Attached files

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EX-31.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 - ANDEAVORtso1q2016ex311.htm
EX-10.1 - AMENDMENT NO. 2 TO SECONDMENT AND LOGISTICS SERVICES AGREEMENT - ANDEAVORtso1q2016ex101.htm
EX-32.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 906 - ANDEAVORtso1q2016ex322.htm
EX-31.2 - CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO SECTION 302 - ANDEAVORtso1q2016ex312.htm
EX-32.1 - CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 906 - ANDEAVORtso1q2016ex321.htm
EX-4.1 - SUPPLEMENTAL INDENTURE, RELATING TO THE COMPANYS 4.250% SENIOR NOTES DUE 2017 - ANDEAVORtso1q2016ex41.htm
EX-4.2 - SUPPLEMENTAL INDENTURE, RELATING TO THE COMPANYS 5.125% SENIOR NOTES DUE 2024 - ANDEAVORtso1q2016ex42.htm

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10‑Q
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2016
or

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from_____________________to__________

Commission File Number 1‑3473

TESORO CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
95‑0862768
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
 
 
 
 
19100 Ridgewood Pkwy, San Antonio, Texas 78259-1828
(Address of principal executive offices) (Zip Code)
210-626-6000
(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 þ No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
þ
 
Accelerated filer
¨
 
 
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
 
Smaller reporting company
¨
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ

There were 119,975,826 shares of the registrant’s Common Stock outstanding at April 28, 2016.

 


TABLE OF CONTENTS
 
 

TESORO CORPORATION
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2016


PART I. FINANCIAL INFORMATION
Page
 
 
 
 
 
 
 
Condensed Consolidated Balance Sheets - March 31, 2016 and December 31, 2015
 
 
Condensed Statements of Consolidated Cash Flows - Three Months Ended March 31, 2016 and 2015
 
 
 
 
 
 
 
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2 | Tesoro Corporation 2016

FINANCIAL STATEMENTS
 
 

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS
 
TESORO CORPORATION
CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS (Unaudited)

 
Three Months Ended
March 31,
 
2016
 
2015
 
(In millions, except per share amounts)
Revenues (a)
$
5,101

 
$
6,463

Costs and Expenses:
 
 
 
Cost of sales (excluding the lower of cost or market inventory valuation adjustment) (a)
3,861

 
5,307

Lower of cost or market inventory valuation adjustment
147

 
(42
)
Operating expenses
616

 
577

Selling, general and administrative expenses
82

 
98

Depreciation and amortization expense
212

 
179

Loss on asset disposals and impairments
4

 
4

Operating Income
179

 
340

Interest and financing costs, net
(60
)
 
(55
)
Equity in earnings of equity method investments
2

 
1

Other income (expense), net
7

 
(2
)
Earnings Before Income Taxes
128

 
284

Income tax expense
30

 
96

Net Earnings from Continuing Operations
98

 
188

Earnings from discontinued operations, net of tax
11

 

Net Earnings
109

 
188

Less: Net earnings from continuing operations attributable to noncontrolling interest
40

 
43

Net Earnings Attributable to Tesoro Corporation
$
69

 
$
145

 
 
 
 
Net Earnings Attributable to Tesoro Corporation
 
 
 
Continuing operations
$
58

 
$
145

Discontinued operations
11

 

Total
$
69

 
$
145

Net Earnings per Share - Basic:
 
 
 
Continuing operations
$
0.49

 
$
1.17

Discontinued operations
0.09

 

Total
$
0.58

 
$
1.17

Weighted average common shares outstanding - Basic
119.6

 
125.2

Net Earnings per Share - Diluted:
 
 
 
Continuing operations
$
0.48

 
$
1.15

Discontinued operations
0.09

 

Total
$
0.57

 
$
1.15

Weighted average common shares outstanding - Diluted
121.2

 
126.9

 
 
 
 
Dividends per Share
$
0.50

 
$
0.425

 
 
 
 
Supplemental Information:
 
 
 
(a) Includes excise taxes collected by our marketing segment
$
142

 
$
140


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

Tesoro Corporation 2016 | 3




FINANCIAL STATEMENTS
 
 

TESORO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

 
March 31,
2016
 
December 31,
2015
 
(In millions, except share data)
ASSETS
 
 
 
Current Assets
 
 
 
Cash and cash equivalents (TLLP: $4 and $16, respectively)
$
439

 
$
942

Receivables, net of allowance for doubtful accounts
954

 
792

Inventories, net
1,875

 
2,302

Prepayments and other current assets
235

 
271

Total Current Assets
3,503

 
4,307

Net Property, Plant and Equipment (TLLP: $3,086 and $3,450, respectively)
9,494

 
9,541

Other Noncurrent Assets
 
 
 
Acquired intangibles, net (TLLP: $970 and $976, respectively)
1,265

 
1,211

Other, net (TLLP: $485 and $214, respectively)
1,749

 
1,273

Total Other Noncurrent Assets
3,014

 
2,484

Total Assets
$
16,011

 
$
16,332

 
 
 
 
LIABILITIES AND EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
1,492

 
$
1,568

Other current liabilities
776

 
962

Total Current Liabilities
2,268

 
2,530

Deferred Income Taxes
1,228

 
1,222

Other Noncurrent Liabilities
809

 
773

Debt, Net of Unamortized Issuance Costs (TLLP: $2,821 and $2,844, respectively)
4,046

 
4,067

Total Liabilities
8,351

 
8,592

Commitments and Contingencies (Note 9)


 


Equity
 
 
 
Tesoro Corporation Stockholders’ Equity
 
 
 
Common stock, par value $0.162/3; authorized 200,000,000 shares; 159,247,717 shares issued (158,457,663 in 2015)
26

 
26

Additional paid-in capital
1,401

 
1,391

Retained earnings
5,962

 
5,954

Treasury stock, 39,320,730 common shares (39,064,342 in 2015), at cost
(2,028
)
 
(2,009
)
Accumulated other comprehensive loss, net of tax
(139
)
 
(149
)
Total Tesoro Corporation Stockholders’ Equity
5,222

 
5,213

Noncontrolling Interest
2,438

 
2,527

Total Equity
7,660

 
7,740

Total Liabilities and Equity
$
16,011

 
$
16,332


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

4 | Tesoro Corporation 2016

FINANCIAL STATEMENTS
 
 

TESORO CORPORATION
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)

 
Three Months Ended
March 31,
 
2016
 
2015
 
(In millions)
Cash Flows From (Used In) Operating Activities
 
 
 
Net earnings
$
109

 
$
188

Adjustments to reconcile net earnings to net cash from operating activities:
 
 
 
Depreciation and amortization expense
212

 
179

Lower of cost or market inventory valuation adjustment, net
147

 
(42
)
Stock-based compensation expense (benefit)
(3
)
 
28

Turnaround and branding charges
(133
)
 
(83
)
Other non-cash operating activities
(3
)
 
(16
)
Changes in current assets and current liabilities
(22
)
 
(428
)
Changes in noncurrent assets and noncurrent liabilities
(123
)
 
26

Net cash from (used in) operating activities
184

 
(148
)
Cash Flows Used In Investing Activities
 
 
 
Capital expenditures
(217
)
 
(271
)
Acquisition, net of cash
(314
)
 

Other investing activities
(4
)
 
(2
)
Net cash used in investing activities
(535
)
 
(273
)
Cash Flows From (Used In) Financing Activities
 
 
 
Borrowings under revolving credit agreements
297

 
99

Repayments on revolving credit agreements
(67
)
 
(124
)
Repayments of debt
(252
)
 

Dividend payments
(60
)
 
(54
)
Net proceeds from issuance of Tesoro Logistics LP common units
5

 
24

Distributions to noncontrolling interest
(48
)
 
(44
)
Purchases of common stock

 
(19
)
Taxes paid related to net share settlement of equity awards
(20
)
 
(39
)
Other financing activities
(7
)
 
37

Net cash used in financing activities
(152
)
 
(120
)
Decrease in Cash and Cash Equivalents
(503
)
 
(541
)
Cash and Cash Equivalents, Beginning of Period
942

 
1,000

Cash and Cash Equivalents, End of Period
$
439

 
$
459


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


Tesoro Corporation 2016 | 5




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 


NOTE 1 – BASIS OF PRESENTATION

ORGANIZATION

As used in this report, the terms “Tesoro,” “we,” “us” or “our” may refer to Tesoro Corporation, one or more of its consolidated subsidiaries or all of them taken as a whole. The words “we,” “us” or “our” generally include Tesoro Logistics LP (“TLLP”) and its subsidiaries as consolidated subsidiaries of Tesoro Corporation with certain exceptions where there are transactions or obligations between TLLP and Tesoro Corporation or its other subsidiaries. When used in descriptions of agreements and transactions, “TLLP” or the “Partnership” refers to TLLP and its consolidated subsidiaries.

PRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION

The interim condensed consolidated financial statements and notes thereto of Tesoro Corporation and its subsidiaries have been prepared by management without audit according to the rules and regulations of the Securities and Exchange Commission (“SEC”) and 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, unless otherwise disclosed. The consolidated balance sheet at December 31, 2015 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 present the information fairly. The accompanying condensed consolidated financial statements and notes should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2015.

We prepare our condensed consolidated financial statements in conformity with U.S. GAAP, which requires management to make estimates and assumptions that affect the reported amounts and disclosures of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. We review our estimates on an ongoing basis. Changes in facts and circumstances may result in revised estimates and 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 prior year balances have been aggregated or disaggregated in order to conform to the current year presentation. For the three months ended March 31, 2016, accumulated other comprehensive income decreased $10 million, net of tax, due to the recognition of a settlement loss for one of our executive retirement plans and remeasurement of the pension liability. Due to there being no material impact to accumulated other comprehensive income for the three months ended March 31, 2016 and 2015, consolidated statements of comprehensive income have been omitted.

Certain reclassifications have been made to prior period presentation to conform to the current year. In 2016, we revised the process by which we reclassify certain logistics costs, primarily recognized by TLLP, during consolidation from operating expenses and selling, general and administrative expense to costs of sales in order to best reflect distribution costs related to Tesoro’s sale of refined products during the ordinary course of business. This change in process did not impact current or prior segment operating results, rather we reclassified $75 million from costs of sales and recognized $68 million in operating expenses and $7 million in selling, general and administrative expenses of in the condensed statement of consolidated operations for the three months ended March 31, 2015 to conform to current period presentation.

TLLP. Our condensed consolidated financial statements include TLLP, a variable interest entity. TLLP is a publicly traded limited partnership that was formed to own, operate, develop and acquire logistics assets. Its assets are integral to the success of Tesoro’s refining and marketing operations and are used to gather crude oil and natural gas, process natural gas, and distribute, transport and store crude oil and refined products. TLLP provides us with various terminal distribution, storage, pipeline transportation, natural gas liquids processing, trucking and petroleum-coke handling services under long-term, fee-based commercial agreements. Each of these agreements, with the exception of the storage and transportation services agreement, contain minimum volume commitments. We do not provide financial or equity support through any liquidity arrangements or financial guarantees to TLLP.


6 | Tesoro Corporation 2016

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

Tesoro Logistics GP, LLC (“TLGP”), our wholly-owned subsidiary, serves as the general partner of TLLP. We held an approximate 36% interest in TLLP at both March 31, 2016 and December 31, 2015, including an approximate 2% general partner interest and all of the incentive distribution rights. This interest at March 31, 2016 includes 32,445,115 common units and 1,900,515 general partner units. As the general partner of TLLP, we have the sole ability to direct the activities of TLLP that most significantly impact its economic performance. We are also considered to be the primary beneficiary for accounting purposes and are TLLP’s primary customer. Under our various long-term, fee-based commercial agreements with TLLP, transactions with us accounted for 56% of TLLP’s total revenues for both the three months ended March 31, 2016 and 2015. In the event TLLP incurs a loss, our operating results will reflect TLLP’s loss, net of intercompany eliminations.

DISCONTINUED OPERATIONS. On September 25, 2013, we completed the sale of all of our interest in Tesoro Hawaii, LLC, which operated a 94 thousand barrels per day Hawaii refinery, retail stations and associated logistics assets (the “Hawaii Business”). The results of operations for this business have been presented as discontinued operations in the condensed statements of consolidated operations for the three months ended March 31, 2016 and 2015. There were no revenues for either the three months ended March 31, 2016 or 2015. We recorded a gain for the three months ended March 31, 2016 of $17 million and $11 million before and after tax, respectively, related to the calendar year 2015 earn-out owed to Tesoro. There were no recorded gains or losses before or after tax for the three months ended March 31, 2015. Cash flows used in discontinued operations were $2 million for the three months ended March 31, 2016. There were no cash flows for the three months ended March 31, 2015. Unless otherwise noted, the information in the notes to the condensed consolidated financial statements relates to our continuing operations.

NEW ACCOUNTING STANDARDS AND DISCLOSURES

REVENUE RECOGNITION. In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”), which provides accounting guidance for all revenue arising from contracts to provide goods or services to customers. ASU 2014-09 is effective for interim and annual periods beginning after December 15, 2017 given the FASB’s recent deferral of ASU 2014-09’s effective date. Entities may choose to early adopt ASU 2014-09 as of the original effective date. The standard allows for either full retrospective adoption or modified retrospective adoption. We are currently evaluating the impact of the standard on our financial statements and related disclosures. Based on our initial evaluation, we believe that the standard could impact the amount and timing of revenues we recognize in our TLLP operating segment as certain revenue arrangements require TLLP to provide multiple services and may include variable consideration.

CONSOLIDATION. In February 2015, the FASB issued ASU 2015-02, “Amendments to the Consolidation Analysis” (“ASU 2015-02”). This standard modifies existing consolidation guidance for reporting organizations that are required to evaluate whether they should consolidate certain legal entities. ASU 2015-02 is effective for interim and annual periods beginning after December 15, 2015, and requires either a retrospective or a modified retrospective approach to adoption. We adopted this guidance using the modified retrospective approach as of January 1, 2016 and performed the required reassessments outlined by the guidance. For further information on the results of the reassessments, refer to Note 4, Investments - Equity Method and Joint Ventures.

BUSINESS COMBINATIONS. In September 2015, the FASB issued ASU 2015-16, “Simplifying the Accounting for Measurement-Period Adjustments” (“ASU 2015-16”). The standard requires an acquirer to recognize the cumulative impact of adjustments to provisional purchase price amounts that are identified during the measurement period in the reporting period, in which the adjustment amounts are determined. The standard also requires an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. ASU 2015-16 is effective for interim and annual periods beginning after beginning after December 15, 2015 and must be applied prospectively to adjustments that occur after the effective date. We adopted this guidance as of January 1, 2016 with no impact to our financial statements.

LEASES. In February 2016, the FASB issued ASU 2016-02, “Leases” (“ASU 2016-02”), which improves transparency and comparability among organizations by requiring lessees to recognize a lease liability and a corresponding lease asset for virtually all lease contracts. It also requires additional disclosures about leasing arrangements. ASU 2016-02 is effective for interim and annual periods beginning after December 15, 2018, and requires a modified retrospective approach to adoption. Early adoption is permitted. At this time, we are evaluating the potential impact of this standard on our financial statements.

SHARE-BASED COMPENSATION. In March 2016, the FASB issued ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”), which simplifies several aspects of the accounting for employee share-based payment

Tesoro Corporation 2016 | 7




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

transactions including accounting for income taxes, cash flow presentation of tax impacts, forfeitures, and liability versus equity accounting due to statutory tax withholding requirements. ASU 2016-09 is effective for interim and annual periods beginning after December 15, 2016, with early adoption permitted. As of January 1, 2016, we early adopted ASU 2016-09 and with respect to the guidance on forfeitures, we have elected to continue to estimate forfeitures on the date of grant to account for the estimated number of awards for which the requisite service period will not be rendered. The adoption of ASU 2016-09 resulted in a $13 million benefit to our income tax provision lowering our effective tax rate for the three months ended March 31, 2016 to 23.4% and an immaterial simplification of our cash flow presentation.

NOTE 2 – INVENTORIES

COMPONENTS OF INVENTORIES (in millions)

 
March 31,
2016
 
December 31,
2015
Domestic crude oil and refined products
$
2,069

 
$
2,142

Foreign subsidiary crude oil
120

 
325

Materials and supplies
134

 
140

Oxygenates and by-products
58

 
54

Less: Lower of cost or market reserve
(506
)
 
(359
)
Total Inventories, net
$
1,875

 
$
2,302


We recorded a lower of cost or market adjustment to cost of sales of $506 million at March 31, 2016 for our crude oil, refined products, oxygenates and by-product inventories to adjust carrying value of our inventories to reflect replacement cost. At December 31, 2015, we recorded a $359 million lower of cost or market adjustment for the same inventories, which was reversed in the first quarter of 2016 as the inventories associated with the adjustment at the end of 2015 were sold or used during the first quarter of 2016.

NOTE 3 – PROPERTY, PLANT AND EQUIPMENT

PROPERTY, PLANT AND EQUIPMENT, AT COST BY SEGMENT (in millions)

 
March 31,
2016
 
December 31,
2015
Refining
$
7,893

 
$
7,504

TLLP
3,502

 
3,847

Marketing
917

 
915

Corporate
309

 
296

Property, Plant and Equipment, at Cost
12,621

 
12,562

Accumulated depreciation
(3,127
)
 
(3,021
)
Net Property, Plant and Equipment
$
9,494

 
$
9,541


We capitalize interest as part of the cost of major projects during the construction period. Capitalized interest totaled $6 million and $9 million for the three months ended March 31, 2016 and 2015, respectively, and is recorded as a reduction to net interest and financing costs in our condensed statements of consolidated operations.

GREAT NORTHERN MIDSTREAM ACQUISITION

On January 8, 2016, we closed the acquisition of Great Northern Midstream LLC, a crude oil logistics provider which owns and operates a crude oil pipeline and gathering system, along with transportation, storage and rail load facilities in the Williston Basin of North Dakota. The acquisition includes a 97-mile crude oil pipeline, a proprietary 28-mile gathering system in the core of the Bakken, and a facility that has capacity of 154 thousand barrels per day (“Mbpd”) for rail loading and 657,000 barrels of storage in Fryburg, North Dakota. This acquisition was immaterial to our condensed consolidated financial statements.


8 | Tesoro Corporation 2016

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

NOTE 4 – INVESTMENTS - EQUITY METHOD AND JOINT VENTURES

For each of the following investments, we have the ability to exercise significant influence over each of these investments through our participation in the management committees, which make all significant decisions. However, since we have equal or proportionate influence over each committee as a joint interest partner and all significant decisions require consent of the other investor(s) without regard to our economic interest, we have determined that these entities should not be consolidated and apply the equity method of accounting with respect to our investments in each entity.

Watson Cogeneration Company (“Watson”) - We own a 51% interest in Watson, which produces steam and electricity at a facility located at our Los Angeles refinery. Our transactions with Watson, which do not have intra-entity profits requiring elimination, consist of sales of fuel gas and water, purchases of steam and electricity and charges for general and administrative support.
Vancouver Energy - We own 50% of a joint venture with Savage Companies to construct, own and operate a unit train unloading and marine loading terminal at Port of Vancouver, USA (the “Vancouver Energy” terminal) with a total capacity of 360 Mbpd allowing for the delivery of cost-advantaged North American crude oil to the U.S. West Coast.
RGS - TLLP has a 78% interest in RGS, which owns and operates the infrastructure that transports gas from certain fields to several re-delivery points in southwestern Wyoming, including natural gas processing facilities that are owned by TLLP or a third party. Prior to 2016, Tesoro and TLLP consolidated RGS, however, upon the reassessment performed in conjunction with the adoption of ASU 2015-02 as of January 1, 2016, we determined RGS represents a variable interest entity to TLLP for which we are not the primary beneficiary. Under the limited liability company agreement, we do not have voting rights commensurate with our economic interest due to veto rights available to our partner in RGS. Certain business decisions, including, but not limited to, decisions with respect to significant expenditures or contractual commitments, annual budgets, material financings, dispositions of assets or amending the members’ gas servicing agreements, require unanimous approval of the members.
Three Rivers Gathering, L.L.C. (“TRG”) - TLLP owns a 50% interest in TRG which operates natural gas gathering assets within the southeastern Uinta Basin and is primarily supported by long-term, fee-based gas gathering agreements with minimum volume commitments.
Uintah Basin Field Services, L.L.C. (“UBFS”) - TLLP owns a 38% interest in UBFS which owns and operates the natural gas gathering infrastructure located in the southeastern Uinta Basin and is supported by long-term, fee-based gas gathering agreements that contain firm throughput commitments, which generate fees whether or not the capacity is used, and is operated by TLLP.

EQUITY METHOD INVESTMENTS (in millions)

 
Watson
 
Vancouver Energy
 
TLLP
 
 
 
 
 
RGS
 
TRG
 
UBFS
 
Total
Balance at December 31, 2015
$
92

 
$
9

 
$

 
$
42

 
$
16

 
$
159

Effect of deconsolidation (a)

 

 
295

 

 

 
295

Equity in earnings (loss)
(2
)
 

 
2

 
1

 
1

 
2

Distributions received

 

 
(9
)
 
(1
)
 
(1
)
 
(11
)
Balance at March 31, 2016
$
90

 
$
9

 
$
288

 
$
42

 
$
16

 
$
445


(a)
The reassessment of the investments performed by TLLP resulted in the deconsolidation of RGS and the reporting of RGS as an equity method investment. TLLP recognized an increase of $295 million to equity method investments as of January 1, 2016 as a result of the deconsolidation in addition to a cumulative effect reduction to opening equity of $2 million related to the difference in earnings under the equity method of accounting in prior periods. The carrying amount of our investment in RGS exceeded the underlying equity in net assets by $139 million at March 31, 2016.


Tesoro Corporation 2016 | 9




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

NOTE 5 – DERIVATIVE INSTRUMENTS

In the ordinary course of business, our profit margins, earnings and cash flows are impacted by the timing, direction and overall change in pricing for commodities used throughout our operations. We use non-trading derivative instruments to manage our exposure to the following:

price risks associated with the purchase or sale of feedstocks, refined products and energy supplies related to our refineries, terminals, marketing fuel inventory and customers;
price risks associated with inventories above or below our target levels;
future emission credit requirements; and
exchange rate fluctuations on our purchases of Canadian crude oil.

Our accounting for derivative instruments depends on whether the underlying commodity will be used or sold in the normal course of business. For contracts where the crude oil or refined products are expected to be used or sold in the normal course of business, we apply the normal purchase normal sale exception and follow the accrual method of accounting. All other derivative instruments are recorded at fair value using mark-to-market accounting.

Our derivative instruments include forward purchase and sale contracts (“Forward Contracts”), exchange-traded futures (“Futures Contracts”), over-the-counter swaps (“OTC Swap Contracts”), options (“Options”), and over-the-counter options (“OTC Option Contracts”). Forward Contracts are agreements to buy or sell the commodity at a predetermined price at a specified future date. Futures Contracts are standardized agreements, traded on a futures exchange, to buy or sell the commodity at a predetermined price at a specified future date. Options provide the right, but not the obligation to buy or sell the commodity at a specified price in the future. OTC Swap Contracts and OTC Option Contracts require cash settlement for the commodity based on the difference between a contracted fixed or floating price and the market price on the settlement date. Certain of these contracts require cash collateral to be received or paid if our asset or liability position, respectively, exceeds specified thresholds. We believe that we have minimal credit risk with respect to our counterparties.

The following table presents the fair value of our derivative instruments as of March 31, 2016 and December 31, 2015. The fair value amounts below are presented on a gross basis and do not reflect the netting of asset and liability positions permitted under the terms of our master netting arrangements including cash collateral on deposit with, or received from, brokers. We offset the recognized fair value amounts for multiple derivative instruments executed with the same counterparty in our financial statements when a legal right of offset exists. As a result, the asset and liability amounts below will not agree with the amounts presented in our condensed consolidated balance sheets.

DERIVATIVE ASSETS AND LIABILITIES (in millions)

 
 
 
Derivative Assets
 
Derivative Liabilities
 
Balance Sheet Location
 
March 31,
2016
 
December 31,
2015
 
March 31,
2016
 
December 31,
2015
Commodity Futures Contracts
Prepayments and other current assets
 
$
532

 
$
711

 
$
582

 
$
673

Commodity Swap Contracts
Prepayments and other current assets
 
9

 
15

 
6

 
14

Commodity Swap Contracts
Receivables
 
5

 
7

 

 

Commodity Forward Contracts
Receivables
 
1

 
2

 

 

Commodity Forward Contracts
Accounts payable
 

 

 
2

 
4

Total Gross Mark-to-Market
   Derivatives
 
 
547

 
735

 
590

 
691

Less: Counterparty Netting and
   Cash Collateral (a)
 
 
(426
)
 
(675
)
 
(535
)
 
(687
)
Total Net Fair Value of Derivatives
 
$
121

 
$
60

 
$
55

 
$
4


(a)
Certain of our derivative contracts, under master netting arrangements, include both asset and liability positions. We offset both the fair value amounts and any related cash collateral amounts recognized for multiple derivative instruments executed with the same counterparty when there is a legally enforceable right and an intention to settle net or simultaneously. As of March 31, 2016 and December 31, 2015, we had provided cash collateral amounts of $109 million and $12 million, respectively, related to our unrealized derivative positions. Cash collateral amounts are netted with mark-to-market derivative assets.

10 | Tesoro Corporation 2016

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

GAINS (LOSSES) ON MARK-TO-MARKET DERIVATIVES (in millions)

 
Three Months Ended
March 31,
 
 
2016
 
2015
Commodity Futures Contracts
$
24

 
$
43

Commodity OTC Swap Contracts
(2
)
 

Commodity Forward Contracts
16

 
2

Foreign Currency Forward Contracts (a)
1

 
(2
)
Total Gain on Mark-to-Market Derivatives
$
39

 
$
43


(a)
Gain (losses) for our foreign currency forward contracts are located in other income, net in our condensed statements of consolidated operations.

INCOME STATEMENT LOCATION OF GAINS ON MARK-TO-MARKET COMMODITY DERIVATIVES (in millions)

 
Three Months Ended
March 31,
 
 
2016
 
2015
Revenues
$
15

 
$
4

Cost of sales
23

 
41

Total Gain on Mark-to-Market Derivatives
$
38

 
$
45


OPEN LONG (SHORT) POSITIONS

OUTSTANDING COMMODITY AND OTHER CONTRACTS (units in thousands)

 
Contract Volumes by Year of Maturity
 
Unit of Measure
Mark-to-Market Derivative Instrument
2016
 
2017
 
2018
 
Crude oil, refined products and blending products:
 
 
 
 
 
 
 
Futures - short
(9,299)
 
 
(23)
 
Barrels
Futures - long
 
8
 
 
Barrels
OTC Swaps - long
451
 
 
 
Barrels
Forwards - long
805
 
 
 
Barrels
Carbon emissions credits:
 
 
 
 
 
 
 
Futures - long
4,725
 
1,000
 
 
Tons
Corn:
 
 
 
 
 
 
 
Futures - short
(670)
 
 
 
Bushels

At March 31, 2016, we had open Forward Contracts to purchase CAD $16 million that were settled on April 25, 2016.

NOTE 6 – FAIR VALUE MEASUREMENTS

We classify financial assets and liabilities according to the fair value hierarchy. Financial assets and liabilities classified as level 1 instruments are valued using quoted prices in active markets for identical assets and liabilities. Level 2 instruments are valued using quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices, such as liquidity, that are observable for the asset or liability. Our level 2 instruments include derivatives valued using market quotations from independent price reporting agencies, third-party brokers and commodity exchange price curves that are corroborated with market data. Level 3 instruments are valued using significant unobservable inputs that are not supported by sufficient market activity. We do not have any financial assets or liabilities classified as level 3 at March 31, 2016 or December 31, 2015.


Tesoro Corporation 2016 | 11




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

Our financial assets and liabilities measured at fair value on a recurring basis include derivative instruments. Additionally, our financial liabilities include obligations for Renewable Identification Numbers (“RINs”) and cap and trade emission credits for the state of California (together with RINs, our “Environmental Credit Obligations”). See Note 5 for further information on our derivative instruments. Our Environmental Credit Obligations represent the estimated fair value amount at each balance sheet date for which we do not have sufficient RINs and California cap and trade credits to satisfy our obligations to the U.S. Environmental Protection Agency (“EPA”) and the state of California, respectively. RINs are assigned to biofuels produced or imported into the U.S. as required by the EPA, which sets annual quotas for the percentage of biofuels that must be blended into transportation fuels consumed in the U.S. As a producer of petroleum transportation fuels, we are required to blend biofuels into the products we produce at a rate that will meet the EPA’s quota. We must purchase RINs in the open market to satisfy the requirement if we are unable to blend at that rate. Our liability for cap and trade emission credits for the state of California represent the deficit of credits to satisfy emission reduction requirements mandated in California’s Assembly Bill 32 for each period which stationary or transportation fuel carbon emissions exceed the level allowed by the regulation.

FINANCIAL ASSETS AND LIABILITIES AT FAIR VALUE (in millions)

 
March 31, 2016

Level 1

Level 2

Level 3
 
Netting and Collateral (a)
 
Total
Assets:





 
 
 
 
Commodity Futures Contracts
$
527

 
$
5

 
$

 
$
(426
)
 
$
106

Commodity Swap Contracts

 
14

 

 

 
14

Commodity Forward Contracts

 
1

 

 

 
1

Total Assets
$
527

 
$
20

 
$

 
$
(426
)
 
$
121










 
 
 
 
Liabilities:








 
 
 
 
Commodity Futures Contracts
$
580

 
$
2

 
$

 
$
(535
)
 
$
47

Commodity OTC Swap Contracts

 
6

 

 

 
6

Commodity Forward Contracts

 
2

 

 

 
2

Environmental Credit Obligations

 
52

 

 

 
52

Total Liabilities
$
580

 
$
62

 
$

 
$
(535
)
 
$
107


 
December 31, 2015
 
Level 1
 
Level 2
 
Level 3
 
Netting and Collateral (a)
 
Total
Assets:
 
 
 
 
 
 
 
 
 
Commodity Futures Contracts
$
711

 
$

 
$

 
$
(660
)
 
$
51

Commodity Swap Contracts

 
22

 

 
(15
)
 
7

Commodity Forward Contracts

 
2

 

 

 
2

Total Assets
$
711

 
$
24

 
$

 
$
(675
)
 
$
60

 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Commodity Futures Contracts
$
673

 
$

 
$

 
$
(673
)
 
$

Commodity OTC Swap Contracts

 
14

 

 
(14
)
 

Commodity Forward Contracts

 
4

 

 

 
4

Environmental Credit Obligations

 
40

 

 

 
40

Total Liabilities
$
673

 
$
58

 
$

 
$
(687
)
 
$
44


(a)
Certain of our derivative contracts, under master netting arrangements, include both asset and liability positions. We offset both the fair value amounts and any related cash collateral amounts recognized for multiple derivative instruments executed with the same counterparty when there is a legally enforceable right and an intention to settle net or simultaneously. As of March 31, 2016 and December 31, 2015, we had provided cash collateral amounts of $109 million and $12 million, respectively, related to our unrealized derivative positions. Cash collateral amounts are netted with mark-to-market derivative assets.


12 | Tesoro Corporation 2016

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

We believe the carrying value of our other financial instruments, including cash and cash equivalents, receivables, accounts payable and certain accrued liabilities approximate fair value. Our fair value assessment incorporates a variety of considerations, including the short-term duration of the instruments and the expected future insignificance of bad debt expense, which includes an evaluation of counterparty credit risk. The borrowings under the Tesoro Corporation revolving credit facility (the “Revolving Credit Facility”), the TLLP senior secured revolving credit agreement (the “TLLP Revolving Credit Facility”) and the secured TLLP drop down credit facility (the “TLLP Dropdown Credit Facility”), which include variable interest rates, approximate fair value. The fair value of our fixed rate debt is based on prices from recent trade activity and is categorized in level 2 of the fair value hierarchy. The carrying values of our debt were approximately $4.1 billion at March 31, 2016 and December 31, 2015, and the fair values of our debt were approximately $4.1 billion at March 31, 2016 and December 31, 2015. These carrying and fair values of our debt do not consider the unamortized issuance costs, which are netted against our total debt.

NOTE 7 – DEBT

DEBT BALANCE, NET OF UNAMORTIZED ISSUANCE COSTS (in millions)

 
March 31,
2016
 
December 31,
2015
Total debt (a)
$
4,126

 
$
4,147

Unamortized issuance costs (b)
(74
)
 
(74
)
Current maturities
(6
)
 
(6
)
Debt, Net of Current Maturities and Unamortized Issuance Costs
$
4,046

 
$
4,067


(a)
Total debt related to TLLP, which is non-recourse to Tesoro, except for TLGP, was $2.9 billion at both March 31, 2016 and December 31, 2015.
(b)
Includes unamortized premium associated with TLLP’s 5.875% Senior Notes due 2020 of $4 million at both March 31, 2016 and December 31, 2015.

REVOLVING CREDIT FACILITIES

AVAILABLE CAPACITY UNDER CREDIT FACILITIES (in millions)
 
Total
Capacity
 
Amount Borrowed as of March 31, 2016
 
Outstanding
Letters of Credit
 
Available Capacity
 
Expiration
Tesoro Corporation Revolving
Credit Facility (a)
$
1,329

 
$

 
$
4

 
$
1,325

 
November 18, 2019
TLLP Revolving Credit Facility
600

 
285

 

 
315

 
January 29, 2021
TLLP Dropdown Credit Facility
1,000

 
250

 

 
750

 
January 29, 2021
Letter of Credit Facilities
1,795

 

 
72

 
1,723

 
 
Total Credit Facilities
$
4,724

 
$
535

 
$
76

 
$
4,113

 
 

(a)
Borrowing base is the lesser of the amount of the periodically adjusted borrowing base or the agreement’s total capacity of $3.0 billion.

TESORO CORPORATION REVOLVING CREDIT FACILITY. Our Revolving Credit Facility provides for borrowings (including letters of credit) up to the lesser of the amount of a periodically adjusted borrowing base, which consists of Tesoro’s eligible cash and cash equivalents, receivables and petroleum inventories, net of the standard reserve as defined, or the Revolving Credit Facility’s total capacity of $3.0 billion. We had unused credit availability of approximately 100% of the eligible borrowing base at March 31, 2016. Our Revolving Credit Facility is guaranteed by substantially all of Tesoro’s active domestic subsidiaries, excluding TLGP, TLLP and its subsidiaries, and certain foreign subsidiaries, and is secured by substantially all of Tesoro’s active domestic subsidiaries’ crude oil and refined product inventories, cash and receivables.


Tesoro Corporation 2016 | 13




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

The Revolving Credit Facility allows us to obtain letters of credit under separate letter of credit agreements for foreign crude oil purchases. Our uncommitted letter of credit agreements had $72 million outstanding as of March 31, 2016. Letters of credit outstanding under these agreements incur fees ranging from 0.40% to 0.90% and are secured by the crude oil inventories for which they are issued. Capacity under these letter of credit agreements is available on an uncommitted basis and can be terminated by either party at any time.

TLLP REVOLVING CREDITY FACILITY AND DROPDOWN CREDIT FACILITY. The TLLP Revolving Credit Facility provides for total loan availability of $600 million as of March 31, 2016. The TLLP Revolving Credit Facility is non-recourse to Tesoro, except for TLGP, and is guaranteed by all of TLLP’s subsidiaries, with the exception of certain non-wholly owned subsidiaries and secured by substantially all of TLLP’s assets. Borrowings are available under the TLLP Revolving Credit Facility up to the total loan availability of the facility. There was $285 million in borrowings outstanding under the TLLP Revolving Credit Facility, which had unused credit availability of approximately 53% of the borrowing capacity. The weighted average interest rate for borrowings under the TLLP Revolving Credit Facility was 2.76% at March 31, 2016.

Additionally, the secured TLLP Dropdown Credit Facility provides for total loan availability of $1.0 billion as of March 31, 2016. The primary use of proceeds under this facility will be to fund its asset acquisitions. The terms, covenants and restrictions under this facility are substantially the same as the amended secured TLLP Revolving Credit Facility. There was $250 million of borrowings outstanding under the TLLP Dropdown Credit Facility, resulting in a total unused loan availability of $750 million or 75% of the borrowing capacity as of March 31, 2016. The weighted average interest rate for borrowings under the TLLP Dropdown Credit Facility was 2.70% at March 31, 2016.

The total aggregate available facility limits for the secured TLLP Revolving Credit Facility and the secured TLLP Dropdown Credit Facility totaled $1.6 billion at March 31, 2016. TLLP is allowed to request the loan availability for both the secured TLLP Revolving Credit Facility and the secured TLLP Dropdown Credit Facility be increased up to an aggregate of $2.1 billion, subject to receiving increased commitments from the lenders. The secured TLLP Revolving Credit Facility and the secured Dropdown Credit Facility ratably share collateral comprised primarily of TLLP property, plant, and equipment and both facilities mature on January 29, 2021. In addition, upon an upgrade of TLLP’s corporate family rating to investment grade, certain covenants and restrictions under each facility will automatically and permanently be eliminated or improved.

TLLP REPAYMENTS. On February 3, 2016, TLLP repaid the full amount of the TLLP Unsecured Term Loan Facility, including accrued interest, with proceeds drawn from the TLLP Dropdown Credit Facility. All commitments under the TLLP Unsecured Term Loan Facility were terminated effective with the repayment.

TLLP EXCHANGE OFFER. On February 26, 2016, TLLP commenced an offer to exchange (the “Exchange”) its existing unregistered 5.50% Senior Notes due 2019 (“2019 Notes”) and 6.25% Senior Notes due 2022 (“2022 Notes”) (together, “Unregistered Notes”) for an equal principal amount of 5.50% Senior Notes due 2019 and 6.25% Senior Notes due 2022 (the “Exchange Notes”), respectively, that were registered under the Securities Act of 1933, as amended. On April 14, 2016, the Exchange was completed for all of the 2019 Notes and substantially all of the 2022 Notes. The terms of the Exchange Notes are identical in all material respects (including principal amount, interest rate, maturity and redemption rights) to the Unregistered Notes for which they were exchanged, except that the Exchange Notes generally are not subject to transfer restrictions. The Exchange fulfills all of the requirements of the registration rights agreements for the Unregistered Notes.

NOTE 8 – BENEFIT PLANS

Tesoro sponsors four defined benefit pension plans, including one funded qualified employee retirement plan and three unfunded nonqualified executive plans. Our funded employee retirement plan fully meets all funding requirements under applicable laws and regulations. We have not made any voluntary contributions to the retirement plan during the three months ended March 31, 2016 to improve the funded status of the plan. Tesoro also provides other postretirement health care benefits to retirees who met certain service requirements and were participating in our group health insurance program at retirement.


14 | Tesoro Corporation 2016

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

COMPONENTS OF PENSION AND OTHER POSTRETIREMENT BENEFIT EXPENSE (in millions)

 
Pension Benefits
 
Three Months Ended
March 31,
 
 
2016
 
2015
Service cost
$
11

 
$
12

Interest cost
8

 
8

Expected return on plan assets
(7
)
 
(7
)
Recognized net actuarial loss
5

 
6

Recognized curtailment loss and settlement cost
5

 

Net Periodic Benefit Expense
$
22

 
$
19

 
 
 
 
 
Other Postretirement Benefits
 
Three Months Ended
March 31,
 
 
2016
 
2015
Service cost
$
1

 
$
1

Interest cost
1

 
1

Amortization of prior service credit
(9
)
 
(9
)
Recognized net actuarial loss
1

 
1

Net Periodic Benefit Income
$
(6
)
 
$
(6
)

NOTE 9 – COMMITMENTS AND CONTINGENCIES

ENVIRONMENTAL LIABILITIES

We are incurring and expect to continue to incur expenses for environmental remediation liabilities at a number of currently and previously owned or operated refining, pipeline, terminal and retail station properties. We have accrued liabilities for these expenses and believe these accruals are adequate based on current information and projections that can be reasonably estimated. Additionally, we have recognized environmental remediation liabilities assumed in past acquisitions from the prior owners that include amounts estimated for site cleanup and monitoring activities arising from operations at refineries, certain terminals and pipelines, and retail stations prior to the dates of our acquisitions. Our environmental accruals are based on estimates including engineering assessments, and it is possible that our projections will change and that additional costs will be recorded as more information becomes available.

Our accruals for environmental expenditures totaled $242 million and $255 million at March 31, 2016 and December 31, 2015, respectively, including $29 million and $33 million for TLLP, respectively. These accruals include $185 million and $192 million at March 31, 2016 and December 31, 2015, respectively, related to amounts estimated for site cleanup activities arising from operations at our Martinez refinery and operations of assets acquired from BP’s integrated Southern California refining, marketing and logistics business (“Los Angeles Acquisition”) prior to their respective acquisition dates. We cannot reasonably determine the full extent of remedial activities that may be required at the Martinez refinery and for assets acquired in the Los Angeles Acquisition and it is possible that we will identify additional investigation and remediation costs for site cleanup activities as more information becomes available. The environmental remediation liabilities assumed in the Los Angeles Acquisition include amounts estimated for site cleanup activities and monitoring activities arising from operations at the Carson refinery, certain terminals and pipelines, and retail stations prior to our acquisition on June 1, 2013. These estimates for environmental liabilities are based on third-party assessments and available information. Our estimates for site cleanup activities reflect amounts for which we are responsible under applicable cost-sharing arrangements.

On July 10, 2015, a federal court issued an order denying coverage pursuant to insurance policies for environmental remediation liabilities at our Martinez refinery and those liabilities are included in our accruals above. The insurer had filed a declaratory relief action challenging coverage of the primary policy assigned to us when we acquired the refinery. The policies provide for coverage up to $190 million for expenditures in excess of $50 million in self-insurance. We have not recognized possible insurance recoveries under the policies and have appealed the order.


Tesoro Corporation 2016 | 15




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

OTHER CONTINGENCIES

The EPA has alleged that we have violated certain Clean Air Act regulations at our Alaska, Washington, Martinez, North Dakota and Utah refineries. We also retained the responsibility for resolving similar allegations relating to our former Hawaii refinery, which we sold in September 2013. We previously received a notice of violation (“NOV”) in March 2011 from the EPA alleging violations of Title V of the Clean Air Act at our Alaska refinery, which arose from a 2007 state of Alaska inspection and inspections by the EPA in 2008 and 2010. We also previously received NOVs in 2005 and 2008 alleging violations of the Clean Air Act at our Washington refinery. We are continuing discussions of all of these claims with the EPA and the U.S. Department of Justice. We have established an accrual for this matter. Although we cannot currently estimate the final timing of its resolution, we will be required to spend material capital expenditures to comply with the terms of a settlement. The majority of these expenditures have been spent in prior years or are budgeted in 2016. The remaining expenditures will be primarily spent in 2017 with additional amounts through 2019. As such, we believe the ultimate resolution of these matters will not have a material impact on our liquidity, results of operations or financial position.

OTHER MATTERS

In the ordinary course of business, we become party to lawsuits, administrative proceedings and governmental investigations, including environmental, regulatory and other matters. Large, and sometimes unspecified, damages or penalties may be sought from us in some matters. We have not established accruals for these types of matters unless a loss is probable, and the amount of loss is currently estimable.

TAX. We are subject to extensive federal, state and foreign tax laws and regulations. Newly enacted tax laws and regulations, and changes in existing tax laws and regulations, could result in increased expenditures in the future. We are also subject to audits by federal, state and foreign taxing authorities in the normal course of business. It is possible that tax audits could result in claims against us in excess of recorded liabilities. However, we believe that resolution of any such claim(s) would not have a material impact on our liquidity, financial position, or results of operations.

NOTE 10 – STOCKHOLDERS’ EQUITY AND EARNINGS PER SHARE

CHANGES TO EQUITY (in millions)

 
Tesoro
Corporation
Stockholders’
Equity
 
Noncontrolling
 Interest
 
Total Equity
Balance at December 31, 2015 (a)
$
5,213

 
$
2,527

 
$
7,740

Net earnings
69

 
40

 
109

Dividend payments
(60
)
 

 
(60
)
Net effect of amounts related to equity-based compensation (b)
(9
)
 
(2
)
 
(11
)
Effect of deconsolidation of RGS (c)
(2
)
 
(84
)
 
(86
)
Net proceeds from issuance of Tesoro Logistics LP common units

 
5

 
5

Distributions to noncontrolling interest

 
(48
)
 
(48
)
Pension liability adjustment, net of tax
10

 

 
10

Other
1

 

 
1

Balance at March 31, 2016 (a)
$
5,222

 
$
2,438

 
$
7,660


(a)
We have 5.0 million shares of preferred stock authorized with no par value per share. No shares of preferred stock were outstanding as of March 31, 2016 and December 31, 2015.
(b)
We issued less than 0.1 million and approximately 0.2 million shares during the three months ended March 31, 2016 and 2015, respectively for proceeds of $1 million and $6 million, respectively, primarily for stock option exercises under our equity-based compensation plans. See Note 11 for more information on stock-based compensation.
(c)
As a result of the reassessment performed in conjunction with the adoption of ASU 2015-02, we deconsolidated RGS, causing the derecognition of noncontrolling interest for the reporting of RGS as an equity method investment.


16 | Tesoro Corporation 2016

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

EARNINGS PER SHARE

We compute basic earnings per share by dividing net earnings attributable to Tesoro Corporation stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share include the effects of potentially dilutive shares outstanding during the period.

SHARES OUTSTANDING (in millions)

 
Three Months Ended
March 31,
 
 
2016
 
2015
Weighted average common shares outstanding
119.6
 
125.2
Common stock equivalents
1.6
 
1.7
Total Diluted Shares
121.2
 
126.9

Potentially dilutive common stock equivalents are excluded from the calculation of diluted earnings per share if the effect of including such securities in the calculation would have been anti-dilutive. Anti-dilutive securities were 0.3 million for both the three months ended March 31, 2016 and 2015, respectively.

SHARE REPURCHASES

We are authorized by our Board of Directors (the “Board”) to purchase shares of our common stock in open market transactions at our discretion. The Board’s authorization has no time limit and may be suspended or discontinued at any time. Purchases of our common stock can also be made to offset the dilutive effect of stock-based compensation awards and to meet our obligations under employee benefit and compensation plans, including the exercise of stock options and vesting of restricted stock and to fulfill other stock compensation requirements. There were no repurchases of our common stock during the three months ended March 31, 2016. During the three months ended March 31, 2015 we purchased approximately 0.3 million shares of our common stock for approximately $19 million.

CASH DIVIDENDS

We paid cash dividends totaling $60 million for the three months ended March 31, 2016, based on a $0.50 per share quarterly cash dividend on common stock in the first quarter. We paid cash dividends totaling $54 million for the three months ended March 31, 2015, based on a $0.425 per share quarterly cash dividend on common stock. On May 3, 2016, our Board declared a cash dividend of $0.50 per share payable on June 15, 2016 to shareholders of record on May 31, 2016.


Tesoro Corporation 2016 | 17




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

NOTE 11 – STOCK-BASED COMPENSATION

STOCK-BASED COMPENSATION EXPENSE (BENEFIT) (in millions)

 
Three Months Ended
March 31,
 
 
2016
 
2015
Stock appreciation rights (a)
$
(13
)
 
$
15

Performance share awards (b)
2

 
4

Market stock units (c)
7

 
5

Other stock-based awards (d)
1

 
4

Total Stock-Based Compensation Expense (Benefit)
$
(3
)
 
$
28


(a)
We had $8 million and $41 million recorded in accrued liabilities associated with our stock appreciation rights (“SARs”) awards at March 31, 2016 and December 31, 2015, respectively. We paid cash of $20 million to settle 0.3 million SARs that were exercised during both the three months ended March 31, 2016 and 2015.
(b)
We granted 0.1 million market condition performance share awards at a weighted average grant date fair value of $87.99 per share under the amended and restated 2011 Long-Term Incentive Plan (“2011 Plan”) during the three months ended March 31, 2016.
(c)
We granted 0.3 million market stock units at a weighted average grant date fair value of $84.66 per unit under the 2011 Plan during the three months ended March 31, 2016.
(d)
We have aggregated expenses for certain award types as they are not considered significant.

The income tax effect recognized in the income statement for stock-based compensation was a benefit of $12 million and $11 million for the three months ended March 31, 2016 and 2015, respectively. Included in the $12 million tax benefit for the three months ended March 31, 2016 was $13 million of tax benefit attributable to excess tax benefits from exercises and vestings that occurred during the period, the effects of which are recorded to the income statement pursuant to ASU 2016-09. The reduction in current taxes payable recognized from tax deductions resulting from exercises and vestings under all of our stock-based compensation arrangements totaled $29 million and $54 million for the three months ended March 31, 2016 and 2015, respectively.

NOTE 12 – OPERATING SEGMENTS

Our refining segment owns and operates six petroleum refineries located in California, Washington, Alaska, North Dakota and Utah that manufacture gasoline and gasoline blendstocks, jet fuel, diesel fuel, residual fuel oil and other refined products. We sell these refined products, together with refined products purchased from third parties, to our marketing segment through terminal facilities and other locations and opportunistically export refined products to foreign markets. TLLP’s assets and operations include certain crude oil gathering assets, natural gas gathering and processing assets and crude oil and refined products terminalling and transportation assets acquired from Tesoro and other third parties. Revenues from the TLLP segment are generated by charging fees for gathering crude oil and natural gas, for processing natural gas, and for terminalling, transporting and storing crude oil, and refined products. Tesoro’s marketing business supplies gasoline and diesel across 16 states through both branded and unbranded marketing channels. We utilize various operating models in the operation of our retail stations. Since we do not have significant operations in foreign countries, revenue generated and long-lived assets located in foreign countries are not material to our operations.

We evaluate the performance of our segments based primarily on segment operating income. Segment operating income includes those revenues and expenses that are directly attributable to management of the respective segment. TLLP and marketing revenues include intersegment transactions with our refining segment. Corporate depreciation and corporate general and administrative expenses are excluded from segment operating income.


18 | Tesoro Corporation 2016

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

SEGMENT INFORMATION RELATED TO CONTINUING OPERATIONS

 
Three Months Ended
March 31,
 
 
2016
 
2015
 
(In millions)
Revenues
 
 
 
Refining:
 
 
 
Refined products
$
4,437

 
$
5,828

Crude oil resales and other
211

 
299

TLLP:
 
 
 
Gathering
91

 
77

Processing
71

 
67

Terminalling and transportation
138

 
119

Marketing:
 
 
 
Fuel (a)
3,298

 
3,948

Other non-fuel
20

 
16

Intersegment sales
(3,165
)
 
(3,891
)
Total Revenues
$
5,101

 
$
6,463

Segment Operating Income (Loss)
 
 
 
Refining
$
(100
)
 
$
187

TLLP (b)
126

 
104

Marketing
227

 
133

Total Segment Operating Income
253

 
424

Corporate and unallocated costs (b)
(74
)
 
(84
)
Operating Income
179

 
340

Interest and financing costs, net
(60
)
 
(55
)
Equity in earnings of equity method investments
2

 
1

Other income (expense), net
7

 
(2
)
Earnings Before Income Taxes
$
128

 
$
284

Depreciation and Amortization Expense
 
 
 
Refining
$
150

 
$
119

TLLP
44

 
44

Marketing
12

 
12

Corporate
6

 
4

Total Depreciation and Amortization Expense
$
212

 
$
179

Capital Expenditures
 
 
 
Refining
$
119

 
$
183

TLLP
41

 
67

Marketing
13

 
4

Corporate
15

 
6

Total Capital Expenditures
$
188

 
$
260


(a)
Federal and state motor fuel excise taxes on sales by our marketing segment at retail sites where we own the inventory are included in both revenues and cost of sales in our condensed statements of consolidated operations. These taxes totaled $142 million and $140 million for the three months ended March 31, 2016 and 2015, respectively.
(b)
We present TLLP’s segment operating income net of general and administrative expenses totaling $12 million representing TLLP’s corporate costs for both the three months ended March 31, 2016 and 2015, which are not allocated by TLLP to its operating segments.


Tesoro Corporation 2016 | 19




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

NOTE 13 – CONDENSED CONSOLIDATING FINANCIAL INFORMATION

Separate condensed consolidating financial information of Tesoro Corporation (the “Parent”), subsidiary guarantors and non-guarantors is presented below. At March 31, 2016, Tesoro and certain subsidiary guarantors have fully and unconditionally guaranteed our 4.250% Senior Notes due 2017, 5.375% Senior Notes due 2022, and 5.125% Senior Notes due 2024. TLLP, in which we had a 36% ownership interest as of March 31, 2016, and other subsidiaries have not guaranteed these obligations. As a result of these guarantee arrangements, we are required to present the following condensed consolidating financial information, which should be read in conjunction with the accompanying condensed consolidated financial statements and notes thereto. This information is provided as an alternative to providing separate financial statements for guarantor subsidiaries. Separate financial statements of Tesoro’s subsidiary guarantors are not included because the guarantees are full and unconditional and these subsidiary guarantors are 100% owned and are jointly and severally liable for Tesoro’s outstanding senior notes. The information is presented using the equity method of accounting for investments in subsidiaries. Certain intercompany and intracompany transactions between subsidiaries are presented gross and eliminated in the consolidating adjustments column. Additionally, the results of operations of the Hawaii Business have been reported as discontinued operations in these condensed consolidating statements of operations and comprehensive income for the three months ended March 31, 2016.

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2016
(In millions)

 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Consolidating Adjustments
Consolidated
Revenues
$

$
5,485

$
749

$
(1,133
)
$
5,101

Costs and Expenses
 
 
 
 
 
Cost of sales (excluding the lower of cost or market
   inventory valuation adjustment)

4,425

489

(1,053
)
3,861

Lower of cost or market inventory valuation adjustment

147



147

Operating, selling, general and administrative expenses
1

644

133

(80
)
698

Depreciation and amortization expense

167

45


212

Loss on asset disposals and impairments

3

1


4

Operating Income (Loss)
(1
)
99

81


179

Interest and financing costs, net
(14
)
(16
)
(30
)

(60
)
Equity in earnings of subsidiaries
71

53


(124
)

Equity in earnings of equity method investments

(2
)
4


2

Other income, net

1

6


7

Earnings Before Income Taxes
56

135

61

(124
)
128

Income tax expense (benefit) (a)
(2
)
31

1


30

Net Earnings from Continuing Operations
58

104

60

(124
)
98

Earnings from discontinued operations, net of tax
11




11

Net Earnings
69

104

60

(124
)
109

Less: Net earnings from continuing operations
   attributable to noncontrolling interest


40


40

Net Earnings Attributable to Tesoro Corporation
$
69

$
104

$
20

$
(124
)
$
69

 
 
 
 
 
 
Comprehensive Income
 
 
 
 
 
Total comprehensive income
$
59

$
104

$
60

$
(124
)
$
99

Less: Noncontrolling interest in comprehensive income


40


40

Comprehensive Income Attributable to Tesoro
   Corporation
$
59

$
104

$
20

$
(124
)
$
59


(a)
The income tax expense (benefit) reflected in each column does not include any tax effect of the equity in earnings from corporate subsidiaries, but does include the tax effect of the corporate partners’ share of partnership income.


20 | Tesoro Corporation 2016

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED MARCH 31, 2015
(In millions)

 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Consolidating Adjustments
Consolidated
Revenues
$

$
6,999

$
914

$
(1,450
)
$
6,463

Costs and Expenses
 
 
 
 
 
Cost of sales (excluding the lower of cost or market
   inventory valuation adjustment)

6,035

661

(1,389
)
5,307

Lower of cost or market inventory valuation adjustment

(42
)


(42
)
Operating, selling, general and administrative expenses
4

609

123

(61
)
675

Depreciation and amortization expense

134

45


179

Loss on asset disposals and impairments

4



4

Operating Income (Loss)
(4
)
259

85


340

Interest and financing costs, net
(11
)
(18
)
(26
)

(55
)
Equity in earnings of subsidiaries
157

16


(173
)

Equity in earnings of equity method investments

(2
)
3


1

Other expense, net

(2
)


(2
)
Earnings Before Income Taxes
142

253

62

(173
)
284

Income tax expense (benefit) (a)
(3
)
95

4


96

Net Earnings
145

158

58

(173
)
188

Less: Net earnings from continuing operations
   attributable to noncontrolling interest


43


43

Net Earnings Attributable to Tesoro Corporation
$
145

$
158

$
15

$
(173
)
$
145

 
 
 
 
 
 
Comprehensive Income
 
 
 
 
 
Total comprehensive income
$
145

$
158

$
58

$
(173
)
$
188

Less: Noncontrolling interest in comprehensive income


43


43

Comprehensive Income Attributable to Tesoro
   Corporation
$
145

$
158

$
15

$
(173
)
$
145


(a)
The income tax expense (benefit) reflected in each column does not include any tax effect of the equity in earnings from corporate subsidiaries, but does include the tax effect of the corporate partners’ share of partnership income.



Tesoro Corporation 2016 | 21




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

CONDENSED CONSOLIDATING BALANCE SHEET
AS OF MARCH 31, 2016
(In millions)

 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Consolidating Adjustments
Consolidated
ASSETS
Current Assets
 
 
 
 
 
Cash and cash equivalents
$

$
400

$
39

$

$
439

Receivables, net of allowance for doubtful accounts

782

172


954

Short-term receivables from affiliates

35

18

(53
)

Inventories, net

1,749

126


1,875

Prepayments and other current assets
93

126

16


235

Total Current Assets
93

3,092

371

(53
)
3,503

Net Property, Plant and Equipment

6,345

3,149


9,494

Investment in Subsidiaries
8,512

506


(9,018
)

Long-Term Receivables from Affiliates
1,159



(1,159
)

Long-Term Intercompany Note Receivable


1,626

(1,626
)

Acquired intangibles, net

296

969


1,265

Other noncurrent assets, net
34

1,230

490

(5
)
1,749

Total Assets
$
9,798

$
11,469

$
6,605

$
(11,861
)
$
16,011

 
 
 
 
 
 
LIABILITIES AND EQUITY
Current Liabilities
 
 
 
 
 
Accounts payable
$
1

$
1,357

$
134

$

$
1,492

Short-term payables to affiliates

18

35

(53
)

Other current liabilities
89

551

136


776

Total Current Liabilities
90

1,926

305

(53
)
2,268

Long-Term Payables to Affiliates

1,005

154

(1,159
)

Deferred Income Taxes
1,233



(5
)
1,228

Other Noncurrent Liabilities
434

328

47


809

Debt, net of unamortized issuance costs
1,193

32

2,821


4,046

Long-Term Intercompany Note Payable
1,626



(1,626
)

Equity-Tesoro Corporation
5,222

8,178

840

(9,018
)
5,222

Equity-Noncontrolling Interest


2,438


2,438

Total Liabilities and Equity
$
9,798

$
11,469

$
6,605

$
(11,861
)
$
16,011



22 | Tesoro Corporation 2016

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

CONDENSED CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 2015
(In millions)

 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Consolidating Adjustments
Consolidated
ASSETS
Current Assets
 
 
 
 
 
Cash and cash equivalents
$

$
895

$
47

$

$
942

Receivables, net of allowance for doubtful accounts

626

166


792

Short-term receivables from affiliates

197


(197
)

Inventories, net

1,971

331


2,302

Prepayments and other current assets
116

140

16

(1
)
271

Total Current Assets
116

3,829

560

(198
)
4,307

Net Property, Plant and Equipment

6,027

3,514


9,541

Investment in Subsidiaries
8,133

493


(8,626
)

Long-Term Receivables from Affiliates
1,517



(1,517
)

Long-Term Intercompany Note Receivable


1,626

(1,626
)

Acquired intangibles, net

234

977


1,211

Other noncurrent assets, net
33

1,026

219

(5
)
1,273

Total Assets
$
9,799

$
11,609

$
6,896

$
(11,972
)
$
16,332

 
 
 
 
 
 
LIABILITIES AND EQUITY
Current Liabilities
 
 
 
 
 
Accounts payable
$

$
1,413

$
155

$

$
1,568

Short-term payables to affiliates


197

(197
)

Other current liabilities
91

764

108

(1
)
962

Total Current Liabilities
91

2,177

460

(198
)
2,530

Long-Term Payables to Affiliates

1,375

142

(1,517
)

Deferred Income Taxes
1,227



(5
)
1,222

Other Noncurrent Liabilities
452

271

50


773

Debt, net of unamortized issuance costs
1,190

33

2,844


4,067

Long-Term Intercompany Note Payable
1,626



(1,626
)

Equity-Tesoro Corporation
5,213

7,753

873

(8,626
)
5,213

Equity-Noncontrolling Interest


2,527


2,527

Total Liabilities and Equity
$
9,799

$
11,609

$
6,896

$
(11,972
)
$
16,332



Tesoro Corporation 2016 | 23




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 

CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 2016
(In millions)

 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Consolidating Adjustments
Consolidated
Cash Flows From (Used In) Operating Activities
 
 
 
 
 
Net cash from (used in) operating activities
$
12

$
(167
)
$
339

$

$
184

Cash Flows From (Used In) Investing Activities
 
 
 
 
 
Capital expenditures

(162
)
(55
)

(217
)
Acquisition, net of cash

(314
)


(314
)
Intercompany notes, net
374



(374
)

Investment in subsidiaries
(319
)
(6
)

325


Other investing activities


(4
)