SUPERVALU's (SVU) CEO Mark Gross on Q4 2016 Results - Earnings Call Transcript

| About: SUPERVALU Inc. (SVU)

SUPERVALU Inc. (NYSE:SVU)

Q4 2016 Earnings Conference Call

April 26, 2016 10:00 AM ET

Executives

Steve Bloomquist – Director-Investor Relations

Mark Gross – President and Chief Executive Officer

Eric Claus – Chief Executive Officer-Save-A-Lot

Bruce Besanko – Director-Investor Relations

Analysts

Chuck Cerankosky – Northcoast Research

Ajay Jain – Pivotal Research Group

Stephen Grambling – Goldman Sachs

Mike Otway – Wolfe Research

Rupesh Parikh – Oppenheimer

Bryan Hunt – Wells Fargo

Bill Kirk – RBC Capital Markets

Edward Kelly – Credit Suisse

Operator

Good morning. My name is Ginger and I will be your conference operator today. At this time, I’d like to welcome everyone to the SUPERVALU’s Fourth Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]

Thank you. Mr. Steve Bloomquist, you may begin your conference.

Steve Bloomquist

Thank you, and good morning, everyone. I want to welcome everyone to SUPERVALU’s fourth quarter fiscal 2016 earnings conference call. Joining me today are Mark Gross, SUPERVALU’s President and Chief Executive Officer; Bruce Besanko, Executive Vice President, Chief Operating Officer and Chief Financial Officer; and Eric Claus, Chief Executive Office of Save-A-Lot. Following prepared remarks, we will open up the call for your questions, so that we can accommodate as many people as possible, I would ask that you limit yourself to one question with one follow-up.

The information presented and discussed today includes forward-looking statements, which are made under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. The risks and uncertainties related to such statements are detailed in our most recent 10-K filing. In addition, certain information presented and discussed today constitutes non-GAAP financial measures. Information required to be disclosed about these measures is included in our earnings release issued earlier today. A replay of today’s call will be available on our corporate website at www.supervalu.com.

With that, let me turn the call over to Mark.

Mark Gross

Thanks, Steve, and welcome everyone to our fourth quarter conference call. Let me begin by saying how thrilled I am to have been chosen to lead SUPERVALU. I’ve admired this company for years, and I’m excited to build on the foundation that’s been set over the past couple of years. My nearly 20-year track record in the wholesale grocery industry is one of creating growth. And we have the assets, people and infrastructure to achieve that here at SUPERVALU.

I’ve been on the job for about two months, during which I’ve spent a good part of my time visiting our operations, meeting employees across the organization and getting to know some of our customers. Several things have become quite apparent to me about our business, and it helped shape my long-term vision of SUPERVALU, which is to be the leading distributor of consumable products and provider of services to retailers, including our own retail banners in the United States. This overarching strategy will help guide our decision-making, allocation of resources and business unit strategies.

Let me provide some details, starting with our wholesale business, which was previously called independent business. As we announced last week, we renamed this business segment wholesale, because that’s our primary function to distribute consumable products to retail stores for final sale. The change was made to highlight and emphasize wholesale as our core business. As a wholesaler, I believe our distribution assets and network designed to most efficiently distribute products to independent retailers are second to none. Further, I believe we can leverage this network in ways that moves us closer to realizing my vision for the company and enabling SUPERVALU to become the supplier of choice for distribution of consumable products.

In addition to a great logistics network, this company has a private brand portfolio that I believe is a true differentiator. The enthusiastic responses I have received when talking with customers about essential everyday are great, and Wild Harvest elicits even more positive feedback. If you’re not familiar with Essential Everyday, this is our national brand equivalent, where we’re making high-quality food affordable. Wild Harvest is our top-notch free from and organic brand. I believe it is superior to anything the competition provides, and we need to show the market where the team has taken this brand.

Third, I’m impressed by the great job we do in providing crucial back office and technical services to one of the largest food retailers in the country. There’s been a fair amount of discussion about the TSA with Albertsons and its wind down, but that misses half of the story. As said slightly differently, we are the back office and technical service provider for one of the country’s fastest growing retailers, and other operators should take advantage of our highly scalable infrastructure.

I therefore concluded that we have opportunities with other retailers to leverage our capacity and service offerings to reduce their costs, bring them a more sophisticated set of operating tools, improve their competitive position, and help them become more successful, which is a great strategic complement to our core wholesale business.

Another of SUPERVALU strength is the depth and vitality of our great customer base. A paramount to our success is a group of innovative and creative independent retailers who operate some of this country’s finest food stores. They understand their customers, they operate well-merchandised stores. There truly are too many great customers and areas of operational excellence to mention by name, but our industry publications are often summarizing what SUPERVALU customers are doing in each major category. I’m proud of these customers and without them we wouldn’t be the company we are today.

A key element of bringing my vision close to reality is a greater level of growth and acquisition activity. To that end, we recently announced the appointment of Jim Weidenheimer as Executive Vice President of Corporate Development and Chief Innovation Officer. Jim will be tasked with executing our market opportunities and improving our existing operations. I’ve worked with Jim in the past, I’m confident of what he will bring to this company, and I’m excited to have him part of the SUPERVALU team. Also, as we reassessed our management structure after my arrival in conjunction with hiring Jim, I decided it make sense for Bruce to retain many of the operational functions he’s taken on, and also resume his prior CFO responsibilities. I look forward to working with him in those capacities.

Moving to Save-A-Lot, I am thrilled, absolutely thrilled to have Eric Claus leading that operation. I’ve known Eric for well over a decade and know him to be one of the most creative merchants in the business. Eric and his team, since his arrival five months ago, have been focused on ways to make Save-A-Lot even better. We’re very encouraged by the early results of his work. Eric will walk you through some of his thinking shortly.

Finally, is our retail business, which today is a good complement to our wholesale business. The team has made good progress over the past several years on improving the basics, cleaning up the stores, working on improving the offering and striving for improved pricing. In addition to generating considerable profits, our retail banners continue to act as a good platform to introduce new products, methods and technologies that in addition to improving the retail customers experience help our other business units. We’ll continue to invest in our retail banners and further the rollout of digital capabilities. So, we’re engaging with our customers in ways that are meaningful and think with how they live their lives. My goal is to ensure our retail stores are relevant to the communities we serve. And again, we would then roll these capabilities from our retail banners to our wholesale customers.

We continue to work on the potential separation of Save-A-Lot and expect to file an amended to the Form-10 within the next several weeks that will contain updated carve out financial information through our fourth quarter. In that amended Form-10, we could provide for a potential modification to the structure such that SUPERVALU’s retained stake in Save-A-Lot would fall in the range of approximately 19% up to approximately 40%. The potentially greater retained interest would provide greater financial flexibility in the future when SUPERVALU chooses to monetize that retained interest, which may be used to delever and grow the company.

We continue to monitor the markets and analyze the pro forma financials for both SUPERVALU and Save-A-Lot as we planned for the best alternative that creates the greatest value for shareholders and the appropriate capital structure for Save-A-Lot as a standalone public company. We currently believe that we’ve capitalized Save-A-Lot with $400 million to $500 million of long-term debt. The net proceeds of which we’d expect to be used to pay down SUPERVALU’s term loan and would also expect to create a new revolving ABL credit facility at Save-A-Lot with an estimated borrowing base of approximately $200 million.

Based on current estimates and our fiscal 2016 segment adjusted EBITDA results released this morning and giving consideration to approximately $75 million to $150 million in aggregate fees, expenses and taxes we expect to pay, as well as the potential TSA economics, on a post spin basis, we’d expect SUPERVALU to have a pro forma leverage ratio in the range of 3.8 times to 4.2 times. This is calculated by dividing total outstanding debt, including capital leases by adjusted EBITDA. The biggest differences in the range of upfront cash requirements relates to the potential factors that could be owed under the alternative where we retain a greater interest in Save-A-Lot, and to a much lesser extent the range of estimated fees and expenses.

Finally, I’d like to briefly comment on the results for the quarter. As you saw this morning’s press release, we reported fourth quarter sales of $3.9 billion, a decline of approximately 3.1% compared to last year’s fourth quarter when adjusted for the extra week in fiscal 2015. Adjusted EBITDA was $177 million and adjusted earnings per share from continuing operation was $0.23, including an approximate $0.05 benefit on the income tax line. Overall, the quarter proved somewhat more challenging than anticipated when the company last gave its outlook on the Q3 call.

Eric will provide some color on Save-A-Lot’s results and their planned initiatives followed by Bruce, who will do the same for wholesale and retail in addition to our financial position. Our team has established key areas of focus for the coming fiscal year. We’ve already begun executing on some of the initiative to drive improvement in our top line and bottom line. Eric?

Eric Claus

Thanks, Mark, and good morning, everyone. It’s a pleasure for me to join today’s call especially in light of it being Mark’s first call as SUPERVALU CEO. With Mark having provided an update on the potential spin, let me address Save-A-Lot’s results and the initiatives our team is working on.

Fourth quarter Network ID sales of Save-A-Lot were negative 2.2%, although still negative this was 120 basis point sequential improvement from the third quarter and was driven by 280 basis points sequential improvement in licensee wholesale ID sales. Deflation remained a headwind particularly in the wholesale side of the business, but lessened somewhat to 5%. This is higher than many of our food retailing and distribution peers due to Save-A-Lot’s higher mix of commodity items such as beef, chicken and eggs. Identical store sales for our corporate stores were negative 1.3% as Q4 customer counts were down 20 basis points, and an average basket declined by 110 basis points. Adjusted EBITDA was $42 million, $19 million lower than last year when adjusted for the extra week and driven by both gross margin and SG&A.

On the margin side, year-over-year gross margin rate was down principally due to the impact of deflation and an increase in advertising spend. On the SG&A side, expense was higher due to a larger mix of corporate stores as well as a pre-opening costs associated with the 20 plus stores we opened in the quarter. Looking forward, the entire Save-A-Lot team is very top and bottom line focused. We’re operating with a high sense of urgency and focused on executing new sales and margin driving initiatives developed with input from a licensee advisory group.

Let me share some of these initiatives with you. First, advertising, we’ve introduced the new ad strategy with changes made to content, cadence, and timing. The new weekly ads are intended to make a much stronger price impression on our customers while emphasizing our differentiating fresh departments. Other more subtle ad changes were designed to encourage shoppers to increase the number of units they purchase on each trip, thus increasing basket size. Second, our stores, we’ve taken a hard look at maximizing our sales productivity.

We’ve completed a full review of all categories and plan to expand growing higher margin categories, while shrinking declining lower margin ones. We will soon embark on an important reset to our stores designed to make it more relevant to our existing customer base as well as to new customers. Each major category will be refreshed and will include the introduction of one to two nationally branded must have items.

As part of this process and to reinforce our strong belief in private-label products, we’ll be launching a major private brand revamp that will be executed in three phases over the next 18 months. Part of this will be the introduction of a new private-label brand that over time will span across a number of our product categories. Our goal will be to create greater brand recognition and loyalty with a single name across much of the store as opposed to individual brand names across categories. I believe the forthcoming changes to our private label assortment and the introduction of select national brands will be well received by our current customers while also attracting and retaining new customers.

These resets are planned to be finished by this coming October and will include both license and corporate stores. We’ve piloted these changes in a limited number of corporate stores beginning in March, and are encouraged by the initial results. We’re also focused on a better, more compelling in-store experience and will be introducing an improved layout that includes a modest amount of new product – produce and bakery fixtures. In addition, the complete store is planned to be enhanced with the new impactful price messaging and sign package.

Lastly, we plan to dedicate a specific special buy and treasure hunt space in all stores. Products offered in this area will include special buy and spot buys, end of lines, packaging changes and other offerings where we can offer even greater values on items for a limited time. This sense of buy now or miss the deal is expected to drive increased items for basket as customers act on deals that may not be available the next time they visit the store.

The majority of our corporate stores are planned to receive the full reset this year including the new fixtures, while a lesser amount are planned to get only the category and item changes. We believe that most license stores will also execute many of these changes this fiscal year as the new model financials appear to be compelling. With these retrofits and refreshes, we’re planning to focus more on our existing store base in fiscal 2017 in an effort to increase the sales performance of our existing units.

However, we will also continue to expand our store footprint and expect to open on a gross basis approximately 75 new stores over the course of this fiscal year.

Before I turn the call over to Bruce, I want to briefly mention that we’ve moved our annual licensee symposium forward from its normal fall time period to early May, in order to introduce these new initiatives in a timely manner. It is a great deal of excitement about these changes, which is reflected in the record number of licensees expected to attend next month symposium.

I’m thrilled to say that over 80% of all licensed stores are planned to be represented at the event. Let me end by saying that these are exciting times at Save-A-Lot, and I’m proud of the great work that’s already been accomplished, since I joined in December. Stay tuned for next quarter’s update, as we aspire to become America’s choice in the hard-discount space.

Now let me turn the call over to Bruce. Bruce?

Bruce Besanko

Thank you, Eric and good morning everyone. I’ll cover our wholesale and retail business as well as provide some additional color on the quarter and our financial position. Let me start with our wholesale segment, where sales for the quarter were $1.7 billion, down approximately $90 million or 4.8% compared to last year, when adjusted for the extra week. The biggest driver of the lower sales was again the lost Albertson’s volume in the Southeast, that I mentioned last quarter, which accounted for close to half of the variance.

The balance was largely softer year-over-year sales to existing customers, partially offset by new customer affiliations as well as new stores operated by current customers. Fourth quarter adjusted EBITDA was $61 million, down $8 million compared to fiscal 2015, also adjusted for the extra week with the primary drivers being higher employee-related costs, as well as lower sales and its deleveraging impact on expenses. As we look to the new fiscal year, our number one priority is to increase sales and our operating and incentive plans have been built to reflect us.

Let me outline our initiatives focused on improving the top line. First and foremost, we’re working to enhance our selling culture within the wholesale team including better leveraging our CRM tools to identify and drive sales accountability with our field sales team. Second, we’re more aggressively pursuing additional wholesale business. We formed and centralized strategic sales team that’s concentrating on significant accounts as well as new business channels working with these organizations and better understanding their needs. This group already has had discussions with a number of companies and we are optimistic about the progress we’re making.

Third, we also see a big opportunity in continuing to enhance and expand our retail back-office technology based and design services, in which all of these professional services can help our customers drive their retail sales while creating operational savings.

Our current offerings include digital marketing, data analytics, promotional management as well as POS, payment processing and e-commerce. Our sales teams will be developing tailored sales plans to market specific targeted services to each customer based on an assessment of their specific needs. One powerful differentiated service we’ve begun offering to your customers is what we’re calling advanced merchandising planning or AMP.

AMP is a proprietary dynamic promotional planning system created for multi-store independent retailers. The system allows customers to use advanced analytics to plan their promotions, sales events and displays while enabling the ability to evaluate actual results against planned performance. We have several retailers already in the process of installing and utilizing AMP and numerous other customer discussions are underway.

Fourth, we see a sizable sales opportunity in produce as we strive to move from being a wholesaler that sells produce to a produce wholesaler with our current produce sales distribution mix at about a third of the average retail sales mix for produce, we’ve got a meaningful sales opportunity with just our existing customer base. Our goal is to create an industry leading national produce program, and to do so we’re reviewing a number of needs in this area including our distribution network where we may look to expand our refrigerated DC footprint where appropriate.

Finally to reiterate Mark’s earlier comments, we plan to be more aggressive in exploring transactions that would complement our organic growth and potentially add to our existing footprint. All-in-all the management team is very excited about the prospects of our wholesale business, and we believe our many initiatives will help drive improved financial performance.

Moving to retail, sales were $1.1 billion, a decrease of 2.6% compared to last year’s fourth quarter excluding last year’s extra week. Identical store sales were negative 3.9% as customer accounts declined by 4.2% partially offset by a 30 basis point increase in basket size. One driver of ID sales this quarter was the relative lack of weather events that is storms and storm warnings this year compared to last year, which curtailed sales in the fourth quarter compared to last year.

We estimate the impact of this to be approximately 170 basis points. In addition, we’ve experienced a higher level of competitive impacts in the past two quarters, which we expect will continue and likely accelerate in FY 2017 in addition to managing through a lower EBT benefit in the marketplace in which we operate.

Fourth quarter adjusted EBITDA was $63 million, $13 million less than last year, excluding the extra week in FY 2015. You may recall that last year we had a very strong fourth quarter including retail where adjusted EBITDA was 6.7% of sales, the highest rate in fiscal 2014. In comparison this year’s fourth quarter came in at 5.7% of sales more in line with our trends and in the range where we think the business should be operated.

To add to Mark’s comments, we’ve made progress on improving our store operations, yet our sales results are clearly not where we want them to be. In fiscal 2017, we’ll focus on five things in an effort to improve the top line, better pricing and promotions, improved store level execution, new merchandising ideas, and enhanced digital platform, and increasing customer segmentation.

First and foremost is our investment in price and traffic driving promotions. In the back half of fiscal 2016, we didn’t invest as heavily in our weekly ads consciously pulling back in our spend level partly to mitigate the impact of lower pharmacy reimbursement rates. As we moved into the new fiscal year, we’ve increased our promotional spending and become more aggressive on price in select key categories. Deeper levels of investment will be partially funded through plant shrink improvements, which was higher in fiscal 2016 compared to fiscal 2015. To address this in late January, we formed a multi-disciplined task force and appointed banner level shrink champions focused solely on improving shrink.

Second, we made some notable people-related investments in order to deliver better more consistent store conditions. This included a handful of new positions across the network as well as additional training focused on our expectations for how our stores must look every day. This investment extends to standardizing many store processes, such as receiving and labor scheduling to name just two. We expect standard approaches to common task will lead to better execution, and the store level cost savings, which amplified across nearly 200 stores over 52 weeks can amount the meaningful dollars.

Third, in addition to stronger pricing and more consistent store conditions, we’ll be working on a number of new merchandizing initiatives including a general denting up of our assortment, promotional pallet drops and incremental displays with faster-moving SKUs have been added to take advantage of underutilized space, while being careful to avoid a sense of clutter in the aisles.

We’ll also be expanding our model store efforts to the bakery and deli departments where our focus will be on core assortment, display standards and new small wears. Some stores will receive new tables and cases to better display product including currently trendy item such as quinoa salads and healthier choices such as cleaner proteins.

Fourth, we’re working to enhance our digital capabilities in presence with our customers. Our goal is to have one million digital accounts by the end of this fiscal year, customers that we know spend more on an average trip than non-digitally engaged shoppers. In addition, I addressed online shopping briefly on the last call and can now tell you that our goal will be to a have click-and-collect capabilities up and running in all five retail banners by the end of this fiscal year with further enhancements coming after that.

Lastly, we’re looking to segment our stores based on characteristics of the neighborhood and customer base they serve. By doing so, we’ll be better positioned to offer the most relevant assortment to each store’s customer base. From a capital perspective, we’ll invest more in our retail banners in fiscal 2017 including three new stores and three store relocations.

Let me now turn to some additional color on our 12-week fourth quarter where as outlined in this morning’s press release, we reported net earnings from continuing operations of $49 million which included $15 million in after-tax cost and charges related to asset impairments, debt refinancing, the potential separation of Save-A-Lot and employee severance. Excluding these items, net earnings from continuing operations were $64 million and earnings per diluted share were $0.23 including an approximately $0.05 income tax benefit related to the resolution of certain federal and state tax matters.

Fourth quarter adjusted EBITDA as outlined in table five of our release was $177 million, down $21 million from last year’s fourth quarter when adjusted for last year’s extra week, but relatively in line with our internal operating plan. Full year adjusted EBITDA was $771 million essentially flat to last year on a 52-week basis.

Consolidated net sales in the quarter were $3.9 billion, a decrease of $128 million or approximately 3.1% compared to last year’s fourth quarter excluding the extra week.

Moving down the P&L, consolidated gross profit was 15.0% of net sales down about 10 basis points from last year’s fourth quarter. This was primarily driven by Save-A-Lot as Eric mentioned deflation and higher ad spending drove margins down. Consolidated SG&A expense, adjusted for the items I noted at the beginning of my remarks was 12.1% of net sales for the fourth quarter compared to a 11.8% last year.

All three segments experienced rate increases, partially due to lower sales and specific to Save-A-Lot the pre-opening cost associated with the 25 new corporate stores opened in Q4.

Net interest expense in the fourth quarter was $48 million and included $10 million in debt refinancing costs and charges related to the redemption of the balance of our 2016 notes and the amendment of our ADL facility. Excluding these charges, net interest expense was $38 million compared to $44 million last year prior to $43 million in refinancing cost and the extra week in the fourth quarter of fiscal 2015. The decrease in adjusted interest expense was primarily driven by lower outstanding debt balances.

Finally, our tax provision was $6 million this quarter, which represents an effective tax rate of approximately 11%. This favorability was primarily due to the resolution of certain federal and state tax matters.

Moving from our consolidated P&L to the segment results, Save-A-Lot’s operating earnings for the quarter prior to store closure, impairment and employee-related charges were $25 million or 2.4% of sales compared to $46 million last year, excluding the extra week and $3 million of store closure and impairment charges or 4.3% of sales.

Higher segment gross margins last year associated with the onset of deflation coupled with this year store opening costs were the primary drivers of the year-over-year decrease. Wholesale operating earnings for the quarter were $50 million or 2.9% of sales compared to last year’s $56 million, excluding the extra week or 3.0% of sales primarily driven by lower sales.

For retail, operating earnings for the quarter were $30 million or 2.7% of sales, compared to last year’s 12-week total of $37 million or 3.2% of sales. The biggest driver was the roughly $30 million reduction in sales, as well as last year’s stronger gross margins in Q4.

Finally, corporate operating income was $10 million excluding the Save-A-Lot separation cost I previously mentioned compared to a loss of $8 million last year, excluding the extra week. The largest contributor to the year-over-year change was a number of favorable items that all fall under the category of employee-related costs, including incentive comp and retirement benefits.

Now let’s turn to the balance sheet. At the end of the quarter, our outstanding debt, including capital lease obligations totaled $2.52 billion, a decrease of approximately $170 million for the full fiscal year. As we mentioned on our last call, we redeem the balance of our outstanding 2016 bonds during the fourth quarter with approximately half funded by borrowings under the ABL and half with cash generated from operations.

Borrowings on the ABL were $138 million at year-end and we had approximately $750 million of available capacity under this credit facility. In early February, we completed the amendment and extension of the ABL facility, extending the maturity date by about 16 months out the February 2021. The amendment also reduces the rate on borrowings under the facility and permits the company and its subsidiaries to undertake certain transactions necessary to effectuate a spinoff of Save-A-Lot.

Turning to cash flow, we generated approximately $420 million in operating cash flow from continuing operations this year, up from last year’s $333 million, largely due to lower cash pension contributions in FY 2016. Cash reinvested in the business totaled nearly $270 million for the year with the balance largely going to lower our outstanding debt.

Looking to the new fiscal year, Eric and I spoke to sales being the number one priority and the many initiatives in place across the business to improve the top line. Our other key metric is adjusted EBITDA, which on a consolidated basis including Save-A-Lot, we expect to be about the same in FY 2017 as the $771 million we reported in FY 2016.

Among the four quarters, we expect Q1 to be down from last year and quarters two through four to be higher than FY 2016. In Q1, we’ll not have yet cycled the loss wholesale business experience in FY 2016 including Haggen and the Albertson’s LLC business. We’re also planning a higher level of year-over-year margin investment in the first quarter and expect deflation to continue albeit a lower level in the back half of FY 2016. From a capital perspective, we plan to invest again on a consolidated basis including Save-A-Lot between $325 million and $350 million back into the business.

And with that, let me turn the call back to Mark.

Mark Gross

Thank you, Bruce. Just plenty to do here. But we’re optimistic that with the team we have assembled and the assets I’ve described, we can grow this business. We are a company that is in business to help feed families across this country and to that end, our mission is to serve the customer and their needs. Our entire team is committed to growing our top line, while judiciously managing our costs.

I look forward to meeting many of you in the coming months and to continue to update you on our key initiatives and performance over the course of the fiscal year.

With that let me open the call up for your question.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Chuck Cerankosky from Northcoast Research.

Chuck Cerankosky

Good morning, everyone. Mark, could you please talk a little bit about, which sounds to me like a broader vision of product selling to wholesale customers, you emphasized consumables and services, and it sounds like you looking at a lot more than just traditional grocers?

Mark Gross

Well, looking – well, thanks, Chuck. I think it’s – I’ll call it multipronged, right. The fundamentals of sales and expanding sales is understanding first the customer’s needs and looking at all aspects of their business. And then to the extent you have the solution explaining that you have that offering and to the extent you don’t is crafting that solution. So, for those parts, it’s selling more to our existing customers of what we have. But also it’s adjusting the offering, and that can be an additional product line, making sure that in all markets, you have the full suite of offerings. And then in some cases, Chuck, it’s also acquiring more customers. I think those are all aspects of different ways to grow sales here on the infrastructure that we have.

Chuck Cerankosky

And that – would that be directed to non-traditional customers?

Mark Gross

So, it’s yes, and I’d say it’s to the customers we have and then – so, yes, and then to I’ll call them more – I’m sorry, and to non-traditional customers as well.

Chuck Cerankosky

And a question for Bruce. Do you have – could you go over the CapEx numbers again for fiscal 2017 and where you excluding Save-A-Lot from those? I just want to make sure I heard that right.

Bruce Besanko

Yes. Hi, Chuck. Good morning. Now, first of all on the second half of the question, no, we didn’t exclude Save-A-Lot. So the ranges that I provided that are $300 million plus in cap that includes all the growth activities and investments in Save-A-Lot. And obviously, we’re making a additional growth in fiscal 2017, relative to fiscal 2016. We think that the prudent use of our resources to grow certainly Save-A-Lot, but to invest in the other areas of the business as well.

Chuck Cerankosky

Thank you.

Bruce Besanko

Thank you, Chuck.

Operator

Our next question is from Ajay Jain from Pivotal Research Group.

Ajay Jain

Yes. Hi, good morning. I have a question on the timing for the spinoff for Save-A-Lot. Can you just give any update on timing and when you expect that process to be completed? Are you still looking at the end of – I think Q2, I think that was what was previously contemplated? Thanks.

Bruce Besanko

Hi, Ajay Jain – AJ, Bruce here. So, in terms of the timing, let me give you an update. So first of all, the process is fluid, we have several work streams that need to be completed that are underway right now before we have any separation. We do need to work the amendment of our term loan, that is a gate-keeping item and the market has been choppy, both in the high yield bond market as well as the term loan market. And so the likely timing now is sometime in the second half of our fiscal year, and we’ll continue to make progress against that as we move forward.

Ajay Jain

Okay. And I have a question for Mark. I’m sure you know that investors are certainly aware that a lot of your background is in the M&A area, and that, that could signal that the board is potentially looking at other strategic alternatives. So as a follow-up question, what would you say or some of the strategic priorities right now apart from Save-A-Lot? Are you precluded in any way from – just from a resource standpoint in terms of looking at other alternatives for other businesses or is it kind of all hands on deck with Save-A-Lot right now?

Mark Gross

Yes. So, I think there are a wealth of opportunities available to SUPERVALU. The Save-A-Lot work stream is important, but it’s just one avenue of the strategic work that we’re doing. Part of what as any CEO comes in is a review of the prior structure of that spin and to look at ways that well maybe that there could be adjustments to it that would give you additional flexibility both operationally and to grow the business. And so you’re seeing in this work then in Save-A-Lot how it connects to the second part of your question, because as you explore other alternatives, other structures for that spin, it’s in a way that can help facilitate the growth of the remaining business at SUPERVALU.

Ajay Jain

Great. Thank you.

Mark Gross

And you’re welcome.

Operator

Our next question is from Stephen Grambling from Goldman Sachs.

Stephen Grambling

Hey, good morning. Thanks for taking the questions. I guess as a follow-up to AJ’s last question. The retail business was referenced as a good complement to the wholesale business and you also referenced some of the testing that goes on there. But how important is the retail arm from a capacity standpoint?

Mark Gross

From a capacity standpoint?

Stephen Grambling

To the wholesale business that is.

Mark Gross

Well, yes, so the retail business is part of being good customers as well to the wholesale business. So, there are warehouses that we use to supply our other wholesale customers and our retail. And we would hope that we are able to grow all aspects of that business.

Stephen Grambling

Okay. And then, I guess another follow-up on the wholesale business. What do you typically hear from customers as a push back to your current produce capabilities?

Mark Gross

Well, it’s interesting. It depends – it depends where the customer is located. So, in facilities where we have a full and complete offering, there’s a increase desire by our customers to take advantage of, and to buy more produce from us.

And there are the warehouses locations where we really don’t have the full set of capabilities that we should have. And I think what you see there is that customer clamoring for us to take those warehouses, do the necessary work in them to provide the offering that we’re able to do in other parts of the country. I think people are excited. When they look at the work we’re able to do for them in other product categories is to think that this push and focus on produce is long overdue.

Stephen Grambling

That’s very helpful. And one last one if I can sneak it in. Just on trade budget optimization, which has been one of these hot topics I think in the CPG world. How does that impact each one of your businesses? And can you maybe even quantify or at least offer some qualitative comments on how much of your wholesale business relies on your servicing trade support or buying forward when those promotions available? Thanks.

Bruce Besanko

Hey, Steven, this is Bruce. So we’ve not seen really any great impact from – or any significant changes in terms of our supplier funds. Obviously, any wholesale businesses has a component of – or retail business for that matter as a component of vendor subsidy, but we had a fulsome merchandising teams that ensure that we get the best value for – for the supplies that we purchased and then onwards over to the consumer.

Stephen Grambling

Great. Thanks. Best of luck this year.

Bruce Besanko

Thank you.

Operator

Our next question comes from Scott Mushkin from Wolfe Research.

Mike Otway

Hey guys, this is actually Mike Otway in for Scott. I appreciate you taking the question. First, I guess to talk about following up on some of the acquisition questions. But it sounded like Mark, you guys are willing to be more acquisitive as you look at growth. Is this predominantly in wholesale and is it in retail too. Do you guys think you need more scale in retail to kind of accomplish what you want to accomplish? And then, it sounded like the leverage pro forma for Save-A-Lot spend would be in the kind of high 3s and low 4s. Are you willing to take that how higher are you willing to take and maybe just a little bit about your acquisition criteria, when you look at assets and as you look at the business going forward?

Mark Gross

Yes. So a couple of answers there. So I am a wholesaler, so that is naturally my focus, and it’s the place that it’s been far easier for me to identify a wealth of opportunities for SUPERVALU’s growth. That’s the first piece. The second part on the acquisitions, there are – I think there are multiple ways to structure transactions with significant whether they’re self-distributing chains or other distributors that you can do business with them, that may or may not be a straight-out acquisition, sometimes that’s the simplest and best way to do a deal, but I think we’ve look at it a number of different ways to do business that would not have as big an impact on that leverage ratio as a straight-out acquisition. And I think we just need to start executing on some of those opportunities and those my comments it will be a lot clearer of what I mean.

Mike Otway

Okay. I appreciate that. And I guess as a follow-up, this is probably for Eric. But on Save-A-Lot, clearly deflation has a significant impact on the business recently. But if you kind of look step back and you look over the last few years, the segment margins have really compressed kind of that low 4% range to a little bit over 3% at the end of this year on an operating margin. With the initiatives, where do you think longer term this business kind of operating margin run rate is? And how do you think about sales and where that needs to be? Thanks.

Eric Johnson

Thanks for the question. I don’t think it’s already deflation driven, and I don’t know that I should throw out a number. I think the biggest thing that I’m really focused on is increasing the performance in the existing boxes that we have. Our sales per square foot is less than what it should be, and I think the opportunity that both the licensees and our corporate store see a really in terms of maximizing what we have. In terms of deflation, deflation is a cyclical thing, and we use – you don’t like to use deflation as an excuse for anything, but obviously when you’re selling two licensees that compresses your deflation, because you’re passing on direct costs.

If you look at the corporate side of the business in the last quarter of last year and into the first half of this year with the onset of deflation on the retail business last year, the reduction of retail did not follow the reduction of cost at the same pace, therefore that expands margin rate. But back to the – I think the more important question is really that the initiatives that I talked about in my intro, are really designed to improve the metrics of the current model, and that’s really where our focus has to be, and that’s why we’ve cut back a little bit on the number of stores. As you recall I think we stated something like 90 stores in the F10, we’re talking about 75 stores, what we’re really doing is reallocating capital from those 15 stores to do the resets of the majority of our corporate stores, which again will be the lead also for our licensees. So, again all that is to drive the model, drive the internal blocks model higher.

Bruce Besanko

Can I just – I want to add on top of what both Mark and Eric said. So these are very exciting times for our company. I couldn’t be more excited frankly. Mark is identifying new opportunities, he’s talked about produce and professional services is two good examples, but he’s identified new opportunities for us. And Eric’s plans at Save-A-Lot couldn’t be more exciting. And then on top of that, the potential separation of Save-A-Lot is also very exciting to our shareholders. So, we have – I couldn’t be more excited with what the opportunity is in front of us, and I think – think we got a lot of great things going.

Mike Otway

Thank you. I appreciate the time.

Bruce Besanko

Thanks, Mike.

Operator

Your next question is from Rupesh Parikh from Oppenheimer.

Rupesh Parikh

Good morning. And thanks for taking my question. So, I wanted to focus more on the top-line expectation for this year, and I know this year deflation was really a big headwind to your business. So, I just want to get a sense for the upcoming year, how are you thinking about the TSA agreement wind down, deflation and lower Albertson’s business? Is there a way if you can maybe help us quantify or how you are thinking about some of those headwinds? And I guess on the positive side, I just wanted to get a sense of how you guys are thinking about the timing of when some of these initiatives can start to help to drive your top line?

Bruce Besanko

Hey, Rupesh, this is Bruce. I will start and then either Mark or – and/or Eric can jump in. So, our number one, number two and number three priorities for the company in fiscal 2017 are sales, sales and sales. Obviously, we’ve had a challenging fourth quarter from a top line perspective. I think we have some exciting opportunities that were talked about in both my prepared remarks, as well as Eric’s prepared remarks, so we have a lot of good things going on in terms of the top line and our independent business, our wholesale business, our retail food and as well as – as well as the Save-A-Lot segment.

So I think there is – our priorities here are to grow sales and we’re all laser focused on that. In terms of the TSA, obviously we are going to continue to assist our retail partners as the TSA particularly at Albertson’s as that process unfolds. We are looking and we are continuing to work on ways to offset any unwind, so we have cost reductions, we did a great job in fiscal 2016 in terms of cost reductions. We’re going to continue that work into FY2017. And then as Mark mentioned, we got certainly business growth opportunities both organic and inorganic, professional services being a really good example. So in total, while we haven’t provided guidance for the top line, we do expect that EBITDA for the year in FY2017 would be flat to what we saw in FY2016.

Mark Gross

And I can just speak for Save-A-Lot, the – we have a lot of initiatives that then I have – I outlined most of those in the prepared remarks – we did some major changes to our advertising in terms of content, cadence and strategy. We have a – and much of that has just started to take place. We have national brand cuttings into our stores, which actually we’re at 100% cutting as of last week in both the license and the corporate, and that’s about 120 different items that we put into the different categories. Then we have a major reset which is the complete revamping and what we did is, we kind of really analyzed the sales and gross margin profits per foot on the average store and re-merchandise the store for much more sales and profitability. So if I look at the whole bucket list of all the initiatives that we outgo in this year, I would say that there is a third of them maybe that start to take effect slowly as we speak, but most of the major effect of our initiatives is going to be in the back half of this year.

I can tell you that the couple of stores that we’ve done in terms of the store resets, we actually have modeled stores for upcoming symposium. The initial results are quite encouraging. And I would say that every initiative that we’ve tested has really tested out very positively. So we are pretty encouraged by it. So, I think – Rome wasn’t built in a day, and you’re going to see it happen over time with most of the initiatives kicking in like I said in the back half of the year.

Rupesh Parikh

Okay. Thank you.

Mark Gross

Thank you, Rupesh.

Operator

Our next question is from Bryan Hunt with Wells Fargo.

Bryan Hunt

Thank you for your time. Eric, I was wondering if we could dive a little bit more to the Save-A-Lot resets that you just were covering. One, how many of those stores have been reset? Two, when you think about the overall SKUs maybe, what type of SKU removal or additions are you putting in either on percentage terms or aggregate terms? And then, I got a follow up.

Mark Gross

Yes. Those are good questions, because the concern is that you always when you reset that you stick to the principles and the disciplines of hard discount. There’ll probably be a net increase of SKUs by the time all is said and done before the end of the year. I would say probably in the range of 200 items to 220 items. One of the things that we’ve done in the resets is that we’ve really reset the stores by the very discipline that hard discount dictates which is that your rate of sale, expected rate of sale per item and pack-out creates a situation that in the merchandising does not affect your labor model. So, that was the premise of any incremental items that we put in to ensure that we don’t get into a situation where we actually put in too many SKUs and start affecting negatively the labor model.

So, that – we’re very, very disciplined when it comes to that. The resets themselves are – basically there’s two types of resets. So, the first and the more major one that’s more capital intensive per store is going to be done in about 320 stores and be completed by the end of the third quarter of this fiscal year. The other 100 and whatever number of stores that aren’t getting the full reset with fixturing will get the actual reset of the merchandising categories. So in other words, they will have all the same item assortments, the same planograms except that they will not be getting new fixtures in produce and bakery and some expanded frozen and cooler also.

We also expect that in these resets that and again this is just an estimate based on kind of the key factor we’ve got from licensees, but that will probably have about 600 license stores and again guessing that maybe at the 600 roughly a third might want to do the full reset with the fixturing which is a little more expensive, and two-thirds is doing the major reset.

So the reset is really designed not so much to increase SKU count, but to have the right categories in the right adjacencies, with the right product. And we’ve also like I mentioned put in the must have national brands. There are certain you couldn’t like coke in the Save-A-Lot before, which to me is not reasonable, and one of the reasons for doing this is that we have a high percentage of our customers that come in only several months and represent a very small percentage of our sales.

So what that was telling us is that, we’re not supplying or we’re not creating an environment where people can feel comfortable doing a full shop. So in resetting these stores and even longer term during the whole national – the new private label initiative, our store has to become much more of a place where you can do your complete shop, and this will increase the customer account in terms of frequency, also it will increase basket size, and I think this bodes well for the whole business.

Bryan Hunt

Got it. And then just my follow-up question. You’ve talked a little bit, Mark, about acquisitions and the spin-off in the cap structure at Save-A-Lot. Can you give us an idea maybe once we’re through the spin-off, which are ideal capital structure would look like either in terms of leverage or run adjusted leverage, I mean, I don’t know if you’re running your business at four times is kind of a target long-term?

Bruce Besanko

Well, let me start then Mark can jump in. So, this is Bruce. We’ve not provided any sort of guidance in terms of our long-term capital structure. But I can tell you that at four times or that kind of level that’s not what we would want. We would want to lower it. So our priorities with respect to how we would deploy capital in the business are no different than they’ve been for the past 2.5 years to three years, which is we’re going to prudently invest in our business to grow. We’re going to pay down our leverage over time, and we’re going to invest in our underfunded pension obligation. And those priorities are going to go forward now so.

And just one other comment in regards to the leverage, as Mark alluded to in the prepared remarks, the 3.8 times to 4.2 times leverage, simple leverage, excludes any monetization of any retained interest we may have in Save-A-Lot and obviously if there were retained interest and we were to monetize that the leverage would be deployed for various uses including deleveraging.

Eric Claus

All right. So let’s talk about that and when you craft a strategy of maximizing shareholder value. So in a spin where it’s in 80:20, you’re sending off these the value of Save-A-Lot to the shareholders, you’re retaining just 20% that you would then monetize. As you potentially increase that level of holdback, you obviously increase your ability to have an asset that you can monetize in the future to reduce the leverage of the business to help grow the remaining company, and that’s the piece that you sit there working through of those different opportunities and inappropriate cap structure.

Bryan Hunt

Thank you so much for your time. I’ll follow-up after the call. Thanks.

Mark Gross

Thank you, Ryan.

Operator

Your next question is from Bill Kirk from RBC Capital Markets.

Bill Kirk

Hi, everyone. Thank you for taking the question. So, the wholesale customer store count looks like it was down a bit from 3Q, but I think the big customer lost you referenced at the time that happened in the Southeast within 3Q. So can you may be either correct me or talk about what happened after 3Q to show this reduction?

Bruce Besanko

Well, this is Bruce. So I’m going to have to maybe come back to you, Bill, on – with a more precisely answer. But suffice to say, what’s happened is, we obviously have the Albertsons loss that had an effect on our sales. We had some earlier losses in the year that were much, much smaller. But look, the important point here is that, we are deploying our resources to grow our wholesale business. As I said before, our priority is around all three of our business segments are to grow the top line. And as I said before, I’m very excited about the opportunities that Mark has identified and the opportunities that Eric has identified could be more – I couldn’t be more than I am now with respect to all the activity that we’ve got going on to help us grow our company.

Bill Kirk

Okay. And in that vein, how much of the incremental CapEx for fiscal 2017 is in Save-A-Lot and how much is kind of behind the wholesale business with the DCs?

Bruce Besanko

Well, we – there’s a little more investment in the distribution center network in fiscal 2017 versus fiscal 2016. There’s a little bit more in terms of the Save-A-Lot investment as well. We’re continuing to deploy capital against our a broader maintenance and IT infrastructure to help us be more productive overall. There is a little bit of investment in our retail segment, particularly at the CUB and Hornbacher’s. As you may know we’ve built two new Hornbacher’s stores, in FY2016 we’ve got a new store at CUB and we’re going to continue to make the investments necessary in all three of our segments to be sure we stay competitive.

Bill Kirk

Is it fair to say Save-A-Lot is the bulk of that year-over-year increase or is it kind of Save-A-Lot in the wholesale business are one and two and retail is three?

Bruce Besanko

I would say the latter, so I don’t know – I’d have to go back and reference exactly how much we’re investing in each of the business. But Save-A-Lot, look Save-A-Lot is a growth company and a growth sector and we’re making, I think good investments there to grow that business. And so, there is a little more investment in fiscal 2017 in Save-A-Lot than there was in fiscal 2016 and there’s a little bit more naïve in the wholesale business as well.

Bill Kirk

Okay. Thank you.

Bruce Besanko

Yes. Thank you.

Mark Gross

Ginger, we’ll take one more question, if we could.

Operator

Your final question is from Edward Kelly from Credit Suisse.

Edward Kelly

Yes, hi. Good morning, guys and thanks for taking my question. So just coming back to Save-A-Lot, our discount seems like it should be a good business. It doesn’t really seem like it’s kind of played out for you guys that over the last couple of years. Could you just maybe take a step back for us and help us sort of understand the background behind the decisions that you’re making today. Sort of like, what specifically you think was sort of wrong and the confidence that you have the right plan now going forward?

Bruce Besanko

Yes. Eric, I’ll take that. It’s a big question. I think that in – I think I know that in North America, the discount model is significantly less or at least in the U.S. developed than it would be in most of Western Europe or in Canada. I think there’s a lot of room for growth in discount. You’ve got the entry of legal coming in, you’ve got all the use of formidable competitor and retailer. I think that the challenges that we’ve had are that we’ve kind of limited ourselves to a model that restricts itself to a too small segment of the population and that were not a broad enough appeal. And saying that, our model has to be an American model and we’ve proved that in Canada, you can look at across the discounters up there very hugely successful, that have sales per square foot that are probably double what we have here with larger footprints both in Loblaws, No Frills Concept, and now Metro is a food basics concept.

So my experience has been up they are, very, very successful, and some of the same strategies we are employing here are as opposed to doing private label by category, we purchased the name Americas Choice, it’s a fabulous name and we want to kind of more most over three phase project over the next 18 months, start building real equity in our private label. We believe that the cutting in, again, just the must have item in national brands in each category are significant. We look very, very closely to our productivity and there is certain things in the America is different to Europe. And if you go to the UK where private label penetration is probably in the 60% range and is probably in the 20% range in those businesses in the U.S. So we are definitely missing opportunities in the national brand.

I mentioned before coke, or if you get into the baby sections, people just don’t do private label baby food and baby formula, people don’t do private label pet. So not that we’re becoming a national brand store and not that we’re strains on the concept of discount, we’re just making it a much better, much more relevant experience. And the picture that I have in my mind is of a box that successfully does significantly more volume compared to what it does today, through all of these combined initiatives, whether there’ll be private label, national brand, the complete new analytics of our set. We’re putting a lot of effort into reordering processes, which previously were based on shelf space as oppose to rate of sale, our advertising strategy is significantly more strong than what it was before.

So all these things combined I – first of all, I think there is a lot of room to grow in the whole space. We’ve got a lot of room to grow within our existing sweet spots which are the circumferences around our distribution centers and so they are not anywhere near full capacity, and the – my belief and it’s a very strong belief and offer that we can all be extend our demographics. And by doing that we can expand in very, very specific markets where we know we’ve had success in the past.

I think something that we don’t talk enough about is our real estate strategy and our real estate strategy is becoming much more precise and the rigor that’s going into to define exactly where we want our new corporate store growth to go relative to our licensed store growth. All of these things I think bode very well for us.

And the last thing and then I’ll leave to – I’ll turn it back to you is that, in the past we haven’t talked a lot about the licensed store growth, and our licensed partners, I have to note in the field every week, two days a week since December meeting with these people, we have some incredibly, talented and very committed licensed operators. And we have the ability to grow with these people at a much more rapid rate perhaps and some other businesses, because the capital required by the corporation is relatively small compared to growing just corporate stores.

So, I think the two-pronged approach is a very precise approach bettering our assortments, ensuring that our pricing strategies are really, really strong against our key competitors, and I think the United States is just got so much room for growth in discounts and even the entry of new players, there is just a lot of room for everybody and we’ve got a – each has their own strategies, which I think is fine.

So, I’m extremely, extremely bullish. I would say this business is a business that just has a whole lot of potential for the long term.

Edward Kelly

Okay. Just a sort of follow-up for you and then I’m done. But this – I think if we look at the filings of Save-A-Lot it’s looks like the wholesale margin there is, I don’t know 7%, 8% something like that. Are we looking at that, right, I guess first of all, and is that the right margin long-term if you’re going to attempt to grow more aggressively the license of these?

Bruce Besanko

Well just – this is Bruce, just remember that those segment or channel – those channel carve out financials that are in the Form-10, which I think is what you’re referencing.

Edward Kelly

Yes.

Bruce Besanko

Those are fully burdened and fully allocated kind of accounting segment results. What I would is that, both the corporate channel, the retail channel and our license channel are both great channels, and I think you’ve heard from Eric in terms of just a tremendous excitement that he has about both of those channels.

Eric Claus

Thanks, Bruce. Let me just add one thing on the license part of the business. It’s not so much the rate that you’re looking at. I’ve said a lot of time with some very, very successful licensed operators, and what excites them is the same thing that excites me, is a possibility that we have within the box to make it so much better. And it makes their model a lot better, it’s a skinny model for them, it’s between us taking our wholesale margin and then working saying competitive at retail it means they’ve got small margins to work at.

Now, by introducing the initiatives that we’re introducing which they wholeheartedly support, we had a management advisory group of 24 of our talented licensed operators that worked on this plan with us, they’re looking if this going – this model makes it, what we plan to do, it is not with this model and make it far more attractive, which also allows us to continue to grow with successful operators because successful operators will put good money after a good project. So again very bullish on that.

Mark Gross

So with that, I hope that Eric, Bruce and I have a dynamic picture for the future of this business. I appreciate you letting us share that picture with you. Thank you for participating, and we look forward to meeting our investors and analysts. With that, Steve?

Steve Bloomquist

Absolutely. We’re done. If anybody has anything to follow-up, I’ll be in my office later today. I’ll be happy to chat. And with that, we’ll signoff the call. Thank you.

Bruce Besanko

Thanks.

Operator

This concludes today’s conference call. Thank you for participating. At this time, you may now disconnect.

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