Good day, ladies and gentlemen. This is your conference operator. At this time, I would like to welcome everyone to the Q1 earnings call for Delek US Holdings, Inc. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I would now like to turn the call over to Keith Johnson. You may begin your conference.
Thank you, Lori. Good morning. I would like to thank everyone for joining us on today's conference call and webcast to discuss DK's first quarter 2019 financial results. Joining me on today's call is Uzi Yemin, our Chairman, President, and CEO, Assi Ginzburg, EVP and CFO, Danny Norris, CAO, Fred Green, EVP and COO, as well as other members of our management team. The presentation materials we'll be using during today's call can be found on the investor relations section of Delek US's website. As a reminder, this conference call may contain forward-looking statements as that term is defined under federal securities laws. Please see slide two for the safe harbor statement. 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 comparable GAAP results, which can be found in the press release, which is posted on the investor relations section of our website. Our prepared remarks are being made assuming that the earnings press release has been reviewed, as we are covering less segment and mark information that is incorporated in the 1Q press release. On today's call, Assi will give an overview of results. Then Fred will cover operations for the quarter. Uzi will offer a few closing strategic comments. With that, I'll turn the call over to Assi.
Thanks, Keith. Great to be back. It's such a great quarter. We had a great financial performance this quarter as we continue to return cash to our shareholders while investing in our businesses. As Fred will discuss in a few minutes, we completed the alky project at Krotz Springs and the turnaround at El Dorado in April. As you can see on slide three, on an adjusted basis for the first quarter of 2019, Delek US reported net income of $121.2 million or $1.54 per diluted share compared to an adjusted net income of $21.5 million or $26 per diluted share in the prior year period. Our adjusted EBITDA increased by 126% to $237.5 million in the first quarter of 2019 compared to $104.9 million in the prior year period. I will turn it over to Danny to discuss financial performance for the quarter.
Thank you, Assi. Delek US reported net income of $149.3 million or $1.90 per diluted share compared to a net loss of $40.4 million or $0.49 per basic share in the first quarter of 2018. Our consolidated contribution margin improved to $333.8 million in the first quarter of this year compared to $152.3 million in the first quarter of 2018. This was led by refining, which generated contribution margin of $294.3 million compared to a contribution margin of $133.2 million in the first quarter of last year. This increase was driven by more favorable Midland-Brent crude oil price differential, lower RINs expense, sustainable commercial performance, and the benefit from an active inventory management strategy during a period of rising prices. In the prior year period, refining results included approximately $90.9 million related to RINs waivers and $24.6 million of income from a biodiesel tax credit.
During the first quarter of this year, results did not include any benefit from regulatory decisions on 2018 RINs waivers or the biodiesel tax credit. We continue to work with the government on both of these matters. There was approximately $61 million on a pre-tax basis of inventory benefit, net of the lower of cost or market adjustment in the reported and adjusted first quarter 2019 results. I do want to note that the inventory benefit in our reported and adjusted results was partially offset by approximately $9 million on a pre-tax basis of cost related to an asset disposal and emissions allowance cost in the refining segment. Our performance during the first quarter of 2019 generated approximately $133 million of cash from continuing operations, as shown on slide four.
This cash flow, combined with our solid financial performance, supported investing in the business through cash capital expenditures of $124 million and returning approximately $67 million of cash to our shareholders. Slide five highlights our capitalization. We ended the first quarter with approximately $1 billion of cash on a consolidated basis and $771 million of net debt. Excluding net debt at Delek Logistics of $700 million, we had net debt of approximately $72 million at March 31 of this year. The financial flexibility provided by our balance sheet should allow us to fund our midstream projects with 60%-70% debt, depending on our cash generation and alternate investment opportunities. On slide six, I want to highlight our EBITDA potential from our current operations. We have used variations of this slide in our slide presentations in the past.
Using the long-term average of $2.50 Midland discount to Cushing and the crack spreads highlighted on the slide, our current operations have the ability to generate approximately $900 million of annual EBITDA. Please note that this includes the alkylation project at Krotz Springs that is now operational, and a benefit from commercial initiatives such as improved crude sourcing and netbacks across our refining system. It also includes a potential benefit from RINs waivers at our El Dorado and Krotz Springs refineries, which we have consistently received in the past. As we complete our midstream initiatives, we should have the potential to generate in excess of $1 billion of EBITDA before any IMO benefit.
As we continue to develop our operations, our goal is to add less crack spread and crude differential-dependent EBITDA over time through the combination of our midstream investments, the alkylation unit at Krotz Springs, and our retail business. On slide seven, I want to provide some guidance for modeling in the second quarter of 2019. We estimate, based on the forward curve, that our realized Midland discount and our gross margin would be in a range of $1.30-$1.50 per barrel, which should help to continue driving cash flow generation from our operations. I do want to note in the second quarter of 2019, we expect a $12 million headwind from the combination of rebuilding inventory levels following the El Dorado turnaround and timing of realized hedging losses.
During the second quarter of 2019, crack spreads have continued to improve, averaging $16.30 per barrel through May 2nd, compared to $13.02 per barrel in the first quarter of 2019, based on the 5-3-2 WTI Gulf Coast crack spread. In addition, the Midland-Cushing discount has widened for May and June crude oil purchases. This should benefit our refining operations in the third quarter, taking into consideration an inventory timing effect. I'll turn the call over to Fred to discuss our operations.
Thanks, Danny. During the first quarter, our total refining system crude oil throughput was approximately 250,000 barrels per day. As shown on slide seven, for the second quarter 2019, we expect crude oil throughput in the refining system to average between 260,000 and 270,000 barrels per day. This takes into account the turnaround at El Dorado. Turnaround began on March 11th and was completed on April 24th. The refinery is now back to normal operations. Total capital cost for this turnaround was approximately $45 million. During the second quarter 2019, we expect the crude oil throughput at El Dorado to average between 50,000 and 55,000 barrels per day. This was a shortened turnaround format that allowed work to be completed on the majority of the process units. On slide eight, I want to highlight our capital spending.
Capital expenditures during the first quarter were $128 million compared to $70 million in the first quarter of 2018. Our 2019 capital expenditures are forecasted to be $394 million. This includes $223 million in refining, $12 million in logistics, $18 million in retail, and $142 million at the corporate level. The spending on the Big Spring gathering system is included in that corporate-level number for 2019 and is currently forecast at $131 million. I'm pleased to announce that our new alkylation unit at the Krotz Springs Refinery was operational in early April. Based on current market prices, the expected annualized EBITDA contribution will be approximately $50 million. As a reminder, the alky unit should provide additional production flexibility at Krotz, as it improves the ability to convert low-value butane and butylene into higher-value gasoline products.
Our future EBITDA generated by the alky unit will also further reduce the portfolio's dependence on crack spreads. Progress continues on our Big Spring gathering project. During 2018, we spent $79 million, and we expect to spend approximately $131 million in 2019. This compares to our previous guidance of approximately $80 million of spending in 2019. The change is due to a number of factors that include the addition of more production areas and an increased number of producers, along with additional storage capability and connections to support future growth of this system. Taking this into consideration, the total expected cost is approximately $210 million compared to our previous estimate of $170 million. This new business line has an expected annualized EBITDA in the range of $40 to $50 million, including a crude quality benefit in our refining segment, which should be fully achieved by 2022.
As a reminder, our capital expenditures for this project may be further adjusted as we develop the system to support our producers' growth plans. Next, I'll turn the call over to Uzi for his closing comments.
Thanks, Fred. Good morning, everybody. This was a great start to 2019. Operational improvements that have been implemented continue to increase our EBITDA in our business. These initiatives include the improvement in Krotz Springs refinery, as well as commercial initiatives that continue to improve the refining system capture rates. These were factors in our first quarter performance and should benefit us going forward. The WTI-linked crude system that we have built benefited from a wider Midland-Brent differential. In addition to the initiatives in place, we should benefit from the new alky unit at Krotz Springs. As we enter the second quarter, market conditions have continued to improve. The crack spreads have increased. The Midland-Brent differential is currently at $11 per barrel. This remains an attractive environment for our business model.
The gathering system is progressing. We continue to work with our producers to add acreage dedications. The increase in crude oil price since the beginning of the year should support drilling activity in the Permian Basin. During the quarter, we exited the proposed PGC partnership. This allows us to explore more favorable options to participate in one of the announced long-haul pipeline projects. As shown on slide nine, the combination of these initiatives, along with other projects, should help us achieve $350 to $370 million of midstream EBITDA by 2023. As shown on slide 10, total cash return to shareholders was approximately $67 million in the first quarter of 2019. Over the last 12 months to March 31st, we've returned $400 million or about 14% of our market capitalization. Our capital allocation program balances cash to shareholders with potential opportunities for growth.
Currently, we believe our stock is an attractive investment. We intend to repurchase $60 million of Delek stock in the second quarter of 2019. In addition, our board of directors approved a 4% increase in our regular quarterly dividend, which marks our fifth consecutive increase since the first quarter of 2018. We remain focused on creating long-term value as we balance returning cash to our shareholders, investing in our business, and exploring opportunities to develop the next stage of our growth. With that, Lori, can you please open the call for questions?
Certainly. At this time, I would like to remind everyone, in order to ask a question over the phone, please press star then the number one on your telephone keypad. Again, that is star one on your telephone keypad. Your first question comes from the line of Manav Gupta from Credit Suisse. Please ask your question.
Good morning, guys. Congrats on the big beat. Somewhere in the mediocre beats of 1Q, we were all hoping there would be a big hidden beat, a PSX-like beat. I'm very glad to see you guys deliver it. What was really good about this one was also the fact that last quarter you had Big Spring and Krotz delivering the beat, this time it was Tyler and El Dorado. The entire portfolio is working. My question is more on the midstream side. Uzi, when we look at the Big Spring gathering project, management and investors both see an eye to eye on it, right? It's a great project. Everybody loves it. The views on PGC were always a little divergent. Delek management made a very strong case for it, investors really never fell in love with it.
That's why when it did not proceed, the stock actually outperformed. What I'm trying to understand is how do we ensure that the next midstream project, which replaces PGC, looks more like the Big Spring gathering project or a project which investors like right away versus management being forced to make an extra effort to bring investors on board. Any comments you could offer in that direction?
Well, first of all, thank you, Manav, for the kind words. The team really worked really hard here over the last few months to make these initiatives happen. I'm very proud of what we achieved. Vis-a-vis your question. The long-haul strategy is something that we need to clarify, and we probably didn't do a good job last time with PGC about the long haul. Our intent all along is to use the excess barrels that we get from our gathering to utilize and to move these barrels both to Midland and to some other places. Obviously, we don't want to destroy our own market. Our commitment, and all along it was our commitment, that we will not enable new projects.
We want to make sure that we are supporting our producers, and the long-haul project should be at least 5 to 7 times EBITDA, and that's on a fully funded project. Obviously, as we mentioned in the past, we're looking at project financing as well, which if we do it at 60% or 70%, the return if you take the 5 to 7 times EBITDA, the return will be pretty healthy. Lastly, I want to emphasize what we just said, that there are several announced projects. We're looking at a few of them, and we will make a decision about them when the time due, and we'll notify the market.
Thanks for those. Uzi, a quick follow-up. DK leases pipes from HEP and has an agreement with HEP that expires somewhere in 2020 if I'm correct. Any comments if you plan to renew it?
Well, the HEP agreement was something that we got from Alon. It expires, I believe, by the end of this year. We did work with several prospects how to go about it, and we are very close to making a decision to go with one option, and we'll notify the market once we do so.
Thanks, Uzi, congrats on the beat again.
Thank you.
Your next question comes from the line of Neil Mehta from Goldman Sachs. Please ask your question.
Hi, good morning. This is Carly on for Neil. Thanks for taking the questions. The first one is just on Midland spreads. I think the expectation is still for Midland diffs to narrow as we move through 2019 as more pipes come online. We've seen those widen more recently. Can you just talk about what you think has driven the recent moves in the diffs, and then how you expect Brent Midland to trend in 2019, 2020?
Well, Carly, thanks for taking the time to ask me questions. The diff in the second quarter and probably early third quarter are wide because we are balanced now. As we get more pipeline, we expect the diff to narrow in Midland. However, I want to emphasize something here. That's all dependent on one big thing, the offtake capacity at Corpus. I'm not sure that the situation in Corpus is clear, and if the terminal in Corpus and the docks in Corpus are ready to take some of these barrels. We may see another wider diff going to the fourth quarter and the first quarter before things will sort themselves out with the Corpus situation. The Corpus situation is pretty much a convoluted situation at this point with several pipelines trying to connect to very few active terminals. That's one thing.
Now, it doesn't change the fact that in our mind, in the long term, and that's our strategy, in the long term, the situation of being close to the barrel, and as we know, the gathering system in Big Spring, and we saw how good it did this quarter, the gathering system in Big Spring will allow us to enjoy the quality of the barrel. By the end of the day, all these barrels need to be exported, not to the Gulf, but somewhere in Europe or Asia. By the end of the day, the diff that we are looking at is much more impacted by the Midland Brent versus Midland WTI.
That's great. Thank you. Appreciate the thoughts on that. The follow-up is just around cash flow. Looked quite strong this quarter. Just wondering, one, if there was any working capital impact to call out in that number. Also just wondering if you can talk about views on capital returns for the rest of the year following another strong quarter on both the buyback and the dividend here.
Sure. Good morning, Carly. First, I'll start with the cash flow. There was some headwind to the cash flow. We built roughly 800,000 barrels of inventory in the Tyler Refinery. That was basically offsetting the great cash flow in the quarter. With that being said, even with that, it was a very strong quarter for Q1. As of capital return, as you know, we are committed to return excess cash to shareholders, this quarter was no different. As results came stronger than even what the market anticipate, materially stronger, we upped the buyback this quarter to $60 million, on top of it, we also increased the dividend. No change in our direction there.
Great. Thank you.
Your next question comes from the line of Phil Gresh from JPMorgan. Please ask your question.
Yes. Hi, good morning. A couple follow-up questions or I guess clarifications. One would just be on the long-haul pipeline. I know it's already been asked about. I'm just trying to think a bit maybe mathematically about this. In your slides, you're implying $150 million of midstream EBITDA improvement, about 50 or so of that is the Big Spring gathering, so it'd be $100 million, I think, still embedded in there for the long-haul pipeline. You mentioned a five to seven times build multiple. You're also talking about potentially getting in on an existing pipeline. Would it be your expectation that you'd still be able to achieve something like that? And would that be the order of magnitude of cash we should be thinking about? You also mentioned project financing, so I'm just trying to tie this all together. Thanks.
Good morning, Phil. There's one missing point in your question, which is the growth in the gathering system. We just need to remember that the gathering system continued to grow. We upped the EBITDA this quarter to $40 to $50 million, slightly. We have more and more producers coming to us and more and more acreage dedication. I wouldn't assume that the EBITDA coming from the gathering system will stick to $40 to $50 million. That's one thing. We see more acreage and more barrels coming our way than we expected. By the way, the growth in the Permian Basin is a little better than what we expected at the beginning of the year. We thought 700,000 barrels. We probably think now closer to 800,000 barrels this year, maybe even a little more. That's one thing. Second, about the long haul.
The long haul, we were very clear in the past, we said, not more than five to seven times EBITDA, that's without the project financing. Obviously, that's fully funded. We still need to make a couple of decisions here, how we go about this, because we certainly don't want to enable a new pipeline. Also, we want to make sure that we are picking the right people to go with.
Right. Okay. Second question on the quarter. Obviously, very strong quarter. If I look at El Dorado, for example, the gross margins there were just well in excess of our expectations. In your press release, you talked about being able to run full amounts of Permian barrels despite the downtime there. Was there an element of reselling Permian barrels in the quarter? I'm just trying to make sense of such a strong result despite the downtime.
First, as we enter into the quarter, we did manage our inventory slightly different going into the turnaround. In the El Dorado refinery, we basically lifted some of the hedges around the J. Aron agreement. As prices come up throughout the quarter, we hedge them internally. There is a profit taking there from managing the inventory, as we mentioned on the cover of the press release. Second, we did sell during the quarter products that we produced in the prior quarter, that provided, I would say, a tailwind to the quarter. As Keith suggested during the script, Uzi, Keith, and Danny Norris suggested during the script, some of it will be reversed in the next quarter, roughly $12 million. Overall, if you look at the amount of crude we ran in the quarter, almost the majority of it was WTS Midland and local crude.
We bought basically no WTI, which we supplement sometimes the refinery. That was the ability to run fully and utilizing all of the 200,000 barrels a day that we have across the system. I can't say that we sold barrels. We just ran the right barrels, enjoyed the inventory benefits, of course, a very low RIN environment. As you know, the prices of RIN came down to, at least the ethanol RINs, to almost $0.12, $0.14 a RIN towards the end of the quarter, which really benefited the refinery.
Okay, thanks. I'll turn it over.
Your next question comes from the line of Matthew Blair from Tudor, Pickering, Holt & Co.. Your line is now open.
Hey, good morning, everyone.
Hey, Matt.
Assi, it sounds like there's a few moving parts on the inventory picture. You had the LCM benefit of $52 million. You sold some inventory for $61 million. I think there might be a third portion here. What about the FIFO benefit at El Dorado, Big Spring, and Krotz? Was there a positive tailwind here on margins in the quarter? If so, can you break out the FIFO versus LIFO impact there? Thanks.
Sure. Let's start with the effect. We had an inventory benefit on the actual results, not the adjusted results, of $112 million. Of that, $52 million was LCM, low cost of market, which we adjusted out. We left with roughly $60 million of FIFO gain, FIFO or LIFO gains across the system, we actually called it out in the press release on the second paragraph. Results were benefited basically from $62, the adjusted results from $60 million on the inventory. Basically, historically, all of Delek inventories were hedged at El Dorado, Krotz, and Big Spring with J. Aron. Towards the early Q1 of this year late last year, we lifted some of those hedges with J. Aron, we put them back across the year as we manage our inventory.
That was a very good benefit, that's part of what we call the inventory management. I will point out, though, that even when you take out the $60 million, the results are still extremely favorable. As we mentioned in our bridge in the slides, commercial did an excellent job during the quarter by basically getting better netbacks across the board, buying cheaper barrels across the board, on top of it, we're able to renegotiate some intermediate product that really benefited our quarter. As you can see, we're now comfortable saying that in a much different environment today, I would say less crack spread, lower Midland diff, we can generate closely $900 million of inventory. I think the missing part is actually how commercial acted this quarter.
Okay. Sounds good. The $61 million, I guess, inventory gain, are you able to split that out by refinery?
We have that between the refineries, but I think it's better that we'll report it separately. I don't want to go into specific detail this quarter at this point.
Okay. Sounds good. Thank you.
Your next question comes from the line of Doug Leggate from Bank of America. Your line is now open.
Hey, guys. Good morning. This is Kalei for Doug. Just have one question on the Permian Basin. Obviously, demand there for fuels is very strong. Wondering if you can talk about the supply-demand balance for that market, and whether any impact is expected as peers extend their reach into Central Texas.
Are you talking about the product balance or the crude balance? I assume product.
Yeah, the product balance.
Yes. Obviously, continues to be very strong. As we know, a couple of companies, or actually one project was announced to expand to bring, I believe, 20,000 barrels or something like that, 25,000 barrels to the region. That will happen sometime in middle of 2020. We are not as concerned, and I'll be clear why. Still bringing it from the Gulf is $0.09. At any given moment, $0.08 or $0.09. Even if somebody signs a take or pay or T&D, and you look at it as a sunk cost, there is the other portion of the pie that people need to pay $0.08 to $0.09 to bring it up. I do believe that we will continue to see very strong margin because we basically have a long-term agreement with different people.
We have a wholesale branded system over there that we don't expect people to change. If anything that we need to be comfortable with is the Big Spring netbacks.
That's awesome. Thanks for answering my question.
Your next question comes from the line of Brad Heffern from RBC Capital Markets. Please ask your question.
Hey, good morning, everyone.
Hey, Brad.
Uzi, I just wanted to beat the dead horse a little bit more, on the pipeline, can you just clarify what exactly the opportunity set is for that? You mentioned that you don't want to support another new build pipeline, are you talking about buying into one of the projects that's currently in flight, or are you talking about buying into an existing pipeline that's already online?
We have several options, since we are in the middle of thinking about that, I would leave it to the comments we made earlier. I'm sure it will clarify itself over the next few months.
Okay, sure. You guys talked last quarter about progressing a new DKL drop with the Krotz Springs assets. Can you give an update on that? Maybe more broadly, just your thinking on the MLP in general right now.
Assi, do you want to take that one?
Sure. For the Krotz drop-down, we continue to look into the best way to do it, taking into consideration the agreements and the type of the assets. We'll probably be able to discuss it with the market, or at least on our decision, sometime next quarter. We still think we'll be able to accomplish the drop by year-end. As of the MLP market, the market is still not as favorable. With that being said, we were very encouraged by the ability of our peers to access the capital markets in the last few weeks. We do see some, I will say, strength and appetite from investors to buy into those units.
Okay, thank you.
Again, if you have any questions at this time, please press star followed by the number one on your telephone keypad. Again, that is star one on your telephone keypad. We'll pause for just a moment to see if there are any additional questions. There are no further questions at this time. I will turn the call over to the management. Do you have any closing remarks?
Yes. Thank you, Lori. I want to thank my friends around the table here. You analysts and investors for supporting us over the last quarter. I'd like to thank the board of directors of Delek US Holdings for helping us making it happen. By the end of the day, without their support, we couldn't do it. Mainly, I'd like to thank every employee of this great company that contributed to this, another wonderful quarter that we just had. Delek US has a bright future. We'll talk to you soon. Thanks.
This concludes today's conference call. Thank you everyone for your participation. You may now disconnect.