Sapiens International Corporation's (SPNS) CEO Roni Al-Dor on Q2 2016 Results - Earnings Call Transcript

| About: Sapiens International (SPNS)

Sapiens International Corporation N.V. (NASDAQ:SPNS)

Q2 2016 Earnings Conference Call

August 03, 2016 09:30 AM ET

Executives

Yaffa Cohen-Ifrah - CMO & Head of Corporate Communications

Roni Al-Dor - President & CEO

Roni Giladi - CFO

Analysts

Bhavan Suri - William Blair & Co

Mayank Tandon - Needham & Co

Tavy Rosner - Barclays

Avishai Kantor - Cowen

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Sapiens International Corporation Second Quarter 2016 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded August 4th, 2016.

It is now my pleasure to introduce your host Ms. Yaffa Cohen-Ifrah, Sapiens CMO and Head of Corporate Communications. Thank you, Ms. Cohen. You may now begin.

Yaffa Cohen-Ifrah

Thank you, and good day, everyone. Our quarterly earnings release was issued before the market opened this morning, and it has been posted on our Company's Website at www.sapiens.com. Representing the Company on the call today are Roni Al-Dor, President and CEO; and Roni Giladi, our CFO. Before we start, I would like to remind everyone that this conference call may contain projections or other forward-looking statements, and the safe harbor provisions in the press release issued today also applies to the content of the call. Sapiens expressly disclaims any obligation to update or revise any of these forward-looking statements, whether because of future events, new information, a change in its views or expectations, or otherwise. Also, during the course of today's call, we will refer to certain non-GAAP financial measures. A reconciliation schedule showing GAAP versus non-GAAP results has been provided in our press release issued before the market opened this morning. A replay of this call will be available after the call on our Investor Relations section of the Company Website or via the Website link which appears in the earning release that we published today.

I will turn the call over to Roni Al-Dor, President and CEO of Sapiens. Roni?

Roni Al-Dor

Thank you, Yaffa, and good morning, everyone. Thank you for joining the call today. Sapiens continues to deliver strong financial results, and I am encouraged by the strategic progress we are making as we extend geographically and bolster our business with our adjacent customer. During this call, we will provide the business update and discuss our second quarter financial results and our outlook for the remainder of 2016. Today, we are reporting revenue of $53 million, up to 22.1% over the second quarter of 2015. We delivered growth and improved performance across all of our offerings and in all territories we are operating in, driven by strong demand from new and existing customers. As in recent quarter, the demand for our products and services remains strong. Overall, we improved our position in the market, and our competitive advantage resulted in winning new businesses with new customers. We expect this momentum in sales to continue throughout the year. I'm confident that, as a global one-stop shop for both products and services, with long-term relationships with our customers, we are well positioned to continue leveraging our land-and-expand business model.

As I said in the previous calls, our land-and-expand strategy involves leveraging customer relationship and geographic presence to cross-sell our solutions. Example of this includes major expansions of new LOB [ph] within the existing customer and new sales to affiliates for existing clients in different geographies and sales for new products to an existing client. At the same time, to further accelerate our growth, we continue to look for additional emerging acquisitions that are aligned with our overall growth strategy. Now, back to our core businesses, on the deal front, in May, we signed a multimillion expansion with Anadolu Insurance Company, a private insurance operating in Turkey. As in many of our other strategic relationships, this win was part of the larger transformation project. We have already successfully launched four lines of business. And with this agreement, the Sapiens IDIT software suite will now expand to support another of Anadolu main lines of businesses, auto and motor insurance.

We view this transaction as yet another key example of how we bring growing value to our clients, as they expand their partnership with us and shift their entire business to run on a single platform, in this case, with Sapiens IDIT software suite for property and casual. Also, during this quarter, we had some great go-live events. In April, Mutual Trust Life, MTL, a Pan-American life insurance company, went into production with Sapiens. The deployment of Sapiens ALIS completed the second phase of a multiphase transformation initiative to modernize MTL's technology infrastructure. This program will utilize the Sapiens ALIS platform to support all of MTL products offerings, for both new businesses and its in-force book of businesses. Later in this quarter, MLOZ, Belgium-based national federation of independent health insurance funds, entered production with the Sapiens IDIT policy administration solution. MLOZ's initial in-production environment included the deployment of two health products to manage hospitalization and dental care claims. And ultimately, IDIT will replace the entire MLOZ legacy health insurance system.

In addition to our various customer wins and engagement, we continued to expand our offering, customer propositions, and market reach. During the second quarter, we were very excited to acquire Maximum Processing, a US-based company serving tier four and five P&C insurance in North America. Maximum Processing is offering a policy administration suite named Stingray and serves nearly 30 insurance customers. With this acquisition and the additional of the Stingray system to our product portfolio, Sapiens has a set first foothold in North America P&C insurance market with an attractive offering for tier four and five carriers, MGAs, TPAs, and brokers. We consider this acquisition consistent with our long-term strategy of organic growth together with our M&A activities. Still in US, we have enhanced our position in North America insurance and retirement services market by expanding our local sales and delivery team to help us to get closer to our customers in this region. We constantly strive to stay a step ahead of our industry and consumer trend and offer our customers the tools to remain ahead of the competition and help transform the manner in which they do business.

On that front, we have recently entered into a partnership agreement with Life.io, a provider for a digital transformation platform that monitors and analyzes policyholder behavior and encourages a healthier lifestyle via incentives. Integrated with Sapiens ALIS, we now offer life insurance with an in-depth and personal view of their customer lifestyles and enable them to rapid launch of the most suitable products to the right customer at the right time. In the second quarter, Sapiens introduced an enhanced version of DECISION manager, which continued to define the rapidly maturing business decision management market. Also with DECISION, last week, we announced that Andre Boisvert joined Sapiens DECISION Board as the Chairman. Andre's impressive experience, vision, and strong relationships will help Sapiens DECISION as we continue to focus our attention and effort to the emerging field of decision management, which we are proud to have pioneered. Our offering remains the most comprehensive and robust in our Company's history and in this industry, allowing us to provide broad range of core and complementary solutions, delivery capability, and services.

Our strong brand recognitions help us to win new customers and expand our business with our existing long-term clients. In addition to the ongoing R&D investments towards improving our core products and in response to the market trends, we are accelerating the investment in our digital suite to provide a full experience that includes advanced analytics and business intelligence, a portal for consumers and agents, mobile access, and self-services and connectivity to the IoT device and wearable technology. The demand for an integrated digital suite in the insurance market is greater than expected. Technologically, we prepared our platform to support external BI and portal solutions. But, many of our customers are currently seeking preintegrated BI and portal solutions from us as their main vendor, capitalize our vast insurance knowledge and technology. We expect this elevated expanding to continue throughout the year as we further enhance our solution to best fit the needs for existing and targeted new customers. We believe this investment will help us win more businesses, expand revenue, and ultimately elevate overall profitability. I would note that we went through a similar investment cycle previously, which led to accelerated revenue and profitability. To conclude my portion, I would like to summarize the key highlights. We posted yet another strong quarter, highlighted by double-digit revenue growth and double-digit operating margin. We continue to win new customers and expand businesses with existing clients across all of our products and geographies. We accelerated the growth and market reach with another strategic acquisition. We remain confident that we will continue achieve double-digit growth throughout 2016.

I would like now to turn the call over to Sapiens CFO Roni Giladi to discuss our financial situation and outlook.

Roni Giladi

Thank you, Roni, and good morning, everyone. Before I jump into our results for the second quarter, as a reminder, we are presenting our result on a non-GAAP basis, which we believe gives a clear view into operational state of the business. There is a detailed reconciliation showing GAAP to non-GAAP results in the financial table of the earnings press release. Revenue in the second quarter was up 22.1% from the second quarter of 2015. Our revenue growth was driven by strong demand from existing customers and from ramping sales from new customers and from the impact of the acquisition we completed last year. Please note that our recent Maximum Processing acquisition, which closed on July 1st, is not included in our Q2 results. Looking at the geographic breakdown of our revenue, in the second quarter, we maintained a diverse geographic mix. We once again achieved revenue growth across all regions, with notable growth in Japan. Our revenue in North America represented 32.4% of total revenue. Europe, which includes our Israeli revenues, represented 49.3% of total revenue. And APAC represents 17.5% of total revenue.

Our gross margin was 42.9%, up from 42.7% in the second quarter of last year. This quarter, we stepped up our expenses with additional team and costs associated with the recruitment and training of delivery team to support future products. R&D expenses in the second quarter of 2016 totaled $5.4 million compared to $3.9 million in the same quarter of last year. As Roni said earlier, in addition to our ongoing investments in our core products, we accelerated our R&D investments in our complementary digital suite. SG&A expenses totaled $9.6 million this quarter compared to $8.2 million in the second quarter of last year. The increase in SG&A was the result of our ongoing increase in sales and marketing investments during the quarter to win new business and gain market share. Our operating income for the second quarter of 2016 increased by 15.3% to $7.4 million from $6.4 million in the second quarter of last year, representing 14% of total revenue compared to 14.8% of last year. Our adjusted EBITDA this quarter totaled $8.1 million, increased by 17.1% from $6.9 million in the second quarter of last year and reflecting 15.2% of total revenue for the quarter compared to 15.9% of last year. The reduction in operating and EBITDA margin is mainly due to higher investment in R&D and delivery and continuous investment in sales and marketing.

Tax expenses this quarter were $1.6 million, representing an effective non-GAAP tax rate of about 20.4% as compared to $1.2 million in the second quarter of last year. Net income for the quarter was $6.3 million or $0.13 per diluted share, up from $5.2 million or $0.11 per diluted share in the second quarter of last year. Turning to our balance sheet, as of June 30th, we had cash and cash equivalents and security investments of approximately $100 million compared to $94 million as of end of 2015. The cash balance is following the distribution of a cash dividend in June of approximately $10 million. This cash position is without any debt. Turning to our 2016 guidance, we are raising our guidance to 2016 full-year revenue of $211 million to $215 million revenue, our annual growth rate of 18% to 20%, up from prior guidance of $207 million to $211 million. This increase in revenue reflects mainly our organic growth. The impact of the acquisition of Max Processing is currently offset by the negative impact of the devaluation of the British pound following the UK decision to exit the EU. To support this expansion and growth, we are increasing our short-term investments in R&D, delivery, sales and marketing. Also, we expect to see the impact of Brexit on our operations. Specifically, on Brexit, we estimate it alone will impact operating margin negatively in the second half of 2016 by approximately 100 basis points. And this is accounted for in our updated guidance. We now expect full-year 2016 operating margin in the range of 13.5% to 14% compared to our previous guidance of 15% to 15.5%. I would like to emphasize that all our established product lines are growing and profitable. Our DECISION product line, which is pioneer in its field, is currently in a growth and investment mode and is currently losing. We are investing in sales, marketing, and product in order to further penetrate this market. And we will continue to invest in this division. Please note that our operating margin will be higher if we exclude DECISION.

At this point, I would like to turn the call back to Roni Al-Dor for closing comments. Roni?

Roni Al-Dor

Thank you, Roni. Our second quarter was marked by continuous strong financial performance based on our business models that generates revenue from a diverse yet complementary suite of solutions across geographies and product sales.

I would now like to turn the call over to the Operator for Q&A. Operator, please poll for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question is from Bhavan Suri of William Blair & Co. Please go ahead.

Bhavan Suri

Hey, guys. Congratulations on some solid numbers there, and nice job. So, I'll just dive right in. There was some really nice upside driven in the period. I'd love to understand sort of what specifically drove that. You talked about some expansions. You've talked about IDIT. But, I'd love to understand sort of what specific products were driving that outside -- or maybe it was across all of them. And I'd love to get a sense of how that pipeline is looking by product, too, just to start off with.

Roni Al-Dor

Hi, Bhavan. Roni Al-Dor. We have a lot of products. So, we cannot go through one -- each one of them. But, in general, we are -- our P&C business is doing very well. We are -- we penetrate to a new territory as well as expanding in the territory that we are there. In the life and the life retirement as well, we can see the same level of growth, but not as good as the P&C. DECISION, there is a lot of demand on DECISION. You know we moved from perpetual to term. So, it's -- again, it takes more time, but we have good interest for this project. We also have a new -- I think that we did in the past -- we call it closed book runoff business, again, a lot of demand in this area, mainly in Europe. We hope to see in the near future a few businesses come from there. So, the overall is positive. The main growth right now is the P&C.

Bhavan Suri

Got it. Got it. And then if I look at retirement services and some of the things you've developed over the last year, year and a half, can you talk a little bit about how those are gaining traction outside of those original customers that you did the co-development with?

Roni Al-Dor

Yes, by the way, it was more than one and a half years. This was almost four or five years. And we are -- we hope to go to production very soon, so the both us and the customer are almost on the go-live very soon. So, that can -- that's very important milestone in order to get more deals in this business. We are not waiting, but we are generating, and we also signed an agreement with big player right now, mainly partners that can -- we can do work with them. But, it's still the -- everybody's waiting for the go-live. And that gives high confidence to the market.

Bhavan Suri

Got it. Got it. And then turning to DECISION, you guys have talked a little bit more about DECISION this quarter. I know you chose to start focusing on selling DECISION into not just financial services, but your insurance customers. I'd love to get just a sense of how that's going. Is it ahead of expectations? Have you started penetrating the insurance market for DECISION? And then I'll have one for Roni Giladi on some of the numbers.

Roni Al-Dor

Okay. So, in terms of insurance business, what we succeed to do is to penetrate to retirement services. So, we have a few new retirement services businesses based on DECISION. In the insurance, we are doing a lot of work in our customer. We have not signed yet. And we also start to integrate IDIT solution. For example, right now, we are thinking about robo-advice and a few other things. But, it's still on the planning. So, we still don't have DECISION running our insurance. But, hopefully, in the near future, we can see. Besides this, what DECISION is doing, and we see good momentum. At the beginning, when we start, we did mainly direct sales. We did a lot of investment at the past with the USI [ph]. And right now, we start to see the fruits of all of the -- those SI [ph]. The last thing, there is one big BPO carrier that's -- again, this is another area that DECISION can help and decrease their costs. And this is something that, again, we can -- so, just to summarize, a lot of demand. It takes time to close deals. But, when the deals is coming, you know at the beginning it start with maybe sometimes five user, 10 user, one area. But, we have a lot of options to expand in all of these giant clients. So, we continue to believe on DECISION. It just takes us time. And the main issue that we now have is all of these costs of the -- to finance the R&D, the sales and the marketing. It's effect of our overall margin. And we try to see how to deal with it.

Bhavan Suri

Got it. Got it. That's helpful. And then just on Brexit, obviously, you gave the margin impact. I'm trying to understand. Is that all because of currency running, or are you actually seeing rougher sales cycles and uncertain and sort of pushback on decision making in either the UK or Europe?

Roni Giladi

Hi, Bhavan. This is Roni G. What we see from our customers today is the same amid [ph] and demand for our products. We do not see differentiation because of the Brexit. Our product is basically built by three-layer, generic, customer or country layer, and then a customer layer. So, obviously, our product is also suited differentiation between the different countries. So, from the market side, we do not see any impact. We are industry of a long sales cycle. And we do not see any difference right now because of this. What we can say, obviously, is the financial, as you mentioned. And if we analyzed this ongoing-forward basis until end of the year, as we mentioned, about 1.5% additional growth can be done if we didn't have this Brexit, and obviously higher profitability on a yearly basis of about 0.5%.

Bhavan Suri

Got it. Got it. That's helpful. And then one last one from me. You guys talked about the sales investment and go to market in new territories, maybe the US, talked about P&C. Can you just clarify sort of, if I was to split between retirement services, ALIS, IDIT, and DECISION, how that sales investment looks like? Is it equal across those? Are you pushing one more than the others, given their past investments? Some color there would be great, Roni.

Roni Al-Dor

We are -- it's interesting your question because, in terms of sales, we are putting a lot of effort in DECISION because we believe -- you know, in DECISION, the good thing that it's more like a pure software than sales, services. So, we have -- when we are selling, the margin is very, very good. But, again, as I mentioned, in order to penetrate, it take you a lot of effort. So, we have -- compared to the other businesses, it's still the lower. But, in terms of proportional from the revenue, this is the area that we are putting much more, for example, marketing. The marketing effort in this business is -- absolute number is higher than the marketing that we are doing in Sapiens at all. In terms of the other business, it's more equal between life and P&C. In retirement right now, we are putting less because we believe we need to -- not to invest as much until we can go live.

Operator

The next question is from Mayank Tandon of Needham & Co.

Mayank Tandon

Roni G, I think, in terms of the guidance on revenue, you may have mentioned this, the increase, is that all acquisition driven, or is there something else embedded in that as well?

Roni Giladi

Hi, Mayank. The guidance increase is mainly coming from organic. I would like to elaborate about this. We see high demand from existing customers and new customers. We see the pipeline. And based on that, obviously, we increased the revenue. Without the impact of Brexit, we've been able even to increase this number slightly higher, as I mentioned, additional, let's say, 1.5% higher than what we have right now. So, the Brexit was offset by the acquisition of Max Processing, almost the same. If you remember, we mentioned the acquisition on a full-year basis of Max Processing was about $6 million. We did the closing only in July. So, the impact only is coming from Q2 and Q3. And this will be offset potentially by the UK, the pound. So, all the additional incremental growth is coming from organic of what we are doing day to day.

Mayank Tandon

Got it. Okay. That makes sense. And then you did answer this question earlier, but I just want a little bit more clarity. The 100 basis point reduction from Brexit on the margin front, is that the pound, or is that also capturing what you just said in terms of the slower growth because of Brexit, and then some maybe dilution from the acquisition as well?

Roni Giladi

The acquisition, I would like to start from then. So, the acquisition, this year, the impact is minimal. So, although it's not accretive to profitability, the impact there is minimal. So, I didn't even emphasize this. The impact on profitability, which is 1%, is totally coming from the pound on a six-month basis, meaning Q3 and Q4. The impact will be about 1% on our margin.

Mayank Tandon

Okay. It's interesting, though, that the impact seems to be less on revenue based on your comments. A little surprised by the extent of the impact on margins versus revenue.

Roni Giladi

I tell you why, Mayank. We do not have the same proportion of revenue in delivery cost in the UK. As a matter of fact, most of the delivery are outside of the UK, not in proportion to revenue. So, impact on revenue on the profit is higher on the profitability.

Mayank Tandon

Got it. Okay. And then as we look ahead into 2017, I know you haven't given formal guidance, but do you think you can return to driving margin expansion as you move into 2017, both on the gross margin line and also leveraging your operating expenses?

Roni Giladi

So, this is a question that we as a management facing every day, how to balance between the growth and profitability. We decided this period right now that we see the demand. Our products are in the leading position. We have a lot of demand to our products. And we decided to, let's say, sacrifice a little bit the profitability in order to capture market share as we are doing. This is also the reason that we increased our guidance. As we see going forward, we'll update the guidance based on this, let's say, formula. So, I think we mentioned what will be the end of this year. Beginning of 2017, we'll provide guidance for the future. I can say, though, that our midterm guidance of 16%, 17% operational profit remains the same.

Mayank Tandon

Okay. And one last question in terms of tax rate. I think you mentioned -- I have 19% non-GAAP tax rate. But, maybe my math is a little bit incorrect. I think you mentioned it was a little bit over 20%. What should we expect for non-GAAP tax rate going forward?

Roni Giladi

The level that we are seeing right now is the level that we should see. I would say 20%, 21%, this is the level that we need to look forward.

Operator

The next question is from Tavy Rosner of Barclays. Please go ahead.

Tavy Rosner

Hi. Everybody -- everything has been answered pretty much. Just a few follow ups on the guidance for the margins. If I do the math, that's roughly 50 basis points coming from your initiative to support growth. Is that the right way to look at it? And is that enough to support your growth initiative in the midterm?

Roni Giladi

So, slightly different, Tavy. This is Roni G. The impact on the profitability is coming -- about 1% is coming from the pound for the next, let's say, Q3 and Q4, and additional, give or take, also 1% coming for initiatives of mainly increasing the delivery, scalability, and resource and to investments on product that Roni mentioned earlier. This is to further build a product suite and be able to do cross-sell and offer more to the market.

Tavy Rosner

Okay. Understood. And then on the -- your acquisition for max capacity, I was wondering about the rationale. You mentioned that gives you a foothold for P&C in the US. So, is it more for the client base in order to get started there, or more for the solution itself? Can you elaborate a little on that?

Roni Al-Dor

Yes, hi. This is Roni Al-Dor. We see Max Processing is a very good solution for tier four, five that we, Sapiens, are not build ourselves for this. So, that acquisition can help us in two areas. One, based on the -- all the analysis and what we did before we acquired them and based on what the PMI that we're doing right now, we feel very high confidence that we continue to grow in US. Second, we are considering to bring Max Processing to the tier four, five out of the US. This is right now just planning. We are not yet there. And the third one is to bring Sapiens IDIT to US for tier two and three, maybe in the future to tier one. And we believe that can help us. In order to knowledge and the amount of people they have, the experience, the delivery experience, there is not a big difference between tier four and tier two. So, in that case, we can use their knowledge, their -- sometimes also some components from their business and to connect to IDIT system.

Tavy Rosner

So, theoretically, their workforce will be able to market IDIT to local customers as well.

Roni Al-Dor

Yes.

Operator

The next question is from Avishai Kantor of Cowen. Please go ahead.

Avishai Kantor

Yes, hi, good morning, everyone. It's Abishy. Thank you so much for taking my question. My first question is -- I understand that you guys have a very long sales cycle. Can you talk a little bit about the rate of adding new logos this year compared to last year?

Roni Giladi

Hi, Abishy. This is Roni G. We do not provide exact number of new logos that are coming year over year. The range is between 10 to 15 new logos year over year. I can say that, based on what we achieved and what is in the pipeline right now, we are in the high range.

Avishai Kantor

Okay. And then going forward, any additional levers that were not discussed in the model that could mitigate the impact on margin?

Roni Giladi

When you mention levers, what do you mean?

Avishai Kantor

Any additional factors that could mitigate the impact on margin, that could help alleviate to expand margin?

Roni Giladi

Yes, as a matter of fact, this is a strategic move from Sapiens. We started late 2014 to look for offshore capabilities. We did two acquisitions during mid-2015 in the India operation and the Poland one. And as we continue, I can say that we are further investing in this capability, in terms of team and management. This will help us to improve profitability, margin going forward.

Avishai Kantor

That's great. Thank you for the color. And then my last question is regarding pricing trends, which are affected in the guidance. I'm not sure if you guys disclosed that, but have pricing trends this year pretty much similar to last year?

Roni Giladi

We do not see any price in customers trend going down or up. We see this the same level. Currently, I do not see any impact or difference.

Operator

[Operator Instructions]. There are no further questions at this time. Before I ask Mr. Al-Dor to go ahead with his closing statement, I would like to remind participants that a replay of this call is scheduled to begin in two hours. In the US, please call 1-888-269-0005. In Israel, please call 039255929. Internationally, please call 972 39255929. Mr. Al-Dor, would you like to make a concluding statement?

Roni Al-Dor

Yes. Thank you to all of the participation for joining us today. Have a good day. Thanks.

Operator

Thank you. This concludes Sapiens International Corporation second quarter 2016 results conference call. Thank you for your participation. You may go ahead and disconnect.

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