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Western Refining Inc. (NYSE:WNR)

Q4 FY07 Earnings Conference Call

February 28, 2008, 11:00 AM ET

Executives

Mark B. Cox - Sr. VP, Treasurer, Director of IR

Paul L. Foster - President and CEO

Mark J. Smith - EVP - Refining

Jeff A. Stevens - EVP

Gary R. Dalke - CFO

Analysts

Jeff Dietert - Simmons & Company International

Daniel Vetter - J.P. Morgan

Ann Kohler - Caris & Company

Chi Chow - Tristone Capital Inc.

Operator

Good day ladies and gentlemen welcome to the Fourth Quarter 2007 Western Refining Earnings Conference Call. My name is Maria and I will be audio coordinator for today. At this time all participants are in a listen-only mode and we will be facilitating a question-and-answer session towards the end of today's conference. [Operator Instructions]. As a reminder this conference is being recorded for replay purposes. I would now like to turn the presentation over to Mr. Mark Cox, Treasurer and Director of Investor Relations. Please proceed.

Mark B. Cox - Senior Vice President, Treasurer, Director of Investor Relations

Thank you, Maria. Good morning every one. I would like to thank you for taking the time for listening today. As always we appreciate your continued interest in the Western Refining. My name is Mark Cox and I am the Company's Treasurer and Director of Investor Relations. Today we will be discussing our fourth quarter and full year 2007 financial and operating results.

Joining me for today's call are Paul Foster, our CEO, Gary Dalke, our CFO, Jeff Stevens, our Executive Vice President, Mark Smith, our Executive Vice President Refining and other members of our senior management team. If you need a copy of the earnings release you may obtain one from the Investor Relation section of our website at www.winr.com.

Today's presentation contains forward-looking statements and I incorporate and refer you to the forward-looking statements section of our earnings release and most recent fillings with the SEC. we assume no obligation to update or revise any 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, and on the Investor Relation section of our website.

At this time I would like to turn the call over to Paul.

Paul L. Foster - President and Chief Executive Officer

Thank you, Mark. I would also like to thank each of you for taking the time to listen in today. Let me begin by saying I am very proud of our record earnings in 2007. We have reported record annual earnings for two consecutive years since going public in January of 06. Our increased earnings in 2007 were primarily the result of higher refinery gross margins and increased refinery throughput at El Paso.

Our financial performance in the fourth quarter of 2007 was adversely impacted by rising crude oil prices throughout most of the quarter. This increase in feedstock cost coupled with softness in finished product prices particularly in gasoline and lower value products such as asphalt, resulted in lower refining margins for the quarter. In addition, to normal seasonal factors, the refining margins we realized in our Southwest markets were negatively impacted by a delay in the capacity expansion and restart of the Kinder Morgan pipeline.

Due to this delay finished products that would normally have been shipped on that pipeline to Tucson and Phoenix was stranded in El Paso. This over supply situation in El Paso depressed margins to the point that the 3/2/1 crack in El Paso was roughly even with the Gulf Coast, where in a normal market, we would expect to see margins in El Paso at $3 to $4 above the Gulf Coast.

Higher operating expenses also impacted earnings in the quarter. In the fourth quarter we incurred expenses associated with planned and unplanned outages at our refineries. At Yorktown we had a planned shutdown on the crude unit at the end of October. And an unplanned outage on the Coker in December. Gallup in El Paso also had unplanned outages in the fourth quarter. During the fourth quarter we expensed approximately $13 million as a result of these outages and other one time expenses. In addition, to direct cost, these outages reduced our gross margin in the fourth quarter as a result of lower crude throughput and reduce high value product recovery.

At Yorktown, we estimate that our gross margin would have been approximately $20 million higher in the quarter if the refinery had operated at current levels of crude oil throughput and produced the current level of finished products. In the Southwest, we estimate that the combined gross margin impact of refinery outages and the Kinder Morgan delay totaled approximately $10 million.

I am very pleased with the progress we have made since acquiring Giant in May of 07. The changes we have made at the former Giant refineries, improve safety and reliability and have also allowed us to increase crude oil throughput. In terms of safety and reliability, we replaced refinery managers and other key staff at the Yorktown and Gallup refineries to instill Western's operating practices. The nearly hired plant managers each bring 30 plus years of refining experience.

We have also hired a corporate process safety management leader to continually foster our culture of reliable and safe operations. As a result of the performance improvement initiatives implemented throughout the second half of 2007, the Yorktown refinery is currently operating at approximately 70,000 barrels per day of crude throughput which is an increase of approximately 8000 barrels per day or about 13% above historical rates. We have significantly improved the utilization of the Coker at Yorktown.

Coker operations have improved to 21,000 barrels per day, an increase of about 17% over historical levels. These higher Coker rates will allow us to process a heavier crude slate at Yorktown and improve the gross margin. We have also improved operations at the Four Corners refineries as we were able to demonstrate crude oil throughput capacity in excess of 40,000 barrels per day early in the fourth quarter. Given the historically strong margin environment in the Four Corners area throughout the high demand, spring and summer months this increased crude throughput capacity should result in a significant financial contribution.

In addition, to the improvements we made in our recently acquired assets we also continue to achieve strong operating performance in 2007 at our El Paso refinery. Total refinery throughput in El Paso increased for the fifth consecutive year to its current level of approximately 134,000 barrels per day. I am optimistic about the remainder of 2008 the DuPont SAR project at the El Paso refinery is currently in the startup phase. Processing of acid gas has begun and we'll begin raising sour crude runs from approximately 10% to 20% of crude throughput at the refinery in the very near future.

Work is continuing on the low sulfur gasoline project at El Paso. Completion of this project is anticipated to be in the second quarter of 2009 at which time we will have the ability to raise our sour crude runs up to 50% of crude oil throughput at the refinery. At Yorktown refinery we will complete the low sulfur gasoline project in the next few weeks. This project is expected to provide several financial benefits. One benefit will be a reduction in freight cost as we will market additional low sulfur gasoline in local markets and over the refinery rather than have it and move it along the East Coast to other markets.

Additionally because the unit is oversized we believe we will have the opportunity to purchase discounted high sulfur gasoline process it in this unit and upgrade it to low sulfur gasoline. We estimate that we can bring in 6000 to 8000 barrels per day of high sulfur gasoline. And depending upon market conditions we can generate a margin of $4 to $8 a barrel as a result of this gasoline upgrade. Finally, this unit will increase our ability to process additional lower cost crude oil at Yorktown.

We are taking a number of significant steps to improve gross margins in all our refineries. We are in the process of negotiating and/or terminating several feedstock agreements. For example, in early 2007 Giant entered into a fixed price ethanol supply agreement for all three of its refineries. This contract was recently terminated and we estimate based upon ethanol spot market prices in the fourth quarter, that we could reduce ethanol cost by approximately $7 million per year at these facilities.

At the Four Corners refineries we are also taking steps to reduce feedstock cost as supply contract either expire or we have the right to terminate and reopen negotiations. Our 2008, budget contemplates much lower operating expenses at our refineries. We believe that the numerous investments we have we made in our refineries in 2007 will result in more efficient lower cost operations as we go forward. Energy cost are a major component of the overall cost structure in refining, and we are working on number of initiatives both in Gallup and in Yorktown to improve our energy efficiency.

In addition, to reducing operating cost in the refining group we have identified approximately $15 million of annual corporate overhead cost reductions in comparison to the 2007 combined level. This savings coupled with earnings contribution that will be generated as a result of the increased throughput and the reduction of feedstock cost will produce synergies well in excess of the $20 million that we believe that was initially attainable.

Now let's look at the first quarter. Refining margins remained soft throughout the month of January. We have recently began to see, marked improvement in margins throughout our markets as these supplies remain tight and the demand for gasoline has begun to increase as we approach the spring and summer driving seasons. In addition, to the improvement in the Gulf Coast margin, we have seen return of the El Paso and Southwest markets to a more normal margin environment relative to the Gulf Coast. And we anticipate much stronger asphalt pricing as we approach the spring and summer season.

Now, I would like to provide our guidance measures for 2008. We expect crude oil throughput in our four refineries to be approximately 211,000 barrels per day in the first quarter, and about 218,000 barrels per day for the year. We expect total refinery throughput in our four refineries to be approximately 235,000 barrels per day for the quarter, and 247,000 barrels per day for the year.

In the first quarter we expect operating cost to be approximately $396 per barrel at El Paso, $650 per barrel at the Four Corners refineries and $460 per barrel at Yorktown refinery. We expect corporate SG&A in the first quarter to be approximately $25 million, interest expense will be about $21 million, and depreciation and amortization will about $26 million for the quarter. We expect our tax rate to be 33% for the quarter. After completing our budgeting process we are now in a position to provide CapEx guidance for 2008, we believe that capital expenditures in 2008 will be approximately $197 million as significant portion of this spending will be for low sulfur gasoline unit in El Paso.

I would like thank all of our employees throughout the company for their hard work and their dedication to safety. We have a number of projects underway at all of our refineries and safe reliable operations along with environmental stewardship, continue to be our to top priorities. I thank you again for listening, we will now open up the call for questions. Maria we are ready for questions.

Question And Answer

Operator

[Operator Instructions]. Your first question comes from the line of Jeff Dietert with Simmons. Please proceed.

Jeff Dietert - Simmons & Company International

Good morning, Paul.

Paul L. Foster - President and Chief Executive Officer

Good morning.

Jeff Dietert - Simmons & Company International

You talked about at Yorktown having better operations of the Coker and the low sulfur gasoline project completing this quarter, could you talk to us about what your crude slate was in 2007 and how you expect that to change in 2008 with these improvements?

Paul L. Foster - President and Chief Executive Officer

Well one thing... this low sulfur gasoline project gives us the capability to look at a lot of different crudes that we haven't really been able to look at in the past. Going forward... we are starting to experiment with several different crudes. In the past we were not really limited but we... I guess self limited ourselves to just run in a couple of different crudes and I think more than anything else what it does is just give us some capability there to pick and choose based on whether its economics or operations and whatever is working best for us.

Jeff Dietert - Simmons & Company International

Can you remind me what the Statoil contract how much volume that is for the you said it accrued?

Mark J. Smith - Executive Vice President - Refining

This is Mark Smith. The contract volume for the Statoil crude is 40,000 and I just would like to add to Paul's comment that our ability to run the corporate at a higher rate has really allowed us to bring all that incremental crude in the second half of the year as heavy crude.

Jeff Dietert - Simmons & Company International

Very good. Second topic, I was wondering if you could talk about diesel production, diesel yields, a lot of your capital projects are aimed at feedstock flexibility but diesel spreads have been wide and I was wondering what you have done, what you could do to improve diesel yield?

Paul L. Foster - President and Chief Executive Officer

Well we're obviously, I guess like everybody else focused on maximizing diesel at all of our facilities, our low sulfur gasoline, or low sulfur diesel units are all operating very well and we continue to focus on that, we continue to work our vacuum towers and pull all the diesel out that we possibly can. Obviously, in every barrel of crude you have gasoline and diesel and we're trying to get as much of both of them as we can. But we have recognized that the trend continues to indicate that the big value is going to be in diesel.

Jeff Dietert - Simmons & Company International

Any low CapEx, short lead time projects that could improve the diesel yield?

Mark J. Smith - Executive Vice President - Refining

Jeff this is Mark Smith, at Yorktown, we've been able to exploit the existing diesel unit and we have been able to produce in excess of 20,000 barrels a day of ULSD at Yorktown which is essentially doubled the capacity of the unit that we build. So we feel like we've been very successful in the second half of the year pushing ULSD at Yorktown.

Jeff Dietert - Simmons & Company International

Thank you, for your comment.

Paul L. Foster - President and Chief Executive Officer

Thank you, Jeff.

Operator

Your next question comes from the line of Daniel Vetter with J.P. Morgan. Please proceed.

Daniel Vetter - J.P. Morgan

Good morning.

Paul L. Foster - President and Chief Executive Officer

Good morning.

Daniel Vetter - J.P. Morgan

I was hoping you could talk about your priorities for uses of cash I know that you have got a debt load on your balance sheet and you have got some regulatory projects left to complete I am just wondering how much discretionary cash you are going to have in the next year or two to pursue strategic projects?

Paul L. Foster - President and Chief Executive Officer

Well I will ask Mark Cox to come in on that I will tell you that in general our... the way we prioritize cash is obviously regulatory safety and environmental projects are at the top of list and have to done. We feel like that we've structured our balance sheet and our company to be in a really good position from a debt standpoint in a cash requirement standpoint. Mark do you want to address sort of our cash?

Mark B. Cox - Senior Vice President, Treasurer, Director of Investor Relations

Sure, yes, Dan I think as Paul said when I think first of all when we look at CapEx we do assume regulatory CapEx, we even do refer to the low sulfur gasoline project here in El Paso I think that's one of our top priorities in 08 we will be looking at that also as well, the first half of 09, looking at growth type projects I think we are trying to evaluate still the Giant assets and see what the opportunity is there or I think we look specifically in Yorktown to see what type of projects maybe available there and then we are also looking at some growth CapEx as well in the retail and the wholesale side. Debt reduction as you can appreciate continues to be more of a high priorities we are looking at opportunities to reduce working capital to squeeze cash out of that to use in the form debt reduction but as Paul said we think that the balance sheet is pretty well structured right now.

Daniel Vetter - J.P. Morgan

Thank you.

Paul L. Foster - President and Chief Executive Officer

Thank you.

Operator

[Operator Instructions]. Your next question comes from the line of Ann Kohler with Caris Company. Please proceed.

Ann Kohler - Caris & Company

Good morning, gentlemen, just a couple of questions, a follow-up on the cash priorities and the regulatory spending could you just walk us to the other regulatory and I guess I think you have some consent degrees, the capital requirement here over the next couple of years beyond this year and the El Paso low sulfur gasoline?

Paul L. Foster - President and Chief Executive Officer

Yes, Mark Smith is going to answer that.

Mark J. Smith - Executive Vice President - Refining

Ann, we expect to spend about $120 million in 2008 on low sulfur gas projects. It's about $100 million in El Paso and $20 million early in the year to finish up the project at Yorktown. The balance of our CapEx budget in refining is about $30 million and that is smaller regulatory projects. There is some consent degree work which totals about $10 million in El Paso for NOx reduction projects, and some amounts of sustaining capital with a turnaround in El Paso in the fall. Going into 2009, we have I think about $30 million to $40 million that carries over on those low sulfur gas projects, to complete those.

Ann Kohler - Caris & Company

Great and then... is there anything left on any of the other consent degrees?

Mark J. Smith - Executive Vice President - Refining

Yes there is a potential scrubber project up in Gallup that is on the order of $25 million that's in our program that will be the most significant piece of the regulatory program.

Ann Kohler - Caris & Company

Great, and then kind of changing gears here could you just give us a little bit of detail on what you are seeing in your retail as well as in the wholesale in terms of demand particularly in the retail side, same-store sales for gasoline and merchandise?

Paul L. Foster - President and Chief Executive Officer

I will ask Jeff Stevens to answer that.

Jeff A. Stevens - Executive Vice President

Yes, Ann we are seeing kind of a mix bag around the region. I would say that retail in the New Mexico area has remained pretty constant and pretty typical normal growth, we have seen a little bit of slowdown in the Tucson market. There's no question that the Arizona market has been impacted by the housing situation. So we have seen a little decline in the Tucson market but in the New Mexico and the Four Corners we are the primarily a retail is, we are seeing pretty standard growth both on the fuel and the merchandise side.

Ann Kohler - Caris & Company

Great, and how about on the wholesale?

Jeff A. Stevens - Executive Vice President

Pretty much the same thing, we have seen that the Phoenix and Tucson markets softened particularly, the home builders and construction. But on the flipside there's been some increased volume in both rail, road in mining particularly in the New Mexico El Paso region remains pretty constant and pretty good. So, really that the softness is relative to the Arizona market.

Ann Kohler - Caris & Company

Okay great, thank you so much.

Paul L. Foster - President and Chief Executive Officer

Thanks Ann.

Operator

Your next question comes from the line of Chi Chow with Tristone Capital. Please proceed.

Chi Chow - Tristone Capital Inc.

Good morning.

Paul L. Foster - President and Chief Executive Officer

Good morning.

Chi Chow - Tristone Capital Inc.

I was wondering looks like you ran a lot of other feedstocks and blend stocks this quarter, could you give us some detail on what you run up in that category?

Paul L. Foster - President and Chief Executive Officer

Yes, maybe somebody else can pull up some actual numbers here but I don't think we did anything unusual in the quarter these extra feedstocks and blend stocks typically are isobutanes and we're bringing in to run the alky units. Ethanol that we used to blend in the winter time so maybe if you are looking at fourth and first quarters versus second and third, you have more ethanol. We also bring alkylate in by pipeline to El Paso and normal butane to the various refineries to blend with gasoline. But I don't think there's anything that we've done that's out of the ordinary in this quarter. Is that okay. I am kind of looking for nodding heads and I am getting on that I think everything we did was pretty much normal operations for us.

Chi Chow - Tristone Capital Inc.

Okay, so... I guess first quarter and fourth quarter exist more of an ethanol situation?

Jeff A. Stevens - Executive Vice President

Yes Chi this is Jeff Stevens. The only change as we did bring in some additional probably brought in a little additional alkylate ahead of the Kinder Morgan expansion to be able to make more of the Phoenix grade gasoline.

Chi Chow - Tristone Capital Inc.

Great, and then secondly as far as debt levels, do you have a target that to cap at your looking to get to by say year end 08?

Paul L. Foster - President and Chief Executive Officer

Gary Dalke will address.

Gary R. Dalke - Chief Financial Officer

Yes, in terms of our debt metrics we look at debt to total EBITDA as a metric and we are comfortable on the two to three times range and right now we're in the middle of that range. In terms of debt to total CapEx it's at the time of the acquisition that was a little higher than we would normally see but that's due to the nature of the fact that we are relatively a young company and our equity hasn't increased much. Over time we would certainly see that percentage push down but the primary metric we focus on right now is debt to total EBITDA and it's within the two to three times comfort range right now.

Chi Chow - Tristone Capital Inc.

Okay, and then maybe a final question, could you give us some sort of guidance on the hedging the inner log [ph] and is there some way to estimate that going forward here?

Gary R. Dalke - Chief Financial Officer

Yes, Chi in the fourth quarter as Paul mentioned, we had kind of an unanticipated shut down of the Kinder Morgan line and that created us to build some inventories both crude oil and finished products that we didn't anticipate. We want to have and put an economic hedge on because we knew that we wouldn't either be able to sell that product or process that crude for the next 60 to 90 days. So that primarily was a mark-to-market in the fourth quarter since then we've got our inventories back to what we would call a normal level and that hedge has been taken off and a large percentage of that has come back to us in the first quarter.

Chi Chow - Tristone Capital Inc.

Okay, great. Thanks a lot.

Paul L. Foster - President and Chief Executive Officer

Thank you, Chi.

Operator

At this time I will now turn the call over to Mr. Paul Foster for final remarks.

Paul L. Foster - President and Chief Executive Officer

All right I just want to thank you all for listening in today. As, I said we are very positive about 2008 in the direction we are going and the assets that we have in our portfolio and we look forward to a great year. Thank you.

Operator

Thank you, for your participation in today's conference. Ladies and gentlemen, all parties may now disconnect. Have a great day.

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Source: Western Refining, Inc. Q4 2007 Earnings Call Transcript
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