Harris & Harris Group Management Discusses Q4 2012 Results - Earnings Call Transcript

Mar.20.13 | About: Harris&Harris Group (TINY)

Harris & Harris Group (NASDAQ:TINY)

Q4 2012 Earnings Call

March 20, 2013 10:00 am ET

Executives

Patricia N. Egan - Chief Financial Officer, Chief Accounting Officer and Treasurer

Douglas W. Jamison - Chairman, Chief Executive Officer, Managing Director and Chairman of Executive Committee

Daniel B. Wolfe - President, Managing Director and Chief Operating Officer

Analysts

Edward M. Woo - Ascendiant Capital Markets LLC, Research Division

Jerry Tweddell

Operator

Good day, ladies and gentlemen, and welcome to the Harris & Harris' Fourth Quarter 2012 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to introduce your host for today's conference, Patty Egan, Chief Financial Officer. Ma'am, you may begin.

Patricia N. Egan

Thank you. This presentation contains statements of a forward-looking nature relating to future events. Statements contained in this presentation that are forward-looking statements are intended to be made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to the inherent uncertainties in predicting future results and conditions. These statements reflect the company's current beliefs, and a number of important factors could cause actual results to differ materially from those expressed herein. Please see the company's annual report on Form 10-K, as well as subsequent filings, filed with the Securities and Exchange Commission, for a more detailed discussion of the risks and uncertainties associated with the company's business, including, but not limited to, the risks and uncertainties associated with venture capital investing and other significant factors that could affect the company's actual results. Except as otherwise required by federal securities laws, Harris & Harris Group, Inc. undertakes no obligation to update or revise these forward-looking statements to reflect new events or uncertainties.

I'll now turn the call over to Doug.

Douglas W. Jamison

Thank you, Patty. Good morning, this is Doug. And welcome to our call reporting on the year-end 2012. Harris & Harris Group is an early-stage active investor in transformative companies. I'll begin this call this morning making a few remarks on our business. I'll then turn it over to Patty Egan to provide a brief summary of our December 31, 2012, financials. Patty will then turn it over to Daniel to make a few additional comments and then we'll open it up for questions. We expect the call to last approximately 45 minutes.

One note, for anybody that's just dialed in, we do plan to show 2 videos during this presentation. And to be able to see those videos, you need to log onto the webcast. Additionally, after the presentation today, you won't be able to access those videos on the webcast, but you will be able to access them on our website. They will be embedded under the portfolio Company Section under the 2 respective companies, D-Wave and SiOnyx. Give us a day or 2 to get them up there.

The economic conditions have not changed drastically since I made the statement during the third quarter call that the current market conditions and trends do not favor Harris & Harris Group. American capital that has not embraced risk is no long-term vision. But I also said that over the coming years, I believe, "We will see a return to scientific innovation to remain competitive." I believe this return to innovation will be led by corporations and not by the financial sector.

Harris & Harris Group is well positioned for the future. We've identified the investment sectors that we believe have the opportunity to provide outsized investment returns over the coming decade. And we continue to make investments in these areas. We believe there are opportunities to partner with third party capital within these areas to provide greater opportunities for growth for Harris & Harris Group.

Our existing portfolio is generating a tremendous amount of excitement. And finally, we see in the dismal state of support for American scientific innovation an opportunity to continue and to strengthen our leadership in bringing early-stage scientific discoveries to market.

As I mentioned in the Annual Letter to Shareholders, we've identified the investment sectors that we believe have the opportunity to provide outsized investment returns over the coming decade and we are making investments in these areas. In 2012, we made 2 new investments. In both cases, we invested more dollars and took a greater ownership position than our historic norm. This is a strategy we implemented over the past 2 years. Daniel will discuss both new investments in a bit.

Our existing portfolio is generating a tremendous amount of excitement. We currently have 24 companies in our equity focused venture capital portfolio that generate revenue as of today. In aggregate, our portfolio companies had approximately $532 million in revenue in 2012, which is a 25% increase from aggregate 2011 revenue. It's a 40% increase from aggregate 2010 revenue and approximately a 99% increase from aggregate 2009 revenue. Companies incorporating nanotechnology are finding resounding commercial success.

Currently, D-Wave is the company generating some of the greatest excitement. The progress made by D-Wave since our initial investment is evidenced by scaling its chips from 2 qubits to over 500 qubits is remarkable. The company raised additional capital in an oversubscribed round of financing from current and new investors, including a personal investment by Jeff Bezos of Amazon. It has secured multiple orders for its computers, that's multiple orders. And it recently expanded its management team with experience in public market companies, the new CFO, Steven Cakebread, brought Pandora public. He was President of Salesforce.com and he was CFO of Autodesk.

In a recent article of New Scientist magazine on March 6, 2013, D-Wave reported that it found evidence of quantum entanglement and experiments with systems of 2 and 8 qubits within its computers. Entanglement is a key component when determining whether quantum effects are occurring. This recent news provides further validation from the scientific community that D-Wave's capabilities are transformational and are solving some of the most challenging computational problems that exist. We recommend that interested shareholders read the article from the New Scientist magazine. It discusses quantum computing far better than I could and some of the problems D-Wave's computers have already solved. A link to the letter can be found in our Annual Letter to Shareholders, which is posted on our website.

Additionally, Lockheed Martin, not us but a major American corporation, Lockheed Martin, created a video that explains the power of D-Wave's computer and discusses how Lockheed is using it to approach problems that are too difficult for existing computational systems. I think it is worth taking a few minutes to watch this video, and we will show it at the end of the presentation today.

I would like to take a few minutes to discuss valuations as well. Harris & Harris Group has historically had the discipline to write down valuations when we believe there is a dislocation between what we witnessed in the public markets in the type of companies we invest in and what we see in the venture capital markets. We practiced this discipline again during the fourth quarter of 2012.

Of the decrease in value over the fourth quarter, $11.8 million was a result of decreases in the value of our privately held venture capital portfolio, offset by an increase of $4.3 million in the value of Xradia. Each company whose valuation changed had specific events and reasons for its valuation change. But there are 2 general reasons for such a large change in valuation during the fourth quarter of 2012. First, we experienced write-downs in several of our early-stage companies. These write-downs are not unusual. As we have discussed historically, some of these early-stage companies will be unsuccessful investments. To be successful is important for us to feed the fat hogs and starve the lean ones. That's why we continue to make new investments and we continue to make early-stage investments.

But historically, we've also taken intermediate write-downs in investments that later proved profitable. Sometimes we have the opportunity to reset the valuations to better represent the risk we see going forward. Sometimes this reset may benefit our ownership, thereby permitting us to realize greater value later, as the company executes on its business plan.

We believe that some of the decreases will be offset later by increases as these companies begin to execute on their plans. Historic examples of this will be NeuroMetrix and BioVex, both of which decreased in value before providing very good returns for Harris & Harris Group.

The second general reason driving changes in our private portfolio is our recognition that the public markets are currently ascribing lower than historical valuations to the type of companies in which we invest. We believe the public markets are undervaluing innovation and growth. Over time, we believe there will be some regression to the mean, driven by a return in the demand for investing in innovation and growth companies.

Write-downs in the values of more mature companies in our portfolio such as Adesto, BridgeLux, Cambrios are in part, representative of this recognition of the mismatch between venture capital pricing and values ascribed to companies at similar stages of development in the public markets. Adesto, BridgeLux and Cambrios all had record years of revenue in 2012. In spite of decreases in value of our holdings of each company as of the end of 2012, we remain excited about the prospects for all 3 companies and for the potential future returns from these investments to Harris & Harris Group above where we value these investments as of December 31, 2012. In all 3 cases, present value may not be indicative of future value.

Patty, will you now take us through the financials?

Patricia N. Egan

Thank you, Doug. At December 31, 2012, we had total assets of approximately $132 million on our balance sheet. Included in our total assets is our venture capital portfolio, which was valued at $108 million versus its cost basis of $111.7 million. Therefore, at December 31, 2012, our venture capital portfolio was in a depreciated state of $3.7 million.

We also held $22.8 million in cash and U.S. Treasuries and had no debt outstanding as of December 31. Included in our cash balance is $1.6 million of premiums from call options that we have collected during the year of 2012.

At December 31, 2012, our primary and secondary liquidity was $38.2 million. Our net assets at December 31 were approximately $128.4 million, and our net asset value per share was $4.13. This is a decrease from our net asset value per share of $4.70 at December 31, 2011.

Turning to our income statement. For the year ended December 31, 2012, we had investment income of approximately $722,000. This compares with approximately $703,000 in investment income during the same period in 2011.

Our total expenses were approximately $9.5 million for the year compared with $9 million during 2012. These expense figures include both cash and noncash-based operating expenses, such as stock-based compensation. Our total cash base and accrued operating expenses for the year ended December 31, 2012, were approximately $6.3 million, which is flat compared to our cash base expenses of $6.3 million in 2011. This yielded a net operating loss of $8.8 million through December 31, 2012, which is an increase to our net operating loss of $8.3 million during 2011.

During 2012, we had total noncash stock-based compensation cost of approximately $2.9 million. In May of 2012, the senior officers of the company voluntarily canceled all of their outstanding stock options. So included in the $2.9 million compensation costs for the year is a onetime noncash charge of $1.4 million related to the voluntary cancellation of these options. This expense would have been recognized as these options vested over days extending out to June 2014. We will not incur any additional compensation expense related to these canceled options in the future. This charge had no impact to NAV.

The remaining stock-based compensation expense relates to outstanding stock options for nonexecutive employees and to restricted stock. These expenses also have no impact to NAV.

I will now hand the call over to Daniel.

Daniel B. Wolfe

Thank you, Patty. As Doug mentioned earlier in the call, we have identified the life science and energy investment sectors as ones that we currently believe have the opportunity to provide outsized investment returns. In our most recent financial statements filed on Form 10-K, we began using the term life sciences rather than healthcare to reflect that portion of our portfolio. We believe life sciences is a more appropriate term than healthcare, owing to the scope of applications of life science-related companies outside of the traditional healthcare markets such as, agriculture, food and industrial biotechnology.

Trends generating disruptive investment opportunities in life sciences include: healthcare budgets are out of balance globally with the aging population jeopardizing the financial viability of leading economies of the world; life science innovations and diagnostics, treatment and monitoring of disease but simultaneously reduce cost and improve the quality of life. Continuing global growth in population and improvements in quality of life substantially increase the demand for raw materials, water, food and energy. This demand cannot be adequately met with conventional methods of manufacturing, generation, mining or harvesting. And the ubiquity of data and Internet access, while stationary and increasingly well mobile, enable handheld devices to become a natural access point for communication and data sharing between healthcare service providers and their patients.

Trends generating disruptive investment opportunities in energy include identification and extraction of natural resources is becoming a more of a science and less of an art. Such a shift in approach is driven in part by the need to manage a significant cost associated with energy-related projects and the availability of new methods of using data that were heretofore not available.

Governments and industry worldwide are looking for new and clear forms of energy. This has increased interest in the ability to produce chemicals and fuels from renewable resources. Additionally, governments and corporations and individuals worldwide also seek to translate significant amounts of data generated by today's monitoring capabilities into ways to optimize the use of energy and resources.

Our interest in life sciences and energy will continue to be multidisciplinary. For example, analytical, modeling and data acquisition techniques accelerated drastically during the first decade of the century, rapidly increasing the development of new diagnostic testing. We believe that this trend will continue owing to the successful migration of well-developed semiconductor manufacturing and computational technologies into life science applications.

Tools that are commonly used for inspection and certification of electronic devices could find use in analyzing soil and rock samples in oil and gas exploration. Organisms that are used to manufacture therapeutics could find use in the producing of renewable chemicals and fuels. These multidisciplinary products and services will seek to improve performance, productivity and efficiency and to reduce environmental impact, waste, cost, energy consumption and raw materials.

We encourage you to read more about our thoughts on these sectors, as well as the electronics sector, beginning on Page 43 of the Management's Discussion and Analysis section of our financial statements as of December 31, 2012, filed on Form 10-K.

During 2012, we added 2 new companies to our pipeline of portfolio of companies. These 2 new investments are AgBiome and Opgen. In December 2012, we made a $2 million investment in AgBiome. We are a founding investor in AgBiome. AgBiome is a provider of early-stage research and discovery for agriculture. It is utilizing the crop microbiome to identify products that reduce risks and improve yield. The founding team has a successful history of building and exiting companies that address agriculture-related needs. The company is currently in stealth mode. We look forward to being able to share more about the company in the future once it emerges from this status.

During 2012, we invested $3.26 million in a company called OpGen. OpGen is an innovator in providing rapid, accurate DNA analysis products and services. The company's proprietary whole genome mapping technology provides high-resolution, whole-genome maps for sequence assembly and validation.

Serine typing and comparative genomics. The company is dedicated to positively influencing individual healthcare outcomes, advancing scientific research and enhancing public health by delivering precise, actionable information and results to customers in the life science and healthcare communities. OpGen's customers include genomic research centers, public health agencies, biodefense organizations, academic institutions, clinical research organizations and biotechnology companies. Each of these investment represents our strategy to invest and own more of our portfolio companies than we have historically, as we would believe doing so could provide more meaningful returns upon our exit from these investments.

In addition to these new investments, we wanted to highlight a maturing company in our electronics portfolio, SiOnyx, which is another example of a company where we have substantial ownership. We originally invested in SiOnyx in 2006 based on its proprietary technology for improving the performance of light-sensing devices commonly used in consumer, commercial and defense-related applications. SiOnyx's image sensors are able to detect light that other similar sensors are unable to detect, particularly, infrared light. The performance of SiOnyx's image sensors, as shown on this video that we will show in a second, has led to the company securing opportunities and interest from market-leading companies in mobile community -- mobile computing, perceptual computing, mobile biometrics and gesture user interface control.

I believe that video will start.

[Presentation]

Daniel B. Wolfe

Lastly, I would like to discuss our strategy and execution for managing our publicly traded portfolio of company positions in Solazyme and NeoPhotonics. We continue to use option contracts to generate income from premium payments and to facilitate the orderly monetization of our publicly traded investments. We began the orderly monetization of our investment in NeoPhotonics during the fourth quarter of 2012 and completed this monetization in the first quarter of 2013. Our average sale price including option premiums, was $5.52 per share. As of the date of this call, we no longer hold any shares of NeoPhotonics Corporation.

We continued monetizing a small portion of our investment with Solazyme during the fourth quarter of 2012 and the first quarter of 2013. As of today, we have sold approximately 758,000 of our 2.3 million shares of Solazyme, generating total proceeds including option premiums, of $9.1 million or $11.94 per share versus our cost basis of our total investment in Solazyme of $5.4 million or $2.36 per share. $1.5 million of our realized returns were generated from premiums received on options that expired on exercise. We still hold approximately 1.55 million shares of Solazyme that currently have a market value of approximately $13 million.

We currently have 390,000 of these 1.55 million shares under call option contracts that expire in June 2013 to sell at $10 per share. Our strategy of using options to monetize our investments in publicly traded companies has thus far generated approximately $2.2 million in cash proceeds to the company.

I'll now hand the call back over to Doug.

Douglas W. Jamison

Thank you, Daniel. Again, we encourage our shareholders and those interested in learning more about our portfolio of companies to go to our website or to our Facebook page, where we have posted links to announcements made by more of our portfolio companies than we have time to discuss on today's call or in the shareholder letters. Good things are happening at many of these companies.

In closing, we believe we have found a solution necessary to make us successful in what has been a very difficult and changing venture capital environment over the last decade. We continue to execute on our priorities. It will take time, but we are excited by the performance of our portfolio and the receptivity to our story outside the financial sector.

What we'll do now is we'll open the line for questions and then we'll follow up the question period with a D-Wave video. So if we could open the line to questions now?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Ed Woo of Ascendiant Capital.

Edward M. Woo - Ascendiant Capital Markets LLC, Research Division

I had a question in terms of the industry performance currently. Do you think that you'll be continuing down and make investments in both healthcare and technology? Or do you think that there's one sector that you think would do better in the near term?

Douglas W. Jamison

So it's a good question. I think that as we look forward, as you know, we historically talked about life sciences, energy and electronics. If you look over at least just the past decade since we focused on nanotechnology, our life science investments and our energy investments have been the best performers and our electronics, thus far, have been a laggard. But as you heard from Daniel, there's a lot of interesting things happening in even electronics that can impact the life science market. So for instance, HzO, that can code electronics to make them waterproof. As applications in medical devices, that could become very important. So I think if you just look historically, we've looked at -- I think our number of life science investments has been increasing, and our 2 investments in 2012 were in the life sciences, but also, our investment in ABS and PWA, which is really in the produced water, in traditional oil and gas that has a fantastic opportunity and are currently preparing to test in Southeast Asia are other areas we're investing. So I think that you'll see us investing in both areas. And I think the thing to watch for is our investments will still continue to be multidisciplinary, so they'll be moving across different industry sectors as well.

Edward M. Woo - Ascendiant Capital Markets LLC, Research Division

Great. And I think in the 10-K there was a mention of one of your companies being approached for a potential acquisition. What is your outlook this year in terms of possibly an exit event?

Douglas W. Jamison

So I think that we will have an exit event this year. Of course, as we say in all of our disclosures, that we cannot, of course, guarantee that and that may not occur. But I think that we will see exit or exits in 2012 -- I'm sorry, in 2013. As often happens, 2011 we sort of had 5 exits, for probably one of the best years in Harris & Harris Group for exits. 2012, we saw that push back. I think I addressed some of that in the shareholder letter, where there are groups that are being approached that have been talking about exits. But the exit environment in the public markets is just not a good environment for companies that have control over their future. If you need the capital, you may have to exit in this environment. But a lot of our companies are in such a position where they don't need to do that. And so why would you subject yourself in the public market, especially if you're going to be a sub billion, sub $500 million market cap company? In the acquisitions space, I think the environment has been better. We talked about that historically with BioVex. I think that potential exit you will see in 2013 will be on the acquisition side rather than the IPO side. But I think we'll have better visibility into other potential exits looking through 2013 into early 2014 over the coming 6 months as well. Daniel, would you add anything to that?

Daniel B. Wolfe

No.

Operator

Our next question comes from Jerry Tweddell of Tweddell, Goldberg, LLC.

Jerry Tweddell

Gentlemen, how long ago was it that you made the announcement that you were seeking to acquire private money to run that money in joint venture in some of your investments? Seems to me that's quite a while ago, and I'm wondering if you've made any progress in that direction.

Douglas W. Jamison

I think we made the announcement really starting at the year-end reporting in 2012. So the beginning -- I'm sorry, year-end report in 2011, so beginning in 2012. We really began that process, I would say, in May of 2012. As we -- and there's not a lot we can say unfortunately as a public company looking to raise private capital. But as we've said historically, we believe that's a 12- to 18-month process. I mean, if you look at what it takes to raise a venture capital fund, and historically for a company like us that has never had limited partners of those partnerships, it takes a while to build those relationships. Those groups are not writing $500,000 checks or $1 million checks. They are writing $10 million, $15 million, $25 million, $50 million checks. So it takes some time to build that. We are actively making progress. But I think as I've said in the letter, that really, we will monitor that progress through 2013.

Jerry Tweddell

Well, my question stems from -- it sounds like your annual expenses are running at 8%, maybe 9%. And without some new source of revenues, that's a heck of a drain on any investment vehicle and that's of real concern to me.

Douglas W. Jamison

So just to be clear, the expenses that you're referencing include a fair number of noncash stock-based compensation. Our expenses actually from a cash base perspective, run about this past year, is about...

Patricia N. Egan

$6.3 million.

Douglas W. Jamison

It's $6.3 million or 4.6% of our total -- of our net assets. So if you do go back and look, I mean, we clearly understand, right? The difficulties Harris & Harris Group has faced historically is to be a public company with our asset size investing in venture capital. Our asset size is too small. We need to grow that asset size. You've heard us also say that we're capital-constrained. And that is something we are working to address. I think that if you look at us compared to a traditional venture capital firm and you remove the expenses of being public, I mean, the incredible amount of director and officer insurance that one needs to cover, the accounting expenses that took off in 2005 from under $100,000 to greater than $400,000. You remove those public expenses and I would argue, we run this company more efficiently than most or all other venture capital firms across the country that are private. We have been addressing that. We did some venture debt. The income coming in from the call options of our public companies has helped offset those expenses annually to a more predictable pattern than our exits have. But our strategy going forward is really to address that. I mean, the position we'd like to be in and that we said publicly, is to really begin removing the expenses annually and having the vehicle be a clear option on the venture capital returns, which are difficult to predict and take some time, but also can be very large exits when they occur. So your point is well taken, we understand that. I think we've done a lot to address it. We've looked at management. I don't think drastically cutting expenses is going to do anything to change our vehicle at this point in time. I think we run it very leanly. I think we need to get to exits and monetization events to provide growth in capital. And again, I think the strategy of managing third party capital that actually brings in income and also brings in carry goes a long way to address that. And that's what we're working on executing on currently.

Jerry Tweddell

So you can't give any guidance about how long we can expect before something materializes or doesn't materialize?

Douglas W. Jamison

So I think, I mean -- 12 to 18 months is what we talked about normally to raise these funds. I think that, that is probably indicative of most venture capital firms. And so I can't give you any guidance other than general in the industry. Unfortunately, that's all. The SEC solicitation rules prevents any one raising private money from discussing any details publicly before it's actually completed.

Jerry Tweddell

You had 5 exit events in 2011. And your investors are no better off now than they were at the bottom of the market crash in March of '09. I've been a long-time investor, but I wonder about the business plan, without infusion any of this private capital. That's why I emphasize it. It doesn't seem to me that it's proving to be a very sustainable business model. It probably was when the company was founded. But the investment world, as you mentioned, is radically different than it was then. So that's my concern.

Douglas W. Jamison

Now, understood. I think that -- look, we don't disagree with you that the investment -- it has changed dramatically. During that period of time, we think that we have articulated a strategy that allows us to move into this new world. Again, we went out to the market and raised capital, significant amounts of capital from '03 through '09. We have not been back to the market since, which means that we funded the company through the realized exits in the portfolio. We believe more are coming. And we believe that with the exits that are coming and with the strategy we've discussed that we have built the company to be successful moving forward.

Operator

[Operator Instructions] At this time, I'm not showing any further questions. So I'd like to turn the call back to management for any further remarks.

Douglas W. Jamison

That's great. Thank you very much. What we'd like to do is just a couple of announcements and then we'd like you to stay online to see the D-Wave video. I will note the D-Wave video not prepared by us. This is prepared by the first customer of D-Wave's computers, Lockheed Martin. It's a video that they put together talking about the power of quantum computing, and I think it really does a great job of discussing why D-Wave is very unique and why this ability to do quantum computing can dramatically change how we think about complex problems, going forward.

I'd also like to note, yesterday afternoon I believe that Amgen announced topline results from a Phase III trial on melanoma for the drug originally developed by our portfolio company, BioVex. I note that because that was successful with a 16% response rate as compared to a 2% response rate in sort of best-of-class therapy to date. So dramatically different matches.

I think what we have seen historically in the Phase II data as well, I think it's interesting to follow because it will certainly impact our milestone payments potentially as well. So that's available publicly, if anybody wants to see it.

And I'd like to thank everyone for their support of Harris & Harris Group. We believe we are taking the right steps to make this company successful for shareholders. I hope you enjoy the D-Wave video. We invest in transformational companies that have the opportunity to really change the world. We think that BioVex, with the first-in-class oncolytic virus, now moving through Phase III clinical trials, we think companies like Solazyme, we think companies like D-Wave, really fit this vision well. And enjoy the video. Thank you.

[Presentation]

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.

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