ARC Document Solutions Inc (ARC) 2011 Q2 法說會逐字稿

Good afternoon. My name is Kristin and I will be your conference operator today. At this time, I would like to welcome everyone to ARC's second quarter 2011 earnings call. (Operator Instructions).

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

Thank you, Kristin. I'd like to welcome everyone to our call today. Joining me are Suri Suriyakumar, our Chairman, President, and Chief Executive Officer, and John Toth, our new Chief Financial Officer who joined us in mid-July.

The financial results of our second quarter 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 ARC'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 a dial-in number for this replay in today's press release. We are webcasting our call today and the replay of the webcast will be available for 90 days on the company's website.

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, August 4, 2011, 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. As we reported earlier today, the second quarter of 2011 delivered $109.6 million in revenue, a gross margin of 32.6%, and $7.3 million in cash flow from operations. Adjusted earnings per share for the quarter came in at $0.00. Unfortunately the first half of the year turned out to be disappointing. Macroeconomic conditions caused by the recovery to stall and based on the current industry projections it appears that the rest of the year will remain challenged. The good news, however, is that we continued our progress in restructuring the company, which resulted in significant improvements in our operating results and advancements on our key initiatives. Here are the highlights.

In the second quarter our revenue increased by $3.1 million while the adjusted EBITDA went up by $3.4 million clearly demonstrating that our efforts to eliminate cost are producing immediate results. Our MPS FM revenue is up 13.1% year-over-year and these revenues make up more than 23% of our overall revenues now. Our color revenue grew 2.5% year-over-year. Our global solutions team continued to make inroads into the top 50 AEC companies. In July we opened our first location in Hong Kong.

In the first six months after launching PlanWell Collaborate, we placed hundred seats a month on average. During that time we [rendered] 907 projects, 335 project files and exposed the product to more than 10,000 construction team members. And later this month we will be releasing Version 2.0 of ishipdocs adding to our cloud-based printing and file sharing application.

While these products have yet to make meaningful contribution to our revenues, it's clear that our products and services are increasingly integrated into our customer's workflow. None of these things could have been accomplished had we not been bold enough to restructure our organization and invest in some of our new initiatives. In fact, our results would have been entirely different.

The company we were would have been a company with an oversized infrastructure with weak sales struggling to find a way to maintain its profitability and size. The company we are has sized itself appropriate to the demands of the market, generates excellent margins, strong cash flow, and its position for growth. The management team at ARC is as nimble now as it ever has been. While current market conditions remain difficult, we are stronger, faster, and more decisive knowing well that it is necessary for our wellbeing now and for our future. During the past seven months we have engaged in a significant and ongoing restructuring that optimizes our operational and management structure for changing market conditions, including the continuing technology transition [operating] in our industry.

The consolidation of our brand has given us excellent opportunities to eliminate redundancies in shard markets and to pull resources across geographical boundaries in ways we never considered in the past. By rationalizing our footprint we've been able to bring more efficiency and productivity to our production teams and streamline our middle management. Again, something we had not done previously. The difficult market conditions also appear to be accelerating the use of technology in document management. This gives us the opportunity to further address infrastructure and operations to not only save money, but also to position our digital solutions and the company for recovery.

As you will recall, during the last earnings call we were well on our way to annualized savings of $14 million. Today I can tell you that we plan to achieve approximately $26 million in annualized savings for 2011 with $16 million to $17 million realizing this year, a truly remarkable accomplishment.

I would also point out that one of the biggest challenges in restructuring a company under conditions like this is to make sure that we don't cut cost too aggressively and jeopardize our opportunity to grow when the recovery takes hold. That has become less of a concern in light of what we are experiencing in the marketplace. With our continuing use of and development of technology, closer ties to our larger customers, greater adoption of MPS, more flexibility in outsource services and document distribution schemes, as well as our ability to compete and win over large competitors in the MPS space I have few reservations when considering additional restructuring of our management team and operations to position the company for success. The market has changed. It has changed aggressively and ARC is changing with it.

Finally, it is important to note that our search for a new CFO was successful and cumulated in the hiring of John Toth who joined us just a few weeks ago. I am happy to introduce him to you now for a review of our quarterly numbers and then we will open the call to your questions, as usual. John?

Thank you, Suri. I'm very glad to be here and to be part of this team, and I'm also looking forward to getting to know our investors and analysts in the months ahead. For now, however, I'll provide some of the details about our second quarter. Our customer mix had nonresidential construction customers delivering 71.3% of our revenue, 5.6% of our revenue came from residential construction customers, and our non-AEC customers provided 23.1% of our revenue.

In terms of product and service lines, Reprographic Services provided 64.3% of our overall revenue. As many of you know, digital services are embedded in this service line and delivered 8.9% of our overall revenue. Facilities management, which includes Managed Print Services or MPS, delivered 23.4% of our overall revenue, while equipment and supplies produced 12.3%.

There were 64 working days for the second quarter of 2011 versus 64 working days in the first quarter; likewise there were 64 in quarter 2 of 2010. On a regional basis our year-over-year revenue performance continued to decline, as we might expect considering the weak demand in the market. Northern California was down 5%, the Pacific Northwest was down 5.8%, our southern region was down 8.7%, the Midwest was down 2.2%, the Northeast was down 5.6%, and Southern California was down 7.2%. While the year-over-year comps remain challenging, once again we saw average daily sales increase sequentially in all but one region. Our Chinese operation produced a strong year-over-year comparison in the second quarter posting 14.7% revenue growth.

I should also point out that the adjusted EBITDA increase Suri mentioned earlier represents an expansion of our adjusted EBITDA margin from 13.9% in the first quarter of this year to 16.7% in the second quarter of this year, a 280 basis point increase. It's a metric that was difficult to achieve and one which we are very proud of.

The ongoing restructuring of our business and continuing focus on cost reductions produced a gross margin of 32.6%, a healthy improvement over the first quarter's gross margin of 31.3%. Amortization of intangible assets for the second quarter increased $2.2 million when compared to the same period in 2010. As a reminder, this is caused by the revision of useful lives assigned to our trade names we made during the fourth quarter of 2010. The period of accelerated amortization for these items will be complete in April of 2012.

Net interest was $7.7 million during the second quarter compared to $5.8 million in the same period in 2010. As you may recall, the increase of $1.9 million includes the effect of amortizing our former interest rate swap and the incurrence of a higher effective interest rate due to the issuance of the high yield notes on December 1, 2010.

There are two other significant items on the P&L that are worthy of some explanation. The first is a goodwill impairment of $23.3 million and the second is a deferred tax asset valuation allowance of $64.3 million. The goodwill impairment is the result of an analysis we believe was required primarily to the economic environment and its effect on our performance and forecasting earnings. Normally we conduct this analysis at the end of September. The results of the company's analysis indicated that six US based reporting units had a goodwill impairment and we recorded a pretax non-cash charge to reduce the carrying value of goodwill by $23.3 million.

The deferred tax asset valuation allowance was the result of previous impairments and other charges ARC has taken over the past three years that had a negative impact on our GAAP earnings. The result of the allowance is a reserve against $64.3 million in deferred tax assets on our balance sheet and a corresponding non-cash tax expense you see on our P&L. The $57.9 million you see on the P&L for the quarter includes certain tax benefits we were able to record prior to the allowance. You can find the reconciliation for these numbers on the tables in today's earnings release. It is important to note that the deferred tax asset valuation allowance is a reserve and thus the deferred tax assets themselves remain available to us for use in the future.

Moving on to the balance sheet, we ended the second quarter of 2011 with a cash balance of $21.9 million. Day's sales outstanding or DSO were 50 days in the second quarter of 2011 down from 51 days in the previous quarter. Total debt, including capital leases, at the end of the second quarter 2011 was $245.7 million down from $247.8 million in the first quarter of 2011. And the ratio of debt to trailing 12 months adjusted EBITDA at the end of the second quarter was 3.7. Cash flow from operations in the second quarter was $7.3 million.

And I think that covers the basics so at this point I'll turn it back to Suri.

Thanks, John. Operator, at this time we are available to take our callers' questions.

(Operator Instructions). And your first question comes from the line of David Manthey with Robert W. Baird.

Hi, guys. Good evening.

Hi, good evening.

First off, I think you gave us the percentages of AEC versus non-AEC. I don't -- forgive me if it's in the release, but could you give us the year-to-year change in each of those categories? And then just anything anecdotal around what you're hearing and sort of the tone of business in each of those categories as well.

So the non-AEC is that AEC nonresidential (inaudible) is 71.3%, am I right, John? And AEC residential part of it is 5.6% and the non-AEC is 23.1%. Okay? And year-over-year second quarter 2010 our nonresidential AEC was 69.7%, which is now 71.3%, and residential AEC, that is residential portion of it was 5.8%, it is at 5.6% now. And the non-AEC, which was at 24.6%, is at 23.1% now. That's the mix.

Okay, thanks. That'll help us get there. In terms of the costs that you've cut out, are there any costs related to the restructuring in the second quarter? Even if you're not calling them out are there some costs that theoretically if things stabilize might come out of the P&L. And then if you can -- can you describe some of these costs today in terms of closing locations or eliminating positions or equipment or where are you getting these -- the $26 million run rate of costs from?

Okay. So fundamentally it is whatever we have there, David, is largely related to some severance related to closing branches and so on that we have not taken any hits on that, but I'll let John give you a little bit color on that. John?

Yes, for Q2 it's, again as Suri said, is primarily severance related and so will go away, and we have no restructuring charges in Q2.

Is that clear, David? Anything else on that?

I'm good. Thank you very much.

You're welcome.

Your next question is from Andrew Steinerman with JP Morgan.

Hi. Could you tell me about the profitability of digital services? I know it's only 9% of revenues now but as it scales what do you think the profit margins could and should be?

Okay. So if you take basically the digital services it's at its early stages, Andrew. But I think as we continue to enhance that business as the revenues pick up I think our gross margins will be -- can really increase much, much more than our traditional gross margins. So right now the digital services -- do you have a number, John, on gross margins? In the 60's? Yes, so it would be in the range of 60's, Andrew, so I would imagine as we continue sell more seat licenses and sell more ishipdocs it could actually go north of 60's into the 70's and further up.

And how about at profitability at the EBIT line, is it profitable right now given the gross margins?

Oh, absolutely. Right now it's profitable because, again, most of our digital services are built over a period of time. We started investing in it very, very early so most of these expenses -- most of them I expensed out, but at the profitability level it's certainly profitable.

A majority of that 60% would go down to the bottom line.

So, what John is adding here --

It's already highly profitable.

Yes, because we -- what we have done is, Andrew, you know from a certain perspective we started developing all our PlanWell platforms and so on in 2000, early part of this decade and over a period of time we have actually used those tools largely to support our branches and improve our operations. And now what we are doing is we are starting to actually expand on those products, which we continue to invest on the digital technologies, but the expenses themselves are not so great.

Right, and there's not a sales force behind digital services? I mean, I don't understand why the profitability drops so quickly from gross margin to EBIT for digital services.

So typically what happens is on the digital services side our existing sales force actually sells most of the digital services because it is added on to as part of the graphics but we do have some salespeople for our new products, like ishipdocs. We have salespeople working there.

Okay. All right, much appreciated, thank you. And welcome, John.

Thank you.

(Operator Instructions). And your next question is from the line of Scott Schneeberger with Oppenheimer.

Hey all, this is Ryan Davis filling in for Scott. I just had a quick question here on the cash flow, operating cash flow and EPS guidance you gave us. What type of revenue and margin expectations are kind of embedded in that?

Ryan, usually we don't give revenue guidance and the whole reason for not giving the revenue guidance is because of the volatility, which revolves around the marketplace today, and it's even more pronounced during this time. So our guidance is largely built on the fact -- the EPS guidance that we can continue to adjust cost and restructure. So unfortunately I won't be able to give you specific guidance on the revenue numbers, but they are all over the place, as you can see.

Thank you. Okay and I guess another question more qualitative. What are the people in the storefront -- your people in the storefront on the street saying? I mean, is ABI right? Can you kind of give us some color there?

You're referring to the Architecture Billing Index, ABI?

Yes. I mean, where is everyone -- what's your -- the end markets, the customers saying kind of to your people in the storefront? Are you kind of hearing much from them?

I mean, certainly in the early part of the year, Ryan, we were certainly expecting a certain amount of recovery to happen and it was actually on its way. We thought, based on coming into this year, it suddenly seemed like the curves were starting to turn and it -- right now what has happened is it just got stalled. So what we are hearing from the branches is people are kind of putting things on hold temporarily until such time things become better, and that typically happens in a downturn like this. When the markets get a little tricky or there is some sense of discomfort in the market, people tend to put things on hold. That is what we're experiencing right now. So the projects which we had thought will get off the ground by midyear is kind of -- is still delayed. That is the kind of sense we are getting.

Okay. All right, well I think that's all I got for you guys. Thanks so much.

All right. Thanks, Ryan.

(Operator Instructions). And I'm showing there are no further questions. Mr. Stickney, do you have any closing remarks?

Thank you very much, Kristin, and thanks everyone for your attention this evening. We appreciate your continued interest in ARC and we look forward to talking with you soon. Have a great night. Bye-bye.

Thank you. This does conclude today's conference call. You may now disconnect.