Pure Cycle's (PCYO) CEO Mark Harding on Q2 2017 Results - Earnings Call Transcript

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Pure Cycle Corporation (NASDAQ:PCYO) Q2 2017 Earnings Conference Call April 11, 2017 4:30 PM ET

Executives

Mark Harding - CEO

Operator

Good day, ladies and gentlemen. And welcome to the Pure Cycle's Second Quarter 2017 Earnings Call. All lines have been placed on a listen-only mode, and the floor will be open for your questions and comments following the presentation [Operator Instructions].

At this time, it is my pleasure to turn the floor over to your host, Mark Harding, CEO. Sir, the floor is yours.

Mark Harding

Thank you very much. I would like to welcome you all to our mid-year earnings call. What we'd like to do today is highlight our results of operations for the first six months of the year. As with most of our calls, we do have a slide deck for this call that can be accessed on our Web site, so it will be on the front page of our Web site, lower middle highlight bar where you can click on that. It will pull up the presentation and I will note the transition of the slides as I progress through the presentation.

So with that, I go ahead and get started. My first slide, it is the Safe Harbor statement. So statements that are not historical facts contained or incorporated or referenced by this presentation, are forward-looking statements pursuant to the Securities and Exchange Act of 1933. I think you all are familiar with the Safe Harbor statement.

Just very quickly and I'll just quickly do this and for those that are new to the Company and new to the story here. Pure Cycle added to DNA is a water utility company. We have about 27,000 acre feet of water resources in the water short Denver metropolitan area that we use to generate revenue, both in terms of the water utility segment, as well as some of the other segments that we have, which I'll highlight in our presentation. Some of those areas are that we provide water to single-family communities and then in addition to providing the utility franchise we also happen to own some land that we’re developing, that I'll highlight a little bit more. We provide water service to the industrial community through oil and gas users to provide water for fracking purposes in the metropolitan area, as well as some royalty interest that we have from a mineral estate that we have.

Moving on to the next slide, we're cradle to grave water utility where we own the water supplies. We develop those water supplies and using that infrastructure that either diverts the water from a stream or from a well. We put that and treat it, put it into a water distribution system. We collect that back from our customers as wastewater. We process that wastewater and then we reuse that wastewater through an irrigation system. How we generate revenues attributable to that. Our portfolio has the capacity to serve approximately 60,000 single-family connections, that's our unit of measure, which is the amount of water that typically serves a single-family customer or about 0.4 acre feet of water per year.

We get revenues from two sources; one is an upfront capital fee where we get one time capital connection charge, which we define as both water or wastewater tap fees. Our water tap fees are right around $25,000 a tap, our sewer tap fees are right around $5,000 a tap. So combined water and sewer tap fees are around $30,000 per connection, and then we get your monthly revenue. So you get your annual water and fuel revenues that you bill to your customers based on mere water usage. And that typically translates into about $1,500 per connection per year in our particular market.

With that, I'll move on to the next slide and talk a little bit about some of the activities that the Company is involved in. We own some land in what we think is the right area, the metropolitan area, the Denver metropolitan area. This will be an aerial illustration, the red highlight outline where our water or where our land interest is. We're right along the Interstate. We have an interchange right at the entrance to our property. We're about four miles south of the Denver airport. Now, we're about 16 miles east of downtown Denver. And really we find ourselves in the largest concentration of economic activity in the metropolitan area it's called the I-70 corridor. It has a very large employment base.

You've got some very significant projects that are under construction, being the Gaylord project; which is a very large hotel resort conference center facility that's currently under construction that's set to open up sometime next year; which will have significant employment in excess of 2,000 employees; and then a very large distribution center that Amazon; and then the Amazon distribution center together with Prologis Park, which has other industrial distribution centers that are also very large employment centers that are really within two miles of our interchange. So our target market for development and this is really a mixed used community that includes single family homes, multifamily homes, commercial retail and industrial uses, so it really positions ourselves very well; our target for housing inventory and a starter home product or looking at the entry level home opportunities with several different products within that entry level home segment.

Moving on to the next slide, I'll give you a little bit more data on where this particular project is and some of the surrounding and neighboring residential developments. We’re really within about a quarter, a half a mile, of some of the more active and probably one of the more active residential areas in the I-70 corridor.

We have zoning for up to 4,400 homes of the mixed type where we'll have some single family detached, single family attached and multifamily homes. We have about 1.35 million square feet of commercial, which should add another 600 to 800 single family equivalent water connections to our system. And it's really, you drill down on just this one asset, and this asset being kind of a real vertical integration, not only do we control the utility side of this but we also control the land side.

If you look at the utility value of call it 5,000 single family connections that's about a $150 million in tap fee numbers, round numbers, and then about $7.5 million annual revenue year-over-year revenue attributable to the project. If you move to the next slide, talk a little bit about some of the infrastructure that we’ve got going. We've been installing infrastructure to deliver our water supplies, which are about four miles south of the both of our water supplies. We have water beneath the property as well. But the bulk of our water portfolio is about four miles south of the property, so we've been extending about eight miles total pipeline where we're connecting all of those supplies up to the property.

We've been accomplishing that over the winter months. We will, we have just completed the physical construction of that pipeline. And then are looking at additional infrastructure, some of this is highlighted where we have a reuse system that purple system we’ll be extending and bringing back our wastewater return flows back to a storage reservoir where we can meet our irrigation demand, as well as looping the water system and some of the roadway infrastructure that will bring access into the site.

And ultimately, what we're looking at doing here is developing our first phase of the project. We'll be developing finished lots and selling those finished lots to home builders in the metropolitan area and looking at targeting about 500 lots, 500 homes for this first phase.

If you move to the next chart or the next slide, this will really highlight how this is likely to progress. We've got the land entitlements for this particular phase; we've got full land entitlements but then we're really getting into class, preliminary class and final class for this first 500 units; working with multiple builders; so this is an illustration of rebuilder model, where we've three separate builders who are working on various sizes of products where they're 45 foot lot, 50 foot lot and 60 foot lot products on this particular configuration; and being able to deliver product and lots from multiple builders simultaneously with each builder likely having maybe two or three different series within that. So you might have six or seven different price point series within this first phase with three different, as many as, three different builders working on it.

Currently, we are working on all the agreements that need to be in place to bring something like this to construction; and that includes lot take down agreements, purchase agreements, tap purchase agreement, absorptions, specifics on how much lots we're delivering per quarter, per builder, per series. So a lot of that activity has been going on for the last three months and we're making very good progress on that; hope to have some clarity as to announce who we're working with, what the structure of those agreements are going to look like; the timing of those agreements, probably within the next, say 60 to 90 days.

Concurrently with that, we're working on engineering permitting and the construction documents for that. So we're paralleling distract where we're getting all the detail that tells us exactly; where all the infrastructure needs to go; where the roads go; where the utilities going, in each of those roadways where each of the curves go, all the alignments attributable to that. We're probably with about 60 days from having construction documents available, so we can start taking that to the market and have most of that work bid out. So the Company will bid that on a competitive bid process sometime later this summer. And then hopefully look to deliver lots probably the first quarter of calendar year 2018. So we're making extremely good progress on that. We will have some lot take downs later this year with some home delivery, sometime first part of next year. So we're very excited about the potential that this represents for the Company.

We have been very encouraged by the demand for this particular product. I think there's a void of having this type of product in the metropolitan area. As many of you heard me say from time-to-time, metropolitan market, historically, has had about 50% of all new home permits qualify in the starter home markets historically and I'll use a 20 year average as the historical segment for that. And those statistics, just for a number of reasons, have really dropped down to less than 4%. So we feel very confident about what is it that we're bringing to market, the demand we've seen for that. And in fact are buoyed so much by that. We're taking a look, not only at this first phase and getting this first phase punched out, but taking a look at what we're doing for our next act.

If you take a look at the next slide, we really highlight the next phase of what it is that we're looking at. So we’ll probably take a look at the next 480 acres of this particular project and that will be a combination of a significant amount of residential activity and that will be the -- the first phase is primarily detach single family lots and homes. And this one will be a combination of detached and some attached product, as well as some commercial product because we've got the interchange right there along the Interstate and then half a mile of frontage along the Interstate. So not only will this be a mixed use in the residential product but it'll also be mixed use with some commercial industrial or retail activity as well.

If you move to the next slide, we've got some illustration of what some of that might look like on the commercial Phase. We are a little bit ahead, a little bit farther ahead, in our thinking on the commercial side of this, having focus most of the residential activity to the neighborhood that we're already working on. And then seeing how that integrates with the next phase of the residential activity. And so what we've also seen, in terms of the demand for the residential product, is a high demand commercial activity and that's primarily because of the uniqueness of the properties positioned along the Interstate with existing zoning, with existing utilities, some available land where not a lot of that exists in the marketplace. So we're excited about not only how this project unfolds from the residential perspective but also from a commercial perspective.

Our likely scenario is to open up that phase once we've got all of the commitments from the builders locked in on the first Phase then we'll start to open up that second phase really look at opportunities with our existing portfolio builders, as well as opportunities for other builders. So we want to expand that out and make sure that not only we have opportunities to continue to produce product or the people that are currently involved with us but also continue to produce product for demand of other builders that may have other types of product categories.

Looking at the next slide that will drill down into a higher view of Sky Ranch, our particular assets are water system. We’ve really interconnected our water systems and supplies, not only that we can deliver what's now effectively build out water supply for Sky Ranch but also continue to service our industrial customers in the oil and gas base to be able to parallel serving water for residential, as well as commercial purposes.

Also I want to talk about and highlight some of our other activities. In addition to our organic growth activities, and I’ll define you know development of Sky Ranch as our organic growth initiatives, but we also have acquisition opportunity. And this year we acquired one of the opportunities that we’ve been evaluating for a bit of time. Little bit south of our existing service area, at the Lowry Range. We acquired the service rights to something called the Wild Pointe Ranch. It's a rural type product where you have large lot development, custom home product that has central water and individual septic sewer for the residential. And then you have municipal sewer through the neighboring town, Town of Elizabeth, for the commercial parcel.

This particular system really fits nicely into our portfolio, and represent some of the -- all the key metrics that we look for. When we look for acquisition targets, it has an existing customer base. So we had about 120 exiting residential customers and probably 20-25 commercial customers. It also has some expandability to it. So in addition to the 120 units, it's probably an additional 40 to 50 single family residential lots still under construction. We’ve got home builders that have those lots that are working and bringing those lots online later this year, and over the next three years.

We also have significant growth opportunities in the commercial corridor. So we think this grows to about 300 single family connections in total. We will participate in getting the tap fee revenue attributable to those, so there is probably another $2.5 million in combined water tap fees from residential commercial connections then ultimately grow to about $350,000 a year-over-year revenue at the full build of the project. We’re generating about $140,000 in water revenues from the existing accounts, so it's a nice opportunity for us. And really emphasizes the opportunity for us to expand our water resources and our operational footprint into other areas.

So like that one, we have our net out for other opportunities that are similar to Wild Pointe in the same geographic proximity. There are a number of systems that are in this area that also have opportunities for us to take a look at bringing value to it, not only as an operator but also as water availability.

Let me move to the next slide, our next slide will really highlight some of our regional water projects that we’re participant with. We’re in the WISE water project, which many of you heard me talk about over the last several years. But we continue to progress on that. We are fully connected to the WISE system as our three other of the partners that we have in this particular project. All the remaining providers are continuing to add that infrastructure, and then hopefully have that infrastructure sometime later this year.

We will have water available this summer. So there are several things that are components to this system. We get about 500 acre feet of additional water supply, so there are water that can come out of that system that will have boost our capacities to provide water to Sky Ranch, as well as the oil and gas industry without any additional CapEx on our part other than completion of the WISE investment as well as some pipeline capacity. So we have about 20 miles of pipeline capacity that interconnects all 10 different water providers. We own about three MGD, million gallons per day, of pipeline capacity that’s interconnected to our partners.

And really the benefits here are going to be, we have additional supply we have additional infrastructure. And then as you’ve heard me talk from time-to-time, this increases the opportunities for regional storage opportunity. So a lot of that infrastructure is going to be interconnected to all of the participants in that, and there is a strong activity for participating and monetizing some of our very valuable storage assets on Lowry as well.

Moving to the next slide, I want to highlight a little bit of activity in the oil and gas space that has picked up again this year. It was been very quiet for the last two years, but it have picked up this year. Interestingly, we have moved from having one dominant operator here who is still dominant, but we now have two other additional operators. So we have three different operators now in this field who are picking up mineral leases and then doing their own pulling of mineral estates for each of their individual wells. And we look to have at least two of them active with rigs this year. So we likely to see two rigs working the fields the latter half of this year, probably somewhere in the 10 to 12 wells in the rest of the year.

And ultimately it kind of depends on the frac design. These typical frac designs are about 10 million gallons per frac. We actually did one at the end of last year for one of the new operators that was twice that, so that set a record for us in terms of water deliveries for our particular frac that was about 20 million gallons for that particular frac. So that 10 million gallons, we generate about $100,000 per well. So we're excited about having that resurface for us and that's very good opportunity for us to deliver available water supply in the area.

Some of the investments that we have in the water transmission line will continue to strengthen our system, and really extend our reach on service ability to that to continue to make it more efficient for oil and gas operators to get their water deliveries to their individual wells. The next slide really just drills down in some of the specifics that many of you already know about, the Niobrara formation, the multiple formations, continues to be a good opportunity for us for the foreseeable future. So we continue to be excited about that opportunity.

So with that, I'd like to talk about some of our numbers for the first half of the year. The next slide really highlights our quarter six month end. So revenues are up about a third and then previous year, and that's almost entirely attributable to the return of the oil and gas opportunities for us. Our municipal water sewer revenues are up slightly, but that's probably a little bit more seasonal, probably due to a mild winter. So we have little bit more activity on the water side over the winter months. And then our oil and gas revenues continue to contribute very nicely to our cash flows. We’re on that the decline curve of that. We have that leveled out for the last three years. So we've seen about three years of production out of our, about 2.5 years of production out of our, oil and gas wells. They are still pumping through a gas driven field, so we still have very robust production out of our oil and gas wells.

Moving on to some of the specific numbers, our balance sheet remained very strong, very liquid. We have approximately $30 million of cash, no debt. Investments for the first half of the year really we are concentrated it to the Wild Pointe acquisition. We spend about $1.6 million on the Wild Pointe acquisition, our Sky Ranch pipeline, about $4.3 million for the Sky Ranch pipeline. We invested about $200,000 into finalizing the WISE Interconnect system and then continue our engineering and development of the Sky Ranch system, the real-estate system out of that. So that really has been some of the investments that we've made for the first six months.

Income statement continues to grow, showing the strength on the oil and gas activity. We look for continued strength in oil and gas, the remainder of the year as well as sort of starting to receive our initial deposits on lots for the sale of our lots to builders for the first phase of this.

So with that I guess I'd like to turn it back over to the operator, open it up to the public for some Q&A. And if there is some color that I can drill down specifically for anybody on our first half year of operations.

Question-and-Answer Session

Operator

Thank you. The floor is now open for questions [Operator Instructions]. And our first question comes from Aaron Steele. Please state your question.

Unidentified Analyst

Just looking at the Wild Pointe acquisitions, when did that officially close?

Mark Harding

So we closed that in December. And so we're just starting to recognize revenue attributable to that. And in fact the nice thing and I should have pointed this out in the text of the call is we're going to start to see tap fee start coming in. So we've already receded tap fees from new connections out there, some tap fees from commercial connections and then also additional residential units. So quarter-over-quarter, our third quarter, you're going to see tap fee revenue coming in and then expansion to our customer base and usage revenues coming in attributable to that acquisition.

Unidentified Analyst

Then are those tap fees similar to the tap fees you will be planning on receiving at Sky Ranch?

Mark Harding

The system that we picked up is a fully developed system, what you're likely to see is really the margin component of those tap fees. So where we look at our tap fees are around $30,000 per connection, combined water and sewer and it's about a 50% margin over the CapEx on that. You're going to see that $15,000 margin component because there's not that amount that's going to go to the CapEx. So that's going to be coming in, they’ll do15,000 but we don't have any additional CapEx attributable to it.

Unidentified Analyst

And then maybe just on the outlook for the frac water supply for some of the wells. How many wells were in the Company supply line for the first half of the year?

Mark Harding

Just the one. So for the first six months, we had the one which was our sort of the 20 million gallon frac, so that was about a 200,000 little more than 200,000. So some operators have brought new designs to that that are increasing the water call on that. Some operators may keep with the same frac design. So we’ll wait and see how each operator forecast that end. What we're planning on is just kind of that 10 to 12 well limit for the reminder of the year, and the experience that we have at that 10 million gallon $100,000 per frac opportunity.

Unidentified Analyst

Then on the royalty interest, you thought that the decline curve, you know it's kind of been flattening out a little bit here, continuing to see that maybe 2.5 to 3 year. At any point, are those wells likely to be refraced?

Mark Harding

They will, so typically they -- what I've seen from other wells in the Niabara formation is that's a five year cycle. So we're about two and a half, we're about half way through that five year cycle. They come in and I do know that they are reworking our well right now. So I'm not sure what they do when they rework that well. But we'll probably pay close attention to see what the production is off of our rework. It's not a refrac, but it is a rework where they'll go in, they’ve got some equipment there that they're doing some stuff down whole on, and then we'll see what that does to stimulate additional performance out of the well and then watch very closely how they start to refrac some of these wells.

Now, that's our particular well. We'll start to see some of those refracs that are a little bit older because our well was the last well drilled; so some of those first wells that are going to be drilling might be within a year of net schedule five year rotation and fracking. So in addition to having some of the drilling activity go-on, you might start to see that start to ramp up from a rework of some of the existing wells that are in the formation. They drilled about 40 wells, so we got 40 operating wells that we supply the water to currently in the formation.

So why we like this space is; not only is it a very efficient way for us to deliver water through the infrastructure that we’ve got invested; and I think that partners very well with our oil and gas operatives; because it's very efficient for them to take those deliveries; but it also allows us a significant opportunity for the capacity that we built over the years. So we looked at serve that capacity for our residential customers. But we have about 1.5 million gallon a day capacity, and that's enough capacity to serve a couple of thousand homes. So we're very still very long on our production capacity compared to what likely absorption is going to look like from our residential development.

Unidentified Analyst

Then on the Sky Ranch side, what is the timeframe on that first phase? And then have you gotten a sense of maybe that appetite for the builder lot take down kind of what those would be on a quarterly basis?

Mark Harding

I do. I have a lot of specifics on that, but I probably can't give you too much of that in advance of having those things, those agreements finalized. We are working with multiple builders. So I'll tell you we've got three builders that we're working with, all are demonstrating significant interest. They want to put a lot of sales force out there, because this is one of their few places where they can get entry level product. Each of them have product that they're very specific about that they're not going to overlap each other, they're not going to cannibalize each other. But yet they can serve very distinct market segments on that. So we're happy with the group that we're working with.

And what I hope to do is probably have some clarity to that within that 60 to 90 day window. And frankly what I'd like to do is probably get another call out there, so I can really detail out the specifics of that for you all at that time. So, let me reserve some of that details and I'll save some of that powder for that particular call.

Operator

And our next question comes from Jasper Scott. Please state your question.

Unidentified Analyst

Quick question on the tap fees. How will you recognize them on your financial statements, which line item will they be in?

Mark Harding

So, you'll see a specific line segment for tap fee revenue increase. So we've got operating revenue that come in, and that's a year-over-year operating revenue. And then you'll start to see -- it's been a number of years. And this particular tap is a new tap for us. We have some commercial taps that we recognize that were part of building our system and we amortized those over a longer period of time. This one is where we're selling residential taps; and because all of the infrastructure is built and delivered pursuant to that; we'll be able to recognize those taps, all concurrently with that, because the sales cycle of that will have been closed. But you'll start to see that as a reportable revenue segment within the income statement.

Unidentified Analyst

So right now, one line item is industrial water used for fracking, one is water and wastewater one is other. And there'll be a fourth item called tap fees received?

Mark Harding

Yes.

Unidentified Analyst

Going to Sky Ranch, you are kinds of working with the housing developers to design product. How do you go about designing the commercial side out? First of all, what is going to be the percentage of Sky Ranch, which is going to be commercial or number of acres or whatever? And then how do you go about deciding, one supermarket, three banks, four to fast food, one dry cleaner. How do you go through that process? Are you doing this by yourself, are you working with somebody?

Mark Harding

I am not doing this by myself. Recognizing as my wife continues to highlight my limitations in this world, I'm not that guy. So we have brought in a team to do that. So we're working with CBRE to be able to help us navigate those fields. So I've got a listing agreement with them. And really taking a look at that front corner, so call it a 160, you take that quarter section up there, probably not quite even that as the 160. But you take a look at that front corner up there and say those are really right up along the Interstate. And if you tuck yourself in that Northeast corner and that's probably pretty good activity for industrial space because it doesn't need the visibility; right on the interchange, you're probably looking at retail space because it has high visibility; high traffic flow; and then transitioning between those two; and that's about as much about commercial as I know.

But then also feathering in where you've got the commercial, then you'll feather into some multi-family. So that'll be some -- maybe some multi-family mixed use apartment type product; and then maybe attached product; and then feathering down into this detached single family product. So there's a transitional area. And so really we work with, both the commercial realtor guys that work with our land planners to really segment that out, and say okay, here is what we're seeing in the market, and we've a high degree of flexibility within our zoning to really establish those pads anyway we want. So, we've got some infrastructure that we can set the whole thing up efficiently and then each individual pad and pads may range from an acre to maybe 20 acres, depending on the type of use on that. And then if you take a look at that as a percentage of the overall project, it could be 20%. We're looking at maybe 600-800 maybe even as much as a 1,000 single family connections attributable to the commercial activity up there.

Unidentified Analyst

What are you thinking about in terms of total value of that commercial part of it?

Mark Harding

Good question, I think Jasper I have…

Unidentified Analyst

You are going to selling us off completely with no residual value other than the water service rights.

Mark Harding

Yes, we’ll have that but there may be some areas where we’ll maintain the super pad and do that on a per square foot lease type basis, we’re evaluating that. So whereas your selling, I can sell a single family fully developed lot in somebody has a building permit on that, a 50 foot lot for $75,000. But I might be able to sell a commercial pad for $4 or $5 foot. So we bought it by the square mile and in some cases we’re going to be selling it per square foot. So that’s going to be a pretty attractive way of us to continue to monetize that. We don’t want to necessarily be in the leasing business, that’s nearly not our business model. So we’re going to favor those types of opportunities where we can sell it on a super pad basis to somebody that would like in that way.

And frankly, what we’ve heard on that is because so much of this property right along the interchanges along the Interstate are owned by people who only lease it by square foot. And there is really a dearth of people out there looking to say yes, I understand that but I really like to own my own building, my own center that’s great we are that type of guy, because that really doesn’t fit with our long term goal. While we like to build our recurring model through usage revenues, we’re also cognizant of trying to stick to those things that we’re good at.

Unidentified Analyst

Looking out over a five year development process of the commercial side, is there a range of dollars that you could be talking about in terms of total sale proceeds?

Mark Harding

I don’t have a good guidance for you on that.

Unidentified Analyst

No even $25 million range?

Mark Harding

I don’t, if I’d be pulling something too far out of the, my rear gear to be able to you to give you a number on that. I do know that that corner is going to be priced per acre, significantly more valuable than our residential price per acre; maybe three-times, three to five times more valuable per acre than our residential components.

Operator

And there appear to be no further questions at this time.

Mark Harding

Okay. So to the extent that anybody couldn’t get the technology to work for them, but you had a question. Certainly feel free to give me a call. And we can drill down into specific color or some of these things. Again, we have made substantial progress in all elements of this. We’re delighted to have the residential opportunities to be opening up sometime later this year. We’re delighted to have oil and gas activities return. We’re going to see multiple phases of this project going on concurrently. So while we’ll have three builders working simultaneously on this first Phase, we’re looking to have multiple builders, multiple phases and multiple categories between residential, commercial activities going on at the same time.

So the Company is really excited. Our Board is excited about the progress that we’ve made, sharing the talents of all the Board members. And they’re all weighing in significantly. So our management depth is not just me out there in the marketplace, I’ve got significant strength and significant support from our Board, great management team. So we’re excited about executing on all avenues of what it is that we’re doing. So stay tuned and please don’t hesitate to reach out and give me a call with any questions. Thank you all.

Operator

Thank you. This does conclude today's call. We thank you for your participation. You may disconnect your lines, at this time, and have a great day.

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