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 JUNE 30, 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)
<Table>
DELAWARE 95-0862768
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</Table>
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
--- ---
----------------------------------
There were 41,364,199 shares of the registrant's Common Stock
outstanding at July 31, 2001.
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2
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2001
TABLE OF CONTENTS
<Table>
<Caption>
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - June 30, 2001 and December 31, 2000 ................ 3
Condensed Statements of Consolidated Operations - Three Months and Six Months
Ended June 30, 2001 and 2000................................................................... 4
Condensed Statements of Consolidated Cash Flows - Six Months Ended
June 30, 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.................................................................................. 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................................... 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.............................................................................. 25
Item 4. Submission of Matters to a Vote of Security Holders............................................ 25
Item 6. Exhibits and Reports on Form 8-K............................................................... 26
SIGNATURES................................................................................................ 27
EXHIBIT INDEX............................................................................................. 28
</Table>
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)
<Table>
<Caption>
June 30, December 31,
2001 2000
------------ ------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents ...................................................... $ 1.9 $ 14.1
Receivables, less allowance for doubtful accounts .............................. 340.5 334.5
Inventories .................................................................... 307.8 274.3
Prepayments and other .......................................................... 8.2 7.3
------------ ------------
Total Current Assets ......................................................... 658.4 630.2
------------ ------------
PROPERTY, PLANT AND EQUIPMENT
Refining and Marketing ......................................................... 1,065.8 991.1
Marine Services ................................................................ 51.2 50.3
Corporate ...................................................................... 29.3 25.1
------------ ------------
1,146.3 1,066.5
Less accumulated depreciation and amortization ................................. 305.6 285.1
------------ ------------
Net Property, Plant and Equipment ............................................ 840.7 781.4
------------ ------------
OTHER ASSETS ...................................................................... 129.8 132.0
------------ ------------
Total Assets ............................................................... $ 1,628.9 $ 1,543.6
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable ............................................................... $ 265.2 $ 281.6
Accrued liabilities ............................................................ 86.1 97.0
Current maturities of debt and other obligations ............................... 3.7 3.8
------------ ------------
Total Current Liabilities .................................................... 355.0 382.4
------------ ------------
DEFERRED INCOME TAXES ............................................................. 120.7 107.2
------------ ------------
OTHER LIABILITIES ................................................................. 78.5 77.3
------------ ------------
DEBT AND OTHER OBLIGATIONS ........................................................ 352.6 306.8
------------ ------------
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;
33,020,881 shares issued (32,739,592 in 2000) ................................ 5.4 5.4
Additional paid-in capital ..................................................... 285.2 280.0
Retained earnings .............................................................. 285.1 239.9
Treasury stock, 1,777,095 common shares (1,920,281 in 2000), at cost ........... (18.6) (20.4)
------------ ------------
Total Stockholders' Equity ................................................... 722.1 669.9
------------ ------------
Total Liabilities and Stockholders' Equity ................................. $ 1,628.9 $ 1,543.6
============ ============
</Table>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
4
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS
(UNAUDITED)
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
REVENUES
Refining and Marketing ..................................... $ 1,252.2 $ 1,176.0 $ 2,433.1 $ 2,188.2
Marine Services ............................................ 47.4 42.2 93.8 85.3
---------- ---------- ---------- ----------
Total Revenues .......................................... 1,299.6 1,218.2 2,526.9 2,273.5
---------- ---------- ---------- ----------
COSTS OF SALES AND OPERATING EXPENSES
Refining and Marketing ..................................... 1,178.0 1,126.2 2,295.4 2,098.9
Marine Services ............................................ 43.4 39.6 86.4 78.3
Depreciation and amortization .............................. 10.2 9.9 21.6 19.8
---------- ---------- ---------- ----------
Total Cost of Sales and Operating Expenses .............. 1,231.6 1,175.7 2,403.4 2,197.0
---------- ---------- ---------- ----------
SEGMENT OPERATING PROFIT ..................................... 68.0 42.5 123.5 76.5
General and administrative expenses .......................... (10.8) (8.9) (21.3) (17.6)
Interest and financing costs, net of capitalized interest .... (6.6) (8.3) (14.1) (17.9)
Interest income .............................................. 0.2 0.3 0.5 1.8
Other expenses ............................................... (1.6) (1.5) (3.1) (3.4)
---------- ---------- ---------- ----------
EARNINGS BEFORE INCOME TAXES ................................ 49.2 24.1 85.5 39.4
Income tax provision ......................................... 19.7 9.5 34.3 15.5
---------- ---------- ---------- ----------
NET EARNINGS ................................................. 29.5 14.6 51.2 23.9
Preferred dividend requirements .............................. 3.0 3.0 6.0 6.0
---------- ---------- ---------- ----------
NET EARNINGS APPLICABLE TO COMMON STOCK ...................... $ 26.5 $ 11.6 $ 45.2 $ 17.9
========== ========== ========== ==========
NET EARNINGS PER SHARE
Basic ...................................................... $ 0.85 $ 0.37 $ 1.46 $ 0.57
========== ========== ========== ==========
Diluted .................................................... $ 0.70 $ 0.35 $ 1.22 $ 0.56
========== ========== ========== ==========
WEIGHTED AVERAGE COMMON SHARES -
BASIC ...................................................... 31.1 31.1 31.0 31.6
========== ========== ========== ==========
WEIGHTED AVERAGE COMMON AND
POTENTIALLY DILUTIVE COMMON SHARES -
DILUTED .................................................... 42.3 41.7 42.0 31.8
========== ========== ========== ==========
</Table>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
5
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
<Table>
<Caption>
Six Months Ended
June 30,
-------------------------
2001 2000
---------- ----------
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Net earnings ........................................................................ $ 51.2 $ 23.9
Adjustments to reconcile net earnings to net cash used in operating activities:
Depreciation and amortization ..................................................... 22.9 21.0
Amortization of refinery turnarounds and other non-cash charges ................... 11.8 11.6
Deferred income taxes ............................................................. 13.5 5.7
Changes in operating assets and liabilities:
Receivables ..................................................................... (10.4) (39.6)
Inventories ..................................................................... (33.5) (100.1)
Accounts payable and accrued liabilities ........................................ (23.9) 53.4
Other assets and liabilities .................................................... (8.4) 1.4
---------- ----------
Net cash from (used in) operating activities .................................. 23.2 (22.7)
---------- ----------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Capital expenditures ................................................................ (81.9) (23.5)
Other ............................................................................... 2.5 1.6
---------- ----------
Net cash used in investing activities ......................................... (79.4) (21.9)
---------- ----------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Net borrowings under revolving credit facility ...................................... 49.0 38.0
Repayments of other debt ............................................................ (0.5) (105.3)
Repurchases of Common Stock ......................................................... -- (15.5)
Payment of dividends on Preferred Stock ............................................. (6.0) (6.0)
Other ............................................................................... 1.5 0.2
---------- ----------
Net cash from (used in) financing activities .................................. 44.0 (88.6)
---------- ----------
DECREASE IN CASH AND CASH EQUIVALENTS .................................................. (12.2) (133.2)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ......................................... 14.1 141.8
---------- ----------
CASH AND CASH EQUIVALENTS, END OF PERIOD ............................................... $ 1.9 $ 8.6
========== ==========
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid, net of capitalized interest .......................................... $ 12.6 $ 3.7
========== ==========
Income taxes paid ................................................................... $ 29.9 $ 8.1
========== ==========
</Table>
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
6
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. Unless otherwise indicated,
the Notes do not include amounts and disclosures related to the acquisitions
described in Note B. 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 - ACQUISITIONS
On July 16, 2001, the Company entered into agreements to acquire certain assets
from affiliates of BP, p.l.c. ("BP") for $677 million, excluding working capital
(the "BP Acquisitions"). The assets to be acquired include a 60,000-barrel per
day refinery in Mandan, North Dakota and a 55,000-barrel per day refinery in
Salt Lake City, Utah together with associated crude and product pipelines in
North Dakota, and bulk storage facilities, eight product distribution terminals
and 43 retail gasoline stations in Utah, Idaho, North Dakota and Minnesota. BP
will also assign to Tesoro contracts to supply refined products to approximately
280 Amoco-branded stations that are owned by about 80 jobbers. Management
anticipates that these transactions will close by the end of the third quarter
or early fourth quarter of 2001, subject to certain closing conditions,
including regulatory approvals.
The purchase price will be financed with debt. In this regard, Tesoro has
obtained a commitment from Lehman Brothers Inc. to arrange a new senior secured
credit facility (the "Senior Secured Credit Facility") in the amount of $1.0
billion. The Senior Secured Credit Facility will consist of a $175 million
Revolving Credit Facility, an $85 million Term Loan A Credit Facility, a $90
million Delayed Draw Term Loan Facility (used solely to fund the purchase of the
North Dakota crude oil pipeline system), a $300 million Term Loan B Credit
Facility and a $350 million Capital Markets Term Loan Facility. The Company
expects to issue approximately $350 million of senior subordinated notes (the
"Notes Offering") to replace the $350 million Capital Markets Term Loan
Facility. The Senior Secured Credit Facility will be guaranteed by substantially
all of the Company's active domestic subsidiaries and will be secured by
substantially all material present and future assets of the Company and its
subsidiaries and will be additionally secured by a pledge of stock of all
current and future subsidiaries.
Borrowings under the Senior Secured Credit Facility, together with the proceeds
of the Notes Offering, will be used to fund the BP Acquisitions, to refinance an
existing credit facility, to pay certain fees and expenses related to the
transactions and for general corporate purposes (including working capital
requirements).
6
7
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE C - INVENTORIES
Components of inventories were as follows (in millions):
<Table>
<Caption>
June 30, December 31,
2001 2000
------------ ------------
Crude oil and refined products, at LIFO ............... $ 282.9 $ 248.0
Fuel products, at FIFO ................................ 2.7 4.5
Merchandise and other ................................. 5.8 5.6
Materials and supplies ................................ 16.4 16.2
------------ ------------
Total inventories ................................. $ 307.8 $ 274.3
============ ============
</Table>
NOTE D - 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 "Existing Credit Facility"). At June 30, 2001, the Company
had $49 million in borrowings outstanding and $1 million in letters of credit
outstanding under the Existing Credit Facility, resulting in unused credit
availability of $200 million. Borrowings under the Existing Credit Facility bear
interest, at the Company's election, at either the Eurodollar Rate plus a margin
ranging from 1.0% to 2.0% (4.9% at June 30, 2001) or a Base Rate (6.75% at June
30, 2001).
For information related to the financing of the pending BP Acquisitions and
replacement of the Existing Credit Facility, see Note B.
The Company had 10,350,000 Premium Income Equity Securities ("PIES") outstanding
at June 30, 2001, which represented fractional interests in the Company's 7.25%
Mandatorily Convertible Preferred Stock. Effective July 1, 2001, the PIES
automatically converted into 10,350,000 shares of Common Stock. Following
conversion, the Company had approximately 41.6 million shares of Common Stock
outstanding. The final quarterly cash dividends on the PIES were paid on July 2,
2001.
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. Through June 30, 2001, the Company had
repurchased 1,627,400 shares of Common Stock. In July 2001, the Company
repurchased an additional 254,000 shares of its Common Stock at an average cost
of $11.45 per share, or an aggregate of approximately $3 million.
NOTE E - OPERATING SEGMENTS
The Company's revenues are derived from two operating segments: (i) Refining and
Marketing and (ii) Marine Services. Management evaluates its segments 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. This measure
may not be comparable to similarly titled measures used by other entities.
Operating segment EBITDA is equal to segment operating profit before
depreciation and amortization related to each segment.
7
8
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
For the periods presented, intersegment revenues were not significant. Segment
information is as follows (in millions):
<Table>
<Caption>
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
REVENUES
Refining and Marketing:
Refined products ...................................... $ 1,175.0 $ 1,066.5 $ 2,282.8 $ 2,022.5
Other, primarily crude oil resales and merchandise .... 77.2 109.5 150.3 165.7
Marine Services ......................................... 47.4 42.2 93.8 85.3
------------ ------------ ------------ ------------
Total Revenues ...................................... $ 1,299.6 $ 1,218.2 $ 2,526.9 $ 2,273.5
============ ============ ============ ============
SEGMENT OPERATING PROFIT
Refining and Marketing .................................. $ 64.7 $ 40.5 $ 117.5 $ 70.7
Marine Services ......................................... 3.3 2.0 6.0 5.8
------------ ------------ ------------ ------------
Total Segment Operating Profit ...................... 68.0 42.5 123.5 76.5
Corporate and Unallocated Costs ......................... (18.8) (18.4) (38.0) (37.1)
------------ ------------ ------------ ------------
Earnings Before Income Taxes ............................ $ 49.2 $ 24.1 $ 85.5 $ 39.4
============ ============ ============ ============
EBITDA
Refining and Marketing .................................. $ 74.2 $ 49.8 $ 137.7 $ 89.3
Marine Services ......................................... 4.0 2.6 7.4 7.0
------------ ------------ ------------ ------------
Total Segment EBITDA ................................ 78.2 52.4 145.1 96.3
Corporate and Unallocated ............................... (11.5) (9.5) (22.6) (18.0)
------------ ------------ ------------ ------------
Total EBITDA ........................................ 66.7 42.9 122.5 78.3
Depreciation and Amortization ........................... (10.9) (10.5) (22.9) (21.0)
Interest and Financing Costs ............................ (6.6) (8.3) (14.1) (17.9)
------------ ------------ ------------ ------------
Earnings Before Income Taxes ............................ $ 49.2 $ 24.1 $ 85.5 $ 39.4
============ ============ ============ ============
DEPRECIATION AND AMORTIZATION
Refining and Marketing .................................. $ 9.5 $ 9.3 $ 20.2 $ 18.6
Marine Services ......................................... 0.7 0.6 1.4 1.2
Corporate ............................................... 0.7 0.6 1.3 1.2
------------ ------------ ------------ ------------
Total Depreciation and Amortization ................. $ 10.9 $ 10.5 $ 22.9 $ 21.0
============ ============ ============ ============
CAPITAL EXPENDITURES
Refining and Marketing .................................. $ 45.3 $ 13.6 $ 76.6 $ 21.0
Marine Services ......................................... 0.8 0.5 1.0 1.9
Corporate ............................................... 2.3 0.1 4.3 0.6
------------ ------------ ------------ ------------
Total Capital Expenditures .......................... $ 48.4 $ 14.2 $ 81.9 $ 23.5
============ ============ ============ ============
</Table>
Identifiable assets are those assets utilized by the segment. Corporate assets
include cash and other assets that are not directly associated with the
operations of a business segment.
<Table>
<Caption>
June 30, December 31,
2001 2000
------------ ------------
IDENTIFIABLE ASSETS
Refining and Marketing ......... $ 1,515.4 $ 1,405.4
Marine Services ................ 70.2 76.8
Corporate ...................... 43.3 61.4
------------ ------------
Total Assets ............... $ 1,628.9 $ 1,543.6
============ ============
</Table>
8
9
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE F - 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 June 30, 2001, the Company's
accruals for environmental expenses totaled approximately $15 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 continues to evaluate 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 this revised gasoline standard at its
existing refineries, the Company expects to make capital improvements of
approximately $40 million to $50 million at its Washington refinery.
The Company expects to spend approximately $15 million in capital improvements
at its existing refineries over the next four years to comply with the second
phase of Maximum Achievable Control Technologies ("Refinery MACT II") which was
signed into law in January 2001. Management expects that the Refinery MACT II
regulations will require new emission controls at certain processing units at
each of the Company's existing refineries. The Company is currently evaluating a
selection of control technologies to assure operations flexibility and
compatibility with long-term air emission reduction goals. As an alternative to
making capital improvements of $15 million solely to meet the Refinery MACT II
requirements, the Company is evaluating making capital improvements of $30
million to meet both the Refinery MACT II requirements and long-term reduction
goals for sulfur emissions.
The EPA has also 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 continues to evaluate the impact of the new diesel fuel standards on
production, equipment requirements and related costs.
9
10
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
To comply with other environmental laws and regulations, the Company anticipates
it will make other 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 six months ended June 30, 2001,
the Company spent approximately $3 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 G - 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 six months ended June 30, 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):
<Table>
<Caption>
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- ----------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
BASIC:
Numerator:
Net earnings ............................................. $ 29.5 $ 14.6 $ 51.2 $ 23.9
Less dividends on Preferred Stock ........................ 3.0 3.0 6.0 6.0
------------ ------------ ------------ ------------
Net earnings applicable to common shares ................. $ 26.5 $ 11.6 $ 45.2 $ 17.9
============ ============ ============ ============
Denominator:
Weighted average common shares outstanding ............... 31.1 31.1 31.0 31.6
============ ============ ============ ============
Basic Earnings Per Share ................................... $ 0.85 $ 0.37 $ 1.46 $ 0.57
============ ============ ============ ============
DILUTED:
Numerator:
Net earnings applicable to common shares ................. $ 26.5 $ 11.6 $ 45.2 $ 17.9
Plus impact of assumed conversion of Preferred Stock ..... 3.0 3.0 6.0 --
------------ ------------ ------------ ------------
Total .................................................. $ 29.5 $ 14.6 $ 51.2 $ 17.9
============ ============ ============ ============
</Table>
10
11
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
<Table>
<Caption>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2001 2000 2001 2000
-------- -------- -------- --------
Denominator:
Weighted average common shares outstanding ............... 31.1 31.1 31.0 31.6
Add potentially dilutive securities:
Incremental dilutive shares from assumed exercise of
stock options and other .............................. 0.9 0.3 0.7 0.2
Incremental dilutive shares from assumed conversion
of Preferred Stock ................................... 10.3 10.3 10.3 --
-------- -------- -------- --------
Total diluted shares ............................... 42.3 41.7 42.0 31.8
======== ======== ======== ========
Diluted Earnings Per Share ................................. $ 0.70 $ 0.35 $ 1.22 $ 0.56
======== ======== ======== ========
</Table>
NOTE H - NEW ACCOUNTING STANDARDS
SFAS NO. 133 AND SFAS NO. 138
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 June 30, 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 June 30, 2001, the Company held exchange traded crude oil futures contracts
to purchase 155,000 barrels in August 2001 at a weighted average price of $26.44
per barrel, or a total of $4 million. The contracts are accounted for at market
prices and had a fair value of $4 million at June 30, 2001.
SFAS NO. 141 AND SFAS NO. 142
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Intangible
Assets." SFAS No. 141 requires the purchase method of accounting for all
business combinations initiated after June 30, 2001 and that certain acquired
intangible assets in a business combination be recognized as assets separate
from goodwill. SFAS No. 142 requires that goodwill and other intangibles,
determined to have an indefinite life, are no longer to be amortized but are to
be tested for impairment at least annually. SFAS No. 142 requires that an
impairment test related to the carrying values of existing goodwill be completed
within the first six months of 2002. Impairment losses on existing goodwill, if
any, would be recorded as the cumulative effect of a change in accounting
principle as of the beginning of 2002. SFAS No. 141 and 142 will apply to the BP
Acquisitions discussed in Note B.
The Company amortizes goodwill on a straight-line basis over 28 years for
Refining and Marketing assets and 20 years for Marine Services assets. As of
June 30, 2001, goodwill amounted to $62 million (net of accumulated amortization
of approximately $9 million). For the six months ended June 30, 2001, the
Company recorded goodwill amortization of $1 million. The Company is currently
evaluating the impact these standards will have on its future results of
operations and financial condition.
11
12
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 23 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.
UNLESS OTHERWISE INDICATED, THE DISCLOSURES IN THIS MANAGEMENT'S DISCUSSION DO
NOT INCLUDE THE BP ACQUISITIONS DESCRIBED IN NOTE B OF NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS IN PART I, ITEM 1 HEREOF.
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 cash flows 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 logistics. The Marine Services segment pursues opportunities for
expansion, as well as optimizing existing operations through ongoing 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.
ACQUISITIONS
Management believes that the refining and marketing industry has been and will
continue to undergo a significant level of asset redeployment and consolidation.
Tesoro has grown and taken advantage of the economies of scale from this
consolidation. Tesoro more than tripled its refining capacity in 1998 and has
demonstrated its ability to improve its financial condition and performance
through its focus on the refining and marketing business. As a result,
management believes that the Company is positioned for growth and improved
financial returns.
On July 16, 2001, the Company entered into agreements to acquire certain assets
from affiliates of BP, p.l.c. ("BP") for $677 million, excluding working capital
(the "BP Acquisitions"). The assets to be acquired include a refinery in Salt
Lake City, Utah and related storage, distribution and gasoline marketing assets
(the "Utah System") and a refinery in Mandan, North Dakota and related storage,
pipeline, distribution and gasoline marketing assets (the "North Dakota
System"). The operations to be acquired are further described below:
The Utah System:
o 55,000 bpd refinery in Salt Lake City, Utah
o 5 terminals, 2 of which are leased, with aggregate capacity of
2.5 million barrels (including refinery tankage)
o 31 Amoco-branded company-owned stations with convenience
stores
o Contracts to supply a jobber network of approximately 200
stations
The North Dakota System:
o 60,000 bpd refinery in Mandan, North Dakota
o 5 terminals with aggregate capacity of 2.8 million barrels
(including refinery tankage)
o A crude oil gathering system and trunkline
o Refined product pipelines connecting the refinery to the owned
terminals, including the Minneapolis/St. Paul market
o 12 Amoco-branded company-owned stations with convenience
stores
o Contracts to supply a jobber network of approximately 80
stations
12
13
Upon completion of the BP Acquisitions, the Company will have an asset base
consisting of five refineries with a rated crude oil throughput capacity of
390,000 barrels per day ("bpd") and over 600 retail gasoline stations. The BP
Acquisitions are expected to add approximately 700 employees to Tesoro.
The purchase price will be financed with debt. Management anticipates that these
transactions will close by the end of the third quarter or early fourth quarter
of 2001, subject to certain closing conditions, including regulatory approvals.
Management believes the pending BP Acquisitions enable the Company to increase
the size and scope of its operations, diversify its earnings and geographic
exposure, and build a platform for additional growth. Management further
believes that the BP Acquisitions will improve the Company's ability to supply
markets in areas that the Company had previously targeted for commercial and
retail marketing expansion, including the Company's Mirastar program. Based on
consistent historical profitability of the Utah System and North Dakota System,
management believes that, after the BP Acquisitions, these operations will be
immediately accretive.
MANUFACTURING
The Company's manufacturing strategy focuses on 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 $58 million had been spent through June 30, 2001. The
upgrade of the fluid catalytic cracking unit, the final major component of the
heavy oil conversion project, is expected to be fully operational in the first
quarter of 2002.
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 July 31, 2001,
management estimates that the heavy oil conversion project would have increased
annual operating profit by $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.
In addition to the heavy oil conversion project, the Company has increased its
asphalt and middle distillate production capabilities at the Washington
refinery. The Company has also implemented programs to improve refinery
reliability and safety. Other programs have been put in place to control
manufacturing costs by upgrading process control systems, consolidating refinery
equipment purchasing and improving the Company's ability to respond to volatile
changes in the cost of utilities at the Washington refinery. Wholesale prices
for purchased electricity at the Washington refinery fluctuated tremendously in
the first six months of 2001, from a low of $20 per megawatt-hour ("MWH") to a
high of $488 per MWH. The Company installed leased, diesel-fueled generators in
late January 2001 to self-generate most of the Washington refinery's power
requirements. The Company has acquired natural gas-fired generators with
emission control packages to replace the leased diesel generators. The natural
gas-fired generators are capable of supplying approximately 90% of the
Washington refinery's present power requirements and provide the flexibility to
better manage the Company's power costs between self-generated power and
purchased electricity.
RETAIL MARKETING
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 July 31, 2001, the Company had 44 Mirastar
stations in operation, 5 Mirastar stations under construction and 57 sites in
various stages of development or evaluation. Management expects to have
approximately 60 to 70 Mirastar stations operating by the end of 2001 and
expects to construct an additional 80 to 90 stations in each of 2002 and 2003.
13
14
The Company is also adding Company-owned stations and branded stations operated
by jobber/dealers to its retail network. As of July 31, 2001, the Company
supplied 300 branded sites including 115 Company-owned and operated sites.
Management has targeted an increase to a range of 350 to 360 sites by year-end
2001, primarily through the growth in the Mirastar and branded jobber/dealer
programs, excluding the impact of the pending BP Acquisitions.
OTHER
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.
In July 2001, the Company commenced the charter of a second double-hull vessel,
the Nantucket Shoals, which is a sister ship of the chartered Cape Lookout
Shoals. The charter for the Nantucket Shoals has a two-year primary term at an
annual cost of approximately $12 million with an option to renew for an
additional year. The charter will be used to transport feedstocks and refined
products between the Company's three refineries.
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 June 30, 2001 and December 31, 2000, the Company's inventories of
refinery feedstocks and refined products totaled 13.2 million barrels and 11.9
million barrels, respectively. During 2000, inventory levels increased 3.3
million barrels over year-end 1999 levels at an average cost of $29.82 per
barrel. Sales that result in a reduction in inventories below 11.9 million
barrels during 2001 would have a per barrel cost of sales equal to the sum of
$29.82 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 in June 2001 was approximately $27.70 per barrel, or approximately
$2.12 per barrel lower than the cost of the 2000 incremental inventory layer.
The average costs of the Company's refinery feedstocks and refined products
inventories as of June 30, 2001 and December 31, 2000 were $21.50 per barrel and
$20.79 per barrel, respectively. 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.
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.
14
15
RESULTS OF OPERATIONS - THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2001
COMPARED WITH THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2000
SUMMARY
Tesoro's net earnings were $29.5 million ($0.85 per basic share or $0.70 per
diluted share) for the three months ended June 30, 2001 ("2001 Quarter"),
compared with net earnings of $14.6 million ($0.37 per basic share or $0.35 per
diluted share) for the three months ended June 30, 2000 ("2000 Quarter"). For
the year-to-date periods, net earnings were $51.2 million ($1.46 per basic share
or $1.22 per diluted share) for the six months ended June 30, 2001 ("2001
Period"), compared with net earnings of $23.9 million ($0.57 per basic share or
$0.56 per diluted share) for the six months ended June 30, 2000 ("2000 Period").
The increase in earnings during the 2001 Quarter and Period 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
<Table>
<Caption>
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------- --------------------------
(Dollars in millions except per barrel amounts) 2001 2000 2001 2000
---------- ---------- ---------- ----------
REVENUES
Refined products .................................... $ 1,175.0 $ 1,066.5 $ 2,282.8 $ 2,022.5
Other, primarily crude oil resales and merchandise .. 77.2 109.5 150.3 165.7
---------- ---------- ---------- ----------
Total Revenues .................................. $ 1,252.2 $ 1,176.0 $ 2,433.1 $ 2,188.2
========== ========== ========== ==========
SEGMENT OPERATING PROFIT
Gross margins:
Refinery (a) ...................................... $ 182.0 $ 148.8 $ 354.6 $ 273.2
Purchased product and crude oil resales .......... 0.8 3.6 5.2 16.0
Merchandise and other ............................. 6.2 6.8 11.6 13.4
---------- ---------- ---------- ----------
Total gross margins ............................. 189.0 159.2 371.4 302.6
Operating expenses (b) .............................. (114.8) (109.4) (233.7) (213.3)
Depreciation and amortization (c) ................... (9.5) (9.3) (20.2) (18.6)
---------- ---------- ---------- ----------
Segment Operating Profit ........................ $ 64.7 $ 40.5 $ 117.5 $ 70.7
========== ========== ========== ==========
REFINERY SYSTEM THROUGHPUT (thousand bpd)
Alaska .............................................. 45.0 50.8 45.3 44.9
Hawaii .............................................. 89.5 80.7 88.1 83.2
Washington .......................................... 125.0 121.4 119.6 113.5
---------- ---------- ---------- ----------
Total Refinery System Throughput ................ 259.5 252.9 253.0 241.6
========== ========== ========== ==========
% HEAVY CRUDE OIL OF TOTAL REFINERY SYSTEM
THROUGHPUT .......................................... 45% 42% 51% 44%
========== ========== ========== ==========
TOTAL REFINERY SYSTEM PRODUCT SPREAD ($/barrel) ........ $ 7.74 $ 6.27 $ 7.73 $ 6.17
========== ========== ========== ==========
REFINED PRODUCTS MANUFACTURED (thousand bpd)
Gasoline and gasoline blendstocks ................... 91.7 100.0 90.1 95.5
Jet fuel ............................................ 58.1 57.5 58.1 55.7
Diesel fuel ......................................... 44.9 41.8 39.6 35.9
Heavy oils, residual products and other ............. 71.2 60.5 72.0 61.8
---------- ---------- ---------- ----------
Total Refined Products Manufactured ............. 265.9 259.8 259.8 248.9
========== ========== ========== ==========
</Table>
15
16
<Table>
<Caption>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
(Dollars in millions except per barrel amounts) 2001 2000 2001 2000
---------- ---------- ---------- ----------
PRODUCT SALES (thousand bpd) (d)
Gasoline and gasoline blendstocks .......... 140.4 145.3 139.7 134.8
Jet fuel ................................... 78.8 76.2 78.0 76.6
Diesel fuel ................................ 62.5 52.0 59.0 47.9
Heavy oils, residual products and other .... 57.1 58.8 58.7 59.2
---------- ---------- ---------- ----------
Total Product Sales ...................... 338.8 332.3 335.4 318.5
========== ========== ========== ==========
PRODUCT SALES PRICES ($/barrel)
Gasoline and gasoline blendstocks .......... $ 45.47 $ 39.07 $ 43.56 $ 38.33
Jet fuel ................................... $ 35.15 $ 34.99 $ 35.88 $ 35.67
Diesel fuel ................................ $ 38.31 $ 34.75 $ 38.11 $ 35.50
Heavy oils, residual products and other .... $ 25.64 $ 26.95 $ 24.98 $ 25.74
PRODUCT SALES MARGIN ($/barrel) (d)
Average sales price ........................ $ 38.11 $ 35.54 $ 37.59 $ 35.04
Average costs of sales ..................... 32.18 30.34 31.66 29.69
---------- ---------- ---------- ----------
Gross Margin ............................. $ 5.93 $ 5.20 $ 5.93 $ 5.35
========== ========== ========== ==========
</Table>
- ----------
(a) Approximates refinery system throughput times refinery system product
spread, adjusted for changes in refined product inventory.
(b) Includes manufacturing costs per throughput barrel of $2.94 and $2.76
for the three months ended June 30, 2001 and 2000, respectively, and
$3.19 and $2.83 for the six months ended June 30, 2001 and 2000,
respectively. Manufacturing costs included non-cash amortization of
maintenance turnaround costs of $4.4 million and $5.1 million for the
three months ended June 30, 2001 and 2000, respectively, and $8.6
million and $10.3 million for the six months ended June 30, 2001 and
2000, respectively.
(c) Includes manufacturing depreciation per throughput barrel of
approximately $0.22 and $0.24 for the three months ended June 30, 2001
and 2000, respectively, and $0.24 and $0.26 for the six months ended
June 30, 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.
THREE MONTHS ENDED JUNE 30, 2001 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2000.
Segment operating profit for the Refining and Marketing segment was $64.7
million in the 2001 Quarter, a 60% increase from the 2000 Quarter. The increase
was primarily driven by strong refined product margins for the first two months
of the 2001 Quarter in combination with record-high refinery throughput. 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 10% to $1,175 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 $38.11 per barrel in the 2001 Quarter from
$35.54 per barrel in the 2000 Quarter. Total product sales averaged 338,800 bpd
in the 2001 Quarter, an increase of 2% from the 2000 Quarter. The decrease in
other revenues was primarily due to lower crude oil resales which totaled
approximately $59 million in the 2001 Quarter compared to $85 million in the
2000 Quarter. The increase in costs of sales primarily reflected higher
purchased product prices and increased volumes.
Refinery gross margin increased more than 20% to $182.0 million in the 2001
Quarter, reflecting higher volumes and a 23% increase in average refinery system
product spread per barrel to $7.74 in the 2001 Quarter. The increased refinery
spread was primarily driven by higher gasoline and diesel fuel margins. Margins
benefitted from concerns that industry supply would be inadequate to meet
seasonal gasoline demand. The Company was able to capitalize on these market
conditions by increasing its refinery throughput to 259,500 bpd in the 2001
Quarter from
16
17
252,900 bpd in the 2000 Quarter. Further, by developing operational flexibility
in its product slate, the Company was able to capture incremental value in the
2001 Quarter by manufacturing more diesel products when diesel prices exceeded
jet prices. The Company's margins also benefitted from the increase in the
amount of lower-cost, heavy crude processed through the Company's refineries. In
addition, 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 $5 million to segment operating profit in the 2001 Quarter as
compared to the values received from sales of conventional gasoline.
The Company's margins on purchased product and crude oil resales declined by
$2.8 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, excluding depreciation, increased by $5.4 million to $114.8
million in the 2001 Quarter, primarily due to higher costs for utilities and
fuel and increased marketing-related employee costs.
SIX MONTHS ENDED JUNE 30, 2001 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2000.
Segment operating profit for the Refining and Marketing segment was $117.5
million in the 2001 Period, an increase of more than 65% from the 2000 Period.
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 10% to $2,283 million in the 2001 Period, compared to the 2000 Period,
due to higher product prices and sales volumes. The Company's average product
sales prices increased 7% to $37.59 per barrel in the 2001 Period from $35.04
per barrel in the 2000 Period. Total product sales averaged 335,400 bpd in the
2001 Period, an increase of 5% from the 2000 Period. The decrease in other
revenues was primarily due to lower crude oil resales which totaled $117 million
in the 2001 Period compared to $134 million in the 2000 Period. The increase in
costs of sales reflected primarily higher purchased product prices and increased
volumes.
Refinery gross margin increased 30% to $354.6 million in the 2001 Period,
reflecting higher volumes and a 25% increase in average refinery system product
spread per barrel to $7.73 in the 2001 Period. Industry refining margins
remained strong in the western U.S. during the 2001 Period, reflecting the
continued tightness of supply and refining capacity in the region. The Company
was able to increase refinery throughput 5% to a record-high first half level of
253,000 bpd in the 2001 Period. The Company's sales of higher-value CARB quality
blendstocks added approximately $13 million to segment operating profit in the
2001 Period as compared to the values received from sales of conventional
gasoline.
The Company's margins on purchased product and crude oil resales declined by
$10.8 million in the 2001 Period as compared to the 2000 Period. Market
conditions during the 2000 Period offered greater profit opportunities compared
to market conditions during the 2001 Period.
Operating expenses, excluding depreciation, increased by $20.4 million to $233.7
million in the 2001 Period, primarily due to higher costs for utilities and fuel
and increased employee costs.
17
18
MARINE SERVICES
<Table>
<Caption>
Three Months Ended Six Months Ended
(Dollars in millions) June 30, June 30,
--------------------- ---------------------
2001 2000 2001 2000
-------- -------- -------- --------
Revenues:
Fuels ............................... $ 39.2 $ 35.3 $ 78.3 $ 70.2
Lubricants and other ................ 4.0 3.8 7.8 7.6
Services ............................ 4.4 3.1 7.9 6.3
Other income (loss) ................. (0.2) -- (0.2) 1.2
-------- -------- -------- --------
Total Revenues .................... 47.4 42.2 93.8 85.3
Costs of Sales ......................... 35.6 32.0 70.9 63.0
-------- -------- -------- --------
Gross Profit ...................... 11.8 10.2 22.9 22.3
Operating Expenses and Other ........... (7.8) (7.6) (15.5) (15.3)
Depreciation and Amortization .......... (0.7) (0.6) (1.4) (1.2)
-------- -------- -------- --------
Segment Operating Profit ............ $ 3.3 $ 2.0 $ 6.0 $ 5.8
======== ======== ======== ========
Sales Volumes (millions of gallons):
Fuels, primarily diesel ............. 45.1 42.5 87.4 84.0
Lubricants .......................... 0.5 0.6 1.0 1.1
</Table>
Segment operating profit for Marine Services improved by $1.3 million and $0.2
million during the 2001 Quarter and 2001 Period, respectively, primarily due to
higher fuel sales volumes and service revenues. Included in the 2000 Period was
other income of $1.2 million from settlement of a service contract. Excluding
this income, operating profit for the 2001 Period improved by 30%, or $1.4
million.
Revenues increased $5.2 million and $8.5 million from the 2000 Quarter and 2000
Period, respectively, reflecting higher fuel prices, fuel sales volumes, and
services revenues. Sales volumes and services revenues increased from the 2000
Quarter and 2000 Period, reflecting an increase in customer exploration and
development activities in the U.S. Gulf of Mexico. The increase in costs 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 $1.9 million and $3.7 million
during the 2001 Quarter and 2001 Period, respectively. The increases were
primarily due to higher employee costs and professional fees.
INTEREST AND FINANCING COSTS
Interest and financing costs, net of capitalized interest, decreased by $1.7
million and $3.8 million during the 2001 Quarter and 2001 Period, respectively,
reflecting the impact of capitalized interest on major projects during the 2001
Period. Capitalized interest amounted to $1.6 million and $2.5 million in the
2001 Quarter and 2001 Period, respectively, while interest capitalized in the
2000 Quarter and 2000 Period was less than $0.1 million. Before capitalized
interest, interest and financing costs decreased $1.3 million during the 2001
Period reflecting lower interest rates on floating rate debt.
INTEREST INCOME
Interest income decreased by $1.3 million from the 2000 Period 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 $10.2 million and $18.8 million in the income tax provision
during the 2001 Quarter and 2001 Period, respectively, primarily reflected the
increase in pretax earnings. The combined federal and state effective income tax
rate was approximately 40% in both the 2001 Quarter and 2001 Period and
approximately 39% in both the 2000 Quarter and 2000 Period.
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OUTLOOK AND OTHER FACTORS
In regard to the current market environment and its implication for the future,
management believes that the industry faces margin uncertainty because of
relatively high inventory levels. Recently, however, management believes that
there have been improvements in the market. If these trends continue during the
remainder of the quarter and if the Company operates its refining system at
about the same level as the second quarter of 2001, management expects earnings
for the 2001 third quarter to be in the range of $0.10 to $0.25 per share.
Previously, based on the expected margin environment, management estimated its
year 2001 earnings could be in the range of $2.40 to $3.00 per share. This range
was based on the industry consensus that very strong margins would continue for
the remainder of 2001, and management's expectation that fourth quarter margins
would decline to levels lower than the fourth quarter of 2000. Given the
Company's actual results for the first half of 2001 and the projected lower
margin environment, management expects earnings per share to be in the range of
$1.50 to $1.75 for the current year, excluding the impact of the pending BP
Acquisitions.
For 2002, management is maintaining its earnings goal of $3.00 per share which
is primarily based on (i) average historical margins for both its current
operations and pending acquisitions, (ii) the backcasts for the last three
quarters of the heavy oil conversion project which have consistently reflected
incremental earnings per share of approximately $0.70, and (iii) the potential
for margin and other earnings improvements.
Future profitability will continue to be influenced by market conditions and
other factors that are beyond the control of the Company. Many 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. See "Forward-looking Statements" on page 23 and
"Business Environment" on page 14 for further information related to these
factors and other factors which could cause results to differ.
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, including the
acquisition debt discussed below. Capital requirements are expected to include
capital expenditures, working capital and debt service. Management believes that
available capital resources will be adequate to meet the Company's 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 June 30, 2001 was comprised of the following
(in millions):
<Table>
Debt and other obligations outstanding, including current maturities:
Existing Credit Facility.......................................................... $ 49
9% Senior Subordinated Notes, due 2008............................................ 297
Other obligations................................................................. 10
--------
Total debt and other obligations............................................... 356
Mandatorily Convertible Preferred Stock............................................. 165
Common stockholders' equity ........................................................ 557
--------
Total Capitalization........................................................... $ 1,078
========
</Table>
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At June 30, 2001, the Company's debt to capitalization ratio was 33% compared
with 32% at year-end 2000, reflecting increased borrowings under the Existing
Credit Facility used primarily to reduce accounts payable and accrued
liabilities.
The Existing Credit Facility and Senior Subordinated Notes 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. Both the
Existing Credit Facility and the Senior Subordinated Notes are guaranteed by
substantially all the subsidiaries of the Company.
EXISTING 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 "Existing 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.
At June 30, 2001, the Company had $49 million in borrowings and $1 million in
letters of credit outstanding under the Existing Credit Facility, resulting in
unused credit availability of $200 million. Based on current operations, the
$250 million capacity under the Existing Credit Facility, together with
internally-generated cash flows, is expected to be sufficient to fund capital
expenditures, working capital requirements and other corporate purposes.
PROPOSED FINANCING
In connection with the pending BP Acquisitions, Tesoro has obtained a commitment
from Lehman Brothers Inc. to arrange a new senior secured credit facility (the
"Senior Secured Credit Facility") in the amount of $1.0 billion. The Senior
Secured Credit Facility will consist of a $175 million Revolving Credit
Facility, an $85 million Term Loan A Credit Facility, a $90 million Delayed Draw
Term Loan Facility (used solely to fund the purchase of the North Dakota crude
oil pipeline system), a $300 million Term Loan B Credit Facility and a $350
million Capital Markets Term Loan Facility. The Company expects to issue
approximately $350 million of senior subordinated notes (the "Notes Offering")
to replace the $350 million Capital Markets Term Loan Facility. The Senior
Secured Credit Facility will be guaranteed by substantially all of the Company's
active domestic subsidiaries and will be secured by substantially all material
present and future assets of the Company and its subsidiaries and will be
additionally secured by a pledge of stock of all current and future
subsidiaries.
Borrowings under the Senior Secured Credit Facility, together with the proceeds
of the Notes Offering, will be used to fund the BP Acquisitions, to refinance
the Existing Credit Facility, to pay certain fees and expenses related to the
transactions and for general corporate purposes (including working capital
requirements).
CONVERSION OF PREFERRED STOCK
On July 1, 2001, the Company's Premium Income Equity Securities ("PIES")
automatically converted into 10,350,000 shares of Common Stock. Following
conversion, the Company had approximately 41.6 million shares of Common Stock
outstanding. This conversion saves the Company approximately $12 million in
annual preferred dividends. The final quarterly cash dividends on the PIES were
paid on July 2, 2001.
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. Through June 30, 2001, the Company had repurchased
1,627,400 shares of Common Stock. In July 2001, the Company repurchased an
additional 254,000 shares of its Common Stock at an average cost of $11.45 per
share, or an aggregate of approximately $3 million.
20
21
CAPITAL SPENDING (EXCLUDING THE PENDING BP ACQUISITIONS)
For the year 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's
Marine Services capital expenditures are planned to be $5 million. 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 Existing Credit Facility.
During the 2001 Period, the Company's capital expenditures totaled $82 million,
which included $35 million for the heavy oil conversion project and $13 million
for the Mirastar and other retail marketing programs. Other capital spending of
$34 million during the 2001 Period was primarily for natural gas-fueled
generators, modernization of refinery control systems, and other system
upgrades.
MAJOR MAINTENANCE COSTS
The Company completed its scheduled turnaround of the Alaska refinery in the
second quarter of 2001 at a cost of approximately $10 million. The Company has
scheduled a turnaround of certain processing units at the Washington refinery
with an estimated cost of $20 million in the first quarter of 2002. Amortization
of turnaround costs, other major maintenance projects and catalysts totaled $6
million and $11 million in the 2001 Quarter and 2001 Period, respectively.
Amortization of these costs are projected to total $21 million in 2001.
CASH FLOW SUMMARY
Components of the Company's cash flows are set forth below (in millions):
<Table>
<Caption>
Six Months Ended
June 30,
-------------------------
2001 2000
---------- ----------
Cash Flows From (Used In):
Operating Activities ................................ $ 23.2 $ (22.7)
Investing Activities ................................ (79.4) (21.9)
Financing Activities ................................ 44.0 (88.6)
---------- ----------
Decrease in Cash and Cash Equivalents ................. $ (12.2) $ (133.2)
========== ==========
</Table>
Net cash from operating activities during the 2001 Period totaled $23 million,
compared to $23 million used in operating activities in the 2000 Period. This
improvement was primarily due to higher earnings before depreciation and
amortization as well as a reduction in operating cash flows used for working
capital. Net cash used in investing activities of $79 million in the 2001 Period
included capital expenditures of $82 million, partly offset by proceeds from
sales of assets. Net cash from financing activities of $44 million in the 2001
Period included net borrowings of $49 million under the Existing Credit
Facility, partly offset by payment of $6 million of dividends on Preferred
Stock. Gross borrowings under revolving credit lines amounted to $466 million
and repayments amounted to $417 million during the 2001 Period. Working capital
totaled $303 million at June 30, 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 owned properties. At June 30, 2001, the Company's accruals for
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environmental expenses totaled approximately $15 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 continues to evaluate 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 this revised gasoline standard at its
existing refineries, the Company expects to make capital improvements of
approximately $40 million to $50 million at its Washington refinery.
The Company expects to spend approximately $15 million in capital improvements
at its existing refineries over the next four years to comply with the second
phase of Maximum Achievable Control Technologies ("Refinery MACT II") which was
signed into law in January 2001. Management expects that the Refinery MACT II
regulations will require new emission controls at certain processing units at
each of the Company's existing refineries. The Company is currently evaluating a
selection of control technologies to assure operations flexibility and
compatibility with long-term air emission reduction goals. As an alternative to
making capital improvements of $15 million solely to meet the Refinery MACT II
requirements, the Company is evaluating making capital improvements of $30
million to meet both the Refinery MACT II requirements and long-term reduction
goals for sulfur emissions.
The U.S. Environmental Protection Agency has also 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 continues to evaluate the
impact of the new diesel fuel standards on production, equipment requirements
and related costs.
To comply with environmental laws and regulations, the Company anticipates it
will make other 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 Period, the Company spent
approximately $3 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 F of Notes to Condensed Consolidated Financial Statements in Part I, Item
1.
NEW ACCOUNTING STANDARDS
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 or cash flows.
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
141, "Business Combinations," and SFAS No. 142, "Goodwill and Intangible
Assets." SFAS No. 141 requires the purchase method of accounting for all
business combinations initiated after June 30, 2001 and that certain acquired
intangible assets in a business combination be recognized as assets separate
from goodwill. SFAS No. 142 requires that goodwill and other intangibles,
determined to have an indefinite life, are no longer to be amortized but are to
be tested for impairment at least annually. SFAS No. 142 requires that an
impairment test related to the carrying values of existing goodwill be completed
within the first six months of 2002. Impairment losses on existing goodwill, if
any, would be recorded as the cumulative effect of a change in accounting
principle as of the beginning of 2002. SFAS No. 141 and 142 will apply to the BP
Acquisitions (see Note B of Notes to Condensed Consolidated Financial Statements
in Part I, Item 1). The Company is currently evaluating the impact these
standards will have on its future results of operations and financial condition.
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FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. These
statements include, among other things, projections of revenues, earnings,
earnings per share, capital expenditures or other financial items and
discussions of estimated future revenue enhancements, potential acquisitions and
cost savings. These statements also include the Company's business strategy,
goals and expectations concerning the Company's market position, future
operations, margins, profitability, liquidity and capital resources. The words
"anticipate," "believe," "could," "estimate," "expect," "intend," "may," "plan,"
"predict," "project," "will" and similar terms and phrases identify
forward-looking statements.
Although management believes the assumptions upon which these forward-looking
statements contained in this Quarterly Report on Form 10-Q are based are
reasonable, any of these assumptions could prove to be inaccurate and the
forward-looking statements based on those assumptions could be incorrect. All
phases of the Company's operations involve risks and uncertainties, many of
which are outside the Company's control, and any one of which, or a combination
of which, could materially affect the Company's results of 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:
o changes in general economic conditions;
o the timing and extent of changes in commodity prices and
underlying demand;
o availability and costs of crude oil, other refinery feedstocks
and refined products;
o changes in the Company's inventory levels;
o changes in the cost or availability of third-party vessels,
pipelines and other means of transporting feedstocks and
products;
o changes in fuel and utility costs for the Company's
facilities;
o disruptions due to equipment interruption or failure at
Company or third-party facilities;
o execution of planned capital projects;
o the Company's ability to make acquisitions and successfully
integrate them, including the BP Acquisitions;
o adverse changes in the credit ratings assigned to the
Company's trade credit and debt instruments;
o 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;
o adverse rulings, judgments, or settlements in litigation or
other legal or tax matters, including unexpected environmental
remediation costs in excess of any reserves;
o actions of customers and competitors;
o weather conditions affecting the Company's operations or the
areas in which the Company's products are marketed;
o earthquakes or other natural disasters affecting operations;
o political developments in foreign countries; and
o the conditions of the capital markets in the period covered by
the forward-looking statements.
Many of these factors are described in greater detail in the Company's other
filings with the SEC. All future written and oral forward-looking statements
attributable to the Company or persons acting on the Company's behalf are
expressly qualified in their entirety by the previous statements. The Company
undertakes no obligation to update any information contained in this Quarterly
Report on Form 10-Q 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
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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
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. In addition, crude
oil supply contracts generally are short-term in nature with market-responsive
pricing provisions. The Company normally 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 June 30, 2001 and December 31, 2000, the Company's inventories of
refinery feedstocks and refined products totaled 13.2 million barrels and 11.9
million barrels, respectively. During 2000, inventory levels increased 3.3
million barrels over year-end 1999 levels at an average cost of $29.82 per
barrel. Sales that result in a reduction in inventories below 11.9 million
barrels during 2001 would have a per barrel cost of sales equal to the sum of
$29.82 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 in June 2001 was approximately $27.70 per barrel, or $2.12 per barrel
lower than the cost of the 2000 incremental inventory layer. The average costs
of the Company's refinery feedstocks and refined products inventories as of June
30, 2001 and December 31, 2000 were $21.50 per barrel and $20.79 per barrel,
respectively. 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 activities 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 June 30, 2001, the Company held exchange
traded crude oil futures contracts to purchase 155,000 barrels in August 2001 at
a weighted average price of $26.44 per barrel, or a total of $4 million. The
contracts are accounted for at market prices and had a total fair value of $4
million at June 30, 2001.
INTEREST RATE RISK
The Company had $49 million of outstanding floating-rate debt under the Existing
Credit Facility and $307 million of fixed-rate debt at June 30, 2001. The
interest rate on the floating-rate debt was 6.75% at June 30, 2001. The impact
on annual cash flow of a 10% change in the floating rate for the Existing Credit
Facility (68 basis points) would be approximately $0.3 million.
The fair market value of the Company's fixed-rate debt at June 30, 2001 was
approximately $12 million greater than its book value of $307 million, based on
recent transactions and bid quotes for the Company's 9% Senior Subordinated
Notes, due in 2008.
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PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As previously reported, on January 19, 2001, Tesoro Alaska Company
("Tesoro Alaska") received a Notice of Violation from the Alaska
Department of Environmental Conservation ("ADEC") which alleged that
Tesoro Alaska failed to perform proper tank inspections and repairs
and to comply with its oil spill contingency plan for one of its
Anchorage, Alaska terminals. The alleged violations were discovered
during the renewal process of Tesoro Alaska's oil spill contingency
plan for the facility. On May 15, 2001, Tesoro Alaska entered into a
Compliance Order by Consent with the ADEC and the oil spill
contingency plan was subsequently renewed. Pursuant to the Compliance
Order, Tesoro Alaska has agreed to inspect each of the above-ground
storage tanks at the facility over the next three years and to
perform certain interim pollution prevention measures. In addition,
Tesoro Alaska paid a monetary civil penalty of $225,000. The Company
believes that the Compliance Order resolves this matter in its
entirety.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The 2001 Annual Meeting of Stockholders of the Company was
held on May 23, 2001.
(b) The following directors were elected at the 2001 Annual
Meeting of Stockholders to hold office until the 2002 Annual
Meeting of Stockholders or until their successors are elected
and qualified. A tabulation of the number of votes for or
withheld with respect to each such director is set forth
below:
<Table>
<Caption>
Name Votes For Withheld
---- --------- --------
Steven H. Grapstein 28,449,762 188,174
William J. Johnson 28,458,317 179,619
Raymond K. Mason, Sr. 28,446,581 191,355
Donald H. Schmude 28,459,647 178,289
Bruce A. Smith 28,457,660 180,276
Patrick J. Ward 28,456,422 181,514
Murray L. Weidenbaum 28,446,934 191,002
</Table>
(c) With respect to the ratification of the appointment of
Deloitte & Touche LLP as the Company's independent auditors
for fiscal year 2001, there were 28,533,780 votes for; 76,067
votes against; 28,089 abstentions; and no broker non-votes.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Management Stability Agreement between the Company
and W. Eugene Burden dated February 11, 2001.
10.2 Management Stability Agreement between the Company
and Sharlene S. Fey dated April 8, 2001.
10.3 Management Stability Agreement between the Company
and Jerry H. Mouser dated April 8, 2001.
10.4 Management Stability Agreement between the Company
and Everett D. Lewis dated March 15, 2000.
(b) Reports on Form 8-K
On July 17, 2001, a Current Report on Form 8-K was filed
reporting under Item 5 that the Company had entered into
agreements to purchase certain assets from affiliates of BP,
p.l.c. A Press Release issued on July 17, 2001 and
presentation data were filed as Exhibits under Item 7 of this
Form 8-K. In addition, information related to a conference
call and webcast were filed under Item 9, Regulation FD
Disclosure.
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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: August 14, 2001 /s/ BRUCE A. SMITH
------------------------------------------
Bruce A. Smith
Chairman of the Board of Directors,
President and Chief Executive Officer
Date: August 14, 2001 /s/ GREGORY A. WRIGHT
------------------------------------------
Gregory A. Wright
Senior Vice President and
Chief Financial Officer
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EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT
NUMBER DESCRIPTION
------ -----------
10.1 Management Stability Agreement between the Company and W.
Eugene Burden dated February 11, 2001.
10.2 Management Stability Agreement between the Company and
Sharlene S. Fey dated April 8, 2001.
10.3 Management Stability Agreement between the Company and Jerry
H. Mouser dated April 8, 2001.
10.4 Management Stability Agreement between the Company and Everett
D. Lewis dated March 15, 2000.
</Table>
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