ARC Document Solutions Inc (ARC) 2009 Q2 法說會逐字稿

Good afternoon and welcome to the American Reprographics second quarter earnings conference call. My name is Katina and I will be facilitating the audio portion of today's interactive broadcast. All lines have been placed on mute to prevent any background noise. If you experience any issues during the call please press star, then zero on your touchtone phone. Each request will be answered as quickly as possible.

At this time I would like to turn the event over to David Stickney, Vice President of Corporate Communications. Please go ahead, sir.

Thank you, Katina, and welcome, everyone. Today I'm joined by Suri Suriyakumar, our Chairman, President and Chief Executive Officer, and Jonathan Mather, our Chief Financial Officer.

The financial results of our second quarter were publicized earlier today in a press release. We'll be providing some additional insight into the quarter on today's call and then answering any questions you may have, as usual. For your reference you can access the press release and the company's other releases from the investor relations section of American Reprographics company's website at E-ARC.com.

Please be advised that we are webcasting our call today. A replay of the webcast will be available on our website for 90 days from today on the Company's website. A taped replay of this call will also be accessible by phone for seven days after the call. The dial-in number for the replay is in today's press release.

This call will contain 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 6th, 2009, and except as required by law, the Company undertakes no obligation to update or revise any of these forward-looking statements.

Finally, this call will 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 AK filing.

At this point I'll turn the call over to our Chairman, President and CEO, Suri Suriyakumar. Suri?

Thank you, David, and good afternoon, everyone. I'm pleased to report that the Company has performed extremely well in spite of the tough market conditions we have experienced in the first half of the year. Our second quarter results also clearly demonstrate that management's efforts to reduce cost and right-size the Company to suit the current market conditions have been very effective.

As I stated earlier this year our primary goals are to right-size the business, optimize profitability and generate a healthy cash flow to comfortably meet our financial obligations during this recession, as well as position the Company's operations to grow as the economy recovers. Jonathan and I will spend the majority of our time on this call reviewing how we are performing against those goals before we move to Q&A.

In the second quarter we delivered $0.14 per share and more than $33 million in cash flow from operations -- an increase of more than $11 million over the first quarter of 2009. This brings our total cash from operations for the year to $55.8 million in the face of declining revenues. You will also note that our gross margin remains very healthy at 37.5%, another increase over our first quarter and again during a period of declining revenues.

While I will not delve into details about our cost reduction exercises here, during the second quarter we continued to implement our stay-fit programs, and eliminated an additional $8.6 million in costs for 2009, primarily in the areas of production, labor, indirect costs and SG&A. We also improved our near-term debt structure by making additional payments of approximately $11 million in an early pay-down of capital lease obligations, which in turn further strengthens our future cash flow position.

We also began a significant realignment of management responsibilities, brought about more accountability to product management, and evaluated new but related markets we could address by making other uses of our existing resources. Our commitment to creating an agile and flexible operational structure, as well as keeping a sharp eye on the future, has kept us strong throughout these challenging times.

It is our strong belief that we will not be the same Company when we emerge from this recession as we were when we entered it. With this in mind, and having largely right-sized the Company to meet the current market conditions we have now begun the process of repositioning the Company to take advantage of the opportunities which should be available to us during the economic recovery. We plan to take full advantage of our national footprint, our core competencies, and our physical presence in most major metropolitan markets to pursue high potential, growth-oriented business opportunities that are driven by technology and which are typically outside the construction industry. Doing so will allow us to reduce our dependency on the AEC sector, which in turn will reduce our exposure to the seasonality and the cyclicality that characterize the building industry.

Our plan is to set up infrastructure across the Company over the next 12 months to serve large national and regional companies in the areas of color graphics and managed print services. While we already have significant operations in color they have been primarily dedicated to AEC work. Our new focus will be aggressively expand those existing capabilities into areas such as retail signage and other graphic marketing applications. Managed print services once again leverages existing resources to take over the entire document management and reproduction facilities of clients both inside and outside of the AEC market. Management services involves the provision of equipment like NFM, but goes beyond it to optimize its implementation and announce its capabilities with digital tools and applications to improve workflow, document management and other business processes. Finally, we will also be focusing on growing small [SM] markets both inside and outside the construction industry that are being driven by explosive growth of the convenience printers in both small and large format applications. All three of these segments are growth-oriented, progressive, and technology-driven. Aligning ourselves to these markets during this downturn will allow us to grow aggressively during the recovery.

While our long-term objectives are tremendously exciting, we remain committed to our near-term financial goals, primarily to generate a healthy cash flow in order to meet our financial obligations, avoid tripping any of our debt covenants, and funding our future growth.

So before we take your questions, we're going to briefly outline where we are today from a financial point of view, and I'm going to ask Jonathan to walk you through those issues. Jonathan?

Thank you, Suri. As mentioned earlier, our cost reduction initiatives, what we like to call our stay-fit plans, continue to provide us incremental improvements in our cost structure.

As most of you know, our business is structured in such a way that labor is our biggest cost. To put our cost-cutting efforts into some perspective, our employee headcount at the end of 2008 was approximately 4,500. Today, we employ approximately 3,500 people. It's a big reduction, and certainly a painful one given the value we place on our people. But these kinds of cuts were absolutely necessary in order to continue to deliver the performance we've demonstrated throughout this recession.

We also took the initiative in paying down the additional debt on capital leases. In this quarter our capital lease commitment also dropped by nearly 50% year-over-year. This year we entered into capital lease commitments of just $9.7 million. Last year, we entered into capital lease commitments of $18.4 million for the same period.

Given the progress we're outlining here, I should also reiterate that the environment for amending our credit facility, especially as it affects our covenants, is quite favorable relative to the recent past. We've maintained an excellent relationship with our banking syndicate and I'm looking forward to working with them to improve our flexibility in the near future.

At this point, I'll run through some of the quarterly information that isn't immediately apparent by looking at the financial tables and then we'll move into Q&A.

Our customer mix stayed roughly the same for the first quarter of 2009. Of our total revenue for the quarter, 21.1% came from the non-AEC segment, with 72.5% coming from the non-residential customers and just 6.4% from our residential customers.

Likewise our base of business by product and service segment stayed relatively constant. Facilities management made up 19% of our revenues. Digital services delivered 8.6% of our sales. 10.1% of our revenue was from equipment and supplies, while the remaining 62.3% came from our traditional base of reprographic services.

There were 64 working days for the second quarter compared to 63 in quarter one of this year. There was also 64 days in quarter two of last year. Day sales outstanding, or DSO, came down from 51 days in the first quarter of 2009 to 48 days in quarter two. Total debt, including capital leases, at the end of the second quarter 2009 were $329.5 million. This is down from the $350.6 million for the first quarter of 2009.

It is important to note that while we reduced our debt by more than $21 million, we also increased our cash holdings by $6.4 million. The ratio of debt to trailing 12-month EBITDA at the end of the second quarter was 2.5 compared to 2.3 at the end of the first quarter, 2009.

That covers the basics, so at this point I will turn it back to our chairman, Suri.

Thank you, Jonathan, and Katina, we are ready for the questions.

(Operator Instructions). Your first question comes from Kevin McVeigh with Credit Suisse. Please go ahead with your question.

Great, thank you. Jonathan, Suri, nice job in obviously a very tough environment here.

Thank you.

I asked this in the first quarter; I'm going to ask it again. Relative to the free cash flow or the operating cash flow it looks like year-to-date you've generated almost $62 million but you reaffirm the guidance is $70 million to $90 million. If you parallel that to last year where year-to-date you generated $57 million and you wound up generating almost $118 million. So could you just help us with the math in the back half of the year? Was it just conservative in the estimates or is there something that we're not factoring in?

Not really, Kevin. Obviously we have been very aggressive in terms as to how we manage the cash this year. Expenses are significantly down, there is no question about it. The only thing that we are reluctant to comment on and we don't know, really, is always the revenue numbers because we are always battling with that and you can see the revenue numbers are down.

But just better cash management, being much more proactive, expense management has significantly contributed to the numbers. But we thought we'll keep the guidance where it is because we are still very comfortable that we'll be able to deliver those numbers. It's very hard to predict in an environment like this how the second half will perform. Would you like to add anything to that, Jonathan?

Suri's right on. We are not willing at this point, while are very pleased with our first half-year cash collections, to change the guidance at this point from the $70 million or $90 million we said on cash.

Okay. And Jonathan, one other. If you could just -- what was your organic growth in the quarter? The organic revenue growth?

We had a decline in organic growth in this quarter of just over 30%.

Just over 30%, okay.

[For the year.]

And then just one other question and I'm going to get back in the queue. Are we still comfortable that we're going to be in compliance with the debt covenants or are they going to need to be renegotiated?

Right at this point in time, Kevin, we seem reasonably comfortable. Obviously given the cash position we have and given the changes we have made to the organization in terms of expenses we seem comfortable with what's going on with the covenants.

Okay, thank you.

You're welcome.

Your next question comes from David Manthey with Robert W. Baird. Please go ahead with your question.

Hi, this is Kyle O'Meara sitting in for Dave.

Hi, Kyle.

Hi. Could you talk about the revenue trends on a monthly basis through the quarter and what you were seeing through July, if anything? Just worsening, improving, just how you saw that trend the last four months.

We have basically -- there is still some amount of slide in the revenue. In other words, the revenue has declined. However, the rate with which it's declining has substantially reduced. In other words, we are closer to being stabilized, but I wouldn't call it stabilization.

Obviously, we won't give you monthly -- we don't specifically break down monthly numbers, but the trend has been that it has been declining, but the decline, the rate with which it's declining, has substantially reduced and it appears that it'll bottom out one of these days.

Great. And then could you just touch on the pricing environment during the quarter?

Yes, the pricing environment remains the same as we had in the last quarter. Certainly there is more pressure from the smaller reprographers, obviously what we refer to as survival battles. But however, the implication of technology helps us to actually -- to some extent to deter that because we use technology to upsell the product we have. Obviously there is zero pricing power, but the erosion has been reasonably negligible.

All right, great. And then on the cost savings side, done a really good job there. Do you feel comfortable with where you guys are today, reducing your head count from 4,500 to 3,500, or is there still some -- as things continue to slide, do you feel like you still have some levers to pull?

Yes, if indeed -- we've always said this, even in the previous quarter I have said this -- that if the situation demands that we make further cuts, we sure will do that. Right now we feel like the Company is substantially largely right-sized, like I said in the earnings call. So I'm fairly comfortable we're at the right size right now. However, should there be significant drop could we make adjustments to our cost structure? Yes, we can. But for now it seems like we are at optimum level.

All right, great. And then last one, if you could just give the number of business days in the third quarter and in the fourth quarter for 2009?

Yes, I can give that number to you right here on the third and the fourth quarter. Third quarter we would be at 64 days, and then the fourth quarter is 63. But again, on the fourth quarter is 63 working days, but you know it will be impacted by where these holidays fall and how people take time off. But on the calendar, it's 63 days.

All right, great. Thanks, guys.

You're welcome.

Your next question comes from Andrew Steinerman with JPMorgan. Please go ahead with your question.

Hi, Suri, hi, Jonathan, this is [Will Leaf] for Andrew Steinerman.

Hi.

What I'm just trying to -- hi. I'm just trying to get a sense of in terms of what revenue levels will you need to have to achieve here, 2009 EPS of $0.50 to $0.75 and then cash flow from operation goals of $70 million to $90 million?

Right. Obviously one of the things we are not doing is we did not actually give guidance on the revenue. Our whole focus has been improving the cash and the profit. Obviously the EPS numbers and the cash numbers are the guidance we gave, so the revenue is going to be, given the volatile market space and especially now that we know that second half, which is pretty seasonal in our industry, second half is always softer than the first half.

There is always going to be movement in our top line, so we are unable to exactly predict that number. That's exactly why we didn't give the guidance. But what we are confident is that given our cash position and given the way we have managed our expenses, we continue to make changes as required as we go along, virtually on a weekly basis, to make sure that we meet our objectives.

Okay. And then just moving on, in your push to have a more managed print services, so outside of the core AEC market, how does that change your set of competitors?

Ask me that question again -- how does it change our competitive position, is that what you mean?

Well, yes, how does it change who you compete against?

Oh, okay. We might be actually competing in some instances, depending on which the segment is, with a company that is other than in the reprographics industry. For example, we could be competing in some instances against large manufacturers of output devices or other companies which are involved in managed print services related work.

There are a lot of other companies, large (inaudible) companies, who basically do a fair amount of work in print room, mailroom, and other related services. So there are other companies like that, so we could be running into some of those companies as well.

But if it is outside of the -- that is, if it is outside of the AEC industry. However, in the AEC industry nobody knows the AEC industry as much as we know, so inside the industry, we'll be very strong and nobody else can do managed print services like we do, especially for the large national companies.

Right, right. Okay, thank you.

You're welcome.

Your next question comes from Scott Schneeberger with Oppenheimer. Please go ahead with your question.

Thanks, good evening. Guys, I missed the -- I heard residential, about 6.4%, but I missed the non-res percent. Could you repeat that for me, please, in the quarter?

Yes. Non-res is 72.2%; residential is 6.2%.

6.2%, okay, thanks. Suri, we saw ABI take a dip down in this most recent month and I'm just curious, were you seeing trends similar to that on the store level? And also just kind of looking out forward how you interpret that.

Right. As you know, Scott, we've always maintained that things like the ABI index, while they are indicative, largely indicative of what goes on in the marketplace we can't specifically tie it into our trends or any specific trend, because of basically different segments.

So what we always do is take ABI in conjunction with FMI, in conjunction with McGraw-Hill, in conjunction with what we see on the ground. So like I said previously, there is certainly -- the revenues are still declining, albeit at a much lower pace, not the same way we experience in the first quarter or the first few months of the year. It's at a much lower rate.

And we also know, given the industry we are in, the second half is softer than the first half. So we have had no surprises, really. It's pretty much tracking where we expected it to be, although the erosion is still there. It's very hard to say how the second half, given the seasonality and cyclicality is going to perform in these difficult market conditions because it wouldn't be unlike customers to say hey, it's a tough market condition, why start this project now? Or why go at full speed, let's slow it down, wait for it to pick up next year.

So we're hearing things like that from the customers. But fundamentally, we kind of expected this environment and that's pretty much on there, and then we kind of sense that that's going to be the way through the end of the year.

Thanks. Suri, you mentioned the second half is seasonally softer. Could you just give us a feel for magnitude in a steady state macroenvironment?

Well, when I say seasonally, if you take the four quarters, Scott, the first one and the second one, the second one is the best quarter. The second one is the best quarter by far. And then the third quarter is slightly lower than that. Fourth quarter is substantially lower than that.

When you say quantify, from last year to this year numbers might be substantially different, but then the first quarter again comes up from the fourth quarter. I won't be able to specifically quantify it but generally the second half of the year would be at least, Jonathan, would you say 10%, 15% off the first half of the year, around?

On an organic basis --

On organic.

-- Suri's right. On an organic basis, yes.

If you took on acquisitions, that's what, Scott, Jonathan means, that it could be off anywhere from 10% to 15%, depending on the year, the season, and so on.

Great, thanks. And then the percentage of res looks like it continues to decline. Could you just give us an update on California res, res overall, and maybe a little taste for the geographies and what you're seeing, good and bad?

Right, so fundamentally what's happening at the res is that when general markets talk about or news media talks about there is life in residential, what they mean is the inventory is moving. But that doesn't mean people are building yet, so the inventory is moving for two reasons. On all of those houses which were repossessed by the bank, they are finally starting to move. There are deals being done there. But that's a good sign, because what happens is when the inventory goes down that's when the building cycle kicks in.

But it has not shown any difference to us at all because what we call the residential marketplace is not building. The companies in the residential world are still not embarked on building. And that will come, but a precursor to that is the fact that the inventories must be depleted, and that's what's happening right now.

Across the nation it's pretty much the same. California is pretty much the same except for the fact that if you compare California to the rest of the nation, because their growth was so high their [deposal] substantially it was pretty deep and it remains there. From our perspective, there's absolutely no movement and there is very little building going on, but the encouraging sign is as long as the inventory gets depleted then obviously people will start building and I think it's sometime next year.

Okay, thanks. And then finally, and I'll hop back, Jonathan, could you speak a little bit to -- obviously you've begun discussions, or maybe they've been ongoing for a while, with the banks about giving another look at the covenants and the facilities.

Could you speak a little bit more to the extent that you can about what they're looking for, how close you may be getting? I know Suri mentioned earlier not necessary because you guys are doing a nice job of cost management, but just a little bit more insight into how those discussions are going? Thanks.

Yes, so Scott, basically we have been continuing to assess the market, the temperament, what the mood is like, and the good news is the banks are far more bullish than what it was, say, four months, even as recently as three months back. So the temperament is good that should we want to make a move we believe that the banks will be very supportive, and the cost -- most importantly, the cost will be substantially lower than what could have been, as you would realize, say three, four months back.

So what we are doing is we're talking to them, we are assessing it, we're looking at our projections, and at the right time, we believe we can talk to them and hopefully when they go to their committees expect that we will get their approval should we want to change the covenants or anything else in the agreement.

The temperament is good is the main message that I will share, and the fact that we as a Company have performed really well, as they see it too, in this environment. Suri wanted to add something.

Yes. Fundamentally, Scott, the way you look at it is to say that our options keep expanding as the year goes along. If we were to do something with our capital structure, let's say three months ago, it would have been much more costly, number one, and much more difficult.

But in today's environment the banks are much more receptive and they are cognizant of what we can do as an organization because we have proved beyond doubt that we can manage the company well and still generate cash, which means we are not bad credit. That adds a huge value to us as a client, whether to a bank or anybody else. So if you look at today's environment we not only have options at the banks, we have options with high-yield and we have a whole lot of other options where we can play around with the capital structure.

So like Jonathan said, our strategy is to be opportunistic -- have all these options available, and when we think the time is right we certainly will make a move.

Sounds good, guys, thanks.

All right, thank you.

(Operator Instructions).

Your next question comes from Franco Turrinelli with William Blair & Company. Please go ahead with your question.

Hi, this is Jeremy Frazer in for Franco. A lot of our questions have kind of been asked already, but could you guys give the geographic breakdown by revenue?

Yes, we can do that. Jonathan, do we have that?

Sure. For the quarter, Northern California, $17.5 million; Pacific Northwest, $10.2 million; Southern region, $33.6 million; Midwest region, $19.6 million; northeast region, $20.8 million; Southern California, $25.7 million; and then international, $3.8 million. We also hope to file the Q by end of the day tomorrow.

Okay, thank you.

You're welcome.

Your next question comes from Kevin McVeigh with Credit Suisse. Please go ahead with your question.

Great. Just a follow-up. As we think about the change in strategy, diversifying away a little bit from non-AEC, longer-term, in terms of revenue, what percentage do you think the contribution will be, number one, and then number two, structurally, how should we think about the EBIT margins of the business on a consolidated basis?

Right. So the whole strategy here, Kevin, is that we talked about how we want to reposition the Company to take advantage of that. So when we actually got into this recession, if you talk about the characteristics of the Company, we are primarily -- we were primarily a reprographics Company. Most of the revenue we had was print-based, and at least 75% of that came from AEC.

And where we want to go is when we come out of this recession we want to make sure a much larger percentage of that business comes from business which is unrelated to AEC. In other words, we want to reduce the dependency on AEC. In a perfect world, we want to be close to 40%, 50% of the business to be non-AEC, so which means our dependency on AEC is not that much. And also, we want to make sure a larger percentage of our business comes from non-print-based revenue, which is related to technology services.

So that's our whole strategy. I don't think there will be a significant change in the EBIT numbers. They're yet to be seen, but the whole idea is to use the same core competencies, the infrastructure we have and the technology we have, and figure out a way to access businesses, which are outside the AEC industry, which is mostly technology and services-driven.

One other thing I'll add to that discussion is that we were previously very division-centric. We acquired reprographic companies and which basically sold primarily reprographic services in local markets.

We are more and more becoming product-driven. In other words, we are developing products related to color strategy or managed print services, or small (inaudible). We've developed that in the corporate office, and we drive those product strategies through the divisions across the nation through our local branches. So instead of being division-centric, we are more product-centric.

Great, and if you said this already, I apologize, but what percentage of the revenue came from digital in the quarter?

Digital exactly is going to be 8.6% for the second quarter. FM contributions were 19%.

Great, thank you.

You're welcome.

(Operator Instructions).

Your next question comes from David Manthey with Robert W. Baird. Please go ahead with your question.

Hi, this is Kyle again. Just a quick gross margin question for you. Despite the sequential decrease in sales, you were able to increase your gross margins. How should we think about gross margin through the back half of the year, with sales likely seasonally slower in the back half? Can you maintain something in this range?

Well, I think we'll be within the range, Kyle, but I think the way to think about it is the second quarter, sequentially, our gross margins did go up. The main reason for that is all of the improvements we did. We talked about it in the first quarter. We couldn't' quite implement all of those cost-saving strategies in the first quarter in full. Many of those things we implemented the effects of were flowing into the second quarter and third quarter.

And that is why in spite of the decline in revenue, because it's no brain surgery, if your revenues decline significantly, then obviously your gross margins are going to decline.

But because of the depth of the resizing we did has substantially benefited us, that we saw an increase in gross margins in the second quarter. Obviously, we can't expect that to happen all along. There would be further decrease in the top line; we know that, given the fact that second half is generally softer than the first half. But I think we'll be still within the range, we won't be off significantly. Because of our cost-cutting exercises, we'll still be within the range, but it'll certainly have an impact on the gross margin numbers.

Great, thanks.

You're welcome.

At this time there are no further questions. Gentlemen, do you have any closing remarks?

Thank you. No, at this time I think we'll go ahead and wrap up the call. I very much appreciate everyone's interest in the Company and continuing support, and we look forward to talking with you again soon. Have a great evening. Bye-bye.

Thank you for participating in today's conference. You may now disconnect.