Filed pursuant to 424b5
Registration No. 333-51789
THE INFORMATION IN THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS IS
NOT COMPLETE AND MAY BE CHANGED. A FINAL PROSPECTUS SUPPLEMENT AND PROSPECTUS
WILL BE DELIVERED TO PURCHASERS OF THESE SECURITIES. THIS PROSPECTUS SUPPLEMENT
AND THE ACCOMPANYING PROSPECTUS IS NOT AN OFFER TO SELL THESE SECURITIES AND IT
IS NOT SOLICITING AN OFFER TO BUY THESE SECURITIES IN ANY STATE WHERE THE OFFER
OR SALE IS NOT PERMITTED.
Subject to Completion, dated February 25, 2002
PROSPECTUS SUPPLEMENT
(To Prospectus dated May 14, 1998)
20,000,000 Shares
[TESORO LOGO]
TESORO PETROLEUM CORPORATION
Common Stock
- --------------------------------------------------------------------------------
We are offering 20,000,000 shares of our common stock. We will receive all of
the net proceeds from the sale of these shares.
Our common stock is listed on the New York Stock Exchange and on the Pacific
Exchange under the symbol "TSO". On February , 2002, the last reported sale
price of our common stock on the New York Stock Exchange was $ per share.
INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE "RISK FACTORS"
BEGINNING ON PAGE S-17 OF THIS PROSPECTUS SUPPLEMENT.
<Table>
<Caption>
PER SHARE TOTAL
--------- -----
Public offering price....................................... $ $
Underwriting discounts and commissions...................... $ $
Proceeds to us (before expenses)............................ $ $
</Table>
We have granted the underwriters a 30-day option to purchase up to an additional
3,000,000 shares of common stock to cover over-allotments.
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved of these securities or determined if this
prospectus supplement or the accompanying prospectus is truthful or complete.
Any representation to the contrary is a criminal offense.
Lehman Brothers, on behalf of the underwriters, expects to deliver the shares of
common stock to purchasers on or about , 2002.
- --------------------------------------------------------------------------------
LEHMAN BROTHERS
GOLDMAN, SACHS & CO.
FRIEDMAN BILLINGS RAMSEY
, 2002
[Inside Front Cover]
TABLE OF CONTENTS
<Table>
<Caption>
PAGE NO.
--------
PROSPECTUS SUPPLEMENT
About this Prospectus Supplement............................ S-1
Incorporation of Certain Information by Reference........... S-2
Forward-Looking Statements.................................. S-3
Prospectus Supplement Summary............................... S-5
Risk Factors................................................ S-17
Use of Proceeds............................................. S-24
Capitalization.............................................. S-26
Pro Forma Financial Statements.............................. S-27
Business.................................................... S-34
Description of Common Stock................................. S-52
Underwriting................................................ S-52
Legal Matters............................................... S-55
Index to Financial Statements............................... F-1
PROSPECTUS
Available Information....................................... i
Incorporation of Certain Documents by Reference............. i
Certain Forward-Looking Statements.......................... ii
The Company................................................. 1
Recent Developments......................................... 1
The Tesoro Capital Trusts................................... 2
Use of Proceeds............................................. 3
Ratio of Earnings to Fixed Charges.......................... 3
Risk Factors................................................ 3
Description of Debt Securities.............................. 4
Description of Preferred Stock.............................. 10
Description of Common Stock................................. 11
Description of The Stock Purchase Contracts and The Stock
Purchase Units............................................ 11
Description of the Trust Preferred Securities............... 12
Description of the Trust Guarantees......................... 13
Relationship Among the Trust Preferred Securities, The
Subordinated Debt Securities and The Guarantees........... 15
Plan of Distribution........................................ 17
Legal Matters............................................... 18
Experts..................................................... 18
</Table>
------------------------
ABOUT THIS PROSPECTUS SUPPLEMENT
We provide information to you about this offering of shares of our common
stock in two separate documents. The accompanying prospectus provides general
information, some of which may not apply to this offering, and this prospectus
supplement describes the specific details regarding this offering. Generally,
when we refer to this "prospectus", we are referring to both documents combined.
Additional information is incorporated by reference in this prospectus. If
information in this prospectus supplement is inconsistent with the accompanying
prospectus, you should rely on this prospectus supplement.
You should rely only upon the information contained or incorporated by
reference in this prospectus. We have not, and the underwriters have not,
authorized any other person to provide you with different information. If anyone
provides you with different or inconsistent information, you should not rely on
it. This prospectus does not constitute an offer to sell, or a solicitation of
an offer to buy, any of the common stock offered hereby by any person in any
jurisdiction in which it is unlawful for such person to make such an offer or
solicitation. You should assume the information appearing in this prospectus
supplement, the accompanying prospectus and the documents incorporated by
reference is accurate only as of their respective dates. Our business, financial
condition, results of operations and prospects may have changed since those
dates.
S-1
INCORPORATION OF CERTAIN INFORMATION BY REFERENCE
This prospectus contains information about certain contracts or other
documents that is not necessarily complete. When we make such statements, we
refer you to the actual copies of the contracts or documents (that we will make
available upon request), because the information is qualified in all respects by
reference to those documents.
We file annual, quarterly and special reports, proxy statements and other
information with the SEC. Our SEC filings are available to the public over the
Internet at the SEC's web site at http://www.sec.gov. You also may read and copy
any document we file at the SEC's public reference room at 450 Fifth Street,
N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further
information on the public reference room. Our common stock is listed and traded
on the New York Stock Exchange and the Pacific Exchange under the trading symbol
"TSO". Our reports, proxy statements and other information filed with the SEC
also can be inspected and copied at the New York Stock Exchange, 20 Broad
Street, New York, New York, and at the Pacific Exchange, 301 Pine Street, San
Francisco, California.
This prospectus "incorporates by reference" the information we file with
the SEC, which means that we can disclose important information to you by
referring you to those documents. The information incorporated by reference is
considered to be part of this prospectus, and information that we file later
with the SEC will automatically update and supersede the information in this
prospectus. We incorporate by reference the documents listed below and any
future filings we make with the SEC under Sections 13(a), 13(c), 14 or 15(d) of
the Securities Exchange Act of 1934, as amended (the "Exchange Act"), until we
complete this offering:
- Our Annual Report on Form 10-K for the year ended December 31, 2001;
- Our Current Report on Form 8-K filed on September 21, 2001, as amended by
Amendment No. 1 to our Current Report on Form 8-K filed on October 24,
2001 and Amendment No. 2 to our Current Report on Form 8-K filed on
November 5, 2001;
- Our Current Report on Form 8-K filed on February 4, 2002;
- Our Current Report on Form 8-K filed on February 5, 2002;
- Our two Current Reports on Form 8-K filed on February 21, 2002;
- Our Current Report on Form 8-K filed on February 22, 2002; and
- The description of our common stock included in our Registration
Statement on Form 8-A dated April 21, 1969, as amended by a Form 8 dated
April 23, 1969.
You may request a copy of these filings at no cost, by writing or
telephoning us at the following address:
Tesoro Petroleum Corporation
Attention: Corporate Communications
300 Concord Plaza Drive
San Antonio, Texas 78216-6999
(210) 828-8484
S-2
FORWARD-LOOKING STATEMENTS
This prospectus supplement includes forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. These
statements are included, or incorporated by reference in, this prospectus
supplement, including in the sections entitled "Prospectus Supplement Summary",
"Risk Factors", and "Business" included herein, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" included in our
Annual Report on Form 10-K for the year ended December 31, 2001, and Exhibit
99.2 included in our Current Report on Form 8-K filed on February 5, 2002, and
relate to, among other things, projections of revenues, earnings, earnings per
share, cash flows, capital expenditures or other financial items, EBITDA (as
defined herein), throughput, expectations regarding the Mid-Continent
Acquisition (as defined herein), expectations regarding the pending acquisition
of the Golden Eagle Assets (as defined herein), discussions of estimated future
revenue enhancements and cost savings. These statements also relate to our
business strategy, goals and expectations concerning our market position, future
operations, margins, profitability, liquidity and capital resources. We have
used the words "anticipate", "believe", "could", "estimate", "expect", "intend",
"may", "plan", "predict", "project", "will" and similar terms and phrases to
identify forward-looking statements in this prospectus supplement.
Although we believe the assumptions upon which these forward-looking
statements are based are reasonable, any of these assumptions could prove to be
inaccurate and the forward-looking statements based on these assumptions could
be incorrect. Our operations involve risks and uncertainties, many of which are
outside our control, and any one of which, or a combination of which, could
materially affect the results of our operations and whether the forward-looking
statements ultimately prove to be correct. Accordingly, these forward-looking
statements are qualified in their entirety by reference to the factors described
in "Risk Factors" and elsewhere in this prospectus supplement.
Actual results and trends in the future may differ materially depending on
a variety of factors including, but not limited to:
- changes in general economic conditions;
- the timing and extent of changes in commodity prices and underlying
demand for our products;
- the availability and costs of crude oil, other refinery feedstocks and
refined products;
- changes in our cash flow from operations, liquidity and capital
requirements resulting from the pending acquisition of the Golden Eagle
Assets;
- our ability to consummate the pending acquisition of the Golden Eagle
Assets;
- our ability to (1) successfully integrate acquisitions, including the
Pipeline System and the pending acquisition of the Golden Eagle Assets,
and (2) identify and complete future strategic acquisitions;
- fluctuations in our stock price, including fluctuations as a result of
the announcement of the pending acquisition of the Golden Eagle Assets;
- adverse changes in the ratings assigned to our trade credit and debt
instruments;
- increased interest rates and the condition of the capital markets;
- the direct or indirect effects on our business resulting from terrorist
incidents or acts of war;
- political developments in foreign countries;
- changes in our inventory levels;
- changes in the cost or availability of third-party vessels, pipelines and
other means of transporting feedstocks and products;
- changes in fuel and utility costs for our facilities;
- disruptions due to equipment interruption or failure at our or
third-party facilities;
- execution of planned capital projects;
- state and federal environmental, economic, safety and other policies and
regulations, any changes therein, and any legal or regulatory delays or
other factors beyond our control;
S-3
- adverse rulings, judgments, or settlements in litigation or other legal
or tax matters, including unexpected environmental remediation costs in
excess of any reserves;
- actions of customers and competitors;
- weather conditions affecting our operations or the areas in which our
products are marketed; and
- earthquakes or other natural disasters affecting operations.
Many of these factors are described in greater detail in our filings with
the SEC. All future written and oral forward-looking statements attributable to
us or persons acting on our behalf are expressly qualified in their entirety by
the previous statements. We undertake no obligation to update any information
contained in this prospectus or to publicly release the results of any revisions
to any forward-looking statements that may be made to reflect events or
circumstances that occur, or that we become aware of, after the date of this
prospectus supplement.
S-4
PROSPECTUS SUPPLEMENT SUMMARY
This summary does not contain all of the information that you should
consider before investing in our common stock. You should read the entire
prospectus carefully, including the matters discussed under the caption "Risk
Factors" and the detailed information and financial statements included or
incorporated by reference in this prospectus. When used in this prospectus
supplement, the terms "Tesoro", "we", "our" and "us" except as otherwise
indicated or as the context otherwise indicates, refer to Tesoro Petroleum
Corporation and its subsidiaries. The term "Acquisitions" refers to the pending
acquisition of the Golden Eagle Assets and the Mid-Continent Acquisition. Unless
otherwise indicated herein or the context indicates otherwise, the information
contained in this prospectus supplement gives effect to the pending acquisition
of the Golden Eagle Assets.
THE COMPANY
OVERVIEW
We are an independent refiner and marketer with three operating
segments -- (1) refining crude oil and other feedstocks and selling petroleum
products in bulk and wholesale markets ("Refining"), (2) selling motor fuels and
convenience products and services in the retail market ("Retail") and (3)
providing petroleum products and logistics services to the marine and offshore
exploration and production industries ("Marine Services"). Through our Refining
segment, we manufacture products including primarily gasoline and gasoline
blendstocks, jet fuel, diesel fuel and residual fuel for sale to a wide variety
of commercial customers in the United States and countries in the Pacific Rim.
Our Retail segment distributes motor fuels through a retail network of gas
stations under the Tesoro, Mirastar, Tesoro Alaska and other brands. Our Marine
Services segment markets and distributes a broad range of petroleum products,
chemicals and supplies and provides logistical support services to the marine
and offshore exploration and production industries operating in the Gulf of
Mexico. We are evaluating various strategic opportunities (including a possible
sale of all or a part of this business) to capitalize on the value of our Marine
Services assets.
THE TRANSFORMATION OF TESORO
Beginning in 1998, we entered into a series of acquisitions and strategic
initiatives that we believe have enhanced our competitive position, the
composition and geographical focus of our assets and our financial performance.
Components of this transformation include:
- expansion of our refining capacity through the acquisition of our Hawaii
and Washington refineries in 1998 and our Mid-Continent refineries in
2001, which increased our rated crude oil capacity (excluding the pending
acquisition of the Golden Eagle Assets) by more than four times the 1997
level;
- divestiture of our exploration and production assets at the end of 1999
to focus on the refining and marketing sector;
- expansion of our branded retail network (excluding the pending
acquisition of the Golden Eagle Assets), as measured by number of
stations, by two and one-half times the 1997 level, increasing our
ability to realize the value of our refined products;
- creation of an integrated refining and marketing system focusing on
connected markets in the western United States;
- our investment in capital projects to increase our ability to process
less expensive feedstocks, maximize high value products and increase
throughput; and
- improvement of our refinery reliability and safety.
The pending acquisition of the Golden Eagle Assets in California is the next
step in our transformation. We expect the pending acquisition of the Golden
Eagle Assets to increase our rated crude oil capacity by an additional 168,000
barrels per day ("bpd") and, in combination with the four refineries acquired
since
S-5
1998, to increase our total rated crude oil capacity to 558,000 bpd from 72,000
bpd in 1997. The following table summarizes the stages of our transformation:
<Table>
<Caption>
REFINING AND RETAIL SEGMENTS
----------------------------------------------------------------
PRO FORMA
1997 1998(A) 2001(B) 2001(C)
------------- ------------- ------------- -------------
REFINING:
Number of Refineries...... 1 3 5 6
Rated Crude Oil Capacity
(thousand bpd).......... 72 275 390 558
Primary Markets Served.... Alaska Alaska Alaska Alaska
Hawaii Hawaii Hawaii
PNW(d) PNW(d) PNW(d)
Utah Utah
North Dakota/ North Dakota/
Minnesota Minnesota
California
RETAIL:
Tesoro-Owned Stations (end
of period).............. 35 61 213 283
Total Branded Stations
(end of period)......... 194 232 677 747
FINANCIAL -- REFINING AND
RETAIL (in millions)(e):
Identifiable Assets (end
of period).............. $337.4 $1,077.7 $2,448.7 $3,679.7
Revenues.................. $720.9 $1,268.0 $5,045.3 $7,940.1
EBITDA(f)................. $33.2 $94.8 $301.2 $670.7
</Table>
- ---------------
(a) Data for the Washington refinery (acquired in August 1998) and the Hawaii
operations (acquired in May 1998) since their date of acquisition.
(b) Data for the Mid-Continent refining and retail operations have been included
in the amounts above since September 6, 2001, their acquisition date.
(c) Pro forma for the Acquisitions as if they had occurred on January 1, 2001.
(d) Pacific Northwest (Washington, Oregon and Idaho).
(e) The Refining and Retail segment excludes corporate and unallocated data.
(f) Earnings before extraordinary items, interest and financing costs, interest
income, income taxes and depreciation and amortization ("EBITDA") is a
measure we use for internal analysis and in presentations to analysts,
investors and lenders. The calculation of EBITDA is not based on accounting
principles generally accepted in the United States ("U.S. GAAP") and should
not be considered as an alternative to net earnings or cash flows from
operating activities (which are determined in accordance with U.S. GAAP), as
an indicator of operating performance or as a measure of liquidity. EBITDA
may not be comparable to similarly titled measures used by other entities.
Pro forma EBITDA is EBITDA as defined before the impact of a year-end,
non-cash $56 million writedown of inventories to current market value for
the Golden Eagle Assets for the year ended December 31, 2001.
PENDING ACQUISITION OF THE GOLDEN EAGLE ASSETS
Through a subsidiary, we entered into a sale and purchase agreement with
Ultramar Inc., a subsidiary of Valero Energy Corporation, on February 4, 2002,
which was amended on February 20, 2002. We agreed to acquire the 168,000 bpd
Golden Eagle refinery located in Martinez, California near the San Francisco Bay
Area along with 70 associated retail sites throughout northern California
(collectively, the "Golden
S-6
Eagle Assets"). The purchase price for the Golden Eagle Assets is $995 million
plus the market value of feedstock and refined product inventories at closing,
assumed to be $130 million.
We expect the pending acquisition of the Golden Eagle Assets to increase
our combined rated crude oil capacity by more than 40% to 558,000 bpd. In
addition, our branded retail network will expand to approximately 750 locations,
including nearly 100 stations in California. We intend to close the pending
acquisition of the Golden Eagle Assets, which is subject to customary conditions
and approval by the Federal Trade Commission and the Attorneys General of the
States of California and Oregon, in April 2002. We intend to finance the
acquisition with a combination of debt (including an amendment to our senior
secured credit facility) and public or private equity. Operating income and
EBITDA (before the impact of a year-end, non-cash $56 million writedown of
inventories to current market value) for the Golden Eagle Assets for the year
ended December 31, 2001 was $147 million and $247 million, respectively. For
this period, based upon information provided by the seller, the average daily
throughput of the Golden Eagle Assets was 142,000 bpd. In March 2001, the seller
restarted the 63,000 bpd No. 3 crude unit, significantly increasing the total
amount of crude oil capacity at the refinery. At the same time, the seller
restarted the 20,000 bpd No. 2 reformer unit, significantly improving the value
of refinery output. As a result of these and other improvements made at the
refinery, we expect average daily throughput at the refinery and the value of
the refined product output, excluding the impact of turnarounds, to be
substantially better than its historical rates and yields.
RECENT ACQUISITIONS
On September 6, 2001, we acquired two refineries in North Dakota and Utah
and related storage, distribution and retail assets from certain affiliates of
BP. The acquired assets include a 60,000 bpd refinery in Mandan, North Dakota
and a 55,000 bpd refinery in Salt Lake City, Utah. The acquired assets also
include related bulk storage facilities, eight product distribution terminals,
and retail assets consisting of 42 retail stations and contracts to supply a
jobber network of over 280 retail stations. In connection with the acquisition
of the North Dakota refinery, we purchased a North Dakota-based, common-carrier
crude oil pipeline and gathering system ("Pipeline System") from certain
affiliates of BP on November 1, 2001. The Pipeline System is the primary crude
supply carrier for our Mandan, North Dakota refinery. The purchase of the
Pipeline System and the acquisition of the North Dakota and Utah refineries and
related storage, distribution and retail assets are collectively referred to as
the "Mid-Continent Acquisition". We assumed certain liabilities and obligations
(including costs associated with transferred employees and environmental
matters) related to the acquired assets, subject to specified levels of
indemnification. The Mid-Continent Acquisition enabled us to increase the size
and scope of our operations and diversify our earnings and geographic exposure.
We paid $756.1 million in cash (including $83.0 million for hydrocarbon
inventories) for these assets. Pro forma operating income and EBITDA for these
assets for the year ended December 31, 2001 (including the period under BP
ownership), was $137.6 million and $163.7 million, respectively.
In November 2001, we acquired 46 retail fueling facilities, including 37
retail stations with convenience stores and nine commercial cardlock facilities,
located in Washington, Oregon and Idaho from a privately-held company based in
Seattle, Washington.
REFINING
We operate the largest refineries in Hawaii and Utah, the second largest
refinery in Alaska, the only refinery in North Dakota and the second largest
refinery in northern California. Our six refineries have a combined rated crude
oil capacity of 558,000 bpd, as follows:
- 168,000 bpd in Martinez, California;
- 108,000 bpd in Anacortes, Washington;
- 95,000 bpd in Kapolei, Hawaii on the island of Oahu;
S-7
- 72,000 bpd in Kenai, Alaska;
- 60,000 bpd in Mandan, North Dakota; and
- 55,000 bpd in Salt Lake City, Utah.
Our refinery system yield consists primarily of gasoline and gasoline
blendstocks, jet fuel, diesel fuel and residual fuel oil. We also manufacture
other products, including liquefied petroleum gas and liquid asphalt. During
2001 (excluding the pending acquisition of the Golden Eagle Assets), products
from our refineries accounted for approximately 79% of our sales volumes, with
the remaining 21% purchased from other refiners and suppliers. Rated crude oil
capacity and actual throughput rates of crude oil and other feedstocks by
refinery are as follows:
<Table>
<Caption>
THROUGHPUT (BPD)
RATED CRUDE -----------------------------
REFINERY OIL CAPACITY 1999 2000 2001
- -------- ------------ ------- ------- -------
(BPD)
CALIFORNIA AND SOUTHWEST(a)
California..................................... 168,000 * * --
PACIFIC NORTHWEST
Washington..................................... 108,000 98,100 116,600 119,400
Alaska......................................... 72,000 48,700 48,500 50,000
MID-PACIFIC
Hawaii......................................... 95,000 86,900 84,400 87,100
MID-CONTINENT(b)
North Dakota................................... 60,000 -- -- 17,100
Utah........................................... 55,000 -- -- 16,500
------- ------- ------- -------
TOTAL REFINERY SYSTEM(a)(b)................. 558,000 233,700 249,500 290,100
======= ======= ======= =======
</Table>
- ---------------
* Throughput rates are not meaningful for the California refinery prior to
ownership by the seller in September 2000 because it was operated as part
of a larger refinery system.
(a) Based upon information provided by the seller, California refinery
throughput since the refinery was acquired by the seller was 45,400 bpd
(averaged over the full year) in 2000 and 142,000 bpd in 2001. Based upon
information provided by the seller, throughput averaged over the 122 days
in 2000 that the seller owned the refinery was 136,200 bpd.
(b) Throughput volumes include the Mid-Continent refineries since we acquired
them on September 6, 2001, averaged over 365 days. Throughput averaged over
the 117 days that we owned the Mid-Continent refineries in 2001 was 53,500
bpd in North Dakota and 51,500 bpd in Utah. Prior to 2001, we believe that
annual throughput averaged 54,500 bpd and 50,600 bpd at the North Dakota
refinery in 1999 and 2000, respectively, and 50,700 bpd and 51,100 bpd at
the Utah refinery in 1999 and 2000, respectively.
At the Washington refinery, throughput was higher than the rated crude oil
capacity in 2000 and 2001 due to operational improvements and the processing of
other feedstocks in addition to crude oil. Throughput at the Alaska refinery has
been below capacity levels, reflecting supply, demand and marketing economics in
the region. Scheduled refinery maintenance turnarounds temporarily reduced
throughput in Washington and Alaska in 1999, in Hawaii and North Dakota in 2000
and in Utah in 2000 and 2001.
The seller of the Golden Eagle Assets has begun construction of a project
at the refinery that we expect will increase the capacity of the California Air
Resources Board ("CARB") gasoline that can be produced at the refinery by 20,000
bpd and enable us to conform with CARB III gasoline specifications scheduled to
be effective on January 1, 2003. Based upon a review by an independent
engineering firm, we believe that this project will cost a total of $122
million, a portion of which has been or will be paid by the seller. We expect to
spend approximately $103 million in 2002 and 2003 to complete this project.
Furthermore, we expect that the project will be substantially complete by the
end of 2002.
S-8
Our manufacturing strategy focuses on improving refinery reliability and
safety and investing in capital projects to increase our ability to process less
expensive feedstocks, maximize high value products and increase throughput. We
commenced a heavy oil conversion project at our Washington refinery in 2000,
which will enable us 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. We expect to spend approximately $116
million (including capitalized interest) for this project, of which $97 million
had been spent through December 31, 2001. The de-asphalting unit, one of the
major components of this project, has been in operation since late September
2001. The upgrade of the fluid catalytic cracking unit, the final major
component of this project, is expected to be fully operational by the end of the
first quarter of 2002. We estimate that the total heavy oil conversion project
will increase annual operating profit by $30 million to $40 million (estimated
$15 million to $20 million in 2002). 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 expenses, including fuel and utility costs.
We also operate refined product terminals in the following states:
- Alaska -- Anchorage and Kenai;
- California -- Martinez, Port Hueneme and Stockton;
- Hawaii -- on the islands of Hawaii, Kauai, Maui and Oahu;
- Idaho -- Boise and Burley;
- Minnesota -- Minneapolis/St. Paul, Moorehead and Sauk Center;
- North Dakota -- Jamestown and Mandan;
- Utah -- Salt Lake City; and
- Washington -- Anacortes, Port Angeles and Vancouver.
In addition, we distribute products through third-party terminals and truck
racks in our market areas. Terminals we operate are supplied primarily by our
refineries. Fuel distributed through third-party terminals also is supplied by
our refineries and through purchases and exchange arrangements with other
refining and marketing companies.
In August 2001, we opened an office in Long Beach, California to provide
supply and marketing activities in the southwestern United States. Our goal is
to establish a marketing operation in California capable of providing us and
other independent marketers in California with a competitive and secure supply
of products. To further these objectives, we lease approximately 500,000 barrels
of storage capacity with waterborne access in southern California through
September 2004. We believe that our Long Beach office and southern California
storage capacity, together with the Golden Eagle Assets, will provide us with a
competitive advantage in connected markets which should lower our operating,
transportation and distribution costs and provide market penetration with
competitive prices. We consider connected markets to include markets that are
connected to our refining operations by pipelines, trucks, railcars, vessels or
other means of conveyance as well as markets that, while not physically
connected, are joined by means of exchange supply agreements between
participants in those markets.
RETAIL
Following the consummation of the acquisition of the Golden Eagle Assets,
our Retail segment will include a network of approximately 750 branded retail
stations (under the Tesoro, Mirastar, Tesoro Alaska and other brands), including
over 280 Tesoro-owned retail gasoline stations and over 460 jobber/dealer
stations (third-party retail distributors) in the western and mid-continental
United States. These numbers include 70 retail stations to be acquired in the
pending acquisition of the Golden Eagle Assets, over 320 retail stations
connected with the Mid-Continent Acquisition and 46 retail fueling facilities
acquired from a privately-held Seattle, Washington company in November 2001. We
are in the process of rebranding the
S-9
exterior signage for our acquired Tesoro-owned stations. Our retail network
provides a committed outlet for a portion of the motor fuels produced at our
refineries and provides a more profitable outlet for motor fuels than the
wholesale market.
We developed our Mirastar brand to be used exclusively under an agreement
with Wal-Mart whereby we build and operate retail fueling facilities on parking
lots of selected Wal-Mart store locations. Our relationship with Wal-Mart covers
17 western states. Each of the sites under our agreement with Wal-Mart is
subject to a ground lease with a ten-year primary term and two options,
exercisable at our discretion, to extend a site's lease for additional terms of
five years. At December 31, 2001, we had 55 Mirastar stations in operation.
Though dependent on Wal-Mart to offer sites, we expect to construct an
additional 50 to 60 stations in each of 2002 and 2003. The average cost of
constructing a standard Mirastar station with four fuel dispensers is
approximately $550,000. The average investment in Mirastar stations will
increase in the future with the construction of stations having more than four
fueling dispensers.
MARINE SERVICES
Our Marine Services segment markets and distributes a broad range of
petroleum products, chemicals and supplies and provides logistical support
services to the marine and offshore exploration and production industries
operating in the Gulf of Mexico. These operations are conducted through a
network of 15 terminals located on the Texas and Louisiana Gulf Coasts. We also
own tugboats, barges and trucks used in the Marine Services operations.
We are evaluating various strategic opportunities (including a possible
sale of all or a part of this business) to capitalize on the value of our Marine
Services assets. Our Marine Services business accounted for approximately 5% of
our operating income and historical EBITDA for the year ended December 31, 2001.
STRATEGY AND COMPETITIVE STRENGTHS
Our goal is to create value by:
- maximizing our earnings, cash flows and return on capital employed by
reducing costs, increasing efficiencies and optimizing existing assets;
and
- increasing our competitiveness by expanding our size and market presence
through a combination of internal growth initiatives and selective
acquisitions that are accretive to earnings and cash flow and provide
operational synergies.
We believe that we are well positioned to execute this strategy as a result
of the following competitive strengths:
Geographic and Cash Flow Diversity. The Mid-Continent Acquisition has
diversified, and we believe the pending acquisition of the Golden Eagle Assets
will further diversify, our geographical and operational sources of earnings and
cash flow. As a result of the Mid-Continent Acquisition, we commenced refining
and marketing operations in the mid-continental United States and expanded our
operations in the western United States. The pending acquisition of the Golden
Eagle Assets will continue our efforts to expand our presence in California and
add another supply point in our core marketing area from which we supply our
growing retail network. This geographical diversity reduces our dependence on
any one market, which we believe should reduce the volatility of our earnings
and cash flow.
Operations in Attractive Markets. Our operations, including the
Acquisitions, are based in markets with industry spreads typically above those
in the Gulf Coast and East Coast markets.
Integrated Refining System. With the addition of the Golden Eagle
refinery, we will enhance our ability to optimize our operations among our
refineries in California, Washington, Hawaii and Alaska. Each of these
refineries has ship docking and off-loading capabilities which allow us to ship
a portion of
S-10
the intermediate feedstock produced at one refinery to another refinery and
process it into finished product with higher economic value (net of
transportation expenses). The waterborne access of these refineries, along with
the tankers we charter, allow us to optimize our crude purchasing activities.
Platform for Retail Expansion. Our retail operations provide a committed
outlet for our products at higher margins than products sold at wholesale. We
are using the North Dakota refinery and related assets as a platform for retail
expansion in the Minneapolis/St. Paul market and the Utah refinery to expand our
proprietary supply to the eastern Washington state market, offering us further
retail expansion opportunities. Our agreement with Wal-Mart provides us
additional growth opportunities to build and operate retail fueling facilities
under the Mirastar brand on sites at selected Wal-Mart store locations in the
western United States.
Solid Track Record. Over the last several years, we have made significant
operating improvements in each of our business segments while reducing our
overall financial leverage. We have established a solid track record of
operating stability and growth, and EBITDA from our Refining and Retail
operations has grown from $33.2 million for the year ended December 31, 1997 to
$670.7 million for the year ended December 31, 2001 (pro forma for the
Acquisitions before the impact of a year-end, non-cash writedown of inventories
to current market value). While leverage has historically increased as a result
of acquisitions, we have successfully decreased debt levels with increased cash
flow, asset sales and aggressive debt repayment efforts. We have significantly
reduced our leverage on two separate occasions since the end of 1993. We
decreased our total debt to capitalization ratio from 82% on December 31, 1993
to 23% on December 31, 1996. Additionally, we reduced this ratio from 56% on
June 30, 1998 to 33% on June 30, 2001. These results demonstrate our experience
and commitment to reducing debt levels, as well as our long-term focus on
operating with a balanced capital structure.
Experienced Management Team. We benefit from a strong and experienced
management team at both the corporate and operating levels. Our senior
management team has an average of 25 years of experience in the energy industry.
Our management team has significantly improved our operating and financial
performance over the last five years. In addition, our management team has
demonstrated its ability to integrate acquisitions involving significant
increases in assets, capacity and employees, as evidenced by our successful
integration of the Washington and Hawaii refineries in 1998 and the Mid-
Continent refineries in 2001.
------------------------
We were incorporated in Delaware in 1968. Our principal executive offices
are located at 300 Concord Plaza Drive, San Antonio, Texas 78216-6999 and our
telephone number is (210) 828-8484.
S-11
THE OFFERING
Common Stock offered.......... 20,000,000 shares
Common Stock to be outstanding
after the offering............ 61,445,297 shares
Dividend Policy............... We do not currently pay dividends on our common
stock and our senior secured credit facility
contains covenants limiting our ability to pay
dividends.
Use of Proceeds............... We estimate that we will receive net proceeds
from the offering, without exercise of the
over-allotment option, of approximately $255.5
million. We intend to use the net proceeds,
along with other sources of cash, to fund the
pending acquisition of the Golden Eagle Assets.
If the pending acquisition of the Golden Eagle
Assets does not occur or if we do not receive
certain consents from existing lenders, we
intend to use the net proceeds to temporarily
pay down existing bank debt until we can amend
our senior secured credit facility. See "Use of
Proceeds".
Over-allotment option......... 3,000,000 shares
New York Stock Exchange
symbol........................ TSO
The number of shares outstanding after the offering is based on the number
of shares of our stock outstanding as of February 1, 2002. Unless we indicate
otherwise, all information in this prospectus supplement assumes that the
underwriters' over-allotment option is not exercised and excludes shares
reserved for issuance on the exercise of options granted or available under our
stock option plans. See "Risk Factors" in this prospectus supplement for a
discussion of certain factors that you should consider before making an
investment in our common stock.
S-12
SUMMARY HISTORICAL AND UNAUDITED PRO FORMA FINANCIAL DATA
The following tables set forth certain of our summary historical condensed
consolidated financial data and certain pro forma information after giving
effect to this offering, the Acquisitions, the related financings and the
conversion of our Premium Equity Securities ("PIES(SM)") into shares of our
common stock. The summary historical financial information presented below for
each of the years ended December 31, 1999, 2000 and 2001 has been derived from
the financial statements incorporated by reference in this prospectus. The pro
forma results of consolidated operations for the year ended December 31, 2001
and the pro forma balance sheet data as of December 31, 2001 are derived from
our unaudited pro forma financial statements included and incorporated by
reference in this prospectus. The unaudited pro forma information set forth
below is not necessarily indicative of the results that actually would have been
achieved had this offering, the Acquisitions, related financings and the
conversion of the PIES(SM) been consummated on January 1, 2001 or December 31,
2001 as the case may be, or that may be achieved in the future. The unaudited
pro forma financial statements do not reflect any benefits from potential cost
savings or revenue enhancements resulting from our integration of the Golden
Eagle Assets or the Mid-Continent Acquisition. You should read this information
in conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" in our Annual Report on Form 10-K incorporated by
reference in this prospectus and the Pro Forma Financial Statements,
Consolidated Financial Statements of Tesoro Petroleum Corporation, the Financial
Statements of the Golden Eagle Refining and Marketing Assets Business and the
Combined Financial Statements of The North Dakota and Utah Refining and
Marketing Business of BP Corporation North America Inc. included or incorporated
by reference in this prospectus.
<Table>
<Caption>
TESORO HISTORICAL PRO FORMA
-------------------------------- ---------
YEARS ENDED DECEMBER 31,
---------------------------------------------
1999 2000 2001(A) 2001
-------- -------- -------- ---------
(DOLLARS IN MILLIONS)
STATEMENT OF OPERATIONS DATA:
Revenues
Refining.................................................. $2,661.7 $4,612.6 $4,554.1 *
Retail.................................................... 227.4 305.0 491.2 *
Marine Services........................................... 111.2 186.8 172.5 *
-------- -------- --------
Total Revenues.......................................... 3,000.3 5,104.4 5,217.8 $8,112.6
-------- -------- -------- --------
Costs of Sales and Expenses
Refining.................................................. 2,516.6 4,388.0 4,288.9 *
Retail.................................................... 209.5 300.1 455.2 *
Marine Services........................................... 102.7 173.7 159.8 *
Corporate and other....................................... 41.0 43.7 57.8 *
Depreciation and amortization............................. 42.9 45.5 57.4 *
-------- -------- -------- --------
Total Costs of Sales and Expenses....................... 2,912.7 4,951.0 5,019.1 7,656.2
-------- -------- -------- --------
Operating Income............................................ 87.6 153.4 198.7 456.4
Interest and Financing Costs, Net of Capitalized Interest... (37.6) (32.7) (52.8) (175.5)
Interest Income............................................. 1.2 2.8 1.0 1.0
-------- -------- -------- --------
Earnings From Continuing Operations Before Income Taxes..... 51.2 123.5 146.9 281.9
Income Tax Provision........................................ 19.0 50.2 58.9 116.4
-------- -------- -------- --------
Earnings From Continuing Operations, Net.................... 32.2 73.3 88.0 165.5
Earnings from Discontinued Operations, Net of Income
Taxes(b).................................................. 42.8 -- -- --
-------- -------- -------- --------
Net Earnings................................................ 75.0 73.3 88.0 165.5
Preferred Dividend Requirements(c).......................... 12.0 12.0 6.0 --
-------- -------- -------- --------
Net Earnings Applicable to Common Stock..................... $ 63.0 $ 61.3 $ 82.0 $ 165.5
======== ======== ======== ========
Earnings Per Share From Continuing Operations
Basic..................................................... $ 0.62 $ 1.96 $ 2.26 $ 2.70
Diluted................................................... $ 0.62 $ 1.75 $ 2.10 $ 2.67
Net Earnings Per Share
Basic..................................................... $ 1.94 $ 1.96 $ 2.26 $ 2.70
Diluted................................................... $ 1.92 $ 1.75 $ 2.10 $ 2.67
Weighted Average Common Shares
Basic..................................................... 32.4 31.2 36.2 61.4
Diluted(c)................................................ 32.8 41.8 41.9 61.9
</Table>
S-13
<Table>
<Caption>
TESORO HISTORICAL PRO FORMA
-------------------------------- ---------
YEARS ENDED DECEMBER 31,
---------------------------------------------
1999 2000 2001(A) 2001
-------- -------- -------- ---------
(DOLLARS IN MILLIONS)
OTHER DATA:
Net Earnings Per Share Before Writedown of Inventories(d)
Basic..................................................... -- -- -- $ 3.26
Diluted................................................... -- -- -- $ 3.23
EBITDA(e)
Refining.................................................. $ 145.1 $ 224.6 $ 265.2 *
Retail.................................................... 17.9 4.9 36.0 *
Marine Services........................................... 8.5 13.1 12.7 *
-------- -------- -------- --------
Total Segment EBITDA................................ 171.5 242.6 313.9 683.4
Corporate and unallocated................................. (41.0) (43.7) (57.8) (57.8)
-------- -------- -------- --------
Total from Continuing Operations.................... 130.5 198.9 256.1 625.6
Discontinued operations................................... 110.3 -- -- --
-------- -------- -------- --------
Total Consolidated EBITDA........................... $ 240.8 $ 198.9 $ 256.1 $ 625.6
======== ======== ======== ========
Cash Flows From (Used In)
Operating activities...................................... $ 112.7 $ 90.4 $ 214.4 *
Investing activities...................................... 166.3 (88.0) (976.7) *
Financing activities...................................... (149.2) (130.1) 800.1 *
-------- -------- -------- --------
Increase (Decrease) in Cash and Cash Equivalents............ $ 129.8 $ (127.7) $ 37.8 *
======== ======== ======== ========
Capital Expenditures(f)
Refining.................................................. $ 54.7 $ 56.5 $ 140.0 *
Retail.................................................... 17.7 31.0 43.2 *
Marine Services........................................... 1.5 3.2 3.1 *
Corporate................................................. 10.8 3.3 23.2 *
-------- -------- -------- --------
Total Continuing Operations......................... 84.7 94.0 209.5 *
Discontinued operations................................... 56.5 -- -- *
-------- -------- -------- --------
Total Capital Expenditures.......................... $ 141.2 $ 94.0 $ 209.5 *
======== ======== ======== ========
Rated Crude Oil Refining Capacity (thousand bpd)............ 275 275 390 558
Number of Branded Retail Stations (end of year)
Tesoro-owned.............................................. 62 83 213 283
Jobber/dealer............................................. 182 193 464 464
-------- -------- -------- --------
Total Stations.......................................... 244 276 677 747
======== ======== ======== ========
BALANCE SHEET DATA:
Cash and Cash Equivalents................................... $ 141.8 $ 14.1 $ 51.9 $ 51.9
Working Capital............................................. 290.0 247.8 339.5 472.7
Property, Plant and Equipment, Net.......................... 731.6 781.4 1,522.3 2,352.3
Total Assets................................................ 1,486.5 1,543.6 2,662.3 3,893.3
Total Debt and Other Obligations(g)......................... 417.6 310.6 1,146.9 2,062.4
Stockholders' Equity(c)(h).................................. 623.1 669.9 757.0 1,012.5
</Table>
- ---------------
* Not available.
(a) Financial results of the Mid-Continent refining and retail operations have
been included in the amounts above since September 6, 2001, their
acquisition date.
(b) In December 1999, we sold our oil and gas exploration and production
operations and recorded an aftertax gain of $39.1 million from the sales of
these operations.
(c) The assumed conversion of PIES(SM) into 10.35 million shares of our common
stock for 1999 produced anti-dilutive results and therefore was not included
in the diluted calculations of earnings per share. The PIES(SM)
automatically converted into shares of common stock in July 2001, which
eliminated our $12 million annual preferred dividend requirement.
(d) Basic and diluted earnings per share before the impact of a year-end,
non-cash $56 million writedown of inventories to current market value for
the Golden Eagle Assets for the year ended December 31, 2001.
(e) The calculation of EBITDA is not based on U.S. GAAP and should not be
considered as an alternative to net earnings or cash flows from operating
activities (which are determined in accordance with U.S. GAAP), as an
indicator of operating performance or as a measure of liquidity. EBITDA may
not be comparable to similarly titled measures used by other entities. Pro
forma EBITDA is EBITDA as defined before the impact of a year-end, non-cash
$56 million writedown of inventories to current market value for the Golden
Eagle Assets for the year ended December 31, 2001.
(f) Capital expenditures excluded $783.4 million in 2001 to fund acquisitions in
the Refining and Retail segments.
S-14
(g) In September 2001, we entered into a senior secured credit facility. We
subsequently issued $215 million principal amount of our 9 5/8% Senior
Subordinated Notes to repay a capital markets term loan under our senior
secured credit facility.
(h) We have not paid dividends on our common stock since 1986.
S-15
SUMMARY REFINING AND RETAIL OPERATING DATA
<Table>
<Caption>
FISCAL YEARS
-----------------------
1999 2000 2001
----- ----- -----
REFINERY THROUGHPUT (thousand bpd):
California Refinery(a)...................................... * * --
Washington Refinery......................................... 98.1 116.6(b) 119.4(b)
Hawaii Refinery............................................. 86.9 84.4 87.1
Alaska Refinery............................................. 48.7 48.5 50.0
North Dakota Refinery(c).................................... -- -- 17.1
Utah Refinery(c)............................................ -- -- 16.5
----- ----- -----
Total Throughput........................................ 233.7 249.5 290.1
----- ----- -----
REFINERY SYSTEM YIELD (thousand bpd):
California and Southwest Refinery(d)........................ * * --
----- ----- -----
Pacific Northwest Refineries
Gasoline and gasoline blendstocks......................... 71.4 74.2 73.1
Jet fuel.................................................. 29.7 31.4 28.4
Diesel fuel............................................... 21.3 27.5 29.5
Heavy oils, residual products and other................... 29.7 38.0 44.3
----- ----- -----
Total for the Pacific Northwest Refineries.............. 152.1 171.1 175.3
----- ----- -----
Mid-Pacific Refinery
Gasoline and gasoline blendstocks......................... 21.5 20.8 19.8
Jet fuel.................................................. 28.6 26.2 27.5
Diesel fuel............................................... 11.4 11.7 14.0
Heavy oils, residual products and other................... 30.2 26.8 26.8
----- ----- -----
Total for the Mid-Pacific Refinery...................... 91.7 85.5 88.1
----- ----- -----
Mid-Continent Refineries(e)
Gasoline and gasoline blendstocks......................... -- -- 17.6
Jet fuel.................................................. -- -- 3.5
Diesel fuel............................................... -- -- 9.4
Heavy oils, residual products and other................... -- -- 4.4
----- ----- -----
Total for the Mid-Continent Refineries.................. -- -- 34.9
----- ----- -----
GROSS REFINING MARGIN ($/barrel):
Pacific Northwest........................................... $6.55 $7.89 $7.42
Mid-Pacific................................................. $4.46 $4.80 $5.85
Mid-Continent............................................... -- -- $8.19(f)
NUMBER OF BRANDED RETAIL STATIONS (end of period):(g)
Tesoro (including Tesoro Alaska) --
Tesoro-owned.............................................. 62 63 138
Jobber/dealer............................................. 182 193 183
Mirastar --
Tesoro-owned.............................................. -- 20 55
Other --
Tesoro-owned.............................................. -- -- 20(h)
Jobber/dealer............................................. -- -- 281
Total Branded Retail Stations --
Tesoro-owned.............................................. 62 83 213
Jobber/dealer............................................. 182 193 464
</Table>
- ---------------
* Throughput and yield rates are not meaningful for the California refinery
prior to ownership by the seller in September 2000 because it was operated
as part of a larger refining system.
(a) Based upon information provided by the seller, California refinery
throughput, since the refinery was acquired by the seller, was 45,400 bpd
(averaged over the full year) in 2000 and 142,000 bpd in 2001. Based upon
information provided by the seller, throughput averaged over the 122 days
in 2000 that the seller owned the refinery was 136,200 bpd.
(b) At the Washington refinery, throughput and refined products manufactured
were higher than the rated crude oil capacity in 2000 and 2001 due to
operational improvements and the processing of other feedstocks in addition
to crude oil.
(c) Throughput volumes include the Mid-Continent refineries since we acquired
them on September 6, 2001, averaged over 365 days. Throughput averaged over
the 117 days that we owned the Mid-Continent refineries in 2001 was 53,500
bpd in North Dakota and 51,500 bpd in Utah. Prior to 2001, we believe that
annual throughput averaged 54,500 bpd and 50,600 bpd at the North Dakota
refinery in 1999 and 2000, respectively, and 50,700 bpd and 51,100 bpd at
the Utah refinery in 1999 and 2000, respectively.
(d) Based upon information provided by the seller, California refinery yield,
since the refinery was acquired by the seller, was 45,000 bpd (averaged
over the full year) in 2000 and 139,700 bpd in 2001. Based upon information
provided by the seller, yield averaged over the 122 days in 2000 that the
seller owned the refinery was 134,900 bpd.
(e) Refinery system yield includes the Mid-Continent refineries since we
acquired them on September 6, 2001, averaged over 365 days. Refinery system
yield averaged over the 117 days that we owned the Mid-Continent refineries
in 2001 was 108,700 bpd.
(f) Gross refining margin for 2001 included amounts for the Mid-Continent
refineries since their acquisition on September 6, 2001.
(g) Excludes 70 retail stations from the pending acquisition of the Golden
Eagle Assets.
(h) We acquired these stations in recent acquisitions and they are in the
process of being rebranded to the Tesoro brand.
S-16
RISK FACTORS
Your investment in our common stock will involve risks. Before you decide
to purchase any common stock, you should carefully consider the following risk
factors and other information contained, or incorporated by reference, in this
prospectus.
RISKS RELATING TO THIS OFFERING
OUR ABILITY TO SELL MORE SHARES IN THE FUTURE MAY ADVERSELY AFFECT THE PRICE OF
OUR COMMON STOCK.
Upon consummation of this offering (assuming no exercise of the
underwriters' over-allotment option), we will have 61,445,297 shares of common
stock outstanding. Future sales of our common stock by existing stockholders
pursuant to Rule 144 under the Securities Act, or through the exercise of
outstanding registration rights or otherwise, could have an adverse effect on
the prevailing market price of our common stock and our ability to raise
additional capital. Except for the common stock to be sold in this offering, we
have agreed not to offer, sell, contract to sell or otherwise issue any shares
of our common stock (except pursuant to outstanding options and warrants) or
other capital stock or securities convertible into or exchangeable for, or any
rights to acquire, common stock or other capital stock, with certain exceptions
including certain exceptions for common stock or other capital stock issued or
sold in connection with future acquisitions by us or in private equity
transactions in connection with the pending acquisition, prior to the expiration
of 30 days from the date of this prospectus supplement without the prior written
consent of Lehman Brothers Inc., on behalf of the underwriters. Our executive
officers and directors have agreed not to sell any such shares for 30 days
following the date of this prospectus supplement without the consent of Lehman
Brothers Inc., on behalf of the underwriters. Thereafter, all such shares held
by our executive officers and directors will be eligible for sale in the public
market (subject, in most cases, to applicable volume limitations and other
resale conditions imposed by Rule 144). The sale, or the availability for sale,
of substantial amounts of our common stock or securities convertible into common
stock in the public market at any time subsequent to the date of this prospectus
supplement could adversely affect the prevailing market price of our common
stock.
OUR GOVERNING DOCUMENTS INCLUDE CHANGE OF CONTROL PROVISIONS WHICH COULD RESULT
IN YOU RECEIVING LESS FOR YOUR SHARES OF COMMON STOCK THAN OTHERWISE MIGHT BE
AVAILABLE.
Certain provisions of our Restated Certificate of Incorporation, as
amended, and Bylaws may have the effect of discouraging or delaying attempts to
gain control of Tesoro, including provisions which could result in our
stockholders receiving less for their shares of common stock than otherwise
might be available in the event of a take-over attempt. These provisions
include: (1) authorizing directors to fill vacancies on our board of directors
that occur between annual meetings; (2) restricting the persons who may call a
special meeting of stockholders; (3) authorizing the issuance of preferred
stock; (4) requiring advance notice for stockholder proposals; and (5) requiring
our board of directors to fix a record date prior to conducting a consent
solicitation. Furthermore, certain provisions of Delaware law may also
discourage or hinder attempts by third parties to obtain control of Tesoro. In
addition, certain events that could lead to a change of control of Tesoro will
constitute a change of control under the indentures relating to our senior
subordinated notes and require us to make an offer to purchase those notes. A
change of control is also a default under our senior secured credit facility.
RISKS RELATING TO THE ACQUISITIONS
THE PENDING ACQUISITION OF THE GOLDEN EAGLE ASSETS IS SUBJECT TO CLOSING
CONDITIONS THAT COULD PREVENT US FROM ACQUIRING THE ASSETS ON THE SCHEDULED
TIMETABLE OR AT ALL, AND WE COULD LOSE OUR $53.75 MILLION DEPOSIT.
We entered into a sale and purchase agreement on February 4, 2002 for the
Golden Eagle Assets, which was amended on February 20, 2002. If the acquisition
is not consummated by May 31, 2002 and the failure to close is a result of our
default (including default because of our failure to obtain adequate financing
for the acquisition) under the sale and purchase agreement, we will forfeit our
$53.75 million
S-17
earnest money deposit. In addition to customary closing conditions, the
consummation of the acquisition is subject to approval by the Federal Trade
Commission and the Attorneys General of the States of California and Oregon. The
failure to obtain these approvals or to meet the customary closing conditions
could delay or prevent the consummation of the acquisition.
WE COULD FACE SIGNIFICANT EXPOSURE TO LIABILITIES THAT WE HAVE ASSUMED OR AGREED
TO ASSUME IN CONNECTION WITH THE MID-CONTINENT ACQUISITION AND, FOLLOWING
CLOSING, THE ACQUISITION OF THE GOLDEN EAGLE ASSETS.
We have assumed or agreed to assume a substantial portion of the sellers'
obligations, responsibilities, liabilities, costs and expenses arising out of or
incurred in connection with the Mid-Continent refineries. This includes, subject
to certain exceptions, certain of the sellers' obligations, liabilities, costs
and expenses for violations of health, safety and environmental laws relating to
the assets, including certain known and unknown obligations, liabilities, costs
and expenses arising or incurred prior to, on or after the closing date. We also
assumed the sellers' obligations and liabilities under a consent decree among
the United States, BP Exploration and Oil Co., Amoco Oil Company and Atlantic
Richfield Company. BP entered into this consent decree for the Mid-Continent
refineries for various alleged violations. As the new owner of these refineries,
we are required to address issues including leak detection and repair, flaring
protection and sulfur recovery unit optimization. We estimate we will have to
spend an aggregate of $18 million to comply with this consent decree. In
addition, we have agreed to indemnify the sellers for all losses of any kind
incurred in connection with or related to these assumed liabilities.
In addition to paying the purchase price for the Golden Eagle Assets, upon
the closing of the acquisition of the Golden Eagle Assets, we have agreed to
assume a substantial portion of the seller's obligations, responsibilities,
liabilities, costs and expenses arising out of or incurred in connection with
the operation of the Golden Eagle Assets. This includes, subject to certain
exceptions, certain of the seller's obligations, liabilities, costs and expenses
for environmental compliance matters relating to the assets, including certain
known and unknown obligations, liabilities, costs and expenses arising or
incurred prior to, on or after the closing date. Subject to certain conditions,
we have also agreed to assume the seller's obligations pursuant to its
settlement efforts with the Environmental Protection Agency concerning the
Section 114 refinery enforcement initiative under the Clean Air Act, except for
any potential monetary penalties, which the seller will retain.
Following the closing of the pending acquisition of the Golden Eagle
Assets, we also will assume and take assignment of certain of the seller's
obligations and rights (including certain indemnity rights) arising out of or
related to the agreement pursuant to which the seller purchased the refinery in
2000. The seller has agreed to use commercially reasonable efforts to persuade
Phillips Petroleum Company, as successor to Tosco Corporation ("Phillips"), to
consent to this assignment, including the seller's rights to indemnification of
up to $50 million on environmental matters existing prior to the seller's
acquisition of the Golden Eagle Assets. If the seller cannot obtain a consent
from Phillips, the seller has agreed to provide us with a "back-to-back"
indemnity that will indemnify us against any liability for which the seller is
entitled to recover under the corresponding indemnity. The seller's indemnity,
however, is non-recourse to the seller and is limited to amounts the seller
actually receives from Phillips, less any legal or other enforcement costs the
seller incurs. Therefore, the indemnification that we may be entitled to receive
may not be sufficient to cover any losses or damages we incur.
The operation of refineries and pipelines is inherently subject to spills,
discharges or other releases of petroleum or hazardous substances. If any of
these events occurred or occurs in connection with the Mid-Continent Acquisition
assets or the pending acquisition of the Golden Eagle Assets, other than events
for which we are indemnified, we will be liable for all costs and penalties
associated with their remediation under federal, state or local environmental
laws or common law, and will be liable for property damage to third parties
caused by contamination from releases and spills. The penalties and clean-up
costs that we could have to pay for releases or spills, or the amounts that we
could have to pay to third parties for damage to their property, could be
significant and the payment of these amounts could have a material adverse
effect on our business, financial condition and results of operations.
S-18
The operation of the Mid-Continent and Golden Eagle refineries is and will
continue to be subject to hazards and risks inherent in refining operations and
in transporting and storing crude oil and refined products, including fires,
natural disasters, explosions, pipeline ruptures and spills and mechanical
failure of equipment. Any of these events can result in environmental pollution
and property damage. Our assumption of liability for these events that occurred
before closing could expose us to significant and costly liabilities, the
payment of which could have a material adverse effect on our business, financial
condition and results of operations.
THE GOLDEN EAGLE REFINERY MAY NOT CURRENTLY MEET OUR SAFETY STANDARDS, WHICH
COULD CAUSE US TO INCUR POTENTIALLY SIGNIFICANT LIABILITY FOR ANY FUTURE
HAZARDS.
The Golden Eagle refinery may not currently meet our internal safety and
environmental standards. We anticipate that it could take several years of
continued focus on improving the reliability and maintenance of the Golden Eagle
refinery before it will comply with our internal safety requirements. Therefore,
we may be required to spend a higher amount on capital expenditures for the
Golden Eagle refinery than for our other refineries. In addition, because of
past incidents at the Golden Eagle refinery, we may face a significantly
increased financial burden in obtaining sufficient property and liability
insurance.
AS A RESULT OF THE MID-CONTINENT ACQUISITION, WE HAVE SIGNIFICANT PIPELINE
CAPACITY AND VARIOUS OBLIGATIONS WITH WHICH WE MAY BE UNFAMILIAR.
Prior to the Mid-Continent Acquisition, we did not own refineries or
pipelines in the mid-continent region and had no experience in operating
pipelines in those states. In addition, the Pipeline System significantly
increased the quantity of crude oil pipeline which we own and operate. Our
management is more experienced at operating refineries than pipelines, so we may
face regulatory and operational matters with which we are unfamiliar. While we
have entered into transition services agreements (as amended) for BP to operate
the refined products pipeline and the crude oil Pipeline System on our behalf
until December 15, 2002, our current knowledge level, infrastructure and
employees may not be sufficient to efficiently operate the Pipeline System if we
are required to suddenly take over its operation. In addition, we have entered
into agreements with BP pursuant to which BP has agreed to purchase some of the
products from the Utah refinery and a majority of the products from the North
Dakota refinery. If, however, BP fails to purchase these products under the
agreements, we currently are unfamiliar with customers in those markets and we
would suffer losses in revenue until we find third-party purchasers.
INTEGRATING OUR OPERATIONS WITH THE MID-CONTINENT ACQUISITION ASSETS AND, IF
ACQUIRED, THE GOLDEN EAGLE ASSETS, MAY STRAIN OUR RESOURCES.
The significant expansion of our business and operations, both in terms of
geography and magnitude resulting from the Mid-Continent Acquisition and the
pending acquisition of the Golden Eagle Assets, may strain our administrative,
operational and financial resources. The integration of the Golden Eagle Assets
will require the dedication of management resources that may temporarily detract
from our day-to-day business or hinder integration of the Pipeline System. These
types of demands and uncertainties could have a material adverse effect on our
business, financial condition and results of operations. We may not be able to
manage the combined operations and assets effectively or realize any of the
anticipated benefits of the Pipeline System or the pending acquisition of the
Golden Eagle Assets.
RISKS RELATING TO OUR BUSINESS
WE HAVE A SUBSTANTIAL AMOUNT OF DEBT THAT COULD LIMIT OUR FLEXIBILITY IN
OPERATING OUR BUSINESS OR LIMIT OUR ACCESS TO FUNDS WE NEED TO GROW OUR
BUSINESS.
Giving effect to the pending acquisition of the Golden Eagle Assets and the
application of the net proceeds as described in this prospectus, our pro forma
consolidated indebtedness as of December 31, 2001 would have been $2,062.4
million (including the outstanding 9% Senior Subordinated Notes due 2008 and
S-19
9 5/8% Senior Subordinated Notes due 2008, but excluding an additional $174
million available under our revolving credit facility). Following our
announcement of the pending acquisition of the Golden Eagle Assets, we were put
on credit watch by the rating agencies. Furthermore, we also will be required to
incur a substantially increased amount of indebtedness to consummate the pending
acquisition of the Golden Eagle Assets. Our high degree of leverage may have
important consequences, including the following:
- we may have difficulties obtaining additional or favorable financing for
capital expenditures, working capital, acquisitions or other purposes;
- a substantial portion of our cash flow will be used to make debt service
payments, which will reduce the funds that would otherwise be available
to us for operations and future business opportunities;
- our debt level could limit our flexibility in planning for, or reacting
to, changes in our business and the industry in which we operate;
- our debt level may place us at a competitive disadvantage to our less
leveraged competitors;
- our debt level makes us more vulnerable to the impact of economic
downturns and adverse developments in our business; and
- our floating rate debt level makes us more vulnerable to the impact of an
increase in interest rates.
Our ability to meet our expenses and debt obligations, to refinance our
debt obligations and to fund capital expenditures will depend on our future
performance, which will be affected by general economic, financial, competitive,
legislative, regulatory and other factors beyond our control.
Our business may not generate sufficient cash flow, or we may not be able
to borrow funds under our senior secured credit facility, in an amount
sufficient to enable us to service our indebtedness or make capital
expenditures. If we are unable to generate sufficient cash flow from operations
or to borrow sufficient funds to service our debt, we may be required to sell
assets, reduce capital expenditures, refinance all or a portion of our existing
debt or obtain additional financing. We may not be able to sell assets,
refinance our debt or borrow more money on terms acceptable to us, if at all.
Additionally, the covenants contained in our senior secured credit facility and
our indentures restrict our ability to incur additional debt.
THE VOLATILITY OF CRUDE OIL PRICES, REFINED PRODUCT PRICES AND FUEL AND UTILITY
SERVICE PRICES MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR CASH FLOW AND RESULTS
OF OPERATIONS.
Our refining and wholesale marketing earnings and cash flows from
operations depend on the margin above fixed and variable expenses (including the
cost of refinery feedstocks) at which we are 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 beyond our control,
including the demand for crude oil, gasoline and other refined products, which
are subject to, among other things:
- changes in the economy and the level of foreign and domestic production
of crude oil and refined products;
- worldwide political conditions;
- availability of crude oil and refined product imports;
- marketing of alternative and competing fuels;
- government regulations; and
- local factors, including market conditions and the level of operations of
other refineries in our markets.
Our sale prices for refined products are influenced by the commodity price
of crude oil. Generally, an increase or decrease in the price of crude oil
results in a corresponding increase or decrease in the price of gasoline and
other refined products. The timing of the relative movement of the prices,
however, as well as the overall change in product prices, can reduce profit
margins and could have a significant impact on our
S-20
refining and wholesale marketing operations and our earnings and cash flows. In
addition, we maintain inventories of crude oil, intermediate products and
refined products, the values of which are subject to rapid fluctuation in market
prices. Also, crude oil supply contracts are generally term contracts with
market-responsive pricing provisions. We purchase our 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 these feedstocks could have a significant effect on our financial
results. We also purchase refined products manufactured by others for sale to
our customers. Price level changes during the periods between purchasing and
selling these products could have a material adverse effect on our business,
financial condition and results of operations.
The rising costs and unpredictable availability of fuel and utility
services used by our refineries and other operations have increased operating
costs and will continue to impact production and delivery of products. Fuel and
utility prices have been and will continue to be affected by supply and demand
for fuel and utility services in both local and regional markets.
TERRORIST ATTACKS AND THREATS OR ACTUAL WAR MAY NEGATIVELY IMPACT OUR BUSINESS.
Our business is affected by general economic conditions and fluctuations in
consumer confidence and spending, which can decline as a result of numerous
factors outside of our control, such as terrorist attacks and acts of war.
Recent terrorist attacks in the United States, as well as events occurring in
response to or in connection with them, including future terrorist attacks
against U.S. targets, rumors or threats of war, actual conflicts involving the
United States or its allies, or military or trade disruptions impacting our
suppliers or our customers, may adversely impact our operations. As a result,
there could be delays or losses in the delivery of supplies and raw materials to
us, decreased sales of our products (especially sales to our customers that
purchase jet fuel) and extension of time for payment of accounts receivable from
our customers (especially our customers in the airline industry). Strategic
targets such as energy-related assets (which could include refineries such as
ours) may be at greater risk of future terrorist attacks than other targets in
the United States. These occurrences could have an adverse impact on energy
prices, including prices for our crude oil and refined products, and an adverse
impact on the margins from our refining and wholesale marketing operations. In
addition, disruption or significant increases in energy prices could result in
government-imposed price controls. It is possible that any or a combination of
these occurrences could have a material adverse effect on our business.
COMPLIANCE WITH VARIOUS ENVIRONMENTAL REQUIREMENTS COULD INCREASE THE COST OF
OPERATING OUR BUSINESS.
All of our operations are subject to extensive requirements relating to air
emissions, water discharges, waste management and other environmental matters
that can entail costly compliance measures. For example, we currently anticipate
that revised standards for low sulfur content in gasoline and highway diesel
fuel will require us to spend approximately $100 million through 2006 and $45
million in years after 2006 to comply with regulations that will be applicable
to several of our currently owned refineries at various dates (depending on the
refinery and the fuel involved) between 2004 and 2010, and that other air
emissions and environmental requirements will require us to spend at least an
additional $60 million through 2006. In addition, the Golden Eagle Assets will
require substantial expenditures to address upcoming "clean fuels" requirements,
including California regulations to phase out the use of the oxygenate known as
MTBE by the end of 2002. Based upon a review by an independent engineering firm,
we believe that clean fuels costs at the Golden Eagle refinery will cost a total
of $122 million, a portion of which has been or will be paid by the seller. We
expect to spend approximately $103 million in 2002 and 2003 to comply with these
requirements. Furthermore, we expect that the project will be substantially
complete by the end of 2002. We also expect to spend approximately $24 million
by 2006 at the Golden Eagle refinery to meet the "ultra low sulfur diesel"
standards. The measures we anticipate for achieving compliance with these and
other obligations may not be sufficient to meet these requirements or our
compliance costs may significantly exceed current estimates. If we fail to meet
environmental requirements, we may be subject to administrative, civil and
criminal proceedings by state and federal
S-21
authorities, as well as civil proceedings by environmental groups and other
individuals, which could result in substantial fines and penalties against us as
well as orders that could limit or halt our operations.
The Golden Eagle Assets are also subject to extensive environmental
requirements. We anticipate that capital expenditures addressing environmental
issues at the refinery such as controls on emission of nitrogen oxides and
piping upgrades required to be made pursuant to orders from California's
Regional Water Quality Control Board with jurisdiction over the refinery, and
requirements as a result of a pending settlement of a lawsuit by a citizens'
group concerning coke dust emissions from the refinery's Pittsburg Dock loading
facility, will total approximately $32 million during 2002. Although some
portion of these costs are being and will continue to be incurred by the seller
of the Golden Eagle Assets prior to the closing of the transaction, a
substantial portion of the work will remain after the closing, the costs of
which we will incur. In addition, we estimate that we will incur approximately
$96 million in environmental capital expenditures at the refinery for similar
projects from 2003 through 2006 and $90 million beyond 2006.
In addition, soil and groundwater conditions at the Golden Eagle refinery
(including the Amorco terminal and the coke terminal) may entail substantial
expenditures over time. Although existing information is limited, our
preliminary estimate of costs to address soil and groundwater conditions at the
refinery in connection with various projects, including those required pursuant
to orders by the California Regional Water Quality Control Board, is
approximately $66 million, of which approximately $43 million is anticipated to
be incurred through 2006 and the balance afterwards. We believe we will be
entitled to indemnification, directly or indirectly, from former owners or
operators of the refinery (or their successors) under two separate
indemnification agreements, for approximately $59 million of such costs. We
cannot assure you that any indemnification will be realized.
Additionally, soil and groundwater conditions at approximately 50 of the 70
retail stations to be acquired through the pending acquisition of the Golden
Eagle Assets may require expenditures of approximately $6 million in the
aggregate, pursuant to orders and regulations set by the California Regional
Water Quality Control Board. We also expect to spend approximately $3 million in
the aggregate on capital improvements to meet new California vapor control
equipment requirements at each of the retail facilities.
Our Refining and Marine Services segments operate in environmentally
sensitive coastal waters, where tanker, pipeline and refined product
transportation operations are closely regulated by local and federal agencies
and monitored by environmental interest groups. Our California, Mid-Pacific and
Pacific Northwest refineries import crude oil feedstocks by tanker.
Transportation of crude oil and refined product over water involves inherent
risk and subjects us to the provisions of the Federal Oil Pollution Act of 1990
and state laws in California, Washington, Hawaii, Alaska and the U.S. Gulf
Coast. The Golden Eagle refinery will be subject to the same federal and to
California laws governing the transportation of crude oil and refined products
over water. Among other things, these laws require us to demonstrate in some
situations our capacity to respond to a "worst case discharge" to the maximum
extent possible. We have contracted with various spill response service
companies in the areas in which we transport crude oil and refined product to
meet the requirements of the Federal Oil Pollution Act of 1990 and state laws.
However, there may be accidents involving tankers transporting crude oil or
refined products, and response services may not respond to a "worst case
discharge" in a manner that will adequately contain that discharge or we may be
subject to liability in connection with a discharge.
Our operations are inherently subject to accidental spills, discharges or
other releases of petroleum or hazardous substances that may make us liable to
governmental entities or private parties under federal, state or local
environmental laws, as well as under common law. These may involve contamination
associated with facilities we currently own or operate, facilities we formerly
owned or operated and facilities to which we sent wastes or by-products for
treatment or disposal and other contamination. Accidental discharges may occur
in the future, future action may be taken in connection with past discharges,
governmental agencies may assess damages or penalties against us in connection
with any past
S-22
or future contamination, or third parties may assert claims against us for
damages allegedly arising out of any past or future contamination.
From time to time we have been, and presently are, subject to litigation
and investigations with respect to environmental and related matters. We may
become involved in further litigation or other proceedings, or we may be held
responsible in any existing or future litigation or proceedings, the costs of
which could be material.
We have in the past operated service stations with underground storage
tanks in various jurisdictions, and currently operate service stations in
Hawaii, Alaska and 16 states in the mid-continental and western United States
that have underground storage tanks. Federal and state regulations and
legislation govern the storage tanks and compliance with these requirements can
be costly. The operation of underground storage tanks also poses certain other
risks, including damages associated with soil and groundwater contamination.
Leaks from underground storage tanks at one or more of our service stations may
occur, or previously operated service stations may impact soil or groundwater
that could result in fines or civil liability for us.
THE DANGERS INHERENT IN OUR OPERATIONS AND THE POTENTIAL LIMITS ON INSURANCE
COVERAGE COULD EXPOSE US TO POTENTIALLY SIGNIFICANT LIABILITY COSTS.
Our operations are subject to hazards and risks inherent in refining
operations and in transporting and storing crude oil and refined products, such
as fires, natural disasters, explosions, pipeline ruptures and spills and
mechanical failure of equipment at our or third-party facilities, any of which
can result in environmental pollution, personal injury claims and other damage
to our properties and the properties of others. We do not maintain insurance
coverage against all potential losses and we could suffer losses for uninsurable
or uninsured risks or in amounts in excess of existing insurance coverage. The
occurrence of an event that is not fully covered by insurance could have a
material adverse effect on our business, financial condition and results of
operations.
IF WE ARE UNABLE TO MAINTAIN AN ADEQUATE SUPPLY OF FEEDSTOCKS, OUR RESULTS OF
OPERATIONS MAY BE ADVERSELY AFFECTED.
We may not continue to have an adequate supply of feedstocks, primarily
crude oil, available to our five refineries to sustain our current level of
refining operations. If additional crude oil becomes necessary at one or more of
our refineries, we intend to implement available alternatives that are most
advantageous under then prevailing conditions. Implementation of some
alternatives could require the consent or cooperation of third parties and other
considerations beyond our control. In particular, the North Dakota refinery is
landlocked and does not have a diversity of pipelines to allow us to transport
crude oil to it. The North Dakota refinery, therefore, is completely dependent
upon the delivery of crude oil through the Pipeline System. If outside events
cause an inadequate supply of crude oil, or if the Pipeline System transports
lower volumes of crude oil, our anticipated revenues could decrease. If we are
unable to obtain supplemental crude oil volumes, or are only able to obtain
these volumes at uneconomic prices, our results of operations could be adversely
affected.
WE ARE SUBJECT TO INTERRUPTIONS OF SUPPLY AND INCREASED COSTS AS A RESULT OF OUR
RELIANCE ON THIRD-PARTY TRANSPORTATION OF CRUDE OIL AND REFINED PRODUCTS.
Our Washington refinery receives all of its Canadian crude oil through
pipelines operated by third parties. During 2001, we also delivered
approximately 24,000 bpd of finished transportation fuels products through
third-party pipelines. Our Hawaii and Alaska refineries receive most of their
crude oil and transport a substantial portion of refined products through ships
and barges. Our Mid-Continent refineries receive substantially all of their
crude oil through pipelines. In addition to environmental risks discussed above,
we could experience an interruption of supply or an increased cost to deliver
refined products to market if the ability of the pipelines or vessels to
transport crude oil or refined product is upset because of accidents,
governmental regulation or third-party action. A prolonged upset of the ability
of a pipeline or vessels to transport crude oil or product could have a material
adverse effect on our business, financial condition and results of operations.
S-23
USE OF PROCEEDS
We estimate our net proceeds from this offering to be approximately $255.5
million after deducting underwriting fees and offering expenses. Assuming
consummation of the acquisition of the Golden Eagle Assets, we will use the net
proceeds of this offering, along with other sources, to fund the acquisition.
The following table illustrates the estimated sources and uses of funds for
this offering and the pending acquisition of the Golden Eagle Assets assuming
consummation of the acquisition:
<Table>
<Caption>
AMOUNT
-----------
(DOLLARS IN
MILLIONS)
SOURCES(a):
Shares of common stock offered hereby....................... $ 270.0
Debt financing.............................................. 915.5
--------
Total Sources.......................................... $1,185.5
========
USES:
Purchase Price for Golden Eagle Assets(b)................... $ 995.0
Feedstock and refined product inventories for the Golden
Eagle Assets(c)........................................... 130.0
Expenses(d)................................................. 60.5
--------
Total Uses............................................. $1,185.5
========
</Table>
- ---------------
(a) We intend to finance the acquisition with a combination of debt (including
an amendment to our senior secured credit facility) and public or private
equity.
(b) On February 4, 2002, we paid a $53.75 million earnest money deposit in
connection with our agreement to purchase the Golden Eagle Assets. The
deposit was funded partially with cash on hand and with borrowings under our
senior secured credit facility.
(c) There will be a post-closing adjustment if the actual value of the feedstock
and refined product inventories differs from this assumed value. We assume
that the current market value of the feedstock and refined product
inventories required for the Golden Eagle Assets is $130 million.
(d) Estimated fees, commissions and expenses related to the pending acquisition
of the Golden Eagle Assets and related debt and equity financing (including
costs of $14.5 million related to this offering).
Pending consummation of the acquisition of the Golden Eagle Assets, we will
invest the proceeds in interest bearing, highly liquid instruments.
While our senior secured credit facility requires that proceeds of an
equity offering be used to repay outstanding debt under the facility if the
proceeds are not reinvested within 30 days, we are seeking a consent to delay
this repayment so that we may use the proceeds of this offering to fund, in
part, the pending acquisition of the Golden Eagle Assets. If we do not receive
the consent from the lenders under our senior secured credit facility or if the
consummation of the acquisition of the Golden Eagle Assets does not occur, we
intend to use the net proceeds from this offering to repay debt under our senior
secured credit facility provided by a syndicate of lenders led by Lehman
Brothers Inc., as Lead Arranger, Lehman Commercial Paper Inc., as Syndication
Agent, and Bank One, NA, as Administrative Agent. Lehman Commercial Paper Inc.,
an affiliate of Lehman Brothers Inc., is a lender under our senior secured
credit facility and therefore may receive proceeds from the repayment of a
portion of our senior secured credit facility that may be repaid with proceeds
from this offering. We intend to repay some or all of the following bank debt,
which was used to fund the Mid-Continent Acquisition:
- the $85 million tranche A term loan, of which $85 million was outstanding
at February 21, 2002;
- the $90 million delayed draw term loan, of which $90 million was
outstanding at February 21, 2002; and
S-24
- the $450 million tranche B term loan, of which $450 million was
outstanding at February 21, 2002.
The tranche A term loan and delayed draw term loan mature on September 6,
2006 and the tranche B term loan matures on September 6, 2007. Borrowings under
our senior secured credit facility bear interest at either a base rate (4.75% at
February 1, 2002) or a eurodollar rate (ranging from 1.7% to 1.9% at February 1,
2002), plus an applicable margin. The applicable margin at February 1, 2002 for
the tranche A term loan and the delayed draw term loan was 1.25% in the case of
the base rate and 2.25% in the case of the eurodollar rate. The applicable
margin for the tranche B term loan was 1.75% in the case of the base rate and
2.75% in the case of the eurodollar rate. Additionally, the tranche B eurodollar
rate is deemed to be no less than 3.0%. These initial applicable margins are the
highest margins applicable to the respective base and eurodollar rates and will
vary in relation to the ratios of our consolidated total debt to consolidated
EBITDA, as defined in our senior secured credit facility.
S-25
CAPITALIZATION
The following table sets forth our consolidated capitalization as of
December 31, 2001 (1) on a historical basis (including the Mid-Continent
Acquisition), (2) as adjusted to give effect to the pending acquisition of the
Golden Eagle Assets, the application of the net proceeds of this offering and
related financings and (3) as adjusted to give effect to the application of the
net proceeds of this offering assuming the pending acquisition of the Golden
Eagle Assets does not occur for reasons other than a default by Tesoro.
You should read this table in conjunction with our consolidated financial
statements and "Management's Discussion and Analysis of Financial Condition and
Results of Operations" in our Annual Report on Form 10-K incorporated by
reference in this prospectus and other financial information included elsewhere
or incorporated by reference in this prospectus.
<Table>
<Caption>
DECEMBER 31, 2001
-------------------------------------------------------
PRO FORMA AS
ADJUSTED FOR
PRO FORMA AS THIS OFFERING
ADJUSTED FOR THE ASSUMING NO
ACQUISITION OF THE ACQUISITION
GOLDEN EAGLE ASSETS, OF THE
THIS OFFERING AND GOLDEN EAGLE
HISTORICAL RELATED FINANCINGS ASSETS
---------- ------------------------ -------------
(DOLLARS IN MILLIONS)
Cash and cash equivalents....................... $ 51.9 $ 51.9(a) $ 51.9
-------- -------- --------
Debt, including current portion:
Senior Secured Credit Facility(b)............. 625.0 625.0(c) 369.5
Debt incurred for acquisition of the Golden
Eagle Assets(c)............................ -- 915.5 --
9% Senior Subordinated Notes due 2008......... 297.6 297.6 297.6
9 5/8% Senior Subordinated Notes due 2008..... 215.0 215.0 215.0
Other debt(d)................................. 9.3 9.3 9.3
-------- -------- --------
Total debt, including current portion...... 1,146.9 2,062.4 891.4
Stockholders' equity(c)......................... 757.0 1,012.5 1,012.5
-------- -------- --------
Total capitalization....................... $1,903.9 $3,074.9 $1,903.9
======== ======== ========
</Table>
- ---------------
(a) On February 4, 2002, we paid a $53.75 million earnest money deposit in
connection with our agreement to purchase the Golden Eagle Assets. The
deposit was funded partially with cash on hand and with borrowings under our
senior secured credit facility.
(b) As of February 1, 2002, the revolving credit facility had total availability
of $165.6 million, which included a sublimit of $90 million for the issuance
of letters of credit. We had outstanding letters of credit in the aggregate
amount of $9.4 million. A portion of the debt financing is expected to be
funded from an amendment to our existing senior secured credit facility.
(c) We intend to finance the acquisition with a combination of debt (including
an amendment to our senior secured credit facility) and public or private
equity.
(d) Other debt consists primarily of capital lease obligations.
S-26
PRO FORMA FINANCIAL STATEMENTS
The following unaudited pro forma combined condensed balance sheet gives
effect to the following events as if each had occurred on December 31, 2001:
- this offering;
- the pending acquisition of the Golden Eagle Assets; and
- borrowings under our senior secured credit facility and other debt
financings, as necessary to consummate the pending acquisition of the
Golden Eagle Assets.
The Mid-Continent Acquisition and the related financings closed during the
course of 2001 and are included in Tesoro's historical balance sheet as of
December 31, 2001 as reported in our Annual Report on Form 10-K for the year
ended December 31, 2001, which is incorporated herein by reference.
The following unaudited pro forma combined condensed statements of
operations give effect to the following events as if each had occurred on
January 1, 2001:
MID-CONTINENT ACQUISITION:
- consummation of the Mid-Continent Acquisition;
- the related borrowings under our existing senior secured credit facility;
and
- the offering of our 9 5/8% Senior Subordinated Notes due 2008.
PENDING ACQUISITION OF THE GOLDEN EAGLE ASSETS:
- this offering;
- the pending acquisition of the Golden Eagle Assets; and
- borrowings under our senior secured credit facility and other debt
financings, as necessary to consummate the pending acquisition of the
Golden Eagle Assets.
OTHER ADJUSTMENT:
- the July 1, 2001 conversion of our PIES(SM) into shares of our common
stock.
As reported in our Annual Report on Form 10-K for the year ended December
31, 2001, Tesoro's historical results of operations for the year ended December
31, 2001 included results of the Mid-Continent Acquisition (excluding the
Pipeline System) and related interest and financing costs for the period
September 6, 2001 (the closing date for those assets) through December 31, 2001
and results of the Pipeline System and related interest and financing costs for
the period November 1, 2001 (the closing date for the Pipeline System) through
December 31, 2001.
The pending acquisition of the Golden Eagle Assets will be accounted for
using the purchase method of accounting. The estimates of the fair value of the
Golden Eagle Assets and related liabilities are based on preliminary valuations.
These valuations will be updated with respect to inventories, property, plant
and equipment, intangible assets and certain assumed liabilities, and will
change from the amounts shown.
The unaudited pro forma combined condensed financial statements are based
on assumptions that we believe are reasonable under the circumstances and are
intended for informational purposes only. They are not necessarily indicative of
the future financial position or future results of the combined companies or of
the financial position or the results of operations that would have actually
occurred had the Acquisitions taken place as of the date or for the periods
presented. The unaudited pro forma combined condensed statement of operations
does not reflect any benefits from potential cost savings or revenue
enhancements resulting from the integration of the operations of the
Acquisitions. The unaudited pro forma combined condensed statement of operations
contains allocations of corporate overhead totaling $23.3 million related
S-27
to the historical Mid-Continent Acquisition and Golden Eagle Assets financial
statements. We believe the actual incremental corporate overhead that we will
incur will be less than the allocated amounts.
These unaudited pro forma combined condensed statements should be read in
conjunction with, "Management's Discussion and Analysis of Financial Condition
and Results of Operations" in our Annual Report on Form 10-K incorporated by
reference in this prospectus, as well as the historical Consolidated Financial
Statements of Tesoro Petroleum Corporation, the Financial Statements of The
North Dakota and Utah Refining and Marketing Business of BP Corporation North
America Inc. and the Financial Statements of Golden Eagle Refining and Marketing
Assets Business (the "Golden Eagle Business") included or incorporated by
reference in this prospectus.
S-28
UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET
DECEMBER 31, 2001
<Table>
<Caption>
HISTORICAL PRO FORMA
-------------------- --------------------------
GOLDEN
EAGLE
TESORO BUSINESS ADJUSTMENTS COMBINED
-------- -------- ----------- ---------
(DOLLARS IN MILLIONS)
ASSETS
Current Assets:
Cash and cash equivalents................... $ 51.9 $ 0.2 $ (0.2)(a) $ 51.9
Receivables................................. 384.9 -- -- 384.9
Inventories................................. 431.8 163.0 (25.0)(b) 569.8
Prepayments and other....................... 9.4 7.7 (7.7)(a) 9.4
-------- -------- ------- --------
Total Current Assets................ 878.0 170.9 (32.9) 1,016.0
-------- -------- ------- --------
Property, Plant and Equipment................. 1,852.7 830.7 (0.7)(b) 2,682.7
Less accumulated depreciation and
amortization............................. (330.4) (58.6) 58.6(b) (330.4)
-------- -------- ------- --------
Net Property, Plant and Equipment........... 1,522.3 772.1 57.9 2,352.3
-------- -------- ------- --------
Goodwill...................................... 95.2 199.4 (177.4)(b) 117.2
Other Assets.................................. 166.8 58.6 146.4(b) 407.8
36.0(c)
-------- -------- ------- --------
Total Assets........................ $2,662.3 $1,201.0 $ 30.0 $3,893.3
======== ======== ======= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable and accrued liabilities.... $ 504.1 $ 110.6 $(105.8)(b) $ 508.9
Lease termination obligation................ -- 36.1 (36.1)(b) --
Current maturities of debt and other
obligations.............................. 34.4 -- --(c) 34.4
-------- -------- ------- --------
Total Current Liabilities........... 538.5 146.7 (141.9) 543.3
Deferred Income Taxes......................... 136.9 85.9 (85.9)(a) 136.9
Other Liabilities............................. 117.4 33.9 21.3(b) 172.6
Debt and Other Obligations.................... 1,112.5 -- 915.5(c) 2,028.0
Net Parent Investment......................... -- 934.5 (934.5)(d) --
Stockholders' Equity:
Common stock................................ 7.2 -- 3.3(e) 10.5
Additional paid-in capital.................. 448.4 -- 252.2(e) 700.6
Retained earnings........................... 321.9 -- -- 321.9
Treasury stock.............................. (20.5) -- -- (20.5)
-------- -------- ------- --------
Total Stockholders' Equity.......... 757.0 -- 255.5 1,012.5
-------- -------- ------- --------
Total Liabilities and
Stockholders' Equity......... $2,662.3 $1,201.0 $ 30.0 $3,893.3
======== ======== ======= ========
</Table>
S-29
NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET
DECEMBER 31, 2001
(a) Represents an adjustment to exclude assets and liabilities of the Golden
Eagle Business we are not acquiring.
(b) The following is a preliminary estimate of the purchase price for the Golden
Eagle Assets (in millions):
<Table>
Purchase price under the sale and purchase agreement........ $ 995.0
Assumed purchased value of feedstock and refined product
inventories............................................... 130.0
Estimated direct costs of acquisition....................... 10.0
--------
Total purchase price................................... $1,135.0
========
</Table>
There will be a post-closing adjustment if the actual value of the feedstock
and refined products inventories differs from the assumed value. We assume
that the feedstock and refined product inventories required for the Golden
Eagle Assets are approximately $130 million.
For purposes of this pro forma analysis, the above estimated purchase price
has been allocated based on a preliminary assessment of the fair value of
the assets to be acquired and liabilities to be assumed as follows (in
millions):
<Table>
Property, plant and equipment............................... $ 830.0
Inventories:
Feedstocks and refined products........................... 130.0
Materials and supplies.................................... 8.0
Other assets, including intangible and turnaround assets.... 205.0
Goodwill.................................................... 22.0
Environmental and employee benefit liabilities.............. (60.0)
--------
Total purchase price................................... $1,135.0
========
</Table>
Preliminarily, we are not recording a liability related to a lease
termination obligation recorded on the seller's historical balance sheet.
This liability was recorded to reflect the remaining lease payments on a
MTBE facility which the seller had planned to stop operating at the end of
2002. However, our present plans are to reconfigure the facility at an
estimated cost of less than $5 million and to operate the facility
throughout the lease term.
(c) Represents an adjustment to aggregate borrowings of $915.5 million to
finance the pending acquisition of the Golden Eagle Assets and to pay an
estimated $36 million in related fees, expenses and debt issuance costs. All
borrowings have been reflected as non-current for the purposes of this pro
forma analysis; however, based on the ultimate terms of our financing, some
of this amount could be classified as current maturities.
(d) Represents the elimination of historical equity related to the Golden Eagle
Business.
(e) Represents $270 million in estimated gross proceeds from this offering used
to finance a portion of the pending acquisition of the Golden Eagle Assets,
less expected issuance costs of $14.5 million.
S-30
UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2001
<Table>
<Caption>
HISTORICAL PRO FORMA HISTORICAL PRO FORMA
--------------------------- ------------------------- ------------ ------------------------
MID-CONTINENT GOLDEN EAGLE
MID-CONTINENT(1) AND OTHER ADJUSTED GOLDEN EAGLE BUSINESS
TESORO ACQUISITION ADJUSTMENTS TESORO BUSINESS ADJUSTMENTS COMBINED
-------- ---------------- ------------- -------- ------------ ------------ --------
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Revenues................ $5,217.8 $972.3(2) $ -- $6,190.1 $2,020.6 $ (98.1)(g) $8,112.6
Costs and Expenses:
Costs of sales and
operating
expenses............ 4,857.5 835.0 (5.5)(a) 5,687.0 1,758.2 (98.1)(g) 7,348.3
1.2(h)
Writedown of
inventories to
market value........ -- -- -- -- 55.9(4) -- 55.9
Selling, general and
administrative
expenses............ 104.2 19.1(3) -- 123.3 15.4(3) -- 138.7
Depreciation and
amortization........ 57.4 15.2 (1.2)(b) 75.3 44.0 (5.4)(i) 113.3
3.9(c) (6.9)(j)
7.5(k)
(1.2)(h)
-------- ------ ------ -------- -------- ------- --------
Operating Income........ 198.7 103.0 2.8 304.5 147.1 4.8 456.4
Interest and Financing
Costs, Net of
Capitalized
Interest.............. (52.8) -- (37.2)(d) (90.0) -- (85.5)(l) (175.5)
Interest Income......... 1.0 -- -- 1.0 -- -- 1.0
-------- ------ ------ -------- -------- ------- --------
Earnings Before Income
Taxes................. 146.9 103.0 (34.4) 215.5 147.1 (80.7) 281.9
Income Tax Provision.... 58.9 41.2 (13.1)(e) 87.0 60.1 (30.7)(m) 116.4
-------- ------ ------ -------- -------- ------- --------
Net Earnings............ 88.0 61.8(2) (21.3) 128.5 87.0 (50.0) 165.5
Preferred Dividend
Requirements.......... 6.0 -- (6.0)(f) -- -- -- --
-------- ------ ------ -------- -------- ------- --------
Net Earnings Applicable
to Common Stock....... $ 82.0 $ 61.8 $(15.3) $ 128.5 $ 87.0 $ (50.0) $ 165.5
======== ====== ====== ======== ======== ======= ========
Weighted Average Common
Shares:
Basic............... 36.2 5.2(f) 20.0(n) 61.4
======== ====== ======= ========
Diluted............. 41.9 20.0(n) 61.9
======== ======= ========
Net Earnings Per Share:
Basic............... $ 2.26 $ 2.70
======== ========
Diluted............. $ 2.10 $ 2.67
======== ========
</Table>
S-31
NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED
STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 2001
INFORMATIONAL NOTES
(1) Includes the Mid-Continent Acquisition (excluding the Pipeline System) for
the period from January 1, 2001 through September 5, 2001, and the Pipeline
System for the period from January 1, 2001 through October 31, 2001. The
results of operations of the Mid-Continent Acquisition (excluding the
Pipeline System) are included in Tesoro's historical results from the date
of acquisition, September 6, 2001 through December 31, 2001. The results of
operations of the Pipeline System are included in Tesoro's historical
results from the date of acquisition, November 1, 2001 through December 31,
2001.
(2) In connection with the Mid-Continent Acquisition, we entered into certain
offtake agreements with BP to provide us with a distribution channel for a
portion of our refined products produced at these refineries. The offtake
agreements commit approximately 37,220 bpd of refined products for a period
ranging from two to five years. Historically, BP sold these volumes through
its distribution network, which included retail stations and jobbers. The
product sales prices that we will receive under the offtake agreements may
be less than BP historically realized. A decrease in product sales price of
1 cent per gallon would have resulted in a decrease in revenues of $5.7
million and a decrease in net earnings of $3.4 million for the year ended
December 31, 2001.
(3) Historical Mid-Continent Acquisition results include $7.9 million, or $0.08
per pro forma diluted share, of allocated corporate overhead. Historical
Golden Eagle Business results include $15.4 million, or $0.15 per pro forma
diluted share, of allocated corporate overhead.
(4) Represents a year-end, non-cash $55.9 million, or $0.56 per pro forma
diluted share, writedown of inventories to current market values. Excluding
the impact of this writedown, pro forma diluted net earnings would have
been $3.23 per share.
MID-CONTINENT ADJUSTMENTS
(a) Represents an adjustment to conform the accounting policy for refinery
maintenance turnaround costs to our policy.
(b) Represents an adjustment in depreciation expense due to the change in
property, plant and equipment from book value to fair value. Pro forma
depreciation is calculated on the straight-line method over estimated
useful lives of 28 years for refinery and pipeline assets and 16 years for
terminals and retail assets.
(c) Represents the amortization of acquired intangible assets over their
estimated useful lives (weighted average life of 19 years). Intangible
assets include jobber agreements, customer contracts, refinery permits and
plans and refinery technology.
(d) Represents additional interest expense and amortization of debt issuance
costs under our senior secured credit facility and senior subordinated
notes, offset by a decrease in interest expense and amortization of debt
issuance costs related to our prior credit facility.
(e) Represents the income tax effect of the adjustments above at a combined
statutory tax rate of 38%.
OTHER ADJUSTMENT
(f) Represents the elimination of the preferred dividend requirements upon
conversion of our PIES(SM) into shares of our common stock on July 1, 2001.
S-32
NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED
STATEMENTS OF OPERATIONS -- (CONTINUED)
GOLDEN EAGLE ADJUSTMENTS
(g) Represents an adjustment to eliminate excise taxes on wholesale sales
collected on behalf of governmental agencies associated with the seller's
operations from both revenues and costs of sales and operating expenses to
conform to our accounting policy.
(h) Represents an adjustment to conform the accounting policy for classifying
amortization of refinery maintenance turnaround costs to our policy.
(i) Represents an adjustment to eliminate the seller's historical goodwill
amortization of $5.4 million. As we will account for our purchase under
SFAS No. 141 and No. 142, we will not amortize goodwill resulting from the
pending acquisition of the Golden Eagle Assets.
(j) Represents an adjustment to record depreciation expense based on our
preliminary allocation of fair values to property, plant and equipment
based on a weighted-average estimated useful life of 22 years and
estimated salvage value of 10%.
(k) Represents an adjustment to record amortization of acquired intangible
assets assuming a weighted average life of 20 years.
(l) Represents an adjustment to record interest expense (and amortization of
deferred financing costs) on borrowings required to finance the pending
acquisition of the Golden Eagle Assets and to pay related fees, expenses
and debt issuance costs at a weighted average annual interest rate of 8%.
A 1/8% change in the interest rate associated with these borrowings would
have a $1.1 million effect on annual interest expense. A $10 million
change in the amount of borrowings necessary to finance the pending
acquisition of the Golden Eagle Assets would have a $0.8 million effect on
annual interest expense.
(m) Represents the income tax effect of the adjustments above at a combined
statutory tax rate of 38%.
(n) Represents an adjustment for this offering of 20 million shares of common
stock at a price of $13.50 per share to yield gross proceeds of $270
million. The pro forma adjustments assume no exercise of the underwriters'
over-allotment option. If the over-allotment option is exercised in full,
the net proceeds would increase by $38.5 million, thereby reducing
borrowings necessary to finance the pending acquisition of the Golden Eagle
Assets and reducing annual interest expense by $3.1 million.
S-33
BUSINESS
We are an independent refiner and marketer with three operating
segments -- (1) refining crude oil and other feedstocks and selling petroleum
products in bulk and wholesale markets ("Refining"), (2) selling motor fuels and
convenience products and services in the retail market ("Retail") and (3)
providing petroleum products and logistics services to the marine and offshore
exploration and production industries ("Marine Services"). Through our Refining
segment, we manufacture products including primarily gasoline and gasoline
blendstocks, jet fuel, diesel fuel and residual fuel for sale to a wide variety
of commercial customers in the United States and countries in the Pacific Rim.
Our Retail segment distributes motor fuels through a retail network of gas
stations under the Tesoro, Mirastar, Tesoro Alaska and other brands. Our Marine
Services segment markets and distributes a broad range of petroleum products,
chemicals and supplies and provides logistical support services to the marine
and offshore exploration and production industries operating in the Gulf of
Mexico. We are evaluating various strategic opportunities (including a possible
sale of all or a part of this business) to capitalize on the value of our Marine
Services assets.
PENDING ACQUISITION OF THE GOLDEN EAGLE ASSETS
We entered into a sale and purchase agreement with Ultramar Inc., a
subsidiary of Valero Energy Corporation, on February 4, 2002, which was amended
on February 20, 2002, in which we agreed to acquire the Golden Eagle Assets. The
purchase price for the Golden Eagle Assets is $995 million plus the market value
of feedstock and refined product inventories at closing, assumed to be $130
million.
We expect the pending acquisition of the Golden Eagle Assets to increase
our combined rated crude oil capacity by more than 40% to 558,000 bpd. In
addition, we expect our branded retail network will expand to approximately 750
locations, including nearly 100 stations in California. We intend to close the
pending acquisition of the Golden Eagle Assets, which is subject to customary
conditions and approval by the Federal Trade Commission and the Attorneys
General of the States of California and Oregon, in April 2002. We intend to
finance the acquisition with a combination of debt (including an amendment to
our senior secured credit facility) and public or private equity. Pro forma
operating income and EBITDA (before the impact of a year-end, non-cash $56
million writedown of inventories to current market value) for the Golden Eagle
Assets for the year ended December 31, 2001 was $147 million and $247 million,
respectively. For this period, the average daily throughput of the Golden Eagle
Assets was 142,000 bpd. In March 2001, the seller restarted the 63,000 bpd No. 3
crude unit, significantly increasing the total amount of crude oil capacity at
the refinery. At the same time, the seller restarted the 20,000 bpd No. 2
reformer unit, significantly improving the value of refinery output. As a result
of these and other improvements made at the refinery, we expect average daily
throughput at the refinery and the value of the refined product output,
excluding the impact of turnarounds, to be substantially better than its
historical rates and yields.
In addition to paying the purchase price for the Golden Eagle Assets, upon
the closing of the acquisition, we have agreed to assume a substantial portion
of the seller's obligations, responsibilities, liabilities, costs and expenses
arising out of or incurred in connection with the operation of the Golden Eagle
Assets. This includes, subject to certain exceptions, certain of the seller's
obligations, liabilities, costs and expenses for violations of environmental
compliance matters relating to the assets, including certain known and unknown
obligations, liabilities, costs and expenses arising or incurred prior to, on or
after the closing date. Subject to certain conditions, we also have agreed to
assume the seller's obligations pursuant to its settlement efforts with the EPA
concerning the Section 114 refinery enforcement initiative under the Clean Air
Act, except for any potential monetary penalties, which the seller will retain.
See "Government Regulation and Legislation -- Environmental Controls and
Expenditures -- Pending Acquisition of Golden Eagle Assets".
Following the closing of the pending acquisition of the Golden Eagle
Assets, we also will assume and take assignment of certain of the seller's
obligations and rights (including certain indemnity rights) arising out of or
related to the agreement pursuant to which the seller purchased the refinery in
2000 from Tosco
S-34
Corporation. The seller has agreed to use commercially reasonable efforts to
persuade Phillips to consent to this assignment, including the seller's rights
to indemnification of up to $50 million on environmental matters existing prior
to the seller's acquisition of the Golden Eagle Assets. If the seller cannot
obtain a consent from Phillips, the seller has agreed to provide us with a
"back-to-back" indemnity that will indemnify us against any liability for which
the seller is entitled to recover under the corresponding indemnity. The
seller's indemnity, however, is non-recourse to the seller and is limited to
amounts the seller actually receives from Phillips, less any legal or other
enforcement costs the seller incurs. Therefore, the indemnification that we may
be entitled to receive may not be sufficient to cover any losses or damages we
incur.
If the pending acquisition of the Golden Eagle Assets is consummated, we
expect our capital spending for 2002 would increase by approximately $128
million, primarily for environmental, regulatory and safety matters.
RECENT ACQUISITIONS
On September 6, 2001, we acquired two refineries in North Dakota and Utah
and related storage, distribution and retail assets from certain affiliates of
BP. The acquired assets include a 60,000 bpd refinery in Mandan, North Dakota
and a 55,000 bpd refinery in Salt Lake City, Utah. The acquired assets also
include related bulk storage facilities, eight product distribution terminals,
and retail assets consisting of 42 retail stations and contracts to supply a
jobber network of over 280 retail stations. In connection with the acquisition
of the North Dakota refinery, we purchased the Pipeline System from certain
affiliates of BP on November 1, 2001. The Pipeline System is the primary crude
supply carrier for our Mandan, North Dakota refinery. We assumed certain
liabilities and obligations (including costs associated with transferred
employees and environmental matters) related to the acquired assets, subject to
specified levels of indemnification. The Mid-Continent Acquisition enabled us to
increase the size and scope of our operations and diversify our earnings and
geographic exposure. We paid $756.1 million in cash (including $83.0 million for
hydrocarbon inventories) for these assets. Pro forma operating income and EBITDA
for these assets for the year ended December 31, 2001 (including the period
under BP ownership), was $137.6 million and $163.7 million, respectively.
In November 2001, we acquired 46 retail fueling facilities, including 37
retail stations with convenience stores and nine commercial cardlock facilities,
located in Washington, Oregon and Idaho from a privately-held company based in
Seattle, Washington.
REFINING SEGMENT
OVERVIEW
We own and operate petroleum refineries in California ("California and the
Southwest"), Alaska and Washington (the "Pacific Northwest"), Hawaii (the
"Mid-Pacific") and North Dakota and Utah (the "Mid-Continent") and sell refined
products to a wide variety of customers in the mid-continental and western
continental United States, Hawaii, Alaska and countries in the Pacific Rim.
During 2001 (excluding the pending acquisition of the Golden Eagle Assets),
products from our refineries accounted for approximately 79% of our sales
volumes, with the remaining 21% purchased from other refiners and suppliers.
Our six refineries have a combined rated crude oil capacity of 558,000 bpd.
We operate the largest refineries in Hawaii and Utah, the second largest
refinery in Alaska, the only refinery in North Dakota and
S-35
the second largest refinery in northern California. Capacity and actual
throughput rates of crude oil and other feedstocks by refinery are as follows:
<Table>
<Caption>
THROUGHPUT (BPD)
RATED CRUDE -----------------------------
REFINERY OIL CAPACITY 1999 2000 2001
- -------- ------------ ------- ------- -------
(BPD)
CALIFORNIA AND SOUTHWEST(a)
California..................................... 168,000 * * --
PACIFIC NORTHWEST
Washington..................................... 108,000 98,100 116,600 119,400
Alaska......................................... 72,000 48,700 48,500 50,000
MID-PACIFIC
Hawaii......................................... 95,000 86,900 84,400 87,100
MID-CONTINENT(b)
North Dakota................................... 60,000 -- -- 17,100
Utah........................................... 55,000 -- -- 16,500
------- ------- ------- -------
TOTAL REFINERY SYSTEM(a)(b)................. 558,000 233,700 249,500 290,100
======= ======= ======= =======
</Table>
- ---------------
* Throughput rates are not meaningful for the California refinery prior to
ownership by the seller in September 2000 because it was operated as part
of a larger refinery system.
(a) Based upon information provided by the seller, California refinery
throughput, since the refinery was acquired by the seller was 45,400 bpd
(averaged over the full year) in 2000 and 142,000 bpd in 2001. Based upon
information provided by the seller, throughput averaged over the 122 days
in 2000 that the seller owned the refinery was 136,200 bpd.
(b) Throughput volumes include the Mid-Continent refineries since we acquired
them on September 6, 2001, averaged over 365 days. Throughput averaged over
the 117 days that we owned the Mid-Continent refineries in 2001 was 53,500
bpd in North Dakota and 51,500 bpd in Utah. Prior to 2001, we believe that
annual throughput averaged 54,500 bpd and 50,600 bpd at the North Dakota
refinery in 1999 and 2000, respectively, and 50,700 bpd and 51,100 bpd at
the Utah refinery in 1999 and 2000, respectively.
At the Washington refinery, throughput was higher than the rated crude oil
capacity in 2000 and 2001 due to operational improvements and the processing of
other feedstocks in addition to crude oil. Throughput at the Alaska refinery has
been below capacity levels, reflecting supply, demand and marketing economics in
the region. Scheduled refinery maintenance turnarounds temporarily reduced
throughput in Washington and Alaska in 1999, in Hawaii and North Dakota in 2000
and in Utah in 2000 and 2001.
In 2001, our refinery system received 13% of its crude input from domestic
mid-continental sources, 40% from foreign sources (including 16% from Canada),
33% from Alaska's North Slope, 11% from Alaska's Cook Inlet and 3% from other
sources. As shown in the table below, in 2001, approximately 45%
S-36
of our total refinery system throughput was heavy crude oil, compared with 42%
in 2000. Actual throughput of crude oil and other feedstocks are summarized
below:
<Table>
<Caption>
1999 2000 2001
------------- ------------- -------------
VOLUME % VOLUME % VOLUME %
------ --- ------ --- ------ ---
THROUGHPUT (volumes in thousand bpd):
CALIFORNIA AND SOUTHWEST(a).................. -- -- -- -- -- --
PACIFIC NORTHWEST
Heavy crude................................ 35.9 25% 59.3 36% 77.9 46%
Light crude................................ 106.0 72 95.8 58 83.6 49
Other feedstocks........................... 4.9 3 10.0 6 7.9 5
----- --- ----- --- ----- ---
Total................................... 146.8 100% 165.1 100% 169.4 100%
===== === ===== === ===== ===
MID-PACIFIC
Heavy crude................................ 45.7 53% 46.7 55% 53.0 61%
Light crude................................ 41.2 47 37.7 45 34.1 39
----- --- ----- --- ----- ---
Total................................... 86.9 100% 84.4 100% 87.1 100%
===== === ===== === ===== ===
MID-CONTINENT(b)
Light crude................................ -- -- -- -- 33.3 99%
Other feedstocks........................... -- -- -- -- 0.3 1
----- --- ----- --- ----- ---
Total................................... -- -- -- -- 33.6 100%
===== === ===== === ===== ===
TOTAL REFINERY SYSTEM(b)
Heavy crude................................ 81.6 35% 106.0 42% 130.9 45%
Light crude................................ 147.2 63 133.5 54 151.0 52
Other feedstocks........................... 4.9 2 10.0 4 8.2 3
----- --- ----- --- ----- ---
TOTAL................................... 233.7 100% 249.5 100% 290.1 100%
===== === ===== === ===== ===
</Table>
- ---------------
(a) Based upon information provided by the seller, California refinery
throughput, since the refinery was acquired by the seller was 45,400 bpd
(averaged over the full year) in 2000 and 142,000 bpd in 2001. Based upon
information provided by the seller, throughput averaged over the 122 days in
2000 that the seller owned the refinery, was 136,200 bpd. Throughput volumes
are not meaningful for the California refinery prior to ownership by the
seller in September 2000 because it was operated as part of a larger
refinery system.
(b) Throughput volumes include the Mid-Continent refineries since we acquired
them on September 6, 2001, averaged over 365 days. Throughput for these
refineries averaged over the 117 days that we owned them in 2001 was 105,000
bpd, which would have increased our total refinery system throughput to
361,500 bpd. Prior to 2001, we believe that annual throughput at the
Mid-Continent refineries averaged 105,200 bpd in 1999 and 101,700 bpd in
2000, which would have increased our total refinery system throughput to
338,900 bpd in 1999 and 351,200 bpd in 2000.
We purchase feedstock for the refineries through term agreements and in the
spot market. We purchase Alaska Cook Inlet, Alaska North Slope, Canadian and
North Dakota crude oils from several suppliers under term agreements with
renewal provisions. Prices under the term agreements fluctuate with market
prices.
We term charter three double-hull U.S. flag tankers to transport crude oil
and refined products. One of the charters has a three-year primary term that
began in May 2000 and two one-year renewal options. In March 2001, we entered
into a charter for a double-hull sister ship for a two-year initial term with an
option to renew for an additional year. In the second half of 2001, we entered
into a one-year term charter
S-37
on a third U.S. flag vessel. We also charter other tankers and ocean-going
barges on a short-term basis to transport crude oil and petroleum products.
Our refinery system yield consists primarily of gasoline and gasoline
blendstocks, jet fuel, diesel fuel and residual fuel oil. We also manufacture
other products, including liquefied petroleum gas and liquid asphalt. Our
refinery system yield, in volume and as a percentage, is summarized below:
<Table>
<Caption>
1999 2000 2001
------------ ------------ ------------
VOLUME % VOLUME % VOLUME %
------ --- ------ --- ------ ---
REFINERY SYSTEM YIELD (volumes in thousand bpd):
CALIFORNIA AND SOUTHWEST REFINERY(a).............. -- -- -- -- -- --
PACIFIC NORTHWEST REFINERIES
Gasoline and gasoline blendstocks............... 71.4 47% 74.2 44% 73.1 42%
Jet fuel........................................ 29.7 20 31.4 18 28.4 16
Diesel fuel..................................... 21.3 14 27.5 16 29.5 17
Heavy oils, residual products and other......... 29.7 19 38.0 22 44.3 25
----- --- ----- --- ----- ---
Total........................................ 152.1 100% 171.1 100% 175.3 100%
===== === ===== === ===== ===
MID-PACIFIC REFINERY
Gasoline and gasoline blendstocks............... 21.5 24% 20.8 24% 19.8 23%
Jet fuel........................................ 28.6 31 26.2 31 27.5 31
Diesel fuel..................................... 11.4 12 11.7 14 14.0 16
Heavy oils, residual products and other......... 30.2 33 26.8 31 26.8 30
----- --- ----- --- ----- ---
Total........................................ 91.7 100% 85.5 100% 88.1 100%
===== === ===== === ===== ===
MID-CONTINENT REFINERIES(b)
Gasoline and gasoline blendstocks............... -- -- -- -- 17.6 50%
Jet fuel........................................ -- -- -- -- 3.5 10
Diesel fuel..................................... -- -- -- -- 9.4 27
Heavy oils, residual products and other......... -- -- -- -- 4.4 13
----- --- ----- --- ----- ---
Total........................................ -- -- -- -- 34.9 100%
===== === ===== === ===== ===
TOTAL REFINERY SYSTEM YIELD(b)
Gasoline and gasoline blendstocks............... 92.9 38% 95.0 37% 110.5 37%
Jet fuel........................................ 58.3 24 57.6 23 59.4 20
Diesel fuel..................................... 32.7 13 39.2 15 52.9 18
Heavy oils, residual products and other......... 59.9 25 64.8 25 75.5 25
----- --- ----- --- ----- ---
Total........................................ 243.8 100% 256.6 100% 298.3 100%
===== === ===== === ===== ===
</Table>
- ---------------
(a) Based upon information provided by the seller, California refinery yield,
since the refinery was acquired by the seller, was 45,000 bpd (averaged over
the full year) in 2000 and 139,700 bpd in 2001. Based upon information
provided by the seller, yield averaged over the 122 days in 2000 that the
seller owned the refinery was 134,900 bpd.
(b) Refinery system yield includes the Mid-Continent refineries since we
acquired them on September 6, 2001, averaged over 365 days. Refinery system
yield for these refineries averaged over the 117 days we owned them in 2001
was 108,700 bpd, which would increase total refinery system yield to 372,100
bpd.
S-38
We operate refined product terminals in the following states:
- Alaska -- Anchorage and Kenai;
- California -- Martinez, Port Hueneme and Stockton;
- Hawaii -- on the islands of Hawaii, Kauai, Maui and Oahu;
- Idaho -- Boise and Burley;
- Minnesota -- Minneapolis/St. Paul, Moorehead and Sauk Center;
- North Dakota -- Jamestown and Mandan;
- Utah -- Salt Lake City; and
- Washington -- Anacortes, Port Angeles and Vancouver.
In addition, we distribute products through third-party terminals and truck
racks in our market areas. Terminals we operate are supplied primarily by our
refineries. Fuel distributed through third-party terminals also is supplied by
our refineries and through purchases and exchange arrangements with other
refining and marketing companies.
CALIFORNIA REFINERY
Refining. The California refinery, located in Martinez, California,
approximately 30 miles east of San Francisco, is a highly complex refinery with
a rated crude oil capacity of 168,000 bpd. Other major units at the refinery
include a fluid catalytic cracker, fluid coker, hydrocracker and alkylation
unit. These product upgrade units enable the refinery to produce primarily motor
fuels including clean burning CARB gasoline and CARB diesel products as well as
conventional gasoline and diesel. Other products produced at the refinery
include liquefied petroleum gas, coke, fuel oil, decant oil and other residual
products. A major turnaround of the refinery, including the refinery's fluid
coker, began in November 2001 and is scheduled to be completed in March 2002. A
turnaround of the larger of the refinery's two crude units is scheduled to begin
in May 2002.
The seller of the Golden Eagle Assets has begun construction for a project
at the refinery that we expect will increase the capacity of the California Air
Resources Board ("CARB") gasoline that can be produced at the refinery by 20,000
bpd and enable us to conform with CARB III gasoline specifications scheduled to
be effective on January 1, 2003. Based upon a review by an independent
engineering firm, we believe that this project will cost a total of $122
million, a portion of which has been or will be paid by the seller. We expect to
spend approximately $103 million in 2002 and 2003 to complete this project.
Furthermore, we expect that the project will be substantially complete by the
end of 2002. We also expect to spend approximately $24 million by 2006 at the
Golden Eagle refinery to meet the "ultra low sulfur diesel" standards.
Beginning with its acquisition of this refinery in August 2000, the seller
of the refinery has implemented an ongoing program designed to enhance the
safety, reliability and overall operating performance of the refinery. For the
next several years, we intend to implement a similar multi-year program to
improve the reliability and safety at the refinery.
Crude Oil Supply. The California refinery's crude oil is sourced primarily
from California and Alaska, with the remainder composed primarily of spot
foreign crude oil cargoes. A portion of the refinery's California and Alaska
crude oil is sourced under term contracts which are primarily short-term
agreements at market-related prices.
Transportation. The refinery has waterborne access that enables it to ship
and receive crude oil through its Amorco wharf and to ship and receive refined
product via its Golden Eagle wharf. The seller of the California refinery
recently upgraded the Amorco wharf in conjunction with the restart of the No. 3
crude unit. The Amorco wharf has a depth of 40 feet and is capable of handling
vessels of up to 188,500
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dead weight tons ("DWT"). The Golden Eagle wharf has a depth of 40 feet with
mooring capacity to handle vessels up to 105,000 DWT, 810 feet length over all.
The refinery also has access to California crude oils via the Unocap,
Equilon and KLM pipelines. In addition, the refinery can receive crude oil via
the third-party Shore Terminal at Martinez and can ship refined products via the
Kinder Morgan product pipeline system.
Terminals. We operate refined product terminals at Stockton and Port
Hueneme, California. We currently distribute product at our Martinez terminal
via barge and may elect in the future to make capital expenditures to enhance
our distribution capabilities at this terminal.
PACIFIC NORTHWEST REFINERIES
Washington
Refining. The Washington refinery, located in Anacortes on the Puget
Sound, about 60 miles north of Seattle, includes fluid catalytic cracking
("FCC"), alkylation, hydrotreating, vacuum distillation and catalytic reformer
units. The FCC and other product upgrade units enable the Washington refinery to
produce about 75% to 85% of its output as gasoline (including cleaner-burning
CARB gasoline), diesel and jet fuel, depending on the mix of crude oil and other
feedstock throughput. The FCC unit also can upgrade heavy vacuum gas oils from
the Alaska and Hawaii refineries and other suppliers. In December 1999, the
Washington refinery completed the installation of a distillate treater that
increased production of low-sulfur diesel and jet fuels. A turnaround of the FCC
and alkylation units is expected to be completed during the first quarter of
2002.
We commenced a heavy oil conversion project at our Washington refinery in
2000, which will enable us 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. We expect to spend
approximately $116 million (including capitalized interest) for this project, of
which $97 million has been spent through December 31, 2001. The de-asphalting
unit, one of the major components of the heavy oil conversion project, has been
in operation since late September 2001. The upgrade of the FCC unit, the final
major component of the heavy oil conversion project, is in progress and we
expect it to be fully operational by the end of the first quarter of 2002.
Crude Oil Supply. The Washington refinery's crude oil is sourced primarily
from Alaska, Canada and Southeast Asia. We receive crude oil from Canada at the
Washington refinery through a third-party pipeline system. Other feedstock is
delivered by tanker at the Washington refinery's marine terminal at Anacortes.
We supply intermediate feedstocks, primarily heavy vacuum gas oil, from some of
our other refineries and by spot market purchases from third-party refineries.
Transportation. The Washington refinery receives crude oil from Canada
through the 24-inch, third-party Transmountain Pipeline, which originates in
Edmonton, Canada. We receive other crude oil through the Washington refinery's
marine terminal. The pipeline and the marine terminal are each capable of
providing 100% of the Washington refinery's feedstock needs. During 2001, the
Washington refinery shipped approximately 24,000 bpd of high-value products
(gasoline, jet fuel and diesel) via the third-party Olympic pipeline system,
which serves the Seattle, Washington area with 16-inch and 20-inch lines and
continues to Portland, Oregon with a 14-inch line. In February 2002, the Olympic
pipeline system increased its tariff rate by 24.3%. We have challenged the
interim tariff and, if successful, will receive a rebate for pipeline tariffs we
pay after February 1, 2002, equal to the difference between the interim rate and
the final approved rate. We also deliver gasoline through a neighboring
refinery's truck rack, and we distribute some diesel fuel through a truck rack
at our refinery. We also ship products by barge and ship. The Washington
refinery can deliver significant volumes of products through our marine terminal
to ships and barges. We ship all of the fuel oil production by water. Propane
and asphalt are shipped by both truck and rail.
Terminals. We operate refined product terminals at Port Angeles and
Vancouver, Washington and at Stockton and Port Hueneme, California. In addition,
we distribute products through third-party terminals
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and truck racks in our market areas. Terminals we operate are supplied primarily
by our refineries. Fuel distributed through third-party terminals also is
supplied by our refineries and through purchases and exchange arrangements with
other refining and marketing companies.
Alaska
Refining. The Alaska refinery is located near Kenai, Alaska, approximately
70 miles southwest of Anchorage, where it has access to Alaskan and imported
crude oil supplies. The Alaska refinery produces liquefied petroleum gas,
gasoline and gasoline blendstocks, jet fuel, diesel fuel, heating oil, liquid
asphalt, heavy oils and residual products. The refinery has a total rated crude
oil capacity of 72,000 bpd and is the second largest refinery in the state. We
completed a scheduled maintenance turnaround of all major process units at the
Alaska refinery in the second quarter of 2001, and the next turnaround is
scheduled for the second quarter of 2003.
Crude Oil Supply. The Alaska refinery runs primarily the Alaska Cook Inlet
crude oil that is produced close to the refinery. To a lesser extent, the
refinery also runs Alaska North Slope and other crude oils. We deliver crude oil
by tanker to the Alaska refinery through the Kenai Pipe Line Company marine
terminal, which is a Tesoro-owned common carrier and marine dock facility, and
to the Kenai Pipe Line Company marine terminal by pipeline connected directly
with some of the Cook Inlet producing fields.
Transportation. We own and operate a common-carrier petroleum products
pipeline, which runs from the Alaska refinery to our terminal facilities in
Anchorage and to the Anchorage airport. This ten-inch diameter pipeline has the
capacity to transport approximately 40,000 bpd of products and allows us to
transport light products to the terminal facilities throughout the year,
regardless of weather conditions. We also own and operate a common-carrier
pipeline and Kenai Pipe Line Company marine terminal, adjacent to the Alaska
refinery, for unloading crude oil feedstocks and loading product inventory on
tankers and barges.
Terminals. We operate refined product terminals at Kenai and Anchorage,
Alaska. In addition, we distribute products through third-party terminals and
truck racks in our market areas. The terminals we operate are supplied primarily
by our refineries. Fuel distributed through third-party terminals also is
supplied by our refineries and through purchases and exchange arrangements with
other refining and marketing companies.
MID-PACIFIC REFINERY
Hawaii
Refining. The Hawaii refinery, located at Kapolei in an industrial park 22
miles west of Honolulu, produces liquified petroleum gas, gasoline and gasoline
blendstocks, jet fuel, diesel fuel and fuel oil. The refinery has a total rated
crude oil capacity of 95,000 bpd and is the largest refinery in the state. Major
product upgrade units include the distillate hydrocracker, vacuum distillation
and catalytic reformer units. We completed a planned maintenance turnaround in
September 2000, and the next major turnaround is scheduled for the third quarter
of 2003.
Crude Oil Supply. The Hawaii refinery's crude oil supply is sourced
primarily from Alaska, Australia and Southeast Asia. We receive crude oil for
the Hawaii refinery through our single-point mooring terminal and pipeline
system that also can be used for receiving and loading refined products.
Transportation. Crude oil is transported to Hawaii by tankers and
discharged through our single-point mooring terminal, about 1.5 miles offshore
from the Hawaii refinery. Three underwater pipelines connect the single-point
mooring terminal to the Hawaii refinery to allow crude oil and products to be
transferred to the Hawaii refinery and to load products from the Hawaii refinery
to ships and barges. We distribute refined products to customers on the island
of Oahu through a pipeline system, which includes connections to the military at
several locations. We also distribute refined products to commercial customers
via third-party terminals at Honolulu International Airport and Honolulu Harbor
and by barge
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to Tesoro-owned and third-party terminal facilities on the islands of Maui,
Kauai and Hawaii. Our product pipelines connect the Hawaii refinery to Barbers
Point Harbor, 2.5 miles away, which is able to accommodate barges and product
tankers up to 800 feet in length and reduces traffic at the single-point mooring
terminal.
Terminals. We operate refined product terminals in Hawaii on the islands
of Hawaii, Kauai, Maui and Oahu. In addition, we distribute products through
third-party terminals and truck racks in our market areas. Terminals we operate
are supplied primarily by our refineries. Fuel distributed through third-party
terminals also is supplied by our refineries and through purchases and exchange
arrangements with other refining and marketing companies.
MID-CONTINENT REFINERIES
North Dakota
Refining. The North Dakota refinery is located near Mandan, North Dakota
on 960 acres of land. The 60,000 bpd refinery is the only one in the state and
serves both in-state needs and those of neighboring Minnesota. The refinery
produces a slate of high-value products derived primarily from local crude oil
supplies in the Williston Basin and also some Canadian crude oil, which both
reach the refinery through the Pipeline System. The North Dakota refinery
produces approximately 60% gasoline, 30% distillates and 10% other products. A
maintenance turnaround is scheduled at the North Dakota refinery in the third
quarter of 2003.
Crude Oil Supply. The North Dakota refinery's crude oil is sourced
primarily from local Williston Basin sweet crude oil. Although the current
tariff structure makes local crude oil more economic, the refinery also has
access to other sources of crude oil.
The Pipeline System consists of over 700 miles of pipeline and delivers all
of the North Dakota refinery's crude oil requirements as well as some crude oil
requirements to regional points where there is additional demand. The Pipeline
System is configured to gather crude oil from the local Williston Basin and
adjacent production areas in North Dakota and Montana and transport it to the
North Dakota refinery. The Pipeline System is a common carrier transporting
crude oil subject to regulation by various local, state and federal agencies,
including the Federal Energy Regulatory Commission. We have entered into
transition services agreements (as amended) for BP to operate the Pipeline
System on our behalf until December 15, 2002.
Transportation. Our refined product pipeline system distributes
approximately 85% of the North Dakota refinery's product. The main product
pipeline is approximately 430 miles and has a capacity of approximately 50,000
bpd. All gasoline and distillate products produced at the North Dakota refinery,
with the exception of railroad-spec diesel fuel, can be shipped on the line to
downstream terminals. An additional pipeline provides railroad-spec diesel fuel
via a five-mile, 5,000 bpd pipeline to the Burlington Northern rail yard in
Bismarck, North Dakota. We have entered into a transition services agreement (as
amended) for BP to operate the refined products pipeline on our behalf until
December 15, 2002.
Terminals. The main product pipeline of our refined product pipeline
system connects the refinery to five owned product marketing terminals located
in: (1) Mandan, at the North Dakota refinery; (2) Jamestown, North Dakota; (3)
Moorehead, Minnesota; (4) Sauk Center, Minnesota; and (5) the Minneapolis/ St.
Paul, Minnesota area. Total capacity for all five terminals is 2,830,000
barrels.
Offtake Agreements. In connection with the Mid-Continent Acquisition, we
entered into certain offtake agreements with BP for a portion of our refined
products produced at these refineries. The offtake agreements related to the
North Dakota refinery commit approximately 30,470 bpd (which represents
approximately 59% of the historical three-year average production of 51,770 bpd)
of the North Dakota refinery product for each of the first three years. In years
four and five the commitment is reduced. Volumes related to the Minneapolis/St.
Paul terminal, committed over five years, will decline after year three. BP
initially will receive approximately 68% of the committed product via the
Minneapolis/St. Paul terminal with the remainder distributed through the other
Minnesota and North Dakota terminals. These
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agreements provide a stable distribution channel for our product, while allowing
time to form relationships and seek new outlets for future product distribution.
Sales prices under the offtake agreements are based on market prices at the time
of sale.
Utah
Refining. The Utah refinery is located in Salt Lake City. The 55,000 bpd
refinery is the largest in the state of Utah and is well-positioned to supply
products to the growing Utah and Idaho marketing areas. The refinery produces a
high-value product slate from Canadian and Rocky Mountain crude oil, which it
receives via pipeline and truck from fields in Utah, Colorado, Wyoming and
Canada. The Utah refinery's primary products include gasoline, diesel fuel and
jet fuel, which are shipped via pipeline, rail car or truck to markets in Utah,
Idaho, Wyoming, Nevada, Oregon and Washington. A maintenance turnaround is
scheduled at the Utah refinery in the first quarter of 2003.
Crude Oil Supply. The Utah refinery processes a low sulfur crude oil slate
and has the flexibility to process different crude oils. As local crude oil
supplies decline, local capacity can be replaced with Canadian Light Sweet or
Syncrude. Local crude oils are delivered primarily via the Amoco "U" Pipeline.
Canadian crude oil and other domestic crudes are delivered primarily through
another pipeline system. The price of local crude oil is primarily based on the
Canadian import alternative.
Transportation. The Utah refinery's products are distributed through a
system of both owned and third-party terminals and third-party pipeline
connections primarily in Utah and Idaho, with some incremental product to
Nevada, Washington and Wyoming.
Terminals. In addition to sales at the refinery, we distribute product
through the Chevron Pipeline to the two terminals we own at Boise and Burley,
Idaho and to two terminals we lease from Northwest Terminalling Company in
Pocatello, Idaho and Pasco, Washington. Total storage capacity for the three
owned terminals, including the Salt Lake City terminal, is 2,467,000 barrels. In
addition, the two leased terminals have an aggregate allocated throughput
capacity of 10,000 bpd.
Offtake Agreements. The offtake agreements for the Utah refinery represent
approximately 6,750 bpd of refined product produced (approximately 14% of the
historical three year-average production of 48,560 bpd) for periods ranging from
two years to three years, depending on the terminal. The commitment under the
agreements has limited gasoline volumes since we acquired substantially all of
BP's retail assets in the region. A majority of the product under the agreements
will be distributed through the Salt Lake City terminal. Sales prices under the
offtake agreements are based on market prices at the time of sale.
WHOLESALE MARKETING
Our Refining segment sells refined products, including gasoline and
gasoline blendstocks, jet fuel, diesel fuel, heavy oil and residual products in
both the bulk and wholesale markets. Sources of our product sales include our
refinery system yield, products drawn from inventory balances and products
purchased from third parties. Our refined products sales in the Refining
segment, including intersegment sales to our Retail operations, consisted of the
following:
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<Table>
<Caption>
1999 2000 2001(a)
------- ---- -------
PRODUCT SALES (thousand bpd)
Gasoline and gasoline blendstocks......................... 124 135 161
Jet fuel.................................................. 76 76 81
Diesel fuel............................................... 47 54 73
Heavy oils, residual products and other................... 56 58 61
--- --- ---
Total Product Sales.................................... 303 323 376
=== === ===
</Table>
- ---------------
(a) Sales volumes for 2001 include amounts for the Mid-Continent operations
since their acquisition on September 6, 2001, averaged over 365 days. These
amounts do not include operations related to the Golden Eagle Assets.
In August 2001, we opened an office in Long Beach, California to provide
supply and marketing activities in California and the southwestern United
States. Our goal is to establish a marketing operation in California capable of
providing us and other independent marketers in California with a competitive
and secure supply of products. To further these objectives, we lease
approximately 500,000 barrels of storage capacity with waterborne access in
southern California through September 2004. We believe that our Long Beach
office and southern California storage capacity, together with the Golden Eagle
Assets, will provide us with a competitive advantage in connected markets which
should lower our operating, transportation and distribution costs and provide
market penetration with competitive prices. We consider connected markets to
include markets that are connected to our refining operations by pipelines,
trucks, railcars, vessels or other means of conveyance as well as markets that,
while not physically connected, are joined by means of exchange supply
agreements between participants in those markets.
Gasoline and Gasoline Blendstocks. We sell gasoline and gasoline
blendstocks in both the bulk and wholesale markets in the mid-continental and
western United States (including Alaska and Hawaii). The demand for gasoline is
seasonal in a majority of our markets, with lowest demand during the winter
months.
We also sell gasoline to wholesale customers and bulk end-users (including
several major oil companies) under various supply agreements. Gasoline also is
delivered to refiners and marketers in exchange for product received at other
locations in the mid-continental and western United States. We also sell, at
wholesale, to unbranded jobbers. We distribute product through Tesoro-owned and
third-party terminals and truck racks. Although our marketing strategy in Hawaii
and Alaska is to maximize in-state sales, gasoline and gasoline components
produced in excess of market demand may be shipped to the U.S. West Coast or
exported to other markets, principally in the Asia/Pacific area.
We sell CARB quality blendstocks in the wholesale bulk market, generally at
higher values than conventional gasoline. We continue to evaluate several
additional projects at our existing refineries to increase our production
capacity of CARB products. In April 2001, we entered into a nonexclusive license
agreement that allows us to make and sell gasoline subject to patents held by
Union Oil Company of California, a subsidiary of Unocal Corporation. This
agreement removes uncertainty regarding patent royalties as we expand production
and marketing of cleaner-burning gasoline.
Jet Fuel. We are a major supplier of commercial jet fuel to passenger and
cargo airlines in Alaska and Hawaii and on the U.S. West Coast. We, along with
other marketers, import jet fuel into Alaska, Hawaii and the U.S. West Coast. We
primarily market commercial jet fuel at airports in Anchorage, Honolulu and
other Hawaiian island locations, as well as at major airports throughout the
western United States.
Diesel Fuel. We sell our diesel fuel production primarily on a wholesale
basis for marine, transportation, industrial and agricultural purposes, as well
as for home heating. We sell lesser amounts to end-users through marine
terminals and for power generation in Hawaii and Washington. Generally, the
production of diesel fuel by refiners in Alaska, Hawaii and our market areas in
the western United States is typically in balance with demand. As a result of
seasonal demand swings, we import and export diesel fuel from Alaska and Hawaii.
See "Government Regulation and Legislation -- Environmental Controls
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and Expenditures" for a discussion of the effect of governmental regulations on
the production of low-sulfur diesel fuel.
Heavy Oil and Residual Products. Our Mid-Pacific and Pacific Northwest
refineries have vacuum units that use atmospheric crude oil tower bottoms as a
feedstock and further process these volumes into light vacuum gas oil, medium
vacuum gas oil, heavy vacuum gas oil and vacuum tower bottoms. Light vacuum gas
oil and medium vacuum gas oil are further processed in the Alaska and Hawaii
hydrocrackers, where they are converted into jet fuel, gasoline blendstocks and
diesel fuel. Heavy vacuum gas oil is used primarily as an FCC feedstock at the
Washington refinery where it is upgraded to gasoline and diesel fuel. The vacuum
tower bottoms are used to produce liquid asphalt, fuel oil and marine bunker
fuel. We sell heavy fuel oils to other refineries, electric power producers and
marine and industrial end-users. We sell our liquid asphalt for paving materials
in Alaska, Hawaii and Washington. In the Pacific Northwest, demand for liquid
asphalt is seasonal because mild weather conditions are needed for highway
construction.
We have marine fuel marketing operations and leased facilities at Port
Angeles and Seattle, Washington, and Portland, Oregon. Marine fuels sold from
these locations are supplied principally by our Pacific Northwest refineries.
Sales of Purchased Products. In the normal course of business, we purchase
refined products manufactured by others for resale to customers. The products,
primarily gasoline, jet fuel, diesel fuel and industrial and marine fuel
blendstocks are purchased primarily in the spot market. Sales of these products
represented approximately 21% of total volumes we sold in 2001. We conduct our
gasoline and diesel fuel purchase and resale activity primarily on the U.S. West
Coast. The jet fuel activity primarily consists of imports into Alaska and
California.
RETAIL SEGMENT
Our Retail segment sells gasoline and diesel in retail markets in the
mid-continental and western United States (including Alaska and Hawaii). The
demand for gasoline is seasonal in a majority of our markets, with highest
demand for gasoline during the summer driving season. We sell gasoline to retail
customers through Tesoro-owned and operated sites and agreements with
third-party, branded jobbers. The addition of retail stations from the
Acquisitions further expands our retail market presence and diversifies our
income stream. Following the consummation of the acquisition of the Golden Eagle
Assets, our Retail segment will include a network of over 750 branded retail
stations (under the Tesoro, Mirastar, Tesoro Alaska and other brands), including
over 280 Tesoro-owned retail gasoline stations and over 460 jobber/dealer
stations (third-party retail distributors) in the western and mid-continental
United States. These numbers include 70 retail stations to be acquired in the
pending acquisition of the Golden Eagle Assets, over 320 retail stations
acquired in the Mid-Continent Acquisition and 46 retail fueling facilities
acquired from a privately-held Seattle, Washington company in November 2001. Our
retail network provides a committed outlet for a portion of the motor fuels
produced at our refineries and provides a more profitable outlet for motor fuels
than the wholesale market. The following table summarizes our retail operations
as of and for the years ended December 31, 1999, 2000 and 2001:
<Table>
<Caption>
1999 2000 2001
------ ------ ------
NUMBER OF BRANDED RETAIL STATIONS (end of period)(a)
Tesoro (including Tesoro Alaska) --
Tesoro-owned.............................................. 62 63 138
Jobber/dealer............................................. 182 193 183
Mirastar --
Tesoro-owned.............................................. -- 20 55
Other --
Tesoro-owned.............................................. -- -- 20(b)
Jobber/dealer............................................. -- -- 281
</Table>
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<Table>
<Caption>
1999 2000 2001
------ ------ ------
Total Branded Retail Stations --
Tesoro-owned (c).......................................... 62 83 213
Jobber/dealer............................................. 182 193 464
------ ------ ------
Total................................................... 244 276 677
====== ====== ======
AVERAGE NUMBER OF BRANDED STATIONS (during year)
Tesoro-owned.............................................. 61 68 132
Jobber/dealer............................................. 177 192 274
------ ------ ------
Total Average Retail Stations........................... 238 260 406
====== ====== ======
TOTAL FUEL VOLUME (millions of gallons)
Tesoro-owned.............................................. 93.5 99.2 209.7
Jobber/dealer............................................. 105.8 115.7 186.1
------ ------ ------
Total Fuel Volumes...................................... 199.3 214.9 395.8
====== ====== ======
AVERAGE FUEL VOLUME PER MONTH PER STATION (thousands of
gallons)
Tesoro-owned.............................................. 126.7 121.5 132.8
Jobber/dealer............................................. 49.9 50.3 56.6
Average Total Stations.................................... 69.8 68.9 81.3
MERCHANDISE AND OTHER REVENUES (in millions)................ $ 51.6 $ 55.4 $ 70.6
MERCHANDISE MARGIN.......................................... 31% 32% 30%
</Table>
- ---------------
(a) Excludes 70 retail stations from the pending acquisition of the Golden Eagle
Assets.
(b) We acquired these stations in recent acquisitions and they are in the
process of being rebranded to the Tesoro brand.
(c) Tesoro-owned stations included 30 in Alaska, 35 in Hawaii, 47 in Washington,
37 in Utah, 11 in North Dakota and 53 in other western states at December
31, 2001.
We developed our Mirastar brand to be used exclusively under an agreement
with Wal-Mart whereby we build and operate retail fueling facilities on parking
lots of selected Wal-Mart store locations. Our relationship with Wal-Mart covers
17 western states. Each of the sites under our agreement with Wal-Mart is
subject to a ground lease with a ten-year primary term and two options,
exercisable at our discretion, to extend a site's lease for additional terms of
five years. As of December 31, 2001, we had 55 Mirastar stations in operation, 4
Mirastar stations under construction and 53 sites in various stages of
development or evaluation. The availability of future sites is determined solely
at Wal-Mart's option, but decisions concerning the development of a Mirastar
station at a site are determined solely by us. We expect to construct an
additional 50 to 60 stations in each of 2002 and 2003. Our average cost of
constructing a standard Mirastar station with four fuel dispensers is
approximately $550,000. The average investment in Mirastar stations will
increase in the future with the construction of stations having more than four
fuel dispensers.
Many of our Tesoro-owned stations include convenience stores with the "2-Go
Tesoro" brand that sell a wide variety of merchandise items or kiosks that sell
limited amounts of merchandise. Our revenues from merchandise sales and other
services, such as carwashes, totaled $51.6 million in 1999, $55.4 million in
2000 and $70.6 million in 2001.
The Mid-Continent Acquisition has created economic benefits for our retail
platform by providing a source of proprietary gasoline supply and additional
opportunities for our expanded retail network. In addition, in November 2001, we
acquired 46 retail fueling facilities, including 37 retail stations with
convenience stores and nine commercial card lock facilities, located in
Washington, Oregon and Idaho from a privately-held company. Our agreement with
Wal-Mart provides us with additional growth opportunities to build and operate
retail fueling facilities under the Mirastar brand on sites at selected Wal-Mart
store locations in the western United States.
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MARINE SERVICES SEGMENT
OVERVIEW
Our Marine Services segment markets and distributes a broad range of
petroleum products, chemicals and supplies and provides logistical support
services to the marine and offshore exploration and production industries
operating in the Gulf of Mexico. These operations are conducted through a
network of 15 terminals located on the Texas and Louisiana Gulf Coasts. We also
own tugboats, barges and trucks used in the Marine Services operations.
We are evaluating various strategic opportunities (including a possible
sale of all or a part of this business) to capitalize on the value of our Marine
Services assets. Our Marine Services business accounted for approximately 5% of
our operating income and historical EBITDA for the year ended December 31, 2001.
FUELS AND LUBRICANTS
Marine Services markets and distributes fuels and lubricants to offshore
drilling rigs, offshore production platforms, and various ships engaged in
seismic surveys. Marine Services also provides petroleum products to the Gulf of
Mexico fishing industry, tugboats and barges using the Intracoastal Canal System
along the Gulf of Mexico and to ships entering various ports in Texas and
Louisiana. Marine Services obtains its supply of fuel from local area refiners.
Total gallons of fuel, primarily diesel fuel, sold by this segment amounted to
approximately 171 million, 170 million and 148 million in 2001, 2000, and 1999,
respectively.
We are a distributor of major brands of marine lubricants and greases,
offering a full spectrum of brands. Total sales of lubricants amounted to
approximately two million gallons in each of the years 1999, 2000 and 2001.
LOGISTICAL SERVICES
Through many of its Gulf Coast terminals, Marine Services provides
full-service shore-based support for offshore drilling rigs and production
platforms. These services include cranes, forklifts and loading docks for supply
boats serving the offshore exploration and production industry. In addition,
Marine Services provides warehousing, office space, living quarters, helicopter
landing pads and long-term parking for offshore workers. Marine Services
terminals also serve as "one-stop shops" for a full range of offshore
exploration and production services. Products and services, such as drilling
muds, environmental services, and equipment repair and fabrication, are provided
through a variety of arrangements with "tenant partners".
COMPETITION AND OTHER
The petroleum industry is highly competitive in all phases, including the
refining of crude oil, the marketing of refined petroleum products and the
marine services business. The industry also competes with other industries that
supply the energy and fuel requirements of industrial, commercial and individual
consumers. We compete with a substantial number of major integrated oil
companies and other companies having greater financial and other resources.
These competitors have a greater ability to bear the economic risks inherent in
all phases of the industry. The recent consolidation experienced in the refining
and marketing industry has reduced the number of competitors; however, it has
not reduced overall competition. In addition, unlike many of our competitors, we
do not produce large volumes of crude oil that can then be used in connection
with our refining operations. Other larger competitors, although they do not
produce crude oil, may have a competitive advantage as larger purchasers when
negotiating with crude oil producers.
The refining and marketing industries are highly competitive, with prices
of feedstocks and products being the principal factors in competition. Our
Washington refinery competes with several refineries on the U.S. West Coast,
including refineries that have higher refining capacity than the Washington
refinery and
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that are owned by substantially larger companies. Our Hawaii refinery competes
primarily with one other refinery in Hawaii that also is located at Kapolei and
that has a rated capacity of 54,000 bpd of crude oil. Historically, the other
refinery produces lower volumes of jet fuel than our Hawaii refinery. The Alaska
refinery competes primarily with other refineries in Alaska and on the U.S. west
coast. Our refining competition in Alaska includes two refineries near Fairbanks
and one refinery near Valdez. We estimate that the other refineries have a
combined capacity to process approximately 270,000 bpd of crude oil. After
processing the crude oil and removing the higher-value products, these refiners
are permitted, because of their direct connection to the Trans Alaska Pipeline
System, to return the remainder of the processed crude oil back into the
pipeline system as "return oil" in consideration for a fee, thereby eliminating
their need to transport and market lower-value products that are not in demand
in Alaska. Our Alaska refinery is not directly connected to the Trans Alaska
Pipeline System, and we, therefore, cannot return our lower-value products to
the Trans Alaska Pipeline System. Our North Dakota refinery is the sole refinery
in North Dakota. Refineries in Wyoming, Montana, the Midwest and the United
States Gulf Coast region are the primary competitors to our North Dakota
refinery. The Utah refinery is the largest of five refineries located in Utah.
We estimate that the other refineries have a combined capacity to process
approximately 107,500 bpd of crude oil. These five refineries collectively
supply an estimated 70% of the gasoline and distillate products consumed in the
States of Utah and Idaho. The bulk of the remainder is imported from refineries
in Wyoming and Montana.
Our jet fuel sales in Alaska are concentrated in Anchorage, where we are
one of the principal suppliers to the Anchorage International Airport, a major
hub for air cargo traffic between manufacturing regions in the Far East and
markets in the United States and Europe. In Hawaii, jet fuel sales are
concentrated in Honolulu, where we are the principal supplier to the Honolulu
International Airport. We also serve four airports on other islands in Hawaii.
In Washington, jet fuel sales are concentrated at the Seattle/Tacoma
International Airport. We also supply jet fuel to customers in Portland, Oregon;
Los Angeles, San Francisco and San Diego, California; Las Vegas and Reno,
Nevada; and Phoenix, Arizona. Other refiners and marketers compete for sales at
all of these airports. In Utah, jet fuel sales are concentrated in Salt Lake
City. We also supply jet fuel to customers in Boise, Burley and Pocatello,
Idaho. The North Dakota refinery supplies jet fuel to customers in
Minneapolis/St. Paul and Moorehead, Minnesota and Bismark, North Dakota. We
produce jet fuel in Alaska and Hawaii, both of which must import product to meet
demand.
Our Refining segment sells its diesel fuel primarily on a wholesale basis,
competing with other refiners and marketers in all of its market areas. Refined
products from foreign sources also compete for distillate markets in our market
areas.
We are a distributor of gasoline in Alaska, Hawaii, Utah, Washington and
other western states through a network of Tesoro-operated retail stations and
branded and unbranded jobbers. We supply a major oil company through a product
exchange agreement, whereby gasoline in Alaska is provided in exchange for
gasoline delivered to us on the U.S. West Coast. We also supply one of these
major oil companies in Alaska and Hawaii through a gasoline sales agreement.
In connection with the Mid-Continent Acquisition, we entered into certain
offtake agreements with BP to provide us with a distribution channel for a
portion of our refined products produced at these refineries. The offtake
agreements related to the North Dakota refinery commit approximately 30,470 bpd
(which represents approximately 59% of the historical three-year average
production of 51,770 bpd) of the North Dakota refinery product for each of the
first three years. In years four and five, the commitment is reduced. Volumes
related to the Minneapolis/St. Paul terminal, committed over five years, will
decline after year three. BP initially will receive approximately 68% of the
committed product via the Minneapolis/St. Paul terminal with the remainder
distributed through the other Minnesota and North Dakota terminals. The offtake
agreements for the Utah refinery represent approximately 6,750 bpd of refined
product produced (approximately 14% of the historical three year-average
production of 48,560 bpd) for periods ranging from two years to three years,
depending on the terminal.
S-48
Competitive factors affecting the retail marketing of gasoline include
factors such as price and quality, together with station appearance, location
and brand-name identification. We compete with other petroleum companies,
distributors and other developers for new locations. We compete against
independent marketing companies and integrated oil companies when engaging in
these marketing operations.
Demand for services and products offered by Marine Services is
significantly affected by the level of oil and gas exploration, development and
production in the Gulf of Mexico. Various factors, including general economic
conditions, demand for and prices of oil and natural gas, availability of
equipment and materials, and government regulations and energy policies cause
exploration and development activity to fluctuate and directly impact the
revenues of Marine Services. We believe the principal competitive factors
affecting the Marine Services operations are location of facilities,
availability of logistical support services, experience of personnel and
dependability of service. The market for Marine Services' products and services,
particularly diesel fuel, is highly competitive and price sensitive.
GOVERNMENT REGULATION AND LEGISLATION
ENVIRONMENTAL CONTROLS AND EXPENDITURES
All of our operations, to some degree, are affected by federal, state,
regional and local laws, regulations and ordinances relating to the protection
of the environment. While we believe our facilities generally are in substantial
compliance with current requirements, over the next several years we expect our
facilities will be engaged in meeting new requirements being adopted and
promulgated by the U.S. Environmental Protection Agency and the states in which
we operate. Under the federal Clean Air Act, as amended in 1990, for example, we
will need to comply with the second phase of regulations establishing Maximum
Achievable Control Technologies for petroleum refineries ("Refinery MACT II").
These regulations, promulgated in January 2001, will require additional air
emission controls for certain processing units at several of our refineries. We
expect to spend approximately $35 million in additional capital improvements at
our refineries through 2006 to comply with the Refinery MACT II standards.
Changes in fuel manufacturing standards, including those related to
gasoline and diesel fuel sulfur concentrations, affect our operations. Starting
January 1, 2004, the sulfur content in gasoline must be reduced to meet the new
fuel manufacturing standard for gasoline. We expect to make approximately $65
million in capital improvements through 2006 and $15 million in years after 2006
to meet the new gasoline fuel standards. In December 2000, the EPA announced
additional standards for allowable sulfur concentrations in highway diesel
fuels. The "ultra low sulfur diesel" standards will, in general, become
effective on June 1, 2006. We expect to spend approximately $35 million in
capital improvements through 2006 and $30 million in years after 2006 to meet
the new diesel fuel standards.
In connection with the Mid-Continent Acquisition, we assumed the sellers'
obligations and liabilities under a consent decree among the United States, BP
Exploration and Oil Co., Amoco Oil Company and Atlantic Richfield Company. BP
entered into this consent decree for the Mid-Continent refineries for various
alleged violations. As the new owner of these refineries, we are required to
address issues including leak detection and repair, flaring protection and
sulfur recovery unit optimization. We estimate we will have to spend an
aggregate of $18 million to comply with this consent decree. In addition, we
have agreed to indemnify the sellers for all losses of any kind incurred in
connection with or related to the consent decree.
During 2001, we spent approximately $7 million on environmental capital
projects. We anticipate we will make additional capital improvements of
approximately $9 million in 2002, primarily for improvements to storage tanks,
tank farm secondary containment and pipelines.
Conditions that require additional expenditures may exist for various of
our sites, including, but not limited to, our 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
regulations. We currently cannot determine the amount of these future
expenditures.
S-49
PENDING ACQUISITION OF GOLDEN EAGLE ASSETS
In addition, the Golden Eagle Assets will require substantial expenditures
to address upcoming "clean fuels" requirements, including California regulations
to phase out the use of the oxygenate known as MTBE by the end of 2002. The
seller of the Golden Eagle Assets has begun construction of a project at the
Golden Eagle refinery that we expect will enable us to conform with CARB III
gasoline specifications scheduled to be effective on January 1, 2003. Based upon
a review by an independent engineering firm, we believe that this project will
cost a total of $122 million, a portion of which has been or will be paid by the
seller. We expect to spend approximately $103 million in 2002 and 2003 to
complete this project. Furthermore, we expect that the project will be
substantially complete by the end of 2002. We also expect to spend approximately
$24 million by 2006 at the Golden Eagle refinery to meet the "ultra low sulfur
diesel" standards.
The Golden Eagle Assets are also subject to extensive environmental
requirements. We anticipate that capital expenditures addressing environmental
issues at the refinery such as controls on emission of nitrogen oxides and
piping upgrades required to be made pursuant to orders from California's
Regional Water Quality Control Board with jurisdiction over the refinery, and
requirements as a result of a pending settlement of a lawsuit by a citizens'
group concerning coke dust emissions from the refinery's Pittsburg Dock loading
facility, will total approximately $32 million during 2002. Although some
portion of these costs are being and will continue to be incurred by the seller
of the Golden Eagle Assets prior to the closing of the transaction, a
substantial portion of the work will remain after the closing, the costs of
which we will incur. In addition, we estimate that we will incur $96 million in
environmental capital expenditures at the refinery for similar projects from
2003 through 2006 and $90 million beyond 2006.
In addition, soil and groundwater conditions at the Golden Eagle refinery
(including the Amorco terminal and the coke terminal) may entail substantial
expenditures over time. Although existing information is limited, our
preliminary estimate of costs to address soil and groundwater conditions at the
refinery in connection with various projects, including those required pursuant
to orders by the California Regional Water Quality Control Board, is
approximately $66 million, of which approximately $43 million is anticipated to
be incurred through 2006 and the balance afterwards. We believe we will be
entitled to indemnification, directly or indirectly, from former owners or
operators of the refinery (or their successors) under two separate
indemnification agreements, for approximately $59 million of such costs. We
cannot assure you that any indemnification will be realized.
Additionally, soil and groundwater conditions at approximately 50 of the 70
retail stations to be acquired through the pending acquisition of the Golden
Eagle Assets may require expenditures of approximately $6 million in the
aggregate, pursuant to orders and regulations set by the California Regional
Water Quality Control Board. We also expect to spend approximately $3 million in
the aggregate on capital improvements to meet new California vapor control
equipment requirements at each of the retail facilities.
OIL SPILL PREVENTION AND RESPONSE
The Federal Oil Pollution Act of 1990 and related state regulations include
requirements that most oil refining, transport and storage companies maintain
and update various oil spill prevention and oil spill contingency plans. We have
submitted these plans and received federal and state approvals necessary to
comply with the Federal Oil Pollution Act of 1990 and related regulations. Our
oil spill prevention plans and procedures are frequently reviewed and modified
to prevent oil releases and to minimize potential impacts should a release
occur.
We currently charter, on a long-term and short-term basis, tankers and
barges for shipment of crude oil from foreign and domestic sources to our
Mid-Pacific and Pacific Northwest refineries. The Federal Oil Pollution Act of
1990 requires, as a condition of operation, that we demonstrate the capability
to respond to the "worst case discharge" to the maximum extent practicable. As
an example, the State of Alaska requires us to provide spill-response capability
to contain or control and cleanup an amount equal to 50,000 barrels of crude oil
for a tanker carrying fewer than 500,000 barrels or 300,000 barrels for a tanker
carrying
S-50
more than 500,000 barrels. To meet these requirements, we have entered into
contracts with various parties to provide spill response services. We have
entered into spill-response agreements with: (1) Cook Inlet Spill Prevention and
Response, Incorporated and Alyeska Pipeline Service Company for spill-response
services in Alaska; (2) Clean Islands Council for response services throughout
the State of Hawaii; and (3) Clean Sound Incorporated for response actions
associated with the Puget Sound, Washington operations. In addition, for larger
spill contingency capabilities, we have entered into contracts with Marine Spill
Response Corporation in Hawaii and in the Gulf Coast region. We believe these
contracts, and those with other regional spill-response organizations that are
in place on a location by location basis, provide the additional services
necessary to meet spill-response requirements established by state and federal
law.
REGULATION OF THE PIPELINE SYSTEM
The Pipeline System and the refined product pipeline systems in Alaska,
North Dakota and Minnesota are common carriers subject to regulation by various
local, state and federal agencies including the Federal Energy Regulatory
Commission ("FERC") under the Interstate Commerce Act. The Interstate Commerce
Act provides that, to be lawful, the rates of common carrier petroleum pipelines
must be "just and reasonable" and not unduly discriminatory. New and changed
rates must be filed with the FERC, which may investigate their lawfulness upon
protest or on its own initiative. The FERC may suspend the effectiveness of the
new rates for up to seven months. If the suspension expires before completion of
the investigation, the rates go into effect, but the pipeline can be required to
refund to shippers, with interest, any difference between the level the FERC
determines to be lawful and the filed rates under investigation. Rates that have
become final and effective may be challenged by complaint to the FERC filed by a
shipper or on the FERC's own initiative. The party filing the complaint may
recover reparations for the two-year period prior to the complaint, if the FERC
finds the rate to be unlawful.
The intrastate operations of the Pipeline System are subject to regulation
by the North Dakota Public Services Commission. The intrastate operations of our
Alaska products pipeline are subject to regulation by the Alaska Public
Utilities Commission. Like the FERC, the state regulatory authorities require
that shippers be notified of proposed intrastate tariff increases and have an
opportunity to protest the increases. The North Dakota Public Services
Commission also files with the state authorities copies of interstate tariff
changes filed with the FERC. In addition to challenges to new or proposed rates,
challenges to intrastate rates that have already become effective are permitted
by complaint of an interested person or by independent action of the appropriate
regulatory authority.
EMPLOYEES
At December 31, 2001, we had approximately 3,290 employees. Approximately
220 employees and 270 employees at the Washington and Mid-Continent refineries,
respectively, are covered by collective bargaining agreements which ran until
January 31, 2002. In November 2001, eligible employees at our Mid-Pacific
refinery voted to be represented by a collective bargaining representative.
Although the collective bargaining agreements expired on January 31, 2002, we
have entered into an agreement with our employees represented by these
agreements that we will adopt the "Industry Pattern Agreement" approved by the
union, a major oil company (Exxon/Mobil, BP/Amoco, Shell or Chevron/Texaco) and
accepted by any two additional companies (Phillips/Tosco, Conoco or CITGO). Our
employees have agreed not to engage in a strike, work stoppage or slowdown, or
any other intentional interference of work production for any reason. However,
with respect to our Hawaii operations, the agreement not to strike or engage in
a work stoppage expires on July 1, 2002. We consider our relations with our
employees to be satisfactory.
S-51
DESCRIPTION OF COMMON STOCK
Our Certificate of Incorporation, as amended, currently authorizes us to
issue up to 100,000,000 shares of common stock, $0.16 2/3 par value. The holders
of our common stock are entitled to one vote for each share held of record on
all matters submitted to a vote of stockholders. Subject to preferences that may
be applicable to any outstanding preferred stock, holders of our common stock
are entitled to receive ratably such dividends as may be declared by our board
of directors out of funds legally available therefor. In the event of our
liquidation, dissolution, or winding up, holders of our common stock are
entitled to share ratably in all assets remaining after payment of liabilities
and liquidation preference of any outstanding preferred stock. Holders of our
common stock have no preemptive rights and have no rights to convert their
common stock into any other securities. There are no redemption provisions with
respect to any shares of our common stock. All of the outstanding shares of our
common stock are, and the common stock offered hereby will be, upon issuance
against full payment of the purchase price therefor, fully paid and
nonassessable. As of February 1, 2002 there were issued and outstanding
41,445,297 shares of our common stock.
The transfer agent and registrar for our common stock is ChaseMellon
Shareholder Services L.L.C.
UNDERWRITING
Under the terms of an underwriting agreement, which will be filed with the
SEC, each of the underwriters named below has agreed to purchase from us the
respective number of shares of common stock opposite its name below:
<Table>
<Caption>
NUMBER OF
UNDERWRITER SHARES
- ----------- ----------
Lehman Brothers Inc.........................................
Goldman, Sachs & Co.........................................
Friedman, Billings, Ramsey & Co., Inc.......................
----------
Total.................................................. 20,000,000
==========
</Table>
The underwriting agreement provides that the underwriters are obligated to
purchase, subject to certain conditions, all of the shares of common stock in
the offering if any are purchased, other than those covered by the
over-allotment option described below. The conditions contained in the
underwriting agreement include the requirements that:
- the representations and warranties we made to the underwriters are true,
- there is no material change in the financial markets, and
- we deliver to the underwriters customary closing documents.
If an underwriter defaults, the underwriting agreement provides that the
purchase commitment of the non-defaulting underwriters may be increased or the
agreement may be terminated.
We have granted to the underwriters a 30-day option after the date of this
prospectus to purchase, in whole or in part, up to an aggregate of an additional
3,000,000 shares at the public offering price less underwriting discounts and
commissions. This option may be exercised to cover over-allotments, if any, made
in connection with the offering. To the extent that the option is exercised,
each underwriter will be obligated, subject to certain conditions, to purchase
its pro rata portion of these additional shares based on the underwriter's
percentage underwriting commitment in the offering as indicated on the preceding
table. The foregoing limitations do not apply to stabilizing transactions,
syndicate covering transactions and penalty bids for the purpose of pegging,
fixing or maintaining the price of the common stock, in accordance with
Regulation M under the Exchange Act.
The underwriters have advised us that they propose to offer shares of
common stock directly to the public at the offering price on the cover of this
prospectus supplement and to selected dealers, who may
S-52
include the underwriters, at such offering price less a selling concession not
in excess of $ per share. The underwriters may allow, and the selected
dealers may re-allow, a discount from the concession not in excess of
$ per share to other dealers. After the offering, the underwriters may
change the public offering price and other offering terms.
The following table summarizes the underwriting discounts and commissions
we will pay to the underwriters. These amounts are shown assuming both no
exercise and full exercise of the underwriters' over-allotment option to
purchase up to 3,000,000 additional shares. The underwriting fee is the
difference between the initial price to the public and the amount the
underwriters pay us for the shares.
<Table>
<Caption>
NO EXERCISE FULL EXERCISE
----------- -------------
Per share underwriting discounts and commissions to
be paid by us............................................. $ $
Total.................................................. $ $
</Table>
We estimate that the expenses of this offering, excluding underwriting
discounts and commissions summarized in the table above, will be
$ .
The underwriters may engage in over-allotment, stabilizing transactions,
syndicate covering transactions and penalty bids or purchases for the purpose of
pegging, fixing or maintaining the price of the common stock, in accordance with
Regulation M of the Exchange Act.
- Over-allotment involves sales by the underwriters of shares in excess of
the number of shares the underwriters are obligated to purchase, which
creates a syndicate short position. The short position may be either a
covered short position or a naked short position. In a covered short
position, the number of shares over-allotted by the underwriters is not
greater than the number of shares that they may purchase in the
over-allotted options. In a naked short position, the number of shares
involved is greater than the number of shares in the over-allotment
options. The underwriters may close out any short position by either
exercising their over-allotment options and/or purchasing shares in the
open market.
- Stabilizing transactions permit bids to purchase the underlying security
so long as the stabilizing bids do not exceed a specified maximum.
- Syndicate covering transactions involve purchases of the common stock in
the open market after the distribution has been completed in order to
cover syndicate short positions. In determining the source of shares to
close out the short position, the underwriters will consider, among other
things, the price at which they may purchase shares through the
over-allotment option. If the underwriters sell more shares than could be
covered by the over-allotment option, which is called a naked short
position, the position can only be closed out by buying shares in the
open market. A naked short position is more likely to be created if the
underwriters are concerned that there could be downward pressure on the
price of the shares in the open market after pricing that could adversely
affect investors who purchase in the offering.
- Penalty bids permit the representatives to reclaim a selling concession
from a syndicate member when the common stock originally sold by the
syndicate member is purchased in a stabilizing or syndicate covering
transaction to cover syndicate short positions.
These stabilizing transactions, syndicate covering transactions and penalty
bids may have the effect of raising or maintaining the market price of our
common stock or preventing or retarding a decline in the market price of our
common stock. As a result, the price of the common stock may be higher than the
price that might otherwise exist in the open market. These transactions may be
effected on the NYSE or otherwise and, if commenced, may be discontinued at any
time.
Neither we nor any of the underwriters make any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the common stock. In addition, neither
we nor any of the underwriters make a representation that the underwriters will
engage
S-53
in these stabilizing transactions or that any transaction, once commenced, will
not be discontinued without notice.
In connection with the offering, we and our executive officers and
directors have agreed that we and they will not, subject to certain limited
exceptions, directly or indirectly, offer, sell, pledge or otherwise dispose of
any shares of common stock or any securities convertible into or exchangeable or
exercisable for common stock or enter into any swap or other derivative
transaction with similar effect as a sale of common stock, for a period of 30
days from the date of this prospectus without the prior written consent of
Lehman Brothers Inc. The restrictions in this paragraph do not apply to:
- the sale of common stock to the underwriters in this offering, including
shares sold pursuant to the over-allotment option,
- the sale or transfer of shares of common stock to us by our directors or
executive officers in connection with the exercise of a currently
outstanding option, warrant or right,
- our issuance of options under any of our currently effective employee
benefit plans, stock option or incentive plans or of shares of common
stock upon the exercise of a currently outstanding option, warrant or
right or the conversion of a security outstanding on the date of this
prospectus,
- our issuance of common stock in a private equity transaction in
connection with the pending acquisition of the Golden Eagle Assets, or
- our issuance of common stock as consideration for the purchase of any
business or assets.
We have agreed to indemnify, under certain circumstances, the underwriters
against liabilities relating to the offering, including liabilities under the
Securities Act of 1933, as amended, and liabilities arising from breaches of the
representations and warranties contained in the underwriting agreement, and to
contribute, under certain circumstances, to payments that the underwriters may
be required to make for these liabilities.
This prospectus supplement and the accompanying prospectus are not, and
under no circumstances are to be construed as, an advertisement or a public
offering of shares in Canada or any province or territory thereof. Any offer or
sale of shares in Canada will be made only under an exemption from the
requirements to file a prospectus supplement or prospectus and an exemption form
the dealer registration requirement in the relevant province or territory of
Canada in which such offer or sale is made.
Purchasers of the shares of common stock may be required to pay stamp taxes
and other charges under the laws and practices of the country of purchase, in
addition to the offering price on the cover of this prospectus supplement.
A prospectus in electronic format may be made available on the Internet
sites or through other online services maintained by one or more of the
underwriters and/or selling group members participating in this offering, or by
their affiliates. In those cases, prospective investors may view offering terms
online, and, depending upon the particular underwriter or selling group member,
prospective investors may be allowed to place orders online. The underwriters
may agree with us to allocate a specific number of shares for sale to online
brokerage account holders. Any such allocation for online distributions will be
made by the underwriters on the same basis as other allocations.
Other than the prospectus in electronic format, the information on any
underwriter's or selling group member's web site and any information contained
in any other web site maintained by an underwriter or selling group member is
not part of this prospectus or the registration statement, has not been approved
and/or endorsed by us or any underwriter or selling group member in its capacity
as underwriter or selling group member and should not be relied upon by
investors.
From time to time, Lehman Brothers Inc. has provided, and may continue to
provide, investment banking or commercial banking services to us for which we
have paid the customary fees and commissions. Lehman Brothers Inc. was among the
initial purchasers of our 9 5/8% Senior Subordinated Notes due 2008 offered in
November 2001. Lehman Commercial Paper Inc., an affiliate of Lehman
S-54
Brothers Inc., is a lender under our senior secured credit facility and
therefore may receive proceeds from the repayment of a portion of our senior
secured credit facility which may be repaid with proceeds from this offering.
Lehman Brothers also acted as our financial advisor in connection with the
pending acquisition of the Golden Eagle Assets. This offering is being conducted
pursuant to NASD Conduct Rule 2710(c)(8).
LEGAL MATTERS
The validity of the common shares will be passed upon for us by Fulbright &
Jaworski L.L.P., Houston, Texas. Certain legal matters with respect to the
common shares will be passed upon for the underwriters by Simpson Thacher &
Bartlett, New York, New York.
S-55
INDEX TO FINANCIAL STATEMENTS
<Table>
<Caption>
PAGE
----
AUDITED FINANCIAL STATEMENTS OF GOLDEN EAGLE REFINING AND
MARKETING ASSETS BUSINESS
Report of Independent Public Accountants.................... F-2
Balance Sheets -- December 31, 2001 and 2000................ F-3
Statements of Income -- Year Ended December 31, 2001 and
Four Months Ended December 31, 2000....................... F-4
Statements of Cash Flows -- Year Ended December 31, 2001 and
Four Months Ended December 31, 2000....................... F-5
Statements of Changes in Net Parent Investment -- Four
Months Ended December 31, 2000 and Year Ended December 31,
2001...................................................... F-6
Notes to Combined Financial Statements...................... F-7
CONSOLIDATED FINANCIAL STATEMENTS OF TESORO PETROLEUM
CORPORATION
Independent Auditors' Report................................ F-22
Statements of Consolidated Operations -- Years Ended
December 31, 2001, 2000 and 1999.......................... F-23
Consolidated Balance Sheets -- December 31, 2001 and 2000... F-24
Statements of Consolidated Stockholders' Equity -- Years
Ended December 31, 2001, 2000 and 1999.................... F-25
Statements of Consolidated Cash Flows -- Years Ended
December 31, 2001, 2000 and 1999.......................... F-26
Notes to Consolidated Financial Statements.................. F-27
</Table>
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
Valero Energy Corporation:
We have audited the accompanying balance sheets of the Golden Eagle
Refining and Marketing Assets Business as of December 31, 2001 and 2000, and the
related statements of income, cash flows and changes in net parent investment
for the year ended December 31, 2001 and the four months ended December 31, 2000
(included herein on pages F-3 through F-21). These financial statements are the
responsibility of Valero Energy Corporation's management. Our responsibility is
to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Golden Eagle Refining
and Marketing Assets Business as of December 31, 2001 and 2000, and the results
of its operations and its cash flows for the year ended December 31, 2001 and
the four months ended December 31, 2000 in conformity with accounting principles
generally accepted in the United States.
/s/ ARTHUR ANDERSEN LLP
San Antonio, Texas
February 14, 2002, except Note 16
to the financial statements for which
the date is February 20, 2002
F-2
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
BALANCE SHEETS
(IN THOUSANDS)
<Table>
<Caption>
DECEMBER 31,
---------------------
2001 2000
---------- --------
ASSETS
CURRENT ASSETS:
Cash...................................................... $ 189 $ 171
Receivable from Tosco Corporation......................... -- 3,014
Inventories............................................... 162,982 169,436
Current deferred income tax asset......................... 2,804 --
Other current assets, net................................. 4,870 5,313
---------- --------
TOTAL CURRENT ASSETS................................... 170,845 177,934
---------- --------
Property, plant and equipment............................... 830,727 712,963
Less accumulated depreciation and amortization.............. (58,575) (21,531)
---------- --------
Property, plant and equipment, net........................ 772,152 691,432
Other assets, net........................................... 258,008 35,742
---------- --------
TOTAL ASSETS........................................... $1,201,005 $905,108
========== ========
LIABILITIES AND NET PARENT INVESTMENT
CURRENT LIABILITIES:
Accounts payable and accrued liabilities.................. $ 90,212 $ 96,482
Taxes other than income taxes............................. 20,405 20,057
Current deferred income tax liabilities................... -- 13,680
Lease termination obligation.............................. 36,088 --
---------- --------
TOTAL CURRENT LIABILITIES.............................. 146,705 130,219
Deferred income tax liabilities............................. 85,872 27,492
Employee benefit obligations................................ 29,930 24,501
Other long-term liabilities................................. 3,954 2,297
---------- --------
TOTAL LIABILITIES...................................... 266,461 184,509
Net parent investment....................................... 934,544 720,599
---------- --------
TOTAL LIABILITIES AND NET PARENT INVESTMENT............ $1,201,005 $905,108
========== ========
</Table>
See accompanying notes to the financial statements.
F-3
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
STATEMENTS OF INCOME
(IN THOUSANDS)
<Table>
<Caption>
YEAR ENDED FOUR MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2001 2000
------------ -----------------
SALES AND OTHER REVENUES.................................... $2,020,596 $841,761
---------- --------
COSTS AND EXPENSES:
Cost of products sold..................................... 1,281,347 612,759
Write-down of inventories to market value................. 55,930 --
Operating expenses........................................ 309,673 91,825
General and administrative expenses....................... 15,378 5,794
Taxes other than income taxes............................. 167,447 45,261
Depreciation and amortization............................. 43,969 12,229
(Gain) loss on sale of property, plant and equipment...... (247) 184
---------- --------
TOTAL COSTS AND EXPENSES............................... 1,873,497 768,052
---------- --------
INCOME BEFORE INCOME TAX EXPENSE............................ 147,099 73,709
Income tax expense........................................ 60,097 30,121
---------- --------
NET INCOME.................................................. $ 87,002 $ 43,588
========== ========
</Table>
See accompanying notes to the financial statements.
F-4
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<Table>
<Caption>
YEAR ENDED FOUR MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2001 2000
------------ -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................................. $ 87,002 $ 43,588
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................. 43,969 12,229
(Gain) loss on sale of property, plant and equipment...... (247) 184
Deferred income taxes..................................... 41,896 24,336
Write-down of inventories to market value................. 55,930 --
Changes in operating assets and liabilities:
Decrease (increase) in receivables..................... 4,825 (3,014)
Increase in inventories................................ (21,785) (6,307)
Decrease (increase) in other current assets............ 443 (3,727)
(Decrease) increase in accounts payable and accrued
liabilities.......................................... (17,559) 93,539
Increase in taxes other than income taxes.............. 348 4,248
Increase in employee benefit obligations.................. 5,429 1,792
(Decrease) increase in other long-term liabilities........ (143) 548
--------- ---------
NET CASH PROVIDED BY OPERATING ACTIVITIES............ 200,108 167,416
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures........................................ (120,693) (21,509)
Earn-out payment, net of working capital settlement, in
connection with the Golden Eagle Refinery acquisition..... (148,219) (905)
Catalyst costs.............................................. (1,362) --
Deferred refinery turnaround costs.......................... (56,519) --
Advances to employees under notes receivable................ (501) (2,842)
Repayments of employee notes receivable..................... 14 --
Proceeds from sale of assets................................ 247 --
--------- ---------
NET CASH USED IN INVESTING ACTIVITIES................ (327,033) (25,256)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net cash advances from (repayments to) parent............... 126,943 (142,141)
--------- ---------
NET CASH PROVIDED BY (USED IN) FINANCING
ACTIVITIES........................................ 126,943 (142,141)
--------- ---------
NET INCREASE IN CASH........................................ 18 19
CASH AT BEGINNING OF PERIOD................................. 171 152
--------- ---------
CASH AT END OF PERIOD....................................... $ 189 $ 171
========= =========
NON-CASH ACTIVITIES:
Increase in receivable from Tosco Corporation............... $ (1,811) $ --
Increase in inventories..................................... (27,691) --
Decrease in property, plant and equipment................... 4,000 4,001
Increase in accounts payable and accrued liabilities........ 47,377 --
Increase in other long-term liabilities..................... 1,800 --
Decrease in employee benefit obligations.................... -- (80)
Increase in goodwill........................................ (23,675) (3,921)
</Table>
See accompanying notes to the financial statements.
F-5
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
STATEMENTS OF CHANGES IN NET PARENT INVESTMENT
(IN THOUSANDS)
<Table>
BALANCE AS OF AUGUST 31, 2000 (UNAUDITED)................... $ 819,152
Net income................................................ 43,588
Net cash repayments to parent............................. (142,141)
---------
BALANCE AS OF DECEMBER 31, 2000............................. 720,599
Net income................................................ 87,002
Net cash advances from parent............................. 126,943
---------
BALANCE AS OF DECEMBER 31, 2001............................. $ 934,544
=========
</Table>
See accompanying notes to the financial statements.
F-6
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2001 AND 2000
NOTE 1: BUSINESS DESCRIPTION
During the period covered by these financial statements, Ultramar Diamond
Shamrock Corporation (UDS), an independent refining and marketing company, owned
and operated 7 refineries and marketed its products through over 4,500
company-operated and dealer-operated convenience stores. Ultramar Inc.
(Ultramar), a subsidiary of UDS, owned and operated two refineries (the Golden
Eagle refinery and the Wilmington refinery) and marketed its products through
over 200 company-operated and dealer-operated convenience stores.
In conjunction with Valero Energy Corporation's (Valero) acquisition of UDS
on December 31, 2001, the U.S. Federal Trade Commission (FTC) approved a consent
decree requiring divestiture of certain UDS assets. Pursuant to the consent
decree, the assets to be divested were required to be put into a trust, with the
future operations of those assets controlled by an independent trustee selected
by the FTC. These assets and their related operations are referred to as the
Golden Eagle Refining and Marketing Assets Business (the Business) and include:
- the 168,000-barrel per day Golden Eagle Refinery located in the San
Francisco Bay area and all tangible assets used in the operation of the
refinery including docks, tanks and pipelines;
- the wholesale marketing business, which includes primarily sales to
unbranded customers located in the northern half of California, Fresno
and north, and Reno, Nevada; and
- 70 Beacon- and Ultramar-branded convenience stores located in Northern
California, including land, buildings, pump equipment, underground
storage tanks and various store equipment.
The Golden Eagle Refinery, which UDS acquired on August 31, 2000, is
located on 2,300 acres in Contra Costa County, California near San Francisco.
The refinery relies primarily on a blend of California and foreign crude oil to
produce conventional gasolines and diesel and California Air Resource Board
(CARB) specification reformulated gasoline and diesel. In addition to the main
refinery processing units, the refinery complex includes three wharves, water
treatment systems, pipelines, and a chemical production facility. The refinery
has approximately 140 tanks with combined capacity of 7,700,000 barrels for
crude oil and other feedstocks and refined products.
The 70 convenience stores sell various grades of gasoline and diesel, and
merchandise products such as cigarettes, beverages, groceries, and health and
beauty aids.
Under the terms of the consent decree, the Business was assigned 6 term
sales contracts (wholesale customers) and 9 refined product exchange contracts.
The exchange contracts provide for the delivery of refined products to
unaffiliated companies at third party terminals in exchange for delivery of a
similar quantity of refined products to the Business by these unaffiliated
companies at specified locations. In addition, Ultramar has the option to
purchase refined products from the Business at market prices to supply branded
convenience stores located in Northern California, which are being retained by
Ultramar.
NOTE 2: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: These audited financial statements have been
prepared in accordance with United States generally accepted accounting
principles. The financial statements represent a carve-out financial statement
presentation of the operations of the Business and reflect UDS' historical cost
basis as of and for the year ended December 31, 2001 and as of and for the four
months ended December 31, 2000. These financial statements do not include any
adjustments that might result from a sale of the Business.
The financial statements include allocations and estimates of direct and
indirect UDS general and administrative costs attributable to the operations of
the Business. In addition, it was assumed that the majority of refined product
sales from the refinery were made to the wholesale marketing business and the
wholesale
F-7
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
marketing business then sold those refined products to third parties, to UDS'
branded jobbers and to the 70 convenience stores being sold. The sales between
the refinery and the wholesale marketing business and between the wholesale
marketing business and the 70 convenience stores being sold have been eliminated
in these financial statements. Management believes that the assumptions,
estimates and allocations used to prepare these financial statements are
reasonable. However, the allocations may not necessarily be indicative of the
costs and expenses that would have resulted if the Business had been operated as
a separate entity.
The Business' results of operations may be affected by seasonal factors,
such as the demand for petroleum products, which vary during the year, or
industry factors that may be specific to a particular period, such as industry
supply capacity and refinery turnarounds.
Use of Estimates: The preparation of financial statements in accordance
with United States generally accepted accounting principles requires management
to make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ from
those estimates. On an ongoing basis, management reviews their estimates based
on currently available information. Changes in facts and circumstances may
result in revised estimates.
Inventories: Crude oil and refined product inventories are valued at the
lower of cost or market (net realizable value). Cost is determined primarily on
the last-in, first-out (LIFO) basis. Materials, supplies and convenience store
merchandise are valued at average cost, but not in excess of market value.
Property, Plant and Equipment: Additions to property, plant and equipment,
including capitalized interest, are recorded at cost. Depreciation is provided
principally using the straight-line method over the estimated useful lives of
the related assets. Leasehold improvements are amortized using the straight-line
method over the shorter of the lease term or the estimated useful life of the
related asset.
Goodwill: The excess of UDS' purchase price over the fair value of net
assets of the Golden Eagle refinery (goodwill) was amortized using the
straight-line method over 20 years. For a discussion of goodwill, see the
discussion of FASB Statement No. 142 below.
Impairment: Long-lived assets, including goodwill, are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. The evaluation of recoverability is
performed using undiscounted estimated net cash flows generated by the related
assets. The amount of impairment is determined as the amount by which the net
carrying value exceeds discounted estimated net cash flows.
Refinery Turnaround Costs: Refinery turnaround costs are deferred when
incurred and amortized over the period of time estimated to lapse until the next
turnaround occurs which is typically three to four years. These costs include,
among other things, the cost to repair, restore, refurbish or replace refinery
equipment such as vessels, tanks, reactors, piping, valves, fittings, rotating
equipment, instrumentation, electrical equipment, heat exchangers, and fired
heaters.
Environmental Remediation Costs: Environmental remediation costs are
expensed and the related accrual established when site restoration and
environmental remediation and cleanup obligations are either known or considered
probable and can be reasonably estimated. Accrued liabilities are not discounted
to present value and are not reduced by possible recoveries from third parties.
Environmental costs include initial site surveys, costs for remediation and
restoration, including direct internal costs, and ongoing monitoring costs, as
well as fines, damages and other costs, when estimable. Adjustments to initial
estimates are recorded, from time to time, to reflect changing circumstances and
estimates based upon additional information developed in subsequent periods. See
Note 12 regarding environmental liabilities retained by Tosco Corporation, which
has been subsequently acquired by Phillips Petroleum Company.
F-8
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Net Parent Investment: The net parent investment represents a net balance
as the result of various transactions between the Business and UDS. The balance
is the result of the Business' participation in UDS' central cash management
program under which all of the Business' cash receipts were remitted to and all
cash disbursements were funded by UDS. Other transactions affecting the net
parent investment include intercompany sales to UDS and administrative and
support expenses incurred by UDS that were allocated to the Business. There are
no terms of settlement or interest charges associated with the net parent
investment balance.
Revenue Recognition: Sales and other revenues are recognized when the
related goods are shipped and all significant obligations have been satisfied.
Shipping and Handling Fees and Costs: Shipping and handling fees and costs
are classified in cost of products sold. Such fees and costs relate to the
transportation (via ship, train, truck or pipeline) of crude oil and other
feedstocks to the refinery and refined products from the refinery to wholesale
markets and company-operated and dealer-operated convenience stores.
Excise Taxes: Federal excise and state motor fuel taxes collected on the
sale of products and remitted to governmental agencies are included in sales and
other revenues and in taxes other than income taxes. For the year ended December
31, 2001 and the four months ended December 31, 2000, excise taxes were
$156,803,000 and $42,247,000, respectively.
Income Taxes: Income taxes are accounted for under the asset and liability
method. Under this method, deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred amounts are measured using enacted tax
rates expected to apply to taxable income in the year those temporary
differences are expected to be recovered or settled.
Historically, the Business' results have been included in the consolidated
federal and state income tax returns filed by UDS. The income tax provisions in
the statements of income represent the current and deferred income taxes that
would have resulted if the Business were a stand-alone taxable entity filing its
own income tax returns. Accordingly, the calculations of income tax provisions
and deferred taxes necessarily require certain assumptions, allocations and
estimates which management believes are reasonable to reflect the tax reporting
for the Business as a stand-alone taxpayer.
Comprehensive Income: The Business has reported no comprehensive income
due to the absence of items of other comprehensive income in all periods
presented.
Derivative Instruments and Hedging Activities: Effective January 1, 2001,
the Business adopted Financial Accounting Standards Board (FASB) Statement No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended.
This statement established accounting and reporting standards for derivative
instruments and for hedging activities. It requires that all derivative
instruments be recognized as either assets or liabilities in the balance sheet
and be measured at their fair value. The statement requires that changes in the
derivative instrument's fair value be recognized currently in earnings unless
specific hedge accounting criteria are met.
The adoption of Statement No. 133, as amended, could increase volatility in
the Business' net income and other comprehensive income based on the level of
derivative instruments utilized and the extent of hedging activities, which are
subject to change from time to time based on management's decision as to the
appropriate strategies and overall risk exposure levels. There was no impact of
adopting Statement No. 133, as amended, on January 1, 2001 as no derivative
assets or liabilities were held.
The Business enters into contracts that provide for the purchase of crude
oil and other feedstocks and for the sale of refined products. Certain of these
contracts meet the definition of a derivative instrument in
F-9
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
accordance with Statement No. 133, as amended. The Business believes that these
contracts qualify for the normal purchases and normal sales exception under
Statement No. 133, as amended, because they will be delivered in quantities
expected to be used or sold over a reasonable period of time in the normal
course of business. Accordingly, these contracts are designated as normal
purchases and normal sales contracts and are not required to be recorded as
derivative instruments under Statement No. 133, as amended.
In addition, the Business uses commodity futures contracts to procure a
large portion of its crude oil requirements and to hedge its exposure to crude
oil, refined product and natural gas price volatility. Under Statement No. 133,
as amended, these commodity futures contracts are not designated as hedging
instruments and therefore are marked to market each period. The Business uses
commodity price swaps to manage its exposure to price volatility related to
forecasted purchases of crude oil, other feedstocks and natural gas and sales of
refined products. Under Statement No. 133, as amended, commodity price swaps are
not designated as hedges and are therefore adjusted to market each period.
NEW ACCOUNTING PRONOUNCEMENTS
FASB Statement No. 141
In June 2001, the FASB issued Statement No. 141, "Business Combinations."
Statement No. 141 addresses financial accounting and reporting for business
combinations and supersedes APB Opinion No. 16, "Business Combinations," and
Statement No. 38, "Accounting for Preacquisition Contingencies of Purchased
Enterprises." All business combinations within the scope of Statement No. 141
are to be accounted for using the purchase method. The provisions of Statement
No. 141 apply to all business combinations initiated after June 30, 2001 and to
all business combinations accounted for using the purchase method for which the
date of acquisition is July 1, 2001 or later. The Business has not entered into
a business combination subsequent to July 1, 2001.
FASB Statement No. 142
Also in June 2001, the FASB issued Statement No. 142, "Goodwill and Other
Intangible Assets." Statement No. 142 addresses financial accounting and
reporting for acquired goodwill and other intangible assets and supersedes APB
Opinion No. 17, "Intangible Assets." Statement No. 142 addresses how intangible
assets that are acquired individually or with a group of other assets (but not
those acquired in a business combination) should be accounted for in financial
statements upon their acquisition. This statement also addresses how goodwill
and other intangible assets should be accounted for after they have been
initially recognized in the financial statements. The provisions of Statement
No. 142 are required to be applied starting with fiscal years beginning after
December 15, 2001. This statement is required to be applied at the beginning of
an entity's fiscal year and to be applied to all goodwill and other intangible
assets recognized in its financial statements at that date. The statement
provides that goodwill and other intangible assets that have indefinite useful
lives will not be amortized but instead will be tested at least annually for
impairment. Intangible assets that have finite useful lives will continue to be
amortized over their useful lives, but such lives will not be limited to 40
years. Goodwill amortization for the year ended December 31, 2001 and the four
months ended December 31, 2000 was $5,348,000 and $558,000, respectively.
Impairment losses that arise due to the initial application of Statement No. 142
are to be reported as resulting from a change in accounting principle. As a
result of this statement, management believes that future reported net income
may be more volatile because impairment losses related to goodwill are likely to
occur irregularly and in varying amounts.
FASB Statement No. 143
In June 2001, the FASB also issued Statement No. 143, "Accounting for Asset
Retirement Obligations." This statement establishes standards for accounting for
an obligation associated with the retirement of a
F-10
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
tangible long-lived asset. An asset retirement obligation should be recognized
in the financial statements in the period in which it meets the definition of a
liability as defined in FASB Concepts Statement No. 6, "Elements of Financial
Statements." The amount of the liability would initially be measured at fair
value. Subsequent to initial measurement, an entity would recognize changes in
the amount of the liability resulting from (a) the passage of time and (b)
revisions to either the timing or amount of estimated cash flows. Statement No.
143 also establishes standards for accounting for the cost associated with an
asset retirement obligation. It requires that, upon initial recognition of a
liability for an asset retirement obligation, an entity capitalize that cost by
recognizing an increase in the carrying amount of the related long-lived asset.
The capitalized asset retirement cost would then be allocated to expense using a
systematic and rational method. Statement No. 143 will be effective for
financial statements issued for fiscal years beginning after June 15, 2002, with
earlier application encouraged. The Business is currently evaluating the impact
of adopting this new statement.
FASB Statement No. 144
In August 2001, the FASB issued Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." Statement No. 144 addresses
financial accounting and reporting for the impairment of long-lived assets and
for long-lived assets to be disposed of. This statement supersedes FASB
Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of," but retains Statement No. 121's
fundamental provisions for recognition and measurement of impairment of
long-lived assets to be held and used and measurement of long-lived assets to be
disposed of by sale. This statement also supersedes APB Opinion No. 30,
"Reporting the Results of Operations -- Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," for the disposal of a segment of a business. Statement
No. 144 does not apply to goodwill or other intangible assets, the accounting
and reporting of which is addressed in newly issued Statement No. 142, "Goodwill
and Other Intangible Assets." The provisions of Statement No. 144 are effective
for financial statements for fiscal years beginning after December 15, 2001, and
interim periods within those fiscal years, with early application encouraged.
The Business is currently evaluating the impact of adopting this new statement.
NOTE 3: ACQUISITION OF THE GOLDEN EAGLE REFINERY BY UDS
On August 31, 2000, Ultramar acquired Tosco Corporation's 168,000 barrel
per day Avon Refinery (renamed the Golden Eagle Refinery) located in the San
Francisco bay area of California. The initial purchase price of $806,812,000
included the crude oil, other feedstock and refined product inventories and the
assumption of certain liabilities. The purchase was funded by UDS through a
combination of proceeds from a bridge loan, sales of accounts receivable under
an existing securitization facility and borrowings under a commercial paper
program. The terms of the purchase and sale agreement also provided for
additional consideration of up to $150,000,000 over an eight-year period if
average annual West Coast refinery margins exceeded historical averages.
The acquisition was accounted for using the purchase method. The purchase
price was allocated based on the estimated fair values of the individual assets
and liabilities at the date of acquisition. During the subsequent year,
September 1, 2000 through August 31, 2001, it was determined that the estimated
fair values of inventories, accrued liabilities, other long-term liabilities and
the lease termination obligation were understated and property, plant and
equipment was overstated. In addition, West Coast refinery margins exceeded
historical averages resulting in the full $150,000,000 of contingent
consideration becoming due to Tosco Corporation. In accordance with the purchase
and sale agreement, the $150,000,000 was paid to Tosco
F-11
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Corporation in November 2001. The following table summarizes the revisions to
the initial allocation of purchase price.
<Table>
<Caption>
ALLOCATION ALLOCATION ALLOCATION
AUGUST 31, DECEMBER 31, AUGUST 31,
2001 2000 2000
---------- ------------ ----------
(IN THOUSANDS)
Inventories and other current assets............... $179,794 $150,292 $150,292
Property, plant and equipment...................... 641,999 645,999 650,000
Goodwill........................................... 205,351 33,458 28,632
Accrued liabilities................................ (11,289) -- --
Employee benefit liabilities....................... (22,032) (22,032) (22,112)
Lease termination obligation....................... (36,088) -- --
Other long-term liabilities........................ (1,800) -- --
-------- -------- --------
Total purchase price..................... $955,935 $807,717 $806,812
======== ======== ========
</Table>
NOTE 4: INVENTORIES
Inventories consisted of the following:
<Table>
<Caption>
DECEMBER 31,
-------------------
2001 2000
-------- --------
(IN THOUSANDS)
Crude oil and other feedstocks.............................. $ 67,855 $ 75,992
Refined products and other finished products and convenience
store items............................................... 85,434 75,681
Materials and supplies...................................... 8,283 --
Refined products due under exchange contracts............... 1,410 17,763
-------- --------
Total inventories................................. $162,982 $169,436
======== ========
</Table>
As of December 31, 2001, the Business recorded a $55,930,000 non-cash
reduction in the carrying value of crude oil and refined product inventories to
reduce such inventories to market value which was lower than LIFO cost.
NOTE 5: OTHER CURRENT ASSETS
Other current assets consisted of the following:
<Table>
<Caption>
DECEMBER 31,
---------------
2001 2000
------ ------
(IN THOUSANDS)
Prepaid expenses (primarily ad valorem taxes)............... $3,644 $5,313
Derivative asset, net of $923 deemed uncollectible.......... 1,226 --
------ ------
Other current assets, net......................... $4,870 $5,313
====== ======
</Table>
F-12
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6: PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consisted of the following:
<Table>
<Caption>
DECEMBER 31,
ESTIMATED -------------------
USEFUL LIVES 2001 2000
------------- -------- --------
(IN THOUSANDS)
Refining facilities.............................. 15 - 30 years $711,408 $645,999
Retail facilities................................ 5 - 30 years 48,053 46,201
Construction in progress......................... 71,266 20,763
-------- --------
Total.................................. 830,727 712,963
Accumulated depreciation and amortization........ (58,575) (21,531)
-------- --------
Property, plant and equipment, net............. $772,152 $691,432
======== ========
</Table>
NOTE 7: OTHER ASSETS
Other assets consisted of the following:
<Table>
<Caption>
DECEMBER 31,
------------------
2001 2000
-------- -------
(IN THOUSANDS)
Goodwill, net of accumulated amortization of $5,906 in 2001
and $558 in 2000.......................................... $199,446 $32,900
Refinery turnaround costs, net of accumulated amortization
of $1,286 in 2001......................................... 55,233 --
Employee notes receivable................................... 3,329 2,842
-------- -------
Other assets, net......................................... $258,008 $35,742
======== =======
</Table>
NOTE 8: INCOME TAXES
The amounts presented below relate only to the Business and were calculated
as if the Business filed separate federal and state income tax returns.
F-13
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The provision for income taxes consisted of the following:
<Table>
<Caption>
YEAR ENDED FOUR MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2001 2000
------------ -----------------
(IN THOUSANDS)
Current:
Federal.............................................. $12,474 $ 4,333
State................................................ 5,727 1,452
------- -------
Total current................................ 18,201 5,785
------- -------
Deferred:
Federal.............................................. 37,144 21,032
State................................................ 4,752 3,304
------- -------
Total deferred............................... 41,896 24,336
------- -------
Provision for income taxes............................. $60,097 $30,121
======= =======
</Table>
Deferred income taxes arise from temporary differences between the tax
bases of assets and liabilities and their reported amounts in the Business'
financial statements. The components of the Business' net deferred income tax
liabilities consisted of the following:
<Table>
<Caption>
DECEMBER 31,
-----------------
2001 2000
------- -------
(IN THOUSANDS)
Deferred income tax assets:
LIFO inventory............................................ $ 1,020 $ --
Goodwill.................................................. -- 191
Accrued liabilities....................................... 1,783 537
Other long-term liabilities............................... 1,167 1,404
Net operating loss carryforwards.......................... -- 795
Alternative minimum tax credit............................ 6,536 4,332
------- -------
Total deferred income tax assets.................. 10,506 7,259
------- -------
Deferred income tax liabilities:
LIFO inventory............................................ -- 14,217
Property, plant and equipment............................. 60,851 24,945
Refinery turnaround costs................................. 31,795 9,269
Goodwill.................................................. 928 --
------- -------
Total deferred income tax liabilities............. 93,574 48,431
------- -------
Net deferred income tax liabilities............... $83,068 $41,172
======= =======
</Table>
F-14
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The differences between the Business' effective income tax rate and the
U.S. federal statutory rate is reconciled as follows:
<Table>
<Caption>
YEAR ENDED FOUR MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2001 2000
------------ -----------------
U. S. federal statutory rate........................... 35.0% 35.0%
State income taxes (net of federal tax benefit)........ 5.8 5.8
Other.................................................. 0.1 0.1
---- ----
Effective income tax rate............................ 40.9% 40.9%
==== ====
</Table>
NOTE 9: RELATED-PARTY TRANSACTIONS
Transactions between the Business and UDS included sales of refined
products from the Business to UDS and the allocation of salary and employee
benefit costs, insurance costs, and administrative fees from UDS to the
Business.
The Business participated in UDS' centralized cash management program under
which cash receipts and cash disbursements were processed through UDS' cash
accounts with a corresponding credit or charge to an intercompany account. This
intercompany account is included in the net parent investment balance.
During the year ended December 31, 2001 and the four months ended December
31, 2000, UDS provided the Business with certain general and administrative
services, including the centralized corporate functions of legal, accounting,
treasury, engineering, information technology, human resources and other
corporate services. Charges for these services were allocated based on various
factors, including investments in property, personnel headcount, and refinery
capacity. Management believes that the amount of general and administrative
expenses allocated to the Business is a reasonable approximation of the costs
related to the Golden Eagle Refinery and northern California retail operations.
For purposes of these financial statements, payables and receivables related to
transactions between the Business and UDS are included as a component of the net
parent investment.
The following table summarizes transactions with UDS:
<Table>
<Caption>
YEAR ENDED FOUR MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2001 2000
------------ -----------------
(IN THOUSANDS)
Sales and other revenues............................... $42,738 $ --
Operating expenses..................................... 77,046 23,750
General and administrative expenses.................... 15,378 5,794
</Table>
NOTE 10: EMPLOYEE BENEFIT PLANS
Employees who work in the Business are included in the various employee
benefit plans of UDS. These plans include qualified, non-contributory defined
benefit retirement plans, defined contribution 401(k) plans, employee and
retiree medical, dental and life insurance plans, long-term incentive plans
(i.e., stock options and bonuses) and other such benefits. For the purposes of
these carve-out financial statements, the Business is considered to be
participating in multi-employer benefit plans of UDS.
The Business' allocated share of UDS employee benefit plan expenses were
$16,996,000 and $4,908,000 for the year ended December 31, 2001 and the four
months ended December 31, 2000, respectively. These employee benefit plan
expenses are included in operating expenses with the related payroll costs.
F-15
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
In connection with the acquisition of the Golden Eagle Refinery on August
31, 2000, UDS assumed $22,032,000 related to employee pension and other
post-retirement benefit obligations. The amount accrued by the Business for
pension and other post-retirement benefit obligations as of December 31, 2001
and 2000 is reflected in the employee benefit obligations in the related balance
sheets. The weighted-average assumptions used in computing the actuarial present
value of such benefit obligations were as follows:
<Table>
<Caption>
YEAR ENDED FOUR MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2001 2000
-------------- -----------------
Discount rate........................................ 7.00% 7.75%
Expected long-term rate of return on plan assets..... 8.75% 9.50%
Rate of compensation increases....................... 5.00% 4.50%
Health care cost trend rate.......................... 10.00% 7.70%
decreasing to decreasing to
ultimate trend ultimate trend
rate of 5.50% rate of 5.60%
in 2006 in 2006
</Table>
NOTE 11: CONTINGENCIES AND COMMITMENTS
Leases and Contracts
The Business leases a wide variety of facilities and equipment under
operating leases, including the MTBE facility discussed below, office equipment
and transportation equipment. Rent expense approximated $10,970,000 (including
$5,720,000 for the MTBE facility lease) and $2,822,000 for the year ended
December 31, 2001 and the four months ended December 31, 2000, respectively.
Future minimum rental payments applicable to non-cancelable operating
leases as of December 31, 2001, excluding the MTBE facility lease payments
subsequent to 2002, are as follows (in thousands):
<Table>
2002........................................................ $ 6,789
2003........................................................ 812
2004........................................................ 612
2005........................................................ 529
2006........................................................ 474
Thereafter.................................................. 3,532
-------
Future minimum lease payments............................. $12,748
=======
</Table>
UDS previously entered into a long-term operating lease arrangement, which
expires in July 2003, with Jamestown Funding, L.P. for several of its
convenience stores. Included in the Jamestown lease arrangement is one of the
Business' retail convenience stores. After the non-cancelable lease term, the
Jamestown lease may be extended by agreement of the parties, or the Business may
purchase or arrange for the sale of the convenience store. The amount necessary
to purchase the convenience store as of December 31, 2001 would have been
$1,578,000.
In conjunction with the acquisition of the Golden Eagle Refinery, UDS
assumed a long-term contract for the supply of hydrogen, which expires in 2009.
The hydrogen contract has take-or-pay provisions requiring a monthly payment
totaling approximately $1,000,000, which is adjusted periodically based on
certain market indices. Also in conjunction with the acquisition of the Golden
Eagle Refinery, UDS assumed an operating lease for the MTBE facility located at
the refinery, which expires in 2010. At the time of the acquisition,
F-16
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
governmental regulations required that the use of MTBE blended gasolines be
phased out by 2004. The Golden Eagle Refinery is completing various capital
projects, which will allow it to phase out MTBE effective December 31, 2002.
Accordingly, a lease termination obligation for the MTBE facility lease of
$36,088,000 was accrued as part of the allocation of the purchase price.
San Francisco Baykeeper's Citizen Suit
On February 16, 2001, an environmental group named San Francisco Baykeeper
(Baykeeper) filed a complaint against Ultramar alleging violations of the Clean
Water Act, the California Water Code, and a storm water pollution prevention
plan pertaining to a petroleum coke loading terminal in Pittsburg, California
owned by Ultramar. In January 2002, Ultramar and Baykeeper entered into a
settlement agreement that is presently awaiting court approval. The settlement
will require Ultramar to reimburse Baykeeper's legal costs, evaluate the use of
the coke terminal and either discontinue its use of the terminal or implement
best available technology. The owner of the terminal will have up to four years
to implement this settlement agreement. Pursuant to the pending sale and
purchase agreement related to the Business between Ultramar and Tesoro Refining
and Marketing Company (Tesoro) dated as of February 4, 2002, as amended (Sale
and Purchase Agreement), which is discussed in Note 16: Sale and Purchase
Agreement with Tesoro below, Tesoro will assume the obligations for
implementation of this settlement agreement.
Communities For A Better Environment
On March 31, 2001, two environmental groups, Communities for a Better
Environment and San Francisco Baykeeper (collectively Plaintiffs), filed a
lawsuit challenging certain orders by the California State Water Resources
Control Board and the San Francisco Regional Water Quality Control Board
(collectively the Boards) that grant the Golden Eagle Refinery a water discharge
permit, also known as a National Pollutant Discharge Elimination System (NPDES)
permit. The lawsuit was brought in the form of a petition for writ of mandamus
against the Boards. Ultramar is named as the real party in interest.
The NPDES permit sets an interim limit and proposals for establishing a
final limit on certain discharges from the refinery. The interim limit could
extend until 2010. The Plaintiffs make three claims, namely that (a) the permit
lacks any "Water Quality Based Effluent Limitation," in violation of the Clean
Water Act, because the interim limit is performance-based, not water quality
based, (b) the new permit violates the Clean Water Act's anti-backsliding
requirement, because the interim limit is less stringent than the facility's
prior NPDES permit, and (c) the schedule for interim and final limits violates
legal limitations in the Clean Water Act and state law, in part because the
period for interim limitations is allegedly too long.
If the Plaintiffs prevail, then the refinery's ultimate permit limits could
be reduced to the prior limits, to an alternative final limit, or to some other
stringent limit. If the refinery is required to meet one of these more stringent
limits, the Business could incur significant capital expenditures to comply with
that limit. Pursuant to the pending Sale and Purchase Agreement with Tesoro,
Tesoro will assume the defense and obligations associated with this litigation.
General
There are various other legal proceedings and claims pending against the
Business which arise in the ordinary course of business. It is management's
opinion, based upon advice of counsel, that these matters, individually or in
the aggregate, will not have a material adverse effect on the results of
operations or financial position of the Business.
F-17
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 12: ENVIRONMENTAL MATTERS
The operations of the Business are subject to environmental laws and
regulations adopted by various federal, state and local governmental authorities
in the jurisdictions in which it operates. Although management believes its
operations are in general compliance with applicable environmental regulations,
risks of additional costs and liabilities are inherent in petroleum refining and
retail marketing operations, and there can be no assurance that significant
costs and liabilities will not be incurred. Moreover, it is possible that other
developments, such as increasingly stringent environmental laws and regulations
and enforcement policies thereunder, and claims for damages to property or
persons resulting from the operations, could result in substantial costs and
liabilities. Accordingly, the Business has adopted policies, practices and
procedures in the areas of pollution control, product safety, occupational
health and the production, handling, storage, use and disposal of hazardous
materials to prevent material environmental or other damage, and to limit the
financial liability which could result from those events. However, some risk of
environmental or other damage is inherent in the Business, as it is with other
companies engaged in similar businesses.
In conjunction with the acquisition of the Golden Eagle Refinery from Tosco
Corporation on August 31, 2000, Tosco Corporation agreed to indemnify UDS for up
to $50,000,000 of environmental liabilities that are discovered subsequent to
the acquisition. Excluded from this indemnification are liabilities that result
from a change in environmental law after August 31, 2000.
The balances of and changes in accruals for environmental matters, which
are primarily related to retail operations and are principally included in other
long-term liabilities, consisted of the following:
<Table>
<Caption>
YEAR ENDED FOUR MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2001 2000
------------ -----------------
(IN THOUSANDS)
Balance at beginning of period......................... $3,446 $2,898
Additions to accrual................................. 223 548
Payments............................................. (806) --
------ ------
Balance at end of period............................... $2,863 $3,446
====== ======
</Table>
The accruals noted above represent the Business' best estimate of the costs
which will be incurred over an extended period for restoration and environmental
remediation at various sites. However, environmental exposures are difficult to
assess and estimate due to unknown factors such as the magnitude of possible
contamination, the timing and extent of remediation, the determination of the
Business' liability in proportion to other parties, improvements in cleanup
technologies and the extent to which environmental laws and regulations may
change in the future. The liabilities reflected above have not been reduced by
possible recoveries from third parties and projected cash expenditures have not
been discounted.
NOTE 13: BUSINESS SEGMENTS
The Business has two reportable segments, refining and retail. The refining
segment includes the Golden Eagle Refinery, and related wholesale marketing
operations. The retail segment includes the operations of the 70
company-operated convenience stores in Northern California. Operations that are
not included in the two reportable segments are included in the Corporate
category and consist primarily of general and administrative expenditures. The
Business' operations are located in the State of California.
The reportable segments are strategic business units that offer different
products and services. They have been historically managed separately as each
business requires different technology and marketing strategies. The accounting
policies for the segments are the same as those described in the summary of
significant
F-18
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
accounting policies. The Business evaluates performance based on earnings before
interest, taxes and depreciation and amortization (EBITDA). The calculation of
EBITDA is not based on United States generally accepted accounting principles
and should not be considered as an alternative to net income or cash flows from
operating activities (which are determined in accordance with US GAAP). This
measure may not be comparable to similarly titled measures used by other
entities as other entities may not calculate EBITDA in the same manner as the
Business. Intersegment sales are generally derived from transactions made at
prevailing market rates. Total expenditures include capital expenditures,
acquisition costs, catalysts, and deferred refinery turnaround costs.
<Table>
<Caption>
REFINING RETAIL CORPORATE TOTAL
---------- -------- --------- ----------
(IN THOUSANDS)
YEAR ENDED DECEMBER 31, 2001:
Sales and other revenues from external
customers.......................... $1,730,154 $290,442 $ -- $2,020,596
Intersegment sales.................... 152,482 -- -- 152,482
EBITDA................................ 190,237 16,209 (15,378) 191,068
Depreciation and amortization......... 41,855 2,114 -- 43,969
Operating income (loss)............... 148,382 14,095 (15,378) 147,099
Total assets.......................... 1,160,257 40,748 -- 1,201,005
Total expenditures.................... 326,732 61 -- 326,793
FOUR MONTHS ENDED DECEMBER 31, 2000:
Sales and other revenues from external
customers.......................... 737,312 104,449 -- 841,761
Intersegment sales.................... 60,994 -- -- 60,994
EBITDA................................ 88,266 3,466 (5,794) 85,938
Depreciation and amortization......... 11,575 654 -- 12,229
Operating income (loss)............... 76,691 2,812 (5,794) 73,709
Total assets.......................... 864,673 40,435 -- 905,108
Total expenditures.................... 20,964 1,450 -- 22,414
</Table>
Sales and other revenues from external customers for the Business'
principal products were as follows:
<Table>
<Caption>
YEAR ENDED FOUR MONTHS ENDED
DECEMBER 31, DECEMBER 31,
2001 2000
------------ ------------------
(IN THOUSANDS)
REFINING:
Gasoline and blendstocks............................. $1,171,950 $491,623
Distillates (diesel and jet fuel).................... 463,940 211,788
Other................................................ 94,264 33,901
RETAIL:
Fuel sales (gasoline and diesel)..................... 242,989 89,848
Merchandise sales.................................... 47,453 14,601
---------- --------
Total sales and other revenues from external
customers....................................... $2,020,596 $841,761
========== ========
</Table>
F-19
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 14: FINANCIAL INSTRUMENTS
Financial instruments consisted of the following:
<Table>
<Caption>
DECEMBER 31,
---------------
2001 2000
------ ------
(IN THOUSANDS)
Cash........................................................ $ 189 $ 171
Employee notes receivable................................... 3,329 2,842
Commodity price swap contracts:
Derivative assets, net.................................... 1,226 --
Derivative liabilities.................................... 2,967 --
</Table>
As of December 31, 2001, the carrying value of the commodity price swaps
approximated fair value and the Business had no commodity futures contracts
outstanding. As of December 31, 2000, the Business had no commodity price swaps
or futures contracts outstanding.
The Business is subject to the market risk associated with changes in the
market price of the crude oil and refined products underlying the derivative
instruments; however, the effect of these changes in values is generally
mitigated by changes in the sales price of the Business' refined products.
NOTE 15: SUBSEQUENT EVENT
Union Oil Company of California Litigation
On January 22, 2002, Union Oil Company of California (Unocal) filed a
patent infringement lawsuit against Valero in California federal court. The
complaint seeks a 5.75 cent per gallon royalty on all reformulated gasoline
infringing on Unocal's '393 and '126 patents. These patents cover certain
compositions of cleaner-burning gasoline. The complaint seeks treble damages for
Valero's alleged willful infringement of Unocal's patents. In a previous
lawsuit, Unocal prevailed against five other major refiners involving its '393
patent.
In August 2001, the FTC announced that it was commencing an antitrust
investigation concerning Unocal's conduct with a joint industry research group
while Unocal was prosecuting its patents at the U.S. Patent and Trademark Office
(PTO). An injunction against Unocal's enforcement of its patents is a potential
outcome of the FTC investigation. In 2001, the PTO commenced a reexamination of
Unocal's '393 patent, and in January 2002, the PTO issued a nonfinal rejection
of all claims of the '393 patent. Unocal has the opportunity to respond. In
January 2002, the PTO reversed an earlier denial and commenced reexamination of
Unocal's '126 patent. Both reexaminations could affect the scope and validity of
the patents.
Notwithstanding the judgment against the other refiners in the previous
litigation, management believes that it has several strong defenses to Unocal's
lawsuit, including those arising from Unocal's misconduct, and management
believes it will prevail in the lawsuit. However, an adverse result could have a
materially adverse effect on the results of operations and financial position of
the Business. Pursuant to the terms of the pending Sale and Purchase Agreement
with Tesoro, Ultramar and its predecessors will retain liability for any
infringement of Unocal's patents at the Golden Eagle Refinery prior to its sale
to Tesoro.
NOTE 16: SALE AND PURCHASE AGREEMENT WITH TESORO
In February 2002, Ultramar entered into the Sale and Purchase Agreement (as
amended February 20, 2002) dated February 4, 2002, with Tesoro whereby Tesoro
will acquire the Golden Eagle Refinery and associated wholesale marketing
operation in Northern California and the network of 70 convenience stores
located in the northern half of California. The total purchase price of
$1,125,000,000 also includes an
F-20
GOLDEN EAGLE REFINING AND MARKETING ASSETS BUSINESS
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
estimated amount for crude oil and refined product inventories and the
assumption of various employee benefit and lease obligations, but excludes
certain liabilities of the Business, including accounts payable, certain accrued
liabilities, and income tax obligations.
F-21
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Tesoro Petroleum Corporation
We have audited the accompanying consolidated balance sheets of Tesoro
Petroleum Corporation and subsidiaries (the "Company") as of December 31, 2001
and 2000, and the related statements of consolidated operations, stockholders'
equity and cash flows for each of the three years in the period ended December
31, 2001. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Tesoro Petroleum Corporation
and subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001 in conformity with accounting principles generally accepted in
the United States of America.
/s/ DELOITTE & TOUCHE LLP
San Antonio, Texas
January 29, 2002
(February 20, 2002 as to Note Q, Subsequent Event)
F-22
TESORO PETROLEUM CORPORATION
STATEMENTS OF CONSOLIDATED OPERATIONS
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
------------------------------
2001 2000 1999
-------- -------- --------
REVENUES.................................................... $5,217.8 $5,104.4 $3,000.3
COSTS AND EXPENSES:
Costs of sales and operating expenses..................... 4,857.5 4,820.3 2,794.8
Selling, general and administrative expenses.............. 104.2 85.2 75.0
Depreciation and amortization............................. 57.4 45.5 42.9
-------- -------- --------
OPERATING INCOME............................................ 198.7 153.4 87.6
Interest and financing costs, net of capitalized interest... (52.8) (32.7) (37.6)
Interest income............................................. 1.0 2.8 1.2
-------- -------- --------
EARNINGS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES..... 146.9 123.5 51.2
Income tax provision........................................ 58.9 50.2 19.0
-------- -------- --------
EARNINGS FROM CONTINUING OPERATIONS, NET.................... 88.0 73.3 32.2
Earnings from discontinued operations, net of income
taxes..................................................... -- -- 42.8
-------- -------- --------
NET EARNINGS................................................ 88.0 73.3 75.0
Preferred dividend requirements............................. 6.0 12.0 12.0
-------- -------- --------
NET EARNINGS APPLICABLE TO COMMON STOCK..................... $ 82.0 $ 61.3 $ 63.0
======== ======== ========
EARNINGS PER SHARE FROM CONTINUING OPERATIONS
Basic..................................................... $ 2.26 $ 1.96 $ 0.62
======== ======== ========
Diluted................................................... $ 2.10 $ 1.75 $ 0.62
======== ======== ========
NET EARNINGS PER SHARE
Basic..................................................... $ 2.26 $ 1.96 $ 1.94
======== ======== ========
Diluted................................................... $ 2.10 $ 1.75 $ 1.92
======== ======== ========
WEIGHTED AVERAGE COMMON SHARES
Basic..................................................... 36.2 31.2 32.4
======== ======== ========
Diluted................................................... 41.9 41.8 32.8
======== ======== ========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
F-23
TESORO PETROLEUM CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
DECEMBER 31,
-------------------
2001 2000
-------- --------
ASSETS
CURRENT ASSETS
Cash and cash equivalents................................. $ 51.9 $ 14.1
Receivables, less allowance for doubtful accounts......... 384.9 334.5
Inventories............................................... 431.8 274.3
Prepayments and other..................................... 9.4 7.3
-------- --------
Total Current Assets................................. 878.0 630.2
-------- --------
PROPERTY, PLANT AND EQUIPMENT
Refining.................................................. 1,522.0 850.9
Retail.................................................... 228.8 140.7
Marine Services........................................... 54.0 50.3
Corporate................................................. 47.9 24.6
-------- --------
1,852.7 1,066.5
Less accumulated depreciation and amortization............ 330.4 285.1
-------- --------
Net Property, Plant and Equipment...................... 1,522.3 781.4
-------- --------
OTHER ASSETS................................................ 262.0 132.0
-------- --------
Total Assets...................................... $2,662.3 $1,543.6
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable.......................................... $ 331.2 $ 281.6
Accrued liabilities....................................... 172.9 97.0
Current maturities of debt and other obligations.......... 34.4 3.8
-------- --------
Total Current Liabilities............................ 538.5 382.4
-------- --------
DEFERRED INCOME TAXES....................................... 136.9 107.2
-------- --------
OTHER LIABILITIES........................................... 117.4 77.3
-------- --------
DEBT AND OTHER OBLIGATIONS.................................. 1,112.5 306.8
-------- --------
COMMITMENTS AND CONTINGENCIES (Note O)
STOCKHOLDERS' EQUITY
Preferred stock, no par value; authorized 5,000,000
shares: 7.25% Mandatorily Convertible Preferred Stock,
103,500 shares issued and outstanding in 2000.......... -- 165.0
Common stock, par value $0.16 2/3; authorized 100,000,000
shares; 43,371,825 shares issued (32,739,592 in
2000).................................................. 7.2 5.4
Additional paid-in capital................................ 448.4 280.0
Retained earnings......................................... 321.9 239.9
Treasury stock, 1,958,147 common shares (1,920,281 in
2000), at cost......................................... (20.5) (20.4)
-------- --------
Total Stockholders' Equity........................... 757.0 669.9
-------- --------
Total Liabilities and Stockholders' Equity........ $2,662.3 $1,543.6
======== ========
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
F-24
TESORO PETROLEUM CORPORATION
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
(IN MILLIONS)
<Table>
<Caption>
PREFERRED STOCK COMMON STOCK ADDITIONAL TREASURY STOCK
---------------- --------------- PAID-IN RETAINED ---------------
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS SHARES AMOUNT
------ ------- ------ ------ ---------- -------- ------ ------
AT JANUARY 1, 1999.................. 0.1 $ 165.0 32.6 $5.4 $278.6 $115.6 (0.3) $ (5.4)
Net earnings...................... -- -- -- -- -- 75.0 -- --
Preferred dividend requirements... -- -- -- -- -- (12.0) -- --
Other, primarily related to stock
options........................ -- -- 0.1 -- 0.4 -- -- 0.5
---- ------- ---- ---- ------ ------ ---- ------
AT DECEMBER 31, 1999................ 0.1 165.0 32.7 5.4 279.0 178.6 (0.3) (4.9)
Net earnings...................... -- -- -- -- -- 73.3 -- --
Preferred dividend requirements... -- -- -- -- -- (12.0) -- --
Shares repurchased and shares
issued for stock options....... -- -- 0.1 -- 1.0 -- (1.6) (15.5)
---- ------- ---- ---- ------ ------ ---- ------
AT DECEMBER 31, 2000................ 0.1 165.0 32.8 5.4 280.0 239.9 (1.9) (20.4)
Net earnings...................... -- -- -- -- -- 88.0 -- --
Preferred dividend requirements... -- -- -- -- -- (6.0) -- --
Preferred stock conversion........ (0.1) (165.0) 10.3 1.7 163.3 -- -- --
Shares repurchased and shares
issued for stock options and
benefit plans.................. -- -- 0.3 0.1 5.1 -- (0.1) (0.1)
---- ------- ---- ---- ------ ------ ---- ------
AT DECEMBER 31, 2001................ -- $ -- 43.4 $7.2 $448.4 $321.9 (2.0) $(20.5)
==== ======= ==== ==== ====== ====== ==== ======
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
F-25
TESORO PETROLEUM CORPORATION
STATEMENTS OF CONSOLIDATED CASH FLOWS
(IN MILLIONS)
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
---------------------------
2001 2000 1999
------- ------- -------
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Continuing operations:
Earnings from continuing operations.................... $ 88.0 $ 73.3 $ 32.2
Adjustments to reconcile earnings from continuing
operations to net cash from operating activities:
Depreciation and amortization........................ 57.4 45.5 42.9
Amortization of refinery turnarounds and other
non-cash charges.................................. 33.8 22.0 8.2
Deferred income taxes................................ 35.5 21.4 12.7
Changes in operating assets and liabilities:
Receivables....................................... (54.8) (58.0) (132.9)
Inventories....................................... (29.1) (92.1) 25.5
Other assets...................................... (15.4) (14.0) 1.0
Accounts payable and accrued liabilities.......... 87.4 82.1 89.5
Other liabilities and obligations................. 11.6 10.2 5.6
------- ------- -------
Total from continuing operations.................. 214.4 90.4 84.7
Discontinued operations................................... -- -- 28.0
------- ------- -------
Net cash from operating activities................ 214.4 90.4 112.7
------- ------- -------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Capital expenditures:
Continuing operations.................................. (209.5) (94.0) (84.7)
Discontinued operations................................ -- -- (56.5)
Acquisitions of refining and retail operations............ (783.4) -- --
Proceeds from asset sales................................. 20.7 2.4 309.4
Other..................................................... (4.5) 3.6 (1.9)
------- ------- -------
Net cash from (used in) investing activities...... (976.7) (88.0) 166.3
------- ------- -------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Borrowings under term loans and other..................... 625.0 -- 50.0
Proceeds from debt offering, net of issuance costs........ 209.9 -- --
Refinancing and repayments of debt and other
obligations............................................ (1.1) (105.9) (123.4)
Repayments under revolving credit and interim facilities,
net.................................................... -- -- (61.2)
Payment of dividends on Preferred Stock................... (9.0) (9.0) (15.0)
Repurchases of Common Stock............................... (3.5) (15.5) --
Financing costs and other................................. (21.2) 0.3 0.4
------- ------- -------
Net cash from (used in) financing activities...... 800.1 (130.1) (149.2)
------- ------- -------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............ 37.8 (127.7) 129.8
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 14.1 141.8 12.0
------- ------- -------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 51.9 $ 14.1 $ 141.8
======= ======= =======
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid, net of capitalized interest................ $ 40.2 $ 17.9 $ 58.0
======= ======= =======
Income taxes paid......................................... $ 47.0 $ 22.6 $ 34.4
======= ======= =======
</Table>
The accompanying notes are an integral part of these consolidated financial
statements.
F-26
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Description and Nature of Business
Tesoro Petroleum Corporation ("Tesoro" or the "Company") was incorporated
in Delaware in 1968 and is an independent refiner and marketer of petroleum
products and provider of marine logistics services. Tesoro owns and operates
five petroleum refineries in the western and mid-continental United States with
a combined rated crude oil capacity of 390,000 barrels per day and sells refined
products to a wide variety of customers in the western and mid-continental
United States and other countries on the Pacific Rim. Tesoro markets products to
wholesale and retail customers, as well as commercial end-users. Tesoro's retail
business includes a network of 677 branded retail stations. The Company also
operates a network of terminals along the Texas and Louisiana Gulf Coast that
provides fuel and logistical support services to the marine and offshore
exploration and production industries.
Tesoro's operations can be influenced by domestic and international,
political, legislative and regulatory environments. In addition, significant
changes in the prices or availability of crude oil and refined products could
have a significant impact on results of operations, cash flows and financial
position of the Company.
Principles of Consolidation
The accompanying Consolidated Financial Statements include the accounts of
Tesoro and its subsidiaries. All significant intercompany accounts and
transactions have been eliminated. Investments in 50% or less owned entities are
accounted for using the equity method.
Basis of Presentation
Certain previously reported amounts have been reclassified to conform to
the 2001 presentation. The Company has reclassified corporate general and
administrative expenses and other expenses to selling, general and
administrative, which is included as a charge to operating income in the
Statements of Consolidated Operations. In addition, the Company has reclassified
segment information to report the following segments: (i) Refining, (ii) Retail
and (iii) Marine Services (see Note D).
Unless otherwise stated, the Notes to Consolidated Financial Statements
exclude discontinued operations (see Note E).
Use of Estimates
Preparation of the Company's Consolidated Financial Statements in
conformity with accounting principles generally accepted in the United States of
America ("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 year. Actual results
could differ from those estimates.
Cash and Cash Equivalents
The Company considers all highly-liquid instruments, such as temporary cash
investments, with a maturity of three months or less at the time of purchase to
be cash equivalents. Cash equivalents are stated at cost, which approximates
market value. The Company's policy is to invest cash in conservative,
highly-rated instruments and to invest in various financial institutions to
limit the amount of credit exposure in any one institution. The Company monitors
the credit standing of these financial institutions.
F-27
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Financial Instruments
The carrying amounts of financial instruments, including cash and cash
equivalents, receivables, accounts payable and certain accrued liabilities,
approximate fair value because of the short maturity of these instruments. The
carrying amounts of the Company's variable rate debt approximates fair value.
The carrying amounts of the Company's fixed-rate debt and other obligations may
vary from the Company's estimates of the fair value of such items. At December
31, 2001, the fair market value of the Company's fixed-rate debt was estimated
by management to be approximately $12 million more than its book value of $522
million.
Inventories
Inventories are stated at the lower of cost or market. The last-in,
first-out ("LIFO") method is used to determine the cost of inventories of crude
oil and refined products in the Refining and Retail segments. The cost of fuel
at Marine Services terminals is determined on the first-in, first-out ("FIFO")
method. The carrying value of petroleum inventories is sensitive to volatile
market prices. Merchandise and materials and supplies are valued at average
cost, not in excess of market value.
Property, Plant and Equipment
Additions to property, plant and equipment and major improvements and
modifications are capitalized at cost. Depreciation of property, plant and
equipment is generally computed on the straight-line method based upon the
estimated useful life of each asset. The weighted average lives range from 27 to
28 years for refineries, 6 to 16 years for terminals, 11 to 16 years for retail
stations, 9 to 29 years for transportation assets, and 3 to 13 years for
corporate and other assets.
The Company capitalizes interest on major projects during extended
construction periods. Such interest is allocated to property, plant and
equipment and amortized over the estimated useful lives of the related assets.
Interest and financing costs incurred totaled $57.9 million, $33.4 million and
$38.2 million in 2001, 2000 and 1999, respectively, of which $5.1 million, $0.7
million and $0.6 million was capitalized during 2001, 2000 and 1999,
respectively.
Environmental Expenditures
Environmental expenditures that extend the life or increase the capacity of
facilities, or expenditures that mitigate or prevent environmental contamination
that is yet to occur, are capitalized. Expenditures that relate to an existing
condition caused by past operations, and which do not contribute to current or
future revenue generation, are expensed. Liabilities are recorded when
environmental assessments and/or remedial efforts are probable. Cost estimates
are based on the expected timing and extent of remedial actions required by
applicable governing agencies, experience gained from similar sites on which
environmental assessments or remediation have been completed, and the amount of
the Company's anticipated liability considering the proportional liability and
financial abilities of other responsible parties. Generally, the timing of these
accruals coincides with the completion of a feasibility study or the Company's
commitment to a formal plan of action. Estimated liabilities are not discounted
to present value.
Other Assets
The cost over the fair value of net assets acquired, or goodwill (excluding
goodwill related to the 2001 acquisitions, as discussed in Note C) is amortized
by the straight-line method over 28 years for Refining and Retail assets, and 20
years for Marine Services assets. Goodwill amortization, which amounted to $2.7
million in 2001, is included in depreciation and amortization in the Statements
of Consolidated Operations. Goodwill will not be amortized in years subsequent
to 2001 as required by Statement of Financial Accounting Standards ("SFAS") No.
142, "Goodwill and Other Intangible Assets".
F-28
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Intangible assets other than goodwill consist primarily of purchased
intangible assets which are stated at fair value as of the date acquired in a
business combination, less accumulated amortization. Amortization is computed on
a straight-line basis over estimated useful lives of 3 to 28 years. Amortization
of intangible assets other than goodwill is primarily included in depreciation
and amortization in the Statements of Consolidated Operations.
Refinery processing units are shut down periodically for major scheduled
maintenance, or turnarounds. Certain catalysts are used in refinery process
units for periods exceeding one year. Also, ships, tugs and barges are drydocked
for periodic maintenance. Turnaround, catalyst and drydocking costs are deferred
and amortized on a straight-line basis over the expected periods of benefit
generally ranging from 23 to 48 months. Amortization of such deferred costs is
included in costs of sales and operating expenses in the Statements of
Consolidated Operations.
Debt issuance costs are deferred and amortized over the estimated terms of
each instrument.
Impairment of Long-Lived Assets
Property, plant and equipment and other long-lived assets, such as goodwill
and intangible assets, are reviewed for impairment whenever events or changes in
business circumstances indicate the carrying values of the assets may not be
recoverable. Impairment losses would be recorded when the undiscounted cash
flows estimated to be generated by those assets are less than the carrying
amount of those assets.
Revenue Recognition
The Company recognizes revenues from product sales and services upon
delivery to customers and when all significant obligations have been satisfied.
Shipping and Handling Fees and Costs
Shipping and handling fees charged to customers are included in revenues
and the related costs are included in costs of sales and operating expenses in
the Statements of Consolidated Operations.
Excise Taxes
Revenues and costs of sales and operating expenses included $81 million and
$43 million of federal excise and state motor fuel taxes collected from
customers and remitted to governmental agencies in 2001 and 2000, respectively.
These taxes were primarily related to sales of gasoline and diesel in the Retail
segment.
Income Taxes
Deferred tax assets and liabilities are recognized for future income tax
consequences attributable to differences between financial statement carrying
amounts of assets and liabilities and their respective tax bases. Measurement of
deferred tax assets and liabilities is based on enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in the period that includes
the enactment date.
Stock-Based Compensation
The Company accounts for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board ("APB") Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, compensation cost for stock options is measured as the excess, if
any, of
F-29
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the quoted market price of the Company's Common Stock at the date of grant over
the amount an employee must pay to acquire the stock (see Note N).
Derivative Instruments
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
Statements of Consolidated Operations and the carrying amounts included in other
current assets or accrued liabilities in the Consolidated Balance Sheets. At
December 31, 2001, the Company had open price swap transactions for 200,000
barrels of gasoline which will settle in the first quarter of 2002. Recording
the fair value of these swaps resulted in a mark-to-market loss of $39,000 in
2001. As of December 31, 2001, the Company did not have any derivative
instruments that were designated and accounted for as hedges. The Company
believes that substantially all of its supply and marketing agreements are
normal purchases and sales and that pricing provisions in other agreements are
not embedded derivatives.
New Accounting Standards and Disclosures
SFAS No. 141 and SFAS No. 142
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
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 apply to
the acquisitions in 2001 discussed in Note C. The Company believes that the
carrying amount of its goodwill has not been impaired although the detailed
evaluations required by SFAS 142 have not been completed.
SFAS No. 143
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 requires an asset retirement obligation to
be recorded at fair value during the period incurred and an equal amount
recorded as an increase in the value of the related long-lived asset. The
capitalized cost is depreciated over the useful life of the asset and the
obligation is accreted to its present value each period. SFAS No. 143 is
effective for the Company beginning January 1, 2003 with earlier adoption
encouraged. The Company is currently evaluating the impact the standard will
have on its future results of operations and financial condition.
F-30
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SFAS No. 144
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets", effective beginning January 1,
2002. SFAS No. 144 retains the requirement to recognize an impairment loss only
where the carrying value of a long-lived asset is not recoverable from its
undiscounted cash flows and to measure such loss as the difference between the
carrying amount and fair value of the asset. SFAS No. 144, among other things,
changes the criteria that have to be met to classify an asset as held-for-sale
and requires that operating losses from discontinued operations be recognized in
the period that the losses are incurred rather than as of the measurement date.
The Company adopted the accounting standard effective January 1, 2002 which did
not have a significant impact on the Company's financial condition or results of
operations. For information regarding the Company's evaluation of strategic
opportunities for the Marine Services segment, see Note D.
Proposed Statement of Position
The American Institute of Certified Public Accountants has issued an
Exposure Draft for a Proposed Statement of Position, "Accounting for Certain
Costs and Activities Related to Property, Plant and Equipment" which would
require major maintenance activities to be expensed as costs are incurred. If
this proposed Statement of Position is adopted in its current form, the Company
will be required to write off the balance of deferred maintenance costs, which
totaled $44.1 million at December 31, 2001, and expense future costs as
incurred.
NOTE B -- 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 Common Stock produced anti-
dilutive results in 1999, and, in accordance with SFAS No. 128, "Earnings per
Share," was not included in the dilutive calculation. The Preferred Stock was
converted into 10.35 million shares of Common Stock in July 2001. Earnings per
share calculations are presented below (in millions except per share amounts):
<Table>
<Caption>
2001 2000 1999
----- ----- -----
BASIC:
Numerator:
Earnings from continuing operations.................... $88.0 $73.3 $32.2
Earnings from discontinued operations, aftertax........ -- -- 42.8
----- ----- -----
Net earnings........................................... 88.0 73.3 75.0
Less dividends on Preferred Stock...................... 6.0 12.0 12.0
----- ----- -----
Net earnings applicable to common shares............... $82.0 $61.3 $63.0
===== ===== =====
Denominator:
Weighted average common shares outstanding............. 36.2 31.2 32.4
===== ===== =====
Basic Earnings Per Share:
Continuing operations.................................. $2.26 $1.96 $0.62
Discontinued operations, aftertax...................... -- -- 1.32
----- ----- -----
Net earnings........................................... $2.26 $1.96 $1.94
===== ===== =====
</Table>
F-31
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
2001 2000 1999
----- ----- -----
DILUTED:
Numerator:
Net earnings applicable to common shares............... $82.0 $61.3 $63.0
Plus income impact of assumed conversion of Preferred
Stock (dilutive in 2001 and 2000).................... 6.0 12.0 --
----- ----- -----
Total.................................................. $88.0 $73.3 $63.0
===== ===== =====
Denominator:
Weighted average common shares outstanding............. 36.2 31.2 32.4
Add potentially dilutive securities:
Incremental dilutive shares from assumed exercise of
stock options and other........................... 0.5 0.3 0.4
Incremental dilutive shares from assumed conversion
of Preferred Stock (dilutive in 2001 and 2000).... 5.2 10.3 --
----- ----- -----
Total diluted shares................................... 41.9 41.8 32.8
===== ===== =====
Diluted Earnings Per Share:
Continuing operations.................................. $2.10 $1.75 $0.62
Discontinued operations, aftertax...................... -- -- 1.30
----- ----- -----
Net earnings........................................... $2.10 $1.75 $1.92
===== ===== =====
</Table>
NOTE C -- ACQUISITIONS AND EXPANSIONS
Acquisitions of Mid-Continent Refineries and Related Retail Operations
On September 6, 2001, the Company acquired two refineries in North Dakota
and Utah and related storage, distribution and retail assets from certain
affiliates of BP p.l.c. ("BP"). The acquired assets include a 60,000 barrels per
day ("bpd") refinery in Mandan, North Dakota and a 55,000 bpd refinery in Salt
Lake City, Utah. The acquired assets also include related bulk storage
facilities, eight product distribution terminals, and retail assets consisting
of 42 retail stations and contracts to supply a jobber network of over 280
retail stations. In connection with the acquisition of the North Dakota
refinery, the Company purchased the North Dakota-based, common-carrier crude oil
pipeline and gathering system ("Pipeline System") from certain affiliates of BP
on November 1, 2001. The Pipeline System is the primary crude supply carrier for
the Company's Mandan, North Dakota refinery. The purchase of the Pipeline System
and the acquisition of the North Dakota and Utah refineries and related storage,
distribution and retail assets are collectively referred to as the
"Mid-Continent Acquisition." The Mid-Continent Acquisition enables the Company
to increase the size and scope of its operations, diversify its earnings and
geographic exposure, and build a platform for additional growth. The Company
paid $756.1 million in cash (including $83.0 million for hydrocarbon
inventories) for these assets. The purchase price was determined through a
competitive bid process. In addition, the Company incurred direct costs related
to this transaction of $8.4 million. The Mid-Continent Acquisition was funded
through borrowings under a new senior secured credit facility and a senior
subordinated notes offering (see Note F).
In connection with the Mid-Continent Acquisition, Tesoro assumed certain
liabilities and obligations (including costs associated with transferred
employees and environmental matters) related to the acquired assets, subject to
specified levels of indemnification. These include, subject to certain
exceptions, certain of the sellers' obligations, liabilities, costs and expenses
for violations of health, safety and environmental laws relating to the assets,
including certain known and unknown obligations, liabilities, costs and expenses
arising or incurred prior to, on or after the closing dates. In addition, the
Company has agreed to indemnify the sellers
F-32
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
for all losses of any kind incurred in connection with or related to these
assumed liabilities. See Note O for environmental matters related to the
Mid-Continent Acquisition.
Under SFAS No. 141, "Business Combinations", the Mid-Continent Acquisition
was accounted for as a purchase, whereby the purchase price was allocated to the
assets acquired and liabilities assumed based upon their respective fair market
values at the date of acquisition. The accompanying financial statements reflect
the preliminary purchase price allocation, which remains subject to change
pending completion of independent appraisals and other evaluations. The 2001
financial statements include the results of operations of the Mid-Continent
Acquisition since the dates of acquisition.
The preliminary purchase price allocation as of December 31, 2001,
including direct costs incurred in the Mid-Continent Acquisition, is as follows
(in millions):
<Table>
Inventories................................................. $127.5
Property, plant and equipment............................... 582.5
Goodwill.................................................... 34.7
Other intangible assets..................................... 67.9
Deferred turnaround costs................................... 10.6
Net deferred tax assets..................................... 9.1
Product exchange payable.................................... (32.6)
Accrued liabilities......................................... (10.6)
Other liabilities........................................... (24.6)
------
Total purchase price...................................... $764.5
======
</Table>
The acquired other intangible assets of $67.9 million have a
weighted-average useful life of approximately 19 years. The other intangible
assets consist of refinery permits and plans totaling $23.9 million (27 year
weighted-average life), jobber agreements totaling $23.5 million (20 year
weighted-average life), customer contracts totaling $16.7 million (5 year
weighted-average life), and refinery technology totaling $3.8 million (28 year
weighted-average life). The Company recorded $34.7 million of goodwill, of which
$21.0 million is expected to be deductible for tax purposes. The goodwill was
preliminarily assigned to the Refining and Retail segments in the amounts of
$25.7 million and $9.0 million, respectively.
The following unaudited pro forma financial information for the years ended
December 31, 2001 and 2000 gives effect to (i) the Mid-Continent Acquisition,
(ii) the financing of the Company's Senior Secured Credit Facility, as amended,
and (iii) the issuance of the 9 5/8% Senior Subordinated Notes (see Note F), as
if each had occurred at the beginning of the periods presented. This pro forma
information is not necessarily indicative of the results of future operations.
<Table>
<Caption>
YEARS ENDED
DECEMBER 31,
-------------------------
2001 2000
----------- -----------
(IN MILLIONS, EXCEPT PER
SHARE AMOUNTS)
Revenues.................................................... $6,190.1 $6,588.2
Net earnings................................................ $ 128.5 $ 91.1
Net earnings per share:
Basic..................................................... $ 3.38 $ 2.54
Diluted................................................... $ 3.07 $ 2.18
</Table>
Refining Expansions
During 2000, the Company commenced a heavy oil conversion project at its
Washington refinery which will enable the Company to process a larger proportion
of lower-cost heavy crude oils, to manufacture a larger
F-33
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
proportion of higher-value gasoline and to reduce production of lower-value
heavy products. The project, which is estimated to cost approximately $116
million (including capitalized interest), is expected to be completed by the end
of the first quarter of 2002. The Company's capital spending totaled
approximately $97 million through 2001 for this project.
Retail Expansions
In January 2000, the Company entered into 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 introduced the new "Mirastar" brand which is used
exclusively in its program with Wal-Mart. Capital spending for the Mirastar
sites and other retail projects, including costs of Company-owned and operated
facilities and expansion of Tesoro's branded jobber/dealer network, totaled
approximately $43 million and $31 million during 2001 and 2000, respectively. In
addition, in November 2001, the Company acquired 46 retail fueling facilities,
including 37 retail stations with convenience stores and nine commercial card
lock facilities, located in Washington, Oregon and Idaho.
NOTE D -- OPERATING SEGMENTS
The Company's revenues are derived from three operating segments: (i)
Refining, (ii) Retail and (iii) Marine Services. Management has identified these
segments for managing operations and investing activities. During the fourth
quarter of 2001, management began evaluating separate financial information of
the Company's retail operations in assessing performance and allocating
resources, reflecting the Company's retail growth through internal expansion,
the acquisition of retail sites from BP in September 2001 and the acquisition of
certain other retail sites. The Company has reclassified previously reported
segment information to present the Retail segment separately from the Refining
segment.
Refining currently owns and operates five petroleum refineries located in
Alaska and Washington (the "Pacific Northwest"), Hawaii (the "Mid-Pacific") and
North Dakota and Utah (the "Mid-Continent"). These refineries manufacture
gasoline and gasoline blendstocks, jet fuel, diesel fuel, heavy oils and other
refined products. These products, together with products purchased from third
parties, are sold at wholesale through terminal facilities and other locations,
primarily in Alaska, California, Hawaii, Idaho, Minnesota, North Dakota, Utah
and Washington. Refining also sells petroleum products to unbranded marketers
and occasionally exports products to other markets in the Asia/Pacific area.
Retail sells gasoline, diesel fuel and convenience store items through
Company-owned retail stations and branded jobber/dealers in 18 western states
from Minnesota to Alaska and Hawaii. Retail operates under the Tesoro, Mirastar
and other brands. Mirastar sites have been developed exclusively for Wal-Mart
stores in an agreement covering seventeen western states. Other branded
jobber/dealers are part of the retail system acquired from BP in September 2001.
Marine Services markets and distributes petroleum products, water, drilling
mud and other supplies and services primarily to the marine and offshore
exploration and production industries operating in the Gulf of Mexico. This
segment operates through terminals along the Texas and Louisiana Gulf Coast. The
Company is evaluating various strategic opportunities to capitalize on the value
of the Marine Services assets, including a possible sale of all or a part of
this business.
The operating segments follow the same accounting policies used for the
Company's Consolidated Financial Statements and described in the summary of
significant policies in Note A. Management evaluates the performance of its
segments and allocates resources based on segment operating income and EBITDA,
as described below.
Segment operating income includes those revenues and expenses that are
directly attributable to management of the respective segment. Intersegment
sales are primarily from Refining to Retail made at
F-34
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
prevailing market rates. Income taxes, interest and financing costs, interest
income and corporate general and administrative expenses are not included in
determining segment operating income.
EBITDA represents earnings before extraordinary items, interest and
financing costs, interest income, income taxes, and depreciation and
amortization. While not purporting to reflect any U.S. GAAP measurement of the
Company's operations or cash flows, EBITDA is used by management for additional
analysis. Operating segment EBITDA is equal to segment operating income before
depreciation and amortization related to each segment. Identifiable assets are
those assets utilized by the segment. Corporate assets are principally cash and
other assets that are not associated with an operating segment.
Segment information as of and for each of the three years in the period
ended December 31, 2001 is as follows (in millions):
<Table>
<Caption>
2001 2000 1999
-------- -------- --------
REVENUES
Refining:
Refined products.................................. $4,625.2 $4,499.3 $2,772.1
Crude oil resales and other....................... 262.8 326.2 28.9
Retail:
Fuel.............................................. 420.6 249.6 175.8
Merchandise and other............................. 70.6 55.4 51.6
Marine Services...................................... 172.5 186.8 111.2
Intersegment sales from Refining to Retail........... (333.9) (212.9) (139.3)
-------- -------- --------
Total Revenues.................................. $5,217.8 $5,104.4 $3,000.3
======== ======== ========
OPERATING INCOME
Refining............................................. $ 224.5 $ 190.8 $ 112.7
Retail............................................... 24.9 (1.7) 12.4
Marine Services...................................... 9.9 10.4 5.9
-------- -------- --------
Total Segment Operating Income.................. 259.3 199.5 131.0
Corporate and Unallocated Costs...................... (60.6) (46.1) (43.4)
-------- -------- --------
Operating Income..................................... $ 198.7 $ 153.4 $ 87.6
======== ======== ========
EBITDA
Continuing Operations:
Refining.......................................... $ 265.2 $ 224.6 $ 145.1
Retail............................................ 36.0 4.9 17.9
Marine Services................................... 12.7 13.1 8.5
-------- -------- --------
Total Segment EBITDA............................ 313.9 242.6 171.5
Corporate and Unallocated............................ (57.8) (43.7) (41.0)
-------- -------- --------
Total Continuing EBITDA......................... 256.1 198.9 130.5
Depreciation and Amortization from Continuing
Operations........................................ (57.4) (45.5) (42.9)
-------- -------- --------
Operating Income..................................... $ 198.7 $ 153.4 $ 87.6
======== ======== ========
</Table>
F-35
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<Table>
<Caption>
2001 2000 1999
-------- -------- --------
DEPRECIATION AND AMORTIZATION
Continuing Operations:
Refining.......................................... $ 40.7 $ 33.8 $ 32.4
Retail............................................ 11.1 6.6 5.5
Marine Services................................... 2.8 2.7 2.6
Corporate......................................... 2.8 2.4 2.4
-------- -------- --------
Total Continuing Operations..................... 57.4 45.5 42.9
Discontinued Operations.............................. -- -- 27.3
-------- -------- --------
Total Depreciation and Amortization............. $ 57.4 $ 45.5 $ 70.2
======== ======== ========
CAPITAL EXPENDITURES
Continuing Operations(a):
Refining.......................................... $ 140.0 $ 56.5 $ 54.7
Retail............................................ 43.2 31.0 17.7
Marine Services................................... 3.1 3.2 1.5
Corporate......................................... 23.2 3.3 10.8
-------- -------- --------
Total Continuing Operations..................... 209.5 94.0 84.7
Discontinued Operations.............................. -- -- 56.5
-------- -------- --------
Total Capital Expenditures...................... $ 209.5 $ 94.0 $ 141.2
======== ======== ========
IDENTIFIABLE ASSETS
Refining............................................. $2,164.9 $1,245.6 $1,117.3
Retail............................................... 283.8 149.6 106.3
Marine Services...................................... 62.0 76.8 66.5
Corporate............................................ 151.6 71.6 196.4
-------- -------- --------
Total Assets.................................... $2,662.3 $1,543.6 $1,486.5
======== ======== ========
</Table>
- ---------------
(a) Excluding refining and retail asset acquisitions of $783.4 million in 2001
(see Note C).
F-36
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE E -- DISCONTINUED OPERATIONS
In December 1999, the Company completed the sales of its domestic and
Bolivian exploration and production operations. The net cash proceeds of
approximately $307 million were used primarily to reduce debt in 1999 and early
2000. Earnings from discontinued operations for the year ended December 31, 1999
were as follows (in millions):
<Table>
Operating Results from Discontinued Operations:
Revenues.................................................. $65.4
Costs and expenses........................................ 44.6
Allocated interest expense................................ 10.6
-----
Results of operations, pretax.......................... 10.2
Income tax expense........................................ 6.5
-----
Results of operations, aftertax........................ 3.7
-----
Gain from Sales of Discontinued Operations:
Gain, pretax.............................................. 62.2
Income tax expense........................................ 23.1
-----
Gain, aftertax............................................ 39.1
-----
Total Discontinued Operations........................ $42.8
=====
</Table>
NOTE F -- DEBT AND OTHER OBLIGATIONS
Debt and other obligations at December 31, 2001 and 2000 consisted of the
following (in millions):
<Table>
<Caption>
2001 2000
-------- ------
Senior Secured Credit Facility-Term Loans................... $ 625.0 $ --
9 5/8% Senior Subordinated Notes............................ 215.0 --
9% Senior Subordinated Notes (net of unamortized discount of
$2.4 in 2001 and $2.7 in 2000)............................ 297.6 297.3
Liability to the Department of Energy, interest at 6%....... 2.6 5.3
Other, primarily capital leases............................. 6.7 8.0
-------- ------
Total debt and other obligations.......................... 1,146.9 310.6
Less current maturities..................................... 34.4 3.8
-------- ------
Debt and other obligations, less current maturities....... $1,112.5 $306.8
======== ======
</Table>
At December 31, 2001, aggregate maturities of outstanding debt and other
obligations for each of the five years following December 31, 2001 were as
follows: 2002 -- $34.4 million; 2003 -- $40.6 million; 2004 -- $40.7 million;
2005 -- $40.7 million; and 2006 -- $49.3 million. Gross borrowings and
repayments under revolving credit lines and interim facilities amounted to $958
million during 2001 and $866 million during 2000. In 1999, gross repayments
under a revolving credit line amounted to $550 million, while gross borrowings
amounted to $489 million.
Senior Secured Credit Facility
In September 2001, the Company entered into a senior secured credit
facility (the "Senior Secured Credit Facility"). The Senior Secured Credit
Facility replaced the Company's previous unsecured credit facility which
provided for $250 million in total commitments. The Senior Secured Credit
Facility, as amended, consists of a five-year $175 million revolving credit
facility (with a $90 million sublimit for letters of credit), a five-year $85
million tranche A term loan, a five-year $90 million delayed draw term loan
(used to
F-37
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
fund the purchase of the Pipeline System), a six-year $450 million tranche B
term loan and a $200 million capital markets term loan. In November 2001, the
Company repaid the $200 million capital markets term loan with the proceeds of
the 9 5/8% Senior Subordinated Notes, as described below. At December 31, 2001,
the Company had no borrowings and $0.8 million in letters of credit outstanding
under the revolving credit facility. Total unused credit available under the
revolving credit facility at December 31, 2001 was $174.2 million.
The Senior Secured Credit Facility is guaranteed by substantially all of
the Company's active domestic subsidiaries and is secured by substantially all
of the Company's material present and future assets as well as all material
present and future assets of the Company's domestic subsidiaries (with certain
exceptions for pipeline, retail and marine services assets), and is additionally
secured by a pledge of all of the stock of all current active and future
domestic subsidiaries and 66% of the stock of the Company's current and future
foreign subsidiaries.
The Senior Secured Credit Facility requires the Company to maintain
specified levels of interest and fixed charge coverage and sets limitations on
the Company's debt-to-capital and leverage ratios. It also contains other
covenants and restrictions customary in credit arrangements of this kind. The
terms allow for payment of cash dividends on the Company's Common Stock and
repurchases of shares of its Common Stock, not to exceed $15 million in any
year.
Borrowings rates under the senior secured credit facility are based on a
pricing grid. Borrowings bear interest at either a base rate (4.75% at December
31, 2001) or a eurodollar rate (ranging from 2.10% to 2.14% at December 31,
2001), plus an applicable margin. The applicable margin at December 31, 2001 for
the tranche A term loan, the delayed draw term loan and the revolving credit
facility is 1.25% in the case of the base rate and 2.25% in the case of the
eurodollar rate. The applicable margin for the tranche B term loan is 1.75% in
the case of the base rate and 2.75% in the case of the eurodollar rate.
Additionally, the tranche B eurodollar rate is deemed to be no less than 3.0%.
These margins are the highest margins applicable to the respective base and
eurodollar rates and will vary in relation to ratios of the Company's
consolidated total debt to consolidated EBITDA, as defined in the Senior Secured
Credit Facility. In addition, at any time during which the Senior Secured Credit
Facility is rated at least BBB- by Standard and Poor's Rating Services and Baa3
by Moody's Investors Service, Inc., each applicable margin will be reduced by
0.125%. The Company is also charged various fees and expenses in connection with
the Senior Secured Credit Facility, including commitment fees and various letter
of credit fees.
9 5/8% Senior Subordinated Notes
In November 2001, the Company issued $215 million aggregate principal
amount of 9 5/8% senior subordinated notes due November 1, 2008 ("9 5/8% Senior
Subordinated Notes"). The 9 5/8% Senior Subordinated Notes have a seven-year
maturity with no sinking fund requirements and are subject to optional
redemption by the Company after four years at declining premiums. The Company,
for the first three years, may redeem up to 35% of the aggregate principal
amount at a redemption price of 109.625% with net cash proceeds of one or more
equity offerings. The indenture for the 9 5/8% Senior Subordinated Notes
contains covenants and restrictions which are customary for notes of this
nature. The restrictions under the indenture are less restrictive than those in
the Senior Secured Credit Facility. To the extent the Company's fixed charge
coverage ratio, as defined in the indenture, allows for the incurrence of
additional indebtedness, the Company is allowed to pay cash dividends on Common
Stock and repurchase shares of Common Stock. The proceeds from the 9 5/8% Senior
Subordinated Notes were used to repay the indebtedness incurred under the
capital markets term loan, to pay accrued interest on the capital markets term
loan, to pay certain fees and expenses related to the 9 5/8% Senior Subordinated
Notes and for general corporate purposes. The 9 5/8% Senior Subordinated Notes
are guaranteed by substantially all of the Company's active domestic
subsidiaries.
F-38
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9% Senior Subordinated Notes
In 1998, the Company issued $300 million aggregate principal amount of 9%
Senior Subordinated Notes due 2008, Series B ("9% Senior Subordinated Notes").
The 9% Senior Subordinated Notes have a ten-year maturity without sinking fund
requirements and are subject to optional redemption by the Company after five
years at declining premiums. The indenture for the 9% Senior Subordinated Notes
contains covenants and restrictions which are customary for notes of this
nature. The restrictions under the indenture are less restrictive than those in
the Senior Secured Credit Facility. To the extent the Company's fixed charge
coverage ratio, as defined in the indenture, allows for the incurrence of
additional indebtedness, the Company is allowed to pay cash dividends on Common
Stock and repurchase shares of Common Stock. The effective interest rate on the
9% Senior Subordinated Notes is 9.16%, after giving effect to the discount at
the date of issue. The 9% Senior Subordinated Notes are guaranteed by
substantially all of the Company's active domestic subsidiaries.
Capital Leases
Capital leases are primarily for tugs and barges used in transportation of
petroleum products in Hawaii. At December 31, 2001 and 2000, the cost of fixed
assets under capital leases was $9.3 million gross (accumulated amortization of
$3.7 million) and $10.0 million gross (accumulated amortization of $3.1
million), respectively. Capital lease obligations included in debt totaled $6.6
million and $7.7 million at December 31, 2001 and 2000, respectively.
NOTE G -- STOCKHOLDERS' EQUITY
The Company has a universal shelf registration statement ("Shelf
Registration") for debt or equity securities to be used for acquisitions or
general corporate purposes. At December 31, 2001, the amount available under the
Shelf Registration was $343 million.
In July 1998, the Company issued 10,350,000 Premium Income Equity
Securities ("PIES(SM)"), representing fractional interests in the Company's
7.25% Mandatorily Convertible Preferred Stock, for gross proceeds of $165
million. Effective July 1, 2001, the PIES(SM) automatically converted into
10,350,000 shares of Common Stock. The final quarterly cash dividends on the
PIES(SM) 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 Common Stock. 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
flow. The stock may be used to meet employee benefit plan requirements and other
corporate purposes. During the year ended December 31, 2000, the Company
repurchased 1.6 million shares of Common Stock for $15.5 million, or an average
cost per share of $9.54. In 2001, the Company repurchased an additional 304,000
shares of its Common Stock at an average cost of $11.50 per share, or an
aggregate of approximately $3.5 million, bringing the cumulative shares
repurchased under the program to 1,931,400.
See Note F for information concerning restrictions on the repurchase of
Common Stock and Note N for information relating to stock-based compensation and
Common Stock reserved for exercise of options.
F-39
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE H -- INCOME TAXES
The income tax provision on earnings from continuing operations for the
years ended December 31, 2001, 2000 and 1999 included the following (in
millions):
<Table>
<Caption>
2001 2000 1999
----- ----- -----
Current:
Federal................................................... $17.7 $24.2 $ 5.9
State..................................................... 5.7 4.6 0.4
Deferred:
Federal................................................... 32.9 19.4 10.5
State..................................................... 2.6 2.0 2.2
----- ----- -----
Income Tax Provision................................... $58.9 $50.2 $19.0
===== ===== =====
</Table>
Deferred income taxes and benefits are provided for differences between
financial statement carrying amounts of assets and liabilities and their
respective tax bases. Temporary differences and the resulting deferred tax
liabilities and assets at December 31, 2001 and 2000 are summarized as follows
(in millions):
<Table>
<Caption>
2001 2000
------- -------
Current Deferred Federal Tax Liability -- LIFO inventory.... $ (9.2) $ (6.6)
Current Deferred Federal Tax Assets -- Accrued
liabilities............................................... 12.1 6.6
Current Deferred State Tax Asset, Net....................... 0.4 --
------- -------
Current Deferred Tax Asset, Net........................ $ 3.3 $ --
======= =======
Noncurrent Deferred Federal Tax Liabilities:
Accelerated depreciation and property related items....... $(140.2) $(115.2)
Deferred maintenance costs, including refinery
turnarounds............................................ (13.4) (9.4)
------- -------
Total Deferred Federal Tax Liability................... (153.6) (124.6)
------- -------
Noncurrent Deferred Federal Tax Assets:
Accrued pension and other postretirement benefits......... 24.4 22.6
Other accrued liabilities................................. 12.8 7.2
Alternative minimum tax credit............................ -- 6.2
------- -------
Total Deferred Federal Tax Assets...................... 37.2 36.0
------- -------
Noncurrent Deferred State Tax Liability, Net................ (20.5) (18.6)
------- -------
Noncurrent Deferred Tax Liability, Net................. $(136.9) $(107.2)
======= =======
</Table>
In 2001, the Mid-Continent Acquisition described in Note C resulted in net
deferred federal tax assets of $8.0 million and net deferred state tax assets of
$1.1 million as of the dates of acquisition.
F-40
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The reconciliation of income tax expense at the U.S. statutory rate to the
income tax expense pertaining to continuing operations is as follows (in
millions):
<Table>
<Caption>
2001 2000 1999
------ ------ -----
Earnings from Continuing Operations Before Income Taxes..... $146.9 $123.5 $51.2
====== ====== =====
Income Taxes at U.S. Federal Statutory Rate................. $ 51.4 $ 43.2 $17.9
Effect of:
State income taxes, net of federal income tax benefit..... 5.3 4.3 1.5
Non-deductible items...................................... 2.0 1.5 0.5
Other..................................................... 0.2 1.2 (0.9)
------ ------ -----
Income Tax Provision........................................ $ 58.9 $ 50.2 $19.0
====== ====== =====
</Table>
The Company's income tax returns are subject to examinations by federal,
state and local tax authorities. The Company believes that it has made adequate
provisions for income taxes that may become payable with respect to examinations
of open tax years.
NOTE I -- RECEIVABLES
Concentrations of credit risk with respect to accounts receivable are
influenced by the large number of customers comprising the Company's customer
base and their dispersion across various industry groups and geographic areas of
operations. The Company performs ongoing credit evaluations of its customers'
financial condition and in certain circumstances requires letters of credit or
other collateral arrangements. The Company's allowance for doubtful accounts is
reflected as a reduction of receivables in the Consolidated Balance Sheets and
amounted to $3.2 million and $2.1 million at December 31, 2001 and 2000,
respectively.
NOTE J -- INVENTORIES
Components of inventories at December 31, 2001 and 2000 were as follows (in
millions):
<Table>
<Caption>
2001 2000
------ ------
Crude oil and refined products, at LIFO..................... $398.4 $248.0
Fuel products, at FIFO...................................... 2.1 4.5
Merchandise and other....................................... 7.9 5.6
Materials and supplies...................................... 23.4 16.2
------ ------
Total Inventories...................................... $431.8 $274.3
====== ======
</Table>
At December 31, 2001 and 2000, inventories valued using LIFO were lower
than replacement cost by approximately $3 million and $120 million,
respectively. During 1999, certain inventory quantities were reduced, resulting
in a liquidation of applicable LIFO inventory quantities carried at lower costs
prevailing in previous years. This LIFO liquidation resulted in a decrease in
cost of sales of $8.4 million and an increase in earnings from continuing
operations of approximately $5.3 million aftertax, or $0.16 per share, during
1999.
F-41
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE K -- OTHER ASSETS
Other assets consisted of the following at December 31, 2001 and 2000 (in
millions):
<Table>
<Caption>
2001 2000
------ ------
Goodwill, net of accumulated amortization of $10.4 in 2001
and $7.7 in 2000.......................................... $ 95.2 $ 63.2
Deferred maintenance costs, including refinery turnarounds,
net....................................................... 44.1 34.4
Debt issuance costs, net.................................... 29.7 10.2
Intangibles, net of accumulated amortization of $4.5 in 2001
and $1.8 in 2000.......................................... 73.3 4.1
Other assets, net........................................... 19.7 20.1
------ ------
Total Other Assets..................................... $262.0 $132.0
====== ======
</Table>
NOTE L -- ACCRUED LIABILITIES
The Company's current accrued liabilities and noncurrent other liabilities
as shown in the Consolidated Balance Sheets at December 31, 2001 and 2000
included the following (in millions):
<Table>
<Caption>
2001 2000
------ -----
Accrued Liabilities -- Current:
Accrued taxes other than income taxes, primarily excise
taxes.................................................. $ 87.8 $28.1
Accrued employee costs.................................... 39.5 27.1
Other..................................................... 45.6 41.8
------ -----
Total Accrued Liabilities -- Current................... $172.9 $97.0
====== =====
Other Liabilities -- Noncurrent:
Accrued pension and other postretirement benefits......... $ 85.1 $67.6
Other..................................................... 32.3 9.7
------ -----
Total Other Liabilities -- Noncurrent.................. $117.4 $77.3
====== =====
</Table>
NOTE M -- BENEFIT PLANS
Pension and Other Postretirement Benefits
The Company sponsors defined benefit pension plans, including an employee
retirement plan, executive security plans and a non-employee director retirement
plan.
For all eligible employees, the Company provides a qualified
noncontributory retirement plan ("Retirement Plan"). Plan benefits are based on
years of service and compensation. The Company's funding policy is to make
contributions at a minimum in accordance with the requirements of applicable
laws and regulations, but no more than the amount deductible for income tax
purposes. Retirement plan assets are primarily comprised of common stock and
bond funds.
The Company's executive security plans ("ESP Plans") provide executive
officers and other key personnel with supplemental death or retirement plan
benefits. Such benefits are provided by two nonqualified, noncontributory plans
and are based on years of service and compensation. The Company makes
contributions to one plan, the "Funded ESP Plan", based upon estimated
requirements. Assets of the Funded ESP plan consist of a group annuity contract.
The Company had previously established an unfunded non-employee director
retirement plan ("Director Retirement Plan") which provided eligible directors
retirement payments upon meeting certain age and other requirements. In 1997,
the Director Retirement Plan was frozen with accrued benefits of current
directors transferred to the Company's Board of Directors Phantom Stock Plan
("Phantom Stock Plan") (see
F-42
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Note N). After the amendment and transfer, only those retired directors or
beneficiaries who had begun to receive benefits remained participants in the
Director Retirement Plan.
SFAS No. 132, "Employers' Disclosures about Pensions and Other
Postretirement Benefits," requires the Company to disclose the aggregate
projected benefit obligations, accumulated benefit obligations and fair value of
plan assets for pension plans with accumulated benefit obligations in excess of
plan assets. At December 31, 2001, the projected benefit obligations,
accumulated benefit obligations and fair values of plan assets aggregated $112.8
million, $86.3 million and $57.6 million, respectively, for three of the plans.
The assets of the Funded ESP Plan exceeded its accumulated benefit obligation at
year-end 2001. At December 31, 2000, the projected benefit obligations,
accumulated benefit obligations and fair values of plan assets aggregated $92.9
million, $71.5 million and $62.3 million, respectively, for three of the plans.
The assets of the Funded ESP Plan exceeded its accumulated benefit obligation at
year-end 2000.
The Company provides to retirees who were participating in the Company's
group insurance program at retirement, health care and, to those who qualify,
life insurance benefits. Health care is provided to qualified dependents of
participating retirees. These benefits are provided through unfunded, defined
benefit plans or through contracts with area health-providers on a premium
basis. The health care plans are contributory, with retiree contributions
adjusted periodically, and contain other cost-sharing features such as
deductibles and coinsurance. The life insurance plan is noncontributory. The
Company funds its share of the cost of postretirement health care and life
insurance benefits on a pay-as-you go basis.
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care and life insurance plans. A
one-percentage-point change in assumed health care cost trend rates could have
the following effects (in millions):
<Table>
<Caption>
1-PERCENTAGE- 1-PERCENTAGE-
POINT INCREASE POINT DECREASE
-------------- --------------
Effect on total of service and interest cost components... $ 1.2 $(0.9)
Effect on postretirement benefit obligations.............. $12.1 $(8.5)
</Table>
F-43
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Financial information related to the Company's pension plans and other
postretirement benefits is presented below (in millions except percentages):
<Table>
<Caption>
OTHER
PENSION BENEFITS POSTRETIREMENT BENEFITS
------------------ ------------------------
2001 2000 2001 2000
------ ------ --------- ---------
Change in benefit obligation:
Benefit obligation at beginning of year.... $108.1 $ 94.4 $ 52.3 $ 38.1
Service cost............................... 8.3 6.1 2.9 1.6
Interest cost.............................. 8.5 7.5 4.3 3.2
Actuarial loss............................. 0.6 6.4 8.3 11.2
Benefits paid.............................. (6.7) (6.2) (1.9) (1.8)
Curtailments, special termination benefits
and other............................... -- (0.1) -- --
Plan amendments............................ 9.0 -- 2.0 --
Acquisitions............................... 1.5 -- 12.3 --
------ ------ ------ ------
Benefit obligation at end of year....... 129.3 108.1 80.2 52.3
------ ------ ------ ------
Change in plan assets:
Fair value of plan assets at beginning of
year.................................... 74.4 79.2 -- --
Actual return on plan assets............... (2.7) (0.4) -- --
Employer contributions..................... 8.5 1.7 -- --
Benefits paid.............................. (6.6) (6.1) -- --
------ ------ ------ ------
Fair value of plan assets at end of
year.................................. 73.6 74.4 -- --
------ ------ ------ ------
Funded status................................ (55.7) (33.7) (80.2) (52.3)
Unrecognized prior service cost.............. 9.2 0.5 2.6 0.7
Unrecognized net transition asset............ -- 0.1 -- --
Unrecognized net actuarial loss.............. 27.6 20.5 12.8 4.6
------ ------ ------ ------
Accrued benefit cost.................... $(18.9) $(12.6) $(64.8) $(47.0)
====== ====== ====== ======
Amounts included in Consolidated Balance
Sheets:
Accrued and other liabilities.............. $(28.1) $(20.6) $(64.8) $(47.0)
Other assets............................... 9.2 8.0 -- --
------ ------ ------ ------
Net amount recognized................... $(18.9) $(12.6) $(64.8) $(47.0)
====== ====== ====== ======
</Table>
<Table>
<Caption>
OTHER
PENSION BENEFITS POSTRETIREMENT BENEFITS
------------------ ------------------------
2001 2000 1999 2001 2000 1999
---- ---- ---- ------ ------ ------
Assumed weighted average % as of December 31:
Discount rate............................... 7.18 7.58 8.25 7.25 7.50 8.25
Rate of compensation increase............... 5.00 5.40 5.62 4.75 5.75 5.75
Expected return on plan assets.............. 8.03 8.07 8.10 -- -- --
</Table>
In 2001, the Company announced amendments to the pension plan by adding a
lump-sum distribution option and enhanced early retirement provisions for
long-term employees. These changes, along with changes to comply with new
regulations, increased the Company's pension benefit obligation by $9 million
and postretirement benefit obligation by $2 million during 2001.
F-44
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The weighted average annual assumed rate of increase in the per capita cost
of covered health care benefits was assumed to be 7.25% for retirees younger
than 65 for 2001, decreasing gradually to 5% by the year 2010, and an initial
9.1% for retirees 65 and older, decreasing gradually to 5.5% by the year 2010
and remaining level thereafter.
<Table>
<Caption>
OTHER
PENSION BENEFITS POSTRETIREMENT BENEFITS
--------------------- -------------------------
2001 2000 1999 2001 2000 1999
----- ----- ----- ------ ------- ------
Components of net periodic benefit cost:
Service cost............................ $ 8.3 $ 6.1 $ 6.6 $2.9 $ 1.6 $1.9
Interest cost........................... 8.5 7.5 6.2 4.3 3.2 2.8
Expected return on plan assets.......... (6.3) (5.9) (5.0) -- -- --
Amortization of unrecognized transition
asset................................ -- -- (0.6) -- -- --
Recognized net actuarial loss (gain).... 2.8 2.2 1.5 0.2 (0.2) --
Curtailments, settlements and special
termination benefits................. -- 0.5 (0.4) -- -- --
----- ----- ----- ---- ----- ----
Net periodic benefit cost.......... $13.3 $10.4 $ 8.3 $7.4 $ 4.6 $4.7
===== ===== ===== ==== ===== ====
</Table>
Thrift Plan and Retail Savings Plan
The Company sponsors an employee thrift plan ("Thrift Plan") which provides
for contributions, subject to certain limitations, by eligible employees into
designated investment funds with a matching contribution by the Company.
Employees may elect tax deferred treatment in accordance with the provisions of
Section 401(k) of the Internal Revenue Code. Effective November 1, 2001, the
Thrift Plan was amended to change the Company's 100% matching contribution, from
a maximum of 6% to 7% of the employee's eligible earnings, with at least 50% of
the Company's matching contribution directed for initial investment in Common
Stock of the Company. Participants may transfer out of Tesoro's Common Stock at
any time, but are limited to four such transfers each calendar year. The
Company's contributions amounted to $6.5 million, $5.4 million and $6.8 million
during 2001, 2000 and 1999, respectively, of which $3.4 million consisted of
treasury stock reissuances in 2001. There were no similar reissuances in 2000 or
1999.
Effective January 1, 2001, the Company began sponsoring a new savings plan,
in lieu of the Thrift Plan, for eligible retail employees who have completed one
year of service and have worked at least 1,000 hours within that time. Eligible
employees receive a mandatory employer contribution equal to 3% of eligible
earnings. If employees elect to make pretax contributions, the Company also
contributes an employer match contribution equal to $0.50 for each $1.00 of
employee contributions, up to 6% of eligible earnings. At least 50% of the
mandatory and matching employer contributions must be directed for initial
investment in Common Stock of the Company. Participants may transfer out of
Tesoro's Common Stock at any time, but are limited to four such transfers each
calendar year. The Company's contributions amounted to $0.1 million during 2001.
NOTE N -- STOCK-BASED COMPENSATION
Incentive Stock Plans
The Company has three employee incentive stock plans, the Key Employee
Stock Option Plan, as amended ("1999 Plan"), the Amended and Restated Executive
Long-Term Incentive Plan ("1993 Plan") and Amended Incentive Stock Plan of 1982
("1982 Plan"). In addition, the Company has the 1995 Non-Employee Director Stock
Option Plan ("1995 Plan"). At December 31, 2001, the Company had 5,387,177
shares of unissued Common Stock reserved for these employee incentive stock
plans and non-employee director plan.
F-45
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Under the 1993 Plan, shares of Common Stock may be granted in a variety of
forms, including restricted stock, incentive stock options, nonqualified stock
options, stock appreciation rights and performance share and performance unit
awards. At the Company's 2000 Annual Meeting of Stockholders held in May 2000,
an amendment was approved by the shareholders which increased the number of
shares available for grant under the 1993 Plan from 4,250,000 to 5,250,000.
Stock options may be granted at exercise prices not less than the fair market
value on the date the options are granted. The options granted generally become
exercisable after one year in 20%, 25% or 33% increments per year and expire ten
years from the date of grant. The 1993 Plan will expire, unless earlier
terminated, as to the issuance of awards in the year 2003. At December 31, 2001,
the Company had 439,040 shares available for future grants under the 1993 Plan.
In November 1999, the Company's Board of Directors approved the 1999 Plan
which provides for the granting of stock options to eligible persons employed by
the Company who are not executive officers of the Company. Under the 1999 Plan,
the total number of stock options which may be granted is 800,000 shares. Stock
options may be granted at not less than the fair market value on the date the
options are granted and generally become exercisable after one year in 25%
increments. The options expire after ten years from the date of grant. The Board
of Directors may amend, terminate or suspend the 1999 Plan at any time. At
December 31, 2001, the Company had 81,000 shares available for future grants
under the 1999 Plan.
The 1982 Plan expired in 1994 as to issuance of stock appreciation rights,
stock options and stock awards; however, grants made before the expiration date,
that have not been fully exercised, remain outstanding pursuant to their terms.
The 1995 Plan provides for the grant of up to an aggregate of 150,000
nonqualified stock options to eligible non-employee directors of the Company.
These automatic, non-discretionary stock options are granted at an exercise
price equal to the fair market value per share of the Company's Common Stock as
of the date of grant. The term of each option is ten years, and an option first
becomes exercisable six months after the date of grant. The 1995 Plan will
terminate as to issuance of stock options in February 2005. At December 31,
2001, the Company had 111,000 options outstanding and 16,000 shares available
for future grants under the 1995 Plan.
A summary of stock option activity for all plans is set forth below (shares
in thousands):
<Table>
<Caption>
NUMBER OF
OPTIONS WEIGHTED-AVERAGE
OUTSTANDING EXERCISE PRICE
----------- ----------------
Outstanding January 1, 1999............................... 2,951.6 $13.28
Granted................................................. 940.0 12.85
Exercised............................................... (42.5) 10.86
Forfeited and expired................................... (95.7) 14.63
-------
Outstanding December 31, 1999............................. 3,753.4 13.17
Granted................................................. 1,492.0 10.01
Exercised............................................... (28.7) 7.42
Forfeited and expired................................... (193.5) 14.03
-------
Outstanding December 31, 2000............................. 5,023.2 12.23
Granted................................................. 98.0 13.18
Exercised............................................... (249.7) 6.12
Forfeited and expired................................... (20.4) 9.21
-------
Outstanding at December 31, 2001.......................... 4,851.1 12.57
=======
</Table>
At December 31, 2001, 2000 and 1999, exercisable stock options totaled 3.1
million, 2.4 million and 2.0 million, respectively.
F-46
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes information about stock options outstanding
under all plans at December 31, 2001 (shares in thousands):
<Table>
<Caption>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------- ------------------------------
WEIGHTED-AVERAGE
RANGE OF NUMBER REMAINING WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
- ---------------- ----------- ---------------- ---------------- ----------- ----------------
$ 5.25 to
$ 8.59........ 209.3 3.6 years $ 7.73 209.3 $ 7.73
$ 8.60 to
$11.94........ 2,014.1 7.6 years 10.19 881.6 10.36
$11.95 to
$15.28........ 1,528.6 6.8 years 13.70 1,043.7 14.06
$15.29 to
$18.63........ 1,099.1 6.5 years 16.30 924.3 16.37
------- -------
$ 5.25 to
$18.63........ 4,851.1 6.9 years 12.57 3,058.9 13.26
======= =======
</Table>
Phantom Stock Plan
Under the Phantom Stock Plan, a yearly credit of $7,250 is made in units to
an account ("Account") of each non-employee director, based upon the closing
market price of the Company's Common Stock on the date of credit. In addition, a
director may elect to have the value of his cash retainer fee deposited
quarterly into the Account in units. Certain non-employee directors also
received a credit in their Account in 1997 arising from the transfer of their
lump-sum accrued benefit under the frozen Director Retirement Plan. The value of
each Account balance, which is a function of the amount, if any, by which the
market value of the Company's Common Stock changes, is payable in cash at
termination (if vested with three years of service) or at retirement, death or
disability. The Company's results of operations included expense of $144,000,
$201,000 and $44,000 in 2001, 2000 and 1999, respectively, related to the
Phantom Stock Plan.
Phantom Stock Agreement
The chief executive officer of the Company holds 175,000 phantom stock
options, which were granted in 1997 at 100% of the fair value of the Company's
Common Stock on the grant date, or $16.9844 per share. At December 31, 2001, all
of the 175,000 phantom stock options were exercisable. Upon exercise, the chief
executive officer would be entitled to receive in cash the difference between
the fair market value of the Common Stock on the date of the phantom stock
option grant and the fair market value of Common Stock on the date of exercise.
At the discretion of the Compensation Committee of the Board of Directors, these
phantom stock options may be converted to traditional stock options under the
1993 Plan.
Incentive Compensation
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.
F-47
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Pro Forma Information on Stock-Based Compensation
The Company applies APB Opinion No. 25 and related interpretations in
accounting for its stock-based compensation. Had compensation cost been
determined based on the fair value at the grant dates for awards in accordance
with SFAS No. 123, "Accounting for Stock-Based Compensation," the Company's pro
forma net earnings in 2001, 2000 and 1999 would have been $85.3 million ($2.19
per basic share, $2.04 per diluted share), $68.9 million ($1.82 per basic share,
$1.65 per diluted share), and $71.4 million ($1.83 per basic share, $1.81 per
diluted share), respectively. The fair value of each option grant was estimated
on the date of grant using the Black-Scholes option-pricing model with the
following weighted-average assumptions: expected volatility of 43%, 57% and 48%;
risk free interest rates of 4.9%, 5.8% and 6.1%; expected lives of seven years;
and no dividend yields. The estimated average fair value per share of options
granted during 2001, 2000 and 1999 were $6.72, $6.21 and $7.48, respectively.
NOTE O -- COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company has various noncancellable operating leases related to
buildings, equipment, property, retail facilities, and ship charters. These
leases have remaining primary terms generally up to ten years, with terms of
certain rights-of-way extending up to 29 years, and generally contain multiple
renewal options.
During January 2000, the Company entered into an agreement with 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. Under the
agreement with Wal-Mart, each site is subject to a lease with a ten-year primary
term and an option, exercisable at the Company's discretion, to extend a site's
lease for two additional terms of five years each.
To transport crude oil and refined products, the Company charters two ships
which have primary terms of three and two years. The aggregate annual cost for
these charters is approximately $22 million ending in 2003 with two one-year
options for one ship and a single one-year option for the other ship. The
Company entered into a one-year term charter on a third ship in the second half
of 2001 with an annual cost of approximately $11 million.
In the fourth quarter of 2001, the Company sold 18 gas-fired power
generators that had been purchased and installed at the Washington refinery. At
the same time, the Company leased back these generators for a three-year term.
The lease contains extension and purchase options at fair market value. The
annual lease commitments, included in the table below, amount to $3.1 million
for each of the three years. The $15 million cost to purchase the generators was
reported in capital expenditures, and the $15 million proceeds from their sale
is reported as proceeds from asset sales in the Statement of Consolidated Cash
Flows.
The Company leases its corporate headquarters from a limited partnership in
which the Company owns a 50% limited partnership interest. The initial term of
the lease is 15 years with two five-year renewal options. Included in total rent
expense below are lease payments and operating costs paid to the partnership
totaling $2.5 million, $1.8 million and $0.5 million in 2001, 2000 and 1999,
respectively. The Company accounts for its interest in the partnership using the
equity method of accounting. As such, the partnership's assets, primarily land
and buildings, totaling approximately $18 million and debt of approximately $14
million are not included in the accompanying Consolidated Financial Statements.
F-48
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Future minimum annual lease payments as of December 31, 2001, for operating
leases having initial or remaining noncancellable lease terms in excess of one
year, including the Wal-Mart leases, ship charters and corporate headquarters,
were as follows (in millions):
<Table>
2002........................................................ $ 52.7
2003........................................................ 37.1
2004........................................................ 26.7
2005........................................................ 21.3
2006........................................................ 20.7
Remainder................................................... 141.1
</Table>
Total rental expense for short-term and long-term leases, excluding marine
charters, amounted to approximately $34 million in 2001, $26 million in 2000,
and $27 million in 1999. Total marine charter expense was $32 million in 2001,
$34 million in 2000 and $37 million in 1999. In addition, the Company leases
tugs and barges for its Hawaii operations under capital leases (see Note F)
whereby the Company pays operating costs, such as personnel, repairs,
maintenance and drydocking costs, which amounted to approximately $8 million in
2001. The Company also enters into various short-term charters for vessels to
transport refined products from the Company's refineries and terminals and to
deliver products to customers.
Other Commitments
In the normal course of business, the Company has long-term commitments to
purchase services, such as electricity, water, oxygen and sulfuric acid for use
by certain of its refineries. The minimum annual payments under these contracts
are estimated to total $11.6 million in 2002, $12.2 million in 2003, $12.2
million in 2004, $3.4 million in 2005, and $3.0 million in 2006. The remaining
minimum commitment totals approximately $31.1 million over 10 years.
Environmental and Other Matters
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
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 impact 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.
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 or install additional controls
or 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.
F-49
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In connection with the acquisition of the Hawaii refinery in 1998,
affiliates of BHP and the Company executed a separate environmental agreement,
whereby the BHP affiliates indemnified the Company for environmental costs
arising out of conditions which existed at or prior to closing. This
indemnification, which is in effect until 2008, is subject to a maximum limit of
$9.5 million ($4.4 million remaining as of December 31, 2001). Under the
environmental agreement, the first $5.0 million of these liabilities was the
responsibility of the BHP affiliates and the next $6.0 million will be shared on
the basis of 75% by the BHP affiliates and 25% by the Company. Certain
environmental claims arising out of prior operations will not be subject to the
$9.5 million limit or the ten-year time limit. The indemnity obligation of the
BHP affiliates is guaranteed by BHP.
Under the agreement related to the acquisition of the Washington refinery
in 1998, an affiliate of Shell generally agreed to indemnify the Company for
environmental liabilities at the Washington refinery arising out of conditions
which existed at or prior to the closing date and identified by the Company
prior to August 1, 2001. The Company did not identify any environmental
liabilities prior to August 1, 2001 subject to the indemnity.
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 December 31, 2001, the Company's
accruals for environmental expenses totaled $38 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 new revisions to the Clean Air
Act regulations which will require a reduction in the sulfur content in gasoline
by January 1, 2004. To meet the revised gasoline standard, the Company expects
to make capital improvements of approximately $65 million in the aggregate
through 2006 and $15 million in years after 2006.
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. The Company
expects to spend approximately $35 million in capital improvements through 2006
and $30 million in years after 2006 to meet the new diesel fuel standards.
The Company expects to spend approximately $35 million in the aggregate in
capital improvements at its refineries over the next four years to comply with
the second phase of Maximum Achievable Control Technologies for petroleum
refineries ("Refinery MACT II") which was signed into law in January 2001.
Management expects that the Refinery MACT II regulations will require new
emission controls at certain processing units at several of the Company's
refineries. The Company is currently evaluating a selection of control
technologies to assure operations flexibility and compatibility with long-term
air emission reduction goals.
In connection with the Mid-Continent Acquisition, the Company assumed the
sellers' obligations and liabilities under a consent decree among the United
States, BP Exploration and Oil Co., Amoco Oil Company and Atlantic Richfield
Company. BP entered into this consent decree for both the North Dakota and Utah
refineries for various alleged violations. As the new owner of these refineries,
the Company is required to address issues including leak detection and repair,
flaring protection and sulfur recovery unit optimization. The Company estimates
it will spend an aggregate of $18 million at the Mid-Continent refineries to
comply with this consent decree. In addition, the Company has agreed to
indemnify the sellers for all losses of any kind incurred in connection with the
consent decree.
The Company anticipates it will make additional capital improvements of
approximately $9 million in 2002 primarily for improvements to storage tanks,
tank farm secondary containment and pipelines. During 2001, the Company spent
approximately $7 million on environmental capital projects.
F-50
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Conditions that require additional expenditures may transpire 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,
federal and local requirements. The Company cannot currently determine the
amount of such future expenditures.
See Note N for information related to special incentive compensation.
NOTE P -- QUARTERLY FINANCIAL DATA (UNAUDITED)
<Table>
<Caption>
QUARTERS
----------------------------------------- TOTAL
FIRST SECOND THIRD FOURTH YEAR
-------- -------- -------- -------- --------
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
2001
Revenues................................. $1,227.3 $1,299.6 $1,412.0 $1,278.9 $5,217.8
Segment Operating Profit (as originally
reported)............................. $ 55.5 $ 68.0 $ 90.0 $ 45.8 $ 259.3
Less: General and administrative
expenses.............................. (10.5) (10.8) (16.1) (16.2) (53.6)
Other expenses...................... (1.5) (1.6) (2.0) (1.9) (7.0)
-------- -------- -------- -------- --------
Operating Income......................... $ 43.5 $ 55.6 $ 71.9 $ 27.7 $ 198.7
======== ======== ======== ======== ========
Net Earnings............................. $ 21.7 $ 29.5 $ 32.8 $ 4.0 $ 88.0
Net Earnings Per Share:
Basic................................. $ 0.61 $ 0.85 $ 0.79 $ 0.10 $ 2.26
Diluted............................... $ 0.52 $ 0.70 $ 0.79 $ 0.10 $ 2.10
2000
Revenues................................. $1,055.3 $1,218.2 $1,394.6 $1,436.3 $5,104.4
Segment Operating Profit (as originally
reported)............................. $ 34.0 $ 42.5 $ 64.1 $ 58.9 $ 199.5
Less: General and administrative
expenses.............................. (8.7) (8.9) (11.4) (11.3) (40.3)
Other expenses...................... (1.9) (1.5) (2.0) (0.4) (5.8)
-------- -------- -------- -------- --------
Operating Income......................... $ 23.4 $ 32.1 $ 50.7 $ 47.2 $ 153.4
======== ======== ======== ======== ========
Net Earnings............................. $ 9.3 $ 14.6 $ 25.0 $ 24.4 $ 73.3
Net Earnings Per Share:
Basic................................. $ 0.20 $ 0.37 $ 0.71 $ 0.69 $ 1.96
Diluted............................... $ 0.20 $ 0.35 $ 0.60 $ 0.59 $ 1.75
</Table>
The third and fourth quarters of 2001 include the results of operations of
the Mid-Continent Acquisition since the dates of acquisition.
NOTE Q -- SUBSEQUENT EVENT
The Company entered into a sale and purchase agreement with Ultramar Inc.,
a subsidiary of Valero Energy Corporation, on February 4, 2002, which was
amended on February 20, 2002. The Company agreed to acquire the 168,000
barrel-per-day Golden Eagle refinery located in Martinez, California near the
San Francisco Bay Area along with 70 associated retail sites throughout northern
California (collectively, the "Golden Eagle Assets"). The transaction, which is
subject to approval by the Federal Trade Commission and the offices of the
Attorneys General of the States of California and Oregon as well as other
customary conditions, is anticipated to close in April 2002. Under the terms of
the Golden Eagle Agreement, the Company paid a $53.75 million earnest money
deposit in February 2002. If the acquisition is not consummated by May 31, 2002
and the failure to close is a result of the Company's default (including default
because of the Company's
F-51
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
failure to obtain adequate financing for the acquisition) under the sale and
purchase agreement, the Company will forfeit its earnest money deposit.
At closing, the Company will pay the seller a cash purchase price of $995
million, less the deposit plus the value of inventory at closing, currently
estimated to be $130 million. The Company intends to finance the acquisition
with a combination of debt (including an amendment to the senior secured credit
facility) and public or private equity.
In addition to paying the purchase price for the Golden Eagle Assets, upon
the closing of the acquisition, the Company has agreed to assume a substantial
portion of the seller's obligations, responsibilities, liabilities, costs and
expenses arising out of or incurred in connection with the operation of the
Golden Eagle Assets. This includes, subject to certain exceptions, certain of
the seller's obligations, liabilities, costs and expenses for violations of
environmental laws relating to the assets, including certain known and unknown
obligations, liabilities, costs and expenses arising or incurred prior to, on or
after the closing date. Subject to certain conditions, the Company has also
agreed to assume the seller's obligations pursuant to its settlement efforts
with the EPA concerning the Section 114 refinery enforcement initiative under
the Clean Air Act, except for any potential monetary penalties which the seller
will retain.
Following the closing of the pending acquisition of the Golden Eagle
Assets, the Company also will assume and take assignment of certain of the
seller's obligations and rights (including certain indemnity rights) arising out
of or related to the agreement pursuant to which the seller purchased the
refinery in 2000. The seller has agreed to use commercially reasonable efforts
to persuade Phillips Petroleum Company, as successor to Tosco Corporation
("Phillips"), to consent to this assignment. If the seller cannot obtain a
consent from Phillips, the seller has agreed to provide the Company with a
"back-to-back" indemnity that will indemnify the Company against any liability
for which the seller is entitled to recover under the corresponding indemnity.
The seller's indemnity, however, is non-recourse to the seller and is limited to
amounts the seller actually receives from Phillips, less any legal or other
enforcement costs the seller incurs. Therefore, the indemnification that the
Company may be entitled to receive may not be sufficient to cover any losses or
damages that are incurred.
F-52
PROSPECTUS
TESORO PETROLEUM CORPORATION
SENIOR DEBT SECURITIES
SUBORDINATED DEBT SECURITIES
PREFERRED STOCK
DEPOSITARY SHARES
COMMON STOCK
STOCK PURCHASE CONTRACTS
STOCK PURCHASE UNITS
---------------------
TESORO CAPITAL TRUST I
TESORO CAPITAL TRUST II
TESORO CAPITAL TRUST III
TRUST PREFERRED SECURITIES
(GUARANTEED TO THE EXTENT SET FORTH HEREIN BY TESORO PETROLEUM CORPORATION)
---------------------
SUBSIDIARY GUARANTORS
(AS DEFINED HEREIN)
SUBSIDIARY GUARANTEES OF DEBT SECURITIES
Tesoro Petroleum Corporation ("Tesoro" or the "Company") may offer and sell
from time to time together or separately in one or more series its (i) unsecured
debt securities which may be senior (the "Senior Debt Securities"), senior
subordinated ("Senior Subordinated Debt Securities") or subordinated (the
"Subordinated Debt Securities" and, together with the Senior Debt Securities and
Senior Subordinated Debt Securities, the "Debt Securities") consisting of notes,
debentures or other evidences of indebtedness, (ii) shares of preferred stock,
no par value (the "Preferred Stock"), which may be issued in the terms of
depositary shares evidenced by depositary receipts (the "Depositary Shares"),
(iii) Depositary Shares, (iv) shares of common stock, par value $0.16 2/3 per
share (the "Common Stock"), (v) stock purchase contracts ("Stock Purchase
Contracts") to purchase shares of Common Stock or Preferred Stock and (vi) stock
purchase units ("Stock Purchase Units"), each representing ownership of a Stock
Purchase Contract and Trust Preferred Securities (as defined below) or debt
obligations of third parties, including U. S. Treasury securities, securing the
holder's obligation to purchase Common Stock or Preferred Stock under the Stock
Purchase Contract, or any combination of the foregoing, either individually or
as units consisting of one or more of the foregoing, in each case in amounts, at
prices and in terms to be determined at or prior to the time of sale. The
Company's payment obligations under any series of Debt Securities may be jointly
and severally guaranteed by certain of the Company's direct and indirect
wholly-owned subsidiaries (each a "Guarantor," and collectively the
"Guarantors").
Tesoro Capital Trust I, Tesoro Capital Trust II and Tesoro Capital Trust
III (individually, a "Tesoro Capital Trust" and collectively, the "Tesoro
Capital Trusts"), each a statutory business trust formed under the laws of the
State of Delaware, may offer and sell, from time to time, trust preferred
securities, representing undivided beneficial interests in the assets of the
respective Tesoro Capital Trusts ("Trust Preferred Securities"). Tesoro will be
the beneficial owner of all the beneficial ownership interests represented by
common securities of each of the Tesoro Capital Trusts (the "Trust Common
Securities" and, together with the Trust Preferred Securities, the "Trust
Securities"). Holders of the Trust Preferred Securities will be entitled to
receive preferential cumulative cash distributions accumulating from the date of
original issuance and payable periodically as specified in the applicable
supplement to this prospectus (a "Prospectus Supplement"). Subordinated Debt
Securities may be issued and sold by Tesoro from time to time in one or more
series to a Tesoro Capital Trust, or a trustee of such Tesoro Capital Trust, in
connection with the investment of the proceeds from the offering of Trust
Securities of such Tesoro Capital Trust. The Subordinated Debt Securities
purchased by a Tesoro Capital Trust may be subsequently distributed pro rata to
holders of Trust Securities in connection with the dissolution of such Tesoro
Capital Trust upon the occurrence of certain events as may be described in a
related Prospectus Supplement. The payment of distributions with respect to
Trust Preferred Securities of each of the Tesoro Capital Trusts out of monies
held by each of the Tesoro Capital Trusts, and payment on liquidation,
redemption or otherwise with respect to such Trust Preferred Securities, will be
guaranteed by Tesoro to the extent described herein (each a "Trust Guarantee").
See "Description of the Trust Guarantees." Tesoro's obligations under the Trust
Guarantees will be subordinate and junior in right of payment to all other
liabilities of Tesoro and rank pari passu with the most senior preferred stock,
if any, issued from time to time by Tesoro.
(Continued on next page)
FOR A DISCUSSION OF CERTAIN RISKS ASSOCIATED WITH AN INVESTMENT IN THE
SECURITIES AND THE TRUST PREFERRED SECURITIES, SEE "RISK FACTORS" ON PAGE 3.
---------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
---------------------
May 14, 1998
(Continued from previous page)
The Common Stock, the Preferred Stock, the Depositary Shares, Debt
Securities, Stock Purchase Units, Stock Purchase Contracts and Trust Securities
offered hereby are collectively hereinafter referred to as the "Securities." The
Securities will be limited to an aggregate initial public offering price not to
exceed approximately $600 million, or, in the case of Debt Securities, the
equivalent thereof in one or more foreign currencies, including composite
currencies. The Securities may be offered, separately or together, in separate
series, in amounts, at prices and on terms to be determined at the time of sale
and set forth in a related Prospectus Supplement.
Certain specific terms of the particular Securities for which this
Prospectus is being delivered will be set forth in a related Prospectus
Supplement, including, where applicable, (i) in the case of Debt Securities and
the Subsidiary Guarantees thereof, the specific designation, aggregate principal
amount, authorized denominations, maturities, interest rate or rates (which may
be fixed or variable), the date or dates on which interest, if any, shall be
payable, the place or places where principal of and premium, if any, and
interest, if any, on such Debt Securities of the series will be payable, terms
of optional or mandatory redemption or any sinking fund or analogous provisions,
currency or currencies, or currency unit or currency units of denomination and
payment if other than U.S. dollars, the initial public offering price, terms
relating to temporary or permanent global securities, provisions regarding
convertibility or exchangeability, if any, provisions regarding registration of
transfer or exchange, the proceeds to the Company and other special terms; (ii)
in the case of Preferred Stock, the specific designations, the number of shares,
dividend rights (including, if applicable, the manner of calculation thereof),
and any liquidation, redemption, conversion, exchange, voting and other rights,
the initial public offering price and other special terms; (iii) in the case of
Depositary Shares, the aggregate number of Depositary Shares offered, the
fractional share of Preferred Stock represented by each such Depositary Share
and the purchase price thereof; (iv) in the case of Common Stock, the terms of
the offering and sales thereof; (v) in the case of Stock Purchase Contracts, the
number of shares of Common Stock issuable thereunder, the purchase price of the
Common Stock, the date or dates on which the Common Stock is required to be
purchased by the holders of the Stock Purchase Contracts, any periodic payments
required to be made by the Company to the holders of the Stock Purchase
Contracts or vice versa, and the terms of the offering and sale thereof, (vi) in
the case of Stock Purchase Units, the specific terms of the Stock Purchase
Contracts and any Trust Preferred Securities or debt obligations of third
parties securing the holder's obligation to purchase the Common Stock under the
Stock Purchase Contracts, and the terms of the offering and the sale thereof,
and (vii) in the case of the Trust Preferred Securities or the related Trust
Guarantees, the specific designation, aggregate offering amount, denomination,
term, coupon rate, time of payment of distributions, terms of redemption at the
option of Tesoro or repayment at the option of the holder, provisions regarding
convertibility or exchangeability for capital stock of Tesoro, the designation
of the Trustee(s) acting under the applicable Indenture or Trust Guarantee and
the public offering price.
The Securities may be offered and sold to or through underwriters, dealers,
or agents as designated from time to time, or through a combination of such
methods, and also may be offered and sold directly to one or more other
purchasers. See "Plan of Distribution." The names of, and the principal amounts
or number of shares to be purchased by, underwriters, dealers or agents, and the
compensation of such underwriters, dealers or agents, including any applicable
fees, commissions, and discounts, will be set forth in the related Prospectus
Supplement. No Securities may be sold without delivery of a Prospectus
Supplement describing such series or issue of Securities and the method and
terms of offering thereof.
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE DEBT SECURITIES,
INCLUDING STABILIZING AND SYNDICATE COVERING TRANSACTIONS. THE UNDERWRITERS MAY
OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE
OF THE SECURITIES OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE
PREVAIL IN THE OPEN MARKET. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "PLAN OF
DISTRIBUTION."
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information may be inspected and copied at the public
reference facilities maintained by the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the following Regional Offices of the Commission:
7 World Trade Center, Suite 1300, New York, New York 10048; and Northwestern
Atrium, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511.
Copies of such material also may be obtained at prescribed rates from the Public
Reference Section of the Commission, 450 Fifth Street, N.W., Washington, D.C.
20549. Such material also may be accessed electronically by means of the
Commission's home page on the Internet at http://www.sec.gov. The Common Stock
is listed for trading on the New York Stock Exchange (the "NYSE") and the
Pacific Stock Exchange (the "PSE") under the trading symbol "TSO," and reports,
proxy statements and other information concerning the Company may be inspected
at the offices of the NYSE, 20 Broad Street, New York, New York 10005, and at
the offices of the PSE, 301 Pine Street, San Francisco, California 94104.
No separate financial statements of the Tesoro Capital Trusts have been
included or incorporated by reference herein. Neither the Tesoro Capital Trusts
nor the Company considers such financial statements material to holders of Trust
Preferred Securities because (i) all of the voting securities of each Tesoro
Capital Trust will be owned, directly or indirectly, by the Company, a reporting
company under the Exchange Act, (ii) no Tesoro Capital Trust has independent
operations but rather each exists for the purpose of issuing securities
representing undivided beneficial interests in the assets of such Tesoro Capital
Trust and investing the proceeds thereof in Subordinated Debt Securities, and
(iii) the obligations of the Tesoro Capital Trusts under the Trust Preferred
Securities are fully and unconditionally guaranteed on a subordinated basis by
the Company to the extent set forth herein. See "The Tesoro Capital Trusts" and
"Description of Trust Guarantees." Upon the granting of relief by the Commission
pursuant to SAB 53, the Company intends to provide only abbreviated information
concerning the Tesoro Capital Trusts in the Company's Exchange Act reports.
This Prospectus does not contain all of the information set forth in the
Registration Statement of which this Prospectus is a part, filed with the
Commission under the Securities Act of 1933, as amended (the "Securities Act").
Reference is made to such Registration Statement for further information with
respect to the Company, the Tesoro Capital Trusts and the Securities offered
hereby. Statements contained herein concerning the provisions of documents are
necessarily summaries of such documents, and each statement is qualified in its
entirety by reference to the copy of the applicable document filed with the
Commission.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents heretofore filed with the Commission by the Company
pursuant to the Exchange Act are incorporated herein by reference:
1. The Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1997, as amended on Form 10-K/A, filed April 30, 1998.
2. The Company's Current Report on Form 8-K, dated as of May 13, 1998.
3. The description of the Common Stock included in the Company's Registration
Statement on Form 8-A dated April 21, 1969, as amended by a Form 8 dated
April 23, 1969.
All documents filed by the Company pursuant to Section 13(a), 13(c), 14 or
15(d) of the Exchange Act subsequent to the date of this Prospectus and prior to
the termination of the offering of the Securities offered hereby shall be deemed
to be incorporated by reference in this Prospectus and to be part hereof from
the date of filing of such documents. Any statement contained in a document
incorporated or deemed to be incorporated by reference herein shall be deemed to
be modified or superseded for purposes of this Prospectus to the extent that a
statement contained therein or in any other subsequently filed document which
also is or is
i
deemed to be incorporated by reference herein modifies or supersedes such
statement. Any such statement so modified or superseded shall not be deemed,
except as so modified or superseded, to constitute a part of this Prospectus.
The Company will provide without charge to each person, including any
beneficial owner of a Security, to whom a copy of this Prospectus is delivered,
upon written or oral request of such person, a copy of any or all documents
incorporated by reference in this Prospectus (other than exhibits to such
documents unless such exhibits are specifically incorporated by reference into
such documents). Requests for such copies should be directed to Tesoro Petroleum
Corporation, 8700 Tesoro Drive, San Antonio, Texas 78217-6218, Attention: Vice
President and Treasurer, (telephone: (800) 837-6768).
CERTAIN FORWARD-LOOKING STATEMENTS
Statements in this Prospectus and the accompanying Prospectus Supplement
(including the documents incorporated by reference herein) concerning the
Company which are (a) projections of revenues, earnings, earnings per share,
capital expenditures or other financial items, (b) statements of plans and
objectives for future operations, including acquisitions, (c) statements of
future economic performance, or (d) statements of assumptions or estimates
underlying or supporting the foregoing are forward-looking statements within the
meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act. The ultimate accuracy of forward-looking statements is subject to a wide
range of business risks and changes in circumstances, and actual results and
outcomes often differ from expectations. Any number of important factors could
cause actual results to differ materially from those in the forward-looking
statements herein, including the following: the timing and extent of changes in
commodity prices and underlying demand and availability of crude oil and other
refinery feedstocks, refined products, and natural gas; actions of customers and
competitors; changes in the cost or availability of third-party vessels,
pipelines and other means of transporting feedstocks and products; 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; execution of planned capital projects; weather conditions
affecting the Company's operations or the areas in which the Company's products
are marketed; future well performance; the extent of Tesoro's success in
acquiring oil and gas properties and in discovering, developing and producing
reserves; political developments in foreign countries; the conditions of the
capital markets and equity markets during the periods covered by the forward-
looking statements; earthquakes or other natural disasters affecting operations;
adverse rulings, judgments, or settlements in litigation or other legal matters,
including unexpected environmental remediation costs in excess of any reserves;
and adverse changes in the credit ratings assigned to the Company's trade
credit. For more information with respect to the foregoing, see the Form 10-K.
The Company undertakes no obligation to publicly release the result of any
revisions to any such forward-looking statements that may be made to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
ii
THE COMPANY
The Company and its subsidiaries are engaged in petroleum refining,
distributing and marketing of petroleum products, marine logistics services and
the exploration and production of natural gas and oil. These operations are
conducted through three business segments: Refining and Marketing, Exploration
and Production, and Marine Services.
The Company's Refining and Marketing segment operates a petroleum refinery
at Kenai, Alaska, markets refined products through a large network of branded
stations in Alaska and is expanding its marketing presence in the Pacific
Northwest. This segment is also a major supplier of jet fuel to the Anchorage
airport and diesel fuel to Alaska's fishing and marine industry. The Company's
Marine Services segment operates through a network of 23 marine terminals
located in Louisiana and Texas and on the West Coast, distributing petroleum
products and providing logistics services to the offshore Gulf of Mexico
drilling industry and other customers. The Company's Exploration and Production
segment focuses on exploration, development and production of natural gas and
oil onshore in Texas, Louisiana and Bolivia. The Company's net proved worldwide
reserves totaled 517 billion cubic feet equivalents of natural gas at year-end
1997. The Company is focused on its long-term strategy to maximize returns and
develop full value of its assets through strategic expansions, acquisitions and
diversifications in all three of its operating segments.
Tesoro was incorporated in Delaware in 1968 (a successor by merger to a
California corporation incorporated in 1939). Its principal executive offices
are located at 8700 Tesoro Drive, San Antonio, Texas 78217-6218 and its
telephone number is (800) 837-6768.
RECENT DEVELOPMENTS
HAWAII REFINERY ACQUISITION
On March 18, 1998, Tesoro entered into a stock sale agreement ("Hawaii
Stock Sale Agreement") to purchase (the "Hawaii Acquisition") all of the
outstanding stock of two subsidiaries of The Broken Hill Proprietary Company
Limited ("BHP") (together, "BHP Hawaii"). BHP Hawaii owns and operates a
95,000-barrel per day refinery in Kapolei, Hawaii, on the island of Oahu,
approximately 20 miles west of Honolulu, and 32 retail gasoline stations on the
islands of Oahu, Maui and Hawaii. The Hawaii Acquisition, which is subject to
regulatory review and other customary conditions, is anticipated to close on May
29, 1998. Under the terms of the Hawaii Stock Sale Agreement, the Company has
deposited $5 million into an escrow account for this acquisition.
At closing the cash purchase price for the Hawaii Acquisition is currently
estimated to be approximately $275 million less the $5 million escrow deposit.
In addition, Tesoro will issue an unsecured, non-interest bearing promissory
note (the "BHP Note") in the amount of $50 million, payable in five equal annual
installments of $10 million each, beginning on the eleventh anniversary date of
the closing. The BHP Note provides for earlier payment if the financial
performance of BHP Hawaii exceeds certain thresholds. The purchase price will be
adjusted after the closing for the amount by which the working capital of BHP
Hawaii differs from $100 million at the closing date.
In order to ensure the continuity of crude supply to Hawaii Refinery,
Tesoro will also enter into a two year agreement with an affiliate of BHP to
assist Tesoro in acquiring crude oil feedstock sources outside of North America
and arranging for transportation of such crude oil to the Hawaii Refinery.
WASHINGTON STATE REFINERY ACQUISITION
On May 1, 1998, the Company entered into a stock purchase agreement
("Anacortes Stock Purchase Agreement") with Shell Refining Holding Company
("Seller") and Shell Anacortes Refining Company ("SARC"), both subsidiaries of
Shell Oil Company, whereby the Company will purchase all of the outstanding
stock of SARC. SARC owns and operates a 108,000-barrel a day refinery in
Anacortes, Washington, which is approximately 60 miles north of Seattle. The
acquisition, which is subject to approval by the Federal Trade Commission and
the offices of the attorneys general of the States of Oregon and
1
Washington as well as other customary conditions, is anticipated to close in mid
to late summer. Under the terms of the Anacortes Stock Purchase Agreement, the
Company has paid a $5 million deposit and has agreed to pay the balance of the
purchase price into an escrow by June 30, 1998 if the stock purchase has not
closed by that date.
At closing the Company will pay the Seller a cash purchase price of $237
million, less the deposit and any escrowed amounts, for the stock of SARC, plus
the value of the working capital of SARC at the time of closing which is
estimated to be approximately $60 million. The SARC Stock Purchase Agreement
contains representations and warranties and other general provisions that are
customary for transactions of this nature.
THE TESORO CAPITAL TRUSTS
Each of Tesoro Capital Trust I, Tesoro Capital Trust II and Tesoro Capital
Trust III is a statutory business trust created under Delaware law pursuant to
(i) a separate declaration of trust (each a "Declaration") executed by Tesoro,
as sponsor for such Tesoro Capital Trust (the "Sponsor"), and the Trustees (as
defined herein) for such Tesoro Capital Trust and (ii) the filing of a
certificate of trust with the Delaware Secretary of State. Each Declaration will
be qualified as an indenture under the Trust Indenture Act of 1939, as amended
(the "TIA"). Each Tesoro Capital Trust exists for the exclusive purposes of (i)
issuing and selling the Trust Securities, (ii) investing the gross proceeds from
the sale of the Trust Securities in Subordinated Debt Securities issued by
Tesoro and (iii) engaging in only those other activities necessary or incidental
thereto.
All of the Trust Common Securities issued by each of the Tesoro Capital
Trusts will be directly or indirectly owned by Tesoro. The Trust Common
Securities will rank pari passu, and payments will be made thereon pro rata,
with the Trust Preferred Securities except that upon an event of default under
the applicable Declaration, the rights of the holders of the Trust Common
Securities to payment in respect of distributions and payments upon liquidation,
redemption, and otherwise will be subordinated to the rights of the holders of
the Trust Preferred Securities. Tesoro will, directly or indirectly, acquire
Trust Common Securities in an aggregate liquidation amount equal to 3% of the
total capital of each Tesoro Capital Trust. A majority of the Trustees (the
"Regular Trustees") of each Tesoro Capital Trust will be persons who are
employees or officers of or affiliated with Tesoro. One trustee of each Tesoro
Capital Trust will be a financial institution that will be unaffiliated with
Tesoro and that will act as property trustee and as indenture trustee for
purposes of the Trust Indenture Act, pursuant to the terms set forth in a
Prospectus Supplement (the "Property Trustee"). In addition, unless the Property
Trustee maintains a principal place of business in the State of Delaware, and
otherwise meets the requirements of applicable law, one trustee of each Tesoro
Capital Trust will have its principal place of business or reside in the State
of Delaware (the "Delaware Trustee" and, together with the Regular Trustees and
the Property Trustee, the "Trustees"). Each Tesoro Capital Trust's business and
affairs will be conducted by the Trustees appointed by the Company, as the
direct or indirect holder of all the Trust Common Securities. Except in certain
limited circumstances, the holder of the Trust Common Securities will be
entitled to appoint, remove or replace any of, or increase or reduce the number
of, the Trustees of a Tesoro Capital Trust. The duties and obligations of the
Trustees shall be governed by the Declaration of each Tesoro Capital Trust. The
Company will pay all fees and expenses related to the Tesoro Capital Trusts and
the offering of Trust Securities, the payment of which will be guaranteed by the
Company. The office of the Delaware Trustee for each Tesoro Capital Trust in the
State of Delaware is Wilmington Trust Company, 1100 North Market Street,
Wilmington, Delaware 19890. The principal place of business of each Tesoro
Capital Trust shall be c/o Tesoro Petroleum Corporation, 8700 Tesoro Drive, San
Antonio 78217-6218 (telephone: (800) 837-6768).
THE SUBSIDIARY GUARANTORS
The Subsidiary Guarantors, listed on the "Table of Other Co-Registrants"
set forth immediately following the cover page of the Registration Statement of
which this Prospectus is a part, constitute substantially all of the direct and
indirect active subsidiaries of the Company, as of the date of this Prospectus.
Each or all Subsidiary Guarantors may jointly and severally guarantee the
payment obligations of the Company under any series of Debt Securities offered
by this Prospectus, as set forth in a related Prospectus Supplement.
2
USE OF PROCEEDS
Unless otherwise specified in a Prospectus Supplement, the net proceeds
received by the Company from the sale of the Securities will be used to finance
acquisitions, refinance certain existing indebtedness and for general corporate
purposes. Funds not required immediately for such purposes may be invested in
marketable securities and short-term investments. The Tesoro Capital Trusts will
use all proceeds received from the sale of the Trust Preferred Securities to
purchase Subordinated Debt Securities from the Company.
RATIO OF EARNINGS TO FIXED CHARGES
<Table>
<Caption>
YEARS ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995 1994 1993
----- ----- ----- ----- -----
Ratio of Earning to Fixed Charges...................... 3.61x 5.64x 3.28x 2.00x 1.97x
Ratio of Earnings to Combined Fixed Charges and
Preferred Stock Dividend Requirements................ 3.61x 5.64x 3.28x 1.80x 1.33x
</Table>
For purposes of calculating this ratio: (i) "fixed charges" consist of
interest expense (whether expensed or capitalized), amortization of debt
discount and issuance costs and the portion of rental expense estimated to be
equivalent to interest; and (ii) "earnings" represent earnings before income
taxes and extraordinary loss on extinguishments of debt plus fixed charges,
excluding capitalized interest.
RISK FACTORS
THE SECURITIES TO BE OFFERED HEREBY MAY INVOLVE A HIGH DEGREE OF RISK. SUCH
RISKS WILL BE SET FORTH IN THE PROSPECTUS SUPPLEMENT RELATING TO SUCH SECURITY.
IN ADDITION, CERTAIN RISK FACTORS, IF ANY, RELATING TO THE COMPANY'S BUSINESS
WILL BE SET FORTH IN A PROSPECTUS SUPPLEMENT.
3
DESCRIPTION OF DEBT SECURITIES
The following is a description of certain general terms and provisions of
the Debt Securities. The particular terms of any series of Debt Securities will
be described in the applicable Prospectus Supplement. If so indicated in a
Prospectus Supplement, the terms of any such series may differ from the terms
set forth below.
Debt Securities may be issued from time to time in one or more series by
the Company. The Debt Securities will constitute either indebtedness designated
as Senior Indebtedness ("Senior Debt Securities"), indebtedness designated as
Senior Subordinated Indebtedness ("Senior Subordinated Debt Securities") or
indebtedness designated as Subordinated Indebtedness ("Subordinated Debt
Securities"). The Company may issue Debt Securities with different terms from
those of Debt Securities previously issued without the consent of holders of
previously issued series of Debt Securities. The particular terms of each series
of Debt Securities offered by a particular Prospectus Supplement will be
described therein. Senior Debt Securities, Senior Subordinated Debt Securities
and Subordinated Debt Securities will each be issued under a separate indenture
(individually, an "Indenture" and, collectively, the "Indentures") to be entered
into prior to the issuance of such Debt Securities. See "-- Subordination".
There will be a separate Trustee (individually, a "Trustee" and, collectively,
the "Trustees") under each Indenture. Information regarding the Trustee under an
Indenture will be included in any Prospectus Supplement relating to the Debt
Securities issued thereunder.
The following discussion includes a summary description of material terms
of the Indentures, other than terms that are specific to a particular series of
Debt Securities and related Subsidiary Guarantees, if any, and that will be
described in the Prospectus Supplement relating to such series. The following
summaries do not purport to be complete and are subject to, and are qualified in
their entirety by reference to, all of the provisions of the Indentures,
including the definitions therein of certain terms capitalized in this
Prospectus. Wherever particular Sections or Articles or defined terms of the
Indentures are referred to herein or in a Prospectus Supplement, such Sections
or defined terms are incorporated herein or therein by reference.
To the extent applicable to the Debt Securities of a particular series, as
indicated in the applicable Prospectus Supplement, there are no provisions of
the Indentures that afford holders of the Debt Securities protection in the
event of a highly leveraged transaction involving the Company.
GENERAL
The Senior Debt Securities will be issued under an indenture (the "Senior
Indenture"), to be entered into among the Company, any Subsidiary Guarantors and
a Senior Indenture Trustee. The Senior Subordinated Debt Securities will be
issued under a separate Indenture (the "Senior Subordinated Indenture") to be
entered into among the Company, any Subsidiary Guarantor and a Senior
Subordinated Indenture Trustee. The Subordinated Debt Securities will be issued
under a separate indenture (the "Subordinated Indenture") also to be entered
into between the Company, any Subsidiary Guarantors and the Subordinated
Trustee. The Senior Indenture, the Senior Subordinated Indenture and the
Subordinated Indenture are sometimes collectively referred to herein as the
"Indentures" and individually as an "Indenture." The Indentures are subject to
and governed by the TIA, and may be supplemented from time to time following
execution.
The terms of the Debt Securities include those stated in the applicable
Indenture and those made part of such Indenture by reference to the TIA. The
Debt Securities are subject to all such terms, and holders of Debt Securities
are referred to the applicable Indenture and the TIA for a statement of those
terms.
The statements set forth below in this section are brief summaries of
certain provisions contained in the Indentures, do not purport to be complete,
and are subject to, and are qualified in their entirety by reference to, the
Indentures, including the definitions of certain terms therein, and the TIA.
Capitalized terms used in this section and not otherwise defined in this section
have the respective meanings assigned to them in the Indentures. For purposes of
this section, the term "Company" refers to Tesoro Petroleum Corporation only and
does not include its subsidiaries.
4
TERMS
The Debt Securities will be direct, unsecured obligations of the Company.
The indebtedness represented by the Senior Debt Securities will rank equally
with all other unsecured and unsubordinated indebtedness of the Company. The
indebtedness represented by the Senior Subordinated Securities will be
subordinated in right of payment to the prior payment in full of all Senior Debt
(as defined in a related Prospectus Supplement and the Applicable Indenture) of
the Company and senior to any future junior subordinated indebtedness of the
Company as described below under "-- Subordination." The indebtedness
represented by the Subordinated Debt Securities will be subordinated in right of
payment to the prior payment in full of the Senior Debt (as defined in a related
Prospectus Supplement and the Applicable Indenture) of the Company as described
below under "-- Subordination."
In the event Subordinated Debt Securities are issued to a Tesoro Capital
Trust or a trustee of such trust in connection with the issuance of Trust
Securities by such Tesoro Capital Trust, such Subordinated Debt Securities
subsequently may be distributed pro rata to the holders of such Trust Securities
in connection with the dissolution of such Tesoro Capital Trust upon the
occurrence of certain events described in the Prospectus Supplement relating to
such Trust Securities. Only one series of Subordinated Debt Securities will be
issued to a Tesoro Capital Trust or a trustee of such trust in connection with
the issuance of Trust Securities by such Tesoro Capital Trust.
Reference is made to the Prospectus Supplement relating to the particular
series offered thereby for the terms of such Debt Securities, including where
applicable: (a) the form and title of the Debt Securities and whether such Debt
Securities are Senior Debt Securities, Senior Subordinated Securities or
Subordinated Debt Securities; (b) the aggregate principal amount of the Debt
Securities and any limit on such aggregate principal amount; (c) the date or
dates on which the Debt Securities may be issued; (d) the date or dates on which
the principal of and premium, if any, on the Debt Securities shall be payable;
(e) the rate or rates (which may be fixed or variable) at which the Debt
Securities shall bear interest, if any, and the date or dates from which such
interest shall accrue; (f) the dates on which interest, if any, shall be payable
and the record dates for the interest payment dates; (g) the place or places
where the principal of and premium, if any, and interest, if any, on the Debt
Securities of the series will be payable; (h) the period or periods, if any,
within which, the price or prices at which, and the terms and conditions upon
which, the Debt Securities may be redeemed at the option of the Company or
otherwise; (i) any optional or mandatory redemption or any sinking fund or
analogous provisions; (j) if other than denominations of $1,000 and integral
multiples thereof, the denominations in which the Debt Securities of the series
shall be issuable; (k) if other than the principal amount thereof, the portion
of the principal amount of the Debt Securities which shall be payable upon
declaration of the acceleration of the maturity thereof in accordance with the
provisions of the applicable Indenture; (l) whether payment of the principal of
and premium, if any, and interest, if any, on the Debt Securities shall be
without deduction for taxes, assessments, or governmental charges paid by the
holders; (m) the currency or currencies, or currency unit or currency units, in
which the principal of and premium, if any, and interest, if any, on the Debt
Securities shall be denominated, payable, redeemable or purchasable, as the case
may be; (n) any Events of Default with respect to the Debt Securities that
differ from those set forth in the applicable Indenture; (o) whether the Debt
Securities will be convertible; (p) whether the Debt Securities of such series
shall be issued as a global certificate or certificates and, in such case, the
identity of the depositary for such series; (q) provisions regarding the
convertibility or exchangeability of the Debt Securities; (r) covenants
restricting the Company's and its subsidiaries' ability to make certain types of
payments and investments, incur indebtedness and dispose of assets; and (s) any
other terms not inconsistent with the provisions of the applicable Indenture.
Unless otherwise indicated in the Prospectus Supplement relating thereto,
the Debt Securities of any series will be issued only in fully registered form
in denominations of $1,000 or any integral multiple thereof. The Debt Securities
of a series may be issuable in the form of one or more global certificates,
which will be denominated in an amount equal to all or a portion of the
aggregate principal amount of such Debt Securities. See "-- Global Debt
Securities."
5
Each Indenture provides that the Debt Securities may be issued in one or
more series, in each case as established from time to time in, or pursuant to
authority granted by, a resolution of the board of directors of the Company or
as established in one or more indentures supplemental to such Indenture. All
Debt Securities of one series need not be issued at the same time and, unless
otherwise provided, a series may be reopened, without the consent of the holders
of the Debt Securities of such series, for issuances of additional Debt
Securities of such series.
One or more series of Debt Securities offered hereby may be sold at a
substantial discount below their stated principal amount, bearing no interest or
interest at a rate that at the time of issuance is below market rates. The
federal income tax consequences and special considerations applicable to any
such series of Debt Securities will be described generally in the Prospectus
Supplement relating thereto.
GLOBAL DEBT SECURITIES
The Debt Securities of a series may be issued in whole or in part in the
form of one or more global certificates that will be deposited with, or on
behalf of, a depositary (the "Global Note Depositary"), or its nominee,
identified in the Prospectus Supplement relating to such series. Unless and
until such global certificate or certificates are exchanged in whole or in part
for Debt Securities in individually certificated form, a global Debt Security
may not be transferred or exchanged except as a whole to a nominee of the Global
Note Depositary for such global Debt Security, or by a nominee for the Global
Note Depositary to the Global Note Depositary, or to a successor of the Global
Note Depositary or a nominee of such successor, except in the circumstances
described in the applicable Prospectus Supplement.
The specific terms of the depositary arrangement with respect to a series
of Debt Securities and the rights of, and limitations on, owners of beneficial
interests in a global Debt Security representing all or a portion of a series of
Debt Securities will be described in the Prospectus Supplement relating to such
series.
SUBSIDIARY GUARANTEES
The Company's payment obligations under any series of the Debt Securities
may be jointly and severally guaranteed (the "Subsidiary Guarantees") by one or
more Subsidiaries of the Company (the "Guarantors"), including the Subsidiary
Guarantors named herein. Any Subsidiary of the Company that guarantees any
Indebtedness of the Company may be required to execute a Subsidiary Guarantee
and become a Guarantor under the applicable Indenture. The terms of any such
Subsidiary Guarantee will be set forth in the applicable Prospectus Supplement.
However, the obligations of each Guarantor under its Subsidiary Guarantee will
be limited to the maximum amount the Guarantors are permitted to guarantee under
applicable law without creating a "fraudulent conveyance."
Each Indenture may restrict the consolidation or merger with or into a
Guarantor or provide for the release of a Subsidiary Guarantee, as set forth in
a related Prospectus Supplement and the Applicable Indenture.
Each of the Indentures may provide that if any Subsidiary of the Company
guarantees any Indebtedness of the Company that is not a party to the Indenture,
then such Subsidiary shall (i) execute a supplemental indenture in form and
substance satisfactory to the Trustee thereunder providing that such Subsidiary
shall become a Guarantor under the applicable Indenture and (ii) deliver an
opinion of counsel to the effect, inter alia, that such supplemental indenture
has been duly authorized and executed by such Subsidiary.
CHANGE OF CONTROL
Each of the Indentures will provide that, with respect to a series of Debt
Securities, in the event that there shall occur a Change of Control (as defined
in a related Prospectus Supplement and the Applicable Indenture), then the
Company may be required to make an Offer (as described under "-- Procedures for
Offers" below) to purchase all or any part (equal to $1,000 or an integral
multiple thereof) of each holder's Debt Securities of the applicable series at a
purchase price equal to 101% of the aggregate principal amount thereof, plus
accrued and unpaid interest to the date of purchase. Such right to require the
repurchase of Debt
6
Securities shall not continue after a discharge of the Company from its
obligations with respect to the Debt Securities. See "-- Defeasance."
A Change of Control purchase feature of a series of Debt Securities may, in
certain circumstances, make it more difficult or discourage a takeover of the
Company and, as a result, may make removal of incumbent management more
difficult. The Company has no present intention to engage in a transaction
involving a Change of Control, although it is possible that the Company could
decide to do so in the future.
If a Change of Control were to occur, the Company may not have sufficient
liquid assets to satisfy its obligation to purchase all of the Debt Securities
that might be delivered by holders seeking to exercise the purchase right and
make any payments that may become necessary, if not waived.
The provisions of each of the Indentures would not necessarily afford
holders of the Debt Securities protection in the event of a highly leveraged
transaction, reorganization, restructuring, merger or similar transaction
involving the Company that may adversely affect such holders.
COVENANTS
The particular covenants, including covenants relating to the issuance of
Subordinated Debt Securities to a Tesoro Capital Trust or a trustee of such
Tesoro Capital Trust, relating to any series of Debt Securities will be
described in the Prospectus Supplement relating to such series. If any such
covenants are described, the Prospectus Supplement will also state whether the
"covenant defeasance" provisions described below also apply.
PROCEDURES FOR OFFERS
Within 30 days following a Change of Control, the Company will mail to each
holder of Debt Securities, at such holder's registered address, a notice
stating: (i) the Offer is being made as a result of a Change of Control, the
length of time the Offer shall remain open, and the maximum aggregate principal
amount of Debt Securities that will be accepted for payment pursuant to such
Offer, (ii) the purchase price, the amount of accrued and unpaid interest as of
the Purchase Date, and the Purchase Date, (iii) the circumstances and material
facts regarding such Change of Control, to the extent known to the Company
(including, but not limited to, information with respect to pro forma and
historical financial information after giving effect to such Change of Control,
and information regarding the Person or Persons acquiring control), and (iv)
such other information required by each of the Indentures and applicable laws
and regulations.
On the Purchase Date for any Offer, the Company will (1) accept for payment
all Debt Securities tendered pursuant to such Offer, (2) deposit with the Paying
Agent the aggregate purchase price of all Debt Securities accepted for payment
and any accrued and unpaid interest on such Debt Securities as of the Purchase
Date, and (3) deliver or cause to be delivered to each of the Trustees all Debt
Securities tendered pursuant to the Offer. If less than all Debt Securities
tendered pursuant to any Offer are accepted for payment by the Company for any
reason, selection of the Debt Securities to be purchased will be in compliance
with the requirements of the principal national securities exchange, if any, on
which any series of Debt Securities is listed or, if not so listed, by lot or by
such method as each of the Trustees shall deem fair and appropriate; provided
that Debt Securities accepted for payment in part shall only be purchased in
integral multiples of $1,000. The Paying Agent will promptly mail to each holder
of Debt Securities accepted for payment an amount equal to the purchase price
for such Debt Securities plus any accrued and unpaid interest. Each of the
Trustees will promptly authenticate and mail to holders of Debt Securities
accepted for payment in part new Debt Securities equal in principal amount to
any unpurchased portion of each holder's Debt Securities, and any Debt
Securities not accepted for payment in whole or in part shall be promptly
returned to the holder thereof. On and after a Purchase Date, interest will
cease to accrue on the Debt Securities accepted for payment. The Company will
announce the results of the Offer to holders of the Debt Securities on or as
soon as practicable after the Purchase Date.
7
The Company will comply with all applicable requirements of Rule 14e-1
under the Exchange Act and all other applicable securities laws and regulations
thereunder, to the extent applicable, in connection with any offer.
EVENTS OF DEFAULT
Each Indenture provides that the following will be Events of Default with
respect to any series of Debt Securities issued thereunder: (a) failure to pay
any interest on any Debt Security of such series when due, continued for 30
days; (b) failure to pay principal of (or premium, if any, on) any Debt Security
of such series when due; (c) failure to perform or comply with any covenant or
warranty of the Company contained in the Debt Securities of such series or in
the applicable Indenture, continued for 30 days after written notice as provided
in the Indenture (other than a default otherwise specifically dealt with in the
applicable Indenture or in any supplemental indenture); (d) failure to deposit a
sinking fund payment, if any, when and as due by the terms of a Debt Security of
such series; (e) except as permitted by the applicable Indenture, any Subsidiary
Guarantee shall be held in any judicial proceeding to be unenforceable or
invalid or shall cease for any reason to be in full force and effect or any
Guarantor, or any Person acting on behalf of any Guarantor, shall deny or
disaffirm its obligations under its Subsidiary Guarantee (other than by reason
of the termination of the Indenture or the release of any such Subsidiary
Guarantee in accordance with the Indenture); (f) certain events in bankruptcy,
insolvency or reorganization affecting the Company or any Guarantor; and (g) any
other Event of Default set forth in the applicable supplemental indenture and
Prospectus Supplement relating to the Debt Securities of such series.
If an Event of Default under either Indenture with respect to Debt
Securities of any series at the time outstanding shall occur and be continuing,
then in every such case either the applicable Trustee or the holders of at least
25% in aggregate principal amount of the outstanding Debt Securities of that
series may accelerate the maturity of all Debt Securities of that series;
provided, however, that after such acceleration, but before a judgment or decree
based on acceleration, the holders of a majority in aggregate principal amount
of outstanding Debt Securities of that series may, under certain circumstances,
rescind and annul such acceleration if all Events of Default, other than the
nonpayment of accelerated principal, have been cured or waived as provided in
the applicable Indenture.
Each Indenture provides that no holder of any Debt Security will have any
right to institute any proceeding with respect to the applicable Indenture or
for any remedy thereunder, unless such holder shall have previously given to the
Trustee thereunder written notice of a continuing Event of Default and unless
the holders of at least 25% in aggregate principal amount of the outstanding
Debt Securities of such series shall have made written request, and offered
reasonable indemnity, to the Trustee to institute such proceeding as Trustee,
and the Trustee shall not have received from the holders of a majority in
aggregate principal amount of the outstanding Debt Securities of such series a
direction inconsistent with such request and shall have failed to institute such
proceeding within 60 days. However, such limitations do not apply to a suit
instituted by a holder of a Debt Security for enforcement of payment of the
principal of (and premium, if any) or interest on such Debt Security on or after
the respective due dates expressed in such Debt Security.
Subject to provisions in each Indenture relating to its duties in case an
Event of Default shall have occurred and be continuing, neither Trustee is under
an obligation to exercise any of its rights or powers under such Indenture at
the request or direction of any holders of Debt Securities then outstanding
under such Indenture, unless such holders shall have offered to the Trustee
thereunder reasonable indemnity. Subject to the provisions in each Indenture for
the indemnification of the Trustee thereunder, the holders of a majority in
aggregate principal amount of the outstanding Debt Securities of any series will
have the right to direct the time, method and place of conducting any proceeding
for any remedy available to the applicable Trustee or exercising any trust or
power conferred on such Trustee.
The Company will be required to furnish to each Trustee annually a
statement as to the performance by the Company of certain of its obligations
under the applicable Indenture and as to any default in such performance.
8
DEFEASANCE
Each Indenture provides that, at the option of the Company, (A) if
applicable, the Company will be discharged from any and all obligations in
respect of the Debt Securities of any series issued under such Indenture or (B)
if applicable, the Company may omit to comply with certain restrictive
covenants, and that such omission shall not be deemed to be an Event of Default
under the applicable Indenture and the Debt Securities of any series issued
thereunder, and that such Debt Securities shall no longer be subject to the
subordination provisions in the case of either (A) or (B) upon irrevocable
deposit with the applicable Trustee, in trust, of money and/or U.S. government
obligations which will provide money in an amount sufficient in the opinion of a
nationally recognized accounting firm to pay the principal of and premium, if
any, and each installment of interest, if any, on such Debt Securities. With
respect to clause (B), the obligations under the applicable Indenture other than
with respect to such covenants and the Events of Default other than the Event of
Default relating to such covenants above shall remain in full force and effect.
Such trust may only be established if, among other things (i) with respect to
clause (A), the Company has received from, or there has been published by, the
IRS a ruling or there has been a change in law, which in the Opinion of Counsel
provides that holders of such Debt Securities will not recognize gain or loss
for federal income tax purposes as a result of such deposit, defeasance and
discharge and will be subject to federal income tax on the same amount, in the
same manner and at the same times as would have been the case if such deposit,
defeasance and discharge had not occurred; or, with respect to clause (B), the
Company has delivered to the applicable Trustee an Opinion of Counsel to the
effect that the holders of such Debt Securities will not recognize gain or loss
for federal income tax purposes as a result of such deposit and defeasance and
will be subject to federal income tax on the same amount, in the same manner and
at the same times as would have been the case if such deposit and defeasance had
not occurred; (ii) no Event of Default or event that, with the passing of time
or the giving of notice, or both, shall constitute an Event of Default with
respect to such Debt Securities shall have occurred or be continuing; (iii) the
Company has delivered to the applicable Trustee an Opinion of Counsel to the
effect that such deposit shall not cause such Trustee or the trust so created to
be subject to the Investment Company Act of 1940; and (iv) certain other
customary conditions precedent.
SUBORDINATION
Upon any distribution to creditors of the Company in a liquidation,
dissolution or reorganization, the payment of the principal of and interest on
the Senior Subordinated Debt Securities and Subordinated Debt Securities will be
subordinated to the extent provided in the respective Senior Subordinated
Indenture and Subordinated Indenture in right of payment to the prior payment in
full of all Senior Debt, but the obligation of the Company to make payment of
the principal of and interest on the Senior Subordinated Debt Securities or
Subordinated Debt Securities will not otherwise be affected. Except as provided
in a Prospectus Supplement, no payment of principal or interest may be made on
the Senior Subordinated Debt Securities or Subordinated Debt Securities at any
time if a default on Senior Debt exists that permits the holders of such Senior
Debt to accelerate its maturity and the default is the subject of judicial
proceedings or the Company receives notice of the default. The Subordinated
Indenture may also provide that Subordinated Debt Securities issued thereunder
are subordinated and junior in right of payment to the prior payment in full of
all existing or future Senior Subordinated Debt Securities. After all Senior
Debt is paid in full and until the Senior Subordinated Debt Securities or
Subordinated Debt Securities (as the case may be) are paid in full, Holders will
be subrogated to the rights of holders of Senior Debt to the extent that
distributions otherwise payable to Holders have been applied to the payment of
Senior Debt. By reason of such subordination, in the event of a distribution of
assets upon insolvency, certain general creditors of the Company may recover
more, ratably, than holders of the Subordinated Debt Securities.
MODIFICATION AND WAIVER
Modifications and amendments of either Indenture may be made by the Company
and the applicable Trustee with the consent of the holders of a majority in
aggregate principal amount of all outstanding Debt Securities issued under such
Indenture which are affected by such modification or amendment; provided,
however, that no such modification or amendment may, without the consent of the
holder of each such Debt Security affected thereby, (a) change the Stated
Maturity of the principal of, or any installment of interest on,
9
any such Debt Security, (b) reduce the principal amount of (or the premium), or
interest on, any such Debt Security, (c) change the place or currency of payment
of principal of (or premium), or interest on, any such Debt Security, (d) impair
the right to institute suit for the enforcement of any payment on or with
respect to any such Debt Security, (e) reduce the above-stated percentage of
outstanding Debt Securities of any series necessary to modify or amend the
applicable Indenture, (f) reduce the percentage of aggregate principal amount of
outstanding Debt Securities of any series necessary for waiver of compliance
with certain provisions of the applicable Indenture or for waiver of certain
defaults, or (g) modify any provisions of such Indenture relating to the
modification and amendment of such Indenture or the waiver of past defaults or
covenants, except as otherwise specified in a Prospectus Supplement.
The holders of a majority in aggregate principal amount of the outstanding
Debt Securities of a series may waive compliance by the Company with certain
restrictive provisions of the applicable Indenture. The holders of a majority in
aggregate principal amount of the outstanding Debt Securities of a series may
waive any past default under the applicable Indenture. In the case of any series
of Subordinated Debt Securities held as trust assets of a Tesoro Capital Trust,
the consent of the holders of all of the holders of the Preferred Trust
Securities and Common Trust Securities of such Tesoro Capital Trust may be
required under the Declaration of Trust of such Tesoro Capital Trust.
THE TRUSTEE
Both Indentures provide that, except during the continuance of an Event of
Default, the Trustee thereunder will perform only such duties as are
specifically set forth in the applicable Indenture. During the existence of an
Event of Default, the Trustee will exercise such rights and powers vested in it
under such Indenture and use the same degree of care and skill in its exercise
as a prudent person would exercise under the circumstances in the conduct of
such person's own affairs.
Both Indentures and the provisions of the TIA incorporated by reference
therein contain limitations on the rights of each of the Trustees, should it
become a creditor of the Company, to obtain payment of claims in certain cases
or to realize on certain property received by it in respect of any such claim as
security or otherwise. Each of the Trustees are permitted to engage in other
transactions with the Company or any Affiliate; provided, however, that if it
acquires any conflicting interest (as defined in the applicable Indenture or in
the TIA), it must eliminate such conflict or resign.
NO PERSONAL LIABILITY OF OFFICERS, DIRECTORS, EMPLOYEES OR STOCKHOLDERS
No director, officer, employee or stockholder, as such, of the Company or
any of its affiliates shall have any personal liability in respect of the
obligations of the Company under either of the Indentures or the Debt Securities
by reason of his, her or its status as such.
APPLICABLE LAW
The Indentures are, and the Debt Securities offered hereby will be,
governed by, and construed in accordance with, the laws of the State of New
York.
DESCRIPTION OF PREFERRED STOCK
The Company's Board of Directors, without any further action by the
stockholders of the Company, is authorized to issue up to 5,000,000 shares of
Preferred Stock, and to divide the Preferred Stock into one or more series, and
to fix by resolution or resolutions any of the designations, powers, preferences
and rights, and the qualifications, limitations, or restrictions of the shares
of each such series, including, but not limited to, dividend rates, conversion
rights, voting rights, terms of redemption and liquidation preferences, and the
number of shares constituting each such series. The issuance of Preferred Stock
may have the effect of delaying, deterring, or preventing a Change in Control of
the Company. Preferred Stock, upon issuance against full payment of the purchase
price therefor, will be fully paid and nonassessable. The specific terms of a
particular series of Preferred Stock will be described in the Prospectus
Supplement relating to that series.
10
The description of the terms of the particular series of Preferred Stock set
forth in the related Prospectus Supplement does not purport to be complete and
is qualified in its entirety by reference to the certificate of designation
relating to the particular series of Preferred Stock.
The designations, powers, preferences and rights, and the qualifications,
limitations, or restrictions of the Preferred Stock of each series will be fixed
by the certificate of designation relating to such series. The Prospectus
Supplement relating to each series will specify the terms of the Preferred Stock
as follows:
(a) The maximum number of shares to constitute such series and the
distinctive designation thereof;
(b) The annual dividend rate, if any, on shares of such series,
whether such rate is fixed or variable or both, the date or dates from
which dividends will begin to accrue or accumulate, and whether dividends
will be cumulative;
(c) The price at which, and the terms and conditions on which, the
shares of such series may be redeemed, including the time during which
shares of such series may be redeemed and any accumulated dividends thereon
that the holders of shares of such series shall be entitled to receive upon
the redemption thereof;
(d) The liquidation preference, if any, and any accumulated dividends
thereon, that the holders of shares of such series shall be entitled to
receive upon the liquidation, dissolution, or winding up of the affairs of
the Company;
(e) Whether or not the shares of such series will be subject to
operation of a retirement or sinking fund, and, if so, the extent and
manner in which any such fund shall be applied to the purchase or
redemption of the shares of such series for retirement or for other
corporate purposes, and the terms and provisions relating to the operation
of such fund;
(f) The terms and conditions, if any, on which the shares of such
series shall be convertible into, or exchangeable for, debt securities,
shares of any other class or classes of capital stock of the Company, or
any series of any other class or classes, or of any other series of the
same class, including the price or prices or the rate or rates of
conversion or exchange, whether such conversion or exchange will be
mandatory and the method, if any, of adjusting the same;
(g) The voting rights, if any, on the shares of such series; and
(h) Any or all other preferences and relative, participating,
operational, or other special rights, qualifications, limitations, or
restrictions thereof.
The federal income tax consequences and special considerations applicable
to any such series of Preferred Stock will be generally described in the
Prospectus Supplement relating thereto.
DESCRIPTION OF DEPOSITARY SHARES
GENERAL
The following summary and the summary in any Prospectus Supplement of the
terms and provisions of the Depositary Shares and Depositary Receipts does not
purport to be complete and is subject to and qualified in its entirety by
reference to the applicable Deposit Agreement, which will be filed as an exhibit
to or incorporated by reference in the Registration Statement of which this
Prospectus is a part.
The Company may, at its option, elect to offer fractional interests in
shares of Preferred Stock, rather than full shares of Preferred Stock. In the
event such option is exercised, the Company will issue to the public receipts
for Depositary Shares, each of which will represent a fraction (to be set forth
in the applicable Prospectus Supplement) of a share of a particular series of
Preferred Stock as described below.
The shares of any series of Preferred Stock represented by Depositary
Shares will be deposited under a Deposit Agreement (a "Deposit Agreement")
between the Company and a bank or trust company selected by
11
the Company having its principal office in the United States and having a
combined capital and surplus of at least $50,000,000 (a "Depositary"). Subject
to the terms of the Deposit Agreement, each owner of a Depositary Share will be
entitled, in proportion to the applicable fraction of a share of Preferred Stock
underlying by such Depositary Share, to all the rights and preferences of the
Preferred Stock underlying such Depositary Share (including dividend, voting,
redemption, conversion and liquidation rights).
The Depositary Shares will be evidenced by depositary receipts issued
pursuant to the Deposit Agreement ("Depositary Receipts"). Depositary Receipts
will be distributed to those persons purchasing the fractional interests in
shares of Preferred Stock in accordance with the terms of the offering.
Pending the preparation of definitive engraved Depositary Receipts, the
Depositary may, upon the written order of the Company, issue temporary
Depositary Receipts substantially identical to (and entitling the holders
thereof to all the rights pertaining to) the definitive Depositary Receipts but
not in definitive form. Definitive Depositary Receipts will be prepared
thereafter without unreasonable delay, and temporary Depositary Receipts will be
exchangeable for definitive Depositary Receipts at the Company's expense. In
addition, subject to the terms of the Deposit Agreement, holders of Depositary
Shares are entitled to withdraw and receive, upon surrender of Depositary
Receipts, certificates evidencing the fractional number of shares of Preferred
Stock (but only whole shares thereof) represented by such Depositary Receipts.
Partial shares of Preferred Stock will not be issued.
DIVIDENDS AND OTHER DISTRIBUTIONS
The Depositary will distribute all cash dividends or other cash
distributions received in respect of the Preferred Stock to the record holders
of Depositary Shares relating to such Preferred Stock in proportion to the
number of such Depositary Shares owned by such holders. The Depositary will
distribute only such amount, however, as can be distributed without attributing
to any holder of Depositary Shares a fraction of one cent, and any balance not
so distributable will be held by the Depositary (without liability for interest
thereon) and will be added to and treated as part of the next sum received by
the Depositary for distribution to record holders of Depositary Receipts then
outstanding.
In the event of a distribution other than in cash, the Depositary will
distribute property received by it to the record holders of Depositary Shares
entitled thereto, in proportion to the number of such Depositary Shares owned by
such holders, unless the Depositary determines that it is not feasible to make
such distribution, in which case the Depositary may, with the approval of the
Company, adopt such method as it deems equitable and practicable to effect such
distribution, including the sale of such property and distribution of the net
proceeds from such sale to such holders.
REDEMPTION OF DEPOSITARY SHARES
If a series of Preferred Stock represented by Depositary Shares is subject
to redemption, the Depositary Shares will be redeemed from the proceeds received
by the Depositary resulting from the redemption, in whole or in part, of such
series of Preferred Stock held by the Depositary. The redemption price per
Depositary Share will be equal to the applicable fraction of the redemption
price per share payable with respect to such series of the Preferred Stock.
Whenever the Company redeems shares of Preferred Stock held by the Depositary,
the Depositary will redeem as of the same redemption date the number of
Depositary Shares representing the shares of Preferred Stock so redeemed. If
fewer than all the Depositary Shares are to be redeemed, the Depositary Shares
to be redeemed will be selected by lot or pro rata as may be determined by the
Depositary.
VOTING THE PREFERRED STOCK
Upon receipt of notice of any meeting at which the holders of the Preferred
Stock represented by Depositary Shares are entitled to vote, the Depositary will
mail the information contained in such notice of meeting to the record holders
of the Depositary Shares relating to such Preferred Stock. Each record holder of
such Depositary Shares on the record date (which will be the same date as the
record date for the Preferred Stock) will be entitled to instruct the Depositary
as to the exercise of the voting rights pertaining to the
12
amount of the Preferred Stock represented by such holder's Depositary Shares.
The Depositary will endeavor, insofar as practicable, to vote the amount of the
Preferred Stock represented by such Depositary Shares in accordance with such
instructions, and the Company will agree to take all action which may be deemed
necessary by the Depositary in order to enable the Depositary to do so. The
Depositary will abstain from voting shares of the Preferred Stock represented by
Depositary Shares to the extent it does not receive specific instructions from
the holders of Depositary Shares representing such Preferred Stock.
AMENDMENT AND TERMINATION OF THE DEPOSITARY AGREEMENT
The form of Depositary Receipt evidencing the Depositary Shares and any
provision of the Deposit Agreement may at any time and from time to time be
amended by agreement between the Company and the Depositary. However, any
amendment that materially and adversely alters the rights of the holders of
Depositary Shares will not be effective unless such amendment has been approved
by the holders of at least a majority of the Depositary Shares then outstanding
under such Deposit Agreement. Each Deposit Agreement will provide that each
holder of Depositary Shares at the time any such amendment becomes effective
that continues to hold such Depositary Shares will be deemed to have consented
to such amendment and will be bound thereby. A Deposit Agreement may be
terminated by the Company or the Depositary only if (i) all outstanding
Depositary Shares relating thereto have been redeemed or (ii) there has been a
final distribution in respect of the Preferred Stock underlying such Depositary
Shares in connection with any liquidation, dissolution or winding up of holdings
and such distribution has been distributed to the holders of the related
Depositary Receipts.
CHARGES OF DEPOSITARY
The Company will pay all transfer and other taxes and governmental charges
arising solely from the existence of the depositary arrangements. The Company
will pay charges of any Depositary in connection with the initial deposit of the
Preferred Stock and the initial issuance of the Depositary Shares and any
redemption or conversion of the Preferred Stock. Holders of Depositary Receipts
will pay other transfer and other taxes and governmental charges and such other
charges, including a fee for the withdrawal of shares of Preferred Stock upon
surrender of Depositary Receipts, as are expressly provided in the relevant
Deposit Agreement to be for their accounts.
MISCELLANEOUS
The Depositary will forward to holders of Depositary Receipts all reports
and communications from the Company that are delivered to the Depositary and
which the Company is required to furnish to the holders of the Preferred Stock.
Neither any Depositary nor the Company will assume any obligation or will
be subject to any liability under a Deposit Agreement to holders of the
Depositary Shares other than for its negligence or willful misconduct. Neither
any Depositary nor the Company will be liable if it is prevented or delayed by
law or any circumstance beyond its control in performing its obligations under a
Deposit Agreement. The obligations of the Company and any Depositary under a
Deposit Agreement will be limited to performance in good faith of their duties
thereunder, and they will not be obligated to prosecute or defend any legal
proceeding in respect of any Depositary Shares or Preferred Stock unless
satisfactory indemnity is furnished. The Company and any Depositary may rely on
written advice of counsel or accountants, on information provided by persons
presenting Preferred Stock for deposit, holders of Depositary Shares or other
persons believed in good faith to be competent to give such information and on
documents believes to be genuine and to have been signed or presented by the
proper party or parties.
RESIGNATION AND REMOVAL OF DEPOSITARY
A Depositary may resign at any time by delivering to the Company notice of
its election to do so, and the Company may at any time remove any Depositary,
any such resignation or removal to take effect upon the appointment of a
successor Depositary and its acceptance of such appointment. Such successor
Depositary
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must be appointed within 60 days after delivery of the notice of resignation or
removal and must be a bank or trust company having its principal office in the
United States of America and having a combined capital and surplus of at least
$50,000,000.
DESCRIPTION OF COMMON STOCK
The Company's Certificate of Incorporation, as amended, currently
authorizes the Company to issue up to 50,000,000 shares of Common Stock. The
holders of Common Stock are entitled to one vote for each share held of record
on all matters submitted to a vote of stockholders. Subject to preferences that
may be applicable to any outstanding Preferred Stock, holders of Common Stock
are entitled to receive ratably such dividends as may be declared by the Board
of Directors of the Company out of funds legally available therefor. In the
event of a liquidation, dissolution, or winding up of the Company, holders of
Common Stock are entitled to share ratably in all assets remaining after payment
of liabilities and liquidation preference of any outstanding Preferred Stock.
Holders of Common Stock have no preemptive rights and have no rights to convert
their Common Stock into any other securities. There are no redemption provisions
with respect to any shares of Common Stock. All of the outstanding shares of
Common Stock are, and the Common Stock offered hereby will be, upon issuance
against full payment of the purchase price therefor, fully paid and
nonassessable. As of April 22, 1998 there were issued and outstanding 26,668,910
shares of Common Stock.
The transfer agent and registrar for the Common Stock is ChaseMellon
Shareholder Services L.L.C.
DESCRIPTION OF THE STOCK PURCHASE CONTRACTS
AND THE STOCK PURCHASE UNITS
The Company may issue Stock Purchase Contracts, including contracts
obligating holders to purchase from the Company, and the Company to sell to the
holders, a specified number of shares of Common Stock or Preferred Stock at a
future date or dates. The consideration per share of Common Stock or Preferred
Stock may be fixed at the time of the Stock Purchase Contracts are issued or may
be determined by reference to a specific formula set forth in the Stock Purchase
Contracts. Any such formula may include anti-dilution provisions to adjust the
number of shares issuable pursuant to such Stock Purchase Contracts upon the
occurrence of certain events. The Stock Purchase Contracts may be issued
separately or as a part of Stock Purchase Units consisting of a Stock Purchase
Contract and Debt Securities, Trust Preferred Securities or debt obligations of
third parties, including U. S. Treasury securities, securing the holders'
obligations to purchase the Common Stock or Preferred Stock under the Stock
Purchase Contracts. The Stock Purchase Contracts may require the Company to make
periodic payments to the holders of the Stock Purchase Contracts or vice versa,
and such payments may be unsecured or prefunded on some basis. The Stock
Purchase Contracts may require holders to secure their obligations thereunder in
a specified manner.
The applicable Prospectus Supplement will describe the terms of any Stock
Purchase Contracts or Stock Purchase Units. The description in the Prospectus
Supplement will not necessarily be complete, and reference will be made to the
Stock Purchase Contracts, and, if applicable, collateral arrangements and
depository arrangements, relating to such Stock Purchase Contracts or Stock
Purchase Units.
DESCRIPTION OF THE TRUST PREFERRED SECURITIES
Each Tesoro Capital Trust may issue, from time to time, only one series of
Trust Preferred Securities having terms described in the Prospectus Supplement
relating thereto. The Declaration of each Tesoro Capital Trust authorizes the
Regular Trustees of such Tesoro Capital Trust to issue on behalf of such Tesoro
Capital Trust one series of Trust Preferred Securities. The Declaration will be
qualified as an indenture under the TIA. The Trust Preferred Securities will
have such terms, including distributions, redemption, voting, conversion,
exchange, liquidation rights and such other preferred, deferred or other special
rights or such restrictions as shall be set forth in the Declaration or made
part of the Declaration by the Trust Indenture Act. Reference is made to the
Prospectus Supplement relating to the Trust Preferred Securities of the Tesoro
Capital Trust for specific terms, including (a) the distinctive designation of
such Trust Preferred Securities;
14
(b) the number of Trust Preferred Securities issued by such Tesoro Capital
Trust; (c) the annual distribution rate (or method of determining such rate) for
Trust Preferred Securities issued by such Tesoro Capital Trust and the date or
dates upon which such distributions shall be payable; provided, however, that
distributions on such Trust Preferred Securities shall be payable on a quarterly
basis to holders of such Trust Preferred Securities as of a record date in each
quarter during which such Trust Preferred Securities are outstanding; (d)
whether distributions on Trust Preferred Securities issued by such Tesoro
Capital Trust shall be cumulative, and, in the case of Trust Preferred
Securities having such cumulative distribution rights, the date or dates or
method of determining the date or dates from which distributions on Trust
Preferred Securities issued by such Tesoro Capital Trust shall be cumulative;
(e) the amount or amounts which shall be paid out of the assets of such Tesoro
Capital Trust to the holders of Trust Preferred Securities of such Tesoro
Capital Trust upon voluntary or involuntary dissolution, winding-up or
termination of such Tesoro Capital Trust; (f) the obligation, if any, of such
Tesoro Capital Trust to purchase or redeem Trust Preferred Securities issued by
such Tesoro Capital Trust and the price or prices at which, the period or
periods within which, and the terms and conditions upon which, Trust Preferred
Securities issued by such Tesoro Capital Trust shall be purchased or redeemed,
in whole or in part, pursuant to such obligation; (g) the voting rights, if any,
of Trust Preferred Securities issued by such Tesoro Capital Trust in addition to
those required by law, including the number of votes per Trust Preferred
Security and any requirement for the approval by the holders of Trust Preferred
Securities, or of Trust Preferred Securities issued by one or more Tesoro
Capital Trusts, or of both, as a condition to specified action or amendments to
the Declaration of such Tesoro Capital Trust; (h) the terms and conditions, if
any, upon which the assets of such Tesoro Capital Trust may be distributed to
holders of Trust Preferred Securities; (i) provisions regarding convertibility
or exchangeability of the Trust Preferred Securities for capital stock of
Tesoro; (j) if applicable, any securities exchange upon which the Trust
Preferred Securities shall be listed; and (k) any other relevant rights,
preferences, privileges, limitations or restrictions of Trust Preferred
Securities issued by such Tesoro Capital Trust not inconsistent with the
Declaration of such Tesoro Capital Trust or with applicable law. All Trust
Preferred Securities offered hereby will be guaranteed by the Company to the
extent set forth below under "Description of the Trust Guarantees." Any U.S.
federal income tax considerations applicable to any offering of Trust Preferred
Securities will be described in the Prospectus Supplement relating thereto.
In connection with the issuance of Trust Preferred Securities, each Tesoro
Capital Trust will issue one series of Trust Common Securities. The Declaration
of each Tesoro Capital Trust authorizes the Regular Trustees of such trust to
issue on behalf of such Tesoro Capital Trust one series of Trust Common
Securities having such terms including distributions, redemption, voting,
liquidation rights or such restrictions as shall be set forth therein. The terms
of the Trust Common Securities issued by a Tesoro Capital Trust will be
substantially identical to the terms of the Trust Preferred Securities issued by
such Tesoro Capital Trust, and the Trust Common Securities will rank pari passu,
and payments will be made thereon pro rata, with the Trust Preferred Securities
except that, upon an event of default under the Declaration, the rights of the
holders of the Trust Common Securities to payment in respect of distributions
and payments upon liquidation, redemption and otherwise will be subordinated to
the rights of the holders of the Trust Preferred Securities. Except in certain
limited circumstances, the Trust Common Securities will also carry the right to
vote to appoint, remove or replace any of the Trustees of a Tesoro Capital
Trust. All of the Trust Common Securities of each Tesoro Capital Trust will be
directly or indirectly owned by the Company.
DESCRIPTION OF THE TRUST GUARANTEES
Set forth below is a summary of information concerning the Trust Guarantees
which will be executed and delivered by Tesoro from time to time for the benefit
of the holders of the Trust Preferred Securities. Each Trust Guarantee will be
qualified as an indenture under the Trust Indenture Act. Wilmington Trust
Company will act as indenture trustee under each Trust Guarantee (the "Trust
Guarantee Trustee"). The terms of each Trust Guarantee will be those set forth
in such Trust Guarantee and those made part of such Trust Guarantee by the Trust
Indenture Act. The summary does not purport to be complete and is subject in all
respects to the provisions of, and is qualified in its entirety by reference to,
the form of Trust Guarantee, which is filed as an exhibit to the Registration
Statement of which this Prospectus forms a part, and the Trust Indenture Act.
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Each Trust Guarantee will be held by the Trust Guarantee Trustee for the benefit
of the holders of the Trust Preferred Securities of the applicable Tesoro
Capital Trust.
GENERAL
Pursuant to each Trust Guarantee, Tesoro will irrevocably and
unconditionally agree, to the extent set forth therein, to pay in full, to the
holders of the Trust Preferred Securities issued by a Tesoro Capital Trust, the
Trust Guarantee Payments (as defined herein) (except to the extent paid by such
Tesoro Capital Trust), as and when due, regardless of any defense, right of
set-off or counterclaim which such Tesoro Capital Trust may have or assert. The
following payments with respect to Trust Preferred Securities issued by a Tesoro
Capital Trust to the extent not paid by such Tesoro Capital Trust (the "Trust
Guarantee Payments"), will be subject to the Trust Guarantee thereon (without
duplication): (i) any accrued and unpaid distributions which are required to be
paid on such Trust Preferred Securities, to the extent such Tesoro Capital Trust
shall have funds available therefor; (ii) the redemption price, including all
accrued and unpaid distributions (the "Redemption Price"), to the extent such
Tesoro Capital Trust has funds available therefor with respect to any Trust
Preferred Securities called for redemption by such Tesoro Capital Trust; and
(iii) upon a voluntary or involuntary dissolution, winding-up or termination of
such Tesoro Capital Trust (other than in connection with the distribution of the
assets of such Tesoro Capital Trust to the holders of Trust Preferred Securities
or the redemption of all of the Trust Preferred Securities), the lesser of (a)
the aggregate of the liquidation amount and all accrued and unpaid distributions
on such Trust Preferred Securities to the date of payment, to the extent such
Tesoro Capital Trust has funds available therefor and (b) the amount of assets
of such Tesoro Capital Trust remaining available for distribution to holders of
such Trust Preferred Securities in liquidation of such Tesoro Capital Trust.
Tesoro's obligation to make a Trust Guarantee Payment may be satisfied by direct
payment of the required amounts by the Company to the holders of Trust Preferred
Securities or by causing the applicable Tesoro Capital Trust to pay such amounts
to such holders.
Each Trust Guarantee will be a full and unconditional guarantee with
respect to the Trust Preferred Securities issued by the applicable Tesoro
Capital Trust, but will not apply to any payment of distributions except to the
extent such Tesoro Capital Trust shall have funds available therefor. If Tesoro
does not make interest payments on the Subordinated Debt Securities purchased by
a Tesoro Capital Trust, such Tesoro Capital Trust will not pay distributions on
the Trust Preferred Securities issued by such Tesoro Capital Trust and will not
have funds available therefor. See "Description of the Subordinated Debt
Securities -- Certain Covenants."
Tesoro has also agreed separately to irrevocably and unconditionally
guarantee the obligations of the Tesoro Capital Trusts with respect to the Trust
Common Securities (the "Trust Common Securities Guarantees") to the same extent
as the Trust Guarantees, except that upon an event of default under the
Subordinated Indenture, holders of Trust Preferred Securities shall have
priority over holders of Trust Common Securities with respect to distributions
and payments on liquidation, redemption or otherwise.
CERTAIN COVENANTS
In each Trust Guarantee, Tesoro will covenant that, so long as any Trust
Preferred Securities issued by the applicable Tesoro Capital Trust remain
outstanding, if there shall have occurred any event that would constitute an
event of default under such Trust Guarantee or the Declaration of such Tesoro
Capital Trust, then (a) Tesoro shall not declare or pay any dividend on, make
any distributions with respect to, or redeem, purchase or make any liquidation
payment with respect to, any of its capital stock (other than (i) purchases or
acquisitions of shares of Tesoro Common Stock in connection with the
satisfaction by Tesoro of its obligations under any employee benefit plans or
the satisfaction by Tesoro of its obligations pursuant to any contract or
security requiring Tesoro to purchase shares of Company Common Stock or, (ii)
the purchase of fractional interests in shares of Company capital stock as a
result of a reclassification of Company capital stock or the exchange or
conversion of one class or series of Company capital stock for another class or
series of Company capital stock or make any guarantee payments with respect to
the foregoing and (b) Tesoro shall not make any payment of interest, principal
or premium, if any, on or repay, repurchase or redeem any debt securities
(including guarantees) issued by Tesoro which rank pari passu with or junior to
the Subordinated Debt Securities.
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MODIFICATION OF THE TRUST GUARANTEES; ASSIGNMENT
Except with respect to any changes which do not adversely affect the rights
of holders of Trust Preferred Securities (in which case no vote will be
required), each Trust Guarantee may be amended only with the prior approval of
the holders of not less than a majority in liquidation amount of the outstanding
Trust Preferred Securities issued by the applicable Tesoro Capital Trust. The
manner of obtaining any such approval of holders of such Trust Preferred
Securities will be as set forth in an accompanying Prospectus Supplement. All
guarantees and agreements contained in a Trust Guarantee shall bind the
successors, assigns, receivers, trustees and representatives of Tesoro and shall
inure to the benefit of the holders of the Trust Preferred Securities of the
applicable Tesoro Capital Trust then outstanding.
TERMINATION
Each Trust Guarantee will terminate as to the Trust Preferred Securities
issued by the applicable Tesoro Capital Trust upon the first to occur of (a)
full payment of the Redemption Price of all Trust Preferred Securities of such
Tesoro Capital Trust, (b) distribution of the assets of such Tesoro Capital
Trust to the holders of the Trust Preferred Securities of such Tesoro Capital
Trust, and (c) full payment of the amounts payable upon liquidation of such
Tesoro Capital Trust in accordance with the Declaration of such Tesoro Capital
Trust. Each Trust Guarantee will continue to be effective or will be reinstated,
as the case may be, if at any time any holder of Trust Preferred Securities
issued by the applicable Tesoro Capital Trust must restore payment of any sums
paid under such Trust Preferred Securities or such Trust Guarantee.
EVENTS OF DEFAULT
An event of default under a Trust Guarantee will occur upon the failure of
Tesoro to perform any of its payment or other obligations thereunder.
The holders of a majority in liquidation amount of the Trust Preferred
Securities relating to such Trust Guarantee have the right to direct the time,
method and place of conducting any proceeding for any remedy available to the
Trust Guarantee Trustee in respect of the Trust Guarantee or to direct the
exercise of any trust or power conferred upon the Trust Guarantee Trustee under
such Trust Preferred Securities. If the Trust Guarantee Trustee fails to enforce
such Trust Guarantee, any holder of Trust Preferred Securities relating to such
Trust Guarantee may institute a legal proceeding directly against Tesoro to
enforce the Trust Guarantee Trustee's rights under such Trust Guarantee, without
first instituting a legal proceeding against the relevant Tesoro Capital Trust,
the Trust Guarantee Trustee or any other person or entity. Notwithstanding the
foregoing, if Tesoro has failed to make a guarantee payment, a holder of Trust
Preferred Securities may directly institute a proceeding against Tesoro for
enforcement of the Trust Guarantee for such payment. Tesoro waives any right or
remedy to require that any action be brought first against such Tesoro Capital
Trust or any other person or entity before proceeding directly against Tesoro.
STATUS OF THE TRUST GUARANTEES
The Trust Guarantees will constitute unsecured obligations of Tesoro and
will rank (i) subordinate and junior in right of payment to all other
liabilities of Tesoro; (ii) pari passu with the most senior preferred or
preference stock now or hereafter issued by Tesoro and with any guarantee now or
hereafter entered into by Tesoro in respect of any preferred or preference stock
of any affiliate of Tesoro; and (iii) senior to the Tesoro Common Stock. The
terms of the Trust Preferred Securities provide that each holder of Trust
Preferred Securities issued by the applicable Tesoro Capital Trust, by
acceptance thereof, agrees to the subordination provisions and other terms of
the Trust Guarantee relating thereto.
The Trust Guarantees will constitute a guarantee of payment and not of
collection (that is, the guaranteed party may institute a legal proceeding
directly against the guarantor to enforce its rights under the Trust Guarantee
without instituting a legal proceeding against any other person or entity).
INFORMATION CONCERNING THE TRUST GUARANTEE TRUSTEE
The Trust Guarantee Trustee, prior to the occurrence of a default with
respect to a Trust Guarantee, undertakes to perform only such duties as are
specifically set forth in such Trust Guarantee and, after default,
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shall exercise the same degree of care as a prudent individual would exercise in
the conduct of his or her own affairs. Subject to such provisions, the Trust
Guarantee Trustee is under no obligation to exercise any of the powers vested in
it by a Trust Guarantee at the request of any holder of Trust Preferred
Securities, unless offered reasonable indemnity against the costs, expenses and
liabilities which might be incurred thereby.
The Company and certain of its affiliates may, from time to time, maintain
a banking relationship with the Trust Guarantee Trustee.
GOVERNING LAW
The Trust Guarantees will be governed by, and construed in accordance with,
the laws of the State of New York.
RELATIONSHIP AMONG THE TRUST PREFERRED SECURITIES,
THE SUBORDINATED DEBT SECURITIES AND THE TRUST GUARANTEES
As long as Tesoro makes payments of interest and other payments when due on
the Subordinated Debt Securities, such payments will be sufficient to cover
distributions and other payments due on the Trust Preferred Securities,
primarily because (i) the aggregate principal amount of the Subordinated Debt
Securities will be equal to the sum of the aggregate stated liquidation
preference of the Trust Securities; (ii) the interest rate and interest and
other payment dates of the Subordinated Debt Securities will match the
distribution rate and distribution and other payment dates for the Trust
Preferred Securities; (iii) Tesoro shall pay for all and any costs, expenses and
liabilities of the Tesoro Capital Trusts except the Tesoro Capital Trusts'
obligations to holders of the Trust Preferred Securities under the Trust
Preferred Securities of the Tesoro Capital Trusts; and (iv) the Declaration of
each Tesoro Capital Trust further provides that such Tesoro Capital Trust will
not engage in any activity that is not consistent with the limited purposes of
such Tesoro Capital Trust.
Payments of distributions and other amounts due on the Trust Preferred
Securities of a Tesoro Capital Trust (to the extent such Tesoro Capital Trust
has funds available for the payment of such distributions) are irrevocably
guaranteed by Tesoro as and to the extent set forth under "Description of Trust
Guarantees." Taken together, Tesoro's obligations under the Subordinated Debt
Securities, the Subordinated Indenture, the Declarations of the Tesoro Capital
Trusts and the Trust Guarantees provide a full, irrevocable and unconditional
guarantee of payments of distributions and other amounts due on the Trust
Preferred Securities. No single document standing alone or operating in
conjunction with fewer than all of the other documents constitutes such
guarantee. It is only the combined operation of these documents that has the
effect of providing a full, irrevocable and unconditional guarantee of each of
the Tesoro Capital Trust's obligations under the Trust Preferred Securities. If
and to the extent that Tesoro does not make payments on the Subordinated Debt
Securities, the Tesoro Capital Trusts will not pay distributions or other
amounts due on the Trust Preferred Securities. The Trust Guarantees do not cover
payment of distributions when a Tesoro Capital Trust does not have sufficient
funds to pay such distributions. In such event, the remedies of a holder of the
Trust Preferred Securities of such Tesoro Capital Trust are described herein
under "Description of the Trust Guarantees -- Events of Default." The
obligations of Tesoro under the Trust Guarantees are subordinate and junior in
right of payment to all Senior Indebtedness of Tesoro.
Notwithstanding anything to the contrary in the Subordinated Indenture and
to the extent set forth therein, Tesoro has the right to set-off any payment it
is otherwise required to make thereunder with and to the extent Tesoro has
theretofore made, or is concurrently on the date of such payment making, a
payment under a Trust Guarantee.
A holder of Trust Preferred Securities of a Tesoro Capital Trust may
institute a legal proceeding directly against Tesoro to enforce its rights under
the Trust Guarantee with respect to such Tesoro Capital Trust without first
instituting a legal proceeding against the Trust Guarantee Trustee, such Tesoro
Capital Trust or any other person or entity.
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The Trust Preferred Securities of a Tesoro Capital Trust evidence a
beneficial interest in such Tesoro Capital Trust. The Tesoro Capital Trusts
exist for the sole purpose of issuing the Trust Securities and investing the
proceeds thereof in Subordinated Debt Securities. A principal difference between
the rights of a holder of Trust Preferred Securities and a holder of
Subordinated Debt Securities is that a holder of Subordinated Debt Securities is
entitled to receive from Tesoro the principal amount of and interest accrued on
Subordinated Debt Securities held, while a holder of Trust Preferred Securities
is entitled to receive distributions from a Tesoro Capital Trust (or from Tesoro
under the Trust Guarantee) if and to the extent such Tesoro Capital Trust has
funds available for the payment of such distributions.
Upon any voluntary or involuntary termination, winding-up or liquidation of
a Tesoro Capital Trust involving the liquidation of the Subordinated Debt
Securities, the holders of the Trust Preferred Securities of such Tesoro Capital
Trust will be entitled to receive, out of assets held by such Tesoro Capital
Trust and after satisfaction of liabilities to creditors of such Tesoro Capital
Trust as provided by applicable law, the liquidation distribution in cash. See
"Description of Trust Preferred Securities." Upon any voluntary or involuntary
liquidation or bankruptcy of Tesoro, the Property Trustee of a Tesoro Capital
Trust, as holder of the Subordinated Debt Securities of such Trust, would be a
subordinated creditor of Tesoro, subordinated in right of payment to all Senior
Indebtedness of Tesoro, but entitled to receive payment in full of principal and
interest, before any shareholders of Tesoro receive payments or distributions.
Since Tesoro is the guarantor under the Trust Guarantees and has agreed to pay
for all costs, expenses and liabilities of the Tesoro Capital Trusts (other than
the Tesoro Capital Trusts' obligations to the holders of the Trust Preferred
Securities), the positions of a holder of Trust Preferred Securities and a
holder of Subordinated Debt Securities relative to other creditors and to
shareholders of Tesoro in the event of liquidation or bankruptcy of Tesoro would
be substantially the same.
A default or event of default under any Senior Indebtedness of Tesoro will
not constitute a default or Event of Default under the Subordinated Indenture.
However, in the event of payment defaults under, or acceleration of, Senior
Indebtedness of Tesoro, the subordination provisions of the Subordinated
Indenture provide that no payments may be made in respect of the Subordinated
Debt Securities until such Senior Indebtedness has been paid in full or any
payment default thereunder has been cured or waived. Failure to make required
payments on the Subordinated Debt Securities would constitute an Event of
Default under the Subordinated Indenture with respect thereto.
PLAN OF DISTRIBUTION
The Company and any Tesoro Capital Trust may offer or sell the Securities
and the Trust Preferred Securities, respectively, to or through one or more
underwriters, dealers or agents as designated from time to time, or through a
combination of such methods and also may offer or sell the Securities and the
Trust Preferred Securities, respectively, directly to one or more other
purchasers. The Company and any Tesoro Capital Trust may sell the Securities and
the Trust Preferred Securities, respectively, as soon as practicable after
effectiveness of the Registration Statement of which this Prospectus is a part.
A Prospectus Supplement will set forth the terms of the offering of the
particular series of Securities offered thereby, including: (i) the name or
names of any underwriters or agents; (ii) the initial public offering or
purchase price of such series of Securities; (iii) any underwriting discounts,
commissions, and other items constituting underwriters' compensation and any
other discount, concessions, or commissions allowed or reallowed or paid by any
underwriters to other dealers; (iv) any commissions paid to any agents; (v) the
net proceeds to the Company from the sales; (vi) the net proceeds to a Tesoro
Capital Trust; and (vii) any securities exchanges or markets on which the
Securities may be listed.
Unless otherwise set forth in the Prospectus Supplement relating to a
particular series of Securities, the obligations of the underwriters to purchase
such series of Securities will be subject to certain conditions precedent and
each of the underwriters with respect to such series of Securities will be
obligated to purchase all of the Securities of such series allocated to it if
any such Securities are purchased. Any initial public offering price and any
discounts or concessions allowed, reallowed, or paid to dealers may be changed
from time to time.
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The Securities may also be offered and sold, if so indicated in the
applicable Prospectus Supplement, in connection with a remarketing upon their
purchase, in accordance with a redemption or repayment pursuant to their terms,
or otherwise, by one or more firms ("remarketing firms"), acting as principals
for their own accounts or as agents for the Company or the Tesoro Capital Trust,
as applicable. Any remarketing firm will be identified and the terms of its
agreement, if any, with the Company or the Tesoro Capital Trust, and its
compensation will be described in the applicable Prospectus Supplement.
Remarketing firms may be deemed to be underwriters, as that term is defined in
the Securities Act, in connection with the Securities remarketed thereby.
The Securities may be offered and sold by the Company or any Tesoro Capital
Trust, respectively, directly or through agents designated by the Company or any
Tesoro Capital Trust from time to time. Unless otherwise indicated in the
related Prospectus Supplement, each such agent will be acting on a best efforts
basis for the period of its appointment. Any agent participating in the
distribution of Securities may be deemed to be an "underwriter," as that term is
defined in the Securities Act, of the Securities so offered and sold. The
Securities also may be sold to dealers at the applicable price to the public set
forth in the Prospectus Supplement relating to such series of Securities. Such
dealers may be deemed to be "underwriters" within the meaning of the Securities
Act. Underwriters, dealers and agents may be entitled, under agreements entered
into with the Company or a Tesoro Capital Trust, to indemnification by the
Company or such Tesoro Capital Trust against certain civil liabilities,
including liabilities under the Securities Act.
Underwriters, dealers and agents may engage in transactions with, or
perform services for, or be customers of, the Company in the ordinary course of
business.
Other than the Common Stock, Preferred Stock and Senior Debt Securities,
all Securities offered will be a new issue of securities with no established
trading market. Any underwriter to whom Securities are sold by the Company for
public offering and sale may make a market in such Securities, but such
underwriters will not be obligated to do so and may discontinue any market
making at any time without notice. The Securities may or may not be listed on a
national securities exchange or a foreign securities exchange, except that the
Common Stock is listed for trading on the NYSE and the PSE. Any Common Stock
sold pursuant to a Prospectus Supplement will be listed for trading on the NYSE
and the PSE, subject to official notice of issuance. No assurance can be given
as to the liquidity of or the trading markets for any Securities.
LEGAL MATTERS
The validity of the Securities will be passed upon for the Company and the
Trusts by Fulbright & Jaworski L.L.P., Washington, D.C. Certain matters of
Delaware law relating to the validity of the Trust Preferred Securities will be
passed upon for the Company and the Tesoro Capital Trusts by ,
Wilmington, Delaware, special Delaware counsel to the Company and the Tesoro
Capital Trusts. If the Securities are being distributed in an underwritten
offering, the validity of the Securities will be passed upon for the
underwriters by counsel identified in the related Prospectus Supplement.
EXPERTS
The consolidated financial statements incorporated in this Prospectus by
reference from the Company's Annual Report on Form 10-K for the year ended
December 31, 1997 have been audited by Deloitte & Touche LLP, independent
auditors, as stated in their report, which is incorporated herein by reference,
and have been so incorporated in reliance upon the report of such firm given
upon their authority as experts in accounting and auditing.
The information incorporated in this Prospectus by reference from the
Company's Annual Report on Form 10-K for the year ended December 31, 1997
relating to estimated proved reserves of oil and gas and the related estimates
of future net cash flows and present values thereof as of December 31, 1995,
December 31, 1996 and December 31, 1997 have been prepared by Netherland, Sewell
& Associates, Inc., independent petroleum engineers, and are incorporated by
reference herein upon the authority of such firm as an expert in petroleum
engineering.
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[GLOBE LOGO]
20,000,000 Shares
[TESORO LOGO]
Common Stock
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Prospectus Supplement
, 2002
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LEHMAN BROTHERS
GOLDMAN, SACHS & CO.
FRIEDMAN BILLINGS RAMSEY