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DKL > SEC Filings for DKL > Form 10-K on 5-Mar-2014All Recent SEC Filings

Show all filings for DELEK LOGISTICS PARTNERS, LP

Form 10-K for DELEK LOGISTICS PARTNERS, LP


5-Mar-2014

Annual Report


ITEM 7. 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 consolidated financial statements and notes thereto.
Forward-Looking Statements
This Annual Report on Form 10-K 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, as amended (the "Exchange Act"). 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 or its assignees and its ability to pay us under our commercial agreements;

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

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 its assignees' 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;

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;

Delek's inability to grow as expected;

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 or 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 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. Business Overview
The Partnership primarily owns and operates crude oil and intermediate 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 Tyler and El Dorado Refineries. A substantial majority of our existing assets are both integral to and dependent upon the success of Delek's refining operations as our assets are contracted exclusively to Delek in support of its Tyler and El Dorado Refineries.
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.


Recent Developments

El Dorado Terminal and Tankage Acquisition

On February 10, 2014, the Partnership and OpCo completed a transaction with Lion Oil, pursuant to which OpCo acquired a refined products terminal, storage tanks and ancillary assets on and adjacent to the El Dorado Refinery. The purchase price paid for the assets acquired was $95.9 million in cash financed with borrowings under the Partnership's amended and restated senior secured revolving credit facility. In addition, the parties entered into several contracts and amended certain existing contracts in connection with the El Dorado Transaction. The assets acquired in the El Dorado Transaction consist of:

The El Dorado Terminal, which consists of a truck loading rack with three loading bays supplied by pipeline from storage tanks located at the El Dorado Refinery, along with certain ancillary assets. Total throughput capacity for the El Dorado Terminal is approximately 26,700 bpd. For the year ended December 31, 2012, approximately 12,649 bpd of refined products were throughput at the El Dorado Terminal.

The El Dorado Storage Tanks, which consist of 158 storage tanks and certain ancillary assets (such as pumps and piping) located adjacent to and at the El Dorado Refinery with an aggregate shell capacity of approximately 2.5 million barrels.

In connection with the El Dorado Transaction, the Partnership entered into and amended, as applicable, the following definitive agreements:

El Dorado Throughput and Tankage Agreement. On February 10, 2014, in connection with the El Dorado Transaction, Lion Oil and OpCo, and for limited purposes, J. Aron & Company ("J. Aron"), entered into the El Dorado Throughput and Tankage Agreement. Under the El Dorado Throughput and Tankage Agreement, OpCo will provide Lion Oil with throughput and storage services in return for throughput and storage fees. The initial term of the El Dorado Throughput and Tankage Agreement is eight years and Lion Oil, at its sole option, may extend the term for two renewal terms of four years each. Effective February 10, 2014, Lion Oil assigned J. Aron its rights to use and transport materials through the El Dorado Terminal and Tank Assets until the expiration of Lion Oil's amended and restated supply and offtake agreement with J. Aron. Despite the assignment Lion Oil still retains certain rights and obligations under the Throughput and Tankage Agreement.

Second Omnibus Amendment. On February 10, 2014, in connection with the El Dorado Transaction, the Partnership entered into the Second Omnibus Amendment with our general partner, OpCo, certain of the Partnership's other subsidiaries, Delek, Lion Oil and Delek Refining, Ltd., a wholly owned subsidiary of Delek. The Second Omnibus Amendment includes the following, among other things: (i) certain modifications in the reimbursement amounts to be paid by Delek and certain of its subsidiaries under the Omnibus Agreement for certain operating expenses and capital expenditures incurred by the Partnership or its subsidiaries; (ii) certain modifications of the indemnification provisions under the Omnibus Agreement in favor of the Partnership with respect to certain environmental matters; and (iii) the increase of the annual administrative fee payable by the Partnership to Delek under the Omnibus Agreement for corporate general and administrative services from $3.0 million to $3.3 million, which is prorated and payable monthly.

El Dorado Lease and Access Agreement. On February 10, 2014, in connection with the El Dorado Transaction, Lion Oil and OpCo entered into the El Dorado Lease. Under the El Dorado Lease, OpCo leases from Lion Oil the real property on which the El Dorado Terminal and Tank Assets are located. The El Dorado Lease has an initial term of 50 years with automatic renewal for a maximum of four successive 10-year periods thereafter.

El Dorado Site Services Agreement. On February 10, 2014, in connection with the El Dorado Transaction, Lion Oil and OpCo entered into the El Dorado Site Services Agreement. Under the El Dorado Site Services Agreement, Lion Oil provides OpCo with shared use of certain services, materials and facilities that are necessary to operate and maintain the El Dorado Terminal and Tank Assets as currently operated and maintained. The term of the El Dorado Site Services Agreement is co-terminous with the El Dorado Lease discussed above.


2013 Developments

Acquisitions
North Little Rock Terminal. On October 24, 2013, we purchased the North Little Rock Terminal from Enterprise Refined Products Company LLC. The aggregate purchase price was approximately $5.0 million, which has been preliminarily allocated to property, plant and equipment and intangible assets. The valuation is subject to change during the purchase price allocation period.
Tyler Terminal and Tank Assets. On July 26, 2013, the Partnership completed the acquisition of the Tyler Terminal and the Tyler Tank Assets. The purchase price paid for the assets acquired was $94.8 million in cash.
Hopewell Pipeline. On July 19, 2013, the Partnership purchased the Hopewell Pipeline, which originates at the Tyler Refinery and terminates at the Hopewell Station, where it effectively connects to the Big Sandy Pipeline. The Hopewell Pipeline and the Big Sandy Pipeline form essentially one pipeline link between the Tyler Refinery and the Big Sandy Terminal. The aggregate purchase price for the Hopewell Pipeline was approximately $5.7 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.
Other Developments
Amended and Restated Credit Facility. On July 9, 2013, we entered into the Amended and Restated Credit Agreement, which amended and restated our senior secured revolving credit agreement, which we originally entered into on November 7, 2012, with Fifth Third Bank, as administrative agent, and a syndicate of lenders. Under the terms of the Amended and Restated Credit Agreement, the lender commitments were increased from $175.0 million to $400.0 million and a dual currency borrowing tranche was added that permits draw downs in U.S. or Canadian dollars. 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 LIBOR, 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 CDOR, plus an applicable margin, at the election of the borrowers. The applicable margin in each case varies based upon the Partnership's most recently reported leverage ratio.
Macedonia Crude Oil Release. On October 7, 2013, a release of crude oil was identified from a gathering line near Macedonia, Arkansas. Approximately 40 barrels of crude oil were recovered from an adjacent small creek. Other than maintaining booms on a portion of the creek, cleanup operations for the creek were essentially concluded in November 2013; however, remediation of impacted soils along the pipeline remains to be completed. Based on current information available to us, we do not believe the total costs associated with this event, including any fines or penalties and net of partial insurance reimbursement, will have a material adverse effect upon our business, financial condition or results of operations.
Magnolia Station Crude Oil Release. On March 9, 2013, a release of crude oil was detected within a pumping facility at our Magnolia Station located west of the El Dorado Refinery. The pumping facility is owned by our subsidiary SALA Gathering Systems, LLC. Since detecting the release we have worked to contain the release, recover the released crude oil and remediate those areas impacted by the release, coordinating our efforts with the EPA and state authorities to restore the impacted area to the satisfaction of the appropriate regulatory authorities. As of the date of this filing, we believe we have substantially completed all necessary remediation, restoration and monitoring of the areas affected by the crude oil release, although there are on-going discussions with ADEQ regarding whether additional monitoring or remediation of soil may be necessary. The release did not impact the delivery of crude oil from the Magnolia Station to the El Dorado Refinery and did not interrupt the operations of the El Dorado Pipeline connected to the Magnolia Station. Business Strategies
Our objectives are to maintain stable cash flows and to grow the quarterly distributions paid to our unitholders. We intend to achieve these objectives through the following business strategies:

Generate Stable Cash Flow. We will continue to pursue opportunities to provide logistics, marketing and other services to Delek and third parties pursuant to long-term, fee-based contracts. In new service contracts, we will


endeavor to negotiate minimum throughput or other commitments similar to those included in our current commercial agreements with Delek.

Focus on Growing Our Business. We intend to evaluate and pursue opportunities to grow our business through both strategic acquisitions and organic expansion projects. We believe that our strong relationship with our sponsor will provide us with several opportunities to grow our business.

            Pursue Acquisitions. We plan to pursue strategic acquisitions that
             both complement our existing assets and provide attractive returns
             for our unitholders. For example, in February 2014, we completed the
             purchase of the El Dorado Terminal and Tank Assets. Additionally,
             Delek has granted us a right of first offer on certain other
             logistics assets that were not transferred to us as part of the
             Offering. Delek is also required, under certain circumstances, to
             offer us the opportunity to purchase additional logistics assets
             that Delek may acquire or construct in the future. Furthermore, we
             believe that our current asset base and our knowledge of the
             regional markets in which we operate will allow us to target and
             consummate attractive third-party acquisitions.



            Pursue Attractive Organic Expansion and Construction Opportunities.
             We intend to pursue organic growth opportunities that complement our
             existing businesses or that provide attractive returns within or
             outside our current geographic footprint. We plan to evaluate any
             potential opportunities to make capital investments that will be
             used to expand our existing asset base through the development and
             construction of new logistics assets for which a need may arise as a
             result of the growth of any of our customers', including Delek's,
             businesses or from increased third-party activity.

Optimize Our Existing Assets and Expand Our Customer Base. We intend to enhance the profitability of our existing assets by adding incremental throughput volumes, improving operating efficiencies and increasing system-wide utilization. For example, we have announced plans to increase the throughput capacity and diversify our product mix at the North Little Rock Terminal by completing certain capital projects that will expand the terminal and enhance its operational capabilities. Additionally, we are considering options to optimize the economics of the Paline Pipeline System over the next few years, including but not limited to, extending the contract with our current customer on terms beneficial to both parties. We also expect to further diversify our customer base by increasing third-party throughput volumes running through certain of our existing systems and expanding our existing asset portfolio to service more third-party customers.

Commercial Agreements
The Partnership has various long-term, fee-based commercial agreements with Delek under which we provide crude oil gathering, crude oil and refined products transportation and storage services and marketing and terminalling services to Delek, and Delek commits to provide us with minimum monthly throughput volumes of crude oil and refined products. For a description of each agreement, see "Item 1-Business-Commercial Agreements-Commercial Agreements in Connection with the Offering" and "Item 1-Business-Commercial Agreements-Commercial Agreements in Connection with the Tyler Acquisition". How We Evaluate Our Operations
We use a variety of financial and operating metrics to analyze our segment performance. These metrics are significant factors in assessing our operating results and profitability and include: (i) volumes (including pipeline throughput and terminal volumes); (ii) contribution margin and gross margin per barrel; (iii) operating and maintenance expenses; and (iv) EBITDA and Distributable Cash Flow (as such terms are defined below).
Volumes. The amount of revenue we generate primarily depends on the volumes of crude oil and intermediate and refined products that we handle in our pipeline, transportation, terminalling and marketing operations. These volumes are primarily affected by the supply of and demand for crude oil and refined products in the markets served directly or indirectly by our assets. Although Delek has committed to minimum volumes under the commercial agreements described above, our results of operations will be impacted by:


Delek's utilization of our assets in excess of its minimum volume commitments;

our ability to identify and execute acquisitions and organic expansion projects, and capture incremental volume increases from Delek or third-parties;

our ability to increase throughput volumes at our refined products terminals and provide additional ancillary services at those terminals, such as ethanol blending and additive injection;

our ability to identify and serve new customers in our marketing operations; and

our ability to make connections to third-party facilities and pipelines.

Contribution Margin and Gross Margin per Barrel. Because we do not allocate general and administrative expense by segment, we measure the performance of our segments by the amount of contribution margin generated in operations. Contribution margin is calculated as net sales less cost of sales and operating expenses. For our wholesale marketing and terminalling segment, we also measure margin per barrel. The gross margin per barrel reflects the gross margin (net sales less cost of sales) of the wholesale marketing operations divided by the number of barrels of refined products sold during the measurement period. Both contribution margin and gross margin per barrel can be affected by fluctuations in the prices of gasoline and distillate fuel.
Operating and Maintenance Expenses. We seek to maximize the profitability of our operations by effectively managing operating and maintenance expenses. These expenses are comprised primarily of labor expenses, lease costs, utility costs, insurance premiums, repairs and maintenance expenses and property taxes. These expenses generally remain relatively stable across broad ranges of throughput volumes but can fluctuate from period to period depending on the mix of activities performed during that period and the timing of these expenses. We will seek to manage our maintenance expenditures on our pipelines and terminals by scheduling maintenance over time to avoid significant variability in our maintenance expenditures and minimize their impact on our cash flow. Our operating and maintenance expenses will also be affected by the imbalance gain and loss provisions in our commercial agreements with Delek. Under our commercial agreements with Delek relating to our Lion Pipeline System and our East Texas Crude Logistics System, we bear any crude oil and refined product volume losses on each of our pipelines in excess of 0.25%. Under our commercial agreements with Delek relating to our Memphis and Big Sandy terminals, we will bear any refined product volume losses in each of our terminals in excess of 0.25%. The value of any crude oil or refined product imbalance gains or losses resulting from these contractual provisions is determined by reference to the monthly average reference price for the applicable commodity. Any gains and losses under these provisions will reduce or increase, respectively, our operating and maintenance expenses in the period in which they are realized. EBITDA and Distributable Cash Flow. We define EBITDA as net income (loss) before net interest expense, income tax expense, depreciation and amortization expense. We define distributable cash flow as EBITDA less net cash paid for interest, maintenance capital expenditures and income taxes. Distributable cash flow will not reflect changes in working capital balances. Distributable cash flow and EBITDA are not presentations made in accordance with accounting principles generally accepted in the United States ("U.S. GAAP").
EBITDA and distributable cash flow are non-U.S. GAAP supplemental financial measures that management and external users of our consolidated financial statements, such as industry analysts, investors, lenders and rating agencies, may use to assess:
our operating performance as compared to other publicly traded partnerships in the midstream energy industry, without regard to historical cost basis, or in the case of EBITDA, financing methods;

the ability of our assets to generate sufficient cash flow to make distributions to our unitholders;

ability to incur and service debt and fund capital expenditures; and

the viability of acquisitions and other capital expenditure projects and the returns on investment of various investment opportunities.

We believe that the presentation of EBITDA and distributable cash flow provides useful information to investors in assessing our financial condition and results of operations. EBITDA and distributable cash flow should not be considered alternatives to net income, operating income, cash from operations or any other measure of financial performance or liquidity presented in accordance with U.S. GAAP. EBITDA and distributable cash flow have important limitations as analytical tools because they exclude some but not all items that affect net income and net cash provided by operating activities. Additionally, because EBITDA and distributable cash flow may be defined differently by other companies in our industry,


our definition of EBITDA may not be comparable to similarly titled measures of other companies, thereby diminishing its utility. For a reconciliation of EBITDA to its most directly comparable financial measures calculated and presented in accordance with U.S. GAAP, please refer to "-Results of Operations." Factors Affecting the Comparability of Our Financial Results Our future results of operations may not be comparable to our historical results of operations for the reasons described below:
Revenues. There are differences between the way the Predecessors recorded revenues and the way the Partnership records revenues after the completion of the Offering and any subsequent acquisitions. Because our assets, including the Tyler Terminal and Tank Assets, were historically a part of the integrated . . .

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