Murphy USA Inc. (NYSE:MUSA)
Analyst Day Conference Call
April 15, 2014 09:30 AM ET
Tammy Taylor - IR
Andrew Clyde - President and CEO
Mindy West - EVP and CFO
Esteban Gomez - JP Morgan
Edwin Johnston - Sandhill Capital Partner
Damian Witkowski - Gabelli & Company
Kevin Dreyer - GAMCO Investors, Inc
Ron Bookbinder - Benchmark Company
Ryan Burtell - Ventura Capital
Good morning, I am Tammy Taylor, Senior Manager of Investor Relations and Corporate Communications. Welcome to the Murphy USA’s First Analyst Day. We thank you for joining whether in person or on the webcast. The format will be a presentation followed by Q&A. We ask you to hold your questions until the presentation is over.
Please note, or cautionary statement. The presentation may contain statements that are forward-looking. Murphy USA takes no duty to publicly update those. I will not bore you with reading it.
With more than 20 years of experience in management consulting, with focus on downstream value chain and gasoline and convenience retailing, Andrew Clyde was uniquely qualified take the helm of a large convenience retailer. As a partner in building company’s global energy practice, Andrew spearheaded the development of the business strategy for Murphy USA and as of being appointed CEO, he led the execution of a seamless spin for Murphy Oil Corporation. Having achieved, authored the organization strategy, leading the company has proven advantages during Murphy USA’s in our growing years, everyone meet Andrew Clyde.
Mindy is the Executive Vice President and Chief Financial Officer at Murphy USA with responsibilities for finance, accounting functions, and renewable energy manufacturing. Mindy’s success is a combination of 17 years of experience with Murphy Oil Corporation in a variety of roles from accounting, employee benefits, planning, investor relations, and Treasury. Mindy is the former Vice President and Treasurer at Murphy Oil Corporation. She is a CTA, a certified Treasury professional.
I will now turn the presentation over to Mindy West
Thank you Tammy and morning everyone. We’re happy that you’re able to join us. I would like to begin by just highlighting some of our accomplishments from last year that we were little busy on spin related activities as you can imagine. We nevertheless remain focused on our strategy and we are able to complete the year with a number of significant accomplishments.
We grew, we opened 39 stations last year and we also established the pipeline of additional sites with expectations to construct up to 70 new sites this year. We continue to diversify our merchandise mix, expanding our non-tobacco sales by 9.8% and our non-tobacco margin dollar by 7%. We were also innovative with promotions by establishing a $0.10 off per gallon of fuel with qualifying beverage purchases. And that is a program we expect to continue and expand in 2014.
At the same time we were able to maintain our class leadership by reducing our per-site OpEx by 0.6%, we continued our strong safety record and we entered the spin with further improvement and overheads in mines. We used market volatility to our advantage by generating over $90 million from rent contribution and we also divested non-core assets generating almost $180 million in proceeds.
And then lastly, we positioned ourselves to be able to invest for the long term. We have large cash balances by year-end, we were able to deleverage the balance sheet percent, and we met our commitments that we made on our road shows and to our rating agencies.
So I am going to start by show you some of our financial results for the year 2011 to 2013, beginning with fuel. Total fuel volume for all year shown here as you can see is about 3.7 billion to 3.8 billion gallon. However, retail fuel volume in 2013, on an average per store basis were 268,500 versus 277,000 the prior year. So that’s lower by 3.1%. Now that decline was due to significantly less price volatility last year versus the prior year. And when Andrew walks you through our business model, he will be able to explain to you why volatility is important in our results. It was also due to overall weaker customer demand.
Now fuel margins did increase slightly to $0.13, even versus 12.9 the prior year, but that’s still on a $0.03 lower than what it was in 2011, when margins were $0.156. Our fuel volume, on a per site basis are higher than our peers. And that’s indicative of business model being fuel focused, and fuel is a major driver for our business. You’ll also note that our margins for fuel are typically lower than our peers and that’s because we’re trying to attract a value concept customer, and we strive to be a low-price leader in the markets in which we operate and all that ability is underpinned by our low-cost operating structure as well as our supply chain advantages which Andrew will discuss with you in a minute.
Now turning to the merchandise side, merchandise sales increased slightly to $2.2 billion in 2013, that’s a $15 million from the prior year. Merchandise margins did decline 0.4% from 13.5 to 13.1. Now our margins does reflect a large proportion of tobacco within our mix at 80% and a decline in margin was caused by the intense pressure on the tobacco category last year. But we partially offset that through increased sale of higher margin non-tobacco item and in fact as you can see non-tobacco sales has grown steadily and in fact we have experienced 50 plus quarters of non-tobacco margin dollar growth on a per-side basis.
Category selling the most improvement last year were Candy, Salty Snacks, Lotto, Lottery and Beverage. Now we’ve also been steadily reducing the percentage of tobacco in our mix, as I mentioned a minute ago, it’s 80% so that’s actually down two percentage points from the prior when it was 82% of the mix. And we do expect that overtime given our emphasis on the larger 1,200 square foot format versus the 208 that we will continue to improve our mix towards higher margin products.
Now, our spin was completed August 30th, 2013 so our asset and liabilities were 100% owned by our parent company Murphy Oil Corp during those years and the income number is also include certain extend allocations for corporate functions that were historically performed by our Parent, so they may not necessarily would have had, had we have been a standalone during those years.
For 2013, we reported net income of $235 million including income from discontinued operations that’s $79 million which gets us to $156 million from continuing operations on revenue of $18.1 billion. Net income for 2012 was $83.6 million or $19.3 billion in revenue. Now the increase in 2013 net income excluding discontinued operations is requested of increased prices for the rent over the prior year, as well as income from our ethanol operation which reflected a loss the previous year.
Now the decline in income from 2011 to 2012, we’ve already explained part of it as you can see at the top fuel margins were $0.03 higher in that year. And also in 2012 as I mentioned our ethanol operation sustained a loss, largely due to the increase in corn prices that occurred during the summer of that year. EBITDA excluding discontinued operations for 2013 was $340 million versus $285 million for 2012 and $377 million in 2011.
At year-end 2013 we had $295 million a cash and cash equivalent in that asset we’re paying down $80 million in long term debt. Historically, the cash presented on our balance sheet $0.03 represent a cash that we had on hand at our local station account before they were swept back to the parent so that explains why the cash balances in 2011 and 2012 are so much lower than they were in 2013.
Now we’ve always said that the [indiscernible] was advantageous for MUSA because we were able to address that the end of August was seasonally high inventory level and we also sign three labor-day weekend and so we were able to keep all the sales proceeds from what is one of our biggest driving holidays of the year. And those results combined with our asset divestitures is what caused us to be able to a math on $300 million by year end.
Looking at CapEx, CapEx for 2013 required cash of $172 million compared to $122 million in 2012 and $100 million in 2011. Now the main driver of our CapEx is stationed billed (Ph) that’s on [indiscernible] case and the increase in 2013 as explained, as our land purchase required under our Walmart agreement for the 200 additional sites we paid roughly 50% down payment on the lands last year.
Now, in connection with our spin, we did enter into a new $450 million ABL facility which continues to be undrawn, we also borrowed $150 million under our term loan and issued $500 million of 6% ten year note and those proceeds along with the proceeds from the term loan we’re used to fund the dividend back to our parent upon spend of $650 million.
Now by year-end we had repaid $80 million of that term loan which left us at the end of the year, with a long term debt balance of $548 million. At spend, shareholders of Murphy Oil Corp perceived one share of MUSA for every four share as Murphy Oil stock that they had. We entered the year with the share price of $41.56 and in equity cap of $1.9 billion. So on balance a very busy year, but a spin that was relatively seamless for us and for our parent, we amassed quite a cash cushion for ourselves and we had good operating performance, all of that setting a stage in 2014 for us to be able to achieve our goal this year and beyond.
And that ends with financial part; I am going now to turn it over to Andrew who will walk you through what is a very unique business model.
Thank you Mindy, I’d like to welcome all of you here, for those who are joining the webcast we’re sitting in the beautiful historic main dining room of the New York Stock Exchange and we’re glad to be back here and we want to thank the New York Stock Exchange for hosting us here. Mindy talked about our 2013 results and we talked about them also in detail on our quarterly earnings calls. I am going to shift the stage and really look forward and talk about our strategy, what makes Murphy USA tick and really what makes us a differentiated business model in this space?
I will try to remember to call out page numbers for those on the webcast who can follow along. So turning to Slide 8, the headline here is we have a very clear strategy and it focuses on our strengths and we get a lot of questions all the time, when we talk to analysts and investors about our strategy. I think sometimes it’s useful to just step back and look at the broader industry and say how are people competing in this space? And we really see three models at scale across the industry and the U.S. and the convenience retailing space.
You see large boxy stores that have a food offer that’s made to order or made the stock and have achieved success with those offers and are rolling them out. In their objective when they build those 5,000 to 7,000 square foot stores that cost $5 million to $7 million in they still with lots of labor and costs it’s to sell a lot of food and convenient items to cover those cost and reduce their breakeven requirement on fuel and in the best cases can actually achieve standalone economics with those stores, meaning they could operate with or without gasoline. But most of them given the high capital cost of those stores will require fuel to be profitable. So that’s one model that we see.
The second model that we see are the grocery store and mass merchants that also sell fuel off in the company by a small box that is part of that integrated offer to that customer. So whether its cost go in the club space or in the grocery store space or Walmart partnered with Murphy USA that’s clearly the space that we participate in. And what we have been able to do since 1996 partnering with Walmart is deliver a low price value offer to its customers. And so we participate on an integrated basis with Walmart in that space.
And the third model frankly we see it scale as the consolidator space, and there is a couple of companies that are very large consolidators in the space and they feel business model and capabilities around consolidating a fragmented industry. With over 150,000 convenient stores out there today almost 125,000 of them have gasoline. And the industry has been under some state of consolidation that happens two to three to 20 to 30 to 200 to 300 sites at a time.
And so if you think about those three models I think from an investor analyst standpoint you should be saying how are you participating in that space, if you have a clear distinctive strategy that allows you to win in one of the chosen models. And let’s be real clear are you at risk of falling somewhere in the middle and not having a clear model. We believe we have a very clear strategy as part of that integrated offer with Walmart. And what we’ll do now is kind of talk through the strategy and strength and use this as a framework for the rest of this morning to discuss our business model.
So the first part of our strategy is to grow and to grow organically. And that leverages this strategic and complementary relationship we have with Walmart. Our second strategy is to diversify our merchandise mix, even though we have relatively small stores and small selling area it grew up largely dependent on tobacco and the improvements that we have been able to make over the last 14 years have allowed us to diversify our mix and not be as dependent on tobacco and the headwinds in that space, and we’re continuing to do that.
If you’re going to be low price and targeting the value conscious customers you have to be low cost. And we’ve developed a very lean business model both in terms of the capital expenditure per site as well as the lean operations on the site and the associated overhead structure. And so our both strategies is to really sustain that cost leadership position.
As Mindy said we’re very committed and engaged in the fuel category more so than most of our peers and the weakest players in this space who frankly I think have partly analyst and investor community to be somewhat fearful of fuel, volatility hurts the weakest players, because they are running on very thin margins, they’re highly levered either with debt or real-estate payments or REITs or all of the above and any volatility in the fuel margin puts their business at risk.
Use of microeconomic term though if you are on the left hand side of the cost supply curve and you got the lowest cost structure and you have a low breakeven and you are earning an attractive margin, volatility is your friend. And so we look to take advantage of market volatility of fuel and we will talk about how we take advantage of that through our distinctive fuel supply chain capabilities. And the last strategy underpinning this is to invest for the long-term, right, because that then provides the fuel for future organic growth and in a industry, in a category like fuel that’s inherently volatile, we want to maintain a resilient financial profile, so that we can maintain low cash breakevens and then be able to return excess returns to our shareholders and reinvested in future organic growth that’s our business model. We see these five strategic points as very coherent. They build on each other and a lot of the questions we get from time to time, the response go back to the Morgan side, how does that fit in or support this strategy and this is what makes us, we believe unique and it’s also building on a set of strengths that are frankly hard to imitate.
So let’s talk through this first one, this unique relationship we have with Walmart. Our strategies continue to build out the Walmart 200 sites in our core markets. These are the sites that we signed a contract for in December 2012, in 2013 we have been working actively to get the out lots conveyed and developed and rest of those will be build out in 2014. We also started the more challenging process of the carve out sites where we have to reopen the plants and go through the planning and permitting cycle and we are starting now to build out on the carve out sites. We also maintain a pipeline of Murphy Express locations near Walmart. This allows us to accelerate the coverage in front of Walmart’s. In most cases where Walmart does not have a location that they could offer us either because the parking lot is too small or the out-lots are in the hands of third-party developers. And so the only real difference in those sites is if they are built as a Murphy Express, they are not initially connected to the Walmart card and discount programs, most other respects are identical to Murphy USA side.
And then the third point of the strategy is to continue to enhance our fuel discount program and joint promotions with Walmart to drive overall traffic. Let’s be clear 99% of our customers are Walmart’s customers. We are there to provide low cost fuel and other items to those customers as part of that overall value proposition and so in a competitive world were Murphy stores offer gasoline and have programs, we need to be consistent with all programs. Now turn to slide 10, let’s talk a little bit about the history. It goes way back to 1996, we opened our first site in Chattanooga, Tennessee in 1997 and if you think about this timeline where we have gone from 1,500 sites to 1,203 sites at end of 2013. I would say there are really four stages of this relationship in terms of this development. There was the start-up period from 1997 to 1998 where we got the initially the Southwest and Southeast side, later came the Midwest sites to Sinnoco at the West Coast and Rocky Mountain sites and the Northwest sites respectively.
With Walmart, we have started up the $0.03 per gallon Walmart shopping card promotion back in 1998 and that really got the ball going. The second period was really between 1999 and 2004-’05, it was a period of rapid growth and a lot of people say gee, how can you get back to building over a 100 sites a year like you did back in the rapid growth cycle. And one thing to remember is as the supercenters were being developed and plotted, there is a location for gasoline being plotted at the same time. And we are working very closely hand-in-hand building a Murphy USA kiosk with gasoline as the supercenter was being built and it was really a joint development process. That slowed in 2005 and ‘06 and in 2007, we were able to acquire the land that we have previously leased from Walmart. For a period of years, we were not getting new sites from Walmart and so we wanted to continue our growth through largely the same business model because of strategy work. And so we have began building on lots adjacent or contiguous or across the street from Walmart with our Murphy Express model.
And then in 2011, we really started working together again on a more integrated basis. We started up the $0.10 discount program. We began discussions on the next 200 sites, we culminated that transaction in December 2012 and now we are back into a growth model with our partner and I think the difference between growing at 60 plus sites a year and 120 plus sites a year are just the bottlenecks in the process because we did the simple site, there is a process to carve out the locations, convey the real estate, reopen the planning and permitting process and that takes the matter of time and that pipeline was full of sites already convey plan and permit or done on a lease basis we’ll be able to accelerate that coverage more quickly and so lot of our efforts in 2013 and early 2014 was actually building that building pipeline for that growth. And we’re continuing to make acquisitions of Murphy Express locations near adjacent to Walmart to be able to continue to low level the construction on our site.
The next slide shows the 1,087 small formats that are located near Walmart Supercenters and you can see the little dots and where they’re spread out in the three regions in which we’ve organized our business the Southwest, the Southeast, and the Midwest. And so this excludes 85 sites that are greater than 1400 square feet, these are standalone larger new stores that are 2000 square feet and 3500 square feet that have largely been built since 2005. We’re continuing to build a handful of those of larger format sites each year, it just another means for growth where we can invest in the larger format stores in very selective markets and provides a good way to test product and have some alternative growth.
The next slide also shows now in the light blue the 31 small format sites that we have at Walmart neighborhood markets. So we have been in front of the number of neighborhood markets, for many years now the larger neighborhood markets that have the parking lots space where out logged developed is very viable for our sites as well. If you got to a very-very small neighborhood market with very limited parking or the new Walmart Express sites that are roughly 10,000 square feet, you able to be unlikely that you would put 1200 square feet of selling space in front of the 10,000 square foot store, but those stores could still benefit from a few offer.
Our current pipeline, the remaining sites on the Walmart 200 batch and the Murphy Express sites that we have in our land bank totaled 198 those are the green sites that we see on the Slide 13 and those will be built out over the next three plus years. When you go beyond the existing portfolio and the roughly 200 sites that we have lined aside for organic growth, there is another 1204 Supercenters not covered in our core markets. And that represents sort of the theoretical opportunity set for our models, some of those locations may not have a gas location available but lot of times when people ask the question about M&A and consolidation, this is one of the things that we point to as what would the next financial growth look like with Walmart, it fits our strategy. We know what the economics and returns are for those. If the M&A consolidation model represent a completely different business model and strategy why we would go into that strategy and business model when we have future growth in front of us with Walmart continuing to participate in that strategy.
And then last because people ask the question, what is the total universe of Supercenters? There are another 852 Supercenters now on Slide 15 noted in red those are largely in the west coast markets where it’s a Sinnoco (Ph) started and the midcontinent Rocky Mountain states as well as in the Northeast states where Sinnoco started. And so we look at those markets and in some cases you’d say look land access is difficult or it’s very expensive or permitting is more difficult or it’s a much higher cost environment to operate, we would stay initially focused, want to stay initially focused in our core markets before reaching out more broadly than that. But that just gives you a sense of what the overall universe looks like.
In terms of the formats that we have turning to Slide 16, our network consists mostly of kiosks and small format stores. And so you see on the left the kiosk locations kind of in groups of every three years since 2001 in the building square footage, actually most of the slides are 150 square foot boxes with several hundred feet of selling areas out in front of them. If you look to 2007 and since most of the formats that we have built on the kiosk site of the 208 square foot boxes that again have the Snack Alley in several hundred square feet in front of them. We’re going to show you a video in a little bit that kind of lays out the format itself. The 112 and 150 square foot stores that we started with when we first got this up and running represented an opportunity to do raising rebuilds or represent an opportunity at the end of their useful life to put up a larger box and we continue to do building canopy in major cooler maintenance programs, and when Mindy talks about the $20 million to $30 million of maintenance CapEx. It includes projects like that we will be consistently upgrading our fuel dispensers, our buildings, our canopies, and our cooler programs and that’s one of the reasons why we are able to demonstrate the same quarter on same quarter. Merchandise growth in the non-tobacco areas, we’re making these small kiosk better every year.
One of the things that we found, especially in 2007 when we started building on our own on the Murphy express locations is, what if you could take the 200 square-foot box in the several hundred feet of selling area out in front of it and put it all under one box. Will that be a better experience for the consumer, you know, especially in cold climates. We had a joke in South Arkansas about the trunk task; you know what do we sell out in front of the 208 square-foot kiosk. You know, it will be candy, and if you can put it in the trunk of your car for a month and if it doesn’t melt and it is still satisfactory, you could put it in your store. We tease about that but you know these kiosk had very limited space for candy; confectionary, salty snacks et cetera.
And so if we could build the 1200 square-foot store, put all of the merchandise in the snack alley into it and offer many-many more items that we couldn’t sell on that limited area, it will be a much better experience for our consumer, yes we are going to invest a little bit more in capital, the operating cost are going to be a little bit higher, but it is going to be much more resilient to the headwinds on tobacco. And so you can see we started with some little bit larger formats, 500 square-foot, 591 square feet, and what we actually found was, that wasn’t quite enough to make a difference. And now we have got is 1200 square-foot format that we have landed on, that we believe is the optimal format for our business. So we believe not only do we have a lot of organic, new to industry side growth in front of us, we have significant opportunities, while we continue to improve the merchandise in our existing stores.
When you look at the formats and format economics on Slide 17, this gives you a sense of how the returns stack up. And let me just say on the left the 1200 square foot format, this is 2013 performance for the 38 sites that are the most recent ones that we've built. These include sites that were built in 2012, and so the sites that were built in the last quarter of 2012, this full year 2013 performance includes the startup activities on the sites were typically you’re a little bit more aggressive in your pricing on fuel and tobacco and other promotional activity, you’re a little bit more aggressive on your labor to make sure that the site is well-staffed. And so these are not limited to sites open 12 months or longer. These were all sites built prior to January 2013. So we will have full 12 months worth of performance, but some of the performances actually what we would include start-up performance.
And the same on the right on the two elite models, these include 26 sites built between 2010 and 2012, and so it gives you a sense of the most recent ones that we built, you know versus the average returns of all the sites built prior to 2010. And I think a couple of key metrics to highlight. The average volume that we are seeing on the 1200 square-foot stores is about 315,000 gallons per site month. That compares to 234,000 gallons for the new elites we are building.
The average sales on the 1200 square-foot stores is around $175,000 per site per month versus 134,000. So you can see the added benefit of the merchandise, increased beverage sales, increased salty snacks, the ability to have a limited coffee in fountain offer in a more conducive environment to our consumer. Our site operating cost were higher, about $10,000 per month per store versus the 208. We're going to do some comparisons to the max industry average and you'll see that those costs are still very-very low relative to the industry average. The total CapEx on the 1200 is around $2 million during this period, that’s land plus the building and equipment, versus $1.6 million for the 208. So you're spending about an additional 400,000 on land building and equipment to generate the higher fuel volume because you've got typically more dispensers on those sites in the higher merchandise sales. If you look at these numbers and say how would these evolve, we would expect a fuel margin in 2014 on these same sites that we had the same market environment to be higher because you didn’t have the startup environment. While these sites ramp up very quickly on both fuel and merchandise, they do continue to ramp up higher over time and you would see the higher margins as you get out of the startup promotional period. We’ve had a lot of questions on our analyst investor calls about returns, we wanted to layout here at the bottom are the various unlevered return metrics one might calculate. One that we look at is the return on invested capital which takes the after tax cash flow divided by the total CapEx and that’s 9.4% on the 1,200 in 2013 and 10% on the 208s. If you looked at the average capital employed over that period again using the after tax cash flow that would be closer to 14.5% and 15%. If you took an EBITDA over the mid life book value you’d be looking at returns at 19% to 20%. Again these are on an unlevered basis, so in some cases we actually do have leases from third parties where you might have a least with Walmart because that’s what’s available, these returns go up when you add some degree of leverage and the form of [indiscernible].
So we believe these are very attractive unlevered returns and frankly most of the returns that you might compare these two on the outside are typically more levered returns either through leases sales lease backs and alike (Ph).
So that’s our first strategy around growth. Who we’re going to grow with? What we’re going to grow with? And why we believe that organic growth is attractive? Our second strategy is around diversifying our merchandize mix and the tact it’s there really around rolling this refined 1,200 square foot format in the new locations of the potential raise and rebuild locations. And in addition the enhancements that you make on the site with et cetera we can do a full raise and rebuild.
Mindy also mentioned some of the innovative promotions that we tested in 2013, we’ve got a full calendar in 2014 of those promotions and we’ll show the type of returns we’re getting and these are really win-wins not only for us but with our great supplier partners. And we also have a unique capability that when we leverage over 8,000 employees on staff to up sell our products our vendors tell us all the time that no one up sells in this space better than Murphy USA. And I know some of you in this room have actually gone on tours of our sites and have been up sold and you can actually see what that does. And we talk a little bit about the promotions and contest we run that allow us to deliver this quarter-on-quarter merchandize growth.
First of all, why is this important? One of the headwinds we face is in cigarette sales and if you look at the red line and I am on Page 19 now for those on the webcast, you will see that cigarette sales peaked in 2011 on an average for store month’s basis and then began to fall off. We’ve seen 4% to 5% decline in demand, we’ve seen more price compression in the last two years in the competitive environment, we’re seeing a lot of new market entrants, in our zip code alone there are now 4,000 additional stores that are selling tobacco than there were just a few years ago.
And we’re also seeing substitution initially from each cigarettes with increasingly now from vapor products. And so you are seeing cigarette sales going down, that was a major part of our business model when we started with these small kiosk. And our strategy is to continue to grow that light blue bar at the bottom which you’ve seen has grown every year from 2009 and you can go back another nine years and see how that’s growing year-on-year since then as well.
And that’s really the key, we delivered to our new 1,200 square foot store, these promotions as well as some investments we’ve made in enhanced capabilities for merchandising, workforce management, optimize the labor when we have the bigger stores as well as being able to have better real time information on margins to make decisions.
What I’d like to do now is have Tammy in the back, switch over and we’re going to show two videos, the first one I believe is our 1,200 square foot store and effectively what we did is we put a [indiscernible] on top of one of our district managers who is writing (Ph) a walk through one of our newest 1,200 square foot stores and we’ll also do the same with our 208 square foot format to try to give you a sense of what these stores look like. So if I could turn it over to the folks in the back.
[Audio Video Presentation]
And so just to be clear on our steps on moving one of our district managers who has narrated that for us the larger format stores who were close to actually the 1,200 square foot stores versus the larger boxes so everything you saw there in terms of the fountain, the coffee, some of the food items the racks of candy et cetera we’ve got it all packaged into a 1,200 square foot store. And so when I talk about being stuck in the middle we believe we can get superior returns through our lien low cost operating model at 1,200 square feet versus going all the way to a 5,000 square foot store which you wouldn’t put in front of Walmart because you would find yourself competing with Walmart and it wouldn’t be complementary with what they saw. And so what you see a lot of in the industry or 2,000 to 3,000 square foot stores that are larger so they have more capital they have more items so that’s a little bit more of the same it has more laboring cost so it’s not efficient. And it’s neither the lien model that we have more the larger box with food offer that the other winning strategies have. So we think this is the right model for us and as you can see the 1,200 is a real big improvement on the early kiosk designs.
One of the things that we’re really excited about that we tested in 2013 was some innovative promotions and they prove really successful for us and our partners. And what we had were promotions where you buy three 20 ounce beverage products and you say $0.10 per gallon and we’ve got some proprietary discount co-technology we own our point of sales system and so buying these three items would give you a unique discount code for qualifying transaction where you could then enter that at the Spencer and get $0.10 off per gallon. And what you can see on the left is simply for the 20 ounce promotional items on a average sales dollar per store month basis and the months where we ran this promotion, we grew 20 ounce items 42% when promoted this way. How did that translate to overall performance? Well, carbonated soft drinks of which those items represented for the industry has been in flat to slow growth 1.1% for the industry our growth was 4.5% and if you look at overall packaged beverage where the growth was 4.16% for the industry our overall growth was 7.5%, right. So through these innovative promotions we’re able to demonstrate same store growth in very competitive flat categories. What we’re really excited about in 2014 if you look at the logos on the right are the number of brands that are going to be participating in this program in 2014. So we’re looking to expand this into candy and salty snacks and tobacco products as well as other beverage items. So we see this is a real winner for our business.
One of the things that makes that promotion highly successful at Murphy USA besides the discount co-technology have is our differentiated capability to up sell product. We have a unique culture out in the field and we’ve got about 8,000 sales associates and they’re running contest every day, every week, every month, out of the year. And at the end of the year they got a really big reward for winning the contest. We bring all of our site managers together once a year to national managers’ meeting no other retailer of this scale in the country does that. We have a vendor expo that’s like a mini NACS exhibit so they’re able to see all of the new items, we basically bring the best of NACS to our national manager meeting so they can see what’s selling, what’s working in the field, and the top ten percent of our store managers and field force the district managers and the division managers are rewarded by winning a circle of stars and we have a event this year, it was two weeks ago in Cancun where we take them and a significant other for a long weekend and celebrate, they’re highly motivated to continue to up sell, our contest in circle of stars competition also involves cost areas like shrink and labor etc, so they are highly motivated to really execute our business model, the other thing is we do benchmarking health and safety on our sites and low cost and high safety performance can be highly correlated when we have an engaged group of people in the field and we have amongst the best, we’re consistently in the top quartile of safety performance onsite when we benchmark against our peers. Some of the example promotions listed there on the right, you know we had two candy items in a two for one promotion. We sold over 1.2 million items in a month, so 2000% sales growth, the incremental per store sales averaged 569 for the promotion month and it contributed over a quarter of a million dollars in incremental growth margin. So these are two candy SKUs (Ph), so think a pack of Skittles, on a two for one basis for one month being up sold by 8000 highly motivated people in the field at 1200 stores and you can drive a quarter of a million dollars worth of incremental gross margin dollars to the bottom line. We’re doing that every month on something and when we do the three fold promotions you can imagine that this field force has. So we’re excited about it, they get pumped up about it, it’s part of a culture that really wins and this is why we love company owned and operated sites because you can live that culture, reinforce that culture and invest in that culture day in, day out.
We’ve talked a lot about cost, you know our strategy is to sustain and cost leadership position and that means we have to have a low cost retail operating model, and we do that in a number of different ways. You know the first is with these low onsite costs with these small formats we’re able to keep our base costs low, but that’s not enough in this business, right, we’re going to have to keep up and beat inflation year on year. People ask this question, what’s your view on long run margins, field margins, our view is not that field margins are growing to rise with inflation. Our view is that there’re going to be ruthless competitors like Murphy USA out there who can hold their cost in line with inflation and you got to be prepared in this industry to survive on flat nominal field margins which therefore decline in real terms. That’s our main model when we think about costs. So we’re going to have to continue to innovate and execute to improve our cost and get out in front of inflation as Mindy said we exited the spin having stood up a number of new functions which provided line of sight on SG&A, overhead opportunities and we’ve already started attacking those and have seen improvement in those areas, so that’s part of our culture as well to stay lean. I’ll give some examples on slide 23, if you look at store level operating expenses on the left, on a average per store month basis you know you can see Murphy’s 2011 performance at 29.5000 per month, 2012 we held cost flat, 2013, we actually had a reduction in cost. What are we seeing NACS industry average. We don’t have the 2013 date, I think it’s going to be released in the next few weeks, but those costs are rising, all right. So our view is we got to keep cost flat to declining, how do we do that, on the right are some selective store level cost where we show the percent change in 2012 versus 2013, wages and benefits on the industry average went up 3.4%, we’re able to hold it at inflation at 2%. Utilities for the industry went up 3.1%, our utility cost declined 1.6%, how do we do that, we invest in tools that allow us to monitor the site electricity use, the amperage, the [indiscernible] the refrigerator, when we see a spike we know we’re about to have a refrigerator go out. We can go out there and either fix the refrigerator and get out front of maintenance or replace it, but we’re not going to sit there with a refrigerator that needs to be repaired that’s drawing additional current and driving our utility cost up, we work with local utilities to install LED lights and get rebates associated with that and in fact in many cases they’re paying for that. Repairs and maintenance, the industry repair and maintenance cost were up 4%, we held our cost to 1.4%, part of it is around things like the refrigerators and the lights, since the spin we also stood up a procurement group and we are now doing sourcing in a lot of these areas and getting more competitive in our bidding process. And we certainly see that as well in supplies where the industry went down 0.3%, where we went 1.6%. So, we have got a unique culture in the field. We have got a very frugal lean culture at the head office but it doesn’t come at the expense of important things like safety or driving sales or innovation. Those things all have to work together. We have to innovate, grow and execute to be a successful retailer. I would like to spend some time now talking about our product supply and wholesale capabilities. This is probably one area where we are different from most of our public peers in the sector. It’s an area we get a lot of questions and one-on-one calls and I think it’s worth spending a little time on it and hopefully this will help provide a deeper level of understanding for this group.
As we said we want to be able to take advantage of market volatility. We are not the marginal guy on the right hand side of the supply curve with the advantage got on the left hand side, so we don’t mind volatility. But some of the fuel chain capabilities that we have and how do us leverage those and so that’s really what we want to talk about today.
Let’s start with why is this important, we are a higher volume retailer even a 270,000 gallons per site per month, we are selling two to three to four times the volume per site as our competitors and we are doing at a lower unit margin. But I would much rather sale three to four times the volume at a $0.13 margin than a third or a quarter of the volume at $0.16, right. This generates a higher fuel gross margin dollar per site than our competitors where some of the dynamics that we faced within this category. At a macro level, gasoline demand in our view is flat, right. We are seeing real gains in vehicle efficiency, more efficient engines, hybrids, plug-in hybrids and that is largely offsetting the increase in vehicle miles travel simply by more people in the population driving.
What we saw in 2013 were real efficiencies in the vehicle fleet but we saw a sluggish economy with vehicle miles travelled didn’t keep up on that front and so we actually saw decline where we expect to see the level out around 275,000 gallons. With the customer segments we are focused on, we are focused on the price oriented value conscious customer and that segment have continue to grow year-on-year. If you buy gasoline from a supermarket or a mass merchant that customer is even more price sensitive and even more promotion sensitive. And so you have got to be low cost on fuel and so that’s one of the reasons why we have invested in capabilities in our fuel supply chain to allow us to have low fuel cost. Volatility, if you look at the wholesale spot market, it’s never this flat although in the first quarter of this year it’s more flat than it’s even been but typically you will see a rising environment usually caused by increases in the cost of crude oil, you may see it due to higher demand, you may see it due to bottlenecks in the buying product supply or the logistic system.
But when you see those rises in wholesale prices that’s a period for the retailer, the price is lagging on the way up and the margins compressed and then when the wholesale price falls and it often falls very sharply it’s a period of expanded margin and that’s the period where a retailer like us given three to four times the volume, is able to capture a large portion of our gross margin dollars and so we like that volatility and plays to our strength. And then having fuel promotions, competitive consistent promotions for our customers is important as well. If I think about our product supply and wholesale group, what is their role? Their mission is to secure low cost supply while capturing incremental value in stable and volatile markets like they do preferred mix of supply contracts in the supporting capabilities and so we are buying product bulk in the refining centers or we call that a proprietary supply. We ship it through the pipeline systems, we are one of the largest shippers on the Colonial pipeline that goes from Texas to Louisiana all the way to the New York Harbor. We have positions in other pipeline systems but we are buying it in the spot market, shipping it, blending it at our terminals but mostly through third-party terminals where we have throughput agreements and then selling it into our retail chain at that point.
And then through that blending process that’s where we capture the reign that we are able to scale back in the markets to rims, to the obligated refiners. We also buy product through our spot index contracts, where we are buying on a spot basis, but we are pulling it from hundreds of terminal supply points across the country. We also buy rack where we do shop the racks and take advantage of lower racks on days when there is deep discount.
We also just sell product in wholesale environment and we are able to do that when wholesale margins are expanded or we do that when we have an excess inventory position and we want to liquidate quickly is selling into the wholesale market over we will turn off wholesale when we are selling higher levels of retail volume. This is a non-contractual unbranded wholesale business, right? It is different from the dealer wholesale business that the branded oil companies have had or that such there in some of the other competitors that we have, where they have a capital dealer wholesale business, they are providing turns, they’re providing logistics et cetera. This is a wholesale channel that we can turn on and off.
Our goal is to secure product prices that are equivalent to the low rack price or better. And with this picture on slide 27 shows, the different markers that you see in the rack markets. If you start on the right-hand side in the green, the branded average price is where the branded retailers, the branded wholesalers are buying products. So if you are a Shell or a Chevron or a BP or an Exxon branded marketer, you are buying at the branded rack price. In return you get a recognized brand name. Some of them are more recognized than the others because of the amount of advertising and promotion dollars they put into the brand.
They get payment terms, they get jobber outlet incentives that help them finance their sites and they get credit card supported marketing. But we pay for that. And, on average, we’re paying $0.025 to $0.035 above the unbranded average price right. So who buy it at the unbranded average, so a lot of the jobber that the wholesalers out there may have some part of the business that as branded but they may have unbranded sites as well under their own brand. And you’ve seen the plethora of unique names of convenience store chains out there. They don’t have a major brand associated with them. It’s typically a independent wholesaler. And they may buy unbranded average price through a variety of types of contracts.
The low 2 is typically the second lowest unbranded price out there, a lot of the index prices are geared towards that. Often that’s a penny or two or three below the unbranded average. To get that, typically means that you have some scale, you know, with the refiner marketer that you are buying from. To set an internal benchmark of being securing supply at the low is really a challenge. And that’s where we set our internal transport price on that. So we need to think about our reporting of retail margin and then the product supply in wholesale margins, that’s the point in which we are making that demarcation.
So we don’t view the product supply team as over the separate profit center over here. But rather we set a really high boggy or benchmark for them to secure product at low cost. Now why I can’t selling out their buy on the Opus low every day. First of all there is not that much product actually sold at the Opus low every day, as usually somebody discounting barrels at the backward dated market and that they are just trying to push barrels out quickly they will sell at that price.
Now that kind of gears you a sense on the price markers out there. So, you know giving us some proof point, how do you actually secure product at lower than the local market average or even the low 2. So here is an example. We opened our site in El Dorado Arkansas, was our 1200th site in December of last year. We have a local refinery in El Dorado and for this period, in this example, the product cost was $2.51, these were products before taxes. The transportation to get it to our site would be a penny, and the lay down cost to get it to our site would be $2.52. That’s going and picking it out at the rack at the local refinery.
On Shreveport, Louisiana, there is a refinery 90 miles away, you know the product cost at the refinery gate is a penny lower, but it would cost $0.05 to transport the product there. So if there is and how that you could clearly go there and pick up the product, but you would be in disadvantage by $0.03 in doing that. You could go to Little Rock. There has been pipelines in the Little Rock. People are barging product in the Little Rock. Again the product cost is little bit lower than the refinery but the transportation cost are even higher.
What did we do? There’s a whole set of refineries called the group 3 refineries, largely in the Oklahoma area around Tulsa and the product cost in that environment was $2.33; $0.18 below the local refinery cost, like those refineries were efficient, it’s a bulk market we’re taking advantage of low cost in Texas in our medium crude, there’s a lot of Bakken crude that’s coming down into that market as well. They are running at high utilizations. They are earning high margins. They’re discounting their product to move it out.
Past this $0.12 to truck that product from Fort Smith, Arkansas to El Dorado when we land in the product $0.07 cheaper, then all of our competitor in town buying from the local refinery. Every day somewhere in our system we are doing this. In some cases, it may be pulling product out of the Denver refineries into the Pan Handle of Texas everyday somewhere we are doing this. Others can do this; they have similar capabilities in software and tools. We’re just doing this at a large scale. Right. So what I want to do is to show a little in sign and to how we’re able to do this day and day out to secure ratable low cost supply.
One of the things that we talked about in our first conference call in the third quarter with the dynamics that we face in the product supply in wholesale area and then again in the fourth quarter and the key take away for those who listen in the call was, gee each quarter has it’s unique set of dynamics in how do you response in those environment and how does your model ensure that you capture low cost supply while creating some additional advantage for the company.
And so what I wanted to do here is just kind of walk through the two environments in the third quarter of 2013. In the fourth quarter of 2014, one thing I can assure you is every quarter is going to have some unique market dynamics, the trick for us is to have fuel supply chain capabilities that allow us to have ratable secure low cost supply for our retail business. And create some additional value for the bottom line. So how do we think about the product supply in a wholesale dynamics?
You know there’s really six things that we look at, plus the refining environment. Our refining margin is high, we reported those as the cracks spread, usually that’s correlated to a high refinery utilization, we’re going to run all out when they are making a lot of money.
In the third quarter, refinery margins were high, utilization was high, we had a lot of refine product in the system in the markets they grew. We also look at the forward market, when you look at the forward market our future price is higher, flat or lower than today’s prices. In the third quarter, the market was in backwardation, meaning the future prices were much lower than today’s prices. So in that environment if you’re sitting on a lot of product you’re going to want to unwind and get out of that product sooner rather than later because you can even with the discounts you might put at the rack, be able to capture more value if you have a view that the markets in deep backwardation.
The arbitrage between the U.S. Gulf Coast and the other major refining center, whether it’s the group in Oklahoma, whether it’s the Chicago’s spot market, whether it’s the New York Harbor. It’s that arbitrage open or close meaning. Can I take Gulf Coast spot, plus all the transportation to get it up the Colonial pipeline, and if I landed in the New York harbor do I still have profit. If I do, it means that New York harbor spot prices elevated, that arbitrage is open and I am going to be highly motivated to sell it, in a district market then in a short market.
So in the third quarter, the arbitrage was mostly close, so the refiners whoever want to sell it more in the local market, versus shipping it all the way to a district market. The pipeline system is all they can constrain to the bottleneck, there were no major constraints in the pipeline systems, product was not being allocated, right. We had plenty of product, we want it to sell it locally, the pipeline systems were wide open, terminal inventory was relatively high, so you’re not out there replenishing inventory levels with this new refined product, we’re competing with it.
Okay. And then RIN, when it was $0.03 to $0.05 at the beginning of 2013 it wasn’t that important, when RIN prices are really high in this case in the third quarter in north of $1, think they feed to the $44 in July. What are the refineries looking at from their standpoint, if I take the product all the way to a terminal, blend it, sell it the wholesale market and capture the RIN myself and let it counting as my obligation, that’s a lot cheaper than selling it in the spot market and paying a $44 for the RIN. And there are some levels of optimization they will do, to determine how much do I need to discount the product at the rack to be able to move that last incremental barrel versus while alternative we’re just selling it in a wholesale bulk market around Pasadena in the Gulf Coast.
Those were the dynamics that took place in the third quarter, lots of product sold at the racks, deep discount, said the rack, and if you are rack buyer your advantage versus someone who borrow on spot, unless you are buying both proprietary spots shipping it yourself and capturing the RIN value which is what Murphy USA was doing. And when we looked at our economics versus spot versus proprietary versus other meetings it actually made sense for us in the third quarter to buy more spot barrels and capture the higher RIN value even though those transfer price based on that opus low price, reflected the discounted market.
We also were very early in including RINs and capturing RINs as part of our spot contracts. So versus some other people who are buying on spot we had some advantages in this period. What happened in Q4, a complete off a instead of dynamics, we kind of returned to more normal refining margins and lower level of utilization the forward market was more flat, the arbitrage was wide open. So refiners wanted to ship product all the way to the New York Harbor bypassing local markets. The logistics systems were tight, colonial was under allocation, maintenance and other factors meant those barrels were very, very tight. So what do we think happens to terminal inventory, it gets pulled down the buyers who are buying on the rack now have highly inflated rack prices, RIN prices are more moderate, they don’t factor in as much.
And so if you’re buying proprietary spotter on a spot index basis you’ve much more advantage versus someone buying on the rack. And in our model because 90 plus percent of our barrels were proprietary spotter spot index we had that advantage, because we had the positions on the pipeline whenever when else is under allocation we allocated a back to our wholesale barrels but we didn’t have to dial back our retail barrels and the wholesale barrels that we did sell were sold at a very strong premium because of the inflated wholesale prices.
There is going to be a story every quarter that’s going to be a little bit different and I can tell you Q1 of 2014 if we look through these dynamics just from a market standpoint it’s different than these quarters. And so I think it’s important to understand that this part of the business is going to be dynamic, it’s going to be volatile. But what is our objective, ratable, low cost, secure supply in these stable and volatile market environments that then still allow us to capture additional value to our retail business even with a very aggressive transfer price to the business.
How has that played out over time in the last couple of years and how does that translate to the bottom line? And so if you look at Slide 30 what you see here is the impact of the product supply and wholesale contribution, on the chart it’s on a dollar basis and in the table below we took that dollar contribution and divided it by the retail gallons. So then you could see what the impact is on our retail margin on a cents per gallon basis, if we included it with our retail margin. And if you look at first quarter of 2012 the gray bar is RINs, the blue bar is product supply and wholesale gross margin and the red bar is the product supply and wholesale cost that we have. The two red and blue together would be what the EBITDA would be if this was reported that way. And it was very little contribution in that market environment, right. We can go back to Q1 ‘12 dynamics and talk about why?
And in Q2 we saw the gross margin increase; in Q4 2012 we had significant product supply and wholesale gross margins. Alright we also had a very much falling wholesale price environment as well. Beginning in Q1 of 2013 you see the gray bar picking up, that’s when RIN started adding significantly to the bottom line. And then now look at Q3 in 2013 and Q4 the two examples that we talked about. Right, in Q4 that very, very difficult price environment where the racks were depressed, cause this transfer to retail to actually go negative. Now that transfer to retail we also had a very positive retail margin during that period, but even during that environment all of those things added together this proves still contributed $0.01 per gallon to the overall retail margin.
When we got to Q4 when product supply and wholesale return positive and you still had a value of the RINs even though was about half of what it was in the prior quarter. It contributed almost $0.04 to the bottom-line. And in the first two quarters of the year it contributed over $0.03. And so this is a capability within our business that it’s consistently generated one to three plus cents per gallon if you looked at it on a retail cents per gallon equivalent.
If you go to the next slide, Slide 31. I think the headline message here is that this capability one increases our competitiveness and also our resilience to the fuel margin volatility. And what we’re showing on this slide in the blue bars is the actual retail margin that we report on a cents per gallon basis going back to the first quarter of 2009. And you can see it’s pretty volatile. So one thing I would observe is that there is more volatility to the upside than there is to the downside which ultimately I think reflects some threshold to floor in terms of how low participants in the industry let margins go.
Two lines that we want to show, the first line at the top the gray bar that goes across is our fuel cash breakeven number. And so this is basically our merchandise gross margin so all the profit we get from merchandising minus all of our site operating cost, minus all of our overhead cost divided by our retail gallons and our target there is to be between $0.65 and $0.07. That’s what we call our fuel can breakeven. And you can see if you go back in time there is only one quarter the first quarter of 2009 where the actual retail margin we realized was below that cash breakeven. You can see a few other quarters where it was close to it kind of right above the line and then a number of quarters where it was well above it. This is one of the most important slides that we talked about on the road show with investors and in our calls because it really kind of underpins the story of why we want to maintain a low cash breakeven in a resilient financial position because if we added a cent of cost or we started adding $0.02 or $0.03 of leverage to this business that cash breakeven number would rise and also have more quarters below your cash breakeven.
The gray bar below that the $0.04 to $0.055 is our cash breakeven, if you included the benefit of product supply in wholesale so if you now take merchandise gross margin minus our site cost, our overhead cost and included the profit from product supply in wholesale and divided that by the gallons that improves our cash breakeven to $0.04 to $0.055 and there is not a quarter that we’ve had in the last five years where we got below our cash breakeven. So when we talk about being more exposed to fuel more engaged in the fuel category this is why we’re not distressed or disturbed it’s not one of the things that keeps Mindy or I or anyone else on our team up at night because we have a low cost position enhanced by unique capability in product supply and wholesale underpinned by resilient balance sheet.
And by the way of quick rule of thumb if you wanted to get from here to our EBITDA number if you saw the annual retail margin earned at the bottom on that table take $0.13 or 2013 you subtract $0.05 for the net cash breakeven the $0.08 met that you realized times to roughly 4 billion gallons gets you to that $300 million, $320 million EBITDA excluding ethanol. So this is our entire business kind of rove up into one chart. Imports are going, merchant diversifying that mix, the imports about keeping on our cost low, keeping our price low and ability to do that adding innovative promotions, targeting that value customer and having this unique product supply and wholesale capability. This kind of wraps it up. And we know we’re going to have years and we them about once every five to six years that look like 2009 where margins below that $0.12 to $0.13 historic average we look at we also know we’re going to have years like 2011 down to once every five to six years where we’re earning 15 cent, 16 cent margins.
I’m going to turn it back over to Mindy she is going to talk about the fifth strategy investing for the long term and importance of having a resilient financial model. But we’ll probably refer back to this as well because this is where we believe by staying resilient we can then return excess returns to grow into our shareholders.
We do have a bias to invest for the long term and that deals on our fifth reinforcing strength of having a resilient financial profile. As Andrew just outlined we do have a low cash breakeven and we want to be able to sustain that over time versus our competition. We were fortunate that we began as a standalone company with a conservative balance sheet and we will seek to maintain that to provide flexibility to fund our organic growth as well as sustaining incremental site improvements. And we want to be able to do that consistently regardless of what’s going on in the fuel environment regardless of what margins are in a particular month or quarter and through our profitable and very unique business model we do seek to return excess cash from above cycle profit that to our shareholders.
Here is a quick look at our balance sheet. Now we were required as I mentioned to takeout some debt to sign dividend to parent and we’ve already been successful of modestly de-levering it during our short tenure as a standalone company. We have high cash balances that are previously meant and retimed through operations and also through asset sales, and we do expect to our cash flow from operations combined with our cash balances to sustain our CapEx program on an ongoing basis.
Now when we went to rating agencies for our initial ratings and then went on our bond and equity road shows, we’ve highlighted several goals that we hope to achieve. One was to opportunistically de-lever the balance sheet and we have. At yearend 2013 as I mentioned before, we repaid $80 million of our $150 million term loan and I can also tell you that subsequent to yearend we have also repaid another $15 million which leave the balance today at $55 million from its original starting point of $150 million. While we run these road shows we also outlined two key metrics that we hope to achieve. One was this year than the other to achieve in the short term, I’ll start with that one and that was a target of less than 2.5 times debt to EBITDA. And today we are very below that at 1.7 times.
The second was the more difficult and that was to achieve less than 45% debt to book capital, difficult because we had to add debt, we had to fund the dividend to parent out of our equity base and then we also had to start over on retained earnings after the dispense. But due to our very strong performance in September through the end of the year along with us modestly de-levering the balance sheet, we were actually able to hit that target right at 45% at yearend well ahead of even our earn expectations been able to do so. So we’re very proud to be able to so quickly deliver on the promises that we made on our road shows.
Now if you look at the bottom in the peer metrics, our balance sheet as you can see also demonstrates away that we’re different from our peers. Looking at the group and we’re showing you EBITDA on a per site basis and for this analysis we have actually extracted the $91 million that we made in the rent from this analysis simply because we don’t need to have that income in their to look conservative because we’re conservative. You have also noticed that we have a high fee simple ownership structure within our model conversely with our peers who have more rental model. So we don’t have high lease payments in our operating model.
And if you look at the debt levels typically we’re lower than the group. And if you look at it on a net basis, net of cash, we are materially lower. And the reasons get us to our fuel focus low price low cost model, retailers typically here have taken on debt or have high lease payment typically can’t compete with Murphy USA on price, and during periods of compressed margins those companies are going to feel the payment quicker than we will. And we believe that to be able to execute on the value proposition for our customer that are fee simple model combined with our conservative financial position allows us to protect one of the main competitive advantages of that low cash breakeven.
And also because of the profitability of our model, we can still execute on our growth plans and achieve high return. This slide illustrates return on average capital employed from 2009 to 2013. I want to go over one caviar through the years 2009 through 2011 not only was Murphy USA part of a parent origination but we were also a subsidiary with embedded refining operation. And so what is depicted here is our best attempt to try to extract all the refining noise from the numbers so what you’re seeing here is a picture of MUSA’s ongoing activities as they exist today with the exception of our ethanol facility which has been removed for the purpose of this analysis.
And what it shows you here and we’re including the year 2009 here where as already mentioned margins were very low that year with the recession very challenging one for Murphy USA, but even if you include that year if you look at any three-year average, our business model is still retuning on average over 10% and some year three-year period markedly higher than that. And that brings us to shareholder priorities and we do have several, the several things that we think about. The first probably being resilient, we want to be resilient as a standalone company. We want to be built so last for the long-term and sustain our competitive advantage of the low cash breakeven. We also want to have the financial flexibility to support our seasonal capital requirement and weather inherently volatile fuel margin environment.
And to-date we have already weathered the traditionally challenging first quarter of the year. Now day today where we’re in our company lifecycle one of our other priorities is growth and we like organic growth. And so we want to be able to invest in that growth and also invest in the consistent manger regardless of what fuel margins are doing rather than sits and starts we want to be able to invest in our business ratably.
We also want retain the financial flexibility to support and accelerate at level of growth as an opportunity presents itself when we feel it’s prudent to do it. And then again we want to opportunistically look to de-lever the balance sheet when we can and we truly believe that by executing on all those things by showing resilience, by expanding our growth and deleveraging, that puts us in a position even as a very young seven months old company to being to have much steeper discussions on how to return capital back to shareholders, and those are conversations I assure you our Board of Directors has been having since their formation.
And with that I’ll turn it back to Andrew for the wrap up.
Thanks Mindy. Our final slide today, Slide 38 just articulates some of our key goals for 2014, the guidance we gave, and our last earnings call tends to fall in line with some of the numbers on this page. And what I hope this discussion has done, it has provided a context not only for why our strategy makes sense for us and how we play and how we compete and look to win with Walmart in this competitive industry but also how some of the tactics and initiatives that we have fit within that and how these five strategies work together as a coherent overall strategy.
So in terms of growth we’re looking this year to build 50 to 70 sites at target returns are better, we look to sustain our year-on-year fuel performance leveraging the Walmart fuel discount program, we want to supplement new site growth by starting a raise and rebuild program which we’re identifying sites and have budget set aside for this year’s capital plan. And we want to maintain a pipeline of Murphy Express locations near Walmart to accelerate coverage especially on locations where Walmart may not have a site to offer, so we can continue to deliver value to that shared customer.
In terms of diversifying our merchandize mix continue to roll out and refine our larger 1,200 square foot format, continued to deliver our year-on-year improvements in non-cigarette merchandize growth. And then launch a full year of these innovative promotions that we talked about with our supplier partners. In terms of cost leadership and sustaining that position we aim to beat inflation on our site operating cost, we want to continue to capture quick wins that we’ve identified from some of the early SG&A opportunities. And then get into a deeper review of how to better scale our overhead structure through enhanced systems, processes, work flows et cetera to make our business more scalable with the growth.
In terms of our product supply and wholesale capabilities continue to generate $40 million to $60 million in contribution from that group leverage those opportunities in our supply contracts to take advantage of RINs while they last. And then continue to divest an encore asset, we believe that the process we ran internally to maximize value at Hankinson generated a lot of value for shareholders, we’re in a position to be able to start those same type of discussions around the Hereford asset as well in 2014.
And then invest for the long-term, so we’re going to be able to fully fund their capital expenditures through our operating cash balances, through earnings and existing balances continue to pay off the balance on the term loan as Mindy said we’ve already elected opportunistically in this first quarter of the year to pay down another $15 million. And then we have been as Mindy said actively engaged with the Board since before the spin when they were formed in August to discuss our shareholder priorities in getting sort of this fourth quarter and first quarter under belt, demonstrate resilience, demonstrate ability to de-lever the balance sheet and meet those important commitments we made to our investors and the rating agencies and now find ourselves in a position to have more active and tangible discussions on those fronts.
So with that we would like to turn it over to Q&A, Mindy and -- excuse me Tammy and Donny will have some microphones in the room. I think for the benefit of those on the webcast if you could say your name and the company that you are with. On the webcast I believe you have the opportunity to email questions to Tammy and she’ll be able to do that. I believe we’re going to run this to 11:30 and which time we will time we will take a break and get prepared for lunch. We will turn off the webcast at that time, but we hope to continue the Q&A dialog and discussion over lunch with those that have joined us in person.
Esteban Gomez - JP Morgan
Good morning, Esteban Gomez of JP Morgan. You have $300 million in cash on the balance sheet. Can you just maybe speak about some of the restrictions in place near term on use of that cash? And then once listed if you could maybe just go in to specifics of what you feel is the best use going through the different kind of opportunities you led out earlier? Thank you.
Sure. Mindy, you want to start with the restructuring?
Sure, I will start with that. And we did tax recently with our parents so obviously within that two year window we don’t want to do anything that might jeopardize the tax later ruling and so really what that prohibits is share repurchases in excess of 20% of your outstanding shares. And so you are able to provide that modest levels of shares to present dilution and so forth where appropriate, so while that requirement is restrictive, we don’t feel that it’s terribly restrictive for us. The other things that we have are in conjunction with our debt agreement, with our credit agreement and indenture agreement, outline various things that we are able to do and then restrict us from things that we are not able to do. And so going to our indenture first, we are able to make what’s called restrictive payment of dividends or share repurchases. If our leverage is less than 2.5 times EBITDA and as I showed you earlier we are well below that. If in fact we were not then we have another ability to pay by using a 50% consolidated net income grower basket and grower in the sense that if you don’t use it then in one year it carried forward. So to the extent that we were more levered than required under the 2.5 times coverage, we would be able to tap into that basket in order to fund shareholder payment.
The other restrictions that we have are the ones contained within our credit agreement and our term loan. So, we negotiated earlier this year our original unrestricted basket meaning we have a freebee of $10 million a year to do these kinds of payments. We amended that earlier in the year to increase the size of that basket to $25 million per year and that allows us to find any combination of dividend or share repurchases from that basket without having to meet any other covenants. Now in order to do something in addition to the $25 million, we have to meet a couple of covenants, one of which are availability under our ABL facility has to be greater than 25% and since our ABL is undrawn we easily meet that target. But the other one is to achieve a fixed charge coverage ratio of 1 to 1 and I said you on at the end of the year we were 1.18.
However due to the fact that we are in a grow phase as a company, we expect our CapEx to be around $200 million this year. It really makes it difficult to achieve a 1 to 1 metric if you talk about doing any kind of share repurchases, dividend of site because that payment actually have to be included in your pro forma ratio and so if we did that that would take, in fact if we use our $25 million basket in its entirety, it would take us from a 1.18 down to 1 to 1 at that point. So, we will be restricted from doing anything further than that unless we work to restructure our credit agreement as per wavier or just restructure the covenant altogether.
So, I think that’s probably most of the first part of the question. So the second part in terms of priorities, clearly as Mindy defined with the unrestricted basket, we are at a point where we can do a nominal dividend, we can do nominal share repurchases. And I think philosophy we talked about getting out in front and inflation and beating inflation. We have a same kind of lean philosophy that relates to dilution, right. We are going to get out in front of dilution and look to do that. With the term loan now $55 million in some of the restrictions, you have got this tension of okay, you are sitting on a lot of cash but you are sitting on a unused ABL and so at the time the term loan is paid off which we could do, you are at a point where you could then have discussions to reduce the restrictive nature of some of the other covenants. The priorities I think resilience is less of a concern. We have kind of gotten through those first two tough quarters and our first six months as a new company.
Growth, we said at the beginning of 2013, we made a large down payment to Walmart for 50% of the land. We thought the next tranche of sites was going to be largely pretty simple and there was going to large down payments. We might want to have some dry powder for that. The flip side of that is that the carve outs take more time and so if there is more emphasis on speed, might do something that didn’t involve big down payment. So, as we work through a number of considerations, I think we are at a point then the term loan paid down, those growth considerations in hand to be able to really start thinking about okay, what would we do with larger distributions. And so I think it’s frankly high class problem, opportunity to have for shareholders, I think we continue to grow with the rate we are growing and be able to fund 5% to 6% organic growth out of free cash flow and cash balances because balances are only going to get bigger. And so I think that’s going to create ongoing opportunities to return value to our shareholders.
And we very focused on that which is why we call it out in this strategy.
Edwin Johnston - Sandhill Capital Partner
Andrew, this is for you, Edwin Johnston, Sandhill Capital Partners. Could you keep fuel margins at $0.12 to $0.13 a gallon over time or put it a different way to your slide, to keep the cash breakeven at $0.040 to $0.045 if RINs go away?
So the $0.12 to $0.13 kind of average margin, I think that’s independent of RINs. That kind of the retail fuel margins, we calculated. That $0.12 lower figure includes the year like 2009. And so you know that’s going to be any three to four year average, I feel pretty comfortable, will be in that $0.12 to $0.13, you discovered realizing you are going to have a 2009 and in 2011, from time to time. You know the cash breakeven of $0.065 to $0.07 without top supply in wholesale, you know all of our tactics and strategies are aligned to do that. Getting it down that $0.040 to $0.055, I mean RINs does make up a part of that. If you look at the slide 30, and you see how much RINs contributes to that. You know, can you get it down to $0.050 to $0.055, absolutely. But let’s don’t get ourselves 90 million in RINs last year, it was a large number, $0.40 to $0.50 in RINs. This year, to date, in terms of what the market has been paying, it’s a large number. I will also say that if you look at Q3 2013, some of that wind value, obviously, was put on the rack, in terms of pricing to pull that down. So I suspect RINs are probably a little over stated in the product supply and wholesale piece is probably a little bit understated. Begetting the $0.04 kind of without RINs, that would be stretch.
Edwin Johnston - Sandhill Capital Partner
And just a quick follow up. Your outlook on RINs, it’s tough to predict, you’ve got regulatory issue, so on and so forth and market forces have worked. Any comments on how that plays out over the next six to eighteen months, if possible?
I wish I could predict the future. We’ve got the government policy, I think many people around the edges will say some element, or does it make sense, in its creation. So the issue is what’s the right level of mandate you’ve got? You know, election period coming up and we’re going to see inertia in this space. So we are going to see some action or not. I wish I could tell you. I think the most important think we said just at the beginning is, our business model does not require that to be profitable, or actively extend our business model captures that advantage and we can deploy that advantage to the benefit of our core business, through low-cost secure supply to retail and then demonstrate as we’ve done by giving that money back to shareholders. And in this case using it to delever the balance sheet, you know, to the extent we continue to have that advantage and that leads to excess returns. We are going to invest it in growth, or we are going to give it back to shareholders. We’re not going to get sloppy in our core business.
Damian Witkowski - Gabelli & Company
Can I just get a sense of how you actually in a year the low cost guy on the block. Can you define what the block is.? Is it a mile radius - 3 mile radius and how do you actually price your gasoline on daily basis? Is it $0.02 versus the nearest competitor?
Sure. The answer to the first question, it depends. So it’s totally easy to talk about the market you see every day over right over Arkansas, it’s the entire El Dorado community, like there is 13 gas stations, and more there that we will look at. What you’re able to quickly do is to identify a couple of key players in the market. There’s one player that might be more motivated to lead restorations, you know, when the price goes up. And that there’s another competitor that is going to lag or may also be a low priced player and you know every market is different. May be a function of your level of volume in that market, and it might be a function of the number of more advanced competitors in the market. If it’s also in one grocery store in a local market, it looks a lot different in a city like Dallas or Atlanta where you got quick trips and race tracks and you got grocery stores of multiple brands and discount clubs, you know selling gas. And so that definition changes quite a bit. If you’re in interstate, you know it might be the exit 5 miles down the road that’s your key competitor to lock in at, which I think leads to the next question of how do you do it? So we do price servings every day. Site managers do them every day, three times a day. District managers are doing that. We have third party data that we use to corroborate that information. And so we know which competitors to pick out. We understand when the moves are being made. I get a report every day. I could hand it at the site level, the state level, the region level. That shows the market moves and sort of taking place all response; today’s margins, tomorrow’s margins, volume and so forth. As a low-priced retailer you want to be the low price in your market area or I think so not about the low price or within a penny of a low price you want to be the low price. There is some markets in competitive dynamics where we can get a penny or two below the next lowest guy consistently. You get that your space you earn it you keep it. They’ve maximized their profit separate there may be other markets where you’re going to be matching the other low player. The one exception that we always talk about which is different that we don’t try to seek to get below is Costco their club membership, they’re targeting a different consumer segment than the typical Walmart super center at the cost clubs they’re not as dense as our other competitors. And so if you say one competitor that gets below you and you let them we would say its Costco serving that different segment. Damian tell me if I answered it.
Damian Witkowski - Gabelli & Company
That’s fine. And if I could just follow up, what do you see on Bloomberg the [indiscernible] attracts RIN prices is that a good way to think about where you can realize in the marketplace on average during the quarter?
The Bloomberg RIN prices?
Damian Witkowski - Gabelli & Company
Yes, the RIN renewable energy prices there on Bloomberg that’s in index trades daily?
Yes, I would think so on the average you’re not going to be fall from that or timing of when we sell them during the ways we’re selling them pretty ratably over a larger period of time how that actually translates to week to week, day to day you could see some variations there but you’re not going to be too far off there.
Damian Witkowski - Gabelli & Company
And then just lastly on any reason why in your example the 208 square foot versus 1,200 square feet the cents per gallon earned were lower at the 1,200 square feet well that just…?
It’s a small number, so both of those included $0.0121 versus the $0.0126 it’s small numbers within that so 26 sites versus 38 sites I mean when you look across tie if you got more sites in one group that were built in 2012 that had more start up economics if you had more sites competing against a certain type of competitor you have some within more within some region versus another so that’s kind of within a half of cents so I wouldn’t take anything from that. So the question in the back I think first. We got a mic here so you trump with hanging.
Kevin Dreyer - GAMCO Investors, Inc
Thanks. Kevin Dreyer with GAMCO. When you do the 10 cent per gallon promotion with Walmart how does that work? Who pays for that?
We don’t get into details about that but I would say it’s jointly funded between us and the partners that are part of that and we optimize our contribution based on the expected uplift the shift in card mix et cetera but it’s designed to be a win-win across the various parties.
Kevin Dreyer - GAMCO Investors, Inc
Okay. And also when I look at these various maps of potential places you can go near Walmart especially when it’s across the street sort of on what presumably people going to Walmart and those locations already get a gas somewhere whether it’s also across the street down the street et cetera. Can you describe the landscape for new stores in terms of places where what’s the competitive landscape going to be as you move on?
Sure. And again it varies all over the map. So there may be a new super center that’s gone up and Walmart will go ahead and buy an acre or two acre plot of land with that and they will dedicate it for gas and that might be one in the sites and the last Walmart 200, all right. And the developer around that site may have already filled up other sites with AAA or Starbucks or whatever that’s going to go there that’s all the nearest gas station maybe a mile down the road or block away. There are other locations we just picked up one Murphy Express site near super center it’s near exit and there is a successful high volume retailer at the interstate exit one down the road one of our larger highest volume stores and one of the metropolitan areas there is a high volume retailer that’s opened up at the exit one down and the exit in the other direction.
And so just depending on land availability whether it’s more urban or rural we’ll determine that environment no bones (Ph) about it, it’s a very competitive environment and we talked about those three models at least two of those models are still doing organic growth the successful big box stores with successful proven food service models and the mass merchant grocers that have gas associated with them.
Kevin Dreyer - GAMCO Investors, Inc
Thanks. And then just one final question in terms of your use of cash flow sounds like you’re talking about basically store growth and then after that return of capital. But you also mentioned that it is to an extent a consolidated or potentially consolidating industry. Would you even consider acquisitions especially would you ever consider them outside your current partnership with Walmart strategy?
Sure. I have learned to say never say never -- when I left Alvarado 30 years ago I’ve never said I’ll never move back to my hometown and win a Fortune 150 company and here I’m and so I think our advisors on the streets say never say never to M&A because you just don’t know, right. I think one of the reasons we showed the additional Supercenters in core markets and other markets was not to get out in front out headlights anyways but just to paint a picture of the universe, there is a lot of locations out there where we have the opportunity to partner with Walmart and continue to grow organically and have an offer than creates a lot of value to that Walmart customer that we share, as I said before 99% of our customers are Walmart’s customers.
And so if we can get those kind of returns even though I’d say average, we’ll have some winners and losers and some average sites within that, that portfolio of 200 sites that we’ve got on average is going to us a good return. How would we think about M&A consolidation acquisitions? Well, if we go back to framework we started with that says look there is three models that scaled you’d have to change your view on either your opportunity with the model you’re in or your view of the economics within that. So if we’ve reached a point where what we’ve just run out of opportunities to growth with Walmart, you’re going to have to step back and tell you what is the growth look like after that, right. We can still do sites like our Murphy Express site, but now you’ve got two other models of scale.
We don’t have a proven fuel service model, right. It’s taking some of our peers companies many-many years to build and develop, they made older model or the central commissaries that you see and they made the stock orders where people colonized local markets where more ruled and urban, so we don’t have centralized commissaries. So if we started to look that’s a path for future growth, it might make sense to acquire to get that capability versus go through the long mile of building it. There consolidates are out there that have over 10,000 sites, right. They have a business model like franchise or something they add to that site that creates some value to that site and add some level of differentiations or some level of synergy.
We would have to have that to be able to outbid them otherwise they should be able to pay a premium above what we could pay because they can add more to that site. So we would have to have capabilities to be successful in that, consolidate them all. They’re going to say, “Hey, we’re going to out by 10 sites.” It’s a lot different to say I’m going to buy the Hess (Ph) network versus having them spin-off and believe we can add value above what they would get from spinning off or someone like a Couche-Tard acquiring them. So I think we’re very focused on capabilities we’re good at. We’re very well into a strategy that’s very coherent and that’s one of the winning strategies of scale and just with the partner that we have been doing this with for a long-time. So our focus is on that line aside growth with them, doing things in a strategic and complementary way for that shared customer. Down the road, there is always that possibility but we’re not focused on that.
Ron Bookbinder - Benchmark Company
When you do these promotions either the three for one on package goods or the $0.10 with Walmart, what sort of gallon comp kick do you experience and do you see any stickiness with those customers that you bring in?
Sure, great question. On the beverage promotions, one of the things that we have observed is our average fill up level per balance fill up increases. And when we roll off, say the Coke promotion and go onto the Pepsi promotion, there may be some Coke users that want to know why we now the Pepsi or Monster, Dr Pepper or whatever so there is a little bit of stickiness there and because people are asking for can I get that deal or not, but I think all the promotions we’ve had worked. The real benefit on those three for promotions is the higher level of sales of those other items more so than a material kick in the gasoline, and we’ve looked at there has been kind of so much noise in the 2013 data with the Walmart program in the summer versus the winter the year before there kind of consumer demand to be able to pull that out.
We do see improvement in the when we have the $0.10 discount program running with Walmart, we haven’t disclosed that number. One of the important things we see though is a just a shift in the card mix as well and there is a halo effect there when that promotion ends, and when we pull the signs down and so forth, there is a lot of consumers that ask, is it still going on and I think in the longer run having a consistent competitive low cost consistent with everyday low price well communicated to the customer promotion would add a lot of value to that consumer because they would like to have it every day and certainly those consumers that are most price sensitive those promotions and also buying new groceries with other places that offer consistent competitive promotions, so it’s part of that changing landscape.
Ron Bookbinder - Benchmark Company
Ron Bookbinder - Benchmark Company
Well, with your low cost model have you ever thought of a, or do you consider ever lowering prices even further to drive greater volume to drive that leverage of SG&A and whole productivity circle or do you go, do you try and maintain margins and what is your preferred operating margin.
Right, that’s probably a question in this, for the sake of time we should answer over lunch because it’s not a simple question. We seek to be very competitive, with that low price position and in some ways volume and margin become an outcome of that, right, and so if we thought we could get another penny or two lower in the market relative to the competitors and that optimized growth margin dollars and had a more competitive break even, that would be the optimal place to price, you know there’re other markets we’re trying to get a penny or two below another advantage for that competitor within a mile, is kind of sense to us, because they’re going to match you, they got a consistent strategy and you’d be giving away a lot of growth margin in that case but there’s always exceptions to that because you might create a price environment where you’re getting people to drive in from even further away. That could create the volume that support that, but we have a real good sense of what elasticity is at the bottom of the market, what that extra penny does, not only going down further but the risk of letting it drift up and so there isn’t a ‘target margin’, it’s really site by site competitive situation by competitive situation.
Tammy I think you said we have one more in the box and that’s it.
Ryan Burtell - Ventura Capital
Yes, it’s Ryan Burtell from Ventura Capital Partners and I just wanted to touch on the real estate value and the fact that you guys own 90% of your real estate which is unique and I think it clearly helps you guys maintain your low cost advantage but it’s also very clear that that’s not being adequately valued by the market and if you just kind of look at how tight the real estate market is right now, you’re talking 7% cap rates versus you guys trading at 7 times EBITDA, so there’s clearly a very big value discrepancy there and if you walk through any if the math, really the value of the real estate doesn’t even matter, if it’s 1.2 to 1.6 billion and then you assume a 7% cap rate, you’re trading it effectively 3.5 times EBITDA. So how do you think about unlocking some of that value, whether it be, you guys are under levered could you potentially finance some of your new properties in the future with some sort of real estate debt or could do a sale lease back for a portion of your facilities or even spin it off to a REIT, how do think about those different options over the medium term.
Sure, and it’s a great question, we talked about it with our board, we talked about it with our advisors and I would say I’d like to take it up at a higher level which is how do we get more overall leverage out of our balance sheet and find way to return excess profits to our shareholders. The thing that’s most concerning about taking all of that real estate and getting it off balance sheet and doing you know a REIT or something like that is over time it will undermine our strategy. Now we go from something that’s not subject to inflation, having built in escalators and the like in there, if you remember our third goal under that tenet of sort of sustained cost leadership we will lose cost leadership over time with that and that will undermine the value proposition to the consumer and will ultimately undermine in a difficult margin environment our price position, and there’s plenty of REITable assets out there in companies where we’re not doing REITs, there’s not very many companies that have sort of ultra low price value propositions that have that kind of form of escalation over time. If you think about in the future, if you had a model that had more leases versus fee simple and you did it on something that didn’t have those kind of escalators built in you could get more leverage out of your balance sheet, the handful of large format sites that we do, year on year, you could sale lease backs on those, could our business model take on more debt, you know over time, I mean if we continue to grow earnings right with these new sites we could certainly afford it and keep Mindy’s ratios intact, I think the key is, kind of once we get through sort of the term loan and some restrictions you know what’s the best way to leverage this model to give back to shareholders and it could be through you know share purchases and other programs versus just doing the REIT ending up with a lot of cash that you don’t need necessarily for growth because you can do without a free cash flow and then all of a sudden how you subjected this strategy that’s meant to be very coherent and fundamentally meant to support our partner in delivering a low price value proposition. We’d rather not do anything that would undermine that, we’d like to find a way to leverage our balance sheet that can do that and generate significant returns for our shareholders and that’s our ultimate goal here, right.
Well thank you very much to those on the webcast we appreciate you joining in and I’m sure that you’ll have follow up questions as always reach out to Tammy Taylor and we can set up some calls, and we’ll conclude the webcast and for those here in the room we really thank you, we look forward to continuing the discussion over lunch and hope all of you can stay for that, so thank you very much.
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