ITEM 3. LEGAL PROCEEDINGS
A refinery in Duncan, Oklahoma, formerly owned by Tosco, is subject to investigation by the Oklahoma Department of Environmental Quality ("ODEQ"). The ODEQ requested that Tosco participate with the former owner, Sun Company, Inc. (R&M) ("Sun"), from whom Tosco purchased the site, and the subsequent owners, including those to whom Tosco sold the site, in the investigation and potential remediation of alleged environmental contamination. On September 29, 1995, Tosco entered into a Consent Agreement and Final Order with ODEQ to investigate the extent of contamination at the refinery, conduct certain interim remedial actions, and prepare a remedial action plan. On April 10, 1995, Tosco filed a complaint for declaratory relief against Sun (TOSCO CORPORATION V. SUN COMPANY, INC. (R&M)), U.S. District Court, Western District of Oklahoma, Case No. Civ. 95 556M) to recover the costs of complying with the ODEQ order, and seeking an order determining Tosco's and Sun's rights and legal relations under various environmental laws, including the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), the Resource Conservation and Recovery Act ("RCRA") and the Oil Pollution Act ("OPA"), and under the Purchase Agreement through which Tosco purchased the Duncan Refinery, relating to the costs of environmental investigation and potential remediation at the site. The complaint was subsequently amended to name Koch Industries, Inc. ("Koch"), another former owner, as another defendant. On February 14, 1996, Tosco obtained default judgments against some of the current owners of the refinery. In January 1998, Tosco entered into a Settlement Agreement with Sun, pursuant to which Sun agreed to pay $7 million in exchange for a release from liability with respect to the site. In early 1998, a trial was held on Tosco's claim against Koch. The court ruled in Tosco's favor that Koch was responsible for effectively 15% of past and future investigation and remediation costs at the site. On May 4, 1998, Koch filed a Notice of Appeal to the 10th Circuit Court of Appeals seeking review of the trial court decision.
Circle K entered into Consent Orders with the Arizona Department of Environmental Quality on September 20, 1994, and September 23, 1994, for sites in Springerville and Phoenix, Arizona, respectively. The sites had releases of petroleum products from USTs or lines. Tosco is subject to these Orders as a result of its 1996 acquisition of the Circle K Corporation. Remediation on the sites is ongoing. Expenses for the remediation are eligible for reimbursement under the Arizona UST Trust Fund.
In a case filed in 1996 by private litigants against all major petroleum refiners, distributors, and retailers in California, including Tosco, alleging that the defendants restrained trade and restricted the supply of a certain type of cleaner burning gasoline sold in California, AGUILAR, ET AL. V. ATLANTIC RICHFIELD CORPORATION, ET AL. (Superior Court of California, County of San Diego, Case No. 00700810), the court granted the Defendants' Motions for Summary Judgment in October 1997; however, on January 29, 1998, the court reversed itself and ordered a new trial. This ruling is pending on appeal. On January 28, 1998, a plaintiff allegedly representing a class of all wholesale purchasers of gasoline in the State of California sued nine petroleum refineries, including Tosco, making essentially the same allegations as those made in the Aguilar case, GILLEY V. ATLANTIC RICHFIELD CORP., ET AL., (U.S. District Court, Southern District of California, Case No. 93-CVU132BTM). The court has stayed all proceedings in this matter pending the decision of the Court of Appeals in the AGUILAR case.
On October 22, 1998, a complaint was filed by a private litigant, purportedly on behalf of a class of all direct or indirect purchasers of California diesel fuel between March 19, 1996 and December 31, 1997, against all California refiners of California diesel fuel (CAL-TEX CITRUS JUICE, ET AL. V. ATLANTIC RICHFIELD COMPANY, ET AL. Superior Court of California, County of Sacramento, Case No. 98AS05227). The complaint alleges violations of various state statutes by the defendants' alleged conspiracy to fix prices of California diesel fuel. Tosco has filed an Answer.
In October 1998, a complaint was filed against gasoline refiners and wholesalers in Hawaii, including Tosco, by the State of Hawaii alleging that defendants fixed the price of gasoline and allocated market share and seeking damages and injunctive relief (BRONSTER V. CHEVRON CORPORATION, ET AL., U.S. District Court, District of Hawaii, Case No. CV9800792SPK). Tosco has filed a Motion to Dismiss.
In three cases, complaints were filed by private litigants and a water company against numerous defendants, including Tosco, alleging violation of state law in the production and sale of gasoline which included an additive, methyl tertiary butyl ether, (KUBAS, ET AL. V. UNOCAL CORPORATION, ET AL., Superior Court of California, County of Los Angeles, Case No. BC191876, COMMUNITIES FOR A BETTER ENVIRONMENT V. UNOCAL CORPORATION, ET AL., Superior Court of California, County of San Francisco, Case No. 997013, SOUTH TAHOE PUBLIC UTILITY DISTRICT V. ATLANTIC RICHFIELD COMPANY, ET AL., U.S. District Court, District of Delaware, Civil Action No. 98-336). It is alleged that the additive contaminated water supplies. Tosco has filed Answers in all cases.
The California Air Resource Board (CARB) has issued a Report of Violation to Tosco alleging that Tosco supplied two service stations for two days with gasoline which did not meet California specifications (ROV-3-2). Tosco has reached a settlement in principle with CARB on this matter and other unrelated matters for a total of $200,000.
The costs of remedial actions are highly uncertain due to, among other items, the complexity and evolving nature of governmental laws and regulations and their interpretations as well as the varying costs and effectiveness of alternative cleanup technologies. However, Tosco presently believes that any cost in excess of the amounts already provided for in the financial statements should not have a materially adverse effect upon Tosco's operations or financial condition. Tosco further believes that a portion of future environmental costs, as well as environmental expenditures previously made, will be recovered from other responsible parties under contractual agreements and existing laws and regulations. See Notes 11 and 18 to the Consolidated Financial Statements.
There are various other suits and claims pending against Tosco and its subsidiaries, which in the opinion of Tosco are not material or meritorious or are substantially covered by insurance. While it is impossible to estimate with certainty the ultimate legal and financial liability with respect to these suits and claims, Tosco believes the aggregate amount of such liabilities will not result in monetary damages that in the aggregate would be material to the business or operations of Tosco.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
EXECUTIVE OFFICERS OF THE REGISTRANT
Served as Principal Occupation Name Age an Officer Since and Positions Held
Thomas D. O'Malley 57 1989 Chairman of the Board and Chief Executive Officer of Tosco since January 1990; President of Tosco from May 1993 to May 1997 and from October 1989 to May 1, 1990.
Jefferson F. Allen 53 1990 President of Tosco since May 1997 and Chief Financial Officer since June 1990; Executive Vice President from June 1990 to May 1997; Treasurer of Tosco from June 1990 to October 1995; various positions, including Chairman and CEO, with Comfed Bancorp, Inc. and related entities from November 1988 to June 1990.
Robert J. Lavinia 52 1993 Executive Vice President of Tosco and President of Tosco Marketing Company (a division of Tosco) since February 1996; Senior Vice President of Tosco from May 1994 to February 1996; Vice President of Tosco from 1993 to May 1994; President, Tosco Energy Corporation during 1992; prior to 1992, various positions with Phibro Energy for a period in excess of five years.
Dwight L. Wiggins 58 1993 Executive Vice President of Tosco and President of Tosco Refining Company (a division of Tosco) since February 1996; Senior Vice President of Tosco from May 1994 to February 1996; Vice President of Tosco from January 1993 to May 1994; President of Bayway Refining Company since January 1993; New Jersey Area Manager for Exxon Company U.S.A. 1990 to 1993.
Wilkes McClave III 51 1989 Senior Vice President of Tosco since May 1996 and General Counsel of Tosco since May 1990; Vice President of Tosco from May 1990 to May 1996; Secretary of Tosco since August 1989; Assistant General Counsel of Tosco from January 1986 to May 1990.
Peter A. Sutton 53 1992 Senior Vice President of Tosco since August 1998; Vice President of Tosco from January 1992 to August 1998; Senior Vice President of Tosco Refining Company since May 1990; various other positions with Tosco for a period in excess of five years.
Duane B. Bordvick 53 1997 Vice President of Tosco for environmental and external affairs since February 1997; Vice President of Tosco Refining Company for a period in excess of five years.
Craig R. Deasy 54 1986 Vice President and Treasurer of Tosco since October 1995; Vice President and Treasurer of Bayway Refining Company since April 1993; various other positions with Tosco for a period in excess of five years.
Ann Farner Miller 47 1996 Vice President of Tosco for governmental relations since May 1996; director of governmental relations of Tosco Refining Company for a period in excess of five years.
Richard W. Reinken 42 1994 Vice President and Chief Information Officer of Tosco since November 1994; Senior Vice President of Tosco Marketing Company since June 1996; Consultant, Andersen Consulting from 1985 to 1994.
Robert I. Santo 55 1992 Vice President of Tosco since January 1998; Chief Accounting Officer of Tosco since January 1992; various other positions with Tosco for a period in excess of five years.
Wanda Williams 52 1996 Vice President of Tosco for human resources since May 1996; Vice President of Tosco Marketing Company since May 1996; Vice President of Circle K for human resources from June 1993 to May 1996; various other positions with Circle K from July 1992 to May 1996; various human resources positions in the oil industry and convenience store industry from 1971 to 1992.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Tosco's Common Stock is traded on the New York Stock Exchange ("NYSE") and the Pacific Stock Exchange. Set forth below are the high and low sales prices as reported on the NYSE Composite Tape. All share and per-share data have been adjusted to reflect the 3-for-1 stock split distributed on February 25, 1997 to shareholders of record on February 13, 1997 and have been rounded to the nearest sixteenth.
The number of Tosco shareholders of record on March 1, 1999 was 9,109.
DIVIDEND POLICY
Tosco has paid a regular quarterly cash dividend on its Common Stock since the third quarter of 1989. Pursuant to the terms of Tosco's Revolving Credit Facility and its bond indentures, dividends on Tosco's Common Stock are permitted to the extent Tosco satisfies certain defined criteria. Continued payment of such quarterly dividend is also subject to profitable results of operations, which are primarily dependent on the continued favorable performance of Tosco's operating facilities and favorable operating margins. There can be no assurance that Tosco will be able to continue payment of such quarterly dividend.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The following Selected Financial Data are qualified in their entirety by the more detailed Consolidated Financial Statements and related Notes at the end of this report. The Selected Financial Data for each of the five years ended December 31, 1998, are derived from the Consolidated Financial Statements of Tosco audited by PricewaterhouseCoopers LLP, independent accountants.
TOSCO CORPORATION AND SUBSIDIARIES SELECTED FINANCIAL DATA (Thousands of Dollars, Except Per Share and Ratio Data)
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
The business environment in 1998 was difficult. While income from operations (before special items) increased over 1997, it fell short of expectations due primarily to poor refining margins. Special items for 1998 were a pre-tax $240 million write-down to reduce the value of LIFO inventories to market, and a $40 million restructuring charge primarily related to the San Francisco Area Refining System. Tosco's marketing division continued to operate well in highly competitive markets. Significant progress was made in integrating the acquired Unocal operations. In February 1999, Standard & Poor's raised Tosco's corporate credit and senior unsecured debt ratings.
On February 23, 1999, a fire occurred at a crude unit at the San Francisco Area Refinery, Avon facility. The fire was quickly isolated and extinguished with no offsite impacts or health risks to the community. On March 2, 1999, Tosco announced that the Avon Refinery would be shutdown for at least 30 days, while a thorough safety review is conducted.
RESULTS OF OPERATIONS
1998 COMPARED TO 1997
Tosco earned net income of $106 million ($0.67 per share) in 1998 compared to $213 million ($1.37 per share) in 1997. Results of operations for 1998 include a $240 million ($140 million after tax, $0.88 per share) non-cash inventory writedown and a $40 million ($23 million after tax, $0.15 per share) restructuring charge. Results of operations for 1997 include a $53 million ($31 million after tax, $0.19 per share) non-cash inventory writedown. Sales in 1998 were $12.022 billion compared to $13.282 billion in 1997. This decrease of $1.260 billion was attributable to lower product prices partially offset by higher refinery throughput and retail fuel sales volumes. The higher throughput and sales volumes resulted from the 76 Products Acquisition (twelve months in 1998 versus nine months in 1997) and the full year operation of the previously shutdown Trainer Refinery, which was reopened on May 8, 1997.
Operating contribution, as restated to exclude depreciation and amortization, of $1.216 billion for 1998 increased by $48 million over 1997. The increase was from refining ($54 million) partially offset by a decrease from marketing ($6 million).
Refining operating contribution for 1998 increased by $54 million to $682 million due primarily to increased throughput (944,800 barrels per day ("B/D") in 1998 compared to 793,400 B/D in 1997) partially offset by lower operating margin per charge barrel ($4.61 in 1998 compared to $4.89 in 1997). The increase in throughput volumes was primarily due to the acquisition of the 76 Product refineries and the start-up of the Trainer Refinery, and to a lesser degree to increases at the Avon and Bayway refineries, both of which experienced no unscheduled shutdowns in 1998. The decrease in operating margin per charge barrel was primarily due to lower product prices experienced throughout 1998. Refining operating contribution includes insurance recoveries related to the unscheduled shutdowns in 1997 of the Bayway Refinery cat cracker and Avon Refinery hydrocracker.
Marketing operating contribution for 1998 was $534 million compared to $540 million in 1997. The decrease of $6 million was due to lower blended fuel margins (12.1 cents per gallon in 1998 versus 12.8 in 1997) partially offset by higher fuel sales volumes from the 76 Products Acquisition and higher merchandise sales volumes and profit margins.
Tosco recorded a $240 million charge for the write-down of raw material and product inventories to their fair value at December 31, 1998. The inventory writedown was the result of the steep market decline in crude oil and product prices in 1998 lowering the value of inventories acquired in connection with Tosco's acquisitions since 1993. During 1997, Tosco recorded a $53 million inventory write-down also as a result of declining prices.
During 1998, Tosco recorded a $40 million charge primarily related to the restructuring of its San Francisco Area Refinery System. The restructuring will result in an increase in the production of clean burning CARB Phase 2 gasoline and is being made to improve efficiency, reliability, and profitability of the system, without compromising safety or environmental compliance. The key component of the restructuring plan revolves around the continued integration of the Avon Refinery and the Rodeo-Santa Maria complex acquired in 1997. The improved operation will involve the shutdown of several of the less efficient processing units at the Avon Refinery with resulting staff reductions. At December 31, 1998, the $40 million charge includes the write-down, shutdown, and dismantling costs of certain processing units and facilities that will no longer be used, contract termination costs, and employee severance. See Notes 8 and 21 to the Consolidated Financial Statements.
Selling, general, and administrative ("SG&A") expenses for 1998 include the recognition of a $10 million gain on the sale of the Revere distribution terminal in Massachusetts, and approximately $3 million of non-recurring costs related to the consolidation of Tosco's offices. SG&A expenses for 1997 include non-recurring transition expenses of $18 million related to the integration of the 76 Products assets into Tosco's operations. Excluding these 1998 and 1997 non-recurring items, SG&A expenses increased by $29 million in 1998, due primarily to the 76 Products Acquisition.
Net interest expense, as restated, for 1998 was $12 million less than 1997 due to lower levels of borrowings and interest rates under the Revolving Credit Facility.
Income taxes, including the benefit associated with the distributions on company-obligated, mandatorily redeemable, convertible preferred securities ("Trust Preferred Securities"), were $75 million for 1998 compared to $151 million in 1997. The decrease was due to lower taxable income in 1998.
1997 COMPARED TO 1996
Tosco earned net income of $213 million ($1.37 per share) in 1997 compared to $146 million ($1.16 per share) in 1996. Results of operations for 1997 include a $53 million ($31 million after tax, $0.19 per share) non-cash inventory writedown as a result of higher levels of inventories from the 76 Products Acquisition and the start-up of the Trainer Refinery combined with declining raw material and product prices in late 1997. Results of operations for 1996 include a pre-tax charge of $13 million ($8 million after-tax, $0.06 per share) for the consolidation of the retail marketing division following the acquisition of Circle K.
Operating contribution (sales less cost of sales) was $1.168 billion in 1997 compared to $0.726 billion in 1996, an increase of $442 million: $155 million for refining and $287 million for marketing. Operating contribution for 1997 and 1996 have been restated to exclude depreciation and amortization previously included in cost of sales.
Refining operating contribution for 1997 increased by $155 million to $628 million due primarily to increased throughput (793,400 barrels per day ("B/D") in 1997 compared to 535,000 B/D in 1996). This increase was due to the acquisition of the 76 Product refineries and the start-up of the Trainer Refinery, partially offset by reduced throughput at the Avon Refinery during the 1997 first and second quarters and an unscheduled shutdown of the Bayway Refinery cat cracker in the 1997 first quarter. Lower throughput at the Avon Refinery was due to the scheduled turnaround of the coker unit and the unscheduled hydrocracker shutdown. The 1997 refining operating margin per charge barrel, which fluctuated significantly during the year, averaged $4.89, consistent with the 1996 average. Refinery operating contribution for 1997 includes insurance recovery accruals related to the Avon hydrocracker and the Bayway cat cracker.
Marketing operating contribution for 1997 increased by $287 million to $540 million primarily due to the 76 Products and Circle K Acquisitions and higher blended fuel margins. The volume of fuel sales approximately doubled to 4.16 billion gallons and the blended fuel margin increased by 1.2 cents per gallon, despite a higher proportion of dealer/jobber sales resulting from the 76 Products Acquisition. Fuel margins at dealer/jobber sites are typically lower than company-operated sites. The increase in blended fuel margins occurred in the fourth quarter due to declining wholesale product prices without a corresponding decline in retail prices. The retail operating contribution also increased in 1997 due to increased merchandise sales ($2.003 billion in 1997 compared to $1.173 billion in 1996) with reasonably consistent margins.
Depreciation and amortization for 1997 was $304 million, a $119 million increase compared to the 1996 balance of $185 million. This increase was primarily due to the 76 Products Acquisition and the Trainer Refinery reopening.
SG&A expenses were $296 million in 1997 compared to $196 million in 1996. The increase of $100 million was primarily attributable to the 76 Products and Circle K Acquisitions, including nonrecurring transition expenses of $18 million related to the integration of 76 Products into Tosco's operations. Incentive compensation also increased in 1997 due to higher levels of operating income.
Net interest expense for 1997 increased by $51 million compared to 1996. This increase is primarily due to higher debt levels incurred to finance Tosco's expanded operations and acquisitions.
Income taxes, including the benefit associated with the distributions on Trust Preferred Securities, were $151 million for 1997 compared to $101 million in 1996. The increase was due to higher taxable income in 1997. The effective income tax rate also reflects the effect of the nondeductibility of amortization of certain intangible assets acquired in the Circle K Acquisition.
OUTLOOK
Results of operations are primarily determined by the operating efficiency of the refineries and by refining and retail fuel margins. On February 23, 1999, a fire occurred at a crude unit at Tosco's Avon Refinery and resulted in four fatalities. On March 2, 1999, Tosco announced that the Avon Refinery will be shutdown for at least 30 days while a thorough safety review is conducted. The refinery, including the crude unit, which was not severely damaged, will be brought back up only when safety issues and concerns have been addressed. The negative impact on the 1999 first and second quarter results can not currently be estimated, given the uncertainty of the shut down period. Tosco also accelerated the start of the previously scheduled third quarter 1999 turnaround of its Fluid Catalytic Cracking Unit at the Bayway Refinery. The turnaround should be completed in April 1999. Except for the Avon Refinery, whose date of return to service is uncertain, Tosco expects, given reasonable margins, to operate its refineries at high levels through the balance of 1999. Refining margins in early 1999 were weak, especially on the East Coast. Retail fuel margins in 1999 were satisfactory through February but have deteriorated in March. While refining margins may improve during the balance of 1999, Tosco is not able to predict the level or timing of operating margins for the year because of the uncertainties associated with oil markets. In view of uncertain operating margins and highly competitive markets, Tosco is committed to improving its results by lowering costs in all areas of operation without compromising safety, reliability, or environmental compliance.
In February 1999, Tosco signed a memorandum of understanding to create a 50/50 joint venture with Union Carbide Corporation ("Union Carbide") for the marketing of polypropylene. A 775 million pounds per year polypropylene plant is planned to be constructed at the Bayway Refinery over the next two years. When completed, the joint venture is expected to be one of the top five suppliers of polypropylene in North America. The production from this new plant and Union Carbide's plants in Seadrift, Texas and Norco, Louisiana, estimated to be 1.6 billion pounds per year, will be committed to the joint venture and marketed by Union Carbide. Completion of the joint venture is subject to execution of definitive documents and satisfactory compliance with various conditions.
Effective January 1, 1999, Tosco will prospectively extend the useful lives of certain refinery and distribution assets in order to better represent the remaining useful lives of the assets, as determined by a third party appraisal. Management estimates that this change in accounting estimate will decrease 1999 depreciation and amortization by approximately $35 million.
Through March 15, 1999, Tosco closed sales for 200 convenience stores for $60 million, plus the cost of inventories. Additionally, Tosco expects to divest approximately 185 additional convenience stores during the balance of 1999. These stores are located in areas of the United States in which Tosco does not have a significant market share. The sale of these convenience stores is not expected to impact 1999 results of operations.
Crude oil and finished product prices have significantly fluctuated in recent years and Tosco believes this pattern will continue throughout 1999. Tosco estimates that a $1.00 per barrel change in raw materials and finished products will have an approximate $50 million impact on its net realizable value reserve of $293 million at December 31, 1998. However, because raw material and finished product prices do not move in unison, the impact on the reserve will vary depending on actual price changes and the mix and level of inventories.
Tosco continues to review acquisition opportunities. However, future acquisitions will occur only at reasonable prices, which are based on realistic earnings in a normalized refining and marketing environment as determined by management.
CASH FLOWS
As summarized in the Consolidated Statement of Cash Flows, cash and cash equivalents decreased by $3 million during 1998. Cash used in investing activities of $485 million and financing activities of $190 million exceeded cash provided by operating activities of $672 million.
Net cash provided by operating activities of $672 million was from cash earnings (net income plus depreciation and amortization, and other non-cash charges and provisions) of $836 million, less net increases in operating assets and liabilities (primarily working capital) and other items of ($151) million and ($13) million, respectively.
Net cash used in investing activities totaled $485 million due to net capital additions of $393 million and spending for turnarounds of $95 million less reduction of other long-term assets of ($3) million.
Net cash used in financing activities totaled $190 million due to scheduled and early principal payments on long-term debt of $79 million, Common Stock repurchases of $101 million, dividend payments of $37 million, and other uses of $3 million which exceeded net borrowings under the revolving credit facility of ($30) million.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity (as measured by cash, cash equivalents, marketable securities, deposits, and availability under the Revolving Credit Facility) was $855 million at December 31, 1998, which is equal to the December 31, 1997 amount. An increase in marketable securities and deposits of $6 million was offset by decreases in cash and cash equivalents of $3 million and availability under the Revolving Credit Facility of $3 million.
At December 31, 1998, total shareholders' equity was $1.913 billion, a $31 million decrease from December 31, 1997. This decrease was due to the Common Stock repurchases of $101 million and dividend payments of $37 million exceeding net income of $106 million and other items of $1 million. Debt, including current maturities and the Revolving Credit Facility, decreased by $37 million to $1.556 billion at December 31, 1998. This decrease was due to scheduled and early payments during 1998 partially offset by a $30 million increase in cash borrowings under the Revolving Credit Facility. The ratio of debt (Revolving Credit Facility and non-current portion of long-term debt) to total capitalization (Revolving Credit Facility, non-current portion of long-term debt, Trust Preferred Securities, and Shareholders' Equity) was 41% at December 31, 1998, consistent with the December 31, 1997 ratio.
During 1998, Tosco adopted a Shareholders Rights Plan. Under the terms of the Shareholders Rights Plan, shareholders received rights to purchase shares of a new preferred stock. The rights expire on December 6, 2008 and are exercisable only if a person or group acquires beneficial ownership of 15% or more of Common Stock, a person commenced a tender or exchange offer for more than 15% of Common Stock, or if an adverse person (as defined by the Company's Board of Directors) acquires beneficial ownership of 10% or more of Common Stock.
In January 1997, Tosco filed a shelf registration statement providing for the issuance of up to $1.5 billion aggregate principal amount of debt and equity securities. Such securities may be offered, separately or together, in amounts and at prices and terms to be set forth in one or more supplements to the shelf registration statement. At December 31, 1998, Tosco may issue up to $779 million of securities pursuant to this shelf registration statement.
In order to reduce financing costs, Tosco elected to not renew its $100 million Facility B under the Revolving Credit Facility which expired on January 12, 1999. The $900 million Facility A under the Revolving Credit Facility continues until January 14, 2002. See Note 9 to the Consolidated Financial Statements. In February 1999, Standard & Poor's raised Tosco's corporate credit and senior unsecured debt rating to "triple-B" from "triple-B-minus." The upgrade reflects the significant progress Tosco has made in integrating its acquisitions into its operations and the announced joint venture with Union Carbide for the marketing of polypropylene.
The Revolving Credit Facility, as well as funds potentially available from the issuance of securities, provides Tosco with adequate resources to meet its expected liquidity demands for at least the next twelve months.
CAPITAL EXPENDITURES
During 1998, Tosco spent $554 million on budgeted capital and turnaround projects. Refining capital spending totaled $337 million: $242 million for property, plant, and equipment and $95 million for turnarounds. The property, plant, and equipment spending consisted primarily of supporting business growth, improving safety and reliability of operations, and environmental compliance. Retail capital spending of $217 million was primarily focused on enhancing existing sites, integrating operations, and completion of underground storage tank upgrades and replacements.
During January 1998, Tosco completed the purchase of approximately 200 convenience stores by paying off the outstanding balance on a real estate installment purchase note, including the settlement of contingent payments, for $65 million. See Note 10 to the Consolidated Financial Statements.
Tosco expects to fund its 1999 refinery and retail capital expenditures from cash provided by operations, available credit, and other resources. Refinery capital spending during 1999 will continue to consist primarily of supporting business growth, improving safety and reliability of operations, and environmental compliance. The polypropylene plant is expected to be constructed and financed by a special purpose entity that will lease the plant to Tosco under a long-term operating lease upon completion. Capital spending for retail operations in 1999 will be primarily focused on enhancing existing retail sites.
RISK MANAGEMENT
Tosco uses a variety of strategies to reduce commodity price, interest, and operational risks. Tosco, at times and when able, uses futures and forward contracts to lock in what it believes to be favorable margins on a varying portion of refinery production by taking offsetting long (obligation to buy at a fixed price) positions in crude oil and short (obligation to deliver at a fixed price) positions in gasoline and heating oil. This strategy hedges Tosco's exposure to fluctuations in refining margins and therefore tends to reduce the volatility of operating results. In addition, Tosco enters into swap contracts with counterparties to hedge sales prices of residual fuels production. Futures and forward contracts are also used to a lesser extent to hedge inventories stored for future sale and to hedge against adverse price movements between the cost of domestic and foreign crude oil.
Tosco uses a value-at-risk ("VAR") model to assess the market risk of its derivative instruments. VAR represents the potential losses for an instrument or portfolio from adverse changes in market factors, for a specified time period and confidence level. Tosco estimates VAR across its derivative instruments using a model with historical volatilities and correlations calculated using a one-day interval. Tosco's measured VAR, using a VAR model with a 95% confidence level and assuming normal market conditions at December 31, 1998, was not material.
Tosco's calculated VAR exposure represents an estimate of reasonably possible net losses assuming hypothetical movements in future market rates and is not necessarily indicative of actual results that may occur. The calculated VAR does not represent the maximum possible loss nor any expected loss that may occur, since actual future gains and losses will differ from those estimated, based upon actual fluctuations in market rates, operating exposures, and the timing thereof, and changes in Tosco's holdings of derivative instruments during the year.
Tosco manages its interest rate risk by maintaining a mix of fixed rate and floating rate debt. Floating rate debt, primarily borrowings under the Revolving Credit Facility that currently provides up to $900 million of uncollateralized revolving credit availability, is used to finance Tosco's working capital requirements. Tosco elected not to renew its $100 million Facility B under the Revolving Credit Facility when it expired on January 12, 1999. Fixed rate debt consists of $600 million of notes and debentures issued in connection with the 76 Products Acquisition, $125 million uncollateralized noncallable notes issued in July 1995 to repay indebtedness under the previously outstanding Collateralized Revolving Credit Facility, $350 million of mortgage bonds issued in 1992 and 1993 to refinance previously outstanding floating rate bank debt and to finance the acquisition of capital assets including the acquisition of the Bayway Refinery, and $240 million uncollateralized noncallable notes issued in May 1996 to finance a portion of the Circle K purchase price.
Tosco carries insurance policies on insurable risks, which it believes to be appropriate at commercially reasonable rates. While Tosco believes that it is adequately insured, future losses could exceed insurance policy limits or, under adverse interpretations, be excluded from coverage. Future costs, if any, incurred under such circumstances would have to be paid out of general corporate funds, if available. See Note 4 to the Consolidated Financial Statements for a discussion of Tosco's strategy to reduce credit risk.
IMPACT OF INFLATION
The impact of inflation has been less significant during the recent years because of the relatively low rates experienced in the United States. Indeed, raw material and petroleum product prices have declined during the last two years. The deflation in raw material and product prices resulted in write-downs of Tosco's inventories and reduced profitability during significant periods over the last two years, when product prices fell faster than raw material costs. The historically low prices for crude oil and products, and low inflation rates generally, are presently forecasted to continue through 1999. Accordingly, Tosco does not expect that inflation will have a significant impact on its 1999 operating results. However, as raw material, energy, and labor are important components of Tosco's costs, inflationary increases could have adverse effects on profitability, especially during high inflation periods when raw material and energy cost increases generally lead finished product prices.
IMPACT OF THE YEAR 2000 ISSUE
Historically, certain computer programs have used two rather than four digits to define a given calendar year. Computer programs that use two digits to define the year may recognize a date using "00" as the year 1900 rather than 2000. This could result in business and field system failures or miscalculations that could cause serious disruptions of operations. This is generally referred to as the "Year 2000 Issue." For several years, Tosco has been proactively upgrading and replacing its information systems. During early 1998, Tosco formed a Year 2000 Program Office to specifically coordinate the efforts of Tosco's operating units and administrative departments. Three primary areas related to the Year 2000 Issue are being addressed: business systems, field systems, and third parties. Each of these areas is being addressed in five overlapping phases: (i) identifying and assessing critical systems, equipment, and business relationships requiring modification or replacement prior to 2000; (ii) formulating compliance action plans; (iii) upgrading, replacing, and/or remediating noncompliant systems and equipment; (iv) testing; and (v) contingency and business continuation planning.
BUSINESS SYSTEMS: These include computer systems and applications relating to financial reporting, human resources, purchasing, commercial, supply, pricing, and marketing activities. Tosco has completed the assessment and planning phases related to its critical business systems and substantially completed these phases for its other business systems. Tosco is currently addressing its Year 2000 issues, primarily through software upgrades and replacements, and remediation of existing systems. Business system testing is also being done on an ongoing and prioritized basis. We believe these systems will be substantially Year 2000 ready by June 30, 1999.
FIELD SYSTEMS: These include embedded computer chips and computer systems relating to Tosco's refining, distribution, and marketing operating assets. Tosco has completed an assessment of the Year 2000 compliance status of substantially all of its field systems and is currently developing and implementing plans related to the replacement and remediation of noncompliant systems. Tosco expects these plans to be substantially implemented by September 30, 1999. The balance of field system replacements and remediation are expected to be performed during scheduled turnarounds of refinery processing units in the fourth quarter. Field system remediation progress is dependent upon the timely delivery of Year 2000 compliant third party software and devices. Internal and vendor assisted testing is being done on an ongoing basis as the systems are replaced or remediated.
THIRD PARTY RELATIONSHIPS: These include Tosco's critical suppliers, vendors, customers, financial institutions, utilities, telecommunication providers, governmental entities, and others with whom Tosco does significant business (collectively "third parties"). Tosco has initiated two-way communications with third parties about their plans and progress in addressing the Year 2000 Issue. Tosco will continue to communicate with and monitor the progress its third parties are making in addressing their Year 2000 Issues. Tosco's ability to accurately assess its third parties' Year 2000 readiness is dependent in large part upon the completeness and reliability of the third parties' representations.
CONTINGENCY PLANS: Tosco has formed a Year 2000 Contingency Task Force (the "Task Force") which includes representatives from all business segments and other functional responsibilities. The Task Force is currently evaluating various business disruption scenarios. As business disruption scenarios are identified, the Task Force will evaluate existing contingency plans, formulate new contingency plans as appropriate, and develop preemptive strategies. Additionally, Tosco will formulate contingency plans based on the progress its third parties are making in addressing their Year 2000 Issues. By June 30, 1999, the Task Force will organize management response teams and formalize these Year 2000 plans and strategies in conjunction with Tosco's existing contingency plans for equipment failures, emergencies, and other business disruptions. Throughout the balance of 1999, the Year 2000 contingency plans and strategies will be modified as facts and circumstances change.
COSTS: Tosco's Year 2000 compliance costs include external consultants and contractors, compensation costs of internal employees working directly on Year 2000 Issues, purchases of software and hardware, and system upgrades and modifications which were accelerated to address the Year 2000 Issue. Year 2000 compliance costs did not have a material effect on Tosco's 1998 operating results or financial position. Year 2000 compliance costs are not expected to have a material effect on Tosco's 1999 operating results or financial position.
RISKS: Tosco believes its business and field systems will be substantially Year 2000 compliant prior to September 30, 1999. Tosco further believes that its critical third party vendors and suppliers are making good progress on their own Year 2000 remediation efforts. In the event that Tosco is unable to make the necessary system changes on a timely basis, fails to identify all critical Year 2000 Issues, or is unable to implement appropriate contingency plans, such inability could cause significant business disruptions. Additionally, Tosco could incur significant business disruptions if one or more of its critical third parties (over whom Tosco does not have control) are not Year 2000 compliant by December 31, 1999. Business disruptions such as production and/or distribution shutdowns, out-of-stock conditions, communication and/or energy outages, or billing and/or collecting problems could negatively effect Tosco's results of operations.
The foregoing Year 2000 disclosure is based on Tosco's current expectations, estimates, and projections, which could ultimately prove to be inaccurate. Because of uncertainties, the actual effect of the Year 2000 Issue on Tosco may be different from our current assessment.
NEW ACCOUNTING STANDARD
During June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. The Company plans to adopt SFAS No. 133 on January 1, 2000. Tosco is currently evaluating the effect SFAS No. 133 will have on its financial position and results of operations.
FORWARD LOOKING STATEMENTS
TOSCO HAS MADE, AND MAY CONTINUE TO MAKE, VARIOUS FORWARD-LOOKING STATEMENTS WITH RESPECT TO ITS FINANCIAL POSITION, BUSINESS STRATEGY, PROJECTED COSTS, PROJECTED SAVINGS, AND PLANS AND OBJECTIVES OF MANAGEMENT. SUCH FORWARD-LOOKING STATEMENTS ARE IDENTIFIED BY THE USE OF FORWARD-LOOKING WORDS OR PHRASES SUCH AS "ANTICIPATES," "INTENDS," "EXPECTS," "PLANS," "BELIEVES," "ESTIMATES," OR WORDS OR PHRASES OF SIMILAR IMPORT. THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO NUMEROUS ASSUMPTIONS, RISKS, AND UNCERTAINTIES, AND THE STATEMENTS LOOKING FORWARD BEYOND 1999 ARE SUBJECT TO GREATER UNCERTAINTY BECAUSE OF THE INCREASED LIKELIHOOD OF CHANGES IN UNDERLYING FACTORS AND ASSUMPTIONS. ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED BY THE FORWARD-LOOKING STATEMENTS.
IN ADDITION TO FACTORS PREVIOUSLY DISCLOSED BY TOSCO AND FACTORS IDENTIFIED ELSEWHERE HEREIN, CERTAIN OTHER FACTORS COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM SUCH FORWARD-LOOKING STATEMENTS. ALL SUBSEQUENT WRITTEN AND ORAL FORWARD-LOOKING STATEMENTS ATTRIBUTABLE TO TOSCO, OR PERSONS ACTING ON BEHALF OF TOSCO, ARE EXPRESSLY QUALIFIED IN THEIR ENTIRETY BY REFERENCE TO SUCH FACTORS.
TOSCO'S FORWARD-LOOKING STATEMENTS REPRESENT ITS JUDGMENT ONLY ON THE DATES SUCH STATEMENTS ARE MADE. BY MAKING ANY FORWARD-LOOKING STATEMENTS, TOSCO ASSUMES NO DUTY TO UPDATE THEM TO REFLECT NEW, CHANGED, OR UNANTICIPATED EVENTS OR CIRCUMSTANCES.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by Part II, Item 8, are included in Part IV, as indexed at Item 14(a) and (a)(2).
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
There is hereby incorporated by reference the information appearing under the caption "Nominees for Election" in Tosco's definitive Proxy Statement relating to its 1999 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission. See also the information appearing under the caption "Executive Officers of the Registrant" in Part I.
Tosco is not aware of any family relationship between any Director or executive officer. Each officer is generally elected to hold office until the next Annual Meeting of the Board of Directors.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
There is hereby incorporated by reference the information appearing under the caption "Executive Compensation" in Tosco's definitive Proxy Statement relating to its 1999 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
There is hereby incorporated by reference the information appearing under the caption "Stock Ownership of Officers and Directors" and "Other Matters - Certain Security Holdings" in Tosco's definitive Proxy Statement relating to its 1999 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There is hereby incorporated by reference the information appearing under the caption "Executive Compensation" in Tosco's definitive Proxy Statement relating to its 1999 Annual Meeting of Shareholders to be filed with the Securities and Exchange Commission.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) AND (a)(2). FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES. The consolidated financial statements and financial statement schedules of Tosco Corporation and subsidiaries, required by Part II, Item 8, are included in Part IV of this report. See Index to Consolidated Financial Statements and Financial Statement Schedules on page.
(a)(3). EXHIBITS
3(a) Amended and Restated Articles of Incorporation of Registrant. Incorporated by reference to Exhibit 3(a) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1996.
3(b) By-laws of Registrant as currently in effect. Incorporated by reference to Exhibit 3(b) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.
4(a) Form of Indenture between Registrant and IBJ Schroder and Trust Company, as Trustee, relating to 9% Series A First Mortgage Bonds due March 15, 1997, and 9 5/8% Series B First Mortgage Bonds due March 15, 2002. Incorporated by reference to Exhibit 4.1 to Registration Statement filed by Registrant on Form S-3 dated March 4, 1992.
4(b) Form of Indenture among Registrant, Bayway Refining Company, and the First National Bank of Boston, as Trustee, relating to 8 1/4% First Mortgage Bonds due 2003. Incorporated by reference to Exhibit 4.1 to Registration Statement filed by Registrant on Form S-4 dated April 29, 1993.
4(c) Form of Indenture dated as of July 7, 1995, between Registrant and The First National Bank of Boston, as Trustee, relating to 7% Notes due 2000. Incorporated by reference to Exhibit 4.1 to Registration Statement filed by Registrant on Form S-3 dated May 18, 1995 (No. 33-59423).
4(d) Form of Indenture dated as of May 1, 1996, between Registrant and State Street Bank and Trust Company. Incorporated by reference to Exhibit 4.1 to Registration Statement filed by Registrant on Form S-3 dated April 15, 1996 (No. 333-521).
4(e) Rights Agreement dated as of November 19, 1998 between Registrant and BankBoston N.A., as Rights Agent. Incorporated by reference to Exhibit 4 to Registrant's Current Report on Form 8-K dated November 30, 1998.
10(a) Fourth Amended and Restated Credit Agreement dated as of January 14, 1997, among Tosco Corporation, as Borrower, and the Banks named therein, as Banks, and The Chase Manhattan Bank as Co-Agent, Bank of America National Trust and Savings Association, as Co-Agent, and the First National Bank of Boston, as Agent. Incorporated by reference to Exhibit 10(a) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1996.
10(b) Severance Agreement dated May 8, 1996, between Registrant and Thomas D. O'Malley, including schedule identifying similar agreements between Registrant, or its subsidiaries, and two of its employees. Incorporated by reference to Exhibit 10(b) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997.
10(c) Indemnification Agreement dated September 30, 1987, between Registrant and Thomas D. O'Malley, including schedule identifying similar agreements between Registrant and its Directors and/or officers, together with related Trust Agreement. Incorporated by reference to Exhibit 10(b) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.
10(d) Trademark License Agreement dated December 28, 1993, between British Petroleum Company p.l.c. and Tosco Corporation. Incorporated by reference to Exhibit 10(s) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993. Schedule identifying (i) Amended and Restated Trademark License Agreement between British Petroleum Company p.l.c. and Tosco Corporation dated as of August 1, 1994, and (ii) Trademark License Agreement (California) between BP Oil Marketing, Inc. and Tosco Corporation dated as of August 1, 1994. These agreements extended the term of the original agreement and expanded the territory of the original agreement. Incorporated by reference to Exhibit 10(d) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997.
10(e) Stock Sale Agreement dated February 16, 1996, by and among Tosco and various stockholders of The Circle K Corporation. Incorporated by reference to Exhibit 1 to Registrant's Schedule 13D dated February 23, 1996, filed with respect to The Circle K Corporation.
10(f) Agreement and Plan of Merger dated as of February 16, 1996, by and among Tosco, Tosco Acquisition Sub, Inc., and The Circle K Corporation. Incorporated by reference to Exhibit 2 to Registrant's Schedule 13D dated February 23, 1996, filed with respect to the Circle K Corporation.
10(g) Sale and Purchase Agreement for 76 Products Company between Union Oil Company of California and Registrant, dated December 14, 1996. Incorporated by reference to Exhibit 10(k) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1996.
10(h) 1996 Long-term Incentive Plan, as amended. Incorporated by reference to Exhibit 10(h) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1997.
10(i) Tosco Corporation Senior Executive Retirement Plan of 1990, as amended and restated as of May 15, 1996. Incorporated by reference to Exhibit 10(i) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1997.
10(j) Tosco Corporation Senior Executive Retirement Plan of 1990, as amended and restated as of September 23, 1993. Incorporated by reference to Exhibit 10(j) to Registrant's Annual Report on Form 10-K for the year ended December 31, 1997.
10(k) Severance Agreements dated January 1, 1993, as amended, between Registrant and Robert J. Lavinia and Dwight L. Wiggins. Incorporated by reference to Exhibit 10(g) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.
21. A list of all subsidiaries of the Registrant.
23. Consent of PricewaterhouseCoopers LLP.
27. Financial Data Schedule.
99. Condensed Consolidating Financial Information and Report of Independent Accountants.
(b). REPORTS ON FORM 8-K
Report dated November 30, 1998, reporting pursuant to Item 5 on Registrant's Rights Agreement.
(c). Financial Statement schedules required by Regulation S-X are excluded from the Annual Report to Shareholders by Rule 14a-3(b)(1). See Schedule II to the Financial Statements, as required by Item 8, and appearing under Item 14 hereof.
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TOSCO CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULE AND FINANCIAL EXHIBITS FILED WITH THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998
PAGE(S)
Report of Independent Accountants
Financial Statements:
Consolidated Balance Sheets as of December 31, 1998 and 1997
Consolidated Statements of Income for the years ended December 31, 1998, 1997, and 1996
Consolidated Statements of Shareholders' Equity for the years ended December 31, 1998, 1997, and 1996
Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997, and 1996
Notes to Consolidated Financial Statements -
Schedule II - Valuation and Qualifying Accounts for the years ended December 31, 1998, 1997, and 1996 (a)
Financial Exhibits:
Exhibit 23 - Consent of Independent Accountants
Exhibit 99 - Condensed Consolidating Financial Information (b):
Report of Independent Accountants on Exhibit 99
Condensed Consolidating Financial Information as of December 31, 1998 and for the year then ended
Condensed Consolidating Financial Information as of December 31, 1997 and for the year then ended
Condensed Consolidating Financial Information for the year ended December 31, 1996
(a) Financial statement schedules, other than Schedule II, have been omitted since they are either not required or applicable, or the required information is presented in the consolidated financial statements and related notes.
(b) The condensed consolidating financial information presents the financial position, operating results, and cash flows of Tosco Corporation ("Tosco"), Bayway Refining Company ("Bayway"), and Tosco's Nonguaranteeing Subsidiaries. This information is provided to meet the reporting and informational requirements of Bayway as guarantor of the 8.25% Bayway Bonds. See Note 10 to the Consolidated Financial Statements.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Tosco Corporation
In our opinion, the consolidated financial statements listed in the accompanying index on page of this Form 10-K present fairly, in all material respects, the financial position of Tosco Corporation and its subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for the each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PricewaterhouseCoopers LLP
Phoenix, Arizona January 29, 1999, except as to the information in Note 21, for which the date is March 2, 1999
TOSCO CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Thousands of Dollars, Except Par Value)
The accompanying notes are an integral part of these financial statements.
TOSCO CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Thousands of Dollars, Except Per Share Data)
TOSCO CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (Thousands of Dollars)
TOSCO CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Thousands of Dollars)
TOSCO CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996
1. NATURE OF BUSINESS
Tosco Corporation ("Tosco" or the "Company") through divisions and subsidiaries is one of the largest independent oil refiners and marketers of petroleum products and operators of company-controlled convenience stores in the United States.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of Tosco and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles requires management estimates and assumptions that affect the reported amounts of assets and liabilities, the reported results of operations, and the disclosure of contingent assets and liabilities.
CASH, CASH EQUIVALENTS, MARKETABLE SECURITIES, AND DEPOSITS
Cash in excess of operating requirements is used to pay down cash borrowings under the Company's Revolving Credit Facility or invested in highly liquid cash equivalents. Margin deposits, based on a percentage of the value of the futures contracts, are maintained with commodity brokers in accordance with the requirements of commodity exchanges. Margin deposits are included in marketable securities and deposits on the balance sheet.
At December 31, 1998 and 1997, the Company had approximately $17,500,000 and $15,000,000, respectively of director and officer liability insurance coverage with a wholly owned subsidiary (amounts approximately equal to the fair value of marketable securities held in trust by the subsidiary). The subsidiary's trust assets are restricted to payment of directors' and officers' liability defense costs and claims. Marketable securities held by the subsidiary, classified as available for sale, consist of highly liquid debt and equity securities. The cost of the marketable securities approximates fair value. Accordingly, unrealized gains and losses, net of related income taxes, are not significant. Debt securities with original maturities of three months or less at the date of purchase are classified as cash equivalents, while debt securities with maturities of twelve months or less from the balance sheet date are included in marketable securities and deposits on the balance sheet.
INVENTORIES
Inventories are stated at the lower of cost or market. The cost of refinery inventories is determined on the last-in, first-out ("LIFO") basis. The cost of retail fuel inventories is determined on the first-in, first-out ("FIFO") basis. The cost of retail merchandise inventories is determined under the retail method.
PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment, including capitalized interest, are carried at cost less accumulated depreciation and amortization. Depreciation and amortization are provided over the estimated useful lives of the respective classes of assets utilizing the straight-line method. Expenditures that materially increase values, change capacities, or extend useful lives are capitalized. Routine maintenance and repairs are expensed. Gains and losses on disposition of assets are reflected in results of operations.
Computer software costs are deferred and amortized over their useful lives, generally not to exceed five years. Certain enterprise-wide information systems are amortized over periods of up to ten years.
DEFERRED TURNAROUNDS
Refinery processing units are periodically shut down for major scheduled maintenance (turnarounds). Turnaround costs are deferred and amortized on a straight-line basis over the expected period of benefit, which generally ranges from 24 to 48 months.
INTANGIBLE ASSETS (PRIMARILY TRADENAMES)
Tradenames acquired in the 76 Products (Note 3) and The Circle K Corporation ("Circle K") acquisitions are amortized on a straight-line basis over 40 years. Other tradenames and intangible assets are amortized on a straight-line basis over periods of up to 15 years.
OTHER DEFERRED CHARGES AND ASSETS
Financing charges related to the acquisition or refinancing of debt are deferred and amortized over the term of the related debt using the effective interest method. Production costs of media advertising are deferred until the advertising occurs. Advertising expense for 1998, 1997, and 1996 was $48,302,000, $43,856,000, and $15,243,000, respectively.
SELF-INSURANCE
The Company is self-insured up to certain limits for workers' compensation (in certain states), property damage, and general liability claims. Accruals for loss incidences are made based on the Company's claims experience and actuarial assumptions followed in the insurance industry. Actual losses could differ from accrued amounts.
EXCISE TAXES
Excise taxes collected on behalf of governmental agencies are excluded from sales, cost of sales, and other expenses. Excise taxes totaled $2,316,524,000, $1,768,078,000, and $1,382,020,000, for 1998, 1997, and 1996, respectively.
DERIVATIVE FINANCIAL INSTRUMENTS
In the normal course of business, the Company, to reduce its exposure to fluctuations in the price of crude oil and other petroleum products, is party to derivative financial instruments with off-balance sheet risk. Such contracts, which are designated as hedges, are recorded using hedge accounting. Gains and losses on these financial instruments are deferred until the underlying physical transaction occurs. The gains and losses are then recognized and reported as a component of the related transaction. Any cash flow recognition resulting from holding these financial instruments are treated in the same manner as the underlying hedge transaction.
ENVIRONMENTAL COSTS
Liabilities for future remediation costs are recorded when environmental assessments and/or remedial efforts are probable and the costs can be reasonably estimated. Other than for assessments, the timing and magnitude of these accruals are generally based on the completion of investigations or other studies or a commitment to a formal plan of action. The gross amount of the liability is based on the Company's best estimate of undiscounted future costs using currently available technology, and applying current regulations, as well as the Company's own internal environmental policies. Estimated reimbursements of remediation costs of petroleum releases from underground storage tanks are recorded as assets when reimbursements from state trust fund programs are probable.
DEFERRED REVENUE
Advances received in connection with long-term supplier marketing or display allowances are amortized to income over the terms of the respective arrangements based on projected purchase levels.
EARNINGS PER SHARE
Basic and diluted earnings per share for all periods are computed in accordance with Statement of Financial Accounting Standard ("SFAS") No. 128 "Earning per Share."
RECLASSIFICATION ENTRIES
Certain reclassifications, primarily the separate disclosure of depreciation and amortization, have been made to the 1997 and 1996 financial statements to conform to the presentation in the 1998 financial statements.
3. 76 PRODUCTS ACQUISITION
On March 31, 1997, the Company acquired Union Oil Company of California's ("Unocal") West Coast petroleum refining, marketing, and related supply and transportation assets (the "76 Products Acquisition"). The purchase price (including environmental and other liabilities assumed) was $1,546,074,000, plus inventories and credit card receivables. In addition, Unocal is entitled to receive contingent participation payments if gasoline margins increase above specified levels (Note 18).
The acquired assets include two petroleum refining systems with an aggregate throughput capacity of approximately 250,000 barrels per day; a retail gasoline system consisting of 76-branded gasoline service stations (most of which are company-controlled); a distribution system comprised of 13 company-owned oil storage terminals; rights with respect to approximately 1,300 miles of crude oil and product pipelines; the worldwide rights to the "76" and "Union" tradenames, together with the distinctive orange ball logo, (except for pre-existing license grants relating to 76 Truckstops and to Uno-Ven); and Unocal's lubricants manufacturing, distribution, and marketing business.
The purchase price paid consisted of cash and shares of common stock of Tosco ("Common Stock") (Note 13). The cash portion was financed from available cash, borrowings under revolving credit facilities (Note 9), and proceeds from the sale of unsecured debt securities (Note 10). In addition, certain gasoline service stations were purchased directly from Unocal by a special purpose entity that leased the service stations to the Company pursuant to a long-term lease (Note 17).
The 76 Products Acquisition has been accounted for as a purchase. The purchase price allocation is summarized below:
(Thousands of Dollars) Current assets $ 500,954 Property, plant, and equipment: Los Angeles Area Refinery System 389,236 Rodeo Refinery 238,240 Santa Maria Refinery 69,161 Other, primarily marketing and distribution assets 771,965 Other noncurrent assets 68,811 Accrued expenses and other current liabilities (193,737) Accrued environmental costs and other noncurrent liabilities (247,275) ---------- $1,597,355 ==========
4. FINANCIAL INSTRUMENTS
FAIR VALUES
The carrying value of cash, cash equivalents, marketable securities, short-term deposits, trade accounts receivable, accounts payable, and other current liabilities approximates their fair value due to the relatively short maturity of these financial instruments. The carrying value of the revolving credit facility approximates fair value due to its variable interest rate. The fair value (based on quoted market prices and estimates) of long (obligation to purchase) and short (obligation to deliver) derivative financial instruments were $55,868,000 and $95,860,000, respectively at December 31, 1998.
Estimated fair values of other financial instruments at December 31, 1998 and 1997 are as follows:
DERIVATIVES
The Company utilizes commodity-based derivative instruments, at times and when able, to reduce a portion of its exposure to price volatility. Commodity futures are used to lock in what the Company considers to be acceptable margins between the sales value of refined products produced and the cost of raw materials purchased on a varying percentage of production, generally for periods not exceeding one year. In addition, the Company enters into swap contracts with counterparties (typically agreeing to sell at fixed forward prices, and to buy at future variable market prices, stated volumes of residual fuels) to hedge sales prices of residual fuels production. Futures and forward contracts are also used to hedge inventories stored for future sale and to hedge against adverse price movements between the cost of foreign and domestic crude oil.
At December 31, 1998 and 1997, the Company had open long and short futures, swap and forward contracts for crude oil and products with a notional volume (number of barrels under contract) and value (number of barrels under contract multiplied by the per-barrel contract value) as follows:
Deferred gains and losses on futures and swap contracts totaled $7,270,000 and $3,648,000 at December 31, 1998 and 1997, respectively. These amounts will be recognized or reversed in the following year as an offset to realized margins on refined products sold.
CREDIT RISK
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash equivalents, marketable securities, short-term deposits, trade receivables, and derivative instruments. The Company places its cash equivalents, marketable securities, and short-term deposits with several high-quality financial institutions. The Company's customer base consists of a large number of diverse customers. The Company conducts ongoing evaluations of its customers and requires letters of credit or other collateral arrangements as appropriate. Accordingly, trade receivable credit losses have not been significant. The Company does not believe that it has a significant credit risk on its derivative instruments which are transacted through the New York Mercantile Exchange, or with counterparties meeting established collateral and credit criteria.
5. ACCOUNTS RECEIVABLE
In March 1998, the Company entered into a three-year agreement with a financial institution to sell on a revolving basis up to $300,000,000 of an undivided percentage ownership interest in a designated pool of accounts receivable (the "Receivable Transfer Agreement"). The Receivable Transfer Agreement replaced a similar agreement with another financial institution. In October 1997, the Company entered into a three-year agreement with a financial institution to sell on a revolving basis up to $100,000,000 of an undivided percentage ownership interest in a designated pool of credit card accounts receivable (the "Credit Card Receivable Transfer Agreement"). Under the Receivable Transfer Agreement and Credit Card Receivable Transfer Agreement, the Company retains substantially the same risk of credit loss as if the receivables had not been sold. The Company also retains collection and administrative responsibilities on the participating interest sold as agent for the financial institution. At December 31, 1998 and 1997, accounts receivable were reduced by $375,000,000 and $400,000,000, respectively, for receivables sold under these programs. Sales of accounts receivables under these programs averaged $903,169,000, $984,216,000, and $506,455,000 per month in 1998, 1997, and 1996, respectively.
6. INVENTORIES
Expenditures for maintenance and repairs (excluding the amortization of turnaround costs) during 1998, 1997, and 1996 were $257,838,000, $210,443,000, and $135,006,000, respectively.
8. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
(THOUSANDS OF DOLLARS) 1998 1997 ------------- ------------- Accrued taxes, other than income taxes $ 191,950 $ 173,115 Accrued compensation and related benefits 130,010 120,221 Restructuring accrual 24,630 Acquisition-related liabilities 5,972 37,326 Dividends payable 9,904 9,375 Other 365,886 414,255 ------------- ------------ $ 728,352 $ 754,292 ============= ============
During 1998, Tosco recorded a $40,000,000 charge primarily related to the restructuring of its San Francisco Area Refinery System. The restructuring will result in an increase in the production of clean burning CARB Phase 2 gasoline and is being made to improve efficiency, reliability, and profitability of the system, without compromising safety or environmental compliance. The key component of the restructuring plan revolves around the continued integration of the Avon Refinery and the Rodeo-Santa Maria complex acquired in 1997. The improved operation will involve the shutdown of several of the less efficient processing units at the Avon Refinery, with resulting staff reductions. At December 31, 1998, the $40,000,000 restructuring charge includes the write-down, shutdown, and dismantling costs of certain processing units and facilities that will no longer be used, contract termination costs, and employee severance (Note 21). Activity for 1998 is summarized below:
(THOUSANDS OF DOLLARS) Impairment of assets $ 15,153 Exit costs 18,904 Employee termination costs 5,943 ------------- 40,000 Utilization, primarily the write-off of refinery assets (15,370) ------------- $ 24,630 ============= 9. REVOLVING CREDIT FACILITY
The Company's revolving credit agreement (the "Revolving Credit Facility") provides a $1,000,000,000 uncollateralized revolving credit facility that is available for working capital and general corporate purposes, including acquisitions. Facility A for $900,000,000 expires on January 14, 2002 and Facility B for $100,000,000 expired on January 12, 1999 (Note 21). The Revolving Credit Facility bears interest at the option of the Company at one of three alternative rates (a federal funds rate, a Eurodollar rate, or a base rate related to prime) plus an incremental margin for each rate option. A commitment fee on the unused portion of the facility is also due. The incremental margin and commitment fee are dependent on the credit rating of the First Mortgage Bonds (Note 10). Prior to January 14, 1997, the Revolving Credit Facility was a $600,000,000 uncollateralized facility. Utilization of the Revolving Credit Facility as of December 31, 1998 and 1997 was as follows:
(THOUSANDS OF DOLLARS) 1998 1997 ------------- -------------- Cash borrowings 196,000 $ 166,000 Letters of credit 30,160 57,241 ------------- -------------- Total utilization 226,160 223,241 Availability 773,840 776,759 ------------- -------------- $ 1,000,000 $ 1,000,000 ============= ==============
10. LONG-TERM DEBT
(THOUSANDS OF DOLLARS) 1998 1997 ------------- -------------- Collateralized debt: First Mortgage Bonds (a) $ 200,000 $ 200,000 Bayway Bonds (b) 150,000 150,000 Real estate installment purchase note (c) 52,563 Other 3,519 3,949 Uncollateralized debt: 7% Notes (d) 125,000 125,000 7.625% Notes (e) 240,000 240,000 Notes and Debentures (f) 600,000 600,000 Other 104 319 Capital leases (g) 41,538 55,334 ------------- -------------- 1,360,161 1,427,165 Less current installments 1,608 11,908 ------------- -------------- $ 1,358,553 $ 1,415,257 ============= ==============
(a) 9.625% first mortgage bonds due March 15, 2002 (the "First Mortgage Bonds"), issued in March 1992. Interest on the First Mortgage Bonds is payable each March 15 and September 15. The First Mortgage Bonds are noncallable and are collateralized by the Avon Refinery and certain related assets.
(b) In connection with the April 1993 acquisition of the Bayway Refinery, the Company issued $150,000,000 of 8.25% mortgage bonds (the "Bayway Bonds") due May 15, 2003. The Bayway Bonds are guaranteed by Bayway Refining Company ("Bayway"), a wholly owned subsidiary of Tosco. Interest is payable semi-annually on May 15 and November 15. The Bayway guarantee is collateralized by the Bayway Refinery and related assets and a guarantee of Tosco.
(c) In January 1998, the Company completed the purchase of approximately 200 convenience stores by paying off the outstanding balance of a real estate installment purchase note for $64,622,000, including the settlement of contingent payments.
(d) On July 12, 1995, $125,000,000 of registered debt securities were issued as 7% uncollateralized, noncallable notes due July 15, 2000 (the "7% Notes"). Semi-annual interest payments on the 7% Notes began January 15, 1996. The net proceeds from the public offering were used to repay debt.
(e) In May 1996, the Company issued $240,000,000 of 7.625% uncollateralized notes due May 15, 2006 (the "7.625% Notes") in connection with the acquisition of Circle K. Semi-annual interest payments on the 7.625% Notes began November 15, 1996.
(f) On January 14, 1997, the Company issued $200,000,000 of 7.25% Notes due on January 1, 2007, $300,000,000 of 7.8% Debentures due on January 1, 2027, and $100,000,000 of 7.9% Debentures due on January 1, 2047 (collectively the "Notes and Debentures"). Interest on the unregistered Notes and Debentures was payable each January 1 and July 1, commencing on July 1, 1997. The proceeds from the unregistered Notes and Debentures were used to finance a portion of the 76 Products Acquisition. In August 1997, the Company exchanged the unregistered Notes and Debentures for fully registered and freely salable notes and debentures having identical terms, including the same interest rates and maturity dates. The Notes and Debentures are non-redeemable and uncollateralized.
(g) The Company's capital lease obligations are collateralized primarily by retail marketing and related assets and mature at varying dates through 2019. The carrying value of the assets under capital lease arrangements approximates the capital lease obligation.
At December 31, 1998 future maturities relating to long-term debt were as follows:
CAPITAL (THOUSANDS OF DOLLARS) DEBT LEASES TOTAL ------------- ------------ ------------- 1999 (a) $ 874 $ 5,005 $ 5,879 2000 125,771 5,014 130,785 2001 771 4,924 5,695 2002 200,771 4,905 205,676 2003 150,771 4,974 155,745 Thereafter 839,665 74,285 913,950 ------------- ------------ ----------- Total future maturities 1,318,623 99,107 1,417,730 Less imputed interest 57,569 57,569 ------------- ------------ ----------- Present value of future maturities $ 1,318,623 $ 41,538 $ 1,360,161 ============= ============ =============
(a) Current maturities of long-term obligations, excluding imputed interest, are $1,608,000 at December 31, 1998.
The debt agreements, including the Revolving Credit Facility (Note 9), contain covenants that limit the Company's ability to incur additional indebtedness, pay dividends, acquire its own equity securities, make investments in certain subsidiaries, and make discretionary capital expenditures. They also require the maintenance of minimum financial ratios and net worth levels. At December 31, 1998, the Company was in compliance with all debt covenants.
11. ACCRUED ENVIRONMENTAL COSTS
The Company is subject to extensive federal, state, and local environmental laws and regulations relating to its petroleum refining, distribution, and marketing operations. These laws and regulations (which are complex, change frequently, and are subject to differing interpretations) regulate the discharge of materials into the environment. The Company is currently involved in a number of environmental proceedings and discussions regarding the removal and mitigation of the environmental effects of subsurface liquid hydrocarbons and alleged levels of hazardous waste at certain of its refineries and other locations, including a site on the Superfund National Priorities List.
In July 1993, outstanding litigation concerning environmental issues was settled with the predecessor owners of the Avon Refinery (the "Settlement Agreement"). Under the Settlement Agreement, the former owners agreed to pay up to $18,000,000 for one-half of the costs that may be incurred for compliance with certain environmental orders and to provide the Company with a $6,000,000 credit for past expenses (which the Company uses to reduce its one-half share of costs). After the $36,000,000 shared cost maximum is expended, the parties may elect to continue the Settlement Agreement or to reinstate litigation. The Company and the former owners have established a committee to review and approve expenditures for environmental investigative and remediation actions at the Avon Refinery. Through December 31, 1998, the committee has spent $5,300,000 on such matters.
By agreement, Exxon Corporation ("Exxon") is responsible for environmental obligations related to or arising out of its ownership and operation of the Bayway Refinery, purchased by the Company in April 1993. The Company has also received similar environmental indemnifications for periods prior to the respective acquisition dates of the Ferndale Refinery, the Trainer Refinery, retail assets in the Pacific Northwest and Northern California from BP Exploration & Oil, Inc., and Arizona retail properties from Exxon.
Through March 31, 2022, Unocal is responsible for all environmental liabilities at the acquired refineries, gasoline stations, oil storage terminals, and pipelines arising out of or relating to the period prior to closing, except that the Company will pay the first $7,000,000 of such environmental liabilities each year, plus 40% of any amount in excess of $7,000,000 per year, with Unocal paying the remaining 60% each year. The aggregate maximum amount that the Company may have to pay in total for the 25-year period for such environmental liabilities is limited to $200,000,000. During 1998 and 1997, the Company incurred environmental costs at the 76 Products sites as follows:
(THOUSANDS OF DOLLARS) 1998 1997 (a) ------------- -------------- Total costs incurred $ 17,981 $ 7,553 Less costs reimbursed by Unocal 5,085 351 ------------ -------------- Costs charged to the environmental accrual $ 12,896 $ 7,202 =========== ==============
(a) Costs and reimbursements are for the nine-month period ended December 31, 1997.
A refinery in Duncan, Oklahoma, formerly owned by the Company, is subject to investigation by the Oklahoma Department of Environmental Quality (the "ODEQ"). In 1995, the Company entered into a Consent Agreement and Final Order with the ODEQ to investigate the extent of contamination at the refinery, conduct certain interim remedial actions, and prepare a remedial action plan. In January 1998, the Company entered into a Settlement Agreement with Sun Company Inc. ("Sun"), a former owner of the refinery, pursuant to which Sun agreed to pay the Company $7,000,000 in exchange for a release from liability with respect to the site. In early 1998, a trial was held on the Company's claim against Koch Industries ("Koch"), another former owner. In March 1998, the court ruled that Koch was responsible for a portion of past and future investigation and remediation costs at the site. Koch has appealed the judgement. In view of the probable costs of remediation of the Duncan refinery site, the settlement with Sun and the judgement against Koch were not recognized in results of operations.
Environmental exposures are difficult to assess and estimate for numerous reasons including the complexity and differing interpretations of governmental regulations, the lack of reliable data, the number of potentially responsible parties and their financial capabilities, the multiplicity of possible solutions, the years of remedial and monitoring activity required, and the identification of new sites. The Company believes that it has adequately provided for environmental exposures. However, should these matters be resolved unfavorably to the Company, they could have a material adverse effect on its long-term consolidated financial position and results of operations.
12. COMPANY-OBLIGATED, MANDATORILY REDEEMABLE, CONVERTIBLE PREFERRED SECURITIES
In December 1996, Tosco Financing Trust (the "Trust"), a Delaware business trust, whose common securities are owned by Tosco, issued, in a private placement, 6,000,000 shares of 5.75% company-obligated, mandatorily redeemable, convertible preferred securities (the "Trust Preferred Securities"). The net proceeds of approximately $291,000,000 were used to purchase an equal amount of 5.75% convertible junior subordinated debentures of Tosco due on December 15, 2026 (the "Convertible Debentures"). The sole assets of the Trust are the Convertible Debentures, guaranteed by Tosco. The Trust Preferred Securities represent preferred undivided interests in the Trust's assets, with a liquidation preference of $50 per security, for a total liquidation preference of $300,000,000.
Distributions on the Trust Preferred Securities, cumulative and payable quarterly in arrears at the annual rate of 5.75% of the liquidation amount, commenced on March 15, 1997. The Company has the option to defer payment of the distributions for an extension period of up to five years if it is in compliance with the terms of the Trust Preferred Securities. Interest at 5.75% will accrue on such deferred distribution throughout the extension period. The Trust Preferred Securities are convertible, at the option of the holder, into 1.51899 shares of Common Stock, equivalent to a conversion price of approximately $32.92 per share of Common Stock, subject to adjustment in certain events. The Trust Preferred Securities do not have a stated maturity date, although they are mandatorily redeemable upon the repayment of the Convertible Debentures, but not before December 18, 1999. The redemption price decreases from 104.025% in 1999 to 100% of the liquidation preference in 2006 and thereafter.
13. CAPITAL STOCK
The Company is authorized to issue 12,000,000 shares of preferred stock, par value $1.00 per share, ("Preferred Stock"). No shares of Preferred Stock are issued or outstanding. At a special stockholder meeting on February 12, 1997, an amendment to increase the number of authorized shares of Common Stock from 50,000,000 to 250,000,000 was approved. The Company subsequently declared and distributed a 3-for-1 Common Stock split, in the form of a 200 percent stock dividend. The number of shares, per share prices, and earnings per share amounts for all periods reflect this 3-for-1 stock split.
In January 1997, the Company filed a shelf registration statement providing for the issuance of up to $1,500,000,000 aggregate principal amount of its securities. The securities may consist of (1) one or more series of debentures, notes or other uncollateralized forms of indebtedness, (2) Common Stock, (3) Preferred Stock, and (4) preferred stock represented by depository shares. The securities may be offered, separately or together, in amounts and at prices and terms to be set forth in one or more supplements to the shelf registration statement. At December 31, 1998, the Company may issue up to $778,950,000 of securities pursuant to this shelf registration statement.
On March 31, 1997, the Company issued 14,092,482 shares of Common Stock to Unocal (the "Unocal Shares"), for aggregate value of $396,880,000. On May 1, 1997, the Company issued 25,300,000 shares of Common Stock pursuant to a prospectus supplement to the shelf registration statement. The net proceeds from this Common Stock offering were $697,396,000. The net proceeds were used to repurchase, as treasury shares, the Unocal Shares for $393,708,000 and to repay borrowings under revolving credit facilities (Note 9).
During 1998, the Company repurchased 4,258,000 shares of Common Stock for $101,089,000 pursuant to a $300,000,000 Board of Directors approved stock repurchase program.
The Company has paid a regular quarterly cash dividend on Common Stock since the third quarter of 1989. Effective with the first quarter of 1997, the Company increased its quarterly cash dividend from $0.0567 per share to $0.06 per share.
14. STOCK OPTION PLANS
The Company has three stock option plans, the 1989 Stock Incentive Plan (the "1989 Plan"), the 1992 Stock Incentive Plan (the "1992 Plan"), and the 1998 Stock Incentive Plan (the "1998 Plan"), that reserve Common Stock for issuance to key employees, consultants, and non-employee directors. The 1989 Plan, 1992 Plan, and 1998 Plan (collectively the "Option Plans") provide for the grant of a maximum of 3,840,000, 6,600,000, and 1,500,000 shares of Common Stock, respectively, in the form of stock options, restricted stock awards, and/or stock appreciation rights. Stock options may be granted as "Incentive Stock Options" (as defined by the Internal Revenue Code of 1986), or as nonqualified options, including nonqualified stock options whose purchase price or vesting requirements are based on the employee's achievement of established performance objectives. Options may be exercised as determined by the Compensation Committee of the Board of Directors but in no event after ten years from the date of grant. The exercise price of nonqualified stock options is determined by the Compensation Committee of the Board of Directors and may be less than the fair value of Common Stock on the date of grant. Awards under the 1989 Plan may no longer be granted. Awards under the 1992 Plan and 1998 Plan may be granted until March 13, 2002 and March 18, 2009, respectively. Subject to severance agreements with certain employees (Note 18), options may be exercised at any time after vesting, currently one to five years. Information regarding the Option Plans as of December 31, 1998, 1997, and 1996 is as follows:
Additional information regarding the Option Plans as of December 31, 1998 is as follows:
The Company has adopted the disclosure-only provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123"). Had the Company elected to adopt the recognition provisions of SFAS No. 123, net income and earnings per share would have been reduced by $3,563,000, ($0.02 per share), $2,968,000 ($0.02 per share), and $1,622,000 ($0.01 per share) for 1998, 1997, and 1996, respectively.
The fair value of options granted in 1998, 1997, and 1996 was estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions:
1998 1997 1996 ----------- -------------- ---------- Assumed risk-free interest rate 5.6% 6.5% 6.2% Expected life 5.7 years 7.2 years 8.3 years Expected volatility 30.6% 28.7% 26.3% Assumed dividend yield 0.8% 0.8% 1.5%
In late 1996, the Company adopted the Tosco Corporation 1996 Long-Term Incentive Plan (the "LTIP") which replaced the granting of incentive awards under the Option Plans to participants in the LTIP. Under the LTIP, the Compensation Committee of the Board of Directors may grant performance units to participants, the payment of which is contingent on the meeting of performance goals as defined and continued employment by the participant. Under certain circumstances, payments in a calendar year may not exceed 400% of the participant's total annual compensation for the year of the award. Based on performance goals achieved, the participants received $30,533,000 on January 4, 1999 and are scheduled to receive approximately 50% of this amount on January 1, 2000 and January 1, 2001. If a participant voluntarily terminates employment with the Company or retires prior to age 65, all unpaid amounts will be forfeited. The Company accrues for such amounts on a ratable basis over the required service period.
15. EMPLOYEE BENEFIT, SAVINGS, AND INCENTIVE COMPENSATION PLANS
PENSION PLANS
The Company has non-contributory, defined benefit pension plans covering substantially all employees located at the Bayway Refinery, the Los Angeles Area Refinery System, and the San Francisco Area Refinery System, its union employees at the Ferndale Refinery, and store employees meeting minimum service periods (collectively, the "Pension Plans"). Benefits under the Pension Plans are generally based on the employee's years of service and average earnings for the three highest consecutive calendar years of compensation during the ten years immediately preceding retirement. Benefits are payable at the normal retirement age of 65, with reduced benefits for early retirement (as defined). Contributions to the Pension Plans are at least sufficient to meet the minimum funding requirements of applicable laws and regulations but no more than the amount deductible for federal income tax purposes. The assets of the Pension Plans are held by a major financial institution and invested in a stock index fund, a Treasury bond index fund, short-term investment funds, and a real estate equity fund.
The Company's change in benefit obligation, change in plan assets, and funded status, using end of year actuarial assumptions, consist of the following at December 31, 1998 and 1997:
(THOUSANDS OF DOLLARS) 1998 1997 ------------- ---------- Benefit obligation at beginning of year $ 137,041 $ 90,849 Service cost (without load for expenses) 15,293 9,669 Interest cost 9,867 8,067 Actuarial loss 4,975 14,061 Benefits paid (3,008) (2,588) 76 Products Acquisition (a) 16,983 ------------ ---------- Benefit obligation at end of year 164,168 137,041 ------------ ----------
Fair value of plan assets at beginning of year 106,842 78,115 Actual return on plan assets 26,351 19,577 Employer contributions 14,500 12,000 Benefits paid (3,008) (2,588) Administrative expenses (287) (262) -------------- ---------- Fair value of plan assets at end of year 144,398 106,842 -------------- ----------
Funded status at end of year (19,770) (30,199) Unrecognized transition obligation 861 1,149 Unrecognized net actuarial (gain) loss (9,585) 3,340 Unrecognized prior service cost 7,614 8,374 ------------- ---------- Accrued benefit liability at end of year $ (20,880) $ (17,336) ============= ===========
(a) In connection with the 76 Products Acquisition, pension benefits and recognition of prior service were extended to substantially all employees located at the acquired refineries. Accrued pension benefits for these employees through March 31, 1997 are the obligation of Unocal.
Net pension cost, using beginning of the year actuarial assumptions, for the years ended December 31, 1998, 1997, and 1996 consists of the following:
(THOUSANDS OF DOLLARS) 1998 1997 1996 ------------ ------------ -------- Service cost $ 15,558 $ 9,669 $ 6,336 Interest cost 9,867 8,067 5,626 Expected return on plan assets (8,432) (6,177) (4,932) Amortization of transition obligation 288 288 288 Amortization of prior service cost 759 759 759 ------------ ------------ ------- $ 18,040 $ 12,606 $ 8,077 ============= ============ =======
The major assumptions used to calculate the Company's pension obligations and pension costs for the years ended December 31, 1998, 1997, and 1996 are as follows:
1998 1997 1996 -------- --------- -------- Assumed discount rate 6.75% 7.00% 7.50% Assumed rate of future compensation increase 5.00% 5.00% 5.00% Expected rate of return on plan assets 7.50% 7.50% 7.50%
The Company has a Senior Executive Retirement Plan ("SERP") that provides retirement benefits to selected senior executives and their beneficiaries. SERP provisions of $2,176,000, $1,908,000, and $2,079,000, are included in selling, general, and administrative expenses in 1998, 1997, and 1996, respectively.
EMPLOYEE AND RETIREE BENEFIT PLANS
The Company provides health care and life insurance benefits for its employees. The Company also provides postretirement health care and life insurance benefits for certain employees (primarily refinery employees). Health care benefits for eligible employees and retirees are provided through insurance companies and health maintenance organizations whose premiums are based on the benefits paid during the year. The health care plans are contributory (with employee/retiree contributions adjusted periodically) and contain other cost-sharing features such as deductibles and coinsurance. The life insurance plans are noncontributory.
The Company's change in benefit obligation, change in plan assets, and funded status, using end of year actuarial assumptions, consists of the following at December 31, 1998 and 1997:
Net postretirement benefit cost, using beginning of the year actuarial assumptions, for the years ended December 31, 1998, 1997, and 1996 consists of the following:
The major assumptions used to calculate the benefit obligation and net postretirement benefit cost for the years ended December 31, 1998, 1997, and 1996 are as follows:
A 1% increase and decrease in the health care cost trend rate would have the following effect on the benefit obligation at December 31, 1998 and aggregate of service and interest cost for 1998, 1997, and 1996:
(THOUSANDS OF DOLLARS) 1% INCREASE 1% DECREASE ------------ ----------- Benefit obligation at December 31, 1998 $ 1,465 $ (1,783) Benefit obligation at December 31, 1997 1,511 (1,839) Aggregate interest and service cost for 1998 202 (240) Aggregate interest and service cost for 1997 183 (217) Aggregate interest and service cost for 1996 88 (105)
SAVINGS PLANS
The Tosco Corporation Capital Accumulation Plan (the "CAP") and the Tosco Store Savings Plan (the "TSSP"), have been established for all eligible non-store and store employees, respectively. Participants may make, within certain limitations, voluntary contributions under Section 401(k) of the Internal Revenue Code of a percentage of their compensation. The Company makes matching contributions to the CAP based upon years of contributory participation, as defined, for employees who elect to make certain specified and minimum contributions. In addition, eligible employees of the CAP receive an additional contribution equal to 5% of their compensation, up to $150,000, in lieu of pension plan benefits. Participants of the CAP and TSSP (collectively the "Savings Plan") are immediately vested in their voluntary contributions. Participants in the CAP are immediately vested in the Company contributions. Contributions by the Company to the Savings Plans for the years ended December 31, 1998, 1997, and 1996 were $20,357,000, $17,766,000, and $9,517,000, respectively.
MANAGEMENT INCENTIVE PLAN
The Tosco Corporation Cash Incentive Plan (the "CIP") has been established for members of middle and senior management. The CIP sets forth discretionary and other awards computed as a variable percentage of a participant's base salary, which percentage is dependent upon pre-tax income, as defined, of the respective participant's operating division. The Company also has a bonus plan for senior executives, who are not participants in the CIP, based on pre-tax income per share, as defined. Results of operations for the years ended December 31, 1998, 1997, and 1996 include incentive compensation of $54,300,000, $56,100,000, and $33,028,000, respectively, of which $5,945,000, $5,845,000, and $3,102,000 were special bonuses awarded to union and other employees not covered by management incentive plans.
16. INCOME TAXES
The provision (benefit) for income taxes for the years ended December 31, 1998, 1997, and 1996 is as follows:
(THOUSANDS OF DOLLARS) 1998 (a) 1997 1996 ------------- -------------- ------------- Current: Federal $ (45,477) $ 87,463 $ 50,720 State (4,981) 23,785 16,959 Foreign 366 233 246 ------------- -------------- ------------- (50,092) 111,481 67,925 ------------- -------------- ------------- Deferred: Federal 108,069 37,200 29,577 State 17,366 2,190 3,294 ------------- -------------- ------------- 125,435 39,390 32,871 ------------- -------------- ------------- $ 75,343 $ 150,871 $ 100,796 ============= ============== =============
(a) The current Federal and state income tax benefits relate primarily to the inventory writedown.
A reconciliation of the provision for income taxes to income taxes computed by applying the statutory federal income tax rate to earnings before income taxes is as follows:
Temporary differences between financial and income tax reporting and tax credit carryforwards that give rise to deferred income tax assets and liabilities as of December 31, 1998 and 1997 are as follows:
17. OPERATING LEASES
The Company distributes petroleum products throughout its marketing areas through a combination of owned and leased terminals. Leases for product distribution terminals are generally for short periods of time and continue in effect until canceled by either party with contracted days of notice, generally 30 to 60 days. Most product distribution terminal leases are subject to escalations based on various factors. The Company subleases portions of its owned and leased product distribution terminals. During December 1997, the Company purchased the Riverhead Terminal pursuant to a purchase option in the lease.
The Company has long-term leases with special purpose entities for land and equipment at the Company's BP California, Exxon Arizona, and certain 76 Products service stations, two refining processing units, and an office building. These leases provide the Company the option to purchase, at agreed-upon contracted prices, (a) not less than all of the leased assets at annual anniversary dates, and (b) a portion of the leased assets for resale to unaffiliated parties at quarterly lease payment dates. The Company may cancel the leases provided that lessors receive minimum sales values for the assets. Minimum annual rentals vary with commercial paper interest rates and the reference interest rate (LIBOR). These leases are accounted for as operating leases and extend, with renewal options, through 2003.
The Company leases certain of its stores and other property and equipment. The store leases generally have primary terms of up to 25 years with varying renewal provisions. Under certain of these leases, the Company is subject to additional rentals based on store sales as well as escalations in the minimum future lease amount. The leases for other property and equipment are for terms of up to 15 years. Most of the Company's lease arrangements provide the Company an option to purchase the assets at the end of the lease term. The Company may also cancel certain of its leases provided that the lessor receives minimum sales values for the leased assets. Most of the leases require that the Company provide for the payment of real estate taxes, repairs and maintenance, and insurance.
Net rental expense for the years ended December 31, 1998, 1997, and 1996 consists of the following:
At December 31, 1998, future minimum obligations under non-cancelable operating leases and warehousing agreements are as follows:
(THOUSANDS OF DOLLARS) 1999 $ 145,209 2000 130,075 2001 (a) 112,068 2002 (a) 93,499 2003 (a) 70,685 Thereafter 399,587 ------------- 951,123 Less future minimum sublease income 86,089 ------------- $ 865,034 =============
(a) Excludes guaranteed residual payments totaling $29,222,000 (2001), $191,501,000 (2002), and $190,250,000 (2003) due at the end of the lease term, which will be reduced by the fair market value of the leased assets.
18. COMMITMENTS AND CONTINGENCIES
There are various legal proceedings and claims pending against the Company that are common to its operations. While it is not feasible to predict or determine the ultimate outcome of these matters, it is the opinion of management that these suits will not result in monetary damages not covered by insurance that in the aggregate would be material to the business or operations of the Company.
As a condition of the 76 Products Acquisition, Unocal is entitled to receive contingent participation payments over the seven year period following the acquisition, up to a maximum of $250,000,000, if retail market conditions and/or California Air Resources Board ("CARB") gasoline margins increase above specified levels. The contingent participation payments will be capitalized, when incurred, as an additional cost of the 76 Products Acquisition. For 1998 and the nine month period ended December 31, 1997, the Company's contingent participation obligation was not material to its consolidated financial position.
Litigation between Unocal Corp. and certain petroleum refiners has contested the validity of patents held by Unocal covering certain formulations for clean burning fuels meeting California fuel specifications and, in turn, alleged infringement of those patents by certain refiners. The Company is not a party to the patent litigation. Under the terms of the 76 Product Acquisition, the Company has no liability to Unocal for any possible past infringement of the patents, including to the date of final resolution of the matter, which, considering appeals, could take several years.
The Company has employment agreements with certain of its executive officers that provide for lump sum severance payments and accelerated vesting of options upon termination of employment under certain circumstances or a change of control, as defined. The Company's potential minimum obligation to eight officers was $6,365,000 at December 31, 1998.
The Company, in keeping with industry practice, schedules periodic maintenance of major processing units for significant non-routine repairs and replacements (turnarounds) as the units reach the end of their normal operating cycles. Unscheduled turnarounds or unit shutdowns also occur because of operating difficulties or external factors. Throughput and earnings are lowered, and deferred turnaround expenditures increased, during such periods.
The Company carries insurance policies on insurable risks, which it believes to be appropriate at commercially reasonable rates. While management believes the Company is adequately insured, future losses could exceed insurance policy limits or, under adverse interpretations, be excluded from coverage. Future liability or costs, if any, incurred under such circumstances would have to be paid out of general corporate funds. Cost of sales was reduced by insurance coverage accruals for property damage and business interruption claims, net of insurance policy deductibles and asset write-offs, related to the unscheduled shutdowns of the Bayway Refinery cat cracker and Avon Refinery hydrocracker in 1997.
In the normal course of business, the Company has entered into numerous crude oil and feedstock supply contracts, finished product sale and exchange agreements, and transportation contracts. Because of the market related pricing structure and/or generally short-term nature of these contracts, they are not expected to negatively impact the Company's future operating results.
19. BUSINESS SEGMENTS
The Company has two operating business segments: refining and marketing. The refining segment includes the acquisition of crude oil and other feedstocks, the production of petroleum products, and the distribution and sale of petroleum products to wholesale customers. The marketing segment includes the sale of petroleum products and merchandise through company owned gasoline stations and convenience stores and branded dealers and jobbers. The nonoperating segment consists of corporate activities and certain nonoperating subsidiaries. Summarized financial information by segment for 1998, 1997, and 1996 is as follows:
20. SUPPLEMENTAL CASH FLOW INFORMATION
21. SUBSEQUENT EVENTS
POLYPROPYLENE JOINT VENTURE
In February 1999, Tosco signed a memorandum of understanding to create a 50/50 joint venture with Union Carbide Corporation ("Union Carbide") for the marketing of polypropylene. A 775 million pounds per year polypropylene plant is planned to be constructed at the Bayway Refinery over the next two years. When completed, the joint venture is expected to be one of the top five suppliers of polypropylene in North America. The production from this new plant and Union Carbide's plants in Seadrift, Texas and Norco, Louisiana, estimated to be 1.6 billion pounds per year, will be committed to the joint venture and marketed by Union Carbide. Completion of the joint venture is subject to execution of definitive documents and satisfactory compliance with various conditions.
REVOLVING CREDIT FACILITY
In order to reduce financing costs, Tosco elected not to renew its $100 million Facility B under the Revolving Credit Facility when it expired on January 12, 1999.
AVON REFINERY INCIDENT
On February 23, 1999, a fire occurred at a crude unit at the San Francisco Area Refinery, Avon facility and resulted in four fatalities. The fire was quickly isolated and extinguished with no offsite impacts or health risks to the community. On March 2, 1999, Tosco announced that the Avon Refinery would be shutdown for at least 30 days, while a thorough safety review is conducted. As a result of this incident, management is assessing various strategies for the Avon Refinery. While such developments do not materially alter the restructuring accrual recorded in 1998 (Note 8), depending on the outcome of such assessment, the restructuring accrual may be modified in 1999.
22. NEW ACCOUNTING STANDARD
During June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 133 "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"). SFAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities. The Company plans to adopt SFAS No. 133 on January 1, 2000. The Company is currently evaluating the effect SFAS No. 133 will have on its financial position and results of operations.
23. QUARTERLY FINANCIAL DATA (UNAUDITED)
TOSCO CORPORATION AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997, AND 1996 (Thousands of Dollars)