ARC Document Solutions Inc (ARC) 2013 Q1 法說會逐字稿

Good afternoon. My name is Michelle and I will be your conference operator today. At this time, I would like to welcome everyone to the ARC First Quarter 2013 Earnings Conference 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)

Thank you. Mr. David Stickney, Vice President of Corporate Communications, you may begin your conference.

Thank you, Michelle and welcome everyone. On the call with me today are Suriyakumar, our Chairman, President and Chief Executive Officer; Dilo Wijesuriya, our COO; John Toth, our CFO; and Jorge Avalos, our Chief Accounting Officer.

Our first quarter financial results for 2013 were publicized earlier today in a press release. The press release and other Company releases are available from our Investor Relations pages on ARC Document Solutions website at the e-arc.com.

A taped replay of this call will be made available several hours after its conclusion. It will be accessible for seven days after the call. The dial-in number is in today's press release. Per our usual practice, we're also webcasting our call today and the replay of the webcast will also be available on ARC's website. Today's 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 7, 2013. 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. Suriyakumar. Suri?

Thank you, David and good afternoon. Today, I am pleased to report sales trends that continue to support our new portfolio of services as well as improved margin performance for the first quarter of 2013. Our results benefited from the quick actions we took to reposition our offerings and restructure the Company in 2012.

As noted in our earnings release, first-quarter revenue was $100 million and gross margin was 32.4%. Our adjusted EBITDA margin was 15.9% and cash flow from operations was $11.9 million or approximately $0.26 a share. Earnings per share were at $0.01. We are maintaining our annual forecast of the full year of 2013 and we expect annual EPS to be in the range of $0.03 to $0.07. We anticipate cash flow from operations to be in the range of $38 million to $45 million.

As has been the case for the past several quarters now our MPS offering continues to lead the way with new sales. We continued to improve our MPS offering to our enterprise level customers with new announcements to all Abacus software, which is actually the heart of our MPS offering. Abacus is [seriously] becoming far more than a typical MPS application. Before long Abacus will not only drive the management of documents, individual printers and equipment fleets but it will also drive intelligent storage of our customers' documents and offer real-time archiving and information management.

Our focus is to continue to develop disruptive solutions which will improve our customers' efficiency in document management and reduce their costs.

Onsite Services grew 9% year-over-year in the first quarter of 2013. Given that this business line helps reduce and control cost associated with document management, it is gaining more traction with clients across our customer base and across geographical boundaries. In recent months, we have expanded our MPS placements with existing Canadian customers, including those in the French-speaking provinces.

Shortly after the close of the first quarter, we introduced a bilingual version of Abacus, our MPS software platform, into Quebec for one of our largest architectural and engineering customers. We also continued to add new locations at a steady pace from previous sales wins throughout North America and we're enclosing negotiations by expansion with other existing customers.

Current FM and MPS contracts number at more than 7,100 a year, year-over-year gain of nearly 1,000 contracts and our pipeline for the new [RFP] is very healthy.

Our newest offering in the document solutions space is AIM or archival information management as we call it. AIM is generating great interest with both large and small customers and it is an area where we have put intense focus over the past year. The service itself is innovative in its approach to the archiving challenge most business face and the research and development behind the technology is cutting edge.

Our platform for archival storage, which we refer to as the PlanWell Cloud is now almost entirely hosted on Amazon giving us tremendous capacity, redundancy and security for our AIM customers. Our continuing development in intelligent search make every document we store for our clients easier to find, more accessible and more valuable from an intellectual property standpoint.

We believe we have a unique and persuasive value proposition, especially with clients who store their documents off-site in paper form. Many of our national and global customers have thousands of boxes stored in warehouses with not ability to access them quickly. While this may be adequate for records relating to, for instance, accounting and finance to meet compliance requirements, many of our customers also keep their intellectual property such as design documents or engineering calculations stored in hard copy format. These documents are difficult to retrieve on short notice and their value is frequently ignored due to the extreme difficulties in finding and accessing the right information.

Our solutions provide a compelling argument for scanning, archiving and posting these valuable documents to an online, on-demand retrieval system which provides ready access without incurring any warehouse retrieval fees, transportation costs or delays. Early signs suggest that we have significant interest in this new offering and we look forward to reporting our progress to you in this area throughout the year.

We also saw progress in our color offering during the first quarter with a 5% year-over-year improvement in sales. Through the combination of our growing brand recognition in Riot and the recent service center optimization that occurred as part of our restructuring efforts, we have the opportunity to consolidate equipment and expertise in some of our locations. This will allow us to increase utilization in our shops and our equipment. We expect such efforts to provide incremental margin expansion in color and make us more competitive in the marketplace.

Equipment and supply sales saw a decline primarily in China where the end of the year strength typically gives way to a slow start to the new year. We remain pleased with our joint venture's performance in general and we were gratified to acquire ISO 9001 certification in China. Given the amount of business that requires this certification as a condition of doing business, especially in the technology and manufacturing sector, we expect this achievement to enhance our success in securing work in each of our markets throughout the continent. As we anticipated, traditional reprographics revenue remains challenged and we expect these conditions to continue until we see a meaningful recovery in non-residential construction.

As I mentioned in our press release today, we are cautiously optimistic about 2013. Our optimism is based on what appears to be a slow recovery in construction, but we remain cautious because the most meaningful part of construction for ARC is non-residential and this segment is yet to emerge with any strength.

Housing improvement is heading the news, but our exposure in that segment is limited. We've seen the commercial and industrial lending environment improve as the employment numbers and vacancy rates inch up. And all three of these trends are key drivers of new construction, however, we have yet to experience a meaningful recovery in the non-residential space. The office market vacancy rate remains above 15% and both industrial and retail vacancy rates are above 12% and that makes for a good deal of capacity to work through, especially in the office market. It keeps the buy versus build decision favored to the buy side, but as the space is taken up, some improvement is likely.

In the end, if the positive trends continue and we can avoid major disruptions in the economy, we should see signs of life this year in non-residential private construction.

In closing, as the non-residential construction sector improves or recovers from its prolonged downturn, we are continuing to position ARC Document Solutions as a premier technology-enabled document management partner to our customers. The process improvement we demonstrate, the savings we generate and the value of the services we provide are consistently reinforced by our customers as we engage them in business reviews and by the progress we have made in transforming our Company.

I look forward to sharing our continuing success with you in the coming quarters. At this point, I'll turn the call over to John Toth, our CFO, for further insight into our financial performance. John?

Thank you, Suri. Beginning with the top of our P&L statement, our consolidated net revenue for the first quarter was $100 million, a 3.4% decrease from the prior year's same period. On a daily sales basis, the decrease versus year ago was only 1.9%. For your daily sales calculations Q1 2013 had 63 working days versus 64 days in Q1 2012.

With regard to our revenue mix by product line and using our five new revenue categories, traditional reprographics was 29.5% of our total net revenue while OnSite Services was 29.0% of our revenue for the quarter. This is only half a point difference in the size between these two business lines. This is compared to a mix a year ago, up 32.2% for traditional reprographics and 25.7% for OnSite Services. The businesses are now essentially the same size in revenue. But where traditional reprographics declined 11% year over year, OnSite Services grew 9%. If these trends continue as expected, OnSite Services will soon be both our largest business line as well as our fastest-growing business line.

Moving to our third business line, color services comprised approximately 21% of our sales for the quarter versus 19% a year ago. This business offering saw a gratifying increase of roughly 5% year-over-year. Digital services revenue made up 8% of our net sales, down from 9% a year ago. Like traditional reprographics, digital services are primarily derived from project-based work and the decline is related to the lack of project-based work performed at our service centers. We're looking forward to the contribution of our AIM business to revitalize this sales category.

Lastly, equipment and supply sales comprised 12% of our total sales, down from 13% last year. This year-over-year decrease was driven primarily by a decline in equipment and supply sales from our Chinese joint venture. Q1 2013 suffers in comparison to Q1 2012 in China due to some large non-recurring equipment orders in the first quarter of 2012.

In summary, two of our five business lines showed mid to high single-digit year-over-year growth and we continue to invest in sales and marketing programs that are very specifically designed to return growth to our consolidated revenue line.

With regard to our customer mix in Q1, revenue from AEC customers accounted for approximately 75% of our total revenue with 25% of our revenue coming from non-AEC customers. As for sales by geography, our year-over-year regional revenue performance for the first quarter was as follows. Northern California was down 3% but Southern California revenue was up 1%. The Pacific Northwest was down 23%. This was due to the non-renewal by a large customer last year and we unfortunately are likely to see these loan numbers for the Pacific Northwest throughout the year. Revenue in our Southern region was down 2%, the Midwest was up 1% and the Northeast region was down 5%. Our international operations, excluding Canada were down 4%, again per prior comment, led by China in a challenging year-over-year comparison.

Moving to the cost portion of our P&L, as noted in our press release today our 32.4% gross margin is a clear demonstration of the power of our recent restructuring effort coming as it does despite a sales decline of 3.4%. I want to stress the targeted nature of the steps we have taken since the fourth quarter to achieve this margin expansion. Our restructuring plan was deliberately designed to address underperforming locations and an over-weighting of resources in our declining business lines. It was surgical and not a flash. The steps taken were to align our cost structure with the future of the business which lies in technology-centric services provided at the customer site.

With that in mind, the recent steps taken to address our variable costs led to a year-over-year contribution margin expansion of roughly 170 basis points from 54.5% in Q1 2012 to 56.2% in Q1 2013. And we were able to hold virtually all of this gain through our gross margin primarily by optimizing our service center footprint. The result was a 160 basis point year-over-year gain in gross margin 32.4% versus 30.8% a year-ago. We continue to execute on the restructuring plan and believe this will lead to further gross margin expansion.

Our SG&A for the first quarter was approximately $23.8 million, essentially flat versus $23.5 million for the same period in 2012. As part of our program of investing in sales resources to drive growth, we increased our selling and marketing expenses by $1.3 million. However, we offset this increased expenditure with steps taken to reduce the general and administrative expenses of the business so the net result is an increase of only $300,000 in SG&A year-over-year.

I want to take a moment to update you on our restructuring expense. The initial gross restructuring expense incurred in the fourth quarter of 2012 was $3.3 million. In the first quarter of this year, we incurred an additional $472,000 of restructuring expense from additional steps taken in our plan, specifically the closure of four additional locations. That brings our current total restructuring expense for the two quarters to $3.8 million. We anticipate minimal additional restructuring expenses in Q2 and 3 of this year.

From a restructuring liability perspective, a balance sheet perspective, during the course of the fourth quarter, we paid roughly $1 million in restructuring costs, reducing the liability to approximately $2.3 million at the end of Q4. In Q1, we increased the liability $472,000 and made $1.6 million in payments towards the restructuring. The net result is a restructuring liability of $1.2 million at the end of Q1. In spite of these payments, our cash is up roughly $1.8 million versus December and up roughly $400,000 versus year-ago and we have achieved this without drawing on the dry powder in our revolver.

Net interest expense was $6 million for the first quarter of the year compared with $7.4 million for the first quarter in 2012. Note that the significant reduction in interest expense is due almost entirely to conclusion in December 2012 of the amortization of an interest rate swap agreement terminated in December 2010.

The result for the quarter was net income of $415,000 or $0.01 of earnings per share. Adding back interest, taxes, depreciation and amortization, our adjusted EBITDA was $15.9 million for the quarter or 15.9% versus year-ago EBITDA margin of 15.4%. The improvement of our adjusted EBITDA margin cascades directly from our strategic management of our gross margin but is offset by the relatively fixed cost of SG&A due again primarily to the deliberate investment in selling and marketing.

Moving now to our cash flow performance, cash flow from operations was $11.9 million for Q1 2013 versus $12.4 million for Q1 2012. And the cash flow from operations for this quarter is depressed by the $1.6 million of restructuring payments. In the balance of 2013, we expect to make greater use of some of the incremental advantageous capital lease facilities we have negotiated and therefore expect our CapEx to decrease year-over-year and thereby result in increased free cash flow.

Our days sales outstanding were 55 in Q1, which although longer than we like is not unexpected for the quarter, particularly given the seasonal-driven increase in receivables in the month of March.

Total debt, including capital leases, at the end of Q1 2013 was $219 million, down from $226.5 million for the same period a year-ago, a 3% decrease on a year-over-year basis. Again, this is largely driven by the very deliberate use of cash instead of lease lines for the acquisition of equipment for the growth of our on-site business. As we shift our balance toward capital leases versus CapEx, I expect our total debt to increase modestly over the course of the year.

With this overview as a basis for discussion and questions, I'll turn the call back over to Suri. Suri?

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

(Operator Instructions)Scott Schneeberger, Oppenheimer.

[Iber] filling in for Scott. Good afternoon, guys.

Good afternoon.

My first question relates to March. Historically, that's been the strongest month of the quarter and for the year and it often gives you a read into what's coming up for the year. So just curious on what you guys see with that.

With March you said, yes, I mean -- yes, I mean it's a month where have the most number of working days. And as we said in our call, overall, we still don't see a whole lot of non-residential activity coming up, although we see housing growing very nicely.

There is definite signs of housing market heating up and activity -- building activity starting to pick up. But in terms of non-residential, we haven't seen a big bump just yet. There are signs of these things coming back and we are certainly seeing more green shoots pop up. But in terms of big projects coming back, we haven't seen anything evident yet. And that seems to be the trend for now. I think we are going to see non-residential come alive during the year. Would you agree John?

Absolutely. I think just to follow up on what Suri said, I think we had a good March relative to the first two months of the year, but it's still green shoots is what we're seeing.

Okay, thank you. And just to follow up on that, given that April is now complete, how have the trends been relative to March?

They seem to be pretty much in line with what's going on. I mean, there's nothing extraordinary. And even if there is anything extraordinary, we wouldn't be able to discuss that. But the trend seems to be very much in line with what's going on.

Okay. And just one last follow-up on that. How do you guys think about visibility? How far out can you guys see right now?

In terms of the new projects coming up?

Correct.

Yes, I mean, we've seen some activity coming up. Like I said, we don't see a whole lot of projects coming up. So we feel like people are starting to make more inquiries. Architecture Billing Index is up which clearly shows there are signs of activity which is going on. Our customers are busy here. But we haven't seen projects -- too many big projects break ground the way they used to be when the market gets normalized. So for the market to get normalized and for the architectural drawings to be completed and bidding process to be completed and the projects to come alive, you probably will have a lag and that's what's probably we're going through.

And I expect in the third quarter or fourth quarter more construction activity, physical construction activity to show up on the radar screen based on what we're hearing right now. But we don't have specific visibility into projects breaking as of now.

Okay. Just lastly, what market verticals within the AEC segment are you guys seeing strengths and weaknesses?

Not specifically. The private construction in terms of the overall non-residential marketplace is yet to come back. That's the kind of reaction we're seeing. Anything to add, John?

Yes, I think following on that comment, we see multi-family as relatively strong within that space, continues to be. But commercial and institutional, we haven't seen a real momentum change from what we characterized as bouncing along the bottom for those segments.

So that's pretty much what we are seeing. Obviously, the schools and some amount of state work seems to be coming along at probably a greater pace compared to the non-residential private construction. But we [haven't seen] -- that is the part which really gets the non-residential construction going like we said in our prepared commentary that private construction is often driven by vacancy rates and unemployment numbers. And we haven't seen a meaningful pickup on that one just yet, but certainly the market is heading in the right direction.

All right. Thank you so much, guys.

You're welcome.

Matthew Kempler, Sidoti & Company.

Good evening. I wanted to review the Onsite Services where you said you saw some good pipeline and activity and the business has increased 9% year-over-year. From your view, based on the activity you're seeing, is that the right target for 2013 or do you expect an acceleration or maybe a pullback from what we saw in the first quarter?

Right now, I mean it seems to be -- I think it's a good target. I mean, it might accelerate a little bit latter part of the year. We are obviously driving that segment very hard. That is very attractive as customers use more digital, they're using more of the output devices or services inside the offices for this printing. So there are two segments we are going after. One is the small customers, that is the number of FMs have gone up to 7,100 this quarter. Right, Dilo?

Yes.

It has gone up 7,100. We certainly expect that number to continue to pick up throughout the year, Matt. With regard to larger customers, the selling cycle that cycle is much too longer. So we have certain number of customers in the pipeline so there will be some growth, but that growth comes slower. So we have continued to work on several new customers. That's obviously a very key offering we have and right now we are in and around that 8% to 10% growth line. That's what we are expecting.

Anything to add, Dilo?

Go ahead, Matt.

Okay. So, next I wanted to ask on the color side. First of all the business there is, like your global customer business, is there a retention among the customers that you've been winning or is this more project-based so let me start with that?

Okay. So there are two types. I mean there is a segment of the work which is project based which we go after because we do have 200-plus sales people on the ground so they bring a lot of project-based work as well. But then we do have large enterprise-level customers who actually require services in multiple cities. Those we get on a regular basis and there are also other AEC clients who consistently on a basis give us color work. So there is some amount of project work, but whenever we get into a big project, then our numbers show healthier. And in the absence of any large project, our numbers are kind of flat.

Dilo would you like to add?

Yes, actually most of the work we don't -- they are not larger RFPs or bids. These are customers that are acquired through our regular selling cycles and these are repeat work. When it comes to color, some of the project which are of large size doesn't repeat every week or every month. It could be every quarter or so. So most of the work is repeat business coming from customers that we acquire through natural normal sales processes and very little RFPs or bids and so forth.

Okay. And then it sounded like in your prepared remarks you're talking about some improved optimization will let you get more aggressive on pricing. Did I hear that correctly and do you expect to be at a price advantage in future quarters?

What we are seeing is we are continuing to fine tune our operating cost with restructure we did. John was referring to them as surgical. So what we are doing is we're taking the perspective that because we have off-site service centers and then Riot service centers we're putting them together and getting better productivity out of these locations so that we can improve the competitivity so we can actually get better results. So in terms of margin expansion do you expect --

Yes, from operationally, like we are cross training the staff so that we don't have dedicated staff to handle Riot and regular ARC type of services. So, cross training of staff, bringing the equipment to manage both type of customer bases, locations when we merge them together it gives us lot more power to price appropriately and some of the projects that are of competitive nature, we are able to price appropriately and win them.

Okay, but are we intending to be a price leader in that market?

Not really.

Not really, Matt. We've talked about the color market previously in the sense that color is a huge marketplace. I mean, obviously the largest are the billboards and the smallest are the no parking signs, the signage companies. All of these people from screen printers to signage companies it's a huge market. But we go after very specific targeted segments which is high-quality, quick turnaround, small -- low-volume market which is basically short-runs. So short-runs, high quality, quick turnaround and higher price, so that's the market we target and go after where which requires high level of service. So these are retail organizations, design organizations, the Disneys of this world. We try to keep go after that particular segment. In that way we make sure that we're not trying to bid for color copies with coffee shops, so to speak.

Okay. And then I just also wanted to follow up on the gross margin. You mentioned that you're targeting additional gross margin expansion. I am wondering what kind of optimization activities you're looking at do that and is that independent of revenue growth seen those margins improve?

Yes. So we've started our restructure sometime last quarter and John referred to specifically them as surgical. We wanted to make sure we have a clear understanding as to how we are approaching this given our new portfolio of services. We had existing infrastructure map when we acquired and we had traditional reprographic services in 200-plus locations under different brand names.

As we centralize the operation and bring everything under the ARC Document Solutions umbrella, we are trying to optimize these branches in terms of back offices, accounting and operations, all of the different aspects of the business so that we can get better results. And it's a long process and we've made substantial progress on that and you can see that the numbers are showing that. But we will continue to work on that so we're just at the stage where we are continuing to improve many aspects in terms of whether it's a color operation or whether it's black and white or it’s financial. John, would you like to add?

Just to expand on the point as Suri said this is margin expansion without necessarily (multiple speakers).

Incremental sales, absolutely.

And it is a continuation as Suri said of what we began in Q4 and continued into Q1 which is consolidation of sites to drive more volume through a smaller fixed cost base. It is more modest steps than what we've taken in the past five months but in the same vein. And we continue to do this not just this quarter, Matt, we'll continue to do this through the year and we expect to have some margin expansion even without incremental sales as John said.

Our objective is to restructure the Company for the new portfolio of services we offer which is largely driven by the digital activities and therefore there is a lot things that we can change and remove inside the deviations which we had previously, which we don't require anymore, and we are focused on that.

Okay. Thank you.

You're welcome.

Glenn Primack, PEAK6.

Hopefully it's not too loud. I'm in an airport operating with a cell phone and deceptively soggy tricky balance. But I do have a couple of questions.

It's not too bad actually, much better than what you said. It sounds pretty clear.

The first one is just the California market, I have read in the last year's K that that's like 30% of revenue. And then one of the trade magazines I was reading that there is like $4 billion of investment going into Northern California from South Korea. I don't know when that would potentially go to design house and into inquiries in your business. Can you just talk about the market in general, what you are seeing in California since it's such a big piece of your revenue base?

Sure. I mean there is definitely signs of a very strong activity which is starting to pick up, but we haven't like I said previously, as you know while we see activity for it to transform to a really project related work it could be six to eight months and bigger projects could be as much as an year. But we're seeing a lot work being talked about for the first time this year, as compared to last year. The last year was better than the previous year. But if you remember that we are coming right from the bottom, really from the bottom. It's going to take a little time to pick up.

Two days ago if I recall right, there was an article on the Wall Street Journal about a $5 billion expansion for the Los Angeles International Airport. That's already approved by the County. That's just two days ago in the Wall Street Journal. And then there is definitely investment from South Korea in Los Angeles as well. In Southern California in a large building complex as well. But we are seeing signs of this activity come up and we're obviously monitoring them very closely. Dilo, would you like to add anything?

Yes. Again, when we say California, we look at the Northern and Southern California. It's two different markets because they generally work in a two different ways. One positive sign we see is definitely the Southern California market where Orange County and all the way through Greater Los Angeles area where things have been very slow. There is momentum there. Meanwhile projects are picking up all the way through to San Diego area, so which we have been blessed to see some of the projects there.

Northern California, a lot of tenant improvement projects are taking place rather than new groundbreaking, a lot of tenant improvement projects are taking place. We can see that very clearly. When you talk about Korean investment, some of -- that specific project probably you're talking about, we are having some great opportunities on that project in the Silicon Valley area. And definitely there is activity. Southern California is leading that, but definitely we can see it in Northern California as well.

Okay, great and then nationally, do you foresee any shortage of architects out there (multiple speakers) gone through the downturn and if there's any type of pick up?

I don't think we've seen that, Glenn just yet. I think there is activity picking up and we definitely see our customers hiring but I haven't heard yet that they are running out of architects so to speak or architects have started doing something else that they had to revert back to architecture, we haven't heard that yet. But that'll be great if we come to that.

Okay and then just the last one, your cash EPS like implied for the year would be what, since again, I don't have (inaudible)?

You calculate cash EPS by adding back depreciation and amortization?

That's Correct. I'm guessing that's probably $0.30 or something.

So quick and dirty calculation would be probably closer to about $0.22.

$0.22, okay.

But I'll follow-up -- I mean, the depreciation is broken out, so about $0.22, $0.23.

All right, $0.22, so and that's a depressed $0.22, [fair enough, right as] if we were at the bottom or trough or something.

Yes.

Okay. Great. All right. That's it. Thank you very much.

All right. Thank you, Glenn.

(Operator Instructions) And I'm showing there are no further questions at this time.

Ladies and gentlemen, thank you very much for your attention and continued interest in ARC Document Solutions. Have a great evening. Take care.

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