ARC Document Solutions Inc (ARC) 2013 Q4 法說會逐字稿

Good day and welcome to the ARC Document Solutions fourth quarter and full-year 2013 earnings conference call. Today's call is being recorded. At this time, I would like to turn the conference over to Mr. David Stickney, Vice President of Corporate Communications. Please go ahead, sir.

Thank you, Jessica, and welcome everyone. On the call with me today are Suri Suriyakumar, our Chairman, President, and Chief Executive Officer; John Toth, our Chief Financial Officer; and Jorge Avalos, our Chief Accounting Officer.

Our fourth quarter and fiscal year-end 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 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 are webcasting our call today and the replay of the webcast will also be available on ARC's website. New to this call will be a brief summary of our results as an introduction to commentary from Suri, our CEO, and John, our CFO. Our intent is to provide a more efficient call and a more direct path to questions from our audience.

With that in mind, 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, February 25, 2014 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.

As we noted in our press release today, the Company reported annual revenue for 2013 of $407.2 million, a year-over-year increase of $1.1 million representing annual growth for ARC for the first time in five years. The increase was driven primarily by sales in onsite services and color.

Our annual gross margin was 33% compared to 30.4% in 2012, a year-over-year improvement of 260 basis points driven primarily by the restructuring activities we initiated in the fourth quarter of 2012 and completed by the end of the fourth quarter in 2013. Adjusted annual EPS was $0.09 based on adjusted annual net income of $4.1 million. Our 2013 adjusted EPS compares to an adjusted negative $0.037 in 2012 and represents a $0.127 year-over-year increase.

Adjusted annual EBITDA for 2013 was $68.2 million or 16.8%, which when compared to our margin of 14.9% in 2012 represents a 190 basis point improvement. Annual cash flow from operations was $46.8 million, a $9.2 million increase over year-end 2012 driven primarily by improved profitability. Our balance sheet remained strong through 2013. We ended the year with cash at $27.3 million, roughly flat to 2012 despite cash outlays of $4.3 million related to our restructuring, more than $12 million in repurchases of our bonds in the open market, and $5 million in cash payments related to our refinancing activities in December.

With regard to our senior debt, on December 20, 2013 we entered into a new term loan credit agreement that consists of a Term B loan facility in the amount of $200 million, the proceeds of which were used to redeem our previously outstanding 10.5% bonds. The new term loan facility bears an initial annual interest rate of 6.25%, which works out to be a 1% LIBOR floor plus 525 basis points, a significant improvement over the 10.5% bonds it replaced.

The retirement of the 10.5% bonds resulted in an accounting loss on extinguishment of debt of $16.3 million, of which $5 million were non-cash charges. Capital expenditures for the full year of 2013 were $18.2 million versus $20.3 million in 2012. The reduction reflects our continued efforts to achieve a 50:50 mix of buy versus lease for equipment acquired for our on-site services customers. Total debt including capital leases at the end of 2013 was $219.8 million versus $213.4 million as of September 30, 2013 and $222.5 million at the end of 2012. The increase is attributable to our refinancing activities. Net interest expense for 2013 was $23.7 million compared to $28.2 million in 2012. The decrease is partly due to a favorable comparison to 2012 as our interest rate swap ended. But it is also due to a reduction of interest payments on bonds repurchased in the open market during 2013.

With these basics as a context for continuing discussion, I'll now turn the call over to our Chairman, President, and CEO; Suri Suriyakumar. Suri?

Thank you, David. As you heard from David's business summary, 2013 was a turning point for the Company. The transformation we worked so hard to achieve was successful and I'm very pleased that based on the strength we demonstrated throughout the year and especially in the third and the fourth quarters, we've been able to achieve year-over-year annual sales growth for the first time in five years. Our Managed Print Services, or MPS as we call it, offering has matured very quickly considering we entered this market just six years ago. MPS comprises 30% of our overall sales and we are now the largest provider in the AEC space. Additionally, Gartner named us as the ninth largest MPS provider in the world. Rightfully so, we will continue to target the top firms in architecture, engineering, and construction as they represent a very fertile market for the foreseeable future.

Like MPS, our efforts to transform our color business have contributed to our success in 2013. This represents another area where we have been able to make a significant impact on the market in a very short time. Developing the right brand to enter the marketing, retail, and entertainment space has opened up a much larger market for us to address and exposed us to a whole new set of clients.

While the lower project-based activity has been the biggest driver of declines in tri-channel reprographics, it still represented 29% of our business in 2013. Thankfully, the market is finally showing some signs of returning to strength. This could very well kick start sales again for us and add to the strength of our business outside of the large format printing. As we all know, the AEC market is one of the largest industries to transform itself by embracing technology.

Given our historical investment in development of technology, I can't emphasize enough how well this positions us with our core customer base. Today, we are building out of our mobile collaboration software offerings. In 2013, we introduced an integrated document workflow for the AEC professionals. Our integrated applications now connect to one another and include MPS software archiving and information management services or AIM as we call it and managed file transfer applications.

We are also introducing new technology to enhance the consumption of data on the job site. We are doing things like providing hyperlink digital drawing sets as well as applying large touch screens to view and mark up two-dimensional plans and three-dimensional BIM models. And digitally archiving all this information continues to excite our customers and drive interest across the country every time we talk about our AIM solutions. We have had small wins throughout 2013 and we're looking forward to reporting on some of the larger ones in the coming year.

The AEC industry still offers enormous potential for products and services that play to our strength, our brand, and our relationships; and we are as excited about the opportunities in the space as we have ever been. These opportunities will add value to our customers' projects and strength to our digital services business line.

Early advances in technology this year include the formal launch of our AIM services, a business intelligence and analytics (inaudible) package for our large customers, as well as enhancements to the Abacus and our MPS software. In fact, Abacus enhancements helped drive our fourth quarter win with (inaudible), a well recognized leader in the AEC space and a company we are enormously proud to be supporting. The exclusive contract will run through 2016 and the rollout of our services is well underway in Canada, the United States, and the United Kingdom.

Addressing these large customers with technology continues to be a priority in our MPS strategy and supports our long-term growth assumptions. It is not just because of the size of such customers, but also because of the commitment these customers are making to become more efficient and competitive in every area of their business. Such customers represent multiple strategic opportunities for ARC and we intend to make most of them.

Second only to our emphasis on sales growth, our focus inside the Company was and remains on margin improvement. The restructuring of the Company that was initiated in December of 2012 while difficult, produced results we continue to build on today. We closed more than 30 small satellite service centers, downsized and consolidated others, and we made selective headcount reductions and yet we were able to increase our overall sales year-over-year.

At the same time, we invested in our sales and marketing teams and based on our full-year performance, it is clear that our planning and foresight paid off as we have avoided disruptions in operations and in customer service and stayed focused on meeting our customers' needs. In 2014, the disciplined work of individual and specific margin improvement projects will cement these changes in place.

In terms of looking ahead, we see construction activity gaining some steam in the foreseeable future. But our relatively optimistic view for 2014 has been tempered by weather-related events in January and February. Unfortunately, the weather in the early part of the year impacted businesses of all kinds and in every area of the country.

The business closures, indeed the closures of whole cities has had an impact on our business like any other. Our estimate so far is that we have lost more than $2 million due to the temporary closures of our service centers and of our customers' offices on the East Coast, in the South and in the Midwest. Thankfully all of our employees have come through the snow and ice storms safe and sound and our facilities by and large have been undamaged.

From what I've heard from customers and our field managers, we served our customers well in alternate locations whenever and wherever we could accommodate them. In what has become a habit however we are not going to spend a whole lot of effort on issues like the weather where we have very little control.

Instead we will continue to build on the solid work we have done in diversifying our business, push hard into new areas like AIM and digital project workflow, look for new technology-enabled opportunities in an improving construction market and expand the base of our business in those areas that are driving growth including services like MPS and color.

With this in mind, our outlook for 2014 for the annual adjusted earnings per share is in the range of $0.19 to $0.23 on a fully diluted basis and our outlook for annual cash flow from operations is in the range of $51 million to $56 million. At this point, I'll let John have the floor to offer some comments on our financial performance and then as usual we will take your questions. John?

Thanks, Suri. As we've already reviewed the numbers for the year, I'd like to focus on some of the 2013 highlights to emphasize not only the strength of our ongoing recovery but also how our results demonstrate the transformation of our Company. First and foremost was our performance in the fourth quarter relative to our third quarter. Obviously, we returned a year-over-year sales growth in the third quarter, but it was the fourth quarter that represented a significant change in pattern for us.

As most of you know, the last quarter of each year has been our traditional soft spot primarily due to the seasonal weather disruptions of construction activity, nobody builds in the snow, and working days reductions that come with the year-end holidays. In 2013 not only did we deliver year-over-year growth again in the fourth quarter, but our sales in Q4 were equivalent to our Q3 sales for the first time in the Company's history absent the impact of acquisitions.

As Suri mentioned last quarter, the stability and predictability of work that comes with MPS engagements is beginning to override the cyclicality and seasonality of traditional reprographics. While our sales performance in the fourth quarter was remarkable, our gross margin performance was even better. At 33.0% our fourth quarter gross margin improved 340 basis points over the fourth quarter in 2012.

This is a significant accomplishment in and of itself, but it was also a sequential bump of 50 basis points over the third quarter 2013 on the same total sales of $101 million. Our improvements in revenue growth and margin expansion had a dramatic impact on our cash flow from operations which improved 25% over 2012. Adding back the restructuring payments we made, our year-over-year growth in cash flow from operations would have been 33%.

Strong cash earnings continues to be a hallmark of our company as we generated over $1 of cash from operations per share. The significant margin expansion coupled with revenue stabilization were the main drivers behind our strong adjusted earnings per share performance. We delivered on the high end of our upwardly adjusted guidance and came in about a penny higher than we expected just 30 days ago as we finalized our year-end accruals which included accruals for executive bonuses. Our restructuring activity delivered a number of benefits to our P&L statement and our profitability and it also helped us drive improvements in our credit metrics and opened up the potential for significant improvements to our capital structure.

As a result, we were extraordinarily pleased to extinguish our 10.5% bonds in December and reduce the interest rate on our long-term debt by more than 40%. Our new Term B loan facility allowed us to move our senior debt into an efficient prepayable structure with minimal covenants, saving us more than $7 million in annual interest that absent other significant and accretive uses of cash is expected to be applied towards reducing our debt. And this sets us up to take advantage of even better terms for our debt as our performance improves.

Lastly I want to point out that we expect to see the benefit of our accumulated net operating losses or NOLs in 2014 and beyond. As our profitability increases, we estimate that our consolidated book taxes will be well below 20% because of our valuation allowance. And on a tax basis as opposed to a book basis, we have more than $90 million in NOLs. These NOLs will allow us to dramatically leverage our profitability into cash and aggressively reduce our debt.

In summary, we do not expect to pay more than $600,000 in cash taxes in 2014 due to our NOLs and we estimate that our book tax rate for 2014 will be below 20% versus our adjusted earnings per share tax rate of an estimated 38%. As a result, we expect our actual EPS to be several cents greater than our adjusted EPS for the foreseeable future. There is much more to talk about and I look forward to talking to you about how we will accelerate our progress going forward.

With that in mind, I'll turn the call back over to Suri.

Thank you, John. At this time, we're available to take our callers' questions. Please be advised that the team is in different locations today. So please direct your questions to me and I'll route them to others, as required. Operator, please go ahead.

(operator instructions) Brandon Dobell, William Blair.

Thanks, guys. Good afternoon. Suri, maybe for you first, the momentum you guys are seeing in the on-site services business, how sustainable is that? I guess to answer that question maybe you could address kind of how renewals are going and how the pipeline of new deals looks to be converting into contracts in 2014.

Okay. So Brandon, in terms of the sustainability, it is very sustainable and the reason I say that is that we basically sell the management services in two major areas. One is obviously on the large customers where we sell them through global solutions, to the top 100 AEC customers and then from a regional perspective, our 200 salespeople sell to what you correctly referred to our 100,000 customer base. Those are largely smaller installations.

In both ends of this business if you take the large customers, we have a grand total of probably 20-plus customers at the larger end of the 100 large AEC customers. These are multi-million dollar contracts and we have a long ways to go in terms of actually penetrating the rest, bearing in mind the fact that we are the largest player in this space, in the AEC space for management services. And if you take the lower end of the business where we go after smaller customers, we have 100,000-plus customers in our database and we have about 7,500, call it 8,000 installation at this point in time. So both areas, both segments, we have significant opportunities to grow our management services business. So that's really an exciting part of our business.

In terms of renewals with customers, the larger customers we renew them either three or five-year contracts and up to now our renewals have been going pretty well. We don't have a whole lot of renewals coming up but whatever has been coming up, we've been able to successfully renew. The smaller customers, the renewal rate is not as high as the larger customers and the main reason is because the smaller customers might actually have inflations based on the projects they have or based on the revenue they are generating year-over-year.

So the smaller customers tend to actually turn over fast, but again the growth opportunities in that space is significant. So in a nutshell, in the bottom level, we could be signing as much as 200-plus contracts on a monthly basis and we could be having 30, 40 contracts coming to a closure because either the projects have finished or they have moved offices or they are going out of business in the downturn or they are looking to maybe upgrade to a different level or they got acquired by another company. So there are various reasons, so it's about 30 to 50, I would think, John or David, you can correct me there, you might have better information on the ground there. And with regard to larger customers our renewal rate has been pretty good.

Okay. Maybe as an extension on that, how important do you think the health of the recovery in the non-res construction industry is going to be to that business i.e., if companies are making more money, do you think they are more or less willing to talk with you about managed print services or other things you can do for them? I'm just trying to get a sense of how the sentiment towards your offering may or may not change as the health of the end market changes.

My perspective is that companies are becoming increasingly aware of the efficiencies which are available in that space. I think this has been ignored for a long time and it also is something that we just come with the consolidation in the industry, especially with larger customers. They have been acquiring companies. There has been significant amount of consolidations which have been going on with the big companies, Brandon, and those consolidations haven't proved or rather delivered the results they are capable of.

And one of the main reasons is that the companies are not totally integrated and they seem to have several layers of suppliers. And what we do in this specific space by installing management services is we try to consolidate all their document requirements as a single source supplier. It's just not only off-site but also on-site, not just large format, but also small format, not just black and white but also color. So we are in a space where we can add tremendous value to our customers.

And increasingly as customers adopt technology they're going to realize that it's going to be much more beneficial to them, not only in terms of saving dollars, but in terms of saving administrative issues and then, for example, storage of their documents, retrieval of their documents, security of their documents. All of that substantially improves when you go to a single source supplier and being able to centralize documents on a single cloud with the kind of services we provide. So we expect this to gain momentum.

The only thing which has been, at least in my perspective in talking to customers, holding this back is the fact that they're still getting familiar with the digital technology and getting comfortable storing all these documents digitally. Largely the construction customers have been driven by paper-based document management and now change in the digital is taking time but they all realize it's time and we think there is significant opportunities for us to accelerate our growth in this space.

Okay. Was there anything within the fourth quarter and I guess I'd focus primarily on color and digital that you thought was not an anomaly but boosted revenues more than you thought. I guess especially in digital given the turnaround in the growth rate there in the fourth quarter from negative to positive, anything you could call out that we should be aware of as we think about modeling the revenue growth in those two service lines for 2014?

For the digital services, one of the things which is fueling that growth is the AIM business, archival information management, and we're starting to see as we said in our prepared comments more excitement from our customers as to how we can really deliver some benefits to them. And those kind of services are -- which we didn't have relatively speaking, 24 months ago, we didn't offer those kind of services and that's actually driving some excitement.

Similarly on the color side, the fact that we offer this high-end color, even our AEC customers who would have used us for color for project-related work, but maybe their marketing department didn't think of us seriously, but now we're able to capture that entire scope of work. That's the one which is driving the business.

Okay. Got you. And then maybe some house cleaning ones, John, I know you guys gave stats for the AEC customers as a percentage of revenue in the fourth quarter. Do you have that, I mean for the full year and for last year's fourth quarter, that 76%/24% split that you mentioned in the release?

We do and I think it's disclosed in our 10-Ks. I'm going to try and put my fingers on it while we're talking, but there is no material change in the balance guidance. I think it may be a 1% change, but nothing more than that.

Nothing major. Last couple of years you guys have spent $18 million, $20 million on CapEx. Is that a decent number that we should use for 2014 as well?

It's probably a bit high. Our machine acquisition rate of about $30 million a year that rate is going to be about stable, but we're going to be shifting our mix as to how we fund that $30 million between CapEx and capital leases, mixing more towards capital leases. So I think we're going to aim for about a 50-50 mix or $15 million CapEx $15 million new capital leases.

Got it, okay. And then final one for me, fourth quarter SG&A as we think about modeling 2014 on a dollar basis, how should the SG&A line move around? I know there are some stock comp in there that maybe you could address also. Just trying to get my arms around if the fourth quarter was a good kind of run rate or if you guys expect some expense growth on that line in 2014?

I think we expect some expense growth as we continue to invest in sales and marketing and Suri may want to comment further on this, but in the fourth quarter because it's not -- although it was a great quarter as I pointed out, we tend to have higher sales in Qs two and three we're going to -- and we're continuing to invest in that group, develop the sophistication of our sales force et cetera. So Q4 is decent but I would expect on a percentage basis of sales, our sales and marketing to be relatively flat over year -- year-over-year.

Got it. Okay. Thanks guys. Appreciate it.

Scott Schneeberger, Oppenheimer.

Thanks. Good afternoon guys. I'm curious about the weather in the quarter. It's been disruptive to a lot of companies we track and obviously project-based work is probably not too active in the first quarter just on seasonality but that that exists probably was affected significantly and then you alluded to obviously some of the managed print services affected as well just because people simply couldn't make it to work.

Could you give us a feel, I think, John, you mentioned maybe $2 million of loss impact, how much more profound is that and in which buckets in the January, February time frame is this relative to normal? Was it big enough to have an impact on how you guided for this year and also historically I recall that there is more in the seasonal project business but you get a pickup in March versus January and February on seasonality. Are you seeing anything there yet and any comments that you can share? I know it's a multi-part question but thanks for taking all of it.

Sure. Okay. I will try to give you the best shot and get John or Jorge to follow up on that as well, Scott. So what's different about this year's weather is like you said, yes, it typically affects. We do have some effect during -- because of the seasonality coming to December and January is slower on offsite work anyway with regard to project site work.

But this time we have literally had cities closed down for days and weeks sometimes and which means that people couldn't get to work and all the offices were closed. So not only project-related work gets impacted but also the AIM-related work or the MPS-related work just a complete shutdown of segments of business that's what -- so it's very unique this time.

We usually have March pick up significantly and we certainly hope that will happen and we certainly hope weather won't play up again, have an impact in March. And in fact if indeed March turns out to be a normal month, we expect that to be very good because all of the pent-up work will actually flow into March. That typically happens and therefore that's a very good possibility that we will have a strong March.

We don't know exactly how these will fall into different buckets. We have obviously been tracking sales. John may be able to add a little more color to that but in a nutshell I think it's just this January, February is very different to what we have experienced in the past.

In fact like we said in our prepared comments, we try not to worry too much about it, it's what we can do and there are some things which are beyond our control. However, March, there is a good chance that if things turn normal we could have a bump in our activity in March more than usual if indeed the weather holds good. John any additional comments on that?

Thanks. I think as Suri said, we're still understanding the impact. And so far, we do expect it to be at least $2 million and likely more. As Suri said, it moves across the buckets. When Atlanta got shut down, everything got shut down, customer offices, our shops, color projects. Houston had snow days, the Northeast.

So unfortunately it is pervasive across our business lines largely. We do expect March to be a pick-up and in the past, when we've seen relatively significant but not to this scale, weather events, you'll see work slip from one month to another, a postponement, but with such a severe weather as we've had, although we expect a good March, we don't expect March to make up for everything that happened in January and February and particularly because February is a short month.

And lastly, you did ask if we'd taken it into consideration in our guidance and the answer is yes. So hopefully that helps.

Yes, thanks. Yes, I think it does and certainly something that's affecting everyone. I'm curious, you talked about AIM on one of the last questions and could you speak anecdotally to some of the wins you've had there? Just how things are developing? I know it's something you've been excited about. So just kind of some anecdotal conversation about what wins you've seen, what impacts that you think that will have and then perhaps maybe digital as a percentage of mix longer term, how you're thinking about that within the business and how AIM is driving it? Thanks.

From a AIM perspective, what we refer to as archival information management, while on its own can be a large segment of the business, what makes it exciting for ARC is the fact that we can tie that AIM business into the other bucket, in other words we can tie that into management services, we can also tie that into the project work, we can also tie that into all of the rest of the documents which the customers have.

So AIM as we put it for ARC has a different meaning because we touch all of our customers' documents in almost all of the segments wherever they touch documents. For example management services, by virtue of the fact that we literally see or touch the documents, all of the documents our customers print, whether they print it onsite or offsite all of that flows through Abacus, so it gives us a natural extension for us to have the ability to store those documents, while printing, before printing, after printing because it's already digitally those documents are flowing in our stream.

So we have the ability to go to our customers and say look you have all these millions of documents flowing through your 146 offices and with literally a press of a button we can make sure they are all stored in the cloud. So therefore it makes -- that leads to the natural business opportunity of saying, that's great which means we don't have to continue to print these and put it in bankers' boxes and store them in warehouses or in our basement. What else could you do to actually make sure that we have similar access to those documents in the basement and that leads us to giving recommendations that we could actually scan all those documents because we have facilities across the United States and we could actually feed those documents also into the same space where we're storing your current documents, it will just be stored in different files or different segments.

And then similarly because we already have their project documents in PlanWell, we help them collaborate, we help them print, we help them share and now we're helping them hyperlink and sync because all those features have been there with a press of a button we literally can move those documents also into the storage space.

So it naturally gives us the ability because of the services we provide to move all these documents into storage and distribution. That is why we're very excited about AIM and that drives, largely drives the digital revenues in two segments. One is the services we provide when they ask us to scan and upload or index drawings, those are all digital services which we can provide them much more efficiently than they can do it themselves. That's number one. Number two is when those documents are stored in the cloud and they are being accessed and when they are being -- they are using our cloud space that gives us the ability to charge them for those services which are digital services on the cloud.

John would you like to add anything to that?

No, I think that's a great explanation of the integration of our services as they evolve. I think we have a lot of folks who are adjusting to the idea of a digital archive, that that is that accessible. We have just put the finishing touches on a proprietary document that is the model retention policy, document retention policy for the AEC industry.

We hired experts, we did a survey of our customers, we collected the data and we assembled it into a 50-page document that is ours and it outlines how companies should save documents, where they should save them, for how long, by type, helps them organize and we're just releasing this document next week to some of our select customers to help them sort through the mountains of data that they have. And we look forward to that release and it's really beginning to set us up as an expert in archiving almost as a consultant. So we're very excited about the progress we're going to make this year.

Okay. Thanks. Sounds good. I will turn it over. Thanks Suri. Thanks John.

Thank you.

(Operator Instructions) Glenn Primack, PEAK6.

Glenn, do we have you?

Glenn has removed himself from queue. (Operator Instructions) And it appears there are no further questions. So I will turn the conference back over to our presenters for any additional or closing remarks.

Ladies and gentlemen, we appreciate your attention and continued interest in ARC Document Solutions. Have a great evening. Good night.

This concludes today's presentation. Thank you for your participation.