QAD Inc (QADA) Q1 2020 Earnings Call Transcript

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QAD Inc (NASDAQ: QADA)
Q1 2020 Earnings Call
May 29, 2019, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the QAD Fiscal 2020 First Quarter Financial Results Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) And as a reminder, the conference is being recorded.

I would now like to turn the conference over to Kara Bellamy, Chief Accounting Officer. Please go ahead.

Kara Bellamy -- Chief Accounting Officer and Corporate Controller

Hello, everybody and welcome to today's call. Before we begin, I'd like to ensure that everybody understands that our discussion may contain forward-looking statements that are based on certain expectations and analysis. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those anticipated. QAD undertakes no obligation to revise or update these forward-looking statements to reflect events or circumstances after the date of this call. For a complete description of these risks and uncertainties, please refer to QAD's 10-K and 10-Q filings with the Securities and Exchange Commission.

Please also note that during this call we will be discussing non-GAAP pre-tax income, which is a non-GAAP financial measure as defined by SEC regulation G. A reconciliation of this non-GAAP financial measure to the most directly comparable GAAP measure is included in today's press release, which is posted on the Company's website.

Now, I would like to turn the call over to our CEO, Anton Chilton.

Anton Chilton -- Chief Executive Officer

Good afternoon and thank you for joining today's call to discuss QAD's fiscal '20 first quarter results. Joining me on the call are Pam Lopker, our President, and Daniel Lender, Chief Financial Officer.

Our first quarter source made (ph) guidance for both subscription and total revenue. Shortly after the end of quarter, we held our annual Global User Conference, Explore, where the focus this year was on increasing levels of disruption and change in manufacturing. We discussed how QAD solutions help companies sense, plan and act swiftly in response to changes in their industries and business models. To that end, at the Explorer event, we launched QAD adaptive applications receiving a very positive reception from our customers and analysts. The quarter also saw strong momentum in the conversion of our existing on-premise customers to QAD Cloud solutions.

I'll now turn it over to Daniel to discuss the financial results.

Daniel Lender -- Chief Financial Officer

Thank you, Anton. First quarter total revenue and subscription revenue met our guidance and both GAAP and non-GAAP pre-tax results exceeded our guidance, with small decreases across all expense categories. Our planned investment in sales and marketing to drive new customer acquisitions remains on track. For the first quarter, currency negatively impacted total revenue by $3.3 million compared with last year, but had a negligible impact compared with the prior sequential quarter. Our bottom line was negatively impacted by about $800,000 versus last year.

My comments today about growth rates are given on a constant currency basis, unless otherwise noted. First quarter revenue was $78 million compared with $86.2 million last year, which was prominently as a result of expected declines in a professional services business, which I'll address in a moment.

Subscription revenue grew 20% and was 32% of our business for the first quarter of 2020. Last quarter, we began providing annualized subscription billings growth statistics. Over the last twelve months our subscription billings grew by 28% with three year CAGR subscription billings growth at 34%. Subscription margins for the quarter were 63%, up from 62% a year ago. As a result of continued investment in cloud growth and infrastructure, we expect subscription margins to stay at current levels or make a small improvement throughout the remainder of this year. Our goal remains to improve subscription margins by 1 percentage points to 2 percentage points per year over the medium term.

Maintenance and other revenues were down slightly on a quarter-over-quarter basis to $29.9 million from $31.5 million. On a constant currency basis, maintenance revenues were down by $400,000. We expect to continue to see the effect of conversions to the cloud on our maintenance revenue line.

Professional services revenue was $18.4 million compared with $26.9 million from last year's first quarter. As expected, the decline primarily resulted from a large multi-site global implementation project that was substantially complete in Q4. We expect Q2 services levels and margin to be similar to this quarter, with improvement in the second half of this year. Services margins were negative 5% for the first quarter as anticipated and we'll continue to expect breakeven services margins for the full year.

License revenue for the fiscal '20 first quarter was $4.5 million compared with $6.3 million last year. In the first quarter, we recognized revenue from one deal greater than $1 million and as in recent quarters, the majority of our license revenue came from existing customers.

Total revenue by vertical for the first quarter was automotive 37%, high tech and industrial 33%, consumer products, and food and beverage 15%, and life sciences and other 15%. By geography, total revenue was, North America 50%, EMEA 28%, Asia Pacific 15%, and Latin America 7%. We discussed our EMEA business last quarter have addressed the challenges we were facing there and how our plans and initiatives under way. While we have made good progress, it will take several quarters before we see the full results of the changes we're implementing.

Gross margin for the quarter improved to 53% from 52%. Sales and marketing expense was $20.9 million or 27% of total revenue versus $19.9 million or 23% of total revenue last year. Our investment in business development, lead generation activities and sales personnel was responsible for the increase.

R&D expense was $14 million for both periods. As a percentage of total revenue, R&D expense was 18% this year and 16% for last year's first quarter. General and administrative expense was $9.4 million for both periods or 12% of total revenue this year compared with 11% last year. Stock compensation expense totaled $2.3 million for fiscal '20 first quarter and $2.1 million last year.

This brings our GAAP pre-tax loss to $2.5 million compared with GAAP pre-tax income of $2.6 million for last year's first quarter. We achieved breakeven non-GAAP pre-tax income versus $4.6 million last year. Our GAAP net loss totaled $3.2 million or $0.17 per Class A and 0.14 per Class B share. In last year's first quarter, GAAP net income was $1.4 million or $0.07 per diluted Class A share and $0.06 per diluted Class B share.

Income tax expense was $700,000 in the first quarter of fiscal 2020 compared with $1.2 million last year. For the full year, we continue to expect tax expense of approximately $3 million.

We ended April with $151 million in cash and equivalents compared with $139 million at the end of fiscal 2019. Our cash flow from operations was $14.2 million for the fiscal '20 first quarter compared with $3.8 million a year ago.

Our accounts receivable was $49 million at April 30 compared with $57 million a year ago and the decrease correlates to lower services billings. Day sales outstanding using the countback method was 55 days for fiscal '20 first quarter versus 56 days for the same period last year.

Our short-term deferred revenue balance at April 30 was $104.5 million versus $103.4 million a year ago. And it includes $33.3 million of deferred subscription versus $28.5 million, $68.4 million of deferred maintenance versus $72.0 million (ph) of deferred professionals fees versus $2.3 million and $800,000 of deferred other versus $400,000. As a reminder, our maintenance contracts are built annually, while our subscription contracts can be built annually or quarterly.

I'll finish my remarks with our second quarter guidance, which is being impacted by our services business. Despite a solid cloud bookings quarter, our anticipated subscription revenue growth quarter-over-quarter does not appear as strong as you might expect. During Q1, a significant portion of deals closed early in the quarter, which benefited Q1 revenue. Therefore, the impact of those deals to Q2 is not a significant of an increase over the prior quarter. While our Q1 subscription guidance included that effect, we are not anticipating a similar impact to our Q2 deal flow. In addition, as Anton mentioned, despite the strong performance in cloud bookings, we were a bit short of our internal goals as some of the deals moved from Q1 to Q2.

We are maintaining our full year guidance as we anticipate the deals that have slipped from Q1 will be closed. However, this has introduced an increased level of risk to our full year revenue. For the 2020 second quarter, we're expecting revenue between $77 million and $79 million, including subscription revenue of $25.5 million to $26 million. GAAP pre-tax loss of $3 million to $4 million. Non-GAAP pre-tax loss of $500,000 to non-cash pre-tax income of $700,000.

And our full year guidance remains unchanged as follows; revenue between $330 million and $335 million, including subscription revenue of $110 million to $112 million. GAAP pre-tax income of breakeven and non-GAAP pre-tax income of $10 million to $13 million.

With that, I'll turn the call back to you, Anton.

Anton Chilton -- Chief Executive Officer

Thank you, Daniel. As discussed on our last call, this year we're investing in sales and marketing with a focus on building substantial lead generation and new business development capabilities. This investment is already generating a solid pipeline and our funnel is increasing. However, we are seeing new deals taking a little bit longer to close. We had 15 new cloud bookings this quarter, with 10 of those conversions of existing customers and five new customers. Although we continue to see about a 50/50 mix between conversions and new customers on an annual basis, this quarter was more heavily weighted toward conversions. Looking forward, we will continue to increase our emphasis on winning new customers away from our competitors as we see substantial opportunity there.

This has been our biggest first quarter cloud bookings result ever and is double what we did last year. That said, we didn't quite reach our internal goals due to some deals slipping into the next quarter. Our cloud funnel remains strong and is up over 25% from this same time last year. As expected, we saw a significant drop in professional services revenue now that a large multi-year implementation is substantially complete.

Looking at the quarter from a geographic perspective, North America had a very strong performance bringing in a significant proportion of the bookings. EMEA was down as a percentage of bookings over the same period last year. However, the challenges discussed in our last call are being addressed and we expect to see improvements in funnel and results over the next few quarters. Asia-Pacific and Latin America also had quieter quarters when compared to last year.

A vertical breakdown saw a drop in performance for our automotive sector likely a reflection of increased caution in that market in general with overall vehicle production volumes down globally. While electronics and industrial sector had stellar performance this quarter, including bringing in our largest deal of the quarter. Life sciences remained steady and no major change in CP and food and beverage verticals.

Our QAD DynaSys division with its world class demand and supply chain planning solutions have another very strong quarter as did our QAD Precision division with our global trade and transportation execution solutions. Indeed, with all the disruption caused by ongoing tariffs and geopolitical uncertainties, we expect to see continuing demand for managing supply chains and global trade more effectively.

On the solution side of the business, we have more than 35 customers now working with QAD Adaptive ERP formerly known as Channel Islands, with 26 live or in the process of going live in the next few months. We have a growing pipeline of customers and prospects that expect to adapt to the ERP solutions in the near term.

In the QAD Labs, we're continuing to expand the capabilities of our shop floor execution solution. We're adding advanced warehousing capabilities and have launched an initiative in the Robotic Process Automation space. We will continue to invest R&D effort in digital transformation and the application of advanced technologies to support efficient and effective manufacturing processes.

I'll now hand over Pam.

Pamela Lopker -- President

Great. Thanks, Anton. I'd like to give another summary of QAD Cloud for Q1. So in Q1, we saw pick up in conversion factor Q4, which was somewhat lighter than (ph) conversion, Q1 had 10 conversions and five net new customers. As Anton indicated, it was our best Q1 ever for cloud, for booking. All regions contributed to cloud bookings with North America leading.

This quarter our industrial segment led all the segments. So I'll highlight some of the new industrial customers. We received a new order from an Italian subsidiary of an American Fortune 100 corporation, which manufactures machinery. This deal represents a continued standardization of QAD by this customer. We also received an order from a France multi-national corporation that produces a variety of construction and high performance materials. In addition, we received an order from a smaller US based company that manufactures fire protection and sprinkler steel pipe.

As with all the cloud customers and the release of QAD Adaptive Applications played a key reason for their purchase as well as their conversions in the cloud. I'd also like to give a little more color on our Explore conference particularly from a product perspective. It was our highest rated Explore event to date. Now I believe a lot of that has to do with the unveiling of QAD Adaptive ERP, which is designed to address the greatest challenges manufacturers face today, change and uncertainty.

You don't have to look hard to find the increasing levels of disruption in our customers industries. The way they manufacture, the geopolitical environment in which they operate and of course the economy with ever changing uncertainty regarding tariffs. Now more than ever, manufacturers need to be able to rapidly respond to changes. We -- customer has demonstrated a strong interest in our new production execution and our adaptive applications. 31% of the attendees visited our hands-on sessions and requested follow-up. 97% of customers attended said they would recommend the Explore conference to colleagues. And we are looking forward to seeing them next year in Las Vegas, May 11 through 14.

Thanks, Anton. Back to you.

Anton Chilton -- Chief Executive Officer

Thank you, Pam. So looking forward, as I said earlier, our investments in sales and marketing are starting to pay off in terms of lead generation. In fact our lead flow volume in Q1 is up 37% when compared to the same period last year. We're also ahead of the targets that we set for our marketing and lead generation teams.

Technology and geo-politics continue to drive change and uncertainty in manufacturing markets around the world. Legacy ERP applications don't provide businesses the flexibility and agility needed to react and rapidly respond to these changes. As Pam said, with the launch of QAD Adaptive Applications, our customers and prospects have access to solutions in the cloud that will support this rapid response. This will be a key source for ongoing growth of our cloud business.

We see a lot of runway in replacing legacy ERP applications and our total addressable market for cloud solutions is increasing. However, we do see an increase in short term risk with some deals taking longer to close. We think this is around tariffs and some negotiations and geopolitical situations around the world. And at this point though we do not expect this to affect our longer term goals.

We will now take questions live. Operator, can you please give the instructions for questions.

Questions and Answers:

Anton Chilton -- Chief Executive Officer

(Operator instructions) And for the first question, we will go to Bhavan Suri at William Blair. Please go ahead.

Bhavan Suri -- William Blair -- Analyst

Hey, guys. Thanks for taking my question. I guess I'll just dive into the last comment and couple it with the challenges you saw in Europe last quarter. I guess just as you think about the business as a whole, are you seeing any macro pressures you raised tariffs, you're talking about sort of a broad base, maybe a little bit of a slowdown in certain areas. I just want to get some color on what exactly are you seeing and is it specific to a region, is this specific to macro, is specific tariff between China and the US? And then how is the Europe business tracking vis-a-vis, the changes you've made, you've brought in sort of a new head of sales from Chicago, Dublin office to Europe to sort of oversee that. Just help me understand how that's playing out? Thank you.

Anton Chilton -- Chief Executive Officer

Thanks, Bhavan. Yeah. So I'd say, while there's a little bit of caution in there, it would remind us that we just did the biggest Q1 bookings quarter ever. So business is there and we are closing it. What I would say at the macro level, I -- we're not seeing broad responses to some of the uncertainty that we see there. I would say that selective customers are being a little bit more cautious and that's based on you know their specific businesses and their kind of management philosophies on what's going on. We do believe that some of that is generally around the tariff negotiations, plus some of the political uncertainties we've seen what's happened with Brexit and so on.

So but -- it would be not right to say that it's completely in one segment. It's specific customers across a range of segments that we're seeing and as an example automotive, yeah, there's a slowdown of vehicle production that everybody is aware of, but there's still some very bright spots in that and we still got some customers that are very active, some that are less so. So I'd say in response to that question, it's not a general trend, just a little bit more caution in some spots.

In terms of how that's impacting the business and how we're addressing I think, we're working to plan in EMEA. We've identified the issues that we've discussed on the last call. We've got recruitment plans under way there. We've made a lot of hires there. We've still got a few more to go. We've made a few more changes around the organization for example we -- a new VP of our services organization, a marketing organization and so on. So some changes organizationally and adding in some more resource to help us boost that. And we see that being on track. You're probably not going to see the results flow through until later in the year, but certainly internally against all the targets we set, we're comfortable with where we're at.

I think the overall condition for the QAD business, the funnel continues to grow as I said. It's over 25% up on the same period last year. We've seen the lead flow go up in Q1, so we're confident that we can get and remain on track for the year guidance as Daniel discussed.

Bhavan Suri -- William Blair -- Analyst

Got it. That's helpful. I guess I'll touch on one more. One of things about the cloud business, you think about that. We're talking about that being 50-50 new and existing customers. And we've talked about the focus on new logos given you can't force the existing customers move over and so that shift of incentives. Might be a little more color, if I fast forward it two or three years from now and you look at that pipeline for the cloud business, how would you expect it to look and how do you expect the sort of revenue break out to be a left out sort of think through that process?

Anton Chilton -- Chief Executive Officer

Yeah. I think for the short term, we see that 50-50 going there. We've still got a big runway in our installed base as well as a big runway of market share we can go and grab from legacy ERP competitors. I would expect over time that the new business is going to create a greater proportion because as we've converted more and more of our customers obviously there will be less of them to go. And so, we started to model that out over a kind of three to five year. But it's that kind of time frame, I think we're talking about before we see a significant shift in the proportion to new business.

Bhavan Suri -- William Blair -- Analyst

Got it. (inaudible) question. This and one more. But if you think about that business, you converted customers to the cloud. But it's been a pretty steady Eddie 30 something whatever the number is customers a year and I wonder there's going to be a hockey stick at some point either because they come up for a hardware refresh or a software refresh or something and there's going to be the obvious, we should book the cloud at some point. And you wouldn't think about that acceleration using about time frame, is that like five years out 10 years out, do you have some idea of how you would think about sort of where that J curve happens on that move from existing on-premise customers who are paying maintenance to cloud?

Anton Chilton -- Chief Executive Officer

So, yeah, I think as we're increasing our sales force and our lead generation capabilities and we're doing that both in the installed base as well as for new business. In fact we have a team that we've set up that looks at lead generation in the installed base specifically around conversions. So we will be putting more and more effort into pushing the conversions very, very heavily.

We see a number of different catalysts for people converting away from on-premise. Certainly hardware and burning platforms around support could be one of those. Another common factor has been where there's a change in management with a focus on getting IT folks really focused on business models and leveraging technology versus operating the technology and in keeping the systems up and running.

And then conversely on the competitive side, we see some competitors that are bringing to end of life some of the current versions and there isn't necessarily a migration path to their latest offering and we think that will drive some of the new business stuff. So we really see big runway in both those spaces.

Bhavan Suri -- William Blair -- Analyst

Got it. One last one for me. Any big competitive displacements this quarter? And who were they again? Thank you. A nice job on the billings number.

Anton Chilton -- Chief Executive Officer

Yeah. So I think the -- Pam highlighted one customer that's continuing to move away from its legacy ERP provider and to continue to consolidate onto the QAD platform. The other one that she referred to is the French organization and they have shown more signs of adopting the QAD platform and indeed moving away from one of our biggest competitors too. So yeah definitely a couple of significant ones there for us.

Pamela Lopker -- President

Those are both companies that have previously committed to an S&P kind of worldwide platform. So --

Anton Chilton -- Chief Executive Officer

Okay. Great. Thanks, Bhavan.

Bhavan Suri -- William Blair -- Analyst

Thank you.

Operator

Thank you. And our next question will come from Brad Reback at Stifel. Please go ahead.

Brad Reback -- Stifel, Nicolaus & Company -- Analyst

Great. Thanks very much. Guess I'm a little confused given that there's so many issues outside of your control impacting the overall demand environment, why not take the opportunity to reduce subscription expectations for the back half of the year? Thanks.

Anton Chilton -- Chief Executive Officer

As I said earlier, Brad, I think the funnel continues to grow and lead flow is up. And so that's giving us confidence that the deals are there to close and we did have the best Q1 bookings quarter we've ever had. We did introduce a little bit more caution around some of the deals that have slipped and so on. So we'll be keeping a close eye on that. But right now that's not insufficient or of sufficient magnitude for us to revise the guidance.

Brad Reback -- Stifel, Nicolaus & Company -- Analyst

Okay. Thanks. And switching gears when a customer moves to the adaptive apps, what type of uplift in revenue do you see from that customer? Thanks.

Anton Chilton -- Chief Executive Officer

So from a -- they -- if they're in the cloud, they get access to the adaptive applications. However, there are additional modules now that they also get access to that are already proving popular even early in their lifecycle. So the production execution module that we have is an example of that. You need to be on later versions of the QAD applications to take advantage of that. And that is a subscription model or module I should say that's purchased through subscription. And we expect to see more and more of that as we extend applications around our enterprise platform that we've introduced with adaptive applications. We'll see more and more of those things coming.

So the move to the adaptive platform itself won't necessarily generate money, but around that we'll have additional modules and capabilities that will be chargeable on a subscription basis for.

Pamela Lopker -- President

We think there are several capabilities, for instance, at the embedded analytic center that I think entice more management to be users. We have a really, really good requisition approval, mobile capabilities that again ask to drive more users today. If we look at (inaudible) percentage of an enterprise users have QAD apps in the component areas typically about 20% and moving up and to the end product med device type products is typically about 45% of the employees. So of course our goal is to move that up even further.

In the September time frame, we'll be releasing the first release of our CRM product built on the platform and we're already seeing tremendous interest in that from our user conference. So we're really looking at generating a bigger percentage of users using our products.

Brad Reback -- Stifel, Nicolaus & Company -- Analyst

Excellent. Thank you very much.

Pamela Lopker -- President

Thanks.

Daniel Lender -- Chief Financial Officer

Thanks, Brad.

Anton Chilton -- Chief Executive Officer

Thanks, Brad.

Operator

And we go now to Zach Cummins with B. Riley. Please go ahead.

Zach Cummins -- B. Riley FBR -- Analyst

Hi, good afternoon. Thanks for taking my questions. Just starting off, it sounds like your pace of hiring in the sales and marketing group is pretty well in line with expectations. So how should we anticipate this really trends over the next few quarters. Is there still some additional hiring that you're planning on doing in the upcoming quarters?

Anton Chilton -- Chief Executive Officer

Yes, there is. So I'd say we've done a substantial portion of it. Indeed, we last quarter ran a large boot camp here in Santa Barbara to welcome the new sales and marketing people into the organization and get them up to speed. We're running another one of those in mid to late July. So there'll be another bunch of people out here and then that will start to kind of tail off in the second half of the year and that's where we expect to see the lead gen results flow through from marketing leads to sales leads to opportunities and then ultimately to close deals. So again from a visibility perspective, start to expect to see that both in funnel terms and deal terms toward the back end of the year.

Zach Cummins -- B. Riley FBR -- Analyst

Understood. And in regards to the new reps, what is the sort of timeline that you're putting on them to get to full productivity?

Anton Chilton -- Chief Executive Officer

So the way that we measure them, we exclude them from our let's call it Internal productivity metrics in sales for the first six months they're on board. That doesn't mean we don't expect them to be productive, but that just allows us to give them the training and the exposure they need to our solutions, our philosophies, customer base, selling methods and everything else. And then after that, we expect them to be fully productive within a six-month period.

Zach Cummins -- B. Riley FBR -- Analyst

Understood. And final question from me. It sounds like you're doing a really good job on the lead generation side of generating the new opportunities, but what in your mind really needs to be done to be able to close these deals with new customers as you go through these next coming quarters?

Anton Chilton -- Chief Executive Officer

Yeah, it's the follow-up and obviously the execution. So the marketing organization and the new structure we've put in place as you rightly say is generating that. It's now getting those sales executives focused on those leads to follow up and creating the compelling messages that convert the interest into real opportunity and then into ultimately into a real deal. We like the fact that with the disruption that's going on, that is creating more and more of an incentive for people to move away from all the ERPs (ph) that's kind of stodgy and hard to change and expensive to change to one that's more rapid and agile. And so that's the message that we're really driving home with prospects and customers is, don't wait for change to come at your door, get ready for it and be on an agile platform that allows you to respond quickly and so that's kind of the core message that we're pushing out there to try and get people to move.

Zach Cummins -- B. Riley FBR -- Analyst

Understood. Well, thank you for taking my questions and best of luck in the coming quarters.

Anton Chilton -- Chief Executive Officer

Thank you, Zach.

Operator

Thank you. That does conclude our Q&A session for today. And we will turn back to Anton for closing remarks.

Anton Chilton -- Chief Executive Officer

Okay well thank you everybody for today's call. We appreciate it. And we look forward to updating you with our Q2 results in the future.

Operator

Ladies and gentlemen, this conference will be available for replay after 4:00 p.m. today through midnight on Thursday, June 6. You may access the AT&T executive replay system at any time a dialing 1800-475-6701 and entering the access code 466853. International participants dial 320-365-3844. Those numbers again are 1800-475-6701 and 320-365-3844. Access code, 466853. That does conclude our conference for today. Thank you for your participation and for using AT&T teleconference. You may now disconnect.

Duration: 32 minutes

Call participants:

Kara Bellamy -- Chief Accounting Officer and Corporate Controller

Anton Chilton -- Chief Executive Officer

Daniel Lender -- Chief Financial Officer

Pamela Lopker -- President

Bhavan Suri -- William Blair -- Analyst

Brad Reback -- Stifel, Nicolaus & Company -- Analyst

Zach Cummins -- B. Riley FBR -- Analyst

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