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GrubHub Inc. (NYSE:GRUB)

Q2 2014 Earnings Conference Call

July 24, 2014 10:00 AM ET

Executives

Anan Kashyap – Corporate Finance & Investor Relations

Matthew M. Maloney – Chief Executive Officer

Adam DeWitt – Chief Financial Officer

Analysts

Aaron Kessler – Raymond James

Michael Graham – Canaccord Genuity

Ryan Ripp – Citigroup Global Markets Inc.

Ralph Schackart – William Blair & Company

Edward Williams – BMO Capital Markets

Operator

Good morning. My name is Mike and I will be your conference operator today. At this time I would like to welcome everyone to the GrubHub Q2 2014 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions) I will now turn the call over to Anan Kashyap. You may begin your conference.

Anan Kashyap

Great thank you, good morning everyone. Welcome to GurbHubs’ second quarter 2014 earnings call. I’m Anan Kashyap, Head of Investor Relations. Joining me today to discuss GrubHub’s results are CEO Matt Maloney and CFO Adam DeWitt. This conference call is available via webcast on the Investor Relation section of our website. In addition, we’ll be referencing our press release which is available on our Investor Relations website.

I’d like to take this opportunity to remind you that during the course of this call management will make forward-looking statements which are made in reliance on the Safe Harbor provisions of Section 21E of the U.S. Securities and Exchange Act of 1934, including guidance as the Company’s future performance. These forward-looking statements are subject to substantial risks known or unknown and uncertainties that may cause actual results to differ materially from those projected in these forward-looking statements. Reported results should not be considered an indication of future performance.

For additional information concerning factors that could affect the Company’s financial results or cause actual results to differ from those in the forward-looking statements. Please refer to the cautionary statements included in the Company’s filings with the Securities and Exchange Commission, including the Risk Factors section of the Company’s prospectus filed with the SEC on April 7, 2014 and the Company’s quarterly reports on From10-Q. The prospectus and other filings we make with the SEC are available electronically on our Investor website at investors.grubhub.com or the SEC’s website at www.sec.gov.

Also I’d like to remind you that during the course of this conference call we will discuss non-GAAP financial measures and talking about the Company’s performance. Reconciliations to the most directly comparable GAAP financial measures are provided in the tables in press release which is available on our Investor website at investors.grubhub.com and has been filed and exhibit to a current report on Form 8-K with the SEC.

And now I will turn the call over to Matt Maloney, GrubHub’s Founder and CEO.

Matthew M. Maloney

Thanks Anan. And thanks to everyone on the call for joining us this afternoon. I’ll start by summarizing our operating results for the second quarter and then provide an update on our business before turning the call over to Adam DeWitt, our CFO, who will give us a more detail look at the numbers and the updated outlook for the third quarter.

So with that let’s talk about the second quarter results. GrubHub has built the largest marketplace in the United States for takeout from independent restaurants by providing compelling value to both restaurants and diners. In the second quarter of 2014 we had a record 4.2 million active diners and processed approximately 175,000 orders per day for our restaurant partners for an annual run rate of $1.7 billion in gross food sales. And we are just scratching the surface with that $1.7 billion compared to the approximately $67 billion in annual takeout just from independent restaurants in the U.S.

With over 95% of that market still being served by paper menu and telephone, this is just the beginning. We continued our momentum from the first quarter with total revenue for the quarter of $60 million, up 48% from the second quarter in 2013.

As a quick reminder to everyone the metrics and financial results we are using throughout this call are pro forma for the combined Seamless and GrubHub platforms regardless of whether the period discussed took place before or after the merger.

We ended the quarter with 4.2 million active dinners at 51% from 2.8 million dinners at the end of last year’s second quarter. As we noted on our last call, we chose to invest more in marketing than we typically would in the second quarter and we saw a lift in new diners across all of our markets, including strong pickups in new diners outside of our largest markets. We processed roughly 175,000 DAGs or Daily Average Grubs during the second quarter, a 34% year-over-year increase from the 130,100 Daily Average Grubs last year.

We also processed $423 million in gross food sales during the quarter, a 38% increase year-over-year. As expected, our DAGs and gross food sales were slightly lower in the second quarter than in the first due mostly the seasonality. In addition, while prolonged cold and high snow totals drove orders to record high in the first quarter, we saw it return to more typical weather patterns in the second quarter.

Last quarter, we talked about our marketing strategy. As a reminder, we are focusing on the GrubHub brand nationally in the Seamless brand only in New York. Regardless of the brand, in order to maximize the effectiveness of our marketing, we use an integrated multi channel approach. Offline advertising like TV and transit continue to drive awareness which we supplement with more direct online advertising, to capture hungry dinners when they are ready to purchase.

Due to positive results from our TV advertising in the first quarter, we decided to spend more on advertising in the second quarter than we typically would. And this included continued investment in television.

As I mentioned earlier, results continue to be positive. Given that so much of the takeout market is still offline, using paper menus. We need an effective way to reach those diners to boost our awareness. And we’ve found that TV is a great way to drive new diner acquisition. TV has been particularly successful in reaching diners in markets that are very early in the developmental stage. Hopefully overtime, this will help us develop those markets more quickly.

On the product front, the rollout of restaurant driven pricing on the Seamless platform has been a positive catalyst for commission rates. Prior to April, Seamless restaurants used to appear alphabetically in default search results. By rolling out GrubHub’s sorting algorithm on the Seamless platform, we’ve given the restaurants on Seamless a way to influence their position in search results.

The new Seamless store is based on an algorithm that includes the commission rate each restaurant is paying. This allows restaurants to compete more effectively to earn a greater share of the available orders. As a result of moving higher paying restaurants up, higher in the sort order, net commission rates improved from 13.5% in the first quarter to 14.2% in the second quarter. We believe this change will create long-term value for our restaurants and a more efficient marketplace for us.

Our mobile applications and mobile web continue to represent a meaningful growth driver for us. We believe that our mobile products provide additional use cases for our diners, particularly as more and more transactions are taking place on smartphones. As a result we continue to invest aggressively in mobile. This past quarter 48% of our orders were mobile, as compared to just 39% in Q2 of last year. These mobile orders monetize at exactly the same rate as our web-based orders, and order via mobile looks exactly the same to our restaurants as a web-based order.

On the investment font, one of the reasons we decided to go public was to generate awareness of GrubHub’s platforms for the 95 plus percent of people that are still using the paper menu to order takeout. While we’ve been very happy with the awareness the IPO generated, we’ve also received an ancillary benefit. It’s been a lot easier for us to hire great engineers.

Since technology expertise is notoriously difficult to hire, and our long-term growth will ultimately be driven by the quality of our products, we’ve taken this opportunity to accelerate hiring in technology. In the second quarter alone, we hired over 30 technologists and plan to continue to hire aggressively through the end of the year.

We believe that having the very best team is critical to capturing more of the market opportunity, driving more orders through our restaurants and giving more control to our diners. We remain extremely excited about the vast opportunity in domestic takeout and our momentum remains very strong. We plan on being the one indispensable takeout platform for connecting diners and independent restaurants across the country.

With that, I’ll turn it over to Adam, so he can walk you through the financials. Adam?

Adam DeWitt

Thanks Matt. I’ll review our second quarter performance in more detail, provide some forward-looking color and then we’ll open the call up to questions.

As of last quarter before I start, I want to clarify that the prior year metrics and financial results I’ll be using for comparison purposes, will be pro forma based on the combined businesses of GrubHub and Seamless even if that period occurred prior to the merger between the two companies, which was completed on August 8, 2013.

This is different from the GAAP presentation which only includes both businesses after the date of the merger. And therefore for the second quarter of 2013, would have included only legacy Seamless results. We believe the pro forma view including the combined businesses is a helpful way to compare historical results to our current quarter.

GrubHub delivered record second quarter revenues of $60 million, 48% growth from the year-ago quarter of $40.7 million. Traditionally, growth in our key metrics has been the primary catalyst of our strong revenue growth. And that strong growth continued in the second quarter.

We ended the second quarter with active diners reaching a record 4.2 million, 51% year-over-year increase. New diner acquisition is driven through product-driven word of mouth referrals and effective advertising.

As mentioned in the last quarter, we had encouraging results from our early experience with television and increased our spend this past quarter. We’ll continue to use TV this quarter and it’ll be an important too for us in the fall as we head into the traditionally busy fourth quarter.

As a result of this growth in diners we processed 175,000 daily average grubs and $423 million in gross food sales, a 34% and 38% year-over-year increase respectively. As expected, both of these totals were slightly less than the first quarter due to seasonality.

As a reminder, we generally expect lower activity in the second and third quarters when the weather is warmer and people are ordering in less. This was particularly true this year as we saw a fairly extreme winter in the first quarter with prolonged periods of cold and snow driving demand for takeout unusually high. As a result, it’s possible the seasonal dip was somewhat stronger this year than a typical year. We did though see outsized growth in revenue compared to gross food sales this quarter due to the implementation of restaurant-driven pricing on the Seamless platform in April.

As Matt mentioned, our net revenues as a percentage of gross food sales, increased from 13.5% in the first quarter to 14.2% in the second quarter. This is a direct result of higher paying restaurants appearing higher in the default search results on Seamless. All restaurants in the Seamless platform now have more control over where they appear relative to other restaurants. We think this will create value over the long-term as it has in the GrubHub platform by letting restaurants set the price in the market.

Turning now to expenses, I’ll start with our largest expense, sales and marketing. Total sales and marketing expenses were $16.2 million, a 53% increase compared to $10.6 million in the same quarter last year. As a percentage of revenue, sales and marketing was up slightly from 26% last year to 27% this quarter.

While we maintained our level of advertising spend in Q2 from Q1, even though it is typically slower for new diner acquisition, we continue to see efficiency from marketing one brand in all of our markets with the exception in New York and continue to get better at spending. We increased active diners by 340,000 during the quarter, a 67% increase over the number of active diners that we added last year while sales and marketing costs increased 53%.

Of note, the national nature of our TV campaign has helped us acquire many new diners in our secondary and even tertiary markets where we previously had less exposure. While we are likely to reduce sales and marketing 5% to 10% in the third quarter due to seasonal adjustments, we plan to increase our level of spend again in the seasonally stronger fourth quarter.

Operations and support expenses were $14.7 million, a 36% increase from the same quarter last year. As a reminder, the operations and support line item is comprised of largely variable costs such as credit card processing, customer care, and menu operations, which generally scale with orders in gross food sales. As a percentage of revenue, ops and support expenses declined slightly from 27% in the second quarter of last year to 25% this year, leverage resulting in part from the increasing commission rates we discussed earlier.

Technology expenses excluding amortization were $6.1 million for the quarter, increasing 44% from the second quarter in 2013. As Matt highlighted earlier, we have been aggressively investing in our technology team for two reasons. One, our long-term growth depends on the quality of our products and, two, we’ve recently been fortunate enough to meet a lot of quality engineers interested in joining GrubHub.

We’re very excited about the depth and breadth of the experience that we’re adding to the team right now. While this has driven technology costs higher this quarter and will likely lead to additional increases in the third and fourth quarters, we’re confident that the long-term return on this investment will be high.

Depreciation and amortization was $5.6 million for the quarter, 119% higher than the second quarter of 2013, but consistent with the first quarter of this year. The year-over-year increase is due to the inclusion of intangibles amortization from the Seamless-GrubHub merger.

G&A costs were $8.6 million, a decrease of 28% from last year, primarily due to merger and restructuring expenses around $7 million in last year’s second quarter. When we exclude those merger and restructuring expenses, the increase was closure to 60% year-over-year driven by higher miscellaneous costs to support the growth in the business, stock-based comp and public company costs.

Adjusted EBITDA was $16.9 million, an increase of 56% from $10.8 million last year. Our adjusted EBITDA margin was 28% this quarter, which is roughly equal to the first quarter. From a margin perspective, the positive impact from higher commission rates on Seamless was offset mostly by the acceleration of technology hiring.

Net income was $2.7 million compared to the prior year of $300,000. GAAP net income for fully diluted common share was $0.03 compared to less than $0.01 from the prior year. Of note, our tax expense this quarter includes a one-time non-cash $2 million charge to increase our deferred tax liability related to a recent change in certain state filing rules. Excluding this item, our tax rate was very similar to the first quarter. For the diluted EPS calculation, there are approximately 82.1 million weighted average fully diluted shares for the quarter.

We ended the second quarter with $207 million in cash and equivalents, which includes $95 million raised from our IPO.

In terms of forward guidance, we are estimating total revenue for the third quarter to be approximately $55.5 million to $57.5 million. As we have mentioned before, we expect activity rates for the third quarter to be slightly lower than the second quarter, due to warmer temperatures, summer travel, and fewer days of college kids on campus.

In terms of profit guidance, due to the accelerated hiring of technologists and forecast level marketing spend, we currently expect adjusted EBITDA margins rates to be slightly below the second quarter level on the third quarter, but increase again in the fourth quarter.

In terms of specific guidance for this quarter, we expect third quarter adjusted EBITDA to be in the range of $13 million to $15 million. The growth opportunity is significant and GrubHub is well positioned to take advantage of it.

With that, I’ll turn it over to the operator to take questions.

Question-and-Answer Session

Operator

(Operator Instructions) First question is from Aaron Kessler with Raymond James.

Aaron Kessler – Raymond James

Hey guys, good quarter. Couple of question. First, just on the take rate of the 14.2%, is that kind of a good baseline level to think of going forward? Also, in terms of if we look at kind of orders per diner per period, I believe that was down about maybe 10%, year-over-year basis slightly lower than the growth rate in Q1. Where do you think orders per diner per period could level out longer-term as well? Thank you.

Matthew M. Maloney

Sure, and this is Matt. In terms of the commission rate change that the obviously the primary cause was the platform change on seamless there some seasonality in there where commission rates in college markets marginally being lower. I’d say that there could be more upside in the future depending how quickly restaurants start adopting this feature, but it’s going to be incremental. It’s definitely not going to be like the big step up we’ve seen in the last couple of quarters.

And then, in terms of frequency, we focused on frequency of diners on a market by market basis which has remained relatively stable. The main factors for what you are looking at is; one, our national advertising means we are attracting more diverse diners and we are diversifying away from New York in corporate diners, which are also vary distinct, but as well as other tier-1 markets. These are still very good diners. They just initially have lower frequencies, because the markets are not as developed. Also, but to a lesser extent I’d say that the higher concentration is new unseasoned diners.

Aaron Kessler – Raymond James

Got it, great. And just from a competitive standpoint, are you seeing any more competition from some of the more new app-based platforms, maybe they even cook home-cooked meals and then deliver it to you. Is that potential competition that you’re seeing?

Matthew M. Maloney

There is a lot of people and offerings on the periphery we are remaining focused on the bigger opportunity. I mean obviously this is a hot space. Our IPO is part of that. And there’s a lot of eyeballs here. What we’ve seen is there’s been no meaningful change in our business our ability to grow. I mean if anything as I just said some of our secondary markets are developing more quickly than our first set of markets. And the reality is nobody is doing what we’re doing.

So, we are connecting over 30,000 restaurants now with over 4 million hungry diners. We are managing a sometimes very complicated and highly unique transaction. We have hundreds of customer service agents who interface with both diners and restaurants. We provide both sides of this two-sided network with unparalleled value.

Our vast networks drive more orders to restaurants they provide diners of numerous choices and we just remain focused on managing the 1,000 of orders per day where we take a deep approach. And no else is doing at this scale.

So, it takes a tremendous effort to do this and really, we are addressing that and we are looking at the real opportunity, which is converting that 95% of the $67 billion that’s on the paper menu over to the online platforms in our online mobile tools.

Aaron Kessler – Raymond James

Great. Thank you and good quarter.

Operator

Next question is from Michael Graham with Canaccord.

Michael Graham – Canaccord Genuity

Hi, thanks. Yes, I just wanted to go into a little bit more detail about the Seamless take rate expansion. I mean it just seems like a really sort of violently positive adjustment upward in a short amount of time and I’m just wondering if you can give us any feel for like, are the take rates on Seamless structurally higher because it’s New York? Or how could that have such a big impact on corporate overall take rates? And then as a related question I understand that you guys are focused on running the two brands in New York now. Could you give us a feel for what kind of considerations you might take into account longer-term in thinking about whether to combine, consolidate the brands longer-term? Thanks.

Adam J. DeWitt

Sure. Hey Mike, it’s Adam. I will take the take rate and then, I’ll turn it over to Matt to talk about the brands. Just to give you a little bit more color why there is a big step up. It’s probably helpful to think about the way that pricing used to work on Seamless. So, the sort order was basically alphabetical, but restaurants did pay different rates based on the volume that they did. So it was a volume driven pure based rate.

So, when we converted to the kind of – this chose your own rate on Seamless we reshuffled, moving restaurants that were paying higher rates to the top of the sort orders. So you have an initial bump up and then what Matt talked about was really in future quarters overtime, as restaurants realized that they have the ability to impact their outcome. We believe that we’ll likely see some incremental improvement, but probably not the big step up that you saw from the first quarter to the two quarter. Matt, you want to…

Matthew M. Maloney

Yes. So, in terms of the brands and having multiple brands specifically there only in the New York, we see lot of value and having a strong portfolio of brands. The way that we manage marketing in our communications is really by ROI and we look at what is the return and we get and Seamless is part of the fabric of takeout in New York. And so, we get a very strong ROI backs spending against the Seamless brand. And so, we don’t see any reason to aggressively change that if we have an opportunity to spend more at scale to get many new diners remember we are still I believe less than 10% what we believe the takeout is in New York on the Seamless platform.

So there is a lot of room to grow just in New York even with both brands. So we are going to take advantage of every opportunity to continue to grow the new diner base and grow the orders and having multiple brands just is helpful for us to do that.

Michael Graham – Canaccord Genuity

Okay, right. Thanks a lot, guys.

Adam J. DeWitt

Thank Mike.

Operator

Next question is from Mark May with Citigroup.

Ryan Ripp – Citigroup Global Markets Inc.

Hi. This is Ryan Ripp on for Mark. Just one quick question. Why was the restaurant food liability down from Q1 to Q2? Is there anything we can read through about this with respect to gross food sales? Thanks.

Adam J. DeWitt

No. There is nothing to read in there. I mean a lot of it has to do with the timing of when we pay restaurants and we pay them on a weekly basis, but it doesn’t necessarily coincide with the calendar and so. It’s really just timing of the payments and as you can see gross food sales were very close to what they were in the first quarter. So it’s a combination, but it’s going to move around a lot quarter-to-quarter based on just the timing of when the quarter closes.

Ryan Ripp – Citigroup Global Markets Inc.

Thanks a lot.

Operator

Next question is from Ralph Schackart with William Blair.

Ralph Schackart – William Blair & Company

Good morning. Talk a little bit on the call about stepping up the spend for technology and engineering hiring. Can you give us a sense maybe kind of where you are with your perspective with the product evolution today? Where do you expect to take that going forward and sort of any implications for driving kind of more orders per diner with the new product step up?

Matthew M. Maloney

Hey Ralph, this is Matt. In terms of the investment technology, we are being very opportunistic or we were planning on bolstering our tech group. But, because the hiring environment has been very good, we are accelerating. We are focused on anything that drives more orders for restaurants and continuing improve the diner experience provide there is more value. And so, by continuing to invest in technology we can accelerate our pace of innovation on the products and platforms just like what you are saying. So in terms of where we are going. I’d say our in-restaurant tablet, the OrderHub is still in the very early stages of its life cycle.

We have a lot of opportunity to continue investing in the restaurants facing tools that we have the driver facing tools that we have anything that connects the restaurants and drivers more closely to both the diners, but also the GrubHub customer service. Team is good for everyone, because we are managing the transaction better.

If you think about the world we live in, the problem of an order being placed on Internet and having to be delivered within 60 minutes really hasn’t been addressed at scale anywhere and that’s exactly what we do. Even if you think about the all the buzz that’s going on around the same day deliveries, what we are doing at same hour, there is a much higher bar when you diner is frustrated within or at 60 minutes if they don’t have their food yet. And so, the more we can do to increase the transparency and control from the diner’s perspective given the high bar there, the better. So, I think we have a ton of innovation to go there and we’re investing heavily on the restaurant and driver-facing tool sets.

In terms of the diner side, we are always looking at using our data, leveraging our data to be more personalized for search, to get more conversion across the funnels. I think I said it on the road show to a bunch of folks, but there’s been so little innovation in this area for so long that really there’s tons of opportunity for us to continue to accelerate our tool sets and products for a very long time.

Ralph Schackart – William Blair & Company

Okay. That’s helpful. Thank you.

Operator

Next question is from Edward Williams with BMO Capital Markets.

Edward Williams – BMO Capital Markets

Good morning. A couple quick questions. First of all, you guys had great success with your marketing and driving 12-month active diners in the June quarter. What’s your thought as to where we can see that number go, looking into the September quarter or looking into the balance of the year?

Matthew M. Maloney

The diner number?

Edward Williams – BMO Capital Markets

The 12 month active diner number, yes.

Matthew M. Maloney

I think what we’re going to see hopefully is continued growth along the same lines that we’ve seen historically. Since we talked reducing our sales and marketing spend a little bit in the third quarter, it may not be up to the level of the second quarter in terms of the net adds, but it won’t be that far off and we certainly think the fourth quarter will be stronger given that it’s a much better season in general and also we’ll be spending more into that strength. So, I think overall we’ll continue to see a steady march up on active new diners or active diners I should say.

Edward Williams – BMO Capital Markets

And then, looking at the technology spend, can you give us a sense as to where you’re sitting directionally now with your headcount and you might be towards the end of the year?

Matthew M. Maloney

Yes. In terms of headcount, we’re very close to where we were at the end of the first quarter overall. But we also have some seasonality in our more variable costs like care. So the June, July, August months are slower than kind of March and April. And so really what we’ve done is swapped out a bunch of customer care folks for the time being for technology folks, but heading into the end of the year we’ll be hiring on both fronts. Customer care will ramp up kind of with the fall ramp up once colleges get back on campus, like September. And technology, we think that we’ll be able to or hopeful we’ll be able to continue to hire at a similar rate through the end of the year.

Edward Williams – BMO Capital Markets

Okay. Thank you.

Operator

The next question is from Michael Graham with Canaccord.

Michael Graham – Canaccord Genuity

Thanks. I just had a follow-up. So thanks for taking it. Just on the suburban markets. It’s an important part of the long-term plan and you mentioned on the call that the national campaign that helped the diners in those markets grow. Just two things. Could you give us any feel for the mix of diner growth in the quarter? Was it more skewed towards the suburban markets or was it sort of normal? Are you seeing any of those suburban markets where the take rates are starting to come up or are they still sort of at a baseline level? And just any sort of commentary you can give us there? Thanks.

Adam DeWitt

Mike, it’s Adam. In terms of new diner growth, we try to highlight it a couple times, both in the press release and also in the script. We definitely had a relative strength in those secondary and tertiary markets. So, more new diners there relative to overall diner representation across all the markets.

The core markets still – we had very good growth in them as well. It’s just that we had a little outsized growth. When talking about suburbs, it’s not just suburbs; it’s also kind of second level cities for us, folks like in Miami, Phoenix, Baltimore, Denvers of the world, but then also some of the more suburban markets. So, we definitely had an outsized representation from those smaller markets because TV helps us reach them in a very scalable way. So, we’re excited about it.

In terms of development and the commission rate in those markets, it’s a little too early to see the results there. We’ve talked about the model for a long time. It’s balanced growth both on the diner side and the restaurant side. So it’s adding diners. Now we have to go into markets where we had some strength in the diners, we had to go in bolster the restaurant presence and then over time we’ll see those rates march up, but nothing that you’re going to see in a quarter or two quarters. It’s a much longer timeframe.

Michael Graham – Canaccord Genuity

Okay. Thanks, Adam.

Operator

There are no further questions. I will turn the call back over to the presenters.

Matthew M. Maloney

Thank you very much. This is the conclusion of our Q2 2014 earnings call and thank you for attending.

Operator

This concludes today’s conference call. You may now disconnect.

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