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American Reprographics Company (NYSE:ARP)

Q3 2010 Earnings Conference Call

November 2, 2010 5:00 PM

Executives

David Stickney – VP, Corporate Communications

Suri Suriyakumar – Chairman, President and CEO

Jonathan Mather – CFO

Analysts

Andrew Steinerman – JP Morgan

Scott Schneeberger – Oppenheimer

Brad Safalow – PAA Research

David Manthey – Robert W. Baird

Operator

Good afternoon, and welcome to the American Reprographics Third Quarter 2010 Call. My name is Christy and I will be facilitating the audio portion of today’s interactive broadcast. (Operator Instructions) Thank you.

At this, I would like to turn the show to David Stickney, Vice President of Corporate Communications.

David Stickney

Thank you, Christine, and good afternoon everyone. Today, I’m joined by Suri Suriyakumar, our Chairman, President, and Chief Executive Officer; and Jonathan Mather, our Chief Financial Officer.

Our third quarter results were summarized in a press release issued earlier today. We’ll be adding further commentary on the quarter, on our call and then we’ll move to Q&A. For your reference, you can access the press release and the company’s other release from the Investor Relations section of American Reprographics Company website at www.e-arc.com.

We are web casting our call today. A replay of the webcast will be available, on our website for 90 days from today. I take the replay of this call will also be accessible by phone for seven days after the call. The dial in number for the replay is 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.

Bear in mind that such statements are only predictions, and actual results may differ materially as a result of risks and uncertainties that pertain to our business. These risks are highlighted in our quarterly and annual SEC filings. The forward-looking statements contained in this call are based on information as of today, November 2nd, 2010 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?

Suri Suriyakumar

Thank you, David; and good afternoon, everyone. Once again American Reprographics performed remarkably well during the third quarter despite a market backlog to confidence as well as new construction projects. While we were disappointed in the appetite for our services, we are certainly not discouraged.

Considering the depth of the financial crisis we have experienced over the past two years, sharp turns head backs are bound to be part of any recovery. From our point of view, we must make good on the opportunities in front of us and I’m pleased to say that we did so during the third quarter.

As we noted on our October call, we continue to see stabilization in our average daily sales number month over month. The third was no exception to this trend. However, each daily sales figures from July, August and September were essentially flat with a small uptick in September.

The upside of this continuing stabilization is that it suggests we may be at the bottom of this cycle. The downside what we did not see a significant return to seasonality as we had expected. Nonetheless, ARC performance remains strong and continue to prove the strength of its operating model and the persistent of its management team.

On revenues of $109.4 million, ARC delivered $0.01 per share in the third quarter of 2010 on an adjusted basis. In spite of our revenue drop, our gross margins remain very healthy at 32%.

At the end of quarter three, we had produced $38 million in cash flow from operations for the year. This translates to $10.3 million for the third quarter. Our ability to generate cash is the core of our operational strength.

While we continue to tighten our cost structure to drive more cash to the bottom line, we are also extracting more cash from our existing operations by further leveraging our dominant position in the industry. As we expand our market share by continuing to acquire large national and global customers, we are able to compete at the entirely different levels and work with our vendors in creative and more cost effective ways.

We have cut more than $12 million of incremental cost so far this year. This is a remarkable amount given the significant cost reductions we already achieved. In addition, and as I have stated previously on several occasions, we have the ability to reduce our operating cost further by adjusting our operating footprint.

It is difficult, if difficult conditions in our end market persist, we can right size our branch network and leverage our digitally infrastructure further to balance capacity against demand. We would of course prefer to remain ready to capture market share in a recovery rather than cut too deeply, especially if recovery is on the horizon.

On top of all this, we also have a market that appears to be conducive to debt restructuring. Throughout this downturn, it has been very clear that banks and lending institutions favor companies with good management and strong cash flow. We will continue to explore our opportunities on this front as well.

With all these options on our site with regard to maintaining our profitability and managing our cost, we are encouraged about our prospect and we continue to drive the business forward.

Meanwhile, our sales and operations teams were hardly idle despite the softness of the quarter. Large firms in the AEC space have been consolidating markets with remarkable enthusiasm. Engineers and architects in particular are acquiring new firms and expanding their base of services as well as their geography footprint.

Our global services team has been capitalizing on the desires of these growing firms to create more efficiency in the existing operations and knew more productive ways to bring on newly acquired operations. Our management services offering couldn’t have been introduced at a better time. Of the six new clients brought on board during the third quarter, five of them hinged on our ability to manage our entire print network, not just the reprographics work. We will see some new business from these clients in 2010, but most of the first year’s revenue approximately $9 million worth will be realized in 2011.

Our right clearly remaining initiative has also made excellent progress during the third quarter. We announced our intention to build this new colored business exactly one year ago and it’s now allowing us to expand our market reach further into the non-AEC world. Eight of our 10 super centers have opened this year and two more scheduled to open before December 31st, considering that we have spent very little to start this business unit by essentially leveraging our existing asset, I am very pleased with the results.

At this point, I’ll turn the call over to Jonathan now for a closer look at some of the financial information we released today. We’ll open the calls for questions after that. Jonathan?

Jonathan Mather

I will run through the basic update first and then address the goodwill impairment as noted in today’s press release. To begin with, our customer mix in the third quarter was very similar to quarter two.

Of our total revenue for the third quarter 24% came from the non-AEC segment, 70.4% came from non-residential construction customers and 5.6% came from our residential construction customers. Our product and service mix change slightly in the third quarter.

Facilities management made up 20.7% of our revenues. Digital services again delivered 9.1% of our sales, 12.9% of our revenue were from equipment and supplies and the remaining 57.3% came from our base of reprographic services.

There was 64 working days in the third quarter, just as there were 64 days in the second quarter. There were also 64 days in quarter three of last year.

On a regional basis, our year-over-year revenue performance was as follows: Southern California was down 12.5%. Northern California was down 8.5%. The Pacific Northwest was down 8%. Our Southern region was down 7.9%. The Midwest was down 12%, and the Northeast was down 11.5%. Our international operations, excluding Canada, continued to perform well and were up 35.8%.

The year-over-year reduction of our gross margin from 34.5% in the third quarter of 2009 to 32% in the third quarter of 2010 is being primarily driven by the change in the mix, I mentioned earlier. Specifically, mercurial cost of the percentage of sales were 280 basis points higher for the three months ended September 30th, 2010, when compared to the same period in 2009. This was mainly due to a larger percentage of equipment and supply sales relative to our total sales.

Interest expense was $5.6 million in the third quarter of this year, down from $5.7 million in the second quarter.

Moving to the balance sheet, we ended the third quarter of 2010 with a cash balance of $29.8 million. Our $50 million revolver remains untouched. Year-to-date, we have made scheduled debt payments of $32.2 million. Day sales outstanding or DSO were 48 days in the third quarter of 2010, up from 46 days in quarter two and consistent in quarter three of 2009.

Total debt, including capital leases, at the end of third quarter 2010 was $248.2 million. This is down from $256.7 million from the second quarter of 2010, and from $274.2 million from the end of 2009. The ratio of net debt to trailing 12-month adjusted EBITDA at the end of the quarter was 3.12.

Cash flow from operations in the third quarter was $10.3 million, as noted in the press release earlier today; as compared to $18.3 million in quarter two.

Finally, the company is operating very comfortably within the confines of its current debt covenants. I believe that covers the basics.

Today, we reported an impairment charge for goodwill in our press release. The results of our analysis in 2010 indicated that 13 of our reporting units, 12 in the United States and one in China had goodwill impairment as of September 30th, 2010. As such, we recorded a pretax non-cash charge for the three and nine-month ended September 30th, 2010 to reduce the carrying value of goodwill by $38.3 million.

With that as a backdrop for further discussion. I’ll turn the call back to our chairman, Suri.

Suri Suriyakumar

Thank you, Jonathan. Operator, at this point, we can open up the calls for questions and answers. Operator, are you available on the call, please.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Andrew Steinerman.

Andrew Steinerman – JP Morgan

Hi, there, gentlemen. Could you give me a sense of what the revenue implied is in your cash flow guidance? How much revenue would you need to achieve to achieve that cash flow guidance?

Suri Suriyakumar

Go ahead, Suri [ph].

Suri Suriyakumar

Andrew, again, on the revenue while we have not even a guidance, it would be in the $440ish billion of revenue to be on the low end of the cash flow guidance.

Andrew Steinerman – JP Morgan

Okay. And Jonathan, you talked about potential, I think you talked about potentially redoing your covenants and your debt relationship. Is there any risk to the covenant right now or do you feel like that’s just a small thing to do?

Jonathan Mather

What I would say is through the next year as we are projecting, we don’t see challenges to the covenant. However, in this environment one has to be careful. So, again, as Suri talked about in his release, we are looking at the various alternatives in front of us. So, we will look at is it amending the covenant, is it? So that our many options that good thing is that we have available in front of us.

Andrew Steinerman – JP Morgan

Okay, sounds good. Thank you.

Jonathan Mather

Okay.

Operator

And your next question comes from Scott Schneeberger with Oppenheimer.

Scott Schneeberger – Oppenheimer

It’s Scott Schneeberger with Oppenheimer. If following up on the debt restructuring. I’m sure you guys are looking into it presently. Would you care to differentiate between perhaps offering high yield notes or doing some restructuring of the, on some of the other maybe revolver, some of the other financial tools. Just any thoughts there that you care to share, thanks.

Suri Suriyakumar

Scott, thanks. We don’t have a specific strategy as to which we are going to go. Obviously, the options are out there, the environment is very conducive. What we know is given the fact that we have a strong cash flow generation and the fact that banks look at us favorably. We are exploring all the different options. I mean there are so many options available, banks certainly want to lend to good companies.

So, we’re just looking at all the different options, obviously the high yield market is there but so is the debt market. I mean they are looking at it very positively. So, our objective is to take into consideration all the different options available and then which is most appropriate for us.

Scott Schneeberger – Oppenheimer

Okay, thanks. And then I missed you at the beginning and this has gone back to the earlier call, in early October. With regard to the monthly pattern in the third quarter, could you refresh us on that, could you also comment if in the past few weeks you’ve seen any change from pattern as oppose to three weeks ago, thanks.

Suri Suriyakumar

The sales have remained relatively flat. What we are basically seeing virtually the whole year is that our sales have remained flat. I mean coming from last year to a year before, it’s pretty clear the sales are flattening out. Every year it has become very – and this year, it is pretty consistent within a $100,000 range up to now, up to this current quarter.

We’ve been pretty flat within our $100,000 range. So, we feel very good that the market is flattening out Scott and I think that’s going to be like that and needless to say, market is still going to need to remain challenge base on the confidence out there. It’s the election year, all that kind of stuff. But nevertheless, its clear indication, the market is flattening and it’s starting to look like it’s bottoming out.

For example, CB Richard Ellis recently released the [inaudible] status stakes and it shows the office vacancy rates has dropped for the first time since second half of 2007 by about 10 basis points, very little but it’s dropped for the first time since 2007. Industrial vacancy rate for the first time declined in three years, again, only 10 basis points, but it’s our first decline, and retail held steady after 17 periods of increase, meaning the vacancy after going up for 17 periods it’s become steady.

You know that and you obviously know about architecture or billing index, you always follow that I know, that’s showing a little bit of life. There are clear signs that the market is starting to bottom out.

Scott Schneeberger – Oppenheimer

Okay, thanks for that. And then finally, just regard with – with regard your expense management and you mentioned holding off until now, until in case anything the environment gets tougher. We’re going into seasonally fairly tough time, what is your update with regard to expense management at this juncture, thanks.

Suri Suriyakumar

Right. So, based on what we know now. I mean when you say, we’re already in that period, Scott, so we are already know we are in tough corner already. So, I mean we’re not talking about this quarter. But fundamentally what I’m trying to point is you’ve done a great job in managing our cost.

We’ve already – on top of the fact that we already is so much cost in 2007 and 2008, at 2008, 2009, we have still manage to reduce up to $12 million, which I think is remarkable given the fact that we ordered a cut to cost. We are also finding more creative ways and means of extracting more cash from our existing operations because this is kind of becoming almost a culture in the company.

So, as we continue to sign up some of the larger accounts, previously we would have said, “We got another big account and then move forward,” but we are now saying, “Hey, we got a big account, did you know what are the cost related to this?” We are going to give that much more equipment business and we are going to give that much more supplies business and we are bidding those opportunities and getting better cost structure on those new accounts we are getting.

In other words, this downturn is not only for us, for all the equipments, suppliers and manufacturers as well. So, we are finding more ways of controlling the cost and what I’ve always said and I repeat again is that we haven’t cut our branch structure given the revenue drop from 2007, although we have significant drop. The branch structure is pretty much intact from about 300 plus branches, we’re still 270 plus branches.

So, we can further trim, if we want but to. I’m saying I just want to make sure for those people who might be a little skeptical about the environment or nervous about the environment, don’t be because we are fully in control of where we are with regard to our cash generation and meeting our debt obligations. And on top of that, we also have a market, which is very conducive to further doing business with companies like us because we have strong cash flow.

So that’s the whole message, so with regard to fourth quarter, I’m not worried at all, I’m feeling very good about it. And the short answer to that is, should there be a need, if for some reason, some unforeseen circumstance, the market turns bad, we still have options even within the existing financial structure.

Scott Schneeberger – Oppenheimer

Okay, thanks for taking my question.

Suri Suriyakumar

Very well.

Operator

(Operator Instructions) And you do have a question from the line of Brad Safalow.

Brad Safalow – PAA Research

Hi, thanks for taking my questions guys.

Suri Suriyakumar

Sure. Sure, Brad.

Brad Safalow – PAA Research

Just a factual question, how many FM contracts did you have at the end of the quarter?

Jonathan Mather

Let me take a quick look at that, 57.91, Brad.

Brad Safalow – PAA Research

Okay.

Jonathan Mather

At the upper load, 90.

Brad Safalow – PAA Research

Okay. So, I guess I’m just looking, I guess in the last two quarters, it looks like year-over-year revenue changes per FM contract have been conservatively better than the year-over-year changes or decline for what you’re seeing at the branch level. Is there anything specific about it? Is there anything we should conclude from that?

Jonathan Mather

No, what is easy – one of the ways to look at it is that Brad that the design work. So, in all the FMs in the architectural offices, the early part of the design work, which is basically check prints is starting to happen. So, there’s some life as you can see.

It declined significantly because most of the FMs, largely are FMs for convenience printing and what they do is check printing out or what do you refer to as Design Schematic Stage Printing. So, from that perspective, we are seeing a little more life as I answer you that I previously heard in a previous question, we are starting to see signs of more activity and stabilization and this is just part of the grid [ph].

Brad Safalow – PAA Research

Okay. So that would be to the extent you would expect FM contract or running in for contracts to improve before you’d see it at the branch.

Jonathan Mather

Yes. Typically, there will be – the FM activity will pick up and our theory is that we could install more FMs. But even if you don’t install more FMs, the revenues from FMs will start to turn positive.

Brad Safalow – PAA Research

Okay. And just shifting gears to the global services side …

Jonathan Mather

Yes.

Brad Safalow – PAA Research

You mentioned in the press release you had about $9 million and kind of new contracts secured that will run through your P&L into 2011.

Jonathan Mather

Yes.

Brad Safalow – PAA Research

Overall, how much in manage print services revenues are expecting for 2011 at this point?

Suri Suriyakumar

Total numbers are you referring to Brad?

Brad Safalow – PAA Research

Correct.

Suri Suriyakumar

This is increasing our managed print services; meaning new business, which will impact 2011 is about $9 million right now.

Brad Safalow – PAA Research

I mean, but did you have a couple of contracts from last quarter as well?

Suri Suriyakumar

Yes, absolutely, absolutely. But these are all managed print services one. But we have had six new accounts out of which five are attributable to managed print services. What we are trying to say is we implemented the new strategy of going after the managed print services account in our AEC segment and it’s starting to benefit us right now.

Brad Safalow – PAA Research

So, overall in 2011, the managed print services will be 2 to 3% of total revenues roughly?

Suri Suriyakumar

Jonathan, do you have an idea no?

Jonathan Mather

The question again you said what percentage do we …

Brad Safalow – PAA Research

What percentage of your total revenues will come from managed print services?

Suri Suriyakumar

Yes, are you talking to 2011 now or 2010, Brad?

Brad Safalow – PAA Research

2011, just based on the contracts you’ve secured here.

Jonathan Mather

So, we have $9 million now. So, as you know these managed print services is the new concept. With large global services, we didn’t have managed print services concept before. We started it only in the middle of the year, so roughly it takes $10 million for now.

Brad Safalow – PAA Research

Okay.

Jonathan Mather

I mean if we sign more accounts during the last quarter, Brad, and I certainly hope we will and can we sign more accounts because it’s a very exciting opportunity for us, it will be going up. But right now, I think I’m just picking a number, you should comfortably expect us to deliver $10 million out of it.

Jonathan Mather

Have we lost you Brad?

David Stickney

You might have lost …

Operator

Brad, your line is open.

David Stickney

I wonder if we maybe loss the signal here. Let’s ask Brad, if you can still hear us to please dial back in and queue back up, if you have further questions. Christy, do we have any other questions at this point?

Operator

One moment. And your next question comes from the line of David Manthey.

David Manthey – Robert W. Baird

Hi, good afternoon. I was wondering could you talk about the average revenues that you might derive from a customer by traditional means and then one that becomes a PlanWell type customer. Just in terms of the dollars that ARP would realize from each of those relationships. What does it look like in each of those scenarios?

Suri Suriyakumar

If I understand your question right, you’re asking me whether there is average volume of revenue from customers and if indeed, they started using technology such as PlanWell. How much would that actually be up? Is that your question David?

David Manthey – Robert W. Baird

Yes.

Suri Suriyakumar

So, it’s very difficult for us to, if not impossible to get an average volume from customers because our revenues are the customer compilation [ph] is extremely, extremely low. So, we have about a 135,000 customers across the nation and the largest customer doesn’t even account for – Jonathan, is it less than 2%?

Jonathan Mather

Yes.

Suri Suriyakumar

Of our annual revenues. So, it’s fairly widespread, David. I mean we have a lot of small customers and then we have larger customers and then of course, we have mega projects. So, there is, we don’t actually have every type. That’s one part of the question.

The second part of the answer would be to your question is that because of the fact that we Reprographics traditionally has been print base, we have incorporated the PlanWell services into the reprographic services, so we don’t separate it and tear off the PlanWell and be able to identify. What we identify is the digital services we provide such as canning, uploading, indexing, all the different functions we do for them digitally. But they are in the PlanWell network.

Now, we have started also charging them for seat licenses and that we started only last quarter. So, I’m afraid I won’t be able to give you that much more clarity to your specification there.

David Manthey – Robert W. Baird

What I’m trying to get to, Suri, is does the revenues you derive let’s say from printing, does it go up or down after someone …

David Stickney

I think we may have just lost another call thanks to cellphone reception. My guess is what David was going to ask Suri is whether or not revenues go up or down once a customer basically adds PlanWell to their account.

Suri Suriyakumar

Right.

David Stickney

And if I heard you right, basically we’re talking about adding document management fees and then adding licensing fees as well.

Suri Suriyakumar

Yes, yes. The short answer is it started – people started using PlanWell and other document management services. Currently, our revenues go up. So, I guess the implied question is because they are using technology, does the print revenue go down? We don’t see a huge evidence of that. People are using different technology tools, but largely print is still a very strong requirement for now in the industry.

So, we don’t see an erosion in it. In fact, I think there is a period during which time we couldn’t knew [ph] to have our print revenues and our technology revenues actually at the [inaudible] on top of our current revenues.

David Stickney

So, we’ve any luck we’ve answered David’s question.

Suri Suriyakumar

I’m sure he’s able to …

David Stickney

To hear us.

Suri Suriyakumar

At least hear us, yes.

David Stickney

Christy, do we have any other questions at this point?

Operator

No, sir. There are no further questions at this time. Do you have any closing remarks?

David Stickney

Yes. Ladies and gentlemen, just simply thank you for joining us today for the call. As always, we appreciate your continuing interest in American Reprographics Company. Have a great evening. We’ll talk with you all soon.

Operator

And this does conclude today’s conference call. You may now disconnect.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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