<PAGE> 1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
-------- --------
COMMISSION FILE NUMBER 1-3473
TESORO PETROLEUM CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 95-0862768
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
300 CONCORD PLAZA DRIVE, SAN ANTONIO, TEXAS 78216-6999
(Address of principal executive offices) (Zip Code)
210-828-8484
(Registrant's telephone number, including area code)
-----------
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 30,814,895 shares of the registrant's Common Stock
outstanding at October 31, 2000.
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<PAGE> 2
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets - September 30, 2000 and December 31, 1999.................... 3
Condensed Statements of Consolidated Operations - Three Months and Nine Months Ended
September 30, 2000 and 1999....................................................................... 4
Condensed Statements of Consolidated Cash Flows - Nine Months Ended
September 30, 2000 and 1999....................................................................... 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............................................................................ 24
Item 6. Exhibits and Reports on Form 8-K............................................................. 24
SIGNATURES................................................................................................. 25
EXHIBIT INDEX.............................................................................................. 26
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
(DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents .................................................. $ 24.5 $ 141.8
Receivables, less allowance for doubtful accounts .......................... 349.1 280.7
Inventories ................................................................ 275.3 182.2
Prepayments and other ...................................................... 8.3 6.9
-------- --------
Total Current Assets ..................................................... 657.2 611.6
-------- --------
PROPERTY, PLANT AND EQUIPMENT
Refining and marketing ..................................................... 941.7 906.6
Marine services ............................................................ 49.3 47.7
Corporate .................................................................. 23.8 21.8
-------- --------
1,014.8 976.1
Less accumulated depreciation and amortization ............................. 273.0 244.5
-------- --------
Net Property, Plant and Equipment ........................................ 741.8 731.6
-------- --------
OTHER ASSETS .................................................................. 131.8 143.3
-------- --------
Total Assets ........................................................... $1,530.8 $1,486.5
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable ........................................................... $ 310.9 $ 214.2
Accrued liabilities ........................................................ 90.2 80.0
Current maturities of debt and other obligations ........................... 3.7 27.4
-------- --------
Total Current Liabilities ................................................ 404.8 321.6
-------- --------
DEFERRED INCOME TAXES ......................................................... 99.0 85.8
-------- --------
OTHER LIABILITIES ............................................................. 72.1 65.8
-------- --------
DEBT AND OTHER OBLIGATIONS .................................................... 307.1 390.2
-------- --------
COMMITMENTS AND CONTINGENCIES (Note F)
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;
32,735,176 shares issued (32,704,856 in 1999) ............................ 5.4 5.4
Additional paid-in capital ................................................. 279.3 279.0
Retained earnings .......................................................... 218.5 178.6
Treasury stock, 1,920,281 common shares (292,881 in 1999), at cost ......... (20.4) (4.9)
-------- --------
Total Stockholders' Equity ............................................... 647.8 623.1
-------- --------
Total Liabilities and Stockholders' Equity ............................. $1,530.8 $1,486.5
======== ========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
<PAGE> 4
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS
(UNAUDITED)
(IN MILLIONS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUES
Operating revenues:
Refining and marketing ........................................ $ 1,347.6 $ 863.5 $ 3,535.8 $ 2,052.1
Marine services ............................................... 46.8 30.0 130.9 73.6
Other income ..................................................... 0.2 -- 1.4 --
--------- --------- --------- ---------
Total Revenues ................................................ 1,394.6 893.5 3,668.1 2,125.7
--------- --------- --------- ---------
OPERATING COSTS AND EXPENSES
Refining and marketing ........................................... 1,275.9 796.9 3,374.8 1,881.3
Marine services .................................................. 43.6 26.7 121.9 68.6
Depreciation and amortization .................................... 11.0 10.1 30.8 29.3
--------- --------- --------- ---------
Total Segment Operating Costs and Expenses .................... 1,330.5 833.7 3,527.5 1,979.2
--------- --------- --------- ---------
SEGMENT OPERATING PROFIT ........................................... 64.1 59.8 140.6 146.5
General and administrative ......................................... (11.4) (8.0) (29.0) (23.3)
Interest and financing costs, net of capitalized interest .......... (7.7) (9.4) (25.6) (28.8)
Interest income .................................................... 0.4 0.3 2.2 0.7
Other expense ...................................................... (2.0) (4.3) (5.4) (6.6)
--------- --------- --------- ---------
EARNINGS FROM CONTINUING OPERATIONS BEFORE
INCOME TAXES ..................................................... 43.4 38.4 82.8 88.5
Income tax provision ............................................... 18.4 15.4 33.9 32.7
--------- --------- --------- ---------
EARNINGS FROM CONTINUING OPERATIONS, NET ........................... 25.0 23.0 48.9 55.8
Earnings from discontinued operations, net of income taxes ......... -- 2.3 -- 2.3
--------- --------- --------- ---------
NET EARNINGS ....................................................... 25.0 25.3 48.9 58.1
Preferred dividend requirements .................................... 3.0 3.0 9.0 9.0
--------- --------- --------- ---------
NET EARNINGS APPLICABLE TO COMMON STOCK ............................ $ 22.0 $ 22.3 $ 39.9 $ 49.1
========= ========= ========= =========
EARNINGS PER SHARE FROM CONTINUING
OPERATIONS
Basic ......................................................... $ 0.71 $ 0.62 $ 1.27 $ 1.44
========= ========= ========= =========
Diluted ....................................................... $ 0.60 $ 0.53 $ 1.17 $ 1.29
========= ========= ========= =========
NET EARNINGS PER SHARE
Basic ......................................................... $ 0.71 $ 0.69 $ 1.27 $ 1.52
========= ========= ========= =========
Diluted ....................................................... $ 0.60 $ 0.58 $ 1.17 $ 1.35
========= ========= ========= =========
WEIGHTED AVERAGE COMMON SHARES - BASIC ............................. 30.8 32.4 31.4 32.4
========= ========= ========= =========
WEIGHTED AVERAGE COMMON AND POTENTIALLY
DILUTIVE COMMON SHARES - DILUTED ................................. 41.4 43.3 41.9 43.1
========= ========= ========= =========
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
<PAGE> 5
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
-----------------
2000 1999
---- ----
<S> <C> <C>
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
Continuing operations:
Earnings from continuing operations, net .................................... $ 48.9 $ 55.8
Adjustments to reconcile earnings from continuing operations
to net cash from operating activities:
Depreciation and amortization ........................................... 32.6 30.8
Amortization of refinery turnarounds and other non-cash charges ......... 17.0 19.5
Deferred income taxes ................................................... 13.2 14.5
Changes in operating assets and liabilities:
Receivables ........................................................... (68.4) (93.4)
Inventories ........................................................... (93.1) 12.2
Accounts payable and accrued liabilities .............................. 106.9 88.5
Other assets and liabilities .......................................... (3.6) (4.8)
------ ------
Total from continuing operations .................................... 53.5 123.1
Discontinued operations ........................................................ -- 22.8
------ ------
Net cash from operating activities ........................................ 53.5 145.9
------ ------
CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
Capital expenditures:
Continuing operations ....................................................... (42.7) (51.7)
Discontinued operations ..................................................... -- (48.0)
Other .......................................................................... 1.8 0.1
------ ------
Net cash used in investing activities .................................... (40.9) (99.6)
------ ------
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
Net repayments under revolving credit facility ................................. -- (61.2)
Repayments of other debt ....................................................... (105.6) (25.5)
Issuance of other debt ......................................................... -- 50.0
Purchases of Common Stock ...................................................... (15.5) --
Payment of dividends on Preferred Stock ........................................ (9.0) (9.0)
Other .......................................................................... 0.2 0.4
------ ------
Net cash used in financing activities .................................... (129.9) (45.3)
------ ------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ................................... (117.3) 1.0
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD ..................................... 141.8 12.0
------ ------
CASH AND CASH EQUIVALENTS, END OF PERIOD ........................................... $ 24.5 $ 13.0
====== ======
SUPPLEMENTAL CASH FLOW DISCLOSURES
Interest paid .................................................................. $ 17.4 $ 40.8
====== ======
Income taxes paid .............................................................. $ 13.6 $ 33.7
====== ======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
<PAGE> 6
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, 1999 has been condensed from the audited
consolidated financial statements at that date. Certain information and notes
normally included in financial statements prepared in accordance with accounting
principles generally accepted in the United States of America 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, 1999.
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.
Certain amounts for the three months and nine months ended September 30, 1999
have been reclassified to reflect the transfer of the West Coast marine fuel
operations from the Marine Services segment to the Refining and Marketing
segment in 2000. Certain other reclassifications have been made to information
previously reported to conform to current presentation.
NOTE B - INVENTORIES
Components of inventories were as follows (in millions):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------ -------------
<S> <C> <C>
Crude oil and refined products, at LIFO............ $ 247.3 $ 147.8
Refined products, at FIFO.......................... 6.0 9.9
Merchandise and other.............................. 5.8 6.0
Materials and supplies............................. 16.2 18.5
------- -------
Total inventories.............................. $ 275.3 $ 182.2
======= =======
</TABLE>
NOTE C - DEBT
On October 4, 2000, the Company and a group of banks entered into a new $250
million unsecured revolving credit facility, consisting of a $150 million,
3-year Revolving Credit Agreement and a $100 million, 364-day Revolving Credit
Agreement (collectively referred to as the "Credit Facility"). Each Revolving
Credit Agreement, which provides for cash borrowings and issuance of letters of
credit, can be extended for up to two one-year periods, subject to bank
approval. Borrowings under the Credit Facility bear interest, at the Company's
election, at either the Eurodollar Rate (as defined in the Credit Facility) plus
a margin ranging from 1.000% to 2.000% or a Base Rate (as defined in the Credit
Facility). The Company is also charged various fees and expenses in connection
with the Credit Facility, including commitment fees and various letter of credit
fees.
The Credit Facility requires the Company to maintain specified levels of
consolidated leverage and fixed charge coverages and includes a limitation on
the Company's debt to capital ratio. It also contains other covenants and
restrictions customary in credit arrangements of this kind. The terms of the
Credit Facility allow for payment of cash dividends on the Company's Common
Stock and repurchases of shares of its Common Stock, not to exceed
6
<PAGE> 7
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
an aggregate of $15 million in any year. The Credit Facility also allows the
Company to repurchase up to 1,372,600 additional shares of its Common Stock
under a share repurchase program (see Note D) and to pay required dividends on
the Company's 7.25% Mandatorily Convertible Preferred Stock, so long as no
default or event of default is in existence.
The Credit Facility replaced the Company's previous credit facility, which would
have expired in 2001 and provided for $175 million in total commitments. The
Company's previous credit facility was secured by substantially all of the
assets of the Company and its subsidiaries.
At September 30, 2000, the Company had no revolving borrowings outstanding and
$1 million in letters of credit outstanding. Based on current needs, the $250
million capacity under the Credit Facility, together with internally-generated
cash flows and existing cash, is expected to be sufficient to fund capital
expenditures, working capital requirements and other corporate purposes.
In March 2000, the Company used a portion of the proceeds from the December 1999
sales of its exploration and production operations to prepay a $24.0 million
note and repay a remaining $80.9 million balance of term loans under its
previous credit facility.
NOTE D - COMMON STOCK
In February 2000, the Company's Board of Directors authorized the repurchase of
up to 3 million shares of Tesoro Common Stock, which represented approximately
9% of the 32.4 million shares then outstanding. Under the program, the Company
repurchases Tesoro Common Stock from time to time in the open market and through
privately negotiated transactions. Purchases depend on price, market conditions
and other factors. The stock may be used to meet employee benefit plan
requirements and other corporate purposes. During the nine months ended
September 30, 2000, the Company repurchased 1,627,400 shares of Common Stock for
approximately $15.5 million. See Note C for information concerning restrictions
on repurchases of shares of Common Stock.
At the Company's 2000 Annual Meeting of Stockholders held in May 2000, an
amendment which increased the number of shares available to grant under the
Amended and Restated Executive Long-Term Incentive Plan from 4,250,000 to
5,250,000 was approved by the shareholders.
NOTE E - OPERATING SEGMENTS
The Company's revenues are derived from two operating segments: (i) Refining and
Marketing and (ii) Marine Services. Segment operating profit includes those
revenues and expenses that are directly attributable to management of the
respective segment. Revenues were generated from sales to external customers,
and intersegment revenues were not significant. Income taxes, interest and
financing costs, interest income and corporate general and administrative
expenses are not included in determining segment operating profit.
EBITDA represents earnings before interest and financing costs, income taxes,
and depreciation 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 and amortization related to each segment.
7
<PAGE> 8
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Segment information is as follows (in millions):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
REVENUES
Operating Revenues:
Refining and Marketing .......................................... $1,347.6 $ 863.5 $3,535.8 $2,052.1
Marine Services ................................................. 46.8 30.0 130.9 73.6
Other Income (primarily Marine Services) .......................... 0.2 -- 1.4 --
-------- -------- -------- --------
Total Revenues ................................................ $1,394.6 $ 893.5 $3,668.1 $2,125.7
======== ======== ======== ========
SEGMENT OPERATING PROFIT
Refining and Marketing ............................................ $ 61.2 $ 57.1 $ 131.9 $ 143.4
Marine Services ................................................... 2.9 2.7 8.7 3.1
-------- -------- -------- --------
Total Segment Operating Profit ................................ 64.1 59.8 140.6 146.5
Corporate and Unallocated Costs ................................... (20.7) (21.4) (57.8) (58.0)
-------- -------- -------- --------
Earnings from Continuing Operations Before Income
Taxes .......................................................... $ 43.4 $ 38.4 $ 82.8 $ 88.5
======== ======== ======== ========
EBITDA
Refining and Marketing ............................................ $ 71.5 $ 66.6 $ 160.8 $ 170.8
Marine Services ................................................... 3.6 3.3 10.6 5.0
-------- -------- -------- --------
Total Segment EBITDA .......................................... 75.1 69.9 171.4 175.8
Corporate and Unallocated ......................................... (12.4) (11.4) (30.4) (27.7)
-------- -------- -------- --------
Total EBITDA - Continuing Operations .......................... 62.7 58.5 141.0 148.1
Depreciation and Amortization from Continuing
Operations ...................................................... (11.6) (10.7) (32.6) (30.8)
Interest and Financing Costs, Net of Capitalized Interest ......... (7.7) (9.4) (25.6) (28.8)
-------- -------- -------- --------
Earnings from Continuing Operations Before Income
Taxes .......................................................... $ 43.4 $ 38.4 $ 82.8 $ 88.5
======== ======== ======== ========
DEPRECIATION AND AMORTIZATION
Continuing Operations:
Refining and Marketing .......................................... $ 10.3 $ 9.5 $ 28.9 $ 27.4
Marine Services ................................................. 0.7 0.6 1.9 1.9
Corporate ....................................................... 0.6 0.6 1.8 1.5
-------- -------- -------- --------
Total Continuing Operations ................................... 11.6 10.7 32.6 30.8
Discontinued Operations ........................................... -- 7.2 -- 21.4
-------- -------- -------- --------
Total Depreciation and Amortization ............................. $ 11.6 $ 17.9 $ 32.6 $ 52.2
======== ======== ======== ========
CAPITAL EXPENDITURES
Continuing Operations:
Refining and Marketing .......................................... $ 17.4 $ 24.2 $ 38.4 $ 44.3
Marine Services ................................................. 0.3 0.3 2.2 1.0
Corporate ....................................................... 1.5 2.1 2.1 6.4
-------- -------- -------- --------
Total Continuing Operations ................................... 19.2 26.6 42.7 51.7
Discontinued Operations ........................................... -- 10.6 -- 48.0
-------- -------- -------- --------
Total Capital Expenditures ...................................... $ 19.2 $ 37.2 $ 42.7 $ 99.7
======== ======== ======== ========
</TABLE>
8
<PAGE> 9
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
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 were as follows (in
millions):
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
IDENTIFIABLE ASSETS
<S> <C> <C>
Refining and Marketing.......................... $ 1,383.6 $ 1,223.6
Marine Services................................. 75.3 66.5
Corporate....................................... 71.9 196.4
--------- ---------
Total Assets ................................. $ 1,530.8 $ 1,486.5
========= =========
</TABLE>
NOTE F - COMMITMENTS AND CONTINGENCIES
The Company is a party to various litigation and contingent loss situations,
including environmental and tax matters, arising in the ordinary course of
business. The Company has made accruals in accordance with Statement of
Financial Accounting Standard ("SFAS") No. 5, "Accounting for Contingencies," in
order to provide for these matters. The ultimate effects of these matters cannot
be predicted with certainty, and related accruals are based on management's best
estimates, subject to future developments. Although the resolution of certain of
these matters could have a material adverse 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 U.S. Environmental Protection Agency
("EPA") regarding a waste disposal site near Abbeville, Louisiana, at which the
Company has been named a potentially responsible party under the Federal
Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"
or "Superfund"). Although the Superfund law may impose joint and several
liability upon each party at the site, the extent of the Company's allocated
financial contributions for cleanup is expected to be de minimis based upon the
number of companies, volumes of waste involved and total estimated costs to
close the site. The Company believes, based on these considerations and
discussions with the EPA, that its liability at the Abbeville site will not
exceed $25,000.
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 owned properties. At September 30, 2000, the Company's
accruals for environmental expenses totaled approximately $12.3 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.
The Company is currently evaluating certain newly-promulgated revisions to the
Clean Air Act regulations which will require a reduction in the sulfur content
in gasoline manufactured at its Washington refinery by January 1, 2004. To meet
the revised gasoline standard, the Company expects to make capital improvements
of approximately $30 million at its Washington refinery. Additionally, the
Company expects to spend approximately $15 million over the next four years to
comply with proposed Maximum Available Control Technology ("MACT II")
regulations for refineries. Management expects that the proposed MACT II
regulations will be finalized in late 2000 and would require new emission
controls at certain processing units at each of the Company's refineries.
9
<PAGE> 10
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
To comply with environmental laws and regulations, the Company anticipates it
will make other capital improvements of approximately $10 million in 2000 and $8
million in 2001. During the nine months ended September 30, 2000, the Company
spent approximately $6 million, primarily for improvements to tanks and tank
farm secondary containment at its refineries.
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 requirements. The
amount of such future expenditures cannot currently be determined by the
Company.
OTHER
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. No costs will be recorded until the First
Performance Target is reached.
NOTE G - EARNINGS PER SHARE
Basic earnings per share are 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
effects of potentially dilutive shares outstanding during the period,
principally the maximum shares which would have been issued assuming conversion
of Preferred Stock at the beginning of the period and stock options. Earnings
per share calculations are presented below (in millions except per share
amounts):
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
BASIC:
Numerator:
Earnings from continuing operations, aftertax ........... $ 25.0 $ 23.0 $ 48.9 $ 55.8
Earnings from discontinued operations, aftertax ......... -- 2.3 -- 2.3
------ ------ ------ ------
Net earnings ............................................ 25.0 25.3 48.9 58.1
Less dividends on preferred stock ....................... 3.0 3.0 9.0 9.0
------ ------ ------ ------
Net earnings applicable to common shares ................ $ 22.0 $ 22.3 $ 39.9 $ 49.1
====== ====== ====== ======
Denominator:
Weighted average common shares outstanding .............. 30.8 32.4 31.4 32.4
====== ====== ====== ======
Basic Earnings Per Share:
Earnings from continuing operations ..................... $ 0.71 $ 0.62 $ 1.27 $ 1.44
====== ====== ====== ======
Net earnings ............................................ $ 0.71 $ 0.69 $ 1.27 $ 1.52
====== ====== ====== ======
</TABLE>
10
<PAGE> 11
TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- ------------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
DILUTED:
Numerator:
Net earnings applicable to common shares ...................... $ 22.0 $ 22.3 $ 39.9 $ 49.1
Plus impact of assumed conversion of preferred stock .......... 3.0 3.0 9.0 9.0
------ ------ ------ ------
Total ......................................................... $ 25.0 $ 25.3 $ 48.9 $ 58.1
====== ====== ====== ======
Denominator:
Weighted average common shares outstanding .................... 30.8 32.4 31.4 32.4
Add potentially dilutive securities:
Incremental dilutive shares from assumed exercise
of stock options and other ................................ 0.3 0.6 0.2 0.4
Incremental dilutive shares from assumed conversion
of preferred stock ........................................ 10.3 10.3 10.3 10.3
------ ------ ------ ------
Total diluted shares .......................................... 41.4 43.3 41.9 43.1
====== ====== ====== ======
Diluted Earnings Per Share:
Earnings from continuing operations ........................... $ 0.60 $ 0.53 $ 1.17 $ 1.29
====== ====== ====== ======
Net earnings .................................................. $ 0.60 $ 0.58 $ 1.17 $ 1.35
====== ====== ====== ======
</TABLE>
NOTE H - NEW ACCOUNTING STANDARDS AND DISCLOSURES
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," and in June
2000, the FASB amended SFAS No. 133 by issuing SFAS No. 138. These statements
establish accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. These statements require an entity to 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 and No. 138 are effective for the
Company on January 1, 2001 and cannot be applied retroactively to financial
statements of prior periods. The Company enters into derivatives activities, on
a limited basis, as part of its programs to acquire refinery feedstocks at
reasonable costs and to manage margins on certain product sales. The Company
also engages in limited petroleum trading activities through the use of
derivatives. Management believes that any potential adverse impact from these
activities would not result in a material adverse effect on the Company's
financial results or financial position.
The Company has been evaluating the effects of implementing SFAS No. 133 and No.
138 and, based on evaluation results to date, expects that substantially all of
its derivative instruments are "normal purchases and sales" and that repricing
provisions in other agreements are not embedded derivatives. Consequently, at
this time, management believes that implementation of these accounting standards
will not have a significant impact on the Company's financial condition, results
of operations or financial reporting and disclosures.
In December 1999, the SEC issued Staff Accounting Bulletin No. 101 ("SAB 101")
on revenue recognition in financial statements. The Company recognizes revenues
from product sales and services upon delivery to customers. Management believes
that the Company's revenue recognition practices conform with those described in
SAB 101 and that no significant change in its policy is required at this time.
In a related matter, the FASB's Emerging Issues Task Force concluded that
shipping and handling costs billed to customers should be reported as revenues.
The Company's financial reporting will not be affected by this issue.
The FASB's Interpretation No.44, "Accounting for Certain Transactions Involving
Stock Compensation," became effective on July 1, 2000. The Interpretation did
not affect the Company's accounting for its stock-based compensation.
11
<PAGE> 12
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 22 FOR DISCUSSION
OF THE FACTORS WHICH COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE
PROJECTED IN SUCH STATEMENTS.
THE COMPANY HAS ENDEAVORED TO PROVIDE A MORE THOROUGH DISCUSSION OF MANAGEMENT'S
EXPECTATIONS AND GOALS FOR THE COMPANY IN THIS MANAGEMENT'S DISCUSSION AND
ANALYSIS AND THE COMPANY ANTICIPATES THAT IT WILL CONTINUE TO DO THE SAME IN
MANAGEMENT'S DISCUSSION AND ANALYSIS IN THE FUTURE. HOWEVER, EXPECTATIONS AND
GOALS MAY CHANGE DURING INTERIM PERIODS OF TIME. THE COMPANY DOES NOT INTEND TO,
AND A READER HEREOF SHOULD NOT EXPECT THAT THE COMPANY WILL, UPDATE THE
INFORMATION CONTAINED HEREIN DURING ANY SUCH INTERIM PERIOD.
STRATEGY
The Company's strategy is to (i) maximize earnings, cash flows and return on
capital employed and increase its competitiveness by reducing costs, increasing
efficiencies and optimizing existing assets and (ii) expand its overall size and
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 is further improving
profitability in the Refining and Marketing segment by enhancing processing
capabilities, strengthening its marketing activities 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. As part of this strategy, the Company
continues to assess its existing asset base in order to maximize returns and
financial flexibility through diversification, acquisitions and divestitures.
Management's goals are to triple its 1999 earnings per share of $0.62 to $1.86
by 2002 and achieve, over time, a 12% aftertax return on capital employed. The
Company's return on capital employed (annualized) was approximately 8.5% for the
nine months ended September 30, 2000.
To improve profitability from the Company's existing asset base, management has
implemented profit improvement programs focused on manufacturing enhancements,
marketing improvements and growth, cost reductions and information system
improvements. Management believes that, based on the current business
environment, these profit improvement programs, which are further discussed
below, will improve profitability and reduce volatility of earnings.
The Company's manufacturing strategy includes improving refinery reliability and
safety, reducing direct manufacturing costs per barrel and improving refining
processes. The Company has commenced a heavy oil conversion project at its
Washington refinery which will enable the Company to process a larger proportion
of lower-cost heavy crude oils, to manufacture a larger proportion of
higher-value gasoline, and to reduce production of lower-value heavy products.
The project, which is estimated to cost $85 million to $95 million, is expected
to be completed in conjunction with the refinery's turnaround in late 2001.
Management believes that this improvement to the Washington refinery will
increase annual operating profit by $30 million to $40 million beginning in
2002. In addition, management believes that the new $13 million distillate
treater, which was placed in service at the Washington refinery in December
1999, has performed ahead of expectations, due in part to strong distillate
margins, and contributed an estimated $8.3 million to operating profit for the
first nine months of 2000. Other manufacturing initiatives focus on increased
asphalt production capabilities, upgrades to process control systems,
modifications to increase jet fuel production, consolidated purchasing and
various other cost-savings projects. Management has established a goal to reduce
total direct manufacturing costs (including depreciation) by at least ten cents
per barrel in 2001 from the $3.09 per barrel average during the first nine
months of 2000. These manufacturing goals for 2001, which include the impact of
the completion of the heavy oil conversion project during the fourth quarter of
2001 and the manufacturing cost-savings mentioned above, are expected to achieve
$13 million to $15 million profit improvement in 2001.
In marketing, the Company's objectives include moving products into higher-value
market channels and developing markets for ratable offtake to reduce seasonal
volatility. The Company's strategies to accomplish these objectives include:
increasing product rack sales and reducing lower-value bulk sales of refined
products, maximizing in-state sales in Alaska and Hawaii, developing
high-volume, low-cost operations for branded gasoline sales (both Company and
customer owned), marketing jet fuel in additional West Coast markets, increasing
the
12
<PAGE> 13
production and sales of asphalt, directly marketing to marine and industrial
fuel markets, and increasing term sales of bunker fuels to tankers and cruise
ships.
As part of its retail marketing initiatives, the Company has an agreement with
Wal-Mart Stores, Inc. to build and operate retail fueling facilities on sites at
selected existing and future Wal-Mart store locations in the western United
States. The Company recently introduced the Mirastar brand which will be used
exclusively in its program with Wal-Mart. As of November 10, 2000, the Company
had 12 Mirastar stations in operation, 14 Mirastar stations under construction
and 51 sites in various stages of development or evaluation. Management expects
to have 19 Mirastar sites operating by the end of 2000 and approximately 90
Mirastar sites operating by the end of 2001. A standard Mirastar site is
expected to have a construction period of 45 to 60 days (excluding time related
to obtaining permits). Management has targeted a 15% return on investment for
this program, assuming average monthly volumes of 200,000 gallons per site by
the end of the first year of operation and an average construction cost for the
standard Mirastar site of approximately $525,000.
In addition, the Company is adding branded stations operated by independent
jobbers. Currently, the Company has 73 branded jobber locations in the western
U.S., excluding Alaska and Hawaii, as compared to 54 at the beginning of 2000.
The typical arrangement for a jobber-owned site includes a five-year supply
arrangement and is targeted to cost the Company between $50,000 and $250,000 per
site. Average volumes per jobber site are targeted at 150,000 gallons per month.
Management believes that the Company's retail capital spending program (for both
Company-owned and branded stations owned by independent jobbers) will total
approximately $25 million to $30 million for the year 2000. Total branded sites,
including Company-owned and operated sites, supplied by the Company are
projected to total 294 by year-end 2000, an increase of 50 sites from the
beginning of the year. Management has targeted an increase to 390 sites by
year-end 2001 due primarily to the Mirastar program. Volumes sold under the
Company's branded programs are expected to average approximately 15,000 barrels
per day ("Bpd") in 2000, as compared to approximately 12,000 Bpd in 1999, with a
management goal of 36,000 Bpd in 2001.
Other product marketing programs are focused on increasing margins by moving
certain volumes into higher-value channels of trade. The Company has entered
into two unbranded, high-volume retail agreements in the Pacific Northwest.
Including these sales, the Company has increased rack sales of unbranded
gasoline from about 15,000 Bpd in 1999 to 22,000 Bpd during the first nine
months of 2000. Management's goal for 2001 is to increase unbranded rack
gasoline sales to 33,000 Bpd in 2001. Diesel rack sales have increased from
about 21,000 Bpd in 1999 to about 24,000 Bpd during the first nine months of
2000, and management's goals include an increase to 27,000 Bpd in 2001.
Management expects an average future uplift in value for unbranded gasoline and
diesel of 75 basis points as compared to bulk sales values. The Company has
experienced from time to time uplifts of greater than 100 basis points in the
price of unbranded gasoline. Management's goals for the Company's gasoline and
commercial fuels marketing programs described above, which assume lower rack
margins and increased competition on jet fuel sales, are expected to add $4
million to $7 million to operating profit in 2001 as compared to 2000.
The Company has positioned itself to take advantage of opportunities to market
higher-value gasoline components, rather than combining all components into
finished gasoline. In the 2000 third quarter, approximately 8,700 Bpd of
high-octane CARB gasoline blendstocks were sold into the California market
rather than blending this material into the refinery's conventional gasoline
production. Management estimates that marketing these individual components
added $4.7 million to operating profit in the third quarter of 2000, as compared
to the values received from sales of conventional gasoline. Assuming market
conditions for CARB gasoline blendstocks remain strong, management goals are to
add $5 million to $6 million to operating profit in the year 2001, when compared
with 2000, from marketing of these individual components as compared to
conventional gasoline.
During 2000, the Company conducted an evaluation of the cost structure of its
Alaska operations. In connection with this evaluation, a full range of options
relative to products in Alaska, such as supplying the Alaska market from other
sources, were evaluated as well as a restructuring that could have included the
sale, or closure of part, or all, of the Alaskan assets. The results of the
Alaska evaluation were presented to the Company's Board of Directors in April
2000 with management's recommendation to continue to operate the refinery and
marketing assets in Alaska. The evaluation showed that this option has more
potential benefit for shareholders than other alternatives. The Company does not
presently intend to commit any significant capital to the Alaska refinery
operations, beyond that required for maintenance, safety and environmental
responsibility. However, the Company is considering a retail capital budget for
Alaska in the range of $5 million for 2001 as part of its strategy to maximize
in-state sales of products.
13
<PAGE> 14
As part of the evaluation of the Company's Alaska operations, the Company has
reorganized the administrative and marketing functions and eliminated positions
in Alaska by consolidating them into the Company's West Coast and San Antonio
offices. In addition, nine of the 31 Company-owned and operated retail sites in
Alaska were identified as candidates for closure. In combination, the annual
savings from these two programs are expected to be between $3 million and $4
million. Additionally, several new marketing and processing initiatives have
been identified for Alaska. The Company has implemented cost reduction programs
and expects to have other improvement plans substantially in place by the end of
2000. If these efforts are successful, the financial impact of these initiatives
could bring Alaska's return on capital employed into a targeted range of
approximately 8% to 10%. The Alaska operations were profitable during the first
nine months of 2000.
The Company's profit improvement programs also include cost reductions in
domestic shipping and other costs. One of the Company's two above-market ship
charters was terminated in late April 2000 and was replaced by a new charter for
a double-hull tanker which has a three-year primary term beginning in May 2000
and two one-year options. The Company terminated the remaining above-market
charter in October 2000. Management believes that this new shipping program,
based on the new term charter for a single ship, will result in annual cost
savings of approximately $10 million in future years as compared to the 2000
domestic shipping program. Management continues to evaluate the Company's
shipping requirements, which may impact its future results of operations.
An integral part of the Company's strategy is the development of a new
enterprise-wide information system to support operations and marketing. The
Company has spent an estimated $28 million on the new system since 1998, of
which approximately one-half has been capitalized. Year-to-date 2000
expenditures totaled $5.8 million, of which $1.1 million has been capitalized.
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 costs of
crude oil and other refinery feedstocks and the prices 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 feedstock
costs. As part of its marketing program, the Company also purchases refined
products manufactured by others that are later resold. Changes in price levels
of crude oil and refined products can result in changes in margins on such
activities. 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 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.
RESULTS OF OPERATIONS - THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2000
COMPARED WITH THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 1999
SUMMARY
Tesoro's earnings from continuing operations were $25.0 million ($0.71 per basic
share or $0.60 per diluted share) for the three months ended September 30, 2000
("2000 Quarter"), compared with earnings from continuing operations of $23.0
million ($0.62 per basic share or $0.53 per diluted share) for the three months
ended September 30, 1999 ("1999 Quarter"). For the year-to-date periods,
earnings from continuing operations were $48.9 million ($1.27 per basic share or
$1.17 per diluted share) for the nine months ended September 30, 2000 ("2000
Period"), compared with earnings from continuing operations of $55.8 million
($1.44 per basic share or $1.29 per diluted share) for the nine months ended
September 30, 1999 ("1999 Period"). The increase in earnings from continuing
operations in the 2000 Quarter, compared to the 1999 Quarter, reflected
increases in gross margins and sales volumes, partially offset by higher
operating expenses as discussed below.
A discussion and analysis of the factors contributing to the Company's results
of operations are presented below. The accompanying consolidated financial
statements and related notes, together with the following information,
14
<PAGE> 15
are intended to provide shareholders and other investors with a reasonable basis
for assessing the Company's operations, but should not serve as the only
criteria for predicting the future performance of the Company.
Certain amounts for the three months and nine months ended September 30, 1999
have been reclassified to reflect the transfer of the West Coast marine fuel
operations from the Marine Services segment to the Refining and Marketing
segment in 2000. Certain other reclassifications have been made to information
previously reported to conform to current presentation.
REFINING AND MARKETING
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------- -----------------
(Dollars in millions except per barrel amounts) 2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Operating Revenues:
Refined products .................................................... $ 1,274.4 $ 845.4 $ 3,296.9 $ 2,000.5
Other revenues (primarily crude oil resales and
merchandise) ..................................................... 73.2 18.1 238.9 51.6
--------- --------- --------- ---------
Total Operating Revenues ....................................... $ 1,347.6 $ 863.5 $ 3,535.8 $ 2,052.1
========= ========= ========= =========
Segment Operating Profit:
Gross margin:
Refinery (a) ..................................................... $ 173.5 $ 142.0 $ 444.7 $ 404.8
Non-refinery:
Merchandise .................................................... 7.6 5.7 21.0 16.3
Other product and crude oil marketing (b) ...................... 1.6 20.4 19.6 41.9
--------- --------- --------- ---------
Total gross margins .......................................... 182.7 168.1 485.3 463.0
Operating expenses and other (c) ................................... (111.2) (101.5) (324.5) (292.2)
Depreciation and amortization (d) .................................. (10.3) (9.5) (28.9) (27.4)
--------- --------- --------- ---------
Segment Operating Profit ......................................... $ 61.2 $ 57.1 $ 131.9 $ 143.4
========= ========= ========= =========
Refinery Throughput (thousands of barrels per day):
Alaska ............................................................. 53.6 56.9 47.8 49.3
Hawaii ............................................................. 79.2 85.1 81.9 88.5
Washington ......................................................... 123.6 103.6 116.9 104.6
--------- --------- --------- ---------
Total Refinery System Throughput ................................. 256.4 245.6 246.6 242.4
========= ========= ========= =========
% Heavy Crude Oil of Total Refinery System Throughput ................. 41.6% 29.1% 43.3% 36.5%
========= ========= ========= =========
Refined Products Manufactured (thousands of barrels per day):
Gasoline and gasoline blendstocks ................................ 98.8 101.5 96.6 96.8
Jet fuel ......................................................... 56.6 60.1 56.0 60.3
Diesel fuel ...................................................... 41.6 37.0 37.8 34.6
Heavy oils, residual products and other .......................... 66.2 56.7 63.3 60.9
--------- --------- --------- ---------
Total Refined Products Manufactured .......................... 263.2 255.3 253.7 252.6
========= ========= ========= =========
Total Refinery System Product Spread ($/barrel) (e) ................... $ 7.36 $ 6.27 $ 6.58 $ 6.12
========= ========= ========= =========
Segment Product Sales (thousands of barrels per day) (f):
Gasoline and gasoline blendstocks .................................. 141.8 130.5 137.1 126.1
Jet fuel ........................................................... 75.2 81.0 76.2 75.3
Diesel fuel ........................................................ 60.4 53.9 52.1 46.3
Heavy oils, residual products and other ............................ 55.4 57.2 57.9 56.8
--------- --------- --------- ---------
Total Product Sales .............................................. 332.8 322.6 323.3 304.5
========= ========= ========= =========
Segment Gross Margins on Product Sales ($/barrel) (g):
Average sales price ................................................ $ 41.61 $ 28.48 $ 37.21 $ 24.07
Average costs of sales ............................................. 35.91 23.37 31.98 18.76
--------- --------- --------- ---------
Gross Margin ..................................................... $ 5.70 $ 5.11 $ 5.23 $ 5.31
========= ========= ========= =========
</TABLE>
----------
(a) Approximates throughput at the Company's refineries times refinery product
spread.
(b) Primarily includes margins on products and crude oil purchased and resold,
and the effects of selling a volume and mix of product that is different
than actual volumes manufactured.
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<PAGE> 16
(c) Includes manufacturing costs per throughput barrel of approximately $2.82
and $2.83 in the third quarter and nine months ended September 30, 2000,
respectively. Manufacturing costs per throughput barrel were $2.90 in the
first quarter of 2000 and $2.76 in the second quarter of 2000.
(d) Includes manufacturing depreciation per throughput barrel of $0.24 and
$0.26 in the third quarter and nine months ended September 30, 2000,
respectively. Manufacturing depreciation per barrel amounted to $0.28 in
the first quarter of 2000 and $0.25 in the second quarter of 2000.
(e) Refinery system product spread represents an average for the Company's
three refineries.
(f) Sources of total product sales include products manufactured at the
refineries, products drawn from inventory balances and products purchased
from third parties.
(g) Gross margins on total product sales include margins on sales of
manufactured and purchased products and the effect of inventory changes.
THREE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED WITH THREE MONTHS ENDED SEPTEMBER
30, 1999. Segment operating profit for the Refining and Marketing segment was
$61.2 million in the 2000 Quarter, an increase of $4.1 million from segment
operating profit of $57.1 million in the 1999 Quarter. The increase was
primarily driven by stronger refined product margins, marketing initiatives and
higher refinery throughput. These improved margins were partially offset by
declines in non-refinery margins from product and crude oil marketing activities
and higher operating expenses.
Revenues from sales of refined products in the Refining and Marketing segment
increased in the 2000 Quarter, compared to the 1999 Quarter, due to higher
product prices and sales volumes. Total product sales averaged 332,800 Bpd in
the 2000 Quarter, an increase of 10,200 Bpd from 322,600 Bpd in the 1999
Quarter. Other revenues increased in the 2000 Quarter primarily due to crude oil
resales of approximately $55 million in the 2000 Quarter. There were no crude
oil resales in the 1999 Quarter. The increase in cost of sales reflected higher
costs of crude oil and purchased products due to higher prices as well as higher
volumes.
Refinery gross margin increased $31.5 million to $173.5 million in the 2000
Quarter due primarily to the increase in average refinery product spread per
barrel to $7.36 in the 2000 Quarter compared to $6.27 in the 1999 Quarter.
Industry refining margins were strong in the western U.S. during the 2000
Quarter, reflecting the tightness of supply and refining capacity in that
region. The Company was able to capitalize on these conditions by operating its
refineries at historically high rates, even with a turnaround in Hawaii during
September 2000.
Non-refinery margins from other product and crude oil marketing activities
declined $18.8 million in the 2000 Quarter as compared to the 1999 Quarter.
Market conditions in 1999, which were affected by product supply disruptions,
offered greater profit opportunities compared to market conditions this year.
Operating expenses and other, excluding depreciation, increased by $9.7 million
to $111.2 million in the 2000 Quarter, primarily due to higher refinery fuel and
utility costs, increased state and local taxes because of higher product values,
and increased marketing expenses as a result of continued retail expansion.
Electricity rates at the Washington refinery increased from $35 per megawatt
hour in the 1999 Quarter to $116 per megawatt hour in the 2000 Quarter,
resulting in an increase of $4.3 million in manufacturing costs. Given the
current high rates, management is evaluating ways to manage utility costs in the
future. If energy prices remain at high levels, operating expenses will be
similarly impacted in the future. Operating expenses also included non-cash
amortization of refinery turnaround costs of $5.3 million and $3.6 million in
the 2000 Quarter and the 1999 Quarter, respectively.
NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 1999. Segment operating profit for the Company's Refining and Marketing
operations was $131.9 million in the 2000 Period, a decrease of $11.5 million
from segment operating profit of $143.4 million in the 1999 Period. The change
in operating profit was primarily due to a decrease in margins from other
product and crude oil marketing activities and an increase in operating
expenses, partly offset by higher sales volumes and refinery margins. Refinery
feedstocks for the 2000 Period consisted of 33% crude oil from foreign sources,
35% crude oil from Alaska's North Slope, 15% crude oil from Canada, 13% crude
oil from Alaska's Cook Inlet, and 4% other feedstocks.
Revenue increased significantly from the 1999 Period, reflecting higher product
prices and sales volumes. Total product sales averaged 323,300 Bpd in the 2000
Period, an increase of 18,800 Bpd from 304,500 Bpd in the 1999 Period. Other
revenues increased in the 2000 Period primarily due to higher crude oil resales,
which were approximately $189 million in the 2000 Period and $6 million in the
1999 Period. The increase in cost of sales reflected higher costs of crude oil
and purchased products due to higher prices as well as higher volumes.
16
<PAGE> 17
Refinery gross margin increased $39.9 million to $444.7 million in the 2000
Period due primarily to the increase in average refinery product spread per
barrel to $6.58 in the 2000 Period compared to $6.12 in the 1999 Period.
Non-refinery margins decreased $17.6 million to $40.6 million in the 2000 Period
due primarily to lower margins on other product and crude oil marketing partly
offset by increased merchandise sales margins through Company-owned retail
stations.
Operating expenses and other, excluding depreciation, increased by $32.3 million
to $324.5 million in the 2000 Period. Electric costs, which began rising early
in the second quarter of 2000, added $5.7 million to operating expenses in the
2000 Period. In addition, increased state and local taxes due to higher product
values and increased marketing expenses as a result of continued retail
expansion contributed to the higher expenses. Operating expenses also included
non-cash amortization of refinery turnaround costs of $15.6 million in the 2000
Period and $11.3 million in the 1999 Period. The Hawaii crude unit turnaround
was moved from 2001 and combined with the September 2000 hydrocracker turnaround
to avoid a temporary reduction in throughput in 2001. The turnaround at the
Washington refinery, originally planned for 2002, was changed to coincide with
the completion of the heavy oil conversion project expected in late 2001.
OUTLOOK AND OTHER FACTORS. Management believes that western U.S. industry
margins should remain strong, compared to historical levels, for the next two to
three years due to, among other things: (i) increased demand for distillates as
a result of a strong U.S. economy together with an anticipated reduction in jet
fuel imports to the West Coast caused by improved economic conditions in the Far
East and higher foreign shipping rates and (ii) increased gasoline demand in the
Pacific Northwest due to continued economic strength in that region which could
be offset by an increased supply of conventional gasoline from California to
Pacific Northwest markets due to more stringent fuel specifications in
California. However, many other factors contribute to the strength of industry
margins, including, among others, cost and availability of crude oil, the
general demand for refined products, changes in product specifications, changes
in refining capacity in the Company's operational regions and other conditions.
In addition, industry margins may be impacted by high-volume retail expansions
and strong competition in the industry due to mergers and acquisitions. See
Forward-Looking Statements on page 22 and Business Environment on page 14 for
further information related to these factors. As previously discussed in
"Strategy" beginning on page 12 of this Management's Discussion and Analysis,
the Company has developed programs to improve the profitability of the Refining
and Marketing segment and to reduce volatility of earnings. Future profitability
of this segment, however, will continue to be influenced by market conditions
and other factors that are beyond the control of the Company.
While Pacific Northwest market conditions were stronger than historical averages
in the first half of the 2000 fourth quarter, margins are currently trending
toward historical averages. Assuming that these industry margins continue to
remain stronger than historical averages and product demand remains healthy,
management expects that the Company's system-wide refinery throughput for the
fourth quarter of 2000 should average between 250,000 Bpd to 260,000 Bpd. The
Company estimates that its system-wide throughput should average about 253,000
Bpd for the year 2000 and projected throughput rates should be approximately
49,000 Bpd in Alaska, 85,000 Bpd in Hawaii and 119,000 Bpd in Washington.
Management expects the Company's refinery throughput to average between 250,000
Bpd to 260,000 Bpd for the year 2001. The Company's current business plan
assumes that the Company's system-wide throughput averages 257,000 Bpd in 2001
and assumes projected throughput rates of approximately 53,000 Bpd in Alaska,
88,000 Bpd in Hawaii and 116,000 Bpd in Washington. Based on the Company's
current business plan refinery projections, prior to completion of the heavy oil
conversion project, feedstocks for the system-wide refineries are expected to
consist of approximately 49% heavy crude oils, 46% light crude oils and 5% other
feedstocks with a system-wide yield, expressed as percentages of throughput
barrels, of 35% gasoline, 25% jet fuel, 17% diesel fuel and 26% residual fuel
oil and other products. Using the Company's current business plan refinery
projections, after completion of the heavy oil conversion project expected in
late 2001, management believes its feedstocks for the system-wide refineries
should consist of approximately 58% heavy crude oils, 40% light crude oils and
2% other feedstocks with a system-wide yield, expressed as percentages of
throughput barrels, of 37% gasoline, 25% jet fuel, 16% diesel fuel and 24%
residual fuel oil and other products.
The Company's actual throughput and refinery yields for the fourth quarter of
2000 and the year 2001 may differ from the projections discussed above due to
market conditions, the availability and costs of crude oil, the demand for
refined products and other factors (see Forward-Looking Statements on page 22
and Business Environment on page 14).
17
<PAGE> 18
MARINE SERVICES
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------ -----------------
(Dollars in millions) 2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Operating Revenues:
Fuels ..................................... $ 40.0 $ 23.4 $110.2 $ 55.7
Lubricants and Other ...................... 3.3 3.3 10.9 10.0
Services .................................. 3.5 3.3 9.8 7.9
------ ------ ------ ------
Operating Revenues ...................... 46.8 30.0 130.9 73.6
Cost of Sales ................................ 36.2 20.0 99.2 47.8
------ ------ ------ ------
Gross Profit ............................ 10.6 10.0 31.7 25.8
Other Income ................................. 0.4 -- 1.6 --
Operating Expenses and Other ................. (7.4) (6.7) (22.7) (20.8)
Depreciation and Amortization ................ (0.7) (0.6) (1.9) (1.9)
------ ------ ------ ------
Segment Operating Profit .................. $ 2.9 $ 2.7 $ 8.7 $ 3.1
====== ====== ====== ======
Sales Volumes (millions of gallons):
Fuels, primarily diesel ................... 41.1 36.7 125.1 106.2
Lubricants ................................ 0.5 0.5 1.6 1.5
</TABLE>
Segment operating profit improved by $0.2 million and $5.6 million during the
2000 Quarter and 2000 Period, respectively, primarily due to higher fuel sales
volumes and service revenues. The higher fuel sales volumes and service revenues
reflected increased customer exploration and development activities in the U.S.
Gulf of Mexico compared with 1999. Operating revenues increased $16.8 million
and $57.3 million from the 1999 Quarter and 1999 Period, respectively,
reflecting higher fuel prices, fuel sales volumes, and service revenues. The
increase in cost of sales also reflected the higher fuel sales volumes and
prices. In addition, the Company realized other income of $1.2 million from
settlement of a service contract in the first quarter of 2000 and $0.4 million
from the sale of excess real estate in the third quarter of 2000.
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.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased by $3.4 million and $5.7 million
during the 2000 Quarter and 2000 Period, respectively. The increases were
primarily due to higher employee costs associated with business development and
organizational realignment. Management believes that its annual general and
administrative expenses should be approximately $40 million for the year 2000.
INTEREST AND FINANCING COSTS
Interest and financing costs decreased by $1.7 million and $3.2 million during
the 2000 Quarter and 2000 Period, respectively, reflecting lower borrowings
partly offset by higher interest rates on floating-rate debt. Proceeds from the
sales of the Company's exploration and production operations were used to repay
debt in December 1999 and in March 2000 (see Note C of Notes to Condensed
Consolidated Financial Statements). The benefits from these debt repayments were
partly offset by higher interest rates on variable-rate debt and additional
borrowings to finance working capital. Increases in inventories and receivables
were due to higher crude oil and product inventory volumes, petroleum prices and
sales activities which were financed by borrowings and trade payables.
INTEREST INCOME
Interest income increased by $1.5 million during the 2000 Period due to the
temporary investment of a portion of the proceeds from the December 1999 sales
of exploration and production operations. A substantial portion of those
proceeds was used to repay debt in March 2000, as discussed above.
18
<PAGE> 19
OTHER EXPENSE
The decreases of $2.3 million and $1.2 million in other expense during the 2000
Quarter and 2000 Period, respectively, were due primarily to a $3 million
provision for a legal settlement recorded in the 1999 Quarter. During the 2000
Period, the Company incurred other expenses related to acquisition strategies
and environmental matters.
INCOME TAX PROVISION
The increase of $3.0 million in the income tax provision during the 2000
Quarter, compared with the 1999 Quarter, reflected the increase in pretax
earnings. The combined federal and state effective income tax rate was 42% for
the 2000 Quarter and 41% for the 2000 Period, reflecting adjustments related to
filing the 1999 federal income tax return in the 2000 Quarter. The lower
effective income tax rates of 40% and 37% in the 1999 Quarter and 1999 Period,
respectively, reflected favorable adjustments related to previous years.
CAPITAL RESOURCES AND LIQUIDITY
OVERVIEW
The Company's primary sources of liquidity are its cash flows from operations
and borrowing availability under revolving lines of credit. Capital requirements
are expected to include capital expenditures, working capital, debt service and
preferred dividend payments. Based upon current needs, management believes that
available capital resources will be adequate to meet the Company's 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 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, fluctuations in seasonal
demand, governmental regulations, the price and availability of alternative
fuels and overall market and economic conditions. The Company's future capital
expenditures, as well as borrowings under its credit arrangements and other
sources of capital, will be affected by these conditions.
CREDIT ARRANGEMENTS
On October 4, 2000, the Company and a group of banks entered into a new $250
million unsecured revolving credit facility, consisting of a $150 million,
3-year Revolving Credit Agreement and a $100 million, 364-day Revolving Credit
Agreement (collectively referred to as the "Credit Facility"). Each Revolving
Credit Agreement, which provides for cash borrowings and issuance of letters of
credit, can be extended for up to two one-year periods, subject to bank
approval. Borrowings under the Credit Facility bear interest, at the Company's
election, at either the Eurodollar Rate (as defined in the Credit Facility) plus
a margin ranging from 1.000% to 2.000% or a Base Rate (as defined in the Credit
Facility). The Company is also charged various fees and expenses in connection
with the Credit Facility, including commitment fees and various letter of credit
fees.
The Credit Facility requires the Company to maintain specified levels of
consolidated leverage and fixed charge coverages and includes a limitation on
the Company's debt to capital ratio. It also contains other covenants and
restrictions customary in credit arrangements of this kind. The terms of the
Credit Facility allow for payment of cash dividends on the Company's Common
Stock and repurchases of shares of its Common Stock, not to exceed an aggregate
of $15 million in any year. The Credit Facility also allows the Company to
repurchase up to 1,372,600 additional shares of its Common Stock under a share
repurchase program and to pay required dividends on the Company's 7.25%
Mandatorily Convertible Preferred Stock, so long as no default or event of
default is in existence.
The Credit Facility replaced the Company's previous credit facility, which would
have expired in 2001 and provided for $175 million in total commitments. The
previous credit facility was secured by substantially all of the assets of the
Company and its subsidiaries.
At September 30, 2000, the Company had no revolving borrowings outstanding and
$1 million in letters of credit outstanding. Based on current needs, the $250
million capacity under the Credit Facility, together with internally-generated
cash flows and existing cash, is expected to be sufficient to fund capital
expenditures, working capital requirements and other corporate purposes.
19
<PAGE> 20
CAPITALIZATION
The Company's capital structure at September 30, 2000 was comprised of the
following (in millions):
<TABLE>
<S> <C>
Debt and other obligations outstanding, including current maturities:
9% Senior Subordinated Notes, due 2008.................................... $297
Capital leases and other obligations...................................... 14
----
Total debt and other obligations....................................... 311
Mandatorily Convertible Preferred Stock..................................... 165
Common stockholders' equity ................................................ 483
----
Total Capitalization................................................... $959
====
</TABLE>
At September 30, 2000, the Company's total debt to capitalization ratio was 32%,
compared with 40% at year-end 1999. In March 2000, the Company repaid $81
million of term loans and prepaid a $24 million note, which were outstanding at
year-end 1999.
The Credit Facility, Senior Subordinated Notes and Preferred Stock impose
various restrictions and covenants on the Company that could potentially limit
the Company's ability to respond to market conditions, to provide for
anticipated capital investments, to raise additional debt or equity capital or
to take advantage of business opportunities.
COMMON STOCK SHARE REPURCHASE PROGRAM
In February 2000, the Company's Board of Directors authorized the repurchase of
up to 3 million shares of Tesoro Common Stock, which represented approximately
9% of the 32.4 million shares then outstanding. Under the program, the Company
repurchases Tesoro Common Stock from time to time in the open market and through
privately negotiated transactions. Purchases depend on price, market conditions
and other factors. The stock may be used to meet employee benefit plan
requirements and other corporate purposes. During the nine months ended
September 30, 2000, the Company repurchased 1,627,400 shares of Common Stock for
approximately $15.5 million.
CAPITAL SPENDING
During the first nine months of 2000, the Company's capital expenditures totaled
$42.7 million, which were funded primarily through existing cash and cash flows
from operations. During this period, the Company incurred initial costs related
to certain manufacturing improvements and marketing programs. In this regard,
the Company commenced a heavy oil conversion project at the Washington refinery.
Management believes that this project, which has an estimated total cost of $85
million to $95 million based on detailed engineering, will be completed in late
2001 and expects to spend approximately $28 million of the total cost in the
year 2000 (of which approximately $9 million was spent during the first nine
months of 2000). As related to its marketing program, the Company has an
agreement with Wal-Mart Stores, Inc. to build and operate retail fueling
facilities on sites at selected existing and future Wal-Mart store locations in
the western United States. The Company recently introduced a Mirastar brand
which will be used exclusively in its program with Wal-Mart. As of November 10,
2000, the Company had 12 Mirastar stations in operation, 14 Mirastar stations
under construction and 51 sites in various stages of development or evaluation.
Capital spending for this retail and other marketing programs totaled $10
million during the first nine months of 2000. Other capital spending during the
2000 Period included $20 million for other refining and marketing projects, $2
million in the Marine Services segment and $2 million for corporate
improvements.
Depending on the timing of expenditures, management believes that the Company's
capital spending will total approximately $88 million to $105 million for the
year 2000, as compared to its previous estimate of $115 million. The 2000
capital program includes $50 million to $60 million for refinery projects, $25
million to $30 million for retail projects, $13 million to $15 million for
Marine Services and other. For the year 2001, management estimates that its
capital spending program will range between $165 million and $190 million,
primarily for manufacturing improvements (expected to total between $110 million
to $120 million), retail marketing expansion (expected to total between $50
million and $60 million), and Marine Services and other ($5 million to $10
million). The 2000 and 2001 programs will be funded with internally-generated
cash flows from operations and borrowings under the Credit Facility.
20
<PAGE> 21
MAJOR MAINTENANCE COSTS
The Company completed a turnaround for certain processing units at its Hawaii
refinery during the third quarter of 2000, at a total cost of approximately $11
million. Amortization of turnaround costs, other major maintenance costs and
catalysts for the Company's operations are projected to total approximately $23
million during the year 2000. The Company has scheduled a turnaround for the
Alaska refinery in the second quarter of 2001 at an estimated cost of $11
million. Certain processing units at the Washington refinery are also scheduled
for turnarounds, primarily in the fourth quarter of 2001, at an estimated total
cost of $18 million.
CASH FLOWS
Components of the Company's cash flows, including discontinued operations in
1999, are set forth below (in millions):
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
------------------
2000 1999
---- ----
<S> <C> <C>
Cash Flows From (Used In):
Operating Activities...................................... $ 53.5 $145.9
Investing Activities...................................... (40.9) (99.6)
Financing Activities...................................... (129.9) (45.3)
------- ------
Increase (Decrease) in Cash and Cash Equivalents.............. $(117.3) $ 1.0
======= ======
</TABLE>
Net cash provided by operating activities totaled $53.5 million during the 2000
Period, compared to $145.9 million provided by operating activities for the 1999
Period. Cash flows from earnings from continuing operations before depreciation
and amortization, deferred income taxes, and other noncash charges decreased
$8.9 million in the 2000 Period, compared with the 1999 Period. Net increases in
operating assets and liabilities in the 2000 Period amounted to $58.2 million
which primarily included increases in inventories due to higher volumes and
prices and higher receivables, partly offset by higher payables. In comparison,
changes in operating assets and liabilities during the 1999 Period resulted in a
net decrease of $2.5 million. Net cash used in investing activities of $40.9
million during the 2000 Period included capital expenditures of $42.7 million,
partly offset by proceeds from sales of assets. Net cash used in financing
activities of $129.9 million in the 2000 Period included repayments of debt
totaling $105.6 million and purchases of Common Stock of $15.5 million. In
addition, payment of dividends on preferred stock totaled $9.0 million. The
Company had no outstanding balances under revolving lines of credit at September
30, 2000 (gross borrowings of $814.5 million offset by gross repayments of
$814.5 million).
At September 30, 2000, the Company's working capital totaled $252.4 million,
which included cash and cash equivalents of $24.5 million. The working capital
ratio was 1.6 to 1 at September 30, 2000, compared to 1.9 to 1 at December 31,
1999.
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 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 September 30, 2000, the Company's
accruals for environmental expenses totaled approximately $12.3 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.
The Company is currently evaluating certain newly-promulgated revisions to the
Clean Air Act regulations which will require a reduction in the sulfur content
in gasoline manufactured at its Washington refinery by January 1, 2004. To meet
the revised gasoline standard, the Company expects to make capital improvements
of approximately $30 million at its Washington refinery. Additionally, the
Company expects to spend approximately $15 million over the next four years to
comply with proposed Maximum Available Control Technology ("MACT II")
regulations for refineries. Management expects that the proposed MACT II
regulations will be finalized in late 2000 and would require new emission
controls at certain processing units at each of the Company's refineries.
21
<PAGE> 22
To comply with environmental laws and regulations, the Company anticipates it
will make other capital improvements of approximately $10 million in 2000 and $8
million in 2001. During the nine months ended September 30, 2000, the Company
spent approximately $6 million, primarily for improvements to tanks and tank
farm secondary containment at its refineries.
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 requirements. The
amount of such future expenditures cannot currently be determined by the
Company.
For further information on environmental and other contingencies, see Note F of
Notes to Condensed Consolidated Financial Statements in Part I, Item 1, and
Legal Proceedings in Part II, Item 1, included herein.
NEW ACCOUNTING STANDARDS AND DISCLOSURES
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 was subsequently amended by SFAS No.
138 in June 2000. These statements establish accounting and reporting standards
for derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities. The Company has been evaluating the
effects of implementing these statements and currently believes these statements
will not have a significant impact on its financial condition, results of
operations or financial reporting and disclosures.
The SEC issued Staff Accounting Bulletin No. 101 ("SAB 101") on revenue
recognition in December 1999. Management believes that the Company's revenue
recognition practices conform with SAB 101. Management also believes that the
Company's financial reporting will not be affected by the FASB's Emerging Issues
Task Force conclusion on reporting billings to customers for shipping and
handling.
The FASB's Interpretation No. 44, "Accounting for Certain Transactions Involving
Stock Compensation," became effective on July 1, 2000. The Interpretation did
not affect the Company's accounting for its stock-based compensation.
For further information related to new accounting standards and disclosures, see
Note H of Notes to Condensed Consolidated Financial Statements in Part I, Item
1.
FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains certain statements that are
"forward-looking" statements within the meaning of the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995, as codified in Section 27A
of the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. These forward-looking statements include,
among other things, projections of revenues, earnings, earnings per share,
capital expenditures or other financial items; discussions of estimated future
revenue enhancements and cost savings; and the Company's business strategy,
goals and expectations concerning the Company's market position, future
operations, margins, profitability, liquidity and capital resources. 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, changes in general economic conditions;
the timing and extent of changes in commodity prices and underlying demand;
availability and costs of crude oil, other refinery feedstocks and refined
products; changes in the cost or availability of third-party vessels, pipelines
and other means of transporting feedstocks and products; changes in utility
costs for the Company's facilities; disruptions due to equipment interruption or
failure at Company or third-party facilities; execution of planned capital
projects; results of management's evaluation of the Company's cost structure;
adverse changes in the credit ratings assigned to the Company's trade credit;
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 or tax matters, including
22
<PAGE> 23
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, 1999 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 update any
information contained herein or to publicly release the results of any revisions
to any such forward-looking statements that may be made to reflect events or
circumstances that occur, or which the Company becomes aware of, after the date
hereof.
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 refining and marketing earnings and cash flows from operations are
dependent upon the margin above fixed and variable expenses (including the costs
of crude oil and other feedstocks) at which the Company is able to sell refined
products. In recent years, the prices of crude oil and refined products have
fluctuated substantially. These prices depend on numerous factors, including the
demand for crude oil, gasoline and other refined products, which in turn depend
on, among other factors, changes in the economy, the level of foreign and
domestic production of crude oil and refined products, worldwide political
conditions, the availability of imports of crude oil and refined products, the
marketing of alternative and competing fuels and the extent of government
regulations. The prices received by the Company for its refined products are
also affected by local factors such as local market conditions and the level of
operations of other refineries in the Company's markets.
The prices at which the Company can sell its refined products are influenced by
the commodity prices of crude oil. Generally, an increase or decrease in the
prices of crude oil results in a corresponding increase or decrease in the
prices of gasoline and other refined products; however, the timing of the
relative movement of the prices can reduce profit margins and could have a
significant impact on the Company's refining operations and the earnings and
cash flows of the Company as a whole. In addition, the Company maintains
inventories of crude oil, intermediate products and refined products, the value
of each of which is subject to rapid fluctuation in market prices. At September
30, 2000 and December 31, 1999, the Company's inventories of refinery feedstocks
and refined products totaled 11.5 million barrels and 8.6 million barrels,
respectively. In addition, crude oil supply contracts are generally contracts
with market-responsive pricing provisions. The Company purchases its refinery
feedstocks prior to selling the refined products manufactured. Price level
changes during the period between purchasing feedstocks and selling the
manufactured refined products from such feedstocks could have a material effect
on the Company's financial results. As part of its marketing program, the
Company also purchases refined products manufactured by others for resale to
customers. Price level changes during the periods between purchasing and selling
such products could have a material effect on financial results.
From time to time, the Company enters into derivatives activities, on a limited
basis, as part of its programs to provide services for suppliers and customers.
These programs assist the Company in accessing refinery feedstocks at reasonable
costs and to manage margins on sales to certain customers. The Company also
engages in limited petroleum trading activities through the use of derivatives.
Management believes that any potential adverse impact from these activities
would not result in a material adverse effect on the Company's financial results
or financial position. At September 30, 2000, the Company held the following
derivative commodity instruments:
o Crude oil futures contracts to purchase 140,000 barrels in November 2000
at a weighted average price of $33.31 per barrel. The total amount of the
contracts was $4.7 million and the fair value was $4.3 million at
September 30, 2000.
o The Company sold put options to purchase 100,000 barrels of crude oil in
November 2000 at a weighted average price of $33.25 per barrel. The
amount received for the options was approximately $0.3 million and the
market value of the options was an unrealized loss of $0.2 million at
September 30, 2000.
23
<PAGE> 24
INTEREST RATE RISK
The Company had no outstanding balances under floating rate debt at September
30, 2000. The fair market value of the Company's fixed-rate debt at September
30, 2000 was approximately $3.3 million less than its book value of $311
million, based on recent transactions and bid quotes for the Company's 9% Senior
Subordinated Notes. Fixed-rate debt of $297 million will mature in 2008, while
other fixed-rate capital leases, notes and other obligations will mature over
varying periods through 2013.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
As previously reported, on May 31, 2000, the Company and certain of
its officers were named defendants in a lawsuit filed in the United
States District Court, Western District of Texas, San Antonio
Division, brought by Group One Limited which seeks to certify as a
class, all persons or entities who purchased the Company's
securities during the period from January 3, 2000 through May 3,
2000. Three other identical lawsuits have also been filed in the
same court. The lawsuits, which have been consolidated, allege that
the defendants issued false and misleading information regarding
the Company's financial condition and operations, which
artificially inflated the market price of the Company's securities
during the period from January 3, 2000 through May 3, 2000. The
plaintiffs seek unspecified damages. The Company believes the
claims are without merit and intends to vigorously defend against
such claims.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 $150,000,000 Revolving Credit Agreement, dated
as of October 4, 2000, among the Company, the
Lenders parties thereto, Banc One Capital
Markets, Inc., as Arranger, Bank One, NA, as
Administrative Agent, The Bank of Nova Scotia,
as Syndication Agent, and ABN AMRO Bank, N.V.,
as Documentation Agent.
10.2 $100,000,000 364-Day Revolving Credit
Agreement, dated as of October 4, 2000, among
the Company, the Lenders parties thereto, Banc
One Capital Markets, Inc., as Arranger, Bank
One, NA, as Administrative Agent, The Bank of
Nova Scotia, as Syndication Agent, and ABN AMRO
Bank, N.V., as Documentation Agent.
27 Financial Data Schedule (September 30, 2000).
(b) Reports on Form 8-K
No reports on Form 8-K have been filed during the quarter
for which this report is filed.
24
<PAGE> 25
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: November 14, 2000 /s/ BRUCE A. SMITH
----------------------------------
Bruce A. Smith
Chairman of the Board of Directors,
President and Chief Executive Officer
Date: November 14, 2000 /s/ DON M. HEEP
-----------------------------------
Don M. Heep
Senior Vice President, Controller
(Chief Accounting Officer)
25
<PAGE> 26
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
-------- -----------
<S> <C>
10.1 $150,000,000 Revolving Credit Agreement, dated as of October 4, 2000,
among the Company, the Lenders parties thereto, Banc One Capital
Markets, Inc., as Arranger, Bank One, NA, as Administrative Agent, The
Bank of Nova Scotia, as Syndication Agent, and ABN AMRO Bank, N.V., as
Documentation Agent.
10.2 $100,000,000 364-Day Revolving Credit Agreement, dated as of October 4,
2000, among the Company, the Lenders parties thereto, Banc One Capital
Markets, Inc., as Arranger, Bank One, NA, as Administrative Agent, The
Bank of Nova Scotia, as Syndication Agent, and ABN AMRO Bank, N.V., as
Documentation Agent.
27 Financial Data Schedule (September 30, 2000).
</TABLE>
