ARC Document Solutions, Inc. (NYSE:ARC) Q1 2023 Earnings Call Transcript

ARC Document Solutions, Inc. (NYSE:ARC) Q1 2023 Earnings Call Transcript May 7, 2023

Operator: Ladies and gentlemen, thank you for standing by, and welcome to the ARC Q1 2023 Earnings Report Call. I would now like to turn the call over to David Stickney, Vice President of Investor Relations. Please go ahead.

David Stickney: Thank you, Mandeep, and welcome, everyone. On the call with me today are Suri Suriyakumar, our CEO and Chairman; our President and Chief Operating Officer, Dilo Wijesuriya; and Jorge Avalos, our Chief Financial Officer. Our first quarter results for 2023 were published 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 and are only predictions based on information as of today, May 3, 2023, and actual results may differ materially as a result of risks and uncertainties that we highlight in our quarterly and annual SEC filings. Any non-GAAP measures discussed today are reconciled in our press release and our Form 8-K filing. I’ll now turn the call over to our Chairman and CEO, Suri Suriyakumar. Suri?

Suri Suriyakumar: Thank you, and welcome, everyone. Today, we reported results that are aligned with our growth strategy and bottom line objectives. Demand for digital printing remains steady. We delivered incremental growth in on-site printing and scanning grew significantly during the quarter. Sales were soft in our equipment and supplies and construction plan printing but as we have stated before, these products and services are not strategic part of our business mix anymore. Absent further pressure on capital spending, which can affect construction printing and equipment purchases, we remain confident in our ability to deliver moderate overall growth in 2023. Our bottom-line results demonstrated the leverage we can exert within our cost model as we continue to improve margin performance faster than sales.

Gross margins grew, operating profits rose and net income was up despite the 1% drop in overall sales. Importantly, cash flows also remained healthy, ensuring an annual dividend equal to or greater than we issued last year. It also leaves us plenty of room to acquire more of our own stock when the opportunity arises. To help explain the environment of our first quarter and how we met the challenges and opportunities it presented, I’ll now turn over the call to Dilo and Jorge for a review. Dilo?

Dilo Wijesuriya: Thank you, Suri. Our strategy to transform our customer base and our services is continuing to pay dividends. If not for the miss in revenue from our equipment and supply sales, we would have had another quarter of overall revenue growth. During the first quarter, the market was inundated with challenging economic , including higher interest rates, employee layoffs, regional banking issues and continuing inflationary pressures. Inside the company, we also saw a reduction in spend from large technology companies and with some design and construction clients. Even with these negative market conditions, we were able to produce good results for the company. Demand for color graphics work was strong, and we saw customers increasing their marketing and trade show activities despite the weaker market conditions.

The COVID-related travel issues are behind us, and our customers are continuing to expand their marketing activities. We also saw an expansion of customers who are looking for high-quality digital printing. As we have discussed before, digital printing doesn’t stop in the face of declining consumer spending or recessionary fears. Big event-driven projects can sometimes be sidelined or delayed in such times, but marketing via our digital printing is needed even more to keep businesses in business. In addition, companies continue to pay attention to their workplaces in order to retain talent and build a good working environment as well as attracting and hiring new talent, interior graphics play a big part in improving the morale and the culture of the workplace.

Our digital interior graphics printing services are well-aligned with this growth segment. As noted earlier, weakness in the construction industry had an impact on plan printing and interest rates suppressed equipment purchases, neither of which drive our growth strategy. By contrast, we had robust growth in document scanning and imaging services more than 10% year-over-year. Customers are recognizing our ability to manage large and complex projects and most importantly, our commitment to complete the project on time and on budget. Good customer referrals are also helping us to establish ARC as a reliable technology-driven document scanning company. Our backlog of work is strong, and our scanning sales pipeline is increasing. With an increase in demand for scanning, we are adding more production capacity at some of our regional centers but these investments are not large enough to have a meaningful impact on capital expenditures.

We noticed that our target customers have funding to digitize their documents and further strengthen their information workflows. We are happy to see improvement of wins from our public sector customers. Their funding is stable, and we intend to capitalize on that opportunity. On-site print volumes were up slightly with incremental activity and we expect small moves up and down for the balance of the year. Our strategy to make ARC-certified devices available for on-site placements and equipment sales is helping our customers to achieve significant cost savings while ARC enjoys a reduction in capital needs and improved margins. Our management teams were able to successfully increase our gross margin. Some of the supply chain issues and wage pressures have calmed down, and investments we made in upgrading our production equipment in the past are helping us to improve production cost and also the quality of our products.

Our teams at all the locations take pride in delivering a memorable service to our customers. Customers have been reciprocating with favorable online reviews. This strategy helps us immensely with our online marketing programs. We are happy with our social and e-mail marketing programs and are continuing to fine-tune the delivery and messaging to attract new customers. We also hold our customers to determine our Net Promoter Score, essentially asking them if they would refer us to a colleague. And our overall score was 87% putting us in the company of some of the best customer service in American business. The referrals we received from our demand gen programs are a driving force for our sales conversions. In quarter one, for example, we won a large multiyear on-site printing deal in Saudi Arabia without having a physical presence in the country, all because of referrals from other large international customers.

We are also looking deep into opportunities from our customers in new industry verticals, aviation and general transportation, to name a few. Our team continuously listens to what our customers need and we make every attempt to design new services that can be produced from any service center and sold to all our customers. We have a great team across our sales, marketing and operations departments and their good work will continue to help us grow throughout the rest of the year. At this point, I’ll give the floor to Jorge for a review of our financial performance. Jorge?

Jorge Avalos: Thank you, Dilo. Overall revenue fell 1% during the first quarter, but if we exclude the drop in equipment and supply sales, we would have reported our eighth consecutive quarter of year-over-year growth. It is important to note that the business lines that experienced contraction during the quarter, namely plan printing and equipment and supply sales, are not strategic to our growth initiatives. Their decline is not surprising considering the increased cost of funds for capital expenditures. Despite the softness in sales, we saw solid improvement in profitability year-over-year, reflecting the efficiency and flexibility of our cost structure. The numbers speak for themselves. Gross margins grew by 100 basis points.

SG&A was flat in the face of higher labor costs and operating income increased nearly $400,000 or 12%. Adjusted net income was up also 10% year-over-year as we delivered EPS of $0.05 for the quarter. While we expect average EBITDA per quarter to be $10 million or more in 2023, this year will likely near 2022 and it’s build up over the three remaining quarters. EBITDA for the first quarter came in slightly under last year’s performance at $8.7 million. We are on track to exceed prior year’s full year cash flows from operations considering the fact that Q1 came in nearly $1 million over prior year. We remain committed to our annual dividend of $0.20 or more for 2023, and the opportunistic purchasing of our own stock on the open market remains a part of our plan to return shareholder value.

As a reminder, with regards to investing and financing cash flows for the year, we expect payments on finance leases will decline by approximately $3 million in 2023. The total annual need for capital expenditures remains low but as interest rates continue to rise, we are choosing to purchase more equipment with available cash versus acquiring it through finance leases. Debt, net of cash, was $50 million as of March 31, which represents a reduction of more than $100 million over the past 5 years and a reduction of more than $50 million from the start of the pandemic. Even with the rise in interest rates, our debt service cost is minimal and our quarterly interest expense of $450,000 will remain consistent throughout the year. As I said last quarter, our focus in 2023 is to grow the bottom-line and increase the cash we generate to support and expand our return of shareholder value.

In that regard, we made good progress in the first quarter. I look forward to sharing more with you as the year continues. With that, I’ll turn the call back to Suri. Suri?

Suri Suriyakumar: Thank you, Jorge. Operator, we are now available for our listeners’ questions.

Q&A Session

Operator: . Our first question comes from the line of Greg Burns from Sidoti & Company. Please proceed.

Greg Burns: Good afternoon. I just want to dig into the digital printing side of the business first. Can you just give us a breakdown of how much plan printing was down versus, how much growth you were seeing in digital printing? And then, specific, were there any specific within digital printing, was there specific vertical markets that were down? Which markets were verticals were down and where were you seeing growth in that side of the business? Thanks.

Suri Suriyakumar: Jorge, do you want to go with that, or Dilo?

Jorge Avalos: Yes. Maybe I’ll give a quick color on the numbers, and then I’ll let Dilo add on. Overall, we were happy with our results in digital printing for the fact that we saw continued solid single-digit growth in our color graphics side of the business. The part of the business that was a bit muted was our construction plan printing, which basically was down also single digits offsetting the increase in our strategic product line, which is the color graphics. Dilo, do you want to add a little bit more color?

Dilo Wijesuriya: Yes. So the easiest way to see that, when Jorge said we were happy with our digital printing side of the business that we’ve been focusing on. We’ve serviced about 50-plus customer verticals today. All of those verticals bought color services from us. So when we say very happy, we are very happy that all of them are able to recognize the level of service that we can provide, the types of digital printing that we can provide for our customers. So they are continuingly using our color services for marketing, trade show work, interior graphics, improvements they are doing for their offices. So therefore, the digital printing is a very good growth area for us because every customer vertical used it and we will continue to market for to that area.

Area that we saw a slowdown was the construction vertical, especially the small subcontractors, building renovations, some of the permitting work that we see at the local city level. That activity slowed down with the interest rates going up. We saw that some amount of the printing work reduced. So that’s a little bit of color on the customer side.

Operator: Our next question comes from the line of , private investor. Please proceed.

Unidentified Analyst: Congratulations on continuing to expand margins and diversify the customer base. Given the recent strength in the business, is management and the Board at all interested in conducting a strategic review of the business for possible sale? With the company’s strong cash flows and lots of dry powder in the private equity markets, it seems that now is an opportune time to maximize shareholder value by conducting a strategic review to possibly sell the company. If there is hesitancy to conduct a strategic review, why not go through the process? And if nothing comes of it, then nothing’s hurt. Just want to get your thoughts on that perspective.

Suri Suriyakumar: Well, that’s not a question we have gotten in the past. But I can tell you this, right now, we don’t see a need or an opportunity to do a strategic review because, as a company, we are continuing to do very well. We have growth coming in our way. Cash flows are strong. Our debts are very good and so from all aspects, we have a very good balance sheet. We don’t see a need to go out there, but we can continue to build on this business.

David Stickney: Mandeep, do we have another question?

Operator: Our final question comes from the line of David Marsh from Singular Research. Please proceed.

David Marsh: Hey, guys. Just wanted to drill into your comments about banks and financial services a little bit. Obviously, it was a challenging quarter for banks in particular. Could you talk about what percentage of revenues banks and financial services represented in FY ’22 and perhaps what the performance looked like on a quarterly basis year-over-year in that specific sector?

Suri Suriyakumar: Dilo?

Dilo Wijesuriya: Yes. Our exposure to the banking sector is very small. In fact, we don’t have a lot of large banks or the national banks working with us for printing and other services. In fact, our exposure is very, very, very small. And we in fact, if we are working with, we mostly work with some of the local banks or the regional banks for some of the marketing activity and so forth. However, that segment vertical is a very small segment for us which we had to continue to develop in the time to come. But based on historical performance, it’s a very, very small amount.

Suri Suriyakumar: .

David Stickney: Mandeep, do we have any further questions?

Operator: Our next question comes from the line of Greg Burns from Sidoti & Company. Please proceed.

Greg Burns: Just one more on the share buyback. What was the status of your current buyback? And what do you look at in terms of how you assess that? And maybe like, I guess, more directly, why aren’t you buying back stock now? Thanks.

Jorge Avalos: I’ll be happy to report that our Board just approved to increase our share buyback from $15 million to $20 million of which we have roughly $12 million left. So that’s definitely a good thing. And to answer your second question, it’s still part of our strategy to opportunistically go out there and buy shares in the open market. Unfortunately, the way the first quarter ended, at the end of the quarter, we had very little time to go out into the open market to buy shares. But it’s something we’re definitely looking to do here in the coming quarters.

Suri Suriyakumar: Yes. Fundamentally, we are being very opportunistic about it, Greg. But obviously, as a small company, we have a lot of restrictions as to when we can buy and when we can trade. For those reasons, sometimes we have limited access to the market but if the opportunity is right, when we have cash in hand, absolutely, we’ll continue to do that.

Operator: Thank you, ladies and gentlemen. This does conclude today’s call. Thank you for your participation. You may now disconnect.