10-Q 1 andv1q201810-q.htm 10-Q Document


 

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, 2018
or

o
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

ANDEAVOR
(Exact name of registrant as specified in its charter)
Delaware
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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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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 o

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,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
þ
 
Accelerated filer
o
 
 
Non-accelerated filer
o (Do not check if a smaller reporting company)
 
Smaller reporting company
o
 
 
 
 
 
Emerging growth company
o
 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

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

There were 151,122,485 shares of the registrant’s Common Stock outstanding at May 3, 2018.
 


Table of Contents
 
 

Andeavor
Quarterly Report on Form 10-Q
For the Quarterly Period Ended March 31, 2018

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

This Quarterly Report on Form 10-Q (including documents incorporated by reference herein) contains statements with respect to our expectations or beliefs as to future events. These types of statements are “forward-looking” and subject to uncertainties. See “Important Information Regarding Forward-Looking Statements” in Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I, Item 2.

2 | 
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Financial Statements

Part I - Financial Statements

Item 1. Financial Statements

Andeavor
Condensed Statements of Consolidated Operations
(Unaudited)

 
Three Months Ended March 31,
 
2018
 
2017
 
(In millions, except per share amounts)
Revenues (a)
$
10,300

 
$
6,638

Costs and Expenses
 
 
 
Cost of materials and other (excluding items shown separately below) (a)
8,609

 
5,426

Operating expenses (excluding depreciation and amortization)
866

 
655

Depreciation and amortization expenses
282

 
226

General and administrative expenses
173

 
135

Loss on asset disposals and impairments

 
1

Operating Income
370

 
195

Interest and financing costs, net
(102
)
 
(98
)
Equity in earnings of equity method investments
10

 

Other income, net
10

 
11

Earnings Before Income Taxes
288

 
108

Income tax expense
59

 
21

Net Earnings from Continuing Operations
229

 
87

Earnings from discontinued operations, net of tax
8

 

Net Earnings
237

 
87

Less: Net earnings from continuing operations attributable to noncontrolling interest
65

 
37

Net Earnings Attributable to Andeavor
$
172

 
$
50

 
 
 
 
Net Earnings Attributable to Andeavor
 
 
 
Continuing operations
$
164

 
$
50

Discontinued operations
8

 

Total
$
172

 
$
50

Net Earnings per Share - Basic
 
 
 
Continuing operations
$
1.08

 
$
0.43

Discontinued operations
0.05

 

Total
$
1.13

 
$
0.43

Weighted average common shares outstanding - Basic
152.9

 
117.1

Net Earnings per Share - Diluted
 
 
 
Continuing operations
$
1.07

 
$
0.42

Discontinued operations
0.05

 

Total
$
1.12

 
$
0.42

Weighted average common shares outstanding - Diluted
153.8

 
118.1

 
 
 
 
Dividends per Share
$
0.59

 
$
0.55

 
 
 
 
Supplemental Information
 
 
 
(a) Excise taxes collected by our Marketing segment included in revenues. Refer to Note 12 in the accompanying notes for adoption of revenue recognition standards.
$

 
$
134

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

 
 
March 31, 2018 |  3

Financial Statements
 
 

Andeavor
Condensed Consolidated Balance Sheets
(Unaudited)

 
March 31,
2018
 
December 31,
2017
 
(In millions, except share data)
Assets
 
 
 
Current Assets
 
 
 
Cash and cash equivalents (Andeavor Logistics: $27 and $75, respectively)
$
433

 
$
543

Receivables, net of allowance for doubtful accounts (Andeavor Logistics: $198 and $219, respectively)
1,934

 
1,961

Inventories
3,484

 
3,630

Prepayments and other current assets
558

 
749

Total Current Assets
6,409

 
6,883

Property, Plant and Equipment, Net
 
 
 
Property, plant and equipment, at cost
19,314

 
18,823

Accumulated depreciation and amortization
(4,257
)
 
(4,081
)
Property, Plant and Equipment, Net (Andeavor Logistics: $5,436 and $5,413, respectively)
15,057

 
14,742

Goodwill (Andeavor Logistics: $684 and $692, respectively)
3,250

 
3,234

Acquired Intangibles, Net (Andeavor Logistics: $1,140 and $1,153, respectively)
1,730

 
1,645

Other Noncurrent Assets, Net (Andeavor Logistics: $418 and $406, respectively)
2,395

 
2,069

Total Assets
$
28,841

 
$
28,573

 
 
 
 
Liabilities and Equity
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
3,049

 
$
3,330

Current maturities of debt
347

 
17

Other current liabilities
1,150

 
1,654

Total Current Liabilities
4,546

 
5,001

Deferred Income Taxes
1,656

 
1,591

Debt, Net of Unamortized Issuance Costs (Andeavor Logistics: $4,148 and $4,127, respectively)
8,386

 
7,668

Other Noncurrent Liabilities
1,100

 
898

Total Liabilities
15,688

 
15,158

Commitments and Contingencies (Note 9)
 
 
 
Equity
 
 
 
Andeavor Stockholders’ Equity
 
 
 
Common stock, par value $0.162/3; authorized 300,000,000 shares; 200,760,979 shares issued (200,095,819 in 2017)
33

 
33

Additional paid-in capital
5,256

 
5,224

Retained earnings
7,715

 
7,651

Treasury stock, 49,650,451 common shares (46,810,338 in 2017), at cost
(3,120
)
 
(2,841
)
Accumulated other comprehensive loss, net of tax
(252
)
 
(252
)
Total Andeavor Stockholders’ Equity
9,632

 
9,815

Noncontrolling Interest
3,521

 
3,600

Total Equity
13,153

 
13,415

Total Liabilities and Equity
$
28,841

 
$
28,573


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

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Financial Statements

Andeavor
Condensed Statements of Consolidated Cash Flows
(Unaudited)

 
Three Months Ended March 31,
 
2018
 
2017
 
(In millions)
Cash Flows From (Used In) Operating Activities
 
 
 
Net earnings
$
237

 
$
87

Adjustments to reconcile net earnings to net cash from operating activities:
 
 
 
Depreciation and amortization expenses
282

 
226

Gain related to Hawaii Business
(10
)
 

Stock-based compensation expense
12

 
14

Deferred income taxes
61

 
38

Turnaround expenditures
(168
)
 
(99
)
Marketing branding costs
(10
)
 
(18
)
Other operating activity
18

 
10

Changes in current assets and current liabilities
(264
)
 
(315
)
Changes in noncurrent assets and noncurrent liabilities
92

 
157

Net cash from operating activities
250

 
100

Cash Flows From (Used In) Investing Activities
 
 
 
Capital expenditures
(467
)
 
(258
)
Acquisitions, net of cash
(340
)
 
(672
)
Deposits for acquisitions
(10
)
 

Other investing activities
1

 
1

Net cash used in investing activities
(816
)
 
(929
)
Cash Flows From (Used In) Financing Activities
 
 
 
Borrowings under revolving credit agreements
1,370

 
44

Repayments on revolving credit agreements
(650
)
 
(334
)
Repayments of debt
(5
)
 
(3
)
Proceeds from inventory financing arrangements
330

 

Repayments of inventory financing arrangements
(116
)
 

Dividend payments
(92
)
 
(65
)
Net proceeds from issuance of Andeavor Logistics LP common units

 
281

Distributions to noncontrolling interest
(99
)
 
(63
)
Purchases of common stock
(256
)
 

Taxes paid related to net share settlement of equity awards
(23
)
 
(22
)
Other financing activities
(3
)
 
(6
)
Net cash from (used in) financing activities
456

 
(168
)
Decrease in Cash and Cash Equivalents
(110
)
 
(997
)
Cash and Cash Equivalents, Beginning of Period
543

 
3,295

Cash and Cash Equivalents, End of Period
$
433

 
$
2,298


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


 
 
March 31, 2018 |  5

Notes to Condensed Consolidated Financial Statements (Unaudited)


Note 1 - Organization and Basis of Presentation

Organization

As used in this report, the terms “Andeavor,” the “Company,” “we,” “us” or “our” may refer to Andeavor, one or more of its consolidated subsidiaries or all of them taken as a whole. The words “we,” “us” or “our” generally include Andeavor Logistics LP (“Andeavor Logistics”), a publicly-traded limited partnership, and its subsidiaries as consolidated subsidiaries of Andeavor with certain exceptions where there are transactions or obligations between Andeavor Logistics and Andeavor or its other subsidiaries.

Western Refining
On June 1, 2017, pursuant to the Agreement and Plan of Merger, dated as of November 16, 2016, by and among Western Refining, Inc. (“Western Refining”), the Company, and our wholly-owned subsidiaries, a wholly-owned subsidiary was merged with and into Western Refining, with Western Refining surviving such merger as a wholly-owned subsidiary of the Company (the “Merger” or the “Western Refining Acquisition”). Refer to Note 2 for more information on the Merger.

Principles of Consolidation and Basis of Presentation

Principles of Consolidation
These interim condensed consolidated financial statements and notes hereto of Andeavor 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. We prepare our condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). However, certain information and notes normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the SEC’s rules and regulations. The consolidated balance sheet at December 31, 2017 has been condensed from the audited consolidated financial statements at that date. 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 the Andeavor Annual Report on Form 10-K for the year ended December 31, 2017.

Basis of Presentation
We are required under U.S. GAAP 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, including the adoption of recent accounting standards discussed further below.

The consolidated statements of comprehensive income for the three months ended March 31, 2018 and 2017 have been omitted, as there was no material change to accumulated other comprehensive income in either period.

Cost Classifications
Cost of materials and other includes the purchase cost of commodities sold within our Refining and Logistics segments along with the cost of inbound transportation and outbound distribution costs incurred to transport product to our customers, gains and losses related to our commodity hedging activities and the cost of merchandise sold through our Marketing segment. Additionally, lower of cost or market valuation adjustments impact our cost of materials and other but are separately presented in our statements of consolidated operations.

Operating expenses are comprised of direct and indirect operating costs. Direct operating expenses reflect costs incurred for direct labor, repairs and maintenance, outside services, chemicals and catalysts, utility costs, including the purchase of electricity and natural gas used by our facilities, property taxes, environmental compliance costs related to current period operations, rent expense and other direct operating expenses incurred in the production of refined products sold through our Marketing or Refining segments or towards the provision of services in our Logistics segment. Indirect operating expenses represent allocated labor and other administrative costs for centralized personnel that influence our underlying operations, environmental remediation costs unrelated to current period operations, and other costs that are related, but not directly, to our segment operations.


6 | 
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Notes to Condensed Consolidated Financial Statements (Unaudited)
 

Operating Expenses (in millions)

 
Three Months Ended March 31,
 
2018
 
2017
Direct operating expenses
$
828

 
$
625

Indirect operating expenses
38

 
30

Operating expenses (excluding depreciation and amortization)
$
866

 
$
655


Depreciation and amortization expenses consist of the depreciation and amortization of property, plant and equipment, deferred turnaround expenditures, marketing branding costs and intangible assets related to our operating segments along with our corporate operations. General and administrative expenses represent costs that are not directly or indirectly related to or otherwise are not allocated to our marketing, logistics or refining operations. Cost of materials and other, any lower of cost or market valuation adjustments, direct operating expenses incurred across our operating segments, and depreciation and amortization expenses recognized by our Marketing, Logistics and Refining segments (refer to amounts disclosed in Note 13) constitute costs of revenue as defined by U.S. GAAP.

Variable Interest Entities
Our condensed consolidated financial statements include a variable interest entity, Andeavor Logistics, which is part of our Marketing and Logistics segments. Andeavor Logistics is a publicly traded limited partnership that we formed to own, operate, develop and acquire logistics assets. Its assets are integral to the success of Andeavor’s refining and marketing operations and are used to gather crude oil, natural gas, and water, process natural gas and distribute, transport and store crude oil and refined products. Andeavor Logistics provides us with various pipeline transportation, trucking, terminal distribution, gathering and processing, storage 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 Andeavor Logistics.

Tesoro Logistics GP, LLC (“TLGP”), our wholly-owned subsidiary, serves as the general partner of Andeavor Logistics. As the general partner of Andeavor Logistics, we have the sole ability to direct the activities of Andeavor Logistics that most significantly impact its economic performance. We are also considered to be the primary beneficiary for accounting purposes and are Andeavor Logistics’ primary customer. We held an approximate 59% interest in Andeavor Logistics at both March 31, 2018 and December 31, 2017. In the event Andeavor Logistics incurs a loss, our operating results will reflect Andeavor Logistics’ loss, net of intercompany eliminations. Andeavor Logistics’ transactions with us under our various long-term, fee-based commercial agreements accounted for 59% and 48% of Andeavor Logistics’ total revenues for the three months ended March 31, 2018 and 2017, respectively.

In January 2018, Andeavor acquired Rangeland Energy II, LLC, (“Rangeland”), which included the acquisition of Rangeland’s 67% interest in Rangeland RIO Pipeline, LLC (“RIO”), a variable interest entity that owns assets in the Delaware and Midland Basins. Andeavor’s interests in RIO include its initial equity investment of $159 million, which is subject to adjustment during the one-year measurement period, and a service agreement through one of its wholly-owned subsidiaries to operate, maintain and repair the assets. As of March 31, 2018, we determined that Andeavor is not the primary beneficiary of RIO, under the partnership agreement, because Andeavor and the other minor shareholder jointly direct the activities of RIO that most significantly impact economic performance. In addition, Andeavor Logistics has a 78% interest in Rendezvous Gas Services, L.L.C (“RGS”). Both RGS and RIO are unconsolidated variable interest entities and we use the equity method of accounting with respect to our investments in each entity.

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 sites and associated logistics assets (the “Hawaii Business”). The sale of the Hawaii Business was subject to an earn-out provision based on the annual gross margin (as defined in sale agreement) in the three annual periods beginning with the year ended December 31, 2014 and ending with the year ended December 31, 2016. Additionally, we retained liability for certain regulatory improvements required at the Hawaii refinery and tank replacement efforts at certain retail sites. The results of operations for this business have been presented as discontinued operations in the condensed statements of consolidated operations. There were no revenues for the three months ended March 31, 2018 and 2017. We recorded $10 million in pre-tax earnings ($8 million after-tax) during the three months ended March 31, 2018 primarily related to final adjustments to previous earn-out periods. No additional earn-outs related to the sale of the Hawaii Business remain to be paid to Andeavor. There were no earnings or loss recorded for the three months ended March 31, 2017. Cash flows from discontinued operations were $8 million for the three months ended March 31, 2018 and cash flows used in discontinued operations were $5 million for the three months ended March 31, 2017. Unless otherwise noted, the information in the notes to the condensed consolidated financial statements relates to our continuing operations.


 
 
March 31, 2018 |  7

Notes to Condensed Consolidated Financial Statements (Unaudited)

New Accounting Standards and Disclosures

Revenue Recognition
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Updated (“ASU”) 2014-09, “Revenue from Contracts with Customers” to replace existing revenue recognition rules with a single comprehensive model to use in accounting for revenue arising from contracts with customers. Under this ASU and the associated subsequent amendments (collectively, “ASC 606”), revenue is recognized when a customer obtains control of promised goods or services for an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. In addition, ASC 606 requires expanded disclosure of the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.

We adopted ASC 606 on January 1, 2018 utilizing the modified retrospective method. We recognized a $16 million reduction to retained earnings and a $9 million reduction to noncontrolling interest on January 1, 2018 for the cumulative effect adjustment related to contracts in process but not substantially complete as of that date. We reflected the aggregate impact of all modifications executed and effective as of January 1, 2018 in applying the new standard to these contracts. The cumulative effect adjustment is primarily related to the period over which revenue is recognized on contracts within our Logistics segment for which our customers pay minimum throughput volume commitments and contain clawback provisions. We also made immaterial adjustments associated with our gift card program and franchise fees. Additionally, upon the adoption of ASC 606, the gross versus net presentation of certain contractual arrangements and taxes has changed as further described in Note 12. The current period results and balances are presented in accordance with ASC 606, while comparative periods continue to be presented in accordance with the accounting standards in effect for those periods.

For the period ending March 31, 2018, we recorded lower revenues of $251 million and correspondingly $251 million in lower cost of materials and other for presentation impacts of applying ASC 606, primarily associated with netting excise and other related taxes in our Marketing segment as described in Note 12. We recorded an additional $2 million in revenues during the quarter ending March 31, 2018 primarily related to the minimum throughput volume commitments in our Logistics segment discussed above as a result of applying the new standard. There were no material impacts during the period to the condensed consolidated balance sheet or condensed statement of consolidated cash flows, as a result of the adoption.

Leases
In February 2016, the FASB issued ASU 2016-02, “Leases” (“ASU 2016-02”), which amends existing accounting standards for lease accounting and adds additional disclosures about leasing arrangements. Under the new guidance, lessees are required to recognize right-of-use assets and lease liabilities on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either a financing lease or operating lease, with classification affecting the pattern of expense recognition in the income statement and presentation of cash flows in the statement of cash flows. The new standard also requires additional disclosures to help financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, and interim reporting periods within those annual reporting periods. Early adoption is permitted and in the original guidance the modified retrospective application was required, however, in March 2018 the FASB approved another transition method in which the effective date would be the date of initial application of transition. Under this optional transition method, we would recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. We expect to elect the optional transition method and will not early adopt the standard.

We are progressing through our implementation plan and continue to evaluate the impact of the standard on our business processes, accounting systems, controls and financial statement disclosures. In addition, we continue to assess the impact in certain areas where industry consensus continues to be formed. While we are still working through our implementation plan, we do expect that the recognition of right-of-use assets and lease liabilities not currently reflected in our balance sheet will have a material impact on total assets and liabilities. However, we do not expect adoption of the standard to have a material impact on our statements of consolidated operations or liquidity. At this time, we are unable to estimate the full impact of the standard until we progress further through our plan and the industry reaches a consensus on certain industry specific issues.

Credit Losses
In June 2016, the FASB issued ASU 2016-13, “Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”), which amends guidance on the impairment of financial instruments. The ASU requires the estimation of credit losses based on expected losses and provides for a simplified accounting model for purchased financial assets with credit deterioration. ASU 2016-13 is effective for annual reporting periods beginning after December 15, 2019, and interim reporting periods within those annual reporting periods. Early adoption is permitted for annual reporting periods beginning after December 15, 2018. While we are still evaluating the impact of ASU 2016-13, we do not expect the adoption of this standard to have a material impact on our financial statements.

Pension and Postretirement Costs
In March 2017, the FASB issued ASU 2017-07, “Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost” (“ASU 2017-07”), which requires the current service-cost component of net benefit costs to be

8 | 
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Notes to Condensed Consolidated Financial Statements (Unaudited)
 

presented similarly with other current compensation costs for related employees on the statements of consolidated operations, and stipulates that only the service cost component of net benefit costs is eligible for capitalization. The Company will present other components of net benefit costs elsewhere on the statements of consolidated operations as discussed further in Note 8. The amendments to the presentation of the statements of consolidated operations in this update should be applied retrospectively while the change in capitalized benefit cost is to be applied prospectively. We adopted ASU 2017-07 as of January 1, 2018. Adoption of the standard resulted in an increase to operating expenses and interest and financing costs of $1 million and $9 million, respectively, with a corresponding decrease to general and administrative expenses and increase to other income of $1 million and $9 million, respectively, for the three months ended March 31, 2017. There was no impact to net earnings and ASU 2017-07 does not impact the consolidated balance sheets or statements of consolidated cash flows.

Stock-based Compensation
In May 2017, the FASB issued ASU 2017-09, “Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting” (“ASU 2017-09”), which provides guidance about which changes to the terms or conditions of a share-based payment awarded require an entity to apply modification accounting. The amendments in ASU 2017-09 are to be applied prospectively to an award modified on or after the adoption date. As such, the impact of ASU 2017-09 is dependent on whether we modify any share-based payment awards and the nature of such modifications. We adopted ASU 2017-09 as of January 1, 2018 with no impact on our financial statements.

Derivatives and Hedging
In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities” (“ASU 2017-12”), which amends and simplifies existing guidance in order to more accurately present the economic effects of risk management activities in the financial statements. ASU 2017-12 is effective for interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. While we are still evaluating the impact of ASU 2017-12, we do not expect the adoption of this standard to have a material impact on our financial statements.

Comprehensive Income
In February 2018, the FASB issued ASU 2018-02, “Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” (“ASU 2018-02”), which allows a reclassification of recorded amounts from accumulated other comprehensive income (“AOCI”) to retained earnings for the adjustment of deferred taxes due to the reduction of the historical corporate income tax rate to the newly enacted corporate income tax rate resulting from the U.S. tax law changes enacted in December 2017. It also requires certain disclosures about these reclassifications. ASU 2018-02 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The new guidance must be applied either on a prospective basis in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the U.S. tax law changes are recognized. While we are still evaluating the impact of ASU 2018-02, we do not expect the adoption of this standard to have a material impact on our financial statements.

Note 2 - Acquisitions

Western Refining Acquisition

On June 1, 2017, we completed the Western Refining Acquisition. Based on our $83.25 per share closing stock price on June 1, 2017, the aggregate value of consideration paid to Western Refining shareholders was $4.0 billion, including approximately $3.6 billion of our stock and approximately $424 million of cash, including cash payable upon accelerated vesting of Western Refining equity awards. The cash portion of the purchase price, along with the settlement of $1.6 billion of certain Western Refining debt and other transaction related costs, was funded using cash on hand and $575 million of funds drawn on the Andeavor Revolving Credit Facility.

We accounted for the Western Refining Acquisition using the acquisition method of accounting, which requires, among other things, that assets acquired at their fair values and liabilities assumed be recognized on the balance sheet as of the acquisition date. The purchase price allocation for the Western Refining Acquisition is substantially complete and has been allocated based on estimated fair values of the assets acquired and liabilities assumed at the acquisition date, pending the completion of the valuation and other information as it becomes available to us. Although the purchase price allocation is substantially complete, the purchase price allocation disclosed could change and adjustments can be made through the end of Andeavor’s measurement period, which is not to exceed one year from the acquisition date. During the three months ended March 31, 2018, we recorded adjustments to our allocation to increase property, plant and equipment by $22 million and other noncurrent liabilities by $35 million offset by decreases in accrued liabilities of $8 million and deferred income taxes of $7 million.


 
 
March 31, 2018 |  9

Notes to Condensed Consolidated Financial Statements (Unaudited)

Acquisition Date Purchase Price Allocation (in millions)

Cash
$
159

Receivables
511

Inventories
805

Prepayments and Other Current Assets
212

Property, Plant and Equipment (a)
3,486

Goodwill
2,948

Acquired Intangibles
315

Other Noncurrent Assets
162

Accounts Payable
(701
)
Accrued Liabilities
(262
)
Current Portion of Long-term Debt
(12
)
Deferred Income Taxes
(711
)
Debt
(2,092
)
Other Noncurrent Liabilities
(121
)
Noncontrolling Interest
(719
)
Total purchase price
$
3,980


(a)
Estimated useful lives ranging from 3 to 28 years have been assumed based on the valuation.

Goodwill
Andeavor evaluated several factors that contributed to the amount of goodwill presented above. These factors include the acquisition of an existing integrated refining, marketing and logistics business located in areas with access to cost-advantaged feedstocks with an assembled workforce that cannot be duplicated at the same costs by a new entrant. Further, the Western Refining Acquisition provides a platform for future growth through operating efficiencies Andeavor expects to gain from the application of best practices across the combined company and an ability to realize synergies from the geographic diversification of Andeavor’s business and rationalization of general and administrative costs. The amount of goodwill by reportable segment is as follows: Marketing $309 million, Logistics $679 million and Refining $1.96 billion. We estimate approximately $1.98 billion of the $2.95 billion in goodwill resulting from the tax-free merger with Western Refining to be non-deductible for tax purposes. As a result of prior acquisitions, Western Refining has tax-deductible goodwill, in which we received carryover basis, providing tax deductibility for an estimated $972 million of the $2.95 billion in goodwill that otherwise would not be deductible.

Property, Plant and Equipment
The fair value of property, plant and equipment is $3.5 billion. This fair value is based on the valuation using a combination of the income, cost and market approaches. The useful lives of acquired assets have been aligned to similar assets at Andeavor.

Acquired Intangible Assets
We estimated the fair value of the acquired identifiable intangible assets at $315 million. This fair value is based on the valuation completed for the business enterprise, along with the related tangible assets, using a combination of the income method, cost method and comparable market transactions. We recognized intangible assets associated with customer relationships, franchise rights and favorable leases, all of which will be amortized over a definite-life. We also recognized an intangible asset of approximately $38 million related to liquor licenses and approximately $113 million related to trade names, both of which have indefinite lives. We considered the assets' historical accounting by Western Refining, our plans for the continued use and marketing of the assets, and how a market participant would use the assets in determining whether the intangible assets have an indefinite or definite life. We amortize acquired intangibles with finite lives on a straight-line basis over an estimated weighted average useful life of 13 years, and we include the amortization in depreciation and amortization expenses on our condensed statement of consolidated operations. The gross carrying value of our finite life intangibles acquired from the Western Refining Acquisition was $164 million and the accumulated amortization was $11 million as of March 31, 2018. Amortization expense is expected to be approximately $13 million per year for the next five years related to the Western Refining acquired intangible assets. Although we have substantially completed our valuation estimate and related evaluation of the useful lives, and accordingly, future amortization of intangible assets related to customer relationships, these may be revised during the measurement period.


10 | 
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Notes to Condensed Consolidated Financial Statements (Unaudited)
 

Contingencies
We assumed environmental, legal and asset retirement obligation liabilities of approximately $49 million in the Western Refining Acquisition. This represents an increase of $30 million during the three months ended March 31, 2018. The fair value of these liabilities is substantially complete but may be adjusted if other information becomes available to us during the measurement period.

Interests in Western Refining Logistics and Minnesota Pipe Line Company
With the Western Refining Acquisition, we acquired a controlling interest in Western Refining Logistics, LP (“WNRL”). The fair value of the non-controlling interest in WNRL is based on the unit price, units outstanding and the percent of public unitholders of WNRL on June 1, 2017. The October 30, 2017 merger between Andeavor Logistics and WNRL in which all WNRL outstanding common units were exchanged for common units in Andeavor Logistics did not impact the fair value of non-controlling interest. Additionally, we acquired a 17% common equity interest in Minnesota Pipe Line Company, LLC (“MPL”). We are accounting for our investment in MPL under the equity method of accounting given our ability to exercise significant influence over MPL.

Acquisition Costs
There were no material acquisition, severance or retention costs incurred in the three months ended March 31, 2018 related to the Western Refining Acquisition. As it relates to severance and retention costs, we had $12 million recognized in accrued liabilities remaining to be paid.

Western Refining Revenues and Earnings Before Income Taxes
For the period from January 1, 2018 through March 31, 2018, we recognized $3.1 billion in revenues and $110 million of earnings before income taxes related to the business acquired. The earnings before income taxes for the period include related acquisition and severance costs along with interest expense incurred related to the acquisition.

Pro Forma Financial Information
The following unaudited pro forma information combines the historical operations of Andeavor and Western Refining, giving effect to the Merger and related transactions as if they had been consummated on January 1, 2017, the beginning of the earliest period presented.

Pro Forma Consolidated Revenues and Consolidated Net Earnings (in millions)

 
Three Months Ended
 
March 31, 2017
Revenues
$
8,989

Net earnings (a)
5


(a)
While many recurring adjustments impact the pro forma figures presented, the decrease in pro forma net earnings compared to our net earnings presented on the condensed statements of consolidated operations for the three months ended March 31, 2017 includes a significant non-recurring adjustment removing acquisition and integration costs from later in 2017 and reflects these costs in the first quarter of 2017, the period the acquisition was assumed to be completed for pro forma purposes.

Rangeland Energy
 
On January 19, 2018, Andeavor completed its announced acquisition of 100% of the equity of Rangeland. Rangeland, including a 67% interest in RIO, owns and operates assets in the Delaware and Midland Basins in New Mexico and Texas, including the recently constructed RIO crude oil pipeline, three crude oil storage terminals, a frac sand storage and truck loading facility. This acquisition is not material to our consolidated financial statements. Operating results of this acquisition are recognized in our Logistics segment.

West Coast Asphalt Terminals
 
On February 12, 2018, Andeavor announced its agreement to acquire the West Coast asphalt terminals of Delek US Holdings, Inc. The assets to be acquired include four wholly-owned asphalt terminals in California and Arizona as well as a terminal in Nevada that is held in a 50% joint venture. The acquisition, which is subject to customary closing conditions including regulatory approval, is not material to our consolidated financial statements.

Wamsutter Pipeline System
 
On May 1, 2018, Andeavor Logistics completed its acquisition of the Wamsutter Pipeline System from Plains All American Pipeline, L.P. The system consists of pipelines that transport crude oil to another third-party pipeline system that supply the Salt Lake City area refineries, including our Salt Lake City refinery. Andeavor Logistics financed the acquisition using the Andeavor Logistics Revolving Credit Facility. This acquisition is not material to our consolidated financial statements.


 
 
March 31, 2018 |  11

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 3 - Inventories

Components of Inventories (in millions)

 
March 31,
2018
 
December 31,
2017
Domestic crude oil and refined products
$
3,066

 
$
3,203

Materials and supplies
229

 
229

Oxygenates and by-products
78

 
85

Merchandise
53

 
50

Foreign subsidiary crude oil and refined products
58

 
63

Total Inventories
$
3,484

 
$
3,630


At March 31, 2018 and December 31, 2017, the replacement cost of our crude oil and refined product inventories exceeded carrying value, both in the aggregate, by approximately $876 million and $703 million, respectively.

Note 4 - Investments - Equity Method and Joint Ventures

We have the ability to exercise significant influence over each of the following 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, 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.

We own a 51% interest in Watson Cogeneration Company (“Watson”), which produces steam and electricity at a facility located at our Los Angeles refinery. We also own a 17% interest in MPL, which owns and operates a crude oil pipeline in Minnesota. Following the acquisition of Rangeland in early 2018, we own a 67% interest in RIO, a recently constructed crude oil pipeline located in the Delaware and Midland basins in west Texas.

Andeavor Logistics 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 Andeavor Logistics or a third party. Andeavor Logistics also owns a 50% interest in Three Rivers Gathering, LLC (“TRG”), which operates natural gas gathering assets in the southeastern Uinta Basin, as well as a 38% interest in Uintah Basin Field Services, L.L.C. (“UBFS”), which owns and operates the natural gas gathering infrastructure located in the southeastern Uinta Basin and is operated by Andeavor Logistics.

Equity Method Investments (in millions)

 
 
 
 
 
 
 
Andeavor Logistics
 
 
 
Watson
 
MPL
 
RIO
 
RGS
 
TRG
 
UBFS
 
Total
Balance at December 31, 2017 (a)
$
78

 
$
120

 
$

 
$
268

 
$
37

 
$
15

 
$
518

Fair value of acquired interest

 

 
159

 

 

 

 
159

Equity in earnings

 
6

 
1

 
1

 
1

 
1

 
10

Cumulative effect of accounting standard adoption

 

 

 

 
(3
)
 

 
(3
)
Distributions received

 
(5
)
 

 
(6
)
 
(1
)
 
(1
)
 
(13
)
Balance at March 31, 2018 (a)
$
78

 
$
121

 
$
160

 
$
263

 
$
34

 
$
15

 
$
671


(a)
The carrying amount of our investments in Watson, MPL, RIO, RGS, TRG and UBFS exceeded the underlying equity in net assets by $62 million, $34 million, $75 million, $129 million, $15 million and $6 million, respectively, at March 31, 2018. The carrying amount of our investments in Watson, MPL, RGS, TRG and UBFS exceeded the underlying equity in net assets by $62 million, $35 million $130 million, $15 million and $6 million, respectively, at December 31, 2017. The carrying amounts of our investments allocated to tangible assets and that exceed the underlying equity in net assets are amortized over the useful life of the underlying fixed assets and included in equity in earnings.

Gray Oak Pipeline and South Texas Gateway Terminal

On April 24, 2018, we announced a 25% participation in a joint venture with Gray Oak Pipeline, LLC ("Gray Oak Pipeline"). The Gray Oak Pipeline will provide crude oil transportation from West Texas to destinations in the Corpus Christi, Sweeny and Freeport areas. In addition, we announced a 25% participation in a new joint venture to develop a deep-water, open access marine terminal in Ingleside, Texas (“South Texas Gateway Terminal"). The South Texas Gateway Terminal includes crude oil storage capacity and will serve as an outlet for crude oil and condensate volumes delivered from the Gray Oak Pipeline.

12 | 
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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. We did not designate any of our derivatives for hedge accounting during the three months ended March 31, 2018 and 2017.

Our derivative instruments can include Forward Contracts, Futures Contracts, Over-the-Counter swaps, including Swap Contracts, Options, and 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. 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, 2018 and December 31, 2017. 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 consolidated balance sheets.

Derivative Assets and Liabilities (in millions)

 
 
Derivative Assets
 
Derivative Liabilities
 
Balance Sheet Location
March 31,
2018
 
December 31,
2017
 
March 31,
2018
 
December 31,
2017
Commodity Futures Contracts
Prepayments and other current assets
$
1,000

 
$
780

 
$
978

 
$
807

Commodity Swap Contracts
Prepayments and other current assets
56

 
48

 
59

 
63

Commodity Swap Contracts
Receivables
10

 
15

 

 

Commodity Swap Contracts
Accounts payable

 

 
19

 
24

Commodity Options Contracts
Prepayments and other current assets
1

 

 
3

 
2

Commodity Forward Contracts
Receivables
1

 
2

 

 

Total Gross Mark-to-Market Derivatives
1,068

 
845

 
1,059

 
896

Less: Counterparty Netting
(1,021
)
 
(813
)
 
(1,021
)
 
(813
)
Add back: Cash Collateral
3

 
67

 

 

Total Net Fair Value of Derivatives
$
50

 
$
99

 
$
38

 
$
83





 
 
March 31, 2018 |  13

Notes to Condensed Consolidated Financial Statements (Unaudited)

Net Gains on Mark-to-Market Derivatives (in millions)

 
Three Months Ended
March 31,
 
2018
 
2017
Commodity Contracts
$
13

 
$
28

Foreign Currency Forward Contracts
1

 

Total Net Gain on Mark-to-Market Derivatives
$
14

 
$
28


Income Statement Location of Net Gains on Mark-to-Market Derivatives (in millions)

 
Three Months Ended
March 31,
 
2018
 
2017
Revenues
$
1

 
$
8

Cost of materials and other
12

 
20

Other income, net
1

 

Total Net Gain on Mark-to-Market Derivatives
$
14

 
$
28


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
2018
 
2019
 
Crude oil, refined products and blending products:
 
 
 
 
 
Futures Contracts - long
3,084
 
 
Barrels
Futures Contracts - short
 
(5)
 
Barrels
Swap Contracts - long
234
 
910
 
Barrels
Swap Contracts - short
(974)
 
(920)
 
Barrels
Options - long
1,400
 
 
Barrels
Options - short
(1,400)
 
 
Barrels
Forwards - short
(501)
 
 
Barrels

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 based on quoted prices in active markets for identical assets and liabilities. Level 2 instruments are valued based on 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, 2018 or December 31, 2017.

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. Amounts presented below for 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.


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Notes to Condensed Consolidated Financial Statements (Unaudited)
 

Financial Assets and Liabilities at Fair Value (in millions)

 
March 31, 2018
 
Level 1
 
Level 2
 
Level 3
 
Netting and Collateral (a)
 
Total
Assets:
 
 
 
 
 
 
 
 
 
Commodity Futures Contracts
$
1,000

 
$

 
$

 
$
(972
)
 
$
28

Commodity Swap Contracts

 
66

 

 
(46
)
 
20

Commodity Options Contracts

 
1

 

 

 
1

Commodity Forward Contracts

 
1

 

 

 
1

Total Assets
$
1,000

 
$
68

 
$

 
$
(1,018
)
 
$
50

 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Commodity Futures Contracts
$
978

 
$

 
$

 
$
(975
)
 
$
3

Commodity Swap Contracts

 
78

 

 
(46
)
 
32

Commodity Options Contracts

 
3

 

 

 
3

Environmental Credit Obligations

 
88

 

 

 
88

Total Liabilities
$
978

 
$
169

 
$

 
$
(1,021
)
 
$
126


 
December 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Netting and Collateral (a)
 
Total
Assets:
 
 
 
 
 
 
 
 
 
Commodity Futures Contracts
$
780

 
$

 
$

 
$
(707
)
 
$
73

Commodity Swap Contracts

 
63

 

 
(39
)
 
24

Commodity Forward Contracts

 
2

 

 

 
2

Total Assets
$
780

 
$
65

 
$

 
$
(746
)
 
$
99

 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Commodity Futures Contracts
$
807

 
$

 
$

 
$
(774
)
 
$
33

Commodity Swap Contracts

 
87

 

 
(39
)
 
48

Commodity Options Contracts

 
2

 

 

 
2

Environmental Credit Obligations

 
43

 

 

 
43

Total Liabilities
$
807

 
$
132

 
$

 
$
(813
)
 
$
126


(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, 2018 and December 31, 2017, we had provided cash collateral amounts of $3 million and $67 million, respectively, related to our unrealized derivative positions. Cash collateral amounts are netted with mark-to-market derivative assets.

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 Revolving Credit Facility, the Andeavor Logistics Revolving Credit Facility and our Term Loan 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 value and fair value of our debt were approximately $8.8 billion and $8.9 billion as of March 31, 2018, respectively, and $7.8 billion and $8.1 billion at December 31, 2017, respectively. These carrying and fair values of our debt do not consider the unamortized issuance costs, which are netted against our total debt.


 
 
March 31, 2018 |  15

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 7 - Debt

Debt Balance, Net of Current Maturities and Unamortized Issuance Costs (in millions)

 
March 31,
2018
 
December 31,
2017
Total debt (a)
$
8,844

 
$
7,799

Unamortized issuance costs and premiums
(111
)
 
(114
)
Current maturities
(347
)
 
(17
)
Debt, Net of Current Maturities and Unamortized Issuance Costs
$
8,386

 
$
7,668


(a)
Total debt related to Andeavor Logistics, which is non-recourse to Andeavor, except for TLGP, was $4.2 billion at both March 31, 2018 and December 31, 2017.

Available Capacity Under Credit Facilities (in millions)

 
Total
Capacity
 
Amount Borrowed as of March 31, 2018
 
Outstanding
Letters of Credit
 
Available Capacity as of March 31, 2018
 
Weighted Average Interest Rate
 
Expiration
Andeavor Revolving Credit Facility
$
3,000

 
$
755

 
$
21

 
$
2,224

 
3.36
%
 
September 30, 2020
Andeavor Logistics Revolving Credit Facility
1,100

 
443

 

 
657

 
3.59
%
 
January 29, 2021
Andeavor Logistics Dropdown Credit Facility
1,000

 

 

 
1,000

 
%
 
January 29, 2021
Letter of Credit Facilities
1,000

 

 
148

 
852

 
 
 
 
Total Credit Facilities
$
6,100

 
$
1,198

 
$
169

 
$
4,733

 
 
 
 

Andeavor Logistics Revolving Credit Facility
On January 5, 2018, Andeavor Logistics amended the existing Andeavor Logistics Revolving Credit Facility and Andeavor Logistics Dropdown Credit Facility to increase the aggregate commitments under the Andeavor Logistics Revolving Credit Agreement from $600 million to $1.1 billion, add certain financial institutions as additional lenders under the Andeavor Logistics Revolving Credit Agreement and make certain changes to both the Andeavor Logistics Revolving Credit Facility and the Andeavor Logistics Dropdown Credit Facility to permit the incurrence of an additional $500 million of incremental loans (in the aggregate) under such facility agreements subject to the satisfaction of certain conditions.

Inventory Financing Arrangement
During the three months ended March 31, 2018, we entered into a $330 million financing arrangement with a third party that was secured by our crude oil inventory (“Inventory Financing Arrangement”). The Inventory Financing Arrangement was repaid in early April and had an effective interest rate of 6.7%. The Inventory Financing Arrangement is included in our current maturities of debt on the condensed consolidated balance sheet at March 31, 2018 and within our financing activities on the condensed statements of consolidated cash flows for the three months ended March 31, 2018.


16 | 
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Notes to Condensed Consolidated Financial Statements (Unaudited)
 

Note 8 - Benefit Plans

Components of Pension and Other Postretirement Benefit Expense (Income) (in millions)

 
Pension Benefits
 
Other Postretirement Benefits
 
Three Months Ended March 31,
 
2018
 
2017
 
2018
 
2017
Service cost
$
17

 
$
13

 
$
1

 
$
1

Interest cost
9

 
8

 
1

 

Expected return on plan assets
(8
)
 
(7
)
 

 

Amortization of prior service credit

 

 
(8
)
 
(8
)
Recognized net actuarial loss
8

 
5

 
1

 
1

Net Periodic Benefit Expense (Income) (a)
$
26

 
$
19

 
$
(5
)
 
$
(6
)

(a)
Service cost is included in operating and general and administrative expenses and interest cost is included in interest and financing costs on the condensed statement of consolidated operations. The remaining components of net periodic benefit expense are included in other income.

Western Refining Benefit Plans
We assumed all of Western Refining’s existing defined contribution and benefit plans as a result of the Merger. All prior plan assets remain within their respective Western Refining and subsidiaries’ plans at this time. Effective January 1, 2018, Western Refining employees began participating in the Andeavor 401(k) and pension plans. The impact of the Western Refining benefit plans is immaterial to our financial statements.

Note 9 - Commitments and Contingencies

Litigation Matters
In the ordinary course of business, we may become party to lawsuits, administrative proceedings and governmental investigations, including environmental, regulatory and other matters. The outcome of these matters cannot always be predicted accurately, but we accrue liabilities for these matters if we have determined that it is probable a loss has been incurred and the loss can be reasonably estimated. While it is not possible to predict the outcome of such proceedings, if one or more of them were decided against us, we believe there would be no material impact on our consolidated financial statements.

Environmental Matters
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 properties. While it is not possible to predict the outcome of such proceedings, if one or more of them were decided against us, we believe there would be no material impact on our consolidated financial statements.

On July 18, 2016, the U.S. Department of Justice (“DOJ”) lodged a complaint on behalf of the EPA and a Consent Decree with the Western District Court of Texas. Among other things, the Consent Decree required our Martinez refinery meet certain annual emission limits for NOx by July 1, 2018. In February 2018, we informed the EPA that we will need additional time to satisfy requirements of the Consent Decree. We are currently negotiating a resolution of this matter with the DOJ and the EPA, including the required timing to complete the project. These expenditures associated with the Consent Decree will not have a material impact on our liquidity, financial position or results of operations.

Tax Matters
We are subject to 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 or decreased 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 consolidated financial statements.

As of March 31, 2018, we have not completed our accounting for the tax effects of enactment of the tax reform legislation (the “Tax Act”) enacted on December 22, 2017 (the “Enactment Date”); however, we have made a reasonable estimate of the effects on our existing deferred tax balances. The SEC issued Staff Accounting Bulletin No. 118 (“SAB 118”) in December 2017 to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared or analyzed in reasonable detail to complete the accounting for certain income tax effects of the Tax Act. Among other things, SAB 118 provides for a period of up to twelve months from the Enactment Date to record the effects of the Tax Act. During the three months ended March 31, 2018, adjustments to the provisional income tax benefit recorded in December 2017 from the enactment of the Tax Act were not material. We may make adjustments to the provisional amount during the SAB 118

 
 
March 31, 2018 |  17

Notes to Condensed Consolidated Financial Statements (Unaudited)

measurement period, which could result from future changes in interpretation of the Tax Act, changes to estimates made by us and/or issuance of additional regulatory guidance.

Note 10 - Stockholders’ Equity and Earnings Per Share

Changes to Equity (in millions)

 
Andeavor
Stockholders’
Equity
 
Noncontrolling
Interest
 
Total Equity
Balance at December 31, 2017 (a)
$
9,815

 
$
3,600

 
$
13,415

Net earnings
172

 
65

 
237

Purchases of common stock
(256
)
 

 
(256
)
Dividend payments
(92
)
 

 
(92
)
Net effect of amounts related to equity-based compensation
11

 
1

 
12

Taxes paid related to net share settlement of equity awards
(23
)
 

 
(23
)
Distributions to noncontrolling interest

 
(99
)
 
(99
)
Transfers to (from) Andeavor paid-in capital related to:
 
 
 
 
 
Andeavor Logistics’ issuance of common units
21

 
(35
)
 
(14
)
Cumulative effect of accounting standard adoption
(16
)
 
(9
)
 
(25
)
Other

 
(2
)
 
(2
)
Balance at March 31, 2018 (a)
$
9,632

 
$
3,521

 
$
13,153


(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, 2018 and December 31, 2017.

Earnings per share

We compute basic earnings per share by dividing net earnings attributable to Andeavor 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 Calculations (in millions)

 
Three Months Ended March 31,
 
2018
 
2017
Weighted average common shares outstanding
152.9

 
117.1

Common stock equivalents
0.9

 
1.0

Total Diluted Shares
153.8

 
118.1


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 of the three months ended March 31, 2018 and 2017.

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 units and to fulfill other stock compensation requirements. During the three months ended March 31, 2018, we repurchased approximately 2.6 million shares of our common stock for approximately $256 million. There were no repurchases of common stock during the three months ended March 31, 2017. Refer to subsequent events in Note 14 for further details regarding restrictions on the Company’s repurchase of shares.

Cash Dividends

We paid cash dividends totaling $92 million and $65 million for the three months ended March 31, 2018 and 2017, respectively, based on a $0.59 per share and $0.55 per share quarterly cash dividend on common stock, respectively. On May 4, 2018, our

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Notes to Condensed Consolidated Financial Statements (Unaudited)
 

Board declared a cash dividend of $0.59 per share payable on June 15, 2018 to shareholders of record on May 31, 2018. Refer to subsequent events in Note 14 for further details regarding the Company’s cash dividends.

Note 11 - Stock-Based Compensation

Stock-Based Compensation Expense (Benefit) (in millions)

 
Three Months Ended March 31,
 
2018
 
2017
Market stock units (a)
$
7

 
$
7

Performance share awards (b)
2

 
5

Other stock-based awards (c)
3

 
2

Total Stock-Based Compensation Expense
$
12

 
$
14


(a)
We granted 0.5 million market stock units at a weighted average grant date fair value of $103.07 per unit under the amended and restated 2011 Long-Term Incentive Plan (“2011 Plan”) during the three months ended March 31, 2018.
(b)
We granted 0.2 million market condition performance share awards at a weighted average grant date fair value of $107.51 per share under the 2011 Plan during the three months ended March 31, 2018.
(c)
We have aggregated expense for certain award types as they are not considered significant, including awards issued by Andeavor Logistics.

The income tax effect recognized in the income statement for stock-based compensation was a benefit of $7 million and $20 million for the three months ended March 31, 2018 and 2017, respectively. Included in the tax benefits were $4 million and $14 million of excess tax benefits from exercises and vestings for the three months ended March 31, 2018 and 2017, respectively. The reduction in current taxes payable recognized from tax deductions resulting from exercises and vestings under all of our stock-based compensation arrangements totaled $19 million and $25 million for the three months ended March 31, 2018 and 2017, respectively.

All outstanding equity awards from Western Refining and NTI stock-based compensation plans were converted to Andeavor shares but remain under their respective Western Refining and NTI plans.

Note 12 - Revenues

We recognize revenue upon transfer of control of promised products or services to customers in an amount that reflects the consideration to which we expect to be entitled in exchange for those products or services. Revenue is recognized net of amounts collected from customers for taxes assessed by governmental authorities on, and concurrent with, specific revenue-producing transactions. This net presentation represents a change upon adoption of ASC 606 as we previously recognized excise and other related taxes on a gross basis associated with sales of gasoline and diesel within our Marketing segment.

Product Revenue
We generate product revenue from sales of transportation fuels and other refined products, crude oil and other feedstocks, residual products, and convenience store merchandise. Our sales of transportation fuels include gasoline and gasoline blendstocks, jet fuel, diesel fuel, heavy fuel oils, and other residual products that are produced primarily at our refineries. Within our Marketing segment, we sell gasoline and diesel fuel through retail, branded and unbranded channels of trade. Retail product revenues include sales of transportation fuels and convenience store merchandise to end consumers at company-owned or leased sites. Branded fuel sales are conducted through jobber/dealers with which we have a contract to sell fuels marketed under one of the various brands we use. Unbranded fuel sales are made under contract through third-party distributors or operators with no associated brand. Within our Logistics segment, we generate product revenue through the sale of natural gas liquids (“NGLs”), residue gas and condensate, using natural gas we acquire and process from producers. We record revenues for the sale of these NGLs and related products at market prices, and record the payments to producers at an agreed-upon percentage of the total sales proceeds as NGL expense, net of certain charges, which is presented within cost of materials and other in our condensed statements of consolidated operations. Within our Refining segment, we record transportation fuel sales, crude oil resales and other residual products through bulk arrangements and to export markets.

Our product sales arrangements are for specified goods for which enforceable rights and obligations are created when sales volumes are established, which typically occur as orders are issued or spot sales are made, but may be determined at contract inception. Each gallon, or other unit of measure of product, is separately identifiable and represents a distinct performance obligation to which the transaction price is allocated based on stand-alone selling price. We use observable market prices for fuel, feedstock and other fuel products, and cost-plus margin for convenience store merchandise, to determine the stand-alone selling price of each separate performance obligation. Product revenues are recognized at a point-in-time, which generally occurs upon delivery and transfer of title to the customer. Product sales are primarily generated from either spot sales or point-of-sale transactions for which variability associated with the transaction price is

 
 
March 31, 2018 |  19

Notes to Condensed Consolidated Financial Statements (Unaudited)

resolved at the time of sale, or from short term duration contracts for which any variability in transaction price is resolved within the reporting period. Payments for product sales are generally received either immediately or within 30 days from when control has transferred.

Service Revenue
Within our Logistics segment, we generate service revenue for gathering and transporting crude oil, natural gas and water; processing and fractionating natural gas and NGLs; and terminalling, transporting, and storing crude oil and refined products. We perform these services under various contractual arrangements with our customers, including fee-based arrangements, for which we receive fixed rate per unit of service we provide, and keep-whole arrangements, for which we receive a combination of fixed rate-per unit of cash consideration and non-cash consideration in the form of NGLs. For many of our fee-based arrangements where we gather or transport crude oil, refined products or natural gas for our customers, we require deficiency payments from our customers when they do not meet their minimum throughput volume commitments. Some of these contracts allow our customers to clawback all or a portion of prior deficiency payments over future periods.

We recognize service revenue over time, as customers simultaneously receive and consume the related benefits that we stand ready to provide. Revenue is recognized using an output measure, such as the throughput volume or capacity utilization, as these measures most accurately depict the satisfaction of our performance obligations. Where contracts contain variable pricing terms, the variability is either resolved within the reporting period, or the variable consideration is allocated to the specific unit of service to which it relates. Deficiency payments under contracts with clawback provisions are deferred and recognized as revenue as customers reclaim amounts by throughputting excess volumes. To the extent it is probable a customer will not recover all or a portion of the deficiency payment, the estimated residual deficiency is recognized ratably over the clawback period. Payments for services rendered are generally received no later than 60 days from month of service, with the exception of deficiency payments described above.

Within certain of our Logistics contracts, we are entitled to receive non-cash consideration for rendering services. For natural gas keep-whole arrangements, we have concluded that we control the NGL inventory extracted through our processing services, have inventory risk, discretion in establishing price, and the ability to direct the use and ultimate disposition of the NGLs. Thus, beginning January 1, 2018, we recognize service revenue for non-cash consideration received in the form of NGLs on a gross basis within revenues, and correspondingly, record NGL expense for the replacement gas we provide to our customers. The amounts are recognized at fair value at the date we obtain control of the respective unit of NGL. Fair value is assessed using the monthly average of published price reports for specific NGL products with consideration for receipt point and grade of product.

Within our Marketing segment, we recognize franchise and royalty fee revenue from granting the license to use ARCO®, ampm® and SUPERAMERICA® retail convenience store brands. Franchise and royalty fee revenues are not material to our condensed consolidated financial statements.

Other Arrangements
We execute certain nonmonetary crude oil and refined product exchange transactions to optimize our refinery supply and enter into purchase and sale transactions with the same counterparty that are in contemplation of one another. These transactions are excluded from the scope of the new revenue standard and are recorded in cost of materials and other on a net basis.

We recognize rental revenue for retail sites we own or lease that are then leased and operated by third parties. These amounts are excluded from the scope of the new revenue standard and are not material to our condensed consolidated financial statements.

Customer Contract Assets

Our receivables are generated primarily from contracts with customers. Our payment terms vary by product or service type and channel of distribution. The period between invoicing and payment is not significant, and our assets associated with contracts with customers consist primarily of billed accounts receivable, which are included in Receivables, net of allowance for doubtful accounts in our condensed consolidated balance sheets. Our assets also include customer incentives, consisting primarily of branding payments made to owners of third party-owned retail sites. These customer incentives are included in other noncurrent assets in our condensed consolidated balance sheets and are amortized to revenue over the term of each contract, which generally ranges from 10 to 20 years.

Customer Contract Liabilities

For certain products or services, we receive payment in advance of when performance obligations are satisfied. These liabilities from contracts with customers consist primarily of certain payments for minimum volume commitments within our Logistics segment, receipts of cash for gift cards in our retail business, and other customer advances. Payments received from customers for minimum volume commitments and other customer advances are included in deferred income within other current liabilities and other noncurrent liabilities based on timing of expected recognition, which may extend up to

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Notes to Condensed Consolidated Financial Statements (Unaudited)
 

fifteen years. Amounts received from gift card sales are included in accounts payable in the condensed consolidated balance sheets. During the three months ended March 31, 2018, we recognized $20 million in revenue from contract liabilities existing as of January 1, 2018.

Summary of Customer Contract Assets and Liabilities (in millions)

 
December 31, 2017
 
Adjustments for
ASC 606
 
Balance at
January 1, 2018
 
March 31, 2018
Receivables from contracts with customers
$
1,875

 
$
(34
)
 
$
1,841

 
$
1,782

Other contract assets

 
34

 
34

 
11

Deferred branding costs, net of amortization
213

 

 
213

 
217

Deferred income, current
9

 
10

 
19

 
14

Deferred income, noncurrent
36

 
22

 
58

 
52

Gift card liability
26

 
(4
)
 
22

 
20


The table above excludes balances associated with equity method investments. We recognized a cumulative adjustment of $3 million as a decrease to other noncurrent assets in our condensed consolidated balance sheet as of January 1, 2018 for the impacts related to TRG, as shown in Note 4. There were no material impacts to this balance during the three months ended March 31, 2018 due to the adoption.

Remaining Performance Obligations

We do not disclose the value of unsatisfied performance obligations for contracts with original expected terms of one year or less, or the value of variable consideration related to unsatisfied performance obligations when such values are not required to be estimated for purposes of allocation and recognition. Our revenues associated with remaining obligations under contracts with terms in excess of one year consist primarily of arrangements for which the customer has agreed to consideration based on minimum throughput volume commitments, fixed fees and revenues to be recognized from gift cards sold but not yet redeemed. As of March 31, 2018, we had $891 million of expected revenues from remaining performance obligations.

The future revenues from our Logistics segment’s service arrangements with fixed or minimum throughput volume commitments will be recognized over the period of performance to which the fixed fee or commitment relates, which primarily range from one year to fifteen years. Specific to our Marketing segment, our gift cards generally have no expiration date, although the amounts are expected to be substantially redeemed within two to four years. We expect approximately 75% of our total remaining performance obligations to be recognized in revenue within 5 years.

Disaggregation

Revenue Disaggregation by Product and Service (in millions)

 
Three Months Ended March 31, 2018
 
Marketing
 
Logistics
 
Refining
Product Revenues
 
 
 
 
 
Refined products (see further breakout below)
$
5,451

 
$

 
$
3,447

Merchandise
176

 

 

Crude, NGL products and other
31

 
70

 
956

Total product revenues
5,658

 
70

 
4,403

Service revenues (see further breakout below)
5

 
147

 
17

Total Revenues
$
5,663

 
$
217

 
$
4,420



 
 
March 31, 2018 |  21

Notes to Condensed Consolidated Financial Statements (Unaudited)

Service Revenue Disaggregation by Type and Product Line (in millions)

 
Three Months Ended March 31, 2018
 
 
 
Logistics
 
 
 
Marketing
 
Gathering and Processing
 
Terminalling and Transportation
 
Refining
Service Revenues
 
 
 
 
 
 
 
Natural gas
$

 
$
98

 
$

 
$

Crude oil and water

 
25

 

 

Refined products

 

 
18

 

Other
5

 
6

 

 
17

Total Service Revenues
$
5

 
$
129

 
$
18

 
$
17


Refined Product Revenue Disaggregation by Sales Channel of Trade (in millions)

 
Three Months Ended March 31, 2018
 
Marketing
 
Refining
Refined Products Revenues
 
 
 
Transportation fuels:
 
 
 
Retail and Branded
$
2,924

 
$

Unbranded
2,527

 
3,074

Other refined products

 
373

Total Refined Products Revenues
$
5,451

 
$
3,447


Note 13 - Operating Segments

The Company’s revenues are derived from three operating segments: Marketing, Logistics and Refining. We evaluate the performance of our segments based primarily on segment operating income and EBITDA. For the purposes of our operating segment disclosure, we present operating income as it is the most comparable measure to the amounts presented in our statements of consolidated operations. Segment operating income includes those revenues and expenses that are directly attributable to management of the respective segment. Marketing and Logistics revenues include intersegment transactions with our Refining segment. Corporate depreciation and corporate general and administrative expenses are excluded from segment operating income.


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Notes to Condensed Consolidated Financial Statements (Unaudited)
 

Segment Information Related to Continuing Operations (in millions)

 
Three Months Ended
March 31,
 
2018
 
2017
Revenues
 
 
 
Marketing:
 
 
 
Fuel (a)
$
5,451

 
$
4,083

Merchandise
176

 
6

Other
38

 
15

Intersegment sales
(2
)
 

Logistics:
 
 
 
Terminalling and transportation
231

 
175

Gathering and processing
295

 
245

Intersegment sales
(309
)
 
(203
)
Refining:
 
 
 
Refined products
8,671

 
5,812

Crude oil resales and other
973

 
244

Intersegment sales
(5,224
)
 
(3,739
)
Total Revenues
$
10,300

 
$
6,638

 
 
 
 
Segment Operating Income
 
 
 
Marketing
$
128

 
$
133

Logistics
188

 
150

Refining
205

 
34

Total Segment Operating Income
521

 
317

Corporate and unallocated costs
(151
)
 
(122
)
Operating Income
370

 
195

Interest and financing costs, net
(102
)
 
(98
)
Equity in earnings of equity method investments
10

 

Other income, net
10

 
11

Earnings Before Income Taxes
$
288

 
$
108

 
 
 
 
Depreciation and Amortization Expenses
 
 
 
Marketing
$
22

 
$
13

Logistics
79

 
58

Refining
173

 
148

Corporate
8

 
7

Total Depreciation and Amortization Expenses
$
282

 
$
226

 
 
 
 
Capital Expenditures
 
 
 
Marketing
$
13

 
$
6

Logistics
83

 
45

Refining
312

 
132

Corporate
12

 
43

Total Capital Expenditures
$
420

 
$
226


(a)
Federal and state motor fuel excise taxes of $134 million on sales by our Marketing segment at retail sites where we own the inventory are included in both revenues and cost of materials and other in our condensed statements of consolidated operations for the three months ended March 31, 2017. Following the adoption of ASC 606, these taxes are now reported net within cost of materials and other and have no impact on revenues for the three months ended March 31, 2018.


 
 
March 31, 2018 |  23

Notes to Condensed Consolidated Financial Statements (Unaudited)

Note 14 - Subsequent Event

Andeavor and Marathon Petroleum Corporation (“MPC”) entered into an Agreement and Plan of Merger, dated as of April 29, 2018 (the “MPC Merger Agreement”), under which MPC will acquire all of our outstanding shares. Our shareholders will have the option to choose shares of MPC stock or cash subject to a proration mechanism that will result in 15 percent of our fully diluted shares receiving cash consideration. The transaction was unanimously approved by the boards of directors of both companies and is subject to regulatory and other customary closing conditions, including approvals from the shareholders of each company.

The Company and MPC have made customary representations, warranties and covenants in the MPC Merger Agreement. Among other things, the MPC Merger Agreement, with certain exceptions as outlined in the agreement, restricts us from issuing shares of our capital stock, from purchasing any of our capital stock and from incurring any additional indebtedness outside the ordinary course of business. The MPC Merger Agreement allows us to continue paying a regular quarterly dividend up to $0.59 per share.

Concurrently with the execution of the MPC Merger Agreement, Andeavor and MPC entered into a voting and support agreement (the “Voting Agreement”) with one of our directors, Paul L. Foster, and Franklin Mountain Investments, LP (together, the “Stockholder”). Under the Voting Agreement, the Stockholder agreed to vote all of our shares beneficially owned by him, excluding certain shares as disclosed in the Voting Agreement, in favor of the adoption of the MPC Merger Agreement and to not vote in favor of any alternative acquisition proposal or other action or agreement that would reasonably be expected to adversely affect the merger with MPC.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Those statements in this section that are not historical in nature should be deemed forward-looking statements that are inherently uncertain. See “Important Information Regarding Forward-Looking Statements” for a discussion of the factors that could cause actual results to differ materially from those projected in these statements. This section should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2017.

Business Strategy and Overview

We are the leading integrated marketing, logistics and refining company in our strategic footprint and are driven to create value by operating an integrated business model. Our diversified and integrated portfolio of assets and operations provides us with strong growth opportunities across our value chains.

In recent years, we have implemented strategies to transform the composition of our portfolio of marketing, logistics and refining assets. In 2010, the majority of our operating income was generated through our Refining segment with only a small portion attributable to our previous retail segment and we did not have commercial logistics operations. However, in recent years, we have successfully implemented strategies to drive operational productivity improvements, organic growth and portfolio enhancing acquisitions. Identifying new value creation opportunities to grow the Company is core to our strategy. Our focused execution of this strategy has resulted in a transformation of the Company into a highly integrated, well diversified marketing, logistics and refining business. As of 2018, our Marketing segment continues to expand and Andeavor Logistics has grown significantly resulting in each having a larger and more balanced contribution to our operating results. We believe our integrated business model coupled with our Guiding Principles and Strategic Priorities will position us to create leading value for our investors.

Our Strategy and Goals

Execution of our strategy and the achievement of our goals across our business segments is driven by our commitment to our Guiding Principles and Strategic Priorities as outlined in our Annual Report on Form 10-K for the year ended December 31, 2017. The following discussion outlines how we create value across our integrated business segments.

Marketing
Our marketing operations provide a secure and ratable off-take of gasoline and diesel production from our refineries and allow us to enhance our margin capture as refined product moves through the value chain. We are driving growth and improvements in our Marketing segment by focusing on higher value, branded distribution channels, adding new retail sites to our network and implementing store improvements to enhance our convenience store position.

Logistics
Our Logistics segment includes assets that establish a market position that helps to minimize our transportation costs as well as maximize our overall performance by focusing on a stable, fee-based business. We achieve value by optimizing our existing asset base, pursuing organic expansion opportunities and growing through strategic acquisitions across our terminalling and transportation and gathering and processing businesses.


24 | 
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Management’s Discussion and Analysis

Refining
In our Refining segment, our strategy focuses on:

driving operational excellence enabling asset availability in excess of 97%;
maintaining strict operating cost discipline;
enhancing capital efficiency through superior execution; and
maximizing capital productivity through process optimization including our ability to access regionally advantaged crude oil.

To meet our strategic objectives, we invest in high return capital projects designed to enhance our feedstock flexibility, improve our yields and lower our costs. In addition to the above strategies and goals, we aim to execute on our strategic priorities to further create value for our shareholders through the achievement of annual improvements to operating income and the capturing of synergies associated with the Western Refining Acquisition.

Accomplishments
Our goals are focused on our Strategic Priorities and, thus far, we have announced or accomplished the following in 2018:
 
 
High-Performing Culture
 
 
Operational
Efficiency &
Effectiveness
 
Value Chain Optimization
 
Financial
Discipline
 
Value
Driven
Growth
Safety. Our Dickinson and Mandan refineries were named winners of American Fuel & Petrochemical Manufacturers Elite Silver Safety Award, which recognizes the top 5 percent of refineries in the industry for safety performance. 
 
ü
 
 
 
 
 
 
Rangeland Energy Acquisition. On January 19, 2018, we completed the acquisition of Rangeland, which owns and operates assets in the Delaware and Midland Basins in New Mexico and Texas and has a 67% joint interest in the RIO pipeline.
 
 
 
ü
 
 
 
ü
Gray Oak Pipeline and South Texas Gateway Terminal Joint Ventures. On April 24, 2018, we announced our participation in a 25% joint venture in Gray Oak Pipeline and a 25% joint venture in the South Texas Gateway Terminal.
 
 
 
ü
 
 
 
ü
West Coast Asphalt Terminal Acquisition. On February 12, 2018, we announced our agreement to acquire five asphalt terminals on the west coast, including a 50% joint venture in one asphalt terminal.
 
 
 
ü
 
 
 
ü
Wamsutter Pipeline Acquisition. On May 1, 2018, Andeavor Logistics completed its acquisition of the Wamsutter Pipeline System, which consists of active pipelines that transport Inland crude oil to Salt Lake City refineries, including our Salt Lake City Refinery.
 
 
 
ü
 
 
 
ü
Marketing Growth. We added 28 Branded stations in Mexico, 17 Branded stations in the U.S. and converted 7 Retail MSO sites to company operated bringing the total converted MSO sites to 57 since the beginning of the fourth quarter of 2017.
 
 
 
ü
 
 
 
ü
Returning Capital to Shareholders. We returned approximately $348 million to shareholders through the repurchase of 2.6 million shares of our common stock for approximately $256 million and $92 million in dividends.
 
 
 
 
 
ü
 
 
Andeavor Logistics Revolving Credit Facility. On January 5, 2018, Andeavor Logistics increased the aggregate commitments under the Andeavor Logistics Revolving Credit Agreement from $600 million to $1.1 billion.
 
 
 
 
 
ü
 
 

Marathon Merger
On April 29, 2018, Andeavor and MPC entered into the MPC Merger Agreement under which MPC will acquire all of our outstanding shares (the “MPC Merger”). Our shareholders will have the option to choose 1.87 shares of MPC stock or $152.27 in cash, subject to a proration mechanism that achieves an aggregate consideration mix of 85% equity and 15% cash. MPC and Andeavor shareholders will own approximately 66% and 34% of the combined company, respectively. The transaction combines two highly complementary businesses to create a premier U.S. integrated marketing, logistics and refining company and establishes a geographically diversified industry leader that is well-positioned for long-term growth and value creation. The transaction was unanimously approved by the boards of directors of both companies and is subject to regulatory and other customary closing conditions, including approvals from the shareholders of each company.


 
 
March 31, 2018 |  25

Management’s Discussion and Analysis
 

Results of Operations

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

Items Impacting Comparability

On June 1, 2017, we closed the Western Refining Acquisition. Our results include the operations from Western Refining for the period of June 1, 2017 onward, and thus prior periods may not be comparable. With the Western Refining Acquisition, we have updated our segments to reflect the results and operations of Western Refining and WNRL. Our Marketing segment reflects our expanded marketing business that, combined with Western Refining, now consists of expanded wholesale marketing operations and approximately 3,300 retail stores marketed under multiple well-known fuel brands including ARCO®, Shell®, Mobil® and SUPERAMERICA®. Our Logistics segment includes the combined results of Andeavor Logistics, excluding the Wholesale business. We now report the Logistics segment’s results for the combined Terminalling and Transportation and Gathering and Processing business lines. Our Refining segment reports the results of our refining system that now consists of ten refineries in the western United States with a combined capacity of approximately 1.2 million barrels per day. The Refining segment includes the results from Andeavor’s existing Refining segment and Western’s Refining segment, excluding third-party wholesale marketing operations that are now reported in our Marketing segment.

On January 1, 2018, we adopted ASC 606 utilizing the modified retrospective method. The current period results and balances are presented in accordance with ASC 606 while comparative periods continue to be presented in accordance with the accounting standards in effect for those periods. Refer to Note 1 and Note 12 within Item 1 for further details regarding ASC 606 and the financial impact due to adoption of the standard.

Market Overview

The markets in which we operate are subject to market volatility through the price of crude oil and other feedstocks we acquire for refining and the price we can sell our refined products through our Marketing, Logistics and Refining segments. Refinery disruptions, planned maintenance, changing logistical infrastructure and healthy domestic macroeconomic conditions continue to influence all portions of our business. Refined product values and crude oil prices are generally set by the global market balances. However, refined product demand trends and crude oil supplies in the U.S. and globally have a significant impact on our business.

Refined Products
Globally, crude and product inventory levels are notably lower than this time last year, but are in line with the 5-year average. Continued growth of the global markets and improvement in macro-economic factors remains supportive to refined product demand growth. Additionally, we continue to see attractive export opportunities for refined products to Latin America due to their persistent low refinery utilization rates.

Logistics
Although our Logistics segment has minimal exposure to commodity prices, pricing conditions were mixed for the products it handles during the first quarter. Crude oil and gasoline prices rose while natural gas and the majority of NGL prices fell. The price of the U.S. domestic benchmark crude, West Texas Intermediate (WTI), gained over $4.50 per barrel in the quarter as the global market continued to show signs of rebalancing and high seasonal refinery runs drove total U.S. crude stocks below the 5-year average. The domestic rig count rose steadily throughout the first quarter, although at a more measured pace than previous quarters, as prices remain above breakeven levels in many basins. Despite the slower rate of rig additions, U.S. crude production notably exceeded historical records as producers continue to implement efficiencies and focus on core acreage. Additionally, growing export opportunities, particularly those to Latin America, are providing an incentive for U.S. refiners to maximize production of gasoline and diesel. These factors create a positive outlook for U.S. oil, gas, natural gas and refined product throughput volumes; however, regional impacts may differ.

Refining
During the first quarter, the markets in which we operate continued to experience volatility. While Brent crude oil started and ended the period at approximately $67 per barrel, the per barrel prices fluctuated between a low of $62 and a high of $70. From a seasonality perspective, domestic crude stocks typically display a large build during the first quarter due to planned refinery maintenance. In contrast, U.S. crude inventories completed the first quarter of 2018 relatively unchanged. U.S. crude production continued to display strong growth due to positive shale economics resulting from operator efficiencies and a supportive price environment. However, robust exports, primarily out of the Gulf Coast, helped balance this new domestic supply. In addition, crude demand was higher than historical norms as some refinery maintenance was scheduled later in the season. As a result, domestic crude inventories finished the quarter notably lower than the same time last year, but approximately at the 5-year average. Although regional gasoline inventories began rising during the latter part of the quarter, mid-continent refining margins were within seasonal norms as refiners benefited from discounted inland crude oil. Additionally, West Coast margins also averaged near seasonal values supported by positive gasoline and diesel demand. Refinery utilization in the Western region was

26 | 
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Management’s Discussion and Analysis

impacted by both planned and unplanned outages but remained slightly elevated relative to seasonal five-year average. We continue to monitor the impact of changes in both market prices and fundamentals on our business.

As a performance benchmark and a comparison with other industry participants, we have utilized the West Coast and Inland crack spreads. The crack spread is a measure of the difference between market prices for crude oil and refined products and is a commonly used proxy within the industry to estimate or identify trends in refining margins. Crack spreads can fluctuate significantly over time as a result of market conditions and supply and demand balances. The West Coast 321 crack spread is calculated using 3 barrels of Alaska North Slope crude oil (“ANS”) producing 2 barrels of Los Angeles CARB gasoline and 1 barrel of Los Angeles CARB diesel. The Inland 321 crack spread is calculated using 3 barrels of WTI crude oil producing 2 barrels of Group 3 gasoline and 1 barrel of Group 3 diesel.

West Coast and Inland crack spreads increased and decreased during the three months ended March 31, 2018 (the “2018 Quarter”) compared to last year. The U.S. West Coast crack spread averaged $16.70 per barrel in the 2018 Quarter compared to $16.57 per barrel in the three months ended March 31, 2017 (the “2017 Quarter”). The Inland crack spread averaged $16.61 per barrel in the 2018 Quarter compared to $16.70 per barrel in the 2017 Quarter.

Our actual refining margins differ from these crack spreads based on the actual slate of crude oil we run at our refineries and the products we produce. The global commodity markets for crude oil and refined products are subject to significant volatility resulting in rapidly changing prices and margin environments. Our refineries process a variety of crude oils that are sourced from around the world. The slate of crude oil we process can vary over time as a result of changes in market prices and shipping rates. Additionally, our refining margin is impacted by the changing crude oil price differentials, which is the difference between the benchmark crude oils, WTI and Brent crude oil, and the actual crude oil we run at our refineries. We may experience financial risk associated with price volatility of crude oil and refined products, and we may utilize financial hedge instruments to help mitigate such risks where possible.

Non-GAAP Measures

Our management uses certain “non-GAAP” performance measures to analyze operating segment performance and non-GAAP financial measures to evaluate past performance and prospects for the future to supplement our GAAP financial information presented in accordance with U.S. GAAP. These financial and operational non-GAAP measures are important factors in assessing our operating results and profitability and include:

EBITDA - U.S. GAAP-based net earnings before interest, income taxes, and depreciation and amortization expenses;
Segment EBITDA - segment’s U.S. GAAP-based operating income before depreciation and amortization expense plus equity in earnings (loss) of equity method investments and other income (expense), net;
Fuel margin - calculated as the difference between total marketing revenues and marketing cost of fuels and other;
Fuel margin per gallon - calculated as the fuel margin divided by our total fuel sales volumes in gallons;
Merchandise margin - calculated as the difference between merchandise sales and purchases of merchandise;
Merchandise margin percentage - calculated as merchandise margin divided by merchandise sales;
Average margin on NGL sales per barrel - calculated as the difference between the NGL sales revenues and the amounts recognized as NGL expenses divided by our NGL sales volumes in barrels presented in thousands of barrels per day (“Mbpd”) multiplied by 1,000 and multiplied by the number of days in the period, (90 days for both the 2018 Quarter and 2017 Quarter);
Refining margin - calculated as the difference between total refining revenues and total cost of materials and other;
Refining margin per throughput barrel - calculated as refining margin divided by our total refining throughput in barrels multiplied by 1,000 and multiplied by the number of days in the period as stated above; and
Manufacturing costs (excluding depreciation and amortization) per throughput barrel - calculated as manufacturing costs divided by our total refining throughput in barrels multiplied by 1,000 and multiplied by the number of days in the period as stated above. Manufacturing costs represent direct operating expenses incurred by our Refining segment for the production of refined products.

We present these measures because we believe they may help investors, analysts, lenders and ratings agencies analyze our results of operations and liquidity in conjunction with our U.S. GAAP results, including but not limited to:

our operating performance as compared to other publicly traded companies in the refining, logistics and marketing industries, without regard to historical cost basis or financing methods;
our ability to incur and service debt and fund capital expenditures; and
the viability of acquisitions and other capital expenditure projects and the returns on investment of various investment opportunities.


 
 
March 31, 2018 |  27

Management’s Discussion and Analysis
 

Management also uses these measures to assess internal performance. Non-GAAP measures have important limitations as analytical tools, because they exclude some, but not all, items that affect net earnings and operating income. These measures should not be considered substitutes for their most directly comparable U.S. GAAP financial measures.

2018 1st Quarter Versus 2017 1st Quarter

Highlights (in millions)

chart-3bb16c32454551599ac.jpgchart-64d99c6356b954669b6.jpgchart-7a3da86121945792bde.jpg
(a)
See “Non-GAAP Reconciliations” section below for further information regarding these non-GAAP measures.

Percentage of Segment Operating Income by Operating Segment

chart-4b1e3b57ec4d546c9aa.jpgchart-18753e4f5843547f8a1.jpg
Net Earnings from Continuing Operations Reconciliation (in millions)

chart-7620c2ef0c705abea35.jpg
(a)
Corporate costs and eliminations
(b)
Interest and financing costs, net
(c)
Equity in earnings of equity method investments


28 | 
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Management’s Discussion and Analysis

Overview
Our net earnings of $237 million ($1.12 per diluted share) for the 2018 Quarter increased compared to $87 million ($0.42 per diluted share) for the 2017 Quarter. Our EBITDA increased $248 million to $680 million compared to the 2017 Quarter. These increases were primarily driven by improved operating results in our Refining and Logistics segments, aided by the Western Refining Acquisition, but were partially offset by a decrease in operating income for our Marketing segment and higher corporate costs. The higher operating income in our Refining segment also included a net benefit of approximately $100 million primarily related to a reduction in the RINs obligation from prior years.

Segment Results
Refer to our detailed discussion of each segment’s operating and financial results contained in this section.

Corporate Costs
General and administrative expenses increased $38 million in the 2018 Quarter compared to the 2017 Quarter largely due to the inclusion of Western Refining and higher costs associated with our Enterprise Resource Planning project.

Interest and Financing Costs
Interest and financing costs of $102 million in the 2018 Quarter were higher than the $98 million for the 2017 Quarter due to higher debt from the $500 million 3.800% Senior Notes due 2028 and $500 million 4.500% Senior Notes due 2048 issued in December 2017 partially offset by lower interest expense from lower interest rates reflecting our improved investment grade credit rating.

Income Taxes
Our income tax expense totaled $59 million in the 2018 Quarter compared to $21 million in the 2017 Quarter primarily due to higher pre-tax earnings during the 2018 Quarter. The combined federal and state effective income tax rate largely remained the same at 20% during the 2018 Quarter compared to 19% in the 2017 Quarter. While the 2018 Quarter benefited from a lower federal tax rate due to the Tax Cuts and Jobs Act enacted in December 2017, the 2017 Quarter benefited more from excess tax benefits related to equity compensation.

Segment Results of Operations
andv_marketinga13.jpg Marketing Segment

Our Marketing segment sells gasoline and diesel fuel in the western and mid-continent United States through Retail, Branded, and Unbranded channels along with convenience store products in our Retail channel. Our Retail business is made up of company-owned or leased properties offering fuel and convenience store products to end-consumers through company-operated stations and third party-operated stations (“MSOs”). The Branded business is comprised primarily of fuel sales through long-term contracts with Jobbers and Dealers utilizing one of the many successful brands in our portfolio. Our Retail and Branded channels primarily use the ARCO®, Shell®, Mobil™ and SUPERAMERICA® brands for fuel sales and ampm®, SUPERAMERICA® and Giant® brands for convenience stores. Capturing this brand value results in higher fuel margins for our Marketing segment. Our Unbranded business includes fuel sales through agreements with third-party distributors/operators without an associated fuel brand. The combined use of these channels provides income from both a profitable outlet for the majority of the fuel produced by our refineries as well as merchandise sales through convenience stores. In addition to added profitability, our Marketing business enables our refineries to run optimally, which lowers overall operating costs on a per barrel basis.

Operational Data and Results
Management uses fuel margin per gallon and merchandise margin to compare results to other companies in the industry. There are a variety of ways to calculate fuel margin per gallon and merchandise margin; different companies may calculate them in different ways. We report fuel margin separate for our retail and branded operations as well as our unbranded operations due to the difference in margin economics in these channels. Fuel margin and fuel margin per gallon include the effect of intersegment purchases from the Refining segment. Merchandise margin is frequently used in the convenience store industry to measure operating results related to merchandise sales. Investors and analysts may use these metrics to help analyze and compare companies in the industry on the basis of operating performance. These financial measures should not be considered alternatives to revenues, segment operating income or any other measures of financial performance presented in accordance with U.S. GAAP.


 
 
March 31, 2018 |  29

Management’s Discussion and Analysis
 

Number of Retail and Branded Stations (at end of period)

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(a)    457 company operated stations and 87 jobber/dealer operated stations acquired with the Western Refining Acquisition.

Site Count Growth

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2018 1st Quarter Versus 2017 1st Quarter

Highlights

chart-b24cc4bb12395b54b9a.jpgchart-1ff5ce3ce8f95818a68.jpgchart-1ebacd11c5315da6a0e.jpg
(a)
See “Non-GAAP Reconciliations” section below for further information regarding these non-GAAP measures.


30 | 
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Management’s Discussion and Analysis

Marketing Fuel Sales (in millions of gallons)

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Marketing Segment Operating Data and Results (dollars in millions)

 
Three Months Ended
March 31,
 
2018
 
2017
Revenues
$
5,665

 
$
4,104

Expenses
 
 
 
Cost of fuels and other (excluding items shown separately below)
5,339

 
3,885

Operating expenses (excluding depreciation and amortization)
167

 
68

Depreciation and amortization expense
22

 
13

Selling, general and administrative expenses
9

 
5

Segment Operating Income
$
128

 
$
133

 
 
 
 
Segment EBITDA (a)
$
152

 
$
146

 
 
 
 
Marketing Margin (a)
Retail and Branded fuel margin
$
214

 
$
189

Unbranded fuel margin
38

 
12

Total Fuel Margin
252

 
201

Merchandise margin
50

 
3

Other margin
24

 
15

Total Convenience Margin
74

 
18

Total Marketing Margin
$
326

 
$
219

 
 
 
 
Fuel Margin (¢/gallon) (a)
Retail and Branded Fuel Margin

16.2
¢
 

17.4
¢
Unbranded Fuel Margin

2.6
¢
 

1.2
¢
Total Fuel Margin

9.1
¢
 

9.6
¢
 
 
 
 
Merchandise Margin % (a)
28.0
%
 
34.4
%

(a)
See section “Non-GAAP Reconciliations” below for further information regarding this non-GAAP measure.

 

Overview
Operating income decreased $5 million to $128 million for the 2018 Quarter compared to the 2017 Quarter as weaker Retail and Branded fuel margins were offset by contributions from the Western Refining Acquisition.

Retail and Branded Fuel Margin
Fuel margin increased $25 million to $214 million during the 2018 Quarter compared to the 2017 Quarter as volume and margin contributions from the Western Refining Acquisition and retail stations acquired in northern California in July 2017 were partially offset by weaker margins in California due to a rise in spot prices with a slower corresponding rise in street prices.

Unbranded Fuel Margin
Fuel margin increased $26 million to $38 million during the 2018 Quarter compared to the 2017 Quarter due to contributions from the Western Refining Acquisition.

Convenience Margin
Convenience margin increased $56 million to $74 million during the 2018 Quarter compared to the 2017 Quarter primarily reflecting contributions from the Western Refining Acquisition, retail stations acquired in northern California in July 2017 and conversions of MSO-operated to company-operated stations. This also resulted in our merchandise margin percentage decreasing to 28.0% in 2018 compared to 34.4% in 2017 due to the change in merchandise product mix of the acquired businesses.

Operating Expenses and Depreciation
Operating expenses increased $99 million and depreciation and amortization expenses increased $9 million in the 2018 Quarter versus the 2017 Quarter primarily due to higher operating costs from company-operated stations acquired in the Western Refining Acquisition.


 
 
March 31, 2018 |  31

Management’s Discussion and Analysis
 

andx_transporta15.jpg andxterminallinga14.jpg andx_gatheringa16.jpg andx_processinga15.jpg Logistics Segment

Our Logistics segment operates across two business lines: Terminalling and Transportation and Gathering and Processing. A significant portion of the assets within this segment are integral to the success of our refining and marketing operations. Refer to
Note 13 within Item 1 for intercompany revenue. These business lines generate revenue by charging fees for:

providing storage services;
transporting refined products;
delivering crude oil, refined products and intermediate feedstocks from vessels to refineries and terminals;
loading and unloading crude oil transported by unit train to our Anacortes refinery;
loading and unloading from marine vessels and barges;
transferring refined products from terminals to trucks, barges, rail cars and pipelines;
providing ancillary services, ethanol blending and additive injection;
handling petroleum coke for our Los Angeles refinery;
gathering and transporting crude oil, natural gas and produced water;
operating storage facilities with tanks located in strategic areas;
operating truck-based crude oil and asphalt gathering; and
processing gas under fee-based processing and percentage-of-proceeds agreements.

Operational Data and Results
Several operating metrics are used by management to evaluate performance and efficiency and compare profitability to other companies in the industry. These metrics include:

Average terminalling revenue per barrel - calculated as total terminalling revenue divided by total terminalling throughput;
Average pipeline transportation revenue per barrel - calculated as total pipeline transportation revenue divided by total pipeline transportation throughput;
Average margin on NGL sales per barrel - calculated as the difference between the NGL sales revenues and the amounts recognized as NGL expense divided by our NGL sales volumes in barrels presented in Mbpd multiplied by 1,000 and multiplied by the number of days in the period;
Average gas gathering and processing revenue per Million British thermal units (“MMBtu”) - calculated as total gathering and processing fee-based revenue divided by total gas gathering throughput; and
Average crude oil and water gathering revenue per barrel - calculated as total crude oil and water gathering fee-based revenue divided by total crude oil and water gathering throughput.

Investors and analysts use these financial measures to help analyze and compare companies in the industry on the basis of operating performance. These financial measures should not be considered as an alternative to segment operating income, revenues and operating expenses or any other measure of financial performance presented in accordance with U.S. GAAP.

2018 1st Quarter Versus 2017 1st Quarter

Highlights (in millions)

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32 | 
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Management’s Discussion and Analysis

Logistics Segment Volumetric Data

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chart-294e422d01d8525ba23.jpgchart-efdcea0e972b5a35921.jpg
(a)
Volumes represent barrels sold under Andeavor Logistics’ keep-whole arrangements, net barrels retained under its percent of proceeds (“POP”) arrangements and other associated products.


 
 
March 31, 2018 |  33

Management’s Discussion and Analysis
 

Logistics Segment Operating Results (in millions, except per barrel and per MMBtu amounts)

 
Three Months Ended
March 31,
 
2018
 
2017
Revenues
 
 
 
Terminalling and Transportation
 
 
 
Terminalling
$
198

 
$
145

Pipeline transportation
31

 
30

Other revenues
2