Delek US Holdings, Inc. (DK) Q2 2018 Earnings Report, Transcript and Summary

Good morning. My name is Don and I will be your conference operator today. At this time, I would like to welcome everyone to the Delek US Holdings Inc. Q2 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. [Operator Instructions] Thank you. Mr. Johnson, the floor is yours.

Thank you, Don. I would like to thank everyone for joining us on today's conference call and webcast to discuss Delek US' second quarter 2018 financial results. Joining me on today's call are Uzi Yemin, our Chairman, President and CEO; Kevin Kremke, EVP and CFO; as well as 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're 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. As a result, 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. In addition to reporting financial results in accordance with generally accepted accounting principles or GAAP, we report certain non-GAAP financial results. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to the comparable GAAP results, which can be found in the press release, which is posted on the Investor Relations section of our website. On today's call, Kevin will begin with a review of the financial performance of the quarter before turning it over to Uzi who will offer a few closing strategic comments. With that, I'll turn the call over to Kevin.

Thanks Keith. For the second quarter 2018, Delek US recorded a net income of $79.1 million or $0.89 per basic share compared to net loss of $37.9 million or $0.61 per basic share in the second quarter of [technical difficulty] 2017. On an adjusted basis for the second quarter Delek US reported net income of $89 million, or $1.03 per diluted share compared to an adjusted net loss of $25 million or $0.40 per basic share in the prior year period. Our adjusted EBITDA was $199.1 million in the second quarter of 2018 compare to $4.2 million in the prior year period. A reconciliation of reported results to adjusted results is included in the financial tables of our press release. During the second quarter of 2018, results were effective by approximately $60.3 million or $0.52 per share after tax of non-cash items. This consisted of approximately $38.5 million or $0.33 per share after tax related to a non-cash inventory timing effect between the purchase price of Permian Basin crude oil and when it is realized as finished products are sold. In addition, results were reduced by non-cash charge of approximately $21.8 million or $0.19 per share after tax related to mark-to-market of our rents [ph] position. This net loan inventory position was the result of the previously announced waiver received for the El Dorado and Krotz Spring refineries in March, 2018. Taking these amounts into considerations results would have been higher by $60.3 million or $0.52 per share which would equate to approximately $259 million of EBITDA and $1.55 per share. On a consolidated basis, line items such as operating expenses G&A and interest increased on a year-over-year basis primarily due to addition of Alon. I would like to note that G&A expense included approximately $2.6 million of transaction cost. Our income tax rate excluding the non-controlling interest income of $7.6 million was 29.1% in the second quarter of 2018. For full year 2018, we expect the combined annual effective tax rate to be in the range of approximately 21% to 23%. Turning now to capital spending. Our capital expenditures during the period were approximately $54.7 million compared to $15 million in the second quarter of last year. During the second quarter 2018, we spent $33.7 million in our refining segment, $2.3 million in our logistics segment, $2.1 million in retail and $16.6 million at corporate. Our 2018 CapEx forecast is right at $228 million. This amount includes $176.5 million in refining, $18.9 million in logistics, $19.5 million in retail and $13.1 million at the corporate level. This amount for 2018 does not include approximately $75.7 million of midstream projects to enhance our position in the Permian Basin. We ended the second quarter with approximately $1.1 billion of cash on a consolidated basis and $910 million of net debt. Excluding net debt at Delek logistics of $732 million, we had net debt of $178 million at June 31, 2018.We had great financial performance during the second quarter of 2018, but I do want to point out that cash from operations was affected by combination of both price changes during the quarter and increased sales volumes resulting in a working capital headwind during the period. We actually had improvement in cash from operations in Q2, which would have been even higher without these working capital headwinds which we expect to reverse and come back to us in Q3. Our disciplined capital allocation program includes returning cash to shareholders, prudently investing in the operations and exploring opportunities for growth. With balances program with the goal of maintaining a strong balance sheet through the cycle, to further strengthen our balance sheet, we will reduce our leverage with the upcoming $150 million convertible debt maturity in September. We plan on settling the principal amount in cash and the premium amount with the DK shares for which we have a hedge in place that will result in zero dilution. You'll note that our diluted share count for the second quarter. There was approximately 2.6 million shares associated with this note. Next I would like to discuss our results by segment. In our refining segment which was just beginning to feel the benefit of the wide Midland differential in the second quarter of 2018. We reported a contribution margin of $177 million compared to a contribution margin of $16.9 million in the second quarter last year. The year-over-year increase in the contribution margin is primarily due to the addition of the Big Spring and Krotz Springs refineries from the Alon transaction. In addition to improve market conditions. As mentioned previously, there was approximately $38.5 million headwind related to an inventory timing effect between the purchase price of Permian Basin in crude and when it was realized, its finished products were sold. Market conditions as measured by the Gulf Coast 5-3-2 crack spread increased on a year-over-year basis to $14.37 per barrel for the second quarter 2018 compared to $10.86 per barrel for the same period last year. In addition the refining system benefited from the Midland WTI crude differential to Brent crude that was an average discount of $15.03 per barrel compared to $3.48 per barrel in second quarter last year. On a lag basis, the Midland WTI crude differential to Cushing was an average discount of $5.14 per barrel second quarter this year compared to $0.83 per barrel in the second quarter of last year. During the second quarter 2018, we estimate that the realized Midland differential and our reported results was approximately $3 per barrel due to the inventory timing effect. Our logistics segment contribution margin was $45.4 million in the second quarter of this year compared to $31.7 million in the prior year period. On a year-over-year basis, improved performance was primarily due to the Big Spring drop down that was effective March 1, 2018 and approved West Texas wholesale business and approved performance from the Paline Pipeline. Contribution margin in the retail segment was $18.6 million. Merchandise sales were approximately $90.2 million with an average margin of 31.7% and approximately $54.1 million of retail fuel gallons that were sold in average margin of $0.24 per gallon. As a reminder, there is no year-over-year comparison for this segment as it was acquired in the Alon transaction on July 1st, 2017. Contribution margin for the Corporate/Other segment was minus $11.8 million in the second quarter of 2018 compared to negative $37.8 million in the prior year period. Included in these results was a net hedging loss of $400,000 for the second quarter this year compared to a loss of $30.9 million in the prior year period. Again as a reminder, the prior year period includes a hedging loss of approximately $31.7 million related to a realized loss on a crude oil inventory hedging strategy associated with Delek US supply and offtake agreement. Before I turn it over to Uzi, I wanted to provide some guidance on our crude oil throughput for modeling consideration. During the second quarter, our total refining system crude oil throughput was approximately 290,600 barrels per day which was an increase from 261,350 per day in the first quarter of this year. For the third quarter, we expect crude oil throughput in the refining system to be approximately 290,000 barrels per day so essentially flat from Q2. In addition based on the forward curve on August 6, we expect to purchase our Midland crude at approximately $13 discount in Cushing in the third quarter. Taking into consideration the inventory timing effect we discussed, we estimate based on the forward curve that our realized Midland discount and our gross margin will be approximately $10.80 per barrel. I also want to note, that backwardation has increased in the market and we estimate that it will be approximately $1.30 per barrels which increases our crude oil cost. With that I'll turn the call over to Uzi.

Thank you Kevin and good morning. It has been just over a year since we completed the acquisition of Alon USA. During that time the team has done a great job to achieve the objective we laid out at the beginning. First; we simplify the corporate structure with the acquisition of Alon USA partner in February 2018. Second; by utilizing our strong balance sheet our average interest rate was reduced through the refinancing completed in March 2018. Third; value was unlocked by divesting approximately $162 million non-core assets on the West Coast and completing the drop down of the Big Spring logistics assets. Finally, our team capture approximately $131 million of synergies on an annualized basis through the second quarter. We're on track to capture approximately $130 million to $140 million of annualized synergies from this transaction. Which is significantly exceeded our original guidance of $85 million to $105 million. We build the Permian basin refining company with access to approximately 75 million barrels annually or 207,000 barrels per day of Midland crude oil which accounts for approximately 70% of our crude play. We continue to make progress on our initiative to get closer to the wellhead. As we gather more barrels to control our crude oil quality and lower our cost. We've added more Midland barrels to the Krotz Spring crude play as in previous quarter which has improved our overall performance. When we include the expected benefit of the Alki unit that is under construction expected operating results from cost should further support the future potential logistics assets drop down to DKL. We ended this great quarter with a cash balance of approximately $1.1 billion. During the second quarter, we purchased $20 million of our stock and have a total remaining authorization of approximately $160 million. On year-to-date basis, we've returned approximately $153 million through June 30, 2018 through dividends and share repurchases. We remain focused on creating long-term value as we balance return cash to our shareholders, investing in our business and aggressively exploring opportunities to develop the next stage of our growth. With that Don, would you please open the call for questions?

[Operator Instructions] our first question comes from the line of Mr. Brad Heffern from RBC Capital Markets. Mr. Heffern, you may ask your question.

Uzi, Plains yesterday announced slightly earlier timing for Sunrise in Cactus II. Can you just give your thoughts in general on how you see spreads trending and when you think that the transportation issues in the Permian might resolve themselves?

Obviously we're familiar with what Plains are trying to do. Let me take it in couple of stages, first of all people were thinking trucks or railcar can help eliminate some of the problem. Well based on our own experience, we tried ourselves to truck some and tried to maybe use our facilities to rail, well it's almost impossible to do so. So the idea of we can truck of millions of barrels probably doesn't exist. The second part is that, to my knowledge producers hesitate to because of what happened in 2015, 2016 hesitate to sign up for big take or pay commitments. So we do think that we will see great spreads at least to the end of 2019. Now if you look at forward curve even 2020 first quarter is starting to get weaker in the last few days. We sold, actually a week ago we sold already at minus two. Now and is it going to stay at minus 17, no. but I want to remind everybody that this quarter was based on realized of minus three. So the EBITDA we achieved is based on minus three. So we think we're very well positioned to a situation that the franchise will come in, even though we don't see it happening this month. The trading month for September is showing on the screen now minus 17 between minus 16 and minus 17 and fourth quarter is getting weaker.

Okay, appreciate that color, Uzi. Thanks. And then I guess just thinking about cash usage, you talked about it a little bit in your prepared remarks. Pretty modest purchase number this quarter just given the amount of cash generated. Should I read into that, that you're seeing a lot of opportunities on the M&A front or just how do you think about balancing, building cash for potential acquisition versus repurchases?

Brad, we were very aggressive and this was something we need to balance. We were very aggressive, we did the repurchase of the shares beginning of over the first quarter then we increased dividend. Then we need to continue to feed - this quarter decided that we're going to look take it on the conservative side and one, with it little bit on the lower side. It doesn't mean anything for the future [indiscernible] we're looking at, are thinking of increasing or more, we're getting more cash to the shareholders, if you will.

Okay, thanks.

Our next question comes from the line of Manav Gupta from Credit Suisse. You may ask your question.

Uzi, so I'm just trying to wrap myself around clean cash flow from operations number excluding working capital and any inventory issues. I think I'm getting to about $213 million in clean cash flow from operations, I just want to know how much I'm off by.

You're in the ball park, Kevin I don't know if you want to take that. But you're in the ball park, go ahead Kevin.

That's about right, Manav. So we actually have - we have a cash flow from operations improvement in Q2, if you look at where we ended in Q1 versus what we had in the earnings release last night or Q2, showing improvement and cash flow from operations. Like we said in the prepared remarks, we did have some working capital changes in the quarter. We're really driven by increased prices and increased sales on, so that number was about $80 million. Yes $175 million to $200 million is probably about the right ball park or sort of “clean and cash from operations for the quarter”.

So let's say it's 200 and then I take out about $50 million from your CapEx that's like $150 million in free cash flow in this quarter, on a $3 barrel realized Midland Cushing differential. Am I thinking about it right? $150 million free cash flow just on $3 differential?

On $3 realized that's exactly right.

So now - so the question which I'm struggling there is, now if I take that to 15 and what are your internal models telling you that if I keep that differential at 15, till Cactus II actually comes online because what Plains is saying is, Cactus II is only partial service in 4Q, 19. Right so if the spread remains at 15, how much cash are you guys generating for the next six quarters in your internal models?

Well, Manav, you don't even need to project something, we just told you that third quarter, very simple. This is realized, this is not - this is asset inventory effect for the third quarter, it traded at $13. We already calculated the inventory effect because we can do that. We already told you, it's 10.80 for the third quarter and we're telling now that for September it's at 17 and September is October because there is one-month delay. So the free cash flow is obviously going to be very big that's the reason we're so optimistic. That the numbers will continue to come in very strong, so if you're looking at fourth quarter right now and showing $15, but September is even better than the fourth quarter right now. September is trading so far and we've have another two weeks to go, $17,so enormous [ph] free cash flow.

I agree and our projections on both [indiscernible] sales are indicating that you could exit 2019 with $2.3 billion to $2.5 billion of cash on your balance sheet. That's just too much for a person who's known to acquire very strategically in downturns. We're not in a downturn, so why is this such a big cash flow built for the next six months?

Well first it needs to be up. Second, look what we're doing. We repurchased $153 million in the first six months, we increased dividend. We will continue to be aggressive giving cash to shareholders and we will continue to look at opportunities. I want to emphasize one thing, as we're getting bigger and bigger on the Permian side more opportunities coming to us in the Permian area. So don't be surprised if we're looking at other opportunities in the Permian.

Perfect. Thank you so much Uzi. Thank you for taking time and answering my questions.

Our next question comes from the line of Mr. Roger Read from Wells Fargo. Mr. Read, you may ask your question.

I was just wondering maybe along the line of Manav there. Uzi you talked about on the logistic side a lot of opportunities that we're finding is probably not worthy asset values really line up, right now. Relative to the last kind of two conference calls, where that's been discussed. Can you talk about maybe how valuation there either better or worse, or there is more or less opportunity? I think you kind of alluded to in the last comments there, but maybe what we should think about that way in terms of cash as opposed to potentially I think as Manav laid out, just buying back all your equity. That's a little tongue cheek there for you as well, of course.

Well that's a different discussion, I think I'm being recorded here Roger so I'm not going that one.

Yes certainly, just really on the acquisition front, what do you see out there?

Well first of all on the Permian there's a combination of acquisition and organic growth. You see that we set aside around $80 million for Permian, if you will, Permian logistics assets we're developing our plain here and as the plain matures, we come to the market with that. I want to emphasize that on the logistics side, still the market is under pressure we know, MLP out of favor and we will need to have hard look on that. Now we don't want and I want to be clear, we do not want to buy something just for the sake of buying something because we have the money. And we try to be disciplined in the past, but we do want to look at it. So that's a balance. Obviously we won't surprise you with an acquisition that is 12 times or 14 times or 16 times that's not who we are. So we just need to remember that this is combination of organic project acquisitions with the right pricing and returning cash to shareholders aggressively.

Okay, thanks. And then retail was an area where you originally started the company, you sold off that particular retail operation but it was result of years of investment improving the operation and getting a premium valuation. As you look at the Alon retail you had at almost a year not really kind of look at it, what is the path there. I mean is that one of the places we should presume some of those CapEx or I say it's CapEx, cash flow could go maybe a higher CapEx. Are there opportunities there or is it more of a - it's good enough and leave it alone as it is?

Well let me tell you, yes there are - well in the last three days we were in Big Spring and Midland, just spent three days over there. And the area is just booming. On the retail side, as you see we have record results on the retail side. I actually think that we will achieve record results every quarter now for the next few quarters just because the market is so strong in the areas that we're in. however the stores that are in the area including our stores are sometimes [indiscernible] stores that need some help and also building some, if you remember megastore like we did with Mapco years ago. So that scenario that we're looking at, we're not talking about here hundreds of millions of dollars. It's probably in the magnitude of call it 10 stores or eight stores to start with. So I wouldn't read much into it, in the great scheme of producing the amount of cash flow that we're producing.

Okay and then maybe just the last way to think about that. You've got one convertible debt piece that's going to go away here at the end of the quarter. What else would you do balance sheet wise as you look forward. I know it's not like a lot of debt necessarily has any prepayment value, but I was just curious is your balancing acquisition share repo stronger balance sheet and for a crude diff environment they all were very favorable for the near term, won't be here forever in terms of cash flow generation. Just how do you look at the overall picture there.

Well thanks again for asking about the convertible, that's an opportunity I neglected to mention that earlier. We will settle the convertibles with cash, the $160 million with cash by the end of September so that's $150 million. Obviously won't impact net debt but in our mind something you had the potential to be semi-equity obviously will go away with cash. So that's going without saying, the other thing we need to look at and does create a lot of noise. [Indiscernible] facility, one of the facilities expired. The West Coast facility that alone has expired two months ago, obviously we didn't renew it and we moved on with our live. The same thing or there are two expirations coming in 2020 for El Dorado and then the remaining of the system early 2021. We're looking at very carefully at this point as Kevin at CNI [ph] talked about that ,our intent is to sell that within our means and more traditional facilities, so that's the next step in that area.

Okay, thank you.

The next question comes from the line of Prashant Rao from Citi. You may ask your question.

I wanted to circle back on the capital allocation and sort of balance sheet cash expectations in, what you guys are seeing out there in the market? Specifically I think there's in terms of IMO 2020 I'm surprised [indiscernible] question yet on the call, but I understand that you guys have a lighter crude play and the story is very Permian focused and that's been the narrative and that's been working, but is there some way that maybe you could take advantage of expectation in widening out like heavy differentials, is that something you're exploring from use of cash perspective in terms of investments or how should we be thinking about that, as the Midland discount sort of tightens back up in transportation problem, at least in intermediate term. I think that might become the next leg of longer term cash flow story, so wanted your latest thoughts on that?

Absolutely, first of all just to remind everybody and I know that you remember that. Both El Dorado and Big Spring can go between light typical WTI that we see now and medium, sour, WTS or mass like so it's - if this one opens up then the two refineries can do it pretty easy, that's their configuration on that side. I do want to emphasize that obviously we're benefiting from Midland right now, but we're taking few steps around the logistics and around other areas to allow us to capture more when IMO showed up. I want to be and maybe I was too conservative when I thought that Midland cannot be minus 17 and now we're at minus 17, all of a sudden. I'm going to little more conservative here on the IMO. I'm not sure we will see the benefit that everybody expects as I think more and more people taking the steps, but again that we need to wait to see, if it comes or not.

Okay, a question then the synergies target just wanted to do ask where the - if there's anything in particular where the upside came from versus your expectations in the ways you guys have been beating the announced target it seems like QoQ for several quarters now, but just in this quarter in particular anything to call out and then going forward, what else is maybe there's dry powdering [indiscernible] backlog that maybe we're not counting.

Yes I actually think that, we haven't informed - I think we're filing the presentation today as well, saying investors in the next two days pretty much Krotz the board. I think we're seeing you guys next week. So on the commercial side, the new estimate is between $33 million to $40 million. On the operation side it's pretty much the same around $23 million to $25 million. Cost of capital what we've reported earlier $35 million and corporate little more between $36 million and $39 million.

Okay, fantastic and just one last one I'm going to take another stab at what Manav was asking earlier. I think previously you guys have called out sort of sensitivity on the re-incremental dollar on the Midland just to be honest, what that means in terms of EBITDA few months ago there's around if I remember correctly, every $1 being $75 million in annualized EBITDA, would you be willing to call out specific sensitivity number or is everything is little [indiscernible] right now?

Well that's exactly the number, the $75 million that's the reason we basically gave you what the - essentially it can move few pennies here, few pennies there because of inventory end of the quarter. But essentially we gave you Midland that you can more or less for the third quarter it's $10.80 so if you take that $10.80 times 75 million barrels divide by four, that's' the impact on the quarter of Midland. If you want to understand the incremental it's $7.80 times 75 million barrels divide by four that's on top of what you saw in the second quarter.

Okay, that's what we probably just wanted to make sure we're - confirmed. Thank you very much I'll turn it over.

The next question comes from the line of Mr. Phil Gresh from JP Morgan. Sir you may ask your question.

I guess I'll just follow-up right there, just to clarify on the back degradation component of that color that you gave in the prepared remarks, you that just be a modest partial offset quarter-over-quarter. I think you said $1.30.

That is correct, that's exactly. Phil we wanted to give you full disclosure. And we see backwardation in the market versus Contango like any other refinery, what the way we buy it, we will suffer from about 30 setback versus last quarter was Contango roughly $0.20 or $0.15. I think that's probably the more for everybody else. That's how everybody buys crude, but just wanted to [indiscernible].

Yes, no that's helpful and then for Kevin just on the cash flow color that you provided on the working capital. How much would you expect to reverse of what's happened in the first half in the back half and secondarily. We don't have the Q yet, but obviously the first quarter had a pretty big headwind on the deferred tax base. Just wanted to clarify how you're thinking about cash taxes relative to book tax rate on a full year basis, is there some reversal that happens there as well.

As of right now we're expecting the full working capital headwind to come, to fully revert back by year end. So we would expect from here on out essentially zero net working capital changes. And then on the cash tax piece, we're estimating about $40 million cash taxes paid in the second half of the year for full year.

$40 million is for the full year.

Yes in Q3 that will hit.

Okay, got it. And then as we think about this capital allocation piece, you mentioned the convert pay down, you mentioned you're looking at some M&A opportunities but obviously everyone is highlighting here that your cash flow generation probably still would exceed all of these things. So are the M&A opportunities you're looking at kind of modest in size. And is there any reason that you couldn't extinguish this buyback in the next two to three quarters anyway even if you're looking at these other things, given your positioning?

We agree. When we say nobody should expect us to write a check of all of sudden $1.5 billion or $2 billion for something, that's one perhaps - unless there's - well I shouldn't say nobody should expect that. Unless there's an opportunity but as it stands right now I don't see that opportunity knocking on our door. We were very conservative in the past and we will continue to be conservative on maintaining our balance sheet. However, let's be clear these - the numbers are pretty big here for upcoming quarters of the free cash flow. So there's no reason to believe that we won't look at it very carefully. Last quarter, we increased the dividend before that we did the special buyback, so there are other means to do it outside just going out to the market and buy day in, day out which - if we see opportunities like that to create value, the shares today at $51, if you remember we was from a loan, a big chunk from a loan is raised. I'm going by memory in the mid 30s. So just bear with us, we want to return cash, we're committed to that. We just want to do it in smart way.

Okay, thanks a lot.

The next question comes from the line of Mr. Paul Cheng from Barclays. Sir, you may ask your question.

Uzi, the utilization rate actually in the last several quarter has been very good. Do you think that is sustainable or that you're just being lucky and don't really have lot of downtime, that what have you done maybe somewhat differently than to achieve that?

That's a great question, as Kevin said earlier we expect the similar situation in the bearing something unusual happening, we expect the same thing in the third quarter. I think Fred and the team, did great job in proving reliability, we took care of the mid [ph] asset. Obviously in couple years ago, three years ago we had growth project but as we completed them our attention got back to reliability and as we control the quality of crude, bear [ph] and bear [ph] to our gathering and checking system. There's no reason to believe that we won't continue performing the way we perform. We do have a turn on coming for El Dorado in the first quarter of 2019, but until then we expect to run pretty smoothly.

And how big is the turnaround for El Dorado in the first quarter 2019?

In terms of dollars or in terms of I'll give you both.

The impact.

Downturn probably 35 and 40 days oil-to-oil, it's a major turnaround. And in terms of cost, we always budgeted $50 million. I would say call it $50 million to $60 million that's the number for the turnaround.

What unit is going to be down?

I'm sorry?

Which units going will be down?

The entire refinery will be down.

The entire.

Yes.

And Uzi, you're talking about one of the reason why you've been able to prioritize that you see more and more oil, you get on your sale. So what is the percent of oil there now? You post that getting by your sale.

I would say that we gather between West Texas in either places probably little more than two-third of our on oil.

So I presume that majority of that you're not getting, is it now you're seeing Krotz Spring or that is too spreaded [ph]?

Some of it, obviously Big Spring is the easiest place to do. So Big Spring is most of it, we do get some actually good portion in Tyler and in El Dorado and now we start to do the same thing as at Krotz.

And what is your target for the next say 12 to 18 months, do you think you can get to 80%, 90% or that's too aggressive.

No, we can. We absolutely can.

Okay, and maybe couple questions for Kevin. Kevin, earlier that when you said $38.5 million order inventory timing is that solely related to J. Aron or that's also including on the three-month impact.

No that has nothing to do with J. Aron that is simply the inventory timing effect between when we purchased Midland crude and when it actually shows up in our P&L. so there's just a physical lag between when we purchased crude, it goes in the inventory and it gets processed through the system and then there's also a FIFO effect on top of that. So if you recall that we've got - we account for inventory with the FIFO method, every refinery except for Tyler. So you're seeing additional delay between purchased crude and kind of the realized impact in the P&L due to that effect.

But the FIFO effect sensory is because of J. Aron, right? Because you're under LIFO for your company.

Yes that's exactly right.

So I'm trying to separate out between the 38.5 what is related to FIFO, which is related to J. Aron and what is the other? Do you have the breakdown?

We didn't it break it down that way, but it's a combination of both the FIFO and just the physical lag in the way we process crude through our inventory system.

Yes because the number that I've some difficulty to fully reconcile earlier that, according to UC [ph] on the spot the Midland is kind of over $8 and that on the three-month over five and your actually realized is three, so the difference between the spot and what you realized is over $5 and you process over 291 day, so that should be $90 million, you talk about everything. So I'm trying to understand what the 38.5 really mean.

I don't know where we got the $8. There's no, I don't think that there's $8.

On the spot, I mean spot price on.

Yes but to remember.

Approaching I guess eight, over eight.

You're right. But we buy it, always we buy it one month ahead of time.

I understand that, that's why I'm trying to understand what is that 38.5?

Okay, the 38.5 is, we buy one month ahead of time. Okay. So if you look at not the spot, but the part that we just mentioned its $5 we bought one month ahead of time. Then we're actually processing the crude one month after we actually bought it. For the $5 that we bought, we're actually now it takes another month to process it. So if you want to calculate back on the envelope, even though we did you the number of $10.80. What you need to do, is to do - the not the spot but the forward month average, but you need to start one month earlier. So for the month of - for the third quarter what you need to do is to take June as it was traded in May, July as it was traded in June. And August as it was traded in July, do the average and you'll get very close to number I just told you.

Yes, I think that - so that means that number is basically the difference between the three month defense [ph] so in what you realized, is that fair to carry that later?

Exactly. Now obviously that will come back in the future because the system doesn't change. So if tomorrow morning Midland will go from 17 to 15, you all of a sudden see a benefit to that of $2.

And Kevin I missed when you were talking about the hedging that, what do you have any realized hedging gain or loss in the quarter?

We have a little bit of hedging gain and loss. However I want to, that's a good point for me to say, that we do look at hedging of the Midland differential, a little bit with the so far. I would call it little less than 10% of the production. It's pretty much. It fluctuates obviously. We're talking about 18 months from now. So we're around the money, we're going to - once it start because we did forward we will start providing you with information, but we do look at hedging a little bit of the Midland forward curve.

All right, then how about in the second quarter we saw, did we have any realized hedging gain or loss?

Hold up for a second, let us look at this.

It was on our table, at the back of the release.

Yes, so if you look on Page 19 of the release Paul, $9.9 million of unrealized hedging loss from the quarter.

Right, I'm talking about realized. I saw that realized. I'm particular with - do you have any realized hedging gain or loss?

[Indiscernible] why don't we look at that number and give it to you, is that okay?

Yes that's fine. A final just Q is that, Uzi when people talking about the cash return some of your competitor debt they have a very explicit way of saying I want to [indiscernible] cycle 30% of the cash flow or 40%. Is that a policy or strategy that you will adopt or that you think you need more flexibility so this is not for you?

That's great question, Paul and I'm going to answer it very directly. Some of our peers that are doing great job trading value for shareholders are much bigger company than us. And they're not based on growth or acquisition and we feel that the value we create to our shareholder is by combination of growth as well as return in cash. So why we want to return cash and be aggressive when we have a - cash flow like now. We still want to maintain [indiscernible] if you will to make sure we can be nimble and to continue to grow our company, like we did with the Alon acquisition or before that the El Dorado acquisition.

Thank you.

Our next question comes from the line of Mr. Paul Sankey from Mizuho Securities. Sir you may ask your question. Mr. Sankey you may ask your question. The next question comes from the line of Mr. Neil Mehta from Goldman Sachs. Sir you may ask your question.

So first question I had given how big or your gathering business has become, you guys are on the spear tip of what's happening in terms of Permian oil production. Given what you're seeing in terms of at the differentials, have you seen any slowdown in terms of activity from your producing customers or suppliers?

Actually the opposite, the way the system works and I'm getting here little technical, but I'll do it anyhow. At the beginning of every month we get projection of production from producers and we do business with many, many of them. So once we get that production plan, that's how we plan our purchases. And every month you by the end of the month, it comes whatever it comes because there was slow down or speed, but that will just go with the flow. Well in the first quarter what we saw the first one, what we saw because of the, if you remember the freezing West Texas huge slowdown. Well now we're in the middle of the summer and just booming and every month what we see from producers is that they call us and say, okay I was wrong. Can you take little more oil? And then obviously once they do that, then you see towards the end of the month, as the differential are tanking and that leads to the weakening of the near following month. So absolutely no slowdown.

Okay, that's helpful. And in terms of Brent WTI. We spent a lot of time talking about WTI and Midland, but you guys are also [indiscernible] to the Brent WTI differential. Cushing is really great basically the effective tanked bottoms here at this point. How do you see that playing out from here? Spread between Brent WTI. One would think that, we'll start to see Cushing inventories build back up and just curios on your latest thoughts there.

You're asking a great question, Neil. I was to emphasize one thing before I answer, just Brent WTI is that we look at Midland Brent which is obviously in access of more around $20, right now. And if Midland continues to do, what it does then Brent cannot go back to $15 in our mine [ph]. However, I do think that there's an opportunity, we do think that there's an opportunity for Brent WTI, to why there's a little bit in the fourth quarter and in the first quarter despite Midland being in such discount. So if you will, I would aim probably a $1.02 to the core and discount between Brent and WTI.

The last question I have is on Krotz. Historically this has been a problematic asset for Alon. This quarter you beat us on operating expenses to the downside and it looks like, it ran pretty well and realized decent margin. Can you talk about where Krotz is in terms of the turnaround because this is a sustainable type of run rate that you can drive performance from the assets and what type of crude were you able to bring into the facility because that's historically I think in the area, the great problem which is just getting discounted crudes into Krotz.

Neil, I'm going to say privately I told you a year ago that either with fixed cost or we'll do something with it. And we put a lot of effort, energy and sweat into this thing bringing crude to the refineries and then also increasing net backs. Obviously we have space on Colonial now. RINs are cheaper, so Krotz is enjoying that as well because of the synergies we combine the space between the two companies and let me just remind you that Krotz has actually positive yield not negative yield. So when prices of crude go to $70, $55 all of the sudden Krotz shows improvement. We still have ways to go, I want to be clear. First of reliability, we're working on it we still have a little tweaking even though we do have a great refinery management over there. The second thing is the Alki. The Alki is a big project, we need to complete it and we need to commission the unit. Sometimes early or in the first part of next year that we're bringing, now there are probably in today's market more than what we said, 35 to 40. We'll stick to 35 and hold 40, but - of EBITDA and then we need to get ready for IMO and maybe the opportunities around us and blending of different things, as Krotz has that opportunity as well. So I wouldn't be surprised if Krotz will continue to perform well for us.

All right, Uzi. Thanks a lot and see you soon.

The next question comes from the line of Mr. Doug Leggate from Bank of America. Sir you may ask your question.

This is Kalei on for Doug. So on the E&P side, there's been a few deals announced where producers are trading longer term margins for nearer flow strength. Wondering if there is any opportunities for DK to participate here? Where deal could potentially prolong to lighter spreads for duration?

Well if you do something like that, you do it away from the market. We do have several deals that we do cash deals and not paper deals, but we haven't done anything behind 2019. So if you ask about long-term behind 2019, we have not done it.

Okay got it. Just wanted to expand on one of Paul's earlier questions. Can you just expand a little bit on the $3 Midland differential on the quarter? I understand the accounting and the impact and the reporting the spread capture there, but it looked like it could have been higher. So my question was, was the buying of the crude perhaps weighted towards the front end of the quarter were the spreads were a bit tighter. And are there any issues that we should be watching out for when we're modeling out for 3Q?

I'll be very, very strong. We buy our crude ratably obviously we play with it a little bit, nothing that you pay attention to, we try to beat the spread just a little. Second we do not and I would ask the question that many times in the past I'll be very strong. Whatever you see on the screen, this is what we get. Not even one penny less. As [indiscernible] because of the gathering little more, but let's just leave it to that. Third; I don't know how you Kalei you got to that is weaker than what you expected. It's very simple. If you think as I said, the formula is very simple because we have inventory for one month and we buy one month ahead of time. So if you take May and you look at what June was traded in May and then you take what July was traded in June and then you take what August was traded in July, you do the average of the three, you will get to the - around there's little noise, but around the 10.80 that we provide you. If you do the same exercise for the second quarter, you take what April was traded, I'm sorry what March was traded in the February. What April was traded in March, what May was traded in April, do the average of the three, you will get to the $3 roughly.

Thanks for the breakdown there and last question, just on the refinery turnaround in 2019, if spreads were as wide as we think they're going to be, would you consider pushing that out to the following year?

No and I'll tell you why. It's very simple. If you remember, we have a system of $207 barrel a day. The refinery will down 75,000 barrels, we will play around with crude to have as much advantage crude going or cheaper crude going through the system. So while it is going to be down. We will try and in the pathway of - we were successful for the most part moving that cheap crude to the system somewhere else.

Thanks for the answers guys.

The next question come from the line of Mr. Silvio Micheloto from Mizuho. Sir you may ask your question.

Can you hear me?

Mr. Sankey, welcome back.

Finally, [indiscernible] Uzi.

I'm so excited.

I'm sorry about the early announcement. I'm trying to get used to new phones at Mizuho. Uzi, there's only one question I can possibly ask you which is, have you considered taking Delek private?

As you probably know many times, yes. However, first we want to continue to grow so if there's an opportunity for us to buy something cheaper than us then we probably shouldn't do that. However, as we look at the screen. We know that we're pretty cheap right now compared to our peers. So I wouldn't say this is something that was considered seriously lately, but if the opportunity comes we will be nimble to do so.

Yes it feels like you've got a lot of good opportunities in the Permian. I guess these gathering type, what is the nature of the opportunities there just industrially.

This pretty much what we're looking at from organic standpoint, we did a lot of work. People want to deal with the refineries directly and people want. There will be opportunities in the Permian. Don't be surprised if there will be some announcement over the last few quarters.

You've been a bit coy on the buyback but I get the feeling it's not because of the certain scale of the or rather it's not because there's huge acquisitions out there. It's just that you're, you know you're being somewhat circumspect. Can you remind us you tend to have a view of the intrinsic value of Delek? Can you talk a little bit more about buyback just to give us more to think about? Thanks.

Well honestly the buyback is now a key component. We were on the light side this quarter as we were looking at different options. But if and there's no reason that it's more mature because we see the cash flow coming in. as it comes in, there's no reason to believe that we won't be more aggressive. I do want to leave it I said in the past quarter and we know each other from many, many years. That I we want to leave some dry powder, if an opportunity arises.

Yes, that's understood. Uzi, I noticed it's past 11, so I'll jump. Look forward to seeing you.

The next question comes from the line of Matthew Blair from Tudor, Pickering, Holt. Mr. Blair, you may ask your question.

So Plains mentioned last night, they may expand the Red River pipeline by 100,000 barrels a day. It seems like additional WTI barrels into Longview will be positive for DK. Can you just talk about this opportunity here and would you consider being a shipper on the expanded line?

Well I won't be going specifically on specific lines here, not going to be professional but we do - as you know have a big hub in Longview. You're absolutely correct. So our opportunity is to bring more barrels to the hub and then by finish unloading the cost of the hub, it makes sense. I'll leave it to that Matt.

Okay and then two questions on hedging. So one on this Midland timing impact, shouldn't you have inventory hedges in place that would really account for this gap between when you purchase the crude and when you actually run it. And then two, you mentioned the sum approximate 10% Mid-Cush basis hedge, was that a negative in 2Q for you.

I'll answer the second question, first no. the answer is no, there was no well if I'm going by memory, well the answer is no. Not negative and not positive. On the inventory, we can but being a bigger company, it doesn't make us to spend money or something that doesn't mean much besides the counting because the cash would come anyhow. Why to spend money on inventory or hedging something that is completely paper. The moment - it's next month the differential will go from 17 to 15, all of a sudden there will be positive impact and not negative, so why to do that. It creates some noise, which we probably need to work on it from an accounting standpoint, but spending money on something that is accounting I don't know, I'm not sure that's something that we should do.

And the 38.5 timing impact, so that cash benefit showed up in your CFO in 2Q, right?

Right.

Okay, thank you very much.

This concludes our question-and-answer session. I would now like to turn the call over to the presenters for the closing. Presenters.

Thank you, Don. I would like to thank everybody for their great interest in us this morning. Thank you for the support. Both analyst and investors. I'd like to thank my colleague here around the table. With the great support they give me and give the company. I'd like to thank the executives and the Board of Directors, but mostly I'd like to thank each one of the employees of our company that makes this company so great. Thank you. We will talk to you in the future.

This concludes today's conference call. Thank you for your participation. You may now disconnect.