Guess? (GES) CEO Victor Herrero on Q3 2017 Results - Earnings Call Transcript

| About: Guess? Inc. (GES)

Guess? Inc. (NYSE:GES)

Q3 2017 Earnings Conference Call

November 30, 2016 4:45 PM ET

Executives

Victor Herrero – Chief Executive Officer

Sandeep Reddy – Chief Financial Officer

Analysts

Randy Konik – Jefferies

Jim House – Piper Jaffray

Alex Pham – Mizuho Securities

Dana Telsey – Telsey Advisory Group

Richard Magnusen – B. Riley & Company

David Buckley – Cowen and Company

Westcott Rochette – Evercore ISI

Bryan Caronia – Wunderlich Securities

Operator

Good day everyone and welcome to the Guess? Third quarter Fiscal 2017 Earnings Conference Call. On the call are Victor Herrero, Chief Executive Officer; and Sandeep Reddy, Chief Financial Officer.

During today’s call, the company will be making forward-looking statements including comments regarding future plans, strategic initiatives, capital allocation and short and long-term financial outlook. The company’s actual results may differ materially from current expectations based on risk factors included in today’s press release and the company’s Quarterly and Annual Reports filed with the SEC.

Now, I would like to turn the call over to Victor Herrero.

Victor Herrero

Good afternoon, everyone. As you saw in our earnings release today, we reported that our third quarter earnings per share finished at the low-end of our guidance. While we recognize the challenges we are facing in the Americas, I am excited to share with you the progress of our initiatives in Europe, Asia, and the Americas consistent with what we saw in the second quarter our international business, which accounts for more than 60% of our sales where we are allocating the majority of our capital investment, continue to outperform our domestic business in the third quarter.

In Europe, revenues in the quarter grew 16% in U.S. dollar and 17% in constant currency and retail comps were up in the mid single-digit in constant currency. All these growth has been driven by new stores, higher traffic, higher conversion and a better product offering. Our European e-commerce business continues to grow significantly and consistently. As a result of this rapid growth, we expect that by the end of this year, the penetration of e-commerce in Europe will be similar to the Americas as a percentage of retail sales.

On the European wholesale business, we have just closed the Spring Summer 2017 book and finished up 1%, marking the second consecutive season of growth now in the wholesale business. During the quarter, we opened 26 directly operated stores in Europe bringing the total net openings for the year so far to 41 and staying on course for our updated store opening plan of 55 stores for the year. We added new stores to our fleet in Italy, France, Belgium, Spain, Portugal, Switzerland, Turkey, Finland, the United Kingdom, Russia and Poland.

Most importantly, the operating margins of the European segment expanded 220 basis points in the quarter, continuing the sequential improvement in profitability that we have seen whole year as we start delivering the returns on our increased allocated capital to the region. In summary, we are executing well in Europe. I am thrilled with the results of our initiatives there and we will continue to allocate capital there for as long as the result continues to be good.

Moving to Asia, third quarter revenues were up 10% in U.S. dollar and up 6% in constant currency. Revenue growth was driven by a store opening and positive comps in greater China. Trends improved in Mainland China relative to the first half while Hong Kong and Macau remain challenging with a continuing drop in tourist traffic. During the quarter, we opened 14 stores on a net basis across Asia. Specifically in China, we opened stores in Shanghai and Beijing; and in addition opened stores in the south in Shenzhen and Quanzhou, in the southwest in Changsha and Guiyang, in the east in Xiamen and Nanjing and in the northeast in Harbin.

So far this year, we opened 41 stores in Asia and we are on track to open 65 directly operated stores on a net basis this year, mostly in Greater China. In summary, although our growth in Asia is a little slower than I would like, we are growing nicely in our great market and with our powerful brand. Moving to the Americas Retail, which includes the U.S., Canada, Mexico and Brazil revenues for the quarter decreased 5% in U.S. dollars and in constant currency.

Both revenue and comps finished near the low-end of our guidance for the Americas Retail segments with the G by Guess concept being our best performing concept and comping positive. When we see our performance in North America, it is very important to note that the number of units sold is flat to last year. So the reduction in revenue is not due to selling less products rather it is due to lower average unit prices caused by unexpected warm weather and to more promotional driven customers in North America.

While we are doing well in Europe and Asia, we are continuing to strengthen our laser focus to improving the profitability of the Americas retail segments; specifically we are executing the following four point plan. Number one, rent reduction. We have already renegotiated 32 leases and we have identified 29 additional leases for renegotiation for a total estimated cash savings of US$9 million per year. Number two is store closures. Since the beginning of last year, we have already closed 52 stores including 14 stores so far this year.

We have identified 50 additional stores that we plan to close through the end of next year unless we can obtain rent reductions to make them profitable. The improving to operating income from these store closure should be approximately $11 million per year. Number three, supply chain. We are executing our supply chain initiatives to drive IMU or product cost improvements, specifically we are developing a sourcing network in new territories like Bangladesh that can offer better cost without compromising quality.

We are consolidating and building a strategic partnership with high quality suppliers to get the scale efficiency and we are implementing a fabric platforming process utilizing common fabrics across multiple style. Number four North America digital strategy. We are launching our digital first campaign, which is enhancing our company’s digital experience in order to help set ourselves apart from other retailers and truly reestablish Guess? as a top brand in North America.

The digital experience includes the following measures: creating interaction between retail, wholesale and e-commerce, improving CRM, focus on unified loyalty programs, emphasizing use of email and social media, creating more innovative user experience, enhancing mobile technology to drive customers to the store through our e-commerce platform or online to offline capabilities.

In summary, I am thrilled that we are coming to the end of our transition year, the year that we built a strong infrastructure in Europe and in Asia and the year that we launch the four initiatives to improve profitability in North America. This is preciously why I am very excited about the coming fiscal year. Sandeep?

Sandeep Reddy

Thank you, Victor, and good afternoon. During this conference call, our comments may reference certain non-GAAP measures. Please refer to today's earnings release for GAAP reconciliations or descriptions of such measures.

Before I get into a more detailed discussion on our results, I would like to highlight that we saw sequential improvement on our P&L in the third quarter relative to the second quarter continuing the improving trend since the first quarter. Revenues moved from flat in the second quarter to being up 3% and our operating margin GAAP improved from a 190 basis point decline in the second quarter to 120 basis point decline. Third quarter revenues were $536 million, up 3% in the U.S. dollars and constant currency versus prior year. Total company gross margin decreased 170 basis points to 33.6% due to the negative impact of markdowns currency and occupancy deleverage in the Americas.

SG&A as a percentage of sales decreased by 50 basis points versus prior year due to cost savings from the global cost reduction plan, lower performance based compensation expense partially offset by build out of our infrastructure in China. Operating income for the third quarter was $15 million. Operating margin finished down 120 basis points at 2.8% including the negative impact of foreign currency of roughly 40 basis points. Please refer to our press release from today for additional information on operating margins by segments.

Our third quarter tax rate were 38% roughly flat with the prior year’s third quarter. Diluted earnings per share finished with a low end of our guidance at $0.11 and this compares to a diluted earnings per share of $0.15 in last year’s third quarter. The net impact of currency on earnings per share in the quarter was minimum. Moving on to the balance sheet, accounts receivable was up 11% in U.S. dollars and 12% in constant currency as we experienced a shift in timing of receipts of non-trade receivables.

Inventories were $428 million, up 15% in U.S. dollars and constant currency versus last year. The increase is driven by timing of receipts, inventory for international new stores, and our build up of inventory in the U.S. and Canada that we expect to be sold through – during the remainder of the year either in market or redeployed to other markets around the globe.

Free cash flow was an outflow of $98 million compared to an inflow of $24 million in the prior year, a decrease of $122 million. This decrease was driven by changes in working capital, lower earnings and increased capital expenditures. We ended the quarter with cash and cash equivalence of $349 million compared to last year’s $402 million, including $35 million related to the sale of our minority interest investment that I discussed last quarter. Cashless debt at the end of the third quarter was $325 million compared to $396 million last year.

Moving on to the guidance, I should point out that our outlook for the fourth quarter of fiscal 2017 and the full fiscal year 2017 excludes any restructuring cost associated with the global cost reduction plan. Also guidance for revenues and comp sales by segment is included in a supplemental table attached to our press release.

Our previous full-year guidance assumed better comps and gross margins in the Americas Retail segment for the fourth quarter that we are now expecting based on our third quarter results and trend so far in the fourth quarter. This is the main driver of the change in company guidance.

In Europe, we expect to continue seeing strong growth in the fourth quarter fuelled by positive comps in our Retail business, revenues generated from new stores, as well as growth in our wholesale order book. In Asia, we expect the revenues for the fourth quarter to benefit from the new stores that we are opening in China as well as positive comps from existing stores there.

I want to update you on our licensing business that as you know is an important part of our profitability. Trends had been soft based on the results of our licensee partners and we are projecting to be down in the low-double digits for the year.

However, as we have said previously, our licensee partners are long-term strategic partners and we have signed multi-year contract renewals with our handbags, watches and footwear partners in the past year that we are very pleased with. Together with our licensee partners, we look forward to returning our licensee businesses to grow on a consistent basis going forward after we ride out this current downturn.

Considering all these factors for the fourth quarter of fiscal 2017 guidance for the company, we expect revenues for the quarter to be up between 4% and 8% in constant currency, driven by expected growth in Europe and China, partially offset by an expected decline in the Americas.

At prevailing exchange rates, we estimate that currency will be a roughly half of a percentage point headwind on consolidated revenue growth for the quarter. While we are pleased our supply chain initiatives have fuelled IMU improvement, as we clear through the inventory build up in the Americas over the holidays, we expect short-term pressure on gross margin. Importantly, we are taking necessary actions with the goal of bringing inventory more in line with forward sales by the end of the year.

The SG&A rate is expected to be up compared to last year, primarily as we are expecting to deleverage of the Americas due to lower comp expectations. We are planning an operating margin for the quarter between 7.5% and 9.5%.

Earnings per share for the quarter is planned in the range of $0.40 per share to $0.50 per share. The negative impact of currency on earnings per share in the quarter based on prevailing rates is expected to be a penny.

We expect consolidated revenues for the year to be up between 1% and 2% in constant currency. At prevailing exchange rates, we estimate that currency will be roughly half of a percentage point headwind on consolidated revenue growth for the year.

For the full-year, we expect gross margins to be down as our improved IMUs will be more than offset by foreign currency headwinds and higher mark downs in the Americas The SG&A rate is expected to be up for the year due to deleverage in the Americas business and investments in the built out of our China infrastructure partially offset by over $10 million of savings, driven by our global cost reduction plan.

We have updated our expectation on the adjusted full-year tax rate from 40% to 42%, due to a geographic shift to the jurisdictions where our profits are generated. We are planning an adjusted operating margin between 3% and 3.5% including the impact of a currency headwind of roughly 60 basis points and our guidance assumes foreign currencies remain roughly at prevailing rates.

Adjusted earnings per share is planned in the range of $0.42 per share and $0.52 per share. The earnings per share guidance includes a currency headwind of roughly $0.14 per share.

CapEx for the year is expected to range from $90 million to $95 million. The Board of Directors has approved a quarterly dividend of $0.225 per share payable to shareholders of record at the close of business on December 14, 2016.

In conclusion, we are pleased with the sequential improvement in financial performance we saw in the third quarter, and are expecting the improvement in our international business to continue through the remainder of the year, while we pursue the initiatives Victor talked about to improve our Americas retail business profitability.

Longer term, we remain committed to the 7.5% operating margin goal we communicated at the beginning of this year.

With that, I will conclude the company’s remarks and open the call up for your questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Randy Konik from Jefferies. Please go ahead.

Randy Konik

Hey, how are you? Sandeep, I have a quick question on the – just to get some more color around the licensing business, it seems like you have good long-term confidence in the business. It seems like there are some difficulties in the near term. Can you give us a little bit more flavour about what we should expect out of that piece of the company and when we should see stabilization in that in that area? Thanks.

Sandeep Reddy

Hi, Randy, it’s Sandeep. So I think on the licensing business what’s really important is we've actually been talking about softness in general especially with our watch licensee and that's been really a category specific thing that impacted us. But broadly I think across all the different categories we've seen general softness this year. But I think the really important thing over here is the signing of these renewals indicates that we're really committed to what we've been saying. These are long-term partnerships that we’ve engaged in, we continue to view them as long-term partners and this is the current downturn. But once we get past this current downturn, we fully intend to actually return the business to where it used to be in the past, but it's going to be – for this, a wait and see approach in terms of when the trends start.

Randy Konik

Can I ask one more question?

Sandeep Reddy

Sure.

Randy Konik

Just the disparity between the Europe business and the U.S. business like what can you give us some perspective on call outs from a product, gender perspective or pricing versus transaction versus conversion? Just kind of curious about the differences between the two regions, it seems like Europe is pretty solid.

Victor Herrero

Hi, Randy, this is Victor. Basically I would say that I mean the main difference between one and the other business or let's say between Europe, Asia and North America is a little bit – the promotional cadence of basically that we are seeing as – in general in North America. So this promotional cadence is affecting us a lot in terms of results whereas in Europe, as I mentioned in previous calls, we are having only a seasonal promotions and same in China. So in the U.S. everyone is more or less on a constant promotion and this basically is affecting our results.

Randy Konik

Got it. It’s very helpful. Thanks guys.

Sandeep Reddy

Thanks.

Operator

Our next question comes from Erinn Murphy from Piper Jaffray. Please go ahead.

Jim House

Hi, this is Jim House on for Erinn Murphy. I have two questions, the first being with the order book for spring and summer 2017 a positive one. You talked about how Northern versus Southern Europe looked. And what were the key regional differences in this growth?

Sandeep Reddy

All right. It’s Sandeep. I think in terms of the order book of plus 1% that we talked about. We definitely saw good stabilization across the entire portfolio and nothing specific to call out in terms of regional differences. So we’re broadly happy and it’s consistent with the trend we saw in the Fall/Winter book of last year.

Victor Herrero

In general our story in Europe is a success story. The good thing is that we don't have kind of different sensation between markets in terms of a positive comps for all the markets. No, I mean, we don't have markets with negative comps and some other markets with positive comps more or less, all the markets are aligned. And even the new markets that we are opening in Europe are quite steady and solid in terms of performance.

Jim House

Okay. And going on for the regional comment from a macro perspective with the referendum vote related for December 4 in Italy, can you talk about how that region may be trending, and if you've seen any volatility there?

Victor Herrero

No. Without any doubt we don't see any volatility. I mean, basically what we saw when we saw the Brexit results is basically that we – didn’t affect us at all and it’s still not affecting us at all. So basically all these referendum or all these kind of a situations in Europe so far is not affecting the other [indiscernible] sometimes is even – sometimes is more positive than negative.

Jim House

Thank you.

Operator

Our next question comes from Betty Chen from Mizuho Securities. Please go ahead.

Alex Pham

Hi there, it’s Alex on for Betty. Thanks for taking our question. I was wondering if you could talk a little bit about Asia, obviously challenging in Hong Kong and Macau, but any color on how you could – how big the China business is currently and maybe when we can see the growth in that portion of the business become a larger driver and maybe improve sales growth? Thanks.

Victor Herrero

Hi, Alex, this is Victor. The most important thing that I want to share with you about the China is that we are very, very happy because I think we create a very strong infrastructure for the future there. And I think we still have the right persons or the right people to develop the business. And we've been a positive comp for the last two quarters and basically we are very happy on the way we are developing things in China.

Only for your reference, our results on the Singles they were very positive comparing with the previous year. And one of the reason is because we have a very close relationship with our partners there like Timol, which belongs to Alibaba and that’s a close relationship we were interacting very well with there and we were having very good results.

Operator

Thank you. And our next question comes from Dana Telsey from Telsey Advisory Group. Please go ahead.

Dana Telsey

Good afternoon, everyone. As you think about the categories of merchandise that you are having in the Americas, how do you plan to move through as we go through the holidays, is there flexibility to potentially move to other regions, what is the process and timeframe look like? Thank you.

Sandeep Reddy

Hi Dana, it's Sandeep.

Dana Telsey

Hi.

Sandeep Reddy

So Dana, I think we said it last quarter as well and I repeated again this quarter. I think where we are from an inventory perspective as we're looking at it on a very global basis. And the good news for us is especially international markets in the Europe and Asia, we’re opening up a number of stores where there is a quite a lot of open to buy to fund the inventory need to theirstores. So we are redeploying some of the inventories to what those markets for those new store openings.

And at the same time I think in the U.S. and Canada, we’ve actually been looking at ways and which we can actually move through the inventory specifically in the fourth quarter, some of the inventories in-stores and I wouldn’t call out any specific categories are little bit heavier than we would like. And so we need to be a bit more promotional to get through this before the end of the holidays.

Dana Telsey

And as you think about inventory levels going into next year, how you are planning them? How are you planning inventories? What is the order book looking like? Thank you.

Sandeep Reddy

Yes. I think from an inventory perspective, we always look to manage our inventories more in line with forward sales. And keep in mind that the store opening plans we have especially internationally, we are going to have a lot of growth required from an inventory perspective to fund those stores, but the principle were still be applied to make sure that we aligned with forward sales.

Dana Telsey

Thank you.

Sandeep Reddy

Thanks.

Operator

[Operator Instructions] Our next question comes from Jeff Van Sinderen from B. Riley & Company. Please go ahead.

Richard Magnusen

Hello, this is Richard Magnusen in for Jeff Van Sinderen. Thank you for taking our call. Could you break out any weather related trends per region in North America or Europe in some detail? And then if you notice any change those trends in the current quarters the end of Q3, could you note those as well.

Sandeep Reddy

Yes. I think from a weather perspective as you heard, Victor said during the prepared remarks September was a warm month and it really affected AURs as because of consumers basically trading into lighter materials lower price raw materials. So that definitely impacted us in a little bit into October as well in North America.

Moving to Europe I think it was a similar situation over there as well it was unusually warm September and as temperature has cooled in October things got better. But for sure there was definitely an impact weather in all regions in which we actually participate in the Americas and Europe.

Richard Magnusen

Okay. And could you comment on how you are just a European inventory and your stores looks now and then maybe comment if you can and how the retail inventory for the industry looks overall in Europe.

Sandeep Reddy

I think our inventory looks in great shape in Europe. We are very pleased with where we are. And then frankly I think with the strategy that we’ve actually just talked about and how we are redeploying inventory around the globe. We are in very good shape in terms of having fresh inventory all the time.

Richard Magnusen

Okay. And then its looks like your e-commerce year-over-year for the quarter was up little over 2% and then you – in the call that you outlined your strategy and campaign for e-commerce growth. And I was wondering if you could provide anymore color on specific targets that you have – now that you have a new campaign and new strategy underway.

Victor Herrero

We don’t have any, this is Victor, Richard. We don’t have any kind of – we can tell you basically that I mean, we have kind of a digital first campaign at this moment as I mentioned on my script. And basically what we are trying to do is unify a little bit all our loyalty programs in order to be much more effective and trying to find a more synergies in the CRM program that we have. Also we are trying to experiencing as much as possible our relationship with our pharmacy marketplace. And also what we are trying to do is to be as innovative and creative as possible in order to be best in class in all the things related with e-commerce activities.

Operator

Thank you. And our next question comes from John Kernan from Cowen and Company. Please go ahead.

David Buckley

Hi guys, this is David Buckley on for John Kernan. Thanks for taking our questions this evening. I was just hoping you guys could speak to some of the factory outlet trends that you saw in Q3 specifically in the Americas if there is any material improvement from the prior two quarters and year-over-year.

Sandeep Reddy

Hi David, it's Sandeep. I think from the factory outlet perspective, we saw relative consistent trends between Q2 and Q3. So I think there is – we would same impact that are there in the industry are there for us as well in terms of mall traffic in general and the factory outlets, but we didn’t see a huge change.

David Buckley

Okay, thanks, Sandeep. And then just on the order book growth in Europe, congratulations on that, but is there any material differences between the men’s and women’s business from the Spring/Summer order book.

Sandeep Reddy

Not really and I think it was pretty consistent across the entire, all the categories, not just men’s and women’s accessories as well, all of it.

Victor Herrero

What is important at this moment I want to share with you as well is the consistency in product. What I was saying on my last analyst call is that basically we are going to try to create a very comprehensive collection where we are trying to capture all the trends in the market. For example, if you ask me what is going to happen in Spring/Summer 2017, I would let you know that is much more is going to be a kind of very basic collection. I think basic is going to be much more important than the fashionable items, but a basic we have touch of fashion. So I think this is the most important, I think more than we will try to have a very strong men’s collection, a very strong ladies collection and very strong accessory collection.

David Buckley

That’s helpful. Thanks guys and best of luck during the holidays.

Sandeep Reddy

Thank you, David.

Operator

And our next question comes from Omar Saad from Evercore ISI. Please go ahead.

Westcott Rochette

Hi guys, this is Westcott on for Omar. So on G by Guess, so did I hear correctly that there was a positive comp in the quarter?

Sandeep Reddy

It is.

Westcott Rochette

Okay. And so when you think about like, I know one point there was a – you want to emphasis kind of G by Guess and it sounds like that’s resonating a little bit more than the kind of core Guess? As you look at your store base and you look at your rent, is there – one, is there an idea to shift some of those Guess? towards to G by Guess and to emphasize that concept? And on top of that if you could just maybe think about or help us understand why you think G by Guess is resonating, is it a value, is it's a design different, is it a communication difference. Why do you think there is a difference in the response to G by Guess versus your regular Guess? Thank you very much.

Sandeep Reddy

Yes, Westcott so I think on G by Guess, it's certainly a concept that we are very happy with and it actually has a number of attributes that are very favorable to it in the space and which it operates. Now first of all, it's certainly a value proposition to the customer and then the more than which we are located which is primarily B and C malls, I think we actually perform very well. And the second is from a gender perspective, it’s a concept where we have 50/50 men’s and women’s and that’s also quite unique and way differentiated from the rest of our concepts.

And so between those two things I think we are resonating very well with the customers in the first part of the year, first nine months of the year. And I think what we see is the numbers of units that customers are buying on the G by Guess concept has been very strong. And we are very pleased with that as we've gone through. But in terms of what we want to do with repurposing real estate, I don’t think that really does make much sense, because the Guess? concept is typically more in A malls and the G by Guess really belongs more in the B and C mall. So the real estate is really can’t be swapped between the two concepts.

Victor Herrero

On a position a point of view basically I think Guess? is much more an aspirational brand where as G by Guess is much more fashion brand. So I mean it’s a completely different concept with a different customer target and basically they are working and they are navigating in a different base.

Westcott Rochette

Okay. Thank you very much guys, good luck.

Sandeep Reddy

Thank you.

Operator

[Operator Instructions] Our next question comes from Bryan Caronia from Wunderlich Securities. Please go ahead.

Bryan Caronia

Yes. Good morning – good afternoon, excuse me, everyone. We were curious to – I'm sure you discuss in terms of any dispersion you saw in terms of sales performance across product lines particularly in the U.S. market, but even overarchingly any products that you saw perform well as well as those might have underperformed in terms of the third quarter performance.

Sandeep Reddy

Bryan, it's Sandeep. I think if you go back to what Victor said earlier, I mean we are really focused on the total outfit approach in terms of the way we are selling our line to the customers. So it's not surely about a specific product category, it's about how the whole thing comes together by using complementary pieces across the different product categories to create an outfit. And that’s really what our focus is and that’s really how we want to emphasis where we are going.

Bryan Caronia

Okay, fair enough. And then if I guess I could add one follow-up in terms of the domestic marketplace specifically obviously you are discussing a lot in terms of uniform performance. But did you see any dispersion whether that was weather driven or just fashion trends in terms of the different geographies domestically.

Sandeep Reddy

I think we didn’t see a huge amount of dispersion across the different geographies domestically, I think what ended up happening was the warm weather impacted almost all of the regions more or less equally and so that impacted us everywhere.

Victor Herrero

In a way I want to share one thing with you guys is that basically we need to have transition at product during the summer month or let’s say August, September and October and we have to have much more summary product on during January February and March. You really need to have much more win theri product, it means outwear and knits and sweaters and all these things. Because it's very – right now I think the weather is changing a little bit and the season is still there. So I mean whenever we present the collection the Spring/Summer collection is January or February, we don’t have time seasonal product there. I think we are losing our commercial opportunity of selling out with at that time.

So you have to be a still quite heavy on outwear, on sweaters during those three months and the same the other way around during August, September and October where we can see every season that there is a unexpected warm weather but it's basically because of the much of the collection.

Bryan Caronia

Thank you.

Operator

Thank you. Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating and you may now disconnect.

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