ARC Document Solutions' (ARC) CEO Suri Suriyakumar on Q2 2016 Results - Earnings Call Transcript

| About: ARC Document (ARC)

ARC Document Solutions, Inc. (NYSE:ARC)

Q2 2016 Earnings Conference Call

August 1, 2016 17:00 ET

Executives

David Stickney - Vice President, Corporate Communications and Investor Relations

Suri Suriyakumar - Chairman, President and Chief Executive Officer

Dilo Wijesuriya - Chief Operating Officer

Jorge Avalos - Chief Financial Officer

Analysts

Ian Corydon - B. Riley & Company

Chris McGinnis - Sidoti & Company

Operator

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

David Stickney

Thank you, Bethany 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 2016 were publicized earlier today in a press release. The press release and other company materials are available from our Investor Relations pages on ARC Document Solutions website at ir.e-arc.com.

Please note that today’s call will contain forward-looking statements that fall within the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are only predictions based on information as of today August 2, 2016 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 will now turn the call over to our Chairman, President and CEO, Suri Suriyakumar. Suri?

Suri Suriyakumar

Thank you, David and good afternoon everyone. All of the new services we offer continue to expand during the second quarter led by year-over-year growth of 9% in archiving and information management. Now, that’s good news. However, the bad news is that our traditional print-based business continued to drop. Consolidated sales in black and white and color printing fell at about 7% a year, year-over-year in a traditionally strong quarter. Considering the decline of print sales in the first quarter was just 2%. The second quarter drop was significant.

We also saw MPS print volume to decline from continuing optimization and the secular trend to reduce the use of [indiscernible]. Directionally, we are working our way through the challenges of a declining traditional market, while building momentum in our new services just as we said we would. However, the growth in our new services is not yet adequate to offset the shrinkage in our traditional business. The type of transition ASP is going through is a tough one requiring change at every level, sales, operations, technologies and finance. We are constantly balancing the future needs of the market against what customers are demanding today. Additionally, large global engineering companies, a key market for us continued to face headwinds due to the industry consolidation pressures as we will have difficult conditions in their oil and energy sectors and that have affected their business.

Despite the difficult sales climate, our financial health remains sound. Our cash generation continues to support stock repurchases and also in reduction of our senior debt. The company’s capital structure remains sound and our ability to keep the business stable and productive during this transition is solid. This is one reason why I continue to emphasize the 24 to 36 months need for us to navigate through this transformation. The early results of our efforts are encouraging and we have the financial resources to see us through the time it will take to accomplish the hard work in front of us.

Sales were down approximately 8% year-over-year. This is largely driven by three elements. The difficulties faced by large engineering companies and a large contract in the sector that didn’t renew in 2015; second, shedding high volume, but low margin color work in the United Kingdom that came to us from a previous acquisition. And finally, a one-time sale of equipment in China last year during the second quarter. On the other hand, our gross margin was healthy coming in above 35%.

SG&A costs dropped by $1.6 million year-over-year and we generated cash flow from operations essentially equal to those we produced last year of the same period. Clearly, we made the most out of all [indiscernible]. However, the revenue softness in the first half of the year will have a significant effect on the second half of the year. And so revision of our 2016 annual forecast is appropriate.

For fully diluted annual adjusted earnings per share, we expect that to be in the range of $0.24 to $0.28. We expect annual adjusted cash provided by operating activities to be in the range of $48 million to $52 million. And we expect the annual adjusted EBITDA to be in the range of $59 million to $63 million.

As we look ahead for opportunities, especially with regard to the development of our new services, the pay continues to improve. AIM continues to show promise as I mentioned earlier. Building information modeling of demand, they call it, has languished for 20 years in construction, but since the recession, its adoption is finally growing at a rate that justifies its promise. We have scalable teams and services to help our customers capitalize on this technology without breaking the bank or bloating a production team.

We have added new and compelling features in the cloud-based project information management and the new interface and new functionality in our facilities information management solutions, which is generating strong interest from our customer base. Along with the significant upgrade to our SKYSITE platform, we expect the technology progress we have made during the second quarter to significantly expand our overall addressable market. We are making great strides in the development of our new offering and they are the future of this company.

As we focus on developing these new tools for the market, we are very much aware that the revenues from our traditional print-based business continued to be an important contributor to our sectors. We fully intend to nurture and preserve that segment of the business to the best of our ability, but the feedback we will see from the field indicates that our print-related business will continue to shrink. Print equipment manufacturers, whom we worked with very closely, support our finding. Our future lies on the tablet, the mobile phone and the computer and not on a piece of paper. We clearly recognize that. That is why we can newly invest in new solutions and in new ways to sell them. I look forward to highlighting their success in the near future.

At this point, Dilo will give you some information on each of our business lines and then Jorge will follow with a more detailed review of the financials. Dilo?

Dilo Wijesuriya

Thank you, Suri. We saw continuing interest and sales in our new offerings within construction document and information management services. Adoption of SKYSITE continued to improve. In July, we added an improved workflow relating to document collaboration and distribution of information in both project management and building operations.

InfoLink, our new facilities management application is offered on the cloud side by side with project length, the original SKYSITE application for active construction project. Each solution can be used independently or they can be used in tandem to address the information needs throughout the design build operate lifecycles.

PBM services also contain a large print component, much of it in color. We made progress improving our color printing business, especially in the UK by closing an underperforming location there. The service center came to us as a part of our largest acquisition several years ago and specialized in higher volumes, but lower margin business. The drop in sales as a result of closing the location was offset by a significant improvement in the quality of our customer base and a better mix of business.

Moving on to managed print services, during the second quarter, we acquired several large regional managed print service customers in North America. Our focus on developing higher volume sales through our regional sales force continues to gain traction and is helping to balance the slower sales cycle of larger national and global customers. Overall, we added 520 managed print services engagements since the second quarter of last year.

Archiving and information management continued with strength in the second quarter. On top of a solid contracted backlog aim, our teams secured large wins in medical campuses, municipalities, grocery store chains and others that will build momentum into the last two quarters of the year. Equipment and supplies continued to provide strong defensive support for the company with sales to clients who cannot benefit from the MPS or other outsourced equipment needs. This business line is also providing an outlet for used equipment placement. Where we encounter price sensitivity, we are making more active use of used and refurbished equipment where the margins are excellent and the barriers to a sale are much lower.

With that as an operational summary, I will turn the call over the Jorge for a look at some of our financial details. Jorge?

Jorge Avalos

Thanks Dilo. As noted in our earnings release year-over-year sales decreased by 8.5% or $9.6 million. Thanks to disciplined cost containments. Our consolidated gross margins remained strong at 35.1% and SG&A reduced by $1.6 million representing a 6% decrease year-over-year. Interest expense for the quarter declined by more than $400,000 as we continue to pay-down our senior debt which in turn reduced the interest rate. As we noted before future cash taxes remain minimal as a direct result of more than $80 million of net operating losses from previous years. A pro forma tax rate of approximately 40% is still a good number for your projections in 2016.

Adjusted EBITDA for the period was $81 million or a decrease of $3.4 million over prior year. The decrease was due to the $9.6 million decrease in sales, which was mitigated by our cost containment efforts during the quarter. Despite the decrease in EBITDA, cash flow from operations remained consistent with prior year at $16.6 million for the quarter or nearly $20 million year-to-date. With the cash generated during the quarter, we continued to strengthen our balance sheet and improve our capital structure by paying down an additional $4.6 million in senior debt. In a span of just 2 years, we have reduced our total debt by more than $45 million and reduced our debt to EBITDA ratio for more than 3x to under 2.5x. We also continued to repurchase our own shares in the open market. As you may recall, our stock repurchase plans authorized the company to purchase up to $50 million of the company’s outstanding common stock through December 31, 2017. During the second quarter, we acquired approximately 600,000 shares for $2.4 million bringing the year-to-date total to 1.3 million shares repurchased or $5.1 million.

Finally, as noted in our earnings release we recorded a $73.9 million non-cash goodwill impairment charge in the second quarter. The triggering event for the charge was a decline in the performance of certain reporting units relative to prior year as well as adjustments to our forecast and the decline in the company’s market capitalization. At the beginning of the year, we committed to grow in our technology based service offerings. Disciplined cost containment then enhances our cash generation and improvements in our capital structure. We continue to execute on these initiatives as evidenced by the growth in our new service lines such as AIM, cash flow from operations being consistent with prior year and continued pay-down of our Term A loan. With the challenges we faced with respect to revenue, we will continue to focus on our cost structure and invest prudently in sales resources and technology to fuel our future growth and continued to report a solid foundation to build on in the future.

At this point I will turn the call back to Suri. Suri?

Suri Suriyakumar

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

Question-and-Answer Session

Operator

[Operator Instructions] And we will take our first question from Ian Corydon of B. Riley & Company.

Ian Corydon

Thank you. So it sounds like in MPS, the weakness that you are seeing in your global accounts is nothing offset by I think you said strength in the regional accounts, maybe you could just give us some color there and maybe what the mix of business is and help us to try get a sense for when that business might turn around if you think again?

Suri Suriyakumar

Sure. I think the biggest impact we have is with the large accounts. This is basically if you take what we refer to as the global accounts and we have as you know 22 of the top 100. About 90% of these accounts are basically from the engineering and construction industries. This is the space which is being seriously affected by the energy and oil crisis and that has really had an impact on our customers. So that space which usually has would – should actually have a reasonable amount of activity, experienced much activity and that combined with the fact that we didn’t have one other renewal was definitely a dent on our revenue as well. The regional accounts usually pick up for it and we have tax sales, but it didn’t have enough to makeup for the flight. So for example, if you think about this is exactly what we have said in my comments earlier that last year first quarter our revenue dropped, right, but that’s actually related to the traditional revenues what we talked about. So yes, that’s just a bit hard, I apologize. So fundamentally what it means is that our MPS is picking softness. And as to when it will really pickup, so from the large clientele perspective if you take the customers who are related in the EMC industry, I don’t expect much of the recovery during the second half of the year. And I think what we need to really focus on is going after the regional clients to try to offset as much as we can during the second half of the year.

Ian Corydon

And have you said what the revenue mix is within MPS between global and regional?

Suri Suriyakumar

Yes. We can give you that, Jorge do you want to?

Jorge Avalos

Roughly the global accounts make up roughly 40% of the business with 60% coming from the local.

Suri Suriyakumar

Local accounts. So the smaller accounts are about 60% and about 40% of that comes from the larger global accounts.

Ian Corydon

Okay. And in the prepared remarks you mentioned you have added some technology functionality that you think will expand your addressable market, could you just give a little more color about what you are talking about there?

Suri Suriyakumar

Sure. So fundamentally, what we released I think this is sometime last year was the SKYSITE platform which is fundamentally addressing the project market, it’s what we refer to as project lane. So this is distribution of documents and information in the project space. And what we did last quarter or this quarter is that we released another version of that same SKYSITE product another segment which we refer to as InfoLink, what it simply meant is that this can actually store, retrieve all the archival documents and all of the facilities management documents. What it does is it allows us to start serving customers in the facilities management space on the same platform using the mobile tools we have. And as you know in the United States there is a large, what you call group of customers in that space who have big facilities whether in retail or whether it’s in healthcare or whether it’s in transportation all these spaces have large facilities and all these facilities have professional facilities manager. And then they want to access information which is primarily related to the facilities. So if you think about it they are largely construction based drawings, they are large format drawing and small format drawings which requires ability to search, the ability to [indiscernible] and store and retrieve that kind of features. Those features are already there in the ProjectLink segment. So, providing that for the facilities managers is going to allow us to expand and spread our tentacles in that space.

Ian Corydon

Got it. That’s helpful. And then any color you could give on SKYSITE revenues either directionally or more specifically would be great?

Suri Suriyakumar

So, I mean, it does not – the revenues have not just picked up meaningful enough to be able to for us to actually come back to the market and talk about it, but directionally, the growth is very good. Dilo, would you like to add any color to that in terms of how we are actually going to the market and what we are seeing in the market?

Dilo Wijesuriya

Yes. So, the SKYSITE adoption is continuing to grow. We have seen large homebuilders, large general contractors, even subcontractors and specialty contractors who really focus on document distribution and specific mobile-based workflows accounting to come into the company and we are very happy to see our current progress on the adoption of the software. The recent upgrade we did is that we brought the archival platform and the facilities management of document platform mowed into the same SKYSITE platform. So, our customers can really use it more between archived documents, workers, new construction projects. Also they can mow the documents and install in a single platform with single login, they will be able to view, manage and distribute and communicate using the same document in the same platform.

Ian Corydon

Appreciate it. That’s all I had. Thank you.

Suri Suriyakumar

Okay.

Operator

And we will take another question from Chris McGinnis of Sidoti & Company.

Chris McGinnis

Good afternoon. Thanks for taking my questions.

Suri Suriyakumar

Sure. Good afternoon.

Chris McGinnis

Just to dig into the decline in the CDIM business, could you just breakout what you maybe exited and what was, I guess the organic decline and I apologize if you have already stated it?

Suri Suriyakumar

No, no. Actually, I thought that was the question on my last question and I almost addressed that, so that’s what we were seeing in the prepared comments as well. Last year in the first quarter, our decline on the CDIM space was only nearly 2%, so we were very encouraged by that and we thought we will kind of keep that trend, but this year was much greater than that. That’s the point I was making. Jorge, can you give us a little bit of color? I mean, it went from 2% to 7%. How did that happen?

Jorge Avalos

Yes. We are looking at the colors. So, we mentioned a little bit about the UK operations and the closure of that facility. So, that was color works that’s embedded in CDIM so that contributed call it maybe about 1%, 2% of that drop in CDIM. And then we have always talked about the continued erosion and the traditional reprographics business that’s making up the bulk of that decrease.

Chris McGinnis

Okay. And so I guess just that 1%, 2% from UK operation will last until next year Q1 I guess when you lap out?

Suri Suriyakumar

Yes, it will continue to apply pressure on our revenue through the balance of this year.

Chris McGinnis

Okay. And it sounds like the pressure that you are seeing in the MTS is just the same, almost the same in the CDIM except for that technology shift as well that kind of correct I am thinking about it?

Suri Suriyakumar

Yes. I think overall in the general market conditions, what you are seeing in the MPS and the CDIM is kind of similar, because MPS by its own nature would actually sync, we know that. But what keeps that revenue on floor about revenue growing is the addition of new clients. But because in managed print services, our promise to the clients is that we will optimize their print, so the strategy is to get the clients and then optimize their print. But what has not happened in the two segments in the MPS space is where you have the large clients and the small clients, there is not a whole lot of upside with the large clients these days because of what’s going on in that space in the engineering and construction space and the number of small clients we are adding is not good enough to make up that difference in the shrinkage.

Chris McGinnis

I think do we just touch maybe on the gross margin, I guess the expectations for the back half of the year is – should we expect that to be a similar kind of year-over-year kind or erosion?

Suri Suriyakumar

Yes. I think that’s a fair directional way to look at it. I mean, second quarter is our strongest quarter with our highest margin. So, we would typically see sequential erosion there and the last year the proxy is a good way to look at it.

Jorge Avalos

Yes. The second quarter is the second strongest quarter, so third and fourth typically will be softer quarters, but one of the things which is happening in this transformation is that as we continue to work through all these new revenue is we are continuing to work on adjusting these numbers as you can see our SG&A dropped some amount. So, we will continue to massage [ph] those numbers and work towards optimizing our infrastructure and the cost trying to keep our margins strong, which is what we have done even in this quarter.

Chris McGinnis

Correct. Okay. And I guess looking at it on a year-over-year basis, I guess that’s similar decline maybe in the back half of the year, you keep your cost structure kind of what you are seeing, the cost structure say if I guess?

Jorge Avalos

Yes. Like I said, that’s a good directional way to look at it, but as Suri mentioned we are always pulling various levers to try to contain our costs.

Suri Suriyakumar

And optimize that number.

Jorge Avalos

Exactly.

Chris McGinnis

Alright. Well, thanks again.

Jorge Avalos

Directionally, the answer is correct. We will try to work on it.

Chris McGinnis

Okay. Thank you very much. I appreciate it.

Suri Suriyakumar

You are welcome.

Operator

[Operator Instructions] And with no further questions in the queue I would like to turn the call back over to Mr. David Stickney.

David Stickney

Ladies and gentlemen, we appreciate your attention this evening and your continued interest in ARC Document Solutions. Have a great evening. Thanks very much. Bye-bye.

Operator

And ladies and gentlemen, this does conclude today’s conference. Thank you everyone for your participation. You may now disconnect.

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