National Penn Bancshares Inc. (NASDAQ:NPBC)
Q4 2008 Earnings Call
January 29, 2009 1:00 pm ET
Michelle Debkowski – Investor Relations
Glenn Moyer – President and Chief Executive Officer
Michael Reinhard – Chief Financial Officer
Scott Fainor – Chief Operating Officer
Welcome today’s program National Penn Bancshares Webinar. At this time all participants are in a listen only mode. Please note this call may be recorded. I’ll be standing by if you should need any assistance. It is now my pleasure to turn the conference over to Michelle Debkowski., please go ahead.
Thank you. Good afternoon and welcome to National Penn Bancshares Fourth Quarter and Year-End 2008 Earnings Webcast. Questions will be accepted up to the conclusion of our prepared remarks via Email.
Please use the Email button located on the conference screen to ask your question. Due to time constraints, we may not be able to answer all of your Emails. Additionally, as we review questions received, we may combine questions that raise similar issues or can other wise be combined for comments.
As part of our webcast presentation you will see that there are slides with financial highlights available for your independent review. The presentation and slides will be available on our Web site, as well as filed on form 8-K with the Securities and Exchange Commission following our webcast.
The presentation contains forward-looking information that is intended to be covered by the Safe Harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. Many of these factors are listed on the slide on your screen. I’ll give you a moment to review the slides.
I’ll now turn today’s presentation over to Glenn Moyer, our President and Chief Executive Officer. Glenn?
Thank you Michelle. Also joining us today is Scott Fainor our Chief Operating Officer and Michael Reinhard our Chief Financial Officer. I will start the call today by noting that our fourth quarter and year end 2008 earnings release is available on the investor relations section of our Web site.
Earlier today we included a press release in a report on form 8-K that we filed with the Securities and Exchange Commission. Mike Reinhard will provide an overview of our financials; Scott Fainor will review our loan and deposit growth and asset quality. I will then wrap out with some concluding comments.
Our overall message today is that National Penn is navigating through this unprecedented economic situation with some disappointments, but positive news as well. Our challenges were outlined in an 8-K that we filed on December 30th 2008 and include increased credit cost, other than temporary impairment in our investment portfolio and a charge for an employee fraud loss.
On the positive side, our core earnings reflected solid loan demand from our customers, success in attracting deposits, and effective expense management. Scott and Mike will provide the details on these items during their remarks. Due to the uncertainty created in this environment we are not optimistic about a significant economic recovery in 2009.
That said we believe that National Penn has sufficient financial strength to take advantage of opportunities that most certainly will occur and that our company will emerge from this period in better condition than many of our peers.
As we talked to stake - shareholders and the analysts who follow our company we find that today capital if first and foremost on their minds. Be assured that capital is high on our list as well. In that regard we undertook two major initiatives during the fourth quarter to improve our capital position.
First, we approved enhancements to the company’s dividend reinvestment and stock purchase plan to provide a 10% discount on dividends reinvested, as well as for new cash purchases made under the plan. Optional cash contributions may now be made in amounts up to $50,000 per month, an increase from the prior monthly limitation of $10,000, thus providing an attractive incentive to increased participation in the plan; initial results have been encouraging.
During November, following announcement of these changes, optional cash contributions were $1.8 million followed by optional cash contributions of $3.7 million during December and $4.4 million during January.
This compares to a monthly average of only $38,000 for the ten month period prior to this change. We are very encouraged by these early results and we intend to complete these purchases by using authorized but unissued shares of our common stock.
Second, we issued $150 million of preferred stock to the US Treasury under the capital purchase program. The receipt of this investment improved National Penn’s tier one risk based capital ratio to 10.67% and total risk based capital ratio to 11.87% as of December 31, 2008 from 9.34% and 10.56% respectively, as of September 30, 2008.
Both of these ratios continue to be an excess of well capitalized requirements of 6% and 10% respectively. I’ll now turn the presentation over to Mike Reinhard, who will provide details about our fourth quarter and full year 2008 financial results.
Thank you and good afternoon. Let me begin by noting that this presentation contains the non-GAAP financial measures return on average tangible equity and core earnings. Due to a number of acquisitions in recent years; purchase accounting rules have negatively impacted our GAAP return on equity.
The non-GAAP return on tangible equity ratio excludes the impact of acquisition related good will and intangibles and is used by National Penn’s Management for comparative purposes in it’s analysis of the companies performance.
Core earnings exclude the impact of certain material non-core items this quarter. Due to material non-core items this quarter, we want to isolate and communicate the core earnings performance of our company.
Reconciliations of our GAAP and non-GAAP return on equity ratios and core earnings are included in our presentation today for your review. I would also like to note that our financial results for 2008 include Christiana Bank and Trust as of January 4th and K&BT Bank Corp as of February 1st, the respective dates they were acquired.
The addition of Christiana and K&BT has significantly changed our financial statements as compared to the periods prior to these acquisitions. Our fourth quarter 2008 results under accounting principals generally accepted in the United States referred to as GAAP reflect a net loss for fourth quarter 2008 of $35.76 million or $0.45 diluted share.
This compares to fourth quarter 2007 net income of $16.71 million or $0.34 per diluted share. Fourth quarter 2008 net income was impacted by four key items, three of which we reported in an 8-K filing on December 30, 2008.
Number one, a non-cash other-than-temporary impairment charge of $79.50 million pre-tax on CDO investments in pooled trust preferred securities plus the reversal of $2.71 million of accrued interest on these investments; this is an increase in the estimated $60 to $65 million charge reported in the December 30, 2008 8-K due to further deterioration in market conditions since that time.
Number two, a fourth quarter provision for credit losses of $18.50 million pre-tax, number three, an employee fraud loss of $4.50 million pre-tax, a significant portion of which will be recoverable in 2009 from insurance and asset recoveries, and number four, a positive fair value accounting mark of $6.50 million pre-tax, related to NPB Capital Trust II. Excluding the impairment charge, the fraud loss, and the positive fair value mark core earnings for the quarter were $0.18 per diluted share.
For the full year 2008, National Penn earned $32.27 million of net income or $0.42 per diluted share, compared to $65.23 million or $1.31 per diluted share for 2007. These results represent a return on average assets of 0.36% and a return on average common shareholders equity of 3.31% compared to 1.16% and 11.95% respectively for 2007.
Net income return on average tangible equity was 7.51% in 2008 compared to 24.52% in 2007. This non-GAAP financial measure is computed by dividing annualized net income by average common equity, that is reduced by average acquisition related good will and intangibles.
A provision for loan losses of $18.50 million was made in fourth quarter 2008, as compared to a provision of $6.88 million in the third quarter 2008. Total net charge offs for fourth quarter 2008 of $18.19 million compared to $4.82 million of net charge offs in third quarter 2008.
The provision for loan losses for the full year of 2008 was $32.50 million versus $7.83 million in 2007, while net charge offs were $29.27 million and $11.24 million for the full year of 2008 and 2007 respectively. Net charge offs were 49 basis points of average loans in 2008 versus 30 basis points in 2007. Scott will discuss credit quality in more detail in his remarks.
Our net interest margin decreased to 3.33% in the fourth quarter 2008, from 3.52% in the third quarter. Our fourth quarter net interest margin was negatively impacted by the write off of $2.71 million of accrued interest related to the impairment charge on the pooled trust preferred investments.
Without this reversal of accrued interest, the net interest margin for the fourth quarter would have been 3.46%, which is six basis points lower than the third quarter net interest margin. We attribute this change to the decrease in the general level of interest rates during the quarter.
We were unable to reduce our funding costs to the extent of the decrease in rates on our earning assets. Specifically, the prime rate fell by the full amount of the decrease in the fed funds rate, but we find that many of our deposit rates were at affective floors.
Additionally the competitive environment for deposits did not allow us to reduce other deposit rates as much as the drop in the prime rate. For the full year of 2008, the net interest margin was 3.47% compared to 3.39% for the full year of 2007.
Absent the positive affect of the amortization of the fair value marks for K&BT, which we described during our first quarter 2008 earnings release we had expected the net interest margin for the entire year of 2008 to be 3.28%, which was simply the weighted average net interest margin of National Penn, Christiana and K&BT combined, without any consideration of interest rate movements or shifts in earning assets.
The positive affect of the amortization of the fair value marks was 20 basis points during 2008. Therefore, without the benefit of the fair value marks, the net interest margin would have been 3.27%. We attribute this negative one basis point difference from internal expectations primarily to deposit price competition.
Our outlook is for continued pressure on the net interest margin in 2009, due to anticipated difficulty and reducing funding costs more then the reduction and asset yields and the reduction in the amortization of the K&BT fair value marks by eight basis points during 2009.
However, we recognize that we are in a dynamic and competitive market where pricing for loans, deposits, and investments can change quickly. Non-interest income was $26.79 million in this year's fourth quarter, excluding the previously mentioned income of $6.50 million related to NPB Capital Trust II and the $61.47 million non-cash impairment charge on the investment portfolio.
This compares to $29.21 million in the third quarter of 2008, excluding non-operating items in that quarter. The primary areas of decreased non-interest income linked quarter were wealth management and bank-owned life insurance.
The bright spot in our wealth unit is the fact that we achieved positive growth in the number of accounts during the year. In the bank-owned life insurance area, we moved a portion of our assets from a mortgage fund to a money market fund to improve the safety of our assets.
Accordingly, we are comfortable with the quality of our Bolle investments, but unfortunately with the higher safety the earnings rate is reduced. Non-interest expense of $59.71 million in this year’s fourth quarter includes the $4.50 million charge for the previously disclosed employee fraud.
Excluding this charge, fourth quarter expenses of $55.21 million exceed third quarter expenses by only $1.12 million. We consider $55 million to be our run rate for quarterly non-interest expenses going forward, excluding the following two items that will increase significantly during 2009.
Number one, we estimate that our FDIC insurance expense in 2009 will increase by approximately $6 million over our 2008 expense, and umber two, we estimate that our pension expense in 2009 will increase by approximately $3 million over our 2008 expense, given the actuarial assumptions for 2009 considering equity market values and the generally low levels of interest rates.
Therefore, including these two items we would expect the quarterly run rate of expenses to be in the $57 million to $58 million range. We believe that we can hold the line on non-interest expenses, considering our emphasis on cost management during tough economic times, offsetting the naturally increasing expenses of a growing company.
We recently completed our analysis of the K&BT cost saves for the full year 2008, and are pleased to report that we achieved in excess of 100% of the cost saves projected when we announced the transaction in September 2007.
We will continue to focus on our expense management strategies throughout 2009. Regarding the balance sheet, total assets grew $74.27 million or 3.17% annualized during fourth quarter 2008 to $9.39 billion, tangible common book value per share slip from $5.77 at September 30, 2008 to $5.52 at year end.
The positive impact of a higher dollar amount of common stock and an improvement in other comprehensive income was more then offset by the negative impact of the quarterly loss of a larger number of shares outstanding at year end.
Tangible common equity to tangible assets decreased to 5.06% from 5.28% at September 30th, due to the same factors above plus a larger amount of assets at year-end. Throughout this year, we’ve discussed in some detail our portfolio of bank and insurance company trust preferred CDO investments.
Last quarter, we recognized the potential for other than temporary impairment within this portfolio. As we prepare our assessment of this portfolio for year end, based on our cash flow approach an in accordance with gap, we recognize that other than temporary impairment had occurred.
As this recognition occurred just prior to year end, we thought it important to communicate this material news to you at that time. We did that via and 8-K filing on December 30, 2008.
Subsequent to year end, given the worsening outlook for the financial services industry, our future cash flow assumptions were refined with the assistance of our outside accounting firm and independent industry experts.
Accordingly, based on the completion of our year end assessment, with 10 of our 23 pools in an interest capitalization mode, a non-cash charge of $79.50 million was necessary for the recognition of other-than-temporary impairments.
We also reversed $2.71 million of accrued interest on these pools. The actual charge is higher than the estimate in the 8-k filings, due to pricing volatility in this asset class. The impairment charge of effectively wrote the value of these pools, down to $0.174 on the dollar in the aggregate.
These 10 pools represent approximately $94 million, or 58% of our cost basis for all 23 pools of approximately $164 million. At year end, our assessment of the remaining 13 pools in our held to maturity investment portfolio, representing a cost basis of approximately $70 million, concluded that there was no other-than-temporary impairment on these pools.
As those of you who follow these investments know, many trust-preferred pools were downgraded during the fourth quarter. Interestingly, none of our bonds that are in interest capitalization mode were downgraded. However, several of our performing pools were downgraded.
Consequently, we chose to favor our cash flow base methodology over reliance on ratings for our impairment's assessment. That said, in light of the outlook for the financial services industry, we cannot rule out a potential charge on any individual issues in the future.
We still believe that if the financial services industry continues to deteriorate, other-than-temporary impairment charges would occur pool by pool, over a period of time. Obviously, we will continue to monitor this situation very closely and communicate material developments as warranted.
I would like to discuss one more recent development. On Friday, January 16th, the Federal Home Loan Bank of Pittsburgh, of which we are a member, conducted a conference call for its members. During this call, they communicated a potential capital shortfall, due to fair value accounting treatment of their investment portfolio.
As a result, they have discontinued paying a dividend on their stock for the foreseeable future, and they have discontinued their practice of returning excess stock holdings to their members. In addition, they warned that a potential course of action, depending on the length and severity of their capital issue, could be to increase their stock ownership requirements.
Obviously, we are uncertain of the potential impact to National Penn, but what we do know today is that we currently own $55 million in Federal Home Loan Bank stock. The immediate impact is the loss of the dividends, which totaled $2.08 million in 2008.
Beyond that, we, and all other members of this Federal Home Loan Bank, will be monitoring this situation closely. Right now, I'd like to introduce Scott Fainor, our Chief Operating Officer.
Thank you, Mike. I'd like to take a few moments to comment on our loan and deposit growth, and then I will discuss credit quality in detail. Total loans were $6.33 billion at December 31, 2008, up $120.43 million, or 1.94% non-annualized from $6.21 billion at September 30, 2008. Total deposits were $6.39 billion at December 31, 2008, up $169.24 million, or 2.72% non-annualized from $6.22 billion at September 30, 2008.
Excess liquidity allowed us to reduce borrowed funds by $231.64 million during this tough period. Organic loan growth was $120.4 million non-annualized, on a linked quarter basis during the fourth quarter of 2008, and $470 million for the full year of 2008.
The net increase in loans, for the full year 2008 is reflective of a $445.3 million increase in C&I loans, an $18.1 million decrease in consumer loans, a $5.2 million increase in residential mortgages, and a $37.6 million increase in commercial real estate loans.
The National Penn relationship managers and credit risk managers remain focused on expanding our current customer relationships and new perspective relationships, through quality credit underwriting and increasing profitable products and services.
As reflected by our fourth quarter loan growth, we still maintain a steady pipeline of loans with continued loan demand across all the markets we do business within. We will continue capitalize on opportunities that bring full customer relationships to National Penn, as clients of larger and smaller competitors seek to establish a meaningful relationship with a quality regional financial institution that is ready and capable of serving their needs for the future.
Regarding the composition of our loan portfolio, we continue to expand the breakdown of our financial data included with our earnings press release. Non-performing assets, plus loans over 90 days delinquent totaled $37.14 million at December 31, 2008, compared to $30.36 million at September 30, 2008.
The breakdown of this category is as follows: commercial and industrial loans reported $12.54 million in non-performing assets, plus 90 days delinquent, as of December 31, 2008, an increase of $138,000, or 1.1% from September 30, 2008.
Our commercial real estate portfolio reported the highest dollar level of non-performing assets, plus 90 days delinquent, with $12.6 million at year end. This is an increase of $4.07 million, or 47.4% from September 30th.
The construction portion of the real estate portfolio, totaling $494.4 million in loans, accounts for most of the non-performing assets, plus 90 days delinquent in this portfolio, with $10.88 million at year end. Residential mortgage, non-performing assets plus 90 days delinquent were slightly down from the third quarter, totaling $5.71 million at December 31st, compared to $5.72 million at the end of the third quarter.
Consumer non-performing assets, plus 90 days delinquent, grew to $6.25 million at year-end, up from $3.66 million at September 30th, a $2.5 million increase. Net charge-offs for the quarter were $18.19 million at December 31, 2008. This compares to $4.82 million during the third quarter.
Charge-off totals were significantly impacted by one $5 million charge-off, related to a long-term private banking relationship, impacted by the Bernard Madoff securities fraud. None the less, charge offs were up in each sector of the portfolio. Total net charge offs for the year 2008 were $29.27 million or 0.46% of loan outstandings at year end.
Despite the trend in our loan portfolio, we believe our overall loan asset quality remains better than industry averages. At year end with our allowance for loan and lease losses at $84 million or 1.33% of loan outstandings, our total coverage of non-performing assets stands at 227%, what we believe is an appropriate position for our company at the current time.
Based on the strength of this coverage, our review of overall credit quality indicators and our ongoing loan monitoring processes, we feel we have adequately provided for loan and lease losses during the fourth quarter of 2008.
Our banking teams are aware of the challenges we face in the current economic slowdown. We will continue to monitor our loan portfolio's risk and concentration exposure diligently through 2009. Organic deposit growth was $169.2 million for the fourth quarter of 2008, up 2.7% non-annualized from September 30, 2008.
For the full year 2008 organic deposit growth was $385.6 million or 9.8%. The primary reason for this growth was our company's focus on corporate wide deposit gathering from our current and new prospective customers.
Core checking account, core money market and multiple CD promotions attracted new customers to the company from other banks where the main concern was moving to a quality regional financial institution and the safety of their funds.
Fiscal year 2009 will continue to have a strong focus at National Penn on deposit gathering across all of our lines of business. In addition to our organic loan and deposit growth for 2008, we remain encouraged by the consistent fee income from deposits, cash management, and electronic banking.
Our company is actively engaged in cross selling all of our products and services, as we continue to deploy National Pen’s strong relationship based business model. I’ll now turn the presentation back to Glen Moyer.
Thank you, Scott. The positive developments we spoke about, such as continuing growth momentum and loans, deposits, and wealth accounts gives us encouragement despite the current environment. Even though we do not provide guidance on earning per share, we believe that with the unprecedented events of 2008 creating a high degree of uncertainty for 2009, we should provide some perspective on specific segments of our earnings.
Accordingly, Mike reported on our outlook for net interest margin and non-interest expenses. We clearly acknowledge that we and most others in our industry are operating in troubling times. The charges we incurred are evidence of current economic conditions to which National Penn is not immune.
That said, we’re all being dealt from the same deck of cards. What remains to be seen, is how well we play them compared to our peers. 2009 will be a challenging year and as in 2008, some things that happened will be beyond our control.
Therefore, we will focus on those things that we can control, capitalizing on the trust and confidence that we've built with our clients. For over 100 years, National Penn has been a positive influence in our communities and our clients recognize the stability of our company.
We’re in this together and together we’ll make it through, and we believe that relative to peers, we’ll make it through in better condition to capitalize on the opportunities that we expect to arise in this environment.
This ends our planed remarks, before we go to questions and answers we do have one correction to make, Mike based on your comments.
Thank you Glenn, I need to clarify one item. I mentioned the non-cash other-than-temporary impairment charges three times during my comments. Two of those times, I correctly said $79.50 million pre-tax, the other time I stated an incorrect amount. The correct amount is $79.50 million pre-tax.
Okay thanks Mike. We’ll now address questions that have been received to this point. Questions that may be received after this point will be addressed as possible in the public filing of the transcript of our question and answer segment. Michelle.
Thank you Glenn, we do have several questions that were presented during the Web cast. Mike I’ll begin with you. Mike what are current CD rates looking like?
Our current CD rates range between 1.39% for a three month CD and 3.25% for a 30 month CD. The predominate area of interest by our customers, is in the 13 month category, currently at a rate 2.75%.
And continuing with CDs what amount of the CD base will re-price in first quarter ’09, or did in late fourth quarter ’08, that would benefit the cost of deposits in first quarter ’08?
Approximately $452 million will re-price in the first quarter of 2009, and those dollars currently carry a rate of 3.42%.
Mike, what is the remaining trust preferred balance and exposure?
The remaining total exposure to trust preferred CDO pools is approximately $84 million.
Thank you and what is the level you are holding the NPB Capital Trust II at, relative to its book value?
NPB Capital Trust II was valued at $19.25 at year end, versus a par value of $25.
Question related to the tarp program participation, can we ever show a profit after paying the 5% interest on the preferred stock?
Obviously, the $7.5 million annual dividend that will be paid on the tarp capital in and of itself is dilutive to earnings per share available to common shareholders, but to the extent that this is capital, it can be leveraged at a level to both overcome the dilutive effect and still be accretive to our capital ratios.
Glenn, I’ll ask you the next question. Is the fact that 55% of our common stock held by institutions good or bad?
As National Penn has grown and evolved, we have enjoyed a diverse stockholder base of both retail and institutional investors. Regardless of category, our approach has been and will continue to be focused on building shareholder value on a total return bases over the longer term.
Our selection in February 2008, to be placed in the S&P Small Cap 600 Index Fund, has increased liquidity in our stock and attracted more institutional investors, both of which we consider positive for our overall investor group.
Thank you, Glenn. Mike, a couple of questions back to you. What is the size and rating of the trust preferred and where are they being carried?
The ten pools of our 23 total pools that had other-than-temporary impairment were marked down to $0.174 on the dollar.
Are there any other [aceteric] securities, CDOs, CMBs?
We have one, literally one private label mortgage back security that’s approximately $4 million. We do have some concerns about this security and we are actively monitoring it.
And Mike was there a dividend cut of $.025? The most recent announced dividend was $0.17 but the prior quarter was $0.1725.
$0.17 is now the maximum amount allowable under National Penn’s participation in the US Treasury’s capital purchase program. The $0.1725 paid in the fourth quarter 2008 was unable to be continued under the Treasury’s rules, as it was after their effective date.
Glenn, is there an expectation for dividend cuts?
We have this item Michelle coming up embedded in a couple of different questions, now let me just comment. First of all, we are committed to maintaining our current cash dividend. We know that this quarterly payment is important to our shareholders, while our board makes the cash dividend decision on a quarterly basis, and we cannot guarantee future performance, I can assure you we will be working hard to keep our focus on our core earnings, which we feel is the best basis for us to calculate future dividends.
And Glenn, tangible common equity to tangible assets is now at 5.1%, is there a potential for a capital raise?
And again, we have this coming in a couple of questions, so let me kind of group those together and make a comment. First and foremost, we intend to stay well capitalized, as we are now. We want to be able to, as they say, play offense when opportunities arise, and we believe there are going to be some opportunities for the strong and forward-looking companies, and we want to view ourselves as being one of those, so we will stay well prepared to raise additional capital when the capital markets improve.
In the meantime, we are going to stay focused on core earnings and dwelling capital through steps like we mentioned where we enhanced our dividend reinvestment plan.
To date we are - our current shareholders have made an additional $9.9 million of investment over the first three months of the program. We think that’s a real positive and hope that it will continue.
Thank you. Mike, is there a potential for a good will impairment charge?
Our impairment analysis for 2008, which was performed by an independent valuation firm, indicated no good will impairment at this time.
Thank you. Scott, a question for you, where, geography wise, are you seeing the most stress from the credit standpoint?
Thank you, Michelle. The only geographical concentration in terms of credit stress is in our commercial residential construction portfolio in Philadelphia and the surrounding county. Montgomery, Delaware, and Chester Counties seem to have the greatest pressure because of the higher level of speculative building that took place in those markets.
Mike, I had a few questions to come back to you for. When the OTTI occurred, how much was taken back into the OCI mark of the original $28.9 million after tax that was there when the security got transferred to health and maturity?
The affect on other comprehensive income for the securities that had the other-than-temporary impairment was $17.1 million.
[MIM] compression was significant during the quarter, how much of the loan portfolio is typed to prime and is net interest margin going to continue to come under pressure?
Well the significance was mostly caused by the $2.71 million of reversal related to the customer-preferred securities that had other-than-temporary-impairment. Our margin for the quarter would have been 3.46% without that reversal.
Beyond that, our outlook for the net interest margin is for continued pressure in 2009, due to anticipated difficulty in reducing funding costs, more then the reduction and asset yields and a reduction in the amortization of the K&BT fair value marks, by eight basis points during 2009.
One final question for you, Mike and then one for you, Scott, the gain on National Penn Capital Trust Preferred; where was that gain recognized on the income statement?
It was reported in the line item called net gains, losses from fair value changes and it was $6.5 million.
And Scott, provisioning expense levels, where do you see them going from the current significant increase during the last quarter?
We finished 2008 at 0.46% of charge off level. We expect 2009 performance to be similar with some additional pressure, but will provide the provision expense to be at least a dollar for dollar match.
That ends our Web cast today and we thank all of you for joining us.
And this concludes your teleconference for today. Thank you for calling.
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