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DKL > SEC Filings for DKL > Form 10-Q on 8-Aug-2013All Recent SEC Filings

Show all filings for DELEK LOGISTICS PARTNERS, LP

Form 10-Q for DELEK LOGISTICS PARTNERS, LP


8-Aug-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Unless the context otherwise requires, references in this report to "Delek Logistics Partners, LP Predecessor," the "Predecessor," and "we," "our," "us" or like terms, when used in the context of periods prior to November 7, 2012, refer to Delek Logistics Partners, LP Predecessor, the Partnership's predecessor for accounting purposes. References to "Delek Logistics Partners, LP," the "Partnership," and "we," "our," "us," or like terms, when used in the present tense or in the context of periods on or after November 7, 2012, refer to Delek Logistics Partners, LP and its general partner and subsidiaries. Unless the context otherwise requires, references in this report to "Delek" refer collectively to Delek US Holdings, Inc. and any of its subsidiaries, other than Delek Logistics Partners, LP, its subsidiaries and its general partner. Those statements in this section that are not historical in nature should be deemed forward-looking statements that are inherently uncertain. See "Forward-Looking Statements" below for a discussion of the factors that could cause actual results to differ materially from those projected in these statements. You should read the following discussion of our financial condition and results of operations in conjunction with our historical condensed consolidated financial statements and notes thereto.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements reflect our current estimates, expectations and projections about our future results, performance, prospects and opportunities. Forward-looking statements include, among other things, the information concerning our possible future results of operations, business and growth strategies, financing plans, expectations that regulatory developments or other matters will not have a material adverse effect on our business or financial condition, our competitive position and the effects of competition, the projected growth of the industry in which we operate, and the benefits and synergies to be obtained from our completed and any future acquisitions, and statements of management's goals and objectives, and other similar expressions concerning matters that are not historical facts. Words such as "may," "will," "should," "could," "would," "predicts," "potential," "continue," "expects," "anticipates," "future," "intends," "plans," "believes," "estimates," "appears," "projects" and similar expressions, as well as statements in future tense, identify forward-looking statements. Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by, which such performance or results will be achieved. Forward-looking information is based on information available at the time and/or management's good faith belief with respect to future events, and is subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in the statements. Important factors that, individually or in the aggregate, could cause such differences include, but are not limited to:
our substantial dependence on Delek and its ability to pay us under our commercial agreements;

the timing and extent of changes in commodity prices and demand for Delek's refined products;

the suspension, reduction or termination of Delek's or any third-party's obligations under our commercial agreements;

disruptions due to acts of God, equipment interruption or failure at our facilities, Delek's facilities or third-party facilities on which our business is dependent;

our reliance on information technology systems in our day to day operations;


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changes in general economic conditions;

competitive conditions in our industry;

actions taken by our customers and competitors;

the demand for crude oil, refined products and transportation and storage services;

our ability to successfully implement our business plan;

our ability to complete internal growth projects on time and on budget;

our growth may be limited by Delek's ability to grow as expected;

operating hazards and other risks incidental to transporting, storing and gathering crude oil and refined products;

natural disasters, weather-related delays, casualty losses and other matters beyond our control;

interest rates;

labor relations;

large customer defaults;

changes in the availability and cost of capital and the price of availability of debt and equity financing;

changes in tax status;

the effects of existing and future laws and governmental regulations, including but not limited to the rules and regulations promulgated by the Federal Energy Regulatory Commission (the "FERC");

changes in insurance markets impacting costs and the level and types of coverage available;

the effects of future litigation; and

other factors discussed elsewhere in this report.

In light of these risks, uncertainties and assumptions, our actual results of operations and execution of our business strategy could differ materially from those expressed in, or implied by, the forward-looking statements, and you should not place undue reliance upon them. In addition, past financial and/or operating performance is not necessarily a reliable indicator of future performance and you should not use our historical performance to anticipate results or future period trends. We can give no assurances that any of the events anticipated by the forward-looking statements will occur or, if any of them do, what impact they will have on our results of operations and financial condition.
Forward-looking statements speak only as of the date the statements are made. We assume no obligation to update forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking information except to the extent required by applicable securities laws. If we do update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect thereto or with respect to other forward-looking statements. Overview
The Partnership owns and operates crude oil and refined products logistics and marketing assets. We gather, transport and store crude oil and market, distribute, transport and store refined products in select regions of the southeastern United States and Texas for Delek and third parties, primarily in support of Delek's refineries in Tyler, Texas (the "Tyler Refinery") and El Dorado, Arkansas (the "El Dorado Refinery"). A substantial majority of our existing assets are both integral to and dependent on the success of Delek's refining operations.
The Partnership is not a taxable entity for federal income tax purposes or the income taxes of those states that follow the federal income tax treatment of partnerships. Instead, for purposes of these income taxes, each partner of the Partnership is required to take into account its share of items of income, gain, loss and deduction in computing its federal and state income tax liabilities, regardless of whether cash distributions are made to the partner by the partnership. The taxable income reportable to each partner takes into account differences between the tax basis and the fair market value of our assets and financial reporting bases of assets and liabilities, the acquisition price of their units and the taxable income allocation requirements under the partnership agreement.


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Our Reporting Segments and Assets

Our business consists of two operating segments: (i) our pipelines and transportation segment and (ii) our wholesale marketing and terminalling segment.

Our pipelines and transportation segment primarily consists of assets divided into four operating systems: (i) our Lion Pipeline System, (ii) our SALA Gathering System, (iii) our Paline Pipeline System, and (iv) our East Texas Crude Logistics System (including the Nettleton Pipeline and McMurrey Pipeline System). These assets provide crude oil gathering, crude oil and refined products transportation and storage services in support of Delek's refining operations in Tyler, Texas and El Dorado, Arkansas. Additionally, this segment provides crude oil transportation services to certain third parties, including a major integrated oil company. In providing these services, we do not take ownership of the products or crude oil that we transport or store; and, therefore, we are not directly exposed to changes in commodity prices.

Our wholesale marketing and terminalling segment consists primarily of the following assets: (i) refined products terminals in Abilene, Texas and San Angelo, Texas, which we lease to Noble Petro, Inc. ("Noble Petro"); (ii) product pipelines in west Texas connecting the Abilene, Texas and San Angelo, Texas terminals to the Magellan Orion pipeline, which we also lease to Noble Petro, and (iii) refined products terminals in Big Sandy, Texas, Memphis, Tennessee, and Nashville, Tennessee. We generate revenue in our wholesale marketing and terminalling segment by providing marketing services for the refined products output of the Tyler Refinery, engaging in wholesale activity at our Abilene, Texas and San Angelo, Texas terminals, as well as at terminals owned by third parties, whereby we purchase light products from third parties for sale and exchange to third parties, and providing terminalling services to independent third parties and Delek.

Recent Developments

Amended and Restated Credit Facility

On July 9, 2013, the Partnership amended and restated the Delek Logistics Revolving Credit Facility by entering into the Amended and Restated Credit Agreement. Under the terms of the Amended and Restated Credit Agreement, the lender commitments were increased from $175.0 million to $400.0 million. The Amended and Restated Credit Agreement also contains an accordion feature whereby the Partnership can increase the size of the credit facility to an aggregate of $450.0 million, subject to receiving increased or new commitments from lenders and the satisfaction of certain other conditions precedent.

Borrowings denominated in U.S. dollars under the Amended and Restated Credit Agreement bear interest at either a U.S. dollar prime rate, plus an applicable margin, or a LIBOR rate, plus an applicable margin, at the election of the borrowers. Borrowings denominated in Canadian dollars under the Amended and Restated Credit Agreement bear interest at either a Canadian dollar prime rate, plus an applicable margin, or a CDOR (Canadian interbank bid) rate, plus an applicable margin, at the election of the borrowers. The applicable margin in each case varies based upon the Partnership's most recently available Leverage Ratio.

Hopewell Acquisition

On July 19, 2013, Delek Logistics purchased (the "Hopewell Acquisition") a 13.5 mile pipeline from Enterprise TE Products Pipeline Company LLC (the "Hopewell Pipeline"). The Hopewell Pipeline originates at the Tyler Refinery and terminates at the Hopewell delivery yard, where it connects to our pipeline that terminates at the Big Sandy terminal. The aggregate purchase price was approximately 5.4 million, which has been preliminarily allocated to property, plant and equipment. The property, plant and equipment valuation is subject to change during the purchase price allocation period.

Amended and Restated Services Agreement (Big Sandy Terminal and Pipeline). In connection with the acquisition of the Hopewell Pipeline, on July 25, 2013 the Partnership and Delek entered into the Amended and Restated Services Agreement (Big Sandy Terminal and Pipeline) (the "Amended and Restated Services Agreement"), which amends and restates the Terminalling Services Agreement (Big Sandy Terminal) dated November 7, 2012 between the Partnership and Delek Refining, Ltd. ("Delek Refining") to, among other things, include a minimum throughput commitment and a per barrel throughput fee that Delek will pay us for throughput along the pipelines from the Tyler Refinery to the Big Sandy terminal.


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Tyler Terminal and Tankage Acquisition

On July 26, 2013, the Partnership, through our subsidiary, Delek Marketing & Supply, LP ("DKL Marketing") completed a transaction (the "Tyler Transaction") with Delek Refining, pursuant to which DKL Marketing acquired a refined products terminal, storage tanks and related assets adjacent to the Tyler Refinery from Delek Refining. The purchase price paid for the assets acquired was $94.8 million in cash, comprised of $77.0 million financed with borrowings under the Partnership's amended and restated senior secured revolving credit facility and $17.8 million in cash on hand. In addition, the parties entered into several contracts and amended certain existing contracts in connection with the Tyler Transaction. The assets acquired in the Tyler Transaction consist of:
The refined products terminal located at the Tyler Refinery (the "Tyler Terminal"), which consists of a truck loading rack with nine loading bays supplied by pipeline from storage tanks located at the Tyler Refinery, along with certain ancillary assets. Total throughput capacity for the terminal is approximately 72,000 bpd. For the year ended December 31, 2012, approximately 55,000 bpd of refined products were throughput at this terminal.

Ninety-six storage tanks and certain ancillary assets (such as tank pumps and piping) located adjacent to the Tyler Refinery with an aggregate shell capacity of approximately 2.0 million barrels (such storage tanks and certain ancillary assets, the "Tyler Storage Tanks"). The Tyler Storage Tanks, together with the Tyler Terminal, are sometimes hereinafter referred to as the "Tyler Assets."

In connection with the Tyler Transaction, the Partnership entered into, amended and terminated, as applicable, the following material definitive agreements:

Tyler Throughput and Tankage Agreement. On July 26, in connection with the Tyler Transaction, Delek Refining and DKL Marketing entered into the Tyler Throughput and Tankage Agreement (the "Throughput and Tankage Agreement"). Under the Throughput and Tankage Agreement, DKL Marketing will provide Delek Refining with throughput and storage services in return for throughput and storage fees. The initial term of the Throughput and Tankage Agreement is eight years and Delek Refining, at its sole option, may extend the term for two renewal terms of four years each.

Amended and Restated Omnibus Agreement. On July 26, 2013, in connection with the Tyler Transaction, the Partnership entered into an Amended and Restated Omnibus Agreement (the "Restated Omnibus Agreement") with our general partner, DKL Marketing, certain of the Partnership's other subsidiaries, Delek US, Delek Refining and Lion Oil Company ("Lion Oil"), a wholly owned subsidiary of Delek US. The Restated Omnibus Agreement amends and restates the omnibus agreement dated November 7, 2012 by and among the parties and includes the following, among others: (i) certain modifications in the reimbursement by Delek US and certain of its subsidiaries for certain operating expenses and capital expenditures incurred by the Partnership or its subsidiaries, (ii) certain modifications of the indemnification provisions in favor of the Partnership with respect to certain environmental matters, and (iii) the increase of the annual administrative fee payable by us to Delek for corporate general and administrative services.

Tyler Lease and Access Agreement. On July 26, 2013, in connection with the Tyler Transaction, Delek Refining and DKL Marketing entered into the Tyler Lease and Access Agreement (the "Tyler Lease"). Under the Tyler Lease, DKL Marketing will lease from Delek Refining the real property on which the Tyler Assets are located. The Tyler Lease has an initial term of 50 years with automatic renewal for a maximum of four successive 10-year period thereafter.

Tyler Site Services Agreement. On July 26, 2013, in connection with the Tyler Transaction, Delek Refining and DKL Marketing entered into the Tyler Site Services Agreement (the "Site Services Agreement"). Under the Site Services Agreement, Delek Refining will provide DKL Marketing with shared use of certain services, materials and facilities that are necessary to operate and maintain the Tyler Assets as currently operated and maintained. The term of the Site Services Agreement is the same as the Tyler Lease discussed above.

Operation and Management Services Agreement. On July 26, 2013, in connection with the Tyler Transaction, the Partnership, our general partner and Delek Logistics Services Company terminated the operation and management services agreement dated as of November 7, 2012. We will continue to reimburse our general partner for services it provides to us, pursuant to the terms of the partnership agreement.

How We Generate Revenue
The Partnership generates revenue by charging fees for gathering, transporting and storing crude oil and for marketing, distributing, transporting and storing refined products. A substantial majority of our contribution margin, which we define as net


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sales less cost of goods sold and operating expenses, is derived from commercial agreements with Delek with initial terms ranging from five to ten years, which we believe enhances the stability of our cash flows. As more fully described below, our commercial agreements with Delek include minimum volume commitments, which we believe will provide a stable revenue stream in the future. Commercial Agreements with Delek
Our commercial agreements with Delek described below became effective on November 7, 2012, concurrently with the completion of the Partnership's initial public offering (the "Offering"). Each of these agreements includes minimum quarterly volume or throughput commitments and has tariffs or fees indexed to inflation, provided that the tariffs or fees will not be decreased below the initial amount. Fees under each agreement are payable to us monthly by Delek or certain third parties to whom Delek has assigned certain of its rights. For a discussion of a third party's involvement in certain agreements, see "El Dorado Refinery Crude Oil and Refined Products Supply and Offtake Arrangement." In most circumstances, if Delek or the applicable third party assignee fails to meet or exceed the minimum volume or throughput commitment during any calendar quarter, Delek, and not any third party assignee, will be required to make a quarterly shortfall payment to us equal to the volume of the shortfall multiplied by the applicable fee.
We also entered into several new agreements with Delek as part of the Tyler Transaction on July 26, 2013. See "Recent Developments-Tyler Terminal and Tankage Acquisition" for more information. Pipelines and Transportation
Lion Pipeline System. We entered into a pipelines and storage facilities agreement with Delek under which we provide transportation and storage services to the El Dorado Refinery. For a discussion of a third party's involvement in this agreement, see "El Dorado Refinery Crude Oil and Refined Products Supply and Offtake Arrangement". Under this pipelines and storage facilities agreement, Delek is obligated to meet certain minimum aggregate throughput requirements on the pipelines of our Lion Pipeline System and our SALA Gathering System as follows:
Lion Pipeline System. The minimum throughput commitment on the Lion Pipeline System crude oil pipelines is an aggregate of 46,000 bpd (on a quarterly average basis) of crude oil shipped on the El Dorado, Magnolia and rail connection pipelines, other than crude oil volumes gathered on our SALA Gathering System, at a tariff rate of $0.85 per barrel through June 30, 2013. For the Lion Pipeline System refined products pipelines, the minimum throughput commitment is an aggregate of 40,000 bpd (on a quarterly average basis) of diesel or gasoline shipped on these pipelines at a tariff rate of $0.10 per barrel through June 30, 2013.

SALA Gathering System. The minimum throughput commitment is an aggregate of 14,000 bpd (on a quarterly average basis) of crude oil transported on the SALA Gathering System at a tariff rate of $2.25 per barrel through June 30, 2013. Volumes initially gathered on the SALA Gathering System before injection into the Lion Pipeline System are not subject to an additional fee for transportation on our Lion Pipeline System to the El Dorado Refinery.

East Texas Crude Logistics System. We entered into a pipelines and tankage agreement with Delek pursuant to which we provide crude oil transportation and storage services for the Tyler Refinery. Under the current pipelines and tankage agreement, Delek is obligated to meet minimum aggregate throughput requirements of at least 35,000 bpd of crude oil, calculated on a quarterly average basis, on our East Texas Crude Logistics System for a transportation fee of $0.40 per barrel. For any volumes in excess of 50,000 bpd, calculated on a quarterly average basis, Delek is required to pay an additional fee of $0.20 per barrel. In addition, Delek pays a storage fee of $250,000 per month for the use of our crude oil storage tanks along our East Texas Crude Logistics system. The East Texas Crude Logistics System is comprised of the Nettleton and McMurrey Pipelines. The Nettleton Pipeline is used to transport crude oil from our tank farms in and around Nettleton, Texas to the Bullard Junction at the Tyler Refinery. The McMurrey Pipeline also begins at our tank farms in and around Nettleton, Texas and then runs roughly parallel to the Nettleton Pipeline. In April 2013, a reconfigured pipeline system that is owned and operated by third parties began transporting crude oil to the Tyler Refinery from west Texas. Delek has a 10-year agreement with such third parties to transport a substantial majority of the Tyler Refinery's crude oil requirements on this reconfigured system. As a result, the crude oil supplied through the Nettleton and McMurrey Pipelines fell below the minimum aggregate throughput requirements during the three months ended June 30, 2013. Going forward, crude oil volumes transported on our East Texas Crude Logistics System will decrease from approximately 55,000 bpd to approximately 12,000 bpd or less. For so long as Delek is required to pay the associated minimum volume commitment under its commercial agreement with us relating to the East Texas Crude Logistics System, Delek will be obligated to pay us throughput fees in an amount equal to the fees it would pay were we to throughput 35,000 bpd, or approximately $5.1 million annually. Such throughput fees are in addition to the storage fees of $3.0 million per year that Delek will be obligated to pay us


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under the agreement. We do not expect to currently realize incremental revenues associated with this fee structure following the commencement of third-party transportation to the Tyler Refinery.
Wholesale Marketing and Terminalling
East Texas. We entered into a marketing agreement with Delek pursuant to which we market 100% of the output of the Tyler Refinery, other than jet fuel and petroleum coke. Under the marketing agreement, Delek is obligated to make available to us for marketing and sale at the Tyler Refinery and/or our Big Sandy terminal an aggregate amount of refined products of at least 50,000 bpd, calculated on a quarterly average basis. In exchange for our marketing services, Delek pays us a base fee of $0.5964 per barrel of products it sells. In addition, Delek has agreed to pay us 50% of the margin, if any, above an agreed base level generated on the sale as an incentive fee, provided that the incentive fee shall not be less than $175,000 nor greater than $500,000 per quarter.
Terminalling. We entered into two terminalling services agreements pursuant to which Delek pays us fees for providing terminalling services to Delek at our Memphis and Big Sandy terminals, as well as for storing product at our Big Sandy terminal. The minimum throughput commitments under these agreements are 10,000 bpd (on a quarterly average basis) for the Memphis terminal, representing approximately 75% of maximum loading capacity, and 5,000 bpd (on a quarterly average basis) for the Big Sandy terminal, representing approximately 55% of maximum loading capacity, in each case at a fee of $0.50 per barrel. The Big Sandy terminal is currently not operational because the Hopewell Pipeline, which is necessary for the use of the terminal, is currently out of service. However, in July 2013, we purchased the Hopewell Pipeline. Although the terminal is not currently operational, Delek paid us to terminal at the Big Sandy terminal a minimum of 5,000 bpd of refined products from the Tyler Refinery and a storage fee of $50,000 per month, the minimum payment due per the agreement. In connection with the acquisition of the Hopewell Pipeline, the terminalling services agreement for the Big Sandy terminal was amended and restated to, among other things, include a minimum throughput commitment and a per barrel throughput fee that Delek will pay us for throughput along the pipelines from the Tyler Refinery to the Big Sandy terminal. See "Recent Developments-Hopewell Acquisition" for more information.
El Dorado Refinery Crude Oil and Refined Products Supply and Offtake Arrangement Pursuant to a supply and offtake arrangement with Delek and Lion Oil to which we are not a party, J. Aron & Company ("Aron") acquires and holds title to all crude oil and refined products transported on our Lion Pipeline System and SALA Gathering System. Aron is therefore considered the shipper on the Lion Pipeline System and the SALA Gathering System. Aron also has title to the refined products stored at our Memphis terminal. Under our pipelines and storage agreement with Lion Oil relating to the Lion Pipeline System and the SALA Gathering System and our terminalling agreement with Lion Oil relating to the Memphis terminal, Lion Oil has assigned to Aron certain of its rights, including the right to have Aron's crude oil and refined products stored in or transported on or through these systems and the Memphis terminal, with Lion Oil acting as Aron's agent for scheduling purposes. Accordingly, even though this is effectively a financing arrangement for Delek and Aron sells the product back to Delek, Aron is technically our primary customer under each of these agreements. Aron will retain these storage and transportation rights for the term of its arrangement with Delek and Lion Oil, which currently runs through April 30, 2014, and Aron will pay us for the transportation and storage services we provide to it. The rights assigned to Aron will not alter Lion Oil's obligations to meet certain throughput minimum volumes under our agreements with respect to the transportation, terminalling and storage of crude oil and refined products through our facilities, but Aron's throughput will be credited toward Lion Oil's minimum throughout commitments. Accordingly, Lion Oil will be responsible for making any shortfall payments incurred under the pipelines and storage agreement . . .

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