ARC Document Solutions Inc (ARC) 2015 Q2 法說會逐字稿

Good afternoon and welcome to the ARC Document Solutions second-quarter 2015 earnings release. Today's call is being recorded. I would now like to turn the conference over to Mr. David Stickney, Vice President of Corporate Communications.

Thank you, Jill, and welcome, everyone. On the call with me today are Suri Suriyakumar, our Chairman, President, and Chief Executive Officer; Dilo Wijesuriya, our Chief Operating Officer; and Jorge Avalos, our Chief Financial Officer.

Our second-quarter financial results for 2015 were publicized earlier today in a press release. The press release and other Company materials are available from our investor relations pages on ARC Document Solutions website at IR.E-ARC.com.

Please note that today's call will contain forward-looking statements that fall within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are only predictions based on information as of today, August 4, 2015, and actual results may differ materially as a result of risks and uncertainties that we highlight in our quarterly and annual SEC filings.

This call will also contain references to certain on GAAP measures, which are reconciled in today's press release and in our Form 8-K filing.

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

Thank you, David, and good afternoon, everyone.

In the second quarter, ARC Document Solutions grew sales across all four of its service lines, maintained a very healthy gross margin, delivered a 30% improvement in the adjusted earnings per share, and generated strong cash flows, which allowed us to further delever the Company. We also delivered another healthy quarter of adjusted EBITDA performance. Our EBITDA margin was 19%, even as we continued our disciplined investments to support sales and marketing of our cloud-based products and services.

In light of these achievements, we are maintaining our previous stated forecast of our financial performance for the year. Our actual diluted annual adjusted earnings per share outlook is in the range of $0.37 to $0.41. The outlook for the annual adjusted cash provided by operating activities is in the range of $61 million to $66 million and annual adjusted EBITDA is in the range of $75 million to $80 million.

A quick review of our second-quarter sales performance. Revenue from construction documents and information management, which we refer to as CDIM, was $58.8 million, an increase of $1.2 million or 2% from the second quarter last year. Management sales were $337.1 million, increasing $1.4 million or 4% from last year. Sales from archiving and information management services were $3.4 million, up an impressive 16%. And equipment and supplies sales were $14.1 million, up by 10%.

Performance in each of our revenue categories were notable for various reasons and provided us with insight to ARC's performance for the rest of the year.

Growth in nonresidential construction has been choppy to date, but it's becoming stronger as the year progresses. The same choppiness seems to characterize the adoption of rates of technology for document management and distribution in the AEC industry. We have seen projects executed with very little printing and others with printing volumes that rivaled the past. We've also seen projects where enterprise technology is used on one project and nothing but iPhone apps are used on another.

Fortunately, no one is in a better position than we are to introduce, educate, and facilitate cloud-based workflow for documents and information. Our deep domain knowledge, our legacy of technology development, our local support footprint, and our commitment to the industry we serve make us a natural technology partner for customers in this area.

We still intend to become the primary source of enterprise-level document management and distribution for the AEC industry, but the industry has yet to standardize on various ways to use technology to improve workflow practices. Thus, during the second half of the year, we expect our CDIM sales to maintain modest year-over-year growth.

Sales growth in MPS was healthy, but off pace we've experienced over the past years. As we have noted previously, we believe MPS sales can continue to grow at 8% to 10% year over year over time. But we've also made it a point that this growth rate can be significantly influenced by timing of the large contract rollouts, as in the case this year.

While we have several major accounts that currently are in negotiations, closing any of them in the third or fourth quarter will add to our MPS sales growth in 2016 and will have minimal impact to sales in 2015. As a result, we expect continued sales growth in MPS to come from local and regional accounts, but somewhat lower over the next two quarters relative to our second-quarter performance.

By contrast, our year-over-year growth in AIM was up significantly in the second quarter. While still in its early stages of development and working from a small revenue base, the dynamic growth continues to fuel our enthusiasm about AIM prospects in the future.

Equipment and supply sales were up by 10%, largely driven by a one-time sale in China, but in the third and the fourth quarters, we expect a return to performance similar to what we saw in the first quarter.

As I mentioned today in our press release, we are eager to accelerate sales growth. The opportunities to do so are abundant, but it's requiring time to raise awareness, to educate clients in new and improved ways to manage and distribute their documents and information, and to create the strategic relationships that will ensure our continued success. We are confident that we can demonstrate the outstanding value of our new solutions over the next 12 to 18 months and build momentum for the future.

With that as an overview of the second quarter, I'll turn the call over to Dilo for an update on our operations. Dilo?

Thank you, Suri.

CDIM grew roughly at the same pace in the second quarter as it did in the first quarter. Four key components inside CDIM demonstrated healthy growth. Color services brought back familiar customers like Westfield malls, Southwest Airlines, AECOM, and other design and construction industry clients.

We also saw new clients like Kaiser Hospital group, Lucky Brand stores, and even NASA joined our customer list with exciting new projects.

On the digital side, we saw solid growth in the sale of both hyperlinking and BIM services projects. Trials of SKYSITE continue since we introduced it at the end of January. Today, we have more than 150 companies that are using our new tool for their document management and communication needs on active projects.

The feedback we've received from our users has led to the introduction of innovative new features that were announced just last week. We have another round of enhancements scheduled for later this year.

As Suri mentioned, standard in construction document workflow has yet to be established, but over time we are in an excellent position to help our customers adopt the benefits of cloud-based document management and our other digital solutions.

Growth in MPS continued in the second quarter, driven by sales at the local, regional, and national levels. Luxury apartment developer Avalon Bay joined our global solutions client list during the second quarter, as did a number of other large regional accounts. We also continued rollouts from our account win earlier in the year, including the implementation of architectural firm Leo A Daly, whom we acquired in the first quarter.

Over the past two quarters, we've also been developing new tools to shorten sales cycles by accelerating audits of customers' print environments. Because we collect and analyze an enormous amount of information, it is a time-consuming exercise, especially with larger clients.

Our new process, which will come online within the next 60 days, should deliver a significant time savings by automating large portions of the process and allow us to cycle through our MPS sales pipeline at a faster pace.

Archiving and information management grew significantly in the second quarter. New business came from a mix of school districts, transportation authorities, health departments, hospitals, and law firms, along with our more traditional customers in the AEC space.

We sell AIM in configurations from simple scanning services to the turnkey solution that includes our cloud-based storage and retriever platform. Our offerings are far less expensive and easier to implement relative to almost any customized archival solution. In this revenue line, one sale inspires another. Each new customer adds clarity to our selling strategy and builds a strong referral base.

I should also mention that growth in equipment and supply sales in China was the result of a major expansion of our accounts with COMAC, the Commercial Aircraft Corporation of China, as they moved to a new corporate campus. Demand for our PlanWell SmartScreens also increased in the quarter.

While there is more to do, our sales and marketing programs are improving. Our investments in this area have clarified our approach to sales, focused on marketing efforts, and brought new ideas and skill sets to our teams that we can leverage today and in the future.

With that as a summary of our operations in the quarter, I'll turn the call over to Jorge for a review of our financials. Jorge?

Thanks, Dilo. Suri has outlined our sales trends and Dilo has described the dynamics in the market. I'll take the next few minutes to outline the underlying numbers and give you an idea of how we will manage the business to our stated guidance for 2015.

The primary drivers for achieving our financial goals are continued sales growth, gross margin expansion, disciplined containment of our costs, and continued reduction in interest expense. All these drivers, coupled with the fact that we won't be paying meaningful cash taxes, culminate in strong cash generation.

Suri outlined the pace of sales growth in each of our business lines and pointed out that our current progress strongly suggests more moderated growth in the remainder of the year. As our performance over the years has demonstrated, however, we have the ability to leverage sales growth at any level.

In the second quarter, we experienced a sales mix that was favorable to the lower-margin characteristic of equipment and supply sales. Its impact on our gross margins, and more specifically material cost as a percent of sales, were about 80 basis points, but because we were able to effectively leverage our labor and overhead, we were able to maintain a very healthy gross margin of 36%.

Underlying gross profit increased by 4.2%, which was in line with our sales growth. We expect to generate similar leverage in the coming quarters.

Combined with the equipment and supply sales expected to return to more normalized levels and ongoing margin expansion initiatives, we expect year-over-year gross margin expansion in the third and fourth quarter.

SG&A for the quarter decreased year over year by approximately $1.2 million, due to the $2.1 million in trade secret litigation costs we incurred in the second quarter of 2014. The decrease was partially offset by planned sales and marketing investments of $900,000.

Most of the spending revolves around hiring, training, and marketing initiatives in support of our technology-enabled offerings in CDIM and AIM. Given our recent performance in these areas, we believe the positive returns on these investments are likely to continue.

Interest expense decreased by $2 million year over year, largely due to the refinancing of our previous term loan. We finished the second quarter with an effective interest rate of 2.8% on our new term loan facility. Year to date, we have paid down $14 million in principal on a new term loan, $7 million more than what was required. Combined with the improvements we made in our EBITDA, our leverage ratio as of June 30 was 2.6 versus 3.0 for the same period last year.

Cash taxes were minimal for the second quarter, due to our cumulative net operating losses from previous years, adding even more momentum to our already strong generation of cash. I expect a favorable tax environment to continue for several more years. For modeling purposes, however, I encourage you to use a pro forma tax rate of 39.5% for the remainder of the year.

Our adjusted earnings per share of $0.13 represents another significant year-over-year improvement, primarily due to increased sales and gross profit, as well as the lower interest on the new term loan. This puts us well within striking distance of our forecasted EPS for the year.

Adjusted cash flow from operations in the second quarter of 2015 was $16.9 million, a 7.6% increase from the prior year. As we mentioned in our last call, our cash flow increased from the seasonal softness of receivables that characterized the first quarter. By way of comparison, our DSO declined to 54 days for the second quarter, compared to 57 days in the first quarter. We expect continued acceleration in cash generation in the second half of the year, again positioning the Company to achieve its annual target in this area.

Adjusted EBITDA for the quarter was $21.6 million, a 3.3% increase and directionally in line with our sales growth for the period, despite our investments in sales and marketing.

The transformation of our business and the ongoing evolution of our market has created both challenges and opportunities. But we have charted a clear path and developed a sound strategy to pursue long-term success. For the remainder of the year, you should expect moderate sales growth, gross margin expansion, and the continuation of our well-established trend in generating strong cash flows.

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

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

(Operator Instructions). Brandon Dobell, William Blair.

I wanted to focus on MPS for a second. I recognize there's timing dynamics around signing up large customers, but if you strip that away, are you guys seeing any change in, I guess let's call it, pipeline conversion dynamics, meaning how people are transitioning from being a leader in inquiry down to signing a contract? Are those conversion rates changing? Is it taking longer? Are the nature of the contracts changing? Just trying to get a sense of, let's call it, growth drivers for the balance of this year once you strip away larger the deals.

Right. No, actually, we're seeing good activity, Brandon, in the pipeline. Customers are getting engaged.

Because these customers are large customers -- many of them are in the top 100; that's our focus -- the time taken to get those contracts done are taking, sometimes it takes long. And it's not uncommon. We had talked about this previously.

But if you ask me whether the activity is strong, yes. Has anything specifically changed inside that space? No. Are the customers taking longer to sign? Not really. It's just how each of those companies process inside their companies to implement an MPS program. Largely an MPS program done right is seen as process improvement and sometimes companies take a little while to set that up, and that's what's happening.

But the pipeline is looking healthy and we are very optimistic. It's just that once they approve the project and we kick-start it, it will take 30, 60, 90 days to wrap the contract up and put everything in place and get it going. That's why we said it's unlikely that we will see any significant impact this year, latter part of this year, but it'll certainly get kicked into gear next year.

Okay. Now as we go out the back half of the year, it sounds like you guys are okay or comfortable. Still seeing growth on the MPS line. Maybe it's somewhere around the results you just posted here in the second quarter, but obviously not the high single digits, but are you guys comfortable saying you're still going to see growth in the back half of this year on that line?

Absolutely. I think we'll continue to grow. It may not be in the higher levels, but certainly in line with what we have experienced, yes.

Okay, got you. And then maybe turning to selling and marketing expenses, this is the first quarter I think in a while, maybe two, three, four years, where we've seen a quarter-to-quarter decline in just the gross number of dollars that you guys spent in SG&A.

And I know you had talked before about the first half of the year being heavier than the back half of the year. Has that dynamic changed at all with how the MPS line is going or should we expect SG&A expenses on a dollar basis to look like they did here in the second quarter through the next couple quarters? Thanks.

I think you hit it on the nail in the last point. I think we kind of established our run rate, if you will, two quarters of SG&A roughly $27 million.

One thing I would like to remind you of, in the second quarter of last year, we had roughly $2 million due to that trade litigation case. So when you look at year over year, that's why you're seeing the drop.

But to your point, the run rate we're seeing now, I think that's a reasonable estimate for the balance of the year.

Okay, and then final one for me. As we think about uses of cash, recognizing there's still opportunities to delever, but as you think about capital expenditures, capital leases, how do we think about the back half of the year compared to what the back half of 2014 looked like as you guys put capital out to keep growing the business?

Yes, I would encourage you to more look at more our recent results, maybe the second quarter, and note (multiple speakers) there and our capital leases there and kind of get that run rate going for the second half of the year. It might be a bit muted. As we've talked with the muting of the MPS revenue, it might decline a little bit, but directionally I think that's a good gauge.

Okay, great. I'll turn it over, thanks.

(Operator Instructions). Alan Weber, Robotti & Co.

When you look out towards like next year, what kind of is your thought process in terms of EBITDA and cash flow relative to this year?

Jorge, do you want to take that? Looking into 2016 EBITDA and cash flow (multiple speakers)

Not (multiple speakers) just directionally or like that in the capital spending?

I think directionally as you look at our Company, we continue to delever and pay down our debt. Likewise, our debt has a reducing interest rate based on our leverage ratio, which will only add to the amount of cash we generate. So we feel very confident to continue to generate strong cash flows as we go into 2016.

Okay, I guess I was kind of wondering when you look at the amount of cash you know you expected to generate this year relative to your capital spending and if the cash flow improves next year, what's the thought process about buying back stock or at what point does delevering not make sense?

At the moment, we obviously are focused on delevering, as we already said. I think debt to EBITDA we are about 2.6, Jorge --

Correct.

-- at this point of time. We have come down from 3.0. We think we will continue to do that until we reach about 1.5, maybe. And I think at that point of time we'll probably look at it and say it doesn't make sense to pay the debt anymore because, obviously, we have a great package here in terms of interest.

So I think our focus would be in general thinking maybe to bring it down to at least 1.5 times EBITDA multiple, and then think about what we want to do with the cash at that point. I mean, that could be a good problem to have.

Right, and then, based upon the way you're going, that's not very far off.

No, no, I don't think so. I don't hope so. I hope we can get there faster than we all think. We are always trying to get there faster.

And then, my other question was -- I kind of misunderstood. Can you talk about the investments that you're making and whether it's the number of sales people that's increasing? I was unclear if something has changed there in terms of the thought process of how much you're going to spend to try to grow the business.

Right. We started this thought process, Jorge, would you say, last year?

Last year, beginning of last year.

Beginning of last year. Sorry?

Third quarter.

We really started thinking about how, in order to drive our organic growth, we need to have certain elements in place to drive organic growth.

And in order to do that, we spent -- started investing on several fronts. One is sales and marketing that is basically training the people. We also spent dollars on marketing dollars, creating awareness in the marketplace. You know, working with marketing companies and advertising companies and promotional companies to take our message out and make sure that people hear what we're doing.

And then, thereafter, we also invested on training, as I said previously. The next thing is we also created business development units. We did this last year in setting up what you call business development units for each of our main solutions, and then each of those business development unit managers would have what you call regional solutions consultants who are experts in that line of business spread across the nation.

So some instances, we had six; some instances, we have eight. If the business starts growing and the need increases, then we will increase that staff.

So it's a fluid number, but it's all about disciplined investment in order to drive growth. That's what we're focused on.

Okay, great, thank you very -- like I said, I was curious because you're in a different position today than a few years ago because you really -- you can afford to invest to grow the business, more so than a few years ago since you have delevered.

Absolutely, absolutely. And that's very much in our mind because we want to drive organic growth up and we certainly are in the right track. If you see all of our solution lines, we are starting to show growth in the right direction.

Granted, you want -- like I said in my script, you want to accelerate the growth. In order to do that, we need to invest wisely so that we can drive that growth and accelerate it.

Okay, great. Thank you very much.

Thank you.

(Operator Instructions). Chris McGinnis, Sidoti & Company.

Can you just maybe just expand on the SKYSITE and at what stage you're at? Is it still in the testing phase? I guess at what point does that go live in terms of maybe the generation of the revenue playing out like how you think it's going to play out?

Right, SKYSITE is already released. We released it -- when did we release it, Dilo? March?

February.

February this year we released the product. That's after all the beta testing and so on. We really released the product in February this year, but it's a brand-new product. Customers are getting used to it and getting comfortable using cloud as a medium to distribute project documents.

So it's out there. We have about 1,000 trials going on at any given time. People come on board, try the product, and then some of them wait for a project to kick off and some of them start using it right away. So it's continuing to grow.

A product like that, once we have released it, we think it will take 12 to 18 months to gain real traction. So since February -- it's March, April, May, June. So it's about four or five months. We expect the traction to grow.

In the meantime, what we are doing is that we are working on further enhancements, like any other product which is in the market to leverage as a cloud-based product. So we are adding features after working with customers and asking them what other preferences they have in terms of uploading photographs or creating a photo library, taking project-site pictures, RFIs. Features like that are being continuously built in to make it even more customer friendly and the distribution of information to be even more efficient.

So it's proceeding along. The product is live. A lot of customers are using it and we are continuing to work on it.

Great, thank you very much.

And with no more questions in queue, I'd like to turn the call back to Mr. Stickney for closing remarks.

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

This concludes today's call. We thank you for your participation.