ARC Document Solutions Inc (ARC) 2005 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to the American Reprographics Company first quarter 2005 earnings conference call.

[Operator Instructions].

As a reminder, this call is being recorded for replay purposes.

And now I would like to turn the presentation over to your host for today's call, Mr. David Stickney, the director of corporate communications. Sir, please proceed.

Thanks, Emma and good afternoon everyone. Joining me for today's call is Mohan Chandramohan, our chairman and CEO, Suri Suriyakumar, our president and COO, and Mark Legg, our CFO.

Earlier this afternoon, the company issued a release reporting financial results for the first quarter of 2005 and in March 31, 2005. This release can be accessed from the investor relations section of our website at www.e-arc.com. Before we begin, here are a few items for everyone's reference.

First, we have arranged for a taped replay of this call which may be accessed by phone. It will be available approximately 1 hour after the call's conclusion and will be accessible for 90 days. The dial in access number for this replay is 617-801-6888. The pass code is 90413811. Secondly, this call is also being web cast live with a web replay also available. Both the call and the web cast can be accessed again from the investor relations section of the company's website at e-arc.com.

Finally, our investor relations firm is Financial Dynamics of San Francisco and their contact information is on our press releases. Please feel free to contact them directly for general information about the company. Before we begin, I would like to make a brief statement regarding forward-looking remarks and the use of non-GAAP financial measures.

This call contains forward-looking statements within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 regarding future events and the future financial performance of the company including 2005 financial guidance. We wish to caution you that such statements are only predictions and actual results may differ materially as a result of risks and uncertainties that pertain to our business.

These risks are highlighted in our SEC filings, specifically under the risk factor section of our annual report on form 10-K for the year ended December 31, 2004 and our final prospectus dated February 3, 2005.

The forward-looking statements contained in this call are based on information as of May 3, 2005 and except as required by law, American Reprographics Company undertakes no obligation to update or revise any of these forward-looking statements.

This call also will contain references to certain non-GAAP measures, such as EBIT and EBITDA. The reconciliation of these non-GAAP measures is set forth in our press release dated May 3, 2005, reporting our financial results for the first quarter of 2005 which is also available on our website and www.e-arc.com.

Now it is my pleasure to turn the call over to our chairman and CEO, Mohan Chandramohan.

Thank you, David. Good afternoon. I wish to thank you for joining us today to discuss ARC's financial performance for the first quarter of 2005. On our last earnings call, we provided a brief overview of our company and our business. An archived web cast of that conference call is still available on our website. For those who are new to the company and want the general overview, we encourage you to listen to that web cast which will remain available until May 31 of this year.

On this call, in addition to discussing our performance for the first quarter, we wish to address specific topics. Among them are a review of trends we see in the non-residential construction sector, a review of the reprographics industry, our position in the industry and a recap of our growth initiatives.

We would like to begin with a brief look at our financials. In the first quarter of 2005, we reported sales of $116.5 million compared to $110.5 million in the first quarter of 2004. Our gross margin for the first quarter was 41.5% and our EBITDA margin was 22%. This compares to a gross margin of 41.5% and EBITDA margin of 21.2% for the same period last year.

Our fully diluted earnings per share for the first quarter of 2005 were $0.19 before a one-time tax benefit related to our IPO. Excluding a $1.5 million write-off of deferred financing costs related to pre-payment of debt from IPO proceeds, fully diluted earnings per share were $0.21. Our Chief Financial Officer, Mark Legg will discuss our first quarter financial performance in greater detail later on this call.

Allow us to take a moment to provide a top down view of our industry. We continue to see positive trends in the architectural, engineering and construction communities commonly referred to as the AEC industry. We constantly perform market intelligence by speaking with executives in our client firms, monitoring our customer product pipelines and communicating with product managers and people on the ground at construction sites where we deliver construction plans.

We anticipate growth to continue in the non-residential construction market. FMI, the construction industry consulting firm is projecting non-residential construction to grow at a compounded annual rate of 5.8% through the end of 2007. Today, we see continuing signs of this projected expansion including positive sentiment from our diverse customer base, a growing pipeline of customer projects and business coming from a broad base of activity.

The primary drivers behind this growth are GDP growth, sustained jobs growth, business investment growth and favorable interest rates. We serve the AEC industry by providing our customers on demand reprographic services. Reprographics is the business of managing and distributing construction documentation. This entails working with thousands of documents used to keep construction teams working from the same information. These teams frequently consist of hundreds of trades and sometimes thousands of trades people for a single construction project.

Fundamentally, our business is document management, document distribution and logistics and print-on-demand. To provide these services, we operate a nation wide infrastructure characterized by the hub and spoke arrangement of digitally connected reprographics service centers in nearly every metropolitan region in which we operate.

Technology is bringing about the conversions of a number of different businesses with the reprographics industry. The two businesses that are converging most quickly with the reprographics industry are the document management business a 13 billion market in the U.S. and the facilities management business, a 5 billion business in the U.S.

The convergence of these 2 businesses with reprographics is fueling 2 powerful trends. First, customers are increasingly requesting web-based document management services which include the ability to view, order, download and digitally distribute construction documentation.

Second, customers are more and more looking for in-house printing capabilities, primarily for their design check printing needs. They also desire to download documents and print short runs in-house without waiting for the reprographics shop to produce them.

In order to capture these shifting and growing markets, we have pursued certain focused growth strategies. Our growth strategies include technology development and licensing, continued growth of our national footprint, facilities management, premiere accounts and greater penetration into non-AEC markets.

Five years ago we designed and developed what has ultimately become the suite of powerful web-based applications and software products under the brand name, PlanWell. Today, PlanWell is one of the most widely used web-based document management applications in the industry, with 279 reprographics service centers both inside and outside of ARC connected to our technology center in the Silicon Valley.

Our technology development strategy includes licensing our technology to other independent reprographics firms to a private trade organization we operate under the name of PEiR, spelled PEiR which stands for profit and education in reprographics.

We will continue to grow our national footprint through a combination of targeted acquisitions and new branch openings. We will pursue acquisitions to expand our hubs or major production facilities and open new branches to serve as spokes for these hubs.

We have been highly focused on growing our facilities management business. These programs are designed to place reprographics equipment and sometimes tasks (ph) in our customer's offices. Our facilities management contracts typically run between 3 to 5 years and at higher gross margins than our centralized reprographics services. We began this initiative in the late 1990's and since December 31, 1997 it has grown at a compounded annual rate of nearly 32%.

A new service brought about by technology is our premier accounts initiative. This service is ideal for large firms that operate in multiple markets and purchase their reprographics services from multiple vendors. In many cases, these firms would rather be served by one reprographics company. Given that our presence across the U.S. represents the only national footprint in our industry, we provide the perfect solution for these customers.

Finally, while we are pursuing opportunities in our core AEC market, we intend to maintain the 80/20 revenue mix of AEC versus non-AEC business as our overall sales grow. The gross margins in our non-AEC work are very similar to our AEC work and the diversity in our revenue stream acts as a buffer for any AEC cyclicality we may experience.

With that as a summary of our growth strategies, I would like to turn the call over to our Chief Operating Officer, Suri for a brief operations update. Suri?

Thanks, Mohan. On the technology front, we continue to enhance and maintain our current solutions and pursue opportunities for new value added products.

Most recently, we have been preparing for a tighter integration of our invitation-to-bid software called BidCaster. With our flagship product which we refer to as PlanWell Enterprise this integration primarily is at the database level and makes the system easier for us to host, while it makes it more efficient for the reprographer and even more convenient for the end user.

We began test licensing the product late in the first quarter of this year and introduced it nationally at an industry trade show just a few weeks ago. In order to maximize some of the resources in our technology development arena, we recently opened a branch in Cocudan (ph), India where we have established excellent contacts. ARC India (inaudible) currently employs 5 programmers, who assist in building our applications.

The design development and architecture of our applications will continue to originate from our technology center in Fremont, California. As for PlanWell, itself, the adoption of our flagship application continues to grow. The system is currently available in 279 locations and hosts more than 77,000 projects with about 9 million documents.

As we have stated previously, part of our strategy is to create technology solutions that will become industry standards in the reprographics world. In order to accomplish that objective, the use of a licensing program and a private industry association we own and operate called PEiR, profit and education in reprographics. They both liberate the plan of technology solutions into the fragmented reprographics market place.

The PEiR group in particular has shown steady growth since it's inception in 2003, with the current roster of more than 70 members and real possibilities for the programs such as in Europe. Both the PEiR group President and I recently spent time with reprographers in U.K., France and Spain. And we were really encouraged by what we saw and heard in terms of education and technology, which are in great demand from an industry perspective and we believe that PEiR group will become a very attractive concept in Europe.

As to the new market and branch openings, we entered four new markets in the first quarter, primarily through branch openings; one in Columbus, Ohio, one in St. Louis, one in Kansas City, Missouri and one in Mexico City, Mexico. All three domestic locations are dynamic markets that hold offices of several of our existing customers. Mexico City is our first location south of the border. Market research with our vendors suggests that it is an excellent opportunity for our services.

As Mohan mentioned our facilities management program continues to flourish. We have added 85 contracts since December 31, 2004 and currently have more than 2,000 contracting places across the U.S.

We continue to build the organizational and market support for premiere accounts. We are finding that our larger customers are attracted to the idea of consistent service levels. A single purchase agreement and a common platform for their construction documentation certified by our technology installation.

However, they frequently need to streamline their own fragmented supply chain management to meet the requirements of a consolidated purchasing strategy.

Fortunately, we can assist them in their efforts since many of these customers are already doing business with us at the local level. As a result, we can continue to support them and assist them while announcing our value to such prospects and patiently advancing what is typically a long sales cycle primarily due to the fragmented nature of our business.

Finally, the mix of AAC and non-AAC work is remaining relatively constant as we grow. Opportunities in color and evolving equipment and the quality standards as we let the growth in the overall economy continue to provide opportunities for us to leverage our core services into the non-traditional reprographics market.

With this discussion as the context for our financial performance, I'll now turn the call over to Mark Legg, our Chief Financial Officer. Mark?

Thank you, Suri and good afternoon to everyone.

I would like to start the financial review with our first quarter results of operations.

Revenue for the first quarter of 2005 was $116.5 million compared to $110.5 million reported in the same period of 2004 for an increase of 5.4%.

Our business has 3 unique product lines. Revenues by product lines in the first quarter were as follows.

Reprographic services came in at $88 million. Utilities management came in at $19 million while equipment and supplies came in at $9 million.

Compared to last year, much of our revenue growth was driven by an increase in facilities management, which grew 13%. This increase partially offsets an anticipated decrease in our equipment and supplies business, which declined 1%.

We expect our equipment business to continue to decline as we convert this revenue base to FM business at higher gross margins.

In addition, there are 6 geographic regions that we track. Revenue per region during the first quarter were as follows.

Southern California was $36 million. Northern California was $22 million. The Pacific Northwest reached $7 million. Our Southern region, which extends from Florida to Las Vegas, achieved $19 million. The Midwest delivered $13 million. And our Northeast division came in at $19 million.

Compared to the first quarter 2004, all geographic regions achieved increased revenue with the Southern region growing the fastest at 11%. California as a whole grew at 4.7% while the Pacific Northwest grew at 9.6%. The Midwest and Northeast grew at 3.2% and 2.5% respectively.

Gross margins for the first quarter came in at 41.5%, which was on par with 2004. While we experienced positive cost of goods sold margin variances in materials and production overhead, these gains were offset by a negative variance in labor margins.

Production labor has increased due to new branch openings and as we gear up for continued revenue growth.

Operating expenses comprised mostly of SG&A came in at the same level as the first quarter 2004 at $27.3 million.

EBITDA of $25.6 million was achieved in Q1 '05 compared to $23.4 million in Q1 '04 for a growth of 9.6%.

EBITDA margins in Q1 '05 came in at 22% compared to 21% last year.

Operating income in Q1 '05 was $21.1 million or 18.1% of revenue. Compared to 18.6%, I'm sorry. Compared to $18.6 million or 16.8% of revenue in Q1 '04.

Operating margins have increased over the first quarter 2004 due to the leverage benefit and thus margin expansion we enjoy from organically derived incremental revenue.

This expansion is the result of our cost structure being approximately 60% fit and the fact that we have additional capacity today on our existing production floors.

Interest expense in Q1 '05 was $8.3 million compared to $8.1 million in Q1 '04. The 2005 interest expense includes $1.5 million of costs related to the early retirement of debt combined with the IPO proceeds.

Without this IPO related expense, interest costs in 2001 first quarter would have been $6.8 million compared to $8.1 million last year. Interest cost is lower because all of our net IPO proceeds from the sale of primary shares were used to pay down debt. In addition to our debt payments from internally generated cash flows made during 2004.

The Company's income tax provision for the first quarter 2005, excluding the one-time income tax benefit from our re-organization to a C corporation, in connection with our IPO was $5 million compared to $2.3 million in 2004.

This increased because a substantial portion of our business was operated as an LLC prior to February 2005 and was taxed as a partnership. Accordingly, no income taxes were provided on the LLC earnings because the members of the LLC pay the income taxes on such earnings, not the LLC itself.

Effective from our re-organization upon the consummation of our IPO, all of our earnings are subject to federal, state, and local taxes at a combined statutory rate of approximately 42%.

In connection with our re-organization from an LLC to a Corp, we recognized a one-time income tax benefit of $27.7 million related to the setting up of deferred income tax accounts from the assets that were previously inside the LLC, primarily comprised of tax related goodwill.

This resulted in an increase in the Company's deferred tax assets of $27.7 million and its corresponding income tax benefit for the same amount. I want to emphasize that this income tax benefit is a non-cash transaction. It is a one-time event resulting from the accounting treatments of this transaction.

Because of its non-recurring nature, we believe that this income tax benefit should be viewed separately from the recurring income tax provision that applies to our income from operations.

Now income for the first quarter 2005 was $35.6 million or $0.85 per share fully diluted. Excluding the IPO related interest charge of $1.5 million and the non-recurring income tax benefit of $27.7 million that I previously discussed. Our first quarter EPS was $0.21 per share fully diluted.

Cash flow from operations in the first quarter 2005 came in at $2.6 million compared to $8.6 million in Q1 '04. This decrease is due to the timing of interest payments on our senior debt. Coupled with an increase in working capital. This increase in working capital primarily relates to a decrease in accounts payable and accrued expenses during the first quarter 2005 due to timing of under payments related to the fourth quarter of 2004.

We expect a large portion of this working capital increase to revert before the end of 2005.

Despite the recent increase, our working capital requirements remain relatively modest. At March 31, 2005 working capital was $29 million or approximately 6.3% of trailing 12-month revenue.

Net accounts receivable increased from $66 million in Q1 '04 to $70 million in Q1 '05 while day sales outstanding remained constant at 54 days.

Inventory at the end of the first quarter 2005 was $6.2 million. This compared to $5.9 million during the same period last year and represents an inventory supply on hand of 31 days.

Total debt including capital leases at the end of the first quarter 2005 was $262 million down from $372 million in Q1 '04.

This $110 million decrease is attributable to net IPO proceeds of $89 million used to retire debt comparable at $21 million in net debt payments from internally generated cash flows.

The $21 million in net debt payments is after paying pre-IPO member distributions for tax purposes of $14 million.

Consistent with the outlook we've provided on our last conference call, for the full year 2005 we believe that ARC will generate revenue of approximately $470 to $480 million. Based on this revenue level, we expect our earnings per share including, excuse me, excluding the non-recurring income tax benefit of $27.7 million to be in the range from $0.79 to $0.81 per share fully diluted.

That concludes our financial discussion. And at this point, I will turn the call back to Mohan for question and answer session. Mohan?

Thank you, Mark. We wish to spend some time taking your questions. For your information, Mark, Suri, and I, the 3 officers of the Company, have dialed in from 3 separate locations. So I will take your questions and where appropriate I will direct them to my fellow officers.

So with that, I would like to turn this over to Emma (ph) for the Q&A.

Thank you, sir.

[OPERATOR INSTRUCTIONS]

And our first question comes from the line of Michael Schneider from Robert W. Baird. Sir, please proceed.

Good afternoon, guys.

Hello, Michael.

I was wondering first if you could slice the repro services number maybe in a different fashion. I'm trying to get a sense of what maybe same store sales would be at some of the more mature stores.

If you look at it in that fashion maybe those open a year or longer? Or if that isn't relevant in your eyes?

Mark, you want to take that?

Yes. Hi, Mike.

Yes, Mike, we have a varying size of stores within our network, within our 180 plus locations. Stores that do $30,000 a month in revenues to stores that do $20 million annually.

And so it's such a wide range, it's really impossible to give you an answer versus how mature a store is. It more has to do with the market it's in and the size of the store, whether it's a satellite or whether it's a hub.

That being said, if you wanted to talk about just new branch openings, typically a new branch opens a market obviously at zero revenue and ramps up to clear the $50,000 per month during the first 12 months of operation.

Okay. I, maybe Mark a better way to answer the question is if you look at the call at the 4 or $5 million increase in services revenue year-over-year, how much of that would be driven by the new branch openings versus same store sales growth?

Same store sales growth, let me put it a different way.

We had during the $6 million increase, during the timeframe during the 12 months from April 1 until the end of this quarter. We had one meaningful acquisition in December '04 that added roughly a million dollars in revenue to Q1 '05.

Okay.

We had 7, 6 other very, very small acquisitions that collectively added less than half a percent to our '05 revenues.

Of course these types of acquisitions, because we're primarily buying a customer list, and in 100% of the cases folding that acquisition into an existing operation, we consider these to be synonymous with branch openings.

The rest of the growth is of course purely organic growth.

Okay. That's helpful.

And maybe for Mohan and Suri, just your idea about or your current read on pricing in the industry as conditions continue to firm. Have you seen any ability of your local operations to raise prices?

Michael, we still haven't seen much pricing power in the marketplace. However, we are able to surcharge our customers for our delivery services due to the increases in the fuel prices.

That is being passed on to our customers.

But beyond that, it's still early in the upturn for us to see any pricing power.

Great. Okay. Thank you.

Next question, please?

Thank you.

And our next question comes from the line of John Schapiro (ph) from Goldman Sachs. Sir, please proceed.

Hi. This is actually Al Cavilly (ph) sitting in for John. A couple of quick questions, first of all I guess with concerns about the economy slowing down, interest rates rising, what are you hearing and seeing from your customers?

Well, like I talked about earlier in my presentation, the key indicators that drive our business have lined up favorably indicating strong numbers initial construction growth, those indicators being DDP growth, sustained jobs growth, business investment growth, and interest rates.

While interest rates are moving up, they are still in our opinion at historic lows.

We haven't seen any of these indicators change significantly to cause us concern. So we still project strong numbers in initial construction growth.

Okay. And then I guess the recent data from the CIRB has showed that the value of building starts in California was up 15% January and February. And then in March it dropped a couple of percent.

I guess when does your business kind of respond to that building starts?

We always lag that trend by up to, from 6 months to a year because from the commencement of starts to the bid and build process there is a time lag. And during the bid process is where we see a bulk of our business.

So that's kind of delayed from the start. So we lag the business by 6 to 12 months. And we expect to see in upturns in those numbers 6 to 12 months down the road.

Okay. Thanks. And then finally on the tax rate, it was a little bit below 40% this quarter. I know you mentioned the statutory tax rate of about 42%. I guess going forward, what should we be modeling for the tax rate, closer to the 42, 43 or closer to this quarter?

Mark?

Going forward we expect to be around 40 to 41, I'm sorry, 40 to 41%. The only reason it fell off the 42% is we had some tax cushion that was allocated to the issues on returns than have passed their statutory dates. So they're not under review anymore. And part of that cushion was released earnings in the first quarter.

Okay. Great. So, I'm sorry.

So are you saying then it's still going to be about 40 to 41 going forward?

Yes.

Okay. Great. That's it. Thank you guys.

Thank you. Next question, please?

[OPERATOR INSTRUCTIONS]

And our next question comes from the line of Eric Sledgister from Credit Suisse First Boston. Please precede, sir.

Good afternoon and thanks for taking my call.

Hello, Eric.

Hello.

My question relates to the guidance. It sounds like the guidance of $0.79 to $.0.81 excludes a non-recurring benefit of $27 million but not the $1.5 million in deferred financing costs?

It is after the deduction of the $1.5 million in financing costs.

Okay. And just to clarify was the $1.5 million costs in your guidance put forth last quarter?

Mark, you want to answer that?

Yes. It was always in the guidance.

Okay.

And it also sounds like digital is picking up steam. Can you update us on the percent of revenue that you receive from digital and whether you're seeing any change either positive or negative in charging for those services?

I'd be happy to.

Because of the changing dynamics in our business, there are 2 areas that we're highly focused on. One is the digital document management service and the second is facilities management services.

We would like to see over the next 3 to 4 years at least a third of our revenues to come from these 2 areas.

As of the end of the first quarter, which is March 31, 2005, these 2 areas represented approximately 19.7% of our total revenues with 16.5% coming from facilities management and 3.2% coming from digital document management, which is a brand-new revenue opportunity.

So we see both of these areas growing nicely and we are very much on track to meet our desires, our goals.

Okay. Thanks a lot.

Thank you. Next question, please?

And, sir we have no further questions. We will turn it back to management for closing remarks.

Thank you very much. This is David Stickney again, the Director of Corporate Communications.

I'd like to thank everyone for joining us today on our second earnings call. For anyone who has a need for further information about the Company, we invite you to call me here in our Walnut Creek office at 925-949-5100 or you can contact Jason Golz of Financial Dynamics, our investor relations firm, at the following number - 415-439-4532.

Thank you again for joining us and have a great evening.

Thank you.

And ladies and gentlemen, we'd like to thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.