Diversified Restaurant Holdings' (SAUC) CEO Michael Ansley on Q2 2016 Results - Earnings Call Transcript

| About: Diversified Restaurant (SAUC)

Diversified Restaurant Holdings, Inc. (NASDAQ:SAUC)

Q2 2016 Earnings Conference Call

August 4, 2016 5:00 PM ET

Executives

Deborah Pawlowski – Kei Advisors LLC

Michael Ansley – Chairman, President and Chief Executive Officer

David Burke – Chief Financial Officer

Analysts

Mark Smith – Feltl & Company

David Burdick – Dougherty & Company

Operator

Greetings, ladies and gentlemen, and welcome to Diversified Restaurant Holdings Second Quarter 2016 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]

It is now my pleasure to introduce your host, Ms. Deborah Pawlowski. Thank you. You may begin.

Deborah Pawlowski

Thank you, and good afternoon everyone. We certainly appreciate your time today and your interest in Diversified Restaurant Holdings. Joining me on the call are Michael Ansley, our Chairman, President and Chief Executive Officer and David Burke, our Chief Financial Officer.

Michael and David are going to review our second quarter results and give an update on the company's outlook of strategic progress, will then open up the call for question-and-answers.

You should have a copy of the financial results that were released today as well as the spin-off announcement separately released and if not, you can access both of these at our Web site diversifiedrestaurantholdings.com.

As you are aware, we may make some forward-looking statements on this call during the formal discussion as well as during the Q&A. These statements apply to future events that are subject to risk and uncertainties, as well as other factors that could cause actual results to differ materially from what is stated on today's call. These risks and uncertainties and other factors are provided in the earnings release as well as with other documents filed by the company with the Securities and Exchange Commission. These documents can be found on the company's Web site or at www.sec.gov.

During today's call, we will discuss non-GAAP measures which we believe will be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. Reconciliations of non-GAAP to comparable GAAP measures are provided with tables accompanying today's earnings release.

So with that, let me turn it over to Michael to begin. Michael?

Michael Ansley

Thank you, Deb, and good afternoon everyone. Let me first provide a brief overview of our results, update you on our strategic alternatives review, decision to spin-off Bagger Dave's which we announce today, and where we are on our management professional plan. I'll then turn it over to David for a review of our financials, business strategy and what we are doing to address the macro sales environment.

Our focus on strengthening our financial performance is clearly demonstrated in our results. New stores drew higher revenue and many actions we have taken over the last year has resulted in significant improvements in operating income, and importantly, most importantly EBITDA. And we are using the cash we generate to fix our plans to reduce debt.

Today we also announced the proposed spin-off of Bagger Dave's. This decision was a result of strategic alternatives review for our Bagger Dave's business that we announced in late-May. The Board concluded that this time a spin-off of Bagger Dave's will be in the best interest of the company and provide the best potential for enhancing shareholder value.

Our BWW business is already the primary focus of our growth efforts and investment. At the same time, we make significant investments over the last year to redefine the Bagger Dave's concept and make operational menu and service improvement. In fact, we are seeing positive results from these efforts; realistically our strong focus on building our BWW business policy [ph], attention and resources we can give Bagger Dave's going forward.

Another important consideration in deciding to spin-off Bagger Dave's were these two -- these are two distinct concepts at that different several respects. There is a fact that BWW is a franchise brand or as we own the Bagger Dave's brand, BWW is of course the mature brand, while Bagger Dave is still in the early stages. We also have learned that the more complex menu in food preparation we have at Bagger Dave's because it has very different management and personal. Separating these two very different businesses one -- each better pursued our strategy and growth plans independently.

The separation of our BWW and our Bagger Dave's business into two separate public companies with the structure of the tax-free spin-off of Bagger Dave's to DRH shareholders. The separation caused us regardless several actions carrying customary, legal and regulatory approvals for status in Bagger Dave's as an independent company publicly trade over the counter.

We have already began developing separation plans to guide us on process which we expect to complete by year-end. Additional information will be provided as a process moves forward. At the end of May we also announced our management succession plan, for DRH I will remain active as the Executive Chairman, David Burke will be promoted to President and Chief Executive Officer. This is an ideal leadership transition, our focus on energies on the broader long-term strategic plan for DRH, while David, whose been our CFO for six years and drive the operations.

He knows our restaurants, markets and industry extremely well and he is proven leader within our organization. The strong financial expertise and deep knowledge of our business are well suited for us as we focused on de-leveraging our balance sheet, improving profitability.

I don't want you to under estimate his capabilities attracting sales. Burke's taking on broader advertising marketing into promotional areas of the BWW business too. As we look forward out we expect to have much stronger balance sheet and to be achieving our financial performance goals. We believe this paves the way for opportunities to prudently expand our business further.

Jason Curtis will continue in his role of Chief Operating Officer. He is been operations leased for almost 15 years and he developed a deep knowledge of Buffalo Wild Wings business operation. He also has hands-on experience that drives our top tier performance. We are in the early stages of our recruiting process for our new CFO, once we find the right candidate, David will resumes his CEO position or otherwise. He will be CEO till January 1st, 2017.

The spin-off of Bagger Dave's is a positive shift on our strategic direction and we are confident this will put us in excellent position and it will take both businesses to higher level. We already rule largest Buffalo Wild Wings franchise and part of the great national brand casual dining structure which gives us the strong platform to grow.

In the Bagger Dave's concept, we definitely gain attraction on its own. We have the opportunity to mature the concept and focus on independent success. With that Bagger Dave's most recent net promoter for us with 65% on all time high we'll open the 23% just two years ago. We believe this change is heading in the right direction given and enhancements we have made to the concept as well the operations. The consolidation is down to the best performing restaurant provides an excellent platform for growth. We believe Bagger has a great future ahead

And I'll turn the call over to David.

David Burke

Thanks, Michael, good afternoon everyone. Our total revenue increased almost 26% to $46.4 million in the second quarter with the increase driven by growth in our restaurant portfolio including the acquisition of 18 Buffalo Wild Wings locations in 2015 and 19 restaurant opening. We added five new Buffalo Wild Wings and four Bagger Dave's since our last year second quarter.

These restaurants growth offset the impact of 2105 restaurant closure as well as the opportunity to grow sales. The transformational acquisition of 18 Buffalo Wild Wings restaurant in St. Louis just over a year ago, roughly total number of our Buffalo Wild Wings restaurants is 54, a 40% increase. We are proud that we have the largest franchise via the Buffalo Wild Wings Grill & Bar system.

This acquisition also provided incremental revenue for us to leverage our operating structure and to drive margin grouping. It's important for us to point out that while five restaurants were actually quite profitable. We believe they sacrifice sales for savings and we are not operating at their full potential. Our plans are to grow average unit volumes increase, sustainability profitability through the implementation of our best practices.

In the quarter we opened two Buffalo Wild Wings restaurants in Florida and the last Bagger Dave's in our development pipeline for the year that wraps it for 2015. We have intentionally reduced the new unit development and focus on increasing profitability and reduce debt.

Debt reduction and driving unit sales increased 38% to $41 million and was 88% of our total revenue. Sales amounted 59% of Buffalo Wild Wings stores were 2.7%, we were hit by the macro trends impacting the entire casual dining sector as well as even specific to our local market. As you are likely aware casual dining has been weak nationally. The trended evident in CCI data which shows the relative value of casual dining down measurably versus grocery, via local market, sporting events have not aligned well for this -- part of this year. Chicago, specifically Blackhawks and the Bolt had 28 fewer playoff games compared to prior year. Tampa also missed the Stanley Cup final. And the Detroit Tigers started out really strong last here but way off their games apart 2016.

Our sports fans are huge driver of our business and when their teams are doing well we feel the same. We also had great weather in our markets in the quarter, while still enjoy and fortunately these results are customers recurring outdoor activities versus within our restaurants.

We and Buffalo Wild Wings have a number of actions and process to increase our value proposition. And it is very competitive environment for the casual dining color. For example, we just started the promotion of Tuesdays and Thursdays menu special. In June we began a testing a pace rollout of Buffalo Wild Wings new plays and rewards royalty program at St. Louis market. Other initiatives that we are testing to drive sales improve to 15-minute lunch in the restaurant large parties and banquets, if home delivery which are popular right now in 18 locations as of this week.

We are working with Rub Hub [ph] and Doorstep, and we expect to have 35 or more restaurants with delivery starting by the end of the year. We also continue to move forward with the remodel of more restaurants with stadium design, which features stadium style sitting and it's proven to be compete here with sports mind customers and a great sales driver and location towards that implement. We believe we are the leaders in this sweet casual dining environment because Buffalo Wild Wings brings the competitive edges being a leading nationwide casual dining operator with a great track record potentially service there. We don't have our data to confirm this but based on our knowledge of the market we would feel that's the overall consumer decline and that we are not losing market share in our competition.

Revenue from Bagger Dave's in the quarter was 5.4 million from 19 restaurants. Average weekly volume was up over 5% or approximately $1,100 to 22,600. Average weekly volume was also up modestly in strong headwinds from 22,500 in the trailing third quarter. We are realizing positive results from our assets to concepts had benefited from the one new opening during the quarter.

Although not yet it's a level we would like to see, we are improving and starting encourage. We are also making solid progress on the expense and earnings side. The St. Louis acquisition added incremental operating expenses on every line item, however, as a percentage of revenue, several other aligning to lower.

Food beverage and packaging costs were up $2.5 million to its highest 50 basis points in the percentage of revenue to 28.1%. The further chicken wings were up year-over-year but pricing and deflation on other item retention fees offset this impact. Consolidated compensation cost were up 20 basis points from 26.7% of revenue from higher labor cost personally offset the pricing.

D&A expenses decline $2.9 million and we're 6.1% of sales down 930 basis points. This represented the effectiveness of our operating leverage, the closure underperforming locations and concentrated effort to reduce cost and is exclusion approximately $2 million -- last year.

The result of D&A savings operating income increased notably to 1 million, the $6.5 million is due to last year's operating loss of $5.5 million. Interest expenses in the quarter increased by 900,000 to 1.4 million on higher debt levels in St. Louis acquisition suffice slightly higher interest rates. Net loss for the quarter was 182,000 a $3.1 million improvement from last year's net loss of $3.3 million.

Recently the adjusted in non-GAAP measure is good measure that accommodator our performance. And given all that we have accomplished that last year it was up 96% or 2.8 million to 5.7 million of the same time last year. Adjusted EBITDA margin expanded a good 440 basis points to 12.2%. Restaurant level EBITDA also improved by nearly 28% to 8.3 million and despite same store sales pressures was up 30 basis points at the percentage of revenue to 17.7%.

Turning to our balance sheet, the second quarter and the cash and cash equivalents are 5.5 million compared to 14.2 million at the end of 2015. Capital expenditures to date were 10.2 million. We invested 2.7 million in the quarter for the completion of three new restaurants summary brushes and for the upgrade of one restaurant with the new stadium design.

We now have 28 restaurants with the stadium design and expect to begin structure more three more before the year-end one of which will be complete next week. Total benefit at the end of the quarter was 122.3 million. We reduced it by 4 million since the end of 2015 making additional discretionary principle payment of $5 million on top of normal and rebasing even as we use power lines for upgrading.

Our plan is to use cash that's available after capital adjustments for the pay down debt. We would pay off at least $15 million this year and our goal is to reach the net debt to EBIT of coverage ratio three times of 28 million.

Regarding our outlook for 2016, we now expect sales of 185 million to 190 million, down from our previous estimate of 194 million to 200 million, the changes plus the severe impact of macro factors impacting the casual dining sector and market specific challenges versus sports model. Our Buffalo Wild Wings restaurants are expected to provide across 164 million to 168 million in sales, for the Bagger Dave's concepts is to generate 21 million to 22 million of sales. Based on these lower sales we have to forecast we are also adjusting the restaurant usage guidance to 33 million to 35 million from 36 million to 38 million. Consolidated adjusted EBITDA is now expected to be in the range of approximately 21 million to 23 million down from our previously provided guidance of 24 million to 26 million.

Including one-time cost to spin-off SG&A is expected to be about 6%, remaining claim and capital expenditures are 46 million same store range is about 40 million and 60 million for the year.

Our close spin-off pro forma of Buffalo Wild Wings restaurant level EBITDA is expected to be 33 million to 35 million. We expected to reduce D&A expenses by approximately 1.5 million to 2 million from the spin-off. We believe that many -- strategic businesses made and are submitted over the 12 months it positions us very well to grow shareholder value. We have laser focus on strengthening our balance sheet and driving profitability. We are taking major cost out of our system with restaurant closures while we increase the operating leverage to the acquisition.

We believe that plans spin-off of Bagger Dave's business positions us on of fully developed concept. We are excited about our future and confidence and the opportunities for Bagger Dave's and our Buffalo Wild Wings franchise operating at other countries.

With that let me open it up for questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Mark Smith with Feltl & Company. Please proceed with your question.

Mark Smith

Good afternoon, guys. First off, can you just walk us through kind of moving parts that are going into the other operating cost at the restaurant level and any opportunity to maybe get more leverage on that line?

David Burke

Yes. Hi, Mark, this is David Burke. How are you?

Mark Smith

Good, Mark. Thanks.

David Burke

Good. Other operating costs as you know includes -- for Buffalo Wild Wings, it includes our royalty expense, the international advertising fee which makes up 8% of sales, rest of -- I think portion of that -- outside of that it's going to be a lot of your buying cost, which are usage-based and somewhat volume-based. There is a variable component to that; utility, etcetera, etcetera.

You know from a spin-off perspective, you will see better leverage of this cost on the Buffalo Wild Wings side, obviously, just give you the volume itself. But as we talked about it in the past, we have quite a few costing initiatives across the Board and really every top categories as a result of vendor consolidation, where you can get some better supply agreements with them from a national inventory, and just managing the each individual comps category [indiscernible] independently. So, we are seeing some progress there getting over the leverage.

Mark Smith

Okay, all right. So, again looking at G&A, it look good during the quarter, just may be give us early thoughts on how you get that the 1.5 million to 2 million of savings post spin-off?

David Burke

Sure. Two components really; two major points, one of them is the salaries that we have dedicated employees for Bagger Dave's predominantly in the operating side, and then we also have marketing spend, which is included in our G&A. So those two components will add up to that in plenty, full out of the DRH and into the Buffalo, or into the Bagger Dave's.

Mark Smith

Okay. So I guess it's fair to say that, post spin-off G&A at minimum would look to be close to 10% high single-digit percent of Bagger Dave's revenue?

David Burke

That's exactly right. Yes.

Mark Smith

Okay. And then just can you remind us when -- what you got for leases signed and when the next restaurant, I know nothing else this year, how are we going into 2017 before we start looking at new Buffalo Wild Wings restaurants getting open?

David Burke

There is one that will start towards the end of the year, probably open in the second quarter and then two later in the year.

Mark Smith

And then just can you give us any update on the restaurants in St. Louis in that market and kind of the impact on restaurant level margins within the Buffalo Wild Wings restaurant for you, during the quarter?

David Burke

Yes, sure. We're still very excited about that acquisition that we also still have some room to grow as we -- I agree with what stated from AV [ph] stand point and we first have a very high margin restaurants, so you know they are more or less on part with our overall system EBITDA range for this, and I really love a dilution there but we importantly anticipating accretion value at once we get that drive from the sales our initiatives in place.

Mark Smith

And if you remind it seems like all along that this was more than just 12 months plan to kind of get this accretion from this restaurant, is this was something going to take a little more time to fully develop with that?

David Burke

Yes. There is -- question you know a lot of this is growing revenue it's not going to happen overnight, and really never as we calculate our customer base with all these different type of marketing initiatives, some of which we were doing incrementally that we just does with delivery etcetera but some of that just more of the traditional marketing method with drive time radio [ph] and go-forward, and putting the money in the right places and keeping the customer base and giving them some -- at least driving rise of the brand, rise for everyday. It's a Midwest region not just that we are few in Detroit and Chicago region that we are in right now, there we have something a lot of confidence that we can get there. And we are also starting to see those services of course improve as well Mark. So unfortunately that takes a word of month to advertising from customers to pass that along.

Mark Smith

And then lastly from me is kind of a big picture question. You know looking back handful of years to go, you guys use to talk a lot about, the positioning of Bagger Dave's and Buffalo Wild Wings as what you guys called ultra cash flow, so kind of a straddle between fast casual and casual dining. Do you still feel like both change sit within there, you feel like change maybe got raised on this due to commodity prices and how are you going to take some prices, that was maybe excessive or may be just big picture how you feel about that?

David Burke

I think the ultra casuals, I mean, probably for steady for Buffalo Wild Wings because of the interchange mix and being the sports the both time trivia, in fact the customers turn to give more noble and that environment is louder lot of the tables and chairs easy to move together for big groups, and we try to limit that a little bit at Bagger Dave's and Bagger Dave's most morn to casual dining then maybe Buffalo Wild Wings. Obviously there is a slow down everywhere; even we are seeing that impact. I think the weather in the Midwest I don't know about Minneapolis, but it's been spin incredible in Michigan and I know St. Louis and Chicago aren't much different. So I am look forward for the summer Olympics the new football season, we'll see how this baseball teams to do. There were several seasons that traffic improve especially at Buffalo Wild Wings this fall.

Mark Smith

Do you feel like follow-up on it, do you feel like the Tuesday, Thursday promotion that you guys are pushing heavier you some of new items maybe push more of a value promotion for customers, if they like -- they are working there?

David Burke

It's too early to tell a lot of new out. We did actually this quarter. In Tampa we are using new message test with Buffalo Wild Wings and we starting using $0.70 its pass off on Tuesdays and Thursdays and not includes the celery, the blue cheese, the ranch, hotel market is extremely competitive, with Buffalo Wild Wings there is a lot of commodities down there. So that value not started in early June. And could take 90 days or so for people to realize that that promotion is in effect, corporate Buffalo Wild Wings is back with advertising but it will take time, post to coming there and understand the promotion but it is much more value driven.

I knows the days that always been there but we thought may be the message wasn't resonating as much as -- you see because back when I started in 1996 there was $0.20 wing Tuesdays and its gotten up to $0.70 and then we are still charging additional charges for blue cheese celery and ranch. So this is new message we think kind of resonate better.

Mark Smith

That's helpful. Thank you.

Operator

Thank you. Our next question comes from the line of Jeremy Hamblin with Dougherty & Company. Please proceed with your question.

David Burdick

Hi, this is David Burdick on for Jeremy. Thanks for taking my question. First just I wanted to started same store sales decline 2.7% what seems to be coming in a little lower than average franchise restaurant decline of 2.6% and in the past year or so you consistently outperformed that average. So I just wanted to get your thoughts on why you think you underperformed the average franchise restaurant this quarter?

David Burke

I think, David, what was out pretty clearly on the Blackhawks, Tampa Bay Lightning both played in the Stanley Cup last year and they both did not make it so that impacted about a third of our restaurant.

David Burdick

Are you able to quantify that type of impact as well as maybe the lift you saw from St. Louis?

Michael Ansley

David you speak to that.

David Burke

Yes, we made some -- obviously we made in Tampa that we believe that's it's a good -- 100 basis point as a result of out of this 14 environment by itself. Looking out there are individual days, the games doing the comparable analysis versus last year.

David Burdick

Okay. And then in terms of how much price did you take in Q2?

Michael Ansley

Just that we didn't -- just over 2%.

David Burdick

Just over two.

Michael Ansley

Yes.

David Burdick

Okay. So it seems like you don't follow corporate when it comes to taking price, how you go about evaluating that and kind of making that decision?

Michael Ansley

I wouldn't say we don't follow them. We recorded in with them on the price of new menus, price of year, [indiscernible] so we work hand-to-hand with them and it just -- the markets are completely that we're in, some are more market mature, some are lesser mature, you have to really look at the -- look way which way to start even where you think getting the money on the table. That we think its testament with quite a few different acquisitions and you take a look at those restaurants and you look at how they are performing versus the pricing to your restaurants versus the pricing to your some of your other stores and you make some assessments. So some time it's not just taking up, a lot of increase and some time it's actually come with the different menus here because we believe that we have the ability to do so.

And we are not just satisfied with our performances with all mean looking at where the comps and where over coming from prior year, I mean we are on over 4% in Q2 of last year keep following off of almost 7.5% and 8% in the first quarter of last year. The clear concept really doing -- is not sustainable forever. So we have always been relatively aggressive with the price given the environment, but obviously do cost deflation and waiver inflation at all the segments. So I got the [indiscernible].

David Burdick

Okay. And then did you mention the wing cost per pound in Q2? What was the cost?

Michael Ansley

It was Q2 -- this year we are about average down 192 a pound versus about a pound is 77 [ph], so you know actually was about 8.5% higher this year than last year. But -- go ahead.

David Burdick

No, you keep going, sorry.

Michael Ansley

Now we're doing despite that we have a better move cost for sale percentage due to some of the price wings that we broke in some other deflationary impacting some other commodity.

David Burdick

Okay. And then what is the cost that implied in your back half year of your guidance?

Michael Ansley

Is more consistent with -- is actually little higher than where we are currently at right now. We are just under $1.80.

David Burdick

Okay. All right. I leave with it, thank you. Appreciate it.

Operator

Thank you. [Operator Instructions] Our next question comes from the line of Kevin Cronin [ph] with Private Investor. Please proceed with your question.

Unidentified Analyst

Thanks. Just two questions you mention the 1.5 million to 2 million G&A, that is moving from Diversified, Bagger Dave's, is there additional G&A because of the incremental losses and suffered public long cost we need to tag on to that for Bagger Dave's going forward?

Michael Ansley

Actually there is not a lot. We are going to -- we are doing some different things over there. That we think we can get pretty creative with, in fact lot of authority and process.

David Burke

So no additional public market cost.

Michael Ansley

Very long it is because it's going to be OTC-traded stock which we have been there before, that's where DRH started. So we have a lot of experience in that environment, and some of those costs are reduced because of that.

Unidentified Analyst

Got it. And then second question I apologize if this have been answered before. I just started looking at company and that is with the exit of the ramp the LA sort of say new stores are you modeling MA second half of it to revenue and EBITDA to stores?

Michael Ansley

You know it's interesting we obviously were aware of that. We acquired stores that public going to happen and they had such a poor following that we are not expecting a huge hit, in fact in some cases we think since there is not a team there and there was such a big following for the Chicago Bears, Green Bay Packers and the Kansas City Chiefs, that are folks going to forced potentially go to our restaurants to watch all these with other teams because the NFL ticket versus prudentially going Downtown or watching again. So we are not expecting a huge hit, not expecting a huge positive impact from it, but it may be a more of neutral environment.

Unidentified Analyst

Got it. Thank you.

Operator

Thank you. At this time there are no further questions. I would like to turn the floor back to Mr. Michael Ansley for any closing comments.

Michael Ansley

I just wanted to say before we left today. That after a lot of hard work by our Board, by some Investment Bank that we engaged and a lot of the management team, are really excited about the new growth strategies for both companies. And we appreciate your time today. Thank you.

Operator

Thank you. Ladies and gentlemen this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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