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Executives

Jeffrey S. Beyersdorfer – SVP, Treasurer and Director of Investor Relations

Gary R. Dalke – CFO

Mark J. Smith – President-Refining and Marketing

Analysts

Chi Chow - Macquarie Capital

Evan Calio – Morgan Stanley

Jeff Dietert – Simmons

Paul Sankey - Deutsche Bank

Jacques Rousseau - RBC

Ed Westwick – Credit Suisse

Ann Kohler – CRT Capital Group

Western Refining, Inc. (WNR) Q3 2011 Earnings Call November 3, 2011 10:00 AM ET

Operator

Good morning and welcome to the Third Quarter 2011 Western Refining Earnings Conference Call. After the speakers’ opening remarks, there will be a question and answer period. (Operator Instructions)

I would now like to turn the call over to Mr. Jeff Beyersdorfer, Treasurer and Director of Investor Relations of Western Refining. Mr. Beyersdorfer, please go ahead sir.

Jeffrey Beyersdorfer

Thanks, Melissa and good morning. I would like to thank you for taking the time to listen in today and for your continued interest in Western Refining. Again, my name is Jeff Beyersdorfer, I am the company’s Treasurer and Director of Investor Relations.

Joining me for today’s call are Gary Dalke, our CFO, Mark Smith, our President - Refining and Marketing and other members of our senior management team. Unfortunately Jeff Stevens, our President and CEO, has the flu and won’t be able to join us today.

Throughout the call this morning, we will be referencing our earnings call slides. The slide presentation, in addition to our earnings release can be found in the IR section of our website at wnr.com.

Before we proceed, I would like to make the following Safe Harbor statement. Today’s presentation will contain forward-looking statements and I incorporate and refer you to the forward-looking statement section of our earnings release and recent filings with the SEC.

We assume no obligation to update or revise any of these forward-looking statements to reflect new or changed events or circumstances. In addition to reporting financial results in accordance with Generally Accepted Accounting Principles or GAAP, we report certain non-GAAP financial results.

Investors are encouraged to review the reconciliation of these non-GAAP financial measures to the comparable GAAP results, which can be found in the press release, which is posted on the Investor Relations section of the website.

After my opening remarks, Gary will elaborate on our third quarter results and the actions that Western is taking to capitalize on the strong market conditions. Following Gary’s comments, we will open up the call for your questions.

As we stated in our press release and on page 3 of the slide presentation, we reported net income of $84.9 million or $0.94 per basic share and $0.81 per diluted share for the quarter ended September 30th, 2011. This compares to Q3, 2010 net income of $6.9 million or $0.08 per basic and diluted share. We mentioned both basic and diluted earnings per share due to Western’s convertible notes which are a potentially dilutive security.

The third quarter results include the impact of an $11.2 million realized loss and $94.6 million non-cash unrealized loss due to our hedging activity excluding the unrealized losses, earnings in the quarter would have been $146.4 million or $1.37 per diluted share.

We reported Q3, 2011 adjusted EBITDA of $202.3 million, which includes the realized and non-cash unrealized losses from hedging activity. This strong net income in EBITDA performance was primarily a result of a strong refining margin environment, which continues to be driven by the wide price spread between WTI and Brent crudes.

For the third quarter, the spread averaged $23.85 per barrel up $9 per barrel for the Q2 2011 average. The Gulf Coast 3-2-1 benchmark crack spread averaged more than $32 per barrel in the third quarter as compared to $8.57 in Q3, 2010 and $26.12 in Q2, 2011.

As shown on page 4 of our slides, our Southwest refineries benefited from the improved margin environment. Excluding the losses on hedging activity, El-Paso and Gallup gross margins increased by more then $17 and $16 per barrel respectively as compared to the third quarter 2010.

Our oil refining margins have come off in the last few days the fourth quarter has started off strong with an average Gulf Coast 3-2-1 in October with more then $30 a barrel. Our refiners continue to run well along as to capitalize on this margin environment. For now I’ll turn the call over to Gary.

Gary Dalke

Thank you, Jeff. Operationally, we had a very good quarter with El Paso and Gallup running near capacity. Overall total throughput averaged to approximately 150,000 barrels per day during the quarter. Also, during the third quarter we authorized construction of new facilities to receive additional quantities of Bone Springs and Avalon crudes which are logistically a yield advantage for the El Paso refinery. We will continue to evaluate opportunities, which will allow us to process additional barrels of local Permian crude.

Another key component of our strategy in this margin environment is our crack spread hedging activity. During the quarter, distillate and gasoline Gulf Coast forward cracks remained well above historical levels. We felt it was pretty need to add to our crack spread hedge positions during the quarter allowing us to lock-in the strong margins on a portion of our future refining production.

A summary of our hedge position as of September 30th can be found on page 5 of our slides. Our current strategy is to hedge up to 35% of our 2012 production and up to 20% of our 2013 and 2014 production.

In our retail business fuel volumes and merchandize sales increased due to the new locations that we added in Tucson in the second quarter. These sales gains were offset by slightly lower fuel and merchandize margins compared to Q3, 2010.

During October we added 34 retail sites through a long term lease arrangement. Most of these new locations were added in and around El Paso. These outlets will be a good addition to our retail group and will provide an integrated demand outlet for our existing Southwest refining in logistic assets. With these recent additions we currently have 206 retail locations.

Our wholesale business in the Southwest continues to perform well with fuel volume up 4.7% and lubricant sales up more than 10% compared to Q3 2010. These volume increases were offset by flat fuel margins and lower lubricant margins and as a result operating income was relatively flat compared to Q3 2010.

On the East Coast, our wholesale volumes were strong at more than 33,000 barrels per day. In Yorktown, we continued to work with interested parties regarding the potential sale of the terminal assets. As we have stated previously, we are working to maximize the value of these assets and we will update you with developments as appropriate.

Now, turning to the income statement, gross margin at our Southwest refineries was $20.51 per barrel during the third quarter compared to $11.19 per barrel in Q3 2010. If you exclude the unrealized losses on hedging, Southwest refining gross margin would have been $27.38 per barrel during that quarter.

El Paso’s direct operating expenses were $3.48 per barrel for the quarter, compared to $3.27 per barrel for Q3 2010. El Paso’s costs for the quarter included an increase in incentive compensation, which was offset by the receipt of approximately $5 million in insurance proceeds related to the February freeze amount and a $2.9 million property tax adjustment.

Gallup’s operating cost were $7.68 per barrel for the quarter compared to $6.21 per barrel in Q3 2010. The increased costs at Gallup were a result of increased incentive compensation and maintenance costs.

Total company SG&A costs were $27.2 million for the quarter, this compares to $23.7 million in Q3, 2010. The increase was primarily due to higher incentive compensation based on the approved financial performance of the company.

Adjusted EBITDA for the quarter was $202.3 million, included in EBITDA is $94.6 million in non-cash unrealized hedging losses which Jeff mentioned earlier. These non-cash unrealized losses are a result of the requirement to mark our future hedge positions to market pricing.

If the forward crack spreads are higher than the strike prices of our hedge positions, we are required to record an unrealized loss. Conversely, if the forward track spreads are lower than our strike prices, we record a gain. These daily mark-to-market calculations are made for all of our outstanding forward hedge positions which currently extend out through 2014, and a resulting unrealized gains or losses are reported at the end of each quarter.

As we shared last quarter, these unrealized gains or losses change each quarter and will flow through the income statement as these positions do not qualify for hedge accounting.

Depreciation and amortization expense for the quarter was $35.6 million. Interest expense was $33.2 million, a $3.9 million decrease compared to Q3 2010, primarily result of both lower average debt levels and interest rates. Our effective tax rate for the second quarter was 35%. Total capital expenditures for the quarter were $18.7 million.

Moving to the balance sheet, Western ended the quarter with approximately $1.06 billion in debt. As shown on page 6 of this slides, we generated a cash build of more than $229 million during the quarter and ended Q3 with approximately $403 million in cash.

Our resulting net debt at the end of Q3 was approximately $660 million. Debt reduction continues to be one of management’s primary objectives. We expect to continue to build cash from operations in the fourth quarter and be in a position to be down the floating rate notes when they become callable at mid December at a 105% of face volume. This will reduce our annual cash interest expense by more then $30 million.

A summary of our capital structure is available on Page 7 of our slides and you will note that total liquidity which we define as cash and availability under our revolver was approximately $697 million at the end of Q3.

Our liquidity continues to show improvement with the daily average liquidity for October coming at approximately $810 million, an increase of approximately $220 million compared to the Q3 daily average.

As we previously disclosed during the quarter, we emended our revolver to increase commitments to $1 billion, extend the maturity through September of 2016 and reduce the interest rate by 50 basis points. Assuming historically usage under the revolver, this should reduce interest expense by approximately $2 million annually.

You can find fourth quarter operating guidance on Page 8 of our slides. I would like to mention two items regarding guidance. At Gallup given the strong margin environment, we are taking the opportunity to perform some additional discretionary maintenance to further increase the reliability of the refinery. These causes were reflected in our guidance for Gallup’s operating expenses.

In terms of Cap Ex, we have modestly increased our full year projection to incorporate some additional regulatory spending at the Gallup refinery.

Wrapping up, we are pleased with our performance during the quarter. We remain encouraged about the business environment and the opportunities that we have as a company. I would like to thank our employees for their hard work and continued focus on safety, reliable and cost. With this focus and the outstanding margin environment, Western is well positioned going forward. Melissa, we will now open up the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from Chi Chow of Macquarie Capital.

Chi Chow - Macquarie Capital

Good morning. Thanks everyone. Hey Gary, you mentioned that East Coast wholesale volumes are strong, does that include any third-party activity at the Yorktown terminal, is it just all internal?

Gary Dalke

That’s all internal. That’s the volume that we purchased from third-parties and sell to our customers, so that was all internal.

Chi Chow - Macquarie Capital

Okay, right. Are you seeing any third-party activity yet at the terminal?

Gary Dalke

No, not at this time.

Chi Chow - Macquarie Capital

Okay. Given the East Coast refinery closures or maybe even contemplated closures upcoming, does that change the value proposition at all on the refining assets at Yorktown?

Gary Dalke

Well, too right, that we’re focused on maximizing the terminal, the value of the terminal, I guess. The process is not going relative to that process and beyond that I really can’t comment at this time. But we do continue to monitor our assumptions that we use in terms of restarting and planning operations and that’s about all I can say.

Chi Chow - Macquarie Capital

Okay. Could you remind me if you potentially sell the terminal, you keep the refining assets is that correct? And also, how did the environmental liabilities work with the potential sale as terminal?

Gary Dalke

I really can’t comment on this specific sort of transaction at this point, Chi.

Chi Chow - Macquarie Capital

Okay.

Gary Dalke

But it’s appropriate, we’ll provide details.

Chi Chow - Macquarie Capital

Okay. I’m going to try one more here on just use of cash, I don’t know if this premature yet, but looks like you’ve got balance sheet improvements coming very soon here. Are you contemplating any additional options for use of cash now that you’ve got the level of debt reduction insight?

Gary Dalke

Well, as we’ve said, our first priority is debt reduction, so once we get to our target that levels, which we believe would be in the $500 million or $600 million total debt outstanding. We may potentially look at higher return capital projects, we have them on the board but nothing specific I can comment on at this point.

Chi Chow - Macquarie Capital

Okay, all right. Thanks Gary, appreciate it.

Operator

Your next question comes from Evan Calio of Morgan Stanley.

Evan Calio – Morgan Stanley

Hey, good morning guys.

Gary Dalke

Good morning.

Evan Calio – Morgan Stanley

May be make some follow-up on cheese question, is there an existing transloader rail facility at your Yorktown site and how does that impact value. I mean, now you -- I know, at least as you think about the refinery you used to run a heavier slate there as well, given rail volumes logistics and pricing, I mean, are there scenarios in which that refinery has value in your view?

Gary Dalke

I will ask Mark to respond to that.

Mark Smith

Hi Evan, as the refinery operated it was all water-borne crude receipts and obviously there is a rail infrastructure in place and potentially that could be contemplated in future operations.

Evan Calio – Morgan Stanley

All right. But, I mean, is there any way to run a lighter slate at a lower level if you wanted to run lighter suite crude that you’d get derail?

Mark Smith

Well, Yorktown is a heavy crude refinery and frankly its economics were primarily driven by the heavy light spread and we have not evaluated the light crude opportunity in Yorktown.

Evan Calio – Morgan Stanley

Can you breakout the current EBITDA from the terminals?

Mark Smith

No. At this point in time, we cannot.

Evan Calio – Morgan Stanley

Okay. Then let me make a follow-up also on the cash question given last night’s Gary William’s acquisition. What are your thoughts to potentially buying assets or did you look at that asset versus return of focusing on your assets or return of capital to shareholders, how do you weigh those two options?

Mark Smith

So really our focus and first priority right now is on debt reduction and beyond that we do not really comment on any potential M&A activity.

Evan Calio – Morgan Stanley

Okay. Can you guys quantify the changes that allow you to receive more Bone Spring or Avalon crudes?

Gary Dalke

I will ask Mark to handle that one.

Mark Smith

Sure. Today we are in the process of developing and implementing some tag age and receiving capability on our basin station and we are looking at putting in the ability to receive up to 40,000 barrels a day of crude from that region. We see some good value in that crude both from a yield perspective there are refinery and obviously things are close to our refinery, they are logistically advantaged. That’s our current plan.

Evan Calio – Morgan Stanley

Good. Thanks guys.

Operator

You next question comes from Jeff Dietert of Simmons

Jeff Dietert – Simmons

Good morning.

Gary Dalke

Good morning, Jeff.

Jeff Dietert – Simmons

You’ve started your hedging program and locked in some attractive cracks on distillate and gasoline. As you look into 2013, 2014 you focused on distillate crack hedging which obviously there are more attractive levels available in the marketplace on distillates and gasoline. But as you think about distillate demand and strength there and declines in the inventories and strong exports of distillates. You know, that product is pretty strong where as gasoline demand is pretty weak. And I was just curious what your thoughts were on hedging gasoline in 2013, 2014 in addition the distillate side?

Gary Dalke

I’ll ask Mark to respond to that.

Mark Smith

Evan, today we have this distillate position in 2013 and 2014, and we’re just going to continue to monitor the gasoline and when we see value, you know we’ll pickup those cracks selectively, but at this point we have chosen not to do that.

Jeff Dietert – Simmons

Could you talk about El Paso third quarter throughput as well it was a little down from second quarter and down from the third quarter of 2010 as well. What contributed to the lower volumes and what are your expectations for fourth quarter volumes at El-Paso?

Mark Smith

There were two factors driving that and the comparison I’ll make is to third quarter of the last year. And our total throughput was down by about 8,000 barrels a day. And there were two factors that drove that, first was, we’re not buying outlet on the Gulf Coast previously we use to buy outlet to blend the Arizona grades of gasoline. And in the last year we built Benzene Saturation unit that given some of the equipment there we were able to make that Arizona grade without blending imported outlet. So, the exchange was about 3500 barrels a day, but economically it’s a very good trade. And then in the third quarter we did have reliability issues primarily related to external power failures, on July 26th, we had a power failure and a lightning strike that damaged some electrical equipment and caused a series electrical outages at El-Paso and probably on the quarter cost us 3000 barrels a day as a result, so that will be the explanation for the change quarter-over-quarter.

Jeff Dietert – Simmons

Fourth quarter rounds are looking more like 130,000 barrels a day or something like that?

Mark Smith

Hedges refer back to our guidance in the slides.

Jeff Dietert – Simmons

Yeah, very good. Thank you.

Operator

Your next question comes from Paul Sankey of Deutsche Bank.

Paul Sankey - Deutsche Bank

Hi, good morning everyone. You referenced that margins have come back a bit recently on average, a bit of short term question. But, is something changing there fundamentally that we should know about or is it just noise? Thanks.

Gary Dalke

I will ask Mark to respond to that?

Mark Smith

I think, it’s just a seasonal change in the gasoline crack and if you look over the past two weeks, I think the gas crack on the Gulf Coast is down about $8 and diesel down about $5 and I just think its validation or hedging program frankly.

Paul Sankey - Deutsche Bank

Yeah, sure. Just a brief follow up, which I always ask you guys about the demand that you’re seeing particularly from your exposure to train and you know, just generally what you’re seeing in your markets and I will leave it there? Thank you.

Mark Smith

Yeah, this is Mark Smith. I think, on gasoline, our markets in the Southwest are probably following the national trend. But in particular, we see the mining, diesel volume as being strong, truck and rail probably being flat in our market and I think there will be a comment there.

Paul Sankey - Deutsche Bank

Okay, thanks a lot.

Operator

Your next question comes from Jacques Rousseau of RBC.

Jacques Rousseau - RBC

Good morning.

Gary Dalke

Good morning, Jacques.

Jacques Rousseau - RBC

Just wanted to see if you could provide us some data on the cost associated with your account still, I know, there had been a number of smaller items in terms of idling cost, enclosure cost that you guys have been paying the last few quarters. And I was just curious on what happened in the third quarter and then the outlook for the subsequent quarters? Thanks.

Gary Dalke

Okay, yes, in terms of what we incurred in the third quarter regarding onetime cash cost which was primarily related to tank cleaning was about $2.1 million and we had our normal ongoing costs related to the idle refinery that was about $3 million and the ongoing cost of operating the terminal assets for our benefit was about $6.5 million.

In terms of looking at future quarters, we would estimate in fourth quarter and maybe some of that goes into the first quarter of next year about another $5 million in tank cleaning and onetime cash cost and then we also have whenever we finalize the termination of the pension plan related to the Yorktown facility we would recognize expense of about $5.5 million that may or may not occur in the fourth quarter but that’s kind of what is out in front of us right now.

Jacques Rousseau - RBC

So, the terminal expense was that included in the wholesale segment?

Gary Dalke

Only a portion of that is allocated to the wholesale segment based on their throughput but as you know we are continuing to ramp up and getting the terminal operations in full swing. So, a small part of that gets allocated the wholesale, I think it was about $1.3 million in the quarter.

Jacques Rousseau - RBC

Okay, so, all in somewhere around $10 million of costs for Yorktown in the quarter?

Gary Dalke

Yeah, $10 million or $11 million, about $11 million.

Jacques Rousseau - RBC

11 okay, great. And any thoughts on the 2012 capital budget?

Mark Smith

This is Mark Smith. Our budget is still under development. Our expectation for 2011, as we will spend about $74 million and kind of in general we probably see more discretionary spending in 2012, we have some good opportunities, we have a turnaround in Gallup in the fall.

And so, we think we have some good projects there, some payout projects. So, I would say, we expect that the capital budget to be somewhat higher in 2012 and having a higher percentage of discretionary type projects. But again, it’s subject to board approval.

Jacques Rousseau - RBC

Thank you.

Operator

(Operator Instructions) Your next question comes from Ed Westwick of Credit Suisse.

Ed Westwick – Credit Suisse

Yeah, good morning everyone. Just on Yorktown you say you are continue to monitoring spreads to see whether it’s make sense to bring it back into production. Just, can you confirm that you also, keeping all the options open in terms of, if a third party wanted to buy that complex, East Cost asset?

Gary Dalke

Well, we continue to be focused on maximizing the value on the terminal assets right now and process is ongoing and I don’t know that I can really provide any color beyond that at this point.

Ed Westwick – Credit Suisse

Okay, thank you and then just on the Permian, I mean, you have given some good volume guidance but, as you run it through your LP, how much sort of dollar per barrel uplift, say against WTI purchasing cost would give you?

Mark Smith

Ed, this is Mark Smith. I would be reluctant to actually quote a number on. We see good value in those crudes, but since we negotiated in the market for those crudes, I would be reluctant to say what I think the value is.

Ed Westwick – Credit Suisse

Would you be able to give a range or order of magnitude?

Mark Smith

No, I think, we are looking at, you know, a number of different crudes. So, I really can’t give guidance on that.

Ed Westwick – Credit Suisse

And, then a final follow up from nearly a question on Gallup, in terms of spending more money, presume that might be to sort of expand capacity of Gallup given that to the extent that you can given the quick discounts in the region?

Mark Smith

Yes, as I have mentioned we have a turnaround in the fall of 2012 and we are looking at several expansion of projects there both on the crude and the FCC and we are developing those projects now.

Ed Westwick – Credit Suisse

Would you be able to -- it’s a 20% expansion or 25?

Gary Dalke

I think, we said in the past that it’s more like a 10% expansion.

Ed Westwick – Credit Suisse

Okay. Great, thanks very much.

Operator

Your next question comes from Ann Kohler of CRT Capital Group.

Ann Kohler – CRT Capital Group

Good morning gentleman. Just a question on the stores that were added in the quarter. Could you just give a little bit more detail in terms of how the volumes and the merchandize sales compared to the stores in your system already?

Gary Dalke

During the quarter we added a little bit of volume, I don’t have the specific numbers in front of me, but it did add some volume. We had some startup costs related to those units. But, as the stores mature we should expect to see some of the results at those new units that we see in rest of our outlets.

Ann Kohler – CRT Capital Group

Great. Thank you.

Operator

Your next question is a follow-up from Chi Chow of Macquarie Capital.

Chi Chow – Macquarie Capital

Great, thanks. Just a follow up on Gallup, you mentioned a couple of times some discretionary maintenance going on here in the current quarters and maintenance issues last quarter, regulatory spending what not. Are there, you were heading into some sort of operating limitations or problems there?

Gary Dalke

I will ask Mark to handle that

Mark Smith

No, actually Gallup had a fantastic quarter on reliability, but we just said with the margin environment that we are seeing we’ve done a number of repairs and some of them have been relatively large repairs like replacing the foundation on a compressor that sort of things. So, we have just taken the opportunity when the margins are good to spend a little extra money on reliability of land. But, all-in-all planned, I think it had its best quarter ever operationally.

So, we are very happy with that and obviously in this margin environment, I think it’s a pay for itself.

Chi Chow - Macquarie Capital

Great, that’s good to hear. And then with the retail expansion, what sort of, can you give like a percent integration on between refining and marketing nature plants now as far as ratable optic to your retail system?

Mark Smith

Well, as we said in the past year about 70% of the volume in Gallup goes into our retail operation and on lot of the business that we have acquired in the El Paso area, we were already supplying that volume. So, we think at El-Paso maybe 30% of the volume ends up in our stores.

Chi Chow – Macquarie Capital

Okay. Great, thanks Mark, I appreciate it.

Operator

That was your final question. I’d now like to return the call to Mr. Gary Dalke.

Gary Dalke

Thank you for your participation in today’s call and your continued interest in Western Refining. We look forward to talking to you next quarter. Thank you.

Operator

Thank you that concludes today’s third quarter 2011 Western Refining earnings conference call. You may now disconnect your lines at this time and have a wonderful day.

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