We recently conducted a survey of 30-35 independent reprographers to gain a better understanding of industry-wide trends during 1Q10, their outlook for 2Q10 and the rest of 2010, and how BIM has impacted the sector thus far. In general the results of our survey suggest that revenue trends for reprographers are slowly stabilizing, albeit at low levels.

As a reminder, gold and institutional subscribers can download the full survey on the “Surveys” page.

Most Reprographers Are Still Witnessing YOY Revenue Declines, but Revenues Appear to be Stabilizing Albeit at Low Levels

Approximately 60% of the reprographers that responded to our survey witnessed a YOY decline in revenues for 1Q10.  In the first quarter of 2009, many reprographers were still benefiting from project work commenced in 2008 that was in the process of winding down.  Although a majority of respondents witnessed a YOY decline in revenues in 1Q10, the magnitude of decline appears to have lessened and there was a solid uptick in the number of firms that  generated positive YOY comps in the quarter.  In our Winter survey, only 12% of respondents indicated that revenues had increased on a YOY basis for 4Q09.  For our Spring survey, that number had increased to 28%.  The charts below compare the YOY revenue change for 1Q10 and 4Q09 witnessed by the independent reprographers we surveyed in the Spring and Winter, respectively.

Source: PAA Research

It appears that trends have improved for most reprographers compared to 4Q09.  We would not get overly enthusiastic about the improvement as it appears to be largely a function of easier comps.

Source: PAA Research

Sequential Uptick in 1Q10 Revenues More Muted Than in Years Past

From 2002 to 2008, ARP generated an 8.3% sequential increase in revenues on average from the fourth quarter to the first quarter.  The company’s fourth quarter is typically the weakest, while the second quarter is the strongest in terms of revenues.  Construction activity typically builds over the course of the year and peaks in the warmer months.  As a result, most reprographers witness similar seasonality in revenues as ARP.  This year it appears that the normal sequential improvement in revenues from the fourth quarter to the first quarter was more muted.  According to our survey, only 31% of respondents generated an increase in revenues in the first quarter compared to the fourth quarter, while another 28% witnessed flat revenues.  Theses results confirm our view that the general improvement in YOY revenue trends is largely a function of easier comps.

Source: PAA Research

Southwest States and California Continue to Exhibit Relative Weakness

As indicated by management on ARP’s most recent earnings conference call, revenue trends for reprographers operating in the Southwest, including California, have been weaker than the national average.  The results of our survey suggest that relative revenue weakness continued in the first quarter. 75% of respondents located in the Southwest witnessed a YOY decline in revenues in 1Q10.  Stated another way, almost half of the repographers that we surveyed that witnessed a decline in revenues in 1Q10 were located in this region.

Source: PAA Research

Capacity Utilization Remains Anemic

Industry-wide capacity utilization remained weak during the quarter.  Improved capacity utilization will be the single largest factor enabling ARP to once again achieve 40% gross margin levels.  The secular decline in print orders per project has lowered capacity utilization for almost every reprographer over the past 5-7 years.  The economic downturn exacerbated this trend and has taken capacity utilization to almost unsustainable levels.  Approximately 45% of reprographers we surveyed utilized less than 50% of their production capacity during the quarter.  These results are consistent with the survey we conducted in the Winter.  Should these trends continue we anticipate that many smaller operators will be forced to close their doors, or at the very least pursue other significant cost reduction efforts.  On a positive note, most reprographers expect capacity utilization to increase by approximately 10% for the second quarter.

Source: PAA Research

Economic Concerns Trump Those About BIM/Digital Solutions

Although many reprographers remain concerned about the proliferation of digital solutions, expansion of BIM adoption, and a potential rebound in paper and fuel costs, the economy remains the largest area of focus for most operators.  According to our survey the overall economic environment and the health of customers remain the two biggest concerns for reprographers.

Source: PAA Research

Most Reprographers Expect to Generate Flat Revenues or a Slight Increase for 2Q10 on a YOY Basis

The reprographers we surveyed are somewhat optimistic that revenue trends will improve on a YOY basis for the second quarter.  It is important to keep in mind that the results of our Spring survey suggest that 1Q10 revenues for most reprographers fell slightly short of their expectations three months ago.  According to our survey, approximately 50% of respondents expect to generate positive revenue growth in 2Q10, while another 22% expect to witness flat revenues.  At this stage, that level of stabilization in revenues on a YOY basis is not reflected in street estimates for 2Q10 for ARP (consensus implies a 12.7% YOY decline).

Source: PAA Research

Measuring BIM’s Impact

The potential impact that the proliferation of Building Information Modeling (BIM) could have on trends in the reprographics industry has become a significant area of concern for operators and investors alike.  At this stage there is a great deal of uncertainty surrounding what impact BIM could have on overall print volumes.  In a recent report we discussed what initiatives ARP management is pursuing to combat declining print volumes and the potential impact of BIM.  These include: expansion into color, facilities management contracts, growth of RCMS Group (ARP’s BIM consulting division), monetization of PlanWell, and continued development of ishipdocs as a distribute and print platform.  In our view, ARP is well positioned to combat any decline in print volumes due to BIM and position itself as a leading managed printing services provider as the industry continues its evolution from print and distribute to distribute and print.  You can read more here.

Given the level of uncertainty surrounding BIM and its impact on reprographers we thought it might be interesting to solicit feedback from operators to see what they have experienced thus far.  The results were somewhat surprising.  It appears that BIM adoption remains in its nascent stages and the overall impact on print volumes, at this point has been less than feared.

BIM Adoption Remains in the Early Stages

Approximately 80% of the respondents to our survey indicated that less than 25% of their clients have adopted BIM as their primary drafting and planning tool.  Although BIM products and solutions have been available in the marketplace for a number of years, it appears that adoption continues at a relatively slow pace. This could accelerate as economic activity increases, but for now architecture, engineering, and construction (AEC) firms have taken a measured approach.  Based on the feedback we have received from AEC operators, adopting and implementing BIM remains a complicated process.  The low penetration rate of BIM solutions should provide ample revenue opportunities for ARP’s RCMS Group.

Source: PAA Research

The Impact on Printing Volumes Thus Far Has Not Been as Significant as Some Have Feared

We were shocked with the responses to our question surrounding the impact BIM has had on print volumes for those clients that have adopted it.  There are some people in the investment community that think that any client that adopts BIM will stop printing plans and other wide format documents altogether.  Thus far this does not appear to be the case.  According to the reprograhpers we surveyed, those clients that have adopted BIM have only reduced print volumes modestly.  It is possible, if not likely that the reduction in print volumes will accelerate over time as more and more firms adopt BIM, but for now, the impact has been less than feared.  The combination of a low penetration for BIM and a modest reduction in print volumes for those firms that have adopted it implies that BIM’s full impact will not be realized for as long as 5-7 years, in our view.

Source: PAA Research

Most Reprographers are Making a Big Push Into Color, Targeting Non-AEC Clients to Offset Revenue Declines

As we discussed in our most recent report on ARP, the secular decline in the number of print orders per project has been ongoing for over a decade now. It’s most easily reflected in the decrease in average revenue per branch that ARP has witnessed over the past 10-years.  ARP’s average revenue per branch has declined more than 50% over the past 10-years.  Of course some of that can be attributed to cyclical factors, but even during the prior economic peak, average-revenue-per branch had declined 30% from 1999 levels.  Over the past 3-6 months APR has introduced a number of initiatives to enhance branch capacity utilization.  The company has started to target more non-AEC clients and introduced “Riot Color”, it’s color printing solution for both AEC and non-AEC clients.  It appears the company is not alone in these strategic pursuits among reprographers.  According to our survey, the majority of respondents expect increased focus on non-AEC clients and expansion of color printing capabilities to serve as an offset to the secular decline in prints ordered per project.  It is clear that ARP is not alone in its efforts to expand beyond traditional reprographics services.  Given its national scale and superior technology platform, we think ARP has unique advantages in these endeavors.  ARP already generates 15-20% of its revenues from color printing services; to some extent the company has a head start. We anticipate both non-AEC print business and color could add 1-3% to revenue growth annually over time for ARP.

Source: PAA Research

Survey Results Support Our 1Q10 and 2010 Estimates for ARP, Another Year of Robust FCF Generation

Overall the results of our survey suggest that ARP should meet, if not exceed consensus estimates.  The company still generates more than 30% of its revenues in the state of California, which remains a drag on the company’s operating results. Additionally, we estimate ARP generates approximately 15-18% of its total revenues in the Northeast and Mid-Atlantic, where severe winter weather forced the closure of several branch locations for as long as 5-10 days in the aggregate during the quarter.  We estimate this could negatively impact revenues by $1.5-$2.0 million for the quarter.  In the table below we outline our estimates compared to street consensus.  Based on the feedback from our survey, ARP’s company specific growth initiatives (color, RCMS group, facilities management, and ishipdocs) we anticipate we could finally start to see positive revisions to revenue forecasts starting with the second quarter.

Source: PAA Research, Yahoo Finance

We currently forecast that ARP will generate $61 million in free cash flow in 2010, which would represent ARP’s fifth consecutive year of generating more than $60 million in free cash flow.  In the short term, we expect ARP to focus on repaying debt until there are stronger signs of a recovery in non-residential construction activity. This implies that shareholder value creation in the short term will come in the form of debt reduction.  We forecast that ARP will reduce its debt outstanding by approximately $50 million this year, which would bring its total leverage (debt/12-month trailing EBITDA) to just over 2.0x.  ARP should exit 2010 with a great deal of financial flexibility and could be well on its way towards becoming a much more modestly levered company.  ARP trades at 7.5x and 5.9x our EBITDA estimates for 2010 and 2011 and also boasts a free cash flow yield of 14%.  We think the stock is poised for continued multiple expansion as investors become more comfortable with the impact BIM could have on the company’s growth prospects and ARP’s ability to evolve into a managed printing services provider.

As always, please act accordingly…