Oracle's (ORCL) CEO Mark Hurd on Q3 2017 Results - Earnings Call Transcript

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Oracle Corporation (NYSE:ORCL) Q3 2017 Earnings Conference Call March 15, 2017 5:00 PM ET

Executives

Ken Bond - Senior Vice President

Safra Catz - Chief Executive Officer

Mark Hurd - Chief Executive Officer

Larry Ellison - Chairman and Chief Technology Officer

Analysts

Kirk Materne - Evercore ISI

Kash Rangan - Bank of America Merrill Lynch

Raimo Lenschow - Barclays Capital

Phil Winslow - Wells Fargo

John DiFucci - Jefferies & Company

Keith Weiss - Morgan Stanley

Sarah Hindlian - Macquarie

Heather Bellini - Goldman Sachs

Operator

Welcome to Oracle's Third Quarter 2017 Earnings Conference Call.

Now, I'd like to turn today's call over to Ken Bond, Senior Vice President. Ken?

Ken Bond

Thank you, Holly. Good afternoon, everyone, and welcome to Oracle's third quarter fiscal year 2017 earnings conference call. A copy of the press release and financial tables, which include a GAAP to non-GAAP reconciliation and other supplemental financial information can be viewed and downloaded from our Investor Relations website. On the call today are Chairman and Chief Technology Officer, Larry Ellison; and CEOs, Safra Catz and Mark Hurd.

As a reminder, today's discussion will include forward-looking statements, including predictions, expectations, estimates or other information that might be considered forward-looking. Throughout today's discussion, we will present some important factors relating to our business, which may potentially affect these forward-looking statements. And these forward-looking statements are also subject to risks and uncertainties that may cause actual results to differ materially from statements being made today.

As a result, we caution you against placing undue reliance on these forward-looking statements and we encourage you to review our most recent reports, including our 10-K and 10-Q and any applicable amendments for a complete discussion of these factors and other risks that may affect our future results or the market price of our stock. Finally, we are not obligating ourselves to revise our results or publicly release any revisions to these forward-looking statements in light of new information or future events. Before taking questions, we'll begin with a few prepared remarks.

With that, I'd like to turn the call over to Safra.

Safra Catz

Thanks, Ken. Good afternoon, everyone. I'm going to focus on our non-GAAP results for Q3, I'll then review guidance for Q4 and then I'll turn the call over to Mark and then Larry. Just so you all know, we're not all in the same place today, so we may all answer at once, so give a chance.

Clearly, we are delighted with our results as software and cloud revenue was at the high end of my guidance and earnings per share $0.06, above the high end of my guidance. Our pivot to the cloud is now clearly in full strength. We continue to see outside growth rates in our cloud business, especially when compared with our key competitors who're all seeing slowing growth. But more importantly, the increase in revenue from our cloud business has overtaken new software license business decline on an annual basis.

Next year I expect our cloud revenue will be larger than our new software license revenue. The investments we've made to transition our business to the cloud has been important to ensure that Oracle remains a technology leader and we're now beginning to see the benefits in our results.

With cloud overtaking new software license revenue, we expect our business to once again exhibit the same pattern we delivered over the previous decade as a license business that is growing revenue with disciplined cost management that results an EPS and cash flow that grow even faster. I expect EPS growth to ramp up throughout next year.

We continue to use constant dollar rates on our quarterly calls, so that we can have some measure of consistency across the quarters, as well as to reflect how we measure the business. This quarter, the effects of currency movement were largely in line with my guidance of 1% currency headwind for revenue, $0.01 negative impact to EPS.

Cloud, SaaS, and PaaS revenues for the quarter were $1.1million, up 86% from last year. You can also see the continued strength of our cloud business in the SaaS and PaaS billings and deferred revenue. The gross deferred revenue balance is now over $2 billion, up 75% in U.S. dollars; and SaaS and PaaS billings grew 111% in U.S. dollars this quarter. We've put the billings numbers up on our website for you to see the detail.

When you add together cloud, SaaS, PaaS revenues, and new software license revenue together, we grew 11% in constant currency. This is a significant milestone in our transformation where the combination of our cloud and new software license businesses added together are growing.

As cloud becomes an even larger percentage of the total, the growth will only accelerate with earnings and cash flow following along. As our SaaS and PaaS business continues to scale and grow dramatically, the gross margin continues to expand. The Q3 gross margin for SaaS and PaaS was 65%, up from 51% last year, and I expect it to be about the same region in Q4. I expect that our total Saas and PaaS gross margin will continue to trend toward 80% overtime.

Cloud infrastructure as a service revenue was 178 million, up 19% from last year. The Q3 gross margin was 30%, as we continue to make the necessary investments to scale out this business. As we make additional investments, the expenses and immediately while the revenues recognized overtime, so the gross margin in this part of the business could decline to roughly about 20% over the next few quarters. After which, I expect gross margin will climb to more than 40% as the business scales.

Total cloud revenue in the quarter was approximately 1.3 billion, with growth modestly accelerating to 72% in constant currency from last year. Total on-premise software revenues were 6.2 billion with software updates and product support revenues at $4.8 billion, up 3% from last year.

Attach and renewal rates remained at their usual high levels, as our installed base of customers continued to grow, in fact they actually increased. New software license revenues were nearly 1.4 billion, down 15%, reflecting the continued emphasis on and migration to cloud. Total hardware, including hardware support was down 9% with hardware systems product revenue of 520 million and hardware support revenue of $508 million, again reflecting our focus on the move to the cloud.

For the company, total revenue for the quarter was 9.3 billion, up 4% from last year. Non-GAAP operating income was 3.9 billion, up 4% from last year and the operating margin was 43%, up from 42% last year.

The non-GAAP tax rate for the quarter was 21.6%, as the rate was favorably impacted by some onetime benefits and some other factors, including favorable geographic mix this quarter.

Non-GAAP earnings per share was $0.69 in USD, up from $0.64 and up 8% in constant currency. The GAAP tax rate was 17% and the GAAP EPS was $0.53 in USD, up from $0.50 last year.

Operating cash flow over the last four quarters was 13.5 billion, which is lower because of the rapid growth we're seeing as we transition to cloud and having an impact on our working capital. Our operational metrics like DSO and Days Payable are stable, so it's just largely an effective growth on working capital and timing.

Capital expenditures for Q3 were 440 million with about third of it from real estate, while most of the rest was cloud build out and internal use. Free cash flow over the last four quarters was 11.8 billion. We now have approximately 69 billion in cash and marketable securities. Net of debt, our cash position is approximately 5 billion.

The short-term deferred revenue balance is 7.4 billion, up 7% in constant currency. This quarter, we purchased approximately 30 million shares for a total of 500 million. Over the last 12 months, we've repurchased 124 million shares for a total of 5 billion and paid out dividends of 2.5 billion. And the Board of Directors increased the quarterly dividend 27% from $0.15 to $0.19 per share.

Now let me go to the guidance. Because we expect to see continued volatility in exchange rates, we do also expect to see significant currency headwind. I am going to give you constant currency guidance, but if the current exchange rates remain the same throughout the quarter as they're right now, we actually expect to see currency headwind of 2% on revenue and $0.02 negative impact on EPS. These currency headwinds are higher than last quarter, meaning that most of your Q4 estimates do not yet reflect the incremental revenue and EPS headwinds of an additional negative impact of 1% and $0.01 to EPS.

All of my guidance today is on a non-GAAP basis. With that my guidance is as follows. SaaS and PaaS revenue including NetSuite is expected to grow 69% to 73%, effectively raising my full year guidance from 80% to 81% for the year. We're beginning to see an increasing and favorable attach between our PaaS and IaaS order. So I'm going to provide guidance on IaaS as well this quarter.

IaaS is expected to grow 25% to 29%. Software and cloud revenue including SaaS, PaaS and IaaS, new software license and software support is expected to grow 1% to 3%. Total revenue is expected to grow from negative 1 to positive 2. EPS is expected to be between $0.78 and $0.82 in constant currency. Now, this assumes a non-GAAP tax rate of 23.5%, but of course the Q4 tax rate could end up being different.

With that I'm going to turn this over to Mark and then Larry follows him.

Mark Hurd

Alright, thanks Safra. We thought Q3 would be strong going in and as you can see it turned out to be just that. I'm going to give you a bunch of numbers hear and try to give you a little bit more insight to the quarter. First, in ARR, we booked 545 million in USD. Every number I'm going to give you was actually in CD, I want to say it differently. 545 in USD, 547 in CD, that is up 73% and the second best quarter we had ever had.

SaaS bookings were 322 million in USD and PaaS infrastructure bookings were 223 in USD. Cloud revenue was up 72% and we're now in an annualized $5 billion run rate. Saas, Paas revenue was up 86%. We're the fastest growing scaled cloud business in the world and that is on top, that growth rate is on top of last year's 60%.

In ERP, we were up 280% organically and with NetSuite ERP is now our largest pillar. Fusion HCM was up 106%, that's more than three times the growth rate of Workday. CX was up 16% with marketing and service both over 100 million in quarterly revenue. Our vertical is up for 109% and also over 100 million in quarterly revenue.

Database as a Service was up 427%. Our database business including all of our on premise businesses net revenue. PaaS was up 375% year-to-date, with cloud services up 300%. As Safra mentioned Saas, PaaS billings were up 111% in USD, Saas, PaaS deferred revenue was up 75% in USD.

Now, some customer metrics, 1,125 new SaaS customers in the quarter, 908 expansions, 210 customers who bought SaaS also bought PaaS. CX, we had 480 new customers and 586 expansions. In HCM, we had 206 new customers and 217 expansions. In ERP, we had 564 new customers that did not include NetSuite; we got 120 expansions. 50% of our new ERP customers never had Oracle ERP before they bought this quarter. Our active base of ERP customers is now approaching 3,700, 1,465 are live, 10X Workday. In total we now have 13,103 customers in our SaaS active base and 25,000 with NetSuite.

Two thirds of our new customer wins were for Fusion. 243 Go-Lives for Fusion, 2,444 customers are now live on Fusion. We have 2,380 PaaS customers in the quarter and 2,586 new customers buying standalone infrastructure as a service. As a point of clarity, PaaS and infrastructure customers accounted for each service that they buy.

Lastly, this was an excellent quarter. Bookings, billings and revenue were all extremely solid. Now, a few predictions, Q3 bookings growth was strong, as I mentioned 73%. We will book at least 2 billion in ARR this year. Q3 revenue growth was impressive at 72% and with revenue now and an annualized run rate of 5 billion; we're clearly the fastest growing cloud company at scale.

With that, I'll turn it over to Larry.

Larry Ellison

Thank you, Mark. Let's say, generation two of Oracle's infrastructure as service cloud now has the ability to run customers' largest databases, something that is impossible to do using Amazon web services. Amazon can only run relatively small Oracle databases in their cloud.

Gen 2 of Oracle IaaS also delivers ultra high database performance and form caller reliability in the cloud. Many Oracle workloads now run ten times faster in the Oracle cloud versus the Amazon cloud. It also costs less to run Oracle workloads in the Oracle cloud than the Amazon cloud.

As a result some of our largest customers' are negotiating huge infrastructure as a service contracts to move all their databases to the Oracle cloud. You can expect some of those big deals to be announced in the coming weeks. Fast growth in the infrastructure as a service business is new for us. We've done well on SaaS and in PaaS over the past few years, but this is the first time we've ever had a technology lead in infrastructure as a service.

We're now in position to help our hundreds of thousands database customers move millions of Oracle databases to our infrastructure as a service cloud. SaaS and PaaS are large, rapidly growing businesses for us. Together SaaS and PaaS grew 85% this past quarter. But soon infrastructure as a service will be growing even faster and before long infrastructure as a service will become Oracle's largest cloud business.

In summary, all of Oracle's cloud businesses are growing rapidly and IaaS will be leading the way in the future. Thanks.

Ken Bond

Thank you, Larry. Holly, if we could prepare the audience for the Q&A portion of the call now.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is going to come from the line of Kirk Materne with Evercore ISI.

Kirk Materne

Thanks, very much and congrats on a very nice third quarter. My question is for Mark. Mark, obviously a really nice quarter across the board, but particularly from cloud bookings perspective, can you talk about what changed if anything in the quarter versus the second quarter either in terms of the macro backdrop or better execution and just relatedly we'll be interested in what you're seeing in the pipeline that gives you further confidence in that $2 billion ARR target. Thanks.

Mark Hurd

Kirk, I thought good about Q1, I thought good about Q2, I feel good about Q3, I didn't feel any major change. It's just really the timing of wins, bookings closed. We had a very strong set of quality wins. I mean if you win into HCM, I mean just to give you some idea Kirk, we closed America Movil in the quarter, Cedars-Sinai Medical Center, Ford, Emerson, Hilton, Hyundai Motor, Jefferies, Rogers Communications, I mean we had a very strong set of logos in the quarter. I mean in ERP, we closed ClubCorp, Cummins, Lufthansa, Dish Network, I mean it was just a - I could go on.

I don't have time to tell you all of these deals. But we saw it going in, we felt it would happen. It did and I think our team executed well. I would say Kirk that there was no - it wasn't geographically centered and it was pillar centered. As I mentioned earlier we had credible growth in ERP 280% organically, we had a 106% growth in HCM, we had strong in our sales automation business and it wasn't unique to one geography, so in the quarter broad based, cross pillar, cross geography.

In terms of going forward, our pipeline is big. I mean I said before, I'll say it again. Our pipeline's growth, if you looked at it year-over-year resembles all of the growth rates you've heard in terms of what you've seen in terms of our bookings growth this quarter. And I think our execution just continues to get better. I'll also add in the quarter that NetSuite's performance accelerated. So from the last reported quarter in terms of bookings growth, their growth in the quarter, which for them was an odd thing because they're not used to having December, January, February quarter, but when compare it apples-to-apples, they grew faster than the last reported quarter in terms of bookings as well, so it's a very good quarter for us.

Kirk Materne

Great, thanks very much.

Operator

Our next question is going to come from the line of Kash Rangan with Bank of America Merrill Lynch.

Kash Rangan

Hi, thank you very much. Mark, you must be wearing a suit and Larry, maybe you're wearing a sweater because you're talking tech and Mark is talking application, so I'm going to direct my applications question to Mark if you don't mind. Mark, can you talk about what's ahead for cloud SaaS, obviously there is manufacturing, order entry, supply chain, those kinds of things that could book to the cloud. How should we think about the cycle ahead in that regard? Thank you very much.

Mark Hurd

It is a big change for us in ERP. This is not the world of two providers and I was talking about upgrade cycles. What happened to us in ERP and I go back to the fact that 50% of our customers in the quarter were just brand-new. So, they never had bought ERP from us before.

Ad what happened is our total available market has just become incredibly large. If you looked at the persona of our customers that are in the ERP cloud today, they were not - most of them, more than 50% of them today were not in Oracle ERP customer her before they bought from us. So, I don't think, cash, it's really more of a cycle. I think it's really more of just an inflection point for us in terms of - we're now at a place where we have almost 4,000 customers in ERP SaaS.

Many of our on-prem customers have not moved and yet we're in a position where we can go get a whole set of customers that we never had access to before. Mid-market customers, we can do that globally and we can go now for customers that want to move to a SaaS application in the cloud and get all of those benefits. Frankly, our competitors' user bases have all opened up to us.

And so, I don't see it quite as a cycle of that. I see it as a big change in the opportunity for us in terms of the total available market we can go after. Larry may have a comment or two he would like to add as well.

Larry Ellison

No, again, I couldn't agree with Mark more. Our ability now to service much smaller customers than we could have serviced in the past is because the cloud allows you to deploy ERP in much, much lower costs. You don't have to have ERP. You don't have to build the data center. Obviously, you don't have to hire programmers. You don't have to hire a bunch of data operations people.

We do all that for you, and therefore the available market has at least doubled what it used to be. And we're also beginning to see, as Mark said, SAP customers moving their ERP and some very, very large SAP customers looking very closely at our ERP systems. So, we expect to have some big wins in the SAP install base, so we're definitely going out from there in the coming month.

Ken Bond

Next question, please.

Operator

And our next question is going to come from the line of Raimo Lenschow with Barclays Capital.

Raimo Lenschow

Hey, thank you and congrats from me as well. I had a question around 12C. So, you have 12C now in the cloud for a good few months and I saw last week that it's now available on-premise. Can you talk a little bit about the early feedback from customers you saw and released to in the cloud and what did it mean - what does it mean now that it's available on-premise? Obviously, in the olden days that kind of spiked a little bit of an uptick in the database license growth, I'm just wondering how we have to think about it now in the new cloud world. Thank you.

Larry Ellison

I will give you one thing that's important to note that our cloud business, our license business per database is growing. So, our on-prem database business continues to grow. I'm not talking about the board, I'm talking about new licenses. That business is growing and grew this past Q3. An awful lot of our customers are planning to move their database workloads to our cloud, but they're going to bring their own license. In other words, they own a bunch of Oracle license and they're just going to move those licenses to our infrastructure as a service.

So, we expect our database license business to continue to grow. That should continue to respond kind of as it had in the past. In other words, the cool new features become available faster in memory processing, the ability to take an existing single tenant application and automatically turn into a multi-tenant application to be very attractive to our customers and our ISDs, they will buy more licenses, they may then in turn bring those licenses to the cloud. So, we expect our on-premise or better said, our database license business to continue to grow and accelerate because of 12.

Raimo Lenschow

Perfect. Thank you.

Mark Hurd

Just as a follow-up because I know what Larry meant, it's our database business grew, support plus license plus database as a service, those three categories together, our database business grew in the quarter. Next question?

Operator

Our next question is going to come from the line of Phil Winslow with Wells Fargo.

Philip Winslow

Hey, thanks guys and congrats on a great quarter. I really wanted to focus on in particular on the PaaS line, because obviously you guys put up a huge ARR quarter there. Safra, you mentioned increasing the PaaS, sort of IaaS to PaaS, part of our thesis has been, since you rolled out the new Datacenter 2.0 model on IaaS, that increasing attach there would then drive acceleration in the PaaS business. So, the question to, I guess, all three of you and I'll jump off, is what are you seeing since the announcement of - you had opened world on the IaaS side and how is that impacting? How do you expect it to impact the PaaS business?

Mark Hurd

Well, I mean, Phil, there is a lot of questions you had in one question there. So, I mean I think the point we've continued to try to indicate is that we've seen a continual connect first PaaS to SaaS. So, we've got a bunch of SaaS customers who typically buy an application and now we're starting to get up into where we see 20%, 25% connectivity. When somebody buys the SaaS application, they buy PaaS.

I think part of what we're talking about with attach with infrastructure is it becomes a bit harder to differentiate in some cases what is a pure infrastructure and what is PaaS, because the customer now buys the computer, buys the computing, buys the storage, et cetera along with PaaS and so you begin to get upward and to a degree of the infrastructure business and the database business, but no question about it. We continue to see the attach rates continue to incline of PaaS to our SaaS business, which I think was your - at the core of your first question, Phil.

Philip Winslow

Yeah, sort of the [indiscernible].

Safra Catz

Yes. For our database customers, when they come in, they can order PaaS. They can bring or they can bring their licenses, use IAS and as a general matter when they are running a database where they got something else too and so they're going to need some IAS to actually run their application when they're not our SaaS application. So, we're seeing these together very often. And so, I figured as we've now moved - as we're moving to our more advanced IAS from what you used to have, I thought I would break it out for you to see it.

Philip Winslow

Great, thanks, guys.

Safra Catz

Okay.

Ken Bond

Operator

Our next question is going to come from the line of John DiFucci with Jefferies and Company.

John DiFucci

Thank you. My question is for Safra. Safra, you've previously talked about double-digit constant currency earnings growth for next year. You had meaningful outperformance this quarter and your guide was better than where the street is. I guess you also mentioned in your prepared remarks about EPS ramping through next year. I guess just to clarify, do you expect to still achieve double-digit growth? And is that exiting the year it'll be double-digit growth or are you talking about for the entire year?

Safra Catz

So, I expect that when you look at the entire year, it will be double-digit growth, but it will start smaller and get bigger as we get through the year. So, Q1, I don't know right now. It's a little too early. We'll talk again as to what I'm going to see. Things look nice. But I'm going to - we'll talk again in June on Q1. And I think by the end of the year, the only question is, which quarter would drive into double-digit? And it's a little too early to tell but I expect to see it for the year.

John DiFucci

Okay, okay. Great and just if I could a quick follow-up on a related profitability note, the one thing in the results this quarter was cash flow actually declined from a year ago, I think, this quarter. You mentioned in your prepared remarks working capital and timing issues. Can you just provide a little more detail on what you mean by that?

Safra Catz

Yeah. I mean there is really nothing in it. It is pretty much just timing of when we paid stuff and things like that. I mean we would be filing our Q, our plan is to filing on Friday. You can spend the weekend digging through it. We dug through. There is nothing interesting going on whatsoever. We're growing and it's really just timing of different working capital impacting account, really nothing in particular.

John DiFucci

Okay, great. Looking forward to that weekend. Thank you.

Ken Bond

Next question, please.

Operator

Our next question is going to come from the line of Keith Weiss with Morgan Stanley.

Keith Weiss

Thank you guys, for taking my question and a nice quarter. A new one for Larry just to clarify sort of the positioning on infrastructure as a service, when we think about sort of Gen 2 offering, is the positioning a platform for your customers to run workloads primarily or was it just more of a general purpose platform that you expect to go head on with AWS and Azure for general purpose type workloads?

Mark Hurd

It's absolutely a general purpose workload, because Oracle database is a backend. We have no idea what that application might be. It could be on our backing application. It could be our DNA, basically our matching application. There are millions or tens of millions of Oracle applications running. They're going to have to move the infrastructure as a service and the backend will probably run all the databases in PaaS, but we have to have a completely generalized infrastructure as a service offering that we built and we think we have performance and cost advantages with our new Gen 2 over both Amazon and Azure.

Keith Weiss

Excellent, thank you.

Operator

And our next question is going to come from the line of Sarah Hindlian with Macquarie.

Sarah Hindlian

Great, thank you so much and congratulations on the quarter, I would love Safra, if you could give us an early indication or any potential impact do you expect on the business model from SaaS B and IaaS B initiating new revenue recognition policies. Whatever you are seeing or thinking there that we should be starting to think about would be helpful.

Safra Catz

Sure, for us it's no big deal actually. It's really very much a non-event. I do hear one of our competitors talking all sorts of stuff about it. No, stuff for us to minimize [ph]. Maybe they're trying to talk about something else, but in our case we're not actually early adopting, but it doesn't make a difference really. Zero impact whatsoever on cash flows and no impact on what we disclosed to you or any of the things that these other companies talking about. For us it's really nothing.

Sarah Hindlian

Alright, thank you. That's very helpful.

Operator

Okay. And our final question will come from the line of Heather Bellini with Goldman Sachs.

Heather Bellini

Great, thank you so much for taking the question. Just one is actually for Larry. I was wondering if you can share with us, it does appear that the company is coming to an inflection point in regards to your transition of the cloud and given the results from today and your commentary about Q4 and the earnings growth for next year, how long do you think this could run?

Larry Ellison

Well, we have a very, very large database business. We have hundreds of thousands of database customers and we have millions and millions of applications that run on the Oracle database. Most of those databases and most of those customers will move most of their databases and most of these workloads to the cloud. And we think our cloud will be - right now we have a huge technology lead over both Amazon and Azure with our new Generation 2 infrastructure as a service. We can deliver ultrahigh performance.

People have been buying these Exadata Database Machines and are getting used to running very large databases very, very fast and we can deliver comparable ultrahigh performance at very, very low cost in our cloud. So, we think how long does it take to migrate several hundred thousand customers and several million databases to the Oracle cloud and I think the rate of migration is going to accelerate over the years, but it's going to be at least a five-year run of very, very rapid growth as our database business begins to move.

You've seen what it's like. Our application business began to move to the cloud several years ago and - but that's a little bit different. I mean we built all new application and they migrated from an old application, either an SAP application or an old PeopleSoft application or E-Business Suite and they migrated to our new Fusion ERP suite. That's a very different than simply lifting up an Oracle database workload and moving it over to Oracle.

The application goes to infrastructure as a service and then the database goes to platform as a service. That's the faster process, but a much larger install base. Again my estimate is that business will move over - the majority will move over the next five years and that's going to give us enormous growth rates over that five-year period.

Heather Bellini

Thank you.

Operator

Thank you. I will now turn the call over to Ken Bond for closing comments.

Ken Bond

Thank you everybody and thank you Holly. A telephonic replay of this conference call will be available for 24 hours. Dial-in information can be found in the press release issues earlier today. Please call the Investor Relations department for any follow-up questions from this call. We look forward to speaking with you. With that, Holly, I want to turn it back to you for closing.

Operator

Once again, we would like to thank you for participating on today's conference call. You may now disconnect.

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