May 27, 2008
Executives
John Colling, Jr. – Vice President & Treasurer Ezra Uzi Yemin – President, Chief Executive Officer & Director Edward Morgan – Principal Financial & Accounting Officer, Vice President & Treasurer Lynwood Gregory – Senior Vice President, Executive Vice President & Chief Operating Officer of MAPCO Express, Inc.
Frederec Green – President & Chief Operating Officer of Delek Refining, Inc. and Vice President of Delek Marketing & Supply, Inc.
Analysts
Jeff Dietert – Simmons & Company International Unidentified Analyst Paul Sankey – Deutsche Bank Unidentified Analyst
Operator
Welcome everyone to the Delek US Holdings first quarter conference call. (Operator Instructions) I will now like to turn the call over to John Colling, Vice President and Treasurer of Delek US.
John Colling, Jr.
Good morning and welcome to the Delek US Holdings conference call for the first 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 law. 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 & Exchange Commission and in its first quarter news release.
As a result actual operations of results may differ materially from the results discussed in the forward-looking statements. Delek undertakes no obligation to publically 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 May 13th by dialing 706-645-9291. The confirmation number for the replay is 43641830.
The replay may also be accessed for the next 90 days at the company’s website www.DelekUS.com or at www.Earnings.com. At this time I will turn the call over to Uzi.
Ezra Uzi Yemin
It is a pleasure to be here with you today to discuss our first quarter 2008 results. We reported a net loss of $5 million or $0.09 per share compared to a net income of $20.9 million or $0.40 per diluted share in the first quarter of 2007.
The first quarter included a non-cash loss of $6.5 million or $0.12 per share associated with our equity investment in Lion Oil. As a reminder, we report our equity investment in Lion two months in arrears.
Therefore, our first quarter results include Lion’s results for the last two months of 2007 and the first month of 2008. Based on early estimates for Lion’s February and March results we anticipate that Lion with enter a positive contribution to our earnings for that period.
During the quarter we recognized mark-to-market hedging income of approximately $2.9 million related to our ethanol swaps which is reflected as a reduction of cost of goods sold in the corporate and other segment. The income was partially offset by crude hedging of approximately $80,000 associated with mark-to-market crude hedging for a net pre-tax income of $2.8 million.
In the quarter each one of our business segments contributed positive to our earnings despite a tough environment faced during that quarter. With our non-refining segment contributing approximately 73% to our total contribution margin.
We improved our balance sheet [inaudible] by reducing our total debt by more than $32 million and our net debt by nearly $23 million to $183.3 million. Turning to our refined segment.
Our realized operating gross margin for the first quarter was $6.31 per barrel compared to $11.47 in the first quarter of 2007 which was affected by the 68% year-over-year increase in average crude prices and the $0.80 market [inaudible] compared to $1.32 [inaudible] market that existed during the first quarter 2007. Residual product prices continued to lag behind the rising prices of crude oil.
We were able to partially offset the lag in these products with the production of nearly 93% of light high value product. In addition, we were able to partially offset the higher crude oil cost by blending nearly 2,100 barrels a day of ethanol and by processing 10.5% of West Texas sour crude during the quarter.
During the quarter we experienced our strongest demand since the fourth quarter 2006 for our refined products as demonstrated by our total sales volume of over 57.5 thousand barrels per day. We continued to blend ethanol in to our gasoline products at the refinery and in March we blended over 2,400 barrels per day of ethanol.
Beginning May 1t we started to offer only E-10 blended gasoline at the refinery rack. Our gasoline [inaudible] project which represents the final phase of our clean fuels program is scheduled to be completed here in the second quarter.
We are proceeding with our crude optimization project and are on schedule to complete two projects by the end of 2008 with the final project, the FCC Reactor revamp being completed in the first quarter of 2009. Our retail segment continued to produce stable cash flows.
Merchandise gross margin for the quarter was 32.3% on merchandise sales of over $97.1 million compared to 31.6% for the full year of 2007. The increase in merchandise margin was supported by the Calfee acquisition.
Our sales to merchandise sales declined 2.2% due primarily to lower consumer spending as a result of core economic conditions and weather related issues experienced during the second part of the quarter. We are encouraged by the results from our 25 reimaged stores in our Chattanooga market which are showing approximately 8% growth in fuel and 7% growth in merchandise sales for the first four weeks of April compared to last year.
This program represents 5% of our stores and we are currently in the process of completing the reimaging of 25 additional stores this quarter. Retail fuel margin increased from $0.123 per gallon in first quarter 2007 to $0.126 per gallon in the first quarter of 2008.
The fuel margin was positively impacted by ethanol blending. During the quarter we blended nearly 40% of our total fuel volume with ethanol and to our aggressive ethanol roll out we increased our ethanol blending to approximately 54% of our fuel volume during the months of March or 62% of our gasoline volume.
We continue to expand our new concept store idea outside of our national market with the opening of a new store in our Memphis market and we expect to open another new concept store in each of the Nashville and Chattanooga market during the second quarter. Our marketing segment continues to produce solid operational results and stable cash flow.
Net sales for the quarter were $184.3 million, an increase of $63.6 million compared to $130.7 million for the first quarter of 2007. Barrels sold averaged 17,215 barrels per day compared to 17,000 for the same period last year.
The contribution margin for the first quarter 2008 was $6.5 million of 23% of the total contribution margin compared to $5.9 million or 11% of the total contribution margin for the first quarter 2007. In summary, despite the tough economic situation we were able to maintain positive contribution for each one of our business segments.
These conditions may also provide us with opportunities to grow our portfolio through strategic acquisitions.
Edward Morgan
Let me spend my time today discussing in more detail the highlights of our operational results for the first quarter. I will then also briefly discuss our capital spend, cash position at the end of the quarter and our effective tax rate going forward.
Let me start though first with some segment level details. The refining contribution margin for the quarter was $7.6 million compared to $36 million in the first quarter of 2007.
The gross margin for the Tyler Refinery excluding service fees paid to our marketing segment during the quarter were $6.31 per barrel compared to the posted Gulf Coast [inaudible] crack spread of $8.84. The market remained in degradation during the first quarter and as a result our margin in the quarter was primarily driven by the cost of crude which has increased 68% over the previous year.
Operating expense per barrel increased approximately 12% to $4.21 per barrel sold compared to $3.76 per barrel for the same quarter last year. The increase in operating expense per barrel was primarily due to higher natural gas and a one week shutdown of DHT Unit which caused maintenance and construction expense to run around $0.21 per barrel sold.
On the retail side of our business we reported a segment contribution margin for the quarter of $10.9 million or 39% of our total contribution margin compared to $11.9 million for the same quarter in 2007. The contribution margin was impacted by $900,000 of higher credit card fees due to higher retail fuel prices and consumer usage as well as $400,000 for tank cleaning to sell ethanol.
Same store merchandise sale were down approximately 2% and gallons were lower for the quarter by just over 1%. We do believe this was the result of combination weather and a general economic slowdown occurring in the United States right now.
In addition, retail gas prices averaged nearly 37% higher over the same period last year at $3.09 per gallon. Retail fuel margin for the quarter was $0.126 per gallon compared to $0.123 per gallon for the same quarter last year.
As Uzi mentioned, our retail fuel margin did benefit from our aggressive ethanol strategy. Ethanol blending provided us approximately $0.02 per gallon benefit in the first quarter and during the quarter we blended approximately 40% of our fuel with ethanol.
As noted in our press release our ethanol hedging strategy did impact our income by an additional $2 million after tax due to mark-to-market accounting. We will continue to monitor this strategy but have not yet been able to qualify for hedge accounting under FAS 133 due to the lack of history in the ethanol markets in the markets that we operate.
The wholesale fuel business reported sales of eight million gallons compared to seven million gallons for the same quarter a year ago. We realized a margin of $0.05 per gallon on these wholesale gallons.
Net sales in our marketing segment were $184.3 million including $3.4 million of service fees paid to our refining segment, an increase of nearly 53% compared to first quarter 2007. This was primarily driven by a nearly 50% increase in the average sales price versus the previous year.
Marketing contribution margin for the quarter was $6.4 million representing an increase of 8.5% compared to the same period a year ago. Our G&A expenses for the quarter were $13.
3 million compared to $12.2 million the same period last year, yet down from $14.4 million in the fourth quarter 2007. Compared to the prior year the increase associated with this overhead expense was primarily due to the increase in store count related to our Calfee acquisition.
Depreciation amortization expense for the quarter was $2.7 million at the refining segment, $700,000 in marketing supply and $6 million at our retail segment for a total of $9.4 million, an overall increase of $2.4 million compared to the first quarter of 2007. The first quarter increase was driven primarily by the increase in stores during the second quarter 2007 and several refining projects that we have been completing throughout the course of 2007 as well.
Our effective tax rate for the quarter was 29%. Although we no longer have the benefit of ultra low sulfur diesel production tax credits.
Refining still does qualify for the 6% Section 199 Tax Deductions for 2008 going forward. During the first quarter of 2008 we also spent nearly $36 million in capital expenditures.
Of this $31 million was spent at the refining segment and just over $4 million at our retail segment. The majority of this refining cap ex was spent on our low sulfur gasoline project.
We did spend $5 million on a crew optimization project still due to be completed in the fourth quarter of 2008 with the FCC Unit coming back on line in the first quarter 2009. We have not reduced our anticipated capital spending in 2008.
At the end of the first quarter our cash and short term investments totaled $139 million and we had $323 million of outstanding debt. Aggregating these we are left with a net debt position of just over $183 million at the end of the quarter.
We did end the first quarter with a debt to total capitalization ratio of 39% slightly down from where we were at year end. And, we were able to reduce our net debt position by better working capital management over the course of the quarter.
At this time I’d like to turn the call back over to Jasper to open up the call for questions and answers.
Operator
(Operator Instructions) Your first question comes from Jeff Dietert – Simmons & Company International.
Jeff Dietert – Simmons & Company International
You talked about in the refining segment using about 2,100 barrels a day of ethanol. Were you blending in the retail segment as well or is the blending that you’re doing primarily at Tyler?
Ezra Uzi Yemin
As we said we blended 40% of our fuel in the first quarter and we do expect to grow this to almost call it 60% with the retail. Now, we didn’t mention it here but the West Texas market but we are working on blending ethanol in West Texas and we expect to start blending very soon, in terms of dates.
Jeff Dietert – Simmons & Company International
And as far as the blending subsidy are you basically keeping 100% of the blending subsidy?
Ezra Uzi Yemin
It depends on the customer and on the market. Just to give you a point of reference, as we said effective May 1 everything that we sell across the rack is being blended with ethanol.
Our cost, including the tax benefit is $0.85 to $0.90 below [inaudible] and we give our customer in average between $0.025 and $0.03 so if we talk about 2,100 barrels for the first quarter we estimate the contribution margin between $4 to $5 million. Obviously now we’re going to blend close to 3,000 barrels so we need to increase that number as well as the West Texas increasing the ethanol blending of the stores.
We feel that the ethanol program as we told you a quarter ago or three months ago is really working for us. I would ignore the mark-to-market for us because of accounting but at the same time we do have almost call it 75% of our fuel being blended and most of it is with vendors and not through the market.
So, for me mark-to-market, yes it’s positive but the main idea is to keep blending and keep enjoying those $0.60, $0.70, $0.80, depends on the market and on the customer.
Jeff Dietert – Simmons & Company International
You talked through some of your hedges on the fourth quarter call, any updates or changes to the hedging of the ethanol price?
Ezra Uzi Yemin
By the end of the quarter it was up, it moves with crude oil. I wouldn’t read too much in to the $2.8, $2.9 million.
I wish we could make it a perfected hedge, we didn’t manage to do that because of correlation. We’ll try to do that in the next few quarters but for us, the main idea was to lock in that differential which we did and we mainly did that on the cash market and not the paper markets.
Operator
Your next question comes from the line of Unidentified Analyst.
Unidentified Analyst
Can you talk about the reimage stores that you’ve done to date and kind of what you’re seeing there on contribution on sales, etc.
Lynwood Gregory
Remember the original reimage store that we tested back in November the best store was trending in April at about a 25% increase in merchandise and a 25% increase in gasoline. Now, we had the next 25 under construction in February and March, completed around April 1st.
They’re trending now about 8% in merchandise and 7% in fuel. So, we’re extremely excited about our reimage program, it certainly differentiates us from everyone else in the market.
We have an additional 25 under construction as we speak with a target completion date of June 1. Thereafter we’ll have 51 in total and will begin our advertising campaign somewhere around the second and third week of June to let the market know that we had that new MAPCO Mart reimage look and that cluster in the Chattanooga Dalton market.
Unidentified Analyst
Can you also just give a little bit of color on the merchandise margin for the quarter and kind of why that was down?
Lynwood Gregory
Well, the margin was down 2%. We ran at 32.3%.
Basically still we had a little bit of transition with [Cormark] with a little bit of write down on candy and snacks as we reset the stores. If you look at that 2% in total it was approximately $175,000.
The other part of the merchandise, it was kind of in the general merchandise category, as the sales are picking up in these reimage stores people are not looking at those new wholesales in the general merchandise category as much as they did prior. Also in addition with the increased food cost and what not over the last four to five months our fountain and food areas trickled down a tad and we’ve adjusted those prices on our food costs and on our retail price structure.
So, you’ll see going in to the second, third and fourth quarter that we made all those adjustments and we really feel good about our trend.
Unidentified Analyst
You’re still comfortable with a kind of a 100 bps increase for the year on merchandise margin?
Ezra Uzi Yemin
As you know, we don’t give numbers but we still have a working year target of 70 to 100 basis points on either basis. So, we feel that we’re still on track for that.
Unidentified Analyst
I missed the fuel and merchandise comps in the quarter.
Ezra Uzi Yemin
A 1.3% reduction in fuel and 2.2% reduction in merchandise.
Unidentified Analyst
Then just last, the Memphis store looks exceptional and I know it’s extremely early but what kind of results are you seeing out of that Memphis stores.
Ezra Uzi Yemin
It is really too early to measure that we’ll add it to the next call. But, it’s in line with what we saw earlier with basically a jump of good portion both outside and inside and obviously we are very pleased with that concept so we are rolling it in every market.
Unidentified Analyst
The Grille Marx Express, the two test locations that you did last quarter, what are you seeing there?
Lynwood Gregory
We’re still working with those two test locations. We’ve basically been concentrating on the 50 reimage stores so we haven’t put as much emphasis on those two but as the reimages get completed June 1st we’re going to switch over and really focus on those two sitting here in Nashville.
Operator
Your next question comes from Paul Sankey – Deutsche Bank.
Paul Sankey – Deutsche Bank
I was just wondering can you share some modeling maybe guidance with us, the G&A and net interest expense and the effective tax rate for the second quarter?
Edward Morgan
On the G&A expenses we did recognize we were just over $1 million short of where we were in the fourth quarter of last year. We’re looking at for 2008 we’re running a little lower in some commodity fees and a number of other items as well.
So, those should churn a little lower. We also didn’t have any transaction costs in the first quarter 2008.
We did have, I believe, about $400,000 in transaction costs in the fourth quarter of last year. In regards to interest –
Paul Sankey – Deutsche Bank
Does that mean G&A, the first quarter run rate is a reasonable one?
Edward Morgan
It is reasonable assuming we don’t have transaction costs.
Paul Sankey – Deutsche Bank
As long as we don’t have transactional costs and that kind of run rate is reasonable?
Edward Morgan
That’s correct Paul.
Paul Sankey – Deutsche Bank
How about DD&A?
Edward Morgan
Well, DD&A will continue to increase, it was down a little bit in the first quarter over fourth quarter of last year because we had some raise and rebuild write offs, or one raise and rebuild write off in the fourth quarter last year. That will incur when we choose a site that we still have book value for and we go to raise that site and put a new site on it so that was sort of a one off event.
I believe your third question was in regard to interest income?
Paul Sankey – Deutsche Bank
And also the tax rate? Did I miss it?
Edward Morgan
We’re using 29% at this point in time for 2008.
Paul Sankey – Deutsche Bank
Going forward?
Edward Morgan
That’s our 2008 projected rate, correct.
Paul Sankey – Deutsche Bank
How about net interest expense?
Edward Morgan
Well, if you recall Paul, in the fourth quarter of last year we told the market we had exited out of auction rate securities which had been a primary investment vehicle for us over the majority of the year. We’re now in 100% of US Treasuries so we’re very conservative in our investments.
I would expect interest income to be much less this year than it was last year.
Ezra Uzi Yemin
Paul, we don’t have any fixed interest if you will. All our interest is floating so we expect the interest expense to keep going down as the Fed keeps lowering interest rates.
Paul Sankey – Deutsche Bank
Uzi, I note that you are a little bit hesitant to disclose too much information about margin. Can you tell us that from November to January what was the refinery run rate of Lion?
And, what kind of gross margin that they may have realized?
Ezra Uzi Yemin
As you know, we are hesitating in regard to Lion just because of the fact that it’s a minority of holding and obviously they are a privately held company and we want to accommodate their desire for privacy. With that being said, their refinery is very similar to other asphalt refineries that produce asphalt.
Winter will be always not good for them with the summer being much better. As we mentioned and you know from the past, the result of the $6.5 million loss here are mainly related to those three months, November through January and not the quarter like we reported.
For us, we knew that the results wouldn’t be good especially in light of the fact of crude rose so much. But, as we go in to the summer we expect the numbers to improve.
Paul Sankey – Deutsche Bank
I understand Uzi but can you at least tell us what is the throughput and the gross margin of Lion doing say November to January? Or, you can’t even discuss it?
Ezra Uzi Yemin
We’re not going to disclose that.
Paul Sankey – Deutsche Bank
So ethanol blending benefit I think adds very high to what is the ethanol benefit in the retail. Do you have a number that you can share?
Ezra Uzi Yemin
We have a rough estimate. Obviously, it is hard to know because of the consumers’ behavior and the competition behavior.
So, for us it’s around $1 million is what we estimated that. Are you asking about the refinery?
Paul Sankey – Deutsche Bank
The refining.
Ezra Uzi Yemin
In regard to refining, as I said $0.85 basically per gallon and we blended 2,100 barrels in the first quarter. We know we get around $0.30 for the first quarter, it’s going to be lower than that going forward just because everybody has bought in to the program.
Now, we’re blending, we’re selling across the rack only blended ethanol, E-10 so it’s going to be 3,000 barrels and I expect it’s going to be the same $0.85 or call it $0.80 less $0.20 for gasoline so $0.60 going forward. Does that answer your question?
Paul Sankey – Deutsche Bank
Uzi, are you talking about the $0.60 per gallon, is that for the refining or you’re talking about the retail.
Ezra Uzi Yemin
No, the refining.
Paul Sankey – Deutsche Bank
The refining, %0.60 so that is net of whatever that you have to pass along to your customer?
Ezra Uzi Yemin
That’s right. And, you can use probably 3,000 barrels going forward effective May 1st.
If you recall we said 2,000 barrels three months ago, now we changed it to 3,000 barrels because of the great results that we got from it.
Paul Sankey – Deutsche Bank
I think that you had indicated that you have choose somewhat of an expense, you highlight one is the ethanol there is a cleanup cost with the tank, I assume that is a one-time cost and all the tankers is already cleaned up so you don’t have to incur additional expense? And the other one you say is credit card $900,000, I would assume that would continue because you are seeing more and more people are going to use the credit card so that is not really going to drop off, it’s going to continue.
Edward Morgan
Let me answer the credit card question first Paul. On the credit card usage, yes that’s probably a fair assumption.
Credit card usage continues to increase in the country and as gas prices rise obviously that percentage we pay of interchange fees will rise accordingly. In regards to your tank question on the retail side yes, the majority of that is a one-time expense.
Going forward though in regards to tanks in the retail side we do have to change filters more often, etc. when we’re selling ethanol so our maintenance cost will be slightly higher but the $400,000 is mostly a one-time.
Paul Sankey – Deutsche Bank
Do we have any one-time, because when you start blending the ethanol and the refining I assume you also have some one-time costs, how big is that?
Edward Morgan
I can speak to what we spent, it was a capital spend, what we spent to add a blending unit at the refinery and Fred can add more details to that if you’d like. But, we spent just over $1.5 million to add that capability at the refinery itself but that was a capital item for us Paul.
Paul Sankey – Deutsche Bank
Because when I’m looking at your unit cash operating cost in the refining is $4.22. You indicate about $0.21 is related to the maintenance work and so if you back that out I think it’s a little bit over $4 that seems a tad high comparing to what in the first half of last year that you’ve been able to do so I just wanted to see whether there’s any other items that’s considered one off or that may be seasonally that we should be aware of?
Frederec Green
Paul, about $0.19 of the increase year-over-year was just related to natural gas prices going up. That was the bulk of the difference if you exclude those other items.
Paul Sankey – Deutsche Bank
Last year you said $3.52 so you add $0.19 that’s.
Edward Morgan
We were at $3.76 last year. It was the natural gas, utility gas and our maintenance contractor costs are almost the entire difference.
Frederec Green
Actually Paul if you’re looking at last year’s model, one of the things that we did at the end of last year is we restated our expenses to include our crude oil pipeline. Before that, they had been included as part of the cost of sales.
Operator
Your next question comes from Unidentified Analyst.
Unidentified Analyst
A couple of quick questions here, most of my question on the retail side have already been asked and answered. But, I guess Ed to start with you, you had made a comment in your remarks about working capital and cash flow and I wanted to get a sense of first off in the quarter where did the working capital improvement come from?
Then, taking that forward, how sustainable were those improvements? Are there more opportunities available going forward in the working capital management?
Edward Morgan
A couple of our segments, at the marketing and supply segment we were able to get back a deposit and replace it with an LOC, that helped our net debt situation. At the refinery we continue to manage our vendor credit better so that’s something that has significantly increased for us over the past 18 to 24 months since we bought the asset.
Can we continue to have success there and maintain that and improve that, I think the answer is I’m always seeking to improve that and I’ve never stopped so I think just looking at our history I think you can see how we plan on moving forward with that.
Unidentified Analyst
Can you comment on how much that deposit you mentioned first, how much that helped?
Edward Morgan
That was approximately $17 million.
Unidentified Analyst
Then, Uzi you had mentioned that Lion Oil in the quarter I believe you said $0.12 negative impact on the P&L for November through January.
Ezra Uzi Yemin
Yes sir.
Unidentified Analyst
Then you made a comment how February/March were positive contributions, or you’re expecting positive contributions from Lion Oil.
Ezra Uzi Yemin
Well, obviously we have our own estimates. We are subject to review of our auditors and obviously the official list of those earnings but initial indications are that February/March were positive.
Unidentified Analyst
Any thoughts on how April may have come through?
Ezra Uzi Yemin
No.
Unidentified Analyst
I know this is all an estimate on your part right now but is it a stretch to think that maybe for the second quarter the P&L impact from Lion Oil could be positive or flat? How should we think about that?
Ezra Uzi Yemin
I gave you exactly what I know, not more, not less.
Unidentified Analyst
My last question I guess is you mentioned 10.5% of your feedstock in the quarter was WTS. If I remember correctly I think you guys are shooting for the around 12% WTS usage for the year.
Is there any opportunity that could actually come through a little higher? I guess I’m trying to get a sense of how conservative of an estimate that is?
Ezra Uzi Yemin
That’s a great question and Fred you may want to take it but I just want to say that we are now having [inaudible] and we look at not only WTS but 20 to 25 [inaudible] of crude. Fred, if you want to take it from here.
Frederec Green
We’re continuing to work to optimize that sour crude percentage and we’re finding some additional opportunities that have higher volume potential for us. So, yes, I think we’re still on track for 12%.
Operator
There are no further questions at this time.
Ezra Uzi Yemin
I’d like to thank everybody for joining this call today. If you have any further questions obviously, don’t hesitate to call us or give us a call.
We look forward to speaking to you in the near future. Thanks again.