<PAGE> 1
Filed pursuant to Rule 424(b)(5)
Registration No. 333-51789
PROSPECTUS SUPPLEMENT Tesoro logo
(To Prospectus dated May 14, 1998)
5,000,000 SHARES
TESORO PETROLEUM CORPORATION
Common Stock
------------------------
All of the shares of Common Stock offered hereby (the "Offering" or the
"Common Stock Offering") are being sold by Tesoro Petroleum Corporation (the
"Company" or "Tesoro"). See "Underwriting."
The Common Stock Offering is being made in connection with the acquisition
(the "Hawaii Acquisition") of BHP Hawaii (as defined herein) and the acquisition
(the "Washington Acquisition," and with the Hawaii Acquisition, the
"Acquisitions") of Shell Washington (as defined herein) by the Company.
Concurrently with the Common Stock Offering, the Company is offering 9,000,000
Premium Income Equity Securities(SM) (the "PIES(SM)") representing interests in
the Company's 7 1/4% Mandatorily Convertible Preferred Stock (the "Mandatorily
Convertible Preferred Stock"), with gross proceeds of $143.4 million.
Concurrently with the syndication of the Senior Credit Facility (as defined
herein), the Company is offering $300.0 million in aggregate principal amount of
its Senior Subordinated Notes (the "Notes"). The Common Stock Offering is not
conditioned upon the closing of the offering of PIES (the "PIES Offering") or
the Notes (the "Notes Offering," and together with the Common Stock Offering and
the PIES Offering, the "Offerings"), nor is the closing of any of the Offerings
conditioned upon the closing of the Washington Acquisition. Net proceeds from
the Offerings, together with borrowings under the Senior Credit Facility, will
be used to fund the cash purchase price of the Washington Acquisition, to
refinance the Interim Credit Facility (as defined herein) (a portion of which
was used to fund the cash purchase price of the Hawaii Acquisition), to pay
certain fees and expenses related to the Transactions (as defined herein) and
for general corporate purposes (including working capital requirements and
capital expenditures). See "Use of Proceeds."
The Common Stock is listed on the New York Stock Exchange (the "NYSE") and
the Pacific Stock Exchange under the symbol "TSO." On June 25, 1998, the last
sales price of the Common Stock, as reported by the NYSE, was $15 15/16 per
share.
------------------------
SEE "RISK FACTORS" BEGINNING ON PAGE S-14 HEREIN FOR A DISCUSSION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ADEQUACY OF THIS PROSPECTUS SUPPLEMENT OR THE ACCOMPANYING PROSPECTUS. ANY
REPRESENTATION
TO THE CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
===============================================================================================================
UNDERWRITING
PRICE TO DISCOUNTS AND PROCEEDS TO
PUBLIC COMMISSIONS(1) COMPANY(2)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share........................ $15.9375 $0.75 $15.1875
- ---------------------------------------------------------------------------------------------------------------
Total(3)......................... $79,687,500 $3,750,000 $75,937,500
===============================================================================================================
</TABLE>
(1) The Company has agreed to indemnify the Underwriters (as defined herein)
against, and to provide contribution with respect to, certain liabilities,
including liabilities under the Securities Act of 1933, as amended (the
"Securities Act"). See "Underwriting."
(2) Before deducting expenses payable by the Company, estimated at $300,000.
(3) The Company has granted an option to the Underwriters to purchase up to
750,000 additional shares of Common Stock on the same terms and conditions
as set forth herein solely to cover over-allotments, if any. If such option
is exercised in full, the total Price to Public, Underwriting Discounts and
Commissions and Proceeds to Company will be $91,640,625, $4,312,500 and
$87,328,125, respectively. See "Underwriting."
------------------------
The shares of Common Stock offered by this Prospectus Supplement are offered
by the Underwriters subject to prior sale, to withdrawal, cancellation or
modification of the offer without notice, to delivery to and acceptance by the
Underwriters and to certain further conditions. It is expected that delivery of
the shares of Common Stock will be made at the offices of Lehman Brothers Inc.,
New York, New York, on or about July 1, 1998.
------------------------
LEHMAN BROTHERS
CIBC OPPENHEIMER
CREDIT SUISSE FIRST BOSTON
MERRILL LYNCH & CO.
SALOMON SMITH BARNEY
JUNE 26, 1998
<PAGE> 2
Tesoro
----------------------------
Tesoro PETROLEUM CORPORATION
Tesoro Petroleum Corporation's operations consist of downstream and upstream
activities in the United States and selected international markets. Downstream,
the Company is involved in petroleum refining, the distribution and marketing of
petroleum products and marine logistics services in Alaska, Hawaii, the Pacific
Northwest, the U.S. West Coast, and the U.S. Gulf Coast. Upstream, the Company
is engaged in the exploration for and production of primarily natural gas in
Texas, Louisiana and Bolivia.
DOWNSTREAM
ALASKA The Company owns and operates a 72,000 barrels per day (bpd) refinery in
Kenai, Alaska and also operates the largest network of branded retail gas
stations throughout the state. Tesoro is a primary supplier of jet fuel in
Alaska to the major trans-polar and trans-Pacific aircraft traffic routes going
through Anchorage. The refinery also exports products to key cities in the
Russian Far East and Asia.
HAWAII The Company owns and operates a 95,000 bpd refinery in Kapolei, Hawaii.
The Company is also a major retailer of gasoline (through 32 branded retail
outlets) and the largest marketer of jet fuel in Hawaii.
WASHINGTON The Company has entered into an agreement to acquire a 108,000 bpd
refinery in Anacortes, Washington. The Washington refinery is a complex,
high-conversion refinery that produces approximately 80 percent gasoline and
middle distillates and can produce significant amounts of cleaner burning CARB
gasoline. The Company is also actively developing a retail market presence in
the Pacific Northwest and currently distributes gasoline through 33
dealer-operated branded retail stations in Washington and Oregon.
MARINE SERVICES The Company's other downstream segment, Marine Services,
operates a network of 23 terminals located in Louisiana, Texas and on the West
Coast. This segment markets and distributes petroleum products, primarily marine
diesel fuel and lubricants, and provides a growing number of logistics services
to the marine and offshore exploration and production industries.
CERTAIN PERSONS PARTICIPATING IN THE COMMON STOCK OR PIES OFFERINGS MAY
ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF
THE COMMON STOCK OR PIES. SUCH TRANSACTIONS MAY INCLUDE THE PURCHASE OF COMMON
STOCK OR PIES FOLLOWING THE PRICING OF THE COMMON STOCK OR PIES OFFERINGS TO
COVER A SYNDICATED SHORT POSITION IN THE COMMON STOCK OR PIES OR FOR THE PURPOSE
OF MAINTAINING THE PRICE OF THE COMMON STOCK OR PIES, AND THE IMPOSITION OF
PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES RELATING TO THIS OFFERING,
SEE "UNDERWRITING."
[map reflecting the locations of certain of the Company's operations]
<PAGE> 3
SUMMARY
The following summary is qualified in its entirety by and should be read in
conjunction with the detailed information and financial statements and notes
thereto appearing elsewhere in this Prospectus Supplement. Prospective investors
should carefully consider the matters discussed under the caption "Risk
Factors." Except as the context otherwise requires, information in this
Prospectus Supplement assumes that (i) the Hawaii Acquisition, (ii) the
Washington Acquisition, (iii) the initial borrowings under the Senior Credit
Facility, (iv) the Notes Offering, (v) the PIES Offering and (vi) the Common
Stock Offering (collectively, the "Transactions") have been consummated. AS USED
IN THIS PROSPECTUS SUPPLEMENT, THE TERM "TESORO" REFERS TO TESORO PETROLEUM
CORPORATION BEFORE THE TRANSACTIONS, AND THE TERM "COMPANY" REFERS TO TESORO
PETROLEUM CORPORATION PRO FORMA FOR THE TRANSACTIONS. The information contained
in this Prospectus Supplement with respect to BHP Hawaii and Shell Washington
has been supplied to Tesoro by BHP (as defined herein) and Shell (as defined
herein), respectively. The closing of the Common Stock Offering is not
conditioned upon the closing of the PIES Offering or the Notes Offering, nor is
the closing of any of the Offerings conditioned upon the closing of the
Washington Acquisition.
THE COMPANY
OVERVIEW
The Company is a diversified natural resource company with operations in
three business segments: (i) refining crude oil and marketing petroleum products
("Refining and Marketing"), (ii) exploration for, and development and production
of, primarily natural gas ("Exploration and Production") and (iii) marketing and
distributing petroleum products and providing logistics services to the marine
and offshore exploration and production industries ("Marine Services"). Tesoro
has demonstrated consistent growth in each of these segments over the past three
years. Tesoro's Normalized EBITDA (as defined herein) has increased from $50.0
million in 1995 to $98.2 million in 1997. Pro forma for the Transactions, the
Company generated Normalized EBITDA of $178.6 million for the year ended
December 31, 1997 (excluding potential cost savings and revenue enhancements
anticipated to result from the Acquisitions), with 65% attributable to Refining
and Marketing, 32% attributable to Exploration and Production and 3%
attributable to Marine Services.
REFINING AND MARKETING
The Company is the second largest independent refiner and marketer of
petroleum products in the Petroleum Administration for Defense District V ("PADD
V"), a federal regional designation encompassing Alaska, Arizona, California,
Hawaii, Nevada, Oregon and Washington. The Company owns and operates three major
West Coast refineries located in: Kenai, Alaska (the "Alaska Refinery"), on the
eastern side of the Cook Inlet; Kapolei, Hawaii (the "Hawaii Refinery"), on the
island of Oahu; and Anacortes, Washington (the "Washington Refinery"), on the
Puget Sound approximately 60 miles north of Seattle. The Alaska Refinery has a
rated capacity of 72,000 barrels per day ("bpd") and is the second largest
refinery in Alaska. The Hawaii Refinery has a rated capacity of 95,000 bpd and
is the largest refinery in Hawaii. The Washington Refinery has a rated capacity
of 108,000 bpd and is the third largest refinery in the Pacific Northwest. The
Company is also a major retailer of gasoline in Alaska and Hawaii and is
continuing to build a retail presence in the Pacific Northwest. As of March 31,
1998, the Company had 160 branded retail stations in Alaska (35 Company owned
and operated), 32 branded retail stations in Hawaii (30 Company owned and
operated) and 33 branded retail stations in the Pacific Northwest.
ALASKA. The Alaskan market is geographically isolated, making
transportation and terminaling costs a significant competitive factor. The
nearest competitive alternative markets to Alaska are Canada and the U.S.
Pacific Northwest. The transportation costs involved to move refined products
between these markets and Alaska are significant, which results in the Company
receiving higher margins on its refined products that are sold in the local
Alaskan market. During 1997, approximately 70% of the refined product volumes
manufactured at the Alaska Refinery were sold within the local Alaskan market.
S-1
<PAGE> 4
Over the last three years, Tesoro has significantly increased its in-state
sales of refined products in Alaska, which have generated substantial
improvements in its Alaska refining and marketing operating results. Tesoro has
accomplished this goal through a combination of (i) capital improvements and
feedstock alterations at its Alaska Refinery that allow the refinery to
manufacture a product slate that is more in line with local market demands, and
(ii) an expansion of its in-state marketing channels for gasoline, heavy oils
and other refined products. As a result of these and other initiatives, Tesoro's
in-state sales of refined products manufactured at the Alaska Refinery have
increased by over 4,500 bpd from 1995 to 1997. Over this same time period, the
Alaska Refinery's product spread has increased from approximately $3.44 per
barrel to $5.09 per barrel and Tesoro's Alaska refining and marketing Normalized
EBITDA has increased from $13 million to $33 million.
Recent major capital improvements to the Alaska Refinery include the
construction of a vacuum unit in late 1994 for approximately $25 million and the
expansion of the hydrocracker unit in late 1997 for approximately $19 million,
which included the introduction of a jet selective catalyst. As a result of
these two refinery upgrades, the Company has significantly increased its
production of jet fuel, which is currently in short supply in Alaska, and
reduced its production of lower margin residual fuel oil and other heavy oils.
The majority of these heavy oils must be exported to markets outside of Alaska
due to the current level of local demand. Prior to these major capital
improvements, the Alaska Refinery's product mix was approximately 37% middle
distillates (primarily jet fuel and diesel fuel), 24% gasoline, and 39% residual
fuel and other heavy oils on total production of 51,100 bpd in 1993, versus a
product mix during the first quarter of 1998 of 44% middle distillates, 26%
gasoline and 30% residual fuel oil and other heavy oils on total production of
57,700 bpd.
The Company also has expanded and enhanced its Alaska retail gasoline
network by converting third-party stations to "Tesoro Alaska" branded stations,
building and acquiring stations, remodeling existing profitable stations and
closing underperforming stations. In the last three years, the number of branded
stations selling Company gasoline in Alaska has increased from 131 to 160. The
Company plans to add additional branded retail stations in 1998 as a part of its
three-year, $50 million Alaskan retail expansion program. Additionally, Tesoro
improved its product spread by beginning to manufacture and market liquid
asphalt in Alaska in 1996. Due to this change in product slate and the
completion of an asphalt terminal in Anchorage, Alaska, sales of liquid asphalt
sold in-state by Tesoro tripled from 1996 to 1997.
HAWAII. The Company's Alaskan operations and its recently acquired Hawaii
operations have many similar characteristics. Both markets are geographically
isolated, making transportation and terminaling costs a significant competitive
factor. Both markets have a small number of local refiners. The Company operates
one of two major refineries in Alaska and the larger of two refineries in
Hawaii. Both markets have similar supply and demand characteristics for most
refined products. Middle distillates account for the largest percentage of total
refined product demand. In-state demand for middle distillates is currently
higher than in-state production and in-state demand for gasoline and heavy oils
is currently lower than in-state production. With these similar market dynamics,
both the Alaska and Hawaii Refineries are configured to maximize production of
middle distillates. Both refineries process similar grades of crude oil and
yield similar refined product slates. Due to the strong similarities between the
Alaska and Hawaii Refineries and the corresponding local markets, the Company
believes there will be significant opportunities to improve the performance of
the Hawaii Refinery by applying some of the same techniques the Company has used
in Alaska.
WASHINGTON. The Washington Acquisition gives the Company a major refining
presence in the Pacific Northwest, an area in which Tesoro has been an active
marketer of refined products since the 1980s. Tesoro currently markets gasoline
(through 33 dealer-operated branded retail stations and one terminal), bunker
fuels and other heavy oil products in the Pacific Northwest. BHP Hawaii also
currently markets certain excess refined products in the Pacific Northwest.
The Company believes that the Pacific Northwest is one of the most
attractive U.S. refining markets. Washington and Oregon are currently ranked as
the sixth and tenth fastest growing states in the U.S., respectively. Population
growth in Washington and Oregon averaged 11% for the five-year period ending
1995. Gasoline production in the Pacific Northwest is currently slightly higher
than local demand. Due to strong
S-2
<PAGE> 5
projected demand growth, however, the Company believes that the gasoline market
will be in balance or slightly short within two to three years.
The Washington Refinery is a relatively complex refinery that produces a
large percentage of gasoline and other high value products. During 1997, the
Washington Refinery's product mix was approximately 53% gasoline, 24% middle
distillates and 23% heavy oils and other. Additionally, the Washington Refinery
can produce significant amounts of CARB gasoline, a gasoline formulation
required in the California market which reduces vehicle emissions.
The Company believes that there are significant cost saving and revenue
enhancement opportunities available through integrating its Washington Refinery
with its Alaska and Hawaii Refineries. The Tesoro management team has currently
identified $25 million of potential annual cost saving and revenue enhancing
synergies including improvements to administrative and logistical efficiencies,
further processing of intermediate products and other marketing and operating
benefits. Management expects to begin to realize such synergies in the fourth
quarter of 1998 with the full annual impact to be achieved in the fiscal year
ending December 31, 1999. In addition, the Company believes that there will be
incremental opportunities, which have not yet been identified, from owning three
refineries in PADD V.
EXPLORATION AND PRODUCTION
The Company is engaged in the exploration for and acquisition, development
and exploitation of primarily natural gas properties in Texas, Louisiana and
Bolivia. As of December 31, 1997, the Company had over 517 billion cubic feet
equivalent ("Bcfe") of proved reserves, 93% of which are natural gas, with a
standardized measure of discounted future net cash flows before income taxes
utilizing a 10% discount rate ("Pre-Tax PV10") of approximately $374 million.
Approximately 30% of the Company's proved reserves and 45% of the Company's
Pre-Tax PV10 are attributable to its U.S. properties.
The Company has a demonstrated track record of finding, developing and
producing oil and gas reserves at a relatively low cost. Over the last five
years, the Company has more than doubled worldwide proved reserves at an average
finding and development cost of approximately $0.52 per thousand cubic feet
equivalent ("Mcfe"). The Company has increased production from approximately 62
million cubic feet equivalents ("MMcfe") per day in 1993 to 109 MMcfe per day in
1997 and was producing approximately 130 MMcfe per day during March 1998. During
1997, the Company increased its domestic proved reserves by 28% and its Bolivian
proved reserves by 45% at a worldwide average finding cost of $0.49 per Mcfe.
The Company believes it is well positioned to further increase its proved
reserves and production in both the U.S. and Bolivia.
In the U.S., Tesoro has assembled a substantial inventory of new
exploration and development prospects. In the last year, the Company almost
tripled its net undeveloped acreage to in excess of 130,000 acres. The Company
is positioned in four core areas: the Val Verde Basin in Southwest Texas, the
Wilcox Trend in South Texas, the Frio/Vicksburg Trend along the U.S. Gulf Coast
and the East Texas Basin. During 1997, the Company's U.S. exploration efforts
resulted in commercial discoveries in three of these core areas. As a result of
these new discoveries, the Company has added a significant inventory of lower
risk development drilling opportunities for 1998.
In Bolivia, a significant portion of the Company's proved developed
reserves are currently shut-in due to limited access to markets. However, during
1997, construction began on a 1,900-mile Bolivia-to-Brazil natural gas pipeline
which the Company believes will significantly increase the market for Bolivian
gas production. The pipeline, which is jointly owned by Enron Corp., Shell
International Gas Ltd. and Petroleo Brasileiro S.A. (known as Petrobras, the
Brazilian state oil company), among others, is expected to be completed by early
1999. Upon completion of the pipeline, the Company believes that it will be able
to increase its Bolivian natural gas production. See "Business -- Exploration
and Production -- Overview." Tesoro's Bolivian production during 1997 averaged
37 MMcfe per day (gross), and the Company estimates that it could currently
produce from its existing proved developed reserve base approximately 120 MMcfe
per day (gross) if access to markets were readily available. The Company's 1998
capital budget includes plans to drill three development wells (gross) and two
exploratory wells (gross) which may increase its productive capacity.
S-3
<PAGE> 6
MARINE SERVICES
Tesoro is the largest operator of marine terminals along the Texas and
Louisiana Gulf Coast and is building a presence on the U.S. West Coast. The
Company currently operates 20 marine terminals in Texas and Louisiana and three
terminals on the U.S. West Coast. Through its terminal facilities, the Company
markets and distributes a broad range of products, including diesel fuel,
lubricants, chemicals and supplies, and provides logistical support services to
the marine and offshore exploration and production industries. The marine
terminals are generally deep water and are bulkheaded and dredged to provide
easy access to vessels receiving products for delivery to customers. Products
are also delivered offshore aboard vessels owned or chartered by customers,
which include companies engaged in oil and gas exploration and production,
seismic evaluation, offshore construction and other drilling-related businesses.
The acquisition of Coastwide Energy Services, Inc. ("Coastwide") in 1996
plus recent facility improvements and cost reduction initiatives have
significantly enhanced the Company's competitive position and operating results
in the marine services industry. The Company's Normalized EBITDA attributable to
its Marine Services segment has increased from a negative $3.3 million in 1995
to a positive $8.0 million in 1997. The marine services industry remains
fragmented. The Company believes that there are significant consolidation
opportunities in this sector as well as additional optimization opportunities
relating to its existing operations that will allow it to continue to profitably
grow this business segment.
STRATEGY AND COMPETITIVE STRENGTHS
The Company's strategy is to (i) maximize return on capital employed and
increase the competitiveness of each of its business units by reducing costs,
increasing operating efficiencies and optimizing existing assets and (ii) expand
its overall market presence through a combination of internal growth initiatives
and selective acquisitions which are both accretive to earnings and provide
significant operational synergies.
The Company believes that it is well positioned to execute its strategy as
a result of the following competitive strengths:
STRONG POSITION IN NICHE MARKETS. In Refining and Marketing, the Company
operates the largest refinery in Hawaii, the second largest refinery in Alaska
and will operate the third largest refinery in Washington. The Company is also a
major retailer of gasoline in Alaska and Hawaii and is enhancing its retail
presence in the Pacific Northwest. In Exploration and Production, the Company
has demonstrated a track record of finding, developing and producing oil and gas
reserves at relatively low costs compared to others in the industry. In Marine
Services, the Company is the largest operator of marine terminals along the
Texas and Louisiana Gulf Coast.
DIVERSIFIED CASH FLOW BASE. Pro forma for the Transactions, for the year
ended December 31, 1997, the Company generated approximately 65% of its
Normalized EBITDA from its Refining and Marketing segment, 32% from its
Exploration and Production segment and 3% from its Marine Services segment
(excluding potential cost savings and revenue enhancement opportunities).
Furthermore, pro forma Normalized EBITDA from the Refining and Marketing segment
would be distributed among its three areas of operations. The diversity of the
Company's assets and successful operation of its three business segments reduce
the Company's dependence on any one area of the natural resources industry,
which subsequently reduces the volatility of the Company's earnings and
Normalized EBITDA.
STRONG TRACK RECORD. Over the last four years, Tesoro has made significant
operating improvements in each of its business segments. From 1993 to 1997,
Tesoro's Normalized EBITDA increased from approximately $35 million to $98
million. During this same time period, Tesoro reduced its total debt and
preferred stock outstanding from $264 million to approximately $132 million.
EXPERIENCED MANAGEMENT TEAM. The Company benefits from a strong and
experienced management team at both the corporate and the operating levels.
Tesoro's senior management team has an average 25 years of experience in the oil
and gas industry. The Company's management team has successfully restructured
each of its operating segments and significantly improved its operating and
financial performance over the last five years.
S-4
<PAGE> 7
THE TRANSACTIONS
THE ACQUISITIONS
THE HAWAII ACQUISITION. On May 29, 1998, Tesoro closed the acquisition (the
"Hawaii Acquisition") of all of the outstanding capital stock of BHP Petroleum
Americas Refining Inc. and BHP Petroleum South Pacific Inc. (together, "BHP
Hawaii"), both of which were affiliates of The Broken Hill Proprietary Company
Limited ("BHP"). BHP Hawaii owns and operates a 95,000 bpd refinery in Kapolei,
Hawaii, on the island of Oahu, approximately 20 miles west of Honolulu, and 32
retail gasoline stations (two of which of are dealer-operated) on Oahu, Maui and
Hawaii.
The cash purchase price for the Hawaii Acquisition was $243.5 million. In
addition, Tesoro issued an unsecured, non-interest bearing promissory note (the
"BHP Note") in the amount of $50 million, payable in five equal annual
installments, beginning in 2009. The BHP Note provides for earlier payment based
on the performance of BHP Hawaii. The purchase price is subject to adjustment
after the closing for the amount by which the working capital of BHP Hawaii on
the closing date differs from $68.5 million, the estimated working capital at
closing. See "Description of Indebtedness -- Other Indebtedness."
In order to ensure the continuity of crude supply to the Hawaii Refinery,
the Company also entered into a two-year agreement with an affiliate of BHP to
assist Tesoro in acquiring crude oil feedstock sourced outside of North America
and in arranging for transportation of such crude oil to the Hawaii Refinery.
See "Business -- Refining and Marketing -- Crude Oil Supply -- Hawaii."
THE WASHINGTON ACQUISITION. On May 1, 1998, Tesoro entered into an
agreement (the "Washington Agreement") to purchase (the "Washington
Acquisition") all of the outstanding capital stock of Shell Anacortes Refining
Company ("Shell Washington"), an affiliate of Shell Oil Company ("Shell"). Shell
Washington owns and operates a 108,000 bpd refinery (the "Washington Refinery")
located in Anacortes, Washington (on the Puget Sound, approximately 60 miles
north of Seattle) and related assets.
Under the terms of the Washington Agreement, the Company has agreed to pay
at closing a purchase price of $237 million plus estimated working capital as of
closing. The Company has made a $5 million earnest money deposit and has agreed
to escrow by July 10, 1998, the balance of the purchase price. Based on the
March 31, 1998 balance sheet the Company estimates that the working capital to
be acquired is to be approximately $43 million. The Washington Agreement
contains representations and warranties and other general provisions that are
customary for transactions of this nature.
Shell is selling Shell Washington pursuant to agreements with the U.S.
Federal Trade Commission (the "FTC") and the states of Oregon and Washington
resulting from its western states refining and marketing joint venture with
Texaco. The closing of the Washington Acquisition is contingent upon the
approval of the FTC and the states of Oregon and Washington and other customary
conditions. Tesoro currently anticipates that the Washington Acquisition will
close on or after August 1, 1998.
The Offerings are not conditioned upon the closing of the Washington
Acquisition.
THE FINANCINGS
THE INTERIM CREDIT FACILITY. In conjunction with closing the Hawaii
Acquisition, Tesoro refinanced substantially all of its then-existing
indebtedness (the "Refinancing"). The total amount of funds required by Tesoro
to complete the Hawaii Acquisition and the Refinancing, to pay related fees and
expenses and for general corporate purposes was approximately $432 million,
which was financed through a secured credit facility (the "Interim Credit
Facility") provided by Lehman Commercial Paper Inc. ("LCPI"), an affiliate of
Lehman Brothers Inc. The Company intends to refinance all borrowings under the
Interim Credit Facility with net proceeds from the Offerings and borrowings
under a new senior credit facility.
S-5
<PAGE> 8
THE SENIOR CREDIT FACILITY. Tesoro has obtained a commitment letter from
LCPI to arrange a new senior credit facility (the "Senior Credit Facility") in
the amount of $500 million. The Senior Credit Facility will be entered into in
connection with the Notes Offering and the Washington Acquisition. The Senior
Credit Facility will be comprised of term loan facilities aggregating $200
million (two $100 million tranches, the "Tranche A Term Loans" and the "Tranche
B Term Loan") and a $300 million revolving credit facility (the "Revolver"). The
Senior Credit Facility will be guaranteed by all of the Company's active direct
and indirect subsidiaries (the "Guarantors") and will be secured by
substantially all of the domestic assets of the Company and each of the
Guarantors. See "Description of Indebtedness -- Senior Credit Facility."
THE OFFERINGS. Concurrently with the Common Stock Offering, the Company is
offering 9,000,000 PIES, representing interests in the Company's Mandatorily
Convertible Preferred Stock, with gross proceeds of $143.4 million (excluding
over-allotment options granted to the underwriters of the PIES). Concurrently
with the syndication of the Senior Credit Facility, the Company will offer $300
million aggregate principal amount of the Notes in the Notes Offering. The
closing of the Common Stock Offering is not conditioned upon the closing of the
PIES Offering or the Notes Offering, nor is the closing of any of the Offerings
conditioned upon the closing of the Washington Acquisition. See "Description of
Indebtedness -- The Notes" and "Description of Capital Stock."
Borrowings under the Senior Credit Facility, together with the net proceeds
from the Offerings, will be used to fund the cash purchase price of the
Washington Acquisition, to refinance the Interim Credit Facility (a portion of
which was used to finance the Hawaii Acquisition), to pay certain fees and
expenses related to the Transactions and for general corporate purposes
(including working capital requirements and capital expenditures). There can be
no assurance that the Company will be able to complete all of the Offerings or
that the proceeds from the Offerings will be as currently contemplated. See
"Capitalization." The following table illustrates the estimated sources and uses
of funds assuming consummation of the Washington Acquisition, the Senior Credit
Facility and the Offerings as of May 29, 1998.
<TABLE>
<CAPTION>
AMOUNT
-------------
(IN MILLIONS)
<S> <C>
SOURCES:
Senior Credit Facility -- Revolver(a)..................... $ 56
Senior Credit Facility -- Tranche A Term Loans(b)......... 50
Senior Credit Facility -- Tranche B Term Loan............. 100
Notes Offering............................................ 300
PIES Offering............................................. 143
Common Stock Offering..................................... 80
------
Total.............................................. $ 729
======
USES:
Washington Acquisition(c)................................. $ 275
Repayment of Interim Credit Facility(d)................... 432
Other(e).................................................. 22
------
Total.............................................. $ 729
======
</TABLE>
- ---------------
(a) The maximum amount available under the Revolver is $300 million, including
availability for letters of credit.
(b) The Tranche A Term Loans provide for additional borrowings of up to $50
million in the aggregate over the first six months following the closing of
the Transactions for general corporate purposes (including capital
expenditures).
(c) Includes $43 million of estimated working capital (based on the March 31,
1998 balance sheet) to be acquired in connection with the acquisition of the
Washington Refinery less the $5 million escrow deposit. The actual amount of
working capital will be determined on the date of the closing of the
Washington Acquisition.
(d) The Company entered into the Interim Credit Facility in order to fund the
cash purchase price of the Hawaii Acquisition, to refinance substantially
all of its indebtedness, to pay related fees and expenses and for general
corporate purposes. The actual amount refinanced will depend on the
Company's revolving borrowings under the Interim Credit Facility.
(e) Includes estimated underwriting and placement discounts, fees and other
expenses related to the Transactions.
S-6
<PAGE> 9
THE COMMON STOCK OFFERING
Common Stock Offered....... 5,000,000 shares
Common Stock outstanding
after the Common Stock
Offering................. 31,558,068 shares (assuming no exercise of the
Underwriters' over-allotment option)
Additional Offerings....... Concurrently with the Common Stock Offering, the
Company is conducting the PIES Offering, with gross
proceeds of $143.4 million (excluding
over-allotment options granted to the underwriters
of the PIES Offering). Concurrently with the
syndication of the Senior Credit Facility, the
Company is conducting the Notes Offering of $300
million aggregate principal amount of Notes. The
closing of the Common Stock Offering is not
conditioned upon the closing of the PIES Offering
or the Notes Offering, nor is the closing of any of
the Offerings conditioned upon the closing of the
Washington Acquisition.
Use of Proceeds............ The Company will use the net proceeds of the
Offerings, together with borrowings under the
Senior Credit Facility, to fund the cash purchase
price of the Washington Acquisition, to repay
amounts owing under the Interim Credit Facility (a
portion of which was used to finance the Hawaii
Acquisition), to pay certain fees and expenses
related to the Transactions and for general
corporate purposes (including working capital
requirements and capital expenditures). See "Use of
Proceeds." Amounts used to repay the Interim Credit
Facility (under which $432 million was outstanding
as of May 29, 1998) will be received by LCPI. In
addition, Lehman Brothers Inc. and LCPI have
received and will receive certain fees in
connection with the Transactions. See "-- The
Transactions" and "Underwriting."
NYSE symbols:
Common Stock............. "TSO"
PIES..................... "TSOPrA"
FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED IN CONNECTION
WITH AN INVESTMENT IN THE COMMON STOCK, SEE "RISK FACTORS."
S-7
<PAGE> 10
SUMMARY HISTORICAL AND PRO FORMA FINANCIAL DATA
The following tables set forth certain summary historical condensed
consolidated financial data for Tesoro and certain historical pro forma
information for the Company. The summary historical financial information
presented below for each of the three years ended December 31, 1997, and for
each of the quarters ended March 31, 1997 and 1998, has been derived from the
financial statements included elsewhere herein. The pro forma statements of
consolidated operations for the year ended December 31, 1997, and the pro forma
statement of consolidated operations for the three months ended March 31, 1998,
give effect to the Transactions as if all had occurred on January 1, 1997. The
pro forma balance sheet gives effect to the Transactions as if all had occurred
on March 31, 1998. The unaudited pro forma information set forth below is not
necessarily indicative of the results that actually would have been achieved had
such Transactions been consummated on January 1, 1997, or that may be achieved
in the future. The unaudited pro forma financial statements do not reflect any
benefits from potential cost savings or revenue enhancements resulting from the
integration of the operations of Tesoro, BHP Hawaii and Shell Washington
(estimated by the Company to be $25 million annually beginning in 1999). The
information should be read in conjunction with the Management's Discussion and
Analysis of Financial Condition and Results of Operations, the Selected
Historical Financial Data, the Pro Forma Combined Condensed Statements of
Operations and the Pro Forma Financial Statements of Tesoro, BHP Hawaii and
Shell Washington and the notes thereto included herein.
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
---------------------------------------- ---------------------------
1997 1998
1995 1996 1997 PRO FORMA 1997 1998 PRO FORMA
-------- -------- ------ --------- ------ ------ ---------
(IN MILLIONS EXCEPT PER SHARE AMOUNTS AND RATIOS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA:
Total revenues(a).................................. $1,002.9 $1,039.8 $943.4 $2,980.4 $234.9 $196.0 $ 607.9
Total segment operating profit(a)(b)............... $ 105.9 $ 144.8 $ 72.7 $ 163.1 $ 15.0 $ 17.9 $ 34.7
Earnings before extraordinary items................ $ 57.5 $ 76.8 $ 30.7 $ 31.9 $ 6.1 $ 6.1 $ 4.9
Earnings per share before extraordinary
items -- basic................................... $ 2.34 $ 2.96 $ 1.16 $ 0.68 $ 0.23 $ 0.23 $ 0.07
Earnings per share before extraordinary
items -- diluted................................. $ 2.29 $ 2.90 $ 1.14 $ 0.67 $ 0.23 $ 0.23 $ 0.07
OTHER DATA:
EBITDA(c):
Refining and marketing........................... $ 12.6 $ 18.5 $ 33.2 $ 148.4 $ 3.2 $ 9.5 $ 32.5
Exploration and production....................... 139.2 159.6 77.2 77.2 22.1 19.0 19.0
Marine services.................................. (4.1) 7.3 8.0 8.0 1.3 2.4 2.4
-------- -------- ------ -------- ------ ------ --------
Total segment EBITDA........................... 147.7 185.4 118.4 233.6 26.6 30.9 53.9
Corporate and unallocated........................ (22.3) (13.4) (16.2) (55.0) (3.7) (4.1) (11.6)
-------- -------- ------ -------- ------ ------ --------
Total consolidated EBITDA...................... $ 125.4 $ 172.0 $102.2 $ 178.6(f) $ 22.9 $ 26.8 $ 42.3(f)
======== ======== ====== ======== ====== ====== ========
Normalized EBITDA(d):
Refining and marketing........................... $ 13.0 $ 19.3 $ 33.2 $ 148.4 $ 3.2 $ 9.5 $ 32.5
Exploration and production....................... 58.8 70.0 73.2 73.2 20.5 19.0 19.0
Marine services.................................. (3.3) 7.3 8.0 8.0 1.3 2.4 2.4
-------- -------- ------ -------- ------ ------ --------
Total segment Normalized EBITDA................ 68.5 96.6 114.4 229.6 25.0 30.9 53.9
Corporate and unallocated........................ (18.5) (14.7) (16.2) (51.0) (3.7) (4.1) (11.6)
-------- -------- ------ -------- ------ ------ --------
Total consolidated Normalized EBITDA........... $ 50.0 $ 81.9 $ 98.2 $ 178.6(f) $ 21.3 $ 26.8 $ 42.3(f)
======== ======== ====== ======== ====== ====== ========
Normalized earnings per share -- basic(e).......... $ (0.73) $ 0.53 $ 1.06 $ 0.68 $ 0.19 $ 0.23 $ 0.07
Normalized earnings per share -- diluted(e)........ $ (0.73) $ 0.53 $ 1.04 $ 0.67 $ 0.19 $ 0.23 $ 0.07
Capital expenditures
Refining and marketing........................... $ 9.3 $ 11.1 $ 43.9 * $ 2.9 $ 2.0 *
Exploration and production....................... 53.4 66.6 92.9 * 11.0 20.5 *
Marine services.................................. 0.4 6.9 9.4 * 2.2 1.2 *
Other............................................ 0.8 0.4 1.3 * 0.2 0.1 *
-------- -------- ------ ------ ------
Total capital expenditures................. $ 63.9 $ 85.0 $147.5 * $ 16.3 $ 23.8 *
======== ======== ====== ====== ======
Total Debt/Normalized EBITDA....................... * 3.03(g)
Normalized EBITDA/Interest......................... 3.40 3.17
Normalized EBITDA/Interest plus Preferred
Dividends........................................ 2.84 2.66
BALANCE SHEET DATA:
Working capital.................................... $ 77.5 $ 99.5 $ 74.3 * $104.8 $ 86.7 $ 200.0
Property, plant and equipment, net................. $ 261.7 $ 316.5 $413.8 * $320.7 $424.4 $ 924.4
Total assets....................................... $ 519.2 $ 582.6 $627.8 * $552.0 $635.4 $1,396.2
Total long-term debt and other obligations......... $ 164.5 $ 89.3 $132.3 * $ 89.3 $147.7 $ 513.1
Stockholders' equity............................... $ 216.5 $ 304.1 $333.0 * $310.4 $339.4 $ 548.0
</TABLE>
- ---------------
* Not available.
S-8
<PAGE> 11
(a) Results for the years 1995 and 1996 include revenues from above-market
pricing provisions of a natural gas contract which was terminated effective
October 1, 1996. Operating profit included $47 million and $25 million in
the years 1995 and 1996, respectively, from the excess of these contract
prices over spot market prices. Upon termination of the contract in 1996,
the Exploration and Production segment also recorded a non-recurring
increase in other income and operating profit of $60 million in connection
with the settlement of the contract. In the year 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 Tesoro's Consolidated Financial Statements.
(b) Segment operating profit equals 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.
(c) EBITDA represents earnings before extraordinary item, interest expense,
income taxes and depreciation, depletion and amortization. Segment EBITDA
represents operating profit before 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.
EBITDA is not a calculation based upon generally accepted accounting
principles ("GAAP"); however, the amounts included in the EBITDA
calculation are derived from amounts included in Tesoro's Consolidated
Financial Statements. In addition, EBITDA should not be considered as an
alternative to net earnings or operating profit, as an indication of the
operating performance of the Company or an alternative to operating cash
flow as a measure of liquidity. EBITDA is not necessarily comparable to
similarly titled items of other companies.
(d) Normalized EBITDA is EBITDA, as defined in (c) above, excluding the impact
of the above-market natural gas contract with Tennessee Gas (as defined
herein) and other significant items which affect the comparability between
the periods presented. The following items have been excluded from EBITDA,
as reported, to generate normalized EBITDA for each segment (in millions):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
-------------------------------- -----------------------
1997 1998
1995 1996 1997 PRO FORMA 1997 1998 PRO FORMA
----- ----- ---- --------- ---- ---- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Refining and Marketing........................... $(0.4) $(0.8) $-- $ -- $-- $-- $ --
----- ----- ---- ----- ---- ---- ----
Exploration and Production:
Excess of contract prices over spot market
prices..................................... 47.1 24.6 -- -- -- -- --
Income from settlement of a natural gas
contract................................... -- 60.0 -- -- -- -- --
Gain on sale of asset........................ 33.5 -- -- -- -- -- --
Other non-recurring income (charges), net.... (0.2) 5.0 4.0 4.0 1.6 -- --
----- ----- ---- ----- ---- ---- ----
Total Exploration and Production........ 80.4 89.6 4.0 4.0 1.6 -- --
----- ----- ---- ----- ---- ---- ----
Marine Services.................................. (0.8) -- -- -- -- -- --
----- ----- ---- ----- ---- ---- ----
Corporate and Unallocated........................ (3.8) 1.3 -- (4.0)(i) -- -- --
----- ----- ---- ----- ---- ---- ----
Total Adjustments....................... $75.4 $90.1 $4.0 $ -- $1.6 $-- $ --
===== ===== ==== ===== ==== ==== ====
</TABLE>
(i) Represents BHP Hawaii employee bonuses of $4 million which were
awarded based upon the performance of BHP operations that are not to
be acquired by Tesoro.
For further information regarding these significant items, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(e) Normalized earnings per share excludes the impact of the items detailed in
footnote (d) above and extraordinary items, all on an after-tax basis.
(f) Pro forma EBITDA represents earnings before extraordinary items plus
interest expense, income taxes, depreciation, depletion and amortization,
and amortization of financing costs, all on a pro forma basis.
(g) Normalized EBITDA for the three-month period has been annualized to
calculate this ratio.
S-9
<PAGE> 12
SUMMARY REFINING AND MARKETING OPERATING DATA
<TABLE>
<CAPTION>
THREE MONTHS
FISCAL YEARS(A) ENDED
-------------------------- MARCH 31,
1995 1996 1997 1998
------ ------ ------ ------------
<S> <C> <C> <C> <C>
REFINERY THROUGHPUT (thousands of bpd)
Alaska Refinery.................................. 50.6 47.5 50.2 56.1
Hawaii Refinery.................................. 90.6 86.7 88.7 86.4
Washington Refinery.............................. 104.9 114.5 113.0 114.6
------ ------ ------ ------
Total Throughput......................... 246.1 248.7 251.9 257.1
====== ====== ====== ======
REFINED PRODUCTS MANUFACTURED (thousands of bpd)
Alaska Refinery --
Gasoline and gasoline blendstocks............. 14.3 12.8 12.8 15.2
Middle distillates, including jet fuel and
diesel fuel................................. 20.7 20.0 21.6 25.2
Heavy oils and residual products.............. 14.5 13.7 14.8 15.1
Other......................................... 2.5 2.6 2.3 2.2
------ ------ ------ ------
Total Alaska Refinery.................... 52.0 49.1 51.5 57.7
------ ------ ------ ------
Hawaii Refinery --
Gasoline and gasoline blendstocks............. 22.1 19.0 22.0 19.8
Middle distillates, including jet fuel and
diesel fuel................................. 39.3 39.6 40.4 40.3
Heavy oils and residual products.............. 27.1 25.9 24.3 23.4
Other......................................... 3.2 2.6 2.9 3.5
------ ------ ------ ------
Total Hawaii Refinery.................... 91.7 87.1 89.6 87.0
------ ------ ------ ------
Washington Refinery --
Gasoline and gasoline blendstocks............. 60.3 64.2 62.1 63.2
Middle distillates, including jet fuel and
diesel fuel................................. 24.1 28.9 28.3 29.9
Heavy oils and residual products.............. 14.9 15.3 17.1 16.2
Other......................................... 9.6 10.4 9.9 10.0
------ ------ ------ ------
Total Washington Refinery................ 108.9 118.8 117.4 119.3
------ ------ ------ ------
Total Refined Products Manufactured...... 252.6 255.0 258.5 264.0
====== ====== ====== ======
REFINERY PRODUCT SPREAD ($/barrel)
Alaska Refinery(b)............................... $ 3.44 $ 4.29 $ 5.09 $ 4.75
Hawaii Refinery(c)............................... $ 5.53 $ 5.48 $ 5.45 $ 4.00
Washington Refinery(b)........................... $ 3.63 $ 3.63 $ 2.89 $ 1.07
NUMBER OF STATIONS SELLING THE REFINERIES'
GASOLINE(d)
Alaska --
Company-operated.............................. 32 33 35 35
Branded jobbers and dealers................... 99 126 129 125
Unbranded jobbers and dealers................. 28 29 28 25
Pacific Northwest -- branded jobbers and
dealers....................................... 10 18 30 33
Hawaii -- Company-operated....................... 28 28 28 30
Hawaii -- Dealer-operated........................ 1 2 2 2
------ ------ ------ ------
Total Stations........................... 198 236 252 250
====== ====== ====== ======
</TABLE>
- ---------------
(a) Amounts for Tesoro and Shell Washington are for fiscal years ended December
31. Amounts for BHP Hawaii are for fiscal years ended May 31. Refining and
marketing data for the Hawaii Refinery and Washington Refinery have been
provided by BHP and Shell, respectively.
(b) Refinery product spread for the Alaska Refinery and Washington Refinery is
calculated as the per barrel difference between the average yield value of
refined products manufactured at the Alaska Refinery or
S-10
<PAGE> 13
Washington Refinery during the periods presented and the average cost to
manufacture these products. Refinery product spread does not take into
account adjustments due to selling a volume and mix of products that is
different than actual volumes manufactured during the periods. Refinery
product spread for the Alaskan Refinery also does not take into account
margins on product purchased and resold.
(c) Refinery product spread for the Hawaii Refinery is calculated as the per
barrel difference between net sales of refined products manufactured and
the landed cost of crude oil processed on a FIFO inventory valuation
method. The calculation is based on sales volumes during the periods
presented and does not include manufacturing cost allocations or refined
products purchased and resold
(d) Branded gasoline stations sell the Alaska Refinery's gasoline under the
"Tesoro Alaska" name in Alaska, Oregon and Washington (191 stations as of
March 31, 1998) and under the "Union 76" name in Southeast Alaska (two
stations as of March 31, 1998). Stations that sell the Company's gasoline
under a different name are considered unbranded. Branded gasoline stations
sell the Hawaii Refinery's gasoline under the "Gas Express" name in Hawaii.
As of March 31, 1998, the Company operated 38 convenience stores located in
Alaska, 35 of which sell gasoline.
S-11
<PAGE> 14
SUMMARY EXPLORATION AND PRODUCTION
RESERVE AND OPERATING DATA
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS ENDED
------------------------ MARCH 31,
1995 1996 1997 1998
------ ------ ------ ------------------
<S> <C> <C> <C> <C>
NET PROVED RESERVES AT END OF PERIOD (BCFE)+
U.S. ........................................... 106.4 117.8 150.4 *
Bolivia......................................... 98.0 253.0 366.4 *
------ ------ ------
Total................................... 204.4 370.8 516.8 *
====== ====== ======
% Natural Gas................................... 95% 94% 93% *
PRE-TAX PV10 AT END OF PERIOD ($ MILLIONS)
U.S. ........................................... $168.8 $222.7 $167.5 *
Bolivia......................................... 48.7 133.8 206.5 *
------ ------ ------
Total................................... $217.5 $356.5 $374.0 *
====== ====== ======
AVERAGE DAILY NET PRODUCTION (MMCFE)+
U.S. ........................................... 114.5 87.8 86.7 100.2
Bolivia......................................... 22.1 23.8 22.7 27.6
------ ------ ------ ------
Total................................... 136.6 111.6 109.4 127.8
====== ====== ====== ======
% Natural Gas................................... 98% 97% 97% 95%
AVERAGE SALES PRICES
Natural gas ($/Mcf):
U.S. --
Spot market(a)............................. $ 1.34 $ 1.95 $ 2.17 $ 2.01
Average(b)................................. $ 2.57 $ 2.75 $ 2.17 $ 2.01
Bolivia...................................... $ 1.28 $ 1.33 $ 1.15 $ 0.97
Oil and condensate ($/barrel) --
U.S. ........................................ $16.82 $21.99 $18.90 $14.13
Bolivia...................................... $14.39 $17.98 $15.71 $15.78
AVERAGE OPERATING EXPENSES ($/MCFE)+
U.S. ........................................... $ 0.35 $ 0.27 $ 0.30 $ 0.32
Bolivia......................................... $ 0.48 $ 0.42 $ 0.42 $ 0.40
THREE-YEAR AVERAGE COSTS OF ADDING
RESERVES($/MCFE)(C)
U.S. ........................................... $ 0.70 $ 0.94 $ 0.85 *
Bolivia......................................... $ 2.86 $ 0.09 $ 0.14 *
Total................................... $ 0.74 $ 0.53 $ 0.43 *
</TABLE>
- ---------------
* Not available
+ Bcfe, MMcfe and Mcfe are based on the assumption that six Mcf of natural
gas is equal to one barrel of crude oil.
(a) Includes effects of the Company's natural gas commodity price agreements
which amounted to a gain of $0.01 per thousand cubic feet ("Mcf") in the
year 1995 and to losses of $0.11 per Mcf and $0.05 per Mcf in the years
1996 and 1997, respectively (see Note N of Notes to Tesoro's Consolidated
Financial Statements).
(b) Average natural gas sales prices for the years 1995 and 1996 include the
effect of above-market pricing provisions under the contract with Tennessee
Gas that terminated effective October 1, 1996 (see Note D of Notes to
Tesoro's Consolidated Financial Statements).
(c) Represents total capital costs for the three years ended 1995, 1996 and
1997, respectively, divided by total proved reserve additions for the same
periods. Total capital costs include exploration, development and property
acquisition costs. Total reserve additions include extensions, discoveries,
purchases of minerals in place and revisions of previous estimates.
S-12
<PAGE> 15
FORWARD-LOOKING STATEMENTS
This Prospectus Supplement contains certain statements that are
"forward-looking" statements within the meaning of Section 27A of the Securities
Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities
and Exchange Act of 1934, as amended (the "Exchange Act"). All statements other
than statements of historical facts included in this Prospectus Supplement,
including without limitation statements that use terminology such as
"anticipate," "believe," "continue," "estimate," "expect," "intend," "may,"
"plan," "predict," "should," "will" and similar expressions, are forward-looking
statements. These forward-looking statements include, among other things,
discussions of anticipated revenue enhancements and cost savings following the
Acquisitions, the Company's business strategy and expectations concerning the
Company's market position, future operations, margins, profitability, liquidity
and capital resources, expenditures for capital projects and attempts to reduce
costs. Although the Company believes that the assumptions upon which the
forward-looking statements contained in this Prospectus Supplement are based are
reasonable, any of the assumptions could prove to be inaccurate and, as a
result, the forward-looking statements based on those assumptions also could be
incorrect. All phases of the operations of the Company involve risks and
uncertainties, many of which are outside the control of the Company and any one
of which, or a combination of which, could materially affect the results of the
Company's operations and whether the forward-looking statements ultimately prove
to be correct. Important factors that could cause actual results to differ
materially from the Company's expectations are set forth under the captions
"Summary," "Risk Factors," "Pro Forma Financial Statements," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business," and elsewhere in this Prospectus Supplement. Actual results and
trends in the future may differ materially depending on a variety of factors
including, but not limited to, 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; changes in the cost or
availability of third-party vessels, pipelines and other means of transporting
feedstocks and products; execution of planned capital projects; adverse changes
in the credit ratings assigned to the Company's trade credit; future well
performance; the extent of the Company's success in acquiring oil and gas
properties and in discovering, developing and producing reserves; 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; adverse rulings, judgments, or settlements in litigation or
other legal matters, including unexpected environmental remediation costs in
excess of any reserves; actions of customers and competitors; weather conditions
affecting the Company's operations or the areas in which the Company's products
are marketed; earthquakes or other natural disasters affecting operations;
political developments in foreign countries; and the conditions of the capital
markets and equity markets during the periods covered by the forward-looking
statements. Future results will also be dependent upon the ability of the
Company to integrate the Acquisitions with the Company's other operations. Many
of the factors are described in greater detail in the Company's Annual Report on
Form 10-K for the year ended December 31, 1997, and other of the Company's
filings with the Securities and Exchange Commission (the "Commission"). All
subsequent written and oral forward-looking statements attributable to the
Company or persons acting on its behalf are expressly qualified in their
entirety by the foregoing. 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.
S-13
<PAGE> 16
RISK FACTORS
Prospective purchasers of the Common Stock should carefully review the
information contained elsewhere in this Prospectus Supplement and should
particularly consider the following matters before making an investment in the
Common Stock. See "Forward-Looking Statements."
SUBSTANTIAL LEVERAGE AND DEBT SERVICE
In connection with the Transactions, the Company has incurred and will
incur substantial additional indebtedness with significant debt service
requirements. Upon issuance of the Notes in the Notes Offering, entering into
the Senior Credit Facility and the application of the estimated net proceeds
therefrom as described in "Use of Proceeds," the Company's pro forma
consolidated indebtedness as of March 31, 1998, would have been $513.1 million
(including the Notes, but excluding an additional $322.2 million available for
borrowings under the Senior Credit Facility). In addition, depending on
prevailing financial, economic and market conditions, the Company may be unable
to consummate one or more of the Offerings. Accordingly, if the Notes Offering
is not consummated, the amount outstanding under the Senior Credit Facility may
be greater than currently contemplated and, if the PIES Offering is not
consummated, stockholders' equity may be lower than currently contemplated. See
"Capitalization." The Company's high degree of leverage may have important
consequences including the following: (i) the ability of the Company to obtain
additional financing for capital expenditures, working capital, acquisitions or
other purposes, if necessary, may be impaired or such financing may not be on
terms favorable to the Company; (ii) a substantial portion of the Company's cash
flow will be used to make debt service payments, which will reduce the funds
that would otherwise be available to the Company for its operations and future
business opportunities; (iii) the Company's flexibility in planning for or
reacting to changes in market conditions may be limited; (iv) the Company may be
more vulnerable to the impact of a downturn in its business or the economy
generally; and (v) to the extent of the Company's outstanding debt under the
Senior Credit Facility, the Company will be vulnerable to the impact of an
increase in interest rates. See "Description of Indebtedness" and "Description
of Capital Stock -- Mandatorily Convertible Preferred Stock."
The Company's ability to make scheduled payments of principal of, or to pay
the interest on, or to refinance, its indebtedness (including the Notes), or to
fund planned capital expenditures, will depend upon its future performance,
which, in turn, is subject to general economic, financial, competitive,
legislative, regulatory and other factors that are beyond its control. Based
upon current levels of operations, the Company believes that its cash flow from
operations, amounts available under the Senior Credit Facility and available
cash will be adequate to meet its anticipated future requirements for working
capital, capital expenditures, scheduled payments of principal and interest on
its indebtedness, including the Notes, and preferred stock dividend payments.
There can be no assurance, however, that the Company's business will generate
cash flow at or above anticipated levels or that the Company will be able to
borrow funds under the Senior Credit Facility in an amount sufficient to enable
the Company to service its indebtedness, including the Notes, preferred stock
dividend payments or make anticipated capital expenditures. If the Company is
unable to generate sufficient cash flow from operations or to borrow sufficient
funds in the future to service its debt and to make its preferred stock dividend
payments, it may be required to sell assets, reduce capital expenditures,
refinance all or a portion of its existing debt (including the Notes) or obtain
additional financing. There can be no assurance that any such financing could be
obtained, particularly in view of the restrictions on the Company's ability to
incur additional debt under the Senior Credit Facility and the Indenture, and
the fact that substantially all of the Company's domestic assets will be pledged
to secure obligations under the Senior Credit Facility.
CONSEQUENCES OF FAILURE TO CLOSE WASHINGTON ACQUISITION
The Offerings are not contingent upon the consummation of the Washington
Acquisition. If the Washington Acquisition is not consummated, or the Washington
Agreement is terminated before such consummation, prior to December 31, 1998,
the Company will be required to redeem 50% of the original aggregate principal
amount of the Notes offered in the Notes Offering at a Special Redemption Price
(as defined herein) plus accrued and unpaid interest and liquidated damages, if
any, to the Special Redemption
S-14
<PAGE> 17
Date (as defined herein). If the Washington Acquisition is not consummated, the
Company's assets, operations, capital and expected financial results will be
substantially different from those set forth herein on a pro forma basis. The
outstanding indebtedness of the Company would be reduced as a result of the
failure to consummate the Washington Acquisition and the subsequent special
redemption of the Notes. See "Capitalization," "Pro Forma Financial Statements"
and "Description of Indebtedness -- The Notes."
RESTRICTIVE DEBT COVENANTS
The Indenture contains covenants that will restrict, among other things,
the ability of the Company to incur additional indebtedness, pay dividends or
make certain other Restricted Payments (as defined therein), enter into
transactions with affiliates, make certain asset dispositions, merge or
consolidate with, or transfer substantially all of its assets to another person,
encumber assets under certain circumstances, restrict dividends and other
payments from Restricted Subsidiaries (as defined therein), issue capital stock
of Wholly Owned Restricted Subsidiaries (as defined therein), engage in certain
business activities, or engage in certain change of control transactions. In
addition, the Senior Credit Facility will contain other and more restrictive
covenants and will prohibit the Company from voluntary or optional prepayments
of certain of its indebtedness, including the Notes. Under the Senior Credit
Facility, the Company will also be required to comply with specified financial
covenants, including a maximum ratio of total debt to EBITDA and a minimum
interest coverage ratio. The failure by the Company to comply with such
financial covenants or to comply with the restrictions contained in the Senior
Credit Facility or the Indenture could result in a default thereunder, which in
turn could cause such indebtedness (and by reason of cross-default provisions,
other indebtedness) to become immediately due and payable. The Company's ability
to comply with such covenants can be affected by many events beyond its control
and no assurance can be given that the Company's future operating results will
be sufficient to enable compliance with such covenants, or in the event of a
default, to remedy such default. See "Description of Indebtedness."
INTEGRATION OF OPERATIONS; THE ACQUISITIONS
Tesoro does not have an operating history with respect to the Hawaii
Refinery (or any other operations of BHP Hawaii) or the Washington Refinery.
These Acquisitions are expected to triple Tesoro's annual revenues. There is no
assurance that, following the Acquisitions, the combination of entities will be
profitable, or will be able to achieve the potential cost savings, revenue
enhancements and operational improvements anticipated by Tesoro or that the
projected demand for or prices of refinery feedstocks and refined products
assumed by Tesoro in connection with the Acquisitions will be realized.
Additionally, although Tesoro has conducted a due diligence investigation in
connection with each of the Acquisitions, the scope of such investigations,
particularly in light of the volume of environmental, litigation and other
matters to be investigated, has necessarily been limited. Both the agreement to
purchase BHP Hawaii (the "Hawaii Agreement") and the Washington Agreement
provide for indemnification with respect to breaches of representations and
warranties made therein and for additional indemnification, subject to certain
terms, conditions and limitations, with respect to other matters. However, there
can be no assurance that other material matters, not identified or fully
investigated in due diligence, will not subsequently be identified or that the
matters heretofore identified will not prove to be more significant than
currently expected, or that the indemnification provisions and monetary limits
thereon associated with each of the Acquisitions will be sufficient to fully
compensate the Company for any environmental or other losses resulting in the
future. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Capital Resources and Liquidity -- Environmental."
While BHP Hawaii and Shell Washington will operate as one or more wholly
owned subsidiaries of the Company, the success of the Acquisitions nevertheless
will depend in part on the ability of management of the Company to integrate the
operations of BHP Hawaii and Shell Washington with those of the Company and to
integrate various departments, systems and procedures. The integration of the
operations of BHP Hawaii and Shell Washington with those of the Company may
require substantial attention of management. The Company anticipates that it
will begin to realize cost savings and revenue enhancements in the fourth
quarter of 1998, with the full impact, which the Company estimates could
approximate $25 million annually, being
S-15
<PAGE> 18
achieved in the fiscal year ended December 31, 1999; however, no assurance can
be given that such cost savings and revenue enhancements will be realized
according to the anticipated time frame or in such amount. Any inability of the
Company to integrate the operations of BHP Hawaii and Shell Washington with
those of the Company in a timely and efficient manner would adversely affect the
Company's ability to realize its planned revenue enhancements and cost savings.
HAWAII REFINED PRODUCT MARKET; ECONOMIC CONDITIONS IN HAWAII
In the Hawaiian refined product market, local refined product supply
currently is reasonably balanced to slightly surplus for all finished products
except jet fuel. This could limit the potential future growth in earnings
generated by the Hawaii Refinery. One competing gasoline marketer has begun
importing gasoline for retail sale in Hawaii. In addition, the growth rate in
Hawaii's gross state product from 1991 through 1997 was substantially below the
U.S. average. If these trends continue, they may have an adverse effect on the
business and results of operations of the Company.
HAWAIIAN STATE GOVERNMENT INVESTIGATIONS AND GASOLINE RETAILING RESTRICTIONS
In September 1990, the Attorney General for the State of Hawaii released a
preliminary report pursuant to an investigation under the Hawaii antitrust
statute indicating that the price of gasoline in Hawaii is persistently higher
than on the mainland. The Attorney General has not found any violations of
federal or state antitrust provisions in the investigation. However, the pricing
investigation remains open and all Hawaii gasoline retailers, including the
Company's Hawaii operations, may be subject to further inquiries and
documentation requests relating to their operations, costs and pricing policies.
In 1991 and 1993 at the request of independent gasoline dealers, the Hawaii
legislature enacted a series of two-year moratorium periods during which
refiners and jobbers were prevented or restricted from operating additional
retail stations pending the outcome of legislative studies. In 1995, legislation
was enacted which restricted refiners and jobbers to only one company-operated
station per dealer station opened, subject to a maximum of two company-operated
stations. In 1997, the Hawaii legislature ended the moratorium with the
enactment of a statute that permits refiners and jobbers to acquire or build any
number of retail stations, provided these are situated at least one-eighth of a
mile from any existing dealer station in the urban Honolulu area and at least
one-fourth of a mile from any existing dealer station in the remainder of the
State.
VOLATILITY OF PRICES; EFFECT ON EARNINGS AND CASH FLOWS
The Company's refining and marketing earnings and cash flow from operations
are dependent upon the margin above fixed and variable expenses (including the
cost of crude oil feedstocks) at which the Company is able to sell refined
products. In recent years, the prices of crude oil and refined products have
fluctuated substantially. These prices depend on numerous factors, including the
demand for crude oil, gasoline and other refined products, which in turn depend
on, among other factors, changes in the economy, the level of foreign and
domestic production of crude oil and refined products, political conditions in
the Middle East, the availability of imports of crude oil and refined products,
the marketing of alternative and competing fuels and the extent of government
regulation. The prices received by the Company for its refined products are also
affected by local factors such as local market conditions and the level of
operations of other refineries in Alaska, Hawaii and Washington.
The price at which the Company can sell its refined products will be
strongly influenced by the commodity price of crude oil. Generally, an increase
or decrease in the price of crude oil results in a corresponding increase or
decrease in the price of gasoline and other refined products and could have a
significant short-term impact on the Company's refining operations and the
earnings and cash flow of the Company as a whole. However, each of the Company's
refineries maintains inventories of crude oil, intermediate products and refined
products, the value of each of which is subject to rapid fluctuations in market
prices. In addition, crude oil supply contracts are generally contracts with
market-responsive pricing provisions.
S-16
<PAGE> 19
Any significant decline in the price for natural gas could have a material
adverse effect on the Company's exploration and production operations and the
financial condition of the Company as a whole. Prices for natural gas are
subject to wide fluctuations in response to relatively minor changes in the
supply of and demand for natural gas, market uncertainty and a variety of
additional factors that are beyond the control of the Company. These factors
include the domestic and foreign supply of natural gas, the level of consumer
demand, weather conditions, domestic and foreign government regulations, the
price and availability of alternative fuels and overall economic conditions.
While the Company from time to time enters into agreements with respect to a
portion of its future production in an effort to reduce price risk, including
commodity price contracts and forward sales agreements, there can be no
assurance that such transactions will reduce risk or mitigate the effect of any
substantial or prolonged decline in the price of natural gas.
CRUDE OIL SUPPLY
The Company believes an adequate supply of crude oil will be available to
its three refineries to sustain the Company's refining operations for the
foreseeable future at substantially the levels currently being experienced.
However, there can be no assurance that this situation will continue. If
additional supplemental crude oil becomes necessary at one or more of its
refineries, the Company intends to implement available alternatives that are
most advantageous under then prevailing conditions. Implementation of some
alternatives could require the consent or cooperation of third parties and other
considerations beyond the control of the Company. If the Company is unable to
obtain such supplemental crude oil volumes, or is only able to obtain such
volumes at uneconomic prices, the Company's results from operations could be
materially adversely effected. See "-- Government Regulations and Environmental
Risks."
RISKS ASSOCIATED WITH BOLIVIAN AND OTHER INTERNATIONAL OPERATIONS
The Company's international operations are primarily conducted in Bolivia,
where it has operated for over 20 years and where it currently explores for and
produces hydrocarbons through four contracts with the Bolivian government.
Substantially all of the Company's current Bolivian production is sold under
contract to the Bolivian government for export to Argentina, as there is
currently little internal demand in Bolivia for natural gas. As a result, the
Company's Bolivian operations are heavily dependent on its relations with the
Bolivian government. Moreover, a majority of the Company's Bolivian reserves are
currently shut-in. The Company believes that the completion of a 1,900-mile
pipeline currently under construction from Bolivia to Brazil will provide access
to gas-consuming markets. In addition, upon completion of the 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 (as defined herein) 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. Upon completion of the Brazil gas pipeline, the Company's Bolivian gas
production will become dependent to a large extent upon the continued demand for
natural gas in Brazil and the stability of such markets. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Exploration and Production -- Bolivia" and
"Business -- Exploration and Production -- Bolivia."
The future success of the Company's international operations in Bolivia and
elsewhere is subject to political, economic and other uncertainties, including,
among others, risk of war, revolution, border disputes, expropriation,
renegotiation or modification of existing contracts, import, export and
transportation regulations and tariffs, taxation policies, including royalty and
tax increases and retroactive tax claims, exchange controls, currency
fluctuations and other uncertainties arising out of foreign government
sovereignty over the Company's international operations. The Company's
international operations may also be adversely affected by laws and policies of
the United States affecting foreign trade, taxation and investment. Furthermore,
in the event of a dispute arising from its Bolivian or other international
operations, the Company may be subject to
S-17
<PAGE> 20
the exclusive jurisdiction of foreign courts or may not be successful in
subjecting foreign persons to the jurisdiction of courts in the United States.
The Company believes Bolivia possesses relatively stable political and economic
environments in which to operate; however, there can be no assurance that
political and economic and other uncertainties will not develop in Bolivia or
neighboring countries. Such uncertainty or instability could result in new
governments or the adoption of new policies that might assume a substantially
more hostile attitude toward foreign investment. In an extreme case, such a
change could result in voiding pre-existing contracts and/or expropriation of
foreign-owned assets.
REPLACEMENT OF RESERVES
The future success of the Company's exploration and production operations
depends upon the ability to find, develop or acquire additional oil and gas
reserves that are economically recoverable. The proved reserves of the Company
will generally decline as reserves are depleted, except to the extent that the
Company conducts successful exploration or development activities, acquires
properties containing proved reserves, or both. In order to increase reserves
and production, the Company must continue its development and exploration
drilling and recompletion programs or undertake other replacement activities.
The Company's current strategy includes continuing to exploit its existing
properties, discovering new reserves through exploration and increasing its
reserve base through acquisitions of producing properties. There can be no
assurance, however, that the Company's planned exploration, development and
acquisition activities will result in significant additional reserves or that
the Company will have continuing success drilling productive wells at low
finding and development costs. For a discussion of the Company's reserves, see
"Business -- Exploration and Production -- U.S. -- Reserves" and
"Business -- Exploration and Production -- Bolivia -- Reserves."
DRILLING RISKS
Drilling activities are subject to many risks, including the risk that no
commercially productive reservoirs will be encountered. There can be no
assurance that new wells drilled by the Company will be productive or that the
Company will recover all or any portion of its investment. Drilling for oil and
natural gas may involve unprofitable efforts, not only from dry wells, but from
wells that are productive but do not produce sufficient net revenues to return a
profit after drilling, completing, operating, and other costs. The cost of
drilling, completing and operating wells is often uncertain. The Company's
drilling operations may be curtailed, delayed or canceled as a result of
numerous factors, many of which are beyond the Company's control, including
title problems, weather conditions, compliance with governmental requirements
and shortages or delays in the delivery of equipment and services.
RELIANCE ON ESTIMATES OF PROVED RESERVES
There are numerous uncertainties inherent in estimating quantities of
proved reserves, including many factors beyond the control of the Company. The
Company's historical reserve information set forth in this Prospectus Supplement
represents estimates based on evaluations audited by Netherland, Sewell &
Associates, Inc., as of December 31, 1997.
Petroleum engineering is not an exact science. Information relating to the
Company's proved oil and gas reserves is based upon engineering estimates.
Estimates of economically recoverable oil and gas reserves and of future net
cash flows necessarily depend upon a number of variable factors and assumptions,
such as historical production from the area compared with production from other
producing areas, the assumed effects of regulations by governmental agencies and
assumptions concerning future oil and gas prices, future operating costs,
severance and excise taxes, development costs and workover and remedial costs,
all of which may in fact vary considerably from actual results. For these
reasons, estimates of the economically recoverable quantities of oil and gas
attributable to any particular group of properties, classifications of such
reserves based on risk of recovery and estimates of the future net cash flows
expected therefrom prepared by different engineers or by the same engineers at
different times may vary substantially. Actual production, revenues and
expenditures with respect to the Company's reserves will likely vary from
estimates, and such variances may be material. See "Business -- Exploration and
Production -- U.S. -- Reserves" and "Business -- Exploration and
Production -- Bolivia -- Reserves."
S-18
<PAGE> 21
The Pre-Tax PV10 referred to in this Prospectus Supplement should not be
construed as the current market value of the estimated oil and gas reserves
attributable to the Company's properties. In accordance with applicable
requirements of the Commission, the estimated discounted future net cash flows
from proved reserves are generally based on prices and costs as of the date of
the estimate, whereas actual future prices and costs may be materially higher or
lower. Actual future net cash flows also will be affected by factors such as the
amount and timing of actual production, supply and demand for oil and gas,
curtailments or increases in consumption by gas purchasers and changes in
governmental regulations or taxation. The timing of actual future net cash flows
from proved reserves, and thus their actual present value, will be affected by
the timing of both the production and the incurrence of expenses in connection
with development and production of oil and gas properties. In addition, the 10%
discount factor, which is required by the Commission to be used to calculate
discounted future net cash flows for reporting purposes, is not necessarily the
most appropriate discount factor based on interest rates in effect from time to
time and risks associated with the Company or the oil and gas industry in
general.
OPERATING HAZARDS AND UNINSURED RISKS
The Company's operations are subject to hazards and risks inherent in
drilling for, producing and transporting oil and natural gas and refining crude
oil, such as fires, natural disasters, explosions, blowouts, cratering, pipeline
ruptures, and spills, any of which can result in loss of hydrocarbons,
environmental pollution, personal injury claims, and other damage to properties
of the Company and others. As protection against operating hazards, the Company
maintains insurance coverage against some, but not all, potential losses. The
Company's coverages include, but are not limited to, operator's extra expense,
physical damage on certain assets, employer's liability, comprehensive general
liability, automobile, workers' compensation and loss of production income
insurance. The Company believes that its insurance is adequate and customary for
companies of a similar size engaged in operations similar to those of the
Company, but losses could occur for uninsurable or uninsured risks or in amounts
in excess of existing insurance coverage. The occurrence of an event that is not
fully covered by insurance could have an adverse impact on the Company's
financial condition and results of operations.
CONCENTRATION OF OPERATIONS
A significant portion of the Company's domestic exploration and production
operations are located in the Wilcox Trend along the Texas and Louisiana Gulf
Coast. At December 31, 1997, approximately 39% of the Company's domestic net
proved gas reserves were located in the Bob West Field, which is located in the
Wilcox Trend. Similarly, all of the Company's international exploration and
production activities are located within two production blocks in Bolivia. As a
result, any interruption of the Company's production in the Bob West Field or in
Bolivia due to any one or more of a variety of conditions and events, including
natural disaster, reservoir damage, mechanical difficulties, unavailability of
equipment and supplies, transportation problems, title and contractual
controversies, government regulation or international political uncertainties
could have a material adverse effect on the Company's operations and its ability
to service the Notes. See "Business -- Exploration and
Production -- U.S. -- Reserves" and "Business -- Exploration and
Production -- Bolivia -- Reserves."
The Company's refining activities currently are conducted at its three
refineries in Hawaii, Alaska and Washington. The refineries are three of the
Company's principal operating assets. As a result, the operations of the
Company, and its ability to service the Notes, are subject to significant
interruption if one or more of the refineries were to experience a major
accident, be damaged by severe weather or other natural disaster, or otherwise
be forced to shut down. Although the Company maintains business interruption
insurance against some types of risks in amounts which the Company believes to
be economically prudent, if the refineries were to experience an interruption in
operations, the Company's business could be materially adversely affected. See
"Business -- Refining and Marketing."
S-19
<PAGE> 22
COMPETITION
The petroleum industry is highly competitive in all phases, including the
refining of crude oil and the marketing of refined petroleum products, the
search for and development of oil and natural gas reserves and the marine
services business. The industry also competes with other industries that supply
the energy and fuel requirements of industrial, commercial and individual
consumers. The Company competes with a substantial number of major integrated
oil companies and other companies having materially greater financial and other
resources than the Company. These competitors have a greater ability to bear the
economic risks inherent in all phases of the industry. In addition, unlike the
Company, many of its competitors produce large volumes of crude oil which can
then be used in connection with their refining operations. See
"Business -- Competition and Other."
GOVERNMENT REGULATIONS AND ENVIRONMENTAL RISKS
The Company's operations are subject to a variety of foreign, federal,
state and local environmental laws and regulations governing the discharge of
pollutants into the air, soil, and water and the generation, treatment, storage,
transportation and disposal of solid and hazardous waste and materials.
Environmental laws and regulations that affect the Company's operations,
processes and margins have become and are becoming increasingly stringent.
Examples are the Clean Air Act Amendments of 1990 (the "Clean Air Act
Amendments") and other additional environmental regulations adopted by the
United States Environmental Protection Agency (the "EPA") and state and local
environmental agencies to implement the Clean Air Act Amendments. Although the
Company believes that it conducts its exploration and production, refining and
marketing and marine services operations in substantial compliance with existing
environmental laws and regulations, the Company cannot predict the nature, scope
or effect of legislation or regulatory requirements that could be imposed or how
existing or future laws or regulations will be administered or interpreted with
respect to products or activities to which they have not been previously
applied. Compliance with more stringent laws or regulations, as well as more
vigorous enforcement policies of the regulatory agencies, could adversely affect
the financial position and the results of operations of the Company and could
require substantial expenditures by the Company. See "Business -- Government
Regulation and Legislation."
Under the agreement related to the Washington Acquisition, Shell Refining
Holding Company, a subsidiary of Shell, generally has agreed to indemnify the
Company for environmental liabilities at the Washington Refinery arising out of
conditions which existed at or prior to the closing date. However, the Company
is responsible for the first $0.5 million in environmental costs in each year
and 50% of environmental costs over $1 million in each year, subject to a
maximum aggregate liability of $5 million. While Tesoro has done environmental
investigations of the Washington and Hawaii Refineries there is no assurance
that the indemnified amounts will be adequate with respect to future
environmental claims or the remediation of existing or unknown environmental
conditions.
The Company's Refining and Marketing segment operates in environmentally
sensitive coastal waters, where tanker and pipeline operations are closely
regulated by local and Federal agencies and monitored by environmental interest
groups. Each of the Company's Refineries imports crude oil feedstocks by tanker.
Transportation of crude oil and refined product by tanker involves inherent risk
and, additionally, subjects the Company to the provisions of the Federal Oil
Pollution Act of 1990 ("OPA 90"), and state laws in Alaska, Hawaii and
Washington, which require the Company to demonstrate its capacity to respond to
a "worst case discharge" to the maximum extent possible. The Company has
contracted with various spill response service companies in the areas in which
the Company transports crude oil and refined product by tanker to meet the
requirements of OPA 90 and state laws. However, there can be no assurance that
there will not be any accidents involving tankers transporting crude oil or
refined product for the Company, or that such response services will respond to
a "worst case discharge" in a manner that will adequately contain such
discharge.
The Company's operations are inherently subject to accidental spills,
discharges or other releases of petroleum or hazardous substances which may give
rise to liability to governmental entities or private parties under foreign,
federal, state or local environmental laws, as well as under common law.
Although the Company has invested substantial resources to prevent future
accidental discharges and to remediate
S-20
<PAGE> 23
contamination resulting from prior discharges, there can be no assurance that
accidental discharges will not occur in the future, that future action will not
be taken in connection with past discharges, that governmental agencies will not
assess penalties against the Company in connection with any past or future
contamination, or that third parties will not assert claims against the Company
for damages allegedly arising out of any past or future contamination.
The Company has been identified by the EPA as a potentially responsible
party ("PRP") pursuant to the Comprehensive Environmental Response, Compensation
and Liability Act ("CERCLA") for the D. L. Mud Superfund site in Abbeville,
Louisiana, but does not believe its liability at such site to be material. See
"Business -- Government Regulation and Legislation." In addition, while the
Company from time to time has been, and presently is, subject to litigation and
investigations with respect to environmental and related matters, the Company
does not believe that such proceedings will have a material adverse effect on
the results of operations or competitive position of the Company. See
"Business -- Legal Proceedings." However, there can be no assurance that the
Company will not become involved in further litigation or other proceedings, or
that if the Company were to be held responsible for damages in any litigation or
proceedings (including existing ones), such costs would not be material.
The Company has in the past operated service stations with underground
storage tanks ("USTs") in various jurisdictions, and currently operates service
stations in Alaska and Hawaii which have USTs. All such storage tanks are
subject to governmental regulation and legislation. See "Business -- Government
Regulation and Legislation." The operation of USTs also poses certain risks
apart from costs associated with regulatory requirements. These risks are
predominantly damages associated with the underground leaks to soil and
groundwater of petroleum products. The Company currently has leak detection and
tank testing programs in effect to mitigate the threat of such risks. However,
there can be no assurance that leaks from USTs at one or more of the Company's
service stations will not occur, or that previously operated service stations do
not have impacted soil or groundwater that could result in fines or civil
liability for the Company.
SHARES OF COMMON STOCK ELIGIBLE FOR FUTURE SALE
Upon consummation of the Offerings (assuming no exercise of the
Underwriters' over-allotment option), the Company will have 31,558,068 shares of
Common Stock outstanding and 9,000,000 PIES (convertible after July 26, 1998,
into 7,609,500 shares of Common Stock, subject to adjustment in certain
circumstances) outstanding. Future sales of Common Stock by existing
stockholders pursuant to Rule 144 under the Securities Act, or through the
exercise of outstanding registration rights or otherwise, could have an adverse
effect on the prevailing market price of the Common Stock and the Company's
ability to raise additional capital. Except for the Common Stock to be sold in
the Common Stock Offering, the PIES, the Mandatorily Convertible Preferred Stock
and shares of Common Stock issued upon conversion of the PIES and the
Mandatorily Convertible Preferred Stock, the Company has agreed not to offer,
sell, contract to sell or otherwise issue any shares of Common Stock (except
pursuant to outstanding options and warrants) or other capital stock or
securities convertible into or exchangeable for, or any rights to acquire,
Common Stock or other capital stock, with certain exceptions including certain
exceptions for Common Stock or other capital stock issued or sold in connection
with future acquisitions by the Company, prior to the expiration of 90 days from
the date of this Prospectus Supplement without the prior written consent of
Lehman Brothers Inc. ("Lehman Brothers"). The Company's executive officers and
directors have agreed not to sell any such shares for 90 days following the date
of this Prospectus without the consent of Lehman Brothers. Thereafter, all such
shares held by the Company's executive officers and directors will be eligible
for sale in the public market (subject, in most cases, to applicable volume
limitations and other resale conditions imposed by Rule 144). The sale, or the
availability for sale, of substantial amounts of Common Stock or securities
convertible into Common Stock in the public market at any time subsequent to the
date of this Prospectus Supplement could adversely affect the prevailing market
price of the Common Stock and the PIES. See "Principal Stockholders,"
"Description of Capital Stock" and "Underwriting."
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<PAGE> 24
CERTAIN ANTI-TAKEOVER CONSIDERATIONS; CHANGE OF CONTROL
Certain provisions of the Company's Restated Certificate of Incorporation
and Bylaws may have the effect of discouraging or delaying attempts to gain
control of the Company, including provisions which could result in the Company's
stockholders receiving less for their shares of Common Stock than otherwise
might be available in the event of a take-over attempt. These provisions
include: (i) authorizing directors to fill vacancies on the Board of Directors
that occur between annual meetings; (ii) restricting the persons who may call a
special meeting of stockholders; (iii) authorizing the issuance of Preferred
Stock; (iv) requiring advance notice for stockholder proposals; and (v)
requiring the Board of Directors to fix a record date prior to conducting a
consent solicitation. Furthermore, certain provisions of Delaware law may also
discourage or hinder attempts by third parties to obtain control of the Company.
See "Description of Capital Stock -- Delaware Law and Certain Charter and Bylaws
Provisions." In addition, certain events that could lead to a change of control
of the Company will constitute a Change of Control under the Indenture relating
to the Notes, and require the Company to make an offer to purchase the Notes. A
Change of Control is also a default under the Senior Credit Facility.
S-22
<PAGE> 25
USE OF PROCEEDS
The net proceeds to be received by the Company from the sale of the Common
Stock, after deducting the expenses of the Common Stock Offering, are expected
to be approximately $76 million. The net proceeds of the Common Stock Offering,
together with the $500 million available under the Senior Credit Facility and
the net proceeds from the Notes Offering and the PIES Offering, will be used to
fund the purchase price of the Washington Acquisition, to refinance amounts
owing under the Interim Credit Facility (a portion of which was used to fund the
cash purchase price of the Hawaii Acquisition), to pay certain fees and expenses
related to the Transactions and for general corporate purposes (including
working capital requirements and capital expenditures).
Amounts used to repay the Interim Credit Facility (under which $432 million
was outstanding as of May 29, 1998) will be received by LCPI. In addition,
Lehman Brothers and LCPI have received and will receive certain fees in
connection with the Transactions. See "Underwriting."
S-23
<PAGE> 26
CAPITALIZATION
The following table sets forth the consolidated capitalization of the
Company as of March 31, 1998 on a (i) historical basis and (ii) as adjusted to
give effect to the Acquisitions, the Offerings (not giving effect to the
exercise of the over-allotment options granted to the underwriters of PIES and
Common Stock) and the initial borrowings under Senior Credit Facility and the
application of the estimated net proceeds therefrom as described under "Use of
Proceeds." The adjustments made assume the ability of the Company to complete
the Offerings in the amounts described below, which the Company believes to be
reasonable in light of its knowledge of current market conditions. There can be
no assurance that the Company will be able to complete the Notes Offering, or
that the proceeds from the Notes Offering will be as currently contemplated. The
closing of the Common Stock Offering is not conditioned upon the closing of the
PIES Offering or the Notes Offering, nor is the closing of any of the Offerings
conditioned upon the closing of the Washington Acquisition.
This table should be read in conjunction with Tesoro's Consolidated
Financial Statements and the Pro Forma Financial Statements, including the notes
thereto, contained elsewhere in this Prospectus Supplement.
<TABLE>
<CAPTION>
MARCH 31, 1998
----------------------------------------------
ADJUSTMENTS AS ADJUSTED
TESORO FOR THE FOR THE
HISTORICAL TRANSACTIONS TRANSACTIONS
---------- ------------ ------------
(IN THOUSANDS OF DOLLARS)
<S> <C> <C> <C>
Total debt and other obligations, including current
maturities:
Senior Credit Facility:
Revolver(a)....................................... $ -- $ 27,847 $ 27,847
Tranche A Term Loans(b)........................... -- 50,000 50,000
Tranche B Term Loan............................... -- 100,000 100,000
BHP Note(c).......................................... -- 14,615 14,615
Liability to State of Alaska......................... 61,780 (61,780) --
Other senior debt and obligations.................... 85,938 (65,335) 20,603(d)
The Notes............................................ -- 300,000 300,000
-------- -------- ----------
Total debt................................... 147,718 365,347 513,065
Mandatorily Convertible Preferred Stock................ -- 143,438(e) 143,438
Common stockholders' equity............................ 339,359 65,192(f) 404,551
-------- -------- ----------
Total capitalization......................... $487,077 $573,977 $1,061,054
======== ======== ==========
</TABLE>
- ---------------
(a) The maximum amount available for the Revolver is $300 million, including
availability of letters of credit.
(b) The Term Loans provide for additional borrowings of up to $50 million in
the aggregate over the first six months following closing of the
Transactions for general corporate purposes (including capital
expenditures).
(c) The amount reflects the scheduled payments of the $50 million, non-interest
bearing BHP Note discounted to present value using a 10% discount rate.
(d) Other debt as adjusted for the Transactions consists primarily of the
Company's obligation to the Department of Energy of approximately $7.9
million and capitalized lease obligations of approximately $9 million for
tugs and barges used in transportation of petroleum products within Hawaii.
The remaining amount consists primarily of obligations of subsidiaries,
none of which are material. See Note I of Notes to Tesoro's Consolidated
Financial Statements.
(e) Includes the impact of the PIES Offering (gross proceeds of $143.4
million).
(f) Includes the impact of the Common Stock Offering (gross proceeds of $79.7
million) and the aftertax charge against earnings for early extinguishment
of debt.
S-24
<PAGE> 27
PRO FORMA FINANCIAL STATEMENTS
The following unaudited pro forma combined condensed financial statements
give effect to the Transactions. There can be no assurance that the Offerings
will be completed as anticipated or that the net proceeds therefrom will be the
amount assumed in the following pro forma financial statements. The Acquisitions
are being accounted for using the purchase method of accounting. These unaudited
pro forma combined condensed statements have been prepared from, and should be
read in conjunction with, the historical consolidated financial statements and
notes thereto, which are included in or incorporated by reference in this
Prospectus Supplement.
The Unaudited Pro Forma Combined Condensed Balance Sheet gives effect to
the Transactions as if each had occurred on March 31, 1998. The Unaudited Pro
Forma Condensed Statements of Operations for the year ended December 31, 1997,
and the quarter ended March 31, 1998, give effect to the Transactions as if each
had occurred on January 1, 1997. BHP Hawaii's results of operations, which are
reported on a fiscal year ending May 31, have been adjusted to Tesoro's
reporting periods. The estimates of the fair value of BHP Hawaii's and Shell
Washington's assets and liabilities are based on valuations that are
preliminary. Such valuations may be updated with respect to the Hawaii
Acquisition and the Washington Acquisition, and may change from the amounts
shown herein; however, the Company does not expect such changes to be material.
The unaudited pro forma combined condensed financial statements are intended for
informational purposes and are not necessarily indicative of the future
financial position or future results of the combined companies or of the
financial position or the results of operations that would have actually
occurred had the Acquisitions been in effect as of the date or for the periods
presented. The Unaudited Pro Forma Combined Condensed Statements of Operations
do not reflect any benefits from potential cost savings or revenue enhancements
resulting from the integration of the operations of Tesoro, BHP Hawaii and Shell
Washington (estimated by the Company to be $25 million annually beginning in
1999). Such cost savings and revenue enhancements are discussed in Note (a) to
the Unaudited Pro Forma Combined Condensed Statements of Operations.
S-25
<PAGE> 28
UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET
MARCH 31, 1998
<TABLE>
<CAPTION>
HISTORICAL
--------------------------------
BHP SHELL PRO FORMA PRO FORMA
TESORO HAWAII WASHINGTON ADJUSTMENTS COMBINED(L)
ASSETS -------- -------- ---------- ----------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Current Assets:
Cash and cash equivalents.......... $ 2,274 $ 2,519 $ 25 $ (2,544)(a) $ 2,274
Receivables........................ 64,518 84,304 12,600 (42,372)(a) 119,050
Inventories........................ 97,793 71,050 41,305 10,891(b) 221,039
Prepayments and other.............. 7,984 3,919 4,349 (688)(c) 15,564
-------- -------- -------- --------- ----------
Total Current Assets....... 172,569 161,792 58,279 (34,713) 357,927
-------- -------- -------- --------- ----------
Property, Plant and Equipment:
Refining and marketing............. 368,183 209,804 372,768 (82,572)(d) 868,183
Exploration and production......... 311,872 -- -- 311,872
Marine services.................... 48,201 -- -- 48,201
Corporate.......................... 13,802 -- -- 13,802
-------- -------- -------- --------- ----------
742,058 209,804 372,768 (82,572) 1,242,058
Less accumulated depreciation,
depletion and amortization.... 317,645 -- 188,127 (188,127)(d) 317,645
-------- -------- -------- --------- ----------
Net Property, Plant and
Equipment..................... 424,413 209,804 184,641 105,555(d) 924,413
-------- -------- -------- --------- ----------
Other Assets......................... 38,447 3,295 8,774 47,271(e) 113,871
17,819(f)
(1,735)(c)
-------- -------- -------- --------- ----------
Total Assets............... $635,429 $374,891 $251,694 $ 134,197 $1,396,211
======== ======== ======== ========= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable................... $ 44,275 $ 46,831 $ 9,819 $ (3,553)(a) $ 97,372
Accrued liabilities and current
income taxes payable............ 30,253 12,901 4,833 9,886(g) 57,873
Current maturities of long-term
debt and other obligations...... 11,428 1,003 -- (9,731)(f) 2,700
-------- -------- -------- --------- ----------
Total Current
Liabilities.............. 85,956 60,735 14,652 (3,398) 157,945
-------- -------- -------- --------- ----------
Deferred Income Taxes................ 31,003 -- 25,523 55,065(i) 111,591
-------- -------- -------- --------- ----------
Other Liabilities.................... 42,821 29,460 14,412 (18,372)(g) 68,321
-------- -------- -------- --------- ----------
Long-Term Debt and Other Obligations,
Less Current Maturities............ 136,290 8,433 -- 365,642(f) 510,365
-------- -------- -------- --------- ----------
Notes Payable to Affiliate........... -- 145,000 -- (145,000)(a) --
-------- -------- -------- --------- ----------
Stockholders' Equity:
Preferred Stock.................... -- -- -- 143,438(k) 143,438
Common Stock....................... 4,419 8,208 3 833(k) 5,252
(8,211)(j)
Additional paid-in capital......... 191,000 52,362 181,011 69,920(k) 260,920
(233,373)(j)
Retained earnings.................. 147,039 70,693 16,093 (86,786)(j) 141,478
(8,178)(f)
2,617(h)
Treasury stock..................... (3,099) -- -- (3,099)
-------- -------- -------- --------- ----------
Total Stockholders'
Equity................... 339,359 131,263 197,107 (119,740) 547,989
-------- -------- -------- --------- ----------
Total Liabilities and
Stockholders' Equity..... $635,429 $374,891 $251,694 $ 134,197 $1,396,211
======== ======== ======== ========= ==========
</TABLE>
S-26
<PAGE> 29
NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED BALANCE SHEET
MARCH 31, 1998
(a) Represents an adjustment to exclude assets and liabilities of BHP Hawaii
and Shell Washington that are not acquired by Tesoro.
(b) Represents an adjustment of finished goods inventories to net realizable
value, less an allowance for a normal profit margin, and of raw materials
inventories to replacement cost.
(c) Represents an adjustment to conform the accounting policy for refinery
maintenance costs to that of Tesoro.
(d) Represents an adjustment of property, plant and equipment to fair value.
(e) Represents the excess purchase price over the book value of net assets
acquired.
(f) Represents an adjustment to reflect the $50 million non-interest bearing
BHP Note (discounted at 10%) plus aggregate borrowings of $478 million to
finance the Acquisitions, to refinance existing indebtedness of Tesoro and
to pay related fees, expenses and debt issue costs.
(g) Represents an adjustment to liabilities for certain employee benefits and
for environmental matters taking into effect environmental agreements which
provide for certain environmental indemnifications.
(h) Represents an adjustment to reduce income taxes payable for the tax effect
resulting from charges to earnings related to the refinancing of existing
indebtedness.
(i) Represents an adjustment to record the deferred tax obligations for
differences in book and tax basis for the Washington Acquisition.
(j) Represents the elimination of historical equity of BHP Hawaii and Shell
Washington.
(k) Represents an adjustment for the issuance of Mandatorily Convertible
Preferred Stock and Common Stock, the proceeds of which were used to
finance the Transactions.
(1) The following are pro forma consolidated balance sheet data excluding the
effects of the Washington Acquisition, but including the effects of the
Offerings and the mandatory special redemption of 50% of the aggregate
principal amount of Notes offered in the Notes Offering:
<TABLE>
<S> <C>
Current assets.............................................. $300,095
Property, plant and equipment, net.......................... $639,413
Total assets................................................ $999,430
Current liabilities......................................... $136,010
Long-term debt and other obligations, less current
maturities................................................ $231,039
</TABLE>
S-27
<PAGE> 30
UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
HISTORICAL
-----------------------------------
BHP SHELL PRO FORMA PRO FORMA
TESORO HAWAII WASHINGTON ADJUSTMENTS(A) COMBINED(L)
-------- ---------- ---------- -------------- -----------
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Revenues:
Refining and marketing....... $720,868 $ 946,727 $1,089,918 $ $2,757,513
Exploration and production... 84,798 -- -- 84,798
Marine services.............. 132,251 -- -- 132,251
Other income................. 5,543 211 52 5,806
-------- ---------- ---------- --------- ----------
Total Revenues....... 943,460 946,938 1,089,970 2,980,368
-------- ---------- ---------- --------- ----------
Operating Costs and Expenses:
Refining and marketing....... 687,036 882,104 1,038,085 1,500(b) 2,608,725
Exploration and production... 13,230 -- -- 13,230
Marine services.............. 124,725 -- -- 124,725
Depreciation, depletion and
amortization.............. 45,729 13,762 12,715 (3,543)(c) 70,554
1,891(d)
Refinery assets writedown.... 88,813 -- (88,813)(e) --
Goodwill write-off........... -- 30,351 -- (30,351)(e) --
-------- ---------- ---------- --------- ----------
Total Operating Costs
and Expenses....... 870,720 1,015,030 1,050,800 (119,316) 2,817,234
-------- ---------- ---------- --------- ----------
Operating Profit (Loss)........ 72,740 (68,092) 39,170 119,316 163,134
General and Administrative..... (13,588) (25,054)(f) (14,277) (52,919)
Interest Expense, Net of
Capitalized Interest......... (6,699) (8,227) (252) 14,291 (g) (52,579)
(51,692)(h)
Interest Income................ 1,597 -- -- 1,597
Other Expense, Net............. (4,930) -- -- (2,894)(i) (7,824)
-------- ---------- ---------- --------- ----------
Earnings Before Income Taxes... 49,120 (101,373) 24,641 79,021 51,409
Income Tax Provision........... 18,435 (27,032) 8,902 19,230(j) 19,535
-------- ---------- ---------- --------- ----------
Earnings Before Extraordinary
Items........................ 30,685 (74,341) 15,739 59,791 31,874
Preferred Dividend............. -- -- -- (10,399)(k) (10,399)
-------- ---------- ---------- --------- ----------
Earnings Before Extraordinary
Items Available for Common
Shares....................... $ 30,685 $ (74,341) $ 15,739 $ 49,392 $ 21,475
======== ========== ========== ========= ==========
Weighted Average Common
Shares -- Basic.............. 26,410 5,000 31,410
======== ========= ==========
Weighted Average Common Shares
and Potentially Dilutive
Common Shares -- Diluted..... 26,868 5,000 31,868
======== ========= ==========
Earnings Before Extraordinary
Items:
Per Share -- Basic........ $ 1.16 $ 0.68
======== ==========
Per Share -- Diluted...... $ 1.14 $ 0.67
======== ==========
</TABLE>
S-28
<PAGE> 31
UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 1998
<TABLE>
<CAPTION>
HISTORICAL
---------------------------------
BHP SHELL PRO FORMA PRO FORMA
TESORO HAWAII WASHINGTON ADJUSTMENTS(A) COMBINED(L)
-------- --------- ---------- -------------- -----------
(IN THOUSANDS OF DOLLARS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
Revenues:
Refining and marketing......... $140,213 $ 210,447 $201,431 $ $ 552,091
Exploration and production..... 22,222 -- 22,222
Marine services................ 32,818 -- 32,818
Other income................... 786 (3) 30 813
-------- --------- -------- --------- ---------
Total Revenues......... 196,039 210,444 201,461 607,944
-------- --------- -------- --------- ---------
Operating Costs and Expenses:
Refining and marketing......... 130,720 191,642 195,685 1,500(b) 519,547
Exploration and production..... 3,925 -- -- 3,925
Marine services................ 30,597 -- -- 30,597
Depreciation, depletion and
amortization................ 12,944 -- 3,703 2,030(c) 19,150
473(d)
Refinery assets writedown...... -- 125,049 -- (125,049)(e) --
-------- --------- -------- --------- ---------
Total Operating Costs
and Expenses......... 178,186 316,691 199,388 (121,046) 573,219
-------- --------- -------- --------- ---------
Operating Profit (Loss).......... 17,853 (106,247) 2,073 121,046 34,725
General and Administrative....... (3,372) (5,139) (2,512) (11,023)
Interest Expense, Net of
Capitalized Interest........... (2,665) (2,436) (10) 4,708(g) (13,326)
(12,923)(h)
Interest Income.................. 108 -- -- 108
Other Expense, Net............... (1,034) -- -- (703)(i) (1,737)
-------- --------- -------- --------- ---------
Earnings Before Income Taxes..... 10,890 (113,822) (449) 112,128 8,747
Income Tax Provision............. 4,831 (33,676) (80) 32,774(j) 3,849
-------- --------- -------- --------- ---------
Earnings Before Extraordinary
Items.......................... 6,059 (80,146) (369) 79,354 4,898
Preferred Dividend............... -- -- -- (2,600)(k) (2,600)
-------- --------- -------- --------- ---------
Earnings Before Extraordinary
Items Available for Common
Shares......................... $ 6,059 $ (80,146) $ (369) $ 76,754 $ 2,298
======== ========= ======== ========= =========
Weighted Average Common Shares
Basic.......................... 26,309 5,000 31,309
======== ========= =========
Weighted Average Common Shares
and Potentially Dilutive Common
Shares -- Diluted.............. 26,789 5,000 31,789
======== ========= =========
Earnings Before Extraordinary
Items:
Per Share -- Basic.......... $ 0.23 $ 0.07
======== =========
Per Share -- Diluted........ $ 0.23 $ 0.07
======== =========
</TABLE>
S-29
<PAGE> 32
NOTES TO UNAUDITED PRO FORMA COMBINED CONDENSED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997 AND THREE MONTHS ENDED MARCH 31, 1998
(a) The Unaudited Pro Forma Combined Condensed Statements of Operations do not
give any effect to potential cost savings or revenue enhancements, which
the Company believes will result from integrating the operations of the
companies after the Acquisitions. Management expects to begin to realize
such projected cost savings and revenue enhancements in the fourth quarter
of 1998. The full annual impact of such projected cost savings and revenue
enhancements is expected to be achieved in the fiscal year ending December
31, 1999, and is estimated to be approximately $25 million annually
beginning in 1999.
(b) Represents an adjustment for a Tesoro contract termination.
(c) Represents an adjustment in depreciation expense due to the change in
property, plant and equipment to fair value. Pro forma depreciation is
calculated on the straight-line method over estimated useful lives of 28
years for refineries and five to ten years for machinery, equipment and
buildings.
(d) Represents the amortization of goodwill over 25 years.
(e) Represents elimination of the charge for asset and goodwill impairment
recognized in the BHP Hawaii historical financial statements.
(f) Includes BHP Hawaii employee bonuses of $4 million in the year ended
December 31, 1997, which were awarded based upon the performance of BHP
operations that are not to be acquired by Tesoro.
(g) Represents elimination of interest on BHP Hawaii's obligations that will
not be assumed by Tesoro and the elimination of interest on Tesoro's
obligations that will be refinanced.
(h) Represents additional interest under the Revolver, the Term Loans, the
Notes and accretion of the $50 million non-interest bearing BHP Note. See
"Description of Indebtedness -- Other Indebtedness."
(i) Represents the amortization of debt issuance costs related to the Revolver,
the Term Loans and the Notes.
(j) Represents the tax effect of the adjustments above, excluding amortization
of goodwill for the Washington Acquisition.
(k) Represents an assumed 7 1/4% annual dividend rate on the Mandatorily
Convertible Preferred Stock.
(l) The following are pro forma consolidated results of operations excluding
the effects of the Washington Acquisition, but including the effects of the
Offerings and the mandatory special redemption of 50% of the aggregate
principal amount of the Notes offered in the Notes Offering:
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
1997 1998
------------ ------------
<S> <C> <C>
Revenues.......................................... $1,890,398 $406,483
Expenses.......................................... $1,846,127 $394,239
Earnings before income taxes...................... $ 44,271 $ 12,244
Income tax provision.............................. $ 16,216 $ 5,388
Earnings before extraordinary items............... $ 28,055 $ 6,856
</TABLE>
S-30
<PAGE> 33
SELECTED HISTORICAL FINANCIAL DATA
The following table sets forth certain selected historical consolidated
financial information for Tesoro based upon its historical financial statements
included in or incorporated by reference in this Prospectus Supplement.
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
--------------------------------------------------- -----------------
1993 1994 1995 1996 1997 1997 1998
------- ------- --------- --------- ------- ------- -------
(IN MILLIONS EXCEPT PER SHARE AMOUNTS AND RATIOS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA
Total revenues....................................... $ 830.4 $ 871.9 $ 1,002.9 $ 1,039.8 $ 943.4 $ 234.9 $ 196.0
Total segment operating profit(a)(b)................. $ 52.3 $ 64.4 $ 105.9 $ 144.8 $ 72.7 $ 15.0 $ 17.9
Net earnings......................................... $ 17.0 $ 15.7 $ 54.6 $ 74.5 $ 30.7 $ 6.1 $ 6.1
Net earnings applicable to common stock.............. $ 7.8 $ 13.0 $ 54.6 $ 74.5 $ 30.7 $ 6.1 $ 6.1
Earnings per share -- basic(c)....................... $ 0.55 $ 0.58 $ 2.22 $ 2.87 $ 1.16 $ 0.23 $ 0.23
Earnings per share -- diluted(c)..................... $ 0.54 $ 0.56 $ 2.18 $ 2.81 $ 1.14 $ 0.23 $ 0.23
OTHER DATA
EBITDA, as reported(d):
Refining and marketing............................. $ 25.5 $ 12.8 $ 12.6 $ 18.5 $ 33.2 $ 3.2 $ 9.5
Exploration and production......................... 51.8 88.6 139.2 159.6 77.2 22.1 19.0
Marine services.................................... (3.2) (2.0) (4.1) 7.3 8.0 1.3 2.4
------- ------- --------- --------- ------- ------- -------
Total segment EBITDA......................... 74.1 99.4 147.7 185.4 118.4 26.6 30.9
Corporate and unallocated.......................... (18.3) (18.6) (22.3) (13.4) (16.2) (3.7) (4.1)
------- ------- --------- --------- ------- ------- -------
Total consolidated EBITDA.................... $ 55.8 $ 80.8 $ 125.4 $ 172.0 $ 102.2 $ 22.9 $ 26.8
======= ======= ========= ========= ======= ======= =======
Normalized EBITDA(e):
Refining and marketing............................. $ 25.5 $ 7.0 $ 13.0 $ 19.3 $ 33.2 $ 3.2 $ 9.5
Exploration and production......................... 32.1 49.7 58.8 70.0 73.2 20.5 19.0
Marine services.................................... (3.2) (0.1) (3.3) 7.3 8.0 1.3 2.4
------- ------- --------- --------- ------- ------- -------
Total segment EBITDA......................... 54.4 56.6 68.5 96.6 114.4 25.0 30.9
Corporate and unallocated.......................... (19.7) (18.5) (18.5) (14.7) (16.2) ( 3.7) ( 4.1)
------- ------- --------- --------- ------- ------- -------
Total consolidated EBITDA.................... $ 34.7 $ 38.1 $ 50.0 $ 81.9 $ 98.2 $ 21.3 $ 26.8
======= ======= ========= ========= ======= ======= =======
Capital expenditures
Refining and marketing............................. $ 7.1 $ 32.0 $ 9.3 $ 11.1 $ 43.9 $ 2.9 $ 2.0
Exploration and production......................... 29.3 65.6 53.4 66.6 92.9 11.0 20.5
Marine services.................................... 0.3 0.2 0.4 6.9 9.4 2.2 1.2
Other.............................................. 0.8 1.8 0.8 0.4 1.3 0.2 0.1
------- ------- --------- --------- ------- ------- -------
Total capital expenditures................... $ 37.5 $ 99.6 $ 63.9 $ 85.0 $ 147.5 $ 16.3 $ 23.8
======= ======= ========= ========= ======= ======= =======
BALANCE SHEET DATA
Working capital...................................... $ 124.5 $ 85.9 $ 77.5 $ 99.5 $ 74.3 $ 104.8 $ 86.7
Property, plant and equipment, net................... $ 213.2 $ 273.3 $ 261.7 $ 316.5 $ 413.8 $ 320.7 $ 424.4
Total assets......................................... $ 434.5 $ 484.4 $ 519.2 $ 582.6 $ 627.8 $ 552.0 $ 635.4
Total long-term debt and other obligations(f)........ $ 185.5 $ 199.6 $ 164.5 $ 89.3 $ 132.3 $ 89.3 $ 147.7
Redeemable preferred stock(f)........................ $ 78.1 $ -- $ -- $ -- $ -- $ -- $ --
Stockholders' equity(f).............................. $ 58.5 $ 160.7 $ 216.5 $ 304.1 $ 333.0 $ 310.4 $ 339.4
</TABLE>
- ---------------
(a) Results for the years 1993, 1994, 1995 and 1996 include revenues from
above-market pricing provisions of a natural gas contract which was
terminated effective October 1, 1996. Operating profit included $20
million, $39 million, $47 million and $25 million in the years 1993, 1994,
1995 and 1996, respectively, from the excess of these contract prices over
spot market prices. Upon termination of the contract in 1996, the
Exploration and Production segment also recorded a non-recurring increase
in other income and operating profit of $60 million in connection with the
settlement of the contract. In the year 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 Tesoro's Consolidated Financial Statements.
(b) Segment operating profit equals 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.
(c) Earnings per share amounts for periods prior to the quarter ended December
31, 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 Tesoro's Consolidated Financial Statements.
(d) EBITDA represents earnings before extraordinary item, interest expense,
income taxes and depreciation, depletion and amortization. Segment EBITDA
represents operating profit before 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.
EBITDA is not a calculation based upon GAAP; however, the amounts included
in the EBITDA calculation are derived from amounts included in Tesoro's
Consolidated Financial Statements. In addition, EBITDA should not be
considered as an alternative to net earnings or operating profit, as an
indication of the operating performance of the Company or an alternative to
operating cash flow as a measure of liquidity. EBITDA is not necessarily
comparable to similarly titled items of other companies.
S-31
<PAGE> 34
(e) Normalized EBITDA is EBITDA, as defined in (d) above, excluding the impact
of the above-market natural gas contract with Tennessee Gas and other
significant items which affect the comparability between the periods
presented. The following items have been excluded from EBITDA, as reported,
to generate normalized EBITDA for each segment (in millions):
<TABLE>
<CAPTION>
THREE
MONTHS
ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
------------------------------------ -----------
1993 1994 1995 1996 1997 1997 1998
----- ----- ----- ----- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Refining and Marketing.............................. $ -- $ 5.8 $(0.4) $(0.8) $-- $-- $--
----- ----- ----- ----- ---- ---- ---
Exploration and Production:
Excess of contract prices over spot market
prices.......................................... 19.7 38.9 47.1 24.6 -- -- --
Income from settlement of a natural gas
contract........................................ -- -- -- 60.0 -- -- --
Gain on sale of asset............................. -- -- 33.5 -- -- -- --
Other non-recurring income (charges), net......... -- -- (0.2) 5.0 4.0 1.6 --
----- ----- ----- ----- ---- ---- ---
Total Exploration and Production............ 19.7 38.9 80.4 89.6 4.0 1.6 --
----- ----- ----- ----- ---- ---- ---
Marine Services..................................... -- (1.9) (0.8) -- -- -- --
----- ----- ----- ----- ---- ---- ---
Corporate and Unallocated........................... 1.4 (0.1) (3.8) 1.3 -- -- --
----- ----- ----- ----- ---- ---- ---
Total Adjustments................................. $21.1 $42.7 $75.4 $90.1 $4.0 $1.6 $--
===== ===== ===== ===== ==== ==== ===
</TABLE>
For further information regarding these significant items, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(f) In 1994, the Company restructured its outstanding debt and preferred stock
by completing a recapitalization and equity offering.
S-32
<PAGE> 35
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following analysis of the financial condition and results of operations
of Tesoro should be read in conjunction with Tesoro's Consolidated Financial
Statements, including the notes thereto, included elsewhere in this Prospectus
Supplement. Those statements in the Management's Discussion and Analysis that
are not historical in nature should be deemed forward-looking statements that
are inherently uncertain. See "Forward-Looking Statements" on page S-13 for
discussion of the factors which could cause actual results to differ materially
from those projected in such statements.
GENERAL
The Company's strategy is to (i) maximize return on capital employed and
increase the competitiveness of each of its business units by reducing costs,
increasing operating efficiencies and optimizing existing assets and (ii) expand
its overall market presence through a combination of internal growth initiatives
and selective acquisitions which are both accretive to earnings and provide
significant operational synergies. 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 the drill bit and
enhanced technical capabilities. The Company has made significant progress in
diversifying its U.S. operations to areas other than the Bob West Field and has
taken steps to begin serving emerging markets in South America. Improved
profitability has positioned the Marine Services segment to participate in the
consolidation of the industry by pursuing opportunities for expansion, as well
as optimizing existing operations.
In May 1998, Tesoro acquired the Hawaiian refining and marketing assets of
two subsidiaries of BHP and entered into an agreement to acquire the Washington
Refinery and related refining assets from a subsidiary of Shell. The
Acquisitions are expected to triple Tesoro's annual revenues and significantly
increase the scope of Tesoro's refining and marketing operations. Tesoro expects
that the results of the Acquisitions will be accretive to earnings and cash
flows beginning in 1999. The impact of the Acquisitions on earnings and cash
flow may be neutral in 1998 primarily due to the mid-year timing of the
Acquisitions and a scheduled maintenance turnaround at the Hawaii Refinery to
begin in the summer of 1998. The Company will continue to pursue other
opportunities that are operationally and geographically complementary with its
asset base.
As part of the Company's long-term strategy, growth initiatives are planned
in 1998 with a capital budget of $195 million, excluding amounts required to
fund the Acquisitions and capital expenditures related to the Hawaii and
Washington operations following such acquisitions, which are projected to be
approximately $15 to $20 million in 1998. The $195 million capital budget
represents an increase of 33% over 1997 capital expenditures. Approximately 71%
of the 1998 capital budget is directed toward increased drilling and other
related exploration costs, both in Bolivia and the U.S. Another 25% is planned
for downstream operations, primarily improvements in the Alaska marketing
operations. The remaining 4% of the 1998 capital budget is dedicated to
corporate expenditures, primarily upgrading information systems.
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
Company uses the last-in, first-out 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. Similarly, 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. Tesoro 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
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<PAGE> 36
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 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
This "Results of Operations" section reflects only the results of
operations of Tesoro for periods prior to the consummation of the Transactions
and does not include any financial information concerning BHP Hawaii and Shell
Washington.
SUMMARY
Tesoro's net earnings of $6.1 million, or $0.23 per share, for the three
months ended March 31, 1998 ("1998 Quarter") compare with net earnings of $6.1
million, or $0.23 per share, for the three months ended March 31, 1997 ("1997
Quarter"). Improved refined product margins combined with higher sales volumes
in the Company's Refining and Marketing segment and Marine Services segment
during the 1998 Quarter were offset by lower natural gas prices in the Company's
Exploration and Production segment.
Tesoro's net earnings for the year 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 the year 1996 and $54.6 million ($2.22 per
basic share, $2.18 per diluted share) in the year 1995. In the years 1996 and
1995, Tesoro 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 the years 1996 and 1995, respectively. Results for the years 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 of operations are highlighted in the
table below (in millions except per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
------------------------- ----------------
1995 1996 1997 1997 1998
------- ------ ------ ------ -------
<S> <C> <C> <C> <C> <C>
Net Earnings as Reported..................... $ 54.6 $74.5 $30.7 $ 6.1 $ 6.1
Extraordinary Loss on Debt Extinguishments,
Net of Income Tax Benefit.................. 2.9 2.3 -- -- --
------ ----- ----- ----- ------
Earnings Before Extraordinary Item........... 57.5 76.8 30.7 6.1 6.1
------ ----- ----- ----- ------
Significant Items Affecting Comparability,
Pretax:
Income from settlement of a natural gas
contract................................ -- 60.0 -- -- --
Operating profit from excess of contract
prices over spot market prices.......... 47.1 24.6 -- -- --
Other, including gain on sale and other
income and expense items................ 28.3 5.5 4.0 1.6 --
------ ----- ----- ----- ------
Total Significant Items, Pretax......... 75.4 90.1 4.0 1.6 --
Income Tax Effect....................... -- 27.2 1.2 0.5 --
------ ----- ----- ----- ------
Total Significant Items, Aftertax....... 75.4 62.9 2.8 1.1 --
------ ----- ----- ----- ------
Net Earnings (Loss) Excluding Significant
Items and Extraordinary Item............... $(17.9) $13.9 $27.9 $ 5.0 $ 6.1
====== ===== ===== ===== ======
</TABLE>
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<PAGE> 37
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
------------------------- ----------------
1995 1996 1997 1997 1998
------- ------ ------ ------ -------
<S> <C> <C> <C> <C> <C>
Earnings Per Share -- Basic:
As reported................................ $ 2.22 $2.87 $1.16 $0.23 $ 0.23
Extraordinary loss......................... (0.12) (0.09) -- -- --
Impact of contract prices over spot market
prices and settlement income............ 1.92 2.28 -- -- --
Effect of other significant items.......... 1.15 0.15 0.10 0.04 --
------ ----- ----- ----- ------
Excluding significant items and
extraordinary item...................... $(0.73) $0.53 $1.06 $0.19 $ 0.23
====== ===== ===== ===== ======
Earnings Per Share -- Diluted:
As reported................................ $ 2.18 $2.81 $1.14 $0.23 $ 0.23
Extraordinary loss......................... (0.11) (0.09) -- -- --
Impact of contract prices over spot market
prices and settlement income............ 1.88 2.23 -- -- --
Effect of other significant items.......... 1.14 0.14 0.10 0.04 --
------ ----- ----- ----- ------
Excluding significant items and
extraordinary item...................... $(0.73) $0.53 $1.04 $0.19 $ 0.23
====== ===== ===== ===== ======
</TABLE>
As shown above, excluding the significant items affecting comparability,
Tesoro's net earnings would have been $27.9 million ($1.06 per basic share,
$1.04 per diluted share) in the year 1997, as compared to net earnings of $13.9
million ($0.53 per basic and diluted share) in the year 1996 and a net loss of
$17.9 million ($0.73 per basic and diluted share) in the year 1995. The
resulting $14 million increase in net earnings in the year 1997 was primarily
attributable to better refined product margins, higher spot market natural gas
prices and lower corporate interest expense.
When comparing the year 1996 to 1995, after excluding significant items,
the improvement in net earnings of approximately $32 million was primarily
attributable to improvements within Tesoro'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
Tesoro's total effective tax rate in the year 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 Tesoro's
operations, but should not serve as the sole criterion for predicting the future
performance of Tesoro.
S-35
<PAGE> 38
REFINING AND MARKETING
The following summarizes the Refining and Marketing segment's results of
operations for the years ended December 31, 1995, 1996 and 1997 and the three
months ended March 31, 1997 and 1998.
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
--------------------------- -----------------
1995 1996 1997 1997 1998
------- ------- ------- ------- -------
(DOLLARS IN MILLIONS EXCEPT PER BARREL AMOUNTS)
<S> <C> <C> <C> <C> <C>
GROSS OPERATING REVENUES
Total refined products..................... $ 664.5 $ 620.8 $ 643.7 $ 155.8 $ 122.7
Other, primarily crude oil resales and
merchandise............................. 106.5 124.6 77.2 18.6 17.5
------- ------- ------- ------- -------
Total Gross Operating Revenues..... $ 771.0 $ 745.4 $ 720.9 $ 174.4 $ 140.2
======= ======= ======= ======= =======
TOTAL OPERATING PROFIT
Gross margin:
Refinery(a)............................. $ 63.5 $ 74.6 $ 93.3 $ 18.3 $ 24.0
Non-refinery(b)......................... 34.1 32.7 36.6 6.4 9.7
------- ------- ------- ------- -------
Total gross margin................. 97.6 107.3 129.9 24.7 33.7
Operating expenses......................... 84.7 87.9 96.0 21.5 24.2
Depreciation and amortization.............. 11.9 12.5 12.7 3.1 3.0
Loss on sales of assets and other.......... 0.3 0.9 0.7 -- --
------- ------- ------- ------- -------
Total Operating Profit............. $ 0.7 $ 6.0 $ 20.5 $ 0.1 $ 6.5
======= ======= ======= ======= =======
CAPITAL EXPENDITURES......................... $ 9.3 $ 11.1 $ 43.9 $ 2.9 $ 2.0
======= ======= ======= ======= =======
REFINERY PRODUCT SPREAD ($/barrel)........... $ 3.44 $ 4.29 $ 5.09 $ 4.13 $ 4.75
======= ======= ======= ======= =======
TOTAL SEGMENT PRODUCT SALES (average bpd)(c)
Gasoline................................... 24,526 17,427 17,393 16,738 14,495
Middle distillates......................... 37,988 29,651 30,576 26,253 32,875
Heavy oils and residual products........... 14,787 15,089 17,929 17,890 18,308
------- ------- ------- ------- -------
Total Product Sales................ 77,301 62,167 65,898 60,881 65,678
======= ======= ======= ======= =======
TOTAL SEGMENT PRODUCT SALES PRICES($/barrel)
Gasoline................................... $ 28.21 $ 32.72 $ 33.71 $ 33.64 $ 28.52
Middle distillates......................... $ 24.40 $ 29.01 $ 28.36 $ 32.09 $ 22.33
Heavy oils and residual products........... $ 13.66 $ 17.61 $ 17.30 $ 18.19 $ 11.32
TOTAL SEGMENT GROSS MARGINS ON PRODUCT SALES
($/barrel)(d)
Average sales price........................ $ 23.55 $ 27.28 $ 26.76 $ 28.43 $ 20.65
Average costs of sales..................... 20.53 23.15 21.92 24.63 15.58
------- ------- ------- ------- -------
Gross Margin....................... $ 3.02 $ 4.13 $ 4.84 $ 3.80 $ 5.07
======= ======= ======= ======= =======
</TABLE>
- ---------------
(a) Represents throughput at the Alaska Refinery times refinery product spread.
(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.
S-36
<PAGE> 39
(c) Sources of total product sales include products manufactured at the Alaska
Refinery, products drawn from inventory balances and products purchased
from third parties. Tesoro's purchases of refined products for resale
averaged approximately 25,500, 11,600 and 11,300 bpd in the years 1995,
1996 and 1997, respectively, and 11,500 and 11,700 bpd in the three months
ended March 31, 1997 and 1998, respectively.
(d) Gross margins on total product sales include margins on sales of purchased
products, together with the effect of changes in inventories.
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31,
1997
The Refining and Marking segment's operating profit of $6.5 million in the
1998 Quarter increased $6.4 million from operating profit of $0.1 million in the
1997 Quarter. The improvement in results from Refining and Marketing was due to
a combination of factors, including improved refined product yields, higher
throughput volumes at the refinery and increased sales within the segment's core
Alaska market, all of which contributed to improved refinery margins. The 1998
Quarter benefitted from an expansion completed in October 1997 of the Alaska
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.
During the 1998 Quarter, throughput at the Alaska Refinery increased by
7,000 bpd, a 14% increase over the 1997 Quarter. Production of middle
distillates increased by 4,300 bpd (a 21% increase over the 1997 Quarter) and
production of gasoline increased by 2,300 bpd (an 18% increase over the 1997
Quarter). Product sales volumes increased by 8% over the 1997 Quarter, which
included a 15% increase within the core Alaska market. The increase in sales in
Alaska was mainly due to a long-term retail capital spending program, primarily
focused in the Anchorage area, which was initiated in 1997. The improved product
slate and marketing efforts contributed to an increase in the Alaska Refinery's
product spread to $4.75 per barrel in the 1998 Quarter, compared to $4.13 per
barrel in the 1997 Quarter, reflecting a 39% decrease in the Company's per
barrel feedstock cost with a 30% decline in per barrel yield value.
Revenues from sales of refined products in the Refining and Marketing
segment decreased during the 1998 Quarter due to a 27% decline in average sales
prices partly offset by the 8% increase in sales volumes. Other revenues
included crude oil resales of $10.5 million in the 1998 Quarter and $10.7
million in the 1997 Quarter. Costs of sales decreased in the 1998 Quarter due to
lower feedstock prices. Margins from non-refinery activities increased to $9.7
million in the 1998 Quarter due primarily to a 14% increase in retail volumes
and improved margins on products sold outside Alaska. Operating expenses were
higher in the 1998 Quarter due to increased marketing costs.
The Company's initiatives to enhance its product slate and sell more
products within Alaska, as discussed above, have improved the fundamental
earnings potential of this segment. Certain of these initiatives, such as the
hydrocracker expansion, were completed in the fourth quarter of 1997. Future
quarters will continue to benefit from the impact of these initiatives. 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 in refined products, and other additional
factors that are beyond the control of the Company. As previously discussed, the
revenues and scope of the Refining and Marketing segment will be significantly
increased upon the consummations of the Hawaii Acquisition and Washington
Acquisition.
Year Ended December 31, 1997 Compared to Year Ended December 31, 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
Tesoro's initiatives to enhance its product slate, improve efficiencies and sell
a larger portion of the Alaska Refinery's production within the core Alaska
market. In these regards, in early October 1997, Tesoro completed an expansion
of the Alaska Refinery's hydrocracker unit which began to favorably impact this
segment's results in the fourth quarter of 1997. With respect to crude oil
supply, during
S-37
<PAGE> 40
1997, Tesoro negotiated contracts to purchase the remaining Cook Inlet crude oil
production available for sale and, in October 1997, began purchasing
approximately 25,000 bpd of Cook Inlet crude oil in addition to the approximate
9,000 bpd 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 Alaskan
retail marketing expansion program initiated in 1997, Tesoro built two new
retail stations, remodeled three stations, bought two stations and closed two
uneconomic stations. At year-end 1997, the total number of retail stations
selling Tesoro'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, Tesoro's production of refined products increased in total by
5% due to higher throughput levels at the Alaska 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 Tesoro'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. Tesoro'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 Tesoro's
refinery spread to $5.09 per barrel in 1997, compared to $4.29 per barrel in
1996, reflecting a 10% decrease in Tesoro'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 Tesoro'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 bpd in 1997 as compared to 62,167 bpd 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. Tesoro had less
crude oil available for resale in 1997 as throughput at the Alaska Refinery
increased by 2,721 bpd, 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 Alaska. Operating expenses increased in 1997 due primarily to higher
employee costs, professional fees and marketing expenses.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Results from Tesoro'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, Tesoro's
production level at the Alaska Refinery was reduced in September 1996 for a
scheduled 30-day maintenance turnaround. Despite these factors, Tesoro was able
to achieve a refinery product spread of $4.29 per barrel for 1996, compared to
$3.44 per barrel in 1995. Tesoro's results were helped by its initiatives to
control costs, improve the Alaska Refinery's product slate and expand the
marketing program for its refined products. Tesoro's average refined product
yield value per barrel increased by 19% in 1996, while Tesoro's feedstock costs
per barrel increased by 17%.
During 1996, Tesoro'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 Tesoro's product supply with demand in Alaska.
During 1996, Tesoro's marketing efforts added 31 stations in Alaska and
eight stations 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 stations in these areas were
closed in 1996. In addition, Tesoro began producing and marketing liquid
asphalt, which is a seasonal product
S-38
<PAGE> 41
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 Tesoro'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 bpd in 1996 as compared to 77,301 bpd in 1995.
This decline reflected the lower production volumes and Tesoro's withdrawal from
certain U.S. West Coast markets during 1996, which also reduced Tesoro's
purchases from other refiners and suppliers to 11,600 bpd in 1996 as compared to
25,500 bpd 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.
EXPLORATION AND PRODUCTION
The following table summarizes the Exploration and Production segment's
results of operations for the years ended December 31, 1995, 1996 and 1997 and
the three months ended March 31, 1997 and 1998.
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
---------------------------- ------------------
1995 1996 1997 1997 1998
-------- ------- ------- ------- --------
(DOLLARS IN MILLIONS EXCEPT PER UNIT AMOUNTS)
<S> <C> <C> <C> <C> <C>
U.S.(a)(b)
Gross operating revenues...................... $ 113.0 $ 93.8 $ 73.6 $ 21.5 $ 19.1
Income from settlement of a natural gas
contract................................... -- 60.0 -- -- --
Other income, including gain on asset sale in
1995....................................... 33.5 4.8 3.2 1.6 0.6
Production costs.............................. 12.0 5.3 7.4 1.7 2.5
Administrative support and other operating
expenses................................... 3.2 3.8 2.3 0.5 0.4
Depreciation, depletion and amortization...... 29.3 25.6 29.8 7.9 8.9
-------- ------- ------- ------- --------
Total Operating Profit -- U.S......... 102.0 123.9 37.3 13.0 7.9
-------- ------- ------- ------- --------
BOLIVIA
Gross operating revenues...................... 11.7 13.7 11.2 1.9 3.1
Other income related to collection of a
receivable................................. -- -- 2.2 -- --
Production costs.............................. 0.6 0.8 0.9 0.2 0.3
Administrative support and other operating expenses... 3.2 2.8 2.4 0.5 0.6
Depreciation, depletion and amortization...... 0.3 1.3 1.5 0.2 0.5
-------- ------- ------- ------- --------
Total Operating Profit -- Bolivia..... 7.6 8.8 8.6 1.0 1.7
-------- ------- ------- ------- --------
TOTAL OPERATING PROFIT -- EXPLORATION AND PRODUCTION... $ 109.6 $ 132.7 $ 45.9 $ 14.0 $ 9.6
======== ======= ======= ======= ========
U.S.
Average Daily Net Production:
Natural gas (Mcf).......................... 114,490 87,654 86,052 94,103 99,135
Oil (barrels).............................. 1 27 118 145 173
Total (Mcfe)............................... 114,496 87,816 86,760 94,973 100,173
Average Prices:
Natural gas ($/Mcf) --
Spot market(c)........................... $ 1.34 $ 1.95 $ 2.17 $ 2.34 $ 2.01
Average(b)............................... $ 2.57 $ 2.75 $ 2.17 $ 2.34 $ 2.01
Oil ($/barrel)............................. $ 16.82 $ 21.99 $ 18.90 $ 21.14 $ 14.13
</TABLE>
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<PAGE> 42
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
---------------------------- ------------------
1995 1996 1997 1997 1998
-------- ------- ------- ------- --------
(DOLLARS IN MILLIONS EXCEPT PER UNIT AMOUNTS)
<S> <C> <C> <C> <C> <C>
Average Operating Expenses ($/Mcfe):
Lease operating expenses................... $ 0.11 $ 0.14 $ 0.20 $ 0.16 $ 0.21
Severance taxes............................ 0.18 0.03 0.03 0.04 0.06
-------- ------- ------- ------- --------
Total production costs................ 0.29 0.17 0.23 0.20 0.27
Administrative support and other........... 0.06 0.10 0.07 0.05 0.05
-------- ------- ------- ------- --------
Total Operating Expenses.............. $ 0.35 $ 0.27 $ 0.30 $ 0.25 $ 0.32
======== ======= ======= ======= ========
Depletion ($/Mcfe)............................ $ 0.69 $ 0.79 $ 0.93 $ 0.91 $ 0.97
Capital Expenditures (including U.S. gas
transportation)............................ $ 49.6 $ 59.7 $ 65.4 $ 7.0 $ 18.2
BOLIVIA
Average Daily Net Production:
Natural gas (Mcf).......................... 18,650 20,251 19,537 10,999 22,769
Condensate (barrels)....................... 567 584 518 316 816
Total (Mcfe)............................... 22,052 23,755 22,645 12,895 27,665
Average Prices:
Natural gas ($/Mcf)........................ $ 1.28 $ 1.33 $ 1.15 $ 1.32 $ 0.97
Condensate ($/barrel)...................... $ 14.39 $ 17.98 $ 15.71 $ 19.28 $ 15.78
Average Operating Expenses ($/Mcfe):
Production costs........................... $ 0.07 $ 0.10 $ 0.11 $ 0.16 $ 0.11
Value-added taxes.......................... 0.06 0.05 -- -- --
Administrative support and other........... 0.35 0.27 0.31 0.41 0.29
-------- ------- ------- ------- --------
Total Operating Expenses.............. $ 0.48 $ 0.42 $ 0.42 $ 0.57 $ 0.40
======== ======= ======= ======= ========
Depletion ($/Mcfe)............................ $ 0.03 $ 0.15 $ 0.19 $ 0.15 $ 0.21
Capital Expenditures.......................... $ 3.8 $ 6.9 $ 27.5 $ 4.0 $ 2.3
</TABLE>
- ---------------
(a) Represents Tesoro's U.S. oil and gas operations combined with gas
transportation activities.
(b) Results for the years 1995 and 1996 included revenues from above-market
pricing provisions of a contract with Tennessee Gas which was terminated
effective October 1, 1996. Operating profit for the years 1995 and 1996
included $47.1 million and $24.6 million, respectively, for the excess of
these contract prices over spot market prices. Net natural gas production
sold under the contract averaged approximately 20 million cubic feet
("MMcf") per day in 1995 and 11 MMcf per day in 1996. Upon termination of
the contract, Tesoro recorded other income and operating profit of $60
million during the fourth quarter of 1996. See Note D of Notes to Tesoro's
Consolidated Financial Statements.
(c) Includes effects of Tesoro's natural gas commodity price agreements which
amounted to a gain of $0.01 per Mcf in the year 1995 and losses of $0.11
per Mcf and $0.05 per Mcf in the years 1996 and 1997 respectively, and a
loss of $0.19 per Mcf for the 1997 Quarter. There were no such agreements
during the 1998 Quarter.
EXPLORATION AND PRODUCTION -- U.S.
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31,
1997
Operating profit from the Company's U.S. exploration and production
operations was $7.9 million in the 1998 Quarter compared with $13 million in the
1997 Quarter. While the Company's production increased by 5%, natural gas prices
declined by $0.33 per Mcf, or 14%, to $2.01 per Mcf in the 1998 Quarter compared
to $2.34 per Mcf in the 1997 Quarter. The 1997 Quarter also benefitted from
income of $1.6 million for retroactive severance tax refunds for production in
prior years, with no substantial refunds received in the 1998 Quarter.
S-40
<PAGE> 43
The Company's production volumes averaged 100.2 MMcfe per day in the 1998
Quarter compared to 95.0 MMcfe per day in the quarter ended March 31, 1997. This
increase in the Company's production consisted of a 30.4 MMcf per day decline
from the Bob West Field offset by a 35.6 MMcfe per day production increase from
other U.S. fields. The Company's production outside of the Bob West Field rose
to 51% of total production during the 1998 Quarter, as compared to 17% in the
1997 Quarter.
Gross operating revenues from the Company's U.S. operations decreased by
$2.4 million, primarily due to lower spot market prices for sales of natural
gas. Other income was lower in the 1998 Quarter due to fewer refunds of
severance taxes. Production costs were higher by $0.8 million ($0.07 per Mcfe)
primarily due to higher lease operating expenses. Lease operating costs in the
aggregate for the Bob West Field remained relatively flat, while production
volumes have declined, resulting in an increase in per unit lease operating
expenses from $0.13 per Mcf in the 1997 Quarter to $0.22 per Mcf in the 1998
Quarter. Lease operating costs in the aggregate for other fields have doubled,
while production volumes have tripled, resulting in a decrease in per unit lease
operating cost from $0.29 per Mcfe to $0.19 per Mcfe. Depreciation, depletion
and amortization increased by $1.0 million, or 13%, due to a higher depletion
rate and increased volumes.
From time to time, the Company enters into commodity price agreements to
reduce the risk caused by fluctuation in the prices of natural gas in the spot
market. During the 1997 Quarter, the Company used such agreements to set the
price of 34% of the natural gas production that it sold in the spot market and
recognized a loss of $1.6 million ($.19 per Mcf) related to these price
agreements. The Company did not have any such transactions during the 1998
Quarter.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Operating profit from Tesoro's U.S. exploration and production 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, Tesoro was selling a portion of the gas produced
in the Bob West Field pursuant to a contract price, which was substantially
above the average spot market price. In total, during 1996, Tesoro received
approximately $120 million in cash for the resolution of litigation and
termination of the Tennessee Gas contract, with Tesoro'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 Tesoro's Consolidated Financial Statements.
Additionally, during 1996, substantially all of Tesoro'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, Tesoro
recognized income of $1.8 million and $5.0 million, respectively, for
retroactive severance tax refunds for production in prior years.
Excluding the impact of the incremental contract value and income from the
severance tax refunds, operating profit from Tesoro'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 Tesoro 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.
Tesoro'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. Tesoro'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. Tesoro'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.
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<PAGE> 44
Gross operating revenues from Tesoro'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, Tesoro 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, Tesoro 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, Tesoro 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). Tesoro had no remaining price agreements
outstanding at December 31, 1997.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Operating profit of $123.9 million from Tesoro's U.S. exploration and
production 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 Tesoro's 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 Tesoro'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 Tesoro 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, Tesoro's
spot production increased by 6,600 Mcf per day during 1996. Tesoro'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. Tesoro's
weighted average sales price increased 7% to $2.75 per Mcf in 1996 as compared
to $2.57 per Mcf in 1995. 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 Tesoro'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.
EXPLORATION AND PRODUCTION -- BOLIVIA
Tesoro'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, Tesoro'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 Tesoro's minimum contract
S-42
<PAGE> 45
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.
Tesoro 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, Tesoro 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 Tesoro 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, Tesoro cannot be assured of the amount of additional volumes that
will be exported to Brazil upon completion of the pipeline.
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31,
1997
Operating profit from the Company's Bolivian operations increased to $1.7
million in the 1998 Quarter, from $1.0 million operating profit in the 1997
Quarter. Although Bolivian natural gas prices fell to $0.97 per Mcf from $1.32
per Mcf realized in the 1997 Quarter, net production volumes more than doubled
to 27.7 Mmcfe per day from 12.9 Mmcfe per day in the 1997 Quarter. Production in
the 1997 Quarter was affected by lower contractual purchases made to balance
prior over-production in 1996 and also by constraints from repairs to a
non-Company-owned pipeline that transports gas from Bolivia to Argentina.
Additionally, production in the 1998 Quarter reflects an increase resulting from
the Company's purchase of interests held by its former joint venture participant
in July 1997.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Operating profit from Tesoro's Bolivian operations decreased to $8.6
million in 1997, from $8.8 million operating profit in 1996. Results for 1997
benefitted 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 Tesoro's purchase of interests held by its former
joint venture participant in July 1997, Tesoro's share of production from
Bolivia increased by approximately 33% beginning in the 1997 third quarter (see
Note C of Notes to Tesoro's Consolidated Financial Statements). However, earlier
in the year, Tesoro'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 third-party pipeline that
transports gas from Bolivia to Argentina. In addition, during 1996, production
was higher due to requests from YPFB for additional production from Tesoro 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.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Operating profit from Tesoro'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.
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<PAGE> 46
MARINE SERVICES
The following table summarizes the Marine Services segment's results of
operations for the years ended December 31, 1995, 1996 and 1997 and the three
months ended March 31, 1997 and 1998.
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
------------------------- ---------------
1995 1996 1997 1997 1998
------ ------ ------- ------ ------
(DOLLARS IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Gross Operating Revenues
Fuels............................................... $61.9 $98.9 $104.5 $28.2 $25.8
Lubricants and other................................ 12.0 14.9 16.4 4.3 4.1
Services............................................ 0.6 8.7 11.3 3.0 2.9
----- ----- ------ ----- -----
Gross Operating Revenues.................... 74.5 122.5 132.2 35.5 32.8
Costs of Sales........................................ 64.9 93.0 96.7 27.3 23.6
----- ----- ------ ----- -----
Gross Profit................................ 9.6 29.5 35.5 8.2 9.2
Operating Expenses and Other.......................... 13.7 22.2 27.5 6.9 6.8
Depreciation and Amortization......................... 0.3 1.2 1.7 0.4 0.6
----- ----- ------ ----- -----
Operating Profit (Loss)..................... $(4.4) $ 6.1 $ 6.3 $ 0.9 $ 1.8
===== ===== ====== ===== =====
Capital Expenditures.................................. $ 0.4 $ 6.9 $ 9.4 $ 2.2 $ 1.2
</TABLE>
Three Months Ended March 31, 1998 Compared to Three Months Ended March 31,
1997
Gross operating revenues declined by $2.7 million during the 1998 Quarter
due primarily to lower fuel sales prices partly offset by increased volumes.
Cost of sales decreased by $3.7 million, which also reflects the lower fuel
prices. In total, operating profit improved by $0.9 million largely due to
increased margins.
The Marine Services business is largely dependent upon the volume of oil
and gas drilling, workover, construction and seismic activity in the Gulf of
Mexico.
Year Ended December 31, 1997 Compared to Year Ended December 31, 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 Tesoro's focus to serve these customers. Additional terminal
locations stemming from an acquisition consummated in February 1996 together
with internal growth initiatives have enabled Tesoro 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.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
In February 1996, Tesoro acquired Coastwide Energy Services, Inc.
("Coastwide") and combined these operations with Tesoro's marine petroleum
products distribution business, forming a Marine Services segment. Operating
results from Coastwide have been included in Tesoro's Marine Services segment
since the date of acquisition. See Note C of Notes to Tesoro's 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
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<PAGE> 47
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 increased from $3.0 million for the
1997 Quarter to $3.4 million for the 1998 Quarter. General and administrative
expenses were $13.6 million in the year 1997, compared with $12.7 million in the
year 1996 and $16.4 million in the year 1995. The increase in the year 1997 was
primarily due to higher employee costs partially offset by lower professional
fees and insurance costs. When comparing the year 1996 to the year 1995, the
decrease was primarily due to lower employee and labor costs resulting from cost
reduction measures implemented by Tesoro in late 1995.
INTEREST EXPENSE AND INTEREST INCOME
Interest expense of $2.7 million for the 1998 Quarter increased from the
$1.6 million in the 1997 Quarter primarily due to higher borrowings under
Tesoro's credit facility to fund net working capital requirements, arising
primarily from higher crude oil levels at the Alaska Refinery and to fund
capital expenditures. Interest expense totaled $6.7 million in the year 1997,
compared with $15.4 million in the year 1996 and $20.9 million in the year 1995.
Tesoro'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 the year 1997, compared with $8.4
million in the year 1996 and $1.8 million in the year 1995. The fluctuation in
the year 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
Tesoro's Consolidated Financial Statements).
OTHER EXPENSE, NET
Other expense was $4.9 million in the year 1997, compared with $10 million
in the year 1996 and $8.5 million in the year 1995. In the year 1996, Tesoro
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 Tesoro's former operations. There were no material comparable costs
recorded in the year 1997. When comparing the year 1996 to the year 1995, the
increase in other expense was due to the costs recorded in the year 1996,
partially offset by lower employee termination and restructuring costs.
INCOME TAX PROVISION
The income tax provision for the 1998 Quarter was $4.8 million (44%
effective tax rate) compared with $3.5 million (36% effective tax rate) for the
1997 Quarter. The increase in effective tax rate primarily reflects an increase
in foreign taxes related to Tesoro's Bolivian revenues. The income tax provision
was $18.4 million in the year 1997, compared with $38.3 million in the year 1996
and $4.4 million in the year 1995. Effective income tax rates were 7%, 33% and
37% in the years 1995, 1996 and 1997, respectively (see Note H of Notes to
Tesoro's Consolidated Financial Statements). The decrease in the income tax
provision in the year 1997 was primarily attributable to lower earnings,
partially offset by a higher effective rate due to Bolivian taxes. When
comparing the year 1996 to the year 1995, the income tax provision increased due
to earnings subject to U.S. taxes exceeding available net operating loss and tax
credit carryforwards.
CAPITAL RESOURCES AND LIQUIDITY
OVERVIEW
The Company's primary sources of liquidity are its cash and cash
equivalents, internal cash generation and external financing. The Company
operates in an environment in which 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.
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<PAGE> 48
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
Following completion of the Transactions, including closing of the Senior
Credit Facility and the Offerings, the Company will have pro forma indebtedness
as of March 31, 1998 of approximately $513.1 million (including the Notes, but
excluding an additional $322.2 million available under the Senior Credit
Facility). The Company's primary capital requirements are expected to include
capital expenditures, working capital and debt service. The primary sources of
capital are expected to be cash flow from operations and borrowings under the
Senior Credit Facility, which will incur interest at variable rates. Based upon
current and anticipated future operations and anticipated future cost savings,
the Company believes that available capital resources will be adequate to meet
anticipated future capital requirements. There can be no assurance, however,
that the Company's business will generate sufficient cash flow that, together
with other sources of capital, will enable the Company to service its
indebtedness, preferred stock dividend payments or make anticipated capital
expenditures. If the Company is unable to generate sufficient cash flow from
operations or to borrow sufficient funds in the future to service its debt, it
may be required to sell assets, reduce capital expenditures, refinance all or a
portion of its existing indebtedness, or obtain additional financing. See "Risk
Factors -- Substantial Leverage and Debt Service."
The Senior Credit Facility, the Notes and PIES will, and other debt
instruments of the Company may, impose various restrictions and covenants on the
Company that could potentially limit the Company's ability to respond to market
conditions, to provide for unanticipated capital investments, to raise
additional debt or equity capital or to take advantage of business
opportunities. See "Description of Indebtedness" and "Description of Capital
Stock."
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 11
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 Tesoro's 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.
For 1998, the Company has a total capital budget of approximately $195
million, excluding amounts required to fund the Acquisitions and capital
expenditures of $15 to $20 million in 1998 related to the Hawaii and Washington
operations following the Acquisitions. Through the quarter ended March 31, 1998,
the Company's capital spending totaled $24 million. 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 gross wells), $17 million for leasehold,
geological and geophysical, and $17 million for exploratory drilling
(participation in 20 gross wells). In Bolivia, the drilling program is budgeted
at $14 million for development drilling (three wells) and $12 million for
exploratory drilling (two gross wells), with the remainder planned for upgrading
a gas processing plant, laying gathering lines to shut-in wells, workovers and
three-dimensional seismic activity. Capital spending, other than capital
expenditures related to the Hawaii and
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<PAGE> 49
Washington operations, for the Refining and Marketing segment is planned at
approximately $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 improvements to the Alaska Refinery. The Marine
Services capital budget is $9 million, primarily directed towards equipment and
facility upgrades together with potential acquisitions. The Company also expects
to spend $7 million for corporate capital projects, including upgrades to
information systems. 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 Senior 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 Tesoro's cash flows are set forth below (in millions):
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
------------------------- ---------------
1995 1996 1997 1997 1998
------ ------ ------- ------ ------
<S> <C> <C> <C> <C> <C>
Cash Flows From (Used In):
Operating Activities................... $ 35.4 $178.9 $ 95.6 $ 23.8 $ 6.4
Investing Activities................... 2.4 (94.2) (151.5) (16.8) (29.5)
Financing Activities................... (37.8) (75.9) 41.5 1.6 17.0
------ ------ ------- ------ ------
Increase (Decrease) in Cash and Cash
Equivalents............................ $ -- $ 8.8 $ (14.4) $ 8.6 $ (6.1)
====== ====== ======= ====== ======
</TABLE>
Net cash from operating activities during the 1998 Quarter totaled $6
million, compared to $24 million in the 1997 Quarter. Although the level of
earnings during both quarters was relatively the same, working capital
components were higher during the 1998 Quarter. Net cash used in investing
activities of $29 million during the 1998 Quarter included capital expenditures
of $24 million, primarily in the Company's exploration and production segment,
and an escrow deposit of $5 million for the Hawaii Acquisition. Net cash from
financing activities of $17 million during the 1998 Quarter included additional
borrowings of $23 million under the Company's credit facility, partially offset
by payments of other long-term debt, including repayment and termination of a
marine services loan. During the 1998 Quarter, gross borrowings under revolving
credit lines were $110 million, with $92 million of repayments. At March 31,
1998, the Company's outstanding borrowings under its current credit facility
were $51 million and net working capital totaled $87 million, which included
cash and cash equivalents of $2.3 million.
During the year 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 Tesoro'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 former 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 Tesoro's former
credit facility were $150 million, with $122 million of repayments. At December
31, 1997, Tesoro's net working capital totaled $74 million, which included cash
and cash equivalents of $8 million.
During the year 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
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<PAGE> 50
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, Tesoro's gross borrowings and repayments
under its corporate revolving credit line amounted to $165 million.
During the year 1995, net cash from operating activities totaled $35
million. Although natural gas production from Tesoro's South Texas operations
increased during 1995, lower cash receipts for sales of natural gas adversely
affected Tesoro'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. Tesoro's gross borrowings and repayments under
the former credit facility totaled $262 million during 1995.
INCENTIVE COMPENSATION STRATEGY
On May 12, 1998, employee incentive payments were triggered when the high
and low trading price of the Company's Common Stock averaged $20 per share over
a 20 consecutive trading day period under an incentive strategy approved by the
Company's Board of Directors in June 1996. The triggering of those awards
reflects an aggregate increase of more than $250 million in the market value of
the Company's Common Stock since June 1996. The triggering of the incentive
program will result in a pretax charge of approximately $23 million (of which
approximately $10 million is non-cash) during the second quarter of 1998. On an
aftertax basis, the charge will be approximately $15 million ($0.57 per share)
which represents approximately 6% of the increase in Tesoro's market value since
June 1996. For further information related to the incentive strategy, see Note K
of Tesoro's Notes to Condensed Consolidated Financial Statements.
ENVIRONMENTAL
In connection with the Hawaii Acquisition, the Company and certain
subsidiaries of BHP (the "BHP Sellers") have executed an environmental agreement
in which the BHP Sellers have agreed to indemnify the Company for environmental
costs arising out of conditions at the Hawaii Refinery, terminals and retail
stations previously operated by BHP Hawaii which existed at or prior to May 31,
1998, the effective closing date of the Hawaii Acquisition, subject to a maximum
limit of $9.5 million. Under the environmental agreement, the first $5 million
of environmental costs are the responsibility of the BHP Sellers and the next $6
million are to be shared on the basis of 75% by the BHP Sellers and 25% by the
Company. The BHP Sellers' environmental indemnification will survive for a
ten-year period. Certain environmental claims arising out of prior operations of
the BHP Sellers are not subject to the $9.5 million limit or ten-year time limit
for claims made.
Under the agreement related to the Washington Acquisition, Shell Refining
Holding Company, a subsidiary of Shell, generally has agreed to indemnify the
Company for environmental liabilities at the Washington Refinery arising out of
conditions which existed at or prior to the closing date. However, the Company
is responsible for the first $0.5 million in environmental costs in each year
and 50% of environmental costs over $1 million in each year, subject to a
maximum aggregate liability of $5 million.
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 alternate secondary
containment systems for existing storage tank facilities are estimated to be $2
million in 1998 and $2 million in 1999 with the remaining $5 million to be spent
by 2002. At the Hawaii Refinery, the Company expects to make capital
improvements, including improvements to sulphur emission controls and new tank
roof seals, of $4 million in 1998 and $1 million in 1999. At the Washington
Refinery, the Company anticipates that it will make capital improvements of
approximately $2 million in 1998 and $1 million in 1999,
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primarily for replacing certain storage tank seals and increasing the hydraulic
capacity of the facility storm water conveyance system.
The Company is subject to extensive foreign, 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 remediation response and
has incurred cleanup expenditures associated with environmental matters at a
number of sites, including certain of its current and prior-owned properties. At
March 31, 1998, Tesoro's accruals for environmental expenses amounted to $8.7
million, which included a noncurrent liability of $2.5 million for remediation
of KPL's properties that has been funded by the former owners of KPL through a
restricted escrow deposit.
Conditions that require additional expenditures may exist for various
Company sites, including, but not limited to, the Alaska Refinery, the Hawaii
Refinery, the Washington Refinery, retail stations (current and closed
locations) and petroleum product terminals, and for compliance with the Clean
Air Act, and other mandated programs. 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 Tesoro's Consolidated
Financial Statements.
YEAR 2000 COMPLIANCE
The efficient operation of Tesoro'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 Tesoro's
business operating systems and controls, including information management
services and financial reporting, as well as in various administrative
functions. Tesoro 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, Tesoro 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 Tesoro's Systems and Programs will be
performed in-house by company personnel. Tesoro believes that, with hardware
replacement and modifications to existing software or conversions to new
software, the year 2000 date change will not pose a significant operational
problem for Tesoro. It is possible that non-compliant third party computer
systems or programs may not interface properly with Tesoro's computer systems.
Tesoro has requested assurance from third parties that their computers, systems
or programs be year 2000 compliant. Tesoro could, however, be adversely affected
by the year 2000 problem if it or unrelated parties fail to successfully address
this issue. Management of Tesoro 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.
Tesoro has recently undertaken a review of the year 2000 compliance status
of BHP Hawaii and Shell Washington, and is currently unable to determine whether
it has exposure to contingencies related to the year 2000 issue in connection
with the Acquisitions.
NEW ACCOUNTING STANDARDS
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
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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. Both 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.
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<PAGE> 53
BUSINESS
GENERAL
The Company is a diversified 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. These
operations are conducted through three business segments: Refining and
Marketing, Exploration and Production, and Marine Services.
The Company is the second largest independent refiner and the fifth largest
refiner overall in PADD V. The Company's Refining and Marketing segment operates
petroleum refineries at Kenai, Alaska; Kapolei, Hawaii; and Anacortes,
Washington. The Company currently sells gasoline through a large network of
branded stations in Alaska and Hawaii and is expanding its retail gasoline
marketing presence in the Pacific Northwest. This segment is also a major
supplier of jet fuel to the Anchorage, Honolulu and the Seattle/ Tacoma airports
and diesel fuel to Alaska, Hawaii and Washington's fishing and marine
industries. The Company's Marine Services segment operates through a network of
23 marine terminals located in Louisiana and Texas and on the U.S. West Coast,
distributing petroleum products and providing logistics services to the offshore
drilling industry and other customers. Upstream, the Company's Exploration and
Production segment focuses on exploration, development and production of natural
gas and oil onshore in Texas, Louisiana and Bolivia. The Company's net proved
worldwide reserves totaled 517 Bcfe of natural gas at year-end 1997.
The Company's strategy is to (i) maximize return on capital employed and
increase the competitiveness of each of its business units by reducing costs,
increasing operating efficiencies and optimizing existing assets and (ii) expand
its overall market presence through a combination of internal growth initiatives
and selective acquisitions which are both accretive to earnings and provide
significant operational synergies.
Tesoro was incorporated in Delaware in 1968 (a successor by merger to a
California corporation incorporated in 1939). Its principal executive offices
are located at 8700 Tesoro Drive, San Antonio, Texas 78217-6218 and its
telephone number is (800) 837-6768.
REFINING AND MARKETING
OVERVIEW
The Company conducts petroleum refining operations in Alaska, Washington
and Hawaii and sells refined products to a wide variety of customers in Alaska
and Hawaii, along the U.S. West Coast, primarily in the Pacific Northwest,
American Samoa, Tahiti and in certain Far Eastern markets, including Russia,
Japan and Korea.
REFINERIES
ALASKA
The Alaska Refinery has a rated throughput capacity of 72,000 bpd and is
capable of producing liquefied petroleum gas, gasoline, jet fuel, diesel fuel,
heating oil, liquid asphalt, heavy oils and residual products. Alaska North
Slope ("ANS") and Cook Inlet crude oils are the primary feedstocks for the
Alaska Refinery. To assure the availability of crude oil to the Alaska Refinery,
the Company has a royalty crude oil purchase contract with the State of Alaska
and contracts with various Cook Inlet producers (see "-- Crude Oil Supply"
discussed below). During 1997, these crude oils were processed to yield refined
products consisting of approximately 25% gasoline, 42% middle distillates, 29%
heavy oils and residual products and 4% other products. Throughput at the Alaska
Refinery was reduced during both 1997 and 1996 for scheduled 30-day maintenance
turnarounds.
In early October 1997, the Company completed an expansion of the Alaska
Refinery's hydrocracker unit, which increased the unit's capacity by
approximately 25% to 12,500 bpd and enables the Company to produce more jet
fuel, a product currently in short supply in Alaska. The expansion, together
with the addition of a new, high-yield jet fuel hydrocracker catalyst, cost
approximately $19 million and has a projected payback
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<PAGE> 54
period of two years. The expansion, together with increased shipments of Cook
Inlet crude oil beginning in October 1997, began to improve the Alaska
Refinery's product slate during the fourth quarter of 1997.
HAWAII
The Hawaii Refinery, located 22 miles west of Honolulu, Hawaii, has a rated
throughput capacity of 95,000 bpd and is the largest refinery in the state. It
is capable of producing liquefied petroleum gas, gasoline, jet fuel, diesel
fuel, fuel oil for ships and electrical power plants and liquid asphalt.
ANS and crude oil from Australia and Southeast Asia are the primary
feedstocks for the Hawaii Refinery. During 1997, these crude oils were processed
to yield refined products consisting of approximately 45% middle distillates,
28% gasoline, naphtha and liquefied petroleum gases, and 27% residual fuel oil.
Crude throughput at the Hawaii Refinery was reduced by 20% in June and July of
1997 to allow a scheduled maintenance turnaround on the marine mooring facility.
Planned shutdowns were taken in January 1996 and March 1997 on the catalytic
reformer unit to allow regeneration of catalyst, and the Hawaii Refinery is
scheduled to shut down for 30 days beginning in late June 1998 for a routine
maintenance turnaround.
In addition to crude and vacuum distillation, refining operations include
catalytic reforming, hydrocracking, hydrogen generation, visbreaking, light ends
recovery and liquid asphalt production.
WASHINGTON
The Washington Refinery has a rated throughput capacity of 108,000 bpd and
is the third largest refinery in the Pacific Northwest. The Washington Refinery
is located approximately 60 miles north of Seattle near Anacortes, Washington.
Approximately 35% of the refinery's crude oil feedstock is ANS with the
remaining sources primarily from Canada. Crude oil feedstock is received via
ship across the Company's dock in the Puget Sound and via pipeline. During 1997,
the Washington Refinery yielded a product slate comprised of approximately 53%
gasoline, 24% middle distillates and 23% residual fuel oil and other heavy oil
products. Although Shell incorporated Shell Washington on January 4, 1996, Shell
Washington commenced operations on May 1, 1996.
CRUDE OIL SUPPLY
ALASKA
The Alaska Refinery is designed to process crude oil with up to 1.0%
sulphur content. As such, the Alaska Refinery can process Cook Inlet, ANS and
certain other foreign and domestic crude oils. Historically, the Company's
Alaska Refinery has processed primarily ANS crude oil. Beginning in the fourth
quarter of 1997, Cook Inlet crude became a major feedstock for the Alaska
Refinery and the Company anticipates that Cook Inlet will be a major feedstock
for 1998.
Cook Inlet Crude Oil. Cook Inlet crude oil, a lighter crude oil that
contains an average of 0.1% sulphur, accounted for 26% of the Alaska Refinery's
feedstock in 1997. In the first nine months of 1997, the Company processed
approximately 9,300 bpd of Cook Inlet crude oil, or 19% of the Alaska Refinery's
throughput, which was obtained from several producers on the Kenai peninsula
under short-term contracts. During October 1997, the Company began purchasing
all of the approximately 34,000 bpd of Cook Inlet production from various
producers under contracts that extend through December 1998. A contract to
purchase 4,500 bpd, of the 34,000 bpd, has been extended through March 31, 2001.
During the fourth quarter of 1997, the Company processed approximately 24,900
bpd of Cook Inlet crude oil, or approximately 44% of the Alaska Refinery's
throughput. During 1998, the Company expects that Cook Inlet crude oil will be a
major feedstock for the Alaska Refinery.
Cook Inlet crude oil is delivered by tanker through KPL's marine terminal
or by pipeline to the Alaska Refinery.
ANS Crude Oil. ANS crude oil, a heavy crude oil which has a sulphur content
of approximately 1.0%, accounted for 71% of the Alaska Refinery's feedstock in
1997. The Company purchased approximately 35,700
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bpd of ANS crude oil during 1997 under the royalty crude oil purchase contract
with the state of Alaska. This contract, which covers the period January 1,
1996, through December 31, 1998, provides for the purchase of 30% of the state
of Alaska's ANS royalty crude oil produced from the Prudhoe Bay Unit at prices
based on royalty values computed by the state of Alaska. The contract contains
provisions that, under certain conditions, allow the Company to temporarily or
permanently reduce its purchase obligation. Under the contract, the Company is
required to utilize in its Alaska Refinery operations volumes equal to at least
80% of the ANS crude oil purchased from the state of Alaska. The Company is
presently in discussions with the state of Alaska in regard to extending this
contract for an additional year.
Tesoro also purchases approximately 6,000 bpd of ANS crude oil from a
producer under a contract with a term of one year which began January 1, 1998.
ANS crude oil feedstock is delivered to the Alaska Refinery by a
Tesoro-chartered tanker through the KPL marine terminal, which is owned and
operated by the Company.
For information related to a settlement of a contractual dispute with the
state of Alaska, see Note I of Notes to Tesoro's Consolidated Financial
Statements.
Other Supply. In 1997, the Alaska Refinery obtained 3% of its feedstock
supply from other sources. The other supply primarily consisted of spot
purchases of crude oil which were delivered to the Alaska Refinery by tanker
through KPL's marine terminal. The Company evaluates the economic viability of
processing various types of foreign and domestic crude oils in the Alaska
Refinery and will occasionally purchase spot quantities to supplement its normal
crude oil supply.
HAWAII
The Hawaii Refinery has the ability to process a wide range of crudes and
is located geographically such that it is economic to transport and receive
crudes from several parts of the world. The Hawaii Refinery is designed to
process crude with a sulphur content as high as 1.0% and also has the capability
to process combinations of crudes with naphtha/gasoline content as high as 35%
and residual fuel oil content as high as 30%. The Hawaii Refinery has processed
crude oil from Alaska, Australia, Malaysia, Indonesia and occasionally from
other countries. The Company evaluates the economics of a wide range of crudes
on a regular basis and is able to respond to movements in regional trading
markets by changing crude selection. The Company currently purchases 10,000 bpd
of Indonesian Duri crude oil from two suppliers under three one-year contracts
and 20,000 bpd of ANS crude oil from a producer under a 90-day contract with an
evergreen clause. All other crude oil is purchased on a spot basis. In
connection with the Hawaii Acquisition, the Company and an affiliate of BHP
entered into a crude supply agreement pursuant to which the BHP affiliate will
assist the Company in acquiring crude oil feedstock sourced outside of North
America and arrange for transportation of such crude oil to the Hawaii Refinery.
The crude supply agreement is for a period of two years and provides for annual
payments of $1.4 million by the Company to the BHP affiliate for such services.
WASHINGTON
Waterborne cargos, primarily ANS, are received over the refinery ship dock
and Canadian crude is received via Transmountain Pipeline. Either facility has
the capability to provide almost 100% of the Washington Refinery's needs.
Historically, approximately 60% of the Washington Refinery's crude supply has
been sweet Canadian crude received from the pipeline. However, after the
expansion of the sulphur plant anticipated to be completed in September 1998,
the Washington Refinery will be able to receive and process heavy Canadian crude
which has a higher sulphur content. Butanes are received through the Washington
Refinery's rail car rack. Small volumes of miscellaneous feedstocks are received
by barge. Both the ANS and Canadian crudes are purchased from a variety of
producers under multiple contracts.
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MARKETING
ALASKA
Gasoline. The Company distributes gasoline to end users in Alaska, either
by retail sales through 35 Company-operated stations, by wholesale sales through
125 branded and 25 unbranded dealers and jobbers (as of March 31, 1998) or by
deliveries to major oil companies for their retail operations in Alaska in
exchange for gasoline delivered to the Company on the U.S. West Coast. During
1997, the Company-operated retail stations sold an aggregate of 93,000 gallons
of gasoline per day.
In 1997, the Company initiated a three-year, $50 million retail marketing
expansion program focused primarily in Anchorage, Alaska, the State's largest
motor fuel market. During the year, two new retail stations were built, three
stations were remodeled and two uneconomic stations were closed. In addition, in
late 1997, the Company purchased the Union 76 marketing assets in Alaska, which
included three retail stations located in Southeast Alaska and the rights to use
the Union 76 trademark within Alaska.
Gasoline produced in excess of Alaska's market demand is shipped to the
U.S. West Coast or exported to the Far East by chartered vessel.
Middle Distillates. The Company is a major supplier of commercial jet fuel
into the Alaskan marketplace, with a majority of its production being marketed
to passenger and cargo airlines. The demand for jet fuel in Alaska is growing
and currently exceeds the production of all refiners in Alaska. Several
marketers, including the Company, import jet fuel into Alaska to meet excess
demand. The expansion of the Alaska Refinery's hydrocracker unit has increased
the Company's jet fuel production to help meet this growing market.
Substantially all of the Company's diesel fuel production is sold on a
wholesale basis in Alaska primarily for marine, transportation and industrial
purposes. As part of the purchase of the Union 76 marketing assets discussed
above, the Company acquired a terminal with a 110,000-barrel capacity in
Ketchikan, Alaska. Diesel fuel will be supplied to this terminal from the Alaska
Refinery and the U.S. West Coast. The product will be delivered to the terminal
by marine barge. Generally, the production of diesel fuel by refiners in Alaska
is in balance with demand; however, because of the variability of the demand,
there are occasions when diesel fuel is imported into or exported from Alaska.
See "-- Government Regulation and Legislation -- Environmental Controls" for a
discussion of the effect of governmental regulations on the production of
low-sulphur diesel fuel for on-highway use in Alaska.
Heavy Oils and Residual Products. The Alaska Refinery's vacuum unit uses
crude tower bottoms as a feedstock and further processes these volumes into
light vacuum gas oil ("LVGO"), heavy vacuum gas oil ("HVGO") and vacuum tower
bottoms ("VTBs"). The LVGO is further processed in the Alaska Refinery's
hydrocracker where it is converted into gasoline and jet fuel. HVGO is sold to
refiners on the U.S. West Coast where it is used as fluid catalytic cracker
feedstock. The VTBs are used to produce liquid asphalt or they are sold on the
U.S. West Coast. The Company sells its liquid asphalt, which is used in the
manufacturing of highway paving materials, primarily in Alaska where the demand
is seasonal because mild weather conditions are needed for highway construction.
During 1997, the Company opened an asphalt marketing facility in Anchorage,
which helped increase sales of this product in Alaska.
HAWAII
Petroleum products manufactured at the Hawaii Refinery are sold under
various contracts on a term basis or on a spot basis principally in Hawaii, the
Far East, the Pacific Islands and, to a lesser extent, the U.S. West Coast.
Gasoline. The Company distributes gasoline to end users in Hawaii by retail
sales through 30 Company-operated stations and by wholesale sales through two
dealer-operated stations or by deliveries to major oil companies for their
retail operations in Hawaii. During 1997, the Company-operated retail stations
sold an average of 120,500 gallons of gasoline and diesel per day.
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In 1994, BHP Hawaii initiated a three-year, $26 million retail gas station
and convenience store upgrade program. Since 1994, three new retail facilities
were built, two were purchased, five stations were rebuilt and 18 stations and
three car washes were remodeled.
Middle Distillates. The Company is the major supplier of commercial jet
fuel into the Hawaiian marketplace with a majority of its production being
marketed to passenger airlines. The demand for jet fuel currently exceeds the
production of both refiners in Hawaii. Several marketers, including BHP Hawaii,
import jet fuel into Hawaii to meet demand.
Substantially all of the Company's diesel fuel production is sold on a
wholesale basis in Hawaii primarily for marine, transportation, utility and
military purposes. Generally, the production of diesel by refiners in Hawaii is
in balance with demand. However, because of the variability of demand, there are
occasions when diesel fuel is imported into or exported from Hawaii.
Heavy Oils and Residual Products. The Hawaii Refinery's vacuum unit uses
crude tower bottoms as feedstock and further processes these volumes into medium
vacuum gas oil ("MVGO"), HVGO and VTBs. The MVGO is further processed in the
Hawaii Refinery's hydrocracker where it is converted into naphtha, jet fuel and
diesel. The HVGO is primarily used within the Hawaii Refinery for fuel oil
blending and occasionally sold to other refiners for use as fluid catalytic
cracker feedstock when inventories and economics are favorable. The VTBs are
used to produce liquid asphalt or are visbroken and blended to produce bunker
fuel or low sulphur fuel for use by utility power producers in Hawaii.
PACIFIC NORTHWEST
The Washington Refinery produces a variety of products including gasoline,
CARB gasoline, diesel, jet fuel, residual fuel and liquefied petroleum gases. Up
to 35% of the gasoline production will be sold to Shell through an off-take
agreement, approximately 30% is sold in the spot market and Chevron receives
approximately 30% in exchange for products in California. Jet fuel is sold
primarily to the Seattle/Tacoma Airport via pipeline. Diesel is sold to barging
companies and via truck rack. Heavy oil and residual products are currently sold
to another refiner and, locally, as bunker fuel. Upon completion of an asphalt
facility, a portion of the bottoms will be marketed as liquid asphalt. Combined
with the Alaska Refinery's production of heavy oil, the Company will be the
largest marketer of bunker fuels in the Pacific Northwest.
The Company conducts wholesale marketing operations along the U.S. West
Coast, primarily in Oregon and Washington, selling refined products in the bulk
market and through eight terminal facilities, including three operated by the
Company. In 1997, these operations sold approximately 10,300 bpd of refined
products, primarily gasoline and diesel fuel, of which approximately 25% was
received from major oil companies in exchange for products from the Alaska
Refinery, approximately 24% was received directly from the Alaska Refinery and
51% was purchased from other suppliers. In January 1998, operations of the three
Company-operated facilities on the U.S. West Coast were transferred to the
Company's Marine Services segment.
The Company's retail presence in Oregon and Washington was expanded during
1997 by adding 12 branded stations, bringing the number of "Tesoro Alaska"
branded gasoline stations in the Pacific Northwest to 30 at year-end. The
Washington Acquisition will not include any retail outlets.
FAR EAST
From time to time, the Company exports refined products from the Alaska
Refinery to certain markets in the Far East, including Russia. These exported
products, primarily gasoline, are transported to the Far East by a chartered
Russian flag vessel, described below, or at times by spot charters. Gasoline
blendstocks (reformate and naphtha) produced in excess of Hawaii's market is
exported to the Far East.
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TRANSPORTATION
ALASKA
The Company charters two American flag vessels, the Potomac Trader and the
Chesapeake Trader. These vessels are used to transport ANS crude oil from the
Trans Alaska Pipeline System ("TAPS") terminal at Valdez, Alaska, and Cook Inlet
crude oil from the Drift River terminal to the Alaska Refinery. The vessels are
also used to transport heavy oils and residual products to the U.S. West Coast
and occasionally to transport other feedstocks or products to the Alaska
Refinery. The Potomac Trader and the Chesapeake Trader are chartered under
five-year agreements expiring in 2000. The Company charters a Russian flag
vessel, the Igrim, to primarily transport refined products from the Alaska
Refinery to the Far East. The Igrim is chartered under an agreement expiring in
June 1999, which may be extended at the Company's option through June 2000. The
Company plans to continue marketing its products in the Far East and is
evaluating transportation alternatives. From time to time, the Company also
charters tankers and ocean-going barges to transport petroleum products to its
customers within Alaska, on the U.S. West Coast and in the Far East.
The Company operates a common carrier petroleum products pipeline from the
Alaska Refinery to its terminal in Anchorage. This ten-inch diameter pipeline
has a capacity to transport approximately 40,000 barrels of petroleum products
per day and allows the Company to transport light products to the terminal
throughout the year regardless of weather conditions. During 1997, the Company
transported for its own account an average of approximately 24,100 barrels of
petroleum products per day through this pipeline. The Company also owns and
operates KPL, a common carrier pipeline and marine dock facility, which assures
the Company of uninterrupted use of the dock and pipeline for unloading crude
oil feedstocks and loading product inventory on tankers and barges. During 1997,
the Company transported for its own account approximately 49,700 barrels of
crude oil per day and 37,300 barrels of refined products per day through the KPL
facilities.
For further information on transportation in Alaska, see "-- Government
Regulation and Legislation -- Environmental Controls."
HAWAII
Crude oil is transported to Hawaii by tankers and discharged through a
single point mooring terminal ("SPM") about 1.5 miles offshore from the Hawaii
Refinery. The Company charters barges and tugs to transport petroleum products
to its customers in the Hawaiian Islands and a foreign flag vessel, the Carla
Hills, to transport diesel fuel, jet fuel and gasoline to customers in American
Samoa, and fuel oil to a customer in Tahiti. The Carla Hills is also used to
transport product imports and exports between Hawaii and the Far East. The
Company also is a party to two Contracts of Affreightment with independent
parties to charter vessels to meet its transportation requirements for crude oil
and clean products.
Three underwater pipelines connect the SPM to the Hawaii Refinery to allow
crude oil and products to be transferred to the Hawaii Refinery and to load
products from the Hawaii Refinery to ships and barges. Refined products are
distributed to customers on the island of Oahu through a pipeline system with
connections to the military at several locations, to commercial customers via
terminals at Honolulu International Airport and Honolulu Harbor, and by barge to
facilities on the outer islands of Maui, Kauai and Hawaii. Four product
pipelines connect the Hawaii Refinery to Barbers Point Harbor which is 2.5 miles
away. The Barbers Point Harbor is able to accommodate barges and product tankers
up to 800 feet in length and helps relieve traffic at the SPM.
WASHINGTON
Crude oils from Canada are received through the 24-inch Transmountain
Pipeline which originates in Edmonton, Canada. Other crudes, including ANS, are
received through the Washington Refinery's ship dock. Both the pipeline and the
ship dock are each capable of providing almost 100% of the Washington Refinery's
feedstock needs.
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Over 90% of the Washington Refinery's clean products (gasoline, jet fuel
and diesel) leave via Olympic Pipeline. Olympic serves the Seattle area with
16-inch and 20-inch lines and continues to Portland with a 14-inch line. Over
20% of the Washington Refinery's clean product is delivered (via Olympic) to
Chevron, for which Shell receives products in California. A small amount of
Shell branded gasoline is delivered over the neighboring Texaco Washington
Refinery's truck rack and jet fuel is occasionally shipped by barge. The
Washington Refinery has the capability to move significant volumes of all clean
products over the ship dock. All of the fuel oil production is shipped by water.
Propane is shipped by both truck and rail.
REFINING AND MARKETING STATISTICS
The following table summarizes the Company's refining and marketing
operations for the fiscal years indicated and three months ended March 31, 1998:
<TABLE>
<CAPTION>
THREE MONTHS
FISCAL YEARS(A) ENDED
--------------------- MARCH 31,
1995 1996 1997 1998
----- ----- ----- ------------
<S> <C> <C> <C> <C>
REFINERY THROUGHPUT (thousands of bpd)
Alaska Refinery..................................... 50.6 47.5 50.2 56.1
Hawaii Refinery..................................... 90.6 86.7 88.7 86.4
Washington Refinery................................. 104.9 114.5 113.0 114.6
REFINED PRODUCTS MANUFACTURED (thousands of bpd)
Alaska Refinery --
Gasoline and gasoline blendstocks................. 14.3 12.8 12.8 15.2
Middle distillates, including jet fuel and diesel
fuel........................................... 20.7 20.0 21.6 25.2
Heavy oils and residual products.................. 14.5 13.7 14.8 15.1
Other............................................. 2.5 2.6 2.3 2.2
----- ----- ----- -----
Total Alaska Refinery........................ 52.0 49.1 51.5 57.7
----- ----- ----- -----
Hawaii Refinery --
Gasoline and gasoline blendstocks................. 22.1 19.0 22.0 19.8
Middle distillates, including jet fuel and diesel
fuel........................................... 39.3 39.6 40.4 40.3
Heavy oils and residual products.................. 27.1 25.9 24.3 23.4
Other............................................. 3.2 2.6 2.9 3.5
----- ----- ----- -----
Total Hawaii Refinery........................ 91.7 87.1 89.6 87.0
----- ----- ----- -----
Washington Refinery --
Gasoline and gasoline blendstocks................. 60.3 64.2 62.1 63.2
Middle distillates, including jet fuel and diesel
fuel........................................... 24.1 28.9 28.3 29.9
Heavy oils and residual products.................. 14.9 15.3 17.1 16.2
Other............................................. 9.6 10.4 9.9 10.0
----- ----- ----- -----
Total Washington Refinery.................... 108.9 118.8 117.4 119.3
----- ----- ----- -----
Total Refined Products Manufactured.......... 252.6 255.0 258.5 264.0
===== ===== ===== =====
NUMBER OF STATIONS SELLING THE REFINERIES' GASOLINE(B)
Alaska --
Company-operated.................................. 32 33 35 35
Branded jobbers and dealers....................... 99 126 129 125
Unbranded jobbers and dealers..................... 28 29 28 25
Pacific Northwest -- branded jobbers and dealers.... 10 18 30 33
Hawaii -- Company-operated.......................... 28 28 28 30
Hawaii -- Dealer-operated........................... 1 2 2 2
----- ----- ----- -----
Total Stations............................... 198 236 252 250
===== ===== ===== =====
</TABLE>
- ---------------
(a) Amounts for Tesoro and Shell Washington are for fiscal years ended December
31. Amounts for BHP Hawaii are for fiscal years ended May 31.
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(b) Branded gasoline stations sell the Alaska Refinery's gasoline under the
"Tesoro Alaska" name in Alaska, Oregon and Washington (191 stations as of
March 31, 1998) and under the "Union 76" name in Southeast Alaska (two
stations as of March 31, 1998). Stations that sell the Company's gasoline
under a different name are considered unbranded. Branded Gasoline stations
sell the Hawaii Refinery's gasoline under the "Gas Express" name in Hawaii.
As of March 31, 1998, the Company operated 38 convenience stores located in
Alaska, 35 of which sell gasoline.
EXPLORATION AND PRODUCTION
OVERVIEW
The Company's Exploration and Production segment is engaged in the
exploration for, and development and production 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. During 1997, the Company increased its worldwide net proved
reserves by 39% to 517 Bcfe of natural gas. Worldwide net production of natural
gas and oil averaged 109 MMcfe per day during 1997 and increased to
approximately 130 MMcfe per day in March 1998.
In the U.S., the Company has made significant progress in diversifying its
operations to areas other than the Bob West Field in South Texas. The Company's
U.S. production from fields other than the Bob West Field rose to 50% of its
total U.S. production in January 1998, as compared to 7% at year-end 1996.
During the past two years, the Company has acquired approximately 120,000 net
undeveloped acres in the U.S., bringing its total to approximately 133,000 net
undeveloped U.S. acres at December 31, 1997. During 1996 and 1997, the
Exploration and Production segment purchased interests in the Frio/Vicksburg
Trend and the Wilcox Trend in South Texas, in the Val Verde Basin in Southwest
Texas and in the East Texas Basin. By January 1998, the Company served as
operator of 44% of its U.S. net production, compared to 5% at year-end 1996.
During 1997, the Company's U.S. net proved reserve volumes increased 27% to 150
Bcfe and net production averaged 87 MMcfe per day. The Company participated in
the completion of nine gross development wells and eight gross exploratory wells
in 1997, with seven gross wells drilling at year-end.
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 natural gas and oil reserves
in Bolivia are shut-in awaiting access to gas-consuming markets which is
expected to be provided by a 1,900-mile pipeline from Bolivia to Brazil.
Pipeline construction began in 1997 and first gas deliveries are expected in
early 1999. Upon completion of the pipeline, the Company will face intense
competition from major and independent natural gas companies operating in
Bolivia for an additional share of the contractual volumes to be exported to
Brazil. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Exploration and Production -- Bolivia." In July 1997,
the Company acquired the interests of its former joint venture participant,
increasing its net proved reserve volumes in Bolivia by 35%. During 1997, the
Company's Bolivian net proved reserve volumes increased in total by 45% to 366
Bcfe and net production averaged 23 MMcfe per day.
WORLDWIDE RESERVE REPLACEMENT AND COSTS OF ADDING RESERVES
In 1997, the Company's worldwide net proved reserve additions included 156
Bcfe from discoveries, extensions and purchases of proved properties (89 Bcfe in
Bolivia and 67 Bcfe domestically) and 30 Bcfe from upward revisions of previous
estimates. Excluding revisions, 156 Bcfe were added for a 390% replacement of 40
Bcfe of production. Additions were realized with a 74% drilling success rate
during 1997, reflecting an 82% success rate on 11 development wells and a 67%
success rate on 12 exploratory wells. The Company's three-year worldwide average
cost of adding these reserves was $0.43 per Mcfe. Domestically, 67 Bcfe were
added through discoveries, extensions and acquisitions for a 209% replacement of
32 Bcfe of production. In Bolivia, 89 Bcfe were added through an acquisition, a
more than tenfold replacement of eight Bcfe of production. The three-year
average cost of adding reserves was $0.85 per Mcfe in the U.S. and $0.14 per
Mcfe in Bolivia. See Note N of Notes to Tesoro's Consolidated Financial
Statements.
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UNITED STATES
RESERVES
The following table shows the estimated net proved reserves, based on
evaluations audited by Netherland, Sewell & Associates, Inc., and gross
producing wells for each of the Company's U.S. fields:
<TABLE>
<CAPTION>
DECEMBER 31,
DECEMBER 31, 1997 1996
------------------------------------------ -------------
NET PROVED NET PROVED
PRESENT VALUE GROSS GAS RESERVES GAS RESERVES
OF PROVED PRODUCTIVE ------------- -------------
FIELD LOCATION TREND RESERVES(A) WELLS BCFE % BCFE %
----- -------- ----- ------------- ---------- ------ ---- ------ ----
($ THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Bob West South Texas Wilcox $ 74,659 63 59.0 39% 88.0 75%
Los Indios South Texas Frio/Vicksburg 11,751 26 15.3 10 16.8 14
Vinegarone East Southwest Texas Val Verde 16,457 4 14.3 10 -- --
Kent Bayou South Louisiana Frio/Vicksburg 13,749 1 10.5 7 -- --
Oak Hill East Texas East Texas Basin 5,389 5 9.9 7 -- --
Berry R. Cox South Texas Wilcox 14,426 5 8.6 6 2.9 3
La Reforma South Texas Frio/Vicksburg 8,558 18 7.7 5 2.8 2
Woodlawn East Texas East Texas Basin 3,883 2 6.5 4 -- --
Carthage East Texas East Texas Basin 2,740 -- 4.7 3 -- --
Other Various Various 15,883 54 13.9 9 7.4 6
-------- --- ----- --- ----- ---
$167,495 178 150.4 100% 117.9 100%
======== === ===== === ===== ===
</TABLE>
- ---------------
(a) Represents the discounted future net cash flows before income taxes. See
Note N of Notes to Tesoro's Consolidated Financial Statements for
additional information regarding the Company's proved reserves and
standardized measure.
Wilcox Trend. The Company has 23,088 net acres, including 17,147 net
undeveloped acres, under lease in the Wilcox Trend. Approximately 52% (78.4
Bcfe) of the Company's U.S. net proved reserve volumes are located in 11
producing fields in this trend, including the Bob West Field, the Company's
largest U.S. field. The Wilcox Trend extends from Northern Mexico through South
Texas into the other Gulf Coast states. Multiple pay sands exist within the
Wilcox Trend, where extensive faulting has trapped hydrocarbons in numerous
producing zones.
Frio/Vicksburg Trend. The Company has 7,667 net acres, including 2,897 net
undeveloped acres, under lease in the Frio/Vicksburg Trend. Approximately 24%
(36.5 Bcfe) of the Company's U.S. net proved reserve volumes are located in
eight producing fields in this trend, primarily the Los Indios, La Reforma and
Kent Bayou Fields. The Frio/Vicksburg Trend lies between the Gulf Coast
shoreline and the Wilcox Trend.
East Texas Basin. The Company has 16,988 net acres, including 14,064 net
undeveloped acres, under lease in the East Texas Basin. The undeveloped acreage
is located on prospects in the Cotton Valley Pinnacle Reef play and on prospects
targeting various Cretaceous aged objectives. The Company is currently acquiring
3-D seismic surveys to evaluate its acreage holdings. Approximately 14% (21.3
Bcfe) of the Company's U.S. net proved reserve volumes are in this basin, which
is located in the northeastern part of Texas.
Val Verde Basin. The Company has 94,761 net acres, primarily undeveloped,
under lease in the Val Verde Basin in Edwards and Val Verde Counties, Texas. As
of December 31, 1997, approximately 10% (14.3 Bcfe) of the Company's U.S. net
proved reserve volumes are in this basin, which is located in the southwestern
part of Texas. In April 1998, the Company completed a new well which
significantly increased proved reserves and production in this basin.
GAS GATHERING AND TRANSPORTATION
The Company owns a 70% interest in the Starr County Gathering System, which
consists of two 10-inch diameter pipelines and one 20-inch diameter pipeline
that transport natural gas eight miles from the Bob West
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<PAGE> 62
Field in South Texas to common carrier pipeline facilities. In addition, the
Company owns a 50% interest in the 20-inch diameter Starr-Zapata Pipe Line,
which transports natural gas 26 miles from the Starr County Gathering System to
a market hub at Fandango, Texas. The Company does not operate either pipeline.
During 1997, gross throughput averaged 169 MMcf per day for both the Starr
County Gathering System and the Starr-Zapata Pipe Line, with approximately 50%
of the throughput consisting of the Company's working interest of Bob West Field
production. The Starr County Gathering System receives a transportation fee of
$0.06 per Mcf and the Starr-Zapata Pipe Line receives a fee of $0.07 per Mcf for
volumes transported.
MARKETING
The Company's U.S. natural gas production is sold on the spot market and
under short-term contracts with a variety of purchasers, including intrastate
and interstate pipelines, their marketing affiliates, independent marketing
companies and other purchasers who have the ability to move the gas under firm
transportation or interruptible agreements. Prices for the Company's natural gas
production are subject to regional discounts or premiums tied to regional spot
market prices.
U.S. ACREAGE AND PRODUCTIVE WELLS
The Company holds its U.S. acreage through oil and natural gas leases and
lease options. The leases have a variety of primary terms and may require delay
rentals to continue the primary term if not productive. The leases may be
surrendered by the operator at any time for various reasons, which may include
cessation of production, fulfillment of commitments, or failure to make timely
payment of delay rentals. The following tables set forth the Company's U.S.
gross and net acreage and productive wells at December 31, 1997:
<TABLE>
<CAPTION>
UNDEVELOPED ACREAGE DEVELOPED ACREAGE
------------------- -----------------
LOCATION GROSS NET GROSS NET
-------- -------- -------- ------- -------
<S> <C> <C> <C> <C>
Val Verde Basin, Southwest Texas................. 98,466 94,401 480 360
East Texas Basin, East Texas..................... 56,278 14,064 3,303 2,924
Wilcox Trend, South Texas........................ 37,986 17,147 19,349 5,941
Frio/Vicksburg Trend, South Texas................ 4,034 2,017 10,556 4,538
Frio/Vicksburg Trend, South Louisiana............ 880 880 315 232
------- ------- ------ ------
Total Leased Acres..................... 197,644 128,509 34,003 13,995
Fee Acres, Various Locations..................... 15,838 4,352 338 325
------- ------- ------ ------
Total Acres............................ 213,482 132,861 34,341 14,320
======= ======= ====== ======
</TABLE>
<TABLE>
<CAPTION>
GAS WELLS OIL WELLS
------------ -----------
GROSS NET GROSS NET
----- ---- ----- ---
<S> <C> <C> <C> <C>
Productive Wells(a)........................................ 168 86.9 10 5.4
</TABLE>
- ---------------
(a) Includes three gross (1.6 net) gas wells and two gross (1.0 net) oil wells
with multiple completions. At December 31, 1997, the Company was
participating in the drilling of seven gross (6.3 net) wells.
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<PAGE> 63
U.S. OPERATING STATISTICS
The following table summarizes the Company's U.S. exploration and
production activities for the years ended December 31, 1995, 1996 and 1997 and
three months ended March 31, 1998:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS
--------------------------- ENDED MARCH 31,
1995 1996 1997 1998
------- ------ ------ ---------------
<S> <C> <C> <C> <C>
Average Daily Net Production:
Natural gas (Mcf)..................... 114,490 87,654 86,052 99,135
Oil (barrels)......................... 1 27 118 173
Total (Mcfe).......................... 114,496 87,816 86,760 100,173
Exploratory Wells Drilled(a):
Productive -- gross................... 5.0 4.0 8.0 3.0
Productive -- net..................... 1.5 1.7 6.3 2.5
Dry holes -- gross.................... 4.0 2.0 4.0 4.0
Dry holes -- net...................... 2.1 1.0 2.9 3.3
Development Wells Drilled(a):
Productive -- gross................... 17.0 15.0 9.0 3.0
Productive -- net..................... 9.7 6.3 5.1 2.3
Dry holes -- gross.................... -- 1.0 2.0 --
Dry holes -- net...................... -- 0.5 1.0 --
</TABLE>
- ---------------
(a) All of the Company's drilling is performed by independent drilling
contractors.
For further information regarding the Company's U.S. exploration and
production operations, see Notes B, C and N of Notes to Tesoro's Consolidated
Financial Statements.
BOLIVIA
The Company's Bolivian exploration, development and production operations
are located in the Chaco Basin in southern Bolivia near the border of Argentina.
The Company has discovered six fields in Bolivia since 1976, five of which have
currently estimated proved reserves totaling 366 Bcfe at December 31, 1997. The
Company intends to complete additional seismic studies and appraisal wells
before assigning proved reserves to the sixth field. With production of 37 MMcfe
per day (gross) in 1997, the Company is one of the largest operators in Bolivia.
The Company estimates that it currently could produce from its existing proved
developed producing reserve base approximately 120 MMcfe per day (gross) if
ready markets were available. The Company holds four shared risk contracts with
YPFB, the Bolivian governmental agency responsible for administration of these
contracts, covering a total of 879,938 gross acres in Block 18 and Block 20.
ACQUISITION
In July 1997, the Company purchased the interests held by its former joint
venture participant in the then existing two contract blocks, consisting of a
25% interest in Block 18 and a 27.4% interest in Block 20. Upon completion of
this purchase, the Company held a 100% interest in both blocks, subject to a
farmout agreement discussed below. The purchase price was approximately $20
million, which included working capital and assumption of certain liabilities.
The Company's net proved Bolivian reserve volumes increased by approximately 35%
as a result of this acquisition.
BOLIVIAN HYDROCARBONS LAW
In 1996, a new Hydrocarbons Law was passed by the Bolivian government that
significantly impacts the Company's operations in Bolivia. The new law, among
other matters, granted the Company the option to convert its Contracts of
Operation to new shared risk contracts. On November 6, 1997, the Company
completed the conversion of its Contracts of Operation into four shared risk
contracts. The new contracts, which have an effective date of July 29, 1996,
extend the Company's term of operation, provide more
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<PAGE> 64
favorable acreage relinquishment terms and provide for a more favorable fiscal
regime of royalties and taxes. The new contract for Block 18 is extended to the
year 2017. The new contracts for Block 20 are extended to the year 2018 for
Block 20-Los Suris, which is in the development phase, and to the year 2029 for
Block 20-West and Block 20-East, which are in the exploration phase.
FARMOUT AGREEMENT
A farmout agreement executed June 19, 1997, between the Company and Total
Exploration Production Bolivie S.A. ("Total"), an affiliate of Total S.A.,
covers a portion of Block 20-West. Pursuant to the farmout agreement, Total
established a financial guarantee to the Bolivian government to guarantee the
performance of exploration work on Block 20-West. Total has the right to drill,
at its sole cost, two exploratory wells to earn a 75% interest in the farmout
area which consists of 315,000 acres of Block 20-West. If Total drills only one
well, Total will earn a 37.5% interest in the farmout area. On December 31,
1997, the Company assigned a 75% interest and operatorship in the farmout area
to Total, subject to reversion if Total does not drill two wells.
YPF AND YPFB CONTRACT
The Company is currently selling all of its natural gas production from
Block 18 to YPFB, which in turn sells the natural gas to YPF, a publicly-held
company based in Argentina. Currently, the Company's sales of natural gas are
based on the volume and pricing terms in the contract between YPFB and YPF. The
Company has historically provided approximately 20% of the contract volumes
required by YPF. The contract to sell gas to YPF expired March 31, 1997, and a
contract extension was signed effective April 1, 1997, extending the contract
term two years to March 31, 1999, with an option to extend the contract a
maximum of one additional year if the 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 because they are linked to a monthly average fuel
oil price posted in the New York spot market.
ACCESS TO NEW MARKETS
A lack of market access has constrained natural gas production in Bolivia.
With little internal gas demand, all of the Company's Bolivian natural gas
production is sold under contract to the Bolivian government for export to
Argentina. Major developments in South America indicate that new markets will
open for the Company's production. Construction of a new 1,900-mile pipeline
that will link Bolivia's extensive gas reserves with markets in Brazil commenced
in 1997 and is expected to be operational in early 1999. The owners of the new
pipeline include Petroleo Brasileiro S.A. (the Brazilian state oil company),
other Brazilian investors, Enron Corp., Shell International Gas Ltd., British
Gas PLC, El Paso Energy Corp., BHP, and Bolivian pension funds. When completed,
the new pipeline will have a capacity of approximately one billion cubic feet
("Bcf") per day. 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. The Company's 1998
capital budget includes plans to drill three development wells (gross) and two
exploratory wells (gross) which may increase its productive capacity.
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<PAGE> 65
RESERVES
The table below shows the estimated proved reserves, based on evaluations
prepared by Netherland, Sewell & Associates, Inc., and productive wells for each
of the Company's Bolivian fields. Each of the following fields is operated by
the Company:
<TABLE>
<CAPTION>
DECEMBER 31,
DECEMBER 31, 1997 1996
-------------------------------------------------------------------- -----------------
NET PROVED RESERVES
-----------------------------------
OIL
PRODUCTIVE (MILLIONS OF GAS TOTAL PV-10 AFTER PV-10 AFTER
FIELD BLOCK WELLS BARRELS) (BCF) (BCFE) % BOLIVIAN TAXES(A) BOLIVIAN TAXES(A)
----- ----- ---------- ------------ ----- ------ --- ----------------- -----------------
($ THOUSANDS) ($ THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Palo Marcado......... 20 2 2.0 140.1 152.1 42% $ 38,871 $24,667
Los Suris............ 20 2 1.1 97.6 104.2 28 32,685 13,135
Escondido............ 18 4 1.6 78.0 87.6 24 23,926 23,330
La Vertiente......... 18 4 0.5 19.0 22.0 6 5,971 3,090
Taiguati............. 18 1 -- 0.4 0.4 -- -- 221
-- --- ----- ----- --- -------- -------
13 5.2 335.1 366.3 100% $101,453 $64,443
== === ===== ===== === ======== =======
</TABLE>
- ---------------
(a) Represents the discounted future net cash flows after Bolivian taxes. See
Note N of Notes to Tesoro's Consolidated Financial Statements for additional
information regarding the Company's proved reserves and standardized
measure.
BOLIVIAN ACREAGE AND PRODUCTIVE WELLS
The following table sets forth the Company's Bolivian gross and net acreage
and productive wells at December 31, 1997:
<TABLE>
<CAPTION>
GROSS NET
------- -------
<S> <C> <C>
Acreage:
Developed................................................. 92,625 92,625
Undeveloped............................................... 787,313 551,063
Productive Gas Wells(a)................................... 13 13
</TABLE>
- ---------------
(a) Included in productive gas wells are five gross (five net) wells with
multiple completions. The Company has no producing oil wells in Bolivia.
BOLIVIA OPERATING STATISTICS
The following table summarizes the Company's Bolivian exploration and
production activities for the years ended December 31, 1995, 1996 and 1997 and
the three months ended March 31, 1998:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS
------------------------ ENDED MARCH 31,
1995 1996 1997 1998
------ ------ ------ ---------------
<S> <C> <C> <C> <C>
Average Daily Net Production:
Natural gas (Mcf)......................... 18,650 20,251 19,537 22,769
Condensate (barrels)...................... 567 584 518 816
Total (Mcfe).............................. 22,052 23,755 22,645 27,665
Exploratory Wells Drilled:
Productive -- gross....................... 1.0 2.0 -- --
Productive -- net......................... 0.7 1.5 -- --
Dry holes -- gross........................ -- -- -- --
Dry holes -- net.......................... -- -- -- --
</TABLE>
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<PAGE> 66
For further information regarding the Company's Bolivian operations, see
Notes B, C and N of Notes to Tesoro's Consolidated Financial Statements.
MARINE SERVICES
OVERVIEW
The Company's Marine Services segment markets and distributes a broad range
of products, including diesel fuel, lubricants, chemicals and supplies, and
provides logistical support services to the marine and offshore exploration and
production industries operating in the Gulf of Mexico. These operations were
conducted in 1997 through a network of 18 marine and two land terminals located
on the Texas Gulf Coast in Galveston, Freeport, Harbor Island, Port O'Connor,
Sabine Pass, Channelview and Houston and along the Louisiana Gulf Coast in
Cameron, Intracoastal City, Berwick, Venice, Port Fourchon, Amelia and Harahan.
The marine terminals are generally deep water and are bulkheaded and dredged to
provide easy access to vessels receiving products for delivery to customers.
Products are delivered offshore aboard vessels owned or chartered by customers,
which include companies engaged in oil and gas exploration and production,
seismic evaluation, offshore construction and other drilling-related businesses.
In January 1998, the Marine Services operations were expanded to include the
operations of three terminals located on the U.S. West Coast, previously
operated by the Company's Refining and Marketing segment (see
"-- Marketing -- Pacific Northwest" discussed above).
FUELS AND LUBRICANTS
Fuels and lubricants, which are used by operations such as offshore
drilling rigs, offshore production and transmission platforms and various ships
and equipment engaged in seismic surveys, are marketed and distributed from the
Company's terminals. These terminals and a fleet of seven tugboats (including
four owned by the Company) and 14 barges (including 12 owned by the Company)
serve offshore workboats, tugboats and barges using the Intracoastal Canal
System, as well as ships entering the ports of Houston, New Orleans, Lake
Charles, Corpus Christi and Port Arthur. The Company obtains its supply of fuel
from refiners in the Gulf Coast area. Total gallons of fuel, primarily diesel
fuel, sold by Marine Services amounted to 112.5 million, 142.7 million and 156.4
million in the years 1995, 1996 and 1997, respectively. During the three months
ended March 31, 1997 and 1998, total gallons of fuel sold by Marine Services
were approximately 39.6 million and 47.9 million, respectively.
The Company is a distributor of major brands of marine lubricants and
greases, offering a full spectrum of grades. Lubricants are delivered to
customers by trucks or tugs and barges. Total gallons of lubricants sold by
Marine Services amounted to 2.5 million, 2.3 million and 2.7 million for the
years ended December 31 1995, 1996 and 1997, respectively. For the three months
ended March 31, 1997 and 1998, total gallons of lubricants were 0.7 and 1.7
million, respectively.
LOGISTICAL SERVICES
Through many of its terminals, the Company provides full-service
shore-based support for offshore drilling rigs and production platforms. These
quayside services provide cranes, forklifts and loading docks for supply boats
serving the offshore exploration and production industry. In addition, the
Company provides long-term parking for offshore workers, helicopter landing pads
and office space with living quarters. The Company's terminals also serve as
delivery points for drilling products, primarily mud, by providing warehousing,
blending, inventory control and delivery services. In the years 1995, 1996 and
1997, revenues from these logistical services were $0.6 million, $8.7 million
and $11.3 million, respectively. In the three months ended March 31, 1997 and
1998, revenues from logistical services were $3.0 million and $2.9 million,
respectively.
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<PAGE> 67
COMPETITION AND OTHER
The petroleum industry is highly competitive in all phases, including the
refining of crude oil, the marketing of refined petroleum products, the search
for and development of oil and gas reserves and the marine services business.
The industry also competes with other industries that supply the energy and fuel
requirements of industrial, commercial and individual consumers. The Company
competes with a substantial number of major integrated oil companies and other
companies having materially greater financial and other resources than the
Company. These competitors have a greater ability to bear the economic risks
inherent in all phases of the industry. In addition, unlike the Company, many of
its competitors produce large volumes of crude oil which can then be used in
connection with their refining operations. The North American Free Trade
Agreement has further streamlined and simplified procedures for the importation
and exportation of natural gas among Mexico, the United States and Canada. These
changes are likely to enhance the ability of Canadian and Mexican producers to
export natural gas and other products to the United States, thereby further
increasing competition for domestic sales.
The refining and marketing businesses are highly competitive, with price
being the principal factor in competition. In the refining industry, the Alaska
Refinery competes primarily with other refineries in Alaska and on the U.S. West
Coast. The Company's refining competition in Alaska includes two refineries
situated near Fairbanks and one refinery situated near Valdez. The Company
estimates that such other refineries have a combined capacity to process
approximately 184,000 bpd of crude oil. The Company believes that ANS crude oil
is the only feedstock used in these competing refineries. After processing the
crude oil and removing the lighter-end products, which the Company believes
represent approximately 30% of each barrel processed, these refiners are
permitted, because of their direct connection to the TAPS, to return the
remainder of the processed crude back into the pipeline system as "return oil"
in consideration for a fee, thereby eliminating their need to market residual
products. The Alaska Refinery is not directly connected to the TAPS, and the
Company, therefore, cannot return its residual products to the TAPS. The
Company's refining competition from the U.S. West Coast includes many large,
integrated oil companies that do business in Alaska and have materially greater
financial and other resources. The Hawaii Refinery competes primarily with one
other refinery in Hawaii which is also located at Kapolei and which has a rated
capacity of 55,000 bpd of crude oil. Historically, the other refinery in Hawaii
produced lower volumes of jet fuel than BHP Hawaii. The Washington Refinery
competes with several refineries on the U.S. West Coast, including refineries
which are larger than the Washington Refinery and which are owned by companies
substantially larger than the Company.
The Company is a major producer and distributor of gasoline in Alaska and
Hawaii through a large network of Company-operated stations and branded and
unbranded dealers and jobbers. The Company is also a supplier to a major oil
company through a product exchange agreement, whereby gasoline in Alaska is
provided in exchange for gasoline delivered to the Company on the U.S. West
Coast. In addition, the Company is a supplier to a major oil company in Hawaii
through a gasoline sales agreement. Competitive factors affecting the marketing
of gasoline in Alaska and Hawaii include such factors as product price, location
and quality together with station appearance and brand-name identification. The
Company competes with other petroleum companies, distributors and other
developers for new locations. The Company believes it is in a position to
compete effectively as a marketer of gasoline in Alaska and Hawaii because of
its strong presence in these markets.
The Company's jet fuel sales in Alaska are concentrated in Anchorage, where
it is one of the principal suppliers to the Anchorage International Airport,
which is a major hub for air cargo traffic between manufacturing regions in the
Far East and consuming regions in the United States and Europe. In Hawaii, jet
fuel sales are concentrated in Honolulu, where the Company is the principal
supplier to the Honolulu Airport. The Company also serves four airports on other
islands in Hawaii. The Company sells its diesel fuel primarily on a wholesale
basis. Refined products from foreign sources also compete for distillate markets
in the Company's Alaskan market area.
The Company's Pacific Northwest marketing business is primarily a
distribution business selling to independent dealers and jobbers. In addition,
the Company sells its gasoline through 30 branded gasoline
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<PAGE> 68
stations in the Pacific Northwest. The Company competes against independent
marketing companies and integrated oil companies when engaging in these
marketing operations.
The exploration for and production of natural gas and oil is highly
competitive in both the United States and in South America. In seeking to
acquire producing properties, new leases, concessions and exploration prospects,
the Company faces competition from both major and independent oil and natural
gas companies. Many of these competitors have financial and other resources
substantially in excess of those available to the Company and, therefore, may be
better positioned to acquire and develop prospects, hire personnel and market
production. The larger competitors may also be able to better respond to factors
that influence the market for oil and natural gas production, such as changes in
worldwide prices and governmental regulations. Such factors are beyond the
control of the Company.
The Company's natural gas production in Bolivia is sold under contract to
YPFB, which in turn exports the natural gas to Argentina, as the internal demand
for natural gas in Bolivia is limited. 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.
Demand for services and products offered by the Company's Marine Services
segment is closely related to the level of oil and gas exploration, development
and production in the Gulf of Mexico. Various factors, including general
economic conditions, demand for and prices of natural gas, availability of
equipment and materials and government regulations and energy policies cause
exploration and development activity to fluctuate and directly impact the
revenues of the Marine Services segment. Management believes that the principal
competitive factors affecting the Marine Services operations are location of
facilities, availability of logistical support services, experience of personnel
and dependability of service. The market for the Marine Services segment's
products and services, particularly diesel fuel, is price sensitive. The Company
competes with several independent operations, and in certain locations with one
or more major mud companies who maintain their own marine terminals.
A portion of the Company's operations are conducted in foreign countries
where the Company is also subject to risks of a political nature and other risks
inherent in foreign operations. The Company's operations outside the United
States in recent years have been, and in the future may be, materially affected
by host governments through increases or variations in taxes, royalty payments,
export taxes and export restrictions and adverse economic conditions in the
foreign countries, the future effects of which the Company is unable to predict.
GOVERNMENT REGULATION AND LEGISLATION
UNITED STATES
Natural Gas and Oil Regulations. Historically, all domestic natural gas
sold in so-called "first sales" was subject to federal price regulations under
the Natural Gas Policy Act of 1978 ("NGPA"), the Natural Gas Act ("NGA") and the
regulations and orders issued by the Federal Energy Regulatory Commission
("FERC") in implementing such Acts. Under the Natural Gas Wellhead Decontrol Act
of 1989, all remaining federal natural gas wellhead pricing and sales regulation
was terminated on January 1, 1993.
The FERC also regulates interstate natural gas pipeline transportation
rates and service conditions, which affect the marketing of gas produced by the
Company, as well as the revenues received by the Company for sales of such gas.
Since the latter part of 1985, through a series of orders, the FERC has
endeavored to make natural gas transportation more accessible to gas buyers and
sellers on an open and non-discriminatory basis,
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and the FERC's efforts have significantly altered the marketing and pricing of
natural gas. These orders have gone through various permutations, but have
generally remained intact as promulgated. The FERC considers these changes
necessary to improve the competitive structure of the interstate natural gas
pipeline industry and to create a regulatory framework that will put gas sellers
into more direct contractual relations with gas buyers than has historically
been the case. The result of the changes has brought to an end the interstate
pipelines' traditional role as wholesalers of natural gas in favor of providing
only gathering, transportation and storage services for others which will buy
and sell natural gas. Although these orders do not directly regulate gas
producers, such as the Company, they are intended to foster increased
competition within all phases of the natural gas industry. It is unclear what
impact, if any, increased competition within the natural gas industry will have
on the Company and its gas sales efforts. Several aspects of these orders are
still being reviewed by the courts and the FERC. It is not possible to predict
what, if any, effect these proceedings will have on the Company. The Company
does not believe, however, that it will be affected any differently than other
gas producers or marketers with which it competes.
The oil and gas exploration and production operations of the Company are
subject to various types of regulation at the state and local levels. Such
regulation includes requiring drilling permits and the maintenance of bonds in
order to drill or operate wells, the regulation of the location of wells, the
method of drilling and casing of wells and the surface use and restoration of
properties upon which wells are drilled, and the plugging and abandoning of
wells. The operations of the Company are also subject to various conservation
regulations, including regulation of the size of drilling and spacing units or
proration units, the density of wells that may be drilled in a given area and
the unitization or pooling of oil and gas properties. In this regard, some
states allow the forced pooling or integration of lands and leases. In addition,
state conservation laws establish maximum rates of production from oil and gas
wells, generally prohibit the venting or flaring of gas and impose certain
requirements regarding the ratability of production. The effect of these
regulations is to limit the amounts of crude oil, condensate and natural gas the
Company can produce from its wells and the number of wells or the locations at
which the Company can drill.
Additional proposals and proceedings that might affect the natural gas
industry are considered from time to time by Congress, the FERC, state
regulatory bodies and the courts. The Company cannot predict when or if any such
proposals might become effective, or their effect, if any, on the Company's
operations.
Environmental Controls. Federal, state, area and local laws, regulations
and ordinances relating to the protection of the environment affect all
operations of the Company to some degree. An example of a federal environmental
law that will require operational additions and modifications is the Clean Air
Act, which was amended in 1990. While the Company believes that its facilities
generally are in substantial compliance with current regulatory standards for
air emissions, over the next several years the Company's facilities will be
required to comply with the new requirements being adopted and promulgated by
the EPA and the states in which the Company operates. These regulations will
necessitate the installation of additional controls or other modifications or
changes in use for certain emission sources at the Alaska, Hawaii and Washington
Refineries. Specifics as to the cost of these requirements, and the necessity
for changes at other Company facilities, are still being determined. As part of
these requirements, the Alaska, Hawaii and Washington Refineries, as well as
some other Company facilities submitted applications for Clean Air Act Amendment
Title V permits. Each application has been deemed complete by their respective
states and will undergo technical review in 1998. The Company believes it can
comply with these new requirements, and in some cases already has done so,
without adversely affecting operations.
The passage of the Federal Clean Air Act Amendments of 1990 prompted
adoption of regulations by the state of Alaska obligating the Company to produce
oxygenated gasoline for delivery to the Anchorage and Fairbanks, Alaska markets
starting on November 1, 1992. Controversies surrounding the potential health
effects in Arctic regions of oxygenated gasoline containing methyl tertiary
butyl ether ("MTBE") prompted early discontinuance of the program in Fairbanks.
The EPA has been directed to conduct studies of potential health effects of
oxygenated fuel in Alaska. The state of Alaska mandated the use of oxygenated
fuels containing ethanol in the Anchorage area. No requirements for use of such
products in Fairbanks have been issued, but are expected. Additional federal
regulations promulgated on August 21, 1990, which went into effect on October 1,
1993, set limits on the quantity of sulphur in on-highway diesel fuels which the
Company
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<PAGE> 70
produces. The state filed an application with the federal government in February
1993 for a waiver from this requirement since only 5% of the diesel fuel sold in
Alaska was for on-highway vehicles. On March 14, 1994, the EPA granted the State
of Alaska a waiver from the requirements of the EPA's low sulphur diesel fuel
program, permanently exempting Alaska's remote areas and providing a temporary
exemption for areas served by the Federal Aid Highway System until October 1,
1996. On August 19, 1996, the EPA extended the temporary exemption until October
1, 1998. The Company estimates that substantial capital expenditures would be
required to enable the Company to produce low-sulphur diesel fuel to meet these
federal regulations. If the state of Alaska is unable to obtain a permanent
waiver from the federal regulations, the Company would discontinue sales of
diesel fuel for on-highway use after October 1, 1998. The Company estimates that
such sales accounted for less than 1% of its refined product sales in Alaska
during 1997. While the Company is unable to predict the outcome of these
matters, their ultimate resolution should not have a material impact on its
operations.
Underground Storage Tanks. Regulations promulgated by the EPA on September
23, 1988, require that all underground storage tanks used for storing gasoline
or diesel fuels either be closed or upgraded not later than December 22, 1998,
in accordance with specified regulatory standards. The Company's gasoline retail
stations which are subject to upgrading requirements are limited to sites in
Alaska and Hawaii. The Company is expected to incur a total cost of
approximately $1 million by December 22, 1998 for the removal, replacement or
upgrading of underground storage tanks at current and former service stations in
Alaska and Hawaii. In Hawaii, all but two gasoline retail stations have been
brought into compliance with the 1998 regulatory requirements. Of the two
remaining, one station is scheduled to be demolished and completely rebuilt to
comply with regulatory requirements. Pending resolution of a dispute over the
lease to the other station, the Company has not to date scheduled nor committed
to complete upgrades until its interests to the property are resolved. If the
Company commits to remain at the site, then the necessary upgrades will be
completed prior to the regulatory deadline.
Total Environmental Expenditures. Tesoro's total capital expenditures for
environmental control purposes were $2.2 million during 1997. Capital
expenditures for the alternate secondary containment systems in Alaska,
discussed above, are estimated to be $2 million in 1998 and $2 million in 1999
with the remaining $5 million to be spent by 2002. Capital expenditures for
other Alaska environmental control purposes are estimated to be $7 million in
1998 and $2 million in 1999. Capital expenditures for Hawaii environmental
controls are expected to be $4 million in 1998 and $1 million in 1999, the
majority of which are to install specific sulphur emission control devices at
the Hawaii Refinery. Capital expenditures for the Washington Refinery are
expected to be $2 million in 1998 and $1 million in 1999, primarily for new
storage tank roof seals and improving drainage controls. For further information
regarding environmental matters, see "-- Legal Proceedings" and
"-- Environmental Controls," "-- Oil Spill Prevention and Response" and
"-- Underground Storage Tanks."
Oil Spill Prevention and Response. The Federal Oil Pollution Act of 1990
("OPA 90") and related state regulations require most refining, transportation
and oil storage facilities to prepare oil spill prevention contingency plans for
use during an oil spill response. The Company has prepared and submitted these
plans for approval and, in most cases, has received federal and state approvals
necessary to meet various regulations and to avoid the potential of negative
impacts on the operation of its facilities.
The Company currently charters tankers to transport crude oil from the
Valdez, Alaska, pipeline terminal through Prince William Sound and Cook Inlet to
the Alaska Refinery. In addition, the Company routinely charters, on a long-term
and short-term basis, additional tankers and barges for shipment of crude oil
and refined products through Alaska, Pacific Northwest and Hawaii waters. OPA 90
requires, as a condition of operation, that the Company demonstrate the
capability to respond to the "worst case discharge" to the maximum extent
practicable. Alaska law requires the Company to provide spill-response
capability to contain or control, and cleanup within 72 hours, an amount equal
to (i) 50,000 barrels for a tanker carrying fewer than 500,000 barrels of crude
oil or (ii) 300,000 barrels for a tanker carrying more than 500,000 barrels. To
meet these requirements, the Company has entered into a contract with Alyeska
Pipeline Service Company ("Alyeska") to provide initial spill response services
in Prince William Sound, with the Company later to assume those responsibilities
after mutual agreement with Alyeska and State and Federal On-Scene
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<PAGE> 71
Coordinators. The Company has also entered into an agreement with Cook Inlet
Spill Prevention and Response, Incorporated for oil spill response services in
Cook Inlet. Similarly, the Company has entered into contracts with the Clean
Islands Council in Hawaii, Clean Sound Cooperative, Inc. in the State of
Washington and the Marine Spill Response Corporation in Hawaii, Washington and
the Texas-Louisiana Gulf Coast, for spill response services. The Company
believes these contracts provide for the additional services necessary to meet
spill response requirements established by state and federal law.
Transportation, storage and refining of crude oil results in the greatest
regulatory impact with respect to oil spill prevention and response. Oil
transportation and terminalling operations at other Company facilities also
result in compliance mandates for oil spill prevention and response. The Company
contracts with various oil spill response cooperatives or local contractors to
provide necessary oil spill response capabilities which may be required on a
location by location basis.
Regulations promulgated by the Alaska Department of Environmental
Conservation ("ADEC") would have required the installation of dike liners in
secondary containment systems for petroleum storage tanks by January 1997.
However, on December 18, 1996, ADEC approved the Company's alternative
compliance schedule which allows the Company until the year 2002 to implement
alternative secondary containment systems for all of the Company's existing
petroleum storage tank facilities. The total estimated cost of these
improvements is approximately $9 million, which is expected to be spent over a
five-year period beginning in 1998.
BOLIVIA
The Company's operations in Bolivia are subject to the Bolivian
Hydrocarbons Law and various other laws and regulations. In the Company's
opinion, neither the Hydrocarbons Law nor other requirements currently imposed
by Bolivian laws, regulations and practices will have a material adverse effect
upon its Bolivian operations. For information on the Bolivian Hydrocarbons Law
and Bolivian taxation, see "-- Exploration and Production -- Bolivia" discussed
above.
EMPLOYEES
At December 31, 1997, Tesoro employed approximately 1,100 persons, of whom
approximately 40 were located in foreign countries, BHP Hawaii employed
approximately 800 persons and Shell Washington employed approximately 300
persons. Approximately 180 employees at the Washington Refinery are covered by a
collective bargaining agreement. The Company considers its relations with its
employees to be satisfactory.
LEGAL PROCEEDINGS
The Company, along with numerous other parties, has been identified by the
EPA as a potentially responsible party ("PRP") pursuant to the Comprehensive
Environmental Response, Compensation and Liability Act ("CERCLA") for the D.L.
Mud Superfund site in Abbeville, Louisiana (the "Site"). The Company arranged
for the disposal of a minimal amount of materials at the Site, but CERCLA might
impose joint and several liability on each PRP at the Site. The EPA is seeking
reimbursement for its response costs incurred to date at the Site, as well as a
commitment from the PRPs either to conduct future remedial activities or to
finance such activities. 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 EPA and other
PRPs involved at the Site. The Company expects, based on these discussions, that
its liability at the Site will not exceed $25,000.
The Hawaii Department of Health ("HDOH"), under authority of the Hawaii
Environmental Response Law, has undertaken an investigation of environmental
conditions within a portion of the Honolulu Harbor area, which has been
designated the Iwilei Unit, to determine the extent of hydrocarbon
contamination. A group of owners and operators at the Iwilei Unit, including BHP
Hawaii, have entered into a voluntary agreement with the HDOH to undertake an
initial phase of environmental site investigation within the Iwilei
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unit in exchange for certain commitments from the HDOH, including the
notification of additional potentially responsible parties to participate in
this activity. The costs associated with this proceeding cannot be determined at
this early stage. BHP Hawaii owned and operated facilities in the Iwilei unit,
including, but not limited to the Pier 29 terminal facilities (which were
returned, upon expiration of the lease term, to the state of Hawaii Department
of Transportation) and the Pier 34 terminal facilities (which are now owned and
operated by the Company under a lease with the same agency). Under the indemnity
provisions of the environmental agreement between the BHP Sellers and the
Company, the Company is fully indemnified for claims arising out of this
proceeding as it relates to the Iwilei Unit by affiliates of BHP and this
indemnity is not subject to the $9.5 million cap or ten-year claim period. See
discussion in "-- Government Regulation and Legislation" above.
The EPA issued a Notice of Violation ("NOV") on June 24, 1997, against the
Hawaii Refinery alleging violations of the Clean Water Act associated with the
content and implementation of the Refinery's Spill Prevention, Control and
Countermeasures ("SPCC") Plan, and further alleging violations based on a series
of oil releases. The Company and the EPA remain engaged in settlement
discussions with remaining issues limited to alleged deficiencies in the content
of the refinery Spill Prevention, Control and Countermeasures Plan. This
proceeding is subject to the indemnity provision of the environmental agreement
between BHP Sellers and the Company.
Also on June 24, 1997, a NOV was issued against BHP Companies pursuant to
Section 103 of CERCLA and Section 304 of the Emergency Planning and Community
Right to Know Act ("EPCRA") regarding past releases of reportable quantities of
regulated substances and oil. This matter remains subject to EPA review and
penalty amounts have not been assessed to date. This proceeding is subject to
the indemnity provisions of the environmental agreement between BHP Sellers and
the Company.
On August 5, 1996, the EPA issued a Finding of Violation ("FOV") against
BHP Hawaii pursuant to disclosures made by BHP Hawaii pursuant to a permit
application for compliance with Title V of the Clean Air Act. The parties have
engaged in settlement negotiations and no penalty amount has been assessed. This
proceeding is subject to the indemnity provision of the environmental agreement
between affiliates of BHP and the Company. See discussion in "-- Government
Regulation and Legislation" above.
The EPA issued a NOV on May 19, 1998, against the Alaska Refinery alleging
violations of the Resource Conservation and Recovery Act ("RCRA") associated
with the failure to maintain closure of certain containers of hazardous waste
when not in use and the failure to retain on-site certain records of land
disposal restriction notifications. The Company has initiated an investigation
into these allegations, but does not believe that the resolution thereof will
have a material effect on the Company.
The EPA has notified Shell that it is a PRP at the Swinomish dump site in
Washington State. In the environmental agreement between Shell Washington and
the Company, Shell has fully indemnified the Company for environmental
liabilities arising from wastes delivered to the Swinomish dump site prior to
the closing of the Washington Acquisition. The Company does not currently plan
to utilize this site following the closing of the Washington Acquisition.
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<PAGE> 73
MANAGEMENT
INFORMATION CONCERNING EXECUTIVE OFFICERS
The following is a list of Tesoro's executive officers, their ages and
their positions with the Company at May 31, 1998.
<TABLE>
<CAPTION>
NAME AGE POSITION POSITION HELD SINCE
- ---- --- -------- -------------------
<S> <C> <C> <C>
Bruce A. Smith.................... 54 Chairman of the Board of June 1996
Directors, President and Chief
Executive Officer
William T. Van Kleef.............. 46 Executive Vice President, September 1996
Operations
James C. Reed, Jr................. 53 Executive Vice President, General September 1995
Counsel and Secretary
Thomas E. Reardon................. 51 Senior Vice President, Corporate May 1998
Resources
Donald A. Nyberg.................. 46 President, Tesoro Marine Services, November 1996
Inc.
Robert W. Oliver.................. 44 President, Tesoro Exploration and September 1995
Production Company
Stephen L. Wormington............. 53 President, Tesoro Alaska Petroleum May 1998
Company, and Executive Vice
President and Chief Operating
Officer of Tesoro Refining,
Marketing & Supply Company
Don E. Beere...................... 57 Vice President, Information May 1998
Technology Projects
Don M. Heep....................... 49 Vice President, Controller May 1998
Gregory A. Wright................. 48 Vice President, Finance and May 1998
Treasurer
</TABLE>
There are no family relationships among the officers listed, and there are
no arrangements or understandings pursuant to which any of them were elected as
officers. Officers are elected annually by the Board of Directors at its first
meeting following the Annual Meeting of Stockholders, each to hold office until
the corresponding meeting of the Board in the next year or until a successor
shall have been elected or shall have qualified.
All of the Company's executive officers have been employed by the Company
or its subsidiaries in an executive capacity for at least the past five years,
except for those named below who have had the business experience indicated
during that period. Positions, unless otherwise specified, are with the Company.
William T. Van Kleef....... Executive Vice President, Operations since
September 1996. Senior Vice President and Chief
Financial Officer from September 1995 to September
1996. Vice President, Treasurer from March 1993 to
September 1995. Independent financial consultant
from January 1992 to February 1993.
Thomas E. Reardon.......... Senior Vice President, Corporate Resources since
May 1998. Vice President, Human Resources and
Environmental, from September 1995 to May 1998.
Vice President, Human Resources and Environmental
Services, of Tesoro Petroleum Companies, Inc., a
subsidiary of the Company, from October 1994 to
September 1995. Vice President, Human Resources, of
Tesoro Petroleum Companies, Inc. from February 1990
to October 1994.
Donald A. Nyberg........... President of Tesoro Marine Services, Inc., a
subsidiary of the Company, since November 1996.
Vice President, Strategic Planning, of MAPCO
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<PAGE> 74
Inc. from January 1996 to November 1996. President
and Chief Executive Officer of Marya Resources from
August 1994 to January 1996. President and Chief
Executive Officer of BP Pipelines Inc. and Vice
President, BP Exploration, of The British Petroleum
Group, Ltd., from 1991 to 1994.
Robert W. Oliver........... President of Tesoro Exploration and Production
Company, a subsidiary of the Company, since
September 1995. Independent consultant from
November 1994 to September 1995. Vice President,
Exploration/Acquisitions, of Bridge Oil (USA) Inc.
from December 1988 to November 1994.
Stephen L. Wormington...... President of Tesoro Alaska Petroleum Company, a
subsidiary of the Company, since September 1995,
and Executive Vice President and Chief Operating
Officer of Tesoro Refining, Marketing & Supply
Company, a subsidiary of the Company, since May
1998. Vice President, Supply and Operations
Coordination, of Tesoro Alaska Petroleum Company
from April 1995 to September 1995. General Manager,
Strategic Projects, from January 1995 to April
1995. Executive Vice President, Special Projects,
of MG Refining & Marketing, Inc. from January 1994
to January 1995. Executive Vice President of MG
Natural Gas Corp. from May 1992 to January 1994.
Don M. Heep................ Vice President, Controller since May 1998. Senior
Vice President, Administration for Tesoro Alaska
Petroleum Company, a subsidiary of the Company,
from November 1996 to May 1998. Senior Vice
President and Chief Financial Officer of Valero
Energy Corporation from 1994 to 1996. Vice
President and Chief Accounting Officer of Valero
Energy Corporation from 1992 to 1994.
Gregory A. Wright.......... Vice President, Finance and Treasurer since May
1998. Vice President and Treasurer from September
1995 until May 1998. Vice President, Corporate
Communications, from February 1995 to September
1995. Vice President, Corporate Communications, of
Tesoro Petroleum Companies, Inc., a subsidiary of
the Company, from January 1995 to February 1995.
Vice President, Business Development, of Valero
Energy Corporation from 1994 to January 1995. Vice
President, Corporate Planning, of Valero Energy
Corporation from 1992 to 1994.
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<PAGE> 75
INFORMATION CONCERNING DIRECTORS
Certain information as to each 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
directors.
<TABLE>
<CAPTION>
SERVED AS
DIRECTOR OF
AGE AT THE COMPANY
MAY 31, 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. 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.
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<PAGE> 76
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 Caltex, positions he held since 1990.
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.
PRINCIPAL STOCKHOLDERS
DIRECTORS AND CERTAIN EXECUTIVE OFFICERS
The following table shows the beneficial ownership of the Company's Common
Stock reported to the Company as of May 31, 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, 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
MAY 31, 1998
-------------------------
PERCENT
SHARES OF CLASS
--------- --------
<S> <C> <C>
Steven H. Grapstein......................................... 855,118(a)(b) 3.222
William J. Johnson.......................................... 6,818(a) 0.026
Alan J. Kaufman............................................. 572,318(a)(c) 2.156
Raymond K. Mason, Sr. ...................................... 26,246(a) 0.099
Bruce A. Smith.............................................. 371,711(d) 1.388
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) 0.416
Stephen L. Wormington....................................... 109,475(h) 0.411
Robert W. Oliver............................................ 94,738(i) 0.356
All directors and executive officers as a group (16
individuals).............................................. 2,505,195(j) 9.169
</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 May 31, 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 May 31, 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. Units of phantom stock payable in cash which have been credited to
the directors under a phantom stock plan are not included in the shares
shown above.
(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.
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<PAGE> 77
(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 May 31, 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 May 31, 1998, or within 60 days thereafter.
(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 May 31, 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 May 31,
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 May 31, 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 9,964 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 May 31,
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.
CERTAIN BENEFICIAL OWNERS
The following table sets forth information based on filings made with the
Commission as to each person or group who on May 31, 1998, beneficially owned
more than five 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 9.689
227 West Monroe Street, Suite 3000
Chicago, IL 60606
Common Stock...................... Heartland Advisors, Inc.(b) 1,721,620 6.488
790 North Milwaukee Street
Milwaukee, WI 53202
</TABLE>
- ---------------
(a) According to Amendment No. 1 to a Schedule 13G filed with the Commission,
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
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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, 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 Commission,
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 five percent of the class. Within
the meaning of Rule 13d-3 of the 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.
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DESCRIPTION OF INDEBTEDNESS
In conjunction with the closing of the Hawaii Acquisition, Tesoro
refinanced substantially all of its existing indebtedness. The total amount of
funds required by Tesoro to complete the Hawaii Acquisition and the Refinancing,
to pay related fees and expenses and for general corporate purposes was
approximately $432 million, which was financed through the Interim Credit
Facility provided by LCPI. The Interim Credit Facility also provides Tesoro with
sufficient additional capacity to fund the cash purchase price of the Washington
Acquisition (if necessary) and the Company's future working capital and general
corporate requirements (including funding a portion of the Company's 1998
capital expenditure budget). The Interim Credit Facility is comprised of $750
million in term loan facilities and a $350 million revolving credit facility, of
which $432 million was outstanding on May 29, 1998. The Company intends to
refinance all borrowings under the Interim Credit Facility with net proceeds
from the Offerings and borrowings under the Senior Credit Facility described
below.
SENIOR CREDIT FACILITY
Upon consummation of the Offerings, the Interim Credit Facility will be
amended and restated as the Senior Credit Facility. The following is a summary
of the material terms and conditions of the Senior Credit Facility and the
various related documents to be entered into a connection therewith.
Loans, Interest Rates. The Senior Credit Facility will be comprised of term
loan facilities aggregating not more than $200 million of Term Loans and a $300
million Revolver, which will be implemented in conjunction with the closing of
the Offerings. The Term Loans will consist of Tranche A Term Loans ($50 million
of which will be initially funded) and a $100 million Tranche B Term Loan, both
available on the date of the closings of the Senior Credit Facility. In
addition, the Company may borrow up to $50 million under the Tranche A Term
Loans, in up to five draws, for a period of up to six months following the
closing of the Senior Credit Facility. The Revolver will be available on a
revolving basis during the period commencing on the date of the closing of the
Senior Credit Facility and ending on the date that is three years after the date
of the closing of the Senior Credit Facility. The Revolver and the Tranche A
Term Loans will bear interest, at the Company's election, at either the Base
Rate (as defined in the Senior Credit Facility) plus a margin ranging from 0.00%
to 0.625% or the Eurodollar Rate (as defined in the Senior Credit Facility) plus
a margin ranging from 1.125% to 2.125%. The Tranche B Term Loan will bear
interest, at the Company's election, at either the Base Rate plus a margin
ranging from 0.50% to 0.625% or the Eurodollar Rate plus a margin ranging from
2.00% to 2.125%.
Repayment. The principal amount of the Tranche A Loans and the Tranche B
Loan is repayable in quarterly installments during their respective terms in the
following approximate aggregate annual amounts:
<TABLE>
<CAPTION>
TRANCHE A LOANS(A) TRANCHE B LOAN
- ------------------------------------- -------------------------------------
YEAR AMOUNT YEAR AMOUNT
---- ----------- ---- -----------
<S> <C> <C> <C>
1...................... $ 0 1...................... $ 1,000,000
2...................... 20,000,000 2...................... 1,000,000
3...................... 25,000,000 3...................... 1,000,000
4...................... 25,000,000 4...................... 1,000,000
5...................... 30,000,000 5...................... 1,000,000
5 1/2.................. 95,000,000
</TABLE>
- ---------------
(a) Assuming the $50 million of additional borrowing capacity under the Tranche
A Term Loans is fully utilized.
Security. The obligations under the Senior Credit Facility and the related
documents will be secured by a first priority lien upon all material domestic
real and personal property of the Company and its subsidiaries, including its
refineries and domestic oil and gas reserves, and a pledge of all of the capital
stock of the Company's active subsidiaries (provided that no lien will be
granted on the assets of foreign subsidiaries and no capital stock of foreign
subsidiaries will be pledged to the extent that the granting of such lien or the
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making of such pledge would result in materially adverse United States Federal
income tax consequences to the Company or would violate applicable law).
Guarantees. The obligations of the Company under the Senior Credit Facility
will be guaranteed by all of the Company's active subsidiaries (provided that no
guarantee by a foreign subsidiary shall be made if such guarantee would result
in materially adverse United States federal income tax consequences to the
Company or would violate applicable law).
Prepayment. The Company will be required to make prepayments to the Tranche
A Term Loans and Tranche B Term Loan, with customary exceptions, in an amount
equal to 100% of the net proceeds of certain incurred indebtedness, 100% of the
net proceeds received by the Company and its subsidiaries (other than certain
net proceeds reinvested in the business of the Company or its subsidiaries) from
the disposition of any assets, including proceeds from the sale of stock of any
of the Company's subsidiaries and a percentage of excess cash flow, depending on
certain credit statistics.
Conditions and Covenants. The obligations of the lenders under the Senior
Credit Facility are subject to the satisfaction of certain conditions precedent
customary in similar credit facilities or otherwise appropriate under the
circumstances. The Company and each of its subsidiaries will be subject to
certain negative covenants contained in the Senior Credit Facility, including,
without limitation, covenants that restrict, subject to specified exceptions:
(i) the incurrence of additional indebtedness and other obligations and the
granting of additional liens; (ii) mergers, acquisitions, investments and
acquisitions and dispositions of assets; (iii) investments, loans and advances;
(iv) dividends, stock repurchases and redemptions; (v) prepayment or repurchase
of other indebtedness and amendments to certain agreements governing
indebtedness, including the Indenture and the Notes; (vi) engaging in
transactions with affiliates; (vii) sales and leasebacks; (viii) changes in
fiscal periods; (ix) changes of lines of business; and (x) entering into
agreements which prohibit the creation of liens or limit the Company's
subsidiaries' ability to pay dividends. The Senior Credit Facility will also
contain customary affirmative covenants, including compliance with environmental
laws, maintenance of corporate existence and rights, maintenance of insurance,
property and interest rate protection, financial reporting, inspection of
property, books and records and agreements to cause Shell Washington and its
subsidiaries, if any, to become Guarantors and to create security interests in
their assets. In addition, the Senior Credit Facility requires the Company to
maintain compliance with certain specified financial covenants including a
maximum ratio of total debt to EBITDA and a minimum interest coverage ratio.
Certain of these financial, negative and affirmative covenants are more
restrictive than those set forth in the Indenture.
Events of Default. The Senior Credit Facility also will include events of
default that are typical for senior credit facilities and appropriate in the
context of the Transactions, including, without limitation, nonpayment of
principal, interest, fees or reimbursement obligations with respect to letters
of credit, violation of covenants, inaccuracy of representations and warranties
in any material respect, cross default to certain other indebtedness and
agreements, bankruptcy and insolvency events, material judgments and
liabilities, defaults or judgments under ERISA and change of control. The
occurrence of any of such events of default could result in acceleration of the
Company's obligations under the Senior Credit Facility and foreclosure on the
collateral securing such obligations, which could have material adverse results
to holders of the Notes.
Failure to Close Washington Acquisition. In the event that the Washington
Acquisition does not close on or prior to December 31, 1998, the difference
between the amount of proceeds used to fund the Special Redemption ($151.5
million) and the amount held in escrow for the Washington Acquisition will be
used first to prepay the Tranche B Term Loan with any remainder to prepay
outstanding Tranche A Term Loans. Simultaneously with such prepayment, (i) the
Revolver will be reduced to $250 million, (ii) the portion of the Revolver
available for letters of credit will be reduced to $150 million and (iii) the
undrawn commitments under the Tranche A Term Loan Facility will be reduced by an
amount equal to the outstanding principal amount of the Tranche A Term Loans
after giving effect to the foregoing prepayment.
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THE NOTES
The Company anticipates that the Notes will be issued in the aggregate
principal amount of $300 million in the Notes Offering and will mature between
2003 and 2008. Except in the event the Washington Acquisition is not
consummated, the Notes will not be subject to any mandatory redemption or
entitled to any sinking fund payment.
The Notes will be general unsecured obligations of the Company subordinate
in right of payment to all existing and future senior debt of the Company and
the guarantors of the Notes, including borrowings under the Senior Credit
Facility, and senior in right of payment to, or pari passu with, all other
present or future indebtedness of the Company. As of March 31, 1998, after
giving pro forma effect to the Transactions, the Company and the guarantors
would have had approximately $213.1 million of such senior debt outstanding
(exclusive of an additional $322.2 million available under the Senior Credit
Facility). The Indenture pursuant to which the Notes will be issued (the
"Indenture") will permit the Company and its subsidiaries to incur additional
indebtedness, including additional senior debt, subject to certain conditions.
The closing of the Common Stock Offering is not conditioned upon the closing of
the Notes Offering.
The Notes will not initially be registered under the Securities Act;
however, the Company has agreed to register the Notes (or a new series of
securities identical in all material respects to Notes) under the Securities Act
within a prescribed time period. If such registration is not effected within
such time period, the holders of the Notes will be entitled to liquidated
damages until such registration is effected.
The Company's payment obligations under the Notes will be jointly and
severally guaranteed on a senior subordinated basis by substantially all of the
Company's direct and indirect active subsidiaries. The guarantees will be
subordinate in right of payment to senior debt of the guarantors, including the
guarantors' guarantees of the Company's obligations under the Senior Credit
Facility.
The Notes will be redeemable at the option of the Company, in whole or in
part, at any time on or after the date set forth in the Indenture at the
redemption prices set forth therein, plus accrued and unpaid interest and
liquidated damages, if any, thereon to the date of redemption. In addition, at
any time prior to an earlier date set forth in the Indenture, the Company may,
at its option, redeem up to 35% of the aggregate principal amount of the Notes
outstanding at a redemption price set forth in the Indenture, plus accrued and
unpaid interest and liquidated damages, if any, thereon, to the date of
redemption, with the net cash proceeds of one or more public equity offerings);
provided that at least 65% of the aggregate principal amount of Notes offered in
the Notes Offering remains outstanding immediately after each such redemption.
If the Washington Acquisition is not consummated, or the related
acquisition agreement is terminated before such consummation, on or prior to the
earlier of December 31, 1998 and the date ten business days following
termination of the related acquisition agreement (the "Special Redemption
Date"), the Company will be required to redeem 50% of the aggregate principal
amount of the Notes offered in the Notes Offering on the Special Redemption Date
at a price equal to 101% of the redeemed principal amount thereof (the "Special
Redemption Price"), plus accrued and unpaid interest and liquidated damages, if
any to the Special Redemption Date. Upon closing of the Notes Offering, a
substantial portion of the net proceeds of the Notes Offering will be deposited
into an escrow account created pursuant to such agreement to secure payment of
the purchase price for the Washington Acquisition. It is expected that the
escrow arrangement created for the Washington Acquisition will provide that in
the event the Washington Acquisition is not consummated (without fault of the
Company), such escrowed funds will be available to fund payment of the Special
Redemption Price to holders of the Notes on the Special Redemption Date.
Upon the occurrence of a Change of Control (as defined in the Indenture),
each holder of the Notes will have the right to require the Company to
repurchase all or any part of such Holder's Notes at a price equal to 101% of
the principal amount thereof, plus accrued and unpaid interest and liquidated
damages, if any, thereon to the date of repurchase.
The Indenture will contain certain covenants that, among other things,
restrict the ability of the Company and its Restricted Subsidiaries (as defined
in the Indenture) to: (i) incur additional indebtedness and issue preferred
stock; (ii) pay dividends or make certain other restricted payments; (iii) enter
into transactions with
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affiliates; (iv) make certain asset dispositions; (v) merge or consolidate with,
or transfer substantially all of its assets to, another person or entity; (vi)
encumber assets under certain circumstances; (vii) restrict dividends and other
payments from Restricted Subsidiaries; (viii) issue capital stock of Wholly
Owned Restricted Subsidiaries; or (ix) engage in certain business activities. In
addition, under certain circumstances, the Company will be required to offer to
repurchase the Notes at a price equal to 100% of the aggregate principal amount
thereof, plus accrued and unpaid interest, if any, thereon to the date of
repurchase, with the excess proceeds of certain asset sales.
OTHER INDEBTEDNESS
After consummation of the Transactions, the Company will have other
indebtedness outstanding consisting primarily of an obligation to the Department
of Energy ("DOE"). See Note I to Tesoro's Consolidated Financial Statements. At
December 31, 1997, the Company's remaining obligation was to pay the DOE $9.2
million, exclusive of interest at 6%, over the next five years. In February
1998, the Company paid the DOE $1.3 million of this amount. The remaining amount
of outstanding indebtedness consists primarily of obligations of subsidiaries
for various equipment and properties, none of which is material to the
consolidated indebtedness of the Company. The Company also has capitalized lease
obligations of approximately $9 million for tugs and barges used in
transportation of petroleum products within Hawaii.
In connection with the Hawaii Acquisition, the Company issued the BHP Note,
an unsecured, non-interest bearing promissory note in the amount of $50 million
payable in five equal annual installments of $10 million each beginning in May
2009. The BHP Note provides for earlier 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
BHP Note, exceed $50 million in any calendar year. Upon acceleration due to an
event of default, the amount outstanding to be paid under the BHP Note will be
reduced to present value using a discount rate of 9%.
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DESCRIPTION OF CAPITAL STOCK
COMMON STOCK
The Company's Restated Certificate of Incorporation, as amended, currently
authorizes the Company to issue up to 50,000,000 shares of Common Stock. The
holders of Common Stock are entitled to one vote for each share held of record
on all matters submitted to a vote of stockholders. Subject to preferences that
may be applicable to any outstanding Preferred Stock (as defined herein),
holders of Common Stock are entitled to receive ratably such dividends as may be
declared by the Board of Directors of the Company out of funds legally available
therefor. In the event of a liquidation, dissolution, or winding up of the
Company, holders of Common Stock are entitled to share ratably in all assets
remaining after payment of liabilities and liquidation preference of any
outstanding Preferred Stock. Holders of Common Stock have no preemptive rights
and have no rights to convert their Common Stock into any other securities.
There are no redemption provisions with respect to any shares of Common Stock.
All of the outstanding shares of Common Stock are, and the Common Stock offered
hereby will be, upon issuance against full payment of the purchase price
therefor, fully paid and nonassessable. As of June 9, 1998, there were issued
and outstanding 26,558,068 shares of Common Stock.
The transfer agent and registrar for the Common Stock is ChaseMellon
Shareholder Services L.L.C.
PREFERRED STOCK
The Company's authorized capital stock includes 5,000,000 shares of
preferred stock, no par value per share (the "Preferred Stock"). The Preferred
Stock may be issued in series, and shares of each series will have such rights
and preferences as are fixed by the Board of Directors in resolutions
authorizing the issuance of that particular series. In designating any series of
Preferred Stock, the Board of Directors may, without further action by the
holders of the Common Stock, fix the number of shares constituting that series
and fix the dividend rights, dividend rate, conversion rights, voting rights
(which may be greater or lesser than the voting rights of the Common Stock),
rights and terms of redemption (including any sinking fund provisions), and the
liquidation preferences of such series of Preferred Stock. Holders of any series
of Preferred Stock, when and if issued, may have priority claims to dividends
and to any distributions upon liquidation of the Company, and other preferences
over the holders of the Common Stock. After giving effect to the Transactions,
90,000 shares of Preferred Stock will be outstanding (assuming no exercise of
the over-allotment options granted to the underwriters of the PIES Offering).
MANDATORILY CONVERTIBLE PREFERRED STOCK
Pursuant to the PIES Offering, the Company will issue PIES, each
representing one one-hundredth of a share of Mandatorily Convertible Preferred
Stock deposited under a Deposit Agreement (the "Deposit Agreement"), among the
Company, The Bank of New York as depositary (the "Depositary"), and the holders
from time to time of depositary receipts executed and delivered thereunder (the
"Depositary Receipts").
Dividends. Holders of the PIES will be entitled to receive, through the
Depositary, when, as and if declared on the Mandatorily Convertible Preferred
Stock represented thereby by the Board of Directors, cash dividends out of funds
legally available therefor from the date of initial issuance of the PIES (which
issuance will be evidenced by the initial issuance of the Depositary Receipts)
at the rate of 7 1/4% per annum or 1.8125% per quarter. Dividends will cease to
become payable by the Company to the Depositary for distribution to the holders
of the PIES when dividends cease to accrue on the Mandatorily Convertible
Preferred Stock represented thereby on the Mandatory Conversion Date or on the
date of the earlier conversion of the PIES at the option of the holder.
Dividends will be paid out of funds legally available therefor.
Mandatory Conversion of PIES. Unless voluntarily converted into Common
Stock prior thereto, on July 1, 2001 (the "Mandatory Conversion Date"), each
PIES will automatically convert into a number of shares of Common Stock at the
Conversion Rate (as defined below) and the holder thereof will have the right to
receive cash in an amount equal to the accrued and unpaid dividends on the
Mandatorily Convertible
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Preferred Stock represented by such PIES to the Mandatory Conversion Date (other
than previously declared dividends deliverable to a holder of record of the
Depositary Receipt evidencing such PIES as of a prior date), whether or not
declared, out of funds legally available for the payment of dividends, subject
to any applicable requirements of other Preferred Stock. The "Conversion Rate"
is equal to (a) if the Conversion Price (as defined below) is greater than or
equal to $18.85 (the "Threshold Appreciation Price"), 0.8455 shares of Common
Stock per PIES, (b) if the Conversion Price is less than the Threshold
Appreciation Price but is greater than $15.9375 (the "Initial Price"), a
fraction, equal to the Initial Price divided by the Conversion Price, of one
share of Common Stock per PIES and (c) if the Conversion Price is less than or
equal to the Initial Price, one share of Common Stock per PIES. The Conversion
Rate, the Threshold Appreciation Price and the Initial Price are each subject to
adjustment in certain circumstances, including if the Company shall (a) pay a
stock dividend or make a distribution with respect to its Common Stock in shares
of Common Stock, (b) subdivide or split its outstanding Common Stock, (c)
combine its outstanding Common Stock into a smaller number of shares, (d) issue
by reclassification of its shares of Common Stock any shares of Common Stock,
(e) issue rights or warrants to all holders of its Common Stock entitling them
to subscribe for or purchase shares of Common Stock at a price per share less
than the Current Market Price (as defined in the Certificate of Designation) of
the Common Stock on the record date for the determination of stockholders
entitled to receive such rights or warrants, or (f) pay certain dividends or
distribute to all holders of its Common Stock evidences of its indebtedness,
cash or other assets or issue rights or warrants (other than those referred to
in clause (e) above) to all holders of its Common Stock entitling them to
subscribe for or purchase any of its securities.
The "Conversion Price" is the average Closing Price per share of Common
Stock for the 20 trading days immediately prior to (but not including) the
Mandatory Conversion Date; provided, however, that, if there are not 20 trading
days for the Common Stock occurring later than the 60th calendar day immediately
prior to, but not including, the Mandatory Conversion Date, the "Conversion
Price" will be the market value per share of Common Stock as of the Mandatory
Conversion Date as determined by a nationally recognized investment banking firm
retained for such purpose by the Company. The Conversion Price is subject to
adjustment in certain circumstances.
Conversion at the Option of the Holder. The PIES are convertible, in whole
but not in part, at the option of the holders thereof, at any time after July
26, 1998 and prior to the Mandatory Conversion Date, into shares of Common Stock
at a rate of 0.8455 shares of Common Stock for each PIES (the "Optional
Conversion Rate"), equivalent, for each PIES, to a conversion price of $18.85
per share of Common Stock (the "Optional Conversion Price"), subject to
adjustment in the circumstances described above with respect to the Conversion
Rate.
Liquidation Rights. In the event of any voluntary or involuntary
liquidation, dissolution or winding up of the Company, and subject to the rights
of holders of any other series of Preferred Stock, the holders of PIES will be
entitled to receive an amount equal to the per share price to the public of the
PIES plus accrued and unpaid dividends on the Mandatorily Convertible Preferred
Stock represented thereby, out of the assets of the Company available for
distribution to stockholders, before any distribution of assets is made to
holders of junior ranking stock upon liquidation, dissolution or winding up.
Voting Rights. The holders of shares of Mandatorily Convertible Preferred
Stock (including shares of Mandatorily Convertible Preferred Stock represented
by PIES) will not be entitled to any voting rights, except as required by
applicable state law and as described below.
In the event that dividends on the Mandatorily Convertible Preferred Stock
(including shares of Mandatorily Convertible Preferred Stock represented by
PIES) or any other series of Preferred Stock are in arrears and unpaid for six
quarterly dividend periods, or if any other series of Preferred Stock shall be
entitled for any other reason to exercise voting rights, separate from the
Common Stock to elect any Directors of the Company ("Preferred Stock
Directors"), the holders of the shares of Mandatorily Convertible Preferred
Stock (voting separately as a class with holders of all other series of
Preferred Stock which do not have a separate class vote and upon which like
voting rights have been conferred and are exercisable), will be entitled
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to vote for the election of two Preferred Stock Directors, such Directors to be
in addition to the number of Directors constituting the Board of Directors
immediately prior to the accrual of such right.
The Company will not, without the approval of the holders of at least
66 2/3% of all the shares of Mandatorily Convertible Preferred Stock then
outstanding: (i) amend, alter or repeal any of the provisions of the Restated
Certificate of Incorporation or the Bylaws of the Company so as to affect
adversely the powers, preferences or rights of the holders of the shares of
Mandatorily Convertible Preferred Stock then outstanding or reduce the minimum
time required for any notice to which only the holders of the shares of
Mandatorily Convertible Preferred Stock then outstanding may be entitled; (ii)
create any series of Preferred Stock ranking prior to the shares of Mandatorily
Convertible Preferred Stock as to payment of dividends or the distribution of
assets upon liquidation; or (iii) authorize or create, or increase the
authorized amount of, any capital stock, or any security convertible into
capital stock, of any class ranking prior to the shares of Mandatorily
Convertible Preferred Stock as to payment of dividends or the distribution of
assets upon liquidation.
Holders of PIES and Mandatorily Convertible Preferred Stock will have no
preemptive rights.
SHARES OF COMMON STOCK ELIGIBLE FOR FUTURE SALE
Upon consummation of the Offerings (assuming no exercise of the
Underwriters' over-allotment option), the Company will have 31,558,068 shares of
Common Stock outstanding and 9,000,000 PIES (convertible after July 26, 1998
into 7,609,500 shares of Common Stock, subject to adjustment in certain
circumstances) outstanding. Future sales of Common Stock by existing
stockholders pursuant to Rule 144 under the Securities Act, or through the
exercise of outstanding options, warrants or otherwise, could have an adverse
effect on the prevailing market price of the Common Stock and the Company's
ability to raise additional capital. Except for the Common Stock to be sold in
the Common Stock Offering, and shares of Common Stock issued upon conversion of
the PIES the Company has agreed not to offer, sell, contract to sell or
otherwise issue any shares of Common Stock (except pursuant to outstanding
options and warrants) or other capital stock or securities convertible into or
exchangeable for, or any rights to acquire, Common Stock or other capital stock,
prior to the expiration of 90 days from the date of this Prospectus Supplement
without the prior written consent of Lehman Brothers. The Company's executive
officers and directors, who beneficially own in the aggregate approximately
2,505,195 shares of Common Stock (including shares issuable upon exercise of
outstanding options and warrants and outstanding shares of restricted stock),
have agreed not to sell any such shares for 90 days following the date of this
Prospectus Supplement without the consent of Lehman Brothers. Thereafter, all
such shares held by the Company's executive officers and directors will be
eligible for sale in the public market (subject, in most cases, to applicable
volume limitations and other resale conditions imposed by Rule 144). The sale,
or the availability for sale, of substantial amounts of Common Stock or
securities convertible into Common Stock in the public market at any time
subsequent to the date of this Prospectus Supplement could adversely affect the
prevailing market price of the Common Stock and the PIES.
DELAWARE LAW AND CERTAIN CHARTER AND BYLAWS PROVISIONS
Certain provisions of the Delaware General Corporation Law (the "Delaware
Law") may also be considered to have an anti-takeover effect. Section 203 of the
Delaware Law prohibits a corporation from engaging in a "business combination"
(as hereinafter defined) with an "interested stockholder" (defined generally to
mean a person who, together with his affiliates, owns, or if the person is an
affiliate of the corporation did own within the last three years, 15% or more of
the outstanding voting stock of the corporation) for a period of three years
after the date of the transaction in which the person became an interested
stockholder, unless (i) prior to the date of the business combination, the board
of directors of the corporation approved the business combination or the
transaction in which the stockholder became an interested stockholder; (ii) as a
result of the business combination, the interested stockholder owned at least
85% of the voting stock of the corporation outstanding at the time the
transaction commenced; or (iii) on or subsequent to the date of the business
combination, the board of directors and the holders of at least 66 2/3% of the
outstanding voting stock not owned by the interested stockholder approve the
business combination. The Delaware Law defines a "business combination"
generally as: (i) a merger or consolidation with the interested
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stockholder or with any other corporation if the merger or consolidation is
caused by the interested stockholder; (ii) a sale or other disposition to or
with an interested stockholder of assets with an aggregate market value greater
than or equal to 10% or more of either the aggregate market value of all assets
of the corporation or the aggregate market value of all of the outstanding stock
of the corporation; (iii) with certain exceptions, any transaction resulting in
the issuance or transfer by the corporation or any majority-owned subsidiary of
any stock of the corporation or such subsidiary to the interested stockholder;
(iv) any transaction involving the corporation or a majority-owned subsidiary
that has the effect of increasing the proportionate share of the stock of the
corporation or any such subsidiary owned by the interested stockholder; or (v)
any receipt by the interested stockholder of the benefit of any loans or other
financial benefits provided by the corporation or any majority-owned subsidiary.
The Delaware Law permits a corporation to elect not to be governed by Section
203. Tesoro has not made such an election.
Tesoro's Restated Certificate of Incorporation contains provisions that
require a higher percentage of stockholders' votes to approve an "interested
combination" (as defined below) than would otherwise be required by Delaware
Law. Pursuant to these provisions, an "involved stockholder" is defined
generally to mean any person, who at the record date for the determination of
stockholders entitled to vote thereon or consent thereto, or at any time within
the preceding twelve months has been, the beneficial owner of 10% or more of the
outstanding shares of stock of Tesoro entitled to vote-in elections of
directors. The holders of not less than 80% of the outstanding shares of capital
stock of Tesoro entitled to vote in the election of directors must approve the
"interested combination" with an "involved stockholder." The term "interested
combination" is defined generally to include any of the following transactions
in which an "involved stockholder" is involved: (i) a merger or consolidation,
(ii) sale or other disposition of all or substantially all the assets, or any
part of such assets having a then fair market value equal to or greater than 50%
of the then fair market value of the total assets of Tesoro, and (iii) the
issuance or transfer by Tesoro of any voting securities of Tesoro in exchange or
payment for the securities or assets of the "involved stockholder."
The special stockholder voting requirement is not applicable to an
"interested combination" involving an "involved stockholder" if the Board of
Directors by resolution shall have approved a memorandum of understanding with
such other person setting forth the principal terms of such transaction and such
transaction is substantially consistent therewith, provided that a majority of
those members of the Board of Directors voting in favor of such resolution were
duly elected and acting members of the Board of Directors prior to the time such
"involved stockholder" became the beneficial owner of 10% or more of the
outstanding shares of Tesoro capital stock entitled to vote in elections of
directors.
In addition, the Restated Certificate of Incorporation and Bylaws of the
Company contain a number of provisions which may be deemed to have the effect of
discouraging or delaying attempts to gain control of the Company, including (i)
authorizing directors to fill vacancies on the Board of Directors that occur
between annual meetings; (ii) restricting the persons who may call a special
meeting of stockholders; (iii) authorizing the issuance of Preferred Stock; (iv)
requiring advanced notice for stockholder proposals; and (v) requiring the Board
of Directors to fix a record date prior to conducting a consent solicitation.
Further, the applicable Indenture requires the Company to make an offer to
purchase the Notes upon a Change of Control (as defined therein) of the Company.
Under certain circumstances, Section 203 of the Delaware Law and Tesoro's
Restated Certificate of Incorporation and Bylaws may make it more difficult for
a person who would be an "interested stockholder" or "involved stockholder" to
effect various business combinations with Tesoro. It is anticipated that the
provisions of Section 203 of the Delaware Law and Tesoro's Restated Certificate
of Incorporation and Bylaws may encourage companies interested in acquiring
Tesoro to negotiate in advance with the Board of Directors. Notwithstanding the
foregoing, Section 203 of the Delaware Law and the Tesoro Restated Certificate
of Incorporation and Bylaws could result in (i) the Company being less
attractive to a potential acquiror, and (ii) the Company's stockholders
receiving less for their shares of Common Stock than otherwise might be
available in the event of a take-over attempt.
S-84
<PAGE> 87
UNDERWRITING
The Company has entered into an Underwriting Agreement dated June 25, 1998
(the "Underwriting Agreement") with the underwriters named below (the
"Underwriters") pursuant to which, on the terms and subject to the conditions
thereof, the Company has agreed to sell to the Underwriters, and the
Underwriters have agreed to purchase from the Company, the aggregate number of
shares of Common Stock set forth opposite their names below:
<TABLE>
<CAPTION>
NUMBER OF
SHARES
UNDERWRITERS ----------
<S> <C>
Lehman Brothers Inc......................................... 1,000,000
CIBC Oppenheimer Corp....................................... 1,000,000
Credit Suisse First Boston Corporation...................... 1,000,000
Merrill Lynch, Pierce, Fenner & Smith
Incorporated................................... 1,000,000
Smith Barney Inc. .......................................... 1,000,000
----------
Total.................................................. 5,000,000
==========
</TABLE>
The Underwriting Agreement provides that the obligation of the Underwriters
to pay for and accept delivery of the shares of Common Stock is subject to
certain conditions, including delivery of certain legal opinions by their
counsel. Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters are committed to take and pay for all of the shares of Common Stock
if any are taken. The Closing of the Common Stock Offering is conditioned upon
the closing of each of the Offerings.
The Company has been advised by the Underwriters that they propose to offer
the Common Stock offered hereby initially at the public offering price set forth
on the cover page of this Prospectus Supplement and to certain selected dealers
(who may include the Underwriters) at such public offering price less a
concession not to exceed $.75 per share. The Underwriters or such selected
dealers may reallow a commission to certain other dealers not to exceed $.10 per
share. After the initial public offering of the Common Stock, the public
offering price, the concession to selected dealers and the reallowance to the
other dealers may be changed by the Underwriters.
In connection with the Offerings, the Company has agreed not to offer,
sell, contract to sell or otherwise dispose of any shares of Common Stock or any
securities convertible into or exercisable for Common Stock for a period of 90
days after the date of this Prospectus Supplement, without the prior written
consent of Lehman Brothers. In addition, the Company's directors and executive
officers have agreed not to offer, sell, contract to sell or otherwise dispose
of any shares of Common Stock or any securities convertible into or exercisable
for Common Stock for a period of 90 days after the date of this Prospectus
Supplement without the prior written consent of Lehman Brothers.
The Company has granted to the Underwriters an option to purchase up to an
additional 750,000 shares of Common Stock, at the public offering price, less
the aggregate underwriting discounts and commissions, shown on the cover page of
this Prospectus Supplement, solely to cover over-allotments, if any. Such option
may be exercised at any time within 30 days after the date of the Underwriting
Agreement. To the extent the Underwriters exercise such option, each of the
Underwriters will be committed, subject to certain conditions, to purchase a
number of the additional shares of Common Stock proportionate to such
Underwriter's initial commitment as indicated in the preceding table.
The Underwriting Agreement provides that the Company will indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act, and will contribute to payments the Underwriters may be required
to make in respect thereof.
The underwriters do not intend to confirm sales to any accounts over which
they exercise discretionary authority.
S-85
<PAGE> 88
If the Underwriters create a short position in the Common Stock in
connection with the Common Stock Offering, (i.e., if they sell more shares of
Common Stock than are set forth on the cover page of this Prospectus
Supplement), the Underwriters may reduce the short position by purchasing Common
Stock in the open market. The Underwriters may elect to reduce any short
position by exercising all or part of the over-allotment option described
herein.
The Underwriters also may impose a penalty bid on certain Underwriters and
selling group members. This means that if the Underwriters purchase shares of
Common Stock in the open market to reduce the Underwriters' short position or to
stabilize the price of the Common Stock, they may reclaim the amount of the
selling concession from the Underwriters and selling group members who sold
those shares as part of the Common Stock Offerings.
In general, purchases of a security for the purpose of stabilization or to
reduce a syndicate short position could cause the price of the security to be
higher than it might otherwise be in the absence of such purchases. The
imposition of a penalty bid might have an effect on the price of a security to
the extent that it were to discourage resales of the security by purchasers in
the applicable offering.
Neither the Company nor any of the Underwriters makes any representation or
prediction as to the direction or magnitude of any effect that the transactions
described above may have on the price of the Common Stock. In addition, neither
the Company nor any of the Underwriters makes any representation that the
Underwriters will engage in such transactions or that such transactions, once
commenced, will not be discontinued without notice.
Lehman Brothers has provided investment banking and other services to the
Company in the past and has acted as financial advisor to the Company in
connection with the Acquisitions, for which it has received customary fees in
connection therewith. LCPI is the lender on the Interim Credit Facility. In
connection with the Offerings, LCPI will be repaid approximately $432 million on
the Interim Credit Facility and the remaining outstanding amounts of
indebtedness will be refinanced through the Senior Credit Facility. LCPI
received customary arranger and syndication fees in connection with providing
the Interim Credit Facility. LCPI will serve as arranger with respect to the
Senior Credit Facility and will receive customary fees in connection therewith.
Lehman Brothers Inc. and LCPI have received and will receive certain fees in
connection with the Acquisitions. Lehman Brothers is acting as lead managing
underwriter on each of the Offerings for which it will receive customary
underwriter compensation. Since the amount to be repaid to LCPI exceeds 10% of
the net proceeds of the Common Stock Offering to be received by the Company, the
Common Stock Offering is being made pursuant to the provisions of Rule
2710(c)(8) of the Conduct Rules of the National Association of Securities
Dealers, Inc.
LEGAL MATTERS
The validity of the Common Stock offered hereby will be passed upon for the
Company by Fulbright & Jaworski L.L.P., Houston, Texas. Certain legal matters in
connection with the Common Stock Offering will be passed upon for the
Underwriters by Andrews & Kurth L.L.P., Houston, Texas.
EXPERTS
The Tesoro Consolidated Financial Statements as of December 31, 1997 and
1996 and for each of the three years in the period ended December 31, 1997,
included in this Prospectus Supplement, have been audited by Deloitte & Touche
LLP, independent auditors, as stated in their report appearing herein and have
been so included in reliance upon the reports of such firm given upon their
authority as experts in accounting and auditing.
The combined balance sheets of BHP Petroleum Americas Refining Inc. and BHP
Petroleum South Pacific Inc. as of May 31, 1997 and 1996, and the related
combined statements of operations, stockholders' equity and cash flows for each
of the three years in the period ended May 31, 1997 included in this Prospectus
Supplement, have been audited by Arthur Andersen LLP, independent public
accountants, as indicated in
S-86
<PAGE> 89
their report with respect thereto, and are included herein in reliance upon the
authority of said firm as experts in accounting and auditing in giving said
report.
The financial statements of Shell Anacortes Refining Company as of December
31, 1997 and 1996 and for the period from inception (January 4, 1996) through
December 31, 1996 and for the year ended December 31, 1997 included in this
Prospectus Supplement have been so included in reliance on the report of Price
Waterhouse LLP, independent accountants, given on authority of said firm as
experts in auditing and accounting.
The information for the year ended December 31, 1997 relating to estimated
proved reserves of oil and gas and the related estimates of future net cash
flows and present values thereof as of December 31, 1995, December 31, 1996 and
December 31, 1997, included in this Prospectus Supplement have been prepared by
Netherland, Sewell & Associates, Inc., independent petroleum engineers, and are
included herein upon the authority of such firm as an expert in petroleum
engineering.
S-87
<PAGE> 90
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
CONSOLIDATED FINANCIAL STATEMENTS OF TESORO PETROLEUM
CORPORATION
Independent Auditors' Report................................ F-2
Statements of Consolidated Operations -- Years Ended
December 31, 1995, 1996 and 1997 and Three Months Ended
March 31, 1997 and 1998................................... F-3
Consolidated Balance Sheets -- December 31, 1996 and 1997
and March 31, 1998........................................ F-4
Statements of Consolidated Stockholders' Equity -- Years
Ended December 31, 1995, 1996 and 1997 and Three Months
Ended March 31, 1998...................................... F-5
Statements of Consolidated Cash Flows -- Years Ended
December 31, 1995, 1996 and 1997 and Three Months Ended
March 31, 1997 and 1998................................... F-6
Notes to Consolidated Financial Statements.................. F-7
AUDITED COMBINED FINANCIAL STATEMENTS OF BHP PETROLEUM
AMERICAS REFINING INC. AND BHP PETROLEUM SOUTH PACIFIC
INC.
Report of Independent Public Accountants.................... F-37
Combined Statements of Operations -- Years Ended May 31,
1995, 1996 and 1997....................................... F-38
Combined Balance Sheets -- May 31, 1996 and 1997............ F-39
Combined Statements of Stockholders' Equity -- Years Ended
May 31, 1995, 1996 and 1997............................... F-40
Combined Statements of Cash Flows -- Years Ended May 31,
1995, 1996 and 1997....................................... F-41
Notes to Combined Financial Statements...................... F-42
UNAUDITED COMBINED FINANCIAL STATEMENTS OF BHP PETROLEUM
AMERICAS REFINING INC. AND BHP PETROLEUM SOUTH PACIFIC
INC.
Combined Statements of Operations -- Seven Months Ended
December 31, 1996 and 1997................................ F-54
Combined Balance Sheets -- December 31, 1996 and 1997....... F-55
Combined Statements of Cash Flows -- Seven Months Ended
December 31, 1996 and 1997................................ F-56
Notes to Combined Financial Statements...................... F-57
UNAUDITED COMBINED FINANCIAL STATEMENTS OF BHP PETROLEUM
AMERICAS REFINING INC. AND BHP PETROLEUM SOUTH PACIFIC
INC.
Combined Statements of Operations -- Ten Months Ended March
31, 1997 and 1998......................................... F-61
Combined Balance Sheets -- March 31, 1997 and 1998.......... F-62
Combined Statements of Cash Flows -- Ten Months Ended March
31, 1997 and 1998......................................... F-63
Notes to Combined Financial Statements...................... F-64
FINANCIAL STATEMENTS OF SHELL ANACORTES REFINING COMPANY
Report of Independent Accountants........................... F-68
Statement of Income -- Period from inception (January 4,
1996) through December 31, 1996 and the year ended
December 31, 1997 and the three months ended March 31,
1997 and 1998............................................. F-69
Consolidated Balance Sheet -- December 31, 1996 and 1997 and
March 31, 1998............................................ F-70
Statement of Shareholder's Equity -- Period from inception
(January 4, 1996) through December 31, 1996 and the year
ended December 31, 1997 and the three months ended March
31, 1998.................................................. F-71
Statement of Cash Flows -- Period from inception (January 4,
1996) through December 31, 1996 and the year ended
December 31, 1997 and the three months ended March 31,
1997
and 1998.................................................. F-72
Notes to Financial Statements............................... F-73
</TABLE>
F-1
<PAGE> 91
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
F-2
<PAGE> 92
TESORO PETROLEUM CORPORATION
STATEMENTS OF CONSOLIDATED OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------------- -------------------
1995 1996 1997 1997 1998
---------- ---------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUES
Refining and marketing........................ $ 771,035 $ 745,413 $720,868 $174,400 $140,213
Exploration and production.................... 124,670 107,415 84,798 23,358 22,222
Marine services............................... 74,467 122,533 132,251 35,495 32,818
Income from settlement of a natural gas
contract.................................... -- 60,000 -- -- --
Gain on sale of assets and other income....... 32,711 4,417 5,543 1,599 786
---------- ---------- -------- -------- --------
Total Revenues......................... 1,002,883 1,039,778 943,460 234,852 196,039
---------- ---------- -------- -------- --------
OPERATING COSTS AND EXPENSES
Refining and marketing........................ 758,329 726,029 687,036 171,154 130,720
Exploration and production.................... 19,055 12,968 13,230 2,845 3,925
Marine services............................... 77,803 115,314 124,725 34,216 30,597
Depreciation, depletion and amortization...... 41,776 40,627 45,729 11,597 12,944
---------- ---------- -------- -------- --------
Total Operating Costs and Expenses..... 896,963 894,938 870,720 219,812 178,186
---------- ---------- -------- -------- --------
OPERATING PROFIT................................ 105,920 144,840 72,740 15,040 17,853
General and Administrative...................... (16,453) (12,733) (13,588) (3,038) (3,372)
Interest Expense, Net of Capitalized Interest in
1997.......................................... (20,902) (15,382) (6,699) (1,570) (2,665)
Interest Income................................. 1,845 8,423 1,597 434 108
Other Expense, Net.............................. (8,542) (10,001) (4,930) (1,291) (1,034)
---------- ---------- -------- -------- --------
EARNINGS BEFORE INCOME TAXES AND EXTRAORDINARY
ITEM.......................................... 61,868 115,147 49,120 9,575 10,890
Income Tax Provision............................ 4,379 38,347 18,435 3,444 4,831
---------- ---------- -------- -------- --------
EARNINGS BEFORE EXTRAORDINARY ITEM.............. 57,489 76,800 30,685 6,131 6,059
Extraordinary Loss on Extinguishments of Debt
(Net of Income Tax Benefit of $886 in 1996)... (2,857) (2,290) -- -- --
---------- ---------- -------- -------- --------
NET EARNINGS.................................... $ 54,632 $ 74,510 $ 30,685 $ 6,131 $ 6,059
========== ========== ======== ======== ========
NET EARNINGS PER SHARE -- BASIC................. $ 2.22 $ 2.87 $ 1.16 $ 0.23 $ 0.23
========== ========== ======== ======== ========
NET EARNINGS PER SHARE -- DILUTED............... $ 2.18 $ 2.81 $ 1.14 $ 0.23 $ 0.23
========== ========== ======== ======== ========
WEIGHTED AVERAGE COMMON SHARES -- BASIC......... 24,557 25,999 26,410 26,430 26,309
========== ========== ======== ======== ========
WEIGHTED AVERAGE COMMON SHARES AND POTENTIALLY
DILUTIVE COMMON SHARES -- DILUTED............. 25,107 26,499 26,868 26,829 26,789
========== ========== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE> 93
TESORO PETROLEUM CORPORATION
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------- MARCH 31,
1996 1997 1998
-------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents................................. $ 22,796 $ 8,352 $ 2,274
Receivables, less allowance for doubtful accounts......... 128,013 76,282 64,518
Inventories............................................... 74,488 87,359 97,793
Prepayments and other..................................... 12,046 9,842 7,984
-------- -------- --------
Total Current Assets............................... 237,343 181,835 172,569
-------- -------- --------
PROPERTY, PLANT AND EQUIPMENT
Refining and marketing.................................... 328,522 370,174 368,183
Exploration and production, full-cost method of
accounting:
Properties being amortized.............................. 179,433 251,604 275,512
Properties not yet evaluated............................ 12,344 31,918 28,556
Gas transportation...................................... 6,703 7,889 7,804
Marine services........................................... 33,820 43,072 48,201
Corporate................................................. 12,531 13,689 13,802
-------- -------- --------
573,353 718,346 742,058
Less accumulated depreciation, depletion and
amortization.......................................... 256,842 304,523 317,645
-------- -------- --------
Net Property, Plant and Equipment.................. 316,511 413,823 424,413
-------- -------- --------
OTHER ASSETS................................................ 28,733 32,150 38,447
-------- -------- --------
Total Assets....................................... $582,587 $627,808 $635,429
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable.......................................... $ 80,747 $ 58,767 $ 44,275
Accrued liabilities....................................... 33,256 31,372 28,626
Current income taxes payable.............................. 13,822 354 1,627
Current maturities of long-term debt and other
obligations............................................. 10,043 17,002 11,428
-------- -------- --------
Total Current Liabilities.......................... 137,868 107,495 85,956
-------- -------- --------
DEFERRED INCOME TAXES....................................... 19,151 28,824 31,003
-------- -------- --------
OTHER LIABILITIES........................................... 42,243 43,211 42,821
-------- -------- --------
LONG-TERM DEBT AND OTHER OBLIGATIONS, LESS CURRENT
MATURITIES................................................ 79,260 115,314 136,290
-------- -------- --------
COMMITMENTS AND CONTINGENCIES (Notes K and 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; 26,414,134, 26,506,601 and 26,515,868 shares
issued and outstanding, respectively.................... 4,402 4,418 4,419
Additional paid-in capital................................ 189,368 190,925 191,000
Retained earnings......................................... 110,295 140,980 147,039
Treasury stock, 200,198 common shares in 1998, at cost
(216,453 in 1997)....................................... -- (3,359) (3,099)
-------- -------- --------
Total Stockholders' Equity.............................. 304,065 332,964 339,359
-------- -------- --------
Total Liabilities and Stockholders' Equity......... $582,587 $627,808 $635,429
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE> 94
TESORO PETROLEUM CORPORATION
STATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY
(INFORMATION FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 1998 IS UNAUDITED)
(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)
Net earnings (unaudited)................. -- -- -- 6,059 -- --
Shares issued pursuant to exercise of
stock options and employee benefit
plans (unaudited)..................... 9 1 75 -- 16 260
------- ------ -------- -------- ---- -------
BALANCE AT MARCH 31, 1998 (unaudited)...... 26,516 $4,419 $191,000 $147,039 (200) $(3,099)
======= ====== ======== ======== ==== =======
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE> 95
TESORO PETROLEUM CORPORATION
STATEMENTS OF CONSOLIDATED CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
--------------------------------- --------------------
1995 1996 1997 1997 1998
-------- -------- --------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Net earnings..................................... $ 54,632 $ 74,510 $ 30,685 $ 6,131 $ 6,059
Adjustments to reconcile net earnings to net cash
from operating activities:
Depreciation, depletion and amortization....... 42,620 41,459 46,363 11,747 13,154
Loss (gain) on sales of assets................. (32,659) 835 523 (18) (59)
Amortization of deferred charges and other..... 1,556 1,601 951 69 5
Extraordinary loss on extinguishments of debt,
net of income tax benefit.................... 2,857 2,290 -- -- --
Changes in operating assets and liabilities:
Receivables.................................. 9,746 (42,542) 56,785 43,533 11,764
Receivable from Tennessee Gas Pipeline
Company................................... (37,456) 50,680 -- -- --
Inventories.................................. (11,599) 7,210 (11,517) (3,089) (10,434)
Other assets................................. (3,573) (3,521) 296 3,487 1,691
Accounts payable and accrued liabilities..... 4,605 28,165 (37,854) (40,741) (15,980)
Deferred income taxes........................ 807 14,649 9,673 1,426 2,179
Obligation payments to State of Alaska....... (2,892) (4,047) (4,401) (1,064) (1,412)
Other liabilities and obligations............ 6,769 7,673 4,131 2,276 (530)
-------- -------- --------- -------- --------
Net cash from operating activities........ 35,413 178,962 95,635 23,757 6,437
-------- -------- --------- -------- --------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Capital expenditures............................. (63,930) (84,957) (147,498) (16,300) (23,761)
Proceeds from sales of assets.................... 69,786 2,569 112 69 46
Deposits and other acquisition costs (Note C).... (3,029) (7,720) (5,086) -- (5,976)
Other............................................ (423) (4,092) 927 (548) 201
-------- -------- --------- -------- --------
Net cash from (used in) investing
activities.............................. 2,404 (94,200) (151,545) (16,779) (29,490)
-------- -------- --------- -------- --------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Payments of long-term debt....................... (2,979) (3,838) (4,095) (764) (732)
Net borrowings under revolving credit
facilities..................................... -- 883 32,728 2,182 17,689
Issuance of long-term debt....................... -- -- 16,200 -- --
Repurchase of common stock....................... -- -- (3,701) -- --
Repurchase of debentures and notes............... (34,634) (74,116) -- -- --
Other............................................ (281) 1,164 334 171 18
-------- -------- --------- -------- --------
Net cash from (used in) financing
activities.............................. (37,894) (75,907) 41,466 1,589 16,975
-------- -------- --------- -------- --------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS... (77) 8,855 (14,444) 8,567 (6,078)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD..... 14,018 13,941 22,796 22,796 8,352
-------- -------- --------- -------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD........... $ 13,941 $ 22,796 $ 8,352 $ 31,363 $ 2,274
======== ======== ========= ======== ========
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid, net of $419 capitalized in the
year 1997...................................... $ 18,132 $ 12,450 $ 2,127 $ 1,010 $ 1,706
======== ======== ========= ======== ========
Income taxes paid................................ $ 4,046 $ 6,285 $ 22,412 $ 14,245 $ 1,379
======== ======== ========= ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE> 96
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(INFORMATION FOR THE THREE-MONTH PERIODS ENDED MARCH 31, 1997 AND 1998 IS
UNAUDITED)
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 periods. Actual results could differ from those estimates.
Interim Reporting
The interim consolidated financial statements are unaudited but, in the
opinion of management, incorporate all adjustments necessary for a fair
presentation of the Company's financial position and results of operations for
such interim periods. Such adjustments are of a normal recurring nature. The
results of operations for any interim period are not necessarily indicative of
results for the full year.
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.
F-7
<PAGE> 97
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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.
F-8
<PAGE> 98
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 are presented below (in
thousands except per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
--------------------------- -------------------
1995 1996 1997 1997 1998
------- ------- ------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Earnings Applicable to Common
Shareholders (Basic and Diluted
Numerator):
Earnings before extraordinary item..... $57,489 $76,800 $30,685 $ 6,131 $ 6,059
Extraordinary loss on extinguishments
of debt, aftertax................... (2,857) (2,290) -- -- --
------- ------- ------- ------- -------
Net earnings........................ $54,632 $74,510 $30,685 6,131 6,059
======= ======= ======= ======= =======
Basic:
Weighted average common shares (Basic
denominator)........................ 24,557 25,999 26,410 26,430 26,309
======= ======= ======= ======= =======
Basic earnings per share --
Before extraordinary item........... $ 2.34 $ 2.96 $ 1.16 $ 0.23 $ 0.23
Extraordinary loss, aftertax........ (0.12) (0.09) -- -- --
------- ------- ------- ------- -------
Net................................. $ 2.22 $ 2.87 $ 1.16 $ 0.23 $ 0.23
======= ======= ======= ======= =======
Diluted:
Weighted average common shares......... 24,557 25,999 26,410 26,430 26,309
Incremental shares from assumed
conversion of stock options and
other............................... 550 500 458 399 480
------- ------- ------- ------- -------
Total diluted shares (Diluted
denominator).. 25,107 26,499 26,868 26,829 26,789
======= ======= ======= ======= =======
Diluted earnings per share --
Before extraordinary item........... $ 2.29 $ 2.90 $ 1.14 $ 0.23 $ 0.23
Extraordinary loss, aftertax........ (0.11) (0.09) -- -- --
------- ------- ------- ------- -------
Net................................. $ 2.18 $ 2.81 $ 1.14 $ 0.23 $ 0.23
======= ======= ======= ======= =======
</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 the years ended December 31, 1995,
1996 and 1997 and the three months ended March 31, 1997 and 1998. No shares were
issuable under this strategy during those periods 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 and March 31, 1998. See Note K regarding information related to the
vesting of these awards and options subsequent to March 31, 1998.
F-9
<PAGE> 99
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
New Accounting Standards
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. Both 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.
The Company adopted SFAS No. 130, "Reporting Comprehensive Income," which
establishes standards for reporting and display of comprehensive income
effective January 1, 1998. There are no material differences between net
earnings and comprehensive income for all periods presented.
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 $18.5 million, $22.0 million and $16.1 million in the
year ended December 31, 1995, 1996 and 1997, respectively, and $6.7 million and
$5.9 million in the three months ended March 31, 1997 and 1998, respectively.
The Company at times resells previously purchased crude oil, sales of which
amounted to $75.8 million, $93.8 million and $44.4 million in the years ended
December 31, 1995, 1996 and 1997, respectively, and $10.7 million and $10.5
million in the three months ended March 31, 1997 and 1998, 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 hydrocar-
F-10
<PAGE> 100
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
bons. 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 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 the year ended December 31, 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 the year ended December 31, 1996
included $60 million of income from termination of a natural gas contract and $5
million for retroactive severance tax refunds, and the year ended December 31,
1995 included a gain of $33 million from the sale of certain interests in the
Bob West Field. In the years ended December 31, 1995 and 1996, the Exploration
and Production segment's operating profit included $47.1 million and $24.6
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 is as follows (in millions):
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------- ---------------
1995 1996 1997 1997 1998
-------- -------- ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
REVENUES
Gross operating revenues:
Refining and Marketing --
Refined products............................ $ 664.5 $ 620.8 $643.7 $155.8 $122.7
Other, primarily crude oil resales and
merchandise.............................. 106.5 124.6 77.2 18.6 17.5
Exploration and Production --
U.S., including gas transportation.......... 113.0 93.8 73.6 21.5 19.1
Bolivia..................................... 11.7 13.7 11.2 1.9 3.1
Marine Services............................... 74.5 122.5 132.2 35.5 32.8
-------- -------- ------ ------ ------
Total Gross Operating Revenues.............. 970.2 975.4 937.9 233.3 195.2
Income from settlement of a natural gas contract
and other..................................... 32.7 64.4 5.5 1.6 0.8
-------- -------- ------ ------ ------
Total Revenues........................... $1,002.9 $1,039.8 $943.4 234.9 196.0
======== ======== ====== ====== ======
</TABLE>
F-11
<PAGE> 101
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------- ---------------
1995 1996 1997 1997 1998
-------- -------- ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING PROFIT (LOSS)
Refining and Marketing.......................... $ 0.7 $ 6.0 $ 20.5 $ 0.1 $ 6.5
Exploration and Production --
U.S., including gas transportation............ 102.0 123.9 37.3 13.0 7.9
Bolivia....................................... 7.6 8.8 8.6 1.0 1.7
Marine Services................................. (4.4) 6.1 6.3 0.9 1.8
-------- -------- ------ ------ ------
Total Operating Profit................... 105.9 144.8 72.7 15.0 17.9
Corporate and Unallocated Costs................. (44.0) (29.7) (23.6) (5.4) (7.0)
-------- -------- ------ ------ ------
Earnings Before Income Taxes and Extraordinary
Item.......................................... $ 61.9 $ 115.1 $ 49.1 $ 9.6 $ 10.9
======== ======== ====== ====== ======
IDENTIFIABLE ASSETS
Refining and Marketing.......................... $ 313.3 $ 317.0 $337.4 $298.6 $333.2
Exploration and Production --
U.S., including gas transportation............ 136.7 143.6 158.2 121.2 165.6
Bolivia....................................... 17.8 27.0 50.8 28.2 51.4
Marine Services................................. 18.0 56.0 59.3 55.9 60.6
Corporate....................................... 33.4 39.0 22.1 48.1 24.6
-------- -------- ------ ------ ------
Total Assets............................. $ 519.2 $ 582.6 $627.8 $552.0 $635.4
======== ======== ====== ====== ======
DEPRECIATION, DEPLETION AND AMORTIZATION
Refining and Marketing.......................... $ 11.9 $ 12.5 $ 12.7 $ 3.1 $ 3.0
Exploration and Production --
U.S., including gas transportation............ 29.3 25.6 29.8 7.9 8.9
Bolivia....................................... 0.3 1.3 1.5 0.2 0.5
Marine Services................................. 0.3 1.2 1.7 0.4 0.6
Corporate....................................... 0.8 0.9 0.7 0.1 0.2
-------- -------- ------ ------ ------
Total Depreciation, Depletion and
Amortization........................... $ 42.6 $ 41.5 $ 46.4 $ 11.7 $ 13.2
======== ======== ====== ====== ======
CAPITAL EXPENDITURES
Refining and Marketing.......................... $ 9.3 $ 11.1 $ 43.9 $ 2.9 $ 2.0
Exploration and Production --
U.S., including gas transportation............ 49.6 59.7 65.4 7.0 18.2
Bolivia....................................... 3.8 6.9 27.5 4.0 2.3
Marine Services................................. 0.4 6.9 9.4 2.2 1.2
Corporate....................................... 0.8 0.4 1.3 0.2 0.1
-------- -------- ------ ------ ------
Total Capital Expenditures............... $ 63.9 $ 85.0 $147.5 $ 16.3 $ 23.8
======== ======== ====== ====== ======
</TABLE>
NOTE C -- ACQUISITIONS, EXPANSIONS AND DIVESTITURES
Hawaii Refinery Acquisition
On March 18, 1998, the Company entered into a stock sale agreement ("Hawaii
Stock Sale Agreement") with BHP Hawaii Inc. and BHP Petroleum Pacific Islands
Inc. (collectively, the "Sellers"), subsidiaries of The Broken Hill Proprietary
Company Limited ("BHP"), whereby Tesoro purchased (the "Hawaii Acquisition") 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
F-12
<PAGE> 102
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
in Hawaii. In addition, Tesoro and a BHP affiliate entered 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 Hawaii refinery.
The Hawaii Acquisition closed effective May 31, 1998. Tesoro paid $243.5
million in cash for the Hawaii Acquisition, including $5 million that was
deposited into an escrow account in March 1998 and $68.5 million for estimated
net working capital. The cash purchase price is subject to post-closing
adjustments. In addition, Tesoro issued 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
provides 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. The Hawaii Acquisition 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.
Washington State Refinery Acquisition
On May 1, 1998, the Company entered into a stock purchase agreement
("Anacortes Stock Purchase Agreement") with Shell Refining Holding Company
("Seller") and Shell Anacortes Refining Company ("SARC"), both subsidiaries of
Shell Oil Company ("Shell"), whereby Tesoro will purchase (the "Washington
Acquisition") all of the outstanding stock of SARC. SARC owns and operates a
108,000-barrel per day refinery in Anacortes, Washington ("Washington
Refinery"). The Washington Acquisition, which is subject to approval by the
Federal Trade Commission and the offices of the attorneys general of the States
of Oregon and Washington as well as of other customary conditions, is
anticipated to close in mid to late summer. Under the terms of the Anacortes
Stock Purchase Agreement, the Company paid a $5 million deposit in May 1998 and
has agreed to pay the balance of the purchase price into an escrow by July 10,
1998, if the stock purchase has not closed by that date.
At closing, the Company will pay the Seller a cash purchase price of $237
million, less the deposit and any escrowed amounts, for the stock of SARC, and
will also pay an additional amount for net working capital of SARC which has
historically averaged approximately $60 million.
See Note I for information related to financings of the Hawaii Acquisition
and proposed Washington Acquisition (collectively, the "Acquisitions") and Note
L for related environmental matters.
Alaska 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 the year ended December 31,
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
F-13
<PAGE> 103
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
reserves and $3.4 million for undeveloped acreage with the remainder for working
capital and assumption of certain liabilities.
In the U.S., the Exploration and Production segment purchased proved and
unproved properties totaling $22 million during the year ended December 31,
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 the year ended December 31, 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 the year ended December 31, 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 the year ended December 31, 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 the year ended December 31, 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.
F-14
<PAGE> 104
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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
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 the year ended
December 31, 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 (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED
------------------------ MARCH 31,
1995 1996 1997 1998
------ ------ ------ ------------
(UNAUDITED)
<S> <C> <C> <C> <C>
Balance at Beginning of Year................... $1,816 $1,842 $1,515 $1,373
Charged to Costs and Expenses.................. 300 589 23 10
Recoveries of Amounts Previously Written Off
and Other.................................... 122 (44) 189 37
Write-off of Doubtful Accounts................. (396) (872) (354) (128)
------ ------ ------ ------
Balance at End of Year....................... $1,842 $1,515 $1,373 $1,292
====== ====== ====== ======
</TABLE>
F-15
<PAGE> 105
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE F -- INVENTORIES
Components of inventories were as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------ MARCH 31,
1996 1997 1998
------- ------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Crude Oil and Wholesale Refined Products, at LIFO... $55,858 $68,227 $75,983
Merchandise and Other Refined Products.............. 13,539 13,377 14,424
Materials and Supplies.............................. 5,091 5,755 7,386
------- ------- -------
Total Inventories................................. $74,488 $87,359 $97,793
======= ======= =======
</TABLE>
At December 31, 1996 and 1997, inventories valued using LIFO were lower
than replacement cost by approximately $17.7 million and $4.4 million,
respectively.
NOTE G -- ACCRUED LIABILITIES
The Company's current accrued liabilities and noncurrent other liabilities
as shown in the Consolidated Balance Sheets included the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------ MARCH 31,
1996 1997 1998
------- ------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Accrued Liabilities -- Current:
Accrued environmental costs....................... $ 5,367 $ 5,817 $ 6,199
Accrued employee costs............................ 7,759 12,406 9,014
Accrued taxes other than income taxes............. 5,988 4,137 2,783
Accrued interest.................................. 1,155 1,349 1,126
Other............................................. 12,987 7,663 9,504
------- ------- -------
Total Accrued Liabilities -- Current........... $33,256 $31,372 $28,626
======= ======= =======
Other Liabilities -- Noncurrent:
Accrued postretirement benefits................... $30,508 $32,206 $32,695
Accrued environmental costs....................... 3,496 2,659 2,489
Other............................................. 8,239 8,346 7,637
------- ------- -------
Total Other Liabilities -- Noncurrent.......... $42,243 $43,211 $42,821
======= ======= =======
</TABLE>
NOTE H -- INCOME TAXES
The income tax provision included the following (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
----------------------------- ------------------
1995 1996 1997 1997 1998
------- ------- ------- ------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Federal -- Current................. $ 708 $16,206 $ 3,413 $1,197 $1,209
Federal -- Deferred................ -- 17,405 9,421 1,254 1,569
Foreign............................ 3,183 3,654 4,920 744 1,378
State.............................. 488 1,082 681 249 675
------- ------- ------- ------ ------
Income Tax Provision............. $ 4,379 $38,347 $18,435 $3,444 $4,831
======= ======= ======= ====== ======
</TABLE>
F-16
<PAGE> 106
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- MARCH 31,
1996 1997 1998
-------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Deferred Federal Tax Assets:
Investment tax and other credits.................. $ 11,962 $ 9,639 $ 9,039
Accrued postretirement benefits................... 9,941 10,480 10,688
Settlement with Department of Energy.............. 3,694 3,233 2,771
Environmental reserve............................. 3,335 3,048 2,901
Other............................................. 1,523 5,265 5,523
-------- -------- --------
Total Deferred Federal Tax Assets.............. 30,455 31,665 30,922
Deferred Federal Tax Liabilities:
Accelerated depreciation and property-related
items.......................................... 47,147 57,778 58,604
-------- -------- --------
Net Deferred Federal Liability...................... 16,692 26,113 27,682
State Income and Other Taxes........................ 2,459 2,711 3,321
-------- -------- --------
Net Deferred Tax Liability........................ $ 19,151 $ 28,824 $ 31,003
======== ======== ========
</TABLE>
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>
THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31,
----------------------------- ----------------
1995 1996 1997 1997 1998
-------- -------- ------- ------ -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Earnings Before Income Taxes and
Extraordinary Item:
U.S............................... $ 55,221 $106,675 $40,200 $8,804 $ 8,669
Foreign........................... 6,647 8,472 8,920 771 2,221
-------- -------- ------- ------ -------
Total Earnings Before Income
Taxes and Extraordinary
Item......................... $ 61,868 $115,147 $49,120 $9,575 $10,890
======== ======== ======= ====== =======
Statutory U.S. Corporate Tax Rate... 35% 35% 35% 35% 35%
Effect of:
Foreign income taxes, net of tax
benefit........................ 5 2 5 3 6
State income taxes, net of tax
benefit........................ 1 1 1 3 4
Accounting recognition of
operating loss tax benefits.... (33) (4) -- -- --
Other............................. (1) (1) (4) (5) (1)
-------- -------- ------- ------ -------
Effective Income Tax Rate........... 7% 33% 37% 36% 44%
======== ======== ======= ====== =======
</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.
F-17
<PAGE> 107
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE I -- LONG-TERM DEBT AND OTHER OBLIGATIONS
Long-term debt and other obligations consisted of the following (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------ MARCH 31,
1996 1997 1998
------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Liability to State of Alaska.......................... $62,079 $ 62,016 $ 61,780
Corporate Revolving Credit Facility................... -- 28,000 51,300
Marine Services Loan Facility......................... 883 5,611 --
Hydrocracker Loan..................................... -- 16,200 16,200
Vacuum Unit Loan...................................... 11,250 9,107 8,572
Liability to Department of Energy..................... 10,555 9,235 7,916
Other................................................. 4,536 2,147 1,950
------- -------- --------
89,303 132,316 147,718
Less Current Maturities............................... 10,043 17,002 11,428
------- -------- --------
$79,260 $115,314 $136,290
======= ======== ========
</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 conjunction with closing the Hawaii Acquisition (see Note C), on May 29,
1998, the Company refinanced substantially all of its existing indebtedness (the
"Refinancing") using revolving credit and term loans through an amended and
restated credit facility, (the "Interim Credit Facility") provided by Lehman
Commercial Paper, Inc. ("LCPI"). The Interim Credit Facility is comprised of a
term loan facility aggregating $750 million and a revolving credit facility in
the amount of $350 million. The Interim Credit Facility is guaranteed by
substantially all of the Company's active direct and indirect subsidiaries
(collectively, the "Guarantors"), and is secured by substantially all the
domestic assets of the Company and each of the Guarantors. The Interim Credit
Facility contains certain financial covenants and requirements customary in
credit facilities of this nature. The total amount of funds required by Tesoro
to complete the Hawaii Acquisition and the Refinancing, to pay related fees and
expenses, and for general corporate purposes was approximately $432 million. The
Company has obtained a commitment letter from LCPI to arrange a new senior
credit facility (the "New Senior Credit Facility") in the amount of $500
million, which will replace the Interim Credit Facility. In addition to funding
the cash consideration of the Acquisitions and Refinancing, the New Senior
Credit Facility will provide the Company with increased letter of credit
capacity and funds for future working capital needs and general corporate
purposes, including the Company's 1998 capital budget. The Company anticipates
recording an extraordinary loss on early extinguishment of debt of approximately
$5 million, net of income tax benefit, for the Refinancing during the second
quarter of 1998.
On May 4, 1998, the Company filed a universal shelf registration statement
("Registration Statement") with the Securities and Exchange Commission ("SEC")
for $600 million of debt or equity securities for acquisitions or general
corporate purposes. The Registration Statement was declared effective by the SEC
on May 14, 1998. The Company plans to offer Common Stock and Premium Income
Equity Securities ("PIES") from the Registration Statement to provide partial
funding for the Acquisitions discussed in Note C. The Company intends to offer
newly issued shares of its Common Stock with estimated gross proceeds to the
Company in the range of $80 million and PIES representing fractional interests
in shares of Mandatorily Convertible Preferred Stock with estimated gross
proceeds to the Company in the range of $143 million. The PIES will pay a cash
dividend and will be mandatorily convertible into shares of Common Stock based
upon a formula dependent upon the market price of Common Stock. The offerings of
Common Stock and PIES are expected to close by the end of June 1998.
F-18
<PAGE> 108
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In addition to the offerings of Common Stock and PIES, the Company plans a
private offering of $300 million in notes ('Senior Subordinated Notes") eligible
for Rule 144A in connection with its plans to finance the Acquisitions discussed
in Note C. The Senior Subordinated Notes are expected to have a ten-year
maturity without sinking fund requirements and will be subject to optional
redemption by the Company after five years at declining premiums.
Former Corporate Revolving Credit Facility
Prior to May 29, 1998, the Company's amended and restated corporate
revolving credit agreement ("Former Credit Facility"), which was replaced by the
Interim Facility, provided total commitments of $150 million from a consortium
of nine banks. The Company, at its option, had activated $100 million of these
commitments. The Credit Facility provided 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 were 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 Former Credit Facility. During 1997, gross borrowings under
the Former Credit Facility were $150 million, with $122 million of repayments.
During 1995 and 1996, the Company's gross borrowings equaled repayments under
the Credit Facility and totaled $262 million and $165 million, respectively.
These cash borrowings were generally used on a short-term basis to finance
working capital requirements and capital expenditures. Under the Former 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 Former Credit
Facility at December 31, 1997 for additional borrowings and letters of credit
totaled $88 million. The Company was also permitted to utilize unsecured letters
of credit outside of the Former Credit Facility up to $40 million (none
outstanding at December 31, 1997).
Cash borrowings under the Former Credit Facility incurred 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 were 1.0% per annum.
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 was 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 Alaska refinery crude unit. In the
year ended December 31, 1995, based on a per barrel throughput charge of 16
cents, the Company's variable payments to the State totaled $2.9 million. In the
years ended December 31, 1996 and 1997, based on a per barrel throughput charge
of 24 cents, the Company's variable payments to the State totaled $4.0 million
and $4.4 million, respectively. In the three months ended March 31, 1998, based
on a per barrel throughput charge of 30 cents, the Company's variable payments
to the State totaled $1.4 million. The per barrel charge increased to 30 cents
in 1998 with one cent annual incremental increases thereafter through 2001. The
Agreement obligated the Company to pay the State $60 million in January 2002;
provided, however, that such payment could 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. Under the Agreement, variable monthly payments made after
January 2002 would 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%.
On May 29, 1998, the State released the Company from all payment
obligations, and all mortgages, liens and security interests in connection
therewith, under the Agreement in exchange for a payment of
F-19
<PAGE> 109
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$66.1 million. The Company is only obligated to continue payment of the per
barrel throughput charge through 2001 with respect to barrels of feedstock
processed at the refinery which exceed 50,000 barrels per day on a monthly
basis, subject to a credit for an amount by which the barrels of feedstock
processed after June 1, 1998 average less than 50,000 barrels per day on a
monthly basis.
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 and terminated in January 1998.
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 which was to mature on or before
April 1, 2005 and required 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 was collateralized by a second lien on the refinery. As
discussed above, the Hydrocracker Loan was repaid and terminated on May 29,
1998.
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 which was to mature on January 1, 2002, required equal
quarterly payments of approximately $536,000 and incurred 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 was
collateralized by a first lien on the Company's refinery. As discussed above,
the Vacuum Unit Loan was repaid and terminated on May 29, 1998.
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 March 31, 1998, the Company's remaining obligation is to pay the DOE
$7.9 million, exclusive of interest at 6%, over the next four 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 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.
F-20
<PAGE> 110
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 are presented below (in
thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------
1995 1996 1997
------- ------- -------
<S> <C> <C> <C>
Service Costs......................................... $ 1,147 $ 1,306 $ 1,502
Interest Cost......................................... 3,549 3,536 3,696
Actual Return on Plan Assets.......................... (8,299) (6,212) (8,817)
Net Amortization and Deferral......................... 4,288 1,687 4,105
------- ------- -------
Net Pension Expense................................. $ 685 $ 317 $ 486
======= ======= =======
</TABLE>
For the three months ended March 31, 1997 and 1998, net pension expense for
the Company's retirement plan totaled $89,000 and $47,000, respectively.
The funded status of the Company's retirement plan and amounts included in
the Company's Consolidated Balance Sheets are set forth in the following table
(in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
------- -------
<S> <C> <C>
Actuarial Present Value of Benefit Obligation:
Vested benefit obligation................................. $40,539 $41,601
======= =======
Accumulated benefit obligation............................ $43,404 $44,877
======= =======
Plan Assets at Fair Value................................... $46,356 $50,982
Projected Benefit Obligation................................ 50,163 52,685
------- -------
Plan Assets Less Than Projected Benefit Obligation.......... 3,807 1,703
Unrecognized Net Loss....................................... (5,903) (2,003)
Unrecognized Prior Service Costs............................ 341 267
Unrecognized Net Transition Asset........................... 3,176 1,940
------- -------
Accrued Pension Liability................................. $ 1,421 $ 1,907
======= =======
</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, 1995, 1996 and 1997. The expected long-term rate of return on
assets was 8 1/2% for 1995, 1996 and 1997.
F-21
<PAGE> 111
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 are
presented below (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------
1995 1996 1997
------ ----- ------
<S> <C> <C> <C>
Service Costs............................................. $ 364 $ 354 $ 521
Interest Cost............................................. 205 204 363
Actual Return on Plan Assets.............................. (325) (439) (596)
Net Amortization and Deferral............................. 471 751 1,196
------ ----- ------
Net Pension Expense..................................... $ 715 $ 870 $1,484
====== ===== ======
</TABLE>
For the three months ended March 31, 1997 and 1998, net pension expense for
the ESP totaled $419,000 and $497,000, respectively.
During the years ended December 31, 1995, 1996 and 1997, the Company
incurred additional ESP expense of $1.5 million, $0.9 million and $1.2 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 are set forth in the following table (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1996 1997
------ ------
<S> <C> <C>
Actuarial Present Value of Benefit Obligation:
Vested benefit obligation................................. $3,300 $4,885
====== ======
Accumulated benefit obligation............................ $4,434 $5,585
====== ======
Plan Assets at Fair Value................................... $7,139 $7,732
Projected Benefit Obligation................................ 6,467 8,683
------ ------
Plan Assets in Excess of (Less Than) Projected Benefit
Obligation................................................ 672 (951)
Unrecognized Net Loss....................................... 4,532 6,442
Unrecognized Prior Service Costs............................ 537 895
Unrecognized Net Transition Obligation...................... 417 314
------ ------
Prepaid Pension Asset..................................... $6,158 $6,700
====== ======
</TABLE>
Assets of the ESP consist of a group annuity contract. Actuarial
assumptions used to measure the projected benefit obligation at December 31,
1995, 1996 and 1997 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 8% for
1995 and 1996 and 7% for 1997.
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
F-22
<PAGE> 112
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 of net periodic postretirement benefits expense, other
than pensions, included the following (in thousands):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------
1995 1996 1997
------ ------ ------
<S> <C> <C> <C>
Health Care:
Service costs.......................................... $ 447 $ 558 $ 676
Interest costs......................................... 1,399 1,294 1,304
------ ------ ------
Net Periodic Postretirement Expense................. $1,846 $1,852 $1,980
====== ====== ======
Life Insurance:
Service costs.......................................... $ 174 $ 158 $ 190
Interest costs......................................... 584 548 580
------ ------ ------
Net Periodic Postretirement Expense................. $ 758 $ 706 $ 770
====== ====== ======
</TABLE>
For the three months ended March 31, 1997 and 1998, retiree health care
benefits totaled $472,000 and $508,000, respectively, and retiree life insurance
benefits totaled $200,000 and $199,000, respectively.
The following tables show the status of the plans reconciled with the
amounts in the Company's Consolidated Balance Sheets (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1997
------- -------
<S> <C> <C>
Health Care:
Accumulated Postretirement Benefit Obligation --
Retirees.................................................. $12,549 $12,591
Active participants eligible to retire.................... 1,203 1,638
Other active participants................................. 4,181 4,584
------- -------
17,933 18,813
Unrecognized Net Gain....................................... 2,621 3,211
------- -------
Accrued Postretirement Benefit Liability............... $20,554 $22,024
======= =======
Life Insurance:
Accumulated Postretirement Benefit Obligation --
Retirees.................................................. $ 6,274 $ 6,393
Active participants eligible to retire.................... 484 608
Other active participants................................. 1,205 1,299
------- -------
7,963 8,300
Unrecognized Net Loss....................................... (115) (380)
------- -------
Accrued Postretirement Benefit Liability............... $ 7,848 $ 7,920
======= =======
</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
F-23
<PAGE> 113
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
postretirement benefit obligation at December 31, 1995, 1996 and 1997 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 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 $0.4 million, $0.8
million and $1.2 million during the year ended December 31, 1995, 1996 and 1997,
respectively. For the three months ended March 31, 1997 and 1998, the Company's
contributions amounted to $0.3 million and $0.4 million, 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,
1996 and 1997, 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 $0.8 million and $0.4 million,
respectively. The Company's Consolidated Balance Sheets at December 31, 1996 and
1997 and March 31, 1998, included $0.7 million, $0.4 million and $0.4 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 the year ended December 31, 1997 and the three months
ended March 31, 1998, the Company incurred expenses of approximately $127,000
and $84,000, respectively, related to the Phantom Stock Plan due to the increase
in the market price of the Company's Common Stock.
NOTE K -- STOCKHOLDERS' EQUITY
For information related to a universal shelf registration and related
offerings of Common Stock and PIES, see Note I.
F-24
<PAGE> 114
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 was scheduled to conclude at the end of
1998. Under the program, subject to certain conditions, the Company repurchased
from time to time Tesoro Common Stock in the open market and through privately
negotiated transactions. Purchases depended on price, market conditions and
other factors and were 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 the year ended December
31, 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. In connection with filing the Registration Statement
discussed in Note I, the Company's Board of Directors approved terminating the
repurchase of Tesoro's Common Stock since it is inconsistent with the shelf
registration and the Company's growth strategy (see Note I).
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 the year ended December 31, 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
F-25
<PAGE> 115
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
On May 12, 1998, the Performance Target was achieved which will result in a
pretax charge of approximately $23 million ($13 million in cash and $10 million
related to the vesting of restricted stock awards and stock options) in the
second quarter of 1998. On an aftertax basis, the charge will be approximately
$15 million, representing 6% of the total aggregate increase in shareholder
value since approval of the special incentive strategy in 1996.
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, 1995, 1996 and 1997, exercisable stock options totaled 0.4
million, 0.4 million and 0.7 million, respectively.
F-26
<PAGE> 116
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 the years ended December 31, 1995, 1996 and
1997 would have been approximately $53.8 million ($2.19 per basic share, $2.15
per diluted share), $72.6 million ($2.79 per basic share, $2.74 per diluted
share), and $28.5 million ($1.08 per basic share, $1.06 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 45%, 30% and 32%; risk free interest
rates of 6.1%, 6.6% and 6.7%; expected lives of seven years; and no dividend
yields for the years 1995, 1996 and 1997, respectively. The estimated fair value
per share of options granted during the years 1995, 1996 and 1997 were $3.65,
$4.26 and $5.96, respectively, and the fair value per share of restricted stock
awards in the year 1996 was $0.95 per share.
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
F-27
<PAGE> 117
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 $10 million, $12 million, $11 million, $4
million and $4 million for the years ended December 31, 1995, 1996 and 1997 and
three months ended March 31, 1997 and 1998, respectively. In addition, expenses
related to charters of marine vessels were approximately $26 million, $30
million, $34 million, $8 million and $8 million for the years ended December 31,
1995, 1996 and 1997 and three months ended March 31, 1997 and 1998,
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 and March 31, 1998, the Company's accruals for
environmental expenses amounted to $8.5 million and $8.7 million, respectively,
which included a noncurrent liability of $2.7 million and $2.5 million,
respectively, for remediation of the Kenai Pipe Line Company's ("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 the year
1998 and $2 million in the year 1999. In addition, capital expenditures for
alternate secondary containment systems for existing storage tank facilities are
estimated to be $2 million in the year 1998 and $2 million in the year 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 the year ended December 31, 1997, the Company
purchased approximately
F-28
<PAGE> 118
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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>
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
Market Price Per Common Share:
High................................ $ 9 1/8 $ 11 5/8 $ 13 1/2 $ 15 1/2
Low................................. $ 8 $ 8 1/4 $ 10 1/2 $ 12 7/8
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
Market Price per Common Share:
High................................ $ 14 1/2 $ 15 $ 18 3/16 $ 18 3/16
Low................................. $ 10 3/8 $ 10 1/4 $ 14 3/4 $ 15
</TABLE>
F-29
<PAGE> 119
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During the three months ended March 31, 1998, the Company's quarterly
financial data was as follows: gross operating revenues of $195.2 million; other
income of $0.8 million; operating profit of $17.9 million; net earnings of $6.1
million; earnings per share, basic and diluted, of $0.23 per share; and high and
low Common Stock market prices per share of $17 7/8 and $14 13/16, respectively.
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.
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.
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,
--------------------------------
1995 1996 1997
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Capitalized Costs:
Proved properties................................ $119,836 $179,433 $251,604
Unproved properties not being amortized.......... 5,118 12,344 31,918
-------- -------- --------
124,954 191,777 283,522
Accumulated depreciation, depletion and
amortization.................................. 51,549 78,222 112,562
-------- -------- --------
Net Capitalized Costs......................... $ 73,405 $113,555 $170,960
======== ======== ========
</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, $5.6 million and $26.3 million of such costs were incurred in
the years ended December 31, 1996 and 1997, respectively. The Company
anticipates that the majority of these costs will be included in the
amortization base during the next two years.
F-30
<PAGE> 120
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Costs Incurred in Oil and Gas Property Acquisition, Exploration and
Development Activities
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
YEAR ENDED DECEMBER 31, 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
======= ======= =======
YEAR ENDED DECEMBER 31, 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
======= ======= =======
YEAR ENDED DECEMBER 31, 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
======= ======= =======
</TABLE>
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>
YEAR ENDED DECEMBER 31, 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>
F-31
<PAGE> 121
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
U.S. BOLIVIA TOTAL
---- -------- -----
(IN THOUSANDS EXCEPT AS INDICATED)
<S> <C> <C> <C>
YEAR ENDED DECEMBER 31, 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
======== =======
YEAR ENDED DECEMBER 31, 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
======== =======
</TABLE>
- ---------------
(a) Revenues included the effects of natural gas commodity price agreements
which amounted to a gain of $0.3 million ($0.01 per thousand cubic feet
("Mcf")) in the year ended December 31, 1995 and losses of $3.1 million
($0.11 per Mcf) and $1.6 million ($0.05 per Mcf) in the years ended
December 31, 1996 and 1997, respectively. The Company had entered into
these agreements to reduce risks caused by fluctuations in the prices of
natural gas in the spot market. During the years ended December 31, 1995,
1996 and 1997, the Company used such agreements to set the price of 38%,
30% and 9%, 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 or March 31, 1998.
(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
F-32
<PAGE> 122
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, 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
======== ======== ========
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, 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>
F-33
<PAGE> 123
TESORO PETROLEUM CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
- ---------------
(a) For Bolivia, the discounted future income tax expense includes Bolivian
taxes of $21.6 million, $69.4 million and $105.0 million as of December 31,
1995, 1996 and 1997, respectively, and U.S. income taxes of $4.3 million,
$10.7 million and $2.3 million at December 31, 1995, 1996 and 1997,
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>
1995 1996 1997
--------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Sales of oil and gas produced, net of production
costs............................................. $(106,378) $(93,275) $(69,567)
Net changes in prices and production costs.......... (32,931) 39,409 (88,473)
Extensions, discoveries and improved recovery....... 83,045 81,201 42,191
Changes in future development costs................. 19,221 (17,704) (7,495)
Revisions of previous quantity estimates............ 60,800 (7,244) 15,819
Purchases (sales) of minerals in-place.............. (48,698) 55,484 79,024
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............................... 14,878 14,563 20,619
Net changes in income taxes......................... 6,917 (71,332) 25,785
--------- -------- --------
Net increase (decrease)............................. (3,146) 60,560 28,174
Beginning of period................................. 148,775 145,629 206,189
--------- -------- --------
End of period....................................... $ 145,629 $206,189 $234,363
========= ======== ========
</TABLE>
F-34
<PAGE> 124
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>
F-35
<PAGE> 125
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.
* * * * * *
F-36
<PAGE> 126
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Stockholders of BHP Petroleum Americas Refining Inc.
and BHP Petroleum South Pacific Inc.:
We have audited the accompanying combined balance sheets of BHP Petroleum
Americas Refining Inc. and BHP Petroleum South Pacific Inc. (the Company) as of
May 31, 1997 and 1996, and the related combined statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended May 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, the financial statements referred to above present fairly,
in all material respects, the combined financial position of BHP Petroleum
Americas Refining Inc. and BHP Petroleum South Pacific Inc. as of May 31, 1997
and 1996, and the combined results of their operations and their cash flows for
each of the three years in the period ended May 31, 1997, in conformity with
generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
Honolulu, Hawaii
March 31, 1998
F-37
<PAGE> 127
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
COMBINED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED MAY 31,
------------------------------------
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
REVENUES
Sales and other revenue -- trade....................... $ 752,044 $ 741,631 $ 886,380
Sales and other revenue -- affiliates.................. 79,908 72,992 111,258
Other income........................................... 750 905 211
---------- ---------- ----------
Total Revenue.................................. 832,702 815,528 997,849
---------- ---------- ----------
OPERATING COSTS AND EXPENSES
Cost of sales.......................................... 720,597 711,131 881,991
Operating and selling.................................. 42,148 43,661 43,363
Depreciation and amortization.......................... 27,745 29,507 30,596
Refinery assets write-down to fair value (Note 5)...... -- -- 88,813
Goodwill write-off (Notes 2 and 5)..................... -- -- 30,351
---------- ---------- ----------
Total Operating Costs and Expenses............. 790,490 784,299 1,075,114
---------- ---------- ----------
OPERATING INCOME (LOSS).................................. 42,212 31,229 (77,265)
General and administrative............................. (22,319) (21,238) (24,731)
Interest............................................... (11,274) (9,887) (9,976)
Capitalized interest................................... 857 765 1,269
---------- ---------- ----------
INCOME (LOSS) BEFORE INCOME TAXES........................ 9,476 869 (110,703)
Income tax benefit (provision)........................... (4,673) (1,474) 30,125
---------- ---------- ----------
NET INCOME (LOSS)........................................ $ 4,803 $ (605) $ (80,578)
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-38
<PAGE> 128
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
COMBINED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF MAY 31,
--------------------
1996 1997
-------- --------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash...................................................... $ 1,043 $ 1,420
Accounts receivable, net.................................. 43,913 47,675
Due from affiliates -- trade.............................. 10,742 9,906
Due from affiliates -- other.............................. 22,369 22,115
Inventories............................................... 52,354 83,864
Other current assets...................................... 5,712 4,802
-------- --------
Total current assets.............................. 136,133 169,782
-------- --------
PROPERTY, PLANT AND EQUIPMENT, net of accumulated
depreciation and amortization(Note 5)..................... 378,235 303,442
-------- --------
NON-CURRENT ASSETS
Goodwill, net of accumulated amortization (Note 5)........ 32,931 --
Other..................................................... 7,653 4,220
-------- --------
Total non-current assets.......................... 40,584 4,220
-------- --------
Total Assets...................................... $554,952 $477,444
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Cash overdraft............................................ $ 6,668 $ 6,840
Accounts payable.......................................... 7,557 12,287
Due to affiliates -- trade................................ 4,587 29,933
Capital lease obligations, current portion................ 685 1,055
Accrued liabilities....................................... 13,213 20,782
-------- --------
Total current liabilities......................... 32,710 70,897
-------- --------
NOTES PAYABLE TO AFFILIATE -- noncurrent.................... 145,000 145,000
CAPITAL LEASE OBLIGATIONS, net of current portion........... 5,917 9,361
DEFERRED INCOME TAXES....................................... 66,014 30,659
OTHER LIABILITIES........................................... 31,746 28,540
COMMITMENTS AND CONTINGENCIES (Note 14)
STOCKHOLDERS' EQUITY
Common stock, no par value, 1,000,500 shares authorized,
issued and outstanding................................. 8,208 8,208
Additional paid-in capital................................ 52,362 52,362
Retained earnings:
BHP Petroleum Americas Refining Inc.................... 204,205 122,378
BHP Petroleum South Pacific Inc........................ 8,790 10,039
-------- --------
Total stockholders' equity........................ 273,565 192,987
-------- --------
Total Liabilities and Stockholders' Equity........ $554,952 $477,444
======== ========
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-39
<PAGE> 129
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
COMBINED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
------------------- PAID-IN RETAINED STOCKHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS EQUITY
--------- ------- ---------- -------- -------------
<S> <C> <C> <C> <C> <C>
Balance May 31, 1994
BHP Petroleum Americas Refining
Inc............................... 500 $ 8,008 $ 42,000 $200,219 $250,227
BHP Petroleum South Pacific Inc...... 1,000,000 200 10,362 8,578 19,140
--------- ------- -------- -------- --------
Total........................ 1,000,500 8,208 52,362 208,797 269,367
Net income........................... -- -- -- 4,803 4,803
--------- ------- -------- -------- --------
Balance May 31, 1995................... 1,000,500 8,208 52,362 213,600 274,170
Net loss............................. -- -- -- (605) (605)
--------- ------- -------- -------- --------
Balance May 31, 1996................... 1,000,500 8,208 52,362 212,995 273,565
Net loss............................. -- -- -- (80,578) (80,578)
--------- ------- -------- -------- --------
Balance, May 31, 1997.................. 1,000,500 $ 8,208 $ 52,362 $132,417 $192,987
========= ======= ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-40
<PAGE> 130
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
COMBINED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEARS ENDED MAY 31,
------------------------------
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)........................................... $ 4,803 $ (605) $(80,578)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Refinery assets write-down to fair value.................. -- -- 88,813
Goodwill write-off........................................ -- -- 30,351
Depreciation and amortization............................. 27,745 29,507 30,596
Deferred income taxes..................................... (6,067) 285 (35,355)
Changes in:
Accounts receivable, net............................... (44,397) 7,767 (3,762)
Due from affiliates, trade and other................... 29,368 (786) 1,090
Inventories............................................ (6,803) 18,916 (31,510)
Other assets........................................... 2,569 (8,903) 4,343
Accounts payable and accrued liabilities............... 13,644 (4,343) 12,471
Due to affiliates, trade............................... (1,274) (15,106) 25,346
Other liabilities...................................... 4,499 4,008 (3,206)
-------- -------- --------
Net cash provided by operating activities................. 24,087 30,740 38,599
CASH FLOWS FROM INVESTING ACTIVITIES --
Additions to property plant and equipment................. (23,461) (29,568) (37,467)
CASH FLOWS FROM FINANCING ACTIVITIES --
Repayment of principal on capital leases.................. (527) (654) (755)
-------- -------- --------
Net increase in cash........................................ 99 518 377
Cash, beginning of period................................... 426 525 1,043
-------- -------- --------
Cash, end of period......................................... $ 525 $ 1,043 $ 1,420
======== ======== ========
Supplemental disclosures:
Acquisition of equipment under capital lease.............. $ -- $ 1,900 $ 4,569
Fixed assets from parent company, at book value........... $ -- $ 7,540 $ --
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-41
<PAGE> 131
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS)
1. ORGANIZATION
BHP Petroleum Americas Refining Inc. (BHPPAR), a Hawaii corporation, and
BHP Petroleum South Pacific Inc. (BHPPSP), a California corporation,
collectively referred to as "the Company," are affiliated companies and
wholly-owned indirect subsidiaries of The Broken Hill Proprietary Company
Limited (BHP), an Australian company. All capital and financing requirements of
the Company are provided for by BHP, except for capital and operating leases.
BHPPAR operates an oil refinery, product storage and distribution
facilities, and retail gasoline stations in the state of Hawaii. Crude oil is
purchased through other BHP affiliates and shipped to Hawaii by tanker. Refined
product exports usually are sold through other BHP affiliates. BHPPSP is a
petroleum products marketer in American Samoa, and operates the government-owned
product storage and distribution facilities. BHPPSP purchases most of its
refined products from BHPPAR.
The Companies were part of a consolidated group, Pacific Resources, Inc.
and Subsidiaries (PRI), purchased by BHP in March 1989. The purchase price was
allocated to assets and liabilities based on fair values at the acquisition
date. The purchase price in excess of fair values was reported as goodwill until
May 1997 when the refinery assets were written down to estimated fair value and
the unamortized goodwill was written off (see Note 5).
There have been changes in the former PRI group since 1989: certain
subsidiaries were liquidated, others were merged or became subsidiaries of other
BHP affiliates. In 1995 two affiliates, BHP Petroleum Americas Terminals Inc.
(Terminals), and BHP Petroleum Americas Gas Express Inc. (Gas Express), were
merged into BHPPAR. In connection with this reorganization, all employees of
Terminals, Gas Express and parent company, BHP Hawaii Inc., became employees of
BHPPAR. The 1995 financial statements reflect the results of operations of these
combined entities, consistent with the presentation in 1996 and 1997.
2. SIGNIFICANT ACCOUNTING POLICIES
Combined Financial Statements -- The combined financial statements include
the accounts of BHPPAR and BHPPSP. These companies are combined to present the
financial position and results of operations of BHP's downstream petroleum
refining and marketing business. The combined financial statements have been
prepared using the historical costs and results of operations of the affiliated
entities. There were no significant differences in accounting methods or their
application among the combining entities. All significant intercompany balances
and transactions between the combined entities are eliminated.
Use of Estimates and Presentation -- Preparation of the combined financial
statements, in conformity with generally accepted accounting principles,
requires management to make estimates and assumptions which affect the amounts
of assets and liabilities, and disclosure of contingencies at the date of the
financial statements, and the reported amounts of revenues and expenses during
the reporting periods. Actual results could differ from these estimates.
Financial Instruments -- The carrying amounts of financial instruments,
including cash, accounts receivable, accounts payable, and certain other current
liabilities, approximate fair value because of the short maturity of these
instruments. The carrying amounts of the Company's long-term notes payable and
other obligations approximate the Company's estimate of fair values of such
items.
Hedging Activities -- The Company periodically enters into hedging
arrangements through BHP affiliates to manage petroleum price risks and not for
speculative purposes. Gains and losses from hedging are recognized in income
when the hedged transaction occurs. Historically, gains and losses from hedging
transactions have not been material.
F-42
<PAGE> 132
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Inventories -- Crude oil and refined products are valued at the lower of
cost or market (net realizable value). Cost is determined primarily on the
last-in, first-out (LIFO) basis. Other inventories held for sale, materials and
supplies are stated at the lower of average cost, not in excess of market.
Property, Plant and Equipment -- Property, plant and equipment is stated at
cost. Major replacements, renewals and improvements are capitalized.
Maintenance, repairs and replacements, which do not improve or extend the lives
of assets, are charged to expense. Depreciation and amortization, including
amortization of assets under capital leases, are computed using the
straight-line method over estimated useful lives or lease terms, if shorter.
Estimated useful lives range up to 20 years for buildings and up to 25 years for
plant and equipment.
Refinery Maintenance Turnaround Costs -- The costs of refinery unit
shutdown and maintenance turnaround costs are included in other assets and
amortized over the estimated period of benefit, generally one to three years,
depending on the process unit.
Goodwill -- Goodwill represents BHP's purchase price in excess of the fair
values of net BHPPAR assets acquired in March 1989, after providing noncurrent
deferred tax liabilities on the difference between the assets' fair values and
their income tax basis. Goodwill was amortized on a straight-line, 20 year rate
until the goodwill was determined to be without further value and was written
off in May 1997 (see Note 5).
Income Taxes -- Deferred tax assets and liabilities are recognized for
future income tax effects of temporary differences between financial statement
carrying amounts and the related income tax bases of assets and liabilities.
Deferred income tax assets and liabilities measurements are based on enacted tax
rates expected to apply when the temporary differences are expected to be
settled. The effect of tax rate changes on deferred tax assets and liabilities
is recognized when rate changes are enacted.
Income taxes are computed and recorded as if each company were filing
separate tax returns, although BHPPAR and BHPPSP are included in different
federal and state consolidated income tax returns which include other BHP
companies in the affiliated groups. Current income tax liabilities or refunds
are settled with BHP through intercompany accounts.
Environmental Expenditures -- Environmental expenditures for current
operations are expensed or capitalized, as appropriate. Expenditures are
capitalized if they extend the useful lives of assets, increase capacity, or
mitigate or prevent environmental contamination. Expenditures are expensed if
they are for existing conditions caused by past operations, and if the
expenditures will not contribute to future revenue generation. Liabilities are
recorded when environmental assessments and/or remedial efforts are probable and
when costs can be estimated reasonably. Such amounts are based on the estimated
timing and extent of remedial actions required by regulatory agencies,
experience gained from other sites where assessments and remediation have been
completed, and the amount of the Company's estimated liability, considering
proportional liability and financial abilities of other responsible parties.
Adjustments to accrued liabilities are made as changes in conditions and
estimated costs become known.
Pension Plans and Other Post-Employment Benefits -- Pension costs are
accounted for in conformity with Statements of Financial Accounting Standards
No. 87 and 88. Funding is based on required contributions under the Employee
Retirement Income Security Act of 1974. Other post-employment benefits,
primarily medical insurance, are accounted for in conformity with Statement of
Financial Accounting Standards No. 106.
3. RECEIVABLES
The Company operates in a single industry, marketing refined petroleum
products in a limited geographic area, primarily Hawaii and American Samoa. The
markets are subject to economic and industry changes,
F-43
<PAGE> 133
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
including changes in market prices and sources of supply. Concentration of
credit risk in trade receivables is limited by the numbers and variety of
customers. In October 1997, BHP sold a Hawaii gas services subsidiary (the Gas
Company) to an unrelated company. The Gas Company continues to purchase naphtha
and propane (LPG) from the refinery. Receivables from the Gas Company amounted
to $3,243 and $3,886 at May 31, 1996 and 1997, respectively.
BHPPSP operates the government-owned fuel storage facilities and markets to
a wide range of customers in American Samoa. The facilities management contract
expired in 1997 and was awarded to a competitor. BHPPSP has contested the award,
but there is no assurance that the company will be able to continue as the
facilities operator and/or as a marketer in American Samoa. Transfer of
operations to a competitor could increase the collection risk of receivables in
that market. BHPPSP's receivables, net of allowance for doubtful accounts,
amounted to $3,331 and $4,273 at May 31, 1996 and 1997, respectively.
The company performs on-going credit evaluations of its customers financial
condition, and in some circumstances requires prepayment or letters of credit.
The allowance for doubtful accounts is included in the combined balance sheets
as a reduction of receivables. The allowance for doubtful accounts as of May 31,
1995, 1996 and 1997, was $1,561, $734 and $698, respectively.
4. INVENTORIES
Inventories at May 31 consisted of:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Crude oil and refined products.............................. $42,107 $73,601
Merchandise and packaged petroleum products................. 896 1,243
Materials and supplies...................................... 9,351 9,020
------- -------
Total inventories........................................... $52,354 $83,864
======= =======
</TABLE>
At May 31, 1996 and 1997, crude oil and product inventories at LIFO cost
amounting to $41.0 million and $71.5 million, respectively, were below current
cost by approximately $10.7 million and $7.0 million, respectively.
5. PROPERTY, PLANT AND EQUIPMENT, GOODWILL, AND RELATED WRITE-DOWNS
Principal assets include the oil refinery, its buildings and its property
site on the island of Oahu. The Company owns pipelines connecting the refinery
to an off-shore, single-point mooring, to a barge harbor near the refinery, and
to Honolulu International Airport and Honolulu Harbor. Marketing facilities
include product storage and distribution terminals on the islands of Maui and
Hawaii, as well as retail gas stations.
In 1997 BHP developed a plan to sell the Company, engaged an investment
advisor, completed an appraisal of assets, and began discussions with potential
buyers. Management determined that net book value of refinery assets had been
impaired based in part on the appraisal. The refinery property, plant and
equipment were written down to estimated fair value in May 1997, based on an
evaluation of these assets, related operating results, and in accordance with
provisions of Statement of Financial Accounting Standards No. 121. The
write-down, net of accumulated depreciation, amounted to $88.8 million ($54.2
million after a $34.6 million reduction in deferred income taxes), as summarized
below. BHP reached an agreement in March 1998 to sell the Company, and as a
result of the sale, the Company anticipates recognizing an estimated loss of
approximately $120-125 million, in addition to the loss recognized in May 1997
(see
F-44
<PAGE> 134
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Note 15). Substantially all of the loss is expected to be allocated to a further
reduction in the fair value of the property, plant and equipment.
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Land and buildings.......................................... $ 67,708 $ 70,451
Plant and equipment, including capital leases............... 548,067 582,076
--------- ---------
Total before revaluation write-down......................... 615,775 652,527
Accumulated depreciation and amortization................... (237,540) (260,272)
--------- ---------
Property, plant and equipment, net before write-down........ 378,235 392,255
--------- ---------
Less write-down to estimated fair value:
Land and buildings........................................ -- (23,451)
Plant and equipment....................................... -- (325,634)
Accumulated depreciation and amortization................. -- 260,272
--------- ---------
Net write-down to estimated fair value............ -- (88,813)
--------- ---------
Property, plant and equipment, net.......................... $ 378,235 $ 303,442
========= =========
</TABLE>
In connection with management's determination that the carrying amount of
refinery assets had become impaired, it was also determined that goodwill had no
continuing value. Therefore, the remaining net goodwill of $30,351 ($51,636, net
of accumulated amortization of $21,285) was also written off in May 1997. Annual
goodwill amortization expense included in statements of operations was $2,580
for each of the three years ended May 31, 1997.
6. LEASES
The company leases equipment and some properties under various lease
agreements covering periods through 2024. Properties include the pipeline
corridor from the refinery to Honolulu International Airport and Honolulu
Harbor, as well as land underlying terminal facilities and most of the gas
stations. The Company also uses product terminals owned by others, including
deliveries at Honolulu Harbor, Honolulu International Airport, and all sales in
American Samoa. Rent, through-put fees, and storage fees are paid for use of
these facilities. Certain operating leases contain provisions for renegotiation
or escalation of rents based on operating costs or usage. Rent expense for
operating leases, including leases with terms of a month or less, was $13,696 in
1995, $13,125 in 1996 and $13,330 in 1997.
Capital leases are for tugs and barges used in transportation of petroleum
products within Hawaii. Cost and accumulated amortization of capitalized leased
assets at May 31 amounted to:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Capitalized leases -- cost.................................. $12,204 $15,023
Accumulated amortization.................................... (5,965) (5,123)
------- -------
Capitalized leases included in property -- net.............. $ 6,239 $ 9,900
======= =======
</TABLE>
F-45
<PAGE> 135
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Minimum lease commitments under non-cancelable leases (excluding leases
with terms of one year or less) at May 31, 1997 are summarized below:
<TABLE>
<CAPTION>
FISCAL OPERATING CAPITAL
YEAR LEASES LEASES
- ------------------------------------------------------------ --------- -------
<S> <C> <C>
1998........................................................ $ 12,186 $ 2,005
1999........................................................ 10,763 1,884
2000........................................................ 9,394 1,677
2001........................................................ 9,441 1,634
2002........................................................ 8,221 1,468
Thereafter.................................................. 96,027 6,659
-------- -------
Total minimum lease payments................................ $146,032 15,327
========
Less amount representing interest........................... (4,911)
-------
Present value of net minimum lease payments................. 10,416
Less current portion........................................ (1,055)
-------
Noncurrent portion.......................................... $ 9,361
=======
</TABLE>
7. ACCRUED LIABILITIES
Accrued current liabilities at May 31 included the following:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Environmental costs......................................... $ 3,190 $ 3,950
Accrued employee compensation............................... 5,502 10,768
Taxes, other than income taxes.............................. 4,239 5,908
Other accrued liabilities................................... 282 156
------- -------
Total accrued liabilities, current.......................... $13,213 $20,782
======= =======
</TABLE>
8. NOTES PAYABLE TO AFFILIATE
Noncurrent debt consists of two unsecured promissory notes totaling $145
million, payable to BHPPAR's parent company, BHP Hawaii Inc. The notes are
payable 395 days from demand, and interest is payable at the monthly average
short-term Applicable Federal Rate, as determined under Internal Revenue Code
Sec. 1274(d). Interest rates ranged from 5.56% to 7.43% in 1995, 5.05% to 6.37%
in 1996, and 5.63% to 6.23% in 1997. The rates for May 1996 and 1997 were 5.76%
and 6.23%, respectively. Interest is paid as accrued through settlement of
inter-company accounts. Interest expense on the notes was $9,415 in 1995, $8,364
in 1996, and $8,734 in 1997.
9. INCOME TAXES
The income tax provision (benefit) for the three years ended May 31, 1997,
included:
<TABLE>
<CAPTION>
1995 1996 1997
------- ------ --------
<S> <C> <C> <C>
Current income tax provision.......................... $10,738 $1,990 $ 5,285
Deferred tax benefit.................................. (6,065) (516) (35,410)
------- ------ --------
Total income tax provision (benefit).................. $ 4,673 $1,474 $(30,125)
======= ====== ========
</TABLE>
F-46
<PAGE> 136
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The deferred income tax benefit in 1997 includes the deferred tax effect of
the fair value write-down of refinery property, plant and equipment.
The following table reconciles taxes on income at the normal 35% Federal
income tax rate with the effective tax rate:
<TABLE>
<CAPTION>
1995 1996 1997
------ ------ ---------
<S> <C> <C> <C>
Earnings (loss) before income taxes................... $9,476 $ 869 $(110,703)
------ ------ ---------
Tax provision (benefit) at U.S. corporate tax rate.... $3,317 $ 304 $ (38,746)
Effect of:
Write-off / amortization of goodwill................ 900 903 11,526
State income taxes, net of Federal tax effects...... 470 149 (3,027)
Other............................................... (14) 118 122
------ ------ ---------
Income tax provision (benefit)........................ $4,673 $1,474 $ (30,125)
====== ====== =========
Effective combined income tax rate.................... 49.3% 169.6% 27.2%
====== ====== =========
</TABLE>
The effective tax rates are significantly different than "normal" because
of the amortization and write-off of goodwill related to BHP's 1989 acquisition
of BHPPAR.
Deferred income tax liabilities and assets, resulting from timing
differences, as of May 31, 1996 and 1997:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Deferred Federal tax assets:
Accrued vacation pay, incentive compensation.............. $ 1,824 $ 692
Accrued retirement benefits............................... 4,376 4,417
Environmental provisions.................................. 7,862 7,236
Other..................................................... 895 995
------- -------
Total deferred tax assets......................... 14,957 13,340
Deferred Federal tax liabilities:
Accelerated depreciation and other property items......... 71,844 39,410
Refinery turn-around costs................................ 2,011 976
Other..................................................... 525 525
------- -------
Total deferred tax liabilities.................... 74,380 40,911
------- -------
Net Federal deferred tax liability.......................... 59,423 27,571
Net State deferred tax liability............................ 6,591 3,088
------- -------
Deferred income tax liability -- net........................ $66,014 $30,659
======= =======
</TABLE>
10. RETIREMENT PLANS
Employees are covered by a qualified noncontributory defined benefit
pension plan. BHPPAR and BHPPSP participate with many other BHP affiliates in
the BHP (USA) Pension Plan, and the plan's actuary allocates assets and
liabilities to the participating entities, as well as determining annual costs
and recommended contributions. The plan's benefit formula is a final-pay
formula. The plan funding policy is to fund a contribution of at least the
minimum funding requirement, but no more than the maximum tax-deductible
contribution.
The following plan information covers all the employees of the Company, as
well as certain employees and retirees of affiliates which were merged into
BHPPAR or disposed of during the three years ended
F-47
<PAGE> 137
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
May 31, 1997. Plan assets exceeded projected benefit obligations, with respect
to BHPPAR and BHPPSP, at May 31, 1996 and 1997. The following tables present
pension expense, funded status and major actuarial assumptions used to determine
amounts.
<TABLE>
<CAPTION>
NET PERIODIC PENSION COST 1995 1996 1997
------------------------- ------- ------- -------
<S> <C> <C> <C>
Service cost.......................................... $ 1,330 $ 1,530 $ 1,550
Interest cost......................................... 1,420 1,470 1,660
Actual return on plan assets.......................... (2,600) (3,000) (4,920)
Net amortization and deferral......................... 1,381 1,521 3,061
------- ------- -------
Net periodic pension cost............................. $ 1,531 $ 1,521 $ 1,351
======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
FUNDED STATUS OF PENSION PLANS AS OF MAY 31 1996 1997
------------------------------------------- ------- -------
<S> <C> <C>
Actuarial present value of accumulated benefit obligation:
Vested.................................................... $13,670 $14,380
Total..................................................... $16,490 $17,610
------- -------
Projected benefit obligation................................ $22,060 $24,420
Plan assets at fair value................................... 22,540 27,120
------- -------
Plan assets in excess of projected benefit obligation....... 480 2,700
Unrecognized net gain....................................... (2,590) (4,800)
Unrecognized prior service cost............................. 1,093 1,002
------- -------
Accrued net pension liability............................... $(1,017) $(1,098)
======= =======
</TABLE>
The accrued net pension liability is included in other liabilities
(noncurrent) in the accompanying balance sheets.
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Discount rate............................................... 8.00% 7.75% 7.75%
Rate of increase in future compensation levels.............. 5.00 5.00 5.00
Expected long-term rate of return on plan assets............ 8.50 8.50 8.50
</TABLE>
In addition to the defined benefit plan, the Company is a participating
sponsor in a defined contribution plan. The BHP Retirement Savings Plan (RSP) is
a deferred compensation plan which covers employees of the Company and other BHP
entities in the U.S. The Company matches and contributes an amount equal to each
employee's contribution up to 6 percent of the employee's salary and incentive
compensation. Plan contributions charged to expense amounted to $1,071, $1,222
and $1,421 in 1995, 1996 and 1997, respectively.
Liabilities also are accrued for supplemental retirement benefits for
executives. The unfunded liabilities and expense are actuarially determined.
Payments are made for vested benefits after retirement.
11. OTHER RETIREMENT BENEFITS
Certain medical and life insurance benefits are provided for qualified
retirees and their qualified dependents. Employees who retire at ages 55-61 with
at least 15 years of continuous service, or who retire at age 62, or later, with
at least 10 years of continuous service, become eligible for these benefits. The
health care plan is contributory with retiree contributions adjusted
periodically. The life insurance plan is noncontributory. Plan expense and
liabilities are accrued as actuarially determined and funded on a pay-as-you-go
basis. The
F-48
<PAGE> 138
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
following tables present the composition of post-retirement benefit expense and
the accumulated post-retirement benefit obligation.
<TABLE>
<CAPTION>
COMPONENTS OF NET PERIODIC POST-RETIREMENT BENEFIT COST 1995 1996 1997
------------------------------------------------------- ---- ---- ----
<S> <C> <C> <C>
Service cost................................................ $108 $100 $ 83
Interest cost on accumulated benefit obligation............. 601 528 424
Amortization of unrecognized net transition asset........... (48) (48) (48)
Amortization of unrecognized (gain) loss.................... 8 -- (78)
---- ---- ----
Net periodic post-retirement benefit cost................... $669 $580 $381
==== ==== ====
</TABLE>
<TABLE>
<CAPTION>
ACCRUED POST-RETIREMENT BENEFIT OBLIGATION AS OF MAY 31 1996 1997
------------------------------------------------------- ------ ------
<S> <C> <C>
Retirees and beneficiaries.................................. $4,742 $4,553
Active participants eligible to retire...................... 264 282
Other active participants................................... 733 873
------ ------
Total post-retirement benefit obligation.................... 5,739 5,708
Unrecognized transition asset............................... 776 728
Unrecognized gain........................................... 1,614 1,441
------ ------
Accrued post-retirement benefit obligation.................. $8,129 $7,877
====== ======
</TABLE>
The accrued obligation is included in other liabilities (noncurrent) in the
accompanying balance sheets. Amounts to be paid during the next twelve months
are included in current liabilities.
The weighted average rate of increase in the per capita cost of covered
health care benefits was assumed to be 8% for 1997, decreasing by 1/2% per year
to 5.5% in 2002 and thereafter. A 1% increase in the health care cost trend rate
would increase the accumulated post-retirement benefit obligation by $149 at May
31, 1997, and the net periodic service and interest cost by $13 for the year.
Actuarial assumptions used to measure the accrued post-retirement obligation at
May 31, 1995, 1996 and 1997 included a discount rate of 7.75% and a compensation
rate increase of 6%.
12. RELATED PARTY BALANCES AND TRANSACTIONS
The Company enters into transactions with BHP-affiliated companies
primarily for petroleum operations and general financing activities. Crude oil
is purchased through BHP Petroleum affiliates in the U.S., Australia and
Singapore. Crude oil transportation costs are either included in the purchase
price or paid to an affiliated BHP Transport company. Export products are sold
through BHP Petroleum affiliates. Amounts due to and from BHP-affiliated
companies as of May 31 were:
<TABLE>
<CAPTION>
1996 1997
-------- --------
<S> <C> <C>
Due from affiliates:
Current -- trade receivables.............................. $ 10,742 $ 9,906
Current -- other.......................................... 22,369 22,115
Due to affiliates:
Current -- trade payables................................. 4,587 29,933
Noncurrent notes payable, interest at variable rate......... 145,000 145,000
</TABLE>
F-49
<PAGE> 139
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Transactions with BHP-affiliated companies for the three years ended May
31, 1997 were:
<TABLE>
<CAPTION>
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
Revenues:
Sales and other revenue............................ $ 79,908 $ 72,992 $111,258
Operating Costs and Expenses:
Petroleum purchases, including freight............. 575,175 584,714 614,076
Guarantee fees, included in operating costs........ 1,213 1,539 617
Interest on noncurrent promissory notes............ 9,415 8,364 8,734
Securitization fees, included in interest.......... 1,287 -- --
</TABLE>
Sales of refined products to BHP affiliates are negotiated with reference
to current published market prices. Sales include export cargoes marketed
primarily in Asia. Also, naphtha and LPG are sold to a Hawaii gas utility
affiliate (the Gas Company) under term contracts. BHP sold the Gas Company to an
unrelated company effective October 31, 1997 (see Note 15).
Domestic (Alaskan North Slope) crude oil is purchased from a BHP Petroleum
affiliate at their cost, net of their price hedging transactions. BHPPAR also
imports crude oil, primarily from Australia and Asia, under term agreements with
BHP Petroleum affiliates, and purchase prices are determined by a formula using
current published market prices.
13. FUTURES CONTRACTS
BHPPAR has a term agreement with a third-party customer for the sale of
physical product in exchange for futures contracts (plus a cash location/quality
differential), which are settled through a BHP Petroleum affiliate. The futures
contracts are sold ratably over each month, and proceeds from selling the
futures contracts at current market prices (plus the cash differential)
determine the sales value of product delivered during the month. Futures
contracts at May 31, 1996 and 1997, are summarized below (amounts in 000's):
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Contract barrels............................................ 250 240
Contract amounts............................................ $ 5,597 $ 5,645
Unrealized gains (losses)................................... $ (257) $ (19)
Maturity dates.............................................. June 1996 June 1997
</TABLE>
14. COMMITMENTS AND CONTINGENCIES
The Company is party to litigation and claims in the normal course of
business. The outcome of individual matters is not predictable. However,
management believes that the ultimate resolution of all of these matters, after
considering insurance coverages, is not likely to have a material adverse effect
on the Company's combined financial statements.
Environmental
The Company's operations are subject to various Federal and state
environmental laws and regulations. The Company has received notices of
violation or potential liability from the U.S. Environmental Protection Agency
(EPA), the State of Hawaii Department of Health (HDOH) and private parties
relating to various environmental matters associated with the Company's
ownership and/or operations of its assets. Generally, the timing of liability
accruals corresponds with the completion of remedial investigations or
feasibility studies, and are adjusted as necessary. Although the amount of
future environmental expenditures cannot be
F-50
<PAGE> 140
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
determined with certainty, Company management believe that compliance with
present laws will not have a material adverse effect on its financial
statements. Environmental provisions as of May 31 were as follows:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Accrued liabilities -- current.............................. $ 3,190 $ 3,950
Other liabilities -- noncurrent............................. 19,785 16,724
------- -------
Total....................................................... $22,975 $20,674
======= =======
</TABLE>
Total environmental expense, including provisions, charged to cost of sales
and operating expense, amounted to $9,003, $7,198 and $4,936 in 1995, 1996, and
1997, respectively.
Refinery -- Based on an inspection conducted by a U.S. EPA consultant, the
EPA issued a Notice of Violation (NOV) in June 1997 against BHP Hawaii and
BHPPAR pursuant to Section 311 of the Clean Water Act (CWA). The NOV alleged
violations of the Spill Prevention, Control and Countermeasures (SPCC)
regulations of the CWA. The Company has submitted information in response to EPA
requests. The EPA has subsequently dropped its allegations relating to the oil
releases and the parties remain engaged in settlement discussions over issues
relating to the refinery's SPCC plan.
In 1993, BHPPAR settled an administrative complaint filed by the EPA in May
1991. The complaint alleged various Resource Conservation and Recovery Act
(RCRA) violations at the refinery involving surface impoundment closure and
groundwater monitoring requirements. The settlement, embodied in a Consent
Agreement/Final Order (dated July 1993) required BHPPAR to pay a fine (which was
satisfied); conduct certain groundwater monitoring tasks and closure of the
surface impoundments (which have been done and for which final EPA approval was
received in January 1996); complete a supplemental environmental project (which
has been done); and investigate and, if required, implement Corrective Action
under RCRA in and about the refinery site (which is in progress). A report of
the investigation results, dated March 1997, was submitted to the EPA. The
majority of the costs related to the closure plans have been expended. At May
31, 1997, $1.9 million remained in other liabilities to provide for estimated
post-closure monitoring costs over a 30 year period.
Under authority of the Emergency Planning and Community Right-to-Know Act
(EPCRA), the EPA issued a Request for Information relating to past releases of
reportable quantities of regulated EPCRA substances and oil. Pertinent data and
documentation were transmitted to the EPA. A Notice of Violation (NOV) was
issued in June 1997 against BHP Hawaii and BHPPAR, alleging eight violations.
The Company has submitted further information in response. The matter remains
subject to EPA review. No penalty amounts have been assessed to date.
Under a permit application and required compliance certification submitted
by BHPPAR pursuant to Title V of the Clean Air Act (CAA), BHPPAR noted several
regulatory requirements that were not being met at the time of submission, and
included a schedule for addressing or correcting these in accordance with
application regulations. BHPPAR has implemented corrective measures to address
the foregoing items in accordance with its proposed compliance schedule. Under
authority of the CAA, the EPA asked for additional information relating to such
past non-compliance matters. BHPPAR provided the information and documents
requested. In 1996 the EPA issued a Finding of Violation (FOV) against BHP
Hawaii and BHPPAR. The parties have engaged in settlement negotiations and no
penalty amount has been assessed. It is not anticipated that any penalty imposed
or settlement concluded will have a material adverse effect on the Company's
financial condition.
Honolulu Harbor -- Properties adjacent to Honolulu Harbor have been
impacted by the conduct of a variety of industrial activities since the
beginning of this century. The HDOH, under the authority of the
F-51
<PAGE> 141
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Hawaii Environmental Response Law, requested information from various owners and
operators in the area surrounding the harbor to determine the extent of
hydrocarbon contamination. A group of owners and operators, including BHP Hawaii
Inc., on behalf of the Company, have entered into a voluntary agreement with the
HDOH to undertake an initial phase of environmental site investigation in
exchange for certain commitments from the HDOH, including the notification of
additional potentially responsible parties to participate in this activity. A
provision of $600 was accrued for the estimated costs of this initial phase. An
additional $2.8 million was accrued to perform hydrogeological studies and
groundwater monitoring in the vicinity of Pier 29 which was formerly leased and
operated by the Company.
Honolulu International Airport -- As a result of environmental site
assessments commissioned by the State of Hawaii Department of Transportation
(HDOT) in conjunction with the proposed development of properties in the
vicinity of the airport, the HDOT requested that costs be shared among certain
facility owners and operators to remedy an alleged hydrocarbon condition in the
area. At the time of the site assessment, BHPPAR operated certain aboveground
fuel tanks located near the development area. The HDOT subsequently deferred its
development plans indefinitely. BHPPAR sold its interests in the fuel tank
facilities and underlying real property to an adjacent tank farm operator which
continues to operate the facilities. To date no claims or demands have been made
against BHPPAR. The Company has accrued $1.6 million for estimated hydrocarbon
recovery and clean-up costs.
Gas Express Retail Gas Stations -- The Company has sixteen stations which
have been subject to known petroleum product releases. Of these, eight have
received "no further action" determinations from the HDOH, and one has a "no
further action" request pending. Of the remaining stations, one site has been
scheduled for demolition and the reconstruction of a new gas station facility.
Contaminated soil is to be removed at the time of demolition. Another station
has been completely reconstructed and a request for "no further action" status
is in the process of being submitted. Five remaining stations are currently
still being investigated and/or remediated in accordance with regulatory
requirements. The Company is responsible to assure proper closure of the
underground storage tank systems in compliance with regulatory requirements when
each of its stations is eventually taken out of service. As closures occur, the
Company incurs costs for the excavation of soils, the removal and disposal of
tanks, environmental site assessments and media remediation, if necessary, as
well as costs to buy-out unexpired lease commitments and write-off any
unamortized improvements. The Company has prepared cost estimates for the
closure of each site. As of May 31, 1997, total closure costs were estimated to
be $14.3 million, of which $7.7 million has been provided for. Of this amount,
$2.7 million was provided for stations with known or suspected product leakage.
The remainder of the estimated closure costs are being accrued over the
remaining terms of stations' respective leases.
Capital Expenditure Commitments
The Company had capital projects in progress at May 31, 1997, which were
expected to require an additional $11.6 million to complete.
15. SUBSEQUENT EVENTS
Sale of Company to Tesoro Petroleum Corporation -- March 1998
On March 18, 1998, the Company's stockholders entered into a stock sale
agreement with Tesoro Petroleum Corporation (Tesoro), whereby Tesoro will
purchase all of the outstanding common stock of BHPPAR and BHPPSP. The sale is
expected to close by the end of May 1998, subject to regulatory review and other
customary conditions. The price to be paid at closing amounts to $275 million in
cash (including a $5 million escrow deposit). After closing, the cash price will
be increased by the amount that net working capital sold exceeds $100 million,
or reduced by the amount that net working capital is less than $100 million. In
addition, Tesoro will issue an unsecured, non-interest bearing, promissory note
for $50 million payable in
F-52
<PAGE> 142
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
five equal annual installments of $10 million each, beginning in 2009. The note
will provide for earlier payment, depending on earnings performance of the
acquired assets.
The parties will execute a separate environmental agreement at closing,
whereby the selling stockholders will indemnify Tesoro and the Company for
environmental costs arising out of conditions which exist at, or existed prior
to, closing subject to a maximum limit of $9.5 million. The environmental
indemnity will survive for a ten-year period. Certain environmental liabilities
of the Companies will be retained by BHP and are not subject to the $9.5 million
indemnity.
As a result of the sale, the Company anticipates recognizing an estimated
loss of approximately $120-125 million. This estimated loss will increase or
decrease based on results of operations and changes in noncurrent assets and
liabilities through the closing date. Substantially all of the loss is expected
to be allocated to a further reduction in the fair value of the property, plant
and equipment.
Sale of the Gas Company -- October 1997
An affiliated Hawaii company, Gasco, Inc. (the Gas Company), was sold
effective October 31, 1997. The Gas Company provides public utility gas service
and non-utility propane (LPG) to residential and commercial customers throughout
Hawaii. The Gas Company continues to purchase naphtha, for the manufacture of
synthetic natural gas, and liquefied petroleum gas from BHPPAR under term
contracts. Sales to the Gas Company are included in sales to affiliates in the
accompanying statements of operations and in related-party information (see Note
12). Sales to the Gas Company amounted to $21.3 million in 1995, $21.4 million
in 1996, and $21.8 million in 1997.
* * * * * *
F-53
<PAGE> 143
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
COMBINED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEVEN MONTHS ENDED
DECEMBER 31,
--------------------
1996 1997
-------- --------
<S> <C> <C>
REVENUES
Sales and other revenue -- trade.......................... $520,483 $456,817
Sales and other revenue -- affiliates..................... 61,929 74,684
Other income.............................................. 3 3
-------- --------
Total Revenue..................................... 582,415 531,504
-------- --------
OPERATING COSTS AND EXPENSES
Cost of sales............................................. 504,913 460,310
Operating and selling..................................... 24,190 25,543
Depreciation and amortization (Note 4).................... 16,834 --
-------- --------
Total Operating Costs and Expenses................ 545,937 485,853
-------- --------
OPERATING INCOME............................................ 36,478 45,651
General and administrative................................ (10,325) (10,648)
Interest.................................................. (5,934) (5,802)
Capitalized interest...................................... 749 1,097
-------- --------
INCOME BEFORE INCOME TAXES.................................. 20,968 30,298
Income tax provision........................................ (8,783) (11,876)
-------- --------
NET INCOME.................................................. $ 12,185 $ 18,422
======== ========
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-54
<PAGE> 144
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
COMBINED BALANCE SHEETS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-------------------
1996 1997
-------- --------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash...................................................... $ 3,978 $ 2,704
Accounts receivable, net.................................. 59,865 45,044
Due from affiliates -- trade.............................. 7,742 7,096
Due from affiliates -- other.............................. 42,333 4,513
Inventories............................................... 63,682 84,331
Other current assets...................................... 3,700 3,539
-------- --------
Total current assets.............................. 181,300 147,227
-------- --------
PROPERTY, PLANT AND EQUIPMENT, net of accumulated
depreciation and amortization............................. 382,101 331,247
-------- --------
NON-CURRENT ASSETS
Goodwill, net of accumulated amortization (Note 4)........ 31,426 --
Other..................................................... 7,570 3,350
-------- --------
Total non-current assets.......................... 38,996 3,350
-------- --------
Total Assets...................................... $602,397 $481,824
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Cash overdraft............................................ $ 8,485 $ 4,842
Accounts payable.......................................... 18,610 10,545
Due to affiliates -- trade................................ 29,799 20,485
Capital lease obligations, current portion................ 685 1,007
Accrued liabilities....................................... 12,842 12,667
-------- --------
Total current liabilities......................... 70,421 49,546
-------- --------
NOTES PAYABLE TO AFFILIATE -- noncurrent.................... 145,000 145,000
CAPITAL LEASE OBLIGATIONS, net of current portion........... 5,496 8,751
DEFERRED INCOME TAXES....................................... 62,839 36,086
OTHER LIABILITIES........................................... 32,891 31,032
COMMITMENTS AND CONTINGENCIES (Note 7)
STOCKHOLDERS' EQUITY
Common stock, no par value, 1,000,500 shares authorized,
issued and
outstanding............................................ 8,208 8,208
Additional paid-in capital................................ 52,362 52,362
Retained earnings:
BHP Petroleum Americas Refining Inc.................... 216,490 140,517
BHP Petroleum South Pacific Inc........................ 8,690 10,322
-------- --------
Total stockholders' equity........................ 285,750 211,409
-------- --------
Total Liabilities and Stockholders' Equity........ $602,397 $481,824
======== ========
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-55
<PAGE> 145
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
COMBINED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEVEN MONTHS ENDED
DECEMBER 31,
-------------------
1996 1997
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income.................................................. $ 12,185 $ 18,422
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................. 16,834 --
Deferred income taxes..................................... (3,175) 5,427
Changes in:
Accounts receivable, net............................... (15,952) 2,631
Due from affiliates, trade and other................... (16,964) 20,412
Inventories............................................ (11,328) (467)
Other assets........................................... 2,095 2,133
Accounts payable and accrued liabilities............... 12,499 (11,855)
Due to affiliates, trade............................... 25,212 (9,448)
Other liabilities...................................... 1,145 2,492
-------- --------
Net cash provided by operating activities................. 22,551 29,747
CASH FLOWS FROM INVESTING ACTIVITIES --
Additions to property plant and equipment................. (19,195) (27,805)
CASH FLOWS FROM FINANCING ACTIVITIES --
Repayment of principal on capital leases.................. (421) (658)
-------- --------
Net increase in cash........................................ 2,935 1,284
Cash, beginning of period................................... 1,043 1,420
-------- --------
Cash, end of period......................................... $ 3,978 $ 2,704
======== ========
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-56
<PAGE> 146
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
1. ORGANIZATION
BHP Petroleum Americas Refining Inc. (BHPPAR), a Hawaii corporation, and
BHP Petroleum South Pacific Inc. (BHPPSP), a California corporation,
collectively referred to as "the Company," are affiliated companies and
wholly-owned indirect subsidiaries of The Broken Hill Proprietary Company
Limited (BHP), an Australian company. All capital and financing requirements of
the Company are provided for by BHP, except for capital and operating leases.
BHPPAR operates an oil refinery, product storage and distribution
facilities, and retail gasoline stations in the state of Hawaii. Crude oil is
purchased through other BHP affiliates and shipped to Hawaii by tanker. Refined
product exports usually are sold through other BHP affiliates. BHPPSP is a
petroleum products marketer in American Samoa, and operates the government-owned
product storage and distribution facilities. BHPPSP purchases most of its
refined products from BHPPAR.
The Companies were part of a consolidated group, Pacific Resources, Inc.
and Subsidiaries (PRI), purchased by BHP in March 1989. The purchase price was
allocated to assets and liabilities based on fair values at the acquisition
date. The purchase price in excess of fair values was reported as goodwill until
May 1997 when the refinery assets were written down to estimated fair value and
the unamortized goodwill was written off.
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
The Company's interim combined financial statements and notes thereto have
been prepared by management without audit. Accordingly, the accompanying
financial statements reflect all adjustments that, in the opinion of management,
are necessary for a fair presentation of results for the periods presented. Such
adjustments are of a normal recurring nature. Certain information and notes
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted. However,
management believes that the disclosures presented herein are adequate to make
the information not misleading.
Combined Financial Statements -- The combined financial statements include
the accounts of BHPPAR and BHPPSP. These companies are combined to present the
financial position and results of operations of BHP's downstream petroleum
refining and marketing business. The combined financial statements have been
prepared using the historical costs and results of operations of the affiliated
entities. There were no significant differences in accounting methods or their
application among the combining entities. All significant intercompany balances
and transactions between the combined entities are eliminated.
Use of Estimates and Presentation -- Preparation of the combined financial
statements, in conformity with generally accepted accounting principles,
requires management to make estimates and assumptions which affect the amounts
of assets and liabilities, and disclosure of contingencies at the date of the
financial statements, and the reported amounts of revenues and expenses during
the reporting periods. Actual results could differ from these estimates.
Financial Instruments -- The carrying amounts of financial instruments,
including cash, accounts receivable, accounts payable, and certain other current
liabilities, approximate fair value because of the short maturity of these
instruments. The carrying amounts of the Company's long-term notes payable and
other obligations approximate the Company's estimate of fair values of such
items.
Hedging Activities -- The Company periodically enters into hedging
arrangements through BHP affiliates to manage petroleum price risks and not for
speculative purposes. Gains and losses from hedging are
F-57
<PAGE> 147
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
recognized in income when the hedged transaction occurs. Historically, gains and
losses from hedging transactions have not been material.
Inventories -- Crude oil and refined products are valued at the lower of
cost or market (net realizable value). Cost is determined primarily on the
last-in, first-out (LIFO) basis. Other inventories held for sale, materials and
supplies are stated at the lower of average cost, not in excess of market.
Property, Plant and Equipment -- Property, plant and equipment is stated at
cost. Major replacements, renewals and improvements are capitalized.
Maintenance, repairs and replacements, which do not improve or extend the lives
of assets, are charged to expense. In accordance with provisions of Statement of
Financial Accounting Standards No. 121, no depreciation or amortization has been
recorded since May 1997. In previous years, depreciation and amortization,
including amortization of assets under capital leases, were computed using the
straight-line method over estimated useful lives or lease terms, if shorter.
Estimated useful lives range up to 20 years for buildings and up to 25 years for
plant and equipment.
Refinery Maintenance Turnaround Costs -- The costs of refinery unit
shutdown and maintenance turnaround costs are included in other assets and
amortized over the estimated period of benefit, generally one to three years,
depending on the process unit.
Goodwill -- Goodwill represents BHP's purchase price in excess of the fair
values of net BHPPAR assets acquired in March 1989, after providing noncurrent
deferred tax liabilities on the difference between the assets' fair values and
their income tax basis. Goodwill was amortized on a straight-line, 20 year rate
until the goodwill was determined to be without further value and was written
off in May 1997.
Income Taxes -- Deferred tax assets and liabilities are recognized for
future income tax effects of temporary differences between financial statement
carrying amounts and the related income tax bases of assets and liabilities.
Deferred income tax assets and liabilities measurements are based on enacted tax
rates expected to apply when the temporary differences are expected to be
settled. The effect of tax rate changes on deferred tax assets and liabilities
is recognized when rate changes are enacted.
Income taxes are computed and recorded as if each company were filing
separate tax returns, although BHPPAR and BHPPSP are included in different
federal and state consolidated income tax returns which include other BHP
companies in the affiliated groups. Current income tax liabilities or refunds
are settled with BHP through intercompany accounts.
Environmental Expenditures -- Environmental expenditures for current
operations are expensed or capitalized, as appropriate. Expenditures are
capitalized if they extend the useful lives of assets, increase capacity, or
mitigate or prevent environmental contamination. Expenditures are expensed if
they are for existing conditions caused by past operations, and if the
expenditures will not contribute to future revenue generation. Liabilities are
recorded when environmental assessments and/or remedial efforts are probable and
when costs can be estimated reasonably. Such amounts are based on the estimated
timing and extent of remedial actions required by regulatory agencies,
experience gained from other sites where assessments and remediation have been
completed, and the amount of the Company's estimated liability, considering
proportional liability and financial abilities of other responsible parties.
Adjustments to accrued liabilities are made as changes in conditions and
estimated costs become known.
Pension Plans and Other Post-Employment Benefits -- Pension costs are
accounted for in conformity with Statements of Financial Accounting Standards
No. 87 and 88. Funding is based on required contributions under the Employee
Retirement Income Security Act of 1974. Other post-employment benefits,
primarily medical insurance, are accounted for in conformity with Statement of
Financial Accounting Standards No. 106.
F-58
<PAGE> 148
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
3. INVENTORIES
Inventories at December 31 consisted of:
<TABLE>
<CAPTION>
1996 1997
------- -------
<S> <C> <C>
Crude oil and refined products.............................. $53,977 $75,366
Merchandise and packaged petroleum products................. 868 1,189
Materials and supplies...................................... 8,837 7,776
------- -------
Total inventories........................................... $63,682 $84,331
======= =======
</TABLE>
At December 31, 1996 and 1997, crude oil and product inventories at LIFO
cost were below current cost by approximately $16.3 million and $7.8 million,
respectively.
4. PROPERTY, PLANT AND EQUIPMENT, GOODWILL, RELATED WRITE-DOWNS, AND CHANGE IN
DEPRECIATION METHOD
In 1997 BHP developed a plan to sell the Company, engaged an investment
advisor, completed an appraisal of assets, and began discussions with potential
buyers. Management determined that net book value of refinery assets had been
impaired based in part on the appraisal. The refinery property, plant and
equipment were written down to estimated fair value in May 1997, based on an
evaluation of these assets, related operating results, and in accordance with
provisions of Statement of Financial Accounting Standards (SFAS) No. 121. The
write-down, net of accumulated depreciation, amounted to $88.8 million ($54.2
million after a $34.6 million reduction in deferred income taxes). In accordance
with SFAS No. 121, no depreciation and amortization expense has been included in
the financial statements since May 1997. BHP reached an agreement in March 1998
to sell the Company, and as a result of the sale, the Company anticipates
recognizing an estimated loss of approximately $120-125 million, in addition to
the loss recognized in May 1997 (see Note 8). Substantially all of the loss is
expected to be allocated to a further reduction in the fair value of the
property, plant and equipment.
In connection with management's determination that the carrying amount of
refinery assets had become impaired, it was also determined that goodwill had no
continuing value. Therefore, the remaining net goodwill of $30,351 ($51,636, net
of accumulated amortization of $21,285) was also written off in May 1997.
Goodwill amortization expense included in statements of operations was $1,505
for the seven months ended December 31, 1996.
5. INCOME TAXES
The income tax provisions were 42% and 39% of income before income taxes
for the seven months ended December 31, 1996 and 1997, respectively. The
effective income tax rates differed from the normal 35% Federal income tax rate
because of state income taxes and the effects of permanent differences between
book and tax income, primarily the amortization of goodwill in 1996.
6. RELATED PARTY BALANCES AND TRANSACTIONS
The Company enters into transactions with BHP-affiliated companies
primarily for petroleum operations and general financing activities. Crude oil
is purchased through BHP Petroleum affiliates in the U.S., Australia and
Singapore. Crude oil transportation costs are either included in the purchase
price or paid to an affiliated BHP Transport company. Export products are sold
through BHP Petroleum affiliates.
Sales of refined products to BHP affiliates are negotiated with reference
to current published market prices. Sales include export cargoes marketed
primarily in Asia. Also, naphtha and LPG were sold to a Hawaii
F-59
<PAGE> 149
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
gas utility affiliate (the Gas Company) under term contracts. BHP sold the Gas
Company to an unrelated company effective October 31, 1997, and continues to
sell products to the Gas Company.
Domestic (Alaskan North Slope) crude oil is purchased from a BHP Petroleum
affiliate at their cost, net of their price hedging transactions. BHPPAR also
imports crude oil, primarily from Australia and Asia, under term agreements with
BHP Petroleum affiliates, and purchase prices are determined by a formula using
current published market prices.
7. COMMITMENTS AND CONTINGENCIES
The Company is party to litigation and claims in the normal course of
business. The outcome of individual matters is not predictable. However,
management believes that the ultimate resolution of all of these matters, after
considering insurance coverages, is not likely to have a material adverse effect
on the Company's combined financial statements.
Environmental
The Company's operations are subject to various Federal and state
environmental laws and regulations. The Company has received notices of
violation or potential liability from the U.S. Environmental Protection Agency
(EPA), the State of Hawaii Department of Health (HDOH) and private parties
relating to various environmental matters associated with the Company's
ownership and/or operations of its assets. There have been no significant
changes in environmental matters disclosed in the audited financial statements
for the fiscal year ended May 31, 1997.
8. SUBSEQUENT EVENT
On March 18, 1998, the Company's stockholders entered into a stock sale
agreement with Tesoro Petroleum Corporation (Tesoro), whereby Tesoro will
purchase all of the outstanding common stock of BHPPAR and BHPPSP. The sale is
expected to close by the end of May 1998, subject to regulatory review and other
customary conditions. The price to be paid at closing amounts to $275 million in
cash (including a $5 million escrow deposit). After closing, the cash price will
be increased by the amount that net working capital sold exceeds $100 million,
or reduced by the amount that net working capital is less than $100 million. In
addition, Tesoro will issue an unsecured, non-interest bearing, promissory note
for $50 million payable in five equal annual installments of $10 million each,
beginning in 2009. The note will provide for earlier payment, depending on
earnings performance of the acquired assets.
The parties will execute a separate environmental agreement at closing,
whereby the selling stockholders will indemnify Tesoro and the Company for
environmental costs arising out of conditions which exist at, or existed prior
to, closing subject to a maximum limit of $9.5 million. The environmental
indemnity will survive for a ten-year period. Certain environmental liabilities
of the Companies will be retained by BHP and are not subject to the $9.5 million
indemnity.
As a result of the sale, the Company anticipates recognizing an estimated
loss of approximately $120-125 million. This estimated loss will increase or
decrease based on results of operations and changes in noncurrent assets and
liabilities through the closing date. Substantially all of the loss is expected
to be allocated to a further reduction in the fair value of the property, plant
and equipment.
* * * * * *
F-60
<PAGE> 150
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
COMBINED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
TEN MONTHS ENDED
MARCH 31,
--------------------
1997 1998
-------- --------
<S> <C> <C>
REVENUES
Sales and other revenue -- trade.......................... $763,454 $651,585
Sales and other revenue -- affiliates..................... 94,322 90,363
-------- --------
Total Revenue..................................... 857,776 741,948
-------- --------
OPERATING COSTS AND EXPENSES
Cost of sales............................................. 759,555 640,699
Operating and selling..................................... 36,807 36,796
Depreciation and amortization (Note 5).................... 24,288 --
Refinery assets write-down to fair value (Note 5)......... -- 125,049
-------- --------
Total Operating Costs and Expenses................ 820,650 802,544
-------- --------
OPERATING INCOME (LOSS)..................................... 37,126 (60,596)
General and administrative................................ (14,363) (15,787)
Interest.................................................. (8,491) (8,309)
Capitalized interest...................................... 1,130 1,168
-------- --------
INCOME (LOSS) BEFORE INCOME TAXES........................... 15,402 (83,524)
Income tax benefit (provision).............................. (6,908) 21,800
-------- --------
NET INCOME (LOSS)........................................... $ 8,494 $(61,724)
======== ========
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-61
<PAGE> 151
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
COMBINED BALANCE SHEETS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
ASSETS
<TABLE>
<CAPTION>
AS OF MARCH 31,
--------------------
1997 1998
-------- --------
<S> <C> <C>
CURRENT ASSETS
Cash...................................................... $ 2,066 $ 2,519
Accounts receivable, net.................................. 69,655 53,245
Due from affiliates -- trade.............................. 15,193 --
Due from affiliates -- other.............................. 16,723 31,059
Inventories............................................... 79,353 71,050
Other current assets...................................... 2,969 3,919
-------- --------
Total current assets.............................. 185,959 161,792
-------- --------
PROPERTY, PLANT AND EQUIPMENT, net of accumulated
depreciation and amortization............................. 383,734 209,804
-------- --------
NON-CURRENT ASSETS
Goodwill, net of accumulated amortization (Notes 2 & 5)... 30,781 --
Other..................................................... 7,314 3,295
-------- --------
Total non-current assets.......................... 38,095 3,295
-------- --------
Total Assets...................................... $607,788 $374,891
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Cash overdraft............................................ $ 6,953 $ 5,130
Accounts payable.......................................... 32,181 11,959
Due to affiliates -- trade................................ 22,923 29,742
Capital lease obligations, current portion................ 685 1,003
Accrued liabilities....................................... 12,340 12,901
-------- --------
Total current liabilities......................... 75,082 60,735
-------- --------
NOTES PAYABLE TO AFFILIATE -- noncurrent.................... 145,000 145,000
CAPITAL LEASE OBLIGATIONS, net of current portion........... 5,350 8,433
DEFERRED INCOME TAXES....................................... 67,794 --
OTHER LIABILITIES........................................... 32,503 29,460
COMMITMENTS AND CONTINGENCIES (Note 8)
STOCKHOLDERS' EQUITY
Common stock, no par value, 1,000,500 shares authorized,
issued and outstanding................................. 8,208 8,208
Additional paid-in capital................................ 52,362 52,362
Retained earnings:
BHP Petroleum Americas Refining Inc.................... 212,325 60,762
BHP Petroleum South Pacific Inc........................ 9,164 9,931
-------- --------
Total stockholders' equity........................ 282,059 131,263
-------- --------
Total Liabilities and Stockholders' Equity........ $607,788 $374,891
======== ========
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-62
<PAGE> 152
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
COMBINED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
TEN MONTHS ENDED
MARCH 31,
--------------------
1997 1998
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss)........................................... $ 8,494 $(61,724)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Refinery assets write-down to fair value.................. -- 125,049
Depreciation and amortization............................. 24,288 --
Deferred income taxes..................................... 1,780 (30,659)
Changes in:
Accounts receivable, net............................... (25,742) (5,570)
Due from affiliates, trade and other................... 1,195 962
Inventories............................................ (26,999) 12,814
Other assets........................................... 3,082 1,808
Accounts payable and accrued liabilities............... 24,036 (9,919)
Due to affiliates, trade............................... 18,336 (191)
Other liabilities...................................... 757 920
-------- --------
Net cash provided by operating activities......... 29,227 33,490
CASH FLOWS FROM INVESTING ACTIVITIES --
Additions to property plant and equipment................. (27,637) (31,411)
CASH FLOWS FROM FINANCING ACTIVITIES --
Repayment of principal on capital leases.................. (567) (980)
-------- --------
Net increase in cash........................................ 1,023 1,099
Cash, beginning of period................................... 1,043 1,420
-------- --------
Cash, end of period......................................... $ 2,066 $ 2,519
======== ========
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-63
<PAGE> 153
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
1. ORGANIZATION
BHP Petroleum Americas Refining Inc. (BHPPAR), a Hawaii corporation, and
BHP Petroleum South Pacific Inc. (BHPPSP), a California corporation,
collectively referred to as "the Company," are affiliated companies and
wholly-owned indirect subsidiaries of The Broken Hill Proprietary Company
Limited (BHP), an Australian company. All capital and financing requirements of
the Company are provided for by BHP, except for capital and operating leases.
BHPPAR operates an oil refinery, product storage and distribution
facilities, and retail gasoline stations in the state of Hawaii. Crude oil is
purchased through other BHP affiliates and shipped to Hawaii by tanker. Refined
product exports usually are sold through other BHP affiliates. BHPPSP is a
petroleum products marketer in American Samoa, and operates the government-owned
product storage and distribution facilities. BHPPSP purchases most of its
refined products from BHPPAR.
The Companies were part of a consolidated group, Pacific Resources, Inc.
and Subsidiaries (PRI), purchased by BHP in March 1989. The purchase price was
allocated to assets and liabilities based on fair values at the acquisition
date. The purchase price in excess of fair values was reported as goodwill until
May 1997 when the refinery assets were written down to estimated fair value and
the unamortized goodwill was written off.
2. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES
The Company's interim combined financial statements and notes thereto have
been prepared by management without audit. Accordingly, the accompanying
financial statements reflect all adjustments that, in the opinion of management,
are necessary for a fair presentation of results for the periods presented. Such
adjustments are of a normal recurring nature. Certain information and notes
normally included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted. However,
management believes that the disclosures presented herein are adequate to make
the information not misleading.
Combined Financial Statements -- The combined financial statements include
the accounts of BHPPAR and BHPPSP. These companies are combined to present the
financial position and results of operations of BHP's downstream petroleum
refining and marketing business. The combined financial statements have been
prepared using the historical costs and results of operations of the affiliated
entities. There were no significant differences in accounting methods or their
application among the combining entities. All significant intercompany balances
and transactions between the combined entities are eliminated.
Use of Estimates and Presentation -- Preparation of the combined financial
statements, in conformity with generally accepted accounting principles,
requires management to make estimates and assumptions which affect the amounts
of assets and liabilities, and disclosure of contingencies at the date of the
financial statements, and the reported amounts of revenues and expenses during
the reporting periods. Actual results could differ from these estimates.
Financial Instruments -- The carrying amounts of financial instruments,
including cash, accounts receivable, accounts payable, and certain other current
liabilities, approximate fair value because of the short maturity of these
instruments. The carrying amounts of the Company's long-term notes payable and
other obligations approximate the Company's estimate of fair values of such
items.
Hedging Activities -- The Company periodically enters into hedging
arrangements through BHP affiliates to manage petroleum price risks and not for
speculative purposes. Gains and losses from hedging are
F-64
<PAGE> 154
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
recognized in income when the hedged transaction occurs. Historically, gains and
losses from hedging transactions have not been material.
Inventories -- Crude oil and refined products are valued at the lower of
cost or market (net realizable value). Cost is determined primarily on the
last-in, first-out (LIFO) basis. Other inventories held for sale, materials and
supplies are stated at the lower of average cost, not in excess of market.
Property, Plant and Equipment -- Property, plant and equipment is stated at
cost. Major replacements, renewals and improvements are capitalized.
Maintenance, repairs and replacements, which do not improve or extend the lives
of assets, are charged to expense. The assets of the Company are held for sale
and, in accordance with provisions of Statement of Financial Accounting
Standards No. 121, the fixed assets have been written down to fair value, and no
depreciation or amortization has been recorded since May 1997. In previous
years, depreciation and amortization, including amortization of assets under
capital leases, were computed using the straight-line method over estimated
useful lives or lease terms, if shorter. Estimated useful lives range up to 20
years for buildings and up to 25 years for plant and equipment.
Refinery Maintenance Turnaround Costs -- The costs of refinery unit
shutdown and maintenance turnaround costs are included in other assets and
amortized over the estimated period of benefit, generally one to three years,
depending on the process unit.
Goodwill -- Goodwill represents BHP's purchase price in excess of the fair
values of net BHPPAR assets acquired in March 1989, after providing noncurrent
deferred tax liabilities on the difference between the assets' fair values and
their income tax basis. Goodwill was amortized on a straight-line, 20 year rate
until the goodwill was determined to be without further value and was written
off in May 1997.
Income Taxes -- Deferred tax assets and liabilities are recognized for
future income tax effects of temporary differences between financial statement
carrying amounts and the related income tax bases of assets and liabilities.
Deferred income tax assets and liabilities measurements are based on enacted tax
rates expected to apply when the temporary differences are expected to be
settled. The effect of tax rate changes on deferred tax assets and liabilities
is recognized when rate changes are enacted.
Income taxes are computed and recorded as if each company were filing
separate tax returns, although BHPPAR and BHPPSP are included in different
federal and state consolidated income tax returns which include other BHP
companies in the affiliated groups. Current income tax liabilities or refunds
are settled with BHP through intercompany accounts.
Environmental Expenditures -- Environmental expenditures for current
operations are expensed or capitalized, as appropriate. Expenditures are
capitalized if they extend the useful lives of assets, increase capacity, or
mitigate or prevent environmental contamination. Expenditures are expensed if
they are for existing conditions caused by past operations, and if the
expenditures will not contribute to future revenue generation. Liabilities are
recorded when environmental assessments and/or remedial efforts are probable and
when costs can be estimated reasonably. Such amounts are based on the estimated
timing and extent of remedial actions required by regulatory agencies,
experience gained from other sites where assessments and remediation have been
completed, and the amount of the Company's estimated liability, considering
proportional liability and financial abilities of other responsible parties.
Adjustments to accrued liabilities are made as changes in conditions and
estimated costs become known.
Pension Plans and Other Post-Employment Benefits -- Pension costs are
accounted for in conformity with Statements of Financial Accounting Standards
No. 87 and 88. Funding is based on required contributions under the Employee
Retirement Income Security Act of 1974. Other post-employment benefits,
primarily medical insurance, are accounted for in conformity with Statement of
Financial Accounting Standards No. 106.
F-65
<PAGE> 155
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
3. SALE OF THE COMPANY TO TESORO PETROLEUM CORPORATION
On March 18, 1998, the Company's stockholders entered into a stock sale
agreement with Tesoro Petroleum Corporation (Tesoro), whereby Tesoro will
purchase all of the outstanding common stock of BHPPAR and BHPPSP. The sale is
expected to close by the end of May 1998, subject to regulatory review and other
customary conditions. The price to be paid at closing amounts to $275 million in
cash (including a $5 million escrow deposit). After closing, the cash price will
be increased by the amount that net working capital sold exceeds $100 million,
or reduced by the amount that net working capital is less than $100 million. In
addition, Tesoro will issue an unsecured, non-interest bearing, promissory note
for $50 million payable in five equal annual installments of $10 million each,
beginning in 2009. The note will provide for earlier payment, depending on
earnings performance of the acquired assets.
The parties will execute a separate environmental agreement at closing ,
whereby the selling stockholders will indemnify Tesoro and the Company for
environmental costs arising out of conditions which exist at, or existed prior
to, closing subject to a maximum limit of $9.5 million. The environmental
indemnity will survive for a ten-year period. Certain environmental liabilities
of the Companies will be retained by BHP and are not subject to the $9.5 million
indemnity.
4. INVENTORIES
Inventories at March 31 consisted of:
<TABLE>
<CAPTION>
1997 1998
------- -------
<S> <C> <C>
Crude oil and refined products.............................. $69,366 $62,519
Merchandise and packaged petroleum products................. 954 1,139
Materials and supplies...................................... 9,033 7,392
------- -------
Total inventories................................. $79,353 $71,050
======= =======
</TABLE>
At March 31, 1997 crude oil and product inventories at LIFO cost were below
current cost by approximately $4.9 million. At March 31, 1998 crude oil and
product inventories were stated at estimated net realizable value which was $7.8
million less than LIFO cost.
5. PROPERTY, PLANT AND EQUIPMENT, GOODWILL, RELATED WRITE-DOWNS, AND CHANGE IN
DEPRECIATION METHOD
In 1997 BHP developed a plan to sell the Company, engaged an investment
advisor, completed an appraisal of assets, and began discussions with potential
buyers. Management determined that net book value of refinery assets had been
impaired based in part on the appraisal. The refinery property, plant and
equipment were written down to estimated fair value in May 1997, based on an
evaluation of these assets, related operating results, and in accordance with
provisions of Statement of Financial Accounting Standards (SFAS) No. 121. The
write-down, net of accumulated depreciation, amounted to $88.8 million. As
described in Note 3, BHP reached an agreement to sell the Company to Tesoro in
March 1998. Based on the provisions of the agreement, assets were written down
an additional $125.0 million. In accordance with SFAS No. 121, no depreciation
and amortization expense has been included in the financial statements since May
1997.
In connection with management's determination that the carrying amount of
refinery assets had become impaired, it was also determined that goodwill had no
continuing value. Therefore, the remaining net goodwill of $30,351 ($51,636, net
of accumulated amortization of $21,285) was also written off in May 1997.
Goodwill amortization expense included in statements of operations was $2,150
for the ten months ended March 31, 1997.
F-66
<PAGE> 156
BHP PETROLEUM AMERICAS REFINING INC.
BHP PETROLEUM SOUTH PACIFIC INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
6. INCOME TAXES
The income tax provision (benefit) was 45% and (26)% of income (loss)
before income taxes for the ten months ended March 31, 1997 and 1998,
respectively. The effective income tax rates differed from the normal 35%
Federal income tax rate because of state income taxes and the effects of
permanent differences between book and tax income, primarily the amortization of
goodwill in 1997. In 1998 the effective income tax benefit was reduced by a
valuation allowance of $10.6 million for all net deferred tax assets as of March
31, 1998. Management believes that it is more likely than not that the net
deferred tax assets will not be realized, in part due to the pending sale of the
Company.
7. RELATED PARTY BALANCES AND TRANSACTIONS
The Company enters into transactions with BHP-affiliated companies
primarily for petroleum operations and general financing activities. Crude oil
is purchased through BHP Petroleum affiliates in the U.S., Australia and
Singapore. Crude oil transportation costs are either included in the purchase
price or paid to an affiliated BHP Transport company. Export products are sold
through BHP Petroleum affiliates.
Sales of refined products to BHP affiliates are negotiated with reference
to current published market prices. Sales include export cargoes marketed
primarily in Asia. Also, naphtha and LPG were sold to a Hawaii gas utility
affiliate (the Gas Company) under term contracts. BHP sold the Gas Company to an
unrelated company effective October 31, 1997, and continues to sell products to
the Gas Company.
Domestic (Alaskan North Slope) crude oil is purchased from a BHP Petroleum
affiliate at their cost, net of their price hedging transactions. BHPPAR also
imports crude oil, primarily from Australia and Asia, under term agreements with
BHP Petroleum affiliates, and purchase prices are determined by a formula using
current published market prices.
8. COMMITMENTS AND CONTINGENCIES
The Company is party to litigation and claims in the normal course of
business. The outcome of individual matters is not predictable. However,
management believes that the ultimate resolution of all of these matters, after
considering insurance coverages, is not likely to have a material adverse effect
on the Company's combined financial statements.
The Company's operations are subject to various Federal and state
environmental laws and regulations. The Company has received notices of
violation or potential liability from the U.S. Environmental Protection Agency
(EPA), the State of Hawaii Department of Health (HDOH) and private parties
relating to various environmental matters associated with the Company's
ownership and/or operations of its assets. There have been no significant
changes in environmental matters disclosed in the audited financial statements
for the fiscal year ended May 31, 1997.
* * * * * *
F-67
<PAGE> 157
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholder of Shell Anacortes Refining Company
In our opinion, the accompanying balance sheet and the related statements of
income and shareholder's equity and of cash flows present fairly, in all
material respects, the financial position of Shell Anacortes Refining Company at
December 31, 1997 and 1996, and the results of its operations and its cash flows
for the year ended December 31, 1997 and for the period from inception (January
4, 1996) through December 31, 1996, in conformity with generally accepted
accounting principles. 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 of these
statements in accordance with generally accepted auditing standards which
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, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
/s/ PRICE WATERHOUSE LLP
Price Waterhouse LLP
Houston, Texas
May 29, 1998
F-68
<PAGE> 158
SHELL ANACORTES REFINING COMPANY
STATEMENT OF INCOME
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
FOR THE PERIOD
FROM INCEPTION FOR THE THREE MONTHS ENDED
(JANUARY 4, 1996) YEAR ENDED MARCH 31,
THROUGH DECEMBER 31, --------------------
DECEMBER 31, 1996 1997 1997 1998
----------------- ------------ -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C>
REVENUES:
Sales
Third Parties......................... $296,168 $ 544,295 $130,553 $127,513
Related Parties....................... 525,120 545,623 160,662 73,918
Interest and other income................ 732 52 120 30
-------- ---------- -------- --------
Total Revenues........................... 822,020 1,089,970 291,335 201,461
-------- ---------- -------- --------
COSTS AND EXPENSES:
Purchases of raw materials
Third Parties......................... 542,949 888,057 260,887 161,142
Related Parties....................... 153,848 61,557 11,442 19,475
Other operating expenses................. 58,352 68,750 3,000 11,025
Depreciation and amortization............ 8,607 12,715 3,101 3,703
Operating taxes.......................... 11,458 18,584 5,043 3,752
Selling, general and administrative...... 7,547 14,277 3,042 2,512
Research and development................. 1,083 1,137 357 291
Interest expense on advances............. 9 252 37 10
-------- ---------- -------- --------
783,853 1,065,329 286,909 201,910
-------- ---------- -------- --------
Income (loss) before income taxes........ 38,167 24,641 4,426 (449)
Income tax............................... 13,444 8,902 1,636 (80)
-------- ---------- -------- --------
Net income (loss)........................ $ 24,723 $ 15,739 $ 2,790 $ (369)
======== ========== ======== ========
</TABLE>
The accompanying notes are an integral part of this statement.
F-69
<PAGE> 159
SHELL ANACORTES REFINING COMPANY
BALANCE SHEET
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
AS OF AS OF AS OF
DECEMBER 31, DECEMBER 31, MARCH 31,
1996 1997 1998
------------ ------------ ------------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents............................. $ 25 $ 25 $ 25
Advances to Shell Oil Company......................... -- 6,470 --
Owing by related parties.............................. 45,991 17,512 11,313
Other receivables..................................... 1,486 363 1,287
Inventories of product and crude...................... 4,987 25,321 37,398
Inventories of materials and supplies................. 3,676 3,774 3,907
Other current assets.................................. 1,777 1,789 4,349
-------- -------- --------
Total Current Assets.......................... 57,942 55,254 58,279
Property, Plant and Equipment at cost, less
accumulated depreciation and amortization.......... 188,876 184,424 184,641
Other Noncurrent Assets............................... 7,524 8,093 8,774
-------- -------- --------
TOTAL ASSETS.................................. $254,342 $247,771 $251,694
======== ======== ========
LIABILITIES AND SHAREHOLDER'S EQUITY
Current Liabilities:
Accounts payable...................................... $ 5,601 $ 5,030 $ 6,266
Advances from Shell Oil Company....................... 5,656 -- --
Income, operating, and consumer taxes................. 4,557 1,290 952
Owing to related parties.............................. 637 380 3,553
Other current liabilities............................. 3,855 3,753 3,881
-------- -------- --------
Total Current Liabilities..................... 20,306 10,453 14,652
Long-Term Liabilities................................. 13,240 14,149 14,412
Deferred Income Taxes................................. 24,059 25,693 25,523
-------- -------- --------
Total Liabilities............................. 57,605 50,295 54,587
-------- -------- --------
Shareholder's Equity:
Common Stock:
3,000 shares authorized, issued and outstanding at
$1.00 par value.................................. 3 3 3
Additional Paid in Capital......................... 181,011 181,011 181,011
Retained Earnings.................................. 15,723 16,462 16,093
-------- -------- --------
Total Shareholder's Equity.................... 196,737 197,476 197,107
-------- -------- --------
TOTAL LIABILITIES AND SHAREHOLDER'S EQUITY.... $254,342 $247,771 $251,694
======== ======== ========
</TABLE>
The accompanying notes are an integral part of this statement.
F-70
<PAGE> 160
SHELL ANACORTES REFINING COMPANY
STATEMENT OF SHAREHOLDER'S EQUITY
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
ADDITIONAL
COMMON PAID-IN RETAINED
STOCK CAPITAL EARNINGS TOTAL
------ ---------- -------- --------
<S> <C> <C> <C> <C>
Initial Capital Contribution........................ $-- $ 1 $ -- $ 1
Contribution of Anacortes refinery net assets....... 3 181,010 -- 181,013
Net income.......................................... -- -- 24,723 24,723
Dividends........................................... -- -- (9,000) (9,000)
--- -------- -------- --------
Balance at December 31, 1996........................ 3 181,011 15,723 196,737
Net income.......................................... -- -- 15,739 15,739
Dividends........................................... -- -- (15,000) (15,000)
--- -------- -------- --------
Balance at December 31, 1997........................ 3 181,011 16,462 197,476
Net income (loss) (unaudited)....................... -- -- (369) (369)
--- -------- -------- --------
Balance at March 31, 1998 (unaudited)............... $ 3 $181,011 $ 16,093 $197,107
=== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of this statement.
F-71
<PAGE> 161
SHELL ANACORTES REFINING COMPANY
STATEMENT OF CASH FLOWS
(THOUSANDS OF DOLLARS)
<TABLE>
<CAPTION>
FROM INCEPTION THREE MONTHS ENDED
(JANUARY 4, 1996) FOR THE MARCH 31,
THROUGH YEAR ENDED --------------------
DECEMBER 31, 1996 DECEMBER 31, 1997 1997 1998
----------------- ----------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C>
Cash Flow Provided by Operating Activities:
Net income (loss).............................. $ 24,723 $ 15,739 $ 2,790 $ (369)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization.............. 8,607 12,715 3,101 3,703
Deferred income taxes...................... 2,620 1,634 1,019 (170)
(Increases) decreases in working capital:
Owing by related parties................ (33,525) 28,479 45,990 6,199
Other receivables....................... (1,419) 1,123 (22,169) (924)
Inventories of product and crude........ 1,013 (20,334) (19,170) (12,077)
Inventories of materials and supplies... 1,252 (98) (48) (133)
Other current assets.................... (447) (12) 88 (2,560)
Accounts payable........................ 2,240 (571) (1,896) 1,236
Income, operating and consumer taxes.... 3,642 (3,267) 1,462 (338)
Owing to related parties................ (1,750) (257) 6,572 3,173
Other current liabilities............... 122 (102) (594) 128
Other noncurrent items..................... 1,450 340 141 (418)
-------- -------- -------- --------
Net Cash Provided by Operating Activities...... 8,528 35,389 17,286 (2,550)
-------- -------- -------- --------
Cash Flow Used for Investing Activities:
Capital expenditures........................... (4,892) (8,157) (2,625) (3,456)
Proceeds from property sales and salvage, net
of removal costs............................. (293) (106) 20 (464)
Advances to Shell Oil Company.................. -- (6,470) (5,275) 6,470
-------- -------- -------- --------
Net Cash Used for Investing Activities......... (5,185) (14,733) (7,880) 2,550
-------- -------- -------- --------
Cash Flow Used for Financing Activities:
Proceeds from issuance of common stock......... 1 -- -- --
Dividends to shareholder....................... (9,000) (15,000) (3,750) --
Advances from Shell Oil Company................ 5,656 (5,656) (5,656) --
-------- -------- -------- --------
Net Cash Used for Financing Activities......... (3,343) (20,656) (9,406) --
-------- -------- -------- --------
Net increase in cash and cash equivalents........ $ -- $ -- $ -- $ --
======== ======== ======== ========
Cash and cash equivalents
Balance at Beginning of period................. $ 25 $ 25 $ 25 $ 25
Increase in cash and cash equivalents...... -- -- -- --
-------- -------- -------- --------
Balance at End of period....................... $ 25 $ 25 $ 25 $ 25
======== ======== ======== ========
Interest Paid.................................... $ 9 $ 252 $ 37 $ 9
======== ======== ======== ========
Income taxes paid................................ $ 28,355 $ 7,700 $ -- $ 1,000
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of this statement.
F-72
<PAGE> 162
SHELL ANACORTES REFINING COMPANY
NOTES TO FINANCIAL STATEMENTS
NOTE 1 -- ORGANIZATION
Shell Anacortes Refining Company ("the Company") was incorporated in the
state of Delaware on January 4, 1996. The total number of authorized shares for
the Company is 3,000 shares of common stock with a par value of $1 per share. On
April 1, 1996, Shell Oil Products Company ("SOPC"), a subsidiary of Shell Oil
Company ("Shell"), acquired 100 shares of common stock of the Company for
$1,000. On April 30, 1996, through a series of transactions amongst Shell
subsidiaries, the 100 shares of the Company's stock, which were previously owned
by SOPC, were transferred to Shell Refining Holdings Company ("SRHC") in
exchange for their stock.
On May 1, 1996, a series of transactions were executed amongst Shell and
certain subsidiaries of Shell which culminated in SRHC contributing the assets
and property described in the Subscription Agreement as Anacortes Refinery
Assets, comprised of property, plant and equipment, crude and product inventory,
store stock, catalysts and deferred taxes on property, plant and equipment, to
the Company in exchange for 2,900 shares of the Company's stock. Prior to May 1,
1996, the Anacortes Refinery Assets were owned by Shell. Therefore, refinery
operations for the Company effectively began on May 1, 1996 upon contribution of
the assets to the Company. The Company recorded the contributed assets at the
predecessor's book value of approximately $181,013 thousand as the assets were
contributed and ultimately held by entities under control.
On May 1, 1996, simultaneously with the contribution of the Anacortes
Refinery Assets, the Company assumed certain Shell net liabilities, as follows,
in exchange for an equal amount of cash to settle these net liabilities (in
thousands):
<TABLE>
<S> <C>
Net Working Capital Deficits................................ $ 7,066
Deferred Tax Assets......................................... (497)
Prepaid Qualified Pension Plan.............................. (7,000)
Unqualified Pension Plan Liabilities........................ 500
Other Postretirement Employee Benefits Liabilities.......... 11,900
Deferred Tax on Postretirement Liabilities.................. (1,890)
-------
Cash Received............................................... $10,079
=======
</TABLE>
The cash payment was accounted for as a component of the Revolver (See Note
3).
NOTE 2 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Uses of Estimates -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
Cash Equivalents -- Cash equivalents consist of all highly liquid
investments that are readily convertible to cash and have a maturity of three
months or less at date of acquisition.
Inventories -- Inventories of crude oil and products are valued at the
lower of cost, predominantly on a last-in, first-out (LIFO) basis, or market,
and include certain costs directly related to the production process. Materials
and supplies are carried at average cost or less.
Depreciation and Amortization -- Properties, plant and equipment are
depreciated on a straight-line basis over their estimated useful lives which
range between four and twenty years. Gains and losses are not recognized for
normal retirements of properties, plant and equipment subject to composite group
amortization or depreciation. Gains or losses from abnormal retirements or sales
are recognized currently in income. Expenditures for maintenance and repairs are
expensed as incurred.
F-73
<PAGE> 163
SHELL ANACORTES REFINING COMPANY
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Income Taxes -- The Company follows Statement of Financial Accounting
Standards ("SFAS") No. 109, "Accounting for Income Taxes". SFAS No. 109
prescribes an asset and liability approach in accounting for income taxes. It
requires that deferred tax assets and liabilities be determined using enacted
tax laws for the estimated future tax effects attributable to temporary
differences and carryforwards; the effects of future tax laws or rates are not
anticipated. Under this method, future financial results will be impacted by the
effect of future changes in income tax rates on cumulative deferred income tax
balances.
Fair Value of Financial Instruments -- The reported amounts of financial
instruments such as cash equivalents, advances to Shell Oil Company and owing by
related parties, approximate fair value because of their short maturities.
Concentration of risk -- All of the Company's trade receivables are from
Shell. Although collection of these receivables could be influenced by economic
factors affecting the petroleum industry, the risk of significant loss is
considered remote.
Impairment of Long-Lived Assets -- Statement of Financial Accounting
Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed of" requires that long-lived assets and
certain identifiable intangibles to be held and used be reviewed for impairment
whenever events or changes in circumstances indicate that the carrying amount of
affected assets may not be recoverable. Long-lived assets were tested for
impairment by comparing carrying amounts with estimated future cash flows
expected from use of the assets and from their disposition. Estimates of future
cash flows were developed utilizing internal estimates of future costs, product
prices, capital costs and salvage values. At December 31, 1996 and December 31,
1997, no impairment write-down of reported balances was necessary.
Interim Financial Data -- The interim financial data for the three months
ended March 31, 1998 and March 31, 1997 is unaudited; however, in the opinion of
the Company, the interim data includes all adjustments, consisting only of
normal recurring adjustments, necessary for a fair statement of the results for
the interim period.
NOTE 3 -- TRANSACTIONS WITH RELATED PARTIES
The Company has entered into transactions with related parties including
Shell and certain of its subsidiaries. Such transactions were in the ordinary
course of business and include the purchase, sale and transportation of crude
oil and refined products, as well as charges for certain general, administrative
and other functions performed by Shell and its affiliates for the Company. The
aggregate amounts of related party transactions during 1997 and 1996 were (in
thousands):
<TABLE>
<CAPTION>
FOR THE PERIOD
FROM INCEPTION
(JANUARY 4, 1996)
THROUGH
1997 DECEMBER 31, 1996
-------- -----------------
<S> <C> <C>
Sales and other operating revenue......................... $545,623 $525,120
Purchases and transportation.............................. 61,557 153,848
Selling, general, and administrative...................... 12,952 6,553
Research and development.................................. 1,137 1,083
Interest income on Revolver............................... 35 732
Interest expense on Revolver.............................. 252 9
</TABLE>
Purchases, Sales and Receivables
Under various agreements between Shell and the Company, Shell arranges on
behalf of the Company feedstock purchases in the Company's name from third
parties and refined product sales in the Company's name to third parties. For
feedstock purchases, Shell remits payments to the suppliers and charges the
F-74
<PAGE> 164
SHELL ANACORTES REFINING COMPANY
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Company for the cost via intercompany accounts. Pursuant to an agreement with
Shell for sales to third parties, the Company records an intercompany receivable
from Shell and Shell collects the payments from the customers on behalf of the
Company and credits the Company through the intercompany account. As a result of
this agreement, the Company has sales and purchases with third parties yet cash
on these transactions is settled via the Company's owing by/to related parties
account with Shell. Since the legal right of offset exists with Shell, trade
receivables and trade payables are reflected as a net amount within the owing
by/to related parties balance. The Company also has entered into transactions
with related parties for the purchase of feedstocks and the sale of refined
products. The related trade payables and trade receivables are also included in
the owing by/to related parties balance.
At December 31, 1997 and 1996, trade receivables and trade payables,
including the reconciliation to owing by related were as follows (in thousands):
<TABLE>
<CAPTION>
AS OF AS OF
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
Trade receivables........................................... $86,502 $111,367
Trade payables.............................................. 67,914 83,708
------- --------
Net owing by related parties balance for trade receivables
and payables.............................................. 18,588 27,659
Receivable for overpayment of taxes (see below)............. -- 17,872
Other owing by related parties, net......................... (1,076) 460
------- --------
Owing by related parties.................................... $17,512 $ 45,991
======= ========
</TABLE>
Advances with Shell
The Company is party to a Revolving Credit and Cash Management Agreement
(the "Revolver") with Shell. Under the Agreement, the Company will advance its
excess cash (including net cash resulting from the proceeds of the refining
business) to Shell, and Shell will pay the Company interest on such advances at
a rate equal to the prime rate established from time to time by The Chase
Manhattan Bank (N.A.), less one percent. In addition, under the Agreement, Shell
has irrevocably committed to make a line of credit available to the Company in
an aggregate principal amount not exceeding $40 million. The Company may draw on
this line of credit on demand. Funds advanced by Shell to the Company under this
line of credit will bear interest at the prime rate established from time to
time by The Chase Manhattan Bank (N.A.).
The funds maintained in the Revolver are liquid and available for use at
the Company's discretion. Funds advanced to Shell under the Revolver as of
December 31, 1997 amounted to $6.5 million and the interest rate on the amount
outstanding at December 31, 1997 was 7.5%. As of December 31, 1996, funds
advanced to the Company by Shell amounted to $5.7 million and the interest rate
on the amount outstanding at December 31, 1996 was 8.25%. Under the Revolver
there were amounts advanced to Shell and amounts due to Shell at various times
throughout the period from the date of commencement of the Revolver (April 1,
1996) to December 31, 1997. Interest income earned on the funds advanced to
Shell for the year ended December 31, 1997 and the period from inception
(January 4, 1996) to December 31, 1996 amounted to $35 thousand and $732
thousand, respectively. Interest expense incurred on the funds advanced from
Shell for the year ended December 31, 1997 and the period from inception
(January 4, 1996) to December 31, 1996 amounted to $252 thousand and $9
thousand, respectively.
Cost Sharing and other charges
Under the Cost Sharing Agreement between Shell and the Company, research,
development, and technology service costs related to the refining of crude oil
and other raw materials are allocated to the
F-75
<PAGE> 165
SHELL ANACORTES REFINING COMPANY
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Company based upon a percentage equal to the Company's equivalent distillation
capacity as compared to the combined capacity for all refineries participating
under the agreement. The Company is required under the agreement to pay Shell
its share of estimated research, development, and technology service costs on a
monthly basis. The Company is also charged for certain overhead administrative
expenses at rates which have been agreed upon by the Company and Shell.
Receivable for overpayment of taxes
The Company files a separate tax return; however, for the period from
inception (January 4, 1996) through December 31, 1996, the Company paid their
estimated tax liability to SRHC which then remitted the taxes for itself and
certain of its subsidiaries, including the Company, to the Internal Revenue
Service. The amount submitted by the Company exceeded their tax liability by
approximately $17 million due to estimates of the tax liability differing from
actual results. The amount due for the overpayment is recorded in the owing by
related parties balance.
NOTE 4 -- INVENTORIES OF CRUDE OILS AND REFINED PRODUCTS
Inventories are carried on a LIFO basis which was lower than current cost
by $1.6 million at December 31, 1997 and $12.3 million at December 31, 1996.
A portion of Shell's inventory was held on consignment by the Company. The
title to and ownership of such inventory is intended to remain with Shell until
purchased by the refining company in accordance with the Feedstock Consignment
Agreement. For the year ended December 31, 1997 and the period from inception
(January 4, 1996) through December 31, 1996, $13,395 thousand and $14,690
thousand, respectively, of crude and refined products were purchased from
consignment. As of December 31, 1997, all the consigned crude inventory had been
purchased by the Company with some product inventory remaining on consignment.
During the period from May 1, 1996, the date of contribution of the
Anacortes Refinery Assets, to December 31, 1996 inventory quantities were
reduced. This reduction resulted in a liquidation of LIFO inventory quantities
carried at lower costs prevailing in prior years, as the inventory was
contributed at book value, as compared with the 1996 purchases for the period
from May 1, 1996 to December 31, 1996, the effect of which decreased operating
expenses by approximately $2,825 thousand.
NOTE 5 -- PROPERTY, PLANT AND EQUIPMENT
Investments in property, plant and equipment as of December 31, 1997 and
1996, respectively, are reported at historical cost as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
------------------------------ ------------------------------
COST RESERVE* NET COST RESERVE* NET
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Land.................. $ 2,808 $ 2,808 $ 2,808 $ 2,808
Manufacturing
assets.............. 342,844 $161,228 181,616 334,693 $148,625 186,068
-------- -------- -------- -------- -------- --------
Total....... $345,652 $161,228 $184,424 $337,501 $148,625 $188,876
======== ======== ======== ======== ======== ========
</TABLE>
* Accumulated depreciation and amortization.
F-76
<PAGE> 166
SHELL ANACORTES REFINING COMPANY
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 6 -- TAXES
Operating and income taxes incurred by the Company in 1997 and 1996 were as
follows (in thousands):
<TABLE>
<CAPTION>
FOR THE PERIOD
FROM INCEPTION
(JANUARY 4, 1996)
THROUGH
DECEMBER 31,
1997 1996
------- -----------------
<S> <C> <C>
Operating Taxes
- ------------------------------------------------------------
Hazardous substance....................................... $ 8,092 $ 3,978
Business and occupation................................... 5,745 4,980
Real and personal property................................ 2,089 1,192
Payroll................................................... 1,377 657
Other..................................................... 1,281 651
------- -------
$18,584 $11,458
======= =======
Federal and Other Incomes Taxes
- ------------------------------------------------------------
Current:
Federal................................................ $ 6,758 $10,484
State.................................................. 510 340
Deferred:
Federal................................................ 1,634 2,620
------- -------
$ 8,902 $13,444
======= =======
</TABLE>
Total income tax expense for 1997 and 1996 was equivalent to an effective
tax rate of 36% and 35%, respectively. Reconciliation to the expected tax at the
U.S. statutory rate of 35% is as follows (in thousands):
<TABLE>
<CAPTION>
FOR THE PERIOD
FROM INCEPTION
(JANUARY 4, 1996)
THROUGH
DECEMBER 31,
1997 1996
------ -----------------
<S> <C> <C>
Expected tax at statutory rate.............................. $8,624 $13,358
State tax................................................... 332 221
Other....................................................... (54) (135)
------ -------
$8,902 $13,444
====== =======
</TABLE>
F-77
<PAGE> 167
SHELL ANACORTES REFINING COMPANY
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Deferred income taxes are provided for the temporary differences between
the tax basis of the Company's assets and liabilities and the amounts reported
in the financial statements. Significant components of deferred tax liabilities
and assets as of December 31, 1997 and December 31, 1996 are as follows (in
millions):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Deferred tax liabilities:
- ------------------------------------------------------------
Depreciation of properties, plant, and equipment.......... $30 $27
Other..................................................... 2 1
--- ---
Total deferred tax liabilities.................... 32 28
--- ---
Deferred tax assets:
- ------------------------------------------------------------
Other postretirement liabilities.......................... 4 4
Other..................................................... 2 --
--- ---
Total deferred tax assets......................... 6 4
--- ---
Net deferred tax liabilities...................... $26 $24
=== ===
</TABLE>
The Company has assessed the need for establishing a valuation allowance
for its deferred tax assets and has determined that such an allowance is
unnecessary.
NOTE 7 -- POSTRETIREMENT BENEFITS
The employees associated with fuels operations of the refinery became
employees of the refinery subsidiary on April 1, 1996. In participation with
Shell, the Company currently provides health care benefits for retired employees
and their dependents. Eligibility for such benefits requires retirement from the
Company with entitlement to an immediate pension generally upon the earlier of
the attainment of age 50, when such age plus years of service equals 80, or the
attainment of age 65. Other postretirement benefits provided to the employees
include life insurance benefits. These life insurance benefits are primarily
funded by employees; as a result, the cost of such benefits to the Company is
not material.
The health care benefits for retired employees and their dependents are
provided by Shell's unfunded defined benefit plans. The benefit is defined as
the Company's contributions to such plans. Annually, retirees are advised of the
amount of the Company's monthly contribution to the plans for the following year
and the monthly amount such retirees must pay for the particular coverage
desired. Retiree health care costs allocated from Shell amounted to $503
thousand in 1997 and $364 thousand in 1996. Other long-term liabilities include
$11.9 million in connection with retiree health care cost allocations as of both
December 31, 1997 and 1996.
As of May 1, 1996, the pre-existing liabilities of the refinery
subsidiaries for post-retirement benefits of $11.9 million were conveyed to the
Company in addition to an equal amount of cash to settle the net liabilities,
based on actuarial data.
F-78
<PAGE> 168
SHELL ANACORTES REFINING COMPANY
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 8 -- PENSION PLAN AND PROVIDENT FUND
The Company participates with Shell in the Shell Pension Plan (Plan), the
Benefit Restoration Plan, the Senior Staff Plan, and the Shell Provident Fund.
The Plan covers substantially all of the Company's employees. Benefits are based
on years of service and the employee's average final compensation. The prepaid
cost (accrued liability) conveyed to the Company on May 1, 1996 in addition to
an equal amount of cash to settle the net liability, based on actuarial data was
as follows (in millions):
<TABLE>
<CAPTION>
MAY 1,
1996
------
<S> <C>
Qualified Pension Plan
Employees................................................. $ 3
Pensioners and deferred vested............................ 4
----
$ 7
====
Non-qualified Pension Plan
Employees................................................. $(.3)
Pensioners and deferred vested............................ (.2)
----
$(.5)
====
</TABLE>
There were no contributions to the Shell Pension Trust since May 1, 1996
due to the full-funding limitation of the applicable law. The Benefits
Restoration Plan generally provides for payments of amounts in excess of limits
imposed by federal tax law on benefit payments under the Shell Pension Plan. The
Senior Staff Plan provides for defined monthly supplemental pension payments to
members of the senior staff (consisting of certain officers and other high
ranking employees). Both of these plans are unfunded. The Shell Provident Fund
covers employees of the Company after stated periods of service, and provides
for contributions by the employing company based on a stated percentage of the
employees' salaries and wages. Employees may also contribute amounts up to a
stated percentage. The Company's portion of the total cost of the Shell
Provident Plan and the Shell Pension Plan was $1,306 thousand and $523 thousand,
respectively, in 1997, and was $774 thousand and $540 thousand, respectively, in
1996.
NOTE 9 -- CONTINGENCIES AND OTHER MATTERS
The Company and related Shell subsidiaries are named defendants in certain
lawsuits and named parties in certain governmental proceedings arising in the
ordinary course of business. While the outcome of such contingencies, lawsuits
or other proceedings against the Company cannot be predicted with certainty,
management expects that such liability, to the extent not provided for through
insurance or otherwise, will not have material adverse effect on the financial
statements of the Company.
In connection with the commencement of operations of the Company, Shell
agreed to retain liability for, and indemnify the Company for all other
liabilities and costs arising as the result of governmental or private claims,
suits or enforcement actions, either threatened or asserted prior to May 1, 1996
or arising out of acts or incidents occurring prior to May 1, 1996, except for
environmental claims, suits or actions. As to environmental claims, suits or
actions, either private or governmental, and all other environmental costs and
expenses, Shell has agreed to indemnify the Company for all liabilities and
costs (including those for claims, suits or actions) in any year which exceed
the budgeted environmental expenditures for such year.
F-79
<PAGE> 169
SHELL ANACORTES REFINING COMPANY
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 10 -- SUBSEQUENT EVENTS
On January 15, 1998, Shell Oil and Texaco Inc. ("Texaco") reached an
agreement on the formation and operational start up of Equilon Enterprises LLC
("Equilon"). Equilon is a joint venture which combines major elements of both
companies' western and midwestern United States refining and marketing
businesses and both companies' nationwide trading, transportation and lubricants
businesses.
The Company will be sold as part of a settlement agreement with the Federal
Trade Commission involving the joint venture with Texaco. Beginning in December
1997, the Company must be held separate from all other operations within Shell
and Texaco. On May 1, 1998, Shell Oil Company entered into an agreement to sell
the stock of the Company to Tesoro Petroleum Corporation ("Tesoro"). Tesoro will
acquire the Company for $237 million plus an additional payment for net working
capital at the time of closing. The Federal Trade Commission and the states of
Oregon and Washington will have final approval of the transaction and Tesoro as
the buyer.
Also as part of Federal Trade Commission agreement, effective January 1,
1998, the Company acquired all the third parties contracts in the state of
Oregon previously held by Shell and purchased the associated inventory in the
state of Oregon.
F-80
<PAGE> 170
PROSPECTUS
TESORO PETROLEUM CORPORATION
SENIOR DEBT SECURITIES
SUBORDINATED DEBT SECURITIES
PREFERRED STOCK
DEPOSITARY SHARES
COMMON STOCK
STOCK PURCHASE CONTRACTS
STOCK PURCHASE UNITS
---------------------
TESORO CAPITAL TRUST I
TESORO CAPITAL TRUST II
TESORO CAPITAL TRUST III
TRUST PREFERRED SECURITIES
(GUARANTEED TO THE EXTENT SET FORTH HEREIN BY TESORO PETROLEUM CORPORATION)
---------------------
SUBSIDIARY GUARANTORS
(AS DEFINED HEREIN)
SUBSIDIARY GUARANTEES OF DEBT SECURITIES
Tesoro Petroleum Corporation ("Tesoro" or the "Company") may offer and sell
from time to time together or separately in one or more series its (i) unsecured
debt securities which may be senior (the "Senior Debt Securities"), senior
subordinated ("Senior Subordinated Debt Securities") or subordinated (the
"Subordinated Debt Securities" and, together with the Senior Debt Securities and
Senior Subordinated Debt Securities, the "Debt Securities") consisting of notes,
debentures or other evidences of indebtedness, (ii) shares of preferred stock,
no par value (the "Preferred Stock"), which may be issued in the terms of
depositary shares evidenced by depositary receipts (the "Depositary Shares"),
(iii) Depositary Shares, (iv) shares of common stock, par value $0.16 2/3 per
share (the "Common Stock"), (v) stock purchase contracts ("Stock Purchase
Contracts") to purchase shares of Common Stock or Preferred Stock and (vi) stock
purchase units ("Stock Purchase Units"), each representing ownership of a Stock
Purchase Contract and Trust Preferred Securities (as defined below) or debt
obligations of third parties, including U. S. Treasury securities, securing the
holder's obligation to purchase Common Stock or Preferred Stock under the Stock
Purchase Contract, or any combination of the foregoing, either individually or
as units consisting of one or more of the foregoing, in each case in amounts, at
prices and in terms to be determined at or prior to the time of sale. The
Company's payment obligations under any series of Debt Securities may be jointly
and severally guaranteed by certain of the Company's direct and indirect
wholly-owned subsidiaries (each a "Guarantor," and collectively the
"Guarantors").
Tesoro Capital Trust I, Tesoro Capital Trust II and Tesoro Capital Trust
III (individually, a "Tesoro Capital Trust" and collectively, the "Tesoro
Capital Trusts"), each a statutory business trust formed under the laws of the
State of Delaware, may offer and sell, from time to time, trust preferred
securities, representing undivided beneficial interests in the assets of the
respective Tesoro Capital Trusts ("Trust Preferred Securities"). Tesoro will be
the beneficial owner of all the beneficial ownership interests represented by
common securities of each of the Tesoro Capital Trusts (the "Trust Common
Securities" and, together with the Trust Preferred Securities, the "Trust
Securities"). Holders of the Trust Preferred Securities will be entitled to
receive preferential cumulative cash distributions accumulating from the date of
original issuance and payable periodically as specified in the applicable
supplement to this prospectus (a "Prospectus Supplement"). Subordinated Debt
Securities may be issued and sold by Tesoro from time to time in one or more
series to a Tesoro Capital Trust, or a trustee of such Tesoro Capital Trust, in
connection with the investment of the proceeds from the offering of Trust
Securities of such Tesoro Capital Trust. The Subordinated Debt Securities
purchased by a Tesoro Capital Trust may be subsequently distributed pro rata to
holders of Trust Securities in connection with the dissolution of such Tesoro
Capital Trust upon the occurrence of certain events as may be described in a
related Prospectus Supplement. The payment of distributions with respect to
Trust Preferred Securities of each of the Tesoro Capital Trusts out of monies
held by each of the Tesoro Capital Trusts, and payment on liquidation,
redemption or otherwise with respect to such Trust Preferred Securities, will be
guaranteed by Tesoro to the extent described herein (each a "Trust Guarantee").
See "Description of the Trust Guarantees." Tesoro's obligations under the Trust
Guarantees will be subordinate and junior in right of payment to all other
liabilities of Tesoro and rank pari passu with the most senior preferred stock,
if any, issued from time to time by Tesoro.
(Continued on next page)
FOR A DISCUSSION OF CERTAIN RISKS ASSOCIATED WITH AN INVESTMENT IN THE
SECURITIES AND THE TRUST PREFERRED SECURITIES, SEE "RISK FACTORS" ON PAGE 3.
---------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
---------------------
May 14, 1998
<PAGE> 171
(Continued from previous page)
The Common Stock, the Preferred Stock, the Depositary Shares, Debt
Securities, Stock Purchase Units, Stock Purchase Contracts and Trust Securities
offered hereby are collectively hereinafter referred to as the "Securities." The
Securities will be limited to an aggregate initial public offering price not to
exceed approximately $600 million, or, in the case of Debt Securities, the
equivalent thereof in one or more foreign currencies, including composite
currencies. The Securities may be offered, separately or together, in separate
series, in amounts, at prices and on terms to be determined at the time of sale
and set forth in a related Prospectus Supplement.
Certain specific terms of the particular Securities for which this
Prospectus is being delivered will be set forth in a related Prospectus
Supplement, including, where applicable, (i) in the case of Debt Securities and
the Subsidiary Guarantees thereof, the specific designation, aggregate principal
amount, authorized denominations, maturities, interest rate or rates (which may
be fixed or variable), the date or dates on which interest, if any, shall be
payable, the place or places where principal of and premium, if any, and
interest, if any, on such Debt Securities of the series will be payable, terms
of optional or mandatory redemption or any sinking fund or analogous provisions,
currency or currencies, or currency unit or currency units of denomination and
payment if other than U.S. dollars, the initial public offering price, terms
relating to temporary or permanent global securities, provisions regarding
convertibility or exchangeability, if any, provisions regarding registration of
transfer or exchange, the proceeds to the Company and other special terms; (ii)
in the case of Preferred Stock, the specific designations, the number of shares,
dividend rights (including, if applicable, the manner of calculation thereof),
and any liquidation, redemption, conversion, exchange, voting and other rights,
the initial public offering price and other special terms; (iii) in the case of
Depositary Shares, the aggregate number of Depositary Shares offered, the
fractional share of Preferred Stock represented by each such Depositary Share
and the purchase price thereof; (iv) in the case of Common Stock, the terms of
the offering and sales thereof; (v) in the case of Stock Purchase Contracts, the
number of shares of Common Stock issuable thereunder, the purchase price of the
Common Stock, the date or dates on which the Common Stock is required to be
purchased by the holders of the Stock Purchase Contracts, any periodic payments
required to be made by the Company to the holders of the Stock Purchase
Contracts or vice versa, and the terms of the offering and sale thereof, (vi) in
the case of Stock Purchase Units, the specific terms of the Stock Purchase
Contracts and any Trust Preferred Securities or debt obligations of third
parties securing the holder's obligation to purchase the Common Stock under the
Stock Purchase Contracts, and the terms of the offering and the sale thereof,
and (vii) in the case of the Trust Preferred Securities or the related Trust
Guarantees, the specific designation, aggregate offering amount, denomination,
term, coupon rate, time of payment of distributions, terms of redemption at the
option of Tesoro or repayment at the option of the holder, provisions regarding
convertibility or exchangeability for capital stock of Tesoro, the designation
of the Trustee(s) acting under the applicable Indenture or Trust Guarantee and
the public offering price.
The Securities may be offered and sold to or through underwriters, dealers,
or agents as designated from time to time, or through a combination of such
methods, and also may be offered and sold directly to one or more other
purchasers. See "Plan of Distribution." The names of, and the principal amounts
or number of shares to be purchased by, underwriters, dealers or agents, and the
compensation of such underwriters, dealers or agents, including any applicable
fees, commissions, and discounts, will be set forth in the related Prospectus
Supplement. No Securities may be sold without delivery of a Prospectus
Supplement describing such series or issue of Securities and the method and
terms of offering thereof.
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE DEBT SECURITIES,
INCLUDING STABILIZING AND SYNDICATE COVERING TRANSACTIONS. THE UNDERWRITERS MAY
OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE
OF THE SECURITIES OF THE COMPANY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE
PREVAIL IN THE OPEN MARKET. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "PLAN OF
DISTRIBUTION."
<PAGE> 172
AVAILABLE INFORMATION
The Company is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports, proxy statements and other information with the
Securities and Exchange Commission (the "Commission"). Such reports, proxy
statements and other information may be inspected and copied at the public
reference facilities maintained by the Commission at 450 Fifth Street, N.W.,
Washington, D.C. 20549, and at the following Regional Offices of the Commission:
7 World Trade Center, Suite 1300, New York, New York 10048; and Northwestern
Atrium, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661-2511.
Copies of such material also may be obtained at prescribed rates from the Public
Reference Section of the Commission, 450 Fifth Street, N.W., Washington, D.C.
20549. Such material also may be accessed electronically by means of the
Commission's home page on the Internet at http://www.sec.gov. The Common Stock
is listed for trading on the New York Stock Exchange (the "NYSE") and the
Pacific Stock Exchange (the "PSE") under the trading symbol "TSO," and reports,
proxy statements and other information concerning the Company may be inspected
at the offices of the NYSE, 20 Broad Street, New York, New York 10005, and at
the offices of the PSE, 301 Pine Street, San Francisco, California 94104.
No separate financial statements of the Tesoro Capital Trusts have been
included or incorporated by reference herein. Neither the Tesoro Capital Trusts
nor the Company considers such financial statements material to holders of Trust
Preferred Securities because (i) all of the voting securities of each Tesoro
Capital Trust will be owned, directly or indirectly, by the Company, a reporting
company under the Exchange Act, (ii) no Tesoro Capital Trust has independent
operations but rather each exists for the purpose of issuing securities
representing undivided beneficial interests in the assets of such Tesoro Capital
Trust and investing the proceeds thereof in Subordinated Debt Securities, and
(iii) the obligations of the Tesoro Capital Trusts under the Trust Preferred
Securities are fully and unconditionally guaranteed on a subordinated basis by
the Company to the extent set forth herein. See "The Tesoro Capital Trusts" and
"Description of Trust Guarantees." Upon the granting of relief by the Commission
pursuant to SAB 53, the Company intends to provide only abbreviated information
concerning the Tesoro Capital Trusts in the Company's Exchange Act reports.
This Prospectus does not contain all of the information set forth in the
Registration Statement of which this Prospectus is a part, filed with the
Commission under the Securities Act of 1933, as amended (the "Securities Act").
Reference is made to such Registration Statement for further information with
respect to the Company, the Tesoro Capital Trusts and the Securities offered
hereby. Statements contained herein concerning the provisions of documents are
necessarily summaries of such documents, and each statement is qualified in its
entirety by reference to the copy of the applicable document filed with the
Commission.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents heretofore filed with the Commission by the Company
pursuant to the Exchange Act are incorporated herein by reference:
1. The Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1997, as amended on Form 10-K/A, filed April 30, 1998.
2. The Company's Current Report on Form 8-K, dated as of May 13, 1998.
3. The description of the Common Stock included in the Company's Registration
Statement on Form 8-A dated April 21, 1969, as amended by a Form 8 dated
April 23, 1969.
All documents filed by the Company pursuant to Section 13(a), 13(c), 14 or
15(d) of the Exchange Act subsequent to the date of this Prospectus and prior to
the termination of the offering of the Securities offered hereby shall be deemed
to be incorporated by reference in this Prospectus and to be part hereof from
the date of filing of such documents. Any statement contained in a document
incorporated or deemed to be incorporated by reference herein shall be deemed to
be modified or superseded for purposes of this Prospectus to the extent that a
statement contained therein or in any other subsequently filed document which
also is or is
i
<PAGE> 173
deemed to be incorporated by reference herein modifies or supersedes such
statement. Any such statement so modified or superseded shall not be deemed,
except as so modified or superseded, to constitute a part of this Prospectus.
The Company will provide without charge to each person, including any
beneficial owner of a Security, to whom a copy of this Prospectus is delivered,
upon written or oral request of such person, a copy of any or all documents
incorporated by reference in this Prospectus (other than exhibits to such
documents unless such exhibits are specifically incorporated by reference into
such documents). Requests for such copies should be directed to Tesoro Petroleum
Corporation, 8700 Tesoro Drive, San Antonio, Texas 78217-6218, Attention: Vice
President and Treasurer, (telephone: (800) 837-6768).
CERTAIN FORWARD-LOOKING STATEMENTS
Statements in this Prospectus and the accompanying Prospectus Supplement
(including the documents incorporated by reference herein) concerning the
Company which are (a) projections of revenues, earnings, earnings per share,
capital expenditures or other financial items, (b) statements of plans and
objectives for future operations, including acquisitions, (c) statements of
future economic performance, or (d) statements of assumptions or estimates
underlying or supporting the foregoing are forward-looking statements within the
meaning of Section 27A of the Securities Act and Section 21E of the Exchange
Act. The ultimate accuracy of forward-looking statements is subject to a wide
range of business risks and changes in circumstances, and actual results and
outcomes often differ from expectations. Any number of important factors could
cause actual results to differ materially from those in the forward-looking
statements herein, including the following: the timing and extent of changes in
commodity prices and underlying demand and availability of crude oil and other
refinery feedstocks, refined products, and natural gas; actions of customers and
competitors; changes in the cost or availability of third-party vessels,
pipelines and other means of transporting feedstocks and products; state and
federal environmental, economic, safety and other policies and regulations, any
changes therein, and any legal or regulatory delays or other factors beyond the
Company's control; execution of planned capital projects; weather conditions
affecting the Company's operations or the areas in which the Company's products
are marketed; future well performance; the extent of Tesoro's success in
acquiring oil and gas properties and in discovering, developing and producing
reserves; political developments in foreign countries; the conditions of the
capital markets and equity markets during the periods covered by the forward-
looking statements; earthquakes or other natural disasters affecting operations;
adverse rulings, judgments, or settlements in litigation or other legal matters,
including unexpected environmental remediation costs in excess of any reserves;
and adverse changes in the credit ratings assigned to the Company's trade
credit. For more information with respect to the foregoing, see the Form 10-K.
The Company undertakes no obligation to publicly release the result of any
revisions to any such forward-looking statements that may be made to reflect
events or circumstances after the date hereof or to reflect the occurrence of
unanticipated events.
ii
<PAGE> 174
THE COMPANY
The Company and its subsidiaries are engaged in petroleum refining,
distributing and marketing of petroleum products, marine logistics services and
the exploration and production of natural gas and oil. These operations are
conducted through three business segments: Refining and Marketing, Exploration
and Production, and Marine Services.
The Company's Refining and Marketing segment operates a petroleum refinery
at Kenai, Alaska, markets refined products through a large network of branded
stations in Alaska and is expanding its marketing presence in the Pacific
Northwest. This segment is also a major supplier of jet fuel to the Anchorage
airport and diesel fuel to Alaska's fishing and marine industry. The Company's
Marine Services segment operates through a network of 23 marine terminals
located in Louisiana and Texas and on the West Coast, distributing petroleum
products and providing logistics services to the offshore Gulf of Mexico
drilling industry and other customers. The Company's Exploration and Production
segment focuses on exploration, development and production of natural gas and
oil onshore in Texas, Louisiana and Bolivia. The Company's net proved worldwide
reserves totaled 517 billion cubic feet equivalents of natural gas at year-end
1997. The Company is focused on its long-term strategy to maximize returns and
develop full value of its assets through strategic expansions, acquisitions and
diversifications in all three of its operating segments.
Tesoro was incorporated in Delaware in 1968 (a successor by merger to a
California corporation incorporated in 1939). Its principal executive offices
are located at 8700 Tesoro Drive, San Antonio, Texas 78217-6218 and its
telephone number is (800) 837-6768.
RECENT DEVELOPMENTS
HAWAII REFINERY ACQUISITION
On March 18, 1998, Tesoro entered into a stock sale agreement ("Hawaii
Stock Sale Agreement") to purchase (the "Hawaii Acquisition") all of the
outstanding stock of two subsidiaries of The Broken Hill Proprietary Company
Limited ("BHP") (together, "BHP Hawaii"). BHP Hawaii owns and operates a
95,000-barrel per day refinery in Kapolei, Hawaii, on the island of Oahu,
approximately 20 miles west of Honolulu, and 32 retail gasoline stations on the
islands of Oahu, Maui and Hawaii. The Hawaii Acquisition, which is subject to
regulatory review and other customary conditions, is anticipated to close on May
29, 1998. Under the terms of the Hawaii Stock Sale Agreement, the Company has
deposited $5 million into an escrow account for this acquisition.
At closing the cash purchase price for the Hawaii Acquisition is currently
estimated to be approximately $275 million less the $5 million escrow deposit.
In addition, Tesoro will issue an unsecured, non-interest bearing promissory
note (the "BHP Note") in the amount of $50 million, payable in five equal annual
installments of $10 million each, beginning on the eleventh anniversary date of
the closing. The BHP Note provides for earlier payment if the financial
performance of BHP Hawaii exceeds certain thresholds. The purchase price will be
adjusted after the closing for the amount by which the working capital of BHP
Hawaii differs from $100 million at the closing date.
In order to ensure the continuity of crude supply to Hawaii Refinery,
Tesoro will also enter into a two year agreement with an affiliate of BHP to
assist Tesoro in acquiring crude oil feedstock sources outside of North America
and arranging for transportation of such crude oil to the Hawaii Refinery.
WASHINGTON STATE REFINERY ACQUISITION
On May 1, 1998, the Company entered into a stock purchase agreement
("Anacortes Stock Purchase Agreement") with Shell Refining Holding Company
("Seller") and Shell Anacortes Refining Company ("SARC"), both subsidiaries of
Shell Oil Company, whereby the Company will purchase all of the outstanding
stock of SARC. SARC owns and operates a 108,000-barrel a day refinery in
Anacortes, Washington, which is approximately 60 miles north of Seattle. The
acquisition, which is subject to approval by the Federal Trade Commission and
the offices of the attorneys general of the States of Oregon and
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Washington as well as other customary conditions, is anticipated to close in mid
to late summer. Under the terms of the Anacortes Stock Purchase Agreement, the
Company has paid a $5 million deposit and has agreed to pay the balance of the
purchase price into an escrow by June 30, 1998 if the stock purchase has not
closed by that date.
At closing the Company will pay the Seller a cash purchase price of $237
million, less the deposit and any escrowed amounts, for the stock of SARC, plus
the value of the working capital of SARC at the time of closing which is
estimated to be approximately $60 million. The SARC Stock Purchase Agreement
contains representations and warranties and other general provisions that are
customary for transactions of this nature.
THE TESORO CAPITAL TRUSTS
Each of Tesoro Capital Trust I, Tesoro Capital Trust II and Tesoro Capital
Trust III is a statutory business trust created under Delaware law pursuant to
(i) a separate declaration of trust (each a "Declaration") executed by Tesoro,
as sponsor for such Tesoro Capital Trust (the "Sponsor"), and the Trustees (as
defined herein) for such Tesoro Capital Trust and (ii) the filing of a
certificate of trust with the Delaware Secretary of State. Each Declaration will
be qualified as an indenture under the Trust Indenture Act of 1939, as amended
(the "TIA"). Each Tesoro Capital Trust exists for the exclusive purposes of (i)
issuing and selling the Trust Securities, (ii) investing the gross proceeds from
the sale of the Trust Securities in Subordinated Debt Securities issued by
Tesoro and (iii) engaging in only those other activities necessary or incidental
thereto.
All of the Trust Common Securities issued by each of the Tesoro Capital
Trusts will be directly or indirectly owned by Tesoro. The Trust Common
Securities will rank pari passu, and payments will be made thereon pro rata,
with the Trust Preferred Securities except that upon an event of default under
the applicable Declaration, the rights of the holders of the Trust Common
Securities to payment in respect of distributions and payments upon liquidation,
redemption, and otherwise will be subordinated to the rights of the holders of
the Trust Preferred Securities. Tesoro will, directly or indirectly, acquire
Trust Common Securities in an aggregate liquidation amount equal to 3% of the
total capital of each Tesoro Capital Trust. A majority of the Trustees (the
"Regular Trustees") of each Tesoro Capital Trust will be persons who are
employees or officers of or affiliated with Tesoro. One trustee of each Tesoro
Capital Trust will be a financial institution that will be unaffiliated with
Tesoro and that will act as property trustee and as indenture trustee for
purposes of the Trust Indenture Act, pursuant to the terms set forth in a
Prospectus Supplement (the "Property Trustee"). In addition, unless the Property
Trustee maintains a principal place of business in the State of Delaware, and
otherwise meets the requirements of applicable law, one trustee of each Tesoro
Capital Trust will have its principal place of business or reside in the State
of Delaware (the "Delaware Trustee" and, together with the Regular Trustees and
the Property Trustee, the "Trustees"). Each Tesoro Capital Trust's business and
affairs will be conducted by the Trustees appointed by the Company, as the
direct or indirect holder of all the Trust Common Securities. Except in certain
limited circumstances, the holder of the Trust Common Securities will be
entitled to appoint, remove or replace any of, or increase or reduce the number
of, the Trustees of a Tesoro Capital Trust. The duties and obligations of the
Trustees shall be governed by the Declaration of each Tesoro Capital Trust. The
Company will pay all fees and expenses related to the Tesoro Capital Trusts and
the offering of Trust Securities, the payment of which will be guaranteed by the
Company. The office of the Delaware Trustee for each Tesoro Capital Trust in the
State of Delaware is Wilmington Trust Company, 1100 North Market Street,
Wilmington, Delaware 19890. The principal place of business of each Tesoro
Capital Trust shall be c/o Tesoro Petroleum Corporation, 8700 Tesoro Drive, San
Antonio 78217-6218 (telephone: (800) 837-6768).
THE SUBSIDIARY GUARANTORS
The Subsidiary Guarantors, listed on the "Table of Other Co-Registrants"
set forth immediately following the cover page of the Registration Statement of
which this Prospectus is a part, constitute substantially all of the direct and
indirect active subsidiaries of the Company, as of the date of this Prospectus.
Each or all Subsidiary Guarantors may jointly and severally guarantee the
payment obligations of the Company under any series of Debt Securities offered
by this Prospectus, as set forth in a related Prospectus Supplement.
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USE OF PROCEEDS
Unless otherwise specified in a Prospectus Supplement, the net proceeds
received by the Company from the sale of the Securities will be used to finance
acquisitions, refinance certain existing indebtedness and for general corporate
purposes. Funds not required immediately for such purposes may be invested in
marketable securities and short-term investments. The Tesoro Capital Trusts will
use all proceeds received from the sale of the Trust Preferred Securities to
purchase Subordinated Debt Securities from the Company.
RATIO OF EARNINGS TO FIXED CHARGES
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995 1994 1993
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Ratio of Earning to Fixed Charges...................... 3.61x 5.64x 3.28x 2.00x 1.97x
Ratio of Earnings to Combined Fixed Charges and
Preferred Stock Dividend Requirements................ 3.61x 5.64x 3.28x 1.80x 1.33x
</TABLE>
For purposes of calculating this ratio: (i) "fixed charges" consist of
interest expense (whether expensed or capitalized), amortization of debt
discount and issuance costs and the portion of rental expense estimated to be
equivalent to interest; and (ii) "earnings" represent earnings before income
taxes and extraordinary loss on extinguishments of debt plus fixed charges,
excluding capitalized interest.
RISK FACTORS
THE SECURITIES TO BE OFFERED HEREBY MAY INVOLVE A HIGH DEGREE OF RISK. SUCH
RISKS WILL BE SET FORTH IN THE PROSPECTUS SUPPLEMENT RELATING TO SUCH SECURITY.
IN ADDITION, CERTAIN RISK FACTORS, IF ANY, RELATING TO THE COMPANY'S BUSINESS
WILL BE SET FORTH IN A PROSPECTUS SUPPLEMENT.
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<PAGE> 177
DESCRIPTION OF DEBT SECURITIES
The following is a description of certain general terms and provisions of
the Debt Securities. The particular terms of any series of Debt Securities will
be described in the applicable Prospectus Supplement. If so indicated in a
Prospectus Supplement, the terms of any such series may differ from the terms
set forth below.
Debt Securities may be issued from time to time in one or more series by
the Company. The Debt Securities will constitute either indebtedness designated
as Senior Indebtedness ("Senior Debt Securities"), indebtedness designated as
Senior Subordinated Indebtedness ("Senior Subordinated Debt Securities") or
indebtedness designated as Subordinated Indebtedness ("Subordinated Debt
Securities"). The Company may issue Debt Securities with different terms from
those of Debt Securities previously issued without the consent of holders of
previously issued series of Debt Securities. The particular terms of each series
of Debt Securities offered by a particular Prospectus Supplement will be
described therein. Senior Debt Securities, Senior Subordinated Debt Securities
and Subordinated Debt Securities will each be issued under a separate indenture
(individually, an "Indenture" and, collectively, the "Indentures") to be entered
into prior to the issuance of such Debt Securities. See "-- Subordination".
There will be a separate Trustee (individually, a "Trustee" and, collectively,
the "Trustees") under each Indenture. Information regarding the Trustee under an
Indenture will be included in any Prospectus Supplement relating to the Debt
Securities issued thereunder.
The following discussion includes a summary description of material terms
of the Indentures, other than terms that are specific to a particular series of
Debt Securities and related Subsidiary Guarantees, if any, and that will be
described in the Prospectus Supplement relating to such series. The following
summaries do not purport to be complete and are subject to, and are qualified in
their entirety by reference to, all of the provisions of the Indentures,
including the definitions therein of certain terms capitalized in this
Prospectus. Wherever particular Sections or Articles or defined terms of the
Indentures are referred to herein or in a Prospectus Supplement, such Sections
or defined terms are incorporated herein or therein by reference.
To the extent applicable to the Debt Securities of a particular series, as
indicated in the applicable Prospectus Supplement, there are no provisions of
the Indentures that afford holders of the Debt Securities protection in the
event of a highly leveraged transaction involving the Company.
GENERAL
The Senior Debt Securities will be issued under an indenture (the "Senior
Indenture"), to be entered into among the Company, any Subsidiary Guarantors and
a Senior Indenture Trustee. The Senior Subordinated Debt Securities will be
issued under a separate Indenture (the "Senior Subordinated Indenture") to be
entered into among the Company, any Subsidiary Guarantor and a Senior
Subordinated Indenture Trustee. The Subordinated Debt Securities will be issued
under a separate indenture (the "Subordinated Indenture") also to be entered
into between the Company, any Subsidiary Guarantors and the Subordinated
Trustee. The Senior Indenture, the Senior Subordinated Indenture and the
Subordinated Indenture are sometimes collectively referred to herein as the
"Indentures" and individually as an "Indenture." The Indentures are subject to
and governed by the TIA, and may be supplemented from time to time following
execution.
The terms of the Debt Securities include those stated in the applicable
Indenture and those made part of such Indenture by reference to the TIA. The
Debt Securities are subject to all such terms, and holders of Debt Securities
are referred to the applicable Indenture and the TIA for a statement of those
terms.
The statements set forth below in this section are brief summaries of
certain provisions contained in the Indentures, do not purport to be complete,
and are subject to, and are qualified in their entirety by reference to, the
Indentures, including the definitions of certain terms therein, and the TIA.
Capitalized terms used in this section and not otherwise defined in this section
have the respective meanings assigned to them in the Indentures. For purposes of
this section, the term "Company" refers to Tesoro Petroleum Corporation only and
does not include its subsidiaries.
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<PAGE> 178
TERMS
The Debt Securities will be direct, unsecured obligations of the Company.
The indebtedness represented by the Senior Debt Securities will rank equally
with all other unsecured and unsubordinated indebtedness of the Company. The
indebtedness represented by the Senior Subordinated Securities will be
subordinated in right of payment to the prior payment in full of all Senior Debt
(as defined in a related Prospectus Supplement and the Applicable Indenture) of
the Company and senior to any future junior subordinated indebtedness of the
Company as described below under "-- Subordination." The indebtedness
represented by the Subordinated Debt Securities will be subordinated in right of
payment to the prior payment in full of the Senior Debt (as defined in a related
Prospectus Supplement and the Applicable Indenture) of the Company as described
below under "-- Subordination."
In the event Subordinated Debt Securities are issued to a Tesoro Capital
Trust or a trustee of such trust in connection with the issuance of Trust
Securities by such Tesoro Capital Trust, such Subordinated Debt Securities
subsequently may be distributed pro rata to the holders of such Trust Securities
in connection with the dissolution of such Tesoro Capital Trust upon the
occurrence of certain events described in the Prospectus Supplement relating to
such Trust Securities. Only one series of Subordinated Debt Securities will be
issued to a Tesoro Capital Trust or a trustee of such trust in connection with
the issuance of Trust Securities by such Tesoro Capital Trust.
Reference is made to the Prospectus Supplement relating to the particular
series offered thereby for the terms of such Debt Securities, including where
applicable: (a) the form and title of the Debt Securities and whether such Debt
Securities are Senior Debt Securities, Senior Subordinated Securities or
Subordinated Debt Securities; (b) the aggregate principal amount of the Debt
Securities and any limit on such aggregate principal amount; (c) the date or
dates on which the Debt Securities may be issued; (d) the date or dates on which
the principal of and premium, if any, on the Debt Securities shall be payable;
(e) the rate or rates (which may be fixed or variable) at which the Debt
Securities shall bear interest, if any, and the date or dates from which such
interest shall accrue; (f) the dates on which interest, if any, shall be payable
and the record dates for the interest payment dates; (g) the place or places
where the principal of and premium, if any, and interest, if any, on the Debt
Securities of the series will be payable; (h) the period or periods, if any,
within which, the price or prices at which, and the terms and conditions upon
which, the Debt Securities may be redeemed at the option of the Company or
otherwise; (i) any optional or mandatory redemption or any sinking fund or
analogous provisions; (j) if other than denominations of $1,000 and integral
multiples thereof, the denominations in which the Debt Securities of the series
shall be issuable; (k) if other than the principal amount thereof, the portion
of the principal amount of the Debt Securities which shall be payable upon
declaration of the acceleration of the maturity thereof in accordance with the
provisions of the applicable Indenture; (l) whether payment of the principal of
and premium, if any, and interest, if any, on the Debt Securities shall be
without deduction for taxes, assessments, or governmental charges paid by the
holders; (m) the currency or currencies, or currency unit or currency units, in
which the principal of and premium, if any, and interest, if any, on the Debt
Securities shall be denominated, payable, redeemable or purchasable, as the case
may be; (n) any Events of Default with respect to the Debt Securities that
differ from those set forth in the applicable Indenture; (o) whether the Debt
Securities will be convertible; (p) whether the Debt Securities of such series
shall be issued as a global certificate or certificates and, in such case, the
identity of the depositary for such series; (q) provisions regarding the
convertibility or exchangeability of the Debt Securities; (r) covenants
restricting the Company's and its subsidiaries' ability to make certain types of
payments and investments, incur indebtedness and dispose of assets; and (s) any
other terms not inconsistent with the provisions of the applicable Indenture.
Unless otherwise indicated in the Prospectus Supplement relating thereto,
the Debt Securities of any series will be issued only in fully registered form
in denominations of $1,000 or any integral multiple thereof. The Debt Securities
of a series may be issuable in the form of one or more global certificates,
which will be denominated in an amount equal to all or a portion of the
aggregate principal amount of such Debt Securities. See "-- Global Debt
Securities."
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<PAGE> 179
Each Indenture provides that the Debt Securities may be issued in one or
more series, in each case as established from time to time in, or pursuant to
authority granted by, a resolution of the board of directors of the Company or
as established in one or more indentures supplemental to such Indenture. All
Debt Securities of one series need not be issued at the same time and, unless
otherwise provided, a series may be reopened, without the consent of the holders
of the Debt Securities of such series, for issuances of additional Debt
Securities of such series.
One or more series of Debt Securities offered hereby may be sold at a
substantial discount below their stated principal amount, bearing no interest or
interest at a rate that at the time of issuance is below market rates. The
federal income tax consequences and special considerations applicable to any
such series of Debt Securities will be described generally in the Prospectus
Supplement relating thereto.
GLOBAL DEBT SECURITIES
The Debt Securities of a series may be issued in whole or in part in the
form of one or more global certificates that will be deposited with, or on
behalf of, a depositary (the "Global Note Depositary"), or its nominee,
identified in the Prospectus Supplement relating to such series. Unless and
until such global certificate or certificates are exchanged in whole or in part
for Debt Securities in individually certificated form, a global Debt Security
may not be transferred or exchanged except as a whole to a nominee of the Global
Note Depositary for such global Debt Security, or by a nominee for the Global
Note Depositary to the Global Note Depositary, or to a successor of the Global
Note Depositary or a nominee of such successor, except in the circumstances
described in the applicable Prospectus Supplement.
The specific terms of the depositary arrangement with respect to a series
of Debt Securities and the rights of, and limitations on, owners of beneficial
interests in a global Debt Security representing all or a portion of a series of
Debt Securities will be described in the Prospectus Supplement relating to such
series.
SUBSIDIARY GUARANTEES
The Company's payment obligations under any series of the Debt Securities
may be jointly and severally guaranteed (the "Subsidiary Guarantees") by one or
more Subsidiaries of the Company (the "Guarantors"), including the Subsidiary
Guarantors named herein. Any Subsidiary of the Company that guarantees any
Indebtedness of the Company may be required to execute a Subsidiary Guarantee
and become a Guarantor under the applicable Indenture. The terms of any such
Subsidiary Guarantee will be set forth in the applicable Prospectus Supplement.
However, the obligations of each Guarantor under its Subsidiary Guarantee will
be limited to the maximum amount the Guarantors are permitted to guarantee under
applicable law without creating a "fraudulent conveyance."
Each Indenture may restrict the consolidation or merger with or into a
Guarantor or provide for the release of a Subsidiary Guarantee, as set forth in
a related Prospectus Supplement and the Applicable Indenture.
Each of the Indentures may provide that if any Subsidiary of the Company
guarantees any Indebtedness of the Company that is not a party to the Indenture,
then such Subsidiary shall (i) execute a supplemental indenture in form and
substance satisfactory to the Trustee thereunder providing that such Subsidiary
shall become a Guarantor under the applicable Indenture and (ii) deliver an
opinion of counsel to the effect, inter alia, that such supplemental indenture
has been duly authorized and executed by such Subsidiary.
CHANGE OF CONTROL
Each of the Indentures will provide that, with respect to a series of Debt
Securities, in the event that there shall occur a Change of Control (as defined
in a related Prospectus Supplement and the Applicable Indenture), then the
Company may be required to make an Offer (as described under "-- Procedures for
Offers" below) to purchase all or any part (equal to $1,000 or an integral
multiple thereof) of each holder's Debt Securities of the applicable series at a
purchase price equal to 101% of the aggregate principal amount thereof, plus
accrued and unpaid interest to the date of purchase. Such right to require the
repurchase of Debt
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<PAGE> 180
Securities shall not continue after a discharge of the Company from its
obligations with respect to the Debt Securities. See "-- Defeasance."
A Change of Control purchase feature of a series of Debt Securities may, in
certain circumstances, make it more difficult or discourage a takeover of the
Company and, as a result, may make removal of incumbent management more
difficult. The Company has no present intention to engage in a transaction
involving a Change of Control, although it is possible that the Company could
decide to do so in the future.
If a Change of Control were to occur, the Company may not have sufficient
liquid assets to satisfy its obligation to purchase all of the Debt Securities
that might be delivered by holders seeking to exercise the purchase right and
make any payments that may become necessary, if not waived.
The provisions of each of the Indentures would not necessarily afford
holders of the Debt Securities protection in the event of a highly leveraged
transaction, reorganization, restructuring, merger or similar transaction
involving the Company that may adversely affect such holders.
COVENANTS
The particular covenants, including covenants relating to the issuance of
Subordinated Debt Securities to a Tesoro Capital Trust or a trustee of such
Tesoro Capital Trust, relating to any series of Debt Securities will be
described in the Prospectus Supplement relating to such series. If any such
covenants are described, the Prospectus Supplement will also state whether the
"covenant defeasance" provisions described below also apply.
PROCEDURES FOR OFFERS
Within 30 days following a Change of Control, the Company will mail to each
holder of Debt Securities, at such holder's registered address, a notice
stating: (i) the Offer is being made as a result of a Change of Control, the
length of time the Offer shall remain open, and the maximum aggregate principal
amount of Debt Securities that will be accepted for payment pursuant to such
Offer, (ii) the purchase price, the amount of accrued and unpaid interest as of
the Purchase Date, and the Purchase Date, (iii) the circumstances and material
facts regarding such Change of Control, to the extent known to the Company
(including, but not limited to, information with respect to pro forma and
historical financial information after giving effect to such Change of Control,
and information regarding the Person or Persons acquiring control), and (iv)
such other information required by each of the Indentures and applicable laws
and regulations.
On the Purchase Date for any Offer, the Company will (1) accept for payment
all Debt Securities tendered pursuant to such Offer, (2) deposit with the Paying
Agent the aggregate purchase price of all Debt Securities accepted for payment
and any accrued and unpaid interest on such Debt Securities as of the Purchase
Date, and (3) deliver or cause to be delivered to each of the Trustees all Debt
Securities tendered pursuant to the Offer. If less than all Debt Securities
tendered pursuant to any Offer are accepted for payment by the Company for any
reason, selection of the Debt Securities to be purchased will be in compliance
with the requirements of the principal national securities exchange, if any, on
which any series of Debt Securities is listed or, if not so listed, by lot or by
such method as each of the Trustees shall deem fair and appropriate; provided
that Debt Securities accepted for payment in part shall only be purchased in
integral multiples of $1,000. The Paying Agent will promptly mail to each holder
of Debt Securities accepted for payment an amount equal to the purchase price
for such Debt Securities plus any accrued and unpaid interest. Each of the
Trustees will promptly authenticate and mail to holders of Debt Securities
accepted for payment in part new Debt Securities equal in principal amount to
any unpurchased portion of each holder's Debt Securities, and any Debt
Securities not accepted for payment in whole or in part shall be promptly
returned to the holder thereof. On and after a Purchase Date, interest will
cease to accrue on the Debt Securities accepted for payment. The Company will
announce the results of the Offer to holders of the Debt Securities on or as
soon as practicable after the Purchase Date.
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The Company will comply with all applicable requirements of Rule 14e-1
under the Exchange Act and all other applicable securities laws and regulations
thereunder, to the extent applicable, in connection with any offer.
EVENTS OF DEFAULT
Each Indenture provides that the following will be Events of Default with
respect to any series of Debt Securities issued thereunder: (a) failure to pay
any interest on any Debt Security of such series when due, continued for 30
days; (b) failure to pay principal of (or premium, if any, on) any Debt Security
of such series when due; (c) failure to perform or comply with any covenant or
warranty of the Company contained in the Debt Securities of such series or in
the applicable Indenture, continued for 30 days after written notice as provided
in the Indenture (other than a default otherwise specifically dealt with in the
applicable Indenture or in any supplemental indenture); (d) failure to deposit a
sinking fund payment, if any, when and as due by the terms of a Debt Security of
such series; (e) except as permitted by the applicable Indenture, any Subsidiary
Guarantee shall be held in any judicial proceeding to be unenforceable or
invalid or shall cease for any reason to be in full force and effect or any
Guarantor, or any Person acting on behalf of any Guarantor, shall deny or
disaffirm its obligations under its Subsidiary Guarantee (other than by reason
of the termination of the Indenture or the release of any such Subsidiary
Guarantee in accordance with the Indenture); (f) certain events in bankruptcy,
insolvency or reorganization affecting the Company or any Guarantor; and (g) any
other Event of Default set forth in the applicable supplemental indenture and
Prospectus Supplement relating to the Debt Securities of such series.
If an Event of Default under either Indenture with respect to Debt
Securities of any series at the time outstanding shall occur and be continuing,
then in every such case either the applicable Trustee or the holders of at least
25% in aggregate principal amount of the outstanding Debt Securities of that
series may accelerate the maturity of all Debt Securities of that series;
provided, however, that after such acceleration, but before a judgment or decree
based on acceleration, the holders of a majority in aggregate principal amount
of outstanding Debt Securities of that series may, under certain circumstances,
rescind and annul such acceleration if all Events of Default, other than the
nonpayment of accelerated principal, have been cured or waived as provided in
the applicable Indenture.
Each Indenture provides that no holder of any Debt Security will have any
right to institute any proceeding with respect to the applicable Indenture or
for any remedy thereunder, unless such holder shall have previously given to the
Trustee thereunder written notice of a continuing Event of Default and unless
the holders of at least 25% in aggregate principal amount of the outstanding
Debt Securities of such series shall have made written request, and offered
reasonable indemnity, to the Trustee to institute such proceeding as Trustee,
and the Trustee shall not have received from the holders of a majority in
aggregate principal amount of the outstanding Debt Securities of such series a
direction inconsistent with such request and shall have failed to institute such
proceeding within 60 days. However, such limitations do not apply to a suit
instituted by a holder of a Debt Security for enforcement of payment of the
principal of (and premium, if any) or interest on such Debt Security on or after
the respective due dates expressed in such Debt Security.
Subject to provisions in each Indenture relating to its duties in case an
Event of Default shall have occurred and be continuing, neither Trustee is under
an obligation to exercise any of its rights or powers under such Indenture at
the request or direction of any holders of Debt Securities then outstanding
under such Indenture, unless such holders shall have offered to the Trustee
thereunder reasonable indemnity. Subject to the provisions in each Indenture for
the indemnification of the Trustee thereunder, the holders of a majority in
aggregate principal amount of the outstanding Debt Securities of any series will
have the right to direct the time, method and place of conducting any proceeding
for any remedy available to the applicable Trustee or exercising any trust or
power conferred on such Trustee.
The Company will be required to furnish to each Trustee annually a
statement as to the performance by the Company of certain of its obligations
under the applicable Indenture and as to any default in such performance.
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DEFEASANCE
Each Indenture provides that, at the option of the Company, (A) if
applicable, the Company will be discharged from any and all obligations in
respect of the Debt Securities of any series issued under such Indenture or (B)
if applicable, the Company may omit to comply with certain restrictive
covenants, and that such omission shall not be deemed to be an Event of Default
under the applicable Indenture and the Debt Securities of any series issued
thereunder, and that such Debt Securities shall no longer be subject to the
subordination provisions in the case of either (A) or (B) upon irrevocable
deposit with the applicable Trustee, in trust, of money and/or U.S. government
obligations which will provide money in an amount sufficient in the opinion of a
nationally recognized accounting firm to pay the principal of and premium, if
any, and each installment of interest, if any, on such Debt Securities. With
respect to clause (B), the obligations under the applicable Indenture other than
with respect to such covenants and the Events of Default other than the Event of
Default relating to such covenants above shall remain in full force and effect.
Such trust may only be established if, among other things (i) with respect to
clause (A), the Company has received from, or there has been published by, the
IRS a ruling or there has been a change in law, which in the Opinion of Counsel
provides that holders of such Debt Securities will not recognize gain or loss
for federal income tax purposes as a result of such deposit, defeasance and
discharge and will be subject to federal income tax on the same amount, in the
same manner and at the same times as would have been the case if such deposit,
defeasance and discharge had not occurred; or, with respect to clause (B), the
Company has delivered to the applicable Trustee an Opinion of Counsel to the
effect that the holders of such Debt Securities will not recognize gain or loss
for federal income tax purposes as a result of such deposit and defeasance and
will be subject to federal income tax on the same amount, in the same manner and
at the same times as would have been the case if such deposit and defeasance had
not occurred; (ii) no Event of Default or event that, with the passing of time
or the giving of notice, or both, shall constitute an Event of Default with
respect to such Debt Securities shall have occurred or be continuing; (iii) the
Company has delivered to the applicable Trustee an Opinion of Counsel to the
effect that such deposit shall not cause such Trustee or the trust so created to
be subject to the Investment Company Act of 1940; and (iv) certain other
customary conditions precedent.
SUBORDINATION
Upon any distribution to creditors of the Company in a liquidation,
dissolution or reorganization, the payment of the principal of and interest on
the Senior Subordinated Debt Securities and Subordinated Debt Securities will be
subordinated to the extent provided in the respective Senior Subordinated
Indenture and Subordinated Indenture in right of payment to the prior payment in
full of all Senior Debt, but the obligation of the Company to make payment of
the principal of and interest on the Senior Subordinated Debt Securities or
Subordinated Debt Securities will not otherwise be affected. Except as provided
in a Prospectus Supplement, no payment of principal or interest may be made on
the Senior Subordinated Debt Securities or Subordinated Debt Securities at any
time if a default on Senior Debt exists that permits the holders of such Senior
Debt to accelerate its maturity and the default is the subject of judicial
proceedings or the Company receives notice of the default. The Subordinated
Indenture may also provide that Subordinated Debt Securities issued thereunder
are subordinated and junior in right of payment to the prior payment in full of
all existing or future Senior Subordinated Debt Securities. After all Senior
Debt is paid in full and until the Senior Subordinated Debt Securities or
Subordinated Debt Securities (as the case may be) are paid in full, Holders will
be subrogated to the rights of holders of Senior Debt to the extent that
distributions otherwise payable to Holders have been applied to the payment of
Senior Debt. By reason of such subordination, in the event of a distribution of
assets upon insolvency, certain general creditors of the Company may recover
more, ratably, than holders of the Subordinated Debt Securities.
MODIFICATION AND WAIVER
Modifications and amendments of either Indenture may be made by the Company
and the applicable Trustee with the consent of the holders of a majority in
aggregate principal amount of all outstanding Debt Securities issued under such
Indenture which are affected by such modification or amendment; provided,
however, that no such modification or amendment may, without the consent of the
holder of each such Debt Security affected thereby, (a) change the Stated
Maturity of the principal of, or any installment of interest on,
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any such Debt Security, (b) reduce the principal amount of (or the premium), or
interest on, any such Debt Security, (c) change the place or currency of payment
of principal of (or premium), or interest on, any such Debt Security, (d) impair
the right to institute suit for the enforcement of any payment on or with
respect to any such Debt Security, (e) reduce the above-stated percentage of
outstanding Debt Securities of any series necessary to modify or amend the
applicable Indenture, (f) reduce the percentage of aggregate principal amount of
outstanding Debt Securities of any series necessary for waiver of compliance
with certain provisions of the applicable Indenture or for waiver of certain
defaults, or (g) modify any provisions of such Indenture relating to the
modification and amendment of such Indenture or the waiver of past defaults or
covenants, except as otherwise specified in a Prospectus Supplement.
The holders of a majority in aggregate principal amount of the outstanding
Debt Securities of a series may waive compliance by the Company with certain
restrictive provisions of the applicable Indenture. The holders of a majority in
aggregate principal amount of the outstanding Debt Securities of a series may
waive any past default under the applicable Indenture. In the case of any series
of Subordinated Debt Securities held as trust assets of a Tesoro Capital Trust,
the consent of the holders of all of the holders of the Preferred Trust
Securities and Common Trust Securities of such Tesoro Capital Trust may be
required under the Declaration of Trust of such Tesoro Capital Trust.
THE TRUSTEE
Both Indentures provide that, except during the continuance of an Event of
Default, the Trustee thereunder will perform only such duties as are
specifically set forth in the applicable Indenture. During the existence of an
Event of Default, the Trustee will exercise such rights and powers vested in it
under such Indenture and use the same degree of care and skill in its exercise
as a prudent person would exercise under the circumstances in the conduct of
such person's own affairs.
Both Indentures and the provisions of the TIA incorporated by reference
therein contain limitations on the rights of each of the Trustees, should it
become a creditor of the Company, to obtain payment of claims in certain cases
or to realize on certain property received by it in respect of any such claim as
security or otherwise. Each of the Trustees are permitted to engage in other
transactions with the Company or any Affiliate; provided, however, that if it
acquires any conflicting interest (as defined in the applicable Indenture or in
the TIA), it must eliminate such conflict or resign.
NO PERSONAL LIABILITY OF OFFICERS, DIRECTORS, EMPLOYEES OR STOCKHOLDERS
No director, officer, employee or stockholder, as such, of the Company or
any of its affiliates shall have any personal liability in respect of the
obligations of the Company under either of the Indentures or the Debt Securities
by reason of his, her or its status as such.
APPLICABLE LAW
The Indentures are, and the Debt Securities offered hereby will be,
governed by, and construed in accordance with, the laws of the State of New
York.
DESCRIPTION OF PREFERRED STOCK
The Company's Board of Directors, without any further action by the
stockholders of the Company, is authorized to issue up to 5,000,000 shares of
Preferred Stock, and to divide the Preferred Stock into one or more series, and
to fix by resolution or resolutions any of the designations, powers, preferences
and rights, and the qualifications, limitations, or restrictions of the shares
of each such series, including, but not limited to, dividend rates, conversion
rights, voting rights, terms of redemption and liquidation preferences, and the
number of shares constituting each such series. The issuance of Preferred Stock
may have the effect of delaying, deterring, or preventing a Change in Control of
the Company. Preferred Stock, upon issuance against full payment of the purchase
price therefor, will be fully paid and nonassessable. The specific terms of a
particular series of Preferred Stock will be described in the Prospectus
Supplement relating to that series.
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The description of the terms of the particular series of Preferred Stock set
forth in the related Prospectus Supplement does not purport to be complete and
is qualified in its entirety by reference to the certificate of designation
relating to the particular series of Preferred Stock.
The designations, powers, preferences and rights, and the qualifications,
limitations, or restrictions of the Preferred Stock of each series will be fixed
by the certificate of designation relating to such series. The Prospectus
Supplement relating to each series will specify the terms of the Preferred Stock
as follows:
(a) The maximum number of shares to constitute such series and the
distinctive designation thereof;
(b) The annual dividend rate, if any, on shares of such series,
whether such rate is fixed or variable or both, the date or dates from
which dividends will begin to accrue or accumulate, and whether dividends
will be cumulative;
(c) The price at which, and the terms and conditions on which, the
shares of such series may be redeemed, including the time during which
shares of such series may be redeemed and any accumulated dividends thereon
that the holders of shares of such series shall be entitled to receive upon
the redemption thereof;
(d) The liquidation preference, if any, and any accumulated dividends
thereon, that the holders of shares of such series shall be entitled to
receive upon the liquidation, dissolution, or winding up of the affairs of
the Company;
(e) Whether or not the shares of such series will be subject to
operation of a retirement or sinking fund, and, if so, the extent and
manner in which any such fund shall be applied to the purchase or
redemption of the shares of such series for retirement or for other
corporate purposes, and the terms and provisions relating to the operation
of such fund;
(f) The terms and conditions, if any, on which the shares of such
series shall be convertible into, or exchangeable for, debt securities,
shares of any other class or classes of capital stock of the Company, or
any series of any other class or classes, or of any other series of the
same class, including the price or prices or the rate or rates of
conversion or exchange, whether such conversion or exchange will be
mandatory and the method, if any, of adjusting the same;
(g) The voting rights, if any, on the shares of such series; and
(h) Any or all other preferences and relative, participating,
operational, or other special rights, qualifications, limitations, or
restrictions thereof.
The federal income tax consequences and special considerations applicable
to any such series of Preferred Stock will be generally described in the
Prospectus Supplement relating thereto.
DESCRIPTION OF DEPOSITARY SHARES
GENERAL
The following summary and the summary in any Prospectus Supplement of the
terms and provisions of the Depositary Shares and Depositary Receipts does not
purport to be complete and is subject to and qualified in its entirety by
reference to the applicable Deposit Agreement, which will be filed as an exhibit
to or incorporated by reference in the Registration Statement of which this
Prospectus is a part.
The Company may, at its option, elect to offer fractional interests in
shares of Preferred Stock, rather than full shares of Preferred Stock. In the
event such option is exercised, the Company will issue to the public receipts
for Depositary Shares, each of which will represent a fraction (to be set forth
in the applicable Prospectus Supplement) of a share of a particular series of
Preferred Stock as described below.
The shares of any series of Preferred Stock represented by Depositary
Shares will be deposited under a Deposit Agreement (a "Deposit Agreement")
between the Company and a bank or trust company selected by
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the Company having its principal office in the United States and having a
combined capital and surplus of at least $50,000,000 (a "Depositary"). Subject
to the terms of the Deposit Agreement, each owner of a Depositary Share will be
entitled, in proportion to the applicable fraction of a share of Preferred Stock
underlying by such Depositary Share, to all the rights and preferences of the
Preferred Stock underlying such Depositary Share (including dividend, voting,
redemption, conversion and liquidation rights).
The Depositary Shares will be evidenced by depositary receipts issued
pursuant to the Deposit Agreement ("Depositary Receipts"). Depositary Receipts
will be distributed to those persons purchasing the fractional interests in
shares of Preferred Stock in accordance with the terms of the offering.
Pending the preparation of definitive engraved Depositary Receipts, the
Depositary may, upon the written order of the Company, issue temporary
Depositary Receipts substantially identical to (and entitling the holders
thereof to all the rights pertaining to) the definitive Depositary Receipts but
not in definitive form. Definitive Depositary Receipts will be prepared
thereafter without unreasonable delay, and temporary Depositary Receipts will be
exchangeable for definitive Depositary Receipts at the Company's expense. In
addition, subject to the terms of the Deposit Agreement, holders of Depositary
Shares are entitled to withdraw and receive, upon surrender of Depositary
Receipts, certificates evidencing the fractional number of shares of Preferred
Stock (but only whole shares thereof) represented by such Depositary Receipts.
Partial shares of Preferred Stock will not be issued.
DIVIDENDS AND OTHER DISTRIBUTIONS
The Depositary will distribute all cash dividends or other cash
distributions received in respect of the Preferred Stock to the record holders
of Depositary Shares relating to such Preferred Stock in proportion to the
number of such Depositary Shares owned by such holders. The Depositary will
distribute only such amount, however, as can be distributed without attributing
to any holder of Depositary Shares a fraction of one cent, and any balance not
so distributable will be held by the Depositary (without liability for interest
thereon) and will be added to and treated as part of the next sum received by
the Depositary for distribution to record holders of Depositary Receipts then
outstanding.
In the event of a distribution other than in cash, the Depositary will
distribute property received by it to the record holders of Depositary Shares
entitled thereto, in proportion to the number of such Depositary Shares owned by
such holders, unless the Depositary determines that it is not feasible to make
such distribution, in which case the Depositary may, with the approval of the
Company, adopt such method as it deems equitable and practicable to effect such
distribution, including the sale of such property and distribution of the net
proceeds from such sale to such holders.
REDEMPTION OF DEPOSITARY SHARES
If a series of Preferred Stock represented by Depositary Shares is subject
to redemption, the Depositary Shares will be redeemed from the proceeds received
by the Depositary resulting from the redemption, in whole or in part, of such
series of Preferred Stock held by the Depositary. The redemption price per
Depositary Share will be equal to the applicable fraction of the redemption
price per share payable with respect to such series of the Preferred Stock.
Whenever the Company redeems shares of Preferred Stock held by the Depositary,
the Depositary will redeem as of the same redemption date the number of
Depositary Shares representing the shares of Preferred Stock so redeemed. If
fewer than all the Depositary Shares are to be redeemed, the Depositary Shares
to be redeemed will be selected by lot or pro rata as may be determined by the
Depositary.
VOTING THE PREFERRED STOCK
Upon receipt of notice of any meeting at which the holders of the Preferred
Stock represented by Depositary Shares are entitled to vote, the Depositary will
mail the information contained in such notice of meeting to the record holders
of the Depositary Shares relating to such Preferred Stock. Each record holder of
such Depositary Shares on the record date (which will be the same date as the
record date for the Preferred Stock) will be entitled to instruct the Depositary
as to the exercise of the voting rights pertaining to the
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amount of the Preferred Stock represented by such holder's Depositary Shares.
The Depositary will endeavor, insofar as practicable, to vote the amount of the
Preferred Stock represented by such Depositary Shares in accordance with such
instructions, and the Company will agree to take all action which may be deemed
necessary by the Depositary in order to enable the Depositary to do so. The
Depositary will abstain from voting shares of the Preferred Stock represented by
Depositary Shares to the extent it does not receive specific instructions from
the holders of Depositary Shares representing such Preferred Stock.
AMENDMENT AND TERMINATION OF THE DEPOSITARY AGREEMENT
The form of Depositary Receipt evidencing the Depositary Shares and any
provision of the Deposit Agreement may at any time and from time to time be
amended by agreement between the Company and the Depositary. However, any
amendment that materially and adversely alters the rights of the holders of
Depositary Shares will not be effective unless such amendment has been approved
by the holders of at least a majority of the Depositary Shares then outstanding
under such Deposit Agreement. Each Deposit Agreement will provide that each
holder of Depositary Shares at the time any such amendment becomes effective
that continues to hold such Depositary Shares will be deemed to have consented
to such amendment and will be bound thereby. A Deposit Agreement may be
terminated by the Company or the Depositary only if (i) all outstanding
Depositary Shares relating thereto have been redeemed or (ii) there has been a
final distribution in respect of the Preferred Stock underlying such Depositary
Shares in connection with any liquidation, dissolution or winding up of holdings
and such distribution has been distributed to the holders of the related
Depositary Receipts.
CHARGES OF DEPOSITARY
The Company will pay all transfer and other taxes and governmental charges
arising solely from the existence of the depositary arrangements. The Company
will pay charges of any Depositary in connection with the initial deposit of the
Preferred Stock and the initial issuance of the Depositary Shares and any
redemption or conversion of the Preferred Stock. Holders of Depositary Receipts
will pay other transfer and other taxes and governmental charges and such other
charges, including a fee for the withdrawal of shares of Preferred Stock upon
surrender of Depositary Receipts, as are expressly provided in the relevant
Deposit Agreement to be for their accounts.
MISCELLANEOUS
The Depositary will forward to holders of Depositary Receipts all reports
and communications from the Company that are delivered to the Depositary and
which the Company is required to furnish to the holders of the Preferred Stock.
Neither any Depositary nor the Company will assume any obligation or will
be subject to any liability under a Deposit Agreement to holders of the
Depositary Shares other than for its negligence or willful misconduct. Neither
any Depositary nor the Company will be liable if it is prevented or delayed by
law or any circumstance beyond its control in performing its obligations under a
Deposit Agreement. The obligations of the Company and any Depositary under a
Deposit Agreement will be limited to performance in good faith of their duties
thereunder, and they will not be obligated to prosecute or defend any legal
proceeding in respect of any Depositary Shares or Preferred Stock unless
satisfactory indemnity is furnished. The Company and any Depositary may rely on
written advice of counsel or accountants, on information provided by persons
presenting Preferred Stock for deposit, holders of Depositary Shares or other
persons believed in good faith to be competent to give such information and on
documents believes to be genuine and to have been signed or presented by the
proper party or parties.
RESIGNATION AND REMOVAL OF DEPOSITARY
A Depositary may resign at any time by delivering to the Company notice of
its election to do so, and the Company may at any time remove any Depositary,
any such resignation or removal to take effect upon the appointment of a
successor Depositary and its acceptance of such appointment. Such successor
Depositary
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must be appointed within 60 days after delivery of the notice of resignation or
removal and must be a bank or trust company having its principal office in the
United States of America and having a combined capital and surplus of at least
$50,000,000.
DESCRIPTION OF COMMON STOCK
The Company's Certificate of Incorporation, as amended, currently
authorizes the Company to issue up to 50,000,000 shares of Common Stock. The
holders of Common Stock are entitled to one vote for each share held of record
on all matters submitted to a vote of stockholders. Subject to preferences that
may be applicable to any outstanding Preferred Stock, holders of Common Stock
are entitled to receive ratably such dividends as may be declared by the Board
of Directors of the Company out of funds legally available therefor. In the
event of a liquidation, dissolution, or winding up of the Company, holders of
Common Stock are entitled to share ratably in all assets remaining after payment
of liabilities and liquidation preference of any outstanding Preferred Stock.
Holders of Common Stock have no preemptive rights and have no rights to convert
their Common Stock into any other securities. There are no redemption provisions
with respect to any shares of Common Stock. All of the outstanding shares of
Common Stock are, and the Common Stock offered hereby will be, upon issuance
against full payment of the purchase price therefor, fully paid and
nonassessable. As of April 22, 1998 there were issued and outstanding 26,668,910
shares of Common Stock.
The transfer agent and registrar for the Common Stock is ChaseMellon
Shareholder Services L.L.C.
DESCRIPTION OF THE STOCK PURCHASE CONTRACTS
AND THE STOCK PURCHASE UNITS
The Company may issue Stock Purchase Contracts, including contracts
obligating holders to purchase from the Company, and the Company to sell to the
holders, a specified number of shares of Common Stock or Preferred Stock at a
future date or dates. The consideration per share of Common Stock or Preferred
Stock may be fixed at the time of the Stock Purchase Contracts are issued or may
be determined by reference to a specific formula set forth in the Stock Purchase
Contracts. Any such formula may include anti-dilution provisions to adjust the
number of shares issuable pursuant to such Stock Purchase Contracts upon the
occurrence of certain events. The Stock Purchase Contracts may be issued
separately or as a part of Stock Purchase Units consisting of a Stock Purchase
Contract and Debt Securities, Trust Preferred Securities or debt obligations of
third parties, including U. S. Treasury securities, securing the holders'
obligations to purchase the Common Stock or Preferred Stock under the Stock
Purchase Contracts. The Stock Purchase Contracts may require the Company to make
periodic payments to the holders of the Stock Purchase Contracts or vice versa,
and such payments may be unsecured or prefunded on some basis. The Stock
Purchase Contracts may require holders to secure their obligations thereunder in
a specified manner.
The applicable Prospectus Supplement will describe the terms of any Stock
Purchase Contracts or Stock Purchase Units. The description in the Prospectus
Supplement will not necessarily be complete, and reference will be made to the
Stock Purchase Contracts, and, if applicable, collateral arrangements and
depository arrangements, relating to such Stock Purchase Contracts or Stock
Purchase Units.
DESCRIPTION OF THE TRUST PREFERRED SECURITIES
Each Tesoro Capital Trust may issue, from time to time, only one series of
Trust Preferred Securities having terms described in the Prospectus Supplement
relating thereto. The Declaration of each Tesoro Capital Trust authorizes the
Regular Trustees of such Tesoro Capital Trust to issue on behalf of such Tesoro
Capital Trust one series of Trust Preferred Securities. The Declaration will be
qualified as an indenture under the TIA. The Trust Preferred Securities will
have such terms, including distributions, redemption, voting, conversion,
exchange, liquidation rights and such other preferred, deferred or other special
rights or such restrictions as shall be set forth in the Declaration or made
part of the Declaration by the Trust Indenture Act. Reference is made to the
Prospectus Supplement relating to the Trust Preferred Securities of the Tesoro
Capital Trust for specific terms, including (a) the distinctive designation of
such Trust Preferred Securities;
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(b) the number of Trust Preferred Securities issued by such Tesoro Capital
Trust; (c) the annual distribution rate (or method of determining such rate) for
Trust Preferred Securities issued by such Tesoro Capital Trust and the date or
dates upon which such distributions shall be payable; provided, however, that
distributions on such Trust Preferred Securities shall be payable on a quarterly
basis to holders of such Trust Preferred Securities as of a record date in each
quarter during which such Trust Preferred Securities are outstanding; (d)
whether distributions on Trust Preferred Securities issued by such Tesoro
Capital Trust shall be cumulative, and, in the case of Trust Preferred
Securities having such cumulative distribution rights, the date or dates or
method of determining the date or dates from which distributions on Trust
Preferred Securities issued by such Tesoro Capital Trust shall be cumulative;
(e) the amount or amounts which shall be paid out of the assets of such Tesoro
Capital Trust to the holders of Trust Preferred Securities of such Tesoro
Capital Trust upon voluntary or involuntary dissolution, winding-up or
termination of such Tesoro Capital Trust; (f) the obligation, if any, of such
Tesoro Capital Trust to purchase or redeem Trust Preferred Securities issued by
such Tesoro Capital Trust and the price or prices at which, the period or
periods within which, and the terms and conditions upon which, Trust Preferred
Securities issued by such Tesoro Capital Trust shall be purchased or redeemed,
in whole or in part, pursuant to such obligation; (g) the voting rights, if any,
of Trust Preferred Securities issued by such Tesoro Capital Trust in addition to
those required by law, including the number of votes per Trust Preferred
Security and any requirement for the approval by the holders of Trust Preferred
Securities, or of Trust Preferred Securities issued by one or more Tesoro
Capital Trusts, or of both, as a condition to specified action or amendments to
the Declaration of such Tesoro Capital Trust; (h) the terms and conditions, if
any, upon which the assets of such Tesoro Capital Trust may be distributed to
holders of Trust Preferred Securities; (i) provisions regarding convertibility
or exchangeability of the Trust Preferred Securities for capital stock of
Tesoro; (j) if applicable, any securities exchange upon which the Trust
Preferred Securities shall be listed; and (k) any other relevant rights,
preferences, privileges, limitations or restrictions of Trust Preferred
Securities issued by such Tesoro Capital Trust not inconsistent with the
Declaration of such Tesoro Capital Trust or with applicable law. All Trust
Preferred Securities offered hereby will be guaranteed by the Company to the
extent set forth below under "Description of the Trust Guarantees." Any U.S.
federal income tax considerations applicable to any offering of Trust Preferred
Securities will be described in the Prospectus Supplement relating thereto.
In connection with the issuance of Trust Preferred Securities, each Tesoro
Capital Trust will issue one series of Trust Common Securities. The Declaration
of each Tesoro Capital Trust authorizes the Regular Trustees of such trust to
issue on behalf of such Tesoro Capital Trust one series of Trust Common
Securities having such terms including distributions, redemption, voting,
liquidation rights or such restrictions as shall be set forth therein. The terms
of the Trust Common Securities issued by a Tesoro Capital Trust will be
substantially identical to the terms of the Trust Preferred Securities issued by
such Tesoro Capital Trust, and the Trust Common Securities will rank pari passu,
and payments will be made thereon pro rata, with the Trust Preferred Securities
except that, upon an event of default under the Declaration, the rights of the
holders of the Trust Common Securities to payment in respect of distributions
and payments upon liquidation, redemption and otherwise will be subordinated to
the rights of the holders of the Trust Preferred Securities. Except in certain
limited circumstances, the Trust Common Securities will also carry the right to
vote to appoint, remove or replace any of the Trustees of a Tesoro Capital
Trust. All of the Trust Common Securities of each Tesoro Capital Trust will be
directly or indirectly owned by the Company.
DESCRIPTION OF THE TRUST GUARANTEES
Set forth below is a summary of information concerning the Trust Guarantees
which will be executed and delivered by Tesoro from time to time for the benefit
of the holders of the Trust Preferred Securities. Each Trust Guarantee will be
qualified as an indenture under the Trust Indenture Act. Wilmington Trust
Company will act as indenture trustee under each Trust Guarantee (the "Trust
Guarantee Trustee"). The terms of each Trust Guarantee will be those set forth
in such Trust Guarantee and those made part of such Trust Guarantee by the Trust
Indenture Act. The summary does not purport to be complete and is subject in all
respects to the provisions of, and is qualified in its entirety by reference to,
the form of Trust Guarantee, which is filed as an exhibit to the Registration
Statement of which this Prospectus forms a part, and the Trust Indenture Act.
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Each Trust Guarantee will be held by the Trust Guarantee Trustee for the benefit
of the holders of the Trust Preferred Securities of the applicable Tesoro
Capital Trust.
GENERAL
Pursuant to each Trust Guarantee, Tesoro will irrevocably and
unconditionally agree, to the extent set forth therein, to pay in full, to the
holders of the Trust Preferred Securities issued by a Tesoro Capital Trust, the
Trust Guarantee Payments (as defined herein) (except to the extent paid by such
Tesoro Capital Trust), as and when due, regardless of any defense, right of
set-off or counterclaim which such Tesoro Capital Trust may have or assert. The
following payments with respect to Trust Preferred Securities issued by a Tesoro
Capital Trust to the extent not paid by such Tesoro Capital Trust (the "Trust
Guarantee Payments"), will be subject to the Trust Guarantee thereon (without
duplication): (i) any accrued and unpaid distributions which are required to be
paid on such Trust Preferred Securities, to the extent such Tesoro Capital Trust
shall have funds available therefor; (ii) the redemption price, including all
accrued and unpaid distributions (the "Redemption Price"), to the extent such
Tesoro Capital Trust has funds available therefor with respect to any Trust
Preferred Securities called for redemption by such Tesoro Capital Trust; and
(iii) upon a voluntary or involuntary dissolution, winding-up or termination of
such Tesoro Capital Trust (other than in connection with the distribution of the
assets of such Tesoro Capital Trust to the holders of Trust Preferred Securities
or the redemption of all of the Trust Preferred Securities), the lesser of (a)
the aggregate of the liquidation amount and all accrued and unpaid distributions
on such Trust Preferred Securities to the date of payment, to the extent such
Tesoro Capital Trust has funds available therefor and (b) the amount of assets
of such Tesoro Capital Trust remaining available for distribution to holders of
such Trust Preferred Securities in liquidation of such Tesoro Capital Trust.
Tesoro's obligation to make a Trust Guarantee Payment may be satisfied by direct
payment of the required amounts by the Company to the holders of Trust Preferred
Securities or by causing the applicable Tesoro Capital Trust to pay such amounts
to such holders.
Each Trust Guarantee will be a full and unconditional guarantee with
respect to the Trust Preferred Securities issued by the applicable Tesoro
Capital Trust, but will not apply to any payment of distributions except to the
extent such Tesoro Capital Trust shall have funds available therefor. If Tesoro
does not make interest payments on the Subordinated Debt Securities purchased by
a Tesoro Capital Trust, such Tesoro Capital Trust will not pay distributions on
the Trust Preferred Securities issued by such Tesoro Capital Trust and will not
have funds available therefor. See "Description of the Subordinated Debt
Securities -- Certain Covenants."
Tesoro has also agreed separately to irrevocably and unconditionally
guarantee the obligations of the Tesoro Capital Trusts with respect to the Trust
Common Securities (the "Trust Common Securities Guarantees") to the same extent
as the Trust Guarantees, except that upon an event of default under the
Subordinated Indenture, holders of Trust Preferred Securities shall have
priority over holders of Trust Common Securities with respect to distributions
and payments on liquidation, redemption or otherwise.
CERTAIN COVENANTS
In each Trust Guarantee, Tesoro will covenant that, so long as any Trust
Preferred Securities issued by the applicable Tesoro Capital Trust remain
outstanding, if there shall have occurred any event that would constitute an
event of default under such Trust Guarantee or the Declaration of such Tesoro
Capital Trust, then (a) Tesoro shall not declare or pay any dividend on, make
any distributions with respect to, or redeem, purchase or make any liquidation
payment with respect to, any of its capital stock (other than (i) purchases or
acquisitions of shares of Tesoro Common Stock in connection with the
satisfaction by Tesoro of its obligations under any employee benefit plans or
the satisfaction by Tesoro of its obligations pursuant to any contract or
security requiring Tesoro to purchase shares of Company Common Stock or, (ii)
the purchase of fractional interests in shares of Company capital stock as a
result of a reclassification of Company capital stock or the exchange or
conversion of one class or series of Company capital stock for another class or
series of Company capital stock or make any guarantee payments with respect to
the foregoing and (b) Tesoro shall not make any payment of interest, principal
or premium, if any, on or repay, repurchase or redeem any debt securities
(including guarantees) issued by Tesoro which rank pari passu with or junior to
the Subordinated Debt Securities.
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MODIFICATION OF THE TRUST GUARANTEES; ASSIGNMENT
Except with respect to any changes which do not adversely affect the rights
of holders of Trust Preferred Securities (in which case no vote will be
required), each Trust Guarantee may be amended only with the prior approval of
the holders of not less than a majority in liquidation amount of the outstanding
Trust Preferred Securities issued by the applicable Tesoro Capital Trust. The
manner of obtaining any such approval of holders of such Trust Preferred
Securities will be as set forth in an accompanying Prospectus Supplement. All
guarantees and agreements contained in a Trust Guarantee shall bind the
successors, assigns, receivers, trustees and representatives of Tesoro and shall
inure to the benefit of the holders of the Trust Preferred Securities of the
applicable Tesoro Capital Trust then outstanding.
TERMINATION
Each Trust Guarantee will terminate as to the Trust Preferred Securities
issued by the applicable Tesoro Capital Trust upon the first to occur of (a)
full payment of the Redemption Price of all Trust Preferred Securities of such
Tesoro Capital Trust, (b) distribution of the assets of such Tesoro Capital
Trust to the holders of the Trust Preferred Securities of such Tesoro Capital
Trust, and (c) full payment of the amounts payable upon liquidation of such
Tesoro Capital Trust in accordance with the Declaration of such Tesoro Capital
Trust. Each Trust Guarantee will continue to be effective or will be reinstated,
as the case may be, if at any time any holder of Trust Preferred Securities
issued by the applicable Tesoro Capital Trust must restore payment of any sums
paid under such Trust Preferred Securities or such Trust Guarantee.
EVENTS OF DEFAULT
An event of default under a Trust Guarantee will occur upon the failure of
Tesoro to perform any of its payment or other obligations thereunder.
The holders of a majority in liquidation amount of the Trust Preferred
Securities relating to such Trust Guarantee have the right to direct the time,
method and place of conducting any proceeding for any remedy available to the
Trust Guarantee Trustee in respect of the Trust Guarantee or to direct the
exercise of any trust or power conferred upon the Trust Guarantee Trustee under
such Trust Preferred Securities. If the Trust Guarantee Trustee fails to enforce
such Trust Guarantee, any holder of Trust Preferred Securities relating to such
Trust Guarantee may institute a legal proceeding directly against Tesoro to
enforce the Trust Guarantee Trustee's rights under such Trust Guarantee, without
first instituting a legal proceeding against the relevant Tesoro Capital Trust,
the Trust Guarantee Trustee or any other person or entity. Notwithstanding the
foregoing, if Tesoro has failed to make a guarantee payment, a holder of Trust
Preferred Securities may directly institute a proceeding against Tesoro for
enforcement of the Trust Guarantee for such payment. Tesoro waives any right or
remedy to require that any action be brought first against such Tesoro Capital
Trust or any other person or entity before proceeding directly against Tesoro.
STATUS OF THE TRUST GUARANTEES
The Trust Guarantees will constitute unsecured obligations of Tesoro and
will rank (i) subordinate and junior in right of payment to all other
liabilities of Tesoro; (ii) pari passu with the most senior preferred or
preference stock now or hereafter issued by Tesoro and with any guarantee now or
hereafter entered into by Tesoro in respect of any preferred or preference stock
of any affiliate of Tesoro; and (iii) senior to the Tesoro Common Stock. The
terms of the Trust Preferred Securities provide that each holder of Trust
Preferred Securities issued by the applicable Tesoro Capital Trust, by
acceptance thereof, agrees to the subordination provisions and other terms of
the Trust Guarantee relating thereto.
The Trust Guarantees will constitute a guarantee of payment and not of
collection (that is, the guaranteed party may institute a legal proceeding
directly against the guarantor to enforce its rights under the Trust Guarantee
without instituting a legal proceeding against any other person or entity).
INFORMATION CONCERNING THE TRUST GUARANTEE TRUSTEE
The Trust Guarantee Trustee, prior to the occurrence of a default with
respect to a Trust Guarantee, undertakes to perform only such duties as are
specifically set forth in such Trust Guarantee and, after default,
17
<PAGE> 191
shall exercise the same degree of care as a prudent individual would exercise in
the conduct of his or her own affairs. Subject to such provisions, the Trust
Guarantee Trustee is under no obligation to exercise any of the powers vested in
it by a Trust Guarantee at the request of any holder of Trust Preferred
Securities, unless offered reasonable indemnity against the costs, expenses and
liabilities which might be incurred thereby.
The Company and certain of its affiliates may, from time to time, maintain
a banking relationship with the Trust Guarantee Trustee.
GOVERNING LAW
The Trust Guarantees will be governed by, and construed in accordance with,
the laws of the State of New York.
RELATIONSHIP AMONG THE TRUST PREFERRED SECURITIES,
THE SUBORDINATED DEBT SECURITIES AND THE TRUST GUARANTEES
As long as Tesoro makes payments of interest and other payments when due on
the Subordinated Debt Securities, such payments will be sufficient to cover
distributions and other payments due on the Trust Preferred Securities,
primarily because (i) the aggregate principal amount of the Subordinated Debt
Securities will be equal to the sum of the aggregate stated liquidation
preference of the Trust Securities; (ii) the interest rate and interest and
other payment dates of the Subordinated Debt Securities will match the
distribution rate and distribution and other payment dates for the Trust
Preferred Securities; (iii) Tesoro shall pay for all and any costs, expenses and
liabilities of the Tesoro Capital Trusts except the Tesoro Capital Trusts'
obligations to holders of the Trust Preferred Securities under the Trust
Preferred Securities of the Tesoro Capital Trusts; and (iv) the Declaration of
each Tesoro Capital Trust further provides that such Tesoro Capital Trust will
not engage in any activity that is not consistent with the limited purposes of
such Tesoro Capital Trust.
Payments of distributions and other amounts due on the Trust Preferred
Securities of a Tesoro Capital Trust (to the extent such Tesoro Capital Trust
has funds available for the payment of such distributions) are irrevocably
guaranteed by Tesoro as and to the extent set forth under "Description of Trust
Guarantees." Taken together, Tesoro's obligations under the Subordinated Debt
Securities, the Subordinated Indenture, the Declarations of the Tesoro Capital
Trusts and the Trust Guarantees provide a full, irrevocable and unconditional
guarantee of payments of distributions and other amounts due on the Trust
Preferred Securities. No single document standing alone or operating in
conjunction with fewer than all of the other documents constitutes such
guarantee. It is only the combined operation of these documents that has the
effect of providing a full, irrevocable and unconditional guarantee of each of
the Tesoro Capital Trust's obligations under the Trust Preferred Securities. If
and to the extent that Tesoro does not make payments on the Subordinated Debt
Securities, the Tesoro Capital Trusts will not pay distributions or other
amounts due on the Trust Preferred Securities. The Trust Guarantees do not cover
payment of distributions when a Tesoro Capital Trust does not have sufficient
funds to pay such distributions. In such event, the remedies of a holder of the
Trust Preferred Securities of such Tesoro Capital Trust are described herein
under "Description of the Trust Guarantees -- Events of Default." The
obligations of Tesoro under the Trust Guarantees are subordinate and junior in
right of payment to all Senior Indebtedness of Tesoro.
Notwithstanding anything to the contrary in the Subordinated Indenture and
to the extent set forth therein, Tesoro has the right to set-off any payment it
is otherwise required to make thereunder with and to the extent Tesoro has
theretofore made, or is concurrently on the date of such payment making, a
payment under a Trust Guarantee.
A holder of Trust Preferred Securities of a Tesoro Capital Trust may
institute a legal proceeding directly against Tesoro to enforce its rights under
the Trust Guarantee with respect to such Tesoro Capital Trust without first
instituting a legal proceeding against the Trust Guarantee Trustee, such Tesoro
Capital Trust or any other person or entity.
18
<PAGE> 192
The Trust Preferred Securities of a Tesoro Capital Trust evidence a
beneficial interest in such Tesoro Capital Trust. The Tesoro Capital Trusts
exist for the sole purpose of issuing the Trust Securities and investing the
proceeds thereof in Subordinated Debt Securities. A principal difference between
the rights of a holder of Trust Preferred Securities and a holder of
Subordinated Debt Securities is that a holder of Subordinated Debt Securities is
entitled to receive from Tesoro the principal amount of and interest accrued on
Subordinated Debt Securities held, while a holder of Trust Preferred Securities
is entitled to receive distributions from a Tesoro Capital Trust (or from Tesoro
under the Trust Guarantee) if and to the extent such Tesoro Capital Trust has
funds available for the payment of such distributions.
Upon any voluntary or involuntary termination, winding-up or liquidation of
a Tesoro Capital Trust involving the liquidation of the Subordinated Debt
Securities, the holders of the Trust Preferred Securities of such Tesoro Capital
Trust will be entitled to receive, out of assets held by such Tesoro Capital
Trust and after satisfaction of liabilities to creditors of such Tesoro Capital
Trust as provided by applicable law, the liquidation distribution in cash. See
"Description of Trust Preferred Securities." Upon any voluntary or involuntary
liquidation or bankruptcy of Tesoro, the Property Trustee of a Tesoro Capital
Trust, as holder of the Subordinated Debt Securities of such Trust, would be a
subordinated creditor of Tesoro, subordinated in right of payment to all Senior
Indebtedness of Tesoro, but entitled to receive payment in full of principal and
interest, before any shareholders of Tesoro receive payments or distributions.
Since Tesoro is the guarantor under the Trust Guarantees and has agreed to pay
for all costs, expenses and liabilities of the Tesoro Capital Trusts (other than
the Tesoro Capital Trusts' obligations to the holders of the Trust Preferred
Securities), the positions of a holder of Trust Preferred Securities and a
holder of Subordinated Debt Securities relative to other creditors and to
shareholders of Tesoro in the event of liquidation or bankruptcy of Tesoro would
be substantially the same.
A default or event of default under any Senior Indebtedness of Tesoro will
not constitute a default or Event of Default under the Subordinated Indenture.
However, in the event of payment defaults under, or acceleration of, Senior
Indebtedness of Tesoro, the subordination provisions of the Subordinated
Indenture provide that no payments may be made in respect of the Subordinated
Debt Securities until such Senior Indebtedness has been paid in full or any
payment default thereunder has been cured or waived. Failure to make required
payments on the Subordinated Debt Securities would constitute an Event of
Default under the Subordinated Indenture with respect thereto.
PLAN OF DISTRIBUTION
The Company and any Tesoro Capital Trust may offer or sell the Securities
and the Trust Preferred Securities, respectively, to or through one or more
underwriters, dealers or agents as designated from time to time, or through a
combination of such methods and also may offer or sell the Securities and the
Trust Preferred Securities, respectively, directly to one or more other
purchasers. The Company and any Tesoro Capital Trust may sell the Securities and
the Trust Preferred Securities, respectively, as soon as practicable after
effectiveness of the Registration Statement of which this Prospectus is a part.
A Prospectus Supplement will set forth the terms of the offering of the
particular series of Securities offered thereby, including: (i) the name or
names of any underwriters or agents; (ii) the initial public offering or
purchase price of such series of Securities; (iii) any underwriting discounts,
commissions, and other items constituting underwriters' compensation and any
other discount, concessions, or commissions allowed or reallowed or paid by any
underwriters to other dealers; (iv) any commissions paid to any agents; (v) the
net proceeds to the Company from the sales; (vi) the net proceeds to a Tesoro
Capital Trust; and (vii) any securities exchanges or markets on which the
Securities may be listed.
Unless otherwise set forth in the Prospectus Supplement relating to a
particular series of Securities, the obligations of the underwriters to purchase
such series of Securities will be subject to certain conditions precedent and
each of the underwriters with respect to such series of Securities will be
obligated to purchase all of the Securities of such series allocated to it if
any such Securities are purchased. Any initial public offering price and any
discounts or concessions allowed, reallowed, or paid to dealers may be changed
from time to time.
19
<PAGE> 193
The Securities may also be offered and sold, if so indicated in the
applicable Prospectus Supplement, in connection with a remarketing upon their
purchase, in accordance with a redemption or repayment pursuant to their terms,
or otherwise, by one or more firms ("remarketing firms"), acting as principals
for their own accounts or as agents for the Company or the Tesoro Capital Trust,
as applicable. Any remarketing firm will be identified and the terms of its
agreement, if any, with the Company or the Tesoro Capital Trust, and its
compensation will be described in the applicable Prospectus Supplement.
Remarketing firms may be deemed to be underwriters, as that term is defined in
the Securities Act, in connection with the Securities remarketed thereby.
The Securities may be offered and sold by the Company or any Tesoro Capital
Trust, respectively, directly or through agents designated by the Company or any
Tesoro Capital Trust from time to time. Unless otherwise indicated in the
related Prospectus Supplement, each such agent will be acting on a best efforts
basis for the period of its appointment. Any agent participating in the
distribution of Securities may be deemed to be an "underwriter," as that term is
defined in the Securities Act, of the Securities so offered and sold. The
Securities also may be sold to dealers at the applicable price to the public set
forth in the Prospectus Supplement relating to such series of Securities. Such
dealers may be deemed to be "underwriters" within the meaning of the Securities
Act. Underwriters, dealers and agents may be entitled, under agreements entered
into with the Company or a Tesoro Capital Trust, to indemnification by the
Company or such Tesoro Capital Trust against certain civil liabilities,
including liabilities under the Securities Act.
Underwriters, dealers and agents may engage in transactions with, or
perform services for, or be customers of, the Company in the ordinary course of
business.
Other than the Common Stock, Preferred Stock and Senior Debt Securities,
all Securities offered will be a new issue of securities with no established
trading market. Any underwriter to whom Securities are sold by the Company for
public offering and sale may make a market in such Securities, but such
underwriters will not be obligated to do so and may discontinue any market
making at any time without notice. The Securities may or may not be listed on a
national securities exchange or a foreign securities exchange, except that the
Common Stock is listed for trading on the NYSE and the PSE. Any Common Stock
sold pursuant to a Prospectus Supplement will be listed for trading on the NYSE
and the PSE, subject to official notice of issuance. No assurance can be given
as to the liquidity of or the trading markets for any Securities.
LEGAL MATTERS
The validity of the Securities will be passed upon for the Company and the
Trusts by Fulbright & Jaworski L.L.P., Washington, D.C. Certain matters of
Delaware law relating to the validity of the Trust Preferred Securities will be
passed upon for the Company and the Tesoro Capital Trusts by ,
Wilmington, Delaware, special Delaware counsel to the Company and the Tesoro
Capital Trusts. If the Securities are being distributed in an underwritten
offering, the validity of the Securities will be passed upon for the
underwriters by counsel identified in the related Prospectus Supplement.
EXPERTS
The consolidated financial statements incorporated in this Prospectus by
reference from the Company's Annual Report on Form 10-K for the year ended
December 31, 1997 have been audited by Deloitte & Touche LLP, independent
auditors, as stated in their report, which is incorporated herein by reference,
and have been so incorporated in reliance upon the report of such firm given
upon their authority as experts in accounting and auditing.
The information incorporated in this Prospectus by reference from the
Company's Annual Report on Form 10-K for the year ended December 31, 1997
relating to estimated proved reserves of oil and gas and the related estimates
of future net cash flows and present values thereof as of December 31, 1995,
December 31, 1996 and December 31, 1997 have been prepared by Netherland, Sewell
& Associates, Inc., independent petroleum engineers, and are incorporated by
reference herein upon the authority of such firm as an expert in petroleum
engineering.
20
<PAGE> 194
[map reflecting the locations of certain of the Company's operations]
UPSTREAM
DOMESTIC EXPLORATION AND PRODUCTION Domestically, the Company's Exploration and
Production operations are focused in Louisiana and Texas. The Company has net
proved reserves in the U.S. of more than 150 Bcfe located in four core areas:
the Wilcox Trend in South Texas, the Val Verde Basin in Southwest Texas, the
Frio/Vicksburg Trend along the U.S. Gulf Coast and the East Texas Basin.
LATIN AMERICAN EXPLORATION AND PRODUCTION Internationally, the Company's
Exploration and Production operations are focused in Bolivia. The Company has
proved reserves in Bolivia of more than 366 Bcfe. A significant portion of the
Company's Bolivian proved developed reserves is currently shut-in due to limited
access to markets. However, during 1997, third parties commenced construction on
a new 1,900-mile gas pipeline from Bolivia to Brazil, which the Company believes
will significantly increase the market for its Bolivian production.
<PAGE> 195
======================================================
No person has been authorized to give any information or to make any
representations in connection with this offering other than those contained in
this Prospectus Supplement, and, if given or made, such other information or
representations must not be relied upon as having been authorized by the Company
or any Underwriter. Neither the delivery of this Prospectus Supplement nor any
sale made hereunder shall, under any circumstances, create any implication that
there has been no change in the affairs of the Company since the date hereof or
that the information contained herein is correct as of any time subsequent to
its date. This Prospectus Supplement does not constitute an offer to sell or a
solicitation of an offer to buy any securities other than the securities to
which it relates. This Prospectus Supplement does not constitute an offer to
sell or the solicitation of an offer to buy such securities in any circumstances
in which such offer or solicitation is unlawful.
---------------------------
TABLE OF CONTENTS
Prospectus Supplement
<TABLE>
<CAPTION>
Page
----
<S> <C>
Summary...................................... S-1
Forward-Looking Statements................... S-13
Risk Factors................................. S-14
Use of Proceeds.............................. S-23
Capitalization............................... S-24
Pro Forma Financial Statements............... S-25
Selected Historical Financial Data........... S-31
Management's Discussion and Analysis of
Financial Condition and Results of
Operations................................. S-33
Business..................................... S-51
Management................................... S-71
Principal Stockholders....................... S-74
Description of Indebtedness.................. S-77
Description of Capital Stock................. S-81
Underwriting................................. S-85
Legal Matters................................ S-86
Experts...................................... S-86
Index to Financial Statements................ F-1
Prospectus
Available Information........................ i
Incorporation of Certain Documents by
Reference.................................. i
Certain Forward-Looking Statements........... ii
The Company.................................. 1
Recent Developments.......................... 1
The Tesoro Capital Trusts.................... 2
The Subsidiary Guarantors.................... 2
Use of Proceeds.............................. 3
Ratio of Earnings to Fixed Charges........... 3
Risk Factors................................. 3
Description of Debt Securities............... 4
Description of Preferred Stock............... 10
Description of Depositary Shares............. 11
Description of Common Stock.................. 14
Description of the Stock Purchase Contracts
and the Stock Purchase Units............... 14
Description of the Trust Preferred
Securities................................. 14
Description of the Trust Guarantees.......... 15
Relationship Among the Trust Preferred
Securities, the Subordinated Debt
Securities and the Trust Guarantees........ 18
Plan of Distribution......................... 19
Legal Matters................................ 20
Experts...................................... 20
</TABLE>
======================================================
======================================================
5,000,000 SHARES
TESORO LOGO
TESORO PETROLEUM
CORPORATION
COMMON STOCK
---------------------------
PROSPECTUS SUPPLEMENT
June 26, 1998
---------------------------
LEHMAN BROTHERS
CIBC OPPENHEIMER
CREDIT SUISSE FIRST BOSTON
MERRILL LYNCH & CO.
SALOMON SMITH BARNEY
======================================================
