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TSO > SEC Filings for TSO > Form 10-Q on 1-Aug-2014All Recent SEC Filings

Show all filings for TESORO CORP /NEW/

Form 10-Q for TESORO CORP /NEW/


1-Aug-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Those statements in this section that are not historical in nature should be deemed forward-looking statements that are inherently uncertain. See "Important Information Regarding Forward-Looking Statements" on page 57 for a discussion of the factors that could cause actual results to differ materially from those projected in these statements. This section should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2013.

BUSINESS STRATEGY AND OVERVIEW

Strategy and Goals

Our vision is to create a safer and cleaner future as efficient providers of reliable transportation fuel solutions. To achieve these goals we are pursuing the following strategic priorities:

improve operational efficiency and effectiveness by focusing on safety and reliability, system improvements and cost leadership;

drive commercial excellence by strengthening our supply, trading and optimization activities to provide additional value to the business;

maintain our financial position by exercising capital discipline and focusing on a balanced use of free cash flow;

capture value-driven growth through a focus on our logistics assets, growing our marketing business and other strategic opportunities accretive to shareholder value; and

maintain a high performing culture by building leadership at all levels of the organization with employees from diverse backgrounds and experiences who are accountable for delivering on our commitments.

Our goals were focused on these strategic priorities and we accomplished the following in the first half of 2014:

                                          Operational                         Value      High
                                         Efficiency &  Commercial Financial   Driven  Performing
                                         Effectiveness Excellence Discipline  Growth   Culture
Captured synergies from the Los Angeles
Acquisition of approximately $100
million and other business improvements        l           l          l         l         l
of approximately $100 million in line
with full year expectations
Leveraged TLLP's logistics operations to
strategically source lower cost crude
oil and continue to capture value-driven       l           l          l         l         l
growth through TLLP's investment in new
assets for crude oil gathering and
refined products distribution
Completed the issuance of $300 million
aggregate principal amount of 5.125%                                  l
Senior Notes due 2024, and redeemed the
outstanding 9.750% Senior Notes due 2019
Purchased 3.7 million shares of our
common stock and paid $0.25 per share                                 l
dividends each quarter
TLLP entered into an agreement to
acquire the West Coast Logistics Assets
from Tesoro for a purchase price of $270                              l         l
million of which the first phase for
$241 million closed on July 1, 2014
TLLP launched its Continuous Offering
Program authorizing the issuance of up
to an aggregate of $200 million of                                    l         l
common units in amounts, at prices, and
on terms determined by market conditions


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Synergy and Business Improvement Objectives

During the first half of 2014, we delivered approximately $200 million in EBITDA
(earnings before interest, income taxes, depreciation and amortization expenses)
improvements as a result of our synergy and business improvement objectives. These EBITDA improvements resulted in approximately $121 million of net earnings for the six months ended June 30, 2014. Our 2014 achievements include the following:

Increased overall refining capture rates from 99% to 104% during the first half of 2014 compared to the second half of 2013 resulting from the Los Angeles Acquisition (as defined on page 39) and the optimization of crude oil cargoes between our California and Anacortes refineries;

Integrated refined products movements between our Carson and Wilmington facilities allowing us to move finished barrels from Wilmington into the new Carson logistics system enhancing our flexibility to blend and share gasoline and jet supplies;

Completed expansion of the Salt Lake City waxy crude unit, which resulted in an increase from 85% to 128% capture of the Group 3 crack spread (the differential between the price of WTI crude oil, as defined on page 33, and the blended refined products price of two-thirds gasoline and one-third diesel in the Mid-Continent region) and the expansion of the Mandan distillate desulfurization unit allowing the refinery to run an additional 3 thousand barrels per day ("Mbpd") of total throughput;

Further optimized our marketing portfolio through the acquisition of 15 retail stations in the Salt Lake City area enhancing our integration in that market; and

Achieved additional value-driven growth through our interest in Tesoro Logistics LP with its continued focus on organic growth projects and acquisition of logistics assets from us.

Refer to page 38 for our reconciliation of net earnings to EBITDA improvements.

Tesoro Logistics LP ("TLLP")

TLLP was formed to own, operate, develop and acquire logistics assets to gather crude oil and distribute, transport and store crude oil and refined products. Tesoro Logistics GP, LLC ("TLGP"), a fully consolidated subsidiary, serves as the general partner of TLLP. We held an approximate 36% interest in TLLP at June 30, 2014, including the general partner interest. Our ownership interest in TLLP include subordinated units that were converted to common units during the second quarter of 2014 and thereafter participate on terms equal with all other common units in distributions of available cash. At the time of conversion, our ownership interest in TLLP and financial position were not impacted. In the first half of 2014, 88% of TLLP's revenue was derived from us primarily under various long-term, fee-based commercial agreements that generally include minimum volume commitments. In accordance with the partnership agreement, common, subordinated and general partner interests are entitled to receive quarterly distributions of available cash.

As of and for the three months ended June 30, 2014 and 2013, certain financial data related to our ownership, including incentive distribution rights, in TLLP is as follows (in millions):

                                                            Three Months Ended June 30,
                                                                2014              2013
Cash distributions received from TLLP (a)                  $          18     $         10
Total market value of TLLP units held by Tesoro (b)                1,403            1,087


__________________


(a) Represents distributions received from TLLP during the three months ended June 30, 2014 and 2013 on units held by Tesoro.

(b) Represents market value of units held at June 30, 2014 and 2013. Tesoro held 19,110,714 common units at a market value of $73.40 per unit based on the closing unit price at June 30, 2014. Tesoro held 2,729,476 common units and 15,254,890 subordinated units at a market value of $60.46 per unit based on the closing unit price at June 30, 2013.

TLLP intends to continue to expand its business through organic growth, including constructing new assets and increasing the utilization of existing assets, and by acquiring assets from us and third parties. TLLP has recently announced plans to expand capacity on its crude oil gathering system ("High Plains System") and grow third-party volumes at its terminals.


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Effective June 23, 2014, TLLP entered into a transaction to purchase certain terminalling and pipeline assets owned by Tesoro and two of our subsidiaries for total consideration of $270 million to be completed in two phases. On July 1, 2014, TLLP purchased the first phase consisting of three marketing terminals and a storage facility in exchange for consideration of $241 million, comprised of approximately $214 million in cash, and the issuance of equity to us with a fair value of $27 million. TLLP's acquisition of a refined products pipeline in the second phase is pending regulatory approval. This approval is expected during the third or fourth quarter of 2014.

On June 25, 2014, TLLP filed a prospectus supplement to its shelf registration statement filed with the SEC in 2012, authorizing the continuous issuance of up to an aggregate of $200 million of common units, in amounts, at prices and on terms to be determined by market conditions and other factors at the time of its offerings (such continuous offering program referred to as the "ATM Program"). During the three months ended June 30, 2014, TLLP sold an aggregate of 5,500 common units under its ATM Program, generating less than $1 million in proceeds, net of offering costs. The net proceeds from these sales will be used for general partnership purposes. TLLP issued an additional 193,900 common units under this program for net proceeds of $14 million that settled in July 2014.

Industry Overview

Our profitability is heavily influenced by the cost of crude oil and aggregate value of products we make from that crude oil and is affected by changes in economic conditions and supply and demand balance. Product values and crude oil prices are set by the market and are outside of our control. The following charts illustrate average benchmark refined product differentials relevant to our markets and comparison to pricing for West Texas Intermediate ("WTI") or Alaska North Slope ("ANS") crude oil.

Average Mid-Continent Benchmark Product Differentials to WTI ($/barrel)
[[Image Removed]]

Source: PLATTS


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Average U.S. West Coast Benchmark
Product Differentials to ANS ($/barrel)
[[Image Removed]]

Source: PLATTS

Average Mid-Continent benchmark gasoline margins and diesel fuel margins were down approximately 38% and 29%, respectively, in the second quarter of 2014 as compared to the second quarter of 2013. Average U.S. West Coast benchmark gasoline margins and diesel fuel margins were down approximately 1% and 2%, respectively, in the second quarter of 2014, as compared to second quarter of 2013.

The following chart illustrates average benchmark crude oil pricing relevant to our markets.

Average Crude Oil Prices ($/barrel)

[[Image Removed]]

Source: PLATTS

Our Mid-Continent and Pacific Northwest refineries have benefited from processing inland U.S. and Canada crude oil priced on the basis of WTI crude oil resulting in discounts compared to benchmark Brent crude oil ("Brent") processed at our coastal refineries. The WTI discount to Brent averaged over $6 per barrel during the second quarter of 2014, compared to approximately $9 per barrel during the second quarter of 2013.


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We supply our North Dakota refinery exclusively with Bakken crude oil, our Washington refinery primarily with Bakken and Canadian Light Sweet crude oil and our Utah refinery with light sweet crude oil from Wyoming and Colorado as well as Uinta Basin waxy crude oil. In the second quarter of 2014, the average discount of Bakken crude oil to WTI increased to about $6 per barrel, compared to an average discount of less than $2 per barrel in the second quarter of 2013. The average discount of Canadian Light Sweet crude oil to WTI increased to about $7 per barrel in the second quarter of 2014, compared to approximately $4 per barrel during the second quarter of 2013. Our California refineries run a significant amount of South American heavy ("Oriente") and San Joaquin Valley Heavy ("SJVH") crude oil and light crude oil from Iraq ("Basrah"), which continued to be priced at a discount to Brent during the second quarter of 2014.

Product Supply and Demand Factors

There are long-term factors, in addition to current market conditions, that may impact the supply and demand of refined products in the U.S. including:

world crude oil prices;

increased federal fuel efficiency standards for motor vehicles;

increased volumes of renewable fuels, mandated by the Energy Independence and Security Act;

various regulations of greenhouse gas emissions from stationary and mobile sources;

potential enactment of federal climate change legislation; and

possible promulgation of national regulations relative to gasoline composition and ozone standards.


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RESULTS OF OPERATIONS

A discussion and analysis of the factors contributing to our results of operations is presented below. The accompanying condensed consolidated financial statements, together with the following information, are intended to provide investors with a reasonable basis for assessing our historical operations, but should not serve as the only criteria for predicting our future performance.

As of December 31, 2013, we began reporting the logistics assets and operations of TLLP as a separate operating segment. In previous periods, when certain quantitative thresholds had not been met, TLLP's assets and operations were presented within our refining operating segment. TLLP's assets and operations include certain crude oil gathering assets and crude oil and refined products terminalling and transportation assets acquired from Tesoro and third parties. The historical results of operations of these assets have been retrospectively adjusted to conform to current presentation. These adjustments resulted in lower gross refining margins. The refining segment now includes costs for transportation and terminalling services provided by TLLP that were previously eliminated with consolidated reporting of TLLP revenues within our refining segment results.

On September 25, 2013, we completed the sale of all of our interest in Tesoro Hawaii, LLC (the "Hawaii Business"). We have reflected its results of operations as discontinued operations in our condensed consolidated statements of operations for all periods presented, and, unless otherwise noted, we have excluded the Hawaii Business from the financial and operational data presented in the tables and discussion that follow.

Our management uses a variety of financial and operating metrics to analyze operating segment performance. To supplement our financial information presented in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP"), our management uses additional metrics that are known as "non-GAAP" financial metrics in its evaluation of past performance and prospects for the future. These metrics are significant factors in assessing our operating results and profitability and include adjusted earnings before interest, income taxes, depreciation and amortization expenses ("Adjusted EBITDA"). We define Adjusted EBITDA as consolidated earnings, including earnings attributable to noncontrolling interest, excluding net earnings (loss) from discontinued operations, before depreciation and amortization expense, net interest and financing costs, income taxes and interest income.

We present Adjusted EBITDA because we believe some investors and analysts use Adjusted EBITDA to help analyze our cash flows including our ability to satisfy principal and interest obligations with respect to our indebtedness and use cash for other purposes, including capital expenditures. Adjusted EBITDA is also used by some investors and analysts to analyze and compare companies on the basis of operating performance and by management for internal analysis. Adjusted EBITDA should not be considered as an alternative to U.S. GAAP net earnings or net cash from operating activities. Adjusted EBITDA has important limitations as an analytical tool, because it excludes some items that affect net earnings and net cash from operating activities.


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Summary
                                                     Three Months Ended           Six Months Ended
                                                          June 30,                    June 30,
                                                     2014            2013         2014         2013
                                                       (In millions, except per share amounts)
REVENUES                                        $     11,104      $  8,897     $ 21,037     $ 16,244
COSTS AND EXPENSES:
Cost of sales                                          9,867         7,909       18,815       14,472
Operating expenses                                       598           441        1,189          809
Selling, general and administrative expenses              92            64          123          175
Depreciation and amortization expense                    135           111          265          216
(Gain) loss on asset disposals and impairments             2             8           (3 )         15
OPERATING INCOME                                         410           364          648          557
Interest and financing costs, net                        (41 )         (33 )       (118 )        (63 )
Other income, net                                          3            56            2           56
EARNINGS BEFORE INCOME TAXES                             372           387          532          550
Income tax expense                                       132           138          188          196
NET EARNINGS FROM CONTINUING OPERATIONS                  240           249          344          354
Loss from discontinued operations, net of tax              -           (11 )         (1 )        (12 )
NET EARNINGS                                             240           238          343          342
Less: Net earnings from continuing operations
attributable to
  noncontrolling interest                                 16            11           41           22
NET EARNINGS ATTRIBUTABLE TO TESORO CORPORATION $        224      $    227     $    302     $    320

NET EARNINGS (LOSS) ATTRIBUTABLE TO TESORO
   CORPORATION
Continuing operations                           $        224      $    238     $    303     $    332
Discontinued operations                                    -           (11 )         (1 )        (12 )
Total                                           $        224      $    227     $    302     $    320

NET EARNINGS (LOSS) PER SHARE - BASIC:
Continuing operations                           $       1.73      $   1.75     $   2.33     $   2.44
Discontinued operations                                    -         (0.08 )      (0.01 )      (0.09 )
Total                                           $       1.73      $   1.67     $   2.32     $   2.35
Weighted average common shares outstanding -
Basic                                                  129.3         135.8        130.3        136.4

NET EARNINGS (LOSS) PER SHARE - DILUTED:
Continuing operations                           $       1.70      $   1.72     $   2.29     $   2.39
Discontinued operations                                    -         (0.08 )      (0.01 )      (0.09 )
Total                                           $       1.70      $   1.64     $   2.28     $   2.30
Weighted average common shares outstanding -
Diluted                                                131.5         138.2        132.7        138.9


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                                             Three Months Ended                 Six Months Ended
                                                  June 30,                          June 30,
                                            2014             2013             2014             2013
                                                                (In millions)
Reconciliation of Net Earnings to
Adjusted EBITDA
Net earnings attributable to Tesoro
Corporation                            $       224       $       227     $       302       $      320
Net earnings attributable to
noncontrolling interest                         16                11              41               22
Loss from discontinued operations, net
of tax                                           -                11               1               12
Depreciation and amortization expense          135               111             265              216
Income tax expense                             132               138             188              196
Interest and financing costs, net               41                33             118               63
Interest income                                  -                 -               -               (1 )
Adjusted EBITDA (a)                    $       548       $       531     $       915       $      828

Reconciliation of Cash Flows from
(used in) Operating Activities to
Adjusted EBITDA
Net cash from (used in) operating
activities                             $       526       $      (408 )   $       376       $     (161 )
Net cash from discontinued operations            -               (91 )             -             (192 )
Debt redemption charges                          -                 -             (31 )              -
Deferred charges                                19               118              79              277
Changes in current assets and current
liabilities                                   (140 )             743             203              702
Income tax expense                             132               138             188              196
Stock-based compensation benefit
(expense)                                      (26 )               4              (8 )            (45 )
Interest and financing costs, net               41                33             118               63
Other                                           (4 )              (6 )           (10 )            (12 )
Adjusted EBITDA (a)                    $       548       $       531     $       915       $      828


________________


(a) For a definition of Adjusted EBITDA, see discussion above.

                                                      Six Months Ended June 30, 2014
Reconciliation of Net
Earnings to EBITDA               California       Enhanced Gross    Business Improvements
  Improvements                 Synergies (a)        Margin (b)               (c)                  Total
Net earnings                  $           63     $           42     $                 16     $         121
Add income tax expense                    37                 26                        9                72
Add depreciation and
amortization expense                       -                  7                        -                 7
EBITDA improvements           $          100     $           75     $                 25     $         200


________________


(a) Our objective to deliver California synergies includes projects and initiatives underway to optimize feedstock supply and product yields, capture operating cost advantages through integration of our southern California facilities and improve utilization of logistics assets acquired as part of the Los Angeles Acquisition (as defined on page 39).

(b) Our objective to enhance our gross margin represents our efforts to create significant value across our existing asset base including projects to capitalize on advantaged crude oil processing, such as the Utah Refinery Expansion project (as defined on page 52) and the expansion at our North Dakota refinery. Additionally, we expect to continue to enhance gross margins through further marketing integration, construction and acquisition of new logistics assets, and increased processing of advantage crude oil through our West Coast refineries upon completion of the Vancouver Energy terminal (as defined on page 53).

(c) Our business improvement initiatives include our efforts to improve processes at our refineries to increase reliability and lower manufacturing costs, improve our supply chain management to reduce costs, and enhance the sustainability of cost improvements through operational excellence management systems and lean six-sigma practices.


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Consolidated Results

Three Months Ended June 30, 2014 versus June 30, 2013

Our net earnings from continuing operations attributable to Tesoro Corporation were $224 million ($1.70 per diluted share) for the three months ended June 30, 2014 ("2014 Quarter") compared to $238 million ($1.72 per diluted share) for the three months ended June 30, 2013 ("2013 Quarter"). Our gross refining margin increased $153 million during the 2014 Quarter compared to the 2013 Quarter driven by higher refined products sales volumes resulting from the acquisition of BP's integrated Southern California refining, marketing and logistics business on June 1, 2013 from BP West Coast Products, LLC and other affiliated sellers (the "Los Angeles Acquisition") that also resulted in higher operating expenses during the 2014 Quarter. The increase in refined products sales volume was offset by a decrease of $1.40 in our gross refining margin per barrel caused by a lower margin environment. Our gross retail margin increased $64 million due to higher fuel sales volume resulting from stations acquired as part of the Los Angeles Acquisition and continued expansion of our retail network. TLLP increased operating income by $30 million due to higher throughput volumes driven by acquired assets and continued expansion of its crude oil gathering assets. Offsetting the increases to net earnings were a decrease to other income, net resulting from a settlement income of $54 million received in the 2013 Quarter that did not occur in the 2014 Quarter and an increase in stock-based compensation charges of $30 million during the 2014 Quarter compared to the 2013 Quarter.

Our selling, general and administrative expenses were $92 million in the 2014 Quarter compared to $64 million in the 2013 Quarter. The difference was primarily attributable to changes in stock-based compensation expense during the 2014 Quarter as compared to the 2013 Quarter, principally related to our stock appreciation rights that are adjusted based on the market price of the stock each period. The stock-based compensation impact on the 2014 Quarter results include an expense of $26 million as compared to the 2013 Quarter results, which included a benefit of $4 million. Our stock price per share increased from $50.59 to $58.67 during the 2014 Quarter compared to a decrease from $58.55 to $52.32 during the 2013 Quarter.

Interest and financing costs increased approximately $8 million to $41 million during the 2014 Quarter from $33 million in the 2013 Quarter. The increase was . . .

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