ARC Document Solutions Inc (ARC) 2014 Q2 法說會逐字稿

Good day, and welcome to the ARC Document Solutions second-quarter earnings call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Dave Stickney. Please go ahead, sir.

Thank you, Janine, 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 second 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 (sic - ir.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, August 5, 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.

With that in mind, I'll now turn the call over to our Chairman, President, and CEO, Suri Suriyakumar. Suri?

Thank you, David. Good afternoon, everyone. I'm pleased to report an excellent second quarter. We are quickly putting the brutal downturn of the past five years behind us. While the nonresidential construction market is still in recovery mode, ARC's performance in the first half of this year is clear evidence that we have turned the corner last year. Momentum is building, and the Company is moving in the right direction.

Our strategy to transform a legacy reprographics organization into a document solutions and information management Company is firmly on track. This is best demonstrated by our year-over-year sales growth of 4.2% quarter. Our success was driven largely by our new revenue line.

Our performance was characterized by double-digit growth in our on-site service programs, significant accomplishments with our technology, new account wins, and growing interest in archiving and information management as well as new activity in the project management space. What is equally encouraging is our ability to generate gross margin in our new lines of business similar to what we have generated with our traditional business in the past. This performance can only improve as our digital services continue to play a growing role in our business mix.

I'm pleased to report the overwhelming majority of this gross margin gain fell to the bottom line and improved our adjusted EBITDA significantly.

Finally, I would remiss in my coverage of the quarter's highlights if I didn't mention the strength of our cash generation and the year-to-date $16.5 million reduction of our senior debt.

While the generation of free cash flow has always been a hallmark of our business, I doubt many observers of the Company have realized the strength we maintain in this area and how powerful our new business line is with regard to delivering value to our investors. As we move forward, ARC Document Solutions will be a strong player in the document solutions and information management business, with an addressable market which is much larger and broader than the reprographics business. Our business lines are futuristic and technology driven and have the ability to significantly improve efficiency and reduce costs for our customers. We are indeed excited about the future of our business.

At this point, I'd like to turn the call over to our Chief Operating Officer, Dila Wijesuriya, to provide some operating highlights of the quarter. Dila?

Thank you, Suri. Our on-site services line grew by 11.6% year over year, driven primarily by our MPS offering. second quarter, we were pleased to announce major account wins with Cardinal and EXP. We also signed a new four-year contract with design and construction firm Ammann & Whitney as they led a four-year renewal of our contract with the billion-dollar global engineering firm Louis Berger. In July we also announced a five-year renewal of our contract with HOK, who is among our largest and longest standing customers. While these winds are very important to us, we also continue to bring focus on our regional on-site services program with additional employee training.

We will be expanding our regional sales team as well. This team will address our customers and prospects who has multiple offices around the US while looking to standardize their services, technology tools, and pricing.

Reprographics remained our second-largest business line and we saw continuing stabilization here with year-over-year revenues falling just 1%. We saw declines narrowing in several regions and even some growth in our Texas Gulf Coast region.

We also grew our color business year-over-year by $1.3 million led by our division in the United Kingdom. Competition for color services is tough in the UK, and our team capitalized on an opportunity to acquire two customer lists from struggling competitors.

Year-over-year sales for equipment and supplies were relatively flat, and digital sales rose slightly on some small but important gains in our archiving and information management sales that I will talk about in a moment.

Among all these activities with our sales force and customers, we also concluded a serial trial in which we filed a complaint against a competitor and former employee in Southern California. We alleged, among other things, that the competitor unlawfully misappropriated ARC trade secrets in the form of proprietary customer lists in an attempt to unfairly acquire their business. We saw similar behavior from this competitor before.

In 2007, we settled prior lawsuits against them which included an injunction. We brought the current case to stop the defendant from using what we felt was similar unfair business practices against us. The case went to trial in May, and a jury verdict was entered for the defendant. The verdict was based on a technical finding that we did not have reasonable controls to maintain the secrecy of our customer list, primarily because they had been told on the former employee's personal mobile phone.

As you might expect, we have since updated these controls. We're still in the process of post-trial motions, so we can't say too much about this matter, but we are considering all our options for further action.

In better news, we have been pleased to receive significant recognition for our technology. In July, we announced the partnership with the China architectural research and design group where we provide MetaPrint software to drive their new digital blueprinting machines. HP also recently announced that Abacus, our flagship MPS software, has been certified as printer fleet management and cost recovery and allocation software for use with HP's entire fleet of design jet printers.

During the second quarter, we also introduced our interactive PlanWell SmartScreen to our design and construction customers. These large touch-enabled whiteboards assist our customers to communicate, share, and work with their drawings and other information in a highly collaborative, entirely digital environment, minimizing the need for paper. Our goal is to provide our customers with information wherever and however they need it, including on their computers, handheld devices, or large wall-mounted tablets such as our SmartScreens. These products fit nicely into our MPS program.

Earlier, Suri mentioned some traction we've gained with our AIM program. In talking with our municipal customers, we discovered that a good solution for infrastructure-related content management has been missing from the markets. In a few recent cases, we've been able to fill that gap with our offering.

Recent wins have come from many city agencies that are digitizing their documents and workflow. We've had early success with power and energy agencies, school districts, and city governments. They need a simple, cloud-based solution that can capture, catalog, and organize both large- and small-format files in the context of a construction document workflow.

As most of you know, we maintain our leadership position by not only offering technology solutions but by using technology ourselves to improve our business. In the second quarter, we improved and upgraded our storage area networks, or SAN, in support of our cloud-based services, and we also purchased a Web marketing automation program to help us more effectively communicate with our customers and prospects.

Overall, our AEC customers are continuing to show increases in project activity. This is helping ARC to create new opportunities with its customers in managed print services and content-related technology solutions. We've also seen more demand for our color services. During the second quarter, we opened two new service centers for Riot Creative Imaging, one in the UK and in Chicago, a vibrant and growing market for colors.

With that as an update of our significant sales and operations activity, I'll turn the call over to John Toth, our CFO, for a brief update on our financials. John?

Thank you, Dila. I think a number of our investors have heard me speak to the idea of acceleration as we move through our P&L, and this quarter's financial performance demonstrates that concept extremely well. Our revenue improvement was a welcome outcome. But it was the increase in our margins, and ultimately our generation of free cash, that tells our story best.

By acceleration through our P&L, I mean that the year-over-year growth in the profit line items on our income statement increases as you move down the P&L from revenue to net income. In Q2, our revenue grew 4%. However, our gross profit dollars grew by 10%, roughly twice the rate of growth of our revenue.

Continuing down our P&L, adjusted EBITDA grew 14%, outpacing our gross profit growth. And continuing to the bottom of the P&L, our earnings grew by more than 500% year over year. We get this acceleration not just from revenue growth but from fundamental margin expansion. Revenue growth alone would produce consistent growth rates in these line items as you go down the P&L. Our growth in profitability and cash flow is accelerating, and it is fundamental. This is the result of a combination of modest sales growth and aggressive business management, both in cost and product mix.

We have been working hard through our product and service diversification to drive sales growth through our high-contribution margin services, thereby leveraging our fixed costs. And, aided by expanded management reporting capabilities, our continued surgical focus on improving margins at the customer location and service center levels increased the margin expansion momentum that our sales growth started.

Lastly, by improving the business mix towards higher-margin, largely technology-driven services and away from sales that require higher material costs also helped us achieve a 36% gross margin for the quarter, fully 200 basis points higher than the same period last year. As you heard, the majority of that improvement flows to the adjusted EBITDA line. This is in spite of the fact that we continue to invest in the evolution of our sales force, with sales and marketing expenses increasing year over year $800,000 for the quarter and $2 million for the first six months of the year. We will continue to invest in sales and marketing as part of our long-term strategy to grow our newer, more technology-based services.

Finishing off the P&L, our earnings grew over 500%, thanks in large measure to the lower cost of interest on our new swiftly diminishing Term B loans.

Our improved performance and dramatic reduction in cash interest expense has also allowed us to accelerate the growth of our free cash flow. Our free cash flow for the quarter grew 199%, aided in part by our reduction of CapEx in favor of the lease market now that our lease rates are below 6%. In addition, our cash taxes will be less than $1 million for the year as we use our net operating losses of over $90 million. As one of our investors has observed, we consistently convert cash out of our income statement much more efficiently than most other companies.

As we've pointed out earlier, we've used this accelerating generation of cash to aggressively reduce our debt, thereby concentrating our enterprise value into our equity and significantly improving the quality of our credit. In recognition of this, Standard & Poor's raised our corporate rating one notch from B+ to double B-, and they moved the rating on our Term B loan up two notches from B+ to BB flat. Our total debt to trailing 12-month adjusted EBITDA stood at 3.0 times on June 30, as compared to 3.6 times a year ago. And taking into account our additional $4 million paydown in July after the quarter closed, our estimated debt to adjusted EBITDA stands at 2.9 times, breaking the 3.0 threshold.

In terms of the specific items we guide to, we delivered adjusted earnings per share of $0.10 for the quarter, cash flows from operations of $14 million, and adjusted EBITDA of $20.9 million. I should point out that our cash flows from operations was $6 million higher than the second quarter of 2013 despite the expenses of the litigation Dila spoke of earlier. I should also note that on a year-to-date basis, cash flows from operations are up just $1.7 million, suffering in comparison to last year when we received a $3.8 million tax refund.

When you follow the growth rates of our margins through the P&L, it's easy to see how powerful this acceleration is. Sales increased by 4%. Gross margin, gross profit increased by 10%. Adjusted EBITDA grew by 14%. Free cash flow grew by 199%, and earnings grew by over 500%. Although I expect the rate of acceleration for free cash flow and earnings to decrease, I expect to see this pattern of acceleration through the P&L continue for the foreseeable future.

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

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

(Operator Instructions) Scott Schneeberger, Oppenheimer.

I wanted to start out just honing in a bit on the project-based work, the construction market. Continued stabilization, and it feels like it's getting a little bit better. It didn't shine through in the results, but you guys sound upbeat for the second half of the year. I just want to gauge how upbeat and what you are seeing. Thanks.

Basically, the project activity is definitely starting to pick up across the country. There is no doubt about that. No matter where you go, you're starting to see cranes, especially in large cities. So that's indicative of what's going on in the project market. And we are sensing that in the work we're doing, Scott. But what we are saying is that nonresidential as a whole -- if you take the statistics, given the decline we have had over a period of time -- has been in a deep hole, and therefore the recovery relatively is still slow. But in terms of activities, we are seeing more activity than we saw last year. So there is definitely signs that it's picking up; it's going in the right direction.

Excellent. Thanks, Suri. On the AIM business, could you talk to us about if -- any of you guys -- the challenges you are facing, the progress you are making, how you are feeling at this juncture. Talk about your interactions with your customers and just giving us a feel for the progression and the trajectory there. Thanks.

Right. So, AIM business, as you know, is one of our new business lines that we've been working at developing over the last year and a half or so. We been actively developing tools, technology tools, search engines for large-format drawings. There are several initiatives we have done on the technology side to make AIM more effective and more powerful. Now, we can have all that information available not just on computers but also on tablets, on SmartScreens. So there are several pieces we have put back together -- put together for the AIM solution. So the solution itself is very exciting.

But this is a new market, and this is a new concept for our customers. And what we are doing is we are introducing this concept to the customers and getting them to think about converting all their traditional hard-copy storage and documents to digital storage so that they can view them from the cloud. The rate with which we are actually engaging the customers is very encouraging because every time we make a presentation there is significant interest, especially as this digital transformation takes hold.

However, the customers are still reluctant because most of them have large volumes of documents, especially in the construction world both large and small. But even customers who are not related to construction, the amount of documents they stow are pretty significant. So it takes a little while for them to understand the impact of this transformation, how the documents are going to be used in the future, the benefits they are going to derive from it, how are their document retention policies going to be impacted. All those this questions come into play. So it's slow to move because customers are still adapting to this change, and we expect this to pick up momentum.

All we know is that every time we present a solution like this to our customers, they are very excited to hear about it. They suddenly realize how easy it is for them to access their legacy documents which are very deep down in some warehouse or in the basement and never accessible; and now it's accessible with a touch of a button, so to speak. So there's a lot of excitement on the AIM business. And it will take a little -- it will take some time for us to build this business, like the managed print services we have -- like we have done in the managed print services segment. But it's definitely off to a great start, Scott.

Great. Thanks. And then Dila, in your section you mentioned your legal matters with a competitor in Southern California. And I apologize; I had some phone issues during Jonathan's piece, so I don't know if you talked about financial impact or consideration going forward. But could you just say -- you spent a bit of time on that. Is that something that has a ripple effect, or is there a larger message from the discussion there that you wanted us to infer? Thank you.

Yes. So Scott, I'll take that one. It's basically, fundamentally, we want to make sure -- as you know, we are across the nation; we are a large company with competitors across the nation. We want to make sure that none of the competitors stoop to something like what has happened here in Southern California, where they access our information -- customer information, trade secrets illegally and put it to use against us.

It's more than anything else, we are sending the message that this is not something that ARC will tolerate. Not in Southern California, not in Northern California, not anywhere. And this particular company, though, we have had the experience in the past, and there has been injunction in spite of the fact they very daringly did the same thing again. And we wanted to take them to task and protect our assets basically. That has been our strategy.

It wouldn't have any rippling effects. I think it's largely over. I hope they got the message by now because they know what it took for them to come to trial and actually have to deal with the legal issues. So we don't expect this to be continuing in any big form. But if they continue their behavior, you can rest assured that we are not going to sit back and watch. We would take action against anybody who inappropriately accessed our customer information, but I don't see this continuing at all from my perspective.

Great. Thanks. I just wanted to be clear on that. I appreciate it. I'll turn it over. Thanks so much.

Brandon Dobell, William Blair.

I just want to focus on the construction market for a second. In the markets where you guys are seeing a recovery in business for you, how does the mix look of, I guess let's call it, paper-based products versus electronic? And I'm trying to get a sense of, in a recovering construction market, how -- what the market size may look like compared to back in 2004, 2005, 2006. Meaning how much has been migrated away from a traditional solution and is now going to be more of an electronic solution? So, again, trying to gauge the pace and the magnitude of the recovery in those markets where you are seeing construction come back.

Right. Brandon, the market is definitely recovering. There's no question. Like I said previously, answering Scott's question, we have been in a deep recession. Especially nonresidential, there has been a lot of excess capacity. So the market is still coming back. However, compared to where we were in 2013 there is significant recovery which is happened.

But we also see very clearly the customer behavior is changing. Increasingly, people are using the technology to significantly reduce the time lag between RFIs or requests for information or change orders; all the changes they are making. Customers are starting to get very comfortable using digital devices and accessing information digitally. To my knowledge -- I'll ask Dila to give a little more color on this because obviously he is in touch with the ground, to my knowledge, even large projects, people are not printing large-scale project documents. Instead, they are selectively printing, and they are using -- adapting digital technologies to be more effective. Dila, would you like to add something?

Yes, Brandon, one big thing that I see between the pre-downturn and post-downturn is the fact that the speed of getting projects to completion has accelerated hugely. So the past -- anytime you work with paper, that process is slow. Right? Now because of the speed at which they want to get things moving, they are embracing digital.

It may not -- the whole project may not take -- get into 100% digital cycle, but, more and more, distribution, document management and consumption is continuing to move towards digital, and just because of speed. And as a Company, our strategy is to influence the speed with our digital technology and make it happen because we know it is going to happen. It's not a matter of when -- the date will happen. It's going to happen. We are just escalating and assisting our customers to get in to that flow and so that they can work faster and get their projects delivered quicker.

Okay. Maybe as a segue to that, you mentioned the opportunity with the SmartScreens. How -- I guess how is that aligned with your comments, Dila, about customers looking for shorter construction times, planning times? Those kinds of things. I guess is the sales force out there looking to get those SmartScreens into markets where you are seeing construction recover, or is it specific customers that are on the cutting edge? Or I guess I'm kind of looking for a go-to-market strategy but also how it aligns with what you're seeing on the ground for kind of a recovery in volumes.

Yes, so basically the way we -- the largest tablets that we talk about are -- for us, it's another device, cloud-connected device connected to the PlanWell cloud, and that's how information is going to flow through to the device. And the way we are doing it our sales force are taking the smart devices right to the project site.

Because if you look at larger project sites, you had the project office and the project site pretty much in the same vicinity. So the teams get together in the project office, have their morning meeting, and then they go to the project site. And when they meet in the morning to huddle, they always huddle around set of documents. They look at it, they look at what needs to be done, they look at the issues that comes around physical construction, and it revolves around paper.

What we are doing is we are bringing -- changing that paper set to a digital SmartScreen where you can digitally download that most current set of documents and view it. And once they -- if they need to take action, they need to make some highlights, mock-ups, and so forth, they can immediately do that on the touch screen and push it into the digital PlanWell workflow that it will move to the architect or the owner and make those questions clarifications done quicker. Earlier, they would've had to have made a print done and push it through delivery mechanics into back to the architect. Now it's basically instant. So we are basically exposing the replacement of paper at the project office with the PlanWell SmartScreens.

It's also interesting. I would just add to say to what Dila said -- it's amazing. In some of the projects we have had, let's say there's a project going on and it's a 25-story building, and the project crew is working at the 20th floor. Remember, it's one extra crane lift. And you can only imagine how many crane lifts they have, you know big projects like that. One extra crane lift, a 60-inch SmartScreen goes to the 20th floor, is connected wirelessly -- all that you need is power -- and suddenly, you can see the 800 drawings right then and there just by touching that screen. So it's really powerful. And it's become an integral part of our solution offering to the construction customers where we can actually deliver them documents anywhere they want it.

Got it. And then maybe a question for John. Given the second-quarter EPS performance relative to what you guys have laid out for 2014, anything in the back half of the year expense-wise or seasonality-wise that would really change the trajectory of the earnings compared to second quarter? I know there was some noise around the winter, so I know there was some timing issues between Q1 and Q2. But just trying to look at second quarter or first half of the year relative to the full-year EPS guidance.

No. There's nothing that we are aware of other than Q4 typical seasonality of a little lower activity and a little higher equipment sales out of China. But nothing that you haven't seen before.

Okay. Great. Thanks, guys. Appreciate it.

Matthew Kempler, Sidoti & Company.

I wanted to dig a little deeper into the stabilization of the service revenues. Is this purely the printing volumes picking up on the reprographics services side? Or are there other services or share gains that are driving the stabilization?

It's actually -- Matt, it's a combination. There's no question there is some print volume. But like we described previously, when the number of projects we have in the system have significantly gone up. Every quarter it has been going up. Obviously there is recovery going on. So the number of projects we typically have in the PlanWell in our system has gone up. So there's no question the number of projects are going up. And therefore, any printing which comes out of it also is going up.

However, what's not happening is the customers are not printing in the same scale that they used to print previously. That is what Dila was saying. So the stabilization, which is resulting in the reprographics line or where the project revenues are coming from, is largely a combination of just not print volumes but also other activities related to the project document work and management work. Dila, will you?

Yes. So the way we look at it, again, the amount of prints per project will continue -- continuing to be challenged and will probably continue to go down. But the way we look at it, those customers that have new projects that we are selling to them the price. We are going after the customer because every time these customers have more projects they are getting busier. So we are able to speak about AIM. We are able to speak about can I get you upgraded a managed print service agreement including the new SmartScreen.

Color -- because if you go to every project site, nobody puts a [fin cell] there and leave it empty. They have nice color images of the project which covers the whole fence. So we have new opportunities that we did not have prior to 2008 to go after with these new enterprises. So that's where, when you talk about the stabilization of our revenue lines it's coming because of the same customers are getting busier but we have more tools to sell to them today.

Okay. And then could you also revisit the offering that you mentioned you are providing to powered energy, school districts and city governments? What exactly are we offering them, and what gap are we filling in their current processes?

These are, I would say, medium to small-size government city agencies. They are -- they want to get into a complete digital workflow. They want to manage their documents digitally. They want to manage their renovations in a digital format and so forth. But they never moved from that paper-based workflow to a digital workflow. So today, because of the PO sheer need, they are converting their paper-based archives to a digital archive.

We have been able to provide the services on-site and off-site for to digitize their content. And most importantly, our PlanWell archive cloud system is meeting their needs. They can see, okay, where are these documents once it gets digitized. Where is it going to go? How am I -- how easy is it for me to search? How can I quickly share it with my architect, my general contractor?

That workflow that has been built around PlanWell Collaborate has been -- is becoming a nice, friendly tool for our customers to say, okay, that's what I need from you. Because these are small, medium city governments that doesn't have a massive budget. So they have to do it on a shoestring budget but work with ARC to get that performance. So that's what we are seeing from that segment of the world.

Most of the work there is -- Matt, just to add, this is Suri. Most of the work there is related to their facility drawings. So it's construction-related in a way. They are buildings, hospitals, or school districts. Most of them are actually facilities drawings which has been archived, and they've been struggling to recover them or struggling to search them. And now when we show them that this can be done, they are really excited about the prospect.

So, more and more of these agencies are looking at these options to just -- you know, it's lower-cost as well. Otherwise, they have an army of people searching these documents, and they never seem to get them in time. And then also it takes a lot of time for them to accomplish their goals. Now that we have them digitally, they realize how easy it is for them to access these documents. So that's the part which is very attractive for them.

Okay. So this is a kind of a hybrid of your AIM services with your PlanWell Collaborate?

Actually, it is one service. When you look at -- when you say our archiving information management, that runs in our PlanWell cloud. It's a one-technology platform that we have for scanning and managing the data.

So from a technology perspective, Matt, it's the same cloud. The information resides in the same place. So you can use any kind of graphic interface -- user interface to access these drawings. Because we have a construction-based user interface for PlanWell Collaborate, we can pretty much use that interface also for AIM, where the documents are properly organized and structured in the same form as the construction drawings are. So that makes it easier. So if they have project documents or if they have facilities documents, if they are mechanical, electrical, whatever they may be, they are in the same format -- in the same file format as the construction drawing.

So for us, we are selling it as AIM service, but the backbone of that, the cloud and the software we use, is pretty much identical is the fact that it's now in archival form as against the current set form. Does that make sense?

That does. I'm just wondering, do you view this as more as one-time project-based work, or are there repeat revenues that come from these customers over time?

So at the time when it is project work, it is active live documents. They are changing it all the time, and the project in the set of documents keep changing. Once they have completed their project, they become as-built. And then that moves into archival form where it actually comes back into the archiver, and now the facilities people occupy the facility whether it's a school or a hospital or whatever. They use those drawings for tenant improvement upgrades, any repair, et cetera. At that time, it's recurring revenue. We are not scanning and uploading anything. All the existing drawings are there. So now it's a service whereby we will have a long tail because they'll consistently have seat licenses and access charges for accessing those documents whenever they want, wherever they want.

Okay, great. And then I just also wanted to follow-up on the gross margin. So obviously we've been seeing some significant improvements here, but you made the comment that we will see continued improvement as digital services play a larger role in revenues. I'm wondering what are the confidence levels about digital becoming a bigger growth driver than what we've seen so far, and what would be the primary contributors? I guess we just talked about one of them, but what else do you have in mind?

Sure. So the digital, if you think about our business, Matt, whether it is in the project-related revenue or whether it is in the management services or whether it is in the archival information management, which we call AIM, even in color the digital is a basic ingredient. In other words, that is the backbone. All of the documents are stowed in the cloud, accessed from the cloud, and then they are viewed or downloaded or distributed or shared from the cloud.

Now, most of these customers are starting to use the digital services to upload it and put it in AIM, all for the purpose of managing the documents. But they are not really fully into making use of these documents on the cloud and then accessing and downloading them. So the use of the cloud is somewhat limited now only by customers who are sophisticated enough to understand how to use the cloud.

Our construction of -- all of our customers -- there is a huge base of customers we have, almost 100,000 customers. And as they use more of our digital services, as we convert more AIM customers, you will see that the user base for those AIM business will start to grow over a period of time. And of course, when we take hard-copy documents and convert them, there is a front-loaded charge for that AIM business to convert that to digital.

But once you convert it to digital for the next X number of years, like in the document storage business with Iron Mountain or Cintas or whoever else does, first to get it in there is a certain amount of charge. But once you get it in, that's always going to be there, and the customers will have charges for accessing and then viewing, downloading, seat licenses, et cetera.

So over a period of time, it's a slow build, but it's a rock-solid build because customers will then start using that. And the margins on the tail end is much greater. John, would you like to add a little going to that?

Yes. To speak to your question, Matt, about signals, one thing you're going to see in these Q2 results in the queue is that the digital service line grew 1% this quarter year over year. And you remember from prior calls, digital services has really been tracking traditional repro historically. And traditional repro went down; digital services went up, and it went up off the AIM revenue of our SoCal division. In SoCal, digital services was up 10%, and that's the first division where we have -- or first region, excuse me, where we have an AIM center. So in terms of confidence level, between the pipeline activity we see, the enthusiasm of the customers, the engagement, and these very preliminary signs on the numbers, we feel very good that AIM is going to be a powerful contributor going forward in the near future.

Okay. That was helpful. Thank you, guys.

Alan Weber, Robotti & Co.

Two questions. Can you talk about on the on-site services, like in the quarter or for the six months, the amount that's actually the managed print services?

Sorry, Alan, can you -- do you want to tell him?

Yes. Are you referring to the number of contracts that we've added? And (multiple speakers)?

Revenues actually.

Revenue.

John, do you want to --?

Hey, Alan. It's John Toth. I'm sorry. I'm still not clear on the question.

Can you repeat the question, Alan?

Sure. When you break out the on-site services, you have the facilities management and the MPS. Right?

Yes.

And I was just curious, what percent is MPS, roughly?

Of the growth or the total?

Of the total, and of the growth.

Of the total, it's probably about 60% or 65% of the total on-site line, with FMs being about 35%.

Okay. And in terms of the growth?

The growth -- MPS is growing, is really driving the growth at probably at about 12% to 15%. FMs are growing at probably of a rate of about 5% estimate.

Okay, okay. And my other question was you talked about several renewals. And I realize you can't go through the absolute revenues and margins by a customer. But can you talk about conceptually what you hope to drive on renewals in terms of comparing the future revenues to what the contract is expiring, margins and like that?

Yes. So for us, it's very important that we renew ongoing management services with the customer. Because when we do our first initial rollout, there is quite a bit of expenses we are incurring in the rollout: designing, installation of software, hardware, training of employees. There's quite a lot of upfront cost that we take. So when you renew the agreement for the second time, all those costs are not there except for the newer machines that we put in place, the -- we are able to not spend so much of our money and get the renewal going. So continuing our margins should continue to improve when we have a good renewal of that contract for another period.

So simply, Alan, another way of putting it is when renewing a contract can be competitive because we have now organized the customer's need, identified issues, put all the machines in place, and know how many machines are in how many locations, how it's working. So in terms of that, you can get a competitive bid.

However, for anybody who's coming in new, it's going to be a harder transition because they have to remove all the equipment, train all the people, put in new software, get in -- get everything installed together. So from our perspective, if we can renew an existing customer, it's beneficial for us because we get a new lease of life, but we don't have all that upfront cost because the customer is already up and running.

In addition to that, as Dila said, many of the equipment we have already installed, we have actually used it. And some of them don't have to be always renewed in three years or two years or whatever. So the existing equipment can continue to actually function, and we can get some use out of it. So we like renewals. Although they are challenging every time because we have to compete for it, a successful renewal is always very margin accretive. Would you agree, Dila?

Yes.

But, as what you offer becomes more complex and you do more of the managed print services, shouldn't that -- shouldn't the percent of renewal continue to be high and actually drive future revenues and future margins really for a long period of time?

Absolutely. So what's happening now, Alan, is that we are starting to incorporate some amount of AIM into these managed print services. In other words, if you are actually -- we are managing all their machines, and we have a software connecting all their machines, that means we see every document they print. Which means, even without their printing, even without -- even before they could think that they want to store these documents, we have the ability to draw them into storage.

So there are other techniques that we are doing with them, and then we are giving them also other financial information to manage their print services better. We have dashboards. We have tracking information available. We have other similar uses -- what kind of people-to-machine ratios they have in the offices. So we'll offer a lot of information, which makes it very compelling.

And over a period of time, like Dila previously mentioned, if you have a managed print services customer, we also want to make them an AIM customer. If you have an AIM customer, we want to make them a managed print services customer. And that if that customer happens to be in construction, we also want to get all of their project documents. And it simplifies things for the customer. We become a single-source vendor. And the fact that we are in 200 locations helps that cause as well.

Okay. Great. Thank you very much.

Glenn Primack, PEAK6.

Lots of great questions have been asked, but just I thought I'd put something down on the notebook paper here that in the traditional repro, you actually saw a market that grew powerful as Texas?

Yes, Dila?

Yes, Texas is southern region for us.

Okay. Great. And that little acquisition you made in the first quarter in the UK, are they trained on, like, having more arrows in the quiver? Does it seem like?

That's -- yes, exactly, Glenn. So I'll let Dila answer that; he's the one who handles that directly. Fundamentally, the two acquisitions we had in UK are largely related to sophisticated color business in England. As you know, UK is a very large color market, and there's a lot of color activity. And our color has been going growing there, and it's a way to access different types of customers. Also, the mix of customers in UK are very different. And now that they have gotten, they are getting to see the rest of the arrows we have in the quiver. So they're starting to kind of sense and feel for the AIM business and for the projects-related work and for the management services work. Dila, would you like to (multiple speakers)?

Yes. I think one major benefit that this particular customer build that came to ARC is enjoying is the fact that we are global. Earlier, this particular company or the vendor that was servicing them had only a UK location. But these customers are bigger than -- they were very large customer, so they couldn't expand their services through this one vendor.

So by coming to ARC, they immediately got the whole of the US and Canada active. So whenever they have large delivery of marketing information, it digitally gets sent to our 13 riot centers in the US and we produce it for this. Similarly, they are able to get it across to China, to India, and Hong Kong. So we have basically given a good footprint to this new customer base that came over, and that's the biggest benefit that we have seen. And obviously, our financial strength and able to sustain large marketing campaigns that these customers do.

Okay. So for a relatively low cost to attain the list and the two little companies the return is giant, would be my guess.

We've already, in a month and a half of working with the assets acquired, we've already more than made back multiples made back of the cash we put out.

Okay. The reason I ask is you're going to continue to generate a bunch of cash and move from, like, term loan B to perhaps term loan A and your interest costs will come down. Then you're going to have to find a place to put more cash. So if there is more little deals like this, that would --?

Absolutely. Big-return deals. We have. Yes.

Big-return deals. Okay. Oh, the next thing -- like, there have been some acquisitions within your customer base.

Yes. Absolutely.

So potentially if you know all the people-to-machine ratio and the acquiring company needs to get synergies, is that a big opportunity for you to land some more top-50 type accounts?

Absolutely. And this is something which is actually continuing to grow, Glenn. You know, we saw a wave of M&A activity in the construction space in the early part of -- latter part of 2012 and 2013 during that space. If you follow the construction market, there has been significant amount of mergers and acquisitions. And it's predicted that, going forward this year and next year, that kind of activity will pick up again, and there will be another round of consolidations which is going to go on. All the big customers we deal with either acquired other customers or in the process of acquiring, and of course we get to know that as well.

Right as we speak, we know of three or four large deals pending out there. Many of them are billion-dollar deals. Of course, everybody knows about the big one which is announced, which is AECOM and URS. But there's many more being considered. And we are being told because in one instance, this particular customer knows this is going to happen. And, in fact, they've already told us, look, you guys want to think about this.

So our strategy is, going forward, that we can actually become partners with our customers in their [ender words] when they have M&A transactions. That's where we want to be.

Sure. Because you help deliver the synergy.

Exactly. If you look at the Company and if you look at what we do, for any large mega-construction company we fall within their top five expenses. If you take document management costs, if you add AIM to that, and if you add all of the logistics costs, we fall within the top five. I will argue if you add AIM to that, we are within the top three costs.

So when a company acquires another company, one of the definite ways of delivering value in that acquisition is consolidation -- streamlining of document management and information management cost, and which is something that we can play a big role in. And this is why we're excited about technology and the digital strategies going forward, because further activity in the M&A marketplace is going to significantly improve our opportunities to deliver real value to our customers. And it's all in the large-customer space.

Okay. That's great. And then on AIM, I went to your website and I watched a couple of case studies. Those are really helpful in terms of understanding what you're doing. But were those wins -- both -- do they happen this year?

Yes. They are both this year, and they --

One win was last year. JCJ was last year.

Yes.

But JCJ has re-upped for the West Coast now, and that's a this-year win.

So there is activity. And the interesting part is, because this does deliver significant value, we feel very confident that it's going to pick up momentum. We just need to fine-tune our sales teams and open more AIM centers so we can facilitate this business.

Okay. And then on the software sales to China, I guess it's hard to predict when those are going to come through, but I'm guessing the gross margin on that is more than double where you're at right now.

Yes. Dila is the China guy. Dila, do you want to comment on that?

Those are handsome opportunities for us. Obviously, we got our first order from China last month, and we are going to get a second order very soon. And the forecast for next year and the year after from our Chinese partner is very encouraging. So we are very anxious about it. Really in the next couple of quarters, we will continue to keep you informed of our progress there.

Excellent. That kind of juices John's April 10, 2014. I can't get the April 10, 2014 out of my head.

Double double double.

Yes, because it is impressive. And speaking of doubles, if I just take the $37 million in adjusted EBITDA and double that, that gets me ahead of where the guidance is for the year. (Laughter). Just saying. (Laughter).

We are going to stay quiet on that one, Glenn.

Okay. No. Well, I'm good at the multiplying by two. The other thing stuff on the growth rates, that's hard for me. Doubling is pretty easy for me to do. I don't even need my 12 see for that. Okay. Great.

The last thing I would like -- obviously, being a shareholder, I am a wee bit frustrated to see what's happened with the stock. But your story is kind of morphing into this kind of software service thing versus a print Company. And those new enterprise content management companies go for multiples of revenue versus one times, maybe.

Yes, yes. I think the market is still coming to terms with who we are, and obviously we have several investors who are very knowledgeable about what's going on and who can see it. But understandably, people gave up on us, Glenn, three or four years ago during the downturn because nobody expected us to actually, number one, survive the market. And 2013, when we survived, they said, okay, you have survived, but are you going to be strong and are you going to be powerful?

And I guess 2014, we are showing we are on track to become that Company who can deliver significant value to our investors. And we are excited, but I think as we do this more and more and the numbers show itself, more investors will realize the potential we have.

Sure. Because your model is so much better than it used to be. Right? I mean, you're going to have that much more visibility going forward on the top line. And the lousy 4% gets you a handsome 14% without the Chinese software.

The majority of our revenue is quickly moving to recurring service-based revenue -- very predictable, very seeable -- in contracts that are software-as-a-service-based. And we are going to continue that arc over the next 18 to 24 months to be an enterprise content management Company.

And it's fundamentally technology-driven. It's technology driven, Glenn. That's what it is. So we are excited, as you can see, and we'll continue to stay on top of it.

Okay. Thanks.

(Operator Instructions) Michael Fox, Park City Capital.

The last question kind of touches on what I was going to talk to you about. It's been impressive to see kind of the transformation of the business and the profitability through the difficult times, and especially the cash flow generation. And obviously you are a significantly large shareholder. So can you talk about how you think about shareholder maximization and how you think it can play out over the next couple of years as the business transitions? And it obviously could be attractive to some sort of a software comp -- or software services company?

Yes, so it's obviously -- it's in the horizon, Michael. Mike, different people will look at it differently. Fundamentally, I think the fundamental shift is that we are from reprographics, which is traditional or print-based. And our revenue model was based on print. That's just how the nature of the beast was for 100 years in the construction industry. So the revenue model was largely print-based.

And therefore, even though we had significant technology influence, we were still considered a reprographics Company and a print-based Company that kind of put us in that slot. What -- on the one hand, as bad as this downturn is and as brutal as it has been, the good news is, when we come out of the recession -- and we predicted this that we'll be a completely different Company. And that is because not only because we want to be, but our customers want to do things differently. And the behavior has changed.

So what is happening now is customers are still the same, the industry is still the same, and what we do for the customers is still the same. They still manage documents, distribute documents. And we store documents; we help them share documents; we do the logistics. But what has changed is how we do it for them. So that is the key change as to how our business has changed. And it is largely driven by technology instead of it being physically done like we did in the past.

So the business has transformed. What transformed the technology behind the business, kind of showing the same thing to be done but done how we do it and done differently. So we will become a Company which delivers document management services and information management to our customers in a very, very efficient way. It's so much so that we will improve the services for our customers and significantly reduce their cost. And as long as we deliver that value, I think we will continue to grow.

And the other aspect -- a large shareholder like me, the way I always think about the business, is that the market -- addressable market has significantly increased. Previously, we would largely due project-related work for our customers in the project. And that's what we call reprographics.

Now we do management services. That's our largest revenue line. Now we are starting to do AIM work. We never had that revenue line. Those market segments are equally and some of them are bigger than the reprographics market segment. So, from a future perspective, it's a technology-driven document management and information management service with the potential to grow much more than what it was and what it is today. So that is how the -- that is how the Company will continue to expand. But now, as to where that will take us, it's anybody's guess, Mike. You can probably guess it, too.

Right, right. Okay. And then from a competitive landscape, in the reprographics business you guys used to compete primarily with local mom-and-pops. And I would imagine the transformation has been hard on then because they don't have the capital and the resources that you guys have. So has your competition changed a lot? Are you competing more with software companies now? Or who is the main competition?

So in our different businesses, we compete in different spaces, Mike. So in the reprographics business, we don't have a whole lot of competition. And the traditional reprographers who have been not been able to change are probably fast becoming copy companies who just basically make copies of documents, which is, as you know, is time-limited with regard to how long you can do that. There will be always a small minority of people who will want prints, but that market will be shrinking and will continue to shrink.

In the managed print services segment, we don't compete with reprographics companies. We largely compete with large manufacturers. We would compete with large manufacturers like Xerox, HP, Canon, Ricoh, Savin, big companies like that. And they are also our largest suppliers. So it's a very interesting business mix we have there. But that segment is largely dominated by equipment manufacturers in that segment.

In the AIM business, in the new world, we compete with a lot of small scanning companies. And there are other companies which are legacy companies which do some of the archival information business. But what -- where we are competing is against hard-copy companies who actually -- and the people who store their documents in the basement. So here, it's converting the customers to -- encouraging them to show -- to convert all their existing hard-copy documents into digital documents, showing them the benefits we can deliver. So in different markets in different segments of the business, we have different competitors.

Great. Thanks for the color, and congratulations on the progress.

All right. Thanks, Mike. Appreciate it.

It appears there are no further questions at this time. Mr. Stickney, I'd like to turn the conference back over to you for any additional or closing remarks.

Ladies and gentlemen, we appreciate your attention and your continued interest in ARC Document Solutions. Have a great evening. Thanks so much. Bye-bye.

And again, this does conclude today's ARC Document Solutions second-quarter earnings call. We thank you again for your participation.