1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM . . . . . . . . . . . TO . . . . . . . . . . .
COMMISSION FILE NUMBER 1-3473
TESORO PETROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-0862768
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
300 CONCORD PLAZA DRIVE, SAN ANTONIO, TEXAS 78216-6999
(Address of principal executive offices) (Zip Code)
210-828-8484
(Registrant's telephone number, including area code)
---------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
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There were 30,952,694 shares of the registrant's Common Stock
outstanding at April 30, 2001.
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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2001
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - March 31, 2001 and December 31, 2000...... 3
Condensed Statements of Consolidated Operations - Three Months Ended
March 31, 2001 and 2000........................................................... 4
Condensed Statements of Consolidated Cash Flows - Three Months Ended
March 31, 2001 and 2000........................................................... 5
Notes to Condensed Consolidated Financial Statements.............................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations..................................................................... 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................ 20
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.................................................. 21
SIGNATURES................................................................................... 22
2
3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
March 31, December 31,
2001 2000
-------- -------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents ..................................................... $ 1.5 $ 14.1
Receivables, less allowance for doubtful accounts ............................. 317.1 334.5
Inventories ................................................................... 274.0 274.3
Prepayments and other ......................................................... 9.8 7.3
-------- -------------
Total Current Assets ........................................................ 602.4 630.2
-------- -------------
PROPERTY, PLANT AND EQUIPMENT
Refining and Marketing ........................................................ 1,021.5 991.1
Marine Services ............................................................... 50.5 50.3
Corporate ..................................................................... 27.1 25.1
-------- -------------
1,099.1 1,066.5
Less accumulated depreciation and amortization ................................ 296.0 285.1
-------- -------------
Net Property, Plant and Equipment ........................................... 803.1 781.4
-------- -------------
OTHER ASSETS ..................................................................... 125.7 132.0
-------- -------------
Total Assets .............................................................. $1,531.2 $ 1,543.6
======== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable .............................................................. $ 217.6 $ 281.6
Accrued liabilities ........................................................... 83.1 97.0
Current maturities of debt and other obligations .............................. 3.7 3.8
-------- -------------
Total Current Liabilities ................................................... 304.4 382.4
-------- -------------
DEFERRED INCOME TAXES ............................................................ 115.3 107.2
-------- -------------
OTHER LIABILITIES ................................................................ 75.6 77.3
-------- -------------
DEBT AND OTHER OBLIGATIONS ....................................................... 346.0 306.8
-------- -------------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Preferred stock, no par value; authorized 5,000,000 shares:
7.25% Mandatorily Convertible Preferred Stock, 103,500 shares issued and
outstanding ................................................................. 165.0 165.0
Common stock, par value $0.16-2/3; authorized 100,000,000 shares;
32,764,378 shares issued (32,739,592 in 2000) ............................... 5.4 5.4
Additional paid-in capital .................................................... 280.3 280.0
Retained earnings ............................................................. 258.6 239.9
Treasury stock, 1,836,763 common shares (1,920,281 in 2000), at cost .......... (19.4) (20.4)
-------- -------------
Total Stockholders' Equity .................................................. 689.9 669.9
-------- -------------
Total Liabilities and Stockholders' Equity ................................ $1,531.2 $ 1,543.6
======== =============
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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4
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS
(UNAUDITED)
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
Three Months Ended
March 31,
----------------------
2001 2000
--------- ---------
REVENUES
Refining and Marketing ........................................ $ 1,180.9 $ 1,012.2
Marine Services ............................................... 46.4 43.1
--------- ---------
Total Revenues ............................................. 1,227.3 1,055.3
--------- ---------
COSTS OF SALES AND OPERATING EXPENSES
Refining and Marketing ........................................ 1,117.4 972.7
Marine Services ............................................... 43.0 38.7
Depreciation and amortization ................................. 11.4 9.9
--------- ---------
Total Cost of Sales and Operating Expenses ................. 1,171.8 1,021.3
--------- ---------
SEGMENT OPERATING PROFIT ........................................ 55.5 34.0
General and administrative expenses ............................. (10.5) (8.7)
Interest and financing costs, net of capitalized interest ....... (7.5) (9.6)
Interest income ................................................. 0.3 1.5
Other expenses .................................................. (1.5) (1.9)
--------- ---------
EARNINGS BEFORE INCOME TAXES ................................... 36.3 15.3
Income tax provision ............................................ 14.6 6.0
--------- ---------
NET EARNINGS .................................................... 21.7 9.3
Preferred dividend requirements ................................. 3.0 3.0
--------- ---------
NET EARNINGS APPLICABLE TO COMMON STOCK ......................... $ 18.7 $ 6.3
========= =========
NET EARNINGS PER SHARE
Basic ......................................................... $ 0.61 $ 0.20
========= =========
Diluted ....................................................... $ 0.52 $ 0.20
========= =========
WEIGHTED AVERAGE COMMON SHARES - BASIC .......................... 30.9 32.2
========= =========
WEIGHTED AVERAGE COMMON AND POTENTIALLY
DILUTIVE COMMON SHARES - DILUTED .............................. 41.8 32.3
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
Three Months Ended
March 31,
----------------------
2001 2000
--------- ---------
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Net earnings ......................................................................................... $ 21.7 $ 9.3
Adjustments to reconcile net earnings to net cash used in operating activities:
Depreciation and amortization ...................................................................... 12.0 10.5
Amortization of refinery turnarounds and other non-cash charges .................................... 5.3 5.4
Deferred income taxes .............................................................................. 8.1 2.1
Changes in operating assets and liabilities:
Receivables ...................................................................................... 17.4 (28.7)
Inventories ...................................................................................... 0.3 (86.1)
Accounts payable and accrued liabilities ......................................................... (77.9) 42.5
Other assets and liabilities ..................................................................... (5.6) 1.8
--------- ---------
Net cash used in operating activities .......................................................... (18.7) (43.2)
--------- ---------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Capital expenditures ................................................................................. (33.5) (9.3)
Other ................................................................................................ 0.7 1.2
--------- ---------
Net cash used in investing activities .......................................................... (32.8) (8.1)
--------- ---------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Net borrowings under revolving credit facility ...................................................... 42.0 45.0
Repayments of other debt ............................................................................. (0.3) (105.0)
Repurchases of Common Stock .......................................................................... -- (6.8)
Payment of dividends on Preferred Stock .............................................................. (3.0) (3.0)
Other ................................................................................................ 0.2 0.3
--------- ---------
Net cash from (used in) financing activities ................................................... 38.9 (69.5)
--------- ---------
DECREASE IN CASH AND CASH EQUIVALENTS ................................................................... (12.6) (120.8)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD .......................................................... 14.1 141.8
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD ................................................................ $ 1.5 $ 21.0
========= =========
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid ........................................................................................ $ 14.2 $ 2.7
========= =========
Income taxes paid .................................................................................... $ 5.4 $ --
========= =========
The accompanying notes are an integral part of these condensed
consolidated financial statements.
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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - BASIS OF PRESENTATION
The interim Condensed Consolidated Financial Statements and Notes thereto of
Tesoro Petroleum Corporation and its subsidiaries (collectively, the "Company"
or "Tesoro") have been prepared by management without audit pursuant to the
rules and regulations of the Securities and Exchange Commission ("SEC").
Accordingly, the accompanying financial statements reflect all adjustments that,
in the opinion of management, are necessary for a fair presentation of results
for the periods presented. Such adjustments are of a normal recurring nature.
The Consolidated Balance Sheet at December 31, 2000 has been condensed from the
audited Consolidated Financial Statements at that date. Certain information and
notes normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States of America ("U.S.
GAAP") have been condensed or omitted pursuant to the SEC's rules and
regulations. However, management believes that the disclosures presented herein
are adequate to make the information not misleading. The accompanying Condensed
Consolidated Financial Statements and Notes should be read in conjunction with
the Consolidated Financial Statements and Notes thereto contained in the
Company's Annual Report on Form 10-K for the year ended December 31, 2000.
The preparation of the Company's Condensed Consolidated Financial Statements in
conformity with U.S. GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the periods. Actual results
could differ from those estimates. The results of operations for any interim
period are not necessarily indicative of results for the full year.
NOTE B - INVENTORIES
Components of inventories were as follows (in millions):
March 31, December 31,
2001 2000
--------- ------------
Crude oil and refined products, at LIFO ..... $ 248.3 $ 248.0
Fuel products, at FIFO ...................... 3.8 4.5
Merchandise and other ....................... 5.6 5.6
Materials and supplies ...................... 16.3 16.2
--------- ------------
Total inventories ....................... $ 274.0 $ 274.3
========= ============
NOTE C - CAPITALIZATION
In 2000, the Company and a group of banks entered into a $250 million unsecured
revolving credit facility, consisting of a $150 million, 3-Year Revolving Credit
Agreement and a $100 million, 364-Day Revolving Credit Agreement (collectively
referred to as the "Credit Facility"). At March 31, 2001, the Company had $42
million in borrowings and $3.8 million in letters of credit outstanding under
the Credit Facility. Borrowings under the Credit Facility bear interest, at the
Company's election, at either the Eurodollar Rate plus a margin ranging from
1.0% to 2.0% (6.29% at March 31, 2001) or a Base Rate (8.0% at March 31, 2001).
The Company has 10,350,000 Premium Income Equity Securities ("PIES")
outstanding, which represent fractional interests in the Company's 7.25%
Mandatorily Convertible Preferred Stock ("Preferred Stock"). Holders of PIES are
entitled to receive a cash dividend until the PIES are converted to Common
Stock. The scheduled dividends on the PIES total $3 million per quarter, with
the last scheduled quarterly payment due on July 1, 2001. The PIES will
automatically convert into shares of Common Stock on July 1, 2001, at a
conversion rate based upon a formula dependent upon the average closing price
per share ("Conversion Price") of Common Stock for the 20 trading days prior to
July 1, 2001. If the Conversion Price is less than or equal to $15.9375, each
PIES outstanding converts into one share of Common Stock. If the Conversion
Price is greater than or equal to $18.85, each PIES outstanding converts into
0.8455 shares of Common Stock. If the Conversion Price is less than $18.85
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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
and more than $15.9375, each PIES outstanding converts into a fraction ($15.9375
divided by the Conversion Price) of a share of Common Stock. Before July 1,
2001, each PIES is convertible, at the option of the holder thereof, into 0.8455
shares of Common Stock, subject to adjustment in certain events.
NOTE D - OPERATING SEGMENTS
The Company's revenues are derived from two operating segments: (i) Refining and
Marketing and (ii) Marine Services. Management evaluates the performance of its
segments and allocates resources based on segment operating profit and EBITDA.
Segment operating profit includes those revenues and expenses that are directly
attributable to management of the respective segment. Income taxes, interest and
financing costs, interest income and corporate general and administrative
expenses are not included in determining segment operating profit. EBITDA
represents earnings before interest and financing costs, income taxes, and
depreciation and amortization. While not purporting to reflect any U.S. GAAP
measurement of the Company's operations or cash flows, EBITDA is used by
management for additional analysis. Operating segment EBITDA is equal to segment
operating profit before depreciation and amortization related to each segment.
For the periods presented, intersegment revenues were not significant. Segment
information is as follows (in millions):
Three Months Ended
March 31,
------------------------
2001 2000
---------- ----------
REVENUES
Refining and Marketing:
Refined products ........................................... $ 1,107.8 $ 956.0
Other, primarily crude oil resales and merchandise ......... 73.1 56.2
Marine Services .............................................. 46.4 43.1
---------- ----------
Total Revenues ........................................... $ 1,227.3 $ 1,055.3
========== ==========
SEGMENT OPERATING PROFIT
Refining and Marketing ....................................... $ 52.8 $ 30.2
Marine Services .............................................. 2.7 3.8
---------- ----------
Total Segment Operating Profit ........................... 55.5 34.0
Corporate and Unallocated Costs .............................. (19.2) (18.7)
---------- ----------
Earnings Before Income Taxes ................................. $ 36.3 $ 15.3
========== ==========
EBITDA
Refining and Marketing ....................................... $ 63.5 $ 39.5
Marine Services .............................................. 3.4 4.4
---------- ----------
Total Segment EBITDA ..................................... 66.9 43.9
Corporate and Unallocated .................................... (11.1) (8.5)
---------- ----------
Total EBITDA ............................................. 55.8 35.4
Depreciation and Amortization ................................ (12.0) (10.5)
Interest and Financing Costs ................................. (7.5) (9.6)
---------- ----------
Earnings Before Income Taxes ................................. $ 36.3 $ 15.3
========== ==========
DEPRECIATION AND AMORTIZATION
Refining and Marketing ....................................... $ 10.7 $ 9.3
Marine Services .............................................. 0.7 0.6
Corporate .................................................... 0.6 0.6
---------- ----------
Total Depreciation and Amortization ...................... $ 12.0 $ 10.5
========== ==========
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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three Months Ended
March 31,
---------------------
2001 2000
--------- ---------
CAPITAL EXPENDITURES
Refining and Marketing ......... $ 31.3 $ 7.4
Marine Services ................ 0.2 1.4
Corporate ...................... 2.0 0.5
--------- ---------
Total Capital Expenditures.. $ 33.5 $ 9.3
========= =========
Identifiable assets are those assets utilized by the segment. Corporate assets
are principally cash and other assets that are not directly associated with the
operations of an operating segment. Segment assets were as follows (in
millions):
March 31, December 31,
2001 2000
--------- ------------
IDENTIFIABLE ASSETS
Refining and Marketing... $ 1,420.6 $ 1,405.4
Marine Services ......... 70.5 76.8
Corporate ............... 40.1 61.4
--------- ------------
Total Assets ........ $ 1,531.2 $ 1,543.6
========= ============
NOTE E - COMMITMENTS AND CONTINGENCIES
The Company is a party to various litigation and contingent loss situations,
including environmental and income tax matters, arising in the ordinary course
of business. The Company has made accruals in accordance with Statement of
Financial Accounting Standard ("SFAS") No. 5, "Accounting for Contingencies," in
order to provide for these matters. The ultimate effects of these matters cannot
be predicted with certainty, and related accruals are based on management's best
estimates, subject to future developments. Although the resolution of certain of
these matters could have a material adverse effect on interim or annual results
of operations, the Company believes that the outcome of these matters will not
result in a material adverse effect on its liquidity or consolidated financial
position.
ENVIRONMENTAL
The Company is subject to extensive federal, state and local environmental laws
and regulations. These laws, which change frequently, regulate the discharge of
materials into the environment and may require the Company to remove or mitigate
the environmental effects of the disposal or release of petroleum or chemical
substances at various sites, install additional controls, or make other
modifications or changes in use for certain emission sources.
The Company is currently involved with the U.S. Environmental Protection Agency
("EPA") regarding a waste disposal site near Abbeville, Louisiana. The Company
has been named a potentially responsible party under the Federal Comprehensive
Environmental Response, Compensation and Liability Act ("CERCLA" or "Superfund")
at this location. Although the Superfund law may impose joint and several
liability upon each party at the site, the extent of the Company's allocated
financial contributions for cleanup is expected to be de minimis based upon the
number of companies, volumes of waste involved and total estimated costs to
close the site. The Company believes, based on these considerations and
discussions with the EPA, that its liability at the Abbeville site will not
exceed $25,000.
The Company is also involved in remedial responses and has incurred cleanup
expenditures associated with environmental matters at a number of sites,
including certain of its owned properties. At March 31, 2001, the Company's
accruals for environmental expenses totaled approximately $14.3 million. Based
on currently available information, including the participation of other parties
or former owners in remediation actions, the Company believes these accruals are
adequate.
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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Company is currently evaluating certain newly-promulgated revisions to the
Clean Air Act regulations which will require a reduction in the sulfur content
in gasoline by January 1, 2004. To meet the revised gasoline standard, the
Company expects to make capital improvements of approximately $40 million to $50
million at its Washington refinery. Additionally, the Company expects to spend
approximately $15 million in capital improvements over the next four years to
comply with the second phase of Maximum Achievable Control Technologies for
petroleum refineries ("Refinery MACT II") which was signed into law on January
18, 2001. Management expects that the Refinery MACT II regulations will require
new emission controls at certain processing units at each of the Company's
refineries.
On December 21, 2000, the EPA announced new standards that will require a
reduction in sulfur content in diesel fuel manufactured for on-road consumption.
In general, the new diesel fuel standards will become effective on June 1, 2006.
Although the Company is evaluating the new diesel fuel standards with respect to
its Alaska operations, the Company estimates that the demand for ultra low
sulfur diesel in Alaska will not be significant and should not have a material
impact on its Alaska operations. The Hawaii refinery is currently capable of
producing diesel fuels that comply with the new standards. For the Washington
refinery, the Company is currently evaluating the impact of the new diesel fuel
standards on production, equipment requirements and related costs.
To comply with other environmental laws and regulations, the Company anticipates
it will make capital improvements of approximately $8 million in 2001 and $9
million in 2002, primarily for improvements to storage tanks, tank farm
secondary containment and pipelines. During the three months ended March 31,
2001, the Company spent approximately $1 million on environmental capital
projects.
Conditions that require additional expenditures may exist for various Company
sites, including, but not limited to, the Company's refineries, tank farms,
retail gasoline stations (operating and closed locations) and petroleum product
terminals, and for compliance with the Clean Air Act and other state and federal
requirements. The amount of such future expenditures cannot currently be
determined by the Company.
OTHER
In October 1998, the Company's Board of Directors unanimously approved the 1998
Performance Incentive Compensation Plan ("Performance Plan"), which is intended
to advance the best interests of the Company and its stockholders by directly
targeting Company performance to align with the ninetieth percentile historical
stock-price growth rate for the Company's peer group. In addition, the
Performance Plan will provide the Company's employees with additional
compensation, contingent upon achievement of the targeted objectives, thereby
encouraging them to continue in the employ of the Company. Under the Performance
Plan, targeted objectives are comprised of the fair market value of the
Company's Common Stock equaling or exceeding an average of $35 per share ("First
Performance Target") and $45 per share ("Second Performance Target") on any 20
consecutive trading days during a period commencing on October 1, 1998 and
ending on the earlier of September 30, 2002, or the date on which the Second
Performance Target is achieved. No costs will be recorded until the First
Performance Target is reached.
NOTE F - EARNINGS PER SHARE
Basic earnings per share are determined by dividing net earnings applicable to
Common Stock by the weighted average number of common shares outstanding during
the period. The calculation of diluted earnings per share takes into account the
effects of potentially dilutive shares outstanding during the period,
principally the maximum shares which would have been issued assuming conversion
of Preferred Stock at the beginning of the period and stock options. The assumed
conversion of Preferred Stock to 10.35 million shares of Common Stock produced
anti-dilutive results for the three months ended March 31, 2000, and in
accordance with SFAS No. 128, "Earnings per Share," was not included in the
dilutive calculation. Earnings per share calculations are presented below (in
millions except per share amounts).
9
10
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three Months Ended
March 31,
-------------------
2001 2000
-------- --------
BASIC:
Numerator:
Net earnings ............................................................... $ 21.7 $ 9.3
Less dividends on Preferred Stock .......................................... 3.0 3.0
-------- --------
Net earnings applicable to common shares ................................... $ 18.7 $ 6.3
======== ========
Denominator:
Weighted average common shares outstanding ................................. 30.9 32.2
======== ========
Basic Earnings Per Share ..................................................... $ 0.61 $ 0.20
======== ========
DILUTED:
Numerator:
Net earnings applicable to common shares ................................... $ 18.7 $ 6.3
Plus impact of assumed conversion of Preferred Stock (dilutive in 2001) .... 3.0 --
-------- --------
Total .................................................................... $ 21.7 $ 6.3
======== ========
Denominator:
Weighted average common shares outstanding ................................. 30.9 32.2
Add potentially dilutive securities:
Incremental dilutive shares from assumed exercise of stock
options and other ...................................................... 0.6 0.1
Incremental dilutive shares from assumed conversion
of Preferred Stock (dilutive in 2001) .................................. 10.3 --
-------- --------
Total diluted shares ..................................................... 41.8 32.3
======== ========
Diluted Earnings Per Share ................................................... $ 0.52 $ 0.20
======== ========
NOTE G - NEW ACCOUNTING STANDARD
Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," as amended by SFAS No. 138. SFAS
No. 133, as amended and interpreted, establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities. SFAS No. 133 requires
all derivatives to be recorded on the balance sheet at fair value. The
accounting for changes in the fair value of a derivative depends on the intended
use of the derivative and the designation if in a hedging relationship. The
adoption of SFAS No. 133 did not have a significant impact on the Company's
financial condition, results of operations or cash flows.
The Company periodically enters into derivatives arrangements, on a limited
basis, as part of its programs to acquire refinery feedstocks at reasonable
costs and to manage margins on certain refined product sales. The Company also
engages in limited non-hedging derivatives, which are marked to market with
changes in the fair value of the derivatives recognized in earnings in the
Condensed Statements of Consolidated Operations and the carrying amounts
included in other current assets or accrued liabilities in the Condensed
Consolidated Balance Sheets. As of March 31, 2001, the Company did not have any
derivative instruments that were designated and accounted for as hedges. The
Company believes that substantially all of its agreements are normal purchases
and sales and that repricing provisions in other agreements are not embedded
derivatives.
At March 31, 2001, the Company held exchange traded crude oil futures contracts
to purchase 169,000 barrels in May 2001 at a weighted average price of $26.85
per barrel, or a total of $4.5 million. The contracts are accounted for at
market prices and had a fair value of $4.4 million at March 31, 2001.
10
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
THOSE STATEMENTS IN THE MANAGEMENT'S DISCUSSION AND ANALYSIS THAT ARE NOT
HISTORICAL IN NATURE SHOULD BE DEEMED FORWARD-LOOKING STATEMENTS THAT ARE
INHERENTLY UNCERTAIN. SEE "FORWARD-LOOKING STATEMENTS" ON PAGE 20 FOR DISCUSSION
OF THE FACTORS WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
PROJECTED IN SUCH STATEMENTS.
THE COMPANY HAS ENDEAVORED TO PROVIDE A MORE THOROUGH DISCUSSION OF MANAGEMENT'S
EXPECTATIONS AND GOALS FOR THE COMPANY IN THIS MANAGEMENT'S DISCUSSION AND
ANALYSIS, AND THE COMPANY ANTICIPATES THAT IT WILL CONTINUE TO DO THE SAME IN
MANAGEMENT'S DISCUSSION AND ANALYSIS IN THE FUTURE. HOWEVER, EXPECTATIONS AND
GOALS MAY CHANGE DURING INTERIM PERIODS OF TIME. THE COMPANY DOES NOT INTEND TO,
AND A READER HEREOF SHOULD NOT EXPECT THAT THE COMPANY WILL, UPDATE THE
INFORMATION CONTAINED HEREIN DURING ANY SUCH INTERIM PERIOD.
STRATEGY
Management's corporate goal is to create shareholder value through improved
financial performance and acquisitions. Its strategic objectives are to (i)
maximize the Company's earnings, cash flows and return on capital employed by
reducing costs, increasing efficiencies and optimizing existing assets and (ii)
increase the Company's competitiveness by expansion in overall size and market
presence through a combination of internal growth initiatives and selective
acquisitions which are both accretive to earnings and provide significant
operational synergies. The Company is also focused on improving profitability in
the Refining and Marketing segment by enhancing processing capabilities,
strengthening its marketing activities and improving supply and transportation
functions. The Marine Services segment pursues opportunities for expansion, as
well as optimizing existing operations through development of customer services
and cost management. As part of this strategy, the Company continues to assess
its existing asset base in order to maximize returns and financial flexibility
through market diversification and related acquisitions. Management's goal is to
achieve a minimum earnings per share of $3.00 for 2002, based on the objective
to acquire strategic assets that will be accretive to earnings and the expected
benefits from profit improvement programs. In addition, management expects to
achieve, over time, a 12% aftertax return on capital employed. For the three
months ended March 31, 2001, the Company earned a 9.8% annualized aftertax
return on capital employed.
The Company's manufacturing strategy includes improving refinery reliability and
safety, improving refining processes, and controlling manufacturing costs. The
Company commenced a heavy oil conversion project at its Washington refinery in
2000, which will enable the Company to process a larger proportion of lower-cost
heavy crude oils, to manufacture a larger proportion of higher-value gasoline,
and to reduce production of lower-value heavy products. The Company expects to
spend approximately $100 million (including capitalized interest) for this
project, of which $38.5 million had been spent through March 31, 2001. The
upgrade of the fluid catalytic cracking unit ("FCC"), the final major component
of the heavy oil conversion project, was originally expected to be fully
operational by late 2001, with construction completed in conjunction with the
turnaround of the FCC. Because margins are expected to be stronger in the fourth
quarter of 2001 than in the first quarter of 2002, the Company has postponed the
planned turnaround of the FCC until the first quarter of 2002. Management
believes that this postponement and other factors will increase average refinery
throughput at least 5,000 barrels per day ("bpd"), resulting in an average
throughput of 255,000 bpd to 260,000 bpd for the year 2001.
The manufacturing goals for 2001 are to achieve $4 million to $6 million in
profit improvement in 2001, which initially included the impact of the
completion of the heavy oil conversion project during late 2001 and other
manufacturing initiatives. Management believes that the impact of delaying the
start-up of the heavy oil conversion project, as previously discussed, will be
more than offset by the Company's ability to run at increased throughput levels
during the fourth quarter of 2001.
Management originally estimated that the total heavy oil conversion project
would increase annual operating profit by $30 million to $40 million. However,
based upon price differentials between light and heavy crude oils and between
light and heavy refined products for the twelve months ended April 30, 2001,
management estimates that the heavy oil conversion project would have increased
annual operating profit by approximately $50 million, if it had been in
operation during that period. The actual profit to be contributed by the heavy
oil conversion project is subject to several factors, including, among others,
refinery throughput; market values of light and heavy refined products;
availability of economic heavy feedstocks; price differentials between light and
heavy crude oils; and operating costs, including fuel and utility costs.
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Other manufacturing initiatives focus on controlling fuel and utility costs,
consolidating refinery purchasing, increasing asphalt production capabilities,
upgrading process control systems, increasing jet fuel production and
implementing various other cost-savings projects. To address high fuel and
utility costs for the near term, the Company installed leased, diesel-fueled
generators in late January 2001 to self-generate most of the Washington
refinery's power requirements. These generators helped mitigate the impact of
high first quarter 2001 electric rates that averaged between $250 per
megawatt-hour ("MWH") and $350 per MWH. By self-generating electricity using
these diesel-fueled generators at a cost of approximately $130 per MWH to $150
per MWH, the Company estimates it saved almost $4 million during the first
quarter of 2001 compared to purchasing electricity at market rates. The Company
is acquiring 22 natural gas-fueled generators with emission control packages
which will replace the leased, diesel-fueled generators later this year. The
natural gas-fueled generators are capable of supplying approximately 22
megawatts of electric power, or approximately 90% to 95% of the Washington
refinery's present requirements.
As part of its retail marketing initiatives, the Company has an agreement with
Wal-Mart Stores, Inc. ("Wal-Mart") to build and operate retail fueling
facilities on sites at selected existing and future Wal-Mart store locations in
the western United States. The Company's "Mirastar" brand is used exclusively in
its program with Wal-Mart. As of April 30, 2001, the Company had 36 Mirastar
stations in operation, 9 Mirastar stations under construction and 50 sites in
various stages of development or evaluation. Management expects to have 80 to 90
Mirastar stations operating by the end of 2001 and expects to construct an
additional 80 to 90 stations in each of 2002 and 2003. The Company is also
adding Company-owned stations and branded stations operated by jobber/dealers to
its retail network. As of April 30, 2001, the Company supplied 288 branded
sites, including 105 Company-owned and operated sites. Management has targeted
an increase to a range of 368 to 378 sites by year-end 2001, primarily through
growth in the Mirastar and branded jobber/dealer programs.
In 2000, the Company identified an opportunity to alter its gasoline blending
process to market higher-value CARB quality blendstocks, rather than including
these materials in the refinery's finished gasoline pool. Sales of these
blendstocks increased operating profit in the year 2000 and in the first quarter
of 2001. In April 2001, the Company entered into a nonexclusive license
agreement that allows the Company to make and sell all gasolines subject to
patents held by Union Oil Company of California, a subsidiary of Unocal
Corporation. This agreement removes uncertainty regarding patent royalties as
the Company expands production and marketing of cleaner-burning gasolines.
BUSINESS ENVIRONMENT
The Company operates in an environment where its results and cash flows are
sensitive to volatile changes in energy prices. Fluctuations in the costs of
crude oil and other refinery feedstocks and the price of refined products can
result in changes in margins from the Refining and Marketing operations, as
prices received for refined products may not keep pace with changes in feedstock
costs. As part of its marketing program, the Company also purchases refined
products for sale to customers. Changes in price levels of crude oil and refined
products can result in changes in margins on such activities. Energy prices,
together with volume levels, also determine the carrying value of crude oil and
refined product inventory. The Company uses the last-in, first-out ("LIFO")
method of accounting for inventories of crude oil and refined products in its
Refining and Marketing segment. This method results in inventory carrying
amounts that are less likely to represent current values and costs of sales that
more closely represent current costs.
The Company maintains inventories of crude oil, intermediate products and
refined products, the values of which are subject to fluctuations in market
prices. At both March 31, 2001 and December 31, 2000, the Company's inventories
of refinery feedstocks and refined products totaled 11.9 million barrels. The
Company continues to monitor its inventory positions, and management expects, at
this time, that inventories will approximate the same level at year-end 2001.
During 2000, inventory levels increased 3.3 million barrels over year-end 1999
levels at an average cost of $29.82 per barrel. Any sales that result in a
reduction in inventories during 2001 would have a per barrel cost of sales equal
to the sum of $29.82 per barrel plus the cost of transportation to market. This
amount could exceed the year-to-date average costs of sales in 2001. The average
cost of refinery throughput as of March 31, 2001 was approximately $27.19 per
barrel, or approximately $2.63 per barrel lower than the cost of the 2000
incremental layer. The average costs of the Company's Refining and Marketing
inventories of refinery feedstocks and refined products as of both March 31,
2001 and December 31, 2000 were $20.79 per barrel. If
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market price levels decline from current levels to a level below the average
cost of these inventories, the Company may be required to write down the
carrying value of its inventory.
Changes in crude oil and natural gas prices also influence the level of drilling
activity in the Gulf of Mexico. The Company's Marine Services segment, whose
customers include offshore drilling contractors and related industries, can be
impacted by significant fluctuations in crude oil and natural gas prices. The
Marine Services segment uses the first-in, first-out ("FIFO") method of
accounting for inventories of fuels. Changes in fuel prices can significantly
affect inventory valuations and costs of sales.
For further information on commodity price and interest rate risks, see
Quantitative and Qualitative Disclosures About Market Risk in Item 3 herein.
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2001 COMPARED WITH
THREE MONTHS ENDED MARCH 31, 2000
SUMMARY
Tesoro's net earnings were $21.7 million ($0.61 per basic share or $0.52 per
diluted share) for the three months ended March 31, 2001 ("2001 Quarter"),
compared with net earnings of $9.3 million ($0.20 per basic share and diluted
share) for the three months ended March 31, 2000 ("2000 Quarter"). The increase
in earnings reflected improvement in operating profit from the Company's
Refining and Marketing segment due to higher refined product margins, refinery
throughput levels and sales volumes, partially offset by higher expenses.
A discussion and analysis of the factors contributing to the Company's results
of operations are presented below. The accompanying Condensed Consolidated
Financial Statements and related Notes, together with the following information,
are intended to provide shareholders and other investors with a reasonable basis
for assessing the Company's operations, but should not serve as the only
criteria for predicting the future performance of the Company.
REFINING AND MARKETING
Three Months Ended
March 31,
-----------------------
(Dollars in millions except per barrel amounts) 2001 2000
--------- ---------
REVENUES
Refined products .................................................. $ 1,107.8 $ 956.0
Other revenues, primarily crude oil resales and merchandise ...... 73.1 56.2
--------- ---------
Total Revenues ................................................ $ 1,180.9 $ 1,012.2
========= =========
SEGMENT OPERATING PROFIT
Gross margins:
Refinery (a) .................................................... $ 172.6 $ 124.4
Purchased product and crude oil resales ........................ 4.4 12.4
Merchandise and other ........................................... 5.4 6.6
--------- ---------
Total gross margins ........................................... 182.4 143.4
Operating expenses and other (b) .................................. (118.9) (103.9)
Depreciation and amortization (c) ................................. (10.7) (9.3)
--------- ---------
Segment Operating Profit ...................................... $ 52.8 $ 30.2
========= =========
REFINERY SYSTEM THROUGHPUT (thousand bpd)
Alaska ............................................................ 45.6 39.0
Hawaii ............................................................ 86.7 85.8
Washington ........................................................ 114.2 105.6
--------- ---------
Total Refinery System Throughput .............................. 246.5 230.4
========= =========
% HEAVY CRUDE OIL OF TOTAL REFINERY SYSTEM THROUGHPUT ................ 56% 46%
========= =========
TOTAL REFINERY SYSTEM PRODUCT SPREAD ($/barrel) ...................... $ 7.71 $ 6.06
========= =========
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Three Months Ended
March 31,
---------------------
2001 2000
--------- ---------
REFINED PRODUCTS MANUFACTURED (thousand bpd)
Gasoline and gasoline blendstocks ................... 88.5 90.9
Jet fuel ............................................ 58.0 54.0
Diesel fuel ......................................... 34.2 30.0
Heavy oils, residual products and other ............. 72.9 63.1
--------- ---------
Total Refined Products Manufactured ................. 253.6 238.0
========= =========
PRODUCT SALES (thousand bpd)(d)
Gasoline and gasoline blendstocks ................... 138.9 124.2
Jet fuel ............................................ 77.3 77.1
Diesel fuel ......................................... 55.4 43.9
Heavy oils, residual products and other ............. 60.4 59.5
--------- ---------
Total Product Sales ................................. 332.0 304.7
========= =========
PRODUCT SALES PRICES ($/barrel)
Gasoline and gasoline blendstocks ................... $ 41.60 $ 37.47
Jet fuel ............................................ $ 36.63 $ 36.34
Diesel fuel ......................................... $ 37.97 $ 36.38
Heavy oils, residual products and other ............. $ 24.23 $ 24.54
PRODUCT SALES MARGIN ($/barrel)(d)
Average sales price ................................. $ 37.06 $ 34.51
Average costs of sales .............................. 31.12 28.99
--------- ---------
Gross Margin ........................................ $ 5.94 $ 5.52
========= =========
- ---------
(a) Approximates refinery system throughput times refinery system product
spread, adjusted for changes in refined product inventory. Refined
product inventory decreased approximately 0.5 million barrels during the
2001 Quarter.
(b) Includes manufacturing costs per throughput barrel of $3.44 and $2.90 for
the three months ended March 31, 2001 and 2000, respectively.
Manufacturing costs included non-cash amortization of maintenance
turnaround costs of $4.2 million and $5.2 million for the three months
ended March 31, 2001 and 2000, respectively.
(c) Includes manufacturing depreciation per throughput barrel of
approximately $0.26 and $0.28 for the three months ended March 31, 2001
and 2000, respectively.
(d) Sources of total product sales included products manufactured at the
refineries, products drawn from inventory balances and products purchased
from third parties. Gross margins on total product sales included margins
on sales of manufactured and purchased products, and the effects of
inventory changes, if any.
Segment operating profit for the Refining and Marketing segment was $52.8
million in the 2001 Quarter, a 75% increase from the 2000 Quarter. The increase
was primarily driven by stronger refined product margins and higher refinery
throughput and sales volumes. The improvement in refinery margins was partially
offset by increases in operating expenses and lower margins from purchased
product resales as discussed below.
Revenues from sales of refined products in the Refining and Marketing segment
increased 16% to $1,107.8 million in the 2001 Quarter, compared to the 2000
Quarter, due to higher product prices and sales volumes. The Company's average
product sales prices increased 7% to $37.06 per barrel in the 2001 Quarter from
$34.51 in the 2000 Quarter. Total product sales averaged 332,000 bpd in the 2001
Quarter, an increase of almost 9% from the 2000 Quarter. Other revenues
increased in the 2001 Quarter primarily due to crude oil resales of
approximately $58.2 million in the 2001 Quarter compared to $40.7 million in the
2000 Quarter. The increase in cost of sales reflected higher costs of crude oil
and purchased products due to higher prices and volumes.
Refinery gross margin increased 39% to $172.6 million in the 2001 Quarter,
reflecting higher volumes and a 27% increase in average refinery system product
spread per barrel to $7.71 in the 2001 Quarter. Industry refining
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margins remained strong in the western U.S. during the 2001 Quarter, reflecting
the continued tightness of supply and refining capacity in the region. The
Company was able to capitalize on these conditions by increasing refinery
throughput 7% to 246,500 bpd in the 2001 Quarter. Margins also benefited by
increasing the amount of lower-cost, heavy crude processed through the
Company's refineries. In marketing, the Company altered its gasoline blending
process to market higher-value CARB quality blendstocks, rather than including
these materials in the finished gasoline pool. The flexibility to sell these
products added approximately $8 million to segment operating profit in the 2001
Quarter as compared to the values received from sales of conventional gasoline.
Margins on purchased product and crude oil resales declined by $8.0 million in
the 2001 Quarter as compared to the 2000 Quarter. Market conditions during the
2000 Quarter offered greater profit opportunities compared to market conditions
during the 2001 Quarter.
Operating expenses and other, excluding depreciation, increased by $15.0 million
to $118.9 million in the 2001 Quarter, primarily due to higher costs for
utilities and fuel, higher throughput and increased employee costs.
MARINE SERVICES
Three Months Ended
March 31,
---------------------
(Dollars in millions) 2001 2000
--------- ---------
Revenues:
Fuels ......................................... $ 39.1 $ 34.9
Lubricants and other .......................... 3.8 3.8
Services ...................................... 3.5 3.2
Other income .................................. -- 1.2
--------- ---------
Total Revenues .............................. 46.4 43.1
Costs of Sales ................................... 35.3 31.0
--------- ---------
Gross Profit ................................ 11.1 12.1
Operating Expenses and Other ..................... 7.7 7.7
Depreciation and Amortization .................... 0.7 0.6
--------- ---------
Segment Operating Profit ...................... $ 2.7 $ 3.8
========= =========
Sales Volumes (millions of gallons):
Fuels, primarily diesel ....................... 42.3 41.5
Lubricants .................................... 0.5 0.5
Segment operating profit declined by $1.1 million during the 2001 Quarter.
Included in the 2000 Quarter was other income of $1.2 million from settlement of
a service contract. Excluding this income, operating profit for the 2001 Quarter
remained flat as compared to the prior year quarter. Revenues increased
approximately 8% from the 2000 Quarter, to $46.4 million, reflecting higher fuel
prices, fuel sales volumes, and services revenues. Sales volumes and services
revenues increased from the 2000 Quarter, reflecting an increase in customer
exploration and development activities in the U.S. Gulf of Mexico compared with
the 2000 Quarter. The increase in cost of sales also reflected the higher fuel
sales volumes and prices.
The Marine Services segment's business is largely dependent upon the volume of
oil and gas drilling, workover, construction and seismic activity in the U.S.
Gulf of Mexico.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses increased by $1.8 million during the 2001
Quarter. The increase was primarily due to higher employee compensation and
benefit costs.
INTEREST AND FINANCING COSTS
Interest and financing costs decreased by $2.1 million during the 2001 Quarter,
reflecting lower borrowings and lower interest rates on floating rate debt.
Capitalized interest on major projects amounted to $0.9 million in the 2001
Quarter, whereas no interest was capitalized in the 2000 Quarter.
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INTEREST INCOME
Interest income decreased by $1.2 million from the 2000 Quarter when a portion
of the proceeds from the December 1999 sales of exploration and production
operations was temporarily invested. A substantial portion of those proceeds was
used to repay debt in March 2000.
INCOME TAX PROVISION
The increase of $8.6 million in the income tax provision during the 2001
Quarter, compared with the 2000 Quarter, reflected the increase in pretax
earnings. The combined federal and state effective income tax rate was
approximately 40% in both the 2001 and 2000 Quarters.
OUTLOOK AND OTHER FACTORS
Management continues to believe that industry margins for 2001 will be better
than the five-year historical average and had previously expected margins for
2001 to be lower than for the prior year; however, management currently expects
margins for 2001 to exceed margins for 2000 due to, among other things:
o Supply/demand balances are currently tight in the western U.S.
o Regional demand is becoming more product specific leading to potential
supply and distribution problems, particularly for gasoline and gasoline
components.
o In advance of a California regulation to eliminate an oxygenate component
from gasoline, certain manufacturers are selling ethanol blended gasoline
on a limited basis. On a larger scale, this change will require an
upgrade of the distribution infrastructure which could further unsettle
the market.
o With continuing growth in demand and minimal growth in regional supply,
unscheduled supply disruptions could result in volatile increases in
prices.
However, many other factors contribute to the strength of industry margins,
including, among others, cost and availability of crude oil, the general demand
for refined products, changes in product specifications, changes in refining
capacity in the Company's operational regions and other conditions. In addition,
industry margins may be impacted by high-volume retail expansions and strong
competition in the industry due to mergers and acquisitions.
Assuming that industry margins continue to remain stronger than historical
averages and product demand remains healthy, management expects the Company's
refinery throughput to be approximately 257,000 bpd for the second quarter of
2001. Management expects throughput to average between 255,000 bpd to 260,000
bpd for the year 2001. Management believes throughput will increase at least
5,000 bpd over the previously announced level due to the postponement of the
Washington refinery turnaround from the 2001 fourth quarter to the 2002 first
quarter and other factors. The Company's actual throughput for 2001 may differ
from the projections discussed above due to market conditions, the availability
and costs of crude oil, the demand for refined products and other factors.
Based on many of the factors above, management expects the Company's earnings
for the second quarter of 2001 to be more than double last year's second quarter
diluted earnings per share of $0.35. Management expects that margins for the
second and third quarters of 2001 will be stronger than the corresponding
quarters in 2000, and that fourth quarter 2001 margins will be weaker than the
first quarter 2001. Given this assessment, the outlook for the year 2001 is now
stronger than 2000. Therefore, management has raised its year 2001 earnings per
share expectation to the range of $2.40 to $3.00 per share from the previously
announced range of $1.60 to $2.00 per share as a result of the Company exceeding
its first quarter forecast, the positive earnings impact of postponing the
Washington refinery turnaround until 2002, and an improved outlook for the 2001
second quarter. However, future profitability of the Company will continue to be
influenced by market conditions and other factors that are beyond the control of
the Company. See "Forward-Looking Statements" on page 20 and "Business
Environment" on page 12 for further information related to these factors.
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CAPITAL RESOURCES AND LIQUIDITY
OVERVIEW
The Company's primary sources of liquidity are its cash flows from operations
and borrowing availability under revolving lines of credit. Capital requirements
are expected to include capital expenditures, working capital, debt service and
preferred dividend requirements. Based upon current needs, management believes
that available capital resources will be adequate to meet the Company's future
capital requirements.
The Company operates in an environment where its liquidity and capital resources
are impacted by changes in the supply of and demand for crude oil and refined
petroleum products, market uncertainty and a variety of additional risks that
are beyond the control of the Company. These risks include, among others, the
level of consumer product demand, weather conditions, fluctuations in seasonal
demand, governmental regulations, the price and availability of alternative
fuels and overall market and economic conditions. The Company's future capital
expenditures, as well as borrowings under its credit arrangements and other
sources of capital, will be affected by these conditions.
CAPITALIZATION
The Company's capital structure at March 31, 2001 was comprised of the following
(in millions):
Debt and other obligations outstanding, including current maturities:
Credit Facility ....................................................... $ 42
9% Senior Subordinated Notes, due 2008 ................................ 297
Other obligations ..................................................... 11
------
Total debt and other obligations ................................... 350
Mandatorily Convertible Preferred Stock ................................. 165
Common stockholders' equity ............................................. 525
------
Total Capitalization ............................................... $1,040
======
At March 31, 2001, the Company's debt to capitalization ratio was 34% compared
with 32% at year-end 2000, reflecting increased Credit Facility borrowings used
primarily to reduce accounts payable.
The Credit Facility, Senior Subordinated Notes and Preferred Stock impose
various restrictions and covenants on the Company that could potentially limit
the Company's ability to respond to market conditions, to raise additional debt
or equity capital, or to take advantage of business opportunities.
CREDIT FACILITY
In 2000, the Company and a group of banks entered into a $250 million unsecured
revolving credit facility, consisting of a $150 million, 3-year Revolving Credit
Agreement and a $100 million, 364-Day Revolving Credit Agreement (collectively
referred to as the "Credit Facility"). Each Revolving Credit Agreement, which
provides for cash borrowings and issuance of letters of credit, can be extended
for up to two one-year periods, subject to bank approval. The Company has until
August 4, 2001 to give notice to extend the 364-Day Revolving Credit Agreement.
Management has not yet determined whether it will request an extension.
At March 31, 2001, the Company had $42 million in borrowings and $3.8 million in
letters of credit outstanding under the Credit Facility, resulting in unused
credit availability of $204.2 million. Based on current needs, the $250 million
capacity under the Credit Facility, together with internally-generated cash
flows, is expected to be sufficient to fund capital expenditures, working
capital requirements and other corporate purposes.
PREFERRED DIVIDENDS
The Company has 10,350,000 Premium Income Equity Securities ("PIES")
outstanding, which represent fractional interests in the Company's 7.25%
Mandatorily Convertible Preferred Stock ("Preferred Stock"). Holders of PIES are
entitled to receive a cash dividend until the PIES are converted to Common
Stock. The scheduled dividends on the PIES total $3 million per quarter, with
the last scheduled quarterly payment due on July 1, 2001. The PIES
17
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will automatically convert into shares of Common Stock on July 1, 2001, at a
rate based upon a formula dependent upon the market price of Common Stock at the
time of conversion. The maximum conversion rate on July 1, 2001 would require
each PIES to convert into one share of Common Stock. Before July 1, 2001, each
PIES is convertible, at the option of the holder thereof, into 0.8455 shares of
Common Stock, subject to adjustment in certain events. For further information,
see Note C of Notes to Condensed Consolidated Financial Statements in Part I,
Item I.
COMMON STOCK REPURCHASE PROGRAM
In February 2000, the Company's Board of Directors authorized the repurchase of
up to 3 million shares of Tesoro Common Stock, which represented approximately
9% of the shares then outstanding. Under the program, the Company may make
repurchases from time to time in the open market and through
privately-negotiated transactions. Purchases depend on price, market conditions
and other factors and have been made primarily from internally-generated cash
flows. The stock may be used to meet employee benefit plan requirements and
other corporate purposes. The Company repurchased 1,627,400 shares of Common
Stock in 2000, and may repurchase up to 1,372,600 additional shares under the
program.
CAPITAL SPENDING
For 2001, the Company's total capital program is $195 million, primarily for
manufacturing improvements and retail marketing expansion. Refinery projects are
planned to total $121 million, including completion of the heavy oil conversion
project and other economic projects, $28 million for sustaining capital, and $12
million for environmental, health, safety and other projects. The Company plans
to spend approximately $59 million to further expand its retail marketing, which
includes construction of new Mirastar stations under the agreement with Wal-
Mart, construction of Company-owned and operated stations, and expansion of
Tesoro's branded jobber/dealer network. The Company plans to build approximately
60 to 70 Mirastar stations in 2001. The Company's Marine Services capital
expenditures are planned to be $5 million, and other capital is budgeted at $10
million, primarily for information systems to support the expanded retail
program and other upgrades. Management plans to fund its capital program in 2001
with internally-generated cash flows from operations and borrowings under the
Credit Facility.
During the 2001 Quarter, the Company's capital expenditures totaled $34 million.
In manufacturing, the Company is constructing a heavy oil conversion project at
its Washington refinery. Management believes that this project, which has an
estimated total cost of approximately $100 million (including capitalized
interest), will be completed in the first quarter of 2002. Capital expenditures
for this project were approximately $16 million in the 2001 Quarter. Capital
spending for the Mirastar and other retail marketing programs totaled $6 million
during the 2001 Quarter. Other capital spending during the 2001 Quarter included
$12 million for other projects, primarily natural gas-fueled generators,
modernization of refinery control systems, and other system upgrades.
MAJOR MAINTENANCE COSTS
The Company has scheduled a turnaround for the Alaska refinery in the second
quarter of 2001 at an estimated cost of $11 million and has rescheduled
turnarounds of certain processing units at the Washington refinery with an
estimated cost of $20 million to the first quarter of 2002. Amortization of
turnaround costs, other major maintenance projects and catalysts are projected
to total $21 million in 2001. Amortization of turnaround costs, other major
maintenance projects and catalysts totaled $5 million in the 2001 Quarter.
CASH FLOW SUMMARY
Components of the Company's cash flows are set forth below (in millions):
Three Months Ended
March 31,
----------------------
2001 2000
--------- ---------
Cash Flows From (Used In):
Operating Activities .................. $ (18.7) $ (43.2)
Investing Activities .................. (32.8) (8.1)
Financing Activities .................. 38.9 (69.5)
--------- ---------
Decrease in Cash and Cash Equivalents ... $ (12.6) $ (120.8)
========= =========
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Net cash used in operating activities during the 2001 Quarter totaled $18.7
million, compared to $43.2 million used in operations in the 2000 Quarter. This
improvement was primarily due to higher earnings before depreciation and
amortization and other non-cash charges. Net cash used in investing activities
of $32.8 million in the 2001 Quarter included capital expenditures of $33.5
million, partly offset by proceeds from sales of assets. Net cash from financing
activities of $38.9 million in the 2001 Quarter included net borrowings of $42
million under the Credit Facility, partly offset by Preferred Stock dividend
payments of $3 million. Gross borrowings amounted to $225 million and repayments
under revolving credit lines amounted to $183 million during the 2001 Quarter.
Working capital totaled $298 million at March 31, 2001 compared to $248 million
at year-end 2000.
ENVIRONMENTAL AND OTHER
The Company is subject to extensive federal, state and local environmental laws
and regulations. These laws, which change frequently, regulate the discharge of
materials into the environment and may require the Company to remove or mitigate
the environmental effects of the disposal or release of petroleum or chemical
substances at various sites, install additional controls, or make other
modifications or changes in use for certain emission sources. The Company is
currently involved in remedial responses and has incurred cleanup expenditures
associated with environmental matters at a number of sites, including certain of
its own properties. At March 31, 2001, the Company's accruals for environmental
expenses totaled approximately $14.3 million. Based on currently available
information, including the participation of other parties or former owners in
remediation actions, the Company believes these accruals are adequate.
The Company is currently evaluating certain newly-promulgated revisions to the
Clean Air Act regulations which will require a reduction in the sulfur content
in gasoline by January 1, 2004. To meet the revised gasoline standard, the
Company expects to make capital improvements of approximately $40 million to $50
million at its Washington refinery. Additionally, the Company expects to spend
approximately $15 million in capital improvements over the next four years to
comply with the second phase of Maximum Achievable Control Technologies for
petroleum refineries ("Refinery MACT II") which was signed into law on January
18, 2001. Management expects that the Refinery MACT II regulations will require
new emission controls at certain processing units at each of the Company's
refineries.
On December 21, 2000, the U.S. Environmental Protection Agency announced new
standards that will require a reduction in sulfur content in diesel fuel
manufactured for on-road consumption. In general, the new diesel fuel standards
will become effective on June 1, 2006. Although the Company is evaluating the
new diesel fuel standards with respect to its Alaska operations, the Company
estimates that the demand for ultra low sulfur diesel in Alaska will not be
significant and should not have a material impact on its Alaska operations. The
Hawaii refinery is currently capable of producing diesel fuels that comply with
the new standards. For the Washington refinery, the Company is currently
evaluating the impact of the new diesel fuel standards on production, equipment
requirements and related costs.
To comply with other environmental laws and regulations, the Company anticipates
it will make capital improvements of approximately $8 million in 2001 and $9
million in 2002, primarily for improvements to storage tanks, tank farm
secondary containment and pipelines. During the 2001 Quarter, the Company spent
approximately $1 million on environmental capital projects.
Conditions that require additional expenditures may exist for various Company
sites, including, but not limited to, the Company's refineries, tank farms,
retail gasoline stations (operating and closed locations) and petroleum product
terminals, and for compliance with the Clean Air Act and other state and federal
requirements. The amount of such future expenditures cannot currently be
determined by the Company.
For further information on environmental matters and other contingencies, see
Note E of Notes to Condensed Consolidated Financial Statements in Part I, Item
I.
NEW ACCOUNTING STANDARD
Effective January 1, 2001, the Company adopted Statement of Financial Accounting
Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended by SFAS No. 138. The adoption of SFAS No. 133 did not
have a significant impact on the Company's financial condition, results of
operations
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or cash flows. For further information on SFAS No. 133, see Note G of
Notes to Condensed Consolidated Financial Statements in Part I, Item I.
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains certain statements that are
"forward-looking" statements within the meaning of the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995, as codified in Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. These forward-looking statements include,
among other things, projections of revenues, earnings, earnings per share,
capital expenditures or other financial items; discussions of estimated future
revenue enhancements and cost savings; and the Company's business strategy,
goals and expectations concerning the Company's market position, future
operations, margins, profitability, liquidity and capital resources. Although
the Company believes that the assumptions upon which the forward-looking
statements contained in this Form 10-Q are based are reasonable, any of the
assumptions could prove to be inaccurate and, as a result, the forward-looking
statements based on those assumptions also could be incorrect. All phases of the
operations of the Company involve risks and uncertainties, many of which are
outside the control of the Company and any one of which, or a combination of
which, could materially affect the results of the Company's operations and
whether the forward-looking statements ultimately prove to be correct. Actual
results and trends in the future may differ materially depending on a variety of
factors including, but not limited to, changes in general economic conditions;
the timing and extent of changes in commodity prices and underlying demand;
availability and costs of crude oil, other refinery feedstocks and refined
products; changes in the Company's inventory levels; changes in the cost or
availability of third-party vessels, pipelines and other means of transporting
feedstocks and products; changes in fuel and utility costs for the Company's
facilities; disruptions due to equipment interruption or failure at Company or
third-party facilities; execution of planned capital projects; results of
management's evaluation of the Company's cost structure; the ability of the
Company to make acquisitions and successfully integrate them; adverse changes in
the credit ratings assigned to the Company's trade credit and debt instruments;
state and federal environmental, economic, safety and other policies and
regulations, any changes therein, and any legal or regulatory delays or other
factors beyond the Company's control; adverse rulings, judgments, or settlements
in litigation or other legal or tax matters, including unexpected environmental
remediation costs in excess of any reserves; actions of customers and
competitors; weather conditions affecting the Company's operations or the areas
in which the Company's products are marketed; earthquakes or other natural
disasters affecting operations; political developments in foreign countries; and
the conditions of the capital markets and equity markets during the periods
covered by the forward-looking statements. Many of the factors are described in
greater detail in the Company's other filings with the SEC. All subsequent
written and oral forward-looking statements attributable to the Company or
persons acting on its behalf are expressly qualified in their entirety by the
foregoing. The Company undertakes no obligation to update any information
contained herein or to publicly release the results of any revisions to any such
forward-looking statements that may be made to reflect events or circumstances
that occur, or which the Company becomes aware of, after the date hereof.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The primary sources of market risk to the Company include changes in commodity
prices and interest rates. The Company has a risk management committee
responsible for overseeing energy risk management activities.
COMMODITY PRICE RISKS
The Company's Refining and Marketing earnings and cash flows from operations are
dependent upon the margin above fixed and variable expenses (including the costs
of crude oil and other feedstocks) at which the Company is able to sell refined
products. In recent years, the prices of crude oil and refined products have
fluctuated substantially. These prices depend on numerous factors, including the
demand for crude oil, gasoline and other refined products, which in turn depend
on, among other factors, changes in the economy, the level of foreign and
domestic production of crude oil and refined products, worldwide political
conditions, the availability of imports of crude oil and refined products, the
marketing of alternative and competing fuels and the extent of government
regulations. The prices received by the Company for its refined products are
also affected by local factors such as local market conditions and the level of
operations of other refineries in the Company's markets.
The prices at which the Company can sell its refined products are influenced by
the commodity price of crude oil. Generally, an increase or decrease in the
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prices of crude oil results in a corresponding increase or decrease in the
prices of gasoline and other refined products; however, the timing of the
relative movement of the prices can impact profit margins which could
significantly affect the Company's earnings and cash flows of the Company as a
whole. In addition, crude oil supply contracts generally are short-term in
nature with market-responsive pricing provisions. The Company purchases its
refinery feedstocks prior to selling the refined products manufactured. Price
level changes during the period between purchasing feedstocks and selling the
manufactured refined products from such feedstocks could have a significant
effect on the Company's financial results. The Company also purchases refined
products manufactured by others for resale to customers. Price level changes
during the periods between purchasing and selling such products could have a
significant effect on financial results.
The Company maintains inventories of crude oil, intermediate products and
refined products, the values of which are subject to fluctuations in market
prices. At both March 31, 2001, and December 31, 2000 the Company's inventories
of refinery feedstocks and refined products totaled 11.9 million barrels. The
Company continues to monitor its inventory positions, and management expects, at
this time, that inventories will approximate the same level at year-end 2001.
During 2000, inventory levels increased 3.3 million barrels over year-end 1999
levels at an average cost of $29.82 per barrel. Any sales that result in a
reduction in inventories during 2001 would have a per barrel cost of sales equal
to the sum of $29.82 per barrel plus the cost of transportation to market. This
amount could exceed the year-to-date average costs of sales in 2001. The average
cost of refinery throughput as of March 31, 2001 was approximately $27.19 per
barrel, or $2.63 per barrel lower than the cost of the 2000 incremental layer.
The average costs of the Company's Refining and Marketing inventories of
refinery feedstocks and refined products as of both December 31, 2000 and March
31, 2001 were $20.79 per barrel. If market price levels decline from current
levels to a level below the average cost of these inventories, the Company may
be required to write down the carrying value of its inventory.
The Company periodically enters into derivative type arrangements on a limited
basis, as part of its programs to acquire refinery feedstocks at reasonable
costs and to manage margins on certain refined product sales. The Company also
engages in limited non-hedging derivatives which are marked to market with
changes in the fair value of the derivatives recognized in earnings. Management
believes that any potential adverse impact from these activities would not
result in a material adverse effect on the Company's financial results,
financial position or cash flows. At March 31, 2001, the Company held exchange
traded crude oil futures contracts to purchase 169,000 barrels in May 2001 at a
weighted average price of $26.85 per barrel, or a total of $4.5 million. The
contracts are accounted for at market prices and had a fair value of $4.4
million at March 31, 2001.
INTEREST RATE RISK
The Company had $42 million of outstanding floating-rate debt under the Credit
Facility and $308 million of fixed-rate debt at March 31, 2001. The weighted
average interest rate on the floating-rate debt was 6.37% at March 31, 2001. The
impact on annual cash flow of a 10% change in the floating rate for the Credit
Facility (64 basis points) would be approximately $0.3 million.
The fair market value of the Company's fixed-rate debt at March 31, 2001 was
approximately $9 million greater than its book value of $308 million, based on
recent transactions and bid quotes for the Company's 9% Senior Subordinated
Notes, due in 2008.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
None.
(b) Reports on Form 8-K.
None.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TESORO PETROLEUM CORPORATION
REGISTRANT
Date: May 15, 2001 /s/ BRUCE A. SMITH
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Bruce A. Smith
Chairman of the Board of Directors,
President and Chief Executive Officer
Date: May 15, 2001 /s/ GREGORY A. WRIGHT
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Gregory A. Wright
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
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