Sunrise Senior Living Investors Q1 2008 Earnings Call Transcript

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 |  About: Welltower Inc. (HCN)
by: SA Transcripts

Sunrise Senior Living (SRZ) Q1 2008 Earnings Call May 8, 2008 4:30 PM ET

Lisa Mayr

Good afternoon and welcome to Sunrise Senior Living investor conference call. This is Lisa Mayr, Senior Vice President of Investor Relations for Sunrise. Joining me today are Paul Klaassen, Sunrise's Founder and CEO; Tiffany Tomasso, our Chief Operating Officer; Mark Ordan, our Chief Investment and Administrative Officer; and Rick Nadeau, our Chief Financial Officer.

Before we begin, let me remind you that this call is being recorded and that the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 applies to this conference call. During the course of this call, the company will make various remarks concerning management's expectations, predictions, plans, and prospects that constitute forward-looking statements. Actual results may differ materially from those anticipated by these forward-looking statements as a result of a variety of factors including those identified in our 2006 Form 10-K that we filed with SEC on March 24, 2008. Any forward-looking statements reflect management's current view only and the company undertakes no obligation to revise or update such statements in the future. For further discussion on the company's forward-looking statements, we refer you to our 2006 Form 10-K.

During this call we will be discussing certain comparative preliminary financial data and operating metrics for the first quarter of 2008 and 2007, including total revenue under management and revenues, average daily rate, expenses and occupancy for our same community portfolio, consolidated communities and unconsolidated ventures. While we believe these metrics are useful indicators of trends in our management business, they should not be considered indicative of the results of operations of the company for the three months ended March 31, 2008 and 2007.

Also, please refer to our May 8 press release and related Form 8-K filing for additional information regarding these metrics and to our 2006 Form 10-K for significant developments that are expected to have a financial impact, a financial statement impact during 2007 and the first quarter of 2008. Any financial information discussed during the call regarding 2007 and the first quarter of 2008 is preliminary and remains subject to review. As such, this information is not final or complete and remains subject to change, possibly materially.

I would like to now turn the call over to Paul Klaassen.

Paul Klaassen

Good afternoon, and thanks for joining us today. As you know, this is our first conference call since completing our restatement, and hopefully the last one where we don't have current financial statements to discuss. Our plan for today's conference call is to review four areas. First, our operations and results for the quarter. Second, our business model. Next, our views on capital markets. And finally, to share some insight into our financial statement filing status and our balance sheet.

So, first, I'd like to have Tiffany, our Chief Operating Officer review with you what our operating results looks like this quarter. Tiffany?

Tiffany Tomasso

Thanks, Paul. Hello, everyone. Our operating teams have been working hard not only serving our residents, but also continuing to drive the positive revenue and expense trends [we saw] over the second half of last year. We are pleased with what they accomplished this past quarter.

As you saw in today's press release, the same community revenues grew about 8% for the quarter or about 7% if you adjust for the extra day of leap year. Approximately, half of this increase came from base rate increases and another third of the increase came from extended care revenues. We charge our residence a base room rate and then based on regular needs assessment developed by our resident care team, and in conjunction with the resident and family, we develop an individualized service plan.

As you know, we have different levels of pricing depending on the care level each resident needs. This past quarter we saw an increase in both rates for extended care, as well an increase in the utilization of these services. On the same community occupancy side, we saw a slight decline year-over-year from 90.6% to 90.3%. The good news is that, we saw an increase in our occupancy on the consolidated portfolio of 1% due to the strategies we began implementing last year to drive occupancy and mix, particularly in skilled nursing.

While we did see an occupancy decline of a little over 1% for the communities and ventures, almost all of this is attributable to eight communities; they are having various operational challenges. We are focused on resolving these issues and seeing the occupancy results improve. The remaining 139 JV communities saw sequential decline of only 0.2%.

We are asked regularly if we are seeing an impact of the housing market on the occupancy, and I can't say that we are. We continue to see new leads consistent with prior year levels and the percentage of leads that are converted to move in is in line with previous trends. We did see a slight increase in move outs primarily due to [debt]. Going forward, we see the opportunity to drive improvement in occupancy by focusing our efforts to reduce our vacant inventory which is primarily in our assisted living product line, and in our smaller studio style units.

We are looking at this closely by community and by market, and we are implementing a variety of strategies to accomplish this.

Next, I'd like to discuss same community operating expenses. As I shared in previous calls, this has been an increased focus of ours through the last 12 months, and we saw the positive trend from the previous two quarters continue this quarter as well. Our key controllable expenses are labor, food, repair and maintenance, utilities and insurance.

Labor makes up about 60% of our operating expenses. While we saw an increase in labor hours, primarily due to the increases in extended care medication fees, other salary increases were moderate as we effectively managed both wage increases and overtime. Our next largest operating expenses are food, utilities, repair and maintenance and insurance which make up about 20% of the same community expenses. These categories combined for only 2% over the prior year.

Our purchasing group has been working over the last year to increase the companywide contracts and to improve compliance with our contracts at a community level. In a period of increasing food costs, we have seen increases below the current inflation rate, while at the same time we have enhanced the quality of these programs for our residence.

Despite recent cost increases in the utilities area, we continue to benefit from the energy contracts we have, as well as the reduced consumption attributable to our 2007 energy efficient lighting retrofit that we did in the first quarter of last year.

On repair and maintenance, we saw a very modest increase over the year ago quarter. In this area we continue to focus on leveraging our purchasing power through both national as well as regional service agreements, and instituting tighter budgeting and expense controls. Additionally, we are benefiting from the implementation of an enterprise wide present at maintenance and reporting system. We believe this will continue to pay-off in future periods.

Finally, on the workers comp and liability insurance, we are renewing premiums at levels slightly below last year. To summarize, we are pleased with the results of our operating team that they delivered this past quarter. Our teams love improving the quality of life for the seniors they serve while also improving the profitability of our [company]. Paul?

Paul Klaassen

Thanks, Tiffany. Now I'd like to take a minute and discuss our business model from a cash flow perspective. And also touch on our strategy of building our core assisted living with memory care model. We have built over 200 of these buildings and they are the most successful communities in our portfolio. This model, which we have been refining for many years now, is very popular with consumers and serves a need-driven segment of the market, difficult for others to replicate and it produces very high customer satisfaction and excellent return.

Building new Sunrise communities is our primary growth engine and with 40 projects under construction and over 100 additional properties under contract, our development pipeline is clearly, very important to our business model and growth strategy and getting lots of attention. Of course, before we can build our prototype assisted living and memory care mansion model, we need to identify a site. We have identified over 350 zip codes in North America where we next want to build. These sites are primarily in the 30 major metropolitan markets of North America and then the United Kingdom; we have a similar process in place. We have a highly developed zip code and site identification process which includes everything from a detailed economic metric modeling to having our own development officers driving around neighborhoods.

Because we are building in market clusters where we are already operating, we have the experience of our other communities in the same geographic area to draw from us well. A typical US Sunrise mansion costs about $25 million to develop, and each mansion serves about 95 to 100 residents in about 80 units. We also build larger campus mansions and they include some independent living units as well.

Development costs vary of course, depending on land values and where we are building. We just develop our communities and ventures where typically our capital partner will own and invest 80% of the project, and we will invest and own 20%. Typically, the projects are financed with 25% equity and the venture obtains a construction loan for the other 75%. Today, because of the tightening of the credit markets, we are actually modeling a 72.5% construction loan and 27.5% equity. Sunrise does not guarantee the principal of the debt and is secured by the communities and venture. So, for a $25 million project, about $7 million of equity is invested and our 20% portion of that will be about 1.4 million.

A typical venture that we are structuring today will produce four different cash flow streams to Sunrise. I will briefly review those. The first are the professional fees that we receive for design, development, preopening sales and marketing, financing, licensing of the building and training. This is typically 7 to 8% of project cost. The second cash flow stream is the 5 to 7% revenue management fee that we receive from the long-term, typically 30-year, management contract. If a community is operating above certain benchmarks, we are sometimes able to receive incentive management fees as well.

The third source of cash flow from each new community is the prorata share of cash flow distributions after debt service that we receive from our ownership percentage which is, as I mentioned earlier, typically 20%. And the fourth source of cash flow is from recapitalizations. While a community is sold to another party or refinanced, we receive our prorata share of the distributions. In addition, we often get what we call a promote. This was the additional amount that we receive above our prorata share if the capital partner's return exceeds a predetermined their predetermined threshold. It is important to note that in the event of the sale to another party, are our management remains nice as does typically our ownership percentage.

Because all of our development activity consumes a great deal of capital, we regularly get questions on what the capital markets are like right now in terms of the availability of debt and equity for our projects. And clearly, these are the most turbulent capital markets in many years. However, the positive aspect of tight credit markets is that it helps ensure that only well-capitalized and well-conceived projects by experienced providers can get funding. This in turn serves as an effective barrier entry and protects against over building.

Because we have about a $1 billion of new constructs underway right now, and we expect to do another billion in the next 12 months, I have asked Mark Ordan, our Chief Investment and Administrative Officer, to comment on capital availability. Mark has only been at Sunrise for a short time, but he has considerable experience in the real estate and capital markets business. Mark?

Mark Ordan

Thanks, Paul. I'd like to share what I've seen in the months I've been here and where we're focused. On the capital market side, we have seen clear interest in financing the growth of our core business, both from debt and equity sources. I expect to be closer to turbulent capital markets, our expanding development base, and just good corporate finance reasons, we will look to broaden our array of financial partners and financing options. For debt, we have generally been at 70% to 75% loan to total cost ratio.

Spreads of course have widened but with lower base rates we are borrowing in line with last year. We have to work harder than we used to and there is some compression on loan to cost ratios, but lenders who know senior housing and want to continue to do business in the sector. On our current pipeline, we have closed loans or identified lenders for all those projects currently under construction. For those starts that we have slated for the rest of the year, we are working hard to raise debt capital one community at a time and we remain cautiously optimistic. We often do not receive final debt commitments until just before construction start dates, so our visibility is somewhat limited.

While we remain cautiously optimistic on our starts for this year, we do want to remind everyone that our pipeline is scalable and flexible. We are not required to begin construction just because we may own the land.

Now, let me step back and assure you that we are driven to strengthen our core, employ our capital very smartly, and work closely with our capital partners. We are considering all ways to increase our profitability and maximize the value of our portfolio. We are determined to review and control all components of G&A and expenses to enhance profitability. As you know, expenses related to our investigation and restatement were very substantial. Of course, this is overwhelmingly a non-recurring expense but we will have to work hard to offset the ongoing costs from some of the changes we have made. We look forward in the coming months to reporting to you on the result of this work. Now, I have the pleasure of turning the conference call over to your Chief Financial Officer, Rick Nadeau?

Rick Nadeau

Thanks, Mark. I am going to briefly explain a change in our disclosure, review some financial information related to our balance sheet. And finally, I will provide an update on our status to become a current filer.

First, regarding the disclosure you found in today's press release. You will note that we changed our community count retroactively. Previously, there were a few legacy communities that had multiple licenses and multiple buildings. We are managing these campuses as one community and the new counts reflect that. This did not change the unit or the resident counts. We also decided to provide you with units as well as residents. We have included a separate line for Greystone communities. Greystone management contracts generally earn a flat fee of about $20,000 per month.

In 2007, we provided professional services for approximately 50 different projects. We also deployed $11 million in seed capital to six projects in 2007 and we expect to receive very good returns on that investment. We plan to provide more information on Greystone when we complete our 2007 financial statements.

The final change we made this quarter was in our calculation of average daily rate for the same community portfolio. We are now including community fees, which is a one-time fee usually representing about one month's rent. The impact on the ADR is about $3.50 in both periods. Each of these changes was made for all periods presented.

Now, let's talk about the balance sheet. We had unrestricted cash of about $80 million at March 31, 2008, down from $150 million in December 2007. In addition, we borrowed another $28 million under our bank credit facility for a net decrease of $98 million. We have used $20 million of this cash on the completion of the restatement, $35 million to pay for our cost over runs for our remaining condo project, and another $8 million for loans to our German venture.

We have also significantly invested in our pipeline. In fact, for the 40 communities currently under construction, Sunrise's remaining equity commitment is only $6 million. We are still in the process of auditing our 2007 numbers and we are not yet able to give you the numbers related to our construction and progress balance, but it has increased.

We are developing five communities on balance sheets and we have purchased a number of land parcels, all of which we expect to move to joint ventures. We did not have much borrowing capacity at March 31, 2008, under our current bank credit facility because we are limited at the $160 million maximum until we file our 2007 financial statements. However, yesterday we received net proceeds of approximately $103 million related to the debt financing of 16 previously unlevered properties owned by Sunrise. We plan to use most of this to pay down our balance on our bank credit facility. We feel comfortable with our current liquidity levels.

There are a handful of other pressing issues we have been hearing about when we talk to our investors. And I would like to address a few of them now. First is G&A. As you heard from Mark, we are focusing our attention on reducing our G&A costs. There are really two components of G&A that you see on Sunrise's financial statements, corporate G&A and regional.

For 2008, we are budgeting approximately 40% of our G&A as regional support for our communities, and the other 60% in corporate and IT costs. During 2008, we do not expect to see any G&A savings as we are in the process of the implementing our remediation plan and ensuring that we have adequate controls in place. Going forward, however, we want to make our corporate G&A structure more scalable and this is our focus in 2008.

Another question we have been asked about lately is capital expenditures. For 2008 maintenance CapEx, we are budgeting from less than $1,000 to $3,000 per unit. The amounts will vary significantly with the age of the community. For communities in ventures, CapEx for the first four years is typically under $1,000 per unit, but for some of our older communities, especially the acquired ones, we can spend up to $3,000 per unit. For our consolidated portfolio, we plan to spend about $24 million on community related CapEx in 2008.

Finally, what I think everyone wants to hear about is when we will be current. We are still targeting completion the 2007 Form 10-K by the bank deadline of July 31, 2008. As I mentioned on our last call, the 2008 quarters will shortly follow the filing of the 2007 10-K. We have made a few steps this quarter to provide additional information in our disclosure, and you will see more coming as we become current. We recognize you are frustrated; we are frustrated that we have been unable to provide you all the tools you need to value our business. We are committed to getting current and bringing fully, and becoming fully transparent in our financial reporting.

We appreciate your patience and your feedback. Now, I will turn it back to Paul for some concluding remarks.

Paul Klaassen

Thanks, Rick. In summary, we are focused on getting our extended pipeline finance and build, improving operate trends and controlling overhead costs, as well as becoming a current financial filer. We are watching our capital allocation carefully and focusing on growing our core businesses. With strong underlying demographic and sector fundamentals and a solid development pipeline now, we are looking forward to the rest of 2008.

I will now like to open the call to any questions that you might have. Operator, you can proceed.

Questions and Answer Session

Operator

Thank you, Mr. Klaassen. (Operator Instructions). We will go to Doug Rothschild of [Garden]. Please go ahead, sir.

Doug Rothschild

Hi, guys. I don't know it became the first question but -- the occupancy for the joint ventures, you mentioned eight facilities that had specific problems. Can you expand a little bit on what the problems are and were and how you intend on fixing them?

Tiffany Tomasso

Okay. Hi, it's Tiffany. I would say some are market specific, but obviously given the labor intensive nature of what we do, there is always a people component to it as well. So, it could be turnover in our Executive Director Positions or [GCRs], but we're focused on it, we're watching it and expect to see that that will improve in those communities over the course of this year.

Doug Rothschild

Okay, great. Thanks.

Operator

(Operator Instructions). We will go to Derrick Dagnan of Avondale Partners. Please go ahead, sir.

Derrick Dagnan - Avondale Partners

Good afternoon. Some of your peers have talked about general economic weakness hitting the business and causing a higher level of move outs, and in your prepared remarks you mentioned that you feel good about the housing market, but could you talk a little bit to maybe just general economic weakness, things like job losses or maybe seniors who look at their portfolios and watch their investment balances dwindle or things like that? Is that having an impact at all, do you think, on move out rates?

Tiffany Tomasso

Well, just to clarify what I said specifically was -- we are asked regularly if we are seeing an impact of the housing market on our occupancy. I can't say definitively that we are or we aren't. The trends would not indicate that, so we are still seeing good leads year over year. We are still seeing good closing ratios year over year. Primarily our business is need driven. The bulk of our units are assisted living, memory care versus independent living and we didn't see a big decline in that portfolio. We continue to see good rate growth. We did see a spiking move out primarily attributable to Jeff, I think there is this typical seasonality that we experienced.

Paul Klaassen

Derrick, your question was very specifically but also with early move outs related to the economy, and I cannot, I've not heard anecdotally much less in any other evidence that we are having move outs because of the economy. I also have been around here long enough to remember the last recession and I can't remember then seeing any of that. So whether or not it's making people cautious, we'll see that 30 basis points in the past year reduction while we have achieved good revenue and ADR growth, I think, and we are monitoring it very closely. But at this stage I would be more concerned if I were not seeing good pricing power because we are seeing good revenue growth. We are monitoring it. We have indicated earlier one of our portfolios we saw an increase in our consolidated portfolio that did see a decrease in our same community and that was somewhat isolated to a group of properties. And we are seeing a little bit more down, a little bit more evidence of softness in Florida, for example. That might be housing related.

Derrick Dagnan - Avondale Partners

Okay. Thanks. And one follow-up if I could. On the margin, the contribution of margin, it looked like you had expansion year-over-year, I was wondering on the same store basis, and I think the same store is a little different this quarter than how you reported it in the fourth quarter of '07. Back of the envelope, I am calculating, there is kind of a significant decline in that margin. Could you add any color there?

Tiffany Tomasso

A significant decline in which portfolio?

Derrick Dagnan - Avondale Partners

The same store, was it consolidated? In general, the same store contribution margin in the first quarter of '08 versus the fourth quarter of '07. I realize that the unit counts are little different. So I know that the same store portfolio has changed a little bit but I am seeing kind of a larger change there sequentially than I would expect to see.

Tiffany Tomasso

Why don't we get back to you on that one?

Derrick Dagnan - Avondale Partners

I maybe mistaken. Thanks, that's all I have.

Tiffany Tomasso

Okay, we'll get back to you on that.

Operator

(Operator Instructions). We will go to Frank Morgan of Jefferies & Company. Please go ahead.

Frank Morgan - Jefferies & Company

Good afternoon, two questions here. In terms of your remaining unencumbered assets, how much additional capital you think you could pull out from that if, I know you said you just completed about $100 million? That's my first question. And then second question kind of comes back to the issue of rates, Paul talked about the healthy rate growth that you've had, but I'm just curious, are any concerns about just how far you can push rates? And have you seen any evidence so far out in the marketplace about people starting to discount to in order to build occupancies? Thanks.

Rick Nadeau

I will take the first part of that question. This is Rick. The 16 consolidated properties that we did finance were the 16 properties that we're having good NOI experience and that made the most sense for us to lever. We don't have a significant amount of completely unlevered assets at this particular time, but we are looking at all of our assets constantly to understand their fair values and whether it would make a financial sense to lever them up. But, yeah, we do have some unlevered communities but we really went in and pulled out the better ones and did the financing than I announced that we closed yesterday. Paul or Tiffany?

Paul Klaassen

On the discounting question, you can have discounting and also the healthy rate growth that we have had over the last several years. So I think, frankly, just we've been focused on that and maintaining that. We are already the price leader and if you got a great product and people want it. Now we will selectively for the smaller rooms, units, the least attractive units in building, take a look at our pricing and may, on occasion, in fact do some incentivizing to move though. But overall, you can see from the history, the last year and the last three or four years now, I think our pricing power has been very good and we are not, we are not buying occupancy. We see a little bit of it out there in the sector in general, but it is usually for supply that is older and less attractively positioned.

Frank Morgan - Jefferies & Company

Thank you very much.

Operator

(Operator Instructions). And we'll take an additional moment for questions to queue.

Tiffany Tomasso

While we are waiting for that, Derrick, it's Tiffany. I just want to get back to on the sequential margin issue on, I think the consolidated portfolio. We believe it's due to the health and dental expense credits in Q4 of '07. So they were onetime, we disclosed them. And if you look at Q1 of '08 versus Q3 of '07, probably a better comparison.

Operator

We will go to [Zayed Hamam] of STS Management. Please go ahead.

Unidentified Analyst

Hi, how are you? My question is regarding, I guess it would seem that at least until the end of 2009, assuming that that the restatement goes as planned, you're going to have plenty of -- I guess lets called it standby liquidity with that facility. So, I guess my question is, what was the purpose for the logic behind doing the mortgage financing if you felt like, assuming that there was plenty of liquidity there?

Rick Nadeau

That financing will save us about 50 basis points right now compared to the rate that's on the bank credit facility. Plus I thought that it made sense to, since I'm held at $160 million right now, I wanted to improve our liquidity, but you are correct in your observation that once we get current with the financial statements our line will spring back the $250 million. At that time I will evaluate whether it makes sense to keep it at 250 or to actually ask for a reduction.

Unidentified Analyst

Okay. So, the other thing I wanted to ask you is, by the way, that makes a lot of sense. And then on the half chance if something goes wrong with the restatement you can buy yourself a little bit of time. The next question I have is regarding the cash flows in the quarter. So I am just sort of trying to guess here, so lets say there was about $100 million decrease in net cash over the quarter, $20 million went to the restatement and $35 million was cost over run, so let's call that $50 million, and then $8 million -- so, let's call it about $60 million. So that means that, about $40 million was committed to the pipeline, or $40 million or $50 million was committed to the pipeline. How quick does that come back? I mean is that a sort of thing where, I know that you are doing some things. I call it on spec but it is really not spec because I think you have some agreements there, so how quickly does it come back out?

Rick Nadeau

It is on spec for a very short period of time. We don't speculate. We don't let ourselves get it too far ahead on the activities. But there will be circumstance where the land is ready to be settled and it makes sense for us to buy it or it will make sense for us to make a few expenditures before we have a joint venture partner or in very limited circumstances before we have construction debt. I think we managed that CIP exactly the way a manufacture would the inventory. They will use it to work on the efficiency of our organization. So, we are a little long on CIP at this point and we are working diligently to get that put into joint ventures, as I said. So I do think that as that occurs, that will bring cash back to us as we push it out in accordance with our business model to develop most of our communities in joint ventures. We also did have in net cash of; we announced back in 2007 that we had some insurance credits to give back to the communities based on some positive experience that we were seeing in health and dental and some positive experience that we were seeing in other insurance lines. Those are also being credited back to the communities in the first quarter, so that's also caused some cash drain during this period.

Unidentified Analyst

Okay. So --

Paul Klaassen

One item on that. Of course the 20% equity, you put into our projects, into our community for the 20% ownership, that's an investment we are making in the long run. And we don't get that back quickly. We get it back through returns, recapitalization through financing. And we like owing that 20%, that's a, we talked around here about that should go to 25 or 30%. That's a very attractive long-term investment for the company and its shareholders and that's the primary use of our operating cash.

Unidentified Analyst

Got it. And then I guess my -- I am just trying to fully understand there. I guess if we normalize out all these onetime costs, restructuring plus pipeline. Is it cash flow; operationally is there cash flow positive or neutral. What was it for the quarter?

Rick Nadeau

We haven't closed the books and I can't give that to you at this time.

Unidentified Analyst

Okay.

Rick Nadeau

We are managing off of cash forecast and --

Unidentified Analyst

Okay. Well, thanks a lot guys. This is a good call.

Paul Klaassen

Thank you.

Operator

(Operator Instructions). At this time we have no further questions. For closing remarks, I will turn it back over to Mr. Paul Klaassen.

Paul Klaassen

Once again, thank you for joining us. We look forward to updating you again in just a few months. Talk to you later.

Operator

This does conclude today's teleconference. You may disconnect at anytime. Thank you and have a great day.

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