<PAGE> 1
SCHEDULE 14A
(RULE 14a-101)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE SECURITIES
EXCHANGE ACT OF 1934 (AMENDMENT NO. )
Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
<TABLE>
<S> <C>
[X] Preliminary Proxy Statement [ ] Confidential, for Use of the
Commission Only (as permitted by
Rule 14a-6(e)(2))
[ ] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to sec. 240.14a-11(c) or sec. 240.14a-12
</TABLE>
TESORO PETROLEUM CORPORATION
- --------------------------------------------------------------------------------
(Name of Registrant as Specified in Its Charter)
- --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (Check the appropriate box):
[X] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.
(1) Title of each class of securities to which transaction applies:
-----------------------------------------------------------------------
(2) Aggregate number of securities to which transaction applies:
-----------------------------------------------------------------------
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the
filing fee is calculated and state how it was determined):
-----------------------------------------------------------------------
(4) Proposed maximum aggregate value of transaction:
-----------------------------------------------------------------------
(5) Total fee paid:
-----------------------------------------------------------------------
[ ] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act
Rule 0-11(a)(2) and identify the filing for which the offsetting fee was
paid previously. Identify the previous filing by registration statement
number, or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
--------------------------------------------------------------------------
(2) Form, Schedule or Registration Statement No.:
--------------------------------------------------------------------------
(3) Filing Party:
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(4) Date Filed:
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<PAGE> 2
TESORO PETROLEUM CORPORATION
---------------------
NOTICE OF 1998 ANNUAL MEETING OF STOCKHOLDERS
JULY 29, 1998
---------------------
The 1998 Annual Meeting of Stockholders of Tesoro Petroleum Corporation
(the "Company") will be held at the Hotel Crescent Court, 400 Crescent Court,
Dallas, Texas, at 10:00 A.M. Central time on Wednesday, July 29, 1998, for the
following purposes:
1. To elect seven directors of the Company;
2. To consider and act upon a proposal to amend the Company's Restated
Certificate of Incorporation to increase the number of authorized shares of
the Company's Common Stock from 50,000,000 to 100,000,000;
3. To consider and act upon a proposal to increase the number of
shares which can be granted under the Amended and Restated Executive
Long-Term Incentive Plan and increase the limit on the number of shares of
restricted stock which can be granted under such plan;
4. To ratify the appointment of Deloitte & Touche LLP as the Company's
independent auditors for fiscal year 1998; and
5. To transact such other business as may properly come before the
meeting or any adjournment thereof.
Holders of Common Stock of record at the close of business on June 9, 1998,
are entitled to notice of and to vote at the annual meeting.
By Order of the Board of Directors,
JAMES C. REED, JR.
Secretary
June 29, 1998
San Antonio, Texas
---------------------
YOUR VOTE IS IMPORTANT. IF YOU DO NOT EXPECT TO ATTEND THE ANNUAL MEETING, OR IF
YOU DO PLAN TO ATTEND BUT WISH TO VOTE BY PROXY, PLEASE DATE, SIGN AND MAIL
PROMPTLY THE ENCLOSED PROXY. A RETURN ENVELOPE IS PROVIDED FOR THIS PURPOSE.
<PAGE> 3
TESORO PETROLEUM CORPORATION
PROXY STATEMENT
---------------------
1998 ANNUAL MEETING OF STOCKHOLDERS
JULY 29, 1998
---------------------
GENERAL INFORMATION
This Proxy Statement is furnished in connection with the solicitation by
the Board of Directors (sometimes referred to herein as the "Board") of Tesoro
Petroleum Corporation ("Tesoro" or the "Company") of proxies to be voted at the
1998 Annual Meeting of Stockholders to be held on Wednesday, July 29, 1998, and
at any adjournment thereof.
Each proxy will be voted as specified thereon by the stockholder. Any duly
executed proxy not specifying the contrary will be voted (i) for the directors
nominated for election at the meeting, (ii) in favor of the proposal to amend
the Company's Restated Certificate of Incorporation to increase the number of
authorized shares of the Company's Common Stock from 50,000,000 to 100,000,000,
(iii) in favor of the proposal to increase the number of shares which can be
granted under the Amended and Restated Executive Long-Term Incentive Plan and
increase the limit on the number of shares of restricted stock which can be
granted under such plan, and (iv) for the ratification of the appointment of
Deloitte & Touche LLP as the Company's independent auditors for fiscal year
1998. A stockholder giving a proxy may revoke it by written notice to the
Secretary of the Company at any time before it is voted.
At the close of business on June 9, 1998, the record date for the 1998
annual meeting, there were outstanding and entitled to vote 26,558,068 shares of
Common Stock of the Company. The holders of Common Stock are entitled to one
vote for each share held by them on all matters submitted to them. The Company
has no other voting securities outstanding.
A copy of the Company's Summary Annual Report for fiscal year 1997 has
previously been mailed to all stockholders as of the record date. The Company's
complete Consolidated Financial Statements, Selected Financial Data and
Management's Discussion and Analysis of Financial Condition and Results of
Operations taken from the Company's Annual Report on Form 10-K for the fiscal
year ended December 31, 1997 are included in Appendix A to this document. Such
Summary Annual Report and Appendix A hereto do not constitute a part of the
proxy materials.
The principal executive offices of the Company are located at 8700 Tesoro
Drive, San Antonio, Texas 78217-6218. This Proxy Statement and accompanying form
of proxy are being mailed to stockholders on or about June 29, 1998.
<PAGE> 4
1. ELECTION OF DIRECTORS
At the 1998 annual meeting, the stockholders are requested to elect seven
directors to hold office until the 1999 Annual Meeting of Stockholders or until
their successors are elected and qualified. Unless otherwise specified, all duly
executed proxies received on a timely basis will be voted for the nominees set
forth below. Each of such nominees has indicated his willingness to serve as a
director, if elected, and the Company has no reason to believe that any nominee
will be unable to serve. The persons designated as proxies, however, reserve
full discretion to cast votes for other persons in the event that any one or
more of the nominees are unable to serve.
The election of director nominees requires a plurality of the votes cast at
the election. Under Delaware law and the Company's Restated Certificate of
Incorporation and By-laws, shares as to which a stockholder withholds authority
to vote on the election of directors ("Abstentions"), and shares as to which a
broker indicates that it does not have discretionary authority to vote ("Broker
Non-Votes") on the election of directors, will not be counted as voting thereon
and will not affect the election of the nominees receiving a plurality of the
votes cast.
On December 26, 1995, the Stockholders' Committee for New Management of
Tesoro Petroleum Corporation (the "Committee"), comprised at that time of five
holders of the Company's Common Stock, announced its intention to engage in a
solicitation of written consents for the primary purpose of removing the then
current members of the Board and replacing them with a new board. On April 4,
1996, a settlement agreement was reached between the Committee and certain
related parties (the "Solicitation Parties"), the Company and Ardsley Advisory
Partners ("Ardsley"), the Company's then largest stockholder. Pursuant to the
settlement agreement, the Solicitation Parties severally agreed, among other
things, that for a period beginning as of April 4, 1996, and ending on the
earlier of the day after the Company's 1999 annual meeting or June 30, 1999 (the
"Standstill Period"), he or it shall not in any way, directly or indirectly,
without the approval of the Board, make, encourage, participate or assist in (a)
any attempt to take control of the Company, (b) any consent solicitation to
remove any member of the Company's Board of Directors, (c) any solicitation of
proxies to vote or become a participant in any election contest to remove any
member of the Company's Board of Directors, (d) the nomination or election of
any alternate director or slate of directors proposed from the floor at any
meeting of the Company's stockholders, or (e) any offers or indications of
interest with respect to the acquisition or disposition of the Company or any of
its business units. In accordance with the settlement agreement, the Board was
expanded with the addition on April 12, 1996, of Alan J. Kaufman, M.D., a
Committee member, and Sanford B. Prater, a Partner of Ardsley, and William J.
Johnson who was selected by the Governance Committee of the Board of Directors
on June 6, 1996. On October 23, 1996, Mr. Prater resigned from the Board
pursuant to a provision in the settlement agreement which provided that, if
Ardsley's holdings of Tesoro Common Stock declined by more than 50 percent, Mr.
Prater was obligated to tender his resignation from the Board. The settlement
agreement further provides that Dr. Kaufman and Mr. Johnson shall continue
subject to the terms of the settlement agreement to be nominated for election as
part of the Board's recommended slate throughout the Standstill Period. In the
case of Dr. Kaufman, the settlement agreement provides that, in the event any of
the Solicitation Parties breaches the terms of the standstill, confidentiality
and non-disparagement provisions of the settlement agreement or in the event Dr.
Kaufman reduces his holdings of Company Common Stock below 400,000 shares or
votes for any nominee for director other than those supported by a majority of
the Board, Dr. Kaufman shall immediately tender his resignation and, at the
option of the Company, be removed from the Board.
The stockholders are being asked to elect seven directors, constituting the
whole Board of Directors, to hold office until the 1999 Annual Meeting of
Stockholders or until their successors are duly elected and qualified, and
proxies cannot be voted for more than seven nominees.
2
<PAGE> 5
INFORMATION CONCERNING DIRECTORS AND NOMINEES
Certain information as to each nominee for director is set forth in the
table below and in the following paragraphs. Certain of the information
appearing in the table and the notes thereto has been furnished to the Company
by the respective nominees.
<TABLE>
<CAPTION>
SERVED AS
DIRECTOR OF
AGE AT THE COMPANY
JUNE 9, OR PREDECESSOR OTHER POSITIONS AND OFFICES
NAME 1998 COMPANIES FROM WITH THE COMPANY
---- --------- -------------- ---------------------------
<S> <C> <C> <C>
Steven H. Grapstein.............. 40 1992 Vice Chairman of the Board of
Directors(a)(b)(c)
William J. Johnson............... 63 1996 (b)(d)
Alan J. Kaufman.................. 60 1996 (b)(d)
Raymond K. Mason, Sr............. 71 1983 (a)(d)
Bruce A. Smith................... 54 1995 Chairman of the Board of Directors,
President and Chief Executive Officer(a)
Patrick J. Ward.................. 67 1996 (c)(d)
Murray L. Weidenbaum............. 71 1992 (a)(c)
</TABLE>
- ---------------
(a) Member of the Executive Committee (Mr. Smith, Chairman).
(b) Member of the Audit Committee (Mr. Grapstein, Chairman).
(c) Member of the Governance Committee (Dr. Weidenbaum, Chairman).
(d) Member of the Compensation Committee (Mr. Mason, Chairman).
------------------------
Steven H. Grapstein has been Chief Executive Officer of Kuo Investment
Company and subsidiaries ("Kuo"), an international investment group, since
January 1997. From September 1985 to January 1997, Mr. Grapstein was a Vice
President of Kuo. He is also a director of several of the Kuo companies. Mr.
Grapstein has been a Vice President of Oakville N.V. ("Oakville") since 1989.
Mr. Grapstein is also a director of Baldwin Plc., which is an entertainment and
leisure-related entity.
William J. Johnson has been a petroleum consultant and investor since 1994.
From 1990 through 1994, Mr. Johnson served as President, Chief Operating Officer
and a director of Apache Corporation, a large independent oil and gas company.
Mr. Johnson is on the Board of Directors of Camco International, Inc., an oil
field equipment and services company; Snyder Oil Corporation, an exploration and
production company; and J. Ray McDermott, S.A., an engineering and construction
company.
Alan J. Kaufman, M.D., is an investor in a number of companies and a
retired neurosurgeon. Since 1987, he has been a director of Newpark Resources,
Inc., a company engaged primarily in providing oil field services.
Raymond K. Mason, Sr., has been Chairman of the Board of Directors of
American Banks of Florida, Inc., since 1978.
Bruce A. Smith has been Chairman of the Board of Directors, President and
Chief Executive Officer of the Company since June 1996. He has been a director
of the Company since July 1995. Mr. Smith was President and Chief Executive
Officer of the Company from September 1995 to June 1996; Executive Vice
President, Chief Financial Officer and Chief Operating Officer of the Company
from July 1995 to September 1995; Executive Vice President responsible for
Exploration and Production and Chief Financial Officer of the Company from
September 1993 to July 1995; and Vice President and Chief Financial Officer of
the Company from September 1992 to September 1993.
Patrick J. Ward has 47 years of experience in international energy
operations with Caltex Petroleum Corporation, a 50/50 joint venture of Chevron
Corp. and Texaco, Inc., engaged in the business of refining and marketing. Prior
to his retirement in August 1995, he was Chairman, President and Chief Executive
Officer of
3
<PAGE> 6
Caltex, positions he had held since 1990. Mr. Ward served on the Board of
Directors of Caltex from 1989 to 1995.
Murray L. Weidenbaum, an economist and educator, has been the Mallinckrodt
Distinguished University Professor and Chairman of the Center for the Study of
American Business at Washington University in St. Louis, Missouri, since 1975.
Dr. Weidenbaum is a director of May Department Stores Company.
No director of the Company has a family relationship with any other
director or executive officer of the Company.
------------------------
The Board of Directors met six times during fiscal year 1997. Each member
of the Board of Directors attended at least 75 percent of the meetings of the
Board and committees on which such director served during fiscal year 1997. The
Board of Directors has an Executive Committee and the following standing
committees: Audit Committee, Compensation Committee and Governance Committee.
The Executive Committee, between meetings of the Board and while the Board
is not in session, has and may exercise all the powers and authority of the
Board in the management of the business and affairs of the Company as provided
in Article III of the By-laws of the Company and has and may exercise such other
powers and authority as may be lawfully delegated to such committee by the
Board, including the power and authority (i) to declare a dividend on the
Company's capital stock, (ii) to authorize the issuance of the Company's capital
stock, (iii) to adopt a certificate of ownership and merger pursuant to Section
253 of the Delaware General Corporation Law, and (iv) to the extent authorized
in any resolution or resolutions providing for the issuance of shares of stock
adopted by the Board or the Executive Committee as provided in subsection (a) of
Section 151 of the Delaware General Corporation Law, to fix the designations and
any of the preferences or rights of such shares relating to dividends,
redemption, dissolution, any distribution of assets of the Company or the
conversion into, or the exchange of such shares for, shares of any other class
or classes or any other series of the same or any other class or classes of
stock of the Company or fix the number of shares of any series of stock or
authorize the increase or decrease of the shares of any series. The Executive
Committee met one time during fiscal year 1997.
The Audit Committee's primary purposes are (i) to aid the individual
directors of the Board of Directors as a whole in performing and fulfilling
their oversight responsibilities for financial reporting to the public; (ii) to
aid in maintaining the corporate image and credibility as it relates to
financial reporting; (iii) to recommend and support, with management and/or the
Board of Directors, as appropriate, efforts to improve and maintain standards
and procedures for financial control and quality financial reporting; (iv) to
provide communication, as necessary, between the Board of Directors and control
and accounting, legal, internal auditing and the external auditors; and (v) to
recommend and support, with management and/or the Board of Directors, as
appropriate, efforts to assure the Company's compliance with the requirements of
the Foreign Corrupt Practices Act of 1977, as amended. The Audit Committee met
four times during fiscal year 1997.
The Compensation Committee's primary purposes are (i) to review and approve
all areas of senior executive compensation including but not limited to salary
adjustments, cash incentive awards and stock incentives, and to review and
approve the aggregate amount of all merit increases, cash incentive awards and
stock incentives for the Company's other executives; (ii) to administer and
interpret the Company's Amended Incentive Stock Plan of 1982 (the "1982 Plan"),
Amended and Restated Executive Long-Term Incentive Plan (the "1993 Plan") and
any future incentive plans, to the extent set forth in such plans; (iii) to
review Company retirement matters, consider amendments to the Company's
retirement plans based on cost and benefit considerations, make recommendations
to the Board of Directors in respect to such amendments and proposals, and
review and approve any overall changes in retirement benefit formulas; (iv) to
review new employment agreements, amendments and extensions of existing
employment agreements, and to make recommendations to the Board of Directors
with respect to such agreements; (v) to administer and interpret employment
agreements and make recommendations to the Board of Directors with respect
thereto; and (vi) to consult with the Board of Directors and review with the
Board the actions of the Compensation Committee as appropriate. The Compensation
Committee met four times during fiscal year 1997.
4
<PAGE> 7
The Governance Committee considers and recommends to the Board from time to
time suitable candidates for membership on the Board, including nominees
recommended by stockholders. Stockholders wishing to submit a recommendation
should write to the Governance Committee. Stockholders may also make nominations
for director at annual or certain special stockholder meetings if they comply
with the procedures described below. The Governance Committee also reviews and
makes recommendations to the Board annually regarding (i) the organization and
structure of the Board and the committees of the Board and director compensation
and (ii) the role and effectiveness of the Chief Executive Officer, the Board
and each committee of the Board. The Governance Committee met three times during
fiscal year 1997.
Under the Company's By-laws, a stockholder of the Company entitled to vote
for the election of directors, may, if he or she complies with the following
procedures, make a nomination for director at a stockholder meeting. Nominations
for director may be made by stockholders only after compliance with the
procedures set forth in the Company's By-laws. The following summary is
qualified in its entirety by reference to the full text of the By-laws. Written
notice of such stockholder's intent to make such nomination must be delivered to
the Company (Attention: Corporate Secretary) on a timely basis as set forth
below and must contain (i) the name and address of the stockholder as it appears
on the Company's books and of the beneficial owner, if any, on behalf of whom
such nomination is made, and (ii) as to each person whom the stockholder
proposes to nominate for election as a director, all information relating to
such person that is required to be disclosed in solicitation of proxies for
election of directors, or is otherwise required, by Regulation 14A under the
Securities Exchange Act of 1934, as amended ("Exchange Act") (including such
person's written consent to being named in the proxy statement as a nominee and
to serving as a director if elected).
In the case of an annual meeting of stockholders, the required notice must
be delivered not less than 60 days nor more than 90 days prior to the first
anniversary of the preceding year's annual meeting; provided that, in the event
that the date of the annual meeting is advanced by more than 30 days or delayed
by more than 60 days from such anniversary date, the notice must be delivered no
earlier than the ninetieth day prior to such annual meeting and not later than
the close of business on the later of the sixtieth day prior to such annual
meeting or the tenth day following the day on which public announcement of the
date of such meeting is first made. If the number of directors to be elected to
the Board is increased and there is no public announcement specifying the size
of the increased Board made by the Company at least 70 days prior to the first
anniversary of the preceding year's annual meeting, a notice will be considered
timely, but only with respect to nominees for any new positions created by such
increase, if delivered not later than the close of business on the tenth day
following the day on which the public announcement is first made by the Company.
In the case of a special meeting of stockholders at which directors are proposed
to be elected in the notice of meeting, the stockholder wishing to make a
nomination for director must deliver the required written notice to the Company
(Attention: Corporate Secretary) not earlier than the ninetieth day prior to the
special meeting and not later than the close of business on the later of the
sixtieth day prior to such meeting or the tenth day following the day on which
public announcement is first made of the date of the special meeting and of the
nominees proposed by the Board to be elected at such meeting.
------------------------
COMPENSATION OF DIRECTORS
Each member of the Board of Directors who is not an officer of the Company
receives a base retainer of $18,000 per year, and an additional $2,000 for each
meeting of the Board of Directors or any committee thereof attended in person,
and $1,000 for each telephone meeting, including committee meetings held on the
same day as a meeting of the Board of Directors. The non-executive Vice Chairman
of the Board of Directors receives $25,000 per year for his service. In
addition, the Chairman of the Audit Committee, Chairman of the Compensation
Committee and Chairman of the Governance Committee each receive $5,000 per year
for their service in such positions. During 1997, Robert J. Caverly received an
aggregate of $17,473 for his service as Chairman Emeritus of the Board until his
retirement from the Board in May 1997. The Company provides group life insurance
benefits in the amount of $100,000 and accidental death and dismemberment
insurance up to a maximum of $350,000 for each of the members of the Board of
Directors who are not employees of the Company. The premium for such insurance
ranged from $144 to $3,286 for each of these directors during
5
<PAGE> 8
fiscal year 1997. Commencing with the 1997 Annual Meeting of Stockholders,
one-half of each of the director's annual retainer is paid in Common Stock of
the Company on an annual basis. The Company issues to each director within 30
days after the annual meeting of stockholders of the Company at which the
director is elected a number of shares equal to one-half of the annual retainer
in effect on the date of such meeting divided by the average of the closing
prices for the Common Stock, as reported on the New York Stock Exchange ("NYSE")
composite tape, for the ten trading days prior to such annual meeting. The
shares of Common Stock issued to the directors will be held by the Company and
will not be sold, pledged or otherwise disposed of and will not be delivered to
the directors until the earlier of (i) the first anniversary date of the annual
meeting which immediately preceded the issuance of such shares or (ii) the date
on which the person ceases to be a director. The directors will have full voting
rights with respect to such shares of Common Stock.
The Company had established an unfunded Non-Employee Director Retirement
Plan (the "Director Retirement Plan") in December 1994 which provided that any
eligible non-employee director who elected to participate in the Director
Retirement Plan and who had served on the Company's Board of Directors for at
least three full years would be entitled to a retirement payment in cash
beginning the later of the director's sixty-fifth birthday or such later date
that the individual's service as a director ended. However, to more closely
align director compensation with shareholders' interests, in March 1997, the
Board of Directors amended the Director Retirement Plan to freeze the plan and
convert the accrued benefits of each current director under the plan to a
lump-sum present value which was transferred to an account ("Account") for each
director in the Tesoro Petroleum Corporation Board of Directors Deferred Phantom
Stock Plan (the "Phantom Stock Plan"). After the amendment and transfer, only
those retired directors or beneficiaries who had begun receiving benefits
remained participants in the Director Retirement Plan. By participating in the
Phantom Stock Plan, each director waives any and all rights under the Director
Retirement Plan. Commencing with 1997, each current and future non-employee
director ("Participant") shall have credited to his Account as of the last day
of the year a yearly accrual equal to $7,250, prorated to $6,042 for 1997
(limited to 15 accruals, including previous accruals of retirement benefits
under the Director Retirement Plan); and each Participant who is serving as a
chairman of a committee of the Board of Directors immediately prior to his
termination as director and who has served at least three years as a director
shall have an additional $5,000 credited to his Account. The Phantom Stock Plan
allows for pro rata calculations of the yearly accrual in the event a director
serves for part of a year. In addition, a Participant may elect to defer any
part or all of the cash portion of his annual director retainer into his
Account. Each transfer, accrual or deferral shall be credited quarterly to the
Participant's Account in units based upon the number of shares that could have
been purchased with the dollars credited based upon the closing price of the
Company's Common Stock on the NYSE on the date the amount is credited. Dividends
or other distributions accrue to the Participant's Account. Participants are
vested 100 percent at all times with respect to deferrals and, if applicable,
the chairman fee portion of his Account. Participants vest in amounts
transferred from the Director Retirement Plan and the yearly accruals upon
completion of three full years of service (including all service prior to March
6, 1997) as a member of the Board. If a Participant voluntarily resigns or is
removed from the Board prior to serving three years on the Board, he shall
forfeit all amounts not vested. If a director dies, retires or becomes disabled,
he shall be 100 percent vested in his Account without regard to service.
Distributions from the Phantom Stock Plan shall be made in cash, in either a
lump-sum distribution or annual installments not exceeding ten years, based on
the closing market price of the Company's Common Stock on the NYSE on the
business day immediately preceding the date on which the cash distribution is to
be made. Death, disability, retirement or cessation of a Participant as a
director of the Company constitute an event requiring a distribution. Upon the
death of a Participant, the Participant's beneficiary will receive the cash
value of the Participant's Account as of the date of death. At December 31,
1997, each Participant's Account was comprised of 3,253 units, 1,169 units,
1,389 units, 13,515 units, 1,611 units and 6,835 units of phantom stock for
Messrs. Grapstein, Johnson, Kaufman, Mason, Ward and Weidenbaum, respectively.
Under the Tesoro Petroleum Corporation Board of Directors Deferred
Compensation Plan (the "Deferred Compensation Plan"), a director electing to
participate may defer between 20 percent and 100 percent of his total cash
compensation for the ensuing year, which deferred fees are credited to an
interest-bearing account maintained by the Company. Interest is applied to each
quarter's deferral at the prime rate published in The Wall Street Journal on the
last business day of such quarter plus two percentage points
6
<PAGE> 9
(10.5 percent at December 31, 1997). All payments under the Deferred
Compensation Plan are the sole obligation of the Company. Upon the death of a
participating director, the balance in his account under the Deferred
Compensation Plan is paid to his beneficiary or beneficiaries in one lump sum.
In the event of the disability, retirement or the removal or resignation prior
to the death, disability or retirement of a participating director, the balance
in his account will be paid to such director in ten equal annual installments.
In the event of a change of control (as "change of control" is defined in the
Deferred Compensation Plan), the balance in each participating director's
account will be distributed to him as a lump sum within 30 days after the date
of the change of control. The Company also has an agreement with Frost National
Bank of San Antonio, Texas, under which the Tesoro Petroleum Corporation Board
of Directors Deferred Compensation Trust was established for the sole purpose of
creating a fund to provide for the payment of deferred compensation to
participating directors under the Deferred Compensation Plan.
The Company's 1995 Non-Employee Director Stock Option Plan (the "1995
Plan") provides for the grant to non-employee directors of automatic,
non-discretionary stock options, at an exercise price equal to the fair market
value of the Common Stock as of the date of grant. Under the 1995 Plan, each
person serving as a non-employee director on February 23, 1995, or elected
thereafter, initially receives an option to purchase 5,000 shares of the
Company's Common Stock. Thereafter, each non-employee director, while the 1995
Plan is in effect and shares are available to grant, will be granted an option
to purchase 1,000 shares of Common Stock on the next day after each annual
meeting of the Company's stockholders but not later than June 1, if no annual
meeting is held. All options under the 1995 Plan become exercisable six months
after the date of grant. The 1995 Plan will terminate as to the issuance of
stock options in February 2005. Under the 1995 Plan, stock options for 1,000
shares with an exercise price of $12.125 per share were granted to each
non-employee director of the Company on May 8, 1997. At June 9, 1998, the
Company had 56,000 options outstanding and 77,000 shares available for future
grants under the 1995 Plan.
7
<PAGE> 10
STOCK OWNERSHIP
The following table shows the beneficial ownership of the Company's Common
Stock reported to the Company as of June 9, 1998, including shares as to which a
right to acquire ownership exists (for example, through the exercise of stock
options or stock awards) within the meaning of Rule 13d-3(d)(1) under the
Exchange Act for each director and nominee, the Chief Executive Officer, the
other four most highly compensated officers of the Company during 1997 and, as a
group, such persons and other executive officers. Unless otherwise indicated,
each person or member of the group listed has sole voting and investment power
with respect to the shares of Common Stock listed.
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP OF
COMMON STOCK ON
JUNE 9, 1998
-------------------------
PERCENT
SHARES OF CLASS
--------- --------
<S> <C> <C>
Steven H. Grapstein......................................... 855,118(a)(b) 3.219
William J. Johnson.......................................... 6,818(a) 0.026
Alan J. Kaufman............................................. 572,318(a)(c) 2.154
Raymond K. Mason, Sr. ...................................... 26,246(a) 0.099
Bruce A. Smith.............................................. 371,711(d) 1.387
Patrick J. Ward............................................. 13,818(a)(e) 0.052
Murray L. Weidenbaum........................................ 9,818(a) 0.037
William T. Van Kleef........................................ 120,289(f) 0.452
James C. Reed, Jr. ......................................... 110,491(g) 0.415
Stephen L. Wormington....................................... 109,475(h) 0.411
Robert W. Oliver............................................ 94,738(i) 0.356
All directors, nominees for election as a director and
executive officers as a group (16 individuals)............ 2,505,230(j) 9.161
</TABLE>
- ---------------
(a) The shares shown for Mr. Grapstein, Mr. Mason and Dr. Weidenbaum include
8,000 shares each which such directors had the right to acquire through the
exercise of stock options on June 9, 1998, or within 60 days thereafter.
The shares shown for Mr. Johnson, Dr. Kaufman and Mr. Ward include 6,000
shares, 7,000 shares and 7,000 shares, respectively, which such directors
had the right to acquire through the exercise of stock options on June 9,
1998, or within 60 days thereafter. In addition, the shares shown for each
director include 818 shares of Common Stock as payment of one-half of each
director's annual retainer for fiscal year 1997 (see page 5). Units of
phantom stock payable in cash which have been credited to the directors
under the Phantom Stock Plan are not included in the shares shown above
(see page 6).
(b) The shares shown include 846,300 shares of the Company's Common Stock owned
by Oakville. Mr. Grapstein is an officer of Oakville. As an officer, Mr.
Grapstein shares voting and investment power with respect to such shares.
(c) The shares shown include 9,000 shares held in the name of Dr. Kaufman's
spouse for which he disclaims beneficial ownership, and 20,000 shares owned
by the Kaufman Children's Trust for which Dr. Kaufman has sole power to
vote and direct the disposition thereof.
(d) The shares shown include 2,696 shares credited to Mr. Smith's account under
the Company's Thrift Plan and 239,267 shares which Mr. Smith had the right
to acquire through the exercise of stock options on June 9, 1998, or within
60 days thereafter.
(e) The shares shown include 6,000 shares owned by the P&L Family Partnership
Ltd. which Mr. Ward and his spouse control through 90 percent ownership.
(f) The shares shown include 1,906 shares credited to Mr. Van Kleef's account
under the Company's Thrift Plan and 66,913 shares which Mr. Van Kleef had
the right to acquire through the exercise of stock options or stock awards
on June 9, 1998, or within 60 days thereafter.
8
<PAGE> 11
(g) The shares shown include 1,171 shares credited to Mr. Reed's account under
the Company's Thrift Plan and 50,267 shares which Mr. Reed had the right to
acquire through the exercise of stock options on June 9, 1998, or within 60
days thereafter.
(h) The shares shown include 1,142 shares credited to Mr. Wormington's account
under the Company's Thrift Plan and 108,333 shares which Mr. Wormington had
the right to acquire through the exercise of stock options on June 9, 1998,
or within 60 days thereafter.
(i) The shares shown include 405 shares credited to Mr. Oliver's account under
the Company's Thrift Plan and 93,333 shares which Mr. Oliver had the right
to acquire through the exercise of stock options on June 9, 1998, or within
60 days thereafter. The shares shown also include 1,000 shares held in the
name of Mr. Oliver's spouse for which he disclaims beneficial ownership.
(j) The shares shown include 9,999 shares credited to the accounts of executive
officers and directors under the Company's Thrift Plan and 787,903 shares
which directors and executive officers had the right to acquire through the
exercise of stock options or stock awards on June 9, 1998, or within 60
days thereafter. The shares shown also include 1,334 shares held in the
name of an executive's spouse for which such executive disclaims beneficial
ownership and 3,000 shares acquired in the name of an executive officer's
mother with respect to which such executive officer has voting and
investment power.
---------------------
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table sets forth information based on filings made with the
Securities and Exchange Commission ("SEC") as to each person or group who on
June 9, 1998, beneficially owned more than 5 percent of the outstanding shares
of Common Stock of the Company.
<TABLE>
<CAPTION>
AMOUNT AND NATURE
OF BENEFICIAL
OWNERSHIP
--------------------
NUMBER PERCENT
TITLE OF CLASS NAME AND ADDRESS OF BENEFICIAL OWNER OF SHARES OF CLASS
-------------- ------------------------------------ --------- --------
<S> <C> <C> <C>
Common Stock...................... Wanger Asset Management, L.P.(a) 2,571,000 9.681
227 West Monroe Street, Suite 3000
Chicago, IL 60606
Common Stock...................... Heartland Advisors, Inc.(b) 1,721,620 6.482
790 North Milwaukee Street
Milwaukee, WI 53202
</TABLE>
- ---------------
(a) According to Amendment No. 1 to a Schedule 13G filed with the SEC, Wanger
Asset Management, L.P. ("WAM"), states that it is a Delaware limited
partnership and an Investment Adviser registered under Section 203 of the
Investment Advisers Act of 1940 and Wanger Asset Management Ltd. states
that it is a Delaware corporation and the General Partner of the Investment
Adviser. Amendment No. 1 to the Schedule 13G indicates that the shares
reported therein have been acquired on behalf of discretionary clients of
WAM and that persons other than WAM are entitled to receive all dividends
from, and proceeds from, the sale of those shares. According to Amendment
No. 1 to the Schedule 13G, WAM, within the meaning of Rule 13d-3 of the
Exchange Act, beneficially owns the shares shown in the table above and
possesses shared power to vote or to direct the vote and shared power to
dispose or direct the disposition of these shares.
(b) According to Amendment No. 1 to a Schedule 13G filed with the SEC,
Heartland Advisors, Inc. ("Heartland"), states that it is a corporation
organized under the laws of the state of Wisconsin and an investment
adviser registered under Section 203 of the Investment Advisers Act of
1940. In Amendment No. 1 to the Schedule 13G, Heartland states that the
shares of the Company's Common Stock are held in investment advisory
accounts of Heartland, and as a result, various persons have the right to
receive or the power to direct the receipt of dividends from, or the
proceeds from the sale of, securities. The interests of one such account,
Heartland Value Fund, a series of Heartland Group, Inc., a registered
investment company, relates to more than 5 percent of the class. Within the
meaning of Rule 13d-3 of the Exchange
9
<PAGE> 12
Act, 1,721,620 shares of the Company's Common Stock may be deemed
beneficially owned by Heartland. According to Amendment No. 1 to the
Schedule 13G, Heartland has sole voting power with respect to 1,677,420 of
these shares and sole dispositive power with respect to 1,721,620 of these
shares.
---------------------
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires the Company's directors,
executive officers and holders of more than 10 percent of the Company's voting
stock to file with the SEC initial reports of ownership and reports of changes
in ownership of Common Stock or other equity securities of the Company. The
Company believes that during the fiscal year ended December 31, 1997, its
directors, executive officers and holders of more than 10 percent of the
Company's voting stock complied with all Section 16(a) filing requirements with
the following exceptions: Mr. Smith failed to timely report a grant of phantom
stock options made to him on October 29, 1997. Mr. Grapstein failed to file two
Form 4s for an aggregate of 21 transactions in October and December 1997 with
respect to 245,600 shares of the Company's Common Stock sold by Oakville, of
which Mr. Grapstein is a Vice President. Mr. Oliver failed to report on Form 3
shares of Common Stock held in the name of his spouse. Mr. Oliver disclaims
beneficial ownership of such shares. Mr. Oliver has subsequently amended his
Form 3 to report such shares. In connection with stock options granted on
October 29, 1997 under the 1993 Plan, Messrs. Van Kleef, Reed, Wormington,
Oliver, Nyberg, Beere and Wright each failed to timely report single
transactions on Form 5s for the fiscal year ended December 31, 1997.
10
<PAGE> 13
EXECUTIVE COMPENSATION
SUMMARY OF COMPENSATION
The following table contains information concerning the annual and
long-term compensation for services in all capacities to the Company for fiscal
years ended December 31, 1997, 1996 and 1995, of those persons who were on
December 31, 1997, (i) the Chief Executive Officer and (ii) the other four most
highly compensated officers of the Company (the "named executive officers").
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION AWARDS
-------------------------------- -------------------------
OTHER ANNUAL RESTRICTED STOCK ALL OTHER
NAME AND SALARY BONUS COMPENSATION STOCK OPTIONS COMPENSATION
PRINCIPAL POSITION YEAR ($) ($) ($)(A) AWARD(S)($) (SHARES)(B) ($)(D)
------------------ ---- ------- ------- ------------ ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Bruce A. Smith............. 1997 578,269 715,000 -- -- 175,000 1,142,017
Chairman of the Board of 1996 510,096 680,960 -- (c) 170,000 790,751
Directors, President 1995 347,692 350,000 -- -- 100,000 320,612
and Chief Executive
Officer
William T. Van Kleef....... 1997 290,231 320,000 -- -- 60,000 369,341
Executive Vice President, 1996 236,269 248,900 -- (c) 100,000 216,207
Operations 1995 169,635 129,000 -- -- 20,000 60,962
James C. Reed, Jr.......... 1997 278,269 295,000 -- -- 45,000 914,363
Executive Vice President, 1996 243,673 232,750 -- (c) 50,000 1,004,676
General Counsel and 1995 192,539 161,000 -- -- 20,000 568,312
Secretary
Stephen L. Wormington(e)... 1997 268,269 280,000 -- -- 45,000 --
President, Tesoro Alaska 1996 -- -- -- -- (c) --
Petroleum Company 1995 -- -- -- -- -- --
Robert W. Oliver(e)........ 1997 208,269 210,000 -- -- 25,000 --
President, Tesoro 1996 -- -- -- -- (c) --
Exploration and
Production 1995 -- -- -- -- -- --
Company
</TABLE>
- ---------------
(a) No payments were made to the named executive officers which are reportable
in Other Annual Compensation. The aggregate amount of perquisites and other
personal benefits was less than either $50,000 or 10 percent of the total
annual salary and bonus reported for the named executive officers for all
periods shown.
(b) Amounts include 175,000 phantom stock options granted to Mr. Smith in
fiscal year 1997 (see page 16). At the discretion of the Compensation
Committee of the Board of Directors, these phantom stock options may be
converted to traditional stock options upon sufficient shares becoming
available under the 1993 Plan. All other amounts represent traditional
stock options.
(c) In 1996, the Compensation Committee of the Board approved a special
incentive strategy comprised of long-term performance-vested restricted
stock and stock options for the executive officers. Under this strategy,
Messrs. Smith, Van Kleef and Reed were awarded 200,000, 75,000 and 75,000
shares, respectively, of restricted Common Stock, and Messrs. Wormington
and Oliver were each granted 75,000 stock options at an exercise price of
$11.375 per share (the fair market value as defined in the 1993 Plan of a
share of the Company's Common Stock on the date of grant). Under the
strategy, awards would be earned only if the market price of the Company's
Common Stock reaches an average price of $20 or higher over any 20
consecutive trading days after June 30, 1997 and before December 31, 1998
(the "Performance Target") (see page 15). On May 12, 1998, the Performance
Target was achieved which
11
<PAGE> 14
resulted in the lapse of restrictions on the restricted Common Stock and
vesting of the stock options which had been awarded under the special
incentive strategy.
(d) All Other Compensation for 1997 includes amounts contributed by the Company
and earnings on the respective executive officer's account in the Funded
Executive Security Plan (see "Retirement Benefits" on page 18) of
$1,135,617, $362,941 and $907,963 for Mr. Smith, Mr. Van Kleef and Mr. Reed,
respectively; and amounts contributed to the Company's Thrift Plan of $6,400
for each of these officers. All Other Compensation for 1996 includes amounts
contributed by the Company and earnings on the respective executive
officer's account in the Funded Executive Security Plan of $786,251,
$211,707 and $1,000,176 for Mr. Smith, Mr. Van Kleef and Mr. Reed,
respectively; and amounts contributed to the Company's Thrift Plan of $4,500
for each of these executive officers. All Other Compensation for 1995
includes amounts contributed by the Company and earnings on the respective
executive officer's account in the Funded Executive Security Plan of
$316,112, $56,462 and $563,812 for Mr. Smith, Mr. Van Kleef and Mr. Reed,
respectively; and amounts contributed to the Company's Thrift Plan of $4,500
for each of these executive officers.
(e) Since Mr. Wormington and Mr. Oliver were not executive officers during 1996
and 1995, information is not given for those years.
---------------------
OPTION GRANTS IN 1997
The following table sets forth information concerning individual grants of
traditional stock options pursuant to the Company's 1993 Plan to the named
executive officers and a grant of phantom stock options to the Chief Executive
Officer during the year ended December 31, 1997. No Stock Appreciation Rights
("SARs") were granted under the 1993 Plan during 1997.
OPTION GRANTS IN 1997
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
----------------------------------------------------- POTENTIAL REALIZABLE
NUMBER OF VALUE AT ASSUMED
SECURITIES % OF TOTAL ANNUAL RATES OF STOCK
UNDERLYING OPTIONS PRICE APPRECIATION FOR
OPTIONS GRANTED TO EXERCISE OR OPTION TERM
GRANTED EMPLOYEES BASE PRICE EXPIRATION -----------------------
NAME (#) IN 1997 ($/SHARE)(A) DATE 5%($) 10%($)
---- ---------- ------------ ------------ ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Bruce A. Smith............ 175,000(b) 29.2 16.9844 10/28/07 1,869,245 4,737,033
William T. Van Kleef...... 60,000(c) 10.0 16.9844 10/28/07 640,884 1,624,126
James C. Reed, Jr......... 45,000(c) 7.5 16.9844 10/28/07 480,663 1,218,094
Stephen L. Wormington..... 45,000(c) 7.5 16.9844 10/28/07 480,663 1,218,094
Robert W. Oliver.......... 25,000(c) 4.2 16.9844 10/28/07 267,035 676,719
</TABLE>
- ---------------
(a) The exercise price per share of these traditional options and phantom stock
options is the average of the high and low prices of the Company's Common
Stock on the NYSE on the date of grant.
(b) The options granted to Mr. Smith represent phantom stock options, which at
the discretion of the Compensation Committee of the Board of Directors may
be converted to traditional stock options upon sufficient shares becoming
available under the 1993 Plan. The phantom stock options vest in 15 percent
increments in each of the first three years and the remaining 55 percent
increment vests in the fourth year. Upon exercise, Mr. Smith would be
entitled to receive in cash the difference between the fair market value of
the Common Stock on the date of the phantom stock option grant (exercise
price) and the fair market value of Common Stock on the date of exercise
(see page 16).
(c) The traditional options granted to Messrs. Van Kleef, Reed, Wormington and
Oliver during 1997 are exercisable in four equal annual installments
beginning one year from the date of grant.
---------------------
12
<PAGE> 15
AGGREGATED OPTION/SAR EXERCISES IN 1997 AND OPTION/SAR VALUES AT DECEMBER 31,
1997
The following table reflects the number of unexercised stock options
(excluding long-term performance-vested options granted in 1996 in connection
with the special incentive compensation strategy (see page 15)) and SARs
remaining at year-end and the potential value thereof based on the year-end
market price of the Company's Common Stock of $15 1/2 per share. No stock
options or SARs were exercised by the named executive officers during 1997.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS/ SARS AT OPTIONS/ SARS AT
SHARES DECEMBER 31, 1997(#) DECEMBER 31, 1997($)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Bruce A. Smith.......... -- -- 239,267 376,733(a) 1,744,975 684,150
William T. Van Kleef.... -- -- 60,913 146,387 254,444 189,963
James C. Reed, Jr....... -- -- 50,267 105,733 265,475 222,400
Stephen L. Wormington... -- -- 33,333 103,667 125,750 193,500
Robert W. Oliver........ -- -- 18,333 56,667 77,187 118,125
</TABLE>
- ---------------
(a) The number of unexercised options/SARs include 175,000 phantom stock options
which were granted to Mr. Smith on October 29, 1997 (see page 16).
---------------------
REPORT OF COMPENSATION COMMITTEE
The Compensation Committee of the Board of Directors of Tesoro Petroleum
Corporation has prepared the following report regarding 1997 executive
compensation. The Compensation Committee, which is composed entirely of
non-employee directors, is responsible for all components of the Company's
senior executive compensation programs and the aggregate cost-related aspects of
other executive compensation. The members of the Compensation Committee for 1997
were Raymond K. Mason, Sr. (Chairman), William J. Johnson, Alan J. Kaufman and
Patrick J. Ward. The Compensation Committee works closely with the entire Board
of Directors in the execution of its duties. This report is required by rules
established by the SEC and provides specific information regarding compensation
for the Company's Chairman, President and Chief Executive Officer and the other
officers named in the Summary Compensation Table, as well as compensation
information of all executive officers of the Company.
COMPENSATION PHILOSOPHY AND OBJECTIVES OF EXECUTIVE COMPENSATION PROGRAMS
It is the philosophy of the Company and the Compensation Committee that all
compensation programs should (i) link pay and performance and (ii) attract,
motivate, reward and retain the executive talent required to achieve corporate
objectives. Tesoro also focuses strongly on stock-based compensation, since this
form of compensation provides the clearest link to enhanced shareholder value.
From time to time, the Compensation Committee works with compensation
consultants to assist with the design, implementation and communication of
various compensation plans.
The Company determines competitive levels of compensation using published
compensation surveys (for energy and general industry companies of comparable
size to the Company as measured by revenues), information obtained from
compensation consultants and an analysis of compensation data contained in the
proxy statements for the energy industry peer companies included in the
Company's Total Shareholder Return Graph (the "Performance Graph").
The elements of the Company's compensation program for executives include
base salaries, annual performance-based incentives, long-term incentives and
certain executive benefits. Each of these elements is further described below.
13
<PAGE> 16
DESCRIPTION OF THE 1997 EXECUTIVE COMPENSATION PROGRAM
This section of the Compensation Committee's report describes each of the
principal elements of the Company's executive compensation program with specific
reference to the objectives discussed above.
Base Salaries
Base salaries for the Company's senior executives in 1997 were reviewed
through comparisons with the market survey data described above. The
Compensation Committee does not consider any financial performance criteria on a
formula basis in determining salary increases. Rather, the Compensation
Committee, using its discretion, considers market base salary rates at the
fiftieth percentile, average annual salary increases for executives in companies
of all sizes across the country, and overall corporate financial performance.
The Compensation Committee also makes a subjective review of individual
performance in making base salary increase decisions for senior executives.
These criteria are assessed in a non-formula fashion and are not weighted. The
current base salary level for each of the named executive officers is, overall,
consistent with the Company's philosophy of targeting the fiftieth percentile of
the published compensation survey data previously described.
Annual Performance-Based Incentives
Under the Company's 1997 annual incentive strategy, executive target awards
were set to bring total annual compensation to the seventy-fifth percentile of
the market survey data upon the achievement of target performance. The strategy
was structured so that 60 percent of annual incentive award opportunities were
tied to corporate performance for corporate positions (and for business unit
positions, a combination of corporate and business unit performance) and 40
percent of the award opportunities are tied to a qualitative assessment of
individual performance.
The corporate financial objectives for 1997 were return on total capital
compared to the industry peers shown in the Performance Graph and earnings
before interest expense, income taxes and depreciation, depletion and
amortization ("EBITDA") relative to the Company's business plan. These measures
were weighted equally. For business unit positions, the quantitative performance
measures, also weighted equally, were return on capital employed and EBITDA
relative to the business plan.
The individual, subjective performance measures varied by executive but
included such items as total shareholder return, acquisitions success, strategy
development and organizational development. In addition to these items, business
unit positions were also evaluated on various cost, safety, environmental and
operating objectives. These objectives were not weighted. Annual incentive
awards in 1997 for executive officers were paid between target and maximum
levels since the Company's performance was well above targeted levels. Payouts
for business unit officers also fell between target and maximum based on
combined corporate and unit results.
Long-Term Incentives
The Company believes that its executive officers should have an ongoing
stake in the success of the Company. The Company also believes these key
employees should have a considerable portion of their total compensation tied to
the Company's stock price performance since stock-related compensation is
directly tied to stockholder value.
In 1997, the Compensation Committee provided stock option and/or phantom
stock option grants to key executives and selected other employees under its
ongoing long-term incentive program. Phantom stock options were provided to the
Chief Executive Officer rather than traditional stock options because an
insufficient number of stock options existed in the 1993 Plan. Upon exercise of
the phantom stock options, the Chief Executive Officer would be entitled to
receive in cash the difference between the fair market value of Common Stock on
the date of the phantom stock option grant and the fair market value of Common
Stock on the date of exercise. These phantom stock options may at the discretion
of the Compensation Committee be converted to traditional stock options upon
sufficient shares becoming available under the 1993 Plan. Phantom
14
<PAGE> 17
stock options and traditional stock options provide a strong tie between pay and
performance, since recipients only realize value from stock options/phantom
options if the Company's share price rises after the date of grant. All stock
options (traditional and phantom) in 1997 were granted at 100 percent of fair
market value at the time of grant. The traditional stock options vest in 25
percent increments per year, and the phantom stock options vest in 15 percent
increments in each of the first three years and the remaining 55 percent
increment vests in the fourth year.
In determining the size of stock option/phantom option grants for executive
officers in 1997, the Compensation Committee considered market data on typical
stock option grants at the market twenty-fifth, fiftieth and seventy-fifth
percentiles. The 1997 stock option/phantom option grants made to executives
ranged between the twenty-fifth and seventy-fifth percentiles based on the Chief
Executive Officer's and Compensation Committee's assessment of the participant's
ability to affect long-term results.
In addition to its ongoing stock option/phantom option program, the Company
has a special incentive compensation strategy comprised of performance-vested
restricted stock and stock options for the executive officers which was
established in 1996. The intent of this strategy is to provide an extraordinary
incentive for achieving outstanding stock price performance. Under this
strategy, executive officers received from the 1993 Plan a significant number of
restricted shares (for three of the named executive officers) or stock options
(for other executive officers) which vest only if the Company's share price
reaches an average of $20 or higher over 20 consecutive trading days after June
30, 1997, and before December 31, 1998. If this share price target is not
achieved, these special performance-vested restricted stock and stock options
are canceled. The intent of this program is to provide market ninetieth
percentile total pay if the Company achieves outstanding stock price growth.
Other Executive Benefits and Perquisites
The Company also provides certain benefits and perquisites to its key
executive officers. These benefits and perquisites are not tied to any formal
performance criteria and are intended to serve as part of a competitive total
compensation package. These benefits and perquisites include, but are not
limited to, supplemental retirement plans, change-in-control arrangements, and,
for certain senior executive officers, a flexible perquisites program (with a
dollar limit placed on perquisite expenses) and employment agreements. Levels of
company benefits and perquisites for executives were in line with market
fiftieth and seventy-fifth percentile levels.
DISCUSSION OF 1997 COMPENSATION FOR THE CHIEF EXECUTIVE OFFICER
The discussion below applies to Mr. Smith's 1997 compensation.
Base Salary
Mr. Smith's annual base salary was increased from $575,000 to $600,000 in
1997. This base salary adjustment placed Mr. Smith's base salary at a level
consistent with the fiftieth percentile for the Company's peer group in the
published compensation surveys previously described. The base salary adjustment
was intended to keep Mr. Smith's base pay at a competitive level and reflected
the Compensation Committee's subjective assessment that Mr. Smith's performance
was very strong.
Annual Incentive Award
Based on the Company's outstanding performance on the measures described
under the Annual Performance-Based Incentives section above (as well as
outstanding individual performance in the areas of progress in establishing the
Company's strategy and taking steps to enhance shareholder values), the
Compensation Committee provided Mr. Smith with an annual incentive of $715,000
for 1997. This award was between the targeted and maximum levels provided under
the program.
15
<PAGE> 18
Stock Options
Mr. Smith received a grant of 175,000 phantom stock options in 1997. These
phantom stock options were granted at 100 percent of the fair market value of
the Company's Common Stock on the grant date and vest in 15 percent increments
in each of the first three years and the remaining 55 percent increment vests in
the fourth year. The size of the phantom stock option grant was established near
the market fiftieth percentile of the published compensation survey data. The
performance sensitivity of phantom stock options is a result of phantom options
only producing income for the recipient if the Company's stock price rises after
the grant date.
POLICY WITH RESPECT TO THE $1 MILLION DEDUCTION LIMIT
Under Section 162(m) of the Internal Revenue Code of 1996, as amended (the
"Code"), publicly traded companies may not receive a tax deduction on
non-performance based compensation to executive officers in excess of $1
million. The Company's stock option and phantom stock option grants qualify as
performance-based compensation under the law. No specific actions have been
taken with regard to cash compensation to comply with Section 162(m) at this
time.
COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS
Raymond K. Mason, Sr., Chairman
William J. Johnson
Alan J. Kaufman
Patrick J. Ward
Approved: April 9, 1998
16
<PAGE> 19
PERFORMANCE GRAPH
The Stock Price Performance Graph below compares the cumulative total
return of the Company's Common Stock to the cumulative total return of the S&P
500 Composite Index and to a composite peer group of companies. Due to a number
of mergers and consolidations in the energy industry, a new composite peer group
(the "New Peer Group") was selected for 1997 which included the following: Holly
Corporation; The Louisiana Land and Exploration Company; MAPCO Inc.; Murphy Oil
Corporation; Oryx Energy Company; Quaker State Corporation; Seagull Energy
Corporation; Tosco Corporation; Ultramar Diamond Shamrock Corporation; Union
Texas Petroleum Holdings, Inc.; and Valero Energy Corporation. Companies in the
old peer group (the "Old Peer Group") were as follows: Diamond Shamrock
Corporation (currently Ultramar Diamond Shamrock Corporation); Getty Petroleum
Marketing Inc. (spinoff from Getty Petroleum Corporation); Holly Corporation;
The Louisiana Land and Exploration Company; Maxus Energy Corporation (through
1994); Murphy Oil Corporation; Oryx Energy Company; Quaker State Corporation;
Tosco Corporation; Total Petroleum (North America) Ltd. (through 1996); Union
Texas Petroleum Holdings, Inc.; and Valero Energy Corporation. This line graph
is for the period of five fiscal years commencing December 31, 1992, and ending
December 31, 1997.
COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN*
AMONG THE COMPANY, S&P 500 INDEX AND COMPOSITE PEER GROUPS
[GRAPH]
<TABLE>
<CAPTION>
TESORO
MEASUREMENT PERIOD PETROLEUM S&P 500 NEW PEER OLD PEER
(FISCAL YEAR COVERED) CORP. . INDEX GROUP GROUP
<S> <C> <C> <C> <C>
12/31/92 100 100 100 100
12/31/93 183.33 110.08 113.28 109.34
12/31/94 308.33 111.53 104.76 102.38
12/31/95 287.50 153.45 115.84 111.51
12/31/96 466.67 188.68 161.44 160.09
12/31/97 516.67 251.63 190.89 192.94
</TABLE>
- ---------------
* Assumes that the value of the investment in Common Stock and each index was
$100 on December 31, 1992, and that all dividends were reinvested. Investment
is weighted on the basis of market capitalization.
NOTE: The stock price performance shown on the graph is not necessarily
indicative of future price performance.
---------------------
17
<PAGE> 20
RETIREMENT BENEFITS
The Company maintains a noncontributory qualified Retirement Plan which
covers officers and other eligible employees. Benefits under the plan are
payable on a straight life annuity basis and are based on the average monthly
earnings and years of service of participating employees. Average monthly
earnings used in calculating retirement benefits are primarily salary and bonus
received by the participating employee during the 36 consecutive months of the
last 120 months of service which produces the highest average monthly rate of
earnings.
In addition, the Company maintains an unfunded executive security plan, the
Amended Executive Security Plan ("Amended Plan"), for executive officers and
other key personnel selected by the Chief Executive Officer. The Amended Plan
provides for a monthly retirement income payment during retirement equal to a
percentage of a participant's Earnings. "Earnings" is defined under the Amended
Plan to mean a participant's average monthly rate of total compensation,
primarily salary and bonus earned, including performance bonuses and incentive
compensation paid after December 1, 1993, in the form of stock awards of the
Company's Common Stock (excluding stock awards under the special incentive
compensation strategy), for the 36 consecutive calendar months within the last
ten-year period which produce the highest average monthly rate of compensation
for the participant. The monthly retirement benefit percentage is defined as the
sum of 4 percent of Earnings for each of the first ten years of employment, plus
2 percent of Earnings for each of the next ten years of employment, plus 1
percent of Earnings for each of the next ten years of employment. The maximum
percentage is 70 percent. The Amended Plan provides for the payment of the
difference, if any, between (a) the total retirement income payment calculated
above and (b) the sum of retirement income payments from the Company's
Retirement Plan and Social Security benefits.
The Company also maintains the Funded Executive Security Plan ("Funded
Plan") which covers only selected persons approved by the Chief Executive
Officer who are also participants in the Amended Plan and provides participants
with substantially the same after-tax benefits as the Amended Plan. Advance
payments are made to the extent a participant is expected to incur a
pre-retirement tax liability as a result of his participation in the Funded
Plan. The Funded Plan is funded separately for each participant on an
actuarially determined basis through a bank trust whose primary asset is an
insurance contract providing for a guaranteed rate of return for certain
periods. Amounts payable to participants from the Funded Plan reduce amounts
otherwise payable under the Amended Plan.
The following table shows the estimated annual benefits payable upon
retirement under the Company's Retirement Plan, Amended Plan and the Funded Plan
for employees in specified compensation and years of benefit service
classifications without reference to any amount payable upon retirement under
the Social Security law or any amount advanced before retirement. The estimated
annual benefits shown are based upon the assumption that the plans continue in
effect and that the participant receives payment for life. As of January 1,
1998, the federal tax law generally limits maximum annual retirement benefits
payable by the Retirement Plan to any employee to $130,000, adjusted annually to
reflect increases in the cost of living and adjusted actuarially for retirement.
However, since the Amended Plan and the Funded Plan are not qualified
18
<PAGE> 21
under Section 401 of the Code, it is possible for certain retirees to receive
annual benefits in excess of this tax limitation.
<TABLE>
<CAPTION>
HIGHEST AVERAGE NUMBER OF YEARS OF BENEFIT SERVICE
ANNUAL RATE --------------------------------------------
OF COMPENSATION 10 15 20 25
- --------------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
$ 100,000............................... $ 40,000 50,000 60,000 65,000
$ 200,000............................... $ 80,000 100,000 120,000 130,000
$ 300,000............................... $120,000 150,000 180,000 195,000
$ 400,000............................... $160,000 200,000 240,000 260,000
$ 500,000............................... $200,000 250,000 300,000 325,000
$ 600,000............................... $240,000 300,000 360,000 390,000
$ 700,000............................... $280,000 350,000 420,000 455,000
$ 800,000............................... $320,000 400,000 480,000 520,000
$ 900,000............................... $360,000 450,000 540,000 585,000
$1,000,000.............................. $400,000 500,000 600,000 650,000
$1,100,000.............................. $440,000 550,000 660,000 715,000
$1,200,000.............................. $480,000 600,000 720,000 780,000
$1,300,000.............................. $520,000 650,000 780,000 845,000
</TABLE>
The years of benefit service as of December 31, 1997, for the named
executive officers were as follows: Mr. Smith, 5 years; Mr. Van Kleef, 4 years;
Mr. Reed, 23 years; Mr. Wormington, 3 years; and Mr. Oliver, 2 years.
In addition to the retirement benefits described above, the Amended Plan
provides for a pre-retirement death benefit payable over eight years of four
times a participant's annual base pay as of December 1 preceding a participant's
date of death, less the amount payable from the Funded Plan at the date of
death. The amount payable from the Funded Plan at death is based on the
actuarial value of the participant's vested accrued benefit, payable in 96
monthly installments or as a life annuity if a surviving spouse is the
designated beneficiary.
EMPLOYMENT CONTRACTS, MANAGEMENT STABILITY AGREEMENTS AND CHANGE-IN-CONTROL
ARRANGEMENTS
Under an employment agreement dated November 1, 1997, Mr. Smith is employed
until November 1, 2000, at an annual base salary of $600,000. Under separate
employment agreements, Mr. Van Kleef and Mr. Reed are employed until December
31, 1998, at annual base salaries of $325,000 and $300,000, respectively. In
addition to their base salaries, each of the employment agreements for the above
executives provide that the Company shall establish an annual incentive
compensation strategy for executive officers in which each executive shall be
entitled to participate in a manner consistent with his position with the
Company and the evaluations of his performance by the Board of Directors or any
appropriate committee thereof. The target incentive bonus under the 1997 annual
incentive compensation strategy was a percentage of the respective executive
officer's annual base salary and was 85 percent for Mr. Smith, 70 percent for
Mr. Van Kleef and 70 percent for Mr. Reed. Each of the employment agreements
also provide that the executive will receive an annual amount (the "flexible
perquisite amount") to cover various business-related expenses such as dues for
country, luncheon or social clubs; automobile expenses; and financial and tax
planning expenses. The executive may elect at any time by written notice to the
Company to receive in cash any of such flexible perquisite amount which has not
been paid to or on behalf of the executive. The annual flexible perquisite
amount is $30,000, $20,000 and $20,000 for Mr. Smith, Mr. Van Kleef and Mr.
Reed, respectively. Each employment agreement also provides that the Company
will pay initiation fees for social clubs and reimburse the executive for
related tax expenses to the extent the Board of Directors or a duly authorized
committee thereof determines such fees are reasonable and in the best interest
of the Company.
Each of the employment agreements with Mr. Smith, Mr. Van Kleef and Mr.
Reed provides that in the event the Company should terminate such executive
officer's employment without cause, if he should resign his employment for "good
reason" (as "good reason" is defined in the employment agreements), or if the
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<PAGE> 22
Company shall not have offered to such executive officer prior to the
termination date of his employment agreement the opportunity to enter into a new
employment agreement, with terms, in all respects, no less favorable to the
executive than the terms of his current employment agreement, such executive
will be paid a lump-sum payment equal to (i) two times the sum of (a) his base
salary at the then current rate and (b) the sum of the target bonuses under all
of the Company's incentive bonus plans applicable to such executive for the year
in which the termination occurs and (ii) if termination occurs in the fourth
quarter of a calendar year, the sum of the target bonuses under all of the
Company's incentive bonus plans applicable to such executive for the year in
which the termination occurs prorated daily based on the number of days from the
beginning of the calendar year in which the termination occurs to and including
the date of termination. Each executive shall also receive all unpaid bonuses
for the year prior to the year in which the termination occurs and shall receive
(i) for a period of two years continuing coverage and benefits comparable to all
life, health and disability insurance plans which the Company from time to time
makes available to its management executives and their families, (ii) a lump-sum
payment equal to two times the flexible perquisites amount and (iii) two years
additional service credit under the Amended Plan and the Funded Plan, or
successors thereto, of the Company applicable to such executive on the date of
termination. All unvested stock options held by the executive on the date of the
termination shall become immediately vested and all restrictions on "restricted
stock" then held by the executive shall terminate, except for the restrictions
on restricted stock awards granted under the special incentive compensation
strategy which vest on a pro-rata basis relative to the period of time of the
Performance Target that such executive was an employee, until it is determined
whether the vesting requirement established in the award has been satisfied.
Each employment agreement further provides that, in the event such
executive officer's employment is involuntarily terminated within two years of a
change of control or if the executive officer's employment is voluntarily
terminated within two years of a change of control "for good reason," as defined
in each of the employment agreements, he shall be paid within ten days of such
termination (i) a lump-sum payment equal to three times his base salary at the
then current rate; (ii) a lump-sum payment equal to the sum of (a) three times
the sum of the target bonuses under all of the Company's incentive bonus plans
applicable to such executive for the year in which the termination occurs or the
year in which the change of control occurred, whichever is greater, and (b) if
termination occurs in the fourth quarter of a calendar year, the sum of the
target bonuses under all of the Company's incentive bonus plans applicable to
such executive for the year in which the termination occurs prorated daily based
on the number of days from the beginning of the calendar year in which the
termination occurs to and including the date of termination; and (iii) a
lump-sum payment equal to the amount of any accrued but unpaid bonuses. The
Company (or its successor) shall also provide (i) for a period of three years
continuing coverage and benefits comparable to all life, health and disability
plans of the Company in effect at the time a change of control is deemed to have
occurred; (ii) a lump-sum payment equal to three times the flexible perquisites
amount; and (iii) three years additional service credit under the Amended Plan
and the Funded Plan, or successors thereto, of the Company applicable to such
executive on the date of termination. A change of control shall be deemed to
have occurred if (i) there shall be consummated (a) any consolidation or merger
of the Company in which the Company is not the continuing or surviving
corporation or pursuant to which shares of the Company's Common Stock would be
converted into cash, securities or other property, other than a merger of the
Company where a majority of the Board of Directors of the surviving corporation
are, and for a two-year period after the merger continue to be, persons who were
directors of the Company immediately prior to the merger or were elected as
directors, or nominated for election as director, by a vote of at least
two-thirds of the directors then still in office who were directors of the
Company immediately prior to the merger, or (b) any sale, lease, exchange or
transfer (in one transaction or a series of related transactions) of all or
substantially all of the assets of the Company, or (ii) the shareholders of the
Company shall approve any plan or proposal for the liquidation or dissolution of
the Company, or (iii) (A) any "person" (as such term is used in Sections 13(d)
and 14(d)(2) of the Exchange Act) other than the Company or a subsidiary thereof
or any employee benefit plan sponsored by the Company or a subsidiary thereof,
shall become the beneficial owner (within the meaning of Rule 13d-3 under the
Exchange Act) of securities of the Company representing 20 percent or more of
the combined voting power of the Company's then outstanding securities
ordinarily (and apart from rights accruing in special circumstances) having the
right to vote in the election of directors, as a result of a tender or exchange
offer,
20
<PAGE> 23
open market purchases, privately negotiated purchases or otherwise, and (B) at
any time during a period of two years thereafter, individuals who immediately
prior to the beginning of such period constituted the Board of Directors of the
Company shall cease for any reason to constitute at least a majority thereof,
unless the election or the nomination by the Board of Directors for election by
the Company's shareholders of each new director during such period was approved
by a vote of at least two-thirds of the directors then still in office who were
directors at the beginning of such period.
In the case of Mr. Smith, his employment agreement further provides that if
remuneration or benefits of any form paid to him by the Company or any trust
funded by the Company during or after his employment with the Company are excess
parachute payments as defined in Section 280G of the Code, and are subject to
the 20 percent excise tax imposed by Section 4999 of the Code, the Company shall
pay Mr. Smith a bonus no later than seven days prior to the due date for the
excise tax return in an amount equal to the excise tax payable as a result of
the excess parachute payment and any additional federal income taxes (including
any additional excise taxes) payable by him as a result of the bonus, assuming
that he will be subject to federal income taxes at the highest individual margin
rate.
The Company has separate Management Stability Agreements ("Stability
Agreements") with Mr. Wormington and Mr. Oliver which are only operative in the
event of a change of control of the Company. The Stability Agreements provide
that, if Mr. Wormington's or Mr. Oliver's employment is involuntarily terminated
within two years of a change of control or if Mr. Wormington's or Mr. Oliver's
employment is voluntarily terminated within two years of a change of control
"for good reason," as defined in the Stability Agreements, he shall be paid
within ten days of such termination (i) a lump-sum payment equal to two times
his base salary at the then current rate and (ii) a lump-sum payment equal to
the sum of (a) two times the sum of the target bonuses under all of the
Company's incentive bonus plans applicable to Mr. Wormington and Mr. Oliver for
the year in which the termination occurs or the year in which the change of
control occurred, whichever is greater, and (b) if termination occurs in the
fourth quarter of a calendar year, the sum of the target bonuses under all of
the Company's incentive bonus plans applicable to Mr. Wormington and Mr. Oliver
for the year in which the termination occurs prorated daily based on the number
of days from the beginning of the calendar year in which the termination occurs
to and including the date of termination. The Company (or its successor) shall
also provide continuing coverage and benefits comparable to all life, health and
disability plans of the Company for a period of 24 months from the date of
termination and Mr. Wormington and Mr. Oliver would each receive two years
additional service credit under the Amended Plan and the Funded Plan, or
successors thereto, of the Company applicable to such executive on the date of
termination. A change of control shall be deemed to have occurred if (i) there
shall be consummated (a) any consolidation or merger of the Company in which the
Company is not the continuing or surviving corporation or pursuant to which
shares of the Company's Common Stock would be converted into cash, securities or
other property, other than a merger of the Company where a majority of the Board
of Directors of the surviving corporation are, and for a two-year period after
the merger continue to be, persons who were directors of the Company immediately
prior to the merger or were elected as directors, or nominated for election as
director, by a vote of at least two-thirds of the directors then still in office
who were directors of the Company immediately prior to the merger, or (b) any
sale, lease, exchange or transfer (in one transaction or a series of related
transactions) of all or substantially all of the assets of the Company, or (ii)
the shareholders of the Company shall approve any plan or proposal for the
liquidation or dissolution of the Company, or (iii) (A) any "person" (as such
term is used in Sections 13(d) and 14(d)(2) of the Exchange Act) other than the
Company or a subsidiary thereof or any employee benefit plan sponsored by the
Company or a subsidiary thereof, shall become the beneficial owner (within the
meaning of Rule 13d-3 under the Exchange Act) of securities of the Company
representing 20 percent or more of the combined voting power of the Company's
then outstanding securities ordinarily (and apart from rights accruing in
special circumstances) having the right to vote in the election of directors, as
a result of a tender or exchange offer, open market purchases, privately
negotiated purchases or otherwise, and (B) at any time during a period of one
year thereafter, individuals who immediately prior to the beginning of such
period constituted the Board of Directors of the Company shall cease for any
reason to constitute at least a majority thereof, unless the election or the
nomination by the Board of Directors for election by the Company's shareholders
of each new director during such period was approved by a vote of at least
two-thirds of the directors then still in office who
21
<PAGE> 24
were directors at the beginning of such period, or (iv) there shall be, in the
cases of Mr. Wormington or Mr. Oliver, the Company's refining and marketing
business or exploration and production business, respectively, (A) a direct or
indirect sale of all or substantially all of the assets of the Company's
refining and marketing business or exploration and production business, or (B)
the sale of stock of a subsidiary (or affiliate) of the Company that conducts
all or substantially all of the Company's refining and marketing business or
exploration and production business, or (C) a merger, joint venture or other
business combination involving the Company's refining and marketing business or
exploration and production business, and as a result of such sale of assets,
sale of stock, merger, joint venture or other business combination, the Company
shall cease to have the power to elect a majority of the Board of Directors (or
the other equivalent governing or managing body) of the entity which acquires,
or otherwise controls or conducts, the Company's refining and marketing business
or exploration and production business.
2. AMEND THE COMPANY'S RESTATED CERTIFICATE OF
INCORPORATION TO INCREASE THE NUMBER OF AUTHORIZED SHARES OF
THE COMPANY'S COMMON STOCK FROM 50,000,000 TO 100,000,000
The Board of Directors has unanimously adopted a resolution declaring it
advisable to amend the Company's Restated Certificate of Incorporation to
increase the number of shares of Common Stock that the Company has the authority
to issue from 50,000,000 to 100,000,000 (the "Common Stock Amendment"). The
Board of Directors further directed that the Common Stock Amendment be submitted
for consideration by stockholders at the Company's 1998 annual meeting of
stockholders. In the event the Common Stock Amendment is approved by
stockholders, the Company will thereafter amend its Restated Certificate of
Incorporation with the Delaware Secretary of State with a filing reflecting such
Common Stock Amendment, which will become effective at the close of business on
the date such filing is accepted by the Secretary of State.
In the event stockholders approve the Common Stock Amendment, the Company
will be authorized to amend the first paragraph of Article IV and subsection (A)
of Article IV of the Restated Certificate of Incorporation by deleting all of
the present first paragraph of Article IV and subsection (A) of Article IV and
inserting in lieu thereof the following first paragraph of Article IV and
subsection (A) of Article IV:
"ARTICLE IV
The total number of shares of all classes of stock which the
Corporation shall have authority to issue is One Hundred Five Million
(105,000,000) shares consisting of
One Hundred Million (100,000,000) shares of the par value $.16 2/3 per
share; and
Five Million (5,000,000) shares with no par value.
(A) Designation of Each Class of Shares.
(1) The One Hundred Million (100,000,000) authorized shares of a
par value of $.16 2/3 shall be designated Common Stock; and
(2) The Five Million (5,000,000) authorized shares with no par
value shall be designated Preferred Stock."
As of June 9, 1998, the Company had 26,558,068 shares of Common Stock
issued and outstanding and 2,200,633 shares reserved for future issuance under
the Company's employee incentive stock plans, of which currently 2,119,760
shares are covered by outstanding grants and approximately 80,873 shares are
available to grant. The Company also has a shelf registration statement on file
with the SEC covering the issuance from time to time of approximately 14,950,000
additional securities, including Common Stock or securities convertible into
Common Stock. Based upon the foregoing number of outstanding and reserved shares
of Common Stock, the Company currently has approximately 6,291,299 shares
remaining available for other purposes.
22
<PAGE> 25
The Board believes that it is in the Company's best interest to increase
the number of authorized but unissued shares of Common Stock in order to have
additional shares available for issuance to meet the Company's future business
needs as they arise. The availability of such additional shares will provide the
Company with the flexibility to issue Common Stock for a variety of proper
corporate purposes as the Board may deem advisable without further action by the
Company's stockholders, except as may be required by law, regulation or the
rules of any national securities exchange or quotation system on which the
shares of the Company's Common Stock are then listed. These purposes could
include, among other things, the sale of stock to obtain additional capital
funds, the purchase of property, the acquisition or merger into the Company of
other companies, the use of additional shares for various equity compensation
and other employee benefit plans, the declaration of stock dividends or
distributions, effecting a stock split and other bona fide corporate purposes.
Were these situations to arise, the issuance of additional shares of Common
Stock could have a dilutive effect on earnings per share, and, for a person who
does not purchase additional shares to maintain his or her pro rata interest, on
a stockholder's percentage voting power in the Company.
Although an increase in the authorized shares of Common Stock could, under
certain circumstances, also be construed as having an anti-takeover effect (for
example, by diluting the stock ownership of a person seeking to effect a change
in the composition of the Board of Directors or contemplating a tender offer or
other transaction for the combination of the Company with another company), the
current proposal to amend the Restated Certificate of Incorporation to increase
the number of authorized shares of Common Stock is not in response to any effort
to accumulate the Company's stock or to obtain control of the Company by means
of a merger, tender offer, solicitation in opposition to management or
otherwise. In addition, the proposal is not part of any plan by management to
recommend a series of similar amendments to the Board of Directors and the
stockholders.
Under the Delaware General Corporation Law, the affirmative vote of the
holders of a majority of the shares of Common Stock entitled to vote at the
annual meeting is required to adopt this proposal. With respect to this proposal
to amend the Company's Restated Certificate of Incorporation to increase the
number of authorized shares of the Company's Common Stock from 50,000,000 to
100,000,000 shares, all such shares will be voted FOR or AGAINST, or not voted,
as specified on each proxy. If no choice is indicated, a proxy will be voted FOR
the proposal to amend the Company's Restated Certificate of Incorporation to
increase the number of authorized shares of the Company's Common Stock from
50,000,000 to 100,000,000 shares. Under Delaware law and the Restated
Certificate of Incorporation and By-laws, Abstentions and Broker Non-Votes to
proposal two will have the same effect as votes against such proposal.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE PROPOSAL TO AMEND THE
COMPANY'S RESTATED CERTIFICATE OF INCORPORATION TO INCREASE THE NUMBER OF
AUTHORIZED SHARES OF COMMON STOCK FROM 50,000,000 TO 100,000,000.
3. INCREASE IN THE NUMBER OF SHARES WHICH CAN BE GRANTED UNDER THE
TESORO PETROLEUM CORPORATION AMENDED AND RESTATED EXECUTIVE
LONG-TERM INCENTIVE PLAN ("1993 PLAN") AND INCREASE THE LIMIT ON THE
NUMBER OF SHARES OF RESTRICTED STOCK WHICH CAN BE
GRANTED UNDER SUCH PLAN
The Board of Directors is unanimously recommending that the Company's
stockholders approve an amendment to the 1993 Plan which would increase the
total number of shares of Common Stock available for grant under the 1993 Plan
from 2,650,000 to 4,250,000 and which would increase the limit on the number of
shares of restricted stock which can be granted under the 1993 Plan to no more
than 750,000 shares of Common Stock. The increase in the total number of shares
available is necessary because, as of June 9, 1998, only 80,873 shares of Common
Stock were available for grant under the 1993 Plan. The Board of Directors
believes that, based upon advice from its independent compensation consultant,
this number is insufficient to provide for the future participation of employees
who are eligible for grants under the 1993 Plan and is below the market median
of shares reserved for stock-based pay. As of June 9, 1998, restricted stock
granted under the 1993 Plan aggregated 350,000 shares. The Board of Directors
has approved this amendment, subject to stockholder approval.
23
<PAGE> 26
If stock incentives covering the additional 1,600,000 shares of Common
Stock are granted by the Company, participants upon exercise of such grants and
outstanding grants under the 1993 Plan and upon issuance of additional
securities, including Common Stock or securities convertible into Common Stock
under a shelf registration on file with the SEC, would hold approximately 10
percent of the outstanding Common Stock (excluding their Common Stock ownership
outside of the 1993 Plan). Persons eligible to participate in the 1993 Plan
include all full-time active employees of the Company and its subsidiaries as
determined by the Compensation Committee of the Board of Directors of the
Company. It is presently estimated that approximately 60 persons, including
approximately ten present officers of the Company, would be considered eligible
to receive stock incentives.
The affirmative vote of the holders of a majority of the outstanding shares
present, or represented, and entitled to vote at the annual meeting is required
to approve the amendment to increase the number of shares which can be granted
under the 1993 Plan and increase the limit on the number of shares of restricted
stock which can be granted under such plan. Under Delaware law and the Restated
Certificate of Incorporation and By-laws, Abstentions as to proposal three will
have the same effect as votes against such proposal. Broker Non-Votes, however,
will be deemed shares not entitled to vote on such matters, and therefore will
not count as votes for or against the proposal, and will not be included in
calculating the number of votes necessary for approval of the proposal.
THE BOARD OF DIRECTORS RECOMMENDS THAT THE STOCKHOLDERS VOTE "FOR" THE
AMENDMENT TO THE TESORO PETROLEUM CORPORATION AMENDED AND RESTATED EXECUTIVE
LONG-TERM INCENTIVE PLAN.
Summary of the 1993 Plan
The 1993 Plan was approved by the Company's stockholders at the annual
meeting of stockholders held on February 9, 1994, and replaced the 1982 Plan,
although grants under the 1982 Plan that have not been fully exercised remain
outstanding pursuant to their terms. The following summarizes the material
provisions of the 1993 Plan, but is qualified in its entirety by reference to
the full text of the 1993 Plan. Persons eligible to participate in the 1993 Plan
include all full-time, active employees of the Company, including directors who
are also employees of the Company. The 1993 Plan is administered by the
Compensation Committee of the Board of Directors consisting of directors who are
not employees of the Company (the "Compensation Committee"). Subject to the
provisions of the 1993 Plan, the Compensation Committee may, from time to time,
select from all eligible employees, those to whom awards will be granted.
The 1993 Plan is a flexible plan that gives the Compensation Committee
broad discretion to fashion the terms of awards in order to provide eligible
participants with stock-based incentives as the Compensation Committee deems
appropriate. It permits the issuance of awards in a variety of forms, including
(i) restricted stock, (ii) incentive stock options, (iii) nonqualified stock
options (incentive and nonqualified stock options are referred to collectively
as "options"), (iv) SARs, and (v) performance share and performance unit awards.
The 1993 Plan provides for the grant of up to 2,650,000 shares of the
Common Stock of the Company which, subject to stockholder approval at this
meeting, will be increased to 4,250,000 shares. The 1993 Plan also provides that
no more than 500,000 shares of restricted stock can be granted, which, subject
to stockholder approval at this meeting, will be increased to 750,000 shares of
restricted stock. The closing price per share of the Company's Common Stock as
traded on the NYSE on June 9, 1998, was $19 7/8. If any award granted under the
1993 Plan is canceled, terminates, expires or lapses for any reason, subject to
certain limited exceptions, any shares subject to such award will become
available for additional awards under the 1993 Plan. However, in the event that
prior to the award's cancellation, termination, expiration or lapse, the holder
of the award at any time received one or more "benefits of ownership" pursuant
to such award (as defined by the SEC, pursuant to any rule or interpretation
promulgated under Section 16 of the Exchange Act), the shares subject to such
award will not be made available for regrant under the 1993 Plan. In the event
of a stock dividend, stock split, recapitalization or similar event, the
Compensation Committee will equitably adjust the
24
<PAGE> 27
aggregate number of shares subject to the 1993 Plan, the number of shares
subject to each outstanding award and the exercise prices of outstanding
options.
The 1993 Plan may be amended, modified or terminated by the Board of
Directors. However, without stockholder approval, no such amendment,
modification or termination may: (a) with limited exceptions, materially
increase the total number of shares which may be issued, (b) materially modify
the eligibility requirements for participation or (c) materially increase the
benefits accruing to participants. Unless earlier terminated by the Board of
Directors or stockholders, the issuance of awards under the 1993 Plan will cease
as of September 15, 2003.
Stock options granted under the 1993 Plan provide for purchase of shares of
Common Stock at prices determined by the Compensation Committee; provided that
the option price shall not be less than the fair market value thereof on the
date the option is granted unless such option is granted in connection with a
deferral election under the 1993 Plan. On May 4, 1995, the stockholders adopted
an amendment to the 1993 Plan which limits the number of stock option shares
that an individual participant may be granted to 500,000 shares during any
fiscal year of the Company.
Options granted under the 1993 Plan are exercisable at such times and
subject to such restrictions and conditions as the Compensation Committee shall
approve, but in no event may any option be exercisable prior to six months
following its grant. Options may only be transferred under the laws of descent
and distribution and shall be exercisable only by the participant during the
participant's lifetime. The option exercise price is payable in cash or in
shares of Common Stock having a fair market value equal to the exercise price or
in a combination of cash and such shares. The Compensation Committee may also
allow, along with other means of exercise, cashless exercise as permitted under
the Federal Reserve Board's Regulation T, subject to applicable securities laws.
Upon the death, disability or retirement of a participant, all outstanding
options shall immediately vest and shall be exercisable for the shorter of their
remaining term or one year after termination of employment in the case of death
or disability, and three years after termination of employment in the case of
retirement. Upon termination of employment of a participant for any reason other
than set forth in the preceding sentence, all options held by the participant
which are not vested as of the effective date of termination shall be forfeited
and options which are vested as of the effective date of termination may be
exercised for three months following the effective date of termination of
employment; provided, however, the Compensation Committee, in its sole
discretion, may immediately vest all or any portion of the options of a
participant not vested as of such date. If employment of a participant is
terminated by the Company for cause, all outstanding options held by the
participant are forfeited immediately to the Company and no additional exercise
period is allowed, regardless of whether any of the options are vested.
There are generally no federal tax consequences either to the optionee or
to the Company upon the grant of a stock option. On exercise of an incentive
stock option, the optionee will not recognize any income and the Company will
not be entitled to a deduction for tax purposes, although such exercise may give
rise to liability for the optionee under the alternative minimum tax provisions
of the Code. Generally, if the optionee disposes of shares acquired upon
exercise of an incentive stock option within two years of the date of grant or
one year of the date of exercise, the optionee will recognize compensation
income and the Company will be entitled to a deduction for tax purposes in the
amount of the excess of the fair market value of the shares of Common Stock on
the date of exercise over the stock option exercise price (or the gain on sale,
if less). Otherwise, the Company will not be entitled to any deduction for tax
purposes upon disposition of such shares, and the entire gain for the optionee
will be treated as a capital gain. On exercise of a nonqualified stock option,
the amount by which the fair market value of the Common Stock on the date of
exercise exceeds the stock option exercise price will generally be taxable to
the optionee as compensation income and will generally be deductible for tax
purposes by the Company. The disposition of shares of Common Stock acquired upon
exercise of a nonqualified stock option will generally result in a capital gain
or loss for the optionee but will have no tax consequences for the Company.
SARs granted under the 1993 Plan may take the form of affiliated SARs,
freestanding SARs, tandem SARs, or any combination of these forms of SARs.
Affiliated SARs may be granted in connection with related stock options and may
be automatically exercised upon exercise of the related stock option, with the
grant
25
<PAGE> 28
price being equal to the option price of the related stock option. Freestanding
SARs may be granted independent of the grant of any stock option with a grant
price at least equal to the fair market value of a share of Common Stock on the
date of grant. Tandem SARs are granted in conjunction with a related stock
option at a grant price equal to the option price of the related stock option.
Either the stock option or the tandem SAR will be adjusted for exercise of the
other since the exercise of a stock option or the tandem SAR requires the
surrender of the right to exercise the equivalent portion of the stock option or
the tandem SAR, as applicable. The term of any SAR granted under the 1993 Plan
may not exceed ten years.
Upon exercise of an SAR, the participant will receive the difference
between the fair market value of one share of Common Stock on the date of
exercise and the grant price, multiplied by the number of shares with respect to
which the SAR is exercised. Payment due upon exercise of an SAR may be in cash,
in shares of Common Stock having a fair market value equal to the value of the
SAR being exercised, or partly in cash and partly in shares of Common Stock, as
determined by the Compensation Committee in its discretion. The Compensation
Committee may impose restrictions on the exercise of SARs, including the
imposition of window periods for exercise of an SAR for persons required to file
reports pursuant to the provisions of Section 16 of the Exchange Act. Upon the
death, disability or retirement of a participant, all outstanding SARs which are
exercisable on the termination date shall remain exercisable for the shorter of
their remaining term or one year after termination of employment in the case of
death or disability and three years after termination of employment in the case
of retirement. Upon the death, disability or retirement of a participant, all
outstanding SARs which are not exercisable on the termination date shall be
forfeited regardless of whether termination is due to death, disability or
retirement. Upon termination of employment of a participant for any reason other
than set forth in the preceding sentence, all SARs held by the participant which
are not vested as of the effective date of termination shall be forfeited and
SARs which are vested as of the effective date of termination may be exercised
for three months following the effective date of termination of employment;
provided, however, that the Compensation Committee, in its sole discretion, may
immediately vest all or any portion of the SARs of a participant not vested as
of such date. If employment of a participant is terminated by the Company for
cause, all outstanding SARs held by the participant are forfeited immediately to
the Company and no additional exercise period is allowed, regardless of whether
any of the SARs are vested. SARs may only be transferred under the laws of
descent and distribution and shall be exercisable during his or her lifetime
only by the participant.
The Compensation Committee may grant restricted shares of Common Stock to
eligible employees, in such amounts, and subject to such terms and conditions
(which may depend upon or be related to performance goals and other conditions)
as the Compensation Committee shall determine in its discretion. Subject to
stockholder approval at this meeting, the total amount of restricted stock which
could be awarded would be limited to 750,000 shares of Common Stock.
Certificates for the shares of Common Stock covered by the award shall have
appropriate restrictive legends placed on them with respect to such
restrictions. Subject to the applicable restrictions, the grantee shall have the
rights of a stockholder with respect to such shares. The shares of restricted
stock may not be sold, transferred, pledged, assigned, or otherwise alienated or
hypothecated until the end of the applicable restriction period established by
the Compensation Committee or upon earlier satisfaction of any other conditions
specified by the Compensation Committee in its sole discretion. In addition, no
restricted stock granted under the 1993 Plan may become vested in a participant
sooner than six months following the date of its grant. In the event employment
of a participant is terminated by reason of death, disability or retirement, all
unvested shares of restricted stock shall immediately be forfeited; provided,
however, that the Compensation Committee, in its sole discretion, shall have the
right to provide for accelerated vesting of some or all unvested shares of
restricted stock. In the event employment of a participant shall terminate for
any other reason, all shares of restricted stock held by the participant which
are not vested as of the effective date of the termination of employment shall
be immediately forfeited and returned to the Company; provided, however, that
the Compensation Committee, in its sole discretion, shall have the right, except
in the case of termination of employment for cause, to provide for the lapse of
restrictions on the restricted stock following employment termination, upon such
terms and provisions as it deems proper.
26
<PAGE> 29
The Compensation Committee may grant performance shares and performance
units awards to eligible employees, in such amounts, and subject to such terms
and conditions as the Compensation Committee shall in its discretion determine.
The grantee of such awards shall receive payment of the value of performance
shares and performance units earned in cash or shares of Common Stock, or in a
combination of cash and shares of Common Stock, which have an aggregate fair
market value equal to the value of the earned performance shares at the close of
the applicable performance period, in such combination as the Compensation
Committee shall, in its sole discretion, determine. In the event the employment
of a participant is terminated by reason of death, disability, retirement or
involuntary termination without cause during the performance period, the
participant shall receive a prorated payout of the performance units and
performance shares earned, which shall be determined by the Compensation
Committee in its sole discretion, and shall be based upon the length of time the
participant held the award during the performance period and shall be further
adjusted based upon the achievement of the preestablished performance goals.
Such payment in the event of termination shall be made at the same time as
payments are made to participants who did not terminate employment during the
applicable performance period; provided, however, that the Compensation
Committee, in its sole discretion, shall have the power to accelerate the
payment of the performance units and performance shares to participants whose
employment has terminated. In the event that a participant's employment
terminates for any reason other than the foregoing reasons, all performance
units and performance shares shall be forfeited by the participant to the
Company. Performance units and performance shares may not be sold, transferred,
pledged, assigned or otherwise alienated or hypothecated, other than by will or
by the laws of descent and distribution. During the participant's lifetime, the
participant's rights under the 1993 Plan shall be exercisable only by the
participant or the participant's legal representative.
In the event that (i) any "person," as that term is defined under the
Exchange Act (other than a trustee or other fiduciary holding securities under
an employee benefit plan of the Company, or a corporation owned directly or
indirectly by the stockholders of the Company in substantially the same
proportions as their ownership of stock of the Company), acquires beneficial
ownership of more than 50 percent of the outstanding voting securities, (ii) a
majority of the individuals who constitute the Board of Directors at any time
shall cease to be made up of "qualified directors," and (iii) the stockholders
of the Company approve a merger or consolidation with or involving any other
corporation, other than in a transaction that would result in the voting
securities of the Company outstanding immediately prior to such transaction
continuing to represent at least 50 percent of the outstanding voting securities
of the Company immediately after such transaction, then any stock option or SAR
outstanding shall become fully vested and fully exercisable, any restriction
periods and restrictions imposed on restricted stock shall lapse, the target
value obtainable under all performance units and performance shares shall be
deemed to have been fully earned for the entire performance period and the
Compensation Committee may, in its discretion, make any other modifications to
any awards as determined by the Compensation Committee to be deemed appropriate
before the effective date of such transaction.
A "qualified director" is a director who meets any of the following
criteria: (1) was a director immediately after the effective date of the
Reclassification (as defined in the Company's Registration Statement on Form
S-4, relating to the 1993 Annual Meeting of Stockholders), including the three
new directors elected in connection therewith; (2) was a director immediately
after the Company's 1994 Annual Meeting of Stockholders; or (3) any director
nominated for election as a director or elected to the Board of Directors by the
directors to fill a vacancy by a vote of directors, and at the time of such
nomination or election at least a majority of the directors were qualified
directors.
4. APPOINTMENT OF AUDITORS
The Board of Directors considers it desirable that its appointment of the
firm of Deloitte & Touche LLP as independent auditors for the Company and its
subsidiaries for fiscal year 1998 be ratified by the stockholders.
Representatives of Deloitte & Touche LLP are expected to be present at the 1998
Annual Meeting of Stockholders and to be available to respond to appropriate
questions. Such representatives will have the opportunity to make a statement at
the annual meeting if they desire to do so. Under Delaware law, the Restated
Certificate of Incorporation and By-laws, a majority of the votes cast are
required to approve the appointment of Deloitte & Touche LLP as auditors.
Abstentions and Broker Non-Votes are not votes "cast"
27
<PAGE> 30
on the question and therefore will not count as votes for or against the
proposal, and will not be included in calculating the number of votes necessary
for approval of the proposal.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE APPOINTMENT OF THE FIRM
OF DELOITTE & TOUCHE LLP AS INDEPENDENT AUDITORS FOR THE COMPANY AND ITS
SUBSIDIARIES FOR FISCAL YEAR 1998.
5. EXPENSES OF SOLICITATION
The Company expects to solicit proxies primarily by mail, but directors,
officers and regular employees of the Company may also solicit in person, by
telephone or telegram. All expenses in connection with the solicitation of
proxies will be borne by the Company. Arrangements will be made by the Company
for the forwarding, at the Company's expense, of soliciting materials by
brokers, nominees, fiduciaries and other custodians to their principals. The
Company has retained a professional proxy soliciting organization, Innisfree M&A
Incorporated, to aid in the solicitation of proxies from brokers, bank nominees
and other institutional owners, and possibly individual holders of record of
1,000 shares or more, by personal interview, telephone, telegram or mail. The
Company will pay such organization its customary fees, estimated not to exceed
$8,500, and will reimburse such organization for certain expenses.
6. STOCKHOLDERS' PROPOSALS
Proposals of stockholders to be presented at the annual meeting to be held
in 1999 must be received for inclusion in the Company's proxy statement and form
of proxy by February 28, 1999.
7. OTHER MATTERS
As of the date of this Proxy Statement, management of the Company has no
knowledge of any matters to be presented for consideration at the meeting other
than those referred to above. If any other matters properly come before the
meeting, the persons named in the accompanying form of proxy intend to vote such
proxy to the extent entitled in accordance with their best judgment.
By Order of the Board of Directors,
JAMES C. REED, JR.
Secretary
June 29, 1998
28
<PAGE> 31
TESORO PETROLEUM CORPORATION
APPENDIX A
TO THE PROXY STATEMENT FOR THE
1998 ANNUAL MEETING OF STOCKHOLDERS
<PAGE> 32
APPENDIX A
In accordance with Rule 14a-3(c) under the Securities Exchange Act of 1934
(the "Exchange Act"), as adapted to the "Summary Annual Report" procedure, this
Appendix and the information contained herein is taken from the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 1997 and is provided
solely for the information of stockholders and the Securities and Exchange
Commission. Such information shall not be deemed to be "soliciting material" or
to be "filed" with the Securities and Exchange Commission or subject to
Regulations 14A and 14C under the Exchange Act (except as provided in Rule
14a-3) or to the liabilities of Section 18 of the Exchange Act.
The information contained in this Appendix contains statements with respect
to the Company's expectations or beliefs as to future events. These type of
statements are forward-looking and subject to uncertainties. See
"Forward-Looking Statements" on page A-22.
FORM 10-K
THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER
31, 1997, HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION. A COPY OF
THIS REPORT MAY BE OBTAINED FREE OF CHARGE FROM CORPORATE COMMUNICATIONS, TESORO
PETROLEUM CORPORATION, 8700 TESORO DRIVE, SAN ANTONIO, TEXAS 78217-6218,
TELEPHONE: (800) 837-6768.
INDEX TO APPENDIX A
<TABLE>
<CAPTION>
PAGE
----
<S> <C> <C>
I. Selected Financial Data..................................... A-3
II. Management's Discussion and Analysis of Financial Condition
and Results of Operations:
General..................................................... A-5
Results of Operations....................................... A-6
Capital Resources and Liquidity............................. A-17
Forward-Looking Statements.................................. A-22
III. Financial Statements:
Independent Auditors' Report................................ A-23
Statements of Consolidated Operations --
Years Ended December 31, 1997, 1996 and 1995................ A-24
Consolidated Balance Sheets --
December 31, 1997 and 1996.................................. A-25
Statements of Consolidated Stockholders' Equity --
Years Ended December 31, 1997, 1996 and 1995................ A-26
Statements of Consolidated Cash Flows --
Years Ended December 31, 1997, 1996 and 1995................ A-27
Notes to Consolidated Financial Statements.................. A-28
</TABLE>
A-2
<PAGE> 33
I. SELECTED FINANCIAL DATA
The selected consolidated financial data of Tesoro Petroleum Corporation
and subsidiaries ("Tesoro" or the "Company") should be read in conjunction with
Management's Discussion and Analysis of Financial Condition and Results of
Operations and the Company's Consolidated Financial Statements, including the
notes thereto, included in this Appendix.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------
1997 1996 1995 1994 1993
------- -------- -------- ------ ------
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
REVENUES
Gross Operating Revenues:
Refining and Marketing
Refined products.................................... $ 643.7 $ 620.8 $ 664.5 $582.7 $590.9
Other, primarily crude oil resales and
merchandise....................................... 77.2 124.6 106.5 104.3 96.3
Exploration and Production
U.S.(a)............................................. 73.6 93.8 113.0 90.6 49.4
Bolivia............................................. 11.2 13.7 11.7 13.2 12.6
Marine Services(b).................................... 132.2 122.5 74.5 77.9 80.7
------- -------- -------- ------ ------
Total Gross Operating Revenues...................... 937.9 975.4 970.2 868.7 829.9
Income from Settlement of a Natural Gas Contract and
Other(a).............................................. 5.5 64.4 32.7 3.2 0.5
------- -------- -------- ------ ------
Total Revenues...................................... $ 943.4 $1,039.8 $1,002.9 $871.9 $830.4
======= ======== ======== ====== ======
SEGMENT OPERATING PROFIT (LOSS)(C)
Refining and Marketing................................ $ 20.5 $ 6.0 $ 0.7 $ 2.4 $ 15.2
Exploration and Production
U.S.(a)............................................. 37.3 123.9 102.0 55.0 32.3
Bolivia............................................. 8.6 8.8 7.6 9.3 8.4
Marine Services(b).................................... 6.3 6.1 (4.4) (2.3) (3.6)
------- -------- -------- ------ ------
Total Segment Operating Profit...................... $ 72.7 $ 144.8 $ 105.9 $ 64.4 $ 52.3
======= ======== ======== ====== ======
EARNINGS BEFORE EXTRAORDINARY ITEM...................... $ 30.7 $ 76.8 $ 57.5 $ 20.5 $ 17.0
EXTRAORDINARY LOSS ON DEBT EXTINGUISHMENTS,
NET OF INCOME TAXES(D)................................ -- (2.3) (2.9) (4.8) --
------- -------- -------- ------ ------
NET EARNINGS............................................ $ 30.7 $ 74.5 $ 54.6 $ 15.7 $ 17.0
======= ======== ======== ====== ======
NET EARNINGS APPLICABLE TO COMMON STOCK................. $ 30.7 $ 74.5 $ 54.6 $ 13.0 $ 7.8
======= ======== ======== ====== ======
NET EARNINGS PER SHARE -- BASIC(E)...................... $ 1.16 $ 2.87 $ 2.22 $ 0.58 $ 0.55
NET EARNINGS PER SHARE -- DILUTED(E).................... $ 1.14 $ 2.81 $ 2.18 $ 0.56 $ 0.54
WEIGHTED AVERAGE COMMON SHARES -- BASIC................. 26.4 26.0 24.6 22.6 14.1
WEIGHTED AVERAGE COMMON SHARES AND POTENTIALLY DILUTIVE
COMMON SHARES -- DILUTED.............................. 26.9 26.5 25.1 23.2 14.3
EBITDA, CONSOLIDATED(F)................................. $ 102.2 $ 172.0 $ 125.4 $ 80.8 $ 55.8
CASH FLOWS FROM (USED IN)
Operations............................................ $ 95.6 $ 178.9 $ 35.4 $ 60.3 $ 21.8
Investing............................................. (151.5) (94.2) 2.4 (91.2) (23.4)
Financing............................................. 41.5 (75.9) (37.8) 8.3 (8.7)
------- -------- -------- ------ ------
Increase (Decrease) in Cash and Cash Equivalents.... $ (14.4) $ 8.8 $ -- $(22.6) $(10.3)
======= ======== ======== ====== ======
CAPITAL EXPENDITURES
Refining and Marketing................................ $ 43.9 $ 11.1 $ 9.3 $ 32.0 $ 7.1
Exploration and Production
U.S................................................. 65.4 59.7 49.6 65.6 29.3
Bolivia............................................. 27.5 6.9 3.8 -- --
Marine Services....................................... 9.4 6.9 0.4 0.2 0.3
Other................................................. 1.3 0.4 0.8 1.8 0.8
------- -------- -------- ------ ------
Total Capital Expenditures.......................... $ 147.5 $ 85.0 $ 63.9 $ 99.6 $ 37.5
======= ======== ======== ====== ======
</TABLE>
A-3
<PAGE> 34
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------------------
1997 1996 1995 1994 1993
------- -------- -------- ------ ------
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET
Current Assets........................................ $ 181.8 $ 237.3 $ 182.5 $182.1 $196.5
Property, Plant and Equipment, Net.................... $ 413.8 $ 316.5 $ 261.7 $273.3 $213.2
Total Assets.......................................... $ 627.8 $ 582.6 $ 519.2 $484.4 $434.5
Current Liabilities................................... $ 107.5 $ 137.8 $ 105.0 $ 96.2 $ 72.0
Long-Term Debt and Other Obligations, Less Current
Maturities(d)(g).................................... $ 115.3 $ 79.3 $ 155.0 $192.2 $180.7
Redeemable Preferred Stock(g)......................... $ -- $ -- $ -- $ -- $ 78.1
Stockholders' Equity(g)(h)............................ $ 333.0 $ 304.1 $ 216.5 $160.7 $ 58.5
Current Ratio......................................... 1.69:1 1.72:1 1.74:1 1.89:1 2.73:1
Working Capital....................................... $ 74.3 $ 99.5 $ 77.5 $ 85.9 $124.5
Long-Term Debt and Redeemable Preferred
Stock to Capitalization(d)(g)....................... 26% 21% 42% 54% 82%
Common Stock Outstanding (millions)(g)................ 26.3 26.4 24.8 24.4 14.1
Book Value Per Common Share........................... $ 12.66 $ 11.51 $ 8.74 $ 6.59 $ 1.81
</TABLE>
- ---------------
(a) Results for 1996, 1995, 1994 and 1993 include revenues from above-market
pricing provisions of a natural gas contract which was terminated effective
October 1, 1996. Operating profit included $25 million, $47 million, $39
million and $20 million in 1996, 1995, 1994 and 1993, respectively, from
the excess of these contract prices over spot market prices. Upon
termination of the contract, the Exploration and Production segment
recorded other income and operating profit of $60 million. In 1995, the
Exploration and Production segment recorded other income and operating
profit of $33 million from the sale of certain interests in the Bob West
Field. See Notes C and D of Notes to Consolidated Financial Statements.
(b) Beginning in February 1996, the Marine Services segment includes the
results of operations of an acquired entity. See Note C of Notes to
Consolidated Financial Statements.
(c) Segment operating profit (loss) is gross operating revenues, gains and
losses on asset sales and other income less applicable segment costs of
sales, operating expenses, depreciation, depletion and other items. Income
taxes, interest expense and corporate general and administrative expenses
are not included in determining operating profit.
(d) Extraordinary losses on debt extinguishments, net of income tax benefits,
were $2.3 million ($0.09 per basic and diluted share), $2.9 million ($0.12
per basic share, $0.11 per diluted share) and $4.8 million ($0.21 per basic
and diluted share) in 1996, 1995 and 1994, respectively. See Note I of
Notes to Consolidated Financial Statements.
(e) Earnings per share amounts for periods prior to 1997 have been restated,
where appropriate, to conform with the requirements of Statement of
Financial Accounting Standard ("SFAS") No. 128. See Note A of Notes to
Consolidated Financial Statements.
(f) EBITDA, consolidated, represents earnings before extraordinary item,
interest expense, income taxes and depreciation, depletion and
amortization. While not purporting to reflect any measure of the Company's
operations or cash flows, EBITDA is presented for additional analysis.
(g) In 1994, the Company restructured its outstanding debt and preferred stock
by completing a recapitalization and equity offering.
(h) The Company has not paid dividends on its Common Stock since 1986.
A-4
<PAGE> 35
II. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Those statements in the Management's Discussion and Analysis of Tesoro
Petroleum Corporation and subsidiaries ("Tesoro" or the "Company") that are not
historical in nature should be deemed forward-looking statements that are
inherently uncertain. See "Forward-Looking Statements" on page A-22 for
discussion of the factors which could cause actual results to differ materially
from those projected in such statements.
GENERAL
The Company is focused on its long-term strategy to maximize returns and
develop full value of its assets through strategic expansions, acquisitions and
diversifications in all of its operating segments. In the Refining and Marketing
segment, the Company has been engaged in studies to improve profitability and
continues to explore and evaluate opportunities for possible expansion through
acquisitions, as well as joint ventures and strategic alliances. Operating
strategies have been implemented to optimize the refinery product slate, improve
efficiencies and reliability, and expand marketing to increase placement of
products in Alaska. In 1998, the Company plans to further improve profitability
in the Refining and Marketing segment by enhancing processing capabilities,
strengthening marketing channels and improving supply and transportation
functions. In the Exploration and Production segment, the strategy includes
evaluating ways in which the Company can continue to diversify its oil and gas
reserve base through both acquisitions and activities at the drill bit and
enhance its technical capabilities. The Company has made significant progress in
diversifying its U.S. operations to areas other than the mature Bob West Field
and has taken steps to begin serving emerging markets in South America. In the
Marine Services segment, improved profitability has positioned this segment to
participate in the consolidation of the industry by pursuing opportunities for
expansion, as well as optimizing existing operations.
In March 1998, the Company entered into an agreement to acquire the
Hawaiian refining and marketing assets of BHP Petroleum Americas Refining Inc.
("BHP Refining") and BHP Petroleum South Pacific Inc. ("BHP South Pacific"). The
acquisition, if consummated, will nearly double Tesoro's annual revenues and
significantly increase the scope of Tesoro's refining and marketing operations.
The Company expects that the results of the acquisition will be accretive to
earnings and cash flows, although it may be neutral in 1998 primarily due to a
scheduled maintenance turnaround at the Hawaii refinery to begin in June. The
Company is currently in discussions with its investment bankers to arrange for
financing of the acquisition and associated working capital and letter of credit
requirements, and in connection with such discussions, the Company has been
advised that sufficient funds will be made available. The Company will continue
to pursue other opportunities that are operationally and geographically
complementary with its asset base. For further information regarding the
proposed acquisition, see "Capital Resources and Liquidity" herein and Note O of
Notes to Consolidated Financial Statements.
As part of the Company's long-term strategy, growth initiatives are planned
in 1998 with a capital budget of $195 million, excluding the acquisition
discussed above. The 1998 capital budget represents an increase of 33% over 1997
capital expenditures. Approximately 70% of the 1998 capital budget is directed
toward increased drilling, both in Bolivia and the U.S. Another 25% is planned
for downstream operations, primarily improvements in the Alaska marketing
operations. External growth initiatives are primarily aimed at acquisitions
which would add value from the combination with the Company's existing assets,
such as strengthening marketing opportunities, reducing logistic expenses or, in
the downstream operations, offering increased processing opportunities.
Initiatives to improve the profitability of each of the business segments,
together with a debt-to-capitalization ratio of 26%, have positioned the Company
to fund possible acquisitions and the capital budget with low-cost capital.
The Company operates in an environment where its results and cash flows are
sensitive to volatile changes in energy prices. Major shifts in the cost of
crude oil used for refinery feedstocks and the price of refined products can
result in a change in margin from the Refining and Marketing operations, as
prices received for refined products may or may not keep pace with changes in
crude oil costs. These energy prices, together with volume levels, also
determine the carrying value of crude oil and refined product inventory. The
A-5
<PAGE> 36
Company uses the last-in, first-out ("LIFO") method of accounting for
inventories of crude oil and U.S. wholesale refined products in its Refining and
Marketing segment. This method results in inventory carrying amounts that are
less likely to represent current values and in costs of sales which more closely
represent current costs. Likewise, changes in natural gas, condensate and oil
prices impact revenues and the present value of estimated future net revenues
and cash flows from the Company's Exploration and Production operations. The
Company may increase or decrease its natural gas production in response to
market conditions. The carrying value of oil and gas assets may be subject to
noncash write-downs based on changes in natural gas prices and other determining
factors. Changes in natural gas prices also influence the level of drilling
activity in the Gulf of Mexico. The Company's Marine Services operation, whose
customers include offshore drilling contractors and related industries, could be
impacted by significant fluctuations in natural gas prices. The Company's Marine
Services segment uses the first-in, first-out ("FIFO") method of accounting for
inventories of fuels. Changes in fuel prices can significantly impact inventory
valuations and costs of sales in this segment.
RESULTS OF OPERATIONS
SUMMARY
Tesoro's net earnings for 1997 were $30.7 million ($1.16 per basic share,
$1.14 per diluted share) compared to $74.5 million ($2.87 per basic share, $2.81
per diluted share) in 1996 and $54.6 million ($2.22 per basic share, $2.18 per
diluted share) in 1995. In 1996 and 1995, the Company incurred noncash aftertax
extraordinary losses of $2.3 million and $2.9 million, respectively, for early
extinguishments of debt. Earnings before extraordinary losses amounted to $76.8
million ($2.96 per basic share, $2.90 per diluted share) and $57.5 million
($2.34 per basic share, $2.29 per diluted share) in 1996 and 1995, respectively.
Results for 1996 and 1995 included revenues from sales of natural gas at
above-market prices under a contract with Tennessee Gas Pipeline Company
("Tennessee Gas") which was terminated effective October 1, 1996. Results of
operations in 1997 and future years no longer benefit from above-market revenues
under this contract. Significant items, including the impact of the Tennessee
Gas contract, which affect the comparability between results for the years ended
December 31, 1997, 1996 and 1995 are highlighted in the table below (in millions
except per share amounts):
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- ------
<S> <C> <C> <C>
Net Earnings as Reported................................... $30.7 $74.5 $ 54.6
Extraordinary Loss on Debt Extinguishments, Net of Income
Tax Benefit.............................................. -- 2.3 2.9
----- ----- ------
Earnings Before Extraordinary Item......................... 30.7 76.8 57.5
----- ----- ------
Significant Items Affecting Comparability, Pretax:
Income from retroactive severance tax refunds............ 1.8 5.0 --
Income from collection of Bolivian receivable............ 2.2 -- --
Income from settlement of a natural gas contract......... -- 60.0 --
Operating profit from excess of contract prices over spot
market prices......................................... -- 24.6 47.1
Interest and reimbursement of fees and costs from
resolution of litigation.............................. -- 8.1 --
Gain (loss) on sale of assets............................ -- (0.8) 33.5
Costs to resolve shareholder consent solicitation........ -- (2.3) --
Employee termination costs and other..................... -- (4.5) (5.2)
----- ----- ------
Total Significant Items, Pretax....................... 4.0 90.1 75.4
Income Tax Effect..................................... 1.2 27.2 --
----- ----- ------
Total Significant Items, Aftertax..................... 2.8 62.9 75.4
----- ----- ------
Net Earnings (Loss) Excluding Significant Items and
Extraordinary Item....................................... $27.9 $13.9 $(17.9)
===== ===== ======
</TABLE>
A-6
<PAGE> 37
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- ------
<S> <C> <C> <C>
Earnings Per Share -- Basic:
As reported.............................................. $1.16 $2.87 $ 2.22
Extraordinary loss....................................... -- (0.09) (0.12)
Impact of contract prices over spot market prices and
settlement income..................................... -- 2.28 1.92
Effect of other significant items........................ 0.10 0.15 1.15
----- ----- ------
Excluding significant items and extraordinary item....... $1.06 $0.53 $(0.73)
===== ===== ======
Earnings Per Share -- Diluted:
As reported.............................................. $1.14 $2.81 $ 2.18
Extraordinary loss....................................... -- (0.09) (0.11)
Impact of contract prices over spot market prices and
settlement income..................................... -- 2.23 1.88
Effect of other significant items........................ 0.10 0.14 1.14
----- ----- ------
Excluding significant items and extraordinary item....... $1.04 $0.53 $(0.73)
===== ===== ======
</TABLE>
As shown above, excluding the significant items, the Company's net earnings
would have been $27.9 million ($1.06 per basic share, $1.04 per diluted share)
in 1997, as compared to net earnings of $13.9 million ($0.53 per basic and
diluted share) in 1996 and a net loss of $17.9 million ($0.73 per basic and
diluted share) in 1995. The resulting $14 million increase in net earnings in
1997 was primarily attributable to better refined product margins, higher spot
market natural gas prices and lower corporate interest expense.
When comparing 1996 to 1995, after excluding significant items, the
improvement in net earnings of approximately $32 million was primarily
attributable to improvements within the Company's Refining and Marketing and
Marine Services segments together with reduced general and administrative
expenses and interest expense. These improvements were partially offset by an
increase in the Company's total effective tax rate in 1996 as earnings subject
to U.S. taxes exceeded available net operating loss and tax credit
carryforwards.
A discussion and analysis of the factors contributing to these results are
presented below. The accompanying consolidated financial statements and related
footnotes, together with the following information, are intended to provide
shareholders and other investors with a reasonable basis for assessing the
Company's operations, but should not serve as the sole criterion for predicting
the future performance of the Company.
A-7
<PAGE> 38
REFINING AND MARKETING
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- ----------
(DOLLARS IN MILLIONS EXCEPT PER BARREL
AMOUNTS)
<S> <C> <C> <C>
GROSS OPERATING REVENUES
Total refined products............................ $ 643.7 $ 620.8 $ 664.5
Other, primarily crude oil resales and
merchandise.................................... 77.2 124.6 106.5
------- ------- -------
Gross Operating Revenues..................... $ 720.9 $ 745.4 $ 771.0
======= ======= =======
TOTAL OPERATING PROFIT
Gross margin:
Refinery(a).................................... $ 93.3 $ 74.6 $ 63.5
Non-refinery(b)(c)............................. 36.6 32.7 34.1
------- ------- -------
Total gross margin........................... 129.9 107.3 97.6
Operating expenses................................ 96.0 87.9 84.7
Depreciation and amortization..................... 12.7 12.5 11.9
Loss on sales of assets and other................. 0.7 0.9 0.3
------- ------- -------
Operating Profit............................. $ 20.5 $ 6.0 $ 0.7
======= ======= =======
CAPITAL EXPENDITURES................................ $ 43.9 $ 11.1 $ 9.3
======= ======= =======
KENAI REFINERY THROUGHPUT
Barrels per day................................... 50,207 47,486 50,569
% Alaska North Slope ("ANS") crude oil............ 71% 72% 68%
REFINED PRODUCTS MANUFACTURED (average daily
barrels)
Gasoline and gasoline blendstocks................. 12,851 12,763 14,298
Middle distillates, including jet fuel and diesel
fuel........................................... 21,636 19,975 20,693
Heavy oils and residual products.................. 14,752 13,739 14,516
Other............................................. 2,279 2,600 2,489
------- ------- -------
Total Refined Products Manufactured.......... 51,518 49,077 51,996
======= ======= =======
REFINERY PRODUCT SPREAD ($/barrel)(c)............... $ 5.09 $ 4.29 $ 3.44
======= ======= =======
TOTAL SEGMENT PRODUCT SALES (average daily
barrels)(d)
Gasoline.......................................... 17,393 17,427 24,526
Middle distillates................................ 30,576 29,651 37,988
Heavy oils and residual products.................. 17,929 15,089 14,787
------- ------- -------
Total Product Sales.......................... 65,898 62,167 77,301
======= ======= =======
TOTAL SEGMENT PRODUCT SALES PRICES ($/barrel)
Gasoline.......................................... $ 33.71 $ 32.72 $ 28.21
Middle distillates................................ $ 28.36 $ 29.01 $ 24.40
Heavy oils and residual products.................. $ 17.30 $ 17.61 $ 13.66
TOTAL SEGMENT GROSS MARGINS ON PRODUCT SALES
($/barrel)(e)
Average sales price............................... $ 26.76 $ 27.28 $ 23.55
Average costs of sales............................ 21.92 23.15 20.53
------- ------- -------
Gross Margin................................. $ 4.84 $ 4.13 $ 3.02
======= ======= =======
</TABLE>
- ---------------
(a) Represents throughput at the Company's refinery ("Kenai Refinery") times
refinery product spread.
A-8
<PAGE> 39
(b) Non-refinery margin includes margins on products purchased and resold,
margins on products sold in markets outside of Alaska, intrasegment
pipeline revenues, retail margins, and adjustments due to selling a volume
and mix of products that is different than actual volumes manufactured.
(c) Amounts reported in prior periods have been reclassified to conform with
current presentation.
(d) Sources of total product sales include products manufactured at the Kenai
Refinery, products drawn from inventory balances and products purchased
from third parties. The Company's purchases of refined products for resale
averaged approximately 11,300, 11,600 and 25,500 barrels per day in 1997,
1996 and 1995, respectively.
(e) Gross margins on total product sales include margins on sales of purchased
products, together with the effect of changes in inventories.
1997 Compared to 1996. The Refining and Marketing segment's operating
profit of $20.5 million in 1997 increased $14.5 million from operating profit of
$6.0 million in 1996. The improvement in results from Refining and Marketing has
been due in part to the Company's initiatives to enhance its product slate,
improve efficiencies and sell a larger portion of the Kenai Refinery's
production within the core Alaska market. In these regards, in early October
1997, the Company completed an expansion of the Kenai Refinery's hydrocracker
unit, which increased the unit's capacity by approximately 25% and enables the
Company to produce more jet fuel, a product in short supply in Alaska. The
expansion, together with the addition of a new, high-yield jet fuel hydrocracker
catalyst, began to favorably impact this segment's results in the fourth quarter
of 1997. The Company estimates that its yield of middle distillates will average
45% of total products manufactured at the Kenai Refinery during 1998. With
respect to crude oil supply, during 1997, the Company negotiated contracts to
purchase the remaining Cook Inlet crude oil production available for sale and,
in October 1997, began purchasing approximately 25,000 barrels per day of Cook
Inlet crude oil in addition to the approximate 9,000 barrels per day under
previously existing contracts. Substantially all of the contracts for purchases
of Cook Inlet crude oil are for various periods extending through December 1998.
As part of a three-year, $50 million retail marketing expansion program
initiated in 1997, the Company built two new retail facilities, remodeled three
stations, bought two stations and closed two uneconomic outlets. At year-end
1997, the total number of retail stations selling the Company's gasoline totaled
222 as compared to 206 in 1996. Of these stations, 30 are located in the Pacific
Northwest, compared to 18 at year-end 1996.
During 1997, the Company's production of refined products increased in
total by 5% due to higher throughput levels at the Kenai Refinery. The
operational changes, previously discussed, resulted in an 8% increase in the
production of middle distillates, primarily jet fuel, while gasoline production
remained flat. Production of heavy oils and residual products increased by 7% in
1997. The improved product slate, which better matches the Company's product
supply with demand in Alaska, reflected the change of a hydrocracker catalyst in
late 1996 and the hydrocracker expansion and catalyst change in late 1997. The
Company's sales of refined products within Alaska increased by 6% in 1997
contributing to higher product margins. The improved product slate and marketing
efforts, together with generally favorable industry conditions, resulted in an
increase in the Company's refinery spread to $5.09 per barrel in 1997, compared
to $4.29 per barrel in 1996, reflecting a 10% decrease in the Company's per
barrel feedstock cost with only a 5% decline in per barrel yield value. Both
years included scheduled 30-day maintenance turnarounds.
Revenues from sales of refined products in the Company's Refining and
Marketing segment increased during 1997 due primarily to a 6% increase in sales
volumes, partially offset by slightly lower average sales prices. Total refined
product sales averaged 65,898 barrels per day in 1997 as compared to 62,167
barrels per day in 1996. Other revenues, which included crude oil resales of
$44.4 million in 1997 and $93.8 million in 1996, declined due to lower sales
volumes and prices. The Company had less crude oil available for resale in 1997
as throughput at the Kenai Refinery increased by 2,721 barrels per day, or 6%,
from 1996 and fewer spot purchases of crude oil were made. Export sales of
refined products, including sales to the Russian Far East, amounted to $16.1
million in 1997 compared to $22.0 million in 1996. Costs of sales decreased in
1997 due to lower spot purchases of crude oil and lower prices. Margins from
non-refinery activities increased to $36.6 million in 1997 due primarily to
higher retail sales and improved margins on products sold outside of
A-9
<PAGE> 40
Alaska. Operating expenses increased in 1997 due primarily to higher employee
costs, professional fees and marketing expenses.
The Company's initiatives to enhance its product slate and sell more
product within Alaska, as discussed above, have improved the fundamental
earnings potential of this segment. Certain of these initiatives, such as the
hydrocracker expansion and additional crude oil supply contracts, were completed
in the fourth quarter of 1997. Future years will benefit from the impact of
these initiatives for a full period. Future profitability of this segment,
however, will continue to be influenced by market conditions, particularly as
these conditions influence costs of crude oil relative to prices received for
sales of refined products, and other additional factors that are beyond the
control of the Company.
1996 Compared to 1995. Results from the Company's Refining and Marketing
segment improved during 1996 with operating profit of $6.0 million, compared to
operating profit of $0.7 million in 1995. This improvement was achieved during a
year when the industry was facing rapidly rising prices in the crude oil market.
In addition, the Company's production level at the Kenai Refinery was reduced in
September 1996 for a scheduled 30-day maintenance turnaround. Despite these
factors, the Company was able to achieve a refinery product spread of $4.29 per
barrel for 1996, compared to $3.44 per barrel in 1995. The Company's results
were helped by its initiatives to control costs, improve the Kenai Refinery's
product slate and expand the marketing program for its refined products. The
Company's average refined product yield value per barrel increased by 19% in
1996, while the Company's feedstock costs per barrel increased by 17%.
During 1996, the Company's production of refined products declined in total
by 6%, which included the impact of the scheduled maintenance period. Of this
decline, gasoline production decreased by 11% and middle distillates decreased
by only 3%. These reductions reflected the change of a hydrocracker catalyst
during the maintenance period, which allows for increased production of jet fuel
and reduced production of gasoline beginning in the fourth quarter of 1996,
which better matches the Company's product supply with demand in Alaska.
During 1996, the Company's marketing efforts added 31 locations in Alaska
and eight locations in the Pacific Northwest, bringing the total to 188 branded,
unbranded and Company-operated stations in Alaska and 18 branded stations in the
Pacific Northwest at year-end 1996. Two uneconomic outlets in these areas were
closed in 1996. In addition, the Company began producing and marketing liquid
asphalt, which is a seasonal product in Alaska. Export sales of refined
products, including sales to the Russian Far East, amounted to $22.0 million in
1996 and $18.5 million in 1995.
Revenues from sales of refined products in the Company's Refining and
Marketing segment decreased in 1996 due primarily to a 20% decline in sales
volumes, partially offset by a 16% increase in average sales prices. Total
refined product sales averaged 62,167 barrels per day in 1996 as compared to
77,301 barrels per day in 1995. This decline reflected the lower production
volumes and the Company's withdrawal from certain U.S. West Coast markets during
1996, which also reduced the Company's purchases from other refiners and
suppliers to 11,600 barrels per day in 1996 as compared to 25,500 barrels per
day in 1995. One of the U.S. West Coast facilities was sold in 1996 resulting in
a loss of $0.8 million. Sales of previously purchased crude oil increased to
$93.8 million in 1996, compared to $75.8 million in 1995, due primarily to
higher crude oil prices and in part due to sales of excess crude supply volumes
during the maintenance period. Costs of sales decreased in 1996 due to lower
volumes of refined products, partially offset by higher prices for crude oil and
refined products. Operating expenses were higher in 1996 due primarily to higher
environmental and employee costs partially offset by lower insurance costs.
A-10
<PAGE> 41
EXPLORATION AND PRODUCTION
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- -----------
(DOLLARS IN MILLIONS EXCEPT PER UNIT
AMOUNTS)
<S> <C> <C> <C>
U.S. (a)(b)
Gross operating revenues............................. $ 73.6 $ 93.8 $ 113.0
Income from settlement of a natural gas contract..... -- 60.0 --
Other income, including gain on asset sale in 1995... 3.2 4.8 33.5
Production costs..................................... 7.4 5.3 12.0
Administrative support and other operating
expenses.......................................... 2.3 3.8 3.2
Depreciation, depletion and amortization............. 29.8 25.6 29.3
------- ------- --------
Operating Profit -- U.S........................... 37.3 123.9 102.0
------- ------- --------
BOLIVIA
Gross operating revenues............................. 11.2 13.7 11.7
Other income related to collection of a receivable... 2.2 -- --
Production costs..................................... 0.9 0.8 0.6
Administrative support and other operating
expenses.......................................... 2.4 2.8 3.2
Depreciation, depletion and amortization............. 1.5 1.3 0.3
------- ------- --------
Operating Profit -- Bolivia....................... 8.6 8.8 7.6
------- ------- --------
TOTAL OPERATING PROFIT -- EXPLORATION AND PRODUCTION... $ 45.9 $ 132.7 $ 109.6
======= ======= ========
U.S.
Average Daily Net Production:
Natural gas (Mcf)................................. 86,052 87,654 114,490
Oil (barrels)..................................... 118 27 1
Total (thousand cubic feet equivalent "Mcfe")..... 86,760 87,816 114,496
Average Prices:
Natural gas ($/Mcf) --
Spot market(c).................................. $ 2.17 $ 1.95 $ 1.34
Average(b)...................................... $ 2.17 $ 2.75 $ 2.57
Oil ($/barrel).................................... $ 18.90 $ 21.99 $ 16.82
Average Operating Expenses ($/Mcfe):
Lease operating expenses.......................... $ 0.20 $ 0.14 $ 0.11
Severance taxes................................... 0.03 0.03 0.18
------- ------- --------
Total production costs....................... 0.23 0.17 0.29
Administrative support and other.................. 0.07 0.10 0.06
------- ------- --------
Total Operating Expenses..................... $ 0.30 $ 0.27 $ 0.35
======= ======= ========
Depletion ($/Mcfe)................................... $ 0.93 $ 0.79 $ 0.69
Capital Expenditures (including U.S. gas
transportation)................................... $ 65.4 $ 59.7 $ 49.6
</TABLE>
A-11
<PAGE> 42
<TABLE>
<CAPTION>
1997 1996 1995
---------- ---------- -----------
(DOLLARS IN MILLIONS EXCEPT PER UNIT
AMOUNTS)
<S> <C> <C> <C>
BOLIVIA
Average Daily Net Production:
Natural gas (Mcf)................................. 19,537 20,251 18,650
Condensate (barrels).............................. 518 584 567
Total (Mcfe)...................................... 22,645 23,755 22,052
Average Prices:
Natural gas ($/Mcf)............................... $ 1.15 $ 1.33 $ 1.28
Condensate ($/barrel)............................. $ 15.71 $ 17.98 $ 14.39
Average Operating Expenses ($/Mcfe):
Production costs.................................. $ 0.11 $ 0.10 $ 0.07
Value-added taxes................................. -- 0.05 0.06
Administrative support and other.................. 0.31 0.27 0.35
------- ------- --------
Total Operating Expenses..................... $ 0.42 $ 0.42 $ 0.48
======= ======= ========
Depletion ($/Mcfe)................................... $ 0.19 $ 0.15 $ 0.03
Capital Expenditures................................. $ 27.5 $ 6.9 $ 3.8
</TABLE>
- ---------------
(a) Represents the Company's U.S. oil and gas operations combined with gas
transportation activities.
(b) Results for 1996 and 1995 included revenues from above-market pricing
provisions of a contract with Tennessee Gas which was terminated effective
October 1, 1996. Operating profit for 1996 and 1995 included $24.6 million
and $47.1 million, respectively, for the excess of these contract prices
over spot market prices. Net natural gas production sold under the contract
averaged approximately 11 million cubic feet ("MMcf") per day in 1996 and
20 MMcf per day in 1995. Upon termination of the contract, the Company
recorded other income and operating profit of $60 million during the fourth
quarter of 1996. See Note D of Notes to Consolidated Financial Statements.
(c) Includes effects of the Company's natural gas commodity price agreements
which amounted to losses of $0.05 per thousand cubic feet ("Mcf") and $0.11
per Mcf in 1997 and 1996, respectively, and a gain of $0.01 per Mcf in
1995.
EXPLORATION AND PRODUCTION -- U.S.
1997 Compared to 1996. Operating profit from the Company's U.S. operations
was $37.3 million in 1997, compared with $123.9 million in 1996. Comparability
between these years was impacted by several major transactions in 1996,
including the favorable resolution in August 1996 of litigation regarding the
Tennessee Gas contract and the termination of the remainder of the contract
effective October 1, 1996. As provided for in the Tennessee Gas contract, which
was to expire in January 1999, the Company was selling a portion of the gas
produced in the Bob West Field pursuant to a contract price, which was above the
average spot market price. In total, during 1996 the Company received
approximately $120 million in cash for the resolution of litigation and
termination of the Tennessee Gas contract, with the Company's Exploration and
Production segment recording operating profit of $60 million upon termination of
the contract. In 1996 and 1995, the Exploration and Production segment's
operating profit also included $24.6 million and $47.1 million, respectively,
from the excess of Tennessee Gas contract prices over spot market prices. See
Note D of Notes to Consolidated Financial Statements.
Additionally, during 1996, substantially all of the Company's proved
producing reserves in the Bob West Field were certified by the Texas Railroad
Commission as high-cost gas from a designated tight formation, eligible for
state severance tax exemptions from the date of first production through August
2001. Accordingly, no severance tax is recorded on current production from the
exempt wells in the Bob West Field beginning in 1996. In 1997 and 1996, the
Company recognized income of $1.8 million and $5.0 million, respectively, for
retroactive severance tax refunds for production in prior years.
A-12
<PAGE> 43
Excluding the impact of the incremental contract value and income from the
severance tax refunds, operating profit from the Company's U.S. operations would
have been $35.5 million in 1997 compared to $34.3 million in 1996. The resulting
increase of $1.2 million was primarily attributable to higher spot market prices
for sales of natural gas, partially offset by higher depletion and operating
expenses.
Prices realized by the Company on its natural gas production sold in the
spot market increased 11% to $2.17 per Mcf in 1997 from $1.95 per Mcf in 1996.
The Company's weighted average sales price, which included the above-market
pricing of the Tennessee Gas contract in 1996, decreased in 1997 due to the
termination of the contract. The Company's net production averaged 86.8 MMcfe
per day in 1997, a decrease of 1.0 MMcfe per day from 1996. This decrease
consisted of a 16.1 MMcf per day decline from the Bob West Field, partially
offset by a 15.1 MMcfe per day increase from other U.S. fields. The Company's
U.S. production outside of the Bob West Field rose to 50% of its total U.S.
production by January 1998, as compared to 7% at 1996 year-end.
Gross operating revenues from the Company's U.S. operations, after
excluding amounts related to Tennessee Gas, increased due to the higher spot
market prices. Production costs were higher by $2.1 million ($0.06 per Mcfe) due
mainly to costs at the Bob West Field, including increased compression costs and
a charge for ad valorem taxes in 1997 as well as the impact of lower processing
fees in 1996. Administrative support and other operating expenses decreased by
$1.5 million. Depreciation and depletion increased by $4.2 million, or 16%, due
to a higher depletion rate.
From time to time, the Company enters into commodity price agreements to
reduce the risk caused by fluctuations in the prices of natural gas in the spot
market. During 1997, 1996 and 1995, the Company used such agreements to set the
price of 9%, 30% and 38%, respectively, of the natural gas production that it
sold in the spot market. During 1997 and 1996, the Company realized losses of
$1.6 million ($0.05 per Mcf) and $3.1 million ($0.11 per Mcf), respectively,
from these price agreements. In 1995, the effects of natural gas price
agreements resulted in a gain of $0.3 million ($0.01 per Mcf). The Company had
no remaining price agreements outstanding at December 31, 1997.
1996 Compared to 1995. Operating profit of $123.9 million from the
Company's U.S. operations in 1996 increased $21.9 million from operating profit
of $102.0 million in 1995. Comparability between these years was impacted by
several major transactions. As discussed above, the 1996 results included the
impact of the incremental value of the Tennessee Gas contract. Operating profit
for 1995 included a gain of $33.5 million from the sale of certain interests in
the Bob West Field (see Note C of Notes to Consolidated Financial Statements).
Excluding the impact of the incremental contract value from both years and the
gain on sale of assets from 1995, operating profit from the Company's U.S.
operations for 1996 would have been $34 million compared to $21 million for
1995. The resulting increase was primarily due to higher spot market prices for
sales of natural gas, as industry demand increased due to unusually cold weather
combined with below-normal storage levels.
Prices realized by the Company on its natural gas production sold in the
spot market increased 46% to $1.95 per Mcf in 1996 from $1.34 per Mcf in 1995.
Excluding 24,500 Mcf per day related to the sold interests from 1995, the
Company's spot production increased by 6,600 Mcf per day during 1996. The
Company's exploration and acquisition programs outside of the Bob West Field
contributed 3,800 Mcf per day of the increase in spot production with the
remaining increase attributable to sales to Tennessee Gas at spot prices
effective October 1, 1996. The Company's weighted average sales price increased
7% to $2.75 per Mcf in 1996 as compared to $2.57 per Mcf in 1995. For the Bob
West Field, production declined by 6,100 Mcf per day after excluding amounts
related to sold interests in 1995.
Gross operating revenues from the Company's U.S. operations, after
excluding $11.7 million related to the sold interests from 1995, decreased by
$7.5 million due primarily to the decline in volumes sold under the Tennessee
Gas contract, and losses under commodity price agreements discussed above,
partially offset by increases in spot market sales prices and production. The
decline in production costs of $6.7 million, or $0.12 per Mcfe, was mainly
attributable to the severance tax exemptions in the Bob West Field. Total
depreciation, depletion and amortization was lower in 1996 due to lower
production volumes, partially offset by a higher depletion rate.
A-13
<PAGE> 44
EXPLORATION AND PRODUCTION -- BOLIVIA
The Company's Bolivian natural gas production is sold to Yacimientos
Petroliferos Fiscales Bolivianos ("YPFB"), a Bolivian governmental agency, which
in turn sells the natural gas to Yacimientos Petroliferos Fiscales, SA ("YPF"),
a publicly-held company based in Argentina. Currently, the Company's sales of
natural gas production are based on the volume and pricing terms in a contract
between YPFB and YPF, which was extended in April 1997 for an additional two
years to March 31, 1999, with an option to extend the contract a maximum of one
additional year if a pipeline being constructed from Bolivia to Brazil is not
complete. In the contract extension, YPF negotiated an 11% reduction in the
minimum contract volume that it is required to import from Bolivia, which in
turn resulted in a corresponding 11% reduction of the Company's minimum contract
volume to 36.9 MMcf per day gross (26.2 net). The contract gas prices fluctuate
since they are linked to a monthly average fuel oil price posted in the New York
spot market.
A lack of market access has constrained natural gas production in Bolivia.
The Company believes that the completion of a 1,900-mile pipeline from Bolivia
to Brazil will provide access to larger gas-consuming markets. Upon completion
of this pipeline, the Company will face intense competition from major and
independent natural gas companies operating in Bolivia for a share of the
contractual volumes to be exported to Brazil. It is anticipated that each
producer's share of the contractual volumes will be allocated by YPFB according
to a number of factors, including each producer's reserve volumes and production
capacity. Although the Company expects gas deliveries on the pipeline to begin
in early 1999, there can be no assurance that the pipeline will be operational
by such date. With the exception of the volumes currently under contract with
the Bolivian government, the Company cannot be assured of the amount of
additional volumes that will be exported to Brazil upon completion of the
pipeline.
1997 Compared to 1996. Operating profit from the Company's Bolivian
operations decreased to $8.6 million in 1997, from $8.8 million operating profit
in 1996. Results for 1997 benefited from income of $2.2 million related to the
collection of a receivable for prior years' production. Without this income,
operating profit would have decreased by $2.4 million in 1997 due to declines in
natural gas and condensate production and prices. With the Company's purchase of
interests held by its former joint venture participant in July 1997, the
Company's share of production from Bolivia increased by approximately 33%
beginning in the 1997 third quarter (see Note C of Notes to Consolidated
Financial Statements). However, earlier in the year, the Company's Bolivian
natural gas production was lower due to a reduction in minimum takes under the
new contract between YPFB and YPF and also due to constraints arising from
repairs to a non-Company-owned pipeline that transports gas from Bolivia to
Argentina. In addition, during 1996, production was higher due to requests from
YPFB for additional production from the Company to meet export specifications.
Natural gas prices fell 14% to $1.15 per Mcf in 1997, compared to $1.33 per Mcf
in 1996. Condensate prices fell 13% to $15.71 per barrel in 1997, compared to
$17.98 per barrel in 1996.
1996 Compared to 1995. Operating profit from the Company's Bolivian
operations increased to $8.8 million in 1996, from the $7.6 million operating
profit in 1995. This improvement was primarily due to a 9% increase in
production of natural gas, primarily due to increased demand from YPFB during
the second and third quarters of 1996, together with higher prices received for
both natural gas and condensate. Operating expenses declined by 12% on a per
unit basis reflecting a 6% decrease in costs combined with the increase in
volumes. Partially offsetting these improvements was an increase in
depreciation, depletion and amortization of $1.0 million.
A-14
<PAGE> 45
MARINE SERVICES
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C>
Gross Operating Revenues
Fuels.................................................. $104.5 $ 98.9 $ 61.9
Lubricants and other................................... 16.4 14.9 12.0
Services............................................... 11.3 8.7 0.6
------ ------ ------
Gross Operating Revenues............................ 132.2 122.5 74.5
Costs of Sales........................................... 96.7 93.0 64.9
------ ------ ------
Gross Profit........................................ 35.5 29.5 9.6
Operating Expenses and Other............................. 27.5 22.2 13.7
Depreciation and Amortization............................ 1.7 1.2 0.3
------ ------ ------
Operating Profit (Loss)............................. $ 6.3 $ 6.1 $ (4.4)
====== ====== ======
Sales Volumes (millions of gallons):
Fuels, primarily diesel................................ 156.4 142.7 112.5
Lubricants............................................. 2.7 2.3 2.5
Capital Expenditures..................................... $ 9.4 $ 6.9 $ 0.4
</TABLE>
1997 Compared to 1996. Gross operating revenues increased by $9.7 million,
which included a $7.1 million increase in fuels and lubricant revenues and a
$2.6 million increase in service revenues. The increase in fuels and lubricant
revenues was primarily due to a 10% increase in sales volumes, partially offset
by lower prices. The service revenue increase of 30% was due in part to
increased rig activity in the Gulf of Mexico and the Company's focus to serve
these customers. Additional terminal locations stemming from an acquisition
consummated in February 1996 together with internal growth initiatives have
enabled the Company to increase its sales activity. Costs of sales increased in
1997 due to the higher volumes. The improvement of $6.0 million in gross profit
was offset by higher operating and other expenses associated with the increased
activity together with upgrades to facilities and services.
The Marine Service's segment business is largely dependent upon the level
of oil and gas drilling, workover, construction and seismic activity in the Gulf
of Mexico.
1996 Compared to 1995. In February 1996, the Company acquired Coastwide
Energy Services, Inc. ("Coastwide") and combined these operations with the
Company's marine petroleum products distribution business, forming a Marine
Services segment. Operating results from Coastwide have been included in the
Company's Marine Services segment since the date of acquisition. See Note C of
Notes to Consolidated Financial Statements.
The Marine Services segment consisted of 20 terminals at year-end 1996,
compared to 14 at the prior year-end. The increase of $39.9 million in fuels and
lubricants revenues was primarily due to the added locations and associated
volumes combined with higher fuel prices. In addition, revenues from services
grew by $8.1 million. These increases in revenues together with improved margins
during 1996 were partially offset by higher operating and other expenses
associated with the increased activity. Depreciation and amortization increased
during 1996 due to capital additions during the year. In total, operating profit
of $6.1 million in 1996 reflected a turnaround from the losses incurred in the
prior year.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $13.6 million in 1997, compared
with $12.7 million in 1996 and $16.4 million in 1995. The increase in 1997 was
primarily due to higher employee costs partially offset by lower professional
fees and insurance costs. When comparing 1996 to 1995, the decrease was
primarily due to lower employee and labor costs resulting from cost reduction
measures implemented by the Company in late 1995.
A-15
<PAGE> 46
INTEREST EXPENSE AND INTEREST INCOME
Interest expense totaled $6.7 million in 1997, compared with $15.4 million
in 1996 and $20.9 million in 1995. The Company's redemption of public debt of
$74.1 million in November 1996 and $34.6 million in December 1995 contributed to
these interest savings.
Interest income was $1.6 million in 1997, compared with $8.4 million in
1996 and $1.8 million in 1995. The fluctuation in 1996 included interest of
approximately $7 million received from Tennessee Gas in conjunction with the
collection of a receivable which resulted from underpayment for natural gas sold
in prior periods (see Note D of Notes to Consolidated Financial Statements).
OTHER EXPENSE, NET
Other expense was $4.9 million in 1997, compared with $10.0 million in 1996
and $8.5 million in 1995. In 1996, the Company incurred costs of $2.3 million to
resolve a shareholder consent solicitation, together with a write-off of
deferred financing costs and increased expenses related to the Company's former
operations. There were no material comparable costs recorded in 1997. When
comparing 1996 to 1995, the increase in other expense was due to the costs
recorded in 1996, partially offset by lower employee termination and
restructuring costs.
INCOME TAX PROVISION
The income tax provision was $18.4 million in 1997, compared with $38.3
million in 1996 and $4.4 million in 1995. Effective income tax rates were 37%,
33% and 7% in 1997, 1996 and 1995, respectively (see Note H of Notes to
Consolidated Financial Statements). The decrease in the income tax provision in
1997 was primarily attributable to lower earnings, partially offset by a higher
effective rate due to Bolivian taxes. When comparing 1996 to 1995, the income
tax provision increased due to earnings subject to U.S. taxes exceeding
available net operating loss and tax credit carryforwards.
A-16
<PAGE> 47
CAPITAL RESOURCES AND LIQUIDITY
OVERVIEW
The Company's primary sources of liquidity are its cash and cash
equivalents, internal cash generation and external financing. During 1997, the
Company made capital expenditures of $147 million, which were funded through a
combination of cash flows from operations of $96 million, external financing and
available cash balances. At December 31, 1997, the Company's
debt-to-capitalization ratio was 26% which enhances the Company's ability to
access capital markets.
Additional financing will be required for the proposed acquisition of BHP
Refining and BHP South Pacific and associated working capital and letters of
credit requirements. The Company is currently in discussions with its investment
bankers to arrange for such financing, and in connection with such discussions,
the Company has been advised that sufficient funds will be made available. See
Note O of Notes to Consolidated Financial Statements.
The Company operates in an environment where its liquidity and capital
resources are impacted by changes in the supply of and demand for crude oil,
natural gas and refined petroleum products, market uncertainty and a variety of
additional risks that are beyond the control of the Company. These risks
include, among others, the level of consumer product demand, weather conditions,
the proximity of the Company's natural gas reserves to pipelines, the capacities
of such pipelines, fluctuations in seasonal demand, governmental regulations,
the price and availability of alternative fuels and overall market and economic
conditions. The Company's future capital expenditures as well as borrowings
under its credit arrangements and other sources of capital will be affected by
these conditions.
CREDIT ARRANGEMENTS
The Company's amended and restated corporate revolving credit agreement
("Credit Facility"), which expires in April 2000, provides total commitments of
$150 million from a consortium of nine banks. The Company, at its option, has
currently activated $100 million of these commitments. The Credit Facility
provides for the issuance of letters of credit, and for cash borrowings up to
$100 million, with the aggregate subject to a borrowing base (which amount
exceeded total commitments at December 31, 1997). Outstanding obligations under
the Credit Facility are collateralized by first liens on substantially all of
the Company's trade receivables, product inventories and South Texas natural gas
reserves and by a third lien on the Kenai Refinery.
At December 31, 1997, the Company had outstanding cash borrowings of $28
million under the Credit Facility. Cash borrowings under the Credit Facility are
generally used on a short-term basis to finance working capital requirements and
capital expenditures. Under the Credit Facility, at December 31, 1997, the
Company had outstanding letters of credit of $34 million, primarily for royalty
crude oil purchases from the State of Alaska. Unused availability, including
unactivated commitments, under the Credit Facility at December 31, 1997 for
additional borrowings and letters of credit totaled $88 million. The Company is
also permitted to utilize unsecured letters of credit outside of the Credit
Facility up to $40 million (none outstanding at December 31, 1997).
The Credit Facility, which has been amended from time to time, requires the
Company to maintain specified levels of consolidated working capital, tangible
net worth, cash flow and interest coverage and contains other covenants
customary in credit arrangements of this kind. Among other matters, the terms of
the Credit Facility allow for general open market stock repurchases and the
payment of cash dividends subject to a cumulative amount available for
restricted payments (defined as the difference of (i) the sum since December 31,
1995, of (a) $5 million and (b) 50% of consolidated net earnings of the Company
in any calendar year and (ii) any restricted payments made since June 1996). At
December 31, 1997, the cumulative amount available for restricted payments was
approximately $58 million. In addition to the cumulative restriction, the Credit
Facility further limits these general open market stock repurchases and cash
dividends to a maximum of $5 million annually. The Credit Facility also permits
the Company to repurchase a limited amount of Common Stock, up to $10 million
annually, specifically for oddlot buyback programs and employee
A-17
<PAGE> 48
benefit or compensation plans. The Board of Directors has no present plans to
pay dividends. However, from time to time, the Board of Directors reevaluates
the feasibility of declaring future dividends.
For further information on the Company's credit arrangements, see Note I of
Notes to Consolidated Financial Statements.
DEBT AND OTHER OBLIGATIONS
Under an agreement reached in 1993, which settled a contractual dispute
with the State of Alaska ("State"), the Company is obligated to make variable
monthly payments to the State through December 2001 based on a per barrel charge
on the volume of feedstock processed through the Kenai Refinery's crude unit. In
1997 and 1996, based on a per barrel throughput charge of 24 cents, the
Company's variable payments to the State totaled $4.4 million and $4.0 million,
respectively. In 1995, based on a per barrel throughput charge of 16 cents, the
Company's variable payments to the State totaled $2.9 million. The per barrel
charge increases to 30 cents in 1998 with one cent annual incremental increases
thereafter through 2001. In January 2002, the Company is obligated to pay the
State $60 million; provided, however, that such payment may be deferred
indefinitely, at the Company's option, by continuing the variable monthly
payments to the State beginning at 34 cents per barrel for 2002 and increasing
one cent per barrel annually thereafter. Variable monthly payments made after
January 2002 will not reduce the $60 million obligation to the State. The $60
million obligation is evidenced by a security bond, and the bond and the
throughput barrel obligations are collateralized by a fourth lien on the Kenai
Refinery. The Company's obligations under the agreement with the State and the
mortgage are subordinated to current and future senior debt of up to $175
million plus any indebtedness incurred subsequent to the date of the agreement
to improve the Kenai Refinery. Loans obtained to finance the expansion of the
hydrocracker unit and install the vacuum unit, discussed in Note I of Notes to
Consolidated Financial Statements, qualify as indebtedness incurred subsequent
to this agreement to improve the Kenai Refinery.
STOCK REPURCHASE PROGRAM
On May 7, 1997, the Company's Board of Directors authorized the repurchase
of up to 3 million shares (approximately 11% of outstanding shares) of Tesoro
Common Stock in a buyback program that will extend through the end of 1998.
Under the program, subject to certain conditions, the Company may repurchase
from time to time Tesoro Common Stock in the open market and through privately
negotiated transactions. Purchases will depend on price, market conditions and
other factors and will be made primarily from cash flows. The repurchased Common
Stock is accounted for as treasury stock and may be used for employee benefit
plan requirements and other corporate purposes. During 1997, the Company used
cash flows of $3.7 million to repurchase 236,800 shares of Common Stock, of
which 20,347 shares have been reissued for an employee benefit plan. For
information related to restrictions under the Credit Facility, see Note I of
Notes to Consolidated Financial Statements.
CAPITAL SPENDING
Capital spending in 1997 totaled $147 million which was funded from
available cash reserves, internally-generated cash flows from operations and
external financing. Capital expenditures for the Exploration and Production
segment were approximately $93 million, including $65 million for U.S.
operations and $28 million for Bolivia operations. In the U.S., capital
expenditures were principally for participation in the drilling of eleven
development wells (nine completed), 12 exploratory wells (eight completed), the
purchase of 33 Bcfe of proved reserves and 82,000 net undeveloped lease acres
and seismic activity. In Bolivia, capital expenditures included the purchase of
contract interests from its former joint venture participant (see Note C of
Notes to Consolidated Financial Statements), exploratory drilling, seismic
activity and workovers. Capital projects for the Refining and Marketing segment
in 1997 totaled $44 million, primarily for costs related to the hydrocracker
expansion and the commencement of a long-term capital program to improve
marketing operations. In the Marine Services segment, capital spending totaled
$9 million during 1997, primarily for expansion and improvement of operations
along the Gulf of Mexico.
A-18
<PAGE> 49
For 1998, the Company has a total capital budget of approximately $195
million, excluding the acquisition of BHP Refining and BHP South Pacific. The
Exploration and Production segment accounts for $139 million, or 71%, of the
budget with $82 million planned for U.S. activities and $57 million for Bolivia.
Planned U.S. expenditures include $25 million for acquisitions, $21 million for
development drilling (participation in 30 wells), $17 million for leasehold,
geological and geophysical, and $17 million for exploratory drilling
(participation in 20 wells). In Bolivia, the drilling program is budgeted at $14
million for development drilling (three wells) and $12 million for exploratory
drilling (two wells), with the remainder planned for upgrading a gas processing
plant, constructing a liquid petroleum gas plant, workovers and three-
dimensional seismic activity. Capital spending, other than acquisitions, for the
Refining and Marketing segment is planned at $39 million, which includes $20
million towards the retail marketing expansion program in Alaska started in
1997, $8 million for environmental and $8 million for refinery improvements. The
Marine Services capital budget is $9 million, primarily directed towards
equipment and facility upgrades together with potential acquisitions. Capital
expenditures for 1998 are expected to be financed through a combination of cash
flows from operations, available cash reserves and additional borrowings under
the Credit Facility. Actual capital expenditures may vary from these projections
due to a number of factors, including the timing of drilling projects and the
extent to which properties are acquired.
CASH FLOW SUMMARY
Components of the Company's cash flows are set forth below (in millions):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------ ------
<S> <C> <C> <C>
Cash Flows From (Used In):
Operating Activities.......................... $ 95.6 $178.9 $ 35.4
Investing Activities.......................... (151.5) (94.2) 2.4
Financing Activities.......................... 41.5 (75.9) (37.8)
------- ------ ------
Increase (Decrease) in Cash and Cash
Equivalents................................... $ (14.4) $ 8.8 $ --
======= ====== ======
</TABLE>
During 1997, net cash from operating activities totaled $96 million,
compared with $179 million in 1996. Operating cash flows in 1997 included a $57
million decrease in receivables due in part to collections related to product
and crude oil sales volumes at 1996 year-end, Bolivian production sold in prior
years and retroactive severance taxes, partially offset by income tax and other
payments. The 1996 operating cash flows included the impact of receipts from
Tennessee Gas. Net cash used in investing activities of $151 million in 1997
included capital expenditures of $93 million for the Company's Exploration and
Production activities, $44 million for Refining and Marketing activities and $9
million for Marine Services. Net cash from financing activities of $41 million
in 1997 included net borrowings of $28 million under the Credit Facility and
receipt of $16 million under a loan for the hydrocracker expansion, partially
offset by payments of other long-term debt and repurchases of Common Stock.
During 1997, gross borrowings under the Credit Facility were $150 million, with
$122 million of repayments. At December 31, 1997, the Company's net working
capital totaled $74 million, which included cash and cash equivalents of $8
million.
During 1996, net cash from operating activities totaled $179 million,
compared with $35 million in 1995. This increase in operating cash flows in 1996
was primarily due to the receipt of $120 million from Tennessee Gas for the
favorable resolution of litigation in August 1996 and termination of the natural
gas purchase and sales contract effective October 1, 1996. In addition, improved
profitability plus noncash items, such as depreciation, depletion and
amortization and deferred income taxes, contributed to higher cash flows from
operations. Partially offsetting these increases were higher net working capital
balances, particularly receivables which increased primarily due to higher
year-end sales volumes together with higher prices. Net cash used in investing
activities of $94 million in 1996 included capital expenditures of $85 million
and cash consideration of nearly $8 million for the acquisition of Coastwide.
Net cash used in financing activities of $76 million during 1996 was primarily
due to the redemption of public debt aggregating $74 million together with
payments of other long-term debt. During 1996, the Company's gross borrowings
and repayments under its corporate revolving credit line amounted to $165
million.
A-19
<PAGE> 50
During 1995, net cash from operating activities totaled $35 million.
Although natural gas production from the Company's South Texas operations
increased during 1995, lower cash receipts for sales of natural gas adversely
affected the Company's cash flows from operations. Net cash from investing
activities of $2 million in 1995 included proceeds of $70 million from sales of
assets, primarily certain interests in the Bob West Field, partially offset by
$64 million of capital expenditures and $3 million for acquisition of the Kenai
Pipe Line Company ("KPL"). Net cash used in financing activities of $38 million
in 1995 was primarily related to the redemption of $34.6 million of public debt
and payments of other long-term debt. The Company's gross borrowings and
repayments under the Facility totaled $262 million during 1995.
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 other modifications or changes in use for certain emission sources. The
Company is currently involved in a remedial response and has incurred cleanup
expenditures associated with environmental matters at a number of sites,
including certain of its own properties. At December 31, 1997, the Company's
accruals for environmental expenses amounted to $8.5 million, which included a
noncurrent liability of $2.7 million for remediation of KPL's properties that
has been funded by the former owners of KPL through a restricted escrow deposit.
Based on currently available information, including the participation of other
parties or former owners in remediation actions, the Company believes these
accruals are adequate.
To comply with environmental laws and regulations, the Company anticipates
that it will make capital improvements of approximately $7 million in 1998 and
$2 million in 1999. In addition, capital expenditures for alternative secondary
containment systems for existing storage tank facilities are estimated to be $2
million in 1998 and $2 million in 1999 with a remaining $5 million to be spent
by 2002.
Conditions that require additional expenditures may exist for various
Company sites, including, but not limited to, the Kenai Refinery, retail
gasoline outlets (current and closed locations) and petroleum product terminals,
and for compliance with the Clean Air Act. The amount of such future
expenditures cannot currently be determined by the Company. For further
information on environmental contingencies, see Note L of Notes to Consolidated
Financial Statements.
CRUDE OIL PURCHASE CONTRACTS
The Company has a contract with the State of Alaska for the purchase of
royalty crude oil, a primary feedstock for the Kenai Refinery, covering the
period January 1, 1996 through December 31, 1998. This contract provides for the
purchase of 30% of the State's ANS royalty crude oil produced from the Prudhoe
Bay Unit at prices based on royalty values computed by the State. During 1997,
the Company purchased approximately 35,700 barrels per day of ANS crude oil
under this contract. The contract contains provisions that, under certain
conditions, allow the Company to temporarily or permanently reduce its purchase
obligations. Under this contract, the Company is required to utilize in its
refinery operations volumes equal to at least 80% of the ANS crude oil purchased
from the State. The Company is presently in discussions with the State in regard
to extending this contract for an additional year.
The Company also purchases approximately 6,000 barrels per day of ANS crude
oil from a producer under a contract with a term of one year beginning January
1, 1998.
During October 1997, the Company began purchasing all of the approximately
34,000 barrels per day of Cook Inlet crude oil production from various producers
under contracts extending through December 1998. A contract to purchase 4,500
barrels per day, of the 34,000 barrels per day, has been extended through March
31, 2001.
A-20
<PAGE> 51
YEAR 2000 COMPLIANCE
The efficient operation of the Company's business is dependent on its
computer hardware, operating systems and software programs (collectively,
"Systems and Programs"). These Systems and Programs are used in several key
areas of the Company's business, including information management services and
financial reporting, as well as in various administrative functions. The Company
has been evaluating its Systems and Programs to identify potential year 2000
compliance problems, as well as manual processes, external interfaces with
customers and services supplied by vendors. The year 2000 problem refers to the
limitations of the programming code in certain existing hardware and software
programs to recognize date sensitive information for the year 2000 and beyond.
Unless replaced or modified prior to the year 2000, such hardware and systems
may not properly recognize such information and could generate erroneous data or
cause a system to fail to operate properly.
Based on current information, the Company expects to attain year 2000
compliance and institute appropriate testing of its modifications and
replacements in a timely fashion and in advance of the year 2000 date change. It
is anticipated that modification or replacement of the Company's Systems and
Programs will be performed in-house by company personnel. The Company believes
that, with hardware replacement and modifications to existing software or
conversions to new software, the year 2000 problem will not pose a significant
operational problem for the Company. It is possible that non-compliant third
party computer systems or programs may not interface properly with the Company's
computer systems. The Company has requested assurance from third parties that
their computers, systems or programs be year 2000 compliant. The Company could,
however, be adversely affected by the year 2000 problem if it or unrelated
parties fail to successfully address this issue. Management of the Company
currently anticipates that the expenses and capital expenditures associated with
its year 2000 compliance project will not have a material effect on its
financial position or results of operations.
NEW ACCOUNTING STANDARDS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Reporting Comprehensive Income," which establishes standards for
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statements. SFAS No. 130, which becomes effective
for the Company in 1998, requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. Also, in June 1997, the FASB issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which
establishes standards for reporting information about operating segments in
annual financial statements and requires that selected information about
operating segments be included in interim financial reports issued to
shareholders. SFAS No. 131 also establishes standards for related disclosures
about products and services, geographic areas and major customers. SFAS No. 131
becomes effective for the Company's 1998 year-end and need not be applied to
interim financial information until 1999. In February 1998, the FASB issued SFAS
No. 132, "Employers' Disclosures about Pensions and Other Postretirement
Benefits," which standardizes the disclosures related to pensions and other
postretirement benefits to the extent practicable, requires additional
information on changes in the benefit obligations and fair values of plan assets
and eliminates certain disclosures previously required. SFAS No. 132 becomes
effective for the Company in 1998. All three statements contain provisions for
restatement of prior period information. The Company is evaluating the effects
that these new statements will have on its financial reporting and disclosures.
The new statements will have no effect on the Company's results of operations,
financial position or cash flows.
A-21
<PAGE> 52
FORWARD-LOOKING STATEMENTS
Statements in this Appendix A to the Proxy Statement for the 1998 Annual
Meeting of Stockholders, including those contained in the foregoing discussion
and other items herein, concerning the Company which are (a) projections of
revenues, earnings, earnings per share, capital expenditures or other financial
items, (b) statements of plans and objectives for future operations, including
acquisitions, (c) statements of future economic performance, or (d) statements
of assumptions or estimates underlying or supporting the foregoing are
forward-looking statements within the meaning of Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The ultimate
accuracy of forward-looking statements is subject to a wide range of business
risks and changes in circumstances, and actual results and outcomes often differ
from expectations. Any number of important factors could cause actual results to
differ materially from those in the forward-looking statements herein, including
the following: the timing and extent of changes in commodity prices and
underlying demand and availability of crude oil and other refinery feedstocks,
refined products, and natural gas; actions of customers and competitors; changes
in the cost or availability of third-party vessels, pipelines and other means of
transporting feedstocks and products; state and federal environmental, economic,
safety and other policies and regulations, any changes therein, and any legal or
regulatory delays or other factors beyond the Company's control; execution of
planned capital projects; weather conditions affecting the Company's operations
or the areas in which the Company's products are marketed; future well
performance; the extent of Tesoro's success in acquiring oil and gas properties
and in discovering, developing and producing reserves; political developments in
foreign countries; the conditions of the capital markets and equity markets
during the periods covered by the forward-looking statements; earthquakes or
other natural disasters affecting operations; adverse rulings, judgments, or
settlements in litigation or other legal matters, including unexpected
environmental remediation costs in excess of any reserves; and adverse changes
in the credit ratings assigned to the Company's trade credit. The Company
undertakes no obligation to publicly release the result of any revisions to any
such forward-looking statements that may be made to reflect events or
circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
A-22
<PAGE> 53
III. FINANCIAL STATEMENTS
INDEPENDENT AUDITORS' REPORT
Board of Directors and Stockholders
Tesoro Petroleum Corporation
We have audited the accompanying consolidated balance sheets of Tesoro
Petroleum Corporation and subsidiaries as of December 31, 1997 and 1996, and the
related statements of consolidated operations, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 1997. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Tesoro Petroleum Corporation
and subsidiaries at December 31, 1997 and 1996, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
San Antonio, Texas
January 28, 1998
A-23
<PAGE> 54
TESORO PETROLEUM CORPORATION
STATEMENTS OF CONSOLIDATED OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1997 1996 1995
-------- ---------- ----------
<S> <C> <C> <C>
REVENUES
Refining and marketing............................... $720,868 $ 745,413 $ 771,035
Exploration and production........................... 84,798 107,415 124,670
Marine services...................................... 132,251 122,533 74,467
Income from settlement of a natural gas contract..... -- 60,000 --
Gain on sale of assets and other income.............. 5,543 4,417 32,711
-------- ---------- ----------
Total Revenues............................... 943,460 1,039,778 1,002,883
-------- ---------- ----------
OPERATING COSTS AND EXPENSES
Refining and marketing............................... 687,036 726,029 758,329
Exploration and production........................... 13,230 12,968 19,055
Marine services...................................... 124,725 115,314 77,803
Depreciation, depletion and amortization............. 45,729 40,627 41,776
-------- ---------- ----------
Total Operating Costs and Expenses........... 870,720 894,938 896,963
-------- ---------- ----------
OPERATING PROFIT....................................... 72,740 144,840 105,920
General and Administrative............................. (13,588) (12,733) (16,453)
Interest Expense, Net of Capitalized Interest in
1997................................................. (6,699) (15,382) (20,902)
Interest Income........................................ 1,597 8,423 1,845
Other Expense, Net..................................... (4,930) (10,001) (8,542)
-------- ---------- ----------
EARNINGS BEFORE INCOME TAXES AND EXTRAORDINARY ITEM.... 49,120 115,147 61,868
Income Tax Provision................................... 18,435 38,347 4,379
-------- ---------- ----------
EARNINGS BEFORE EXTRAORDINARY ITEM..................... 30,685 76,800 57,489
Extraordinary Loss on Extinguishments of Debt (Net of
Income Tax Benefit of $886 in 1996).................. -- (2,290) (2,857)
-------- ---------- ----------
NET EARNINGS........................................... $ 30,685 $ 74,510 $ 54,632
======== ========== ==========
NET EARNINGS PER SHARE -- BASIC........................ $ 1.16 $ 2.87 $ 2.22
======== ========== ==========
NET EARNINGS PER SHARE -- DILUTED...................... $ 1.14 $ 2.81 $ 2.18
======== ========== ==========
WEIGHTED AVERAGE COMMON SHARES -- BASIC................ 26,410 25,999 24,557
======== ========== ==========
WEIGHTED AVERAGE COMMON SHARES AND POTENTIALLY DILUTIVE
COMMON SHARES -- DILUTED............................. 26,868 26,499 25,107
======== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
A-24
<PAGE> 55
TESORO PETROLEUM CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1997 1996
-------- --------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents................................. $ 8,352 $ 22,796
Receivables, less allowance for doubtful accounts......... 76,282 128,013
Inventories............................................... 87,359 74,488
Prepayments and other..................................... 9,842 12,046
-------- --------
Total Current Assets.............................. 181,835 237,343
-------- --------
PROPERTY, PLANT AND EQUIPMENT
Refining and marketing.................................... 370,174 328,522
Exploration and production, full-cost method of
accounting:
Properties being amortized............................. 251,604 179,433
Properties not yet evaluated........................... 31,918 12,344
Gas transportation..................................... 7,889 6,703
Marine services........................................... 43,072 33,820
Corporate................................................. 13,689 12,531
-------- --------
718,346 573,353
Less accumulated depreciation, depletion and
amortization.......................................... 304,523 256,842
-------- --------
Net Property, Plant and Equipment...................... 413,823 316,511
-------- --------
OTHER ASSETS................................................ 32,150 28,733
-------- --------
Total Assets...................................... $627,808 $582,587
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable.......................................... $ 58,767 $ 80,747
Accrued liabilities....................................... 31,372 33,256
Current income taxes payable.............................. 354 13,822
Current maturities of long-term debt and other
obligations............................................ 17,002 10,043
-------- --------
Total Current Liabilities......................... 107,495 137,868
-------- --------
DEFERRED INCOME TAXES....................................... 28,824 19,151
-------- --------
OTHER LIABILITIES........................................... 43,211 42,243
-------- --------
LONG-TERM DEBT AND OTHER OBLIGATIONS, LESS CURRENT
MATURITIES................................................ 115,314 79,260
-------- --------
COMMITMENTS AND CONTINGENCIES (Note L)
STOCKHOLDERS' EQUITY
Preferred stock, no par value; authorized 5,000,000 shares
including redeemable preferred shares; none issued or
outstanding
Common stock, par value $0.16 2/3; authorized 50,000,000
shares; 26,506,601 shares issued (26,414,134 in
1996).................................................. 4,418 4,402
Additional paid-in capital................................ 190,925 189,368
Retained earnings......................................... 140,980 110,295
Treasury stock, 216,453 common shares in 1997, at cost.... (3,359) --
-------- --------
Total Stockholders' Equity............................. 332,964 304,065
-------- --------
Total Liabilities and Stockholders' Equity........ $627,808 $582,587
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
A-25
<PAGE> 56
TESORO PETROLEUM CORPORATION
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
RETAINED
COMMON STOCK ADDITIONAL EARNINGS TREASURY STOCK
--------------- PAID-IN (ACCUMULATED ----------------
SHARES AMOUNT CAPITAL DEFICIT) SHARES AMOUNT
------ ------ ---------- ------------ ------ -------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1994............ 24,390 $4,065 $175,514 $(18,847) -- $ --
Net earnings.......................... -- -- -- 54,632 -- --
Shares issued pursuant to exercise of
stock options and stock awards..... 390 65 1,085 -- -- --
------ ------ -------- -------- ---- -------
BALANCE AT DECEMBER 31, 1995............ 24,780 4,130 176,599 35,785 -- --
Net earnings.......................... -- -- -- 74,510 -- --
Issuance of Common Stock.............. 1,308 218 11,054 -- -- --
Shares issued pursuant to exercise of
stock options and stock awards..... 326 54 1,715 -- -- --
------ ------ -------- -------- ---- -------
BALANCE AT DECEMBER 31, 1996............ 26,414 4,402 189,368 110,295 -- --
Net earnings.......................... -- -- -- 30,685 -- --
Shares repurchased.................... -- -- -- -- (236) (3,701)
Shares issued pursuant to exercise of
stock options and stock awards and
employee benefit plans............. 45 7 440 -- 20 342
Other................................. 48 9 1,117 -- -- --
------ ------ -------- -------- ---- -------
BALANCE AT DECEMBER 31, 1997............ 26,507 $4,418 $190,925 $140,980 (216) $(3,359)
====== ====== ======== ======== ==== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
A-26
<PAGE> 57
TESORO PETROLEUM CORPORATION
STATEMENTS OF CONSOLIDATED CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1997 1996 1995
--------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Net earnings.............................................. $ 30,685 $ 74,510 $ 54,632
Adjustments to reconcile net earnings to net cash from
operating activities:
Depreciation, depletion and amortization............... 46,363 41,459 42,620
Loss (gain) on sales of assets......................... 523 835 (32,659)
Amortization of deferred charges and other............. 951 1,601 1,556
Extraordinary loss on extinguishments of debt, net of
income tax benefit................................... -- 2,290 2,857
Changes in operating assets and liabilities:
Receivables.......................................... 56,785 (42,542) 9,746
Receivable from Tennessee Gas Pipeline Company....... -- 50,680 (37,456)
Inventories.......................................... (11,517) 7,210 (11,599)
Other assets......................................... 296 (3,521) (3,573)
Accounts payable and accrued liabilities............. (37,854) 28,165 4,605
Deferred income taxes................................ 9,673 14,649 807
Obligation payments to State of Alaska............... (4,401) (4,047) (2,892)
Other liabilities and obligations.................... 4,131 7,673 6,769
--------- -------- --------
Net cash from operating activities................ 95,635 178,962 35,413
--------- -------- --------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Capital expenditures...................................... (147,498) (84,957) (63,930)
Proceeds from sales of assets............................. 112 2,569 69,786
Other..................................................... (4,159) (11,812) (3,452)
--------- -------- --------
Net cash from (used in) investing activities...... (151,545) (94,200) 2,404
--------- -------- --------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Payments of long-term debt................................ (4,095) (3,838) (2,979)
Net borrowings under revolving credit facilities.......... 32,728 883 --
Issuance of long-term debt................................ 16,200 -- --
Repurchase of common stock................................ (3,701) -- --
Repurchase of debentures and notes........................ -- (74,116) (34,634)
Other..................................................... 334 1,164 (281)
--------- -------- --------
Net cash from (used in) financing activities...... 41,466 (75,907) (37,894)
--------- -------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS............ (14,444) 8,855 (77)
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR................ 22,796 13,941 14,018
--------- -------- --------
CASH AND CASH EQUIVALENTS, END OF YEAR...................... $ 8,352 $ 22,796 $ 13,941
========= ======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid, net of $419 capitalized in 1997............ $ 2,127 $ 12,450 $ 18,132
========= ======== ========
Income taxes paid......................................... $ 22,412 $ 6,285 $ 4,046
========= ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
A-27
<PAGE> 58
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE A -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The accompanying Consolidated Financial Statements include the accounts of
Tesoro Petroleum Corporation and its subsidiaries (collectively, the "Company"
or "Tesoro"). All significant intercompany accounts and transactions have been
eliminated. Tesoro is a natural resource company engaged in petroleum refining,
distributing and marketing of petroleum products, marine logistics services and
the exploration and production of natural gas and oil.
Use of Estimates and Presentation
The preparation of the Company's Consolidated Financial Statements in
conformity with generally accepted accounting principles required the use of
management's best estimates and judgment that affect the reported amounts of
assets and liabilities and disclosures of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the year. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash equivalents consist of highly-liquid debt instruments such as
commercial paper and certificates of deposit purchased with an original maturity
date of three months or less. Cash equivalents are stated at cost, which
approximates market value. The Company's policy is to invest cash in
conservative, highly-rated instruments and to invest in various institutions to
limit the amount of credit exposure in any one institution. The Company performs
ongoing evaluations of the credit standing of these financial institutions.
Inventories
Inventories are stated at the lower of cost or market. The last-in,
first-out ("LIFO") method was used to determine the cost of the Company's
refining and marketing inventories of crude oil and U.S. wholesale refined
products. The cost of remaining refined product inventories, including fuel at
the Company's marine service terminals, was determined principally on the
first-in, first-out ("FIFO") method. Merchandise and materials and supplies are
valued at average cost, not in excess of market value. See Note F.
Property, Plant and Equipment
Additions to property, plant and equipment and major improvements and
modifications are capitalized at cost. Maintenance and repairs are charged to
operations when incurred. Depletion of oil and gas producing properties is
determined principally by the unit-of-production method and is based on
estimated recoverable reserves. Depreciation of other property, plant and
equipment is generally computed on the straight-line method based upon the
estimated useful life of each asset. The weighted average lives range from 12 to
30 years for refining, marketing and pipeline assets, 11 to 16 years for service
equipment and marine fleets, and five to seven years for corporate and other
assets.
Oil and gas properties are accounted for using the full-cost method of
accounting. Under this method, all costs associated with property acquisition
and exploration and development activities are capitalized into cost centers
that are established on a country-by-country basis. For each cost center, the
capitalized costs are subject to a limitation so as not to exceed the present
value of future net revenues from estimated production of proved oil and gas
reserves, net of income tax effect, plus the lower of cost or estimated fair
value of unproved properties included in the cost center. Capitalized costs
within a cost center, together with estimates of costs for future development,
dismantlement and abandonment, are amortized on a unit-of-production method
using the proved oil and gas reserves for each cost center. The Company's
investment in certain oil and gas properties is excluded from the amortization
base until the properties are evaluated. Gain or loss is
A-28
<PAGE> 59
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
recognized only on the sale of oil and gas properties involving significant
reserves. Proceeds from the sale of insignificant reserves and undeveloped
properties are applied to reduce the costs in the cost centers.
Income Taxes
Deferred tax assets and liabilities are recognized for future income tax
consequences attributable to differences between financial statement carrying
amounts of assets and liabilities and their respective tax bases. Measurement of
deferred tax assets and liabilities is based on enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in the period that includes
the enactment date.
Environmental Expenditures
Environmental expenditures that relate to current operations are expensed
or capitalized as appropriate. Expenditures that extend the life, increase the
capacity, or mitigate or prevent environmental contamination, are capitalized.
Expenditures that relate to an existing condition caused by past operations, and
which do not contribute to current or future revenue generation, are expensed.
Liabilities are recorded when environmental assessments and/or remedial efforts
are probable and the cost can be reasonably estimated. Such amounts are based on
the estimated timing and extent of remedial actions required by applicable
governing agencies, experience gained from similar sites on which environmental
assessments or remediation has been completed, and the amount of the Company's
anticipated liability considering the proportional liability and financial
abilities of other responsible parties. Generally, the timing of these accruals
coincides with completion of a feasibility study or the Company's commitment to
a formal plan of action. Estimated liabilities are not discounted to present
value.
Financial Instruments
The carrying amount of financial instruments including cash and cash
equivalents, accounts receivable, accounts payable and certain accrued
liabilities approximates fair value because of the short maturity of these
instruments. The carrying amount of the Company's long-term debt and other
obligations approximated the Company's estimates of the fair value of such
items.
A-29
<PAGE> 60
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Earnings Per Share
Earnings per share have been determined in accordance with Statement of
Financial Accounting Standard ("SFAS") No. 128 which establishes standards for
computing and presenting basic and diluted earnings per share calculations.
Basic earnings per share is determined by dividing net earnings by the weighted
average number of common shares outstanding during the period. The Company's
calculation of diluted earnings per share takes into account the effect of
potentially dilutive shares, principally stock options, outstanding during the
period. Prior period amounts have been restated to conform with the requirements
of SFAS No. 128. Earnings per share calculations for the years ended December
31, 1997, 1996 and 1995 are presented below (in thousands except per share
amounts):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Earnings Applicable to Common Shareholders (Basic and
Diluted Numerator):
Earnings before extraordinary item.................. $30,685 $76,800 $57,489
Extraordinary loss on extinguishments of debt,
aftertax......................................... -- (2,290) (2,857)
------- ------- -------
Net earnings..................................... $30,685 $74,510 $54,632
======= ======= =======
Basic:
Weighted average common shares (Basic
denominator)..................................... 26,410 25,999 24,557
======= ======= =======
Basic earnings per share --
Before extraordinary item........................ $ 1.16 $ 2.96 $ 2.34
Extraordinary loss, aftertax..................... -- (0.09) (0.12)
------- ------- -------
Net.............................................. $ 1.16 $ 2.87 $ 2.22
======= ======= =======
Diluted:
Weighted average common shares...................... 26,410 25,999 24,557
Incremental shares from assumed conversion of stock
options and other................................ 458 500 550
------- ------- -------
Total diluted shares (Diluted denominator).......... 26,868 26,499 25,107
======= ======= =======
Diluted earnings per share --
Before extraordinary item........................ $ 1.14 $ 2.90 $ 2.29
Extraordinary loss, aftertax..................... -- (0.09) (0.11)
------- ------- -------
Net.............................................. $ 1.14 $ 2.81 $ 2.18
======= ======= =======
</TABLE>
In accordance with SFAS No. 128, restricted Common Stock awards totaling
350,000 shares and options to purchase 340,000 shares of Common Stock under the
Company's special incentive compensation strategy (see Note K) were not included
in the computations of earnings per share in 1997 and 1996. No shares were
issuable under this strategy since the attainment of a specified market price of
the Company's Common Stock had not been reached during the periods presented.
These awards and options remained outstanding at December 31, 1997.
Stock-Based Compensation
The Company accounts for stock-based compensation using the intrinsic value
method prescribed in Accounting Principles Board ("APB") No. 25, "Accounting for
Stock Issued to Employees," and related interpretations. Accordingly,
compensation cost for stock options is measured as the excess, if any, of the
quoted market price of the Company's Common Stock at the date of grant over the
amount an employee must pay to acquire the stock. The Company has adopted the
disclosure requirements of SFAS No. 123, "Accounting for Stock-Based
Compensation," as included in Note K.
A-30
<PAGE> 61
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
New Accounting Standards
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 130, "Reporting Comprehensive Income," which establishes standards for
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statements. SFAS No. 130, which becomes effective
for the Company in 1998, requires that all items that are required to be
recognized under accounting standards as components of comprehensive income be
reported in a financial statement that is displayed with the same prominence as
other financial statements. Also, in June 1997, the FASB issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information," which
establishes standards for reporting information about operating segments in
annual financial statements and requires that selected information about
operating segments be included in interim financial reports issued to
shareholders. SFAS No. 131 also establishes standards for related disclosures
about products and services, geographic areas and major customers. SFAS No. 131
becomes effective for the Company's 1998 year-end and need not be applied to
interim financial information until 1999. In February 1998, the FASB issued SFAS
No. 132, "Employers' Disclosures about Pensions and Other Postretirement
Benefits," which standardizes the disclosures related to pensions and other
postretirement benefits to the extent practicable, requires additional
information on changes in the benefit obligations and fair values of plan assets
and eliminates certain disclosures previously required. SFAS No. 132 becomes
effective for the Company in 1998. All three statements contain provisions for
restatement of prior period information. The Company is evaluating the effects
that these new statements will have on its financial reporting and disclosures.
The new statements will have no effect on the Company's results of operations,
financial position or cash flows.
NOTE B -- BUSINESS SEGMENTS
The Company's revenues are derived from three business segments: Refining
and Marketing, Exploration and Production, and Marine Services.
Refining and Marketing operates a petroleum refinery at Kenai, Alaska,
which manufactures gasoline, jet fuel, diesel fuel, heavy oils and residual
products. These products, together with products purchased from third parties,
are sold at wholesale through terminal facilities and other locations in Alaska
and the Pacific Northwest. In addition, Refining and Marketing markets gasoline,
other petroleum products and convenience store items at retail through 35
Company-operated stations in Alaska. Refining and Marketing also markets
petroleum products through 129 branded and 28 unbranded stations located in
Alaska and the Pacific Northwest. Revenues from export sales, primarily to Far
East markets, amounted to $16.1 million, $22.0 million and $18.5 million in
1997, 1996 and 1995, respectively. The Company at times resells previously
purchased crude oil, sales of which amounted to $44.4 million, $93.8 million and
$75.8 million in 1997, 1996 and 1995, respectively.
The Exploration and Production segment is engaged in the exploration,
production and development of natural gas and oil onshore in Texas, Louisiana
and Bolivia. This segment also includes the transportation of natural gas,
including the Company's production, to common carrier pipelines in South Texas.
In Bolivia, the Company operates under four contracts with the Bolivian
government to explore for and produce hydrocarbons. The Company's Bolivian
natural gas production is sold under contract to the Bolivian government for
export to Argentina. The majority of the Company's Bolivian natural gas and oil
reserves are shut-in awaiting access to gas-consuming markets. Major
developments in South America indicate that new markets may open for the
Company's production in the near future. Construction of a new 1,900-mile
pipeline that will link Bolivia's gas reserves with markets in Brazil commenced
in 1997 and is expected to be operational in early 1999.
Marine Services markets and distributes petroleum products and provides
logistics services, primarily to the marine and offshore exploration and
production industries operating in the Gulf of Mexico. This segment
A-31
<PAGE> 62
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
currently operates through 20 terminals along the Texas and Louisiana Gulf Coast
and three terminals on the U.S. West Coast.
Segment operating profit is gross operating revenues, gains and losses on
asset sales and other income less applicable segment costs of sales, operating
expenses, depreciation, depletion and other items. Income taxes, interest
expense, interest income and corporate general and administrative expenses are
not included in determining operating profit. In the Exploration and Production
segment, operating profit in 1997 included income of $1.8 million for severance
tax refunds and $2.2 million related to the collection of a receivable for prior
years Bolivian production. Operating profit in the Exploration and Production
segment in 1996 included $60 million of income from termination of a natural gas
contract and $5 million for retroactive severance tax refunds, and 1995 included
a gain of $33 million from the sale of certain interests in the Bob West Field.
In 1996 and 1995, the Exploration and Production segment's operating profit
included $24.6 million and $47.1 million, respectively, from the excess of
natural gas contract prices over spot market prices (see Note D).
Identifiable assets are those assets utilized by the segment. Corporate
assets are principally cash, investments and other assets that cannot be
directly associated with the operations of a business segment. Segment
information for the years ended December 31, 1997, 1996 and 1995 is as follows
(in millions):
<TABLE>
<CAPTION>
1997 1996 1995
------ -------- --------
<S> <C> <C> <C>
REVENUES
Gross operating revenues:
Refining and Marketing --
Refined products.................................. $643.7 $ 620.8 $ 664.5
Other, primarily crude oil resales and
merchandise.................................... 77.2 124.6 106.5
Exploration and Production --
U.S., including gas transportation................ 73.6 93.8 113.0
Bolivia........................................... 11.2 13.7 11.7
Marine Services..................................... 132.2 122.5 74.5
------ -------- --------
Total Gross Operating Revenues.................... 937.9 975.4 970.2
Income from settlement of a natural gas contract and
other............................................... 5.5 64.4 32.7
------ -------- --------
Total Revenues................................. $943.4 $1,039.8 $1,002.9
====== ======== ========
OPERATING PROFIT (LOSS)
Refining and Marketing................................. $ 20.5 $ 6.0 $ 0.7
Exploration and Production --
U.S., including gas transportation.................. 37.3 123.9 102.0
Bolivia............................................. 8.6 8.8 7.6
Marine Services........................................ 6.3 6.1 (4.4)
------ -------- --------
Total Operating Profit......................... 72.7 144.8 105.9
Corporate and Unallocated Costs........................ (23.6) (29.7) (44.0)
------ -------- --------
Earnings Before Income Taxes and Extraordinary Item.... $ 49.1 $ 115.1 $ 61.9
====== ======== ========
</TABLE>
A-32
<PAGE> 63
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
1997 1996 1995
------ -------- --------
<S> <C> <C> <C>
IDENTIFIABLE ASSETS
Refining and Marketing................................. $337.4 $ 317.0 $ 313.3
Exploration and Production --
U.S., including gas transportation.................. 158.2 143.6 136.7
Bolivia............................................. 50.8 27.0 17.8
Marine Services........................................ 59.3 56.0 18.0
Corporate.............................................. 22.1 39.0 33.4
------ -------- --------
Total Assets................................... $627.8 $ 582.6 $ 519.2
====== ======== ========
DEPRECIATION, DEPLETION AND AMORTIZATION
Refining and Marketing................................. $ 12.7 $ 12.5 $ 11.9
Exploration and Production --
U.S., including gas transportation.................. 29.8 25.6 29.3
Bolivia............................................. 1.5 1.3 0.3
Marine Services........................................ 1.7 1.2 0.3
Corporate.............................................. 0.7 0.9 0.8
------ -------- --------
Total Depreciation, Depletion and
Amortization................................. $ 46.4 $ 41.5 $ 42.6
====== ======== ========
CAPITAL EXPENDITURES
Refining and Marketing................................. $ 43.9 $ 11.1 $ 9.3
Exploration and Production --
U.S., including gas transportation.................. 65.4 59.7 49.6
Bolivia............................................. 27.5 6.9 3.8
Marine Services........................................ 9.4 6.9 0.4
Corporate.............................................. 1.3 0.4 0.8
------ -------- --------
Total Capital Expenditures..................... $147.5 $ 85.0 $ 63.9
====== ======== ========
</TABLE>
NOTE C -- ACQUISITIONS, EXPANSIONS AND DIVESTITURES
Refining and Marketing
In October 1997, the Company completed an expansion of its refinery
hydrocracker unit which enables the Company to increase its jet fuel production.
The expansion, together with the addition of a new, high-yield jet fuel
hydrocracker catalyst, was completed at a cost of approximately $19 million. For
information on financing of this expansion, see Note I.
In December 1997, the Refining and Marketing segment purchased the Union 76
marketing assets in Southeast Alaska, consisting of one terminal, two retail
stations and the rights to use the Union 76 trademark within Alaska. The Company
also expanded its Alaskan retail operations throughout the year with
construction of two new facilities and remodeling of three existing stations.
Two uneconomic outlets in Alaska were closed in 1997.
Exploration and Production
In July 1997, the Company purchased the interests held by its former joint
venture participant in the then existing two contract blocks in southern
Bolivia, consisting of a 25% interest in Block 18 and a 27.4% interest in Block
20. The purchase price was approximately $20 million, which included $11.9
million for proved reserves and $3.4 million for undeveloped acreage with the
remainder for working capital and assumption of certain liabilities.
A-33
<PAGE> 64
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In the U.S., the Exploration and Production segment purchased proved and
unproved properties totaling $22 million during 1997. These purchases included
the acquisition of interests in the Kent Bayou Field in Terrebonne Parish in
southern Louisiana for $5 million and interests in the La Blanca, San Salvador
and San Carlos Fields in the Frio/Vicksburg Trend of Hildago County in South
Texas for $3.1 million during November 1997. Also included was the acquisition
of interests in three natural gas fields in East Texas, including the Carthage
Field in Panola County, the Woodlawn Field in Harrison County and the Oak Hill
Field in Rusk County, for $5.1 million in December 1997.
During 1996, the Company's Exploration and Production segment recorded
acquisitions of proved and unproved properties totaling $25.7 million. The most
significant of these was the purchase in December 1996 of interests in the Los
Indios and La Reforma Fields, located in Hidalgo and Starr counties of South
Texas, for $15 million. These two fields are in the Frio/Vicksburg Trend, which
lies immediately adjacent to the Wilcox Trend. Other acquisitions in 1996
included the purchase of interests in the Berry R. Cox and the West Goliad
Fields, both located in the Wilcox Trend, for $5.4 million and the purchase of
acreage in East Texas for $5.3 million.
In September 1995, the Company sold, effective April 1, 1995, certain
interests in its producing and non-producing oil and gas properties located in
the Bob West Field in South Texas. The interests sold included the Company's
approximate 55% net revenue interest and 70% working interest in Units C, D and
E and a convertible override in Unit F of the Bob West Field. Excluded from the
sale were the Company's interests in the State Park and Sanchez-O'Brien leases
and the Ramirez USA E-6 well within the Bob West Field. In total, the sale
included interests in 14 gross producing wells amounting to 77 Bcf, or 40%, of
the Company's total net proved domestic reserves at the time of the sale (see
Note N). For 1995, natural gas production from the interests sold had
contributed approximately $11.7 million to revenues and $4 million to operating
profit in the Company's Exploration and Production segment. Consideration for
the sale was $74 million, which was adjusted for production, capital
expenditures and certain other items after the effective date to approximately
$68 million in cash received at closing, resulting in a gain of approximately
$33 million in the 1995 third quarter. The consideration received by the Company
was used to redeem $34.6 million of the Company's outstanding 12 3/4%
Subordinated Debentures in 1995, reduce borrowings under the Company's revolving
credit facility and improve corporate liquidity (see Note I).
For further information related to exploration and production activities,
see Note N.
Marine Services
In February 1996, the Company purchased 100% of the capital stock of
Coastwide Energy Services, Inc. ("Coastwide"). The consideration included
approximately 1.4 million shares of Tesoro's Common Stock and $7.7 million in
cash. The market price of Tesoro's Common Stock was $9.00 per share at closing
of this transaction. In addition, Tesoro repaid approximately $4.5 million of
Coastwide's outstanding debt. Coastwide was primarily a provider of logistical
support services and a distributor of petroleum products to the offshore oil and
gas industry in the Gulf of Mexico. The Company combined the Coastwide operation
with its marine petroleum distribution operations, forming a Marine Services
segment. The acquisition was accounted for as a purchase whereby the purchase
price was allocated to the assets acquired and liabilities assumed based upon
their estimated fair values.
NOTE D -- GAS PURCHASE AND SALES CONTRACT
Resolution of Litigation in 1996
On August 16, 1996, the Supreme Court of Texas issued a mandate that denied
a motion for rehearing by Tennessee Gas Pipeline Company ("Tennessee Gas") and
upheld all aspects of a Gas Purchase and Sales Agreement ("Tennessee Gas
Contract") which had been the subject of litigation since 1990. As provided for
A-34
<PAGE> 65
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
in the Tennessee Gas Contract, the Company was selling a portion of the gas
produced from the Bob West Field to Tennessee Gas at a maximum price as
calculated in accordance with Section 102(b)(2) ("Contract Price") of the
Natural Gas Policy Act of 1978. Subsequent to the mandate, the Company received
cash of $67.7 million from Tennessee Gas, which included collection of a $59.6
million bonded receivable for underpayment for natural gas sold in prior
periods. The remaining $8.1 million received was for interest and reimbursement
of legal fees and court costs, which resulted in income during the 1996 third
quarter. Tennessee Gas resumed paying the Contract Price to the Company for gas
taken beginning with May 1996 volumes up until termination of the Tennessee Gas
Contract discussed below.
Settlement and Termination of Contract in 1996
On December 24, 1996, the Company settled all other claims and disputes
with Tennessee Gas, including litigation in Zapata County, Texas filed by
Tennessee Gas, and agreed to terminate the Tennessee Gas Contract effective
October 1, 1996. The Tennessee Gas Contract would have extended through January
1999. Under the settlement, the Company received $51.8 million and the right to
recover severance taxes paid by Tennessee Gas of approximately $8.2 million,
which resulted in income of $60 million to the Company during the 1996 fourth
quarter. The severance taxes were subsequently collected in 1997.
NOTE E -- RECEIVABLES
Concentrations of credit risk with respect to accounts receivable are
limited, due to the large number of customers comprising the Company's customer
base and their dispersion across the Company's industry segments and geographic
areas of operations. The Company performs ongoing credit evaluations of its
customers' financial condition and in certain circumstances requires letters of
credit or other collateral arrangements. The Company's allowance for doubtful
accounts is reflected as a reduction of receivables in the Consolidated Balance
Sheets. The following table reconciles the change in the Company's allowance for
doubtful accounts for the years ended December 31, 1997, 1996 and 1995 (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Balance at Beginning of Year............................. $1,515 $1,842 $1,816
Charged to Costs and Expenses............................ 23 589 300
Recoveries of Amounts Previously Written Off and Other... 189 (44) 122
Write-off of Doubtful Accounts........................... (354) (872) (396)
------ ------ ------
Balance at End of Year................................. $1,373 $1,515 $1,842
====== ====== ======
</TABLE>
NOTE F -- INVENTORIES
Components of inventories at December 31, 1997 and 1996 were as follows (in
thousands):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Crude Oil and Wholesale Refined Products, at LIFO........... $68,227 $55,858
Merchandise and Other Refined Products...................... 13,377 13,539
Materials and Supplies...................................... 5,755 5,091
------- -------
Total Inventories......................................... $87,359 $74,488
======= =======
</TABLE>
At December 31, 1997 and 1996, inventories valued using LIFO were lower
than replacement cost by approximately $4.4 million and $17.7 million,
respectively.
A-35
<PAGE> 66
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE G -- ACCRUED LIABILITIES
The Company's current accrued liabilities and noncurrent other liabilities
as shown in the Consolidated Balance Sheets at December 31, 1997 and 1996
included the following (in thousands):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Accrued Liabilities -- Current:
Accrued environmental costs............................... $ 5,817 $ 5,367
Accrued employee costs.................................... 12,406 7,759
Accrued taxes other than income taxes..................... 4,137 5,988
Accrued interest.......................................... 1,349 1,155
Other..................................................... 7,663 12,987
------- -------
Total Accrued Liabilities -- Current................... $31,372 $33,256
======= =======
Other Liabilities -- Noncurrent:
Accrued postretirement benefits........................... $32,206 $30,508
Accrued environmental costs............................... 2,659 3,496
Other..................................................... 8,346 8,239
------- -------
Total Other Liabilities -- Noncurrent.................. $43,211 $42,243
======= =======
</TABLE>
NOTE H -- INCOME TAXES
The income tax provision for the years ended December 31, 1997, 1996 and
1995 included the following (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- ------
<S> <C> <C> <C>
Federal -- Current..................................... $ 3,413 $16,206 $ 708
Federal -- Deferred.................................... 9,421 17,405 --
Foreign................................................ 4,920 3,654 3,183
State.................................................. 681 1,082 488
------- ------- ------
Income Tax Provision................................. $18,435 $38,347 $4,379
======= ======= ======
</TABLE>
Deferred income taxes and benefits are provided for differences between
financial statement carrying amounts of assets and liabilities and their
respective tax bases. Temporary differences and the resulting deferred tax
assets and liabilities at December 31, 1997 and 1996 are summarized as follows
(in thousands):
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Deferred Federal Tax Assets:
Investment tax and other credits.......................... $ 9,639 $ 11,962
Accrued postretirement benefits........................... 10,480 9,941
Settlement with Department of Energy...................... 3,233 3,694
Environmental reserve..................................... 3,048 3,335
Other..................................................... 5,265 1,523
-------- --------
Total Deferred Federal Tax Assets...................... 31,665 30,455
Deferred Federal Tax Liabilities:
Accelerated depreciation and property-related items....... (57,778) (47,147)
-------- --------
Net Deferred Federal Liability.............................. (26,113) (16,692)
State Income and Other Taxes................................ (2,711) (2,459)
-------- --------
Net Deferred Tax Liability................................ $(28,824) $(19,151)
======== ========
</TABLE>
A-36
<PAGE> 67
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following tables set forth the components of the Company's results of
operations (in thousands) and a reconciliation of the normal statutory federal
income tax rate with the Company's effective tax rate:
<TABLE>
<CAPTION>
1997 1996 1995
------- -------- -------
<S> <C> <C> <C>
Earnings Before Income Taxes and Extraordinary Item:
U.S................................................ $40,200 $106,675 $55,221
Foreign............................................ 8,920 8,472 6,647
------- -------- -------
Total Earnings Before Income Taxes and
Extraordinary Item............................ $49,120 $115,147 $61,868
======= ======== =======
Statutory U.S. Corporate Tax Rate.................... 35% 35% 35%
Effect of:
Foreign income taxes, net of tax benefit........... 5 2 5
State income taxes, net of tax benefit............. 1 1 1
Accounting recognition of operating loss tax
benefits........................................ -- (4) (33)
Other.............................................. (4) (1) (1)
------- -------- -------
Effective Income Tax Rate............................ 37% 33% 7%
======= ======== =======
</TABLE>
At December 31, 1997, the Company had approximately $6.9 million of
investment tax credits and employee stock ownership credits available for
carryover to subsequent years, which, if not used, will expire in the years 1999
through 2006. Additionally, at December 31, 1997, the Company had approximately
$2.7 million of alternative minimum tax credit carryforwards, with no expiration
dates, to offset future regular tax liabilities.
NOTE I -- LONG-TERM DEBT AND OTHER OBLIGATIONS
Long-term debt and other obligations at December 31, 1997 and 1996
consisted of the following (in thousands):
<TABLE>
<CAPTION>
1997 1996
-------- -------
<S> <C> <C>
Liability to State of Alaska................................ $ 62,016 $62,079
Corporate Revolving Credit Facility......................... 28,000 --
Marine Services Loan Facility............................... 5,611 883
Hydrocracker Loan........................................... 16,200 --
Vacuum Unit Loan............................................ 9,107 11,250
Liability to Department of Energy........................... 9,235 10,555
Other....................................................... 2,147 4,536
-------- -------
132,316 89,303
Less Current Maturities..................................... 17,002 10,043
-------- -------
$115,314 $79,260
======== =======
</TABLE>
Aggregate maturities of long-term debt and obligations for each of the five
years following December 31, 1997 are as follows: 1998 -- $17.0 million;
1999 -- $11.9 million; 2000 -- $40.1 million; 2001 -- $13.6 million; and
2002 -- $5.6 million. In addition, in the year 2002, a $60 million payment is
due to the State of Alaska, but may be deferred indefinitely, at the Company's
option, by continuing a variable per barrel throughput charge described below.
A-37
<PAGE> 68
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
State of Alaska
In 1993, the Company entered into an agreement ("Agreement") with the State
of Alaska ("State") that settled a contractual dispute with the State. Under the
Agreement, the Company is obligated to make variable monthly payments to the
State through December 2001 based on a per barrel charge on the volume of
feedstock processed through the Company's refinery crude unit. In 1997 and 1996,
based on a per barrel throughput charge of 24 cents, the Company's variable
payments to the State totaled $4.4 million and $4.0 million, respectively. In
1995, based on a per barrel throughput charge of 16 cents, the Company's
variable payments to the State totaled $2.9 million. The per barrel charge
increases to 30 cents in 1998 with one cent annual incremental increases
thereafter through 2001. In January 2002, the Company is obligated to pay the
State $60 million; provided, however, that such payment may be deferred
indefinitely, at the Company's option, by continuing the variable monthly
payments to the State beginning at 34 cents per barrel for 2002 and increasing
one cent per barrel annually thereafter. Variable monthly payments made after
January 2002 will not reduce the $60 million obligation to the State. The
imputed rate of interest used by the Company on the $60 million obligation was
13%. The $60 million obligation is evidenced by a security bond, and the bond
and the throughput barrel obligations are collateralized by a fourth lien on the
Company's refinery. The Company's obligations under the Agreement and the
mortgage are subordinated to current and future senior debt of up to $175
million plus any indebtedness incurred subsequent to the date of the Agreement
to improve the Company's refinery. Loans obtained to finance the expansion of
the hydrocracker unit and install the vacuum unit, both discussed below, qualify
as indebtedness incurred subsequent to the Agreement to improve the Company's
refinery.
Corporate Revolving Credit Facility
The Company's amended and restated corporate revolving credit agreement
("Credit Facility"), which expires in April 2000, provides total commitments of
$150 million from a consortium of nine banks. The Company, at its option, has
currently activated $100 million of these commitments. The Credit Facility
provides for the issuance of letters of credit, and for cash borrowings up to
$100 million, with the aggregate subject to a borrowing base (which amount
exceeded total commitments at December 31, 1997). Outstanding obligations under
the Credit Facility are collateralized by first liens on substantially all of
the Company's trade receivables, product inventories and South Texas natural gas
reserves and by a third lien on the Company's refinery.
At December 31, 1997, the Company had outstanding cash borrowings of $28
million under the Credit Facility. During 1997, gross borrowings under the
Credit Facility were $150 million, with $122 million of repayments. During 1996
and 1995, the Company's gross borrowings equaled repayments under the Credit
Facility and totaled $165 million and $262 million, respectively. These cash
borrowings are generally used on a short-term basis to finance working capital
requirements and capital expenditures. Under the Credit Facility, at December
31, 1997, the Company had outstanding letters of credit of $34 million,
primarily for royalty crude oil purchases from the State of Alaska. Unused
availability, including unactivated commitments, under the Credit Facility at
December 31, 1997 for additional borrowings and letters of credit totaled $88
million. The Company is also permitted to utilize unsecured letters of credit
outside of the Credit Facility up to $40 million (none outstanding at December
31, 1997).
Cash borrowings under the Credit Facility bear interest at (i) the London
Interbank Offered Rate ("LIBOR") plus 1.0% per annum or (ii) the prime rate per
annum, at the Company's option. Fees on outstanding letters of credit under the
Credit Facility are 1.0% per annum.
The Credit Facility, which has been amended from time to time, requires the
Company to maintain specified levels of consolidated working capital, tangible
net worth, cash flow and interest coverage and contains other covenants
customary in credit arrangements of this kind. Among other matters, the terms of
the Credit Facility allow for general open market stock repurchases and the
payment of cash dividends subject to a
A-38
<PAGE> 69
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
cumulative amount available for restricted payments (defined as the difference
of (i) the sum since December 31, 1995, of (a) $5 million and (b) 50% of
consolidated net earnings of the Company in any calendar year and (ii) any
restricted payments made since June 1996). At December 31, 1997, the cumulative
amount available for restricted payments was approximately $58 million. In
addition to the cumulative restriction, the Credit Facility further limits these
general open market stock repurchases and cash dividends to a maximum of $5
million annually. The Credit Facility also permits the Company to repurchase a
limited amount of Common Stock, up to $10 million annually, specifically for
oddlot buyback programs and employee benefit or compensation plans.
Marine Services Loan Facility
In January 1998, the Company terminated a $10 million loan facility which
had provided a three-year line of credit to the Marine Services segment at the
bank's prime rate. The outstanding balance of $5.6 million at December 31, 1997
was repaid subsequent to year-end.
Hydrocracker Loan
In October 1997, the National Bank of Alaska ("NBA") and the Alaska
Industrial Development and Export Authority ("AIDEA"), under a loan agreement
("Hydrocracker Loan") entered into between the Company and NBA, provided a $16.2
million loan to the Company towards the cost of its refinery hydrocracker
expansion (see Note C). One-half of the loan was funded by NBA and the other
half was funded by AIDEA. The Hydrocracker Loan matures on or before April 1,
2005 and requires 28 equal quarterly principal payments beginning April 1998
together with interest at the unsecured 90-day commercial paper rate (5.55% at
December 31, 1997) adjusted quarterly plus (i) 2.6% per annum on 50% of the
amount borrowed and (ii) 2.35% per annum on the other 50% borrowed. The
Hydrocracker Loan is collateralized by a second lien on the refinery. Under the
terms of the Hydrocracker Loan, the Company is required to maintain specified
levels of working capital and tangible net worth.
Vacuum Unit Loan
In 1994, the NBA and the AIDEA provided a $15 million loan to the Company
towards the cost of the Company's refinery vacuum unit ("Vacuum Unit Loan"). The
Vacuum Unit Loan matures January 1, 2002, requires equal quarterly payments of
approximately $536,000 and bears interest at the unsecured 90-day commercial
paper rate, adjusted quarterly, plus 2.6% per annum (8.11% at December 31, 1997)
for two-thirds of the amount borrowed and at the National Bank of Alaska
floating prime rate plus one-fourth of 1% per annum (8.75% at December 31, 1997)
for the remainder. The Vacuum Unit Loan is collateralized by a first lien on the
Company's refinery. Under the terms of the Vacuum Unit Loan, as amended, the
Company is required to maintain specified levels of working capital and tangible
net worth.
Department of Energy
A Consent Order entered into by the Company with the Department of Energy
("DOE") in 1989 settled all issues relating to the Company's compliance with
federal petroleum price and allocation regulations from 1973 through decontrol
in 1981. At December 31, 1997, the Company's remaining obligation is to pay the
DOE $9.2 million, exclusive of interest at 6%, over the next five years.
Repurchase of Debentures and Notes
In November 1996, the Company fully redeemed its two public debt issues,
totaling approximately $74 million, at a price equal to 100% of the principal
amount, plus accrued interest to the redemption date. The redemption of debt was
comprised of $44.1 million of outstanding 13% Exchange Notes and $30 million of
outstanding 12 3/4% Subordinated Debentures ("Subordinated Debentures"). The
redemption was
A-39
<PAGE> 70
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
accounted for as an early extinguishment of debt in the 1996 third quarter,
resulting in a pretax charge of $3.2 million ($2.3 million aftertax) which
represented a write-off of unamortized bond discount and issue costs. The
extraordinary loss on debt extinguishments of $2.9 million in 1995 related to
the redemption of $34.6 million principal amount of Subordinated Debentures in
December 1995.
NOTE J -- BENEFIT PLANS
Retirement Plan
For all eligible employees, the Company provides a qualified
noncontributory retirement plan. Plan benefits are based on years of service and
compensation. The Company's funding policy is to make contributions at a minimum
in accordance with the requirements of applicable laws and regulations, but no
more than the amount deductible for income tax purposes. The components of net
pension expense for the Company's retirement plan for the years ended December
31, 1997, 1996 and 1995 are presented below (in thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Service Costs......................................... $ 1,502 $ 1,306 $ 1,147
Interest Cost......................................... 3,696 3,536 3,549
Actual Return on Plan Assets.......................... (8,817) (6,212) (8,299)
Net Amortization and Deferral......................... 4,105 1,687 4,288
------- ------- -------
Net Pension Expense................................. $ 486 $ 317 $ 685
======= ======= =======
</TABLE>
The funded status of the Company's retirement plan and amounts included in
the Company's Consolidated Balance Sheets at December 31, 1997 and 1996 are set
forth in the following table (in thousands):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Actuarial Present Value of Benefit Obligation:
Vested benefit obligation................................. $41,601 $40,539
======= =======
Accumulated benefit obligation............................ $44,877 $43,404
======= =======
Plan Assets at Fair Value................................... $50,982 $46,356
Projected Benefit Obligation................................ 52,685 50,163
------- -------
Plan Assets Less Than Projected Benefit Obligation.......... (1,703) (3,807)
Unrecognized Net Loss....................................... 2,003 5,903
Unrecognized Prior Service Costs............................ (267) (341)
Unrecognized Net Transition Asset........................... (1,940) (3,176)
------- -------
Accrued Pension Liability................................. $(1,907) $(1,421)
======= =======
</TABLE>
Retirement plan assets are primarily comprised of common stock and bond
funds. Actuarial assumptions used to measure the projected benefit obligations
included a discount rate of 7 1/2% and a compensation increase rate of 5% for
December 31, 1997, 1996 and 1995. The expected long-term rate of return on
assets was 8 1/2% for 1997, 1996 and 1995.
A-40
<PAGE> 71
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Executive Security Plan
The Company's executive security plan ("ESP") provides executive officers
and other key personnel with supplemental death or retirement benefits in
addition to those benefits available under the Company's group life insurance
and retirement plans. These supplemental retirement benefits are provided by a
nonqualified, noncontributory plan and are based on years of service and
compensation. Contributions are made by the Company based upon the estimated
requirements of the plan. The components of net pension expense for the ESP for
the years ended December 31, 1997, 1996 and 1995 are presented below (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------ ----- -----
<S> <C> <C> <C>
Service Costs............................................. $ 521 $ 354 $ 364
Interest Cost............................................. 363 204 205
Actual Return on Plan Assets.............................. (596) (439) (325)
Net Amortization and Deferral............................. 1,196 751 471
------ ----- -----
Net Pension Expense..................................... $1,484 $ 870 $ 715
====== ===== =====
</TABLE>
During 1997, 1996 and 1995, the Company incurred additional ESP expense of
$1.2 million, $0.9 million and $1.5 million, respectively, for settlements,
curtailments and other benefits resulting from employee terminations.
The funded status of the ESP and amounts included in the Company's
Consolidated Balance Sheets at December 31, 1997 and 1996 are set forth in the
following table (in thousands):
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Actuarial Present Value of Benefit Obligation:
Vested benefit obligation................................. $4,885 $3,300
====== ======
Accumulated benefit obligation............................ $5,585 $4,434
====== ======
Plan Assets at Fair Value................................... $7,732 $7,139
Projected Benefit Obligation................................ 8,683 6,467
------ ------
Plan Assets in Excess of (Less Than) Projected Benefit
Obligation................................................ (951) 672
Unrecognized Net Loss....................................... 6,442 4,532
Unrecognized Prior Service Costs............................ 895 537
Unrecognized Net Transition Obligation...................... 314 417
------ ------
Prepaid Pension Asset..................................... $6,700 $6,158
====== ======
</TABLE>
Assets of the ESP consist of a group annuity contract. Actuarial
assumptions used to measure the projected benefit obligation at December 31,
1997, 1996 and 1995 included a discount rate of 7 1/2% and a compensation
increase rate of 5%. The expected long-term rate of return on assets was 7% for
1997 and 8% for 1996 and 1995.
Retiree Health Care and Life Insurance Benefits
The Company provides health care and life insurance benefits to retirees
who were participating in the Company's group insurance program at retirement.
Health care is also provided to qualified dependents of participating retirees.
These benefits are provided through unfunded, defined benefit plans. The health
care plans are contributory, with retiree contributions adjusted periodically,
and contain other cost-sharing features such as deductibles and coinsurance. The
life insurance plan is noncontributory. The Company funds its share of the cost
of postretirement health care and life insurance benefits on a pay-as-you-go
basis. The components
A-41
<PAGE> 72
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of net periodic postretirement benefits expense, other than pensions, for the
years ended December 31, 1997, 1996 and 1995 included the following (in
thousands):
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Health Care:
Service costs.......................................... $ 676 $ 558 $ 447
Interest costs......................................... 1,304 1,294 1,399
------ ------ ------
Net Periodic Postretirement Expense................. $1,980 $1,852 $1,846
====== ====== ======
Life Insurance:
Service costs.......................................... $ 190 $ 158 $ 174
Interest costs......................................... 580 548 584
------ ------ ------
Net Periodic Postretirement Expense................. $ 770 $ 706 $ 758
====== ====== ======
</TABLE>
The following tables show the status of the plans reconciled with the
amounts in the Company's Consolidated Balance Sheets at December 31, 1997 and
1996 (in thousands):
<TABLE>
<CAPTION>
1997 1996
------- -------
<S> <C> <C>
Health Care:
Accumulated Postretirement Benefit Obligation --
Retirees.................................................. $12,591 $12,549
Active participants eligible to retire.................... 1,638 1,203
Other active participants................................. 4,584 4,181
------- -------
18,813 17,933
Unrecognized Net Gain....................................... 3,211 2,621
------- -------
Accrued Postretirement Benefit Liability............... $22,024 $20,554
======= =======
Life Insurance:
Accumulated Postretirement Benefit Obligation --
Retirees.................................................. $ 6,393 $ 6,274
Active participants eligible to retire.................... 608 484
Other active participants................................. 1,299 1,205
------- -------
8,300 7,963
Unrecognized Net Loss....................................... (380) (115)
------- -------
Accrued Postretirement Benefit Liability............... $ 7,920 $ 7,848
======= =======
</TABLE>
The weighted average annual rate of increase in the per capita cost of
covered health care benefits is assumed to be 8% for 1998, decreasing gradually
to 6% by the year 2005 and remaining at that level thereafter. This health care
cost trend rate assumption has a significant effect on the amount of the
obligation and periodic cost reported. For example, an increase in the assumed
health care cost trend rates by one percentage point in each year would increase
the accumulated postretirement obligation at December 31, 1997 by $3.8 million
and the aggregate of service cost and interest cost components of net periodic
postretirement benefits for the year then ended by $0.5 million. Actuarial
assumptions used to measure the accumulated postretirement benefit obligation at
December 31, 1997, 1996 and 1995 included a discount rate of 7 1/2% and a
compensation rate increase of 5%.
Thrift Plan
The Company sponsors an employee thrift plan which provides for
contributions by eligible employees into designated investment funds with a
matching contribution by the Company. Employees may contribute
A-42
<PAGE> 73
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
up to 10% of their compensation, subject to certain limitations, and may elect
tax deferred treatment in accordance with the provisions of Section 401(k) of
the Internal Revenue Code. Effective October 1, 1996, the thrift plan was
amended to change the Company's matching contribution from 50% (of up to 6% of
the employee's eligible contribution) to 100% (of up to 4% of the employee's
eligible contributions), with at least 50% of the Company's match invested in
Common Stock of the Company. The Company's contributions amounted to $1.2
million, $0.8 million and $0.4 million during 1997, 1996 and 1995, respectively.
Non-Employee Director Retirement Plan and Phantom Stock Plan
The Company had previously established an unfunded Non-Employee Director
Retirement Plan ("Director Retirement Plan"), which provided that any eligible
non-employee director who had served on the Company's Board of Directors for at
least three full years would be entitled to a retirement payment in cash
beginning the later of the director's sixty-fifth birthday or such later date
that the individual's service as a director ended. However, to more closely
align director compensation with shareholders' interests, in March 1997, the
Board of Directors amended the Director Retirement Plan to freeze the plan and
convert all of the accrued benefits of the current directors under the plan to a
lump-sum present value which was transferred to and became the initial account
balance of the directors in the Tesoro Petroleum Corporation Board of Directors
Deferred Phantom Stock Plan ("Phantom Stock Plan"). After the amendment and
transfer, only those retired directors or beneficiaries who had begun receiving
benefits remained participants in the Director Retirement Plan. At December 31,
1997 and 1996, the projected benefit obligation and present value of the vested
and accumulated benefit obligations, discounted at 7 1/2%, of the Director
Retirement Plan were estimated to be $0.4 million and $0.8 million,
respectively. The Company's Consolidated Balance Sheets at December 31, 1997 and
1996 included $0.4 million and $0.7 million, respectively, in other liabilities
related to the Director Retirement Plan.
Upon establishment of the Phantom Stock Plan, the lump-sum accrued benefit
of each of the current non-employee directors was transferred from the Director
Retirement Plan into an account ("Account") in the Phantom Stock Plan. Under the
Phantom Stock Plan, a yearly credit of $7,250 (prorated to $6,042 for 1997) is
made to the Account of each director in units, based upon the closing market
price of the Company's Common Stock on the date of credit. In addition, a
director may elect to have the value of his cash retainer fee deposited
quarterly into the Account in units. The value of each Account balance, which is
a function of the amount, if any, by which the market value of the Company's
Common Stock changes, is payable in cash at retirement, death, disability or
termination, if vested. In 1997, the Company incurred expenses of approximately
$127,000 related to the Phantom Stock Plan due to the increase in the market
price of the Company's Common Stock.
NOTE K -- STOCKHOLDERS' EQUITY
Stock Repurchase Program
On May 7, 1997, the Company's Board of Directors authorized the repurchase
of up to 3 million shares (approximately 11% of current outstanding shares) of
Tesoro Common Stock in a buyback program that will extend through the end of
1998. Under the program, subject to certain conditions, the Company may
repurchase from time to time Tesoro Common Stock in the open market and through
privately negotiated transactions. Purchases will depend on price, market
conditions and other factors and will be made primarily from cash flows. The
repurchased Common Stock is accounted for as treasury stock and may be used for
employee benefit plan requirements and other corporate purposes. During 1997,
the Company used cash flows of $3.7 million to repurchase 236,800 shares of
Common Stock, of which 20,347 shares have been reissued for an employee benefit
plan. For information related to restrictions under the Credit Facility, see
Note I.
A-43
<PAGE> 74
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Stock Plans and Incentive Compensation Strategy
The Company has two employee incentive stock plans, the Amended and
Restated Executive Long-Term Incentive Plan ("1993 Plan") and Amended Incentive
Stock Plan of 1982 ("1982 Plan"), and the 1995 Non-Employee Director Stock
Option Plan ("1995 Plan") (collectively, the "Plans"). Shares of unissued Common
Stock reserved for the Plans were 2,717,611 at December 31, 1997.
The 1993 Plan provides for the grant of up to 2,650,000 shares of the
Company's Common Stock in a variety of forms, including restricted stock,
incentive stock options, nonqualified stock options, stock appreciation rights
and performance share and performance unit awards. Stock options may be granted
at exercise prices not less than the fair market value on the date the options
are granted. The options granted generally become exercisable after one year in
20%, 25% or 33% increments per year and expire ten years from date of grant. The
1993 Plan will expire, unless earlier terminated, as to the issuance of awards
in the year 2003. At December 31, 1997, the Company had 66,420 shares available
for future grants under the 1993 Plan.
In 1997, the Compensation Committee of the Board of Directors granted
175,000 phantom stock options to an executive officer of the Company. These
phantom stock options, which were granted at 100% of the fair market value of
the Company's Common Stock on the grant date, vest in 15% increments in each of
the first three years and the remaining 55% increment vests in the fourth year.
Upon exercise, the executive officer would be entitled to receive in cash the
difference between the fair market value of the Common Stock on the date of the
phantom stock option grant and the fair market value of Common Stock on the date
of exercise. At the discretion of the Compensation Committee, these phantom
stock options may be converted to traditional stock options upon sufficient
shares becoming available under the 1993 Plan.
The 1982 Plan expired in 1994 as to issuance of stock appreciation rights,
stock options and stock awards; however, grants made before the expiration date
that have not been fully exercised remain outstanding pursuant to their terms.
The 1995 Plan provides for the grant of up to an aggregate of 150,000
nonqualified stock options to eligible non-employee directors of the Company.
The option price per share is equal to the fair market value per share of the
Company's Common Stock on the date of grant. The term of each option is ten
years, and an option first becomes exercisable six months after the date of
grant. Under the 1995 Plan, each person serving as a non-employee director on
February 23, 1995 or elected thereafter, initially received an option to
purchase 5,000 shares of Common Stock. Thereafter, each non-employee director,
while the 1995 Plan is in effect and shares are available to grant, will be
granted an option to purchase 1,000 shares of Common Stock on the next day after
each annual meeting of the Company's stockholders but not later than June 1, if
no annual meeting is held. At December 31, 1997, the Company had 68,000 options
outstanding and 77,000 shares available for future grants under the 1995 Plan.
In June 1996, the Company's Board of Directors unanimously approved a
special incentive compensation strategy in order to encourage a longer-term
focus for all employees to perform at an outstanding level. The strategy
provides eligible employees with incentives to achieve a significant increase in
the market price of the Company's Common Stock. Under the strategy, awards would
be earned only if the market price of the Company's Common Stock reaches an
average price per share of $20 or higher over any 20 consecutive trading days
after June 30, 1997 and before December 31, 1998 (the "Performance Target"). In
connection with this strategy, non-executive employees will be able to earn cash
bonuses equal to 25% of their individual payroll amounts for the previous twelve
complete months and certain executives have been granted, from the 1993 Plan, a
total of 340,000 stock options at an exercise price of $11.375 per share, the
fair market value (as defined in the 1993 Plan) of a share of the Company's
Common Stock on the date of grant, and 350,000 shares of restricted Common
Stock, all of which vest only upon achieving the Performance Target.
A-44
<PAGE> 75
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of stock option activity in the Plans is set forth below:
<TABLE>
<CAPTION>
NUMBER OF
OPTIONS WEIGHTED-AVERAGE
OUTSTANDING EXERCISE PRICE
----------- ----------------
<S> <C> <C>
Outstanding December 31, 1994............................ 1,496,293 $ 6.37
Granted................................................ 450,000 8.34
Exercised.............................................. (507,467) 4.85
Forfeited and expired.................................. (266,745) 9.10
---------
Outstanding December 31, 1995............................ 1,172,081 7.16
Granted................................................ 1,095,500 13.45
Exercised.............................................. (315,664) 5.67
Forfeited and expired.................................. (95,171) 8.50
---------
Outstanding December 31, 1996............................ 1,856,746 11.05
Granted................................................ 431,000 16.73
Exercised.............................................. (43,800) 8.45
Forfeited and expired.................................. (36,013) 8.40
---------
Outstanding December 31, 1997............................ 2,207,933 12.26
=========
</TABLE>
At December 31, 1997, 1996 and 1995, exercisable stock options totaled 0.7
million, 0.4 million and 0.4 million, respectively.
The following table summarizes information about stock options outstanding
under the Plans at December 31, 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
------------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED-AVERAGE ------------------------------
RANGE OF NUMBER REMAINING WEIGHTED-AVERAGE NUMBER WEIGHTED-AVERAGE
EXERCISE PRICES OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE
--------------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$ 3.92 to $ 7.19 179,740 5.2 years $ 4.52 159,272 $ 4.42
$ 7.20 to $10.45 551,100 7.5 years 8.65 279,300 8.84
$10.46 to $13.72 398,593 8.4 years 11.41 31,593 11.68
$13.73 to $16.98 1,078,500 9.2 years 15.72 210,173 14.94
--------- ---------
$ 3.92 to $16.98 2,207,933 8.3 years 12.26 680,338 9.82
========= =========
</TABLE>
The Company applies APB No. 25 and related interpretations in accounting
for its stock plans. Accordingly, no compensation expense has been recognized
for stock option transactions or the incentive compensation strategy discussed
above. Had compensation cost for the Plans been determined based on the fair
value at the grant dates for awards (granted after January 1, 1995) in
accordance with SFAS No. 123, "Accounting for Stock-Based Compensation," the
Company's pro forma net earnings in 1997, 1996 and 1995 would have been
approximately $28.5 million ($1.08 per basic share, $1.06 per diluted share),
$72.6 million ($2.79 per basic share, $2.74 per diluted share), and $53.8
million ($2.19 per basic share, $2.15 per diluted share), respectively. The fair
value of each option grant was estimated on the date of grant using the Black-
Scholes option-pricing model with the following weighted-average assumptions:
expected volatility of 32%, 30% and 45%; risk free interest rates of 6.7%, 6.6%
and 6.1%; expected lives of seven years; and no dividend yields for 1997, 1996
and 1995, respectively. The estimated fair value per share of options granted
during 1997, 1996 and 1995 were $5.96, $4.26 and $3.65, respectively, and the
fair value per share of restricted stock awards in 1996 was $0.95 per share.
A-45
<PAGE> 76
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE L -- COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company has various noncancellable operating leases related to
buildings, equipment, property and other facilities. These long-term leases have
remaining primary terms generally up to ten years, with terms of certain
rights-of-way extending up to 34 years, and generally contain multiple renewal
options. Future minimum annual lease payments as of December 31, 1997, for
operating leases having initial or remaining noncancelable lease terms in excess
of one year, excluding marine charters, were as follows (in thousands):
<TABLE>
<S> <C>
1998........................................................ $ 6,135
1999........................................................ 3,378
2000........................................................ 2,907
2001........................................................ 2,514
2002........................................................ 2,272
Remainder................................................... 13,962
-------
Total Minimum Lease Payments.............................. $31,168
=======
</TABLE>
In addition to the long-term lease commitments above, the Company has
leases for two vessels that are primarily used to transport crude oil and
refined products to and from the Company's refinery. At December 31, 1997,
future minimum annual lease payments remaining for these two vessels, which
include operating costs, are approximately $28 million for each of the years
1998 and 1999 and $16 million for the year 2000. Operating costs related to
these vessels, which may vary from year to year, comprised approximately 30% of
the total minimum payments during 1997. The Company also enters into various
month-to-month and other short-term rentals, including a charter of a vessel
primarily used to transport refined products from the Company's refinery to the
Far East.
Total rental expense for short-term and long-term leases, excluding marine
charters, amounted to approximately $11 million, $12 million and $10 million for
1997, 1996 and 1995, respectively. In addition, expenses related to charters of
marine vessels were approximately $34 million, $30 million and $26 million for
1997, 1996 and 1995, respectively.
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 other modifications or changes in use for certain emission sources. The
Company is currently involved with a waste disposal site near Abbeville,
Louisiana, at which it has been named a potentially responsible party under the
Federal Superfund law. Although this law might impose joint and several
liability upon each party at the site, the extent of the Company's allocated
financial contributions to the cleanup of the site is expected to be limited
based upon the number of companies, volumes of waste involved, and an estimated
total cost of approximately $500,000 among all of the parties to close the site.
The Company is currently involved in settlement discussions with the
Environmental Protection Agency ("EPA") and other potentially responsible
parties at the Abbeville, Louisiana site. The Company expects, based on these
discussions, that its liability will not exceed $25,000. The Company is also
involved in remedial responses and has incurred cleanup expenditures associated
with environmental matters at a number of sites, including certain of its own
properties.
At December 31, 1997, the Company's accruals for environmental expenses
amounted to $8.5 million, which included a noncurrent liability of $2.7 million
for remediation of the Kenai Pipe Line Company's
A-46
<PAGE> 77
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
("KPL") properties that has been funded by the former owners of KPL through a
restricted escrow deposit. Based on currently available information, including
the participation of other parties or former owners in remediation actions, the
Company believes these accruals are adequate.
To comply with environmental laws and regulations, the Company anticipates
that it will make capital improvements of approximately $7 million in 1998 and
$2 million in 1999. In addition, capital expenditures for alternative secondary
containment systems for existing storage tank facilities are estimated to be $2
million in 1998 and $2 million in 1999 with a remaining $5 million to be spent
by 2002.
Conditions that require additional expenditures may exist for various
Company sites, including, but not limited to, the Company's refinery, retail
gasoline stations (current and closed locations) and petroleum product
terminals, and for compliance with the Clean Air Act. The amount of such future
expenditures cannot currently be determined by the Company.
Crude Oil Purchase Contracts
The Company has a contract with the State of Alaska for the purchase of
royalty crude oil covering the period January 1, 1996 through December 31, 1998.
The contract provides for the purchase of 30% of the State's ANS royalty crude
oil produced from the Prudhoe Bay Unit at prices based on royalty values
computed by the State. During 1997, the Company purchased approximately 35,700
barrels per day of ANS crude oil under this contract. The contract contains
provisions that, under certain conditions, allow the Company to temporarily or
permanently reduce its purchase obligations. Under this contract, the Company is
required to utilize in its refinery operations volumes equal to at least 80% of
the ANS crude oil purchased from the State. The Company is presently in
discussions with the State in regard to extending this contract for an
additional year.
The Company also purchases approximately 6,000 barrels per day of ANS crude
oil from a producer under a contract with a term of one year beginning January
1, 1998.
During October 1997, the Company began purchasing all of the approximately
34,000 barrels per day of Cook Inlet crude oil production from various producers
under contracts extending through December 1998. A contract to purchase 4,500
barrels per day, of the 34,000 barrels per day, has been extended through March
31, 2001.
A-47
<PAGE> 78
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE M -- QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
QUARTERS
--------------------------------- TOTAL
FIRST SECOND THIRD FOURTH YEAR
------ ------ ------ ------ --------
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
1997
Revenues:
Gross operating revenues........................ $233.3 $210.7 $251.0 $242.9 $ 937.9
Other income.................................... 1.6 2.6 0.4 0.9 5.5
------ ------ ------ ------ --------
Total Revenues............................. $234.9 $213.3 $251.4 $243.8 $ 943.4
====== ====== ====== ====== ========
Operating Profit................................... $ 15.0 $ 19.9 $ 19.4 $ 18.4 $ 72.7
====== ====== ====== ====== ========
Net Earnings....................................... $ 6.1 $ 9.7 $ 8.0 $ 6.9 $ 30.7
====== ====== ====== ====== ========
Net Earnings Per Share -- Basic.................... $ 0.23 $ 0.36 $ 0.30 $ 0.26 $ 1.16
Net Earnings Per Share -- Diluted.................. $ 0.23 $ 0.36 $ 0.30 $ 0.26 $ 1.14
1996
Revenues:
Gross operating revenues........................ $238.6 $233.8 $262.8 $240.2 $ 975.4
Income from settlement of natural gas
contract...................................... -- -- -- 60.0 60.0
Other income.................................... 5.0 0.1 (0.7) -- 4.4
------ ------ ------ ------ --------
Total Revenues............................. $243.6 $233.9 $262.1 $300.2 $1,039.8
====== ====== ====== ====== ========
Operating Profit................................... $ 20.7 $ 27.6 $ 25.2 $ 71.3 $ 144.8
====== ====== ====== ====== ========
Earnings Before Extraordinary Item................. $ 6.0 $ 12.0 $ 16.2 $ 42.6 $ 76.8
Extraordinary Loss on Debt Extinguishments, Net.... -- -- (2.3) -- (2.3)
------ ------ ------ ------ --------
Net Earnings............................... $ 6.0 $ 12.0 $ 13.9 $ 42.6 $ 74.5
====== ====== ====== ====== ========
Net Earnings Per Share -- Basic.................... $ 0.24 $ 0.46 $ 0.53 $ 1.62 $ 2.87
Net Earnings Per Share -- Diluted.................. $ 0.23 $ 0.45 $ 0.52 $ 1.59 $ 2.81
</TABLE>
Pretax other income related to severance tax refunds of $1.6 million and
$0.2 million were recorded in the 1997 first and second quarters, respectively.
Pretax other income of $2.2 million related to the collection of a Bolivian
receivable for prior years production was recorded in the 1997 second quarter.
The 1996 first quarter included pretax other income of $5 million related
to retroactive severance tax refunds. The 1996 third quarter included pretax
income of $8 million for interest and reimbursement of costs from Tennessee Gas
(see Note D) and an aftertax extraordinary loss of $2.3 million for the early
extinguishment of debt (see Note I). The contract with Tennessee Gas was
terminated during the 1996 fourth quarter resulting in pretax income of $60
million (see Note D). Operating profit included approximately $8 million pretax
in each of the first, second and third quarters of 1996 from the excess of
natural gas contract prices over spot market prices.
A-48
<PAGE> 79
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE N -- OIL AND GAS PRODUCING ACTIVITIES
The information presented below represents the oil and gas producing
activities of the Company's Exploration and Production segment, excluding
amounts related to its U.S. natural gas transportation operations. Other
information pertinent to the Exploration and Production segment is contained in
Notes B, C and D.
Capitalized Costs Relating to Oil and Gas Producing Activities
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------
1997 1996 1995
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Capitalized Costs:
Proved properties................................ $251,604 $179,433 $119,836
Unproved properties not being amortized.......... 31,918 12,344 5,118
-------- -------- --------
283,522 191,777 124,954
Accumulated depreciation, depletion and
amortization.................................. 112,562 78,222 51,549
-------- -------- --------
Net Capitalized Costs......................... $170,960 $113,555 $ 73,405
======== ======== ========
</TABLE>
The Company's investment in oil and gas properties included $31.9 million
in unevaluated properties, primarily undeveloped leasehold costs and seismic
costs, which have been excluded from the amortization base at December 31, 1997.
Of this amount, $26.3 million and $5.6 million of such costs were incurred in
1997 and 1996, respectively. The Company anticipates that the majority of these
costs will be included in the amortization base during the next two years.
Costs Incurred in Oil and Gas Property Acquisition, Exploration and
Development Activities
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
1997
Property acquisitions --
Proved........................................... $14,723 $11,892 $26,615
Unproved......................................... 7,127 3,370 10,497
Exploration......................................... 24,584 10,972 35,556
Development......................................... 17,798 1,279 19,077
------- ------- -------
$64,232 $27,513 $91,745
======= ======= =======
1996
Property acquisitions --
Proved........................................... $20,454 $ -- $20,454
Unproved......................................... 5,216 -- 5,216
Exploration......................................... 11,830 6,704 18,534
Development......................................... 22,228 149 22,377
------- ------- -------
$59,728 $ 6,853 $66,581
======= ======= =======
1995
Property acquisition, unproved...................... $ 1,432 $ -- $ 1,432
Exploration......................................... 10,011 2,994 13,005
Development......................................... 38,003 792 38,795
------- ------- -------
$49,446 $ 3,786 $53,232
======= ======= =======
</TABLE>
A-49
<PAGE> 80
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Results of Operations from Oil and Gas Producing Activities
The following table sets forth the results of operations for oil and gas
producing activities, in the aggregate by geographic area, with income tax
expense computed using the statutory tax rate for the period adjusted for
permanent differences, tax credits and allowances.
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
---- -------- -----
(IN THOUSANDS EXCEPT AS INDICATED)
<S> <C> <C> <C>
1997
Gross revenues -- sales to unaffiliates(a)........ $ 68,843 $11,189 $ 80,032
Production costs.................................. 7,424 932 8,356
Administrative support and other.................. 2,217 2,321 4,538
Depreciation, depletion and amortization.......... 29,350 1,538 30,888
Other income(b)................................... 3,238 2,184 5,422
-------- ------- --------
Pretax results of operations...................... 33,090 8,582 41,672
Income tax expense................................ 11,582 4,915 16,497
-------- ------- --------
Results of operations from producing
activities(c).................................. $ 21,508 $ 3,667 $ 25,175
======== ======= ========
Depletion per net equivalent thousand cubic feet
("Mcfe")....................................... $ 0.93 $ 0.19
======== =======
1996
Gross revenues -- sales to unaffiliates(a)........ $ 88,358 $13,701 $102,059
Production costs.................................. 5,326 837 6,163
Administrative support and other.................. 3,649 2,830 6,479
Depreciation, depletion and amortization.......... 25,235 1,279 26,514
Income from settlement of a natural gas
contract(d).................................... 60,000 -- 60,000
Income from severance tax refunds................. 5,000 -- 5,000
-------- ------- --------
Pretax results of operations...................... 119,148 8,755 127,903
Income tax expense................................ 41,702 5,439 47,141
-------- ------- --------
Results of operations from producing
activities(c).................................. $ 77,446 $ 3,316 $ 80,762
======== ======= ========
Depletion per Mcfe................................ $ 0.79 $ 0.15
======== =======
1995
Gross revenues -- sales to unaffiliates(a)........ $107,276 $11,707 $118,983
Production costs.................................. 12,005 600 12,605
Administrative support and other.................. 2,842 3,289 6,131
Gain on sales of assets(e)........................ 33,532 -- 33,532
Depreciation, depletion and amortization.......... 29,004 250 29,254
-------- ------- --------
Pretax results of operations...................... 96,957 7,568 104,525
Income tax expense................................ 33,935 4,718 38,653
-------- ------- --------
Results of operations from producing
activities(c).................................. $ 63,022 $ 2,850 $ 65,872
======== ======= ========
Depletion per Mcfe................................ $ 0.69 $ 0.03
======== =======
</TABLE>
- ---------------
(a) Revenues included the effects of natural gas commodity price agreements
which amounted to losses of $1.6 million ($0.05 per thousand cubic feet
("Mcf")) and $3.1 million ($0.11 per Mcf) in 1997 and 1996, respectively,
and to a gain of $0.3 million ($0.01 per Mcf) in 1995. The Company had
entered into these agreements to reduce risks caused by fluctuations in the
prices of natural gas in the spot market. During 1997, 1996 and 1995, the
Company used such agreements to set the price of 9%, 30% and 38%,
A-50
<PAGE> 81
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
respectively, of the natural gas that it sold in the spot market. The
Company has no remaining natural gas price agreements outstanding at
December 31, 1997.
(b) Primarily represents income from retroactive severance tax refunds in the
U.S. operations and income related to a collection of a receivable in
Bolivian operations.
(c) Excludes corporate general and administrative expenses and financing costs.
(d) See Note D.
(e) Represents gain on sale of certain interests in the Bob West Field (see
Note C).
Standardized Measure of Discounted Future Net Cash Flows Relating to Proved
Reserves (Unaudited)
The following table sets forth the computation of the standardized measure
of discounted future net cash flows relating to proved reserves and the changes
in such cash flows in accordance with SFAS No. 69. The standardized measure is
the estimated excess future cash inflows from proved reserves less estimated
future production and development costs, estimated future income taxes and a
discount factor. Future cash inflows represent expected revenues from production
of year-end quantities of proved reserves based on year-end prices and any fixed
and determinable future escalation provided by contractual arrangements in
existence at year-end. Escalation based on inflation, federal regulatory changes
and supply and demand are not considered. Estimated future production costs
related to year-end reserves are based on year-end costs. Such costs include,
but are not limited to, production taxes and direct operating costs. Inflation
and other anticipatory costs are not considered until the actual cost change
takes effect. Estimated future income tax expenses are computed using the
appropriate year-end statutory tax rates. Consideration is given for the effects
of permanent differences, tax credits and allowances. A discount rate of 10% is
applied to the annual future net cash flows.
The methodology and assumptions used in calculating the standardized
measure are those required by SFAS No. 69. The standardized measure is not
intended to be representative of the fair market value of the Company's proved
reserves. The calculations of revenues and costs do not necessarily represent
the amounts to be received or expended by the Company.
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
DECEMBER 31, 1997
Future cash inflows.............................. $347,904 $490,337 $838,241
Future production costs.......................... 81,011 86,546 167,557
Future development costs......................... 29,362 48,860 78,222
-------- -------- --------
Future net cash flows before income tax
expense....................................... 237,531 354,931 592,462
10% annual discount factor....................... 70,036 148,461 218,497
-------- -------- --------
Discounted future net cash flows before income
taxes......................................... 167,495 206,470 373,965
Discounted future income tax expense(a).......... 32,284 107,318 139,602
-------- -------- --------
Standardized measure of discounted future net
cash flows(b)................................. $135,211 $ 99,152 $234,363
======== ======== ========
</TABLE>
A-51
<PAGE> 82
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
DECEMBER 31, 1996
Future cash inflows.............................. $376,103 $368,119 $744,222
Future production costs.......................... 66,524 72,766 139,290
Future development costs......................... 13,156 30,632 43,788
-------- -------- --------
Future net cash flows before income tax
expense....................................... 296,423 264,721 561,144
10% annual discount factor....................... 73,687 130,915 204,602
-------- -------- --------
Discounted future net cash flows before income
taxes......................................... 222,736 133,806 356,542
Discounted future income tax expense (a)......... 70,251 80,102 150,353
-------- -------- --------
Standardized measure of discounted future net
cash flows.................................... $152,485 $ 53,704 $206,189
======== ======== ========
DECEMBER 31, 1995
Future cash inflows.............................. $265,379 $120,510 $385,889
Future production costs.......................... 53,095 32,005 85,100
Future development costs......................... 8,625 7,548 16,173
-------- -------- --------
Future net cash flows before income tax
expense....................................... 203,659 80,957 284,616
10% annual discount factor....................... 34,920 32,231 67,151
-------- -------- --------
Discounted future net cash flows before income
taxes......................................... 168,739 48,726 217,465
Discounted future income tax expense(a).......... 45,939 25,897 71,836
-------- -------- --------
Standardized measure of discounted future net
cash flows.................................... $122,800 $ 22,829 $145,629
======== ======== ========
</TABLE>
- ---------------
(a) For Bolivia, the discounted future income tax expense includes Bolivian
taxes of $105.0 million, $69.4 million and $21.6 million as of December 31,
1997, 1996 and 1995, respectively, and U.S. income taxes of $2.3 million,
$10.7 million and $4.3 million at December 31, 1997, 1996 and 1995,
respectively.
(b) Gross rates for the Company's Bolivian production were increased from 40
million cubic feet ("MMcf") per day to 120 MMcf per day in the year 2000
due to the anticipated completion of the Bolivia-Brazil pipeline during
early 1999 as discussed in Note B. This increase accounted for
approximately $57 million of the standardized measure of discounted future
net cash flows for Bolivia at December 31, 1997.
Changes in Standardized Measure of Discounted Future Net Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Sales of oil and gas produced, net of production
costs............................................. $(69,567) $(93,275) $(106,378)
Net changes in prices and production costs.......... (88,473) 39,409 (32,931)
Extensions, discoveries and improved recovery....... 42,191 81,201 83,045
Changes in future development costs................. (7,495) (17,704) 19,221
Revisions of previous quantity estimates............ 15,819 (7,244) 60,800
Purchases (sales) of minerals in-place.............. 79,024 55,484 (48,698)
Changes in timing of Bolivian production............ 10,271 -- --
Extension of Bolivian contract terms................ -- 26,564 --
Other changes in Bolivian Hydrocarbons Law.......... -- 32,894 --
Accretion of discount............................... 20,619 14,563 14,878
Net changes in income taxes......................... 25,785 (71,332) 6,917
-------- -------- ---------
Net increase (decrease)............................. 28,174 60,560 (3,146)
Beginning of period................................. 206,189 145,629 148,775
-------- -------- ---------
End of period....................................... $234,363 $206,189 $ 145,629
======== ======== =========
</TABLE>
A-52
<PAGE> 83
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Reserve Information (Unaudited)
The following estimates of the Company's net proved oil and gas reserves
are based on evaluations prepared by Netherland, Sewell & Associates, Inc.,
except for U.S. net reserves at December 31, 1997 which were prepared by
in-house engineers and audited by Netherland, Sewell & Associates, Inc. Reserves
were estimated in accordance with guidelines established by the Securities and
Exchange Commission and Financial Accounting Standards Board, which require that
reserve estimates be prepared under existing economic and operating conditions
with no provision for price and cost escalations except by contractual
arrangements.
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
------- ------- -------
<S> <C> <C> <C>
NET PROVED GAS RESERVES (millions of cubic feet)(a)
December 31, 1994......................................... 129,099 95,756 224,855
Revisions of previous estimates........................ 46,239 (553) 45,686
Extensions, discoveries and other additions............ 50,201 -- 50,201
Production............................................. (41,789) (6,807) (48,596)
Sales of minerals in-place............................. (77,373) -- (77,373)
------- ------- -------
December 31, 1995......................................... 106,377 88,396 194,773
Extension of Bolivian contract terms(b)................ -- 32,998 32,998
Other changes in Bolivian Hydrocarbons Law(b).......... -- 56,704 56,704
Revisions of previous estimates........................ (4,792) (149) (4,941)
Extensions, discoveries and other additions............ 22,977 59,964 82,941
Production............................................. (32,081) (7,412) (39,493)
Purchases of minerals in-place......................... 24,309 -- 24,309
------- ------- -------
December 31, 1996......................................... 116,790 230,501 347,291
Revisions of previous estimates........................ (3,063) 30,567 27,504
Extensions and discoveries............................. 33,648 -- 33,648
Production............................................. (31,409) (7,131) (38,540)
Purchases of minerals in-place......................... 30,527 81,229 111,756
------- ------- -------
December 31, 1997 (c)..................................... 146,493 335,166 481,659
======= ======= =======
NET PROVED DEVELOPED GAS RESERVES (millions of cubic feet)
December 31, 1994......................................... 110,071 81,558 191,629
December 31, 1995......................................... 95,930 72,500 168,430
December 31, 1996......................................... 107,509 123,154 230,663
December 31, 1997 (c)..................................... 112,385 181,402 293,787
</TABLE>
A-53
<PAGE> 84
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
------- ------- -------
<S> <C> <C> <C>
NET PROVED OIL RESERVES (thousands of barrels)(a)
December 31, 1994......................................... -- 1,793 1,793
Revisions of previous estimates........................ 1 10 11
Extensions, discoveries and other additions............ 8 -- 8
Production............................................. (1) (207) (208)
------- ------- -------
December 31, 1995......................................... 8 1,596 1,604
Extension of Bolivian contract terms(b)................ -- 459 459
Other changes in Bolivian Hydrocarbons Law(b).......... -- 913 913
Revisions of previous estimates........................ (4) 150 146
Extensions, discoveries and other additions............ -- 840 840
Production............................................. (10) (214) (224)
Purchases of minerals in-place......................... 188 -- 188
------- ------- -------
December 31, 1996......................................... 182 3,744 3,926
Revisions of previous estimates........................ (5) 349 344
Extensions and discoveries............................. 87 -- 87
Production............................................. (43) (189) (232)
Purchases of minerals in-place......................... 430 1,301 1,731
------- ------- -------
December 31, 1997 (c)..................................... 651 5,205 5,856
======= ======= =======
NET PROVED DEVELOPED OIL RESERVES (thousands of barrels)
December 31, 1994......................................... -- 1,627 1,627
December 31, 1995......................................... 4 1,407 1,411
December 31, 1996......................................... 126 2,291 2,417
December 31, 1997 (c)..................................... 296 3,137 3,433
</TABLE>
- ---------------
(a) The Company is required to file annual estimates of its proved reserves with
the Department of Energy. Such filings have been consistent with the
information presented herein.
(b) Under a new Hydrocarbons Law passed by the Bolivian government in 1996, the
Company converted its Contracts of Operation for Block 18 and Block 20 into
four Shared Risk Contracts, which, among other matters, extend the Company's
term of operation, provide more favorable acreage relinquishment terms and
provide for a more favorable royalty and tax structure.
(c) No major discovery or adverse event has occurred since December 31, 1997
that would cause a significant change in net proved reserve volumes.
NOTE O -- SUBSEQUENT EVENT (UNAUDITED)
On March 18, 1998, the Company entered into a stock sale agreement with BHP
Hawaii Inc. and BHP Petroleum Pacific Islands Inc., subsidiaries of The Broken
Hill Proprietary Company Limited ("BHP"), whereby Tesoro will purchase all of
the outstanding stock of BHP Petroleum Americas Refining Inc. ("BHP Refining")
and BHP Petroleum South Pacific Inc. ("BHP South Pacific"). The primary assets
of BHP Refining and BHP South Pacific include a 95,000-barrel per day refinery
and 32 retail gasoline stations located in Hawaii. In addition, Tesoro and a BHP
affiliate will enter into a two-year crude supply agreement pursuant to which
the BHP affiliate will assist Tesoro in acquiring crude oil feedstock sourced
outside of North America and arrange for the transportation of such crude oil to
the Hawaiian refinery. The acquisition is expected to close by the end of May
1998, subject to regulatory review and other customary conditions. Under the
terms of the stock sale agreement, the Company has deposited $5 million into an
escrow account for this acquisition. The purchase price to be paid at closing
includes $275 million in cash, less the amount of the escrow deposit. After
closing, the cash purchase price will be increased by an amount that net working
capital acquired
A-54
<PAGE> 85
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
exceeds $100 million or reduced by an amount that the net working capital
acquired is less than $100 million. In addition, Tesoro will issue an unsecured,
non-interest bearing, promissory note for the purchase in the amount of $50
million, payable in five equal annual installments of $10 million each,
beginning in 2009. The note will provide for early payment to the extent of
one-half of the amount by which earnings from the acquired assets, before
interest expense, income taxes and depreciation, depletion and amortization, as
specified in the note, exceed $50 million in any calendar year. Upon
acceleration due to an event of default, the amount outstanding to be paid under
the note will be reduced to present value using a discount rate of 9%. The
acquisition, which significantly increases the scope of the Company's refining
and marketing operations, will be accounted for as a purchase whereby the
purchase price will be allocated to the assets acquired and liabilities assumed
based on their estimated fair values at the date of acquisition. The Company is
currently in discussions with its investment bankers to arrange for financing of
the acquisition and associated working capital and letter of credit
requirements.
A-55
<PAGE> 86
TESORO PETROLEUM CORPORATION
THRIFT PLAN
ANNUAL MEETING OF STOCKHOLDERS, JULY 29, 1998
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS.
The undersigned participant in the TESORO PETROLEUM CORPORATION THRIFT
PLAN (the "Plan") hereby acknowledges receipt of the Notice of the Annual
Meeting of Stockholders to be held at the Hotel Crescent Court, 400 Crescent
Court, Dallas, Texas, on Wednesday, July 29, 1998, at 10:00 A.M. Central time,
and directs the Fidelity Management Trust Company, Trustee, to vote (or cause to
be voted) all shares of Tesoro Common Stock allocated to the undersigned's
account under the Plan and held in the Trustee's name on June 9, 1998, at said
meeting and at any adjournment thereof. Said Trustee is authorized to vote in
accordance with the Proxy Statement for the election of the persons nominated
pursuant thereto as directors (unless authority is withheld as provided below),
as indicated below upon the following proposals, more fully set forth in the
Proxy Statement, and in its discretion upon such other matters as may properly
come before the meeting.
(Continued and to be signed on the reverse side)
<PAGE> 87
PLEASE MARK YOUR CHOICE LIKE THIS X IN BLUE OR BLACK INK [X]
THE BOARD OF DIRECTORS RECOMMENDS YOU VOTE "FOR" THE NOMINEES LISTED IN ITEM 1
AND "FOR" ITEM 2, ITEM 3 AND ITEM 4.
ITEM 1 - Election of 7 directors (all nominated as directors to serve for the
terms indicated in the Proxy Statement).
[ ] FOR all nominees [ ] WITHHELD for all nominees
Nominees: Steven H. Grapstein; William J. Johnson; Alan J. Kaufman; Raymond K.
Mason, Sr.; Bruce A. Smith; Patrick J. Ward; and Murray L. Weidenbaum.
INSTRUCTIONS: TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE, DRAW A
LINE THROUGH OR STRIKE OUT THAT NOMINEE'S NAME AS SET FORTH ABOVE.
ITEM 2 - Proposal to amend the Company's Restated Certificate of Incorporation
to increase the number of authorized shares of the Company's Common Stock from
50,000,000 to 100,000,000.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
ITEM 3 - Proposal to increase the number of shares which can be granted under
the Amended and Restated Executive Long-Term Incentive Plan and increase the
limit on the number of shares of restricted stock which can be granted under
such plan.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
ITEM 4 - Ratification of the appointment of Deloitte & Touche LLP as the
Company's independent auditors for fiscal year 1998.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
ITEM 5 - To transact such other business as may properly come before the meeting
or any adjournment thereof.
Dated: , 1998
---------------------------
Signature:
------------------------------
PLEASE SIGN EXACTLY AS NAME APPEARS ABOVE. WHEN SIGNING AS ATTORNEY, EXECUTOR,
ADMINISTRATOR, TRUSTEE OR GUARDIAN, PLEASE GIVE FULL TITLE AS SUCH.
<PAGE> 88
TESORO PETROLEUM CORPORATION
ANNUAL MEETING OF STOCKHOLDERS, JULY 29, 1998
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS.
PLEASE MARK, SIGN, DATE AND RETURN IN THE ENCLOSED ENVELOPE.
The undersigned hereby appoints BRUCE A. SMITH and JAMES C. REED, JR.,
and each of them, as proxies of the undersigned, each with full power to act
without the other and with full power of substitution, to vote all the shares of
Common Stock of Tesoro Petroleum Corporation held in the name of the undersigned
at the close of business on June 9, 1998, at the Annual Meeting of Stockholders
to be held at the Hotel Crescent Court, 400 Crescent Court, Dallas, Texas, on
Wednesday, July 29, 1998, at 10:00 A.M. Central time, and at any adjournment
thereof, with all the powers the undersigned would have if personally present,
upon the matters set forth in the Notice of such meeting and as indicated in the
following sentence. Said proxies are authorized to vote in accordance with the
Proxy Statement for the election of the persons nominated pursuant thereto as
directors (unless authority is withheld as provided below), as indicated below
upon the following proposals, more fully set forth in the Proxy Statement, and
in their discretion upon such other matters as may properly come before the
meeting.
(Continued and to be signed on the reverse side)
<PAGE> 89
PLEASE MARK YOUR CHOICE LIKE THIS X IN BLUE OR BLACK INK [X]
THE BOARD OF DIRECTORS RECOMMENDS YOU VOTE "FOR" THE NOMINEES LISTED IN ITEM 1
AND "FOR" ITEM 2, ITEM 3 AND ITEM 4.
ITEM 1 - Election of 7 directors (all nominated as directors to serve for the
terms indicated in the Proxy Statement).
[ ] FOR all nominees [ ] WITHHELD for all nominees
Nominees: Steven H. Grapstein; William J. Johnson; Alan J. Kaufman; Raymond K.
Mason, Sr.; Bruce A. Smith; Patrick J. Ward; and Murray L. Weidenbaum.
INSTRUCTIONS: TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE, DRAW A
LINE THROUGH OR STRIKE OUT THAT NOMINEE'S NAME AS SET FORTH ABOVE.
ITEM 2 - Proposal to amend the Company's Restated Certificate of Incorporation
to increase the number of authorized shares of the Company's Common Stock from
50,000,000 to 100,000,000.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
ITEM 3 - Proposal to increase the number of shares which can be granted under
the Amended and Restated Executive Long-Term Incentive Plan and increase the
limit on the number of shares of restricted stock which can be granted under
such plan.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
ITEM 4 - Ratification of the appointment of Deloitte & Touche LLP as the
Company's independent auditors for fiscal year 1998.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
ITEM 5 - To transact such other business as may properly come before the meeting
or any adjournment thereof.
THIS PROXY WHEN PROPERLY EXECUTED AND
RETURNED WILL BE VOTED IN THE MANNER
DIRECTED BY THE UNDERSIGNED STOCKHOLDER.
IF NO DIRECTION IS GIVEN, THIS PROXY WILL
BE VOTED FOR THE NOMINEES LISTED IN ITEM
1 AND FOR ITEMS 2, 3 AND 4.
Dated: , 1998
------------------------------
Signature:
-------------------------------
Signature:
-------------------------------
PLEASE SIGN EXACTLY AS NAME APPEARS ABOVE. WHEN SHARES ARE HELD BY JOINT
TENANTS, BOTH SHOULD SIGN. WHEN SIGNING AS ATTORNEY, EXECUTOR, ADMINISTRATOR,
TRUSTEE OR GUARDIAN, PLEASE GIVE FULL TITLE AS SUCH. IF A CORPORATION, PLEASE
SIGN IN FULL CORPORATION NAME BY PRESIDENT OR OTHER AUTHORIZED OFFICER. IF A
PARTNERSHIP, PLEASE SIGN IN PARTNERSHIP NAME BY AUTHORIZED PERSON.
