ePlus' (PLUS) CEO Phillip Norton on Q3 2016 Results - Earnings Call Transcript

| About: ePlus Inc. (PLUS)

ePlus Inc. (NASDAQ:PLUS)

Q3 2016 Earnings Conference Call

February 4, 2016 4:30 PM ET

Executives

Kleyton Parkhurst - Senior Vice President and Assistant Secretary

Phillip Norton - Chairman, Chief Executive Officer and President

Mark Marron - Chief Operating Officer and President, ePlus Technology, Inc.

Elaine Marion - Chief Financial Officer

Analysts

Bhavan Suri - William Blair & Company

Matt Ramsay - ‎Canaccord Genuity Inc.

Nikhil Kumar - Stifel Financial Corp.

Matthew Galinko - Sidoti & Company, LLC

Operator

Good day, ladies and gentlemen. And welcome to the ePlus Earnings Results Conference Call. At this time, all participant lines are in a listen-only mode to reduce background noise. But later, we will be conducting a question-and-answer session. Instructions will follow at that time. [Operator Instructions] As a reminder, today’s conference call is being recorded.

I would now like to introduce your first speaker for today, Kley Parkhurst, Senior Vice President. You have the floor, sir.

Kleyton Parkhurst

Thank you, Andrew. And thank you, everyone, for joining us today. With me are Phil Norton, Chairman, President and CEO of ePlus; Mark Marron, Chief Operating Officer and President of ePlus Technology; Elaine Marion, Chief Financial Officer; and Erica Stoecker, General Counsel.

I want to take a moment to remind you that the statements we make this afternoon that are not historical facts may be deemed to be forward-looking statements and are based on management’s current plans, estimates, and projections. Actual and anticipated future results may vary materially due to certain risks and uncertainties detailed in the earnings release we issued this afternoon and our periodic filings with the Securities and Exchange Commission, including our Form 10-K for the year ended March 31, 2015, and our 10-Q for the quarter ended December 31, 2015, when filed.

The company undertakes no responsibility to update any of these forward-looking statements in light of new information or future events. In addition, during the call we may make reference to non-GAAP financial measures. So we have posted the GAAP financial reconciliation on the Shareholder Information section of our website at www.eplus.com.

I’d now like to turn the call over to Phil Norton. Phil?

Phillip Norton

Thank you, Kley. And thank you, everyone, for joining our fiscal Q3 earnings call this afternoon. We continue to execute well in the third quarter across important key metrics consistent with our long-term growth strategy. And we have continued to make the appropriate investments during the year to ensure we are meeting our customers’ demand for security, services, and advanced technology solutions.

In the quarter, we achieved mid-single-digit growth and non-GAAP gross sales of product and services of 4.4%, $394 million, and slightly improved gross margins. We believe our consistent focus on delivering comprehensive lifecycle solutions continues to have relevance for our customers and differentiates ePlus from the competition.

In addition, we recorded a record percentage of non-GAAP gross sales of product and services and the security stack up 300 basis points to 16.2% as compared to 13.2% for the nine-month period.

Security remains top of mind for our customers and touches many of the solutions we sell. During the quarter, net sales declined 2.5% from last year’s comparative quarter. Net sales declined relative to non-GAAP gross sales for two reasons. First, we experienced an increase in adjustments of gross to net, as the relative percentage of third-party software assurance, maintenance and services we sold increased as a percentage of the whole.

As we discussed in prior conference calls, we do this as a positive development, as it shows we are capturing ongoing revenues from our customers. Second, we experienced a spike in shipments in transit of about $7 million more than normal. This means there were $7 million of sales we couldn’t recognize in the quarter.

These are related to late in the quarter of customer orders, which were not delivered to our customers by the end of the quarter. The $7 million figure is the amount in excess of our last four quarters’ average.

We continue to make investments to ensure that ePlus meets marketplace opportunities and is well positioned for long-term success. Notably, our technology segment had 1,006 employees as of December 31, 2015, an increase of 79 or 8.5% from 927 as of December 31, 2014.

We continue to invest in people to gain territory coverage, new perspectives and new skill-sets to provide new technologies and solutions to our current and new customers. As a result of our investments in people, acquisition expenses, lower gross profit dollars due to some of the pricing pressures on a few large customer orders, and some other costs, which Elaine will discuss later in the call; our diluted EPS for the quarter declined to $1.40 versus non-GAAP diluted EPS of $1.64 a year ago.

While we aren’t satisfied with the bottom-line results for the quarter, we don’t see any long-term adverse trends in the industry for our model. Customer demand remains strong and we remain well-positioned in the relevant emerging technologies. We keep a close line on cost and investments to optimize financial results.

We have a long-term strategy that we are successfully executing. And we believe our year-to-date metrics, which Elaine will discuss in more detail, are better measurement of our success. Late in the quarter, we acquired IGX, a Northeast UK based security solutions provider, with a great set of customers and employees.

It is our first international presence, which creates exciting new opportunities for ePlus. Like all of our acquisitions, the IGX U.S. operations were integrated into our platform to gain maximum synergies.

One of the key strengths of our management team and operations is our experience and expertise in identifying, acquiring and integrating acquisitions. We are excited about IGX, our growth initiatives and the potential for future acquisitions. We remain confident in our model and ability to capture market share.

We will continue to make the right investments for the long-term benefit of our shareholders. Now, I will turn the call over to Mark Marron for his prepared remarks. Mark?

Mark Marron

Thank you, Phil. As Phil said, ePlus continues to execute against its long-term strategy of providing the solutions and services our customers need to succeed in today’s market. Our base of more than 3,000 customers is facing an ever more complex set of IT challenges and opportunities that require upfront consultant services to help develop and design solutions that provide the right business outcomes.

To help address this concern, we have continued to expand our solutions, go-to-market and emerging technologies teams; to provide solutions, services and support needed to optimize their IT environments. Part of our strategy has been to expand our footprint and overall technical capabilities through organic growth and acquisitions.

During the past year, we had an 8.5% increase in overall headcount, with the majority of these being customer facing sales and engineering headcount. Our client facing teams now comprise more than 750 people, which has helped us to continue to maintain growth rates above those of the overall IT market in the highest growth areas of technology; namely, security, mobility, cloud and hyper-converged infrastructure.

As we discussed previously, there is a lag between revenue production and expense, as it can take at least six months for new salespeople to become earnings positive and several months for engineers to become fully engaged and productive. Therefore, we have to balance new employee investments to meet demand and grow our solution-set, which is our long-term strategy against the short-term costs.

For example, last month we just added Hybrid IT Monitoring as additional services for our customers. This new capability provides automated detection and tracking across multiple technology silos, allowing our clients to innovate without concern for cloud-sprawl or a loss of visibility. This is a natural fit for our suite of cloud-based managed services and will additional annuity style revenue for ePlus.

Overall, we continue to expand our customer count and feel that we are focused on the right customers, where we can grow wallet share.

In the quarter, we closed several large competitive deals, where we see long-term growth opportunity, but where initial orders had somewhat lower gross margin. We will continue to do this when we believe that potential returns warrant the short-term investment.

Our financial results year-to-date show the success of our growth strategy. We’ve grown our non-GAAP gross revenue on product and services by 5.7%. Both gross margins on product and services grew by 50 basis points to 19.7%.

As Phil mentioned, we faced several factors in the third quarter in terms of both revenue-timing and expenses which impacted our earnings for this quarter. This has not impacted our confidence and the outlook for our business though. Customer demand remains strong, and we believe that our solution-set, including security, is among the best in the business.

Also, during the quarter we continue to execute on our plan to build out our footprint and enhance our security capabilities with our acquisition of IGX. IGX was a successful reseller of security products and services with operations in metro New York, New England and the UK.

This acquisition provides the opportunity for the IGX sales team to up-sell and cross-sell to their customers the solutions and services that ePlus currently sells such as managed services financing, and our key vendors in compute, storage and networking such as Cisco, NetApp, Pure, EMC and many others. This acquisition also expands our presence in the UK and allows us to better support some of our larger global enterprise customers. But I must note that it will take some time in investment to bring ePlus solutions and vendor credentials to overseas markets.

In conclusion, we remain positive on the outlook for our business. The demand for complex multivendor IT solutions continues to grow. We will continue to build and improve our infrastructure and expertise to meet this demand. And we believe that we will continue to post growth rates ahead of the overall IT market.

I’ll now turn the call over to Elaine for a closer look at our financials.

Elaine Marion

Thank you, Mark, and afternoon, everyone. As you heard from Phil and Mark, third quarter sales were affected by several factors. Net sales for the quarter declined 2.5% to $298.6 million. Conversely non-GAAP gross sales reached $393.9 million, 4.4% ahead of the similar period last year.

At the end of the quarter, we had shipments in transit to our customers that were higher than the average of the last four quarters. While we always have had shipments in transit at the end of every quarter, the variation from the norm was approximately $7 million more than the average. This means we had approximately $7 million of net sales which were not recorded in the quarter and are expected to be recorded in our fourth quarter. Considering this factor, net sales this quarter would have been about flat year-on-year.

Turning back to non-GAAP gross sales of product and services, which grew 4.4% in the quarter, we had a greater proportion of sales of third-party maintenance, software assurance and services this quarter at 27% as compared to last year at 22% of non-GAAP gross sales of product and services. These transactions we record 100% of the gross profit on the transaction as net sales.

Consolidated gross margin and gross margin of sales of product and services were both up from a year earlier at 21.5% and 19.6% respectively. While consolidated gross profit declined 2.1% to $64.1 million, tracking the net sales result, adjusted EBITDA and operating income both increased from the third quarter of fiscal 2015 to $19 million and $17.6 million respectively, primarily as a result of headcount additions and acquisition related expenses, which I’ll discuss in more detail when I review the segment results in a moment.

Diluted EPS was $1.40 per diluted share, below the $1.64 in non-GAAP EPS reported in last year’s third quarter. You may recall that last year’s quarter included one - included a one-time gain equal to $0.49 per share, which is excluded from non-GAAP EPS I just mentioned.

Now, moving on to our results by segments, net sales in our technology segment fell by 2.8% to $289.4 million. Non-GAAP gross sales of product and services increased 4.4% to $393.9 million. Gross margin on product and services was up 20 basis points to 19.6%, but gross profit decreased 2.9% to $57.9 million, on lower net sales by 2.8%.

Several large product sales to enterprise customers in the quarter, that Mark spoke about earlier, were heavily competed, but as we mentioned, strategically aligned with our objectives of driving broader and deeper relationships over time. The short-term impact, however, pressured gross margin and therefore gross profit in the third quarter.

Operating expenses in the technology segment increased 3.8% to $43.2 million. The largest increase was in salaries and benefits line item, which increased 4.6% as a result of additional 79 people, 80 of whom are customer-facing and 48 of whom came from the IGX acquisition.

Additionally, we incurred professional fees related to the acquisition of about $300,000. Also included in operating expenses is $680,000 in amortization of acquisition related intangible assets of which $175,000 related to the IGX acquisition. Amortization of acquisition related intangibles in our fiscal fourth quarter is expected to be approximately $1 million. Technology segment earnings were $14.7 million compared with $18 million a year earlier.

Moving to the financing segment, net sales in our financing segment were up 10.2% to $9.3 million as a result of higher post-contract earnings. Operating expenses for the segment declined 1.5% from the previous year due to lower debt and lower interest rates. Operating income increased 16.8% to $3 million.

Net earnings for the financing segment decreased to $3 million from $8.7 million last year. In the year ago quarter, net earnings included $6.2 million in other income resulting from a claim in a class action lawsuit.

Looking at our year-to-date consolidated results, net sales were up $3.3 million to $904.8 million. Non-GAAP gross sales of product and services were up 5.7% to $1.2 billion. And technology segment net sales were up 3.2% to $876.9 million.

Consolidated gross profit for the first nine months of fiscal 2016 increased 5% to a $195.1 million. Consolidated gross margin was 21.6%, up 40 basis points. Gross margin on the sale of product and services expanded 50 basis points to 19.7%. Adjusted EBITDA grew 7.4% to $63.1 million and operating income increased 6.7% to $59.4 million from $55.6 million.

Our diluted EPS per share for the nine months ended December 31, 2015 was $4.74, up from non-GAAP EPS of $4.38 which excludes other income of $7.6 million resulting from a gain on a retirement of a liability and a gain from a claim in a class-action lawsuit.

Turning now to the balance sheet, we ended the third quarter with a cash position of $66.6 million, an increase from the $62.8 million at the end of the second quarter, despite the use of funds for the acquisition of IGX of $16.6 million. The cash conversion cycle for our technology segment was 20 days as compared to 18 days a year ago.

Our balance sheet remains healthy with a strong cash position of $4.1 million of recourse debt and stockholders’ equity of more than $315 million. This gives us the flexibility to support organic growth and strategic acquisitions in the quarters ahead.

I’ll now turn the call back over to Phil for closing remarks.

Phillip Norton

Thanks, Elaine. In closing, I would like to reiterate that our solid year-to-date results evidence that our long-term strategy is grounded and working. We expect to continue to benefit from the significant investments we have made by adding sales and engineering headcount and in expanding our leading-edge technologies including security, mobility, hyper-converged infrastructure and cloud-based solutions.

We are also better-positioned than ever to increase wallet share among our existing customers with an expanded geographic footprint now that IGX is on board.

Finally, we ended this quarter with approximately $67 million of cash, a nominal recourse long-term corporate debt. And we’ll continue to evaluate the best way for increased shareholder value using the solid cash flow of the business. Our returns on capital remain among the best in the industry.

Operator, we like to open the room to questions. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Bhavan Suri from William Blair. Your line is open.

Bhavan Suri

Hey, guys. Thanks for taking my question. Just to start off, overall in the demand environment, outside sort of the shipment issue, just any color on sort of - are you seeing any softness in the U.S.? And, are there any sort of verticals or areas you might see slight softness just from a demand perspective or CapEx perspective? Any help there would be great.

Phillip Norton

Well, we actually don’t see any softness in the overall market for us and our customers. But there are some headwinds with the margins in certain cases. But we think that market is pretty good and we’re continuing to take market share from our customers.

Bhavan Suri

Okay. And, I guess, when we talk about the margin perspective, I guess, you said, sort of in the - at least the comments sort of just some pricing pressure with certain customers. Can we get just a little more color on sort of, A, any vertical-specific areas or any product-specific areas would be helpful to?

Mark Marron

Well, in terms - hey, Bhavan, it’s Mark. How are you?

Bhavan Suri

Hey, Mark. Good, man.

Mark Marron

How is everything? So in terms of the margins and some of the things that we did, we had a few clients that we made a strategic decision that we were going to take down at lower margins and basically expand the margins over time; so kind of a land and grab, if you will, and then expand over time.

In terms of the verticals, still the same top-five verticals. We saw a little pressure in the telecom space, but technology was up to offset it. And then, if I were looking at the quarter overall from an outlook standpoint, look, if - I don’t think anybody here is satisfied with the quarter.

Bhavan Suri

Right.

Mark Marron

But if you look at the trend, the gross sales were up both for the quarter and for the year. If you look at how it affected some of our - I’ll call it, GP. You had the large shipment in transit, the land and grab on some of the deals. And those were some of the things that affected our GP, if you will.

But the thing that I would tell you, it’s not really pricing pressure, Bhavan, it’s more us making a conscientious decision to grab some strategic accounts that have a large IT spend that we think we can land and expand over time.

Bhavan Suri

Okay, okay. And then two more quick ones for me, if I may; just change in the competitive environment. I look at other guys that they plan it for every smaller account, pick CDW or someone, or even the system-engineering [ph] guys, growth seem reasonable for them. And I’m just wondering sort of what that, I mean, you might be seeing that’s different from them vis-à-vis just overall growth rates?

Mark Marron

Okay. As it relates to the competition, I don’t think we should…

Bhavan Suri

Yes, exactly.

Mark Marron

Some are not an apples-to-apples compare. But if you look at our gross sales for the quarter they were up 4.4%, for the year-to-date they were up 5.7%. I don’t think we’re seeing any competitive pressures. Touching on something that, Phil said, if you look at some of the things going on in the storage market, although it’s getting competitive with some of the legacy vendors with the emerging technologies, we actually see it as an opportunity for us to grab additional market share and line share over time; but nothing that we see from the competitors that would show. So…

Bhavan Suri

Got you. Got you. And then, one just on the services growth, I know, you guys don’t break it out. But when you look at that growth over last year, 18 months, is that sort of in line with our expectations or has that been ahead of expectations, and how should we think about that going forward?

Mark Marron

In terms of the overall margins or services?

Bhavan Suri

The growth of the services business, obviously the shifts and the incentives.

Mark Marron

Growth of services?

Bhavan Suri

Yes.

Mark Marron

Yes. Right now, the growth is up year-over-year versus the 14.8%. So we feel very good about where our services solutions are going as well as our revenue, gross margins and GP in that space.

Bhavan Suri

Okay, okay. Helpful, guys. Thank you for taking my questions.

Mark Marron

No problem. Take care, Bhavan.

Operator

Our next question comes from the line of Matt Ramsay from ‎Canaccord Genuity. Your line is open.

Matt Ramsay

Yes. Thank you very much. Good afternoon. I guess, there are some - obviously, some well-covered and well-publicized mergers going on in this space with EMC and Dell, and lots of other chatter about different suppliers potentially getting consolidated with each other. I mean that’s all rumored and debated. But have you seen any from the broad customer base in U.S., just slowdown in maybe deployments or plans or spending as people wait to see how some of this stuff is going to play out over the next six months or so?

Mark Marron

Sure, Matt. As it relates to Dell and EMC, we haven’t seen any slowdown, but obviously what’s going to happen there is - the Dell EMC teams need to figure out what the product roadmap is once they kind of merge and integrate. They need to figure out their go-to-market strategies. The good news is, and this is from when I used to work on the vendor side, and used to run a channel at a large vendor years ago, as you normally go to the partners that have the capability in what you’d call the compute, storage, networking space, so the multi-vendor space which they play in, if you will, or compete against.

And I think we are pretty well-positioned to kind of take some additional market, leveraging our relationships with EMC and Dell as well as our expertise in that space.

Matt Ramsay

That makes a lot of sense. I guess, that’s just going to have to play out over a multi-quarter or multi-year period to see the big effects. One thing that I’ll be, I guess, happy to see is that the security products and services were up as a percentage of sales. Maybe you could talk about the trajectory of that particular piece of business and what that can become as part of the mix over a multi-quarter period.

Mark Marron

Sure. So if you look at our security, for the quarter it was 17.8% of our non-GAAP gross product and services. I think we feel in Q2 it was 15.5%. We’ve made a large investment both in resources and talent to provide the consultative upfront services in the security space to our customers. And we continue to expand our capabilities in that space.

If you look at it for the first three quarters year-to-date over year-to-date it’s grown from like 13.2% to 16.2%. So it’s been a significant growth in revenue for us and margin - and GP, sorry about that.

Matt Ramsay

That’s great. And then, I think you guys have proven that from the results that you can sort of outgrow the overall industry macro. And I think the overbearing concerns around technology stocks in general right now is just the macro-environment. So if we think about your business outgrowing that macro by some level, have you changed your view about overall enterprise macro spend over the next two, three year period in the U.S?

And maybe you could give us your view of maybe what that growth rate is that we should benchmark your company against over the medium-term to outgrow. Because I am little bit concerned that the expectation of overall growth from an investor perspective is down versus where it might have been a quarter or so ago across a number of markets, but enterprise IT is one of those for sure.

Mark Marron

Yes. I would agree, Matt. This one is a little bit tougher to kind of give you a real quick easy answer on. But I think if you look at our year-to-date trends and what we’ve done historically, that’s probably more in line. It’s a steady trend that you can track. And I think that’s what we would expect and we continue to outpace the IT market. We believe we’ll continue to outpace the IT market. Those would be the bigger pieces.

If you look at our gross product and services growth, if you will as well, the areas that we’re invested in are high growth areas. So when you talk about the cloud, when you talk about security, when you talk about the services, both managed services, professional services, staffing; I think we’re very well-positioned to kind of continue to grab market and continue to grow our gross margins and GP over time.

Matt Ramsay

Well, thank you for the color. I’ll jump back in the queue. I appreciate it.

Operator

Our next question comes from the line of Nikhil Kumar from Stifel. Your line is open.

Nikhil Kumar

Yes, hi. Can you please provide more color on IGX? What kind of margin structure looks like and how it should going to impact SG&A going forward?

Mark Marron

Okay. So I’ll take the IGX in terms of what we believe we’re getting out of IGX and how we’ll continue to leverage it. And I don’t know if Elaine or Phil wants to jump in on the other piece. But here is the easier thing on the IGX. What it gives to us is it expands our presence in New York and New England, so New York metro and New England. They’ve got some great security expertise and resources that we can now leverage across that region and get additional sales from a security perspective based on their capabilities.

But just as importantly, they’ve got some really nice customer - they’ve got a nice customer-base that we can actually go back in and sell all the things that we sell at ePlus, such as managed services. We have financing capabilities, dealing with compute, storage and networking with Cisco, NetApp, EMC, Pure and all the different players there. So there is real nice opportunity for us to go back. And we really picked up some real talented and good people to add to the ePlus portfolio.

Elaine Marion

Yes. In terms of the margin profile, they had a very similar margin profile to us. So I would expect that to continue and file in very nicely with our model.

Nikhil Kumar

So on SG&A you talked about a $1 million next quarter coming from amortization and then you should have incremental SG&A coming from IGX side. Is that the right way to think about it?

Elaine Marion

Yes. That’s correct.

Nikhil Kumar

Okay. Perfect, perfect. And in terms of like hiring– adding headcount, I think you added about 100 people in last two quarters and you are adding about 80 people from IGX. So should we think you’re going to take a pause here or continue adding people?

Mark Marron

So, Nikhil, it’s Mark here. We haven’t added a 100 people. It was actually about 8.5%, which I believe was around 80 people year-over-year. And some of those with the IGX team as well. So I think the easy thing to say is, we’ll continue to invest in headcount. We’ll be opportunistic when we can see you if we can bring on some talented folks, but you’re probably looking at about the 4% to 5% range if I had to get put a range on it.

Nikhil Kumar

Okay. Got it, got it. That’s helpful. And lastly, on the top line, I mean, looking towards the March quarter and rest of the year, I mean, should we think, you should get back to year-over-year growth, given IGX coming along and may change seasonality as well?

Mark Marron

Here’s what I tell you there. I think, you got to - like I mentioned earlier, as you got to look at the year-to-date trends and in that space short-term. And that’s probably where we’re about. So we’ll continue to outpace the IT market. But in terms of IGX, if you look at them, just from a - if you look at our press release, if you wanted to model it, it was about $51 million, so just to kind of give you a feel on the top line.

Elaine Marion

Right, that’s what we’d expect in the short-term in the quarters. And we will expect that to grow over time, as we added our core competencies to that acquisition, as we’ve done with other acquisitions in the past.

Nikhil Kumar

Okay. Got it. Thank you.

Elaine Marion

Sure.

Operator

Thank you. Our next question comes from the line of Matthew Galinko from Sidoti. Your line is open.

Matthew Galinko

Hey, guys. Thanks for taking my question. Just on the shipments in transit piece, I know, you mentioned they were up beyond the historical norm, but was there anything different about the quarters? Is there any color you can give us to, again, why this isn’t necessarily the start of a different or kind of elevated level for that going forward?

Elaine Marion

No, it was purely a timing aspect within the quarter. There is nothing that I can point to that would tell you that this would or would not occur in the quarter. It’s purely a timing issue.

Matthew Galinko

Okay. Fair enough. Thank you.

Elaine Marion

Yes, sure.

Phillip Norton

Take care, Matt.

Operator

[Operator Instructions] That’s all the questioners that I see in the queue at this time. So I would like to turn the call back over to management for closing remarks.

Phillip Norton

We’d like to thank you, and thank our shareholders for their support and confidence. Thank you for your time and interest today. And we look forward to speaking with you again next quarter. Thank you.

Operator

Ladies and gentlemen, thank you again for your participation in today’s conference. This now concludes the program and you may all disconnect your telephone lines at this time. Everyone have a great day.

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