ARC Document Solutions Inc (ARC) 2014 Q1 法說會逐字稿

Good day, and welcome to the ARC Document Solutions First Quarter 2014 Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. David Stickney, Vice President of Corporate Communications and Investor Relations. Please go ahead, sir.

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

Our first quarter financial results for 2014 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.

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 6, 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 revenue for the first quarter of 2014 of $100.4 million, a year-over-year increase of approximately $400,000 or 0.3%. The increase was achieved despite the loss of approximately $1 million to $1.5 million in sales due to the effects of severe weather in the first few months of the quarter.

Our gross margin for the first quarter of 2014 was 33.8%, compared to 32.4% in 2013, a year-over-year improvement driven primarily by the continuing effects of our restructuring activities that were initiated in the fourth quarter of 2012 and completed in the fourth quarter of 2013.

Adjusted EPS for the period was $0.03 based on adjusted net income of $1.5 million. This compares to adjusted EPS of $0.01 and adjusted net income of $554,000 in the first quarter of 2013.

Adjusted EBITDA for the first quarter of 2014 was $15.7 million, or 15.7%, a year-over-year decrease from 15.9% in the first quarter of 2013, primarily attributable to fixed SG&A costs in the face of lower-than-expected sales due to weather.

First quarter cash flow from operations was $7.7 million, compared to $11.9 million in the first quarter of 2013. A $3.8 million tax refund in the first quarter of last year is largely responsible for the difference.

We ended the period with $24 million in cash after the payment of performance bonuses for senior executives for the first time in six years, and accelerating principal payments on our senior debt. Cash on the balance sheet for the first quarter of 2013 was $27.4 million. Our revolving debt facility remains undrawn.

Total debt including capital leases at the end of the first quarter was $216.4 million, versus $219.7 million as of December 31, 2013 (sic - see press release, "$219.4 million")

Net interest expense for the first quarter was $3.9 million compared to $6 million for the same period in 2013. The decrease is due to the purchase and redemption of all our outstanding bonds in 2013 and replacing them with a term loan announced last year.

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

Thank you, David. Our performance for the first quarter of 2014 was a continuing demonstration of the strength of our new business model and reinforces our outlook for the year and the longer term. As noted in our press release today, January and February were difficult months due to the weather, but the strength we saw in March helped us achieve growth and bodes well for the remainder of the year.

While the growth we see in the construction market is nothing I would call robust, discussions with our customers about upcoming activity are a welcome sign. While I remain cautiously optimistic about the muted construction market, I am completely confident in our ability to generate strong and consistent financial results with our new business configuration.

The sales growth we achieved in the quarter was less than 1%, yet the increase in our gross margin was significantly greater. (inaudible) any major disruptions in the economy, I fully expect to see the positive impact of our recent restructuring continue well into this year, though in a somewhat less dramatic fashion than what we saw in 2013.

Our sales and marketing investments outside of our normal SG&A spending consist primarily of sales training and marketing initiatives, to help support our go-to-market efforts in our new document management services, archiving and information management services, and our new mobile workflow applications. We are also preparing for a launch of a new, integrated suite of enterprise content management and communication tools for the construction industry.

These initiatives advance our goals to become a more valuable partner to the AEC enterprise and less dependent on the non-residential construction cycle.

While the investments to support these initiatives tend to put temporary pressure on our bottom line, they are necessary steps in the development of our new offerings. We fully expect to reap increases in revenue and earnings as our customers recognize the compelling benefits these new services bring to an evolving and increasingly digital workflow in the AEC market.

In the first quarter, our sales was led by an 8.3% year-over increase in our on-site business services business line. The number of MPS locations grew approximately 200 since the beginning of the year, with a significant increase in locations coming from the new CH2M Hill agreement we completed in the first quarter of 2013.

Our largest and fastest rollout to date, this engagement had our teams installing hundreds of pieces of equipment, training more than 2,000 people on the benefits of our Abacus software and outfitting more than 25 domestic and international cities for this one client alone. We also continued rolling out our services for Parsons Brinckerhoff, which we won last year, as well as more locations for AECOM.

In the first quarter, we were also pleased to win an exclusive MPS contract with EXP, one of the fastest-growing engineering and consulting firms in North America. With corporate headquarters in Ontario, Canada, dozens of the offices across the continent and more than 3,000 employees, we are looking forward to our relationship with our newest global solutions client.

Traditional reprographics offered more than usual seasonality with the effects of the winter storms earlier this year, decreasing 4.2% year-over-year. We saw decreased volume in our service centers and delays of project work in January and February.

The color market remains a strong contributor to our success. While we felt some pressure from the loss of a large broker of our services in Southern California region, as well as regional pressures due to the weather in the Midwest and east coast, we still posted 1.2% growth in this business line. We continue to find interest in our high-quality national and regional capabilities with large franchises and other retail clients.

Revenue from digital services remained consistent at 8% of our overall sales for the period. Given that much of our technology outside of MP as a name, is driven by project activity, it wasn't surprising that our first quarter performance felt the brunt of the seasonal trends. That said, we are encouraged by the enthusiasm shown by our clients over the integrated solutions we are introducing to the market.

As we refine our ability to facilitate enterprise content, content management, and project communication, and connect content, devices and our logistic services throughout the cloud, visitors to our tech center are exploring new ways to equip the offices and job sites by using ARC workflow solutions.

They are beginning to experiment with the use of PlanWell SmartBoards -- large, touch-enabled Smart TVs, actually -- as well as hyperlinked drawing sets, fast internet connections to the PlanWell cloud, PlanWell Collaborate software to many of their projects, and PlanWell-enabled printers and scanners that give them the best of both digital and analog capabilities from a simple job [trainer].

As our clients embrace more digital services on the jobsite, we are offering them choices that not only improve the efficiency on a given project, but tie into all of their content across the enterprise.

Sales from equipment and supplies declined slightly due to primarily severe, several large, non-recurring orders in the US during 2013. Sales in China, through our joint venture were essentially flat as the larger Chinese holidays are typically celebrated in the first quarter.

In terms of looking ahead, we see construction activity getting a late but encouraging start in 2014. Knowing that forecasts have been anything but reliable in the past few years, however, we will be methodical and disciplined as we pursue the opportunities before us.

With this in mind, our outlook for 2014 and annual adjusted earnings per share remains unchanged and in the range of $0.19 to $0.23 on a fully-diluted basis. Our outlook for annual cash flow from operations also remains unchanged and it is in the range of $51 million to $56 million.

Lastly, in response to many of the conversations we have had recently with our shareholders, we will provide guidance on our annual adjusted EBITDA beginning this quarter. We believe this is an increasingly compelling metric to our shareholder base and our first insight into the value of the Company and our plans to enhance it.

With that in mind, our outlook for ARC's annual adjusted EBITDA is in the range of $69 million to $73 million for 2014.

At this point, I'll let John have the floor and offer some comments on our financial performance, and then we'll take your questions. John?

Thanks, Suri. There are a few highlights in these Q1 numbers that underscore the continued strengthening of our financial model and our rapidly-accelerating return on invested capital. We continue to attack these objectives through a combination of margin expansion and capital management initiatives. As David mentioned, our gross margin showed a 140 basis point improvement year-over-year on a sales increase of less than half a percentage point. Expanding gross margin is critical to making more cash from operations available to be deployed for investment and generate higher future returns.

There are three primary drivers to our year-over-year increase in gross margin. First, we drove improvements through our expanded local margin improvement programs that specify precise actions for individual customers and at individual locations based on close analysis. As a whole, these surgical initiatives make significant contributions to our gross margin improvement and will continue to do so in the future.

Secondly, we are benefiting from the full-year impact of our restructuring initiatives taken throughout 2013 with the bulk of it attributable to the reduction of overhead costs from facility closures and related cost reductions in response to declining sales in our service centers. And third, we also experienced a lift from our business mix as we shift away from low-margin equipment and supply sales and emphasize higher margin and greater customer value-added services such as on-site.

Expansion of our gross margin gives us the cash to invest in products and people development. The gain we made in the gross margin we use to further train our salespeople and improve our go-to-market for our newer and higher-margin services. This meant more dollars running through SG&A which was planned, and combine that with the lower-than-expected sales due primarily to weather, our adjusted EBITDA margin year-over-year was slightly down.

Absent the impact of weather, our adjusted EBITDA margin would have been slightly up due to the relatively fixed nature of SG&A. And as we move through this phase of our life cycle, of higher investment in the sales force, we expect to see greater consistency between our gross margin and adjusted EBITDA margin.

It should also be noted that on-site services continues to be our largest revenue generator comprising 31% of our overall sales for the period.

As Suri discussed, growth continues to remain strong and just as important, far less vulnerable to the seasonal activity that characterized our former project-centric business model. This means that our largest offering provides relatively stable recurring revenue. Being less exposed to seasonal trends, we've seen fairly consistent sequential growth since the third quarter of last year driven primarily by work from both our global solutions team as well as our local and regional accounts.

With 12% year-over-year growth in this line in Q4 last year, and 8% year-over-year growth this quarter, we continue to average roughly 10% year-over-year growth in this revenue line. In addition to these operational steps taken to expand our margin, we continue to manage our capital structure to further improve the conversion of our income into cash. We continue to drive down our use of capital for equipment purchases, and make increased use of the improved lease lines we were able to secure last year.

We expected to reach a balanced use of these two equipment acquisition methods, cash and lease, later in 2014, but our growing success in winning MPS contracts and therefore our growing leverage with our vendors, has provided an excellent environment for us to accelerate our goals.

In the first quarter, we acquired approximately 50% of our equipment at a blended lease rate of about 7% with the other 50% of our equipment acquired with cash, achieving the balance we've targeted since last year. The result is capital expenditures for the first quarter of 2014 were $3.6 million versus $5.6 million in 2013. By increasing the use of leases as opposed to CapEx, we are able to accelerate the growth of our free cash flow.

In addition to capital lease management, the refinancing of our bonds has made a significant improvement in our ability to generate cash and apply it toward the reduction of our long-term debt. Paying down the debt has a variety of virtues including increasing our return on invested capital today and in the future.

As a reminder, we expect the recent reduction of our effective interest rate on our long-term debt to save nearly $9 million in interest payments per year.

As an indication of the strength of our margin expansion, and of our capital management initiatives, we were able to double the principal payment required under our new term loan, reducing our principal from $200 million to $195 million. This is a reduction of 2.5% of our long-term debt with just one quarter's worth of cash flow, and a quarter that is seasonally weak for us in addition to being challenged by severe winter weather.

Our plan is to continue to aggressively reduce our long-term debt, and thereby our invested capital in the foreseeable future.

It should be noted that as a result of this strategy, we would expect our cash levels to remain relatively consistent as we apply "excess cash" to debt repayment.

For these reasons, margin expansion and capital management, we delivered significantly improved performance in earnings per share. The net income improved as dramatically as it did is a strong reflection of the character of our business and financial transformation.

As discussed, to provide greater transparency to our investors with regard to the progress of our financial model, we will begin this quarter providing guidance on adjusted EBITDA. By guiding to a proxy for cash flow that is not influenced by changes in levels of working capital, and which is free of taxes and interest, we believe investors will have greater visibility into our value creation. And while adjusted EBITDA margin fell slightly because of our deliberate investments and the relatively fixed-cost nature of SG&A against lower-than-expected sales, it was assisted by our strong gross margin performance, a trend that is likely to continue over the long term.

With our cost structure so tightly aligned with our new business configuration, we expect to increase adjusted EBITDA faster than sales in the future, increasing shareholder value as well.

With those highlights from our financials, I'll now turn the call back to Suri. Suri?

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

Operator, please go ahead.

(Operator Instructions). We'll go first to Scott Schneeberger with Oppenheimer.

Thanks, good afternoon, guys. I guess the first question I'm curious to hear, how weather did influence through the quarter, and on the -- is it something that you're able to recoup at all in March or April, was the $1 million to $1.5 million quantified something that you think just gets lost forever? Just curious of what type of impact that had, and then a follow-up on that (inaudible).

Scott, this is Dila. The basic, the weather-related shortfall on the sale did happen primarily in the month of January and the mid part of February. Usually now the -- in project cycles, what you lose today does not come back as double tomorrow. You know, what is gone, is typically gone. But however, what is encouraging is that as soon as the weather-related issues went away, the general activity in projects went back to the normal level. So, during the month of -- like the month of March and obviously early visibility to April are normal.

Thanks Dila, excellent. And the follow-up question to that was yeah, historically -- and I think it's been more in the project-based work, you get a real feel for what the year's going to shape up to be in March and then clearly you've announced in April. It sounds like what you've seen is pretty good. Is that dynamic still in place? Obviously you still have the project exposure, plenty of it, but with the shift in business model and the other business, the pieces of the business going well, I'm just curious to get a little bit further into what you guys see at the beginning of the year and what you think it means for the rest, thanks.

Scott, the robustness in the project activity is no way near 2007-2008. However, if you compare year-over-year, there's a lot more promise, what we see on the ground, projects that are being started by customers. It can be small project, medium size projects. They are -- we see a lot of encouragement on those projects, new activities on the ground, and based on what I see how the year started except the weather-related activities, what you see in March and a little bit in April, I'm confident that the activity is not -- never going to be normal for a long time, but I think we are positively encouraged by what I see on the ground.

Okay, that's great to hear. A couple more from me. Archival information management business, could you just speak to how that's progressing to the extent you care to go into it? Is there any meaningful recent wins and just anecdotally how that's going?

Yes, so again as you know, AIM is a baby product for us. It was introduced middle of last year. We are continuing to communicate the value of our AIM strategy to our customers all around. A lot of customers are listening to us, they are getting demonstrations of our cloud software, for AIM-related activity. We have had some positive wins in the last few months, meaning we can talk about AECOM. AECOM has started an AIM project with us and likewise we see that some other customers in the next few months or quarters will come our way. They may not be very large wins to talk about on a call, but however the momentum is in the right direction.

John, do you want to add anything?

No, I think we're -- as Dila said, it's an early stage product for us, but the pipeline is robust. The life cycle from introducing the idea to actual sale is taking longer than we originally expected, but we expect to have some good wins later this year as customers begin to realize the opportunity we afford them.

Great thanks, and John, the last one from me -- the -- thanks for the EBITDA guidance, I think that'll be good and it looks good, what you're initiating with. Could you just give, for the public call here, the components of how you calculate just so we're clear? Thanks.

Sure. We take -- we build it back up from earnings, adding back interest, taxes, depreciation, and we also add back shareholders or stock-based compensation, excuse me. Those are the primary components.

Got it, thanks very much.

And we move now to Alan Weber with Robotti & Company.

Oh, good afternoon. Something I'm not clear on -- when you talk about adding 200 on-site service contracts, is -- what percent of that is for the managed print services?

As opposed to FMs, Alan, is that what you're asking for? The distinction?

Yes, in other words, when you talk about the 200 contracts, are these what you're going to be doing more than just the printing, or is it more what you used to refer to as facilities management?

Yes, so typically, out of our total portfolio of contracts won, approximately 30% to 40% of those wins are coming from managed print service contracts. The rest of it is [sadly] the management agreement that primarily focuses on hardware, that get placed on project sites and project offices.

And is that the same kind of percent, when you look at the 7,900 customers?

No, out of the 79 -- as you know our managed -- sorry, FM services, we started way back 15 years ago. So, we have a very large portfolio of FM customers. Our managed print service portfolio is probably three years old, so we are still building that portfolio.

And when you talked about -- just so I understand, when you talked about the CH2, can you talk about -- because that was, if I understand right, that was kind of what you did refer to as facilities management, originally and then it became managed print service kind of contract? Is that correct?

No, see -- not really. CH2M is a complete managed print services agreement. There we take over all their print equipment that are placed in their offices that are used for the general business use. Machines that are used for project activity in their offices as well as all the equipment that goes on to project site. So, we manage all their equipment in their network that manages print activity.

Alan, if I could jump in, this is David. I think probably what you're referring to is whether or not we've done work for CH2M Hill in the past, and given that we have been -- we're nationwide with the service centers, we've done work with most of our larger clients in former incarnations, whether that was reprographics work or specific project work. But the MPS agreement that we spoke about in the script and that Dila just outlined is an exclusive MPS, essentially managing that internal print network. Does that make sense?

Right, but previously you had -- you did business with them at their facilities, correct?

At their construction sites.

At the construction sites, okay. I guess on a separate note, can you talk about what do you expect for two -- I don't know if they had it in a press release for 2014 CapEx to be, and how much from capital leases?

We don't have it explicitly in the press release, but kind of annualizing off our Q1 numbers is a reasonable -- I think is a reasonable methodology.

Okay, and that was, you said that was basically kind of 50/50 CapEx and capital leases, correct?

Yes, the funding mechanism for the acquisition of machines was split roughly 50/50 between CapEx and cap leases, yep.

Okay great, thank you very much.

Thanks, Alan.

And we go next to Glen Primack with Peak Six.

Hey, good afternoon. Should we continue to expect you know, dimes and quarters accreting to equity holders over time as you take advantage of the leases and generate more cash and pay down debt? Is that -- think that'll continue?

Absolutely.

Glen Primack: Okay.

The capital management program is to do exactly that.

Excellent, and then CH2M Hill, has that allowed you to go after other -- landing that customer on MPS, has that allowed you to get after other you know, decent-sized [EAC] customers?

Absolutely, CH2M Hill is one of the gold star organizations in the AEC construction space and we have -- with that win we have good momentum to make that win a standard and go after other prospects, so we have, are looking forward to take this opportunity to go after other customers.

Okay, and then the new customer you landed, this EXP, seems like it's a decent-sized company both in Canada and the US, and it's owned by private equity so I'm assuming if you do a good job of saving that money, that PE partner could take it to outside, you know, of the AEC industry?

We hope so, that's one of our primary goals of showing them value, of improvement in service as well as showing them how to save some money in the organization.

Sure, because they wouldn't spend on it if they didn't think it'd have a chance at like reaping the benefit.

Exactly. These large customers in the AEC space, for the last so many years they always bought their machines, they had their procurement division which bought their machine, they bought their paper, toner, service, separated from individuals and placed it all around the offices, right? And they have a fixed cost, with the project activity going up and going down, it continues to stay, it goes -- they're not able to right-size their fleet so with us, we are bringing that service to them and that opportunity, and we look forward to showing them some great benefits.

Okay, and again, but this one's different from those other ones just because you've got a PE sponsor here?

Yes.

I don't know if they were involved in the decision-making process at all, but --

They were not. They were not, we worked with the senior company executives and showed our opportunities to save money and consolidate the services.

Okay. Then again I think the EBITDA guidance is good and I hope you're compensated on it. (laughter)

I like the way you say that Glen, we'll make sure that happens. (laughter)

(Operator instructions) We have no further questions at this time.

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

This concludes our conference. Thank you for your participation.