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)
1,075,000 COMMON UNITS
REPRESENTING LIMITED PARTNER INTERESTS
--------------------------------------------------------------------------------
We are offering to sell up to 1,075,000 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 August 5, 2003 was $41.15 per
unit.
Investing in the common units involves risk. "Risk Factors" begin on page S-11
of this prospectus supplement and on page 4 of the accompanying prospectus.
PER COMMON UNIT TOTAL
--------------- -----------
Public offering price....................................... $41.15 $44,236,250
Underwriting discount....................................... $ 1.85 $ 1,988,750
Proceeds to Valero L.P. (before expenses)................... $39.30 $42,247,500
We have granted the underwriter a 30-day option to purchase up to 161,250 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 expects to deliver the common units on or about August 11, 2003.
--------------------------------------------------------------------------------
LEHMAN BROTHERS
AUGUST 5, 2003
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superseded in their entirety by the similarly titled sections included in this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-11
Use of Proceeds....................... S-14
Capitalization........................ S-15
Price Range of Common Units and
Distributions....................... S-16
Tax Considerations.................... S-17
Underwriting.......................... S-17
Notice to Canadian Residents.......... S-20
Validity of the Securities............ S-21
Experts............................... S-21
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.
- Our Annual Report on Form 10-K for the year ended December 31, 2002.
- Our Quarterly Report on Form 10-Q for the quarterly period ended March
31, 2003.
- Our Current Reports on Form 8-K filed on March 14, 2003, March 17, 2003
and April 2, 2003.
- The description of our common units contained in our registration
statement on Form 8-A, filed on March 30, 2001.
- Any future filings made with the SEC under Sections 13(a), 13(c), 14 or
15(d) of the Securities Exchange Act of 1934 (excluding any information
furnished pursuant to Item 9 or Item 12 on any Current Report on Form
8-K) subsequent to the date of this prospectus supplement and until all
of the securities offered by this prospectus supplement 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. Other information on our
website is not incorporated by reference in this prospectus supplement or the
accompanying prospectus.
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 carefully the entire prospectus supplement, the accompanying
prospectus, the documents incorporated by reference and the other documents to
which we refer. Please read "Risk Factors" beginning on page S-11 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. 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.
VALERO L.P.
We are a publicly traded Delaware limited partnership that owns crude oil
and refined products pipeline, terminalling and storage assets in Texas,
Oklahoma, New Mexico, Colorado and California. Our assets support seven of
Valero Energy Corporation's refineries, including the McKee, Three Rivers, Texas
City, Corpus Christi East and Corpus Christi West refineries located in Texas,
the Ardmore refinery located in Oklahoma and the Benicia refinery located in
California.
Our network includes:
- approximately 783 miles of crude oil pipelines, including approximately
31 miles jointly owned with third parties, and five major associated
crude oil storage facilities with a total storage capacity of
approximately 3.3 million barrels;
- approximately 3,314 miles of refined product pipelines, including
approximately 1,996 miles jointly owned with third parties, and 18
refined product terminals (including two asphalt terminals and one idle
terminal), one of which is jointly owned, with a total storage capacity
of approximately 3.9 million barrels;
- 58 crude oil and intermediate feedstock storage tanks located at Valero
Energy's Corpus Christi West, Texas City and Benicia refineries, with a
total storage capacity of 11.0 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
refined product terminals and the services provided by our crude oil storage
tanks. We do not own any of the crude oil or refined products transported
through our pipelines or stored in our terminals or storage tanks, 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.
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, terminals and storage
assets;
- increasing volumes in our existing pipelines and shifting volumes to
higher tariff pipelines;
- increasing our pipeline, terminal and storage 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.
S-1
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 and Three Rivers refineries in Texas and its Ardmore refinery in
Oklahoma, and provide a major outlet for refined products from Valero
Energy's Corpus Christi East and West refineries.
- Our refined product pipelines serve Valero Energy's marketing operations
in South Texas as well as 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.
- Our crude oil storage tanks provide most of the crude oil storage
capacity at Valero Energy's Corpus Christi West, Texas City and Benicia
refineries.
- We believe our pipeline, terminalling and storage assets are modern,
efficient and well maintained.
- 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 in Texas, Oklahoma, California, 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 of its Corpus Christi East, Corpus Christi West, McKee, Three Rivers
and Ardmore refineries. Valero Energy also depends on us for most of the crude
oil storage services at its Corpus Christi West, Texas City and Benicia
refineries. At the same time, we are dependent on the continued use of our
pipelines, terminals and storage tanks 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 year ended December 31,
2002 and the three months ended March 31, 2003. Although we intend to pursue
third party business as opportunities 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
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 owns
and operates 14 refineries, seven of which are served by our pipelines,
terminals and storage assets. The current total capacity of each of those seven
refineries to process crude oil and other feedstocks is as follows:
TOTAL CAPACITY
--------------
REFINERY (BARRELS/DAY)
--------
Texas City, Texas....................................... 243,000
Corpus Christi West, Texas.............................. 225,000
Benicia, California..................................... 180,000
McKee, Texas............................................ 170,000
Corpus Christi East, Texas.............................. 115,000
Three Rivers, Texas..................................... 98,000
Ardmore, Oklahoma....................................... 85,000
S-2
Valero Energy markets the refined products produced by these seven
refineries primarily in Texas, Oklahoma, California, 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.
RECENT DEVELOPMENTS
CRUDE OIL STORAGE TANK AND SOUTH TEXAS PIPELINE SYSTEM CONTRIBUTIONS
On March 18, 2003, Valero Energy contributed 58 crude oil and intermediate
feedstock storage tanks and related assets with an aggregate storage capacity of
approximately 11.0 million barrels to us for $200 million. 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 storage tanks and intermediate feedstock storage tanks
located at Valero Energy's Corpus Christi West, Texas City and Benicia
refineries.
Valero Energy also contributed 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. The
three pipeline systems that make up the South Texas pipeline system are
intrastate common carrier refined product pipelines that connect Valero Energy's
Corpus Christi East and Corpus Christi West refineries to the Houston and Rio
Grande Valley, Texas markets and the Three Rivers refinery to the San Antonio
market and to the Corpus Christi refineries.
VALERO L.P. COMMON UNIT OFFERING AND VALERO LOGISTICS SENIOR NOTES OFFERING
On March 18, 2003, we issued and sold 5,750,000 common units in a public
offering and on April 16, 2003, we issued and sold an additional 581,000 common
units pursuant to the underwriters' over-allotment option, for aggregate net
proceeds, before offering expenses, of $223 million. Our general partner made an
aggregate $4.7 million capital contribution to us to maintain its 2% general
partner interest. Also on March 18, 2003, Valero Logistics issued and sold $250
million of 6.05% Senior Notes due 2013 in a private placement to institutional
investors.
REDEMPTION OF COMMON UNITS OWNED BY VALERO ENERGY AND AMENDMENT TO OUR
PARTNERSHIP AGREEMENT
Common Unit Redemption. Immediately following our common unit offering and
the offering by Valero Logistics of its 6.05% senior notes, we redeemed from
Valero Energy 3,809,750 common units for approximately $134.1 million, or $35.19
per unit, which is equal to the net proceeds per unit, before expenses, received
by us in the public offering of our common units on March 18, 2003. Immediately
following this redemption, we canceled the common units redeemed from Valero
Energy and redeemed a corresponding portion of Valero Energy's general partner
interest for $2.9 million so that it maintained its 2% general partner interest.
Amendment to Partnership Agreement. Also on March 18, 2003, immediately
upon the closing of the offerings, we amended our partnership agreement to
reduce the percentage of the vote of holders of our outstanding common units and
subordinated units necessary to remove our general partner from 66 2/3% to 58%.
The amendment also excludes the common units and subordinated units held by
affiliates of our general partner from the removal vote. Prior to this
amendment, Valero Energy and its affiliates were allowed to vote their units and
thus effectively block removal of the general partner. We further amended 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.
S-3
DOS LAREDOS PROJECT
On June 25, 2003, Valero Energy announced that it had entered into a
five-year supply agreement with MGI Supply Limited, a subsidiary of Pemex-Gas y
Petroquimica Basica, to supply 5,000 barrels per day of propane to Northern
Mexico beginning in the first quarter of 2004. Valero Energy and Valero L.P.
intend to enter into a five-year throughput agreement for the shipment of these
5,000 barrels per day in Valero L.P.'s pipelines to MGI Supply Limited. In
addition to using its existing pipeline infrastructure to ship these volumes,
Valero L.P. intends to:
- acquire and activate 59 miles of currently idle pipeline from Odem, Texas
to Three Rivers, Texas from Valero Energy;
- construct approximately 25 miles of new pipeline, including a 10-mile
segment to connect the Odem pipeline to the Corpus Christi West and East
refineries and an 11-mile cross-border pipeline underneath the Rio Grande
River; and
- build a new propane terminal in Nuevo Laredo, Mexico.
The aggregate cost of the project is expected to be approximately $20
million.
INCREASE IN QUARTERLY CASH DISTRIBUTION
On July 28, 2003, we declared an increased cash distribution for the second
quarter of 2003 of $0.75 per unit payable August 14, 2003 to holders of record
as of August 5, 2003. This distribution represents an increase of $0.05 per unit
over the distribution for the first quarter of 2003 paid in May 2003 and is the
third $0.05 per unit increase in the quarterly distribution since we went public
in April 2001. None of the common units sold in this offering are eligible to
receive this distribution for the second quarter of 2003.
S-4
SECOND QUARTER RESULTS
On July 28, 2003, we announced financial results for the three and six
months ended June 30, 2003. Set forth below is the unaudited consolidated
financial information for the three and six month periods ended June 30, 2003
and 2002.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
------------------------------- -----------------------------
2003 2002 2003 2002
-------------- -------------- ------------- -------------
(IN THOUSANDS, EXCEPT PER UNIT DATA AND BARREL/DAY INFORMATION)
STATEMENT OF INCOME DATA:
Revenues................................. $ 47,542 $ 30,030 $ 79,358 $ 56,054
----------- ----------- ----------- -----------
Costs and expenses:
Operating expenses..................... 16,335 9,565 27,996 18,749
General and administrative expenses.... 1,670 1,698 3,514 3,487
Depreciation and amortization
expense............................. 7,269 3,876 11,552 8,231
----------- ----------- ----------- -----------
Total costs and expenses............ 25,274 15,139 43,062 30,467
----------- ----------- ----------- -----------
Operating income......................... 22,268 14,891 36,296 25,587
Equity income from Skelly-Belvieu
Pipeline Company.................... 600 844 1,331 1,522
Interest expense, net.................. (4,736) (796) (7,113) (1,352)
----------- ----------- ----------- -----------
Income before income tax expense......... 18,132 14,939 30,514 25,757
Income tax expense..................... -- -- -- 395
----------- ----------- ----------- -----------
Net income............................... 18,132 14,939 30,514 25,362
----------- ----------- ----------- -----------
Net income applicable to general
partner including incentive
distributions....................... (1,066) (299) (1,690) (1,144)
----------- ----------- ----------- -----------
Net income applicable to limited
partners............................... $ 17,066 $ 14,640 $ 28,824 $ 24,218
=========== =========== =========== ===========
Net income per unit applicable to limited
partners............................... $ 0.79 $ 0.76 $ 1.40 $ 1.26
Weighted average number of limited
partnership units outstanding.......... 21,702,990 19,253,894 20,635,667 19,247,789
EBITDA(1)................................ $ 30,137 $ 19,611 $ 49,179 $ 35,340
Distributable cash flow(1)............... 24,234 18,081 39,724 32,558
OPERATING DATA (BARRELS/DAY):
Crude oil pipeline throughput.......... 348,390 360,558 340,619 336,605
Refined product pipeline throughput.... 396,639 303,654 347,000 283,375
Refined product terminal throughput.... 233,881 179,915 205,495 177,877
Crude oil and intermediate feedstock
storage tank throughput............. 475,280 -- 277,468 --
JUNE 30, DECEMBER 31,
2003 2002
-------- ------------
(IN THOUSANDS)
BALANCE SHEET DATA:
Long-term debt, including current portion................. $365,231 $109,658
Partners' equity.......................................... 385,636 293,895
Debt-to-capitalization ratio.............................. 48.6% 27.2%
---------------
(1) See page S-7 for a reconciliation of EBITDA and distributable cash flow to
income before income tax expense.
S-5
The increase in net income for the second quarter of 2003 was primarily
related to the benefit from the South Texas pipeline system and the crude oil
storage tanks acquired March 18, 2003 from Valero Energy. The increase was
partially offset by the effect of reduced throughput volumes related to
unplanned refinery outages at Valero Energy's Benicia, Texas City and Ardmore
refineries during the quarter.
The statement of income for the three months ended June 30, 2003, includes
$8.5 million of operating income related to the crude oil storage tanks and the
South Texas pipeline system and $0.4 million of operating income related to the
Telfer asphalt terminal in Pittsburg, California, which Valero L.P. acquired for
$15.1 million effective January 7, 2003. The statement of income for the six
months ended June 30, 2003, includes $10.4 million of operating income related
to the crude oil storage tanks and the South Texas pipeline system for the
period from March 19, 2003 through June 30, 2003, and $0.9 million of operating
income related to the Telfer asphalt terminal. Partially offsetting the increase
in operating income resulting from the acquisitions is an increase in net
interest expense due to additional borrowings to partially fund the redemption
of common units and these acquisitions.
Interest expense increased for the three and six months ended June 30, 2003
as compared to the three and six months ended June 30, 2002 primarily due to
interest expense related to $250.0 million of 6.05% senior notes issued on March
18, 2003 and $100.0 million of 6.875% senior notes issued in July of 2002. A
portion of the proceeds from the 6.875% senior note offering were used to repay
borrowings under the variable-rate revolving credit facility. The private
placement of the 6.05% senior notes and $25.0 million of borrowings under the
revolving credit facility were used to fund a portion of the crude oil storage
tank and South Texas pipeline system acquisitions and the redemption of common
units. During the six months ended June 30, 2003, Valero Logistics entered into
various interest rate swaps, which effectively convert $167.5 million of fixed
rate debt to variable rate debt.
Net income is allocated between limited partners and the general partner's
interests. Then such apportioned net income applicable to the limited partners
is divided by the weighted average number of limited partnership units
outstanding for such class. Net income per unit applicable to limited partners
for the three months ended June 30, 2003 was impacted by the net increase in
common units outstanding as a result of the March 2003 common unit offering and
redemption and the April 2003 overallotment option exercise. As a result, the
sum of the net income per unit applicable to limited partners for the first and
second quarters of 2003 does not equal the year-to-date 2003 per unit amount.
Non-GAAP financial measures. We utilize two financial measures, earnings
before interest, income taxes, depreciation and amortization (EBITDA) and
distributable cash flow, which are not defined in United States generally
accepted accounting principles. Management presents both EBITDA and
distributable cash flow in our filings under the Securities Exchange Act of
1934. Management uses these financial measures because they are widely accepted
financial indicators used by some investors and analysts to analyze and compare
partnerships on the basis of operating performance. In addition, distributable
cash flow is used to determine the amount of cash distributions to Valero L.P.'s
unitholders. Neither EBITDA nor distributable cash flow are intended to
represent cash flows for the period, nor are they presented as an alternative to
operating income or income before income tax expense. They should not be
considered in isolation or as substitutes for a measure of performance prepared
in accordance with United States generally accepted accounting principles. Our
method of computation for both EBITDA and distributable cash flow may or may not
be comparable to other similarly titled measures used by other partnerships.
S-6
The following is a reconciliation of EBITDA and distributable cash flow to
income before income tax expense:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------- -----------------
2003 2002 2003 2002
-------- -------- ------- -------
(UNAUDITED, IN THOUSANDS)
Income before income tax expense............... $18,132 $14,939 $30,514 $25,757
Plus interest expense, net................... 4,736 796 7,113 1,352
Plus depreciation and amortization expense... 7,269 3,876 11,552 8,231
------- ------- ------- -------
EBITDA......................................... 30,137 19,611 49,179 35,340
Less equity income from Skelly-Belvieu
Pipeline Company.......................... (600) (844) (1,331) (1,522)
Less interest expense, net................... (4,736) (796) (7,113) (1,352)
Less reliability capital expenditures........ (1,446) (741) (2,638) (1,530)
Plus distributions from Skelly-Belvieu
Pipeline Company.......................... 879 851 1,627 1,622
------- ------- ------- -------
DISTRIBUTABLE CASH FLOW........................ $24,234 $18,081 $39,724 $32,558
======= ======= ======= =======
PARTNERSHIP STRUCTURE AND MANAGEMENT
Valero Energy owns and controls Riverwalk Logistics, L.P., which serves as
our general partner with a 2% general partner interest. Valero Energy also
indirectly owns an aggregate 46.2% limited partner interest in us. Giving effect
to this common unit offering, Valero Energy will own a 44.1% limited partner
interest in us.
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.
- 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 partnership agreement;
- UDS Logistics LLC, the sole limited partner of Riverwalk Logistics and an
indirect wholly owned subsidiary of Valero Energy, currently owns an
aggregate 45.9% limited partner interest in us and will own an aggregate
43.8% limited partner interest in us after 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 and will
own after this common unit offering, a 0.3% non-voting limited partner
interest in us. 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 this common unit offering.
S-7
(Valero Logistics Operations Chart)
--------------------------------------------------------------------------------
------------------------------------------------
| Ownership of Valero L.P. |
| Public Common Units.................. 53.9% |
| Valero Energy's Common Units ........ 3.0% |
| Valero Energy's Subordinated Units... 41.1% |
| Valero Energy's General Partner |
| Interest.......................... 2.0% |
| TOTAL........................... 100.0% |
-----------------------------------------------
--------------------------------
| Valero Energy |
| and its |
| wholly owned subsidiaries |
--------------------------------
| |
| 100% Indirect Ownership |
| |
------------------------ ---------------------------------
| Valero GP, LLC(1) | | UDS Logistics, LLC |
| 73,319 Common Units | | 9,599,322 Subordinated Units |
------------------------ | 614,572 Common Units |
| | ---------------------------------
| | 0.1% General | |
| | Partner Interest | |
| | | 99.9% | 43.8%
0.3% | --------------------------------- Limited | Limited
Limited | | Riverwalk Logistics, L.P. | Partner | Partner
Partner | | (the General Partner | Interest | Interest
Interest | | of the Partnership) | |
| | Incentive Distribution Rights | |
| --------------------------------- |
| | |
| | 2.0% General Partner |
| | Interest |
| | |
| ---------------------------------- | --------------
| | |---------- | Public |
|---------| Valero L.P. |------------|Unitholders |
| (the Partnership) | 53.9% | 12,592,931 |
---------------------------------- Limited |Common Units|
| | Partner --------------
100% | | Interest
| |
-------------------------- |
| Valero GP, Inc. | | 99.99%
| (the General Partner | | Limited
| of the Operating | | Partner
| Partnership) | | Interest
-------------------------- |
| |
| 0.01% |
| General |
| Partner |
| Interest |
----------------------------------
| Valero Logistics |
| Operations, L.P.(2) |
| (the Operating Partnership) |
----------------------------------
---------------
(1) Valero GP, LLC has relinquished 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-8
THE OFFERING
Common units offered by Valero
L.P. ......................... 1,075,000 common units
Units to be outstanding after
this offering................. 13,280,822 common units
9,599,322 subordinated units.
Use of proceeds............... We estimate that we will receive net proceeds
from this common unit offering of approximately
$42.2 million, or approximately $48.6 million
if the underwriters' over-allotment option is
exercised in full. We plan to use net proceeds
from this common unit offering for working
capital and general partnership purposes,
including future acquisitions and expansion
capital projects.
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 May 15, 2003, we paid a quarterly cash
distribution for the first quarter of 2003 of
$0.70 per unit or $2.80 per unit on an
annualized basis.
On July 28, 2003, we declared a cash
distribution for the second quarter of 2003 of
$0.75 per unit, payable on August 14, 2003 to
holders of record as of August 5, 2003. None of
the common units sold in this offering are
eligible to receive this distribution for the
second quarter of 2003.
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.
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
2006, you will be allocated, on a cumulative
basis, an amount of federal taxable income for
the period 2003 through 2006 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-17 of this
prospectus supplement for the basis of this
estimate.
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.
S-9
Risk factors.................. An investment in our common units involves
risks. Please read "Risk Factors" beginning on
page S-11 of this prospectus supplement and
page 4 of the accompanying prospectus.
New York Stock Exchange
symbol........................ VLI
S-10
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. In addition, please read carefully the following risks
relating to our business.
WE DEPEND ON VALERO ENERGY FOR SUBSTANTIALLY ALL OF THE CRUDE OIL AND REFINED
PRODUCT THROUGHPUT HANDLED BY THE CRUDE OIL STORAGE TANKS AND THE SOUTH TEXAS
PIPELINE SYSTEM, AND IF THERE IS ANY REDUCTION IN THIS THROUGHPUT, OUR REVENUES
WILL BE REDUCED AND THEREFORE OUR ABILITY TO MAKE CASH DISTRIBUTIONS TO OUR
UNITHOLDERS MAY BE ADVERSELY AFFECTED.
Because of the geographic location of the crude oil storage tanks and the
South Texas pipeline system, which serve Valero Energy's Corpus Christi East,
Corpus Christi West, 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 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
also in 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 crude oil storage tanks and the South Texas pipeline system are subject
to the same business risks applicable to our other pipeline, terminalling and
storage 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 4 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 the various terminalling and throughput agreements with
us. 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, which 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 DEBT AGREEMENTS AND BY OUR LEVERAGE AND VALERO ENERGY'S
LEVERAGE.
Our leverage is significant in relation to our consolidated partners'
equity. Our total outstanding debt as of June 30, 2003 is $365.2 million, which
represents approximately 46% of our total capitalization, after giving effect to
this common unit offering.
Debt service obligations, restrictive covenants in Valero Logistics'
revolving credit facility and the indentures governing Valero Logistics' $100
million 6.875% senior notes due 2012 and $250 million 6.05% senior notes due
2013 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. We are
prohibited from making cash distributions to our unitholders during an event of
default under any of our debt agreements.
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
S-11
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 Valero
Logistics' current indebtedness or any new indebtedness could have similar or
greater restrictions.
Valero Logistics' revolving credit facility and the indentures governing
the 6.875% senior notes and the 6.05% senior notes contain 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.
Further, if one or more credit rating agencies were to 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, refinance existing indebtedness and 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 29% of our operating expenses for the year
ended December 31, 2002 and approximately 25% of our operating expenses for the
three months ended March 31, 2003. We use mainly electric power at our pipeline
pump stations and at our terminals and this 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 ARE
SUBSTANTIAL AND REDUCE OUR CASH AVAILABLE FOR DISTRIBUTION TO UNITHOLDERS.
Prior to making any distribution on the common units, we have agreed to pay
Valero Energy and its affiliates aggregate annual fees for various
administrative services in the current amount of $5.2 million in addition to
reimbursements for direct expenses incurred by affiliates of Valero Energy on
our behalf. For the year ended December 31, 2002 and the three months ended
March 31, 2003, we reimbursed to Valero Energy and its affiliates approximately
$13.8 million and $4.1 million, respectively, of direct expenses. The amount of
reimbursable expenses is determined by our general partner in its sole
discretion. Further, we have agreed to pay Valero Energy an annual fee in the
current amount of $3.5 million for services provided in connection with the
crude oil storage tanks. The payment of these fees and the reimbursement of
these expenses to Valero Energy and its affiliates could adversely affect our
ability to make cash distributions to unitholders.
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.
On September 11, 2001, the United States was the target of terrorist
attacks of unprecedented scope, and the United States and others instituted
military action in response. 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. These developments subject energy-related operations to
increased risks, are likely to cause continued volatility in the energy markets
and may cause disruptions in the supply of crude oil and thus adversely impact
the throughput levels in our pipelines,
S-12
terminals and storage tanks and our results of operations, financial condition
and ability to make cash distributions to unitholders.
In addition, political uncertainties and unrest in crude oil producing
countries 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, which could adversely
impact the throughput levels in our pipelines, terminals and storage tanks and
thus our results of operations, financial condition and ability to make cash
distributions to unitholders.
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, you may not
be able to recover from Arthur Andersen for 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 the
registration statement and prospectus.
CHANGES IN FEDERAL INCOME TAX LAW COULD AFFECT THE VALUE OF OUR COMMON UNITS.
Recently enacted legislation has reduced the rate of federal income tax
applicable to qualified dividend income of individuals. Qualified dividend
income includes dividends received from domestic corporations and certain
foreign corporations. This legislation will not affect our ability to make
quarterly distributions, but may affect the attractiveness of an investment in
our common units and, as a result, the value of our common units.
S-13
USE OF PROCEEDS
We will receive net proceeds from this common unit offering of
approximately $42.0 million, after deducting underwriting discounts and
commissions and offering expenses. We anticipate using the net proceeds from
this offering and from the related capital contribution of our general partner
of approximately $0.9 million for working capital and general partnership
purposes, including future acquisitions and expansion capital projects. We are
continuing to evaluate potential acquisitions of various logistics assets from
third parties as well as Valero Energy, including, but not limited to, the
Southlake refined products pipeline from Valero Energy. We cannot predict when
or whether we will be able to reach any agreements to purchase any of these
assets on terms acceptable to us. Pending application of the net proceeds, we
will invest the proceeds in short-term, investment grade, interest-bearing
securities.
S-14
CAPITALIZATION
The following table shows:
- our historical capitalization as of March 31, 2003; and
- our as adjusted capitalization as of March 31, 2003, adjusted to reflect
this common unit offering and the application of the net proceeds we
receive in this offering in the manner described under "Use of Proceeds."
This table should be read together with our consolidated financial
statements and the accompanying notes incorporated by reference into this
prospectus supplement.
AS OF MARCH 31, 2003
----------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
Revolving credit facility................................... $ 25,000 $ 25,000
8.0% Note payable, including current portion................ 9,660 9,660
6 7/8% Senior Notes due 2012................................ 99,624 99,624
6.05% Senior Notes due 2013................................. 249,607 249,607
-------- --------
Total debt........................................ 383,891 383,891
-------- --------
Partners' Equity:
Common units.............................................. 238,886 280,883
Subordinated units........................................ 116,048 116,048
General partner's equity.................................. 7,656 8,541
-------- --------
Total partners' equity................................. 362,590 405,472
-------- --------
Total capitalization.............................. $746,481 $789,363
======== ========
This table does not give effect to the issuance on April 16, 2003, of an
additional 581,000 common units pursuant to the underwriters' over-allotment
option. We used the net proceeds of approximately $20 million to pay down
amounts outstanding under our revolving credit facility.
S-15
PRICE RANGE OF COMMON UNITS AND DISTRIBUTIONS
Our initial public offering was completed on April 16, 2001. As of June 30,
2003, there were 12,205,822 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. In addition, as of June 30,
2003, we have 9,599,322 subordinated units 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
closing 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 August 5, 2003 was $41.15 per unit.
PRICE RANGE
--------------- CASH DISTRIBUTIONS
HIGH LOW PER UNIT(1)
------ ------ ------------------
YEAR ENDED 2003
Third Quarter (through August 5, 2003).............. $44.58 $41.15 $ --
Second Quarter...................................... 43.46 36.69 0.75
First Quarter....................................... 40.64 36.03 0.70
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. The $0.75 per unit cash distribution
for the second quarter of 2003 will be paid on August 14, 2003 to holders of
record on August 5, 2003. None of the common units sold in this offering are
eligible to receive this distribution for the second quarter of 2003. 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 $2.2 million and $0.7 million for the year
ended December 31, 2002 and the three months ended March 31, 2003,
respectively. Included in the general partner cash distribution for the year
ended December 31, 2002 and the three months ended March 31, 2003 are $1.1
million and $0.4 million, respectively, of incentive distributions.
S-16
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 2006, you will be allocated, on a cumulative basis,
an amount of federal taxable income for the period 2003 through 2006 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.
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, Lehman
Brothers Inc. has agreed to purchase from us, and we have agreed to sell to the
underwriter, all 1,075,000 common units that are being sold in this offering.
The underwriting agreement provides that the underwriter is 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-
S-17
allotment option described below. The conditions contained in the underwriting
agreement include requirements that:
- the representations and warranties made by us to the underwriter are
true;
- there has been no material adverse change in our financial condition or
in the financial markets; and
- we deliver the customary closing documents to the underwriter.
OVER-ALLOTMENT OPTION
We have granted the underwriter a 30-day option after the date of the
underwriting agreement to purchase, in whole or part, up to an aggregate of
161,250 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.
COMMISSION AND EXPENSES
We have been advised by the underwriter that they 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 underwriter) at the offering price less a selling concession not in
excess of $1.11 per unit. The underwriter 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 underwriter may change the
offering price and other selling terms.
The following table shows the underwriting discounts and commissions we
will pay to the underwriter. These amounts are shown assuming both no exercise
and full exercise of the underwriter's over-allotment option to purchase
additional common units. The underwriting fee is the difference between the
public offering price and the amount the underwriter pays to us to purchase the
common units from us.
NO EXERCISE FULL EXERCISE
----------- -------------
Per Unit.................................................... $ 1.85 $ 1.85
Total............................................. $1,988,750 $2,287,063
We estimate that the total expense of the offering, excluding underwriting
discounts and commissions, will be approximately $250,000.
STABILIZATION, SHORT POSITIONS AND PENALTY BIDS
In connection with this offering, the underwriter 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 underwriter of the
common units in excess of the number of common units the underwriter is
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 underwriter 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 underwriter 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 underwriter will consider,
among other things,
S-18
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 underwriter sells 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
underwriter is 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 underwriter to reclaim a selling concession from
another broker-dealer 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. On the date of this prospectus supplement, the
underwriter purchased 32,800 common units at a price of $41.035 per common unit.
Neither we nor the underwriter makes 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 the
underwriter makes any representation that the underwriter 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 the underwriter. This agreement does not apply to any
existing employee benefit plans.
The underwriter, 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, the
underwriter 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
underwriter 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
The underwriter has performed investment banking, commercial banking and
advisory services for us from time to time for which they have received
customary fees and expenses. The underwriter may, from time to time in the
future, engage in transactions with and perform services for us in the ordinary
course of their business.
S-19
NASD CONDUCT RULES
The compensation received by the underwriter in connection with this common
unit offering does not exceed 10% of the gross proceeds from this common unit
offering and 0.5% 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 underwriter has 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
underwriter 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
underwriter 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 the
underwriter's or selling group members' website and any information contained in
any other website maintained by the underwriter or 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 the
underwriter in its capacity as underwriter 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, the purchaser is purchasing as principal and not
as agent; and
- the purchaser has reviewed the text above under Resale Restrictions.
S-20
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 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 judgment against us or those persons in Canada or to
enforce a judgment obtained in Canadian courts against us or those persons
outside of Canada.
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
Lehman Brothers 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, incorporated by reference in
this prospectus supplement have been audited by Ernst & Young LLP, independent
auditors, as set forth in their reports thereon incorporated by reference into
this prospectus supplement, and are incorporated by reference in reliance upon
such reports given on the authority of such firm as experts in accounting and
auditing.
S-21
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
7
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
8
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.
16
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.
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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;
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- 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
26
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.
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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.
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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.
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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."
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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.
48
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.
52
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
(VALERO LP LOGO)
1,075,000 COMMON UNITS
REPRESENTING LIMITED PARTNER INTERESTS
----------------------------
PROSPECTUS SUPPLEMENT
AUGUST 5, 2003
----------------------------
LEHMAN BROTHERS