ARC Document Solutions Inc (ARC) 2010 Q3 法說會逐字稿

Good afternoon, and welcome to the American Reprographics third quarter 2010 call. My name is Christie, 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. (Operator instructions.)

At this time, I'd like to turn the show over to David Stickney, Vice President of Corporate Communications.

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

Our third quarter results were summarized in a press release issued earlier today. We'll be adding further commentary on the quarter on our call and then we'll move to Q&A.

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 www.e-arc.com.

We are webcasting our call today. A replay of the webcast will be available on our website for 90 days from today. 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, November 2nd, 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. Suri?

Thank you, David. And good afternoon, everyone. Once again, American Reprographics performed remarkably well during the third quarter despite a market that lacked confidence, as well as new construction projects. While we were disappointed in the appetite for our services, we are certainly not discouraged. Considering the depth of the financial crisis we have experienced over the past two years short-term setbacks are bound to be part of any recovery. From our point of view, we must make good on the opportunities in front of us, and I am pleased to say that we did so during the third quarter.

As we noted on our October call, we continue to see stabilization in our average daily sales numbers month over month. The third quarter was no exception to this trend. Our average daily sales figures from July, August, and September were essentially flat with a small uptick in September. The upside of this continuing stabilization is that it suggests we may be at the bottom of this cycle. The downside is what we did not see, a significant return to seasonality as we had expected. Nonetheless, ARC's performance remained strong and continued to prove the strength of its operating model and the persistence of its management team.

On revenues of $109.4 million ARC delivered $0.01 per share in the third quarter of 2010 on an adjusted basis. In spite of our revenue drop our gross margins remained very healthy at 32%.

At the end of quarter three we had produced $38 million in cash flow from operations for the year. This translates to $10.3 million for the third quarter. Our ability to generate cash is the core of our operational strength.

While we continue to tighten our cost structure to drive more cash to the bottom line, we are also extracting more cash from our existing operations by further leveraging our dominant position in the industry. As we expand our market share by continuing to acquire large national and global customers we are able to compete at entirely different levels and work with our vendors in creative and more cost effective ways. We have cut more than $12 million of incremental costs so far this year. This is a remarkable amount given the significant cost reductions we already achieved.

In addition, and as I have stated previously on several occasions, we have the ability to reduce our operating costs further by adjusting our operating footprint. It is difficult. If difficult conditions in our end market persist we can right-size our branch network and leverage our digital infrastructure further to balance capacity against demand. We would, of course, prefer to remain ready to capture market share in a recovery rather than cut too deeply, especially if a recovery is on the horizon.

On top of all this we also have a market that appears to be conducive to debt restructuring. Through all this downturn it has been very clear that banks and lending institutions favor companies with good management and strong cash flow. We will continue to explore our opportunities on this front, as well.

With all these options on our side with regard to maintaining our profitability and managing our costs we are encouraged about our prospects and we continue to drive the business forward.

Meanwhile, our sales and operations teams were hardly idle, despite the softness of the quarter. Large firms in the AEC space have been consolidating their markets with a remarkable enthusiasm. Engineers and architects, in particular, are acquiring new firms and expanding their base of services, as well as their geographic footprint.

Our Global Services team has been capitalizing on the desires of these growing firms to create more efficiency in their existing operations and new, more productive ways to bring-on newly acquired operations.

Our managed print services offering couldn't have been introduced at a better time. Of the six new clients brought on board during the third quarter, five of them hinged on our ability to manage their entire print network, not just the reprographics work. We will see some new business from these clients in 2010, but most of the first year's revenue, approximately $9 million worth, will be realized in 2011.

Our Riot Creative Imaging initiative has also made excellent progress during the third quarter. We announced our intention to build this new color business exactly one year ago, and it's now allowing us to expand our market reach further into the non-AEC world. Eight of our 10 super centers have opened this year, and two more scheduled to open before December 31st. Considering that we have spent very little to start this business unit by essentially leveraging our existing assets, I am very pleased with the results.

At this point, I'll turn the call over to Jonathan now for a closer look at some of the financial information we released today. We'll open the call for questions after that. Jonathan?

Thanks, Suri. I will run through the basic update first, and then address the goodwill impairment as noted in today's press release.

To begin with, our customer mix in the third quarter was very similar to quarter two. Of our total revenue for the third quarter 24% came from the non-AEC segment, 70.4% came from nonresidential construction customers, and 5.6% came from our residential construction customers.

Our product and service mix changed slightly in the third quarter. Facilities management made up 20.7% of our revenues. Digital services delivered 9.1% of our sales. 12.9% of our revenue was from equipment and supplies. And the remaining 57.3% came from our base of reprographic services.

There were 64 working days for the third quarter, just as there were 64 days in the second quarter. There were also 64 days in quarter three of last year.

On a regional basis our year-over-year revenue performance was as follows. Southern California was down 12.5%. Northern California was down 8.5%. The Pacific Northwest was down 8%. Our Southern Region was down 7.9%. The Midwest was down 12%. And the Northeast was down 11.5%. Our international operations, excluding Canada, continued to perform well, and were up 35.8%.

The year-over-year reduction of our gross margin from 34.5% in the third quarter of 2009 to 32% in the third quarter of 2010 is being primarily driven by the change in the mix I mentioned earlier. Specifically, material costs as a percentage of sales were 280 basis points higher for the three months ended September 30th, 2010 when compared to the same period in 2009. This was mainly due to a larger percentage of equipment and supply sales relative to our total sales.

Interest expense was $5.6 million in the third quarter of this year, down from $5.7 million in the second quarter.

Moving to the balance sheet, we ended the third quarter of 2010 with a cash balance of $29.8 million. Our $50 million revolver remains untouched. Year to date we have made scheduled debt payments of $32.2 million.

Days sales outstanding, or DSO, were 48 days in the third quarter of 2010, up from 46 days in quarter two, and consistent with quarter three of 2009.

Total debt including capital leases at the end of the third quarter 2010 was $248.2 million. This is down from $256.7 million from the second quarter of 2010 and from $274.2 million from the end of 2009. The ratio of debt to trailing 12-month adjusted EBITDA at the end of the quarter was 3.12.

Cash flow from operations in the third quarter was $10.3 million, as noted in the press release early today, as compared to $18.3 million in quarter two.

Finally, the Company is operating comfortably within the confines of its current debt covenants.

I believe that covers the basics.

Today we reported an impairment charge for goodwill in our press release. The results of our analysis in 2010 indicated that 13 of our reporting units, 12 in the United States and one in China, had a goodwill impairment as of September 30th, 2010. As such, we recorded a pretax noncash charge for the three and nine months ended September 30th, 2010 to reduce the carrying value of goodwill by $38.3 million.

With that as a backdrop for further discussion, I'll turn the call back to our Chairman, Suri.

Thank you, Jonathan.

Operator, at this point we can open-up the call for questions and answers.

Operator, are you available on the call, please?

(Operator instructions.)

And your first question comes from the line of Andrew Steinerman.

Hi, there, gentlemen. Could you give me a sense of what the revenue implied is in your cash flow guidance? How much revenue would you need to achieve to achieve that cash flow guidance?

Go ahead.

Okay. Andrew, again, on the revenue while we have not given guidance, it would be in the $440-ish million of revenue to be on the low end of the cash flow guidance.

Okay, and, Jonathan, I think you talked about potentially redoing your covenants and your debt relationship. Is there any risk to the covenants right now or do you feel like that's just a smart thing to do?

What I would say is through the next year as we are projecting we don't see challenges to the covenants, however, in this environment one has to be careful. So, again, as Suri talked about in his release, we are looking at the various alternatives in front of us. So we will look at as if amending the covenants (inaudible.) So there are many options, that the good thing is that we have available in front of us.

Okay, sounds good. Thank you.

And your next question comes from the line of Schneeberger with Oppenheimer.

Hi, it's Scott Schneeberger with Oppenheimer. Just following up on the debt restructuring. I'm sure you guys are looking into it presently. Would you care to differentiate between perhaps offering high-yield notes or doing some restructuring of the -- your revolver or some of the other financing -- financial tools? Just any thoughts there that you care to share. Thanks.

Scott, thanks. We don't have a specific strategy as to which way we are going to go. Obviously, the options are out there. The environment is very conducive. What we know is given the fact that we have a strong cash flow generation and the fact that banks look at us favorably, we are exploring all the different options.

I mean there are so many options available. Banks certainly want to lend to good companies, so we're just looking at all the different options. Obviously, the high-yield market is there, but so is the debt market. I mean they are looking at it very positively. So our objective is to take into consideration all the different options available and then decide which is most appropriate for us.

Okay. Thanks. And then I missed you at the beginning, and this going back to the earlier call in early October, with regard to the monthly pattern in the third quarter. Could you refresh us on that? Could you also comment if in the past few weeks you've seen any change from pattern as opposed to three weeks ago? Thanks.

The sales have remained relatively flat. What we are basically seeing virtually the whole year is that our sales have remained flat. I mean coming from last year to year before it's pretty clear the sales are flattening out. Every year it has become better, and this year it is pretty consistent within a 100,000 range up to now, up to this current quarter. We've been pretty tight within our 100,000 range, so we feel very good that the market is flattening out, Scott.

And I think that's going to be like that. And, needless to say, you know, the market is still continuing to remain challenged based on the confidence out there, it's an election year, all that kind of stuff. But nevertheless it's a clear indication the market is flattening, and it's starting to look like it's bottoming out.

For example, CB Richard Ellis recently released their statistics and it shows the office vacancy rates has dropped for the first time since second half of 2007 by about 10 basis points. Very little but it's dropped for the first time, you know, since 2007. Industry vacancy rates for the first time declined in three years. Again, only 10 basis points but it's a first decline. And retail held steady after 17 periods of increase, meaning the vacancy, after going up for 17 periods, it's become steady. I mean that, and you obviously know about architectural billing index, you always follow that I know. That's showing a little bit of life. There are clear signs that the market is starting to bottom out.

Okay, thanks for that. And then, finally, just with regard, your expense management, you mentioned you're holding off until now until -- in case anything gets -- the environment gets tougher. We're going into a seasonally fairly tough time. What is your update with regard to expense management at this juncture? Thanks.

Right. So based on what we know now, I mean when you say we're already in that period, Scott, so we already know we are in a tough quarter already. So I mean we're not talking about this quarter. But fundamentally what I'm trying to point out is we've done a great job in managing our costs. We've already -- on top of the fact that we reduced so much cost in 2007, 2008 -- 2008, 2009 we've still managed to reduce up to $12 million, which I think is remarkable given the fact that we already cut the costs.

We are also finding more creative ways and means of extracting more cash from our existing operations because this is kind of becoming almost the culture in the Company. So as we continue to sign up some of the larger accounts, previously we would have said, "Oh, we've got another big account," and then move forward. But we are now saying, "Hey, we got a big account, you know, what are the costs related to this?" We are going to give that much more in [people] investments and we are going to [give] that much more supplies business. And we are bidding those opportunities and getting better cost structure on those new accounts we are getting. In other words, this downturn is not only for us, for all the equipment suppliers and manufacturers, as well.

So we are finding more ways of controlling the cost, and what I've always said and I repeat again is that we haven't cut our branch structure. Given the revenue drop from 2007, although we had a significant drop, the branch structure is pretty much intact. From about 300-plus branches we are still 270-plus branches, you know?

So we can further trim if we wanted to. I'm saying I just want to make sure for those people who might be a little skeptical about the environment, or nervous about the environment, don't be because we are fully in control of where we are with regard to our cash generation and meeting our debt obligations.

And on top of that we also have a market which is very conducive to further doing business with companies like us because we have strong cash flow. So that's the whole message.

So with regard to fourth quarter I'm not worried, at all. I'm feeling very good about it, and the short answer to that is should there be a need, if for some reason, some unforeseen circumstance the market turns bad we still have options even within the existing financial structure.

Okay. Thanks for taking my questions.

You're welcome.

(Operator instructions.) And you do have a question from the line of Brad Safalow.

Hi, thanks for taking my questions, guys.

Sure, sure, Brad.

Just a factual question, how many FM contracts did you have at the end of the quarter?

Let me take a quick look at that -- FM contracts, I think was something like -- 5,791, Brad.

Okay.

We're [up about] 90..

Okay, so I guess I'm just looking I guess for the last two quarters it looks like your year-over-year revenue changes per FM contract have been considerably better than the year-over-year changes or declines for what you're seeing at the branch level. Is there anything specific to that? Is there anything we should conclude from that?

No, well, what it is, you know, one of the ways to look at it is, Brad, that the design work, so in all of the FMs, in the architectural offices the early part of the design work which is basically [check prints] is starting to happen. So there is some life, as you can see. You know, it declined significantly because most of the FMs largely are FMs for convenience printing, and what they do is check printing, what we refer to as design schematic stage printing. So-- and from that perspective we are seeing a little more life. As I answered -- you would have previously heard in a previous question, they start -- we are starting to see signs of more activity and stabilization, and this is just part of the equation.

Okay, so that would be -- you would expect FM contracts or revenue for contracts to improve before you'd see it at the branch?

Yes, typically, the FM activity will pick-up, and our theory is that we could install more FMs, but even if you don't install more FMs the revenues from FMs will start to turn positive.

Okay, and just shifting gears to the Global Services side, you mentioned in the press release you had about $9 million in kind of new contracts secured that will run through your P&L in 2011. Overall how much in managed print services revenues are you expecting for 2011 at this point?

Total numbers are you referring to, Brad?

Correct, so --

This is increasing our managed print services, meaning new business, which will impact 2011 is about $9 million right now.

I know, but didn't you have a couple contracts from last quarter, as well?

Yes, absolutely, absolutely. But these are all managed print services ones, but we've had six new accounts out of which five are attributable to managed print services. What we are trying to say is we implemented the new strategy of going after the managed print services accounts in our AEC segment, and it's starting to benefit us right now.

So overall in 2011 managed print services will be 2% to 3% of total revenues, roughly?

Jonathan, do you have an idea?

The question, again, you said what percentage?

What percentage of your total revenues will come from managed print services?

Yes, are you talking 2011 or 2010, Brad?

2011, just based on the contracts that you've secured this year?

Okay, we have $9 million now. So as you know this managed print services is a new concept with large Global Services accounts. We didn't have managed print services concept before. We started it only in the middle of the year, so roughly take $10 million for now.

Okay.

I mean if we sign more accounts during the last quarter, Brad, and I certainly hope we will, continue to sign more accounts because it's a very exciting opportunity for us, it'll be going up. But right now I think -- I'm just picking a number, you should comfortably expect us to deliver $10 million out of it.

Have we lost you, Brad?

Sir, your line is open.

I wonder if we maybe lost his signal here. Let's ask Brad, if you can still hear us to please dial back-in and queue back up if you have further questions.

Christie, do we have any other questions at this point?

One moment. And your next question comes from the line of David Manthey.

Hi, good afternoon. I was wondering could you talk about the average revenues that you might derive from a customer by traditional means and then one that becomes a PlanWell type customer, just in terms of the dollars that ARP would realize from each of those relationships? What does it look like in each of those scenarios?

That's, if I understand your question right, you're asking me what is average volume of revenue from customers and if, indeed, they started using technology tools such as PlanWell, how much would that actually be up -- is that your question, David?

Yes.

Okay, so it's very difficult for us to, if not impossible, to get an average volume from customers because our revenues are, or the customer concentration is, extremely, extremely low. So we have about 135,000 customers across the nation, and the largest customer doesn't even account for -- Jonathan, is it less than 2%?

Yes.

Of our annual revenues. So it's fairly widespread, David. I mean we have a lot of small customers and then we have larger customers and then, of course, we have mega projects. So there's -- we don't actually have average size. That's one part of the question.

The second part of the answer would be to your question is that because of the fact that we -- Reprographics traditionally has been print based we incorporated the PlanWell services into the Reprographics services, so we don't separate it and tear off the PlanWell as -- and be able to identify. What we identify is the digital services we provide, such as [caning], uploading, indexing, all the different functions we do for them digitally. But they are in the PlanWell network. Now we have started also charging them for seat licenses, and that we started only last quarter. So I'm afraid I won't be able to give you that much more clarity to your specific question there.

But what I'm trying to get to, Suri, is does the revenues you derive, let's say, from printing, does it go up or down after someone --

I think we may have just lost another call thanks to cell phone reception. My guess is what David was going to ask, Suri, is whether or not revenues go up or down once a customer basically adds PlanWell to their account? And if I heard you right basically we're talking about adding document management fees and then adding licensing fees, as well?

Yes, yes. The short answer is if people started using PlanWell and other document management services, currently our revenues go up. So I guess the implied question is because they're using technology does the print revenue go down? We haven't seen a huge evidence of that. People are using different technology tools but largely print is still a very strong requirement for now in the industry. So we haven't seen any erosion in it. In fact, I think there is a period during which time we continue to have our print revenues and our technology revenues are actually additive on top of our current revenues.

So with any luck we've answered David's question and he was able to hear us.

At least hear us, yes.

Christie, do we have any other questions at this point?

No, sir, there are no further questions at this time. Do you have any closing remarks?

Yes, ladies and gentlemen, just simply thank you for joining us today for the call. As always, we appreciate your continuing interest in American Reprographics Company. Have a great evening. We'll talk with you all soon.

And this does conclude today's conference call. You may now disconnect.