ARC Document Solutions, Inc.
Q2 2015 Earnings Call Transcript

Published: 5 Aug 2015

[Operator:]

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 the turn conference over to Mr. David Stickney, Vice President of Corporate Communications.

[David Stickney:]

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 Solution's 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 non-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?

[Suri Suriyakumar:]

Thank you, David, and good afternoon everyone. In the second quarter, ARC Document Solutions grew sales across all four of the service lines, maintained a very healthy gross margin, deliver 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. ARC fully 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, document 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. Managed print sales were $37.1 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 performance for the rest of the year. Growth in non-residential 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 rival the fact. We have 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 document 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 all sales we have experienced over the past year. As we have noted previously, we believe MPS sales can continue to grow at 8% to 10% year-over-year over time. But we have also made it a point that this growth rate can be significantly influenced by timing of the large contract rollout 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 we’ll have minimal impact to sales in 2015. As a result, we expect continuing 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 Supplies 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 its 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 months 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?

[Dilo Wijesuriya:]

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 join our customer list with exciting new projects. On the digital side, we saw solid growth in the sales of both hyperlinking and DIM 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 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, standards in Construction Document workflow have yet to be established, but over time we are in an excellent position to help our customers to 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 level. Luxury apartment developer AvalonBay joined our global solutions client list during the second quarter has did a number of other large regional accounts. We also continued rollouts from our account wins 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 have also been developing new tools to shorten sales cycles by accelerating audits of customers print environment 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 on live within the next 60 days, should deliver a significant time saving 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 retrieval platform. Our offerings are fast, far less expensive, and easier to implement relative to almost any customized archival solutions. In this revenue line, one sale inspires another. Each new customer adds clarity to our selling strategy and built a strong referral base. I should also mention that growth in Equipment and Supplies sales in China was a result of a major expansion of our accounts with Comac, The Commercial Aircraft Corporation of China, as they move 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 test 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 George, for a review of our financials. Jorge?

[Jorge Avalos:]

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

[Suri Suriyakumar:]

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

[Operator:]

Yes, thank you. [Operator Instruction] And we’ll go first to Brandon Dobell with William Blair.

[Brandon Dobell:]

Thanks. Good afternoon guys.

[Suri Suriyakumar:]

Good afternoon.

[Brandon Dobell:]

One of the focus on MPS for a second, I recognize there is 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, you know, how people are transitioning from being a later inquiry down to signing a contract, is it those conversion rates changing, is it taking longer or the nature of the contracts changing? I am just trying to get a sense of, let’s call it, growth drivers for the balance of this year once you strip away the larger deals?

[Suri Suriyakumar:]

Right, no – actually we have seen good activity Brandon on the pipe – in the pipeline. Customers are getting engaged by 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 its not uncommon, we have talked about this previously, but if you ask me whether the activity is strong, yes. Has anything specifically changed inside the 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 start kick study, it will take 30 days, 60 days, 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 – later part of this year, but it will certainly get kick into gear next year.

[Brandon Dobell:]

Okay. So as we go to back half of the year, it sounds like you guys are okay, you’re comfortable, still seeing growth in the MPS line, may be it’s somewhere around the results you disposed it here in the second quarter, but obviously not the higher single-digits. But are you guys comfortably saying you’re still going to see growth in the back half of that – back of this year on that line?

[Suri Suriyakumar:]

Absolutely…

[Brandon Dobell:]

Okay.

[Suri Suriyakumar:]

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

[Brandon Dobell:]

Okay, gotcha. And then may be turning to selling and marking expenses, this is the first quarter I think in a while may be two, three, four years where we seen a quarter-to-quarter decline in just the gross number of dollars that you guys spent in SG&A. I know you have 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 the SG&A expenses on a dollar basis to look like they did here in the second quarter through the next couple quarters? Thanks.

[Suri Suriyakumar:]

Yes, I think you hit on the nail on the last point. I think we have kind of established our run rate if you will..

[Brandon Dobell:]

Okay.

[Suri Suriyakumar:]

Two quarters of SG&A roughly $27 million. One thing I would like to remind you, 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. To your point, the run rate we’re seeing now, I think that’s a reasonable estimate for the balance of the year.

[Brandon Dobell:]

Okay. And then final one from me, as we think about uses of cash recognized and there are still opportunities to delever. But if 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 looks like as you guys put capital out to keep growing the business?

[Suri Suriyakumar:]

Yes, I would encourage you to look at more our recent results, may be the second quarter, and noting that our cash CapEx there, and our capital leases there, and kind of get that run rate going for the second half of the year might be a bit muted as we’ve talked about with the muting of the MPS revenue. So it might decline a little bit, but that – directionally I think that’s a good gauge.

[Brandon Dobell:]

Okay, great. I’ll turn it over. Thanks.

[Suri Suriyakumar:]

Thank you.

[Operator:]

[Operator Instructions] We will go next to Alan Weber with Robotti and Company.

[Alan Weber:]

Good afternoon.

[Suri Suriyakumar:]

Good afternoon.

[Alan Weber:]

When you look out – all right, 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?

[Suri Suriyakumar:]

Jorge, do you want to take that looking into 2016 EBITDA and cash flow?

[Jorge Avalos:]

Yes, I mean…

[Alan Weber:]

Yes, I’m not [indiscernible] just directionally like that in the capital spending…

[Jorge Avalos:]

I mean it directionally as you look at our company, we continue to de-lever and pay down our debt likewise our debt has a reducing interest rate based on our leverage ratio. It’s going to 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.

[Alan Weber:]

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

[Suri Suriyakumar:]

So at the moment we obviously focused on delevering as we always said I think debt to EBITDA, we are about $2.6, Jorge.

[Jorge Avalos:]

Correct.

[Suri Suriyakumar:]

At this point of time, we have come down from 3. We think we will continue to do that until we reach about 1.5 million may be. 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 may be to bring it down to at least 1.5 times EBITDA multiple and then think about what you want to do with the cash at that point I mean that to be a good problem to have.

[Alan Weber:]

Nice. And then based upon the way you’re going that’s not very far off?

[Suri Suriyakumar:]

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

[Alan Weber:]

And then my other question was, I kind of misunderstood, can you talk about the investments that you’re making and how like whether it’s a number of sales people that’s increasing. I was unclear if some things changed there in terms of the thought process of how much you’re going to spend to try and grow the business.

[Suri Suriyakumar:]

Right. No, I mean, this is – we’ve started this thought process, Jorge would you say last year?

[Jorge Avalos:]

Beginning of last year…

[Suri Suriyakumar:]

Beginning of the last year…

[Jorge Avalos:]

Third quarter.

[Suri Suriyakumar:]

I am sorry…

[Jorge Avalos:]

Third quarter.

[Suri Suriyakumar:]

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’ve 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. Working with marketing companies and advertising companies and promotional companies to take our message out and make sure that people hear what we are 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 have six, some instances we have eight. If the business starts growing and the need increases then we will increase that stuff. So it’s a fluid number, but it’s all about disciplined investment in order to drive growth that’s what we are focused on.

[Alan Weber:]

Okay, great. Thank you very – I just have – I was curious because you are in a different position today than a few years ago because you can’t afford to invest to grow the business more so than a few years ago since you have delevered.

[Suri Suriyakumar:]

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 product – our solution lines. They are starting to show growth in the right direction. Granted we want – like I said in my script, we 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.

[Alan Weber:]

Okay, great. Thank you very much.

[Suri Suriyakumar:]

Thank you.

[Operator:]

[Operator Instruction] We’ll go next to Chris McGinnis with Sidoti and Company.

[Chris McGinnis:]

Hi. Good afternoon. Thanks for taking my question.

[Suri Suriyakumar:]

You’re welcome.

[Chris McGinnis:]

If look at – can you just maybe just expand on the SKYSITE and where – and what stage you’re at, is it still on the testing phase and I guess at what point does that go live in terms of may be if the generation of the revenue and playing out like how you think it’s going to play out?

[Suri Suriyakumar:]

Right. SKYSITE has already released. We released it – when did we released it Dilo? March…

[Dilo Wijesuriya:]

February.

[Suri Suriyakumar:]

February this year, we released the product. That’s our – that’s after all the manifesting 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 in using cloud as a medium to distribute project documents. So it’s out there we have about 1,000 trials going on at 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 released it. We think it will take 12 to 18 months to gain real traction. So since February, its March, April, May, June, so it’s about four, five months. We expect the traction to grow. In the meantime, what we’re doing is just that we are working on further enhancements like any other product which is in the market today, which is a cloud based product. So we are adding features after working with customers and asking them what other preferences they have in terms of that uploading photographs while 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.

[Chris McGinnis:]

Great, thank you very much.

[Suri Suriyakumar:]

You’re welcome.

[Operator:]

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

[David Stickney:]

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

[Operator:]

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