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EX-32.2 - EXHIBIT 32.2 - CFO CERTIFICATION - Delek Logistics Partners, LPdkl-ex322xcfocertification.htm
EX-32.1 - EXHIBIT 32.1 CEO CERTIFICATION - Delek Logistics Partners, LPdkl-ex321xceocertification.htm
EX-31.2 - EXHIBIT 31.2 CFO CERTIFICATION - Delek Logistics Partners, LPdkl-ex312xcfocertification.htm
EX-31.1 - EXHIBIT 31.1 - CEO CERTIFICATION - Delek Logistics Partners, LPdkl-ex311xceocertification.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
 
 
 
For the quarterly period ended March 31, 2017
or
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
 
 
 
For the transition period from                      to                     
Commission file number 001-35721

DELEK LOGISTICS PARTNERS, LP
(Exact name of registrant as specified in its charter)
Delaware
 
45-5379027
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
 
 
7102 Commerce Way
 
 
Brentwood, Tennessee
 
37027
(Address of principal executive offices)
 
(Zip Code)
(615) 771-6701
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
 
Accelerated filer þ
 
Non-accelerated filer o
 
Smaller reporting company o
 
Emerging growth company o
 
 
 
 
(Do not check if a smaller reporting company)
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
At May 4, 2017, there were 24,328,607 common limited partner units and 496,502 general partner units outstanding.



TABLE OF CONTENTS
 
 
 
 
Condensed Consolidated Balance Sheets as of March 31, 2017 and December 31, 2016 (Unaudited)
 
 
Condensed Consolidated Statements of Income and Comprehensive Income for the three months ended March 31, 2017 and 2016 (Unaudited)
 
 
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2017 and 2016 (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT

2


Part I.
FINANCIAL INFORMATION

Item 1. Financial Statements
Delek Logistics Partners, LP

Condensed Consolidated Balance Sheets (Unaudited)
(in thousands, except unit and per unit data)

 
 
March 31, 2017
 
December 31, 2016
ASSETS
 
 
 
 
Current assets:
 
 
 
 
Cash and cash equivalents
 
$
33

 
$
59

Accounts receivable
 
23,812

 
19,202

Accounts receivable from related parties
 

 
2,834

Inventory
 
6,328

 
8,875

Other current assets
 
804

 
1,071

Total current assets
 
30,977

 
32,041

Property, plant and equipment:
 
 
 
 
Property, plant and equipment
 
345,172

 
342,407

Less: accumulated depreciation
 
(96,263
)
 
(91,378
)
Property, plant and equipment, net
 
248,909

 
251,029

Equity method investments
 
102,975

 
101,080

Goodwill
 
12,203

 
12,203

Intangible assets, net
 
14,154

 
14,420

Other non-current assets
 
4,385

 
4,774

Total assets
 
$
413,603

 
$
415,547

LIABILITIES AND DEFICIT
 
 
 
 
Current liabilities:
 
 
 
 
Accounts payable
 
$
13,117

 
$
10,853

Accounts payable to related parties
 
343

 

Excise and other taxes payable
 
4,535

 
4,841

Tank inspection liabilities
 
1,013

 
1,013

Pipeline release liabilities
 
1,072

 
1,097

Accrued expenses and other current liabilities
 
2,315

 
2,925

Total current liabilities
 
22,395

 
20,729

Non-current liabilities:
 
 
 
 
Revolving credit facility
 
392,000

 
392,600

Asset retirement obligations
 
3,845

 
3,772

Other non-current liabilities
 
14,348

 
11,730

Total non-current liabilities
 
410,193

 
408,102

Deficit:
 
 
 
 
Common unitholders - public; 9,131,036 units issued and outstanding at March 31, 2017 (9,263,415 at December 31, 2016)
 
181,775

 
188,013

Common unitholders - Delek; 15,197,571 units issued and outstanding at March 31, 2017 (15,065,192 at December 31, 2016)
 
(194,419
)
 
(195,076
)
General partner - 496,502 units issued and outstanding at March 31, 2017 (496,502 at December 31, 2016)
 
(6,341
)
 
(6,221
)
Total deficit
 
(18,985
)
 
(13,284
)
Total liabilities and deficit
 
$
413,603

 
415,547

 

See accompanying notes to the condensed consolidated financial statements

3


Delek Logistics Partners, LP

Condensed Consolidated Statements of Income and Comprehensive Income (Unaudited)
(in thousands, except unit and per unit data)
 
 
Three Months Ended
 
 
March 31,
 
 
2017
 
2016
Net sales:
 
 
 
 
   Affiliate
 
$
36,619

 
$
38,760

   Third party
 
92,854

 
65,296

     Net sales
 
129,473

 
104,056

Operating costs and expenses:
 
 
 
 
Cost of goods sold
 
92,590

 
66,753

Operating expenses
 
10,358

 
10,464

General and administrative expenses
 
2,848

 
2,913

Depreciation and amortization
 
5,193

 
4,996

Loss (gain) on asset disposals
 
12

 
(44
)
Total operating costs and expenses
 
111,001

 
85,082

Operating income
 
18,472

 
18,974

Interest expense, net
 
4,071

 
3,199

(Income) loss from equity method investments
 
(245
)
 
229

Total non-operating expenses
 
3,826

 
3,428

Income before income tax expense
 
14,646

 
15,546

Income tax expense
 
51

 
98

Net income attributable to partners
 
$
14,595

 
$
15,448

Comprehensive income attributable to partners
 
$
14,595

 
$
15,448

 
 
 
 
 
Less: General partner's interest in net income, including incentive distribution rights
 
4,109

 
2,253

Limited partners' interest in net income
 
$
10,486

 
$
13,195

 
 
 
 
 
Net income per limited partner unit (1):
 
 
 
 
Common units - (basic)
 
$
0.43

 
$
0.54

Common units - (diluted)
 
$
0.43

 
$
0.54

Subordinated units - Delek (basic and diluted)
 
$

 
$
0.54

 
 
 
 
 
Weighted average limited partner units outstanding (1):
 
 
 
 
  Common units - (basic)
 
24,328,607

 
17,024,490

  Common units - (diluted)
 
24,380,770

 
17,115,198

  Subordinated units - Delek (basic and diluted)
 

 
7,252,299

 
 
 
 
 
Cash distributions per limited partner unit
 
$
0.690

 
$
0.610

            
(1) We base our calculation of net income per unit on the weighted-average number of common and subordinated limited partner units outstanding during the period. The weighted-average number of common and subordinated units reflect the conversion of the subordinated units to common units on February 25, 2016. See Note 6 for further discussion.
See accompanying notes to the condensed consolidated financial statements

4


Delek Logistics Partners, LP
Condensed Consolidated Statements of Cash Flows (Unaudited)
(in thousands)
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Cash flows from operating activities:
 
 
 
 
Net income
 
$
14,595

 
$
15,448

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
5,193

 
4,996

Amortization of deferred revenue
 
(280
)
 
(196
)
Amortization of deferred financing costs
 
365

 
365

Accretion of asset retirement obligations
 
73

 
67

Deferred income taxes
 
25

 

(Income) loss from equity method investments
 
(245
)
 
229

Loss (gain) on asset disposals
 
12

 
(44
)
Unit-based compensation expense
 
174

 
108

Changes in assets and liabilities:
 
 
 
 
Accounts receivable
 
(4,610
)
 
5,882

Inventories and other current assets
 
2,814

 
4,559

Accounts payable and other current liabilities
 
2,296

 
2,153

Accounts receivable/payable to related parties
 
3,149

 
(7,356
)
Non-current assets and liabilities, net
 
(87
)
 
163

Net cash provided by operating activities
 
23,474

 
26,374

Cash flows from investing activities:
 
 
 
 
Purchases of property, plant and equipment
 
(3,764
)
 
(1,911
)
Proceeds from sales of property, plant and equipment
 

 
175

Equity method investment contributions
 
(1,650
)
 
(14,819
)
Net cash used in investing activities
 
(5,414
)
 
(16,555
)
Cash flows from financing activities:
 
 
 
 
Distributions to general partner
 
(3,994
)
 
(1,801
)
Distributions to common unitholders - public
 
(6,291
)
 
(5,592
)
Distributions to common unitholders - Delek
 
(10,252
)
 
(1,651
)
Distributions to subordinated unitholders - Delek
 

 
(7,080
)
Proceeds from revolving credit facility
 
69,100

 
84,400

Payments of revolving credit facility
 
(69,700
)
 
(78,100
)
Reimbursement of capital expenditures by Delek
 
3,051

 
209

Net cash used in financing activities
 
(18,086
)
 
(9,615
)
Net (decrease) increase in cash and cash equivalents
 
(26
)
 
204

Cash and cash equivalents at the beginning of the period
 
59

 

Cash and cash equivalents at the end of the period
 
$
33

 
$
204

Supplemental disclosures of cash flow information:
 
 
 
 
Cash paid during the period for:
 
 
 
 
Interest
 
$
3,693

 
$
2,890

Non-cash investing activities:
 
 

 
 

Decrease in accrued capital expenditures
 
$
(973
)
 
$
(827
)
Non-cash financing activities:
 
 
 
 
Sponsor contribution of fixed assets
 
$
67

 
$
609



See accompanying notes to the condensed consolidated financial statements

5


Delek Logistics Partners, LP

Notes to Condensed Consolidated Financial Statements (Unaudited)

1. Organization and Basis of Presentation

As used in this report, the terms "Delek Logistics Partners, LP," the "Partnership," "we," "us," or "our" may refer to Delek Logistics Partners, LP, one or more of its consolidated subsidiaries or all of them taken as a whole. References in this report to "Delek" refer collectively to Delek US Holdings, Inc. and any of its subsidiaries, other than Delek Logistics Partners, LP and its subsidiaries and its general partner (as hereinafter defined).

The Partnership is a Delaware limited partnership formed in April 2012 by Delek and its subsidiary Delek Logistics GP, LLC, our general partner (our "general partner").

Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles ("U.S. GAAP") have been condensed or omitted, although management believes that the disclosures herein are adequate to make the financial information presented not misleading. Our unaudited condensed consolidated financial statements have been prepared in conformity with U.S. GAAP applied on a consistent basis with those of the annual audited financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2016 (our "Annual Report on Form 10-K"), filed with the Securities and Exchange Commission (the "SEC") on February 28, 2017. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2016 included in our Annual Report on Form 10-K.

In the opinion of management, all adjustments necessary for a fair presentation of the financial position and the results of operations for the interim periods presented have been included. All significant intercompany transactions and account balances have been eliminated in the consolidation. Such intercompany transactions do not include those with Delek or our general partner. All adjustments are of a normal, recurring nature. Operating results for the interim period should not be viewed as representative of results that may be expected for any future interim period or for the full year.

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
New Accounting Pronouncements

In January 2017, the Financial Accounting Standards Board (the "FASB") issued guidance that eliminates Step 2, which required a comparison of the implied fair value of goodwill of a reporting unit with the carrying amount of that goodwill for that reporting unit, from the goodwill impairment test. It also eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative assessment, to perform Step 2 of the goodwill impairment test. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. This guidance is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We expect to adopt this guidance on or before the effective date and are currently evaluating the impact that adopting this new guidance will have on our business, financial condition and results of operations.

In January 2017, the FASB issued guidance clarifying the definition of a business in order to assist entities with evaluating when a set of transferred assets and activities is considered a business. In general, we expect that the revised definition will result in fewer acquisitions being accounted for as business combinations than under the current guidance. This guidance is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted under certain circumstances. We expect to adopt this guidance on or before the effective date and are currently evaluating the impact that adopting this new guidance will have on our business, financial condition and results of operations.

In March 2016, the FASB issued guidance that simplifies several aspects of the accounting for share-based payment award transactions, including the accounting for excess tax benefits and deficiencies, classification of awards as either equity or liabilities and classification of excess tax benefits on the statement of cash flows.  This guidance is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years and can be early adopted for any interim or annual financial statements that have not yet been issued.  We prospectively adopted this guidance on the effective date and the adoption did not have a material impact on our business, financial condition or results of operations.
 

6


In July 2015, the FASB issued guidance requiring entities to measure FIFO or average cost inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.  This guidance does not change the measurement of inventory measured using LIFO or the retail inventory method.  This guidance is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years.   We adopted this guidance on the effective date and the adoption did not have a material impact on our business, financial condition or results of operations. 
In May 2014, the FASB issued guidance regarding “Revenue from Contracts with Customers,” to clarify the principles for recognizing revenue. The core principle of the new guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires improved interim and annual disclosures that enable the users of financial statements to better understand the nature, amount, timing, and uncertainty of revenues and cash flows arising from contracts with customers. The new guidance is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period, and can be adopted retrospectively. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. We expect to adopt this guidance on January 1, 2018. We have formed a project implementation team as well as a project time-line to evaluate this new standard. We have reviewed and gained an understanding of the new revenue recognition accounting guidance and completed our revenue stream scoping process. We have preliminarily elected to use the modified retrospective adoption method to apply this standard, under which the cumulative effect of initially applying the new guidance will be recognized as an adjustment to the opening balance of retained earnings in the first quarter of 2018. We are still evaluating the impact that adopting this standard will have on our business processes, systems and controls, and interpretative and industry specific guidance is still developing.


2. Related Party Transactions

Commercial Agreements

The Partnership has a number of long-term, fee based commercial agreements with Delek under which we provide various services, including crude oil gathering and crude oil, intermediate and refined products transportation and storage services, and marketing, terminalling and offloading services to Delek. Most of these agreements have an initial term ranging from five to ten years, which may be extended for various renewal terms at the option of Delek. The initial terms for agreements effective in November 2012 were to expire in November 2017. Delek has opted to renew these agreements for subsequent five-year terms. In the case of our marketing agreement with Delek, the initial term has been extended through 2026. The fees under each agreement are payable to us monthly by Delek or certain third parties to whom Delek has assigned certain of its rights and are generally subject to increase or decrease on July 1 of each year, by the amount of any change in various inflation-based indices, including the Federal Energy Regulatory Commission oil pipeline index or various iterations of the consumer price index and the producer price index; provided, however, that in no event will the fees be adjusted below the amount initially set forth in the applicable agreement.

See our Annual Report on Form 10-K for a more complete description of certain of our commercial agreements and other agreements with Delek.

Omnibus Agreement. The Partnership entered into an omnibus agreement with Delek, our general partner, Delek Logistics Operating, LLC, Lion Oil Company and certain of the Partnership's and Delek's other subsidiaries on November 7, 2012, which was subsequently amended and restated on July 26, 2013, February 10, 2014 and March 31, 2015 in connection with our subsequent acquisitions of certain assets from Delek (collectively, as amended, the "Omnibus Agreement"). Additionally, the Partnership entered into an amendment to the Omnibus Agreement on August 3, 2015, with an effective date of April 1, 2015. This amendment eliminated a $1.0 million per event deductible that applied to certain asset failures before Delek was required to reimburse the Partnership.

Pursuant to the terms of the Omnibus Agreement, we were reimbursed for certain capital expenditures in the amount of $3.1 million and $0.2 million during the three months ended March 31, 2017 and 2016, respectively. These amounts are recorded in other long term liabilities and are amortized to revenue over the life of the underlying revenue agreement corresponding to the asset. Additionally, we were reimbursed or indemnified, as the case may be, for costs incurred in excess of certain amounts related to certain asset failures, pursuant to the terms of the Omnibus Agreement. We were reimbursed a nominal amount and $0.9 million for these matters during the three months ended March 31, 2017 and 2016, respectively, which are recorded as a reduction to operating expense.
   
Summary of Transactions

Revenues from affiliates consist primarily of revenues from gathering, transportation, storage, offloading, Renewable Identification Numbers, wholesale marketing, and products terminalling services provided primarily to Delek based on regulated tariff rates or contractually based fees,

7


and product sales to Alon USA Energy, Inc., an equity method investee of Delek. Affiliate operating expenses are primarily comprised of amounts we reimburse Delek or our general partner, as the case may be, for the services provided to us under the First Amended and Restated Agreement of Limited Partnership (the "Partnership Agreement"). These expenses could also include reimbursement and indemnification amounts from Delek, as provided under the Omnibus Agreement. Additionally, the Partnership is required to reimburse Delek for direct or allocated costs and expenses incurred by Delek on behalf of the Partnership and for charges Delek incurred for the management and operation of our logistics assets, including an annual fee for various centralized corporate services, which are included in general and administrative services. In addition to these transactions, we purchase finished products and bulk biofuels from Delek, the costs of which are included in cost of goods sold.

A summary of revenue and expense transactions with Delek and its affiliates are as follows (in thousands):

 
 
Three Months Ended March 31,
 
 
2017
 
2016
Revenues
 
$
36,619

 
$
38,760

Cost of goods sold
 
$
8,928

 
$
10,690

Operating and maintenance expenses 
 
$
7,096

 
$
7,665

General and administrative expenses 
 
$
1,693

 
$
1,346


Quarterly Cash Distribution

Our common and general partner unitholders and the holders of incentive distribution rights ("IDRs") are entitled to receive quarterly distributions of available cash as it is determined by the board of directors of our general partner in accordance with the terms and provisions of our Partnership Agreement. In February 2017 and 2016, we paid quarterly cash distributions, of which $14.2 million and $10.5 million, respectively, were paid to Delek and our general partner. On April 24, 2017, our general partner's board of directors declared a quarterly cash distribution totaling $21.0 million, based on the available cash as of the date of determination for the end of the first quarter of 2017, payable on May 12, 2017, of which $14.7 million is expected to be paid to Delek and our general partner, including the payment for the IDRs.

3. Inventory

Inventories consisted of $6.3 million and $8.9 million of refined petroleum products as of March 31, 2017 and December 31, 2016, respectively. Cost of inventory is stated at the lower of cost or net realizable value, with cost determined on a first-in, first-out basis. We recognize lower of cost or net realizable value charges as a component of cost of goods sold in the consolidated statements of income and comprehensive income, which amounted to a nominal amount and $0.1 million during the three months ended March 31, 2017 and March 31, 2016, respectively.

4. Second Amended and Restated Credit Agreement

We entered into a senior secured revolving credit agreement on November 7, 2012 , with Fifth Third Bank, as administrative agent, and a syndicate of lenders. The agreement was amended and restated on July 9, 2013 (the "Amended and Restated Credit Agreement") and was most recently amended and restated on December 30, 2014 (the “Second Amended and Restated Credit Agreement”). Under the terms of the Second Amended and Restated Credit Agreement, the lender commitments were increased from $400.0 million to $700.0 million. The Second 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 $800.0 million, subject to receiving increased or new commitments from lenders and the satisfaction of certain other conditions precedent. The Second Amended and Restated Credit Agreement contains an option for Canadian dollar denominated borrowings.

Borrowings denominated in U.S. dollars bear interest at either a U.S. dollar prime rate, plus an applicable margin, or the London Interbank Offered Rate ("LIBOR"), plus an applicable margin, at the election of the borrowers. Borrowings denominated in Canadian dollars bear interest at either a Canadian dollar prime rate, plus an applicable margin, or the Canadian Dealer Offered Rate, plus an applicable margin, at the election of the borrowers. The applicable margin in each case varies based upon the Partnership's most recent leverage ratio calculation delivered to the lenders, as called for and defined under the terms of the credit facility. At March 31, 2017, the weighted average interest rate for our borrowings under the facility was approximately 3.6%. Additionally, the Second Amended and Restated Credit Agreement requires us to pay a leverage ratio dependent quarterly fee on the average unused revolving commitment. As of March 31, 2017, this fee was 0.5% per year.

The obligations under the Second Amended and Restated Credit Agreement remain secured by first priority liens on substantially all of the Partnership's and its subsidiaries' tangible and intangible assets. Additionally, Delek Marketing & Supply, LLC ("Delek Marketing"), a direct wholly owned subsidiary of Delek, continues to provide a limited guaranty of the Partnership's obligations under the Second Amended and Restated Credit Agreement. Delek Marketing's guaranty is (i) limited to an amount equal to the principal amount, plus unpaid and accrued interest, of a

8



promissory note made by Delek US in favor of Delek Marketing (the "Holdings Note") and (ii) secured by Delek Marketing's pledge of the Holdings Note to our lenders under the Second Amended and Restated Credit Agreement. As of March 31, 2017, the principal amount of the Holdings Note was $102.0 million, plus unpaid interest accrued since the issuance date. The Second Amended and Restated Credit Agreement matures on December 30, 2019.
As of March 31, 2017, we had $392.0 million in outstanding borrowings under the Second Amended and Restated Credit Agreement. Additionally, we had in place letters of credit totaling $7.5 million, primarily securing obligations with respect to gasoline and diesel purchases. No amounts were drawn under these letters of credit at March 31, 2017. Unused credit commitments under the Second Amended and Restated Credit Agreement as of March 31, 2017 were $300.5 million.

5. Income Taxes

For tax purposes, each partner of the Partnership is required to take into account its share of income, gain, loss and deduction in computing its federal and state income tax liabilities, regardless of whether cash distributions are made to such partner by the Partnership. The taxable income reportable to each partner takes into account differences between the tax basis and fair market value of our assets, the acquisition price of such partner's units and the taxable income allocation requirements under our Partnership Agreement.

6. Net Income Per Unit

We use the two-class method when calculating the net income per unit applicable to limited partners because we have more than one participating class of securities. Our participating securities consist of common units, subordinated units, general partner units and IDRs. The two-class method is based on the weighted-average number of common units outstanding during the period. Basic net income per unit applicable to limited partners (including subordinated unitholders) is computed by dividing limited partners’ interest in net income, after deducting our general partner’s 2% interest and IDRs, by the weighted-average number of outstanding common and subordinated units. Our net income is allocated to our general partner and limited partners in accordance with their respective partnership percentages after giving effect to priority income allocations for IDRs, which are held by our general partner pursuant to our Partnership Agreement. The IDRs are paid following the close of each quarter.
 
Earnings in excess of distributions are allocated to our general partner and limited partners based on their respective ownership interests. Payments made to our unitholders are determined in relation to actual distributions declared and are not based on the net income allocations used in the calculation of net income per unit.

Diluted net income per unit applicable to common limited partners includes the effects of potentially dilutive units on our common units. At present, the only potentially dilutive units outstanding consist of unvested phantom units. Basic and diluted net income per unit applicable to subordinated limited partners are the same because there are no potentially dilutive subordinated units outstanding.

Following the February 12, 2016 payment of the cash distribution attributable to the fourth quarter of 2015 and confirmation by the board of directors of our general partner (based on the recommendation of the Conflicts Committee) on February 25, 2016 that the requirements under the Partnership Agreement for the conversion of all subordinated units into common units were satisfied, the subordination period ended. As a result, in the first quarter of 2016, each of the Partnership's 11,999,258 outstanding subordinated units converted into common units and began participating pro rata with the other common units in distributions of available cash. The conversion did not impact the amount of the cash distribution paid or the total number of the Partnership's outstanding units representing limited partner interests. The Partnership's net income was allocated to the general partner and the limited partners, including the holders of the subordinated units through February 24, 2016, in accordance with our Partnership Agreement.


9


Our distributions earned with respect to a given period are declared subsequent to quarter end. Therefore, the table below represents total cash distributions applicable to the period in which the distributions are earned. The expected date of distribution for the distributions earned during the period ended March 31, 2017 is May 12, 2017. The calculation of net income per unit is as follows (dollars in thousands, except units and per unit amounts):
 
 
Three Months Ended
 
 
March 31,
 
 
2017
 
2016
Net income attributable to partners
 
$
14,595

 
$
15,448

Less: General partner's distribution (including IDRs) (1)
 
4,237

 
2,286

Less: Limited partners' distribution
 
16,787

 
10,385

Less: Subordinated partner's distribution
 

 
4,424

Distributions in excess of earnings
 
$
(6,429
)
 
$
(1,647
)
 
 
 
 
 
General partner's earnings:
 
 
 
 
Distributions (including IDRs) (1)
 
$
4,237

 
$
2,286

Allocation of distributions in excess of earnings
 
(128
)
 
(33
)
Total general partner's earnings
 
$
4,109

 
$
2,253

 
 
 
 
 
Limited partners' earnings on common units:
 
 
 
 
Distributions
 
$
16,787

 
$
10,385

Allocation of distributions in excess of earnings
 
(6,301
)
 
(1,132
)
Total limited partners' earnings on common units
 
$
10,486

 
$
9,253

 
 
 
 
 
Limited partners' earnings on subordinated units:
 
 
 
 
Distributions
 
$

 
$
4,424

Allocation of distributions in excess of earnings
 

 
(482
)
Total limited partners' earnings on subordinated units
 
$

 
$
3,942

 
 
 
 
 
Weighted average limited partner units outstanding (2):
 
 
 
 
Common units - (basic)
 
24,328,607

 
17,024,490

Common units - (diluted)
 
24,380,770

 
17,115,198

Subordinated units - Delek (basic and diluted) (3)
 

 
7,252,299

 
 
 
 
 
Net income per limited partner unit (2):
 
 
 
 
Common units - (basic)
 
$
0.43

 
$
0.54

Common units - (diluted)
 
$
0.43

 
$
0.54

Subordinated units - Delek (basic and diluted)
 
$

 
$
0.54

            

(1) General partner distributions (including IDRs) consist of the 2% general partner interest and IDRs, which represent the right of the general partner to receive increasing percentages of quarterly distributions of available cash from operating surplus in excess of $0.43125 per unit per quarter. See Note 7 for further discussion related to IDRs.
(2) We base our calculation of net income per unit on the weighted-average number of common and subordinated limited partner units outstanding during the period. The weighted-average number of common and subordinated units reflects the conversion of the subordinated units to common units on February 25, 2016.
(3) On February 25, 2016, each of the Partnership's 11,999,258 outstanding subordinated units converted into common units and began participating pro rata with the other common units in distributions of available cash. Distributions and the Partnership's net income were allocated to the subordinated units through February 24, 2016.

10



7. Equity

We had 9,131,036 common limited partner units held by the public outstanding as of March 31, 2017. Additionally, as of March 31, 2017, Delek owned a 61.2% limited partner interest in us, consisting of 15,197,571 common limited partner units and a 94.9% interest in our general partner, which owns the entire 2.0% general partner interest consisting of 496,502 general partner units. Affiliates who are also members of our general partner's management and board of directors own the remaining 5.1% interest in our general partner.

Equity Activity

The table below summarizes the changes in the number of units outstanding from December 31, 2016 through March 31, 2017.

 
 
Common - Public
 
Common - Delek
 
General Partner
 
Total
Balance at December 31, 2016
 
9,263,415

 
15,065,192

 
496,502

 
24,825,109

Delek unit repurchases from public
 
(132,379
)
 
132,379

 

 

Balance at March 31, 2017
 
9,131,036

 
15,197,571

 
496,502

 
24,825,109


The summarized changes in the carrying amount of our equity from December 31, 2016 through March 31, 2017 are as follows (in thousands):
 
 
 
Common - Public
 
Common - Delek
 
General Partner
 
Total
Balance at December 31, 2016
 
$
188,013

 
$
(195,076
)
 
$
(6,221
)
 
$
(13,284
)
Cash distributions
(6,291
)
 
(10,252
)
 
(3,994
)
 
(20,537
)
Sponsor contribution of fixed assets

 
65

 
2

 
67

Net income attributable to partners
3,936

 
6,550

 
4,109

 
14,595

Unit-based compensation
154

 
257

 
(237
)
 
174

Delek unit repurchases from public
(4,037
)
 
4,037

 

 

Balance at March 31, 2017
 
$
181,775

 
$
(194,419
)
 
$
(6,341
)
 
$
(18,985
)

Allocations of Net Income

Our Partnership Agreement contains provisions for the allocation of net income and loss to the unitholders and our general partner. For purposes of maintaining partner capital accounts, the Partnership Agreement specifies that items of income and loss shall be allocated among the partners in accordance with their respective percentage interest. Normal allocations according to percentage interests are made after giving effect to priority income allocations in an amount equal to incentive cash distributions allocated 100% to our general partner.

11


The following table presents the allocation of the general partner's interest in net income (in thousands, except percentage of ownership interest):
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Net income attributable to partners
 
$
14,595

 
$
15,448

Less: General partner's IDRs
 
(3,895
)
 
(1,984
)
Net income available to partners
 
$
10,700

 
$
13,464

General partner's ownership interest
 
2.0
%
 
2.0
%
General partner's allocated interest in net income
 
$
214

 
$
269

General partner's IDRs
 
3,895

 
1,984

Total general partner's interest in net income
 
$
4,109

 
$
2,253


Incentive Distribution Rights

The following table illustrates the percentage allocations of available cash from operating surplus between the unitholders and our general partner based on the specified target distribution levels. The amounts set forth under “Marginal Percentage Interest in Distributions” are the percentage interests of our general partner and our unitholders in any available cash from operating surplus that we distribute up to and including the corresponding amount in the column “Total Quarterly Distribution per Unit Target Amount.” The percentage interests shown for our unitholders and our general partner for the minimum quarterly distribution are also applicable to quarterly distribution amounts that are less than the minimum quarterly distribution. The percentage interests set forth below for our general partner include its 2.0% general partner interest and assume that (i) our general partner has contributed any additional capital necessary to maintain its 2.0% general partner interest, (ii) our general partner has not transferred its IDRs, and (iii) there are no arrearages on common units.

 
 
 
Target Quarterly Distribution per Unit
 
Marginal Percentage Interest in Distributions
 
 
 
Target Amount
 
Unitholders
 
General Partner
Minimum Quarterly Distribution
 
 
$
0.37500

 
98.0
%
 
2.0
%
First Target Distribution
 
above
$
0.37500

 
98.0
%
 
2.0
%
 
 
up to
$
0.43125

 
 
 
 
Second Target Distribution
 
above
$
0.43125

 
85.0
%
 
15.0
%
 
 
up to
$
0.46875

 
 
 
 
Third Target Distribution
 
above
$
0.46875

 
75.0
%
 
25.0
%
 
 
up to
$
0.56250

 
 
 
 
Thereafter
 
thereafter
$
0.56250

 
50.0
%
 
50.0
%


12


Cash Distributions

Our Partnership Agreement sets forth the calculation to be used to determine the amount and priority of available cash distributions that our limited partner unitholders and general partner will receive. Our distributions earned with respect to a given period are declared subsequent to quarter end. The table below summarizes the quarterly distributions related to our quarterly financial results:
Quarter Ended
 
Total Quarterly Distribution Per Limited Partner Unit
 
Total Quarterly Distribution Per Limited Partner Unit, Annualized
 
Total Cash Distribution, including general partner interest and IDRs (in thousands)
 
Date of Distribution
 
Unitholders Record Date
March 31, 2016
 
$
0.610

 
$
2.44

 
$
17,095

 
May 13, 2016
 
May 5, 2016
June 30, 2016
 
$
0.630

 
$
2.52

 
$
18,085

 
August 12, 2016 
 
August 5, 2016
September 30, 2016
 
$
0.655

 
$
2.62

 
$
19,302

 
November 14, 2016
 
November 7, 2016
December 31, 2016
 
$
0.680

 
$
2.72

 
$
20,537

 
February 14, 2017
 
February 3, 2017
March 31, 2017
 
$
0.690

 
$
2.76

 
$
21,024

 
May 12, 2017 (1)
 
May 5, 2017
            
(1) Expected date of distribution.

The allocation of total quarterly cash distributions expected to be made on May 12, 2017 to general and limited partners for the three months ended March 31, 2017 and the allocation of total quarterly cash distributions for the three months ended March 31, 2016 are set forth in the table below. Distributions earned with respect to a given period are declared subsequent to quarter end. Therefore, the table below presents total cash distributions applicable to the period in which the distributions are earned (in thousands, except per unit amounts):
 
 
 
Three Months Ended March 31,
 
 
2017
 
2016
General partner's distributions:
 
 
 
 
     General partner's distributions
 
$
342

 
$
302

     General partner's IDRs
 
3,895

 
1,984

          Total general partner's distributions
 
4,237

 
2,286

 
 
 
 
 
Limited partners' distributions:
 
 
 
 
     Common
 
16,787

 
10,385

     Subordinated
 

 
4,424

          Total limited partners' distributions
 
16,787

 
14,809

               Total cash distributions
 
$
21,024

 
$
17,095

 
 
 
 
 
Cash distributions per limited partner unit
 
$
0.690

 
$
0.610


8. Equity Based Compensation

We incurred approximately $0.2 million and $0.1 million of unit-based compensation expense related to the Partnership during the three months ended March 31, 2017 and 2016, respectively. These amounts are included in general and administrative expenses in the accompanying condensed consolidated statements of income and comprehensive income. The fair value of phantom unit awards under the Delek Logistics GP, LLC 2012 Long-Term Incentive Plan (the "LTIP") is determined based on the closing price of our common limited partner units on the grant date. The estimated fair value of our phantom units is amortized over the vesting period using the straight line method. Awards vest over one- to five-year service periods, unless such awards are amended in accordance with the LTIP. As of March 31, 2017, there was $0.5 million of total unrecognized compensation cost related to non-vested equity-based compensation arrangements, which is expected to be recognized over a weighted-average period of 1.6 years.



13




9. Equity Method Investments

In March 2015, the Partnership, through its indirect wholly owned subsidiary DKL Caddo, LLC ("DKL Caddo"), became a member of Caddo Pipeline, LLC ("CP LLC") by entering into an amended and restated limited liability company agreement (the “Caddo LLC Agreement”) with Plains Pipeline, L.P. ("Plains"), an affiliate of Plains All American Pipeline, L.P. CP LLC was formed to plan, develop, construct, own, operate and maintain a pipeline system and certain ancillary assets originating near Longview, Texas and extending to Shreveport, Louisiana (the "Caddo Pipeline System"). Pursuant to the terms of the Caddo LLC Agreement, DKL Caddo and Plains each own a 50% membership interest in CP LLC. Construction on the pipeline has been completed, and operations began in January 2017. Plains has primary responsibility for the pipeline's day-to-day operations.

In March 2015, the Partnership, through its indirect wholly owned subsidiary, DKL RIO, LLC ("DKL RIO"), became a member of Rangeland RIO Pipeline, LLC ("Rangeland RIO") by entering into an amended and restated limited liability company agreement (the "Rangeland LLC Agreement") with Rangeland Energy II, LLC ("Rangeland"). Rangeland RIO was formed to plan, develop, construct, own, operate and maintain a pipeline system and certain ancillary assets extending from Loving County, Texas to Midland, Texas (the "RIO Pipeline"). Pursuant to the terms of the Rangeland LLC Agreement, DKL RIO owns 33% of Rangeland RIO, and Rangeland owns 67%. Construction on the pipeline has been completed, and operations began in September 2016. Rangeland has primary responsibility for the pipeline's day-to-day operations.

The Partnership's investments in these two entities were financed through a combination of cash from operations and borrowings under the Second Amended and Restated Credit Agreement.  As of March 31, 2017, the Partnership's investment balance in these joint ventures was $103.0 million.

We do not consolidate any part of the assets or liabilities of our equity investees. Our share of net income or loss of the investees will increase or decrease, as applicable, the carrying value of our investments in unconsolidated affiliates. With respect to CP LLC and Rangeland RIO, we determined that these entities do not represent variable interest entities and consolidation was not required. We have the ability to exercise influence over each of these joint ventures through our participation in the management committees, which make all significant decisions. However, since all significant decisions require the consent of the other investor(s) without regard to economic interest, we have determined that we have joint control and have applied the equity method of accounting. Our investment in these joint ventures is reflected in our pipelines and transportation segment.

Summarized Financial Information

Combined summarized financial information for our equity method investees is shown below (in thousands):

 
 
March 31, 2017
 
December 31, 2016
Current assets
 
$
9,774

 
$
7,760

Noncurrent assets
 
$
239,897

 
$
237,516

Current liabilities
 
$
2,895

 
$
4,512

 
 
 
 
 
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Revenues
 
$
5,671

 
$

Gross profit
 
$
5,671

 
$

Net income (loss)
 
$
1,013

 
$
(526
)
 
 
 
 
 
10. Segment Data

We aggregate our operating segments into two reportable segments: (i) pipelines and transportation and (ii) wholesale marketing and terminalling:
  
The assets and investments reported in the pipelines and transportation segment provide crude oil gathering and crude oil, intermediate and finished products transportation and storage services to Delek's refining operations and independent third parties.

The wholesale marketing and terminalling segment provides wholesale marketing and terminalling services to Delek's refining operations and independent third parties.


14


Our operating segments adhere to the accounting policies used for our consolidated financial statements. Our operating segments are managed separately because each segment requires different industry knowledge, technology and marketing strategies. Decisions concerning the allocation of resources and assessment of operating performance are made based on this segmentation. Management measures the operating performance of each of its reportable segments based on segment contribution margin. Segment contribution margin is defined as net sales less cost of goods sold and operating expenses.




15


The following is a summary of business segment operating performance as measured by contribution margin for the periods indicated (in thousands):
 
 
Three Months Ended
 
 
March 31,
 
 
2017
 
2016
Pipelines and Transportation
 
 
 
 
Net sales:
 
 
 
 
     Affiliate
 
$
26,500

 
$
26,306

     Third party
 
2,177

 
6,477

          Total pipelines and transportation
 
28,677

 
32,783

     Operating costs and expenses:
 
 
 
 
     Cost of goods sold
 
4,405

 
4,776

     Operating expenses
 
8,155

 
7,740

     Segment contribution margin
 
$
16,117

 
$
20,267

 Capital spending (excluding business combinations)
 
$
2,137

 
$
706

 
 
 
 
 
Wholesale Marketing and Terminalling
 
 
 
 
Net sales:
 
 
 
 
     Affiliate
 
$
10,119

 
$
12,454

     Third party
 
90,677

 
58,819

          Total wholesale marketing and terminalling
 
100,796

 
71,273

     Operating costs and expenses:
 
 
 
 
     Cost of goods sold
 
88,185

 
61,977

     Operating expenses
 
2,203

 
2,724

     Segment contribution margin
 
$
10,408

 
$
6,572

 Capital spending (excluding business combinations)
 
$
654

 
$
378

 
 
 
 
 
Consolidated
 
 
 
 
Net sales:
 
 
 
 
     Affiliate
 
$
36,619

 
$
38,760

     Third party
 
92,854

 
65,296

          Total consolidated
 
129,473

 
104,056

     Operating costs and expenses:
 
 
 
 
     Cost of goods sold
 
92,590

 
66,753

     Operating expenses
 
10,358

 
10,464

     Contribution margin
 
26,525

 
26,839

     General and administrative expenses
 
2,848

 
2,913

     Depreciation and amortization
 
5,193

 
4,996

     Loss (gain) on asset disposals
 
12

 
(44
)
     Operating income
 
$
18,472

 
$
18,974

 Capital spending (excluding business combinations) 
 
$
2,791

 
$
1,084




16


The following table summarizes the total assets for each segment as of March 31, 2017 and December 31, 2016 (in thousands).

 
 
March 31, 2017
 
December 31, 2016
Pipelines and transportation
 
$
338,072

 
$
337,349

Wholesale marketing and terminalling
 
75,531

 
78,198

     Total assets
 
$
413,603

 
$
415,547


Property, plant and equipment and accumulated depreciation as of March 31, 2017 and depreciation expense by reporting segment for the three months ended March 31, 2017 were as follows (in thousands):
 
 
Pipelines and Transportation
 
Wholesale Marketing and Terminalling
 
Consolidated
Property, plant and equipment
 
$
281,918

 
$
63,254

 
$
345,172

Less: accumulated depreciation
 
(71,306
)
 
(24,957
)
 
(96,263
)
Property, plant and equipment, net
 
$
210,612

 
$
38,297

 
$
248,909

Depreciation expense
 
$
4,065

 
$
862

 
$
4,927


In accordance with ASC 360, Property, Plant & Equipment, we evaluate the realizability of property, plant and equipment as events occur that might indicate potential impairment. There were no indicators of impairment of our property, plant and equipment as of March 31, 2017.

11. Fair Value Measurements

The fair values of financial instruments are estimated based upon current market conditions and quoted market prices for the same or similar instruments. Management estimates that the carrying value approximates fair value for all of our assets and liabilities that fall under the scope of ASC 825, Financial Instruments.

We apply the provisions of ASC 820, which defines fair value, establishes a framework for its measurement and expands disclosures about fair value measurements. ASC 820 applies to commodity and interest rate derivatives that are measured at fair value on a recurring basis. The standard also requires that we assess the impact of nonperformance risk on our derivatives. Nonperformance risk is not considered material as of March 31, 2017.

ASC 820 requires disclosures that categorize assets and liabilities measured at fair value into one of three different levels depending on the observability of the inputs employed in the measurement. Level 1 inputs are quoted prices in active markets for identical assets or liabilities. Level 2 inputs are observable inputs other than quoted prices included within Level 1 for the asset or liability, either directly or indirectly through market-corroborated inputs. Level 3 inputs are unobservable inputs for the asset or liability reflecting our assumptions about pricing by market participants.

Over the counter ("OTC") commodity swaps and any interest rate swaps and caps are generally valued using industry-standard models that consider various assumptions, including quoted forward prices, spot prices, interest rates, time value, volatility factors and contractual prices for the underlying instruments, as well as other relevant economic measures. The degree to which these inputs are observable in the forward markets determines the classification as Level 2 or 3. Our contracts are valued based on exchange pricing and/or price index developers such as Platts or Argus and are, therefore, classified as Level 2.

17


The fair value hierarchy for our financial assets accounted for at fair value on a recurring basis at March 31, 2017 and December 31, 2016 was as follows (in thousands):

 
 
As of March 31, 2017
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
OTC commodity swaps
 
$

 
$
10

 
$

 
$
10

     Total assets
 

 
10

 

 
10

Liabilities
 
 
 
 
 
 
 


OTC commodity swaps
 

 
(223
)
 

 
(223
)
Net liabilities
 
$

 
$
(213
)
 
$

 
$
(213
)
 
 
As of December 31, 2016
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
OTC commodity swaps
 
$

 
$
9

 
$

 
$
9

     Total assets
 

 
9

 

 
9

Liabilities
 
 
 
 
 
 
 
 
OTC commodity swaps
 

 
(82
)
 

 
(82
)
Net liabilities
 
$

 
$
(73
)
 
$

 
$
(73
)

The derivative values above are based on analysis of each contract as the fundamental unit of account as required by ASC 820. Derivative assets and liabilities with the same counterparty are not netted where the legal right of offset exists. This differs from the presentation in the financial statements which reflects our policy under the guidance of ASC 815-10-45, wherein we have elected to offset the fair value amounts recognized for multiple derivative instruments executed with the same counterparty where the legal right of offset exists.

As of March 31, 2017, $0.3 million of cash collateral was held by counterparty brokerage firms and has been netted with the net derivative positions with each counterparty. As of December 31, 2016, we had a cash deficit of $0.6 million netted with the net derivative positions of one of our counterparties.

12. Derivative Instruments

From time to time, we enter into forward fuel contracts to limit the exposure to price fluctuations for physical purchases of finished products in the normal course of business. We use derivatives to reduce normal operating and market risks with a primary objective in derivative instrument use being the reduction of the impact of market price volatility on our results of operations.

Typically, we enter into forward fuel contracts with major financial institutions in which we fix the purchase price of finished grade fuel for a predetermined number of units with fulfillment terms of less than 90 days.

From time to time, we may also enter into interest rate hedging agreements to limit floating interest rate exposure under the Second Amended and Restated Credit Agreement. Our initial credit facility required us to maintain interest rate hedging arrangements on at least 50% of the amount funded on November 7, 2012 under the credit facility, which was required to be in place for at least a three-year period beginning no later than March 7, 2013. Accordingly, effective February 25, 2013, we entered into an interest rate hedge in the form of a LIBOR interest rate cap for a term of three years for a total notional amount of $45.0 million, thereby meeting the requirements in effect at that time. These requirements were eliminated in connection with the Amended and Restated Credit Agreement in July 2013, but the interest rate hedge remained in place in accordance with its term through its maturity date in February 2016.

18



The following table presents the fair value of our derivative instruments as of March 31, 2017 and December 31, 2016. The fair value amounts below are presented on a gross basis and do not reflect the netting of asset and liability positions permitted under our master netting arrangements, including any cash collateral on deposit with our counterparties. We have elected to offset the recognized fair value amounts for multiple derivative instruments executed with the same counterparty in our financial statements. As a result, the asset and liability amounts below may differ from the amounts presented in our accompanying consolidated balance sheets. During the three months ended March 31, 2017 and March 31, 2016, we did not elect hedge accounting treatment for these derivative positions. As a result, all changes in fair value are marked to market in the accompanying condensed consolidated statements of income and comprehensive income.

(in thousands)
 
 
 
March 31, 2017
 
December 31, 2016
Derivative Type
 
Balance Sheet Location
 
Assets
 
Liabilities
 
Assets
 
Liabilities
Derivatives:
 
 
 
 
 
 
 
 
OTC commodity swaps (1)
 
Other current assets
 
$
10

 
$
(223
)
 
$
9

 
$
(82
)
Total gross value of derivatives
 
10

 
(223
)
 
9

 
(82
)
Less: Counterparty netting and cash collateral (2)
 
(72
)
 
(223
)
 
9

 
621

Total net fair value of derivatives
 
$
82

 
$

 
$

 
$
(703
)
            

(1) As of March 31, 2017 and December 31, 2016, we had open derivative contracts representing 103,000 barrels and 93,000 barrels, respectively, of refined petroleum products.

(2) As of March 31, 2017, $0.3 million of cash collateral was held by counterparty brokerage firms and has been netted with the net derivative positions with each counterparty. As of December 31, 2016, we had a cash deficit of $0.6 million netted with the net derivative positions of one of our counterparties.

Recognized gains (losses) associated with our derivatives for the three months ended March 31, 2017 and 2016 were as follows (in thousands):
 
 
 
 
Three Months Ended March 31,
Derivative Type
Income Statement Location
 
2017
 
2016
Commodity derivatives
Cost of goods sold
 
510

 
(177
)

13. Commitments and Contingencies

Litigation

In the ordinary conduct of our business, we are from time to time subject to lawsuits, investigations and claims, including environmental claims and employee-related matters. Although we cannot predict with certainty the ultimate resolution of lawsuits, investigations and claims asserted against us, including civil penalties or other enforcement actions, we do not believe that any currently pending legal proceeding or proceedings to which we are a party will have a material adverse effect on our business, financial condition or results of operations. See "Crude Oil Releases" below for a potential enforcement action.

Environmental, Health and Safety

We are subject to extensive and periodically changing federal, state and local laws and regulations relating to the protection of the environment, health and safety. Among other things, these laws and regulations govern the emission or discharge of pollutants into or onto the land, air and water, the handling and disposal of solid and hazardous wastes and the remediation of contamination and the protection of workers and the public. Compliance with existing and anticipated environmental laws and regulations increases our overall cost of business, including our capital costs to develop, maintain, operate and upgrade equipment and facilities. Numerous permits or other authorizations are required under these laws for the operation of our terminals, pipelines, and related operations, and may be subject to revocation, modification and renewal. These laws and permits may become the basis for future claims and lawsuits involving environmental and safety matters, which could include soil and water contamination, air pollution, personal injury and property damage allegedly caused by substances which we manufactured, handled, used, released or disposed of, or that relate to pre-existing conditions for which we have assumed or are assigned responsibility.


19


Releases of hydrocarbons or hazardous substances into the environment could, to the extent the event is not insured or a reimbursable event under the Omnibus Agreement, subject us to substantial expenses, including costs to respond to, contain and remediate a release, to comply with applicable laws and regulations and to resolve claims by third parties for personal injury, property damage, or natural resources damages. These impacts could directly and indirectly affect our business. We cannot currently determine the amounts of such future impacts; however, we accrue liabilities for such events when we are able to determine if an amount is probable and can be reasonably estimated.

Crude Oil Releases

We have experienced several crude oil releases involving our assets, including, but not limited to, the following releases:

In January 2016, a crude oil release of less than 30 barrels occurred from a gathering line at the Modisette pumping station near El Dorado, Arkansas (the "Modisette Release");
In January 2016, a crude oil release of approximately 350 barrels occurred from the Paline Pipeline near Woodville, Texas (the "Paline Release");
In March 2013, a release of approximately 5,900 barrels of crude oil, the majority of which was contained on-site, occurred from a pumping facility at our Magnolia Station located west of the El Dorado Refinery (the "Magnolia Release").

Cleanup operations and site maintenance and remediation efforts on these and other releases have been substantially completed. We may incur additional expenses as a result of further scrutiny by regulatory authorities and continued compliance with laws and regulations to which our assets are subject. As of March 31, 2017, we have accrued $0.1 million for the Paline Release. Expenses incurred for the remediation of these crude oil releases are included in operating expenses in our consolidated statements of income and comprehensive income and are subsequently reimbursed by Delek pursuant to the terms of the Omnibus Agreement. Reimbursements are recorded as a reduction to operating expense. We do not believe the total costs associated with these events, whether alone or in the aggregate, 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 as we are reimbursed by Delek for such costs.

In June 2015, the United States Department of Justice notified the Partnership that it was evaluating an enforcement action on behalf of the Environmental Protection Agency (the "EPA") with regard to potential Clean Water Act violations arising from the Magnolia Release. We are currently attempting to negotiate a resolution to this matter with the EPA and the State of Arkansas, which may include monetary penalties and/or other relief. As of March 31, 2017, we have accrued $1.0 million, which we have recorded in pipeline release liabilities in our condensed consolidated balance sheet, for the Magnolia Release in connection with these proceedings.

Contracts and Agreements

The majority of the petroleum products we sell in west Texas are purchased from Noble Petro, Inc. ("Noble Petro"). Under the terms of a supply contract (the "Abilene Contract") with Noble Petro, we have the right to purchase up to 20,350 bpd of petroleum products at the Abilene, Texas terminal, which we own, for sales and exchange with third parties at the Abilene and San Angelo terminals. We lease the Abilene and San Angelo, Texas terminals to Noble Petro, under a separate Terminal and Pipeline Lease and Operating Agreement, with a term that runs concurrent with that of the Abilene Contract. The Abilene Contract expires on December 31, 2017 and does not include any options for renewal. We also purchase spot barrels from various third parties and from Delek for sale to wholesale customers in west Texas.

Letters of Credit

As of March 31, 2017, we had in place letters of credit totaling $7.5 million under the Second Amended and Restated Credit Agreement, primarily securing obligations with respect to gasoline and diesel purchases. No amounts were drawn under these letters of credit at March 31, 2017.

Operating Leases

We lease certain equipment and have surface leases under various operating lease arrangements, most of which provide the option, after the initial lease term, to renew the leases. None of these lease arrangements include fixed rental rate increases. Lease expense for all operating leases totaled $1.3 million and $1.6 million for the three months ended March 31, 2017 and 2016, respectively.


14. Subsequent Events

Distribution Declaration


20



On April 24, 2017, our general partner's board of directors declared a quarterly cash distribution of $0.69 per limited partner unit, payable on May 12, 2017, to unitholders of record on May 5, 2017.



21


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Unless the context otherwise requires, references in this report to "Delek Logistics Partners, LP," the "Partnership," "we," "us," "our," or like terms, may refer to Delek Logistics Partners, LP, one or more of its consolidated subsidiaries or all of them taken as a whole. References in this report to "Delek" refer collectively to Delek US Holdings, Inc. and any of its subsidiaries, other than Delek Logistics Partners, LP and its subsidiaries and its general partner. Those statements in this section that are not historical in nature should be deemed forward-looking statements that are inherently uncertain. See "Forward-Looking Statements" below for a discussion of the factors that could cause actual results to differ materially from those projected in these statements.

You should read the following discussion of our financial condition and results of operations in conjunction with our historical condensed consolidated financial statements and notes thereto.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Exchange Act of 1934, 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, 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:

our substantial dependence on Delek or its assignees and their respective ability to pay us under our commercial agreements;
the age and condition of our assets and operating hazards and other risks incidental to transporting, storing and gathering crude oil, intermediate and refined products, including, but not limited to, costs, penalties, regulatory or legal actions and other effects related to spills, releases and tank failures;
changes in insurance markets impacting costs and the level and types of coverage available;
the timing and extent of changes in commodity prices and demand for refined products;
the wholesale marketing margins we are able to obtain and the number of barrels of product we are able to sell in our west Texas wholesale business;
the suspension, reduction or termination of Delek's or its assignees' or any third party's obligations under our commercial agreements;
the results of our investments in joint ventures;
the ability to secure commercial agreements with Delek or third parties upon expiration of existing 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 the availability and cost of capital of debt and equity financing;
our reliance on information technology systems in our day-to-day operations;
changes in general economic conditions;
the effects of existing and future laws and governmental regulations, including, but not limited to, the rules and regulations promulgated by the Federal Energy Regulatory Commission ("FERC") and those relating to environmental protection, pipeline integrity and safety;

22


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;
an inability to have growth projects completed on time and on budget;
an inability of Delek to grow as expected;
our ability to successfully integrate acquired businesses;
natural disasters, weather-related delays, casualty losses and other matters beyond our control;
changes or volatility in interest and inflation rates;
labor relations;
large customer defaults;
changes in tax status and regulations;
the effects of future litigation; and
other factors discussed elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2016.

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, intermediate and refined products logistics and marketing assets. We gather, transport, offload and store crude oil and intermediate products and market, distribute, transport and store refined products primarily in select regions of the southeastern United States and Texas for Delek and third parties. A substantial majority of our existing assets are both integral to and dependent upon the success of Delek’s refining operations, as many of 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 such 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 the partner's units and the taxable income allocation requirements under the Partnership's First Amended and Restated Agreement of Limited Partnership (the "Partnership Agreement").

Our Reporting Segments and Assets

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


23


The assets and investments in our pipelines and transportation segment consist of and have been made in pipelines, tanks, offloading facilities, trucks and ancillary assets, which provide crude oil gathering and crude oil, intermediate and refined products transportation and storage services primarily in support of Delek's refining operations in Tyler, Texas and El Dorado, Arkansas. Additionally, the assets in this segment provide crude oil transportation services to certain third parties. In providing these services, we do not take ownership of the products or crude oil that we transport or store; and, therefore, we are not directly exposed to changes in commodity prices with respect to this operating segment.

The assets in our wholesale marketing and terminalling segment consist of refined products terminals and pipelines in Texas, Tennessee and Arkansas. We generate revenue in our wholesale marketing and terminalling segment by providing marketing services for the refined products output of the Tyler Refinery, engaging in wholesale activity at our terminals in west Texas and at terminals owned by third parties, whereby we purchase light products for sale and exchange to third parties, and by providing terminalling services at our refined products terminals to independent third parties and Delek.

Recent Developments

Caddo Pipeline. In March 2015, we entered into a joint venture with an unrelated third party to construct a pipeline system and certain ancillary assets extending from Longview, Texas to destinations in the Shreveport, Louisiana area (the "Caddo Pipeline"). The joint venture that owns the Caddo Pipeline was formed pursuant to an agreement between our subsidiary DKL Caddo, LLC ("DKL Caddo") and Plains Pipeline, L.P., an affiliate of Plains All American Pipeline, L.P. ("Plains"), under which DKL Caddo and Plains each own a 50% membership interest. Operations on the Caddo Pipeline began in January 2017.

How We Generate Revenue     

The Partnership generates revenue by charging fees to Delek and third parties for gathering, transporting, offloading and storing crude oil and for marketing, distributing, transporting, throughputting and storing intermediate and refined products. We also wholesale market refined products in the west Texas market. A substantial majority of our contribution margin, which we define as net sales less cost of goods sold and operating expenses, is derived from commercial agreements with Delek with initial terms ranging from five to ten years, which gives us a contractual revenue base that we believe enhances the stability of our cash flows. As more fully described below, our commercial agreements with Delek typically include minimum volume or throughput commitments by Delek, which we believe will provide a stable revenue stream in the future. The fees charged under our agreements with Delek and third parties are indexed to inflation-based indices. In addition, the rates charged with respect to our assets that are subject to inflation indexing may increase or decrease, typically on July 1 of each year, by the amount of any change in various inflation-based indices, including FERC, provided that in no event will the fees be adjusted below the amount initially set forth in the applicable agreement.

Commercial Agreements

The Partnership has a number of long-term, fee-based commercial agreements with Delek under which we provide various services, including crude oil gathering and crude oil, intermediate and refined products transportation and storage services, and marketing, terminalling and offloading services to Delek, and Delek commits to provide us with minimum monthly throughput volumes of crude oil, intermediate and refined products. Generally, these agreements include minimum quarterly volume, revenue or throughput commitments and have tariffs or fees indexed to inflation-based indices, provided that the tariffs or fees will not be decreased below the initial amount. See our Annual Report on Form 10-K for the year ended December 31, 2016 (our "Annual Report on Form 10-K"), filed with the Securities and Exchange Commission (the "SEC") on February 28, 2017 for a discussion of our material commercial agreements with Delek.

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, intermediate and refined products that we handle in our pipeline, transportation, terminalling, storage and marketing operations. These volumes are primarily affected by the supply of and demand for crude oil, intermediate and refined products in the markets served directly or indirectly by our assets. Although Delek has committed to minimum volumes under certain of the commercial agreements, as described above, our results of operations will be impacted by:

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

24


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;
our ability to identify and serve new customers in our marketing and trucking 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 expenses 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 goods sold and operating expenses.

For our wholesale marketing and terminalling segment, we also measure gross margin per barrel. Gross margin per barrel reflects the gross margin (net sales less cost of goods sold) 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 and cost of gasoline, distillate fuel, ethanol and Renewable Identification Numbers ("RINs"). Historically, the profitability of our wholesale marketing operations has been affected by commodity price volatility, specifically as it relates to changes in the price of refined products between the time we purchase such products from our suppliers and the time we sell the products to our wholesale customers, and the fluctuation in the value of RINs. Commodity price volatility may also impact our wholesale marketing operations when the selling price of finished products does not adjust as quickly as the purchase price. Our wholesale marketing gross margin can also be impacted by fixed price ethanol agreements that we enter into to fix the price we pay for ethanol.

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. Additionally, compliance with federal, state and local laws and regulations relating to the protection of the environment, health and safety may require us to incur additional expenditures. We 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.

EBITDA and Distributable Cash Flow. We define EBITDA as net income (loss) before net interest expense, income tax expense, depreciation and amortization expense. During the year ended December 31, 2016, we revised our definition of distributable cash flow to include the reconciliation of this non-GAAP measure from U.S. GAAP net cash from operating activities rather than from EBITDA. Distributable cash flow is derived from net cash flow from operating activities plus or minus changes in assets and liabilities, less maintenance capital expenditures net of reimbursements and other adjustments not expected to settle in cash. We believe this revision is a more appropriate reflection of a liquidity measure by which users of our financial statements can assess our ability to generate cash. Additionally, 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 condensed 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;
our 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 flow from operating activities 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 and distributable cash flow may not be comparable to similarly titled measures of other companies, thereby diminishing its utility. For a reconciliation of EBITDA and distributable cash flow to its most directly comparable financial measures calculated and presented in accordance with U.S. GAAP, please refer to "Results of Operations—Statement of Operations Data" below.

Financing. The Partnership has declared its intent to make a cash distribution to its unitholders at a distribution rate of $0.69 per unit for the quarter ended March 31, 2017 ($2.76 per unit on an annualized basis). Our First Amended and Restated Agreement of Limited Partnership

25


(the "Partnership Agreement") requires that the Partnership distribute to its unitholders quarterly all of its available cash as defined in the Partnership Agreement. As a result, the Partnership expects to fund future capital expenditures primarily from operating cash flows, borrowings under our senior secured revolving credit agreement, and any potential future issuances of equity and debt securities.

Market Trends

Master Limited Partnerships

Fluctuation in crude oil prices and the prices of related refined products impact our operations and the operations of other master limited partnerships in the midstream energy sector. In particular, crude oil prices and the prices of related refined products have the ability to influence drilling activity in many basins and the amounts of capital spending that crude oil exploration companies and smaller producers incur to support future growth. During the first half of 2016, depressed crude oil prices resulted in a reduction in drilling activity, which created excess capacity and reduced throughput on many crude oil pipelines in the United States and limited the need for new infrastructure projects as crude oil production in the United States was in a period of decline. However, in the latter half of 2016 and the first quarter of 2017, market conditions improved. The prices of crude oil and related refined products have increased. Drilling activity, particularly in the Permian basin, has escalated as a result of increasing prices and the discovery of a large oil deposit in the area. As market conditions improve and demand benefits from increased drilling activity, we expect our operations to benefit from the trend and have a corresponding improvement, particularly in the west Texas area where we are most susceptible to the effects of market factors. Additionally, improving market conditions allow for the development of profitable growth projects that are needed to support future distribution growth in the midstream energy sector and for the Partnership.

West Texas Marketing Operations

Overall demand for gathering and terminalling services in a particular area is generally driven by crude oil production in the area, which can be impacted by crude oil prices, refining economics and access to alternate delivery and transportation infrastructure. Additionally, volatility in crude oil, intermediate and refined products prices in the west Texas area and the value attributable to RINs can affect the results of our west Texas operations. For example, as discussed above, drilling activity and the prices of crude oil and related refined products have recently increased, resulting in higher demand for finished products from our west Texas operations to industries that support crude oil exploration and production. See below for the high, low and average price per barrel of WTI crude oil for each of the quarterly periods in 2016 and for the three months ended March 31, 2017.


dkl-10qx0331_chartx40878.jpg

Also, the volatility of finished products prices may impact our margin in the west Texas operations when the selling price of finished products does not adjust as quickly as the purchase price. See below for the range of prices per gallon of gasoline and diesel for each of the quarterly periods in 2016 and for the three months ended March 31, 2017.

26


dkl-10qx0331_chartx42582.jpg

dkl-10qx0331_chartx44268.jpg


Our west Texas operations can benefit from RINs that are generated by ethanol blending activities. As a result, changes in the price of RINs can affect our results of operations. The RINs we generate are sold primarily to Delek at market prices. We sold approximately $1.1 million and $1.5 million of RINs to Delek during the three months ended March 31, 2017 and 2016, respectively. See below for the high, low and average prices of RINs for each of the quarterly periods in 2016 and for the three months ended March 31, 2017.


27


dkl-10qx0331_chartx45762.jpg


All of these factors are subject to change over time. As part of our overall business strategy, management considers aspects such as location, acquisition and expansion opportunities and factors impacting the utilization of the refineries (and therefore throughput volumes), which may impact our performance in the market.

Seasonality and Customer Maintenance Programs

The volume and throughput of crude oil, intermediate and refined products transported through our pipelines and sold through our terminals and to third parties is directly affected by the level of supply and demand for all such products in the markets served directly or indirectly by our assets or our customers. Supply and demand for such products fluctuates during the calendar year. Demand for gasoline, for example, is generally higher during the summer months than during the winter months due to seasonal increases in motor vehicle traffic. In addition, our refining customers, such as Delek, occasionally reduce or suspend operations to perform planned maintenance during the winter, when demand for their products is lower. Accordingly, these factors affect the need for crude oil or finished products by our customers and therefore limit our volumes or throughput during these periods, and our operating results will generally be lower during the first and fourth quarters of the year. We believe, however, that many of the potential effects of seasonality on our revenues and contribution margin will be substantially mitigated due to our commercial agreements with Delek that include minimum volume and throughput commitments.

Contractual Obligations

There have been no material changes to our contractual obligations and commercial commitments during the three months ended March 31, 2017 from those disclosed in our Annual Report on Form 10-K.

Critical Accounting Policies

The preparation of our condensed 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, complex or subjective judgments or estimates. Based on this definition and as further described in our Annual Report on Form 10-K, we believe our critical accounting policies include the following: (i) evaluating impairment for property, plant and equipment and definite life intangibles, (ii) valuing goodwill and evaluating potential impairment, and (iii) estimating environmental expenditures. For all financial statement periods presented, there have been no material modifications to the application of these critical accounting policies or estimates since our Annual Report on Form 10-K.


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Results of Operations

A discussion and analysis of the factors contributing to our results of operations is presented below. The financial statements, together with the following information, are intended to provide investors with a reasonable basis for assessing our historical operations, but should not serve as the only criteria for predicting our future performance.

The following table and discussion present a summary of our consolidated results of operations for the three months ended March 31, 2017 and 2016, including a reconciliation of EBITDA to net income and distributable cash flow to net cash provided by operating activities (in thousands, except unit and per unit amounts).
 
 
Three Months Ended
 
 
March 31,
 
 
2017
 
2016
Statement of Operations Data:
 
 
 
 
Net sales:
 
 
 
 
Pipelines and transportation
 
$
28,677

 
$
32,783

Wholesale marketing and terminalling
 
100,796

 
71,273

Total
 
129,473

 
104,056

Operating costs and expenses:
 
 
 
 
Cost of goods sold
 
92,590

 
66,753

Operating expenses
 
10,358

 
10,464

General and administrative expenses
 
2,848

 
2,913

Depreciation and amortization
 
5,193

 
4,996

Loss (gain) on asset disposals
 
12

 
(44
)
Total operating costs and expenses
 
111,001

 
85,082

Operating income
 
18,472

 
18,974

Interest expense, net
 
4,071

 
3,199

(Income) loss from equity method investments
 
(245
)
 
229

Total non-operating costs and expenses
 
3,826

 
3,428

Income before income tax expense
 
14,646

 
15,546

Income tax expense
 
51

 
98

Net income attributable to partners
 
$
14,595

 
$
15,448

Comprehensive income attributable to partners
 
$
14,595

 
$
15,448

EBITDA(1)
 
$
23,910

 
$
23,741

 
 


 
 
Less: General partner's interest in net income, including incentive distribution rights
 
4,109

 
2,253

Limited partners' interest in net income
 
$
10,486

 
$
13,195

 
 
 
 
 
Net income per limited partner unit (2):
 
 
 
 
Common units - (basic)
 
$
0.43

 
$
0.54

Common units - (diluted)
 
$
0.43

 
$
0.54

Subordinated units - Delek (basic and diluted)
 
$

 
$
0.54

 
 
 
 
 
Weighted average limited partner units outstanding (2):
 
 
 
 
Common units - (basic)
 
24,328,607

 
17,024,490

Common units - (diluted)
 
24,380,770

 
17,115,198

Subordinated units - Delek (basic and diluted)
 

 
7,252,299


(1) For a definition of EBITDA, see "How We Evaluate Our Operations—EBITDA and Distributable Cash Flow" above.

(2) We base our calculation of net income per unit on the weighted-average number of common and subordinated limited partner units outstanding during the period. The weighted-average number of common and subordinated units reflects the conversion of the subordinated units to common units on February 25, 2016. See Note 6 to our accompanying condensed consolidated financial statements for further discussion.

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(in thousands)
 
Three Months Ended
 
 
March 31,
 
 
2017
 
2016
Reconciliation of EBITDA to net income:
 
 
 
 
Net income
 
$
14,595

 
$
15,448

Add:
 
 
 
 
Income tax expense
 
51

 
98

Depreciation and amortization
 
5,193

 
4,996

Interest expense, net
 
4,071

 
3,199

EBITDA (1)
 
$
23,910

 
$
23,741

 
 
 
 
 
Reconciliation of net cash from operating activities to distributable cash flow:
 
 
 
 
Net cash provided by operating activities
 
$
23,474

 
$
26,374

Changes in assets and liabilities
 
(3,562
)
 
(5,401
)
Maintenance and regulatory capital expenditures (2) 
 
(2,243
)
 
(736
)
Reimbursement from Delek for capital expenditures (3)
 
3,051

 
209

Accretion of asset retirement obligations
 
(73
)
 
(67
)
Deferred income taxes
 
(25
)
 

(Loss) gain on asset disposals
 
(12
)
 
44

Distributable cash flow (1)
 
$
20,610

 
$
20,423

            

(1) For a definition of EBITDA and distributable cash flow, please see "How We Evaluate Our Operations—EBITDA and Distributable Cash Flow" above.

(2) Maintenance and regulatory capital expenditures represent cash expenditures (including expenditures for the addition or improvement to, or the replacement of, our capital assets, and for the acquisition of existing, or the construction or development of new, capital assets) made to maintain our long-term operating income or operating capacity. Examples of maintenance and regulatory capital expenditures are expenditures for the repair, refurbishment and replacement of pipelines and terminals, to maintain equipment reliability, integrity and safety and to address environmental laws and regulations.

(3) For the three month periods ended March 31, 2017 and 2016, Delek reimbursed us for certain capital expenditures pursuant to the terms of the Omnibus Agreement (as defined in Note 2 to our condensed consolidated financial statements).
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Segment Data:

The following is a summary of business segment capital expenditures for the periods indicated (in thousands):
 
 
 
Three Months Ended
 
 
March 31,
 
 
2017
 
2016
 Capital spending (excluding business combinations)
 
 
 
 
     Pipelines and Transportation
 
$
2,137

 
$
706

    Wholesale Marketing and Terminalling
 
$
654

 
$
378





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Consolidated Results of Operations — Comparison of the Three Months Ended March 31, 2017 compared to the Three Months Ended March 31, 2016

The table below presents a summary of our consolidated results of operations and our segment operating performance for the three months ended March 31, 2017 and 2016. The discussion immediately following presents the consolidated results of operations (in thousands).

 
 
Three Months Ended
 
 
March 31,
 
 
2017
 
2016
Pipelines and Transportation
 
 
 
 
Net Sales:
 
 
 
 
     Affiliate
 
$
26,500

 
$
26,306

     Third-Party
 
2,177

 
6,477

          Total Pipelines and Transportation
 
28,677

 
32,783

     Operating costs and expenses:
 
 
 
 
          Cost of goods sold
 
4,405

 
4,776

          Operating expenses
 
8,155

 
7,740

     Segment contribution margin
 
$
16,117

 
$
20,267

 
 
 
 
 
Wholesale Marketing and Terminalling
 
 
 
 
Net Sales:
 
 
 
 
     Affiliate
 
$
10,119

 
$
12,454

     Third-Party
 
90,677

 
58,819

          Total Wholesale Marketing and Terminalling
 
100,796

 
71,273

     Operating costs and expenses:
 
 
 
 
          Cost of goods sold
 
88,185

 
61,977

          Operating expenses
 
2,203

 
2,724

     Segment contribution margin
 
$
10,408

 
$
6,572

 
 
 
 
 
Consolidated
 
 
 
 
Net Sales:
 
 
 
 
     Affiliate
 
$
36,619

 
$
38,760

     Third-Party
 
92,854

 
65,296

     Net sales
 
129,473

 
104,056

     Operating costs and expenses:
 
 
 
 
     Cost of goods sold
 
92,590

 
66,753

     Operating expenses
 
10,358

 
10,464

     Contribution margin
 
26,525

 
26,839

     General and administrative expenses
 
2,848

 
2,913

     Depreciation and amortization
 
5,193

 
4,996

     Gain on asset disposals
 
12

 
(44
)
     Operating income
 
$
18,472

 
$
18,974



 
Net Sales

We generated net sales of $129.5 million for the first quarter of 2017 compared to $104.1 million for the first quarter of 2016, an increase of $25.4 million, or 24.4%. The increase was primarily attributable to increases in the average sales prices per gallon of gasoline and diesel in our west Texas marketing operations. The average sales prices per gallon of gasoline and diesel sold increased $0.47 per gallon and $0.58 per gallon, respectively, during the first quarter of 2017 compared to the first quarter of 2016. Partially offsetting the increase was a decline in fees on our Paline Pipeline System. During the first quarter of 2017, the Paline Pipeline System was a FERC regulated pipeline with a tariff established for potential shippers, compared to the first quarter of 2016, when the pipeline capacity was under contract with two third parties for a monthly fee.

Cost of Goods Sold

Cost of goods sold was $92.6 million for the first quarter of 2017 compared to $66.8 million for the first quarter of 2016, an increase of $25.8 million, or 38.7%. The increase in cost of goods sold was primarily attributable to increases in the average cost per gallon of gasoline and diesel purchased in our west Texas marketing operations. The average cost per gallon of gasoline and diesel purchased increased $0.42 per gallon and $0.54 per gallon, respectively, during the first quarter of 2017 compared to the first quarter of 2016.

Operating Expenses

Operating expenses were $10.4 million for the first quarter of 2017 compared to $10.5 million for the first quarter of 2016, a decrease of $0.1 million, or 1.0%. The decrease in operating expenses in the first quarter of 2017 compared to the first quarter of 2016 was primarily due to a reduction in operating expenses for one of our terminal locations at which we incurred costs related to internal tank contamination during the first quarter of 2016. Also contributing to the decrease in operating expenses were decreases in maintenance costs at our Memphis Terminal during the first quarter of 2017 compared to the first quarter of 2016. Partially offsetting the decreases were increases in maintenance costs associated with certain of our tanks at our tank farms in the first quarter of 2017 compared to the first quarter of 2016.

Contribution Margin

Contribution margin for the first quarter of 2017 was $26.5 million compared to $26.8 million for the first quarter of 2016, a decrease of $0.3 million, or 1.2%. The decrease in contribution margin was primarily attributable to a decline in fees on our Paline Pipeline System as described above. This decrease was partially offset by improved contribution margin in our west Texas operations as a result of increased drilling activity in the region, which has improved market conditions and increased demand.  Further offsetting the decreases were increases in contribution margin at our terminals as a result of volume increases at our Nashville and El Dorado Terminals and a reduction in operating expenses at our

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Memphis Terminal during the first quarter of 2017 compared to the first quarter of 2016.
 
 
 
 
 
General and Administrative Expenses

General and administrative expenses were $2.8 million for the first quarter of 2017 compared to $2.9 million for the first quarter of 2016, a decrease of $0.1 million, or 2.2%. The decrease in general and administrative expense was primarily due to decreases in professional services fees and certain direct employee costs allocated to us for the first quarter of 2017 compared to the first quarter of 2016.

Depreciation and Amortization

Depreciation and amortization was $5.2 million for the first quarter of 2017 compared to $5.0 million for the first quarter of 2016, an increase of $0.2 million, or 3.9%. The increase in depreciation and amortization was primarily due to the addition of assets to our asset base as a result of the completion of capital projects that were placed into service throughout 2016 and the first quarter of 2017.

Interest Expense

Interest expense was $4.1 million for the first quarter of 2017 compared to $3.2 million for the first quarter of 2016, an increase of $0.9 million, or 27.3%. This increase was primarily attributable to increases in interest costs under our revolving credit facility due to changes in debt utilization and interest rates thereunder as a result of increased borrowings incurred in connection with continued investments made in our joint ventures.

Income Tax Expense

Income tax expense was $0.1 million for each of the first quarters of 2017 and 2016. Our effective tax rate was 0.3% for the first quarter of 2017, compared to 0.6% for the first quarter of 2016. The Partnership is not subject to federal income taxes as a limited partnership. Accordingly, our taxable income or loss is included in the federal and state income tax returns of our partners. Income tax expense represents amounts incurred for state income taxes.



















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Operating Segments

We review operating results in two reportable segments: (i) pipelines and transportation and (ii) wholesale marketing and terminalling. Decisions concerning the allocation of resources and assessment of operating performance are made based on this segmentation. Management measures the operating performance of each reportable segment based on the segment contribution margin. Segment contribution margin is defined as net sales less cost of goods sold and operating expenses, excluding depreciation and amortization. Segment reporting is more fully discussed in Note 10 to our accompanying condensed consolidated financial statements.

Pipelines and Transportation Segment

Our pipelines and transportation segment assets provide crude oil gathering and crude oil, intermediate and refined products transportation and storage services to Delek and third parties. These assets include the Lion Pipeline System, the SALA Gathering System, the Paline Pipeline System, the East Texas Crude Logistics System, the Tyler-Big Sandy Pipeline, the El Dorado Tank Assets, the Tyler Tank Assets, the Greenville-Mount Pleasant Pipeline and Greenville Storage Facility, the El Dorado Rail Offloading Racks, the Tyler Crude Tank and refined product pipeline capacity leased from Enterprise TE Products Pipeline Company LLC that runs from El Dorado, Arkansas to our Memphis terminal. In addition to these operating systems, we own 123 trucks and 205 trailers used to haul primarily crude oil and other products for related and third parties.

The following table and discussion present the results of operations and certain operating statistics of the pipelines and transportation segment for the three months ended March 31, 2017 and 2016:

 
 
Three Months Ended March 31,
 
 
2017
 
2016
Throughputs (average bpd)
 
 
 
 
 Lion Pipeline System:
 
 
 
 
Crude pipelines (non-gathered)
 
58,744

 
56,342

Refined products pipelines to Enterprise Systems
 
51,355

 
53,779

SALA Gathering System 
 
16,531

 
19,001

East Texas Crude Logistics System
 
16,176

 
9,346


Comparison of the Three Months Ended March 31, 2017 compared to the Three Months Ended March 31, 2016

Net Sales

Net sales for the pipelines and transportation segment were $28.7 million for the first quarter of 2017 compared to $32.8 million for the first quarter of 2016, a decrease of $4.1 million, or 12.5%. The decrease was primarily attributable to declines in fees on our Paline Pipeline System. During the first quarter of 2017, the Paline Pipeline System was a FERC regulated pipeline with a tariff
 
established for potential shippers, compared to the first quarter of 2016, when the pipeline capacity was under contract with two third parties for a monthly fee.

Cost of Goods Sold

Cost of goods sold was $4.4 million for the first quarter of 2017 compared to $4.8 million for the first quarter of 2016, a decrease of 0.4 million, or 7.8%. The decrease in cost of goods sold was attributable to lower pipeline allowance losses on our Paline Pipeline System and reduced costs associated with our leased refined product pipeline capacity as a result of lower volumes on the pipeline during the first quarter of 2017 compared to the first quarter of 2016.

Operating Expenses

Operating expenses were $8.2 million for the first quarter of 2017 compared to $7.7 million for the first quarter of 2016, an increase of $0.5 million, or 5.4%. The increase in operating expenses was primarily due to increases in maintenance costs associated with certain of our tanks at our tank farms in the first quarter of 2017 compared to the first quarter of 2016.

Contribution Margin

Contribution margin for the pipelines and transportation segment was $16.1 million, or 60.8% of our consolidated segment contribution margin in the first quarter of 2017, compared to $20.3 million, or 75.5% of our consolidated segment contribution margin, in the first quarter of 2016, a decrease of 4.2 million, or 20.5%. The decrease in the pipelines and transportation segment contribution margin was primarily attributable to decreases in net sales related to our Paline Pipeline System as described above.

Wholesale Marketing and Terminalling Segment

We use our wholesale marketing and terminalling assets to generate revenue by providing wholesale marketing and terminalling services to Delek’s refining operations and to independent third parties.

The table and discussion below present the results of operations and certain operating statistics of the wholesale marketing and terminalling segment for the three months ended March 31, 2017 and 2016:
 
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Operating Information:
 
 
 
 
East Texas - Tyler Refinery sales volumes (average bpd) 
 
63,396

 
66,414

West Texas marketing throughputs (average bpd)
 
14,467

 
14,370

West Texas marketing margin per barrel
 
$
2.72

 
$
0.53

Terminalling throughputs (average bpd) 
 
114,900

 
118,218


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Comparison of the Three Months Ended March 31, 2017 compared to the Three Months Ended March 31, 2016

Net Sales

Net sales for the wholesale marketing and terminalling segment were $100.8 million for the first quarter of 2017 compared to $71.3 million for the first quarter of 2016, an increase of $29.5 million, or 41.4%. The increase was primarily attributable to increases in the average sales prices per gallon of gasoline and diesel sold in our west Texas marketing operations. The following charts show summaries of the finished products volume and average sales prices per gallon of gasoline and diesel impacting our west Texas operations during the first quarter of 2017 compared to the first quarter of 2016.

dkl-10qx0331_chartx41129.jpg

dkl-10qx0331_chartx42064.jpg

 
Cost of Goods Sold

Cost of goods sold for our wholesale marketing and terminalling segment was $88.2 million in the first quarter of 2017, compared to $62.0