Thursday, May 7, 2009

When you consider what the reprographics industry has been facing these past few months, ARC's Q1 2009 results are stunning!

Okay, ARC reported its Q1 2009 results this afternoon, and after looking over the numbers ARC reported, I AM ….. STUNNED! ….., and here’s why I’m stunned.

First, as I’ve previously explained on this blog, I was, until I left the company we sold in December 2007, deeply involved in the reprographics business and industry – and was involved for many years – two different extended careers – and both of the companies I was involved with were fairly sizable enterprises. Second, I’m a financial person by educational background (Accounting/Finance/CPA), and it has always been my habit to look at the performance of companies in the reprographics industry both from a management and strategy perspective and a financial/performance perspective. What I’m trying to point out is that, while I may not be a genius (nor even particularly smart), I do have an excellent understanding of the numbers involved in the reprographics business and industry, and ego aside, I’m probably in the top 5% in the industry regarding those who understand the numbers, including what had to have happened behind the scenes to make the numbers happen.

That out of the way, let me explain why I’m stunned by ARC’s Q1 2009 numbers:

#1 – ARC’s total revenues, Q1 2008 vs. Q1 2009, declined approximately 25%, YET, in spite of that sizeable decline, ARC STILL EARNED A SUBSTANTIAL PRE-TAX PROFIT! Holy cow - - - if you surveyed 100 companies in the reprographics business and asked them, “would you be able to continue earning a profit if your sales very quickly dropped 25%?”, the substantial majority would say, “probably not”, followed by, “please don’t pursue this, because I’m already getting serious heartburn just thinking about it.”

#2 – What makes ARC’s Q1 2009 pre-tax profit performance even more remarkable is the fact that ARC’s “reprographics services” revenue segment declined by nearly 30% when compared to Q1 2008. All reprographics companies have significant investments in their “production centers” (some of us call them “stores.”) And, production centers do require substantial fixed-cost investments. FOR A “reprographics” COMPANY TO EXPERIENCE A 30% DECLINE IN SALES AT ITS PRODUCTION CENTERS, BUT STILL BE ABLE TO EARN A SUBSTANTIAL PRE-TAX PROFIT (NEARLY 10%), IS TRULY REMARKABLE.

I did notice that there was only about a 10% decline in FM sales, YOY, Q1 2008 vs. 2009, and I’m guessing that that “not- so-bad decline” was aided by the “national” FM deal ARC announced, last year, with a very sizeable company, HDR, one of the premier engineering/architecture companies in the U.S. (and a bunch of very nice people, speaking from my own personal experience with HDR.)

#3 - Most reprographers who experience a 30% drop in sales would go from earning profits to realizing losses! Of course this is just my opinion, but I DO THINK THAT ARC’S MANAGEMENT TEAM HAS (AND, HERE, I’M EXTENDING THIS TO ARC’S REGIONAL CEO TEAM AND TO ARC’S DIVISION OPERATING TEAMS HAVE) DONE AN AMAZING JOB AT “RIGHT-SIZING” ARC’S BUSINESS UNITS.

Early this evening, I learned that Morningstar’s analysts had issued an updated report on ARC, so I visited Morningstar’s report on ARC (I am a Morningstar subscriber.) I don’t think that Morningstar’s analysts yet have a firm grip on what a reprographics company is and how the business and industry work.

Here’s a small excerpt from the commentary that Morningstar’s analysts said this afternoon:

“Despite ARC's size, we have a few concerns. First, the construction industry accounted for almost 90% of ARC's revenue during 2008. Not surprisingly, the downturn in the construction industry has hurt demand for ARC's solutions. Second, the firm can be outbid by regional reprographers for smaller jobs that don't require the superior delivery and information flow management that are ARC's forte. On the national level, wide-format printer distributors vie to place and service their equipment at clients' facilities, thus capturing ARC's facilities-management revenue. Finally, the copy and printing businesses with large hub-and-spoke networks can be replicated by other firms, such as FedEx Kinko's FDX.”

Okay, now for my comments about Morningstar’s comments:

a) ARC cannot be outbid by any reprographics firm in the U.S. (or, for that matter, in the world.), unless ARC wants to be outbid. ARC has a cost-advantage over every company in the reprographics business. Evidently, Morningstar doesn’t have a clue about that …or why that is.

b) The industry’s largest wide-format equipment vendor does not compete for FM business in the A/E/C segment in the U.S. This vendor does do that big-time in Europe, but not at all in the U.S. [And, according to that company’s president for wide-format equipment in the U.S., who I do know and did query personally about this particular issue, that vendor has zero plans to compete with reprographers (including ARC) in the A/E/C FM space.] And, the industry’s second largest wide-format equipment vendor does not compete for FM business in the A/E/C segment in the U.S. (or, for that matter, not at all in Europe.) I don’t know what the guys/gals at M’Star are smokin’ (must be some good stuff), but A/E/C firms who truly understand the reprographer-FM concept would not bother to even consider acquiring equipment (from the industry’s equipment manufacturer-vendors) via purchase or lease.

c) Fedex’s Kinko’s business unit is a complete “non-factor” in the A/E/C space. Kinko’s has never been a player in the A/E/C reprographics industry and, unless Fedex hires someone who has significant experience in the A/E/C reprographics space (and, that presumes that Fedex management wants to do that, which I seriously doubt is the case), Fedex’s Kinko’s business unit will continue to be no competition to ARC or the A/E/C reprographics industry overall.

Finally, I’d just like to say that I extend my congratulations to ARC’s management team (not just to the corporate team but to the regional CEO’S and their teams as well) on another excellent quarter. Q1 2009 was, in all likelihood, the most challenging quarter the reprographics industry has faced since the beginning of the Great Depression …. And ARC still managed to earn very decent money. Damn, that’s outstanding performance!

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