ARC Document Solutions, Inc.
Q2 2009 Earnings Call Transcript

Published: 7 Aug 2009

[Operator:]

Good afternoon and welcome to the American Reprographics second quarter Earnings Call. My name is Katrina and I will be facilitating the audio portion of today's indirective broadcast. (Operator Instructions). At this time I would like to turn the event over to. David Stickney, Vice President of Corporate Communications. Please go ahead sir.

[David Stickney:]

Thank you, Katrina. And welcome everyone. Today I am joined by Suri Suriyakumar, our Chairman, President and Chief Executive Officer; and Jonathan Mather, our Chief Financial Officer. The financial results of our second quarter were publicized earlier today in a press release. We will be providing some additional insight into the quarter on today's call and then answering any questions you may have as usual. For your reference you can access the press release and the company's other releases from the Investor Relations section of American Reprographics Company's website at e-arc.com. Please be advised that we are webcasting our call today. A replay of the webcast will be available on our website for 90 days from today on the company's website. A taped replay of this call will also be accessible by phone for seven days after the call, the dial-in number for this replay in today’s press release. This 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. 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 6, 2009 and except as required by law the Company undertakes no obligation to update or revise any of these forward-looking statements. Finally, this call will contain references to certain non-GAAP measures. The reconciliation of these non-GAAP measures is set forth in today’s press release and in our Form 8-K filing. At this point, I will turn the call over to our Chairman, President and CEO, Suri Suriyakumar. Suri?

[Kumarakulasingam Suriyakumar:]

Thank you, David and good afternoon everyone. I am pleased to report that the company has performed extremely well in spite of the tough market conditions we have experienced in the first half of the year. Our second quarter results also clearly demonstrate that management efforts to reduced cost and right sized the company to suite the current market conditions have been very effective. As I've stated earlier this year, our primary goals are to right size the business optimize profitability and generate a healthy cash flow to comfortably meet our financial obligations during this recession, as well as position the company's operations to grow as the economy recovers. Jonathan and I will spend the majority of our time on this call reviewing how we are performing against those goals before we move to Q&A. In the second quarter, we delivered $0.14 per share and more than $33 million in cash flow from operations, an increase of more than $11 million over the first quarter of 2009. This brings our total cash from operations for the year to $55.8 million in the face of declining revenues. You will also note that our gross margin remains very healthy at 37.5% another increase over our first quarter and again during a period of declining revenues. While I will not delve into details about our cost reduction exercises here during the second quarter we continued to implement our stay fit programs and eliminated an additional $8.6 million in cost for 2009 primarily in the areas of production labor indirect cost and SG&A. We also improved our near term debt structure by making additional payments of approximately $11 million in an early pay down of capital lease obligations which in turn further strengthens our future cash flow position. We also began a significant realignment of management responsibilities brought about more accountability to product management and evaluated new but related markets we could address by making other uses of our existing resources. Our commitment to creating an agile and flexible operational structure as well as keeping a sharp eye on the future has kept us strong throughout these challenging times. It is our strong belief that we will not be the same company when we emerge from this recession as we were when we entered it. With this in mind and having largely right sized the company to meet the current market condition we have now begun the process of repositioning the company to take advantage of the opportunities which should be available to us during the economic recovery. We plan to take full advantage of our national footprint, our core competencies and our physical presence in most major metropolitan markets to pursue high potential growth oriented business opportunities that are driven by technology and which are typically outside the construction industry. Doing so will allow us to reduce our dependency on the AEC sector which in turn will reduce our exposure to the seasonality and the cyclicality that characterize the building industry. Our plan is to setup infrastructure across the company over the next 12 months to sever large national and regional companies in the areas of color graphics and manage print services. While we already have significant operations in color they have been primarily dedicated to AEC work. Our new focus will be aggressively expand those existing capabilities into area such as retail signage and other graphic marketing applications. Managed print services once again leverages existing resources to take over the entire document management and reproduction facilities of clients both inside and outside of the AEC market. Managed print services involves the provision of equipment like an FM, but goes beyond it to optimize it's implementation and enhance its capabilities with digital tools and applications to improve work flow, document management and other business processes. Finally, we will also be focusing on growing small FM markets both inside and outside the construction industry that are being driven by explosive growth of the convenience printer in both small and large format applications. All three of these segments are growth oriented, progressive and technology driven. Aligning ourselves to these markets during this downturn will allow us grow aggressively during the recovery. While, our long-term objectives are tremendously exciting, we remain committed to our near term financial goals. Primarily to generate a healthy cash flow in order to meet our financial obligations, avoid tripping any of our debt covenants and finding our future growth. So, before we take your questions, we want to briefly outline where we are today from a financial point of view and I'm going to ask Jonathan to walk you through those issues. Jonathan?

[Jonathan Mather:]

Thank you, Suri. As mentioned earlier, our cost reduction initiatives what we like to call our stay fit plans continue to provide us incremental improvements in our cost structure. As most of you know, our business is structured in such way that labor is our biggest cost. To put our cost cutting efforts into some prospective our employee head count at the end of 2008 was approximately 4,500. Today, we employ approximately 3,500 people. It’s a big reduction and certainly a painful one given the value we place on our people. But these kinds of cuts were absolutely necessary in order to continue to deliver the performance, we have demonstrated throughout this recession. We also took the initiative in paying down the additional debt on capital leases. In this quarter our capital lease commitment also dropped by nearly 50% year-over-year. This year we entered into capital lease commitments of just $9.7 million. Last year we entered into capital lease commitments of $18.4 million for the same period. Given the progress we are outlining here I should also reiterate that the environment for amending our credit facility especially as it affects our covenants is quite favorable relative to the recent past. We have maintained an excellent relationship with our banking syndicate and I am looking forward to working with them to improve our flexibility in the near future. At this point I will run through some of the quarterly information that isn’t immediately apparent by looking at the financial tables and then we will move into Q&A. Our customer mix stayed roughly the same for the first quarter of 2009. Of our total revenues for the quarter 21.1% came from the non-AEC segment, with 72.5% coming from the non-residential customers and just 6.4% from our residential customers. Likewise, our base of business by product and service segment stayed relatively constant. Facilities management made up 19% of our revenues digital services delivered 8.6% of our sales. 10.1% of our revenue was from equipment and supplies while the remaining 62.3% came from our traditional base of reprographic services. There were 64 working days for the second quarter compared to 63 in quarter one of this year. There was also 64 days in quarter two of last year. Day sales outstanding or DSO came down from 51 days in the first quarter of 2009 to 48 days in quarter 2. Total debt including capital leases. At the end of the second quarter 2009 were $329.5 million. This is down from the $350.6 million for the first quarter of 2009. It is important to note that while we reduced our debt by more than $21 million we also increased our cash holdings by $6.4 million. The ratio of debt to trailing per month EBITDA at the end of the second quarter was 2.5 compared to 2.3 at the end of the first quarter 2009. That covers the basics. So at this point I will turn it back to our Chairman Suri.

[Kumarakulasingam Suriyakumar:]

Thank you Jonathan. And Katrina we are ready for the questions.

[Operator:]

(Operator Instructions). Your first question comes from Kevin McVeigh with Credit Suisse. Please go ahead with your question.

[Kevin McVeigh:]

Thank you. Jonathan and Suri nice job and obviously very tough environment here.

[Kumarakulasingam Suriyakumar:]

Thank you.

[Kevin McVeigh:]

I asked this in first quarter and I am going to ask it again, just relative to the free cash flow or the operating cash flow, it looks like year-to-date you have generated almost $62 million but you reaffirm the guidance of 70 to 90, have you paralleled that to last year where year-to-date you generated 57 million, you want to generating almost 118 million. So, can you just help us with the math and the back half of the year, was it just conservative in that estimates or was there something that we're not factoring in?

[Kumarakulasingam Suriyakumar:]

Not really Kevin. I mean obviously we have been very aggressive in terms as to how we manage the cash this year. Expenses are significantly down there is no question about it. The only thing that we are reluctant to comment on and we don't know really is always the revenue numbers because we are always battling with it. And, you can see the revenue numbers are down but just better cash management being much more proactive expense management has significantly contributed to the numbers but we thought we'll keep the guidance where it is because we are still very comfortable that we'll be deliver those numbers. It’s very hard to predict in an environment like this, how the second half will perform. Do you like to add anything to that Jonathan?

[Jonathan Mather:]

Suri is right on. We are not willing at this point while we are very pleased with our first half year cash collections to change the guidance at this point from the $70 million to $90 million we said on cash.

[Kevin McVeigh:]

Okay. And Jonathan, one other, if we could just what was your organic growth in the quarter? The organic revenue growth.

[Jonathan Mather:]

We had a decline in organic growth in this quarter, just over 30%.

[Kevin McVeigh:]

Just over 30%. Okay. And, then just one other question and I'm going to get back in the queue. Are we still comfortable that we are going be compliance with debt covenants, are they going need to be renegotiated?

[Kumarakulasingam Suriyakumar:]

Right at this point of time Kevin, we seem reasonably comfortable. Obviously given the cash position we have and given the changes we have made to the organization in terms of expenses. We seem comfortable with what’s going on with the covenants.

[Kevin McVeigh:]

Okay. Thank you.

[Jonathan Mather:]

You're welcome.

[Operator:]

Your next question comes from David Manthey with Robert W. Baird. Please go ahead with your question.

[Kyle O'Meara:]

Hi this is Kyle O'Meara sitting in for Dave.

[Kumarakulasingam Suriyakumar:]

Hi Kyle.

[Kyle O'Meara:]

Hi. Could you talk about the revenue trends on a monthly basis through the quarter and what you are seeing through July, if anything just worsening improving just how you saw that trend in the last four months?

[Jonathan Mather:]

All right.

[Kumarakulasingam Suriyakumar:]

We are basically seeing there is still some amount of slide in the revenue. In other words the revenue has declined. However, the rate with which it's declining has substantially reduced. In other words we are closer to being stabilized but I wouldn’t call it stabilization obviously we wont give you monthly we don’t specifically break down monthly numbers but the trend has been that it has been declining but the decline the rate with which it is declining has substantially reduced and it appears that it will bottom out one of these days.

[Kyle O'Meara:]

Great and then could you just touch on the pricing environment during the quarter?

[Kumarakulasingam Suriyakumar:]

Yes the pricing environment remains the same as we had in the last quarter, certainly there is more pressure from the smaller reprographers obviously what we refer to as survival battles but however the implication of technology helps us to actually to some extent to deter that because we use technology to up sell the product we have, obviously there is zero pricing power but the erosion has been reasonably negligible.

[Kyle O'Meara:]

All right great and then on the cost savings side, done a really good job there. Do you feel comfortable with where you guys are today reducing your headcount from 4500 to 3500 is there still some things continue to slide do you feel that you still have some levers to pull?

[Kumarakulasingam Suriyakumar:]

Yeah I mean if in deed we have always said this even in the previous quarter I have said this that if the situation demands that we make further cuts we are sure we will do that, right now we feel like the company is substantially largely right sized like I said in the earnings call so I am fairly comfortable we are at the right size right now however should there be a significant drop could we make adjustments to our cost structure yes we can but for now we’d seem like we are at the optimum level.

[Kyle O'Meara:]

All right great and then one last one can you just get the number of business days in the third quarter and the fourth quarter for 2009?

[Jonathan Mather:]

Yes, I can give that number to you right here. On the third and fourth quarter, third quarter we would be at 64 days and then the fourth quarter is 63. But again on the fourth quarter its 63 working days but you know it will be impacted by where these holidays fall and how people take time off. But on the calendar it's 63 days.

[Kyle O'Meara:]

All right, great. Thanks guys.

[Jonathan Mather:]

You’re welcome.

[Operator:]

Your next question comes from Andrew Steinerman with JPMorgan. Please go ahead with your question.

[William Lee:]

Hi Suri, hi, Jonathan this is Will Lee for Andrew Steinerman.

[Kumarakulasingam Suriyakumar:]

Hi.

[William Lee:]

I am just trying to get a sense of in terms of what revenue levels will you need to have to achieve your 2009 EPS of $0.50 to $0.75 and on and then cash flow from operations goes up 70 to 90 million?

[Kumarakulasingam Suriyakumar:]

Right. Obviously one of the things we are not doing is we did not actually give guidance on the revenue. Our whole focus has been improving the cash and profit obviously that the EPS numbers and the cash numbers are the guidance we gave. So the revenue is going to be given the volatile market space and especially now that we know that second half which is pretty seasonal in our industry, second half is always softer than the first half. There is always going to be a moment in our top-line. So we are unable to exactly predict that number that's exactly why didn't give the guidance. But what we are confident is that given our cash position and given the way we have managed our expenses we continue to make changes as required as we go along virtually on a weekly basis to make sure that we meet our objectives.

[William Lee:]

Okay. And then just moving on and your push to have a more managed print services so outside of the core AEC market how does that change yourself competitors?

[Kumarakulasingam Suriyakumar:]

Ask me that question again, how does it change our competitive position is that what you mean?

[William Lee:]

How does it change, who compete against?

[Kumarakulasingam Suriyakumar:]

Okay. We might be actually competing in some instances depending on which the segment is with competitive other than in the reprographics industry. For example, we could be competing in some instances against large manufacturers of output devices or other companies which I involved in management services related work you know there are lot of other companies, large FM companies, who basically do a fair amount of work in print room, mail room and other related services. So, there are other companies like that. So, we could be running into some of those companies as well. But if it is outside of the -- that is -- if it is outside of AC industry. However, in the AC industry nobody knows AC industry as much as we know so inside the industry we will be very strong and nobody else can do managed print services like we do. Especially, for the large national companies.

[William Lee:]

Right, right. Okay. Thank you.

[Kumarakulasingam Suriyakumar:]

You're welcome.

[Operator:]

Your next question comes from Scott Schneeberger with Oppenheimer. Please go ahead with your question.

[Scott Schneeberger:]

Thanks. Good evening. Guys, I missed the -- I heard residential about 6.4%, but I missed the non-res percent could you repeat that for me, please in the quarter?

[Kumarakulasingam Suriyakumar:]

Non-res is 72.2, residential is 6.2.

[Scott Schneeberger:]

6.2. Okay. Thanks. We ABI take a dip down in these most recent months. And I'm just curios, were you seeing trends similar to that on the store level and also just kind of looking out forward how you interpret that?

[Kumarakulasingam Suriyakumar:]

Right as you know Scott we have always maintained that, things like the ABI index while they are indicative largely indicative of what goes on in the market place we can specifically tie it into our trends or any specific trend because basically you know different segments so what we always do is take ABI in conjunction with FMI in conjunction with McGraw-Hill, in conjunctions with what we see on the ground. So like I said previously the revenues are still declining albeit at a much lower phase not the same way we experienced in the first quarter or the first few months of the year so it is at a much lower rate and we also know given the industry we are in the second half is softer than the first half. So we have that no surprises really it is pretty much tracking where we expected it to be although the erosion is still there it is very hard to say how the second half given the seasonality and cyclicality is going to perform in these difficult market conditions because it wouldn’t be unlike customers to say hey it is a tough market condition why start this project now or why go at full speed lets slow it down wait for it to pick up next year so we are hearing things like that from the customers. But fundamentally we kind of expected this environment and that is pretty much on there and then we kind of sense that that is going to be the way through the end of the year.

[Scott Schneeberger:]

Thanks I am sure you mentioned the second half seasonally softer could you just give us a feel for magnitude in a steady state macro environment?

[Kumarakulasingam Suriyakumar:]

Well, even I say seasonally if you take the four quarter's card the first one and the second one, second one is the best quarter, the second one is the best quarter by far and then the third quarter is slightly lower than that fourth quarter is substantially lower than that. When you see quantify from last year to this year numbers might be substantially different. But the first quarter gain comes up from the fourth quarter. I won't be able to specifically quantify it, but generally the second half of the year would be at least Jonathan would you say 10% - 15% of the first half of the year, around.

[Jonathan Mather:]

On a organic basis it is, Suri is right. On an organic basis, yes.

[Kumarakulasingam Suriyakumar:]

If you took out acquisitions that's what Scott, Jonathan means that it could be of anywhere from 10% to 15% depending on the year the season and so on.

[Scott Schneeberger:]

Great, thanks. And then the percentage of res, looks like it continues to decline, could you just give us an update on California res, res overall and maybe a little taste for the geographies and what you are saying could impact.

[Kumarakulasingam Suriyakumar:]

Right. So, fundamentally what's happening at the res is that when general markets talk about, all news media talks about there is life in residential what they mean is the inventory is moving, but that doesn't mean people are building yet. So the re-inventory is moving for two reasons, on all those houses which were repossessed by the bank they are finally starting to move. There are deals being done there and but that's a good sign because what happens is when the inventory goes down that's when the building cycle kicks in. But it should have not shown any difference to us at all because the residential market place is not building, the companies in the residential world are still not embarked on building. And that will come but a precursor to that is the fact that the inventories must be depleted. And, that’s what happening right now. Across the nation it's pretty much the same. California is pretty much the same except for the fact that, if you compare California to the rest of the nation, because their growth was so high, their dip also was substantially it was pretty deep. And, it remains that, from our prospective there is absolutely no movement and there is very little building going on. But the encouraging sign is as long as the inventory gets depleted then obviously people will start building and I think it’s sometime next year.

[Scott Schneeberger:]

Okay. Thanks. And, then finally in I'll hop back. Jonathan could you speak a little bit to obviously being on discussions or maybe they have been ongoing for while with the banks about give me an outlook with covenants and the facilities? Could you speak a little bit more to the extent that you can about what they are working for, how close you maybe getting and I'm sorry you mentioned earlier not necessary because you guys are doing a nice job of cost management? But just a little bit more insight into how the discussions are going? Thanks.

[Jonathan Mather:]

Scott. Basically, we have been continuing to assess the market, the temperament what the mood is like and the good news is the banks are far more bullish than what it was a four months even as recently a three months back. So, the temperament is good that should we want to make a move, we believe that the banks will be very supportive and the cost most importantly the cost will be substantially lower than what could have been as you will then realize, say three, four months back. So, what we are doing is we are talking to them. We are assessing it. We are looking at our projections and at the right time, we believe we can talk to them and hopefully when they go to their committees et cetera we will get the approval should we want to change the covenants or anything else in the agreement. The temperament is good, is the main message that I will share. And the fact that we as a company have performed really well as they see it too in this environment. Suri, you wanted to add something.

[Kumarakulasingam Suriyakumar:]

Fundamentally Scott, the way you look at it is say that our options keep expanding as the year goes along if we were to do something with our capital structure lets say three months ago we did have a much more costly number one and much more difficult. In today’s environment the banks are much more receptive and they are cognizant of what we can do as an organization because we have proved beyond doubt that we can manage the company well and still generate cash which means we are not bad credit that adds a huge value to us as a client whether to a bank or anybody else. So if you look at today’s environment we not only have options with the banks we have options with high yield and we have a whole lot of other options where we can play around with the capital structure so like Jonathan said our strategy is to be opportunistic, how all these options available and when we think the time is right we certainly will make a move.

[Scott Schneeberger:]

Sounds good guys thanks.

[Kumarakulasingam Suriyakumar:]

All right. Thank you.

[Operator:]

(Operator Instructions). Your next question comes from Franco Turrinelli with William Blair & Company please go ahead with your question.

[Jeremy Frazer:]

Hi this is Jeremy Frazer in for Franco, a lot of our questions have kind of been asked already but could you guys give the geographic breakdown by revenue?

[Kumarakulasingam Suriyakumar:]

Yes we can do that. Jonathan do you have it?

[Jonathan Mather:]

Sure, for the quarter the Northern California 17.5 million, Pacific Northwest 10.2, Southern region 33.6, Midwest region 19.6, Northeast region 20.8, Southern California 25.7 and then international 3.8. We also hope to file the Q, by end of the day tomorrow.

[Jeremy Frazer:]

Okay. Thank you.

[Jonathan Mather:]

You are welcome.

[Operator:]

Your next question comes from Kevin McVeigh with Credit Suisse. Please go ahead with your question.

[Kevin McVeigh:]

Great. Just a follow-up. As we think about change in strategy diversifying a little bit from non-AEC longer term in terms of revenue what percentage do you think the contribution be number one? And then number two, structurally how should we think about the EBIT margins, the business on a consolidated basis?

[Kumarakulasingam Suriyakumar:]

Right. So the whole strategy here Kevin is that we talked about how we want to reposition the Company to take advantage of that. So, when we actually got into this recession if we talk about the characteristic of the Company, we were primarily a reprographics Company. Most of the revenue we had was print based and at least 75% of that came from AEC. And where we want to go is when we come out of this recession we want to make sure much larger percentage of that business comes from business which is unrelated to AEC. In other words we want to reduce the dependency on AEC. In a perfect world, we want to be close to 40% - 50% of the business to be non-AEC. So, which means our dependency on AEC is not that much. And also we want to make sure a larger percentage of our business comes from non-print based revenue which is related to technology services. So, that's our whole strategy. I don't think there will be significant change in the EBIT numbers. They are yet to be seen, but the whole idea is to use the same co-competencies. The infrastructure we have and the technology we have and figure out a way to access businesses, which are outside the AEC industry, which is mostly technology and services driven. One other things, I'll add to that discussion is that we were previously very division-centric. We acquired reprographic companies and which basically sold primarily reprographic services in local markets. We are more and more becoming product driven. In other words, we are developing products whether it’s a product strategy or management services or small essence, we have developed that in the corporate office and we drive those product strategies through the divisions across the nation through our local branches. So, instead of being division-centric we are more product-centric.

[Kevin McVeigh:]

Great. And, if you have said this really I apologize, but what percentage of the revenue came from digital in quarter?

[Kumarakulasingam Suriyakumar:]

Digital exactly is going to be 8.6% for the second quarter. FM contributions were 19%.

[Kevin McVeigh:]

Great. Thank you.

[Kumarakulasingam Suriyakumar:]

You're welcome.

[Operator:]

(Operator Instructions). Your next question comes from David Manthey with Robert W. Baird. Please go ahead with your question.

[Kyle O'Meara:]

Hi this is Kyle, again. Just a quick gross margin question for you, despite the sequential decrease in sales, you are actually able to increase your gross margins. How should we think about the gross margin through the back half of the year, I mean with sales likely seasonally slow in the back half. Can you maintain something in this range?

[Kumarakulasingam Suriyakumar:]

Well I think we will be reviewing the range, Kyle. But I think the way to think about is, the second quarter sequentially our gross margins did go up. The main reason for that is all of the improvements we did, we talked about it in the first quarter. We couldn’t quite implement all those cost savings strategies in the first quarter info. Many of those things we implemented the effects of were flowing into the second quarter and third quarter, and that is why in spite of the declining revenue, because its no brain surgery if your revenues decline significantly, then obviously your gross margins are going to decline. But because of the depth of resizing we did, has substantially benefited us, that we saw an increase in gross margins in the second quarter, obviously we can't expect that to happen all along, there would be further decrease in the top line we know that, given the fact that second half is generally softer than the first half, but I think we will be still within the range we won't be off significantly because of our cost cutting exercises, we'll still be within the range, but it'll certainly have an impact on the gross margin numbers.

[Kyle O'Meara:]

Great thanks.

[Kumarakulasingam Suriyakumar:]

You are welcome.

[Operator:]

At this time there are no further questions, gentlemen do you have any closing remarks?

[Kumarakulasingam Suriyakumar:]

Thank you. No at this time I think we'll go ahead and wrap up the call. I very much appreciate everyone’s interest in the Company and continuing support, we look forward to talking with you again soon. Have a great evening bye bye.

[Operator:]

Thank you for participating in today’s conference you may now disconnect.