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Delek Logistics Partners LP (NYSE:DKL)

Q3 2013 Earnings Conference Call

November 6, 2013 10:00 AM ET

Executives

Keith Johnson – Vice President of Investor Relations

Ezra Uzi Yemin –Chairman and Chief Executive Officer

Assaf Ginzburg – Executive Vice President and Chief Financial Officer

Danny Norris – Vice President of Finance

Analysts

Mark L. Reichman – Simmons & Co. International

Theresa Chen – Barclays Capital

Cory J. Garcia – Raymond James & Associates, Inc.

Brian Brazinski – Bank of America Merrill Lynch

Operator

Good morning. My name is Pamela, and I will be your conference operator today. At this time, I would like to welcome everyone to the Delek Logistics Partners’ Third Quarter Earnings Call. All lines have been placed on mute to prevent background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

Now we’ll turn the call over to Keith Johnson. Sir, you may begin.

Keith Johnson

Thank you, Pam. Good morning. I would like to thank everyone for joining us on this webcast to discuss Delek Logistics Partners’ third quarter 2013 financial results. Joining me on today’s call will be Uzi Yemin, our General Partners, Chairman and CEO; Assi Ginzburg, our CFO; Danny Norris, VP of Finance, and other members of our management team.

As a reminder, this conference call may contain forward-looking statements as that term is defined under Federal Securities Laws. For this purpose, any statements made during this call that are not statements of historical fact maybe deemed to be forward-looking statements. Without limiting the foregoing, the words believes, anticipates, plans, expects, and similar expressions are intended to identify forward-looking statements. You are cautioned that these statements may be affected by important factors set forth in our filings with the Securities and Exchange Commission and in our latest earnings release. As a result, actual operations or results may differ materially from the results discussed in the forward-looking statements. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events, or otherwise.

Today’s call is being recorded and will be available for replay beginning today and ending February 6, 2014 by dialing 855-859-2056 with a confirmation ID number 80257122. An online replay may also be accessed for the next 90 days at the partnership’s website at deleklogistics.com.

As you may know, Delek Logistics commenced operations on November 7, 2012, upon successful completion of its initial public offering. Operations prior to November 7, 2012 include results from assets and entities comprising Delek Logistics Partners LP predecessor. Because management believes that results presented from the prior periods are not generally comparable, this earnings call will focus on results for the third quarter of 2013.

Last night, we distributed a press release that provides the summary of our third quarter 2013 results. This press release is available on our corporate website and through various news outlets. On today’s call, Assi will begin with a few financial comments and Danny will review our financial performance, then Uzi will offer a few closing strategic remarks.

With that, I’ll turn the call over to Assi.

Assi Ginzburg

Thanks Keith. Delek Logistics performed well during the third quarter. Our EPS of $12.9 million was ahead of our IPO forecast. EBITDA was $15.7 million for the third quarter and $42 million year-to-date. Based on our strong performance we are pleased to be able to increase our quarterly distribution to $40.05 per unit for the quarter ended September 30, 2013, which is a 2.5% increase from our previous distribution. This is our third increase in 2013 and 8% above the MQD of $37.05 per unit.

We are on target to show a double-digit increase in our distribution in the first year of operation at DKL. As a reminder, in early July our revolving credit facility was amended to increase lender complement to $400 million from $175 million, improving our financial flexibility to support future growth initiative. During the third quarter we completed two acquisitions for a total of approximately $100 million and recently completed a third acquisition in October. We will review this more detail later in the call.

Now I will turn the call over to Danny to discuss the financial results.

Danny Norris

Thank you, Assi. For the third-quarter 2013, Delek Logistics reported net income of $11.4 or $0.51 per diluted limited partner unit. Revenues during the third quarter were $243.3 million and contribution margin was $17.6 million. Total operating expenses of $7.5 million or higher than expected, primarily due to the addition of the Tyler, Texas assets acquired in July. General administrative expenses of $1.9 million were below expectations provided in the prospects.

Now I will spend a few minutes discussing our two reporting segments. For the third quarter 2013 our pipeline and transportation segment performed well, as a benefited from elevated throughput of approximately 21,900 barrels per day in the Sala Gathering System, which compares to 19,500 barrels per day, included in the IPO forecast.

During the third quarter 2013, crude volume on the Lion pipeline system was approximately 47,700 barrels per day, which is above minimum commitment levels of 46,000 barrels per day. Also this segment benefited from storage associated with the Tyler, Texas, tank farm, acquired on July 26.

Our East Texas crude logistics system delivered approximately 10,150 barrels per day during the quarter. As anticipated, fees derived from the East Texas system continued at minimal contractual levels due to the reconfiguration of a third-party pipeline in April 2013, to supply crude to Delek U.S.’ Tyler, Texas, refinery. Performance in our wholesale Marketing and Terminalling segment benefited from higher volumes and ongoing blending activities.

Under our East Texas marketing agreement approximately 61,700 barrels per day of refined products were marketed from Delek U.S.’ Tyler, Texas, refinery. This was better than the 52,000 barrels per day included in the IPO forecast due to increased throughput at that refinery. Also, volume in our West Texas wholesale operation increased approximately 13% on a year-over-year basis to approximately 18,970 barrels per day.

As in previous quarters, demand for refined products in our West Texas remained robust, as oil drilling activity in this region has increased economic activity. The gross margin of $1.63 per barrel in the third quarter of 2013, compares to $3 and $0.01 per barrel in the prior year period. The margin per barrel included approximately $2 million, or $1.13 per barrel from RINs generated in our ongoing ethanol blending activities during the third quarter of 2013.

Ethanol RIN values averaged approximately $0.84 per RIN in the third quarter 2013, compared to $0.82 in the second quarter 2013. Market prices for RINs declined through the third quarter from highs reached in July. A combination of less attractive ethanol blending economics and a decline in fuel prices from August through September, negatively affected margins in a competitive West Texas market.

The increase in terminalling volumes was due to the acquisition of the Tyler, Texas, terminal on July 26. Volume through that terminal was approximately 60,000 barrels per day during the third quarter. This was higher than $55,000 barrel per day rate in 2012, which was the basis of our forecasted performance from this acquisition.

As of September 30, 2013, Delek Logistics had a cash balance of $6.7 million and total debt was $161 million. This increase in borrowings from June 30, 2013 was due to acquisitions completed in July. We ended the quarter with $225.5 million of availability on our $400 million credit facility. And the adjusted leverage ratio was 2.28 times, which was well within the four times allowable under the facility.

Capital expenditures were approximately $1 million of which $153,000 was reimbursed under our omnibus agreement with Delek U.S.

Maintenance capital expenditures were approximately $924,000 in the third quarter of 2013 and growth related projects were $93,000. Total capital expenditures for 2013 are now expected to be $6.5 million, compared to a pervious estimate of $10.2 million. This decrease is associated with a reduction in maintenance CapEx. Approximately $2.5 reimbursed under our omnibus agreement with Delek US.

Our discussion around CapEx is focused on the assets owned by Delek Logistics and does not include historical predecessor amounts associated with the Tyler assets. Before turning the call over to Uzi, I want to review the acquisitions we have completed. On July 26, we purchased the Tyler, Texas, storage tanks and product terminal for $94.8 million in cash. These assets will continue to support Delek US’ Tyler, Texas, refinery and are expected to contribute approximately $10.5 million of EBITDA annually.

On July 19, we acquired the Hopewell Tyler products pipeline. This pipeline will allow our Big Sandy terminal to become fully operational and be served directly by Delek US’ Tyler, Texas, refinery. We plan to spend approximately $1.3 million to refurbish this pipeline, which is expected to be completed during the fourth quarter of 2013.

We expect approximately $700,000 of annual EBITDA from this acquisition. Also in late October, we completed the acquisition of a terminal in North Little Rock, Arkansas. This terminal will be supported by Delek US’ Eldorado refinery, and is expected to contribute approximately $800,000 of EBITDA in its first 12 months of operations. Over time, we plan to spend approximately $5.4 million of capital on projects to increase blending capability and throughput capacity to approximately $17,500 barrels per day at this terminal.

With that, I will turn the call over to Uzi for his closing comments.

Ezra Uzi Yemin

Thank you, Danny. During the third quarter, we executed our growth strategy with two acquisitions that enhanced our position in East Texas through the Tyler assets and the Hopewell pipeline. In October, we completed the acquisition of the North Little Rock terminal, which provides a strategic position in that market with the ability to grow over time.

We remain focused on creating additional growth through future growth of Delek Logistics’ assets from our sponsor, Delek US, as well as a focus on third-party acquisitions. We believe the remaining drop-downs identified in the prospectus have the potential to create an additional $15 million to $20 million of EBITDA and we expect to complete this drop-down within six to 12 months from today. This should provide Delek Logistics with the solid foundation to provide growth and value for our unit holders.

With that, Pam, would you please open the call for questions?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Mark Reichman with Simmons.

Mark L. Reichman – Simmons & Co. International

First, on the Tyler tank farm product terminal drop-down, you had mentioned the throughputs, and I think the per barrel fees are pretty much set. I wanted to ask you about how has OpEx tracked. I mean, relative to your original expectations and in terms of the EBITDA contribution to-date, is that tracking to the $10.5 million or do you see either improvements in volumes or changes in OpEx to get you, to your expectation on the contribution from that drop down?

Assaf Ginzburg

Mark, good morning, it's Assi. Thank you for the question. If you remember, when we gave the initial guidance on the forecast, we thought that we based them on Tyler runs in 2012 and Tyler sold in 2012, 55,000 barrels per day as you can see in this quarter it was slightly about 60,000 barrels per day. So on the revenue side we were above our expectation, and on operating costs, we were in line with expectations. So overall contribution margins from these assets is likely better compared to historical and compared to the forecasts we have given. And overall, you can look at the Tyler refinery already in Q2 and Q3 around they were better than basically what we saw in 2012.

Mark Reichman – Simmons & Company International

Okay. So performing above expectations. And then the Tyler/Hopewell pipeline, you had mentioned that that's going into – be operational by year end, and expected to spend $1.3 million. That's kind of – that information has kind of been out there. But can you tighten that up a little in terms of when you think that's going to go into service since we're already into the fourth quarter, and then how much have you spent to-date of that $1.3 million?

Ezra Uzi Yemin

This is Brad. I'll answer that one. What we've done since we did the acquisition of that pipeline is basically do a full inspection of the line. We've hydro tested the line and run a pig through it; we wanted to have a good starting point in terms of our operation. We're finishing up some electrical and instrumentation work at the location where the Tyler products inject into the pipeline. So we're, I would say, within the next 30 days, we'll be in a position to start moving products on the line. And you know, in terms of the money spent, we're coming in so far a little bit under our $1.3 million budget.

Mark Reichman – Simmons & Company International

Okay. And then I guess just, you know, lastly just kind of bigger picture, you know, I think myself, I mean, we kind of focused on the immediate drop down opportunities and is there anything you would like to add in terms of activities of the parent in terms of increasing utilization at the refineries or your joint activities in evaluating acquisition opportunities together? That you might want to add some color on or how you are thinking about it that could benefit the MLP beyond just the immediate drop down opportunities?

Ezra Uzi Yemin

Mark, this is Uzi. I'll take that in two stages if you will. Two parts. The first part is the increasing utilization in our refineries. So we already announced that we are going to have a project in January for the Eldorado refinery that will allow us to run roughly 10,000 barrels more or eight to 10 barrels more like crud that by definition will allow us to run more barrels.

Obviously as we announced already in January, we're going to have a turnaround coming for coming for the Eldorado refinery. But immediately after that we will be able to run if economics makes sense which right now they do around 80,000 or a little more 80,000 barrels a day. So that by definition will increase the utilization in that refinery.

In regard to Tyler, we mentioned in the past that we're looking at Tyler. And once we have a decision about Tyler, we'll make that announcement. Obviously come first at the parent or at the DK level. So that’s for one part of your question in regards to organic growth. On top of that, I would like to see in regard to organic growth is that we'll see more activity in activity in the areas that we're in coming with drilling, and West Texas, the Gathering System and east Texas, all enjoy that activity. It is inching up. It's not in massive, thousands of barrels per day, but it is inching up.

The third part of your question was in regard to M&A activity and acquisitions. As you see, we were able and as you see we are able to very attractive assets in great valuation as demonstrated by the last two, three acquisitions that we have done and we believe that we can – we have the ability to identify them and improve them, and also we believe that since we are very well known in the market as players that are willing to move quickly people approach us with M&A activities. We remain committed and we believe that our target was $150 million EBITDA, three years from the moment of the IPO am we believe that we are on track to get that number achieved.

Mark Reichman – Simmons & Company International

Great. Listen, I really appreciate it. Thank you.

Ezra Uzi Yemin

Thank you.

Operator

Your next question comes from the line of Theresa Chen with Barclays Capital.

Theresa Chen – Barclays Capital

On the question of organic growth, could you give us an update on your current outlook for the recontracting of the Paline pipeline at Nuray after the current contract expires at the end of next year, please?

Ezra Uzi Yemin

That’s a great question. As you know his line is being leased to a third-party and you mentioned that it will go into expire by the end of 2014. Differentials have widened up lately and we are confident that we can get this contract renegotiated with a higher value. Now it’s a matter of finding combination between three elements. The length of the contract, how much market risk we are willing to take, and how much capacity we want to give to other party. We are still in the process of deciding that internally, but we're confident that the value that will come out of Paline is higher than what we see today.

Theresa Chen – Barclays Capital

Thank you. And on the products terminal acquisition in North Little Rock, when do you expect the capacity expansion to be completed or over what time is that $5.4 million going to be spent?

Ezra Uzi Yemin

Over the next 12 months to 18 months.

Theresa Chen – Barclays Capital

Okay great and then on the 800,000 of EBITDA contribution for that, is this under any sort of throughout agreement or is that number expected to move around a bit?

Ezra Uzi Yemin

It is under a throughput agreement with minimum requirements from Lion or the Eldorado refinery.

Theresa Chen – Barclays Capital

Thank you very much.

Ezra Uzi Yemin

Just to clear on that topic, we do expect to start operating the North Little Rock in the next few weeks. So the $800,000 is unrelated to the improvement. It’s part of the initial agreement, and as we put more money into work, that $800,000 is expected to grow.

Theresa Chen – Barclays Capital

Got it. Thank you.

Operator

Your next question comes from the line of Cory Garcia with Raymond James.

Cory J. Garcia – Raymond James & Associates, Inc.

Wanted to kind of circle around on wholesale margins and sort of look at that excluding the ethanol RIN blending, it remained weaker, I think, than expected again this quarter. I was hoping for a little more color. Are you seeing this really on a regional basis, the competitive pressures in West Texas and/or Tyler, and sort of how that is progressing? Then also, given the fact that ethanol RIN values have actually come down a bit in recent months, have you seen any of those competitive pressures lighten up a bit?

Ezra Uzi Yemin

Well, that’s a great question. Let me take it. Let me clear something off the table. There is no market risk or no wholesale issue for the most part in East Texas. So East Texas is very simple volume-based fee agreement. So it's unrelated to the RIN in East Texas. In regard to West Texas, that's a good question. The West Texas margin are actually pretty good. However, and we need to be clear here. There is transit time and inventory moving from the places we move inventory.

As price is coming down, there is pressure on the inventory level or inventory value. That is being offset by the RINs and was offset by the RINs and now it’s being offset by one more thing. If in the third quarter, the price of ethanol wasn't – compared to gasoline, wasn't attractive, now, we do enjoy the margins that are coming between ethanol, which is roughly today $1.80 and $1.80 at ARGO versus gasoline. So we take that blending and put some of it into our pocket.

So there are three components here that influence the wholesale margin. The first one is obviously the wholesale margin, the stop. Second is the RINs in the ethanol blending, which ethanol – RINs came down, but ethanol blending economics came up actually. So it’s the opposite way and third the pressure because of inventory value coming down. So that’s what you saw in the third quarter and that’s what we need to expect in the fourth quarter.

Cory J. Garcia – Raymond James & Associates, Inc.

Okay. That definitely helps clear things up. So it definitely seems like it’s much more of an inventory drag versus the spot market in the West Texas area being weakened, is that correct?

Ezra Uzi Yemin

That is correct. You can see by the volume. Volume is up every quarter, so that means that there is still demand and healthy margins. The – we as part of the system, we choose or we chose almost never to hedge this inventory as we expect eventually this to go up and down by the market. We – so the pressure is on the inventory side and not on the margin side.

Cory J. Garcia – Raymond James & Associates, Inc.

Okay. Thank you very much for clarifying.

Operator

Your next question comes from the line of Gabe Moreen with Bank of America.

Brian Brazinski – Bank of America Merrill Lynch

This is actually Brian Brazinski on Gabe's team. The first question I have is just regarding modeling assumptions. In terms of the drop down of assets with $15 million to $20 million of annual EBITDA within the next six to 12 month, what's the fair EBITDA multiple that we should be thinking about?

Ezra Uzi Yemin

Well, we are a still looking at that. Assi, last time, we used 9x?

Assaf Ginzburg

That’s right. It totally depends on the amount of CapEx that these assets will acquire and how much upside those assets. But we're not trying to – we understand that the refining are trading at 3x and the MLP is trading at 12x to 13x. So we know there is a place in billion between. We actually in general hire a third party to help us assess that multiple and we want to make sure it’s fair to the MLP and it will be accretive to MLP earnings.

Brian Brazinski – Bank of America Merrill Lynch

Okay. Great.

Ezra Uzi Yemin

Well, just to give you a benchmark; last time, we did use 9x.

Brian Brazinski – Bank of America Merrill Lynch

Thank you. I appreciate that. The other question I have is that Magellan Midstream has an ongoing open season for refined products pipeline that would terminate in Little Rock, just wondering if you could discuss the dynamics of the refined products market there and just share your thoughts on the project, whether it could potentially connect to your facilities?

Ezra Uzi Yemin

Well, first, the possibility that if it’s going to [indiscernible], we need to probably ask Magellan. We are obviously very well aware of that activity. Right now, as you know, we or Delek Refining, the Eldorado refinery, is the only supplier of distillate into that market [indiscernible] bring product by volume or other means. We do think that we, especially, after the expansion of the Eldorado refinery during the next turnaround, which is coming in January, as I mentioned, we think that we can supply the entire market. We do know that Magellan has that open season and you probably need to ask them of their status.

Brian Brazinski – Bank of America Merrill Lynch

Understood. All right. Thank you very much.

Operator

(Operator Instructions) And there are no further questions at this time.

Ezra Uzi Yemin

Yes. I would like to thank everybody around this table. I’d like to thank our shareholders, our unitholders, and mainly, I’d like to thank our employees that make this company the great company it is. Have a great day. We’ll talk to you soon.

Operator

And this concludes today’s conference call. Thank you for your participation. You may now disconnect.

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