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Edited Transcript of SRLP earnings conference call or presentation 10-Mar-17 6:00pm GMT

Thomson Reuters StreetEvents

Q4 2016 Sprague Resources LP Earnings Call

Portsmouth Mar 10, 2017 (Thomson StreetEvents) -- Edited Transcript of Sprague Resources LP earnings conference call or presentation Friday, March 10, 2017 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Glendon

Sprague Resources LP - President and CEO

* Gary Rinaldi

Sprague Resources LP - CFO and COO

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Conference Call Participants

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* Justin Jenkins

Raymond James Limited - Analyst

* Unidentified Participant

- Analyst

* Michael Gyure

Janney Montgomery Scott - Analyst

* Lin Shen

HITE Hedge Asset Management - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Sprague Resources fourth-quarter and full-year 2016 earnings conference call.

(Operator Instructions)

Now I would like to welcome and turn the call to David Glendon, President and CEO.

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David Glendon, Sprague Resources LP - President and CEO [2]

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Thank you, Carmen. Good afternoon, everyone, and welcome to Sprague Resources' fourth-quarter 2016 conference call. Joining me today are Gary Rinaldi, our Chief Operating Officer and Chief Financial Officer; John Moore, our Vice President and Chief Accounting Officer; and Paul Scoff, our Vice President and General Counsel.

Some of today's call will include forward-looking statements. While Sprague believes these statements to be reasonable as of today's date, future results are subject to many risks and uncertainties that are difficult to predict and outside of management's control. Any forward-looking statements we make are qualified by the risk factors in our most recently filed SEC Form 10-K and future filings with the SEC. Sprague Resources LP undertakes no obligation to publicly update or revise any forward-looking statements as a result of new information, future events, or otherwise.

You can find a discussion of our use of non-GAAP measures, as well as reconciliations between these measures and their most comparable GAAP figures in our earnings press release on Form 8-K with the SEC, as well as additional disclosures and reconciliations in the investor relations section of our website.

A year ago, I communicated a belief that Sprague's performance checked the box on every metric MLP investors find important. I'm pleased to report today that Sprague continues to wield its Sharpie effectively in delivering value for unit holders, with another year of solid financial and operational performance under our belts.

Although not without challenges, 2016 clearly demonstrated the resiliency of our unique business model. We delivered a third consecutive year of double-digit distribution growth, while maintaining a coverage ratio above 1.6 times. We executed on a strategic acquisition at a first-year EBITDA multiple below 3 times, and we maintained balance sheet strength. Finally, despite unsupportive weather in the northeast, we met or exceeded our guidance targets, delivering adjusted EBITDA of $109 million for the year, only $1 million below the $110 million recorded in 2015.

I'm also pleased that Sprague has extended our track record of driving meaningful growth through accretive, bolt-on acquisitions across all three business segments already in 2017, surpassing our guidance of one to two transactions per year. The three transactions already closed this year represent more than $70 million in capital obligations with no external equity raise, all while maintaining our permanent leverage ratio at the low end of our target range.

Collectively, these three acquisitions are expected to contribute an estimated $6 million to $7 million to 2017 adjusted EBITDA, ramping up to $10 million to $13 million annually. The purchase of Global's natural gas marketing and electricity brokering business continued the consolidation strategy initiated with Metromedia in 2014 and extended to Santa Buckley Energy in 2016.

This transaction adds approximately 4,000 customer locations, 8 billion cubic feet of annual gas demand, and 1 billion kilowatt hours of electricity brokerage demand. Our experience integrating the Metromedia and Santa transactions provides confidence in our ability to leverage our supply and logistics capabilities, capturing further upside value.

In our refined products business, we see the LE Belcher acquisition as a natural extension of our terminal network into Western Massachusetts. Having been the exclusive supplier to this facility for nearly two decades, we're very familiar with the local market dynamics and the opportunities for supply optimization inherent in the nearly 300,000 barrels of added storage capacity. Additionally, we see the potential to build on the Belcher legacy of successful wholesale and commercial fuels marketing in the region.

Finally, the capital acquisition cements our marketing position in East Providence, allowing us to make growth capital investments and optimize storage at our legacy Providence terminal, improving both assets' ability to generate more ratable long-term cash flows. Backed by agreements with a credit-worthy counterparty, our purchase will increase throughput and material handling fees, further mitigating the seasonality of Sprague's business.

I am particularly impressed by the creativity and vision our team demonstrated, seeing the potential transformation of these proximate assets, and for their determination in executing the necessary three-corner bank shot. This entrepreneurial approach has been central to Sprague's success for nearly 150 years and remains core to our culture today.

I will now turn the call over to Gary for a detailed review of our results. Gary?

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Gary Rinaldi, Sprague Resources LP - CFO and COO [3]

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Thank you, David, and good afternoon, everyone. I am pleased to once again present strong financial and operational results for Sprague. We've delivered on our guidance, increased distributions at a double-digit rate, maintained a conservative balance sheet, and continue to invest in new assets, all financed with internally generated cash flow. These results are a testament to our uniquely diversified business model and ability to deliver strong financial performance and stable cash flows under varying market conditions and weather.

Sprague's adjusted gross margin for the fourth quarter was $69.4 million, a decrease of $1.4 million, or 2%, compared to the prior year, as strong natural gas performance was offset by weaker results in refined products and marginally lower materials handling results. For the full year, Sprague's adjusted gross margin off $259 million was 6% below 2015, as again, natural gas was offset by lower refined products margins associated with the decrease in volumes related to the warm first quarter.

Adjusted EBITDA for the quarter of $30.4 million was slightly better than the fourth quarter of 2015. For the year, adjusted EBITDA of $109 million was marginally down $1.4 million from last year's record and finished within our previously issued guidance. For 2017, we estimate that adjusted EBITDA will be between $115 million and $130 million, which incorporates the impact of weather through February, as well as the contribution from our recent acquisitions.

Sprague's operating expenses for the quarter decreased 2% to $16.8 million, despite a 10% increase in refined products volumes. For the year, operating expenses were down $5.6 million, or 8%, as lower terminal activity in the first quarter led to a reduction in employee-related cost and repairs and maintenance expenses. OpEx for the year was at the low end of our guidance, and we expect 2017 operating expenses to range between $69 million and $74 million.

SG&A expenses decreased 5% to $22.2 million in the fourth quarter. For the full year, SG&A expenses were materially lower by $10.1 million, or 11%. This was primarily driven by a decrease in employee-related costs, including sales commission, as well as a reduction in incentive compensation based on the lower distributable cash flow for the year.

In addition, professional fees and acquisition-related expenses were also significantly down year over year. We expect that 2017 SG&A expenses will range between $90 million and $95 million. In 2016, cash interest of $23.2 million declined modestly versus last year, and we expect cash interest to be between $26 million and $30 million this year.

Maintenance CapEx increased $600,000 to $2.3 million for the fourth quarter, primarily resulting from project timing differences. Maintenance CapEx for the full year of $9.4 million was $500,000 higher than 2015. For 2017, we expect maintenance CapEx to range between $14 million and $17 million.

Although acquisitions form the cornerstone of our growth strategy, we're continuing to make significant investments in organic growth projects, which this year will total between $19 million and $22 million. At our River Road terminal, a $3 million investment in an asphalt storage conversion project is almost complete, which is in support of a significant materials handling contract.

In addition, an $8 million investment in our recently acquired East Providence terminal will convert distillate storage to gasoline, backed by a 10-year throughput agreement with a credit-worthy counterparty. And $3 million will be invested in our Providence terminal to convert distillate and heavy fuel oil storage to handle asphalt, also backed by a 10-year throughput agreement. These expansion capital projects will increase cash flow ratably and further mitigate the weather impacts on our business.

For the year, distributable cash flow of $79.1 million was $10.6 million below the prior year. This was primarily driven by the positive adjustments in DCF in 2015. More specifically, higher incentive compensation paid in units, acquisition expenses related to the three transactions that closed in the fourth quarter of 2014, and the noncash write-downs of tank bottoms related to the declining oil prices during the year. Despite the lower DCF, Sprague's distribution coverage for the year remain strong at 1.6 times.

Based on the strength of Sprague's balance sheet and strong liquidity in both the working capital acquisition facilities, we remain well positioned from a financing perspective, with significant flexibility to capitalize and execute on accretive transactions. As of year end, liquidity in our working capital facility was $184 million, with working capital debt averaging $259 million over the trailing 12 months, and available liquidity in our acquisition facility was $305 million at year end.

As we enter 2017, and after closing on the three recent transactions, over $247 million of acquisition liquidity remains. Since our IPO, Sprague has generated approximately $115 million of distributable cash flow in excess of distributions, which was used to fund the expansion capital projects and acquisitions.

We ended 2016 with a permanent leverage ratio of 2.3 times, below our long-term target of 2.5 times to 3.5 times. With a strong balance sheet and low leverage, we have significant optionality to execute on strategic transactions while managing to a long-term optimal capital structure.

Now turning to the business segments. Refined product sales volumes for the quarter increased by 37 million gallons, or 10%, given more normal weather in the northeast. For the full year, refined product sales volumes declined by 17% to 1.4 billion gallons, primarily due to the unsupported weather early in the year.

Refined products adjusted gross margin for the fourth quarter decreased by $7.8 million, to $38.5 million, primarily relating to the retroactive reinstatement of the biodiesel tax credit in December 2015. Weaker heating oil spreads and [basis] appreciation relative to last year also impacted the quarter's results.

For the year, refined product's adjusted gross margin of $143 million declined 16%, consistent with the sales volume decline for the year. Despite the decrease in refined products volume, Sprague's market position remained strong and our unit margins held, a trend that we believe will continue.

We're excited about the ongoing growth in our natural gas business. The Santa Energy acquisition has far exceeded expectations established in our initial valuation economics, and we remain optimistic regarding the potential for the recent Global transaction.

Natural gas sales volumes increased 20% for the quarter and 9% for the year to 61.7 billion cubic feet, primarily resulting from the Santa acquisition. Natural gas adjusted gross margin rose $8.3 million to $18.7 million in the fourth quarter compared to a year ago. This increase is the result of the strong contribution from the Santa acquisition, as well as the positive impact from basis gains in supply optimization opportunities.

For the year, healthy increases in both volumes and unit margins combined to increase the natural gas adjusted gross margin by 22% to $62.4 million. Natural gas unit margins for the year also increased by 13% to a little over $1 per dekatherm. The Santa acquisition, logistics optimization, and an increase in the valuation of forward contracts related to narrowing credit spreads, all combined to drive the full-year out-performance.

In Sprague's material handling business, adjusted gross margin of $9.9 million for the fourth quarter was down $1.8 million compared to 2015. Decreased dry bulk activity related to rose fall accounted for a majority of the decline, as inventory levels coming into the quarter were near will capacity due to the mild winter experience last year.

Windmill handling and pulp export activity each accounted for a modest reduction, which was offset by an increase in gypsum handling. Adjusted gross margin for the full year of $45.7 million was slightly higher than last year, demonstrating diversification and liability of the cash flows that exist within this business segment.

A heavy oil storage agreement secured in late 2015 at Kildair, along with an increase in Sprague's construction-related bulk handling activity, was partially offset by lower salt handling, pulp exports, and windmill activity in 2016. Overall, our performances here highlights the benefits of Sprague's diversified business model, the ongoing margin expansion towards more fixed and ratable cash flows, and the strength the reliability of our distributable cash flow and coverage.

Sprague has delivered consistent financial and operational performance through volatile market conditions, extreme weather changes, and rapidly changing price environments. We're confident that during 2017, Sprague will deliver full-year adjusted EBITDA within the previously stated range of $115 million to $130 million, while maintaining distribution coverage in excess of 1.4 times.

Adding to the 11 consecutive quarters of distribution growth that Sprague has delivered, we're extending our guidance to increase distributions by $0.015 per unit, per quarter until the end of 2019, which does not account for the impact of any future acquisitions. At the same time, we expect to maintain permanent leverage within our long-term target of 2.5 to 3.5 times, and our capacity and flexibility to capitalize on accretive acquisitions positions Sprague for continued success well into the future.

This concludes my remarks, and I will let David wrap up before we take questions.

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David Glendon, Sprague Resources LP - President and CEO [4]

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Thank you, Gary. I'd like to take an opportunity to highlight our safety performance, and I am pleased to report the achievement of a major milestone within our break bulk material handling business. With hard-work and a focus on continuous improvement, the break bulk material handling team has achieved a reportable injury frequency of zero, which reflects no OSHA-reportable injuries with in the last 12 months. To help put this in perspective, the comparable industry average frequency for this business is 5.6. We also recently had the opportunity to recognize six of our terminal operators for 20 years of continuous safe work with Sprague, and I'd like to offer my congratulations and appreciation for this achievement.

Let's open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Justin Jenkins, Raymond James.

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Justin Jenkins, Raymond James Limited - Analyst [2]

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Thank you for all the details today on guidance and everything else, and all the color on the quarter. Maybe I will start on the M&A front, clearly a busy start for the year for you guys. I'm just curious on the pipeline for deals now as we look going forward. I would also like your thoughts maybe on the organization's capacity to integrate the deals already completed, while maybe still pursuing other opportunities that might be out there.

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David Glendon, Sprague Resources LP - President and CEO [3]

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Good question, Justin. I'd say the environment remains and we remain quite active, so we're very pleased to have closed on three transactions, which we've been working on throughout 2016. And we still have a pretty full pipeline of activities that we're considering.

To answer your second question, in terms of the integration challenges, it really depends on the business that we have acquired. So if you look at the last three that we've closed on this year, I would say that two of them are quite easy to integrate, the Springfield LE Belcher terminal asset and the Capital terminal.

In both cases, we were very familiar with those assets, have been operating out of those assets. In fact, we've been the exclusive lessor of the capital terminal. And so, it's really a pretty quick and smooth transition to move those into the Sprague system.

Within the natural gas business that we acquired from Global, candidly, there were some challenges there, primarily on the integration of systems. There's always human asset challenges in any acquisition, but the systems for natural gas and the ability to interact with all the utilities and move those utility pools onto Sprague's system is about a 3- to 6-month transition process.

I could stay with, we have a high degree of confidence, given that we have effectively done that twice now in the last 2 years. So, but it does take some time. So that would be an area where it would be a little bit of a challenge to bring a new natural gas marketing business onstream in the next several months or so, but, again, we feel highly confident in our ability to integrate all three of these acquisitions while we're looking at new opportunities.

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Gary Rinaldi, Sprague Resources LP - CFO and COO [4]

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Justin, this is Gary. We would have acquired eight acquisitions in the last three years, including these three. So there have been a lot of lessons learned going back to the end of 2014 and 2015 that benefits us as we move forward on these more recent acquisitions.

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Justin Jenkins, Raymond James Limited - Analyst [5]

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Great, that's really helpful. Maybe changing gears, on the regulatory environment, seems like things are trending in at least a better direction there recently. Any thoughts maybe on incremental opportunities or challenges for Sprague maybe on the natural gas front more so, if we see more of these projects in the northeast enter construction and reach completion?

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David Glendon, Sprague Resources LP - President and CEO [6]

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Good point, Justin. I would say, yes, the regulatory environment has -- looks more favorable for energy projects in general. I would say there's no direct benefit to us necessarily from that, given the nature of our business. You've heard me in the past say, from a natural gas pipeline capacity in the northeast perspective, we don't mind the inherent volatility associated with being at the end of the pipeline and being in a constrained environment.

But we do expect there to be some capacity constructed in the five-year time horizon. The northeast clearly needs some additional capacity, but candidly, I'd expect there to continue to be some degree of constraint in the northeast gas markets.

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Justin Jenkins, Raymond James Limited - Analyst [7]

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Okay, great, and then if I could squeeze one more in. It seems like for the 2017 guide, even if you back out the expected contribution from the acquired assets just recently here, seems like the midpoint would still show growth relative to last year, even if we've had a reasonably tough start to the year from a whether perspective again in 2017. Maybe if you could provide a little more color on what you've seen so far in 2017 and maybe the push/pull on what to expect throughout the year.

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David Glendon, Sprague Resources LP - President and CEO [8]

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I think you characterized it effectively, Justin. Jan/Feb of 2017 was remarkably even a little warmer than Jan/Feb of 2016, but I am quite pleased to report that winter has arrived in the northeast today. So we're all quite bullish on the prospects for March.

So yes, I think you've characterized it appropriately. We obviously factor in the fact that we've had a warm Jan/Feb in providing that guidance, but yes, the core business, if you will, is expected to be up modestly.

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Gary Rinaldi, Sprague Resources LP - CFO and COO [9]

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Also, Dave, thanks, also we're forecasting, obviously a normal November, December from a weather standpoint. We have a bit of an uplift in our materials handling business related to the asphalt expansion project at River Road terminal. And we're expecting strong results at Kildair relating to asphalt, or related to asphalt marketing and the MGO project that was in operation for 5 months last year and 12 months in 2017. Also, a continued focus on cost management and the synergies related to the past acquisitions that we've done, will continue to drive our cost base down.

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Justin Jenkins, Raymond James Limited - Analyst [10]

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Great, appreciate all the color today, guys, and have a good weekend.

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Operator [11]

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Jeremy Tonet, JPMorgan.

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Unidentified Participant, - Analyst [12]

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This is Charlie in for Jeremy, actually. A lot of my questions there were answered, but still on the M&A front real quick, obviously a lot left in the acquisition facility. Coverage is good, leverage is good. Just more so focusing on the nat gas side, in DC, you're still pushing that footprint further south now that you've really bolstered your current footprint in the northeast.

And then just secondly, just a secondary question separate from that. You noted $6 million to $7 million in 2017 that are coming from those acquisitions, and then eventually ramps up to $10 million to $12 million. Just trying to understand the delta there. I know that's driven by the minimum volume increases at the Capital terminal. Just trying to understand the increments there, and how we basically -- how long will it take to get to the $10 million to $12 million mark?

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David Glendon, Sprague Resources LP - President and CEO [13]

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You're absolutely right, the vast majority of the delta between the near-term forecast and the ramp up is associated with the Capital terminal and conversion to gasoline and asphalt there. Overall, it's a 4- to 5-year ramp-up horizon. We will see that full benefit. There's also some benefit from just, as Gary mentioned earlier, a synergistic realization across each of the acquisitions.

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Unidentified Participant, - Analyst [14]

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Is that 4 to 5, should I just think about that as pretty balanced and sequential?

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David Glendon, Sprague Resources LP - President and CEO [15]

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I think that's a fair way of extrapolating the cash flows. And then, your second question, sorry -- or your first question that I didn't answer was natural gas expansion beyond the current footprint. The short answer is yes, we're looking at opportunities, we'll continue to look at opportunities.

And candidly, while we love the fill-in nature of the northeast acquisitions we have made there are limited appropriate targets within the northeast. So our sights will turn more to adjacent marketplaces.

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Gary Rinaldi, Sprague Resources LP - CFO and COO [16]

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Both south and west, stepping out geographically.

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Unidentified Participant, - Analyst [17]

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Great, thanks.

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Operator [18]

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Mike Gyure, Janney.

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Michael Gyure, Janney Montgomery Scott - Analyst [19]

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Can you talk a little bit about the SG&A increase, I think it's going from about $84 million, I think you said on the guidance between $90 million, $95 million. I assume that is acquisition-related. But maybe can you talk about the structure or maybe the cost structure that the acquisitions, that that is really driving there and what (inaudible).

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Gary Rinaldi, Sprague Resources LP - CFO and COO [20]

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The primary driver of the SG&A increase relates one to the -- primarily to the Global natural gas acquisition from a sales-force standpoint. Number two is with a higher distributable cash flow related to the uplift in earnings, there will be an increase in incentive compensation and those are the two primary drivers.

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Michael Gyure, Janney Montgomery Scott - Analyst [21]

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Great. Can you talk a little bit about the growth projects? The asphalt expansion, I think you said at River Road, what you're thinking of doing there?

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Gary Rinaldi, Sprague Resources LP - CFO and COO [22]

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Sure, you've seen in the guidance a big increase in our expansion capital and growth projects from prior years. We've got our guidance is $19 million to $22 million in 2017; that really relates to four specific projects. One is with the capital acquisition, the conversion in East Providence to gasoline; in our own Providence terminal, conversion to asphalt; and then River Road, we have asphalt expansion project; and at Kildair, we have got 12 months of the MGO tank conversion project.

Some of the Kildair project, and it specifically started last year and is into this year. So we have got about $19 million of expansion CapEx hitting 2019, with an uplift in EBITDA between $5 million in $6 million, growing to $7 million to $8 million in 2018 and will continue to grow a bit after that related to a step-up in the minimum related to the East Providence project.

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Operator [23]

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Lin Shen, HITE.

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Lin Shen, HITE Hedge Asset Management - Analyst [24]

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I just wanted to ask about the margin for refund products. I understand that last quarter was lower year over year due to the biodiesel ex credit. But how should I think about the rising crude price has any effect on your margin?

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David Glendon, Sprague Resources LP - President and CEO [25]

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Good question, Lin. I'd say we'd certainly encourage you look at it on an annualized basis in both businesses, natural gas and refined products, because there is some noise quarter to quarter. If you look at annualized refined product unit margins, it's pretty consistent year over year.

It's almost exactly in parity year over year, and we expect that those average unit margin levels to hold going forward as well. As you know, we're agnostic to crude pricing; it really has a derivative effect to us and our working capital and interest charges. But it doesn't really directly affect the unit margin realization in the business.

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Lin Shen, HITE Hedge Asset Management - Analyst [26]

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Great, and also maybe I missed that, but what was the reason for last quarter's (inaudible) material handling lower also?

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Gary Rinaldi, Sprague Resources LP - CFO and COO [27]

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Lin, it's Gary. It primarily relates to a drop in salt activity year over year. That was partially offset by an increase in gypsum, but salt was down in 2016 throughout the whole year relative to 2015 as we came out of 2015 with high inventories, then with lack of weather, our salt activity was down. We're expecting salt to be up materially in 2017.

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David Glendon, Sprague Resources LP - President and CEO [28]

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While the winter hasn't been particularly compelling from a degree days perspective, there has been more storms in the northeast this year, which cuts -- which adds to salt usage.

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Lin Shen, HITE Hedge Asset Management - Analyst [29]

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Great, thank you very much.

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Operator [30]

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Than, you, I don't see any other questions in the queue. I would like to turn the call back to management for final remarks.

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David Glendon, Sprague Resources LP - President and CEO [31]

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Thanks very much, Carmen. We appreciate everybody making the time to join us this afternoon and look forward to updating you in future calls. Have a great weekend, everybody.

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Operator [32]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes the program and you may all disconnect. Have a wonderful day.