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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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 64,609,232 shares of the registrant's Common Stock
outstanding at August 1, 2002.
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1
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - June 30, 2002 and December 31, 2001....................... 3
Condensed Statements of Consolidated Operations - Three Months and Six Months Ended
June 30, 2002 and 2001............................................................................ 4
Condensed Statements of Consolidated Cash Flows - Six Months Ended June 30, 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...................................................................................... 18
Item 3. Quantitative and Qualitative Disclosures About Market Risk......................................... 32
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.......................................................... 34
Item 4. Submission of Matters to a Vote of Security Holders................................................ 34
Item 6. Exhibits and Reports on Form 8-K................................................................... 35
SIGNATURES...................................................................................................... 37
EXHIBIT INDEX................................................................................................... 38
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)
JUNE 30, DECEMBER 31,
2002 2001
------------- -------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents ................................................................... $ 43.0 $ 51.9
Receivables, less allowance for doubtful accounts ........................................... 503.6 384.9
Inventories ................................................................................. 545.3 431.8
Prepayments and other ....................................................................... 20.5 9.4
------------- -------------
Total Current Assets ...................................................................... 1,112.4 878.0
------------- -------------
PROPERTY, PLANT AND EQUIPMENT
Refining .................................................................................... 2,317.6 1,522.0
Retail ...................................................................................... 330.2 228.8
Marine Services ............................................................................. 56.0 54.0
Corporate ................................................................................... 53.7 47.9
------------- -------------
2,757.5 1,852.7
Less accumulated depreciation and amortization .............................................. 368.1 330.4
------------- -------------
Net Property, Plant and Equipment ......................................................... 2,389.4 1,522.3
------------- -------------
OTHER ASSETS
Goodwill .................................................................................... 95.2 95.2
Acquired intangibles, net ................................................................... 199.4 73.3
Other, net .................................................................................. 165.4 93.5
------------- -------------
Total Other Assets ........................................................................ 460.0 262.0
------------- -------------
Total Assets .......................................................................... $ 3,961.8 $ 2,662.3
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable ............................................................................ $ 418.5 $ 331.2
Accrued liabilities ......................................................................... 172.3 172.9
Current maturities of debt and other obligations ............................................ 54.9 34.4
------------- -------------
Total Current Liabilities ................................................................. 645.7 538.5
------------- -------------
DEFERRED INCOME TAXES .......................................................................... 159.5 136.9
------------- -------------
OTHER LIABILITIES .............................................................................. 220.0 117.4
------------- -------------
DEBT ........................................................................................... 2,005.5 1,112.5
------------- -------------
COMMITMENTS AND CONTINGENCIES (Note H)
STOCKHOLDERS' EQUITY
Common stock, par value $0.16-2/3; authorized 100,000,000 shares;
66,380,927 shares issued (43,371,825 in 2001) ............................................. 11.0 7.2
Additional paid-in capital .................................................................. 689.8 448.4
Retained earnings ........................................................................... 248.4 321.9
Treasury stock, 1,771,695 common shares (1,958,147 in 2001), at cost ........................ (18.1) (20.5)
------------- -------------
Total Stockholders' Equity ................................................................ 931.1 757.0
------------- -------------
Total Liabilities and Stockholders' Equity ............................................ $ 3,961.8 $ 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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
REVENUES ...................................................... $ 1,745.7 $ 1,299.6 $ 2,988.9 $ 2,526.9
COSTS AND EXPENSES
Costs of sales and operating expenses .................... 1,678.6 1,210.9 2,926.4 2,359.2
Selling, general and administrative expenses ............. 33.8 22.2 72.3 45.7
Depreciation and amortization ............................ 23.6 10.9 43.7 22.9
------------- ------------- ------------- -------------
OPERATING INCOME (LOSS) ....................................... 9.7 55.6 (53.5) 99.1
Interest and financing costs, net of capitalized interest ..... (41.6) (6.6) (71.9) (14.1)
Interest income ............................................... 2.1 0.2 2.8 0.5
------------- ------------- ------------- -------------
EARNINGS (LOSS) BEFORE INCOME TAXES ........................... (29.8) 49.2 (122.6) 85.5
Income tax provision (benefit) ................................ (11.9) 19.7 (49.1) 34.3
------------- ------------- ------------- -------------
NET EARNINGS (LOSS) ........................................... (17.9) 29.5 (73.5) 51.2
Preferred dividends ........................................... -- 3.0 -- 6.0
------------- ------------- ------------- -------------
NET EARNINGS (LOSS) APPLICABLE TO COMMON STOCK................. $ (17.9) $ 26.5 $ (73.5) $ 45.2
============= ============= ============= =============
NET EARNINGS (LOSS) PER SHARE
Basic .................................................... $ (0.28) $ 0.85 $ (1.30) $ 1.46
============= ============= ============= =============
Diluted .................................................. $ (0.28) $ 0.70 $ (1.30) $ 1.22
============= ============= ============= =============
WEIGHTED AVERAGE COMMON SHARES
Basic .................................................... 64.6 31.1 56.4 31.0
============= ============= ============= =============
Diluted .................................................. 64.6 42.3 56.4 42.0
============= ============= ============= =============
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)
SIX MONTHS ENDED
JUNE 30,
----------------------------
2002 2001
------------ ------------
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Net earnings (loss) ....................................................... $ (73.5) $ 51.2
Adjustments to reconcile net earnings (loss) to net cash from (used in)
operating activities:
Depreciation and amortization ......................................... 43.7 22.9
Amortization of refinery turnarounds and other non-cash charges ....... 28.9 11.8
Deferred income taxes ................................................. 22.6 13.5
Changes in operating assets and liabilities:
Receivables ...................................................... (118.7) (10.4)
Inventories ...................................................... 35.8 (33.5)
Accounts payable and accrued liabilities ......................... 78.4 (23.9)
Other assets and liabilities ..................................... (41.5) (8.4)
------------ ------------
Net cash from (used in) operating activities ................. (24.3) 23.2
------------ ------------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Capital expenditures ...................................................... (96.4) (81.9)
Acquisition ............................................................... (933.9) --
Other ..................................................................... (11.7) 2.5
------------ ------------
Net cash used in investing activities ........................ (1,042.0) (79.4)
------------ ------------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Proceeds from debt offering, net of issuance costs of $9.4 ................ 440.6 --
Proceeds from equity offering, net of issuance costs of $13.7 ............. 245.1 --
Borrowings under term loans ............................................... 425.0 --
Net borrowings under revolving credit facilities .......................... -- 49.0
Repayments of term loans and other ........................................ (23.3) (0.5)
Payment of dividends on Preferred Stock ................................... -- (6.0)
Financing costs and other ................................................. (30.0) 1.5
------------ ------------
Net cash from financing activities ........................... 1,057.4 44.0
------------ ------------
DECREASE IN CASH AND CASH EQUIVALENTS .......................................... (8.9) (12.2)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ................................. 51.9 14.1
------------ ------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ....................................... $ 43.0 $ 1.9
============ ============
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid, net of capitalized interest ................................ $ 43.7 $ 12.6
============ ============
Income taxes paid ......................................................... $ -- $ 29.9
============ ============
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. As
described in Note C, financial results of the acquired assets have been included
in Tesoro's consolidated results since the date of the acquisition. 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. 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 and six months
ended June 30, 2002, and was not included in the calculation of diluted earnings
per share. For the three months and six months ended June 30, 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 Six Months Ended
June 30, June 30,
=============-----============ =============-----============
2002 2001 2002 2001
============= ============= ============= =============
BASIC:
Numerator:
Net earnings (loss) ................................... $ (17.9) $ 29.5 $ (73.5) $ 51.2
Less dividends on preferred stock ..................... -- 3.0 -- 6.0
------------- ------------- ------------- -------------
Net earnings (loss) applicable to common shares ....... $ (17.9) $ 26.5 $ (73.5) $ 45.2
============= ============= ============= =============
Denominator:
Weighted average common shares outstanding ............ 64.6 31.1 56.4 31.0
============= ============= ============= =============
Basic Earnings (Loss) Per Share ......................... $ (0.28) $ 0.85 $ (1.30) $ 1.46
============= ============= ============= =============
6
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
DILUTED:
Numerator:
Net earnings (loss) applicable to common shares ............ $ (17.9) $ 26.5 $ (73.5) $ 45.2
Plus impact of assumed conversion of preferred stock ....... -- 3.0 -- 6.0
------------- ------------- ------------- -------------
Total .................................................... $ (17.9) $ 29.5 $ (73.5) $ 51.2
============= ============= ------------- =============
Denominator:
Weighted average common shares outstanding ................. 64.6 31.1 56.4 31.0
Add potentially dilutive securities:
Incremental dilutive shares from assumed exercise
of stock options (anti-dilutive in 2002) ............... -- 0.9 -- 0.7
Incremental dilutive shares from assumed
conversion of preferred stock .......................... -- 10.3 -- 10.3
------------- ------------- ------------- -------------
Total diluted shares ..................................... 64.6 42.3 56.4 42.0
============= ============= ============= =============
Diluted Earnings (Loss) Per Share ............................ $ (0.28) $ 0.70 $ (1.30) $ 1.22
============= ============= ============= =============
NOTE C - ACQUISITION AND POTENTIAL DIVESTITURES
GOLDEN EAGLE ACQUISITION
On May 17, 2002, the Company acquired 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") from Ultramar Inc., a subsidiary of Valero Energy
Corporation. The cash purchase price for the Golden Eagle Assets was
approximately $925 million, including approximately $130 million for feedstock,
refined product and other inventories, subject to post-closing adjustments. In
addition, the Company issued to the seller two ten-year junior subordinated
notes with face amounts aggregating $150 million, with a present value of
approximately $61 million (see Note D). The purchase price was determined as
part of a competitive bid process. The Company incurred direct costs related to
this transaction of approximately $9 million. The Golden Eagle Assets increased
the size and scope of the Company's operations in California, and they enable
the Company to increase its yield of higher-value products, increase its
processing of heavier lower-cost crude oil, diversify its earnings and
geographic exposure, and build a platform for additional growth.
In connection with the acquisition of the Golden Eagle Assets, the Company
assumed certain related liabilities and obligations (including costs associated
with employee benefits, a lease obligation and environmental matters) subject to
specific levels of indemnification. The Company recorded approximately $106
million related to these liabilities, including $7 million for environmental
matters, as part of the preliminary purchase price allocation. These liabilities
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, the Company also assumed 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.
See Note H for further information on environmental matters related to the
Golden Eagle Assets.
The Company also assumed and took assignment of certain of the seller's
obligations and rights (including certain indemnity rights) arising out of or
related to the agreement pursuant to which the seller purchased the refinery in
2000. In addition, upon the acquisition of the Golden Eagle Assets, the Company
took assignment from the seller of two
7
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
environmental insurance policies. The policies provide $140 million of coverage
in excess of a $50 million environmental indemnity.
The purchase price was allocated to the assets acquired and liabilities assumed
based upon their respective fair market values at the date of acquisition. The
accompanying financial statements reflect the preliminary purchase price
allocation, pending completion of independent appraisals and other evaluations.
The accompanying financial statements include the results of operations of the
Golden Eagle Assets since the date of acquisition.
The following unaudited pro forma financial information for the three months and
six months ended June 30, 2002 and 2001 gives effect to the acquisition of the
Golden Eagle Assets and related financings, including, (i) the March 2002
underwritten public offering of 23 million shares of common stock, (ii)
additional borrowings under our amended and restated senior secured credit
facility, and (iii) the issuance of the 9-5/8% senior subordinated notes due
2012 (see Note D below), as if each had occurred at the beginning of the periods
presented. This pro forma information is based on historical data (in millions
except per share amounts) and the Company believes it is not indicative of the
results of future operations.
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
Revenues .................................... $ 2,005.4 $ 1,890.0 $ 3,662.7 $ 3,601.1
Net earnings (loss) ......................... $ (48.2) $ 63.8 $ (128.2) $ 104.4
Net earnings (loss) per share:
Basic .................................... $ (0.75) $ 1.12 $ (1.98) $ 1.82
Diluted .................................. $ (0.75) $ 0.93 $ (1.98) $ 1.51
POTENTIAL DIVESTITURES
In June 2002, the Company announced a goal to reduce debt by $500 million by the
end of 2003. As part of the debt reduction, the Company's goal is to generate
net proceeds of $200 million through asset sales. In addition to the previously
announced review of the Company's Marine Services operations, the assets under
review include the crude and product pipeline systems around the North Dakota
refinery and selected retail sites, including 70 retail stations in California
recently acquired as part of the Golden Eagle Assets. Although the Company had
announced that it was evaluating possible asset sales, as of June 30, 2002,
management had not yet determined that sales of these assets were probable.
Therefore, these assets were classified as "held and used" in the accompanying
condensed consolidated financial statements.
8
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE D - CAPITALIZATION
DEBT AND MATURITIES
Debt and other obligations consisted of the following (in millions):
June 30, December 31,
2002 2001
------------- -------------
Credit Facility - Tranche A Term Loan ........................... $ 231.3 $ 175.0
Credit Facility - Tranche B Term Loan ........................... 796.0 450.0
9 5/8% Senior Subordinated Notes Due 2012 ....................... 450.0 --
9 5/8% Senior Subordinated Notes Due 2008 ....................... 215.0 215.0
9% Senior Subordinated Notes Due 2008 ........................... 297.7 297.6
Junior Subordinated Notes ....................................... 62.1 --
Other, primarily capital leases ................................. 8.3 9.3
------------- -------------
Total debt and other obligations ............................. 2,060.4 1,146.9
Less current maturities ......................................... 54.9 34.4
------------- -------------
Debt and other obligations, less current maturities .......... $ 2,005.5 $ 1,112.5
============= =============
Aggregate maturities of debt and other obligations for each of the five 12-month
periods following June 30, 2002 were as follows: 2002-2003 - $54.9 million;
2003-2004 - $52.9 million; 2004-2005 - $59.2 million; 2005-2006 - $59.2 million;
and 2006-2007 - $65.3 million.
SENIOR SECURED CREDIT FACILITY
On May 17, 2002, the Company amended and restated its senior secured credit
facility (as amended and restated, the "Credit Facility") to increase the
facility to $1.275 billion from $1.0 billion to partially fund the acquisition
of the Golden Eagle Assets. As of June 30, 2002, the Credit Facility consisted
of a five-year $225 million revolving credit facility (with a $150 million
sublimit for letters of credit), a five-year tranche A term loan and a six-year
tranche B term loan. As of June 30, 2002, the Company had no borrowings and $3.7
million in letters of credit outstanding under the revolving credit facility,
resulting in total unused credit available of $221.3 million. In addition to the
Credit Facility, in June 2002, the Company obtained a $20 million secured letter
of credit line with a bank, under which no amounts were outstanding as of June
30, 2002.
The Credit Facility is guaranteed by substantially all of the Company's active
domestic subsidiaries and is secured by substantially all of the Company's
material present and future assets, as well as all material present and future
assets of the Company's domestic subsidiaries (with certain exceptions for
pipeline, retail and marine services assets), and is additionally secured by a
pledge of all of the stock of all current active and future domestic
subsidiaries and 66% of the stock of the Company's current and future foreign
subsidiaries.
The Credit Facility requires the Company to meet certain financial covenants,
some of which use a measure of cash flow called EBITDA, as defined in the Credit
Facility. The financial covenants specify thresholds of the following ratios
which use EBITDA: senior debt to EBITDA, EBITDA to fixed charges and EBITDA to
interest expense. The initial calculations of these ratios are to be made in
relation to the four quarters ending September 30, 2002 (with a provision to
annualize Golden Eagle EBITDA based on the period of time owned by the Company).
In addition, the financial covenants set a maximum threshold for a total senior
debt to total capitalization ratio, as defined in the Credit Facility, each
quarter-end commencing with June 30, 2002. For the quarter ended June 30, 2002,
the financial covenants also required the Company to have consolidated EBITDA of
at least $40 million.
The Company satisfied all of the financial covenants under the Credit Facility
for the quarter ended June 30, 2002. However, continued compliance with the
financial covenants cannot be assured. Many of the financial covenants require
EBITDA levels that cannot be achieved unless the current margin environment
improves. Although margins
9
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
typically improve in the third quarter due to seasonal factors, the Company
believes that it is prudent to seek an amendment to its Credit Facility and has
initiated discussions with its lenders to amend the financial covenants to
levels that reflect the potential for a continued weak margin environment. The
Company has no reason to believe that it will not be able to obtain an amendment
to the financial covenants and, accordingly, expects to be in compliance with
its covenants in the future.
The Credit Facility also contains a provision that requires the Company to
consummate one or more transactions resulting in the receipt of net proceeds of
at least $125 million by December 31, 2002 from 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 to prepay any outstanding revolving credit facility
loans, none of which were outstanding at June 30, 2002. If any of such net
proceeds remain after prepaying the outstanding revolving credit facility loans,
such remaining amount up to $62.5 million shall be deposited in an account that
shall be pledged to the banks but may be used for general corporate purposes,
including but not limited to working capital and capital expenditures. To the
extent there is still a cash balance in the account at such time as the
Company's debt-to-capital ratio falls below 0.55 to 1.00, the funds will become
available to the Company for any purpose, including to further pay down debt.
The Credit Facility also limits the Company's capital expenditures to no more
than $275 million in 2002 and $302.5 million in 2003 and thereafter unless the
Company's debt-to-capital ratio falls below 0.58 to 1.00.
The 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.
Borrowing rates under the Credit Facility are based on a pricing grid. At June
30, 2002, interest rates were 4.84% to 4.86% on the tranche A term loan and 6.5%
on the tranche B term loan. Borrowings bear interest at either a base rate
(4.75% at June 30, 2002) or a eurodollar rate (ranging from 1.84% to 1.86% at
June 30, 2002), plus an applicable margin. The applicable margin at June 30,
2002 for the tranche A term loan and the revolving credit facility was 2.0% in
the case of the base rate and 3.0% in the case of the eurodollar rate. The
applicable margin for the tranche B term loan was 2.5% in the case of the base
rate and 3.5% in the case of the eurodollar rate. Additionally, the tranche B
eurodollar rate is deemed to be no less than 3.0%. These margins are the highest
margins applicable to the respective base and eurodollar rates and will vary in
relation to ratios of the Company's consolidated total senior debt to
consolidated EBITDA, as defined in the Credit Facility. In addition, at any time
during which the 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%. The Company is also charged various fees and expenses in
connection with the Credit Facility, including commitment fees and various
letter of credit fees.
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 and Regulation S. 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. In addition,
the Company, for the first three years, may redeem up to 35% of the aggregate
principal amount at a redemption price of 109.625% with proceeds of certain
equity issuances. 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 were used to
partially fund the acquisition of the Golden Eagle Assets.
10
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
JUNIOR SUBORDINATED NOTES
In connection with the Golden Eagle Assets acquisition, the Company issued to
the seller two ten-year junior subordinated notes with face amounts aggregating
$150 million. The notes consist of: (i) a $100 million junior subordinated note,
due July 2012, which is non-interest bearing for the first five years and
carries a 7.5% interest rate for the remaining five-year period, and (ii) a $50
million junior subordinated note, due July 2012, which has no interest payment
in year one and bears interest at 7.47% for the second through the fifth years
and 7.5% for years six through ten. The two junior subordinated notes with face
amounts of $100 million and $50 million were recorded at a combined present
value of approximately $61 million, discounted at rates of 15.625% and 14.375%,
respectively. The discount is being amortized over the terms of the notes.
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
$245.1 million, after deducting underwriting fees and offering expenses, were
used to partially fund the acquisition of the Golden Eagle Assets.
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.
Segment information is as follows (in millions):
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
REVENUES
Refining:
Refined products ........................................ $ 1,564.8 $ 1,156.1 $ 2,651.1 $ 2,249.4
Crude oil resales and other ............................. 97.0 61.0 188.4 120.8
Retail:
Fuel .................................................... 234.4 91.5 402.3 162.6
Merchandise and other ................................... 33.2 16.2 56.0 29.5
Marine Services .......................................... 31.4 47.4 57.8 93.8
Intersegment Sales from Refining to Retail ............... (215.1) (72.6) (366.7) (129.2)
------------- ------------- ------------- -------------
Total Revenues ...................................... $ 1,745.7 $ 1,299.6 $ 2,988.9 $ 2,526.9
============= ============= ============= =============
SEGMENT OPERATING INCOME (LOSS)
Refining ................................................. $ 36.8 $ 57.4 $ 1.0 $ 108.2
Retail ................................................... (7.4) 7.3 (17.1) 9.3
Marine Services .......................................... 0.1 3.3 0.5 6.0
------------- ------------- ------------- -------------
Total Segment Operating Income (Loss) ................... 29.5 68.0 (15.6) 123.5
Corporate and Unallocated Costs .......................... (19.8) (12.4) (37.9) (24.4)
------------- ------------- ------------- -------------
Operating Income (Loss) ................................. 9.7 55.6 (53.5) 99.1
Interest and Financing Costs, Net of Capitalized Interest (41.6) (6.6) (71.9) (14.1)
Interest Income .......................................... 2.1 0.2 2.8 0.5
------------- ------------- ------------- -------------
Earnings (Loss) Before Income Taxes ..................... $ (29.8) $ 49.2 $ (122.6) $ 85.5
============= ============= ============= =============
11
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Three Months Ended Six Months Ended
June 30, June 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
DEPRECIATION AND AMORTIZATION
Refining ..................................... $ 17.6 $ 7.6 $ 32.9 $ 15.5
Retail ....................................... 3.9 1.9 7.3 4.7
Marine Services .............................. 0.7 0.7 1.4 1.4
Corporate .................................... 1.4 0.7 2.1 1.3
------------- ------------- ------------- -------------
Total Depreciation and Amortization ..... $ 23.6 $ 10.9 $ 43.7 $ 22.9
============= ============= ============= =============
CAPITAL EXPENDITURES
Refining ..................................... $ 27.0 $ 38.8 $ 63.3 $ 65.3
Retail ....................................... 15.3 7.4 25.4 13.0
Marine Services .............................. 0.9 0.8 2.1 1.0
Corporate .................................... 0.6 1.4 5.6 2.6
------------- ------------- ------------- -------------
Total Capital Expenditures .............. $ 43.8 $ 48.4 $ 96.4 $ 81.9
============= ============= ============= =============
Identifiable assets are those assets utilized by the segment. Corporate assets
are principally cash, income tax receivables and other assets that are not
associated with an operating segment. Segment assets were as follows (in
millions):
June 30, December 31,
2002 2001
------------- -------------
IDENTIFIABLE ASSETS
Refining .................................................... $ 3,240.2 $ 2,164.9
Retail ...................................................... 396.1 283.8
Marine Services ............................................. 63.0 62.0
Corporate ................................................... 262.5 151.6
------------- -------------
Total Assets ............................................. $ 3,961.8 $ 2,662.3
============= =============
NOTE F - INVENTORIES
Components of inventories were as follows (in millions):
June 30, December 31,
2002 2001
------------- -------------
Crude oil and refined products, at LIFO ......................... $ 498.3 $ 398.4
Fuel products, at FIFO .......................................... 2.8 2.1
Merchandise and other ........................................... 11.3 7.9
Materials and supplies .......................................... 32.9 23.4
------------- -------------
Total Inventories ........................................ $ 545.3 $ 431.8
============= =============
12
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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. The Company has ceased amortizing
goodwill and determined as of January 1, 2002, that its goodwill was not
impaired.
The following table reflects reported net earnings and earnings per share,
adjusted to exclude goodwill amortization (in millions except per share
amounts):
Three Months Six Months
Ended Ended
June 30, 2001 June 30, 2001
------------- -------------
Reported net earnings ............................................................ $ 29.5 $ 51.2
Goodwill amortization, net of income taxes ....................................... 0.6 1.2
------------- -------------
Adjusted net earnings ............................................................ $ 30.1 $ 52.4
============= =============
Basic earnings per share:
Reported basic earnings per share ........................................... $ 0.85 $ 1.46
Goodwill amortization, net of income taxes .................................. 0.02 0.04
------------- -------------
Adjusted basic earnings per share ........................................... $ 0.87 $ 1.50
============= =============
Diluted earnings per share:
Reported diluted earnings per share ......................................... $ 0.70 $ 1.22
Goodwill amortization, net of income taxes .................................. 0.01 0.03
------------- -------------
Adjusted diluted earnings per share ......................................... $ 0.71 $ 1.25
============= =============
The net carrying value of goodwill as of June 30, 2002 and December 31, 2001 by
operating segments 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):
June 30, 2002 December 31, 2001
------------------------------------------ ------------------------------------------
Gross Net Gross Net
Carrying Accumulated Carrying Carrying Accumulated Carrying
Amount Amortization Value Amount Amortization Value
------------ ------------ ------------ ------------ ------------ ------------
Refinery permits and plans ......... $ 150.4 $ 1.3 $ 149.1 $ 23.9 $ 0.3 $ 23.6
Jobber agreements .................. 23.5 1.0 22.5 23.5 0.4 23.1
Customer contracts ................. 18.9 3.1 15.8 16.8 1.3 15.5
Other intangibles .................. 15.0 3.0 12.0 13.6 2.5 11.1
------------ ------------ ------------ ------------ ------------ ------------
Total ..................... $ 207.8 $ 8.4 $ 199.4 $ 77.8 $ 4.5 $ 73.3
============ ============ ============ ============ ============ ============
13
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The intangible assets as of June 30, 2002 include amounts attributable to the
Golden Eagle Assets acquired in May 2002. Those amounts are preliminary, pending
completion of independent appraisals.
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; and other intangible assets - 9 years.
Amortization expense of acquired intangible assets other than goodwill amounted
to $2.2 million and $0.2 million for the three months ended June 30, 2002 and
2001, respectively, and $3.9 million and $0.3 million for the six months ended
June 30, 2002 and 2001, respectively. Estimated aggregate amortization expense
for each of the five years beginning January 1 is as follows: 2002 - $10.3
million; 2003 - $12.7 million; 2004 - $12.4 million; 2005 - $11.8 million; and
2006 - $10.9 million. These estimates are preliminary, pending completion of
independent appraisals of the Golden Eagle Assets.
NOTE H - COMMITMENTS AND CONTINGENCIES
The Company is a party to various litigation and contingent loss situations,
including environmental and 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.
INCOME TAXES
In the normal course of business, the Company is subject to audits by federal,
state and local taxing authorities. While the Company has been assessed
additional state income taxes and interest, management believes that the
ultimate resolution of ongoing audits will not materially affect the Company's
consolidated financial position or results of operations.
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.
Environmental Remediation Liabilities
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.
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, the Company's 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 thereafter. The Company believes that it will be
entitled to indemnification for approximately $59 million of such costs,
directly or
14
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
indirectly, from former owners or operators of the refinery (or its successors)
under two separate indemnification agreements.
The Company is currently involved in remedial responses and has incurred cleanup
expenditures associated with environmental matters at a number of sites,
including certain of its owned properties. At June 30, 2002, the Company's
accruals for environmental expenses totaled approximately $42 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.
Environmental Capital
In February 2000, the EPA finalized new regulations pursuant to the Clean Air
Act requiring reduction in the sulfur content in gasoline by January 1, 2004. To
meet this revised gasoline standard, the Company expects to make capital
improvements of approximately $65 million 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 $59
million in capital improvements through 2006 and $30 million in years after 2006
to meet the new diesel fuel standards.
The Golden Eagle refinery will require substantial expenditures to meet
California's CARB III gasoline requirements, including the mandatory phase out
of using the oxygenate known as MTBE, by the end of 2003. The Company expects to
spend approximately $74.5 million in 2002 and 2003 to comply with these
requirements, of which approximately $5 million was spent in the second quarter
of 2002. The Company expects to complete the project in the first quarter of
2003.
The Company expects to spend approximately $35 million in additional capital
improvements through 2006 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 to comply with this consent decree. In addition, the Company has agreed
to indemnify the sellers for all losses of any kind incurred in connection with
the consent decree.
The Company anticipates that capital expenditures addressing environmental
issues at the Golden Eagle refinery (including expenditures for work completed
during the second quarter of 2002 to comply with the California 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
citizen's group concerning coke dust emissions from the refinery's Pittsburg
Dock loading facility) will total approximately $17 million during 2002, of
which approximately $4 million was spent in the second quarter of 2002. The
Company will need to spend additional amounts for capital expenditures on
similar projects at the Golden Eagle refinery estimated at approximately $96
million in years 2003 through 2006 and $90 million beyond 2006. In addition, the
Company may choose to spend additional discretionary amounts.
The Company anticipates it will make additional environmental capital
improvements of approximately $9 million in 2002, primarily for improvements to
storage tanks, tank farm secondary containment and pipelines. During the six
months ended June 30, 2002, the Company spent approximately $3 million on these
environmental capital projects.
15
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Conditions that require additional expenditures may transpire for various
Company sites, including, but not limited to, the Company's refineries, tank
farms, retail gasoline stations (operating and closed locations) and petroleum
product terminals, and for compliance with the Clean Air Act and other state,
federal and local requirements. The Company cannot currently determine the
amount of such future expenditures.
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. 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 retained 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, changed 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. This new standard had no
impact on the Company's consolidated financial statements during the first six
months of 2002.
SFAS NO. 145
In April 2002, the FASB issued SFAS No.145, "Recission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13 and Technical Corrections." SFAS
No. 145 clarifies guidance related to the reporting of gains and losses from
extinguishment of debt and resolves inconsistencies related to the required
accounting treatment of certain lease modifications. SFAS No. 145 also amends
other existing pronouncements to make various technical corrections, clarify
meanings or describe their applicability under changed conditions. The
provisions relating to the reporting of gains and losses from extinguishment of
debt become effective for the Company beginning January 1, 2003 with earlier
adoption encouraged. All other provisions of this standard have been effective
for the Company as of May 15, 2002 and did not have a significant impact on the
Company's financial condition or results of operations.
SFAS NO. 146
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 requires costs associated with
exit or disposal activities to be recognized when they are incurred rather than
at the date of a commitment to an exit or disposal plan. SFAS No. 146 is
effective for the Company beginning January 1, 2003. The Company is currently
evaluating the impact this provision will have on its future results of
operations and financial condition.
EITF ISSUE NO. 02-3
In June 2002, the Emerging Issues Task Force ("EITF") of the FASB reached a
consensus that all mark-to-market gains and losses on energy trading contracts
should be shown net in the income statement whether or not settled physically.
In addition, entities should disclose the gross transaction volumes for those
energy trading contracts that are physically settled. The Company believes that
it has a limited number of transactions that could be considered energy trading
contracts. Such transactions are generally settled with physical product or
crude oil deliveries. The Company is
16
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
currently evaluating the impact of this statement to determine whether it will
have a material effect on reported revenues and costs of sales. This EITF
consensus will be effective for the Company in the third quarter of 2002 and any
reclassification that may be made will not have an impact on the Company's
financial position or net earnings.
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, such as refinery turnarounds, 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 and expense future costs as incurred. At
June 30, 2002, deferred major maintenance costs totaled $60 million. 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.
17
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 31 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.
STRATEGY
Our goal is to create value by: (i) maximizing our earnings, cash flows and
return on capital employed by reducing costs, increasing efficiencies and
optimizing existing assets, (ii) reducing our debt levels through optimizing
working capital, reducing costs, selling assets, reducing capital programs and
achieving synergies from our recent acquisition of assets in California, and
(iii) increasing our competitiveness by expanding our size and market presence
through growth initiatives. 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. In certain of our
regions 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.
In June 2002, we announced our goal to reduce our debt by $500 million by the
end of 2003. The overall debt reduction goal is focused on several strategic
initiatives that we have instituted, including a working capital optimization
program, a cost reduction program, asset sales, reducing capital expenditures
and achieving synergies from our recent acquisition of refinery assets in
California. Our first initiative was to optimize inventories, and in the month
of June we reduced company-wide crude oil and product inventories by
approximately 1.5 million barrels, with a market value of approximately $45
million. We continue to review our inventory levels and our receivables, and we
expect that a sustainable reduction in working capital of at least $50 million
is possible in 2002.
Our second program focuses on pursuing the synergies from the Golden Eagle
refinery acquisition, which we estimate to be between $30 million and $50
million annually. Our announced goal for this year was to capture $10 million,
and in the second quarter, we achieved approximately $5 million of our $10
million goal. We expect to achieve our synergy goal through the optimization of
our refinery system. Even during the Golden Eagle refinery turnaround in June
2002, we were able to achieve benefits that would otherwise be unavailable. For
example, we were able to upgrade the value of intermediate feedstock produced by
our other refineries through supply to Golden Eagle during the turnaround. In
addition, we were able to upgrade unfinished gasoline components from elsewhere
in our refinery system by blending them into the Golden Eagle gasoline product
pool.
While we made progress in both working capital and synergy programs, the largest
contributor to our debt reduction goal this year is expected to come from sales
of assets. We identified three asset groups to be evaluated to meet the goal of
raising $200 million by the end of 2002. The assets under review include our
Marine Services operations, the North Dakota crude and product pipeline systems
and the 70 Beacon retail stations recently acquired in California. Potential
buyers are conducting their reviews and field visits. Based on indicative bids,
we believe that the sale of all of these assets could result in proceeds
exceeding $200 million.
18
We have reduced our planned capital expenditures for 2002 and 2003, and we
continue to review our capital projects and refinery turnaround plans. We expect
to spend approximately $250 million for both 2002 and 2003, including refinery
turnaround costs. We spent $61 million in the second quarter and $133 million
during the six months ended June 30, 2002, including refinery turnaround costs.
We also expect to reduce our cost structure by $75 million over the next two
years. Although we are pursuing this program, we expect that the majority of the
cost reductions will be realized in 2003.
GOLDEN EAGLE ASSETS ACQUISITION
On May 17, 2002, we acquired the 168,000 barrel-per-day ("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") from Ultramar Inc., a subsidiary of Valero Energy
Corporation. The cash purchase price for the Golden Eagle Assets was
approximately $925 million, including approximately $130 million for feedstock,
refined product and other inventories, subject to post-closing adjustments. In
addition, we issued to the seller two ten-year junior subordinated notes with
face amounts aggregating $150 million. For further information on our financing
of the acquisition, see "Capital Resources and Liquidity-Capitalization,"
herein.
The Golden Eagle Assets increased the size and scope of our operations in
California and enables us to increase our yield of higher-value products,
increase our processing of heavier lower-cost crude oil, diversify our earnings
and geographic exposure, and build a platform for additional growth.
BUSINESS ENVIRONMENT
We operate in an environment where our operating 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.
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 AND SIX MONTHS ENDED JUNE 30, 2002 COMPARED
WITH THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2001
SUMMARY
Our net loss was $17.9 million ($0.28 net loss per basic share and diluted
share) for the three months ended June 30, 2002 ("2002 Quarter") compared with
net earnings of $29.5 million ($0.85 per basic share or $0.70 per diluted share)
for the three months ended June 30, 2001 ("2001 Quarter"). For the year-to-date
periods, our net loss was $73.5 million ($1.30 net loss per basic share and
diluted share) for the six months ended June 30, 2002 ("2002 Period"), compared
with net earnings of $51.2 million ($1.46 per basic share or $1.22 per diluted
share) for the six months ended June 30, 2001 ("2001 Period"). The net loss for
the 2002 Quarter and 2002 Period was primarily the result of weak margins in
each of our operating segments, which are discussed below, and additional
interest and financing costs related to acquisitions in the second half of 2001
and in May 2002. Financing and integration costs primarily associated with the
19
acquisition of the Golden Eagle Assets resulted in charges of approximately $7
million pretax, or $0.06 per share, in the 2002 Quarter and $17 million pretax,
or $0.18 per share, in the 2002 Period.
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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------- ----------------------------
(DOLLARS IN MILLIONS EXCEPT PER BARREL AMOUNTS) 2002 2001 2002 2001
------------ ------------ ------------ ------------
REVENUES
Refined products (a) ........................ $ 1,564.8 $ 1,156.1 $ 2,651.1 $ 2,249.4
Crude oil resales and other ................. 97.0 61.0 188.4 120.8
------------ ------------ ------------ ------------
Total Revenues .......................... $ 1,661.8 $ 1,217.1 $ 2,839.5 $ 2,370.2
============ ============ ============ ============
REFINING THROUGHPUT (thousand bpd)
Pacific Northwest
Washington .............................. 116.9 125.0 101.0 119.6
Alaska .................................. 59.7 45.0 55.0 45.3
Mid-Pacific
Hawaii .................................. 88.5 89.5 85.2 88.1
Mid-Continent
North Dakota ............................ 52.1 -- 50.8 --
Utah .................................... 55.4 -- 51.3 --
California (b) .............................. 60.2 -- 30.3 --
------------ ------------ ------------ ------------
Total Refining Throughput .......... 432.8 259.5 373.6 253.0
============ ============ ============ ============
% HEAVY CRUDE OIL OF TOTAL REFINERY THROUGHPUT ... 45% 45% 41% 51%
============ ============ ============ ============
YIELD (thousand bpd) (b)
Gasoline and gasoline blendstocks ........... 204.1 91.7 161.3 90.1
Jet fuel .................................... 69.3 58.1 65.7 58.1
Diesel fuel ................................. 76.8 44.9 64.9 39.6
Heavy oils, residual products and other ..... 97.4 71.2 91.6 72.0
------------ ------------ ------------ ------------
Total Yield ............................. 447.6 265.9 383.5 259.8
============ ============ ============ ============
GROSS REFINING MARGIN ($/throughput barrel) (c)
Pacific Northwest ........................... $ 5.86 $ 8.16 $ 4.81 $ 8.10
Mid-Pacific ................................. $ 3.00 $ 4.84 $ 3.40 $ 5.38
Mid-Continent ............................... $ 5.53 $ -- $ 4.35 $ --
California (b) .............................. $ 9.16 $ -- $ 9.16 $ --
Total Gross Refining Margin ........ $ 5.67 $ 7.01 $ 4.72 $ 7.15
SEGMENT OPERATING INCOME
Gross refining margins (after inventory
changes) (c) (d) ........................ $ 218.4 $ 164.7 $ 323.6 $ 328.1
Expenses (e) ............................... 164.0 99.7 289.7 204.4
Depreciation and amortization (f) ........... 17.6 7.6 32.9 15.5
------------ ------------ ------------ ------------
Segment Operating Income ........... $ 36.8 $ 57.4 $ 1.0 $ 108.2
============ ============ ============ ============
20
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ---------------------------
(DOLLARS IN MILLIONS EXCEPT PER BARREL AMOUNTS) 2002 2001 2002 2001
------------ ------------ ------------ ------------
PRODUCT SALES (thousand bpd) (a) (g)
Gasoline and gasoline blendstocks ................. 254.3 140.4 231.3 139.7
Jet fuel .......................................... 95.7 78.8 91.9 78.0
Diesel fuel ....................................... 99.7 62.5 97.6 59.0
Heavy oils, residual products and other ........... 74.3 57.1 66.9 58.7
------------ ------------ ------------ ------------
Total Product Sales ...................... 524.0 338.8 487.7 335.4
============ ============ ============ ============
PRODUCT SALES MARGIN ($/barrel) (g)
Average sales price ............................... $ 32.66 $ 37.50 $ 30.03 $ 37.04
Average costs of sales ............................ 28.09 32.18 26.28 31.66
------------ ------------ ------------ ------------
Product Sales Margin ..................... $ 4.57 $ 5.32 $ 3.75 $ 5.38
============ ============ ============ ============
----------
(a) Includes intersegment sales to our Retail segment at prices which
approximate market of $215.1 million and $72.6 million for the three
months ended June 30, 2002 and 2001, respectively and $366.7 million
and $129.2 million for the six months ended June 30, 2002 and 2001,
respectively.
(b) Volumes and margins for 2002 include amounts for the California
operations since acquisition on May 17, 2002 averaged over the periods
presented. Throughput and yield averaged over the 45 days of operation
were 121,800 bpd and 130,400 bpd, respectively.
(c) The value of internally produced fuel is included in the gross refining
margin, offset by a charge to refinery manufacturing expense. Total
gross refining margin per barrel, net of the value of internally
produced fuel, would have been $4.60 and $5.86 for the three months
ended June 30, 2002 and 2001, respectively, and $3.73 and $5.93 for the
six months ended June 30, 2002 and 2001, respectively.
(d) Approximates total refining throughput multiplied by 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 increased by 3.8
million barrels (including the Golden Eagle acquisition) and 0.4
million barrels during the 2002 Quarter and 2001 Quarter, respectively,
and increased 2.4 million barrels (including the Golden Eagle
acquisition) during the 2002 Period and decreased 0.1 million barrels
during the 2001 Period. Gross refining margins include the effect of
intersegment sales to the Retail segment at prices which approximate
market.
(e) Includes manufacturing costs per throughput barrel of $3.36 and $2.94
for the three months ended June 30, 2002 and 2001, respectively, and
$3.31 and $3.19 for the six months ended June 30, 2002 and 2001,
respectively. Manufacturing costs include non-cash amortization of
maintenance turnaround costs of $0.11 per barrel (aggregate $4.2
million) and $0.19 per barrel (aggregate $4.4 million) for the three
months ended June 30, 2002 and 2001, respectively, and $0.12 per barrel
(aggregate $8.4 million) and $0.19 per barrel (aggregate $8.6 million)
for the six months ended June 30, 2002 and 2001, respectively.
Manufacturing costs also include the cost of internally produced fuel
of $1.07 per barrel and $1.15 per barrel for the three months ended
June 30, 2002 and 2001, respectively, and $0.99 per barrel and $1.22
per barrel for the six months ended June 30, 2002 and 2001,
respectively.
(f) Includes manufacturing depreciation per throughput barrel of
approximately $0.44 and $0.22 for the three months ended June 30, 2002
and 2001, respectively, and $0.42 and $0.24 for the six months ended
June 30, 2002 and 2001, respectively.
(g) Sources of total product sales included products manufactured at the
refineries, products drawn from inventory balances and products
purchased from third parties. Total product sales margin included
margins on sales of manufactured and purchased products and the effects
of inventory changes.
THREE MONTHS ENDED JUNE 30, 2002 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2001.
Operating income from our Refining segment was $36.8 million in the 2002 Quarter
compared to $57.4 million for the 2001 Quarter. Our results for the 2002 Quarter
included amounts from acquired operations since the dates of acquisition. We
acquired the Mid-Continent operations in September 2001 and the California
refinery in mid-May 2002.
The $20.6 million decrease in our operating income was primarily due to weak
refined product margins in the 2002 Quarter. Our total refinery system gross
margins averaged $5.67 per barrel, a 19% decrease from the prior year quarter,
reflecting lower margins in our Pacific Northwest and Mid-Pacific regions, which
on a per-barrel basis declined 28% and 38%, respectively. Industry margins
declined primarily due to high industry inventory levels, rising crude oil
21
prices and increased competition from product imports. Warmer winter weather,
reduced jet fuel demand and lower natural gas prices impacted overall industry
inventory levels and margins for distillates and other related fuel oil
products. In addition, our margins were negatively impacted due to tightening of
the light to heavy crude oil differential, primarily affecting our Pacific
Northwest region.
On an aggregate basis, our total gross refining margins increased 33% from the
2001 Quarter to $218.4 million in the 2002 Quarter, reflecting throughput
volumes from the Mid-Continent and California refineries, which added 167,700
bpd to our total refinery system throughput in the 2002 Quarter.
Revenues from sales of refined products increased 35% to $1,564.8 million in the
2002 Quarter, from $1,156.1 million in the 2001 Quarter, due to increased sales
volumes from the Mid-Continent and California refineries, partly offset by lower
product prices. Total product sales averaged 524,000 bpd in the 2002 Quarter, an
increase of 55% from the 2001 Quarter, while average product prices dropped 13%
to $32.66 per barrel. The increase in other revenues was primarily due to higher
crude oil resales which totaled $97 million in the 2002 Quarter compared to $59
million in the 2001 Quarter. The increase in costs of sales was due to the
increased throughput resulting from the Mid-Continent and California refineries,
largely offset by lower prices for feedstocks and product supply compared with
the 2001 Quarter.
Expenses, excluding depreciation, increased by 64% to $164.0 million in the 2002
Quarter, primarily due to additional operating expenses of approximately $72
million from the Mid-Continent and California refineries. Excluding these new
operations, expenses decreased 8% from the 2001 Quarter, primarily the result of
lower costs for utilities and fuel. Depreciation and amortization increased to
$17.6 million, primarily due to depreciation and amortization of $8.9 million
from the Mid-Continent and California refineries.
The newly-acquired California operations contributed approximately $13 million
to our operating income (Refining and Retail) even though the refinery was in a
major maintenance turnaround for most of the month of June. Our total refinery
system capacity of 558,000 bpd is available with the completion of the
turnaround at the California refinery. Actual throughput rates, however, during
the remainder of 2002 will be dependent on the margin environment and seasonal
demand.
SIX MONTHS ENDED JUNE 30, 2002 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2001.
Operating income for the Refining segment was $1.0 million in the 2002 Period
compared to $108.2 million for the 2001 Period. The decrease was mainly driven
by weaker refined product margins, as discussed above. In addition, operating
income was impacted by scheduled downtime at our Washington refinery and
unscheduled downtime at our Washington and Utah refineries in the first quarter
of 2002. Our results for the 2002 Period include the Mid-Continent refineries
which we acquired in September 2001 and the California refinery acquired in
mid-May 2002.
Our gross refining margin decreased to $323.6 million in the 2002 Period, from
$328.1 million in the 2001 Period, reflecting lower per-barrel refining margins
at our Pacific Northwest and Mid-Pacific refineries, largely offset by increased
throughput volumes from the Mid-Continent and California refineries. Due to the
scheduled turnaround at the Washington refinery during the 2002 first quarter,
we were not able to process a higher percentage of lower-cost heavy crude oil,
which represented 36% of refining throughput in the 2002 first quarter, compared
with 56% in the 2001 first quarter. We estimate that our gross refining margin
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 increased 18% to $2,651.1 million in the
2002 Period, from $2,249.4 million in the 2001 Period due to increased sales
volumes from the Mid-Continent and California refineries which added 132,400 bpd
to our total refinery system throughput offset by lower product prices. Total
product sales averaged 487,700 bpd in the 2002 Period, an increase of 45% from
the 2001 Period, while average product prices dropped 19% to $30.03 per barrel.
The increase in other revenues was primarily due to higher crude oil resales
which totaled $188 million in the 2002 Period compared to $117 million in the
2001 Period. The increase in costs of sales was due to the increased throughput
resulting from the Mid-Continent and California refineries largely offset by
lower prices for feedstocks and product supply compared with the 2001 Period.
22
Expenses, excluding depreciation, increased by 42% to $289.7 million in the
2002 Period, primarily due to additional operating expenses of approximately
$107 million from the Mid-Continent and California refineries. Excluding these
new operations, expenses decreased 11% from the 2001 Period, primarily the
result of lower costs for utilities and fuel partially offset by expenses of
approximately $3 million due to the unscheduled downtime at the Washington and
Utah refineries. Depreciation and amortization increased to $32.9 million,
primarily due to depreciation and amortization of $14.9 million from the
Mid-Continent and California refineries.
RETAIL SEGMENT
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------------- -----------------------------
(Dollars in millions except per gallon amounts) 2002 2001 2002 2001
------------ ------------ ------------ ------------
REVENUES
Fuel ................................................ $ 234.4 $ 91.5 $ 402.3 $ 162.6
Merchandise and other ............................... 33.2 16.2 56.0 29.5
------------ ------------ ------------ ------------
Total Revenues ................................ $ 267.6 $ 107.7 $ 458.3 $ 192.1
============ ============ ============ ============
FUEL SALES (millions of gallons) ....................... 202.3 74.1 374.8 135.3
FUEL MARGIN ($/gallon) ................................. $ 0.10 $ 0.25 $ 0.09 $ 0.25
MERCHANDISE MARGIN (in millions) ....................... $ 8.3 $ 4.8 $ 14.0 $ 8.8
MERCHANDISE MARGIN (percent of sales) .................. 26% 31% 26% 31%
AVERAGE NUMBER OF STATIONS (during the period) ......... 709 289 696 284
SEGMENT OPERATING INCOME (LOSS)
Gross Margins
Fuel (a) ...................................... $ 19.3 $ 18.9 $ 35.6 $ 33.4
Merchandise and other non-fuel margin ......... 9.8 5.4 16.7 9.9
------------ ------------ ------------ ------------
Total gross margins ...................... 29.1 24.3 52.3 43.3
Expenses .......................................... 32.6 15.1 62.1 29.3
Depreciation and amortization ..................... 3.9 1.9 7.3 4.7
------------ ------------ ------------ ------------
Segment Operating Income (Loss) ............... $ (7.4) $ 7.3 $ (17.1) $ 9.3
============ ============ ============ ============
---------
(a) Includes the effect of intersegment purchases from our Refining segment
at prices which approximate market.
THREE MONTHS ENDED JUNE 30, 2002 COMPARED WITH THREE MONTHS ENDED JUNE 30, 2001.
The operating loss for our Retail segment was $7.4 million in the 2002 Quarter,
compared to operating income of $7.3 million in the 2001 Quarter. Total gross
margins increased 20% to $29.1 million from $24.3 million during the 2002
Quarter reflecting increased sales volume, offset largely by lower fuel margins
per gallon. Fuel margin decreased to $0.10 per gallon in the 2002 Quarter from
$0.25 per gallon in the 2001 Quarter, reflecting continued competitive price
pressures and changes in the geographic mix of our Retail sites. Total gallons
sold increased to 202.3 million, reflecting the increase in average station
count to 709 in the 2002 Quarter from 289 in the 2001 Quarter. This increase was
primarily due to the Mid-Continent operations acquired in September 2001 and the
California operations acquired in mid-May 2002.
Revenues on fuel sales grew to $234.4 million in the 2002 Quarter, from $91.5
million in the 2001 Quarter, while merchandise and other revenues more than
doubled to $33.2 million. Merchandise margin decreased, however, as a percent of
sales, reflecting changes in the mix of merchandise offerings. With our
increased number of stations, expenses and depreciation also doubled to $32.6
million and $3.9 million, respectively.
SIX MONTHS ENDED JUNE 30, 2002 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2001. The
operating loss for our Retail segment was $17.1 million in the 2002 Period,
compared to operating income of $9.3 million in the 2001 Period. Total gross
margins increased 21% to $52.3 million from $43.3 million during the 2002 Period
reflecting increased sales
23
volume, offset largely by lower fuel margins per gallon. Fuel margin decreased
to $0.09 per gallon in the 2002 Period from $0.25 per gallon in the 2001 Period,
reflecting continued competitive price pressures and changes in the geographic
mix of our Retail sites. Total gallons sold increased to 374.8 million,
reflecting the increase in average station count to 696 in the 2002 Period from
284 in the 2001 Period. This increase was primarily due to the Mid-Continent
operations acquired in September 2001 and the California operations acquired in
mid-May 2002.
Revenues on fuel sales grew to $402.3 million in the 2002 Period, from $162.6
million in the 2001 Period, while merchandise and other revenues increased by
90% to $56.0 million. Merchandise margin decreased, however, as a percent of
sales, reflecting changes in the mix of merchandise offerings. With our
increased number of stations, expenses more than doubled to $62.1 million and
depreciation increased to $7.3 million in the 2002 Period.
MARINE SERVICES SEGMENT
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------ ------------------------------
2002 2001 2002 2001
------------- ------------- ------------- -------------
(DOLLARS IN MILLIONS)
Revenues
Fuels ....................................... $ 25.7 $ 39.2 $ 46.2 $ 78.3
Lubricants and other ........................ 3.2 4.0 6.7 7.8
Services .................................... 2.5 4.4 5.0 7.9
Other income (loss) ......................... -- (0.2) (0.1) (0.2)
------------- ------------- ------------- -------------
Total Revenues .......................... 31.4 47.4 57.8 93.8
Costs of Sales .............................. 24.0 35.6 42.8 70.9
------------- ------------- ------------- -------------
Gross Profit ............................ 7.4 11.8 15.0 22.9
Expenses ......................................... (6.6) (7.8) (13.1) (15.5)
Depreciation and Amortization .................... (0.7) (0.7) (1.4) (1.4)
------------- ------------- ------------- -------------
Segment Operating Income .................... $ 0.1 $ 3.3 $ 0.5 $ 6.0
============= ============= ============= =============
Sales Volumes (millions of gallons)
Fuels, primarily diesel ..................... 34.5 45.1 66.1 87.4
Lubricants .................................. 0.4 0.5 0.9 1.0
Marine Services operating income decreased by $3.2 million and $5.5 million
during the 2002 Quarter and 2002 Period, respectively. 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 and 2002 Period.
Revenues decreased $16.0 million and $36.0 million from the 2001 Quarter and
2001 Period, respectively, reflecting lower fuel sales prices and fuel volumes.
The decrease in costs of sales also reflected the lower prices for fuel supply
and lower volumes.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses increased by $11.6 million and
$26.6 million during the 2002 Quarter and 2002 Period, respectively. The
increases were partially due to higher expenses in the Refining and Retail
segments associated with the Mid-Continent and California operations of $4.4
million and $8.6 million during the 2002 Quarter and 2002 Period, respectively.
Corporate expenses accounted for $7.4 million and $13.5 million of the increase
during the 2002 Quarter and 2002 Period, respectively, resulting from
acquisition and integration costs, as well as higher employee costs and
professional fees.
24
INTEREST AND FINANCING COSTS
Interest and financing costs, net of capitalized interest, increased by $35.0
million and $57.8 million during the 2002 Quarter and 2002 Period, respectively.
The increases were primarily due to the additional debt we incurred in 2001 and
2002 in connection with our acquisitions of the Mid-Continent and California
operations. We also expensed $3.5 million and $12.6 million in the 2002 Quarter
and 2002 Period, respectively, related to bridge and other financing fees for
the acquisition of the Golden Eagle Assets.
INCOME TAX PROVISION (BENEFIT)
The income tax benefit amounted to $11.9 million and $49.1 million for the 2002
Quarter and 2002 Period, respectively, compared to the income tax provisions of
$19.7 million and $34.3 million for the 2001 Quarter and 2001 Period,
respectively. The benefits reflected the pretax losses for the 2002 Quarter and
2002 Period. The tax benefit from these losses is included in receivables in
the accompanying condensed balance sheet as of June 30, 2002. The combined
Federal and state effective income tax rate was approximately 40% in both the
2002 and 2001 Quarters and the 2002 and 2001 Periods.
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, availability of trade credit, 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 31 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 have been cash flows from operations, issuance
of equity and debt, and borrowing availability under revolving lines of credit.
We believe available capital resources will be adequate to meet our capital
expenditure, working capital and debt service requirements for existing
operations. Currently we have no plans to issue additional debt or equity
securities.
We ended the second quarter of 2002 with $43.0 million of cash and cash
equivalents on our balance sheet, no borrowings and less than $2 million in
outstanding trade letters of credit under our revolving credit facility. Because
of the current weakness in industry refinery margins, economic uncertainty,
stock market weakness, and the recent collapse of some large U.S. corporations,
we, like many other companies, have seen a tightening of the trade credit we
receive while we have tightened the trade credit we extend. Under current
economic conditions and in light of the general uncertainty which surrounds
business, we cannot give assurance that the credit we extend or the trade credit
extended to us will not be further tightened. We continue to operate at optimal
production levels considering current market conditions, through our management
of working capital, capital expenditures, available lines of trade credit and
operating cash flows. We believe that we will be able to continue to run our
refineries at optimal production levels, based on market conditions.
25
CAPITALIZATION
Our capital structure at June 30, 2002 was comprised of the following (in
millions):
Debt and other obligations, including current maturities:
Senior Secured Credit Facility - Tranche A Term Loan ............... $ 231
Senior Secured Credit Facility - Tranche B Term Loan ............... 796
Senior Secured Credit Facility - Revolver .......................... --
9-5/8% Senior Subordinated Notes due 2012 .......................... 450
9-5/8% Senior Subordinated Notes due 2008 .......................... 215
9% Senior Subordinated Notes due 2008 .............................. 298
Junior subordinated notes .......................................... 62
Other debt, primarily capital leases ............................... 8
------------
Total debt and other obligations ................................ 2,060
Common stockholders' equity ....................................... 931
------------
Total Capitalization ............................................ $ 2,991
============
At June 30, 2002, our debt to capitalization ratio was 69% compared with 60% at
year-end 2001, primarily reflecting additional borrowings under our amended and
restated senior secured credit facility and the issuance of $450 million
aggregate principal amount of 9-5/8% senior subordinated notes due 2012,
partially offset by the public equity offering of 23 million shares of common
stock.
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;
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 senior 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
On May 17, 2002, we amended and restated our senior secured credit facility to
increase the facility to $1.275 billion from $1.0 billion to partially fund the
acquisition of the Golden Eagle Assets. As of June 30, 2002, the senior secured
credit facility consisted of a five-year $225 million revolving credit facility
(with a $150 million sublimit for letters of credit), a five-year tranche A term
loan and a six-year tranche B term loan. As of June 30, 2002, we had no
borrowings and $3.7 million in letters of credit outstanding under the revolving
credit facility, resulting in total unused credit available of $221.3 million.
In addition to the senior secured credit facility, in June 2002, we obtained a
$20 million
26
secured letter of credit line with a bank, under which no amounts were
outstanding as of June 30, 2002.
The senior secured credit 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 (with certain exceptions for pipeline, retail and
marine services assets), and is additionally secured by a pledge of all of the
stock of all current active and future domestic subsidiaries and 66% of the
stock of our current and future foreign subsidiaries.
The senior secured credit facility requires us to meet certain financial
covenants, some of which use a measure of cash flow called EBITDA, as defined in
the senior secured credit facility. The financial covenants specify thresholds
of the following ratios which use EBITDA: senior debt to EBITDA, EBITDA to fixed
charges and EBITDA to interest expense. The initial calculations of these ratios
are to be made in relation to the four quarters ending September 30, 2002 (with
a provision to annualize Golden Eagle EBITDA based on the period of time owned
by us). In addition, the financial covenants set a maximum threshold for a total
senior debt to total capitalization ratio, as defined in the senior secured
credit facility, each quarter-end commencing with June 30, 2002. For the quarter
ended June 30, 2002, the financial covenants also required us to have
consolidated EBITDA of at least $40 million.
We satisfied all of the financial covenants under the senior secured credit
facility for the quarter ended June 30, 2002. However, continued compliance with
the financial covenants cannot be assured. Many of the financial covenants
require EBITDA levels that cannot be achieved unless the current margin
environment improves. Although margins typically improve in the third quarter
due to seasonal factors, we believe that it is prudent to seek an amendment to
our senior secured credit facility and have initiated discussions with our
lenders to amend the financial covenants to levels that reflect the potential
for a continued weak margin environment. We have no reason to believe that we
will not be able to obtain an amendment to the financial covenants and,
accordingly, expect to be in compliance with our covenants in the future.
The senior secured credit facility also contains a provision that requires us to
consummate one or more transactions resulting in the receipt of net proceeds of
at least $125 million by December 31, 2002 from 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 to prepay any outstanding revolving credit facility
loans, none of which were outstanding at June 30, 2002. If any of such net
proceeds remain after prepaying the outstanding revolving credit facility loans,
such remaining amount up to $62.5 million shall be deposited in an account that
shall be pledged to the banks but may be used for general corporate purposes,
including but not limited to working capital and capital expenditures. To the
extent there is still a cash balance in the account at such time as our
debt-to-capital ratio falls below 0.55 to 1.00, the funds will become available
to us for any purpose, including to further pay down debt. The senior secured
credit facility also limits our capital expenditures to no more than $275
million in 2002 and $302.5 million in 2003 and thereafter unless our
debt-to-capital ratio falls below 0.58 to 1.00.
The senior secured credit facility 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. At June 30, 2002, interest rates were 4.84% to 4.86% on the tranche A term
loan and 6.5% on the tranche B term loan. Borrowings bear interest at either a
base rate (4.75% at June 30, 2002) or a eurodollar rate (ranging from 1.84% to
1.86% at June 30, 2002), plus an applicable margin. The applicable margin at
June 30, 2002 for the tranche A term loan and the revolving credit facility was
2.0% in the case of the base rate and 3.0% in the case of the eurodollar rate.
The applicable margin for the tranche B term loan was 2.5% in the case of the
base rate and 3.5% 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 senior 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
27
charged various fees and expenses in connection with the senior secured credit
facility, including commitment fees and various letter of credit fees.
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 and Regulation S. 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. In addition, for the
first three years, we may redeem up to 35% of the aggregate principal amount at
a redemption price of 109.625% with proceeds of certain equity issuances. 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 were used to partially fund the acquisition of
the Golden Eagle Assets.
JUNIOR SUBORDINATED NOTES
In connection with the Golden Eagle Assets acquisition, we issued to the seller
two ten-year junior subordinated notes with face amounts aggregating $150
million. The notes consist of: (i) a $100 million junior subordinated note, due
July 2012, which is non-interest bearing for the first five years and carries a
7.5% interest rate for the remaining five-year period, and (ii) a $50 million
junior subordinated note, due July 2012, which has no interest payment in year
one and bears interest at 7.47% for the second through the fifth years and 7.5%
interest rate for years six through ten. The two junior subordinated notes with
face amounts of $100 million and $50 million were recorded at a combined present
value of approximately $61 million, discounted at a rate of 15.625% and 14.375%,
respectively.
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 $245.1
million, after deducting underwriting fees and offering expenses, were used to
partially fund the acquisition of the Golden Eagle Assets.
CASH FLOW SUMMARY
Components of our cash flows are set forth below (in millions):
SIX MONTHS ENDED
JUNE 30,
----------------------------
2002 2001
------------ ------------
Cash Flows From (Used In):
Operating Activities ............................................... $ (24.3) $ 23.2
Investing Activities ............................................... (1,042.0) (79.4)
Financing Activities ............................................... 1,057.4 44.0
------------ ------------
Decrease in Cash and Cash Equivalents ................................ $ (8.9) $ (12.2)
============ ============
Net cash used in operating activities during the 2002 Period totaled $24
million, compared to $23 million from operating activities in the 2001 Period.
The decrease was primarily due to lower earnings before depreciation and
amortization and payments for scheduled refinery turnarounds partly offset by
lower working capital requirements. Net cash used in investing activities of $1
billion in the 2002 Period included $934 million for the acquisition of the
Golden Eagle Assets and $96 million for capital expenditures. Net cash from
financing activities of $1 billion in the 2002 Period included net proceeds of
$245 million from our equity offering, net proceeds of $441 million from our
notes offering and borrowings of $425 million under the senior secured credit
facility, partly offset by repayments of debt and financing costs. Gross
borrowings and repayments under revolving credit lines amounted to $514 million
during the 2002 Period. Working capital totaled $467 million at June 30, 2002
compared to $340 million at year-end 2001, reflecting increases related to the
Golden Eagle acquisition.
28
CAPITAL SPENDING
We have been revising our 2002 capital spending plans in response to the weaker
refining and retail margin environment. We have reduced our spending plans for
discretionary projects while maintaining spending to meet environmental, safety,
regulatory and other operational requirements. We currently estimate that our
2002 capital spending will total approximately $250 million, including $42
million for refinery maintenance turnarounds.
During the 2002 Period, our capital expenditures totaled $96 million, which
included $21 million for completion of the heavy oil conversion project at our
Washington refinery and $25 million for retail marketing programs. In addition,
we spent approximately $10 million at our California refinery, including $5
million for a project to meet CARB III gasoline production requirements and $4
million to complete a nitrogen oxide emissions control project. Other capital
spending was primarily for various refinery improvements and environmental
requirements.
During the remainder of 2002, we expect to spend approximately $70 million for
environmental projects at our refineries, primarily for the CARB III and other
projects at our California refinery. Although we reduced our 2002 capital
spending for retail projects, we expect to spend approximately $15 million
during the remainder of 2002 for our branded dealer network and our Mirastar
brand sites at Wal-Mart locations.
We expect to fund the 2002 capital spending program primarily from cash flow
from operations, including benefits from our working capital reductions, cost
savings and acquisition synergies. In addition, proceeds from asset dispositions
and, if needed, borrowings under our revolving credit facility, could supplement
funding for these expenditures. The volatility of certain commodity prices could
reduce our cash flows from operations and may require us to further reduce
discretionary capital expenditures.
MAJOR MAINTENANCE COSTS
We completed our scheduled turnaround of certain processing units at our Golden
Eagle refinery in the 2002 Quarter at a total estimated cost of $15 million. We
completed a scheduled turnaround of the Washington refinery in the first quarter
of 2002 at a total cost of $25 million, of which $19 million was spent in 2002.
Amortization of turnaround costs, other major maintenance projects and catalysts
is projected to total approximately $27 million in 2002, of which $11 million
was amortized in the 2002 Period.
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.
Environmental Remediation Liabilities
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 for approximately $59 million of such costs, directly or
indirectly, from former owners or operators of the refinery (or their
successors) under two separate indemnification agreements.
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 June 30, 2002, our accruals for
environmental expenses totaled $42 million. Based on currently available
information, including the participation of other parties or former owners in
remediation actions, we believe these accruals are adequate.
29
Environmental Capital
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 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 $59 million in
capital improvements through 2006 and $30 million in years after 2006 to meet
the new diesel fuel standards.
The Golden Eagle refinery will require substantial expenditures to meet
California's CARB III gasoline requirements, including the mandatory phase out
of using the oxygenate known as MTBE, by the end of 2003. We expect to spend
approximately $74.5 million in 2002 and 2003 to comply with these requirements,
of which approximately $5 million was spent in the second quarter of 2002. We
expect to complete the project in the first quarter of 2003.
We expect to spend approximately $35 million in additional capital improvements
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 the capital expenditures addressing environmental issues at the
Golden Eagle refinery (including expenditures for work completed during the
second quarter of 2002 to comply with the California Bay Area Air Quality
Management District's requirements for controlling emissions of nitrogen oxides,
the Regional Water Quality Control Boards' 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 $17 million during 2002, of which
approximately $4 million was spent in the second quarter of 2002. We will need
to spend additional amounts for capital expenditures on similar projects at the
Golden Eagle refinery estimated at approximately $96 million in years 2003
through 2006 and $90 million beyond 2006. In addition, we may choose to spend
additional discretionary amounts.
We anticipate that we will make additional environmental capital improvements of
approximately $9 million in 2002, primarily for improvements to storage tanks,
tank farm secondary containment and pipelines. During the 2002 Period, we spent
approximately $3 million on these 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 compliance with the Clean Air Act and other state and federal
requirements. We cannot currently determine the amount of these future
expenditures.
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
30
beginning January 1, 2003. We are currently evaluating the impact the standard
will have on our 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 retained 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, changed 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. This new standard had no
impact on our consolidated financial statements during the first six months of
2002.
In April 2002, the FASB issued SFAS No.145, "Recission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13 and Technical Corrections." SFAS
No. 145 clarifies guidance related to the reporting of gains and losses from
extinguishment of debt and resolves inconsistencies related to the required
accounting treatment of certain lease modifications. SFAS No. 145 also amends
other existing pronouncements to make various technical corrections, clarify
meanings or describe their applicability under changed conditions. The
provisions relating to the reporting of gains and losses from extinguishment of
debt become effective for us beginning January 1, 2003 with earlier adoption
encouraged. All other provisions of this standard have been effective for us as
of May 15, 2002 and did not have a significant impact on our financial condition
or results of operations.
In June 2002, the FASB issued FASB No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 requires costs associated with
exit or disposal activities to be recognized when they are incurred rather than
at the date of a commitment to an exit or disposal plan. SFAS No. 146 is
effective for us beginning January 1, 2003. We are currently evaluating the
impact the standard will have on our future results of operations and financial
condition.
In June 2002, the Emerging Issues Task Force ("EITF") of the FASB reached a
consensus that all mark-to-market gains and losses on energy trading contracts
should be shown net in the income statement whether or not settled physically.
In addition, entities should disclose the gross transaction volumes for those
energy trading contracts that are physically settled. We believe that we have a
limited number of transactions that could be considered energy trading
contracts. Such transactions are generally settled with physical product or
crude oil deliveries. We are currently evaluating the impact of this statement
to determine whether it will have a material effect on reported revenues and
costs of sales. This EITF consensus will be effective for us in the third
quarter of 2002 and any reclassification that may be made will not have an
impact on our financial position or net earnings.
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, such as refinery turnarounds, 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 and expense future costs as incurred. At June
30, 2002, deferred major maintenance costs totaled $60 million.
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, working capital or other financial items, throughput,
expectations regarding the 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, potential
dispositions, 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
31
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;
o our ability to successfully integrate acquisitions including
the Pipeline System and the Golden Eagle Assets;
o our ability to complete future strategic dispositions;
o our ability to achieve our debt reduction goal;
o adverse changes in the ratings assigned to our trade credit
and debt instruments;
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.
32
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. 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.
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 21.8 million and 17.2 million barrels at June 30, 2002 and
December 31, 2001, respectively. The average cost of our refinery feedstocks and
refined product as of June 30, 2002 was $22.90 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 June 30, 2002, we had open futures
positions for 253,000 barrels of gasoline and heating oil which expire in the
third quarter of 2002. Recording the fair value of these positions resulted in a
mark-to-market loss of $0.1 million during the three months ended June 30, 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 June 30, 2002, we had $1.027 billion of outstanding floating-rate debt under
the senior secured credit facility and $1.033 billion of fixed-rate debt. The
weighted average interest rate on the floating-rate debt was 6.1% at June 30,
2002. The impact on annual cash flow of a 10% change in the floating-rate for
our senior secured credit facility (61 basis points) would be approximately $6
million.
The fair market value of our fixed-rate debt at June 30, 2002 was approximately
$80 million less than its book value of $1 billion, based on recent transactions
and bid quotes for our senior subordinated notes.
33
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
In May 2002, the Company amended and restated its senior secured
credit facility which requires the Company to maintain specified
levels of interest and fixed charge coverage and sets limitations on
the Company's debt-to-capital and senior leverage ratios. The senior
secured credit facility contains a provision that requires the
Company to consummate one or more transactions resulting in the
receipt of net proceeds of at least $125 million by December 31,
2002. The senior secured credit facility also contains other
covenants and restrictions customary in credit arrangements of this
kind.
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 restrictions and covenants in the
amended and restated senior secured credit facility and 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
(a) The 2002 Annual Meeting of Stockholders of the Company was held
on June 20, 2002.
(b) The following directors were elected at the 2002 Annual Meeting of
Stockholders to hold office until the 2003 Annual Meeting of
Stockholders or until their successors are elected and qualified. A
tabulation of the number of votes for or withheld with respect to
each such director is set for below:
Name Votes for Withheld
---- --------- --------
James F. Clingman, Jr. 55,813,559 3,964,809
Steven H. Grapstein 55,600,301 4,178,067
William J. Johnson 55,601,724 4,176,644
A. Maurice Myers 55,499,910 4,278,458
Donald H. Schmude 55,608,517 4,169,851
Bruce A. Smith 55,815,429 3,962,939
Patrick J. Ward 55,830,947 3,947,421
(c) With respect to an increase in the number of shares which can
be granted under the Amended and Restated Executive Long-Term
Incentive Plan from 5,250,000 to 7,250,000, there were
46,802,486 votes for; 12,048,696 votes against; 927,186
abstentions; and no broker non-votes.
(d) With respect to an increase in the number of shares which can be
granted under the 1995 Non-Employee Director Stock Option Plan from
150,000 to 300,000, there were 51,280,244 votes for; 7,572,022
votes against; 926,102 abstentions; and no broker non-votes.
(e) With respect to the ratification of the appointment of Deloitte &
Touche LLP as the Company's independent auditors for fiscal year
2002, there were 57,408,668 votes for; 1,530,903 votes against;
838,797 abstentions; and no broker non-votes.
34
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
(b) Reports on Form 8-K.
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 April 22, 2002, an Amendment No. 1 to Current Report on
Form 8-K (filed on February 25, 2002) was filed restating in
its entirety the Consent of Arthur Andersen LLP included 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.
On May 24, 2002, a Current Report on Form 8-K was filed
reporting under Item 2, Acquisition or Disposition of Assets,
that the Company completed the acquisition of the Golden Eagle
refinery located in Martinez, California in the San Francisco
Bay area along with 70 associated retail sites throughout
northern California. In addition, the Company reported under
Item 5, Other Events, that the Company amended and restated
its Senior Secured Credit Facility. Included under Item 7 of
this Form 8-K were the following: (i) Sale and Purchase
Agreement for Golden Eagle Refining and Marketing Assets; (ii)
$100 million Promissory Note; (iii) $50 million Promissory
Note; (iv) Letter to the State of California Department of
Justice, Office of the Attorney General; and (v)
$1,275,000,000 Amended and Restated Credit Agreement. On July
16, 2002, an Amendment No. 1 to Current Report on Form 8-K was
filed providing the Unaudited Financial Statements of Golden
Eagle Refining and Marketing Assets Business as of March 31,
2002 and December 31, 2001 and for the three months ended
March 31, 2002 and March 31, 2001 included under Item 7 of
this Form 8-K. On July 24, 2002, an Amendment No. 2 to
Current Report on Form 8-K was filed providing the Unaudited
Pro Forma Combined Condensed Financial Statements as of March
31, 2002 and for the year ended December 31, 2001 and three
months ended March 31, 2002 included under Item 7 of this Form
8-K.
On June 18, 2002, a Current Report on Form 8-K was filed
reporting under Item 9, Regulation FD Disclosures, information
related to a presentation primarily relating to the Company's
debt reduction goal. The presentation data was filed as an
Exhibit under Item 7 of this Form 8-K.
On July 1, 2002, a Current Report on Form 8-K was filed
reporting under Item 5, Other Events, that the Company had
issued a press release announcing its goals to reduce debt by
$500 million by the end of 2003 and its updated forecast for
the second quarter of 2002. The Press Release was filed as an
Exhibit under Item 7 of this Form 8-K.
35
On August 13, 2002, a Current Report on Form 8-K was filed reporting
under Item 9, Regulation FD Disclosures, that the Company's
Principal Executive Officer and Principal Financial Officer
submitted to the SEC sworn statements pursuant to Securities and
Exchange Commission Order No. 4-460. The statements were filed as
Exhibits under Item 7 of this Form 8-K.
36
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TESORO PETROLEUM CORPORATION
REGISTRANT
Date: August 14, 2002 /s/ BRUCE A. SMITH
-------------------------------------
Bruce A. Smith
Chairman of the Board of Directors,
President and Chief Executive Officer
Date: August 14, 2002 /s/ GREGORY A. WRIGHT
-------------------------------------
Gregory A. Wright
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)
37
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------ -----------
99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
38