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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the transition period from . . . . . . . . . . . to . . . . . . . . . . .

Commission File Number 1-3473

TESORO PETROLEUM CORPORATION

300 Concord Plaza Drive, San Antonio, Texas 78216-6999
(Address of principal executive offices) (Zip Code)

210-828-8484
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X]       No [   ]

There were 64,614,008 shares of the registrant’s Common Stock outstanding at May 1, 2003.

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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003

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PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in millions except per share amounts)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS
(Unaudited)
(In millions except per share amounts)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
(In millions)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE A – BASIS OF PRESENTATION

The interim Condensed Consolidated Financial Statements and Notes thereto of Tesoro Petroleum Corporation and its subsidiaries (collectively, the “Company” or “Tesoro”) have been prepared by management without audit pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, the accompanying financial statements reflect all adjustments that, in the opinion of management, are necessary for a fair presentation of results for the periods presented. Such adjustments are of a normal recurring nature. The Consolidated Balance Sheet at December 31, 2002 has been condensed from the audited Consolidated Financial Statements at that date. Certain information and notes normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to the SEC’s rules and regulations. However, management believes that the disclosures presented herein are adequate to make the information not misleading. The accompanying Condensed Consolidated Financial Statements and Notes should be read in conjunction with the Consolidated Financial Statements and Notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

The preparation of the Company’s Condensed Consolidated Financial Statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods. Actual results could differ from those estimates. The results of operations for any interim period are not necessarily indicative of results for the full year.

Certain amounts previously reported during 2002 have been reclassified to conform with the current presentation and the presentation in the consolidated financial statements for the year ended December 31, 2002. The Company reclassified the amortization of major maintenance refinery turnaround, catalyst and drydocking costs from costs of sales and operating expenses to depreciation and amortization in the Condensed Statements of Consolidated Operations. The Company also reclassified revenues and costs of sales in the Condensed Statements of Consolidated Operations to report certain crude oil and product purchases and resales on a net basis following guidance issued in 2002 by the Emerging Issues Task Force of the Financial Accounting Standards Board.

NOTE B – EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share are determined by dividing net earnings (loss) by the weighted average number of common shares outstanding during the period. For the three months ended March 31, 2003, the calculation of diluted earnings per share takes into account the effects of potentially dilutive common stock options outstanding during the period. The assumed exercise of common stock options produced anti-dilutive results for the three months ended March 31, 2002, and was not included in the calculation of diluted earnings per share. Earnings (loss) per share calculations are presented below for the three months ended March 31, 2003 and 2002 (in millions except per share amounts):

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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE C – DEBT

On April 17, 2003, the Company replaced its $1.275 billion senior secured credit facility (the “Credit Facility”) with a new credit agreement, senior secured term loans and 8% senior secured notes due 2008 (described below).

Credit Facility

As of March 31, 2003, the Company’s Credit Facility consisted of a five-year $225 million revolving credit facility (with a $150 million sublimit for letters of credit), a five-year tranche A term loan and a six-year tranche B term loan. As of March 31, 2003, the Company had no borrowings and $85.1 million in letters of credit outstanding under the revolving credit facility, resulting in total unused credit available of $139.9 million. Interest rates were 6.34% on the tranche A term loan and 8.5% on the tranche B term loan at March 31, 2003. The Company repaid $76.3 million on the term loans during the quarter ended March 31, 2003, which consisted of a $16.3 million prepayment in January 2003 from the proceeds of asset sales and a $60.0 million payment in March 2003, of which $13.0 million was a scheduled payment and $47.0 million was a voluntary prepayment. The Credit Facility required the Company to meet certain financial covenants, all of which were satisfied for the quarter ended March 31, 2003. In connection with the extinguishment of the Credit Facility in April 2003, the Company will expense $33 million of unamortized debt issuance costs during the 2003 second quarter.

Credit Agreement

On April 17, 2003, the Company entered into a new $650 million credit agreement (the “Credit Agreement”), consisting of a $500 million revolving credit facility (with a $400 million sublimit for letters of credit) maturing in June 2006 and a $150 million term loan maturing in April 2007. The Credit Agreement, together with the net proceeds of the $200 million senior secured term loans and $375 million aggregate principal amount of 8% senior secured notes discussed below, replaced the Company’s Credit Facility. In addition, $25 million of the proceeds were used to repurchase existing 9-5/8% senior subordinated notes.

The Credit Agreement provides for borrowings (including letters of credit) up to the lesser of $650 million or the amount of a weekly-adjusted borrowing base with respect to the Company’s eligible cash and cash equivalents, receivables and petroleum inventories, as defined in the Credit Agreement. As of April 30, 2003, the borrowing base under the Credit Agreement was $595 million of which $226 million was borrowed, including the $150 million term loan, and $198 million in letters of credit were outstanding.

The Credit Agreement contains covenants and conditions that, among other things, limit the Company’s ability to pay dividends, incur indebtedness, create liens and make investments. The Company is also required to maintain specified levels of fixed charge coverage and tangible net worth. Beginning with the quarter ending March 31, 2004, the fixed charge coverage ratio is waived if available borrowings under the Credit Agreement exceed 15% of the eligible borrowing base then in effect. The Credit Agreement requires the Company to maintain a collection account for cash receipts which will be used to repay borrowings outstanding on the revolving credit facility daily. The Credit Agreement is guaranteed by substantially all of the Company’s active subsidiaries and is secured by substantially all of the Company’s cash and cash equivalents, petroleum inventories and accounts receivable.

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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Borrowings under the Credit Agreement bear interest at either a base rate (4.25 % at April 30, 2003) or a eurodollar rate (1.32% at April 30, 2003), plus an applicable margin. The applicable margins at April 30, 2003 for the revolving credit facility were 1.5 % in the case of the base rate and 3.25 % in the case of the eurodollar rate. The applicable margins under the revolving credit facility vary based on borrowing levels. The applicable margins for the term loan were 2.25% in the case of the base rate and 4.0 % in the case of the eurodollar rate.

Senior Secured Term Loans

On April 17, 2003, the Company entered into new $200 million senior secured term loans due April 15, 2008 (“Term Loans”). The Term Loans are subject to optional redemption by the Company after one year at declining premiums of 3% in year two, 1% in year three and at par thereafter. In addition, the Company, for the first year, may use proceeds from certain equity issuances to redeem up to 35% of the aggregate principal amount, subject to a prepayment premium equal to the annual interest rate then in effect. The Term Loans contain covenants and restrictions which are less restrictive than those in the Credit Agreement. The Term Loans and the 8% senior secured notes described below are secured by substantially all of the Company’s Refining property, plant and equipment and are guaranteed by substantially all of our active subsidiaries.

Borrowings under the Term Loans bear interest at either a base rate (4.25 % at April 30, 2003) or a eurodollar rate (1.32 % at April 30, 2003), plus an applicable margin. The applicable margins at April 30, 2003 for the Term Loans were 4.5% in the case of the base rate and 5.5 % in the case of the eurodollar rate.

8% Senior Secured Notes Due 2008

On April 17, 2003, the Company issued $375 million aggregate principal amount of 8% Senior Secured Notes due April 15, 2008 (“2008 Notes”) through a private offering eligible for Rule 144A. The 2008 Notes have a five-year maturity with no sinking fund requirements and are subject to optional redemption by the Company after three years at a premium of 4% in year four and at par thereafter. In addition, the Company, for the first three years, may redeem up to 35% of the aggregate principal amount at a redemption price of 108% with proceeds from certain equity issuances. The indenture for the 2008 Notes contains covenants and restrictions which are customary for notes of this nature and are similar to the covenants in the indentures for the Company’s existing senior subordinated notes. The 2008 Notes and the Term Loans are secured by substantially all of the Company’s Refining property, plant and equipment and guaranteed by substantially all of Tesoro’s active subsidiaries. The 2008 Notes were issued at 98.994% of par, resulting in proceeds to the Company of $371.2 million. The effective interest rate on the 2008 Notes is 8.25%, after giving effect to the discount at the date of issue.

Debt Maturities

As of March 31, 2003, the aggregate scheduled maturities of debt for each of the five following 12-month periods were as follows: 2003-2004, $52.5 million; 2004-2005, $49.7 million; 2005-2006, $52.2 million; 2006-2007, $208.0 million; and 2007-2008, $489.3 million. Giving effect to the new financing on April 17, 2003, described above, our maturities for each of the five 12-month periods following March 31, 2003, would be as follows: 2003-2004, $7.4 million; 2004-2005, $5.0 million; 2005-2006, $5.0 million; 2006-2007, $4.5 million; and 2007-2008, $290.1 million. The above maturities exclude repayments of borrowings under our new revolving credit facility.

NOTE D – OPERATING SEGMENTS

The Company’s revenues are derived from two major operating segments, Refining and Retail. The Company also derives revenues from marine services activities included in the Other operating segment. Management has identified these segments for managing operations and investing activities and evaluates the performance of these segments and allocates resources based primarily on segment operating income. Segment operating income includes those revenues and expenses that are directly attributable to management of the respective segment. Intersegment sales from Refining to Retail are made at prevailing market rates.

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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Operating income includes charges for voluntary early retirement benefits and severance costs totaling $8.8 million in the 2003 first quarter, including a non-cash pretax charge of $7.0 million. The $8.8 million charge includes $2.6 million in Refining, $1.2 million in Retail, $0.4 million in Other and $4.6 million in Corporate. The Company offered voluntary early retirement benefits to 91 qualified employees, 50 of whom accepted. Income taxes, interest and financing costs, interest income, corporate general and administrative expenses and losses on asset sales are not included in determining segment operating income. Segment information is as follows (in millions):

Capital expenditures do not include major maintenance refinery turnaround, catalyst and drydocking costs of $8.5 million and $19.7 million for the three months ended March 31, 2003 and 2002, respectively.

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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Identifiable assets are those assets utilized by the segment. Corporate assets are principally cash, income taxes receivable and other assets that are not associated with an operating segment. Segment assets were as follows (in millions):

NOTE E – INVENTORIES

Components of inventories were as follows (in millions):

NOTE F – STOCK-BASED COMPENSATION

The Company accounts for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, compensation cost for stock options is measured as the excess, if any, of the quoted market price of the Company’s Common Stock at the date of grant over the amount an employee must pay to acquire the stock. The following table represents the effect on net earnings and earnings per share if the Company had applied a fair value based method and recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” for the grant of stock options (in millions except per share amounts):

For purposes of the pro forma disclosures above, the estimated fair value of stock-based compensation plans is amortized to expense primarily over the vesting period. The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model.

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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE G – COMMITMENTS AND CONTINGENCIES

The Company is a party to various litigation and contingent loss situations, including environmental and tax matters, arising in the ordinary course of business. The Company has made accruals in accordance with SFAS No. 5, “Accounting for Contingencies,” in order to provide for these matters. The ultimate effects of these matters cannot be predicted with certainty, and related accruals are based on management’s best estimates, subject to future developments. Although the resolution of certain of these matters could have a material adverse effect on interim or annual results of operations, the Company believes that the outcome of these matters will not result in a material adverse effect on its liquidity or consolidated financial position.

In the normal course of business, the Company is subject to audits by federal, state and local taxing authorities. It is possible that tax audits could result in claims against the Company in excess of liabilities currently recorded. Management believes, however, that the ultimate resolution of these matters will not materially affect the Company’s consolidated financial position or results of operations.

Environmental

The Company is subject to extensive federal, state and local environmental laws and regulations. These laws, which change frequently, regulate the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites, or install additional controls, or make other modifications or changes in use for certain emission sources.

Environmental Remediation Liabilities

The Company is currently involved with the U.S. Environmental Protection Agency (“EPA”) regarding a waste disposal site near Abbeville, Louisiana. The Company has been named a potentially responsible party under the Federal Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA” or “Superfund”) at this location. Although the Superfund law may impose joint and several liability upon each party at the site, the extent of the Company’s allocated financial contributions for cleanup is expected to be de minimis based upon the number of companies, volumes of waste involved and total estimated costs to close the site. The Company believes, based on these considerations and discussions with the EPA, that its liability at the Abbeville site will not exceed $25,000.

Soil and groundwater conditions at the California refinery may require substantial expenditures over time. The Company’s current estimate of costs to address environmental liabilities including soil and groundwater conditions at the refinery in connection with various projects, including those required pursuant to orders by the California Regional Water Quality Control Board, is approximately $73 million. The Company believes that approximately $63 million of such costs will be paid, directly or indirectly, by former owners or operators of the refinery (or their successors) under two separate indemnification agreements. Additionally, if remediation expenses are incurred in excess of the indemnification, the Company expects to receive coverage under certain environmental insurance policies.

The Company is currently involved in remedial responses and has incurred cleanup expenditures associated with environmental matters at a number of sites, including certain of its owned properties. At March 31, 2003, the Company’s accruals for environmental expenses totaled approximately $40 million. The Company’s accruals for environmental expenses include retained liabilities for previously owned or operated properties, refining, pipeline, terminal and marine services operations and retail service stations. Based on currently available information, including the participation of other parties or former owners in remediation actions, the Company believes these accruals are adequate.

Environmental Capital

In February 2000, the EPA finalized new regulations pursuant to the Clean Air Act requiring reduction in the sulfur content in gasoline beginning January 1, 2004. To meet this revised gasoline standard, the Company currently estimates it will make capital improvements of approximately $37 million through 2006 and an additional $15 million thereafter. This will permit all of the Company’s refineries to produce gasoline meeting the limits imposed by the EPA.

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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The EPA also promulgated new regulations in January 2001 pursuant to the Clean Air Act requiring a reduction in the sulfur content in diesel fuel manufactured for on-road consumption. In general, the new diesel fuel standards will become effective on June 1, 2006. Based on the latest engineering estimates, the Company expects to spend approximately $55 million in capital improvements through 2007. The Company does not plan to make similar expenditures at the Alaska refinery because limited demand for low sulfur diesel presently does not justify the capital investment. The Company expects to meet this demand from other sources.

The Company expects to spend approximately $50 million in additional capital improvements through 2006 to comply with the second phase of the Maximum Achievable Control Technologies standard for petroleum refineries (“Refinery MACT II”), promulgated in April 2002. The Refinery MACT II regulations require new emission controls at certain processing units at several of the Company’s refineries. The Company is currently evaluating a selection of control technologies to assure operations flexibility and compatibility with long-term air emission reduction goals.

The California refinery has made substantial expenditures to meet California’s CARB III gasoline requirements, including the mandatory phase-out of using the oxygenate known as MTBE by the end of 2003. To comply with these requirements, the Company spent approximately $75 million since May 2002, including $15.4 million in the first quarter of 2003. The CARB III project was substantially completed and commenced operations in March 2003.

In connection with the 2001 acquisition of the North Dakota and Utah refineries, the Company assumed the sellers’ obligations and liabilities under a consent decree among the United States, BP Exploration and Oil Co., Amoco Oil Company and Atlantic Richfield Company. BP entered into this consent decree for both the North Dakota and Utah refineries for various alleged violations. As the new owner of these refineries, the Company is required to address issues, including leak detection and repair, flaring protection and sulfur recovery unit optimization. The Company currently estimates it will spend an aggregate of $7 million to comply with this consent decree. In addition, the Company has agreed to indemnify the sellers for all losses of any kind incurred in connection with the consent decree.

In connection with the 2002 acquisition of the California refinery, subject to certain conditions, the Company also assumed the seller’s obligations pursuant to its settlement efforts with the Environmental Protection Agency concerning the Section 114 refinery enforcement initiative under the Clean Air Act, except for any potential monetary penalties, which the seller retains. The Company believes these obligations will not have a material impact on its financial position.

Based on latest estimates, the Company will need to spend additional capital at the California refinery for reconfiguring and replacing above ground storage tank systems and upgrading piping within the refinery. Those costs are currently estimated at approximately $130 million through 2007 and an additional estimated $90 million through 2011. Both of these estimates are subject to further review and analysis by the Company.

Conditions that require additional expenditures may transpire for various Company sites, including, but not limited to, the Company’s refineries, tank farms, retail gasoline stations (operating and closed locations) and petroleum product terminals, and for compliance with the Clean Air Act and other state, federal and local requirements. The Company cannot currently determine the amounts of such future expenditures.

Other

Union Oil Company of California has asserted claims against other refining companies for infringement of patents related to the production of certain reformulated gasoline. The Company’s California refinery produces grades of gasoline that might be subject to similar claims. Since the validity of those patents is being questioned by the U.S. Patent Office and the Federal Trade Commission, the Company has not paid or accrued liabilities for patent royalties that might be related to production at the California refinery.

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TESORO PETROLEUM CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE H – NEW ACCOUNTING STANDARDS

SFAS No. 143

On January 1, 2003, the Company adopted SFAS No. 143, “Accounting for Asset Retirement Obligations,” which addresses financial accounting and reporting for legal obligations associated with the retirement of long-lived assets. The Company has identified asset retirement obligations that are within the scope of the standard, including obligations imposed by certain state laws pertaining to closure and/or removal of storage tanks, and contractual removal obligations included in certain lease and right-of-way agreements associated with the Company’s retail, pipeline and terminal operations. The Company has estimated the fair value of its asset retirement obligations, based in part on the terms of the agreements and the probabilities associated with the eventual sale or other disposition of these assets. The Company cannot currently make reasonable estimates of the fair values of some retirement obligations, principally those associated with refineries, certain pipeline rights-of-way and certain terminals, because the related assets have indeterminate useful lives which preclude development of assumptions about the potential timing of settlement dates. Such obligations will be recognized in the period in which sufficient information exists to estimate a range of potential settlement dates. The present value of obligations was accrued to the extent that settlement dates could be estimated, primarily for assets on leased sites. The effect of adopting this accounting standard on January 1, 2003, was to increase property, plant and equipment by approximately $0.6 million, net of accumulated amortization and increase noncurrent other liabilities by approximately $1.7 million. The cumulative effect charge of approximately $1.1 million pretax is included in operating income due to immateriality. Additional depreciation and operating expense was less than $0.1 million for the three months ended March 31, 2003, and similarly, would not have had a material effect on the three months ended March 31, 2002, if the standard had been adopted in 2002.

Proposed Statement of Position

In 2001, the American Institute of Certified Public Accountants (“AICPA”) issued an Exposure Draft for a Proposed Statement of Position, “Accounting for Certain Costs and Activities Related to Property, Plant and Equipment.” The proposed Statement of Position (“SOP”), as originally written, would require major maintenance activities, such as refinery turnarounds, to be expensed as costs are incurred. If this proposed SOP is adopted as originally written, the Company would be required to write off the unamortized carrying value of deferred major maintenance costs and to expense future costs as incurred. At March 31, 2003, deferred major maintenance costs, which are included in other noncurrent assets – other in the Condensed Consolidated Balance Sheet, totaled $63.6 million.

FIN 46

In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which requires the consolidation of variable interest entities, as defined. FIN 46 applies immediately to variable interest entities created after January 31, 2003. The consolidation requirements apply to older entities in the first fiscal year or interim period beginning after June 15, 2003. Certain of the disclosure requirements apply to all financial statements issued after January 31, 2003, regardless of when the variable interest entity was established. The Company believes that FIN 46 will not result in the consolidation of any material variable interest entities.

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

Those statements in this section that are not historical in nature should be deemed forward-looking statements that are inherently uncertain. See “Forward-Looking Statements” on page 26 for a discussion of the factors that could cause actual results to differ materially from those projected in these statements.

BUSINESS OVERVIEW

Our earnings, cash flows from operations and liquidity depend upon many factors, including producing and selling refined products at margins above fixed and variable expenses. The prices of crude oil and refined products have fluctuated substantially in our markets. Our operating results can be significantly influenced by the timing of changes in crude oil costs and how quickly refined product prices adjust to reflect these changes. These price fluctuations depend on numerous factors beyond our control, including the demand for crude oil, gasoline and other refined products, which is subject to, among other things, changes in the economy and the level of foreign and domestic production of crude oil and refined products, worldwide political conditions, threatened or actual terrorist incidents or acts of war, availability of crude oil and refined product imports, the infrastructure to transport crude oil and refined products, weather conditions, earthquakes and other natural disasters, seasonal variation, government regulations and local factors, including market conditions and the level of operations of other refineries in our markets. As a result of these factors, margin fluctuations during any reporting period can have a significant impact on our results of operations, cash flows, liquidity and financial position.

During the first quarter of 2003, uncertainties related to the conflict in Iraq resulted in significant fluctuations in crude oil prices and refined product margins. Industry margins were negatively affected in January but recovered later in the quarter. Industry margins in the first quarter of 2003 in our market areas averaged above our five-year average (January 1, 1998 through December 31, 2002). We determine our “five-year average” by comparing gasoline, diesel and jet fuel prices to crude oil prices in our market areas, with volumes weighted according to our typical refinery yields, excluding heavy fuel oils. The cold winter in 2003 increased demand and margins for distillates. Jet fuel demand slowly improved and approached pre-September 11, 2001 levels. Gasoline supply tightened due to several factors, including changes in gasoline specifications related to the phase-out of MTBE in California.

To better enable us to withstand a low margin environment similar to that experienced in 2002, our 2003 goals include the reduction of ongoing cash expenses and elimination or deferral of capital expenditures. We also replaced our senior secured credit facility in April 2003 with a new credit agreement, term loans and senior secured notes, which provide increased financing flexibility, lower interest rates and the ability to accelerate debt reduction.

We expect a profitable second quarter of 2003, assuming industry margins continue near the five-year average and we achieve continued progress toward our debt reduction initiatives described below under “Business Strategy.” The second quarter will include a non-cash, pre-tax charge of $33 million for the unamortized debt issue costs related to our previous credit facility.

BUSINESS STRATEGY

Our strategy is to create a geographically focused, value-added refining and marketing business that has (i) economies of scale, (ii) a low-cost structure, (iii) superior management information systems and (iv) outstanding employees focused on business excellence, and that seeks to provide stockholders with competitive returns in any economic environment. Our immediate focus is to reduce our level of debt through a combination of cash flow from operations, cost savings and revenue enhancements.

Debt Reduction Initiatives

In June 2002, we announced our goal to reduce debt by $500 million by the end of 2003. As reflected in our 2002 operating results, we experienced a weak margin environment in 2002, which negatively affected our debt reduction plans. Nevertheless, through March 31, 2003, we have repaid $200 million of term loan debt since May 2002 of which $76 million was repaid in the 2003 first quarter, including a $16 million prepayment in January 2003, a $13 million scheduled payment in

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March 2003 and a $47 million voluntary prepayment in March 2003. We continue to pursue our goal to further reduce debt through positive operating cash flows and cash conservation measures based on the following initiatives: (i) a cost reduction and refinery improvement program, (ii) elimination or deferral of capital expenditures and refinery turnaround spending, (iii) achievement of system-wide synergies from the acquisition of our California refinery, (iv) asset sales and (v) increasing cash available to reduce debt through the reduction of early payments and prepayments by the use of letters of credit under our new credit agreement. Our next goal is to pay down at least an additional $150 million of debt by the end of the 2003 second quarter, assuming that the industry does not experience substantial increases in crude oil prices.

Cost Reduction and Refinery Improvement Program

Our largest initiative is to realize $65 million of operating income improvements in 2003 through cost reductions and refining improvements that do not require significant capital investments. During the 2003 first quarter we continued programs to consolidate our marketing organization, eliminate non-essential travel and reduce contract labor in both operations and administration. We completed a workforce reduction program in the first quarter which included a voluntary early retirement offer and various position eliminations. We estimate that the results of the workforce reduction program will yield annual savings of approximately $20 million. In addition, we made other reductions in manufacturing costs, but they were partially offset by higher utility expenses. Through these programs and other efficiencies, we achieved $15 million in operating improvements during the 2003 first quarter, including $10 million in cost reductions and $5 million in refining improvements. For the remainder of 2003, we expect to further reduce operating expenses by achieving economies in refinery maintenance and purchasing and other cost savings.

Reductions in Capital Expenditures and Refinery Turnaround Spending

Another initiative is to reduce capital expenditures and refinery turnaround spending. We currently expect to spend approximately $164 million in 2003, including approximately $47 million for major turnarounds at three of our refineries and approximately $5 million for retail projects. Capital expenditures in 2002 totaled $191 million for refining projects (including refinery turnaround and other major maintenance projects), $41 million for retail projects and $12 million for corporate and other projects. The reduced capital spending for retail projects reflects our current strategy of flat to modest growth that will focus on jobber investments in selected markets. We do not expect to build any new retail stations in 2003. We spent $36 million in the 2003 first quarter, which included $15 million for the CARB III project at the California refinery and $8 million for refinery turnaround and other major maintenance costs. With the March 2003 completion of the CARB III project, our California refinery can produce up to 93,000 barrels per day of CARB III gasoline.

Achievement of Synergies

We also are focusing on pursuing new synergies from our refinery system following the acquisition of the California refinery. Our goal is to achieve $25 million of annual system synergies by the end of 2003, and we achieved approximately $12 million in synergies in the 2003 first quarter. During the first quarter, we were able to achieve benefits that otherwise would have been unavailable without the California refinery. For example, we were able to increase the value of certain gasoline volumes through movements between refineries.

RESULTS OF OPERATIONS – THREE MONTHS ENDED MARCH 31, 2003 COMPARED WITH THREE MONTHS ENDED MARCH 31, 2002

Summary

Our net earnings were $20.4 million ($0.32 per basic share and diluted share) for the three months ended March 31, 2003 (“2003 Quarter”) compared with a net loss of $55.6 million ($1.15 net loss per basic share and diluted share) for the three months ended March 31, 2002 (“2002 Quarter”). The net earnings for the 2003 Quarter were primarily the result of our California refinery operations and improved margins in our Refining segment as discussed below, partially offset by additional interest and financing costs related to the acquisition of the California operations in May 2002. Voluntary early retirement benefits and severance costs resulted in charges of $8.8 million pretax, or $0.08 per share, in the 2003 Quarter.

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A discussion and analysis of the factors contributing to our results of operations are presented below. The accompanying Condensed Consolidated Financial Statements and related Notes, together with the following information, are intended to provide investors with a reasonable basis for assessing our operations, but should not serve as the only criteria for predicting our future performance.

Refining Segment

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Three Months Ended March 31, 2003 Compared with Three Months Ended March 31, 2002. Operating income from our Refining segment was $109 million in the 2003 Quarter compared to an operating loss of $36 million for the 2002 Quarter. Our results for the 2003 Quarter included operating income from the California refinery acquired in May 2002. The California operations contributed approximately $70 million to our Refining segment operating income during the 2003 Quarter.

The $145 million increase in our operating income was primarily due to the California refinery operations and improved refined product margins during the latter half of the 2003 Quarter, compared with the low margins in the 2002 Quarter. Our total refinery system gross margin averaged $6.92 per barrel in the 2003 Quarter compared to $2.52 in 2002 Quarter, reflecting California’s margin contribution and higher gross margins in all of our other regions. Gross margins per-barrel in our Pacific Northwest and Mid-Continent regions increased 150% and 107%, respectively. Our Pacific Northwest margins also were improved by an increase in throughput, compared with 2002 when the Washington refinery was in turnaround and its heavy oil conversion project was being completed. Industry margins on a national basis improved primarily due to increased demand and below average inventory levels for finished products. The cold winter in 2003 increased demand and margins for distillates. Jet fuel demand slowly improved and approached pre-September 11, 2001 levels. Increased distillate demand reduced overall industry inventory levels and gasoline production. In addition, the political instability in Venezuela and higher than normal industry maintenance during the 2003 Quarter reduced overall industry product inventory levels. Furthermore, west coast gasoline supply tightened due to several factors, including changes in gasoline specifications related to the phase-out of MTBE in California.

On an aggregate basis, our total gross refining margins increased from $80 million to $295 million in the 2003 Quarter, reflecting higher per-barrel refining margins in all of our regions and throughput volumes from the California refinery, which added 158 thousand barrels per day (“Mbpd”) to our total refinery system throughput in the 2003 Quarter compared to the 2002 Quarter. Throughput volumes were increased to approximately 483 Mbpd in March 2003 (despite a reduction of approximately 30 Mbpd at our Utah refinery due to a scheduled turnaround) due to the strong refined product margins. Based on the current margin environment, we anticipate throughput at our refineries to be between 510 and 520 Mbpd during the 2003 second quarter, taking into account the 30-day scheduled turnaround at our Alaska refinery which began in late April.

Revenues from sales of refined products increased 94% to $2,083 million in the 2003 Quarter, from $1,076 million in the 2002 Quarter, due to increased sales volumes from the California refinery and significantly higher product sales prices. Total product sales averaged 544 Mbpd in the 2003 Quarter, an increase of 21% from the 2002 Quarter. Our average product prices increased 63% to $42.59 per barrel. Costs of sales also increased due to the additional throughput from the California refinery and higher average prices for feedstocks and purchased product supply compared with the 2002 Quarter.

Expenses, excluding depreciation, increased to $156 million in the 2003 Quarter, primarily due to additional operating expenses of approximately $61 million from the California refinery. Depreciation and amortization increased to $30 million primarily due to depreciation and amortization from the California refinery.

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Retail Segment