10-Q 1 a2012930-tsox10q.htm 10-Q 2012.9.30-TSO-10Q
                                            

 

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

FORM 10‑Q
(Mark One)
R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
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  R   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 R 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  R
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  R
    
There were 140,435,119 shares of the registrant's Common Stock outstanding at October 29, 2012.
    
 


                                            

TESORO CORPORATION

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2012

TABLE OF CONTENTS




PART I. FINANCIAL INFORMATION
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 



2

PART I — FINANCIAL INFORMATION


ITEM 1. FINANCIAL STATEMENTS

TESORO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
September 30,
2012
 
December 31,
2011
 
(Dollars in millions except per share amounts)
ASSETS
CURRENT ASSETS
 
 
 
Cash and cash equivalents
$
1,367

 
$
900

Receivables, less allowance for doubtful accounts
1,584

 
1,272

Inventories
1,739

 
1,763

Prepayments and other current assets
166

 
216

Total Current Assets
4,856

 
4,151

PROPERTY, PLANT AND EQUIPMENT
 
 
 
Property, plant and equipment, at cost
7,440

 
7,055

Less accumulated depreciation and amortization
(2,099
)
 
(1,907
)
Net Property, Plant and Equipment
5,341

 
5,148

OTHER NONCURRENT ASSETS
 
 
 
Acquired intangibles, net
217

 
226

Other, net
573

 
367

Total Other Noncurrent Assets
790

 
593

Total Assets
$
10,987

 
$
9,892

 
 
 
 
LIABILITIES AND EQUITY
CURRENT LIABILITIES
 
 
 
Accounts payable
$
2,531

 
$
2,305

Accrued liabilities
661

 
526

Current maturities of debt
2

 
418

Total Current Liabilities
3,194

 
3,249

DEFERRED INCOME TAXES
949

 
815

OTHER NONCURRENT LIABILITIES
557

 
567

DEBT
1,584

 
1,283

COMMITMENTS AND CONTINGENCIES (Note J)


 


EQUITY
 
 
 
TESORO CORPORATION STOCKHOLDERS' EQUITY
 
 
 
Common stock, par value $0.162/3; authorized 200,000,000 shares; 152,202,267 shares issued (150,733,991 in 2011)
25

 
25

Preferred stock, no par value; authorized 5,000,000 shares; 0 shares issued

 

Additional paid-in capital
1,054

 
1,000

Retained earnings
3,643

 
2,944

Treasury stock, 11,907,322 common shares (10,769,510 in 2011), at cost
(256
)
 
(226
)
Accumulated other comprehensive loss
(75
)
 
(75
)
Total Tesoro Corporation Stockholders' Equity
4,391

 
3,668

NONCONTROLLING INTEREST
312

 
310

Total Equity
4,703

 
3,978

Total Liabilities and Equity
$
10,987

 
$
9,892



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


3

                                            

TESORO CORPORATION
CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS AND COMPREHENSIVE INCOME
(Unaudited)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
 
2012
 
2011
 
2012
 
2011
 
(In millions except per share amounts)
REVENUES (a)
$
8,776

 
$
8,101

 
$
24,701

 
$
22,590

 
 
 
 
 
 
 
 
COSTS AND EXPENSES:
 
 
 
 
 
 
 
Cost of sales (a)
7,609

 
6,980

 
21,662

 
19,700

Operating expenses
412

 
374

 
1,136

 
1,117

Selling, general and administrative expenses
129

 
44

 
238

 
166

Depreciation and amortization expense
116

 
103

 
328

 
312

Loss on asset disposals and impairments
4

 
3

 
16

 
60

OPERATING INCOME
506

 
597

 
1,321

 
1,235

Interest and financing costs
(66
)
 
(38
)
 
(136
)
 
(141
)
Other income (expense), net
(2
)
 
3

 
(19
)
 
3

Foreign currency exchange loss

 

 
(1
)
 
(1
)
EARNINGS BEFORE INCOME TAXES
438

 
562

 
1,165

 
1,096

Income tax expense
158

 
210

 
430

 
415

NET EARNINGS
280

 
352

 
735

 
681

Less net earnings attributable to noncontrolling interest
7

 
7

 
19

 
11

NET EARNINGS ATTRIBUTABLE TO TESORO CORPORATION
$
273

 
$
345

 
$
716

 
$
670

NET EARNINGS PER SHARE:
 
 
 
 
 
 
 
Basic
$
1.96

 
$
2.42

 
$
5.13

 
$
4.71

Diluted
$
1.92

 
$
2.39

 
$
5.06

 
$
4.65

WEIGHTED AVERAGE COMMON SHARES:
 
 
 
 
 
 
 
Basic
139.6

 
142.5

 
139.6

 
142.3

Diluted
142.1

 
144.1

 
141.5

 
144.2

 
 
 
 
 
 
 
 
DIVIDENDS PER SHARE
$
0.12

 
$

 
$
0.12

 
$

 
 
 
 
 
 
 
 
COMPREHENSIVE INCOME
 
 
 
 
 
 
 
Total comprehensive income
$
280

 
$
352

 
$
735

 
$
681

Less noncontrolling interest in comprehensive income
7

 
7

 
19

 
11

COMPREHENSIVE INCOME ATTRIBUTABLE TO TESORO CORPORATION
$
273

 
$
345

 
$
716

 
$
670

 
 
 
 
 
 
 
 
SUPPLEMENTAL INFORMATION:
 
 
 
 
 
 
 
(a) Includes excise taxes collected by our retail segment (excluding credits)
$
140

 
$
97

 
$
351

 
$
280

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


4

                                            

TESORO CORPORATION
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
 
Nine Months Ended September 30,
 
 
2012
 
2011
 
(Dollars in millions)
CASH FLOWS FROM (USED IN) OPERATING ACTIVITIES
 
 
 
Net earnings
$
735

 
$
681

Adjustments to reconcile net earnings to net cash from (used in) operating activities:
 
 
 
Depreciation and amortization expense
328

 
312

Amortization of debt issuance costs and discounts
9

 
14

Loss on asset disposals and impairments
16

 
60

Stock-based compensation expense
93

 
25

Charges for remaining unamortized debt issue costs and discounts
5

 
14

Provision for bad debts
2

 

Deferred income taxes
105

 
174

Excess tax benefits from stock-based compensation arrangements
(7
)
 
(8
)
Other changes in noncurrent assets and liabilities
(203
)
 
(73
)
Changes in current assets and current liabilities:
 
 
 
Receivables
(314
)
 
(242
)
Inventories
31

 
(450
)
Prepayments and other
70

 
(81
)
Accounts payable and accrued liabilities
305

 
436

Net cash from operating activities
1,175

 
862

CASH FLOWS FROM (USED IN) INVESTING ACTIVITIES
 
 
 
Capital expenditures
(382
)
 
(187
)
Proceeds from asset sales
3

 
1

Acquisitions
(39
)
 

Advance payment made for BP acquisition
(90
)
 

Net cash used in investing activities
(508
)
 
(186
)
CASH FLOWS FROM (USED IN) FINANCING ACTIVITIES
 
 
 
Proceeds from debt offering
1,275

 

Borrowings under revolving credit agreements
185

 
135

Repayments on revolving credit agreements
(352
)
 
(215
)
Repayments of debt
(1,224
)
 
(329
)
Dividend payments
(17
)
 

Proceeds from stock options exercised
23

 
7

Proceeds from issuance of common units -Tesoro Logistics LP

 
288

Distributions to noncontrolling interest
(17
)
 
(4
)
Purchases of common stock
(31
)
 
(45
)
Excess tax benefits from stock-based compensation arrangements
7

 
8

Payments of debt issuance costs
(22
)
 

Financing costs and other
(27
)
 
(34
)
Net cash used in financing activities
(200
)
 
(189
)
 
 
 
 
INCREASE IN CASH AND CASH EQUIVALENTS
467

 
487

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
900

 
648

CASH AND CASH EQUIVALENTS, END OF PERIOD
$
1,367

 
$
1,135

SUPPLEMENTAL CASH FLOW DISCLOSURES
 
 
 
Interest paid, net of capitalized interest
$
79

 
$
61

Income taxes paid, net
$
161

 
$
144

SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING ACTIVITIES
 
 
 
Capital expenditures included in accounts payable and accrued liabilities at end of period
$
46

 
$
27

Purchases of common stock included in accounts payable at end of period
$

 
$
56

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

5

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



NOTE A – BASIS OF PRESENTATION

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.

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”). The accompanying condensed consolidated 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, unless otherwise disclosed.

The consolidated balance sheet at December 31, 2011, 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, 2011.

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 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 presented. We review our estimates on an ongoing basis, based on currently available information. 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 reclassified in order to conform to the current year presentation.

Our consolidated financial statements include TLLP, a variable interest entity. 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 long-term transportation agreements with TLLP (discussed further below), transactions with us accounted for 89% and 90% of TLLP’s total revenues for the three and nine months ended September 30, 2012, respectively. As TLLP does not derive a significant amount of revenue from third parties, there is limited risk to Tesoro associated with TLLP’s operations. However, in the event that TLLP incurs a loss, our operating results will reflect TLLP’s loss, net of intercompany eliminations, to the extent of our ownership interest in TLLP.

New Accounting Standards

The Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update (“ASU”) in July 2012 related to testing indefinite-lived intangible assets for impairment. This ASU provides the option to assess qualitative factors first to determine whether it is necessary to perform the quantitative impairment test. If the Company believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of the indefinite-lived intangible asset is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required. The Company can choose to assess qualitative factors on none, some or all of its indefinite-lived intangible assets. The standard is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. However, an entity can choose to early adopt the standard, provided that the entity has not yet performed its 2012 annual impairment test or issued its financial statements. Our indefinite-lived intangible assets are immaterial to our condensed consolidated financial statements. The adoption of this standard will not have a material impact on our consolidated financial statements.
 
The FASB issued an ASU in December 2011, which requires an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of these arrangements on its financial position. The guidance requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. These provisions are effective for interim and annual reporting periods beginning on January 1, 2013. The adoption of this guidance will not have a material impact on our financial position, but may result in additional disclosures.

6

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)



The FASB issued an ASU in May 2011 related to fair value measurements and disclosures to achieve common fair value measurements and additional consistency of disclosures between U.S. GAAP and International Financial Reporting Standards. This standard includes amendments that clarify the application of existing fair value measurements and disclosure requirements, while other amendments change a principle or requirement for fair value measurements or disclosures. Some of the changes include (1) the application of the highest and best use and valuation premise concepts, (2) measuring the fair value of an instrument classified in a reporting entity’s shareholders’ equity, and (3) quantitative information required for fair value measurements categorized within level 3 of the fair value hierarchy. In addition, this standard requires additional disclosure for level 3 measurements regarding the sensitivity of fair value to changes in unobservable inputs and any interrelationships between those inputs. The adoption of this guidance, effective January 1, 2012, did not have a material impact on our condensed consolidated financial statements.

NOTE B – TESORO LOGISTICS LP

Tesoro Logistics LP 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 distribute, transport and store crude oil and refined products. Its assets consist of a crude oil gathering system in the Bakken Shale/Williston Basin area of North Dakota and Montana, eight refined products terminals in the midwestern and western United States, two marine terminals, storage tanks and short-haul pipelines in California, a crude oil and refined products storage facility and five related short-haul pipelines in Utah.

Effective April 1, 2012, Tesoro entered into a transaction (the “Martinez Marine Terminal Sale”) to sell to TLLP the Martinez crude oil marine terminal assets (collectively, the “Martinez Crude Oil Marine Terminal”) and associated pipelines for $75 million, comprised of $67.5 million in cash financed with borrowings under the senior secured revolving credit agreement (“TLLP Revolving Credit Facility”) and the issuance of equity with a fair value of $7.5 million. The Martinez Crude Oil Marine Terminal consists of a single-berth dock, which has an estimated throughput capacity of approximately 145 thousand barrels per day (“Mbpd”), five associated crude oil storage tanks with a combined capacity of 425,000 barrels, two firewater tanks with 48,000 barrels of shell capacity and related pipelines that receive crude oil from third-party vessels for delivery to our Martinez refinery and a third-party terminal.

Effective September 14, 2012, Tesoro entered into a transaction (the “Long Beach Assets Sale”) to sell to TLLP the Long Beach marine terminal assets and related short-haul pipelines, including the Los Angeles (“LA”) short-haul pipelines (collectively, the “Long Beach Assets”), in exchange for total consideration from TLLP of $210 million, comprised of $189 million in cash financed with borrowings under TLLP’s private placement debt offering and the issuance of TLLP equity with a fair value of $21 million. These assets, located near our Wilmington refinery, consist of a two-vessel berth dock leased from the City of Long Beach, six storage tanks with a combined capacity of 235,000 barrels and six related pipelines with 70 Mbpd throughput capacity connecting our Wilmington refinery to the marine terminal and other third-party facilities.
TLLP generates revenue by charging fees for gathering, transporting and storing crude oil and for terminalling, transporting and storing refined products. We do not provide financial or equity support through any liquidity arrangements and/or financial guarantees to TLLP.

TLLP provides us with various pipeline transportation, trucking, terminal distribution and storage services under various long-term, fee-based commercial agreements expiring 2016 through 2022, including the following commercial agreements that were entered into in connection with the Martinez Marine Terminal Sale and the Long Beach Assets Sale:

a 10- year terminalling use and throughput agreement, effective April 1, 2012, under which TLLP provides terminalling services at the Martinez Crude Oil Marine Terminal;
a 10- year berth access, use and throughput agreement, effective September 14, 2012, under which TLLP provides terminalling services at the Long Beach marine terminal; and
a 10- year pipeline transportation services agreement, effective September 14, 2012, under which TLLP transports our refined products on two short-haul pipelines from our Wilmington refinery to a third-party terminal.

Each of the agreements with TLLP described above contain minimum volume commitments. Each agreement has fees that are indexed for inflation and provides us with options to renew for two additional five-year terms.


7

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


In addition to commercial agreements, we are also party to an omnibus agreement with TLLP, which among other things, addresses the payment of an annual fee to us, currently $2.5 million, for the provision of various general and administrative services provided to TLLP. The omnibus agreement was most recently amended in September 2012 (“Amended Omnibus Agreement”) in connection with the Long Beach Assets Sale. Under the Amended Omnibus Agreement, TLLP reimburses us for the provision of certain operational services in support of their pipelines, terminals and storage facility. Additional sales of assets from the Company and its affiliates to TLLP, including the assets in the Martinez Marine Terminal Sale and Long Beach Assets Sale, are governed by the Amended Omnibus Agreement. The fee payable to us for the provision of various general and administrative services under the Amended Omnibus Agreement did not change.

Effective March 30, 2012 and August 17, 2012, TLLP amended the TLLP Revolving Credit Facility with a syndicate of banks and financial institutions. TLLP is an excluded subsidiary under the Tesoro Corporation Revolving Credit Facility (“Revolving Credit Facility”).

Effective September 14, 2012, TLLP completed a private offering of $350 million aggregate principal amount of 5.875% Senior Notes due 2020 (“TLLP 2020 Notes”). The proceeds of this offering were used to fund TLLP's acquisition of the Long Beach Assets and to repay the outstanding balance on the TLLP Revolving Credit Facility, with the remaining amounts to be used for general partnership purposes.

For additional information regarding our credit facilities, the TLLP Revolving Credit Facility amendment and the TLLP 2020 Notes, see Note G.

On October 5, 2012, TLLP closed an offering (“TLLP Equity Issuance”) of 4,255,000 common units at a public offering price of $41.80 per unit, which included a 555,000 unit over-allotment option that was exercised by the underwriters. Net proceeds to TLLP from the sale of the units were approximately $171 million.

As of September 30, 2012, we owned a 53% interest in TLLP, including a 2% general partner interest, which includes 974,077 common units, 15,254,890 subordinated units and 636,307 general partner units. Subsequent to the TLLP Equity Issuance on October 5, 2012, we owned an approximate 47% interest in TLLP, including an approximate 2% general partner interest.


8

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


TLLP is a consolidated variable interest entity. With the exception of affiliate balances, which are eliminated upon consolidation, and their impact on equity, the TLLP condensed combined consolidated balance sheets as of September 30, 2012 and December 31, 2011, as presented below, are included in the condensed consolidated balance sheets of Tesoro Corporation.
 
 
September 30,
2012
 
December 31,
2011 (a)
 
 
(In millions)
ASSETS
Cash and cash equivalents
 
$
55

 
$
18

Receivables, less allowance for doubtful accounts
 
 
 
 
Trade
 
1

 
4

Affiliate
 
14

 
12

Prepayments and other current assets
 
1

 
1

Net Property, Plant and Equipment
 
211

 
196

Other Noncurrent Assets
 
9

 
3

Total Assets
 
$
291

 
$
234

LIABILITIES AND EQUITY
Accounts payable
 
 
 
 
Trade
 
$
9

 
$
7

Affiliate
 
5

 
3

Deferred revenue - affiliate
 
2

 
2

Accrued liabilities
 
3

 
3

Other noncurrent liabilities
 

 
2

Debt
 
350

 
50

Equity (deficit) (b)
 
(78
)
 
167

Total Liabilities and Equity
 
$
291

 
$
234

________________
(a)
Adjusted to include the historical results of the Martinez Crude Oil Marine Terminal and Long Beach Assets.
(b)
As TLLP is an entity under common control with Tesoro, TLLP records the assets that it acquires from Tesoro on its balance sheet at historical book value instead of fair value. Additionally, any excess of cash paid over the historical book value of the assets acquired from Tesoro is recorded within equity. As a result of this accounting treatment, the Martinez Marine Terminal Sale and the Long Beach Assets Sale caused TLLP's equity balance to decrease $196 million from December 31, 2011 to September 30, 2012.


9

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE C – 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.

Share and per share calculations are presented below (in millions except per share amounts):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
 
2012
 
2011
 
2012
 
2011
Basic:
 
 
 
 
 
 
 
Net earnings attributable to Tesoro Corporation stockholders
$
273

 
$
345

 
$
716

 
$
670

Weighted average common shares outstanding
139.6

 
142.5

 
139.6

 
142.3

Basic Earnings Per Share
$
1.96

 
$
2.42

 
$
5.13

 
$
4.71

Diluted:
 
 
 
 
 
 
 
Net earnings attributable to Tesoro Corporation stockholders
$
273

 
$
345

 
$
716

 
$
670

Weighted average common shares outstanding
139.6

 
142.5

 
139.6

 
142.3

Common stock equivalents
2.5

 
1.6

 
1.9

 
1.9

Total diluted shares
142.1

 
144.1

 
141.5

 
144.2

Diluted Earnings Per Share
$
1.92

 
$
2.39

 
$
5.06

 
$
4.65


Potentially dilutive common stock equivalents consisted of stock options excluded from the calculation of diluted earnings per share as the exercise prices were greater than the average market price of the common stock during each respective reporting period and the effect of including such securities would have been anti-dilutive. The anti-dilutive stock options were as follows (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Stock options
1.9
 
3.1
 
2.6
 
3.1

NOTE D – INVENTORIES
Components of inventories were as follows (in millions):
 
September 30,
2012
 
December 31,
2011
Domestic crude oil and refined products
$
1,385

 
$
1,273

Foreign subsidiary crude oil
204

 
346

Materials and supplies
92

 
87

Oxygenates and by-products
42

 
43

Merchandise
16

 
14

Total Inventories
$
1,739

 
$
1,763


We use the last-in, first-out cost method as the primary method to determine the cost of crude oil held by our U.S. subsidiaries and refined product inventories in our refining and retail segments. We determine the carrying value of inventories of crude oil held by our foreign subsidiaries, oxygenates, and by-products using the first-in, first-out cost method. The total carrying value of our crude oil and refined product inventories was less than replacement cost by approximately $2.1 billion and $1.7 billion at September 30, 2012 and December 31, 2011, respectively.


10

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE E – FAIR VALUE MEASUREMENTS

We classify financial assets and financial liabilities into the following fair value hierarchy:

level 1 - valued based on quoted prices in active markets for identical assets and liabilities;
level 2 - valued based on quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability; and
level 3 - valued based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

We measure fair value using level 1 inputs, when available, because they provide the most reliable evidence of fair value. Derivative instruments and our Renewable Identification Numbers (“RINs”) are our only financial assets and financial liabilities measured at fair value on a recurring basis. We did not have any financial assets or liabilities classified as level 3 at September 30, 2012 or December 31, 2011. See Note F for further information on the Company’s derivative instruments.

Our derivative instruments consist primarily of options (“Options”), exchange-traded futures (“Futures Contracts”), over-the-counter swaps and options (“OTC Swap Contracts” and “OTC Option Contracts,” respectively), and physical commodity forward purchase and sale contracts (“Forward Contracts”). Futures Contracts are valued based on quoted prices from exchanges and are categorized in level 1 or level 2 of the fair value hierarchy based on the liquidity of the instrument. OTC Swap Contracts, OTC Option Contracts and Forward Contracts are valued using third-party broker quotes, industry pricing services and price curves derived from commodity exchange postings, with consideration of counterparty credit risk. These quotes are corroborated with market data and are categorized in level 2 of the fair value hierarchy.

Our RINs obligation represents a liability for the purchase of RINs to satisfy the requirement to blend biofuels into the products we produce.  RINs are assigned to biofuel produced or imported into the U.S. as required by the U.S. Environmental Protection Agency (“EPA”). This requirement was implemented in accordance with the Renewable Fuel Standard of the Energy Policy Act of 2005 and expanded by the Energy Independence and Security Act of 2007.  The EPA sets annual quotas for the percentage of biofuels that must be blended into transportation fuels consumed in the U.S., and as a producer of transportation fuels from petroleum, we are required to blend biofuels into the products we produce at a rate that will meet the EPA’s quota.  To the degree we are unable to blend at that rate, we must purchase RINs in the open market to satisfy the requirement.  Our RINs obligation is based on the amount of RINs we must purchase and the price of those RINs as of the balance sheet date.  Our RINs obligation is categorized in level 2 of the fair value hierarchy and is measured at fair value using the market approach based on quoted prices from an independent pricing service.

Financial instruments recognized at fair values in our condensed consolidated balance sheets by level within the fair value hierarchy were as follows (in millions):

Level 1

Level 2

Level 3
 
Netting and Collateral (a)
 
Total as of September 30, 2012
Assets:





 
 
 
 
Commodity Futures Contracts
$
279


$
8


$

 
$
(229
)
 
$
58

Commodity OTC Swap Contracts


1



 
(1
)
 

Total Assets
$
279


$
9


$

 
$
(230
)
 
$
58







 
 
 
 
Liabilities:








 
 
 
 
Commodity Futures Contracts
$
304


$
4


$

 
$
(287
)
 
$
21

Commodity OTC Swap Contracts


4



 
(1
)
 
3

RINs Obligation


2



 

 
2

Total Liabilities
$
304


$
10


$

 
$
(288
)
 
$
26



11

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
Level 1
 
Level 2
 
Level 3
 
Netting and Collateral (a)
 
Total as of December 31, 2011
Assets:
 
 
 
 
 
 
 
 
 
Commodity Futures Contracts
$
86

 
$
9

 
$

 
$
(61
)
 
$
34

Commodity OTC Swap Contracts

 
3

 

 
(2
)
 
1

Commodity Forward Contracts

 
4

 

 

 
4

Total Assets
$
86

 
$
16

 
$

 
$
(63
)
 
$
39

 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Commodity Futures Contracts
$
130

 
$
6

 
$

 
$
(136
)
 
$

Commodity OTC Swap Contracts

 
3

 

 
(2
)
 
1

Commodity Forward Contracts

 
1

 

 

 
1

RINs Obligation

 
3

 

 

 
3

Total Liabilities
$
130

 
$
13

 
$

 
$
(138
)
 
$
5

________________
(a)
Represents the impact of netting assets, liabilities and cash collateral when a legal right of offset exists. As of September 30, 2012 and December 31, 2011, cash collateral amounts of $58 million and $75 million, respectively, are netted with mark-to-market derivative assets.

Certain of our derivative contracts, under master netting arrangements, include both asset and liability positions. We have elected to 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.

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 (less than one percent of our trade receivables and payables are outstanding for greater than 90 days); and
the expected future insignificance of bad debt expense, which includes an evaluation of counterparty credit risk.

The fair value of our debt is based on prices from recent trade activity and is categorized in level 2 of the fair value hierarchy. The carrying value and fair value of our debt at September 30, 2012, were approximately $1.6 billion and $1.7 billion, respectively. The carrying value and fair value of our debt at December 31, 2011, were approximately $1.7 billion and $1.8 billion, respectively.

There were no material nonfinancial assets or liabilities that were measured at fair value during the nine months ended September 30, 2012.

NOTE F - DERIVATIVE INSTRUMENTS

The timing, direction and overall change in refined product prices versus crude oil prices impacts profit margins and has a significant impact on our earnings and cash flows. Consequently, we use non-trading derivative instruments to manage exposure to commodity price risks associated with the purchase or sale of feedstocks, refined products and energy supplies to or from the Company’s refineries, terminals, retail operations and customers. We also use non-trading derivative instruments to manage price risks associated with inventories above or below our target levels. To achieve our objectives, we use derivative instruments such as Options, Futures Contracts, OTC Swap Contracts, OTC Option Contracts and Forward Contracts, all generally with maturity dates of less than 18 months. We believe that there is minimal credit risk with respect to our counterparties.

We may use our excess storage capacity in Panama to take advantage of contango markets when the future price of crude oil is higher than the current spot price. We use commodity derivatives to manage price risk and hedge crude oil held in connection with these arbitrage opportunities.

We are exposed to exchange rate fluctuations on our purchases of Canadian crude oil. We enter into Forward Contracts of Canadian dollars to manage monthly exchange rate fluctuations.


12

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The accounting for changes in the fair value of a commodity derivative depends on whether the derivative has been designated in a hedging relationship and whether we have elected the normal purchases and normal sales exception. The accounting for the change in fair value can be summarized as follows:
Derivative Treatment
 
Accounting Method
Normal purchases and normal sales exception
 
Accrual accounting
Designated in qualifying hedging relationship
 
Hedge accounting
All other derivatives
 
Mark-to-market accounting

The primary derivative instruments that we use have the following characteristics. Options provide the right, but not the obligation to buy or sell the commodity at a specified price in the future. Futures Contracts include a requirement to buy or sell the commodity at a fixed price in the future. OTC Swap Contracts, OTC Option Contracts and Forward 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 if our liability position exceeds specified thresholds. At September 30, 2012, we had no cash collateral outstanding related to our OTC Swap Contracts.

The following table presents the fair value (in millions) of our derivative instruments as of September 30, 2012 and December 31, 2011. 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 have elected to offset the recognized fair value amounts for multiple derivative instruments executed with the same counterparty in our financial statements. As a result, the asset and liability amounts below will not agree with the amounts presented in our condensed consolidated balance sheets.
 
 
 
Derivative Assets
 
Derivative Liabilities
 
Balance Sheet Location
 
September 30,
2012
 
December 31,
2011
 
September 30,
2012
 
December 31,
2011
Mark-to-Market Derivatives (a):
 
 
 
 
 
 
 
 
 
Commodity Futures Contracts
Prepayments and other current assets
 
$
287

 
$
95

 
$
308

 
$
136

Commodity OTC Swap Contracts
 Receivables
 
1

 
1

 

 

Commodity OTC Swap Contracts
Accounts payable
 

 
2

 
4

 
3

Commodity Forward Contracts
Receivables
 

 
4

 

 

Commodity Forward Contracts
Accounts payable
 

 

 

 
1

Total Gross Mark-to-Market Derivatives
 
 
288

 
102

 
312

 
140

Less: Counterparty Netting and Cash Collateral (b)
 
 
(230
)
 
(63
)
 
(288
)
 
(138
)
Total Net Fair Value of Derivatives
 
 
$
58

 
$
39

 
$
24

 
$
2

________________
(a)
The above fair values are presented as gross amounts, including when the derivatives are subject to master netting arrangements and qualify for net presentation in the condensed consolidated balance sheet.
(b)
As of September 30, 2012 and December 31, 2011, cash collateral amounts of $58 million and $75 million, respectively, are being netted with mark-to-market derivative assets.


13

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Gains (losses) for our mark-to market derivatives for the three and nine months ended September 30, 2012 and 2011, were as follows (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
Mark-to-Market Derivatives:
2012
 
2011
 
2012
 
2011
Commodity Futures Contracts
$
(60
)
 
$
89

 
$
(22
)
 
$
121

Commodity OTC Swap Contracts
(4
)
 
20

 
(10
)
 
21

Commodity Forward Contracts
(5
)
 
1

 
(2
)
 

Foreign Currency Forward Contracts
1

 
(4
)
 

 
(5
)
Total Mark-to-Market Derivatives
$
(68
)
 
$
106

 
$
(34
)
 
$
137


The income statement location of gains (losses) for our mark-to market derivatives above were as follows (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
Income Statement Location:
2012
 
2011
 
2012
 
2011
Revenues
$
(17
)
 
$
14

 
$
4

 
$
14

Cost of sales
(52
)
 
96

 
(38
)
 
128

Foreign currency exchange loss
1

 
(4
)
 

 
(5
)
Total Gain (Loss) on Mark-to-Market Derivatives
$
(68
)
 
$
106

 
$
(34
)
 
$
137


Gains (losses) on our derivatives designated for hedge accounting during the three and nine months ended September 30, 2012 and 2011, were as follows (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
Derivatives Designated for Hedge Accounting:
2012
 
2011
 
2012
 
2011
Commodity Futures Contracts (a):
 
 
 
 
 
 
 
Recognized in Income on Derivatives
$

 
$
2

 
$

 
$
5

Recognized in Income on Hedged Item

 

 

 
(4
)
Recognized in Income on Ineffective Portion of Derivative (b)

 
2

 

 
1

________________
(a)
Gains (losses) recognized in income on the derivative and the hedged item are included in cost of sales in the statements of condensed consolidated operations.
(b)
For fair value hedges, no component of the derivative instruments’ gains or losses was excluded from the assessment of hedge effectiveness. No amounts were recognized in income for hedged firm commitments that no longer qualify as fair value hedges.

Open Long (Short) Positions

All of our open positions are scheduled to mature within 18 months. As of September 30, 2012, we had open forward contracts to purchase CAD $36 million and CAD $33 million that mature on October 25, 2012 and November 26, 2012, respectively. We did not have any open contract volumes designated for fair value hedge accounting as of September 30, 2012.


14

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


The information below presents the net volume of outstanding commodity contracts by type of instrument and year of maturity as of September 30, 2012 (volumes in thousands of barrels):
Mark-to-Market Derivatives
Derivative instrument and Year of maturity
 
Long (Short) Contract Volumes
Futures
 
 
2012
 
(6,220)
2013
 
144
Swaps
 
 
2012
 
(50)
Forwards
 
 
2012
 
360
Options
 
 
2012
 
10

NOTE G – DEBT

Our total debt at September 30, 2012 and December 31, 2011, was comprised of the following (in millions):
Debt, including current maturities:
September 30,
2012
 
December 31,
2011
Tesoro Corporation Revolving Credit Facility
$

 
$

Tesoro Panama Company S.A. (“TPSA”) Revolving Credit Facility

 
117

TLLP Revolving Credit Facility

 
50

6.250% Senior Notes due 2012

 
299

6.625% Senior Notes due 2015

 
450

4.250% Senior Notes due 2017
450

 

6.500% Senior Notes due 2017

 
473

9.750% Senior Notes due 2019 (net of unamortized discount of $9 million)
291

 
291

5.875% TLLP Senior Notes due 2020
350

 

5.375% Senior Notes due 2022
475

 

Capital Lease Obligations and Other
20

 
21

Total Debt
$
1,586

 
$
1,701


Credit Facilities Overview

As of September 30, 2012, our credit facilities were subject to the following expenses and fees:
Credit Facility
 
30 day Eurodollar (LIBOR) Rate
 
Eurodollar Margin
 
Base Rate
 
Base Rate Margin
 
Commitment Fee
(unused portion)
Tesoro Corporation Revolving Credit Facility ($1.85 billion) (a)
 
0.21%
 
1.75%
 
3.25%
 
0.75%
 
0.375%
TLLP Revolving Credit Facility ($300 million) (a)
 
0.21%
 
2.50%
 
3.25%
 
1.50%
 
0.50%
________________
(a)
We have the option to elect if the borrowings will bear interest at either a base rate plus the base rate margin, or a Eurodollar rate, for the applicable period, plus, the Eurodollar margin at the time of the borrowing. Letters of credit outstanding under the Tesoro Corporation Revolving Credit Facility incur fees at the Eurodollar margin rate.


15

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Tesoro Corporation Revolving Credit Facility

The Revolving Credit Facility is guaranteed by substantially all of Tesoro’s active domestic subsidiaries excluding Tesoro Logistics GP (“TLGP”) and 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. For additional information regarding TLLP, see Note B.

We amended our Revolving Credit Facility in June 2012 and August 2012. The June 2012 amendment provides for the application of certain credit enhancements to transfer the credit risk associated with certain commercial trade receivables. The August 2012 amendment allows Tesoro Canada Supply & Distribution Ltd. and TPSA to become subsidiary guarantors upon the satisfaction of certain conditions, which were satisfied in August 2012. In addition, the August amendment includes changes to financial contracts to reflect updated market standards and to incorporate our risk management policy.

At September 30, 2012, our Revolving Credit Facility provided for borrowings (including letters of credit) up to the lesser of the amount of a periodically adjusted borrowing base of approximately $4.1 billion, consisting 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 $1.85 billion. The total available capacity can be increased up to an aggregate amount of $2.25 billion, subject to receiving increased commitments. As of September 30, 2012, we had no borrowings and $1.1 billion in letters of credit outstanding under the Revolving Credit Facility, resulting in total unused credit availability of approximately $777 million or 42% of the eligible borrowing base. The Revolving Credit Facility is scheduled to mature on March 16, 2016.

Our Revolving Credit Agreement and senior notes each limit our restricted payments (as defined) including our ability to pay cash dividends, purchase our common stock or make voluntary repayments of subordinate debt. The aggregate amount of restricted payments cannot exceed an amount defined in each of the debt agreements. The indentures for our senior notes also limit our subsidiaries ability to make certain payments and distributions.

Letter of Credit Agreements

The Revolving Credit Facility allows us to obtain letters of credit under separate letter of credit agreements for foreign crude oil purchases. As of September 30, 2012, our four separate uncommitted letter of credit agreements had $404 million outstanding. Letters of credit outstanding under these agreements incur fees 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.

TPSA Revolving Credit Facility

TPSA, a directly and wholly owned subsidiary of Tesoro, entered into a 364-day uncommitted, secured revolving credit agreement in October 2011. Effective August 16, 2012, we terminated the TPSA revolving credit facility agreement. TPSA had no borrowings under the agreement at the time of termination and did not incur any early termination penalties.

TLLP Revolving Credit Facility

TLLP amended the TLLP Revolving Credit Facility effective March 30, 2012. Concurrent with the execution of the amendment, and pursuant to the terms of the original agreement, TLLP exercised its option to increase the total loan availability under the TLLP Credit Agreement from $150 million to an aggregate of $300 million. The amendment allows TLLP to request that the availability be increased up to an aggregate of $450 million, subject to receiving increased commitments from the lenders, compared to the original agreement, which allowed an aggregate capacity of $300 million.

TLLP entered into the second amendment to the TLLP Revolving Credit Facility on August 17, 2012, to revise the interest coverage and leverage ratios that TLLP is required to maintain. TLLP used a portion of the proceeds from the TLLP 2020 Notes offering to repay the outstanding balance on the TLLP Revolving Credit Facility during the three months ended September 30, 2012. As of September 30, 2012, TLLP had no borrowings outstanding under this facility.

The TLLP Revolving Credit Facility is non-recourse to Tesoro, except for TLGP, and is guaranteed by all of TLLP’s subsidiaries and secured by substantially all of TLLP’s assets. Borrowings are available under the TLLP Revolving Credit Facility up to the total available revolving capacity of the facility. The TLLP Revolving Credit Facility is scheduled to mature on April 25, 2014.


16

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


6.250% Senior Notes due November 2012

We redeemed all of our outstanding $299 million 6.250% Senior Notes due November 2012 during the three months ended September 30, 2012.

4.250% Senior Notes due 2017 and 5.375% Senior Notes due 2022

In September 2012, we issued $450 million aggregate principal amount of 4.250% Senior Notes due 2017 (“2017 Notes”) and $475 million aggregate principal amount of 5.375% Senior Notes due 2022 (“2022 Notes”). We may redeem some or all of the 2017 Notes and 2022 Notes at any time prior to September 1, 2017 and October 1, 2017, respectively, at a make-whole price plus accrued and unpaid interest. From September 1, 2017 through the maturity date of October 1, 2017, the 2017 Notes may be redeemed at a price equal to 100% of the principal amount plus accrued and unpaid interest. The 2022 Notes may be redeemed on or after October 1, 2017 at premiums of 2.688% through September 30, 2018; 1.792% from October 1, 2018 through September 30, 2019; 0.896% from October 1, 2019 through September 30, 2020; and at par thereafter, plus accrued and unpaid interest in all circumstances. In addition, at any time prior to October 1, 2015, we may redeem up to 35% of the aggregate principal amount of the 2022 Notes at 105.375% of face value with proceeds from certain equity issuances through October 1, 2015.

The 2017 and 2022 Senior Notes contain terms, events of default and covenants that are customary for notes of this nature. These notes are unsecured obligations and guaranteed by certain of our domestic subsidiaries, excluding TLGP and TLLP and its subsidiaries.

6.625% Senior Notes due 2015 and 6.500% Senior Notes due 2017

In conjunction with the issuance of the 2017 Notes and 2022 Notes, we commenced offers to purchase (“Tender Offers”) any and all of our $450 million outstanding 6.625% Senior Notes due 2015 and $473 million outstanding 6.500% Senior Notes due 2017. On September 27, 2012, we purchased all of the existing Senior Notes validly tendered pursuant to the Tender Offers for approximately $558 million and deposited with the trustee approximately $412 million to satisfy and discharge remaining obligations for the outstanding notes under optional redemption provisions in the indentures. The aggregate purchase price for these notes totaled approximately $970 million including accrued interest and premiums of $24 million and $23 million, respectively. In addition, we expensed $4 million of remaining unamortized debt issuance costs on these notes.

5.875% TLLP Senior Notes due 2020

Effective September 14, 2012, TLLP completed a private offering of $350 million aggregate principal amount of the TLLP 2020 Notes. The proceeds of this offering were used to fund TLLP’s acquisition of the Long Beach Assets and to repay the outstanding balance on the TLLP Revolving Credit Facility, with the remaining amounts to be used for general partnership purposes.

The TLLP 2020 Notes have no sinking fund requirements. TLLP may redeem some or all of the TLLP 2020 Notes prior to October 1, 2016 at a make-whole price plus accrued and unpaid interest. On or after October 1, 2016, the TLLP 2020 Notes may be redeemed at premiums equal to 2.938% through October 1, 2017; 1.469% from October 1, 2017 through October 1, 2018; and at par thereafter, plus accrued and unpaid interest in all circumstances. TLLP will have the right to redeem up to 35% of the aggregate principal amount at 105.875% of face value with proceeds from certain equity issuances through October 1, 2015.

The TLLP 2020 Notes are subject to a registration rights agreement under which TLLP has agreed to exchange the notes for registered publicly-traded notes having substantially identical terms as the TLLP 2020 Notes. The TLLP 2020 Notes also contain customary terms, events of default and covenants. The TLLP 2020 Notes are unsecured and guaranteed by all of TLLP’s domestic subsidiaries, except Tesoro Logistics Finance Corp., the co-issuer of the TLLP 2020 Notes.


17

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE H - PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment, at cost, is as follows (in millions):
 
September 30,
2012
 
December 31,
2011
Refining
$
6,475

 
$
6,161

Retail
743

 
679

Corporate
222

 
215

Property, plant and equipment, at cost
7,440

 
7,055

Accumulated depreciation
(2,099
)
 
(1,907
)
Net property, plant and equipment
$
5,341

 
$
5,148


We capitalize interest as part of the cost of major projects during the construction period. Capitalized interest totaled $5 million and $4 million for the three months ended September 30, 2012 and 2011, respectively, and $13 million and $11 million for the nine months ended September 30, 2012 and 2011, respectively, and is recorded as a reduction to interest and financing costs.

NOTE I – BENEFIT PLANS

Tesoro sponsors the following four defined benefit pension plans: the funded qualified employee retirement plan, the unfunded nonqualified executive security plan, the unfunded nonqualified restoration retirement plan and the unfunded nonqualified supplemental executive retirement plan. Although our funded employee retirement plan fully meets all funding requirements under applicable laws and regulations, we voluntarily contributed $36 million during the nine months ended September 30, 2012 to improve the funded status of the plan.

The components of pension benefit expense and other postretirement benefit expense (income) included in the condensed statements of consolidated operations for the three and nine months ended September 30, 2012 and 2011, were (in millions):
 
Pension Benefits
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
 
2012
 
2011
 
2012
 
2011
Service cost
$
7

 
$
7

 
$
21

 
$
21

Interest cost
7

 
7

 
22

 
22

Expected return on plan assets
(6
)
 
(5
)
 
(18
)
 
(15
)
Amortization of prior service cost
1

 
1

 
1

 
1

Recognized net actuarial loss
5

 
5

 
16

 
15

Recognized curtailment loss

 

 

 
3

Net Periodic Benefit Expense
$
14

 
$
15

 
$
42

 
$
47

 
 
 
 
 
 
 
 
 
Other Postretirement Benefits
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
 
2012
 
2011
 
2012
 
2011
Service cost
$
2

 
$
1

 
$
4

 
$
4

Interest cost
1

 
1

 
3

 
3

Amortization of prior service credit
(9
)
 
(9
)
 
(28
)
 
(28
)
Recognized net actuarial loss
2

 
3

 
8

 
9

Net Periodic Benefit Income
$
(4
)
 
$
(4
)
 
$
(13
)
 
$
(12
)


18

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE J - COMMITMENTS AND CONTINGENCIES

Environmental and Tax Matters

We are a party to various litigation and contingent loss situations, including environmental and income tax matters, arising in the ordinary course of business. Although we cannot predict the ultimate outcomes of these matters with certainty, we have accrued for the estimated liabilities, when appropriate. We believe that the outcome of these matters will not have a material impact on our liquidity or financial position, although the resolution of certain of these matters could have a material impact on our interim or annual results of operations. Additionally, if applicable, we accrue receivables for probable insurance or other third-party recoveries.

We are 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 us to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites, install additional controls, or make other modifications to certain emission sources, equipment or facilities.

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. We believe that resolution of any such claim(s) would not have a material impact on our financial position, results of operations and liquidity. We do not expect our unrecognized tax benefits to change significantly over the next twelve months.

Environmental Liabilities

We are incurring and expect to continue to incur expenses for environmental 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. 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 $89 million and $93 million at September 30, 2012 and December 31, 2011, respectively. These accruals include $55 million at the end of both periods, related to environmental liabilities for site cleanup activities assumed from a prior owner, arising from operations at our Martinez refinery prior to August 2000. Of the $55 million accrued, approximately $46 million is subject to a cost-share agreement where we are responsible for 75% of the expenditures. We cannot reasonably determine the full extent of remedial activities that may be required at the Martinez refinery. Therefore, it is possible that we will identify additional investigation and remediation costs as more information becomes available. We have filed insurance claims under environmental insurance policies that provide coverage up to $190 million for expenditures in excess of $50 million in self-insurance, but the insurer has challenged coverage and filed a declaratory relief action in federal court. We have not recognized possible insurance recoveries related to this matter.

We have investigated conditions at certain active wastewater treatment units at our Martinez refinery.  The investigation was driven by an order received in 2004 from the San Francisco Bay Regional Water Quality Control Board. The order named us as well as two previous owners of the Martinez refinery.  We cannot currently estimate the amount of the ultimate resolution of the order, but we believe it will not have a material adverse impact on our financial position, results of operations or liquidity.

Washington Refinery Fire

The naphtha hydrotreater unit at our Washington refinery was involved in a fire in April 2010, which fatally injured seven employees and rendered the unit inoperable. The Washington State Department of Labor & Industries (“L&I”), the U.S. Chemical Safety and Hazard Investigation Board (“CSB”) and the EPA initiated separate investigations of the incident. L&I completed its investigation in October 2010, issued citations and assessed a $2.4 million fine, which we appealed. L&I reassumed jurisdiction of the citation and affirmed the allegations in December 2010. We disagree with L&I's characterizations of operations at our Washington refinery and believe, based on available evidence and scientific reviews, that many of the agency's conclusions are mistaken. We filed an appeal of the citation in January 2011. The EPA and CSB investigations are ongoing.


19

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


In July 2012, we settled all claims brought by the estates and families of the seven fatally injured employees and a third-party truck driver (Donald and Peggy Zimmerman et al. v. Tesoro Corporation and Tesoro Refining and Marketing et al.).  The resolution of these claims did not have a material impact on our financial position, results of operations or liquidity.

We have filed business interruption insurance claims related to down time from this incident and have collected $87 million total in 2010 and 2011. Certain business interruption claims remain open as of September 30, 2012.

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 matters unless a loss is probable, and the amount of loss is currently estimable. On the basis of existing information, we believe that the resolution of these matters, individually or in the aggregate, will not have a material adverse impact on our liquidity or financial position, although the resolution of certain of these matters could have a material impact on our interim or annual results of operations.

Legal

We are a defendant, along with other manufacturing, supply and marketing defendants, in two remaining lawsuits alleging methyl tertiary butyl ether (“MTBE”) contamination in groundwater. The defendants are being sued for having manufactured MTBE and having manufactured, supplied and distributed gasoline containing MTBE. The plaintiffs in the remaining cases, all in California, are municipalities and governmental authorities. The plaintiffs allege, in part, that the defendants are liable for manufacturing or distributing a defective product. The suits generally seek individual, unquantified compensatory and punitive damages and attorney's fees. We intend to vigorously assert our defenses against these claims. While we cannot currently estimate the amount or timing of the resolution of these matters, we have established an accrual for these matters and believe that the outcome will not have a material impact on our financial position, results of operations or liquidity.

During 2009, Chevron filed a lawsuit against us claiming they are entitled to a share of the refunds we received in 2008 from the owners of the Trans Alaska Pipeline System (“TAPS”). We received $50 million in 2008, net of contingent legal fees, for excessive intrastate rates charged by TAPS during 1997 through 2000, and the period of 2001 through June 2003. Chevron is asserting that it is entitled to a share of its portion of the refunds for retroactive price adjustments under our previous crude oil contracts with them. The trial court judge granted Chevron's motion for summary judgment and awarded them $16 million, including interest in September 2010. We disagree with the trial court and have appealed the decision to the Alaska Supreme Court, in which the proceeding is now pending. We have established an accrual for this matter and the resolution of this matter will not have a material impact on our financial position, results of operations or liquidity.

Environmental

The EPA has alleged that we have violated certain Clean Air Act regulations at our Alaska, Washington, Martinez, Hawaii and Utah refineries. We are continuing discussions of the EPA’s claims with the EPA and the U.S. Department of Justice (“DOJ”). 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. The alleged violations in the NOV arise from a 2007 state of Alaska inspection and inspections by the EPA in 2008 and 2010. We also previously received NOV’s in 2005 and 2008 alleging violations of the Clean Air Act at our Washington refinery. We are discussing all of these allegations with the EPA and DOJ. The ultimate resolution of these matters could require us to incur material capital expenditures and/or civil penalties. While we cannot currently estimate the amount or timing of the resolution of these matters, and currently believe that the outcome of these matters will not have a material impact on our liquidity or financial position, the ultimate resolution could have a material impact on our interim or annual results of operations.

20

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE K - STOCKHOLDERS' EQUITY

See Note L for information relating to stock-based compensation. Changes to equity during the nine months ended September 30, 2012, are presented below:
 
Tesoro Corporation Stockholders' Equity
 
Noncontrolling
 Interest
 
Total Equity
Balance at December 31, 2011
$
3,668

 
$
310

 
$
3,978

Net earnings
716

 
19

 
735

Shares issued for equity-based compensation awards
24

 

 
24

Excess tax benefits from stock-based compensation arrangements
6

 

 
6

Amortization of equity settled awards
25

 

 
25

Dividend payments
(17
)
 

 
(17
)
Purchases of common stock
(31
)
 

 
(31
)
Distributions to noncontrolling interest

 
(17
)
 
(17
)
Balance at September 30, 2012
$
4,391

 
$
312

 
$
4,703


We issued approximately 1.5 million and 1.6 million shares primarily for stock option exercises under our equity-based compensation plans during the nine months ended September 30, 2012 and twelve months ended December 31, 2011, respectively. 

During 2011, our Board of Directors approved a program designed to offset the dilutive effect of future stock-based compensation awards. We purchased approximately 1.0 million shares of our common stock at a weighted average price of $24.81 per share for approximately $26 million during the nine months ended September 30, 2012, to offset the impact of 2012 grants under the 2011 Long-Term Incentive Plan (“2011 Plan”).

In August 2012, our Board of Directors authorized an additional $500 million share repurchase program and the initiation of a regular quarterly cash dividend of $0.12 per share. Under the program, management will purchase Tesoro common stock at its discretion in the open market. The authorization has no time limit and may be suspended or discontinued at any time. On October 31, 2012, our Board of Directors approved an increase of the quarterly cash dividend to $0.15 per share, payable on December 14, 2012 to shareholders of record on November 30, 2012. In September 2012, we paid cash dividends on common stock of $0.12 per share, or $17 million.

Our Revolving Credit Agreement and senior notes each limit our ability to pay cash dividends or buy back our stock. The limitation in each of our debt agreements is based on limits on restricted payments (as defined in our debt agreements), which include dividends, purchases of our stock or voluntary repayments of subordinate debt. The aggregate amount of restricted payments cannot exceed an amount defined in each of the debt agreements. The indentures for our senior notes also limit our subsidiaries ability to make certain payments and distributions.

NOTE L - STOCK-BASED COMPENSATION

Stock-based compensation expense (credit) included in our condensed statements of consolidated operations was as follows (in millions):    
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
 
2012
 
2011
 
2012
 
2011
Stock appreciation rights
$
56

 
$
(12
)
 
$
59

 
$
10

Performance share awards
6

 

 
10

 
1

Market stock units
4

 
2

 
10

 
3

Other stock-based awards
6

 

 
14

 
11

Total Stock-Based Compensation Expense (Credit)
$
72

 
$
(10
)
 
$
93

 
$
25



21

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


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 $26 million benefit and $4 million expense for the three months ended September 30, 2012 and 2011, respectively, and a benefit of $33 million and $8 million for the nine months ending September 30, 2012 and 2011, respectively. The income tax benefit recognized from tax deductions resulting from exercises and vestings under all of our stock-based compensation arrangements totaled $11 million and $1 million for the three months ended September 30, 2012 and 2011, respectively, and $25 million and $16 million for the nine months ended September 30, 2012 and 2011, respectively.

Stock Appreciation Rights

A stock appreciation right (“SAR”) entitles an employee to receive cash in an amount equal to the excess of the fair market value of one share of common stock on the date of exercise over the grant price of the SAR. The fair value of each SAR is estimated at the end of each reporting period using the Black-Scholes option-pricing model. We have not granted any SARs since 2010. We paid cash of $30 million to settle approximately 1.7 million SARs that were exercised during the nine months ended September 30, 2012. We had $84 million and $55 million recorded in accrued liabilities associated with our SARs awards at September 30, 2012 and December 31, 2011, respectively. A summary of SAR activity is set forth below (shares in thousands):
 
Number of
SARs
 
Weighted Average
 Exercise Price
 
Weighted Average
 Remaining Contractual Term
Outstanding at January 1, 2012
6,037

 
$
23.72

 
3.5 years
Exercised
(1,698
)
 
$
14.95

 
 
Forfeited
(106
)
 
$
29.61

 
 
Outstanding at September 30, 2012
4,233

 
$
27.09

 
2.6 years
Vested or expected to vest at September 30, 2012
4,233

 
$
27.09

 
2.6 years
Exercisable at September 30, 2012
4,101

 
$
27.55

 
2.5 years

Performance Share Awards

Performance Conditions

We granted performance condition performance share awards under the 2011 Plan in February 2012. The vesting percentages of these equity awards, range from 0-200%, and are tied to performance conditions over the three-year period. These performance share awards represent the right to receive a target number of shares that will vest at the end of the performance period and be issued within two and one-half months of the vesting date. The fair value of each performance share award is tied to performance measures estimated using the market price of our common stock on the grant date. The estimated fair value of these performance share awards is amortized over the three-year vesting period using the straight-line method. The value of the award ultimately paid will be based on return on capital employed, which is measured against the performance peer group.

Market Conditions

We granted market condition performance share awards under the 2011 Plan in February 2012. The vesting percentages of these equity awards, range from 0-200%, and are tied to market conditions over the three-year performance period. These performance share awards represent the right to receive a target number of shares that will vest at the end of the performance period and be issued within two and one-half months of the vesting date. The fair value of each performance share award is estimated using a Monte Carlo simulation model and is estimated at the end of each reporting period. The estimated fair value of these performance share awards is amortized over the three-year vesting period using the straight-line method. The value of the award ultimately paid will be based on relative total shareholder return, which is measured against the performance peer group and the S&P 500 Index.


22

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Total unrecognized compensation cost related to all non-vested performance share awards totaled $18 million as of September 30, 2012, which is expected to be recognized over a weighted average period of 2.0 years. As of September 30, 2012, the estimated weighted average payout percentage for these awards was approximately 118%. A summary of all performance share award activity, assuming a 100% payout, is set forth below (shares in thousands):
 
Number of
Shares
 
Weighted Average Grant-
Date Fair Value
 
 
 
 
Non-vested at January 1, 2012
274

 
$
31.53

Granted
380

 
$
30.98

Forfeited
(15
)
 
$
31.40

Non-vested at September 30, 2012
639

 
$
31.20


Market Stock Units

We granted market stock units under the 2011 Plan in February 2012. These market stock units represent the right to receive a target number of shares that will vest at the end of the three-year performance period. The number of shares ultimately issued will be based on Tesoro's stock price changes over the performance period. The market stock units' potential payout can range from 50-200% of targeted award value, unless the average closing stock price at vesting has decreased more than 50% from the average closing stock price at the grant date, then no market stock units will be paid out. The fair value of each market stock unit is estimated on the grant date using a Monte Carlo simulation model. The estimated fair value of these market stock units is amortized over the three-year vesting period using the straight-line method. As of September 30, 2012, the estimated weighted average payout percentage for these awards was 162%. Total unrecognized compensation cost related to non-vested market stock units totaled $21 million as of September 30, 2012, which is expected to be recognized over a weighted average period of 2.1 years. The intrinsic value of the outstanding market stock units were $71 million and $9 million as of September 30, 2012 and December 31, 2011, respectively. A summary of our market stock unit award activity, assuming a 100% payout, is set forth below (units in thousands):
 
Number of
Units
 
Weighted Average Grant-
Date Fair Value
 
 
 
 
Non-vested at January 1, 2012
424

 
$
34.22

Granted
665

 
$
33.93

Forfeited
(50
)
 
$
34.14

Non-vested at September 30, 2012
1,039

 
$
34.04


NOTE M - OPERATING SEGMENTS

The Company's revenues are derived from two operating segments, refining and retail. We own and operate seven petroleum refineries located in California, Washington, Alaska, Hawaii, North Dakota and Utah. These refineries 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, at wholesale through terminal facilities and other locations. Our refining segment also sells refined products to unbranded marketers and opportunistically exports refined products to foreign markets. Our retail segment sells gasoline, diesel fuel and convenience store items through company-operated retail stations and branded jobber/dealers in 18 states. We do not have significant operations in foreign countries. Therefore, 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. Intersegment sales from refining to retail are made at prevailing market rates. Income taxes, other income (expense), foreign currency exchange loss, interest and financing costs, interest income, corporate depreciation and corporate general and administrative expenses are excluded from segment operating income. Identifiable assets are those used by the segments, whereas corporate assets are principally cash and other assets that are not associated with a specific operating segment.

23

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Segment information is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
 
2012
 
2011
 
2012
 
2011
Revenues
(In millions)
Refining:
 
 
 
 
 
 
 
Refined products
$
8,451

 
$
7,745

 
$
23,793

 
$
21,650

Crude oil resales and other
171

 
227

 
462

 
568

Retail:
 
 
 
 
 
 
 
Fuel (a)
1,694

 
1,382

 
4,507

 
3,851

Merchandise and other
65

 
61

 
183

 
170

Intersegment sales from Refining to Retail
(1,605
)
 
(1,314
)
 
(4,244
)
 
(3,649
)
Total Revenues
$
8,776

 
$
8,101

 
$
24,701

 
$
22,590

Segment Operating Income
 
 
 
 
 
 
 
Refining (b)
$
610

 
$
600

 
$
1,446

 
$
1,302

Retail
18

 
22

 
88

 
62

Total Segment Operating Income
628

 
622

 
1,534

 
1,364

Corporate and unallocated costs (c)
(122
)
 
(25
)
 
(213
)
 
(129
)
Operating Income (d)
506

 
597

 
1,321

 
1,235

Interest and financing costs (e)
(66
)
 
(38
)
 
(136
)
 
(141
)
Other income (expense), net (f)
(2
)
 
3

 
(19
)
 
3

Foreign currency exchange loss

 

 
(1
)
 
(1
)
Earnings Before Income Taxes
$
438

 
$
562

 
$
1,165

 
$
1,096

Depreciation and Amortization Expense
 
 
 
 
 
 
 
Refining
$
97

 
$
91

 
$
282

 
$
276

Retail
10

 
9

 
29

 
28

Corporate
9

 
3

 
17

 
8

Total Depreciation and Amortization Expense
$
116

 
$
103

 
$
328

 
$
312

Capital Expenditures
 
 
 
 
 
 
 
Refining
$
116

 
$
69

 
$
328

 
$
162

Retail
14

 
13

 
46

 
20

Corporate
3

 
4

 
9

 
9

Total Capital Expenditures
$
133

 
$
86

 
$
383

 
$
191

________________
(a)
Federal and state motor fuel taxes on sales by our retail segment are included in both revenues and cost of sales in our condensed statements of consolidated operations. These taxes, excluding credits, totaled $140 million and $97 million for the three months ended September 30, 2012 and 2011, respectively, and $351 million and $280 million for the nine months ended September 30, 2012 and 2011, respectively.
(b)
Includes impairment charges related to the change in scope of a capital project at our Wilmington refinery of $48 million for the nine months ended September 30, 2011.
(c)
Includes stock-based compensation expense of $72 million and $92 million for the three and nine months ended September 30, 2012, respectively, primarily as a result of significant increases in Tesoro's stock price during the periods as compared to the three and nine months ended September 30, 2011. For additional information regarding our stock-based compensation expense, see Note L.
(d)
Includes business interruption and property damage insurance recoveries related to the April 2, 2010 incident at the Washington refinery of $37 million for the nine months ended September 30, 2011.
(e)
Includes a charge of $27 million for premiums and unamortized debt issuance costs associated with the redemption of our 6.625% and 6.500% Senior Notes for the three and nine months ended September 30, 2012. Also includes charges of $22 million related to the early redemption of the Junior Subordinated Notes due 2012 and a portion of our 6.250% and 6.500% Senior Notes for the nine months ended September 30, 2011.
(f)
Includes accruals related to certain legal matters partially offset by receipts associated with the settlement of a pipeline rate proceeding for the nine months ended September 30, 2012.

24

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


 
September 30,
2012
 
December 31,
2011
Identifiable Assets:
(In millions)
Refining
$
8,730

 
$
8,152

Retail
778

 
644

Corporate
1,479

 
1,096

Total Assets
$
10,987

 
$
9,892


NOTE N - ACQUISITIONS

Acquisition of BP's Southern California Refining and Marketing Business

On August 8, 2012, we entered into a purchase and sale agreement with BP West Coast Products, LLC and certain other sellers to purchase BP’s integrated Southern California refining and marketing business (“BP Acquisition”). The assets to be acquired include BP’s 266 Mbpd Carson refinery located adjacent to our Wilmington refinery, three marine terminals, four land storage terminals, over one hundred miles of pipelines, four product marketing terminals and approximately 800 dealer-operated retail stations in Southern California, Nevada and Arizona. In addition, the assets include the ARCO® brand and associated registered trademarks, as well as a master franchisee license for the ampm® convenience store brand. Additionally, we will acquire the sellers’ 51% ownership in the 400 megawatt gas fueled Watson cogeneration facility; and also a 350,000 metric ton per year anode coke calcining operation, both located near the Carson refinery.

The purchase price is $1.175 billion, plus the value of inventories at the time of closing. The purchase and sale agreement required an advance payment of $90 million to secure the acquisition. Upon the closing of the BP Acquisition, the sellers have agreed, subject to certain limitations, to retain certain obligations, responsibilities, liabilities, costs and expenses arising out of the pre-closing operations of the assets. We have agreed to assume certain obligations, responsibilities, liabilities, costs and expenses arising out of or incurred in connection with decrees, orders and settlements the sellers entered into with governmental and non-governmental entities prior to closing. We expect that upon closing the BP Acquisition, we will record certain assumed environmental liabilities. We do not expect such liabilities will have a material impact on our liquidity. The BP Acquisition, which is subject to customary closing conditions and will require approval from the Federal Trade Commission and the California Attorney General, is expected to close before mid-2013. The purchase and sale agreement provides for us to pay a break-up fee of up to $140 million in the event that we terminate the agreement (except for termination for specified reasons).

Retail Acquisition

In January 2012, we acquired 49 retail stations located primarily in Washington, Oregon, California, Nevada, Idaho, Utah and Wyoming, from SUPERVALU, Inc. We paid approximately $37 million for the assets, including inventories of approximately $3 million. We assumed the obligations under the seller's leases. SUPERVALU, Inc. retained certain pre-closing liabilities, including environmental matters. We spent approximately $4 million to replace the dispensers at these stations. This acquisition is not material to our condensed consolidated financial statements.

NOTE O - CONDENSED CONSOLIDATING FINANCIAL INFORMATION

Separate condensed consolidating financial information of Tesoro Corporation (the “Parent”), subsidiary guarantors and non-guarantors are presented below. As noted in Note G, we redeemed all of our outstanding $299 million 6.250% Senior Notes due November 2012 and satisfied our obligations on our 6.625% Senior Notes due 2015 and 6.500% Senior Notes due 2017, thereby releasing the guarantors of these notes' guarantees. At September 30, 2012, Tesoro and certain subsidiary guarantors have fully and unconditionally guaranteed our 4.250% Senior Notes due 2017, 9.750% Senior Notes due 2019 and 5.375% Senior Notes due 2022. TLLP, in which we had a 53% ownership interest as of September 30, 2012, 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. 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 jointly and severally liable for Tesoro's outstanding senior notes. The information is presented using the equity method of accounting for investments in subsidiaries.


25

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


As of December 31, 2011, we adopted a new accounting standard, which requires companies to report comprehensive income in either a single continuous statement of comprehensive income, or in two separate but consecutive statements. The guidance under the new standard also applies to the separate condensed consolidating financial information of the Parent, subsidiary guarantors and non-subsidiary guarantors. The condensed consolidating financial information included in our Annual Report on Form 10-K for the year ended December 31, 2011, does not include this information. In 2011, 2010 and 2009, the only components of other comprehensive income related to our pension and other postretirement benefits, which relate 100% to the Parent. The condensed consolidating financial information below includes this information. For the nine months ended September 30, 2012 and 2011, there are no other comprehensive income items.

Condensed Consolidating Balance Sheet as of September 30, 2012
(In millions)
 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Eliminations
Consolidated
ASSETS
Current Assets:
 
 
 
 
 
Cash and cash equivalents
$

$
1,066

$
301

$

$
1,367

Receivables, less allowance for doubtful accounts
2

1,426

156


1,584

Inventories

1,535

204


1,739

Prepayments and other current assets
82

72

12


166

Total Current Assets
84

4,099

673


4,856

Net Property, Plant and Equipment

5,045

296


5,341

Investment in Subsidiaries
5,151

(229
)
182

(5,104
)

Long-Term Receivables from Affiliates
1,973



(1,973
)

Other Noncurrent Assets
47

734

119

(110
)
790

Total Assets
$
7,255

$
9,649

$
1,270

$
(7,187
)
$
10,987

LIABILITIES AND EQUITY
Current Liabilities:
 
 
 
 
 
Accounts payable and accrued liabilities
$
212

$
2,659

$
321

$

$
3,192

Current maturities of debt

2



2

Total Current Liabilities
212

2,661

321


3,194

Long-Term Payables to Affiliates

1,918

55

(1,973
)

Debt
1,326

18

350

(110
)
1,584

Other Noncurrent Liabilities
1,326

179

1


1,506

Equity-Tesoro Corporation
4,391

4,873

231

(5,104
)
4,391

Equity-Noncontrolling interest


312


312

Total Liabilities and Equity
$
7,255

$
9,649

$
1,270

$
(7,187
)
$
10,987



26

TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Condensed Consolidating Balance Sheet as of December 31, 2011
(In millions)
 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Eliminations
Consolidated
ASSETS
Current Assets:
 
 
 
 
 
Cash and cash equivalents
$

$
805

$
95

$

$
900

Receivables, less allowance for doubtful accounts
1

1,189

82


1,272

Inventories

1,416

347


1,763

Prepayments and other current assets
106

88

22


216

Total Current Assets
107

3,498

546


4,151

Net Property, Plant and Equipment

4,925

223


5,148

Investment in Subsidiaries
4,436

(284
)
282

(4,434
)

Long-Term Receivables from Affiliates
1,944