ARC Document Solutions Inc (ARC) 2012 Q2 法說會逐字稿

Good afternoon. My name is Alaya, and I will be your conference operator today. At this time, I would like to welcome everyone to the ARC second-quarter earnings results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions).

I would like to now turn the call over to our host, Mr. Stickney. Sir, you may begin your conference.

Thank you, Alaya. I'd like to welcome everyone to our call today. Joining me are Suri Suriyakumar, our Chairman, President, and Chief Executive Officer, Dilo Wijesuriya, our Chief Operating Officer, John Toth our Chief Financial Officer, and Jorge Avalos, our Chief Accounting Officer.

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 Relation 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 7 days after the call. You can find the dial-in number for this replay in today's press release. We are webcasting our call today as usual, and the re-play 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 7th, 2012, 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, in the second quarter of 2012, ARC delivered $106.2 million in revenue, a gross margin of 31.8%, and $4.5 million in cash flow from operations. Adjusted earnings per share for the quarter came in at $0.02. Year-to-date, our cash flow remains strong at nearly $17 million. And, as noted, our revolver remains undrawn.

As you've seen in the past, we continue to manage our business effectively, even under very challenging market conditions, enabling us to meet our financial obligations comfortably. We have also repeatedly said that we are positioning the company for recovery. Most of this positioning has been in the form of structural changes to our workforce, footprint, and cost structure.

During the past 2 quarters, however, we have also started to aggressively increase our investment in the business with the recovery in mind. During the second quarter, we hired more than 65 college graduates from all over the country, engaged them in an intense and focused training program, and we are now in the process of deploying them in the field under the guidance of executive mentors, senior salespeople, and, of course, our deeply experienced sales management team.

Our business is evolving into a much more digital, technology-driven document solutions environment, and our new recruits are coming to the business without the preconceptions that often accompany experienced reps from our traditional market. Bringing a fresh infusion of energy and zeal into the company will also help us change our culture, which has been structured to serve a traditional business [over decades]. This investment is an acknowledgement that our customer culture is changing too.

Technology continues to exert its influence over tradition, and the ongoing economic pressure on the industry continues to accelerate the adoption of new techniques for managing construction. A cultural change, while sometimes difficult, is a critical component of our evolution as we become a technology-enabled, document solutions company.

In addition to announcing our sales team, we deployed a single CRM system across the entire company, completing the sales team integration that began with the consolidation of all brands at the beginning of 2011. We now have complete visibility into the sales activity anywhere we operate, which allows us to direct sales operations more efficiently and effectively than ever before. This is a major improvement [over the] more than 40 separately managed sales teams we all saw in the past.

These investments in sales amount to [annual] cost of estimated $4 million, with more than $2 million impacting our annual 2012 results.

With regard to generating new sales opportunities, we were very pleased to announce a major technology and marketing partnership with Hewlett Packard the end of the second quarter. As some of you may have seen in the press releases and advertising, we integrated our PlanWell Collaborate software into HP's line of engineering printers, offering customers the ability to both access their documents from the cloud and post new documents to the cloud directly from the device itself with no need for a connected computer.

55 of these machines reside in our busiest service centers to help promote and sell the solution across the country. Both HP and ARC sales forces have been heavily incentivized to move the solution into the marketplace aggressively.

On another marketing front, we invested a major upgrade to our technology center in Silicon Valley, creating a more accessible and announced environment for demonstrating our technology solutions, hosting our cloud-based services, and housing our engineering staff here in the US. Along with our customers, we're encouraging our investors to join us there to explore what we have to offer.

Further, consolidating our position as the leading document solutions provider in our space, our websites and our marketing [collateral] have been upgraded, not only to reflect our single brand, but our unique value proposition. In recognition of our recent efforts, Gartner, a leading information and technology advisory company, positioned ARC in their magic quadrant for MPS Worldwide as a niche service provider.

Finally, we made (inaudible) investments to expand our color capabilities in 7 of our 13 Riot Creative Imaging Centers. These flatbed and latex printers bring cutting-edge production quality to these facilities and will allow us to compete head-to-head with both local and regional color bureaus.

On the business front, our management services offering continues to gain momentum. We are repeatedly demonstrating strong value to large AEC entities by combining MPS with offsite services and technology solutions based on cloud printing. Our success continues to grow in providing these larger companies a compelling reason to select ARC as a single source for their document workflow. The best evidence of this success is the 7.4% year-over-year sales increase in our facilities management and management services line during the second quarter. Our pipeline is very healthy in global solutions.

We are also starting to experience some growth in the number of our more traditional large format FM placements. While the revenue from these placements have not made a significant impact to our numbers, we read this as a positive sign of our investment in our sales efforts.

Similar to last year, however, macroeconomic conditions remain difficult in our traditional markets. While January and February provided optimism for the future -- or for the near future, subsequent months failed to deliver on the [price]. At this point, we don't expect improvement in our traditional markets through the end of the year.

As bullish as we [are] about the potential of our business in the long term, the large economy continues to remain sluggish, and this has compelled us to adjust our forecast for the year. Based on current market condition, we expect to deliver fully diluted adjusted annual EPS in the range of negative $0.03 to positive $0.03, and annual cash flow from operations in the range of $35 million to $45 million.

Our actions and investments over the past quarter speak to how aggressive we remain about returning growth to the top line of our business. While we are positioning the company to take advantage of non-residential recovery, we are also building new lines, business lines that are countercyclical and far less dependent on project work associated with our traditional business.

Addressing both issues is necessary part of our transformation into a true technology-enabled document solutions provider. And we are doing so while maintaining the operating cash flow required to comfortably meet our financial obligations.

At this point, I'll turn the call over to John for a review of our quarterly performance, and then we will open the call to your questions as per our usual practice. John.

Thank you, Suri. As usual, I will summarize and add some more color to our financial results for the quarter starting with revenue trends and then working my way down the income statement to our earnings results. Finally, I will speak to our balance sheet and cash flow results.

Net revenue for the quarter was $106.2 million, a $2.6 million -- a 2.6% increase over first quarter revenue, but a 3.1% decrease for the quarter on a year-over-year basis. For your daily sales calculations, the second quarter of 2012, had 64 days, as did the first quarter of 2012, and the second quarter of 2011.

With regard to customer mix, revenue from AEC customers accounted for 77% of our total revenue, with 23% of our revenue coming from non-AEC customers. This is largely unchanged from the trend of previous quarters, and this stability continues to provide us with the ability to dig the well deeper with existing clients, primarily in areas adjacent to our traditional project services, namely, management services and technology solutions.

As we diversify and grow the number of products and services we sell into the AEC industry, we reduce our direct exposure to the construction project dependent revenue.

With regard to sales by geography, our year-over-year regional revenue performance for Q2 2012 was as follows. Our northern California team continues to do a strong job, and, contrary to our overall trend, was up 1%. Southern California, however, revenue was down 9%, as was revenue in our northeast region. Revenue in the Pacific Northwest was down 7%. Our southern region revenue was down 8%, and our revenue from the Midwest was down 3%.

Our international operations, excluding Canada, are up 48%, largely due to another strong quarterly showing in China.

With regard to revenue mix by service, we continue to trend -- we continue the trend seen in the past few quarters of shifting our sales from off customer site traditional reprographics service to on customer site facilities management and MPS. Reprographic services delivered roughly 60% of our overall revenue for Q2, versus approximately 64% in Q2 2011.

Our facilities management sales category, which, again, includes MPS, delivered approximately 26% of our revenue, versus 23% in Q2 2011. And equipment and supply sales delivered approximately 13.5% of our revenue versus 12.5% for the same quarter last year. Digital services delivered 9% of our total revenue for the quarter and is reported in our reprographics services line.

Moving to gross margin, our gross margin for the quarter was 31.8%, which is up 100 basis points versus the first quarter of this year. This is down from our 32.6% level in Q2 2011, due to a higher mix of equipment sales, which has higher material costs than our other business lines, as well as lower overall sales levels.

As I noted last quarter, our amortization of intangible assets is trending lower because of the accelerated amortization of our trade name, which we initiated during the fourth quarter of 2010, and which was roughly $800,000 per month, and ended April 30th. We recorded $2.8 million in the second quarter of this year, as compared to $4.7 million in the second quarter of 2011.

Moving on to net interest expense, it was $7.3 million during the second quarter, compared to $7.7 million in the same period of 2011, and consists primarily of accrued interest on our 10.5% high-yield notes issued December of 2010.

Our SG&A for the quarter was $24 million versus $27 million in the second quarter of 2011. This is indicative of our continued management of G&A expenses. However, with the increased investment in sales staff, we expect this number to grow over the balance of the year with commissions. The result is adjusted net income of approximately $1 million and earnings per share of $0.02.

Moving on to cash flow, our adjusted EBITDA for the quarter was $17 million, a $1 million improvement over the prior quarter, and our year-to-date adjusted EBITDA was $33 million, which is the same as it was for the same period last year, in spite of our decline in sales. Therefore, our adjusted EBITDA margin is 15.8% year-to-date, which is up over 15.3% for the same period last year, a testament to our operational management.

Our cash flow from operations was $4.5 million for the quarter, versus $7.3 million for Q2 2011. As a reminder, our cash flow from operations was significantly impacted the second quarter by the $10.5 million biannual interest payment on those notes. The next payment is December of this year. Looking at it on a year-to-date basis, our year-to-date cash flow from operations was $17 million, versus $12 million for the same period last year, and our year-to-date free cash flow was $8 million versus only $4 million for the same period last year.

Moving to the balance sheet and related metrics, we ended the second quarter of 2012, with cash balance of $23.3 million. Our day sales outstanding were 51 days in the second quarter of 2012, a decrease of one day compared to our Q1 performance. And we continue our strategy of deleveraging and creating more capital flexibility for the company. As such, total debt including capital leases at the end of the second quarter of 2012, was $224 million, down from $246 million for the same period last year, a 9% decrease on a year-over-year basis. And on a related note, our $50 million senior facility remains undrawn.

The ratio of debt to trailing 12-month adjusted EBITDA at the end of the second quarter was 3.4, and adjusted EBITDA coverage of interest was 2.2 times.

With that as a basic overview, I wanted to continue to stress how actively and aggressively we are managing the company's financial position, especially with regard to the investments we are making now to build our business in the face of a difficult non-residential construction market. We continue to deleverage the company while still using our capital for targeted, high-return opportunities. This is evidenced by our cash and cash equivalence is up more than 6% on a year-over-year basis. Our debt plus capital leases is down from $426 million -- $446 million -- excuse me -- to $224 million on a year-over-year basis. And our new revolver remains untapped.

In addition, we continue to manage our cash flow tightly as evidenced by our year-to-date cash from operations at $17 million versus $12 million for the same period last year, and our adjusted EBITDA margin is 15.8% for the first 6 months of the year, versus 15.3% for the same period last year.

In spite of this active management of our cash and liquidity, we decided to adjust our guidance primarily due to macroeconomic reasons. Earlier this year, the macro forecasts were more consistent and more bullish than they are now. The volatility of the forecast this year and the overall uncertainty in the economy appears to continue to create a level of fear that is delaying large capital spending in the private sector.

The hesitancy that our customers are [experience] with regard to new projects in the US non-residential building environment is a trend we can't ignore, in spite of our growth in non-traditional business lines. However, make no doubt we remain enthusiastic about our progress and investments in business initiatives that are more under our control and less directly exposed to the non-residential construction market.

At this point, I'll turn the call back to Suri. Suri.

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

Alaya, are you on the line?

(Operator Instructions) We will pause for just a moment to compile the Q&A roster. Andrew Steinerman.

I wanted to hear about your traditional competitors in reprographics, if you (inaudible) competing vendors going away and leaving the market. And I also wanted to hear about pricing in reprographics and MPS, what are the trends in the market in terms of pricing?

All right. In terms of the traditional competition and what we are sensing is that there's a significant amount of staying, obviously, because there's been -- there's downturn, there's no doubt it significantly affected the competition.

With regard to exactly whether they are all going away, I wouldn't say that just yet. I mean, there has been several cases where people have shut down or applied for Chapter 11 (inaudible). As you know, most of these companies are family-owned companies, so they significantly downsize but continue to operate, don't really go away. But a good indication of how badly these companies affected is how -- a measure of what's going on with IRGA, the International Reprographics Association. We used to have 1,500, 2,000, 2,500 members, and last year it was down to 700, and this year we did not even have 100 - as such, IRGA actually canceled their annual show. And the association still remains.

We also have the Central Reprographics Association, which closed down. Western Reprographics Association, which closed down. Only the Eastern Reprographics Association remains, continues to operate. So those are indication as to where the competitors are. We can't specifically, obviously, because they're all private companies, we don't have specific details into their revenues or how they're performing.

With regard to competition and pricing, we have some impact on the pricing. But the true effect of what the pricing would be is when the projects come back and when you start competing. Right now, from the reprographers, there isn't enough jobs for us to be able to compare it, Andrew. So we do get jobs on and off. We do get a few bids here and there. But we haven't seen a significant drop in the pricing as such.

There is some impact in local markets or there's a small job or a big government bid. We've experienced that it's being aggressively bidded. But there is no evidence to suggest that across the board we have a significant impact in terms of pricing. At least we haven't sensed that just yet.

And, Suri, could you talk about MPS, which obviously has a much different dynamic, the pricing there?

Yes. MPS, of course, for that segment of the business, Andrew, we don't compete with the other reprographers. We have not come across a situation where we have competed with another reprographer for a major MPS installation. So when I say major, multiple cities or states or a region, a lot of global customers.

We have had situations where we [are] competing with other reprographers on and off in FM placement. But if it is true MPS installation in a very large national or a global customer, then we often run into either Xerox or HP or Canon [or the likes]. The manufacturers are the ones who are more often prevalent there.

With regard to small regional customers, we run into reprographers on and off, but pricing don't seem to be a major issue there, it's -- because when we do MPS installation, we largely price based on what customer is vending today and how much value or savings that we can bring to the customer. So we don't run into [competitor] bids as frequently as we do on [project] work.

Right. That makes sense. And, John, could you just give a direction to gross margin going into the second half?

Going into the second half of the year, we expect to see similar trends to what we've seen in prior years. Q3 is pretty comparable to Q2, on a gross margin basis. We do expect in Q4, as historically we see more equipment sales, and we have holidays, that gross margin declines in the fourth quarter, typically.

Okay. Perfect. Thanks for the time today.

Scott Schneeberger.

On the non-residential construction market, Suri, could you just talk to anything that you're seeing positively, signs of hope anywhere out there? Has it just directionally from first quarter gone up, down, sideways? And what will it take, what will you need to see when you know things are getting going again? Thanks.

So, Scott, we haven't seen -- there's nothing positive to report, unfortunately. That's what we were trying to point out. It's bouncing along the bottom, so-to-speak. We haven't seen upward movement in any one of those. There's no question that several customers are talking about new projects. People are inquiring about new construction projects or a deal, but nothing seems to materialize. But I think there is -- there is no question that this is election year and there's a market [confidency] not knowing. You know, uncertainty is the biggest issue here.

So we don't seem to have any positive movement in that regard. I mean, we're not hearing projects coming up.

Needless to say, many of the architectural customers are talking about new projects and new activity. But most of them seem to be international, and there doesn't seem to be a whole lot of activity here locally. And I think it's election year, there's a lot of uncertainty. So I think if that changes, we might see a change. But as for now, there isn't a whole lot of enthusiasm about new projects coming up between now and the end of the year.

Okay. Thanks on that. Could you speak to Boeing and what -- how that -- where that stands with regard to a few years ago? Thanks.

Boeing, obviously, the contract renewal came up, and Boeing renewed only part of the contract with us because they actually decided to award that contract to someone else who they might favor. And we understand that. So we basically have part of the contract at Boeing, and that finishes at the end of the year. Sometime end of the year, Dilo? And what they will do at that point in time, we don't know. And if they ask for our services, we'll be more than happy to help.

But right now, we have about the rest of the year left on the project, which is about 50% of the revenue we had last year.

And, Suri, other sizeable pieces of business, are there many out there or is it really just onesies, twosies with regard to what you're looking at? Thanks.

Say that again, Scott. I want to understand that question better. Are you saying whether there are other businesses like Boeing out there in large numbers? Is that your question?

Right, sizeable pieces of business out there to grab or is it more smaller pieces of business and just many of them?

Yes, yes, yes. Yes. Yes, okay. I got it. Absolutely. I mean, there's a lot there to be grabbed. Lot there to be grabbed, especially in the management services area, we are -- that's one of our strategies, to go after the top 100 E&R companies (inaudible), most of the engineering and construction companies. That's our specialty. In many ways, Scott, in that space we stand alone. The reason why you are seeing 7%, 7.4% growth, which we talked about in the management services year-over-year, is simply because we are very strong in that area. That's the area also we do very well in the AEC space, because we not only provide management services, but we also provide off site services and technology solutions to wrap up the whole thing and become the single-source service provider. In other words, we'll provide one bill for all the work done in house and all the work done offsite and any technology-related work we do, which is based on cloud printing.

So in that space, we are alone and there are no other reprographers competing. And it's difficult for equipment manufacturers to actually compete with us in that space. And so if you take that space, Scott, we probably are doing business with 15 of the top 100 companies. There's a lot more to be gained. These are big contracts. They take awhile to get there, but we are definitely making significant progress in this area.

Excellent, Suri. Thanks. And then, finally, you've historically spoken that you wouldn't restart acquisitions until you could get a good look at your target trailing 12-months EBITDA. And as things persist to be bad, does that mean that you're probably at least a year away from becoming active again? Let's say the balance sheet's in decent shape. So still that wouldn't be something of consideration by early next year? Or am I wrong on that?

I think we're going to take the wait-and-see approach, Scott, because most of these companies are seriously affected by the downturn as well. We would like to understand where they are in the cycle. As you know, we are last to get in and last to get out as well. So we want to make sure that if, indeed, we invest in an asset, generally, generally as a practice, we want to make sure that investment is safe.

So even if we were to do an acquisition, I think we'll be very careful as to how we look at that acquisition, depending on where the cycle is and what we are doing.

The other element, which is important one to understand is that the market has substantially changed. Our customer behavior has substantially changed. Our industry and what the customers are looking to us these days is very different to what used to be in the past.

So even when the projects come back, we're not sure some of our competitors would actually draw the same level of revenues that they would have otherwise drawn prior to the downturn.

So short answer is we're going to wait and see. And if somebody really picks up moment and really are able to generate a lot of revenue, certainly they might become targets. But right now we are taking the wait-and-see approach.

Great. Thanks very much.

[Tim O'Connor].

Wanted to dig in a little bit on cash flow, particularly, and I apologize if you've already mentioned it, but the accounts payable line, and then for free cash flow. CapEx looked like it was a little bit up as a percentage of revenue. Could you just talk about those two items and if you expect them to reverse in the third and fourth quarters?

John, would you like to --

Sure. So I'm not sure I caught the question on cash flow. I'll start with accounts payable. Accounts payable is following a fairly difficult trajectory for us on a quarterly basis. And candidly, I just wouldn't read too much into that balance sheet number that moves from quarter to quarter or month to month based on the time of our vendor receipts. So it's not a material move from our perspective.

And I'm sorry, could you repeat your question with regard to cash flow?

Yes. CapEx as a percentage of revenue rose in the quarter. Is that something that -- was that a one-time thing or was it a more sustained increase?

CapEx, two things going on in the CapEx. One, as Suri mentioned in the earlier part of the call, we are investing actively in the business and we're funding that in a number of ways. Some of that's been -- some of that investment shows up flowing through our income statement as an expense, some is CapEx for systems related.

In addition, we are using our cash more aggressively versus the lease market, to bring our lease costs down. Sometimes we threaten to use cash to purchase equipment to get the pricing of the lease, offered lease down, and sometimes we outwardly buy the equipment to show that we're not bluffing. So a portion of that increase is more purchasing as opposed to leasing as we bring down our lease costs. So, and I've split that increment in about half. I'd attribute about half the increased purchasing as opposed to leasing, and the other half is more one-time investment in the business.

Okay. And last quarter you said you were confident in the cash flow forecast for the year. Is the change in guidance related to top line or was there something else?

It's, as you'll notice, we adjusted our cash flow from operations guidance less than we adjusted our earnings per share. It is, kind of per our discussion, it's much more of a feature of the macro environment and the difficult non-residential construction environment we see, and that tends to go through our top line.

We are making investments - that impacts the earnings line and lowering the income statement. But the majority of it is due to the challenging market environment we continue to face.

Okay. And I wanted to dig in on the geographical differences, particularly in California. Northern California versus southern California were very different for the second quarter in a row. Is that a function of different store counts or is it something else?

Well, fundamentally, we see a little more life in northern California because of the technology aspect as well because there's a greater technology influence, technology companies are a little more active. So in general we always find that there is more active -- there's a lot of activity in northern California.

In addition to that, they also have large global solutions customers. And large global solutions customers have agreements with us and there's a lot of new management solutions installations which actually pushes that number up.

So, for example, when we sign up a management services agreement with a national customer, we would start installing them state to state. So we will go from southern California, then we'll get in northern California, and then we might go to the south and then we might go to the east coast, depending on where these operations are.

So sometimes when we sign a large customer like that, a few of those installations might come [primarily] in northern California, and that is definitely the case. We obviously don't divulge the name of the customers for confidentiality reasons. But sometimes we are doing more than one installation in northern California, and that could have happened in southern California as well. That's why there is a marked difference.

But in general, northern California, the activity relative to southern California is higher because of the impact of the technology companies and the general business environment is a little more upbeat then southern California.

Okay. Thank you. Final question from me. Couple quarters ago you talked about stability in the business returning particularly in the repro side from day-to-day and week-to-week. Did you see a change in that? Are you seeing more volatility or is it simply a slightly lower level but consistently lower?

Yes, overall the -- last year we thought the market is going to come back. The whole thing about this non-residential construction business is how much of the activity will come back because there's more confidence in the market. And what has happened over a period of time is although there were brighter sparks at the middle of last year, thinking that we thought by the end of the year there'll be recovery, and that did not happen. But then again early part of this year there was much more optimism about the non-residential market and the things were going the right direction. There again, that kind of faded off by March-April and kind of took a negative turn.

So we're just not seeing enough confidence in the market for new products to take off, although there are several projects being held waiting for capital or waiting for approvals. So we don't see any life just yet on the non-residential side.

Sorry, just a quick follow-up. Can you talk about the projects that are waiting for approval and where you're seeing those and what types of projects?

Right. I mean, there are stadiums, ballparks, hospital projects. I wouldn't obviously name all of them. But like, for example, the 49er stadium, the drawing's already done, design work is done, it has been approved by the (inaudible), but obviously some financing has to be done. So as a result, that's being held.

But there are several hospital projects like that. There are other stadium projects like that. So all those projects tend to get held up, and we know it's in the works, but all those get moved to the next stage once the confidence is back and the capital is available.

Okay. Thank you.

(Operator Instructions) And there are no questions at this time.

Thank you, Alaya. Ladies and gentlemen, thank you very much for your attention this evening and your continued interest in ARC. Have a great evening.

This does conclude today's conference call. You may now disconnect at this time.