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Alon USA Energy, Inc. (NYSE:ALJ)

Q2 2010 Earnings Call

August 6, 2010 10:00 AM ET

Executives

Claire Hart – Senior Vice President

Jeff Morris – Chief Executive Officer

Paul Eisman – President

Shai Even – Chief Financial Officer

Analysts

Ann Kohler – Caris & Company

Jeff Dietert – Simmons & Company

Chi Chow – Macquarie

Christina Cheng – Barclays Capital

Evan Templeton – Jefferies & Company

Operator

Good morning, ladies and gentlemen and thank you for standing by. Welcome to the Alon USA’s Second Quarter Earnings Conference Call. During today’s presentation all parties will be in a listen-only mode, and following the presentation conference will be open for questions, and instructions will be given at that time. As a reminder, today’s conference is being recorded today is Friday, August 06, 2010.

And now I’d like to turn the conference over to Claire Hart, Senior VP. Please go ahead.

Claire Hart

Thank you, Josh. Good morning, everyone. Welcome to Alon USA second quarter 2010 earnings conference call. With me are Jeff Morris, Chief Executive Officer; Paul Eisman, President; Shai Even, Chief Financial Officer, along with other members of our senior management team.

You should have received yesterday our earnings release, in case you didn’t, you can obtain a copy from our website, alonusa.com, under the Investor Relations section. Before I turn the call over to Jeff, please be aware that information reported on this call speaks only as of today, August 6, 2010, and therefore you are advised that time-sensitive information may no longer be accurate as of the time of any replay.

Also let remind you that certain statements made by management during this call may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based upon management’s current expectations, include known and unknown risks, uncertainties and other factors, many of which the company is unable to predict or control, that may cause the company’s actual results or performance to materially differ from any future results or performance expressed or implied by those statements.

These risks and uncertainties include the risk factors disclosed by the company from time to time in its filings with the SEC. Furthermore, as we start this call, please also refer to the statement regarding forward-looking statements incorporated in our news release issued yesterday, and please note that those contents of our conference call today are covered by these statements.

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

Jeff Morris

Thank you, Claire. In the second we performed as was expected and I tell you, I’m very satisfied with the progress that we made in the quarter towards implementing Alon’s long-term strategy. First, we completed an agreement with [JM] for the Krotz Springs refinery which provides crude supply and product takeaway for the refinery, but also retains for us full access to our refining margins.

This arrangement does not include any of the constraints of the classical borrowing based facility and is also at a lower cost than our previous working capital facility. Thus, this agreement provides significant additional flexibility for Krotz Springs at reduced cost. Paul Eisman will update you on the specific operational results. But we are very happy to have Krotz Springs running again.

Secondly, we completed the acquisition of the Bakersfield refinery. The total cost of this acquisition to us, to Alon USA was $18.7 million for the assets and $11.5 million for the inventory. Of the $18.7 million, we received an advance payment from a major crude supplier to lease the crude tanks at Bakersfield, which we will not need in our planned configuration. Additionally, we are recovering and selling the platinum and palladium from the second reformer, which we will not operate for about $5 million.

And finally, we financed the inventory via short-term note, but we are liquidating this inventory now and will payoff this note by the end of August. There’s a potential that the total proceeds from the sale of inventory will exceed the $11.5 million, which will further reduce the net purchase cost.

Thus, we believe the final net purchase price for the Bakersfield refinery to Alon will be in the range of zero to $5 million.

We are very excited by this outcome since this acquisition will allow us to increase the throughput of the refinery to 60,000 barrels per day and avoid the expenditure of hundreds of millions of dollars to build a new hydrocracker. It’s a very significant step towards the execution of our long-term plan.

In addition, our Board of Directors has instructed us to pursue a Rights Offering of convertible preferred shares from which we expect net proceeds of $40 million or more. We have also received an indication of interest from our shareholder, Alon Israel, to exercise its rights and to invest in the Rights Offering up to $30 million This offering will further facilitate the execution of our long-term plan.

I will now ask Paul Eisman to provide a more detailed review of our operations.

Paul Eisman

Thank you, Jeff. In the second quarter we made significant progress towards getting our operations where they need to be to be profitable over the long-term and cash flow positive in almost any economic environment. Specifically, I’d like to highlight three areas in which we made strides that are going to improve the long-term performance of the company.

First, I’d like to address the operations of the Big Spring refinery. As you all aware, the refinery has been in a recovery mode since February 2008 explosion and fire. Our long-term focus at all of our refineries is to operate them safely and reliably. Till that end, in 2009, we hired a leading consulting firm as another set of eyes to review our operations and make recommendations for improvements.

One of the primary recommendations from this study was the need to review all of our operating procedures, make the necessary updates and ensure that all of our operators are fully trained in these procedures.

We are committed to this process and are currently spending a significant amount of money and effort to complete this work. While we are in this process, we are running the refinery at lower rates, allowing us to operate as conservatively and prudently as possible. We increased our rate in June to more than 51,000 barrels per day and expect to increase crude rate gradually for the remainder of the year.

The Big Spring refinery is generally running well although we did take a short outage of our SEC in July to make some repairs to the regenerator. Our focus on the refinery for the short-term is stability of operation while maximizing yields and managing operating costs. The Big Spring refinery is our legacy refinery and it is one that historically generate consistent cash flow for the company. We fully expect refinery to return to that role in the coming months.

Secondly, we returned the Krotz Springs refinery from turnaround operation in June. I’m pleased to say that the refinery generally came up very well, despite being down for over seven months. We ran 60,000 barrels per day of crude in the refinery in June as we worked to optimize the yields and the operation of the facility.

As we accomplished this, we expect to increase charge rates to 72,000 barrels per day over the next couple of months. Despite being relatively low complexity refinery, it has configured to produce approximately 101.5% liquid volume recovery in which more than 90% will be gasoline or diesel. Going forward we are looking at opportunities to increase the crude oil flexibility in this refinery.

Finally, we are actively developing to execute our plants to integrate the Paramount and Bakersfield refineries into one full conversion California refinery. As you all aware, our strategy is to use the hydrocracker and other selected equipment at Bakersfield to process the gas all produced at Paramount is clearly sold to third parties.

The resulting increase cost stability of this operation will provide the financial driver necessary to increase the throughputs at Paramount. We fully believe that once we integrate these two refineries the increase in operating margins will support Paramount throughput in the 60,000 barrel per day range.

Engineering is clearly underway on the revisions necessary at both facilities to transport and process the gas at Bakersfield. We don’t at this time have a fully developed schedule of cost for this work, but expect today that we will be able to operate the Bakersfield refinery during the last half of 2011.

I would also like to comment on our other two businesses, asphalt marketing and Alon Brands. With the downturn in the housing market and stretched state and local budgets, asphalt demand is down an estimated 37% from levels we saw just a few years ago. Our sales volume of asphalt is down by approximately the same amount during the period.

However, we’ve been able to maintain margins during this difficult period by capitalizing on our position in premium asphalts. As you all aware, we are the largest marketer in the United States of asphalt produced with recycled ground tire rubber. We are also the largest purchaser of polymers used to modify asphalt to improve their performance.

We found that this leadership position in a premium asphalt business allows us to capture higher prices per product because of the premium performance they provide. It is our intent to build upon and expand our exposure to these premium asphalt markets going forward.

Finally, the performance of our Alon Brands group this year has been exceptional, versus the same quarter last year, retail gasoline sales volume is up 17% and in-store sales are up over 4%. We’ve been able to improve the in-store gross margin to 32.6% and our transaction count is up 5% over what it was a year ago.

This has been accomplished by an aggressive program to improve the image of the stores, improve merchandise management and the attention to detail that is critical to the success of our retail operation. Alon Brands is on track to deliver record EBITDA in 2010, exceeding the record that was set in 2009.

While we are certainly not satisfied with our overall financial performance during the first half of the year, we are confident about where we are headed. We have firm plans in place to improve the financial performance of all our refineries and believe that all three can be cash flow positive in the toughest of environments. Our asphalt marketing and Alon Brands groups continue to operate at high levels of performance.

With that, I’ll turn it back to Jeff.

Jeff Morris

Thank you, Paul. Operator, we are ready for questions at this time.

Question-and-Answer Session

Operator

Yes, sir. (Operator Instructions) And our first question comes from the line of Ann Kohler with Caris & Company. Please go ahead.

Ann Kohler – Caris & Company

Good morning, gentlemen. A couple of questions. One, could you provide a little bit of color maybe around the Rights Offering, the timing sort of any of the terms that might be associated with that?

Jeff Morris

Ann, this is Jeff. I’m going to be very cautious on that, again, jumping rules as you’re aware. I really can’t tell you more than what we’ve put in our release for rate. I think this is an important step for us and we certainly are appreciated by that support that’s indicated by Alon Israel. As we move forward, we will update you as we’ll be filing -- making the filings here pretty soon and you’ll see the results out of the filings.

Ann Kohler – Caris & Company

Okay. Great. And can you just give us a little bit of color and update on -- is there are any changes to your capital plans for this year and maybe look at next year?

Jeff Morris

Ann, I reviewed my comments last call where I indicated to you that our CapEx spend for the year was going to be around $60 million. Obviously, with the results we’ve had, we’ve been very disciplined about our capital plans and doing the sustained type capital investments as we move forward with our projects at Bakersfield. So right now I project for this year about $45 million of CapEx spend.

Ann Kohler – Caris & Company

Great. At this point you don’t have any update in terms of the cost or anything associated with integrating the Bakersfield and Paramount, right?

Jeff Morris

We should have much better information on that by the end of the next quarter. We’re finalizing the engineering now.

Ann Kohler – Caris & Company

Okay. Great. Thank you.

Operator

Thank you. And our next question comes from the line of Jeff Dietert with Simmons & Company. Please go ahead.

Jeff Dietert – Simmons & Company

Appreciate the update, Paul on each and Jeff, on each of the refineries. Could you talk a little bit about the free cash flow positive and focus on the timing as to when you expect especially Krotz and Paramount to shift into positive free cash flow mode? Could you help me with that?

Jeff Morris Jeff Morris

Sure, Jeff. First, as you are aware, Big Spring is there now

Jeff Dietert – Simmons & Company

Yeah. So, I was assuming that it was comfortably free cash flow positive now or at least cash flow positive now?

Jeff Morris

It is and so Big Spring is there now. I would -- we expect the Krotz Springs can be free cash flow positive with the yields that it can achieve in a both -- in a $6 plus HSD 211 WTI crack, Gulf Coast crack. So that’s generally with the forward curve. So we expect, at this point, we’re at those yields today. We’re performing at that level today as far as the yields, 72,000 barrels per day throughput.

Paul Eisman

In September

Jeff Morris

Yeah. In September, so I would expect very soon, assuming that cracks are over $6, that it would be into free cash flow positive. As far as, Paramount, its likely going to be next year and the primary reason for that, we have to get Bakersfield online. Last year Paramount was free cash flow positive, as it was in 2008 because of the very good results from our asphalt business. We did $50 million EBITDA in the last two years in asphalt and the way we view the California business is the asphalt and the refinery together since that’s the way we acquired it.

And with the recovery in asphalt business next year, one thing I like about asphalt business is we’re still getting over 100% of WTI price for the asphalt. That will help. But the Bakersfield startup will get us very strong cash flow positive next year.

Jeff Dietert – Simmons & Company

On an annual basis, post the integration of Bakersfield, what do you think the California complex could generate on an annual basis as far as EBITDA or operating cash flow?

Jeff Morris

It is pretty mature for us to put that out. We’re finalizing all of the work at this point in time. We’ll present that to you probably at the end of the next quarter but the -- it will be a significant amount. We’re selling our gas contracts at L.A. which we describe in the past, are at Gulf Coast plus 7. And we will improve that to (inaudible) in Bakersfield. And historically crake price at Bakersfield and Gulf Coast plus 20.

Jeff Dietert – Simmons & Company

And how much volume is that?

Jeff Morris

15 to 20,000 barrel per day.

Jeff Dietert – Simmons & Company

Thank you for that. It seems as though most people on the asphalt side have been experiencing better margins but have presented a more cautious outlook on demand in sales volumes. Could you talk about what you’re expecting to see in 3Q on the asphalt side?

Jeff Morris

Okay. Our updated plan is for 850,000 tons for the year. That’s what our projections are now.

Jeff Dietert – Simmons & Company

And are margins holding in in 3Q similar to 2Q?

Paul Eisman

They seem to be, we actually got some attractive contracts that are coming online in the third quarter. So, we expect margins to be holding in there pretty much where they are right now.

Jeff Dietert – Simmons & Company

Good. Thanks, Jeff. Thanks, Paul.

Operator

Thank you. (Operator Instructions) And our next question comes from the line of Chi Chow with Macquarie. Please go ahead.

Chi Chow – Macquarie

Hey. Thanks. Good morning. Jeff, can you mention anything at all about the use of funds on the Rights issue?

Jeff Morris

No. Chi, I really can’t at this point in time. It will be for general use of the company. You’re well aware of our strategies and things we’re implementing and have the cash flow models. But I can be very specific.

Chi Chow – Macquarie

Okay. That’s fine. You talked about in your comments, procedures review with the consultants. Could you discuss the issues that they identified and is this something that’s just – that you’re undertaking just as Big Spring or are you going to move to the other refineries as well on these studies?

Paul Eisman

Well, Chi, this is sort of a constant effort at all refineries, obviously, the work was accelerated and more critical nature. At Big Spring, given the incident in February of 2008. So, we are currently focused on that and we had an opportunity to do that. The general sort of procedures that, we use every day to operate our refineries and we’re constantly adapting those and changing those, and improving those based on opportunities we have to do that. But, this is not outside the normal nature of business. It’s just a matter of taking opportunity to get this done at Big Spring.

Chi Chow – Macquarie

All right. And you mentioned that you’re going to be running Big Spring at 51,000 barrels a day, is that, I didn’t catch it, was it just in June or is that for the whole quarter? I’m sorry, does that carry into July?

Jeff Morris

Yeah. That was in June. We expect to continue to operate that level, gradually increase through the remainder of the year.

Chi Chow – Macquarie

Okay. Great. And then on Bakersfield, is there any update on the situation with the pipeline access between Paramount and Bakersfield?

Paul Eisman

We’re continuing our dialogues. We have exchanged some documentation and so we’re moving that forward. But we don’t have any specific timing. But in the interim, we’re actually moving forward to initiate our, do the upgrades to the truck racks and the rail racks so we can, the pipeline will not be a pacing item. That’s more an opportunity item at this point.

Chi Chow – Macquarie

Okay. Great. Thanks a lot.

Jeff Morris

Thanks, Chi.

Operator

Thank you. And our next question comes from the line of Christina Cheng with Barclays Capital. Please go ahead

Christina Cheng – Barclays Capital

Good morning. Can you tell me if there was any meaningful inventory gain or loss by segment in the quarter?

Jeff Morris

Shai will address that for you.

Shai Even

Basically, inventories on the Big Spring, total impact of -- on the company was about $14 million positive for the quarter and about $16 million for the six months.

Christina Cheng – Barclays Capital

Can it is possible to break it up by refinery?

Shai Even

We have broken by refinery, we have about $2 positive in Big Springs, $1.50 on the Paramount refinery and negative $0.30 on the Krotz Springs.

Christina Cheng – Barclays Capital

Okay. And can you tell me the CMA benefit in the quarter?

Shai Even

Well, in the first quarter, I don’t have that.

Christina Cheng – Barclays Capital

Okay.

Paul Eisman

We have, listen, if I recall correctly, it was in the $2 range over the quarter. We have in May it was very high, it was over $4 for that month. But I think on average for the quarter, it was something over $2.

Christina Cheng – Barclays Capital

Okay. And can you just talk a little bit about Krotz Springs in the quarter, specifically the marginalization. Was there anything special in the quarter and how -- and around what time in June was Krotz operational?

Paul Eisman

Yeah. We actually started running crude to the refinery very late in the month of May, but averaged -- and we ramped it up during the month of June to where we averaged 60,000 barrels per day. Obviously, if you look at June, June was a startup month for us. So it’s not reflective of what we think the refinery will do in the long-term.

I mentioned in my comments that, the refinery has historically produced about 101.5% liquid volume recovery and of which 90% of gasoline and diesel. We did not do that in the month of June, but we’ve actually, as Jeff mentioned, made significant progress toward achieving those results in the month of August and expect to fully get there in September.

It’s an issue of optimizing our FCC, as you start up the units, you tend to beat up the catalyst a little bit and it takes a while to optimize the catalyst and get the yields to where they need to be in and the Krotz Springs refinery, the FCC operation is really key to yield structure of the refinery.

Christina Cheng – Barclays Capital

Do you have the liquids percent that were running in the second quarter?

Paul Eisman

Welsh in the month of June, the liquid volume recovery was 99% and our liquid -- our gasoline plus diesel yield was about 80%. So, obviously, we were not optimized in the month of June with the startup process. But we, as I said, we’ve significantly moved in that direction and there’s no reason we can’t achieve historical results in that refinery.

Christina Cheng – Barclays Capital

Okay. And just a couple balance sheet items. What was your market value inventory over book value and long-term debt?

Shai Even

The inventory (inaudible) book value by approximately $100 million.

Jeff Morris

Long-term debt is…

Shai Even

And we have total short-term debt of approximately $40 million.

Christina Cheng – Barclays Capital

Okay. Thank you.

Shai Even

Sorry, $50 million.

Christina Cheng – Barclays Capital

Thank you.

Operator

Thank you. (Operator Instructions) And our next question comes from the line of Evan Templeton with Jefferies & Company. Please go ahead.

Evan Templeton – Jefferies & Company

Hi. Thanks. I was wondering if you could clarify just on the Krotz production volumes. Just where you are now and I think you said 72, was that by the end of September, timeframe?

Jeff Morris

Right. That’s the net average for September.

Evan Templeton – Jefferies & Company

Okay.

Paul Eisman

We’re at 65 today.

Evan Templeton – Jefferies & Company

Okay. Great. That’s it. Thank you.

Operator

Thank you. And management, I’m showing no further questions in the queue. Please continue with any further remarks.

Jeff Morris

Thank you, Josh. Thank you to you for your interest and time, support and as I said earlier, we’re very encouraged about the direction that we’re going. Thank you again.

Operator

Ladies and gentlemen, that does conclude our conference call for today. Thank you for your participation and you may now disconnect.

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Source: Alon USA Energy, Inc. Q2 2010 Earnings Call Transcript

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