Starbucks Corporation (NASDAQ:SBUX)
Morgan Stanley Global Consumer Conference Call
November 19, 2013 8:00 AM ET
Troy Alstead – Group President-Global Business Services and Chief Financial Officer
Cliff Burrows – Group President-Americas, Europe, Middle East and Africa and Teavana
John S. Glass – Morgan Stanley & Co. LLC
John S. Glass – Morgan Stanley & Co. LLC
Good morning, everyone. On behalf of the Morgan Stanley Research Team, I’d like to welcome you to our 16th Annual Global Consumer Conference. My name is John Glass, I cover the restaurants. And over the next day and a half, you are going to have an opportunity to meet many of my colleagues in research as well as some of the leading consumer staples and discretionary companies in the world.
Just looking down today’s schedule you will get a sense of the breadth of the conference. Starting with Starbucks this morning but then quickly going to Procter & Gamble. Luxury goods maker, Michael Kors. Then Lorillard. In between those presentations we are going to have a few of our own. Starting today at lunch, our strategist Adam Parker is going to lead a panel including the analysts talking about best ideas as well as equity strategy.
Later in the day there is going to be a panel lunch shareholder activism, and finishing the day there is going to be a panel from our trading group talking about consumer trading. I am going to end the entire day with a cocktail party at 5 O’clock, somewhere out in the lobby out there.
A couple of notes on logistics; the sessions are held in this room and the room adjacent. All the breakout sessions are held down at the end of the hallways on the same floor. Then if you do have a one-on-one they are on various hotel floors, I think between 5th and 18. There will be a box lunch served in this room.
Let me quickly change hats and I will make a quick introduction. I have the pleasure of following Starbucks since nearly its time as a public company. In fact, I keep still in my desk, a initiation, a coverage report my predecessors wrote in 1992. At that time Starbucks had 140 stores in four states and one province of Canada. Had a market cap of $340 million and what was interesting is in that report, they all stated that someday Starbucks would have 5,000 stores in the United States. One of the few times I think sell side analysts have actually under estimated something like that.
Anyway today we’ve got a couple of veterans at Starbucks and speaking on behalf of the Company. Troy Alstead joined the Company in 1992 in finance. He was actually in 1991 early days. I think when a very smart and wise move part of the IPO and Al was this Company’s Chief Financial Officer. In addition we’ve got Cliff Burrows, he is the President of the Americas as well Europe, Middle East and Africa and the Teavana brand and which recently opened its first store in New York City. Cliff joined in 2001 and runs the U.K. business.
In addition, we have JoAnn DeGrande in the audience. She runs the Investor Relations as wells as Greg Smith.
So with that, it’s my pleasure to turn it over to Troy.
Thank you, John. Good morning everybody. It’s good to be here and yes I was hired in late 1991, so you take me back memory lane talking through that. I was either very smart or very lucky at the time. Hopefully I was a little smart, but I think I was a lot of lucky to join the company way back when I did.
Starbucks heritage is in the Starbucks store. In fact when I joined and the introduction just heard, that’s really what’s Starbucks was all about with the store. Starting with a store like this is Seattle and a handful other stores that back at that time as you know was only about the specialty coffees and fine teas and spices and coffee making equipment from all over the world.
Today, we have 20,000 stores in more than 50 countries all around the world serving 70 million customers each week and increasingly with a very strategic leadership position in at home and away from the Starbucks store coffee.
Over the last four years, in particularly, we've been able to produce very strong and built strong and consistent levels of same store sales growth quarter-in and quarter-out. That consistency of sales growth has been driven by product innovation, things like beverages, often new beverage platforms such as the Refreshers platform which we launched just a year ago.
Hazelnut Macchiato, a new product innovation just earlier this year, that was right in the heart of our espresso category and yet was highly innovative and highly incremental for the platform.
New product innovation which has been very hard hitting and contributory to comp growth, as well as those returning favor, our best example that Cliff and I love to talk about is Pumpkin Spice Latte. We are celebrating its 10th year this year. It comes into the stores every year during the fall, goes back at again. We are continually, frankly even amazed internally at its ability to keep driving it’s proposition, counting over itself ever year.
And frankly how it’s become one of those iconic products that many of our customers measure the seasons by, when Pumpkin Spice Latte hits this fall. When the Red Cups comes into Starbucks stores, it’s time to think Christmas. We’ve actually become in many of our cases some of those iconic products that really signal things in people’s lives as we become more pronounced.
Food has been a significant contributor particularly over the past year to our quarterly comp growth and that is by the way even prior to the La Boulange roll out, which we’re in the midst of rolling throughout the United States today. As we’ve up leveled food in the last two years as we heavily focused on food offerings that are very relevant to the day parts, we’ve driven very significant and meaningful steady contribution incrementally from food in the system.
Our loyalty program has been a great contributor as well, really an umbrella to everything we’ve done. We have found a way with loyalty to engage and resonate with our customers in ways that perhaps no other loyalty program really has, given the frequency of that customer transaction and I think the natural loyalty people has for that Starbucks experience every day and there is not question to loyalty program, it has contributed to a consistency of comp growth throughout this period of time.
Day parts expansion, while we have had very enviable comp growth at all day parts even during our busiest morning day parts, the mid day and the afternoon, very consciously, very deliberately and very thankfully have been stronger even than the morning day part as we’re specking those day parts progressively over time.
All of that is enabled by and you’ll hear Cliff talk a little bit about this in just a moment. All that’s been even further enabled by work to drive productivity in those busy morning day parts, to move that line faster, through technology, through procedural works, through lean processes, through work routines, our ability to list the lid on what used to be constraint busiest CAP hours in the mornings, progressively continues and it’s allowed us to drive productivity higher every year, recently and it’s allowed us to raise average unit volumes in our stores to levels that we don’t really know what that limits can be now over time as we continue to innovate across the store.
We delivered another strong result in fiscal 2013 as you heard us talk about in recent quarters. Revenue growth of 12% up to $14.9 billion and while we’ve been driving revenue growth rates steadily over the last few years, in particular expanding operating margin 150 basis points of operating margins of that non-GAAP 16.5% margin in fiscal 2013. On the strength of that top line growth in that margin expansion, we drove 26% growth in earnings per share to $2.26.
We have drove earnings fourfold over this span of time as you can see and we have kind of weighted the strength of revenue growth through the heavy listing of continually squeaking out tens of basis points throughout the middle of the P&L in every opportunity we can to drive earnings growth consistently, effectively double the rate of our revenue growth.
And that revenue growth has become increasingly diverse; diverse by geography, diverse by business channel, diverse by day partners as I mentioned and diverse by product category. In the Americas, we produced revenue growth of 11%, that’s by far our biggest business unit that we have. It continues to grow very steadily and consistently. In the Americas, the strength of very strong same store sales growth and a moderate pace of new store development as we go.
EMEA, which has been a more challenged part of the world for us, has been improving and we moved into positive comp growth as we moved into the back half of the year and is contributing once again to revenue growth for the company.
Our channel development business, which is the business we are really cracking the seeds for that future growth going forward as we continue to aspire to and strategically go after and out of store consumption pattern, where we’ve historically been under represented and we see a tremendous opportunity, and I’ll come back to that in a moment.
And then our China and Asia-Pacific business, our fastest growing revenue business, a very healthy 27% revenue growth. That is driven both by a healthy same store sales growth similar to the level we see in the Americas and then also in China and Asia Pacific, really significantly contributed by an acceleration in new store development, very accretive high profit, high return on capital new store development.
Now while we have driven revenue growth, we have expanded margins. Each of our four operating segments contributed to margin expansion over the past year, again the Americas, the most mature already a high profit, high returning business for us and continues to drive margin expansion. Again contributed by the sales leverage and a very strong comp growth in those elevating, averaging volumes that we have across the U.S. system and then also as I mentioned the great work around continually looking for tens of basis points of efficiency and waste management and the costs of goods lines and the labor line throughout the P&L.
EMEA, not unlike what we’ve done in the last few years around transforming the U.S. business if we go back to 2008 and 2009 and even into 2010. We are now in the last 18 months to 24 months approaching EMEA with that same kind of sever around transforming the business and it’s clearly paying off for us now. As we grew margins every single quarter of fiscal 2013, we’ve reached again graph is starting from a lower base, but a good improvement over the course of the year and we exited the year in that fourth quarter with greater than 9% operating margin in EMEA.
The path forward in the EMEA looks bright for us. It will be a bit lumpy as we go through various initiatives. We have been improving that business over time, but we were very pleased with the trajectory we have. We see a clear path for us to execute to move that business into the mid teens and then progressively towards the upper teens over time, well within our grasp to reach that over the coming couple of years.
Channel development, the business expanded margins in fiscal 2013. That is the segment we have that most benefits from the coffee tailwind. Our retail geographic segments are proportionately less benefit or impact from coffee cost, but Channel Development takes the full benefit or brunt of that over time and that’s some of the benefits that you see on that margin.
And then CAP, not only the fastest revenue growing business that we have, but also the highest margin business that we have in the company.
Now just another moment about Channel Development. There was as I go back all the way to where I started the presentation, a point in our history where we are very content to be the world’s premium operator of Starbucks stores, starting first in the U.S. and then rapidly expanding all around the world.
In recent years, in particular, we’ve strategically set our sights on all of that consumption of our core products of coffee and tea and those things that surround the coffee and tea and the coffee house experience outside of the store, with a huge amount of global consumption and where we’ve always been underrepresented and under shared. And we’re very excited to now strategically be going after that and had great success in it in these early days to have gained 30% share of the U.S. at-home coffee market and growing and that is heavy fueled by the leadership position we’ve quickly taken in the rapidly growing premium single-cup business.
Now, our ability to take the Starbucks brand and our products and what we do and extend those outside of the Starbucks store happens because we build the brand and we build those experiences and we create that environment first through the store in any geography that we may be in. The store has not only set us up for the opportunity to then extend the consumption at home and in the office and when people are traveling, but the stores themselves are also very powerful engines of growth and profitability with growing AUVs, growing four wall profitability, strong incremental capital returns.
Now, speaking of stores, I’ll pause for a moment. I’m going to turn it over to Cliff Burrows who not only runs the majority of our stores globally and has responsibility for those in the Americas and now in the EMEA. He’s been with the Company for a long time, as you know, and I think he’s also the leader with the longest title within Starbucks.
Thank you, Troy. Good morning, ladies and gentlemen. It’s a great opportunity to be here. I’ve been at Starbucks for 12 years, started my career in the U.K. for five of those years, moved over to take responsibility for Europe, Middle East and Africa. No sooner they got there then I was requested to come to the U.S. and run the U.S. stores and I started that in the beginning of 2008 and it’s been an amazing journey.
In recent years I took on an expanded role to cover the whole of Americas and six months ago picked up EMEA again and our latest brand Teavana. And there are lots of similarities around the work. There is lots of points of leverage, particularly around the people and the operational approach to that work.
I’m delighted to be here today in New York. New York is one of those places that has been incredibly good for Starbucks. It’s been very kind over these years. Now, a lot of exiting things are happening in Starbucks today. And all the time when we’re introducing this new ideas, new innovations, new programs my primary responsibility is make sure that we can handle it in our store environment and also that it enhances the customer experience.
We’ve done a lot of work over recent years to simplify the work to make it much more consistent and also invested a tremendous amount of money in our stores, hundreds of millions of dollars to make sure they stay relevant and they can keep pace with all the things we’re doing, same time very, very focused that we need the people, we need to be partners in the stores to be able to deliver and to manage all these changes. So that’s been my primary focus over that time.
We also know that the customer really appreciates and is very focused on the friendliness of the store partners. The taste of their beverage is made just the way they like it and also it has to be fast enough for them to respecting their time and focusing on speed is really important. And just trying to get that whole balance, which is the Starbucks experience for us and we know the quality of everything we do has to match the quality of the beverage, which has been a driver of our business for so long.
We’ve also focused in recent times on our growth and we know it all starts with the stores. We know we have an opportunity for more stores and the only opportunities in the four walls with the new innovations make me really excited about the growth and they also make me not only confident about the fall walls but about the opportunity to continue to grow. We always get asked few questions, is the U.S. in saturation, and the answer is very simple. Not at all, well not even close.
Last year we opened 512 new stores in the U.S. The dark green dots are the stores without drive through. So you could call them cafe-only and you can see how widely they are distributed around the country. The light green dots are our drive through and more than 65% of the new development last year was in drive through and that has presented a big opportunity for us. And not everyone knows it, we describe this as a company on market, but we have a third of our stores on license. We obviously prefer to own and run and operate our stores, but we recognized it through channels whether it’s grocery or through captive channels such as airports. We have to partner with people and more than 4,000 store in that licensed area and more than half our stores open last year, we’re in license business. But the customer really tells us that access and convenience is what is most important for them.
Now investing in the stores, is not only in the new stores, it is about renovations. It is about investing in new technologies. And I just talked for a moment about drive-through. We have focused on improving the experience. Drive-through is something we had. But it wasn’t something we really focused on. We’ve seen from best to worse. There is huge opportunity to improve it. To study what the best in the industry is doing has also helped us increase the experience, enhance that experience and increase the throughput. So drive-throughs are more expensive, by the nature of the size. They cost us more, but we get a significant improvement in the profitability of drive-throughs, thereby 25% higher in average revenues and they produce a good margin for us.
We’ve now got some pretty major program going on over the next three years, which will be an investment in the physical space and technology to enhance that experience. What you’ll start to see is live, and I think the highlight of this is the live face-to-face video conversation that can take place between the customer and the car and our barrister who is saving them. They’ll also be able to use their mobile devices to pay for the orders and we think all of that helps enhance the experience for the customer.
So a lot of new opportunities for us and the focus on the remodels in our stores, as I say, we have focused on keeping those stores relevant. It’s always been about location. It’s always starting with store, but we’ve kept pace and I think you’ll see we’ve moved away very definitely from the historical cookie-cutter approach. Each store we make it locally relevant to the customer. We try and use local materials and all of that is designed to enhance the experience of the customer. About 3,000 stores have been renovated, either minor or major, over the last two years.
Now when we do renovation, we’ve already built in the cost of that renovation for minor, and a minor I’d describe as a coat of paint, replacing damaged furniture, to repair, just keeping the store in good order. And that happens usually every five years. Every 10 years we do a major renovation, which is really putting the store back together to deal with the many hundreds of customers who are coming to the store everyday.
We don’t expect to see a significant uplift by staying relevant. We do want to make sure as the portfolio ages, it does not look like it is aging. Where we do a significant enhancement, increased space, put in an extra number of seats, where we change a configuration to improve flow, or where we’re putting something like clovers in addition, then sure enough we see an improvement.
Now the store and focusing on what we offer the customer is really important, and we’ve talked a lot about La Boulange, but food is been a growing part of significance over the last decade. It’s started – I mean, our journey started with really enhancing and introducing breakfast sandwiches into our stores and they resonate with our customers. We’ve changed ingredients over time to be much more natural, cleaned up those ingredients. We brought in oatmeal which is a great addition and very simple product that’s come into our stores and then enhanced the ticket and enhanced the opportunity for the customer. Food is important and we’ve got to deliver great quality food.
In recent monsoon, over the last couple of years we’ve introduced salads, we’ve introduced lunch, which has given again a much better opportunity for the customer to access the food they are want. But just over twelve months ago, we started to introduce La Boulange, and La Boulange starts with great quality ingredients. We have taken a point of view on food and so far we’ve rolled out over 3,500 stores. And we have put in not only great food in the stores, we’ve also put the backend which is manufacturing, we’ve put in the distribution, we’ve put in the logistics to be able to deliver those stores, those products to store in a way that they are freshest, in a way they can be served with prides of the customers and also help us control wastage, while we grow our sales.
So we see huge benefits there. We do see that we can move this needle to the mid-20’s overtime. But you can appreciate; we’re not going to slowdown the beverage sales to wait until the food catch up. So this is going to be convergence overtime.
Biggest single opportunity building a quality bakery is lunch. We have a very, very small participation in the lunch market, which is huge. So if we can introduce food that is relevant, start to build the reputation for it that combined with the innovations around TV, innovations around combination, around refreshers, all helps us hopefully build a second peak to match our morning daypart.
Troy talked then I’ll just talk briefly about the productivity over time. If you look back to 2008, you’d seen these eight transactions Olibra, we base it on transactions. So when you add food in, it increases ticket. But we still expect, and we still find ways to improve our productivity over time. We will see this continue to growth and it’s not only looking at how we do our work, how we construct the beverages, how we are putting the backboard to help support the sale of food. All of that, plus lean principles and the investment we make in trading our partners is all helping us to growth that productivity.
I have a real passion for retail. I have a passion for service. I have a passion for merchandising. But I think one of the most significant changes overtime, is been our relationship with our customers through Starbucks Card program, through the My Starbucks Rewards and more recently through the digital ability to pay and track the card and the track the whole program.
We are seeing reloads on the card in the last 12 months, 3.7 billion on the My Starbucks Rewards and the Starbucks Card program. We have also seen that reloads have grown 70% over the last few years. More than 6 million people are active members on the Card program and 4 million are at Gold level, all of which bodes exceptionally well. One history of our transaction is paid for by the Card and My Starbucks Rewards and we know in the U.S. about 23% comes from our most loyal MSR customers. And I think that growth in digital is just the beginning.
The customer adoption despite age, despite confidence with technology people are using as their way into technology. So we have a lot of exciting stuff and not least is what happened on 85th & Madison, we opened just over four weeks ago – just over three weeks, I should say, our first new store. We acquired Teavana, which is a mall-based business on retail teas and merchandise that will carry on. This Teavana store is the first of many and it brings together the Teavana expertise around tea and merchandise Starbucks’ ability to create a fantastic environment and now creates a – start to create beverages, which we hope will become a tea ritual to match our coffee ritual over time.
Imagine what we could do in tea if it’s anything like our coffee journey and you’ve heard the very early days how small we were. So we’re really excited about the opportunity that we have in tea and tea today is only 8% of Starbucks store business. Again we think that Teavana in our portfolio gives us a huge opportunity to grow that segment to complement what happens around coffee.
And I think, finally, just to wrap it up, we recognize we are adding more into the stores. We are so proud of the people who work for us, the 200,000 partners everyday who put on the green apron. They are committed, they’re passionate and they’re dedicated to what they do and without them it would not be possible. So we owe them an enormous gratitude of debt. Thank you for your time today. I’m going to hand it back to Troy to finish off.
Thank you, Cliff. Back in 2008 and 2009 when we, under Cliff’s leadership, in particular in the U.S., took a step back at restructuring trend from the business in many ways and changed the company from what had been a rapid growth company for many, many years to what again is a rapid growth company, but in a very different way today. Today we are rapidly growing and heavily focused on driving same-store sales, drop the stores, by leveraging that existing asset we have, by growing through day parts, by expanding product offering that still is relevant and core within that Starbucks experience for driving growth in geographies, for driving growth in categories, for driving growth in channels of distribution.
And while we’ve returned the company now firmly into a growth mode, much more diverse and much healthier than ever before. We’ve also implemented all throughout the company levels financial discipline like we never had previously. That enhanced capability and financial discipline has allowed us to consistently deliver strong financial results in fiscal 2013 once again with revenue growth of 12% and 150 basis points of margin expansion and very strong earnings growth. And it also gives us confidence in fiscal 2014 and the years ahead in our ability to drive continued disciplined growth and enhanced bottom line.
Once again in 2014, we’re expecting double-digit revenue growth, driven by mid-single-digit comp growth and 1,500 net new stores around the world. We also expect at least as much margin expansion in 2014 than we just delivered in 2013. We delivered 150 basis points of expansion in 2013. We anticipate somewhere between 150 basis points and 200 basis points of margin expansion in fiscal 2014. That revenue growth in that margin expansion contributes to our EPS range of $2.55 to $2.65 with some offset in there a bit due to a higher tax rate that we anticipate in this current fiscal year as well as highest interest expanse.
Now just a brief comment about coffee; consistent with what we have been saying for quite sometime, in fiscal 2014, we expect another year of Coffee tailwinds, we have virtually locked all of our coffee needs for 2014 at prices that will lead a net $0.09 to $0.10 benefit to the P&L this year. It’s a gross coffee benefit less some investments in the business and part of which is and the single biggest of which those investment is the price reduction we took in our CPG channel this past year, passing along some of that coffee benefit along to the consumers.
In fiscal 2015, we do not have much buying at all, having done yet into 2015, but given where the market is at today, we would anticipate another year of tailwind in 2015. It will not be as high as 2014, the peak we believe on our P&L is 2014, 2015 will be a tailwind, but not quite as high.
There is a couple of reasons I should point out for that, I think sometimes are lost. One of which is where the seed prices trading at today is frankly too low, it’s below the cost of production in some of the growing regions and in some countries around the world. As we have done for decades, when coffee falls to that level, we got to convince our farmers to pay them what it really takes for them to grow their coffee, so they can make a living and sustain what they are doing.
So as the seed price falls further, we will benefit not at all from the seed pricing falling. In fact, we are not fully benefiting from where the seed is at today, given that we will support our farmers with incremental payments to make sure they can do the right thing. We are in this for the long game. We are going to take care of our farmers in the process that’s something we have done for a long time and are committed to.
One other element that’s important to recognize is, as we buy 300 million or 400 million pounds of coffee every year and roast and sell that, it’s fair amount of that we roast and then sell under licensees around the world who operates Starbucks stores and our food service partners. Where we do that all that benefit of the seed price reduction passes along to the licensees. So on that 300 million or 400 million pounds that we roast, not all of that reduction in price that we generate from year-to-year shows up on our P&L, some of that goes to the benefit of our licensee or food service partner.
We have been committed to and remain committed to investing into the growth opportunities in the future and then balancing that at the same time with increasing returns to shareholders over time.
In the last 10, 12 years in particular, while we have grown the top line, while we have expanded margins, while we have driven earnings stocks through them with revenue growth and while importantly, we’ve been investing into the business in heavy ways, investing in our people, in our capability, in our infrastructure and a few acquisitions here and there, investing and planting the seeds of growth of the future, at the same time, we have significantly increased our return on capital as a company, tripling that rate of ROIC over the last several years in fiscal 2013, reaching above 24% and we believe we can continue expanding ROIC from year-to-year as we go from here by virtue of driving growth and in many cases, a less capital intensive growth going forward.
We are also been committed to increasing returns to shareholders. We delivered $1.2 billion of cash back to shareholders in fiscal 2013. With respect to dividends, we are committing to growing dividends over time as we have in the past years. Dividends have grown as earnings have grown, but we have also recently expanded and elevated the top end of that targeted payout ratio range and that elevation of that range just reflects the fact that we have a very strong balance sheet, strong predictable cash flow generation, we have got a business that can afford to continue to deliver consistent and growing dividends over time.
With respect to share repurchases, we think about repurchases in two ways; the first part of our repurchase program is to offset the dilution that comes from our very broad based equity programs. Since we are a privately held company we had stock options that went out to part-time reapers in our stores and we continue to have that equity program today.
First target is to aim to buy enough back and given you to offset that delusion of at least hold the share count even. Beyond that then where market conditions are appropriate and where we think is right will be in the market and take some additional shares off the table from time to time. In any event I would anticipate that over time we will elevate both dividends and share repurchases.
We’ve a very strong, very healthy balance sheet, healthy and predictive cash flow generation, both operating cash flow and free cash flow, a conservative balance sheet in the fact of relatively little debt. We recently completed a $750 million debt offering. We did that in advance of knowing arbitrators decision, but we wanted to take advantage of market conditions at the time. So that $750 million that we placed recently of 10-year notes was at the low end of our financing range that we were looking for, but we went there, again wanted to take advantage of the conditions at the time.
We will now, as I discussed last week, issue another $750 million sometime soon. They kind of top off that recent round of financing. That next upcoming $750 million will be in the shorter range of – end of maturities.
And then just to wrap it up, I would say I hope you’ve heard from Cliff, you’ve heard from me. We feel like we’re phenomenally well positioned to move forward from here given our responsibility in the business, our coffee leadership, our global footprint, this powerful flywheel we’ve created between the brand experiences and the stores, enhancing that with the digital connection to the customer and then leveraging that into the store, huge opportunity that we have to build going forward, will position with a healthy balance sheet, a strong P&L and an ability to continue to drive growth going forward.
With that, I will stop. Thank you for your time this morning and we’ll go from here. Thank you very much.
John S. Glass – Morgan Stanley & Co. LLC
[No Q&A session for this event]
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