NeoPhotonics' (NPTN) CEO Tim Jenks on Q1 2016 Results - Earnings Call Transcript

NeoPhotonics Corp (NYSE:NPTN)

Q1 2016 Earnings Conference Call

April 28, 2016 16:30 AM ET

Executives

Erica Mannion - IR, President of Sapphire IR

Tim Jenks - Chairman, President, CEO

Ray Wallin - CFO, SVP

Analysts

Alex Henderson - Needham & Company

Mauricio Munoz - Raymond James

Richard Shannon - Craig-Hallum Capital Group

Tim Savageaux - Northland Securities

Troy Jensen - Piper Jaffray

Operator

Welcome to the NeoPhotonics 2016 First Quarter Conference Call. This call is being webcast live on the NeoPhotonics event calendar webpage at www.neophotonics.com. This call is the property of NeoPhotonics and any recording, reproduction or transmission of this call without the express written consent of NeoPhotonics is prohibited. You may listen to a webcast replay of this call by visiting the event calendar page of the NeoPhotonics Web site.

I would now like to turn the call over to Erica Mannion at Sapphire Investor Relations, Investor Relations for NeoPhotonics.

Erica Mannion

Thank you. Good afternoon. Thank you for joining us to discuss NeoPhotonics’ operating results for the first quarter of 2016 as well as the Company’s outlook for the second quarter of 2016. With me today are Tim Jenks, Chairman and CEO, and Ray Wallin, Chief Financial Officer.

Tim will begin with a review of the first quarter results. Ray will provide a financial update including results for the first quarter and the outlook for the second quarter, and then Tim will summarize before opening the call up for questions.

Material contained in the webcast is the sole property and copyright of NeoPhotonics, with all rights reserved. Certain statements in this conference call, which are not historical facts, may be considered forward-looking statements that involve risks and uncertainties, and include statements regarding future business results, levels of sales and profitability, subsequent events, product and technology development, customer demand, inventory levels and economic and industry projections. Various factors could cause actual results to differ materially. Some of these risk factors have been set forth in our press release dated April 28, 2016 and are described in our SEC filings, including our Annual Report on Form 10-K for the year ended December 31, 2015, which was filed on March15, 2016.

Listeners may obtain a copy of the Company’s press release by visiting the Company’s Web site.

Now, I will turn the call over to CEO, Tim Jenks.

Tim Jenks

Thank you for joining us today. In our first quarter, NeoPhotonics delivered excellent results. We achieved record revenue, record year-over-year growth and sequential growth, record EBITDA, and record revenue from 100 gigabit products.

Revenue grew by 11% sequentially to $99.1million, up from our previous record high fourth quarter. Driving the $10 million increase over the prior quarter and $4 million increase over the mid-point of our Q1 outlook was the strength in demand across our key 100 gigabit products including 100 gigabit components and 100 gigabit modules and switches. High Speed 100 gigabit and above products were $64.1 million, or 65% of revenue, which we continue to believe is the highest in the industry. The rapid increase in demand for 100 gigabit products from China and worldwide is a very positive contrast to our normal seasonal pattern in the first quarter as we sold out our capacity for certain key products.

In addition, with this overall growth, improved fab utilization, and a mix shift to higher margin products, we expanded non-GAAP gross margins to32.8%, a 0.4 percentage point sequential expansion, again in contrast to normal Q1 seasonality. Therefore, we are augmenting and accelerating key capacity additions that we discussed last quarter, and as Ray will describe in more detail later. Non-GAAP profitability increased to $7.0 million, or15 cents per diluted share and we generated record $12.3 million of adjusted EBITDA.

As we articulated on our last call, and as demonstrated in our performance this quarter, we believe that the industry has entered an expansion cycle where 100 gigabit deployments are expanding globally for both Telecom and Datacenter applications and that these two segments are in sync. And within the China market, we expect the strength we’ve seen in 100 gigabit deployments to continue as we anticipate awards for approximately 30,000 100 gigabit ports for the second half of the year and into 2017.

Outside of China, we continue to see an on-going worldwide ramp of 100 gigabit deployments, particularly in North America and Europe, driven by Verizon and other major carriers, as well as strong growth in the Datacenter Interconnect market. Within the various end-markets, long haul remain sstrong while metro 100G build-outs are beginning and are expected to ramp materially in the second half of 2016, through 2017 and beyond.

We have previously articulated several drivers affecting our business. Cloud services are driving a shift in communications architectures to enable high bandwidth, connection density and rapid reconfiguration. Further, 100 gigabit Coherent transmission is the technology of choice for long haul, metro and DCI connections, and the use of contentionless switching architectures in coherent networks is expanding, and is critical for Software Defined Networks for Content Providers’ Datacenters.

Finally, data lanes in datacenters are rapidly moving to 25 gigabit from 10 gigabit and increasingly using single-mode instead of multi-mode fiber. These trends are favorable to NeoPhotonics. And as a result, demand for our coherent product suite, our multi-cast switch products, our client and datacenter 100 gigabit transceivers, our EML lasers and our high speed IC components is expected to continue to grow throughout 2016 and beyond.

Continuing our leadership in 100 gigabit and beyond solutions, we introduced a number of exciting new products and technologies at OFC last month and at the recent FOE trade show in Japan. On the line side, these included our multi-rate CFP2-ACO coherent module as well as our new high bandwidth coherent receiver, which enables 400 gigabit transmission using a single DWDM wavelength. For applications inside the datacenter, we announced development of a 400 gigabit transceiver based on eight of our 28 gigabaud EML lasers using PAM4 transmission, and followed up with 56 gigabaud EML lasers that can reach 400 gigabit with only four lasers, again utilizing PAM4.

Our leading product performance in ultra-narrow linewidth tunable lasers, high speed and high sensitivity coherent receivers, and high data-rate EML lasers has allowed us to rapidly move to new 400 gigabit telecom and datacenter applications and to provide our customers with future proof solutions for today and tomorrow.

As I have previously stated, our goal is to continue our leadership in High Speed 100 gigabit and beyond product solutions while delivering sustained profitability. With seven consecutive profitable quarters, we have established a firm track record, having converted our market success into robust bottom line profitability. Further, we are working hard to add manufacturing capacity for key product capabilities as we strive to accelerate our growth with forecasted demand growth.

In addition, we see the overall environment for 100 gigabit and beyond products globally for both telecom and datacenter applications being very robust. Given the acceleration in the organic demand we are experiencing, we are now expecting revenue growth to be in the range of 20% to 25% for the year.

I will now turn the call over to Ray Wallin, our Chief Financial Officer.

Ray Wallin

Thank you, Tim, and good afternoon. Revenue for the first quarter totaled $99.1 million, coming in above the high end of our outlook range, an increase of 22% from the year ago period and up 11% from the fourth quarter of 2015.

Our non-GAAP gross margin was 32.8%, which was up 1.5 percentage points compared to the prior year and up 0.4 percentage points versus the December quarter, and close to the high-end of our outlook range, driven by favorable mix and strong manufacturing utilization. Also, due to industry supply constraints, we were able to maintain favorable pricing for certain products in the quarter.

Non-GAAP operating expense for the quarter was $23 million, or 23% of sales, which represents a 14% increase versus the prior year period and a 2% increase versus the prior quarter, driven by our continuing investments in 100G components, modules and switches. Our quarterly non-GAAP operating expense run rate continues to reflect the controls we established to be consistent with our target model, reflecting leverage in our operating model. I would like to note that in the last seven quarters we have operated at or below our target model of 25% for operating expenses, which we continue through 2016.

Non-GAAP operating income for the first quarter was $9.5 million, or 10% of revenue, up almost 80% from the prior year period, and up 52% from the prior quarter, reflecting our continuing focus on profitable growth. Our non-GAAP results exclude $1.3 million of amortization of acquisition-related intangibles and $3.4 million of stock-based compensation driven by a greater number of in-the-money common stock equivalents due to an increase in our stock price.

Our non-GAAP tax rate for the first quarter was approximately 14%, which is closely in line with our anticipated non-GAAP tax rate in the range of 15 to 20%. Overall, we recorded non-GAAP net income in the first quarter of $7 million, or 7% of revenue, as compared to 5% of revenue in the prior year period and 8% of revenue in the prior quarter. Based on a fully diluted share count of 45.1 million shares, this translates to earnings of $0.15 per share. Our non-GAAP net income was impacted by foreign exchange losses, principally from strength of the Japanese Yen against a softer U.S. dollar. This resulted in a $1 million after tax reduction in income, or $0.02 per share. Over the past five quarters, inclusive of Q1 2016, foreign exchange fluctuations have either impacted or benefited our non-GAAP net income by $0.01 to $0.02 per share per quarter.

Now excluding these foreign exchange fluctuations, our non-GAAP earnings per share has improved by approximately $0.04 per share over this five quarter period. Now these foreign exchange fluctuations in our non-GAAP earnings per share, which are generally non-cash, are driven by intercompany balances associated with our global manufacturing operations in geographies including China and Japan.

For the first quarter, adjusted EBITDA was $12.3million, or 12% of revenue, which was up from $9.9 million recorded in the year ago period and $11.8 million in the prior quarter. Depreciation and amortization expense in the first quarter was $5.5 million.

On a GAAP basis, first quarter gross margin was 31%, up from 30% in the prior year period and up from 28% in the fourth quarter of 2015. And GAAP operating expenses were $26.4 million, or 27% of revenue. On a GAAP basis in the first quarter, we continued to generate positive earnings, recording net income of $2.3 million, or $0.05 per fully diluted share.

Now, geographically, our revenue mix for the first quarter of 2016 was 20% in the Americas, as compared to 17% in the fourth quarter of 2015. China continued very strong at 62% in the first quarter of 2016 compared to 67% in the fourth quarter. And Japan was 5%, compared to 3% in the fourth quarter, and the rest of the world was 13%, the same as in the fourth quarter, based on shipment destination.

We had two 10% or greater customers in the first quarter of 2016: Ciena comprised approximately 16% of our total revenue compared to 14% in the fourth quarter; Huawei Technologies comprised 54% of our total revenue compared to 55% in the fourth quarter. Now these percentages are inclusive of revenue from Huawei affiliate Hi-Silicon Technologies; a full reconciliation of our GAAP to non-GAAP results for the quarter is included in our press release.

Now turning to the balance sheet. We finished the quarter with $103.8 million in cash, cash equivalents, short-term investments and restricted cash. And our total debt as of March 31, 2016 was $44.8 million. Accounts receivable increased by $4 million in the first quarter, ending at $87.2 million, with day sales outstanding decreasing to 79 from 84 days in the prior quarter, reflecting our strong sales during the quarter and our emphasis on managing working capital. Net inventory decreased $3.1 million during the first quarter to $62.5 million, with days of inventory on hand decreasing to 83 days from 92 days in the prior quarter, reflecting strong demand for our products.

Now as Tim noted, we have accelerating demand, notably for 100G components and modules, such that we now expect revenue growth of 20% to 25% for the year. In the last quarter, we increased our capital expenditures forecast for the coming full year to a range of 7% to 9% of revenue. We also noted previously that capacity for our key 100G products was booked out and in the first quarter we shipped at full capacity for certain products, resulting in record revenue.

Now our capacity remains booked out for the second quarter as well, and we see demand continuing to grow from the convergence of strength in China, and from Datacenter and Metro deployments. Therefore, we are augmenting and accelerating the capacity expansion plans we discussed on our previous call, adding module, component and chip level capacities. We expect to double our capacity for switches and increase coherent receiver, ultra-narrow linewidth tunable laser and 100G module capacities by 50% or more over previously planned levels. And of necessity, these capacity increases will occur incrementally over the next quarters.

Now we saw a surge in 4Q and 1Q due to current market strength, and demand in China. As I noted earlier, with resulting industry supply constraints, we enjoyed favorable pricing for certain products and solid manufacturing utilization through the quarter. We do expect our second quarter manufacturing capacity to be up incrementally as compared to our first quarter, while demand continues to grow.

Therefore, as our new capacity adds come on line, we expect to see increasing benefits from the third quarter on, and we expect that in Q2 gross margins will be impacted by the realization of ASP changes together with our ramping up manufacturing inventories to enable our higher volumes overall. With these higher purchase volumes, we anticipate that we will see continued cost reductions that will be favorable to forward margins. All of these elements are reflected in our outlook.

For the second quarter of 2016, the Company’s expectations are: revenue in the range of $97 million to $102 million; non-GAAP gross margin in the range of 29% to 31%; GAAP diluted net income or loss per share in the range of a $0.02 loss to earnings of $0.05, and non-GAAP diluted earnings per share in the range of $0.08 to $0.15. This is reflective of approximately $0.10 per share of after-tax non-GAAP adjustments and an assumed share count of 46 million shares.

I want to remind everyone to refer to our public filings with the SEC and our Safe Harbor statement included in our press release that discuss the risks and uncertainties that could affect future performance causing actual results to differ materially from our forward-looking statements. We do not plan to update, nor do we take on any obligation to update this outlook in the future.

Now I will turn the call back over to Tim.

Tim Jenks

Thank you, Ray. As I noted earlier, we are seeing a strong market such that we are forecasting an acceleration in our growth in the quarters ahead, to a range of 20% to 25% growth for the year. I would like to thank our global employees for their diligent efforts to enable these results and our continuing optimism.

This concludes our formal comments and now I would like to ask the operator to open up the line for questions. Thank you very much, Operator.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Alex Henderson with Needham & Company.

Alex Henderson

First off, congratulation definitely in orders, it's just great news. Can you talk a little bit about, I mean obviously the demand that came in from China in 4Q and continued in 1Q is great news. And it sounded like you’ve got some pretty good visibility to another 30,000 lines out of China. Can you talk about what’s your expectations are relative to that timing of the systems, orders from the service providers to the OEMs in China that give you the confidence that that’s real demand and that you have visibility to the timing of that order flow generation. Anything along those lines would be very helpful. Thank you.

Tim Jenks

The most recent significant element was China Mobile, who a few months ago, announced tenders that were in the range of low 30,000 lines. And the expectation is to have another 15,000 to 20,000 lines between the third and fourth quarter. We also look at China Unicom and China Telecom; one as a bid in process the other one has a bid that we think is closed. And together, these are probably another 7,000 to 8,000 lines. So, in total, it's in the range of 25,000 to 30,000 lines. All four award probably in the third and fourth quarter of this year with shipments in fourth quarter and into 2017. Last year the timing was in the third quarter and the expectation could be very similar this year.

Alex Henderson

And then the second question is, just to make sure I’ve got straight what you said. You’re doubling the capacity for your multicast switch product. Was that correct?

Tim Jenks

That’s correct, yes.

Alex Henderson

And that’s achieved by what time frame?

Tim Jenks

So all of the capacity increases will happen in the range of one to three quarters, it depends on at what level. The assembly manufacturing comes on more quickly, and when we get to chip level capacity, that can take a bit longer. But essentially for switches, we would expect that to be online early in the second half, so really in the third quarter.

Alex Henderson

And then one last question and I’ll see the floor. You had favorable pricing in the quarter. Can you describe what you mean by that? Is that a lesser rate of decline, or actually positive pricing? And then you’ve made a comment, I thought I heard that there was more of a negative impact on pricing going forward. I was a little confused by what you meant that for, the price impact in 2Q.

Tim Jenks

Sure. So we do pricing negotiations generally in the fourth quarter, but we were also experiencing a surge in the fourth quarter and the first quarter. So, some of the pricing held longer than normal from customers who had meaningful increases in their shipment quantities. We were able to hold the prices. So, essentially the price impact to some extent has a full effect in the second quarter, instead of the first quarter. And that’s the net outcome, it's just some delay in when the full effect of pricing, annual pricing, changes impact us.

Operator

Your next question comes from the line of Simon Leopold with Raymond James.

Mauricio Munoz

This is Mauricio on behalf of Simon Leopold. Just a quick housekeeping item, you provided the percentages of revenue from Ciena. I didn’t quite get that. Could you repeat it one more time please?

Ray Wallin

16%, it was 16%. This is Ray.

Mauricio Munoz

Thank you, Ray. Okay. And now, Tim, if you could please, just wanted to get your thoughts regarding the Verizon strike and any potential revenue delays that you might see from Verizon Metro build that could negatively affect your -- the projects and revenue for NeoPhotonics?

Tim Jenks

Mauricio, I think it's a little bit early to tell how the Verizon strike might affect the component level vendors, if at all. It has to flow through several levels of the supply chain. But it is possible that there could be some delays in Metro deployment, but we actually haven’t seen anything concrete at this point. So, I can’t tell you with knowledge anymore than that.

Mauricio Munoz

And also just wanted to ask you about Chinese carriers. Could you provide an update regarding the demand for ROADM architectures, and the implications for NeoPhotonics?

Tim Jenks

For Chinese carriers, the first point I think of ROADMs is typically we’re referring to whether they’re used in different types of network architecture, whether they’re MESH architectures as is normally the case, in Metro U.S. or Ring architectures. And the Chinese carriers historically or traditionally really have not deployed full ROADMs. Their architecture didn’t really require that. But now they are considering ROADMs as they move to architectures that have software defined features. And so we do expect some increase over time in ROADM use for China domestic carriers, but I think we’re really in the early days at present.

Mauricio Munoz

One more if I may, this is in regards of again China. And I was wondering if you could explain the disconnect between these Chinese carriers, their initiatives of flashing topics for 2016. But yet it seems that the optical sector remains healthy. Could you please elaborate on that?

Tim Jenks

Yes. So, there are a couple of things that I ought to go through there. The overall CapEx of course covers their entire business. So, it covers their access network, their wire lines, their wireless, their legacy and all of the maintenance. And so, they are continuing to do strong installations for backbone networks, notably for the 100 gig. And generally speaking their overall CapEx rates, even after some reductions, are well above the traditional CapEx rates from Western carriers. So even after reductions, they’re still on the 25% to 30% of revenue range.

So, we also see that in China there is tremendous amount of investment in infrastructure that are supported by these deployments. So, the new technology installations, which at present, include the 100 gig backbone networks as well as 4G wireless installations, these are taking the lion share of the CapEx investment that is going on.

Mauricio Munoz

And what is the percentage of the opportunity for NeoPhotonics on the demand for 100 gig backbones?

Tim Jenks

The 100 gig deployments in China are generally supported by handful of network equipment manufacturers, really all of which are customers of ours. The largest of course is Huawei, it was our largest customer. But we’re also well positioned that other network equipment manufacturers in China. The other -- in China strong players in addition Huawei would include the ZTE fiber home technologies and Alcatel Shanghai Bell, now part of Nokia. So, each of these companies are participating in the network build outs there.

Operator

Your next question comes from the line of Richard Shannon with Craig-Hallum.

Richard Shannon

Thank you for taking my questions, and let me echo congratulations on a great start to the year. I just have two quick questions. If I look at your new revenue growth guidance for the year, going from 15% to range of 20% to 25%, how much of that is due to the improved outlook for 100 gig long haul in China versus all the other initiatives that you have going on, and discuss like in multicast switch datacenter and others, I would imagine the China 100 gig is most of it. But in any way you can give us some color there would be great to hear?

Tim Jenks

So the increase that we’ve said, we have previously guided to about 15% growth. And we saw revenue increase by $10 million in the fourth quarter to the first quarter, and then it will continue strong in the second quarter as capacity add go on. So, we think we’ll be well north of that 50% number and we think we’ll be readily able to support the demand, which is what gives us confidence in the 20% to 25% in addition to the additional China deployments that I talked about in the script.

So, it’s true the China is an important part of the increase, but really all are strong. So, it gives us more share not only in China but also in North America for example and in the Metro build outs here. We have, among our top customers, each of the players supporting Verizon and the other western deployments. So, I would say that the proportion of the increase, i. e. China, is really about the same probably as our overall China concentration. It's not decisively different than that.

Richard Shannon

Great details there. And my second question maybe more for Ray on gross margin, so obviously a great first quarter number. And you explained the change here in the second quarter. As you add capacity over the course of the year, where can gross margins go? Can you see them higher than your first quarter number, or should that be the high watermark for the year?

Ray Wallin

The short answer is they could be higher than the first quarter number. As we add capacity, we’re adding capacity in the areas that are supporting our higher margin products. In addition, we have very segment ongoing cost reduction efforts underway here. Lots of things that are going on to reduce cost in terms of the higher volumes that we’re purchasing, but also some other design efforts that are reducing costs, and the price reductions that we’ve seen for all the negotiations are largely over after Q2. So, I think we’ll be back to our normal pattern of increasing gross margins throughout the year, and I would seem that they would be higher than first quarter number as we go through the year.

Operator

Your next question comes from Tim Savageaux with Northland Capital Markets.

Tim Savageaux

I wanted to get back to that last question, which was [indiscernible] got right, which is to say you expect after this, I guess, what you’re characterizing is delayed reaction to the annual price negotiations that you expect margins in the second half of the year to be greater than first quarter levels. Is that what you said?

Tim Jenks

Yes, that is correct.

Tim Savageaux

And in general, and I guess the dip for the annual price negotiations wouldn’t be necessarily unusual. But given the sold out nature of the industry, and given the relative and you can tell me if you disagree with this. Relative comparative -- competitive stability that I think characterizes much of your major product markets. It still might be surprising to see that degree of pressure. I wonder if you can talk about those industry dynamics with regard to playing off price and volume in a sold out environment where in many cases you have very significant market share. Why weren’t we able to maybe blunt that pricing impact altogether, I guess?

Tim Jenks

So, a number of -- the price reductions that are built in are date back from the fourth quarter. And as we’ve mentioned, some of those got a bit delayed. Nonetheless, the volumes continue to go up and our historical pattern actually will see some decrease in revenue from the fourth quarter to the first quarter. But in fact what you saw was $10 million increase and then we expect to be at that level or higher in the second quarter as well, and then continuing to grow for third quarter and fourth quarter.

So, I think while there is an element of price, it's a relatively small one between the first quarter and the second quarter. The real issue is very strong level of volume increases on the first quarter over the fourth quarter and then another level of volume increases in the second quarter over the first quarter. So, these are the things that we’re seeing and we’re supporting with the capacity adds and with the demand growth. So, as Ray mentioned in the last set of questions, so pricing changes are now behind us, essentially for the rest of the year.

Operator

[Operator Instructions] Your next question comes from the line of Troy Jensen with Piper Jaffray.

Troy Jensen

So maybe quick for Ray. Could you give us any sense what the book to bill was in the quarter?

Tim Jenks

Troy let me take that, it's Tim. We’ve seen a strong book to bill and we’ve been able to maintain book to bill above 1. But just as a reminder, the vast majority of our shipments are out of vendor managed inventory. And so the book to bill is actually reflecting well less than half of our business. But it has been able to stay above one and we’ve continued to see an increasing amount of orders that are actually firm orders out through the second half of the year. So, it's positive. But taken in isolation, the book to bill alone, because of the large amount of our business, that’s VMI, the book to bill doesn’t really express the whole picture.

Troy Jensen

So then Ray, also maybe about adding 50% capacity increases, we see little bit more color on that. I mean, does that mean if you were going to add 20% sequentially, now you’ve loosen it to 30% or, just want to make sure I understood that comment.

Ray Wallin

I think it goes to the back to the…

Tim Jenks

Troy I’ll just -- its Tim, in response to your last question though just book to bill was just under about 1.2 in the quarter.

Ray Wallin

So, overall what we said was that we’re going to double our capacity for the switches. And then for the Coherent Receivers and the ultra-narrow line-width tunable lasers and 100G module capacities by 50%, or more over previously planned levels. So, we already baked in a capacity increase and that’s an additional 50% over that level that we had previously announced.

Troy Jensen

And maybe Tim just last one for you, just an update on the ACOs. I know the announcement about a month ago, but just want to get some feedback on reception of it and remind us on when you can start shipping and more volumes, samples or some update please.

Tim Jenks

Sure. So, we had announced the first version of our CFP2-ACO, which was a Class 3 product. And we expect to be -- that product is sampling to certain customers and in testing. But we expect it’ll be shipping in the second half. The other note that we expect is in the second half, we’ll be introducing the next Class 2 product. And so that will be an important addition to the product line. So we’re continuing to move along in the ACO development and customer engagement for those important products.

Operator

You have a follow up question from Tim Savageaux with Northland Capital markets.

Tim Savageaux

I just remembered, I’ve missed the High Speed versus Network Products breakout. I am not sure you probably gave that earlier, I wonder if you might be able to provide me with it.

Tim Jenks

Yes, it was the High Speed, it was $64.1 million, which is 65% of revenue, and so Network Products and Solutions is 35% of revenue for the quarter.

Operator

I will now turn the call back over to Tim Jenks for closing remarks.

Tim Jenks

Thank you very much operator. In closing, I would like to thank all of you for taking the time to join our call today. And we do look forward to updating you on our progress on our next call. Thank you and have a good evening.

Operator

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

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