Good morning. My name is Pasha. I will be your conference operator today. At this time, I would like to welcome everyone to the Delek US Holdings Q2 2017 earnings call. 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 followed by 1 on your telephone keypad. If you would like to withdraw your question, simply press the pound key. Thank you. I would now like to turn the conference over to Mr. Keith Johnson. Please go ahead, sir.
Thank you, Pasha. Good morning. I would like to thank everyone for joining us on today's conference call and webcast to discuss Delek US Holdings' second quarter 2017 financial results. Joining me on today's call is Uzi Yemin, our Chairman, President, and CEO, Kevin Kremke, CFO, and other members of our management team. As a reminder, this conference call may contain forward-looking statements as that term is defined under 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 our filings with the Securities and Exchange Commission and in our latest earnings release.
Actual operations or results may differ materially from results discussed in the forward-looking statements. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events, or otherwise. On today's call, Kevin will begin with a review of the financial performance for the quarter. I'll turn it over to Uzi for a few closing strategic comments. With that, I'll turn the call over to Kevin.
Thanks, Keith. For the second quarter of 2017, Delek US reported a net loss of $37.9 million, or $0.61 per basic share, compared to a net loss of $7 million, or $0.11 per basic share in the second quarter of last year. On an adjusted basis for the second quarter of 2017, Delek US reported an adjusted net loss of $25 million, or $0.40 per share, compared to an adjusted net loss of $5.1 million, or $0.08 per basic share in the prior year period. A reconciliation of reported results to adjusted results is included in the financial tables of our press release.
Both reported and adjusted results in the second quarter of 2017 included a hedging loss of $31.7 million, or $0.31 per share after tax, related to a realized loss on a crude oil inventory hedging strategy associated with the J. Aron supply and offtake agreement at El Dorado. The hedges were entered into in late 2014 in anticipation of the expiration of the supply and offtake agreement in the second quarter of this year. We elected to extend the maturity of that agreement until April of 2020. The primary driver of the change on a year-over-year basis was reduced performance in our refining segment, which I will discuss in more detail in a few minutes. We completed the acquisition of the remaining outstanding common stock of Alon that we did not already own in an all-stock transaction on July 1st.
For the second quarter of 2017, our 47% investment in Alon USA resulted in a pre-tax income of $400,000, compared to a loss of $10.4 million in the prior year period. Delek's equity investment income from Alon was reduced by approximately $1.1 million for transaction costs that Alon incurred during the second quarter of 2017. Due to the timing of the completion of the acquisition on July 1st, Alon will not file a quarterly report on Form 10-Q or issue a press release to announce quarterly results. I would like to point out that Delek US provided supplemental financial data for Alon's second quarter performance on a Form 8-K filed August 2nd, 2017. Our operating expenses increased by $4.3 million compared to the second quarter of last year, driven primarily by increased outside and contract services.
General and administrative expenses increased $3.9 million on a year-over-year basis, mostly due to transaction-related costs. Finally, our income tax rate, excluding the non-controlling interest income associated with Delek Logistics of $5.7 million, was 41.6% in the second quarter of 2017. Turning now to capital spending, our CapEx during the period was approximately $15 million compared to $7.1 million in the second quarter last year. During this second quarter, we spent $11.2 million on our refining segment, $2.1 million in our logistics segment, and $1.7 million at corporate. Our 2017 capital expenditures are forecast to be $95 million, which compares to $46.3 million in 2016. This amount includes $63 million in our refining segment, $21.1 million in our logistics segment, and $10.9 million at the corporate level. This compares to our previous estimate of $89.2 million for Delek US prior to the Alon transaction.
During the second half of 2017, we expect to spend approximately $75 million related to the Alon operations acquired on July 1st. This equates to a 2017 forecast capital spending of approximately $170 million total. We ended the second quarter with approximately $572 million of cash on a consolidated basis and $250.2 million of net debt. Excluding net debt at Delek Logistics of $392 million, we had net cash of approximately $142 million at June 30th, 2017. Alon had approximately $250 million of cash and $564.8 million of total debt. On a combined basis at June 30th, the company would have had a projected capitalization of approximately $790 million of cash and a net debt position of approximately $600 million. If the net debt at DKL is excluded from the combined capitalization, the net debt position would be $208 million.
Now I would like to discuss our results by segment. In our refining segment, we reported a contribution margin of negative $14 million compared to a contribution margin of $40 million in the second quarter of last year. Market conditions improved on a year-over-year basis as the Gulf Coast's 5-3-2 crack spread increased to $10.86 per barrel for the second quarter of 2017 compared to $9.80 per barrel for the same period last year. Also, RINs expenses declined to $5.5 million in the refining segment from $12.3 million a year ago. These improvements were offset by a combination of factors. First, there was an inventory charge of $14 million in the second quarter of this year, compared to a benefit of $12.9 million in the prior year period.
Second, this quarter included a net hedging loss of $29.5 million compared to a $17.4 million hedging loss in the prior year period. As I described earlier, this hedging loss includes the approximately $31.7 million realized loss on hedges associated with the J. Aron agreement that reduced performance at the El Dorado refinery. Third, lower margins on residual products, including asphalt, contributed to reduced margins at El Dorado. The combined Contango and Midland Cushing differential benefit declined by approximately $0.24 per barrel on a year-over-year basis. This consists of a favorable differential between Midland and Cushing that averaged $0.83 per barrel discount in the second quarter of 2017 compared to a discount of $0.18 per barrel in the prior year period.
Contango in the crude oil futures market that was $0.54 per barrel in the second quarter of 2017 compared to Contango of $1.43 per barrel last year. Now I'd like to review our logistics segment, which is comprised of the results from Delek Logistics Partners. Our logistics segment contribution margin was $31.7 million in the second quarter of this year compared to $30 million in the prior year period. On a year-over-year basis, improved performance in the West Texas wholesale business offset lower performance from the Paline Pipeline and SALA Gathering System. I will now turn the call over to Uzi for his closing remarks.
Thank you, Kevin. First, I would like to thank the employees of both Delek and Alon for their efforts to close the transaction on July 1st. We are very excited about the future of the combined company and look forward to working with both organizations as we integrate the operations. We are on track to create approximately $95 million of synergies in 2018. Integration is moving forward with efforts underway to apply best practices of both companies to the combined organization. In addition, our teams are focused on unlocking the value of approximately $78 million of logistics EBITDA to future potential drop-downs to DKL. We believe that our company is well-positioned in the Permian Basin with approximately 200,000 barrels per day of access or approximately 75 million barrels a year.
By partnering with DKL, we can utilize our logistics system to support this larger operation through crude oil and light product initiatives in the future. Based on June 30th, the combined Delek and Alon cash balance was approximately $790 million. This financial flexibility should support our efforts as we move forward with the integration and evaluation of potential growth opportunities while remaining focused on creating long-term value for our shareholders. With that, Pasha, would you please open the call for questions? Pasha?
Ladies and gentlemen, as a reminder, in order to ask a question, please press star followed by the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question is from the line of Roger Read.
Sorry, I had to get the mute off there. I guess I'd like to get into what exactly we should think about the performance of El Dorado. Kind of a tough quarter here. I know you called out the non-clean products, but would've expected a light crude refiner to have done a little bit better in that region this quarter. Just curious if there was anything else that went on there.
That's a great question, Roger. Good morning. We didn't want to go on the press release with the noise that we had in El Dorado this quarter. All over in El Dorado, we had $12 million, if you will, of charges and stuff that usually doesn't happen. Let me call these three components. The first one, we had a true-up of some benzene credit that we bought three years ago or a couple of years ago. The market on benzene credit went down, and we bought that two years ago with much higher price. We still have the credit, but we marked it down. That's a non-cash event. That's around $4 million. Also, we had Colonial impacting us and the netbacks along the Colonial, which since then improved by $4 million.
We did say the asphalt impact, we could quantify it for you guys, it's around $5 million. Altogether, we're talking about $12 million, $13 million. We round it down to $12 million. If you take that $12 million and you apply it by barrel, you'll get the difference in why there was so much noise in this quarter that shouldn't exist in other quarters.
Okay. Yeah, it looks transitory for the most part.
That is correct. When Keith will talk to you guys and other investors, he will explain that we didn't want to go into much details in the press release or in the conference around that, but that $12 million are certainly missing in El Dorado for the quarter. Obviously, we don't expect them to continue in the future. For sure, the markdown of benzene credit shouldn't happen anymore. Actually, it's a benefit of these credits, and they went down.
Okay, great. I know you're probably a little early in the integration process to give us a whole lot to think about different than what's been laid out with the Alon acquisition. From a cash standpoint, like you called out Kevin earlier on the call, really strong balance sheet here. Uzi, where do you think you are in terms of changes to shareholder returns, whether it's a higher dividend, share repurchase? What's the way to think about that process?
Roger, you know that we are early in this process. We said very strongly in our comments, our prepared comments, that the synergies that we see, we don't feel that we're coming short of these synergies. Actually, we are very encouraged with what we see, and we expect to start seeing some benefit in the near future. With that being said, the third quarter started pretty nicely. Margins are good. The synergies are going our way. Fourth quarter is doing fine with Midland being $150 under. If this continues, we will need to consider very carefully if we want to start being more aggressive via our buyback program, which we have. We need to be a little more patient with that, we are pretty optimistic about it.
Okay, great. Thank you.
Your next question comes from the line of Theo Grish.
Yes, hi, good morning.
Good morning.
First question, I just wanted to clarify the capital spending numbers that you gave. I think you said $75 million for the ALJ assets in the second half. Is that correct?
That is correct.
Okay. I think, obviously things change, standalone ALJ was $80 million for the full year previously. Maybe you could just elaborate on what types of things you're spending money on in the second half of the year for ALJ.
Well, as you probably saw, the Big Spring refinery is about to sign a consent decree. That will require some projects in Big Spring. Also, as we are looking forward, and that's more important, on the Krotz situation, we know it needs attention. We haven't decided to do everything, but we're looking at it very carefully. We have a program that will try to improve Krotz significantly, and we wanted to come to the market and say that there is a possibility that we'll start spending money on this facility.
Sure. Okay. Second question is just with the potential drop-down through the second half of the year. Is your expectation at the DK level that it would be 100% cash proceeds? How are you thinking about debt-equity mix? Is there any circumstance where you would take units?
If DK-
Yes.
As we see today, probably not.
Okay, 100% cash. Okay.
Everything can change. The market can go up or down, but as we see it today, probably not.
Okay. I guess, and I know Roger kind of asked this, but maybe a slightly different way to ask it would be, how do you think about leverage, pro forma leverage moving forward, and where you'd be comfortable having it? I know there's some balls in the air here, ALDW, and maybe additional spend across and other things.
Yeah, that's a great question. Excluding DKL, we never want to be more than one time.
Okay. Got it. Okay, that's it for me, thanks.
Thank you.
Your next question comes from the line of Paul Cheng.
Hey, guys. Good morning.
Hey, Cheng. Good morning.
Uzi, that curious that maybe it's way too early. Is there a timeline that you would put for the resolution for ALDW?
It's too early to discuss it. We're obviously looking at that. We said all along, it doesn't make sense to have three public companies, or actually it used to be four, now it's three. Also, it depends on the returns, and if the ALDW doesn't make sense, we already proved the market, that we can be patient. It makes sense, obviously, to consolidate that thing, but it needs to make sense also from economic standpoint.
Sure. Why at this moment that you do not have any definitive timeline that you will be able to share?
we are doing the work that we can pull the trigger, the trigger, it depends on the market condition. It's not that we are sitting on our butts and do nothing. We are doing the work.
we are obviously not going to overpay for ALDW. We need to be patient.
somewhat similar question that in terms of the timeline for your evaluation for Krotz Springs, that has always been probably the weakest asset. You were talking about that you may want to spend some money, but what kind of matrix you're going to measure them against, and how much time you're going to give that facility before you may decide that whether that it should be a continual operation?
That's a great question, Paul. As we told the market, I told you privately in the past, there are three components to Krotz. First, the cost to bring the barrels to quote, not the barrels themselves, because some of them are actually Midland. The problem is the cost to bring it over. Second, is the operation itself, which requires capital, as you know. Third, the sale of the product that needs attention as well. We have a full team already sitting and thinking about these three components. We meet on a regular basis, we need to see if we can come to a resolution that we can find a way to improve it. Right now, I am more optimistic about it than I was in the past, I don't want to declare any victory or to be ahead of myself in that area.
I think you're probably well aware that the IMO 2020 is probably going to make it very challenging for a facility with the current configuration of Krotz Springs. It's either that you're going to make the investment there to try and deal with the high sulfur product or that maybe that you should really consider shutting that down.
Well, I wouldn't jump into conclusion that we need to do a high sulfur or low ultra-low sulfur diesel in Krotz. If you remember, or maybe let me refresh your memory. We have access capacity both in Tyler and in El Dorado. We already have a project that is working. We just now started that we are selling in Tyler, ultra-low sulfur diesel barrels to Mexico.
The netbacks are pretty healthy over there. I wouldn't jump into conclusion that we need to put that investment in place. I'm very well aware of the 2020.
On retail, is that going to be viewed as internally a core part of your long-term portfolio or that you will be looking at to monetize it given the continual very strong valuation on the market for asset being changed? How should we look at the retail inside your portfolio?
Well, as you know, we weren't afraid to monetize our Delek Retail few months ago, but the Alon retail will need attention again. It will need some capital with megastores, building megastores. That's our plan today. We'll start building megastores and then prove to ourselves, because the market over there is very, very strong because of the premium activity. Down the road, maybe we'll look at it, but it's not on the table and not for sale for the next year or two.
Okay. Two final quick one. One is a simple accounting question. Given for the full year your average ownership for ALJ will be way over 50%. Is that at some point you need to restate the first half result to comply to the fully consolidated operation instead of partial consolidation using equity accounting in the first half? Final one, as the company become bigger, will you re-look at your hedging strategy and whether that you should continue to do hedging? I think we have seen many of your peers, especially the bigger one, they have tried and have been quite unsuccessful in their hedging strategy, and ultimately they just abandoned and not doing hedging.
Let me take the second one because it's a business question and not an accounting, and then Danny or Kevin will take the first one. The hedging program was very successful for us. I realize that we have a charge here of $0.31 because of our protection of inventory with J. Aron. Let's be clear. If we want to get out of these agreements, we really don't want prices to go up because then we will need to pay tremendous amount of money for that inventory. That was the idea behind that. Do I like to lose $0.31? Absolutely not. At the same time, do I want crude oil to go back to $80 and need to pay somebody $200 million against that? That's probably extra. That's probably something I don't want to do either. Let's just put that in context.
From a big picture standpoint, yes, there are quarters that there's noise against, and there are quarters that it goes with you. In the last few quarters, because of all this geo situation, it went against us. At the same time, it was very successful for us, and we will need to evaluate that every quarter, but that's another tool in our toolbox. In regard to the accounting question, Danny, I don't know if you want to take that one.
Sure, Paul, it's Danny. As you're aware, the investment that we had in Alon prior to July 1 was treated for accounting purposes as an equity investment. July 1 forward, we will be consolidating those Alon assets into Delek US, and be fair valuing that balance sheet and bringing that into the consolidated Delek US. Did that answer your question, or do you have a further question based on that?
When you report the 10-K on the full year basis, since you have way more than 50% equity ownership average for the year, do you need to, in the 10-K, report it as a fully consolidated operation?
We are still looking at that, Paul. Right now, our thought is that we'll just report the last six months of the year under fully consolidated, and then the 47% we had prior to that stay in equity income. That's still under review, not fully decided, but that's where we're at at the moment.
Thank you.
Your next question comes from the line of Neil Mehta.
Hey, good morning, team.
Hey, Neil.
Morning, Neal.
I'm sorry, Neil's question was withdrawn. We do have Chi Tao on line.
I'm sorry?
Chi, are you on?
Yeah, I am.
Okay.
Oh, I'm sorry, Chi. Good morning.
Good morning. Not quite sure what happened there. Okay, yeah, just a couple of questions here. On the upcoming midstream drop, do you have the EBITDA associated with the asphalt terminals?
We didn't disclose that just yet. We do have the EBITDA. Let us work on that a little more and then start thinking about dropping it down.
Okay. Any thoughts on the pace of the remaining drops going forward?
I'm sorry, what is the question?
The pace of the remaining midstream drops.
Yeah. 18 to 24 months.
Okay. Great. I guess another question back on El Dorado. The benzene credits.
Chi, just one thing. Let me have a correction here. We have it public, so let me give you the asphalt terminals. It's $11 million-$13 million.
Sure.
My apologies.
11 to 13?
Yes.
Okay. Thanks for that. Back on El Dorado. This benzene credit mark-to-market issue, is that truly one time, or is this going to float around every quarter?
I need to explain it again, and again, it's a little technical. El Dorado is short on benzene credits. We went ahead two years ago and bought a bunch of them. Price of benzene credit went down. We took the hit this quarter for all of that benzene credit inventory. It's a non-cash event. It used to be $1, now it's $0.20. If the market goes to $0.10, you'll have another charge, but nothing to this magnitude.
Okay. Technically, it's going to float every quarter. Is that correct?
Maybe $200,000, but not $4 million.
Okay. You mentioned, I think it came up, this IMO bunker fuel spec change. How are you thinking about that impact longer term on the asphalt market? You have a high yield of asphalt at El Dorado. You've got the asphalt terminals. Any concerns on that part of the business once the IMO spec-
Well, first, let's talk about the high yield of it. It's roughly 10%. We have in Big Spring 3,000 or 4,000. We're talking about 10,000 barrels out of 300,000. We're looking at that. We think this is an opportunity because the demand for asphalt is growing. Hopefully, the bill will pass finally. That's, of course, an area that we're looking at.
Your next question comes from the line of Neal Mehta.
Hey, good morning, team. Can you hear me?
Hey, Neal. Good morning.
Morning. I want to start off to talk a little bit about the $95 million of synergies. I know it's early. We're going to get a little bit more color later this year. Anything that you're seeing that would lead you to think that you can't achieve the $95 million of synergies run rate, or that there could be potential areas for upside, and can you talk about where those potential value drivers can be?
It's too early to talk about upside. We see no reason to believe that $95 won't be achieved.
Got it. All right. Then ALDW, I know there's the element of not wanting to broadcast the strategy here. Can you just talk about how you think about ultimately bringing that into the fold?
Absolutely. As I said, it doesn't make sense to have ALDW as a different public company. At the same time, it needs to make sense financially. We're doing the work. We'll be ready, if the market is right. If not, we'll wait. Similar to what happened with ALJ.
Got it. All right. On WTI Midland, we haven't talked about it a lot on this call. There have been some pipes that have been announced. Not a lot of them have been contracted out. What are your thoughts in terms of the differential from here, and let's break it up into two parts, kind of more of a near-term look and then a longer-term look for the spread.
Near term, I think that $1 to $1.50, we actually see the forward curve at $1.50 for the fourth quarter. Next year, I would say anywhere between over the next two years, $1 to $2. After that, I think it's around $1.50.
Perfect. Okay, last one, Uzi, is just, we've talked a lot about the MidCon, and the need for consolidation. You're doing a good job of starting that process. Obviously, Tesoro is as well with Western, but there's still a lot of little players out there. How do you think about the role of Delek in terms of consolidation and incremental M&A in the MidCon area?
Well, I didn't change my mind, Neal, that consolidation needs to continue. Not only in the MidContinent, several small companies, us included, as the time goes by, will consolidate with each other. Do I know of anything specific for Delek? Absolutely not. Delek will be a player. Delek is not afraid to be active in the M&A market. We believe with the synergies of Alon and again, it's early to say, but we're very optimistic with the things that we see now. That needs to still be played out in order to see how it is being translated to the M&A market.
All right. Great. Thanks, Uzi. Appreciate the time.
Appreciate you, Neil. Thanks.
Your next question comes from the line of Kaylee Akmani.
Hey, guys. Good morning.
Good morning.
Hey, just a couple housekeeping questions from me on the drop-downs. As it relates to ALDW, does the entity need to be consolidated into DK before you can execute on those planned drop-downs of the Big Spring assets into DKL?
We prefer that. Hey, guys, I hear myself twice. We do prefer that, but it's not a must. We can work around it, and we are doing the work both ways.
Got it. I understand. Separately, Alon currently reports asphalt as a standalone segment, and you guys are talking about stripping out the terminals in drop-downs. This essentially exacerbates those already pretty volatile earnings. Are you going to continue to report this segment as a standalone going forward?
We haven't decided that, but probably not.
All right. Thanks for your answers.
Thank you.
As a reminder, if you would like to ask a question, please press star followed by 1 on your telephone keypad. Again, that's star one. At this time, there are no further questions.
Thank you, Pasha. First, I'd like to thank my colleagues around the table for the hard work that they're putting into this company. I'd like to thank you guys on the phone and other investors and analysts for your interest in our company. Lastly, I'd like to thank our employees for the great work that they are doing for this company. Thanks, and we'll talk to you soon.
Thank you, ladies and gentlemen. This concludes today's teleconference.