UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM . . . . . TO . . . . .
COMMISSION FILE NUMBER 1-3473
TESORO PETROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-0862768
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
8700 TESORO DRIVE, SAN ANTONIO, TEXAS 78217-6218
(Address of principal executive offices) (Zip Code)
210-828-8484
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
------ ------
There were 32,341,362 shares of the registrant's Common Stock outstanding at
April 30, 1999.
<PAGE>
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - March 31, 1999 and
December 31, 1998 . . . . . . . . . . . . . . . . . . . . . 3
Condensed Statements of Consolidated Operations - Three Months
Ended March 31, 1999 and 1998. . . . . . . . . . . . . . . . 4
Condensed Statements of Consolidated Cash Flows - Three Months
Ended March 31, 1999 and 1998. . . . . . . . . . . . . . . . 5
Notes to Condensed Consolidated Financial Statements . . . . . 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations. . . . . . . . . . . . . . 11
Item 3. Quantitative and Qualitative Disclosures About Market
Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . 22
Item 5. Other Information . . . . . . . . . . . . . . . . . . . 22
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . 23
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
EXHIBIT INDEX. . . . . . . . . . . . . . . . . . . . . . . . . . . 25
2
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
March 31, December 31,
1999 1998<F1>
---- ----
ASSETS
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . $ 6.8 $ 12.9
Receivables, less allowance for doubtful accounts . . . . . . . . 164.2 157.5
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . 214.7 208.2
Prepayments and other . . . . . . . . . . . . . . . . . . . . . . 11.8 12.0
-------- --------
Total Current Assets . . . . . . . . . . . . . . . . . . . . . . 397.5 390.6
-------- --------
PROPERTY, PLANT AND EQUIPMENT
Refining and marketing. . . . . . . . . . . . . . . . . . . . . . 850.7 841.0
Marine services . . . . . . . . . . . . . . . . . . . . . . . . . 51.0 50.8
Exploration and production, full-cost method of accounting. . . . 449.9 426.5
Corporate . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25.0 21.4
-------- --------
1,376.6 1,339.7
Less accumulated depreciation, depletion and amortization . . . . 461.6 445.1
-------- --------
Net Property, Plant and Equipment. . . . . . . . . . . . . . . . 915.0 894.6
-------- --------
OTHER ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . 133.0 143.2
-------- --------
Total Assets. . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,445.5 $ 1,428.4
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . $ 175.9 $ 126.4
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . 64.8 69.3
Current maturities of long-term debt and other obligations. . . . 19.7 12.5
-------- --------
Total Current Liabilities. . . . . . . . . . . . . . . . . . . . 260.4 208.2
-------- --------
DEFERRED INCOME TAXES. . . . . . . . . . . . . . . . . . . . . . . 70.0 69.9
-------- --------
OTHER LIABILITIES . . . . . . . . . . . . . . . . . . . . . . . . 63.2 59.7
-------- --------
LONG-TERM DEBT AND OTHER OBLIGATIONS, LESS CURRENT
MATURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . 495.4 531.4
-------- --------
COMMITMENTS AND CONTINGENCIES (Note D)
STOCKHOLDERS' EQUITY
Preferred stock, no par value; authorized 5,000,000 shares:
7.25% Mandatorily Convertible Preferred Stock, 103,500 shares
issued and outstanding . . . . . . . . . . . . . . . . . . . . . 165.0 165.0
Common stock, par value $0.16-2/3; authorized 100,000,000 shares;
32,661,384 shares issued (32,654,138 in 1998). . . . . . . . . . 5.4 5.4
Additional paid-in capital. . . . . . . . . . . . . . . . . . . . 278.6 278.6
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . 112.9 115.6
Treasury stock, 320,022 common shares, at cost. . . . . . . . . . (5.4) (5.4)
-------- --------
Total Stockholders' Equity . . . . . . . . . . . . . . . . . . . 556.5 559.2
-------- --------
Total Liabilities and Stockholders' Equity. . . . . . . . . . . $ 1,445.5 $ 1,428.4
======== ========
<FN>
<F1> The balance sheet at December 31, 1998 has been condensed from the audited consolidated financial
statements at that date.
The accompanying notes are an integral part of these condensed consolidated financial statements.
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS
(UNAUDITED)
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
Three Months Ended
March 31,
-----------------
1999 1998
---- ----
<S> <C> <C>
REVENUES
Refining and marketing. . . . . . . . . . . . . $ 472.2 $ 140.2
Marine services . . . . . . . . . . . . . . . . 21.2 32.8
Exploration and production. . . . . . . . . . . 15.1 22.2
Other income. . . . . . . . . . . . . . . . . . 0.1 0.8
------- -------
Total Revenues . . . . . . . . . . . . . . . . 508.6 196.0
------- -------
OPERATING COSTS AND EXPENSES
Refining and marketing. . . . . . . . . . . . . 445.9 130.7
Marine services . . . . . . . . . . . . . . . . 20.1 30.5
Exploration and production. . . . . . . . . . . 4.1 3.9
Depreciation, depletion and amortization. . . . 16.9 13.0
------- -------
Total Segment Operating Costs and Expenses . . 487.0 178.1
------- -------
SEGMENT OPERATING PROFIT . . . . . . . . . . . . 21.6 17.9
General and administrative expense . . . . . . . (6.9) (3.4)
Interest and financing costs . . . . . . . . . . (12.7) (3.0)
Interest income. . . . . . . . . . . . . . . . . 0.1 0.1
Other expense, net . . . . . . . . . . . . . . . (0.8) (0.7)
------- -------
EARNINGS BEFORE INCOME TAXES . . . . . . . . . . 1.3 10.9
Income tax provision . . . . . . . . . . . . . . 1.0 4.8
------- -------
NET EARNINGS . . . . . . . . . . . . . . . . . . 0.3 6.1
Preferred dividend requirements. . . . . . . . . 3.0 -
------- -------
NET EARNINGS (LOSS) APPLICABLE TO COMMON STOCK . $ ( 2.7) $ 6.1
======= =======
NET EARNINGS (LOSS) PER SHARE - BASIC. . . . . . $ (0.08) $ 0.23
======= =======
NET EARNINGS (LOSS) PER SHARE - DILUTED. . . . . $ (0.08) $ 0.23
======= =======
WEIGHTED AVERAGE COMMON SHARES - BASIC . . . . . 32.3 26.3
======= =======
WEIGHTED AVERAGE COMMON AND POTENTIALLY
DILUTIVE COMMON SHARES - DILUTED. . . . . . . . 32.3 26.8
======= =======
The accompanying notes are an integral part of these condensed consolidated financial statements.
</TABLE>
4
<PAGE>
<TABLE>
<CAPTION>
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
Three Months Ended
March 31,
------------------
1999 1998
---- ----
<S> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Net earnings . . . . . . . . . . . . . . . . . . . $ 0.3 $ 6.1
Adjustments to reconcile net earnings to net cash
from operating activities:
Depreciation, depletion and amortization . . . . 17.4 13.2
Amortization of deferred charges and other . . . 1.5 (0.1)
Changes in operating assets and liabilities:
Receivables . . . . . . . . . . . . . . . . . . (6.7) 11.7
Inventories . . . . . . . . . . . . . . . . . . (6.5) (10.4)
Accounts payable and accrued liabilities. . . . 45.0 (16.0)
Other assets and liabilities. . . . . . . . . . 10.9 1.9
------- -------
Net cash from operating activities . . . . . . 61.9 6.4
------- -------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Capital expenditures . . . . . . . . . . . . . . . (36.8) (23.8)
Acquisition costs and other. . . . . . . . . . . . (0.4) (5.7)
------- -------
Net cash used in investing activities. . . . . (37.2) (29.5)
------- -------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Repayments under revolving credit facilities,
net of borrowings . . . . . . . . . . . . . . . . (61.2) 17.7
Repayments of other debt and obligations . . . . . (16.5) (0.7)
Issuance of other long-term debt . . . . . . . . . 50.0 -
Payment of dividends on preferred stock. . . . . . (3.0) -
Other. . . . . . . . . . . . . . . . . . . . . . . (0.1) -
------- -------
Net cash from (used in) financing activities . (30.8) 17.0
------- -------
DECREASE IN CASH AND CASH EQUIVALENTS. . . . . . . . (6.1) (6.1)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD . . . 12.9 8.4
------- -------
CASH AND CASH EQUIVALENTS, END OF PERIOD . . . . . . $ 6.8 $ 2.3
======= =======
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid. . . . . . . . . . . . . . . . . . . $ 20.4 $ 1.7
======= =======
Income taxes paid. . . . . . . . . . . . . . . . . $ 3.0 $ 1.4
======= =======
The accompanying notes are an integral part of these condensed consolidated financial statements.
</TABLE>
5
<PAGE>
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - BASIS OF PRESENTATION
The interim condensed consolidated financial statements and notes thereto of
Tesoro Petroleum Corporation and its subsidiaries (collectively, the "Company"
or "Tesoro") have been prepared by management without audit pursuant to the
rules and regulations of the Securities and Exchange Commission ("SEC").
Accordingly, the accompanying financial statements reflect all adjustments that,
in the opinion of management, are necessary for a fair presentation of results
for the periods presented. Such adjustments are of a normal recurring nature.
Certain information and notes normally included in financial statements prepared
in accordance with generally accepted accounting principles have been condensed
or omitted pursuant to the SEC's rules and regulations. However, management
believes that the disclosures presented herein are adequate to make the
information not misleading. The accompanying condensed consolidated financial
statements and notes should be read in conjunction with the consolidated
financial statements and notes thereto contained in the Company's Annual Report
on Form 10-K for the year ended December 31, 1998.
The preparation of these condensed consolidated financial statements 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. The results of operations for any interim period are not
necessarily indicative of results for the full year.
The 1999 financial statements include the results of operations and cash flows
related to Hawaii and Washington refining and marketing operations acquired in
mid-1998. Certain reclassifications have been made to information previously
reported to conform to current presentations.
NOTE B - INVENTORIES
Components of inventories at March 31, 1999 and December 31, 1998 were as
follows (in millions):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
Crude oil and wholesale refined products, at LIFO . $ 183.4 $ 182.4
Merchandise and other refined products. . . . . . . 16.0 10.5
Materials and supplies. . . . . . . . . . . . . . . 15.3 15.3
------ ------
Total inventories . . . . . . . . . . . . . . . . $ 214.7 $ 208.2
====== ======
</TABLE>
NOTE C - OPERATING SEGMENTS
The Company's revenues are derived from three operating segments: Refining and
Marketing, Marine Services and Exploration and Production. Management has
identified these segments for managing operations and investing activities. The
segments are organized primarily by petroleum industry classification as
upstream (Exploration and Production) and downstream (Refining and Marketing,
and Marine Services). These classifications represent significantly different
activities with respect to investment, asset development, asset valuations,
production, maintenance, supply and market distribution. The downstream
businesses are organized into two segments representing (i) the manufacturing
and marketing of refined products, and (ii) the product distribution and
logistics services provided to the marine industry.
Segment operating profit includes those revenues and expenses that are directly
attributable to management of the respective segment. For the periods
presented, revenues were generated from sales to external customers, and
intersegment revenues were not significant. Income taxes, interest and
financing costs, interest income and corporate general and administrative
expenses are not included in determining segment operating profit.
EBITDA represents earnings before interest and financing costs, income taxes,
and depreciation, depletion and amortization. While not purporting to reflect
any measure of the Company's operations or cash flows, EBITDA is presented for
additional analysis. Operating segment EBITDA is equal to segment operating
profit before depreciation, depletion and amortization related to each segment.
6
<PAGE>
Segment information for the three months ended March 31, 1999 and 1998 is as
follows (in millions):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
REVENUES
Gross operating revenues:
Refining and Marketing. . . . . . . . . . . . . . .$ 472.2 $ 140.2
Marine Services . . . . . . . . . . . . . . . . . . 21.2 32.8
Exploration and Production -
U.S. . . . . . . . . . . . . . . . . . . . . . . . 13.9 19.1
Bolivia . . . . . . . . . . . . . . . . . . . . . 1.2 3.1
------- -------
Total Gross Operating Revenues . . . . . . . . . . 508.5 195.2
Other income . . . . . . . . . . . . . . . . . . . . 0.1 0.8
------- -------
Total Revenues . . . . . . . . . . . . . . . . .$ 508.6 $ 196.0
======= =======
SEGMENT OPERATING PROFIT
Refining and Marketing . . . . . . . . . . . . . . .$ 17.5 $ 6.5
Marine Services. . . . . . . . . . . . . . . . . . . 0.4 1.8
Exploration and Production -
U.S.. . . . . . . . . . . . . . . . . . . . . . . . 3.8 7.9
Bolivia . . . . . . . . . . . . . . . . . . . . . . (0.1) 1.7
------- -------
Total Segment Operating Profit . . . . . . . . . . 21.6 17.9
Corporate and Unallocated Costs. . . . . . . . . . . (20.3) (7.0)
------- -------
Earnings Before Income Taxes . . . . . . . . . . . .$ 1.3 $ 10.9
======= =======
EBITDA
Refining and Marketing . . . . . . . . . . . . . . .$ 26.3 $ 9.5
Marine Services. . . . . . . . . . . . . . . . . . . 1.1 2.4
Exploration and Production -
U.S.. . . . . . . . . . . . . . . . . . . . . . . . 10.8 16.8
Bolivia . . . . . . . . . . . . . . . . . . . . . . 0.3 2.2
------- -------
Total Operating Segment EBITDA . . . . . . . . . . 38.5 30.9
Corporate and Unallocated . . . . . . . . . . . . . (7.1) (3.8)
------- -------
Total Consolidated EBITDA. . . . . . . . . . . . . 31.4 27.1
Depreciation, Depletion and Amortization . . . . . . (17.4) (13.2)
Interest and Financing Costs . . . . . . . . . . . . (12.7) (3.0)
------- -------
Earnings Before Income Taxes . . . . . . . . . . . .$ 1.3 $ 10.9
======= =======
DEPRECIATION, DEPLETION AND AMORTIZATION
Refining and Marketing . . . . . . . . . . . . . . .$ 8.8 $ 3.0
Marine Services. . . . . . . . . . . . . . . . . . . 0.7 0.6
Exploration and Production -
U.S.. . . . . . . . . . . . . . . . . . . . . . . . 7.0 8.9
Bolivia . . . . . . . . . . . . . . . . . . . . . . 0.4 0.5
Corporate. . . . . . . . . . . . . . . . . . . . . . 0.5 0.2
------- -------
Total Depreciation, Depletion and Amortization. . .$ 17.4 $ 13.2
======= =======
CAPITAL EXPENDITURES
Refining and Marketing . . . . . . . . . . . . . . .$ 11.1 $ 2.0
Marine Services. . . . . . . . . . . . . . . . . . . 0.2 1.2
Exploration and Production -
U.S.. . . . . . . . . . . . . . . . . . . . . . . . 14.8 18.2
Bolivia . . . . . . . . . . . . . . . . . . . . . . 8.6 2.3
Corporate. . . . . . . . . . . . . . . . . . . . . . 2.1 0.1
------- -------
Total Capital Expenditures. . . . . . . . . . . . .$ 36.8 $ 23.8
======= =======
</TABLE>
7
<PAGE>
Identifiable assets are those assets utilized by the segment. Corporate assets
are principally cash and other assets that are not directly associated with the
operations of a business segment. Segment assets as of March 31, 1999 and
December 31, 1998 were as follows (in millions):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
IDENTIFIABLE ASSETS
Refining and Marketing . . . . . . . . . . . $ 1,090.4 $ 1,077.7
Marine Services. . . . . . . . . . . . . . . 57.4 59.2
Exploration and Production -
U.S.. . . . . . . . . . . . . . . . . . . . 181.7 175.8
Bolivia . . . . . . . . . . . . . . . . . . 64.1 58.9
Corporate. . . . . . . . . . . . . . . . . . 51.9 56.8
------- -------
Total Assets . . . . . . . . . . . . . . . $ 1,445.5 $ 1,428.4
======= =======
</TABLE>
As of March 31, 1999, capitalized costs of the Company's U.S. oil and gas
properties exceeded the full-cost ceiling limitation by approximately $11
million pretax; however, no write-down was recorded because prices increased
significantly during April 1999.
NOTE D - COMMITMENTS AND CONTINGENCIES
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 the Environmental Protection Agency
("EPA") regarding a waste disposal site near Abbeville, Louisiana and the
Casmalia Disposal Site in Santa Barbara County, California. The Company has
been named a potentially responsible party ("PRP") under the Federal
Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"
or "Superfund") at both sites. Although the Superfund law might impose joint
and several liability upon each party at the sites, the extent of the Company's
allocated financial contributions for cleanup is expected to be de minimis based
upon the number of companies, volumes of waste involved and total estimated
costs to close each site. The Company believes, based on these considerations
and discussions with the EPA, that its liability at the Abbeville site will not
exceed $25,000. The Company believes that its liability at the Casmalia Site is
de minimis based on a 1999 notification from the EPA that the Company's
liability will not exceed $125,000.
In connection with the 1998 acquisition of Hawaii refining and marketing
operations from affiliates of The Broken Hill Proprietary Company Limited ("BHP
Sellers"), the BHP Sellers and the Company executed a separate environmental
agreement, whereby the BHP Sellers indemnified the Company for environmental
costs arising out of conditions which existed at or prior to closing. This
indemnification is subject to a maximum limit of $9.5 million and expires after
a period of ten years. Under the environmental agreement, the first $5.0
million of these liabilities will be the responsibility of the BHP Sellers and
the next $6.0 million will be shared on the basis of 75% by the BHP Sellers and
25% by the Company. Certain environmental claims arising out of prior
operations will not be subject to the $9.5 million limit or the ten-year time
limit.
Under the agreement related to the 1998 acquisition of the Washington refinery
from an affiliate of Shell Oil Company ("Shell Seller"), the Shell Seller
generally agreed to indemnify the Company for environmental liabilities at the
Washington refinery arising out of conditions which existed at or prior to the
closing date and identified by the Company prior to August 1, 2001. The Company
is responsible for environmental costs up to the first $0.5 million each year,
after which the Shell Seller will be responsible for annual environmental costs
up to $1.0 million. Annual costs greater than $1.0 million will be shared
equally between the Company and the Shell Seller, subject to an aggregate
maximum of $5.0 million and a ten-year term.
8
<PAGE>
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 March 31, 1999, the Company's
accruals for environmental expenses amounted to $9.1 million. Based on
currently available information, including the participation of other parties or
former owners in remediation actions, the Company believes these accruals are
adequate.
To comply with environmental laws and regulations, the Company anticipates that
it will make capital improvements of approximately $12 million in 1999 and $5
million in 2000. In addition, capital expenditures for alternative secondary
containment systems for existing storage tank facilities are estimated to be $2
million in 1999 and $1 million in 2000, with a remaining $4 million expected to
be spent in 2002.
Conditions that require additional expenditures may exist for various Company
sites, including, but not limited to, the Company's refineries, retail gasoline
stations (operating and closed locations) and petroleum product terminals, and
for compliance with the Clean Air Act and other state and federal regulations.
The amount of such future expenditures cannot currently be determined by the
Company.
For further information regarding environmental matters, see Legal Proceedings
in Part II, Item 1, included herein.
LITIGATION
On October 1, 1998, the Attorney General for the State of Hawaii filed a lawsuit
in the U.S. District Court for the District of Hawaii against thirteen oil
companies, including Tesoro Petroleum Corporation and Tesoro Hawaii Corporation,
alleging anti-competitive marketing practices in violation of federal and state
anti-trust laws, and seeking injunctive relief and compensatory and treble
damages and civil penalties against all defendants in an amount in excess of
$500 million. On March 25, 1999, the Attorney General filed an amended
complaint with the U.S. District Court seeking damages against all defendants
for such alleged anti-competitive marketing practices in an amount in excess of
$1.3 billion. The Company believes that it has not engaged in any
anti-competitive activities and will defend this litigation vigorously. This
proceeding is subject to the indemnity provision of the stock sale agreement
between the BHP Sellers and the Company which provides for indemnification in
excess of $2 million and not to exceed $65 million.
INCENTIVE COMPENSATION
In October 1998, the Company's Board of Directors unanimously approved the 1998
Performance Incentive Compensation Plan ("Performance Plan"), which is intended
to advance the best interests of the Company and its stockholders by directly
targeting Company performance to align with the ninetieth percentile historical
stock-price growth rate for the Company's peer group. In addition, the
Performance Plan will provide the Company's employees with additional
compensation, contingent upon achievement of the targeted objectives, thereby
encouraging them to continue in the employ of the Company. Under the
Performance Plan, targeted objectives are comprised of the fair market value of
the Company's Common Stock equaling or exceeding an average of $35 per share
("First Performance Target") and $45 per share ("Second Performance Target") on
any 20 consecutive trading days during a period commencing on October 1, 1998
and ending on the earlier of September 30, 2002, or the date on which the Second
Performance Target is achieved ("Performance Period"). The Performance Plan has
several tiers of awards, with the award generally determined by job level. Most
eligible employees have contingent cash bonus opportunities of 25% of their
annual "basic compensation" (as defined in the Performance Plan) and three
executive officers have contingent awards totaling 655,000 shares of phantom
stock which will be payable solely in cash. Upon achievement of the First
Performance Target, one-fourth of the contingent award will be earned, with
payout deferred until the end of the Performance Period. The remaining 75% will
be earned only upon achievement of the Second Performance Target, with payout
occurring 30 days thereafter. Employees will need to have at least one year of
regular, full-time service at the time the Performance Period ends in order to
be eligible for a payment. No costs will be recorded until the First
Performance Target is reached. The Company estimates that it will incur
aftertax costs of approximately 1% of the total aggregate increase in
shareholder value if the First Performance Target is reached and will incur an
additional 2% aftertax charge if the Second Performance Target is reached.
9
<PAGE>
NOTE E - EARNINGS PER SHARE
Basic earnings per share is determined by dividing net earnings applicable to
common stock by the weighted average number of common shares outstanding during
the period. The calculation of diluted earnings per share takes into account
the effect of potentially dilutive shares, principally stock options,
outstanding during the period. The assumed conversion of preferred stock to
8.75 million shares of common stock in the 1999 period produced an anti-dilutive
result and, in accordance with Statement of Financial Accounting Standard No.
128, was not included in the dilutive calculation. Earnings per share
calculations for the three months ended March 31, 1999 and 1998 are presented
below (in millions except per share amounts):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
BASIC:
Numerator:
Net earnings . . . . . . . . . . . . . . . . . . . . . $ 0.3 $ 6.1
Less dividends on preferred stock. . . . . . . . . . . (3.0) -
------ ------
Net earnings (loss) applicable to common shares. . . . $ (2.7) $ 6.1
====== ======
Denominator:
Weighted average common shares outstanding . . . . . . 32.3 26.3
====== ======
Net Earnings (Loss) Per Share . . . . . . . . . . . . . $ (0.08) $ 0.23
====== ======
DILUTED:
Numerator:
Net earnings (loss) applicable to common shares. . . . $ (2.7) $ 6.1
Plus earnings impact of assumed conversion of
preferred stock (only if dilutive). . . . . . . . . . - -
------ ------
Net earnings (loss) applicable to common shares. . . . $ (2.7) $ 6.1
====== ======
Denominator:
Weighted average common shares outstanding . . . . . . 32.3 26.3
Add potentially dilutive securities:
Incremental dilutive shares from assumed exercise
of stock options and other (only if dilutive) . . . - 0.5
Incremental dilutive shares from assumed conversion
of preferred stock (only if dilutive) . . . . . . . - -
------ ------
Total diluted shares . . . . . . . . . . . . . . . . . 32.3 26.8
====== ======
Net Earnings (Loss) Per Share . . . . . . . . . . . . . $ (0.08) $ 0.23
====== ======
</TABLE>
10
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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 21 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 earnings, cash flows and 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 plans to
further improve profitability in the Refining and Marketing segment by enhancing
processing capabilities, strengthening marketing channels and improving supply
and transportation functions. The Marine Services segment pursues opportunities
for expansion, as well as optimizing existing operations through development of
customer services and cost management. In the Exploration and Production
segment, the strategy focuses on generating and operating exploration projects
in an effort to diversify its oil and gas reserve base. Selectively, the
Company uses acquisitions 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.
Tesoro acquired Hawaii refining and marketing assets in May 1998 and acquired a
Washington refinery and related assets in August 1998. These acquisitions are
expected to triple Tesoro's historical annual revenues and have significantly
increased the scope of its Refining and Marketing operations. During the first
quarter of 1999, results from the acquired operations were accretive to the
Company's earnings and cash flows. In conjunction with the acquisitions, the
Company has identified $25 million of potential annual cost-saving and
revenue-enhancing synergies that will be achieved during 1999 from the
integration of the Hawaii refinery and Washington refinery with the Alaska
operations. A significant portion of the synergies was achieved during the 1999
first quarter. The Company will continue to pursue other opportunities that are
operationally and geographically complementary with its asset base.
BUSINESS ENVIRONMENT
The Company operates in an environment where its results and cash flows are
sensitive to volatile changes in energy prices. Fluctuations in the cost of
crude oil used for refinery feedstocks and the price of refined products can
result in changes in margins from the Refining and Marketing operations, as
prices received for refined products 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 ("LIFO") method of accounting for inventories of crude oil
and U.S. wholesale refined products in its Refining and Marketing segment. This
method results in inventory carrying amounts that are less likely to represent
current values and in costs of sales which more closely represent current costs.
Changes in crude oil and natural gas prices influence the level of drilling
activity in the Gulf of Mexico. The Company's Marine Services segment, whose
customers include offshore drilling contractors and related industries, can be
impacted by significant fluctuations in crude oil and natural gas prices. The
Marine Services segment uses the first-in, first-out ("FIFO") method of
accounting for inventories of fuels. Changes in fuel prices can significantly
affect inventory valuations and costs of sales.
Changes in natural gas, condensate and oil prices impact revenues and the
present value of estimated future net revenues and cash flows from the
Exploration and Production segment. The Company may increase or decrease its
natural gas production in response to market conditions. The carrying costs of
oil and gas assets are subject to noncash write-downs based on decreases in
natural gas and oil prices and other determining factors.
11
<PAGE>
RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 1999 COMPARED WITH
THREE MONTHS ENDED MARCH 31, 1998
SUMMARY
Tesoro's net earnings were $0.3 million for the three months ended March 31,
1999 ("1999 Quarter"), compared with net earnings of $6.1 million for the three
months ended March 31, 1998 ("1998 Quarter"). After dividends on preferred
stock, the net loss per share for the 1999 Quarter was $0.08 (basic and
diluted), compared to net earnings per share of $0.23 (basic and diluted) in the
1998 Quarter. Higher operating profits from the Refining and Marketing segment
were offset by reduced profits from the Marine Services and Exploration and
Production segments and increased interest and financing costs. On a per share
basis, net earnings also were reduced by dividends on preferred stock and the
impact of issuing additional shares of common stock in mid-1998.
A discussion and analysis of the factors contributing to the Company's results
of operations are presented below.
<TABLE>
<CAPTION>
REFINING AND MARKETING
Three Months Ended
March 31,
--------------------
(Dollars in millions except per barrel amounts) 1999 1998
---- ----
<S> <C> <C>
Gross Operating Revenues:
Refined products. . . . . . . . . . . . . . . . . . . . . . . . . . $ 453.6 $ 122.7
Other, primarily crude oil resales and merchandise. . . . . . . . . 18.6 17.5
------ ------
Gross Operating Revenues . . . . . . . . . . . . . . . . . . . . . $ 472.2 $ 140.2
====== ======
Segment Operating Profit:
Gross margin:
Refinery <F1>. . . . . . . . . . . . . . . . . . . . . . . . . . . $ 102.6 $ 30.0
Non-refinery <F2>. . . . . . . . . . . . . . . . . . . . . . . . . 12.8 3.7
------ ------
Total gross margins . . . . . . . . . . . . . . . . . . . . . . . 115.4 33.7
Operating expenses and other. . . . . . . . . . . . . . . . . . . . 89.1 24.2
Depreciation and amortization . . . . . . . . . . . . . . . . . . . 8.8 3.0
------ ------
Segment Operating Profit . . . . . . . . . . . . . . . . . . . . . $ 17.5 $ 6.5
====== ======
Refinery Throughput (thousands of barrels per day):
Alaska. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44.4 56.1
Hawaii <F3> . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87.4 -
Washington <F3> . . . . . . . . . . . . . . . . . . . . . . . . . . 97.2 -
------ ------
Total Refinery Throughput. . . . . . . . . . . . . . . . . . . . . 229.0 56.1
====== ======
Refined Products Manufactured (thousands of barrels per day) <F3>:
Gasoline and gasoline blendstocks . . . . . . . . . . . . . . . . . 88.2 15.2
Jet fuel. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56.4 19.8
Diesel fuel . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30.7 5.4
Heavy oils and residual products. . . . . . . . . . . . . . . . . . 41.7 15.1
Other, including synthetic natural gas and liquefied petroleum gas. 17.6 2.2
------ ------
Total Refined Products Manufactured. . . . . . . . . . . . . . . . 234.6 57.7
====== ======
Refinery Product Spread ($/barrel) . . . . . . . . . . . . . . . . . $ 4.98 $ 5.94
====== ======
Segment Product Sales (thousands of barrels per day) <F3><F4>:
Gasoline and gasoline blendstocks . . . . . . . . . . . . . . . . . 109.6 14.5
Middle distillates. . . . . . . . . . . . . . . . . . . . . . . . . 108.6 32.9
Heavy oils, residual products and other . . . . . . . . . . . . . . 59.6 18.3
------ ------
Total Product Sales. . . . . . . . . . . . . . . . . . . . . . . . 277.8 65.7
====== ======
Segment Gross Margins on Product Sales ($/barrel) <F5>:
Average sales price . . . . . . . . . . . . . . . . . . . . . . . . $ 18.14 $ 20.75
Average costs of sales. . . . . . . . . . . . . . . . . . . . . . . 13.72 15.68
------ ------
Gross Margin . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 4.42 $ 5.07
====== ======
12
<PAGE>
<FN>
<F1> Represents throughput at the Company's refineries times refinery product spread.
<F2> Non-refinery margin includes merchandise margins, margins on products purchased
and resold, and adjustments due to selling a volume and mix of product that is
different than actual volumes manufactured.
<F3> Volumes for 1999 include amounts from the Hawaii and Washington operations
acquired in mid-1998.
<F4> Sources of total product sales include products manufactured at the refineries,
products drawn from inventory balances and products purchased from third parties.
<F5> Gross margins on total product sales include margins on sales of manufactured
and purchased products and the effect of inventory changes.
</TABLE>
Segment operating profit for the Company's Refining and Marketing operations was
$17.5 million in the 1999 Quarter, an increase of $11.0 million from segment
operating profit of $6.5 million in the 1998 Quarter. The improvement in
results from Refining and Marketing was primarily due to higher throughput and
sales volumes from the refineries acquired in mid-1998. Severe weather
conditions and seasonally low product demand adversely impacted throughput and
margins in Alaska and Washington in January and February. However, market
conditions on the West Coast rebounded in March as product supply shortages from
other refinery outages resulted in significantly improved product margins
towards the end of the quarter.
Revenues from sales of refined products in the Refining and Marketing segment
increased in the 1999 Quarter, compared to the 1998 Quarter, primarily due to
the higher sales volumes from the acquisitions, partially offset by lower sales
prices. Other revenues increased in the 1999 Quarter due to higher merchandise
sales, primarily from the Hawaii acquisition, offset by lower crude oil resales.
The increase in costs of sales reflected higher volumes associated with the
acquisitions, partly offset by lower feedstock prices.
Refinery gross margin increased to $102.6 million in the 1999 Quarter due to the
higher throughput volumes partially offset by a decrease in average refinery
product spread per barrel to $4.98 in the 1999 Quarter compared to $5.94 in the
1998 Quarter. Margins from non-refinery activities increased to $12.8 million
in the 1999 Quarter due primarily to higher sales of purchased products and
increased merchandise sales through the acquired retail stations in Hawaii.
Operating expenses and depreciation and amortization also increased during this
period primarily due to the acquisitions.
Although the Company benefited from strong product margins in March 1999,
current product margins continue to fluctuate. Future profitability of this
segment will continue to be influenced by market conditions, particularly as
these conditions influence costs of crude oil relative to prices received for
sales of refined products and other additional factors that are beyond the
control of the Company.
13
<PAGE>
<TABLE>
<CAPTION>
MARINE SERVICES
Three Months Ended
March 31,
------------------
(Dollars in millions) 1999 1998
---- ----
<S> <C> <C>
Gross Operating Revenues:
Fuels . . . . . . . . . . . . . . . . . . . . . . $ 15.6 $ 25.8
Lubricants and other. . . . . . . . . . . . . . . 3.3 4.1
Services. . . . . . . . . . . . . . . . . . . . . 2.3 2.9
---- ----
Gross Operating Revenues . . . . . . . . . . . . 21.2 32.8
Costs of Sales . . . . . . . . . . . . . . . . . . 12.9 23.6
---- ----
Gross Profit . . . . . . . . . . . . . . . . . . 8.3 9.2
Operating Expenses and Other . . . . . . . . . . . 7.2 6.8
Depreciation and Amortization. . . . . . . . . . . 0.7 0.6
---- ----
Segment Operating Profit . . . . . . . . . . . $ 0.4 $ 1.8
==== ====
Sales Volumes (millions of gallons):
Fuels, primarily diesel . . . . . . . . . . . . . 36.9 47.9
Lubricants. . . . . . . . . . . . . . . . . . . . 0.5 0.7
</TABLE>
The Marine Services segment's business is largely dependent upon the volume of
oil and gas drilling, workover, construction and seismic activity in the U.S.
Gulf of Mexico. The low level of drilling rig activity in the Gulf during the
1999 Quarter contributed to an overall decline of $1.4 million in the Marine
Services segment's operating profit. Gross operating revenues declined by $11.6
million from the 1998 Quarter, reflecting lower fuel prices, reduced service
revenues and a 23% reduction in fuel sales volumes. The decrease in costs of
sales reflected the lower fuel volumes and prices.
In May 1999, the Company agreed to purchase the U.S. West Coast marine fuels
operations of BP Marine, a division of BP Amoco PLC, subject to regulatory
approvals and other conditions. The purchase includes facilities at Port
Angeles and Seattle, Washington; Portland, Oregon; and Los Angeles, California.
The total storage capacity at these terminals is 605,000 barrels.
14
<PAGE>
<TABLE>
<CAPTION>
EXPLORATION AND PRODUCTION
Three Months Ended
March 31,
------------------
1999 1998
---- ----
(Dollars in millions except per unit amounts)
<S> <C> <C>
U.S. <F1>:
Gross operating revenues . . . . . . . . . . . . . . . . . . . $ 13.9 $ 19.1
Other income . . . . . . . . . . . . . . . . . . . . . . . . . - 0.6
Production costs . . . . . . . . . . . . . . . . . . . . . . . 2.5 2.5
Administrative support and other operating expenses. . . . . . 0.6 0.4
Depreciation, depletion and amortization . . . . . . . . . . . 7.0 8.9
------ ------
Segment Operating Profit - U.S. . . . . . . . . . . . . . . . 3.8 7.9
------ ------
BOLIVIA:
Gross operating revenues . . . . . . . . . . . . . . . . . . . 1.2 3.1
Production costs . . . . . . . . . . . . . . . . . . . . . . . 0.4 0.3
Administrative support and other operating expenses. . . . . . 0.5 0.6
Depreciation, depletion and amortization . . . . . . . . . . . 0.4 0.5
------ ------
Segment Operating Profit (Loss) - Bolivia . . . . . . . . . . (0.1) 1.7
------ ------
Total Segment Operating Profit - Exploration and Production . . $ 3.7 $ 9.6
====== ======
U.S.:
Average Daily Net Production:
Natural gas (million cubic feet, "MMcf"). . . . . . . . . . . 80.1 99.1
Oil (thousand barrels). . . . . . . . . . . . . . . . . . . . 0.5 0.2
Total (million cubic feet equivalent, "MMcfe") . . . . . . . 83.1 100.2
Average Prices:
Natural gas ($/thousand cubic feet, "Mcf") <F2> . . . . . . . $ 1.76 $ 2.01
Oil ($/barrel). . . . . . . . . . . . . . . . . . . . . . . . $ 11.31 $ 14.13
Average Operating Expenses ($/thousand cubic feet equivalent,
"Mcfe"):
Lease operating expenses. . . . . . . . . . . . . . . . . . . $ 0.29 $ 0.21
Severance taxes . . . . . . . . . . . . . . . . . . . . . . . 0.04 0.06
------ ------
Total production costs . . . . . . . . . . . . . . . . . . . 0.33 0.27
Administrative support and other. . . . . . . . . . . . . . . 0.06 0.05
------ ------
Total Operating Expenses . . . . . . . . . . . . . . . . . . $ 0.39 $ 0.32
====== ======
Depletion ($/Mcfe) . . . . . . . . . . . . . . . . . . . . . . $ 0.91 $ 0.97
====== ======
BOLIVIA:
Average Daily Net Production:
Natural gas (MMcf). . . . . . . . . . . . . . . . . . . . . . 12.6 22.8
Condensate (thousand barrels) . . . . . . . . . . . . . . . . 0.3 0.8
Total (MMcfe). . . . . . . . . . . . . . . . . . . . . . . . 14.6 27.7
Average Prices:
Natural gas ($/Mcf) . . . . . . . . . . . . . . . . . . . . . $ 0.60 $ 0.97
Condensate ($/barrel) . . . . . . . . . . . . . . . . . . . . $ 13.18 $ 15.78
Average Operating Expenses ($/Mcfe):
Production costs. . . . . . . . . . . . . . . . . . . . . . . $ 0.32 $ 0.11
Administrative support and other. . . . . . . . . . . . . . . 0.46 0.29
------ ------
Total Operating Expenses . . . . . . . . . . . . . . . . . . $ 0.78 $ 0.40
====== ======
Depletion ($/Mcfe) . . . . . . . . . . . . . . . . . . . . . . $ 0.26 $ 0.21
====== ======
<FN>
<F1> Represents the Company's U.S. oil and gas operations combined with gas
transportation activities.
<F2> Includes gains from commodity price agreements of $0.09 per Mcf for the three
months ended March 31, 1999. There were no such gains or losses during the
three months ended March 31, 1998.
</TABLE>
15
<PAGE>
U.S.
Segment operating profit from the Company's U.S. exploration and production
operations was $3.8 million in the 1999 Quarter compared with $7.9 million in
the 1998 Quarter. The decline in operating profit was primarily due to lower
natural gas prices and lower production volumes. The Company's U.S. net
production volumes decreased 17% to 83.1 MMcfe per day in the 1999 Quarter,
compared to 100.2 MMcfe per day in the 1998 Quarter. Total production from
fields outside of the Bob West Field was largely unchanged from the prior year
quarter, while Bob West Field production declined approximately 16 MMcfe per
day.
Gross operating revenues from the Company's U.S. operations decreased by $5.2
million due to the lower production and a 12% decline in natural gas prices from
$2.01 per Mcf in the 1998 Quarter to $1.76 per Mcf in the 1999 Quarter. Natural
gas prices began to recover late in the 1999 Quarter which improves the outlook
for these operations. Net production costs per Mcfe increased from $0.27 to
$0.33, primarily due to decreased production volumes while total production
costs remained flat. Depreciation, depletion and amortization decreased by $1.9
million, or 21%, due to lower volumes and a reduced depletion rate. The
depletion rate was reduced in part by the fourth quarter 1998 ceiling test
write-down of capitalized costs and in part by approximately 21 billion cubic
feet equivalent ("Bcfe") of reserves added during the first quarter of 1999,
increasing domestic proved reserves to 188 Bcfe from 174 Bcfe at 1998 year-end.
Reserve additions in the 1999 Quarter resulted primarily from drilling successes
that had finding costs of approximately $0.70 per Mcfe excluding revisions. As
of March 31, 1999, capitalized costs of the Company's U.S. oil and gas
properties exceeded the full-cost ceiling limitation by approximately $11
million pretax; however, no write-down was recorded because prices increased
significantly during April 1999.
For information related to natural gas commodity price agreements, see Item 3
contained herein.
BOLIVIA
Segment operating results from the Company's Bolivian operations decreased to a
loss of $0.1 million, compared to operating profit of $1.7 million in the 1998
Quarter. This decrease in segment operating profit was due to lower production
and prices. Bolivian natural gas prices, which are contractually indexed to a
six-month average of posted New York fuel oil prices, fell 38% from $0.97 per
Mcf in the 1998 Quarter to $0.60 per Mcf in the 1999 Quarter. Net production
volumes decreased 47% from 27.7 MMcfe per day to 14.6 MMcfe per day, resulting
in an imbalance in the take-or-pay contract with Yacimientos Petroliferos
Fiscales Bolivianos ("YPFB"), a Bolivian government agency. The Company expects
YPFB to make up this imbalance in the latter half of 1999.
A lack of market access has constrained natural gas production in Bolivia.
Management believes that a new third-party pipeline from Bolivia to Brazil,
which is expected to begin operations during the second quarter of 1999, will
provide access to potentially larger gas-consuming markets.
GENERAL AND ADMINISTRATIVE
The $3.5 million increase in general and administrative expenses included $1.5
million for implementation of an integrated enterprise-wide software system
together with higher employee costs associated with organizational development
and growth.
INTEREST AND FINANCING COSTS
Interest and financing costs increased by $9.7 million from the 1998 Quarter,
reflecting higher borrowings which funded the 1998 Hawaii and Washington
acquisitions and continuing investments in natural gas exploration and
development.
INCOME TAX PROVISION
The decrease of $3.8 million in the income tax provision included a reduction in
U.S. state and federal income taxes due to the Company's lower consolidated
earnings and a reduction in foreign taxes due to lower Bolivian natural gas
production.
16
<PAGE>
CAPITAL RESOURCES AND LIQUIDITY
OVERVIEW
The Company's primary sources of liquidity are its cash flows from operations
and borrowing availability under a revolving line of credit. Capital
requirements are expected to include capital expenditures, working capital, debt
service and preferred dividend payments. Based upon current and anticipated
needs, management believes that available capital resources will be adequate to
meet anticipated future capital requirements.
The Company operates in an environment where its liquidity and capital resources
are impacted by changes in the supply of and demand for crude oil, natural gas
and refined petroleum products, market uncertainty and a variety of additional
risks that are beyond the control of the Company. These risks include, among
others, the level of consumer product demand, weather conditions, the proximity
of the Company's natural gas reserves to pipelines, the capacities of such
pipelines, fluctuations in seasonal demand, governmental regulations, the price
and availability of alternative fuels and overall market and economic
conditions. The Company's future capital expenditures, as well as borrowings
under its credit arrangements and other sources of capital, will be affected by
these conditions.
CAPITAL SPENDING
During the 1999 Quarter, the Company's capital expenditures totaled $37 million
which were primarily financed with internally-generated cash flows. The Company
has announced a capital spending plan of $170 million for the total year 1999.
This plan is under continuing review, considering requirements and business
conditions in each operating segment, and is expected to be funded primarily
with cash flows from operations supplemented with borrowings, if necessary,
under the Senior Credit Facility. Refining and Marketing capital expenditures
of $11 million in the 1999 Quarter included various refinery projects and
reimaging of retail gas stations in Hawaii and Alaska. Exploration and
development expenditures in the 1999 Quarter were $15 million in the U.S. and $8
million in Bolivia. In the 1999 Quarter, the Company participated in drilling
eleven exploration wells (six completed) and five development wells (one
completed) in the U.S. and one exploration well in Bolivia which was drilling at
quarter-end.
CREDIT ARRANGEMENTS AND CAPITALIZATION
Significant changes in the Company's credit arrangements and capitalization
since the 1998 year-end were as follows:
. Under the Senior Credit Facility, the Company repaid $61 million
outstanding under the revolving credit and letter of credit facility
("Revolver") and borrowed an additional $34 million under term loans
during the 1999 Quarter.
. In April 1999, the Company reduced commitments under the Revolver from
$300 million to $175 million.
At March 31, 1999, the Company had outstanding borrowings of $183 million under
the Term Loans and no outstanding borrowings under the Revolver. Since the
Company expects to fund capital expenditures primarily with internally-generated
cash flows, the Company elected to reduce availability under the Revolver in
April 1999, which will result in lower commitment fees. The remaining credit
capacity is expected to be sufficient to fund future capital expenditures and
working capital requirements. Unused availability under the Revolver, after the
impact of the commitment reduction, would have been $169 million at March 31,
1999. The Company's total debt to capitalization ratio was 48% at quarter-end.
The Senior Credit Facility requires the Company to maintain specified levels of
consolidated leverage and interest coverage and contains other covenants and
restrictions customary in credit arrangements of this kind. The Company was in
compliance with these financial covenants at March 31, 1999 and, based on
improved market conditions since the early part of the 1999 Quarter, the Company
expects to be in compliance with these covenants through the remainder of 1999.
However, future compliance with the financial covenants, which start becoming
more restrictive during the third quarter of 1999, will continue to be dependent
on the Company's cash flows which are sensitive to changes in market conditions.
The terms of the Senior Credit Facility allow for payment of cash dividends on
the Company's Common Stock not to exceed an aggregate of $10 million in any year
and also allow for payment of required dividends on its Preferred Stock. The
Board of Directors has no present plans to pay dividends on Common Stock.
However, from time to time the Board of Directors reevaluates the feasibility of
declaring future dividends.
17
<PAGE>
Provisions of the Senior Credit Facility require prepayments of the Term Loans,
with certain defined exceptions, in an amount equal to: (i) 100% of the net
proceeds of certain incurred indebtedness; (ii) 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 the
Company's subsidiaries; and (iii) a percentage of excess cash flows, as defined,
depending on certain credit statistics.
CASH FLOWS
Components of the Company's cash flows are set forth below (in millions):
<TABLE>
<CAPTION>
Three Months Ended
March 31,
-----------------
1999 1998
---- ----
<S> <C> <C>
Cash Flows From (Used In):
Operating Activities . . . . . . . . . . . . . $ 61.9 $ 6.4
Investing Activities . . . . . . . . . . . . . (37.2) (29.5)
Financing Activities . . . . . . . . . . . . . (30.8) 17.0
------ ------
Decrease in Cash and Cash Equivalents. . . . . . $ (6.1) $ (6.1)
====== ======
</TABLE>
Net cash from operating activities totaled $62 million during the 1999 Quarter,
compared to $6 million for the 1998 Quarter. This increase reflected positive
changes in working capital components. Cash flows from earnings before
depreciation, depletion and amortization and other noncash charges were $19
million in both the 1999 and 1998 Quarters. Net cash used in investing
activities of $37 million during the 1999 Quarter included capital expenditures
of $11 million in Refining and Marketing and $23 million in Exploration and
Production. Financing activities in the 1999 Quarter included gross repayments
of $120 million under the Senior Credit Facility offset by gross borrowings of
$92 million. Payment of dividends on preferred stock totaled $3 million in the
1999 Quarter. At March 31, 1999, the Company's working capital totaled $137
million, which included cash and cash equivalents of $7 million. The working
capital ratio was 1.5:1 at March 31, 1999, compared to 1.9:1 at December 31,
1998, reflecting short-term fluctuations in components of working capital.
ENVIRONMENTAL
The Company is subject to extensive federal, state and local environmental laws
and regulations. These laws, which change frequently, regulate the discharge of
materials into the environment and may require the Company to remove or mitigate
the environmental effects of the disposal or release of petroleum or chemical
substances at various sites or install additional controls or other
modifications or changes in use for certain emission sources. The Company is
currently involved in remedial responses 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, 1999, the Company's
accruals for environmental expenses totaled $9.1 million. Based on currently
available information, including the participation of other parties or former
owners in remediation actions, the Company believes these accruals are adequate.
To comply with environmental laws and regulations, the Company anticipates it
will make capital improvements totaling approximately $12 million in 1999 and $5
million in 2000. In addition, capital expenditures for alternate secondary
containment systems for existing storage tank facilities are estimated to be $2
million in 1999 and $1 million in 2000, with a remaining $4 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 refineries, retail stations
(operating and closed locations) and petroleum product terminals, and for
compliance with the Clean Air Act and other state and federal regulations. The
amount of such future expenditures cannot currently be determined by the
Company.
For further information on environmental and other contingencies, see Note D of
Notes to Condensed Consolidated Financial Statements in Part I, Item 1, and
Legal Proceedings in Part II, Item 1, included herein.
YEAR 2000 READINESS DISCLOSURE
The efficient operation of the Company's business is dependent on its computer
hardware, operating systems and software programs (collectively, "Systems and
Programs"). These Systems and Programs are used in several key areas of the
Company's business, including production and distribution, information
management services and financial reporting, as well as in various
administrative functions. The goal of the Company's Year 2000 project is to
prevent any disruption to the Company's business processes or its ability to
conduct business resulting from Year 2000 computer issues.
18
<PAGE>
The Year 2000 may cause problems in systems that use dates. Many systems such
as computers, computer applications, process equipment used in refineries, phone
systems, and electrical components have embedded chips that are subject to
failure. Failures result from the practice of representing the year as a
2-digit number, and then treating "00" as the year 1900, not 2000. Other
failures may result if the Year 2000 is not recognized as a leap year.
Disruptions may also be caused by computer failures of external sources such as
vendors, service providers and customers.
To identify and eliminate potential disruptions, the Company developed a Year
2000 compliance plan ("Compliance Plan") with respect to those Systems and
Programs that are deemed to be critical to the Company's operations and safety.
The Compliance Plan, which covers information technology ("IT") and non-IT
aspects, is divided into the following sections: Plant Facilities (includes
non-IT embedded systems such as process control systems, environmental systems
and the physical equipment and facilities at the Company's exploration and
production locations, refineries and transportation vessels), Business Systems
(includes IT hardware, software, and network systems serving the Company's
business units), Office Facilities (includes telephone, security, and office
equipment) and External Sources (customers, suppliers and vendors).
Implementation of the Compliance Plan is led by an oversight committee, made up
of representatives from each of the Company's major facilities. The Compliance
Plan is monitored weekly and progress is reported to management and the Board of
Directors.
The Compliance Plan includes the following phases and scheduled completion
dates:
<TABLE>
<CAPTION>
Scheduled
% Complete Completion Date
<S> <C> <C>
. Awareness: Establish a Year 2000 team and develop a detailed plan . . 100 Complete
. Assessment: Identify critical business processes and systems
that must be modified; assess and prioritize risk factors. . . . . . . 100 Complete
. Remediation: Convert, replace or eliminate hardware and software . . . 90 July 1999
. Validation: Test and verify. . . . . . . . . . . . . . . . . . . . . . 85 July 1999
. Implementation: Put new and renovated systems into production;
monitor and continually evaluate . . . . . . . . . . . . . . . . . . . 80 July 1999
. Contingency Plans: Develop contingency plans for critical items that
cannot be tested.. . . . . . . . . . . . . . . . . . . . . . . . . . . 20 September 1999
</TABLE>
The Company has utilized both internal and external resources in evaluating its
Systems and Programs, as well as manual processes, external interfaces with
customers and services supplied by vendors, to identify potential Year 2000
compliance problems. The Company has identified and is replacing a number of
Systems and Programs that are not Year 2000 compliant. Based on current
information, the Company expects to attain Year 2000 compliance and complete
appropriate testing of its modifications and replacements in advance of the Year
2000 date change. Modification or replacement of the Company's Systems and
Programs is being performed in-house by Company personnel and external
consultants.
The Company 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 the Company. However, because
most computer systems are, by their very nature, interdependent, it is possible
that non-compliant third-party computer systems or programs may not interface
properly with the Company's computer systems.
The Company has requested assurance from third parties that their computers,
systems or programs will be Year 2000 compliant. Approximately 3,000
questionnaires were sent to vendors who were identified as providing goods and
services to the Company's operations. Vendors were asked questions relating to
their Year 2000 preparation and readiness. Over 90% of the vendors either
returned the questionnaire or were contacted and interviewed personally. Of
those contacted, none could foresee that they would have a problem with the
delivery of goods or services on or after January 1, 2000. Efforts will
continue to contact the remaining critical vendors by June 1999. The utility
companies providing electricity and water to the Company's various locations
were contacted and questioned about their ability to provide uninterrupted
service and have all responded positively.
The Company is in the process of contacting 500 key customers to determine their
Year 2000 preparation and readiness. This effort is expected to be completed by
June 1999. Although the effort of contacting key customers and vendors is not
complete, management believes that the Company's risk is minimal as it relates
to key vendors and suppliers.
19
<PAGE>
The Company expects that expenses and capital expenditures associated with the
Year 2000 compliance project will not have a material effect on its business,
financial condition or results of operations. Costs to become Year 2000
compliant are estimated to total $6 million, of which $1 million was spent in
1998. It is estimated that approximately one-half of these costs will be
capital expenditures. The costs of Year 2000 compliance are the best estimates
of the Company's management and are believed to be reasonably accurate. In the
event the Compliance Plan is not successfully or timely implemented, the Company
may need to devote more resources to the process and additional costs may be
incurred. The costs of implementing the integrated enterprise-wide system are
excluded as this system implementation was undertaken primarily to improve
business processes.
If the Company were not able to satisfactorily complete its Compliance Plan,
including identifying and resolving problems encountered by the Company's
external service providers, potential consequences could include, among other
things, unit downtime at, or damage to, the Company's refineries, gas stations,
terminal facilities and pipelines; delays in transporting refinery feedstocks
and refined products; reduction in natural gas production; impairment of
relationships with significant suppliers or customers; loss of accounting data
or delays in processing such data; and loss of or delays in internal and
external communications. The occurrence of any or all of the above could result
in a material adverse effect on the Company's results of operations, liquidity
or financial condition. Although the Company currently believes that it will
satisfactorily complete its Compliance Plan prior to January 1, 2000, there can
be no assurance that it will be completed by such time or that the Year 2000
problem will not adversely affect the Company and its business.
The foregoing statements in the above paragraphs under "Year 2000 Readiness
Disclosure" herein are intended to be and are hereby designated "Year 2000
Readiness Disclosure" statements within the meaning of the Year 2000 Information
and Readiness Disclosure Act.
NEW ACCOUNTING STANDARD
In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standard ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes accounting and reporting
standards for derivative instruments, including certain derivative instruments
embedded in other contracts and for hedging activities. SFAS No. 133 requires
that an entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value.
The accounting for changes in the fair value of a derivative depends on the
intended use of the derivative and the resulting designation. SFAS No. 133 is
effective for the Company on January 1, 2000 and cannot be applied retroactively
to financial statements of prior periods. From time to time, the Company enters
into agreements to reduce commodity price risks. Gains or losses on these
hedging activities are recognized when the related physical transactions are
recognized as sales or purchases. The Company is evaluating the effects that
this new statement will have on its financial condition, results of operations
and financial reporting and disclosures.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company utilizes various financial instruments and enters into agreements
which inherently have some degree of market risk. The primary sources of market
risk include fluctuations in commodity prices and interest rate fluctuations.
PRICE FLUCTUATIONS
The Company's results of operations are highly dependent upon prices received
for refined products and natural gas production and on the prices paid for crude
oil and other refinery feedstocks.
From time to time, the Company enters into commodity price agreements to reduce
the risk caused by fluctuations in the prices of natural gas in the spot market.
During the 1999 Quarter, the Company used such agreements to set the price of
approximately 25% of the natural gas production that it sold in the spot market
and recognized a gain of $0.7 million ($0.09 per Mcf) from these price
agreements. As of March 31, 1999, the Company had remaining price agreements
outstanding through March 2000 for 11.6 billion cubic feet of natural gas
production with an average Houston ship channel floor price of $1.82 per Mcf and
an average ceiling price of $2.20 per Mcf.
20
<PAGE>
INTEREST RATE RISK
Total debt at March 31, 1999, included $332 million of fixed-rate debt and $183
million of floating-rate debt attributed to the Term Loans. As a result, the
Company's annual interest cost in 1999 will fluctuate based on short-term
interest rates. The impact on annual cash flow of a 10% change in the floating
rate (approximately 70 basis points) would be approximately $1.3 million.
At March 31, 1999, the fair market value of the Company's fixed-rate debt
approximated its book value of $332 million. The floating-rate debt will mature
over varying periods through 2003. Fixed-rate debt of $297 million will mature
in 2008, while other fixed-rate notes and obligations will mature over varying
periods through 2013.
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q 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
Exchange Act of 1934, as amended (the "Exchange Act"). These forward-looking
statements include, among other things, discussions of anticipated revenue
enhancements and cost savings following the acquisitions in 1998, 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 Form 10-Q 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. 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. 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, 1998, and
other of the Company's filings with the SEC. 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.
21
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As previously reported, the Company has been involved with a waste water
disposal site in Redwood City, California. On December 18, 1998, the Port
of Redwood City filed suit against numerous defendants including the
Company, for contribution pursuant to the Federal Comprehensive
Environmental Response, Compensation and Liability Act and the Resource
Conservation and Recovery Act. The Company has negotiated a settlement with
the Port of Redwood City for $30,000, which the court approved on May 10,
1999.
As previously reported, on August 26, 1998, the United States Coast Guard
issued a Notice of Federal Interest For An Oil Pollution Incident to Tesoro
Hawaii Corporation ("Tesoro Hawaii"), a subsidiary of the Company, in
connection with an oil spill which occurred on August 24, 1998, at Tesoro
Hawaii's single point mooring at Barbers Point, Oahu, Hawaii. Tesoro
Hawaii, the Coast Guard and the Hawaii Department of Health ("HDOH")
responded to the spill immediately and clean up efforts have been
completed. Under the Federal Water Pollution Control Act and the Oil
Pollution Act of 1990, the responsible party is liable for removal costs
and damages, including damages from injury to natural resources and may be
assessed administrative or civil penalties. The Company carries insurance
to provide protection against pollution damages. On April 5, 1999, the
Coast Guard assessed Tesoro Hawaii a civil penalty in the amount of
$10,000. The Company believes that the resolution of this oil spill will
not have a material adverse effect on the Company.
As previously reported, on October 16, 1998, the HDOH issued a Notice of
Apparent Violation of Hawaii state law to Tesoro Hawaii in connection with
a spill on September 23, 1998. During the loading of a barge sub-chartered
to Tesoro Hawaii, diesel fuel was spilled into the state waters at Barbers
Point Harbor, Oahu, Hawaii. On April 5, 1999, the United States Coast
Guard assessed Tesoro Hawaii a civil penalty in the amount of $6,000
alleging a violation of the Federal Water Pollution Control Act. The
Company is evaluating the assessed penalty and believes the resolution of
this matter will not have a material adverse effect on the Company.
ITEM 5. OTHER INFORMATION
The 1999 Annual Meeting of Stockholders of the Company will be held at the
Hotel Crescent Court, 400 Crescent Court, Dallas, Texas, at 10:00 A.M.
Central time on Wednesday, September 15, 1999. Holders of Common Stock of
record at the close of business on August 3, 1999, are entitled to notice
of and to vote at the annual meeting.
22
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule (March 31, 1999).
27.2 Restated Financial Data Schedule (March 31, 1998).
(b) Reports on Form 8-K
No reports on Form 8-K have been filed during the quarter for which this
report is filed.
23
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
TESORO PETROLEUM CORPORATION
Registrant
Date: May 17, 1999 /s/ BRUCE A. SMITH
Bruce A. Smith
Chairman of the Board of Directors,
President and Chief Executive Officer
Date: May 17, 1999 /s/ DON M. HEEP
Don M. Heep
Vice President, Controller
(Chief Accounting Officer)
24
<PAGE>
EXHIBIT INDEX
Exhibit
Number
27.1 Financial Data Schedule (March 31, 1999).
27.2 Restated Financial Data Schedule (March 31, 1998).
25
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM TESORO
PETROLEUM CORPORATION'S FINANCIAL STATEMENTS AS OF AND FOR THE THREE MONTH
PERIOD ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE
TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 6,800
<SECURITIES> 0
<RECEIVABLES> 165,900
<ALLOWANCES> 1,700
<INVENTORY> 214,700
<CURRENT-ASSETS> 397,500
<PP&E> 1,376,600
<DEPRECIATION> 461,600
<TOTAL-ASSETS> 1,445,500
<CURRENT-LIABILITIES> 260,400
<BONDS> 495,400
0
165,000
<COMMON> 5,400
<OTHER-SE> 386,100
<TOTAL-LIABILITY-AND-EQUITY> 1,445,500
<SALES> 508,500
<TOTAL-REVENUES> 508,600
<CGS> 470,100
<TOTAL-COSTS> 470,100
<OTHER-EXPENSES> 17,400
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 12,700
<INCOME-PRETAX> 1,300
<INCOME-TAX> 1,000
<INCOME-CONTINUING> 300
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 300
<EPS-PRIMARY> (0.08)
<EPS-DILUTED> (0.08)
<FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 2,300
<SECURITIES> 0
<RECEIVABLES> 65,800
<ALLOWANCES> 1,300
<INVENTORY> 97,800
<CURRENT-ASSETS> 172,600
<PP&E> 742,100
<DEPRECIATION> 317,700
<TOTAL-ASSETS> 635,400
<CURRENT-LIABILITIES> 85,900
<BONDS> 136,300
0
0
<COMMON> 4,400
<OTHER-SE> 335,000
<TOTAL-LIABILITY-AND-EQUITY> 635,400
<SALES> 195,200
<TOTAL-REVENUES> 196,000
<CGS> 165,100
<TOTAL-COSTS> 165,100
<OTHER-EXPENSES> 13,200
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,000 <F1>
<INCOME-PRETAX> 10,900
<INCOME-TAX> 4,800
<INCOME-CONTINUING> 6,100
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,100
<EPS-PRIMARY> 0.23
<EPS-DILUTED> 0.23
<FN>
<F1> Certain reclassifications have been made to information previously
reported to conform to current presentation.
</TABLE>
