ARC Document Solutions' (ARC) CEO Suri Suriyakumar on Q1 2014 Results - Earnings Call Transcript

May. 6.14 | About: ARC Document (ARC)

ARC Document Solutions, Inc. (NYSE:ARC)

Q1 2014 Earnings Conference Call

May 6, 2014 5:00 PM ET

Executives

Kumarakulasingam Suriyakumar – Chairman, President and Chief Executive Officer

David Stickney – Vice President-Corporate Communications and Investor Relations

John E.D. Toth – Chief Financial Officer

Dilantha Wijesuriya – Chief Operating Officer

Analysts

Scott A. Schneeberger – Oppenheimer & Co., Inc.

Alan W. Weber – Robotti & Co. Advisors LLC

Glenn W. Primack – PEAK6 Advisors LLC

Operator

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

David Stickney

Thank you, Stephanie 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; John Toth, our Chief Financial Officer; and Jorge Avalos, our Chief Accounting Officer.

Our first quarter financial results for 2014 were publicized earlier today in a press release

The press release and other company releases are available from our Investor Relations pages on ARC Document Solution's Web site at e-arc.com.

A taped replay of this call will be made available several hours after its conclusion. It will be accessible for seven days after the call. The dial-in number is in today's press release. Per our usual practice, we are also webcasting our call today and the replay of the webcast will also be available on ARC's Web site.

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 pertains to our business. These risks are highlighted in our quarterly and annual SEC filings.

The forward-looking statements contained in this call are based on information as of today, May 6, 2014, and except as required by law the Company undertakes no obligation to update or revise any of these forward-looking statements. Finally, this call will call will contain references to certain non-GAAP measures, the reconciliation of these non-GAAP measures is set forth in today’s press release and in our Form 8-K filing.

As we noted in our press release today, the Company reported revenue for the first quarter of 2014 of $100.4 million, a year-over-year increase of approximately $400,000 or 0.3%. The increase was achieved despite the loss of approximately $1 million to $1.5 million in sales, due to the effects of severe weather in the first few months of the quarter.

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

Adjusted EPS for the period was $0.03 based on adjusted net income of $1.5 million. This compares to adjusted EPS of $0.01 and adjusted net income of $544,000 in the first quarter of 2013. Adjusted EBITDA for the first quarter of 2014 was $15.7 million or 15.7%. A year-over-year decrease from 15.9% in the first quarter of 2013, primarily attributable to fixed SG&A cost in the phase of lower than expected sales due to weather.

First quarter cash flow from operations was $7.7 million, compared to $11.9 million in the first quarter of 2013. A $3.8 million cash refund in the first quarter of last year is largely responsible for the difference. We ended the period with $24 million in cash after the payments of performance bonuses for senior executives for the first time in six years and accelerating principal payments on our senior debt.

Cash on the balance sheet for the first quarter of 2013 was $27.4 million. Our revolving debt facility remains undrawn. Total debt including capital leases at the end of the first quarter was $216.4 million versus $219.7 million as of December 31, 2013. Net interest expense for the first quarter was $3.9 million compared to $6 million for the same period in 2013, the decrease is due to the purchase and redemption of all our outstanding bonds in 2013 and replacing them with a term loan announced last year.

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

Kumarakulasingam Suriyakumar

Thank you, David. Our performance for the first quarter of 2014 was a continuing demonstration of the strength of our new business model and reinforces our outlook for the year and the longer term.

As noted in our press release today, January and February were difficult months due to the weather, but the strength we saw in March helped us to achieve growth and bodes well for the remainder of the year. While the growth we see in construction market, it is nothing I would call robust discussions with our customers about upcoming activity are a welcome sign.

While I remain cautiously optimistic about the muted construction market, I’m completely confident in our ability to generate strong and consistent financial results with our new business configuration.

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

Our sales and marketing investment outside of our normal G&A spending consist primarily of sales training and marketing initiative. To help support our go-to-market efforts in our new document management services, Archiving & Information Management services and our new mobile work flow applications.

We’re also preparing for a launch of a new integrated suite of enterprise content management and communication tools for the construction industry. These initiatives advance our goals to become a more valuable partner to the AEC enterprise and less dependent on the non-residential construction cycle. While the investments to support these initiatives tend to put temporary pressure on our bottom line there are necessary steps in the development of our new offerings.

We fully expect to reap increases in revenue and earnings as our customers recognized that compelling benefits, these new services bring to an evolving and increasing digital workflow in the AEC market.

In the first quarter, our sales was led by an 8.3% year-over-year increase in our Onsite business services business line. The number of MPS locations grew approximately 200 since the beginning of the year, with a significant increase in locations coming from the new CH2M Hill agreement, we completed in the first quarter of 2013. Our largest and the fastest rollout to-date this engagement had our teams installing hundreds of pieces of equipment training more than 2,000 people when the benefits of our Abacus software and outfitting more than 25 in domestic and international cities for this one client alone. We also continue rolling out our services for Parsons Brinckerhoff, which we run last year as well as more locations what (indiscernible).

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

Traditional Reprographics suffered more than usual seasonality with the effects of the winter storms earlier this year. Decreasing 4.2% year-over-year, we saw decrease volume in our service center and delays of project work in January and February.

The color market remains a strong contributor to our success. While we felt some pressure from the loss of a large broker of our services in Southern California region, as well as regional pressures due to the weather in the Midwest and East Coast we still posted 1.2% growth in this business line.

We continue to find interest in our high quality national and regional capabilities with large franchises and other retail clients. Revenues from digital services remain consistent at 8% of our overall sales for the period. Given that much of our technology outside of MPS our name is driven by project activity. It wasn’t surprising that our first quarter performance felt the brunt of the seasonal trend.

That said, we are encouraged by the enthusiasm shown by our clients over the integrated solutions we are introducing to the market.

I see the final ability to facilitate enterprise content, content management and project communication and connect content, devices and our logistics services throughout the cloud. Visitors to our tech center are exploring new ways to encrypt their offices and job sites by using ARC workflow solutions.

They are beginning to experiment with the use of PlanWell SmartBoards, large touch-enabled smart TVs actually as well as hyperlink drawing sets, fast Internet connection to the PlanWell cloud, PlanWell Collaborate software to manage their projects and PlanWell enabled printers and scanners that give them the best of both digital and analog capabilities from a simple job trailer.

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

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

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

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

Lastly, in response to many of the conversations we have had recently with our shareholders, we will provide guidance on our annual adjusted EBITDA beginning this quarter. We believe this is an increasingly compelling metric to our shareholder base and our first insight into the value of the company and our plans to enhance. With that in mind, our outlook for annual adjusted EBITDA is in the range of $59 million to $73 million for 2014.

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

John E.D. Toth

Thanks Suri. There are a few highlights in these Q1 numbers that underscore the continued strengthening of our financial model and our rapidly accelerating return on invested capital. We continue to attack these objectives through a combination of margin expansion and capital management initiatives.

As David mentioned, our gross margin showed 140 basis point improvement year-over-year on a sales increase of less than 0.5 percentage point. Expanding gross margin is critical to making more cash from operations available to be deployed for investment and generate higher future returns. There are three primary drivers to our year-over-year increase in gross margin.

First, we drove improvement through our expanded local margin improvement program that specify precise actions for individual customers and at individual locations based on close analysis. As a whole these surgical initiatives make significant contributions to our gross margin improvement and will continue to do some in the future.

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

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

Absent the impact of weather, our adjusted EBITDA margin would have been slightly up due to the relatively fixed nature of SG&A. And as we move through this phase of our lifecycle of high investment in the sales force, we expect to see greater consistency between our gross margin and adjusted EBITDA margin. It should also be noted that on-site services continues to be our largest revenue generator comprising 31% of our overall sales for the period.

As Suri discussed, growth continues to remain strong and just as important far less vulnerable to the seasonal activity that characterize our former project centric business model. This means that our largest offering provides relatively stable recurring revenue.

Being less exposed to seasonal trends, we’ve seen fairly consistent sequential growth since the third quarter of last year, driven primarily by work from both our global solutions team as well as our local and regional accounts.

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

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

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

In addition to capital lease management, the refinancing of our bonds have made a significant improvement in our ability to generate to cash and apply it towards the reduction of our long-term debt. Paying down the debt has a variety of virtues including increasing our return on invested capital today and in the future. As a reminder, we expect the recent reduction of our effective interest rate on our long-term debt to save nearly $9 million in interest payments per year.

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

Our plan is to continue to aggressively reduce our long-term debt and thereby our invested capital in the foreseeable future. It should be noted that as a result of this strategy we would expect our cash levels to remain relatively consistent as we apply growth excess cash and core to debt repayment.

For these reasons margin expansion and capital management, we delivered significantly improved performance in earnings per share and net income improved as dramatically as it did is a strong reflection of the character of our business and financial transformation. As discussed to provide greater transparency to our investors with regard to the progress of our financial model. We will begin this quarter providing guidance on adjusted EBITDA, by guiding to a proxy for cash flow that is not influenced by changes in levels of working capital and which is free of taxes and interest we believe inventors will have greater visibility into our value creation.

And while adjusted EBITDA margin fell slightly because of our deliberate investments and the relatively fixed cost nature of SG&A against the lower than expected sales. It was assisted by our strong gross margin performance a trend that is likely to continue over the long-term.

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

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

Kumarakulasingam Suriyakumar

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we’ll go first to Scott Schneeberger with Oppenheimer.

Scott A. Schneeberger – Oppenheimer & Co., Inc.

Thanks. Good afternoon, guys. I guess first question, I am curious to hear how weather did influence you in the quarter and is it something like you’re able to recoup it all and March or April was the 1 million to 1.5 million quantified company that we think adjusted loss. But I was just curious of what type of impact that had and then a follow-up on that?

Dilantha Wijesuriya

This is Dilo. The weather related short poll on the sales did happen primarily in the month of January and the mid part of February. Usually in project cycle what you lose today does not come back as double tomorrow. What is gone is typically gone, but however, what is encouraging you is that as soon as the weather related issues went away the general activity in project went back to the normal level. So during the month of – latter month of March, and obviously early visibility to the April are normal.

Scott A. Schneeberger – Oppenheimer & Co., Inc.

Excellent, and then a follow-up to question, was yes, historically and I think it’s been more on the project phase work, you get a real feel of what the year is going to shape up to be in March and then clearly is now seeing in April, it sounds like what you seen is pretty good, is that dynamic still in place. So, obviously you still have the target of exposure from the other. But with the shifting business model and the other business – pieces of the going well, I just curios to get a little bit further into what – we’re seeing in the beginning of the year, what do you think it means to the ARC, thanks.

Kumarakulasingam Suriyakumar

Scott, the robustness in the project activity nowhere near 2007, 2008. However if you compare year-over-year, there is lot more promise what we see on the ground projects that are being started by customers it can be small project, medium sized project. They are – we see lot of encouragement on those project new activities on the ground. And based on what are you see, how the year started except the weather related activities what we see in March and little bit in April. I’m confident that activity is never going to be normal for a long time. But I think we have positively encouraged by what we see on the ground.

Scott A. Schneeberger – Oppenheimer & Co., Inc.

Okay, it’s great to hear. A couple of more from me, a couple on information management business, could you just speak to how that progressing, to the extend any capital into it, is there any meaningful recent wins and just anecdotal how that’s going?

Kumarakulasingam Suriyakumar

Yes, so again, as you know AIM is the baby product for us, it was introduced middle of last year. We are considering to communicate the value of our AM strategy to our customers all around. Lot of customers are listening to us, they are getting demonstrations of our cloud software for AM related activity, we have had some positive wins in the last few months naming, we can talk about Akon has started AM project with us, and likewise we see that some other customers in the next few months or quarters will come our way. They may not be very large wins to talk about on our call, but however the momentum is in the right direction. John you want to add anything?

John E. D. Toth

No I think, as you know, that's an early stage product for us but the pipeline is robust. The lifecycle from introducing the EBITDA actual sale is taking longer than we originally expected but we expect to have some good wins later this year. As customers begin to realize the opportunity we afford them.

Scott A. Schneeberger – Oppenheimer & Co., Inc.

Great. And John now the last one for me, thanks for the EBITDA guidance. I think that will we bad and it looks good which you are initiating with. Could you just hear for that in the public call yet the components of how we calculate that is so incorrect?

Kumarakulasingam Suriyakumar

Sure we built it back up from earnings adding that interest, taxes, depreciation and we also add that shareholders or a stock-based compensation, excuse me was a primary component.

Scott A. Schneeberger – Oppenheimer & Co., Inc.

Got it. Thanks very much.

Operator

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

Alan W. Weber – Robotti & Co. Advisors LLC

Good afternoon. Something that's I’m not clear on, when you talk about adding 200 on-site service contract. What percent of that is for the Managed Print Services?

Kumarakulasingam Suriyakumar

As opposed to FMs, Alan, is that what you’re asking for, the distinction?

Alan W. Weber – Robotti & Co. Advisors LLC

Yes, in another words, when you talked about 200 contracts, so these will be doing more than just the printing or is it more what you sort of refer to those Facilities Management?

Kumarakulasingam Suriyakumar

Yes. So typically out of our total portfolio of contracts, one – approximately 30% to 40% of those wins are coming from Management Print Services contracts. Rest of it is Facility Management agreement that primarily focuses on hardware that’s based on project size and project offices.

Alan W. Weber – Robotti & Co. Advisors LLC

And is that the same kind of percent when you look at the 17,900 customers?

Kumarakulasingam Suriyakumar

No. Out of the 17,900, as we know, our FM services we started back 15 years ago. So now have a very large portfolio of FM customers. Our Managed Print Service portfolio is probably three years old. So we are still building that portfolio.

Alan W. Weber – Robotti & Co. Advisors LLC

And when you talked about – just so I understand, when you talked the CH2, can you talk about because that was – if I understand, like what was kind of you what you figured to a facilities management originally and then became management service contracts. Is that correct?

Kumarakulasingam Suriyakumar

No. Not really. CH2M is a complete Managed Print Services agreement. There we take over all their print equipment that are printed in their offices, that are used for just general business use. Machines that are used project activity in the offices as well as all it depends that it goes on to project site so we manage all the equipment in the network that manages print activity.

Alan W. Weber – Robotti & Co. Advisors LLC

Okay.

David Stickney

Allen, if could jump in. This is David. I think probably what you are referring to is whether or not we’ve done work for CH2M Hill in the past, and given that we have been, we were nation wide with the service centers, we’ve done work with most of our larger clients and former incarnations whether that was reprographics worker specific project work. But MPS agreement that we spoke about in the script and Dilo just outlined is an exclusive MPS, essentially – managing that internal print network. Does that make sense?

Alan W. Weber – Robotti & Co. Advisors LLC

Previously you had, you did business with them at their facilities correct?

Kumarakulasingam Suriyakumar

At their construction site.

Alan W. Weber – Robotti & Co. Advisors LLC

At the construction site okay, I guess on a separate note, can you talk about what you expect for two – I don’t know if you have in the press release for 2014 CapEx to be and how much in capital leases.

Kumarakulasingam Suriyakumar

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

Alan W. Weber – Robotti & Co. Advisors LLC

Okay, and that you said that was basically kind of 50-50 CapEx in capital, is this correct?

Kumarakulasingam Suriyakumar

The funding mechanism for the acquisition of machines was roughly 50-50 between CapEx and capital leases up.

Alan W. Weber – Robotti & Co. Advisors LLC

Okay great. Thank you very much.

Kumarakulasingam Suriyakumar

Thanks, Allen.

Operator

And we go next to Glenn Primack with PEAK6.

Glenn W. Primack – PEAK6 Advisors LLC

Hi, good afternoon.

Kumarakulasingam Suriyakumar

Good afternoon.

Glenn W. Primack – PEAK6 Advisors LLC

Should we continue to expect guidance in quarters creating the equity holders over time as you take advantage of the leases and generate more cash did on that. That will continue.

Kumarakulasingam Suriyakumar

Okay.

David Stickney

Absolutely, the capital management program is to do exactly that.

Glenn W. Primack – PEAK6 Advisors LLC

Excellent and then CH2M Hill, is that the logic to go after other landing that customer and MPS, is that inline to get out through other decent size, EHP customers?

Kumarakulasingam Suriyakumar

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

Glenn W. Primack – PEAK6 Advisors LLC

Okay and then the new customers you’ve added that seems like it's a decent sized company both in Canada and the US, and it’s owned by private equity so I’m assuming if you do a good job in saving that that money that PE partner can take it outside of their AEC industry.

John E. D. Toth

We hope so. That’s one of our primary goals of showing them value of improvement in service as well as showing them how to save some money in their organization.

Glenn W. Primack – PEAK6 Advisors LLC

Sure, because they want to spend on it and they can have a chance like – reap the benefit.

Kumarakulasingam Suriyakumar

Exactly. These large customers in the easy space, for the last so many years they always bought their machine. They have their document division, which bought their machines, they bought their (indiscernible) service separated from individuals and paste it all around the offices and they have a fixed cost with the project activity going up and going down. It continues. They’re not able to right size their fleet. So we thought of bringing that service to them and that opportunity and we look forward to showing them some great benefit.

Glenn W. Primack – PEAK6 Advisors LLC

Okay. And again – but this one is different from those other ones, because we got a PE sponsor here.

Kumarakulasingam Suriyakumar

Yes.

Glenn W. Primack – PEAK6 Advisors LLC

I don’t know if they were involved in those decision making process at all but…

Kumarakulasingam Suriyakumar

They were not, we work with those – the senior company executives and sort our opportunities to save money and consolidate our services.

Glenn W. Primack – PEAK6 Advisors LLC

Okay, again I think the EBITDA guidance is good, and I hope you’re compensated out.

Kumarakulasingam Suriyakumar

I like the way you say that man, we’ll make sure that happens.

Operator

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

Kumarakulasingam Suriyakumar

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

Operator

This concludes our conference. Thank you for your participation.

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