iGATE Corp. Q1 2008 Earnings Call Transcript

May. 9.08 | About: iGATE Corporation (IGTE)

iGATE Corp. (NASDAQ:IGTE)

Q1 2008 Earnings Call

April 18 2008 8:00 am ET

Executives

Salil Ravindran - Director of IR

Phaneesh Murthy - President, CEO and Director

Ramachandran Natesan - CFO

Hari Murthy - Chief Sales Officer

Analysts

Jon Maietta - Needham & Company

Brian Kinstlinger - Sidoti & Company

Vincent Colicchio - Noble Financial

Operator

Good evening, ladies and gentlemen, I am Rita, the moderator for this conference. Welcome to the iGate Corporation's Q1 2008 Earnings Call.

For the duration of the presentation, all participant lines will be in a listen-only mode. After the presentation, the question-and-answer session will be conducted for participants connected to WebEx International. After that, the question-and-answer session will be conducted for participants connected to India. I would like to remind all of you that this conference is being recorded. It is now my pleasure to introduce your host, Mr. Salil Ravindran, Director of Investor Relations for iGate.

I would now like to hand over the floor to Mr. Ravindran. Thank you, and over to you, sir.

Salil Ravindran

Thank you, Rita. Good morning, everyone. And welcome to the first-quarter 2008 earnings call of iGate. With me on the call today are Phaneesh Murthy, President and Chief Executive Officer of iGate, Ramachandran Natesan, iGate's Chief Financial Officer, Steve Shangold, Chief Executive Officer of iGate Professional Services, Hari Murthy, Chief Sales Officer, Sean Narayanan, Chief Delivery Officer, and Sumit Ganguli, Head of Consulting and Intellectual Property Rights.

This call is being webcast and a replay of this call will be available within a few hours. Our earnings release, which had been forwarded to all of you, is now posted on our Web site.

I would like to remind everyone that statements made during this call that are not historical facts are forward-looking statements. These forward-looking statements include our financial growth and liquidity positions, as well as statements about our plans, strategies, intentions or beliefs concerning our business, cash flow, costs and the markets in which we operate. Without limiting the foregoing, the words believes, anticipates, plans, expects and similar expressions are intended to identify certain forward-looking statements. These statements are based on information currently available to us and we assume no obligation to update these statements as circumstances change.

There are risks and uncertainties that could cause actual events to differ materially from these forward-looking statements, including those registered in the cautionary language at the end of our news release, some of which are beyond our control. As a reminder, we will not discuss further guidance during the quarter in one-on-one meetings or calls and we have no intention at this time of updating our guidance as circumstances change.

I will now turn the call over to Phaneesh.

Phaneesh Murthy

Thank you, Salil. Good morning to all of you in North America and good evening in different parts of the world. It gives me great pleasure to report a fairly strong quarter from an earnings point of view. I think we had a very strong increase in earnings per share. We had an earnings per share of $0.13, an increase of 46% from the previous quarter, and an increase of 57% from the corresponding quarter last year.

On the iGATE Solution segment, the revenue from operations were at 54.9%, an increase of 4% sequentially and 15% year-on-year. The sequential growth was slightly lesser than what we had anticipated because some of our top customers have ramped up or are ramping up significantly and they are expected to cross the threshold for higher volume discounts and in anticipation we have provided for the discounts at higher rates from this quarter. The revenues are therefore slightly depressed as the higher discounts are shown as a reduction from revenue as per U.S. GAAP.

We also had a positive quarter from the number of new customers added. For the fourth time in a long, long time we went up adding seven new customers during the quarter and the other big news of the quarter, of course, is the fact that because the divestiture of the iGATE Professional Services segment, the Mastech Professional Services segment is looking like a spin-off more than a sale. We cannot treat it as discontinued operations as maybe we were anticipating and consequently, we have continued to report it as continuing operations of iGate. We added 307 net employees in the iGATE Solution segment, taking the total to 6,566 as of March 31, 2008.

I think the other strong positive note is the fact that we're adding a number of new iTOPS customers and we anticipate that our iTOPS revenues will start growing in future quarters, which should have both, a positive revenue and an improved margin impact for our business going forward.

As a quick reminder and I think most of you know this already, as a quick reminder, the April, May, June quarter is traditionally the biggest quarter by way of margins because of the fact that we do our salary increases. This year we have done a rough 12% salary increase, including some corrections in India and roughly 2% in the U.S. This is going to impact our growth in net margins downwards in the quarter April, May, June.

Overall, I think the environment in the U.S. continues to be a little uncertain. We do not see, in many of our customers, we have not seen any signs of concern on the economy. On the other hand, we actually have been impacted in one or two places. Bear Stearns was a customer of ours and with the Bear Stearns acquisition by JPMorgan Chase, some of the work that we were doing for Bear Stearns is going away. We also had one more project cancellation. So I think while the overall environment doesn't look too troubling, there are these one or two pockets where I think we've had a little bit of challenge.

If the U.S. actually does become negative growth and the extra $200 billion or $250 billion of charges in the financial services segment, which everybody is still talking about which still needs to be taken results in more companies going out of business. We just have to hope that it's not one of our companies that we're doing business with.

So all in all, I will summarize by saying, strong quarter with increased number of client additions, so seven new client wins, strong quarter with very good margins, dramatic increase in gross margins of iGATE Solution segment and on the revenue line we had a decent increase but because of the fact that we are anticipating that some of our top customers which have started ramping up significantly are expected to cross the threshold for higher volume discounts, we have to take it out from revenue, the discounts are out from revenue as per U.S. GAAP.

And, going to request, and then on the Professional Services, on the Mastech Professional Services side, revenues for the quarter declined a shade to $24.9 million compared to $27 million in the same period last year and $26 million in the previous quarter. The gross profit margin was at 20% compared to 23% in the corresponding quarter last year and 30% in the previous quarter. Operating income declined to $1.3 million from $2.2 million in the same period last year and $1.4 million in the previous quarter. The operating margins stand with 5% of revenue.

So with this, I'm going to request Ram, our Chief Financial Officer, to take you through the detailed financial highlights and then we will open up for questions and answers. Thank you.

Ramachandran Natesan

Thank you, Phaneesh. Good morning, everyone, and good evening for those who are in India. I will take this opportunity to briefly discuss with you the key highlights. But before I do that, just repeating a couple of corporate level developments, as you may be aware, we announced earlier during the quarter our plan to divest Professional Services business. Presently, it looks more likely that this divestiture will take the form of a spin-off rather than a sale. Consequently, the Professional Services segment is still being reported as continuing operations, as required under the U.S. GAAP because of the likely event of a spin-off that may happen. We also announced our plan to sell the clinical research business. The results of the clinical research business have been reported as discontinued operations in the quarter. the figures for the previous periods of the clinical research business have been reclassified accordingly.

Let me now take you through the financial highlights. The first quarter of 2008 has been a reasonably satisfying quarter on both the revenue and margin fronts. Consolidated revenues were $79.8 million compared to $74.9 million in the corresponding quarter and $78.9 million in the previous quarter, a growth of 7% year-on-year and 1% sequentially. While the iGATE Global segment grew 15% from the corresponding quarter last year and 4% sequentially, iPS, that is the Professional Services segment, declined 8% from the last year and 4% sequentially. The improvement in revenue of iGate Global segment was due to increase in the number of customers added, ramp-ups from existing customers and improved bill dates. However, the revenue for the quarter for iGATE Global segment was impacted by more than 1% due to certain large customers coming into a higher bracket of volume discount.

We continue to focus on efficiency and management, which resulted in an increase in our gross profit which was higher by 18% at $25.3 million from corresponding quarter. And the gross margin improved more than 300 basis points to 32% from 29% in the same period last year. iGATE Global witnessed a significant increase in gross margin to 37% from 32% in the corresponding quarter last year and from 35% in the previous quarter. The improvement in margin of iGATE Global Solutions is due to increase in the contribution from higher-margin customers, improved average realizations, and reduction in attrition rates.

Selling and General Administrative expenses for the quarter was $18.8 million, as compared to $16.9 million in the first quarter of last year and $17.9 million in the preceding quarter. The depreciation and amortization expense for the quarter was $2.9 million. Selling and General Administrative expenses has remained flat at 23% of the revenue compared to 23% in the corresponding quarter and in the previous quarter.

Operating income improved significantly to $6.5 million from $4.6 million in the same period last year and $4.9 million in the previous quarter. Operating margin was 8% of revenue compared to 6% in the corresponding quarter and in the last quarter. Net income increased by 71% to $7.4 million or $0.13 per diluted share, compared to net income of $4.3 million or $0.08 per diluted share in the same period last year and $4.9 million or $0.09 per diluted share in the previous quarter.

The net profit margin improved 9% from 6% in the same quarter last year and in the previous quarter. Net cash flow from operations for the quarter was $7.3 million. The capital expenditure at the end of the quarter was $2.4 million. Our company continues to maintain a very strong balance sheet. At the end of the quarter, we had $56.5 million in cash and short-term investments and no outstanding borrowing or debts.

The DSOs were 66 days at the end of March 2008, compared to 61 days at the end of the previous quarter. Our largest customer accounted for 17% of the first-quarter revenues and our top five customers accounted for approximately 43% of our revenues. At the end of the quarter, our worldwide headcount was 7,317 people.

In the quarter, we again repurchased about 1.6 million shares for $16.9 million of our subsidiary, iGATE Global Solutions, as a part of delisting it from Indian stock exchanges. Since the announcement of our intention to delist iGATE Global Solutions in October 2007, we have purchased a total of 5.6 million shares for $58 million, increasing iGATE's total shareholding in the subsidiary to 98.2%.

That's all that I have in the highlights. I would now turn the call back to Salil.

Salil Ravindran

Thanks, Ram. We will now throw open the floor for questions. Rita?

Questions-and-Answers Session

Operator

Thank you very much, sir. At this moment, I would like to hand over the proceedings to WebEx International moderator to conduct the Q&A session for participants connected to WebEx International. After this, we will have a question-and-answer session for participants connected to India. Thank you, and over to you, Laurie.

Operator

Thank you, Rita. We will now begin the Q&A session for participants connected to the WebEx International bridge. (Operator Instructions). Your first question comes from the line of Jon Maietta of Needham & Company.

Jon Maietta - Needham & Company

Hey. Thanks very much. The first question I had, Ram, maybe if you could help me think about the earnings contribution from the iGS business, if I wanted to think about that as a stand-alone.

Phaneesh Murthy

The earnings contribution, this is Phaneesh. Hi, Jon.

Jon Maietta - Needham & Company

Hi, Phaneesh.

Phaneesh Murthy

Good morning. I think the contribution is $0.11 and $0.02. $0.11 from the Solutions business and $0.02 from the starting business.

Jon Maietta - Needham & Company

Okay, good. That's what I had.

Phaneesh Murthy

(Technical difficulty)

Jon Maietta - Needham & Company

Okay. Then the second question I had, Phaneesh, as we look across this fiscal year, should we see gross margins in the second half of the year get back to the 37% range or potentially even above that 30% range that we had this quarter?

Phaneesh Murthy

I think our philosophy, Jon, has been that, until we reach the industry best-in-class kind of gross margins, corresponding quarters compared to the previous year, we are striving for higher gross margin. And right now, I think that's all I can say. We do know for a fact that it will dip this quarter, both in the gross and the net margin level because of the seasonality factor because of the payroll. But otherwise I think, Jon, our goal is to make sure that, compared to the previous year same quarter, our margins are higher.

Jon Maietta - Needham & Company

Okay, great. And then just the last question I had, and either Phaneesh or Hari perhaps, maybe if you could give me one or two examples as to a typical conversation that you're having with customers in the field today, given the soft economy here in the U.S., how are folks thinking about reducing expenses and potentially moving work offshore?

Phaneesh Murthy

I will take the first shot and then I will request Hari to add to it. At the broadest level, Jon, I think what we are finding is where the relationships are stable and working really well, it's easy to start expanding on those relationships in an environment like this. So for example, some of our customers like RBC, etc., Union Bank of California, those kinds where the relations have been there for some time are stable.

We are finding significant ramp ups are likely or significant ramp ups this year and the next year because of the slowing economy. On the other hand, where the customers are very new or have just started, I think there is a little more uncertainty in whether there will be ramp-up or not, and so on and so forth. Hari, you can add.

Hari Murthy

Yes, it will now come back but until we are seeing a lot of our customers who have been customers of ours for quite some time at a certain rate of engagement, if definitely finding many more new conversations about things that were never on the table, driven by their need to manage costs much more aggressively. And these are customers from the manufacturing, financial services and as well as retail and real estate, pretty much across the board. We are also finding new initiatives coming on by way of prospects who have got into the game, who were late adopting offshore, I think there is definitely a trend towards seeking out income based pricing and risk sharing and those kinds of deals that have been put out. At least it feels like it is underway and we still need to fear that some of these will happen but the sales cycles are underway.

So we definitely see a changed market dynamic, and not all of it is negative. We think it is net positive and we are seeking to, that's where our iTOPS model is actually playing out really well, where we are able to propose taking cost structures out for our customers, our complete cost structures of larger IT costs out, or operations costs out, but the complete cost structure of the whole processes and we see that happening. Its resulted in a couple of sales which are done in this past quarter, I think that trend is going to continue.

Jon Maietta - Needham & Company

Okay, thank you very much.

Operator

Your next question comes from the line of Brian Kinstlinger of Sidoti & Company.

Brian Kinstlinger - Sidoti & Company

Yeah. Hi, good morning.

Phaneesh Murthy

Hi, Brian.

Brian Kinstlinger - Sidoti & Company

Well, good evening to you guys. The first question I wanted to ask was related to the volume that you're talking about the differences, and so it impacted you 1% this quarter. Will that impact you again next quarter? Because once you hit those volume thresholds, you don't have a tougher quarter-on-quarter comparison, so how many quarters might this impact you from a revenue standpoint, from a comparison standpoint?

Hari Murthy

Not really because as we go on, we expect these customers to ramp up, so therefore, we will deliver higher-level revenues and it would not have this kind of an impact. It's only in the beginning that the impact is trended the most.

Brian Kinstlinger - Sidoti & Company

Of course. So what I'm asking is, have all of those companies that you expect this year to hit that threshold that have already hit it in the first quarter? Or do you expect a couple more in the second or the third to hit it, which also might slow sequential revenue growth?

Phaneesh Murthy

No, I think the customers with which we have volume discount agreements, based on the ramp ups that they have projected, we have anticipated at the higher level and provided at the higher level, and that actually takes away from revenue under U.S. GAAP.

Brian Kinstlinger - Sidoti & Company

Right, of course. So everyone has already hit that threshold that's going to hit it this year?

Phaneesh Murthy

The ones that are, we, yes, the ones that we have volume discounts with, yes.

Brian Kinstlinger - Sidoti & Company

Okay. So you gave volume discounts, yet your gross margin you think might go down a little bit on that, at least temporarily, and they didn't, so we don't get that same threshold as you used to with utilization and all that. So can you give us sort of the utilization and bill rates and maybe that will help us distinguish why gross margins went up so much?

Phaneesh Murthy

I didn’t get that much time. I think we did well on gross margins, no question. I think we have two or three reasons for it. Utilization has not gone up; it's been roughly stable. Bill rates have gone up marginally. And keeping is, the bill rates have gone up marginally because of higher value services which we have been offering, and that's the large chunk of the gain. So I think it's really coming partly as bill rates.

And the other thing is we have been also managing our average, our attrition came down dramatically last quarter, so that helped them out, too. And also, we've been managing our average cost per employee to be relatively stable, so essentially what we've been doing is that we've been expanding the pyramid in which we've been working. So if you look at it over the last few years, we've actually brought down the average years of experience quite nicely and that's really what’s been helping the gross margins also.

Brian Kinstlinger - Sidoti & Company

Right, so that goes over time. I guess it's just a dramatic impact. You had 200 basis points gross margin from December to March. So something had to be a major change there on only 4% volume increases. You know, I understand the SG&A side. So was there a shift maybe in some of the gross costs into SG&A where you had a large increase in SG&A?

Phaneesh Murthy

No, no, sorry. No, also on to, just to clarify also, what happened is that your revenue gets depressed a little I think margins as a percentage tend to go up marginally. Right? So what happened is that, because of the volume discounts which ended up going out from revenue, margins went up marginally because of that. On the G&A side, I'm just letting Ram give you a flavor of what happened.

Ramachandran Natesan

G&A, if you look at, we have done a lot of restructuring of our iGATE Shared Services, so some of the cost from there has moved to the Global Solutions because we transition most of it to India. But going forward, we can expect the SG&A to be, as a percentage of revenue, coming down from these levels.

Brian Kinstlinger - Sidoti & Company

Okay. What are you expecting the time loss, and this is moving to a complete different direction, the timing of the spin-off? I mean, is that months away? Is that weeks away? You know, what's the feeling of when that transaction will get going?

Phaneesh Murthy

We anticipate that it should be completed by June 30, but a lot depends on the SEC. Because we would be possibly filing the documents by the end of May and from there, you know, it takes about I believe three to four weeks to wrap up the other processes. So therefore, we expect, at this point in time, to complete the process by June 30.

Brian Kinstlinger - Sidoti & Company

And what about the sale of the clinical research business? Is that something that you are in negotiations with? Or is that going to take a little bit longer?

Phaneesh Murthy

No. We have already executed the sale agreement, and the closing can happen in the next two or three weeks.

Brian Kinstlinger - Sidoti & Company

And is there going to be any cash benefit to the Company?

Phaneesh Murthy

Very, very small. A very small gain would be accrued on that sale.

Brian Kinstlinger - Sidoti & Company

Okay. And in terms of

Phaneesh Murthy

Your question, sorry, was for cash benefit, did you say? Or some other benefits?

Brian Kinstlinger - Sidoti & Company

Right; how much? Was there a purchase price, a sale price?

Hari Murthy

Yes, the purchase price, the sales price is $3.8 million and we would account for a small gain from that sale.

Brian Kinstlinger - Sidoti & Company

Right. And I remember last quarter we talked about the cash position. Is that all settled with the iGS payment or is that cash positioning going to come down? You know, just give us a sense of where that stands based on just the transactions that are going on.

Phaneesh Murthy

So, there is 1.8% of the outstanding stock left, Brian, which will cost the Company roughly $5.5 million over the next several months to acquire.

Brian Kinstlinger - Sidoti & Company

Perfect. And so I guess the only last question that I have are related to all of the different, well, first of all, did you provide a $1 million client number that you had provided in the past? You know, how many have reached that threshold?

Ramachandran Natesan

29.

Brian Kinstlinger - Sidoti & Company

29. So that doesn't seem to be moving. And so, I know you guys are doing a good job but I'm just trying to focus on where there could be improvement, so I'm curious why you think that that was the same point last year, that that's not moving forward.

Phaneesh Murthy

I think there are two or three things, Brian, on that. Actually a lot of them are or not a lot. Some of our customers have exited the system. Last year, if you look at it at this time, there were some of our clients who are in the mortgage and other industries who were large clients and basically some of them have exited the system. And overtime we have been acquiring new customers who have come into the system. Having said that, I think you'll find that number changing over the next two or three quarters.

Brian Kinstlinger - Sidoti & Company

Good. And the other question before, I had just a general question, is that seven client wins that you gave, are those all, you guys have given client wins and then you guys have also given significant client wins or whatever one wants to call, are those seven all the Fortune kind of declines that you're looking for?

Phaneesh Murthy

Most of the clients, barring one government agency and two clients, those others are all Fortune 1000, Global 2000 kind of clients. And I think clearly they are very high-quality names, Brian, and one of our goals here is to manage clients upward to make sure that clients which are open are going to generate in excess of $1 million and $2 million for us. So we are managing it slightly differently this year than the previous years.

Brian Kinstlinger - Sidoti & Company

Then just a final question, that old press releases you used to provide that had the top 1, 5, 10, the bill rates, the billable headcount utilization. Will that no longer be provided? Are those questions we should start asking on the call instead of, or will that be offered to us for the quarter, somewhere?

Phaneesh Murthy

We will offer it to you. We will send it to you.

Brian Kinstlinger - Sidoti & Company

Okay. Great. Thank you.

Phaneesh Murthy

Thank you.

Operator

(Operator Instructions). Your next question comes from the line of Vincent Colicchio of Noble Financial.

Vincent Colicchio - Noble Financial

Good morning, guys. Phaneesh, what type of sequential growth should we be thinking about for the next three quarters?

Phaneesh Murthy

I think that's a tougher question. I think the couple of project cancellations that we've had with have kind of put us in a stage where we've entered a realm where signed contracts and signed statements of work are not necessarily revenue. So to that extent, we may be looking at slightly lower growth rates in April, May, June, and then get back to slightly higher rates in July, August, September and October, November, December.

Vincent Colicchio - Noble Financial

Okay. Has there been any change in your focus from the sales side to outside the U.S., given some of the economic issues? You landed this Australian deal. Is there more to come outside the U.S.?

Phaneesh Murthy

If I look at that mix of businesses, that mix of seven customers that we won, really only two are U.S., two are Australia, one is U.K., one in Japan and one in Canada. So clearly, the fact is that the wins that we're getting is because multiple channels and multiple engines from our sales force are firing. We're hoping that if we can do another couple quarters of six, seven clients each that will start putting us on a good, healthy growth rate.

Vincent Colicchio - Noble Financial

Are there any specific service categories? I know iTOPS is doing well. That where you are seeing an extraordinary slowing such as ERP that you could talk to?

Phaneesh Murthy

If I look at the services which are really doing well in terms of winning new deals, clearly our testing service is helping us win new deals, so testing continues to be an important component of strength. And also the regular work around application maintenance and support, to try and reduce costs in application maintenance and so forth.

Vincent Colicchio - Noble Financial

Okay, thank you.

Operator

(Operator Instructions). You have a follow up question from the like of Brian Kinstlinger of Sidoti & Company.

Brian Kinstlinger - Sidoti & Company

Again, the first question is related to the salary increases. They seem to be coming down a little bit in the industry overall, at least from a fixed standpoint. So I'm curious, is there a change in the variable compensation for your employees and what they have to meet, for example, from a revenue or earning standpoint? Have you bumped up the incentives to compensate for that change in fixed? Or would that not be the case?

Phaneesh Murthy

We have a variable payout in our compensation for all employees, or most employees, I should say, but (inaudible) over certain grade and the variable comp, that variable portion is a budget which is released is based on the company performance. So the company performed well, or based on what we were expecting to perform or slightly better than what we were expecting to perform, so example for the JFM quarter, we actually released the full 100%. If the company performs a little poorly or a little less than our expectations or short of what we were thinking, then that budgeted payout actually comes down a little.

Brian Kinstlinger - Sidoti & Company

Right. So I guess I'm curious.

Phaneesh Murthy

And in the past two years, I think we've been paying roughly from about 70% to 100% based on the company performance.

Brian Kinstlinger - Sidoti & Company

Right. So I guess what I'm curious is, for example, in 2007, if you hit those goals versus 2008, if you hit those goals, will the incentives actually be greater, from a dollar standpoint to employees given that they are not getting as big of fixed increases? Or is that not the case? That makes sense?

Phaneesh Murthy

No, that is not the case.

Brian Kinstlinger - Sidoti & Company

Okay.

Phaneesh Murthy

This 10% includes the variable increase.

Brian Kinstlinger - Sidoti & Company

Okay. And in terms of financial services, what percentage of iGS is financial services?

Ramachandran Natesan

52.

Phaneesh Murthy

52%.

Brian Kinstlinger - Sidoti & Company

Does that include insurance?

Phaneesh Murthy

Yes, that includes insurance costs.

Brian Kinstlinger - Sidoti & Company

Okay. And I think that would actually be it for now. I appreciate it. Thank you.

Phaneesh Murthy

While we are waiting, there are just two more small announcements I do want to make. The name of iGATE Mastech Professional Services has been changed to, will be changed to Mastech Professional Services shortly. So, the Board just approved the change of the name to Mastech Professional Services. And the name of iGate Corp. is officially being changed to iGATE Global Solutions. It will continue on the same symbol of IGTE. The next question?

Operator

(Operator Instructions). At this moment, there are no further questions from participants at WebEx International Center. I would like to hand over the proceedings back to Rita.

Operator

Thank you, Laurie. We will now begin the Q&A session for participants connected to India Bridge. (Operator Instructions).

Salil Ravindran

Rita, if we don't have any questions, we can wind up the proceedings.

Operator

At this moment, there are no further questions from participants.

Salil Ravindran

Thank you, Rita. Thank you, everybody for joining this call. If you have any follow-up questions, feel free to e-mail me or give me a call. And with that I would like, we come to an end of this earnings call. See you all in a short period of three months. Good day.

Phaneesh Murthy

Thank you.

Ramachandran Natesan

Thank you.

Operator

Ladies and gentlemen, thank you for choosing WebEx Conferencing Service. That concludes this conference call. Thank you for your participation. You may now disconnect your lines. Thank you, and have a nice evening.

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