Oct 30, 2010
Executives
Jason VanWees - VP, Corporate Development and Investor Relations Robert Mehrabian - Chairman, President and CEO Dale Schnittjer - SVP and CFO John Kuelbs - EVP, General Counsel and Secretary
Analysts
Peter Skibitski - SunTrust Mark Jordan - Noble Financial Steve Levenson - Stifel Nicolaus Chris Quilty - Raymond James Jeremy Devaney - BB&T Capital Markets
Operator
Welcome to the Teledyne Technologies Third Quarter Earnings Call. At this time all participants are in listen-only mode.
(Operator Instructions) As a reminder, today’s conference is being recorded. Now I turn the conference to Mr.
Jason VanWees. Please go ahead.
Jason VanWees
This is Jason VanWees, Vice President, Corporate Development and Investor Relations at Teledyne Technologies. I would like to welcome everyone to Teledyne Technologies third quarter 2010 earnings release conference call.
We released our earnings earlier this morning before the market open. Joining me today are Teledyne Technologies’ Chairman, President and CEO, Robert Mehrabian, Senior Vice President and CFO, Dale Schnittjer and Executive Vice President, General Counsel and Secretary, John Kuelbs.
After remarks by Robert and Dale we will ask for your questions. However, before we get started our attorneys have reminded me to tell you that all forward-looking statements made this morning are subject to various assumptions, risks and caveats as noted in the earnings release and our periodic SEC filings and of course actual results may differ materially.
In order to avoid potential selective disclosures this call is also simultaneously being webcast and a replay both via webcast and dial-in will be available for approximately one month. Here’s Robert.
Robert Mehrabian
Before commenting on the specific results within our segment, I have some general comments about our businesses and about our performance in the third quarter. First our businesses performed strongly in the quarter, driven by growth in our commercial markets.
Total sales increased 3.4% with 10.2% sales growth in the Electronics and Communications segment led by 17% growth in our commercial instrumentation businesses. Operating margin increased 39 basis points to 10.6% despite $3 million of pretax acquisition relative cost, which negatively affect that margin by 68 basis points.
While earnings per share were lowered than the third quarter of last year, please note our last year’s earnings included $0.25 of tax credit versus just positive $0.03 of net operating items this quarter, i.e., $0.08 of tax credit offset by $0.05 of acquisition-related cost. Also total orders were strong in the quarter exceeding sales by almost 9.5%.
In fact quarter funded backlog was $884 million just high of record level of $891 million in the second quarter of 2008, that’s before of course the global financial crisis. Second, during the quarter we want some significant contracts.
As example, Teledyne Scientific or research laboratory was awarded the single largest contract in the businesses history at $25 million DARPA contract known as EXACTO. The purpose of the program is to develop and demonstrate an actively-guided maneuverable 50-caliber bullet capable of addressing moving targets at extreme ranges in high winds.
Also in the marine domain last week our Engineered Systems segment assisted by Marine Instrumentation businesses was awarded with contract by the US Navy Special Operations Command for phase 1 of the design and development of Shallow Water Combat Submersible a replacement vehicle for the current naval sea delivery system. The additional contract is just value at $1.2 million, but is awarded to Teledyne, the entire contract including engineering, development and production phases could be worth up to $400 million over five years.
Third, we closed two acquisitions during the quarter. The acquisitions of Intelek Plc further expanded our capabilities and microwave systems, especially for commercial customers.
We also recently acquired the manufacturer of Gavia Autonomous Underwater Vehicle or AUV. The Gavia AUV system broadens our portfolio of autonomous marine vehicle system as the detection and surveying capabilities of this AUV complements our current marine glider systems used for long-term sensing and observation including the Littoral Battlespace Sensing-Gliders for the US Navy.
Finally, in September we funded $250 million private placement of senior notes at a weighted average interest rate of 4.8% ad our current $590 million bank line is virtually undrawn. We freed our bank line not only because fixed rate are low at the present time, but because our current pipeline of complementary potential acquisition is nearly the largest in the company’ history.
Now turn to our business segment and the third quarter performance. Third quarter sales in our Electronics and Communications segment as I noted increased by 10.2% and segments operating profit increased 9.1%.
On a GAAP basis segment operating margin decreased 13 basis points. However, the quarter’s margin was negatively impacted by 92 basis points due to the $3 million pre-tax acquisition-related costs that I mentioned earlier.
In the third quarter, sales of Defense Electronics increased 5.7% primarily driven by acquisition and as I mentioned earlier sales for our electronic instrumentation businesses increased 17% to approximately $150 million mainly due to 22.7% increase in sales of marine instrumentation primarily resulting from strong sales of geophysical sensors, our oil exploration as well as subsea interconnect system. Global subsea oil production capital expenditures remain stable especially in West Africa, South America and Asia.
In addition, in our environmental monitoring instrument and industrial instrumentation businesses, sales increased 10% and 5% respectively in the quarter. Finally, sales for our Avionic and Other Commercial Electronics businesses increased for the first time in two-and-half years led by growth in our electronic relays and avionics businesses.
Turning to our Engineered System segment, in the third quarter the expected revenue decreased of about 18%, reflected lower sales from nuclear manufacturing, missile defense engineering and NASA programs partially offset by our growing capabilities in real-time distributed testing and other software programs. While operating profit decreased 10.3%, operating margin increased 292 basis points to near record level.
Currently, most of our nuclear manufacture in relates to USEC’s American Centrifuge Project. In late July 2010 USEC updated this application for a long guarantee to the partner of energy.
In anticipation of favorable judgment by the DOE USEC began the mobilization of project in early September. As a consequence, we anticipate some additional sales in the fourth quarter of this year.
Should the long guarantee be approved, this could result in $25 million of additional revenue for Teledyne in 2011. Turning to our Engineered, Aerospace Engines and Components segment sales increased 11.8% compared to last year.
We reported an operating income of $1 million versus an operating income of $1.2 million in third quarter of 2009. The 2009 $1.2 million was primarily due to reduction in certain insurance reserves.
In the general aviation market, demand for less expensive OEM piston aircraft typically beat recoveries. While still only half of the 2008 volume, quarter sales of engines to aircraft OEMs increased for the third consecutive quarter and improved 80% over the third quarter of 2009.
In addition, we continue to invest in new product development such as the Turbo Diesel Engine in order to increase overseas sales particularly in Asia. For your reference, there are less than 1,000 general aviation aircraft in China at the moment, compared to over 200,000 in North America.
Finally, in our Energy and Power Systems segments sales decreased about 18.4% compared to last year, as a result of reduced revenue from turbine engines for the Joint Air-to-Surface Standoff Missile or JASSM. JASSM engine sales are expected to resume late this year and to continue through 2011.
In conclusion, business in each of our major commercial market continued to recover nicely in 2010. In the third quarter, sales related to energy exploration and production, power generation, air and water quality monitoring and commercial aviation all increased compared to last year.
Going forward, we intend to continue investing in our instrumentation businesses, especially in the marine, electro-optical and infrared imaging domain, as well as perhaps expand our nuclear manufacturing capabilities. I will now turn the call over to Dale Schnittjer.
Dale Schnittjer
I will first discuss some additional financials for the quarter not covered by Robert and then I will discuss our 2010 outlook. On cash flow in the third quarter, cash provided from operating activities was $23.7 million compared with $46.9 million with the same period of 2009.
The lower operating cash flow reflects a tough comparison with last year and increased working capital requirements including higher deferred accounts receivable. Free cash flow for the third quarter of 2010 was $16.8 million compared with $37.6 million for 2009.
We made voluntary pension contributions of $37 million in each of the third quarters of the 2010 and 2009. Adjusting for pension contributions net of taxes, free cash flow was $39.3 million in the third quarter of 2010, and was 30% greater than net income.
Capital expenditures were $6.9 million in the third quarter compared with $9.3 million for the same period of 2009. Depreciation and amortization expense was $12.6 million in the quarter compared with $10.2 million last year.
We ended the quarter with $242 million of net debt. Our balance sheet remains strong with net debt-to-capital ratio of 24.2%.
Our credit facility has $590 million of bank commitments and expires in July of 2011. We recently began the process to renew the credit facility.
As Robert mentioned in September, we funded a private placement of $250 million of senior unsecured debt. The notes have a weighted average interest rate of 4.8% and consisted $75 million with 5-year maturity, $100 million with 7-year maturity and $75 million with 10-year maturity.
The proceeds were used to pay down the existing revolving credit facility, because the borrowing cost of our floating rate bank debt was roughly 75 basis points and the senior fixed rate notes are at 4.8%. We expect higher interest expense in the fourth quarter of 2010 and the full year of 2011.
On pension, in the third quarter of 2010 gross pension expense was $1.3 million compared with gross pension expense of $5.7 million in the same period of 2009. Net pension income after recovery of allowable cost pursuant to the Government Cost Accounting Standards or CAS was $1.1 million in the third quarter of 2010 compared with $2.6 million of net pension expense in the third quarter of 2009.
On stock option, stock option compensation expense was $1.2 million in the third quarter of 2010 compared with $1.3 million in the third quarter of 2009. Now let me turn to the 2010 outlook.
Management currently believes that GAAP earnings per share in the fourth quarter of 2010 will be in the range of $0.78 to $0.81. We expect full year 2010 earnings per share of approximately $3.06 to $3.09, an increase from our previous outlook of $2.95 to $3.0.
Regarding our pension for the full year 2010, we anticipated approximately $5.2 million of gross pension expense under FAS 87 and FAS 158. However, given recovery of allowable pension costs from our CAS covered government contracts, we expect net pension income of $4.4 million or $0.07 per share in 2010, compared to $0.17 per share of net pension expense in 2009.
The decrease in full year 2010 pension expense reflects higher investment returns and the impact of pension contributions made since 2007. In addition, as many other companies have mentioned this earnings season as a result of the current low interest rate environment, we could face a fairly substantial reduction in our discount rate used for pension accounting.
A potential 100% basis point reduction from our current discount rate of 6.25% could result in a $0.20 negative earning per share impact in 2011. Finally, as a reminder full year 2009 earning per share included $0.42 of tax credits mostly related to non-recurring prior period research and development tax credits.
For the full year of 2010, we expect capital expenditures of approximately $30 million and depreciation and amortization expense of approximately $46 million. I will now pass the call back to Robert.
Robert Mehrabian
We would like to now take your questions, operator if you are ready to proceed with questions-and-answers, please go ahead.
Operator
(Operator Instructions) Our first question is from line of Peter Skibitski with SunTrust.
Peter Skibitski - SunTrust
I may have missed this, but I was just wondering what drove the tax gain this quarter?
Dale Schnittjer
The main driver for the improvement in the tax rate was the additional pickup in the federal R&D tax credit through 2000 to 2005. That was actually some interest on the return.
We also had the impact of the 2006 R&D tax credit.
Peter Skibitski - SunTrust
Will it go back to a normalized 37% or so in Q4?
Dale Schnittjer
Normalized would be closer to 38.5%.
Peter Skibitski - SunTrust
Then can you give us any sense of your initial outlook for 2011 yet?
Dale Schnittjer
We are not prepared to do that at this time.
Peter Skibitski - SunTrust
Okay. I tell you what, in terms of how you think about things right now.
I know the price of oil has been a bit on the rise, it sounds like it positively impacted your Marine Instrumentation Unit here in this past quarter. Do you sense that the outlook is pretty strong over the next 12 months for you guys in that unit given where oil is right now?
Robert Mehrabian
Pete, in general the outlook is going to be similar to what we enjoying now. The only negative is there is one is the halt in the oil production in the Gulf of Mexico, but as you look forward into 2011 about 35% of subsea capital expenditures are what people refer to as trees, subsea trees that are put on well heads is going to be from Petrobras and they are very good customers of ours.
We should be okay.
Operator
Question from Mark Jordan with Noble Financial.
Mark Jordan - Noble Financial
You had mentioned that there is the opportunity for the Centrifuge business to rebound and if we make the assumption that it does come back and you get the incremental $25 million in revenue out of that. Is that sufficient to offset the erosion created by the OCI issues and declining NASA revenue in that group next year?
Robert Mehrabian
Good question. Probably not because the $25 million or so that really has to offset about I’d say $50 million or so in detriment.
It’s not just missile defense, but NASA in a state of flux as you know. If we have some positive optic on the NASA especially since we have good engineering program that may work the way you described it, but right now as I look at it, it probably wouldn’t cover all of it.
Mark Jordan - Noble Financial
You mentioned in your wish list of areas, where you would like to invest in Marine Instruments, Nuclear, you did not mention Defense Electronics. Do you feel is that a function of not having good targets out there or do you think that market will be more under pressure given budgetary issues over the next year or so?
Robert Mehrabian
Mark, I feel that we are well situated in the Defense Electronics domain. As you know we are not very platform dependent in that area and we have some very strong programs and favorable trends in UAV communication, in the EXACTO program that I mentioned, in our glider programs.
Having said that, it would be prudent for a company like ours, over a period of time to decrease our dependence on defense. Right now we are about I would say somewhere between 46% and 47% defense dependence.
A big junk of that is of course our Defense Electronics.
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Mark Jordan - Noble Financial
Final question for Dale relative to the bank lines, it looks like that your existing bank line, looks like it is LIBOR plus about 50. Could you guess as to what the spread will be when you renegotiate your lines?
Dale Schnittjer
The spread will be between 175 and 200 basis points.
Robert Mehrabian
Does that help mark?
Operator
Next question is from Steve Levenson with Stifel Nicolaus.
Steve Levenson - Stifel Nicolaus
On the potential replacement for the SEAL Delivery Vehicle, is that all development work or is that something Teledyne could actually build in the future? Or would you have to partner up with a shipyard?
Robert Mehrabian
Well, we will partner up with someone perhaps not the shipyard, but we also can build a significant part of that because we do have large manufacturing capabilities. As you know, a lot of our Marine Instrumentation businesses are really going to be very helpful because we not only have the senses, but we have the various programs to make that happen.
The answer is, we will have a partner, but we can build it ourselves mostly too.
Steve Levenson - Stifel Nicolaus
In relation to Marine Instrumentation on the commercial side, as rig count increases should your sales grow at an accelerated rate beyond changes in the rig count or more evenly?
Robert Mehrabian
The other side is that because of the hiatus in the Gulf of Mexico there is going to be more requirement as you well know in controlling the wellheads being able to detect any irregularities and that would also favor us.
Steve Levenson - Stifel Nicolaus
Last one you mentioned Electro-Optical a little bit and you have made some recent acquisitions and investments. Do you think you got gimbal product, for example, that can challenge some of the incumbents on contracts that are up for re-completes?
Robert Mehrabian
Our gimbal product at least the one that we are working with the Optical Alchemy is on the smaller scale. As you know, gimbal’s varying size from 6 to 7 inches up to 24 to 30 inches in size.
The one that is Optical Alchemy has developed and is actually now in production on is the very small size gimbal. For small UAVs and its a very interesting system because its not only the small gimbal that initially stabilize, but it also is able to give geo-referenced positions, that is you not only provide information, but you also provide targets specific locations.
We will make some inroads there, but I do not know if we would be replacing any of the large existing platforms. On the other hand we are also working very hard to get our own cameras and lenses, so that we will be able to offer a cool platform as well as some software there.
Operator
Next question is from Chris Quilty with Raymond James.
Chris Quilty - Raymond James
Robert, can you talk about two big programmatic changes with NASA? Constellation and it looks like the Ares I is going away and move towards some commercial launch and maybe a new Ares V heavy lift.
How all of that impacts you and presumably that is all in your guidance? Actually we will hit that and I will ask a second.
Robert Mehrabian
Let me start with NASA. There is uncertainty.
Let me start. There is a whole lot of uncertainty about the exploration program specially the Constellation, where we have a strong position.
Overall our NASA programs last year were close to $100 million. This year they are going to be closer to $80 million.
It is down about $20 million from there. As you said, funding for Ares I have been reduced by 50% and that might even be further reduced.
On the other hand there is a heavy lift vehicle and Orion Spacecraft, which we can participate in. We are also pretty positioned to capitalize on any changes in the Human Space Flight program because we have a very flexible task order, set of contracts we brought scope and because we didn’t told any large prime contracts for hardware development.
The future is not as clear as it can be, but there are some compromises being considered between Congress and the White House. Once that’s done, we should do okay since we do have a lot of capabilities and we can participate in the heavy launch vehicle development, robotic precursor mission as well as spacecraft development, so all in all will be okay.
Chris Quilty - Raymond James
You think next year is flattish?
Robert Mehrabian
Yes, I would think flattish except this there were some significant new developments will hold our own.
Chris Quilty - Raymond James
The second question on the GMD program, that is up for bid on the follow-on sustainment contract. You are just teamed with the Boeing incumbent?
Robert Mehrabian
Actually, we used to be, but right now we are with Lockheed as a second tier sub in some of that work. We have a number of programs there as you know.
We also have of course work with Boeing as well. We have two pieces there.
One of them is, in the missile defense development and the other one is in the part of our work that is SETA work with the systems engineering and technical assistance. Both of those programs have declined.
We don’t expect that those programs would improve significantly just to give you Chris ballpark number. Last year we had about $136 million in total, among all of these programs in revenue.
This year we expect it to be closer to $100 million. If we can hold that, we would be fortunate.
That’s why I said earlier that really we have to reduce our dependence on defense programs as going forward as a company because as you and I will know it is not possible to expect significant investments in this program considering the status of our deficit nationally.
Chris Quilty - Raymond James
The migration of that program as it stands now, they have stopped putting GDI’s in holes and they are moving on towards more of a testing phase. Wouldn’t you benefit from a higher level of operational tests?
Robert Mehrabian
In general you are absolutely correct. On the other hand the increases in GMD for example, the $300 million that took it to $1.3 million that’s primarily aimed at preserving supply chain capabilities and that one effects us positively because that will again be used for hardware procurement.
You are right. The more they move towards, they seem to better that is for it so that’s why I said we might be able to hold our own in this program.
Chris Quilty - Raymond James
In your Environmental Test Equipment, have you yet felt the free flow of TARP money help in any of your end-markets there?
Robert Mehrabian
Yes.
Chris Quilty - Raymond James
Are you laughing?
Robert Mehrabian
You may have asked me that question before. Well, let’s see, how should I answer that.
Without being political I would say, no.
Chris Quilty - Raymond James
Final question here, the glider business, A, have you bought up every glider company that exists yet and B, can you give us a sense of what the run rate of those businesses are today and what the opportunity might be? Is it just the proliferation of dozens and dozens of these things into the ocean keeps the growth going or is it more of a service to maintain the number of gliders that exist today?
Robert Mehrabian
There are two parts. First, let me correct, we haven’t bought all the underwater vehicle businesses.
There is one at least big one out there that we know of. Having said that, there are a number of different sets of underwater vehicles as you know, glider is one and I’ll come back to that in a second.
These underwater systems called floats, which at about 3,000 of those across the world that essentially measures temperature conductivity or salinity density and relay that information to a satellite and various researchers use that. There are the gliders, there is a floats and then there is the underwater vehicles that are powered.
Those come in to domains. One are tethered that is they have an umbilical cord and the second are free and those are powered by usually a lithium batteries.
To answer your question, our underwater vehicle business is still relatively small it’s about $30 million. What is in terms of glider deployment the biggest program that we currently have is the one I mentioned earlier, which is the battleship, in front of the battleship they deploy gliders to be able to battleship, I should say, they deploy gliders to be able to detect and measures temperature and density so that they can accurately then resolve chronic signals.
In that program is in early development and testing now and it has been very successful and that program in itself could have as many as a 100 gliders in this total. The navy is testing those.
In the next week off the San Diego coast. That’s a $55 million program by itself.
Let’s see. That’s about I can say and of course we are not only investing before in gliders because we want to have gliders and UAVs because we also have so many different sensors we want to have a truck to be able to add our sensors and test them collectively so others can also deploy them in their systems.
I hope that answers the question.
Chris Quilty - Raymond James
It does and actually just a follow-up on Mark’s question about the mini-sub program. I guess the actual news I had seen today was that the SEALs were canceling their SEAL Delivery Vehicle follow-on program is that?
Robert Mehrabian
Not that I know off. I have not seen that.
I know we were awarded this program only last week and it maybe that they are stopping production of the existing system, but not future.
Chris Quilty - Raymond James
The legacy AFSPS?
Robert Mehrabian
I do not know the name, Chris. I do know that this new program was competitively bid and there were two winners for the first stage.
Hold on a second. That’s a sub.
I’m being told that you mentioned is a sub.
Chris Quilty - Raymond James
Yes. That was the dry vehicle.
Robert Mehrabian
This is not.
Chris Quilty - Raymond James
Got it. Just want to make sure.
Robert Mehrabian
Ours is flooded.
Chris Quilty - Raymond James
On purposes, you should say.
Robert Mehrabian
On purpose.
Chris Quilty - Raymond James
Okay. That’s good.
Alright, thanks guys.
Operator
Next question is from Peter Skibitski with SunTrust.
Peter Skibitski - SunTrust
I’m just curious maybe you could make some comments on how pricing is trending? I guess specifically in the Electronics segment.
Robert Mehrabian
In the defense side of the electronics there is going to be continuous pressure on reducing prices from the primes. On the other hand, we have scaled our company as a whole including that business, so that our breakeven points have gone down, costs have gone down.
We haven’t been adding people like many other companies. Our cost structure is fairly stable.
We should be okay there. There is anything that goes of course overseas now the dollar is trending in a direction that’s favorable to us.
Peter Skibitski - SunTrust
On the commercial side, you are seeing more favorable pricing I suppose?
Robert Mehrabian
I think so. Especially if it is exporter related because of the cheaper dollar.
Peter Skibitski – SunTrust
Robert, anything bid in terms of competitive opportunities out there over the next 12 months like the Shallow Water Combat Submersible?
Robert Mehrabian
Yes, we had actually bidding on a number of programs especially in the nuclear domain, which might be favorable. There is a program as I mentioned we have some very strong software capabilities in our Engineered Systems.
One program that we are bidding on is the objective simulation framework program. It’s a software intensive program that could have a substantial affect on us if we were the winners.
Peter Skibitski – SunTrust
Are you bidding as prime?
Robert Mehrabian
Yes, we are and that’s why so exciting and of course we have talked about USEC. I will take on that.
Operator
We have a question from Jeremy Devaney with BB&T Capital Markets.
Jeremy Devaney - BB&T Capital Markets
Actually Robert I wanted to go back to USEC. I apologize if you have already spoken on it.
I’m bouncing between two calls here. I wanted to explore USEC a little bit more.
Are you still anticipating when that program comes live that it would be on the order of $10 million to $11 million a quarter?
Robert Mehrabian
You are right maybe a little less. I would say $30 million to $35 million a year.
There was 1news out of USEC only last night, I just forgot to mention. It seems that is a positive development with the DOE.
DOE’s evaluation of their loan guarantee proposal has two faces. There is a technical face and financial phase in the evaluation.
Their news release said that they had been given instructions on a framework, which sounded like it was going for the financial. It warmer to look at it more positively one can assume that is technical parts of their program has been they made a lot of progress on what else I guess they wouldn’t go to the financial part.
Their announcement that they have made significant progress with DOE vis-à-vis there are too busy in loan guarantee. It’s positive news for us too.
Jeremy Devaney - BB&T Capital Markets
That certainly is positive. Then separately I was wondering, I had a discussion with someone recently about some of the alternative energy initiatives going on over at DOD.
I was wondering if you had explored all of the positioning of your hydrogen generators in relation to DOD’s fossil fuel consumption and what you think your opportunities are there to leverage your alterative energy into DOD?
Robert Mehrabian
I’m not sure really about that. We have some small contracts with DOE, not DOD.
These are R product e-contracts. We also have some other work with government agencies with our alternative fuel programs.
I just don’t see it. They talk about these programs, but I just don’t see them
Jeremy Devaney - BB&T Capital Markets
Alright, great. Thank you for the answers and keep up the good work.
Operator
At this time there are no further questions in queue.
Robert Mehrabian
Thanks, Paul. I will now ask Jason to conclude our conference call.
Jason VanWees
Thanks Robert. Again thank you everyone for joining us morning.
If you have follow-up questions, please feel free to call me, my number is on the earnings release. Operator, if you would go ahead and give the replay information and then conclude the call.
We appreciate it.
Operator
Ladies and gentlemen, this conference will be available for replay after 10 am Pacific Time today through midnight Pacific Time on November 28th. You may access the AT&T Executive Replay Service at anytime by dialing 1-800-475-6701 entering the access code 167791.
International participants dial 320-365-3844 and access code 167791. That does conclude your conference for today.
Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.
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