Delek US Holdings' CEO Discusses Q3 2013 Results - Earnings Call Transcript

| About: Delek US (DK)

Delek US Holdings, Inc. (NYSE:DK)

Q3 2013 Earnings Conference Call

November 7, 2013 10:00 ET

Executives

Uzi Yemin - Chairman, President and Chief Executive Officer

Assi Ginzburg - Chief Financial Officer

Fred Green - Executive Vice President and President, Refining

Danny Norris - Vice President, Finance

Analysts

Paul Sankey - Deutsche Bank

Roger Read - Wells Fargo

Paul Cheng - Barclays

Jeff Dietert - Simmons

Rakesh Advani - Credit Suisse

Operator

Good morning. My name is Summer. I will be your conference operator today. At this time, I would like to welcome everyone to the Delek US Holdings Third Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

I will now turn the conference over to Mr. Keith Johnson. You may begin.

Keith Johnson - Investor Relations

Thank you, Summer. Good morning. I would like to thank everyone for joining us on today’s conference call and webcast to discuss Delek US Holdings’ third quarter 2013 financial results. Joining me on today’s call will be Uzi Yemin, our Chairman, President and CEO; Assi Ginzburg, our CFO; Fred Green, our Executive VP and President of Refining; and Danny Norris, Vice President of Finance; as well as other members of our management team.

As a reminder, this conference call may contain forward-looking statements, as that term is defined under Federal Securities laws. For this purpose, any statements made during this call that are not statements of historical fact maybe deemed to be forward-looking statements. Without limiting the foregoing, the words believes, anticipates, plans, expects and similar expressions are intended to identify forward-looking statements.

You are cautioned that these statements may be affected by important factors set forth in our filings with the Securities and Exchange Commission and in our latest earnings release. As a result, actual operations or results may differ materially from the results discussed in the forward-looking statements. We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise.

Today’s call is being recorded and will be available for replay beginning today and ending February 7, 2014 by dialing 855-859-2056 with the confirmation ID number 20226424. An online replay may also be accessed for the next 90 days at the company’s website at delekus.com. Last night, we distributed a press release that provides a summary of our third quarter 2013 results. This press release is available on our corporate website and through various news outlets.

On today’s call, Assi will begin with a few opening remarks on financial performance for the quarter. Danny will cover additional financial details before turning it over to Fred to discuss initiatives in our Refining segment. Then Uzi will offer a few closing strategic comments.

With that, I’ll turn the call over to Assi.

Assi Ginzburg - Chief Financial Officer

Thank you, Keith. During the third quarter of 2013, market condition in our refining segment were less favorable compared to strong condition in third quarter 2012. A combination of factors including an increase in crude oil prices and declining Gulf Coast crack spreads and a narrowing of the Midland crude oil price differentials resulting in a decline in our refining margins on a year-over-year basis. We are able to partially offset the decline in refining margin with improved performance in our logistics and retail operations during the quarter. We ended up the quarter in a solid financial position with $428 million of cash and $59 million of net cash position.

Now, I will turn it over to Danny to discuss additional financial details.

Danny Norris - Vice President, Finance

Thank you, Assi. For the third quarter of 2013, Delek US reported a net loss of $1.7 million or $0.03 per basic share. This compares to a net income of $94.5 million, or $1.57 per diluted share in the third quarter last year. During the third quarter 2013, net income was also negatively affected by approximately $4 million after-tax or $0.07 per share primarily due to inventory mark-to-market adjustments and a combination of other cost related to acquisitions, higher tax rate and cost associated with financing related activities. The change in year-over-year earnings in the third quarter was driving primarily by lower margins in our refining segment.

As Assi mentioned, a combination of factors during the third quarter of 2013 created a challenging market. The Gulf Coast 5-3-2 crack spread was $12.30 per barrel in the third quarter this year compared to $29.96 per barrel in the third quarter of 2012 and $19.83 per barrel in the second quarter of this year. Second, the average WTI Midland crude discount to WTI Cushing narrowed to $0.28 per barrel in the third quarter of 2013 from $1.74 per barrel in the prior year period. As the price of crude oil increased from the second quarter of 2013 to the third quarter of ’13 the price of residuals including asphalt at El Dorado did not show a corresponding increase and margins were reduced. Also the crude futures market was backward dated in August and September, which further increases crude oil pricing on the majority of our crude due to contract pricing mechanisms.

Finally, during July and August wholesale rack prices were under pressure as a result of increased RIN values, which reduced the netbacks for gasoline at El Dorado during that period.

Now I would like to discuss a few additional items on the income statement. Total operating expenses increased by $3.8 million to $96.6 million in the third quarter when compared to the prior year period. This increase was primarily due to the addition of biodiesel plant acquired in January of 2013 and variable operating cost due to higher production levels in the refining segment.

General and administrative expenses increased to $27 million in the third quarter of ‘13 compared to $23 million in the prior year period. This increase was primarily due to legal, other taxes and outside services. Interest expense was $9.6 million in the third quarter of 2013 compared to $11.2 million in the third quarter 2012. This decrease in interest expense was primarily attributable to the reduction in overall debt levels, mark to market of interest rate hedges and lower utilization of our credit facilities. Our effective income tax rate was 14.3% in the third quarter 2013 compared to 35% in the third quarter of 2012. We continue to forecast the income tax rate to be no more than 36.5% on an annualized basis.

Turning now to capital spending, our capital expenditures during the third quarter of 2013 were $52.8 million, of which approximately $32.9 million was spent on our refining segment, $1 million in our logistics segment, $9.5 million in our retail segment and $9.4 million at the corporate level. Our 2013 capital expenditures are forecasted to be approximately $192 million. This amount includes $119.7 million in our refining segment, $6.5 million in our logistics segment, $34.8 million in our retail segment and $31 million at the corporate level. This increase from our previous forecast of $174.5 million is primarily due to shifting turnaround work from 2014 into the fourth quarter of 2013 in the refining segment and spending related to new store locations in retail.

Now I would like to discuss our results by segment. Our refining segment represented approximately 64% of the total contribution margin generated in the period. As mentioned earlier market conditions were less favorable in the third quarter. Our refining segment contribution margin was $38.7 million during the third quarter of 2013 compared to $186.6 million in the third quarter last year. El Dorado contribution margin was $9.7 million compared to $84.5 million in the third quarter of 2012. Our Tyler refinery contribution margin was $25.7 million in the third quarter of 2013 compared to $101.2 million in the same period last year. From a combined basis, our refining segment had a total throughput of approximately 139,000 barrels per day. At Tyler, we processed approximately 60,600 barrels per day of crude compared to approximately 60,000 barrels per day in the third quarter of 2012. The refinery continues to operate consistently near nameplate capacity.

Our El Dorado refining – refinery processed approximately 66,900 barrels per day of crude during the third quarter of 2013 compared to approximately 62,600 barrels per day in the year ago period. During the quarter, we averaged approximately 8,300 barrels per day of rail supply crude, of which approximately 4,200 barrels per day was heavy Canadian. As crude oil price differentials narrowed in the third quarter, our crude supply flexibility at El Dorado allowed us to reduce rail supplied crude.

Now, I would like to review our Logistics segment. Delek Logistics commenced operation on November 7, 2012 and results prior to this date are reported on a predecessor basis. The predecessor period includes assets contributed to Delek Logistics at tariff rates that were in effect prior to November 7, 2012. Contribution margin was $17.6 million in the third quarter of 2013. Results benefited from several factors: higher volumes in our Texas marketing operations, increased results and the segment benefited from approximately $2 million of RINs generated from our ongoing ethanol blending activities in West Texas. Additionally, the contribution from contracts associated with services provided to Delek US’ refineries and the reversal of the Paline Pipeline were also factors in higher results. Finally, on July 26, 2013, a subsidiary of Delek US sold substantially all of the storage tanks and the product terminal at the Tyler refinery to Delek Logistics, which improved performance in the quarter.

Moving on to the Retail segment. Retail’s contribution margin increased to $16.6 million in the third quarter of this year compared to $11 million in the third quarter of last year. Higher fuel margins during the period offset lower merchandise margins. We continue to focus on our initiative of building large format stores and completed six during the first nine months of 2013. Our goal is to complete an additional four to six stores in the fourth quarter.

I will now turn the call over to Fred to review initiatives in our Refining segment.

Fred Green - Executive Vice President and President, Refining

Thanks, Danny. I’d like to give you an update on our upcoming turnarounds at both refineries and projects we are planning to complete during that time. The El Dorado refinery is scheduled to begin its turnaround work on January 4 and based on projected schedule is expected to be down for 38 days. Expected total cost for this turnaround is $41 million, with $7 million being spent during 2013.

As we have discussed in the past, we will debottleneck the crude pre-flash tower to increase our flexibility to process an additional 10,000 barrels per day of light crude. In order to handle the additional barrels of light crude, the gasoline hydrotreater will also be expanded. These projects have a total estimated capital cost of approximately $12.5 million, which is in addition to the turnaround cost. Based on forward curve prices, we believe that these projects will generate approximately $9 million to $14 million of incremental contribution margin on an annual basis. We completed the first phase of the DHT expansion and demonstrated the ability to run 33,000 barrels per day which we believe can increase contribution margin by $6 million annually based on current market conditions. The final portion of this project which will increase production by 1,000 barrels a day to a total of 34,000 barrels per day will be completed during the turnaround. We expect this to add another $2 million annually to contribution margin based on current market conditions.

During October, we completed a turnaround of the Alki unit at Tyler and we are planning work for December on the DHT Coker and platform. This work is being done to improve the scheduling and efficiency of the upcoming five-year term. As a result of this downtime, crude throughput is expected approximately 55,000 barrels per day at Tyler for the fourth quarter. While we move some turnaround related work at Tyler into the fourth quarter of this year, we have decided to move the full turnaround from the fourth quarter of 2014 to the first quarter of 2015. We are planning to replace the FCC reactors at each refinery during each respective turnaround with state-of-the-art technology. On a combined basis, the expected cost is $18.3 million, which is in addition to turnaround cost. And we believe that the annual contribution margin will be increased by approximately $25 million to $30 million annually based on current market conditions.

Finally the Alki compressor at El Dorado was completed in early July. The project cost is $4.2 million and allows us to further optimize the operation of the FCC unit and increase gasoline production, this project on track to have a payback of less than one year based on current market conditions. On the final note, on August 1, enterprise converted one of its pipelines that provided distillates to Arkansas to other uses. Since then we are focused on providing ULSD into this market. With the upcoming projects scheduled to be completed at El Dorado, we should improve our ability to serve Central Arkansas once the turnaround is completed in the first quarter of 2014.

Now I will turn the call over to Uzi for his closing remarks.

Uzi Yemin - Chairman, President and Chief Executive Officer

Thank you, Fred. While the third quarter refining environment was challenging, we continued to focus on our operations and take advantage of growth opportunities. We increased our throughput in our refining system year-over-year and adjusted our crude supplies at El Dorado as the markets changed. Our logistics segment continued to grow through a dropdown of Logistics assets and that unlock value from the Tyler refinery. In addition we have completed two third party acquisitions of logistic assets including a terminal in North Little Rock, Arkansas in October. This terminal will be supported by the El Dorado refinery going forward. In an effort to take advantage of Canadian opportunities, we opened an office in Calgary during the third quarter and look forward to continuing to go our presence in that market.

We are focused on upcoming turnaround at our refineries that will allow us to complete projects that will further enhance good flexibility at El Dorado and improve throughput efficiencies at both refineries. Based on the forward curve prices these projects should generate approximately $50 million of contribution margin between production increases and yield improvement. With 87,000 barrels per day of Midland crude in our refinery system, we are well-positioned to benefit from the widening discount between WTI Midland and WTI Cushing that approached $4 to $5 per barrel in late October.

Our balance sheet remained strong and we have the flexibility to continue to focus on creating value to a combination of investing in our business and growing through acquisitions while retaining value to the shareholders. With that Summer, would you please open the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Your first question comes from Paul Sankey of Deutsche Bank.

Paul Sankey - Deutsche Bank

Hi guys. Uzi somewhat specifically Midland has been quite heavily discounted, can you talk about the dynamics around that market and remind us how sensitive your earnings after that discount? Thank you.

Uzi Yemin

Good morning Paul. Out of our system as of today and the system will change as we mentioned after the turnaround because of the increase of another 10,000 barrels of light. But as of today 87 out of call it 140 - 135 is Midland, so roughly two-third. As of this morning since we expected that we looked at the market the market is $5 under $4.90 under. As we see more of production coming online in Midland, there is some infrastructure coming and the Longhorn is still on the horizon, but production is rapidly exceeding the infrastructure. And honestly I am little surprised or we are little surprised that we see $5. We can actually lock first quarter of next year for $3.50 and we can lock for entire year to under we haven’t done it, but the opportunity exists.

Paul Sankey - Deutsche Bank

Interesting. And do you think that’s – so you don’t want to do it because you don’t think it’s attractive or?

Uzi Yemin

Well, we know that the biggest players in Midland people that take refineries that take Midland directly have some turnaround coming. If you include four refineries that are going to have turnaround coming in the next three to five months, so we actually see it widening only a month ago it’s worth a buck today its $5. So we still see it widening and as I mentioned as long as WTI I mentioned that to you in the past as always WTI stays above $85 to $90 there is a huge incentive produces to get out of the ground as quickly as possible and just sell it out right.

Paul Sankey - Deutsche Bank

Thanks Uzi. And then this follow-up, I think we kind of agree on crude markets and obviously they seem attractive to refiners, the concern is product markets, could you talk about product market dynamic as for as you are concerned? Thanks Uzi.

Uzi Yemin

Again that’s another great one. Third quarter we suffered badly from a netback and we spoke about these netbacks in the last call. This call is a different call now. If you look at Gulf Coast this morning it traded $2.24. However, New York however is traded over $2.50 i.e. $0.25, $0.26 higher over the Gulf Coast. So if you go along colonial, which we ship on colonial some of our products, markets that we serve like Nashville. Today Nashville is $2.47 or Chattanooga $2.45, Birmingham $2.53. So there are 25 states over Gulf Coast. So the netback that we see in these markets improved dramatically compared to what we saw in the third quarter. Now obviously Gulf Coast is having discount - discounted $0.25 cent under the screen, but the local markets Arkansas looks much more positive than the stream itself for the Gulf Coast barrels.

Paul Sankey - Deutsche Bank

Thanks Uzi.

Operator

Your next question comes from Roger Read of Wells Fargo.

Roger Read - Wells Fargo

Yes. Good morning.

Uzi Yemin

Good morning Roger.

Roger Read - Wells Fargo

I guess maybe following up on the last commentary there was a pipeline that was delivering product into the Arkansas area that was going to be shutdown. I can’t remember the exact day on that, but what are your comments about netbacks being better in that area a reflection of that or is that still something to come?

Uzi Yemin

Well, you are asking about the enterprise pipeline or the old difficult pipeline that used to go from the Gulf to the Midwest, that pipeline actually was shut. And we do see netback improving in Arkansas. And we do see Central Arkansas netbacks enjoying a wider margin and netbacks are going north. We have still didn’t see the full effect in October but as we are going forward we feel and we see it actually got the netback on distillate especially are getting better.

Roger Read - Wells Fargo

Okay, that’s helpful. And then if we could maybe just going back through the additional changes are making in the crudes that you can run. So if I understood correctly you are adding 10,000 barrels a day of light capacity at El Dorado, is that accurate?

Danny Norris

Yes, that’s correct.

Roger Read - Wells Fargo

Okay. In terms of adding that capacity what does that mean in terms of running Canadian barrels, are you limiting it all the type of heavy barrel or are we simply seeing a change from maybe a medium shower or a heavy suite and then switching that to a light suite – I mean have you lost flexibility. I guess it’s really where I am trying to go with the question.

Danny Norris

In fact that’s exactly the opposite. We are just adding the flexibility to be able to run at full rates in the refinery on the much lighter slate. We’re not losing any of the flexibility to shift it towards heavy when asphalt economics make sense.

Roger Read - Wells Fargo

Okay and then along those lines here the fourth quarter, how quickly have you been able to ramp up crude by rail deliveries given differentials it have opened up quite considerably from more we saw most of the third quarter.

Danny Norris

Obviously, we watch the market as much as you do Roger. And we see the Canadian as it’s been heavily discounted. So we are running more crude by rail right now as it may affect Paul asked earlier about Midland another component that helps us nicely now a days is the heavy Canadian being $40 under and we’re – we have the ability to run up to 12,000 of that Canadian heavy and as well as 35,000 barrels of crude by rail. And that’s the preference of our office now we have an office in Calgary we have local purchases in Calgary and we have an operation in Calgary.

Roger Read - Wells Fargo

Okay. Well that’s it for me. Thank you.

Uzi Yemin

Thank you.

Operator

Our next question comes from Paul Cheng with Barclays.

Paul Cheng - Barclays

Hey good morning guys. You said – just I want to make sure I understand we know what is your capability, in the fourth quarter are you actually running at 12,000 barrels per of heavy and 35,000 barrel per day of light or what that?

Uzi Yemin

No

Paul Cheng - Barclays

Or that’s difficulty in securing the supply?

Uzi Yemin

No, no, no, not that the ability, no, no, no we’re not running, no, no.

Paul Cheng - Barclays

Can you tell us that, how much you are running?

Uzi Yemin

Well we usually do not give guidance. We did say something about Tyler because of the littler turnaround that we are conducting in order to push the big turnaround. And now that we are in Tyler we are running 55 and in El Dorado we are running based on the normal schedule that usually see out from us.

Paul Cheng - Barclays

No, no I am talking about how much oil by rail you are running in the fourth quarter I am not asking that what is your total fourth quarter – you are running into fourth quarter. I mean that we know what is our capability, but how much is the actually is running. I mean with (indiscernible) if you are not running at your full capability is that means that and you have difficulty in securing the supply or that you really don’t have that capability yet?

Uzi Yemin

Well, no, no I will say it in a different way. We are running it based on economics, we are not constrained by either supply or by the railcar or by the oil floating facility. So let me be clear, we are running it based on economics and three is no constraint right now so we can run…

Paul Cheng - Barclays

Do they discount that you can’t – the economic will not justify to run that 12,000 barrel per day of heavy oil?

Uzi Yemin

Well you just assume that there is no alternative to that and without going into too much detail there is alternative to some of the barrels that is actually cheaper.

Paul Cheng - Barclays

I see and when you are looking at bringing the oil (indiscernible) for light oil while that Permian obviously there is a big discount but the Bakken discount is even lighter, from the economic standpoint is this still better offer to bring the Bakken light oil than the Permian for you guys or that is the other way now?

Fred Green

No, no it’s the Permian.

Paul Cheng - Barclays

Is the Permian is better for you at this point?

Uzi Yemin

Yes.

Paul Cheng - Barclays

Interesting, a final one on RIN I am not talking about the actual purchase cost, but I am talking about the impact on the marketplace, I think that in the early part of this year we have seen as RIN cost going up at the wholesale market and at these certain market that their wholesale price got impact and as s result of margin capture we go down as the price come down have you started to see a normalization of the wholesale market?

Uzi Yemin

It may affect surprisingly it’s different. As the RINs prices came down and the difference between the newer cargo and Gulf Coast stays as wide it was, wholesale margin actually came up surprisingly enough, if you do it net of RINs. So just as I mentioned earlier I am just giving this as an example. The Nashville market today 23, 24 trains the wholesale market is above the Gulf Coast. So, it’s anywhere between it’s based on colonial now being traded $0.20 per gallon which in my career I never thought I would see $0.02 now I see $0.20, so wholesale market looks very attractive along the colonial line.

Paul Cheng - Barclays

For Tyler when you are starting to it local market is that the margin being impacted by the Gulf Coast or that you are also seeing the improvement there?

Uzi Yemin

We are able to maintain our regular netbacks in Tyler. We never lost it and we are able to maintain it now.

Paul Cheng - Barclays

Okay, final one CapEx for 2014 is there any estimate?

Uzi Yemin

Well, you– let me look at this. Assi, do you want to take that one on the CapEx side?

Assi Ginzburg

I think we are going to finalize this in the next few weeks and now that we postpone the 2014 turnaround to 2015. The number may go down much we thought initially. And then we have other projects that we are looking to do during the turnaround. So I think it’s a little bit too early to give that number.

Paul Cheng - Barclays

Okay, that’s fine. Thank you.

Operator

And your next question comes from Jeff Dietert of Simmons.

Jeff Dietert - Simmons

Hey, it’s Jeff Dietert with Simmons. I was wondering if you could talk about asphalt pricing and demand in the third quarter, I know with oil prices rising in the third quarter, those margins got squeezed, but what did the asphalt demand look like?

Uzi Yemin

Well, again Jeff, we discussed at our last call. And we as a company always prefer price of crude oil coming down. So the wholesale price was around call it $92 and $93. It’s still about that number. Now in terms of demand, that was a very wet summer, so people didn’t pave as much, but luckily for us, we ran in third quarter close to 10% of asphalt and not 15%, but it still hurt us dramatically in the third quarter when prices hit 110 for WTI of the peak 112. And compared to what we see today we see 94 less $5 of the Midland, it’s 89. So demand was soft and still where we get of the season is not great.

Jeff Dietert - Simmons

Yes, yes I understand. Could you help me with you talked about the increase in Canadian heavy and I understand the steep discounts there, but I would also anticipate a fair amount of the yield is asphalt, how are you managing that and what are those economics look like relative to bringing in light crudes by rail?

Uzi Yemin

Let’s put it this way. Right now, we are now constrained with the light up to 72, 73. So it depends of the economics. However, you are absolutely right, WCS lays in almost 45% above, 35%, 35% to 45%. So in the winter, that’s the reason the prices are so depressed. That’s the reason we need to balance between the heavy and the light crude. And as we discussed earlier with the previous question, that’s the reason we are not bringing to 1,000 barrels of heavy Canadian even though we have the capability.

Jeff Dietert - Simmons

I understand. Thanks for your comments.

Uzi Yemin

Thank you, Jeff.

Operator

Your next question comes from Ed Westlake of Credit Suisse.

Rakesh Advani - Credit Suisse

Actually, this is Rakesh Advani. Just sort of quick question on the Gulf Coast refiners, especially the large ones are you seeing them encroach into your kind of market areas and putting pressure on margins over there?

Uzi Yemin

No, not really, Rakesh.

Rakesh Advani - Credit Suisse

No.

Uzi Yemin

We pretty much enjoy the niche. Now, especially obviously in Tyler for everybody, especially with the change of enterprise in Arkansas, we pretty much enjoy nice niche.

Rakesh Advani - Credit Suisse

Okay, so there is nothing and that was it for me. Thanks

Operator

(Operator Instructions) And there are no further questions.

Uzi Yemin - Chairman, President and Chief Executive Officer

Well, I would like to thank my colleagues around the table, our employees for putting a lot of hard work. That wasn’t an easy quarter. A combination of expensive crude, narrow differentials, very little netbacks didn’t help our performance. However as we go through the fourth quarter, falling price of crude, much better differentials especially in the Permian basin and much better netbacks will help our performance. Thank you. And we will talk to you soon.

Operator

This concludes today’s conference call. You may now disconnect.

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