce our
ability to make cash distributions to our unitholders.
The tank assets and South Texas pipelines and terminals will generally be
subject to the same business risks as our existing assets, such as disruptions
in refinery production, changes in market conditions, competing refined product
pipelines, reductions in tariff rates and adverse changes in the price of crude
oil. Please see "Risk Factors -- Risks Inherent in Our Business" beginning on
page 5 of the accompanying prospectus for a discussion of these business risks.
Valero Energy does not have an obligation to utilize our assets for a fixed
amount of volumes under either the existing throughput agreement or the
throughput agreements for the tank assets and South Texas pipelines and
terminals. Rather, the throughput commitments are generally a function of
production levels at the refineries. Accordingly, if refinery throughput is
suspended or reduced for any reason, Valero Energy's throughput commitments to
us with respect to our assets that serve that refinery will be suspended or
proportionately reduced. If, as a result, Valero Energy suspends or reduces its
usage of any of our assets, that could have a material adverse effect on us and
on our ability to make distributions to unitholders. Operations at a refinery
could be partially or completely shut down, temporarily or permanently, as a
result of a number of circumstances, none of which are within our control.
OUR FUTURE FINANCIAL AND OPERATING FLEXIBILITY MAY BE ADVERSELY AFFECTED BY
RESTRICTIONS IN OUR CREDIT AGREEMENT AND BY OUR LEVERAGE AND VALERO ENERGY'S
LEVERAGE.
Upon closing of this offering and the related transactions, our leverage
will be significant in relation to our consolidated partners' equity. After
giving effect to this common unit offering and the Valero Logistics private
placement of senior notes, our total outstanding debt will be approximately $393
million, representing approximately 52% of our total capitalization. Immediately
prior to this offering, our total outstanding debt was approximately 27% of our
total capitalization.
Debt service obligations, restrictive covenants in our debt agreements and
maturities resulting from this leverage may adversely affect our ability to
finance future operations, pursue acquisitions, fund other capital needs and pay
cash distributions to unitholders, and may make our results of operations more
susceptible to adverse economic or operating conditions. Our ability to repay,
extend or refinance our existing debt obligations and to obtain future credit
will depend primarily on our operating performance, which will be affected by
general economic, financial, competitive, legislative, regulatory, business and
other factors, many of which are beyond our control. We are prohibited from
making cash distributions to our unitholders during an event of default under
any of our debt agreements.
S-19
We currently expect to meet our anticipated future cash requirements,
including scheduled debt repayments, through operating cash flows and the
proceeds of one or more future equity or debt offerings. However, our ability to
access the capital markets for future offerings may be limited by adverse market
conditions resulting from, among other things, general economic conditions,
contingencies and uncertainties, which are difficult to predict and beyond our
control. If we were unable to access the capital markets for future offerings,
we might be forced to seek extensions for some of our short-term maturities or
to refinance some of our debt obligations through bank credit, as opposed to
long-term public debt securities or equity securities. The price and terms upon
which we might receive such extensions or additional bank credit could be more
onerous than those contained in our existing debt agreements. Any such
arrangement could, in turn, increase the risk that our leverage may adversely
affect our future financial and operating flexibility.
Valero Logistics' revolving credit facility contains restrictive covenants
that limit its ability to incur additional debt and to engage in some types of
transactions. These limitations could reduce our ability to capitalize on
business opportunities that arise. Any subsequent refinancing of our current
indebtedness or any new indebtedness could have similar or greater restrictions.
The revolving credit facility contains provisions relating to changes in
ownership. If these provisions are triggered, the outstanding debt may become
due. If that happens, we may not be able to pay the debt. Our general partner
and its direct and indirect owners are not prohibited by the partnership
agreement from entering into a transaction that would trigger these
change-in-ownership provisions.
On March 6, 2003 Moody's Investors Service downgraded Valero Logistics'
6.875% senior notes due 2012 from Baa2 to Baa3, with a stable outlook. The
downgrade was prompted by Moody's downgrade of the ratings of Valero Energy's
debt from Baa2 to Baa3 on the same date. Moody's stated that the ratings of
Valero Logistics were tied to Valero Energy's ratings because of Valero Energy's
ownership interest in and control of us and Valero Logistics, the strong
operational links between Valero Energy and Valero Logistics and the reliance of
Valero Logistics on Valero Energy for over 90% of its revenues. On March 7,
2003, Standard and Poor's affirmed the debt rating of the 6.875% senior notes at
BBB, with a negative outlook.
If one or more credit rating agencies were to further downgrade the
outstanding indebtedness of Valero Energy, we could experience a similar
downgrade of our outstanding indebtedness, an increase in our borrowing costs,
difficulty accessing capital markets or a reduction in the market price of our
common units. Such a development could adversely affect our ability to finance
acquisitions and refinance existing indebtedness and could adversely affect our
ability to make cash distributions to our unitholders.
CONTINUED HIGH NATURAL GAS PRICES COULD ADVERSELY AFFECT OUR ABILITY TO MAKE
CASH DISTRIBUTIONS TO OUR UNITHOLDERS.
Power costs constitute a significant portion of our operating expenses.
Power costs represented approximately 31% of our operating expenses for the year
ended December 31, 2001 and 29% of our operating expenses for the year ended
December 31, 2002. We use mainly electric power at our pipeline pump stations
and at our terminals and such electric power is furnished by various utility
companies that use primarily natural gas to generate electricity. Accordingly,
our power costs typically fluctuate with natural gas prices. The recent
increases in natural gas prices have caused our power costs to increase. If
natural gas prices remain high or increase further, our cash flows may be
adversely affected, which could adversely affect our ability to make cash
distributions to our unitholders.
COST REIMBURSEMENTS AND FEES DUE OUR GENERAL PARTNER AND ITS AFFILIATES WILL BE
SUBSTANTIAL AND WILL REDUCE OUR CASH AVAILABLE FOR DISTRIBUTION TO UNITHOLDERS.
Prior to making any distribution on the common units, we have agreed to pay
Valero Energy an administrative fee that currently equals $5.2 million on an
annualized basis in exchange for providing corporate, general and administrative
services to us. Our general partner, with approval and consent of the conflicts
committee of its general partner, will have the right to increase the annual
administrative fee by up to 1.5% each year, as further adjusted for inflation,
during the eight-year term of the services agreement and may agree to further
increases in connection with expansions of our operations through the
acquisition or
S-20
construction of new logistics assets that require additional administrative
services. In addition to the administrative fee, Valero Logistics has agreed to
pay Valero Energy $3.5 million on an annualized basis for services provided
under the services and secondment agreements it will enter into in connection
with the crude oil tank contribution. During the first five years of these
services and secondment agreements, these fees may be increased by Valero Energy
based on increases in the consumer price index. After five years, these fees may
be increased or decreased to more accurately reflect the actual costs to Valero
Energy for the services being provided at that time. Additionally, we reimburse
Valero Energy for direct expenses it incurs to provide all other services to us
(for example, salaries for pipeline operations personnel). The direct expenses
we reimbursed to Valero Energy were approximately $13.8 million in 2002. The
payment of the annual administrative fee, the fees under the services and
secondment agreements and the reimbursement of direct expenses could adversely
affect our ability to make cash distributions to unitholders.
WAR, TERRORIST ATTACKS, THREATS OF WAR OR TERRORIST ATTACKS OR POLITICAL OR
OTHER DISRUPTIONS THAT LIMIT CRUDE OIL PRODUCTION COULD HAVE A MATERIAL ADVERSE
EFFECT ON OUR BUSINESS.
The potential for war with Iraq, increasing military tension with regard to
North Korea, as well as the terrorist attacks of September 11, 2001 and
subsequent terrorist attacks and unrest, have caused instability in the world's
financial and commercial markets and have contributed to volatility in prices
for crude oil and natural gas. The United States has deployed a large military
force in the Persian Gulf and may take military action within a short period of
time. War in Iraq or threats or rumors of war or other armed conflict in Iraq or
elsewhere may cause further uncertainties and disruption to financial and
commercial markets, further increase our energy costs or limit deliveries of
foreign crude oil, which could cause a reduction in throughput in our pipelines.
Any of these conditions could have a material adverse effect on our business and
therefore on our ability to make cash distributions to our unitholders.
In addition, political uncertainties and unrest in crude oil producing
countries may adversely impact Valero Energy's refinery production and, as a
result, throughput levels in our pipelines and terminals, which may adversely
impact our results of operations and financial condition. Events such as the
recent oil workers' strike in Venezuela may cause disruptions or shutdowns in
crude oil production, adversely impacting the availability of crude oil and
other feedstocks and causing crude oil and other feedstock economics to be
unfavorable. Primarily as a result of this strike, during the first two months
of 2003, Valero Energy reduced production at several of its refineries,
including the McKee, Three Rivers and Ardmore refineries, by as much as 15%,
which had an unfavorable impact on the throughput levels in our pipelines and
terminals and our results of operations.
Since the September 11, 2001 terrorist attacks, the United States
government has issued warnings that energy assets, including our nation's
pipeline infrastructure and refineries, may be a target of future terrorist
attacks. War in Iraq or other developments could increase the risk of terrorist
attacks. A terrorist attack on our pipelines or on one of Valero Energy's
refineries could result in the loss of our personnel or assets and curtail or
reduce our throughput. As a result of turmoil in the insurance markets and
significant premium increases, neither we nor Valero Energy is fully insured
against acts of terrorism. Terrorist attacks involving assets of ours or Valero
Energy's could have a material adverse effect on our operations and result in
losses against which we would not be insured.
OUR FORMER USE OF ARTHUR ANDERSEN LLP AS OUR INDEPENDENT PUBLIC ACCOUNTANTS MAY
LIMIT YOUR ABILITY TO SEEK POTENTIAL RECOVERIES FROM THEM RELATED TO THEIR WORK.
Arthur Andersen LLP, independent public accountants, audited our financial
statements as of December 31, 2000 and for the years ended December 31, 2000 and
2001 incorporated by reference in this prospectus supplement. On March 22, 2002,
we dismissed Arthur Andersen and engaged Ernst & Young LLP. In June 2002, Arthur
Andersen was convicted on a federal obstruction of justice charge.
Moreover, Arthur Andersen has ceased operations. As a result, any recovery
you may have from Arthur Andersen related to any claims that you may assert
related to the financial statements audited by Arthur Andersen, including under
Section 11 of the Securities Act for material misstatements or omissions, if
any, in
S-21
the registration statement and prospectus, may be limited by the financial
circumstances of Arthur Andersen. Should it declare bankruptcy or avail itself
of other forms of protection from creditors, it is unlikely you would be able to
recover damages from Arthur Andersen for any claim against them.
PROPOSED CHANGES IN FEDERAL INCOME TAX LAW COULD MATERIALLY AFFECT THE VALUE OF
OUR COMMON UNITS.
On January 7, 2003, the Bush Administration released a proposal that would
exclude certain corporate dividends from an individual's federal taxable income.
Enactment of legislation reducing or eliminating the federal income tax on
corporate dividends may cause certain investments to be a more attractive
investment to individual investors than an investment in our common units. As of
the date of this prospectus supplement, we cannot predict whether the Bush
Administration's plan will ultimately be enacted into law, and if so, the form
or effective date of that legislation. Enactment of legislation reducing or
eliminating the federal income tax on corporate dividends could materially
affect the value of our common units.
S-22
THE TRANSACTIONS
CRUDE OIL TANK CONTRIBUTION
We have entered into two contribution agreements with Valero Energy
pursuant to which, upon closing of this common unit offering and the private
placement of senior notes and upon satisfaction of customary closing conditions,
Valero Energy will contribute 58 crude oil and intermediate feedstock storage
tanks and related assets to us for $200 million in cash.
The tank assets consist of all of the tank shells, foundations, tank
valves, tank gauges, pressure equipment, temperature equipment, corrosion
protection, leak detection, tank lighting and related equipment and
appurtenances associated with the specified crude oil tanks and intermediate
feedstock tanks located at Valero Energy's:
- West plant of the Corpus Christi refinery in Corpus Christi, Texas, which
has a current total capacity to process 225,000 barrels per day of crude
oil and other feedstocks;
- Texas City refinery in Texas City, Texas, which has a current total
capacity to process 243,000 barrels per day of crude oil and other
feedstocks; and
- Benicia refinery in Benicia, California, which has a current total
capacity to process 180,000 barrels per day of crude oil and other
feedstocks.
The Corpus Christi refinery consists of two plants, the West plant and the East
plant, with a combined total capacity to process 340,000 barrels per day of
crude oil and other feedstocks. Since June 1, 2001 (the date Valero Energy began
operating the East plant), Valero Energy has operated both plants as one
refinery. Unless otherwise indicated, references to the Corpus Christi refinery
include both the West and the East plants.
Historically, nearly all of the crude oil and intermediate feedstocks that
are used in the West plant of the Corpus Christi refinery, the Texas City
refinery and the Benicia refinery have passed through these tanks. These
feedstocks are held in the tanks or are segregated and blended to meet the
refineries' process requirements. These tanks have approximately 11.0 million
barrels of storage capacity in the aggregate. The following table reflects the
number of crude oil and intermediate feedstock tanks and storage capacity, as
well as mode of receipt and delivery, for each of the West plant of the Corpus
Christi refinery, the Texas City refinery and the Benicia refinery.
NUMBER OF MODE OF MODE OF
LOCATION CAPACITY TANKS RECEIPT DELIVERY
-------- ---------- --------- ------- --------
(BARRELS)
Corpus Christi, TX (West plant)...... 4,023,000 26 Marine Pipeline
Texas City, TX....................... 3,199,000 16 Marine Pipeline
Benicia, CA.......................... 3,815,000 16 Marine/Pipeline Pipeline
---------- --
Total.............................. 11,037,000 58
========== ==
The tanks are, on average, approximately 25 years old. The tank assets have
been well maintained and we estimate that they have remaining useful lives of 25
to 30 years. The crude oil tank contribution does not include a transfer of the
refined product tanks or the land underlying the tank assets at these three
refineries nor does it include any of the crude oil and other feedstock or
refined product tankage currently owned by Valero Energy at the East plant of
Valero Energy's Corpus Christi refinery or its other nine refineries. The land
on which the tank assets are located will be leased to Valero Logistics by
Valero Energy for an aggregate of $700,000 per year. The initial term of each
lease will be 25 years, subject to automatic renewal for successive one-year
periods thereafter. We may terminate any of these leases upon 30 days notice
after the initial term or at the end of a renewal period. In addition, we may
also terminate any of these leases upon 180 days notice prior to the expiration
of the current term if we cease to operate the tank assets or cease business
operations.
S-23
The following table sets forth the average daily throughput of the
specified feedstocks (crude oil, gas oil, residual fuel oil, vacuum gas oil,
vacuum tower bottoms and light cycle oil) for these tanks for each of the West
plant of the Corpus Christi refinery, the Texas City refinery and the Benicia
refinery for the five-year period ended December 31, 2002.
YEARS ENDED DECEMBER 31,
-----------------------------------------------
LOCATION 1998 1999 2000 2001 2002
-------- ------- ------- ------- ------- -------
(BARRELS/DAY)
Corpus Christi, TX (West plant)...... 148,501 140,013 157,684 157,452 150,809
Texas City, TX....................... 156,389 156,448 158,183 185,109 146,068
Benicia, CA(1)....................... -- -- 141,353 141,934 136,603
------- ------- ------- ------- -------
Total Average Throughput........... 304,890 296,461 457,220 484,495 433,480
======= ======= ======= ======= =======
---------------
(1) Valero Energy acquired the Benicia refinery on May 15, 2000. The throughput
volumes for 2000 are based on the period from May 16, 2000 through December
31, 2000.
Throughputs of the specified feedstocks at these refineries vary from year
to year as a result of market conditions and maintenance turnarounds, as well as
increases in refinery capacities resulting from capital expenditures. In 2002,
refined product inventories industry-wide were high and imports of refined
products were at record levels, resulting in unfavorable refining and marketing
conditions. According to the Energy Information Agency, U.S. refinery
utilization in 2002 was 89.9% of capacity compared to an average utilization of
93.6% for the period from 1997 through 2001. As a result of these conditions,
Valero Energy initiated economic-based refinery production cuts, by as much as
25% during certain times of the year, at certain of its refineries. As refining
margins increased in the latter half of 2002, the refineries returned to normal
operating levels; however, full year 2002 throughput levels were lower than in
2001. Volumes at the West plant of the Corpus Christi refinery were negatively
impacted by market conditions in 1999 and 2002. Additionally, the West plant of
the Corpus Christi refinery underwent a maintenance turnaround for a period of
20 days in 2002 that involved its heavy oil cracker.
Volumes at the Texas City refinery were adversely impacted in 2002 by
market conditions and a 45-day plant-wide turnaround in which major units at the
facility were expanded and upgraded. However, in 2001, volumes benefited from
above-average refining margins and high refinery production rates. Additionally,
2000 volumes were adversely impacted by construction and maintenance activities
related to the expansion of two crude units.
Volumes at the Benicia refinery were adversely impacted by unplanned
downtime in 2002. There have been no major turnarounds needed since Valero
Energy purchased this refinery in 2000. Although this refinery is completing a
capital project to convert its gasoline production to meet stricter California
gasoline standards by the end of 2003, we do not believe that this project will
materially impact volumes at this refinery.
Valero Energy does not have any significant turnarounds planned for 2003 at
any of these refineries.
Throughput Fee. In connection with the crude oil tank contribution, Valero
Logistics and Valero Energy will enter into a handling and throughput agreement
pursuant to which Valero Energy will agree to pay Valero Logistics a fee, for an
initial period of ten years, for 100% of specified feedstocks delivered to each
of the West plant of the Corpus Christi refinery, the Texas City refinery or the
Benicia refinery and to use Valero Logistics for handling all deliveries to
these refineries as long as Valero Logistics is able to provide the handling and
throughput services. Subject to force majeure and other exceptions, Valero
Logistics will reimburse Valero Energy for the cost of substitute services
should Valero Logistics not be able to provide these services. Valero Logistics
and Valero Energy will agree, pursuant to the handling and throughput
S-24
agreement, to the following initial throughput fee per barrel for each barrel of
the specified feedstocks received by these refineries:
THROUGHPUT FEE PER BARREL
REFINERY FOR THE YEAR 2003
-------- -------------------------
West plant of Corpus Christi................................ $0.203
Texas City.................................................. 0.121
Benicia..................................................... 0.296
For specified feedstocks delivered by Valero Logistics to these refineries after
December 31, 2003, the throughput fee per barrel will be adjusted annually,
generally based on 75% of the regional consumer price index applicable to the
location of each refinery. The initial term of the handling and throughput
agreement will be ten years and may be extended by Valero Energy for up to an
additional five years.
Operating Expenses. Valero Logistics will enter into services and
secondment agreements with Valero Energy pursuant to which we anticipate that 25
employees, on a full-time equivalent basis, of Valero Energy will be seconded to
Valero Logistics to provide operating and routine maintenance services with
respect to the tank assets under the direction, supervision and control of a
designated employee of Valero GP, LLC performing services for Valero Logistics.
Valero Logistics will reimburse Valero Energy for the costs and expenses of the
employees providing these operating and routine maintenance services. The annual
reimbursement for services is an aggregate $3.5 million for the year following
closing that will be subject to adjustment for the actual operating and routine
maintenance costs and expenses incurred and increases in the regional consumer
price index. In addition, we have agreed to pay Valero Energy $700,000 a year
for the lease of the real property on which the tank assets are located. The
initial terms of the services and secondment agreements will be ten years with
an option to extend for an additional five years. Valero Logistics may terminate
these agreements upon 30 days written notice.
In addition to the fees we have agreed to pay Valero Energy under the
services and secondment agreement, we will be responsible for operating expenses
and specified capital expenditures related to the tank assets that are not
addressed in the services and secondment agreement. These operating expenses and
capital expenditures include tank safety inspections, maintenance and repairs,
certain environmental expenses, insurance premiums and ad valorem taxes. Based
on our experience operating and maintaining similar assets and our knowledge of
these assets, we estimate that:
- tank safety inspections, maintenance and repairs will initially cost
approximately $4.5 million per year;
- environmental expenses, insurance premiums and ad valorem taxes will
initially be approximately $1.2 million per year; and
- maintenance capital expenditures will initially be approximately $600,000
per year.
The operating expenses and maintenance capital expenditures that are not
addressed in the services and secondment agreement are estimates only, even
though they are based on assumptions made by us based on our experience
operating and maintaining similar assets and our knowledge of these assets.
Should our assumptions and expectations related to these operating expenses
differ materially from actual future results, we may not be able to generate net
income sufficient to sustain an increase in available cash per unit at currently
expected levels or at all.
Environmental Indemnification. In connection with the crude oil tank
contribution, Valero Energy has agreed to indemnify us from environmental
liabilities related to:
- the tank assets that arose as a result of events occurring or conditions
existing prior to the closing of the crude oil tank contribution;
- any real or personal property on which the tank assets are located that
arose prior to the closing of the crude oil tank contribution; and
S-25
- any actions taken by Valero Energy before, on or after the closing of the
crude oil tank contribution, in connection with the ownership, use or
operation of the West plant of the Corpus Christi refinery, the Texas
City refinery and the Benicia refinery or the property on which the tank
assets are located, or any accident or occurrence in connection
therewith.
No Historical Financial Information. Historically, the tank assets have
been operated as part of Valero Energy's refining operations and, as a result,
no separate fee has been charged related to these assets and, accordingly, no
revenues related to these assets have been recorded. The tank assets have not
been accounted for separately and have not been operated as an autonomous
business unit. Instead, they have been operated as part of business units that
comprise part of Valero Energy's refining operations, and operating decisions
have been made to maximize the overall profits of the operating divisions rather
than the profits of any individual refinery asset such as the tank assets. We
intend to manage and operate the tank assets to maximize revenues and cash
available for distribution to our unitholders by charging Valero Energy and
third parties a market-based throughput fee.
Financial Impact. Based on historical throughput volumes for the year
ended December 31, 2002 and throughput fees for the year 2003 as agreed upon
with Valero Energy, our aggregate revenues for the tank assets would have been
approximately $32.4 million for the year ended December 31, 2002. Many factors
could cause future results to differ from expected results, including a decline
in Valero Energy's refining throughput, due to market conditions or otherwise,
at the West plant of the Corpus Christi refinery, the Texas City refinery or the
Benicia refinery.
Conflicts Committee Approval. The crude oil tank contribution has been
approved by a conflicts committee of the board of directors of Valero GP, LLC
based on an opinion from its independent financial advisor that the
consideration to be paid by us pursuant to the contribution agreement related to
the crude oil tank contribution is fair, from a financial point of view, to us
and our public unitholders.
Under the terms of the contribution agreements, the crude oil tank
contribution is subject to customary closing conditions, including the absence
of any material adverse change in the condition of the tank assets and our
ability to obtain financing.
SOUTH TEXAS PIPELINE CONTRIBUTION
We have entered into a contribution agreement with Valero Energy pursuant
to which, upon closing of this common unit offering and the private placement of
senior notes and upon satisfaction of customary closing conditions, Valero
Energy will contribute the South Texas pipeline system, comprised of the Houston
pipeline system, the San Antonio pipeline system and the Valley pipeline system
and related terminalling assets, to us for $150 million in cash. The three
pipeline systems that make up the South Texas pipeline assets are intrastate
common carrier refined product pipelines that connect Valero Energy's Corpus
Christi refinery to the Houston and Rio Grande Valley, Texas markets and connect
Valero Energy's Three Rivers refinery to the San Antonio, Texas market and to
Valero Energy's Corpus Christi refinery. The San Antonio pipeline system (the
Pettus to San Antonio and the Pettus to Corpus Christi refined product
pipelines) connects with the Three Rivers to Pettus refined product pipelines
already owned by us. The San Antonio pipeline system delivers refined products
to the San Antonio and Corpus Christi, Texas markets that it receives through
the two existing pipelines. Each of the three intrastate pipelines is subject to
the regulatory jurisdiction of the Texas Railroad Commission.
On June 1, 2001, Valero Energy and subsidiaries of El Paso Corporation
consummated two capital leases with an associated purchase option with respect
to the East plant of the Corpus Christi refinery and the related South Texas
pipeline and terminal assets. Valero Energy has been operating these assets
since that date. On February 28, 2003, Valero Energy exercised the purchase
option for approximately $289.3 million in cash.
The following table sets forth the average daily throughput of gasoline,
distillate and blendstock volumes transported from the Corpus Christi refinery
and the Three Rivers refinery and the mode of transportation for
S-26
these volumes for the period from June 1, 2001 through December 31, 2001 and for
the year ended December 31, 2002.
AVERAGE THROUGHPUT
-------------------------------------
JUNE 1, 2001
THROUGH YEAR ENDED
DECEMBER 31, 2001 DECEMBER 31, 2002
----------------- -----------------
(BARRELS/DAY)
CORPUS CHRISTI REFINERY:
South Texas pipeline system(1).................... 113,896 114,947
Other(2).......................................... 132,888 113,236
------- -------
TOTAL.......................................... 246,784 228,183
======= =======
THREE RIVERS REFINERY:
South Texas pipeline system(3).................... 25,240 26,153
Other pipelines owned by Valero L.P............... 44,774 43,199
Other(4).......................................... 10,206 9,649
------- -------
TOTAL.......................................... 80,220 79,001
======= =======
---------------
(1) Represents throughput in the Corpus Christi to Houston and Corpus Christi to
Edinburg refined product pipelines.
(2) Represents volumes that were transported by truck, marine and rail.
(3) All volumes transported through the South Texas pipeline system are first
transported in the Three Rivers to Pettus refined product pipelines. These
volumes have been excluded from the volumes included under "Other pipelines
owned by Valero L.P."
(4) Represents volumes that were delivered via Valero Energy's truck loading
rack at this refinery.
The Houston pipeline system and the Valley pipeline system provide the
primary pipeline access for refined products from Valero Energy's Corpus Christi
refinery. Other than pipelines, marine transportation has historically been the
primary mode of transportation for refined products from this refinery. The San
Antonio pipeline system, in conjunction with existing refined product pipelines
we own, provide essentially the only pipeline access to end markets from Valero
Energy's Three Rivers refinery. Refined products are also delivered via Valero
Energy's truck loading rack at this refinery.
Houston Pipeline System. The Houston pipeline system includes the Corpus
Christi to Houston refined product pipeline, which is a 12-inch refined product
pipeline that runs approximately 204 miles from Valero Energy's Corpus Christi
refinery located in Corpus Christi, Texas, to Placedo, Texas and on to Pasadena,
Texas. This pipeline interconnects with major third party pipelines with
delivery points throughout the eastern United States. In October 2002, the
Corpus Christi to Houston refined product pipeline was expanded from 95,000
barrels per day to 105,000 barrels per day. At present we are transporting over
100,000 barrels per day of refined product in this pipeline. In 2002, the Corpus
Christi refinery provided 88% of the pipeline's throughput and third party
shippers provided the remaining 12%. In addition, this pipeline system includes
the following four refined product terminals:
- Hobby Airport refined product terminal located at Hobby airport in
Houston, Texas, which includes 107,100 barrels of jet fuel storage and
associated truck rack and re-fueler facilities;
- Placedo refined product terminal located near Victoria, Texas, which
includes 98,000 barrels of refined product storage and associated truck
loading rack;
- Houston asphalt terminal located on the Houston ship channel, which
includes 75,000 barrels of asphalt storage, truck loading facilities and
a barge dock; and
S-27
- Almeda refined product terminal located in south Houston, which includes
105,800 barrels of refined product storage and associated truck loading
rack, which is currently idle.
San Antonio Pipeline System. The San Antonio pipeline system is comprised
of two segments: the north segment, which runs from Pettus to San Antonio and
the south segment, which runs from Pettus to Corpus Christi. The north segment
originates in Pettus, Texas, where it connects to our existing 12-inch Three
Rivers to Pettus refined product pipeline and terminates in San Antonio, Texas
at the San Antonio refined product terminal. This San Antonio refined product
terminal, which has approximately 148,200 barrels of storage capacity and an
associated truck loading rack, is separate from the San Antonio terminal
currently owned by us. The north segment is 74 miles long and consists of 6-inch
and 12-inch pipeline segments with a capacity of approximately 24,000 barrels
per day. This pipeline segment transports refined products from the Three Rivers
refinery, located between Corpus Christi and San Antonio, to the San Antonio
refined product terminal.
The south segment originates in Pettus, Texas, where it connects to our
existing 8-inch Three Rivers to Pettus refined product pipeline and terminates
in Corpus Christi, Texas at Valero Energy's Corpus Christi refinery. The south
segment is 60 miles long and consists of 6-inch, 8-inch, 10-inch and 12-inch
pipeline segments with a capacity of approximately 15,000 barrels per day. This
pipeline segment transports distillates and blendstocks, primarily raffinate,
from the Three Rivers refinery to the Corpus Christi refinery. Valero Energy is
the only shipper in both segments of the San Antonio pipeline system. Although
it is possible to operate the two segments of the San Antonio pipeline as a
continuous pipeline from Corpus Christi to San Antonio, this is rarely done and
we have no present intention to do so.
Valley Pipeline System. The Valley pipeline system contains the Corpus
Christi to Edinburg refined product pipeline and the Edinburg refined product
terminal. This pipeline is a refined product pipeline that consists of 6-inch
and 8-inch segments and extends 130 miles from Corpus Christi, Texas to
Edinburg, Texas. The capacity of the Corpus Christi to Edinburg refined product
pipeline was expanded in 2002 from 24,000 barrels per day to approximately
27,100 barrels per day. Refined products shipped on the Valley pipeline system
are distributed in the Southern Rio Grande Valley area of Texas, which includes
the cities of Edinburg and McAllen, Texas with occasional spot sales to
Petroleos Mexicanos for distribution in Mexico. Valero Energy is the only
shipper in this pipeline. The Edinburg refined product terminal includes
approximately 184,600 barrels of refined product storage and an associated truck
loading rack.
The following table sets forth the origin and destination, length in miles,
ownership percentage, capacity and average throughput for the period from June
1, 2001 (the date Valero Energy began operating the South Texas pipelines and
terminals) through December 31, 2001 and the year ended December 31, 2002, for
each refined product pipeline associated with the South Texas pipeline
contribution.
AVERAGE THROUGHPUT
---------------------------
JUNE 1, 2001
THROUGH YEAR ENDED
DECEMBER 31, DECEMBER 31,
ORIGIN AND DESTINATION LENGTH OWNERSHIP CAPACITY 2001 2002
---------------------- ------- --------- ------------- ------------ ------------
(BARRELS/DAY) (BARRELS/DAY)
HOUSTON PIPELINE SYSTEM:
Corpus Christi refinery to
Pasadena, TX(1)......... 204 100% 105,000 94,292 92,591
SAN ANTONIO PIPELINE SYSTEM:
Pettus, TX to San Antonio,
TX...................... 74 100% 24,000 19,021 19,747
Pettus, TX to Corpus
Christi, TX............. 60 100% 15,000 6,219 6,406
VALLEY PIPELINE SYSTEM:
Corpus Christi refinery to
Edinburg, TX............ 130 100% 27,100 19,604 22,356
--- ------- ------- -------
468 171,100 139,136 141,100
=== ======= ======= =======
---------------
(1) Including volumes delivered to Placedo and Pasadena, Texas.
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The following table outlines the location, capacity, number of tanks, mode
of receipt and delivery and average throughput for the period from June 1, 2001
(the date Valero Energy began operating the South Texas pipelines and terminals)
through December 31, 2001 and the year ended December 31, 2002, for each refined
product terminal associated with the South Texas pipeline contribution.
AVERAGE THROUGHPUT
---------------------------
JUNE 1, 2001
THROUGH YEAR ENDED
NUMBER OF MODE OF MODE OF DECEMBER 31, DECEMBER 31,
TERMINAL LOCATION CAPACITY TANKS RECEIPT DELIVERY 2001 2002
----------------- --------- --------- -------- -------- ------------ ------------
(BARRELS) (BARRELS/DAY)
HOUSTON PIPELINE
SYSTEM:
Houston, TX
Hobby Airport... 107,100 6 Pipeline Truck/Pipeline 4,524 4,436
Placedo 98,000 4 Pipeline 4,113 3,030
(Victoria).... Truck
Asphalt......... 75,000 3 Marine Truck 2,019 1,453
Almeda(1)....... 105,800 6 Pipeline Truck 2,724 969
SAN ANTONIO PIPELINE
SYSTEM:
San Antonio, TX.... 148,200 8 Pipeline Truck/Pipeline 19,021 19,747
VALLEY PIPELINE
SYSTEM:
Edinburg, TX....... 184,600 7 Pipeline Truck 19,604 22,356
------- -- ------ ------
718,700 34 52,005 51,991
======= == ====== ======
---------------
(1) The Almeda terminal is currently idle.
S-29
The following table sets forth the tariff rate for each pipeline and the
throughput fee for each terminal for 2003. In addition, the table reflects the
overall impact, if any, to the historical revenues for the year ended December
31, 2002 for each of the Houston, San Antonio and Valley pipeline systems had
the 2003 tariff rates and throughput fees been in effect beginning January 1,
2002 and if 2002 throughput volumes were unchanged.
2003 TARIFF YEAR ENDED DECEMBER 31, 2002
RATES AND --------------------------------------
THROUGHPUT HISTORICAL AS ADJUSTED (DECREASE)
FEES REVENUES REVENUES OR INCREASE
------------ ---------- ----------- -----------
(PER BARREL) (IN THOUSANDS)
PIPELINES:
----------
HOUSTON PIPELINE SYSTEM:
Corpus Christi refinery to Pasadena, TX.... $0.485 $15,854 $15,854 $ --
Corpus Christi refinery to Placedo, TX..... 0.375 415 415 --
SAN ANTONIO PIPELINE SYSTEM:
Pettus, TX to San Antonio, TX.............. 0.150 2,196 1,177 (1,019)
Pettus, TX to San Antonio, TX to Union
Pacific Railroad........................ 0.600 248 248 --
Pettus, TX to Corpus Christi, TX........... 0.315 737 737 --
VALLEY PIPELINE SYSTEM:
Corpus Christi refinery to Edinburg, TX.... 0.705 5,753 5,753 --
------- ------- -------
TOTAL PIPELINES....................... 25,203 24,184 (1,019)
------- ------- -------
TERMINALS(1):
----------
HOUSTON PIPELINE SYSTEM:
Houston, TX
Hobby Airport........................... 0.28 340 456 116
Placedo (Victoria)...................... 0.31 216 339 123
Asphalt................................. 1.75 530 928 398
Almeda(2)............................... -- 75 75 --
SAN ANTONIO PIPELINE SYSTEM:
San Antonio, TX(3)......................... 0.34 106 2,473 2,367
VALLEY PIPELINE SYSTEM:
Edinburg, TX............................... 0.35 1,427 2,844 1,417
------- ------- -------
TOTAL TERMINALS....................... 2,694 7,115 4,421
------- ------- -------
TOTAL PIPELINES AND TERMINALS......... $27,897 $31,299 $ 3,402
======= ======= =======
---------------
(1) The 2003 terminal throughput fees are based on the contractual fee of $0.252
per barrel for terminalling gasoline and distillates, $1.75 per barrel for
terminalling asphalt, $0.122 per barrel for gasoline additive blending and
$0.03 per barrel for filtering jet fuel. The 2003 throughput fees in the
table above are based on actual 2002 refined products terminalled and the
impact of blending and filtering.
(2) The Almeda terminal is currently idle.
(3) Historical revenues for the San Antonio terminal for the year ended December
31, 2002 were based primarily on a monthly amount per a contractual
arrangement. Effective March 1, 2003, Valero Energy began charging a
terminal fee and an additive blending fee for all throughput volumes
terminalled at the San Antonio terminal. If the current terminal and
additive blending fees had been implemented effective January 1, 2002,
revenues for the year ended December 31, 2002 would have increased by $1.4
million.
S-30
For the year ended December 31, 2002, the South Texas pipelines and
terminals generated aggregate revenues of $27.9 million, EBITDA of $11.3 million
and income before income taxes of $164,000. These items include $820,000 of
general and administrative expenses allocated to these assets. After the South
Texas pipeline contribution, general and administrative expenses related to
these assets will be covered by the annual service fee we pay Valero Energy.
Maintenance capital expenditures during 2002 were $843,000; however we expect
annual maintenance capital expenditures on these pipelines and terminals over
the next three years to be approximately $3 million to $5 million as a result of
various maintenance projects. Additionally, the 2002 financial results included
a $636,000 loss for volumetric expansions, contractions and measurement
variances in the South Texas pipelines. Effective March 1, 2003, these
volumetric variances will be the responsibility of the shipper. Please read
"Valero South Texas Pipelines and Terminals Business Financial Statements"
beginning on page F-31 of this prospectus supplement.
EBITDA is presented because EBITDA is a widely accepted financial indicator
used by some investors and analysts to analyze and compare companies on the
basis of operating performance. However, EBITDA is not intended to represent
cash flows for the period, nor is it presented as an alternative to operating
income or income before income tax. It should not be considered in isolation or
as a substitute for a measure of performance prepared in accordance with United
States generally accepted accounting principles. Our method of computation may
or may not be comparable to other similarly titled measures used by other
partnerships. Set forth below is our reconciliation of income before income tax
expense to EBITDA for the South Texas pipelines and terminals for 2002 (in
thousands).
Income before income tax expense............................ $ 164
Plus interest expense....................................... 7,743
Plus depreciation and amortization.......................... 3,390
-------
EBITDA...................................................... $11,297
=======
Environmental and Other Indemnification. In connection with the South Texas
pipeline contribution, Valero Energy has agreed to indemnify us from
environmental liabilities related to:
- the South Texas pipelines and terminals that arose as a result of events
occurring or conditions existing prior to the closing of the South Texas
pipeline contribution; and
- any real or personal property on which the South Texas pipelines and
terminals are located that arose prior to the closing of the South Texas
pipeline contribution;
that are known at closing or are discovered within 10 years after the closing of
the South Texas pipeline contribution.
Valero Energy is currently addressing soil or groundwater contamination at
11 sites associated with the South Texas pipelines and terminals through
assessment, monitoring and remediation programs with oversight by the applicable
state agencies. In the aggregate, we have estimated that the total liability for
remediating these sites will not exceed $3.5 million although there can be no
guarantee that the actual remedial costs or associated liabilities will not
exceed this amount. Valero Energy has agreed to indemnify us for these
liabilities.
Valero Energy has indicated to us that the segment of the Corpus Christi to
Edinburg refined product pipeline that runs approximately 60 miles south from
Corpus Christi to Seeligson Station may require repair and, in some places,
replacement. Valero Energy has agreed to indemnify us for any costs we incur to
repair and replace this segment in excess of $1.5 million, which is
approximately the amount of capital expenditures we expect to spend on this
segment for the next three years.
S-31
Throughput Commitment Agreement. Pursuant to the South Texas pipelines and
terminals throughput commitment agreement, Valero Energy will commit, during
each quarterly measurement period, for an initial period of seven years:
- to transport in the Houston and Valley pipeline systems an aggregate of
40% of the Corpus Christi gasoline and distillate production but only if
the combined throughput on these pipelines is less than 110,000 barrels
per day;
- to transport in the Pettus to San Antonio refined product pipeline 25% of
the Three Rivers gasoline and distillate production and in the Pettus to
Corpus Christi refined product pipeline 90% of the Three Rivers raffinate
production;
- to use the Houston asphalt terminal for an aggregate of 7% of the asphalt
production of the Corpus Christi refinery;
- to use the Edinburg refined product terminal for an aggregate of 7% of
the gasoline and distillate production of the Corpus Christi refinery,
but only if the throughput at this terminal is less than 20,000 barrels
per day; and
- to use the San Antonio refined product terminal for 75% of the throughput
in the Pettus to San Antonio refined product pipeline.
The minimum commitment percentages detailed above are lower than the percentages
of refined products transported through each of these assets in 2002. With the
exception of the Houston asphalt terminal, Valero Energy's commitments reflect
75% or more of the actual percentages in 2002. Valero Energy's commitment at the
Houston asphalt terminal reflects approximately 50% of the actual throughput of
this terminal in 2002.
In the event Valero Energy does not transport in our pipelines or use our
terminals to handle the minimum volume requirements and if its obligation has
not been suspended under the terms of the agreement, it will be required to make
a cash payment determined by multiplying the shortfall in volume by the
applicable weighted average tariff rate or terminal fee. Also, Valero Energy
agreed to allow us to increase our tariff to compensate for any revenue
shortfall in the event we have to curtail throughput on the Corpus Christi to
Edinburg refined product pipeline as a result of repair and replacement
activities.
Terminalling Agreement. Pursuant to the terminalling agreement, Valero
Energy will pay to us a terminalling fee of:
- $0.252 per barrel for all diesel fuel, motor fuel and jet fuel;
- $1.75 per barrel for all conventional asphalt; and
- $2.20 per barrel for all modified grade asphalt
stored or handled by or on behalf of Valero Energy at the terminals associated
with the South Texas pipeline systems.
In addition to the terminalling fee, Valero Energy will pay us a $0.122 per
barrel additive fee for generic gasoline additives should Valero Energy elect to
receive these additives in the products. If Valero Energy or its customers elect
to directly supply a proprietary additive, Valero Energy will pay us an additive
handling fee of $.092 per barrel. This additive fee applies to all terminals
associated with the South Texas pipeline systems other than the Hobby Airport
refined product terminal and Houston asphalt terminal. Valero Energy will pay us
a $0.0298 per barrel filtering fee for products stored or handled at the Hobby
Airport refined product terminal.
The initial term of the terminalling agreement will be five years, subject
to automatic renewal for successive one-year periods thereafter. Either party
may terminate the terminalling agreement after the initial term upon 30 days
notice at the end of a renewal period.
Conflicts Committee Approval. The South Texas pipeline contribution has
been approved by a conflicts committee of the board of directors of Valero GP,
LLC based on an opinion from its independent financial
S-32
advisor that the consideration to be paid by us pursuant to the contribution
agreement related to the South Texas pipeline contribution is fair, from a
financial point of view, to us and our public unitholders.
Under the terms of this contribution agreement, the South Texas pipeline
contribution is subject to customary closing conditions, including the absence
of any material adverse change in the condition of the pipelines and terminals
and our ability to obtain financing.
PRIVATE PLACEMENT OF SENIOR NOTES
Concurrently with this offering, Valero Logistics is offering $250 million
in aggregate principal amount of senior notes in a private placement. The senior
notes are being offered only to qualified institutional investors in reliance on
Rule 144A under the Securities Act and to non-U.S. persons in offshore
transactions pursuant to Regulation S under the Securities Act. The senior notes
will be unsecured and guaranteed by us. This prospectus supplement and the
accompanying prospectus shall not be deemed to be an offer to sell or a
solicitation of an offer to buy any senior notes offered in the private
placement. There is no assurance that this private placement will be completed
or, if it is completed, that it will be completed for the amount contemplated.
The private placement is conditioned upon the consummation of this common unit
offering, and this common unit offering is conditioned upon the consummation of
the private placement.
REDEMPTION OF COMMON UNITS OWNED BY VALERO ENERGY AND AMENDMENT TO PARTNERSHIP
AGREEMENT
Common Unit Redemption. Immediately following the closing of this common
unit offering and the private placement of senior notes, we will redeem from
Valero Energy 3,809,750 common units for approximately $134.1 million, which
will reduce Valero Energy's aggregate ownership interest in us to 49.5%. We will
redeem the common units for $35.19 per unit, which is equal to the net proceeds
per unit we receive in this public offering of common units before expenses.
Immediately following the redemption, we will cancel the common units redeemed
from Valero Energy. We will also redeem the corresponding portion of Valero
Energy's general partner interest. The redemption transaction is conditioned
upon the closing of this common unit offering and the closing of the concurrent
private placement of senior notes by Valero Logistics.
Conflicts Committee Action. The conflicts committee of Valero GP, LLC
concluded that the pricing mechanism in this offering would produce a fair price
for us for the common units we intend to redeem from Valero Energy.
Amendment to Partnership Agreement. Immediately upon closing of the
offerings, we will amend our partnership agreement to provide that our general
partner may be removed by the vote of the holders of at least 58% of our
outstanding common units and subordinated units, excluding the common units and
subordinated units held by affiliates of our general partner. We will also amend
our partnership agreement to provide that the election of a successor general
partner upon any such removal be approved by the holders of a majority of the
common units, excluding the common units held by affiliates of our general
partner.
Currently, our partnership agreement provides that the general partner may
be removed by the vote of the holders of at least 66 2/3% of our outstanding
common units and subordinated units, including the common units and subordinated
units held by affiliates of our general partner, which effectively allows Valero
Energy to block removal of the general partner by virtue of its indirect
ownership of approximately 73% of our outstanding common units and subordinated
units. Furthermore, our partnership agreement currently provides that any
removal is conditioned upon the election of a successor general partner by the
holders of a majority of the common units, voting as a separate class, and by
the holders of a majority of the subordinated units, voting as a separate class,
including the units held by affiliates of our general partner.
If our general partner is removed without cause during the subordination
period and units held by the general partner or its affiliates are not voted in
favor of that removal, all remaining subordinated units will automatically be
converted into common units and any existing arrearages on the common units will
be extinguished. Cause is narrowly defined to mean that a court of competent
jurisdiction has entered a final, non-appealable judgment finding the general
partner liable for actual fraud, gross negligence, or willful or wanton
misconduct in its capacity as our general partner.
S-33
USE OF PROCEEDS
We will receive net proceeds from this common unit offering of
approximately $202.3 million after deducting underwriting discounts and
commissions. We anticipate using the net proceeds from this offering and from
the related net capital contribution of our general partner of approximately
$1.5 million, together with the proceeds from the private placement of senior
notes by Valero Logistics, which will be approximately $248.0 million, and the
$34.3 million of borrowings under the revolving credit facility to finance the
following transactions with Valero Energy:
- $200 million for the crude oil tank contribution;
- $150 million for the South Texas pipeline contribution;
- $134.1 million for the redemption of common units; and
- an estimated $2 million for aggregate transaction costs.
We expect the crude oil tank contribution and the South Texas pipeline
contribution to close immediately upon the closing of this common unit offering,
the private placement of senior notes by Valero Logistics and the redemption of
the common units. If the crude oil tank contribution or the South Texas pipeline
contribution is not completed, we will use all of the net proceeds from this
common unit offering for working capital and general partnership purposes.
Pending these uses, the proceeds will be invested in investment grade
securities. The proceeds from any exercise of the underwriters' over-allotment
option will be used to pay off borrowings under the amended revolving credit
facility or for working capital and general partnership purposes.
S-34
CAPITALIZATION
The following table shows:
- our historical capitalization as of December 31, 2002; and
- our as adjusted capitalization as of December 31, 2002, adjusted to
reflect this common unit offering, the private placement of senior notes
by Valero Logistics, the borrowings under the revolving credit facility,
the redemption of a portion of Valero Energy's common units and the
application of the net proceeds we receive in this common unit offering
and those financings in the manner described under "Use of Proceeds."
This table should be read together with our consolidated and combined financial
statements and the accompanying notes included elsewhere in this prospectus
supplement.
AS OF DECEMBER 31, 2002
------------------------
ACTUAL AS ADJUSTED
--------- ------------
(IN THOUSANDS)
Revolving credit facility................................... $ -- $ 34,320
Long-term debt, including current portion................... 9,958 9,958
6.875% Senior Notes due 2012................................ 99,700 99,700
6.05% Senior Notes due 2013................................. -- 249,298
-------- --------
Total debt............................................. 109,658 393,276
-------- --------
Partners' Equity:
Common units.............................................. 170,655 238,933
Subordinated units........................................ 117,042 117,042
General partner's equity.................................. 6,198 7,653
-------- --------
Total partners' equity.................................... 293,895 363,628
-------- --------
Total capitalization................................... $403,553 $756,904
======== ========
S-35
PRICE RANGE OF COMMON UNITS AND DISTRIBUTIONS
Our initial public offering was completed on April 16, 2001. As of December
31, 2002, there were 9,654,572 common units outstanding, held by approximately
65 holders, including common units held in street name. The common units are
traded on the New York Stock Exchange under the symbol VLI. An additional
9,599,322 subordinated units are outstanding. The subordinated units are held by
an affiliate of our general partner and are not publicly traded.
The following table sets forth, for the periods indicated, the high and low
sales prices for the common units, as reported on the New York Stock Exchange
Composite Transactions Tape, and quarterly cash distributions paid to our
unitholders. The last reported sale price of common units on the New York Stock
Exchange on March 12, 2003 was $36.75 per unit.
PRICE RANGE CASH
---------------- DISTRIBUTIONS
HIGH LOW PER UNIT(1)
------ ------- -------------
YEAR ENDED 2003
First Quarter (through March 12, 2003)............... $40.64 $ 35.86 N/A
YEAR ENDED 2002
Fourth Quarter....................................... $39.75 $ 35.10 $0.70
Third Quarter........................................ 37.48 33.15 0.70
Second Quarter....................................... 39.50 36.10 0.70
First Quarter........................................ 42.10 37.00 0.65
YEAR ENDED 2001
Fourth Quarter....................................... $40.40 $ 33.10 $0.60
Third Quarter........................................ 35.60 30.00 0.60
Second Quarter....................................... 31.95 27.66 0.50
---------------
(1) Represents cash distributions attributable to the quarter and declared and
paid within 45 days after quarter end. We paid an identical cash
distribution to the holders of our subordinated units for each period shown
in this table. We paid cash distributions to our general partner which
totaled $667,000 and $2,206,000 for the years ended December 31, 2001 and
2002, respectively. Included in the general partner cash distribution for
the year ended December 31, 2002 is $1,103,000 of incentive distributions.
S-36
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The following discussion and analysis of our results of operations and
financial condition should be read in conjunction with "Business," "Summary
Financial and Operating Data" and our financial statements and supplementary
data beginning on page F-1 of this prospectus supplement. However, our results
of operations and financial data do not include any results from the
contributions, nor do they give effect to the redemption of common units from
Valero Energy, all of which are discussed under "The Transactions" beginning on
page S-23 of this prospectus supplement.
The introduction to "Summary Financial and Operating Data" as well as "Note
1: Organization, Business and Basis of Presentation" to the consolidated and
combined financial statements beginning on page F-9 of this prospectus
supplement provide a description of our current and prior organization.
SEASONALITY
Our operating results are affected by factors affecting the business of
Valero Energy, including refinery utilization rates, crude oil prices, the
demand for refined products and industry refining capacity.
The throughput of crude oil that we transport is directly affected by the
level of, and refiner demand for, crude oil in markets served directly by our
crude oil pipelines. Crude oil inventories tend to increase due to
overproduction of crude oil by producing companies and countries and planned
maintenance turnaround activity by refiners. To bring crude oil inventories back
in line with demand, refiners reduce production levels, which also has the
effect of increasing crude oil market prices.
The throughput of the refined products that we transport is directly
affected by the level of, and user demand for, refined products in the markets
served directly or indirectly by our refined product pipelines. Demand for
gasoline in most markets peaks during the summer driving season, which extends
from May through September, and declines during the fall and winter months.
Demand for gasoline in the Arizona market, however, generally is higher in the
winter months than summer months due to greater tourist activity and second home
usage in the winter months.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001
The results of operations for the year ended December 31, 2002 presented in
the following table are derived from the consolidated statement of income for
Valero L.P. and subsidiaries for the year ended December 31, 2002, which
includes the Wichita Falls Business for the month ended January 31, 2002 prior
to its actual acquisition on February 1, 2002. The results of operations for the
year ended December 31, 2001 presented in the following table are derived from
the consolidated statement of income for Valero L.P. and subsidiaries for the
period from April 16, 2001 through December 31, 2001 and the combined statement
of income for Valero L.P. and Valero Logistics for the period from January 1,
2001 through April 15, 2001, which in this discussion are combined and referred
to as the year ended December 31, 2001.
S-37
Financial Data:
YEARS ENDED
DECEMBER 31,
-------------------
2001 2002
-------- --------
(IN THOUSANDS)
STATEMENT OF INCOME DATA:
REVENUES.................................................... $ 98,827 $118,458
-------- --------
COSTS AND EXPENSES:
Operating expenses........................................ 33,583 37,838
General and administrative expenses....................... 5,349 6,950
Depreciation and amortization............................. 13,390 16,440
-------- --------
TOTAL COSTS AND EXPENSES............................... 52,322 61,228
-------- --------
OPERATING INCOME............................................ 46,505 57,230
Equity income from Skelly-Belvieu Pipeline Company........ 3,179 3,188
Interest expense, net..................................... (3,811) (4,880)
-------- --------
INCOME BEFORE INCOME TAX EXPENSE............................ 45,873 55,538
Income tax expense........................................ -- 395
-------- --------
NET INCOME.................................................. 45,873 55,143
Less net income applicable to general partner............. (715) (2,187)
Less net income related to the period from January 1, 2001
through April 15, 2001 and net income related to the
Wichita Falls Business for the month ended January 31,
2002................................................... (10,126) (650)
-------- --------
NET INCOME APPLICABLE TO THE LIMITED PARTNERS' INTEREST..... $ 35,032 $ 52,306
======== ========
S-38
Operating Data:
The following table reflects throughput barrels for our crude oil and
refined product pipelines and the total throughput for all of our refined
product terminals for the years ended December 31, 2001 and 2002.
YEARS ENDED
DECEMBER 31,
-----------------
2001 2002 % CHANGE
------- ------- --------
(IN THOUSANDS
OF BARRELS)
Crude oil pipeline throughput:
Dixon to McKee....................................... 20,403 15,970 (22)%
Wichita Falls to McKee............................... -- 26,313 --
Wasson to Ardmore.................................... 29,612 27,294 (8)%
Ringgold to Wasson................................... 13,788 12,630 (8)%
Corpus Christi to Three Rivers....................... 28,689 25,075 (13)%
Other crude oil pipelines............................ 18,399 19,746 7%
------- -------
Total crude oil pipelines......................... 110,891 127,028 15%
======= =======
Refined product pipeline throughput:
McKee to Colorado Springs to Denver.................. 8,838 7,405 (16)%
McKee to El Paso..................................... 24,285 24,121 (1)%
McKee to Amarillo to Abernathy....................... 13,747 13,304 (3)%
Amarillo to Albuquerque.............................. 4,613 4,022 (13)%
McKee to Denver...................................... 4,370 4,303 (2)%
Ardmore to Wynnewood................................. 20,835 19,780 (5)%
Three Rivers to Laredo............................... 4,479 4,711 5%
Three Rivers to San Antonio.......................... 10,175 9,322 (8)%
Other refined product pipelines...................... 21,095 20,873 (1)%
------- -------
Total refined product pipelines................... 112,437 107,841 (4)%
======= =======
Refined product terminal throughput.................... 64,522 64,079 (1)%
======= =======
Net income for the year ended December 31, 2002 was $55,143,000 as compared
to $45,873,000 for the year ended December 31, 2001. The increase of $9,270,000
was primarily attributable to the additional net income generated from the four
acquisitions completed since July of 2001 (the Southlake refined product
terminal, the Ringgold crude oil storage facility, the Wichita Falls Business
and the crude hydrogen pipeline). The increase in net income was partially
offset by the impact of lower throughput barrels in 2002 resulting from
economic-based refinery production cuts at the three Valero Energy refineries
served by our pipelines and terminals. Valero Energy initiated economic-based
refinery production cuts as a result of significantly lower refinery margins
industry-wide in the first half of 2002.
Revenues for the year ended December 31, 2002 were $118,458,000 as compared
to $98,827,000 for the year ended December 31, 2001, an increase of 20% or
$19,631,000. This increase was due primarily to the addition of the Wichita
Falls crude oil pipeline revenues, the Southlake refined product terminal
revenues and the crude hydrogen revenues, partially offset by decreases in
revenues on most of our other pipelines. The following discusses significant
revenue increases and decreases by pipeline:
- revenues for the year ended December 31, 2002 include $22,894,000 of
revenues related to the Wichita Falls to McKee crude oil pipeline,
including $1,740,000 of revenues (2,000,000 barrels of throughput)
related to the month ended January 31, 2002, which was included in our
revenues for 2002 as a result of the common control transfer between
Valero Energy and us;
S-39
- revenues for the McKee to Colorado Springs to Denver refined product
pipeline and the Amarillo to Albuquerque refined product pipeline
decreased $2,630,000 due to a combined 15% decrease in throughput
barrels, resulting from reduced production at the McKee refinery. During
the first quarter of 2002, Valero Energy completed several planned
refinery turnaround projects at the McKee refinery which significantly
reduced production and thus reduced throughput barrels in our pipelines;
- revenues for the Corpus Christi to Three Rivers crude oil pipeline
decreased $2,392,000 due to a 13% decrease in throughput barrels, as a
result of reduced production at the Three Rivers refinery. During the
first half of 2002, Valero Energy initiated economic-based refinery
production cuts at the Three Rivers refinery. In addition, during the
first quarter of 2002, Valero Energy completed several refinery
turnaround projects resulting in a partial shutdown of the refinery and
reduced throughput barrels in our pipelines;
- revenues for the crude hydrogen pipeline, which was acquired on May 29,
2002, were $828,000 for the seven months ended December 31, 2002;
- revenues for the Ringgold to Wasson crude oil pipeline increased
$749,000, despite an 8% decrease in throughput barrels resulting from
reduced production at the Ardmore refinery, due to a tariff rate increase
effective December 1, 2001 related to the Ringgold crude oil storage
facility acquisition;
- revenues for the Dixon to McKee crude oil pipeline decreased $430,000 due
to a 22% decrease in throughput barrels, as a result of Valero Energy
supplying greater quantities of crude oil to the McKee refinery from the
Wichita Falls to McKee crude oil pipeline during 2002 instead of
gathering crude oil barrels near Dixon; and
- revenues for the refined product terminals, excluding the Southlake
terminal, decreased $665,000 primarily due to a decrease in revenues for
the Corpus Christi refined product terminal. In 2002, as a result of
Valero Energy's economic-based refinery production cuts at the Three
Rivers refinery, lower volumes of benzene, toluene and xylene were
transported to Corpus Christi. Revenues for the Southlake terminal, which
was acquired on July 1, 2001, were $2,327,000 and throughput was
7,959,000 barrels for the year ended December 31, 2002 as compared to
revenues of $1,341,000 and throughput of 4,601,000 barrels for the six
months ended December 31, 2001.
Operating expenses increased $4,255,000 for the year ended December 31, 2002 as
compared to the year ended December 31, 2001 primarily due to the following
items:
- the acquisitions of the Wichita Falls Business, the Southlake refined
product terminal and the crude hydrogen pipeline increased operating
expenses by $6,565,000;
- insurance expense, excluding the impact of acquisitions, increased by
$292,000, or 45%, due to higher rates charged for the property and
liability policies we have in place;
- utility expenses, excluding the impact of acquisitions, decreased by
$2,300,000, or 22%, due to lower electricity rates as a result of lower
natural gas prices, participation in Texas deregulation, negotiating
lower rates with utility providers and implementation of power
optimization software; and
- maintenance expenses, excluding the impact of acquisitions, decreased
$499,000, or 14%, due primarily to fewer pipeline and terminal
inspections being required during 2002 as compared to 2001.
S-40
General and administrative expenses were as follows:
YEARS ENDED
DECEMBER 31,
---------------
2001 2002
------ ------
(IN THOUSANDS)
Services Agreement.......................................... $5,200 $5,200
Third party expenses........................................ 730 1,650
Compensation expense related to contractual rights to
receive common units...................................... -- 721
General and administrative expenses related to the Wichita
Falls Business for the month ended January 31, 2002....... -- 40
Reimbursement from partners on jointly owned pipelines...... (581) (661)
------ ------
$5,349 $6,950
====== ======
General and administrative expenses increased 30% for the year ended
December 31, 2002 as compared to 2001 due primarily to an increase in general
and administrative costs related to Valero L.P. being a publicly held entity and
the recognition of compensation expense related to the award of common units to
officers and directors in January of 2002 (see Note 14: Employee Benefit Plans,
Long-Term Incentive Plan). In addition to the annual fee charged by Valero
Energy to us for general and administrative services, we incur costs (e.g.,
unitholder annual reports, preparation and mailing of income tax reports to
unitholders and director fees) as a result of being a publicly held entity.
Depreciation and amortization expense increased $3,050,000 for the year
ended December 31, 2002 as compared to the year ended December 31, 2001 due to
the additional depreciation related to the acquisitions of the Southlake refined
product terminal, the Ringgold crude oil storage facility, the Wichita Falls
Business and the crude hydrogen pipeline. Included in 2002 is $160,000 of
depreciation expense related to the Wichita Falls Business for the month ended
January 31, 2002.
Equity income from Skelly-Belvieu Pipeline Company for the year ended
December 31, 2002 was comparable to equity income recognized in 2001 as
throughput barrels in the Skellytown to Mont Belvieu refined product pipeline
increased 2% during 2002.
Interest expense for the year ended December 31, 2002 was $4,880,000, net
of interest income of $248,000 and capitalized interest of $255,000, as compared
to $3,811,000 of interest expense for 2001. Interest expense was higher in 2002
due to additional borrowings to fund the acquisitions of the Southlake refined
product terminal, the Ringgold crude oil storage facility, the Wichita Falls
Business and the crude hydrogen pipeline. Included in interest expense for 2002
was interest expense related to the fixed-rate senior notes issued in July of
2002, the proceeds of which were used to repay borrowings under the
variable-rate revolving credit facility. Included in interest expense for 2001
was interest expense of $2,513,000 for the period from January 1, 2001 through
April 15, 2001 related to the $107,676,000 of debt due to parent that we assumed
on July 1, 2000 and paid off on April 16, 2001 upon the closing of our initial
public offering.
Income tax expense for the year ended December 31, 2002 represents income
tax expense incurred by the Wichita Falls Business during the month ended
January 31, 2002, prior to the transfer of the Wichita Falls Business to us.
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
The results of operations for the year ended December 31, 2001 presented in
the following table are derived from the consolidated statement of income for
Valero L.P. and subsidiaries for the period from April 16, 2001 through December
31, 2001 and the combined statement of income for Valero L.P. and Valero
Logistics for the period from January 1, 2001 through April 15, 2001, which in
this discussion are combined and referred to as the year ended December 31,
2001. The results of operations for the year ended December 31, 2000 presented
in the following table are derived from the statement of income of the Ultramar
Diamond Shamrock Logistics Business for the six months ended June 30, 2000 and
the combined statement
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of income of Valero L.P. and Valero Logistics for the six months ended December
31, 2000, which in this discussion are combined and referred to as the year
ended December 31, 2000.
Financial Data:
YEARS ENDED
DECEMBER 31,
------------------
2000 2001
-------- -------
(IN THOUSANDS)
STATEMENT OF INCOME DATA:
REVENUES.................................................... $ 92,053 $98,827
-------- -------
COSTS AND EXPENSES:
Operating expenses........................................ 33,505 33,583
General and administrative expenses....................... 5,139 5,349
Depreciation and amortization............................. 12,260 13,390
-------- -------
TOTAL COSTS AND EXPENSES............................. 50,904 52,322
-------- -------
OPERATING INCOME............................................ 41,149 46,505
Equity income from Skelly-Belvieu Pipeline Company........ 3,877 3,179
Interest expense, net..................................... (5,181) (3,811)
-------- -------
INCOME BEFORE INCOME TAX BENEFIT............................ 39,845 45,873
Income tax benefit........................................ (30,812) --
-------- -------
NET INCOME.................................................. $ 70,657 $45,873
======== =======
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Operating Data:
The following table reflects throughput barrels for our crude oil and
refined product pipelines and the total throughput for all of our refined
product terminals for the years ended December 31, 2000 and 2001. The throughput
barrels for the year ended December 31, 2000 combine the barrels transported by
the Ultramar Diamond Shamrock Logistics Business for the six months ended June
30, 2000 with the barrels transported by Valero Logistics for the six months
ended December 31, 2000.
YEARS ENDED
DECEMBER 31,
-----------------
2000 2001 % CHANGE
------- ------- --------
(IN THOUSANDS OF BARRELS)
Crude oil pipeline throughput:
Dixon to McKee....................................... 22,736 20,403 (10)%
Wasson to Ardmore.................................... 28,003 29,612 6%
Ringgold to Wasson................................... 10,724 13,788 29%
Corpus Christi to Three Rivers....................... 31,271 28,689 (8)%
Other crude oil pipelines............................ 15,157 18,399 21%
------- -------
Total crude oil pipelines......................... 107,891 110,891 3%
======= =======
Refined product pipeline throughput:
McKee to Colorado Springs to Denver.................. 8,982 8,838 (2)%
McKee to El Paso..................................... 22,277 24,285 9%
McKee to Amarillo to Abernathy....................... 13,219 13,747 4%
Amarillo to Albuquerque.............................. 4,714 4,613 (2)%
McKee to Denver...................................... 4,307 4,370 1%
Ardmore to Wynnewood................................. 20,705 20,835 1%
Three Rivers to Laredo............................... 5,886 4,479 (24)%
Three Rivers to San Antonio.......................... 9,761 10,175 4%
Other refined product pipelines...................... 23,537 21,095 (10)%
------- -------
Total refined product pipelines................... 113,388 112,437 (1)%
======= =======
Refined product terminal throughput.................... 60,629 64,522 6%
======= =======
Revenues for the year ended December 31, 2001 were $98,827,000 as compared
to $92,053,000 for the year ended December 31, 2000, an increase of 7% or
$6,774,000. This increase in revenues is due to the following items:
- revenues for the Ringgold to Wasson and the Wasson to Ardmore crude oil
pipelines increased $1,400,000 due to a combined 12% increase in
throughput barrels, resulting from Valero Energy purchasing greater
quantities of crude oil from third parties near Ringgold instead of
gathering crude oil barrels near Wasson. In March 2001, Ultramar Diamond
Shamrock sold its Oklahoma crude oil gathering operation which was
located near Wasson;
- revenues for the Corpus Christi to Three Rivers crude oil pipeline
increased $1,390,000 despite the 8% decrease in throughput barrels for
the year ended December 31, 2001 as compared to 2000. The Corpus Christi
to Three Rivers crude oil pipeline was temporarily converted into a
refined product pipeline during the third quarter of 2001 due to the
alkylation unit shutdown at Valero Energy's Three Rivers refinery. The
increase in revenues is primarily due to the increased tariff rate
charged to transport refined products during the third quarter of 2001.
In addition, effective May of 2001, the crude oil tariff rate was
increased to cover the additional costs (dockage and wharfage fees)
associated with operating a marine-based crude oil storage facility in
Corpus Christi;
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- revenues for the McKee to El Paso refined product pipeline increased
$1,187,000 primarily due to a 9% increase in throughput barrels resulting
from an increase in Valero Energy's sales into the Arizona market. The
McKee to El Paso refined product pipeline connects with a third party
pipeline which runs to Arizona;
- revenues for the Three Rivers to Laredo refined product pipeline
decreased by $464,000 due to a 24% decrease in throughput barrels
partially offset by an increase in the tariff rate effective July 1,
2001. The Laredo refined product terminal revenues also decreased by
$290,000 due to the 24% decrease in throughput barrels. The lower
throughput barrels were a result of Pemex's expansion of its Monterrey,
Mexico refinery that increased the supply of refined products to Nuevo
Laredo, Mexico, which is across the border from Laredo, Texas;
- revenues for the Southlake refined product terminal, acquired on July 1,
2001, were $1,341,000 and throughput was 4,601,000 barrels for the six
months ended December 31, 2001; and
- revenues for all refined product terminals, excluding the Southlake and
Laredo refined product terminals, increased $1,343,000 primarily due to
an increase in the terminalling fee charged at our marine-based refined
product terminals to cover the additional costs (dockage and wharfage
fees) associated with operating a marine-based refined product terminal
and the additional fee of $0.042 per barrel charged for blending
additives into certain refined products.
Operating expenses increased $78,000 for the year ended December 31, 2001
as compared to the year ended December 31, 2000 primarily due to the following
items:
- during the year ended December 31, 2000, a loss of $916,000 was
recognized due to the impact of volumetric expansions, contractions and
measurement discrepancies in the pipelines related to the six months
ended June 30, 2000. Beginning July 1, 2000, the impact of volumetric
expansions, contractions and measurement discrepancies in the pipelines
is borne by the shippers and is therefore no longer reflected in
operating expenses;
- utility expenses increased by $1,538,000, or 17%, due to higher
electricity rates during the year ended December 31, 2001 as compared to
the year ended December 31, 2000 resulting from higher natural gas costs;
- the acquisition of the Southlake refined product terminal increased
operating expenses by $308,000;
- employee-related expenses increased due to higher accruals for incentive
compensation; and
- other operating expenses decreased due to lower rental expenses for fleet
vehicles, satellite communications and safety equipment as a result of
more favorable leasing arrangements.
General and administrative expenses were as follows:
YEARS ENDED
DECEMBER 31,
---------------
2000 2001
------ ------
(IN THOUSANDS)
Services Agreement.......................................... $2,600 $5,200
Allocation of UDS general and administrative expenses for
the six months ended June 30, 2000........................ 2,839 --
Third party expenses........................................ 200 730
Reimbursement from partners on jointly owned pipelines...... (500) (581)
------ ------
$5,139 $5,349
====== ======
General and administrative expenses increased 4% for the year ended
December 31, 2001 as compared to 2000 due to increased general and
administrative costs related to Valero L.P. being a publicly held entity. Prior
to July 1, 2000, Ultramar Diamond Shamrock allocated approximately 5% of its
general and administrative expenses incurred in the United States to its
pipeline, terminalling and storage operations to
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cover costs of centralized corporate functions such as legal, accounting,
treasury, engineering, information technology and other corporate services.
Effective July 1, 2000, Ultramar Diamond Shamrock entered into a services
agreement with us to provide the general and administrative services noted above
for an annual fee of $5,200,000, payable monthly. This annual fee is in addition
to the incremental general and administrative costs incurred from third parties
as a result of being a publicly held entity.
Depreciation and amortization expense increased $1,130,000 for the year
ended December 31, 2001 as compared to the year ended December 31, 2000 due to
the additional depreciation related to the Southlake refined product terminal
and Ringgold crude oil storage facility acquired during 2001 and additional
depreciation related to completed capital projects.
Equity income from Skelly-Belvieu Pipeline Company for the year ended
December 31, 2001 decreased $698,000, or 18%, as compared to 2000 due primarily
to a 13% decrease in throughput barrels in the Skellytown to Mont Belvieu
refined product pipeline. The decreased throughput in 2001 is due to both Valero
Energy and ConocoPhillips utilizing greater quantities of natural gas to run
their refining operations instead of selling the natural gas to third parties in
Mont Belvieu.
Interest expense for the year ended December 31, 2001 was $3,811,000 as
compared to $5,181,000 for 2000. During the period from January 1, 2001 through
April 15, 2001, we incurred $2,513,000 of interest expense related to the
$107,676,000 of debt due to parent that Valero Logistics assumed on July 1, 2000
and paid off on April 16, 2001. In addition, beginning April 16, 2001, Valero
Logistics borrowed funds under its revolving credit facility resulting in
$738,000 of interest expense for the eight and a half months ended December 31,
2001. Interest expense prior to July 1, 2000 relates only to the debt due to the
Port of Corpus Christi Authority of Nueces County, Texas. Interest expense from
July 1, 2000 through April 15, 2001 relates to the debt due to parent and the
debt due to the Port of Corpus Christi Authority. Interest expense subsequent to
April 16, 2001 relates to the borrowings under the revolving credit facility and
the debt due to the Port of Corpus Christi Authority.
Effective July 1, 2000, Ultramar Diamond Shamrock transferred the assets
and certain liabilities of the Ultramar Diamond Shamrock Logistics Business to
Valero Logistics. As a limited partnership, Valero Logistics is not subject to
federal or state income taxes. Due to this change in tax status, the deferred
income tax liability of $38,217,000 as of June 30, 2000 was written off in the
statement of income of the Ultramar Diamond Shamrock Logistics Business for the
six months ended June 30, 2000. The resulting net benefit for income taxes of
$30,812,000 for the six months ended June 30, 2000, includes the write-off of
the deferred income tax liability less the income tax expense of $7,405,000 for
the six months ended June 30, 2000. The income tax expense for the six months
ended June 30, 2000 was based upon the effective income tax rate for the
Ultramar Diamond Shamrock Logistics Business of 38%. The effective income tax
rate exceeds the U.S. federal statutory income tax rate due to state income
taxes.
Income before income tax benefit for the year ended December 31, 2001 was
$45,873,000 as compared to $39,845,000 for the year ended December 31, 2000. The
increase of $6,028,000 is primarily due to the increase in revenues resulting
from higher tariff rates and higher throughput barrels in our pipelines and
terminals for 2001 as compared to 2000.
FINANCIAL OUTLOOK
Due to a combination of circumstances in the first two months of 2003,
Valero Energy reduced its production at several of its refineries, including the
McKee, Three Rivers and Ardmore refineries, by as much as 15%, for economic
reasons. The primary reason for the reduction was the unfavorable impact the oil
workers' strike in Venezuela had on crude oil and other feedstock supplies in
the market, which caused sweet crude oil and other feedstock processing
economics to be unfavorable. The oil workers' strike in Venezuela has reduced
the amount of Venezuelan crude oil received by the Three Rivers refinery under
its purchase agreement with PDVSA, the national oil company of Venezuela. In
addition, beginning in mid-March of 2003, a 20-day plant-wide turnaround of the
Ardmore refinery will lower pipeline throughputs related to that refinery.
S-45
As a result of Valero Energy's reduction in refinery production during the
first quarter of 2003, throughput in our pipelines and terminals in the first
quarter of 2003 is expected to be lower than throughput levels in the fourth
quarter of 2002 and comparable to throughput levels in the first quarter of
2002. Accordingly, net income per unit applicable to limited partners for the
first quarter of 2003 is expected to be in the range of $0.55 per unit, which
compares to $0.50 per unit in the first quarter of 2002 and $0.74 per unit in
the fourth quarter of 2002. Based on the net income expected to be generated
during the first quarter of 2003, we expect to have sufficient cash available
for distribution to distribute $0.70 per unit for the first quarter of 2003.
More recently, however, a combination of strong refining and marketing
fundamentals and increased crude oil availability have improved conditions
substantially from earlier this year. If these improved conditions continue, we
expect average pipeline and terminal throughput levels for the remainder of 2003
to return to historical levels.
LIQUIDITY AND CAPITAL RESOURCES
Our primary cash requirements, in addition to normal operating expenses,
are for capital expenditures (both maintenance and expansion), business and
asset acquisitions, distributions to partners and debt service. We expect to
fund our short-term needs for such items as maintenance capital expenditures and
quarterly distributions to the partners from operating cash flows. Capital
expenditures for long-term needs resulting from future expansion projects and
acquisitions are expected to be funded by a variety of sources including cash
flows from operating activities, borrowings under the amended revolving credit
facility and the issuance of additional common units, debt securities and other
capital market transactions.
AMENDED REVOLVING CREDIT FACILITY
On March 6, 2003, Valero Logistics amended its five-year revolving credit
facility, increasing its credit limit to $175,000,000. The revolving credit
facility expires on January 15, 2006. At Valero Logistics' option, borrowings
under the revolving credit facility bear interest based on either an alternative
base rate or LIBOR. Valero Logistics also incurs a facility fee on the aggregate
commitments of lenders under the revolving credit facility, whether used or
unused. Borrowings under the revolving credit facility may be used for working
capital and general partnership purposes; however, borrowings to fund
distributions to our unitholders are limited to $40,000,000. All borrowings
designated as borrowings subject to the $40,000,000 sublimit must be reduced to
zero for a period of at least 15 consecutive days during each fiscal year. The
credit facility also allows Valero Logistics to issue letters of credit for an
aggregate of $75,000,000. The borrowings under the revolving credit facility are
unsecured and rank equally with all of Valero Logistics' outstanding unsecured
and unsubordinated debt. The revolving credit facility is irrevocably and
unconditionally guaranteed by us. Our guarantee ranks equally with all of our
existing and future unsecured senior obligations.
The revolving credit facility requires that Valero Logistics maintain
certain financial ratios, including a Consolidated Debt Coverage Ratio (debt to
EBIDTA), as defined in the revolving credit facility, not exceeding 4.0 to 1.0.
The revolving credit facility includes other restrictive covenants, including a
prohibition on distributions by Valero Logistics to us if any default, as
defined in the revolving credit facility, exists or would result from the
distribution. The revolving credit facility also includes a change-in-control
provision, which requires that Valero Energy owns, directly or indirectly, 51%
of our general partner interest, we and/or Valero Energy owns at least 100% of
the general partner interest in Valero Logistics or at least 100% of the
outstanding limited partner interests in Valero Logistics. Management believes
that Valero Logistics is in compliance with all of these ratios and covenants.
During the first quarter of 2002, Valero Logistics borrowed $64,000,000
under the revolving credit facility to purchase the Wichita Falls Business from
Valero Energy and during the second quarter of 2002, Valero Logistics borrowed
an additional $11,000,000 to purchase a hydrogen pipeline from Valero Energy.
During the third quarter of 2002, the outstanding balance under the revolving
credit facility of $91,000,000 was paid off with proceeds from the senior notes
issued in July of 2002 under the shelf registration statement. As of December
31, 2002, Valero Logistics had no outstanding borrowings under the revolving
credit facility.
S-46
SHELF REGISTRATION STATEMENT
On June 6, 2002, Valero L.P. and Valero Logistics filed a $500,000,000
universal shelf registration statement with the Securities and Exchange
Commission. On July 15, 2002, Valero Logistics completed the sale of
$100,000,000 of 6.875% senior notes, issued under its shelf registration, for
total proceeds of $99,686,000. The net proceeds of $98,207,000, after deducting
underwriters' commissions and offering expenses of $1,479,000, were used to pay
off the $91,000,000 outstanding under the revolving credit facility.
INTEREST RATE SWAP
On February 14, 2003, Valero Logistics entered into an interest rate swap
agreement to manage its exposure to changes in interest rates. The interest rate
swap has a notional amount of $60,000,000 and is tied to the maturity of the
6.875% senior notes discussed below. Under the terms of the interest rate swap
agreement, we will receive a fixed 6.875% rate and will pay a floating rate
based on LIBOR plus 2.45%.
6.875% SENIOR NOTES
The senior notes are due July 15, 2012 with interest payable on January 15
and July 15 of each year. The senior notes do not have sinking fund
requirements. The senior notes rank equally with all other existing senior
unsecured indebtedness of Valero Logistics, including indebtedness under the
revolving credit facility. The senior notes contain restrictions on Valero
Logistics' ability to incur secured indebtedness unless the same security is
also provided for the benefit of holders of the senior notes. In addition, the
senior notes limit Valero Logistics' ability to incur indebtedness secured by
certain liens and to engage in certain sale-leaseback transactions. The senior
notes are irrevocably and unconditionally guaranteed on a senior unsecured basis
by Valero L.P. The guarantee by Valero L.P. ranks equally with all of its
existing and future unsecured senior obligations.
At the option of Valero Logistics, the senior notes may be redeemed in
whole or in part at any time at a redemption price, which includes a make-whole
premium, plus accrued and unpaid interest to the redemption date. The senior
notes also include a change-in-control provision, which requires that an
investment grade entity own and control the general partner of Valero L.P. and
Valero Logistics. Otherwise Valero Logistics must offer to purchase the senior
notes at a price equal to 100% of their outstanding principal balance plus
accrued interest through the date of purchase.
INITIAL PUBLIC OFFERING
On April 16, 2001, Valero L.P. completed its initial public offering of
5,175,000 common units at a price of $24.50 per unit. Total proceeds were
$126,787,000 before offering costs and underwriters' commissions. In addition,
Valero Logistics borrowed $20,506,000 under its revolving credit facility. We
used $143,504,000 of the total proceeds to repay the debt due to parent
($107,676,000), reimburse affiliates of Ultramar Diamond Shamrock for previous
capital expenditures ($20,517,000), pay offering costs and underwriters'
commissions ($14,875,000) and pay debt issuance costs ($436,000). The net
remaining proceeds of $3,789,000 were used for working capital and general
partnership purposes.
DISTRIBUTIONS
Valero L.P.'s partnership agreement, as amended, sets forth the calculation
to be used to determine the amount and priority of cash distributions that the
common unitholders, subordinated unitholders and the general partner will
receive. During the subordination period, the holders of Valero L.P.'s common
units are entitled to receive each quarter a minimum quarterly distribution of
$0.60 per unit ($2.40 annualized) prior to any distribution of available cash to
holders of Valero L.P.'s subordinated units. The subordination period is defined
generally as the period that will end on the first day of any quarter beginning
after March 31, 2006 if (1) Valero L.P. has distributed at least the minimum
quarterly distribution on all outstanding units with respect to each of the
immediately preceding three consecutive, non-overlapping four-quarter periods
and (2) Valero L.P.'s adjusted operating surplus, as defined in the partnership
agreement, during such periods equals or exceeds the amount that would have been
sufficient to enable Valero L.P. to distribute the minimum
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quarterly distribution on all outstanding units on a fully diluted basis and the
related distribution on the 2% general partner interest during those periods. If
the subordination period ends, the rights of the holders of subordinated units
will no longer be subordinated to the rights of the holders of common units and
the subordinated units may be converted into common units, on a one-for-one
basis. The general partner is entitled to incentive distributions if the amount
we distribute with respect to any quarter exceeds $0.60 per unit.
The following table reflects the allocation of the total cash distributions
to the general and limited partners applicable to the period in which the
distributions are earned:
YEARS ENDED
DECEMBER 31,
---------------------
2001 2002
--------- ---------
(IN THOUSANDS, EXCEPT
PER UNIT DATA)
General partner interest.................................... $ 667 $ 1,103
General partner incentive distribution...................... -- 1,103
------- -------
Total general partner distribution........................ 667 2,206
Limited partnership units................................... 32,692 52,969
------- -------
Total cash distributions.................................. $33,359 $55,175
======= =======
Cash distributions per unit applicable to limited
partners.................................................. $ 1.70 $ 2.75
======= =======
The distributions for the year ended December 31, 2001, represent the
minimum quarterly distribution for the period subsequent to our initial public
offering, the period from April 16, 2001 through December 31, 2001. In February
2003, we paid a quarterly cash distribution of $0.70 per unit for the fourth
quarter of 2002.
CAPITAL REQUIREMENTS
The petroleum pipeline industry is capital-intensive, requiring significant
investments to maintain, upgrade or enhance existing operations and to comply
with environmental and safety regulations. Our capital expenditures consist
primarily of:
- maintenance capital expenditures, such as those required to maintain
equipment reliability and safety and to address environmental
regulations; and
- expansion capital expenditures, such as those to expand and upgrade
pipeline capacity and to construct new pipelines, terminals and storage
facilities. In addition, expansion capital expenditures may include
acquisitions of pipelines, terminals or storage assets.
For 2003, we expect to incur approximately $41,099,000 of capital expenditures,
including approximately $3,322,000 for maintenance capital expenditures and
approximately $37,777,000 for expansion capital expenditures. The 2003 expansion
capital expenditures include the $15,000,000 we incurred in January 2003 for the
Telfer asphalt terminal acquisition. We expect to fund our capital expenditures
from cash provided by operations and to the extent necessary, from proceeds of
borrowings under the revolving credit facility or debt and equity offerings.
During the year ended December 31, 2002, we incurred maintenance capital
expenditures of $3,943,000 primarily related to tank and automation upgrades at
both the refined product terminals and the crude oil storage facilities and
corrosion protection and automation upgrades for refined product pipelines. Also
during the year ended December 31, 2002, we incurred expansion capital
expenditures of $76,761,000 for acquisitions and capital projects. Effective
February 1, 2002, we exercised our option to purchase the Wichita Falls Business
from Valero Energy at a cost of $64,000,000. The Wichita Falls Business
consisted of the following assets:
- A 272-mile crude oil pipeline originating in Wichita Falls, Texas and
ending at Valero Energy's McKee refinery in Dumas, Texas. The pipeline
has the capacity to transport 110,000 barrels per day of
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crude oil gathered or acquired by Valero Energy at Wichita Falls. The
Wichita Falls crude oil pipeline connects to third party pipelines that
originate along the Texas Gulf Coast.
- Four crude oil storage tanks located in Wichita Falls, Texas with a total
capacity of 660,000 barrels.
During the year ended December 31, 2002, capital projects included
$1,278,000 for completion of the Amarillo to Albuquerque refined product
pipeline expansion, which is net of ConocoPhillips' 50% share of costs.
On May 29, 2002, we purchased a 30-mile pure hydrogen pipeline from Valero
Energy for $11,000,000 and subsequently exchanged that pipeline for a 25-mile
crude hydrogen pipeline owned by Praxair, Inc. The crude hydrogen pipeline
originates at Celanese Ltd.'s chemical facility in Clear Lake, Texas and ends at
Valero Energy's Texas City refinery in Texas City, Texas. The pipeline supplies
crude hydrogen to the refinery under a long-term supply arrangement between
Valero Energy and BOC (successor to Celanese Ltd.).
During the year ended December 31, 2001, we incurred maintenance capital
expenditures of $2,786,000 primarily related to tank and automation upgrades at
the refined product terminals and cathodic (corrosion) protection and automation
upgrades for both refined product and crude oil pipelines. Also during the year
ended December 31, 2001, we incurred expansion capital expenditures of
$15,140,000 for various acquisitions and capital projects. Acquisitions included
the July of 2001 purchase of the Southlake refined product terminal from Valero
Energy for $5,600,000 and the December of 2001 purchase of the Ringgold crude
oil storage facility from Valero Energy for $5,200,000. Capital projects
included $1,813,000 for rights-of-way related to the expansion of the Amarillo
to Albuquerque refined product pipeline, which is net of ConocoPhillips' 50%
share of such costs.
During the year ended December 31, 2000, we incurred $7,022,000 of capital
expenditures, including $4,704,000 relating to expansion capital projects and
$2,318,000 related to maintenance projects. Expansion capital projects included
the project to expand the capacity of the McKee to Colorado Springs refined
product pipeline from 32,000 barrels per day to 52,000 barrels per day, which
was completed in the fourth quarter of 2000.
On January 7, 2003, we purchased an asphalt terminal from Telfer Oil
Company (Telfer) for $15,000,000, which included two storage tanks with a
combined storage capacity of 350,000 barrels, six 5,000-barrel polymer modified
asphalt tanks, a truck rack, rail facilities and various other tanks and
equipment. In conjunction with the Telfer acquisition, we entered into a
six-year terminal storage and throughput agreement with Valero Energy.
We believe we have sufficient funds from operations, and to the extent
necessary, from public and private capital markets and bank markets, to fund our
ongoing operating requirements. We expect that, to the extent necessary, we can
raise additional funds from time to time through equity or debt financings.
However, there can be no assurance regarding the availability of any future
financings or whether such financings can be made available on terms acceptable
to us.
LONG-TERM CONTRACTUAL OBLIGATIONS
The following table presents our long-term contractual obligations and
commitments and the related payments due, in total and by period, as of December
31, 2002. We have no unconditional purchase obligations as of December 31, 2002.
PAYMENTS DUE BY PERIOD
--------------------------------------------
LESS THAN OVER
1 YEAR 1-3 YEARS 4-5 YEARS 5 YEARS TOTAL
--------- --------- --------- -------- --------
(IN THOUSANDS)
Long-term debt (stated
maturities)...................... $747 $1,575 $1,272 $106,064 $109,658
Operating leases................... 227 664 342 1,266 2,499
Right-of-way payments.............. 6 18 12 65 101
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The operating lease amounts in the above table include minimum rentals due
under the various land leases for the refined product terminals and the Corpus
Christi crude oil storage facility.
We do not have any long-term contractual obligations related to the
Skelly-Belvieu Pipeline Company, an equity method investment, other than the
requirement to operate the pipeline on behalf of the members and to fund our
share of capital expenditures as they arise. Skelly-Belvieu Pipeline Company
does not have any outstanding debt as of December 31, 2002.
RELATED PARTY TRANSACTIONS
SERVICES AGREEMENT
Effective July 1, 2000, Ultramar Diamond Shamrock entered into the services
agreement with us whereby Ultramar Diamond Shamrock agreed to provide the
corporate functions of legal, accounting, treasury, engineering, information
technology and other services for an annual fee of $5,200,000 for a period of
eight years. As a result of the acquisition of Ultramar Diamond Shamrock by
Valero Energy, Valero Energy assumed Ultramar Diamond Shamrock's obligation
under the services agreement. The $5,200,000 is adjustable annually based on the
Consumer Price Index published by the U.S. Department of Labor, and may also be
adjusted to take into account additional service levels necessitated by the
acquisition or construction of additional assets. Management believes that the
$5,200,000 is a reasonable approximation of the general and administrative costs
related to our current pipeline, terminalling and storage operations. This
annual fee is in addition to the incremental general and administrative costs
incurred from third parties as a result of Valero L.P. being a publicly held
entity.
The services agreement also requires that we reimburse Valero Energy for
various recurring costs of employees who work exclusively within the pipeline,
terminalling and storage operations and for certain other costs incurred by
Valero Energy relating solely to us. These employee costs include salary, wage
and benefit costs.
Prior to July 1, 2000, Ultramar Diamond Shamrock allocated approximately 5%
of its general and administrative expenses incurred in the United States to its
pipeline, terminalling and storage operations to cover costs of centralized
corporate functions and other corporate services. A portion of the allocated
general and administrative costs is passed on to third parties, which jointly
own certain pipelines and terminals with us. Also, prior to July 1, 2000, the
Ultramar Diamond Shamrock Logistics Business participated in Ultramar Diamond
Shamrock's centralized cash management program, wherein all cash receipts were
remitted to Ultramar Diamond Shamrock and all cash disbursements were funded by
Ultramar Diamond Shamrock. Other related party transactions include intercompany
tariff and terminalling revenues and related expenses, administrative and
support expenses incurred by Ultramar Diamond Shamrock and allocated to the
Ultramar Diamond Shamrock Logistics Business and income taxes.
PIPELINES AND TERMINALS USAGE AGREEMENT
On April 16, 2001, Ultramar Diamond Shamrock entered into the pipelines and
terminals usage agreement with us, whereby Ultramar Diamond Shamrock agreed to
use our pipelines to transport at least 75% of the crude oil shipped to and at
least 75% of the refined products shipped from the McKee, Three Rivers and
Ardmore refineries and to use our refined product terminals for terminalling
services for at least 50% of all refined products shipped from these refineries
until at least April of 2008. Valero Energy also assumed the obligation under
the pipelines and terminals usage agreement in connection with the acquisition
of Ultramar Diamond Shamrock by Valero Energy. For the year ended December 31,
2002, Valero Energy used our pipelines to transport 97% of its crude oil shipped
to and 80% of the refined products shipped from the McKee, Three Rivers and
Ardmore refineries, and used our terminalling services for 59% of all refined
products shipped from these refineries.
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HYDROGEN TOLLING AGREEMENT
In conjunction with our acquisition of the crude hydrogen pipeline, we and
Valero Energy entered into a hydrogen tolling agreement. The hydrogen tolling
agreement provides that Valero Energy will pay us minimum annual revenues of
$1,400,000 for transporting crude hydrogen from Celanese Ltd.'s chemical
facility in Clear Lake, Texas to Valero Energy's Texas City refinery.
EQUITY OWNERSHIP
UDS Logistics, LLC, an indirect wholly owned subsidiary of Valero Energy,
owns 4,424,322 of our outstanding common units and all 9,599,322 of our
outstanding subordinated units. In addition, Valero GP, LLC, also an indirect
wholly owned subsidiary of Valero Energy, owns 73,319 of our outstanding common
units. As a result, Valero Energy owns a 71.6% limited partner interest in us
and Riverwalk Logistics owns a 2% general partner interest in us. We own a
99.99% limited partner interest in Valero Logistics and our wholly owned
subsidiary, Valero GP, Inc., owns a 0.01% general partner interest in Valero
Logistics.
After this common unit offering and the common unit redemption, UDS
Logistics will own 614,572 common units and 9,599,322 subordinated units. As a
result, Valero Energy will own an aggregate 47.5% limited partner interest in
us.
In addition, prior to its acquisition by Valero L.P. on February 1, 2002,
the Wichita Falls Business was wholly owned by Valero Energy, and such ownership
interest is reflected as net parent investment in the consolidated balance sheet
as of December 31, 2001.
ENVIRONMENTAL
In connection with the transfer of assets and liabilities from the Ultramar
Diamond Shamrock Logistics Business to Shamrock Logistics Operations on July 1,
2000, Ultramar Diamond Shamrock agreed to indemnify Shamrock Logistics for
environmental liabilities that arose prior to July 1, 2000. In connection with
the initial public offering of Shamrock Logistics on April 16, 2001, Ultramar
Diamond Shamrock agreed to indemnify Shamrock Logistics for environmental
liabilities that arose prior to April 16, 2001 and are discovered within 10
years after April 16, 2001. Excluded from this indemnification are liabilities
that result from a change in environmental law after April 16, 2001. In
conjunction with the acquisitions of the Southlake refined product terminal on
July 1, 2001 and the Ringgold crude oil storage facility on December 1, 2001,
Ultramar Diamond Shamrock agreed to indemnify us for environmental liabilities
that arose prior to the acquisition dates and are discovered within 10 years
after acquisition. Effective with the acquisition of Ultramar Diamond Shamrock
by Valero Energy, Valero Energy assumed these environmental indemnifications. In
conjunction with the sale of the Wichita Falls Business to Valero L.P., Valero
Energy has agreed to indemnify Valero L.P. for any environmental liabilities
that arose prior to February 1, 2002 and are discovered by April 15, 2011. As an
operator or owner of the assets, we could be held liable for pre-acquisition
environmental damage should Valero Energy be unable to fulfill its obligation.
However, we believe that such a situation is remote given Valero Energy's
financial condition. As of December 31, 2002, we are not aware of any material
environmental liabilities that were not covered by the environmental
indemnifications.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in accordance with United States
generally accepted accounting principles requires management to select
appropriate accounting policies and to make estimates and assumptions that
affect the amounts reported in the consolidated and combined financial
statements and accompanying notes. Actual results could differ from those
estimates. See Note 2: Summary of Significant Accounting Policies on page F-10
for our significant accounting policies.
On an ongoing basis, management reviews its estimates based on currently
available information. Changes in facts and circumstances may result in revised
estimates. Any effects on our financial position or results of operations
resulting from revisions to estimates are recorded in the period in which the
facts and
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circumstances that give rise to the revision become known. We deem the following
estimates and accounting policies to be critical:
Revenue Recognition. Revenues are derived from interstate and intrastate
pipeline transportation, storage and terminalling of crude oil and refined
products. Transportation revenues are based on tariff rates that are subject to
extensive federal and/or state regulation. Terminalling revenues, including
revenues for blending additives, are based on fees which we believe are market
based. Reductions to the current tariff rates or terminalling fees charged could
have a material adverse effect on our results of operations. Currently, 99% of
our revenues are derived from Valero Energy and Valero Energy has agreed not to
challenge our tariff rates or terminalling fees until at least April of 2008.
See Note 13: Related Party Transactions on page F-23 for a discussion of our
relationship with Valero Energy.
Depreciation. Depreciation expense is calculated using the straight-line
method over the estimated useful lives of our property, plant and equipment.
Because of the expected long useful lives of the property, plant and equipment,
we depreciate them over a 3-year to 40-year period. Changes in the estimated
useful lives of the property, plant and equipment could have a material adverse
effect on our results of operations.
Goodwill. Goodwill is the excess of cost over the fair value of net assets
acquired in September of 1997. Effective January 1, 2002, with the adoption of
Financial Accounting Standards Board (FASB) Statement No. 142, "Goodwill and
Other Intangible Assets," amortization of goodwill ceased and the unamortized
balance will be tested annually for impairment. Management's estimates will be
crucial in determining whether an impairment exists and, if so, the effect of
such impairment. We believe that future reported net income may be more volatile
because impairment losses related to goodwill are likely to occur irregularly
and in varying amounts.
Income Allocation. Our net income for each quarterly reporting period is
first allocated to the general partner in an amount equal to the general
partner's incentive distribution declared for the respective reporting period.
The remaining net income is allocated among the limited and general partners in
accordance with their respective 98% and 2% interests, respectively.
RECENT ACCOUNTING PRONOUNCEMENT
In June 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations." This statement establishes standards for accounting for
an obligation associated with the retirement of a tangible long-lived asset. An
asset retirement obligation should be recognized in the financial statements in
the period in which it meets the definition of a liability as defined in FASB
Concepts Statement No. 6, "Elements of Financial Statements." The amount of the
liability would initially be measured at fair value. Subsequent to initial
measurement, an entity would recognize changes in the amount of the liability
resulting from (a) the passage of time and (b) revisions to either the timing or
amount of estimated cash flows. Statement No. 143 also establishes standards for
accounting for the cost associated with an asset retirement obligation. It
requires that, upon initial recognition of a liability for an asset retirement
obligation, an entity capitalize that cost by recognizing an increase in the
carrying amount of the related long-lived asset. The capitalized asset
retirement cost would then be allocated to expense using a systematic and
rational method. Statement No. 143 will be effective for financial statements
issued for fiscal years beginning after June 15, 2002, with earlier application
encouraged. We are currently evaluating the impact of adopting this new
statement, however, at the present time we do not believe it will have a
material impact on our financial position or results of operations.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Historically we did not engage in interest rate, foreign currency exchange
rate or commodity price hedging transactions. However, in February 2003, we
entered into an interest rate swap agreement to manage our exposure to changes
in interest rates.
Our principal market risk (i.e., the risk of loss arising from adverse
changes in market rates and prices) is interest rate risk on its debt. We manage
our debt considering various financing alternatives available in the
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market and manage our exposure to changing interest rates principally through
the use of a combination of fixed and floating rate debt. Borrowings under the
revolving credit facility expose us to increases in the benchmark interest rate
underlying its floating rate revolving credit facility.
As of December 31, 2002, our fixed rate debt consisted of the 6.875% senior
notes with a carrying value of $99,700,000 and an estimated fair value of
$99,780,000, and the 8% Port of Corpus Christi Authority note payable with a
carrying value of $9,958,000 and an estimated fair value of $10,142,000. As of
December 31, 2001, our fixed rate debt consisted of the 8% Port of Corpus
Christi Authority note payable with a carrying value of $10,122,000 and an
estimated fair value of $11,240,000. The fair values were estimated using
discounted cash flow analysis, based on our current incremental borrowing rates
for similar types of borrowing arrangements.
S-53
BUSINESS
GENERAL
We are a Delaware limited partnership that was formed on December 7, 1999.
Our principal executive offices are located at One Valero Place, San Antonio,
Texas 78212 and our telephone number is (210) 370-2000. The operations are
conducted through a subsidiary entity, Valero Logistics.
We were originally formed under the name of "Shamrock Logistics, L.P.," and
changed our name to "Valero L.P." effective January 1, 2002, following
completion of Valero Energy Corporation's acquisition of Ultramar Diamond
Shamrock Corporation on December 31, 2001. In addition, Valero Logistics changed
its name from "Shamrock Logistics Operations, L.P." effective January 1, 2002.
On April 16, 2001, we completed our initial public offering of 5,175,000
common units, representing approximately 26% of our outstanding units. Our
common units are listed on the New York Stock Exchange under the symbol "VLI."
Valero Energy, through its wholly owned subsidiaries, currently owns a
total of 4,497,641 common units and 9,599,322 subordinated units, representing
an aggregate 71.6% limited partner interest in us. Valero Energy owns and
controls our general partner, Riverwalk Logistics, L.P., which owns a 2%
interest in us and has incentive distribution rights giving it higher
percentages of our quarterly cash distributions as various target distribution
levels are met.
We generate revenue from our pipeline operations by charging tariffs for
transporting crude oil, other refinery feedstocks and refined products through
our pipelines. We also generate revenue through our terminalling operations by
charging a terminalling fee to our customers. The terminalling fee is earned
when refined products enter the terminal and includes the cost of transferring
the refined products from the terminal to trucks. An additional fee is charged
at the refined product terminals for blending additives into various refined
products. We currently do not generate any separate revenue from our crude oil
storage facilities. Instead, the costs associated with these facilities were
considered in establishing the tariff rates charged for transporting crude oil
from the storage facilities to the refineries. Our primary customer for our
pipelines and our terminalling operations is Valero Energy, which accounted for
99% of our revenues for the year ended December 31, 2002.
The term "throughput" generally refers to the crude oil or refined product
barrels, as applicable, that pass through each pipeline, even if those barrels
also are transported in another of our pipelines for which a separate tariff is
charged.
PIPELINE OPERATIONS
GENERAL
We have an ownership interest in nine crude oil pipelines with an aggregate
length of approximately 783 miles and 19 refined product pipelines with an
aggregate length of approximately 2,846 miles. We also own a 25-mile-long crude
hydrogen pipeline. We operate all but three of the pipelines. For the pipelines
in which we own less than a 100% ownership interest, we fund capital
expenditures in proportion to our respective ownership percentage.
For all but two of the pipelines, Valero Energy is the only customer for
transportation of crude oil or refined products.
CRUDE OIL PIPELINES
Our crude oil pipelines deliver crude oil and other feedstocks, such as gas
oil and normal butane, from various points in Texas, Oklahoma, Kansas and
Colorado to Valero Energy's McKee, Three Rivers and
S-54
Ardmore refineries. The following table sets forth the average daily number of
barrels of crude oil and other feedstocks we transported through our crude oil
pipelines, in the aggregate, in each of the years presented.
AGGREGATE THROUGHPUT YEARS ENDED DECEMBER 31,
-----------------------------------------------
1998 1999 2000 2001 2002
------- ------- ------- ------- -------
(BARRELS/DAY)
Crude Oil and Other Feedstocks....... 265,243 280,041 294,784 303,811 348,023
The following table sets forth information about each of our crude oil
pipelines.
YEAR ENDED
DECEMBER 31, 2002
---------------------------
CAPACITY
ORIGIN AND DESTINATION LENGTH OWNERSHIP CAPACITY THROUGHPUT UTILIZATION
---------------------- ------- --------- ------------- ------------- -----------
(MILES) (BARRELS/DAY) (BARRELS/DAY)
Cheyenne Wells, CO to McKee..... 252 100% 17,500 8,264 47%
Dixon, TX to McKee.............. 44 100% 85,000 43,753 51%
Hooker, OK to Clawson, TX(1).... 31 50% 22,000 18,542 84%
Clawson, TX to McKee(2)......... 41 100% 36,000 12,431 86%
Wichita Falls, TX to McKee(3)... 272 100% 110,000 72,091 66%
Corpus Christi, TX to Three
Rivers........................ 70 100% 120,000 68,701 57%
Ringgold, TX to Wasson, OK(2)... 44 100% 90,000 34,602 55%
Healdton, OK to Ringling, OK.... 4 100% 52,000 14,861 29%
Wasson, OK to Ardmore, OK....... 25 100% 90,000 74,778 83%
--- ------- -------
783 622,500 348,023 61%
=== ======= =======
---------------
(1) We receive 50% of the tariff with respect to 100% of the barrels transported
in the Hooker to Clawson crude oil pipeline. Accordingly, the capacity,
throughput and capacity utilization are given with respect to 100% of the
pipeline.
(2) This pipeline transports barrels relating to two tariff routes, one of which
begins at this pipeline's origin and ends at its destination and one of
which is a longer tariff route with an origin or destination on another
pipeline of our's which connects to this pipeline. Throughput disclosed
above for this pipeline reflects only the barrels subject to the tariff
route beginning at this pipeline's origin and ending at this pipeline's
destination. To accurately determine the actual capacity utilization of the
pipeline, as well as aggregate capacity utilization, all barrels passing
through the pipelines have been taken into account.
(3) On February 1, 2002, we acquired the Wichita Falls crude oil pipeline from
Valero Energy. For the month ended January 31, 2002, 2,000,000 barrels of
throughput is included in the above throughput barrels and capacity
utilization percentage.
REFINED PRODUCT PIPELINES
Our refined product pipelines transport refined products from Valero
Energy's McKee, Three Rivers and Ardmore refineries to our terminals or to
interconnections with third-party pipelines, for further distribution in markets
in Texas, Oklahoma, Colorado, New Mexico, Arizona and other mid-continent
states. The refined products transported in these pipelines include gasoline,
distillates (including diesel and jet fuel), natural gas liquids (such as
propane and butane), blendstocks and petrochemical raw materials such as
toluene, xylene and raffinate. During the year ended December 31, 2002, gasoline
and distillates represented approximately 65% and 23%, respectively, of the
total throughput in our refined product pipelines.
S-55
The following table sets forth the average daily number of barrels of
refined products we transported through our refined product pipelines, in the
aggregate, in each of the years presented.
AGGREGATE THROUGHPUT YEARS ENDED DECEMBER 31,
-----------------------------------------------
1998 1999 2000 2001 2002
------- ------- ------- ------- -------
(BARRELS/DAY)
Refined products..................... 268,064 297,397 309,803 308,047 295,456
The following table sets forth information about each of our refined
product pipelines. In instances where we own less than 100% of a pipeline, our
ownership percentage is indicated, and the capacity, throughput and capacity
utilization information reflects only our ownership interest in these pipelines.
YEAR ENDED
DECEMBER 31, 2002
---------------------------
CAPACITY
ORIGIN AND DESTINATION LENGTH OWNERSHIP CAPACITY THROUGHPUT UTILIZATION
---------------------- ------- --------- ------------- ------------- -----------
(MILES) (BARRELS/DAY) (BARRELS/DAY)
McKee to El Paso, TX............ 408 67% 40,000 37,921 95%
McKee to Colorado Springs,
CO(1)......................... 256 100% 52,000 11,426 37%
Colorado Springs, CO to
Airport....................... 2 100% 12,000 1,242 10%
Colorado Springs, CO to Denver,
CO............................ 101 100% 32,000 7,619 24%
McKee to Denver, CO............. 321 30% 12,450 11,790 95%
McKee to Amarillo, TX
(6")(1)(2).................... 49 100% 51,000 28,708 70%
McKee to Amarillo, TX
(8")(1)(2).................... 49 100%
Amarillo, TX to Abernathy, TX... 102 39% 6,812 7,742 114%
Amarillo, TX to Albuquerque,
NM............................ 293 50% 17,150 11,018 64%
McKee to Skellytown, TX......... 53 100% 52,000 9,563 18%
Skellytown, TX to Mont Belvieu,
TX (Skelly-Belvieu)........... 571 50% 26,000 16,718 64%
Three Rivers to San Antonio,
TX............................ 81 100% 33,600 25,539 76%
Three Rivers to Laredo, TX...... 98 100% 16,800 12,908 77%
Three Rivers to Corpus Christi,
TX............................ 72 100% 15,000 4,752 32%
Three Rivers to Pettus, TX
(12")......................... 29 100% 24,000 19,746 82%
Three Rivers to Pettus, TX
(8").......................... 29 100% 15,000 6,406 43%
Ardmore to Wynnewood, OK........ 31 100% 90,000 54,193 60%
El Paso, TX to Kinder Morgan.... 12 67% 40,000 28,165 70%
Other refined product
pipeline(3)................... 289 50% N/A N/A N/A
----- ------- -------
2,846 535,812 295,456 58%
===== ======= =======
---------------
(1) This pipeline transports barrels relating to two tariff routes, one of which
begins at this pipeline's origin and ends at this pipeline's destination and
one of which is a longer tariff route with an origin or destination on
another pipeline of ours that connects to this pipeline. Throughput
disclosed above for this pipeline reflects only the barrels subject to the
tariff route beginning at this pipeline's origin and ending at this
pipeline's destination. To accurately determine the actual capacity
utilization of the pipeline, as well as aggregate capacity utilization, all
barrels passing through the pipelines have been taken into account.
(2) The throughput, capacity, and capacity utilization information listed
opposite the McKee to Amarillo 6-inch pipeline includes both McKee to
Amarillo pipelines on a combined basis.
(3) Represents the idled 6-inch sections of the Amarillo to Albuquerque refined
product pipeline.
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STORAGE AND TERMINALLING OPERATIONS
We own a total of five crude oil storage facilities in Texas and Oklahoma.
These facilities have a total of 15 tanks with a capacity of 3,326,000 barrels.
We also own 12 refined products terminals in Texas, Colorado, New Mexico and
California, including an asphalt terminal in Pittsburg, California that we
acquired in January 2003. These terminals have a total of 136 tanks with a
combined capacity of 3,192,000 barrels.
CRUDE OIL STORAGE FACILITIES
Our crude oil storage facilities serve the needs of Valero Energy's McKee,
Three Rivers and Ardmore refineries.
The following table sets forth information about the crude oil storage
facilities:
AVERAGE
THROUGHPUT
NUMBER OF MODE OF MODE OF YEAR ENDED
LOCATION CAPACITY TANKS RECEIPT DELIVERY DECEMBER 31, 2002
-------- --------- --------- -------- -------- -----------------
(BARRELS) (BARRELS/DAY)
Corpus Christi, TX(1)....... 1,600,000 4 Marine Pipeline 68,701
Dixon, TX................... 240,000 3 Pipeline Pipeline 43,753
Ringgold, TX................ 600,000 2 Pipeline Pipeline 34,602
Wichita Falls, TX(2)........ 660,000 4 Pipeline Pipeline 72,091
Wasson, OK.................. 226,000 2 Pipeline Pipeline 74,778
--------- -- -------
3,326,000 15 293,925
========= == =======
---------------
(1) We own the Corpus Christi crude oil storage facility and the land underlying
the facility is subject to a long-term operating lease.
(2) On February 1, 2002, we acquired the Wichita Falls crude oil storage
facility from Valero Energy. For the month ended January 31, 2002, 2,000,000
barrels of throughput is included in the above throughput barrels.
REFINED PRODUCT TERMINALS
Our 12 refined product terminals have automated loading facilities and are
available 24 hours a day. Billing of Valero Energy's customers is electronically
accomplished by the Fuels Automation and Nomination System (FANS). This
automatic system provides for control of allocations, credit and carrier
certification by remote input of data by customers. All terminals have an
electronic monitoring and control system that monitors the effectiveness of the
ground protection and vapor control and will cause an automated shutdown of the
terminal operations if necessary. For environmental and safety protection, all
terminals have primary vapor control systems consisting of flares, vapor
combustors or carbon absorption vapor recovery units.
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The following table sets forth information about each of our refined
product terminals:
AVERAGE
THROUGHPUT
YEAR ENDED
NUMBER OF MODE OF MODE OF DECEMBER 31,
TERMINAL LOCATION CAPACITY TANKS RECEIPT DELIVERY 2002
----------------- --------- --------- -------- -------- -------------
(BARRELS) (BARRELS/DAY)
Abernathy, TX................. 171,000 11 Pipeline Truck 7,215
Amarillo, TX.................. 271,000 14 Pipeline Truck/Pipeline 20,731
Albuquerque, NM............... 193,000 10 Pipeline Truck/Pipeline 10,494
Denver, CO.................... 111,000 10 Pipeline Truck 17,019
Colorado Springs, CO(1)....... 324,000 8 Pipeline Truck/Pipeline 11,426
El Paso, TX(2)................ 347,000 22 Pipeline Truck/Pipeline 39,756
Southlake, TX................. 286,000 6 Pipeline Truck 21,806
Corpus Christi, TX(1)......... 371,000 15 Pipeline Marine/Pipeline 7,290
San Antonio, TX............... 221,000 10 Pipeline Truck 18,160
Laredo, TX.................... 203,000 6 Pipeline Truck 12,908
Harlingen, TX(1).............. 314,000 7 Marine Truck 8,754
Pittsburg, CA (asphalt
terminal)(3)................ 380,000 17 Rail Truck N/A
--------- --- -------
3,192,000 136 175,559
========= === =======
---------------
(1) We own the Colorado Springs, Corpus Christi and Harlingen refined products
terminals and the land underlying these facilities is subject to long-term
operating leases.
(2) We have a 66.67% ownership interest in the El Paso refined product terminal.
The capacity and throughput amounts represent the proportionate share of
capacity and throughput attributable to our ownership interest. The
throughput represents barrels distributed from the El Paso refined product
terminal and deliveries to a third-party refined product pipeline.
(3) We acquired the asphalt terminal in Pittsburg, California from Telfer Oil
Company in January 2003.
PIPELINE, STORAGE FACILITY, AND TERMINAL CONTROL OPERATIONS
All of our crude oil and refined product pipelines are operated via
satellite communication systems from one of two central control rooms located in
San Antonio and Dumas, Texas (near Valero Energy's McKee refinery). Each control
center can provide backup capability for the other, and each center is capable
of monitoring and controlling all of the pipelines. There is also a backup
control center located at the San Antonio refined product terminal approximately
25 miles from the primary control center in San Antonio.
The control centers operate with modern, state-of-the-art System Control
and Data Acquisition systems (SCADA). The control centers are equipped with
computer systems designed to continuously monitor real time operational data,
including crude oil and refined product throughput, flow rates and pressures. In
addition, the control centers monitor alarms and throughput balances. The
control centers operate remote pumps, motors, engines and valves associated with
the delivery of crude oil and refined products. The computer systems are
designed to enhance leak-detection capabilities, sound automatic alarms if
operational conditions outside pre-established parameters occur and provide for
remote-controlled shutdown of pump stations on the pipelines. Pump stations,
crude oil storage facilities and meter-measurement points along the pipelines
are linked by satellite or telephone communication systems for remote monitoring
and control.
A number of our crude oil storage facilities and refined product terminals
are also operated through the central control centers. Other crude oil storage
facilities and refined product terminals are modern, automated facilities but
are locally controlled.
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OUR RELATIONSHIP WITH VALERO ENERGY
GENERAL
Valero Energy owns and operates 12 refineries, three of which are served by
our pipelines and terminals:
- the McKee refinery, which has a current total capacity to process
approximately 170,000 barrels per day of crude oil and other feedstocks,
making it the largest refinery located between the Texas Gulf Coast and
the West Coast;
- the Three Rivers refinery, which has a current total capacity to process
approximately 98,000 barrels per day of crude oil and other feedstocks;
and
- the Ardmore refinery, which has a current total capacity to process
approximately 85,000 barrels per day of crude oil and other feedstocks.
Valero Energy markets the refined products produced by these three
refineries primarily in Texas, Oklahoma, Colorado, New Mexico, Arizona and other
mid-continent states through a network of company-operated and dealer-operated
convenience stores, and through wholesale and spot market sales and exchange
agreements.
During the year ended December 31, 2002, we generated revenues of
$118,458,000, with Valero Energy accounting for 99% of this amount. Although we
intend to pursue strategic third-party acquisitions as opportunities may arise,
management expects to continue to derive most of our revenues from business with
Valero Energy for the foreseeable future.
PIPELINES AND TERMINALS USAGE AGREEMENT
Our operations are strategically located within Valero Energy's refining
and marketing supply chain, but we do not own or operate any refining or
marketing assets. Valero Energy is dependent upon us to provide transportation
services that support the refining and marketing operations in the markets
served by Valero Energy's McKee, Three Rivers and Ardmore refineries. Under a
pipelines and terminals usage agreement, Valero Energy has agreed through April
1, 2008:
- to transport in our crude oil pipelines at least 75% of the aggregate
volumes of the crude oil shipped to the McKee, Three Rivers and Ardmore
refineries;
- to transport in our refined product pipelines at least 75% of the
aggregate volumes of the refined products (excluding residual oils,
primarily asphalt and fuel oil) shipped from these refineries; and
- to use our refined product terminals for terminalling services for at
least 50% of the refined products (excluding residual oils, primarily
asphalt and fuel oil) shipped from these refineries.
Valero Energy met and exceeded its obligations under the pipelines and
terminals usage agreement during the year ended December 31, 2002. In addition,
Valero Energy has agreed to remain the shipper for crude oil and refined
products owned by it that are transported through our pipelines, and neither
challenge, nor cause others to challenge, our interstate or intrastate tariff
rates for the transportation of crude oil and refined products until at least
April 1, 2008.
Valero Energy's obligation to use our crude oil and refined product
pipelines and terminals may be suspended if Valero Energy ceases to own the
refineries, if material changes in the market conditions occur for the
transportation of crude oil and refined products, or in the markets served by
these refineries, that have a material adverse effect on Valero Energy, or if we
are unable to handle the volumes Valero Energy requests to be transported due to
operational difficulties with the pipelines or terminals. In the event Valero
Energy does not transport in our pipelines or use our terminals to store and
ship the minimum volume requirements and our obligation to do so has not been
suspended under the terms of the agreement, it is required to make a cash
payment determined by multiplying the shortfall in volume by the weighted
average tariff rate or terminal fee charged.
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SERVICES AGREEMENT
We do not have any employees. Under a services agreement with Valero
Energy, employees of Valero Energy perform services on our behalf, and Valero
Energy is reimbursed for the services rendered by its employees. In addition, we
pay Valero Energy an annual fee of $5,200,000 under the services agreement to
perform and provide other services, including legal, accounting, treasury,
engineering and information technology. The fee is adjustable annually based on
the Consumer Price Index published by the U.S. Department of Labor and may be
adjusted to take into account additional service levels required by the
acquisition or construction of additional assets.
OMNIBUS AGREEMENT
The omnibus agreement governs potential competition between Valero Energy
and us. Under the omnibus agreement, Valero Energy has agreed, and will cause
its controlled affiliates to agree, for so long as Valero Energy controls the
general partner, not to engage in, whether by acquisition or otherwise, the
business of transporting crude oil and other feedstocks or refined products,
including petrochemicals, or operating crude oil storage facilities or refined
product terminalling assets in the United States. This restriction does not
apply to:
- any business retained by Ultramar Diamond Shamrock (and now part of
Valero Energy) as of April 16, 2001, the closing of our initial public
offering, or any business owned by Valero Energy at the date of its
acquisition of Ultramar Diamond Shamrock on December 31, 2001;
- any business with a fair market value of less than $10 million;
- any business acquired by Valero Energy in the future that constitutes
less than 50% of the fair market value of a larger acquisition, provided
we have been offered and declined the opportunity to purchase the
business; and
- any newly constructed pipeline, terminalling or storage assets that we
have not offered to purchase at fair market value within one year of
construction.
Also under the omnibus agreement, Valero Energy has agreed to indemnify us
for environmental liabilities related to the assets transferred to us in
connection with our initial public offering that arose prior to April 16, 2001
and are discovered within 10 years after April 16, 2001 (excluding liabilities
resulting from a change in law after April 16, 2001).
MAINTENANCE
We perform scheduled maintenance on all of our pipelines, terminals and
related equipment and make repairs and replacements when necessary or
appropriate. We believe that all of our pipelines, terminals and related
equipment have been constructed and are maintained in all material respects in
accordance with applicable federal, state and local laws and the regulations and
standards prescribed by the American Petroleum Institute, the Department of
Transportation and accepted industry practice.
COMPETITION
As a result of our physical integration with Valero Energy's McKee, Three
Rivers and Ardmore refineries and our contractual relationship with Valero
Energy, we believe that we will not face significant competition for barrels of
crude oil transported to, and barrels of refined products transported from, the
McKee, Three Rivers and Ardmore refineries, particularly during the term of the
pipelines and terminals usage agreement with Valero Energy. However, we face
competition from other pipelines that may be able to supply Valero Energy's
end-user markets with refined products on a more competitive basis. If Valero
Energy reduced its retail sales of refined products or its wholesale customers
reduced their purchases of refined products, the volumes transported through our
pipelines would be reduced, which would cause a decrease in cash and revenues
generated from our operations.
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Valero Energy owns or leases certain pipelines that deliver crude oil and
refined products to markets served by our pipelines and terminals. Specifically,
Valero Energy owns a refined products pipeline that runs from its Corpus
Christi, Texas refinery to Edinburg, Texas. Valero Energy's Edinburg refined
product terminal serves markets that are also served by our Harlingen refined
product terminal. Also, Valero Energy owns two refined product pipelines that
run from Pettus to Corpus Christi and Pettus to San Antonio. As discussed above,
we have an agreement to acquire the Corpus Christi to Edinburg refined product
pipeline, the Edinburg refined product terminal, the Pettus to San Antonio
refined product pipeline, the Pettus to Corpus Christi refined product pipeline
and the San Antonio refined product terminal. In addition, Valero Energy owns
certain crude oil gathering systems that deliver crude oil to the McKee
refinery.
The Texas and Oklahoma markets served by the refined product pipelines
originating at the Three Rivers and Ardmore refineries are accessible by Texas
Gulf Coast refiners through common carrier pipelines, with the exception of the
Laredo, Texas and Nuevo Laredo, Mexico markets. The Nuevo Laredo, Mexico market
is accessible by refineries operated by Pemex. In addition, the markets served
by the refined product pipelines originating at the McKee refinery are also
accessible by Texas Gulf Coast and Midwestern refiners through common carrier
pipelines.
We believe that high capital requirements, environmental and safety
considerations and the difficulty in acquiring rights-of-way and related permits
make it difficult for other entities to build competing pipelines in areas
served by our pipelines. As a result, competing pipelines are likely to be built
only in those cases in which strong market demand and attractive tariff rates
support additional capacity in an area. We know of two refined product pipelines
that are in various stages of completion that may serve our market areas:
- The Longhorn Pipeline is a common carrier refined product pipeline with
an initial capacity of 70,000 barrels per day. It will be capable of
delivering refined products from the Texas Gulf Coast to El Paso, Texas.
Most of the pipeline has been constructed and startup is expected to
occur before the end of 2003. We expect that a portion of the refined
products transported into the El Paso area in the Longhorn Pipeline will
ultimately be transported into the Phoenix and Tucson, Arizona markets
via SFPP, L.P.'s east pipeline, which is currently capacity constrained.
As a result of these constraints, Valero Energy's allocated capacity in
the SFPP East Line may be reduced. SFPP, L.P. has proposed to expand the
SFPP East Line, and if it proceeds with the expansion, the expanded
pipeline should alleviate the existing capacity constraints and could
increase demand for transportation of refined products from McKee to El
Paso. However, the increased supply of refined products entering the El
Paso and Arizona markets through the Longhorn Pipeline and the likely
increase in the cost of shipping product on SFPP East Line could also
cause a decline in the demand for refined products from Valero Energy. In
either case, the demand for transportation of refined products from McKee
to El Paso might be reduced.
- Shell Pipeline Company previously announced a refined product pipeline
project from Odessa, Texas to Bloomfield, New Mexico. Refined products
would be transported from West Texas to the Bloomfield, New Mexico area.
The project would also require new pipeline connections on the southern
and northern ends of the project. This project also includes a new
refined product terminal near Albuquerque, New Mexico. This proposed
Odessa to Bloomfield refined product pipeline could cause a reduction in
demand for the transportation of refined products to the Albuquerque
market in our refined product pipeline. This proposed Shell refined
product pipeline would also cross two of our refined product pipelines,
the McKee to El Paso refined product pipeline and the Amarillo to
Albuquerque refined product pipeline. Although construction has not yet
commenced on this project, it is anticipated to be completed in 2005.
Given the expected increase in demand for refined products in the
southwestern and Rocky Mountain market regions, we do not believe that these new
refined product pipelines, when fully operational, will have a material adverse
effect on our financial condition or results of operations.
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GENERAL RATE REGULATION
Prior to July 2000, affiliates of Valero Energy owned and operated our
pipelines. These affiliates were the only shippers in most of the pipelines,
including the common carrier pipelines. In preparation for our initial public
offering, we filed revised tariff rates with the appropriate regulatory
commissions to adjust the tariff rates on many of our pipelines to better
reflect current throughput volumes and market conditions or cost-based pricing.
Also in connection with our initial public offering, we obtained the agreement
of Valero Energy, which is the only shipper in most of the pipelines, not to
challenge the validity of the tariff rates until at least April 1, 2008.
INTERSTATE RATE REGULATION
The Federal Energy Regulatory Commission regulates the rates and practices
of common carrier petroleum pipelines, which include crude oil, petroleum
product and petrochemical pipelines, engaged in interstate transportation under
the Interstate Commerce Act. The Interstate Commerce Act and its implementing
regulations require that the tariff rates and practices for interstate oil
pipelines be just and reasonable and non-discriminatory. The Interstate Commerce
Act permits challenges to proposed new or changed rates or practices by protest
and challenges to rates and practices that are already on file and in effect by
complaint. Upon the appropriate showing, a successful complainant may obtain
damages or reparations for generally up to two years prior to the filing of a
complaint. Valero Energy has agreed to be responsible for any Interstate
Commerce Act liabilities with respect to activities or conduct occurring during
periods prior to April 16, 2001, and we will be responsible for Interstate
Commerce Act liabilities with respect to activities or conduct occurring after
April 16, 2001.
The FERC is authorized to suspend the effectiveness of a new or changed
tariff rate for a period of up to seven months and to investigate the rate. The
FERC may also place into effect a new or changed tariff rate on at least one
day's notice, subject to refund and investigation. If upon the completion of an
investigation the FERC finds that the rate is unlawful, it may require the
pipeline operator to refund to shippers, with interest, any difference between
the rates the FERC determines to be lawful and the rates under investigation. In
addition, the FERC will order the pipeline to change its rates prospectively to
the lawful level. In general, petroleum pipeline rates must be cost-based,
although settlement rates, which are rates that have been agreed to by all
shippers, are permitted, and market-based rates may be permitted in certain
circumstances.
ENERGY POLICY ACT OF 1992 AND SUBSEQUENT DEVELOPMENTS
The Energy Policy Act deemed certain interstate petroleum pipeline rates
that were in effect on the date of enactment of the Energy Policy Act, to be
just and reasonable (i.e., "grandfathered") under the Interstate Commerce Act.
Some of the our pipeline rates were grandfathered under the Energy Policy Act,
which has the benefit of making those rates more difficult to challenge.
The Energy Policy Act further required FERC to issue rules establishing a
simplified and generally applicable ratemaking methodology for interstate
petroleum pipelines and to streamline procedures in petroleum pipeline
proceedings. FERC responded to this mandate by adopting a new indexing rate
methodology for interstate petroleum pipelines. Under these regulations,
effective January 1, 1995, petroleum pipelines are able to change their rates
within prescribed ranges that are tied to changes in the Producer Price Index
for Finished Goods (PPI), minus one percent. The new indexing methodology is
applicable to any existing rates, including grandfathered rates, and the scope
of any challenges to rate increases made under the indexing methodology are
limited. As a result of FERC's reassessment of this index and certain court
litigation, on February 24, 2003, FERC changed the index to equal the PPI. Under
FERC's February 24, 2003 Order, pipelines may file to change their tariff rates
to reflect the applicable ceiling levels bases on the PPI, calculated as though
this index had been in effect from July 1, 2001.
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INTRASTATE RATE REGULATION
The rates and practices for our intrastate common carrier pipelines are
subject to regulation by the Texas Railroad Commission and the Colorado Public
Utility Commission. The applicable state statutes and regulations generally
require that pipeline rates and practices be reasonable and non-discriminatory.
OUR PIPELINES RATES
Neither the FERC nor the state commissions have investigated our rates or
practices. We do not believe that it is likely that there will be a challenge to
our rates by a current shipper that would materially affect our revenues or cash
flows because Valero Energy is the only current shipper in substantially all of
our pipelines. Valero Energy has committed not to challenge our rates until at
least April 2008. However, the FERC or a state regulatory commission could
investigate our tariff rates at the urging of a third party. Also, because our
pipelines are common carrier pipelines, we may be required to accept new
shippers who wish to transport in our pipelines. It is possible that any new
shippers may decide to challenge our tariff rates. If a rate were challenged, we
would seek to either rely on a cost of service justification or to establish
that, due to the presence of competing alternatives to our pipeline, the tariff
rate should be a market-based rate. Although no assurance can be given that our
intrastate rates would ultimately be upheld if challenged, we believe that the
tariffs now in effect are not likely to be challenged. However, if any rate
challenge or challenges were successful, cash available for distribution to
unitholders could be materially reduced.
ENVIRONMENTAL REGULATION
GENERAL
Our operations are subject to extensive federal, state and local
environmental laws and regulations, including those relating to the discharge of
materials into the environment, waste management and pollution prevention
measures, and to environmental regulation by several federal, state and local
authorities. The principal environmental risks associated with our operations
relate to unauthorized emissions into the air and unauthorized releases into
soil, surface water or groundwater. Our operations are also subject to extensive
federal and state health and safety laws and regulations, including those
relating to pipeline safety. Compliance with these laws, regulations and permits
increases our capital expenditures and our overall costs of business. However,
violations of these laws, regulations and/or permits can result in significant
civil and criminal liabilities, injunctions or other penalties. Accordingly, we
have adopted policies, practices and procedures in the areas of pollution
control, product safety, occupational health and the handling, storage, use and
disposal of hazardous materials in an effort to prevent material environmental
or other damage, and to ensure the safety of our pipelines, our employees, the
public and the environment. Future governmental action and regulatory
initiatives could result in changes to expected operating permits, additional
remedial actions or increased capital expenditures and operating costs that
cannot be assessed with certainty at this time. In addition, contamination
resulting from spills of crude oil and refined products occurs within the
industry. Risks of additional costs and liabilities are inherent within the
industry, and there can be no assurances that significant costs and liabilities
will not be incurred in the future.
In connection with our initial public offering on April 16, 2001 and our
acquisition of crude oil and refined products pipeline and terminalling assets
from Valero Energy's predecessor, Valero Energy agreed to indemnify us for
environmental liabilities that arose prior to April 16, 2001 and are discovered
within 10 years after April 16, 2001. Excluded from this indemnification are
costs that arise from changes in environmental law after April 16, 2001. In
addition, as an operator or owner of the assets, we could be held liable for
pre-April 16, 2001 environmental damage should Valero Energy be unable to
fulfill its obligation. As of December 31, 2002, we have not incurred any
material environmental liabilities that were not covered by the environmental
indemnification.
WATER
The Oil Pollution Act was enacted in 1990 and amends provisions of the
Federal Water Pollution Control Act of 1972, also referred to as the Clean Water
Act, and other statutes as they pertain to prevention and
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response to petroleum spills. The Oil Pollution Act subjects owners of
facilities to strict, joint and potentially unlimited liability for removal
costs and other consequences of a petroleum spill, where the spill is into
navigable waters, along shorelines or in the exclusive economic zone of the U.S.
In the event of a petroleum spill into navigable waters, substantial liabilities
could be imposed upon us. States in which we operate have also enacted similar
laws. Regulations developed under the Oil Pollution Act and state laws may also
impose additional regulatory burdens on our operations. Spill prevention control
and countermeasure requirements of federal laws and some state laws require
diking, booms and similar structures to help prevent contamination of navigable
waters in the event of a petroleum overflow, rupture or leak. In addition, these
laws require, in some instances, the development of spill prevention control and
countermeasure plans. Additionally, the United States Department of
Transportation's Office of Pipeline Safety (OPS) has approved our petroleum
spill emergency response plans.
The Clean Water Act imposes restrictions and strict controls regarding the
discharge of pollutants into navigable waters. Permits must be obtained to
discharge pollutants into federal and state waters. The Clean Water Act imposes
substantial potential liability for the costs of removal, remediation and
damages. In addition, some states maintain groundwater protection programs that
require permits for discharges or operations that may impact groundwater
conditions.
AIR EMISSIONS
Our operations are subject to the Federal Clean Air Act and comparable
state and local statutes. Amendments to the Federal Clean Air Act enacted in
late 1990 require most industrial operations in the U.S. to incur capital
expenditures in order to meet air emission control standards developed by the
Environmental Protection Agency and state environmental agencies. In addition,
Title V of the 1990 Federal Clean Air Act Amendments created a new operating
permit program for major sources, which applies to some of our facilities. We
will be required to incur certain capital expenditures in the next several years
for air pollution control equipment in connection with maintaining or obtaining
permits and approvals addressing air emission related issues.
SOLID WASTE
We generate non-hazardous solid wastes that are subject to the requirements
of the Federal Resource Conservation and Recovery Act and comparable state
statutes. The Federal Resource Conservation and Recovery Act also governs the
disposal of hazardous wastes. We are not currently required to comply with a
substantial portion of the Federal Resource Conservation and Recovery Act
requirements because our operations generate minimal quantities of hazardous
wastes. However, it is possible that additional wastes, which could include
wastes currently generated during operations, will in the future be designated
as "hazardous wastes." Hazardous wastes are subject to more rigorous and costly
disposal requirements than are non-hazardous wastes.
HAZARDOUS SUBSTANCES
The Comprehensive Environmental Response, Compensation and Liability Act,
referred to as CERCLA, also known as Superfund, imposes liability, without
regard to fault or the legality of the original act, on some classes of persons
that contributed to the release of a "hazardous substance" into the environment.
These persons include the owner or operator of the site and entities that
disposed or arranged for the disposal of the hazardous substances found at the
site. CERCLA also authorizes the Environmental Protection Agency and, in some
instances, third parties to act in response to threats to the public health or
the environment and to seek to recover from the responsible classes of persons
the costs that they incur. In the course of our ordinary operations, we may
generate waste that falls within CERCLA's definition of a "hazardous substance."
While we responsibly manage the hazardous substances that we control, the
intervening acts of third parties may expose us to joint and several liability
under CERCLA for all or part of the costs required to clean up sites at which
these hazardous substances have been disposed of or released into the
environment.
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We currently own or lease, and have in the past owned or leased, properties
where hydrocarbons are being or have been handled. Although we have utilized
operating and disposal practices that were standard in the industry at the time,
hydrocarbons or other wastes may have been disposed of or released on or under
the properties owned or leased by us or on or under other locations where these
wastes have been taken for disposal. In addition, many of these properties have
been operated by third parties whose treatment and disposal or release of
hydrocarbons or other wastes was not under our control. These properties and
wastes disposed thereon may be subject to CERCLA, the Federal Resource
Conservation and Recovery Act and analogous state laws. Under these laws, we
could be required to remove or remediate previously disposed wastes (including
wastes disposed of or released by prior owners or operators), to clean up
contaminated property (including contaminated groundwater) or to perform
remedial operations to prevent future contamination.
ENDANGERED SPECIES ACT
The Endangered Species Act restricts activities that may affect endangered
species or their habitats. The discovery of previously unidentified endangered
species could cause us to incur additional costs or operational restrictions or
bans in the affected area.
HAZARDOUS MATERIALS TRANSPORTATION REQUIREMENTS
OPS has promulgated extensive regulations governing pipeline safety. These
regulations generally require pipeline operators to implement measures designed
to reduce the environmental impact from onshore crude oil and refined product
pipeline releases and to maintain comprehensive spill response plans, including
extensive spill response training certifications for pipeline personnel. These
regulations also require pipeline operators to develop qualification programs
for individuals performing "covered tasks" on pipeline facilities to ensure
there is a qualified work force and to reduce the risk of accidents from human
error. In addition, OPS regulations contain detailed specifications for pipeline
operation and maintenance, such as the implementation of integrity management
programs that continually assess the integrity of pipelines in high consequence
areas (such as areas with concentrated populations, navigable waterways or other
unusually sensitive areas). In addition to federal regulations, some states,
including Texas and Oklahoma, have certified state pipeline safety programs
governing intrastate pipelines. Other states, such as New Mexico, have entered
into agreements with OPS to help implement safety regulations on intrastate
pipelines.
PIPELINE SAFETY IMPROVEMENT ACT OF 2002
In December 2002, the Pipeline Safety Improvement Act of 2002 was enacted.
This expands the government's regulatory authority over pipeline safety and,
among other things, requires pipeline operators to maintain qualification
programs for key pipeline operating personnel, to review and update their
existing pipeline safety public education programs, and to provide information
for the National Pipeline Mapping System. The act also strengthens the national
"One-call" system, which is intended to minimize the risk of pipelines being
damaged by third-party excavators and provides "whistleblower" protection to
pipeline employees and contractors who identify pipeline safety risks. Some of
the act's requirements are effective immediately, while other requirements will
become effective during 2003 and 2004. We believe that we are in substantial
compliance with the act, and will continue to be in substantial compliance with
the act following the effectiveness of these other requirements. In addition,
while this act may affect our maintenance capital expenditures and operating
expenses, we believe that the act does not affect our competitive position and
will not have a material affect on our financial conditions or results of
operations.
OSHA
We are subject to the requirements of the Federal Occupational Safety and
Health Act and comparable state statutes that regulate the protection of the
health and safety of workers. In addition, the Federal Occupational Safety and
Health Act hazard communication standard requires that information be maintained
about hazardous materials used or produced in operations and that this
information be provided to employees, state and local government authorities and
citizens.
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TITLE TO PROPERTIES
We believe that we have satisfactory title to all of our assets. Although
title to these properties is subject to encumbrances in some cases, such as
customary interests generally retained in connection with acquisition of real
property, liens related to environmental liabilities associated with historical
operations, liens for current taxes and other burdens and minor easements,
restrictions and other encumbrances to which the underlying properties were
subject at the time of acquisition by us or our predecessors, we believe that
none of these burdens will materially detract from the value of these properties
or from our interest in these properties or will materially interfere with our
use in the operation of our business. In addition, we believe that we have
obtained sufficient rights-of-way grants and permits from public authorities and
private parties for us to operate our business in all material respects as
described in this prospectus supplement.
EMPLOYEES
Riverwalk Logistics, our general partner, is responsible for the management
of Valero L.P. Valero GP, LLC, the general partner of Riverwalk Logistics, is
responsible for managing the affairs of the general partner, and through it, the
affairs of Valero L.P. and Valero Logistics. As of January 1, 2003, Valero GP,
LLC, on our behalf, employed approximately 200 individuals that perform services
for us. We also receive administrative services from other Valero Energy
employees under the services agreement. Prior to January 1, 2003 these employees
were employed by Valero Energy.
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TAX CONSIDERATIONS
The tax consequences to you of an investment in our common units will
depend in part on your own tax circumstances. For a discussion of the principal
federal income tax considerations associated with our operations and the
purchase, ownership and disposition of common units, please read "Tax
Considerations" beginning on page 37 of the accompanying prospectus. You are
urged to consult your own tax advisor about the federal, state, foreign and
local tax consequences peculiar to your circumstances.
We estimate that if you purchase a common unit in this offering and hold
the common unit through the record date for the distribution with respect to the
fourth calendar quarter of 2005, you will be allocated, on a cumulative basis,
an amount of federal taxable income for the period 2003 through 2005 that will
be less than 20% of the amount of cash distributed to you with respect to that
period.
This estimate is based upon many assumptions regarding our business and
operations, including assumptions with respect to capital expenditures, cash
flows and anticipated cash distributions. This estimate and our assumptions are
subject to, among other things, numerous business, economic, regulatory,
competitive and political uncertainties beyond our control. Further, this
estimate is based on current tax law and tax reporting positions that we have
adopted and with which the Internal Revenue Service might disagree. Accordingly,
we cannot assure you that this estimate will be correct. The actual percentage
of distributions that will constitute taxable income could be higher or lower,
and any differences could materially affect the value of the common units.
Ownership of common units by tax-exempt entities, regulated investment
companies and foreign investors raises issues unique to such persons. Please
read "Tax Considerations -- Tax-Exempt Organizations and Other Investors" in the
accompanying prospectus.
Recently issued final regulations require taxpayers to report certain
information on Internal Revenue Service Form 8886 if they participate in a
"reportable transaction." A transaction may be a reportable transaction based
upon any of several factors, including the existence of book-tax differences
common to financial transactions, one or more of which may be present with
respect to your investment in our common units. The Internal Revenue Service has
issued a list of items that are excepted from these disclosure requirements. You
should consult your own tax advisor concerning the application of any of these
factors to your investment in our common units. Congress is considering
legislative proposals that, if enacted, would impose significant penalties for
failure to comply with these disclosure requirements. The new regulations also
impose obligations on "material advisors" that organize, manage, or sell
interests in registered "tax shelters." As described in the accompanying
prospectus, we have registered as a tax shelter, and, thus, one of our material
advisors will be required to maintain a list with specific information,
including your name and tax identification number, and to furnish this
information to the Internal Revenue Service upon request. Investors should
consult their own tax advisors concerning any possible disclosure obligation
with respect to their investment and should be aware that we and our material
advisors intend to comply with the list and disclosure requirements.
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UNDERWRITING
Under the underwriting agreement, which we will file as an exhibit to our
current report on Form 8-K relating to this common unit offering, each of the
underwriters named below have severally agreed to purchase from us the
respective number of common units indicated in the following table:
NUMBER OF
UNDERWRITERS COMMON UNITS
------------ ------------
Lehman Brothers Inc......................................... 1,437,500
Goldman, Sachs & Co......................................... 805,000
Morgan Stanley & Co. Incorporated........................... 805,000
Salomon Smith Barney Inc.................................... 805,000
UBS Warburg LLC............................................. 805,000
Credit Suisse First Boston LLC ............................. 402,500
RBC Dain Rauscher Inc. ..................................... 402,500
Sanders Morris Harris Inc................................... 287,500
-----------
Total............................................. 5,750,000
===========
The underwriting agreement provides that the underwriters are obligated to
purchase, subject to certain conditions, all of the common units in the offering
if any are purchased, other than those covered by the over-allotment option
described below. The conditions contained in the underwriting agreement include
requirements that:
- the representations and warranties made by us to the underwriters are
true;
- there has been no material adverse change in our condition or in the
financial markets; and
- we deliver the customary closing documents to the underwriters.
OVER-ALLOTMENT OPTION
We have granted the underwriters a 30-day option after the date of the
underwriting agreement to purchase, in whole or part, up to an aggregate of
862,500 additional common units at the public offering price less the
underwriting discounts and commissions. Such option may be exercised to cover
over-allotments, if any, made in connection with the common unit offering. To
the extent that the option is exercised, each underwriter will be obligated,
subject to certain conditions, to purchase its pro rata portion of these
additional common units based on the underwriter's percentage underwriting
commitment in the offering as indicated on the preceding table.
COMMISSION AND EXPENSES
We have been advised by the underwriters that the underwriters propose to
offer the common units directly to the public at the price to the public set
forth on the cover page of this prospectus supplement and to selected dealers
(who may include the underwriters) at the offering price less a selling
concession not in excess of $0.96 per unit. The underwriters may allow, and the
selected dealers may reallow, a discount from the concession not in excess of
$0.10 per unit to other dealers. After the common unit offering, the
underwriters may change the offering price and other selling terms.
The following table shows the underwriting discounts and commissions we
will pay to the underwriters. These amounts are shown assuming both no exercise
and full exercise of the underwriters' over-allotment option to purchase
additional common units. The underwriting fee is the difference between the
public offering price and the amount the underwriters pay to us to purchase the
common units from us.
NO EXERCISE FULL EXERCISE
----------- -------------
Per Unit.................................................... $ 1.56 $ 1.56
Total..................................................... $8,970,000 $10,315,500
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We estimate that the total expenses for this common unit offering and
related transactions, excluding underwriting discounts and commissions, will be
approximately $2.0 million.
STABILIZATION, SHORT POSITIONS AND PENALTY BIDS
In connection with this offering, the underwriters may engage in
stabilizing transactions, over-allotment transactions, syndicate covering
transactions, and penalty bids or purchases for the purpose of pegging, fixing
or maintaining the price of the common units in accordance with Regulation M
under the Exchange Act.
- Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specified maximum.
- Over-allotment transactions involve sales by the underwriters of the
common units in excess of the number of common units the underwriters are
obligated to purchase, which creates a syndicate short position. The
short position may be either a covered short position or a naked short
position. In a covered short position, the number of common units
over-allotted by the underwriters is not greater than the number of
common units that they may purchase in the over-allotment option. In a
naked short position, the number of common units involved is greater than
the number of common units in the over-allotment option. The underwriters
may close out any short position by either exercising their
over-allotment option and/or purchasing the common units in the open
market.
- Syndicate covering transactions involve purchases of the common units in
the open market after the distribution has been completed in order to
cover syndicate short positions. In determining the source of the common
units to close out the short position, the underwriters will consider,
among other things, the price of common units available for purchase in
the open market as compared to the price at which they may purchase
common units through the over-allotment option. If the underwriters sell
more common units than could be covered by the over-allotment option, a
naked short position, the position can only be closed out by buying
common units in the open market. A naked short position is more likely to
be created if the underwriters are concerned that there could be downward
pressure on the price of the common units in the open market after
pricing that could adversely affect investors who purchase in the
offering.
- Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the common units originally sold by the
syndicate member are purchased in a stabilizing or syndicate covering
transaction to cover a syndicate short position.
These stabilizing transactions, syndicate covering transactions and penalty
bids may have the effect of raising or maintaining the market price of our
common units or preventing or retarding a decline in the market price of the
common units. As a result, the price of the common units may be higher than the
price that might otherwise exist in the open market. These transactions may be
effected on the New York Stock Exchange or otherwise and, if commenced, may be
discontinued at any time.
Neither we nor any of the underwriters make any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the common units. In addition, neither
we nor any of the underwriters make any representation that the underwriters
will engage in these stabilizing transactions or that any transaction, once
commenced, will not be discontinued without notice.
LOCK-UP AGREEMENTS
We, our affiliates that own common units and the executive officers and
directors of the general partner of our general partner have agreed that we and
they will not, subject to limited exceptions, directly or indirectly, sell,
offer, pledge or otherwise dispose of any common units or any securities
convertible into or exchangeable or exercisable for common units or enter into
any derivative transaction with similar effect as a sale of common units for a
period of 90 days after the date of this prospectus supplement without the prior
written consent of Lehman Brothers Inc. The restrictions described in this
paragraph do not apply to the sale of common units to the underwriters. This
agreement does not apply to any existing employee benefit plans.
S-69
Lehman Brothers Inc., in its discretion, may release the common units
subject to lock-up agreements in whole or in part at any time with or without
notice. When determining whether or not to release common units from lock-up
agreements, Lehman Brothers Inc. will consider, among other factors, the
unitholders' reasons for requesting the release, the number of common units for
which the release is being requested, and market conditions at the time.
LISTING
Our common units are traded on the New York Stock Exchange under the symbol
"VLI".
INDEMNIFICATION
We, our general partner and Valero Logistics have agreed to indemnify the
underwriters against certain liabilities, including liabilities under the
Securities Act of 1933, or to contribute to payments that may be required to be
made in respect of these liabilities.
AFFILIATIONS
Some of the underwriters have performed investment banking, commercial
banking and advisory services for us and for Valero Energy from time to time for
which they have received customary fees and expenses. The underwriters may, from
time to time in the future, engage in transactions with and perform services for
us or Valero Energy in the ordinary course of their business.
Royal Bank of Canada, an affiliate of RBC Dain Rauscher Inc., which is one
of the underwriters, is one of the lenders to Valero Logistics under its credit
facility, for which they have received customary compensation. Another affiliate
of RBC Dain Rauscher Inc. will act as an initial purchaser in the proposed
private placement of senior notes, for which they will receive customary
compensation. None of the net proceeds of this offering will be used to repay
amounts outstanding under the credit facility or principal or interest on Valero
Logistics' senior notes.
NASD CONDUCT RULES
The compensation received by the underwriters in connection with this
common unit offering does not exceed 10% of the gross proceeds from this common
unit offering for commission and .5% for due diligence.
Because the NASD views the common units offered hereby as interest in a
direct participation program, the offering is being made in compliance with Rule
2810 of the NASD Conduct Rules. Investor suitability with respect to the common
units should be judged similarly to the suitability with respect to other
securities that are listed for trading on a national securities exchange.
DISCRETIONARY SALES
No sales to accounts over which the underwriters have discretionary
authority may be made without the prior written approval of the customer.
ELECTRONIC DISTRIBUTION
A prospectus in electronic format may be made available on the Internet
sites or through other online services maintained by one or more of the
underwriters and/or selling group members participating in this common unit
offering, or by their affiliates. In those cases, prospective investors may view
offering terms online and, depending upon the particular underwriter or selling
group member, prospective investors may be allowed to place orders online. The
underwriters may agree with us to allocate a specific number of common units for
sale to online brokerage account holders. Any such allocation for online
distributions will be made by the representatives on the same basis as other
allocations.
Other than the prospectus in electronic format, the information on any
underwriter's or selling group members' website and any information contained in
any other website maintained by any underwriter or
S-70
selling group member is not part of the prospectus or the registration statement
of which this prospectus supplement forms a part, has not been approved and/or
endorsed by us or any underwriter or selling group member in its capacity as
underwriter or selling group member and should not be relied upon by investors.
NOTICE TO CANADIAN RESIDENTS
RESALE RESTRICTIONS
The distribution of the common units, also referred to in this section as
the securities, in Canada is being made only on a private placements basis
exempt from the requirement that we prepare and file a prospectus with the
securities regulatory authorities in each province where trades of the
securities are made. Any resale of the securities in Canada must be made under
applicable securities laws which will vary depending on the relevant
jurisdiction, and which may require resales to be made under available statutory
exemptions or under a discretionary exemption granted by the applicable Canadian
securities regulatory authority. Purchasers are advised to seek legal advice
prior to any resale of the securities.
REPRESENTATIONS OF PURCHASERS
By purchasing the securities in Canada and accepting a purchase
confirmation a purchaser is representing to us and the dealer from whom the
purchase confirmation is received that:
- the purchaser is entitled under applicable provincial securities laws to
purchase the securities without the benefit of a prospectus qualified
under those securities laws;
- where required by law, that the purchaser is purchasing as principal and
not as agent; and
- the purchaser has reviewed the text above under Resale Restrictions.
RIGHTS OF ACTION -- ONTARIO PURCHASERS
Under Ontario securities legislation, a purchaser who purchases a security
offered by this prospectus during the period of distribution will have a
statutory right of action for damages, or while still the owner of the shares,
for rescission against us in the event that this prospectus contains a
misrepresentation. A purchaser will be deemed to have relied on the
misrepresentation. The right of action for damages is exercisable not later than
the earlier of 180 days from the date the purchaser first had knowledge of the
facts giving rise to the cause of action and three years from the date on which
payment is made for the shares. The right of action for rescission is
exercisable not later than 180 days from the date on which payment is made for
the securities. If a purchaser elects to exercise the right of action for
rescission, the purchaser will have no right of action for damages against us.
In no case will the amount recoverable in any action exceed the price at which
the securities were offered to the purchaser and if the purchaser is shown to
have purchased the securities with knowledge of the misrepresentation, we will
have no liability. In the case of an action for damages, we will not be liable
for all or any portion of the damages that are proven to not represent the
depreciation in value of the securities as a result of the misrepresentation
relied upon. These rights are in addition to, and without derogation from, any
other rights or remedies available at law to an Ontario purchaser. The foregoing
is a summary of the rights available to an Ontario purchaser. Ontario purchasers
should refer to the complete text of the relevant statutory provisions.
ENFORCEMENT OF LEGAL RIGHTS
All of our directors and officers as well as the experts named herein may
be located outside of Canada and, as a result, it may not be possible for
Canadian purchasers to effect service of process within Canada upon us or those
persons. All or a substantial portion of our assets and the assets of those
persons may be located outside of Canada and, as a result, it may not be
possible to satisfy a judgement against us or those persons in Canada or to
enforce a judgment obtained in Canadian courts against us or those persons
outside of Canada.
S-71
TAXATION AND ELIGIBILITY FOR INVESTMENT
Canadian purchasers of the securities should consult their own legal and
tax advisors with respect to the tax consequences of an investment in the
securities in their particular circumstances and about the eligibility of the
debentures for investment by the purchaser under relevant Canadian legislation.
VALIDITY OF THE SECURITIES
The validity of the common units and certain federal income tax matters
related to the common units will be passed upon for Valero L.P. by Andrews &
Kurth L.L.P., Houston, Texas. Certain legal matters in connection with the
common units offered by this prospectus supplement will be passed upon for the
underwriters by Baker Botts L.L.P., Houston, Texas. Baker Botts L.L.P. has, from
time to time, performed legal services for Valero Energy.
EXPERTS
The consolidated balance sheets of Valero L.P. and its subsidiaries as of
December 31, 2002 and 2001, and the related consolidated statements of income,
cash flows and partners' equity for the year ended December 31, 2002 and the
balance sheet of the Valero South Texas Pipeline and Terminal Business as of
December 31, 2002, and the related statements of income, cash flows and changes
in net parent investment for the year then ended, appearing in this prospectus
supplement have been audited by Ernst & Young LLP, independent auditors, as set
forth in their reports thereon appearing elsewhere herein, and are included in
reliance upon such reports given on the authority of such firm as experts in
accounting and auditing.
S-72
INDEX TO FINANCIAL STATEMENTS
VALERO L.P. AND SUBSIDIARIES
Report of Independent Auditors........................... F-2
Report of Independent Public Accountants................. F-3
Consolidated Balance Sheets as of December 31, 2002 and
December 31, 2001...................................... F-4
Consolidated and Combined Statements of Income for the
years ended December 31, 2002 and 2001, the six months
ended December 31, 2000 (successor) and six months
ended June 30, 2000 (predecessor)...................... F-5
Consolidated and Combined Statements of Cash Flows for
the years ended December 31, 2002 and 2001, the six
months ended December 31, 2000 (successor) and six
months ended June 30, 2000 (predecessor)............... F-6
Combined Statements of Partners' Equity/Net Parent
Investment for the six months ended December 31, 2000
and the six months ended June 30, 2000................. F-7
Consolidated and Combined Statements of Partners' Equity
for the years ended December 31, 2002 and 2001......... F-8
Notes to Consolidated and Combined Financial
Statements............................................. F-9
VALERO SOUTH TEXAS PIPELINE AND TERMINAL BUSINESS
Report of Independent Auditors........................... F-31
Balance Sheet as of December 31, 2002.................... F-32
Statement of Income for the year ended December 31,
2002................................................... F-33
Statement of Cash Flows for the year ended December 31,
2002................................................... F-34
Statement of Changes in Net Parent Investment for the
year ended December 31, 2002........................... F-35
Notes to Financial Statements............................ F-36
F-1
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Unitholders of Valero L.P.
We have audited the accompanying consolidated balance sheets of Valero L.P.
and subsidiaries (a Delaware limited partnership, the Partnership) as of
December 31, 2002 and 2001, and the related consolidated statements of income,
cash flows and partners' equity for the year ended December 31, 2002. These
financial statements are the responsibility of the Partnership's management. Our
responsibility is to express an opinion on these financial statements based on
our audit. The financial statements of Valero L.P. for the years ended December
31, 2001 and 2000 were audited by other auditors who have ceased operations.
Those auditors expressed an unqualified opinion on those financial statements in
their report dated May 14, 2002.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Valero L.P. and
subsidiaries as of December 31, 2002 and 2001, and the results of their
operations and their cash flows for the year ended December 31, 2002 in
conformity with accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
San Antonio, Texas
March 6, 2003
F-2
THIS IS A COPY OF THE AUDIT REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP IN
CONNECTION WITH THEIR AUDITS OF VALERO L.P. AS OF DECEMBER 31, 2001 AND 2000 AND
FOR THE THREE YEARS ENDED DECEMBER 31, 2001. THIS AUDIT REPORT HAS NOT BEEN
REISSUED BY ARTHUR ANDERSEN LLP AS THEY HAVE CEASED OPERATIONS. THE "(AS
RESTATED -- SEE NOTE 2)" REFERENCE BELOW RELATES TO THE RESTATEMENT OF THE
DECEMBER 31, 2001 BALANCE SHEET FOR THE WICHITA FALLS BUSINESS ACQUISITION
DISCLOSED IN NOTE 4 OF NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Unitholders of Valero L.P.:
We have audited the accompanying consolidated and combined balance sheets
of Valero L.P., formerly Shamrock Logistics, L.P. (a Delaware limited
partnership) and Valero Logistics Operations, L.P., formerly Shamrock Logistics
Operations, L.P. successor to the Ultramar Diamond Shamrock Logistics Business
(a Delaware limited partnership) (collectively, the Partnerships) as of December
31, 2001 and 2000 (successor), and the related consolidated and combined
statements of income, cash flows (as restated -- see Note 2), partners'
equity/net parent investment for the year ended December 31, 2001 and the six
months ended December 31, 2000 (successor) and the related combined statements
of income, cash flows (as restated -- see Note 2), partners' equity/net parent
investment for the six months ended June 30, 2000 and the year ended December
31, 1999 (predecessor). These financial statements are the responsibility of the
Partnership's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated and combined financial position of
the Partnerships as of December 31, 2001 and 2000, and the results of their
operations and their cash flows (as restated) for each of the three years in the
period ended December 31, 2001 in conformity with accounting principles
generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
San Antonio, Texas
May 14, 2002
F-3
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
---------------------
2002 2001
--------- ---------
(IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents................................. $ 33,533 $ 7,796
Receivable from parent.................................... 8,482 5,816
Accounts receivable....................................... 1,502 2,855
Other current assets...................................... 177 --
--------- ---------
Total current assets................................... 43,694 16,467
--------- ---------
Property, plant and equipment............................... 486,939 470,401
Less accumulated depreciation and amortization.............. (137,663) (121,389)
--------- ---------
Property, plant and equipment, net........................ 349,276 349,012
Goodwill, net of accumulated amortization of $1,279 as of
2002 and 2001............................................. 4,715 4,715
Investment in Skelly-Belvieu Pipeline Company............... 16,090 16,492
Other noncurrent assets, net of accumulated amortization of
$250 and $90 as of 2002 and 2001, respectively............ 1,733 384
--------- ---------
Total assets........................................... $ 415,508 $ 387,070
========= =========
LIABILITIES AND PARTNERS' EQUITY
Current liabilities:
Current portion of long-term debt......................... $ 747 $ 462
Accounts payable and accrued liabilities.................. 8,133 4,175
Taxes other than income taxes............................. 3,797 1,458
--------- ---------
Total current liabilities.............................. 12,677 6,095
Long-term debt, less current portion........................ 108,911 25,660
Other long-term liabilities................................. 25 2
Deferred income tax liabilities............................. -- 13,147
Commitments and contingencies (see note 10)
Partners' equity:
Common units (9,654,572 and 9,599,322 outstanding as of
2002 and 2001, respectively)........................... 170,655 169,305
Subordinated units (9,599,322 outstanding as of 2002 and
2001).................................................. 117,042 116,399
General partner's equity.................................. 6,198 5,831
Net parent investment in the Wichita Falls Business....... -- 50,631
--------- ---------
Total partners' equity................................. 293,895 342,166
--------- ---------
Total liabilities and partners' equity................. $ 415,508 $ 387,070
========= =========
See accompanying notes to consolidated and combined financial statements.
F-4
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
CONSOLIDATED AND COMBINED STATEMENTS OF INCOME
SUCCESSOR PREDECESSOR
---------------------------------------- -----------
SIX MONTHS SIX MONTHS
YEARS ENDED DECEMBER 31, ENDED ENDED
------------------------- DECEMBER 31, JUNE 30,
2002 2001 2000 2000
----------- ----------- ------------ -----------
(IN THOUSANDS, EXCEPT UNIT AND PER UNIT DATA)
REVENUES................................... $ 118,458 $ 98,827 $47,550 $ 44,503
----------- ----------- ------- --------
COSTS AND EXPENSES:
Operating expenses....................... 37,838 33,583 15,593 17,912
General and administrative expenses...... 6,950 5,349 2,549 2,590
Depreciation and amortization............ 16,440 13,390 5,924 6,336
----------- ----------- ------- --------
TOTAL COSTS AND EXPENSES.............. 61,228 52,322 24,066 26,838
----------- ----------- ------- --------
OPERATING INCOME........................... 57,230 46,505 23,484 17,665
Equity income from Skelly-Belvieu
Pipeline Company...................... 3,188 3,179 1,951 1,926
Interest expense, net.................... (4,880) (3,811) (4,748) (433)
----------- ----------- ------- --------
INCOME BEFORE INCOME TAX EXPENSE
(BENEFIT)................................ 55,538 45,873 20,687 19,158
Income tax expense (benefit)............. 395 -- -- (30,812)
----------- ----------- ------- --------
NET INCOME................................. $ 55,143 $ 45,873 $20,687 $ 49,970
=========== =========== ======= ========
ALLOCATION OF NET INCOME:
Net income............................... $ 55,143 $ 45,873
Less net income applicable to the period
January 1, 2001 through April 15,
2001.................................. -- (10,126)
Less net income applicable to the Wichita
Falls Business for the month ended
January 31, 2002...................... (650) --
----------- -----------
Net income applicable to the general and
limited partners' interest............ 54,493 35,747
General partner's interest in net
income................................ (2,187) (715)
----------- -----------
Limited partners' interest in net
income................................ $ 52,306 $ 35,032
=========== ===========
Basic and diluted net income per unit
applicable to limited partners........ $ 2.72 $ 1.82
=========== ===========
Weighted average number of basic and
diluted units outstanding............. 19,250,867 19,198,644
=========== ===========
See accompanying notes to consolidated and combined financial statements.
F-5
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS
SUCCESSOR PREDECESSOR
----------------------------------- -----------
YEARS ENDED SIX MONTHS SIX MONTHS
DECEMBER 31, ENDED ENDED
-------------------- DECEMBER 31, JUNE 30,
2002 2001 2000 2000
-------- --------- ------------ -----------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.............................................. $ 55,143 $ 45,873 $ 20,687 $ 49,970
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization......................... 16,440 13,390 5,924 6,336
Equity income from Skelly-Belvieu Pipeline Company.... (3,188) (3,179) (1,951) (1,926)
Distributions of equity income from Skelly-Belvieu
Pipeline Company.................................... 3,493 2,874 1,951 1,926
Provision (benefit) for deferred income taxes......... 54 -- -- (36,677)
Changes in operating assets and liabilities:
Decrease (increase) in receivable from parent....... (2,666) 16,532 (22,347) --
Decrease (increase) in accounts receivable notes
receivable........................................ 1,353 (469) (1,676) 263
Decrease (increase) in other current assets......... (177) 3,528 (3,528) --
Increase (decrease) in accounts payable and accrued
liabilities....................................... 3,958 1,359 1,481 (106)
Increase (decrease) in taxes other than income
taxes............................................. 2,369 (2,394) 1,329 598
Other, net............................................ 877 (382) -- (137)
-------- --------- -------- --------
NET CASH PROVIDED BY OPERATING ACTIVITIES........... 77,656 77,132 1,870 20,247
-------- --------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Maintenance capital expenditures........................ (3,943) (2,786) (619) (1,699)
Expansion capital expenditures.......................... (1,761) (4,340) (1,518) (3,186)
Acquisitions............................................ (75,000) (10,800) -- --
Distributions in excess of equity income from
Skelly-Belvieu Pipeline Company....................... 97 -- 401 380
-------- --------- -------- --------
NET CASH USED IN INVESTING ACTIVITIES............... (80,607) (17,926) (1,736) (4,505)
-------- --------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from senior note offering, net of issuance
costs................................................. 98,207 -- -- --
Proceeds from other long-term debt borrowings........... 75,000 25,506 -- --
Repayment of long-term debt............................. (91,164) (10,068) (134) (284)
Distributions to unitholders and general partner........ (52,843) (21,571) -- --
Distributions to parent and affiliates.................. (512) (29,000) -- (15,458)
Partners' contributions................................. -- -- 1 --
Net proceeds from sale of common units to the public.... -- 111,912 -- --
Distribution to parent and affiliates for reimbursement
of capital expenditures............................... -- (20,517) -- --
Repayment of debt due to parent......................... -- (107,676) -- --
-------- --------- -------- --------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES........................................ 28,688 (51,414) (133) (15,742)
-------- --------- -------- --------
Net increase in cash and cash equivalents............... 25,737 7,792 1 --
Cash and cash equivalents as of the beginning of
period................................................ 7,796 4 3 3
-------- --------- -------- --------
Cash and cash equivalents as of the end of period....... $ 33,533 $ 7,796 $ 4 $ 3
======== ========= ======== ========
NON-CASH ACTIVITIES -- Adjustment related to the
transfer of the Wichita Falls Business to Valero L.P.
by Valero Energy:
Property, plant and equipment......................... $ 64,160 $ (64,160) $ -- $ --
Accrued liabilities and taxes other than income
taxes............................................... (382) 382 -- --
Deferred income tax liabilities....................... (13,147) 13,147 -- --
Net parent investment................................. (50,631) 50,631 -- --
See accompanying notes to consolidated and combined financial statements.
F-6
SHAMROCK LOGISTICS, L.P. AND SHAMROCK LOGISTICS OPERATIONS, L.P.
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
COMBINED STATEMENTS OF PARTNERS' EQUITY/NET PARENT INVESTMENT
SIX MONTHS ENDED DECEMBER 31, 2000 AND SIX MONTHS ENDED JUNE 30, 2000
(IN THOUSANDS)
BALANCE AS OF JANUARY 1, 2000............................... $ 254,807
Net income................................................ 49,970
Net change in parent advances............................. (15,458)
Formalization of the terms of debt due to parent.......... (107,676)
---------
BALANCE AS OF JUNE 30, 2000................................. 181,643
Net income................................................ 20,687
Partners' contributions................................... 1
Environmental liabilities as of June 30, 2000 retained by
Ultramar Diamond Shamrock Corporation.................. 2,507
---------
BALANCE AS OF DECEMBER 31, 2000............................. $ 204,838
=========
See accompanying notes to consolidated and combined financial statements.
F-7
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
CONSOLIDATED AND COMBINED STATEMENTS OF PARTNERS' EQUITY
YEARS ENDED DECEMBER 31, 2002 AND 2001
LIMITED PARTNERS TOTAL
------------------------ GENERAL NET PARENT PARTNERS'
COMMON SUBORDINATED PARTNER INVESTMENT EQUITY
--------- ------------ ------- ---------- ---------
(IN THOUSANDS)
COMBINED BALANCE AS OF JANUARY 1,
2001................................. $ 202,790 $ -- $ 2,048 $ -- $204,838
Net income applicable to the period
January 1, 2001 through April 15,
2001................................. 10,025 -- 101 -- 10,126
Distributions to affiliates of Ultramar
Diamond Shamrock Corporation of net
income applicable to the period July
1, 2000 through April 15, 2001....... (28,710) -- (290) -- (29,000)
Distribution to affiliates of Ultramar
Diamond Shamrock Corporation for
reimbursement of capital
expenditures......................... (20,517) -- -- -- (20,517)
Issuance of common and subordinated
units for the contribution of Valero
Logistics Operations' limited partner
interest............................. (113,141) 109,453 3,688 -- --
Sale of common units to the public..... 111,912 -- -- -- 111,912
Net income applicable to the period
from April 16, 2001 through December
31, 2001............................. 17,516 17,516 715 -- 35,747
Cash distributions to partners......... (10,570) (10,570) (431) -- (21,571)
Adjustment for the Wichita Falls
Business transaction................. -- -- -- 50,631 50,631
--------- -------- ------- -------- --------
CONSOLIDATED BALANCE AS OF DECEMBER 31,
2001................................. 169,305 116,399 5,831 50,631 342,166
Net income............................. 26,225 26,081 2,187 650 55,143
Cash distributions to partners......... (25,585) (25,438) (1,820) -- (52,843)
Adjustment resulting from the
acquisition of the Wichita Falls
Business on February 1, 2002......... -- -- -- (51,281) (51,281)
Other.................................. 710 -- -- -- 710
--------- -------- ------- -------- --------
CONSOLIDATED BALANCE AS OF DECEMBER 31,
2002................................. $ 170,655 $117,042 $ 6,198 $ -- $293,895
========= ======== ======= ======== ========
See accompanying notes to consolidated and combined financial statements.
F-8
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002 AND 2001 AND SIX MONTHS ENDED
DECEMBER 31, 2000 AND SIX MONTHS ENDED JUNE 30, 2000
NOTE 1: ORGANIZATION, BUSINESS AND BASIS OF PRESENTATION
ORGANIZATION AND BUSINESS
Valero L.P. (formerly Shamrock Logistics, L.P.), a Delaware limited
partnership, through its wholly owned subsidiary, Valero Logistics Operations,
L.P. (Valero Logistics) owns and operates most of the crude oil and refined
product pipeline, terminalling and storage assets that service three of Valero
Energy Corporation's (Valero Energy) refineries. These refineries consist of the
McKee and Three Rivers refineries located in Texas, and the Ardmore refinery
located in Oklahoma. The pipeline, terminalling and storage assets provide for
the transportation of crude oil and other feedstocks to the refineries and the
transportation of refined products from the refineries to terminals or
third-party pipelines for further distribution. The Partnership's revenues are
earned primarily from providing these services to Valero Energy (see Note 13:
Related Party Transactions).
As used in this report, the term Partnership may refer, depending on the
context, to Valero L.P., Valero Logistics, or both of them taken as a whole.
Riverwalk Logistics, L.P., a wholly owned subsidiary of Valero Energy, is the 2%
general partner of Valero L.P. Valero Energy, through various affiliates, is
also a limited partner in Valero L.P., resulting in a combined ownership of
73.6%. The remaining 26.4% limited partnership interest is held by public
unitholders.
Valero Energy is an independent refining and marketing company. Its
operations consist of 12 refineries with a total throughput capacity of
1,900,000 barrels per day and an extensive network of company-operated and
dealer-operated convenience stores. Valero Energy's refining operations rely on
various logistics assets (pipelines, terminals, marine dock facilities, bulk
storage facilities, refinery delivery racks and rail car loading equipment) that
support its refining and retail operations, including the logistics assets owned
and operated by the Partnership. Valero Energy markets the refined products
produced at the McKee, Three Rivers and Ardmore refineries primarily in Texas,
Oklahoma, Colorado, New Mexico, Arizona and several mid-continent states through
a network of company-operated and dealer-operated convenience stores, as well as
through other wholesale and spot market sales and exchange agreements.
THE PARTNERSHIP'S OPERATIONS
The Partnership's operations include interstate and intrastate pipelines,
which are subject to extensive federal and state environmental and safety
regulations. In addition, the tariff rates and practices under which the
Partnership offers interstate and intrastate transportation services in its
pipelines are subject to regulation by the Federal Energy Regulatory Commission
(FERC), the Texas Railroad Commission or the Colorado Public Utility Commission,
depending on the location of the pipeline. Tariff rates and practices for each
pipeline are required to be filed with the respective commission upon completion
of a pipeline and when a tariff rate is being revised. In addition, the
regulations include annual reporting requirements for each pipeline.
The Partnership has an ownership interest in 9 crude oil pipelines with an
aggregate length of approximately 783 miles and 19 refined product pipelines
with an aggregate length of approximately 2,846 miles. In addition, the
Partnership owns a 25-mile crude hydrogen pipeline. The Partnership operates all
but three of the pipelines.
The Partnership also owns 5 crude oil storage facilities with a total
storage capacity of 3,326,000 barrels and 12 refined product terminals
(including the asphalt terminal acquired on January 7, 2003) with a total
storage capacity of 3,192,000 barrels.
F-9
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
BASIS OF PRESENTATION
Prior to July 1, 2000, the Partnership's pipeline, terminalling and storage
assets were owned and operated by Ultramar Diamond Shamrock Corporation (UDS),
and such assets serviced the three refineries discussed above, which were also
owned by UDS at that time. These assets and their related operations are
referred to herein as the Ultramar Diamond Shamrock Logistics Business
(predecessor). Effective July 1, 2000, UDS transferred the Ultramar Diamond
Shamrock Logistics Business, along with certain liabilities, to Shamrock
Logistics Operations, L.P. (Shamrock Logistics Operations), a wholly owned
subsidiary of Shamrock Logistics, L.P. (Shamrock Logistics). Shamrock Logistics
was wholly owned by UDS. On April 16, 2001, Shamrock Logistics closed on an
initial public offering of its common units, which represented 26.4% of its
outstanding partnership interests.
On May 7, 2001, Valero Energy announced that it had entered into an
Agreement and Plan of Merger with UDS whereby UDS agreed to be acquired by
Valero Energy for total consideration of approximately $4.3 billion and the
assumption of approximately $2.0 billion of debt. The acquisition of UDS by
Valero Energy became effective on December 31, 2001. This acquisition included
the acquisition of UDS's majority ownership interest in Shamrock Logistics.
Effective January 1, 2002, Shamrock Logistics changed its name to Valero L.P.,
and Shamrock Logistics Operations changed its name to Valero Logistics.
On February 1, 2002, the Partnership acquired the Wichita Falls Crude Oil
Pipeline and Storage Business (the Wichita Falls Business) from Valero Energy
for $64,000,000.
The accompanying financial statements for the six months ended June 30,
2000, reflect the operations of the Ultramar Diamond Shamrock Logistics Business
(the predecessor to Shamrock Logistics) as if it had existed as a single
separate entity from UDS. The transfer of the Ultramar Diamond Shamrock
Logistics Business to Shamrock Logistics Operations represented a reorganization
of entities under common control and was recorded at historical cost. The
consolidated and combined financial statements for the six months ended December
31, 2000, and for the years ended December 31, 2001 and 2002, represent the
consolidated operations of Valero L.P., formerly known as Shamrock Logistics.
The consolidated balance sheet as of December 31, 2001 has been restated to
reflect the acquisition of the Wichita Falls Business because the Partnership
and the Wichita Falls Business came under the common control of Valero Energy
commencing on that date and thus, represented a reorganization of entities under
common control. Similarly, the statements of income and cash flows for the year
ended December 31, 2002 reflect the operations of the Wichita Falls Business for
the entire year.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation: All interpartnership transactions have been eliminated in
the consolidation of Valero L.P. and its subsidiaries. In addition, the
operations of certain of the crude oil and refined product pipelines and refined
product terminals that are jointly owned with other companies are
proportionately consolidated in the accompanying financial statements.
Use of Estimates: The preparation of financial statements in accordance
with United States generally accepted accounting principles requires management
to make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ from
those estimates. On an ongoing basis, management reviews its estimates,
including those related to commitments, contingencies and environmental
liabilities, based on currently available information. Changes in facts and
circumstances may result in revised estimates.
Cash and Cash Equivalents: All highly liquid investments with an original
maturity of three months or less when purchased are considered to be cash
equivalents.
F-10
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Property, Plant and Equipment: Property, plant and equipment is stated at
cost. Additions to property, plant and equipment, including maintenance and
expansion capital expenditures and capitalized interest, are recorded at cost.
Maintenance capital expenditures represent capital expenditures to replace
partially or fully depreciated assets to maintain the existing operating
capacity of existing assets and extend their useful lives. Expansion capital
expenditures represent capital expenditures to expand the operating capacity of
existing assets, whether through construction or acquisition. Repair and
maintenance expenses associated with existing assets that are minor in nature
and do not extend the useful life of existing assets are charged to operating
expenses as incurred. Depreciation is provided principally using the
straight-line method over the estimated useful lives of the related assets. When
property, plant and equipment is retired or otherwise disposed of, the
difference between the carrying value and the net proceeds is recognized as gain
or loss in the statement of income in the year retired.
Impairment of Long-Lived Assets: Long-lived assets, including property,
plant and equipment and the investment in Skelly-Belvieu Pipeline Company, are
reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount may not be recoverable. The evaluation of
recoverability is performed using undiscounted estimated net cash flows
generated by the related asset. If an asset is deemed to be impaired, the amount
of impairment is determined as the amount by which the net carrying value
exceeds discounted estimated net cash flows.
Goodwill: Goodwill represents the excess of cost over the fair value of
net assets acquired in 1997. The Partnership adopted Financial Accounting
Standards Board (FASB) Statement No. 142, "Goodwill and Other Intangible Assets"
effective January 1, 2002 resulting in the cessation of goodwill amortization
beginning January 1, 2002. For the years ended December 31, 2001 and 2000,
goodwill amortization expense totaled $299,000 and $301,000, respectively, or
approximately $0.02 per unit per year, assuming 19,198,644 common and
subordinated units outstanding. In addition to the cessation of amortization,
Statement No. 142 requires that goodwill be tested initially upon adoption and
annually thereafter to determine whether an impairment has occurred. An
impairment occurs when the carrying amount exceeds the fair value of the
recognized goodwill asset. If impairment has occurred, the difference between
the carrying value and the fair value is recognized as a loss in the statement
of income in that period. Based on the results of the impairment tests performed
upon initial adoption of Statement No. 142 as of January 1, 2002, and the annual
impairment test performed as of October 1, 2002, no impairment had occurred.
Investment in Skelly-Belvieu Pipeline Company, LLC: Formed in 1993, the
Skelly-Belvieu Pipeline Company, LLC (Skelly-Belvieu Pipeline Company) owns a
natural gas liquids pipeline that begins in Skellytown, Texas and extends to
Mont Belvieu, Texas near Houston. Skelly-Belvieu Pipeline Company is owned 50%
by Valero Logistics and 50% by ConocoPhillips (previously Phillips Petroleum
Company). The Partnership accounts for this investment under the equity method
of accounting (see Note 6: Investment in Skelly-Belvieu Pipeline Company).
Deferred Financing Costs: Deferred financing costs are amortized using the
effective interest method.
Environmental Remediation Costs: Environmental remediation costs are
expensed and the associated accrual established when site restoration and
environmental remediation and cleanup obligations are either known or considered
probable and can be reasonably estimated. Accrued liabilities are not discounted
to present value and are not reduced by possible recoveries from third parties;
however, they are net of any recoveries expected from Valero Energy related to
the environmental indemnifications. Environmental costs include initial site
surveys, costs for remediation and restoration and ongoing monitoring costs, as
well as fines, damages and other costs, when estimable. Adjustments to initial
estimates are recorded, from time to time, to reflect changing circumstances and
estimates based upon additional information developed in subsequent periods.
F-11
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Revenue Recognition: Revenues are derived from interstate and intrastate
pipeline transportation, storage and terminalling of refined products and crude
oil. Transportation revenues (based on pipeline tariff rates) are recognized as
refined product or crude oil is transported through the pipelines. In the case
of crude oil pipelines, the cost of the storage operations are included in the
crude oil pipeline tariff rates. Terminalling revenues (based on a terminalling
fee) are recognized as refined products are moved into the terminal and as
additives are blended with refined products (see Note 13: Related Party
Transactions).
Operating Expenses: Operating expenses consist primarily of fuel and power
costs, telecommunication costs, labor costs of pipeline field and support
personnel, maintenance, utilities, insurance and taxes other than income taxes.
Such expenses are recognized as incurred (see Note 13: Related Party
Transactions).
Federal and State Income Taxes: Valero L.P. and Valero Logistics are
limited partnerships and are not subject to federal or state income taxes.
Accordingly, the taxable income or loss of Valero L.P. and Valero Logistics,
which may vary substantially from income or loss reported for financial
reporting purposes, is generally includable in the federal and state income tax
returns of the individual partners. For transfers of publicly held units
subsequent to the initial public offering, Valero L.P. has made an election
permitted by section 754 of the Internal Revenue Code to adjust the common unit
purchaser's tax basis in Valero L.P.'s underlying assets to reflect the purchase
price of the units. This results in an allocation of taxable income and expense
to the purchaser of the common units, including depreciation deductions and
gains and losses on sales of assets, based upon the new unitholder's purchase
price for the common units.
The Wichita Falls Business was included in UDS' (now Valero Energy's)
consolidated federal and state income tax returns. Deferred income taxes were
computed based on recognition of future tax expense or benefits, measured by
enacted tax rates that were attributable to taxable or deductible temporary
differences between financial statement and income tax reporting bases of assets
and liabilities. No recognition will be given to federal or state income taxes
associated with the Wichita Falls Business for financial statement purposes for
periods subsequent to its acquisition by Valero L.P. The deferred income tax
liabilities related to the Wichita Falls Business as of February 1, 2002 were
retained by Valero Energy and were credited to net parent investment upon the
transfer of the Wichita Falls Business to Valero L.P.
For the periods prior to July 1, 2000, the Ultramar Diamond Shamrock
Logistics Business was included in the consolidated federal and state income tax
returns of UDS. Deferred income taxes were computed based on recognition of
future tax expense or benefits, measured by enacted tax rates that were
attributable to taxable or deductible temporary differences between financial
statement and income tax reporting bases of assets and liabilities. The current
portion of income taxes payable prior to July 1, 2000 was due to UDS and has
been included in the net parent investment amount.
Partners' Equity: Effective April 16, 2001, Valero L.P. completed its
initial public offering of common units by selling 5,175,000 common units to the
public. After the offering, outstanding partners' equity included 9,599,322
common units (4,424,322 of which are held by an affiliate of Valero Energy),
9,599,322 subordinated units held by an affiliate of Valero Energy and a 2%
general partner interest held by Riverwalk Logistics, L.P. In addition, Valero
GP, LLC, the general partner of Riverwalk Logistics, L.P. and an affiliate of
Valero Energy, holds 55,250 common units to settle awards of contractual rights
to receive common units previously issued to officers and directors of Valero
GP, LLC. The common units held by the public represent a 26.4% ownership
interest in the Partnership as of December 31, 2002.
Net Parent Investment: The net parent investment as of December 31, 2001
represents the historical cost to Valero Energy, net of deferred income tax
liabilities and certain other accrued liabilities, related to the Wichita Falls
Business. The Wichita Falls Business was consolidated with the Partnership as of
December 31,
F-12
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
2001 due to a reorganization of entities under common control resulting from the
acquisition of the Wichita Falls Business by the Partnership (see Note 1:
Organization, Business and Basis of Presentation).
The net parent investment prior to July 1, 2000, represented a net balance
as the result of various transactions between the Ultramar Diamond Shamrock
Logistics Business and UDS. There were no terms of settlement or interest
charges associated with this balance. The balance was the result of the Ultramar
Diamond Shamrock Logistics Business' participation in UDS's central cash
management program, wherein all of the Ultramar Diamond Shamrock Logistics
Business' cash receipts were remitted to UDS and all cash disbursements were
funded by UDS. Other transactions included intercompany transportation, storage
and terminalling revenues and related expenses, administrative and support
expenses incurred by UDS and allocated to the Ultramar Diamond Shamrock
Logistics Business, and income taxes. In conjunction with the transfer of the
assets and liabilities of the Ultramar Diamond Shamrock Logistics Business to
Shamrock Logistics Operations on July 1, 2000, Shamrock Logistics and Shamrock
Logistics Operations issued limited and general partner interests to various UDS
subsidiaries (see Note 1: Organization, Business and Basis of Presentation).
Income Allocation: The Partnership's net income for each quarterly
reporting period is first allocated to the general partner in an amount equal to
the general partner's incentive distribution declared for the respective
reporting period. The remaining net income is allocated among the limited and
general partners in accordance with their respective 98% and 2% interests,
respectively.
Net Income per Unit Applicable to Limited Partners: The computation of
basic net income per unit applicable to limited partners is based on the
weighted-average number of common and subordinated units outstanding during the
year. Net income per unit applicable to limited partners is computed by dividing
net income applicable to limited partners, after deducting the general partner's
2% interest and incentive distributions, by the weighted-average number of
limited partnership units outstanding. The general partner's incentive
distribution allocation for the year ended December 31, 2002 was $1,103,000 and
there were no incentive distributions for the period April 16 through December
31, 2001. In addition, the Partnership generated sufficient net income such that
the amount of net income allocated to common units was equal to the amount
allocated to the subordinated units.
Segment Disclosures: The Partnership operates in only one segment, the
petroleum pipeline segment of the oil and gas industry.
Derivative Instruments: The Partnership currently does not hold or trade
derivative instruments.
RECENT ACCOUNTING PRONOUNCEMENT
In June 2001, the FASB issued Statement No. 143, "Accounting for Asset
Retirement Obligations." This statement establishes standards for accounting for
an obligation associated with the retirement of a tangible long-lived asset. An
asset retirement obligation should be recognized in the financial statements in
the period in which it meets the definition of a liability as defined in FASB
Concepts Statement No. 6, "Elements of Financial Statements." The amount of the
liability would initially be measured at fair value. Subsequent to initial
measurement, an entity would recognize changes in the amount of the liability
resulting from (a) the passage of time and (b) revisions to either the timing or
amount of estimated cash flows. Statement No. 143 also establishes standards for
accounting for the cost associated with an asset retirement obligation. It
requires that, upon initial recognition of a liability for an asset retirement
obligation, an entity capitalize that cost by recognizing an increase in the
carrying amount of the related long-lived asset. The capitalized asset
retirement cost would then be allocated to expense using a systematic and
rational method. Statement No. 143 will be effective for financial statements
issued for fiscal years beginning after June 15,
F-13
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
2002, with earlier application encouraged. The Partnership is currently
evaluating the impact of adopting this new statement, however, at the present
time does not believe the statement will have a material impact on its financial
position or results of operations.
NOTE 3: INITIAL PUBLIC OFFERING
As discussed in Note 1, on April 16, 2001, Shamrock Logistics completed its
initial public offering of common units, by selling 5,175,000 common units to
the public at $24.50 per unit. Total proceeds before offering costs and
underwriters' commissions were $126,787,000. Concurrent with the closing of the
initial public offering, Shamrock Logistics Operations borrowed $20,506,000
under its existing revolving credit facility. The net proceeds from the initial
public offering and the borrowings under the revolving credit facility were used
to repay the debt due to parent, make a distribution to affiliates of UDS for
reimbursement of previous capital expenditures incurred with respect to the
assets transferred to the Partnership, and for working capital purposes.
A summary of the proceeds received and use of proceeds is as follows (in
thousands):
Proceeds received:
Sale of common units to the public........................ $126,787
Borrowings under the revolving credit facility............ 20,506
--------
Total proceeds......................................... 147,293
--------
Use of proceeds:
Underwriters' commissions................................. 8,875
Professional fees and other costs......................... 6,000
Debt issuance costs....................................... 436
Repayment of debt due to parent........................... 107,676
Reimbursement of capital expenditures..................... 20,517
--------
Total use of proceeds.................................. 143,504
--------
Net proceeds used for working capital and general
partnership purposes...................................... $ 3,789
========
NOTE 4: ACQUISITIONS
BUSINESS ACQUISITION -- WICHITA FALLS BUSINESS
On February 1, 2002, the Partnership acquired the Wichita Falls Business
from Valero Energy for a total cost of $64,000,000, which the Partnership had an
option to purchase pursuant to the Omnibus Agreement between the Partnership and
Valero Energy (see Note 13: Related Party Transactions -- Omnibus Agreement).
The purchase price was funded with borrowings under the Partnership's revolving
credit facility.
The Wichita Falls Business consists of the following assets:
- A 272-mile crude oil pipeline originating in Wichita Falls, Texas and
ending at Valero Energy's McKee refinery in Dumas, Texas. The pipeline
has the capacity to transport 110,000 barrels per day of crude oil
gathered or acquired by Valero Energy at Wichita Falls. The Wichita Falls
crude oil pipeline connects to third party pipelines that originate along
the Texas Gulf Coast.
- Four crude oil storage tanks located in Wichita Falls, Texas with a total
capacity of 660,000 barrels.
F-14
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Since the acquisition of the Wichita Falls Business represented the
transfer of a business between entities under the common control of Valero
Energy, the consolidated balance sheet as of December 31, 2001 and the
statements of income and cash flows for the month ended January 31, 2002
(preceding the acquisition date) have been restated to include the Wichita Falls
Business. The balance sheet of the Wichita Falls Business as of December 31,
2001, which is included in the consolidated balance sheet of the Partnership as
of December 31, 2001, is summarized below, as well as, a reconciliation to the
adjustment recorded when the acquisition was consummated on February 1, 2002.
WICHITA FALLS
BUSINESS
--------------
(IN THOUSANDS)
BALANCE SHEET AS OF DECEMBER 31, 2001:
Property, plant and equipment............................. $ 64,160
Accounts payable and accrued liabilities.................. (131)
Taxes other than income taxes............................. (251)
Deferred income tax liabilities........................... (13,147)
--------
Net parent investment as of December 31, 2001.......... 50,631
Net income for the month ended January 31, 2002............. 650
--------
Adjustment resulting from the acquisition of the Wichita
Falls Business on February 1, 2002..................... $ 51,281
========
The following unaudited pro forma financial information for the year ended
December 31, 2001 assumes that the Wichita Falls Business was acquired on
January 1, 2001 with borrowings under the revolving credit facility.
PRO FORMA YEAR
ENDED
DECEMBER 31, 2001
-----------------
(IN THOUSANDS)
PRO FORMA INCOME STATEMENT INFORMATION:
Revenues.................................................. $117,312
Total costs and expenses.................................. (59,993)
Operating income.......................................... 57,319
Net income................................................ 53,686
Since Shamrock Logistics did not complete its IPO until April 16, 2001, pro
forma net income applicable to the period from April 16, 2001 through December
31, 2001 would have been $41,844,000, of which $41,007,000 would have related to
the limited partners. Pro forma net income per unit applicable to the period
after April 15, 2001 would have been $2.14 per unit.
ASSET ACQUISITIONS
Crude Hydrogen Pipeline Acquisition
In May of 2002, Valero Energy completed the construction of a 30-mile pure
hydrogen pipeline, which originates at Valero Energy's Texas City refinery and
ends at Praxair, Inc.'s La Porte, Texas plant. The total cost to construct the
pipeline was $11,000,000.
F-15
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
On May 29, 2002, the Partnership acquired the 30-mile pure hydrogen
pipeline from Valero Energy for $11,000,000, which was funded with borrowings
under the Partnership's revolving credit facility. The Partnership then
exchanged, on May 29, 2002, this 30-mile pure hydrogen pipeline for Praxair,
Inc.'s 25-mile crude hydrogen pipeline, which originates at BOC's (successor to
Celanese Ltd.) chemical facility in Clear Lake, Texas and ends at Valero
Energy's Texas City refinery in Texas City, Texas, under an exchange agreement
previously negotiated between Valero Energy and Praxair, Inc. In conjunction
with the exchange, the Partnership entered into an operating agreement with
Praxair, Inc. whereby Praxair, Inc. will operate the pipeline for an annual fee
of $92,000, plus reimbursement of repair, replacement and relocation costs.
Valero Energy owns the crude hydrogen transported in the pipeline, and the
transportation services provided by the Partnership to Valero Energy are subject
to a Hydrogen Tolling Agreement. The Hydrogen Tolling Agreement provides that
Valero Energy will pay the Partnership minimum annual revenues of $1,400,000 for
transporting crude hydrogen.
Southlake Refined Product Terminal and Ringgold Crude Oil Storage Facility
Acquisitions
On July 2, 2001, the Partnership acquired the Southlake refined product
terminal located in Dallas, Texas from UDS for $5,600,000, which was funded with
available cash on hand. On December 1, 2001, the Partnership acquired the crude
oil storage facility at Ringgold, Texas from UDS for $5,200,000, which was
funded with borrowings under the revolving credit facility. The Partnership had
options to purchase both of these assets pursuant to the Omnibus Agreement
between the Partnership and UDS.
NOTE 5: PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, at cost, consisted of the following:
ESTIMATED DECEMBER 31,
USEFUL ----------------------
LIVES 2002 2001
--------- --------- ---------
(YEARS) (IN THOUSANDS)
Land.............................................. -- $ 820 $ 820
Land improvements................................. 20 68 68
Buildings......................................... 35 5,647 5,392
Pipeline and equipment............................ 3 - 40 442,681 427,227
Rights of way..................................... 20 - 35 29,860 29,857
Construction in progress.......................... -- 7,863 7,037
--------- ---------
Total........................................... 486,939 470,401
Accumulated depreciation and amortization......... (137,663) (121,389)
--------- ---------
Property, plant and equipment, net.............. $ 349,276 $ 349,012
========= =========
Capitalized interest costs included in property, plant and equipment were
$255,000 and $298,000 for the years ended December 31, 2002 and 2001,
respectively. No interest was capitalized in the six months ended December 31,
2000 or in the six months ended June 30, 2000.
F-16
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6: INVESTMENT IN SKELLY-BELVIEU PIPELINE COMPANY
The Partnership owns a 50% interest in Skelly-Belvieu Pipeline Company,
which is accounted for under the equity method. The following presents
summarized unaudited financial information related to Skelly-Belvieu Pipeline
Company as of December 31, 2002 and 2001, for the years ended December 31, 2002
and 2001 and for the six months ended December 31, 2000 and the six months ended
June 30, 2000:
YEARS ENDED SIX MONTHS ENDED
DECEMBER 31, -----------------------
----------------- DECEMBER 31, JUNE 30,
2002 2001 2000 2000
------- ------- ------------ --------
(IN THOUSANDS)
STATEMENT OF INCOME INFORMATION:
Revenues.................................... $12,849 $12,287 $6,883 $6,902
Income before income tax expense............ 5,605 5,587 3,517 3,469
The Partnership's share of net income....... 3,188 3,179 1,951 1,926
The Partnership's share of distributions.... 3,590 2,874 2,352 2,306
DECEMBER 31,
-----------------
2002 2001
------- -------
(IN THOUSANDS)
BALANCE SHEET INFORMATION:
Current assets.............................................. $ 1,572 $ 1,653
Property, plant and equipment, net.......................... 48,739 50,195
------- -------
Total assets.............................................. $50,311 $51,848
======= =======
Current liabilities......................................... $ 150 $ 111
Members' equity............................................. 50,161 51,737
------- -------
Total liabilities and members' equity..................... $50,311 $51,848
======= =======
The excess of the Partnership's 50% share of members' equity over the
carrying value of its investment is attributable to the step-up in basis to fair
value of the initial contribution to Skelly-Belvieu Pipeline Company. This
excess, which totaled $8,990,000 as of December 31, 2002 and $9,376,000 as of
December 31, 2001, is being accreted into income over 33 years.
NOTE 7: LONG-TERM DEBT
Long-term debt consisted of the following:
DECEMBER 31,
------------------
2002 2001
-------- -------
(IN THOUSANDS)
6.875% senior notes, net of unamortized discount of $300.... $ 99,700 $ --
Port Authority of Corpus Christi note payable............... 9,958 10,122
$120,000,000 revolving credit facility...................... -- 16,000
-------- -------
Total debt................................................ 109,658 26,122
Less current portion........................................ (747) (462)
-------- -------
Long-term debt, less current portion...................... $108,911 $25,660
======== =======
F-17
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The long-term debt repayments are due as follows (in thousands):
2003........................................................ $ 747
2004........................................................ 485
2005........................................................ 524
2006........................................................ 566
2007........................................................ 611
Thereafter.................................................. 106,725
--------
Total repayments.......................................... $109,658
========
Interest payments, excluding related party interest payments, totaled
$1,988,000, $1,559,000, $441,000 and $433,000 for the years ended December 31,
2002 and 2001, the six months ended December 31, 2000 and the six months ended
June 30, 2000, respectively.
Valero L.P. has no operations and its only asset is its investment in
Valero Logistics, which owns and operates the Partnership's pipelines and
terminals. Valero L.P. has fully and unconditionally guaranteed the senior notes
issued by Valero Logistics and any obligations under Valero Logistics' revolving
credit facility.
6.875% SENIOR NOTES
On July 15, 2002, Valero Logistics completed the sale of $100,000,000 of
6.875% senior notes due 2012, issued under the Partnership's shelf registration
statement, for total proceeds of $99,686,000. The net proceeds of $98,207,000,
after deducting underwriters' commissions and offering expenses of $1,479,000,
were used to repay the $91,000,000 outstanding under the revolving credit
facility. The senior notes do not have sinking fund requirements. Interest on
the senior notes is payable semiannually in arrears on January 15 and July 15 of
each year.
The senior notes rank equally with all other existing senior unsecured
indebtedness of Valero Logistics, including indebtedness under the revolving
credit facility. The senior notes contain restrictions on Valero Logistics'
ability to incur secured indebtedness unless the same security is also provided
for the benefit of holders of the senior notes. In addition, the senior notes
limit Valero Logistics' ability to incur indebtedness secured by certain liens
and to engage in certain sale-leaseback transactions. The senior notes are
irrevocably and unconditionally guaranteed on a senior unsecured basis by Valero
L.P. The guarantee by Valero L.P. ranks equally with all of its existing and
future unsecured senior obligations.
At the option of Valero Logistics, the senior notes may be redeemed in
whole or in part at any time at a redemption price, which includes a make-whole
premium, plus accrued and unpaid interest to the redemption date. The senior
notes also include a change-in-control provision, which requires that an
investment grade entity own and control the general partner of Valero L.P. and
Valero Logistics. Otherwise Valero Logistics must offer to purchase the senior
notes at a price equal to 100% of their outstanding principal balance plus
accrued interest through the date of purchase.
$120,000,000 REVOLVING CREDIT FACILITY
On December 15, 2000, Valero Logistics (formerly Shamrock Logistics
Operations) entered into a five-year $120,000,000 revolving credit facility. The
revolving credit facility expires on January 15, 2006 and borrowings under the
revolving credit facility bear interest based on either an alternative base rate
or LIBOR at the option of Valero Logistics. Valero Logistics also incurs a
facility fee on the aggregate commitments of lenders under the revolving credit
facility, whether used or unused. Borrowings under the revolving credit
F-18
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
facility may be used for working capital and general partnership purposes.
Borrowings to fund distributions to unitholders; however, is limited to
$25,000,000 and such borrowings must be reduced to zero for a period of at least
15 consecutive days during each fiscal year. The amounts available to the
Partnership under the revolving credit facility are not subject to a borrowing
base computation; therefore as of December 31, 2002, the entire $120,000,000 was
available.
Borrowings under the revolving credit facility are unsecured and rank
equally with all of Valero Logistics' outstanding unsecured and unsubordinated
debt. The revolving credit facility requires that Valero Logistics maintain
certain financial ratios and includes other restrictive covenants, including a
prohibition on distributions by Valero Logistics if any default, as defined in
the revolving credit facility, exists or would result from the distribution. The
revolving credit facility also includes a change-in-control provision, which
requires that Valero Energy and its affiliates own, directly or indirectly, at
least 20% of Valero L.P.'s outstanding units or at least 100% of Valero L.P.'s
general partner interest and 100% of Valero Logistics' outstanding equity.
Management believes that the Partnership is in compliance with all of these
ratios and covenants.
See Note 17: Subsequent Events -- Amended Revolving Credit Facility for a
discussion of an amendment to this revolving credit facility finalized in March
of 2003.
PORT AUTHORITY OF CORPUS CHRISTI NOTE PAYABLE
The Ultramar Diamond Shamrock Logistics Business previously entered into a
financing agreement with the Port of Corpus Christi Authority of Nueces County,
Texas (Port Authority of Corpus Christi) for the construction of a crude oil
storage facility. The original note totaled $12,000,000 and is due in annual
installments of $1,222,000 through December 31, 2015. Interest on the unpaid
principal balance accrues at a rate of 8% per annum. In conjunction with the
July 1, 2000 transfer of assets and liabilities to the Partnership, the
$10,818,000 outstanding indebtedness owed to the Port Authority of Corpus
Christi was assumed by the Partnership. The land on which the crude oil storage
facility was constructed is leased from the Port Authority of Corpus Christi
(see Note 10: Commitments and Contingencies).
SHELF REGISTRATION STATEMENT
On June 6, 2002, Valero L.P. and Valero Logistics filed a $500,000,000
universal shelf registration statement with the Securities and Exchange
Commission covering the issuance of an unspecified amount of common units or
debt securities or a combination thereof. Valero L.P. may, in one or more
offerings, offer and sell common units representing limited partner interests in
Valero L.P. Valero Logistics may, in one or more offerings, offer and sell its
debt securities, which will be fully and unconditionally guaranteed by Valero
L.P. As a result of the July 2002 senior note offering by Valero Logistics, the
remaining balance under the universal shelf registration statement is
$400,000,000 as of December 31, 2002.
NOTE 8: DEBT DUE TO PARENT
UDS, through various subsidiaries, constructed or acquired the various
crude oil and refined product pipeline, terminalling and storage assets of the
Ultramar Diamond Shamrock Logistics Business. In conjunction with the initial
public offering of common units of Shamrock Logistics, the subsidiaries of UDS
which owned the various assets of the Ultramar Diamond Shamrock Logistics
Business formalized the terms under which certain intercompany accounts and
working capital loans would be settled by executing promissory notes with an
aggregate principal balance of $107,676,000, and this was made effective as of
June 30, 2000. The promissory notes required that the principal be repaid no
later than June 30, 2005 and bear interest at a rate of 8% per annum on the
unpaid balance. Effective July 1, 2000, the $107,676,000 of
F-19
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
debt due to parent was assumed by Shamrock Logistics Operations. Interest
expense accrued and recorded as a reduction of receivable from parent totaled
$4,307,000 for the six months ended December 31, 2000 and $2,513,000 for the
period from January 1, 2001 through April 15, 2001.
Concurrent with the closing of Shamrock Logistics' initial public offering
on April 16, 2001, the Partnership repaid these promissory notes using a portion
of the net proceeds from the initial public offering and borrowings under the
$120,000,000 revolving credit facility (see Note 3: Initial Public Offering).
NOTE 9: ENVIRONMENTAL MATTERS
The Partnership's operations are subject to extensive federal, state and
local environmental laws and regulations. Although the Partnership believes its
operations are in substantial compliance with applicable environmental laws and
regulations, risks of additional costs and liabilities are inherent in pipeline,
terminalling and storage operations, and there can be no assurance that
significant costs and liabilities will not be incurred. Moreover, it is possible
that other developments, such as increasingly stringent environmental laws,
regulations and enforcement policies thereunder, and claims for damages to
property or persons resulting from the operations, could result in substantial
costs and liabilities. Accordingly, the Partnership has adopted policies,
practices and procedures in the areas of pollution control, product safety,
occupational health and the handling, storage, use and disposal of hazardous
materials to prevent material environmental or other damage, and to limit the
financial liability which could result from such events. However, some risk of
environmental or other damage is inherent in pipeline, terminalling and storage
operations, as it is with other entities engaged in similar businesses.
In connection with the transfer of assets and liabilities from the Ultramar
Diamond Shamrock Logistics Business to Shamrock Logistics Operations on July 1,
2000, UDS agreed to indemnify Shamrock Logistics Operations for environmental
liabilities that arose prior to July 1, 2000. In connection with the initial
public offering of Shamrock Logistics, UDS agreed to indemnify Shamrock
Logistics for environmental liabilities that arose prior to April 16, 2001 and
that are discovered within 10 years after April 16, 2001. In conjunction with
the acquisitions of the Southlake refined product terminal on July 2, 2001 and
the Ringgold crude oil storage facility on December 1, 2001, UDS agreed to
indemnify the Partnership for environmental liabilities that arose prior to the
acquisition dates and are discovered within 10 years after acquisition. Excluded
from this indemnification are liabilities that result from a change in
environmental law after April 16, 2001. Effective with the acquisition of UDS,
Valero Energy has assumed these environmental indemnifications. In addition, as
an operator or owner of the assets, the Partnership could be held liable for
pre-acquisition environmental damage should Valero Energy be unable to fulfill
its obligation. However, the Partnership believes that such a situation is
remote given Valero Energy's financial condition.
In conjunction with the sale of the Wichita Falls Business to the
Partnership, Valero Energy agreed to indemnify the Partnership for any
environmental liabilities that arose prior to February 1, 2002 and that are
discovered by April 15, 2011.
Environmental exposures and liabilities are difficult to assess and
estimate due to unknown factors such as the magnitude of possible contamination,
the timing and extent of remediation, the determination of the Partnership's
liability in proportion to other parties, improvements in cleanup technologies
and the extent to which environmental laws and regulations may change in the
future. Although environmental costs may have a significant impact on the
results of operations for any single period, the Partnership believes that such
costs will not have a material adverse effect on its financial position. As of
December 31, 2002, the Partnership has not incurred any material environmental
liabilities that were not covered by the environmental indemnifications.
F-20
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10: COMMITMENTS AND CONTINGENCIES
The Ultramar Diamond Shamrock Logistics Business previously entered into
several agreements with the Port Authority of Corpus Christi including a crude
oil dock user agreement, a land lease agreement and a note agreement. The crude
oil dock user agreement, which renews annually in May, allows the Partnership to
operate and manage a crude oil dock in Corpus Christi. The Partnership shares
use of the crude oil dock with two other users, and operating costs are split
evenly among the three users. The crude oil dock user agreement requires that
the Partnership collect wharfage fees, based on the quantity of barrels
offloaded from each vessel, and dockage fees, based on vessels berthing at the
dock. These fees are remitted to the Port Authority of Corpus Christi monthly.
The wharfage and one-half of the dockage fees that the Partnership pays for the
use of the crude oil dock reduces the annual amount it owes to the Port
Authority of Corpus Christi under the note agreement discussed in Note 7: Long
Term Debt. The wharfage and dockage fees for the Partnership's use of the crude
oil dock totaled $1,092,000, $1,449,000, $692,000 and $698,000 for the years
ended December 31, 2002 and 2001, the six months ended December 31, 2000 and the
six months ended June 30, 2000, respectively.
The Ultramar Diamond Shamrock Logistics Business previously entered into a
refined product dock user agreement, which renews annually in April, with the
Port Authority of Corpus Christi to use a refined product dock. The Partnership
shares use of the refined product dock with one other user, and operating costs
are split evenly between the two users. The refined product dock user agreement
requires that the Partnership collect and remit the wharfage and dockage fees to
the Port Authority of Corpus Christi. The wharfage and dockage fees for the
Partnership's use of the refined product dock totaled $174,000, $166,000,
$86,000 and $114,000 for the years ended December 31, 2002 and 2001, the six
months ended December 31, 2000 and the six months ended June 30, 2000,
respectively.
The crude oil and the refined product docks provide Valero Energy's Three
Rivers refinery access to marine facilities to receive crude oil and deliver
refined products. For the years ended December 31, 2002, 2001 and 2000, the
Three Rivers refinery received 86%, 92% and 93%, respectively, of its crude oil
requirements from crude oil received at the crude oil dock. Also, for each of
the years ended December 31, 2002, 2001 and 2000, 6% of the refined products
produced at the Three Rivers refinery were transported via pipeline to the
Corpus Christi refined product dock.
The Partnership has the following land leases related to refined product
terminals and crude oil storage facilities:
- Corpus Christi crude oil storage facility: a 20-year noncancellable
operating lease on 31.35 acres of land through 2014, at which time the
lease is renewable every five years, for a total of 20 renewable years.
- Corpus Christi refined product terminal: a 5-year noncancellable
operating lease on 5.21 acres of land through 2006, and a 5-year
noncancellable operating lease on 8.42 acres of land through 2007, at
which time the agreements are renewable for at least two five-year
periods.
- Harlingen refined product terminal: a 13-year noncancellable operating
lease on 5.88 acres of land through 2008, and a 30-year noncancellable
operating lease on 9.04 acres of land through 2008.
- Colorado Springs airport terminal: a 50-year noncancellable operating
lease on 46.26 acres of land through 2043, at which time the lease is
renewable for another 50-year period.
All of the Partnership's land leases, including the above leases, require
monthly payments totaling $19,000 and are adjustable every five years based on
changes in the Consumer Price Index.
F-21
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
In addition, the Partnership leases certain equipment and vehicles under
operating lease agreements expiring through 2003. Future minimum rental payments
applicable to noncancellable operating leases as of December 31, 2002, are as
follows (in thousands):
2003........................................................ $ 227
2004........................................................ 226
2005........................................................ 226
2006........................................................ 212
2007........................................................ 186
Thereafter.................................................. 1,422
------
Future minimum lease payments............................. $2,499
======
Rental expense for all operating leases totaled $326,000, $281,000, $53,000
and $203,000 for the years ended December 31, 2002 and 2001, the six months
ended December 31, 2000 and the six months ended June 30, 2000, respectively.
The Partnership is involved in various lawsuits, claims and regulatory
proceedings incidental to its business. In the opinion of management, the
outcome of such matters will not have a material adverse effect on the
Partnership's financial position or results of operations.
NOTE 11: INCOME TAXES
As discussed in "Note 2: Summary of Significant Accounting Policies,"
Valero L.P. and Valero Logistics are limited partnerships and are not subject to
federal or state income taxes. However, the operations of the Ultramar Diamond
Shamrock Logistics Business were subject to federal and state income taxes and
the results of operations prior to July 1, 2000 were included in UDS'
consolidated federal and state income tax returns. The amounts presented below
relate only to the Ultramar Diamond Shamrock Logistics Business prior to July 1,
2000 and were calculated as if the Business filed a separate federal and state
income tax return. The transfer of assets and liabilities from the Ultramar
Diamond Shamrock Logistics Business to Shamrock Logistics Operations was deemed
a change in tax status. Accordingly, the deferred income tax liability as of
June 30, 2000 of $38,217,000 was written off through the statement of income in
the caption, income tax expense (benefit).
Income tax expense (benefit) consisted of the following:
SIX MONTHS
ENDED JUNE 30,
2000
--------------
(IN THOUSANDS)
Current:
Federal................................................... $ 5,132
State..................................................... 733
Deferred:
Federal................................................... 1,415
State..................................................... 125
Write-off of the deferred income tax liability.............. (38,217)
--------
Income tax expense (benefit).............................. $(30,812)
========
F-22
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The differences between the Ultramar Diamond Shamrock Logistics Business'
effective income tax rate and the U.S. federal statutory rate is reconciled as
follows:
SIX MONTHS
ENDED JUNE 30,
2000
--------------
U.S. federal statutory rate................................. 35.0%
State income taxes, net of federal taxes.................... 3.1
Non-deductible goodwill..................................... 0.3
----
Effective income tax rate................................. 38.4%
====
Income taxes paid to UDS totaled $5,865,000 for the six months ended June
30, 2000.
In addition, the Wichita Falls Business was subject to federal and state
income taxes prior to its acquisition on February 1, 2002. The $395,000 of
income tax expense included in the consolidated statement of income for the year
ended December 31, 2002 represents the Wichita Falls Business' income tax
expense for the month ended January 31, 2002, which was calculated as if the
Business filed a separate federal and state income tax return.
NOTE 12: FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
The estimated fair value of the Partnership's fixed rate debt as of
December 31, 2002 and 2001 was $109,922,000 and $11,240,000, respectively, as
compared to the carrying value of $109,658,000 and $10,122,000, respectively.
These fair values were estimated using discounted cash flow analysis, based on
the Partnership's current incremental borrowing rates for similar types of
borrowing arrangements. The Partnership has not utilized derivative financial
instruments related to these borrowings. Interest rates on borrowings under the
revolving credit facility float with market rates and thus the carrying amount
approximates fair value.
Substantially all of the Partnership's revenues are derived from Valero
Energy and its subsidiaries. Valero Energy transports crude oil to three of its
refineries using the Partnership's various crude oil pipelines and storage
facilities and transports refined products to its company-owned retail
operations or wholesale customers using the Partnership's various refined
product pipelines and terminals. Valero Energy and its subsidiaries are
investment grade customers; therefore, the Partnership does not believe that the
trade receivable from Valero Energy represents a significant credit risk.
However, the concentration of business with Valero Energy, which is a large
refining and retail marketing company, has the potential to impact the
Partnership's overall exposure, both positively and negatively, to changes in
the refining and marketing industry.
NOTE 13: RELATED PARTY TRANSACTIONS
The Partnership has related party transactions with Valero Energy for
pipeline tariff and terminalling fee revenues, certain employee costs, insurance
costs, administrative costs and interest expense (for the period from July 1,
2000 through April 15, 2001) on the debt due to parent. The receivable from
parent as of December 31, 2002 and 2001 represents the net amount due from
Valero Energy for these related party transactions and the net cash collected
under Valero Energy's centralized cash management program on the Partnership's
behalf.
F-23
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes transactions with Valero Energy:
YEARS ENDED SIX MONTHS SIX MONTHS
DECEMBER 31, ENDED ENDED
------------------ DECEMBER 31, JUNE 30,
2002 2001 2000 2000
-------- ------- ------------ -----------
(IN THOUSANDS)
Revenues................................. $117,804 $98,166 $47,210 $44,187
Operating expenses....................... 13,795 11,452 5,718 5,393
General and administrative expenses...... 5,921 5,200 2,600 2,839
Interest expense on debt due to parent... -- 2,513 4,307 --
SERVICES AGREEMENT
Effective July 1, 2000, UDS entered into a Services Agreement with the
Partnership, whereby UDS agreed to provide the corporate functions of legal,
accounting, treasury, engineering, information technology and other services for
an annual fee of $5,200,000 for a period of eight years. The $5,200,000 is
adjustable annually based on the Consumer Price Index published by the U.S.
Department of Labor, and may also be adjusted to take into account additional
service levels necessitated by the acquisition or construction of additional
assets. Concurrent with the acquisition of UDS by Valero Energy, Valero Energy
became the obligor under the Services Agreement. Management believes that the
$5,200,000 is a reasonable approximation of the general and administrative costs
related to the pipeline, terminalling and storage operations. This annual fee is
in addition to the incremental general and administrative costs to be incurred
from third parties for services Valero Energy does not provide under the
Services Agreement (see Note 14: Employee Benefit Plans).
The Services Agreement also requires that the Partnership reimburse Valero
Energy for various recurring costs of employees who work exclusively within the
pipeline, terminalling and storage operations and for certain other costs
incurred by Valero Energy relating solely to the Partnership. These employee
costs include salary, wage and benefit costs.
Prior to July 1, 2000, UDS allocated approximately 5% of its general and
administrative expenses incurred in the United States to its pipeline,
terminalling and storage operations to cover costs of centralized corporate
functions and other corporate services. A portion of the allocated general and
administrative costs is passed on to third parties, which jointly own certain
pipelines and terminals with the Partnership. The net amount of general and
administrative costs allocated to partners of jointly owned pipelines totaled
$661,000, $581,000, $251,000 and $249,000 for the years ended December 31, 2002
and 2001, the six months ended December 31, 2000 and the six months ended June
30, 2000, respectively.
PIPELINES AND TERMINALS USAGE AGREEMENT
On April 16, 2001, UDS entered into a Pipelines and Terminals Usage
Agreement with the Partnership, whereby UDS agreed to use the Partnership's
pipelines to transport at least 75% of the crude oil shipped to and at least 75%
of the refined products shipped from Valero Energy's McKee, Three Rivers and
Ardmore refineries and to use the Partnership's refined product terminals for
terminalling services for at least 50% of all refined products shipped from
these refineries until at least April of 2008. Valero Energy also assumed the
obligation under the Pipelines and Terminals Usage Agreement in connection with
the acquisition of UDS by Valero Energy. For the year ended December 31, 2002,
Valero Energy used the Partnership's pipelines to transport 97% of its crude oil
shipped to and 80% of the refined products shipped from the McKee, Three
F-24
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Rivers and Ardmore refineries, and Valero Energy used the Partnership's
terminalling services for 59% of all refined products shipped from these
refineries.
If market conditions change with respect to the transportation of crude oil
or refined products, or to the end markets in which Valero Energy sells refined
products, in a material manner such that Valero Energy would suffer a material
adverse effect if it were to continue to use the Partnership's pipelines and
terminals at the required levels, Valero Energy's obligation to the Partnership
will be suspended during the period of the change in market conditions to the
extent required to avoid the material adverse effect.
OMNIBUS AGREEMENT
The Omnibus Agreement governs potential competition between Valero Energy
and the Partnership. Under the Omnibus Agreement, Valero Energy has agreed, and
will cause its controlled affiliates to agree, for so long as Valero Energy and
its affiliates control the general partner, not to engage in the business of
transporting crude oil or refined products including petrochemicals or operating
crude oil storage facilities or refined product terminals in the United States.
This restriction does not apply to:
- any business retained by UDS (and now part of Valero Energy) as of April
16, 2001, the closing of the Partnership's initial public offering, or
owned by Valero Energy at the date of its acquisition of UDS on December
31, 2001;
- any business with a fair market value of less than $10 million;
- any business acquired by Valero Energy that constitutes less than 50% of
the fair market value of a larger acquisition, provided the Partnership
has been offered and declined the opportunity to purchase the business;
and
- any newly constructed logistics assets that the Partnership has not
offered to purchase at fair market value within one year of construction.
Also under the Omnibus Agreement, Valero Energy has agreed to indemnify the
Partnership for environmental liabilities related to the assets transferred to
the Partnership in connection with the Partnership's initial public offering,
provided that such liabilities arose prior to and are discovered within 10 years
after that date (excluding liabilities resulting from a change in law after
April 16, 2001).
NOTE 14: EMPLOYEE BENEFIT PLANS
The Partnership, which has no employees, relies on employees of Valero
Energy and its affiliates to provide the necessary services to operate the
Partnership's assets. The Valero Energy employees who operate the Partnership's
assets are included in the various employee benefit plans of Valero Energy and
its affiliates. These plans include qualified, non-contributory defined benefit
retirement plans, defined contribution 401(k) plans, employee and retiree
medical, dental and life insurance plans, long-term incentive plans (i.e. unit
options and bonuses) and other such benefits.
The Partnership's share of allocated Valero Energy employee benefit plan
expenses, excluding the compensation expense related to the contractual rights
to receive common units, was $1,698,000, $1,346,000, $662,000 and $702,000 for
the years ended December 31, 2002 and 2001, the six months ended December 31,
2000 and the six months ended June 30, 2000, respectively. These employee
benefit plan expenses are included in operating expenses with the related
payroll costs.
F-25
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
LONG-TERM INCENTIVE PLAN
The Board of Directors of Valero GP, LLC, a wholly owned subsidiary of
Valero Energy and the general partner of Riverwalk Logistics, L.P., previously
adopted the "2000 Long-Term Incentive Plan" (the LTIP) under which Valero GP,
LLC may award up to 250,000 common units to certain key employees of Valero
Energy's affiliates providing services to Valero L.P. and to directors and
officers of Valero GP, LLC. Awards under the LTIP can include unit options,
restricted common units, distribution equivalent rights (DERs), contractual
rights to receive common units, etc.
Under the LTIP, in July of 2001, Valero GP, LLC granted 205 restricted
common units and DERs to each of its then two outside directors. The restricted
common units were to vest at the end of a three-year period and be paid in cash.
The DERs were to accumulate equivalent distributions that other Valero L.P.
unitholders receive over the vesting period. For the year ended December 31,
2001, the Partnership recognized $2,000 of compensation expense associated with
these restricted common units and DERs, which is included in other long-term
liabilities as of December 31, 2001. As a result of the change in control
related to Valero Energy's acquisition of UDS on December 31, 2001, the
restricted common units vested and the accrued amounts were paid to the
directors.
In January of 2002, under the LTIP, Valero GP, LLC granted 55,250
contractual rights to receive common units and DERs to its officers, certain
employees of its affiliates and its outside directors. In conjunction with the
grant of contractual rights to receive common units under the LTIP, Valero L.P.
issued 55,250 common units to Valero GP, LLC on January 21, 2002 for total
consideration of $2,262,000 (based on the then $40.95 market price per common
unit), the receivable for which is classified in equity in the consolidated
balance sheet as of December 31, 2002.
One-third of the contractual rights to receive common units awarded by
Valero GP, LLC will vest at the end of each year of a three-year vesting period.
Accordingly, the Partnership recognized $721,000 of compensation expense
associated with these contractual rights to receive common units for the year
ended December 31, 2002, including $11,000 related to payroll taxes.
NOTE 15: PARTNERS' EQUITY, ALLOCATIONS OF NET INCOME AND CASH DISTRIBUTIONS
PARTNERS' EQUITY
In addition to common units, Valero L.P. has issued and outstanding
subordinated units that are held by UDS Logistics, LLC, a wholly owned
subsidiary of Valero Energy and the limited partner of Riverwalk Logistics,
L.P., and there is no established public market for their trading.
In addition, all of the subordinated units may convert to common units on a
one-for-one basis on the first day following the record date for distributions
for the quarter ending December 31, 2005, if Valero L.P. meets the tests set
forth in the partnership agreement. If the subordination period ends, the rights
of the holders of subordinated units will no longer be subordinated to the
rights of the holders of common units and the subordinated units may be
converted into common units.
ALLOCATIONS OF NET INCOME
Valero L.P.'s partnership agreement, as amended, sets forth the calculation
to be used to determine the amount and priority of cash distributions that the
common unitholders, subordinated unitholders and general partner will receive.
The partnership agreement also contains provisions for the allocation of net
income and loss to the unitholders and the general partner. For purposes of
maintaining partner capital accounts, the partnership agreement specifies that
items of income and loss shall be allocated among the partners in
F-26
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
accordance with their respective percentage interests. Normal allocations
according to percentage interests are done after giving effect, if any, to
priority income allocations in an amount equal to incentive cash distributions
allocated 100% to the general partner.
CASH DISTRIBUTIONS
During the subordination period, the holders of the common units are
entitled to receive each quarter a minimum quarterly distribution of $0.60 per
unit ($2.40 annualized) prior to any distribution of available cash to holders
of the subordinated units. The subordination period is defined generally as the
period that will end on the first day of any quarter beginning after March 31,
2006 if (1) Valero L.P. has distributed at least the minimum quarterly
distribution on all outstanding units with respect to each of the immediately
preceding three consecutive, non-overlapping four-quarter periods and (2) Valero
L.P.'s adjusted operating surplus, as defined in the partnership agreement,
during such periods equals or exceeds the amount that would have been sufficient
to enable Valero L.P. to distribute the minimum quarterly distribution on all
outstanding units on a fully diluted basis and the related distribution on the
2% general partner interest during those periods.
During the subordination period, Valero L.P.'s cash is distributed first
98% to the holders of common units and 2% to the general partner until there has
been distributed to the holders of common units an amount equal to the minimum
quarterly distribution and arrearages in the payment of the minimum quarterly
distribution on the common units for any prior quarter. Secondly, cash is
distributed 98% to the holders of subordinated units and 2% to the general
partner until there has been distributed to the holders of subordinated units an
amount equal to the minimum quarterly distribution. Thirdly, cash in excess of
the minimum quarterly distributions is distributed to the unitholders and the
general partner based on the percentages shown below.
The general partner is entitled to incentive distributions if the amount
Valero L.P. distributes with respect to any quarter exceeds specified target
levels shown below:
PERCENTAGE OF
DISTRIBUTION
---------------------
GENERAL
QUARTERLY DISTRIBUTION AMOUNT PER UNIT UNITHOLDERS PARTNER
-------------------------------------- ----------- -------
Up to $0.60................................................. 98% 2%
Above $0.60 up to $0.66..................................... 90% 10%
Above $0.66 up to $0.90..................................... 75% 25%
Above $0.90................................................. 50% 50%
F-27
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The following table reflects the allocation of total cash distributions to
the general and limited partners applicable to the period in which the
distributions are earned:
YEAR ENDED APRIL 16 THROUGH
DECEMBER 31, DECEMBER 31,
2002 2001
------------ ----------------
(IN THOUSANDS, EXCEPT
PER UNIT DATA)
General partner interest................................. $ 1,103 $ 667
General partner incentive distribution................... 1,103 --
------- -------
Total general partner distribution..................... 2,206 667
Limited partnership units................................ 52,969 32,692
------- -------
Total cash distributions............................... $55,175 $33,359
======= =======
Total cash distributions per unit applicable to
partners............................................... $ 2.75 $ 1.70
======= =======
NOTE 16: QUARTERLY FINANCIAL DATA (UNAUDITED)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER TOTAL
------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER UNIT DATA)
2002:
Revenues............................ $26,024 $30,030 $32,161 $30,243 $118,458
Operating income.................... 10,696 14,891 15,845 15,798 57,230
Net income(1)....................... 10,423 14,939 14,950 14,831 55,143
Net income per unit applicable to
limited partners.................. 0.50 0.76 0.72 0.74 2.72
Cash distributions per unit
applicable to limited partners.... 0.65 0.70 0.70 0.70 2.75
2001:
Revenues............................ $23,422 $23,637 $26,857 $24,911 $ 98,827
Operating income.................... 10,361 10,319 13,430 12,395 46,505
Net income.......................... 8,786 10,356 13,771 12,960 45,873
Net income per unit applicable to
limited partners(2)............... -- 0.46 0.70 0.66 1.82
Pro forma net income per unit
applicable to limited
partners(3)....................... 0.45 0.53 0.70 0.66 2.34
Cash distributions per unit
applicable to limited
partners(2)....................... -- 0.50 0.60 0.60 1.70
---------------
(1) Net income for the first quarter of 2002 includes $650,000 (net of income
taxes of $395,000) for the Wichita Falls Business for the month ended
January 31, 2002, which was allocated entirely to the general partner.
(2) Net income and cash distributions for the first quarter of 2001 and through
April 15, 2001 were allocated entirely to the general partner. Net income
per unit applicable to limited partners and cash distributions per unit
applicable to limited partners for the second quarter of 2001 are based on
net income and cash distributions from April 16, 2001 through June 30, 2001.
F-28
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(3) Pro forma net income per unit applicable to limited partners for 2001 is
determined by dividing net income that would have been allocated to the
common and subordinated unitholders, which is 98% of net income, by the
weighted average number of common and subordinated units outstanding for the
period from April 16, 2001 through December 31, 2001. The 2% general partner
allocation of pro forma net income did not assume the effect of incentive
distributions as none were declared in 2001.
NOTE 17: SUBSEQUENT EVENTS
ACQUISITION OF TELFER ASPHALT TERMINAL AND STORAGE FACILITY
On January 7, 2003, the Partnership completed its acquisition of Telfer Oil
Company's (Telfer) California asphalt terminal and storage facility for
$15,000,000. The asphalt terminal and storage facility assets include two
storage tanks with a combined storage capacity of 350,000 barrels, six
5,000-barrel polymer modified asphalt tanks, a truck rack, rail facilities and
various other tanks and equipment. In conjunction with the Telfer asset
acquisition, the Partnership entered into a six-year Terminal Storage and
Throughput Agreement with Valero Energy. The agreement includes (a) a lease of
the asphalt storage tanks and related equipment for a monthly fee of $0.60 per
barrel of storage capacity, (b) the right to move asphalt through the terminal
during the term of the Terminal Storage and Throughput Agreement in
consideration for $1.25 per barrel of throughput with a guaranteed minimum
annual throughput of 280,000 barrels, and (c) reimbursement to the Partnership
of certain costs, including utilities.
The Partnership will account for the Telfer acquisition as a purchase of a
business in accordance with FASB Statement No. 141 and allocate the purchase
price to the individual asset and liabilities acquired based on their fair value
on January 7, 2003. A portion of the purchase price represented payment to the
principal owner of Telfer for a non-compete agreement and for the lease of
certain facilities adjacent to the terminal operations.
UNITS ISSUED UNDER LTIP
On January 24, 2003, under the LTIP, Valero GP, LLC granted 30,000
contractual rights to receive common units and DERs to its officers and
directors, excluding the outside directors. In conjunction with the grant of
contractual rights to receive common units under the LTIP, Valero GP, LLC
purchased 30,000 newly issued Valero L.P. common units from Valero L.P. for
total consideration of $1,149,000. Also in January of 2003, one-third of the
previously issued contractual rights vested and Valero GP, LLC distributed
actual Valero L.P. common units to the officers and directors. Certain of the
officers and directors settled their tax withholding on the vested common units
by delivering 6,491 common units to Valero GP, LLC. As of February 1, 2003,
Valero GP, LLC owns 73,319 common units of Valero L.P.
DISTRIBUTIONS
On January 24, 2003, the Partnership declared a quarterly distribution of
$0.70 per unit payable on February 14, 2003 to unitholders of record on February
5, 2003. This distribution related to the fourth quarter of 2002 and totaled
$14,121,000, of which $622,000 represented the general partner's share of such
distribution. The general partner's distribution included a $340,000 incentive
distribution.
INTEREST RATE SWAP
On February 14, 2003, Valero Logistics entered into an interest rate swap
agreement to manage its exposure to changes in interest rates. The interest rate
swap has a notional amount of $60,000,000 and is tied to the maturity of the
6.875% senior notes. Under the terms of the interest rate swap agreement, the
F-29
VALERO L.P. AND SUBSIDIARIES
(FORMERLY SHAMROCK LOGISTICS, L.P. AND SUBSIDIARY)
(SUCCESSOR TO THE ULTRAMAR DIAMOND SHAMROCK LOGISTICS BUSINESS)
NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Partnership will receive a fixed 6.875% rate and will pay a floating rate based
on LIBOR plus 2.45%. The Partnership will account for the interest rate swap as
a fair value hedge, with changes in the fair value recorded as an adjustment to
interest expense in the consolidated statement of income.
AMENDED REVOLVING CREDIT FACILITY
On March 6, 2003, Valero Logistics entered into an amended revolving credit
facility with the various banks included in the existing facility and from a
group of new banks to increase the revolving credit facility to $175,000,000. In
addition to increasing the aggregate amount available under the facility, the
amount that may be borrowed to fund distributions to unitholders was increased
from $25,000,000 to $40,000,000. No other significant terms and conditions of
the revolving credit facility were changed, except that the "Total Debt to
EBITDA Ratio" as defined in the revolving credit facility was changed such that
the ratio may not exceed 4.0 to 1.0 (as opposed to 3.0 to 1.0 in the original
facility), and Valero L.P. is now irrevocably and unconditionally guaranteeing
the revolving credit facility. This guarantee by Valero L.P. ranks equally with
all of its existing and future unsecured senior obligations.
REDEMPTION OF COMMON UNITS AND AMENDMENT TO THE PARTNERSHIP AGREEMENT
Valero L.P. intends to redeem from UDS Logistics a number of Valero L.P.
common units sufficient to reduce Valero Energy's aggregate ownership interest
in Valero L.P. to 49.5% or less, including Riverwalk Logistics' 2% general
partner interest. Valero L.P. intends to redeem the common units with the
proceeds from debt financings, which are expected to be completed in the first
quarter of 2003.
In addition to the redemption of common units, Valero L.P. intends to amend
its partnership agreement to provide that the general partner may be removed by
the vote of the holders of at least 58% of its outstanding units, excluding the
common and subordinated units held by affiliates of the general partner.
ASSET CONTRIBUTION TRANSACTIONS
On March 6, 2003, the Partnership entered into the following contribution
agreements:
- Affiliates of Valero Energy intend to contribute to the Partnership
certain crude oil and other feedstock tank assets located at Valero
Energy's West plant of the Corpus Christi refinery, Texas City refinery
and Benicia refinery to Valero Logistics in exchange for an aggregate
amount of $200,000,000 in cash; and
- Affiliates of Valero Energy intend to contribute to the Partnership
certain refined product pipelines and refined product terminals connected
to Valero Energy's Corpus Christi and Three Rivers refineries (referred
to as the South Texas Pipelines and Terminals) in exchange for an
aggregate amount of $150,000,000 in cash.
The contribution transactions are expected to be completed in March 2003
and are conditioned upon the ability of the Partnership to obtain equity and
debt financing in sufficient amounts.
F-30
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
Valero Energy Corporation
We have audited the accompanying balance sheet of the Valero South Texas
Pipeline and Terminal Business as of December 31, 2002, and the related
statements of income, cash flows, and changes in net parent investment for the
year then ended. These financial statements are the responsibility of Valero
Energy Corporation's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Valero South Texas
Pipeline and Terminal Business as of December 31, 2002 and the results of its
operations and its cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
San Antonio, Texas
March 6, 2003
F-31
VALERO SOUTH TEXAS PIPELINE AND TERMINAL BUSINESS
BALANCE SHEET
DECEMBER 31,
2002
--------------
(IN THOUSANDS)
ASSETS
CURRENT ASSETS:
Accounts receivable....................................... $ 300
Other current assets...................................... 1,370
--------
TOTAL CURRENT ASSETS................................... 1,670
--------
Property, plant and equipment............................... 112,873
Less accumulated depreciation and amortization.............. (5,367)
--------
Property, plant and equipment, net........................ 107,506
--------
TOTAL ASSETS........................................... $109,176
========
LIABILITIES AND NET PARENT INVESTMENT
CURRENT LIABILITIES:
Accounts payable and accrued liabilities.................. $ 3,243
Taxes other than income taxes............................. 322
--------
TOTAL CURRENT LIABILITIES.............................. 3,565
Long-term capital lease obligation.......................... 99,280
Deferred income tax liabilities............................. 16,703
Net parent investment....................................... (10,372)
--------
TOTAL LIABILITIES AND NET PARENT INVESTMENT............ $109,176
========
See accompanying notes to the financial statements.
F-32
VALERO SOUTH TEXAS PIPELINE AND TERMINAL BUSINESS
STATEMENT OF INCOME
YEAR ENDED
DECEMBER 31,
2002
--------------
(IN THOUSANDS)
REVENUES.................................................... $27,897
-------
COSTS AND EXPENSES:
Operating expenses........................................ 15,780
General and administrative expenses....................... 820
Depreciation and amortization............................. 3,390
-------
TOTAL COSTS AND EXPENSES............................... 19,990
-------
OPERATING INCOME............................................ 7,907
Interest expense.......................................... (7,743)
-------
INCOME BEFORE INCOME TAX EXPENSE............................ 164
Income tax expense........................................ 66
-------
NET INCOME.................................................. $ 98
=======
See accompanying notes to the financial statements.
F-33
VALERO SOUTH TEXAS PIPELINE AND TERMINAL BUSINESS
STATEMENT OF CASH FLOWS
YEAR ENDED
DECEMBER 31,
2002
--------------
(IN THOUSANDS)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................. $ 98
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................. 3,390
Accretion of capital lease obligation..................... 1,457
Deferred income taxes..................................... 66
Changes in operating assets and liabilities:
Decrease in accounts receivable........................ 642
Decrease in other current assets....................... 104
Increase in accounts payable and accrued liabilities... 1,015
Increase in taxes other than income taxes.............. 243
-------
NET CASH PROVIDED BY OPERATING ACTIVITIES......... 7,015
-------
CASH FLOWS FROM INVESTING ACTIVITIES:
Maintenance capital expenditures............................ (843)
Expansion capital expenditures.............................. (1,235)
-------
NET CASH USED IN INVESTING ACTIVITIES............. (2,078)
-------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net cash repayments to parent............................... (4,937)
-------
NET CASH USED IN FINANCING ACTIVITIES............. (4,937)
-------
NET INCREASE IN CASH........................................ --
CASH AT BEGINNING OF PERIOD................................. --
-------
CASH AT END OF PERIOD....................................... $ --
=======
INTEREST PAID............................................... $ 6,286
=======
See accompanying notes to the financial statements.
F-34
VALERO SOUTH TEXAS PIPELINE AND TERMINAL BUSINESS
STATEMENT OF CHANGES IN NET PARENT INVESTMENT
YEAR ENDED
DECEMBER 31,
2002
--------------
(IN THOUSANDS)
BALANCE AS OF JANUARY 1, 2002............................... $ (5,533)
Net income................................................ 98
Net cash repayments to parent............................. (4,937)
--------
BALANCE AS OF DECEMBER 31, 2002............................. $(10,372)
========
See accompanying notes to the financial statements.
F-35
VALERO SOUTH TEXAS PIPELINE AND TERMINAL BUSINESS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2002
NOTE 1: BUSINESS DESCRIPTION
Valero Energy Corporation (Valero Energy), through capital lease agreements
entered into with certain wholly owned subsidiaries of El Paso Corporation (El
Paso) effective June 1, 2001, leases and operates certain pipeline and terminal
assets in south Texas, referred to herein as the South Texas Pipeline and
Terminal Business (the Business). The Business is comprised of three intrastate
common carrier pipelines and related terminalling assets. The three pipeline
systems connect Valero Energy's refineries in Corpus Christi and Three Rivers,
Texas to the Houston, San Antonio and Rio Grande Valley, Texas markets. Each of
the three pipelines are subject to regulation by the Texas Railroad Commission.
These regulations include rate regulations, which govern the tariff rates
charged to pipeline customers for transportation through a pipeline. Tariff
rates for each pipeline are required to be filed with the Texas Railroad
Commission upon completion of a pipeline and when a tariff is being revised. In
addition, the regulations include annual reporting requirements for each
pipeline.
The Business consists of the following assets:
- The Houston Pipeline, a 204-mile pipeline originating in Corpus Christi,
Texas and ending in the Houston ship channel area of Pasadena, Texas. The
pipeline has the capacity to transport 105,000 barrels per day of refined
product produced at Valero's Corpus Christi refinery and third party
refineries located in Corpus Christi.
- The San Antonio pipeline which is comprised of two segments: the north
segment, which runs from Pettus, Texas to San Antonio and the south
segment which runs from Pettus, Texas to Corpus Christi. The north
segment is 74 miles long and has a capacity of 24,000 barrels per day.
This segment ends in San Antonio at the San Antonio terminal. The south
segment is 60 miles long and has a capacity of 15,000 barrels per day and
ends at Valero Energy's Corpus Christi refinery.
- The Valley Pipeline, a 130-mile pipeline originating in Corpus Christi
and ending at Edinburg, Texas. The pipeline has the capacity to transport
27,100 barrels per day of refined products produced at Valero's Corpus
Christi refinery.
- A terminal located near Victoria, Texas with a storage capacity of 98,000
barrels.
- A terminal located in San Antonio, Texas with a storage capacity of
148,200 barrels.
- A terminal located in Edinburg, Texas with a storage capacity of 184,600
barrels.
- Three terminals located in Houston, Texas with a total capacity of
212,900 barrels of refined product storage and 75,000 barrels of asphalt
storage.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: These audited financial statements have been
prepared in accordance with United States generally accepted accounting
principles and include all adjustments considered necessary for a fair
presentation. The financial statements represent a carve-out financial statement
presentation of the operations of the Business and reflect Valero Energy's
historical cost basis as of and for the year ended December 31, 2002.
On February 27, 2003, Valero Energy's Board of Directors approved the
contribution of certain assets and liabilities of the Business to Valero L.P., a
publicly traded limited partnership in which Valero Energy currently owns an
approximate 73.6% interest, in exchange for a cash amount of $150 million. These
financial statements do not include any adjustments that might result from the
transfer of the Business.
F-36
VALERO SOUTH TEXAS PIPELINE AND TERMINAL BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The financial statements include allocations and estimates of direct and
indirect Valero Energy general and administrative costs attributable to the
operations of the Business. In addition, the majority of the Business' revenues
are derived from transportation services provided to Valero Energy, the
Business' primary customer. Management believes that the assumptions, estimates
and allocations used to prepare these financial statements are reasonable.
However, the allocations may not necessarily be indicative of the costs and
expenses that would have resulted if the Business had been operated as a
separate entity.
The Business' results of operations may be affected by seasonal factors,
such as the demand for petroleum products, which vary during the year, or
industry factors that may be specific to a particular period, such as industry
supply capacity and refinery turnarounds.
Use of Estimates: The preparation of financial statements in accordance
with United States generally accepted accounting principles requires management
to make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ from
those estimates. On an ongoing basis, management reviews their estimates based
on currently available information. Changes in facts and circumstances may
result in revised estimates.
Property, Plant and Equipment: Property, plant and equipment is stated at
cost. Additions to property, plant and equipment, including maintenance and
expansion capital expenditures and capitalized interest, are recorded at cost.
Maintenance capital expenditures represent capital expenditures to replace
partially or fully depreciated assets to maintain the existing operating
capacity of existing assets and extend their useful lives. Expansion capital
expenditures represent capital expenditures to expand the operating capacity of
existing assets, whether through construction or acquisition. Repair and
maintenance expenses associated with existing assets that are minor in nature
and do not extend the useful life of existing assets are charged to operating
expenses as incurred. Depreciation and amortization is provided principally
using the straight-line method over the estimated useful lives of the related
assets.
Impairment of Long-Lived Assets: Long-lived assets are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. The evaluation of recoverability is
performed using undiscounted estimated net cash flows generated by the related
asset. If an asset is deemed to be impaired, the amount of impairment is
determined as the amount by which the net carrying value exceeds discounted
estimated net cash flows.
Environmental Remediation Costs: Environmental remediation costs are
expensed and an associated accrual established when site restoration and
environmental remediation and cleanup obligations are either known or considered
probable and can be reasonably estimated. Accrued liabilities are not discounted
to present value and are not reduced by possible recoveries from third parties.
Environmental costs include initial site surveys, costs for remediation and
restoration, and ongoing monitoring costs, as well as fines, damages and other
costs, when estimable. Adjustments to initial estimates are recorded, from time
to time, to reflect changing circumstances and estimates based upon additional
information developed in subsequent periods. See Note 8 regarding certain
environmental liabilities retained by El Paso and Valero Energy.
Net Parent Investment: The net parent investment represents a net balance
as the result of various transactions between the Business and Valero Energy.
The balance is the result of the Business' participation in Valero Energy's
centralized cash management program under which all of the Business' cash
receipts were remitted to and all cash disbursements were funded by Valero
Energy. Other transactions affecting the net parent investment include
intercompany transportation and terminalling revenues and related expenses,
administrative and support expenses incurred by Valero Energy and allocated to
the Business, and income taxes. There are no terms of settlement or interest
charges associated with the net parent investment balance.
Revenue Recognition: Revenues are derived from pipeline transportation and
terminalling of refined products. Transportation revenues (based on pipeline
tariff rates) are recognized as refined products are transported through the
pipeline. Rate regulations govern the tariff rates charged to pipeline
customers.
F-37
VALERO SOUTH TEXAS PIPELINE AND TERMINAL BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Terminalling revenues are recognized as refined products are moved out of the
terminal and as additives are blended with refined products.
Operating Expenses: Operating expenses consist primarily of fuel and power
costs, telecommunication costs, labor costs of pipeline field and support
personnel, maintenance, utilities and insurance. Such expenses are recognized as
incurred.
Federal and State Income Taxes: Income taxes are accounted for under the
asset and liability method. Under this method, deferred income tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred amounts are measured
using enacted tax rates expected to apply to taxable income in the year those
temporary differences are expected to be recovered or settled.
Historically, the Business' results have been included in the consolidated
federal income tax returns filed by Valero Energy and have been included in
state income tax returns of subsidiaries of Valero Energy. The income tax
provision in the statement of income represents the current and deferred income
taxes that would have resulted if the Business were a stand-alone taxable entity
filing its own income tax returns. Accordingly, the calculations of the income
tax provision and deferred income taxes necessarily require certain assumptions,
allocations and estimates which management believes are reasonable to reflect
the tax reporting for the Business as a stand-alone taxpayer.
Interest Expense: Interest expense consists of interest incurred on
capital lease obligations.
Comprehensive Income: The Business has reported no comprehensive income
due to the absence of items of other comprehensive income in the period
presented.
Segment Disclosures: The Business operates in only one segment, the
petroleum pipeline segment of the oil and gas industry.
Derivative Instruments and Hedging Activities: The Business currently does
not hold or trade derivative instruments.
NEW ACCOUNTING PRONOUNCEMENT
In June 2001, the Financial Accounting Standards Board issued Statement No.
143, "Accounting for Asset Retirement Obligations." This statement establishes
standards for accounting for an obligation associated with the retirement of a
tangible long-lived asset. An asset retirement obligation should be recognized
in the financial statements in the period in which it meets the definition of a
liability as defined in FASB Concepts Statement No. 6, "Elements of Financial
Statements." The amount of the liability would initially be measured at fair
value. Subsequent to initial measurement, an entity would recognize changes in
the amount of the liability resulting from (a) the passage of time and (b)
revisions to either the timing or amount of estimated cash flows. Statement No.
143 also establishes standards for accounting for the cost associated with an
asset retirement obligation. It requires that, upon initial recognition of a
liability for an asset retirement obligation, an entity capitalize that cost by
recognizing an increase in the carrying amount of the related long-lived asset.
The capitalized asset retirement cost would then be allocated to expense using a
systematic and rational method. Statement No. 143 will be effective for
financial statements issued for fiscal years beginning after June 15, 2002, with
earlier application encouraged. The Business is currently evaluating the impact
of adopting this new statement, however, at the present time does not believe
the statement will have a material impact on its financial position or results
of operations.
F-38
VALERO SOUTH TEXAS PIPELINE AND TERMINAL BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 3: PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, which primarily represents assets leased
from El Paso under capital leases, consisted of the following:
ESTIMATED DECEMBER 31,
USEFUL LIVES 2002
------------ --------------
(YEARS) (IN THOUSANDS)
Land........................................................ -- $ 1,146
Pipelines, terminals and related buildings and equipment.... 16 - 33 97,419
Rights of way............................................... 33 11,708
Construction in progress.................................... -- 2,600
--------
Total..................................................... 112,873
Accumulated depreciation and amortization................... (5,367)
--------
Property, plant and equipment, net........................ $107,506
========
As of December 31, 2002, assets held under capital lease had a net book
value of $104.9 million, net of accumulated amortization of $5.4 million.
NOTE 4: INCOME TAXES
The amounts presented below relate only to the Business and were calculated
as if the Business filed separate federal and state income tax returns.
The provision for income taxes consisted of the following:
YEAR ENDED
DECEMBER 31,
2002
--------------
(IN THOUSANDS)
Deferred:
Federal................................................... $57
State..................................................... 9
---
Total deferred......................................... 66
---
Provision for income taxes.................................. $66
===
F-39
VALERO SOUTH TEXAS PIPELINE AND TERMINAL BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Deferred income taxes arise from temporary differences between the tax
bases of assets and liabilities and their reported amounts in the Business'
financial statements. The components of the Business' net deferred income tax
liabilities consisted of the following:
DECEMBER 31,
2002
--------------
(IN THOUSANDS)
Deferred income tax assets:
Net operating loss carry-forward.......................... $ 1,633
-------
Total deferred income tax assets....................... 1,633
-------
Deferred income tax liabilities:
Property, plant and equipment............................. 18,298
Other liabilities......................................... 38
-------
Total deferred income tax liabilities.................. 18,336
-------
Net deferred income tax liabilities......................... $16,703
=======
The differences between the Business' effective income tax rate and the
U.S. federal statutory rate is reconciled as follows:
YEAR ENDED
DECEMBER 31,
2002
------------
U.S. federal statutory rate................................. 35.00%
State income taxes (net of federal tax benefit)............. 5.24
-----
Effective income tax rate................................. 40.24%
=====
NOTE 5: RELATED-PARTY TRANSACTIONS
Transactions between the Business and Valero Energy included pipeline
tariff and terminal throughput revenues received by the Business from Valero
Energy and the allocation of salary and employee benefit costs, insurance costs,
and administrative fees from Valero Energy to the Business. Such transactions
cannot be presumed to be carried out on an arm's length basis as the requisite
conditions of competitive, free-market dealings may not exist. For purposes of
these financial statements, payables and receivables related to transactions
between the Business and Valero Energy are included as a component of the net
parent investment.
The Business participated in Valero Energy's centralized cash management
program under which cash receipts and cash disbursements were processed through
Valero Energy's cash accounts with a corresponding credit or charge to an
intercompany account. This intercompany account is included in the net parent
investment balance.
During the year ended December 31, 2002, Valero Energy provided the
Business with certain general and administrative services, including the
centralized corporate functions of legal, accounting, treasury, environmental,
engineering, information technology, and human resources. For these services,
Valero Energy charged the Business approximately 0.5% of its total general and
administrative expenses incurred in the United States, with this allocation
based on investments in property and personnel headcount. Management believes
that the amount of general and administrative expenses allocated to the Business
is a reasonable approximation of the costs related to the Business.
F-40
VALERO SOUTH TEXAS PIPELINE AND TERMINAL BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes transactions between the Business and
Valero:
YEAR ENDED
DECEMBER 31,
2002
--------------
(IN THOUSANDS)
Revenues.................................................... $25,801
Operating expenses.......................................... 3,606
General and administrative expenses......................... 820
NOTE 6: EMPLOYEE BENEFIT PLANS
Employees who work in the Business are included in the various employee
benefit plans of Valero Energy. These plans include qualified, non-contributory
defined benefit retirement plans, defined contribution 401(k) plans, employee
and retiree medical, dental and life insurance plans, long-term incentive plans
(i.e., stock options and bonuses) and other such benefits. For the purposes of
these carve-out financial statements, the Business is considered to be
participating in multi-employer benefit plans of Valero Energy.
The Business' allocated share of Valero Energy employee benefit plan
expenses were $501,000 for the year ended December 31, 2002. These employee
benefit plan expenses are included in operating expenses with the related
payroll costs.
NOTE 7: LEASES
In connection with the capital lease agreements with El Paso discussed in
Note 1, approximately $97,024,000 of capital lease obligation was attributed to
the Business as of June 1, 2001. The lease agreements are for a term of 20 years
and require Valero Energy to make total annual lease payments of $18.5 million
for each of the first two years and increasing amounts thereafter. Approximately
$6.3 million of those annual lease payments are attributable to the Business. As
payments during the first two years of the capital lease term were less than
interest incurred during that period, the capital lease obligation has increased
since June 1, 2001. Accretion for the year ended December 31, 2002 and since the
inception of the lease was $1,457,000 and $2,143,000, respectively. The
Business' future minimum lease payments under the capital lease with El Paso are
as follows (in thousands):
Minimum lease payments...................................... $102,537
Less interest expense..................................... (3,257)
--------
Capital lease obligation.................................... $ 99,280
========
Valero Energy has the option to purchase the facilities at the end of the
second year of the lease and for increasing amounts each succeeding year through
the end of the lease term. The minimum lease payments above represent payments
from January 1, 2003 through June 1, 2003 (the purchase option date) plus the
amount of the purchase option. See the discussion regarding the exercise of that
option in Note 10, "Subsequent Events".
F-41
VALERO SOUTH TEXAS PIPELINE AND TERMINAL BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
In addition, the Business leases certain equipment and vehicles under
operating lease agreements expiring through 2007. Future minimum rental payments
applicable to noncancellable operating leases as of December 31, 2002, are as
follows (in thousands):
2003........................................................ $ 91
2004........................................................ 90
2005........................................................ 89
2006........................................................ 54
2007........................................................ 9
----
Future minimum lease payments............................. $333
====
Rental expense for all operating leases totaled $80,000 for the year ended
December 31, 2002.
NOTE 8: ENVIRONMENTAL MATTERS
The operations of the Business are subject to environmental laws and
regulations adopted by various federal, state and local governmental authorities
in the jurisdictions in which it operates. Although management believes its
operations are in general compliance with applicable environmental regulations,
risks of additional costs and liabilities are inherent in the petroleum pipeline
industry, and there can be no assurance that significant costs and liabilities
will not be incurred. Moreover, it is possible that other developments, such as
increasingly stringent environmental laws and regulations and enforcement
policies thereunder, and claims for damages to property or persons resulting
from the operations, could result in substantial costs and liabilities.
Accordingly, the Business has adopted policies, practices and procedures in the
areas of pollution control, product safety, occupational health and the
handling, storage, use and disposal of hazardous materials to prevent material
environmental or other damage, and to limit the financial liability which could
result from those events. However, some risk of environmental or other damage is
inherent in the Business, as it is with other companies engaged in similar
businesses.
In connection with Valero Energy's lease of the El Paso assets, Valero
Energy assumed all environmental liabilities related to the facilities with
certain exceptions. El Paso retained liabilities for, and agreed to indemnify
Valero Energy against (a) all environmental claims and costs related to offsite
hazardous materials on or under certain adjacent properties, and all claims and
costs pertaining to offsite environmental conditions arising under the
requirements of an agreed final judgment dated April 1, 1998 between the State
of Texas and Coastal Refining and Marketing, Inc. (a subsidiary of El Paso), (b)
any environmental claim or cost related to the transportation or offsite
disposal of any hazardous substance related to the facilities prior to June 1,
2001, (c) bodily injury and property damage resulting from exposure to or
contamination by hazardous materials arising from El Paso's operation and use of
the facilities prior to June 1, 2001, and (d) environmental claims and costs
relating to the presence of hazardous materials resulting from El Paso's
continued use of its assets that are located at or adjacent to the site of the
facilities leased by Valero Energy. El Paso also retained liabilities for any
pre-existing orders, judgments or citations that El Paso failed to disclose
prior to June 1, 2001. Valero Energy's assumed liabilities include certain
environmental remediation obligations relating primarily to soil and groundwater
contamination at the leased facilities. These assumed liabilities are monitored
by a corporate environmental area which is responsible for determining the
propriety of any payments or adjustments to accruals related to the liabilities
that arose prior to the inception of the lease with El Paso. These assumed
environmental liabilities are considered the responsibility of Valero Energy,
rather than the Business, and thus are not included in these financial
statements. Liabilities pertaining to the Business arising subsequent to the
inception of the lease are the responsibility of the Business and such costs are
charged to the Business. However, no liabilities have arisen since the inception
of the lease, and thus no environmental liability is reflected in the balance
sheet as of December 31, 2002.
F-42
VALERO SOUTH TEXAS PIPELINE AND TERMINAL BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 9: CONTINGENCIES AND COMMITMENTS
There are various legal proceedings and claims pending against the Business
which arise in the ordinary course of business. It is management's opinion,
based upon advice of counsel, that these matters, individually or in the
aggregate, will not have a material adverse effect on the results of operations
or financial position of the Business.
NOTE 10: SUBSEQUENT EVENT
On February 28, 2003, Valero exercised its option to purchase from El Paso
the refinery in Corpus Christi and the related South Texas pipeline and
terminalling assets that it had been leasing and operating since June 1, 2001.
These assets were purchased for an aggregate consideration of approximately
$289.3 million.
Effective March 1, 2003, the impact of volumetric variances in the
pipelines will be borne by the shippers in the Business' pipelines. The net
reduction to income before income tax expense of volumetric variances in the
pipelines was $636,000 for the year ended December 31, 2002.
F-43
PROSPECTUS
$500,000,000
VALERO L.P.
COMMON UNITS
---------------------
VALERO LOGISTICS OPERATIONS, L.P.
DEBT SECURITIES
FULLY AND UNCONDITIONALLY GUARANTEED BY VALERO L.P.
---------------------
Valero L.P. may, in one or more offerings, offer and sell common units
representing limited partner interests in Valero L.P.
Valero Logistics Operations may, in one or more offerings, offer and sell
its debt securities, which will be fully and unconditionally guaranteed by
Valero L.P.
The aggregate initial offering price of the securities that we offer by
this prospectus will not exceed $500,000,000. We will offer the securities in
amounts, at prices and on terms to be determined by market conditions at the
time of our offerings. We will provide the specific terms of the securities in
supplements to this prospectus. The applicable prospectus supplement may also
add, update or change information contained in this prospectus.
You should read this prospectus and the prospectus supplement carefully
before you invest in any of our securities. This prospectus may not be used to
consummate sales of our securities unless it is accompanied by a prospectus
supplement.
Valero L.P. common units are listed for trading on The New York Stock
Exchange under the symbol "VLI."
SEE "RISK FACTORS" ON PAGE 4 TO READ ABOUT IMPORTANT RISKS THAT YOU SHOULD
CONSIDER BEFORE BUYING OUR SECURITIES.
---------------------
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED WHETHER
THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this prospectus is June 17, 2002.
TABLE OF CONTENTS
ABOUT VALERO L.P. AND VALERO LOGISTICS OPERATIONS, L.P...... 1
ABOUT THIS PROSPECTUS....................................... 1
WHERE YOU CAN FIND MORE INFORMATION......................... 1
FORWARD-LOOKING STATEMENTS.................................. 3
RISK FACTORS................................................ 4
Risks Inherent In Our Business............................ 4
Risks Inherent In An Investment In Valero L.P............. 12
Tax Risks................................................. 14
USE OF PROCEEDS............................................. 16
RATIO OF EARNINGS TO FIXED CHARGES.......................... 16
DESCRIPTION OF COMMON UNITS................................. 17
Number of Units........................................... 17
Voting.................................................... 17
Listing................................................... 18
Transfer Agent and Registrar.............................. 18
CASH DISTRIBUTIONS.......................................... 18
Distributions Of Available Cash........................... 18
Operating Surplus, Capital Surplus And Adjusted Operating
Surplus................................................ 18
Subordination Period...................................... 19
Distributions of Available Cash from Operating Surplus
During the Subordination Period........................ 20
Distributions of Available Cash from Operating Surplus
After the Subordination Period......................... 20
Incentive Distribution Rights............................. 21
Percentage Allocations Of Available Cash From Operating
Surplus................................................ 21
Distributions From Capital Surplus........................ 22
Adjustment To The Minimum Quarterly Distribution And
Target Distribution Levels............................. 22
Distributions Of Cash Upon Liquidation.................... 23
DESCRIPTION OF DEBT SECURITIES.............................. 25
Parent Guarantee.......................................... 25
Specific Terms of Each Series of Debt Securities in the
Prospectus Supplement.................................. 25
Provisions Only in the Senior Indenture................... 26
Provisions Only in the Subordinated Indenture............. 30
Consolidation, Merger or Asset Sale....................... 30
Modification of Indentures................................ 31
Events of Default and Remedies............................ 32
Registration of Debt Securities........................... 33
Minimum Denominations..................................... 33
No Personal Liability of General Partner.................. 33
Payment and Transfer...................................... 33
Form, Exchange, Registration and Transfer................. 33
Discharging Valero Logistics' Obligations................. 34
The Trustee............................................... 34
Governing Law............................................. 35
BOOK ENTRY, DELIVERY AND FORM............................... 35
TAX CONSIDERATIONS.......................................... 37
Partnership Status........................................ 37
Tax Treatment Of Unitholders.............................. 39
Tax Treatment Of Operations............................... 42
Disposition Of Common Units............................... 44
Tax-Exempt Organizations And Other Investors.............. 46
Administrative Matters.................................... 47
State, Local, And Other Tax Considerations................ 49
Tax Consequences of Ownership of Debt Securities.......... 50
INVESTMENT IN US BY EMPLOYEE BENEFIT PLANS.................. 51
PLAN OF DISTRIBUTION........................................ 52
VALIDITY OF THE SECURITIES.................................. 53
EXPERTS..................................................... 53
CHANGE IN INDEPENDENT PUBLIC ACCOUNTANTS.................... 53
ii
ABOUT VALERO L.P. AND VALERO LOGISTICS OPERATIONS, L.P.
Valero L.P. is a publicly traded Delaware limited partnership formed in
1999 that owns, through its 100%-owned operating subsidiary, Valero Logistics
Operations, L.P. (Valero Logistics), most of the crude oil and refined product
pipeline, terminalling, and storage assets located in Texas, Oklahoma, New
Mexico and Colorado that support Valero Energy Corporation's McKee, Three
Rivers, and Ardmore refineries located in Texas and Oklahoma. We transport crude
oil to these refineries and transport refined products from these refineries to
our terminals for further distribution to Valero Energy's company-operated
convenience stores or wholesale customers located in Texas, Oklahoma, Colorado,
New Mexico, and Arizona.
The general partner of Valero L.P., Riverwalk Logistics, L.P. (Riverwalk
Logistics), holds no assets other than its investment in Valero L.P. Riverwalk
Logistics is an indirect wholly owned subsidiary of Valero Energy, a publicly
held company whose annual and quarterly financial statements are filed with the
Securities and Exchange Commission. The financial information of Riverwalk
Logistics is included in the consolidated financial statements of Valero Energy.
Our principal executive offices are located at One Valero Place, San
Antonio, Texas 78212, and our phone number is (210) 370-2000.
ABOUT THIS PROSPECTUS
This prospectus is part of a registration statement that we have filed with
the Securities and Exchange Commission using a "shelf" registration process.
Under this shelf registration process, we may sell up to $500,000,000 in total
offering amount of the common units of Valero L.P. or debt securities of Valero
Logistics described in this prospectus in one or more offerings. This prospectus
generally describes us and the common units of Valero L.P. and debt securities
of Valero Logistics. Each time we sell common units or debt securities with this
prospectus, we will provide a prospectus supplement that will contain specific
information about the terms of that offering and the securities offered by us in
that offering. The prospectus supplement may also add to, update or change
information in this prospectus. The information in this prospectus is accurate
as of its date. You should carefully read both this prospectus and any
prospectus supplement and the additional information described below under the
heading "Where You Can Find More Information."
As used in this prospectus, "we," "us," and "our" and similar terms mean
either or both of Valero L.P. and Valero Logistics, except that those terms,
when used in this prospectus in connection with
- the common units described herein mean Valero L.P. and
- the debt securities described herein mean Valero Logistics,
unless the context indicates otherwise.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement with the SEC under the Securities
Act of 1933 that registers the securities offered by this prospectus. The
registration statement, including the attached exhibits, contains additional
relevant information about us. The rules and regulations of the SEC allow us to
omit some information included in the registration statement from this
prospectus.
In addition, Valero L.P. files annual, quarterly and other reports and
other information with the SEC. You may read and copy any document we file at
the SEC's public reference room at 450 Fifth Street, N.W., Washington, D.C.
20549. Please call the SEC at 1-800-SEC-0330 for further information on the
operation of the SEC's public reference room. Our SEC filings are also available
at the SEC's web site at http://www.sec.gov.
1
The SEC allows us to "incorporate by reference" the information Valero L.P.
has filed with the SEC. This means that we can disclose important information to
you without actually including the specific information in this prospectus by
referring you to another document filed separately with the SEC. The information
incorporated by reference is an important part of this prospectus. Information
that Valero L.P. files later with the SEC will automatically update and may
replace information in this prospectus and information previously filed with the
SEC.
We incorporate by reference the documents listed below that Valero L.P. has
previously filed with the SEC. They contain important information about us, our
financial condition and results of operations. Some of these documents have been
amended by later filings, which are also listed.
- Valero L.P.'s Annual Report on Form 10-K for the year ended December 31,
2001 (as amended on April 4, 2002);
- Valero L.P.'s Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 2002;
- Valero L.P.'s Current Report on Form 8-K dated February 1, 2002 (as
amended on April 16, 2002);
- Valero L.P.'s Current Report on Form 8-K dated May 15, 2002;
- Valero L.P.'s Current Report on Form 8-K dated May 30, 2002;
- Valero L.P.'s Current Report on Form 8-K dated June 6, 2002;
- the description of our common units contained in our registration
statement on Form 8-A, filed on March 30, 2001; and
- any future filings made with the SEC under Sections 13(a), 13(c), 14 or
15(d) of the Securities Exchange Act of 1934 subsequent to the date of
this prospectus and until all of the securities offered by this
prospectus have been sold.
We also incorporate by reference any future filings made with the SEC under
Sections 13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the date of
the initial registration statement and prior to effectiveness of the
registration statement.
You may obtain any of the documents incorporated by reference in this
document through us or from the SEC through the SEC's website at the address
provided above. Documents incorporated by reference are available from us
without charge, excluding any exhibits to those documents, unless the exhibit is
specifically incorporated by reference in this document, by requesting them in
writing or by telephone from us at the following address:
Investor Relations
Valero L.P.
One Valero Place
San Antonio, Texas 78212
Telephone: (210) 370-2000
2
FORWARD-LOOKING STATEMENTS
Some of the information included in this prospectus, the accompanying
prospectus supplement and the documents we incorporate by reference contain
"forward-looking" statements as such term is defined in Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934,
and information relating to us that is based on the beliefs of our management as
well as assumptions made by and information currently available to management.
The words "anticipate," "believe," "estimate," "expect," and "intend" and words
or phrases or similar expressions, as they relate to us or our management,
identify forward-looking statements. These statements reflect the current views
of management with respect to future events and are subject to certain risks,
uncertainties and assumptions relating to the operations and results of
operations, including as a result of:
- competitive factors such as competing pipelines;
- pricing pressures and changes in market conditions;
- reductions in production at the refineries that we supply with crude oil
and whose refined products we transport;
- inability to acquire additional nonaffiliated pipeline entities;
- reductions in space allocated to us in interconnecting third party
pipelines;
- shifts in market demand;
- general economic conditions; and
- other factors.
Should one or more of these risks or uncertainties materialize, or should
any underlying assumptions prove incorrect, actual results or outcomes may vary
materially from those described herein as anticipated, believed, estimated,
expected or intended.
Finally, our future results will depend upon various other risks and
uncertainties, including, but not limited to, those detailed in Valero L.P.'s
other filings with the SEC. For additional information regarding risks and
uncertainties, please read Valero L.P.'s other current filings with the SEC
under the Exchange Act and the Securities Act, particularly under "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
Valero L.P.'s Current Report on Form 8-K dated May 15, 2002.
3
RISK FACTORS
Limited partner interests are inherently different from the capital stock
of a corporation, although many of the business risks to which we are subject
are similar to those that would be faced by a corporation engaged in a similar
business. You should carefully consider the following risk factors together with
all of the other information included in this prospectus in evaluating an
investment in our securities.
If any of the following risks were actually to occur, our business,
financial condition, or results of operations could be materially adversely
affected. In that case, the trading price of our securities could decline and
you could lose all or part of your investment.
RISKS INHERENT IN OUR BUSINESS
WE MAY NOT BE ABLE TO GENERATE SUFFICIENT CASH FROM OPERATIONS TO ENABLE US TO
PAY THE REQUIRED PAYMENTS TO OUR DEBT HOLDERS OR THE MINIMUM QUARTERLY
DISTRIBUTION ON THE COMMON UNITS EVERY QUARTER.
Because the amount of cash we are able to pay to our debt holders or
distribute on the common units is principally dependent on the amount of cash we
are able to generate from operations, which will fluctuate from quarter to
quarter based on our performance, we may not be able to pay all our debt or the
minimum quarterly distribution on the common units for each quarter. The amount
of cash flow we generate from operations is in turn principally dependent on the
average daily volumes of crude oil and refined products transported through our
pipelines, the tariff rates and terminalling fees we charge, and the level of
operating costs we incur.
Other factors affecting the actual amount of cash that we will have
available include the following:
- required principal and interest payments on our debt;
- the costs of acquisitions;
- restrictions contained in our debt instruments;
- issuances of debt and equity securities;
- fluctuations in working capital;
- capital expenditures; and
- adjustments in reserves made by the general partner in its discretion.
Cash distributions to debt and equity holders are dependent primarily on
cash flow, including cash flow from financial reserves and working capital
borrowings, and not solely on profitability, which is affected by non-cash
items. Therefore, we may make cash distributions during periods when we record
losses and may not make cash distributions during periods when we record net
income.
YOU MAY RECEIVE LESS THAN YOUR DEBT PAYMENTS OR THE MINIMUM QUARTERLY
DISTRIBUTION BECAUSE FEES AND COST REIMBURSEMENTS DUE TO VALERO ENERGY AND ITS
AFFILIATES MAY BE SUBSTANTIAL AND WILL REDUCE OUR CASH AVAILABLE FOR
DISTRIBUTION.
Prior to making any distribution on the common units, we have agreed to pay
Valero Energy and its affiliates an administrative fee that currently equals
$5.2 million on an annualized basis in exchange for providing corporate, general
and administrative services to us. Valero L.P.'s general partner, with approval
and consent of the conflicts committee of its general partner, will have the
right to increase the annual administrative fee by up to 1.5% each year, as
further adjusted for inflation, during the eight-year term of the services
agreement and may agree to further increases in connection with expansions of
our operations through the acquisition or construction of new logistics assets
that require additional administrative services. Additionally, we reimburse
Valero Energy and its affiliates for direct expenses it incurs to provide all
other services to us (for example, salaries for pipeline operations personnel).
The direct expenses we reimbursed to Valero Energy and its affiliates were
approximately $12 million in 2001. The payment of the
4
annual administrative fee and the reimbursement of direct expenses could
adversely affect our ability to make cash distributions to our unitholders.
WE DEPEND UPON VALERO ENERGY FOR THE CRUDE OIL AND REFINED PRODUCTS
TRANSPORTED IN OUR PIPELINES AND HANDLED AT OUR TERMINALS AND STORAGE
FACILITIES, AND ANY REDUCTION IN THOSE QUANTITIES COULD REDUCE OUR ABILITY TO
MAKE CASH DISTRIBUTIONS TO OUR UNITHOLDERS OR PAYMENTS TO OUR DEBT HOLDERS.
Because of the geographic location of our pipelines, terminals, and storage
facilities, we depend almost exclusively upon Valero Energy to provide
throughput for our pipelines and terminals. If Valero Energy were to decrease
the throughput of crude oil and/or refined products transported in our pipelines
for any reason, we would experience great difficulty in replacing those lost
barrels. For example, during January and February of 2002, Valero Energy
initiated economic-based refinery production cuts as a result of significantly
lower refining margins industry-wide, resulting in a decrease in throughput
barrels and revenues from some of our pipelines. Because our operating costs are
primarily fixed, a reduction in throughput would result in not only a reduction
of revenues but a decline in net income and cash flow of similar or greater
magnitude, which would reduce our ability to make cash distributions to our
unitholders or payments to our debt holders.
Valero Energy may reduce throughput in our pipelines either because of
market conditions that affect refineries generally or because of factors that
specifically affect Valero Energy. These conditions and factors include the
following:
- a decrease in demand for refined products in the markets served by our
pipelines;
- a temporary or permanent decline in the ability of the McKee, Three
Rivers, or Ardmore refineries to produce refined products;
- a decision by Valero Energy to redirect refined products transported in
our pipelines to markets not served by our pipelines or to transport
crude oil by means other than our pipelines;
- a decision by Valero Energy to sell one or more of the McKee, Three
Rivers, or Ardmore refineries to a purchaser that elects not to use our
pipelines to deliver crude oil to, or transport refined products from,
the refinery;
- a loss of customers by Valero Energy in the markets served by our
pipelines or a failure to gain additional customers in growing markets;
and
- the completion of competing refined product pipelines in the western,
southwestern, and Rocky Mountain market regions.
DISTRIBUTIONS TO UNITHOLDERS OR PAYMENTS TO OUR DEBT HOLDERS COULD BE
ADVERSELY AFFECTED BY A SIGNIFICANT DECREASE IN DEMAND FOR REFINED PRODUCTS IN
THE MARKETS SERVED BY OUR PIPELINES.
Any sustained decrease in demand for refined products in the markets served
by our pipelines could result in a significant reduction in throughput in our
crude oil and refined product pipelines and therefore in our cash flow, reducing
our ability to make distributions to our unitholders or payments to our debt
holders. Factors that could lead to a decrease in market demand include:
- a recession or other adverse economic condition that results in lower
spending by consumers on gasoline, diesel, and travel;
- higher fuel taxes or other governmental or regulatory actions that
increase, directly or indirectly, the cost of gasoline or diesel;
- an increase in fuel economy, whether as a result of a shift by consumers
to more fuel-efficient vehicles or technological advances by
manufacturers. Pending legislation in the U.S. Congress, such as the
National Fuel Savings and Security Act of 2002 and the Fuel Economy and
Security Act of 2002, may mandate such increases in fuel economy in the
future;
5
- an increase in the market price of crude oil that leads to higher refined
product prices, which may reduce demand for gasoline or diesel. Market
prices for crude oil and refined products are subject to wide fluctuation
in response to changes in global and regional supply over which neither
we nor Valero Energy have any control, and recent significant increases
in the price of crude oil may result in a lower demand for refined
products; and
- the increased use of alternative fuel sources, such as battery-powered
engines. Several state and federal initiatives mandate this increased
use. For example, the Energy Policy Act of 1992 requires 75% of all new
vehicles purchased by federal agencies since 1999, 75% of all new
vehicles purchased by state governments since 2000, and 70% of all new
vehicles purchased for private fleets in 2006 and thereafter to use
alternative fuels. Additionally, California has enacted a regulation
requiring that by the year 2003, 10% of all fleets delivered to
California for sale be zero-emissions vehicles.
OUR ABILITY TO MAKE PAYMENTS TO DEBT HOLDERS OR DISTRIBUTIONS TO UNITHOLDERS
COULD BE REDUCED BY A MATERIAL DECLINE IN PRODUCTION BY ANY OF VALERO ENERGY'S
MCKEE, THREE RIVERS, OR ARDMORE REFINERIES.
Any significant curtailing of production at the McKee, Three Rivers, or
Ardmore refineries could, by reducing throughput in our pipelines, result in our
realizing materially lower levels of revenues and cash flow for the duration of
the shutdown. Operations at a refinery could be partially or completely shut
down, temporarily or permanently, as the result of a number of circumstances,
none of which are within our control, such as:
- scheduled turnarounds or unscheduled maintenance or catastrophic events
at a refinery;
- labor difficulties that result in a work stoppage or slowdown at a
refinery;
- environmental proceedings or other litigation that compel the cessation
of all or a portion of the operations at a refinery;
- increasingly stringent environmental regulations, such as the
Environmental Protection Agency's Gasoline Sulfur Control Requirements
and Diesel Fuel Sulfur Control Requirements which limit the concentration
of sulfur in gasoline and diesel fuel;
- a disruption in the supply of crude oil to a refinery; and
- a governmental ban or other limitation on the use of an important product
of a refinery.
The magnitude of the effect on us of any shutdown will depend on the length
of the shutdown and the extent of the refinery operations affected by the
shutdown. Furthermore, we have no control over the factors that may lead to a
shutdown or the measures Valero Energy may take in response to a shutdown.
Valero Energy will make all decisions at the refineries concerning levels of
production, regulatory compliance, refinery turnarounds, labor relations,
environmental remediation, and capital expenditures.
VALERO ENERGY'S SEVEN-YEAR AGREEMENT TO USE OUR PIPELINES AND TERMINALS WILL
BE SUSPENDED IF MATERIAL CHANGES IN MARKET CONDITIONS OCCUR THAT HAVE A
MATERIAL ADVERSE EFFECT ON VALERO ENERGY, WHICH COULD ADVERSELY AFFECT OUR
ABILITY TO MAKE PAYMENTS TO DEBT HOLDERS OR DISTRIBUTIONS TO UNITHOLDERS.
If market conditions with respect to the transportation of crude oil or
refined products or with respect to the end markets in which Valero Energy sells
refined products change in a material manner such that Valero Energy would
suffer a material adverse effect if it were to continue to use our pipelines and
terminals at the required levels, Valero Energy's obligation to us will be
suspended during the period of the change in market conditions to the extent
required to avoid the material adverse effect. Any suspension of Valero Energy's
obligation could adversely affect throughput in our pipelines and terminals and
therefore our ability to make payments to debt holders or distributions to
unitholders.
The concepts of a material change in market conditions and material adverse
effect on Valero Energy are not defined in the agreement. However, situations
that might constitute a material change in market
6
conditions having a material adverse effect on Valero Energy include the cost of
transporting crude oil or refined products by our pipelines becoming materially
more expensive than transporting crude oil or refined products by other means or
a material change in refinery profit that makes it materially more advantageous
for Valero Energy to shift large volumes of refined products from markets served
by our pipelines to pipelines retained by Valero Energy or owned by third
parties. Valero Energy may suspend obligations by presenting a certificate from
its chief financial officer that there has been a material change in market
conditions having a material adverse effect on Valero Energy. If we disagree
with Valero Energy, we have the right to refer the matter to an independent
accounting firm for resolution.
ANY LOSS BY VALERO ENERGY OF CUSTOMERS IN THE MARKETS SERVED BY OUR REFINED
PRODUCT PIPELINES MAY ADVERSELY AFFECT OUR ABILITY TO MAKE PAYMENTS TO DEBT
HOLDERS OR DISTRIBUTIONS TO UNITHOLDERS.
Should Valero Energy's retail marketing efforts become unsuccessful and
result in declining or stagnant sales of its refined products, Valero Energy
would have to find other end-users for its refined products. It may not choose
or be able to replace lost branded retail sales through wholesale, spot, and
exchange sales. Any failure by Valero Energy to replace lost branded retail
sales could adversely affect throughput in our pipelines and, therefore, our
cash flow and ability to make payments to debt holders or distributions to
unitholders.
IF OUR ASSUMPTIONS CONCERNING POPULATION GROWTH ARE INACCURATE OR VALERO
ENERGY'S GROWTH STRATEGY IS NOT SUCCESSFUL, OUR ABILITY TO MAKE PAYMENTS TO
DEBT HOLDERS OR DISTRIBUTIONS TO UNITHOLDERS MAY BE ADVERSELY AFFECTED.
Our growth strategy is dependent upon:
- the accuracy of our assumption that many of the markets that we serve in
the southwestern and Rocky Mountain regions of the United States will
experience population growth that is higher than the national average;
and
- the willingness and ability of Valero Energy to capture a share of this
additional demand in its existing markets and to identify and penetrate
new markets in the southwestern and Rocky Mountain regions of the United
States.
If our assumption about growth in market demand proves incorrect, Valero
Energy may not have any incentive to increase refinery capacity and production,
shift additional throughput to our pipelines, or shift volumes from our lower
tariff pipelines to our higher tariff pipelines, which would adversely affect
our growth strategy. Furthermore, Valero Energy is under no obligation to pursue
a growth strategy with respect to its business that favors us. If Valero Energy
chooses not, or is unable, to gain additional customers in new or existing
markets in the southwestern and Rocky Mountain regions of the United States, our
growth strategy would be adversely affected.
NEW COMPETING REFINED PRODUCT PIPELINES COULD CAUSE DOWNWARD PRESSURE ON
MARKET PRICES, AND AS A RESULT, VALERO ENERGY MIGHT DECREASE THE VOLUMES
TRANSPORTED IN OUR PIPELINES.
We are aware of a number of proposals or industry discussions regarding
refined product pipeline projects that, if or when undertaken and completed,
could adversely impact some of the most significant markets we serve. One of
these projects, the Longhorn Pipeline, will transport refined products from the
Texas Gulf Coast to El Paso. Most of the pipeline has been constructed, and it
has obtained regulatory approval and is expected to begin operation by the end
of 2002. The completion of the Longhorn Pipeline will increase the amount of
refined products available in the El Paso, New Mexico, and Arizona markets,
which could put downward pressure on refined product prices in those markets. As
a result, Valero Energy might not find it economically attractive to maintain
its current market share in those markets and might decrease the throughput in
our pipelines to those markets. In addition, two other refined product pipeline
projects have been announced, the Williams Pipeline project from northwestern
New Mexico to Salt Lake City, Utah and the Equilon Pipeline project from Odessa,
Texas to Bloomfield, New Mexico. It is uncertain if and when these proposed
pipelines will commence operations. If completed, these proposed
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pipeline projects could cause downward pressure on market prices in the New
Mexico and Arizona markets and could cause Valero Energy to decrease the volumes
transported in our pipelines.
IF ONE OR MORE OF OUR TARIFF RATES IS REDUCED, IF FUTURE INCREASES IN OUR
TARIFF RATES DO NOT ALLOW US TO RECOVER FUTURE INCREASES IN OUR COSTS, OR IF
RATEMAKING METHODOLOGIES ARE ALTERED, OUR ABILITY TO MAKE PAYMENTS TO DEBT
HOLDERS OR DISTRIBUTIONS TO UNITHOLDERS MAY BE ADVERSELY AFFECTED.
Our interstate pipelines are subject to extensive regulation by the Federal
Energy Regulatory Commission under the Interstate Commerce Act. This Act allows
the FERC, shippers, and potential shippers to challenge our current rates that
are already effective and any proposed changes to those rates, as well as our
terms and conditions of service. The FERC may subject any proposed changes to
investigation and possible refund or reduce our current rates and order that we
pay reparations for overcharges caused by these rates during the two years prior
to the beginning of the FERC's investigation. In addition, a state commission
could also investigate our intrastate rates or our terms and conditions of
service on its own initiative or at the urging of a shipper or other interested
parties.
Valero Energy has agreed not to challenge, or cause others to challenge,
our tariff rates until 2008. This agreement does not prevent other shippers or
future shippers from challenging our tariff rates. At the end of this time,
Valero Energy will be free to challenge, or cause other parties to challenge,
our tariff rates. If Valero Energy or any third party is successful in
challenging our tariff rates, we may not be able to sustain our rates, which may
adversely affect our revenues. Cash available for payments to debt holders or
distribution to unitholders could be materially reduced by a successful
challenge to our rates.
Despite Valero Energy's agreement not to challenge rates, adverse market
conditions could nevertheless cause us to lower our tariff rates. Valero Energy
may find it economically advantageous to reduce the feedstock consumption or the
production of refined products at the McKee, Three Rivers, or Ardmore refineries
or to transport refined products to markets other than those we serve, any of
which would have the effect of reducing throughput in our pipelines. If a
material change in market conditions occurs, the pipelines and terminals usage
agreement allows Valero Energy to reduce throughput in our pipelines.
Accordingly, we could be forced to lower our tariff rates in an effort to make
transportation through our pipelines economically attractive to Valero Energy in
order to maintain throughput volumes. However, even a significant reduction of
our tariffs may not provide enough economic incentive to Valero Energy to
maintain historical throughput levels.
Under the FERC's current ratemaking methodology, the maximum rate we may
charge with respect to interstate pipelines is adjusted up or down each year by
the percentage change in the producer price index for finished goods minus 1%.
The FERC's current methodology also allows us, in some circumstances, to change
rates based either on our cost of service, or market-based rates, or on a
settlement or agreement with all of our shippers, instead of the index-based
rate change. Under any of these methodologies, our ability to set rates based on
our true costs may be limited or delayed. If for any reason future increases in
our tariff rates are not sufficient to allow us to recover increases in our
costs, our ability to make payments to debt holders or distributions to
unitholders may be adversely affected.
Potential changes to current ratemaking methods and procedures of the FERC
and state regulatory commissions may impact the federal and state regulations
under which we will operate in the future. In addition, if the FERC's petroleum
pipeline ratemaking methodology were reviewed by a federal appeals court and
changed, this change could reduce our revenues and reduce cash available for
payments to debt holders or distribution to our unitholders.
A MATERIAL DECREASE IN THE SUPPLY, OR A MATERIAL INCREASE IN THE PRICE, OF
CRUDE OIL AVAILABLE FOR TRANSPORT THROUGH OUR PIPELINES TO VALERO ENERGY'S
REFINERIES, COULD MATERIALLY REDUCE OUR ABILITY TO MAKE PAYMENTS TO DEBT
HOLDERS OR DISTRIBUTIONS TO UNITHOLDERS.
The volume of crude oil we transport in our crude oil pipelines depends on
the availability of attractively priced crude oil produced in the areas
accessible to our crude oil pipelines, imported to our Corpus Christi storage
facilities, and received from common carrier pipelines outside of our areas of
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operations. If Valero Energy does not replace volumes lost due to a material
temporary or permanent decrease in supply from any of these sources with volumes
transported in one of our other crude oil pipelines, we would experience an
overall decline in volumes of crude oil transported through our pipelines and
therefore a corresponding reduction in cash flow. Similarly, if there were a
material increase in the price of crude oil supplied from any of these sources,
either temporary or permanent, which caused Valero Energy to reduce its
shipments in the related crude oil pipelines, we could experience a decline in
volumes of crude oil transported in our pipelines and therefore a corresponding
reduction in cash flow. Furthermore, a reduction of supply from our pipelines,
either because of the unavailability or high price of crude oil, would likely
result in reduced production of refined products at the McKee, Three Rivers, and
Ardmore refineries, causing a reduction in the volumes of refined products we
transport and our cash flow. Some of the local gathering systems that supply
crude oil that we transport to the McKee and Ardmore refineries are experiencing
a decline in production. Furthermore, international political and economic
uncertainties over which neither we nor Valero Energy have any control may
affect imports of crude oil.
IF WE ARE NOT ABLE TO SUCCESSFULLY ACQUIRE, EXPAND, AND BUILD PIPELINES AND
OTHER LOGISTICS ASSETS OR ATTRACT SHIPPERS IN ADDITION TO VALERO ENERGY, THE
GROWTH OF OUR BUSINESS WILL BE LIMITED.
We intend to grow our business in part through selective acquisitions,
expansions of pipelines, and construction of new pipelines, as well as by
attracting shippers in addition to Valero Energy. Each of these components has
uncertainties and risks associated with it, and none of these approaches may be
successful.
We may be unable to consummate any acquisitions or identify attractive
acquisition candidates in the future, to acquire assets or businesses on
economically acceptable terms, or to obtain financing for any acquisition on
satisfactory terms or at all. Valero Energy may not make any acquisitions that
would provide acquisition opportunities to us or, if these opportunities arose,
they may not be on terms attractive to us. Moreover, Valero Energy is not
obligated in all instances to offer to us logistics assets acquired as part of
an acquisition by Valero Energy. Valero Energy is also under no obligation to
sell to us any pipeline assets it owns.
Acquisitions involve numerous risks, including difficulties in the
assimilation of the operations, technologies, and services of the acquired
companies or business segments, the diversion of management's attention from
other business concerns, and the potential loss of key employees of the acquired
businesses. As a result, our business could be adversely affected by an
acquisition.
The construction of a new pipeline or the expansion of an existing
pipeline, by adding additional horsepower or pump stations or by adding a second
pipeline along an existing pipeline, involves numerous regulatory,
environmental, political, and legal uncertainties beyond our control. These
projects may not be completed on schedule or at all or at the budgeted cost.
Moreover, our revenues may not increase immediately upon the expenditure of
funds on a particular project. For instance, if we build a new pipeline, the
construction will occur over an extended period of time and we will not receive
any material increases in revenues until after completion of the project. This
could have an adverse effect on our ability to make payments to debt holders or
distributions to unitholders.
Once we increase our capacity through acquisitions, construction of new
pipelines, or expansion of existing pipelines, we may not be able to obtain or
sustain throughput to utilize the newly available capacity. The underutilization
of a recently acquired, constructed, or expanded pipeline could adversely affect
our ability to make payments to debt holders or distributions to unitholders.
We may not be able to obtain financing of any acquisitions, expansions, and
new construction on satisfactory terms or at all. Furthermore, any debt we incur
may adversely affect our ability to make payments to debt holders or
distributions to unitholders.
We also plan to seek volumes of crude oil or refined products to transport
on behalf of shippers other than Valero Energy. However, volumes transported by
us for third parties have been very limited historically and because of our lack
of geographic relationship or interconnections with other refineries, we may not
be able to obtain material third party volumes.
9
ANY REDUCTION IN THE CAPACITY OF, OR THE ALLOCATIONS TO, OUR SHIPPERS IN
INTERCONNECTING THIRD PARTY PIPELINES COULD CAUSE A REDUCTION OF VOLUMES
TRANSPORTED IN OUR PIPELINES AND COULD NEGATIVELY AFFECT OUR ABILITY TO MAKE
PAYMENTS TO DEBT HOLDERS OR DISTRIBUTIONS TO UNITHOLDERS.
Valero Energy and the other shippers in our pipelines are dependent upon
connections to third party pipelines both to receive crude oil from the Texas
Gulf Coast, the Permian Basin, and other areas and to deliver refined products
to outlying market areas in Arizona, the midwestern United States, and the Rocky
Mountain region of the United States. Any reduction of capacities in these
interconnecting pipelines due to testing, line repair, reduced operating
pressures, or other causes could result in reduced volumes transported in our
pipelines. Similarly, any reduction in the allocations to our shippers in these
interconnecting pipelines because additional shippers begin transporting volumes
over the pipelines could also result in reduced volumes transported in our
pipelines. Any reduction in volumes transported in our pipelines could adversely
affect our revenues and cash flows.
VALERO ENERGY AND ITS AFFILIATES HAVE CONFLICTS OF INTEREST AND LIMITED
FIDUCIARY RESPONSIBILITIES, WHICH MAY PERMIT THEM TO FAVOR THEIR OWN INTERESTS
TO THE DETRIMENT OF OUR SECURITY HOLDERS.
Valero Energy and its affiliates currently have an aggregate 71.58% limited
partner interest in us and own and control both Valero L.P.'s general partner
and Valero Logistics Operations' general partner. Conflicts of interest may
arise between Valero Energy and its affiliates, including the general partners,
on the one hand, and us, on the other hand. As a result of these conflicts, the
general partners may favor their own interests and the interests of their
affiliates over the interests of the unitholders. These conflicts include, among
others, the following situations:
- Valero Energy, as the primary shipper in our pipelines, has an economic
incentive to seek lower tariff rates for our pipelines and lower
terminalling fees;
- Some officers of Valero Energy, who provide services to us, also devote
significant time to the businesses of Valero Energy and are compensated
by Valero Energy for the services rendered by them;
- Neither of the respective partnership agreements nor any other agreement
requires Valero Energy to pursue a business strategy that favors us or
utilizes our assets, including any increase in refinery production or
pursuing or growing markets linked to our assets. Valero Energy's
directors and officers have a fiduciary duty to make these decisions in
the best interests of the stockholders of Valero Energy;
- Valero Energy and its affiliates may engage in limited competition with
us;
- Valero Energy may use other transportation methods or providers for up to
25% of the crude oil processed and refined products produced in the
Ardmore, McKee, and Three Rivers refineries and is not required to use
our pipelines if there is a material change in the market conditions for
the transportation of crude oil and refined products, or in the markets
for refined products served by these refineries, that has a material
adverse effect on Valero Energy;
- Valero L.P.'s general partner is allowed to take into account the
interests of parties other than us, such as Valero Energy, in resolving
conflicts of interest, which has the effect of limiting its fiduciary
duty to the unitholders;
- Valero L.P.'s general partner may limit its liability and reduce its
fiduciary duties, while also restricting the remedies available to
unitholders for actions that might, without the limitations, constitute
breaches of fiduciary duty. As a result of purchasing common units,
holders consent to some actions and conflicts of interest that might
otherwise constitute a breach of fiduciary or other duties under
applicable state law;
- Valero L.P.'s general partner determines the amount and timing of asset
purchases and sales, capital expenditures, borrowings, issuance of
additional limited partner interests and reserves, each of which can
affect the amount of cash that is paid to our holders of securities;
10
- Valero L.P.'s general partner determines which costs incurred by Valero
Energy and its affiliates are reimbursable by us;
- Neither partnership agreement restricts Valero L.P.'s general partner
from causing us to pay the general partner or its affiliates for any
services rendered on terms that are fair and reasonable to us or entering
into additional contractual arrangements with any of these entities on
our behalf;
- Valero L.P.'s general partner controls the enforcement of obligations
owed to us by Valero L.P.'s general partner and its affiliates, including
the pipelines and terminals usage agreement with Valero Energy;
- Valero L.P.'s general partner decides whether to retain separate counsel,
accountants, or others to perform services for us; and
- In some instances, Valero L.P.'s general partner may cause us to borrow
funds in order to permit the payment of distributions, even if the
purpose or effect of the borrowing is to make a distribution on the
subordinated units or to make incentive distributions or to hasten the
expiration of the subordination period.
Valero L.P.'s partnership agreement gives the general partner broad
discretion in establishing financial reserves for the proper conduct of our
business. These reserves also will affect the amount of cash available for
distribution. The general partner may establish reserves for distributions on
the subordinated units, but only if those reserves will not prevent us from
distributing the full minimum quarterly distribution, plus any arrearages, on
the common units for the following four quarters.
OUR INDEBTEDNESS MAY LIMIT OUR ABILITY TO BORROW ADDITIONAL FUNDS, MAKE
DISTRIBUTIONS TO UNITHOLDERS, OR CAPITALIZE ON BUSINESS OPPORTUNITIES.
As of March 31, 2002, our total indebtedness was $90.1 million, consisting
of approximately $80 million outstanding under our revolving credit facility and
$10.1 million of other debt. On May 29, 2002, we borrowed an additional $11
million under our revolving credit facility to pay for the cash purchase price
of our acquisition of a 25-mile crude hydrogen pipeline. Our leverage may:
- adversely affect our ability to finance future operations and capital
needs;
- limit our ability to pursue acquisitions and other business
opportunities; and
- make our results of operations more susceptible to adverse economic or
operating conditions.
We currently make interest payments of approximately $3.4 million on an
annualized basis on the amount of debt outstanding, of which approximately $2.6
million are interest payments under our revolving credit facility and the
remainder are interest payments on the debt assumed July 1, 2000.
In addition, we currently have approximately $29.0 million of aggregate
unused borrowing capacity under our revolving credit facility. Future
borrowings, under our revolving credit facility or otherwise, could result in a
significant increase in our leverage.
The payment of principal and interest on our indebtedness will reduce the
cash available for payments to debt holders and distributions to the
unitholders. We will not be able to make any distributions to our unitholders if
there is or will be an event of default under our debt agreements. Our ability
to make principal and interest payments depends on our future performance, which
is subject to many factors, several of which are outside our control.
The revolving credit facility contains restrictive covenants that limit our
ability to incur additional debt and to engage in some types of transactions.
These limitations could reduce our ability to capitalize on business
opportunities that arise. Any subsequent refinancing of our current indebtedness
or any new indebtedness could have similar or greater restrictions.
The revolving credit facility contains provisions relating to changes in
ownership. If these provisions are triggered, the outstanding debt may become
due. If that happens, we may not be able to pay the debt.
11
Valero L.P.'s general partner and its direct and indirect owners are not
prohibited by the partnership agreement from entering into a transaction that
would trigger these change-in-ownership provisions.
THE TRANSPORTATION AND STORAGE OF CRUDE OIL AND REFINED PRODUCTS IS SUBJECT TO
FEDERAL AND STATE LAWS RELATING TO ENVIRONMENTAL PROTECTION AND OPERATIONAL
SAFETY AND RESULTS IN A RISK THAT CRUDE OIL AND OTHER HYDROCARBONS MAY BE
RELEASED INTO THE ENVIRONMENT, POTENTIALLY CAUSING SUBSTANTIAL EXPENDITURES
THAT COULD LIMIT OUR ABILITY TO MAKE PAYMENTS TO DEBT HOLDERS AND
DISTRIBUTIONS TO UNITHOLDERS.
Our operations are subject to federal and state laws and regulations
relating to environmental protection and operational safety. Risks of
substantial costs and liabilities are inherent in pipeline, gathering, storage,
and terminalling operations, and we may incur these costs and liabilities in the
future.
Moreover, it is possible that other developments, such as increasingly
strict environmental and safety laws, regulations and enforcement policies of
those laws, and claims for damages to property or persons resulting from our
operations, could result in substantial costs and liabilities to us. If we were
not able to recover these resulting costs through insurance or increased
revenues, cash distributions to unitholders or payments to debt holders could be
adversely affected. The transportation and storage of crude oil and refined
products results in a risk of a sudden or gradual release of crude oil or
refined products into the environment, potentially causing substantial
expenditures for a response action, significant government penalties, liability
for natural resources damages to government agencies, personal injury, or
property damages to private parties and significant business interruption.
RISKS INHERENT IN AN INVESTMENT IN VALERO L.P.
EVEN IF THE UNITHOLDERS ARE DISSATISFIED, THEY CANNOT REMOVE OUR GENERAL
PARTNER WITHOUT ITS CONSENT.
Valero L.P.'s general partner manages our operations. Unlike the holders of
common stock in a corporation, unitholders have only limited voting rights on
matters affecting our business. Unitholders have no right to elect the general
partner or the directors of its general partner on an annual or other continuing
basis. Furthermore, our general partner and its affiliates own sufficient units
to be able to prevent its removal as general partner.
In addition, the effect of the following provisions of the partnership
agreement may be to discourage a person or group from attempting to remove our
general partner or otherwise change our management:
- if the holders of at least 66 2/3% of the units remove Valero L.P.'s
general partner without cause and units held by Valero L.P.'s general
partner and its affiliates are not voted in favor of that removal, all
remaining subordinated units will automatically convert into common units
and will share distributions with the existing common units pro rata,
existing arrearages on the common units will be extinguished, and the
common units will no longer be entitled to arrearages if we fail to pay
the minimum quarterly distribution in any quarter. Cause is narrowly
defined to mean that a court of competent jurisdiction has entered a
final, non-appealable judgment finding the general partner liable for
actual fraud, gross negligence, or willful or wanton misconduct in its
capacity as general partner;
- any units held by a person that owns 20% or more of any class of units
then outstanding, other than Valero L.P.'s general partner and its
affiliates, cannot be voted on any matter; and
- Valero L.P.'s partnership agreement contains provisions limiting the
ability of unitholders to call meetings or to acquire information about
our operations, as well as other provisions limiting the unitholders'
ability to influence the manner or direction of management.
As a result of these provisions, the price at which the common units will
trade could be diminished because of the absence or reduction of a takeover
premium in the trading price.
12
WE MAY ISSUE ADDITIONAL COMMON UNITS WITHOUT UNITHOLDER APPROVAL, WHICH MAY
DILUTE EXISTING UNITHOLDERS' INTERESTS.
During the subordination period, Valero L.P.'s general partner, without the
approval of the unitholders, may cause us to issue common units in a number of
circumstances such as the conversion of the general partner interest and the
incentive distribution rights as a result of the withdrawal of Valero L.P.'s
general partner.
The issuance of additional common units or other equity securities of equal
or senior rank will have the following effects:
- an existing unitholder's proportionate ownership interest in Valero L.P.
will decrease;
- the amount of cash available for distribution on each unit may decrease;
- since a lower percentage of total outstanding units will be subordinated
units, the risk that a shortfall in the payment of the minimum quarterly
distribution will be borne by the common unitholders will increase;
- the relative voting strength of each previously outstanding unit may be
diminished; and
- the market price of the common units may decline.
After the end of the subordination period, we may issue an unlimited number
of limited partner interests of any type without the approval of the
unitholders. Valero L.P.'s partnership agreement does not give the unitholders
the right to approve our issuance of equity securities ranking junior to the
common units at any time.
THE GENERAL PARTNER OF VALERO L.P. HAS A LIMITED CALL RIGHT THAT MAY REQUIRE A
UNITHOLDER TO SELL ITS COMMON UNITS AT AN UNDESIRABLE TIME OR PRICE.
If at any time the general partner and its affiliates own 80% or more of
the common units, the general partner will have the right, but not the
obligation, which it may assign to any of its affiliates or to us, to acquire
all, but not less than all, of the remaining common units held by unaffiliated
persons at a price not less than their then-current market price. As a result,
at such time, a unitholder may be required to sell its common units at an
undesirable time or price and may therefore not receive any return on the
unitholder's investment. A unitholder may also incur a tax liability upon a sale
of its units.
A UNITHOLDER MAY NOT HAVE LIMITED LIABILITY IF A STATE OR COURT FINDS THAT WE
ARE NOT IN COMPLIANCE WITH THE APPLICABLE STATUTES OR THAT UNITHOLDER ACTION
CONSTITUTES CONTROL OF OUR BUSINESS.
The limitations on the liability of holders of limited partner interests
for the obligations of a limited partnership have not been clearly established
in some states. A unitholder could be held liable in some circumstances for
Valero L.P.'s obligations to the same extent as a general partner if a state or
a court determined that:
- Valero L.P. had been conducting business in any state without compliance
with the applicable limited partnership statute; or
- the right or the exercise of the right by the unitholders as a group to
remove or replace Valero L.P.'s general partner, to approve some
amendments to the partnership agreement, or to take other action under
the partnership agreement constituted participation in the "control" of
Valero L.P.'s business.
Valero L.P.'s general partner, under applicable state law, has unlimited
liability for the obligations of Valero L.P., for example its debts and
environmental liabilities, if any, except for those contractual obligations of
Valero L.P. that are expressly made without recourse to the general partner.
In addition, under some circumstances a unitholder may be liable to Valero
L.P. for the amount of a distribution for a period of three years from the date
of the distribution.
13
TAX RISKS
For a discussion of all of the expected material federal income tax
consequences of owning and disposing of common units, please read "Tax
Considerations."
THE IRS COULD TREAT US AS A CORPORATION, WHICH WOULD SUBSTANTIALLY REDUCE THE
CASH AVAILABLE FOR DISTRIBUTION TO UNITHOLDERS.
The federal income tax benefit of an investment in us depends largely on
our classification as a partnership for federal income tax purposes. We have not
requested, and do not plan to request, a ruling from the IRS on this or any
other matter affecting us. We have, however, received an opinion of counsel
that, based on current law, we have been and will be classified as a partnership
for federal income tax purposes. Opinions of counsel are based on specified
factual assumptions and are not binding on the IRS or any court.
If we were classified as a corporation for federal income tax purposes, we
would pay tax on our income at corporate rates, currently 35%, distributions
would generally be taxed again to you as corporate distributions, and no income,
gains, losses, or deductions would flow through to you. Because a tax would be
imposed upon us as an entity, the cash available for distribution to you would
be substantially reduced. Treatment of us as a corporation would result in a
material reduction in the anticipated cash flow and after-tax return to you and
thus would likely result in a substantial reduction in the value of the common
units.
Current law may change so as to cause us to be taxable as a corporation for
federal income tax purposes or otherwise to be subject to entity-level taxation.
Our partnership agreement provides that, if a law is enacted or existing law is
modified or interpreted in a manner that subjects us to taxation as a
corporation or otherwise subjects us to entity-level taxation for federal, state
or local income tax purposes, then distributions will be decreased to reflect
the impact of that law on us.
A SUCCESSFUL IRS CONTEST OF THE FEDERAL INCOME TAX POSITIONS WE TAKE MAY
ADVERSELY IMPACT THE MARKET FOR COMMON UNITS AND THE COSTS OF ANY CONTEST WILL
BE BORNE BY SOME OR ALL OF THE UNITHOLDERS.
We have not requested any ruling from the IRS with respect to our
classification as a partnership for federal income tax purposes or any other
matter affecting us. The IRS may adopt positions that differ from counsel's
conclusions expressed in this prospectus. It may be necessary to resort to
administrative or court proceedings in an effort to sustain some or all of
counsel's conclusions or positions we take. A court may not concur with some or
all of our conclusions. Any contest with the IRS may materially and adversely
impact the market for the common units and the prices at which common units
trade. In addition, the costs of any contest with the IRS will be borne directly
or indirectly by some or all of the unitholders and the general partner.
YOU MAY BE REQUIRED TO PAY TAXES ON INCOME FROM US EVEN IF YOU DO NOT RECEIVE
ANY CASH DISTRIBUTIONS.
You will be required to pay federal income taxes and, in some cases, state
and local income taxes on your share of our taxable income, whether or not you
receive cash distributions from us. You may not receive cash distributions equal
to your allocable share of our taxable income or even the tax liability that
results from that income. Further, you may incur a tax liability, in excess of
the amount of cash you receive, upon the sale of your common units.
TAX GAIN OR LOSS ON THE DISPOSITION OF COMMON UNITS COULD BE DIFFERENT THAN
EXPECTED.
Upon a sale of common units, you will recognize gain or loss equal to the
difference between the amount realized and your adjusted tax basis in those
common units. Prior distributions from us in excess of the total net taxable
income you were allocated for a common unit which decreased your tax basis in
the common unit will, in effect, become taxable income if the common unit is
sold at a price greater than your tax basis in the common unit, even if the
price is less than your original cost. A portion of the
14
amount realized, whether or not representing gain, will likely be ordinary
income. Furthermore, should the IRS successfully contest some conventions we
use, you could realize more gain on the sale of common units than would be the
case under those conventions without the benefit of decreased income in prior
years.
INVESTORS, OTHER THAN INDIVIDUALS WHO ARE U.S. RESIDENTS, MAY HAVE ADVERSE TAX
CONSEQUENCES FROM OWNING COMMON UNITS.
Investment in common units by some tax-exempt entities, regulated
investment companies, and foreign persons raises issues unique to these persons.
For example, virtually all of the taxable income derived by most organizations
exempt from federal income tax, including individual retirement accounts and
other retirement plans, from the ownership of a common unit will be unrelated
business income and thus will be taxable to the unitholder. Very little of our
income will be qualifying income to a regulated investment company.
Distributions to foreign persons will be reduced by withholding taxes. Foreign
persons will be required to file federal income tax returns and pay taxes on
their share of our taxable income.
WE HAVE REGISTERED AS A "TAX SHELTER" WITH THE SECRETARY OF THE TREASURY. THIS
MAY INCREASE THE RISK OF AN IRS AUDIT OF US OR A UNITHOLDER.
We have registered as a "tax shelter" with the Secretary of the Treasury.
As a result, we may be audited by the IRS and tax adjustments could be made. The
rights of a unitholder owning less than a 1% interest in us to participate in
the income tax audit process are very limited. Further, any adjustments in our
tax returns will lead to adjustments in your tax returns and may lead to audits
of your tax returns and adjustments of items unrelated to us. You would bear the
cost of any expenses incurred in connection with an examination of your personal
tax return.
WE TREAT A PURCHASER OF COMMON UNITS AS HAVING THE SAME TAX BENEFITS AS THE
SELLER. A SUCCESSFUL IRS CHALLENGE COULD ADVERSELY AFFECT THE VALUE OF THE
COMMON UNITS.
Because we cannot match transferors and transferees of common units, we
have adopted certain depreciation conventions that do not conform with all
aspects of final Treasury Regulations. A successful IRS challenge to those
conventions could adversely affect the amount of tax benefits available to you
or could affect the timing of these tax benefits or the amount of gain from the
sale of common units and could have a negative impact on the value of the common
units or result in audit adjustments to your tax returns.
YOU WILL LIKELY BE SUBJECT TO STATE AND LOCAL TAXES AND RETURN FILING
REQUIREMENTS AS A RESULT OF AN INVESTMENT IN COMMON UNITS.
In addition to federal income taxes, unitholders will likely be subject to
other taxes, such as state and local taxes, unincorporated business taxes and
estate, inheritance, or intangible taxes that are imposed by the various
jurisdictions in which we do business or own property. You will likely be
required to file state and local income tax returns and pay state and local
income taxes in some or all of the various jurisdictions in which we do business
or own property and may be subject to penalties for failure to comply with those
requirements. We own property and conduct business in Texas, Colorado, New
Mexico, Kansas, and Oklahoma. Of these states, Colorado, New Mexico, Kansas, and
Oklahoma currently impose a personal income tax. It is the responsibility of
each unitholder to file all federal, state, and local tax returns that may be
required of the unitholder. Our counsel has not rendered an opinion on the state
or local tax consequences of an investment in us.
15
USE OF PROCEEDS
Except as otherwise provided in the applicable prospectus supplement, we
will use the net proceeds we receive from the sale of the securities offered by
this prospectus for general corporate purposes. These general corporate purposes
could include, among other things:
- repayment of debt;
- working capital;
- capital expenditures; and
- future acquisitions, which may consist of acquisitions of discrete assets
or businesses.
The actual application of proceeds from the sale of any particular tranche
of securities issued using this prospectus will be described in the applicable
prospectus supplement relating to such tranche of securities. The precise amount
and timing of the application of these proceeds will depend upon our funding
requirements and the availability and cost of other funds.
RATIO OF EARNINGS TO FIXED CHARGES
The ratio of earnings to fixed charges for each of the periods indicated is
as follows:
THREE MONTHS
TWELVE MONTHS ENDED DECEMBER 31, ENDED
------------------------------------ MARCH 31,
1997 1998 1999 2000 2001 2002
----- ----- ----- ---- ----- ------------
Ratio of Earnings to Fixed Charges....... 44.1x 59.5x 70.8x 8.7x 11.8x 17.6x
For purposes of calculating the ratio of earnings to fixed charges:
- "fixed charges" represent interest expense (including amounts capitalized
and amortization of debt costs) and the portion of rental expense
representing the interest factor; and
- "earnings" represent the aggregate of pre-tax income from continuing
operations (before adjustment for income from equity investees), fixed
charges, amortization of capitalized interest and distributions from
equity investees, less capitalized interest.
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DESCRIPTION OF COMMON UNITS
References in this "Description of Common Units" to "we," "us" and "our"
mean Valero L.P.
NUMBER OF UNITS
We currently have 9,654,572 common units outstanding, of which 5,230,250
are held by the public and 4,424,322 are held by an affiliate of our general
partner. We also have 9,599,322 subordinated units outstanding, all of which are
held by an affiliate of our general partner, for which there is no established
public trading market. The common units and the subordinated units represent an
aggregate 98% limited partner interest and the general partner interests
represent an aggregate 2% general partner interest in Valero L.P.
Under our partnership agreement we may issue, without further unitholder
action, an unlimited number of additional limited partner interests and other
equity securities with such rights, preferences and privileges as may be
established by our general partner in its sole discretion. However, during the
subordination period, we may not issue equity securities senior to the common
units or an aggregate of more than 4,462,161 common units or other units having
rights to distributions or in liquidation ranking on a parity with the common
units without the prior approval of at least a majority of the outstanding
common units voting as a class and at least a majority of the outstanding
subordinated units voting as a class; provided that, we may issue an unlimited
number of additional common units or parity securities prior to the end of the
subordination period and without unitholder approval for acquisitions which
increase cash flow from operations per unit on a pro forma basis.
VOTING
Each holder of common units is entitled to one vote for each common unit on
all matters submitted to a vote of the unitholders; provided that, if at any
time any person or group, except our general partner, owns beneficially 20% or
more of all common units, the common units so owned may not be voted on any
matter and may not be considered to be outstanding when sending notices of a
meeting of unitholders (unless otherwise required by law), calculating required
votes, determining the presence of a quorum or for other similar purposes under
our partnership agreement.
Holders of subordinated units will sometimes vote as a single class
together with the common units and sometimes vote as a class separate from the
holders of common units and, as in the case of holders of common units, will
have very limited voting rights. During the subordination period, common units
and subordinated units each vote separately as a class on the following matters:
- a sale or exchange of all or substantially all of our assets;
- the election of a successor general partner in connection with the
removal of our general partner;
- dissolution or reconstitution of Valero L.P.;
- a merger of Valero L.P.;
- issuance of limited partner interests in some circumstances; and
- specified amendments to our partnership agreement, including any
amendment that would cause us to be treated as an association taxable as
a corporation.
The subordinated units are not entitled to vote on approval of the
withdrawal of our general partner or the transfer by our general partner of its
general partner interest or incentive distribution rights under some
circumstances. Removal of our general partner requires:
- a two-thirds vote of all outstanding units voting as a single class; and
- the election of a successor general partner by the holders of a majority
of the outstanding common units and subordinated units, voting as
separate classes.
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LISTING
Our outstanding common units are listed on The New York Stock Exchange
under the symbol "VLI". Any additional common units we issue will also be listed
on the NYSE.
TRANSFER AGENT AND REGISTRAR
Our transfer agent and registrar for the common units is Mellon Investor
Services, LLC.
CASH DISTRIBUTIONS
References in this "Cash Distributions" section to "we," "us" and "our"
mean Valero L.P.
DISTRIBUTIONS OF AVAILABLE CASH
General. Within approximately 45 days after the end of each quarter, we
will distribute all of our available cash to unitholders of record on the
applicable record date and to our general partner.
Definition of Available Cash. Available cash generally means, for each
fiscal quarter, all cash on hand at the end of the quarter:
- less the amount of cash that our general partner determines in its
reasonable discretion is necessary or appropriate to:
- provide for the proper conduct of our business;
- comply with applicable law, any of our debt instruments, or other
agreements; or
- provide funds for distributions to our unitholders and to our general
partner for any one or more of the next four quarters;
- plus all cash on hand on the date of determination of available cash for
the quarter resulting from working capital borrowings made after the end
of the quarter. Working capital borrowings are generally borrowings that
are made under our credit facility and in all cases are used solely for
working capital purposes or to pay distributions to partners.
Intent to Distribute the Minimum Quarterly Distribution. We intend to
distribute to holders of common units and subordinated units on a quarterly
basis at least the minimum quarterly distribution of $0.60 per quarter or $2.40
per year to the extent we have sufficient cash from our operations after the
establishment of reserves and the payment of fees and expenses, including
payments to our general partner. However, there is no guarantee that we will pay
the minimum quarterly distribution on the common units in any quarter.
Event of Default under the Credit Facility. We will be prohibited from
making any distributions to unitholders if it would cause an event of default,
or if an event of default is existing, under Valero Logistics' revolving credit
facility.
Increase in Quarterly Distribution. On April 19, 2002, we announced an
increase in the quarterly distribution from $0.60 per unit to $0.65 per unit for
the 2002 first quarter cash distribution, which was paid on May 15, 2002.
OPERATING SURPLUS, CAPITAL SURPLUS AND ADJUSTED OPERATING SURPLUS
General. All cash distributed to unitholders will be characterized either
as operating surplus or capital surplus. We distribute available cash from
operating surplus differently than available cash from capital surplus.
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Definition of Operating Surplus. For any period, operating surplus
generally means:
- our cash balance on the closing date of our initial public offering; plus
- $10 million; plus
- all of our cash receipts since the closing of our initial public
offering, excluding cash from borrowings that are not working capital
borrowings, sales of equity and debt securities and sales or other
dispositions of assets outside the ordinary course of business; plus
- working capital borrowings made after the end of a quarter but before the
date of determination of operating surplus for the quarter; less
- all of our operating expenditures since the closing of our initial public
offering, including the repayment of working capital borrowings, but not
the repayment of other borrowings, and including maintenance capital
expenditures; less
- the amount of reserves that our general partner deems necessary or
advisable to provide funds for future operating expenditures.
Definition of Capital Surplus. Capital surplus will generally be generated
only by:
- borrowings other than working capital borrowings;
- sales of debt and equity securities; and
- sales or other dispositions of assets for cash, other than inventory,
accounts receivable and other current assets sold in the ordinary course
of business or as part of normal retirements or replacements of assets.
Characterization of Cash Distributions. We will treat all available cash
distributed as coming from operating surplus until the sum of all available cash
distributed since we began operations equals the operating surplus as of the
most recent date of determination of available cash. We will treat any amount
distributed in excess of operating surplus, regardless of its source, as capital
surplus. We do not anticipate that we will make any distributions from capital
surplus.
Definition of Adjusted Operating Surplus. Adjusted operating surplus is
intended to reflect the cash generated from operations during a particular
period and therefore excludes net increases in working capital borrowings and
net drawdowns of reserves of cash generated in prior periods.
Adjusted operating surplus for any period generally means:
- operating surplus generated with respect to that period; less
- any net increase in working capital borrowings with respect to that
period; less
- any net reduction in reserves for operating expenditures with respect to
that period not relating to an operating expenditure made with respect to
that period; plus
- any net decrease in working capital borrowings with respect to that
period; plus
- any net increase in reserves for operating expenditures with respect to
that period required by any debt instrument for the repayment of
principal, interest or premium.
SUBORDINATION PERIOD
General. During the subordination period, the common units have the right
to receive distributions of available cash from operating surplus in an amount
equal to the minimum quarterly distribution of $0.60 per unit, plus any
arrearages in the payment of the minimum quarterly distribution on the common
units from prior quarters, before any distributions of available cash from
operating surplus may be made on the subordinated units. The purpose of the
subordinated units is to increase the likelihood that during the subordination
period there will be available cash to be distributed on the common units.
19
Definition of Subordination Period. The subordination period will extend
until the first day of any quarter beginning after March 31, 2006 that each of
the following tests are met:
- distributions of available cash from operating surplus on each of the
outstanding common units and subordinated units equaled or exceeded the
minimum quarterly distribution for each of the three consecutive,
non-overlapping four-quarter periods immediately preceding that date;
- the adjusted operating surplus generated during each of the three
immediately preceding non-overlapping four-quarter periods equaled or
exceeded the sum of the minimum quarterly distributions on all of the
outstanding common units and subordinated units during those periods on a
fully diluted basis and the related distribution on the 2% general
partner interest during those periods; and
- there are no arrearages in payment of the minimum quarterly distribution
on the common units.
Effect of Expiration of the Subordination Period. Upon expiration of the
subordination period, each outstanding subordinated unit will convert into one
common unit and will then participate pro rata with the other common units in
distributions of available cash. In addition, if the unitholders remove our
general partner other than for cause and units held by our general partner and
its affiliates are not voted in favor of this removal:
- the subordination period will end and each subordinated unit will
immediately convert into one common unit;
- any existing arrearages in payment of the minimum quarterly distribution
on the common units will be extinguished; and
- our general partner will have the right to convert its general partner
interest and its incentive distribution rights into common units or to
receive cash in exchange for those interests.
DISTRIBUTIONS OF AVAILABLE CASH FROM OPERATING SURPLUS DURING THE SUBORDINATION
PERIOD
We will make distributions of available cash from operating surplus for any
quarter during the subordination period in the following manner:
- First, 98% to the common unitholders, pro rata, and 2% to our general
partner until we distribute for each outstanding common unit an amount
equal to the minimum quarterly distribution for that quarter;
- Second, 98% to the common unitholders, pro rata, and 2% to our general
partner until we distribute for each outstanding common unit an amount
equal to any arrearages in payment of the minimum quarterly distribution
on the common units for any prior quarters during the subordination
period;
- Third, 98% to the subordinated unitholders, pro rata, and 2% to our
general partner until we distribute for each subordinated unit an amount
equal to the minimum quarterly distribution for that quarter; and
- Thereafter, in the manner described in "-- Incentive Distribution Rights"
below.
DISTRIBUTIONS OF AVAILABLE CASH FROM OPERATING SURPLUS AFTER THE SUBORDINATION
PERIOD
We will make distributions of available cash from operating surplus for any
quarter after the subordination period in the following manner:
- First, 98% to all unitholders, pro rata, and 2% to our general partner
until we distribute for each outstanding unit an amount equal to the
minimum quarterly distribution for that quarter; and
- Thereafter, in the manner described in "-- Incentive Distribution Rights"
below.
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INCENTIVE DISTRIBUTION RIGHTS
Incentive distribution rights represent the right to receive an increasing
percentage of quarterly distributions of available cash from operating surplus
after the minimum quarterly distribution and the target distribution levels have
been achieved. Our general partner currently holds the incentive distribution
rights, but may transfer these rights separately from its general partner
interest, subject to restrictions in the partnership agreement.
If for any quarter:
- we have distributed available cash from operating surplus to the common
and subordinated unitholders in an amount equal to the minimum quarterly
distribution; and
- we have distributed available cash from operating surplus on outstanding
common units in an amount necessary to eliminate any cumulative
arrearages in payment of the minimum quarterly distribution;
then, we will distribute any additional available cash from operating surplus
for that quarter among the unitholders and our general partner in the following
manner:
- First, 90% to all unitholders, pro rata, 8% to the holders of the
incentive distribution rights, and 2% to our general partner, until each
unitholder receives a total of $0.66 per unit for that quarter (the
"first target distribution");
- Second, 75% to all unitholders, pro rata, 23% to the holders of the
incentive distribution rights, and 2% to our general partner, until each
unitholder receives a total of $0.90 per unit for that quarter (the
"second target distribution"); and
- Thereafter, 50% to all unitholders, pro rata, 48% to the holders of the
incentive distribution rights, and 2% to our general partner.
In each case, the amount of the target distribution set forth above is exclusive
of any distributions to common unitholders to eliminate any cumulative
arrearages in payment of the minimum quarterly distribution.
PERCENTAGE ALLOCATIONS OF AVAILABLE CASH FROM OPERATING SURPLUS
The following table illustrates the percentage allocations of the
additional available cash from operating surplus between the unitholders and our
general partner up to the various target distribution levels. The amounts set
forth under "Marginal Percentage Interest in Distributions" are the percentage
interests of our general partner and the unitholders in any available cash from
operating surplus we distribute up to and including the corresponding amount in
the column "Total Quarterly Distribution Target Amount," until available cash
from operating surplus we distribute reaches the next target distribution level,
if any. The percentage interests shown for the unitholders and our general
partner for the minimum quarterly distribution are also applicable to quarterly
distribution amounts that are less than the minimum quarterly distribution.
MARGINAL PERCENTAGE INTEREST IN
TOTAL QUARTERLY DISTRIBUTIONS
DISTRIBUTION -------------------------------
TARGET DISTRIBUTION TARGET AMOUNT UNITHOLDERS GENERAL PARTNER
------------------- --------------- ------------ ----------------
Minimum Quarterly Distribution................ $0.60 98% 2%
First Target Distribution..................... 0.66 90% 10%
Second Target Distribution.................... 0.90 75% 25%
Thereafter.................................... above 0.90 50% 50%
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DISTRIBUTIONS FROM CAPITAL SURPLUS
How Distributions from Capital Surplus Will Be Made. We will make
distributions of available cash from capital surplus in the following manner:
- First, 98% to all unitholders, pro rata, and 2% to our general partner,
until we distribute for each common unit, an amount of available cash
from capital surplus equal to the initial public offering price;
- Second, 98% to the common unitholders, pro rata, and 2% to our general
partner, until we distribute for each common unit that was issued in the
offering, an amount of available cash from capital surplus equal to any
unpaid arrearages in payment of the minimum quarterly distribution on the
common units; and
- Thereafter, we will make all distributions of available cash from capital
surplus as if they were from operating surplus.
Effect of a Distribution from Capital Surplus. The partnership agreement
treats a distribution of capital surplus as the repayment of the unit price from
our initial public offering, which is a return of capital. The initial public
offering price less any distributions of capital surplus per unit is referred to
as the unrecovered initial unit price. Each time a distribution of capital
surplus is made, the minimum quarterly distribution and the target distribution
levels will be reduced in the same proportion as the corresponding reduction in
the unrecovered initial unit price. Because distributions of capital surplus
will reduce the minimum quarterly distribution, after any of these distributions
are made, it may be easier for our general partner to receive incentive
distributions and for the subordinated units to convert into common units.
However, any distribution of capital surplus before the unrecovered initial unit
price is reduced to zero cannot be applied to the payment of the minimum
quarterly distribution or any arrearages.
Once we distribute capital surplus on a unit issued in this offering in an
amount equal to the initial unit price, we will reduce the minimum quarterly
distribution and the target distribution levels to zero and we will make all
future distributions from operating surplus, with 50% being paid to the holders
of units, 48% to the holders of the incentive distribution rights and 2% to our
general partner.
ADJUSTMENT TO THE MINIMUM QUARTERLY DISTRIBUTION AND TARGET DISTRIBUTION LEVELS
In addition to adjusting the minimum quarterly distribution and target
distribution levels to reflect a distribution of capital surplus, if we combine
our units into fewer units or subdivide our units into a greater number of
units, we will proportionately adjust:
- the minimum quarterly distribution;
- target distribution levels;
- unrecovered initial unit price;
- the number of common units issuable during the subordination period
without a unitholder vote; and
- the number of common units into which a subordinated unit is convertible.
For example, if a two-for-one split of the common units should occur, the
minimum quarterly distribution, the target distribution levels and the
unrecovered initial unit price would each be reduced to 50% of its initial
level. We will not make any adjustment by reason of the issuance of additional
units for cash or property.
In addition, if legislation is enacted or if existing law is modified or
interpreted in a manner that causes us to become taxable as a corporation or
otherwise subject to taxation as an entity for federal, state or local income
tax purposes, we will reduce the minimum quarterly distribution and the target
distribution levels by multiplying the same by one minus the sum of the highest
marginal federal corporate income tax rate that could apply and any increase in
the effective overall state and local income tax rates. For
22
example, if we became subject to a maximum marginal federal and effective state
and local income tax rate of 38%, then the minimum quarterly distribution and
the target distribution levels would each be reduced to 62% of their previous
levels.
DISTRIBUTIONS OF CASH UPON LIQUIDATION
If we dissolve in accordance with the partnership agreement, we will sell
or otherwise dispose of our assets in a process called a liquidation. We will
first apply the proceeds of liquidation to the payment of our creditors. We will
distribute any remaining proceeds to the unitholders and our general partner, in
accordance with their capital account balances, as adjusted to reflect any gain
or loss upon the sale or other disposition of our assets in liquidation.
The allocations of gain and loss upon liquidation are intended, to the
extent possible, to entitle the holders of outstanding common units to a
preference over the holders of outstanding subordinated units upon the
liquidation of Valero L.P., to the extent required to permit common unitholders
to receive their unrecovered initial unit price plus the minimum quarterly
distribution for the quarter during which liquidation occurs plus any unpaid
arrearages in payment of the minimum quarterly distribution on the common units.
However, there may not be sufficient gain upon liquidation of Valero L.P. to
enable the holder of common units to fully recover all of these amounts, even
though there may be cash available for distribution to the holders of
subordinated units. Any further net gain recognized upon liquidation will be
allocated in a manner that takes into account the incentive distribution rights
of our general partner.
Manner of Adjustments for Gain. The manner of the adjustment is set forth
in the partnership agreement. If our liquidation occurs before the end of the
subordination period, we will allocate any gain to the partners in the following
manner:
- First, to our general partner and the holders of units who have negative
balances in their capital accounts to the extent of and in proportion to
those negative balances;
- Second, 98% to the common unitholders, pro rata, and 2% to our general
partner, until the capital account for each common unit is equal to the
sum of:
(1) the unrecovered initial unit price for that common unit; plus
(2) the amount of the minimum quarterly distribution for the quarter
during which our liquidation occurs; plus
(3) any unpaid arrearages in payment of the minimum quarterly
distribution on that common unit;
- Third, 98% to the subordinated unitholders, pro rata, and 2% to our
general partner, until the capital account for each subordinated unit is
equal to the sum of:
(1) the unrecovered initial unit price on that subordinated unit; and
(2) the amount of the minimum quarterly distribution for the quarter
during which our liquidation occurs;
- Fourth, 90% to all unitholders, pro rata, 8% to the holders of the
incentive distribution rights, and 2% to our general partner, pro rata,
until we allocate under this paragraph an amount per unit equal to:
(1) the sum of the excess of the first target distribution per unit
over the minimum quarterly distribution per unit for each quarter
of our existence; less
(2) the cumulative amount per unit of any distributions of available
cash from operating surplus in excess of the minimum quarterly
distribution per unit that we distributed 90% to the units, pro
rata, and 10% to our general partner, pro rata, for each quarter of
our existence;
23
- Fifth, 75% to all unitholders, pro rata, 23% to the holders of the
incentive distribution rights, and 2% to our general partner, until we
allocate under this paragraph an amount per unit equal to:
(1) the sum of the excess of the second target distribution per unit
over the first target distribution per unit for each quarter of our
existence; less
(2) the cumulative amount per unit of any distributions of available
cash from operating surplus in excess of the first target
distribution per unit that we distributed 75% to the unitholders,
pro rata, 23% to the holders of the incentive distribution rights,
and 2% to our general partner for each quarter of our existence;
- Thereafter, 50% to all unitholders, pro rata, 48% to the holders of
incentive distribution rights, and 2% to our general partner.
If the liquidation occurs after the end of the subordination period, the
distinction between common units and subordinated units will disappear, so that
clause (3) of the second bullet point above and all of the third bullet point
above will no longer be applicable.
Manner of Adjustments for Losses. Upon our liquidation, we will generally
allocate any loss to the general partner and the unitholders in the following
manner:
- First, 98% to holders of subordinated units in proportion to the positive
balances in their capital accounts and 2% to our general partner until
the capital accounts of the holders of the subordinated units have been
reduced to zero;
- Second, 98% to the holders of common units in proportion to the positive
balances in their capital accounts and 2% to our general partner until
the capital accounts of the common unitholders have been reduced to zero;
and
- Thereafter, 100% to our general partner.
If the liquidation occurs after the end of the subordination period, the
distinction between common units and subordinated units will disappear, so that
all of the first bullet point above will no longer be applicable.
Adjustments to Capital Accounts. We will make adjustments to capital
accounts upon the issuance of additional units. In doing so, we will allocate
any unrealized and, for tax purposes, unrecognized gain or loss resulting from
the adjustments to the unitholders and our general partner in the same manner as
we allocate gain or loss upon liquidation. In the event that we make positive
adjustments to the capital accounts upon the issuance of additional units, we
will allocate any later negative adjustments to the capital accounts resulting
from the issuance of additional units or upon our liquidation in a manner which
results, to the extent possible, in our general partner's capital account
balances equaling the amount which they would have been if no earlier positive
adjustments to the capital accounts had been made.
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DESCRIPTION OF DEBT SECURITIES
The following description sets forth the general terms and provisions that
apply to the debt securities. Each prospectus supplement will state the
particular terms that will apply to the debt securities included in the
supplement.
The debt securities will be either senior debt securities or subordinated
debt securities of Valero Logistics, which does not have any debt securities
outstanding at this time. All debt securities will be unsecured. The senior debt
securities will have the same rank as all of Valero Logistics' other unsecured
and unsubordinated debt. The subordinated debt securities will be subordinated
to senior indebtedness as described under "Provisions Only in the Subordinated
Indenture -- Subordinated Debt Securities Subordinated to Senior Debt" below.
If Valero Logistics offers senior debt securities, it will issue them under
a senior indenture. If Valero Logistics offers subordinated debt securities, it
will issue them under a subordinated indenture. In addition to the following
summary, you should refer to the applicable provisions in the senior indenture
and the subordinated indenture for more detailed information. Valero Logistics
has filed forms of each of the senior indenture and the subordinated indenture
as exhibits to the registration statement of which this prospectus is a part.
Neither indenture limits the aggregate principal amount of debt securities
that Valero Logistics may issue under that indenture. The debt securities may be
issued in one or more series as Valero Logistics may authorize from time to
time.
PARENT GUARANTEE
Valero Logistics' payment obligations under any series of debt securities
will be fully and unconditionally guaranteed by Valero L.P. Valero L.P. will
execute a notation of guarantee as further evidence of its guarantee. The
applicable prospectus supplement will describe the terms of any guarantee by
Valero L.P.
Pursuant to the parent guarantee, Valero L.P. will guarantee the due and
punctual payment of the principal of, and interest and premium, if any, on, the
debt securities of a particular series, when the same shall become due, whether
by acceleration or otherwise. The parent guarantee will be enforceable against
Valero L.P. without any need to first enforce any debt securities against Valero
Logistics.
Valero L.P.'s guarantee of the senior debt securities:
- will be Valero L.P.'s unsecured and unsubordinated general obligation;
and
- will rank on a parity with all of Valero L.P.'s other unsecured and
unsubordinated indebtedness.
If a series of subordinated debt securities is guaranteed by Valero L.P.,
then the guarantee will be subordinated to the senior debt of Valero L.P. to
substantially the same extent as the series of subordinated debt securities is
subordinated to the senior debt of Valero Logistics.
SPECIFIC TERMS OF EACH SERIES OF DEBT SECURITIES IN THE PROSPECTUS SUPPLEMENT
Valero Logistics will prepare a prospectus supplement and a supplemental
indenture or authorizing resolutions relating to any series of debt securities
being offered, which will include specific terms relating to such debt
securities. These terms will include some or all of the following:
- the form and title of the debt securities;
- the total principal amount of the debt securities;
- the date or dates on which the debt securities may be issued;
- whether the debt securities are senior or subordinated debt securities;
- the currency or currencies in which principal and interest will be paid,
if not U.S. dollars;
25
- the portion of the principal amount which will be payable if the maturity
of the debt securities is accelerated;
- any right Valero Logistics may have to defer payments of interest by
extending the dates payments are due and whether interest on those
deferred amounts will be payable as well;
- the dates on which the principal of the debt securities will be payable;
- the interest rate that the debt securities will bear and the interest
payment dates for the debt securities;
- any conversion or exchange provisions;
- any optional redemption provisions;
- any sinking fund or other provisions that would obligate Valero Logistics
to repurchase or otherwise redeem the debt securities;
- any changes to or additional events of default or covenants;
- the subordination, if any, of the debt securities and any changes to the
subordination provisions of the subordinated indenture; and
- any other terms of the debt securities.
PROVISIONS ONLY IN THE SENIOR INDENTURE
SUMMARY
The senior debt securities will rank equally in right of payment with all
other senior and unsubordinated debt of Valero Logistics and senior in right of
payment to any subordinated debt (including the subordinated debt securities) of
Valero Logistics. The senior indenture will contain restrictive covenants,
including provisions that:
- limit the ability of Valero Logistics to put liens on any of its property
or assets; and
- limit the ability of Valero Logistics to sell and lease back its
principal assets.
Subordinated debt securities issued under the subordinated indenture may or
may not be subject to similar provisions, as will be specified in the applicable
prospectus supplement. Valero Logistics has described below these provisions and
some of the defined terms used in them.
LIMITATION ON LIENS
The senior indenture will provide that Valero Logistics will not, nor will
it permit any subsidiary to, create, assume, incur or suffer to exist any lien
upon any property or assets, whether owned or leased on the date of the senior
indenture or thereafter acquired, to secure any of its debt or debt of any other
person (other than the senior debt securities issued thereunder), without in any
such case making effective provision whereby all of the senior debt securities
outstanding thereunder shall be secured equally and ratably with, or prior to,
such debt so long as such debt shall be so secured.
This restriction does not apply to:
1. Permitted Liens, as defined below;
2. any lien upon any property or assets of Valero Logistics or any
subsidiary in existence on the date the senior debt securities of
such series are first issued or created pursuant to an "after-
acquired property" clause or similar term or provided for pursuant
to agreements existing on such date;
3. any lien upon any property or assets created at the time of
acquisition of such property or assets by Valero Logistics or any
subsidiary or within one year after such time to secure all
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or a portion of the purchase price for such property or assets or
debt incurred to finance such purchase price, whether such debt was
incurred prior to, at the time of or within one year after the date
of such acquisition;
4. any lien upon any property or assets existing thereon at the time of
the acquisition thereof by Valero Logistics or any subsidiary;
provided, however, that such lien only encumbers the property or
assets so acquired;
5. any lien upon any property or assets of a person existing thereon at
the time such person becomes a subsidiary by acquisition, merger or
otherwise; provided, however, that such lien only encumbers the
property or assets of such person at the time such person becomes a
subsidiary;
6. any lien upon any property or assets to secure all or part of the
cost of construction, development, repair or improvements thereon or
to secure debt incurred prior to, at the time of, or within one year
after completion of such construction, development, repair or
improvements or the commencement of full operations thereof,
whichever is later, to provide funds for any such purpose;
7. liens imposed by law or order as a result of any proceeding before
any court or regulatory body that is being contested in good faith,
and liens which secure a judgment or other court-ordered award or
settlement as to which Valero Logistics or the applicable subsidiary
has not exhausted its appellate rights;
8. any lien upon any additions, improvements, replacements, repairs,
fixtures, appurtenances or component parts thereof attaching to or
required to be attached to property or assets pursuant to the terms
of any mortgage, pledge agreement, security agreement or other
similar instrument creating a lien upon such property or assets
permitted by clauses (1) through (7) above;
9. any extension, renewal, refinancing, refunding or replacement (or
successive extensions, renewals, refinancings, refundings or
replacements) of any lien, in whole or in part, referred to in
clauses (1) through (8), inclusive, above; provided, however, that
the principal amount of debt secured thereby shall not exceed the
principal amount of debt so secured at the time of such extension,
renewal, refinancing, refunding or replacement (plus in each case
the aggregate amount of premiums, other payments, costs and expenses
required to be paid or incurred in connection with such extension,
renewal, refinancing, refunding or replacement); provided, further,
however, that such extension, renewal, refinancing, refunding or
replacement lien shall be limited to all or a part of the property
(including improvements, alterations and repairs on such property)
subject to the encumbrance so extended, renewed, refinanced,
refunded or replaced (plus improvements, alterations and repairs on
such property); or
10. any lien resulting from the deposit of moneys or evidence of
indebtedness in trust for the purpose of defeasing debt of Valero
Logistics or any subsidiary.
Notwithstanding the foregoing, Valero Logistics may, and may permit any
subsidiary to, create, assume, incur, or suffer to exist any lien upon any
property or assets to secure its debt or debt of any person (other than the
senior debt securities) that is not excepted by clauses (1) through (10),
inclusive, above without securing the senior debt securities issued under the
senior indenture, provided that the aggregate principal amount of all debt then
outstanding secured by such lien and all similar liens, together with all
Attributable Indebtedness, as defined below, from Sale-Leaseback Transactions,
as defined below (excluding Sale-Leaseback Transactions permitted by clauses (1)
through (4), inclusive, of the first paragraph of the restriction on
sale-leasebacks covenant described below) does not exceed 10% of Consolidated
Net Tangible Assets (as defined below).
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"Permitted Liens" means:
1. Liens upon rights-of-way for pipeline purposes created by a person
other than Valero Logistics;
2. any statutory or governmental lien or lien arising by operation of
law, or any mechanics', repairmen's, materialmen's, suppliers',
carriers', landlords', warehousemen's or similar lien incurred in
the ordinary course of business which is not yet due or which is
being contested in good faith by appropriate proceedings and any
undetermined lien which is incidental to construction, development,
improvement or repair;
3. the right reserved to, or vested in, any municipality or public
authority by the terms of any right, power, franchise, grant,
license, permit or by any provision of law, to purchase or recapture
or to designate a purchaser of, any property;
4. liens of taxes and assessments which are (A) for the then current
year, (B) not at the time delinquent, or (C) delinquent but the
validity of which is being contested in good faith at the time by
Valero Logistics or any subsidiary;
5. liens of, or to secure the performance of, leases, other than
capital leases;
6. any lien upon, or deposits of, any assets in favor of any surety
company or clerk of court for the purpose of obtaining indemnity or
stay of judicial proceedings;
7. any lien upon property or assets acquired or sold by Valero
Logistics or any subsidiary resulting from the exercise of any
rights arising out of defaults on receivables;
8. any lien incurred in the ordinary course of business in connection
with worker's compensation, unemployment insurance, temporary
disability, social security, retiree health or similar laws or
regulations or to secure obligations imposed by statute or
governmental regulations;
9. any lien in favor of Valero Logistics or any subsidiary;
10. any lien in favor of the United States of America or any state
thereof, or any department, agency or instrumentality or political
subdivision of the United States of America or any state thereof, to
secure partial, progress, advance, or other payments pursuant to any
contract or statute, or any debt incurred by Valero Logistics or any
subsidiary for the purpose of financing all or any part of the
purchase price of, or the cost of constructing, developing,
repairing or improving, the property or assets subject to such lien;
11. any lien securing industrial development, pollution control or
similar revenue bonds;
12. any lien securing debt of Valero Logistics or any subsidiary, all or
a portion of the net proceeds of which are used, substantially
concurrent with the funding thereof (and for purposes of determining
such "substantial concurrence," taking into consideration, among
other things, required notices to be given to holders of outstanding
senior debt securities under the senior indenture in connection with
such refunding, refinancing or repurchase, and the required
corresponding durations thereof), to refinance, refund or repurchase
all outstanding senior debt securities under the senior indenture
including the amount of all accrued interest thereon and reasonable
fees and expenses and premium, if any, incurred by Valero Logistics
or any subsidiary in connection therewith;
13. liens in favor of any person to secure obligations under the
provisions of any letters of credit, bank guarantees, bonds or
surety obligations required or requested by any governmental
authority in connection with any contract or statute; or
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14. any lien upon or deposits of any assets to secure performance of
bids, trade contracts, leases or statutory obligations.
"Consolidated Net Tangible Assets" means, at any date of determination, the
total amount of assets after deducting therefrom:
- all current liabilities, excluding (A) any current liabilities that by
their terms are extendable or renewable at the option of the obligor
thereon to a time more than 12 months after the time as of which the
amount thereof is being computed, and (B) current maturities of long-term
debt, and
- the value, net of any applicable amortization, of all goodwill, trade
names, trademarks, patents, unamortized debt discount and expense and
other like intangible assets,
all as set forth on the consolidated balance sheet of Valero L.P. for its most
recently completed fiscal quarter, prepared in accordance with United States
generally accepted accounting principles.
RESTRICTIONS ON SALE-LEASEBACKS
The senior indenture will provide that Valero Logistics will not, and will
not permit any subsidiary to, engage in the sale or transfer by Valero Logistics
or any subsidiary of any property or assets to a person (other than Valero
Logistics or a subsidiary) and the taking back by Valero Logistics or any
subsidiary, as the case may be, of a lease of such property or assets (a
"Sale-Leaseback Transaction"), unless:
1. the Sale-Leaseback Transaction occurs within one year from the date
of completion of the acquisition of the property or assets subject
thereto or the date of the completion of construction, development
or substantial repair or improvement, or commencement of full
operations on such property or assets, whichever is later;
2. the Sale-Leaseback Transaction involves a lease for a period,
including renewals, of not more than three years;
3. Valero Logistics or such subsidiary would be entitled to incur debt
secured by a lien on the property or assets subject thereto in a
principal amount equal to or exceeding the Attributable Indebtedness
from such Sale-Leaseback Transaction without equally and ratably
securing the senior debt securities issued under the senior
indenture; or
4. Valero Logistics or such subsidiary, within a one-year period after
such Sale-Leaseback Transaction, applies or causes to be applied an
amount not less than the Attributable Indebtedness from such
Sale-Leaseback Transaction to (A) the prepayment, repayment,
redemption, reduction or retirement of Pari Passu Debt of Valero
Logistics, or (B) the expenditure or expenditures for property or
assets used or to be used in the ordinary course of business of
Valero Logistics or its subsidiaries.
Notwithstanding the foregoing, Valero Logistics may, and may permit any of
its subsidiaries to, effect any Sale-Leaseback Transaction that is not excepted
by clauses (1) through (4), inclusive, above; provided that the Attributable
Indebtedness from the Sale-Leaseback Transaction, together with the aggregate
principal amount of then outstanding debt other than the senior debt securities
secured by liens upon any property or assets of Valero Logistics or its
subsidiaries not excepted by clauses (1) through (10), inclusive, of the second
paragraph of the limitation on liens covenant described above, do not exceed 10%
of the Consolidated Net Tangible Assets.
"Attributable Indebtedness," when used with respect to any Sale-Leaseback
Transaction, means, as at the time of determination, the present value,
discounted at the rate set forth or implicit in the terms of the lease included
in the transaction, of the total obligations of the lessee for rental payments,
other than amounts required to be paid on account of property taxes,
maintenance, repairs, insurance, assessments, utilities, operating and labor
costs and other items that constitute payments for property rights, during the
remaining term of the lease included in the Sale-Leaseback Transaction,
including any period for which the lease has been extended. In the case of any
lease that is terminable by the lessee upon the payment of
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a penalty or other termination payment, the amount shall be the lesser of the
amount determined assuming termination upon the first date the lease may be
terminated, in which case the amount shall also include the amount of the
penalty or termination payment, but no rent shall be considered as required to
be paid under the lease subsequent to the first date upon which it may be so
terminated, or the amount determined assuming no termination.
"Pari Passu Debt" means any debt of Valero Logistics, whether outstanding
on the date any senior debt securities are issued under the senior indenture or
thereafter created, incurred or assumed, unless in the case of any particular
debt, the instrument creating or evidencing the same or pursuant to which the
same is outstanding expressly provides that such debt shall be subordinated in
right of payment to the senior debt securities.
PROVISIONS ONLY IN THE SUBORDINATED INDENTURE
SUBORDINATED DEBT SECURITIES SUBORDINATED TO SENIOR DEBT
The subordinated debt securities will rank junior in right of payment to
all of the Senior Debt of Valero Logistics. "Senior Debt" is generally defined
to include all notes or other evidences of indebtedness for money, including
guarantees, borrowed by Valero Logistics, that are not expressly subordinate or
junior in right of payment to any other indebtedness of Valero Logistics.
PAYMENT BLOCKAGES
The subordinated indenture will provide that no payment of principal,
interest and any premium on the subordinated debt securities may be made in the
event that Valero Logistics fails to pay when due any amounts on any Senior Debt
and in other instances specified in the subordinated indenture.
NO LIMITATION ON AMOUNT OF SENIOR DEBT
The subordinated indenture will not limit the amount of Senior Debt that
Valero Logistics may incur.
CONSOLIDATION, MERGER OR ASSET SALE
Pursuant to each of the indentures, Valero Logistics may not consolidate
with or merge into any other entity or sell, lease or transfer its properties
and assets as, or substantially as, an entirety to, any entity, unless:
- (a) in the case of a merger, Valero Logistics is the surviving entity, or
(b) the entity formed by such consolidation or into which Valero
Logistics is merged or the entity which acquires by sale or transfer, or
which leases, Valero Logistics' properties and assets as, or
substantially as, an entirety expressly assumes the due and punctual
payment of the principal of and any premium and interest on all the debt
securities under the applicable indenture and the performance or
observance of every covenant of the applicable indenture on the part of
Valero Logistics to be performed or observed and shall have expressly
provided for conversion rights in respect of any series of outstanding
securities with conversion rights;
- the surviving entity or successor entity is an entity organized and
existing under the laws of the United States of America, any state
thereof or the District of Columbia;
- immediately after giving effect to such transaction, no default or event
of default shall have occurred and be continuing under the applicable
indenture; and
- Valero Logistics has delivered to the trustee under the applicable
indenture an officers' certificate and an opinion of counsel regarding
compliance with the terms of the applicable indenture.
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MODIFICATION OF INDENTURES
Valero Logistics may modify or amend each indenture if the holders of a
majority in principal amount of the outstanding debt securities of all series
issued under the indenture affected by the modification or amendment consent to
it. Without the consent of the holders of each outstanding debt security
affected, however, generally no modification may:
- change the stated maturity of the principal of or any installment of
principal of or interest on any debt security;
- reduce the principal amount of, the interest rate on or the premium
payable upon redemption of any debt security;
- change the redemption date for any debt security;
- reduce the principal amount of an original issue discount debt security
payable upon acceleration of maturity;
- change the place of payment where any debt security or any premium or
interest on any debt security is payable;
- change the coin or currency in which any debt security or any premium or
interest on any debt security is payable;
- impair the right to institute suit for the enforcement of any payment on
any debt security;
- modify the provisions of the applicable indenture in a manner adversely
affecting any right to convert or exchange any debt security into another
security;
- reduce the percentage in principal amount of outstanding debt securities
of any series necessary to modify the applicable indenture, to waive
compliance with certain provisions of the applicable indenture or to
waive certain defaults and their consequences; or
- modify any of the above provisions.
Valero Logistics may modify or amend each indenture without the consent of
any holders of the debt securities in certain circumstances, including:
- to provide for the assumption of obligations of Valero Logistics under
such indenture and the debt securities issued thereunder by a successor;
- to provide for the assumption of Valero L.P.'s guarantee under such
indenture by a successor;
- to add covenants and events of default or to surrender any rights Valero
Logistics has under such indenture;
- to secure the senior debt securities as described above under "Provisions
Only in the Senior Indenture -- Limitations on Liens;"
- to make any change that does not adversely affect any outstanding debt
securities of a series in any material respect;
- to supplement such indenture in order to establish a new series of debt
securities under such indenture;
- to provide for successor trustees;
- to cure any ambiguity, omission, defect or inconsistency;
- to provide for uncertificated securities in addition to certificated
securities;
- to supplement any provision of such indenture necessary to permit or
facilitate the defeasance and discharge of any series of debt securities
issued thereunder so long as that action does not adversely affect the
interests of the holders of any outstanding debt securities issued
thereunder;
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- to comply with the rules or regulations of any securities exchange or
automated quotation system on which any of the debt securities issued
thereunder may be listed or traded; and
- to qualify such indenture under the Trust Indenture Act.
The holders of a majority in principal amount of the outstanding debt
securities of any series issued under either of the indentures may waive past
defaults, with respect to such series, under such indenture. The holders of a
majority in principal amount of the outstanding debt securities of all affected
series issued under either of the indentures (voting as one class) may waive
compliance by Valero Logistics with its covenants with respect to the debt
securities of those series. Those holders may not, however, waive any default in
any payment on any debt security of that series or compliance with a provision
that cannot be modified or amended without the consent of each holder affected.
EVENTS OF DEFAULT AND REMEDIES
"Event of Default" when used in each indenture, means any of the following
with respect to debt securities of any series:
- failure to pay interest on any debt security of that series for 30 days;
- failure to pay the principal of or any premium on any debt security of
that series when due;
- failure to perform any other covenant or warranty in such indenture
(other than a term, covenant or warranty a default in whose performance
or whose breach is elsewhere in this event of default section
specifically dealt with or which has expressly been included in the
applicable indenture solely for the benefit of a series of debt
securities other than that series) that continues for 60 days after
written notice is given to Valero Logistics by the trustee or to Valero
Logistics and the trustee by the holders of at least 25% in principal
amount of the outstanding debt securities of the series, specifying such
default and requiring it to be remedied and stating that such notice is a
"Notice of Default" under the applicable indenture;
- failure to pay any indebtedness of Valero Logistics for borrowed money in
excess of $25 million, whether at final maturity (after the expiration of
any applicable grace periods) or upon acceleration of the maturity
thereof, if such indebtedness is not discharged, or such acceleration is
not annulled, within 10 days after written notice is given to Valero
Logistics by the trustee or to Valero Logistics and the trustee by the
holders of at least 25% in principal amount of the outstanding debt
securities of the series, specifying such default and requiring it to be
remedied and stating that such notice is a "Notice of Default" under the
applicable indenture;
- certain events of bankruptcy, insolvency or reorganization of Valero
Logistics; or
- any other Event of Default with respect to debt securities of that series
included in such indenture or supplemental indenture.
The subordination provisions of the subordinated indenture do not affect
the obligation of Valero Logistics, which is absolute and unconditional, to pay,
when due, the principal of and any premium and interest on the subordinated debt
securities. In addition, such subordination provisions do not prevent the
occurrence of any default under the subordinated indenture.
An Event of Default for a particular series of debt securities does not
necessarily constitute an Event of Default for any other series of debt
securities issued under either indenture. The trustee may withhold notice to the
holders of debt securities of any default, except in the payment of principal or
interest, if it considers such withholding of notice to be in the best interests
of the holders.
If an Event of Default for any series of debt securities occurs and
continues, the trustee or the holders of at least 25% in aggregate principal
amount of the debt securities of the series may declare the entire principal of
(or, if any of the debt securities of that series are original issue discount
debt securities, the portion of the principal specified in the terms of those
securities), and accrued but unpaid interest, if any, on all the debt securities
of that series to be due and payable immediately. If this happens, subject to
32
certain conditions, the holders of a majority of the aggregate principal amount
of the debt securities of that series can rescind the declaration. If an event
of default relating to certain events of bankruptcy, insolvency or
reorganization occurs, the entire principal of all the outstanding notes shall
be due and payable immediately without further action or notice.
Other than its duties in case of a default, a trustee is not obligated to
exercise any of its rights or powers under either indenture at the request,
order or direction of any holders, unless the holders offer the trustee
reasonable indemnity. If they provide this reasonable indemnification, the
holders of a majority in principal amount of any series of debt securities may,
subject to certain limitations, direct the time, method and place of conducting
any proceeding or any remedy available to the trustee, or exercising any power
conferred upon the trustee, for any series of debt securities.
REGISTRATION OF DEBT SECURITIES
Valero Logistics may issue debt securities of a series in registered,
bearer, coupon or global form.
MINIMUM DENOMINATIONS
Unless the prospectus supplement for each issuance of debt securities
states otherwise, the debt securities will be issued in registered form in
amounts of $1,000 each or multiples of $1,000.
NO PERSONAL LIABILITY OF GENERAL PARTNER
Unless otherwise stated in a prospectus supplement and supplemental
indenture relating to a series of debt securities being offered, the general
partner of Valero Logistics and its directors, officers, employees and
stockholders (in their capacity as such) will not have any liability for its
obligations under the indentures or the debt securities. In addition, Valero GP,
LLC, the general partner of Valero L.P.'s general partner, and the directors,
officers, employees and members of Valero GP, LLC will not have any liability
for Valero L.P.'s obligations as a guarantor under the indentures or the debt
securities. Each holder of debt securities by accepting a debt security waives
and releases all such liability. The waiver and release are part of the
consideration for the issuance of the debt securities. This waiver may not be
effective, however, to waive liabilities under the federal securities laws and
it is the view of the SEC that such a waiver is against public policy.
PAYMENT AND TRANSFER
Principal, interest and any premium on fully registered securities will be
paid at designated places. Payment will be made by check mailed to the persons
in whose names the debt securities are registered on days specified in the
indentures or any prospectus supplement. Debt securities payments in other forms
will be paid at a place designated by Valero Logistics and specified in a
prospectus supplement.
Fully registered securities may be transferred or exchanged at the
corporate trust office of the trustee or at any other office or agency
maintained by Valero Logistics for such purposes, without the payment of any
service charge except for any tax or governmental charge.
FORM, EXCHANGE, REGISTRATION AND TRANSFER
Debt securities of any series will be exchangeable for other debt
securities of the same series, the same total principal amount and the same
terms but in different authorized denominations in accordance with the
applicable indenture. Holders may present debt securities for registration of
transfer at the office of the security registrar or any transfer agent Valero
Logistics designates. The security registrar or transfer agent will effect the
transfer or exchange when it is satisfied with the documents of title and
identity of the person making the request. Valero Logistics will not charge a
service charge for any registration of transfer or exchange of the debt
securities. Valero Logistics may, however, require the payment of any tax or
other governmental charge payable for that registration.
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Valero Logistics will appoint the trustee under each indenture as security
registrar for the debt securities issued under that indenture. Valero Logistics
is required to maintain an office or agency for transfers and exchanges in each
place of payment. Valero Logistics may at any time designate additional transfer
agents for any series of debt securities. In the case of any redemption in part,
Valero Logistics will not be required
- to issue, register the transfer of or exchange debt securities of a
series either during a period beginning 15 business days prior to the
selection of debt securities of that series for redemption and ending on
the close of business on the day of mailing of the relevant notice of
redemption or
- to register the transfer of or exchange any debt security, or portion of
any debt security, called for redemption, except the unredeemed portion
of any debt security Valero Logistics is redeeming in part.
DISCHARGING VALERO LOGISTICS' OBLIGATIONS
Valero Logistics may choose to either discharge its obligations on the debt
securities of any series in a legal defeasance, or to release itself from its
covenant restrictions on the debt securities of any series in a covenant
defeasance. Valero Logistics may do so at any time on the 91st day after it
deposits with the applicable trustee sufficient cash or government securities to
pay the principal, interest, any premium and any other sums due on the stated
maturity date or a redemption date of the debt securities of the series. If
Valero Logistics chooses the legal defeasance option, the holders of the debt
securities of the series will not be entitled to the benefits of the applicable
indenture except for registration of transfer and exchange of debt securities,
replacement of lost, stolen or mutilated debt securities, conversion or exchange
of debt securities, sinking fund payments and receipt of principal and interest
on the original stated due dates or specified redemption dates.
Valero Logistics may discharge its obligations under the indentures or
release itself from covenant restrictions only if it meets certain requirements.
Among other things, Valero Logistics must deliver to the trustee an opinion of
its legal counsel to the effect that holders of the series of debt securities
will not recognize income, gain or loss for federal income tax purposes as a
result of such defeasance and will be subject to federal income tax on the same
amount and in the same manner and at the same times as would have been the case
if such deposit and defeasance had not occurred. In the case of legal defeasance
only, this opinion must be based on either a ruling received from or published
by the IRS or change in federal income tax law. Valero Logistics may not have a
default on the debt securities discharged on the date of deposit. The discharge
may not violate any of its agreements. The discharge may not result in Valero
Logistics becoming an investment company in violation of the Investment Company
Act of 1940.
THE TRUSTEE
RESIGNATION OR REMOVAL OF TRUSTEE
Under provisions of the indentures and the Trust Indenture Act of 1939, as
amended, governing trustee conflicts of interest, any uncured Event of Default
with respect to any series of senior debt securities will force the trustee to
resign as trustee under either the subordinated indenture or the senior
indenture. Also, any uncured Event of Default with respect to any series of
subordinated debt securities will force the trustee to resign as trustee under
either the senior indenture or the subordinated indenture. Any resignation will
require the appointment of a successor trustee under the applicable indenture in
accordance with the terms and conditions of such indenture. Valero Logistics may
appoint a separate trustee for any series of debt securities. The term "trustee"
refers to the trustee appointed with respect to any such series of debt
securities. The holders of a majority in aggregate principal amount of the debt
securities of any series may remove the trustee with respect to the debt
securities of such series.
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LIMITATIONS ON TRUSTEE IF IT IS A CREDITOR OF VALERO LOGISTICS
There are limitations on the right of the trustee, in the event that it
becomes a creditor of Valero Logistics, to obtain payment of claims in certain
cases, or to realize on certain property received in respect of any such claim
as security or otherwise.
ANNUAL TRUSTEE REPORT TO HOLDERS OF DEBT SECURITIES
The trustee is required to submit an annual report to the holders of the
debt securities regarding, among other things, the trustee's eligibility to
serve as such, the priority of the trustee's claims regarding certain advances
made by it, and any action taken by the trustee materially affecting the debt
securities.
CERTIFICATES AND OPINIONS TO BE FURNISHED TO TRUSTEE
Every application by Valero Logistics for action by the trustee shall be
accompanied by a certificate of certain of Valero Logistics' officers and an
opinion of counsel (who may be Valero Logistics' counsel) stating that, in the
opinion of the signers, all conditions precedent to such action have been
complied with by Valero Logistics.
GOVERNING LAW
The indentures and the debt securities will be governed by the laws of the
State of New York.
BOOK ENTRY, DELIVERY AND FORM
The debt securities of a series may be issued in whole or in part in the
form of one or more global certificates that will be deposited with a depositary
identified in a prospectus supplement.
Unless otherwise stated in any prospectus supplement, The Depository Trust
Company (DTC) will act as depositary. Book-entry notes of a series will be
issued in the form of a global note that will be deposited with or on behalf of
DTC. This means that Valero Logistics will not issue certificates to each
holder. One or more global notes will be issued to DTC who will keep a
computerized record of its participants (for example, a broker) whose clients
have purchased the notes. The participant will then keep a record of its clients
who purchased the notes. Unless it is exchanged in whole or in part for a
certificated note, a global note may not be transferred; except that DTC, its
nominees and their successors may transfer a global note as a whole to one
another.
Beneficial interests in global notes will be shown on, and transfers of
global notes will be made only through, records maintained by DTC and its
participants.
DTC advises us that it is:
- a limited-purpose trust company organized under the New York Banking Law;
- a "banking organization" within the meaning of the New York Banking Law;
- a member of the United States Federal Reserve System;
- a "clearing corporation" within the meaning of the New York Uniform
Commercial Code; and
- a "clearing agency" registered under the provisions of Section 17A of the
Exchange Act.
DTC holds securities that its participants ("Direct Participants") deposit
with DTC. DTC also records the settlement among Direct Participants of
securities transactions, such as transfers and pledges, in deposited securities
through computerized records for Direct Participants' accounts. This eliminates
the need to exchange certificates. Direct Participants include securities
brokers and dealers, banks, trust companies, clearing corporations and certain
other organizations.
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DTC's book-entry system is also used by other organizations such as
securities brokers and dealers, banks and trust companies that work through a
Direct Participant. The rules that apply to DTC and its participants are on file
with the SEC.
DTC is owned by a number of its Direct Participants and by the New York
Stock Exchange, Inc., The American Stock Exchange, Inc. and the National
Association of Securities Dealers, Inc.
Valero Logistics will wire principal and interest payments on the global
notes to DTC's nominee. Valero Logistics and the trustee will treat DTC's
nominee as the owner of the global notes for all purposes. Accordingly, Valero
Logistics, the trustee and any paying agent will have no direct responsibility
or liability to pay amounts due on the global notes to owners of beneficial
interests in the global notes.
It is DTC's current practice, upon receipt of any payment of principal or
interest on the global notes, to credit Direct Participants' accounts on the
payment date according to their respective holdings of beneficial interests in
the global notes as shown on DTC's records. In addition, it is DTC's current
practice to assign any consenting or voting rights to Direct Participants whose
accounts are credited with notes on a record date, by using an omnibus proxy.
Payments by participants to owners of beneficial interests in the global notes,
and voting by participants, will be governed by the customary practices between
the participants and owners of beneficial interests, as is the case with notes
held for the account of customers registered in "street name." However, payments
will be the responsibility of the participants and not of DTC, the trustee or
Valero Logistics.
Debt securities represented by a global note will be exchangeable for
certificated notes with the same terms in authorized denominations only if:
- DTC notifies Valero Logistics that it is unwilling or unable to continue
as depositary or if DTC ceases to be a clearing agency registered under
applicable law and a successor depositary is not appointed by Valero
Logistics within 90 days; or
- Valero Logistics determines not to require all of the debt securities of
a series to be represented by a global note and notifies the trustee of
the decision of Valero Logistics.
36
TAX CONSIDERATIONS
This section is a summary of the material tax considerations that may be
relevant to an investment in our securities and, unless otherwise noted in the
following discussion, expresses the opinion of Andrews & Kurth Mayor, Day,
Caldwell & Keeton L.L.P., our tax counsel, insofar as it relates to matters of
United States federal income tax law and legal conclusions with respect to those
matters. This section is based upon current provisions of the Internal Revenue
Code, existing and proposed regulations and current administrative rulings and
court decisions, all of which are subject to change. Later changes in these
authorities may cause the tax consequences to vary substantially from the
consequences described below. Unless the context otherwise requires, references
in this section to us are references to both Valero L.P. and Valero Logistics.
No attempt has been made in the following discussion to comment on all
federal income tax matters affecting us or the unitholders. Moreover, the
discussion focuses on unitholders who are individual citizens or residents of
the United States and has only limited application to corporations, estates,
trusts, non-resident aliens or other unitholders subject to specialized tax
treatment, such as tax-exempt institutions, foreign persons, individual
retirement accounts, real estate investment trusts or mutual funds. Accordingly,
we recommend that you consult, and depend on your own tax advisor in analyzing
the federal, state, local and foreign tax consequences to you of an investment
in our securities.
All statements as to matters of law and legal conclusions, but not as to
factual matters, contained in this section, unless otherwise noted, are the
opinion of counsel and are based on the accuracy of the representations we make.
No ruling has been or will be requested from the IRS regarding any matter
affecting us or prospective unitholders. An opinion of counsel represents only
that counsel's best legal judgment and does not bind the IRS or the courts.
Accordingly, the opinions and statements made here may not be sustained by a
court if contested by the IRS. Any contest of this sort with the IRS may
materially and adversely impact the market for the common units and the prices
at which the common units trade. In addition, the costs of any contest with the
IRS will be borne directly or indirectly by the unitholders and the general
partner. Furthermore, the treatment of us, or an investment in us, may be
significantly modified by future legislative or administrative changes or court
decisions. Any modifications may or may not be retroactively applied.
For the reasons described below, counsel has not rendered an opinion with
respect to the following specific federal income tax issues:
1. the treatment of a unitholder whose common units are loaned to a
short seller to cover a short sale of common units (please read "-- Tax
Treatment of Unitholders -- Treatment of Short Sales");
2. whether our monthly convention for allocating taxable income and
losses is permitted by existing Treasury Regulations (please read
"-- Disposition of Common Units -- Allocations Between Transferors and
Transferees"); and
3. whether our method for depreciating Section 743 adjustments is
sustainable (please read "-- Disposition of Common Units -- Section 754
Election").
PARTNERSHIP STATUS
A partnership is not a taxable entity and incurs no federal income tax
liability. Instead, each partner is required to take into account his allocable
share of items of income, gain, loss, and deduction of the partnership in
computing his federal income tax liability, regardless of whether cash
distributions are made. Distributions of cash by a partnership to a partner are
generally not taxable unless the amount of cash distributed to a partner is in
excess of the partner's adjusted basis in his partnership interest.
No ruling has been or will be sought from the IRS with respect to our, or
Valero Logistics', classification as a partnership for federal income tax
purposes or whether our operations generate "qualifying income" under Section
7704 of the Internal Revenue Code or any other matter affecting us or
37
prospective unitholders. Instead, we have relied on the opinion of counsel that,
based upon the Internal Revenue Code, Treasury Regulations, published revenue
rulings and court decisions and the representations described below, each of
Valero L.P. and Valero Logistics has been and will continue to be classified as
a partnership for federal income tax purposes.
In rendering its opinion that we have been and will continue to be treated
as partnerships for federal income tax purposes, Andrews & Kurth Mayor, Day,
Caldwell & Keeton L.L.P. has relied on the following factual representations and
covenants made by us and the general partner:
- Neither Valero L.P. nor Valero Logistics has elected or will elect to be
treated as an association or corporation;
- Valero L.P. and Valero Logistics have been and will be operated in
accordance with all applicable partnership statutes, the applicable
partnership agreement and in the manner described in this prospectus; and
- For each taxable year, more than 90% of our gross income has been and
will be derived from the exploration, development, production,
processing, refining, transportation, storage or marketing of any mineral
or natural resource, including oil, gas, or products thereof which come
from either a crude oil refinery or a natural gas processing facility, or
other items of income as to which counsel has opined or will opine are
"qualifying income" within the meaning of Section 7704(d) of the Internal
Revenue Code.
Section 7704 of the Internal Revenue Code provides that publicly-traded
partnerships will, as a general rule, be taxed as corporations. However, an
exception, referred to as the "qualifying income exception," exists with respect
to publicly-traded partnerships of which 90% or more of the gross income for
every taxable year consists of "qualifying income." Qualifying income includes
income and gains derived from the transportation and marketing of crude oil,
natural gas, and products thereof. Other types of qualifying income include
interest from other than a financial business, dividends, gains from the sale of
real property, and gains from the sale or other disposition of capital assets
held for the production of income that otherwise constitutes qualifying income.
We estimate that less than 4% of our current income is not qualifying income;
however, this estimate could change from time to time. Based upon and subject to
this estimate, the factual representations made by us and the general partner
and a review of the applicable legal authorities, counsel is of the opinion that
at least 90% of our gross income constitutes qualifying income.
If we fail to meet the qualifying income exception, other than a failure
which is determined by the IRS to be inadvertent and which is cured within a
reasonable time after discovery, we will be treated as if we had transferred all
of our assets, subject to liabilities, to a newly formed corporation, on the
first day of the year in which we fail to meet the qualifying income exception,
in return for stock in that corporation, and then distributed that stock to the
partners in liquidation of their interests in us. This contribution and
liquidation should be tax-free to us and the unitholders so long as we, at that
time, do not have liabilities in excess of the tax basis of our assets.
Thereafter, we would be treated as a corporation for federal income tax
purposes.
If Valero L.P. or Valero Logistics were treated as an association taxable
as a corporation in any taxable year, either as a result of a failure to meet
the qualifying income exception or otherwise, its items of income, gain, loss
and deduction would be reflected only on its tax return rather than being passed
through to the unitholders, and its net income would be taxed at corporate
rates. In addition, any distributions we made to a unitholder would be treated
as either taxable dividend income, to the extent of Valero L.P.'s current or
accumulated earnings and profits, or, in the absence of earnings and profits, a
nontaxable return of capital, to the extent of the unitholder's tax basis in his
common units, or taxable capital gain, after the unitholder's tax basis in the
common units is reduced to zero. Accordingly, treatment of either Valero L.P. or
Valero Logistics as an association taxable as a corporation would result in a
material reduction in a unitholder's cash flow and after-tax return and thus
would likely result in a substantial reduction of the value of the common units.
38
The discussion below is based on Andrews & Kurth Mayor, Day, Caldwell &
Keeton L.L.P.'s opinion that we will be classified as a partnership for federal
income tax purposes.
TAX TREATMENT OF UNITHOLDERS
Limited Partner Status. Unitholders who have become limited partners of
Valero L.P. will be treated as partners of Valero L.P. for federal income tax
purposes. Assignees who have executed and delivered transfer applications, and
are awaiting admission as limited partners, and unitholders whose common units
are held in street name or by a nominee and who have the right to direct the
nominee in the exercise of all substantive rights attendant to the ownership of
their common units will also be treated as partners of Valero L.P. for federal
income tax purposes. Because there is no direct authority addressing assignees
of common units who are entitled to execute and deliver transfer applications
and thereby become entitled to direct the exercise of attendant rights, but who
fail to execute and deliver transfer applications, counsel's opinion does not
extend to these persons. Furthermore, a purchaser or other transferee of common
units who does not execute and deliver a transfer application may not receive
some federal income tax information or reports furnished to record holders of
common units unless the common units are held in a nominee or street name
account and the nominee or broker has executed and delivered a transfer
application for those common units.
A beneficial owner of common units whose common units have been transferred
to a short seller to complete a short sale would appear to lose his status as a
partner with respect to these common units for federal income tax purposes.
Please read "-- Treatment of Short Sales."
Income, gain, deductions, or losses would not appear to be reportable by a
unitholder who is not a partner for federal income tax purposes, and any cash
distributions received by a unitholder who is not a partner for federal income
tax purposes would therefore be fully taxable as ordinary income. These holders
should consult their own tax advisors with respect to their status as partners
of Valero L.P. for federal income tax purposes.
Flow-Through of Taxable Income. We will not pay any federal income tax.
Instead, each unitholder will be required to report on his income tax return his
allocable share of our income, gains, losses, and deductions without regard to
whether corresponding cash distributions are received by that unitholder.
Consequently, a unitholder may be allocated a share of our income even if he has
not received a cash distribution. Each unitholder must include in income his
allocable share of our income, gain, loss, and deduction for our taxable year
ending with or within his taxable year.
Treatment of Distributions. Our distributions to a unitholder generally
will not be taxable to the unitholder for federal income tax purposes to the
extent of his tax basis in his common units immediately before the distribution.
Our cash distributions in excess of a unitholder's tax basis generally will be
considered to be gain from the sale or exchange of the common units, taxable in
accordance with the rules described under "-- Disposition of Common Units"
below. Any reduction in a unitholder's share of our liabilities for which no
partner, including the general partner, bears the economic risk of loss, known
as "nonrecourse liabilities," will be treated as a distribution of cash to that
unitholder. To the extent that our distributions cause a unitholder's "at risk"
amount to be less than zero at the end of any taxable year, he must recapture
any losses deducted in previous years that are equal to the amount of that
shortfall.
A decrease in a unitholder's percentage interest in us because of our
issuance of additional common units will decrease his share of our nonrecourse
liabilities, and thus will result in a corresponding deemed distribution of
cash. A non-pro rata distribution of money or property may result in ordinary
income to a unitholder, regardless of his tax basis in his common units, if that
distribution reduces the unitholder's share of our "unrealized receivables",
including depreciation recapture, and/or substantially appreciated "inventory
items", both as defined in Section 751 of the Internal Revenue Code, and
collectively, "Section 751 assets." To that extent, a unitholder will be treated
as having been distributed his proportionate share of the Section 751 assets and
having exchanged those assets with us in return for the non-pro rata portion of
the actual distribution made to him. This latter deemed exchange will generally
result in the unitholder's realization of ordinary income under Section 751(b)
of the Internal Revenue
39
Code. That income will equal the excess of the non-pro rata portion of that
distribution over the unitholder's tax basis for the share of the Section 751
assets deemed relinquished in the exchange.
Tax Rates. In general, the highest effective United States federal income
tax rate for individuals for 2002 is 38.6% and the maximum United States federal
income tax rate for net capital gains of an individual is generally 20% if the
asset was held for more than 12 months at the time of disposition.
Alternative Minimum Tax. Each unitholder will be required to take into
account his distributive share of any items of our income, gain, deduction or
loss for purposes of the alternative minimum tax. The minimum tax rate for
noncorporate taxpayers is 26% on the first $175,000 of alternative minimum
taxable income in excess of the exemption amount and 28% on any additional
alternative minimum taxable income. Prospective unitholders should consult with
their own tax advisors as to the impact of an investment in common units on
their liability for the alternative minimum tax.
Basis of Common Units. A unitholder will have an initial tax basis for his
common units equal to the amount he paid for the common units plus his share of
our nonrecourse liabilities. That basis will be increased by his share of our
income and by any increases in his share of our nonrecourse liabilities. That
basis will be decreased, but not below zero, by distributions from us, by the
unitholder's share of our losses, by any decrease in his share of our
nonrecourse liabilities and by his share of our expenditures that are not
deductible in computing our taxable income and are not required to be
capitalized. A limited partner will have no share of our debt which is recourse
to the general partner, but will have a share, generally based on his share of
profits, of our nonrecourse liabilities.
Limitations on Deductibility of Our Losses. The deduction by a unitholder
of his share of our losses will be limited to the tax basis in his common units
and, in the case of an individual unitholder or a corporate unitholder that is
subject to the "at-risk" rules, to the amount for which the unitholder is
considered to be "at risk" with respect to our activities, if that is less than
his tax basis. A unitholder must recapture losses deducted in previous years to
the extent that distributions cause his at risk amount to be less than zero at
the end of any taxable year. Losses disallowed to a unitholder or recaptured as
a result of these limitations will carry forward and will be allowable to the
extent that his tax basis or at risk amount, whichever is the limiting factor,
subsequently increases. Upon the taxable disposition of a common unit, any gain
recognized by a unitholder can be offset by losses that were previously
suspended by the at risk limitation but may not be offset by losses suspended by
the basis limitation. Any excess loss above that gain previously suspended by
the at risk or basis limitations is no longer utilizable.
In general, a unitholder will be at risk to the extent of the tax basis of
his common units, excluding any portion of that basis attributable to his share
of our nonrecourse liabilities, reduced by any amount of money he borrows to
acquire or hold his common units, if the lender of those borrowed funds owns an
interest in us, is related to the unitholder, or can look only to the common
units for repayment. A unitholder's at risk amount will increase or decrease as
the tax basis of the unitholder's common units increases or decreases, other
than tax basis increases or decreases attributable to increases or decreases in
his share of our nonrecourse liabilities.
The passive loss limitations generally provide that individuals, estates,
trusts and some closely-held corporations and personal service corporations can
deduct losses from passive activities, which are generally activities in which
the taxpayer does not materially participate, only to the extent of the
taxpayer's income from those passive activities. The passive loss limitations
are applied separately with respect to each publicly-traded partnership.
Consequently, any passive losses we generate will only be available to offset
our passive income generated in the future and will not be available to offset
income from other passive activities or investments, including other
publicly-traded partnerships, or salary or active business income. Passive
losses that are not deductible because they exceed a unitholder's share of our
income may be deducted in full when he disposes of his entire investment in us
in a fully taxable transaction to an unrelated party. The passive activity loss
rules are applied after other applicable limitations on deductions, including
the at risk rules and the basis limitation.
40
A unitholder's share of our net income may be offset by any suspended
passive losses, but it may not be offset by any other current or carryover
losses from other passive activities, including those attributable to other
publicly-traded partnerships.
Limitations on Interest Deductions. The deductibility of a non-corporate
taxpayer's "investment interest expense" is generally limited to the amount of
that taxpayer's "net investment income." The IRS has announced that Treasury
Regulations will be issued that characterize net passive income from a
publicly-traded partnership as investment income for this purpose. In addition,
the unitholder's share of our portfolio income will be treated as investment
income. Investment interest expense includes:
- interest on indebtedness properly allocable to property held for
investment;
- our interest expense attributed to portfolio income; and
- the portion of interest expense incurred to purchase or carry an interest
in a passive activity to the extent attributable to portfolio income.
The computation of a unitholder's investment interest expense will take
into account interest on any margin account borrowing or other loan incurred to
purchase or carry a common unit. Net investment income includes gross income
from property held for investment and amounts treated as portfolio income under
the passive loss rules, less deductible expenses, other than interest, directly
connected with the production of investment income, but generally does not
include gains attributable to the disposition of property held for investment.
Allocation of Income, Gain, Loss, and Deduction. In general, if we have a
net profit, our items of income, gain, loss, and deduction are allocated among
the general partner and the unitholders in accordance with their particular
percentage interests in us. At any time that distributions are made to the
common units and not to the subordinated units, or that incentive distributions
are made to the general partner, gross income is allocated to the recipients to
the extent of these distributions. If we have a net loss, the amount of that
loss will be allocated first, to the general partner and the unitholders in
accordance with their particular percentage interests in us to the extent of
their positive capital accounts as maintained under the partnership agreement,
and, second, to the general partner.
Specified items of our income, deduction, gain, and loss are allocated to
account for the difference between the tax basis and fair market value of
property contributed to us by the general partner and affiliates of the general
partner, and to account for the differences between the fair market value of our
assets and their carrying value on our books at the time of any offering made
pursuant to this prospectus, referred to in this discussion as "contributed
property." The effect of these allocations to a unitholder purchasing common
units pursuant to this prospectus will be essentially the same as if the tax
basis of our assets were equal to their fair market value at the time of
purchase. In addition, specified items of recapture income are allocated to the
extent possible to the partner who was allocated the deduction giving rise to
the treatment of that gain as recapture income in order to minimize the
recognition of ordinary income by some unitholders. Finally, although we do not
expect that our operations will result in the creation of negative capital
accounts, if negative capital accounts nevertheless result, items of our income
and gain will be allocated in an amount and manner sufficient to eliminate the
negative balance as quickly as possible.
An allocation of items of our income, gain, loss, or deduction, other than
an allocation required by the Internal Revenue Code to eliminate the difference
between a partner's "book" capital account, credited with the fair market value
of contributed property, and "tax" capital account, credited with the tax basis
of contributed property, will generally be given effect for federal income tax
purposes in determining a partner's distributive share of an item of income,
gain, loss or deduction only if the allocation has substantial economic effect.
In any other case, a partner's distributive share of an item will be determined
on the basis of the partner's interest in us, which will be determined by taking
into account all the facts and circumstances, including the partner's relative
contributions to us, the interests of the partners in economic profits and
losses, the interests of the partners in cash flow and other nonliquidating
distributions, and rights of the partners to distributions of capital upon
liquidation.
41
Counsel is of the opinion that, with the exception of the issues described
in "-- Disposition of Common Units -- Section 754 Election" and "-- Disposition
of Common Units -- Allocations Between Transferors and Transferees," allocations
under our partnership agreement will be given effect for federal income tax
purposes in determining a partner's distributive share of an item of income,
gain, loss or deduction.
Entity-Level Collections. If we are required or elect under applicable law
to pay any federal, state or local income tax on behalf of any unitholder or any
general partner or any former unitholder, we are authorized to pay those taxes
from our funds. That payment, if made, will be treated as a distribution of cash
to the partner on whose behalf the payment was made. If the payment is made on
behalf of a person whose identity cannot be determined, we are authorized to
treat the payment as a distribution to all current unitholders. We are
authorized to amend our partnership agreement in the manner necessary to
maintain uniformity of intrinsic tax characteristics of common units and to
adjust later distributions, so that after giving effect to these distributions,
the priority and characterization of distributions otherwise applicable under
our partnership agreement is maintained as nearly as is practicable. Payments by
us as described above could give rise to an overpayment of tax on behalf of an
individual partner, in which event the partner could file a claim for credit or
refund.
Treatment of Short Sales. A unitholder whose common units are loaned to a
"short seller" to cover a short sale of common units may be considered as having
disposed of ownership of those common units. If so, he would no longer be a
partner with respect to those common units during the period of the loan and may
recognize gain or loss from the disposition. As a result, during this period:
- any of our income, gain, deduction or loss with respect to those common
units would not be reportable by the unitholder;
- any cash distributions received by the unitholder with respect to those
common units would be fully taxable; and
- all of these distributions would appear to be treated as ordinary income.
Counsel has not rendered an opinion regarding the treatment of a unitholder
whose common units are loaned to a short seller to cover a short sale of common
units; therefore, unitholders desiring to assure their status as partners and
avoid the risk of gain recognition should modify any applicable brokerage
account agreements to prohibit their brokers from borrowing their common units.
The IRS has announced that it is actively studying issues relating to the tax
treatment of short sales of partnership interests. Please also read
"-- Disposition of Common Units -- Recognition of Gain or Loss."
TAX TREATMENT OF OPERATIONS
Accounting Method and Taxable Year. We currently use the year ending
December 31 as our taxable year and we have adopted the accrual method of
accounting for federal income tax purposes. Each unitholder will be required to
include in income his allocable share of our income, gain, loss and deduction
for our taxable year ending within or with his taxable year. In addition, a
unitholder who has a taxable year ending on a date other than December 31 and
who disposes of all of his common units following the close of our taxable year
but before the close of his taxable year must include his allocable share of our
income, gain, loss and deduction in income for his taxable year, with the result
that he will be required to include in income for his taxable year his share of
more than one year of our income, gain, loss and deduction. Please read
"-- Disposition of Common Units -- Allocations Between Transferors and
Transferees."
Tax Basis, Depreciation, and Amortization. The adjusted tax basis of our
assets will be used for purposes of computing depreciation and cost recovery
deductions and, ultimately, gain or loss on the disposition of these assets. The
federal income tax burden associated with the difference between the fair market
value of our assets and their tax basis immediately prior to an offering will be
borne by the contributing partners and other unitholders at that time. Please
read "-- Tax Treatment of Unitholders -- Allocation of Income, Gain, Loss and
Deduction."
42
To the extent allowable, we may elect to use the depreciation and cost
recovery methods that will result in the largest deductions being taken in the
early years after assets are placed in service. We will not be entitled to any
amortization deductions with respect to any goodwill conveyed to us on
formation. Property we subsequently acquire or construct may be depreciated
using accelerated methods permitted by the Internal Revenue Code.
If we dispose of depreciable property by sale, foreclosure, or otherwise,
all or a portion of any gain, determined by reference to the amount of
depreciation previously deducted and the nature of the property, may be subject
to the recapture rules and taxed as ordinary income rather than capital gain.
Similarly, a partner who has taken cost recovery or depreciation deductions with
respect to property we own may be required to recapture those deductions as
ordinary income upon a sale of his interest in us. Please read "-- Tax Treatment
of Unitholders -- Allocation of Income, Gain, Loss and Deduction" and
"-- Disposition of Common Units -- Recognition of Gain or Loss."
Costs incurred in our organization are being amortized over a period of 60
months. The costs incurred in promoting the issuance of common units (i.e.
syndication expenses) must be capitalized and cannot be deducted currently,
ratably or upon our termination. Uncertainties exist regarding the
classification of costs as organization expenses, which may be amortized, and as
syndication expenses, which may not be amortized. The underwriting discounts and
commissions we incur are treated as syndication costs.
Uniformity of Units. Because we cannot match transferors and transferees
of common units, uniformity of the economic and tax characteristics of the
common units to a purchaser of these common units must be maintained. In the
absence of uniformity, compliance with a number of federal income tax
requirements, both statutory and regulatory, could be substantially diminished.
A lack of uniformity can result from a literal application of Treasury
Regulation Section 1.167(c)-1(a)(6). Any non-uniformity could have a negative
impact on the value of the common units. Please read "-- Disposition of Common
Units -- Section 754 Election."
Consistent with the regulations under Section 743 of the Internal Revenue
Code, we intend to depreciate the portion of a Section 743(b) adjustment
attributable to unrealized appreciation in the value of contributed property or
adjusted property, to the extent of any unamortized Section 704(c) built-in
gain, using a rate of depreciation or amortization derived from the depreciation
or amortization method and useful life applied to the common basis of that
property, or treat that portion as nonamortizable, to the extent attributable to
property the common basis of which is not amortizable, even though that position
may be inconsistent with Treasury Regulation Section 1.167(c)-1(a)(6). To the
extent that the Section 743(b) adjustment is attributable to appreciation in
value in excess of the unamortized Section 704(c) built-in gain, we apply rules
described in the regulations and legislative history. If we determine that this
position cannot reasonably be taken, we may adopt a depreciation and
amortization convention under which all purchasers acquiring common units in the
same month would receive depreciation and amortization deductions, whether
attributable to a common basis or Section 743(b) adjustment, based upon the same
applicable rate as if they had purchased a direct interest in our property. If
this position is adopted, it may result in lower annual depreciation and
amortization deductions than would otherwise be allowable to some unitholders
and risk the loss of depreciation and amortization deductions not taken in the
year that these deductions are otherwise allowable. This position will not be
adopted if we determine that the loss of depreciation and amortization
deductions will have a material adverse effect on the unitholders. If we choose
not to utilize this aggregate method, we may use any other reasonable
depreciation and amortization convention to preserve the uniformity of the
intrinsic tax characteristics of any common units that would not have a material
adverse effect on the unitholders. The IRS may challenge any method of
depreciating the Section 743(b) adjustment described in this paragraph. If this
type of challenge were sustained, the uniformity of common units might be
affected, and the gain from the sale of common units might be increased without
the benefit of additional deductions. Please read "-- Disposition of Common
Units -- Recognition of Gain or Loss."
Valuation and Tax Basis of Our Properties. The federal income tax
consequences of the ownership and disposition of common units will depend in
part on our estimates of the relative fair market values,
43
and determinations of the initial tax bases, of our assets. Although we may from
time to time consult with professional appraisers regarding valuation matters,
we will make many of the relative fair market value estimates ourselves. These
estimates and determinations of basis are subject to challenge and will not be
binding on the IRS or the courts. If the estimates of fair market value or
determinations of basis are later found to be incorrect, the character and
amount of items of income, gain, loss, or deductions previously reported by
unitholders might change, and unitholders might be required to adjust their tax
liability for prior years.
DISPOSITION OF COMMON UNITS
Recognition of Gain or Loss. A unitholder will recognize gain or loss on a
sale of common units equal to the difference between the amount realized and the
unitholder's tax basis for the common units sold. A unitholder's amount realized
will be measured by the sum of the cash or the fair market value of other
property received plus his share of our nonrecourse liabilities. Because the
amount realized includes a unitholder's share of our nonrecourse liabilities,
the gain recognized on the sale of common units could result in a tax liability
in excess of any cash received from the sale.
Prior distributions from us in excess of cumulative net taxable income for
a common unit that decreased a unitholder's tax basis in that common unit will,
in effect, become taxable income if the common unit is sold at a price greater
than the unitholder's tax basis in that common unit, even if the price is less
than his original cost.
Except as noted below, gain or loss recognized by a unitholder, other than
a "dealer" in common units, on the sale or exchange of a common unit held for
more than one year will generally be taxable as capital gain or loss. Capital
gain recognized by an individual on the sale of common units held for more than
12 months will generally be taxed at a maximum rate of 20%. A portion of this
gain or loss, which will likely be substantial, however, will be separately
computed and taxed as ordinary income or loss under Section 751 of the Internal
Revenue Code to the extent attributable to assets giving rise to depreciation
recapture or other "unrealized receivables" or to "inventory items" we own. The
term "unrealized receivables" includes potential recapture items, including
depreciation recapture. Ordinary income attributable to unrealized receivables,
inventory items and depreciation recapture may exceed net taxable gain realized
upon the sale of the common unit and may be recognized even if there is a net
taxable loss realized on the sale of the common unit. Thus, a unitholder may
recognize both ordinary income and a capital loss upon a disposition of common
units. Net capital loss may offset no more than $3,000 of ordinary income in the
case of individuals and may only be used to offset capital gain in the case of
corporations.
The IRS has ruled that a partner who acquires interests in a partnership in
separate transactions must combine those interests and maintain a single
adjusted tax basis for all those interests. Upon a sale or other disposition of
less than all of those interests, a portion of that tax basis must be allocated
to the interests sold using an "equitable apportionment" method. On the other
hand, a selling unitholder who can identify common units transferred with an
ascertainable holding period may elect to use the actual holding period of the
common units transferred. A unitholder electing to use the actual holding period
of common units transferred must consistently use that identification method for
all subsequent sales or exchanges of common units.
Specific provisions of the Internal Revenue Code affect the taxation of
some financial products and securities, including partnership interests, by
treating a taxpayer as having sold an "appreciated" partnership interest, one in
which gain would be recognized if it were sold, assigned or terminated at its
fair market value, if the taxpayer or a related person enters into a short sale,
an offsetting notional principal contract or a futures or forward contract with
respect to the partnership interest or substantially identical property.
Moreover, if a taxpayer has previously entered into a short sale, an
offsetting notional principal contract or a futures or forward contract with
respect to the partnership interest, the taxpayer will be treated as having sold
that position if the taxpayer or a related person then acquires the partnership
44
interest or substantially similar property. The Secretary of the Treasury is
also authorized to issue regulations that treat a taxpayer that enters into
transactions or positions that have substantially the same effect as the
preceding transactions as having constructively sold the financial position.
Allocations Between Transferors and Transferees. In general, our taxable
income and losses are determined annually, are prorated on a monthly basis and
are subsequently apportioned among the unitholders in proportion to the number
of common units owned by each of them as of the opening of the NYSE on the first
business day of the month (the "allocation date"). However, gain or loss
realized on a sale or other disposition of our assets other than in the ordinary
course of business is allocated among the unitholders on the allocation date in
the month in which that gain or loss is recognized. As a result, a unitholder
transferring common units in the open market may be allocated income, gain, loss
and deduction accrued after the date of transfer.
The use of this method may not be permitted under existing Treasury
Regulations. Accordingly, counsel is unable to opine on the validity of this
method of allocating income and deductions between the transferors and the
transferees of common units. If this method is not allowed under the Treasury
Regulations, or only applies to transfers of less than all of the unitholder's
interest, our taxable income or losses might be reallocated among the
unitholders. We are authorized to revise our method of allocation between
transferors and transferees, as well as among partners whose interests otherwise
vary during a taxable period, to conform to a method permitted under future
Treasury Regulations.
A unitholder who owns common units at any time during a quarter and who
disposes of these common units prior to the record date set for a cash
distribution with respect to that quarter will be allocated items of our income,
gain, loss and deductions attributable to that quarter but will not be entitled
to receive that cash distribution.
Section 754 Election. We have made the election permitted by Section 754
of the Internal Revenue Code. The election is irrevocable without the consent of
the IRS. The election generally permits us to adjust a common unit purchaser's
tax basis in our assets ("inside basis") under Section 743(b) of the Internal
Revenue Code to reflect his purchase price. This election does not apply to a
person who purchases common units directly from us. The Section 743(b)
adjustment belongs to the purchaser and not to other partners. For purposes of
this discussion, a partner's inside basis in our assets will be considered to
have two components, (1) his share of our tax basis in our assets ("common
basis") and (2) his Section 743(b) adjustment to that basis.
Treasury Regulations under Section 743 of the Internal Revenue Code require
a partnership that adopts the remedial allocation method (which we have done) to
depreciate a portion of the Section 743(b) adjustment attributable to recovery
property over the remaining cost recovery period for the Section 704(c) built-in
gain. Under Treasury Regulation Section 1.167(c)-1(a)(6), a Section 743(b)
adjustment attributable to property subject to depreciation under Section 167 of
the Internal Revenue Code rather than cost recovery deductions under Section 168
is generally required to be depreciated using either the straight-line method or
the 150% declining balance method. Under our partnership agreement, we have
adopted a convention to preserve the uniformity of common units even if that
convention is not consistent with these Treasury Regulations. Please read
"-- Tax Treatment of Operations -- Uniformity of Units."
Although Andrews & Kurth, May, Day, Caldwell & Keeton L.L.P. is unable to
opine as to the validity of this method because there is no clear authority on
this issue, we intend to depreciate or amortize the portion of a Section 743(b)
adjustment attributable to unrealized appreciation in the value of contributed
property, to the extent of any unamortized Section 704(c) built-in gain, using a
rate of depreciation or amortization derived from the depreciation or
amortization method and useful life applied to the common basis of the property,
or treat that portion as non-amortizable to the extent attributable to property
the common basis of which is not amortizable. This method is consistent with the
regulations under Section 743 of the Internal Revenue Code but is arguably
inconsistent with Treasury Regulation Section 1.167(c)-1(a)(6). To the extent
this Section 743(b) adjustment is attributable to appreciation in value in
excess of the unamortized Section 704(c) built-in gain, we will apply the rules
45
described in the Treasury Regulations and legislative history. If we determine
that this position cannot reasonably be taken, we may adopt a depreciation or
amortization convention under which all purchasers acquiring common units in the
same month would receive depreciation or amortization, whether attributable to
common basis or Section 743(b) adjustment, based upon the same applicable rate
as if they had purchased a direct interest in our assets. This kind of aggregate
approach may result in lower annual depreciation or amortization deductions than
would otherwise be allowable to specified unitholders. Please read "-- Tax
Treatment of Operations -- Uniformity of Units."
A Section 754 election is advantageous if the transferee's tax basis in his
common units is higher than the common units' share of the aggregate tax basis
of our assets immediately prior to the transfer. In that case, as a result of
the election, the transferee would have a higher tax basis in his share of our
assets for purposes of calculating, among other items, his depreciation and
depletion deductions and his share of any gain or loss on a sale of our assets.
Conversely, a Section 754 election is disadvantageous if the transferee's tax
basis in his common units is lower than those common units' share of the
aggregate tax basis of our assets immediately prior to the transfer. Thus, the
fair market value of the common units may be affected either favorably or
adversely by the election.
The calculations involved in the Section 754 election are complex, and we
will make them on the basis of assumptions as to the value of our assets and
other matters. The determinations we make may be successfully challenged by the
IRS and the deductions resulting from them may be reduced or disallowed
altogether. Should the IRS require a different basis adjustment to be made, and
should, in our opinion, the expense of compliance exceed the benefit of the
election, we may seek permission from the IRS to revoke our Section 754
election. If permission is granted, a subsequent purchaser of common units may
be allocated more income than he would have been allocated had the election not
been revoked.
Notification Requirements. A unitholder who sells or exchanges common
units is required to notify us in writing of that sale or exchange within 30
days after the sale or exchange. We are required to notify the IRS of that
transaction and to furnish specified information to the transferor and
transferee. However, these reporting requirements do not apply with respect to a
sale by an individual who is a citizen of the United States and who effects the
sale or exchange through a broker. Additionally, a transferee of a common unit
will be required to furnish a statement to the IRS, filed with its income tax
return for the taxable year in which the sale or exchange occurred, that
describes the amount of the consideration paid for the common unit. Failure to
satisfy these reporting obligations may lead to the imposition of substantial
penalties.
Constructive Termination. We will be considered to have been terminated
for tax purposes if there is a sale or exchange of 50% or more of the total
interests in our capital and profits within a 12-month period. Our termination
will cause a termination of Valero Logistics. Our termination would result in
the closing of our taxable year for all unitholders. In the case of a unitholder
reporting on a taxable year other than a fiscal year ending December 31, the
closing of our taxable year may result in more than 12 months of our taxable
income or loss being includable in his taxable income for the year of
termination. We would be required to make new tax elections after a termination,
including a new election under Section 754 of the Internal Revenue Code, and a
termination could result in a deferral of our deductions for depreciation. A
termination could also result in penalties if we were unable to determine that
the termination had occurred. Moreover, a termination might either accelerate
the application of, or subject us to, any tax legislation enacted before the
termination.
TAX-EXEMPT ORGANIZATIONS AND OTHER INVESTORS
Ownership of common units by employee benefit plans, other tax-exempt
organizations, nonresident aliens, foreign corporations, other foreign persons,
and regulated investment companies raises issues unique to those investors and,
as described below, may have substantially adverse tax consequences. Employee
benefit plans and most other organizations exempt from federal income tax,
including individual retirement accounts and other retirement plans, are subject
to federal income tax on unrelated business taxable
46
income. Virtually all of our taxable income allocated to a unitholder which is a
tax-exempt organization will be unrelated business taxable income and will be
taxable to that unitholder.
A regulated investment company or "mutual fund" is required to derive 90%
or more of its gross income from interest, dividends and gains from the sale of
stocks or securities or foreign currency or specified related sources. It is not
anticipated that any significant amount of our gross income will include that
type of income.
Non-resident aliens and foreign corporations, trusts, or estates that own
common units will be considered to be engaged in business in the United States
on account of ownership of common units. As a consequence they will be required
to file federal tax returns for their share of our income, gain, loss, or
deduction and pay federal income tax at regular rates on any net income or gain.
Generally, a partnership is required to pay a withholding tax on the
portion of the partnership's income that is effectively connected with the
conduct of a United States trade or business and which is allocable to the
foreign partners, regardless of whether any actual distributions have been made
to these partners. However, under rules applicable to publicly-traded
partnerships, we will withhold taxes on actual cash distributions made quarterly
to foreign unitholders at the highest marginal rate applicable to individuals at
the time of the distribution. Each foreign unitholder must obtain a taxpayer
identification number from the IRS and submit that number to our transfer agent
on a Form W-8 BEN or applicable substitute form in order to obtain credit for
the taxes withheld. A change in applicable law may require us to change these
procedures.
Because a foreign corporation that owns common units will be treated as
engaged in a United States trade or business, that corporation may be subject to
United States branch profits tax at a rate of 30%, in addition to regular
federal income tax, on its allocable share of our income and gain, as adjusted
for changes in the foreign corporation's "U.S. net equity," which are
effectively connected with the conduct of a United States trade or business.
That tax may be reduced or eliminated by an income tax treaty between the United
States and the country in which the foreign corporate unitholder is a "qualified
resident." In addition, this type of unitholder is subject to special
information reporting requirements under Section 6038C of the Internal Revenue
Code.
Under a ruling of the IRS, a foreign unitholder who sells or otherwise
disposes of a common unit will be subject to federal income tax on gain realized
on the disposition of that common unit to the extent that this gain is
effectively connected with a United States trade or business of the foreign
unitholder. Apart from the ruling, a foreign unitholder will not be taxed or
subject to withholding upon the disposition of a common unit if that foreign
unitholder has owned 5% or less in value of the common units during the five-
year period ending on the date of the disposition and if the common units are
regularly traded on an established securities market at the time of the
disposition.
ADMINISTRATIVE MATTERS
Information Returns and Audit Procedures. We intend to furnish to each
unitholder, within 90 days after the close of each calendar year, specific tax
information, including a Schedule K-1, which describes each unitholder's share
of our income, gain, loss and deduction for our preceding taxable year. In
preparing this information, which will generally not be reviewed by counsel, we
will use various accounting and reporting conventions, some of which have been
mentioned in the previous discussion, to determine the unitholder's share of
income, gain, loss and deduction. Any of those conventions may not yield a
result that conforms to the requirements of the Internal Revenue Code,
regulations or administrative interpretations of the IRS. The IRS may
successfully contend in court that those accounting and reporting conventions
are impermissible. Any challenge by the IRS could negatively affect the value of
the common units.
The IRS may audit our federal income tax information returns. Adjustments
resulting from an audit of this kind may require each unitholder to adjust a
prior year's tax liability, and possibly may result in an
47
audit of that unitholder's own return. Any audit of a unitholder's return could
result in adjustments not related to our returns as well as those related to our
returns.
Partnerships generally are treated as separate entities for purposes of
federal tax audits, judicial review of administrative adjustments by the IRS and
tax settlement proceedings. The tax treatment of partnership items of income,
gain, loss and deduction are determined in a partnership proceeding rather than
in separate proceedings with the partners. The Internal Revenue Code provides
for one partner to be designated as the "tax matters partner" for these
purposes. Our partnership agreement appoints the general partner as the tax
matters partner of Valero L.P.
The tax matters partner will make some elections on our behalf and on
behalf of unitholders. In addition, the tax matters partner can extend the
statute of limitations for assessment of tax deficiencies against unitholders
for items in our returns. The tax matters partner may bind a unitholder with
less than a 1% profits interest in us to a settlement with the IRS unless that
unitholder elects, by filing a statement with the IRS, not to give that
authority to the tax matters partner. The tax matters partner may seek judicial
review, by which all the unitholders are bound, of a final partnership
administrative adjustment and, if the tax matters partner fails to seek judicial
review, judicial review may be sought by any unitholder having at least a 1%
interest in our profits and by the unitholders having in the aggregate at least
a 5% profits interest. However, only one action for judicial review will go
forward, and each unitholder with an interest in the outcome may participate.
A unitholder must file a statement with the IRS identifying the treatment
of any item on his federal income tax return that is not consistent with the
treatment of the item on our return. Intentional or negligent disregard of the
consistency requirement may subject a unitholder to substantial penalties.
Nominee Reporting. Persons who hold an interest in us as a nominee for
another person are required to furnish to us:
(a) the name, address and taxpayer identification number of the
beneficial owner and the nominee;
(b) whether the beneficial owner is
(1) a person that is not a United States person,
(2) a foreign government, an international organization or any
wholly-owned agency or instrumentality of either of the
foregoing, or
(3) a tax-exempt entity;
(c) the amount and description of common units held, acquired or
transferred for the beneficial owner; and
(d) specific information including the dates of acquisitions and
transfers, means of acquisitions and transfers, and acquisition
cost for purchases, as well as the amount of net proceeds from
sales.
Brokers and financial institutions are required to furnish additional
information, including whether they are United States persons and specific
information on common units they acquire, hold or transfer for their own
account. A penalty of $50 per failure, up to a maximum of $100,000 per calendar
year, is imposed by the Internal Revenue Code for failure to report that
information to us. The nominee is required to supply the beneficial owner of the
common units with the information furnished to us.
Registration as a Tax Shelter. The Internal Revenue Code requires that
"tax shelters" be registered with the Secretary of the Treasury. Although we may
not be subject to the registration requirement on the basis that we do not
constitute a tax shelter, we have registered as a tax shelter with the Secretary
of the Treasury in light of the substantial penalties which might be imposed if
registration is required and not undertaken.
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OUR TAX SHELTER REGISTRATION NUMBER IS 00294000008. ISSUANCE OF THIS
REGISTRATION NUMBER DOES NOT INDICATE THAT AN INVESTMENT IN US OR THE CLAIMED
TAX BENEFITS HAVE BEEN REVIEWED, EXAMINED OR APPROVED BY THE IRS.
A unitholder who sells or otherwise transfers a common unit in a later
transaction must furnish the registration number to the transferee. The penalty
for failure of the transferor of a common unit to furnish the registration
number to the transferee is $100 for each failure. The unitholders must disclose
our tax shelter registration number on Form 8271 to be attached to the tax
return on which any deduction, loss or other benefit we generate is claimed or
on which any of our income is included. A unitholder who fails to disclose the
tax shelter registration number on his return, without reasonable cause for that
failure, will be subject to a $250 penalty for each failure. Any penalties
discussed are not deductible for federal income tax purposes.
Accuracy-related Penalties. An additional tax equal to 20% of the amount
of any portion of an underpayment of tax that is attributable to one or more
specified causes, including negligence or disregard of rules or regulations,
substantial understatements of income tax and substantial valuation
misstatements, is imposed by the Internal Revenue Code. No penalty will be
imposed, however, for any portion of an underpayment if it is shown that there
was a reasonable cause for that portion and that the taxpayer acted in good
faith regarding that portion.
A substantial understatement of income tax in any taxable year exists if
the amount of the understatement exceeds the greater of 10% of the tax required
to be shown on the return for the taxable year or $5,000 ($10,000 for most
corporations). The amount of any understatement subject to penalty generally is
reduced if any portion is attributable to a position adopted on the return:
(1) for which there is, or was, "substantial authority"; or
(2) as to which there is a reasonable basis and the pertinent facts of
that position are disclosed on the return.
More stringent rules apply to "tax shelters," a term that in this context
does not appear to include us. If any item of income, gain, loss or deduction
included in the distributive shares of unitholders might result in that kind of
an "understatement" of income for which no "substantial authority" exists, we
must disclose the pertinent facts on our return. In addition, we will make a
reasonable effort to furnish sufficient information for unitholders to make
adequate disclosure on their returns to avoid liability for this penalty.
A substantial valuation misstatement exists if the value of any property,
or the adjusted basis of any property, claimed on a tax return is 200% or more
of the amount determined to be the correct amount of the valuation or adjusted
basis. No penalty is imposed unless the portion of the underpayment attributable
to a substantial valuation misstatement exceeds $5,000 ($10,000 for most
corporations). If the valuation claimed on a return is 400% or more than the
correct valuation, the penalty imposed increases to 40%.
STATE, LOCAL, AND OTHER TAX CONSIDERATIONS
In addition to federal income taxes, a unitholder will be subject to other
taxes, including state and local income taxes, unincorporated business taxes,
and estate, inheritance, or intangible taxes that may be imposed by the various
jurisdictions in which he resides or in which we do business or own property.
Although an analysis of those various taxes is not presented here, each
prospective unitholder should consider their potential impact on his investment
in us. We own assets or do business in Texas, Colorado, New Mexico, Kansas, and
Oklahoma. Of these states, Colorado, New Mexico, Kansas, and Oklahoma currently
impose a personal income tax. A unitholder will be required to file state income
tax returns and to pay state income taxes in some or all of these states in
which we do business or own property and may be subject to penalties for failure
to comply with those requirements. In some states, tax losses may not produce a
tax benefit in the year incurred and also may not be available to offset income
in subsequent taxable years. Some of the states may require us, or we may elect,
to withhold a percentage of income from amounts to be distributed to a
unitholder who is not a resident of the state. Withholding, the amount of which
may be greater or less than a particular unitholder's income tax liability to
the state, generally
49
does not relieve a nonresident unitholder from the obligation to file an income
tax return. Amounts withheld may be treated as if distributed to unitholders for
purposes of determining the amounts distributed by us. Please read "-- Tax
Treatment of Unitholders -- Entity-Level Collections." Based on current law and
our estimate of our future operations, our general partner anticipates that any
amounts required to be withheld will not be material.
It is the responsibility of each unitholder to investigate the legal and
tax consequences, under the laws of pertinent states and localities, of his
investment in us. Accordingly, each prospective unitholder should consult, and
must depend upon, his own tax counsel or other advisor with regard to those
matters. Further, it is the responsibility of each unitholder to file all state
and local, as well as United States federal tax returns that may be required of
him. Counsel has not rendered an opinion on the state or local tax consequences
of an investment in us.
TAX CONSEQUENCES OF OWNERSHIP OF DEBT SECURITIES
A description of the material federal income tax consequences of the
ownership and disposition of debt securities will be included in the prospectus
supplement relating to the offering of debt securities.
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INVESTMENT IN US BY EMPLOYEE BENEFIT PLANS
An investment in Valero L.P. by an employee benefit plan is subject to
additional considerations because the investments of these plans are subject to
the fiduciary responsibility and prohibited transaction provisions of ERISA, and
restrictions imposed by Section 4975 of the Internal Revenue Code. For these
purposes the term "employee benefit plan" includes, but is not limited to,
qualified pension, profit-sharing and stock bonus plans, Keogh plans, simplified
employee pension plans and tax deferred annuities or IRAs established or
maintained by an employer or employee organization. Among other things,
consideration should be given to:
(a) whether the investment is prudent under Section 404(a)(1)(B) of
ERISA;
(b) whether in making the investment, that plan will satisfy the
diversification requirements of Section 404(a)(1)(C) of ERISA; and
(c) whether the investment will result in recognition of unrelated
business taxable income by the plan and, if so, the potential
after-tax investment return.
The person with investment discretion with respect to the assets of an
employee benefit plan, often called a fiduciary, should determine whether an
investment in Valero L.P. is authorized by the appropriate governing instrument
and is a proper investment for the plan.
Section 406 of ERISA and Section 4975 of the Internal Revenue Code
prohibits employee benefit plans, and also IRAs that are not considered part of
an employee benefit plan, from engaging in specified transactions involving
"plan assets" with parties that are "parties in interest" under ERISA or
"disqualified persons" under the Internal Revenue Code with respect to the plan.
In addition to considering whether the purchase of common units is a
prohibited transaction, a fiduciary of an employee benefit plan should consider
whether the plan will, by investing in Valero L.P., be deemed to own an
undivided interest in the assets of Valero L.P., with the result that the
general partner would also be a fiduciary of the plan and the operations of
Valero L.P. would be subject to the regulatory restrictions of ERISA, including
its prohibited transaction rules, as well as the prohibited transaction rules of
the Internal Revenue Code.
The Department of Labor regulations provide guidance with respect to
whether the assets of an entity in which employee benefit plans acquire equity
interests would be deemed "plan assets" under some circumstances. Under these
regulations, an entity's assets would not be considered to be "plan assets" if,
among other things,
(a) the equity interests acquired by employee benefit plans are
publicly offered securities -- i.e., the equity interests are
widely held by 100 or more investors independent of the issuer and
each other, freely transferable and registered under some
provisions of the federal securities laws,
(b) the entity is an "operating company," -- i.e., it is primarily
engaged in the production or sale of a product or service other
than the investment of capital either directly or through a
majority-owned subsidiary or subsidiaries, or
(c) there is no significant investment by benefit plan investors,
which is defined to mean that less than 25% of the value of each
class of equity interest, disregarding some interests held by our
general partner, its affiliates, and some other persons, is held
by the employee benefit plans referred to above, IRAs and other
employee benefit plans not subject to ERISA, including
governmental plans.
Valero L.P.'s assets should not be considered "plan assets" under these
regulations because it is expected that the investment will satisfy the
requirements in (a) above.
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Plan fiduciaries contemplating a purchase of common units should consult
with their own counsel regarding the consequences under ERISA and the Internal
Revenue Code in light of the serious penalties imposed on persons who engage in
prohibited transactions or other violations.
PLAN OF DISTRIBUTION
We may sell the securities being offered hereby:
- directly to purchasers,
- through agents,
- through underwriters or dealers, or
- pursuant to delayed delivery contracts or forward contracts.
We, or agents designated by us, may directly solicit, from time to time,
offers to purchase the securities. Any such agent may be deemed to be an
underwriter as that term is defined in the Securities Act of 1933, as amended.
We will name the agents involved in the offer or sale of the securities and
describe any commissions payable by us to these agents in the prospectus
supplement. Unless otherwise indicated in the prospectus supplement, these
agents will be acting on a best efforts basis for the period of their
appointment. The agents may be entitled under agreements which may be entered
into with us to indemnification by us against specific civil liabilities,
including liabilities under the Securities Act. The agents may also be our
customers or may engage in transactions with or perform services for us in the
ordinary course of business.
If any underwriters are utilized in the sale of the securities in respect
of which this prospectus is delivered, we will enter into an underwriting
agreement with those underwriters at the time of sale to them. The names of
these underwriters and the terms of the transaction will be set forth in the
prospectus supplement, which will be used by the underwriters to make resales of
the securities in respect of which this prospectus is delivered to the public.
The underwriters may be entitled, under the relevant underwriting agreement, to
indemnification by us against specific liabilities, including liabilities under
the Securities Act. The underwriters may also be our customers or may engage in
transactions with or perform services for us in the ordinary course of business.
If a dealer is utilized in the sale of the securities in respect of which
this prospectus is delivered, we will sell those securities to the dealer, as
principal. The dealer may then resell those securities to the public at varying
prices to be determined by the dealer at the time of resale. Dealers may be
entitled to indemnification by us against specific liabilities, including
liabilities under the Securities Act. The dealers may also be our customers or
may engage in transactions with, or perform services for, us in the ordinary
course of business.
Common units and debt securities may also be sold directly by us. In this
case, no underwriters or agents would be involved. We may use electronic media,
including the Internet, to sell offered securities directly.
To the extent required, this prospectus may be amended or supplemented from
time to time to describe a specific plan of distribution.
The place and time of delivery for the securities in respect of which this
prospectus is delivered will be set forth in the accompanying prospectus
supplement.
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VALIDITY OF THE SECURITIES
The validity of the securities and certain federal income tax matters
related to the securities will be passed upon by Andrews & Kurth Mayor, Day,
Caldwell & Keeton L.L.P., Houston, Texas. Any underwriter will be advised about
other issues relating to any offering by its own legal counsel.
EXPERTS
The financial statements of:
- Valero L.P., formerly Shamrock Logistics, L.P. and Valero Logistics
Operations, L.P., formerly Shamrock Logistics Operations, L.P. (successor
to the Ultramar Diamond Shamrock Logistics Business), (collectively, the
Partnerships) as of December 31, 2001 and 2000 (successor), and for the
year ended December 31, 2001 and the six months ended December 31, 2000
(successor) and for the six months ended June 30, 2000 and the year ended
December 31, 1999 (predecessor) included in Valero L.P.'s Annual Report
on Form 10-K for the year ended December 31, 2001, and incorporated by
reference in this prospectus and elsewhere in the registration statement;
- Wichita Falls Crude Oil Pipeline and Storage Business as of December 31,
2001 and 2000, and for each of the three years in the period ended
December 31, 2001 included in Valero L.P.'s Current Report on Form 8-K/A
filed April 16, 2002, and incorporated by reference in this prospectus
and elsewhere in the registration statement; and
- Valero L.P., formerly Shamrock Logistics, L.P. and Valero Logistics
Operations, L.P., formerly Shamrock Logistics Operations, L.P. (successor
to the Ultramar Diamond Shamrock Logistics Business), (collectively, the
Partnerships) as of December 31, 2001 (restated) and 2000 (successor),
and for the year ended December 31, 2001 and the six months ended
December 31, 2000 (successor) and for the six months ended June 30, 2000
and the year ended December 31, 1999 (predecessor) included in Valero
L.P.'s Current Report on Form 8-K filed May 16, 2002, and incorporated by
reference in this prospectus and elsewhere in the registration statement;
have been audited by Arthur Andersen LLP, independent public accountants, as
indicated in their reports with respect thereto, and are incorporated by
reference herein in reliance upon the authority of said firm as experts in
giving said reports.
CHANGE IN INDEPENDENT PUBLIC ACCOUNTANTS
On March 22, 2002, upon the recommendation of the audit committee, the
board of directors approved the dismissal of Arthur Andersen LLP (Arthur
Andersen) as Valero L.P.'s independent public accountants and the selection of
Ernst & Young LLP (Ernst & Young) as Valero L.P.'s new independent public
accountants to audit the consolidated financial statements of Valero L.P. for
the year ending December 31, 2002. This change became effective upon the
completion by Arthur Andersen of its audits of the financial statements of the
Wichita Falls Crude Oil Pipeline and Storage Business, which were filed on Form
8-K/A on April 16, 2002. It should be noted that Arthur Andersen has not
audited, or performed a review in accordance with standards established by the
American Institute of Certified Public Accountants of, any financial statements
of Valero L.P. as of any date or for any period subsequent to December 31, 2001.
53
5,750,000 COMMON UNITS
REPRESENTING LIMITED PARTNER INTERESTS
(VALERO LP LOGO)
----------------------------
PROSPECTUS SUPPLEMENT
MARCH 12, 2003
----------------------------
LEHMAN BROTHERS
GOLDMAN, SACHS & CO.
MORGAN STANLEY
SALOMON SMITH BARNEY
UBS WARBURG
CREDIT SUISSE FIRST BOSTON
RBC CAPITAL MARKETS
SANDERS MORRIS HARRIS
LOGO