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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM . . . . . . . TO . . . . . .
COMMISSION FILE NUMBER 1-3473
TESORO PETROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-0862768
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
300 CONCORD PLAZA DRIVE, SAN ANTONIO, TEXAS 78216-6999
(Address of principal executive offices) (Zip Code)
210-828-8484
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
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There were 64,595,323 shares of the registrant's Common Stock
outstanding at May 1, 2002.
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - March 31, 2002 and December 31, 2001................... 3
Condensed Statements of Consolidated Operations - Three Months Ended
March 31, 2002 and 2001........................................................................ 4
Condensed Statements of Consolidated Cash Flows - Three Months Ended
March 31, 2002 and 2001........................................................................ 5
Notes to Condensed Consolidated Financial Statements........................................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.................................................................................. 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk..................................... 28
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds...................................................... 30
Item 6. Exhibits and Reports on Form 8-K............................................................... 30
SIGNATURES.................................................................................................. 32
EXHIBIT INDEX............................................................................................... 33
2
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
March 31, December 31,
2002 2001
------------- -------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents .............................................. $ 0.2 $ 51.9
Receivables, less allowance for doubtful accounts ...................... 434.7 384.9
Inventories ............................................................ 418.6 431.8
Prepayments and other .................................................. 14.9 9.4
------------- -------------
Total Current Assets ................................................. 868.4 878.0
------------- -------------
PROPERTY, PLANT AND EQUIPMENT
Refining ............................................................... 1,555.9 1,522.0
Retail ................................................................. 238.8 228.8
Marine Services ........................................................ 55.1 54.0
Corporate .............................................................. 53.2 47.9
------------- -------------
1,903.0 1,852.7
Less accumulated depreciation and amortization ......................... 346.8 330.4
------------- -------------
Net Property, Plant and Equipment .................................... 1,556.2 1,522.3
------------- -------------
OTHER ASSETS
Deposit and restricted funds ........................................... 300.0 --
Goodwill ............................................................... 95.2 95.2
Acquired intangibles, net .............................................. 71.7 73.3
Other, net ............................................................. 107.1 93.5
------------- -------------
Total Other Assets ................................................... 574.0 262.0
------------- -------------
Total Assets ...................................................... $ 2,998.6 $ 2,662.3
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable ....................................................... $ 381.5 $ 331.2
Accrued liabilities .................................................... 150.5 172.9
Current maturities of debt and other obligations ....................... 34.0 34.4
------------- -------------
Total Current Liabilities ............................................ 566.0 538.5
------------- -------------
DEFERRED INCOME TAXES ..................................................... 148.5 136.9
------------- -------------
OTHER LIABILITIES ......................................................... 118.7 117.4
------------- -------------
DEBT AND OTHER OBLIGATIONS ................................................ 1,217.4 1,112.5
------------- -------------
COMMITMENTS AND CONTINGENCIES (Note H)
STOCKHOLDERS' EQUITY
Common stock, par value $0.16-2/3; authorized 100,000,000 shares;
66,372,575 shares issued (43,371,825 in 2001) ........................ 11.0 7.2
Additional paid-in capital ............................................. 689.5 448.4
Retained earnings ...................................................... 266.3 321.9
Treasury stock, 1,827,564 common shares (1,958,147 in 2001), at cost ... (18.8) (20.5)
------------- -------------
Total Stockholders' Equity ........................................... 948.0 757.0
------------- -------------
Total Liabilities and Stockholders' Equity ........................ $ 2,998.6 $ 2,662.3
============= =============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS
(UNAUDITED)
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
Three Months Ended
March 31,
------------------------------
2002 2001
------------- -------------
REVENUES ................................................... $ 1,243.2 $ 1,227.3
COSTS AND EXPENSES
Costs of sales and operating expenses .................... 1,247.8 1,148.3
Selling, general and administrative expenses ............. 38.5 23.5
Depreciation and amortization ............................ 20.1 12.0
------------- -------------
OPERATING INCOME (LOSS) .................................... (63.2) 43.5
Interest and financing costs, net of capitalized interest .. (30.3) (7.5)
Interest income ............................................ 0.7 0.3
------------- -------------
EARNINGS (LOSS) BEFORE INCOME TAXES ........................ (92.8) 36.3
Income tax provision (benefit) ............................. (37.2) 14.6
------------- -------------
NET EARNINGS (LOSS) ........................................ (55.6) 21.7
Preferred dividends ........................................ -- 3.0
------------- -------------
NET EARNINGS (LOSS) APPLICABLE TO COMMON STOCK ............. $ (55.6) $ 18.7
============= =============
NET EARNINGS (LOSS) PER SHARE
Basic .................................................... $ (1.15) $ 0.61
============= =============
Diluted .................................................. $ (1.15) $ 0.52
============= =============
WEIGHTED AVERAGE COMMON SHARES
Basic .................................................... 48.2 30.9
============= =============
Diluted .................................................. 48.2 41.8
============= =============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
Three Months Ended
March 31,
------------------------------
2002 2001
------------- -------------
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Net earnings (loss) ................................................... $ (55.6) $ 21.7
Adjustments to reconcile net earnings (loss) to net cash used in
operating activities:
Depreciation and amortization ...................................... 20.1 12.0
Amortization of refinery turnarounds and other non-cash charges .... 16.9 5.3
Deferred income taxes .............................................. 11.6 8.1
Changes in operating assets and liabilities:
Receivables ...................................................... (49.8) 17.4
Inventories ...................................................... 13.2 0.3
Accounts payable and accrued liabilities ......................... 21.9 (77.9)
Other assets and liabilities ..................................... (26.2) (5.6)
------------- -------------
Net cash used in operating activities .......................... (47.9) (18.7)
------------- -------------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Capital expenditures .................................................. (52.6) (33.5)
Deposit and restricted funds .......................................... (300.0) --
Other ................................................................. (0.1) 0.7
------------- -------------
Net cash used in investing activities .......................... (352.7) (32.8)
------------- -------------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Net borrowings under revolving credit facilities ...................... 115.0 42.0
Proceeds from equity offering, net .................................... 244.9 --
Repayments of debt .................................................... (7.9) (0.3)
Payment of dividends on Preferred Stock ............................... -- (3.0)
Financing costs and other ............................................. (3.1) 0.2
------------- -------------
Net cash from financing activities ............................. 348.9 38.9
------------- -------------
DECREASE IN CASH AND CASH EQUIVALENTS ..................................... (51.7) (12.6)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ............................ 51.9 14.1
------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD .................................. $ 0.2 $ 1.5
============= =============
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid, net of capitalized interest ............................ $ 25.1 $ 14.2
============= =============
Income taxes paid ..................................................... $ -- $ 5.4
============= =============
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - BASIS OF PRESENTATION
The interim Condensed Consolidated Financial Statements and Notes thereto of
Tesoro Petroleum Corporation and its subsidiaries (collectively, the "Company"
or "Tesoro") have been prepared by management without audit pursuant to the
rules and regulations of the Securities and Exchange Commission ("SEC").
Accordingly, the accompanying financial statements reflect all adjustments that,
in the opinion of management, are necessary for a fair presentation of results
for the periods presented. Such adjustments are of a normal recurring nature.
The Consolidated Balance Sheet at December 31, 2001 has been condensed from the
audited Consolidated Financial Statements at that date. Certain information and
notes normally included in financial statements prepared in accordance with
accounting principles generally accepted in the United States of America ("U.S.
GAAP") have been condensed or omitted pursuant to the SEC's rules and
regulations. However, management believes that the disclosures presented herein
are adequate to make the information not misleading. Unless otherwise indicated,
the Notes do not include amounts and disclosures related to the pending
acquisition described in Note C. The accompanying Condensed Consolidated
Financial Statements and Notes should be read in conjunction with the
Consolidated Financial Statements and Notes thereto contained in the Company's
Annual Report on Form 10-K for the year ended December 31, 2001.
The preparation of the Company's Condensed Consolidated Financial Statements in
conformity with U.S. GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the periods. Actual results
could differ from those estimates. The results of operations for any interim
period are not necessarily indicative of results for the full year.
NOTE B - EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share are determined by dividing net earnings (loss)
applicable to Common Stock by the weighted average number of common shares
outstanding during the period. The assumed conversion of common stock
equivalents produced anti-dilutive results for the three months ended March 31,
2002, and was not included in the dilutive calculation. For the three months
ended March 31, 2001, 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 Preferred Stock was converted into 10.35 million shares of Common Stock in
July 2001. Earnings (loss) per share calculations are presented below (in
millions except per share amounts):
Three Months Ended
March 31,
------------------------------
2002 2001
------------- -------------
BASIC:
Numerator:
Net earnings (loss) ........................................ $ (55.6) $ 21.7
Less dividends on preferred stock .......................... -- 3.0
------------- -------------
Net earnings (loss) applicable to common shares ............ $ (55.6) $ 18.7
============= =============
Denominator:
Weighted average common shares outstanding ................. 48.2 30.9
============= =============
Basic Earnings (Loss) Per Share ............................... $ (1.15) $ 0.61
============= =============
6
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three Months Ended
March 31,
------------------------------
2002 2001
------------- -------------
DILUTED:
Numerator:
Net earnings (loss) applicable to common shares ................. $ (55.6) $ 18.7
Plus impact of assumed conversion of preferred stock ............ -- 3.0
------------- -------------
Total ......................................................... $ (55.6) $ 21.7
============= =============
Denominator:
Weighted average common shares outstanding ...................... 48.2 30.9
Add potentially dilutive securities:
Incremental dilutive shares from assumed exercise of stock
options (anti-dilutive in 2002) ............................. -- 0.6
Incremental dilutive shares from assumed conversion
of preferred stock .......................................... -- 10.3
------------- -------------
Total diluted shares .......................................... 48.2 41.8
============= =============
Diluted Earnings (Loss) Per Share .................................. $ (1.15) $ 0.52
============= =============
NOTE C - PENDING ACQUISITION
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 and May 3, 2002. The Company agreed to acquire the 168,000
barrel-per-day Golden Eagle refinery located in Martinez, California in the San
Francisco Bay area along with 70 associated retail sites throughout northern
California (collectively, the "Golden Eagle Assets"). Under the terms of the
sale and purchase agreement, the Company paid a $53.75 million earnest money
deposit in February 2002. The transaction has been approved by the Federal Trade
Commission and the offices of the Attorneys General of the States of California
and Oregon. The Company expects to close the acquisition on May 17, 2002, but in
the event 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 failure to obtain adequate financing for the acquisition), the Company
would forfeit its earnest money deposit. The deposit is included in noncurrent
Other Assets - Deposit and Restricted Funds in the Condensed Consolidated
Balance Sheet at March 31, 2002.
The purchase price for the Golden Eagle Assets, as amended, is $945 million,
plus $130 million for feedstock and refined product inventories, subject to
post-closing adjustments. The Company will issue to the seller two ten-year
junior subordinated notes with face amounts aggregating $150 million as part of
the $945 million purchase price. The amount of debt that will be recorded on the
balance sheet for the $150 million notes will reflect an appropriate discount
rate. The notes consist of: (i) a $100 million junior subordinated note, due
July 2012, which will be non-interest bearing for the first five years and carry
a 7.5% interest rate for the remaining five-year period and (ii) a $50 million
junior subordinated note, due July 2012, which will have no interest payment in
year one, will include a 7.47% effective interest rate for the second through
the fifth years, and will bear interest at 7.5% for years six through ten. The
Company intends to further finance the pending acquisition with the proceeds of
a recent common stock offering, a recent senior subordinated notes offering and
additional borrowings under a proposed amendment to its senior secured credit
facility (see Note D).
7
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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. These include, 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 environmental and other indemnity
rights) arising out of or related to the agreement pursuant to which the seller
purchased the refinery from Tosco Corporation ("Tosco") in 2000. The seller has
agreed to use commercially reasonable efforts to persuade Tosco to consent to
this assignment. If the seller cannot obtain a consent from Tosco, 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 Tosco, less any legal or other enforcement costs the seller
incurs.
In addition, upon the closing of the pending acquisition of the Golden Eagle
Assets, the Company expects to take assignment from the seller of two
environmental insurance policies. The policies provide $140 million of coverage
in excess of a $50 million environmental indemnity from Tosco. In the event the
insurers do not consent to the assignment from the seller to the Company, the
seller has agreed to have the Company named as an additional insured under both
policies.
The Golden Eagle Assets will require substantial expenditures to address
"clean fuels" requirements and other capital projects.
NOTE D - CAPITALIZATION
SENIOR SECURED CREDIT FACILITY
As of March 31, 2002, the Company's senior secured credit facility, as amended,
the ("Senior Secured Credit Facility") consisted of a five-year $175 million
revolving credit facility (with a $90 million sublimit for letters of credit), a
five-year $175 million tranche A term loan and a six-year $450 million tranche B
term loan. As of March 31, 2002, the Company had $115 million in borrowings and
$3 million in letters of credit outstanding under the revolving credit facility.
Total unused credit available under the revolving credit facility at March 31,
2002 was $57 million. On April 19, 2002, the Company exercised its right to
increase the revolving credit facility from $175 million to $225 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.
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. The Company did not meet the
required ratio of total debt to earnings before interest, taxes, depreciation
and amortization for the four quarters ended March 31, 2002. However, the
lenders have waived compliance with this requirement. See discussion below
regarding the proposed amendment to the Senior Secured Credit Facility.
The Senior Secured Credit Facility 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 repurchase of shares
of its common stock, not to exceed $15 million in any year.
8
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Borrowing rates under the Senior Secured Credit Facility are based on a pricing
grid. Borrowings bear interest at either a base rate (4.75% at March 31, 2002)
or a eurodollar rate (ranging from 1.88% to 1.91% at March 31, 2002), plus an
applicable margin. The applicable margin at March 31, 2002 for the tranche A
term loan and the revolving credit facility 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%.
To partially fund the pending acquisition of the Golden Eagle Assets, the
Company will amend the Senior Secured Credit Facility which will substantially
increase borrowing levels and modify covenants. Management believes the Company
will be able to comply with the new covenants or will be able to obtain
additional waivers if required.
EQUITY OFFERING
On March 6, 2002, the Company completed an underwritten public offering of 23
million shares of common stock. The net proceeds from the stock offering of
$244.9 million, after deducting underwriting fees and offering expenses, will be
used to partially fund the pending acquisition of the Golden Eagle Assets. At
March 31, 2002, the net proceeds were held in a cash collateral account and
included in noncurrent Other Assets - Deposit and Restricted Funds in the
Condensed Consolidated Balance Sheet. If the Company does not close the
acquisition of the Golden Eagle Assets, the net proceeds will be used to pay
down term loans.
NOTES OFFERING
On April 9, 2002, the Company issued $450 million aggregate principal
amount of 9-5/8% Senior Subordinated Notes due April 1, 2012 ("2012 Notes")
through a private offering eligible for Rule 144A. The 2012 Notes have a
ten-year maturity with no sinking fund requirements and are subject to optional
redemption by the Company after five 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%. The indenture for the 2012 Notes
contains covenants and restrictions which are customary for notes of this
nature, and the 2012 Notes are guaranteed by substantially all of the Company's
active domestic subsidiaries. The proceeds from the 2012 Notes and accrued
interest are being held in escrow and will be used to partially fund the pending
acquisition of the Golden Eagle Assets. If the Company does not close the
acquisition of the Golden Eagle Assets, the proceeds and interest will be paid
to the holders of the 2012 Notes.
OTHER
The Company has an effective universal shelf registration statement for debt or
equity securities to be used for acquisitions or general corporate purposes. At
March 31, 2002, the amount available under the shelf registration was
approximately $85 million. The Company recently filed a second shelf
registration statement for an additional $1 billion of debt or equity securities
to be used for acquisitions, refinancing of existing indebtedness or general
corporate purposes, which has not yet been declared effective.
NOTE E - 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 and evaluates the performance
of these segments and allocates resources based primarily on segment operating
income. 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 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.
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.
9
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Segment information is as follows (in millions):
Three Months Ended
March 31,
------------------------------
2002 2001
------------- -------------
REVENUES
Refining:
Refined products ........................................... $ 1,086.3 $ 1,093.3
Crude oil resales and other ................................ 91.4 59.8
Retail:
Fuel ....................................................... 167.9 71.1
Merchandise and other ...................................... 22.8 13.3
Marine Services .............................................. 26.4 46.4
Intersegment Sales from Refining to Retail ................... (151.6) (56.6)
------------- -------------
Total Revenues ........................................... $ 1,243.2 $ 1,227.3
============= =============
SEGMENT OPERATING INCOME (LOSS)
Refining ..................................................... $ (35.8) $ 50.8
Retail ....................................................... (9.7) 2.0
Marine Services .............................................. 0.4 2.7
------------- -------------
Total Segment Operating Income (Loss) ...................... (45.1) 55.5
Corporate and Unallocated Costs .............................. (18.1) (12.0)
------------- -------------
Operating Income (Loss) .................................... (63.2) 43.5
Interest and Financing Costs, Net of Capitalized Interest .... (30.3) (7.5)
Interest Income .............................................. 0.7 0.3
------------- -------------
Earnings (Loss) Before Income Taxes ........................ $ (92.8) $ 36.3
============= =============
DEPRECIATION AND AMORTIZATION
Refining ..................................................... $ 15.3 $ 7.9
Retail ....................................................... 3.4 2.8
Marine Services .............................................. 0.7 0.7
Corporate .................................................... 0.7 0.6
------------- -------------
Total Depreciation and Amortization ...................... $ 20.1 $ 12.0
============= =============
CAPITAL EXPENDITURES
Refining ..................................................... $ 36.3 $ 26.5
Retail ....................................................... 10.1 5.6
Marine Services .............................................. 1.2 0.2
Corporate .................................................... 5.0 1.2
------------- -------------
Total Capital Expenditures ............................... $ 52.6 $ 33.5
============= =============
10
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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. Corporate assets as of March 31, 2002 include the deposit and
restricted funds of $300 million for the pending acquisition of the Golden Eagle
Assets.
March 31, December 31,
2002 2001
------------- -------------
IDENTIFIABLE ASSETS
Refining ...................................... $ 2,181.9 $ 2,164.9
Retail ........................................ 287.2 283.8
Marine Services ............................... 60.6 62.0
Corporate ..................................... 468.9 151.6
------------- -------------
Total Assets .............................. $ 2,998.6 $ 2,662.3
============= =============
NOTE F - INVENTORIES
Components of inventories were as follows (in millions):
March 31, December 31,
2002 2001
------------- -------------
Crude oil and refined products, at LIFO ... $ 383.5 $ 398.4
Fuel products, at FIFO .................... 3.5 2.1
Merchandise and other ..................... 8.1 7.9
Materials and supplies .................... 23.5 23.4
------------- -------------
Total Inventories ..................... $ 418.6 $ 431.8
============= =============
NOTE G - GOODWILL AND OTHER INTANGIBLE ASSETS
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 upon adoption. The Company has not completed its initial impairment
review, but believes that the carrying amount of its goodwill has not been
impaired.
The following table adjusts reported net earnings and earnings per share to
exclude goodwill amortization for the three months ended March 31, 2001 (in
millions except per share amounts):
Reported net earnings.............................................. $ 21.7
Goodwill amortization, net of income taxes......................... 0.6
-------
Adjusted net earnings.............................................. $ 22.3
=======
Basic earnings per share:
Reported basic earnings per share............................... $ 0.61
Goodwill amortization, net of income taxes...................... 0.02
-------
Adjusted basic earnings per share............................... $ 0.63
=======
11
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Diluted earnings per share:
Reported diluted earnings per share............................. $ 0.52
Goodwill amortization, net of income taxes...................... 0.01
-------
Adjusted diluted earnings per share............................. $ 0.53
=======
The net carrying value of goodwill as of March 31, 2002 by operating segment is
as follows (in millions):
Refining........................................................... $ 86.9
Retail............................................................. 5.9
Marine Services.................................................... 2.4
-------
Total....................................................... $ 95.2
=======
The following table provides the gross carrying amount and accumulated
amortization for each major class of acquired intangible assets, excluding
goodwill (in millions):
March 31, 2002 December 31, 2001
------------------------------------ ------------------------------------
Gross Net Gross Net
Carrying Accumulated Carrying Carrying Accumulated Carrying
Amount Amortization Value Amount Amortization Value
---------- ------------ ---------- ---------- ------------ ----------
Refinery permits and plans ......... $ 23.9 $ 0.5 $ 23.4 $ 23.9 $ 0.3 $ 23.6
Jobber agreements .................. 23.5 0.7 22.8 23.5 0.4 23.1
Customer contracts ................. 16.8 2.2 14.6 16.8 1.3 15.5
Refinery technology ................ 3.7 0.1 3.6 3.7 0.1 3.6
Other intangibles .................. 10.0 2.7 7.3 9.9 2.4 7.5
---------- ---------- ---------- ---------- ---------- ----------
Total ....................... $ 77.9 $ 6.2 $ 71.7 $ 77.8 $ 4.5 $ 73.3
========== ========== ========== ========== ========== ==========
The weighted average lives of acquired intangible assets are as follows:
refinery permits and plans - 27 years; jobber agreements - 20 years; customer
contracts - 5 years; refinery technology - 28 years; and other intangible assets
- 13 years.
Amortization expense of acquired intangible assets other than goodwill amounted
to $1.7 million and $0.1 million for the three months ended March 31, 2002 and
2001, respectively. Estimated aggregate amortization expense for each of the
next five years beginning January 1, 2002 is as follows: 2002 - $6.7 million;
2003 - $6.7 million; 2004 - $6.4 million; 2005 - $5.8 million; and 2006 - $4.9
million.
NOTE H - COMMITMENTS AND CONTINGENCIES
The Company is a party to various litigation and contingent loss situations,
including environmental and income tax matters, arising in the ordinary course
of business. The Company has made accruals in accordance with SFAS No. 5,
"Accounting for Contingencies," in order to provide for these matters. The
ultimate effects of these matters cannot be predicted with certainty, and
related accruals are based on management's best estimates, subject to future
developments. Although the resolution of certain of these matters could have a
material adverse effect on interim or annual results of operations, the Company
believes that the outcome of these matters will not result in a material adverse
effect on its liquidity or consolidated financial position.
12
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
ENVIRONMENTAL
The Company is subject to extensive federal, state and local environmental laws
and regulations. These laws, which change frequently, regulate the discharge of
materials into the environment and may require the Company to remove or mitigate
the environmental effects of the disposal or release of petroleum or chemical
substances at various sites, or install additional controls, or make other
modifications or changes in use for certain emission sources.
The Company is currently involved with the U.S. Environmental Protection Agency
("EPA") regarding a waste disposal site near Abbeville, Louisiana. The Company
has been named a potentially responsible party under the Federal Comprehensive
Environmental Response, Compensation and Liability Act ("CERCLA" or "Superfund")
at this location. Although the Superfund law may impose joint and several
liability upon each party at the site, the extent of the Company's allocated
financial contributions for cleanup is expected to be de minimis based upon the
number of companies, volumes of waste involved and total estimated costs to
close the site. The Company believes, based on these considerations and
discussions with the EPA, that its liability at the Abbeville site will not
exceed $25,000.
The Company is currently involved in remedial responses and has incurred cleanup
expenditures associated with environmental matters at a number of sites,
including certain of its owned properties. At March 31, 2002, the Company's
accruals for environmental expenses totaled approximately $37 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.
In February 2000, the EPA finalized new regulations pursuant to the Clean Air
Act requiring reduction in the sulfur content in gasoline starting January 1,
2004. To meet this 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 also promulgated new regulations in January 2001 pursuant to the Clean
Air Act requiring a reduction in the 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 the Maximum Achievable Control Technologies standard for
petroleum refineries ("Refinery MACT II"), promulgated in April 2002. The
Refinery MACT II regulations 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 2001 acquisition of the North Dakota and Utah refineries,
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 currently estimates it will spend an aggregate of $7
million at the North Dakota and Utah 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 or related to the consent decree.
The Company anticipates it will make additional environmental capital
improvements of approximately $11 million in 2002, primarily for improvements to
storage tanks, tank farm secondary containment and pipelines. During the three
months ended March 31, 2002, the Company spent approximately $1 million on
environmental capital projects.
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
13
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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.
OTHER
In October 1998, the Company's Board of Directors unanimously approved the 1998
Performance Incentive Compensation Plan ("Performance Plan"), which would
provide the Company's employees with additional compensation, contingent upon
achievement of targeted objectives. Under the Performance Plan, targeted
objectives are comprised of the fair market value of the Company's Common Stock
equaling or exceeding an average of $35 per share ("First Performance Target")
and $45 per share ("Second Performance Target") on any 20 consecutive trading
days during a period commencing on October 1, 1998 and ending on the earlier of
September 30, 2002, or the date on which the Second Performance Target is
achieved. No costs will be recorded until the First Performance Target is
reached.
NOTE I - NEW ACCOUNTING STANDARDS
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.
SFAS NO. 144
Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." 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 adoption of SFAS No.
144 did not have a significant impact on the Company's financial condition or
results of operations.
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 would be
required to write off the unamortized carrying value of deferred major
maintenance costs, primarily for refinery turnarounds, which totaled $59 million
at March 31, 2002 and expense future costs as incurred. Deferred major
maintenance costs are included in noncurrent Other Assets - Other in the
Condensed Consolidated Balance Sheets, and the amortization of such costs are
included in Costs of Sales and Operating Expenses in the Condensed Statements of
Consolidated Operations.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THOSE STATEMENTS IN THIS SECTION THAT ARE NOT HISTORICAL IN NATURE SHOULD BE
DEEMED FORWARD-LOOKING STATEMENTS THAT ARE INHERENTLY UNCERTAIN. SEE
"FORWARD-LOOKING STATEMENTS" ON PAGE 27 FOR A DISCUSSION OF THE FACTORS THAT
COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE PROJECTED IN THESE
STATEMENTS.
WE HAVE ENDEAVORED TO PROVIDE A MORE THOROUGH DISCUSSION OF OUR EXPECTATIONS AND
GOALS IN THIS SECTION, AND WE ANTICIPATE THAT WE WILL CONTINUE TO DO THE SAME IN
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS IN THE FUTURE. HOWEVER, EXPECTATIONS AND GOALS MAY CHANGE DURING
INTERIM PERIODS OF TIME. WE DO NOT INTEND TO, AND YOU SHOULD NOT EXPECT THAT WE
WILL, UPDATE THE INFORMATION CONTAINED HEREIN DURING ANY SUCH INTERIM PERIOD.
UNLESS OTHERWISE INDICATED, THE DISCLOSURES IN THIS SECTION DO NOT INCLUDE THE
PENDING ACQUISITION OF THE GOLDEN EAGLE ASSETS DESCRIBED IN NOTE C OF NOTES TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS IN PART I, ITEM 1 HEREOF.
STRATEGY
Our goal is to create value by: (i) maximizing our earnings, cash flows and
return on capital by reducing costs, increasing efficiencies and optimizing
existing assets and (ii) 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 flows and provide
significant operational synergies. We acquire and develop assets that we believe
will provide us with a competitive advantage in connected markets which should
lower our per barrel 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.
We are also focused on improving profitability in our Refining segment by
enhancing processing capabilities, strengthening our wholesale marketing
activities and improving supply and transportation logistics. Our Retail segment
operations are an important component of our corporate strategy as they provide
a ratable offtake for our products at higher margins than products sold at
wholesale. The Marine Services segment seeks to optimize existing operations
through ongoing development of customer services and cost management. As part of
this strategy, we continue to assess our existing asset base to maximize returns
and financial flexibility through market diversification and related
acquisitions. We are 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.
As a result of recent acquisitions and the pending Golden Eagle Assets
acquisition, our total debt to capitalization ratio is projected to increase to
a level which will prevent us from pursuing additional acquisitions until such
time as our debt is significantly reduced. In connection with such proposed debt
reductions, we are exploring divestitures of certain non-strategic retail and
logistics assets.
PENDING ACQUISITION
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 and May 3, 2002. We agreed to acquire the 168,000-bpd Golden Eagle
refinery located in Martinez, California in the San Francisco Bay area along
with 70 associated retail sites throughout northern California (collectively,
the "Golden Eagle Assets"). Under the terms of the sale and purchase agreement,
we paid a $53.75 million earnest money deposit in February 2002. The transaction
has been approved by the Federal Trade Commission and the offices of the
Attorneys General of the States of California and Oregon. We expect to close the
acquisition on May 17, 2002, but in the event 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), we would forfeit our earnest money deposit.
15
The purchase price for the Golden Eagle Assets, as amended, is $945 million,
plus $130 million for feedstock and refined product inventories, subject to
post-closing adjustments. We will issue to the seller two ten-year junior
subordinated notes with face amounts aggregating $150 million as part of the
$945 million purchase price. The amount of debt that will be recorded on the
balance sheet for the $150 million notes will reflect an appropriate discount
rate. The notes consist of: (i) a $100 million junior subordinated note, due
July 2012, which will be non-interest bearing for the first five years and carry
a 7.5% interest rate for the remaining five-year period and (ii) a $50 million
junior subordinated note, due July 2012, which will have no interest payment in
year one, will include a 7.47% effective interest rate for the second through
the fifth years, and will bear interest at 7.5% for years six through ten. We
intend to further finance the acquisition with the proceeds of a recent common
stock offering, a recent senior subordinated notes offering and additional
borrowings under a proposed amendment to our senior secured credit facility.
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. These include, 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 also have 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 environmental and other indemnity rights) arising out
of or related to the agreement pursuant to which the seller purchased the
refinery from Tosco in 2000. The seller has agreed to use commercially
reasonable efforts to persuade Tosco to consent to this assignment. If the
seller cannot obtain a consent from Tosco, 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 Tosco, less any legal or other
enforcement costs the seller incurs.
In addition, upon the closing of the pending acquisition of the Golden Eagle
Assets, we expect to take assignment from the seller of two environmental
insurance policies. The policies provide $140 million of coverage in excess of a
$50 million environmental indemnity from Tosco. In the event the insurers do not
consent to the assignment from the seller to us, the seller has agreed to have
us named as an additional insured under both policies.
For further information regarding environmental expenditures, see "Environmental
and Other", herein.
BUSINESS ENVIRONMENT
We operate in an environment where our results and cash flows are sensitive to
volatile changes in energy prices. Fluctuations in the costs of crude oil and
other refinery feedstocks and the price of refined products can result in
changes in refining margins as prices received for refined products may not keep
pace with changes in feedstock costs. As part of our marketing program, we also
purchase refined products for sale to customers, and fluctuations in price
levels can result in changes in product sales margins. Prices, together with
volume levels, also determine the carrying value of crude oil and refined
product inventory. We use the last-in, first-out ("LIFO") method of accounting
for inventories of crude oil and refined products in our Refining and Retail
segments. This method results in inventory carrying amounts that may be less
than current values and costs of sales that more closely represent current
costs.
Changes in crude oil and natural gas prices also influence the level of drilling
activity in the Gulf of Mexico. Our Marine Services segment, whose customers
include offshore drilling contractors and related industries, can be impacted by
significant fluctuations in crude oil and natural gas prices. The Marine
Services segment uses the first-in, first-out ("FIFO") method of accounting for
inventories of fuels. Changes in fuel prices can significantly affect inventory
valuations and costs of sales.
16
For further information on commodity price and interest rate risks, see
Quantitative and Qualitative Disclosures About Market Risk in Item 3 herein.
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2002 COMPARED WITH THREE
MONTHS ENDED MARCH 31, 2001
SUMMARY
Our net loss was $55.6 million ($1.15 net loss per basic share and diluted
share) for the three months ended March 31, 2002 ("2002 Quarter") compared with
net earnings of $21.7 million ($0.61 per basic share or $0.52 per diluted share)
for the three months ended March 31, 2001 ("2001 Quarter"). The net loss for the
2002 Quarter was primarily a result of weak margins in each of our operating
segments, scheduled downtime at our Washington refinery, unscheduled downtime at
our Washington and Utah refineries, and financing and integration costs
primarily associated with the pending acquisition of the Golden Eagle Assets.
The financing and integration costs and unscheduled downtime incurred in the
2002 Quarter resulted in pretax charges of approximately $12 million or $0.15
per share.
A discussion and analysis of the factors contributing to our results of
operations are presented below. The accompanying Condensed Consolidated
Financial Statements and related Notes, together with the following information,
are intended to provide investors with a reasonable basis for assessing our
operations, but should not serve as the only criteria for predicting our future
performance.
REFINING SEGMENT
THREE MONTHS ENDED
MARCH 31,
------------------------------
2002 2001
------------- -------------
(DOLLARS IN MILLIONS EXCEPT
PER BARREL AMOUNTS)
REVENUES
Refined products (a) .................................... $ 1,086.3 $ 1,093.3
Crude oil resales and other ............................. 91.4 59.8
------------- -------------
Total Revenues .................................... $ 1,177.7 $ 1,153.1
============= =============
REFINING SEGMENT THROUGHPUT (thousand bpd)
Pacific Northwest
Washington ........................................... 84.8 114.2
Alaska ............................................... 50.3 45.6
Mid-Pacific
Hawaii ............................................... 82.0 86.7
Mid-Continent
North Dakota ......................................... 49.5 --
Utah ................................................. 47.1 --
------------- -------------
Total Refining Segment Throughput ................. 313.7 246.5
============= =============
GROSS REFINING MARGIN ($/throughput barrel)
Pacific Northwest refineries ............................ $ 3.45 $ 8.04
Mid-Pacific refinery .................................... $ 3.83 $ 5.94
Mid-Continent refineries ................................ $ 3.04 $ --
Total Refining Segment ............................ $ 3.41 $ 7.30
SEGMENT OPERATING INCOME (LOSS)
Gross refining margins (after inventory changes) (b) .... $ 105.2 $ 163.4
Expenses (c) ............................................ 125.7 104.7
Depreciation and amortization (d) ....................... 15.3 7.9
------------- -------------
Segment Operating Income (Loss) ................... $ (35.8) $ 50.8
============= =============
17
THREE MONTHS ENDED
MARCH 31,
-----------------------------
2002 2001
------------- -------------
(DOLLARS IN MILLIONS EXCEPT
PER BARREL AMOUNTS)
PRODUCT SALES (thousand bpd) (a) (e)
Gasoline and gasoline blendstocks ............. 208.0 138.9
Jet fuel ...................................... 88.0 77.3
Diesel fuel ................................... 95.5 55.4
Heavy oils, residual products and other ....... 59.4 60.4
------------- -------------
Total Product Sales ..................... 450.9 332.0
============= =============
PRODUCT SALES MARGIN ($/barrel) (e)
Average sales price ........................... $ 26.77 $ 36.57
Average costs of sales ........................ 24.16 31.12
------------- -------------
Gross Margin ............................ $ 2.61 $ 5.45
============= =============
----------
(a) Includes intersegment sales to our Retail segment at prices which
approximate market of $151.6 million and $56.6 million for the three months
ended March 31, 2002 and 2001, respectively.
(b) Approximates total refining segment throughput times the gross refining
margin, adjusted for changes in refined product inventory due to selling a
volume and mix of product that is different than actual volumes
manufactured. Refined product inventories decreased by 1.4 million barrels
and 0.5 million barrels during the 2002 Quarter and 2001 Quarter,
respectively. Includes the effect of intersegment sales to the Retail
segment at prices which approximate market.
(c) Includes manufacturing costs per throughput barrel of $3.25 and $3.44 for
the three months ended March 31, 2002 and 2001, respectively. Manufacturing
costs include the cost of internally produced fuel of $0.88 per barrel and
$1.28 per barrel for the three months ended March 31, 2002 and 2001,
respectively. Manufacturing costs included non-cash amortization of
maintenance turnaround costs of $0.15 per barrel (aggregate $4.1 million)
and $0.19 per barrel (aggregate $4.2 million) for the three months ended
March 31, 2002 and 2001, respectively.
(d) Includes manufacturing depreciation per throughput barrel of approximately
$0.37 and $0.26 for the three months ended March 31, 2002 and 2001,
respectively.
(e) Sources of total product sales included products manufactured at the
refineries, products drawn from inventory balances and products purchased
from third parties. Gross margins on total product sales included margins
on sales of manufactured and purchased products and the effects of
inventory changes.
THREE MONTHS ENDED MARCH 31, 2002 COMPARED WITH THREE MONTHS ENDED MARCH 31,
2001. The operating loss for the Refining segment was $35.8 million in the 2002
Quarter compared to operating income of $50.8 million for the 2001 Quarter. The
operating loss was mainly driven by weaker refined product margins. Industry
refining margins declined nearly 50% in our market areas compared to the margins
in the 2001 Quarter. Low jet fuel and diesel fuel demand caused high inventory
levels and rising crude costs put added pressure on refining margins. Our
results for the 2002 Quarter include amounts from the Mid-Continent operations
which we acquired in September 2001.
Our gross refining margin decreased 36% from the 2001 Quarter to $105.2 million
in the 2002 Quarter reflecting lower refining margins at all of our refineries
partly offset by increased volumes from the Mid-Continent operations. Refining
throughput at the Pacific Northwest refineries declined from the 2001 Quarter
reflecting the effect of the scheduled turnaround at the Washington refinery
during the 2002 Quarter and lower product demand. Due to the scheduled downtime
at the Washington refinery, we were not able to process a higher percentage of
lower cost heavy crude oil, which represented 36% of refining throughput in the
2002 Quarter, compared with 56% in the 2001 Quarter. We estimate that our
refining margins would have been $20 million higher had the Washington refinery
been fully operational during the 70-day turnaround, during which the heavy oil
conversion project was completed.
Revenues from sales of refined products decreased to $1,086.3 million in the
2002 Quarter, from $1,093.3 million in the 2001 Quarter, due to lower product
prices substantially offset by increased sales volumes from the Mid-Continent
refineries. Total product sales averaged 450,900 bpd in the 2002 Quarter, an
increase of 36% from the 2001 Quarter, while average product prices dropped 27%
to $26.77 per barrel. The increase in other revenues was primarily due to higher
crude oil resales which totaled $90.5 million in the 2002
18
Quarter compared to $58.2 million in the 2001 Quarter. The increase in costs of
sales was due to the increased throughput resulting from the Mid-Continent
operations, largely offset by lower prices for feedstocks and product supply
compared with the 2001 Quarter.
Expenses, excluding depreciation, increased by 20% to $125.7 million in the 2002
Quarter, primarily due to additional operating expenses of $34.6 million from
the Mid-Continent operations. Excluding these new operations, expenses decreased
13% from the 2001 Quarter as a result of lower throughput for the Pacific
Northwest and Mid-Pacific refineries. Depreciation and amortization increased
to $15.3 million, primarily due to depreciation of $5.9 million from the
Mid-Continent operations. During the 2002 Quarter, we also had unscheduled
downtime at the Washington and Utah refineries resulting in expenses of
approximately $2.7 million.
RETAIL SEGMENT
THREE MONTHS ENDED
MARCH 31,
-------------------------------
2002 2001
------------- -------------
(DOLLARS IN MILLIONS EXCEPT
PER GALLON AMOUNTS)
REVENUES
Fuel ............................................... $ 167.9 $ 71.1
Merchandise and other .............................. 22.8 13.3
------------- -------------
Total Revenues ............................... $ 190.7 $ 84.4
============= =============
FUEL SALES (millions of gallons) ...................... 172.5 61.2
FUEL MARGIN ($/gallon) ................................ $ 0.09 $ 0.24
MERCHANDISE MARGIN (in millions) ...................... $ 5.7 $ 4.0
MERCHANDISE MARGIN % .................................. 26% 31%
AVERAGE NUMBER OF STATIONS (during the period) ........ 679 277
SEGMENT OPERATING INCOME (LOSS)
Gross Margins
Fuel (a) ........................................ $ 16.3 $ 14.5
Merchandise and other non-fuel margin ........... 6.9 4.5
------------- -------------
Total gross margins .......................... 23.2 19.0
Expenses ........................................... 29.5 14.2
Depreciation and amortization ...................... 3.4 2.8
------------- -------------
Segment Operating Income (Loss) .............. $ (9.7) $ 2.0
============= =============
----------
(a) Includes the effect of intersegment purchases from our Refining segment at
prices which approximate market.
THREE MONTHS ENDED MARCH 31, 2002 COMPARED WITH THREE MONTHS ENDED MARCH 31,
2001. The operating loss for our Retail segment was $9.7 million in the 2002
Quarter, compared to operating income of $2.0 million in the 2001 Quarter. Total
gross margins increased 22% to $23.2 million from $19.0 million during the 2002
Quarter reflecting increased sales volume, offset largely by lower fuel margins
per gallon. Margins in the retail segment continued to be under strong
competitive pressure during the 2002 Quarter leading to a decrease in fuel
margin to $0.09 per gallon in the 2002 Quarter from $0.24 per gallon in the 2001
Quarter. Total gallons sold increased to 172.5 million, reflecting the increase
in average station count. The average station count increased to 679 in the 2002
Quarter from 277 in the 2001 Quarter, primarily due to the Mid-Continent
operations acquired in September 2001.
Revenues on fuel sales grew to $167.9 million in the 2002 Quarter, from $71.1
million in the 2001 Quarter, while merchandise and other revenues increased by
71% to $22.8 million. Merchandise margin, however, as a percent of sales
decreased. With our increased number of stations, expenses increased to $29.5
million and depreciation increased to $3.4 million in the 2002 Quarter.
Expenses on a per-gallon basis, however, decreased in the 2002 Quarter as
compared to the 2001 Quarter.
19
MARINE SERVICES SEGMENT
THREE MONTHS ENDED
MARCH 31,
------------------------------
2002 2001
------------- -------------
(DOLLARS IN MILLIONS)
Revenues
Fuels ..................................... $ 20.5 $ 39.1
Lubricants and other ...................... 3.5 3.8
Services .................................. 2.5 3.5
Other income (loss) ....................... (0.1)
------------- -------------
Total Revenues .......................... 26.4 46.4
Costs of Sales ............................... 18.8 35.3
------------- -------------
Gross Profit ............................ 7.6 11.1
Expenses ..................................... 6.5 7.7
Depreciation and Amortization ................ 0.7 0.7
------------- -------------
Segment Operating Income .................. $ 0.4 $ 2.7
============= =============
Sales Volumes (millions of gallons)
Fuels, primarily diesel ................... 31.6 42.3
Lubricants ................................ 0.5 0.5
THREE MONTHS ENDED MARCH 31, 2002 COMPARED WITH THREE MONTHS ENDED MARCH 31,
2001. Marine Services operating income decreased by $2.3 million during the 2002
Quarter from the 2001 Quarter. Lower sales volumes and service revenues
contributed to this decrease. The Marine Services segment is largely dependent
on the volume of oil and gas drilling, workover, construction and seismic
activity in the U.S. Gulf of Mexico. The significant decline in industry
drilling activity negatively impacted our Marine Services sales and operating
income during the 2002 Quarter.
Revenues decreased $20.0 million during 2001 reflecting lower fuel sales prices
and fuel volumes. The decrease in costs of sales during the 2002 Quarter
reflected the lower prices for fuel supply and lower volumes.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses of $38.5 million during the 2002
Quarter increased from $23.5 million in the 2001 Quarter. This increase was
partially due to higher expenses in the Refining and Retail segments associated
with the Mid-Continent operations of $4 million and the acquisition of
additional retail stations in the fourth quarter of 2001. Corporate expenses
accounted for $6 million of the increase resulting from acquisition and
integration costs in the 2002 Quarter, as well as higher employee costs and
professional fees.
INTEREST AND FINANCING COSTS
Interest and financing costs, net of capitalized interest, were $30.3 million in
the 2002 Quarter compared to $7.5 million in the 2001 Quarter. This increase was
primarily due to the additional debt we incurred in 2001 related to the
acquisition of the North Dakota and Utah refineries and costs of approximately
$9 million related to bridge financing for the pending acquisition of the Golden
Eagle Assets.
INCOME TAX PROVISION (BENEFIT)
The income tax benefit amounted to $37.2 million for the 2002 Quarter compared
to the income tax provision of $14.6 million for the 2001 Quarter. The benefit
reflected the pretax loss for the 2002 Quarter. The combined Federal and state
effective income tax rate was approximately 40% in both the 2002 and 2001
Quarters.
20
CAPITAL RESOURCES AND LIQUIDITY
We operate in an environment where our liquidity and capital resources are
impacted by changes in the supply of and demand for crude oil and refined
petroleum products, market uncertainty and a variety of additional factors
beyond our control. These risks include, among others, the level of consumer
product demand, weather conditions, fluctuations in seasonal demand,
governmental regulations, the price and availability of alternative fuels and
overall market and economic conditions. See "Forward-Looking Statements" on page
27 for further information related to risks and other factors. Our future
capital expenditures, as well as borrowings under our senior secured credit
facility and other sources of capital, will be affected by these conditions.
OVERVIEW
Our primary sources of liquidity are cash flows from operations and borrowing
availability under revolving lines of credit. We expect our capital requirements
to include non-discretionary capital expenditures, working capital and debt
service. We believe available capital resources will be adequate to meet our
capital requirements for existing operations. We have an effective universal
shelf registration statement for debt or equity securities to be used for
acquisitions or general corporate purposes. At March 31, 2002, the amount
available under the shelf registration was approximately $85 million. We
recently filed a second shelf registration statement for an additional $1
billion of debt or equity securities to be used for acquisitions, refinancing
of existing indebtedness or general corporate purposes, which has not yet been
declared effective. Currently we have no plans to issue additional debt or
equity securities.
CAPITALIZATION
Our capital structure at March 31, 2002 was comprised of the following (in
millions):
Debt and other obligations, including current maturities:
Senior Secured Credit Facility - Revolver......................................... $ 115
Senior Secured Credit Facility -- Term Loans...................................... 617
9-5/8% Senior Subordinated Notes due 2008......................................... 215
9% Senior Subordinated Notes due 2008............................................. 298
Other debt, primarily capital leases.............................................. 6
--------
Total debt and other obligations............................................. 1,251
Common stockholders' equity.......................................................... 948
--------
Total Capitalization......................................................... $ 2,199
========
At March 31, 2002, our debt to capitalization ratio was 57% compared with 60% at
year-end 2001, primarily reflecting the public equity offering of 23 million
shares of common stock offset by additional borrowings under the revolving
credit facility. Subsequent to March 31, 2002, we issued $450 million aggregate
principal amount of 9-5/8% senior subordinated notes (see below). Had these
notes been outstanding as of March 31, 2002, our debt to capitalization ratio
would have been 64%.
Our senior secured credit facility and senior subordinated notes impose various
restrictions and covenants on us that could potentially limit our ability to
respond to market conditions, to raise additional debt or equity capital, or to
take advantage of business opportunities. Each of these obligations is
guaranteed by substantially all of our active domestic subsidiaries.
The indentures relating to our senior subordinated notes contain covenants that
limit, among other things, our ability to:
o pay dividends and other distributions with respect to our capital
stock and purchase, redeem or retire our capital stock;
21
o incur additional indebtedness and issue preferred stock;
o enter into asset sales;
o enter into transactions with affiliates;
o incur liens on assets to secure certain debt;
o engage in certain business activities; and
o engage in certain mergers or consolidations and transfers of assets.
The indentures limit our subsidiaries' ability to create restrictions on making
certain payments and distributions. In addition, our senior secured credit
facility contains other and more restrictive covenants, including the
prohibition on making voluntary or optional prepayments of certain of our
indebtedness. Under our senior secured credit facility, we are required to
comply with specified financial covenants, including maintaining specified
levels of consolidated leverage and interest and fixed charge coverages and
limiting our debt to capital ratio. These financial ratios become more
restrictive over the life of our senior secured credit facility. For further
information on our capital structure, see Note D of Notes to Condensed
Consolidated Financial Statements in Part I, Item I.
SENIOR SECURED CREDIT FACILITY
As of March 31, 2002, our senior secured credit facility, as amended, consisted
of a five-year $175 million revolving credit facility (with a $90 million
sublimit for letters of credit), a five-year $175 million tranche A term loan
and a six-year $450 million tranche B term loan. As of March 31, 2002, we had
$115 million in borrowings and $3 million in letters of credit outstanding under
the revolving credit facility. Total unused credit available under the revolving
credit facility at March 31, 2002 was $57 million. On April 19, 2002, we
exercised our right to increase the revolving credit facility from $175 million
to $225 million.
Our senior secured facility is guaranteed by substantially all of our active
domestic subsidiaries and is secured by substantially all of our material
present and future assets as well as all material present and future assets of
our domestic subsidiaries.
The senior secured credit facility requires us to maintain specified levels of
interest and fixed charge coverage and sets limitations on our debt-to-capital
and leverage ratios. As a result of the poor operating results for the 2002
Quarter, we did not meet the required ratio of total debt to earnings before
interest, taxes, depreciation and amortization for the four quarters ended March
31, 2002. However, the lenders have waived compliance with this requirement. To
partially fund the pending acquisition of the Golden Eagle Assets, we will amend
the senior secured credit facility which will substantially increase borrowing
levels and modify covenants. However, if we do not close on the pending
acquisition of the Golden Eagle Assets and do not amend our senior secured
credit facility, additional future waivers may be required if the poor margin
environment that we have experienced during the first quarter and during the
first half of the second quarter continues.
The senior secured credit facility also contains other covenants and
restrictions customary in credit arrangements of this kind. The terms allow for
payment of cash dividends on our common stock and repurchase of shares of our
common stock, not to exceed $15 million in any year.
Borrowing rates under our senior secured credit facility are based on a pricing
grid. Borrowings bear interest at either a base rate (4.75% at March 31, 2002)
or a eurodollar rate (ranging from 1.88% to 1.91% at March 31, 2002), plus an
applicable margin. The applicable margin at March 31, 2002 for the tranche A
term loan and the revolving credit facility 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 margins are the highest margins applicable to the
respective base and eurodollar rates and will vary in relation to ratios of our
consolidated total debt to consolidated EBITDA, as defined in our senior secured
credit facility. In addition, at any time during which the senior secured credit
facility is rated at least BBB- by Standard & Poor's Rating Services and Baa3 by
Moody's Investors Service, Inc., each applicable margin, other than in one
instance with respect to the tranche B term loan, will be reduced by 0.125%. We
are also charged various fees and expenses in connection with the senior secured
credit facility, including commitment fees and various letter of credit fees.
22
PROPOSED AMENDMENT TO SENIOR SECURED CREDIT FACILITY
To partially fund the acquisition of the Golden Eagle Assets, scheduled to close
on May 17, 2002, we have negotiated an amendment and restatement to our existing
senior secured credit facility to substantially increase the borrowing levels
thereunder, which will be entered into effective on the closing of the Golden
Eagle Assets transaction. The amended facility, the terms of which are
substantially similar to the existing senior secured credit facility, will
consist of a $225 million revolving credit facility (with a $150 million
sublimit for letters of credit) which will terminate on September 6, 2006, a
$250 million tranche A term loan and an $800 million tranche B term loan.
The amended facility will contain a new provision which will require us to
consummate one or more transactions resulting in our receipt of net proceeds of
at least $125 million by December 31, 2002 from the proceeds of the sale of
assets or the sale of common stock, preferred stock mandatorily convertible
into common stock within three years of the date of its issuance, or other
equity acceptable to the majority of agent banks. Fifty percent of the net
proceeds are required to be applied to prepay the term loans, and the remaining
fifty percent of the net proceeds shall be applied, first to prepay any
outstanding revolving credit facility loans, and second if any of such net
proceeds remain after paying the outstanding revolving credit facility loans,
such remaining amount shall be deposited in an account which shall be pledged
to the banks to be used for our general corporate purposes, including but not
limited to working capital and capital expenditures. The amended facility also
limits our capital expenditures to no more than $275 million in 2002 and $302.5
million in 2003, and thereafter until the ratio of our debt to capitalization
falls below 0.58:1.00.
The amended facility will eliminate the total debt to EBITDA test and will
substitute a new senior debt to EBITDA test. The amended facility will include
interest and fixed charge coverage tests similar to the existing senior secured
credit facility except that the new facility will provide that for purposes of
determining compliance with the tests and the requirement, earnings before
interest, taxes, depreciation and amortization attributable to the Golden Eagle
Assets shall be based on the results of operations after the acquisition
thereof. Management believes, however, that we will be able to comply with the
new covenants or will be able to obtain additional waivers if required. No
assurance can be given that we will be able to meet these tests if we continue
to have the unusually low operating margin environment experienced during the
first quarter and during the first half of the second quarter. However, the
second quarter generally benefits from, and is expected to benefit from,
seasonal improvements in refining margins.
EQUITY OFFERING
On March 6, 2002, we completed an underwritten public offering of 23 million
shares of our common stock. The net proceeds from the stock offering of $244.9
million, after deducting underwriting fees and offering expenses, will be used
to partially fund the pending acquisition of the Golden Eagle Assets. At March
31, 2002, the net proceeds were held in a cash collateral account. If we do not
close the pending acquisition of the Golden Eagle Assets, the net proceeds will
be used to pay down term loans.
NEW SENIOR SUBORDINATED NOTES DUE 2012
On April 9, 2002, we issued $450 million aggregate principal amount of
9-5/8% Senior Subordinated Notes due April 1, 2012 ("2012 Notes") through a
private offering eligible for Rule 144A. The 2012 Notes have a ten-year maturity
with no sinking fund requirements and are subject to optional redemption by us
after five years at declining premiums. For the first three years, we may redeem
up to 35% of the aggregate principal amount at a redemption price of 109.625%.
The indenture for the 2012 Notes contains covenants and restrictions which are
customary for notes of this nature. The 2012 Notes are guaranteed by
substantially all of our active domestic subsidiaries. The proceeds from the
2012 Notes and accrued interest are being held in escrow and will be used to
partially fund the pending acquisition of the Golden Eagle Assets. If we do not
close the pending acquisition of the Golden Eagle Assets, the proceeds and
interest will be paid to the holders of the 2012 Notes.
23
CASH FLOW SUMMARY
Components of our cash flows are set forth below (in millions):
Three Months Ended
March 31,
------------------------------
2002 2001
------------- -------------
Cash Flows From (Used In):
Operating Activities ............................... $ (47.9) $ (18.7)
Investing Activities ............................... (352.7) (32.8)
Financing Activities ............................... 348.9 38.9
------------- -------------
Decrease in Cash and Cash Equivalents .................. $ (51.7) $ (12.6)
============= =============
Net cash used in operating activities during the 2002 Quarter totaled $48
million, compared to $19 million in the 2001 Quarter. The decrease was primarily
due to lower earnings before depreciation and amortization and payments for a
scheduled refinery turnaround. Net cash used in investing activities of $353
million in the 2002 Quarter included $300 million for a deposit and placement of
the net proceeds from the common stock offering into a restricted account,
pending the acquisition of the Golden Eagle Assets. In addition, capital
expenditures totaled $53 million during the 2002 Quarter. Net cash from
financing activities of $349 million in the 2002 Quarter included net borrowings
of $115 million under the revolving credit facility and net proceeds of $245
million from our equity offering, partly offset by repayments of debt and
financing costs of $11 million. Gross borrowings under revolving credit lines
amounted to $288 million and repayments amounted to $173 million during the 2002
Quarter. Working capital totaled $302 million at March 31, 2002 compared to $340
million at year-end 2001.
CAPITAL SPENDING
We are in the process of revising our 2002 capital spending plans in response to
the weaker refining and retail margin environment. While a review of our capital
requirements is not yet complete, we have identified approximately $25 million
in reductions from our original budget of $150 million. Approximately $14
million of the reduction reflects a slowdown in our retail capital spending. The
remaining $11 million reduction is mainly from discretionary refining and
corporate projects. Taking into account these reductions, partially offset by
additional spending on our heavy oil conversion project incurred in the 2002
Quarter, we currently estimate our 2002 capital spending to total $140 million
(before requirements from the pending Golden Eagle Assets acquisition). We
expect to fund our capital program in 2002 with internally-generated cash flows
from operations and, to a lesser extent, from borrowings under our senior
secured credit facility. However, the volatility of certain commodities prices
could reduce our cash flows from operations and may require us to further reduce
discretionary capital expenditures.
We completed a heavy oil conversion project at the Washington refinery at the
end of the 2002 first quarter which enables 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. The upgraded
fluid catalytic cracking unit, the final major component of the heavy oil
conversion project, was fully operational at the end of the first quarter of
2002. The total cost of the project was approximately $121 million (including
capitalized interest), of which $21 million was spent in the three months ended
March 31, 2002.
During the 2002 Quarter, our capital expenditures totaled $53 million, which
included $21 million for the completion of the heavy oil conversion project and
$10 million for retail marketing programs. Other capital spending was primarily
for refinery improvements.
Assuming the consummation of the pending acquisition of the Golden Eagle Assets,
we currently anticipate our capital spending for 2002 will increase by
approximately $110 million, primarily for environmental, regulatory and safety
matters including a project to meet the proposed CARB III gasoline production
requirements and to address upcoming "clean fuels" requirements. The seller of
the Golden Eagle Assets has agreed to spend through closing $47.5 million of the
$122 million cost for the CARB III project.
24
MAJOR MAINTENANCE COSTS
We completed our scheduled turnaround of certain processing units at our
Washington refinery in the 2002 Quarter at a total cost of $25 million, of which
$19 million was spent in the 2002 Quarter. Amortization of turnaround costs,
other major maintenance projects and catalysts is projected to total
approximately $25 million in 2002 of which $5 million was amortized in the 2002
Quarter.
In conjunction with the pending acquisition of the Golden Eagle Assets, we
expect that our turnaround and catalyst costs will increase by approximately $19
million and $3 million in 2002 and 2003, respectively.
ENVIRONMENTAL AND OTHER
Extensive federal, state and local environmental laws and regulations govern our
operations. These laws, which change frequently, regulate the discharge of
materials into the environment and may require us to remove or mitigate the
environmental effects of the disposal or release of petroleum or chemical
substances at various sites, install additional controls, or make other
modifications or changes in use for certain emission sources. We are currently
involved in remedial responses and have incurred cleanup expenditures associated
with environmental matters at a number of sites, including certain of our own
properties. At March 31, 2002, our accruals for environmental expenses totaled
$37 million. Based on currently available information, including the
participation of other parties or former owners in remediation actions, we
believe these accruals are adequate.
In February 2000, the EPA finalized new regulations pursuant to the Clean Air
Act requiring a reduction in the sulfur content in gasoline by January 1, 2004.
To meet the revised gasoline standard, we expect to make capital improvements of
approximately $65 million in the aggregate through 2006 and $15 million in years
after 2006.
The EPA also promulgated new regulations in January 2001 pursuant to the Clean
Air Act requiring a reduction in the sulfur content in diesel fuel manufactured
for on-road consumption. In general, the new diesel fuel standards will become
effective on June 1, 2006. We expect to spend approximately $35 million capital
improvements through 2006 and $30 million in years after 2006 to meet the new
diesel fuel standards.
We expect to spend approximately $35 million in the aggregate for additional
capital improvements at our refineries through 2006 to comply with the second
phase of the Refinery MACT II regulations promulgated in April 2002. The
Refinery MACT II regulations will require new emission controls at certain
processing units at several of our refineries. We are currently evaluating a
selection of control technologies to assure operations flexibility and
compatibility with long-term air emission reduction goals.
In connection with the 2001 acquisition of the North Dakota and Utah refineries,
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 both the North Dakota
and Utah 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 currently
estimate that we will spend an aggregate of $7 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 the consent decree.
We anticipate that we will make additional environmental capital improvements of
approximately $11 million in 2002, primarily for improvements to storage tanks,
tank farm secondary containment and pipelines. During the 2002 Quarter, we spent
approximately $1 million on environmental capital projects.
Conditions that require additional expenditures may transpire for our various
sites, including, but not limited to, our refineries, tank farms, retail
gasoline stations (operating and closed locations) and petroleum product
terminals, and for
25
compliance with the Clean Air Act and other state and federal requirements. We
cannot currently determine the amount of these future expenditures.
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 2003. The seller of
the Golden Eagle Assets has begun construction of a project at the Golden Eagle
refinery that we expect will enable it to comply with California's regulations
to phase out MTBE and meet the proposed CARB III gasoline production
requirements. Based upon a review by an independent engineering firm, management
believes that this project will cost approximately $122 million, of which the
seller has agreed to spend $47.5 million through closing. We expect that we will
have to spend approximately $74.5 million in 2002 and 2003 to complete the CARB
III project. Furthermore, we expect 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.
We anticipate that capital expenditures addressing environmental issues at the
Golden Eagle refinery (including California's Bay Area Air Quality Management
District's requirements for controlling emissions of nitrogen oxides, the
Regional Water Quality Control Board's order requiring piping upgrades and
requirements as a result of a 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. We will need to spend additional amounts for capital
expenditures at the Golden Eagle refinery in subsequent years and we may choose
to spend additional discretionary amounts.
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 $65 million, of which approximately $43 million is anticipated to
be incurred through 2006 and the balance afterwards. Management believes that 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.
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 or delegated local enforcement agencies. We also
expect to spend approximately $5 million in the aggregate on capital
improvements to meet new California vapor control equipment requirements at the
retail facilities.
SECOND QUARTER 2002 OUTLOOK
Late March and early April industry margins improved from average first quarter
2002 levels; however, since early April, margins have again deteriorated.
Gasoline demand appears stronger than last year at this time, but prices have
been weak with high apparent production and imports. Jet fuel demand has almost
returned to prior year's levels but distillate inventories remain somewhat high
keeping prices down. At the same time, international tensions have been pushing
crude prices up, further compressing margins.
Most refineries in the U.S. are likely operating at very low or negative
profitability in the current market environment. We believe this is not a
long-term sustainable situation and the industry will respond, with the
potential for improving margins by the end of the quarter. It appears unlikely
at this point that margins for the quarter can reach trailing five-year average
levels barring a substantial supply disruption.
26
Tesoro's refining capacity of 360,000 to 370,000 bpd is fully available with the
completion of the turnaround at the Washington refinery and the repairs at the
Utah refinery. Actual run rates in the quarter will be dependent on the margin
environment as the quarter progresses.
NEW ACCOUNTING STANDARDS
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 us
beginning January 1, 2003 with earlier adoption encouraged. We are currently
evaluating the impact the standard will have on its future results of operations
and financial condition.
Effective January 1, 2002, we adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." 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 adoption of SFAS No.
144 did not have a significant impact on our financial condition or results of
operations.
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, we would be required to
write off the unamortized carrying value of deferred major maintenance costs,
primarily for refinery turnarounds, which totaled $59 million at March 31, 2002
and expense future costs as incurred.
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. These
statements are included throughout this Form 10-Q and relate to, among other
things, projections of revenues, earnings, earnings per share, cash flows,
capital expenditures or other financial items, throughput, expectations
regarding the pending or completed acquisitions, 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 Quarterly Report on Form 10-Q.
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.
Actual results and trends in the future may differ materially depending on a
variety of factors including, but not limited to:
o changes in general economic conditions;
o the timing and extent of changes in commodity prices and underlying
demand for our products;
o the availability and costs of crude oil, other refinery feedstocks and
refined products;
o changes in our cash flow from operations, liquidity and capital
requirements resulting from acquisitions;
o our ability to (1) successfully integrate acquisitions, and (2)
identify and complete future strategic acquisitions;
27
o fluctuations in our stock price;
o adverse changes in the ratings assigned to our trade credit and debt
instruments;
o changes in credit terms;
o increased interest rates and the condition of the capital markets;
o the direct or indirect effects on our business resulting from
terrorist incidents or acts of war;
o political developments in foreign countries;
o changes in our inventory levels and carrying costs;
o changes in the cost or availability of third-party vessels, pipelines
and other means of transporting feedstocks and products;
o changes in fuel and utility costs for our facilities;
o disruptions due to equipment interruption or failure at our or
third-party facilities;
o execution of planned capital projects;
o state and federal environmental, economic, safety and other policies
and regulations, any changes therein, and any legal or regulatory
delays or other factors beyond our control;
o adverse rulings, judgments, or settlements in litigation or other
legal or tax matters, including unexpected environmental remediation
costs in excess of any reserves;
o actions of customers and competitors;
o weather conditions affecting our operations or the areas in which our
products are marketed and;
o 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 herein 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 becomes aware of, after the date of this Quarterly Report
on Form 10-Q.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Changes in commodity prices and interest rates are our primary sources of market
risk. We have a risk management committee responsible for overseeing energy risk
management activities.
COMMODITY PRICE RISKS
Our earnings and cash flows from operations depend on the margin above fixed and
variable expenses (including the costs of crude oil and other feedstocks) at
which we are able to sell refined products. The prices of crude oil and refined
products have fluctuated substantially in recent years. These prices depend on
many factors, including the demand for crude oil, gasoline and other refined
products, which in turn depend on, among other factors, changes in the economy,
the level of foreign and domestic production of crude oil and refined products,
worldwide political conditions, the availability of imports of crude oil and
refined products, the marketing of alternative and competing fuels and the
extent of government regulations. The prices we receive for refined products are
also affected by local factors such as local market conditions and the level of
operations of other refineries in our markets.
The prices at which we sell our 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, can impact profit margins which could significantly affect our earnings
and cash flows. In addition, crude oil supply contracts generally are short-term
in nature with market-responsive pricing provisions. We normally purchase
refinery feedstocks prior to selling the refined products manufactured. Our
financial results can be affected significantly by price level changes during
the period between purchasing refinery feedstocks and selling the manufactured
refined products from such feedstocks. We also purchase refined products
manufactured by others for resale to our customers. Our financial results can be
affected significantly by price level changes during the periods between
purchasing and selling such products.
28
We maintain inventories of crude oil, intermediate products and refined
products, the values of which are subject to fluctuations in market prices. In
our Refining and Retail segments, inventories of refinery feedstocks and refined
products totaled 16.6 million and 17.2 million barrels at March 31, 2002 and
December 31, 2001, respectively. During 2001, inventory levels increased 5.3
million barrels over the year-end 2000 levels at an average cost of $28.52 per
barrel. Any sales that result in a reduction in inventories during 2002 could
have a per barrel cost of sales in excess of the current cost of sales during
2002. The average cost of our refinery feedstocks and refined product as of
March 31, 2002 was $23.96 per barrel. If market prices for refined products
decline to a level below the average cost of these inventories, we may be
required to write down the carrying value of our inventory.
We periodically enter into derivative type arrangements on a limited basis, as
part of our programs to acquire refinery feedstocks at reasonable costs and to
manage margins on certain refined product sales. We also engage in limited
non-hedging activities which are marked to market with changes in the fair value
of the derivatives recognized in earnings. At March 31, 2002, we had open price
swap transactions for an aggregate of 240,000 barrels of gasoline, naphtha and
diesel fuel which settle in the second quarter of 2002. Recording the fair value
of these swaps resulted in a mark-to-market loss of $1 million during the three
months ended March 31, 2002. We believe that any potential impact from these
activities will not result in a material adverse effect on our results of
operations, financial position or cash flows.
INTEREST RATE RISK
At March 31, 2002, we had $732 million of outstanding floating-rate debt under
the senior secured credit facility and $519 million of fixed-rate debt. The
weighted average interest rate on the floating-rate debt was 5.3% at March 31,
2002. The impact on annual cash flow of a 10% change in the floating-rate for
our senior secured credit facility (53 basis points) would be approximately $4
million.
The fair market value of our fixed-rate debt at March 31, 2002 was approximately
$4 million more than its book value of $519 million, based on recent
transactions and bid quotes for our senior subordinated notes due 2008.
On April 9, 2002, we issued $450 million aggregate principal amount of 9-5/8%
senior subordinated notes maturing in 2012. The net proceeds will be used to
partially fund the pending acquisition of the Golden Eagle Assets.
29
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In April 2002, the Company issued $450 million aggregate principal amount
of 9-5/8% Senior Subordinated Notes due 2012. The indenture for the notes
contains covenants and restrictions which are customary for notes of this
nature. For further information related to these restrictions and covenants
in the 9-5/8% Senior Subordinated Notes due 2012, see Note D of Notes to
Condensed Consolidated Financial Statements in Part I, Item 1, and "Capital
Resources and Liquidity" in Management's Discussion and Analysis of
Financial Condition and Results of Operations in Part I, Item 2, contained
herein.
For information related to a proposed amendment to the Senior Secured
Credit Facility, see "Capital Resources and Liquidity" in Management's
Discussion and Analysis of Financial Condition and Results of Operations in
Part I, Item 2, contained herein.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
10.1 Management Stability Agreement between the Company and G. Scott
Spendlove dated January 24, 2002.
10.2 Copy of the Company's Amended and Restated 1995 Non-Employee
Director Stock Option Plan, as amended through March 15, 2000.
10.3 Copy of the Company's Key Employee Stock Option Plan dated
November 12, 1999.
(b) Reports on Form 8-K.
On February 4, 2002, a Current Report on Form 8-K was filed reporting
under Item 5, Other Events, information (1) updating certain
supplemental financial and operational data for both the fourth
quarter and the year ended December 31, 2001 through the Company's
website and (2) regarding a press release issued on January 30, 2002
announcing the Company's earnings for the fourth quarter and year
ended December 31, 2001 and its capital spending plans for 2002. The
website data and press release were filed as Exhibits under Item 7 on
this Form 8-K.
On February 5, 2002, a Current Report on Form 8-K was filed reporting
under Item 5, Other Events, information that the Company had entered
into an asset purchase agreement relating to the purchase of the
Golden Eagle Assets from Valero Energy Corporation. A Press Release
issued on February 5, 2002 and presentation data related to a
conference call and webcast were filed as Exhibits under Item 7 of
this Form 8-K.
On February 21, 2002, a Current Report on Form 8-K was filed reporting
under Item 5, Other Events, that the Company had issued a press
release containing its first quarter 2002 earnings update. The Press
Release was filed as an Exhibit under Item 7 of this Form 8-K.
On February 22, 2002, a Current Report on Form 8-K was filed reporting
under Item 5, Other Events, that the Company had entered into an
amendment to the asset purchase agreement relating to the purchase
agreement for the Golden Eagle Assets. The Press Release announcing
the amendment was filed as an Exhibit under Item 7 of this Form 8-K.
30
On February 25, 2002, a Current Report on Form 8-K was filed reporting
under Item 5, Other Events, information (1) updating the pending
Golden Eagle Assets purchase and (2) regarding a press release
announcing that the Company intends to offer 20,000,000 newly issued
shares of its common stock. Included under Item 7 of this Form 8-K
were the following: (i) Audited Financial Statements of Golden Eagle
Refining and Marketing Assets Business as of December 31, 2000 and
2001 and for the year ended December 31, 2001 and four months ended
December 31, 2000; (ii) Unaudited Pro Forma Combined Condensed
Financial Statements as of and for the year ended December 31, 2001;
(iii) Consent of Arthur Andersen LLP; and (iv) the Press Release
issued on February 22, 2002. On April 22, 2002, an Amendment No. 1 to
Current Report on Form 8-K was filed restating in its entirety the
Consent of Arthur Andersen LLP included under Item 7 of this Form 8-K.
On March 5, 2002, a Current Report on Form 8-K was filed reporting
under Item 5, Other Events, that the Company had entered into an
Underwriting Agreement to issue 20,000,000 shares of its common stock
and had also granted the Underwriters an option to purchase up to an
additional 3,000,000 shares of its common stock. Included under Item 7
of this Form 8-K were the following: (i) Underwriting Agreement; (ii)
Opinion of Fulbright & Jaworski L.L.P.; (iii) Consent of Fulbright &
Jaworski L.L.P.; and (iii) two Press Releases issued on March 1, 2002.
On April 9, 2002, a Current Report on Form 8-K was filed reporting
under Item 9, Regulation FD Disclosures, information related to a
presentation concerning the pending acquisition of the Golden Eagle
Assets. The presentation data was filed as an Exhibit under Item 7 of
this Form 8-K.
On May 9, 2002, a Current Report on Form 8-K was filed reporting under
Item 5, Other Events, that the Company had entered into a second
amendment to the asset purchase agreement relating to the purchase
agreement for the Golden Eagle Assets. The Second Amendment and the
Press Release were filed as Exhibits under Item 7 of this Form 8-K.
31
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TESORO PETROLEUM CORPORATION
REGISTRANT
Date: May 15, 2002 /s/ BRUCE A. SMITH
-------------------------------------------------
Bruce A. Smith
Chairman of the Board of Directors,
President and Chief Executive Officer
Date: May 15, 2002 /s/ GREGORY A. WRIGHT
-------------------------------------------------
Gregory A. Wright
Senior Vice President and Chief Financial Officer
(Principal Financial Officer)
32
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.1 Management Stability Agreement between the Company and G.
Scott Spendlove dated January 24, 2002.
10.2 Copy of the Company's Amended and Restated 1995 Non-Employee
Director Stock Option Plan, as amended through March 15, 2000.
10.3 Copy of the Company's Key Employee Stock Option Plan dated
November 12, 1999.
33