ARC Document Solutions, Inc. (NYSE:ARC) Q4 2013 Earnings Conference Call February 25, 2014 5:00 PM ET
David Stickney - VP, Corporate Communications
Suri Suriyakumar - Chairman, President & CEO
John Toth - CFO
Jorge Avalos - Chief Accounting Officer
Brandon Dobell - William Blair & Company
Scott Schneeberger - Oppenheimer
Good day and welcome to the ARC Document Solutions Fourth Quarter and Full Year 2013 Earnings Conference Call. (Operator Instructions). At this time I would like to turn the conference over to Mr. David Stickney, VP of Corporate Communications. Please go ahead, sir.
Thank you, Jessica and welcome everyone. On the call with me today are Suri Suriyakumar, our Chairman, President and Chief Executive Officer; John Toth, our Chief Financial Officer; and Jorge Avalos, our Chief Accounting Officer.
Our fourth quarter and fiscal year-end financial results for 2013 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 website 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 website.
New to this call will be a brief summary of our results as an introduction to commentary from Suri our CEO and John our CFO. Our intent is to provide a more efficient call and a more direct path to questions from our audience. With that in mind 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 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, February 25, 2013 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.
As we noted in our press release today the company reported annual revenue for 2013 a $407.2 million, a year-over-year increase of $1.1 million representing annual growth for ARC for the first time in five years. The increase was driven primarily by sales in on sight services and color. Our annual gross margin was 33% compared to 30.4% in 2012, a year-over-year improvement of 260 basis points driven primarily by the restructuring activities we initiated in the fourth quarter of 2012 and completed by the end of the fourth quarter in 2013.
Adjusted annual EPS was $0.09 based on adjusted annual net income of $4.1 million. Our 2013 adjusted EPS compares to an adjusted negative $0.37 in 2012 and represents a $0.127 year-over-year increase.
Adjusted annual EBITDA for 2013 was $68.2 million or 16.8% which when compared to our margin of 14.9% in 2012 represents a 190 basis points improvement. Annual cash flow from operations was $46.8 million, a $9.2 million increase over year-end 2012 driven primarily by improved profitability.
Our balance sheet remained strong through 2013. We ended the year with cash at $27.3 million roughly flat to 2012 despite cash outlays of $4.3 million related to our restructuring more than $12 million in repurchases of our bonds in the open market and $5 million in cash payments related to our refinancing activities in December.
With regard to our senior debt on December 20th, 2013 we entered into a new term loan credit agreement that consists of a Term B loan facility in the amount of $200 million the proceeds of which were used to redeem our previously outstanding 10.5% bonds. The new term loan facility bears an initial annual interest rate of 6.25% which works out to be a 1% LIBOR floor plus 525 basis points a significant improvement over the 10.5% bonds it replaced.
The retirement of the 10.5% bonds resulted in an accounting loss on extinguishment of debt of $16.3 million of which $5 million were non-cash charges. Capital expenditures for the full year of 2013 were $18.2 million versus 20.3 million in 2012; the reduction reflects our continued efforts to achieve a 50-50 mix of buy versus lease for equipment acquired for our onsite services customers. Total debt including capital leases at the end of 2013 was $219.8 million versus $213.4 million as of September 30, 2013 and $222.5 million at the end of 2012.
The increase is attributable to our refinancing activities, net interest expense for 2013 was $23.7 million compared to $28.2 million in 2012. The decrease is partly due to a favorable comparison to 2012 and our interest rate swap ended but it is also due to a reduction of interest payments on bonds repurchase in the open market during 2013. With these basics as a context for continuing discussions I will now turn the call over to our Chairman, President and CEO, Suri Suriyakumar. Suri?
Thank you David. As you’ve heard from David’s business summary 2013 was a turning point for the company. The transformation we work so hard to achieve were successful and I’m very pleased that based on the strength we demonstrated throughout the year and especially in the third and the fourth quarter we have been able to achieve year-over-year annual sales growth for the first time in five years. Our management services, our MPS as we call it offering as matured very quickly considering we entered this market just six years ago. MPS comprises 30% of our overall sales and we are now the largest provider in the AEC space. Additionally Gartner named us as the 9th largest MPS provider in the world. Rightfully so we will continue to target the top firms in architecture engineering and construction as they represent a very fertile market for the foreseeable future.
Like MPS our efforts to transform our color business has contributed to our success in 2013, this represents another area where we have been able to make a significant impact on the market in a very short time developing the right brand to enter the marketing, retail and entertain space has opened up a much larger market for us to address and exposed us to a whole new set of clients.
While the lower project space activity has been the biggest driver of declines in traditional reprographics it still represents a 29% of our business in 2013. Thankfully the market is finally showing some signs of returning to strength, this could very well kick start sales again for us and add to the strength of our business outside of the large format printing. As we all know the AEC market is one of the largest industries to transform itself by embracing technology. Given our historical investment in development of technology I can’t emphasize enough how well this position serves with our core customer base. Today we’re building out of our mobile collaboration software offerings; in 2013 we introduced an integrated document workflow for the AEC professionals.
Our integrated applications now connect to one and another and include MPS software archiving and information management services or AIM as we call it and managed file transfer applications.
We’re also introducing new technology to enhance the consumption of data on the job site. We are doing this, we’re doing things like providing hyperlink digital drawing sets as well as supplying large touch screens to view and markup two dimensional plans and three dimensional BIM models.
And digitally archiving all this information continues to excite our customers and drive interest across the country every time we talk about our AIM solutions. We had small wins to our 2013 and we’re looking forward to reporting on some of the larger ones in the coming year. The AEC industry still offers enormous potential for products and services that play to our strength, our brand and our relationships and we’re as excited about the opportunities in the space as we have ever been.
These opportunities will add value to our customer’s projects and extend to our digital services business line. Other advances in technology this year include the formal launch of our AIM services, a business intelligence and analytics (indiscernible) package for our large customers as well as enhancements to the Abacus and our MPS software.
In fact Abacus enhancements help drive our fourth quarter win with CH2M HILL [ph], a well-recognized leader in the AEC space and a company we’re enormously proud to be supporting.
The exclusive contract will run through 2016 and the roll-out of our services is well underway in Canada, the United States and the United Kingdom. Addressing these large customers with technology continues to be a priority in our MPS strategy and supports our long term growth assumptions.
It is not just because of the size of such customers but also because of the commitment these customers are making to become more efficient and competitive in every area of their business. Such customers represent multiple strategic opportunities for ARC and we intend to make most of them. Second only to our emphasis on sales growth our focus inside the company was and remains on margin improvement. The restructuring of the company that was initiated in December of 2012 while difficult to produce results we continued to build on today.
We closed more than 30 smaller satellite center, downsized and consolidated others and we made selective headcount reductions and yet we were able to increase our overall sales year-over-year.
At the same time we invested in our sales and marketing teams and based on our full year performance it is clear that our planning and foresight paid off as we have avoided disruptions in operations and in customer service and stayed focus on meeting our customer’s needs. In 2014 the disciplined work of individual and specific margin improvement projects will cement these changes in place.
In terms of looking ahead we see construction activity gaining some speed in the foreseeable future but our relatively optimistic views for 2014 has been tempered by weather related events in January and February. Unfortunately in the early part of the year impacted businesses of all kinds and in every area of the country. The business closures indeed the closures of whole cities has had an impact on our business like any other. Our estimate so far is that we have launched more than $2 million due to the temporary closures of our service centers and of our customer’s officers in the East Coast in the South and in the Midwest.
Thankfully all of our employees have come through the snow and ice storm safe and sound and our facilities by and large have been undamaged. From what I’ve heard from customers and our field managers we served our customers well in alternate locations whenever and wherever we could accommodate them. In what has become a habit however we’re not going to spend a whole lot of efforts on issues like the weather where we have very little control. Instead we will continue to build on the solid work we have done in diversifying our business push hard into new areas like AIM and digital project workflow, look for new technology, enable the opportunities in an improving construction market and expand the base of our business in those areas that are driving growth including services like MPS and color.
With this in mind our outlook for 2014 for the annual adjusted earnings per share is in the range of $0.19 to $0.23 on a fully diluted basis and our outlook for annual cash from operations is in the range of $51 million to $56 million.
At this point I let John have the floor to offer some comments on our financial performance and then as usual we will take your questions. John?
As we have already reviewed the numbers for the year I would like to focus on some of the 2013 highlights to emphasis not only the strength of our ongoing recovery but also how our results demonstrate the transformation of our company. First and foremost was our performance in the fourth quarter relative to our third quarter. Obviously we returned the year-over-year sales growth in the third quarter but it was the fourth quarter that represented a significant change in pattern for us. As most of you know the last quarter of each year has been our traditional soft spot primarily due to the seasonal weather disruptions of construction activity nobody dwells in the snow and working days reduction that come with the year-end holidays.
In 2013 not only did we deliver year-over-year growth again in the fourth quarter but our sales in Q4 were equivalent to our Q3 sales for the first time in the company’s history as from the impact of acquisition. As Suri mentioned last quarter the stability and the predictability of work that comes with MPS engagements is beginning to override the cyclicality and seasonality of traditional reprographics.
While our sales performance in the fourth quarter was remarkable, our gross margin performance was even better. At 33.0% our fourth quarter gross margin improved 340 basis points over the fourth quarter in 2012. This is a significant accomplishment in and of itself but it was also a sequential bump of 50 basis points over the third quarter of 2013 on the same total sales of a $101 million. Our improvement in revenue growth and margin expansion had a dramatic impact on our cash flow from operations which improved 25% over 2012. Adding back the restructuring payments we made, our year-over-year growth in cash flow from operations would have been 33%.
Strong cash earnings continues to be a hallmark of our company as we generated over $1 of cash from operations per share. The significant margin expansion coupled with revenue stabilization where the main drivers behind the strong adjusted earnings per share performance. We delivered on a high end of our upwardly adjusted guidance and came in about a penny higher than we expected just 30 days ago as we finalized our year-end accruals which included accruals for executive bonuses.
Our restructuring activity delivered a number of benefits to our P&L statement and our profitability and it also helped us drive improvements in our credit metrics and opened up the potential for significant improvements to our capital structure. As a result we were extraordinarily pleased to extinguish our 10.5% bonds in December and reduced the interest rate on our long term debt by more than 40%. Our new Term B loan facility allowed us to move our senior debt into an efficient prepayable structure with minimal covenants saving us more than $7 million in annual interest that adds in other significant and accretive uses of cash is expected to be applied towards reducing our debt and this sets us up to take advantage of even better terms for our debt as our performance improves. Lastly I want to point out that we expect to see the benefit of our accumulative net operating losses or NOLs in 2014 and beyond.
As our profitability increases we estimate that our consolidated book taxes will be well below 20% because of our valuation allowance and on a tax basis as opposed to a book basis we have more than $90 million in NOLs. These NOLs will allow us to dramatically leverage our profitability into cash and aggressively reduce our debt. In summary we do not expect to pay more than $600,000 in cash taxes in 2014 due to our NOLs and we estimate that our book tax rate for 2014 will be below 20% versus our adjusted earnings per share tax rate of an estimated 38%.
As a result we expect our actual EPS to be several cents greater than our adjusted EPS for the foreseeable future. There is much more to talk about and I look forward to talking to you about how we will accelerate our progress going forward.
With that in mind I will turn the call back over to Suri. Suri?
Thank you John. At this time we’re available to take our callers questions. Please be advised that the team is in different locations today so please direct your questions to me and I will route them to others as required. Operator please go ahead.
(Operator Instructions). And our first question comes from Brandon Dobell from William Blair.
Brandon Dobell - William Blair & Company
Suri maybe for you first. The momentum you guys are seeing in the onsite services business, how sustainable is that and I guess to answer that question maybe you could address kind of how renewals are going and how the pipeline of new deals looks to be converting into contract in 2014?
So Brandon In terms of the sustainability, it is very sustainable and the reason I say that is we basically sell the management services in two major areas one is obviously on the large customers where we sell them through global solutions to the Top 100 AEC customers and then from a regional perspective our 200 sales people sell to 100,000 customer base. Those are largely smaller installations. In both ends of this business if you take the large customers we have a grand total of probably you know 20 plus customers at the larger end of the 100 large AEC customers, these are multi-million dollar contracts and we have long ways to go in terms of actually penetrating the rest, bearing in mind the fact that we’re the largest player in this space in the AEC space for management services and if you take the lower end of the business we have go after smaller customers we have 100,000 plus customers in our database and we have about 7500 call it 8000 installation at this point of time.
So both areas, both segments we have significant opportunities to grow our management services business. So that’s really an exciting part of our business. In terms of renewals with customers the larger customers you know they might have 3 or 5 year contracts and up till now our renewals have been going pretty well, we don’t have a whole other renewals coming up but whatever has been coming up we have been able to successfully renew. The smaller customers the renewal rate is not as high as the larger customers and the main reason is because of smaller customers might actually have inflations based on the projects they have or you know based on the revenue they are generating year-over-year. So the smaller customers tend to actually turnover fast but again the growth opportunities in that space is significant. Actually in the bottom level we could be signing as much as 200 plus contracts on a monthly basis and we could be having 30-40 contracts come into a closer because either the projects are finished or they have moved offices or they are going out of business in a downturn or they are looking to maybe upgrade to a different level or they got acquired by another company so there are various reasons but so it's about 30 to 50 I would think, John or David you can correct me there. You might have the information on the counter and with regard to larger customers our renewal rate has been pretty good.
Brandon Dobell - William Blair & Company
And maybe as an extension on that how important do you think the health or the recovery and the non-res construction industry is going to be to that business i.e. if companies are making more money do you think there are more or less willing to talk with you about managed print services or other things you can do for them, I’m just trying to get a sense of how they are the sentiment towards your offering may or may not change as the health of the end market changes.
My perspective is that companies are becoming increasingly aware of the efficiencies which are available in that space. I think this has been ignored for a long time and it's also is something that which has come with the consolidation in the industry especially with larger customers, they have been acquiring companies you know there has been significant amount of consolidation which has been going on with the big companies and those consolidations haven't proved or rather delivered the results they are capable of and one of the main reasons is that you know the companies are not totally integrated and they seem to have several layers of suppliers and what we do in this specific space by installing management services is we try to consolidate all their document requirements as a single source supplier. It's just not only offsite but also onsite, not just large format but also small format. Not just black and white but also color. So we’re in that space which where we connect tremendous value to our customers and increasingly as customers adapt technology they are going to realize that it's going to be much more beneficial to them not only in terms of saving dollars but in terms of saving you know administrative issues and then for example storage of their documents, retrieval of their documents, security of their documents, all of that substantially improves when you go to a single source supplier and be able to centralize documents on a single cloud with the kind of services we provide. So we expect this to gain momentum, the only thing which has been at least in my perspective in talking to customers holding this back is the fact that they are still getting familiar with the bit of technology and getting comfortable storing all these documents digitally, largely the construction customers have been driven by paper based document management and now change in the digital is taking time but they all realize it's time and we think they have significant opportunities for us to accelerate our growth in this space.
Brandon Dobell - William Blair & Company
Was there anything within the fourth quarter and I guess I would focus primarily on color and digital that you thought was not an anomaly but boasted revenues more than you thought. I guess specifically digital given the turn around and the growth rate there in the fourth quarter from negative to positive, anything you could call out that we should be aware of it, as you think about modeling the revenue growth and those two service lines for 2014?
So the digital services you know one of the things which we’re just feeling that growth is the AIM business archival information management and we’re starting to see as we said in our prepared comments more excitement from our customers as to how we can really deliver some benefits to them and those kinds of services we didn’t have relatively speaking 24 months ago, within also those kinds of services and that’s actually driving some excitement. Similarly on the color side the fact that we offer this high end color even though an easy customers who would have used us for color for project related work but maybe their marketing departments didn’t think of us seriously but now we are able to capture that entire scope of work that’s one which is driving the business.
Brandon Dobell - William Blair & Company
And then maybe some housekeeping ones, John maybe you guys gave stats for the AEC customers as a percentage of revenue in the fourth quarter. Do you have that, I mean if the full year and for last year’s fourth quarter that 76:24 split as you mentioned in the your release?
We do and I think it's disclosed in our 10K so I’m going to (indiscernible) my fingers while we’re talking but there is no material change in the balance. It may be a 1% change but nothing more than that.
Brandon Dobell - William Blair & Company
Nothing major. Last couple of years you guys have spent 18 million – 20 million bucks on CapEx is that a decent number that we should use for 2014 as well?
It's probably a bit high, our machine acquisition rate is about 30 million a year that rate is going to be that stable but we’re going to be shifting our mix at how we fund that $30 million between CapEx and capital leases mixing more towards capital leases. So I think we’re going to aim for that a 50-50 mix or a 50 CapEx, 50 new capital leases.
Brandon Dobell - William Blair & Company
And then final one for me, fourth quarter SG&A as we think about model in 2014 on a dollar basis how should the SG&A line move around on other some stock comp and then maybe if you could address also just trying to get my arms around the fourth quarter is a good kind of run rate or if you guys expect some expense growth on that line in ’14?
I think we expect some expense growth as we continue to invest in sales and marketing and certainly don’t want to comment further on this but in the fourth quarter because it's not although it was a great quarter as I pointed out we tend to have higher sales in Q2 and Q3, and we’re continuing to invest in that group developed with sophistication of our sales force et cetera. So Q4 is decent but I would expect on a percentage basis of sales our sales and marketing to be relatively flat year-over-year.
We will now go to Scott Schneeberger from Oppenheimer.
Scott Schneeberger – Oppenheimer
I’m curious about the weather in the quarter. It's been disruptive to a lot of companies we track and obviously project based work it's probably not too active in the first quarter I guess on seasonality but that exist probably was affected significantly and then you alluded to obviously some of the managed print services affected as well because people simply couldn’t make it to work. Could you give us a feel I think John you mentioned maybe 2 million of loss impact, how much more profound is that and then which bucket in the January, February time frame is this relative to normal was it big enough to have an impact on how you guided for this year and also historically I recall that it's more in the seasonal project business but you get a pickup in March versus January and February and seasonality. Are you seeing anything there yet and any comments that you can share, I know it's a multi-part question but thanks for taking all of it.
I will try to give the best shot and get John or Jorge to follow-up on that as well. Scott so you know what’s different about this year is where you like you said it typically effect; we do have some effect during because of the seasonality coming to December and January is slower on offsite work anyway with regard to project site work but this time we have literally had cities closed down for days and weeks sometimes and which means that people couldn’t get to work and all the offices were closed. So not only project related work gets impact but also the AIM related work or the MPS related work just you know complete chip down of segments of business that’s what so it's very unique this time. We usually have March pick up significantly and we certainly hope that will happen and we certainly hope weather won't play up again, you know have an impact in March and in fact if indeed March turns out to be a normal month we expect that to be variegate because all of the pent up work will actually flow into March. That typically happens and therefore that’s a very good possibility that we will have a strong March.
We don’t know exactly how these will fall into different buckets, we have obviously been tracking sales. You know John may be able to add a little more color to that but in a nut shell I think it's just this January, February is very different to what we have experienced in the past. In fact we likely said in our prepared comments we try not to worry too much about it, it's what we can do and there are something’s that which are beyond our control. However you know March it is a good chance that if things turn normal we could have a bump in our activity in March more than usual if indeed you know the way that holds. John any additional comments on that?
I think as Suri said we’re still understanding the impact and we so far we do expect it to be at least 2 million and likely more. As Suri said it moves across the buckets, when Atlanta got shutdown everything got shutdown. Customers offices, our shops, color projects, Houston had snow days, the Northeast, so unfortunately it is pervasive across our business lines largely. We do expect March to be a pickup and in the past one we see relatively significant but not to this scale weather events you will see work slip from one month another a postponement but with such a severe weather obviously we have had, although we expect a good March we don’t expect March to make up for everything that happened in January and February and particularly because February is a short month and lastly you did ask if we take it into consideration in our guidance and the answer is yes. So hopefully that helps.
Scott Schneeberger – Oppenheimer
I’m curious you talked about AIM on one of the last question and could you speak anecdotally some of the wins you’ve there. Just how things are developing? I know it's something you’ve been excited about. So it's just some kind of anecdotal conversation about what will you see, what impacts that you think that will have and then perhaps maybe digital as a percentage of mix longer term, how you’re thinking about that within the business and how AIM is driving it? Thanks.
From an AIM perspective, what we refer to as archival information management, you know while on it's own can be a large segment of the business. What makes it exciting for ARC is the fact that we can tie that AIM business into the other bucket, in another words we can tie that into management services, we can also tie that into the project work, we can also tie that into all of the rest of the documents which the customers have. So AIM as we put it for ARC has different meaning because we touch all of our customer’s documents in almost all of the segments wherever they touch documents. For example management services, by virtue of the fact that we literally see or touch the documents all of the documents our customers print whether they print it onsite or offsite all of that flows through Abacus, so it gives us a natural extension for us to have the ability to store those documents, licensing, before printing, after printing because it's already digitally those documents are flowing in our stream. So we have the ability to go to our customers and say look you know you’ve all these millions of documents flowing through your 146 offices and with literally a press of a button we can make sure they are all stored in the cloud. So therefore you would make that leads to the natural business opportunity you’re saying, that’s great which means we don’t have to continue to (indiscernible) and put it in bankers boxes and store them in warehouses or in our basement. What else could you do to actually make sure that we have similar access to those documents in the basement and that leads us to giving recommendations that we could actually scan all those documents because we have facilities across the United States and we could actually feed those documents also into the same space where we’re storing your current documents it will just be stored in different files or different segments and then similarly because we already have their project documents in plan we help them collaborate, we help them print, we help them share and now we’re helping them hyperlink and sync because all those features have been there with a press of a button we literally can move those documents also into the storage space.
So it naturally gives us ability because of the services we provide to move all these documents into storage and distribution that is why we’re very excited about AIM and that drives largely drives the digital revenues in two segments, one is the services we provide when they ask us to scan and upload or index drawings those are all digital services which we can provide them much more efficiently than they can do it themselves that’s number one. Number two is when those documents are stored in the cloud and they are being accessed and when they are being they are using our cloud space that gives us the ability to charge them for those services which are digital services on the cloud.
John would you like to add anything to that?
No I think that’s a great explanation of the integration of our services as they evolve. I think we have a lot of folks who are adjusting to the idea that digital archives that is that accessible. We have just put the finishing touches on a proprietary document that is the model retention policy, document retention policy for the AEC industry. We hired experts, we did a survey of our customers, we collected the data and we assembled it into a 50 page document that is ours and it outlines how companies should save documents, where they should save them, for how long, by type, helps them organize and we’re just releasing this document next week to some of our select customers to help them sort through the mountains of data that they have and we look forward to that release and it's really beginning to set us up as an expert in archiving almost as a consultant. So we’re very excited about the progress we’re going to make this year.
(Operator Instructions). We will now go to (indiscernible). Glen has removed himself from queue. (Operator Instructions). And it appears there are no further questions. I will turn the conference back over to our presenters for any additional or closing remarks.
Ladies and gentlemen we appreciate your attention and continued interest in our document solutions. Have a great evening. Good night.
This concludes today’s presentation. Thank you for your participation.