UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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 32,349,542 shares of the registrant's Common Stock outstanding at
July 31, 1999.
<PAGE>
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999
TABLE OF CONTENTS
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - June 30, 1999
and December 31, 1998 . . . . . . . . . . . . . . . . . . . . 3
Condensed Statements of Consolidated Operations - Three Months
and Six Months Ended June 30, 1999 and 1998. . . . . . . . . . 4
Condensed Statements of Consolidated Cash Flows - Six Months
Ended June 30, 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 . . . . . . . . . . . . . . 12
Item 3. Quantitative and Qualitative Disclosures About
Market Risk . . . . . . . . . . . . . . . . . . . . . . . . . . 23
PART II. OTHER INFORMATION
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . 25
Item 5. Other Information . . . . . . . . . . . . . . . . . . . 25
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . 25
SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
EXHIBIT INDEX. . . . . . . . . . . . . . . . . . . . . . . . . . . 27
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)
June 30, December 31,
1999 1998
---- ----
ASSETS
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . . $ 11.3 $ 12.9
Receivables, less allowance for doubtful accounts . . . . . . . . 213.4 157.5
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . . 228.5 208.2
Prepayments and other . . . . . . . . . . . . . . . . . . . . . . 10.3 12.0
-------- --------
Total Current Assets . . . . . . . . . . . . . . . . . . . . . . 463.5 390.6
-------- --------
PROPERTY, PLANT AND EQUIPMENT
Refining and marketing. . . . . . . . . . . . . . . . . . . . . . 855.0 841.0
Marine services . . . . . . . . . . . . . . . . . . . . . . . . . 52.8 50.8
Exploration and production, full-cost method of accounting. . . . 463.9 426.5
Corporate . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26.9 21.4
-------- --------
1,398.6 1,339.7
Less accumulated depreciation, depletion and amortization . . . . 479.5 445.1
-------- --------
Net Property, Plant and Equipment. . . . . . . . . . . . . . . . 919.1 894.6
-------- --------
OTHER ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . 139.9 143.2
-------- --------
Total Assets. . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,522.5 $ 1,428.4
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . . $ 157.2 $ 126.4
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . 97.2 69.3
Current maturities of long-term debt and other obligations. . . . 20.2 12.5
-------- --------
Total Current Liabilities. . . . . . . . . . . . . . . . . . . . 274.6 208.2
-------- --------
DEFERRED INCOME TAXES. . . . . . . . . . . . . . . . . . . . . . . 72.4 69.9
-------- --------
OTHER LIABILITIES . . . . . . . . . . . . . . . . . . . . . . . . 65.5 59.7
-------- --------
LONG-TERM DEBT AND OTHER OBLIGATIONS, LESS CURRENT
MATURITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . 524.0 531.4
-------- --------
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;
32,669,564 shares issued (32,654,138 in 1998). . . . . . . . . . 5.4 5.4
Additional paid-in capital. . . . . . . . . . . . . . . . . . . . 278.6 278.6
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . 142.4 115.6
Treasury stock, 320,022 common shares, at cost. . . . . . . . . . (5.4) (5.4)
-------- --------
Total Stockholders' Equity . . . . . . . . . . . . . . . . . . . 586.0 559.2
-------- --------
Total Liabilities and Stockholders' Equity. . . . . . . . . . . $ 1,522.5 $ 1,428.4
======== ========
<FN>
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 Six Months Ended
June 30, June 30,
------------------ ----------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUES
Refining and marketing. . . . . . . . . . . . $ 711.1 $ 207.6 $ 1,183.3 $ 347.8
Marine services . . . . . . . . . . . . . . . 27.7 29.1 48.9 61.9
Exploration and production. . . . . . . . . . 15.2 21.6 30.3 43.8
Other income . . . . . . . . . . . . . . . . 0.1 20.6 0.2 21.4
-------- -------- -------- --------
Total Revenues . . . . . . . . . . . . . . . 754.1 278.9 1,262.7 474.9
-------- -------- -------- --------
OPERATING COSTS AND EXPENSES
Refining and marketing. . . . . . . . . . . . 633.5 182.8 1,079.4 313.5
Marine services . . . . . . . . . . . . . . . 26.8 27.0 46.9 57.5
Exploration and production. . . . . . . . . . 5.3 3.5 9.4 7.4
Depreciation, depletion and amortization. . . 16.5 14.8 33.4 27.8
-------- -------- -------- --------
Total Segment Operating Costs and Expenses . 682.1 228.1 1,169.1 406.2
-------- -------- -------- --------
SEGMENT OPERATING PROFIT . . . . . . . . . . . 72.0 50.8 93.6 68.7
Other operating costs and expenses . . . . . . - (7.9) - (7.9)
General and administrative expense . . . . . . (8.4) (3.8) (15.3) (7.2)
Interest and financing costs . . . . . . . . . (11.8) (6.8) (24.5) (9.8)
Interest income. . . . . . . . . . . . . . . . 0.3 0.3 0.4 0.4
Other expense, net . . . . . . . . . . . . . . (1.5) (13.6) (2.3) (14.3)
-------- -------- -------- --------
EARNINGS BEFORE INCOME TAXES AND
EXTRAORDINARY ITEM. . . . . . . . . . . . . . 50.6 19.0 51.9 29.9
Income tax provision . . . . . . . . . . . . . 18.1 8.2 19.1 13.0
-------- -------- -------- --------
EARNINGS BEFORE EXTRAORDINARY ITEM . . . . . . 32.5 10.8 32.8 16.9
Extraordinary loss on extinguishment of debt,
net of income tax benefit of $2.4 in 1998 . . - (4.6) - (4.6)
-------- -------- -------- --------
NET EARNINGS . . . . . . . . . . . . . . . . . 32.5 6.2 32.8 12.3
Preferred dividend requirements. . . . . . . . 3.0 - 6.0 -
-------- -------- -------- --------
NET EARNINGS APPLICABLE TO COMMON STOCK. . . . $ 29.5 $ 6.2 $ 26.8 $ 12.3
======== ======== ======== ========
NET EARNINGS PER SHARE - BASIC . . . . . . . . $ 0.91 $ 0.23 $ 0.83 $ 0.47
======== ======== ======== ========
NET EARNINGS PER SHARE - DILUTED . . . . . . . $ 0.76 $ 0.23 $ 0.76 $ 0.46
======== ======== ======== ========
WEIGHTED AVERAGE COMMON SHARES - BASIC . . . . 32.3 26.5 32.3 26.4
======== ======== ======== ========
WEIGHTED AVERAGE COMMON AND POTENTIALLY
DILUTIVE COMMON SHARES - DILUTED. . . . . . . 43.0 27.2 42.9 27.0
======== ======== ======== ========
<FN>
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)
Six Months Ended
June 30,
----------------
1999 1998
---- ----
<S> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Net earnings. . . . . . . . . . . . . . . . . . . . $ 32.8 $ 12.3
Adjustments to reconcile net earnings to net
cash from operating activities:
Depreciation, depletion and amortization. . . . . 34.3 28.2
Loss on extinguishment of debt, net of income
tax benefit. . . . . . . . . . . . . . . . . . - 4.6
Amortization of deferred charges and other. . . . 4.1 0.7
Changes in operating assets and liabilities:
Receivables. . . . . . . . . . . . . . . . . . . (55.9) 14.7
Inventories. . . . . . . . . . . . . . . . . . . (20.3) (16.8)
Accounts payable and accrued liabilities . . . . 54.9 (4.1)
Other assets and liabilities . . . . . . . . . . 15.5 4.3
------ ------
Net cash from operating activities . . . . . . 65.4 43.9
------ ------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Capital expenditures. . . . . . . . . . . . . . . . (62.5) (62.3)
Acquisition costs and other . . . . . . . . . . . . 0.4 (253.3)
------ ------
Net cash used in investing activities. . . . . (62.1) (315.6)
------ ------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Repayments under revolving credit and interim
facilities, net of borrowings. . . . . . . . . . (28.2) 393.0
Repayments of other debt and obligations. . . . . . (20.7) (91.9)
Issuance of other long-term debt. . . . . . . . . . 50.0 -
Payment of dividends on preferred stock . . . . . . (6.0) -
Financing costs and other . . . . . . . . . . . . . - (11.4)
------ ------
Net cash from (used in) financing activities . (4.9) 289.7
------ ------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS. . . (1.6) 18.0
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD. . . . 12.9 8.4
------ ------
CASH AND CASH EQUIVALENTS, END OF PERIOD. . . . . . . $ 11.3 $ 26.4
====== ======
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid . . . . . . . . . . . . . . . . . . . $ 22.9 $ 3.6
====== ======
Income taxes paid . . . . . . . . . . . . . . . . . $ 11.1 $ 6.0
====== ======
<FN>
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.
The balance sheet at December 31, 1998 has been condensed from the audited
consolidated financial statements at that date. Certain information and notes
normally included in financial statements prepared in accordance with 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 June 30, 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 . $ 195.9 $ 182.4
Merchandise and other refined products. . . . . . . 14.4 10.5
Materials and supplies. . . . . . . . . . . . . . . 18.2 15.3
----- -----
Total inventories . . . . . . . . . . . . . . . . $ 228.5 $ 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 extraordinary item, 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 and six months ended June 30, 1999 and
1998 is as follows (in millions):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUES
Gross operating revenues:
Refining and Marketing. . . . . . . . . . . . $ 711.1 $ 207.6 $ 1,183.3 $ 347.8
Marine Services . . . . . . . . . . . . . . . 27.7 29.1 48.9 61.9
Exploration and Production -
U.S. . . . . . . . . . . . . . . . . . . . . 13.8 18.7 27.7 37.8
Latin America. . . . . . . . . . . . . . . . 1.4 2.9 2.6 6.0
------ ------ -------- --------
Total Gross Operating Revenues . . . . . . . 754.0 258.3 1,262.5 453.5
Other income . . . . . . . . . . . . . . . . . 0.1 20.6 0.2 21.4
------ ------ -------- --------
Total Revenues . . . . . . . . . . . . . . $ 754.1 $ 278.9 $ 1,262.7 $ 474.9
====== ====== ======== ========
SEGMENT OPERATING PROFIT
Refining and Marketing . . . . . . . . . . . . $ 68.6 $ 20.0 $ 86.1 $ 26.5
Marine Services. . . . . . . . . . . . . . . . 0.2 1.6 0.6 3.4
Exploration and Production -
U.S.. . . . . . . . . . . . . . . . . . . . . 3.6 28.5 7.4 36.4
Latin America . . . . . . . . . . . . . . . . (0.4) 0.7 (0.5) 2.4
------ ------ -------- --------
Total Segment Operating Profit . . . . . . . 72.0 50.8 93.6 68.7
Corporate and Unallocated Costs. . . . . . . . (21.4) (31.8) (41.7) (38.8)
------ ------ -------- --------
Earnings Before Income Taxes and
Extraordinary Item. . . . . . . . . . . . . . $ 50.6 $ 19.0 $ 51.9 $ 29.9
====== ====== ======== ========
EBITDA
Refining and Marketing . . . . . . . . . . . . $ 77.6 $ 24.3 $ 103.9 $ 33.8
Marine Services. . . . . . . . . . . . . . . . 0.9 2.1 2.0 4.5
Exploration and Production -
U.S.. . . . . . . . . . . . . . . . . . . . . 10.0 37.8 20.8 54.6
Latin America . . . . . . . . . . . . . . . . - 1.4 0.3 3.6
------ ------ -------- --------
Total Operating Segment EBITDA . . . . . . . 88.5 65.6 127.0 96.5
Corporate and Unallocated. . . . . . . . . . . (9.2) (24.8) (16.3) (28.6)
------ ------ -------- --------
Total Consolidated EBITDA. . . . . . . . . . 79.3 40.8 110.7 67.9
Depreciation, Depletion and Amortization . . . (16.9) (15.0) (34.3) (28.2)
Interest and Financing Costs . . . . . . . . . (11.8) (6.8) (24.5) (9.8)
------ ------ -------- --------
Earnings Before Income Taxes and
Extraordinary Item . . . . . . . . . . . . . $ 50.6 $ 19.0 $ 51.9 $ 29.9
====== ====== ======== ========
DEPRECIATION, DEPLETION AND AMORTIZATION
Refining and Marketing . . . . . . . . . . . . $ 9.0 $ 4.3 $ 17.8 $ 7.3
Marine Services. . . . . . . . . . . . . . . . 0.7 0.5 1.4 1.1
Exploration and Production -
U.S.. . . . . . . . . . . . . . . . . . . . . 6.4 9.3 13.4 18.2
Latin America . . . . . . . . . . . . . . . . 0.4 0.7 0.8 1.2
Corporate. . . . . . . . . . . . . . . . . . . 0.4 0.2 0.9 0.4
------ ------ -------- --------
Total Depreciation, Depletion and Amortization $ 16.9 $ 15.0 $ 34.3 $ 28.2
====== ====== ======== ========
CAPITAL EXPENDITURES
Refining and Marketing . . . . . . . . . . . . $ 7.9 $ 5.2 $ 19.0 $ 7.2
Marine Services. . . . . . . . . . . . . . . . 1.6 1.4 1.8 2.6
Exploration and Production -
U.S.. . . . . . . . . . . . . . . . . . . . . 9.9 20.3 24.7 38.5
Latin America . . . . . . . . . . . . . . . . 4.1 9.2 12.7 11.5
Corporate. . . . . . . . . . . . . . . . . . . 2.2 2.4 4.3 2.5
------ ------ -------- --------
Total Capital Expenditures. . . . . . . . . . $ 25.7 $ 38.5 $ 62.5 $ 62.3
====== ====== ======== ========
</TABLE>
7
<PAGE>
Other income for the three months and six months ended June 30, 1998, included
receipt of $21.3 million from an operator in the Bob West Field, representing
funds that were no longer needed as a contingency reserve for litigation. This
income is included in U.S. Exploration and Production segment operating profit
and EBITDA.
Corporate and unallocated costs for the three months and six months ended June
30, 1998, included $19.9 million (of which $7.9 million related to the operating
segments) for special incentive compensation which was earned when the market
price of the Company's common stock achieved a certain performance target in May
1998.
Identifiable assets are those assets utilized by the segment. Corporate assets
are principally cash, property and other assets that are not directly associated
with the operations of an operating segment. Segment assets as of June 30, 1999
and December 31, 1998 were as follows (in millions):
<TABLE>
<CAPTION>
1999 1998
---- ----
<S> <C> <C>
IDENTIFIABLE ASSETS
Refining and Marketing . . . . . . . . . . . $ 1,153.4 $ 1,077.7
Marine Services. . . . . . . . . . . . . . . 69.2 59.2
Exploration and Production -
U.S.. . . . . . . . . . . . . . . . . . . . 182.3 175.8
Latin America . . . . . . . . . . . . . . . 67.2 58.9
Corporate. . . . . . . . . . . . . . . . . . 50.4 56.8
------- -------
Total Assets . . . . . . . . . . . . . . . $ 1,522.5 $ 1,428.4
======= =======
</TABLE>
In May 1999, the Company announced that its Board of Directors had approved
seeking alternative value creating opportunities, including a spin-off, trade,
sale and other options, for its Exploration and Production segment. Both the
Refining and Marketing and Exploration and Production segments have growth
opportunities which require additional investment. Given the Company's
strategic objectives and its desire to improve financial flexibility, it
believes that it would not be able to prudently fund all these opportunities.
The Company is in the early stages of evaluating alternatives which could
improve its capital structure, provide additional financial flexibility, and
increase focus on its downstream businesses. There can be no assurance as to
whether or when any alternatives would be pursued.
NOTE D - COMMITMENTS AND CONTINGENCIES
The Company is a party to various litigation and contingent loss situations,
including environmental matters, arising in the ordinary course of business.
The Company has made accruals in accordance with Statement of Financial
Accounting Standards No. 5, "Accounting for Contingencies," in order to provide
for such matters. The ultimate effects of these matters cannot be predicted
with certainty, and related accruals are based on management's best estimates,
subject to future developments. Although the resolution of certain of these
matters could have a material adverse impact on interim or annual results of
operations, the Company believes that the outcome of these matters will not
result in a material adverse effect on its liquidity or consolidated financial
position.
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
8
<PAGE>
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.
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 June 30, 1999, the Company's
accruals for environmental expenses amounted to $11.5 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 $8 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 by 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.
OTHER
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.
9
<PAGE>
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.
10
<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 and the maximum shares which would have been issued assuming
conversion of preferred stock at the beginning of the period. The preferred
stock is represented by Premium Income Equity Securities ("PIES") which will
automatically convert into shares of common stock on July 1, 2001, at conversion
rates ranging from 0.8455 shares to 1.0 shares of common stock for each PIES,
depending upon the market price of the common stock. Before July 1, 2001, each
PIES is convertible at the option of the holder thereof into 0.8455 shares of
common stock. The maximum conversion rate of 1.0 common share for each PIES is
used in the 1999 earnings per share calculations. Earnings per share
calculations for the three months and six months ended June 30, 1999 and 1998
are presented below (in millions except per share amounts):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
BASIC:
Numerator:
Net earnings . . . . . . . . . . . . . . . . . . . . $ 32.5 $ 6.2 $ 32.8 $ 12.3
Less dividends on preferred stock. . . . . . . . . . 3.0 - 6.0 -
---- ---- ---- ----
Net earnings applicable to common shares . . . . . . $ 29.5 $ 6.2 $ 26.8 $ 12.3
==== ==== ==== ====
Denominator:
Weighted average common shares outstanding . . . . . 32.3 26.5 32.3 26.4
==== ==== ==== ====
Net Earnings Per Share. . . . . . . . . . . . . . . . $ 0.91 $ 0.23 $ 0.83 $ 0.47
==== ==== ==== ====
DILUTED:
Numerator:
Net earnings applicable to common shares . . . . . . $ 29.5 $ 6.2 $ 26.8 $ 12.3
Plus earnings impact of assumed conversion of
preferred stock (only if dilutive). 3.0 - 6.0 -
---- ---- ---- ----
Net earnings applicable to common shares . . . . . . $ 32.5 $ 6.2 $ 32.8 $ 12.3
==== ==== ==== ====
Denominator:
Weighted average common shares outstanding . . . . . 32.3 26.5 32.3 26.4
Add potentially dilutive securities:
Incremental dilutive shares from assumed exercise
of stock options and other (only if dilutive) . . 0.4 0.7 0.3 0.6
Incremental dilutive shares from assumed conversion
of preferred stock (only if dilutive) . . . . . . 10.3 - 10.3 -
---- ---- ---- ----
Total diluted shares . . . . . . . . . . . . . . . . 43.0 27.2 42.9 27.0
==== ==== ==== ====
Net Earnings Per Share. . . . . . . . . . . . . . . . $ 0.76 $ 0.23 $ 0.76 $ 0.46
==== ==== ==== ====
</TABLE>
The 1998 extraordinary loss on early extinguishment of debt of $4.6 million
aftertax ($7.0 million pretax) amounted to $0.17 per basic and diluted share for
the three months and six months ended June 30, 1998.
11
<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 24 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 refining and marketing assets in Hawaii in May 1998 and acquired
a Washington refinery and related assets in August 1998. These acquisitions
have significantly increased Tesoro's historical annual revenues and the scope
of its Refining and Marketing operations. During the first half of 1999,
results from the acquired operations added substantially to the Company's
earnings and cash flows. These acquisitions positioned Tesoro to participate
actively in the atypical market conditions experienced on the West Coast which
contributed significantly to profitability in the second quarter of 1999.
Tesoro is also realizing cost savings and profit generating synergies among the
three refineries and is on track to realize approximately $25 million from such
synergies in 1999. The Company will continue to pursue other opportunities that
are operationally and geographically complementary with its asset base.
In May 1999, the Company announced that its Board of Directors had approved
seeking alternative value creating opportunities, including a spin-off, trade,
sale and other options, for its Exploration and Production segment. Both the
Refining and Marketing and Exploration and Production segments have growth
opportunities which require additional investment. Given the Company's
strategic objectives and its desire to improve financial flexibility, it
believes that it would not be able to prudently fund all these opportunities.
The Company is in the early stages of evaluating alternatives which could
improve its capital structure, provide additional financial flexibility, and
increase focus on its downstream businesses. There can be no assurance as to
whether or when any alternatives would be pursued.
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 natural gas and
oil prices and other determining factors.
12
<PAGE>
RESULTS OF OPERATIONS - THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 1999 COMPARED
WITH THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 1998
SUMMARY
Tesoro's net earnings were $32.5 million ($0.91 per basic share or $0.76 per
diluted share) for the three months ended June 30, 1999 ("1999 Quarter"),
compared with net earnings of $6.2 million ($0.23 per basic and diluted share)
for the three months ended June 30, 1998 ("1998 Quarter"). For the year-to-date
periods, net earnings were $32.8 million ($0.83 per basic share or $0.76 per
diluted share) for the six months ended June 30, 1999 ("1999 Period"), compared
with $12.3 million ($0.47 per basic share or $0.46 per diluted share) for the
six months ended June 30, 1998 ("1998 Period").
The improvement in 1999 earnings was due to higher operating profit from the
Company's Refining and Marketing segment. Increased throughput and sales
volumes from operations acquired in mid-1998, refinery efficiency and
reliability, and profits from purchasing and selling products manufactured by
others contributed to the Refining and Marketing results. Partially offsetting
these improvements were reduced profits from the Marine Services and Exploration
and Production segments and increased interest and financing costs. On a per
share basis, net earnings were impacted by the issuance of preferred stock and
additional shares of common stock in mid-1998.
Significant items which occurred in 1998 and affect the comparability with 1999
are highlighted in the table below (in millions, except per share amounts):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -------------------
1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net Earnings as Reported . . . . . . . . . . . . . . $ 32.5 $ 6.2 $ 32.8 $ 12.3
Extraordinary Loss on Debt Extinguishment, Net of
Income Tax Benefit. . . . . . . . . . . . . . . . . - 4.6 - 4.6
------ ------ ------ ------
Earnings Before Extraordinary Item . . . . . . . . . 32.5 10.8 32.8 16.9
------ ------ ------ ------
Significant Items Affecting Comparability, Pretax:
Income from receipt of contingency funds from an
operator. . . . . . . . . . . . . . . . . . . . . - 21.3 - 21.3
Charge for special incentive compensation . . . . . - (19.9) - (19.9)
------ ------ ------ ------
Total Significant Items, Pretax. . . . . . . . . . - 1.4 - 1.4
Income Tax Effect. . . . . . . . . . . . . . . . . - 0.5 - 0.5
------ ------ ------ ------
Total Significant Items, Aftertax. . . . . . . . . - 0.9 - 0.9
------ ------ ------ ------
Net Earnings Excluding Significant Items and
Extraordinary Item. . . . . . . . . . . . . . . . . 32.5 9.9 32.8 16.0
Preferred Dividend Requirements. . . . . . . . . . . 3.0 - 6.0 -
------ ------ ------ ------
Net Earnings Applicable to Common Stock, Excluding
Significant Items and Extraordinary Item. . . . . . $ 29.5 $ 9.9 $ 26.8 $ 16.0
====== ====== ====== ======
Earnings Per Share - Basic:
As reported . . . . . . . . . . . . . . . . . . . . $ 0.91 $ 0.23 $ 0.83 $ 0.47
Extraordinary loss. . . . . . . . . . . . . . . . . - (0.17) - (0.17)
Effect of other significant items . . . . . . . . . - 0.03 - 0.04
------ ------ ------ ------
Excluding significant items and extraordinary item. $ 0.91 $ 0.37 $ 0.83 $ 0.60
====== ====== ====== ======
Earnings Per Share - Diluted:
As reported . . . . . . . . . . . . . . . . . . . . $ 0.76 $ 0.23 $ 0.76 $ 0.46
Extraordinary loss. . . . . . . . . . . . . . . . . - (0.17) - (0.17)
Effect of other significant items . . . . . . . . . - 0.04 - 0.04
------ ------ ------ ------
Excluding significant items and extraordinary item. $ 0.76 $ 0.36 $ 0.76 $ 0.59
====== ====== ====== ======
</TABLE>
A discussion and analysis of the factors contributing to the Company's results
of operations are presented below.
13
<PAGE>
<TABLE>
<CAPTION>
REFINING AND MARKETING
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
(Dollars in millions except per barrel amounts) 1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Gross Operating Revenues:
Refined products. . . . . . . . . . . . . . . . . . . . . $ 696.4 $ 184.9 $ 1,150.0 $ 307.6
Other, primarily crude oil resales and merchandise. . . . 14.7 22.7 33.3 40.2
----- ----- ------- -----
Gross Operating Revenues . . . . . . . . . . . . . . . . $ 711.1 $ 207.6 $ 1,183.3 $ 347.8
===== ===== ======= =====
Segment Operating Profit:
Gross margin:
Refinery <F1>. . . . . . . . . . . . . . . . . . . . . . $ 160.4 $ 53.1 $ 263.0 $ 83.1
Non-refinery <F2>. . . . . . . . . . . . . . . . . . . . 18.1 7.0 30.9 10.7
----- ----- ------- -----
Total gross margins . . . . . . . . . . . . . . . . . . 178.5 60.1 293.9 93.8
Operating expenses and other. . . . . . . . . . . . . . . 100.9 35.8 190.0 60.0
Depreciation and amortization . . . . . . . . . . . . . . 9.0 4.3 17.8 7.3
----- ----- ------- -----
Segment Operating Profit . . . . . . . . . . . . . . . . $ 68.6 $ 20.0 $ 86.1 $ 26.5
===== ===== ======= =====
Total Refinery System Throughput (thousands of barrels
per day) <F3>. . . . . . . . . . . . . . . . . . . . . . 252.4 81.0 240.7 68.7
===== ===== ======= =====
Refined Products Manufactured (thousands of barrels
per day) <F3>:
Gasoline and gasoline blendstocks. . . . . . . . . . . . 98.7 20.7 94.4 17.9
Jet fuel . . . . . . . . . . . . . . . . . . . . . . . . 62.8 27.0 60.4 23.5
Diesel fuel. . . . . . . . . . . . . . . . . . . . . . . 35.5 8.4 33.3 6.9
Heavy oils and residual products . . . . . . . . . . . . 47.1 23.0 44.9 19.1
Other, including synthetic natural gas and liquefied
petroleum gas. . . . . . . . . . . . . . . . . . . . . 18.3 4.5 18.1 3.3
----- ----- ------- -----
Total Refined Products Manufactured . . . . . . . . . . 262.4 83.6 251.1 70.7
===== ===== ======= =====
Refinery Product Spread ($/barrel) . . . . . . . . . . . . $ 6.98 $ 7.20 $ 6.04 $ 6.69
===== ===== ======= =====
Segment Product Sales (thousands of barrels per day)<F3><F4>:
Gasoline and gasoline blendstocks . . . . . . . . . . . . 138.1 29.1 124.0 21.8
Middle distillates. . . . . . . . . . . . . . . . . . . . 121.0 43.0 114.8 38.0
Heavy oils, residual products and other . . . . . . . . . 50.1 25.9 54.8 22.1
----- ----- ------- -----
Total Product Sales. . . . . . . . . . . . . . . . . . . 309.2 98.0 293.6 81.9
===== ===== ======= =====
Segment Gross Margins on Product Sales ($/barrel)<F5>:
Average sales price . . . . . . . . . . . . . . . . . . . $ 24.75 $ 20.73 $ 21.64 $ 20.74
Average costs of sales. . . . . . . . . . . . . . . . . . 18.60 14.76 16.31 15.35
----- ----- ------- -----
Gross Margin . . . . . . . . . . . . . . . . . . . . . . $ 6.15 $ 5.97 $ 5.33 $ 5.39
===== ===== ======= =====
<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. Volumes for
1998 include Hawaii operations for June, averaged over the periods presented.
<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>
14
<PAGE>
THREE MONTHS ENDED JUNE 30, 1999, COMPARED WITH THREE MONTHS ENDED JUNE 30,
1998. Segment operating profit for the Company's Refining and Marketing
operations was $68.6 million in the 1999 Quarter, an increase of $48.6 million
from segment operating profit of $20.0 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 and
additional sales of purchased product to supply U.S. West Coast markets.
Refining margins in the western United States were strong in the 1999 Quarter
due to seasonal demand, product supply disruptions caused by operating problems
at other refineries, and a rupture of a major refined products pipeline which
serves the Pacific Northwest region. The disruptions began in the middle of the
first quarter and extended through the second quarter of 1999. Product
movements out of Tesoro's Anacortes, Washington refinery were not significantly
affected by the pipeline rupture, allowing Tesoro to operate at full capacity
and to continue to supply its customers.
Operating management was able to increase its system-wide refinery throughput to
an average of 252 barrels per day, even though the Alaska refinery underwent a
major turnaround during the 1999 Quarter. This represents a 92% utilization
rate based on system-wide refinery capacity. Tesoro's high refinery utilization
rate during this period of strong West Coast refining margins was critical to
achieving increased profitability in the 1999 Quarter.
Management believes that stronger than normal market conditions on the West
Coast added up to $0.75 per barrel to the Company's refined product margin,
compared to historical market conditions. In addition, Tesoro's strengthening
marketing presence allowed the Company to increase 1999 Quarter profitability by
$13 million from the sale of purchased refined products.
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 and higher product prices. Other
revenues included higher retail 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, increased prices for
feedstock and higher purchased product volumes.
Overall refinery gross margin increased to $160.4 million in the 1999 Quarter
due to the higher throughput volumes partially offset by a decrease in average
refinery product spread per barrel to $6.98 in the 1999 Quarter compared to
$7.20 in the 1998 Quarter. Margins from non-refinery activities increased to
$18.1 million in the 1999 Quarter due primarily to higher sales of purchased
products and increased merchandise sales. Operating expenses and depreciation
and amortization also increased primarily due to the acquisitions.
The unusual market conditions experienced on the West Coast, which added
profitability during the 1999 Quarter, are continuing into the third quarter.
Future profitability of this segment will continue to be influenced, either
positively or negatively, by market conditions and other additional factors that
are beyond the control of the Company. A maintenance turnaround of the crude
distillation and catalytic reformer units at the Company's Anacortes,
Washington, refinery is scheduled for the fourth quarter of 1999.
SIX MONTHS ENDED JUNE 30, 1999, COMPARED WITH SIX MONTHS ENDED JUNE 30, 1998.
Segment operating profit for the Company's Refining and Marketing operations was
$86.1 million in the 1999 Period, an increase of $59.6 million from segment
operating profit of $26.5 million in the 1998 Period. As discussed above, this
increase was primarily due to the operating results from the Hawaii and
Washington refineries purchased in mid-1998 and stronger than normal market
conditions on the West Coast during recent months. Refining and Marketing
operations are also profiting from Tesoro's focus on manufacturing efficiency
and reliability, as well as marketing flexibility. Revenues, costs, margins and
sales volumes more than tripled in the 1999 Period, compared to the 1998 Period.
15
<PAGE>
<TABLE>
<CAPTION>
MARINE SERVICES
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
(Dollars in millions) 1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
Gross Operating Revenues:
Fuels . . . . . . . . . . . . . . . . $ 21.9 $ 22.5 $ 37.5 $ 48.3
Lubricants and other. . . . . . . . . 3.5 3.8 6.8 7.9
Services. . . . . . . . . . . . . . . 2.3 2.8 4.6 5.7
---- ---- ---- ----
Gross Operating Revenues . . . . . . 27.7 29.1 48.9 61.9
Costs of Sales . . . . . . . . . . . . 19.1 19.8 32.0 43.4
---- ---- ---- ----
Gross Profit . . . . . . . . . . . . 8.6 9.3 16.9 18.5
Operating Expenses and Other . . . . . 7.7 7.2 14.9 14.0
Depreciation and Amortization. . . . . 0.7 0.5 1.4 1.1
---- ---- ---- ----
Segment Operating Profit. . . . . . . $ 0.2 $ 1.6 $ 0.6 $ 3.4
==== ==== ==== ====
Sales Volumes (millions of gallons):
Fuels, primarily diesel . . . . . . . 45.1 43.6 82.0 91.5
Lubricants. . . . . . . . . . . . . . 0.5 0.5 1.0 1.2
</TABLE>
Effective June 17, 1999, the Company purchased the U.S. West Coast marine fuels
operations of BP Marine, a division of BP Amoco PLC. The purchase included
facilities at Port Angeles and Seattle, Washington, and Portland, Oregon, plus
working capital. These operations contributed revenues of $3.0 million (7.0
million sales gallons) to Tesoro's results in the 1999 Quarter. These
operations are expected to add $0.5 million to $1.0 million to future quarterly
operating profit.
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 1999
contributed to an overall decline of $1.4 million and $2.8 million in the Marine
Services segment's operating profit during the 1999 Quarter and 1999 Period,
respectively. The declines of $1.4 million and $13.0 million in gross revenues
during the 1999 Quarter and 1999 Period, respectively, reflected lower fuel
prices, reduced service revenues and a reduction in fuel sales volumes in the
Gulf of Mexico, partly offset by the revenues from the new West Coast
operations. Likewise, the decrease in costs of sales reflected the lower fuel
volumes and prices in the Gulf of Mexico, partly offset by increased volumes
from the new West Coast operations.
16
<PAGE>
<TABLE>
<CAPTION>
EXPLORATION AND PRODUCTION
Three Months Ended Six Months Ended
June 30, June 30,
------------------ -----------------
(Dollars in millions except per unit amounts) 1999 1998 1999 1998
---- ---- ---- ----
<S> <C> <C> <C> <C>
U.S. <F1>:
Gross operating revenues. . . . . . . . . . . . . . . . . . . . $ 13.8 $ 18.7 $ 27.7 $ 37.8
Other income (expense). . . . . . . . . . . . . . . . . . . . . (0.6) 21.7 (0.6) 22.3
Production costs . . . . . . . . . . . . . . . . . . . . . . . 2.6 2.0 5.1 4.5
Administrative support and other operating expenses . . . . . . 0.6 0.6 1.2 1.0
Depreciation, depletion and amortization. . . . . . . . . . . . 6.4 9.3 13.4 18.2
----- ----- ----- -----
Segment Operating Profit - U.S.. . . . . . . . . . . . . . . . 3.6 28.5 7.4 36.4
----- ----- ----- -----
LATIN AMERICA:
Gross operating revenues. . . . . . . . . . . . . . . . . . . . 1.4 2.9 2.6 6.0
Other income (expense). . . . . . . . . . . . . . . . . . . . . (0.4) (0.5) (0.4) (0.5)
Production costs. . . . . . . . . . . . . . . . . . . . . . . . 0.3 0.2 0.7 0.5
Administrative support and other operating expenses . . . . . . 0.7 0.8 1.2 1.4
Depreciation, depletion and amortization. . . . . . . . . . . . 0.4 0.7 0.8 1.2
----- ----- ----- -----
Segment Operating Profit (Loss)- Latin America . . . . . . . . (0.4) 0.7 (0.5) 2.4
----- ----- ----- -----
Total Segment Operating Profit - Exploration and Production. . . $ 3.2 $ 29.2 $ 6.9 $ 38.8
===== ===== ===== =====
U.S.:
Average Daily Net Production:
Natural gas (million cubic feet, "MMcf") . . . . . . . . . . . 72.0 93.1 76.0 96.1
Oil (thousand barrels) . . . . . . . . . . . . . . . . . . . . 0.6 0.3 0.5 0.2
Total (million cubic feet equivalent, "MMcfe"). . . . . . . . 75.3 94.6 79.2 97.4
Average Prices:
Natural gas ($/thousand cubic feet, "Mcf") <F2>. . . . . . . . $ 1.89 $ 2.06 $ 1.82 $ 2.04
Oil ($/barrel) . . . . . . . . . . . . . . . . . . . . . . . . $ 15.84 $ 12.66 $ 13.73 $ 13.25
Average Operating Expenses ($/thousand cubic feet
equivalent, "Mcfe"):
Lease operating expenses . . . . . . . . . . . . . . . . . . . $ 0.34 $ 0.22 $ 0.31 $ 0.21
Severance taxes. . . . . . . . . . . . . . . . . . . . . . . . 0.05 0.01 0.05 0.04
----- ----- ----- -----
Total production costs. . . . . . . . . . . . . . . . . . . . 0.39 0.23 0.36 0.25
Administrative support and other . . . . . . . . . . . . . . . 0.09 0.06 0.08 0.05
----- ----- ----- -----
Total Operating Expenses. . . . . . . . . . . . . . . . . . . $ 0.48 $ 0.29 $ 0.44 $ 0.30
===== ===== ===== =====
Depletion ($/Mcfe). . . . . . . . . . . . . . . . . . . . . . . $ 0.90 $ 1.06 $ 0.91 $ 1.01
===== ===== ===== =====
LATIN AMERICA:
Average Daily Net Production:
Natural gas (MMcf) . . . . . . . . . . . . . . . . . . . . . . 11.9 26.5 12.2 24.6
Condensate (thousand barrels). . . . . . . . . . . . . . . . . 0.4 0.7 0.4 0.8
Total (MMcfe) . . . . . . . . . . . . . . . . . . . . . . . . 14.4 30.8 14.5 29.2
Average Prices:
Natural gas ($/Mcf). . . . . . . . . . . . . . . . . . . . . . $ 0.59 $ 0.83 $ 0.69 $ 0.90
Condensate ($/barrel). . . . . . . . . . . . . . . . . . . . . $ 15.89 $ 12.90 $ 13.27 $ 14.42
Average Operating Expenses ($/Mcfe):
Production costs . . . . . . . . . . . . . . . . . . . . . . . $ 0.21 $ 0.10 $ 0.27 $ 0.10
Administrative support and other . . . . . . . . . . . . . . . 0.56 0.25 0.51 0.27
----- ----- ----- -----
Total Operating Expenses. . . . . . . . . . . . . . . . . . . $ 0.77 $ 0.35 $ 0.78 $ 0.37
===== ===== ===== =====
Depletion ($/Mcfe). . . . . . . . . . . . . . . . . . . . . . . $ 0.27 $ 0.22 $ 0.27 $ 0.22
===== ===== ===== =====
<FN>
<F1> Represents the Company's U.S. oil and gas operations combined with gas transportation activities.
<F2> Includes effects of commodity price agreements which amounted to a loss of $0.07 per Mcf and a gain of $0.02
per Mcf for the three months ended June 30, 1999 and 1998, respectively, and gains of $0.01 per Mcf during
both six-month periods.
</TABLE>
17
<PAGE>
U.S.
THREE MONTHS ENDED JUNE 30, 1999, COMPARED WITH THREE MONTHS ENDED JUNE 30,
1998. Segment operating profit from the Company's U.S. exploration and
production operations was $3.6 million in the 1999 Quarter compared with $28.5
million in the 1998 Quarter. The 1998 Quarter benefited from receipt of $21.3
million from an operator in the Bob West Field, representing funds no longer
needed as a contingency reserve for litigation. Excluding the receipt of those
funds from the 1998 Quarter, segment operating profit decreased by $3.6 million
during the 1999 Quarter due primarily to lower natural gas prices and lower
production volumes. The Company's U.S. net production volumes decreased
approximately 20% to 75.3 MMcfe per day in the 1999 Quarter, compared to 94.6
MMcfe per day in the 1998 Quarter, primarily due to Bob West Field production
which declined approximately 15 MMcfe per day. Production from other fields
also declined slightly due to the Company's decision earlier in the year to
tightly manage its capital expenditure program. However, three significant
discoveries made in Texas and offshore Louisiana during the 1999 Quarter are
expected to increase production levels for the remainder of the year.
Gross operating revenues from the Company's U.S. operations decreased by $4.9
million due to the lower production and an 8% decline in natural gas prices from
$2.06 per Mcf in the 1998 Quarter to $1.89 per Mcf in the 1999 Quarter. Net
production costs per Mcfe increased from $0.23 to $0.39 primarily due to
decreased production volumes. Depreciation, depletion and amortization
decreased by $2.9 million, or 31%, due to lower volumes and a reduced depletion
rate.
SIX MONTHS ENDED JUNE 30, 1999, COMPARED WITH SIX MONTHS ENDED JUNE 30, 1998.
Segment operating profit from the Company's U.S. exploration and production
operations was $7.4 million in the 1999 Period compared with $36.4 million in
the 1998 Period. Excluding the $21.3 million receipt from an operator in the
1998 Period discussed above, segment operating profit decreased by $7.7 million
during the 1999 Period. This decrease was primarily due to lower natural gas
prices and lower production volumes. The Company's U.S. net production volumes
decreased almost 19% to 79.2 MMcfe per day in the 1999 Period, compared to 97.4
MMcfe per day in the 1998 Period, primarily due to declines in the Bob West
Field and, to a lesser extent, to lower capital spending in other fields.
Gross operating revenues from the Company's U.S. operations decreased by $10.1
million due to the lower production and an 11% decline in natural gas prices
from $2.04 per Mcf in the 1998 Period to $1.82 per Mcf in the 1999 Period. Net
production costs per Mcfe increased from $0.25 to $0.36 primarily due to
decreased volumes. Depreciation, depletion and amortization decreased by $4.8
million, or 26%, 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 reserve additions during the 1999
Period.
For information related to natural gas commodity price agreements, see Item 3
contained herein.
LATIN AMERICA
THREE MONTHS ENDED JUNE 30, 1999, COMPARED WITH THREE MONTHS ENDED JUNE 30,
1998. Segment operating results from the Company's Latin American operations
decreased to a loss of $0.4 million, compared to operating profit of $0.7
million in the 1998 Quarter. This decrease in segment operating profit was due
to lower production and natural gas prices. Bolivian natural gas prices, which
are contractually indexed to a six-month average of posted New York fuel oil
prices, fell 29% from $0.83 per Mcf in the 1998 Quarter to $0.59 per Mcf in the
1999 Quarter. Net production volumes decreased 53% from 30.8 MMcfe per day to
14.4 MMcfe per day, primarily due to the transition from Argentine markets to
Brazilian markets. Lower production in 1999 resulted 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. A
new third-party pipeline from Bolivia to Brazil, which began operations July
1999, will provide access to potentially larger gas-consuming markets. Tesoro's
current natural gas production in Latin America is up to 50 MMcf per day, gross,
due to the beginning of sales to Brazilian markets. On a net basis, this
represents approximately 36 MMcf per day, significantly higher than recent
average production levels. Sales prices to the Brazilian market are currently
estimated at approximately $0.80 per Mcf, and sales to Argentine markets,
scheduled to be phased out by the end of August 1999, are currently estimated at
$0.70 per Mcf. Increased third-quarter production and higher natural gas prices
in the last half of 1999 are expected to improve results for Tesoro's Latin
America operations.
18
<PAGE>
SIX MONTHS ENDED JUNE 30, 1999, COMPARED WITH SIX MONTHS ENDED JUNE 30, 1998.
Segment operating results from the Company's Latin American operations decreased
to a loss of $0.5 million, compared to operating profit of $2.4 million in the
1998 Period. This decrease in segment operating profit was due to lower
production and prices. Bolivian natural gas prices fell 23% from $0.90 per Mcf
in the 1998 Quarter to $0.69 per Mcf in the 1999 Quarter. As discussed above,
net production volumes decreased 50% from 29.2 MMcfe per day to 14.5 MMcfe per
day.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased by $4.6 million and $8.1 million
during the 1999 Quarter and 1999 Period, respectively. These increases were
primarily due to costs of implementing 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 $5.0 million and $14.7 million during
the 1999 Quarter and 1999 Period, respectively. These increases reflected the
higher debt levels which funded the 1998 Hawaii and Washington acquisitions.
OTHER OPERATING COSTS AND OTHER EXPENSES
Other operating costs and other expenses for the 1998 Quarter and 1998 Period
included a charge of $19.9 million for special incentive compensation, of which
$7.9 million related to operating segment employees. The special compensation
was earned in May 1998 when the Company's common stock achieved a certain
performance target.
INCOME TAX PROVISION
The increase of $9.9 million in the income tax provision in the 1999 Quarter,
compared with the 1998 Quarter, reflected the increase in pretax earnings,
primarily from the Refining and Marketing segment. Similarly, the income tax
provision increased $6.1 million to $19.1 million in the 1999 Period, compared
with $13.0 million in the 1998 Period, due to the Company's higher consolidated
earnings partially offset by reduced foreign taxes due to lower Bolivian natural
gas production.
In response to low product prices, the Bolivian government has given the Company
approval to produce "new hydrocarbons" in place of "existing hydrocarbons" (as
defined by the Hydrocarbon Law) for gross volumes over 20 MMcf per day through
the end of 1999. "New hydrocarbons" are subject to a combined royalty and tax
rate of 18 percent while "existing hydrocarbons" are subject to a combined
royalty and tax rate of 60 percent. Although this change will have a favorable
effect on Bolivia tax rates, it is not expected to have a material effect on the
Company's consolidated income tax provision in 1999.
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.
19
<PAGE>
CAPITAL SPENDING
During the first six months of 1999, the Company's capital expenditures totaled
$63 million which were financed primarily with internally-generated cash flows.
Capital expenditures for the Exploration and Production segment were
approximately $37 million, including $24 million for U.S. operations and $13
million for Bolivia operations. During the 1999 Period, the Company
participated in drilling 14 exploratory wells (12 completed) and five
developments wells (all completed) in the U.S. and one exploratory well in
Bolivia which was completed. Capital improvements for the Refining and
Marketing segment in the 1999 Period totaled $19 million, which included various
refinery and retail gas station projects. Other capital spending during the
1999 Period were primarily related to the implementation of the integrated
enterprise-wide system and purchase of the West Coast marine fuel operations.
The Company's capital spending is under continuing review, considering
requirements and business conditions in each operating segment. Although
capital expenditures for the 1999 year had been projected at $170 million,
actual expenditures will be less due to a number of factors, including the
timing of refining and marketing and other capital projects. Total capital
expenditures for the remainder of the year are currently estimated to range from
$85 million to $95 million, which include costs for exploration and production
activities, refining and marketing projects and implementation of the integrated
enterprise-wide system. These capital expenditures are expected to be funded
primarily with cash flows from operations supplemented with borrowings, if
necessary, under the Company's revolving credit facility.
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 $28 million net under
the revolving credit and letter of credit facility ("Revolver") and borrowed
an additional $34 million net under term loans during the 1999 Period.
. In April 1999, the Company reduced commitments under the Revolver from $300
million to $175 million.
At June 30, 1999, the Company had outstanding borrowings of $183 million under
the term loans and $33 million 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
reduces 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 was $138 million at June 30, 1999. The
Company's total debt to capitalization ratio was 48% at June 30, 1999.
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 June 30, 1999, and 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 fourth 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.
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.
20
<PAGE>
CASH FLOWS
Components of the Company's cash flows are set forth below (in millions):
<TABLE>
<CAPTION>
Six Months Ended
June 30,
-----------------
1999 1998
---- ----
<S> <C> <C>
Cash Flows From (Used In):
Operating Activities . . . . . . . . . . . . . $ 65.4 $ 43.9
Investing Activities . . . . . . . . . . . . . (62.1) (315.6)
Financing Activities . . . . . . . . . . . . . (4.9) 289.7
------ -------
Increase (Decrease) in Cash and Cash Equivalents $ (1.6) $ 18.0
====== =======
</TABLE>
Net cash from operating activities totaled $65 million during the 1999 Period,
compared to $44 million for the 1998 Period. This increase primarily reflected
improved earnings, partially offset by higher working capital components. Cash
flows from earnings before depreciation, depletion and amortization and other
noncash charges increased $25 million in the 1999 Period, compared with the 1998
Period. Net cash used in investing activities of $62 million during the 1999
Period included capital expenditures of $19 million in Refining and Marketing
and $37 million in Exploration and Production. Financing activities in the 1999
Period included gross repayments of $218 million under the Revolver offset by
gross borrowings of $190 million. In addition, $50 million was issued under
term loans partly offset by debt payments of $21 million. Payment of dividends
on preferred stock totaled $6 million in the 1999 Period. At June 30, 1999, the
Company's working capital totaled $189 million, which included cash and cash
equivalents of $11 million. The working capital ratio was 1.7:1 at June 30,
1999, compared to 1.9:1 at December 31, 1998.
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 owned properties. At June 30, 1999, the Company's accruals for
environmental expenses totaled $11.5 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 $8 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 expected 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.
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
21
<PAGE>
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, estimated progress toward
completion and scheduled completion dates:
Estimated Scheduled
% Complete Completion Date
. 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. . . . . . . . . . . . . . . . . . . . 95 August 1999
. Validation: Test and verify . . . . . . . . . . . . 90 August 1999
. Implementation: Put new and renovated systems into
production; monitor and continually evaluate. . . . 90 August 1999
. Contingency Plans: Develop contingency plans for
critical items that cannot be tested. . . . . . . . 50 September 1999
Although the first two phases of the Compliance Plan have been completed, other
non-compliant items may be discovered during remediation and validation phases
which could affect the estimates and the scheduled dates above. 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 95% of the vendors either
returned the questionnaire or were contacted and interviewed. All of the
vendors contacted, including all of the vendors identified as being critical,
provided a positive response. None could foresee having problems providing
goods and services on or after January 1, 2000. The utility companies servicing
the Company's various sites were contacted and all responded favorably about
their ability to provide uninterrupted service.
Ninety percent of Tesoro's customers, including all of the critical customers,
were contacted to determine their Year 2000 preparedness. All customers
contacted indicated that they will be ready and do not anticipate any
significant problems. Management believes that the Company's risk is minimal as
it relates to key vendors, suppliers and customers.
22
<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 $5 million, of which $2.4 million was spent
through June 30, 1999. It is estimated that approximately 60% 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 the 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 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, 2001 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 Period, the Company used such agreements to set the price of
approximately 40% of the natural gas production that it sold in the spot market
and recognized a gain of $0.2 million ($0.01 per Mcf) from these price
agreements. As of June 30, 1999, the Company had remaining price agreements
outstanding through March 2000 for 8.0 billion cubic feet of natural gas
production with an average Houston ship channel floor price of $1.85 per Mcf and
an average ceiling price of $2.25 per Mcf.
23
<PAGE>
INTEREST RATE RISK
Total debt at June 30, 1999, included $328 million of fixed-rate debt and $216
million of floating-rate debt attributed to the Term Loans and the Revolver. 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 (68 basis points) would be approximately $1.5 million.
At June 30, 1999, the fair market value of the Company's fixed-rate debt
approximated its book value of $328 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.
24
<PAGE>
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On May 14, 1999, the San Joaquin Valley Unified Air Pollution Control
District ("District") issued a Notice of Violation of its rules and
regulations in connection with the operation of an oil water separator at
the Company's Stockton, California diesel and gasoline terminal. The
District alleges that the separator was operated without a permit. While
the Company believes the separator is exempt from permitting requirements,
it has been removed from service. The Company believes the resolution of
this matter will not have a material adverse effect on the Company.
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 U.S. 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 proposed a civil penalty in the amount of $10,000. The Company
resolved the civil penalty by payment of $6,000 on June 9, 1999. The
Company believes that the resolution of any remaining issues 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 proposed a civil penalty in the amount of $6,000 alleging a violation
of the Federal Water Pollution Control Act. The Company resolved the civil
penalty by payment of $4,000 on June 15, 1999. The Company believes there
are no remaining issues to be resolved.
ITEM 5. OTHER INFORMATION
On May 26, 1999, the Company announced that its Board of Directors had
approved seeking alternative value creating opportunities, including a
spin-off, trade, sale and other options for its Exploration and Production
operations. Such opportunities are in the early stage of evaluation.
There can be no assurance as to whether or when any alternatives would be
pursued.
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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 Financial Data Schedule (June 30, 1999).
27.2 Restated Financial Data Schedule (June 30, 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.
25
<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: August 13, 1999 /s/ BRUCE A. SMITH
Bruce A. Smith
Chairman of the Board of Directors,
President and Chief Executive Officer
Date: August 13, 1999 /s/ DON M. HEEP
Don M. Heep
Vice President, Controller
(Chief Accounting Officer)
26
<PAGE>
EXHIBIT INDEX
EXHIBIT
NUMBER
27.1 Financial Data Schedule (June 30, 1999).
27.2 Restated Financial Data Schedule (June 30, 1998).
27
<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 SIX MONTH PERIOD
ENDED JUNE 30, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 11,300
<SECURITIES> 0
<RECEIVABLES> 215,100
<ALLOWANCES> 1,700
<INVENTORY> 228,500
<CURRENT-ASSETS> 463,500
<PP&E> 1,398,600
<DEPRECIATION> 479,500
<TOTAL-ASSETS> 1,522,500
<CURRENT-LIABILITIES> 274,600
<BONDS> 524,000
0
165,000
<COMMON> 5,400
<OTHER-SE> 415,600
<TOTAL-LIABILITY-AND-EQUITY> 1,522,500
<SALES> 1,262,500
<TOTAL-REVENUES> 1,262,700
<CGS> 1,135,700
<TOTAL-COSTS> 1,135,700
<OTHER-EXPENSES> 34,300
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 24,500
<INCOME-PRETAX> 51,900
<INCOME-TAX> 19,100
<INCOME-CONTINUING> 32,800
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 32,800
<EPS-BASIC> 0.83
<EPS-DILUTED> 0.76
<FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 26,400
<SECURITIES> 0
<RECEIVABLES> 113,900
<ALLOWANCES> 1,900
<INVENTORY> 175,400
<CURRENT-ASSETS> 322,900
<PP&E> 997,900
<DEPRECIATION> 331,700
<TOTAL-ASSETS> 1,041,900
<CURRENT-LIABILITIES> 160,700
<BONDS> 451,700
0
0
<COMMON> 4,500
<OTHER-SE> 345,900
<TOTAL-LIABILITY-AND-EQUITY> 1,041,900
<SALES> 453,500
<TOTAL-REVENUES> 474,900
<CGS> 378,400
<TOTAL-COSTS> 378,400
<OTHER-EXPENSES> 28,200
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 9,800 <F1>
<INCOME-PRETAX> 29,900
<INCOME-TAX> 13,000
<INCOME-CONTINUING> 16,900
<DISCONTINUED> 0
<EXTRAORDINARY> (4,600)
<CHANGES> 0
<NET-INCOME> 12,300
<EPS-BASIC> 0.47 <F2>
<EPS-DILUTED> 0.46 <F2>
<FN>
<F1> Certain reclassifications have been made to information previously
reported to conform to current presentation.
<F2> Earnings per share is after an extraordinary loss of $4.6 million
($0.17 loss per basic and diluted share) on extinguishment of debt.
</TABLE>
