NorthWestern Corporation Q4 2008 Earnings Call Transcript

Feb.13.09 | About: NorthWestern Corporation (NWE)

NorthWestern Corporation (NYSE:NWE)

Q4 2008 Earnings Call

February 13, 2009 2:00 pm ET

Executives

Dan Rausch – IR

Bob Rowe – President & CEO

Brian Bird – VP & CFO

Analysts

Chris Ellinghaus – Shields & Company

Brian Russo – Ladenburg Thalmann

Paul Ridzon – KeyBanc

Unspecified Analyst

Operator

Welcome to the Northwestern Corporation’s year end 2008 financial results. (Operator instructions) I would now like to turn the conference over to our host, Mr. Dan Rausch; please go ahead.

Dan Rausch

Good afternoon and welcome to NorthWestern Corporation’s December 31, 2008 year-end financial results conference call and webcast. NorthWestern's results have been released and the release is available on our website at www.northwesternenergy.com.

We also filed our 10-K pre market open this morning. Joining us today are Bob Rowe, President and CEO; Brian Bird, Chief Financial Officer; Miggie Cramblit, General Counsel; and Kendall Kliewer, Controller.

This presentation contains forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based only upon our current expectations and speak only as of this date.

Our actual results may differ materially and adversely from those expressed in our forward-looking statements as a result of various factors and uncertainties, including those listed in our Annual Report on Form 10-K, recent and forthcoming 10-Qs, recent Form 8-Ks, and other filings with the SEC. We undertake no obligation to revise or publicly update our forward-looking statements for any reason.

I'll now turn it over to President and CEO, Bob Rowe.

Bob Rowe

Thank you Dan, as many of you know I have been with NorthWestern for about six months now. We have done a tremendous amount during that time. I want to start the call by saying that I am deeply impressed by our employees at all levels of the company, particularly by their determination to provide real value for shareholders and for customers alike.

We have worked very hard to communicate this commitment to all of our stakeholders and then to live up to it. Thanks to hard work, discipline, and a long-term perspective, NorthWestern Energy ended 2008 with an increase in net income of 27% over the prior year. We also took significant steps toward our goal of being a fully regulated company.

In Montana, the Montana Public Service Commission approved adding to utility ratebase our 30% interest in Colstrip Unit 4 effective January 1 of this year. This is the beginning step in becoming a vertically integrated utility in Montana. We no longer have any significant unregulated assets and again this was an important milestone for the company.

In South Dakota of course our electric business continues to be and always has been vertically integrated. We have worked very hard and earned an increase in our debt ratings and our stock performance notably exceeded the utility indices. More specifically our net income improved to $67.6 million for 2008 compared with $53.2 million in 2007.

For the shareholders the Board was able to approve increasing our quarterly dividend to $0.33.5 per share and we also completed a share buyback program of approximately 3.1 million shares for approximately $78 million. In addition we settled the Montana Electric and Natural Gas general rate filing, that resulted in a $15 million increase in base rates which was the first such increase to base rates in nearly eight years in Montana.

In Montana we filed for advanced approval with the PSC for constructing the 150MW Mill Creek Generating Station which is necessary to meet our regulating needs. The hearing on our Mill Creek application is set for later this month. If approved the plan could come online by the end of 2010.

Just last month the Montana Department of Environmental Quality or DEQ, issued the air quality permit for Mill Creek related to the MSTI project our major transmission initiative. In June 2008 we filed the Montana Major Facilities Siting Act application with the Montana DEQ and that application was deemed complete in December of 2008. This was of course a significant milestone in that project.

So we are delighted with our operational progress and our increased earnings during 2008. We look forward to next year. We are initiating guidance for 2009 of $1.85 to $2.00 per fully diluted share and now its my pleasure to turn the call over to our CFO Brian Bird to discuss our 2008 financial results in more detail.

Brian Bird

Thanks Bob, as Bob mentioned financially and otherwise the company had a good year in 2008. Consolidated net income was $67.6 million, or $1.77 per diluted share for 2008 compared with consolidated net income of $53.2 million or $1.44 per diluted share for 2007.

Operating income was $170.2 million compared with operating income of $140.1 million during 2007. The main drivers to our operating income and earnings increase during 2008 were as follows. First gross margins increased by $30.4 million primarily due to the combination of increased electric rates in Montana, and increased gas rates in Montana, South Dakota, and Nebraska of approximately $20 million.

We also had 11.7% increase in volumes in our regulated gas segment due primarily to colder winter weather. Offsetting these increases were primarily a reduction in unregulated electric margin due to lower average contracted prices, and lower recovery of property taxes and revenues primarily as a result of lower property taxes in Montana in 2008.

For the ending December 31, 2008 our total operating expenses were effectively flat as compared to 2007 but included some items worth noting. First and foremost we had increased pension expense of about $8 million compared with 2007. You may recall during the third quarter we thought our pension expense would actually increase to about $15 million for 2008, but we did receive an accounting order from the MPSC in December that enabled us to spread the increased pension expense over five years thereby reducing the impact down to the $8 million for 2008 I mentioned earlier.

We also experienced increased labor and benefit costs in 2008 due to a combination of compensation increases, severance costs, and higher medical claims. In addition higher professional fees related to the Colstrip Unit 4 transaction and other matters occurred. An increase in depreciation expense due to the purchase of our previously leased interest in Colstrip Unit 4 and finally we had lower environmental expense in 2007 due to a settlement to recover manufactured gas plant clean up costs in our South Dakota natural gas rate case.

These increased costs were offset by insurance reimbursements, and settlement proceeds we received in 2008, also a decrease in property taxes of about $7 million due to a $4.6 million property tax refund in Montana as a result of a settlement with the Montana Department of Revenue, and a reduction of approximately $2.4 million due to lower property tax valuation in Montana as compared with 2007.

Finally we had lower lease costs related to the purchase of our previously leased interest in Colstrip Unit 4. Below the operating expense line our interest expense increased approximately $7 million primarily due to additional debt incurred with the purchase of our previously leased interest in Colstrip Unit 4.

Our fourth quarter net income for 2008 increased by $2.8 million over the same period in 2007. The increase is primarily due to rate increases, litigation settlement proceeds, and lower 2008 property taxes. These items were partially offset by a credit to customers related to the property tax settlement, a change in the calculation by the MPSC to reduce the allocation of property taxes to Montana electric retail customers, lower environmental expense in 2007 due to a settlement to recover MGP clean up costs in our South Dakota natural gas rate case, and finally an increase in interest expense.

Let’s move our attention to the balance sheet, our balance sheet, and cash flow remains strong. As of December 31, 2008 cash and cash equivalents were $11.3 million compared with $12.8 million at 12/31/07. The company had revolver availability of $86.2 million at December 31, 2008 compared with $158.7 million at 12/31/07. This decrease in revolver availability was due to the share buyback program of approximately $78 million that was completed during the third quarter of 2008.

Total debt at December 31, 2008 was $862 million compared with $806 million at 12/31/07 and the company maintains a strong long-term debt to total capitalization ratio of approximately 53% at December 31, 2008.

Cash provided by operating activities totaled $198 million during 2008 and was relatively flat when compared with $202 million during 2007. The company used $124.4 million for investment activities during the year ended December 31, 2008 compared with $256.5 million during the year ended December 31, 2007.

The primary difference from last year is that the company used about $140 million in 2007 to purchase the previously leased interest in Colstrip Unit 4. Capital expenditures for the year ended 2008 were $124 million compared with $117 million in 2007.

The company used $75 million in financing activities during the year ended December 31, 2008 compared to finance activities providing about $65 million for the year ended 2007. First the company used approximately $78 million to repurchase 3.1 million shares of our common stock during 2008. The repurchases occurred from July to September and the average repurchase price was approximately $24.83.

Second proceeds from [warrant exercises] provided about $69 million in late 2007.

In summary our cash and liquidity positions are strong. We have two debt facilities maturing at the end of 2009, the first is for our $200 million unsecured revolving line of credit that matures on November 1, 2009. The current balance on that line is $109 million. The second is our $100 million non-recourse loan for the purchase of the previously leased interest in Colstrip Unit 4 which matures December 31, 2009.

Our current debt financing plans for 2009 include issuing up to $350 million of long-term senior debt securities to refinance our Colstrip loan maturing in December 2009, financing a portion of the proposed Mill Creek generation project, in addition funding and utility capital expenditures and providing funds for general corporate purposes.

In addition we plan to enter into a new revolving credit facility with availability between $200 to $250 million to replace our existing revolving credit facility maturing in November 2009. The timing of those financings will depend on when we can opportunistically enter the debt markets.

Also the company is rated investment grade by Moody’s, S&P, and Fitch. In January 2009 Fitch upgraded both our secured and unsecured debt by another notch. In addition Moody’s still has us on positive watch.

Now let talk about our 2009 earnings outlook, our guidance for fully diluted earnings in 2009 is expected to be between $1.85 to $2.00 per share. Our assumptions include the following expectations, 2009 net income will increase by approximately $9 million or $0.25 a share as a result of the inclusion of our interest in Colstrip Unit 4 and regulated electric ratebase. Also assuming the pension expense will be flat with the 2008 pension expense and assumes an 8% return on assets during 2009.

Regarding volumes our retail electric volumes will be flat compared to 2008 volumes. Residential commercial natural gas volumes will also be relatively flat compared to 2008 volumes. Wholesale electric volumes in South Dakota will decrease due to a planned outage in 2009. We are also assuming fully diluted average shares outstanding of 36.5 million and normal weather in the company’s electric and natural gas service territories for 2009.

So basically we expect 2009 earning to grow between 5% and 13% over 2008 earnings of $1.77 per share. Now let me turn it back over to Bob.

Bob Rowe

Thank you Brian, I’d like to discuss our prospects for growing the company. Our service territory is located in portions of the United States that are generally insulated from large economic fluctuations. To be clear we are not immune but generally we do see more stable economies in our region. As many of you know we previously announced three significant transmission growth projects which I will turn to after first discussing our supply initiatives.

On the generation side several items are worth mentioning. Earlier I stated that our interest in Colstrip Unit 4 was approved for an inclusion in utility ratebase in Montana effective January 1, 2009 at a market determined value of $407 million. Brian previously noted the resulting increase in our earnings. More importantly this unit will initially supply an estimated 13% of our Montana customers base load requirements through 2010 and about 25% thereafter at prices we anticipate will be more stable and lower then the prices in the marketplace.

The Montana Commission I believe indicated a strong recognition of the benefits to customers of ratebase supply and has given very constructive policy direction that can continue to guide us. In addition as I mentioned we have another generation project in front of the Montana PSC right now, the Mill Creek Generating Station will provide a regulating asset, a generation plant designed to keep the overall system in balance.

Together Colstrip 4 and Mill Creek will allow us to continue adding diverse, cost effective resources including renewable resources to our Montana ratebase. On the transmission side of the business as we’ve stated previously our Montana transmission assets are strategically located to contribute to the expansion of the transmission grid in the western United States.

This expansion will be driven in particular by demand for wind and other renewable resources to meet renewable portfolio standards throughout the west. Interest in new generation projects in Montana remain strong with over 5000 MW of proposed generation seeking to connect to our system. Not all of the generation projects will be built but there continues to be strong interest for developing new generation, again predominantly wind in Montana.

With any of these generation projects construction of new transmission lines is critical for transporting power to loads both within and outside of Montana as well as to alleviate congestion issues that are prevalent on existing lines. Its significant that the typical development time for a wind farm is much less then for a transmission project., again creating a sense of real urgency about transmission expansion and this sense of urgency is driven by national policy as you are aware by concern within the region and by state policy as well.

The three transmission projects that we have proposed are first, an upgrade to our existing 500 KV Colstrip transmission line running from east to west out of Montana to the pacific northwest. Second, the Montana collector system and third the mountain state’s transmission intertie or MSTI. I’ll talk more specifically about all these projects but before I do its important that I emphasize that we will only move forward with any of these projects when they make economic sense.

We have no appetite at this company to force these projects to move along at a pace that fails to match the demand for the particular project.

I’ll start with our proposed Mill Creek Generating plant, the Mill Creek plant will be designed as a generating facility that will serve again as a regulating resource and will provide services to our [native] service territory. As a system operator NorthWestern must adhere to stringent federal regulations to balance the moment to moment variations between load and supply and that’s particularly critical with wind resources which continue to come on to our system.

We received the final air quality permit from the Montana Department of Environmental Quality or DEQ just last month. In addition in August of 2008 we requested advanced approval from the MPSC related to Mill Creek and we expect a ruling by the PSC during the second quarter of 2009. The capital cost of the project is estimated to be around $200 million. The project is expected to have a capacity of between 125 MW and 150 MW which equates to approximately 85 MW of regulation capability.

The hearing concerning Mill Creek is expected to begin on February 25 at the PSC in Helena, Montana and the PSC is required to issue its decision during the second quarter of this year. The entire filing can be found on our website.

Now let me move to the proposed upgrade to the Colstrip 500 KV line, in August 2008 we announced that we and the other ownership partners in the existing Colstrip transmission system would work together to identify and evaluate one or more potential transmission system upgrades to the existing system to accommodate the transmission of wind and other renewable generation, again primarily in the pacific northwest. The other partners are Portland General Electric, Puget Sound Energy, PacifiCorp, and Avista. Additionally BPA, Bonneville Power Administration, has now decided to join this effort.

The parties have agreed to share the cost of conducting an independent review of the power transmission alternatives and potential ownership structures. Each party has agreed to contribute up to $100,000 toward the engineering review. The ownership structure will be determined once the projects if any are identified and agreed to by the participating utilities.

At this point we anticipate the capital spend for the entire undertaking could range between $200 million and $250 million. Our portion of the total capital on the project would depend on the ownership structure determined once the independent review has been concluded. Assuming all five partners decide to participate in building the project our portion would likely be between $50 and $60 million.

The project and depending on outcomes of the study would be completed by the end of 2011. In addition we are also looking at constructing a collector system to gather wind resources in Montana, you could think of these almost as a series of funnels. As stated earlier interest in Montana energy resources continues to grow. We recently filed with the federal energy regulatory commission to conduct an open season on this proposed collector system of up to five new transmission lines in Montana that would connect new generation, primarily wind farms and our proposed MSTI line.

Most of the new proposed wind generation that would be served by the collector system would be located in north central, central, south central, and eastern Montana, regions that have very high quality wind. While the regional economy certainly has slowed utilities across the west are still required to meet state renewable portfolio standards for their customers over the next several years, so the project, the collector system is designed to collect renewable energy generation resources from these various concentrated geographic areas and deliver that energy across the transmission system to facilitate access to market.

Again much of this is driven by the strong commitment to RPS standards throughout the western United States. The project is expected to cost between $150 million and $200 million and to be completed by the end of 2014. Now moving on to the Mountain States Transmission Intertie or MSTI, the proposed MSTI 500 KV line would extend from a new substation to be build near Townsend, Montana to the existing [bora] or midpoint substation located in Idaho.

The transmission line’s main purpose will be to meet requests for a transmission service from customers and relieve constraints in the high voltage transmission network in the region. The MSTI line provide additional capacity on a historically constrained path and connects expanding new markets in Idaho, Utah, and the southwest United States.

We recently filed the Montana Major Facilities Siting Act application and will be submitting the federal application soon. We have selected a preferred route as well as two alternative routes which will be reviewed as part of the environmental reviews. MSTI is currently undergoing environmental review with a draft EDIS due in mid 2009. The line would be approximately 400 miles in length and would cost around $800 million to $1 billion to construct.

We recently filed with the [FERK] a second open meeting open season on the MSTI line to allow new primarily renewable participants the opportunity to reserve capacity on that line and provide existing participants an opportunity to reaffirm their existing reservations. NorthWestern currently has 539 MW of expressed interest in the project and we are permitting this line 500 KV transmission line however we ultimately will match the capacity of the line to the market demand at the time of construction.

Based on our current timeline we anticipate the line could be in service by 2014. Now let me turn my attention to South Dakota, ITC Holdings Company recently announced work to develop a 765 KV line which they call the Green Power Express. This would be a network of transmission lines that would facilitate the movement of approximately 12,000 MW of power from wind abundant areas to populated areas. The Green Power Express project would traverse portions of North Dakota, South Dakota, Minnesota, Iowa, Wisconsin, Illinois, and Indiana and would ultimately include approximately 3000 miles of extra high voltage, again 765 KV transmission [inaudible] near Chicago.

This new project addresses a recognized lack of electric transmission infrastructure that is needed to integrate wind within the region. Portions of the Green Power Express fall within our South Dakota service territory. This project is in the very preliminary stages and will be evolving over the next several years. The path and the number of miles will obviously determine the total cost of the project. None of that has been determined and may not determined for a number of years.

At this point the Green Power Express is essentially conceptual and there will be more to discuss about the project in the future. But we announced our participation now because we do want people to know that we’re eager to be part of any energy solution that is proposed in our backyard, certainly in our South Dakota service territory. As a result we look forward to exploring potential opportunities with ITC and we are excited to be working toward providing renewable energy solutions in and around our South Dakota service territory as well.

So in summary we are very pleased with the results of the year and with our financial position. The company has achieved and maintains solid ratings with the ratings agencies, we are rated investment grade by Moody’s, S&P, and Fitch. We have modest debt maturity later in the year, no need to raise capital currently. Our earnings in 2008 grew 27% over 2007 and we expect 2009 earnings to grow between 5% and 13% over 2008.

We operate in a stable part of the United States that typically avoids the highs and the lows of other regions of the US economy. And finally we are optimistic about the future prospects of the company to enhance shareholder value and to provide great service to all of our customers. The utility industry is being called on to help lead the nation out of recession and to address multiple natural resource issues.

We at NorthWestern are very pleased to be in a position to do our part and do so responsibly and prudently producing value for our customers and for our shareholders.

With that we are ready for comments and questions. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Chris Ellinghaus – Shields & Company

Chris Ellinghaus – Shields & Company

Can you just review the, in the fourth quarter the tax and insurance recovery issues, what was non recurring.

Brian Bird

We had a $6 million insurance recovered. I would deem that as non recurring item going forward. I’m not sure if we had, I think that was the most significant recovery during the quarter.

Chris Ellinghaus – Shields & Company

I gather from the income statement that the shares are average basis, do you have the diluted shares?

Brian Bird

Average diluted, 37,976 shares.

Chris Ellinghaus – Shields & Company

In the guidance are you including anything for unusual tax or insurance recoveries for 2009?

Brian Bird

We have nothing in there that we don’t already know that we’ll receive.

Operator

Your next question comes from the line of Brian Russo – Ladenburg Thalmann

Brian Russo – Ladenburg Thalmann

You mentioned earlier that your regional economy is somewhat insulated from what we’re seeing around the country by yet you’re forecasting flat electricity sales, I’m wondering is it just the year over year comps because last year was a solid sales year or is there something else going on.

Bob Rowe

I want to be careful about what we say about the economy, we’re expecting new hook-ups to be relatively stable. We’re not experiencing some of the difficulties with collections that other utilities are. But in this economy stable is a pretty good place to be.

Brian Russo – Ladenburg Thalmann

What should we look for for you for there to be a bias towards the upside of your guidance range, better sales growth then you originally forecasted.

Brian Bird

Certainly that would help. I’ll tell you that expectations in terms of expense growth to be different then we forecasted as well.

Brian Russo – Ladenburg Thalmann

Is it safe to assume that these growth projects excluding MSTI can be funded with external debt and internally generated cash.

Brian Bird

Yes and remember on MSTI, let’s first talk about Mill Creek. That would certainly be with external debt and internally generated cash. I’ve mentioned previously is we were to do MSTI there would be a point in time where we would have to raise equity associated with that transaction.

Brian Russo – Ladenburg Thalmann

Have you been in talks with anyone in terms of forming some sort of partnership to lessen the balance sheet burden if you pursue MSTI.

Bob Rowe

We don’t comment on specific negotiations of that kind. We are as a general matter open to partnerships.

Brian Russo – Ladenburg Thalmann

In the guidance what kind of actual ROE are you assuming.

Brian Bird

When we actually calculate our guidance we don’t, we can back into an ROE but that’s not how we look at providing guidance in terms of an ROE. We do expect our ROE in 2009 to be better then it was in 2008, that’s all I’ll say.

Brian Russo – Ladenburg Thalmann

Can you tell us what it was in 2008?

Brian Bird

ROE was approximately 9%. In response to Mr. Ellinghaus’ question earlier, I believe the number I read to Chris was the basis number, the fully diluted number is 38.277 was the number I wanted to use.

Operator

Your next question comes from the line of Paul Ridzon – KeyBanc

Paul Ridzon – KeyBanc

Where do the NOL’s stand at year end 2008.

Brian Bird

They didn’t change much during the year, the NOL’s are right at $350 million. The reason it didn’t change is that we were able to utilize bonus appreciation to a great extent during 2008.

Paul Ridzon – KeyBanc

Are we still looking for the NOL’s to last into 2012?

Brian Bird

Yes.

Paul Ridzon – KeyBanc

There was no mark-to-market impact, that now flow through directly correct, that’s accrual accounting now?

Brian Bird

Yes and I want to clarify my earlier answer, on reserved basis the NOL’s will last through 2012.

Paul Ridzon – KeyBanc

Was this the normal time when you would address the dividend or was the June increase out of phase.

Brian Bird

To be quite honest we haven’t been all that consistent, we’ve changed the dividend policy we talked about dividend policy frequently every quarter we talk about it. We felt this time it was appropriate to make the change.

Paul Ridzon – KeyBanc

The stability of the economy, what do you think gives you that luxury as opposed to other regions.

Bob Rowe

It starts with the housing sector, there wasn’t the run up in most of our region that you saw in other areas. As a result there weren’t the huge numbers of foreclosures generally. Parts of our economy were, never as overheated as were some others. They tended to be more slow and steady and the bases remain relatively stable. Again that’s not to sell the situation. We are monitoring many of our larger accounts quite closely. We’re being mindful of what the situation is but again as I mentioned it’s a better situation then companies are facing in many other regions.

Operator

Your next question comes from the line of Unspecified Analyst

Unspecified Analyst

With regards to the NOL’s on your December presentation on your webpage, you talk about a potentially large tax payment sometime after 2012, it equaled the reserved amount, do you have an estimate right now, or a range of what that payment would be in 2012 or post 2012?

Brian Bird

I don’t have that information handy at this time.

Unspecified Analyst

Have you provided a range or estimate in the past?

Brian Bird

No. I don’t believe we’ve done so.

Unspecified Analyst

How would one go about to try to estimate something like that.

Brian Bird

That’s a great question. We haven’t talked about that publically at the point in time that we’ve drawn into that calculation a comfortable share and then we can share that at that time.

Unspecified Analyst

When you looked at your various growth opportunities it didn’t appear to me on the surface that the transmission projects have any potential incentive returns compared to some of the other ones that we’ve seen in other parts of the country, is that simply a matter of being conservative at this point or are there inherent characteristics that these projects which would not permit them to potentially qualify for [FERK] incentive returns.

Bob Rowe

No we are in fact being conservative as you suggested but our analysis does believe that [FERK] incentives would be appropriate.

Unspecified Analyst

Would that be for all the transmission projects listed or only for the MSTI.

Bob Rowe

Clearly for MSTI, we believe appropriately for the collector system as well.

Unspecified Analyst

And that issue will be resolved when roughly for the collector system?

Bob Rowe

We would expect in 2009.

Unspecified Analyst

With regards to your payout goal can you talk a bit about your philosophy given that you have capital opportunities here meanwhile you’ve been able to fund a lot of things internally and still provide a healthy yield how you balance the growth opportunities and outside capital with payout ratio as well as a competitive current income.

Brian Bird

We talked a lot about the dividend in light of current economic environment that’s going on and from our perspective as you point out our capital projects going forward, we believe that a slight increase in our dividend is still merited. We also want to consider if you take a look at the midpoint of our guidance and take a look at our dividend payout, we would be within that 60% to 70% range. And that’s been a goal of ours and we expect to do that in 2009 and its something we’ve committed to in terms of getting to that targeted range and at the same time we didn’t want to grow our dividends too much because we do have capital needs that are increasing over time.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Bob Rowe

Thank you all very much we appreciate your interest and look forward to meeting with you in the future.

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