Qualcomm's Management Presents at Raymond James Systems, Semiconductors, Software & Supply Chain Conference (Transcript)

Dec.10.13 | About: Qualcomm Inc. (QCOM)

Qualcomm Inc. (NASDAQ:QCOM)

Raymond James Systems, Semiconductors, Software & Supply Chain Conference

December 10, 2013, 2:30 PM ET

Executives

William Davidson - Senior Vice President, Strategy and Operations

Analysts

Unidentified Analyst

Thanks a lot for coming with us, being with us. We're really happy this afternoon to have with us from Qualcomm, Bill Davidson, Senior Vice President, Strategy. He's going to run through presentation, and then leave a few minutes at the end for Q&A. So Bill, take it away.

William Davidson

Great. Thank you very much. So I will make forward-looking statements today. I will not be updating guidance, no matter how hard you try. So my comments will be based on the last point that we gave guidance. I'll be discussing our businesses. I'd encourage you to go to our most recent earnings release in our 10-K that we filed with the SEC for description of those businesses and associated risks.

So it's incredible for me, when I look at these numbers, 10 years ago or a little only even five years ago, looking now at the scale that we've achieved in our two larger businesses, the chipset and the licensing businesses. So more than 15 billion cumulative ASIC shipments. And if you look last year, we shipped 716 million MSM. So just extraordinary the scale that the chipset business has achieved. And then, now more than 250 licensees for our patent portfolio.

And I think even more importantly is looking at the area still yet to come, where we think wireless will have a tremendous impact whether it's in marketing or adjacent opportunities that we'll talk about, new opportunities, new pieces of hardware that our chipsets can go into as well as network capabilities. So we'll talk a little bit about a few of them.

I wanted to start though, I enjoy, I hope you enjoy, telling some of the beginnings of the company, because it's very, very important context for why we find ourselves, where we find ourselves today. So for the first few minutes, I'll just go back and give you a little bit of a history about how we came into being and why we enjoy the position that we enjoy today.

So if you go back to our beginnings, 28 years ago, the industry was grappling with an issue that we grapple with today and I think we always will, which was how do we get more spectrum or how do we become more efficient in the spectrum that we have, right. The industry was looking at how to move from analog to digital in the wireless networks.

And of course, there was that famous McKinsey study that really caused AT&T a divestiture to let the wireless licenses go to the Regional Bell Operating Companies. And McKinsey forecast that by the year 2000 there would be 900,000 wireless users in United States. There were up by a little bit. It was about a 109 million. And that was a key decision for the phone company at break up, as I said to let those licenses go to the Regional Bells.

So therefore, we're spectrum constrained and how are we going to get more capacity on these analog networks that are out there, so the industry was making the move to digital. And they were doing that through time division technology. So GSM and you maybe remember TDMA being here in the U.S., really both the same technology, but they called it TDMA here.

And so we came along and we had a better idea, and the time division technologies were going to increase capacity about three times over analog. And what we said was with CDMA, we think we can do eight to 10 times and maybe even ultimately 30 to 40 times the capacity over the analog networks. And thankfully, we've over the years achieved that or even exceeded it.

So we couldn't just be a little bit better, we had to be a lot better than what was out there at the time. But very important context was nobody believed that CDMA would work. There is a famous quote from a Stanford professor that said CDMA defied the laws of physics and electrical engineering. So when our founder goes out and speaks on the subject, he still says that, 3G, CDMA is alive and well around the world and working well, except within a 10-mile radius of the Stanford's campus.

But it's really important context, because therefore we were left to do everything on our own. The rest of the industry didn't believe it would work, said some very unkind things about the company actually. And it left us to do the development on CDMA. So we had to start our own chipset business, we had to start our own infrastructure business and had to start our own handset business.

And then going back again at the time, the industry was really dominated by three large players, and not because they did anything inappropriate, but they were just the ones that had the scale to have their own chipset infrastructure and handset businesses. So along comes Qualcomm with this better idea and we go to pioneer CDMA on our own, and we had acquired Omnitracs, which ironically we just divested, to help fund the research and development for CDMA.

That eventually proved to not be enough. Unlike every other startup, we have stories of people mortgaging their homes and literally we got to the point where we were at risk of not making payroll. And so it was the legal team, at that point in time we have been issued I think 50 patents, and they said, well maybe we could go out and drive some license revenue from a couple of these patents and keep the company going.

And it was actually our first licensees who said, we know you're the only ones working on this. I think they handicapped the chances of it ever seeing the light of day as very low. So they said we don't want to deal with you and your patents again, why don't you just license them all to us. So that was a grand birth of the portfolio licensing program. So not a well sort out business plan on how to capitalize the company, one of just being opportunistic.

Thankfully, the legal team did it one better and said not only will we license you what we have today, but we'll agree on a period in time going forward that you'll also get access to the inventions that we create over that period of time. What that's become is the vast majority of our licensees on evergreen license, where there license agreement renews for the life of the most recently used patent.

So kind of an interesting story on how it came about and why I think we are where we are today, as we were doubted. And I guess thankfully that still is the case today, it keeps us scrappy as a company that no matter what we tend to try to go off and do, there are some doubters, and therefore your achievements look like achievements, when you make them.

We were able to divest the handset business in 2001 to Kyocera. We sold the infrastructure business to Ericsson in 1999. We retained chipsets, because they are really the path to market for our innovations. So we do all this incredible research and development over $5 billion last year, and that gets passed to the industry through a licensing program. So we've become this aggregation of research and development for industry, to where people will even refer to us now as the Bell Labs for wireless in terms of the role that we serve.

And I think these two businesses together is actually very good, because two-thirds of the earnings coming from licensing, means that most people walk through the door at Qualcomm everyday trying to think about how to grow the overall opportunity. I'd like to say most companies worry about their market share and we actually worry about growing the opportunity for everyone, because we want our licensees to succeed. And then of course we scrap it out for a fair share of the chipset opportunity with our own business there. So a great model and one that kind of works in perpetuity for us.

I thought I'd just spend a minute kind of recapping some of the growth opportunities that we sited at our Analyst Day back in November. Looking at smartphone growth and innovation, thankfully despite a few people getting worried last year, that trend continues to be very strong for us, so the adoption of smartphones globally and the continued growth there.

And facilitating data growth, so back to the comment I made about the McKinsey study, we always seem to be in a state of trying to figure out how to be more efficient or gain more spectrum or obviously both at the same time. That's a hallmark for Qualcomm in terms of efficiency over the airlink, developing adjacent opportunities both for licensing and chipsets. We'll talk about a few of those. And then creating a digital sixth sense, we believe your phone can actually do things for your and be this digital sixth sense. So we'll go through them.

Your smartphone is a one-to-one relationship, right. I look at my house, we have a couple of computers sitting around, that's one to many. We are, my wife, I and one of my children might go in and use that, but your phone is yours. And it's amazing to me how integral part of our lives this device has become. I fall well outside of this 18 to 24 year old demographic, but I know the last thing I do before I go to bed and the first thing I do when I wake up is check my phone. I haven't had an alarm clock next to my bed in years. It's my phone that I use for that as well.

We look at our phones once every six minutes during waking hours to give you an idea of how, I'm sure you all know an ingrained piece of our lives this has become. A 106 average daily app launches by U.S. android users, just extraordinary. 94% use their device to look for local information.

And then video, 79% use it to watch video. There are three hours of YouTube video content uploaded every minute around the world through mobile devices. This is creating a tremendous challenge for the network operators and we'll talk about some of the things that we're trying to do help and solve that.

As I said, a lot of consternation for a period of time, this calendar year, our last fiscal year, doubting our smartphones over, is it the end. And I think sometimes we get to have a bit of U.S. perspective, where we see everybody here using one. The joke, as I remember, there were a group of people that thought everybody at Blackberry back in the year 2000. So I think sometimes become a victim of what we see rather than recognizing that across most of the rest of the world this transition is really just getting started.

So if you look that's resulting in our prediction of 20% compound annual growth rate for shipments between '12 and '17, and translating into 7 billion accumulative shipments from 2013 to 2017. So I'd still call that a fairly healthy opportunity for the company going forward. And we've seen no signs of that slowing down.

Obviously, the business is comprised of both replacement devices and then new opportunities. And clearly the emerging markets are what are providing the new opportunity. But I think we gave people some comfort, when we talked about the fact that ASPs and emerging regions are actually rising.

So as we see the transition from 2G to 3G happening and people going from feature phones to smartphones, they're actually paying up a lot more than I think people would have expected. And at our Analyst Day, we talked about the emerging market ASP for fiscal '13 being $190. So still I think much higher than people would have expected and actually is helping the overall average as we see people migrating from feature phones to smartphones.

Back to the network issue, the average smartphone uses about 50 times more data than the average feature phone. So great that people are converting over, but it's creating this forward challenge for the industry on capacity on the networks.

And then clearly, one of the hallmarks for Qualcomm has been doing a tremendous amount of innovation across all of the different technology vectors in the phone. We need to be good in a number of different areas, and I'll highlight a few of them in a minute, but we'll get comments from time to time about a particular feature or particular capability.

And I remember, back when we were a single core product and one of our competitors had dual core, and two was going to be better than one, our single core outperformed their dual core. Then they went to the quad core and we had two cores, and four was going to be better than two, and our two core outperformed their quad.

The point is that a phone unlike a computer, the CPU was the focus in the computer, CPU and a phone for us is less than 20% of the actual silicon content. So in wireless, in phones and in tablets, it's about doing the whole thing well. You can't just be good in CPU, you have to bring this whole solution together very elegantly.

And as evidenced by just all the different things that we have to move from our technology vector standpoint and be good at whether it's GPS or Bluetooth or Wi-Fi, all the different capabilities in the GPU, computational camera, stereoscopic photography, just across all the different vectors in the CPU, the GPU, the DSP, location-based services, the successful players have to be good at all of them.

And a key one for us, the modem, I think was getting ignored for a while. In particular, I think its why some coming from the computing space to try to compete with us have been challenged, is they really looked at the modem as a commoditized peripheral and that the heart of device was the CPU.

And so it's almost like they were treating the modem and wireless like it was Hayes 212A modem from the days. But it's actually where there is a tremendous amount of innovation that's taken place and a tremendous amount yet to come. So you have to be really good at the modem and there is no question that we're known for that. And it's been very helpful to sell LTE and the migration to LTE around the world.

We now have more than 220 networks launch globally. Of those, 23 are LTE TDD. And important to note that during the standards process in 3GPP, LTE, both the TDD variant and the FDD variant, the desire was to have the difference between them be de minimis. And it's so that there is manufacturing scale around both flavors. Our chipsets have supported both FDD and TDD modes from the outset.

And you can see the growth in connections year-over-year, 195%. That's about 144 million connections now for LTE. So if you look at total wireless connections at 6.8 billion, 3G 4G at about 2.3 billion and of that $144 million are LTE. We, Qualcomm, had a long runway for growth without any new devices being connected to the network, just the conversion of that remaining 6.8 billion to come over and then the eventual upgrades that we'll see at around the world to LTE.

Replacement rate was another area of focus. Replacement rates have been holding fairly stable. And we talked about for '14 being flattish across both emerging and developed region. So the rate at which people are upgrading their phone is holding in very well. We've seen some recent announcements here in the U.S. on plans, where we actually will see consumers have the ability to trade up more often. We'll be watching that closely to see the uptake there.

And then ASPs, this to me is one of the most remarkable charts. I love showing it how for 10 years I have heard about concerns around ASP and ASP decline. And while we always talk about modeling kind of low-single digit decline in our business plan, there has always seem to have been something that came in at the high-end, so that we've seen this divergence around the mean, where the low-end has gone lower, but the high-end has actually gone higher over time.

And so while we have in our plans, this modest decline, there are clearly opportunities that we could see offset that. But I think it's prudent just because of the trend in technology that you plan for a modest ASP decline. And by the way our forecast for the next year represents a $3 decline or just about 1%. So again I think laying some of the fears that were created about ASPs coming down.

Key point in ASP too is that the fluctuation you'll see quarter-to-quarter on ASP both in the device business in specific to our chipsets is much more about mix. I some time see people getting concern and thinking that its price erosion, but really what drives those fluctuations in our business is mix, is the point I was making there that both replacement rates and ASPs are holding up quite well. So it really just depends on the mix in any given quarter where devices are shipping or what kind of inventory is needed that moves that ASP around.

Now, here, again just trying to show the different way and these are not to scale, so we encourage people not to get their ruler out and try to figure out how much of our die size is the CPU. But really, just meant to be illustrative of all the things that we have to manage within the chipset and be really good at.

If I went back six or seven, eight years ago, we were a modem company, and now you look at the capabilities that we're putting into the GPU, the type of engineers that we've hired over the last five years, while we still look for good modem engineers, have been much more around the software side.

I don't think we get enough credit for being the software business that we actually are. Got to take all these technologies and move them very rapidly, which makes it much harder for others to compete there. And as I said, we're kind of known for the modem, but I don't think we're known for some of these other areas and our focus here is led to a bunch of industry first, so I won't read them all.

But as I said, I don't think people realize whether it's the things we've done in video, the Snapdragon 805 that we announced, the first device supporting Ultra HD and 4K video. So if you're sitting with a tablet in your lap, looking at Ultra HD or 5.1 or 7.1 surround sound were through a standard set of headphones. If any of you were at CES last year, you could come into our booth and hear us doing surround sound just through software and the chipset.

So just incredible innovation going in across the GPU, the DSP, the CPU, supporting all the different location-based services, which us adopting some of the new technologies from some of the new satellite arrays, has also helped us from a share standpoint. Remember, here in the U.S. it was the E911 mandate that really got us to put location-based services into the chipset, but you think about with all those capabilities, the devices that you used to have that you no longer need, whether it's a GPS receiver or digital camera or video camera, I continue to be amazed at the capabilities that continue to come into the device.

And what's that translated to? We had a pretty good year in terms of flagship designs over fiscal '13. I'm sure you'll recognize many of them, but it really leading in that high-end is important, because if we can lead in the high-end, and especially if you look LTE and OEM will design a device with LTE, but want to leverage that industrial design globally.

So it might be in LTE SKU in a market where we have LTE or region where we have LTE, but it might be a 3G SKU elsewhere, well, given the pin-compatibility in our chipsets and the ability for us to work with a common set of software, manufacturer can leverage that across the globe. So winning in the high-end has a very good effective trickling down into other design activity, so important for us to stay on the leading edge there.

And what that's translated to is more than a 1,000 LTE devices either carrier accepted or in-design, so just amazing scale and breadth that we bring to the table and being able to work with our partners and have a pretty broad launch perspective with them, that's 380% growth year-over-year. And of course we announced our fourth generation LTE device back around Analyst Day in November.

So now let's move to, how are we going to get more data across the network and this is an internal rallying cry that we have within the company. We're calling it the 1,000x data challenge and the goal is that over the next decade we need to be able to support a 1,000 times the data coming to the device than comes to at today.

I remember it took about 100 years for data traffic to overtake voice traffic in the wireline network. So 1876 to 1976, we're already there in the wireless networks. And if you look globally, wireless broadband connections surpassed fixed back in 2010. So that's the way most people in the world are going to get on to the internet.

And now looking at the adjacent opportunities we want to expand into, it's very, very important that we have a pathway for good growth for capacity in the networks and also trying to bring the cost down to transmit a bit across the network, so that what happened with voice pricing when you think about in the early 2000s, we want to see the same thing happen with data pricing that we can radically change the economics and make it viable to offer much lower pricing or even getting back to some fixed pricing model, so that consumers don't have to worry about running up that large bill.

And the way we're going to do it, more spectrum as always in higher and lower bands and we've been working to pioneer this idea of authorized shared access, so take for example coastal radar, that spectrum that's being used for coastal radar, isn't being used in the middle of the country where is no coast, so why shouldn't we take advantage of that spectrum that's sitting idol. Or there is spectrum that's used maybe sometimes and not others. Our view is there should be a secondary participant in that spectrum other than the incumbent, so that they can take advantage of it when it's available. So that's one of the models, and then the other will just be getting new spectrum.

More small cells, so the original deployment model for a macro cellular was obviously -- and by the way, what was contemplated back then was so different from how we use our devices today. Or do you think about how many times are you within arm's reach of a wireline phone when you're on cell phone. I know, I do it at my desk all day along, I do it at my house. The original networks were never designed with that in mind.

It was going to be a macro cellular deployment. You're going to be out in your car driving. There wasn't this concept of just this massively dense need for capacity and coverage to where we've evolved to. So the outside in-model, as we call it of putting up big towers and then splitting them to gain capacity, and putting more in, to get in-building coverage, we think that to get this 1000x capability, we have to invert that.

And do what's called an inside-out model. So instead of trying to get the signal from outside the building in, our view is that we're going to see the deployment of these very small base stations, the size of a phone in building, and then that coverage will actually radiate out. And with very modest penetration levels, something like 20% you can see a doubling in capacity on the network. So it's just some thing we'll be working on the years to come, but much like today you probably have a broadband access point sitting in a closet or in the computer room in your house somewhere that provides Wi-Fi, vision is you'll have a device that will broadcast wide area coverage as well.

The interest thing to see the business models that could crop up around this, whether it's the operators in one region who sell it, maybe there is a third-party who resells it to all the operators, maybe the cable companies get involved, who knows. And maybe the business model will be that if you're willing to have one of these devices, you'll be in the club and you will take advantage of the lower rate. If you're not willing to have one, well, then maybe you pay more. But we think this dense deployment model is the only way forward to get the kind of economic change that we need in the industry.

And then what that does actually is, it make some of the higher frequency bands useable. Today, the higher you get in the frequency band, the less distance that the signal will travel and therefore you need more base stations if you're operating in 1.9 instead of 800 megahertz, you need more base stations to provide the same amount of coverage. In this small cell model, that's exactly what we want. We don't want the coverage to go too far and cause interference. So therefore it makes these upper spectrum bands usable for something that before previously would have been unthought-of.

I talked about adjacent opportunities. I'll focus on the wearables, toq.qualcomm.com to get your smartwatch. It makes a great holiday gift. We rolled out our smartwatch, and I can tell you I stopped wearing the watch about five or six years ago because I always had my phone with me, and with traveling I just didn't want another thing that have to take with me.

Now I think if you took this away from me, I'd be very upset, because I get all my text, notifications on the device. I have my outlook calendar here. I could set it absolutely fine doing GPS pedestrian, I could get my turn-by-turn on the watch. So I've just become very, very attached to it.

So that once every six minutes that I looked at my phone, I now actually go into the watch for a lot of the alerts and I've shut my phone alerts off completely. I am also not constantly powering up this thing that uses the most battery life in my phone, which is the display. So I'm a big believer based on the fact that I wasn't even a watch wearer anymore in wearable technology.

We actually had sensors. They are great innovations. And it's a mirasol display, so highly reflective. It's wirelessly charged. We are the first true stereo Bluetooth headsets to go with it that don't have a chord between them. They are front-loaded with an LED, so just great device, so I had to put in that plugs, since we just launched it.

But you can see the opportunities that we have, whether it's into healthcare, education, we just think wireless will make this dramatic difference. We can't think of a device that wouldn't be better, if it was connected to the network enabled to exchange information.

And it's interesting, I mean when you look at tablets, the architecture for a tablet is a smartphone moving up, not a computer coming down. And I think that's another reason why we've seen success, is that the computing mentality doesn't work coming down to a device that people don't want to have to plug in all the time, and as mobile, it doesn't have coax coming into the back with the gobs of bandwidth. You have to live in a spectrum and tower constrained environment. That's what we're good at designing to.

That's why I think tablets have really been the phone architecture moving up. And if you look at the development community, the development community is now focused on the phone primarily first, because that's where the traction is. That's the bigger market, so I think the days of designing for the desktop are really gone and it's going to be much more about designing for these highly portable wireless devices giving them access to information in the cloud.

Put up our 3G, 4G device forecast for '14 representing 11% to 18% improvement over last year and we also put some third-party data up at the Analyst Day just to show this isn't our view, but the bar chart to the right in 2017 is a third-party view. And what's instructive of it is the breakout of non-handsets as part of the total volume out in '17. We've not done that before. We thought this would be helpful, an illustrative of what the opportunities are and what at least one analyst firm is sizing the opportunity at, so 400 million non-handset devices out there in 2017.

And obviously, therefore, what we believe is we can apply mobile technologies to everything and eventually everyone. Imagine I had to sit through being still a Giant season ticket holder, back here where I grew up, the Santiago game this weekend, which was very difficult to take.

But imagine if I had gone into the Charger stadium as a visiting fan of the Giants, and that I got greeted when the network sensed that I entered the parking lot. And I therefore could get direction to the concessions, and I could be in proximity to something and find out information about it. These are the types of things that we think we're going to enable through your handset. And there is Internet of Everything, that that non-handset devices, 25 billion by 2020, so just remarkable growth that we'll see there in the non-handset space.

Finally, I thought I'd just show you a couple of examples of what our view of the digital sixth sense is. What I'm showing here is a combination of augmented reality and sensors. So we're holding the phone up at this window to overlay digital content in the physical world.

Now, your first example of ever seeing that was probably the yellow first down line in football. So that's putting digital content on to the physical world and using it, Fox tried it with hockey, if you remember way back, one with the blue dot, it was atrocious didn't work well at all. And then John Madden got to draw all over the screen, so that's the goal here.

But we can use the phone as this viewfinder to discover things around us and then we want the things around us to have sensors so that phone can then interact. So I've taken you to a family room setting here, where I can see ambient temperature both inside and out, I can do certain things by making the world clickable to me, and interact with my environment around me.

Basically, if you look at what the phone is capable of today, it knows where it is, it knows whether it's moving, it can see, it can hear, it will be able to smell soon, and so it becomes this extra sensory, the phone should be able to do things for you. So the example I gave of the stadium. Why?

When I walk into the grocery store, why shouldn't I have been able to input my shopping list ahead of time, as I go into the grocery store, it recognizes I am there, my grocery store application takes over my phone and leads me isle by isle to item level location and walks me through the store and shops for me. Those are the sorts of things that we want to enable.

Now obviously, privacy is key in these areas. We're big believers in consumer should be able to manage what and who the people are and what they know about them and how they find it. So the platforms that we've developed to accomplish is, are all TRUSTe certified, and the data actually that's collected about the user resides on their device, not on the cloud, so they can wipe it out at anytime and start over. But I think it will prove to be very, very useful for consumers.

I like in it too if you get that blue envelope of Valpak coupons on the mail that you just kind of throw in the trash, I pick out the dry cleaning one, I'll admit to it, but I don't need drive driveway sealing and I don't need blinds, but imagine you had a digital version of that, that when it arrived, and you open the envelope, everything you took out of it was that's where I buy my coffee, that's where I buy my gasoline, that's where I shop, that's the sort of relevance that we can provide, and therefore I think people will see great value in it.

Finishing off on return to capital, we obviously accelerated that in 2013. We up the dividend 40% at stockholder meeting in March and buyback activity was about $4.6 billion last year. We've updated to say that we're going to target 75% of free cash flow for return to capital, we can grow the dividend in excess of the earnings growth and our baseline now is an anti-dilutive policy and still being opportunistic around executing on bigger opportunities around the buyback when they are accretive. We've got a pretty good track record there of doing that.

And just to sum up, good news is that smartphone adoption continues. No sign of slowing down there. The appetite for people to upgrade their devices and also for people who don't have them, to get them, continues. We'll see many more 3G and now even 4G deployments in emerging regions, QTL and QCT, pretty good story in both cases, stable ASPs, stable replacement rate. QCT having continued industry leadership and forecast for improving margins exiting the year.

We're managing our expenses. We talked about certain R&D programs that we're curtailing, but not at the expense of maintaining our leadership position. We spent over $5 billion in R&D last year. And then our continued focus on innovation and commitment to capital return for the stockholder. So setting up to be another good year for us. And I thank you for your time.

Unidentified Analyst

Thank you very much. Appreciate it.

William Davidson

I'm happy to take your question if we have time.

Unidentified Analyst

Why don't we just [indiscernible].

Question-and-Answer Session

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