Tuesday, November 8, 2011

American Reprographics (ARC) Q3 2011 Results - Joel's comments on the transcript of the earnings calls

On November 7th, I put up a post on Reprographics 101 about ARC's Q3 results, so today's post is a 'follow-up' post of sorts.

At 5:00 pm on November 2nd, ARC’s management team held an “earnings call” to discuss, with financial analysts who follow ARC, ARC’s Q3 2011 results. The next morning, a written transcript of the conference call – statements made by ARC’s management team, questions asked by financial analysts, and responses to those questions by ARC’s management team – was posted on the web-site of www.seekingalpha.com. (SeekingAlpha is a fantastic resource for information about public companies.) If you want to access the written transcript of ARC’s earnings call, go to seekingalpha’s web-site and enter ARC in the search window.

In this morning’s blog post, I’m going to publish a few of the things that were published in the transcript (Q&A’s), so that I can comment on them.

Scott Schneeberger – Financial Analyst, Oppenheimer & Co.

Great. One more if I could. The (gross) margin was solid in the quarter, do you feel like the (your) cost structure is appropriate for this stabilized level of revenue? Is that more that you would like to do on that front, and if so what are the areas you are focused on? Thanks.

Suri Suriyakumar – Pres & CEO, ARC

It is appropriate where the cost structure is. Obviously like I said in my – when I was talking we certainly are very aggressive in taking quick action to make sure to keep the costs under control. We have always been like that Scott. So what we have done has produced the results, within virtually a couple of quarters. However, there are a lot of things that we did during the early part of the year, which is in the pipeline, such as you know whether you talk about leases, or whether you talk about equipment. Many of the things we are doing to restructure and rebalance the organization in order to position the organization for growth, all that is an ongoing thing now.

And as a result, there is more of it happening even as we talk. It is what we call the stay fit exercise. We are constantly looking at locations, we are constantly repositioning equipment and that is an ongoing thing now. Where we’re taking that in order to make sure we have the maximum efficiency. But right now the cost structure is pretty good for the revenues we have, and therefore any pick up on the revenues can only bring us tremendous benefits to the bottom line.

JOEL’S COMMENTS: ARC’s largest line-item cost is the cost of labor. That’s no different for any reprographer. During his presentation at the ERA Convention, Suri said that ARC employed nearly 6,000 people prior to the beginning of the recession, but, now, ARC employees approximately 2,800. That means that over 3,000 employees have had to be cut, during the recession (the latter, as we know, is still not over and done with in the A/E/C industry, the industry that most reprographers are heavily tied to.) Cutbacks in staffing are a natural consequence of ARC’s “stay-fit” exercise, and, in my opinion, cutbacks in staffing have contributed more to ARC’s cost-reductions than have re-negotiated leases and location consolidations. You could tell by Suri’s comments about ARC’s employment numbers that it causes him a lot of pain. He may be one to operate by the numbers, but he is, after all, human. As to the last comment that Suri made in the last paragraph of the portion of the transcript I posted above, the fact that ARC’s margins have improved, rather than declined, in spite of reduced revenues, means that ARC is doing a good job holding prices. ARC’s margin performance shows no evidence of ARC slashing prices to maintain revenues. When the A/E/C industry finally begins to show evidence of a recovery – and provided that demand for prints on paper come back strong (which some do question) – ARC should benefit, in a serious way, from that recovery, and experience an expansion in its margin …. and a rapid expansion in operating profit. ARC’s sales peaked at around $700 million, but, this year, will, I estimate, come in at around $420 million (see post I did a couple of days ago for my estimates of ARC’s forward revenues). While ARC’s employee population has declined by more than 50%, ARC’s sales have not declined as much, proportionately speaking, which means that ARC’s “revenues per employee” have actually increased. That’s a measurable gain in employee productivity and operating efficiency. My prediction: Two years from now, ARC’s gross margin will be 40.0% This past quarter, it was at 32.4%.

David Manthey – Financial Analyst, R.W. Baird & Co.

First off, could you tell us what you are all including in digital revenues today, and then if you talk about your transition to the seat license model and how that is doing, and also if you could address – I heard you talk about (inaudible) this quarter?

Suri Suriyakumar

Right. You know in terms of digital revenues it is all of the activities which comes from scanning, indexing, all of the services we provide customers, where they ask us to perform services related to digital activity. So it could be scanning, it could be indexing, it could be setting up files, all of the digital charges we have is what we are basically doing plus seat license. The dealer adds them. In addition to that we do have seat licenses.

So when we talk about the transition model, the seat licenses is only one aspect of it David. Obviously we have some software such as Planwell, which is actually the planroom, which is Planwell Enterprise and then we have Planwell Collaborate, and then we do have tools like (inaudible) Abacus and MetaPrint. So wherever we have customers engaged this software or employ this software to use we would charge them seat licenses. So that is a component of our digital revenues.

In addition to that, we would also have digital services, which is scanning, indexing, or any kind of outsourced work we’re doing for them in converting drawings and so on. Then on top of that with some customers when we provide them consultancy services that is you know again digital revenue as well.

JOEL’S COMMENTS: Sometime in the late summer or early fall of 2010, ARC reportedly began charging “seat license fees” to its end-user PlanWell customers and to non-ARC-owned reprographers who use PlanWell. Prior to that, ARC did not charge “seat license fees” to PlanWell users. Dave Manthey’s question, quite basically, was directed at the question of …. “did users accept (buy-into) that fee?” Quite recently, I posted a couple of articles on Reprographics 101 about an industry vendor called “ReproConnect.” ReproConnect offers e-planroom software (server-based or cloud-based, your choice), but, unlike ARC, ReproConnect does not charge “seat license fees.” Apparently, ReproConnect has been able to grow its reprographer-client base during the recession, and one (like me) wonders if some of that growth has come at the expense of ARC. I know of one reprographer who recently dropped PlanWell and went, instead, with ReproConnect, and one of the main reasons he/she gave me, was the fact that ARC began charging him for “seat licenses”, even though that was not part of the original deal when he first acquired PlanWell. It’s my understanding – and I could be wrong about this – that several PlanWell-user reprographers were told, after ARC first implemented the new “seat license fees” for PlanWell, that they did not have to pay the seat license fees, at least for the time being. And, oh by the way, there are still reprographers who offers the use of e-planroom services without charge for the e-planroom services. In fairness to ARC, ARC’s PlanWell e-planroom does offer features that ReproConnect’s e-planroom does not offer. According to the ReproConnect management guy I spoke to, one of his primary goals was to keep ReproConnect a very, very user-friendly, easy software to use.

David Manthey – Robert W. Baird

Okay, thank you. And could you give us an update on ishipdocs, any kind of growth numbers or anything?

Suri Suriyakumar

In terms of the ishipdocs, we had ishipdocs 1, and we just released ishipdocs 2. ishipdocs 2 is still at its very early stages. So the numbers haven’t changed, but with regard to ishipdocs 1, which is the primary driver of shipping documents and sharing documents within the construction space we are tracking about $6.5 million in revenues in that segment.

JOEL’S COMMENTS: Prior to implementing iShipDocs, ARC’s operations, across the U.S. (and outside of the U.S.) were certainly capable of transferring digital files to the city where the “completed, printed documents” were to be delivered. In other words, ARC’s locations were already capable of transferring print jobs to remote locations, instead of printing in the city where the order originated and then shipping the printed documents (the completed order) somewhere else. For all intents and purproses, ARC’s iShipDocs software is, in my opinion, mostly a “branding/marketing” initiative, at least for jobs that originate with from an existing ARC customer and are printed and delivered by an ARC-owned location. In those cases, ARC’s revenue from iShipDocs is not, in my mind, incremental (i.e., “new”) revenue. In my mind, “new” revenue (to ARC) is generated when a non-ARC customer is, because of iShipDocs, convinced to divert orders to ARC that would have been done by an ARC competitor. And, “new” revenue (to ARC) would include orders submitted through iShipDocs by non-ARC reprographers and orders submitted by ARC-operations to non-ARC reprographers. Because of this, I really wish that financial analysts would revise their questions about iShipDoc’s revenues and progress …. to ferret out the “new, incremental” revenues that iShipDocs is generating. Even without iShipDocs, reprographers, located in different markets, have, for years, been digitally transferring print jobs to other reprographers. Heck, I can remember back in the mid 1980’s, when we shipped hard-copy originals from Washington, DC to Los Angeles, so that the reprographer in L.A. (Blair Graphics) could “print and deliver locally in L.A.” without our customer having to pay substantial freight charges. Personally, I think ARC’s development of iShipDocs was a very wise idea - - - I just don’t know, at this point, how much “new incremental” revenue ARC is generating because of iShipDocs, because the analysts aren’t asking that question.

Suri Suriyakumar

Okay. So that category, Matt, when we take that category, we are actually categorizing when we say FM, it is actually FM/MPS. Am I right, Dilo. So what is happening there is most of the growth you are seeing, almost all of that is largely coming from the MPS growth. the number of FMs continued to stay stable. I think it is at 5000. Let me take a quick look here. 5900, 5895, so that is pretty stable, 5900. There are few customers here and there we would remove the FMs and there will be a few we will be installing.

JOEL’S COMMENT ABOUT ARC’S FM’s: Suri stated that ARC has around 5,900 FM deals in place. I’m so old that I can remember when the original ARC company – Ford Graphics – had zero FM’s.

David Manthey – Robert W. Baird

Okay, and then as it relates to the acquisition landscape, could you talk about, what it looks like today and how interested are you in doing deals at this point?

Suri Suriyakumar

Right. So obviously the landscape is not very good. When I say not very good as you know the industry has been pretty much devastated because of the downturn. And there are not a whole lot of competitors who are in good shape with regard to the companies themselves, because obviously many of them had substantial erosion of revenues and quite a few of them have got into financial difficulty, or operating purely marginally.

So where we are looking at David is that there are companies, which actually are unable to continue. If so we’re buying customer bases from them. So we typically refer to them as tuck in acquisitions. So we could actually if a company is nearly folding up and they didn’t have a whole lot of assets to sell, and they don’t have a structure. They can’t continue to run. Then we would actually providing – we’re legally clear, and we can acquire the customer base, then we would acquire those customer bases.

We call them tuck in acquisitions. There are a few we are doing like that, not a whole lot. but in terms of having large acquisitions, unless this is in an area where we have no presence at all we’re kind of not very interested in acquiring these companies for many reasons. One, the industry has substantially changed in the way we are operating. So these companies who had a traditional model would be significantly behind in terms of employing technology, document management or providing services to the customers.

So they are not wholly attractive, unless it is a market that we don’t have any presence on and there are a few markets like that in the United States, and might consider acquisitions in those markets. But largely where we would probably look for tucked in acquisitions and not necessarily a whole lot of acquisitions in the reprographics world.

JOEL’S COMMENTS ABOUT ARC’S ACQUISITION INITIATIVES : My conclusions, right or wrong, based on what Suri said .... (a) If you’re a reprographer in a market where ARC already has operations, don’t hold your breath waiting for ARC to come make you an offer. I think the exception would be that, if you are the dominant player (in terms of market share) in a major market where ARC has operations but scant market share (take for example, the Boston, MA market), I would think that you’ll get a call from ARC. (b) if you are a smaller reprographer and are hurting badly and can’t figure out how to stay the course, you might be suitable as a “tuck-in” acquisition for ARC. If you aren’t going to stay the course, why would you close up shop and get nothing at all, when ARC may be interested in paying you at least something for your customer base? One last comment about this, as to tuck-in acquisitions; there are other reprographers who may be interested in doing tuck-in acquisitions, in other words, ARC is not the only end-game for you. Better to have competition for your accounts than no completion at all.

End of post.

1 comment:

  1. I agree with your comments regarding ishipdocs. Right on.