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Delek US Holdings, Inc. (NYSE:DK)

Q2 2008 Earnings Call Transcript

August 7, 2008 11:00 am ET

Executives

Nole Ryan [ph] – Director of IR

Uzi Yemin – President and CEO

Ed Morgan – VP and CFO

Fred Green – VP and COO

Lyn Gregory – SVP

Analysts

Ben Brownlow – Morgan Keegan

Mark Miller – William Blair & Co.

Bryan Shore [ph]

Paul Cheng – Lehman Brothers

Jeff Dietert – Simmons & Co.

Operator

Good morning. My name is Ron and I will be your conference operator today. At this time, I would like to welcome everyone to the Delek US Holdings second quarter 2008 earnings conference call. (Operator instructions) Thank you.

Mr. Nole Ryan [ph], Director of Investor Relations, sir, you may begin your conference.

Nole Ryan

Thank you, Ron.

Good morning and welcome to the Delek US Holdings conference call for the second quarter 2008. Our host for today’s call is Uzi Yemin, President and Chief Executive Officer of Delek US. Joining Uzi on the call is Ed Morgan, Delek’s Chief Financial Officer. Other members of the management team will be available during the question and answer portion of the call.

As a reminder, this conference call may contain forward-looking statements as that term is defined under the federal securities laws. For this purpose, any statements made during this call that are not statements of historical fact may be 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 Delek’s filings with the Securities and Exchange Commission and its second quarter news release. As a result, actual operations or results may differ materially from the results discussed in the forward-looking statements. Delek undertakes 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 August 14, 2008, by dialing 706-645-9291. The confirmation number for the replay is 57361879. The replay may also be accessed for the next 90 days at the company’s website delekus.com or at www.earnings.com.

At this time, I will turn the call over to Uzi Yemin.

Uzi Yemin

Thank you, Nole.

Good morning and welcome to our second quarter 2008 conference call. During today’s call, I will provide high-level commentary on our performance in the second quarter followed by a progress update on our refining retail and marketing businesses. Ed Morgan, our CFO, will then provide a summary of our second quarter financial results. At the conclusion of our prepared remarks, we will open the call for questions.

Despite facing a number of macro economic headwinds during the second quarter, including volatile commodity pricing, a tight competitive climate and a cautious customer spending environment, each one of our three business segment reported positive contribution margins in the quarter. For the second quarter ended June 30, 2008, we reported net income of $4 million or $0.07 per fully diluted share or net sales of $1.45 billion compared with net income of $67.2 million or $1.29 per fully diluted share on net sales of $1.1 billion in the second quarter of 2007.

Our second quarter performance was negatively impacted by several factors including a 42.7% year-over-year decline in the 5-3-2 crack spread, high crude oil prices and increased operating expenses, primarily associated with higher natural gas cost. Second quarter results were positively impacted by a stronger distillate crack, continued margin benefit from the company‘s ethanol blending program which resulted in higher fuel margins, stable merchandise margins in addition to a $2.9 million pretax gain on the sale of a store operated by a third party.

In the three months ended June 30, 2008, we lowered our 2008 estimated ending inventory level which led us to recording a free tax gain of $12.5 million associated with a permanent reduction to inventory under LIFO accounting. This gain which was reflected as a reduction to cost of goods sold in our refining segment served to partially offset a mark to market pretax loss of approximately $13.2 million related to existing ethanol swap agreements. As you may recall, we ended the ethanol blending business in fall 2007 to take advantage of the discount at which ethanol was trading to gasoline.

At that time, we formulated a derivative trading strategy which figured the differential between ethanol and gasoline future stocks for the second half of 2008 and all of 2009. When combined with federal ethanol blending credit, this trading strategy looked locked in certain financial benefits from ethanol blending in each of our business segments. Ed will provide more color on this issue shortly.

During the second quarter, our refining and retail segment enjoyed continued margin benefit from ethanol blending as retail fuel margins increased $0.018 per gallon during the quarter due primarily to the ethanol blending program, while at the refinery we recognized a benefit of approximately $6 million for the same reason. Further impacting second quarter profitability was a $0.6 million loss resulting from our investment in Lion Oil.

Turning to our refining segment, although refining segment managed to remain profitable in the comparative operating environment, we faced several macro and company specific challenges this quarter which affected our results, most of which included the impact of higher commodity costs and lower utilization of the refinery. The refining margin adding back inter company marketing fees of $0.76 per gallon – per barrel, was $10.49 per barrel sold or 79.2% of the 5-3-2 crack spread compared to $24.06 per barrel sold or 104.2% of the 5-3-2 crack spread in the same period last year.

The refining margin was negatively impacted by several factors. First, the 5-3-2 declined 42.7% to $13.24 in the second quarter of 2008 when compared to the year ago period. Secondly, there was a 91% upward spike in the price of crude oil to $124.28 per barrel during the second quarter up from $65.06 in the year ago period. Third, during the second quarter, we realized a $6.1 million loss related to crude futures which we entered in order to protect the value of excess inventory in a volatile market. We sold these contracts in June 2008. Finally, for most of the second quarter, the crude futures market was in backwardation and decreased our refining gross margin by approximately $0.82 per barrel. So, towards the end of the quarter, the market moved back into contango for a period of time.

While we saw an increase in residual product prices during the quarter, they continued to lag behind the high cost of crude oil. We were able to partially offset the lagging pricing by producing high value products which composed 90.3% of our slate during the quarter, an increase from 87.9% last year. In addition in the month of June, we blended a record of 2,600 barrels per day of ethanol and ended the second quarter blending an average of nearly 2,400 barrels per day. This activity benefited gross margin by approximately $6 million in the quarter for this segment. All of this, along with the LIFO adjustment resulted in a realized margin of more $10 per barrel during the quarter.

In June, we completed our gasoline hydrotreater project on schedule and below target. As you all will recall, this project was performed in accordance with environmental compliance standards. With the completion of this project we’ve increased our national [ph] complexity from 7.9 at the time of acquisition to roughly 9.4 today.

Turning now to our retail segment, the total retail contribution margin in the second quarter 2008 was $20.2 million including the $2.9 million pretax gain on the sale of the third party operating side compared to $18.4 million in the year ago quarter. During the second quarter, same store retail fuel gallons sold declined 4%. However, we were able to increase our retail fuel margin from $0.158 per gallon in the second quarter of 2007 to $0.176 per gallon in the second quarter of 2008 due to benefits from the ethanol blending program.

Merchandise margin increased to 31.9% in the second quarter of 2008 up from 31.6% in the prior year period offset by a 3.1% decline in same store merchandize. Looking ahead, we believe the impact of ethanol blending and the recent decrease in the wholesale price of fuel should continue to positively impact fuel margins given the federal economy.

During June 2008, we successfully replaced a major fuel supply contract with Valero, our largest fuel supplier with new supply contract with multiple vendors, including Valero. We believe the new contract reduced our dependency on a large supplier and will have no significant impact on our operating profitability.

Also during the quarter, we completed the reimaging of an additional 25 stores in our Chattanooga market bringing our total number of reimaged stores to 48 or 9.6% of our – 97 locations. In the second quarter, we completed our newest store location in addition to two raze and rebuilds. The two raze and rebuilds were the first Mapco Mart (inaudible) location in Memphis and Chattanooga respectively introducing our new concept store in those markets. Overall, we are encouraged by the initial impact of our reimaging programs on store sales.

Results from the first 26 newly reimaged stores including the reimaged location we completed in the fourth quarter of 2007 have shown approximately 7% growth in merchandize sales and more than 10% growth in fuel sales for the three months ended June 30, 2008, compared to the same time period last year.

In our marketing segment, net sales for the quarter was $236.5 million, an increase of $55.3 million compared to $181.2 million for the second quarter of 2007. Barrel sales averaged 17,746 barrels per day compared to 20,000 for the same period last year. The contribution margin for the second quarter 2008 was $6.1 million compared to $9.3 million for the second quarter of 2007. On a trailing quarter basis, through June 30, 2008, the marketing segment has contributed $26 million in contribution margins with less than $1 million in capital expenditure required to support ongoing operations during the same 12 months.

In summary, although challenging economic conditions continue to impact our operations, we remain committed to our existing growth strategy which emphasizes one, organic growth through operation execution and disciplined expenses management, and two, the opportunistic acquisition of undervalued assets. We continue to remain selective in terms of how we allocate capital while seeking to remain conservative in managing our capital structure.

Next, I will hand the call to Ed Morgan to comment on our financial results for the quarter. Ed?

Ed Morgan

Thank you, Uzi.

As Uzi mentioned, I will begin today by discussing second quarter financial results at our segments in more detail and then briefly discuss our consolidated financial results for the quarter at the Delek US level.

Turning to our refining segment first, refining contribution margin for the quarter was $20.5 million compared to $95.1 million in the second quarter of 2007. For the three months ended June 30, we sold nearly 52,000 barrels per day, a decline of 3.8% when compared to the prior year period.

The decline in sales volume was the result of lower utilization at the refinery during the month of April due principally to unscheduled maintenance conducted on our DHT and Platformer. Other refinery utilization dropped to 79% in April as a result of this maintenance. Utilization improved in the later two months of the quarter from April levels.

Operating expense per barrel at the refinery increased more than 39% to $5.38 per barrel sold compared to $3.86 per barrel sold in the same quarter last year due primarily to increased natural gas costs associated with running our refinery. To put the full impact of the higher natural gas expense in context, natural gas per million Btus has increased more than 50% between the second quarter of 2007 and the second quarter of 2008. On an operating expense per barrel sold basis, utilities increased $1.02 to $2.16 per barrel sold in the second quarter of 2008 compared to the prior year quarter.

Looking at our retail segment, the second quarter retail segment contribution margins was $17.3 million compared with $18.4 million in the same quarter of 2007. Retail contribution margin was negatively impacted by increased credit card expenses resulting from higher credit card usage and higher average retail fuel prices in the period. This is illustrated by a 200 basis point increase in credit expense as a percentage of retail gross margin in the second quarter 2008, as compared to the year ago quarter.

Same store merchandize sales declined 3.1% in the second quarter due primarily to a decline in retail gasoline consumption. We’ve experienced a reduction in consumer trips which is primarily a reflection of higher fuel prices. Because we get out to you the typical sales lift brought about by select promotions on certain products, to improve merchandize margins, we chose to forfeit such promotions during the second quarter. The increases in merchandize margin was largely attributable to sales mix and pricing. Right now, Jason John Bubbahead [ph] with moustache would be a hot item.

Retail fuel margin increased 11.4% to $0.176 per gallon in the second quarter 2008 compared to $0.158 per gallon in the year ago period due primarily to the positive impact of ethanol blending. Unfortunately, retail gasoline gallons sold on a same store basis declined 4% during the second quarter as consumers reduced consumption amid a 31% year-over-year increase in retail price of gasoline. Our wholesale fuel business reported sales for the quarter of 8.2 million gallons compared to 8 million gallons sold for the same quarter year ago. We did realize a margin of $0.10 a gallon on these wholesale gallons.

Now turning to our consolidated financial results, our general and administrative expenses for the quarter decreased approximately 9% to $12.6 million primarily as a result of a one time decrease related to reversals of 2007 incentive compensation accruals. Depreciation and amortization expense was $2.8 million at the refining segment 700,000 at marketing and supply and $5.7 million at our retail segment. On a consolidated basis, depreciation and amortization was $9.2 million, an overall increase of $1.2 million compared to the second quarter of 2007.

This year-over-year increase was mainly driven by capital project at the refinery that were brought on line during 2008 in addition to discretionary spending in the retail segment related to several raze and rebuild projects.

Our expected effective tax rate for 2008 is 36.4%. The increase in 2008 tax rate is related to the loss of certain benefits pertaining to the sale of ultra low sulfur diesel that occurred in 2007 as well as limitations on both deductions in credits on the expected lower income in 2008.

Turning to our capital expenditures, our total capital investments in the second quarter of 2008 were $35.6 million. Of this $26.7 million was allocated to refinery segment, $8.4 million was allocated to our retail segment. The majority of the refining CapEx was spend on our low sulfur gasoline project which was completed in June. On a year to date basis, our capital expenditures are $71.5 million of which approximately 81% is related to capital projects at the refinery.

Given the current market conditions, we have reduced our full year 2008 CapEx target by $25 million to $125 million. This reduction is mainly due to our decision to push out the turnaround that was originally scheduled for the second half of 2008 into 2009. In addition to our decision to postpone discretionary spending on various C-Store related capital projects.

Turning to our capital structure, as of June 30, our cash and cash equivalents totaled $97.8 million and we have $320 million of outstanding debt. Aggregating these we had a net debt position of $222 million at the conclusion of the second quarter. Delek US and its subsidiaries were in compliance with all of our debt covenants as well. We hit the second quarter with a debt to total capitalization ratio of 39.3%.

The year-over-year decrease in our cash and cash equivalents was due primarily to an increase in working capital requirements at the refinery in addition to ongoing debt reduction efforts within our retail segment. Year to date at the retail segment we have reduced our debt obligations by $23.5 million.

Interest expenses declined $2.6 million to $5.7 million in the second quarter of 2008 when compared to the year ago quarter. The decrease was primarily due to an overall reduction in variable rates on our debt which averaged 7.9% in the comparative quarter last year and was only 5.2% in the second quarter of 2008. Additionally, capitalized interest for the quarter was nearly $1 million higher compared to the same quarter a year ago.

Now, let me provide you a bit more color on our existing ethanol swap agreement as of June 30, 2008. As you will recall at the conclusion of the first quarter, our ethanol gasoline swap had a positive value of $2.8 million. During the second quarter, we suffered a pretax mark to market loss of $13.2 million which resulted in an increase in our cost of good sold in the period. The majority of our ethanol RBOB swaps expire at various intervals between now and the end of 2009 allowing the possibility that current mark to market losses could be reversed in coming quarters given changing market dynamics.

Now for a brief explanation of the LIFO adjustment taken in the quarter as well. During the quarter in response to rapidly escalating crude costs, operations determined that they could function at a lower volume of crude intermediate in peak stock inventory levels. Consequently, we adjusted our target LIFO levels to reflect these lower operating volumes. During the three months into June 30, 2008, we incurred a permanent reduction in the LIFO layer resulting in a liquidation in our refinery work in process and finished good inventory in the amount of $12.5 million in addition to the permanent reduction incurred during the first quarter of 2008 in the amount of $2.4 million. These liquidations represent a reduction of approximately 214,000 barrels and were recognized as reduction of cost of good sold in the six months ended June 30.

With that I will turn the call over back over to Ron, the operator, for questions.

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Ben Brownlow with Morgan Keegan.

Ben Brownlow – Morgan Keegan

Hi, good morning. Uzi, can you talk a little bit about the acquisition environment, obviously there are lot of opportunities out there and just kind of tie that in with reduction in CapEx and just your thoughts on maintaining a healthy balance sheet versus growth?

Uzi Yemin

Well, good morning. Are you talking about the C-Store environment or refining or both?

Ben Brownlow – Morgan Keegan

Both.

Uzi Yemin

Okay, let me start with the c-stores. You already know that Exxon announced that they want to sell I think 2,600 stores. And that would put I think pressure on the market with the announcement, apparently they are not going to do any acquisitions this year. We see the multiples coming down. You know as much as I am that the c-stores environment was really tough up to the month of call it July when prices start to decline a little bit. You see many competitors closing their stores. We in the markets that we are in we see many stores just shut down because they don’t have the ability to finance the working capital. All this puts a lot of pressure in the marketplace favorably toward people that want to be acquired.

We are preparing ourselves in that regard by lowering and you don’t have the number is front of you but I can give you that, lowering our debt at the macro side. Ed mentioned that we went down to I think $170 million and with much better margins in the last call it five six weeks, we are able to lower that leverage even much more. That will free up capacity to make acquisitions under the Mapco facility we hope. The leverage on the Mapco is going down dramatically, that’s on that side.

Refining, most refineries in the country as you all know, they make too much money in the last 12 months. Multiples are again down but not only multiples are going down, EBITDA is going down dramatically, and we know of several refineries that are for sale. Today I think Western announced that they are going to sell the Yorktown Refinery and I think with many refineries don’t make money we’ll see more and more refineries coming to the market. I think that sellers still need to adjust to the new number but eventually it will happen. And let me remind all of us 2001, 2002 were very similar in the refining environment to what we see today and that resulted in many transactions that ended up producing a lot of cash and money to the purchasers.

Ben Brownlow – Morgan Keegan

Okay. And the reduction in CapEx, what is specifically that are you pulling back on that?

Uzi Yemin

I am sorry, reduction in CapEx with us or reduction of CapEx of the industry?

Ben Brownlow – Morgan Keegan

With you?

Uzi Yemin

Go ahead, Ed.

Ed Morgan

As I mentioned earlier, we cushioned back the turnaround scheduled for the end of the year this year to 2009 and we are pulling back on some discretionary capital spend at the retail segment, that’s the $25 million reduction.

Ben Brownlow – Morgan Keegan

Okay.

Uzi Yemin

And by the way, just to give you a point of reference, GHT, I don’t know if we broke it down in the past and gave you a number for GHT but the GHT project was completed under budget and obviously on time but we do see a little bit of slowdown in the market of CapEx spending. Obviously C-Store announced that they are going to slow down their CapEx project, I think Valero are going to do the same thing, or they are doing the same thing. So that will – that should bring some of the cost a little bit down.

Ben Brownlow – Morgan Keegan

Okay. Looking at the refinery on the operating cost side, with the natural gas prices coming down, can you just give us your thoughts on operating expenses per barrel? And on the refinery margin with that LIFO gain, am I doing the math correctly in that added about $2.50 a barrel?

Uzi Yemin

Well, let’s talk about the natural gas. Natural gas, we did the calculation, if we – going back to $8, it’s approximately and I am going on the top of my head still it’s now at – 8, I think 8.50 this morning, 8.70. We are talking about one dollar less on utilities and natural gas and that’s a rough number. On the other operating cost, Fred, do you want a couple of comments and then we will mention the LIFO.

Fred Green

Sure. Ben, two other things impacted operating costs in the second quarter, one was the divisor was lower by roughly4%, so that’s about $0.15 cents a barrel on its own in terms of fewer product sold. But the other was we had a fair amount of maintenance expenses and also operator training and overtime costs related to our DHTN Platformer outage and also the commissioning on the gasoline hydrotreater. So, those should not be recurring expenses.

Uzi Yemin

In regard to the LIFO, every company makes the decision to move inventory. We didn’t do that because of financial gain. We are concerned – we were concerned and apparently it happened a month ago or six weeks ago, I spoke in a conference and I mentioned that I don’t think that – or we don’t think as a company that crude oil can sustain 145, 150 levels. And we were very concerned about that and we at that time I mentioned that we were going to reduce our inventories dramatically just because of the fear that prices will go down. We still have on our books another $80 million of LIFO reserve which will intake into profit, this $80 million are basically unrealized profit as we use the FIFO method. We are not – we are going to mange our inventory and this isn’t related to the (inaudible).

Ben Brownlow – Morgan Keegan

Okay, great. I will jump back in the queue, thank you.

Uzi Yemin

No problem.

Operator

And your next question comes from the line of Mark Miller.

Mark Miller – William Blair & Co.

Hi, good morning everyone.

Uzi Yemin

Good morning, mark.

Mark Miller – William Blair & Co.

Could you update us on the crude optimization project and I am inferring that those are presumably going to be pushed out along with the turnaround, I guess where we are at in terms of the capital spend on those, what’s your timeframe that you expect those to be completed now? Thanks.

Uzi Yemin

Okay, well thanks for the question, Mark. We haven’t made a final decision in regard to that. Either we are going to push it to early 2009, or later in 2009. And the reason we didn’t made a decision yet is we want to see the benefit in the next couple of months we are gong to measure that almost on a weekly basis or bi-weekly basis. We are going to look into the not only the capital spending because we have the cash on our balance sheet, but other acquisition opportunities as well as the light sweet or heavy sour crude and that will drive the decision. It is going to be call it two months delay or layer in 2009. at this point I don’t want to made a decision or we don’t want to make a decision, we’ll measure that in the next two months and then notify the market. So far what we see is the same benefit of between $25 million to $30 million EBITDA that we spoke about all along. We still see the same benefit with the same cost of around $60 million to $65 million on this project.

Mark Miller – William Blair & Co.

Wouldn’t it make operational sense to have that be in the same timeframe as the turnaround?

Uzi Yemin

Absolutely. We are going to do that together. Go ahead, Fred.

Fred Green

Mark, the turnaround schedule, we had changed it off of our normal four year schedule to try to accommodate earlier completion on the crude optimization project. So we will still execute both at the same time but we are not pressed to go into an early turnaround.

Mark Miller – William Blair & Co.

Okay. Sort of paraphrase, the turnaround could also be later ’09 as well and you will also let us know by the time we report third quarter earnings what your plan is going to be?

Uzi Yemin

I believe that we will report to the market even before that. We need to plan for that and right now we are planning everything to be February, but this is subject to change. Again, as I mentioned it is a matter of acquisition opportunity as well.

Mark Miller – William Blair & Co.

And can you just I guess put some perspective around the ethanol blending, sort of where the organization is at in terms of the benefit you derived throughout the company this quarter, do you see that benefit improving to you sequentially or how close are we to the sort of the peak end of the organization, can you go significantly higher from 83% of your stores. I am also interested in roughly what percent of those store locations have competitors that are also blending ethanol and how much are you having to get back to the market ?

Uzi Yemin

With the refinery we still have a little room for improvement. Take for sure, we have room for improvement. With regard to the stores, some of our competitors are doing that, I want to go buy market specific or by competitor specific because I don’t want to lose, we don’t want to lose the advantage edge that we have or the edge that we have with our competitors. Lyn, do you want to comment on the programs with the stores?

Lyn Gregory

I agree with you, I’d rather keep that information to ourselves. I mean it is a good competitive advantage. The margin came in at 17.6 versus same quarter last year of 15. 8%. 83% of our stores are converted, we are looking at some individual stores. As we speak there will be some that has some overtags that we might convert.

Mark Miller – William Blair & Co.

In your prepared comments you said it drove the market , did it – without blending ethanol would your margins have been up at retail year-on-year?

Uzi Yemin

Well, it’s hard to measure just because of the simple fact that the competitors changes their behavior a little bit but without the ethanol for sure bandwidth was much lower.

Mark Miller – William Blair & Co.

Okay, my final question, I will turn it over is, what was the amount of the compensation – incentive compensation that was reversed in the period? Thank you very much.

Uzi Yemin

It’s $1 million.

Operator

And your next question comes for the line of Bryan Shore [ph].

Bryan Shore

Good morning everyone, how are you all?

Fred Green

Bryan, how are you?

Uzi Yemin

Good morning, Bryan.

Bryan Shore

Thanks for taking my question. On the refining side, the decline in barrels per day of sales both sequentially and year-over-year, you mentioned the maintenance on the hydrotreaters, one explanation is that pretty much the sole reason behind that or are you guys cutting any runs here, I guess for strategic reasons?

Uzi Yemin

Well, good morning, Bryan. Thanks for your question. I will let Fred compete the answer but let me tell you that we did try several different crudes in the second quarter. We tried several sour crudes to see how the refinery works especially in light of the fact that we are coming to a point we’ve got to change our crudes as a result of the project. So, no, we didn’t cut runs because of lower margins, but we did try cheaper crude during the quarter. Fred, do you want to say something?

Fred Green

Obviously April was significantly impacted by that outage and we did build some intermediate feedstocks. So, knowing coming out of April that we had intermediates that we could either sell or process, we took that opportunity as Uzi mentioned, to start bringing in some alternative crudes that were identified by our LP programs as potentially significantly more profitable. Also knowing that our gasoline hydrotreater was nearing completion, that was one of our major limitations on increasing our sour crude runs. We tried to take advantage of lining up more sour for the month of June as well.

Bryan Shore

Okay. And that was actually going to lead into another of my questions, I think last quarter your guidance ran about 10.5% of WTS, what was the percentage in the second quarter?

Uzi Yemin

Do you have that number, Fred?

Fred Green

Total sour was almost 11% in second quarter.

Bryan Shore

And then building upon sort of your, Uzi, your explanation of the acquisitions market on the refining side, what – certainly without – I know you guys are still evaluating your options, but what sort of benefit improvement do you guys think you could add doing acquisitions, or would it just be because the market, the way it is you could get it for cheap?

Uzi Yemin

The fact that you get something cheap doesn’t make it right. We as you all saw, we when asked about potential acquisitions, and then we are looking on other potential opportunities. The main focus – obviously price is important, but the main focus of when we do our due diligence is to make sure that we can improve the assets. And we’ve got to prove the assets as much as we think we can, as much as we think we should, then we basically drop and go away from the opportunity. So for me, yes, cheap price is very important, but at the same time we want to make sure that we can increase utilization, we can improve crude strength and other benefits from refining assets that are in the market.

Bryan Shore

Okay, great. And then over on to the retail side, the decline in same store sales, you guys obviously noted the weaker consumer environment and fewer gasoline gallons sold, are you seeing I guess is it a lower percentage of your customers coming into the store, are they reducing their basket size, it is sort of all of the above, can you sort of break that on that 3.1%?

Lyn Gregory

Yeah, this is Lyn. Basically where we are the decline is on the general merchandize category, basically the novelties where there is a lot of discretionary spending, and also on the soft drink side. We ran a lot of promotions last year on fall soft drinks which we elected not to do this year. Our transactions were down 5% to 6% but again the market basket continues to go up, it’s up to $4.57 or a 1.3% increase.

Bryan Shore

Okay, great.

Lyn Gregory

Talking about the guidance, if you will, to be honest, the reason that we have a month ago or six weeks ago made the comment that crude can sustain a year is we see customers stop driving all across the board with customers reducing their gallons. So, the demand is certainly lower and I think from here crude will keep going down. We saw a drop of almost $30 in the last three, four weeks, and I think crude will keep going down in the next few months.

Bryan Shore

Okay. So Uzi on that point, obviously you mentioned the decline in July to the first part of August, you guys still think there is room for crude to slide down?

Uzi Yemin

Absolutely. I think that this is our perspective of the market but I think that it doesn’t made sense and that crude will be $120 today or $147 only three weeks ago and refining margin or frac spread will be so low. If demand is there, frac spread should be $40. If demand is not there, crude prices should go down, and we see the combination. In the last few weeks if you recall, crude dropped while gasoline crack went from almost zero to $8, $9 today. So, we see the improvement on both sides.

Bryan Shore

Okay, great. That’s great color, I appreciate it guys, thanks.

Uzi Yemin

Thank you.

Operator

And your next question comes from the line of Paul Cheng.

Paul Cheng – Lehman Brothers

Hi, guys.

Uzi Yemin

Good morning, Paul.

Paul Cheng – Lehman Brothers

Good morning. Have to apologize because I came in a bit late, didn’t get all your numbers, so if you’ve already covered it, I apologize.

Uzi Yemin

Okay sure, no problem.

Paul Cheng – Lehman Brothers

Uzi, in the Maine [ph], any color how the operation is doing or that – I mean I thought in the first quarter at the time a few independents saying that do you think that they would be pop up outside your earning contribution from various negatives, is that something subsequently has happened or that’s how we looked in the second quarter on that?

Uzi Yemin

Well, at the time I mentioned that as a results of two months, I didn’t have the results obviously of April. So, at that time, it looked more positive that it happened eventually. With regard to the operations, obviously we have Fred and us sitting on their board, do you want to make comment with regard to Lion?

Fred Green

No. I mean they are where we reported for our second quarter and earnings and operations was normal during that period.

Uzi Yemin

Okay, well. Then I think with regard to Lion, we will see what happens in the next quarter and I think that there is nothing unusual to report in regard to that.

Paul Cheng – Lehman Brothers

Uzi, I know that you guys are being very hesitant because of the majority shareholder wishes, is there any operating statistic or anything that you can share, just by giving out a operating contribution?

Uzi Yemin

Not at this point.

Paul Cheng – Lehman Brothers

The second question, I think this is probably for maybe for Fred or maybe – I don’t know, you’ve cut your (inaudible) for this year to 125, wondering if under the worst case scenario, if you really have to cut through the bone and not strengthen the reliability and safety of the facility, what is the minimum spending requirement for this year and next year (inaudible)?

Uzi Yemin

Let me remind you that we’ve did already spend $71 million mainly on the GHT side. I think and we didn’t calculate that to the penny and correct me if I am wrong Fred, I think that in order to cut to bare bones we are not talking about more than $15 million at the refinery from now on for the next 12 months, if you will, and another call it $2 million per quarter, so $8 million at the retail side. So you are talking about $20 million to $25 million for the next 12 months. Fred, do you agree/disagree maybe?

Fred Green

Well, the only caveat to that would be refinery turnaround and the timing on that.

Uzi Yemin

But if we are pushing the turnaround away to $25 million, or call it $20 million to 25 million.

Paul Cheng – Lehman Brothers

But I mean the main turnaround you are already pushing one, I assume you can’t really push it further out?

Uzi Yemin

Well, we pushed it only two months, we didn’t push it to long. We just changed it from – in the past, we were talking about having half of the turnaround this year and half of the turnaround next year, now we are saying we’ll do everything early next year.

Paul Cheng – Lehman Brothers

Right. I mean that for 2009, you have to still have to spend is unlikely, you can push it into 2010?

Fred Green

Actually, we’re approaching the four year mark on the crude unit side of the refinery, but that portion of the refinery doesn’t really have any operational issues or constraints. So, all we have to do is go through a management of change process to extend that runway. And we could probably still do some kind of mini turnaround for any critical item, so it’s only five to seven days type of activity, not a three week outage. The FCC side of the refinery, it’s turnaround was in December of ’05, so we can – our 48 months is not up until December of ’09, so we could still potentially push that one out of ’09 into 2010.

Paul Cheng – Lehman Brothers

Fred, based on what you are saying, maybe Ed can comment, under the worst case scenario, really wonder if you can go by with about $60 million in next year capital spending?

Uzi Yemin

Our worst case scenario next year?

Paul Cheng – Lehman Brothers

Yeah, for 2009, under the worst case scenario that you really want push everything to the minimum?

Uzi Yemin

I don’t know that I agree with that number. It depends on our decision on the crude optimization project. If we decide to do only turnaround in the $50 million, we are talking about %40 million, so I don’t that we are talking about $65 million.

Fred Green

We do still have some remaining milestone payments on major equipment like the FCC reactor, but that wouldn’t come close to $20 million.

Uzi Yemin

And let me tell you one more thing that I mentioned earlier, maybe you missed it Paul. If you look at our capital structures, the majority of our debt, there is no debt at the refinery, obviously. The refinery’s only seasonal or couple of million boring, nothing, by the end of the quarter. The majority of our debt is our debt under the Mapco facility, and that Mapco facility, we paid debt dramatically in the second quarter or in the first six months, and we keep lowering our, if you will, debt at the Mapco side. We see that trend going everyday especially in light of the good margins that we performed in the second quarter and we see a continuation of that into the third quarter.

Paul Cheng – Lehman Brothers

Okay. If I could two, hopefully, short questions. One Fred, what is the expected refinery throughput you are looking for in the third quarter for China? And second question maybe for Uzi, looking at your (inaudible) how strong does your realized margins comparing to the first quarter as well as the second quarter last year, with the rapid run up in crude prices, I think (inaudible) has been struggling on that, is there anything that you need that you have done or that we should be aware why the margin appears to be so strong?

Uzi Yemin

You want to take the refining, I don’t know that we are giving any guidance. Paul, we didn’t report anything unusual for the second – for the third quarter, so we are in normal operations. You may have just missed one thing we mentioned which we are trying different types of crudes.

Paul Cheng – Lehman Brothers

So should we assume that you would be able to do about 55 or so?

Uzi Yemin

Well, we don’t give guidance, so I wouldn’t comment. I’d just say that there is nothing unusual. That’s one thing. In regard to the C-Store side, and I think that’s something that will happen shortly with the refining industry as well. Six months ago, eight months ago, the C-Store industry hit the bottom and we got into a situation that a lot of C-store chains or operators decided just to close down. And the fact was that when gallon jumped to $4, credit card fees went dramatically higher. So we made the decision and we see it in the marketplace with other competitors that we made the decision that they made the same decision to actually increase margins as much as we can, and we see that behavior continue into the third quarter. So, for me, second quarter results weren’t a bet but third quarter we see that same trend coming up with companies pushing their margins as high as they can just to compensate themselves on high cost of utilities, credit cards, labor and so on. Lyn, do you want to add to that?

Lyn Gregory

I agree pretty well so.

Paul Cheng – Lehman Brothers

Okay. Great, thank you.

Operator

And your next question is from the line of Jeff Dietert.

Jeff Dietert – Simmons & Co.

Good morning.

Uzi Yemin

Good morning, Jeff.

Jeff Dietert – Simmons & Co.

Uzi, I was hoping you could compare and contrast the relative attractiveness of C-Store acquisitions versus refining acquisitions in the current market?

Uzi Yemin

What’s been now – you know this is an equation I struggle with on a daily basis, and I will tell you why. Refining margins or refining sector came from the best year ever in 2007, so people have still – even though the market is much worse, on the refining side, people have much strong balance sheets. So, for me that’s something that price of refining still I think prices of in the marketplace that you see on the screen don’t reflect with acquisitions there. It’s coming, but not that fast. On the other hand, C-Stores, you see people that already hit the bottom. The first quarter and first part of the second quarter was the worst part for that industry in my mind. We are coming out of it very nicely. So, what’s more attractive, by the end of the day it depends on the location, it depends on the seller and more than anything it depends on our ability to improve our target if you will. And we passed on many acquisitions because we didn’t feel that we can improve the target the way we wanted. So, by the end of the day, I think all equal both industries present, if you will, great opportunities for buyers that are willing to put the capital into the marketplace in today’s tough environment

Now, let me just mention one more thing. We have a great supporter out of main shareholders in Israel, and while we were looking on an acquisition they supported with a level of $200 million. They will give us an equity contribution. So, for me the fact that the dollar is weak allow us to get foreign capital, if you will, and they don’t see it as expensive as we are and, hopefully, we’ll remain active in the marketplace in regard to these acquisitions. At the same time we want to be very disciplined like we were in the past. And the reason we passed on several acquisitions was that we couldn’t see it working, so I know that there were some concerns in the marketplace about us being too aggressive with acquisitions, but you’d see that we spoke about many acquisitions and we didn’t too much lately just because of the fact that we didn’t feel that the price was right or the target presented opportunity going forward.

Jeff Dietert – Simmons & Co.

Would you agree that demand has a similar influence on both retail and refining, that it would appear with many other recent closure on the retail side that capacity is declining there, whereas on the refining side it appears capacity is increasing with some of the expansion plans?

Uzi Yemin

That being said, you are right. However you read the news as much as I am and look on all those maintenance projects and reduction of cutting utilization, you look at the screen and you see 27% utilization rates while a year ago it was 96%. So for me the moment crude dropped, and it dropped as you see, utilization will go higher because the demand will come back.

Jeff Dietert – Simmons & Co.

Thanks for you comments.

Uzi Yemin

Thank you.

Operator

(Operator instructions) And we have no further questions, sir.

Uzi Yemin

Well, I appreciate that. That concludes our conference call today. We look forward to speaking with you during our third quarter 2008 conference call. Should you have any questions in the interim, please contact our newly hired director Nole, we didn’t give him the opening to speak, but Nole Ryan or any other member of the team. Again, thank you for interest in the company.

Operator

This concludes today’s conference call, you may now disconnect.

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Source: Delek US Holdings, Inc. Q2 2008 Earnings Call Transcript

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