ARC Document Solutions Inc (ARC) 2006 Q3 法說會逐字稿

Good day ladies and gentlemen, and welcome to the Third Quarter 2006 American Reprographics Company Earnings Conference Call. My name is Anthony, 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 call, Mr. David Stickney, Vice President of Corporate Communications. Please proceed sir.

Thanks Anthony, welcome to the call everyone. Joining me today are Mohan Chandramohan, our Chairman and Chief Executive Officer, Suri Suriyakumar, our President and Chief Operating Officer, and Mark Legg, our Chief Financial Officer. Earlier today, the company issued a release reporting financial results for the third quarter of 2006 ending September 30, 2006.

You can access this release and other previous releases from the Investor Relations section of our website at www.e-arc.com. About an hour after we finish this call, you can listen to a taped replay at your convenience. It will be accessible for seven days after the call. The dial-in number for this replay is in our press release. You should also know that this call is being webcast live. A replay of the webcast will be available for 90 days from today, and you can access it from the Investor Relations section on our website.

Before we begin, I'm required to make a brief statement regarding forward-looking remarks and the use of non-GAAP financial measures. 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 financial outlook. 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 quarterly and annual SEC filings. The forward-looking statements contained in this call are based on information as of today, November 2, 2006, and except as required by law, the company undertakes no obligation to update or revise any of these forward-looking statements. This call will also contain references to certain non-GAAP measures. The reconciliation of these non-GAAP measures is set forth in today's press release and in our Form-8-K filing.

With that out of the way, I'll turn the call over to our Chairman and CEO, Mohan Chandramohan.

Thank you, David. Good afternoon. Thank you for joining us. I will begin today's call with an overview of our financial performance for the quarter, and a brief explanation of what we see happening the near future. I will also give you our perspective on the state of the construction industry and focus on both the Commercial construction sector as well as the Residential sector. Following my remarks, Suri will provide you with a picture of our operations for the quarter. And finally, Mark will discuss the details as reported on our financial statements. As usual, we will take your questions after that.

The third quarter of ARC was another successful one. The company reported 2006 sales for the third quarter of 152.5 million, compared to 127.5 million in the third quarter of 2005, a 19.6% increase year-over-year. Our gross margin for the third quarter was 43.9%, which compares to 41.2% for the same period in 2005. Our EBITDA margin for the quarter was 24.9%, which compares to 22.5% in the third quarter of 2005. Earnings per share for the third quarter of 2006 were $0.35.

In view of what we see for the remainder of the year, we are maintaining our forecast for 2006 of revenues in the range of 585 million to 595 million, and earnings per share in the range of $1.27 to $1.30 excluding the [Louis Fry] charge. While we are on the subject of forecasting, 2007 is nearly upon us, and we are feeling confident that the performance of the construction industry will remain robust.

For the past six quarters, I have repeatedly expressed my belief that the company has the potential for 10% to 15% revenue growth per year based on both organic and acquired business. Based on current trend, we feel that our revenue growth performance in 2007 should be closer to 15%, the high end of our range. I will provide you with specific details for our revenue and EPS expectations for 2007 on the next earnings call.

As a way of offering you insight into why we are so positive, I would like to turn to the topic of the construction industry itself, especially as it relates to the reprographics industry. The construction industry, as you know, is a $1.2 trillion industry today. Residential construction makes up 55% of that figure while non-residential makes up 35%, and non-building work such as public and frost structure construction makes up the remaining 10%.

While non-residential components represent only 45% of the total, they produce more than 80% of all construction-related reprographics. This is why reprographers place so much emphasis on non-residential work. Reprographic services are used far more extensively in commercial construction than they are in any other sector including housing. Non-residential building, from a simple tenant improvement or renovation project to a large port facility or skyscraper is complex.

Hundreds and sometimes thousands of please participate in the building process, and most need plans. The review, permitting and compliance procedures are very involved, and plan sets change constantly as a result. Thus, the overwhelming majority of a reprographic company's construction-related revenue is devised from commercial or other non-residential construction clients.

By contrast, residential building is far simpler. It has fewer trades, permitting procedures and processes involved. As with any construction project, there is design work and the actual work of construction. But most projects, whether large or small, are based on a fixed and relatively small numbers of home designs, so the ebb and flow of building cycles don't significantly affect the volume of plans being produced. Put simply, the volume of building does not significantly affect the volume of reprographic services.

ARC's revenue mix closely mirrors our industry's norm. We derive 65% of our revenue from non-residential construction with 15% of our revenue coming from residential work. The remaining 20% of sales comes from leveraging our core competencies in document management, distribution and print on demand into fields outside of the AUC market. For us, the 15% of sales derived from the residential sector is a fairly stable revenue base. For a clear indication of the kind of consistency we experience with homebuilders, look to the period between 2001 and 2003.

Our revenues remained flat during this period despite the expansion in the residential sector. Home building was very active, yet it had a minimal affect on overall company revenues. In the same way, we don't expect to experience significant changes in this revenue category in a down market. As for what we are seeing in the non-residential construction market, the signs remain positive that the activity levels we have seen over the past year will continue.

FMI has maintained its positive outlook for non-residential construction throughout the year. They've continued to project growth about 8% through 2010. Hence, we are very confident going into next year. We believe that we are executing well against a strategy that takes advantage of the present and is well positioned to address the potential of the future.

For those of you joining us for the first time, ARC's strategy, in a nutshell, is to expand our national footprint of Reprographics production centers and to increase the population of our on-site service placements. At the same time, we will advance our development and market penetration of proprietary technologies to seamlessly link our services and our production centers, so our customers can access and use in on demand wherever they work.

Our initiatives are highly focused on growth and include acquisitions, new branch openings, continued strong growth on on-site services or FMs, increased development of digital services and digital service revenue, building a base of strong regional and national clients through premier accounts and extending our lead in web-based construction document management technology.

Our intention is to stick to our core competencies and relentlessly execute against these objectives so that ARC continues to grow in strength, capacity and capability into the future. While we are on the topic of the future, I would like to inform you of an anticipated change within our executive structure. Most of you know Mark Legg, our CFO. Mark has been with us since 1998. With eight years with ARC, he has been a strong contributor to our success and has been a valued member of our management team.

Recently, Mark came to me and told me that he intends to retire in the near future and suggested that we actively engage in succession planning for his position. While he has no definitive date of departure in mind, after a long and successful career, he is ready to move on. As such, Mark thought it would be best to identify a candidate that he could work with to create a smooth transition. We wish Mark well going forward, and we have begun the search for his replacement.

That concludes my remarks for today's call. At this time, I will turn the call over to Suri to refocus your attention on the success of the past three months by providing an update on the operations of the company during the third quarter. Suri?

Thanks, Mohan. To begin with, we added 14 new locations in the third quarter. We close or consolidated four locations during the same time period, leaving us with a net gain of ten. As you will recall, we closed our acquisition of Reliable Graphics at the beginning of the quarter, and we are very pleased with the way integration is proceeding. Reliable has a great team and great people. Our cultures are well aligned, and we expect their contributions to further advance our financial success and add strength to our divisional management team.

As we have stated before, we have adopted the Nielsen's Media research of Top 50 Markets list as our definition of major metropolitan areas. Today, we have a presence in 42 of the 50, and by our own estimates, we hold a number one or number two market share in 28 of them. Specifically, we experienced some of our strongest growth during the quarter in the San Francisco Bay area of the country.

Given how hard the area was hit after the bursting of the .com bubble, it was gratifying to note that commercial [reconciliates] in the area are projected to be in the single digits next year. And, one of the area's major design firms just hired 30 new architects to handle upcoming projects in the region. Ironically though, we are also seeing significant opportunities with home builders in the region.

As new building slows, the desire for greater business efficiency increases. Recently one of our Bay area divisions finalized a [staff FN] contract with the regional office of one of the largest home builders in the country, a client I might add we weren't working with previously. But why now?

Primarily because of our ability to assemble the technology and service package, to pull cost and time out of an operation that is being forced to do more with less, placing the component staff on site, creating more efficiency with technology, dual [board] bidding and construction and providing single solutions for document management created new business from a market segment that is slimming down as it prepares for leaner times. Circumstances like this create very real sales opportunities for ARC.

We are addressing them with our management expertise, our creative approach to document management and a technology portfolio designed to integrate greater productivity over traditional methods of reprographics services. Be rest assured that we will be pursuing similar sales with other home builders throughout the country in the coming months.

Turning now to our trade acquisition for independent reprographers, the peer group as we call it, profit and integration in reprographics added two more member companies to its roster, bringing the total of new members in 2006 to 17 and the general membership to 140 reprographic firms. In addition to its advocacy of professionalism and its contribution to our purchasing power, the peer group helps us achieve greater penetration with our technology.

After surveying our members this quarter we found that while 140 companies license plan their technology for their main locations, these companies are also actively promoting PlanWell throughout their own branch networks. When combined with ARC's locations and our international peer members, customers can access PlanWell technology in more than 500 locations worldwide.

5.5% of our revenues in the third quarter came from digital services. Offering these services provide us with sale opportunities we otherwise wouldn't have, as mentioned a moment ago in the case of the home builder. We also provide another tool with which to navigate the technology transition offering in the construction industry. To give you an idea of the significance of the transition, consider that in our first year with PlanWell we put about a million documents into the system.

Today, just after five years later, we are consistently posting more than half a million documents to PlanWell every month. The adoption of PlanWell technology as a standard, developing online applications and software for reprographers and their customers and testing markets with new initiatives are all intended to solidify and strengthen our position as the digital transition progresses, both underground and on the land.

Speaking of which, the construction space on the web continues to draw interest from customers and funding from investors as new players enter the field. This supports our belief that, while it is happening at different rates and different parts of the industry, the technology is driving productivity and efficiency improvements in construction and that it is in our best interest to invest, to develop tools and techniques to support this change. We continue to explore the subcontractor and invitation to the bid market with [sub's].

As we noted on the last call, we are implementing a new work flow that allows general contractors to issue big notifications to their subcontractors via email and fax and provide a better way tract their bidding activity. We think this will create new opportunities for us in the future with subcontractors as well as general contractors who are our bread and butter customers.

Turning now onto our On-Site Services segment, we are also pleased to report that the number of IFM contracts grew by 298 during third quarter. This represents an 11% increase from the second quarter and was due in part to the acquisition of a customer list in Houston that is focused almost entirely on FMs. That list accounted for about approximately 100 new accounts of the 298 I mentioned. Premier accounts also progressed nicely during the quarter.

As to staffing, we continue to look for the key personnel to fill out our team. But in the meantime activity is on the rise. We added Burns & McDonnell, a national architecture and engineering firm, to our client list in October. We also upgraded OneView, our red based premier accounts customer portal this summer. We added functionality, greater data consolidation and an improved interface to make it even easier for these large customers to work with us.

Finally we remain in vigorous pursuit of an appeal in the Louis Frey case we informed you about in the second quarter. We filed an initial brief a week and a half ago with the Southern District Court of New York and the timing for further action is in their hands at this time.

With that synopsis of our operations, I will now turn the call over to Mark for a review of our financials. Mark?

Thank you, Suri, and good afternoon to everyone. I will start the financial review today with our third quarter results of operations. As Mohan mentioned earlier, revenue for the third quarter of 2006 was 152.5 million compared to 127.5 million reported in the same period of 2005, or an increase of 19.6%.

Segmented by our three primary product lines, revenue in the third quarter was as follows, Reprographic Services was 111.2 million, On-Site Services or Facilities Management was 25.8 million and Equipment and Supplies came in at 15.5 million. Reprographics Services and Facilities Management business grew at 17.4% and 19.6% respectively, while Equipment and Supplies business increased by 39.1%.

Third quarter revenues by geographic region were as follows. Southern California was 47.6 million, Northern California was 24 million, the Pacific Northwest reached 8.1 million, our Southern region which extends from Florida to Las Vegas was 33 million, the Midwest delivered 19.1 million and our Northeast division came in at 20.7 million. All geographic regions achieved growth over the third quarter of last year.

Gross margin for the third quarter was 43.9%. This compares to 41.2% for the same period in 2005 or an increase of 270 basis points. Our incremental gross margins, generated on our increased revenue, came in at 58% or an increase of 140% over Q3 2005. The increase in our gross margin was driven by various factors including the increase in Digital Services and Facilities Management revenues that carry higher gross margins than our traditional business. Additionally, as our production centers continue to increase capacity utilization, they become more cost effective.

Our SG&A expenses came in at 34.5 million during the third quarter 2006 as compared to 28.3 million in the same quarter of 2005. This increase was due primarily to acquisition activity and increased fees related to our SOX or Sarbanes-Oxley compliance work. Operating income in the third quarter came in at 30.9 million or 20.3% of revenue. This compared to 23.6 million or 18.5% of revenue in the third quarter of last year. Operating margins achieved on our incremental revenue of 25 million came in at 29.2% or 158% of our base margin.

Interest expense during the third quarter was 5.8 million, compared to 6.1 million in Q3 2005, despite an increase in global interest rates. It is important to note that interest costs in the third quarter 2006 includes 204,000 of interest expense related to the Louis Frey litigation reserve, which continues to accrue interest as we enter into the appeal stage of this litigation.

The overall decrease in interest expense during the third quarter is a result of the refinancing of our bank debt in December 2005 at a more favorable interest rate. The company's income tax provision for the third quarter 2006 was $9 million, compared to $7 million in 2005. The effective tax rate in the third quarter came in at 36.3% compared to 40% in 2005. This decrease in effective tax rate is due to the release of tax cushion related to a discreet item from 2002 in which the tax statute has expired.

Net income for the third quarter 2006 was 15.8 million or $0.35 per share fully diluted. This compares to net income for the third quarter 2005 of 10.5 million or $0.23 per share fully diluted. Fully diluted shares outstanding have increased from 45.5 million during the second quarter of this year to 45.7 million during the third quarter of this year. This increase is due primarily to shares issued in conjunction with acquisition activity.

Cash flow from operations in the third quarter of 2006 came in at $30.2 million compared to $18 million in Q3 of 2005 or an increase of 67.8%. This increase is due to an additional 5.2 million in net income, coupled with a decrease in working capital of 4 million and an increase in non-cash expenses of 2.7 million.

These non-cash expenses include depreciation, amortization of acquisition intangibles and stock-based compensation charges. Working capital, excluding unrestricted cash at September 30, 2006, was 20.9 million or approximately 3.7% of trailing 12 month revenue. This compared to 18.3 million or approximately 3.8% of trailing revenues in 2005.

Total debt including capital leases at the end of the third quarter 2006 was 289.2 million, up from 258.3 million in Q3 2005. This increase is primarily related to acquisition activities. Despite the year-over-year increase in debt, we did pay down 13 million in bank debt during the third quarter of 2006 and have paid down an additional 5 million since the end of the third quarter.

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

Thanks, Mark. As usual I will take care of questions and where necessary I will redirect them to Suri and/or Mark. With that I would like to pass this call back to the Operator for Q&A.

[OPERATOR INSTRUCTIONS]

Our first question comes from Matt Litfin from William Blair & Company. Please proceed.

Congratulations on another very strong quarter.

Thank you, Matt.

Your cash flow statement indicates that you spent $43 million on acquisitions in the third quarter, was that all for Reliable or were there other acquisitions? And if so, what is the run rate of the revenue for those?

Yes. Now it was mostly for Reliable. A couple of things that I'd like to highlight here is many of our acquisitions or almost of our acquisitions have earn out provisions so those earn outs are also paid. So that includes a significant earn out payment as well. But it is that and Reliable.

Okay thanks. And Mohan, the revenue growth next year that you referred to of around 15%, how much of that growth is already in the bag so to speak, i.e. what acquisition related growth is implied in that preliminary guidance if you will?

Well I would say in that guidance organic growth would be about 7 to 8% and the balance would be acquisitions. As I mentioned in our last call, acquisitions represent presently about 4% of that growth, acquisitions already completed but carry away fact for that. So combined at the present time we believe 15% is a very reachable number.

Okay thanks. And I know that you've been increasing margin substantially over the past few years, what would be a maximum margin over which you don't think ARC could actually go, or should go, given the necessary investments in the business?

Presently as we go through the transition, Matt, as you know transitions are expensive because we are forced to operate two platforms, the analog platform that applies to a large portion of our customer base and the digital platform that we have to provide for our more progressive customers. So as a result that's very expensive because while maintaining we're also investing.

So during this period I have said anywhere between 22 to 24% EBITDA, which where we're at right now, would be about the right level to maintain while we invest in the future. Now once the transition is complete or as we hit the tipping point of this transition, things could be quite different because then we will have moved to a much more efficient platform completely. At that point margin expansion could be tremendous.

And a final follow-up to that, can you assess the chances that 2007 might represent the year in which that tipping point would occur?

It's too early to say. Because the construction industry is so fragmented, the transition is slow, which also benefits us at some level because it erects barriers to pure technology firms. So we are enjoying this right now. We like the way it's going, we can maintain high margins, we can invest in the future and also keep the barriers high.

Okay thank you, Mohan, and thank you, Mark, for your service to the company.

Thank you. Operator, next question? Hello?

It appears we may have lost our Operator for this call, if you are still listening and still with us, please bear with us while we deal with the technology differently.

Mohan, are you there?

Yes.

Well as we're waiting for the Operator to come back, it's Matt Litfin again, I could ask you another question.

Please do.

Can you break out for us in the third quarter the organic revenue growth versus acquired growth?

Absolutely. Organic revenue was 8.3%, acquired was approximately 11.3%.

Okay. And one other one I was thinking of since it's an open mike, what tax rate is implied in the fourth quarter by your updated guidance here?

40%.

Okay. Now I'll let someone else jump in.

Thank you, Matt.

Ladies and gentlemen, this is David Stickney, Vice President of Corporate Communication for ARC. Unfortunately it appears we have a technology differently, however from the looks of our communications line, at the moment there are no more questions in the queue. That may also be due to a technical differently.

We apologize for this, but there's no point really in keeping you on the call. Please be advised that both myself and all three of the executives will be available after this call for your questions and we'll be happy to take them here in either our Walnut Creek office where I am located at 925-949-5114, or at the Glendale office, area code 818-500-0225. Again my apologies for the abrupt end to this call, we look forward to talking with you soon. Thank you.