Mad Catz Interactive, Inc (NYSEMKT:MCZ)
Q1 2015 Earnings Conference Call
August 04, 2014, 05:00 PM ET
Norberto Aja - Investor Relations, Jaffoni & Collins Inc
Darren Richardson - President and Chief Executive Officer
Karen McGinnis - Chief Financial Officer
Justin Ruiss - Sidoti & Company
Welcome to the Mad Catz Fiscal 2015 first quarter results conference call. (Operator Instructions) I would now turn the conference call over to Norberto Aja, Investor Relations. Please go ahead, sir.
Thank you, operator. Good afternoon, everyone, and welcome to Mad Catz's fiscal 2015 first quarter results. With me on the call today are Darren Richardson, Mad Catz's President and Chief Executive Officer; and Karen McGinnis, Mad Catz's Chief Financial Officer. Darren will provide an overview of the results and the principle drivers behind them, and afterwards, Karen will review the financial results in greater detail, before turning the call back to Darren for some closing remarks.
Before we begin, however, let me just take a few minutes to read the Safe Harbor language. As today's discussion will contain forward-looking statements about the company's financial results, estimates, business prospects that involve substantial risks and uncertainties. The company assumes no obligation to update the forward-looking statements contained in this conference call as a result of any new information or future events or developments. You can identify these statements by the fact that they use words such as anticipate, estimate, expect, project, intend, should, plan, goal, believe and other words in terms of similar meaning in connection with any discussion or future operating or financial performance.
Among the factors that could cause actual future results to differ materially are the following: the ability to maintain or renew the company's licenses, competitive developments affecting the company's current products, first party price reductions, availability of capital under our credit facility, commercial acceptance of new in-home gaming consoles, and the ability to successfully market both new and existing products domestically as well as internationally, difficulties or delays in manufacturing, and an anticipated product delays or downturn in the market or industry. A further list and description of these risks, uncertainties and other matters can be found in the company's reports filed with the appropriate regulatory authorities.
Today's call and webcast on August 4, 2014, include non-GAAP financial measures within the meaning of the SEC Regulation G. When required, a reconciliation of all non-GAAP financial measures to the most directly comparable financial measure calculated and represented in accordance with GAAP can be found in today's press release.
With that, I would now like to introduce Darren Richardson, President and Chief Executive Officer of Mad Catz. Darren, please go ahead.
Thank you, Norberto, and good afternoon, everyone. We appreciate you joining us on the call today to review our fiscal 2015 first quarter financial results.
At Mad Catz, we are focused on developing products for passionate gamers, and by that we mean people who play games as part of their lifestyle and not just when there is nothing interesting to watch on the TV. Passionate gamers play games across multiple platforms in different settings.
And as a result, our products and our approach has to be platform agnostic, so that we can reach gamers wherever they are looking to engage. And today, that means developing products for consoles as well as the PCs and increasingly for mobile devices.
With that in mind, I'd like to take a few minutes to review the industry as we see it today, and more importantly, what we think it will look like in the not too distant future.
The 2013 holiday quarter was certainly pivotal for the games [Technical Difficulty] for two new game consoles, marking the inflection point in the console transition. Even more exciting for our longer-term outlook, our strong sales figure to date of the new consoles, setting new adoption records and exceeding the already lofty expectations.
Although, sales of accessory products for the new consoles, typically lag the console launch, we believe the new consoles open opportunities for innovation that will kick-start another multiyear period of excitement and revenue growth for console products as a whole. As an example, products for the next gen consoles accounted for 12% of sales for our first quarter, clear evidence that our console business is already rebounding strongly.
The PC games market continues to attract hardcore gamers. We added our first PC products to our sales mix a few years ago and products for PC gaming have steadily grown, accounting for 47% of our sales. These products include our one-of-a-kind R.A.T. gaming mice, S.T.R.I.K.E. keyboards, F.R.E.Q. and TRITTON gaming headsets and Saitek flight simulation products.
Lastly, the single largest opportunity in consumer products today is in the mobile space. Smart devices are rapidly establishing themselves as very capable platforms for all forms of the entertainment, including music, movies, books, social media and games. It's also important to note the relative size of the market.
For the Xbox 360 has sold over 80 million units in the seven years since it launched, a considerable accomplishment for gaming console. There were over 1.2 billion smartphones and tablets sold in 2013 alone, and over 2 billion units forecasted to be sold in 2017.
Gaming is a leading activity on the mobile platform by almost any measure, including hours spent, apps downloaded or revenue generated. Until recently, all games brought to mobile devices have focused on a single method of control, the touch screen. While the touch screen is great for many games, it's not ideal for first-person shooters and sports games, two of the most popular gaming genres.
The recent announcements from Apple and Google, introducing support for controllers and other gaming peripherals establishes the infrastructure to support a core gaming experience on mobile. And by core gaming experience, I am referring to mobile gaming on a big screen in the living room and via peripherals rather than simply playing on a touch screen.
We launched our M.O.J.O. Micro-Console last year, Amazon recently launched the Fire TV, Google announced the upcoming launch of Android TV and Apple are also rumored to be launching some form of Micro-Console later this year, all with the purpose of enabling this more immersive gaming experience that is now possible across mobile devices.
In particular, Google's announcement of Android TV is a key milestone on the way to delivering a core gaming experience on smart devices. Android TV will be embedded in a range of devices, most notably smart TVs, and it will bring the ever-expanding universe of android apps to the big screen. Android TV also incorporates gamepad support and opens the door to a multitude of new applications for our GameSmart ecosystem of products.
At the Worldwide Developers Conference held in June, Apple introduced their new Metal API that their spokesman said would deliver dual core rates up to 10 times faster than the current API and bring console-level graphics to iPhones and iPads. Apple also showed demos from leading game developers, such as Crytek, Epic and EA, including a clip of EA's Plants versus Zombies, and described it as a consoled level title and something they felt would never come to mobile.
All of these developments point to a fast emerging opportunity for core gaming on mobile devices and exciting opportunities to the entire ecosystem of our GameSmart products.
Also around our mobile gaming initiative, we've now launched the OUYA Everywhere with the inclusion of OUYA's portfolio over 680 games on our M.O.J.O. Micro-Console. We'll be working closely with OUYA to promote the OUYA Everywhere app.
We are also excited to be working with OnLive to optimize and promote their cloud gaming service on M.O.J.O. OnLive allows gamers to play hundreds of AAA PC games streamed to M.O.J.O. from the cloud. And through their Cloudlift service, play a selection of Cloudlift-enabled PC games from your Steam account. OnLive delivers hundreds of PC games from AAA publishers and makes them playable in the living room on M.O.J.O.
We believe these developments present a great opportunity for our GameSmart product range as well as our M.O.J.O Micro-Console, because it expands the user base and validates the concept of mobile gaming beyond what we notice today.
There's no doubt controller supported games on mobile devices is an emerging category, and it's going to take some time for game developers to leverage the full potential of the new operating systems to exploit the graphics and add full controller compatibility. But we believe it will happen and we believe the opportunity will take shape this year, given the recent initiatives we have seen from various gaming industry leaders and the strong demand from gamers.
Products from smart devices accounted for 8% of our sales in the first quarter, up from 4% last quarter, a clear demonstration that we're making progress on this front, and that mobile gaming is becoming increasingly more popular.
In short, our console-related sales are rebounding on the back of a hugely successful next gen console introduction. We have exciting new PC products launching later this year that will helps us to drive PC sales. And while the mobile opportunity is still in the early stages, there were some really exciting early signs that will continue to increase in adoption rates, and everything we get from mobile is incremental to our existing console and PC sales.
Our focus and our goal is to bring to market compelling products for passionate gamers on a global basis. We believe that Mad Catz can succeed, if we build on our strength to pursue targeted segments within the games industry and leverage our strong and deep distribution footprint to deliver products, with the right design and features that are central to the passionate gamers' experience.
With that, I'd now like to turn the call over to Karen, to provide some additional color on the results. Karen?
Thanks Darren. I'll begin my comments with a review of our income statement. Net sales for the first quarter were $16.7 million, which represents a 10% decline from the first quarter last year.
The first quarter of last year was one of the strongest first quarters in the company's history, which was followed by exciting sales starting in the second quarter of fiscal 2014, ahead of the console transition in November. This resulted in a difficult comp for this quarter and as we stated previously, we did not expect to see year-over-year sales growth until our second quarter of fiscal 2015.
The 10% decline in net sales was largely the result of a 17% decline in net sales across both EMEA and the Americas, partially offset by a 49% increase in net sales in the Asia-Pacific region.
In each region, we experienced the decline in sales of product developed for legacy consoles, as a result of the console transition, particularly in our audio products. However, sales of products related to the new consoles, primarily audio, represented 12% of our total sales during the current quarter, as the installed base of new consoles continues to increase at record breaking rates.
Outside of console gaming products, we also experienced a decline in sales of product designed for the PC and Mac. This decline is primarily related to a decrease in sales of our gaming mice, which was driven by a reduction in product placement at some U.S. accounts compared to the prior year, and to a lesser extent a slight decline in sales ahead of our new R.A.T. product launches, including our recently launched R.A.T. Tournament Edition.
These decreases were partially offset by an increase in sales of our Saitek flight simulation products, as we brought new products to the market, including the Saitek X-55 RHINO as well as increased marketing activities related around the Saitek line of products. Saitek branded products represented 18% of our sales in the first quarter compared to 11% in the first quarter last year.
We also experienced an increase in sales of products developed for smart devices, which represented 8% of our net sales this quarter compared to only 1% in the same period last year. This increase was driven primarily by gaming controllers sold to a customer in the Asia-Pacific region under our private-label program.
As Darren discussed, we remain very excited about the future growth potential of our GameSmart line of products, which has been developed specifically for gaming on mobile and smart devices.
Looking at the results by geographies. First quarter net sales in EMEA declined 17% to $8.4 million and represented 50% of total net sales in the quarter compared to 54% a year ago. The decline in EMEA in the first quarter was driven primarily by a decrease in sales of audio products for legacy consoles, and to a lesser extent a decline in sales of gaming mice ahead of our new R.A.T. product launches as noted before.
First quarter net sales in the Americas declined 17% to $5.4 million, due to weakness in legacy console-related sales and a significant reduction in product placements across some key U.S. accounts compared to the prior year. Net sales in the Americas represented 33% of total net sales in the first quarter compared to 35% a year ago.
As we bring to market new products and work through the new console cycle, we expect sales in the Americas to regain momentum and represent a greater percentage of overall sales. Additionally, we have invested additional sales resources in this region over the past couple of quarters that we believe will help drive growth in our existing customer base as well as expand product placements at new account.
First quarter net sales in Asia-Pacific increased 49% to $2.9 million and represented 17% of total net sales in the first quarter, up from 11% a year ago. This increase was driven primarily by gaming controllers for smart devices sold to a customer in this region, under a private-label program. Offset partially by weakness in legacy console-related sales consistent with our other geographies. We expect sales in this region to grow as our presence and focus increases.
As we stated in last quarter, we expect to deliver sales growth starting in the second quarter and for the full year fiscal year 2015. Although, we experienced a 10% decrease in net sales, gross profit for the first quarter decreased by 6% compared to the prior year and gross margin improved to 30% compared to 29% in the first quarter of last year.
This was due primarily to a decrease in royalties and licenses as a percentage of net sales. As we stated last quarter, we expect gross profit and gross margin for the full year fiscal 2015 to increase compared to fiscal 2014.
Total operating expenses in the first quarter were $6.2 million, down 17% from the first quarter of last year. The decrease in the first quarter was primarily due to concerted effort to reduce overall operating expenses and timing of certain marketing activities compared to the prior year, a reduction in software development cost and a reimbursement of engineering work performed on behalf of the third-party. The reductions were partially offset by an increase in incentive compensation expense.
We will continue to closely manage operating expenses across the board, while investing in strategic areas to drive growth. As a result, we expect operating expenses in fiscal 2015 on an absolute dollar basis to be relatively flat compared to fiscal 2014.
Despite the decline in net sales compared to the prior year, our increase in gross margin and operating expense reduction effort resulted in an operating loss of $1.1 million, an improvement from the $2.1 million operating loss we generated in the first quarter last year.
Other income and expense, which primarily represents interest expense on our outstanding debt, foreign currency exchange gains and losses and changes in the fair value of our warrant liability resulted in expense of $130,000 in the first quarter of fiscal 2015 compared to $88,000 in the first quarter last year. The majority of the increase was driven by interest expense associated with a note payable that did not exist in the prior year.
The income tax benefit of $17,000 for the first quarter of this year and $140,000 for the first quarter last year reflects effective income tax rates of 1% and 6%, respectively. Our effective income tax rate fluctuates, depending on which jurisdictions generate taxable income or losses.
For entities that generate taxable losses, we may not always be able to record a tax benefit for those losses, if we cannot reasonably predict the ability to use the loss carry forwards in the future. As a result, our effective tax rate can fluctuate greatly. Overall, we generated net loss in the first quarter of fiscal 2015 of $1.2 million or a loss of $0.02 per share compared to a net loss of $2.1 million or a loss of $0.03 per share in the first quarter last year.
Moving on to our cash flow statement and balance sheet. Net cash used by operating activities was $577,000 for the first quarter of fiscal 2015 compared to $1.3 million from the first quarter last year. The use of cash this quarter primarily reflects the net loss for the period before non-cash items; an increase in inventory of $493,000, due to forecasted demand; and a decrease in accrued liability of $262,000, due to timing of payment. These decreases in operating cash flow were offset partially by a $629,000 decrease in accounts receivable, resulting primarily from a decrease in net sales as well as improved collection.
Our DSOs were 69 days this quarter compared to 74 days in the first quarter a year ago. And our inventory turns on a trailing-four quarter basis were 3x this quarter compared to 3.2x in the first quarter a year ago.
As of June 30, 2014, we had cash balance of $2.5 million and borrowings under our credit facility of $7.8 million. As a result, we ended the quarter with a net position of bank loan less cash of $5.3 million compared to $8.4 million a year ago, and $4.1 million last quarter.
Overall, we are pleased with the results throughout our initiative to reduced operating expenses, improved gross margins and launched new products across various platforms. We remain confident that our business strategy, product offerings and financial position are prime to deliver improved results in fiscal year 2015.
With that, I'd like to turn the call back to Darren, to discuss our fiscal 2015 strategic and operational objectives and closing remarks, after which we'll open the call for questions. Darren?
Thanks Karen. In fiscal 2015, our goal is to return to growth and profitability by focusing on a number of strategic and operational objectives including: designing innovative products for passionate gamers and executing strong global market launches of those products; growing the market for accessories designed for smart devices; expanding our global sales reach with particular focus on the Asia-Pacific region; continuing our discipline in working capital management and product placement profitability; expanding our Saitek flight simulation business; and identifying strategic opportunities for the expansion of products in adjacent and compatible categories; and transactions where Mad Catz can leverage its global distribution capabilities.
In terms of outlook for fiscal 2015, our console business is rebounding on the back of strong next gen console sales. Products for next gen console sales accounted for 12% of our first quarter sales, and we expect that growth to accelerate following the recent launch of our Xbox One headset range. We are adding key new products to our mice and keyboard category, which we believe will revitalize growth of our PC and Mac products.
We are seeing the early signs of traction in our GameSmart products for smart devices. Products for smart devices accounted for 8% of our sales in the fourth quarter, and we expect that growth to accelerate with the launch of new controller-enabled games and a growing installed base of Micro-Consoles.
While sales of our legacy console products are likely to decline, we believe that the console manufacturers' commitment to support the legacy consoles over the next few years, will allow us to continue to sell these legacy products, as we build out our line of next gen products.
And we remain focused on working capital management and OpEx management, and expect to return to sales growth and profitability in fiscal 2015. For the current quarter, the second quarter of fiscal 2015, we're expecting the sales decline to stabilize and mark an inflection point in our return growth and profitability for the full year fiscal 2015.
Before we move to Q&A, I just want to take a moment to thank our talented and dedicated team at Mad Catz, who are ultimately responsible for moving us forward with our key initiatives.
I'll now turn the call back to the operator, so we can answer any questions. Operator?
(Operator Instructions) Our first question comes from Justin Ruiss from Sidoti & Company.
Justin Ruiss - Sidoti & Company
I just have a few questions. Just looking at what's coming out, obviously, for the holiday period, and kind of looking at your SKU count at this point, are we going to see any kind of change materially in SKU count for headsets, for mice, for anything like that? Or will be there like a net decline, will be there net increase, now do with the new consoles that are around?
We're starting with actually limited selection of headsets and then we'll broader that across time, mainly sort of kicking off with the more entry-level products, which is really where the market kind of kicks off for headsets, just because of price point. And then second, in terms of -- what was the second part of the question again?
Justin Ruiss - Sidoti & Company
Just if are you going to see any kind of like net decline or net increase in the amount of SKUs that you have?
It's going to grow. But at the same time, if you look at the sales of legacy products, we'll be deleting products in the legacy range. In fact, a lot of the deletions have already happened. So I think on a net-net basis, we'll actually grow the number of SKUs across the balance of the year.
Justin Ruiss - Sidoti & Company
And now just looking at it, that's across all, it would be more like TRITTON, Mad Catz, Saitek, the whole brand labels.
Correct. And if you look at mice and keyboards, for example, I mean we kicked off with leading products for gaming mice with the R.A.T. with being predominantly full function on aluminum chassis and all those kind of things, which were always at a premium price to anybody that we competed with. And this year, we've got a range of products coming out that are focused on weight reduction, ultra-lightweight, and we'd be able to hit the price points, all the key price points within each of those segments.
So all of our premium aluminum chassis products will remain in the market, but we'll then add to that a really nice portfolio of products that hit those big mass market price point. So I think that will actually put us in the position to really drive some growth as we go through the balance of the year.
Justin Ruiss - Sidoti & Company
And speaking of price points actually, leading into my next topic. Just looking at the margin differentiation for the next-gen versus legacy, is there a big opportunity there for any kind of increase in margin just on the next-gen products alone?
Yes. I think it's actually going to be more a matter of as we move through the exit of a lot of the legacy business. We avoid price protections, temporary price concessions and inventory write-downs and all those kind of things that all flow through the margin line.
And so if you look, coming out of the last console transition, we had margins running up in around sort of 34 points. And then that sort of deteriorated quite significantly in the last year where we're down more in the 25 point, 26 points. And so this quarter is a very nice quarter to be bouncing back up into the 30 points.
And as we have said many times, if we are under-30 points of margin, that's not a great place for us to be in and that's very disappointing, but we certainly want to get up into that low-mid-30 points, which is where we should be, just the way we were before. And we're committed to getting back there.
Justin Ruiss - Sidoti & Company
So it's maybe a little bit of a slower take when you're deleting some of the legacy products, but that margin shouldn't be too affected by it?
If you look at the fall-off in the legacy products, I mean that's where the bulk of the sales fall-off is, and now we're starting to see the new products come out and the margins starting to rebound as a result.
Justin Ruiss - Sidoti & Company
And then just lastly, just looking at the software titles that are coming out, is there anything that's exciting to you guys, in terms of software that maybe the consumers are excited for, that's looking at attaining new headsets or mice or anything in the TRITTON or Saitek or Mad Catz brands?
The back half softwares flight release is going to be really strong compared to the launch here, which is absolutely standard there. The installed base of consoles is really going to continue decline. So by the time, we get through the holiday; a, you have a bigger installed base; and b, there will be a much larger portfolio of games to actually use headsets, and those kind of things.
And then also with our products like our steering wheel, obviously having more driving games coming out over the course of the year, I certainly hopes that that part of the business is growing. We'll see that on all sorts of different fronts. So overall, everyday it gets better than the day before, now that we're actually back into the sort of growth mode.
Justin Ruiss - Sidoti & Company
And then lastly, if you could just comment on the industry, or where at least, you're looking at the mobile gaming space? I mean how did you feel, so far now having the M.O.J.O. out there for a couple of quarters, I mean looking at it and seeing the mobile space grow. I mean I'd just like to hear your thoughts on that?
The whole mobile play for us was very much a wildcard. We actually have been working on that for a couple of years. We played an important role in structuring the way that the mobile space has actually evolved. And it's something that's been a key strategic focus for us. And when we went into it, we said it was very ambitious.
But I think one of the things that's exciting on mobile -- and if you just look at the whole sort of social media experience, migrating from the PC and something that you did on the computer, to then migrating quickly out into mobile, which was our key migration, I think we're going to see the next migration for a lot of the social experience into the living room. And so the Micro-Console will bring a lot of that social activity into the living room and with that we'll bring gaming and all those kind of things into the living room as well.
Given that gaming is the toughest used case in terms of peripherals and controlled devices, then your gaming peripherals and gaming controlled devices will become the de facto controlled devices for bringing that whole social experience on to the big screen TV. And so I think that's just starting to happen now.
I think the leading-edge people who are into that in a hardcore way are starting to actually get there today, and having things like Facebook and all those kinds of things on your big screen in the living room as a mainstream entertainment option as opposed to watching TV is key. But once you actually get over those devices and the Micro-Consoles hooked up to TVs, again on mobile, the number one activity on mobile across almost any measure is gaming, and so it will bring gaming along with it and a lot of people are focused on that.
And so I think you will see in the next 12 months a potential explosion in that whole Micro-Console attached to a big screen TV. So I think we have put ourselves in a really good position in terms what's potentially a massive emerging opportunity. We now need to capitalize on that.
Our next question comes from [ph] Edward Erikson.
A quick question. I've been following the sales of the Xbox One headset, the GameStop, it shot right up to number two in whole accessories. Are you experiencing that kind of sale growth with the Xbox One headset?
Well, we have just launched the Xbox One headset. We have got the first SKUs going in. They're just rolling out into the distribution. Obviously, every single sale there is an incremental sale. We don't have the channel field at this stage, but we're strongly in the process. So we're excited about the Xbox One headset.
Given the audio traditionally, it's about 50% of the business and was the section that was hit most by the console transition, going from $60 million in sales down to the $40 million in sales. The PlayStation 4 headsets are doing really well for us and have started to pull that back, but there is no question Xbox One headsets being added to that will start to pull that back quite quickly. So that's why we're fairly confident that our second quarter is going to be a nice growth quarter for us.
Our next question comes from [ph] Arnold Radar with RLP Partners.
Question about gross margin. So I see inventories are down quite a bit from where they were last year at this time. Are you comfortable with inventory levels that you've got out of most of the legacy inventory that was really dead? And do you think we can get back to those mid-30s gross margin levels at some time this year?
And then the other question I had was, Karen, I didn't quite understand. Did you say, Karen, that operating expenses you expect to be flat for the year versus where they were last year, so that is doing their increased sales obviously that would leverage the margins, the operating margins quite a bit?
Yes. If I kick off on the inventory first, I think we've done a really good job of managing inventory down. And frankly, you want to be in a situation, where other than summer you're saying you're on tight inventory. I don't think we have too many concerns in terms of legacy inventory. The last couple of quarters we've been very aggressive in doing some special pricing, moving out any inventory buckets that we have.
The products that we have left in inventory are products that we have good ongoing sales on and we think there is still another couple of year's life. So the inventory; a, is low; and b, is in really good quality. And we will sort of start to build back on the inventory as we come up to holiday to take advantage of sales.
Yes. And your question about operating expenses, we were down in Q1. For the full year, I expect operating expenses will be relatively flat, if not down slightly compared to the prior year. I think you're right, with increased sales and increased margins that will give us some leverage on the operating income line, which is why we also said, we expect return to profitability in fiscal year 2015.
And then getting back to the gross margin issue, you said your goal would be to get it up to the mid-30s. Do you think that's something that's possible going towards the back half of the year or is that a few years out?
I don't think its a few years down, but certainly want to hit Q3. If we can get a good Q3 holiday quarter, you'll start to get leverage over a lot of your fixed infrastructure and fixed headcount, and all those kind of things that are in that COGS line. And obviously, avoiding inventory write-downs and all those kinds of things is a great way to drive margins up.
And frankly, the products that we're shipping now, the products that are on inventory are products that have a couple of year's life to them. So we don't foresee anything that should be a normalized in terms of negatively impacting margins. So we're back up to up our 30 points of margin. And we are pushing hard to get margins back up over, well comfortably over the 30 points.
There are no further questions at this time. I'll turn the call back to you for closing remarks.
Excellent. Well, thank you all for joining us on the call today. I look forward to seeing many of you by this week at the Needham & Company Interconnect Conference, held at the Westin Grand Hotel in New York City this Wednesday. Management will be hosting a formal presentation and webcast that day starting at 2:30 PM Eastern time. Please contact our Investor Relations firm, JCIR at 212-835-8500, if you'd like to arrange a meeting with management. And we look forward to updating you on our progress when we host our fiscal second quarter 2015 call. Thanks again.
Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation. And ask that you please disconnect your line.
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