Altra Holdings' (AIMC) CEO Carl Christenson on Q1 2016 Results - Earnings Call Transcript

| About: Altra Industrial (AIMC)

Altra Holdings, Inc. (NASDAQ:AIMC)

Q1 2016 Earnings Conference Call

April 29, 2016 10:00 AM ET

Executives

David Calusdian - VP

Carl Christenson - CEO

Christian Storch - CFO

Analysts

Matt Duncan - Stephens Incorporated

Rupinder Bora - Jefferies

Scott Graham - BMO Capital Markets

James Picariello - KeyBanc Capital Markets

Mike Halloran - Robert W. Baird

Operator

Greetings and welcome to Altra Industrial Motion First Quarter 2016 Financial Results. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. David Calusdian. Thank you. You may begin.

David Calusdian

Thank you, Rob. Good morning, everyone and welcome to the call. With me today are Chief Executive Officer, Carl Christenson; and Chief Financial Officer, Christian Storch. To help you follow management discussion on this call, they will be referencing slides that are posted to the altramotion.com website, under Events and Presentations in the Investor Relations section. Please turn to slide one.

During the call, management will be making forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are inherently uncertain and investors must recognize that events can differ significantly from management's expectations. Please refer to the risks, uncertainties and other factors described in the company's quarterly reports on Form 10-Q and annual report on Form 10-K and in the Company's other filings with the U.S. Securities and Exchange Commission. Except as required by applicable law, Altra Industrial Motion Corp does not intent to update or alter its future-looking statements, whether as a result new information, future events or otherwise.

On today's call, management will refer to non-GAAP diluted earnings per share, non-GAAP income from operations, non-GAAP net income, non-GAAP gross margin and non-GAAP free cash flow. These metrics exclude certain items discussed in our slide presentation and in our press release under the heading Discussion of non-GAAP Financial Measures and any other items that management believes should be excluded when reviewing continuing operations. The reconciliations of Altra's non-GAAP measures to the comparable GAAP measures are available on the financial tables of the Q1, 2016 financial results press release on Altra's website.

I'll now turn the call over to Altra's CEO, Carl Christenson.

Carl Christenson

Thank you, David. Please turn to slide 2. Our first quarter results were in line with our expectations, provide us the confidence in our full-year top and bottom line guidance. We executed well on our business simplification initiative and operations excellence contributed favorably to our results. While these initiatives are benefiting the bottom line, they were mostly offset by the effect of the lower sales volume and unfavorable product mix in the first quarter, resulting in modest improvements in gross profit and operating income margins.

Gross margin percentage increased 10 basis points to 30.3% and revenues decreased by 6.7%. We are very pleased that gross margin percentage increased even though revenues declined. Income from operations was 8.3% and non-GAAP income from operations was 9.2%. Cash flow from operations enabled us to maintain our balanced capital allocation, as we repurchased 91,000 shares of Altra's stock. Looking at the big picture, the progress we've made is very exciting and right in line with our expectations. Our team is doing a great job in controlling what we can control and making Altra a stronger company. We continue to face a soft economic environment for several of our end markets and we expect to see strong operating leverage when these out of favor end markets return.

Now, please turn to slide 3, as we discuss the condition in our end markets. We'll begin our market discussion with distribution, which is predominantly made up of sales of aftermarket parts and original equipment parts for small OEMs. Distribution was down single digits year-over-year, but was up by single digits sequentially. We believe that the underlying demand is down from last year and will continue to be relatively weak in the channel. In Turf and Garden, after turning in two straight record years, we're off to another strong start in 2016. Sales were up single digits year-over-year as a result of our execution and a continued strength of the domestic housing market. The Turf and Garden industry is expecting modest growth in 2016 and we're on track to have a similar year to the one we had in 2015.

Conversely, the agriculture market remains very weak and our sales were down significantly for the quarter from a year ago. Low commodity prices and fewer incentives are resulting in soft ag equipment purchases. We did see a sequential increase in sales from the fourth quarter although it is far too early to determine if this is the start of a positive trend. At this point, we expect continued softness in 2016. Transportation was up for the quarter, both year-over-year and sequentially driven by automotive program demand. Our sales tend to be lumpy in this area as a result of order timing. Materials handling was down both year-over-year and sequentially, driven by weakness in elevators and conveyors. This was primarily due to the negative impact of foreign exchange, which we expect to continue to affect sales in these markets as a result of the strong dollar. Soft elevator and conveyor sales were partially offset by continued strength in forklift trucks.

Turning to energy, energy overall was down from a year ago and on a sequential basis, driven by the continued and significant decline in the oil and gas sector. We expect that oil and gas will remain weak for at least the remainder of the year. Renewables on the other hand continue to be strong on a constant currency basis and were up slightly both sequentially and year-over-year even when you include the FX effect. We're seeing strong sales in Europe, China, South Africa and the US and expect global demand trends to continue through 2016. We plan to capitalize on that trend with aggressive new product development efforts out of our svendborg business. In addition, during the quarter, we shipped our first wind turbine brakes out of our facility in Brazil. Power generation was down slightly in the quarter from a year ago, but was up slightly from Q4. We continue to expect this market to be relatively flat. The metals market weakened further during the quarter with sales down double digits year-over-year and sequentially. Overcapacity in China and global pricing continue to affect this market.

We do expect demand for aftermarket parts to continue to be relatively stable. After two consecutive sequential increases, mining sales declined significantly in Q1 on both a sequential and year-over-year basis. The mines continue to dramatically cut capital spending, which is having a negative impact on our OEM mining equipment customers and we continue to expect that mining will be worse in 2016 than in 2015 as a result of the economic slowdown in China and the emphasis on reducing coal consumption. Finally, aerospace and defense is off to a slow start in 2016 with sales down year-over-year for the first quarter. This is timing-related however and we expect aerospace and defense to be relatively strong in 2016. Demand will come from the commercial aerospace side with the defense business continuing to be under pressure.

And now, I'll turn the call over to Christian and close with the discussion of our strategic initiatives. Christian?

Christian Storch

Thank you, Carl and good morning, everyone. Please turn to slide 4. We're pleased with Altra's start to 2016. In a challenging end-market environment, the company delivered an overall improvement in gross profit margin and realized positive price. Two of our three segments showed a meaningful improvement in segment operating margins, driven by our consolidation and procurement efforts. Consistent with our strategy, we continue to execute the steps necessary to position the company to deliver margin expansion when the end markets recover. For the first quarter of 2016, non-GAAP diluted EPS was $0.38 a share versus $0.42 a year ago. Looking at the top line, foreign exchange rates had a negative impact of approximately 180 basis points, driven by continued strength in the US dollar. Volume declined 5.8% while our strategic pricing initiative added 90 basis points. Net of foreign exchange, sales declined 4.9% year-over-year.

Geographically, excluding the effect of foreign exchange, North American revenues declined 8.2% year-over-year, European revenues were down 1.9% and sales to Asia Pacific and other geographies were up 7.8%.

During the quarter, the average price of the company's common stock did not exceed the current per share conversion price of our convertible notes. As a result, the notes were not dilutive to earnings. We recorded a tax rate of 28.7% during the quarter which was down from 30.6% a year ago.

Please turn to slide five for a discussion of our segment performance. Please note that segment results are not adjusted for one-time items. As a reminder, beginning with the third quarter of last year, we reorganized our three segments as part of our business simplification efforts. The new structure is better aligned across our present markets and better facilitates the company's strategic initiatives for procurement and facility consolidation.

For the first quarter of 2016 net sales in couplings, clutches and brakes were $75.6 million, down 15.2% when compared with $89.1 million in the year-ago quarter. This segment has Altra's highest exposure to oil and gas, metals and mining. Segment operating income was $6.3 million down from $10 million a year ago.

Net sales in the electromagnetic clutches and brake segment were $57.3 million essentially flat when compared with the first quarter of 2015. Despite a weak agricultural market, the segment performed well as a result of continued strength in turf and garden as well as the slow exposure to oil and gas, mining end markets. In addition, the segment is starting to benefit from Altra’s facility consolidation and procurement efforts. As a result, segment operating income increased 21% to $6.5 million or 11.3% of segment sales.

Finally, net sales in the gearing segment were $48.9 million compared with $49.2 million in the year-ago quarter. Despite the flat sales, segment operating income was up 21% to $5.8 million as a result of our margin improvement initiatives primarily at Bauer. That business is now approaching 8% operating margins driven by – and drove the segment operating income margins to almost 12%.

Please turn to slide six. Our balance sheet remains strong, book equity was $251 million and our cash balance was $44.8 million at the end of the quarter. During the quarter we repurchased 91,000 shares of Altra stock for a total of about $2.2 million under our $50 million stock buyback program that will expire at the end of 2016. Since the program's inception we have purchased approximately $37.1 million or about the 1.3 million shares. We are active in the market and will continue repurchase Altra shares from time to time as market conditions warrant. Capital investment totaled $5.7 million for the quarter well below our depreciation and amortization for the quarter of $7.2 million.

Please turn to slide seven and our guidance for 2016. We continue to expect sales in the range of $700 million to $720 million and further expect non-GAAP diluted EPS in the range of $1.40 to $1.50 for 2016. We expect our tax rate for the full year to be approximately 29% to 31% before discrete items and we also expect capital expenditures in the range of $20 million to $24 million and depreciation and amortization in the range of $30 million to $32 million.

With that I will turn the discussion back to Carl.

Carl Christenson

Thank you, Christian. And please turn to slide eight. I’d like to provide you with an update on our business simplification plan. The first component of our plan is facility consolidation initiative. On our last call we discussed three consolidations that have already been completed and we expect an additional closure in Q1. We're essentially on schedule and have closed 5 facilities so far. We will complete the closure of the sixth facility early in the third quarter and will announce the closure of a seventh facility before the end of the third quarter.

Additional consolidations beyond these will require that we expand a receiving facility. Therefore, these consolidations will not be initiated until late 2017. In total, we anticipate consolidating 8 to 10 facilities with the savings of approximately $7 million. As I mentioned last quarter, we have successfully eliminated approximately 130,000 square feet of floor space thus far without losing any capacity.

A second key to the business simplification plan is our supply chain initiative where we continue to make good progress in developing a world-class procurement organization. We are now completing the training and reorganization of our purchasing group. At the same time, we are aggressively looking for opportunities to reduce cost. As we execute this plan, we will benefit from the investments we have made in our global IT system. The company-wide implementation of our SAP system will help the team to be data driven and highly analytical throughout the supply chain. Even in this extremely challenging pricing environment, we continue to identify anomalies and opportunities utilizing our strategic pricing tools.

Finally, we are very pleased with the cultural changes that are occurring in our operations which is evidenced by our continuous improvement activities that are helping drive margin enhancement at all of our businesses.

Regarding our European restructuring and cost reduction efforts, we're seeing excellent results out of Bauer. That business is now reaching operating margins approaching 8% as a result of our profit improvement plans. We remain cautious for the remainder of 2016 although some sources indicate that we may see a slight recovery in the second half of the year.

We are now passing anniversary when several of all our end markets begin to weaken. Therefore we will have easier comparisons as we approach the second half of the year and we expect that year-over-year shipment in order declines will begin to moderate. When our most out of favor markets do return, we have the potential for significant margin appreciation as a result of our aggressive performance improvement actions. We've been executing to plan and expect further progress as we proceed through 2016.

Thank you for your continued support of Altra and we will now open up the call to your questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from Matt Duncan with Stephens Incorporated. Please proceed with your question.

Matt Duncan

Hey, good morning guys. Nice job this quarter.

Carl Christenson

Thanks, Matt.

Matt Duncan

So the first question I've got just, Carl, following up on the comments you just made about some sources pointing to potential improvement in demand in the back half, can you talk about what you're seeing there and in your conversations with your customers is that showing up as well?

Carl Christenson

Yeah, I think it’s more industry publication than industry groups that are talking about the potential and we're not - we haven't seen enough evidence yet to buy into it. But the recovery in oil pricing and our take on it is that it’s going to be a while before people start drilling holes again. There is enough holes out there for a while. So we still remain very cautious, Matt, even though some of general industrial publications are talking about an improvement in the second half.

Matt Duncan

Okay, that's helpful. And then maybe just taking just a step further what you're seeing in your order book right now and what are sales trends looking like month to month?

Carl Christenson

Yeah, it’s relatively flat. We looked at through the quarter and when we look at last or the fourth quarter of last year we saw kind of a drop-off in orders at the end of the year. We think that was primarily inventory adjustments. And then we saw a pickup at the beginning of the year and then since then it has been relatively flat.

Matt Duncan

Okay. So is it too early to say that that maybe is a sign of a bottoming process starting here or what do you think that means?

Carl Christenson

I'm not calling a bottom. I have called the bottom in mining seven times now and I am not going to do it again.

Matt Duncan

Yes, I get that’s clearly a tough market. Okay. And then one more thing for me, and I’ll hop back in queue here. Just on the cost savings, remind us what the annual run rate is that you're at right now? Out of the $7 million, how much of that is in place at this point?

Christian Storch

We think we would exit this calendar year with a run rate of around $3.5 million to $4 million, of which we currently have in place what may we have seen in the first quarter, maybe $1 million of that, and the rest will gradually grow as we go through the quarter.

Matt Duncan

Okay. Thanks Christian. I appreciate that.

Christian Storch

One caveat is that, as we close facilities in the receiving ends, often in the beginning, you see some productivity losses at the receiving end as they go up the learning curve and so that’s a little bit the wild card in this -- with these numbers.

Matt Duncan

Okay. Thanks guys.

Christian Storch

Okay, thanks, Matt.

Operator

Our next question is from Rupinder Bora with Jefferies. Please proceed with your question.

Rupinder Bora

Hey, good morning, Carl and Christian. So just on the previous question here we spoke about destocking, which I remember Christian, you have been talking since October last year and we saw some of that happen in the fourth quarter. Are we behind from most of the destocking or -- you mentioned about orders being kind of flattish now? Can you give us some color like [Technical Difficulty]

Carl Christenson

Yes, it depends on the market certainly some markets and we think our distributors’ inventory in general is in pretty good shape. But if you look at oil and gas industry, there is still substantial destocking that will occur there in my opinion. And there is also -- we’ll be scavenging off of existing equipment, which is kind of pseudo-inventory. So there is still significant destocking to go in that industry and I think similar to other downturns in that market. In prior downturns, we saw that for quite a while.

Mining, we think that the destocking has – they are probably in pretty good shape on inventories. We've seen some nice orders from some of the mines for aftermarket parts. And then in the ag industry, we think that has affected our sales to some effect, some degree as they have – as they are still large inventories of equipment out there and so that will probably continue. And the general industrial side, it's probably in fairly good shape.

Christian Storch

And distribution, I think as we go through the quarter, we saw stronger bookings in margin than prior two months. We saw I think – we saw some destocking in the fourth quarter. So it appears from when we look at bookings at that destocking that occurred at the end of the year that that might be over.

Rupinder Bora

Okay. Just a follow-on turf and garden that was pretty strong in the first quarter, and we have heard like some companies talking about good weather kind of pulling forward some sales from the second quarter, I don’t know if you saw that or that’s pretty normalized sales?

Carl Christenson

For that market, what we tend to see is in the fourth quarter and first quarter is when they are really building and then if the sales do flow through, they’re building for position for what they are going to sell-through in the spring and in the summer. And if we have favorable weather conditions and the housing industry is strong, we typically see that that build cycle goes further out into the year. And we're just entering that point in time right now where we don't know yet what the actual demand of their equipment will be to know how far that build cycle will go. But it’s been very good so far and we expect to have this year similar to what we had last year, which was an outstanding year.

Rupinder Bora

Okay. And then just a last question on China, basically Asia-Pac, it was up pretty strong. Christian, if you want to give some color on that like what drove that sales.

Christian Storch

As far China, what helps us in China is our winter business there. Winter sales in China are strong into the wind turbines. I think our elevator business over there also did very well. Our brake business, electromagnetic brakes in China done well in the quarter. Those are the top two markets that we serve in China and so they make a big difference for us. They do well.

Rupinder Bora

Okay. Thanks a lot guys.

Operator

Our next question is from Scott Graham with BMO Capital Markets. Please proceed with your question.

Scott Graham

Hey, good morning. Nice quarter. So your thinking on pricing, I think was a little positive, but a little guarded on a go-forward basis in the last call. Yet, it looks like you did about 90 basis points, which I think is little higher than we have seen in the last couple of quarters. Could you talk about the dynamic a bit?

Carl Christenson

I’ll start and then Christian can follow-up. I think what we’re seeing is that the general pricing environment is extremely challenging. And what we are really getting it is on the strategic pricing where there are some areas that – targeted areas that we can achieve some price increase. So it is extremely challenging and as we – and even on the strategic pricing side, it’s getting more difficult, that’s why we are being cautious. I don’t know if you want to add anything Christian.

Scott Graham

Well, the other thing – yes, I had a feeling it was strategic pricing, but the – would it be fair to say that if we kind of disaggregated these that with pricing outside of what you’re doing on strategic pricing, the sort of slightly down and strategic pricing is maybe up more than 100 basis points, is that maybe a way to look at?

Carl Christenson

No, I think if you look at the data about 70% of that 90 basis points, 70% of that is strategic pricing and 30% is general price increases. So we do get some general price increases, mainly in distribution, very little of that on the OEM side.

Scott Graham

That’s very helpful. Thank you. The end market that’s obviously the largest one that you guys talk about in distribution, just down mid-single and that’s where you have your after-market, which would at least to me suggest that your OE was maybe down sort of upper-single on after-market sort of closer to the – to flattish or something like that. What part of distribution – and I know, you call distribution because you cannot certainly tell. To the best of your ability, could you tell us kind of what markets you think these small OEs are weak in?

Carl Christenson

I really think that distribution is being impacted by some of the same end-markets that our large OE customers are. So they serve the mining industry, they serve oil and gas industry and I think if you looked at their breakout by market, you would see some very significant declines in those markets, but that’s kind of offsetting what they are seeing in some of their other markets like food and some other areas.

Scott Graham

That makes sense. Last question. You have risen your Bauer margins to a nice level in the 8% facility and I know that that was not a factor for what you – that doesn’t affect future M&A, but it does look like without Svendborg, you kind of have you know you got a little secret sauce in here, I was just wondering what the M&A pipeline looked like going forward, it looks like you have a capacity, could you comment on that?

Carl Christenson

Yeah, I think the M&A market or environment for us has been challenging over the last couple of years and we've talked about that on prior calls. I'm hopeful that if things do start to improve a little bit that it will get better that people will say this starting to get to be a better time to sell some of the good companies that are in our space. So I'm hopeful that we'll start to see it recover and get a little bit better for us.

Christian Storch

But we want to make acquisitions like, that's part of our - and always part of our goal. We are just not prepared to pay ten times plus. And we have seen very few assets actually come to market and those that did sold for north of 10 times. Although we're hopeful that that is changing, a lot of companies are not putting the business up for sale because they don't want to sell at the bottom, they don't want to look back two years and say why did we sell at the bottom, so that's another issue I think that we're facing. But we'll continue to actively knock on doors and we're confident that eventually we'll be able to make that next deal.

Operator

Our next question is from Jeff Hammond with KeyBanc Capital Markets. Please proceed with your question.

James Picariello

Hi guys, this is James Picariello. Congratulations on another strong margin quarter, if I just take a look, you guys have strung together four quarters now really with detrimentals in the 15% to 20%. To get to even the high end of your guidance, it does bake in some pretty high decrimentals in the back half. So I'm just wondering, is there any embedded spend, you did mention Svendborg that you guys have some pretty aggressive new launches there. So just color around how we should think about margins would be helpful? Thank you.

Carl Christenson

I don't think there is any incremental spend. There is two really factors embedded in there, one is we only have limited visibility with our business about three months out, so the second half is a big unknown for us and whether we're going to start to see some slow recovery or whether things are going to continue to deteriorate in mining, and oil and gas. The others we do we have and these are not significant numbers but we do have some start-up costs at Bauer, we are in-sourcing our [indiscernible] production there, we're starting to make the first parts right now and have hired about 20 people and so that will grow some cost relative to that start-up but eventually it was going to save us a million euros a year as we in-sourced that piece and the other as we mentioned early on the call as we shut down facilities we may see some productivity declines at the receiving end and historically those have been some of the things we in six months before they are able to ramp up and produce at the same productivity levels [indiscernible]. So those are some of the unknowns and therefore we just remain cautious as we provide our guidance for the balance of the year.

Christian Storch

So those are some risks and we're going to manage those as best we can. We just didn't think it was prudent to go revise guidance at this point with the lack of --.

James Picariello

That's fair. In terms of visibility, you guys did mention a pick-up, a slight pick-up in aerospace and alternative energy, the renewable side still continues to be strong. To what extend do you guys have visibility beyond six months or so for those businesses and how are you thinking about those particular end markets for the rest of the year.

Carl Christenson

Aerospace is really very small for us and doesn't really move the needle, so it's not really --.

Christian Storch

It’s more project driven for us, I won't take a REIT for defense and aerospace in general out of our comments, this is particular to certain projects we win or - and we won a few very good projects. So we're really pleased with it. We're talking about it but it's not going to move the needle significantly. And then the win business, we've got a new product that we're bringing in, that we've been approved on and towards the second half of the year beginning in 2017, we'll be ramping up on production on that and we're really pleased with that. But we also don't get a tremendous amount of visibility from our customers there where we have very good cycle times and we're on essentially weekly, monthly releases from them. So we don't get, we get a forecast remember we don't get a tremendous build out in the order book.

James Picariello

Got it. For the Svendborg new product, is that specific to a region or is that a product that could be applied globally?

Carl Christenson

That's a product that can be applied globally and it's one particular customer now that we developed this product with and we hope we would spend extend it to other customers over the next few years.

Operator

Our next question is from Mike Halloran with Robert W. Baird. Please proceed with your question.

Mike Halloran

So just on the FX side, any thoughts to how that's going to track to the year for you guys at this point. For the assumptions underlying guidance about that?

Carl Christenson

Assumption is that FX remains where it was in the first quarter. So we use typically the end of the quarter spot rates to kind of embed those rates into our guidance.

Mike Halloran

So at this point, are we looking at a neutral impact in the back half of the year?

Carl Christenson

Yes.

Operator

Our next question is from Rupinder Bora with Jefferies. Please proceed with your question.

Rupinder Bora

Just a follow up for Carl on the - I remember like Carl you talked about in the last call, the trade violation related to some of the shipments or import from China and Canada, just wanted to see like if you have any updates on that? Thanks.

Carl Christenson

Yeah actually the preliminary duties have been published and there is some public information out there and so far things have gone very much in our favor and we should get final duties by the end of the year. So they assign preliminary duties and then they start. The people in the industry have to start assuming those duties are going to be there and then they will assess the final duties at the end of the year. So it's gone very favorable for us and we're starting to ramp up some capacity here domestically to - in that product range.

Rupinder Bora

So at the most, this will be kind of a 2017 event right, if anything happens basically?

Carl Christenson

Yes. There may be little impact at the end of the year but primarily it will impact 2017.

Operator

There are no further questions, at this time I'd like to turn the call back over to Carl Christenson for closing comments.

Carl Christenson

And I would just like to thank everybody for attending the call and look forward to talking to you on the next call. Thank you.

Operator

This concludes today's teleconference. We thank you for your participation. You may disconnect your lines at this time.

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