RTI Surgical's (RTIX) CEO Brian Hutchison on Q4 2015 Results - Earnings Call Transcript

| About: RTI Surgical, (RTIX)

RTI Surgical, Inc. (NASDAQ:RTIX)

Q4 2015 Earnings Conference Call

February 16, 2016 08:30 A.M. ET

Executives

Wendy Crites Wacker - VP, Global Communications

Brian K. Hutchison - President and CEO

Robert P. Jordheim - EVP and CFO

Analysts

Matt Hewitt - Craig-Hallum Capital Group

Chris Cooley - Stephens, Inc.

Michael Rich - Raymond James & Associates

Operator

Good day ladies and gentlemen and welcome to the RTI Q4 and Year-End 2015 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder today's conference is being recorded. I would now like to introduce your host for today's conference, Wendy Crites Wacker, Vice President, Global Communications. Ma'am please go ahead.

Wendy Crites Wacker

Good morning and thank you for joining RTI Surgical for our fourth quarter and year-end 2015 conference call. Today we will be hearing from Brian Hutchison, President and Chief Executive Officer, and Rob Jordheim, Executive Vice President and Chief Financial Officer.

Before we start, let me make the following disclosure about forward-looking statements. The earnings and other matters we will be discussing on this conference call will involve statements that are forward-looking. These statements are based on our management's current expectations, but they are subject to various risks and uncertainties associated with our lines of business and with the economic environment in general.

Our actual results may vary from any statements concerning our expectations about future events that are made during the course of this meeting, and we make no guarantees as to the accuracy of these statements. Accordingly, we urge you to consider all information about the company and not to place undue reliance on these forward-looking statements. Now, I'll turn the call over to Brian Hutchison.

Brian K. Hutchison

Thank you, Wendy. Good morning everyone and thank you for joining us. We have a lot to cover this morning as we reflect on a solid performance in 2015 and look forward to 2016. First I will give you an overview of our 2015 performance then Rob will discuss our financial results. As many of you saw in our press release going forward in 2016, we will be reporting revenue on our business a little differently.

Rob will go over the new revenue reporting structure then I will go over our expectations for 2016. As detailed in the press release we issued in January and our press release issued this morning we reported fourth quarter revenues of $76.1 million, a 7% increase over the fourth quarter of 2014 and an 8% increase on a constant currency basis. We also reported fourth quarter adjusted net income per fully diluted common share of $0.09 compared to adjusted net income per fully diluted common share of $0.05 in the fourth quarter of 2014.

For the full year of 2015, we achieved record revenues of $282.3 million, a 7% increase over the full year of 2014 and a 9% increase on a constant currency basis. For the full year of 2015 we reported adjusted net income per fully diluted common share of $0.23 compared to adjusted net income for a fully diluted common share of $0.11 for the full year of 2014. This represents an increase of 109%.

At this point I am going to review the full year of 2015 for each of our lines of business in the way that we have historically covered them. Full year spine revenue decreased 7% compared to full year of 2014. The decrease was driven by declines in our commercial business attributed to lower orders from some of our large customers.

Momentum was strong in the fourth quarter for the U.S. direct spine hardware with a 25% sequential increase in average daily revenue over the third quarter of 2015. So far in 2016 we’re seeing that volume continue to pickup. Recall, then in the third quarter of 2015 we made some changes in our sales leadership on our spine team, which attributed in part to the sequential growth in the fourth quarter.

Additionally in the fourth quarter we expanded the spine distribution team to include our first direct sales employees in areas where we do not have distributors. We’ll continue to expand this team over the course of 2016. The strategy of leading with our best in class biologics employing through our high quality hardware is working. Our direct spine team increased our biologic revenue which is currently reported in the BGS/GO revenue line more than 30% for the year.

Our sports business was flat compared to the full year of 2014. During the year we started to see some mix shift towards lower price grafts due to trends in surgical technique as well as shift to allograft in some regions due to changing healthcare dynamics. To respond to these challenges in the marketplace our sports team has sought an expansion to penetrating new geographies. Additionally the team will continue to seek relevant opportunities that would further enhance our current product portfolio. We feel strongly that our sports biologics portfolio is the best on the market and our team is working diligently to expand our market share.

Full year surgical specialties revenue decreased 13% compared to full year of 2014. This is due primarily to a decrease in revenue from our commercial distributor in the hernia and breast reconstruction markets offset by growth in our direct surgical specialties. Our direct surgical specialties business had a record quarter in the fourth quarter of 2015, and we anticipate this momentum to continue into 2016.

Full year BGS general orthopedic revenues increased 15% compared to full year 2014. The increase in revenue was due to strong growth for our U.S. direct businesses partially offset by declines in our international and commercial businesses. We had excellent growth this year in our direct BGS/GO portfolio specifically with our focused products of map3 Cellular Allogeneic Bone Grafts and nanOss Advanced Bone Graft Substitutes.

Full year dental revenues decreased 14% compared to 2014. The increase was due to higher than expected orders from our dental distributor. Full year revenue for ortho fixation increased 50% compared to the full year 2014. Both our commercial business and our direct cardiothoracic businesses did extremely well this year. We experienced higher than expected orders from commercial ortho fixation distributors in 2015 primarily due to industry consolidation. The increase in our direct cardiothoracic business is due to continued sales expansion throughout the year which we anticipate will continue in 2016.

At this point Rob will provide some detail on our financial results.

Robert P. Jordheim

Thank you, Brian. Worldwide revenue of $71.6 million in the fourth quarter increased 7.4% compared to the fourth quarter of 2014. Domestic revenue was $70.6 million for the fourth quarter compared to $65.4 million for the fourth quarter of 2014. International revenue, which includes exports and distribution from our German and Dutch facilities, was $5.5 million for the fourth quarter of 2015, which was comparable to the fourth quarter of 2014. On a constant currency basis, international revenues increased 11% over the fourth quarter of 2014.

Net income applicable to common shares for the fourth quarter 2015 was $3.3 million or $0.06 per fully diluted common share based on 58.5 million fully diluted shares outstanding. This compares to net loss applicable to common shares for the fourth quarter of 2014 of $136,000 or $0.00 per fully diluted common share based on 56.9 million fully diluted shares outstanding.

Fourth quarter 2015 included a pretax severance charge of $995,000. Pretax litigation settlement charges of $804,000, and pretax asset abandonments of $814,000. On an adjusted basis excluding the previous mentioned severance charge, litigation and settlement charges, and asset abandonments, the company reported adjusted net income applicable to common shares of $5.1 million and adjusted net income for fully diluted common share of $0.09 for the fourth quarter of 2015. This compares to adjusted net income applicable to common shares of $2.7 million and adjusted net income for fully diluted common share of $0.05 for the fourth quarter 2014.

The company's fourth quarter adjusted earnings before interest, taxes, depreciation, and amortization or adjusted EBITDA was $14.1 million or 18% from revenues for the fourth quarter of 2015. This compares to $10.2 million or 14% of revenues for the fourth quarter of 2014. Adjusted EBITDA growth for the fourth quarter of 2015 was 39% over the fourth quarter 2014.

Gross margin for the fourth quarter of 2015 was 53%. Gross margin was relatively flat compared to the fourth quarter of 2014 primarily due to higher orders from our lower margin commercial business.

During the quarter, marketing, general and administrative expenses totaled $27.4 million, a decrease of 2.6% compared to the fourth quarter of 2014. The decrease was primarily due to lower compensation expenses resulting primarily from the corporate reorganization to flatten our organizational structure in 2014.

Research and development expenses totaled $3.6 million, a decrease of $565,000 or 13.7% lower than the fourth quarter of 2014. The decrease was primarily due to lower research study-related expenses. During the quarter we continued to control operating expenses and delivered an operating margin of 8.9%, excluding the asset abandonments, litigation settlement charges, and severance charges adjusted operating margin for the fourth quarter of 2015 was 12.3%.

Our tax rate for the fourth quarter 2015 was 34.3% compared to 17.3% in the fourth quarter of 2014. A tax benefit of the 2014 and 2015 research tax credit were both fully recognized in the fourth quarters of 2014 and 2015 respectively. However, due to higher profitability in the fourth quarter of 2015, the tax benefit from the research tax credit has significantly less impact on our effective tax rate as compared to the fourth quarter of 2014.

Turning to the balance sheet, our cash position at the end of the fourth quarter was $12.6 million compared to $15.7 million at the end of 2014. The decrease was primarily due to increased payments to vendors and principal payments on long-term debt obligations. For 2016 we anticipate being cash flow positive from operations. We are confident that with current cash balances and available debt we have adequate list of liquidity to support our future operations and meet our financing obligations.

Working capital at the end of fourth quarter totaled a $131.8 million, a decrease of $1.7 million compared to working capital in December 31, 2014. During the fourth quarter the company made the fourth quarterly principal payment of $1.1 million on the $60 million term loan. At the end of the fourth quarter, we had $79.6 million of debt and approximately $6.4 million available under our revolving credit facilities.

In order to provide better clarity on our revenue performance, we are adjusting the way we report revenue going forward. We will now be reporting our direct revenues and commercial revenues separately. In our direct business, we will breaking out our revenue into the following components. Spine which will include U.S. revenues from spine hardware as well as BGS/GO products including the previously mentioned focused products of map3 and nanOss distributed into the U.S. spine marketplace.

Sports and orthopedics which will include U.S. sports tissue based implants as well as BGS/GO products including map3 distributed into the U.S. sports and orthopedic marketplace. Surgical specialties which will include all surgical mesh products distributed into the U.S. hernia and breast reconstruction marketplace. Cardiothoracic, formally included in the ortho fixation revenue line which will include products distributed into the U.S. sternal closure marketplace. And finally international, which will encompass all products distributed to our direct effort outside of the U.S.

In this new revenue reporting structure, the BGS/GO line items will no longer be reported separately. It will now be reflected in the above mentioned spine and sports and orthopedics revenue numbers. In addition to the changes in the direct revenue reporting, we will also consolidate the commercial business into one global revenue line.

We believe that these changes will facilitate a better understanding of our business and align more closely with the end markets in which we compete. To reflect on the full year 2015, and the new revenue reporting structure, the worldwide direct business grew 7% overall with 11% growth in spine, 4% growth in sports and orthopedics, 86% growth in surgical specialties, and 24% growth in cardiothoracic. This was partially offset by a 10% decline in the international business.

Full year 2015, the worldwide commercial business grew 7% with strong growth in ortho fixation and dental primarily due to higher order of volumes which we believe can be attributed to consolidation among our commercial customers in the year. For convenience, in the press release issued this morning we have included both the traditional and new revenue formats. In addition we have posted on our website www.rtix.com both revenue formats for each of 2015, 2014, and 2013 to facilitate historical comparisons.

With that I will turn the call back over to Brian.

Brian K. Hutchison

Thanks, Rob. For those of you who have followed the history of RTI you would recall that we embarked on a strategic plan almost five years ago to invest in our direct business as well as diversify and broaden our implant portfolios in spine and orthopedics. We knew that we needed to establish a direct spine channel for our map3 Allograft and we knew we needed to broaden our portfolio to include metals and synthetics to prepare for long-term growth in the changing healthcare markets.

While it is vital and necessary part of our strategy, the commercial business specifically the tissue based implants is historically very lumpy as many of you know. We do not expect that to change. We will continue to maximize each of our commercial relationships that we have while at the same time grow our direct business to increase profitability and improve predictability in our business.

The ratio of commercial business to direct business has changed significantly over the years and we expect to make even more progress in the coming years. Five years ago our direct business contributed less than 40% of our total revenue. Today direct businesses contribute around 50% of our total revenue and long-term we expect the direct business to contribute more than 60% of our total revenue.

Through the plan to grow our direct business came the acquisition of Pioneer Surgical Technologies in 2013. Over the past two and half years we have seen steady progress in building this direct business and we foresee continued success in driving growth in revenues as well as having steady improvements in our profitability and cash flow long-term.

We have been talking about our pathway to 500 million in revenues over the past year. Hitting that milestone in revenue is something we are working towards. However, while growing the revenue is important the critical component of this pathway is to grow in the right areas as well as maintain disciplined cost controls that will drive the improvements in our gross margins and our operating income.

For our long-term goal we anticipate reaching gross margins around 60% and operating income approaching 20% of total revenue. Those metrics are key to a healthy, profitable growth in our company. So how are we doing on our pathway to 500 million. If we look at the metrics that we laid out base biologics, hardware, and focused products we see base biologics decline by 3% overall due to declines in commercial biologics revenue. However, in direct biologics revenue increased 3%.

In the key growth area of hardware, revenue grew 22%. And our focused products of map3 Cellular Allograft and nanOss Advanced Bone Graft Substitutes and Fortiva Porcine Dermis grew 48% with balanced growth in all three product areas. As we have said we do not expect our pathway to be linear in any long-term plan or external market shifts and changing dynamics that every business must react to. While we have a long-term goal, we will remain flexible to react to changes and changing market dynamics and take advantage of opportunities as they arise.

One important change this year is expanding our focused products to include the entire direct surgical specialties line, Fortiva Porcine Dermis, Fortiva Human Dermis, Tutomesh and Tutopatch Bovine Pericardium. In the course of 2015, regulatory activities related to the use of Porcine Dermis in the breast reconstruction market altered the growth trajectory of Fortiva in the U.S. and switched the opportunity to Cortiva Allograft Dermis implants. Because RTI is the only company that has a full portfolio of biologic surgical specialties implants we were able to quickly adapt to the change in the market and meet the needs of our surgeons and their patients.

In the U.S. our Cortiva Allograft Dermis grew dramatically in the second half of 2015. Therefore it makes sense to reflect our entire surgical specialties portfolio as a growth driver in our focused products. Over the long-term window additional product launches will also play a role in the growth of the company.

In 2016 we anticipate a number of product launches primarily for our direct spine business that will help drive growth over the next few years. As just one example, last week we announced an agreement with Oxford Performance Materials, a pioneer in advanced materials and 3D printing for biomedical applications. The agreement grants RTI an exclusive license to OPMs OsteoFab technology platform for spinal applications in all U.S. markets.

The OsteoFab process and the OXPEKK polymer material combined to create implants that are designed to enable bone on growth. The OXPEKK biomaterial -- biocompatible material is a strong pure radiolucent, hydrophilic load bearing material which boasts a successful history in orthopedic implant applications. With this agreement we can begin product development and we anticipate launching products in 2017. This will be an exciting innovative material and it would be a nice addition to our current portfolio. Additionally as many of you saw in our press release, we’ll be spending an incremental $1.4 million in 2016 on our long-term bovine tendon projects.

We’re excited to announce that our investigator team is in place and we expect our first human implantation in the EU in the first half of 2016 pending Ethical Committee reviews. As we have discussed before this is an exciting product project that could revolutionize treatment for ligament reconstruction. Preclinical data from animal studies as well as bench testing performed by our independent researchers has produced compelling results for strength and safety of this graft. This is a large and growing market and this would be the first product that will have level 1 clinical data. We will keep you updated on this project as we have more to report.

Turning to guidance in our press release issued this morning we’ve outlined expectations for revenue and EPS for the first quarter and full year of 2016. For the first quarter of 2016 we expect revenues to be between $65 million and $66 million. This would result in a 4% decrease in revenues compared to Q1 at the midpoint of our guidance. The decrease is due to low double-digit declines in our commercial distributors and commercial line of businesses partially offset by high single-digit growth in our direct business for the first quarter.

In addition first quarter of 2015 we recorded a $1.5 million nonrecurring acceleration of deferred revenue related to the loss of exclusivity of one of our distribution customers. We expect net income per fully diluted common share for the first quarter of 2016 to be approximately $0.03 based on 59 million fully diluted common shares outstanding. We expect full year revenues to be between $280 million and $290 million. This would result in an increase of 1% year-over-year at the midpoint of our guidance compared to 2015. We expect full year revenue from our direct business to be between $156 million to $160 million representing growth in the mid-teens over the full year of 2015 at midpoint.

We expect full year revenue from our commercial and other businesses to be between $124 million to $130 million representing a decline in low double digits at the midpoint. The primary reason for this decline is that we do not expect the benefits that we experienced in 2015 from the consolidation of some of our commercial customers to continue into 2016.

Full year net income for fully diluted common share is expected to be in the range of $0.18 to $0.21 based on 59.8 million fully diluted common shares outstanding. As mentioned previously, we expect to invest an incremental $1.4 million or $0.02 per fully diluted common share to fund our bovine tendon program. We have to see some of you this quarter, we will presenting at the Canaccord Musculoskeletal Conference on March 1st in Orlando and we’ll be at the America Academy of Orthopedic Surgeons, March 2nd through March 4th. At this time let's take questions. Liz?

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from the line of Matt Hewitt with Craig-Halum Capital Group. Your line is now open.

Matt Hewitt

Good morning gentlemen, congratulations on a strong finish to the year.

Brian K. Hutchison

Thank you.

Matt Hewitt

First one, traditionally you provided guidance for the revenue segments, is that -- with the change is that not going to occur this quarter?

Brian K. Hutchison

That Matt is correct. Right now we’re going to give guidance for the total business for the quarter and the year. We’re just switching to this new format so I think we need to wait and see how this works.

Matt Hewitt

Okay, fair enough. Secondly, and you touched on this a little bit, its basically flat the 1% growth year-over-year, some of that’s coming from the commercial side but as you look at the year and particularly these new segments, some of the new opportunities that you’re seeing where are the opportunities for you to see some nice growth this year, I would assume that obviously the focus products are still a hot area? Do you think that picks up in the back half of the year, is that -– I mean essentially what the guidance is implying?

Brian K. Hutchison

That is how the year is based. We have been converting hospitals and reps and surgeons and distributors using the focus products as the driver and sometimes it takes a while for the distributor or mobile hospital sometimes they bring them on one at a time to get through all the committees that they have to go through these days inside a hospital. So, we expect to build momentum all year long.

Matt Hewitt

Okay, great. One last one from me, regarding the R&D spend, the 1.4 incremental is that off of the 2015 base so is -- 15.1 million in 2015 add the 1.4 I would assume that there is some growth in addition beyond that 1.4. I am just trying to get a sense for what we should be anticipating for - a good number for 2016 for R&D?

Robert P. Jordheim

Yes Matt, this is Rob. That’s correct the $1.4 million is fully incremental off the base of 2015 in R&D. There is also some additional clinical spend in areas for instance map3 where we’re going to be generating some clinical data there to support that product. So R&D is going to be a bigger investment in 2016 and frankly beyond as we pursue those tendon projects. Having said that as a percent of revenue I would expect that to tick up a little bit from where we are in 2015 closer to more of the 6% to 6.5% of revenue.

Matt Hewitt

That’s very helpful. Thank you.

Operator

Our next question comes from the line of Chris Cooley with Stephens. Your line is now open.

Chris Cooley

Thank you, good morning. I appreciate you taking the questions. Just two for me then I’ll get back in queue, I appreciate the shift or the pivot here to focus more on direct versus commercial and like that revenue breakout, but was curious if you could just give us some additional color as to why not breaking out the focus products as well there maybe into the new format will be addressing that verbally on the calls, just would like to get a little bit more color around that? And then just as follow up, I want to make sure I am getting the comparatives correct there, you mentioned that you’d be adding of course to surgical specialties and others like Tutomesh, Tutopatch, and the Bovine Pericardium in the future to that. So I just want to make sure anything about the growth statistics that we’re seeing here, will that be the traditional map3, nanOss, and Fortiva that we were all thinking about, plus that on a go forward basis just kind of help me reconcile? Thanks so much.

Brian K. Hutchison

This is Brian I will start and I will let Rob finish up. So Chris you’re on top of a topic that we talked about quite a bit which is focused products and we will break it out verbally on our calls and then our investor meetings, the way we have talked about it and we will try to be extremely consistent. So when we report growth year-over-year it will be apples to apples so they will include all the surgical specialties in the history as well as going forward. So we’re going to talk about, the focused products today would still be what I would describe as three things, it is still map3 which is sold only through our direct sales force and it is both in spine and sports, primarily foot and ankle. But it is also being used in orthopedic revision cases, it is being used in many areas of the body today. And then it will also include nanOss which is primarily sold -- it is entirely sold for our U.S. direct sales forces today. It will also cross into international as we have a number of market approvals for nanOss. And then we will also have in there our surgical specialties category that is our direct U.S. so our direct business only. That will be included as well. And we will try to make it as clear as we can apples to apples but that you are still -- on spot that is really a key to our growth. Our rapid growth and our improved profitability because all those products come with higher margins and much higher growth rates.

Chris Cooley

Yes, sorry go ahead.

Brian K. Hutchison

Go ahead.

Chris Cooley

I just feel if I can squeeze one additional question just for clarification. Rob, I think in your prepared remarks you mentioned 1.05 million of accelerated recognition of revenue in the 1Q, could you give us some more color around that agreement and then how much is assumed for the full year in the guidance, is it just the 1.05 in the quarter or does that have a continuation?

Robert P. Jordheim

The 1.05 was in 2015.

Chris Cooley

Okay, I misunderstood my apologies.

Robert P. Jordheim

Okay, fair enough.

Chris Cooley

Thanks.

Brian K. Hutchison

Did we answer the other question that you had Chris?

Chris Cooley

You did, thanks.

Operator

Our next question comes from the line of Michael Rich with Raymond James. Your line is now open.

Michael Rich

Good morning, thank you for taking the questions. Can you hear me okay?

Brian K. Hutchison

Yes.

Michael Rich

Great, a couple of quick ones here. Can you give us an idea what's assumed in the guidance for our gross margin?

Brian K. Hutchison

The assumption for gross margin is mid 50s. As we’ve stated on previous calls our goal over the long-term is to get our margins to get up to approaching 60%. So over that period we would expect to step up so we’ll see a step up in 2016 over 2015 as we get to that 60% over the long-term.

Michael Rich

Okay, and then can you give us an idea, I realize the guidance implies decline in the commercial business but is that more of a one year blip as you anniversary some things or is that expected to be sort of a continued decline after 2016.

Brian K. Hutchison

No, I would tell if you took the base year of 2014 when we created this multi-year plan and you applied 1% to 2% annual growth rate to commercial over that five to six year window, you’d be where you need to be. The difficulty with 2015 and 2016 is 2015 we grew 7% and we got a wind in our sales if you will from the consolidation of some big players that are customers. And so we benefitted by basically inventory pipeline fill. This year we expect to decline because we won't see those orders come in this year. So we expect right now a decline for this year, then it will normalize so we expect it to grow and we still expect that we’ll be back on pace to take that business where it should ultimately go. So we still have the partnerships and we’re still adding partnerships. And we’re still developing new products with many of the partners. So we’re not going away from any of them we’re just trying to focus our growth on other areas where we can get predictability and visibility. We’ll maintain the commercial relationships where they all makes sense.

Michael Rich

Got it and then just looking at the guidance for the direct growth, it looks like that’s going to be pretty strong again in 2016 but given that you’re not breaking out the segment specific guidance can you maybe point to maybe the top one or two areas of that growth in 2016?

Robert P. Jordheim

I think when you look at the growth in the direct business the direct is as we said is going to grow in the mid-teens or expecting to grow in the mid-teens and its really pretty balanced growth. I would say we’re looking for spine to perform well in 2016 and then as you’ll see in our new revenue reporting you will be able to see cardiothoracic and you will be able to see direct surgical specialties, all are going to grow well above 20% to 30%.

Michael Rich

Okay, great. Thank you for taking the question.

Operator

And I am showing no further questions in queue at this time. I’d like to turn the call back to Mr. Hutchison for closing remarks.

Brian K. Hutchison

Thank you for joining us on this call. We look forward to seeing many of you over the next few months and we’ll chat with you again in 90 days.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program and you may now disconnect. Everyone have a great day.

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