NetSol Technologies' (NTWK) CEO Najeeb Ghauri on Q2 2016 Results - Earnings Call Transcript

| About: NetSol Technologies (NTWK)

NetSol Technologies Inc. (NASDAQ:NTWK)

Q2 2016 Earnings Conference Call

February 11, 2016 09:00 ET

Executives

Patti McGlasson - Senior Vice President, Legal and Corporate Affairs, General Counsel and Corporate Secretary

Najeeb Ghauri - Chairman and Chief Executive Officer

Roger Almond - Chief Financial Officer

Naeem Ghauri - President and Head, Global Sales

Analysts

Howard Halpern - Taglich Brothers

Mike Hughes - SGF Capital

Mike Vermut - Newland Capital

Jon Evans - JWest

Operator

Good morning and welcome to the NetSol Second Quarter 2016 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Patti McGlasson, Senior Vice President, Legal and Corporate Affairs, General Counsel and Corporate Secretary. Please go ahead.

Patti McGlasson

Good morning, everyone and thank you for joining us today to discuss NetSol Technologies’ fiscal 2016 second quarter results. On the call today are Najeeb Ghauri, Chairman and Chief Executive Officer; Roger Almond, Chief Financial Officer; and Naeem Ghauri, President and Head of Global Sales. Following a review of the company’s business highlights and financial results, we will open the call up for questions. The call is scheduled for 1 hour.

First, some housekeeping before we begin. Please note that all of the information discussed on today’s call is covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act. The company’s discussion may include forward-looking information reflecting management’s current forecast of certain aspects of the company’s future and our actual results could differ materially from those stated or implied. These forward-looking statements are qualified by the cautionary statements contained in NetSol’s press releases and SEC filings, including its annual reports on 10-K and quarterly reports on Form 10-Q.

I would also like to point out that NetSol will be discussing certain non-GAAP measures. The release issued earlier today contains a reconciliation of these non-GAAP financial results to the most comparable GAAP measures. In addition, I would like to remind everyone that today’s call is being webcast at www.netsoltech.com. At the conclusion of the call, the webcast maybe accessed on the NetSol website, where it will be archived for 90 days.

With that, I will now turn the call over to Najeeb. Najeeb?

Najeeb Ghauri

Thank you, Patti and welcome everyone. To those in the call in the U.S. and North America as well as those coming from Europe and Asia, I am very pleased to be reporting from NetSol’s global delivery center in Lahore, Pakistan, while Naeem Ghauri from Bangkok and Roger Almond from our headquarters in Los Angeles.

We are very pleased with our results today, highlighting the leverage we have built into our business. We also are pleased to reinstate guidance, the first time we have done from a qualitative standpoint since before our NFS Ascent transition period as a result of greater visibility in part due to multiple longer term contracts underway, including our 12 country NFS Ascent contract.

Further underscoring our confidence are a number of positive developments. New wins in Europe, including an important win for NFS Ascent in the region with a Tier 1 asset finance institution, which serves as a strong reference point for all our marketing efforts; continued requests; and a growing new business pipeline in China something I have highlighted in the past few quarters and which continues to be the case today; increased utilization in change order requests by current customers; and strong revenue contributions from our joint venture with The Innovation Group, where we provide outsourced technology services.

We are also now exploring additional opportunities in high-valued technology outsourcing services to further our growth in this portion of our business. This all adds up to more predictable and stable growth building upon our existing revenue streams. The large 12-country NFS Ascent implementations, along with the new Ascent win in Europe are having a positive impact on our new business pipeline. Demos and discussions are being held throughout the world with both current and potential new customers. Indeed, it is a very exciting time in the history of NetSol.

With that, I will turn the call over to Roger Almond to review our financial performance and then to Naeem Ghauri to provide more color on our 12-country implementation. Roger, please? Roger?

Operator

Mr. Almond, your line maybe muted.

Roger Almond

Are you there? Sorry about that. Thank you, Najeeb. We reported strong results for the quarter as the net revenue grew 31% to $16.2 million with $12.2 million coming from total services revenue. This growth combined with our cost containment efforts led to our achieving GAAP profitability, recording $0.08 in diluted earnings per share for the quarter, or on a non-GAAP basis, $0.32 per adjusted diluted share. This compares with a $0.14 GAAP loss per diluted share for the same period last year, or $0.14 per adjusted diluted share. The adjusted EPS adds back stock-based compensation to EBITDA and we believe this metric is a better indicator of our performance moving forward.

License fees were $710,000 in Q2 compared with $2.1 million last year with the difference being related to the sales mix. Total maintenance fees, including related party maintenance fees, remain consistent at $3.3 million for both 2015 and 2014. As a percentage of total revenue, total cost of revenue for the second quarter 2016 decreased to 50% from 60% for the same period last year. Gross profit rose to $8 million from $5 million last year. Operational expenses were nearly flat year-over-year with an increase in selling and marketing expenses related to new business efforts offset by a decrease in general and administrative expenses as a result of cost rationalization initiatives.

For the first 6 months of fiscal 2016, total revenue increased to $29.5 million from $22.6 million for the same period 1 year ago. The company reported GAAP net income of $464,000 or $0.04 per diluted share for the first 6 months of fiscal 2016 versus a net loss of $3.2 million or $0.34 per diluted share for the same period last year.

Non-GAAP adjusted EBITDA was $4.8 million or adjusted EPS of $0.46 per diluted share for the first 6 months of fiscal 2016 compared with $2.4 million or adjusted EPS of $0.26 per diluted share for the same period in fiscal 2015. At December 31, 2015, cash and cash equivalents were approximately $14 million versus $14.2 million at June 30, 2015. Accounts receivable and accounts receivable related party combined were $11.8 million, up from approximately $10 million at June 30, 2015. The quality of our receivables remains strong.

Turning now to our outlook, looking at the remainder of the fiscal year, we currently expect minimum revenues of $62 million with positive GAAP earnings per share and continued adjusted EPS growth. Now, I will turn the call over to Naeem to discuss our 12-country NFS Ascent deal. Naeem?

Naeem Ghauri

Thank you, Roger. In late December, we announced a transformative 20-country deal, upgrading an existing customer to NetSol’s new NFS Ascent platform in Australia, China, Hong Kong, India, Japan and a host of additional countries included for the first time, South Africa. I am pleased to share that we are now implementing Ascent for this customer in China, who soon will be kicking off the projects in Australia, South Africa and South Korea.

Revenue from these implementations are anticipated to begin in the current quarter and will be more meaningful later fiscal 2017 and beyond. However, from a marketing standpoint, this contract represents a strong endorsement for a prestigious and very longstanding customer and a development that we are already leveraging. As many of you had questions on how the $100 million deal would manifest in our financials, I would like to provide a little more context to help you gain a better understanding. When we announced the agreement, we stated the contract was valued at more than $100 million. We translated into euros – to dollars at a rate €1.09 to $1. Since the conflict is in euros, my discussion will be in euros.

The contract states that we will be paid €71 million for license and maintenance over the 10-year period and that each individual country will contract for the services to customize and implement the software. The services component becomes a little trickier to estimate. For example, services revenue can be broken down into three buckets. Continue services for the legacy products for each country until NFS Ascent is implemented in that particular country, customization and implementation of NFS Ascent and change requests and services for NFS Ascent once it is installed. As services are up to each individual country, we were required to be conservative. However, we already are seeing service levels higher than what we had originally forecasted, which leads us to believe that the total revenue – total value of the contract over the period could considerably be more than $100 million value we announced. This means that we would expect around €7 million to €8 million per year on top of the what we already received from the customer in new revenue. As we have stated in the past, this provides for a stable base of revenue on which we will continue to build. We look forward to executing against this contract and updating you periodically as we progress.

With that, I will turn the call back over to Najeeb.

Najeeb Ghauri

Thank you, Naeem. With a number of large contracts underway and a growing new business pipeline throughout the world comprised of entire product portfolio, we are so excited about the opportunity ahead and confident in our growth trajectory.

With that, I will now open the call up to questions. Operator?

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question will come from Howard Halpern from Taglich Brothers. Please go ahead.

Howard Halpern

Congratulations guys. This is great take-off I guess your second quarter but off to the calendar 2016, great quarter.

Najeeb Ghauri

Thank you.

Howard Halpern

First question, I guess is – this is a modeling question going forward, what do you see as the actual mix between the three components of revenue, because in this quarter, it was essentially 75% services, 20% maintenance, do you see that changing as the quarters go by?

Najeeb Ghauri

Are you referring about three points licenses, maintenance, services, three components?

Howard Halpern

Yes. I mean, essentially the three buckets license fees, the maintenance fees and then you have the service fees, including the related party in each of those other components. But if you just take those three buckets, the services were made up 75% of the total revenue, is that the mix that you see going forward or you think there will be adjustments to that mix?

Najeeb Ghauri

Naeem, do you want to answer this?

Naeem Ghauri

Yes. Sure. So Howard, the license revenue as you can see historically has been higher percentage in the past, right. So this is quite unusual. And it’s clearly because of how the existing products solution, which is our current NFS R1 solution, is sun-downing and how Ascent is starting to pick up. So you can see we have not factored in much, if any license from Ascent. So starting from that low base now, which is under $1 million in this quarter, we only see upside on license from here. Okay.

Howard Halpern

And is the license revenue now from the large contract, is that going to be, again country-by-country as you start implementing through the 20 countries?

Naeem Ghauri

I think in order to figure that out, I think it’s going to be amortized over a period and so you start to see quite regular chunks of license coming in, in the next fiscal year, especially...

Najeeb Ghauri

Let me make a correction Howard, it’s 12 countries, not 20 countries.

Howard Halpern

Sorry, 12. Yes.

Roger Almond

Howard let me – this is Roger. I can just add a little color on that. So what will happen with the NFS Ascent deal, we will recognize the license revenue over the period of the installation, so if you figure you have 5 years – 5 years to 6 years of installation, then the license fee will be recognized evenly – or not evenly, ratably would be a better world. Ratably over the 5-year period as we install in each of the individual countries.

Howard Halpern

Okay. And with this contract kicking in now, can we model in that gross margin will continue to improve from this level?

Najeeb Ghauri

Yes. I think if you noticed with almost 45%, 47% in the Q2 and absolutely I am pretty confident if you look at the minimum guidance to $32 million [ph], that we will be doing at least what it says in the guidance at least $32 million to $33 million and I am very optimistic the margins will continue to improve.

Howard Halpern

Okay. And one final one, just about – just the general economic environment that we see and you probably see better globally are the companies that you are in touch with, are they really looking more and planning for longer term investments and ignoring sort of the noise that’s going on, on a daily or a weekly basis with currency fluctuations and perceived economic disruptions that might occur?

Najeeb Ghauri

Actually, on the contrary Howard, we are seeing a lot more traction as Naeem mentioned in his prepared remarks since the announcement of this contract then with Ascent. We are seeing lot more interest from U.S., from China, from Europe. So really, maybe our niche is so amazingly strong that we can continue to penetrate now that we are growing and our next generation is pretty much on track and some countries will be going live, the ones we saw before. So I don’t really feel that way. Naeem, do you agree with me?

Naeem Ghauri

Well, we actually experienced the converse since this year started, especially. We have had a whole lot of activity. I think probably the news helped and there have been a lot of new interest from companies we hadn’t spoken to before. So there is one or two quite – if you like more on the cutting edge companies in the U.S. who are starting to talk to us. So I think that’s only helping us.

Howard Halpern

Okay.

Najeeb Ghauri

A relevant point would be also – sorry Howard, let me just add one more point. A relevant point to your question is if you look at the China of course there is a lot of noise about China’s issues, but in our case our customers – existing customers and the new customers are really busy selling a lot of cars and a lot of leases, so to the point that we are actually seeing a lot of the opportunities in that market.

Howard Halpern

Okay. Well, guys, congratulations and keep up the great work. We look forward to more contracts on the way.

Najeeb Ghauri

That’s the plan.

Operator

Our next question will come from Mike Hughes from SGF Capital. Please go ahead.

Mike Hughes

Thank you. Good morning. Just a question on the services revenue, the unrelated party portion, it was $6.8 million in the September quarter and then it was $9.6 million in the quarter you just reported, can you just give a little bit of color on the sequential ramp, is that mostly related to the big deal or is something else going on there?

Najeeb Ghauri

Roger, please?

Roger Almond

So I think that’s across the board. I mean, you still have revenue that is coming in from the $16 million that we discussed, but if you look across the board and all of our customers, we are seeing increased service revenue for – in our European areas in the U.S. and especially in the APAC regions. And so as we continue to add customers – and these are, even if you add the R1 customers which we announced over the last couple of years, which shows that higher revenue for license, as we add those customers on and then the services, the change requests, those continue to grow. So I wouldn’t say it’s all tied to the new contract as it’s tied to all of the different services across the entire company.

Mike Hughes

Roger, would you be willing to say how much of it was related to the new contract, just rough ballpark?

Roger Almond

Yes, I can give that. So, if you look at 9/30, we only had $902,000 – let’s say $900,000 related to the new contract. And then we had in the next quarter basically $700,000. So we even had a little bit of a slowdown in services in that second quarter here for the large contracts. So as you can see, the bulk of our services is coming from all customers which is a good sign, because it’s not just coming from one large contract. And we will continue now in the third and fourth quarters to see that services continue to increase as we start the implementation of the NFS Ascent with the new large contract that we assigned.

Mike Hughes

Okay, that’s really encouraging. Just a point of clarification, Naeem had – I was a little bit confused. He had commented that there would be $7 million to $8 million in euro terms on top of some existing revenue? Naeem, could you just explain that once more? I apologize.

Naeem Ghauri

Sure, sure. So, what we are looking at first we have to establish what was the current revenue from the same client. So, we normalized that, let’s say, for next year. And we said with that as the baseline and then on top of that incremental growth from this client is roughly €7 million to €8 million in new revenue. So, this goes straight on top.

Mike Hughes

Okay, good. Thank you very much. And then you had very impressive operating cash flow in the quarter, a little over $5 million. I saw on the Karachi stock exchange that you have been continuing to buyback shares in NetSol PK. Will we continue to see that or what are the plans for the cash flow over time?

Najeeb Ghauri

Yes, I think as we did mention a few times in the past and lot of questions were asked, we did start buying in the Q2 period. And I think we have now about 66% ownerships by this point and then we continued onward this respective quarter. We report that in the end of the quarter. I cannot say what is happening in the next quarter about our plan, but it’s all encouraging and we saw an opportunity and we continue to manage our cash in a way that we continue to grow the company, do all the things that we need to really continue this momentum and then based on that we will see we hadn’t seen, but we have a board meeting next week in – for the whole parent company in Lahore and we will further look at some other new ideas also.

Mike Hughes

Okay, great. And then one last one for you, Najeeb, did you say there was a new European client win in the quarter? Is that correct or is that something you had announced in the past?

Najeeb Ghauri

Yes, I think that was the one in Q2, right, Naeem.

Naeem Ghauri

Yes. There was a win – I don’t know which quarter it came in, the news or it’s difficult to say, but there has been one big win in Europe and….

Najeeb Ghauri

Yes, I think it was the Q2 quarter.

Mike Hughes

Okay.

Najeeb Ghauri

I think it was back in October. That was $8 million...

Naeem Ghauri

Yes, that’s right. That’s already factored in into – not all of it, but some of the revenue is starting to come in from that contract.

Najeeb Ghauri

Yes, yes.

Mike Hughes

Alright, super. Thank you for your time.

Najeeb Ghauri

Thank you.

Roger Almond

Thanks Mike.

Operator

[Operator Instructions] Our next question will come from Mike Vermut from Newland Capital. Please go ahead.

Mike Vermut

Hi, guys. Fantastic quarter there. Quick question for you. When you announced the $100 million deal in a multi-country rollout, are you seeing that type of interest with some of your other very large customers the discussion now maybe. We upgrade to the NFS Ascent and maybe not of that scale, but that’s the kind of a trigger to start pushing more conversions to Ascent?

Najeeb Ghauri

Yes, Naeem is the best one to answer that.

Naeem Ghauri

Yes. Mike, if you look at our client list, which is on the website, our current platform is already servicing at least maybe 20 very large auto capture clients around the world. And all of these are potential targets for us to upgrade to – every single one of them is a potential upgrade prospect. So, you can imagine as heading sales, for me the first go-to client would be the one who has already outlined. So yes, absolutely, we are very, very aggressively going after some of our existing clients to convert. They are in different stages. It’s difficult for me and early for me to share any progress, but all I can say is that they are our natural targets, all of them.

Mike Vermut

And then can you also give me a little help thinking about the size and types of contracts in the U.S. and Europe now? Is that – are those going to be in the $5 million to $10 million range or how do those look, because that’s – if you start moving into the U.S. market, that’s the whole another branch for us?

Naeem Ghauri

Well, we have plans to launch very, very soon and it’s almost imminent into the U.S. market with Ascent. And we have already started speaking to two or three clients. And so our next big initiative will be in the U.S. The typical Ascent client is really at a different level to what R1 clients were. It’s a solution based on a totally different level in terms of pricing and its complexity and its flexibility. So, we are actually looking at much bigger ticket deals. It may not be as many deals, but each deal is much bigger ticket in its overall value, 10-year value.

Najeeb Ghauri

Yes, U.S. is a very big market for us. And now we feel that a bit maturity of Ascent now we can go after the U.S. market. So, it is a good time for us.

Mike Vermut

Excellent. And then one other last question, on the large deal announced, is there a linear growth progression we can assume over fiscal ‘17, ‘18 and ‘19 just for modeling purposes? Does it grow year-by-year or is it going to be kind of flat-lined year-to-year?

Najeeb Ghauri

I don’t believe it has flat-lined.

Naeem Ghauri

There is no way that is flat-lined, Mike. I am not the CFO, but I can tell you from my perspective, the way the financial model works is that it is back-end loaded and what is happening in the first 5 years already very healthy, but it is back-end loaded. So it will continue to grow in terms of yearly revenue. It will be growing year-over-year.

Mike Vermut

That’s fantastic. Exciting times for the company guys. Congratulations.

Najeeb Ghauri

Thank you.

Mike Vermut

Thank you.

Operator

Our next question will come from Jon Evans of JWest. Please go ahead.

Jon Evans

I was curious just to talk to you a little bit about the license fee piece and so if you look at the 6 months license fees as a percent of your revenue, it’s about 6.5%. And last year, it was about 16%. And I guess as you go through the back half or you go into ‘17, do you see that percentage then of licensee fees getting back up into the mid to high teens as a part of the revenue?

Naeem Ghauri

I think I answered that early, but I will reiterate. The license fee that you see in the 6 months past, they are a little bit of an aberration and not the trend because of sun-downing our existing product. So, we had made the market aware that the current platform – license revenues will start to decrease as Ascent starts to pickup. So, as you see this is probably our low point in terms of the current product rates and its license fees. And Ascent hasn’t factored in yet into this mix. So as Ascent starts to factor in, especially for the large contract, you see these license numbers go up.

Jon Evans

Great. But I mean when you think about that, do you think that you would get kind of into the mid-teens or like 20% of revenue, I mean obviously you are going to have a lot of services and I don’t want to pin you down from a number standpoint, but the margins related to software are so much higher than services. And – I mean if you come in with I mean 18% or 20%, you are going to see gross margins go up 900 basis points to 1,000 basis points in a quarter, so that’s what I am trying to understand, is it – do you go back that more normal or – in the back half?

Naeem Ghauri

Well, I think it’s – I am not the CFO, but I can tell you one thing, this is probably a low point in percentage volumes. So if you can imagine, the very large deal on its own, we haven’t even factored in license in yet, Roger, have we. Have you put any license in from the second quarter?

Roger Almond

Yes, we do have license. Jon, let me see if I can just kind of explain what’s happening kind of the two different license revenues that you would see. So basically, you are going to have your R1, our legacy product and that’s kind of the off-the-shelf product. And so as we sign a new customer – in China, that’s a really hot market for us with our R1, is you are going to see out of $1.5 million contract, you are going to pick up $1 million in license fee and $500,000 in services to get them up and running. Now with NFS Ascent, it turns completely the opposite direction. If you look at the $16 million deal that we signed, about $1.8 million of that was license, almost $8 million was going to be your services to get that up and running customization, and then you have your maintenance on the back end. So going forward, you are going to see license as a percentage of the total mix as a smaller portion, because of the customization and the services associated with it. Now, as Naeem said our $700,000 for this quarter is very low and as we start implementing NFS, this big deal that we just signed $100 million deal, you are going to start seeing higher license revenue as we start amortizing that into revenues. So I think you are at a low point, as Naeem said right now, but it will not get up to the percentages that it was in the past.

Jon Evans

Roger, will you break that out – so in other words, we have maybe two revenue lines, one for the license fee, which is kind of the older off-the-shelf product and one that is for the new product and that’s more custom, etcetera or no…?

Roger Almond

No, we will probably just leave it all at license and then we will probably break it out in the MD&A section as we talk about the change or whatnot. We kind have done that a little bit in our MD&A just talking about the mix of our revenue there. But you will see that services will continue to increase and then we will be – license revenue will still be getting strong, but as a percentage, it won’t be up to where it used to be.

Najeeb Ghauri

I wild like to add one point, Roger. I think probably what we are confusing with is that when services increase in a big way, then license percentage even though in value, they will grow but in percentage terms, it may be still smaller because services revenue is just spiking. And the other point to note is the services revenue for Ascent is at a much higher mandate rate than we are traditionally been charging for our legacy product. So it’s more profitable revenue, about 40%, 50% higher in per-man day rate that we charge our clients than we would use to be charging for R1. So overall, the percentage of the license revenue might be lower, but the values will grow because service revenue is growing disproportionately higher.

Roger Almond

And if license revenues can get back up to the same levels that they have been in the past with the signing of these new deals, but because services are so – we are going to spend so much – receive so much revenue in services, as a percentage, it’s going to go down but dollar value wise, it’s still going to be very good.

Jon Evans

Got it. And then just…

Najeeb Ghauri

Also I think guys, I want to make one comment, as these implementations happen in each country, I think then we will ramp up, alright Roger each country will have more license revenue we recognize once you go live on each country?

Roger Almond

Correct.

Jon Evans

So Roger, can I just ask you relative to the software, so the new software does it have the same type of gross margins as the R1 product or is it less or more?

Roger Almond

Well, I guess it’s kind of a tricky question because it depends on the product to get R1 installed was a very quick – we charge let’s say $1 million for license and then you had $250,000, $500,000 in services. So once you have that customer up, then your earning service revenue as you have different change requests. On this new deal that we signed, as Naeem pointed out, we have higher mandate rates for the – built into the services portion. So we have pretty good rates, I guess on the gross margin there. So what you really have is you have your total salaries and consultants and whatnot for your cost of revenue and that’s kind of going to be at a base rate. It will be incremental for raises throughout the – for each year and then as you add additional people depending on the size of – how large a company gets. So to basically say, it’s not like building a widget that you can say exactly what that cost of revenue is going to be. So that these – we do have higher margins built into the services on this new deal, which should provide better margin for us going forward.

Jon Evans

Okay, great. Thanks Roger, I appreciate it.

Operator

[Operator Instructions] Having no further questions, this will conclude our question-and-answer session. I would like to turn the conference back over to Najeeb Ghauri for any closing remarks.

Najeeb Ghauri

Well, thank you very much for joining us today. As you can see, we are very excited about the number we have just delivered and the big contract which is under implementation phases. We are really bullish about the way the company is growing and becoming much more stable, really to predict. So as always, on behalf of our Board and management team throughout the globe, I express my deep gratitude to our shareholders for their continued support and trust in our business strategy. Thank you and have a good day.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may all now disconnect your lines.

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