ARC Document Solutions Inc (ARC) 2007 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the American Reprographics Company second quarter earnings conference call.

(OPERATOR INSTRUCTIONS)

It is now my pleasure to introduce your host, Mr. David Stickney.

Thank you, Mr. Stickney. You may begin.

Thank you, Rahm, and welcome to the call everyone. Joining me today are Suri Suriyakumar, our President and Chief Executive Officer and Jonathan Mather, our Chief Financial Officer.

A short time ago, the Company issued a release reporting financial results for the second quarter and year ending June 30, 2007. You can access this release and the Company's other releases from the investor relations section of American Reprographics Company's website at www.e-arc.com. You can listen to a taped replay of this call at your convenience, beginning about an hour after its conclusion. It will be accessible for seven days after the call.

You can find the dial-in number for this replay in today's press release. This call is also being webcast live. A replay of the webcast will be available for 90 days from today, and, again, you can access it from the investor relations section on the Company's website.

Before we begin, please note that 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, August 8, 2007, and except as required by law, the 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. The reconciliation of these non-GAAP measures is set forth today in our press release and in our 8-K filing.

At this point, it is my pleasure to turn the call over to our President and CEO, Suri Suriyakumar.

Suri?

Thank you, David, and good afternoon, everyone. Thanks for joining. Today, I'll be giving you an overview of our performance in the second quarter, followed by a close review of the key issues that have affected our business year-to-date. At that point, I will ask Jonathan to provide you with more depth on the financial side of the business and then we will open the call to your questions, as usual.

To begin with, our sales grew 17.3% in the second quarter compared to the same period last year. With sales of $177.8 million for the quarter, we are clearly on solid ground and the fundamentals of the business remain strong. The Company's EBITDA margin for the quarter was healthy and growing at 26.9%, compared to 25.5% in the same period last year, excluding the Louis Frey litigation charges, of course.

Earnings per share for the second quarter of 2007 were $0.43, fully diluted. In light of our performance and the confidence we have in the continuing strength of our core business, we are reiterating our full year's forecast of revenue in the range of $690 million to $710 million and earnings per share of $1.58 to $1.61.

Our gross margin for the second quarter was 42.1%, compared to 43.4% in the second quarter of 2006. The slight decrease in gross margin was due to the large base of acquisitions that were completed in the first four months of the year. As we have always stated, acquisitions are dilutive to our gross margins in the short term, particularly large acquisitions the size of MBC and Imaging Technologies, which we announced earlier this year.

However, the opportunity to sell our products and services into a new and larger customer base is very compelling and accretive in the long run. In fact, the combination of margin improvement and the opportunity to sell our products and services to a new and larger customer base is indeed the core of the ARC acquisition strategy, a strategy, I might add, that continues to hold tremendous promise, given our increased acquisition activity.

I'm pleased to report that our acquisition growth is outpacing our expectation at a healthy 11.2% for the year. Using our commanding position in the industry, we will continue to spread our footprint into new and existing markets with an objective of establishing a leading position in each one of these markets. Thus our acquisition plan remains vital and with pipeline as full as it is, we will continue to execute against it in the coming years.

At 4.4%, our year-to-date organic growth is obviously lower than we planned for, mainly due to the downturn in residential construction. Unfortunately, some of the areas where the housing market was hit worst were indeed the regions in which we hold a very high business concentration.

To give you some perspective, we estimate $1.9 million in sales were lost in Orange County alone in Southern California. The loss is directly attributable to 53 homebuilding customers who either reduced their work drastically or who simply decided to wait out the storm.

While the residential market did eat into our organic growth, the Company did have a healthy growth quarter-over-quarter. It is important to remember that sales from residential construction comprise just 15% of our overall revenues. Therefore, it is unlikely that it will affect our overall growth strategy in the long term.

Moreover, it is very important to consider that 85% of our revenues come from markets that are expected to grow and grow at a very healthy pace. Projections from the experts are certainly good for commercial construction and our non-AEC business.

But what we are experiencing in our shops and on the streets today provides tremendous support to our position. 20% of our sales come from non-AEC business and our previously announced contract with Boeing is just one example in this segment of our business, delivering a tremendous amount of work and our services to them ramped up far more quickly than we anticipated.

We expected to be fully engaged with this project only in early June, but we have already done over $4 million worth of work to date. Given the intense flow of work in the recent past, we still expect to see the bulk of the revenues generated by this account in the last half of the year.

This was an immensely gratifying start to our relationship and represents a landmark in our approach to non-traditional markets. An account like this is the perfect proving ground for a company of our caliber to demonstrate its capabilities and power in addressing non-AEC customers.

Premier Accounts is actively seeking out other such large customers and marketing similar services to attract them. We are proving that our technology, workflow and service mix can address far larger industrial clients than any conventional reprographer ever thought possible. And we intend to capitalize on this experience in the future.

Another significant part of our non-AEC work involves leveraging our color expertise into retail marketing, point of purchase and a variety of corporate and commercial communication initiatives.

A perfect example of expanding our customer base in non-AEC markets is OCB, our largest operating division. Located in Orange County, California, OCB has been focusing on the hospitality industry, city, county, state government, retail and fitness customers. They have also been actively exploring customers who work outside of the construction market but who could still use the organizational access and archival power of PlanWell, our online plan room.

It is this kind of agility and contact with the market on the ground that provides the comfort and the confidence we feel in continuing penetration of the non-AEC market. As excited as we are about our non-AEC work, our primary market remains commercial construction.

Again, recent forecasts and our experience on the ground suggest that non-residential construction remains robust. We can see that FMI is forecasting 9% growth in the non-residential market and the latest U.S. Census Department data shows that non-residential construction put in place is on track to deliver more than 14% growth year-over-year.

Cap that off with low office vacancy rates and jobs data in healthy territory and what you'll end up with is an exciting trend for commercial construction for the remainder of the year. In fact, huge projects are being announced or bid in areas all over the country.

Las Vegas has more than $20 billion of projects under construction, and not just in casinos and resorts, but in infrastructure, as well. For example, MGM has identified a 60-acre site on the north end of the strip, where they will build a project similar to the $8 billion CityCenter, which is currently underway and which we have the contract for.

Looking elsewhere around the country for examples, you'll find downtown Denver's Four Seasons Hotel project is currently budgeted at $300 million. Just down the street, in Boulder, IBM has announced an $86 million green computing hub.

The Chicago Spire skyscraper project has just been approved. And while the Minnesota Twins are building their new stadium, the University of Minnesota's Gopher Stadium is going up right next door.

In Washington, DC, between the pharmaceutical industry, educational institutions, the government and the medical establishment, there is more than $4 billion of high-profile projects underway. And hopping back to the West Coast, you'll find millions of square feet of stadium and retail and residential space in Silicon Valley, and more.

If that weren't enough, we must consider government building activity from the continuing reconstruction efforts around Katrina. In addition, the ballot initiatives that were prefunded and passed in 2006 elections are yet to get off the ground. Even the recent unfortunate incident concerning the collapse of the bridge in Minnesota points to urgent and important needs outside of new construction.

Finally, if you look beyond the borders of the U.S., you'll find our largest clients there busy with international design and building work. Quite frankly, with all of the activity we see on the ground today, it is difficult to understand why any pessimism in the current market for non-residential construction.

This work is our bread and butter. We serve commercial construction all over the country and frequently out of the country, day in, day out. We are the largest player by far in the industry. No one comes close in the depth of our infrastructure, management, technology or digital backbone, not to mention buying power, overall size or ability to acquire other businesses.

Our expertise, technology and workflow solutions allow us to move more information more often to more places than any other company in reprographics. When you look at the future of American Reprographics Company, it is important to remember that no one can enable construction clients the way we can.

This can only strengthen our position, even in any economic climate. In our ongoing efforts to serve our customers wherever they are, our footprints continue to grow. We completed our acquisition of Imaging Technology Services early in the second quarter. We also added locations in Wichita, Kansas, San Diego and Lancaster, California, and in Dayton and Troy, Ohio. We ended the quarter with 284 locations in North America.

I'll take a moment here to provide you with a snapshot of some of our other key metrics. Our current FM count stands at 3,923. We added [175] new FMs this quarter. We currently have 17 Premier accounts, with the most recent addition being Adolfson & Peterson construction, a $425 million commercial construction company, ranked number 82 on the E&R 400 and Wood Partners, the third-largest multifamily homebuilder in the country. Currently, the peer group has 198 members, who represent 384 locations, combined with ARC's 284 locations, our PlanWell technology is available in more than 650 locations around the world.

On the technology front, our digital sales contributed 6.2% of our revenue and we continued to refine our products and pursue technology partnerships that will bring material benefits to our customers. One of the best examples of this expanding implementation of digital downloading of plans and specifications, which also has a direct relationship to our FM program.

To explain, while most of our customers in the AEC industry still prefer paper plans, getting them in remote location is challenging outside of the traditional print and ship model. Our ability to deliver files to them digitally, wherever they are, and supply them with the equipment and software to print on site allows us to follow the drawing files beyond our local markets, add value and generate revenue.

The use of our technology inside the Company is also delivering significant benefits, not only in efficiencies, but also in cost savings. By implementing MetaPrint, our proprietary driver of both printing and scanning equipment, we are saving money on software for thousands of machines we operate.

MetaPrint Abacus, our print cost recovery system, is currently in place in 186 locations, with about 3,400 users. That also represents significant savings over purchasing and maintaining third-party products for machines we place through our FM contracts. Incidentally, the adoption rate here is impressive. At the beginning of this year, we had about 30 installations, with only about 200 users.

Finally, we were able to bring closure to a menacing lawsuit in Southern California, where we were the plaintiffs. We were fortunate enough to recover most of the expenses related to this lawsuit. Of the settlement of $3.3 million, $1.6 million relates to costs incurred during this year.

The benefit for this year from prior year's cost is estimated at $1.7 million, which works out to an EPS of $0.02 after tax. Unfortunately, this was more than offset by additional depreciation, amortization and the interest expenses incurred in the increased acquisition activities. Jonathan will give you more color in this regard.

Before we get into financials, you should also know that the Company's Board of Directors authorized management to negotiate with our lenders to remove the share repurchase restrictions from its current debt agreements. The idea of a share repurchase is a continuing topic of discussion here and we will revisit this subject once we remove the restrictions on our debt agreement.

With that as the broad positioning of the Company's performance and activity, I will now turn the call over to Jonathan for a closer look at the financials.

Jonathan?

Thank you, Suri. Revenue for the second quarter of 2007 was $177.8 million, compared to $151.5 million in the second quarter of 2006, an increase of 17.3%. Revenue by segment were as follows.

Reprographic Services, $133.3 million, representing 16.2% year-over-year growth, On-Site Services, or FMs, $29 million, representing 17.4% year-over-year growth. Equipment and Supplies, $15.5 million, representing 27.6% year-over-year growth.

Second quarter revenues by geographic region were as follows -- Southern California, $48.5 million, Northern California, $27.2 million, Pacific Northwest, $10.6 million, the South, $43.7 million, Midwest, $20.3 million and, Northeast, $27.5 million.

With regard to revenue trends in quarter two versus quarter one, we continued to enjoy positive growth in all regions. Southern California was up 1.9%. Northern California was up 5.8%. Pacific Northwest was up 16.2%. The South was up 27.1%. Midwest was up 3.7%. Northeast was up 15.4%.

Gross margin for the second quarter was 42.1%. This compares to 42.3% in the first quarter 2007 and 43.4% for the second quarter in 2006. In this quarter, we experienced higher-than-normal dilution to gross margin as a result of accelerated acquisitions. In particular, the two large acquisitions, MBC, acquired in March, and ITS, acquired end of April, both of which had less than 31% gross margins.

The two acquisitions alone impacted this quarter's gross margin by 80 basis points. Typically, as Suri mentioned, acquired companies have a much lower margin than our fully integrated companies and thus temporarily dilute our margins. However, as we implement our best practices, including lower procurement costs, we begin to see improvement in margins in these companies, bringing them in line with our corporate gross margin levels.

Our SG&A expense as a percentage of revenue decreased to 19.4% during the second quarter of 2007, as compared to 21.4% in the first quarter of 2007, and 21.9% in the same quarter of 2006. The SG&A expense in this quarter benefited from the settlement of the litigation Suri mentioned earlier, which was mainly for reimbursement of all costs incurred by ARC.

SG&A in this quarter, adjusted for prior-period reimbursement would have been 20.6%. Reimbursement settlement of costs incurred prior to this period is estimated at $2.2 million, which computes to an after-tax EPS of $0.03. The benefit for this year as a result of reimbursements from prior-year costs was estimated at $1.7 million pretax, or after-tax EPS of $0.02.

Operating income in the second quarter was $37.9 million, or 21.3% of revenue, compared to $31.8 million, or 19.9% in the first quarter of 2007 and $20.6 million, or 13.6% of revenue in the second quarter of 2006. In the second quarter of 2007, total depreciation, amortization and interest was $16.7 million, made up of depreciation at $7.6 million, amortization expense at $2.5 million and total interest expense at $6.6 million.

This compares to quarter one 2007 total of $13.5 million, made up of depreciation at $6.6 million, amortization at $1.7 million and interest at $5.2 million. The increase in these costs quarter-over-quarter amounted to an after-tax EPS of approximately $0.04.

The increase in these costs came mainly as a result of acquisitions. I am pointing this out as I have noted that investors have in the past underestimated these costs in projecting earnings per share.

Net income for the second quarter of 2007 was $19.6 million, or $0.43 per share, fully diluted. This compares to net income for the first quarter of $16.8 million, or $0.37 per share, fully diluted, and the second quarter 2006 of $8.4 million, or $0.18 per share, fully diluted.

It must also be pointed out that EBITDA for the second quarter 2007 was $47.9 million or 26.9%, compared to $40.2 million, or 25.1% in the prior quarter and $27.4 million, or 18.1% in the second quarter 2006.

Fully diluted shares outstanding were 45.880 million at the end of second quarter 2007. Moving onto the balance sheet, we ended the second quarter 2007 with working capital, excluding restricted cash, of $16.6 million, or approximately 2.6% of trailing 12 months revenue. This compares to $15.5 million for March 2007, or approximately 2.5% of trailing 12 months revenue.

DSOs, days sales outstanding, were 50 days in the second quarter 2007, compared to 51 days in the second quarter of 2006. Total debt, including capital leases, at the end of second quarter 2007 was $349.1 million, up from [$268.4] million for the same period 2006. The ratio of debt to trailing 12 months EBITDA at the end of the second quarter was 2.2, compared to 1.9 at the end of the first quarter of 2007, excluding cost from the Louis Frey litigation.

Trailing 12 month cash flow from operations was $101.3 million as of June 30, 2007, or $2.21 per fully diluted share. Cash flow from operating activities year-to-date, ending June 30, 2007, was $45.4 million, compared to $42.4 million in the same period of 2006.

Year-to-date, payments for acquisitions and payments associated with the acquisitions, including earn outs to sellers, amounted to $86.5 million, compared to $16.1 million in the same period last year. Finally, we continue to predict corporate tax rate for the balance of the year to be at 38.2%. That concludes our financial discussion.

At this point, I will turn the call back to our CEO, Suri.

Thank you, Jonathan. Before I hand you back to the operator, please note that the correct EPS forecast for the year is $1.58 to $1.62. I might have misstated this number earlier. Thank you, and, operator, we are at this time available to take the calls.

(OPERATOR INSTRUCTIONS)

Our first question comes from the line of Mike Fox with JPMorgan. Please proceed with your question, sir.

Good afternoon, guys. Can you tell us what the organic growth was for the second quarter and then what you forecast it to be for the second half and for the full year?

The organic growth, Mike, for the second quarter, is 4.3%. And, obviously, as we stated, the organic growth has been eaten into or impacted by the trends in the housing market, particularly because that has been in the areas where we are heavily concentrated. And therefore we think that over the year it will probably, instead of the organic growth, as we predicted earlier, where we thought it will be 7% to 8%, we might now have 5% to 6%.

Okay. So you still expect the acceleration in the second half.

Yes.

And then with regard to the Boeing contract, you said it was $4 million to date. Can you talk about how much it was in the second quarter and what you expect the impact to be for the second half?

The original contract, Mike, for Boeing was supposed to be anywhere between $12 million to $15 million per annum for three years. So based on the fact that we would start work on the 1st of June, we expected it to be about $6 million. That's what we had in our guidance for the second quarter -- for the year.

But work started much earlier than we expected, given the fact that Boeing was terminating their previous contractor earlier than expected. And, for this quarter, the exact number in Boeing is something I don't have off the cuff, but we can get that number across to you.

Okay, what about -- so that $12 million to $15 million, should we expect that number on an annual rate to be higher, or do you think that it's just going to be a little bit better than you expected this year because it started earlier, or do you think the contract could actually be higher value than you originally anticipated?

We are talking currently to see -- obviously, Boeing is very happy with what we are doing right now, and we are looking into expanding this into other areas, which was not originally in this stage, but we have no confirmation on that yet. However, the volume of work that we got definitely is higher simply because of the fact that we started the contract earlier, Mike.

Okay, great. And then with regard to the Boeing contract, is it too early to see what the gross margins and the operating margins are going to look like, or do you have an idea what that' s going to look like?

We expected it to be in line with our regular business, but it's actually too early to be exactly answering that question, Mike.

Okay, great. And then with regard to acquisitions, can you just talk about it sounds like the pipeline's still strong. So can we assume that you're likely to make another acquisition between now and year end?

Yes, that's a possibility. Obviously, as you know, Mike, we don't talk about it until we really have -- are fully engaged or complete an acquisition. But definitely the pipeline is very healthy and there is a lot of interest and that has been continuing throughout the years. So we certainly expect to do a few more acquisitions.

Okay, and then kind of change the tone a little bit. With regard to color as a percent of your business at the Reprographics Services, do you have an idea or an estimate what percent of your revenues are generated from color printing?

No, we have not broken that down, Mike. Obviously, some of the color goes into the Reprographics Services, which we do for our AEC customers, and some of the color goes into the non-AE customers. But we have not taken color as a whole and separated it as a segment of the business.

It does seem like it's pretty high-margin business. Do you expect that to grow significantly or grow healthily over the next couple of years, because it seems like the trend is definitely -- or at least customers seem like they're pretty positive on color, and they don't seem too reluctant to spend more on that particular product.

Yes. Color is obviously increasing in popularity, Mike. More and more customers are using color. There are also two sides to the color. The lower end of the color business, which is fundamentally the color copy business, straightforward copies, is not necessarily high-margin business. But as we continue to serve customers in other areas, point of purchase, all of their marketing materials, all of the presentation materials, that's definitely high-margin business and that's definitely growing.

And what we are doing is we are making use of the same co-competencies and the same infrastructure and the same software we have which is used to serve AEC customers to go ahead and serve non-AEC customers, and that's definitely a growth segment.

Okay, great, and just one final question. With regard to the dialogue about the stock repurchase, can you just talk about how you guys are thinking about that? Is it just that you guys think that given that the stock, where it is, it's just a very attractive investment or can you just talk about how you look at that? Thanks.

Yes, Mike. Obviously, with where the stock price is, it's definitely, we feel like it's a great opportunity to think about stock repurchase. However, the biggest challenge we have is the clause we have in our debt agreement, which we talked about. It prevents us from doing any stock repurchase.

And the concern we have is given the credit market at this point in time, Mike, which is very tight, we want to be careful before making any commitments, because whatever we do in that regard, we want it to benefit our stockholders and we want it to benefit the Company.

We want it to be, if possible, accretive, and not necessarily a drain on our EPS. So we will know that only when we have further discussions with our lenders. Now, obviously, the first job is to try to get that restriction out of the debt agreement. That's what we are negotiating now, and there might be costs involved in that.

Once that's done, then we can examine what the credit situation is in order to exercise this option and see whether that will benefit our stockholders.

Okay, thanks a lot.

You're welcome, Mike.

Our next question comes from the line of Mike Schneider with Robert Baird. Please proceed with your question.

Good afternoon, guys.

Good afternoon, Mike.

Maybe first just sticking on the organic growth question, what do you expect to drive the acceleration in the second half, if you expect it to reach this 5% or 6%. Obviously, it needs to go to probably 6% to 7% to make the weighted average work out.

Is it the Boeing contract alone? Have you expected an improvement in the residential market? Any color would be helpful to it, so we understand what you're modeling.

Sure, sure. As you know, Mike, there are several elements to that aspect that we have considered. Obviously, when we gave the original forecast of the guidance, we expected housing or residential to have a zero impact. And what happened actually is it turned out to be a negative on that 15% of the segment of the business we have. But what we are thinking about going forward is, number one, the non-AEC marketplaces, such as contracts like Boeing. When we announced the Boeing contract the early part of the year, we were not even sure how that was going to go, because this was a completely new experience for us.

And having gotten into the account, and now that we have operated the account three or four months, the contract is going very well. In fact, they are thinking about giving more work to us. We are emboldened by the fact that we can take our technology and the platform and actually serve many other customers out there.

So we really think -- I talked about this being a landmark, because now we are much more confident about what we can do with a customer like this. So we think there are big opportunities on the non-AEC side.

Secondly, like we said, we want to try to make up for the loss of these revenues in the housing area with AEC and color-related business. So we are aggressively going up and replacing that business. Thirdly, we are using our technology platform to see where else we can enable our customers, because the movement of documents across the nation is becoming a very critical element.

So there are several areas we are looking at to continue to expand. So we think while the housing market has eaten into our organic growth, which is the case, we will aggressively fill in that work or that amount of growth with non-AEC business and AEC business. Because the combination of non-AEC and non-residential is about 85%, and we are confident that we can deliver for the year 5% to 6% growth.

Okay, and if I do some simple math, it looks like your growth rate has come down about three points, which if you assume residential is 15% of the mix, it looks like you're down in line with the markets, something between 25% and 30% in your residential business.

Right.

Okay. And as far as the forecast for the year-end revenue, $690 million to $710 million, did you increase your acquisition assumption within there?

No, Mike. We took a principled decision, particularly after the last call, that we would not include any acquisitions in the guidance.

And Jonathan, to get granular here for a minute, it looks like acquisitions contributed $19.7 million in revenue to the total Company for the quarter. Do you know what amount of that actually flowed into the Reprographics Services line.

I don't have the number, but I can tell you something. Most of the businesses we acquire are very reprographic. They'll have minimal digital services, maybe some FM business. But most of them are very strong on a higher percentage reprographic.

And in fact on digital, what was digital as a percent of revenue and what was the growth rate in the quarter.

I can tell you digital as a total company, as Suri pointed out, was 6.2%.

And the growth rate in that, roughly, Jonathan?

Once again, growth rate in quarter one, we were at $8.912 million and in quarter two we are at $11.059 million. That is digital revenue. So the growth is 24%?

Okay, sequentially.

Yes.

And final question, I'll get back in line, just on pricing. With the market as soft as it is, at least on the residential-related areas, can you update us on the status of pricing nationally, and if you've seen pricing pressure emerge in these hardest-hit areas and have you actually seen some pricing pressure in the areas that have not been hit by residential?

Not really, Mike. We haven't sensed that part of it. The way we are looking at pricing is that we definitely don't have the pricing power, as we talked about. But in areas where customers -- there was a time, particularly in the early part of year end, end of last year, we were encouraging customers to use digital technologies and solutions without a whole lot of increased costs.

And the customers have gotten comfortable with it and more of them are using the technology tools we offer. We are starting to think about charging to those customers for those technology-related services so that we can add to our digital revenue.

So the answer to that is we don't definitely see a pricing pressure yet. Because, in fact, you asked this question from Jonathan in acquiring, what do you call it, other reprographic companies. Remember the fact that we had a more-than-usual erosion is simply because of the fact that the markets we dominated had a very high level of housing activity. So when the housing market got hit, that impacted us.

But, generally, by average, in other markets, it doesn't affect us a whole lot. So the answer to your question with regard to pricing is there is no pricing pressure we are sensing right now.

Okay, thank you.

You're welcome.

Our next question comes from the line of Al Kabili with Goldman Sachs.

Please proceed with your question.

Great, good afternoon, guys.

Good afternoon, Al.

A question on the SG&A. It was a $0.03 boost from prior litigation expenses and a $0.02 boost from current. Is that how we should think about it, for a total $0.05 of SG&A?

No, no, no, no. Let me go with that. From prior periods, that is, quarter one and last year, what we benefited in this quarter was $0.03. Okay?

Okay.

However, when we look at it on a full-year basis, 2007, that is, from January through June, costs that we incurred in 2006 and prior was $0.02, $1.7 million, so when we look at our EPS year-to-date, six months is $0.80. Do you follow me, Kabili?

Yes. I think so.

So then that is $0.02. But the $0.43 we're talking of today for quarter two, we're saying the benefit from the settlement is $0.03.

Okay.

However, so that's key. But also remember, as I pointed out, the depreciation, interest and amortization went much higher, which offset, or in fact was higher by about $0.04. I just wanted to make sure we remember that.

Right, okay. And if we think about the two acquisitions that you just recently completed, I believe you mentioned it was 80 basis points of gross margin that it ended up hitting, if I got that right.

Correct.

So if I take the gross margin that you did in this quarter of 42.1%, and I add that 80 basis points, that gets me 42.9% of gross margin and it's still below the 43.4% of margin that you did in the second quarter last year. Anything else hitting your margins?

Yes, two points here let me stress. With respect to the 43.4%, between that time and this June, if you can observe, we have been doing lots of acquisitions. So, as an example, when you look at what we paid for in cash this year, so we've done a lot of acquisitions. This year alone, we have done six acquisitions, three clear, MBC and ITS and another reasonable-sized acquisition. So my point here is we only pointed out two acquisitions, MBC and ITS, which is 80 basis points. But there are other acquisitions that will also drag on the gross margin, not to the same extent as 80 basis point.

In addition to that, in addition to that, there was on the labor, and mainly on the labor side, absorption. When Suri mentioned that, like, for example, on the Southern California region, yes, revenue was affected, but the labor is not 100% variable. The labor absorption was lower, which negatively impacted the gross margin. But the bigger element is the MBC, ITS acquisitions.

Right, okay, because if the organic growth is still positive, 4%, you're still getting a good fixed cost absorption on the existing branches, or on the branches you didn't acquire.

Okay. And, if you could, could you help us with the buckets of 15% residential, the 20% non-AEC and the 65% of commercial-related construction, could you help us think about what the growth rates this quarter were and what your outlook is for the year to get to your organic growth number?

: Right, I'll give you as to how our guidance was structured, Al. Obviously, 65% was non-residential and that was originally forecast at 6% to 7% -- 7% to 8% from FMI, sorry. So that still holds good.

Okay.

Residential, when we gave the guidance, we expected the 15% of residential to have a zero impact, but the reality now we find is down about 15% to 20% in that segment. And then on the non-AEC we always said it follows the GDP, which is about 2.5% to 3%.

Okay, so if I do the weighted average of the 7% to the 8% on the non-res, but down 15% to 20% on the res, and the up 2% to 3% let's call it on the non-AEC, on the back half, you'd be shy of your 7% to 8% overall organic growth estimates. So is the makeup there the Boeing contract that's going to kick in?

: Right, a couple of things, Al. Number one, you must also make sure, because remember when we say 8% growth, when FMI predicts that, they are talking about construction dollars.

So you have to actually adjust that for inflation to start with, and then you work the numbers, 65, 15 and 20. And you will find that number to be around 5%, 4.89%.

Right, okay, but to get to your upper end of the range, I guess you guys were thinking 5% to 6% organic growth for the year. Then you add the Boeing in.

Yes, and what happened is -- Al, I was just giving you the original thought. The original thought was the rest of it was considered to be market share growth, market growth combined with the market share growth. So what we are saying is given the fact we are impacted by the housing the way we are impacted, we still think that we can make five to six points by making up with non-AEC business and increasing non-residential business, which we are pushing for.

Okay, and in terms of the Boeing contract, is that then -- looking out to next year, does that present now a tough comp for you going into '09, or I'm sorry, '08, or is the Premier account such that you think you can add more sizable contracts like Boeing when we start to look at '08 and compare growth rates versus '07.

Obviously, like I stated earlier, Al, our objective is to identify. Because Premier, Boeing is actually an extraordinary account. It's the kind of accounts that we have previously not serviced. But what this is doing is giving us an opportunity to prove that we can actually serve large industrial manufacturing customers like this.

So we have already started expanding our horizon, and Premier Accounts is aggressively looking into getting accounts like that. In addition to the fact, we have never been so busy in Premier Accounts, since we established Premier Accounts division in the Company, because more and more large customers in the country who are involved in construction are looking at solutions across the nation in a single platform.

So the combination of both that is definitely -- because any account we get in Premier Accounts is obviously going to be new growth for us. So we certainly expect that to grow.

Great. I think that's it, guys. Thanks a lot.

(OPERATOR INSTRUCTIONS)

Ladies and gentlemen, our next question comes from the line of Scott Schneeberger with CIBC.

Please proceed with your question.

Hey, good afternoon, guys.

Good afternoon, Scott.

Would you say that the 15, 20, 65 mix is still fair for you going forward? I know you've alluded to hopes of improvement in residential, but should we think about that total revenue mix a little differently now?

That's a good question, Scott, a really good question. We've been talking about it, but it's too early for us to see as to how those numbers will vary. We don't have enough history with it to be able to come back and predict this is how it's going to be, because one of the things we struggle with is that is this drop in business simply because of the excess capacity in the market, or is it how it's going to be? That is something we haven't established, but obviously because of the sudden downturn, the excess capacity in the marketplace, so there is a fair amount of slowdown.,

So if we wait a couple of months, then we will have a sense as to where [that rate] really levels off. Right now, it seems to be a bad time to be able to judge, but that is something that we talked about. We won't have an exact idea, but I'm not sure. I am unable to predict the [rate] will change right now.

Okay, and I was for the most part following you on the last question, as you went from the old guidance to the new guidance and breaking it out. Could you just help us a little further, the roughly 4.5 year-to-date organic growth. Could you break out each piece of what it's been year-to-date thus far?

I'm looking at Jonathan here to see whether he has any more information. The year-to-date number breaking out, we don't have the exact details. But what I was trying to explain to Al, Scott, is more than anything else how we structured our guidance. So, firstly, FMI said the business is going to be 8% plus in terms of the organic growth. And those are in hard construction dollars. So first we discount that for inflation. And then what we do is 65% of our business comes from non-residential and 15% comes from residential and 20% comes from non-AEC.

So the non-residential, we obviously calculated at 7%, and we took the non-residential business to be flat. We didn't expect it to be that negative, and then of course we took the non-AEC business to be at the rate of 2.5 to 3 GDP. That's how we arrived at the number of almost 4.9%. And the rest in our minds were actually expected to be market growth, given our size and scope and technology, et cetera.

What we are seeing now is given the erosion on the housing side, on the residential side, and not knowing, of course, to answer your specific question, whether it's going to be consistently like that, we think we will be able to accomplish an organic growth rate of 5% to 6%. Anything to add, Jonathan?

Yes. If your question was -- if I understood your question was in addition to what Suri explained, can you give us the breakdown of the 4.3%, how much was AEC, how much was non-AEC, how much was residential, was that your question?

Yes, precisely.

Yes, that's what I thought. We don't have that at this moment, except I can tell you, going back to what Suri said earlier in the call, as an example, when he talked about we estimate $1.9 million in sales were lost in Orange County alone in Southern California, as an example, clearly our residential side of the business year-over-year came down.

But we don't have exactly how much of the 4.3% is commercial, non-commercial. Again, we have 280 locations, with all these -- each customer identifying that by who is a residential customer. We don't have that at our fingertips.

We don't usually break that down, Scott, but I gave you the fundamentals of our guidance.

Okay, I understand. I guess what I was trying to back into there, and I realize it's difficult the way you categorize everyone, but I was kind of trying to gauge just kind of year-to-date how you were tracking on non-residential. Suri, you gave some very strong prepared remarks that you're not seeing any weakness there.

But if residential is essentially offsetting non-AEC, and maybe I don't have that piece right, but if those are negating each other, then perhaps we're growing at 4.5% on non-res. Would that be thinking about it the right way, you don't have the breakdown of it?

We don't have the breakdown of it and obviously we are expecting non-res to pick up, the combination of non-residential is what we are hoping, but you are thinking about it the right way. It's just that whether the numbers will be identical is yet to be seen, Scott.

Okay.

If I may just add to that, Scott, as I pointed out, Suri's mentioning earlier, Southern California, a larger region, the 153 homebuilders, et cetera. Clearly what shows is that residential, while we don't have the numbers, was negative growth. However, validating the fact that in commercial construction, the non-residential, has to be much stronger than the 4.3% to arrive at a net. Simple math.

If we exclude non-AEC. And then that would have a positive, so that would reduce the non-res part. But I guess let me take it in a different direction. In the non-res environment nationwide, is it strictly residential you're seeing? Are you seeing non-res follow that res weakness, or are you -- you gave bullish remarks, but are you seeing any hints of weakness in non-res I guess is the specific question.

Okay, not at all, Scott. The non-res seems to be really sound. That's the statement I made. This is not just because we are studying stats. Of course, there are several stats showing to be positive. There are one or two stats showing it could be getting affected and so on. But what we judge mostly as to how the market is doing is the information on the ground. That's one advantage of being a nationwide company.

We are not in a specific region, so we are able to get a good measure of what's going on in almost all of the major metropolises, and there is vibrant activity, and nobody has put the projects on hold or said slow down. It's just business as usual and all of the large projects are proceeding as expected.

Okay, thanks, that's helpful. Switching gears a little bit, we had a few one-time items in the quarter. Could you give us an idea as to what to expect, perhaps having an EPS impact in the second half of this year with regard to one-time items?

No. We're not projecting anything in one-time items. The lawsuit, as Suri mentioned, we are glad it's behind us. Yes we basically got reimbursement of costs that we have incurred in the Company in the last 12, 18 months, nothing else that we see out there. And the EPS guidance we have given, $1.58, $1.62, is based on the revenue, $690 to $710.

Okay, thanks, that's helpful. That's all set for me. Thanks, guys.

Thanks, Scott.

Our next question comes from the line of Piyush Sharma with Longbow Research.

Please proceed with your question.

Hi, guys.

Hi, Piyush.

The first question is year-to-date what kind of market share have you gained?

When you say year-to-date -- say that again, Piyush. In what segment?

I'm saying if you look at your non-residential business, how much market share have you gained in the first half of the year?

I don't think we have the exact numbers on that one. Jonathan?

No. Market share, not really, Piyush, because, again, in this industry, we don't have that kind of information of who tracks exactly. We can roughly say we feel that in the commercial or non-residential area, we believe we are gaining.

The way to look at that, Piyush, is we can look at it from a macro perspective, but we are unable to identify which part is market share. Of course, we can talk about organic growth and how the business is growing, but specifically there is no why to measure the market share aspect of it.

Right. If I go back over the previous five quarters, and I basically map the industry wide growth, and for the 20% of your business and the solid 2.5% to 3% growth, I calculated that four out of the last five quarters your organic growth was actually ahead of that weighted average number.

I would think that most likely because of some share gains. And all of a sudden I don't see that residual anywhere in these numbers. So that makes me think that in terms of market share gains, is that activity going down a little bit?

It's hard to -- it all depends, Piyush, how you dissected those numbers, because remember because of the acquisition activities, most of those numbers, if you break that down, you will assume that to be the same breakdown, and they might actually vary.

Okay. Secondly, and this is again laboring the point here, but, I mean, given that 65% of your business is from the non-residential market, I'm curious that the market is up about 14% to 15% year-to-date. Even if you deflate it for materials construction, that's another 3%.

It's still on a nominal basis up 12%. FMI is projecting 9% and that's on a real basis. And I'm just trying to understand here, what are the expectations for the second half? Is non-res expected to slow down significantly?

Not really. No. We're not seeing any signs at all, Piyush. Now, when you say 14% to 15%, you are referring to construction put in place. The challenge in the construction industry is that you get stats of all kinds. Some people track permits, some people track construction put in place, and the reason we like FMI is that's the complete way of forecasting. They take demographics into consideration, the state government figures, the state numbers, and it's a very well balanced view as to how the non-residential is growing.

And if you look at the architectural index or if you look at the billing index or if you look at what do you call construction put in place, there are different perspectives, but they can often be misleading. So the fact that construction put in place is a higher number this month or this quarter doesn't necessarily indicate that construction work significantly went up this quarter alone, because that number can be spread out through a much longer period of time.

But, in general, if your question is how is non-residential looking, the answer is given the information we have on the ground, it's very supportive of the fact that it's continuing to grow at the same rate it was predicted earlier in the year, or latter part of last year, which is 8% to 9%.

And if I may just add to that to clarify a point that you just made, FMI, when you said 9%, before the inflation for material -- right?

Yes.

Yes. So when you adjust for that, or from what our experience is, you adjust for it 25% to 30%. So careful when you say 9%, you've got to adjust it down by 25% to 30%.

Okay, so basically bring it down to 300 basis points, which is essentially the materials inflation year-to-date.

Correct.

Okay, and lastly, on the incremental acquisition activity, it appears that that impacted your pretax with $3.2 million, and that's a blended number. Can you specifically tell me how much of that was depreciation only?

Yes, I called it out. Let me tell you. The depreciation for this quarter -- one second. This quarter was $6.6 million, compared to last quarter -- sorry, this quarter was $7.6 million, compared to last quarter was $6.6, a $1 million increase in depreciation just in one quarter.

Okay.

And part of it is acquisitions.

And then, finally, on your top-line forecast for the year, what is the acquisition -- the contribution from acquisitions that you're baking in that are already closed?

We have not baked in anything for the second quarter, Piyush. We don't do that. At least we decided not to do that. So only when we wrap up an acquisition, then we'll announce it.

Right, but I am talking about acquisitions that have already been closed.

Yes, we have taken the run rate of those acquisitions that we acquired in the Company is in our projections of $690 million to $710 million. So, of example, when Suri earlier said our year-to-date acquisitions accounted for 11.2% and our guidance, as previously we said we are 8% to 12% for the year, at that run rate, when you calculate it, we are already at the high end of our guidance for acquisitions. And that's in our projections.

Okay, so you're saying 11.2% contribution, if I may --

The level year-to-date, and year-to-date, we didn't acquire from day one. So what I'm saying is it's in the high end the 11%.

The impact of those acquisitions.

All right. Okay, that's all the questions I had, guys. Thanks a lot.

Thank you.

Thank you, gentlemen. There are no further questions at this time. I would like to turn the floor back to management for any additional comments.

Ladies and gentlemen, this is David Stickney again. Thanks for joining us this afternoon. We appreciate your continuing support and interest in ARC. Have a great evening.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.