ARC Document Solutions Inc (ARC) 2007 Q4 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the American Reprographics Company fourth-quarter 2007 results conference call. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. David Stickney, Vice President of Corporate Communications. Thank you, Mr. Stickney. You may begin.

Thank you, Rob, and welcome to everyone on the call. With me today are Suri Suriyakumar, our President and Chief Executive Officer, and Jonathan Mather, our Chief Financial Officer. The Company's release reporting financial results for the fourth quarter and year ending December 31, 2007 was issued earlier today. You can access it and the Company's other releases from the Investor Relations section of American Reprographics Company's website at www.e-arc.com.

A taped replay of this call will be made available 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 the replay in today's press release.

This call is also being webcast live. A replay of the webcast will be available on our website for 90 days from today, again at www.e-arc.com.

Please be aware 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, February 12, 2008, 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 the SEC.

At this point I will turn the call over to our President and CEO Suri Suriyakumar. Suri?

Thank you, David, and good afternoon, everyone. I'm delighted to present our fourth-quarter results to you today.

As we approached the last quarter of 2007, it was clear that the decline in the residential market was playing havoc across the economy. We were faced with uncertain market conditions and a sliding investor confidence in construction-related stocks. This also impacted the earnings in our first three quarters, resulting in a significant decline in our stock value.

Realizing the importance of demonstrating that American Reprographics can operate successfully under tough market conditions, I challenged my management team to tackle the fourth quarter aggressively both from a sales perspective and an expense perspective. We took several initiatives and relieved the divisions across the country to inspire them to use our size, our technology and our dominant position in the industry to go after new business and increase sales while we reduced expenses without any compromise.

The outcome, ladies and gentlemen, was tremendous.

I'm pleased to report that we were able to deliver one of the best fourth quarters in the Company's history in spite of the fact that Christmas fell on a Tuesday, resulting in the loss of several business days in the last week of December.

Our fourth-quarter results are as follows. With sales of $174.1 million in the fourth quarter, we achieved an 18.5% increase over the same period last year. Clearly the adjustments we made to address a softer market, combined with our continuing focus on cost reductions and efficiencies, are contributing to meaningful improvements in the uncertain environment. Acquired revenue growth for the period was approximately 12.4%, and organic growth for the quarter was 6.1%, up from 4.6% in the third quarter.

In addition, under difficult conditions, we were able to deliver a gross margin of 41.2%, down slightly from 41.6% during the same period in 2006 when the business environment was vibrant. One must also bear in mind that we had a record number of acquisitions in 2007, and acquisitions have a dilutive effect on our gross margin.

The Company's EBITDA margin for the quarter rose to 25.8% compared to 23.7% in the same period last year. This is a clear example of how we continue to harness operating efficiencies from our growing business.

Actual net income for the fourth quarter of 2007 was $16.7 million or $0.37 per diluted share. We settled the Louis Frey litigation in the fourth quarter for significantly less than the original judgment and the result we had established to address it.

While we had a gain of $0.05 from this, we also had a loss of $0.02 due to the charge we incurred in refinancing our debt. Therefore, the fourth-quarter EPS number that most accurately reflects the real performance of the Company is $0.33 fully diluted. Again I wish to state that this is clear evidence that the Company and the management is well positioned to operate successfully, even under tough market conditions.

This will bring us to our annual results. For the full year, we reported sales of $688.4 million compared to $591.8 million in 2006. This represents an annual increase of 16.3%. Our gross margin for the year was 41.7% compared to 43% in 2006. And here again, I want to point to our very aggressive acquisition strategy in 2007, which produced a temporary dilutive effect on our gross margin.

The Company's EBIT margin for 2007 was at 25.6% compared to the 2006 EBITDA margin of 22.7%. Fully diluted earnings per share for 2007 were $1.51. Adjusting for the Louis Frey settlement and the refinancing charges, fully diluted EPS comes to $1.48.

I would also like to point out that our aggressive acquisition activity has escalated our amortization costs by at least $4 million this year, reflecting the appropriate purchase accounting rules. From a PO performance perspective, this would have added an additional $0.05 to our earnings per share.

In spite of the adverse market conditions and the negative investor sentiments toward the construction-related stocks, what we were able to accomplish in American Reprographics in 2007 was pretty significant.

Let me give you a brief recap. Firstly, we had a new CFO take charge early this year. After Jonathan Mather joined us in late 2006, he settled in quickly, made several changes and has done a tremendous job in streamlining our financing division. Our finance team has never been so strong.

Secondly, my friend and long-time business partner, Chandra Mohan, retired from the CEO position in June. After I took over, we made significant changes to the management team. I'm pleased to report that the management transition has been extremely smooth as evidenced by our operating results. We are now well-positioned to grow the Company through the next decade.

Thirdly, as I mentioned earlier, we made a record number of acquisitions in 2007, entering several new markets while solidifying our dominance in several important regions, including the mid-Atlantic and Southeast. This is no easy feat. No other company in our industry is able to acquire and consolidate new business like we can. These new companies will significantly improve our ability to serve national customers across the country.

Fourthly, we refinanced our debt during a very difficult time. Simply put, we were able to get more money with better terms in spite of the fact that we are closely related to the construction industry.

This is a significant accomplishment in comparison to what we had negotiated several years ago when the credit markets were much healthier. We, of course, had to withstand significant scrutiny and due diligence from some of the top banks in the nation. The fact that we were oversubscribed in this effort is a true testament to our Company's ability to perform under tough conditions.

Fifth, we were able to break ground with some significant new accounts in the non-AEC segment of our business. This we believe will continue to grow and add value to our business in the future.

Finally, our agreement with UNIS in China was a significant accomplishment from a long-term perspective. We expect to finalize our permits and commence business activity sometime in the middle of 2008.

Our (inaudible) program continues to produce excellent results, contributing more than 16.5% of our revenue this year with a total of 4592 accounts at the year-end.

Digital services, another high margin service line, produced 6.1% of our revenue for the year.

The fires in Southern California gave us a scare in early autumn, but in spite of the loss days and recovery time, we came through relatively unscathed from a business point of view. Against the background of significant challenges in 2007, I am proud of our performance on the whole.

So that brings to our outlook into the future. As I stated earlier today, we are cautiously optimistic about our performance in 2008. With the slowing or even recessionary environment, we can bring to bear strength and advantages that no one else has in our industry. Those advantages and strengths, and by that I mean our ability to acquire new companies, leverage technology, offer services and support consistent with our size, as well as balance the Company's operating capacity, have the potential to deliver real market share gains while other small players are simply struggling to hold on. While nothing is certain, I believe we can continue to deliver solid results in the months ahead.

Thus, we're forecasting 2008 revenues to be in the range of $720 million to $760 million, and then earnings per share will be in the range of $1.52 to $1.60 on a fully diluted basis. I'm sure you will want to explore some of these issues and others in our Q&A session in just a few minutes.

But before we begin, I will turn the call over to Jonathan for some color behind the financials. Jonathan?

Thank you, Suri, and good afternoon, everyone. Allow me to provide you with more depth to the numbers we disclosed in the fourth-quarter earnings release today.

Beginning with revenue by product categories, in quarter four 2007, reprographic services grew 19.7% compared to quarter four in 2006. Digital services, which are included in our overall reprographic services, grew 37.6% year-over-year and contributed 6.7% of total revenue in this quarter compared to 5.6% over the same period last year.

Facilities management grew 9.5% compared to the same period in quarter four 2006, while revenue from equipment and supplies grew 27.2% over the same period last year.

Revenue and revenue trend by geographical segment in this quarter were as follows. Southern California $43.1 million, down 4.6%. Northern California $24.3 million, up 7.7%. Pacific Northwest $11.9 million, up 49.1%. The South $46 million, up 42.1%. Midwest $22.8 million, up 25.8%. And Northeast $26.1 million, up 25.6%.

As noted in the earnings release, gross margin for the fourth quarter was 41.2%. This compares to 41.2% in the third quarter, 42.1% in the second quarter of 2007 and 42.3% for the first quarter of 2007.

Suri pointed out that we continue to experience higher than normal dilution to gross margin as a result of our addressing acquisition activity throughout the year 2007.

Comparing the fourth quarter of 2007 with the same period last year, the dilution from these acquisitions accounted for approximately 140 basis points of margin dilution, and labor accounted for 60 basis points of dilution. However, we were favorably affected in material cost by 60 basis points, and overhead absorption provided 100 basis points of improvement.

Our SG&A expense as a percentage of revenue decreased to 21.8% during the fourth quarter of 2007, reflecting Suri's earlier point of closely watching cost in this difficult environment. This compares to 22.2% in the fourth quarter of 2006.

In the fourth quarter, we achieved a settlement of the Louis Frey bankruptcy litigation case. Pursuant to the settlement, the Company agreed to pay $10.5 million relative to the reserve we had established of $14.4 million. Stock-based compensation is included in our SG&A expense. In quarter four 2007, stock-based compensation was $900,000 compared to $800,000 in quarter four 2006, and a $1 million in quarter three 2007.

In the fourth-quarter 2007, total depreciation, amortization and interest was $16.3 million, made up of depreciation at $8.1 million, amortization expense at $2.5 million and interest expense at $5.7 million. This compares to quarter four 2006 of $14.2 million with depreciation at $6.5 million, amortization at $1.8 million and interest of $5.9 million.

The refinancing of our principal debt in December also resulted in an after-tax charge of approximately $800,000 related to the extinguishment of our prior debt. As noted in our press release earlier today, this non-recurring charge had a $0.02 impact on both our quarterly and annual earnings per share.

EBITDA for the fourth quarter was $44.9 million or 25.8%. This compares to 23.7% in quarter four 2006 and 24.7% in quarter three 2007.

At this point we will look briefly at the balance sheet. We ended the fourth quarter of 2006 -- sorry, 2007 -- with working capital excluding restricted cash and current payables on the senior secured term loan of $16.4 million or approximately 2.4% of trailing 12 months revenue. This compares to $28.1 million for September 2007 or approximately 4.3% of trailing 12 months revenue.

Day sales outstanding or DSO were 50 days in the fourth quarter 2007 compared to 51 days in the fourth quarter of 2006. Total debt, including capital leases at the end of the fourth quarter 2007, was $390.3 million, up from $351.9 million for the third quarter of 2007. The ratio of debt to trailing 12-month EBITDA at the end of the fourth quarter was 2.2 compared to 2.1 at the end of the third quarter of 2007.

Cash flow from operations was $101.4 million in 2007 or $2.21 per fully diluted share. This compares to $98.4 million in the same period of 2006. 2007 payments were acquisitions and payments associated with acquisitions, including earnouts to sellers amounted to $132.7 million compared to $62.2 million in the same period last year.

In closing, let me add that we purchased Company stock in the fourth quarter amounting to $7.7 million.

That concludes our financial discussion. At this point I will turn the call back to our CEO, Suri.

Thank you, Jonathan. Operator, we are ready to take the calls.

(OPERATOR INSTRUCTIONS). Mike Schneider, Robert W. Baird.

First, if you can just speak to the guidance which I'm sure will be a hot topic this afternoon, and can you address as to based on the exit organic growth rate your forecast and your modeling for organic growth and what amount of acquisition required revenue you had built into the guidance?

Okay. Fundamentally the way we are looking at this is that we obviously are taking into consideration what is going on in the macroeconomic environment, you know from my predictions, (inaudible) predictions and every other bit of information we have. And then tie that with what is going on on the ground and come up with what we think is a reasonable projection for the year 2008.

So based on what FMIS stated and we must bear in mind what FMI and McGraw-Hill has stated is that at least six to seven weeks old, and since then market has deteriorated further. We are mindful of that, taking that into consideration and we looked at the three key segments of our market. So that is non-res, residential and, of course, non-AEC. So we think the non-res would be down by about 5% over the year based on all of the information we have, and the strategy behind that, as you know, in the reprographics industry we are last in and last out.

So while the market does not show at least on the ground we don't seem to have the big negative going on right now, we think by the latter part of the year we will start to experience some of the effects of what is going on in the larger market space. You know relatively the private cash and the cost of capital going up and so on will start to reflect the latter part of the year.

With regard to residential, we think residential will be down 5% throughout the year. However, the way we are looking at that, Mike, is that in the early part of the year since we are always comparing quarter to quarter, so which means that we will compare the first quarter or the second quarter to actually the first quarter of 2007 and second quarter of 2007. So the earlier quarter, the drop will be significant. Because in early 2007 the housing market was still holding on, and it was still sliding.

So the way we look at it is that the earlier part of the year, we will have a higher drop in the housing, and then in the latter part of the year, it will just taper off.

With regard to non-AEC, we always tied that the GDP. So we think that will be tied to GDP, which is around hovering around 1, 1.5%. But we think because of the fact that we have additional $6 million worth of Boeing business, at least $6 million worth of Boeing business coming in, we think the GDP part of it, the non-AEC part of it will grow by about 2%.

So the combination of all that is what we took into consideration. And we also took into consideration the fact that we have about $71 million -- I'm right, Jonathan -- flowing into front last year. That is the flow-through on acquisitions. So we did about 688 last year and 71 million flows in. So that is the number that we took into consideration. We have not built in any acquisitions this year, and we certainly plan to do some acquisitions, but we want to be very watchful of the market and be proactive. So we have not added acquisitions into our guidance.

Does that give you a snapshot, Mike?

Yes. So to be clear, the organic growth number, if you blend the three markets, is basically down call it 4.5 or 4% for the year?

Yes. (multiple speakers). It is down to -- it will vary between 3.5 to 4.5%.

Okay. Based on numbers I guess coming out of your non-res portion of the business, can you give us a sense, though, what you're seeing today and maybe the trendlines during Q4?

Absolutely. Absolutely, Mike. Now what we are seeing right now on the ground is pretty encouraging. Because to this date, we have not seen a significant drop in business volumes. What we are experiencing is that projects are slower to start, but the work is coming on. And we are not surprised by that because, as you always know, we are the last to get in and the last to get out from a recessionary cycle perspective as evidenced by the residential cycle as well. So you know so we did not expect any difference.

The last quarter turned out to be really good. And, of course, like I said in my call, we made significant changes. Knowing what was coming on in the last quarter, we actually started reacting to the market conditions right away. We put several controls in place. We had several new initiatives. We drove our sales teams even harder, and as you know, since I took over in June, I have been talking about becoming a more sales-oriented company. So we had already put in several initiatives in place starting from June last year, the impact of which we did not quite sense in the third quarter because it was too early. But by the time the fourth quarter came in, with all of our additional initiatives, we really did well in the fourth quarter, and that is reflected in the numbers.

Okay. And just final question and I will get back in line. The breakdown then between AEC growth and non-AEC growth, you did 6% organic growth this quarter, which I think was much better than anybody anticipated. Is the growth coming still out of AEC, or is it contracts like Boeing, and can you really dissect the organic growth looking at the markets that way?

It is hard, Mike. We have not done that before. We don't break it down because obviously they can be coming, but if you just work the Boeing numbers, that is just over 1% I would imagine in terms of what we got from Boeing. Everything else is new accounts we have got, and we have some tuck-ins coming along. So it is a combination of numbers there.

However, we are confident like I stated in my call that given where American Reprographics is positioned, we are really starting to push our position, our dominant position, our new markets and drive the business. And that is why we are confident that whatever the market conditions may be, even if it is challenging, I think relative to the market we will do very well. Because I think we are -- we have the right infrastructure, we have the technology, we have the premier accounts, and we obviously have the footprint. That is going to allow us to drive this market.

Franco Turrinelli, William Blair.

It is snowing hard in Chicago, so everyone should stay away from Chicago. I was interested in your comments, and congratulations on the quarter before I ask my question. On the looking ahead now, you mentioned and we certainly agree that you have increased the sales focus of the organization, the sales culture. Where do you really have your salespeople focus right now? Is it really trying to get that extra little bit of business from your existing customers, or are you really challenging them to go get new business? What are you doing on the non-AEC front? To what extent can you leverage Boeing? Can you give us a little bit more color on that side of the equation?

Sure, absolutely. We can do that -- you know we do -- it is a combination of all the following which I am going to say.

Number one, from our existing customers, obviously during challenging times, we're having a greater sales focus, which means now each and every division. We have over 340 plus salespeople across the nation. That is a moving target, as you know, as we continue to acquire the companies. But our business is basically one-on-one sales directly with our customers and accounts. So this is basically making sales calls.

So we have been directing our salespeople to do this but for the fact that the focus is much greater now because from the President downwards is talking about how many sales calls we're making, who are we seeing. And what we're doing is we're doubling the efforts. We're saying tough times call for tough measures. So we are going out there, and we are going to hustle for the business. So that in itself is one drive.

But with regard to where it is coming from, it is coming from the existing customers. We're also going after new customers because we do have a larger territory. We do have opportunities like premier accounts, which can cover our national customers, and then, of course, we're also going into non-AEC customers like Boeing. With the kind of credibility we have in operating accounts like Boeing, we're going after non-AEC clients and providing that same service.

It is also announced, further announced by new products we have. So, for example, we have our FM strategy, but we have talked about developing smaller FMs for all smaller customers because using the same infrastructure we have, same technology we have, we can actually facilitate smaller clients to have announced facilities at a lower cost, but also at lesser administration hassles for us.

So we have produced different things like that and come up with strategies to go after smaller FMs and then also provide new digital services where we can actually bring about process improvement for our customers.

So it is overall looking at what else can we sell, what infrastructure we have, and leverage everything we have. So it's a combination of all, and it is starting to show, and it clearly shows in the quarter results, and I am very encouraged about this year.

Is the time right for a greater international push, or is the time now to hunker down to make sure the core business is looked after?

Right. Interesting you asked that question. Whether we like it or not, we are getting more and more involved from an international perspective. Now last year we talked about this agreement with UNIS in China. Obviously that is moving along very slowly, though, given how we do business in China. That is coming along very nicely, and we think somewhere in the middle of the year we will start full-scale operations there. We're working in the (inaudible) stages.

But amazingly what is happening is increasingly we're dealing with projects in London, in Dubai, in Abu Dhab, in Japan, in France. More and more international projects are being done by architects here. And where they are coming to us is they are saying, look, we're tired of printing all these things and carting these things or shipping these things. Can you guys figure out a way to get these documents delivered for us when we will land there? Which means we upload all these documents in PlanWell and retrieve documents out of PlanWell.

I mean just in a place like Dubai alone, billions worth of projects which is going on. And, in fact, as we talk, one of our senior managers is attending a construction conference just in order to see how (inaudible) did that.

But to answer your question, yes, we are actually focused on the local marketplace. That is the right thing to do. Because we are still only 12% of the marketplace. And given our position and dominance in the marketplace, we really think we can continue to announce our position here in the US.

But I must tell you, though, the international business comes our way by virtue of the fact that we serviced so many large architectural land construction clients.

One final question and then I will get back into queue as well. I mean clearly the guidance that you have provided recognizes the tough environment out there, but nevertheless is in line with certainly our estimates. I mean from my perspective, it seems like we may have reached the bottom. Now listening carefully to your comments, though, I think what you're really saying is that collectively we should expect kind of a bottom to be the summer of this year before things really start to look better both from an end market and from a comparisons point of view. Is that fair?

Yes. I would say that is an accurate well put statement.

Scott Schneeberger, Oppenheimer.

I guess following up on Franco's questions, with the new business you are pursuing, new customers, existing customers, what is the pricing environment? I think you had said in prepared remarks that with your size and scale, you have the opportunity to be flexible with what you do to pricing. If you could just give us a little bit more on that guidance?

Yes. We don't -- the pricing has not yet got affected just yet. Given what is going on in the marketplace, like I said before in the reprographics environment and in the construction, particularly in non-AEC, the business seems to be slightly slower but is pretty strong still. So we have not run into the pricing situation yet.

But what can happen, which we expect to happen later in the year, is that if the market gets tough and the work gets difficult to get, then obviously the prices will start sliding down. Up til now we have not seen any erosion in the price. We don't expect that to happen in the early part of the year. I think, though, in the middle and the latter part of the year, if market tracks the way it is tracking currently, there is a chance that the pricing can slip.

Okay, thanks. That is helpful. I guess with the guidance, is there anything interesting we should know about number of days year-over-year, and then any thoughts on what you're looking at on the cost lines that we should think about as we move forward into '08?

Right. The number of days, I can give you a quick snapshot of that. In 2008 we would have one day extra. We would have 64 days in quarter one, 64 in quarter two, 64 in quarter three and 63 in quarter four. That is the grand total. That is a day more than 2007 and two days more than 2006.

But, as you know, Scott, it also depends in some instances what happens is depends on where the holidays fall. So if a holiday falls, for example, this year it was devastating because Christmas fell on a Tuesday. So people take Monday off, and then Tuesdays off, and Wednesday nobody shows up to work, and inevitably many offices are closed Thursday and Friday as well. But, on the other hand, if the Christmas falls on Monday, it is just perfect for us.

So other than those windows, in 2008 we expect to have 255 days and quarterly the breakdowns I gave you. Did you ask something else?

Yes. Just on the cost lines, how we should be thinking about the cost lines in the margins as we look at '08?

Right, like Jonathan pointed out this as well. One of the things which effects our margins is when we acquire a company, the operating margins tend to slip. But we believe based on what we're doing, there is no reason to expect the current situation to slip any further. Because we have done about 107 -- $130 million worth of acquisitions last year, and we are continuing to improve those companies. Some of them were done in the latter part of last year. So there will be some improvement, and there's not a whole lot of acquisitions we're trying to line up.

Obviously in January we're watching to see what turns the market takes. We want to be careful about what we are acquiring. So I don't expect the margins to slip down a whole lot. I think we will hold similar margins to 2007.

Okay. And I guess should we be thinking that the guidance does not include much for acquisitions? And you say that you're being cautious at the start of the year. Wouldn't this not be a good time, might multiples be lower to acquire, or are you really cautious as we proceed?

Right. The first thing we have not included any acquisitions in the guidance. We have not included that. So the numbers I just as clean as the account. When we do acquisitions, then, of course, then we will do the right thing and let the market know and make the changes required.

With regard to the acquisition and what we're planning to do, as I said before, because in the reprographics industry, we're last in to last out, the companies have not really felt the pain not just yet. Everybody knows the market is tricky. Everybody knows the market is volatile. But the impact of that is not realized just yet, and it will be in the middle of the year or latter part of the year.

That is when we have that opportunity you're talking about where there we could be buying it at a lower multiple.

Now we already have taken that position with the people we're talking to. So the way we look at it is we take, as you know, we buy in trailing 12 month EBITDA, and we have four to six multiples. That is our usual strategy in acquisitions.

What we're doing now is we're taking the trailing 12 months EBITDA, and we give that a 10% to 15% haircut so to speak knowing very well the market is going to slip. And then we say instead of buying closer to 6, we will try to buy closer to 4. That is our fundamental strategy, and that is the right thing to do.

However, for that to really take foothold, we are probably looking at second and third quarter because the market is very volatile, and we certainly do not want to approach anybody at this point in time who has fairly good results in 2007, and we don't want to take those numbers for granted because we are fairly certain, particularly with small operators, that will run into some rough waters later in the year.

Okay. Thanks. Just one real quick one if I can sneak it in. Jonathan, I assume the EPS guidance does not include share repurchases and just any thoughts on that.

You are right on. We did not assume any share repurchase that we may do during the 2000 year.

Al Kabili, Goldman Sachs.

Just also a question on the guidance. In terms of the gross margins, I think you highlighted you're hoping to keep them flattish in 2008 or maybe slightly down. But given the organic growth potentially being down in 2008 and seeing negative fixed cost absorption as a result of that, how do you keep your gross margins flat in that environment?

Because that is a good question. But what will happen also don't forget that we have acquired about $130 million worth of companies, and we will have margin improvement in those companies. They obviously -- you know we cannot take anything for granted. But the good thing about our business is because we ended on $130 plus million worth of business, we now have the chance to consolidate them and improved margin and we do that. We generally do that in 90 to 120 days, 3 to 5 points, and then our theory is 12 to 24 months we bring them up to 20%.

However, in a tough margin marketplace, it might be tougher. But we are fairly certain given that we have such large volume of acquisitions and the fact that we are working hard on controlling expenses and improving performance, we can still deliver those numbers. We are very comfortable with that.

Okay. An update, if you could, on fixed costs as your COGS cost of sales breakdown, you know fixed costs, are they still about 60% of the total?

Jonathan, would you like to address that?

Yes, what we have done for internal purposes what we're using is a 50 percentile, 50% of costs are call it somewhat fixed.

Okay. And then any opportunity -- you know you highlighted cost savings in the fourth quarter, and certainly the year-over-year margin comparison certainly improved versus the last couple of quarters. Any opportunity for additional cost savings in 2008, and if so, any way you could help us quantify or think about that?

It is hard to quantify that, but our general strategy is that obviously during 2007, particularly in 2006 and 2007, we are growing very fast. We had a significant number of acquisitions. So when the market is so good and the business is so good, it is hard to keep the cost down and control it, particularly when you're growing very aggressively.

What we have now going on is that from the last quarter onwards a tremendous focus on keeping the costs down. So it is hard to quantify.

But I think as we go along, again for the same reasons because we have acquired companies, we can continue to trim those costs down. I would not venture to quantify them, but I think we will continue to improve the performance in those companies which will contribute to our numbers.

Okay, got it. And then I guess on the share repurchases versus acquisitions that an earlier caller had asked about, I think given in the short-term your more cautious outlook on acquisitions, how do you balance that with share repurchases this year? Is this an opportunity in the near-term to use the extra free cash flow you're generating for share repurchases, or do you see increasing cash for dry powder down the road for acquisitions?

Sure. You know, the very interesting part of our business is that I have always said that every year we are almost able to do all of our acquisitions with our own cash. And that is because we have very strong free cash flow in the Company. Of course, due to timing differences or because in some instances when a credit sponsor sells a company, we have to pay all cash, we might need the cash. But pretty much we have a very strong free cash flow, and we're able to finance our acquisitions through our own cash.

In addition to that, as we talked about it earlier, we did refinance our debt. And so we do have dry powder left. So fortunately we do not have to make that choice of whether to buy shares or acquired companies. We can do both at the same time in a balanced way.

But what the current market conditions are presenting to us is that we must be cautious about acquiring companies not knowing which way it is turning. Once we get a feel for how the market is going, then we can move on acquisitions. Obviously our pipeline was full even as of the end of last year, and we still have a lot of companies who are interested. We are just slowing it down in order to make sure that we keep it at the right time, at the right price. And we want to be really opportunistic about it.

If I may add to what Suri said and I think also to get a little bit more specific with your question, with respect to the share buyback, absolutely what Suri has talked of on the money, etc., but our credit agreement has certain limitations. As you know, last year we did have a release where we said the board approved credit agreement allowed us to buy up to $200 million. Our board approved it by $150 million, but again there is only so much we are allowed to buy under the credit agreement based on our operating cash flow. The bigger chunk of it has to be bought with a sub debt. So there are some limitations to the cash as to how much we can use to buy stock.

Can you update us how much right now is available for stock repurchase? I missed how much you have already purchased.

As I said in the call earlier, we have already spent in the fourth quarter last year during our open window that we could buy back, we spent $7.7 million. Okay? That is out of our operating cash flow.

Now the agreements, our credit agreements are filed. You can go into that. Basically we could buy on an annual basis another on a $10 million with a maximum $15 million on the whole agreement. So the real chunk of what we can buy in this stock buyback is coming from by issuing sub debt.

It is fundamentally -- sorry, go ahead.

No, I'm sorry.

I mean fundamentally so the answer is that if we were to do a meaningful stock buyback, that probably will be using sub debt avenue than the cash generated by us.

Okay, got it. And then final question on California. I think in Southern California where you saw actually a decline in revenues, and if you could just give us some color there. Is that just, the bulk of that at this point still residential, or are you also seeing some weakness now in the nonresidential markets down there as well?

Mostly it is on the residential. That is what we have seen. The non-res has not taken ahead yet. Obviously what -- the part which grew very fast was the Southern California residential market. And also last year when the bottom fell off, the part which fell apart is the fact that while the rest of the nation was down 20 to 25%, Southern California was down 40% plus on the residential.

We don't see any negativity on the non-res part of it at all. But I think the impact, which is brought about by Southern California, will be lesser this year, but it will still be there a little bit of negative effect.

But what we're doing is we're focusing our energies on nonresidential and non-AEC accounts which is the right thing to do.

(OPERATOR INSTRUCTIONS). Mike Schneider, Robert W. Baird.

Can we spend a minute on PlanWell? Just what impact if any of these spending cuts has been taken out of PlanWell? Just the momentum of PlanWell as you finish the year, and again maybe what you expect out of PlanWell in the coming year given the softer markets?

Sure. The spending cuts none whatsoever, Mike. In fact, we probably are spending more money on PlanWell. And the reason I'm saying that is one of the things which is very positive for us in a downturn or in a recessionary environment is that people are always looking to save money. That is the customers are looking to save money and improve the process, and that is where PlanWell becomes useful. We can now go to customers, officers and talk about process improvement and reducing time and money.

So we really believe in an environment like this, we will actually have a positive impact with regard to our digital sales. Because people who did not consider digital before because they were too busy and they thought it would take too much time for them to learn, will now look at the products and say, yes, we would like to use it. Yes, we would like to save money.

So our technology expense has not gone down, and we don't expect to trim that down. We expect that to stay where it is, and in fact, if we have to build on it, we're not reluctant to build on it.

So obviously there are a few areas we are investing in. The areas we're investing in is sales and marketing. New products, new strategies for marketing and getting across to the customers premier accounts and technologies that may be one of them.

For example, there are a couple of new tools actually services that we're trying to develop for premier accounts to further enhance premier accounts position so that we can go after national accounts. And that we really believe this year premier accounts will take off, and I can sense that already.

Okay. And the PlanWell position I guess do you have any idea as to how many licenses you have out now? And I guess to the extent you can what marketshare you believe you have in the digital realm?

Sure. In terms of the locations, we're up to 344 locations with PlanWell technologies. In [Pier] we have 205 members. So that is continuing to grow very nicely. Now we are posting between 700,000 and 800,000 new documents per month on PlanWell. So that part is going very well.

So all of the initiatives from AFM PlanWell part of it is going on very well. We continue to fine-tune the internal features of PlanWell. There is a feature which is called BidCaster. We upgraded certain elements of BidCaster again based on how people are using it, what they are applying it for.

So the technology continues to improve, and we continue to announce those technologies and bring about additional technologies for distribution of documents. Because that is becoming more and more a common concern for all of our customers. They are saying, why do we have to have such larger number of documents printed and FedExed or UPSed. Why can't you accomplish that for us digitally given the fact that you are in 300 plus locations? We are now in 308 locations.

And what we are using is, we are starting to investigate and develop technologies which can take large files, convert them and zip them across the nation and have them printed and delivered. We will start with what we call remote printing features. We're starting to develop that, and it is coming along very nicely.

Okay and just a more conceptual question. With non-res being forecasted to be down 5% in '08, can you at least position that relative to some of the pressures on printing volume? Have you assumed that, no wait, we see some acceleration in the rate of decline of printing from whether it is half sized printing or selective printing by certain contractors, etc.? Or is it just a market decline of 5% you're anticipating and no real reduction in true printing volume?

Your second -- the last part is the correct one. We are just basically looking at the market decline. And that is an estimation based on the information we have on the macroeconomic climate. I mean that is not a specific identified target. We're just looking at the macroeconomic environment. Given all of the projections, we believe based on the information we have, particularly the latter part of the year, we will soften down.

But in terms of the printing volumes, we really don't think that will come down. Now the only thing which can impact the printing volume is that the customers start to use more digital because that is to their benefit. However, that is offset by the fact that we are aggressively expanding our FM base. We continue to sell more FMs. And by selling more FMs, what we do is we capture those clicks. So that is often offset. In fact, we will have additional clicks.

I think that what we gain out of FM will be more than what we lose out of half sizes or digital transition. So we don't expect to see any meaningful decline in our print volumes.

Okay. Then actually a good segue to the FM business. It was actually flat sequentially in dollars. Can you give us some color because you have obviously been adding 10s of clients if not hundreds of clients each quarter. Why would revenue have been flat?

You know, Mike, I don't have the numbers -- the exact numbers in front of me, but I can explain that to you. Because one of the things which happens with FMs is that when we acquire companies, we have a certain number of FMs which come along with it.

For example, if you take the fourth quarter, I have the number, we have a total of 402 FMs. 107 of that was acquired. Then I can tell you based on what I know from what we generally experience in this marketplace, the profitability or the numbers in those 107 would be vastly different to the 300 plus we have sold. Because it is just that we sell FM as a strategy, and our buying power and our leveraging is much greater.

So what happens is, the numbers get skewed with the acquisitions. But one of the things we do is, as we get into those FMs, then we look to upgrade those FMs or make changes in those FMs as those contracts come up. Our good customers with upgrades in order to bring them up to spar with what we have.

So the revenue being flat sequentially, is that a roundabout way of saying you are pruning less profitable FMs at this point?

No, I mean it only means that we have brought FMs from outside, and the revenues might be impacted by the fact that they are not all FMs that we signed.

And then as I'm recollect in 2006, we also had a fabric collector, a couple of hundred thousand dollars or maybe 500,000 or $600,000 catchup on FM revenue in the last quarter of '06.

Okay. (multiple speakers)

In the '06 forth quarter. So fourth-quarter '06 had FM revenue slightly higher than real billings because of (multiple speakers) catching up and making sure everything was billed to end of 31st of December.

Okay. And then (multiple speakers)

We will do a little more research on that and give you a little more color.

Okay. Fair enough. And just final question, just on the sales initiatives. Can you give us some sense as to what initiatives that were implemented during the middle of the year, R&D gaining traction at this point and driving the organic growth?

Sure. You know overall what we established is we realized that in acquiring the companies, we just take our business model and look at how we operate. Fundamentally what is happening is we are a company spread across the nation with different brand names, so we have 44 plus brand names. And they are very much independently run because these are individual entrepreneurs that we acquire, and we maintain those brand names, and then we pretty much dependent on these independent entrepreneurs to drive the sales.

So when we decided, okay, you know we really need to focus on sales, we brought about more of a central strategy to selling, which we did not have before. Previously we would say, okay we have these products. We have planned well. We have MetaPrint. We have Abacus. These tools and these technologies are passed on to these divisions, and the local presidents and local CEOs decided what they would sell, how they would sell and which one is applicable to their customers. We never had a central selling strategy.

What we did in the middle of last year is when we started this initiative, we created a team in the corporate office, and we got a group of CEOs and we said, okay, from this room we are going to drive sales aggressively. We're going to monitor sales in every company, in every division and break it down by segments and follow up on what is going on.

So we have a room here in the Walnut Creek office where three or four of the CEOs and corporate executives sit, and across the walls all the numbers are posted. They are live numbers, which means on a daily basis the numbers are updated. So we call it the war room actually. It is a fun name, and if you come here to say war room. Do not enter.

And what happens there is that the numbers are posted. I mean basically on a live basis you can actually ask a president of a company why is that the second week of the month your sales are lacking? Which areas are you falling short? What do you need in terms of help? Do you need training? Do you need equipment? Is it a customer problem? What everthat might be.

And then what happens is that every three or four weeks we would actually have conference calls where we would have all of the presidents of the divisions broken down to four groups. And I would sit on those conference calls and quickly review sales performance. What is going on, how are we tracking, what is happening in the sales, and all of those divisions were they are failing to meet the budgets, we take corrective action. What should we do different? Do you need help? Do you need a sales consultant to fly down? Do you need somebody from another office to come and teach you about FMs because you are falling short in FMs?

So it is much more hands-on, much more directed specifically controlled strategy. As it was in the past, we always had the divisions say, these are entrepreneurial divisions, we buy companies, and we let them run with their own sales strategy. Now the sales strategy is directly directed from the corporate office, and in many instances that comes out of my office.

John Emerich, Iron Works Capital.

A couple of unrelated questions if I could ask them separately. One, what is the approximate tax rate you're using for next year?

Jonathan?

38% we will use for 2008.

Okay. And what is the discrepancy -- what allows the discrepancy, if you will, between your depreciation and your capital expenditures, and is that sustainable?

Okay, the main item is capital leases. In the cash flow, at the bottom of the cash flow, you see the number of capital leases we have entered into and that is depreciated. But it is not reflected in the cash flow as capital expenditure because it is not capital expenditure.

Got you. You were walking through and the question about your organic growth assumptions for 2008, you walk through non-res minus 5 and res minus 5. Were those assumptions about your organic growth within those segments or the end market organic market growth, if you will, in those segments?

Based on what we know from the market, the macromarket, and the information we have. So the way we look at that is to find out information. We track FMI very closely, McGraw-Hill, the architectural billing index, and then, of course, any information which comes out of the US Census Bureau. And then we have information on the ground.

So it is monitoring all of that and then marrying with the information we have and coming up with what we think is the projection for us. So it is actually we are projecting that our nonres will be down by 5%, and our residential business also will be down by 5%. I verified that early in the year it will be down by a larger percentage, and it will tail off during the latter part of the year. And then, of course, non-AEC we think it will grow by a percent -- we always said it tracks GDP.

Let me just drill down on one of them for instance. In residential construction I think it is finally being more widely accepted, and I subscribe to it, that housing starts are going to be down another 20% in '08 versus '07.

Starting with that number, how do you get back to minus 5% organic growth rate for you guys?

Right. Now if you break down our business, our business breaks down 65% of our business. Traditionally we always said 65% of our business is nonres, 15% of our business is residential, and 20% of our business is non-AEC. In other words, nonconstruction-related.

Last year when we took the sample after going through what we have gone through, our nonres has gone up to 68.4%, and then our residential has come down to just under 12%.

So the way we look at it is we look at our 12% business, and that is not necessarily consistent across the board. Because in places like Southern California, we had a higher percentage. So what we did is we took that business and said, if 15% or 12% of our business would be down by 5% -- and why do we say 5%? Because from our perspective what we are seeing is that if you compare our -- for example, let's take an example.

Let's take our first-quarter numbers. If our first-quarter numbers is compared to the last quarter -- the last, what do you call it, 2007 first quarter, we think that will be down about 10%. We don't think it will go down any further, but I think it will be down 10%.

Because what happens there in 2007 the numbers got increasingly worse from 2007 first quarter, second quarter. So we think -- so the difference is going to be in 2007, we think will be down first quarter about 10%, second quarter 7.5%, third quarter 5% and the last quarter maybe 2.5%. That is how we came out at an average of 5.

Okay. If you don't mind my asking, is your Q1 business for residential actually trending only down 10%?

Yes, in general when we're looking at it, we're actually very comfortable. In fact, we were talking this morning it looks like it is keeping track. Because from our perspective. we feel like the residential has fairly bottomed out. I mean I know the whole residential market as an industry, it is going to be suffering a heck of a lot more because it involves mortgages, finances, all of it. But if you look at the construction side of the business, almost all of the houses which were in the pipeline are almost constructed and finished. So, as a result, we don't see the effect as much as it will affect the overall industry.

Okay. And then the last question is, you did just refinance I think. What is the -- I do not know how to word it -- the debt covenant of all of the debt covenants you have that you are closest to understanding that you have lots of room to begin with. But is it a debt to EBITDA or interest coverage? What would you be closest to?

Jonathan?

You know, if you look at our debt covenants, we have plenty of room. The one that I watch very closely is the risk coverage and interest coverage, etc. We have plenty of room.

So to answer your question, specifically one that I would be closest to, is the fact than on capital expenditure you know we are allowed to spend $15 million a year, and last year we spent $8.something million. You can just imagine the amount of room we have in our covenants.

Sure. Perfect. Thank you very much.

Ladies and gentlemen, we have reached the end of our allotted time for questions. I would like to turn the floor back over to management for closing comments.

Thanks, everyone, for joining us today. We appreciate your interest and continuing support of ARC. If you have any further questions, please feel free to call our corporate offices and ask for me specifically, David Stickney, at 925-949-5100.

Thanks very much for your attention and your respect. Good night.

This concludes today's conference. Thank you for your participation.