DELEK US HOLDINGS, INC.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") is management's analysis of our financial performance and of
significant trends that may affect our future performance. The MD&A should be
read in conjunction with our condensed consolidated financial statements and
related notes included elsewhere in this Quarterly Report on Form 10-Q and in
the Annual Report on Form 10-K as filed with the Securities and Exchange
Commission ("SEC") on February 28, 2020 (the "Annual Report on Form 10-K").
Those statements in the MD&A that are not historical in nature should be deemed
forward-looking statements that are inherently uncertain.
Unless otherwise noted or the context requires otherwise, the terms "we," "our,"
"us," "Delek" and the "Company" are used in this report to refer to Delek and
its consolidated subsidiaries for all periods presented. 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.
The Company announces material information to the public about the Company, its
products and services and other matters through a variety of means, including
filings with the Securities and Exchange Commission , press releases, public
conference calls, the Company's website (www.delekus.com), the investor
relations section of its website (ir.delekus.com), the news section of its
website (www.delekus.com/news), and/or social media, including its Twitter
account (@DelekUSHoldings). The Company encourages investors and others to
review the information it makes public in these locations, as such information
could be deemed to be material information. Please note that this list may be
updated from time to time.
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, as amended, and
Section 21E of 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, statements regarding the effect, impact, potential duration
or other implications of, or expectations expressed with respect to, the recent
outbreak COVID-19 and the actions of members of the Organization of Petroleum
Exporting Countries ("OPEC") and Russia with respect to oil production and
pricing, and statements regarding our efforts and plans in response to such
events, the information concerning our possible future results of operations,
business and growth strategies, financing plans, expectations that regulatory
developments or other matters will or 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, 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:
•volatility in our refining margins or fuel gross profit as a result of changes
in the prices of crude oil, other feedstocks and refined petroleum products and
the impact of the COVID-19 Pandemic on such demand;
•reliability of our operating assets;
•actions of our competitors and customers;
•changes in, or the failure to comply with, the extensive government regulations
applicable to our industry segments, including current and future restrictions
on commercial and economic activities in response to the COVID-19 Pandemic;
•the possibility of inefficiencies, curtailments, or shutdowns in refinery
operations or pipelines, whether due to infection in the workforce or in
response to reductions in demand as a result of the COVID-19 Pandemic;
•our ability to execute our strategy of growth through acquisitions and capital
projects and changes in the expected value of and benefits derived therefrom,
including any ability to successfully integrate acquisitions, realize expected
synergies or achieve operational efficiency and effectiveness;
•diminishment in value of long-lived assets may result in an impairment in the
carrying value of the assets on our balance sheet and a resultant loss
recognized in the statement of operations;
•the unprecedented market environment and economic effects of the COVID-19
Pandemic, including uncertainty regarding the timing, pace and extent of
economic recovery in the United States due to the COVID-19 Pandemic;
40 | [[Image Removed: dk-20200930_g3.jpg]]
--------------------------------------------------------------------------------
Management's Discussion and Analysis
•general economic and business conditions affecting the southern, southwestern and westernUnited States , particularly levels of spending related to travel and tourism and the ongoing and future impacts of the COVID-19 Pandemic; •volatility under our derivative instruments; •deterioration of creditworthiness or overall financial condition of a material counterparty (or counterparties); •unanticipated increases in cost or scope of, or significant delays in the completion of, our capital improvement and periodic turnaround projects; •risks and uncertainties with respect to the quantities and costs of refined petroleum products supplied to our pipelines and/or held in our terminals; •operating hazards, natural disasters, casualty losses and other matters beyond our control; •increases in our debt levels or costs; •possibility of accelerated repayment on a portion of the J. Aron supply and offtake liability if the purchase price adjustment feature triggers a change on the re-pricing dates; •changes in our ability to continue to access the credit markets; •compliance, or failure to comply, with restrictive and financial covenants in our various debt agreements; •the suspension of our quarterly dividend; •seasonality; •acts of terrorism (including cyber-terrorism) aimed at either our facilities or other facilities that could impair our ability to produce or transport refined products or receive feedstocks; •future decisions by OPEC+ members regarding production and pricing and disputes between OPEC+ members regarding such; •disruption, failure, or cybersecurity breaches affecting or targeting our IT systems and controls, our infrastructure, or the infrastructure of our cloud-based IT service providers; •changes in the cost or availability of transportation for feedstocks and refined products; and •other factors discussed under the headings "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Risk Factors" and in our other filings with theSEC . 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 future results or period trends. We can give no assurances that any of the events anticipated by any forward-looking statements will occur or, if any of them do, what impact they will have on our results of operations and financial condition. All forward-looking statements included in this report are based on information available to us on the date of this report. We undertake no obligation to revise or update any forward-looking statements as a result of new information, future events or otherwise. Executive Summary Business Overview We are an integrated downstream energy business focused on petroleum refining, the transportation, storage and wholesale distribution of crude oil, intermediate and refined products and convenience store retailing. Our operating segments consist of refining, logistics, and retail, and are discussed in the sections that follow. The outbreak of COVID-19 and its development into a pandemic inMarch 2020 (the "COVID-19 Pandemic" or the "Pandemic") has resulted in significant economic disruption globally, including inthe United States ("U.S.") and specific geographic areas where we operate. Actions taken by various governmental authorities, individuals and companies around the world to prevent the spread of COVID-19 through both voluntary and mandated social distancing, curfews, shutdowns and expanded safety measures have restricted travel, many business operations, public gatherings and the overall level of individual movement and in-person interaction across the globe. This has in turn significantly reduced global economic activity which has had a significant impact on the nature and extent of travel. The COVID-19 Pandemic has had a devastating impact on the airline industry, dramatically reducing the number of domestic flights and, due to foreign travel bans and immigration restrictions abroad as well as traveler concerns over exposure, virtually eliminating international travel originating from theU.S. to many parts of the world. Additionally, the COVID-19 Pandemic has had a significant negative impact on motor vehicle use at a time when seasonal driving patterns typically result in an increase of consumer demand for gasoline. As a result, there has 41 | [[Image Removed: dk-20200930_g3.jpg]] -------------------------------------------------------------------------------- Management's Discussion and
Analysis
also been a decline in the demand for, and thus also the market prices of, crude oil and certain of our products, particularly our refined petroleum products and most notably gasoline and jet fuel. In April andJune 2020 , agreements were reached to cut oil production between the members ofOPEC and other leading oil producing countries (together withOPEC , "OPEC+"), as part of the efforts to resolve the oil production disputes that significantly affected crude oil prices beginning in the first quarter of 2020 (the "OPEC Production Disputes"), and to provide stability in the oil markets. While OPEC+ have reached an agreement to cut oil production, the uncertainty about the duration of the COVID-19 Pandemic has caused storage constraints in theU.S. resulting from over-supply of produced oil. Based on these conditions and events, downward pressure on commodity prices, crack spreads and demand remains a significant risk and could continue for the foreseeable future. During the latter part of the second quarter of 2020, governmental authorities in various states across theU.S. , particularly those in ourPermian Basin andU.S. Gulf Coast regions, began to lift many of the restrictions created by actions taken to slow down the spread of COVID-19. These actions have resulted in an increase in the level of individual movement and travel and, in turn, an increase in the demand and market prices for some of our products relative to lateMarch 2020 . However, many of the states where such restrictions were lifted have recently experienced a marked increase in the spread of COVID-19 and many governmental authorities in such areas have responded by reimposing certain restrictions they had previously lifted. This response, as well as the increased infection rates, impacts regions that we serve and could significantly impact demand in ways that we cannot predict. Additionally, increased infection rates could impact our refining, logistics and retail operations, particularly in high-infection states, if our employees are personally affected by the illness, both through direct infection and quarantine procedures. During the three and nine months endedSeptember 30, 2020 , Delek has experienced the impact on demand and pricing of these unprecedented conditions, most notably in our refining segment. Our business and our third quarter 2020 results reflect the impact of decreased demand combined with crack spreads that are 53% to 71% lower, on average, compared to the same quarter in the prior year. We have also experienced operational constraints as well, including COVID-19 infections at certain of our company locations that have resulted in re-imposed or expanded remote policies and quarantine protocols. And we continue to be faced with risk from our suppliers and customers who are facing similar challenges. We have identified the following known uncertainties resulting from the COVID-19 Pandemic, which is ongoing: •Significant declines and/or volatility in prices of refined products we sell and the feedstocks we purchase as well as in crack spreads resulting from the COVID-19 Pandemic and the OPEC Production Disputes could have a significant impact on our revenues, cost of sales, operating income and liquidity, as well to the carrying value of our long-lived or indefinite-lived assets; •A decline in the market prices of refined products and feedstocks below the carrying value in our inventory may result in the adjustment of the value of our inventories to the lower market price and a corresponding loss on the value of our inventories (see also Note 1 to our Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional discussion of specific financial statement risks); •The decline in demand for refined product could significantly impact the demand for throughput at our refineries, unfavorably impacting operating results at our refineries, and could impact the demand for storage, which could impact our logistics segment; •The decline in demand and margins impacting current results and forecasts could result in impairments in certain of our long-lived or indefinite-lived assets, including goodwill, or have other financial statement impacts that cannot currently be anticipated (see also Note 1 to our Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional discussion of specific financial statement risks); •A significant reduction or suspension inU.S. crude oil production could adversely affect our suppliers and sources of crude oil; •An outbreak in one of our refineries, exacerbated by a limited pool of qualified replacements as well as quarantine protocols, could cause significant disruption in our production or, worst case, temporary idling of the facility; •The restrictions on travel and requirements for social distancing could significantly impact the traffic at our convenience stores, particularly the demand for fuel; •Customers of the refining segment as well as third-party customers of the logistics segment may experience financial difficulties which could interrupt the volumes ordered by those customers and/or could impact the credit worthiness of such customers and the collectability of their outstanding receivables; •The impact of COVID-19 or protocols implemented in response to COVID-19 by key or specialty suppliers may negatively affect our ability to obtain specialty equipment or services when needed; •Equity method investees may be significantly impacted by the COVID-19 Pandemic and/or the OPEC Production Disputes, which may increase the risk of impairment of those investments; •Access to capital markets may be significantly impacted by the volatility and uncertainty in the oil and gas market specifically which could restrict our ability to raise funds; 42 | [[Image Removed: dk-20200930_g3.jpg]] -------------------------------------------------------------------------------- Management's Discussion and
Analysis
•While our current liquidity needs are managed by existing facilities, sources of future liquidity needs may be impacted by the volatility in the debt market and the availability and pricing of such funds as a result of the COVID-19 Pandemic and the OPEC Production Disputes; and •TheU.S. Federal Government has enacted certain stimulus and relief measures, including the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") passed onMarch 27, 2020 , and is continuing to consider additional relief legislation. Beyond the direct impact of existing legislation on Delek in the current period, the extent to which the provisions of the existing or any future legislation will achieve its intention to stimulate or provide relief to the greaterU.S. economy and/or consumer, as well as the impact and success of such efforts, remains unknown. Other uncertainties related to the impact of the COVID-19 Pandemic as well as global geopolitical factors may exist that have not been identified or that are not specifically listed above, and could impact our future results of operations and financial position, the nature of which and the extent to which are currently unknown. Actions taken by OPEC+ in April andJune 2020 , including the agreement for management of crude oil supply in the hopes of contributing to market stabilization (the "Oil Production Cuts"), as well as theU.S. Federal Government's passage and/or enactment of additional stimulus and relief measures, as well as their future actions may impact the extent to which the risk underlying these uncertainties are realized. To the extent these uncertainties have been identified and are believed to have an impact on our current period results of operations or financial position based on the requirements for assessing such financial statement impact underU.S. Generally Accepted Accounting Principles ("GAAP"), we have considered them in the preparation of our unaudited financial statements as of and for the nine months endedSeptember 30, 2020 , which are included in Item 1, of this Quarterly Report on Form 10-Q. In addition, management continues to actively respond to the continuing impact of the COVID-19 Pandemic on our business. Such efforts include (but are not limited to) the following: •Reviewing planned production throughputs at our refineries and planning for optimization of operations; •Coordinating planned maintenance activities with possible downtime as a result of possible reductions in throughputs; •Searching for additional storage capacity if needed to store potential builds in crude oil or refined product inventories; •Finding additional suppliers for key or specialty items or securing inventory or priority status with existing vendors; •Reducing planned capital expenditures for 2020; •Suspending the share repurchase program until our internal parameters are met for resuming such repurchases, which will continue to include evaluation of our undervalued stock price in relation to opportunities to provide alternative returns and/or accretive value to investors; •Taking advantage of the income and payroll tax relief afforded to us by the CARES Act; •Implementing regular site cleaning and disinfecting procedures; •Adopting remote working where possible. Where on-site operations are required, masks are mandatory and our employees have adopted social distancing; •Reviewing dividend strategy to align with market changes and current economic conditions; •Identifying alternative financing solutions to enhance our access to sources of liquidity; and •Enacting cost reduction measures across the organization, including reducing contract services, reducing overtime and other employee related costs, workforce reduction and reducing or eliminating non-critical travel which serves the dual purpose of also complying with recommendations made by the state and federal governments because of the COVID-19 Pandemic. The most significant of these efforts to date as well as specifically identified measures that are anticipated in the near term, in terms of realized or anticipated impact, include the following: Pursuant to the provisions of the CARES Act, we recognized$16.8 million of current federal income tax benefit for the nine months endedSeptember 30, 2020 , attributable to anticipated tax refunds from net operating loss carryback to prior 35% tax rate years. Additionally, we recorded an income tax receivable totaling$165.6 million as ofSeptember 30, 2020 related to the net operating loss carryback, which we expect to collect in the first half of 2021. Finally, we deferred$7.8 million of payroll tax payments under the provisions of the CARES Act during the nine months endedSeptember 30, 2020 , which will be payable in equal installments inDecember 2021 andDecember 2022 . Beginning in the second quarter 2020, we made significant efforts to reduce our capital spending, particularly on growth and non-critical sustaining maintenance projects. As a result, we have spent$208.0 million in capital expenditures (as discussed further in the "Capital Spending" section of the "Liquidity and Capital Resources" section of Item 2. Management's Discussion and Analysis) during the nine months endedSeptember 30, 2020 compared to our initial full-year forecast included in ourDecember 31, 2019 Annual Report on Form 10-K of$325.7 million . See the "Liquidity and Capital Resources" section of Item 2. Management's Discussion and Analysis for further information. 43 | [[Image Removed: dk-20200930_g3.jpg]] -------------------------------------------------------------------------------- Management's Discussion and
Analysis
In light of the weak macro-economic environment, we elected to pull forward turnaround work into the fourth quarter of 2020 on certain units at theKrotz Springs refinery that will be conducted on a straight-time basis. This will allow us to continue running the more profitable units of the refinery and should help improve economics toward a break-even level. After this work is complete in the first quarter of next year and depending on market conditions, we have the flexibility to optimize operations atKrotz Springs by operating only the units that are producing favorable margins, thereby reducing unnecessary operating expenses, or moving back to full utilization at the facility, should the macro-economic environment and margins improve. Additionally, we have developed a cost savings plan for 2021 designed to significantly reduce operating expenses and general and administrative expenses. The majority of the expected operating expenses reduction is attributable to the temporary unit optimization at theKrotz Spring refinery , while other efforts such as targeted budgeting around outside contractor expenses and deferral of certain non-critical, non-capitalizable maintenance activities are also expected to have a favorable impact. Furthermore, both operating and general and administrative expenses will be favorably impacted by a cumulative reduction in workforce, the first of these reductions of which began in the second quarter 2020, and which are expected to be completed by the fourth quarter. Reductions in workforce are made possible in large part by significant efforts to improve process efficiency and leverage technology where cost-effective. For the three and nine months endedSeptember 30, 2020 , we have incurred incremental severance costs of$1.8 million and$4.6 million related to these workforce reductions. We have also incurred$2.4 million of severance costs subsequent toSeptember 30, 2020 . Finally, we have elected to suspend dividends beginning in the fourth quarter 2020 in order to conserve capital. We expect this will help us maintain our liquidity and manage our cost of capital in light of the COVID-19 Pandemic and lower oil prices. We also believe it will provide us with flexibility to pursue opportunities to provide value to investors with respect to our stock price, which we believe is undervalued. The combination of these efforts are expected to have a favorable impact on cash flows on a prospective basis and continuing in 2021, which will reinforce our liquidity positioning in anticipation of the continued economic impacts of the COVID-19 Pandemic. See the "Liquidity and Capital Resources" section of Item 2. Management's Discussion and Analysis for further information. The extent to which our future results are affected by the COVID-19 Pandemic will depend on various factors and consequences beyond our control, such as the duration and scope of the Pandemic; additional actions by businesses and governments in response to the Pandemic, and the speed and effectiveness of responses to combat the virus. The COVID-19 Pandemic, and the volatile regional and global economic conditions stemming from the Pandemic, could also exacerbate the risk factors identified in our Annual Report on Form 10-K for the fiscal year endedDecember 31, 2019 and in this Form 10-Q. The COVID-19 Pandemic may also materially adversely affect our results in a manner that is either not currently known or that we do not currently consider to be a significant risk to our business. See also "Risk Factors" in Part II, Item 1A. of this Quarterly Report on Form 10-Q for further discussion of risks associated with the COVID-19 Pandemic and the OPEC Production Disputes. Refining Overview The refining segment processes crude oil and other feedstocks for the manufacture of transportation motor fuels, including various grades of gasoline, diesel fuel and aviation fuel, asphalt and other petroleum-based products that are distributed through owned and third-party product terminals. The refining segment has a combined nameplate capacity of 302,000 barrels per day as ofSeptember 30, 2020 . A high-level summary of the refinery activities is presented below:El Dorado, Arkansas
Tyler, Texas refinery refinery (the "El Dorado
(the "
(the "Tyler refinery") refinery") refinery") Springs refinery")
Total Nameplate
Capacity (barrels per
day ("bpd")) 75,000 80,000 73,000 74,000
Gasoline, jet fuel, Gasoline, jet fuel, Gasoline, jet fuel,
ultra-low-sulfur diesel, Gasoline, ultra-low-sulfur ultra-low-sulfur diesel, high-sulfur diesel, light Primary Products liquefied petroleum diesel, liquefied petroleum liquefied petroleum gases, cycle oil, liquefied
gases, propylene, gases, propylene, asphalt propylene, aromatics and petroleum gases, propylene
petroleum coke and sulfur and sulfur sulfur and ammonium thiosulfate
Relevant Crack Spread
Benchmark (1) Gulf Coast 5-3-2 Gulf Coast 5-3-2 (2)
The refining segment's petroleum-based products are
marketed primarily in the south central, southwestern
Marketing and and western regions of
brand through various terminals to supply Alon or Delek branded retail sites. In addition, we sell motor
fuels through our wholesale distribution network on an unbranded basis.
(1) The term "crack spread" is a measure of the difference between market prices for crude oil and refined products. (2) While there is variability in the crude slate and the product output at theEl Dorado refinery , we compare our per barrel refined product margin to theU.S. Gulf Coast ("Gulf Coast ") 5-3-2 crack spread because we believe it to be the most closely aligned benchmark. 44 | [[Image Removed: dk-20200930_g3.jpg]] -------------------------------------------------------------------------------- Management's Discussion and
Analysis
(3) OurBig Spring refinery is capable of processing substantial volumes of sour crude oil, which has historically cost less than intermediate, and/or substantial volumes of sweet crude oil, and therefore theWest Texas Intermediate ("WTI")Cushing / West Texas Sour ("WTS") price differential, taking into account differences in production yield, is an important measure for helping us make strategic, market-respondent production decisions. (4)The Krotz Springs refinery has the capability to process substantial volumes of light sweet crude oil to produce a high percentage of refined light products.
Our refining segment also owns and operates three biodiesel facilities involved
in the production of biodiesel fuels and related activities, located in
Logistics Overview
Our logistics segment gathers, transports and stores crude oil and markets,
distributes, transports and stores refined products in select regions of the
southeastern United States and West Texas for our refining segment and third
parties. It is comprised of the consolidated balance sheet and results of
operations of Delek Logistics Partners, LP ("Delek Logistics", NYSE:DKL), where
we owned an 80.0% interest in Delek Logistics at September 30, 2020 . Delek
Logistics was formed by Delek in 2012 to own, operate, acquire and construct
crude oil and refined products logistics and marketing assets. A substantial
majority of Delek Logistics' assets are currently integral to our refining and
marketing operations. The logistics segment's pipelines and transportation
business owns or leases capacity on approximately 400 miles of crude oil
transportation pipelines, approximately 450 miles of refined product pipelines,
an approximately 700-mile crude oil gathering system and associated crude oil
storage tanks with an aggregate of approximately 10.2 million barrels of active
shell capacity. Our logistics segment owns and operates nine light product
terminals and markets light products using third-party terminals. The logistics
segment also has strategic investments in pipeline joint ventures that provide
access to pipeline capacity as well as the potential for earnings from joint
venture operations. Additionally, on March 31, 2020 , the logistics segment
acquired from another of our segments approximately 200 miles of gathering and
ancillary assets located in Howard , Borden and Martin Counties, Texas . In May
2020 , the logistics segment acquired from another of our segments certain leased
and owned tractors and trailers and related assets. The logistics segment owns
or leases approximately 273 tractors and 324 trailers used to haul primarily
crude oil and other products for related and third parties.
Retail Overview
Our retail segment at September 30, 2020 includes the operations of 253 owned
and leased convenience store sites located primarily in Central and West Texas
and New Mexico . Our convenience stores typically offer various grades of
gasoline and diesel under the DK or Alon brand name and food products, food
service, tobacco products, non-alcoholic and alcoholic beverages, general
merchandise as well as money orders to the public, primarily under the 7-Eleven
and DK or Alon brand names pursuant to a license agreement with 7-Eleven, Inc.
In November 2018 , we terminated the license agreement with 7-Eleven, Inc. This
agreement was amended in April 2020 to extend date for the required removal of
all 7-Eleven branding on a store-by-store basis from December 31, 2021 to
December 31, 2022 . As of September 30, 2020 , we have removed the 7-Eleven brand
name at 57 of our store locations. Merchandise sales at our convenience store
sites will continue to be sold under the 7-Eleven brand name until 7-Eleven
branding is removed pursuant to the termination. Substantially all of the motor
fuel sold through our retail segment is supplied by our Big Spring refinery ,
which is transferred to the retail segment at prices substantially determined by
reference to published commodity pricing information. In connection with our
retail strategic initiatives, as of September 30, 2020 , we have closed or sold
46 under-performing or non-strategic store locations of which one was closed
during the nine months ended September 30, 2020 .
The cost to acquire the refined fuel products we sell to our wholesale customers
in our logistics segment and at our convenience stores in our retail segment
depends on numerous factors beyond our control, including the supply of, and
demand for, crude oil, gasoline and other refined petroleum products which, in
turn, depend on, among other factors, changes in domestic and foreign economies,
weather conditions, domestic and foreign political affairs, production levels,
the availability of imports, the marketing of competitive fuels and government
regulation. Our retail merchandise sales are driven by convenience, customer
service, competitive pricing and branding. Motor fuel margin is sales less the
delivered cost of fuel and motor fuel taxes, measured on a cents per gallon
basis. Our motor fuel margins are impacted by local supply, demand, weather,
competitor pricing and product brand.
Corporate and Other Overview
Our corporate activities, results of certain immaterial operating segments, including our asphalt terminal operations, our recently commenced wholesale crude operations, and intercompany eliminations are reported in corporate, other and eliminations in our segment disclosures. Additionally, our corporate activities include certain of our commodity and other hedging activities. 45 | [[Image Removed: dk-20200930_g3.jpg]]
--------------------------------------------------------------------------------
Management's Discussion and Analysis
Strategic Overview
The Company's overall strategy has been to take a disciplined approach that
looks to balance returning cash to our shareholders and prudently investing in
the business to support safe and reliable operations, while exploring
opportunities for growth. Our goal has been to balance the different aspects of
this program based on evaluations of each opportunity and how it matches our
strategic goals for the company, while factoring in market conditions and
expected cash generation.
In the face of the economic impact of the COVID-19 Pandemic and the OPEC
Production Disputes, our overall strategy remains unchanged and continues to be
focused on the following objectives:
I. Safety and wellness.
II. Reliability and integrity.
III. Systems and processes.
IV. Risk-based decision making.
V. Positioning for growth.
In addition to the above, it continues to be a strategic and operational
objective to manage price and supply risk related to crude oil that is used in
refinery production, and to develop strategic sourcing relationships. For that
purpose, from a pricing perspective, we enter into commodity derivative
contracts to manage our price exposure to our inventory positions, future
purchases of crude oil and ethanol, future sales of refined products or to fix
margins on future production. We also enter into future commitments to purchase
or sell renewable identification numbers ("RINs") at fixed prices and
quantities, which are used to manage the costs of our credits for commitments
required by the U.S. Environmental Protection Agency ("EPA ") to blend biofuels
into fuel products ("RINs Obligation"). Additionally, from a sourcing
perspective, we often enter into purchase and sale contracts with vendors and
customers or take financial commodity positions for crude oil that may not be
used immediately in production, but that may be used to manage the overall
supply and availability of crude expected to ultimately be needed for production
and/or to meet minimum requirements under strategic pipeline arrangements, and
also to optimize and hedge availability risks associated with crude that we
ultimately expect to use in production. Such transactions are inherently based
on certain assumptions and judgments made about the current and possible future
availability of crude. Therefore, when we take physical or financial positions
for optimization purposes, our intent is generally to take offsetting positions
in quantities and at prices that will advance these objectives while minimizing
our positional and financial statement risk. However, because of the volatility
of the market in terms of pricing and availability, it is possible that we may
have material positions with timing differences or, more rarely, that we are
unable to cover a position with an offsetting position as intended. Such
differences could have a material impact on the classification of resulting
gains/losses, assets or liabilities, and could also significantly impact net
earnings.
With these objectives serving as our guiding principles, we are applying the
short-term measures to mitigate the impact of the COVID-19 Pandemic and the OPEC
Production Disputes described in the 'Business Overview' above. And with these
objectives in mind, we have achieved the following successes to date in 2020:
2020 Developments
Transactions designed to maximize shareholder return
Dividend Suspension
On November 5, 2020 , we announced that we have elected to suspend dividends
beginning in the fourth quarter of 2020 in order to conserve capital. Our
previous quarterly cash dividend amounts ranged between $0.27 to $0.30 per share
for dividends paid throughout 2019 and was $0.31 per share for the dividends
paid during each of the three quarterly periods of 2020. The declaration, amount
and payment of any future dividends on our common stock will be at the sole
discretion of our Board of Directors, and we are not obligated to declare or pay
any dividends.
46 | [[Image Removed: dk-20200930_g3.jpg]]
--------------------------------------------------------------------------------
Management's Discussion and Analysis
Share Repurchases During the nine months endedSeptember 30, 2020 , Delek repurchased 58,713 shares for an aggregate purchase price of$1.9 million under the most recent share repurchase plan which provided for repurchases of up to$500.0 million and was approved by the board onNovember 6, 2018 . As ofSeptember 30, 2020 , there remained$229.7 million available for repurchases under the most recent repurchase plan. In our efforts to conserve capital, for the time being, we have temporarily suspended the repurchase of shares. However, in light of ourNovember 2020 decision to suspend dividends, we acknowledge that share repurchases could resume and that potential share repurchases would take priority over future dividends or growth capital. Transactions designed to maximize return on assets Investment inMidstream Ventures InJuly 2019 , we acquired a 15% ownership interest in Wink to Webster Pipeline ("WWP"). WWP intends to construct and operate a crude oil pipeline system fromWink, Texas toWebster, Texas along with certain pipelines fromWebster, Texas to other destinations in theGulf Coast area. It is expected to span approximately 650 miles at completion. Under the agreements governing the joint venture, we must contribute our percentage interest of the applicable construction costs (including certain costs previously incurred by WWP), and it is anticipated that our capital contributions will total approximately$340 million to$380 million over the course of construction (expected to be two to three years). Construction of the crude oil pipeline system remains on schedule, and the main segment of the pipeline system is expected to commence operations in the fourth quarter of 2020, with additional segments expected to be placed in service throughout 2021. OnFebruary 21, 2020 , we, through our wholly-owned direct subsidiaryDelek Energy , entered into theW2W Holdings LLC ("HoldCo") Agreement withMPLX Operations LLC ("MPLX") (collectively, with its wholly-owned subsidiaries, the "WWP Project Financing Joint Venture" or the "WWP Project Financing JV"). The WWP Project Financing JV was created for the specific purpose of obtaining financing, through its wholly-owned subsidiary,W2W Finance LLC , to fund the majority of our combined capital calls resulting from and occurring during the construction period of the pipeline system under the WWP Joint Venture, and to service that debt. In connection with the arrangement, bothDelek Energy and MPLX contributed their respective 15% ownership interests to theWWP Project Financing JV as collateral for and in service of the related project financing. Accordingly, distributions received from WWP through the WWP Project Financing JV will first be applied in service of the related project financing debt, with excess distributions being made to the members of the WWP Project Financing JV as provided for in the W2W Holdings LLC Agreement and as allowed under the project financing debt. The obligations of the members under the W2W Holdings LLC Agreement are guaranteed by the parents of the members of theWWP Project Financing JV (i.e., for the Delek member, the guarantee is fromDelek US Holdings, Inc. ). Our investment is accounted for as an equity method investment. See further discussion in Note 5 of our condensed consolidated financial statements included in Item 1. Financial Statements, of this Quarterly Report on Form 10-Q.Increased Investment in Delek Logistics EffectiveAugust 13, 2020 , Delek Logistics completed a restructuring transaction to eliminate the incentive distribution rights held by us and convert the 2.0% economic general partner interest into a non-economic general partner interest, in exchange for a total consideration consisting of$45.0 million in cash and 14.0 million newly issued common limited partner units. Contemporaneously, we repurchased 5.2% ownership interest inDelek Logistics GP LLC , the general partner, from our affiliates, who are also members of the general partner's management and board of directors, for$23.1 million in cash. Subsequent to these transactions, we owned 34,745,868 common limited partner units increasing our ownership to 80.0% of the outstanding common units, and 100% of the outstanding interest in the general partner,Delek Logistics GP, LLC . EffectiveMay 1, 2020 , Delek through its wholly owned subsidiariesLion Oil Company ("Lion Oil") andDelek Refining, Ltd. ("Delek Refining") contributed certain leased and owned tractors and trailers and related assets used in the provision of trucking and transportation services for crude oil, petroleum and certain other products throughoutArkansas ,Oklahoma andTexas toDelek Trucking, LLC ("Delek Trucking "), a direct wholly owned subsidiary of Lion Oil. Following this contribution, Lion Oil sold all of the issued and outstanding membership interests inDelek Trucking (the "Acquisition") toDKL Transportation, LLC ("DKL Transportation"), a wholly owned subsidiary of Delek Logistics. Promptly following the consummation of the Acquisition,Delek Trucking merged with and into DKL Transportation, with DKL Transportation continuing as the surviving entity. Total consideration for the Acquisition was approximately$48.0 million in cash, subject to certain post-closing adjustments, primarily financed with borrowings under Delek Logistics' revolving credit facility. EffectiveMarch 31, 2020 , Delek Logistics, through its wholly-owned subsidiaryDKL Permian Gathering, LLC , acquired the Big Spring Gathering System, located inHoward ,Borden andMartin Counties,Texas , from Delek. Delek Logistics will operate and maintain the Big Spring Gathering System connecting our interests in and to certain crude oil production with the Delek Logistics'Big Spring, Texas terminal and provide gathering, transportation and other related services. The total consideration was subject to certain post-closing adjustments and was comprised of$100.0 million in cash and 5.0 million common units representing limited partner interest in Delek Logistics. The 47 | [[Image Removed: dk-20200930_g3.jpg]] -------------------------------------------------------------------------------- Management's Discussion and
Analysis
cash component of this dropdown was financed with borrowings on the Delek Logistics Credit Facility (as defined in Note 8 of our condensed consolidated financial statements included in Item 1. Financial Statements). Additionally, inMarch 2020 , we purchased 451,822 of Delek Logistics limited partner units from a public investor for approximately$5.0 million . As a result of these transactions, our ownership in Delek Logistics' common limited partner units was increased to 70.5% at that time. These continued investments enhance our ability to maximize the value of our logistics assets. See further discussion in Note 4 of our condensed consolidated financial statements included in Item 1. Financial Statements, of this Quarterly Report on Form 10-Q. Sale ofBakersfield Non-Operating Refinery OnMay 7, 2020 , we sold our equity interests inAlon Bakersfield Property, Inc. , an indirect wholly-owned subsidiary that owns our non-operating refinery located inBakersfield, California , to a subsidiary of Global Clean Energy Holdings, Inc. ("GCE") for total cash consideration of$40 million . GCE intends to repurpose the refinery into a renewable diesel plant. As part of the transaction, GCE granted a call option to Delek to acquire up to a 33 1/3% interest in the acquiring subsidiary, GCE Acquisitions, exercisable by Delek through the 90th day after GCE demonstrates commercial operations, as contractually defined. See further discussion in Note 2 of our condensed consolidated financial statements included in Item 1. Financial Statements, of this Quarterly Report on Form 10-Q. Transactions designed to minimize the cost of capital/manage financial risk exposures 2020 Amendments to Supply and Offtake Agreements InJanuary 2020 , we amended our three Supply and Offtake Agreements withJ. Aron which applies to theEl Dorado refinery , theBig Spring refinery and theKrotz Springs refinery so that the repurchase of Baseline Volumes at the end of the Supply and Offtake Agreement term (representing the "Baseline Step-Out Liability" or, collectively, the "Baseline Step-Out Liabilities") will be based on market-indexed price subject to commodity price risk with corresponding changes to underlying market-based indices and certain differentials. The amendments resulted in Baseline Step-Out Liabilities for which the fair value is no longer subject to interest rate risk but is now subject to commodity price volatility. InApril 2020 , we amended and restated our three Supply and Offtake Agreements to amend and extend the terms toDecember 30, 2022 , withJ. Aron having the sole discretion to further extend toMay 30, 2025 by providing at least six months notice prior to the maturity date. As part of this amendment, there were changes to the underlying market index, annual fee, the crude purchase fee, crude roll fees and timing of cash settlements related to periodic price adjustments on the fixed differential component of the Baseline Volume Step-Out Liabilities. The amendments provide us dedicated financing for the barrels covered through at leastDecember 2022 , and certain specific market-indexed provisions improve our ability to manage our exposure to commodity price volatility during the term of the Agreements. See further discussion in Note 7 of our condensed consolidated financial statements included in Item 1. Financial Statements, of this Quarterly Report on Form 10-Q. 2020 Amendment to the Term Loan Credit Facility OnMay 19, 2020 , we amended the Term Loan Credit Facility agreement (as defined in Note 8 of our condensed consolidated financial statements included in Item 1. Financial Statements) and borrowed$200.0 million in aggregate principal amount of incremental term loans (the "Third Incremental Term Loan") at an original issue discount of 7.00%, requiring quarterly principal amortization payments of$0.5 million commencing withJune 30, 2020 . The Third Incremental Term Loan constitutes a separate class of term loans under the Term Loan Credit Facility from those initially borrowed inMarch 2018 and the incremental term loans borrowed inMay 2019 andNovember 2019 . There are no restrictions on the Company's use of the proceeds of the Third Incremental Term Loan, and the proceeds may be used (i) for general corporate purposes and (ii) to pay transaction fees and expenses associated with the Third Incremental Term Loan. See further discussion in Note 8 of our condensed consolidated financial statements included in Item 1. Financial Statements, of this Quarterly Report on Form 10-Q. 48 | [[Image Removed: dk-20200930_g3.jpg]] --------------------------------------------------------------------------------
Management's Discussion and Analysis
Market Trends
Commodity Prices
Our results of operations are significantly affected by fluctuations in the
prices of certain commodities, including, but not limited to, crude oil,
gasoline, distillate fuel, biofuels, natural gas and electricity, among others.
Historically, our profitability has been affected by commodity price volatility,
specifically as it relates to the price of crude oil and refined products. We
have significant sources of WTI Midland crude because of our gathering system,
and so accordingly favorable pricing of WTI Midland crude compared to other WTI
crude can favorably impact our cost of materials and other and therefore our
margins compared to other refiners.
The table below reflects the quarterly average prices of WTI Midland and WTI
Cushing crude oil for each of the quarterly periods in 2019 and for the three
quarterly periods in 2020. As shown in the historical graph, WTI Midland crude
prices have generally been favorable as compared to WTI Cushing, though that
trend has reversed slightly in the fourth quarter 2019 and the third quarter of
2020.
[[Image Removed: dk-20200930_g4.jpg]]
Crack Spreads
Crack spreads are used as benchmarks for predicting and evaluating a refinery's product margins by measuring the difference between the market price of feedstocks and crude oil and refined products. Generally, crack spreads represent the approximate refining margin resulting from processing one barrel of crude oil into its outputs, generally gasoline and diesel fuel. The table below reflects the quarterly averageGulf Coast 5-3-2 Ultra Low Sulfur Diesel ("ULSD"), 3-2-1 and 2-1-1 crack spreads for each of the quarterly periods in 2019 and for the three quarterly periods in 2020. As the chart illustrates, the 3-2-1 crack spread has consistently outperformed the 5-3-2 and the 2-1-1 crack spreads. In such conditions, things being equal (i.e., near-capacity throughputs and no significant outages), ourBig Spring refinery , whose benchmark is the 3-2-1 crack spread, should outperform our other refineries in terms of refining margin. [[Image Removed: dk-20200930_g5.jpg]] 49 | [[Image Removed: dk-20200930_g3.jpg]] --------------------------------------------------------------------------------
Management's Discussion and Analysis
Refined Product Prices
Our refineries produce the following products:
Tyler Refinery El Dorado Refinery Big Spring Refinery Krotz Springs Refinery
Gasoline, jet fuel, Gasoline, jet fuel, Gasoline, jet fuel,
ultra-low-sulfur diesel, Gasoline,ultra-low-sulfur ultra-low-sulfur diesel, high-sulfur diesel, light Primary Products
liquefied petroleum gases, diesel, liquefied petroleum liquefied petroleum gases, cycle oil, liquefied
propylene, petroleum coke gases, propylene, asphalt propylene, aromatics and petroleum gases,
and sulfur and sulfur sulfur propylene and ammonium
thiosulfate
The charts below illustrate the quarterly average prices of Gulf Coast Gasoline,
Crude Pricing Differentials
As U.S. crude oil production has increased over recent years, domestic producers
have benefited from the discount for WTI Cushing compared to Brent, a global
benchmark crude. This generally leads to higher margins in our refineries, as
refined product prices are influenced by Brent crude prices and the majority of
our crude supply is WTI-linked. Because of our positioning in the Permian basin,
we are even further benefited by discounts in the WTI Midland/WTI Cushing
differential. When these discounts shrink or become premiums, our reliance on
WTI-linked crude pricing, and specifically WTI Midland crude can negatively
impact our results. Conversely, as these price discounts increase, so does our
competitive advantage, created by our access to WTI-linked crude oil pricing,
and specifically WTI Midland crude sources through our gathering systems.
The chart below illustrates the differentials of both Brent crude oil and WTI
Midland crude oil as compared to WTI Cushing crude oil as well as WTI Cushing as
compared to Louisiana Light Sweet crude oil ("LLS") for each of the quarterly
periods in 2019 and for the three quarterly periods in 2020.
[[Image Removed: dk-20200930_g7.jpg]]
50 | [[Image Removed: dk-20200930_g3.jpg]]
--------------------------------------------------------------------------------
Management's Discussion and Analysis
RIN Volatility
Environmental regulations continue to affect our margins in the form of
volatility in the cost of RINs. On a consolidated basis, we work to balance the
cost of our RINs Obligation in order to minimize the effect of RINs on our
results. While we generate RINs in both our refining and logistics segments
through our ethanol blending and biodiesel production, our refining segment
needs to purchase additional RINs to satisfy its obligations. As a result,
increases in the price of RINs generally adversely affect our results of
operations. It is not possible at this time to predict with certainty what
future volumes or costs may be, but given the volatile price of RINs, the cost
of purchasing sufficient RINs could have an adverse impact on our results of
operations if we are unable to recover those costs in the price of our refined
products. The chart below illustrates the volatility in RINs prices over several
quarterly periods, beginning with the first quarter of 2019 through the third
quarter of 2020.
[[Image Removed: dk-20200930_g8.jpg]]
51 | [[Image Removed: dk-20200930_g3.jpg]]
--------------------------------------------------------------------------------
Management's Discussion and Analysis
Contractual Obligations Information regarding our known contractual obligations and commercial commitments of the types described below as ofSeptember 30, 2020 , is set forth in the following table (in millions):
Payments Due by Period
<1 Year 1-3 Years 3-5 Years >5 Years Total Long term debt and notes payable obligations$ 33.4 $ 986.0
84.4 161.2 82.0 - 327.6
Operating lease commitments(2) 54.8 73.5 39.9 51.8 220.0
Purchase commitments(3) 562.2 - - - 562.2
Transportation agreements(4) 124.8 244.7 129.1 75.3 573.9
J. Aron supply and offtake
obligations (5) 15.5 239.8 - - 255.3
Total $ 875.1 $ 1,705.2 $ 1,738.3 $ 127.1 $ 4,445.7
(1) Expected interest payments on debt outstanding at September 30, 2020 .
Floating interest rate debt is calculated using September 30, 2020 rates. For
additional information, see Note 8 of our condensed consolidated financial
statements included in Item 1. Financial Statements, of this Quarterly Report on
Form 10-Q.
(2) Amounts reflect future estimated lease payments under operating leases
having remaining non-cancelable terms in excess of one year as of September 30,
2020 .
(3) We have supply agreements to secure certain quantities of crude oil,
finished product and other resources used in production at both fixed and market
prices. We have estimated future payments under the market-based agreements
using current market rates. Excludes purchase commitments in buy-sell
transactions which have matching notional amounts with the same counterparty and
are generally net settled.
(4) Balances consist of contractual obligations under agreements with third
parties (not including Delek Logistics) for the transportation of crude oil to
our refineries.
(5) Balances consists of contractual obligations under the J. Aron Supply and
Offtake Agreements, including annual fees and principal obligation for the
Baseline Volume Step-Out Liability. For additional information, see Note 7 of
our condensed consolidated financial statements included in Item 1. Financial
Statements, of this Quarterly Report on Form 10-Q.
Critical Accounting Policies
The preparation of our consolidated financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses and related disclosure of contingent assets and
liabilities. The SEC has defined critical accounting policies as those that are
both most important to the portrayal of our financial condition and results of
operations, and require our most difficult, subjective or complex judgments or
estimates. Based on this definition and as further described in our 2019 Annual
Report on Form 10-K, we believe our critical accounting policies include the
following: (i) estimating our quarterly inventory adjustments using the last-in,
first-out valuation method for the Tyler refinery , (ii) evaluating impairment
for property, plant and equipment and definite life intangibles, (iii)
evaluating potential impairment of goodwill, (iv) estimating environmental
expenditures, and (v) estimating asset retirement obligations.
During the nine months ended September 30, 2020 , we updated our critical
accounting policies to include accounting policies that have become critical as
a result of new transactions. Accordingly, we are adding a critical accounting
policy related to evaluating variable interest entities to reflect the
significant judgment that is involved when determining whether an entity is a
variable interest entity ("VIE") and evaluating whether we are the primary
beneficiary in connection with our new investment in W2W Holdings LLC . See Note
5 of the condensed consolidated financial statements in Item 1. Financial
Statements, for discussion of our investment in W2W Holdings LLC and the related
accounting treatment.
Evaluation of Variable Interest Entities
Our consolidated financial statements include the financial statements of our
subsidiaries and VIEs, of which we are the primary beneficiary. We evaluate all
legal entities in which we hold an ownership or other pecuniary interest to
determine if the entity is a VIE. Variable interests can be contractual,
ownership or other pecuniary interests in an entity that change with changes in
the fair value of the VIE's assets. If we are not the primary beneficiary, the
general partner or another limited partner may consolidate the VIE, and we
record the investment as an equity method investment. Significant judgment is
exercised in determining that a legal entity is a VIE and in evaluating whether
we are the primary beneficiary in a VIE. Generally, the primary beneficiary is
the party that has both the power to direct the activities that most
significantly impact the VIE's economic performance and the right to receive
benefits or obligation to absorb losses that could be potentially significant to
the VIE. We evaluate the entity's need for continuing financial support; the
equity holder's lack of a controlling financial interest; and/or if an equity
holder's voting interests are disproportionate to its obligation to absorb
expected losses or receive residual returns. We evaluate our interests in a VIE
to determine whether we are the primary beneficiary. We use a primarily
qualitative analysis to determine if we are deemed to have a controlling
financial interest in the VIE, either on a standalone basis or as part of a
related party group. We continually monitor our interests in legal entities for
changes in the design or activities of an entity and changes in our interests,
including our status as the primary beneficiary to determine if the changes
require us to revise our previous conclusions.
52 | [[Image Removed: dk-20200930_g3.jpg]]
--------------------------------------------------------------------------------
Management's Discussion and Analysis
Additionally, due to the economic and industry impact of the COVID-19 Pandemic and the OPEC Production Disputes, we also modified the application of certain of our critical accounting policies during and as of the nine months endedSeptember 30, 2020 as follows:Goodwill and Potential Impairment Our annual goodwill impairment analysis is performed during the fourth quarter of each year. Under Accounting Standards Codification ("ASC")ASC 350, Intangibles -Goodwill and Other, goodwill of a reporting unit shall be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. In our assessment of the potential indicators of impairment, we considered the continued impact of the COVID-19 pandemic, including the significant decline in our stock price. We noted a decline in our stock price, which resulted in a decline in our market capitalization sinceJune 30, 2020 . To determine whether the decline in market capitalization and other negative developments arising due to the Pandemic that occurred throughSeptember 30, 2020 , would more likely than not reduce the fair value of a reporting unit below its carrying amount, we performed certain analyses on the most significant inputs in our valuation model to evaluate the impact of these events on the fair value of our reporting units. Based on our initial qualitative analysis, we noted that the refining segment was most at risk for potential impairment. Therefore, we performed extensive additional sensitivity analysis and stress testing on certain of the key assumptions our valuation model. Based on our analyses, we determined that there was sufficient risk present associated with both ourBig Spring refinery ("BSR") andKrotz Springs refinery ("KSR") reporting units to indicate that the fair values of those reporting units were more likely than not to have declined below the carrying value as ofSeptember 30, 2020 . Accordingly, we updated our estimates of fair value for the BSR and KSR reporting units as ofSeptember 30, 2020 , using updated inputs and assumptions based on third party data where available. The estimated fair values of the reporting units were determined using a combination of a discounted cash flow ("DCF") analysis and a market approach. The DCF analysis was based on our current projection of cash flows which reflected our updated estimates for long-term growth rates, gross margin, capital expenditures and the Weighted Average Cost of Capital or "WACC", which we adjusted to reflect the uncertainties that exist in the market as a result of the Pandemic. For the market approach, we applied an average historical multiple for guideline companies to estimated income before taxes, interest, depreciation, and amortization. Our analysis included a reconciliation of the estimated fair value of all reporting units to the company's market capitalization. Based on these quantitative analyses, we concluded that the goodwill balances attributed to the BSR and KSR reporting unit were not impaired as ofSeptember 30, 2020 . The fair value measurements for the individual reporting units' estimated fair values represent Level 3 measurements. We performed a sensitivity analysis on our impairment test as ofSeptember 30, 2020 , noting the following: Sensitivity Increase
in WACC that Decrease in long-term
Total Goodwill Balance % Estimated Fair Value could cause impairment growth rate that could
at September 30, 2020 exceeds Carrying Value (1) cause impairment (1)
BSR $528.0 < 10% 0.5%-1.0% 1%
KSR 237.2 <10% 1.0%-1.5% 1%
(1) Assumes no other changes in any of the key assumptions.
Fair value determinations require considerable judgment and are sensitive to
changes in underlying assumptions and factors. As a result, there can be no
assurance that the estimates and assumptions made for purposes of the interim
goodwill impairment test will prove to be an accurate prediction of the future.
Our assessment was performed based on events that had occurred and conditions
that existed as of September 30, 2020 . Because conditions and events are rapidly
changing, we continue to monitor developments with these events and their impact
on our valuation. Continued or worsening adverse changes to these factors, as
well as their impact on our cash flows, market capitalization and other
assumptions and inputs, may result in the need to recognize an impairment in
future periods. Specifically with respect to the BSR and KSR reporting units, it
is at least reasonably possible that continued or worsening adverse change to
these factors, or the presence of new factors having a negative impact on our
projection of future cash flows not known as of September 30, 2020 , may result
in a future impairment which could be material. We will perform our annual
goodwill assessment during the fourth quarter.
Other than as described above, for all financial statement periods presented,
there have been no material modifications to the application of these critical
accounting policies or estimates since our most recently filed Annual Report on
Form 10-K. See Note 1 of the condensed consolidated financial statements in Item
1. Financial Statements, for discussion of updates to our accounting policies.
53 | [[Image Removed: dk-20200930_g3.jpg]]
--------------------------------------------------------------------------------
Management's Discussion and Analysis
Non-GAAP Measures Our management uses certain "non-GAAP" operational measures to evaluate our operating segment performance and non-GAAP financial measures to evaluate past performance and prospects for the future to supplement our GAAP financial information presented in accordance withU.S. GAAP. These financial and operational non-GAAP measures are important factors in assessing our operating results and profitability and include: •Refining margin - calculated as the difference between net refining revenues and total cost of materials and other; •Refined product margin - calculated as the difference between net revenues attributable to refined products (produced and purchased) and related cost of materials and other (which is applicable to both the refining segment and the westTexas wholesale marketing activities within our logistics segment); and •Refining margin per barrels sold - calculated as refining margin divided by our average refining sales in barrels per day (excluding purchased barrels) multiplied by 1,000 and multiplied by the number of days in the period. We believe these non-GAAP operational and financial measures are useful to investors, lenders, ratings agencies and analysts to assess our ongoing performance because, when reconciled to their most comparable GAAP financial measure, they provide improved comparability between periods through the exclusion of certain items that we believe are not indicative of our core operating performance and they may obscure our underlying results and trends. Non-GAAP measures have important limitations as analytical tools, because they exclude some, but not all, items that affect net earnings and operating income. These measures should not be considered substitutes for their most directly comparableU.S. GAAP financial measures. Non-GAAP Reconciliations The following table provides a reconciliation of refining margin to the most directly comparableU.S. GAAP measure, gross margin: Reconciliation of refining margin to gross margin Refining Segment Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Net revenues$ 1,563.5 $ 2,176.8 $ 4,368.4 $ 6,636.6 Cost of sales 1,631.6 2,061.3 4,749.2 6,085.4 Gross margin (68.1) 115.5 (380.8) 551.2 Add back (items included in cost of sales): Operating expenses (excluding depreciation and amortization) 102.1 120.7 302.5 356.7 Depreciation and amortization 50.3 34.6 132.3 98.9 Refining margin$ 84.3 $ 270.8 $ 54.0 $ 1,006.8 54 | [[Image Removed: dk-20200930_g3.jpg]]
--------------------------------------------------------------------------------
© Edgar Online, source
