McGrath RentCorp. Q2 2010 Earnings Call Transcript

| About: McGrath RentCorp (MGRC)

McGrath RentCorp. (NASDAQ:MGRC)

Q2 2010 Earnings Call

August 05, 2010 05:00 pm ET


Geoffrey Buscher - IR, SBG Investor Relations

Keith Pratt - SVP and CFO

Dennis Kakures - President and CEO


David Gold – Sidoti & Co.

Scott Schneeberger - Oppenheimer

Jamie Sullivan – RBC Capital Markets


Welcome to the McGrath RentCorp Second Quarter 2010 Conference Call. At this time, all conference participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator instructions). This conference is being recorded today, Thursday August 5, 2010.

Now, I would like to turn the conference over to Geoffrey Buscher of SBG Investor Relations. Please go ahead, sir.

Geoffrey Buscher

Good afternoon. I am the Investor Relations Advisor to McGrath RentCorp, and will be acting as moderator of the conference call today. Representatives on the call today from McGrath RentCorp are Dennis Kakures, President and CEO, and Keith Pratt, Vice President and CFO.

Please note that this call is being recorded and will be available for telephone replay for up to 48 hours following the call by dialing 1800-406-7325 for domestic callers, and 1-303-590-3030 for international callers. The pass code for the call replay is 4329570.

This call is also being broadcast live via the Internet and will be available for replay. We encourage you to visit the Investor Relations section of the company's website at

A press release was sent out today at 4:05 pm Eastern Time or 1:05 pm Pacific Time. If you did not receive a copy, but would like one, it is available online in the Investor Relations section of our website, or you may call 1206-652-9704 and one will be sent to you.

Before getting started, let me remind everyone that the matters we will be discussing today that are not truly historical are forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, including statements regarding McGrath RentCorp's expectations, beliefs, intentions or strategies regarding the future.

All forward-looking statements are based upon information currently available to McGrath RentCorp, and McGrath RentCorp assumes no obligation to update any such forward-looking statements.

Forward-looking statements involve risks and uncertainties, which could cause actual results to differ materially from those projected. These and other risks relating to McGrath RentCorp's business are set forth in the documents filed by McGrath RentCorp with the Securities and Exchange Commission, including the company's most recent Form 10-K and Form 10-Q.

I would now like to turn the call over to Keith Pratt.

Keith Pratt

Thank you, Geoffrey. In addition to the press release issued today, the company also filed with the SEC the earnings release on Form 8-K, the second quarter 2010 Form 10-Q.

For the second quarter 2010, total revenues were flat at $66.5 million compared to the same period in 2009. Net income increased 5% to $7.4 million, or $0.31 per diluted share from $7 million or $0.30 per diluted share for the same period in 2009.

Reviewing the second quarter results for the company's Mobile Modular division compared to the second quarter of 2009, total revenues decreased $7.1 million, or 19% to $29.9 million due to lower rental, rental related services and sales revenues.

Gross profit on rents decreased $4.1 million, or 27% to $11.2 million due to 13% lower rental revenues with rental margins decreasing to 55% from 65% in 2009. Lower rental margins were a result of lower rental revenues combined with flat depreciation, and $1 million higher other direct costs, for labor and materials to support higher activity levels.

Selling and administrative expenses, increased 3% to $7.3 million as a result of increased investment, in our Mid-Atlantic and Portable Storage, growth initiatives.

The lower gross profit on rents, $1.2 million lower gross profit on sales and increased selling and administrative expenses resulted in the decrease in operating income of $5.5 million, or 45% to $6.7 million.

Finally, average modular rental equipment for the quarter was $489 million, an increase of $12 million. Average utilization for the second quarter decreased from 75.3% in 2009 to 67.7% in 2010.

Turning next to second quarter results for the company's TRS-RenTelco division compared to the second quarter of 2009. Total revenues increased $1.6 million, or 7% to $25.7 million, due to higher rental revenues.

Gross profit on rents increased $2.7 million, or 53% to $7.6 million. Rental revenues increased $2 million, or 11%, and rental margins increased to 39% from 28%, as depreciation as a percentage of rents decreased to a 46% from 57%.

Selling and administrative expenses increased $0.4 million, or 7%, to $6.1 million. As a result, operating income increased $2.7 million, or 193% to $4 million, from $1.4 million.

Finally, average electronics rental equipment at original cost for the quarter was $242 million, a decrease of $7 million. Average utilization for the second quarter increased from 59.5% in 2009 to 66.2% in 2010.

Turning next to second quarter results for the company's Adler Tanks division compared to the second quarter of 2009. Total revenues increased $4.8 million, or 92% to $10 million, primarily due to higher rental revenues.

Gross profit on rents increased $3.1 million or 134% to $5.4 million. Rental revenues increased $3.9 million, or 103% and rental margins increased to 71% from 62% as depreciation as a percentage of rents decreased to 17% from 21%.

Selling and administrative expenses increased $0.9 million, or 40% to $3 million. As a result, operating income increased $2.4 million, or over four-fold to $3 million.

Finally, average rental equipment for the quarter was $93 million, an increase of $38 million. Average utilization for the second quarter increased from 53.3% to 66.2%. On a consolidated basis interest expense for the second quarter 2010 decreased $1.4 million to $1.5 million from the same period in 2009 as result of company's lower average interest rates and lower average debt levels. The second quarter provision for income taxes was based on an effective tax rate of 38.8% compared to 39.1% in the second quarter of 2009.

Next, I like to review our 2010 cash flows. For the six months ended June 30th, 2010, highlights in our cash flows included net cash provided by operating activities was $43.2 million, a decrease of 23.5 million, or 34% compared to 2009. The decrease was primarily attributable to a lower decrease in accounts receivables and other balance sheet changes together with lower operating results.

We invested $5.2 million for rental equipment purchases, compared to $33.7 million for the same period in 2009, partly offset $11 million in proceeds from the used rental equipment sales.

Property, plants and equipment purchases increased $3 million to $3.6 million in 2010. Dividend payments to shareholders were $10.6 million and net borrowings increased $16.2 million from $247.3 million at the end of 2009 to $263.5 million at the end of the second quarter of 2010.

We had total debt at quarter end of $263.5 million, the company had capacity to borrow an additional $103.5 million under its lines of credit, and the ratio of funded to the last 12 months actual adjusted EBIDTA was 2.12 to 1. We continue to have solid low average balance sheet.

For 2010, second quarter adjusted EBIDTA decreased $0.3 million, or 1% to 30 million compared to the same period in 2009. We had consolidated adjusted EBITDA margin at 45% compared to 46% in 2009. Our definition of adjusted EBITDA and a reconciliation of adjusted EBITDA to net income are included in our press release and Form 10-Q for the quarter.

Turning next to 2010 earnings guidance, at this time, based on the results for the first six months of 2010 and our outlook for the remainder of the year, we are confirming our previous 2010 full year earnings guidance range of $1.30 to $1.45 per diluted share.

At this point, I would like to turn the call over to Dennis.

Dennis Kakures

Thank you, Keith. Let's go right to our results for our Modular rental business. Mobile Modular's rental revenues for the quarter decreased by $3.1 million, or 13% from a year ago to $20.4 million. Sequentially, from the first quarter 2010, rental revenues were down less than 1% from $20.6 million.

During the first half of 2010, our Modular rental business continued to face challenges, particularly in the California market due to an unsettled fiscal landscape and high unemployment. However, during the second quarter, there were a number of positive developments that indicate we are likely in the early stages of stabilization and recovery.

First, rental equipment utilization rose slightly in both May and June from preceding months. Second, sequentially from the first quarter of 2010, in quarter-over-quarter, rental revenue bookings were higher in each of our operating geographies.

During the second quarter, we continued to see a flow of larger, commercial construction project opportunities in California, primarily associated with state infrastructure development and public works projects. These projects are for waterway, public transit, healthcare, roadway and other public infrastructure improvement.

We also experienced a higher volume of commercial construction projects in our Texas, Mid-Atlantic and Florida markets. School booking levels were moderate in Northern California and Texas, however stronger in Southern California, Florida, and the Mid-Atlantic. Although not robust by historical standards, overall for the division second quarter rental bookings were at their highest level since the third quarter of 2008.

With the slightly positive increases in utilization in both May and June, second quarter period in utilization rose to 67.9%, compared to 67.6% at the end of the first quarter. Although the period in increase was small, it represents the first quarter end increase in utilization, since the fourth quarter of 2008.

It's important to keep in mind that our modular rental business results, tend to behave differently than other types of businesses during the economic recession in recovery. During the downturn, due to the larger installed base of rental contracts, the orderly return of equipment overtime as customers needs are fulfilled tends to lower rental revenues graduate.

Same dynamic applies during the recovery in that new rentals coming online, add to the lower installed base of rental contracts and builds overtime. In other words, typically they are not dramatic swings down or up with rental revenue levels in the near-term.

As 2010 progresses, we are cautiously optimistic and we will see higher business activity levels in improving market conditions for a Modular division. However, we expected to remain a very price competitive environment in all the markets in which operate until utilization levels begin to rise across the industry.

Keep in mind that as the Modular business returns to grow, it will require limited new capital investment to increase rental revenues and we would expect to see a disproportionate share of this revenue dropped to the pretax line.

Now, let me turn our attention to TRS-RenTelco and their results. TRS-RenTelco's rental revenues for the period increased by $2 million or 11% to $19.8 million from a year ago. However, income from operations nearly tripled to $4 million from 2009 level.

In addition to the higher rental revenue levels, our electronics business also benefited from lower depreciation expense and higher gross profit on equipment sales quarter-over-quarter.

The pipeline of order opportunities during the second quarter was very strong and this trend has continued into the third quarter. We are seeing favorable demand across a number of end markets including semiconductors and communication products in networks.

Although, our rental revenue levels in our electronic division have grown very favorably thus far in 2010. We continue to be disciplined in what level of inventory to carry on specific products, what orders we would like to pursue and at what rates.

We are also doing a good job of taking cost out of the business by selling underutilized equipment and eliminating its associated depreciation expense. These disciplines in the management of our inventory and pricing levels should benefit us in driving greater profitability over an extended period time through good and bad economies.

During the quarter, our gross margin percentage on sales was 43 an increase of 36% in the first quarter of 2010, and speaks to the health of the secondary broker and end-customer sales markets.

The result of our higher business activity levels and more tightening managing our rental inventory. Ending second quarter utilization increased to 67% compared to ending first quarter 2010 utilization of 65.8%.

Due to higher business activity levels and strong pipeline of opportunities we are experiencing today. Our outlook for the performance of electronic business in the second half of 2010 is very favorable.

Now let's turn our attention to Adler Tank Rentals. Our tank rental business more than doubled to rental revenues to $7.6 million from the year ago. The strong increase in rental revenues was directly related to higher business activity levels supported by the addition of new branch locations, a larger sales force and expanding Adler's rental equipment inventory.

We serving a wide variety of market segments including industrial plant, petrochemical, pipeline, oil and gas, waste management, environmental field service and heavy construction. Quarter-over-quarter income from operations was up over four-fold to $3 million, as prior quarter new employee and other start-up investments to ramp the Adler business began to payoff.

Business activity levels in bookings have continued very favorably into the third quarter of 2010. Period end utilization for the second quarter of 2010 increased to 70.5% compared to 63.2% at the end of the first quarter of 2010.

Looking forward, we are very enthusiastic about the prospects for Adler become increasingly significant contributor to McGrath RentCorp's earnings.

Now let me take a moment and update everyone on our organic initiatives. First, TRS-Environmental, our environmental test for the rental initiative continue to make very favorable strides in growing its number of opportunities rental customers and rental revenues during the second quarter of 2010.

We increased our rental bookings by 50% and rental revenues by 41% over the first quarter of 2010. This is cheaply due to gaining more traction with customers and improving market place in to a lesser degree seasonality factors during the first quarter.

Our outlook for the remainder of the year is very positive. We believe that as the economy improves and project work increases coupled with our country's increasing sensitivity on environmental matters we can become a significant rental provider in the environmental test equipment industry.

Our portable storage initiative made good progress during the quarter. Rental revenues continued to increase on a sequential quarterly basis in the second quarter as they have each quarter since the business was launched in 2008. We are working hard at expanding our portable storage business in the California, Texas and Florida markets and we're continuing to explore smaller fleet acquisition opportunities to accelerate our growth. We also continue to add sales professionals and operations staff in growing the business. Looking forward, we are anticipating continued growth in our portable storage initiative during the second half of 2010.

Lastly, our Mid-Atlantic modular expansion continues to achieve favorable growth. Quarterly rental revenues increased sequentially during the second quarter of 2010 as they had done during each quarter of 2009 and in the first quarter of 2010. We are continuing to make good progress in capturing new educational classroom rental business with their innovative classroom products designed specifically for these markets.

We're also growing our level of commercial market opportunities. Our outlook for growing the base of rental revenues and profitability for the Mid-Atlantic region during second half of 2010 is very positive.

Keep in mind that all of these new initiatives are relatively small today compared to our legacy rental businesses and Adler Tank Rentals, collectively between our environmental test equivalent, portable storage in Mid-Atlantic initiatives, they're contributing on an annualized basis approximately $6.5 million in rental revenues based on the second quarter of 2010 run-rate.

It should also be noted that these results have been achieved in a very challenging economy. That being said, we believe that we will be able to grow the current base of rental revenues for each of these initiatives to much higher levels as we move forward in an improving economy.

Now for some closing remarks. Although our modular rental business has slid

Now for some closing remarks. Although our modular rental business has split significantly from its peak 2007 earnings levels, the strong operating results of our electronics and tank rental divisions have driven our first quarter over quarter rental revenue and net income increases in over a year.

At the same time, we realized that generating stronger earnings growth in quarters ahead, is contention upon the recovery of our modular business, and in particular the California market place. Despite California's challenges, we are seeing improvement in booking levels for our modular business, in both the educational and commercial sectors. We are hopeful that these trends continue.

With McGrath RentCorp's broader platform of rental products in geographies today, it will support earnings, if weakness hits one of our business units and also produce more substantial earnings growth in the future.

And now Keith and I welcome your questions.

Question-and-Answer Session


Thank you sir, we will now begin the question-and-answer session. (Operators Instructions). Our first question is from the line of David Gold with Sidoti & Co.

David Gold – Sidoti & Co.

A couple of questions for you. First I guess, the obvious, and California. So two things there on modular, more broadly. The tick up that you saw in utilization, presumably that wasn't from classroom, that was more from the construction side, or was it classroom?

Keith Pratt

Since most classroom shipped later. After the school year ends, it's mostly from the commercial construction sector.

David Gold – Sidoti & Co.

Okay, great, got you. How is that we should think better, what does it take really from here for that business, for the classroom site to return to more normal booking of growth? Is it simple as the budget getting passed this year? Or have we missed a lot of the booking season and does it shift into next year?

Keith Pratt

Well, at this point, our booking season really runs from pretty much February through June and then we get sometimes additional order opportunities later in the year in July and August. So from here we will have to see the third quarter numbers to see how the booking side played out, and that will give us a much better indicator.

Now going forward from here, the good news is there is still 1.3 billion left in modernization funds on the state level, and the state has been, just recently, disbursing more monies for modernization projects to move forward. So the third quarter will give a good indication of really what's coming online this year, and as I said a moment ago, there are available funds for districts both on a state level basis and locally to push modernization projects ahead in spite of the budget dynamics.

Although, school districts with the budget impasse still being present in California currently, which is really become quite a norm. They are continuing to move forward with their particular needs on a district-by-district basis.

David Gold – Sidoti & Co.

Okay. And then shifting to TRS for a second. Strong performance there, but I am just curious what are you seeing by way of price these days? It looks for like we ticked down a little bit, I guess, year-to-year despite the return of some demands. So just curious what you are seeing out there?

Keith Pratt

On the pricing?

David Gold – Sidoti & Co.


Dennis Kakures

Rates were actually up year-over-year and quarter-over-quarter for TRS, they were up 3% year-over-year and 3.5% Q2 over Q1.

David Gold – Sidoti & Co.

Let me see, I must have misread, okay. So, presumably all is good there.

Keith Pratt

Well, it's a very healthy robust market.

David Gold – Sidoti & Co.

Okay, alright, and then just lastly on Adler, picking up cue, it looks like very big, even bigger ramp up in equipment at the quarter and even better utilization. So just curious how much more capital you might think to put in there and what sort of thinking if there is any seasonality that we should aware of?

Keith Pratt

Let me answer the latter part first. There definitely can be seasonality in the business especially in the winter months, December through February and into early spring especially with oil and gas well drilling type of activity and certain types of construction projects that are not going to move forward in the colder months.

That being said, we are also trying to be very prudent about how much equipment we're putting into the business and I think we've done a good job there and we're still learning. But when you look at capital spend from here, we're really doing that on a basis of understanding the specific opportunities in each of our legacy markets or additional opportunities in some of the special areas like the gas fields and so forth.

So we monitor it quarter-to-quarter and we'll continue to invest in the business as we prudently can keep the equipment utilized. That's how we run all of our businesses.


Our next question is from the line of Scott Schneeberger with Oppenheimer.

Scott Schneeberger - Oppenheimer

One obvious question comes to mind, with the activity in the Gulf these days, is that having an impact on Adler? Anything you can elaborate on there?

Keith Pratt

What we did with respect to Adler did have an impact but what we took was an approach, a very measured approach in how much equipment we were going to deploy into the Gulf because what was most important to us was the fact that we need to make certain our core markets are going to build over time and establish customer basis and that those had ample equipment. So that was our first priority when the Gulf opportunity started coming in.

Then, when you look at an event like the oil spill in the Gulf, environmental projects such as that or cleanups, they really have an beginning and an end, and we know that from our past practices in our businesses as well as what's taken place in the tank rental over time. So those are kind of less attractive as opposed to being able again to deploy equipment into core markets or with customers that we are really going to build long-term relationships with.

So we did put a very limited amount of tanks into the Gulf spill and in some of the various southern Gulf states and also some box rentals as well but I wouldn't term any of that significant by any means.

Scott Schneeberger - Oppenheimer

Okay, thanks. Shifting up the gears a little bit over to TRS. What, with regard to your products, your equipment, what are products that you are seeing that are underutilized and where are areas that you are adding and are you happy with where you are right now or do you think you are going to see more ebb or flow in assets in that area?

Keith Pratt

Well, I won't give it for competitive reason. I won't give into any particular products, but we've actually seen fairly broad based lift here. So we manage our inventory very tight and we've even done a tighter job of that or more prudent approach to that over the past year where we are not investing in as many products of certain types that are lower margin type opportunities or are more highly competitive and our goal here is to keep a much more healthy inventory levels in all areas through good and downturn economies.

Dennis Kakures

And Scott, you have heard, a year ago, we are definitely turning over the equipment pool more, demand is healthy, our capital spend was a little heavier in the first half of this year compared to the first half of last year and I characterize that as TRS getting back to a normal level of capital spend whereas last year given the severity of the recession, it was really a below normal year.

Scott Schneeberger - Oppenheimer

Spinning around, have to cover modular as well. I am curious, I want to ask you from the perspective of what your sales force hears at the street level with regard to, and primarily in California, but this is a broad based question, of what the need is and just kind of a street level question as to, are people looking to spend, need to spend, is dependent on the bonds, just any color you can elaborate on there. Thanks.

Keith Pratt

I would say that must start with commercial construction. I think what we have seen here and this has really been for the first half of 2010, is that we have seen more larger construction projects and as I mentioned earlier, a lot of these are public works related. There are some stimulus funds in there supporting that but even beyond that, we are seeing projects for universities, we are seeing them for hospitals, we are seeing them more for that quasi-governmental type of work which, a lot of that is not stimulus related. So it seems to me that that's been very healthy for a while now.

We haven't seen the lift in the single and double like core commercial piece yet that's yet to come, and then the educational side, quite frankly it's gotten better. So, its bit early and the good thing about austerity over the past year or so in a couple of years with schools and all is the fact that demand will build over time and especially like in the California market, we are expecting growth in the school age population here in the next year and over the next couple of year. So, there is some good guys there, but it's much more positive tone, when you talked to the sales force and you get a feel for what they are hearing and our sales team especially in California have been very busy over the last couple of months as they are getting more calls and more opportunities.

Scott Schneeberger - Oppenheimer & Company

One final one if I could. How do you think about capital structure use of cash right now?

Keith Pratt

The last quarter we invested very heavily from a CapEx point of view and then we had a bit of comparative reduction in working capital. We saw a little bit of uptick in our accounts receivable really related to growth in the business and a bit more of a shift in the business mix towards Adler in particular, where it's a longer collection cycle.

So, when we look at capital structure we are very comfortable with where we are today. We've accessed the capital as we needed and we are investing very heavily. Overall CapEx is $58 million invested in the first six months of this year. We will probably spend significantly in the second half, although perhaps not as much as we spend in the first half, but overall we feel comfortable with where we are at.


(Operator Instruction) Our next question is from the line of Jamie Sullivan with RBC Capital Markets.

Jamie Sullivan – RBC Capital Markets

The Mods bookings that you called out there is some increases in May and June, just wondering what the historically pattern has been in that business in 2Q?

Keith Pratt

Second quarter is typically a pretty significant booking quarter. We would expect that in the third quarter tend to be our strongest booking quarters of the year.

Jamie Sullivan - RBC Capital Markets

Okay. It feels more like a normal year or getting back to normal seasonality, is that a fair way to characterize it?

Keith Pratt

I'd characterize it like this, I say things are improved. I don't think we are back to a pre-recession state, but it certainly significantly better than it was a year ago.

Dennis Kakures

Jamie if I could add, one way to think of the Modular fee is the rental revenues that we see each quarter reflect the net effect of new business offset by returns, where units that where out and rent come back to us and what we have seen is the level of returns was very high last year. It's not as high this year and the level of new business is better this year than it was last year, but again when you look at the net effect of it rents did drop a bit, as we moved from the first quarter through to the second quarter. Although the drop was much less than we experienced a year ago.

Keith Pratt

Keep in mind the lot of the bookings in Q2 will not come into the income stream until Q3. Lot of its classroom and large classes for instance we had a lot of equipment that we are preparing in the second quarter that we are shipping in the third quarter and we won't see that rental revenue impact until the Q3 numbers.

Jamie Sullivan - RBC Capital Markets

So, where we stand today, last quarter, you saw a pretty nice uptick in activity. It seems like bookings are recovering in Modular. You are expecting a strong half in TRS. Adler continues to be strong. As we look at the range of the guidance, keeping at where it was, what should we think about that you are contemplating at the low end and the high end?

Keith Pratt

Yes, Jamie. First comment would be we are very comfortable with the range and I'd say we are really pleased with the second quarter results, very pleased with the increasing profit contributions we saw from Adler and TRS and obviously signs the stability in the Modular business. As Dennis remarked, we've seen some very positive trends across each division even through the beginning of the third quarter.

So we fully expect stronger earnings in the second half of the year and that's very typical in our business. I think the things that we want to keep monitoring during the third quarter. A couple of things, one is as we just discussed, we want to see the final outcome on the Modular side as to if there's recovery, just how strong it is. Also the third and to some extent the fourth quarter, very important quarters from a sales point of view and we want to see exactly how those sales numbers come in.

So, it's just a little early to really make an adjustment to the range, but we are very comfortable and we think it's been a good first half and good trends in the business as we enter the second half of the year.

Jamie Sullivan - RBC Capital Markets

So, in California once, if we think about the bookings that you've seen thus far in the year and in the following, let's say the traditional pace, how would you categorize them at this point?

Dennis Kakures

Well, as I said a moment ago, I'd categorize this as feeling significantly better than last year at this time, but not up to what we pre-recession numbers, but certainly up until the right and feeling a lot better.

Jamie Sullivan - RBC Capital Markets

Now it's in the education bookings right?

Dennis Kakures

Its in. Both commercial as well as in education, that's correct.

Jamie Sullivan - RBC Capital Markets

If we think about the education bookings alone, would that still apply there or is it a little bit more uncertain this year?

Dennis Kakures

I'd say that commercial construction is certainly been strong. Education has been, they are both stronger than a year ago, and I'd say that I wouldn't give either one of those more weight than the other at this point.


At this time, I would like to turn the conference back to management for any closing remarks.

Dennis Kakures

Well, I want to thank everybody for joining Keith and me on our call today. I will look forward to having you join us on our Q3 results in early November. So, thanks so much and have a good evening.


Ladies and gentlemen, this conference will be available for replay after 7 PM Eastern Standard Time today through August 12, 2010 at midnight Eastern Standard Time. You may access the replay system at any time by dialing 1800-406-7325 or 303-590-3030 and entering the access code 4329570 followed by the pound key. This concludes the McGrath RentCorp second quarter 2010 conference call. We thank you for your participation. You may now disconnect.

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