S&W Seed's (SANW) CEO Mark Grewal on Q2 2017 Results - Earnings Call Transcript

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S&W Seed Company (NASDAQ:SANW) Q2 2017 Earnings Conference Call February 9, 2017 4:30 PM ET

Executives

Robert Blum - Lytham Partners

Mark Grewal - President and CEO

Matthew Szot - CFO

Analysts

Tyler Etten - Piper Jaffray

Mike Malouf - Craig-Hallum Capital Group

Gerry Sweeney - Roth Capital

Operator

Good afternoon. And welcome to the S&W Seed Company Report Second Quarter Fiscal Year 2017 Financial Results conference call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded.

I would now like to turn the conference over to Robert Blum. Please go ahead.

Robert Blum

Thanks, Carrie, and thank you all for joining us to discuss the financial results for S&W Seed Company for the second quarter of fiscal year 2017, ended December 31, 2016. With us on the call representing the Company today are Mark Grewal, President and Chief Executive Officer; and Matthew Szot, Chief Financial Officer. At the conclusion of today's prepared remarks, we will open the call for a question-and-answer session. Before we begin with prepared remarks, we submit for the record the following statement.

Statements made by the management team of S&W Seed Company during the course of this conference call may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended, and such forward-looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Forward-looking statements describe future expectations, plans, results or strategies, and are generally preceded by words such as may, future, plan or planned, will or should, expected, anticipates, draft, eventually or projected. Listeners are cautioned that such statements are subject to a multitude of risks and uncertainties that could cause future circumstances, events or results to differ materially from those projected in the forward-looking statements, including the risk that actual results may differ materially from those projected in the forward-looking statements as a result of various factors and other risks identified in the Company's 10-K for the fiscal year ended June 30, 2016, and other filings made by the Company with the Securities and Exchange Commission.

With that said, let me turn the call over to Mark Grewal, Chief Executive Officer for S&W Seed Company. Mark?

Mark Grewal

Thank you, Robert and good afternoon to all of you. We are pleased with the performance in our core alfalfa seed operations during the second quarter and the progress that's been made in advancing our new products, including hybrid sorghum, hybrid sunflower and stevia, all of which will be key drivers of growth for us in the coming years.

From a high level, gross profit margins improved by 480 basis points to 21.5% compared to 16.7% in the second quarter of the prior year. This increase in gross profit margins on a slight uptick in sales lead to a 68% increase in our adjusted EBITDA., but we also continue to pay down our convertible debt, which now has only 190,000 remaining and is expected to be paid-off on March 1st of this year. Again, from an operational perspective, we continue to execute.

Now, the second quarter is typically characterized by significant shipments of our dormant alfalfa seed varieties, and this year was no different. Nearly two-thirds of our revenue was derived from the dormant channel, including shipments made to our distribution partner DuPont Pioneer. The demand plan with Pioneer remains on track. While we are seeing solid demand and overall stable markets across most of the world, we are seeing some uncertainty in Saudi Arabia as regulatory discussions surrounding water use restrictions continue to occur.

While these discussions have been ongoing for many years, which has led to the transition of certain alfalfa production in the region to surrounding countries, the recent dialogue has caused certain Saudi distributors to defer purchases and/or limit inventory levels until there is further clarity. Ultimately, demand for alfalfa by the dairy industry in Saudi is expected to remain consistent. It's simply a matter of where the alfalfa hay is being grown. The cows need to be fed and the Saudis do not have the infrastructure to import hay as a replacement to production within the country.

We think the shift of production to other areas will take many years and be a slow transition. Ultimately, with our wide and diversified production capabilities, particularly in the Middle East and North Africa, we will be prepared to meet the alfalfa demands for the dairies wherever alfalfa production might be.

One of the key drivers to our growth, going forward, will be our sorghum operations. S&W acquired the operations of SV Genetics sorghum program in May of 2016 with the goal of advancing deployment of the proprietary high-yielding disease resistant germ plasm worldwide. While the Company has royalty based licensing agreements with 12 partners in nine countries, our ability to transition into the vertical production model for this gluten free non-GMO wholegrain will allow us to capture a higher gross profit dollar and move closer to the end customer.

This move to a vertical production model within hybrid grain and hybrid forage sorghum aligns more closely with the Company's existing alfalfa seed operations where we develop, produce and sell. And S&W anticipates producing seed that will be sold to existing and new sales channels under both branded and private label programs. Sorghum continues to gain increased traction across the United States, and the world for its high protein levels, excellent fiber source and other nutritional benefits. Similarly, we have also recently commenced commercial seed production for one of the Company’s proprietary hybrid sunflower seed varieties in New South Wales, Australia, making our initial entry into the 1 billion sunflower seed market. Again, this move continues S&Ws recent strategic initiative to expand vertically by leveraging the Company's key distribution and production capabilities.

We are initially producing the hybrid sunflower seed in the Murrumbidgee Irrigation Area of New South Wales, Australia with the initial end-customer markets of Australia, South Africa, Brazil and Pakistan, through distribution partners under both branded and private lable programs. Overall, we see tremendous potential in both our sorghum and sunflower seed operations to expand vertically and drive growth and profits into the future. We see this business contributing more than $30 million in sales five years from now.

So on the product development side, we have made significant progress. In particular, we recently announced advancement of 45 new varieties for the dormant and non-dormant alfalfa seed market to our proprietary seed portfolio, including varieties developed for multiple pests resistance for its quality and yield, which we have not previously marketed in the past. These advancements are the result of our internal research and development groups. For the dormant market, we are advancing traits with high resistance to aphanomyces root rot race 1 and 2, which is the highest in the industry, giving life of stand protection to this test compared to rely on seed fungicides. High resistance to alfalfa stem nematode, tolerance to lodging and highest disease resistance index possible in many products.

On the non-dormant side, we continue to improve disease resistance for most pests, including Anthracnose by tofu root rot, aphanomyces, vertisol and [indiscernible] stem nematode, aphids, including pea, spot, blue and black aphids, and maintain our leadership position with the industry's highest salt tolerance. Our alfalfa seed product development team continues to do an outstanding job developing varieties that meet the needs of farmers around the world. The synergies that we have benefited from by bringing together three of the industry's most well known trade developers, leveraging the strengths and knowhow of each team member is tremendous.

And with that said, let me turn the call over to Matt Szot for a review of the quarterly results. Matt?

Matthew Szot

Thank you, Mark. And thank you to everyone on the call today. For the second quarter, revenue was consistent with the second quarter of the prior year, and our expectations. Nearly 66% of our revenue, during the second quarter, consisted of dormant varieties sold into our DuPont Pioneer distribution channel. This was an increase of $1.9 million over Q2 of the prior year.

Now, as we look to year-to-date sales, sales into Saudi are down $4 million. However, we did experienced growth in both Argentina and Mexico.

Gross profit margins during the second quarter were 21.5% compared to 16.7% in the second quarter of last year. The 480 basis point improvement in gross profit margins was largely attributable to decreases in the cost to good sold and favorable sales mix to higher margin dormant varieties. We continue to anticipate gross margins to improve over the course of fiscal '17 versus '16. However, the uncertainty in Saudi, as Mark just touched on and recent devaluations of peso in Mexico are creating certain headwinds from a margin perspective.

SG&A for the second quarter was $2.6 million, which was up $285,000 compared to the second quarter of the prior year. R&D was basically flat at $750,000 and depreciation and amortization was up $50,000 compared to the year ago period. Overall, operating expenses increased by about $350,000 compared to the second quarter the prior year. And this increase is largely due to our SVG operations, which were not included in the year ago period.

Now, our outstanding balance on the convertible debenture as of today is only a 190,000, it is our expectation that we will retire the remaining balance by March 1st.

To-date, we've had $3.2 million of debentures convert to equity. And as a result of the decreased balance on the convertible debentures, our interest expense continues to decrease at a significant pace. During the quarter, we incurred approximately $295,000 in cash interest expense, which is nearly half of the amount incurred during the second quarter of the prior year. We've retired nearly $27 million of convertible debt over the last 26 months, demonstrating our ability to execute on our strategic initiative and continue to drive value for our shareholders.

The de-leveraging of our balance sheet has added a significant amount of flexibility and strength, and we are well positioned to take advantage of opportunities in the coming periods.

Adjusted EBITDA was $2.2 million compared to $1.3 million during the second quarter of last year, an increase of 68%. Now, for Q2, non-GAAP net income was $467,000 or $0.03 per basic and diluted share compared to non-GAAP net income of $164,000 or a penny per basic and diluted share in the second quarter of the prior year. Again, this backs out certain non-recurring expenses, as well as non-cash gains and losses.

On a GAAP basis, net income for the second quarter was $1.2 million or $0.07 per basic and a penny per diluted share compared to GAAP net income of $1.4 million or $0.10 per basic and diluted share in the year ago period. The difference between our GAAP basic EPS and diluted EPS in the current period is being driven by the accounting treatment for the non-cash gain on our derivative warrant liabilities.

With our commitment to debt reduction and initiative to expand margins, we believe we are well positioned to deliver improvements in profitability as we go forward. We feel good about our cash balances and our availability on our lines to support the ongoing business. And I know we went through a lot of data here. So if you have any questions, please feel free to ask.

I'll turn the call back over to Mark.

Mark Grewal

Thank you, Matt. Though I know many of you have had a keen interest in our stevia program for many years. While we are currently restricted from disclosing certain key details, we have recently signed an agreement with a large and well known consumer products manufacturer for R&D collaboration. This is clearly a significant milestone for our stevia program as we look to commercialize our stevia opportunities. And we look forward to being able to share with you about this exciting collaboration in the near future.

We had a solid second quarter. We're making tremendous progress on the product development front, and advancing key traits to farmers around the world are looking for. Commercial scale production of our sorghum and sunflower operations, which will allow us to capture higher gross profit dollar and move closer to the end customer. And we have reached a significant milestone in our stevia program.

While the uncertainty in Saudi Arabia is creating a disruption to the normal supply-chain inventory levels, we expect this to normalize over the next few months as clarity on the regulatory front occurs. We believe we are well positioned in our core alfalfa seed operations for continued steady growth and margin improvement in the years to come. While sorghum, sunflower, stevia have significant opportunities to be growth catalyst for us in the coming years.

We think this is an incredibly exciting time to be involved in agriculture. With all the recent transactions taking place in the space, there will be a number of exciting opportunities for S&W, whether as a result of regulatory requirements or portfolio reviews by the larger companies in the industry. For us to expand our existing product lines are entered complementary crops. S&W is in a great position with our strong base to the assets, including a worldwide distribution base, a large and diversified production base and integrated research and development capabilities that we look forward to leveraging in the years to come.

As always, we thank you for your support. And now let's open up the call for your questions. Carrie?

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Tyler Etten of Piper Jaffray. Please go ahead.

Tyler Etten

I wonder if you could give us an early look into the Australian harvest. How is it looking compared to last year? And is there any opportunity to increase acreage in Australia, either in this year and next year with more opportunity there?

Mark Grewal

Tyler, the first, let's take it all apart. But of course, we are going to increase our acreage production and everything as we move forward in Australia. It’s a very important component to our optimization program, and how we’re going to continue to hopefully drive our cost down and at the same time improve the margins. It’s a little bit too early to talk about where the Australian crop currently is. But if you give Matt, or myself a couple of months, we’ll have a real detail.

But I am down in Australia, I lead the 16th right from the Tulare farm show, and we’ll be down there for two to three weeks. I won’t come back till March. But we will have an answer for you on that as soon as we look at the crop together with all the agronomist. On a kind of -- not knowing, because I haven’t seen it, it is a little bit behind last years from what I am being told. But it's coming in pretty well right now. So, they were pretty wet at one year. So, the timing of the crop to be a little bit later than last year's, which quite frankly really helped us, because we were able to move our product out in the last quarter, because of the early crop they had last year. What was the other part?

Tyler Etten

I believe you covered it all. Just looking forward, any timeline on the ramp-up Australian in acreage?

Mark Grewal

We hope -- Tyler, we’re very close to some new distribution agreements, and those will coincide with some announcements we hope that hopefully come out by March. So, I think we’ll be able to answer some of the forward-looking statements that you are looking for.

Matthew Szot

Tyler, also -- so that we -- harvest gets wrapped up in late May in Australia, so we start -- our contract growers start planting in June-July. So, we’ll have a lot more clarity on how many additional incremental acres we secure in Australia in that late June timeframe.

Mark Grewal

And Tyler I'd add for Matt too that we have expanded the areas out of South Australia into New South Wales, Victoria and Queensland. So, we're expanding our current grower base, which is large to begin with. So we can get into more S&W proprietary varieties being grown down under.

Tyler Etten

Maybe shifting to the Saudi regulation, just what sort of, if there were to be some sort of regulation that hindered sales into the region, how quickly do you think the acres would be displaced into the surrounding regions? And how quickly would you be able to enter those surrounding regions to give some of those [indiscernible]?

Mark Grewal

The short answer is we're continually working into regions around the area. The longer answer is that it's going to take them a long time to transition, what the government wants to do if they so choose to go that way after they review their costing. So first of all I mean the real key thing, Tyler, is we're shifting a lot of our alfalfa seed to Saudi Arabia. And we’re in a very regular communications with our customers in the region. What's happening with the Saudi is the government for many years has discussed a desire to decrease its own water utilization, and that is not unique to alfalfa, but all crops.

And there's been an ongoing long-term debate about this. And the reality is the current infrastructure in Saudi will not allow or be able to physically have importing, even a small percentage of the crops being internally produced in the kingdom. And so, while the -- this would likely to produce crops in other regions. The current infrastructure just prevents this from happening period right now. So, I don't see it. I mean, what we're trying to do is this is, I think our -- the people that we worked with and have worked with for last 20 plus years, it’s a conservative reaction. And the deal -- from the dealers in the region, and they're taking a bit more of a hand to mouth mentality by limiting their inventories.

So right now, we're seeing a little over a million pounds of seed that we have earmarked to go into Saudi that may [technical difficulty] will remain strong in Saudi, and we believe we are better positioned than our competition to take advantage of any long-term shift of hay production out of Saudi and into the surrounding areas. So that's it. We just want to be cautious. Our sales guys are cautiously optimistic, for example, that from our California supplies and S&W, we’ll be moving about the same amount as did last year. But it has slowed up a bit, and we want to make sure our investors understand that.

Tyler Etten

And then one more, and then I'll pass it along. Just the opportunity you've been the new crops being sorghum and the sunflowers and others, its $30 million opportunity in the next five years. When do you start seeing that impact the model? And I guess, any sort of timeline would be helpful.

Mark Grewal

We just had a pretty big meeting last week. And Matt and the Group really ran some detailed numbers. So, let me have Matt give you more timeline on that, so you get it. But you got to remember what we're doing as we've broken down the world geographically into areas that we really want to focus on royalty type arrangements, and they have great production in-house. And we trust their ability to move the product, and to keep it on time. And that we get paid for our crop or for royalties. At the same time, there is areas in the world, geographically, that we need to control. And so, we need to control the production and make sure that goes out right that is on time. And that we capture the biggest share of what we think we could get. So we’re trying to be conservative on this. Some of our guys have really are experts in same thing. The number is bigger. But we’re just trying to be conservative with our investors. So, I am going to let Matt run you to maybe a small overview of where we think we’re going.

Matthew Szot

I mean, Tyler, I think as we’ve guided to before, the sorghum and sunflower it's going to be a nominal contributor to the current year result, just probably to stay under $1 million worth of revenues. But really, as we move into fiscal '19, which is one we’re done with a lot of our trialing, that’s when we really start seeing a ramp in revenues. So, we’ll probably be 25% of the way on that $13 million target by then. And then we’ll probably get to 50% by 2020, and then it’ll ramp up from there. So, in the first couple of years, it's going to be a slower start and then we’ll start seeing the next financial growth.

Operator

The next question comes from Mike Malouf of Craig-Hallum Capital Group. Please go ahead.

Mike Malouf

So, I am interested in this announcement on the stevia side consumer products company. Is it -- some of this more focused in on the food side, or is it on the beverage side? I mean, can you give us at least a little bit color on where we’re talking?

Mark Grewal

This should be a turn [multiple speakers]. We’re strictly --Mike, there is some contract things that got to complete, and gets signed-off on. So, the parties involved have no issues with other parties that they were involved with. So, we can't really speak anymore on it. It's just, there has been -- it’s ongoing and it’s a real deal.

Mike Malouf

And it’s a large company though it's not small one…

Mark Grewal

Yes. So, we look forward to quickly announcing some of the stuff, and we also have a couple other deals on the works too. So it's finally Dan Gardner has proved finally of clicking off some stuff that’s pretty, pretty big, so…

Mike Malouf

And how would this play out? I mean, if you guys do get it signed. How would it play out for you…

Mark Grewal

If it's an -- the R&D and developing the products at each company once to have in his portfolio and product programs, and then it's moving it onto large production. So, I kind of put it similar to what not Matt just laid out in his sorghum presentation a little bit. But just gives us a couple years. So, the good thing is that we have four packed innings, and they’re very product. So some of the players are testing our product lines right now to see if it meets what they want to have.

Matthew Szot

And Mike just to provide a little bit more clarity on that this well-known consumer products, hopefully that we’re referring to, we actually have -- we do have a signed R&D collaboration agreement with them. We’re just not in a position to disclose to you that as of this point, not collaboration agreement has defined, and on a revenue that we’ll be generating the way the performance milestones happen in that, that revenue is going to get, initially gets recorded in December of '17, so about 11 months up from now. But we really -- well, what's more exciting is we think that's really just sort of phase one of a much larger opportunity.

Mike Malouf

And then you mentioned a couple of opportunities that might pop-up this year with some of the consolidation that’s happening within the industry. Can you maybe expand a little bit on that, and how big of opportunities is out there? And how you could execute on those opportunities?

Mark Grewal

Mike, as the Dow DuPont mergers, the Monsanto-Bayer mergers, this part potentials inject the mergers, they're going to have to spin-off or have partners do things that they normally did, because with the merger they already have two companies, and anti-trust will allow them to keep the percentage that they have. And so, there is a lot of potential things that could happen, I believe they will happen. But it's going to be -- it’s really exciting for S&W where we're sitting, because we've done some of these already; for example, the Pioneer as one and then our entry into sorghum, which is very exciting for a lot of the big basics. So you know corn, there's just a lot of deals, the non-GMO stuff that could actually be hands on in our specialty crop division. So, there's a lot of potential here, and it's going to get pretty exciting down the road.

Operator

[Operator Instructions] Our next question comes from Gerry Sweeney of Roth Capital. Please go ahead.

Gerry Sweeney

Congratulations on the margins, I do want to touch upon that in one second. But I apologize, I do want to talk a little bit more about what's going on the Saudi side. The phone broke up a little bit, so I may have missed some of the earlier discussion. But my thoughts around that were as before previously, you were talking about maybe holding back some sales to rebuild inventory for this year, essentially bringing to -- put yourself in a position where you can grow some more seed for the years further out. How much is that Saudi revenue? And it did sounded like as though there was a lot of other growth elsewhere that was absorbing some of that slowdown in that region. Is that fair from that perspective?

Mark Grewal

I'm going to let Matt really get into it. But about 30% of our sales are in that region, historically. So I'll let Matt…

Matthew Szot

Yes Mark, that’s amazing. Last year, we did $31 million of the sales in the Saudi market, and a good chunk of that is actually occurs in our fourth quarter. Year-to-date, our sales into Saudi are down $4.4 million through December, we're obviously hopeful to recapture that in the second half of the year. But with the uncertainty that Mark just talked through, we don't have crystal visibility as to what's going to play out here in Q4. But we're actually getting orders out in Saudi. It's just there's a certain amount of product at risk maybe about a million pounds that might shift into next year.

Gerry Sweeney

Could you reallocate that to other areas that we’re seeing growth that you're thinking about maybe pulling back-on?

Mark Grewal

Gerry, that's actually just an excellent question. Because remember, it depends on the product mix and the dormancy and the branding to determine the market. So, some of that's not like an old tide just shift to another distributor, because it doesn't meet their geography or their criteria, or their brands that are registered for their region. So, as we worked through that type of stuff, all of that will be sold. Every time we have this, every quarter I mean and guys get frustrated with it. But the bottom line is timing, its timing, and its timing to sale. If we’re going to sale it, it's just the time.

Gerry Sweeney

Now, I figured it was harder than just boxing that into another crate and shipping it somewhere else, so that’s helpful. And then sticking to margins, congratulations, I mean obviously up substantially over the last year. You talked about I think in the past we’ve also talked about, there is two things, one the cost of goods sold. You had some lower production, so that will go out to the market and buy some seeds to fill some requirements. But through the optimization program, as we look at the margins today and the improvement year-over-year, how much was the improvement from cost of goods sold? How much is it from the optimization program? And then the third part is I used to target 25% gross margins just for that alfalfa business. Is that still fair assumption at some point in the future?

Matthew Szot

Gerry, this is Matt here. As it relates the quarter-over-quarter margin improvement that we just experienced in Q2 that was really driven by two things. One, sales mix. Q2 had a higher concentration of our dormant varieties getting sold into DuPont Pioneer channel, and that share is the higher margin. That was the main contributor. And additional to that, the cost of goods sold on our non-dormant varieties were lower due to the fact that we were entered into more favorable production arrangements this year than we did last year when we had certain contracts that had or taken out some subject to yield risks. So it’s a combination of those two factors that drove the margin improvement for the year.

The optimization margins improvement that we’re really excited about, and that comes more into play in Q4 when we have the Australian crop come-off. Right now, we have nominal levels of our Australian product on-hand, so there is not much optimization that can even occur. But that happens in Q4, and certainly into next year. And then I think your question is, is 25% margins what we’re targeting for alfalfa. Absolutely, it's not going to happen this year. But we see a clear path for how we’re going to do this over next say three years or so, how we’re going to ratchet up, selling that methodically up to 25% margins.

Operator

The next question comes from Jill Wickersham, a Private Investor. Please go ahead.

Unidentified Analyst

So, this is my first shareholders call, and this is a general question. But I am just wondering why the stock price seems still quite low? Why it hasn’t been able to get over $5? I mean, besides the obvious, more people selling the shares and some buying them.

Mark Grewal

Well, Jill, I am not a stock guy, I am agronomist and farmer. But we have a tremendous amount of holders of the stock that do not sale period. So, the flow is very low. And we have $17 million outstanding, and maybe $5 million is actually to flow. So, it's going to help us to freeze-up. But the bottom line is, it just based on the main results and performance. So, I wouldn't be too concerned about it, we’re building it. This Company is really building into a fine quality go-to-forage company. So I think every year that's actually got better. Although, the stock price doesn't indicate that, it's a much stronger company than it was back in 2013.

Matthew Szot

And then Jill maybe one other factor and it’s really hard to quantify. But we did, over the last three months, did have debt-to-equity conversions of approximately $3.2 million. And we suspect that a lot of those conversions were probably sold right back into the market, which did have some, probably downward pressure, on the stock. But obviously, we're really excited now, because that convertible debt balance is only $190,000, it’s basically gone at this point. So, we don’t think that that should be a headwind in the future. And at the end of the day, we can't control what the stock price does on a daily basis where we have our heads down and we’re focusing on growing this business and expanding the profitability.

Operator

And this concludes our question and answer session. I would now like to turn the conference back over to Mark Grewal for any closing remarks.

Mark Grewal

Thank you, Carrie. The world population continues to grow. They continue to demand higher levels of protein and improved nutritional benefits, and S&W will continue to meet these demands in the years to come. Again, our thanks to everyone for participating on today's call, and we look forward to talking with you again at the conclusion of the current quarter. Have a great evening. Thanks for your attendance today. Take care.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day.

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