Silicon Graphics International's CEO Discusses F3Q 2014 Results - Earnings Call Transcript

| About: Silicon Graphics (SGI)

Silicon Graphics International Corp. (NASDAQ:SGI)

F3Q 2014 Earnings Conference Call

April 30, 2014 17:00 ET


John Swenson - VP of Investor Relations and Corporate Treasurer

Jorge Titinger - President, CEO

Bob Nikl - CFO, EVP


Alex Kurtz - Sterne, Agee

Glenn Hanus - Needham

Glenn Mattson - Sidoti


Good day, ladies and gentlemen, and welcome to the Silicon Graphics International Corp. Third Quarter 2014 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the call over John Swenson. Mr. Swenson, you may begin.

John Swenson

Thank you. Good afternoon, and welcome to the SGI third quarter fiscal 2014 earnings conference call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a Q&A session. I’m John Swenson, VP of Corporate Development and Treasurer of SGI. Joining me on today's call are Jorge Titinger, SGI's CEO; and Bob Nikl, CFO.

Today's press release is available on the Investor Relations section of our Web site at This call is being webcast, and a replay of the webcast will be available on our Web site 2 hours after the conclusion of the call and will remain available until the next earnings call.

Please note the Safe Harbor disclosure in our earnings release regarding forward-looking information. Today's conference call includes forward-looking statements, including the general outlook for our business and for certain financial measures, growth expectations for certain products, and various operational and product development plans. There can be no assurance that we will achieve our financial objectives, and we ask that you refer to our most recent filings with the SEC for important risk factors that could cause actual results to differ materially from these forward-looking statements.

All statements made in this conference call are made only as of today's date. SGI undertakes no obligation to update the information in this conference call, whether as a result of new information, future events or otherwise. To obtain copies of our latest SEC filings, please visit or our Web site.

Also during today's call, we will make reference to several non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures to GAAP financial measures in our earnings press release, which again is posted on our Web site.

Now to our conference call. Jorge will provide some highlights of the company's performance for the third quarter as well as an update on the state of the business. Bob will give further detail on the Q3 fiscal 2014 results and our outlook. And we'll then take your questions.

With that, I'll turn the call over to Jorge Titinger, SGI's CEO. Jorge?

Jorge Titinger

Thank you, John, and good afternoon to you all.

Overall results for the fiscal third quarter were within the range of our expectations. Core revenue was $122 million up from $107 million in the prior quarter. Outside of the federal space, core revenue in Q3 was up 24% from the prior quarter and would be 11% compared with the same quarter last year. This is a strong validation of the positive turnaround in this part of our HPC business.

Revenue in our federal business was essentially flat with Q2 up only $1 million from the prior quarter, which reflects the continued weakness and intelligence-related spending, which has been an area of strength for SGI historically. We disappointed in this level of performance in our federal business and we are working multiple paths to both diversify and grow our federal revenue within the next few quarters.

On a product basis, revenue related to our UV scalable shared memory solution roughly doubled quarter-over-quarter. And we saw the pace to grow approximately 30% for the full year. In Q3, we deployed recognized revenue on three large UV systems in Japan including the Institute for Statistical Mathematics and the Japan Agency for Marine and Earth Sciences or JAMESTC.

JAMESTC UV 2000 solution is one of the largest shared memory systems ever deployed powered by 2560 Intel Xeon Cores and 32 terabytes of shared memory in a single system instance. This allows JAMESTC to run very large scale fine-grained simulations for which the UV is the only viable solution.

In addition, today we announced that Massachusetts General Hospital and the Harvard Medical School Center for Advanced Medical Imaging Sciences or CAMIS have selected SGI UV and data management solutions to enhance their research capabilities for diagnostic medical imaging.

We also had a solid quarter for ICE X high-performance cluster supercomputer including a large expansion of the Pleiades system at NASA Ames and a large oil and gas win in Brazil with [Semisemantic] (ph) a project funded by British Gas. This was a highly competitive win against all four of our principal competitors. ICE X was chosen because of our superior performance on the customers’ calls as well as a strong reference at Total in France. As we mentioned last quarter, ICE X is on a pace to exceed $90 million in revenue and will be our strongest compute product line this year.

In storage and data management, we won a multi-year engagement with the world's largest commercial imaging provider. This customer required an overall data management solution for large and small data files. We designed for them a comprehensive data management solution including DMS, storage, asset management and professional services to help them manage this complex data problem.

We also won three deals with a total value of $13 million to expand the storage offerings of three federal sites beating IBM and HP for the opportunities. In the commercial manufacturing vertical, we are a leader in providing high performance compute and data management to the global automotive industry.

In Q3, we booked a sizable order from a leading German automaker to provide our [tiered and our spiral] (ph) storage solutions as add-ons to our existing HPC computing.

Now, I want to shift the discussion to our perspective going forward. We are focused on three specific initiatives that will drive growth in FY'15 and beyond. Number one is focus on large deals in high performance computing both in the federal space and elsewhere. Number two, its crisp execution in all aspects of the rollout of our UV appliance for SAP HANA and number three, this continued optimization of our cost structure to enable increase investments in new products and emerging technologies.

The first and most important initiative is to sharpen our focus on winning large supercomputer procurements in both the public and private sectors. Over the next three years, our goal is to grow our ICE X revenue to more than $200 million, which by fiscal 2017, we expect to pull through an additional $100 million plus storage and services. We have grown the pipeline for ICE X to more than $800 million roughly doubled what it was a year ago.

IBM is the leading supplier of x86 based supercomputers, which account for nearly 60% of IBMs presence in the top 500 supercomputing ranking. We believe that IBMs exit from the x86 space is a significant opportunity particularly in the U.S. federal market, which has been confirmed by many of our customers. Accordingly, we will be aggressively targeting the refresh opportunity within this account base with appropriate solutions and sales incentives. The long-term value of these key accounts in our estimation warrants an aggressive focus on this great opportunity.

The second major focus for the company is execution on our substantial opportunity with the UV appliance for SAP HANA. The UV is our most differentiated hardware platform as defined by both unique value proposition for the user and highly dependable technology position for SGI. The UV will be a nearly 50 million product line for SGI this fiscal year, which represents approximately 30% growth over FY'13.

We believe that UV is poised to sustain even stronger growth going forward to the upcoming introduction of the UV 300. This new product platform will provide a purpose-built architecture for our growing list of in-memory applications such as SAP HANA.

As we said on the last call, we estimate that a total addressable market for the HANA appliance including attach storage and services is approximately $2 billion by our fiscal 2017. We estimate that the serve market is at least $700 million within this same timeframe.

To address this growing market opportunity, SGI have spent the past 18 months rearchitecting the UV to address the usage profile of IO centric applications. While the UV 2000 and other configurations of the current UV that is trying to maximize core count to address the needs of technical applications. The new UV300 family is designed to maximize memory density and can deliver 24 terabytes in a 32-socket configuration. This translates to 3x the memory density of the UV 2000.

This combination of extreme memory density combined with the ability to seamlessly scale beyond the current 8-socket threshold of traditional x86 solutions positions SGI to deliver the simplicity and superior performance of a single server solution at scale, which is something that our competitors can only address with a cluster.

We currently have HANA up and running on multiple UV 300 systems and our engineers are working closely with their SAP counterparts to be sure that we are on track to launch the joined appliance solution at the SAP SAPPHIRE Conference in June.

We are working with a number of marquee customers to identify beta sides for later in the calendar year. And we continue to expect our first revenue in the fiscal third quarter ending March 2015. This is a transformation opportunity and is a direct result of the strategy we rolled out two years ago leveraging key software partners to deliver differentiated horizontal scale-up solutions. Success will require incremental investments in people and capital to enable this opportunity. But, we believe that a return on this investment will be substantial.

Of course, we are continuing to market the UV into other technical computing and big data opportunities, the 30% growth, we will achieve this year in UV has been driven by a continuing penetration of these segments. In addition, year-to-date we have placed 97 of our small UV configurations with customers many of them new names and we already have seen some of these upgrade to larger UV systems.

The third major focus area for the company is continuing the optimization of our costs, expenses and investments to make room for the people and technology that will drive differentiation and growth. For example, we are shifting resources in our storage business to increase emphasis on our tier data management software solutions. We also will be investing in our go-to-market capabilities to support HANA opportunity.

In summary, we are making great progress and delivering on the key initiatives we introduced in our strategic plan less than two years ago. Although the current malaise in our federal business have the late fulfillment of our financial model, our margins and expense profile are on track to achieve the financial objectives as revenue recovers.

More importantly for the long-term, we are maintaining a high level of investment in product innovation and in the go-to-market capabilities that will support profitable revenue growth in fiscal 2015.

This concludes my prepared remarks. So let me turn it over to Bob Nikl for more on the Q3 results and outlook. Bob?

Bob Nikl

Thank you, Jorge, and good afternoon everyone.

Let me begin with our third quarter results. As a reminder, many of the financial measures that I will be discussing today are on a non-GAAP basis unless otherwise indicated. A full reconciliation to our GAAP financial results is provided in our press release.

Third quarter revenue of $124 million was up 7% from the prior quarter. Core revenue which we define HPC, Big Data, storage and services and excludes revenue related to legacy cloud infrastructure as well as the low margin deals in prior fiscal periods was $122 million.

This was up 14% compared with $107 million in the prior quarter but down 19% from the third quarter last year due to solely the weakness in our federal intelligence business.

Core revenue in our federal business, which includes U.S. government customers, system integrators and higher education institutions was $45 million up from $44 million in the prior quarter but down from $82 million in the same quarter last year. Our federal business continues to be very challenging in the near term as spend budgets and approvals undergo increased scrutiny.

The intelligence sector were customer spending is running well below our averages of the past two years has been hit especially hard. However, as Jorge mentioned during the quarter we recognized in revenue one large federal deal valuated greater than $10 million our ICE X expansion at NASA Ames. We expect to see continued investment from NASA and other civilian customers in future quarters. However, no large deal deployments are currently scheduled for Q4 in federal and we expect total fed business to be essentially flat quarter-on-quarter.

Outside of the federal business, which includes our commercial accounts as well as the non-U.S. public sector, core revenue was $77 million in the quarter up 24% from $62 million in the prior quarter and up 11% from $69 million in the same quarter a year ago. We are expecting a strong second half in this category due to the previously discussed large deal that we won in the U.K., significant deals for the UV in Japan and a large ICE X oil and gas deployment in Latin America.

We therefore see the non-fed business very much inline with our prior forecast with core revenues set to grow approximately 35% in the second half and 10% to 15% for the full year.

Third quarter revenue for the legacy cloud which is generally commodity services for cloud infrastructure is only $2 million, which compares with $9 million in the prior quarter and $32 million in the fiscal third quarter of 2013. We expect a very little contribution from this category going forward.

Products represented 69% of total revenue for the quarter with compute at 85% of total product revenue, while storage was 15% compared with a 78:22 split in the prior quarter.

In our market sectors, the public sector, which includes both U.S. and foreign government in addition to higher ed and research was approximately 74% of total revenue, while commercial was 26%. And this compares with a 49:51 split last quarter.

Domestic revenue was 42% of total revenue, while international was 58% and this compares with a 52:48 split in Q2. Approximately 77% of revenue came from direct sales, while 23% was from systems integrators and other channel partners compared with a 79:21 split in Q2. During the quarter, we had two customers representing greater than 10% of total revenue.

Our non-GAAP gross margin was 28.6% down approximately 2 points from the previous quarter, but up almost 6 points from the year ago. The sequential margin decline was primarily – driven primarily by a higher mix of product versus service revenue and slightly lower service margins.

Product margins were also impacted by a higher mix of third-party product which generally carry lower margins. You will recall that this decline is consistent with our comments last quarter. We continue to expect to see an overall year-on-year gross margin improvement for FY'14 of 3 to 3.5 points.

Non-GAAP operating expenses in the quarter were $43 million up approximately $1 million from the prior quarter and at the low-end of our beginning of quarter expectation. The sequential increase in operating expenses reflected additional engineering investment related to UV as well as U.S. payroll withholding taxes that resumed on January 1st, partially offset by head count reduction savings.

Consistent with our turnaround strategy, we have been focused on rationalizing both costs and expenses and expect to end the fiscal year, showing a year-over-year decline of approximately $11 million to $12 million in total operating expenses.

Going forward, our goal is to continue to manage operating expenses in a manner that balances that need to support key growth initiatives including the UV SAP HANA program launch, ICE X for HPC and enhancements in our go-to-market capabilities. We currently expect Q4 OpEx to be flat to slightly down, although R&D will be up quarter-on-quarter and for the full year will be essentially flat consistent with our investment theme.

As part of our strategic planning process, we currently are evaluating product roadmaps and other investment requirements as well as opportunities for additional cost savings. On our next earnings call, we expect to have additional directional guidance for operating expense in FY'15.

During the quarter, we implemented a voluntary severance and center program in the United States. And as a result, our worldwide head count at quarter end including full time and temporary employees was 1,239 down 86 from the prior quarter.

Net loss for the third quarter on a GAAP basis was $0.64 per share and non-GAAP net loss was $0.22 per share and excludes approximately $14 million of non-GAAP adjustments as detailed in our press release.

Now, some brief comments on the balance sheet. Ending cash was $80 million down $38 million from last quarter. The change in cash for the quarter was consistent with our expectations based on working capital requirements to support the second half revenue plan, restructuring of severance costs and capital expenditures.

We expect cash to rebound in the June quarter back to approximately $100 million as we will collect on a number of large systems in Japan and collect milestone payments and other large system deployments. Net capital expenditures in Q3 were $3 million, while depreciation and amortization expense was $4 million.

During the quarter we repurchased approximately 20,000 shares of our common stock at a cost of $240,000 for an average of $11.95 per share. Since we started the program just over a year ago, we have repurchased approximately 780,000 shares at a total cost of $10.8 million. With the additional $15 million buyback authorization announced in November of last year, we have approximately $19 million of remaining authorization for the program through December 31st of this year.

Now to our outlook. Total revenue for the fiscal second half is expected to be in the range of $260 million to $270 million. This is at the lower end of our January guidance for the period reflecting the continuing weakness on our federal revenue due to both lower spending in defense-related accounts and the push out to some programs into FY'15.

Excluding federal, core revenue for the second half of fiscal 2014 is expected to be in the range of $170 million to $175 million up approximately 35% from the second half of fiscal 2013 including expected year-over-year growth of more than 60% in the fiscal fourth quarter. Note that this includes revenue contribution from the previously discussed $26 million in the U.K. as well as the $9 million oil and gas deal in Latin America.

For the fiscal fourth quarter, total revenue is expected to be in the range of $135 million to $145 million with services revenue expected to be essentially flat with the current quarter's $38 million.

GAAP net loss for the fiscal fourth quarter is expected to be in the range of $8 million to $11 million or minus $0.23 to minus $0.30 per share. Non-GAAP net loss for the fiscal fourth quarter is expected to be in the range of $3 million to $6 million or negative $0.08 to negative $0.15 per share.

Non-GAAP net loss is expected to exclude approximately $5 million of adjustments as detailed in the press release. Also note that both EPS calculation assume $34.8 million weighted average shares outstanding.

In closing, we will continue to invest in key strategic initiatives that will drive our revenue growth at margins consistent with our target financial model.

With that, I will turn the call over to the operator to open the line for your questions. Kevin?

Question-and-Answer Session


Thank you. (Operator Instructions) First question comes from Alex Kurtz of Sterne, Agee. Please proceed with your question.

Alex Kurtz - Sterne, Agee

Yes. Hey, guys. Thanks for taking a couple of questions here. So from 90 days ago when we last spoke in, you sort of outlined what was going on with the federal opportunities especially in intelligence. What was your expectation 90 days ago and what really happened in the preceding months here to – to come to this kind of outcome. That's my first question.

Jorge Titinger

Alex, how are you? So I will take the question on the – essentially what we are seeing with federal and I will speak about it in two segments, one being the traditional areas of federal where we have been competing, so mostly DoD and intelligence community. What we are seeing is actually slower releases of funding, the more scrutiny on projects although we are also seeing activity levels steadily improve by that I mean there are more meetings, more of discussions, more business are being discussed.

But, as far as actual capital outflows, they are starting to flow but are starting to flow more slowly than we anticipated 90 days ago. So that continues to be the slow gear if you will in our revenue outlook.

On the other side, as I mentioned in the comments that I gave earlier, we are continuing to work on diversifying federal business outside of just those areas, right, so civilian agencies and other agencies. And there we are continuing to make progress, those sales cycles tend to be fairly long and so the – we should start seeing those reflected in our next fiscal year numbers.

Alex Kurtz - Sterne, Agee

And –

Bob Nikl

Alex, its Bob.

Alex Kurtz - Sterne, Agee


Bob Nikl

Just to build on that point so, I think the other thing that's different from 90 days ago was that when they finally passed a budget, there was an expectation that would take a while to get back into gear, if you will. At least in our space, intelligence that seems to be more protracted. And it seems to be somewhat driven by the fact that there is a change in leadership at the top of that agency. And there is still a lack of vision with regard to what the changes to mission will be. I was at the Geospatial Intelligence Conference that was held in Tampa a couple of weeks ago where; there is roughly 5000 people from the government and the military as well as industry talking about that space.

And the key message takeaway was the budget is going to force people to be more disciplined about how they go about funding programs. And the word eye capturing was scrutiny, scrutiny because essentially the budgets, they got to figure out a way to get more for less. So I think everybody stole a little bit gunshot in terms of how they go about moving programs forward.

That's for me is a different feel than I have 90 days ago, I think its picking up. In fact, in March just in March, the conversations, the discussions, the context, I think picked up more than incrementally in that space for us. So we were cautiously optimistic that it's starting to turn on, but it still remains to be seen for us.

Alex Kurtz - Sterne, Agee

My last question then is Bob, not knowing sort of what the future holds for – the release the funds in that – in the ICE, then how shall we think about OpEx going into next year. I mean, is there going to be a further rationalization that you have done likely, you have done in fiscal 2014, should we thinking about try and take out maybe another $5 million to $7 million of OpEx out of next year's number too?

Bob Nikl

I would say Alex, its premature at this point. What we are trying to do is maintain the appropriate balance between investments that we think are really going to pay back. Example, the SAP HANA appliance but we're very mindful and very cost conscious about wherever there is redundancy waste to drive that out of the system. So for the moment, I would say until we get our full year planning concluded, which will have obviously in time for our next earnings call, reluctant to modulate much up or down from current levels.

Alex Kurtz - Sterne, Agee

Okay. All right. Thanks guys.

Bob Nikl

Yes. Thanks Alex.


Thank you. Your next question comes from Glenn Hanus of Needham. Please proceed with your question.

Glenn Hanus - Needham

Hi. Good afternoon.

Bob Nikl

Hi, Glenn.

Jorge Titinger

Hi, Glenn.

John Swenson

Hey, Glenn before you ask you question, how is the sound quality this time?

Glenn Hanus - Needham

Much better. Thanks.

John Swenson

And how do the financials look on the Web site now?

Glenn Hanus - Needham


John Swenson

Thank you.

Glenn Hanus - Needham

Well, let's put it this way. Even I can read them. All right. So no problem there guys. Thank you. So let me ask the federal question this way. My understanding was, there was very little revenue the last couple of quarters and going into the next fiscal quarter, from the agency, the intelligence agency that has the change in leadership and most of the mid-fortyish percent revenue was kind of from other places. So first of all, am I right about that?

And then can you help me understand – I assume that the intelligence stays fairly flattish for a while. And then help me understand the ramp of the rest of the federal revenue and how you think about that over the next few quarters?

Jorge Titinger

So you are correct in the – the mix if you will or where the federal revenue is coming, right? So we are continuing to see strength in some of the areas that where non-intelligence community related. But we started to see some revenue in the intelligence community a small. And like I said earlier, we think – we are also seeing this increase level of activity, so we are working to continue to be optimistic that as soon as it starts recovering, it's clearly recovering more slowly than we had anticipated.

But, areas like civilian agencies, NASA, post office et cetera the customers that we have done business before there upgrading and enhancing their installed base with our products, we continue to see that as strong. And then we are, as I said earlier we are competing now for some of the civilian agencies business and while that is that longer sales cycle, we are going to have success that will show up in our fiscal 2015.

Glenn Hanus - Needham

Maybe give us an update on, I mean, I know you have some new top leadership on the sales side there. What are some of the – give us a sense of what changes have taken place over the last 90 days. And how far along are you in let's say making all the changes you feel you need to make, when do you think you never done, when will you essentially have the thing in place as you feel needed to really drive growth?

Jorge Titinger

Yes. The first 90 days as you can imagine have been spent to a great extent really understanding a lot of our customers. Liz has been on I think travelling most of the quarter that she has been here meeting customers, meeting our teams in all of the regions.

Some of the focus areas that I spoke about for the company, for example this almost maniacal focus on large deal wins comes from that listening, right? We know we need to do better in that area. We are putting all the process in place to actually be able to drive that. This opportunity created by IBM is one of the things that we are focusing on. All of the things that are targeted, it were driven by her.

With regards to structure and changes from processes and what not, those were probably done by the end of this quarter, so by the end of June, so we can enter our fiscal 2015 with the right processes, the right teams in place and the right directions for the sales team.

Glenn Hanus - Needham

Okay. And last question on, if I certainly look at the Street consensus for fiscal 2015 year, its up around 645 or so. And that would imply if federal is going to have a little bit of growth, if the core business that would imply 25, maybe 25ish percent growth or maybe more in the core non-federal. Maybe you could give us your confidence level and something like that happening and sort of give us the three or four key things to make that happen and sort of rank those?

Jorge Titinger

So we are in the early stages of actually doing our planning for fiscal 2015. The math that you presented here would be accurate, right? And so the rest of the business would have to continue to grow and the kind of pace that it's been growing in the last half – two halves.

So again, some of the key focus areas what we spoke about large deal wins making sure that we implement the plan for SAP HANA UV program that we are structuring right into the second half. The continued improvement in some of our regional performance both Europe and Japan had been strong and we need to continue to drive that.

Those are the kinds of things that we are going to focus on to get to the right growth level for fiscal 2015. We are not prepared at the moment to talk about what the number will be, but that's a kind of – those are the kinds of actions that we are driving internally to ensure that we continue to see growth.

Glenn Hanus - Needham

Okay. Thank you.


Thank you. (Operator Instructions) And the next question comes from Glenn Mattson of Sidoti. Please proceed with your question.

Glenn Mattson - Sidoti

Yes. I'm just wondering kind of the pipeline beyond these three large deals that are going to close or I guess maybe its two remaining deals are going to close in Q4. And also about kind of the federal, forget intelligence, but the non-federal business as -- kind of as you head into September that's kind of a bigger quarter for federal anyway. So is there any sequential uptick that you might see just from that x Intel federal businesses you had coming into September?

Bob Nikl

So the product pipeline that we have is about $1.6 billion. Again, that is a multi-year pipeline. So that's actually really strong. As I said during the comments about half of that is our ICE X product line which is our specifically designed for high performance computing clusters. So we see a lot of these large deals are actually ICE X deals. Some of them include UVs, but the predominant product line for the large deals is the ICE X. So we feel very, very good about that pipeline as I mentioned early it doubled compared to last year.

And so – sorry, what was the second part of your question, one was pipeline and the other was –

Glenn Mattson - Sidoti

Just about federal, much typical June to September in federal, I realize the intelligence community (indiscernible) thing, but just if you are – of you take that part out and look at the core federal that you are working with now. Would you expect that to uptick in September due to the seasonality of the – into your budget? Thanks.

Bob Nikl

So we actually have seen it's more governed by large deal wins and seasonality. We – last year, I remember talking about the size of that people are going to spend their budgets and we are not – actually didn't happen. So I'm reluctant to comment on what might happen this September. But it's really mostly driven about specific large deal wins and when they get to revenue based on fairly lengthy sign-up processes. But, we are anticipating somewhat flattish quarter-to-quarter in that space.

Glenn Mattson - Sidoti

Okay. All right. Thanks.

Bob Nikl

You are welcome.


I'm not showing any further questions at this time. Swenson you may continue with any further remarks.

John Swenson

Okay. Very good. Kevin thanks for your help. Everyone else thanks for joining us. Now, we will be presenting at two conferences in May, the Robert Baird Growth Conference on May 6th in Chicago, and the D.A. Davidson Conference on May 28 in New York. So look forward to seeing some of you there. And we will speak to you soon. Thanks.


Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone have a great day.

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