ARC Document Solutions Inc (ARC) 2005 Q2 法說會逐字稿

Good day ladies and gentlemen and welcome to the quarter 2 2005 American Reprographics Company earnings conference call. My name is Jon and I will be your coordinator for today.

[Operator Instructions]

I would now like to turn the presentation over to your host for today's conference, Mr. David Stickney, Director of Corporate Communications. Please proceed sir.

Thanks Jon, and good afternoon everyone. Joining me for today's call is Mohan Chandramohan, our Chairman and Chief Executive Officer, Suri Suriyakumar, our President and Chief Operating Officer and Mark Legg, our Chief Financial Officer.

As some of you are aware our financial results were inadvertently released at 11:32 am pacific time, prior to the close of the market. We have investigated the early release and the initial indication is that as a result of a miscommunication our financial printer inadvertently forwarded our 8K to the SEC prior to the close of the market.

We apologize for any confusion this may have caused. We will now proceed with the presentation of our financial results for the second quarter of 2005 ended June 30. as noted earlier this afternoon the company issued a release reporting financial results for the second quarter of 2005. This release can be accessed from the investor relation section of our web site 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 54886806.

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 web site 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 in this call. This call contains forward looking statements that fall 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 the company's 2005 financial outlook.

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 our quarterly report on form 10Q for the quarter ended March 31st, 2005. under the ritz factor section of our annual report on form 10K for the year ended December 31, 2004, and our final prospectus dated February 3rd, 2005.

The forward-looking statements contained in this call are based on information as of August 3rd, 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 EBITDA, EBIT, pro forma incremental tax provision and pro forma net income. The reconciliation of these non-GAAP measures is set forth in our press release dated August 3rd, 2005. reporting our financial results for the second quarter of 2005, which is also available on our web site at www.e-arc.com.

At this time I'll turn the call over to our Chairman and CEO, Mohan Chandramohan.

Thank you David. Good afternoon and thank you for joining us today as e discuss ARC's second quarter financial and operating performance for 2005. We also intend to spend some time explaining some of the details of our operating infrastructure for those of you who are just getting to know ARC. Lets begin with a brief look at our financials. ARC reported sales for the second quarter of 125.6 million compared to 115.6 million in the second quarter of 2004. our gross margin for this period was 42.7% and our EBITDA margin was 23.6%.

We reported an operating profit of 25.1 million and net income of 11.4 million, or fully diluted earnings per share of $0.25. Additionally we generated significant operating cash flow as Mark will elaborate later in this call. I would also like to take this opportunity to update our outlook for the year.

We anticipate the revenue will be 485 to 490 million, up from our previous estimate of 470 to 480 million and fully diluted earnings per share will be between $0.82 to $0.84 per share again up from our previous estimate of $0.79 to $0.89 per share. We continue to experience positive trends in our industry. The macro economic trends facilitating this ongoing expansion in the AEC industry including expanding employment, strong business investment growth and declining commercial vacancy rates.

On today's call I would like to take a moment to elaborate on our operating infrastructure. As you may know, a significant portion of our historical growth has come from acquisitions. We have a tremendous track record of successfully integrating our acquisitions due to 2 primary reasons.

First we have maintained the brand and reputation of the platform acquisitions. We have done over the years. Second, we have supported these companies as they have come on board through a strong organizational and training structure. As a result, you will rarely see a sign in front of our local operations bearing the ARC name. Instead, we are represented by 42 different brands throughout the country. This structure provides our organization and our customers the best of both worlds in fulfilling local and national needs. ARCs strength in logistics and our technological backbone make all of this possible.

Our local brands represent trust, loyalty, and a direct relationship with the community. Since more than 75% of a construction projects labor, supplies and services are provided from within a 35-mile radius of the project, local relationships are key to acquiring businesses - business in a local community. It is for these reasons that we maintain the local brand in each market.

Nationally however, our premiere accounts customers benefit from ARC's network of local companies acting in concert. Our large regional and national customers can use our local service centers as access points or channels to reach a more geographically diverse group of participants for larger more collaborative projects. Speed, cost and efficiency are the primary benefits to our customers.

For example, a recently completed resort and casino in Southern California was built in a remote part of the inland empire. The project architects however were in, were based in Las Vegas. Our divisions in southern California and Nevada used our online applications and digital backbone to send mountains of rapidly changing information back and forth seamlessly between the design and construction teams to get the project completed on time.

This type of coordinated support supplied by ARC was critical to the project's success. Our decentralized management structure and digital network combined with our ability to distribute and print makes operations like this example possible. In addition our premier accounts one-view portal provides our customers and our account reps a single administration and management tool to track billing and project activity across multiple locations. These capabilities are unique in commercial reprographics and represent a few of ARC's key differentiators.

We manage ARC through 9 regional CEOs who focus on the achievement of corporate initiatives in specific areas of the country. Because our regional CEOs are former divisional executives they also bring their deep operational experience to bear on effectively managing their territories. From an executive development standpoint our strategy to promote from within for these positions has leveraged our operational expertise and provided career opportunities for our best and brightest.

Each local division operates in a hub and spoke structure, configured to locate our production facilities within a 5-mile radius of our customer communities. Many of the thousands of orders we receive in a day need to be handled and delivered back to the customer in less than 2 hours. A hub and spoke structure enables us to load balance the cross service centers thus making best use of excess capacity.

From an expansion point of view it also allows us to enter near by markets, open satellite shops and expand contiguous service territories in a relatively inexpensive way, making efficient use of capital.

And speaking of expansion. I would like to make a special note about the peer group. The trade association we operate for independent topographers. During the second quarter of this year the peer group recorded the highest level of new memberships in any single period of its existence, by adding 45 new companies to its roster.

We believe this reflects not only the value we bring to the independent topographers as an industry advocate but also the optimism our invested peers demonstrate when they know they have the support of a strong and professional organization behind them.

I hope this overview provides you with a clearer picture of our operating structure and gives you some insight into our success. And now I would like to call upon Suri for an operations update. Suri?

Thank you Mohan. We have strong performance across our business during the second quarter with a few significant high spots in (inaudible - accent) operating units. One of those high spots occurred within our private industry association the peer group. As Mohan mentioned the organization experienced very strong growth during the period going from 63 members at the end of the first quarter to 108 members at the end of the second quarter. This represents membership growth of more than 50%. We believe the increase in membership growth is due not only to our marketing efforts, but also to the high level of value and support that independent topographers receive from their membership in the peer group.

The opportunity to increase the market penetration of our PlanWell of our technology products increases with our membership growth. Our goal to become the industry standard for the construction document management comes into sharper focus with each new peer member group in the group.

As evidence of our growth in PlanWell penetration large format document usage--

Maybe about 20 after.

In PlanWell, passed a major milestone in the second quarter as well. In June our PlanWell systems report showed more than 10 million large former documents have been posted to the system since its inception. These documents represent more than 80,000 construction projects and more than have a million uses of plan out.

While our focus remains firmly on growing the US market we continue to see potential for this trade association in Europe, initially in France. Our entry-level online plan room product has been translated into French, a European distributor has been selected and the French version of the associations web site was posted several weeks ago. In addition, the first members from the UK will be coming onboard in the coming months.

We are encouraged by these first steps on the European continent and will continue to quietly market our trade association and technology in this market.

Our onsite service business, which often we refer to as facilities management, continues to be a growing part of our product and service offerings. These contracts represent ARC equipment and services placed inside a customer's office and billed on a pay-per-use basis. During the second quarter we saw the addition of 88 new locations for onsite equipment and services throughout the country. And the total number of locations grew to more than 2100 as of June 30th, this year.

As for our centralized topographics operations we entered new markets in the Midwest, new facilities in both Cleveland and Cincinnati in Ohio and we expect to continue our expansion there.

In the second quarter we were happy to welcome a new premiere account. MA Mortenson Company is one of the top 50 construction companies in the US in terms of dollar volume of construction. It operates as a diversified construction organization in the US and in several international locations. Our premiere account relationship with Mortenson include providing onsite services in each of their home cities across the United States as well as local centralized services at their project locations.

Finally, the build out of our second technology center in Silicon Valley was completed in June. It is now the primary day-to-day network operation center for PlanWell and our other web based applications. The increased capacity and scalability provide much greater operational flexibility and our oral network improvements have delivered a noticeable speed difference to our web based customers.

Our real technology center now houses our engineering development team but can act as a fully functional back up for our day-to-day operations if necessary.

With that operation summary as a background for our financials I'll turn the call over to our CFO, Mark. Mark?

Thank you Suri and good afternoon to everyone. I'd like to start the financial review today with our second quarter results of operation. Revenue for the first quarter of 2005 came in at 125.6 million compared to 115.6 million reported in the same period of 2004, or an increase of 8.6%.

Segmented by our 3 primary product lines, revenue in the second quarter was as follows. Reprographic services 94.7 million. Facilities management 21 million, and equipment and supplies 9.8 million.

The increase in our onsite services, or facilities management business which grew about 14.9% during the second quarter is a key contributor to our revenue growth. This increase partially offsets an anticipated decrease in our equipment and supplies business, which declined 4.8% during the second quarter. As we stated in the past we expect our equipment business to continue to decline as we convert this revenue base to onsite service business at higher gross margin.

We track 6 geographic regions in our company, revenues per region were as follows. Southern California was $39 million, Northern California was 23.2 million, the Pacific Northwest reached 7.3 million, our Southern region which extends from Las Vegas to Florida came in at 19.9 million, the Midwest delivered 15.5 million and our Northeast division came in at 20.7 million. Compared to the second quarter of 2004 all geographic regions achieved increased revenue. California as a whole grew up 6.6% while the Pacific Northwest grew at 9.2%. The Southern and Northeast regions grew at 9.2% and 7.3% respectively. The Midwest region grew at 18% primarily due to a small strategic acquisition made in December 2004. without that addition location revenues in the Midwest were essentially flat.

Gross margin for the second quarter came in at 42.7%, similar to the same period in 2004. While we experienced positive cost to consol margin variances in both materials and production overhead, these gains were offset by an anticipated increase in our production labor. Production labor has been increased to staff our new branch locations and to gear up for additional revenue growth.

Our SG&A expenses came in at 28.1 million, about the same level as second quarter of 2004 despite and 8.6% growth in revenue. EBITDA of 29.6 million was achieved in the second quarter of 2005 compared to 25.8 million in the second quarter of 2004, or a growth of 14.7%. EBITDA margins in the second quarter of '05 came in at 23.6% compared to 22.3% last year.

Operating income in the second quarter of '05 was 25.1 million or 20% of revenue compared to 20.6 million or 17.8% of revenue in the second quarter of 2004. operating margins have increased over the second quarter 2004 due to the leverage benefit invest margin expansion we enjoy from organically derived incremental revenue. This expansion is a result of our cost structure being approximately 60% fixed and the fact that we have additional capacity on our existing production floors.

Interest expense in the second quarter of 2005 was 6.2 million. This compared to 8.4 million in the second quarter of 2004. interest cost is lowered because al of the company's proceeds from our IPO were used to pay down debt. In addition to the $37 million of debt payments made from internally generated cash flow since June of last year.

The company's income tax provision in the second quarter of 2005 was $7.6 million compared to $2.7 million in 2004. this increased because a substantial portion of our business was operated in an LLC prior to February 2005 and was taxed as a partnership. Accordingly no income taxes were recorded on the LLC earnings because the members of the LLC paid the income taxes on such earnings, not the LLC itself.

Excepted from our reorganization upon the confirmation of our IPO, all of our earnings are subject to federal, state and local taxes at a combined statutory rate of approximately 42%. Had ARC been a C corporation in 2004 as opposed to an LLC, we would have recorded taxes of approximately $5.7 million.

Net income for the second quarter of 2005 was 11.4 million or $0.25 per share fully diluted. This represents a 39% increase in our EPS compared to the same period last year. Our second quarter '04 net income adjusted for the incremental income tax provision, assuming we were a C corp in 2004, amounted to 6.9 million or $0.18 per share fully diluted.

Our cash flow from operations in the second quarter 2005 came in at $22 million compared to $2.6 million in the first quarter of '05. This increases was attributable to a reduction in our working capital since the first quarter primarily in accounts receivable. Our day sales outstanding in accounts receivable has improved to 50 days as of June 2005 compared to 52 days as of June 2004.

Total debt including capital leases at the end of the second quarter 2005 was 256.4 million. This is down from 379 - excuse me 370.9 million in the second quarter of 2004. this decrease is attributable to net IPO proceeds of 89 million used to retire debts coupled with a 37 million of net debt payments made from internally generated cash flow since June of last year.

As Mohan noted earlier in his call we are updating our annual 2005 outlook and anticipate that revenues will be in the range of 485 million to 490 million and our earnings per share will be between $0.82 and $0.84 per share fully diluted. That concludes our financial discussion and at this point I will turn the call back to Mohan for the question and answer session. Mohan?

thank you Mark. The officers of ARC, myself included have dialed in for this call from separate locations, so hence I will take your questions and where appropriate I will direct them to either Suri or Mark. So with that I will turn it over to the operator for the Q&A.

[Operator Instructions]

And we'll take our first question from the line of Jonathan Shapiro of Goldman Sachs. Please proceed.

Hi, thanks, good afternoon.

Good afternoon Jonathan.

I just wanted to see if you could give an update, you talked a little bit about FM, if you could talk a little bit about some of the stuff you're seeing in the non-AEC markets in terms of sort of as a growth initiative and then also market conditions, if you could maybe talk nationally and then maybe some of the highlights from some markets around the country, what you're seeing for construction activity.

Yes, facilities management or in-house front centers are our goal for the year of 16% of revenues. And we are well ahead of that goal as of June 30, where our revenues from FM stand at 16.6 million. As Suri noted, we've signed 88 new FM contracts due in the quarter. In terms of non-AEC business, our goal is to maintain moneys here around 20% of our overall, overall revenues and we have done that successfully.

So as of the end of the second quarter we are at 20%. In terms of construction activity around the country, what we are seeing is its strong in the west, southwest and southern regions and there are early indications that the northeast and the Midwest will be strong going into 2006 as our customers are indicating that they are just beginning to hire because of upcoming projects. So that is, does that answer all your questions?

It answers those questions. One last question on the gross margin, when do you guys think you see, start to see the lift, I mean you are growing revenue fairly rapidly, when do you start to see the lift on the labor and I guess also the other thing is then the implication is I guess that you're not seeing all that much on pricing specifically, if you could just, that'd be great.

Yes, new branch openings is going to be an ongoing part of ARCs expansion over the next several years and that, the labor component as a result of that our ideas on that will be high as, until these branches reach maturity. Also we are in a transition and as you know transitions can be expensive because you have to offer the old as well as the emerging services to your customers so we will see labor rates settling down once we have made the transition fully. In terms of - what was the second part of your question?

Well, I was just saying to the extent you might be getting any pricing specifically revenue lift from pricing as opposed to from volume increases, you might actually see a lift even with the larger, with the higher labor component, so I was just wondering what you were seeing in pricing, or I guess the implication of the flattish gross margins means you're not seeing much in pricing. Just want to make sure I have that right.

Yes, that's one. The second component on gross margins is that a third of our growth, projected growth will come from folded acquisitions and these acquisitions have a dilutive effective on gross margin because they come in at much lower gross margins than our mainstream or mature companies, so that's component number two. Thirdly, it's too early for pricing power in the marketplace. The economic expansion, we would characterize this as moderate, although sustainable so it's still early.

Okay, that's great. Thank you.

Thank you.

And your next question will come from the line of Michael Schneider of Robert W. Baird. Please proceed.

Good afternoon guys.

Hello Michael.

I want to spend a minute just talking about the green field of the two Ohio operations and then what you actually acquired in the quarter, maybe just first in revenue if you could tell us what your acquired branch is actually contributed in the quarter and then maybe what actually you did in the quarter in terms of acquisitions.

Let me give you outlook, based on the outlook what we see. Updated outlook for the year. we are projecting 6.5% of our growth coming from organic growth and up to 3.5% of the growth coming from acquired growth. The organic growth consists of 2 factors, the first is growth coming from the uptick and nonessential construction activity. Like I said its moderate and sustainable, we believe that continuing well into 2007.

The second part is the green field, or new branch openings. Our goal is to open 15 new branches this year and as of the end of the second quarter, as of June 30, 2005, we have opened 9 new branches so we are well ahead of schedule on that. In terms of the acqu9isitions we believe 3.5% of our growth will come from that and this morning we closed on the first, what we would term significant acquisition. It's a company in Cincinnati called Queen City Reprographics, a family owned business that approximately 14 million in annualized revenues. The impact from that acquisition will be a little over a percent of our annual revenues.

Which Mohan implies that you expect to do another 2.5 points of acquisitions in the balance of the year.

That's correct.

Okay, and of the 9 branches you've opened this year, did you actually green field those or are they brand new branches or were they just small acquisitions?

6 of them were brand-new branches, 3 of them were real small branches in the Ventura County area of Southern California.

Okay, and then switching to just the quarter itself, do you happen to know what dollar amount of revenue was contributed from the acquisitions?

6 - 6.7% of the second quarter growth came from organic growth.

Okay, thank you. and switching to plan wealth, how many contracts are you at these days and maybe what percent of revenue digital is contributing?

I would like Suri, Suri could you take that question?

Right, in terms of the number of contracts Michael, what we have, what we track is the number of contracts we have construction projects we have posted to date because the projects, number of projects we have is a very, very fluid target, it's a moving target because constantly projects come on board and then when they get wrapped up they get wrapped up so what - the number we have is the documents represent the number, number of documents posted which passed the 10 million mark the large form of documents represent about 80,000 projects.

Let me rephrase it? Is there a number of PlanWell licenses, I believe the last quarter you reported, I'd have to dig out the number, but I believe it was 277 sites licensed for PlanWell.

Yes, every peer group member who gets added onto the peer group membership adds an additional license. That's why we are so excited about the peer group growth because every time we sign up a peer member he must get a PlanWell license, that's one of the conditions.

Okay great.

So every time we add on a peer member it continues - in some instances where you have a peer member who has multiple locations they might buy 2 or 3 licenses but most of the time its single licenses.

And a final question, just market share, I know it's a moving target in every industry. Are you able to tell with 6.7% organic growth, do you believe the market is up more than that, less than that, just any color on that would be helpful.

The way I would judge that is from the many acquisition possibilities that we have looked into and the good reflected by these prospects is the number significantly lower than that. The second way for us to measure market share is how our large suppliers are performing and if you look at Osley(ph), which is a publicly traded company I think you should be able to find there half year report and they are about 1% ahead of last year.

Okay, thank you again guys.

Thank you.

Thank you.

[Operator instructions]

And your next question will come from the line of Eric Sledgister(ph) of CSSB. Please Proceed

Good afternoon and thanks for taking my call.

Hello Eric.

I was hoping to get more of an update on the opportunity in Europe, if you see that more of a digital opportunity or eventually you may be able to open some branches over there.

I will direct this to Suri.

Hi Eric, in terms of Europe what we are seeing now is that the need for digital solutions for the construction documentation industry. When we talked to some of the Europeans when they were here for IRGA and found out what they're looking for, they were very excited to find out that PlanWell had such solutions and also they were very, very interested in the peer contact, that is the profit and education confab offer the peer group.

The parrot association we run. There is, there is nothing like peer operating in Europe although there are other trade associations who are operating there. So we made our first trip early this year and found that there is a lot of interest and we are just proceeding to take advantage of that so we are setting up, we set up a dealer there, a distributor, a European distributor and we translated one of the products in French and that has been very successful and now we have about 3 different companies showing a lot of interest to come on board from UK and there are the companies in Germany and France interested in coming onboard. So all of this shows there is potential for peer so our objective is to while focusing on US and growing new (inaudible) quietly continue to grow the European side. In terms of whether we'll be there or whether we'll be acquiring, right how we don't have plans to do that. Our focus is obviously United States because we see great potential here, where we are but who knows what will happen in the future.

Okay, just a quick question on the US. Can you tell us what capacity is today and also where you stand in terms of the number of markets you operate versus those you identify as a potential metropolitan area.

Mark are you want to touch on that? The first question, the first part of the question?

Yes, I believe that we are operating at 75 to 80% capacity today. Its very easy for us to expand capacity the quickest and the way we generally do this is by adding shifts to our production center. For example production centers that operate in 2 shifts now would add a third shift the production center obviously with only one can add another shift and again this can be done without adding any incremental equipment. And as we've stated before we feel we have enough capacity built into our system today that we do not need to invest in our existing production floors visavis new equipment until 2007.

Far as how many markets we operate in I think I'll ask Suri to comment on that.

Ask me that question again, what exactly was the question in terms of number of markets?

Yes, just how many markets have you identified as an opportunity and what's your penetration of those markets today?

In terms of the market, in terms of identifying the markets we've identified all the space in the US we want to be in every state in the US, in all 50 states and our plan is not only just penetrating that with our own divisions but also using peer to penetrate the construction documentation marketplace. So wherever we get an opportunity we will expand into that market when we have an acquisition there. Or where we have a large operation or a large customer looking for services in a (inaudible - accent) market place then we'll open up branches there as well.

and to add to that Eric we are - we fill less than 10% of the industry in terms of revenue, we are less than 10% of the industry operating out of approximately 185 locations. So we have ample room for growth. If you're looking for a particular focus area, that would be the West and the Sunbelt states, which we believe are the fastest growing areas.

Okay, thanks a lot. I'll turn it over.

Ladies and gentlemen this concludes today's - I'm sorry, we do have another question coming from the line of Michael Schneider of Robert W. Baird. Please proceed.

I'm just, want to circle back to gross margins, I'm wondering if there was any expense reclassification that went on year over year that might explain why gross margins actually were flat year over year. if there was any movement between SG&A and gross cost of goods sold?

Mark?

Yes, I'll take that. No the answer was absolutely not. We had talked about, we went through that exercise in '04 and since that time there has been no further reclassification.

And one more thing Michael is what I said in addition to what Mark had to say, when you have acquisitions coming in in a 3.5% of the revenues and acquisitions coming in at gross margins significantly lower than ours that too has a dilutive effect on gross margins and earnings for sure as a result of that.

Okay, but Mark again, but there was a reclassification last year that would have impacted the second quarter of last year, which distorts the year over year comparison.

No because we restated history when we filed our S1.

Got it. Okay. Thank you.

and your next question will come from the line of George Dye(ph) of Weatherby. Please proceed

Yes, say good afternoon.

good afternoon.

One question is the digital service as a percentage of revenue in the first quarter I believe it was 3.2% could you give us the number for the second quarter.

Yes, the second quarter came in at 3.3%.our goal for the year George was 3% so we are ahead of it and building, building on it. I believe we will far exceed our goal by year-end.

All right thank you.

And ladies and gentlemen this concludes the question and answer session. I'll now turn the call back over to Mr. David Stickney for closing remarks.

Thanks Jon. Everyone we appreciate your participation today in today's call and your continuing interest in American Reprographics Company. Have a great evening and good bye.

Ladies and gentlemen we thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Have a great day.