ARC Document Solutions Inc (ARC) 2010 Q1 法說會逐字稿

Good afternoon. My name is Dawn, and I will be your conference operator today. At this time I would like to welcome everyone to the American Reprographics first quarter 2010 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions). Mr. David Stickney, Vice President of Corporate Communications, you may begin your conference.

I'd like to welcome everyone to our call today. Joining me are Suri Suriyakumar, our Chairman, President and Chief Executive Officer; and Jonathan Mather, our Chief Financial Officer.

The call today will provide you with some insight into our first quarter, the financial results of which were publicized earlier today in a press release. 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.

A taped replay of this call will be made available beginning about an hour after its conclusion. It will be accessible for about seven days after the call. You can find the dial-in number for this replay in today's press release.

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.

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. Bear in mind that such statements are only predictions, and actual results may differ materially as a result of risks and uncertainties that pertain to our business.

These risks are highlighted in our quarterly and annual SEC filings.

The forward-looking statements contained in this call are based on information as of today, May 4, 2010, 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 8-K filing.

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

Thank you David, and good afternoon everyone. American Reprographics Company continues to perform well in the face of decreased commercial construction activity.

As noted in our earnings release, at the end of the first quarter of 2010, we delivered $0.02 per share and $9.5 million in cash flow from operations.

Operating cash flow was temporarily affected by the timing of anticipated tax credits and certain payables in the quarter, and Jonathan will have more color on that topic in a few minutes.

We are affirming our annual forecast today. We expect annual EPS to be in the range of $0.15 to $0.30 and cash flow from operations to be in the range of $65 million to $80 million.

As I stated in my previous call regarding our 2009 results, 2010 will test our mettle. While there are signs that the AEC market is finding its bottom, we expect the industry to face continuing challenges this year.

In 2010 we are likely to see incremental improvements in GDP, employment, and some easing of credit in the coming months. While all these metrics and drivers for non-residential construction activities, such improvements are likely to be in advance of recovery in the AEC market.

As we have stated previously, we expect construction to lag the general economy by nine to 12 months, as it has in the past. As such our operating plans and business forecasts revolve around this timeline.

Our ability to manage costs, generate cash and meet our obligation throughout the downturn have been proven, and we have every reason to believe we can continue to deliver solid performance in the coming quarters.

What is more, when the recovery begins to take hold, we expect our margins to improve dramatically due to the cost control measures put in place over the past 12 months. I expect a material portion of these cuts will be permanent. Thus a greater portion of incremental revenue will fall to the bottom line.

In addition, we are reengineering aspects of the company in anticipation of changes that are likely to take place in our end markets. We will continue to explore ways to leverage our core competencies into different markets and to make the most of our technology development efforts.

For example, we've recently opened our sixth Riot Creative Imaging Center in New Jersey. And there are early signs of success in our ability to address the digital color market more effectively with a single dedicated brand.

While there is still work to do as we build our new color initiative, this is an excellent time to create it. We have excess capacity to apply to a dynamic new market, the operations have required very little new capital to develop, and Riot continues to be a source of excitement and improve morale inside the company.

We also believe that as we emerge from the downturn, our traditional market is likely to have a new appreciation for our technology products and services. Historically reluctant to adopt technology, we think the construction industry as a whole will be forced to look at new ways to improve productivity and efficiency, especially considering that more than 2 million people have lost their jobs in the construction field.

Digital shipping, building information modeling, tools that allow project management and document management applications to communicate better, and process improvement applications remain a focus of our development and sales efforts. We believe they represent significant opportunities for us to capture market share in the coming months.

Growth through acquisition remains extremely compelling, but purchasing depreciating assets does not. As a result, when considering an acquisition, we will reprioritize our criteria. We will look closely at the depth of any new company's customer base, the quality of its management, and the effectiveness of its sales force, to help determine that value. We are well aware of the dynamic the economic environment continues to be.

However, the constants that have driven the ARC success in the past continue to remain relevant. Throughout the year you will continue to see us aggressively managing our costs, preserving cash and servicing our debt. We also intend to stay focused on productive uses of our excess capacity and emphasize business and technology issues that will deliver growth in excess of our end markets' performance.

As I mentioned at the beginning of my comments, we expect challenges in the coming quarters, but we are confident in our ability to meet them.

With that, I'll turn the call over to Jonathan for some insight into our financial position in the first quarter.

We continue to see a stabilizing trend in our daily sales throughout ARC. However, the effects of seasonality and (technical difficulty) continued (technical difficulty) [uncertainty] in our end markets are still causing some mild fluctuations.

In quarter one we saw an incremental change in our customer mix as a percentage of our overall revenue. Non-AEC revenue was up over quarter four by 150 basis points at 23.2%. Nonresidential construction delivered 71.2% of our revenue, and 5.6% of our business came from residential construction.

ARC's product and service mix also saw an incremental change. Our Chinese operations contributed more sales of equipment and supplies than we expected. The first quarter is typically the weakest quarter in China, but the team in Beijing and Shanghai are making good progress against their sales targets, regardless of the season.

12% of our revenue came from equipment and supplies in the first quarter of 2010, as compared to 9.2% in quarter one of 2009.

Facilities management made up 20% of our revenues.

Digital services delivered 9% of our sales.

The remaining 59% came from our traditional base of reprographic services.

There were 63 working days for the first quarter of 2010, the same number of days in the fourth quarter of 2009. There were also 63 days in quarter one of last year.

On a regional basis, our year over year revenue performance declined. Southern California was down 24%, Northern California was down 17.2%. The Pacific Northwest was down 16.4%. Our southern region was down 22.3%. Midwest was down 16.6%, and the Northeast was down 28.4%.

That said, we saw average daily sales for the quarter increase sequentially over quarter four in all but our Southern California and Northeast regions.

As noted, our Chinese team is hitting their stride. They contributed strongly to the performance of our international operations, excluding Canada, which are up 92%.

Our gross margin of 32.9% is being driven primarily by our product mix and absorption of overhead. We also are beginning to feel a slight impact from a material price increase that we have yet to be able to pass on to our customers.

As a final note on the P&L, our interest expense was in line with our expectations for quarter one. It was similar to the interest expense in quarter four of 2009, excluding the one-time cost of amending our credit agreement.

In reviewing the balance sheet, we ended the first quarter of 2010 with a cash balance of $[26.2] million, even as we paid down $12 million in debt during the quarter.

Days sales outstanding, or DSO, were 47 days in the first quarter of 2010, as compared to 51 days in quarter one of 2009 and 43 days in quarter four, 2009.

Total debt, including capital leases, at the end of first quarter 2010 was $264 million. This is down from $274.2 million for the fourth quarter of 2009.

The ratio of debt to trailing 12 month EBITDA at the end of first quarter was 2.8, excluding the goodwill and intangible impairments and stock-based compensation.

Cash flow from operations in the first quarter was $9.5 million. Operating cash flows were negatively impacted by the timing of tax credits, certain payables in the quarter, and a sequential increase of four days in our DSO, which affected the collection of our receivables.

I think that covers the fundamentals for the moment, so at this point I'll turn the call back to Suri.

Thank you Jonathan. Operator, at this time we are available to take our callers' questions.

(Operator Instructions). Andrew Steinerman, JPMorgan.

Suri, when you talked about prospective signs of improvement in employment, vacancy rates and credit availability, were you talking about things that you hear from your customers, or things that are really kind of common knowledge in the newspapers?

Mostly common knowledge in the newspapers, and also some of the stuff we are seeing with our customers. Some of our customers are saying they are starting to hire some staff, such as the architects, for the first time in several quarters. And so that's an indication as well.

Okay. Could you talk about the pricing environment with your customers in your core business as well as and in color printing?

What environment did you say? (multiple speakers)

In your core business, as well as in your newer color printing business.

Okay. So there are two elements. One is with regard to the basic reprographics environment, the pricing continues to overall, based on the conditions we have experienced or the erosion we have experienced, relative to that seems to be reasonably stable. However, I must tell you, last quarter and this quarter for the first time we're starting to see a little more pressure, and this is expected given the decrease in volume of business we have.

But again, I have been maintaining all of last year -- mostly all of last year that pricing has relatively remained stable. So we see some pressure in that one, and we expect that to be the case in 2010. Like I said in my call, 2010 will really test our mettle, so to speak, because this is the last stretch before the market recovers, and the industry will experience some difficulties, and I think we will have a little difficulty from a pricing perspective, probably from the smaller reprographic companies.

With regard to the color market, Andrew, we are (inaudible) concerned with the AEC market, we still have that same margins and the same pricing pressure we would expect in the black-and-white market. However, the color market in the AEC industry is slightly different to the color market we are getting into, like non-AEC. There margins are a little more competitive in the color marketplace. So there's a slight difference in margin, not wholly different, but that marketplace is very aggressive and very competitive. But that's a market we are entering into. But with regard to the AEC market, it would have the same pressures as it would have in the black-and-white business.

Understand, thank you from the comments.

Scott Schneeberger, Oppenheimer.

I guess first question would be, Jonathan, if we could talk about the cash flow and the -- you mentioned tax credits, accounts payables, and a DSO increase. Could you take us a level or two deeper on each of those, please?

Yes. Again, the best way to look at it is, while we didn't provide quarterly guidance on cash flow, if you normalize assuming equal, you could talk $15 million to $20 million is the expected cash flow on a quarterly basis on a revenue volume of where we expect to be based on our EPS guidance.

The -- this quarter, we (inaudible) short of that, call it a $15 million to $20 million run of cash. Now, there were three components.

The main component, DSO receivables, four days. Again, while DSO is calculated on a quarterly basis when you don't have visibility on a monthly basis, that accounted for $3 million to $4 million of cash flow.

Second one, element is the payables side, various payables, including payroll accrued, which you'll see it in the balance sheet. That accounted for again about $2 million to $3 million, sheer timing from quarter -- from just the end of the quarter.

And the third element is the tax credits, which we are expecting for various employment zone tax credits, but then in two years, going back to 2005 through 2007, especially in California, when you ask for a refund, it is -- they go through a stronger review process. Then the following years we claimed it against the taxes we've paid, and obviously therefore we [did] pay the tax. So that's again close to about $1.5 million.

Those are the three main components for that cash flow from -- being short of the expected amount.

The follow-up question to that then is -- will you have a nice snap back in 2Q? Will you be able to get back at or above the run rate? Obviously you've maintained the guidance, so you think so. But just a little bit of color on how you can take it forward and on things like DSO get that improved.

I think, again, DSO -- we should get some of that cash in the quarter two, but the tax credit I will not till we see it, because of the -- California going through the review process. We'll get it sometime this year. But I'm a little cautious in telling you we'll get it in quarter two.

Fair enough. Switching it up a bit, the -- and you didn't mention it, and I think that's always a good thing, but weather was pretty tough in February nationwide. Could you give us a feel for what type of impact you think it may have had in the quarter and how we should think about that going forward as what it may have impacted you by?

Yes, that did. And again, we wanted to make sure that it doesn't come across like an excuse or anything like that. But in total we have four full days of closure in all of the East Coast locations. So that did -- what you call -- contribute a substantial amount of revenue, so a noticeable amount of revenues, given our revenues these days. During good times if you had a typical first quarter, probably we would have sniffed at that number. But losing $3 million, $4 million would be substantial in terms of the numbers these days. We don't have -- I think we counted them as full working [days] (technical difficulty)

I'm sorry, Suri, I think you just cut out on me.

Oh, okay. Sorry. We just counted them as full working days.

Oh, okay. Thanks.

(multiple speakers) days worth of revenues is what we lost in all of our East Coast locations.

In all of the East Coast. And could one of you remind me how many days in each of the next three quarters?

In each of the next three quarters. We can give you the exact numbers here. So in quarter two would be 64, quarter three would be 64, and quarter four would be 62. And quarter one is 63. So total number of days would be 253.

That's again 254 and 2009.

Thanks. Then just one last one if I could. How are things looking out -- in non-AEC with regard to major contracts. I know everything is tough out there, and we have a little bit more to go on Boeing and this question pertains to Boeing, but also just the opportunity and where you're hunting for new business and what you're seeing out on the non-AEC front? Thanks.

Non-AEC front -- across the board in terms of bringing in non-AEC business, especially we are focused on looking on the color. So that has given us a fair amount of activity on the non-AEC business.

With regard to the FM/MPS kind of business in non-AEC, we don't have anything major to report like Boeing. But obviously we are looking at customers like that. But in the FM and MPS business our major focus obviously is related to AEC.

But in the non-AEC business, mostly color and local businesses such as businesses, technology companies, schools, educational institutions, all that kind of area sounds like they're looking for color and black-and-white business.

Great. Thanks.

(Operator Instructions). [Brad Profelo], [PAD Research].

Just a quick question on the sequential revenue trend. Historically I think you've seen a 3% to 8% sequential increase from first quarter to second quarter. I know you guys are talking about a bottoming out of revenue trend. Should we expect a normal seasonal trend over the course of this fiscal year?

I would say not this year. This year is going to be challenged, 2010. And this is something we always talk about, because we lag the economy, given the fact that although we are seeing positive trends out there in employment, in vacancy rates, to some extent in credit and so on and so forth, this is what we are talking about. The general economy is -- there is a tendency to pick up, but we will lag that generally eight to 12 months, nine to 12 months, depending on how bad the recession was.

So from our perspective, from a reprographics perspective, we will be lagging that. For example, sequentially from quarter to quarter I think we are up like 0.4. But at least I am grateful that it's not a negative number. If you adjust that seasonally, obviously it is -- we can't talk about it like growth. But what we are watching now is from last -- end of last year, month to month as to how our sequential revenue is performing. And that is the one which gives us confidence that we have bottomed out.

And then I think you mentioned in -- to the prior question that there was a $3 million to $4 million impact from weather. Can we extrapolate what you just said with the weather effect to say you will see some sequential increase just because of seasonal factors in the weather, but otherwise you're on a similar revenue run rate on a month-to-month basis?

Yes, exactly. Now, actually there is no question that if we do take that into consideration, our first quarter should've been better. And (technical difficulty) [first quarters] are usually much better than the last quarter. But of course we didn't have the benefit of those days.

Then just shifting gears, I probably should know this, but what is the -- does your credit agreement have a mandated free cash flow recapture for debt repay-down? (multiple speakers)

No, not a mandated. We have a voluntary -- we can pay a bit down, cash as we wish.

Should we assume that you're going to use the lion's share of your free cash flow generation this year to repay debt?

We'll assess that. We look at that very closely. I'll tell you a reason, this comes up at our Board meetings, Suri and I talk about it. Yes, definitely something that if we have excess cash, we will do, but also you've got to take into consideration the fact that the fixed charge coverage ratio computation for -- of the covenant, the excess cash is something that we can use if we get too close. And as you know, that's the covenant that is the -- can get a little too close sometime.

Okay. And then a totally separate topic -- I think -- I don't know it was this past quarter or the quarter before that you made a significant hire, an executive, someone with a background in managed print services. Can you talk a little bit about what your approach is going to be to that segment of the marketplace and what your plans are over the -- let's say over the next couple of quarters in terms of investment there?

Sure. What we are basically doing is putting together a team to go after managed print services aspect. As you know, we already do -- we do have a (technical difficulty) fair amount of (technical difficulty) excellence in the AEC industry. And we provide services for customers inside their offices, which is on-site services. It's what we call SFMs.

Now, if you take that and then add all of the office services, all of the small format copiers, fax machines, all of the other output devices where -- multifunction printers, etc., then that -- and put it in one box, then that basically converts itself to the management services.

So we plan to actually execute this in two levels. One is obviously at the local level, because we have 44 locations and we have two hundred and thirty (inaudible) divisions and 230 plus locations. So in all of those locations, all of our customers, we will try to go after every FM customer and every other customer we have and try to incorporate the managed print services concept with our customers.

And then on the global solution side, where we go after national customers, we'll try to incorporate the managed print solutions concept to our national customers.

So what we've done is we have acquired software to support those efforts, to make sure we have the right processes so we can sell that concept to the customers, and of course we need to have qualified staff who will be able to understand and sell the managed print services -- all of which is what we are building right at this point in time, and over the next two, three quarters we continue to attack that. Whether we will have revenue benefits in this year is questionable. Maybe last quarter or maybe early next year. But that's certainly an area we are investing in.

So you'll have both a go-to-market strategy for the AEC business, which is obviously your FM business, maybe you get a more targeted approach nationally, and then -- just so I understand -- you're going to have a very specific approach to non-AEC clients for managed print services, something you expect to generate revenues towards the end of this year or early next year?

Yes, yes. And the -- we are most effective in those marketplaces that is when we have a customer who not only wants managed print services inside, but that managed print services component includes outsourced services, because of the fact that we have locations on the ground in almost all of these major cities.

So in those areas we can compete better than anybody else because that's -- a perfect example is volume. We are in 18 locations, but in all those 18 locations, we take all the work which we don't have to do or we shouldn't be doing inside Boeing's facilities to our facilities and then return that work to them. So in areas like that, we are much more effective than any other provider.

Final question on this topic, will you integrate your fulfillment with your ishipdocs partners, is that kind of a longer-term plan so you can fulfill managed print services on a global basis? Or --?

Absolutely. For ishipdocs the idea is, as we continue to refine the product, as we continue to add more muscle to the product, so we want to build more concept of moving documents peer to peer and include the technology in terms of uploading speed, etc. When we do that, we'll incorporate ishipdocs into virtually every -- any and every service we provide. Why not? That's a great tool us to be able to provide services to customers, especially during difficult times. Where you have difficulty in shipping physically, we will be able to actually ship documents digitally and remotely and get it delivered at the location.

Thanks for all the color.

(Operator Instructions). Luke Junk, Baird.

You mentioned that material price increases were a negative impact to gross margin during the quarter, and in addition to absorption, just the mix shift towards China. Could you maybe quantify that either sequentially or year-over-year relative to those other [drags]?

I'll let the second part of the question to Jonathan. I'm not sure he can qualify it, but I'll pass it on to him. I pass on all the difficult questions to him.

So with regard to the difference in material pricing, there are two elements here. One is we add some price increases from our suppliers. And given the market conditions, usually we would pass them on immediately to our customers. There was a little bit of time gap, and as a result there was an impact on our material costs. That is what we referred to. So that is one.

Second thing is that equipment supply -- and supply sales in China are a larger component of the Chinese business as against when you compare it with the business in the United States. The business in China, just because how it has evolved over a period of time, more people buy equipment there and there's much less leasing and much less renting; those concepts are new. But they are becoming better. We are working on it. So as I said, what happens is whenever we incorporate the numbers from China, it affects our percentages because our equipment supplies segment is now a higher portion of our revenues.

Jonathan, would you like to add some color?

Sure. So the questions you asked was regarding the price increase and the dollar value to our material cost. Again, we saw partial impact of the price increase in the latter part of the quarter. So we don't have an exact dollar amount, but it is not significant impacting the quarter once gross margin.

However, depending on how much of that price increase with the price that we can pass it on to our customers, it can have an effect in the future quarters, till the price increase's offsetting takes into full effect.

The other question was, how much is the material sort of the mix change? The equipment supplies accounted for about 12% of our quarter one sales -- very similar to quarter four, 2009. Thereby, as you can see, the gross margin was relatively -- reasonably close to quarter four. So again, a dollar impact -- if you go back to the quarter one of 2009 when equipment sales was 9.2% of our sales and of course revenue much higher, we had a [37.1]% gross margin.

Okay. That's helpful. Just drilling down on the negative impact that you saw from the price increases this quarter that you mentioned kind of impacting later in the quarter, given your expectations for the environment to remain challenging in 2010, would you expect to be able to push some of those price increases through to your customers, call it in the second or third quarter? Or is that something that's just going to have to wait until the construction trends get a little better?

No, not really. We would certainly push them to the customers. And we've already started that effort, and we will definitely get that done, because even though the environment is tough, we've determined to do that because it is not something -- it's something we have to pass through. So we expect that to be passed to our customers very shortly here.

Thanks guys.

There are no further questions at this time.

I think we'll go ahead and end the call at this time. Thank you very much for your attention and continued interest in American Reprographics Company. Have a great evening.

This concludes today's conference call. You may now disconnect.