ARC Document Solutions, Inc. (NYSE:ARC) Q1 2024 Earnings Call Transcript

ARC Document Solutions, Inc. (NYSE:ARC) Q1 2024 Earnings Call Transcript May 7, 2024

ARC Document Solutions, Inc. beats earnings expectations. Reported EPS is $0.06, expectations were $0.05. ARC Document Solutions, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by. My name is Pam, and I’ll be your conference operator today. At this time, I’d like to welcome everyone to the Q1 2024 ARC Document Solutions Earnings Report. [Operator Instructions] Thank you. I’d now like to turn the conference over to David Stickney, Vice President of Investor Relations. You may begin.

David Stickney: Thank you, Pam, 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 2024 were publicized 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 7, 2024. 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 Form 8-K filing. I’ll turn the call over to our Chairman and CEO, Suri Suriyakumar. Suri?

Kumarakulasingam Suriyakumar: Thank you, David. I’m happy to report that our business transformation remains on track with nearly 3% increase in overall sales in the first quarter, along with an increase in earnings per share. We think the year is off to a good start, but the business conditions continue to remain tough. Our strategic sales focus drove top-line growth, even while operating costs in the first quarter were pressurized due to increased material and labor expenses. We believe color and scanning and archiving will continue to drive our momentum this year. On-site services will provide a steady base with some potential upside and continuous cross-selling. And planned printing and equipment and sales will continue to be pressurized by the high cost of capital.

Despite some uncertainty percolating up from macro events at home and around the world, many of our customers and markets are making their own way and not waiting for things to settle down. Whether it is a stronger trade show presence, a planned expansion of locations, a more aggressive local marketing at the store level, or a new national campaign, our forward-looking customers are engaging in creative and compelling marketing, and we are in a perfect position to assist. As with document scanning and archiving, and the desire to continue to converting paper documents to digital files remains very high in nearly every market we serve, while the benefits of digital archives are obvious under any circumstances, any uncertainty in the economy, disruption in business, or even natural disasters seem to increase the demand for scanning.

We feel very strongly that we remain in the early stages of document conversion and retention, and that there is a very long runway for this service line. As our performance for the quarter shows, we have potential to grow in 2024, but we have to work for it. That said, we are confident that we can continue to produce healthy margins and cash flows, and remain committed to our 20% annual dividend and opportunistic share repurchases. To help explain some of the details about how we executed our plans during the first quarter of 2024, I’ll turn the call over to Dilo and Jorge for their comments. Dilo?

Dilantha Wijesuriya: Thank you, Suri. We are pleased with our first quarter results, especially in light of some of the economic uncertainty we experienced over the past few months. Our strategy of focusing on new key business lines and the efforts of our teams rewarded us with nearly 3% growth in net sales for the period. U.S., Canadian, U.K., and other international locations all had positive sales momentum. But everything we achieved was due to relentless focus and well-orchestrated execution by our teams. Little of our work was simply handed to us. We stayed focused on what we could control, and worked hard to win every opportunity that came our way. Everyone was focused on delighting our customers, and we did so. Despite the decline we’ve seen in capital spending in construction and design, many of the new business segments, as we serve, were resilient and continue to make sensible investments to fight for new business.

Trade shows, sports and entertainment events, athletic programs in schools, retail, and many other segments are pursuing growth initiatives with their marketing, and we don’t see any customers slowing down in this area. Visually compelling color graphics communicate brand promise and add value to their marketing programs, so demand for these services remains high. As a result, our position in the visual marketing industry is getting stronger. Unlike the past, we are selling into more and more customer verticals with services and production solutions that deliver outsized benefits in a marketing budget. When such customers spend with us, they know they are getting greater value, whether they are spending a lot or a little. This is a true testament of our transformation.

Our story is simple and defines our strategy. We help our clients grow their brands and marketing activities with customized color graphics, and we help optimize their document-related workflows with scanning and onsite print management services. As a result, our addressable market has grown tremendously. Looking at our individual business lines, digital print services grew 3.3% and color led the way. Our 140 digital print centers were well-placed to help our clients to get what they want done wherever they need it, at a competitive cost, and with a single point of contact. In 2024, we improved our production capabilities and capacity with prudent investments in equipment and labor, and those investments are already showing returns in new business.

Meanwhile, we are taking market share from vendors who print and ship from one location, outsource key parts of production, or require outside expertise to get a job done. Customers who work with us get everything they need in one place at a fair price, and without having to manage multiple vendors. Plant printing that is directly tied to the construction and design verticals, however, continue to be pressured. While there is still activity, future planning has slowed significantly. The architectural billing index was down for all three months of the first quarter, and we saw a billing decline of more than 10% from our architectural clients for the period. Until interest rates start to come down, we will not see growth in this revenue segment.

That said, we are protecting our share of plant printing and expanding our customer base where possible. We fought back hard with color and scanning so that this business line did not drag us into a revenue loss. On-site print services sales continue to decline, but the offering remains attractive to many of our customers. We continue to add new customers as well, and we expect to moderate the first quarter’s drop over the next few quarters. By contrast, our document scanning revenue segment increased significantly in the first quarter, growing 23% year-over-year. The growth remains steady throughout all three months as we sped up clearing the backlog in our production centers with the new capacity we’ve added last year. Our contract backlog for future quarters is promising.

There isn’t a customer vertical that does not have intentions to improve access to their critical information. Whether that information is private or public, all clients are improving their digital workflows and getting paper converted to digital documents, and the market remains robust. As a result, there are many scanning companies in the market, but we are continuing to create more and more distance between us and them. Document scanning is easy, but few companies are creating processes to capture information efficiently and at a scale, as well as building technology to access information on demand the way ARC is. We use webinars and customer white papers to both educate customers on how to organize and prepare to digitize large volumes of documents and how to select a responsible vendor who will not abandon them in the middle of a project’s complexity and size.

Equipment and supply sales, a defensive revenue source for ARC, saw a drop of 3% year-over-year. Like construction printing, we will see moderation in the revenue segment as rates begin to ease. Our marketing activities are continuing to help us to secure new leads for our sales reps. Email marketing, online advertising, Google-based SEO, keyword searches, and positive online customer reviews are helping us to open more doors. Our focus has been on organic marketing results and creating long-term opportunities. With regard to profitability, most of our investments in hardware have been completed. During the last two quarters, we’ve also filled most of our sales vacancies and upgraded key positions in our color production team. Our scanning operations also added additional headcount to get ahead of the production backlog and prepare for existing contract backlog.

These moderate but important investments decreased our first quarter gross margin by a little more than 1% and may continue to put mild pressure on our profitability throughout the year. We are now focused on improving the skills of our new employees as we cross-train them to perform in several departments. We are very focused on employee retention and building a better future for them so we can ensure a better future for ARC. These are very important strategies for our company as we continue to invest in training, community, diversity, and wellness programs. At ARC, we know exactly where we are headed and how we will remain relevant to our customers while improving our long-term performance. This past quarter, you witnessed several positive results of our strategic execution and foresight in an environment that certainly wasn’t bad, but had its share of challenges.

No matter what lies ahead, our management teams around the company continue to be focused on becoming the best digital print company in the U.S. while delivering significant value to the company’s shareholders. I will now ask Jorge to give you an update on our financial results. Jorge?

Jorge Avalos: Thank you, Dilo. As we pointed out, we continue to transform the top line of the company. While things like interest rates, a slowdown in the economy, and global events can mute general progress, none of that stopped us from maintaining our forward momentum. As Dilo outlined a moment ago, during the second half of last year, we began to make the prudent and necessary investments to drive future growth and secure our competitive position in the markets we serve. Equipment acquisitions were a part of that process, but hiring and ongoing inflationary labor costs were the driving force behind the 110 basis points decline in our gross margins. The nature of the investment is long-term, but ultimately, our increase in expertise, efficiency, and productivity will pay dividends in the future.

Looking ahead at the rest of the year, our current labor expenses will not rise in a dramatic way at all, but we don’t expect to reduce them significantly either. As always, we will continuously look for ways to improve efficiencies and ways to reduce material and overhead costs. We may not be able to match last year’s gross margins, but we do expect the decline in margins from the first quarter to moderate for the balance of the year. SG&A for the quarter fell slightly due to reduced professional service expenses, partially offset by labor cost increases. Even so, operating income increased by $300,000, or 8.6%, outpacing our growth and sales. Earnings per share were a penny higher than prior year, and EBITDA was essentially flat. We continue to maintain a rock-solid capital structure.

Our cash balance is more than $50 million. Our net debt is less than $10 million. Our leverage ratio, net of cash, is under 0.5 times. Our cash flow from operations came in at $3.7 million for the quarter, roughly in line with the prior year. Consistent with historical trends, Q1 is our lowest quarter as cash flows from operations ramp up as we progress through the year. For the fourth year in a row, we plan to issue an annual dividend of $0.20, and we will continue to purchase our own stock in the open market. Our commitment to returning shareholder value is firmly in place. To sum up the quarter, we are very happy with the start we had to 2024. Our strategic business lines are growing. Our pipeline is robust. We made the necessary investments to strengthen our operations and sales force, and are taking steps to mitigate the impact of increased labor and material costs.

At this point, I’ll turn the call back to Suri. Suri?

Kumarakulasingam Suriyakumar: Thank you, Jorge. Operator, now we are ready for any questions from our listeners.

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Q&A Session

Operator: Thank you. [Operator Instructions] And your first question comes from the line of Greg Burns of Sidoti Company. Please go ahead.

Gregory Burns: Good afternoon. In the color printing portion of the business, can you give us any color around customer types? Are you having greater traction with enterprise type customers? Where are you seeing the growth in that market? And then maybe we could just start there?

Kumarakulasingam Suriyakumar: Yes, you would like to?

Dilantha Wijesuriya: Yes, thanks, Greg. So basically, the nice part about the color growth that we are seeing, or we saw in the first quarter, is that there is no one special category of customers. The good part is that virtually almost all the verticals are continuing to grow. But if I summarize outside of what they are doing, why these customers are doing, it’s all related to market activities, marketing activities, the trade show business, sports stadiums, sports centers, events are continuing to flourish. And almost all of those events, are all directly tied to large format color graphics. You know, they are advertising, and they are making those events a lot more beautiful. We had so many opportunities in the sports arenas, stadiums as well during this quarter. So overall, there is no one specific segment. Obviously, there are some very high profile jobs that we did for sports stadiums and so forth. However, almost all the verticals are doing very well.

Gregory Burns: Okay. And then can you just maybe give us an idea of why maybe a customer chooses you over someone else in the market? I know you highlighted it. It’s definitely a competitive market, but why does ARC win? And then maybe can you talk about your pipeline of opportunities there and your win rates? Are you happy with how you’ve been performing? Thank you.

Dilantha Wijesuriya: Yes, so one of the things that while there is spending for marketing activities from various customers, one of the things that we clearly see is that every client is very focused on making sure that their spend is valued properly, that they get the best value, unlike in the past, right? So one of the key benefits that we’ve seen the customers getting from ARC is the fact that our operating expenses, we keep it very, very low. And that we are able to price it very, very competitively, especially when these customers have worked in multiple parts of the country, right? Because they may be designing from one area, but the project or the trade show might be in another city, completely far away from where they were.

And many of them in the past used to print from their local print provider And they would ship it all across the country, and get it installed by someone else. So there was a lot of cost built into those type of projects. So with ARC, we have been able to completely eliminate that shipping expenses, and some of the project management times and costs as well. So, we’ve been able to win some of those work, by being very smart in the way we price and also adding value to our workflow. So therefore, we are able to win some of the newer projects, especially on the larger projects, by being able to produce that work right, close to where the event is. With regard to the pipeline, pipeline is continuing to grow. And we have a very good mixture of local work, regional work, and some of the projects are national.

As you know, we’ve been always focusing on trying to drive up our sales organization from very local business to more regional. And then to go after some of the national work as well. So we are continuing, we are seeing some opportunities. Our sales reps are getting trained. Marketing activities are bringing good opportunities at a regional and national level as well for sales teams. So from a pipeline backlog, the visibility we see for the rest of the year is very, very good for the company.

Gregory Burns: Okay. And then just lastly, you didn’t buyback much stock in the quarter. What’s, I know you have an authorization, but what’s holding you back? And maybe how do you view your buyback and how you look to deploy that? Thank you.

Jorge Avalos: Yes, during the first quarter, we ran into the same issue we ran into last year. If you see the numbers, we also didn’t buy any back in the first quarter, and it’s a timing issue. We file our 10-K at the end of, or in the beginning of March. Our window closes a week before the quarter end. It just doesn’t give us any time to buy back shares. How do we look at it for a full year? We’re still committed to it. We’re committed to matching or exceeding what we did last year. It’ll just be back-loaded in the second half of the year, same as it was last year.

Gregory Burns: Okay. Thank you.

Operator: Your next question comes from the line of Glenn Primack of Lisa Investment Group. Please go ahead.

Glenn Primack: Hi. Good afternoon, gang.

Kumarakulasingam Suriyakumar: Good afternoon, buddy.

Glenn Primack: Two quick questions. First one, have you seen over the past, like, I don’t know, 12 to 15 months, any jobs come through in relation to the Infrastructure Investment Jobs Act?

Dilantha Wijesuriya: Yes, so we – haven’t seen much work for color, digital color services, but when it comes to planned printing, some of the chip manufacturing plants that are getting built in the country, we are very close to them. We have been enjoying some of the construction-related printing work.

Glenn Primack: Okay. Great. And I can’t help but say this transformation’s gone pretty well. So good job to you, Suri and Dilo, and the whole team. As you look forward, do you have any, let’s just call it, artificial intelligence tools or services that you can begin to offer to the customer base, or use internally?

Kumarakulasingam Suriyakumar: We can use tools like that, Glenn, in, for example, scanning services and so on and so forth. We are exploring some of those. We, in fact, use some of the tools. But obviously, in anything related to printed, they are printing days not a whole lot to do. But in terms of scanning and imaging and actually extracting information from there, there is some amount of activity there.

Glenn Primack: Sure, so you might not see it from that customer perspective, but they need this stuff scanned in order to get the data, to run models at their businesses. Is that fair?

Kumarakulasingam Suriyakumar: Yes, exactly, yes. That’s accurate.

Glenn Primack: Okay. Go ahead and put the artificial intelligence on the website, I like that.

Kumarakulasingam Suriyakumar: Thank you.

Operator: [Operator Instructions] Your next question comes from the line of, I apologize, he has withdrawn his question.

Kumarakulasingam Suriyakumar: So Pam, we’re seeing Robert Maltbie on.

Operator: Yes, yes. Okay, so he, right. Your next question comes from Robert Maltbie from Singular Research. Please go ahead.

Robert Maltbie: Hi, I’m, as you can tell, a substitute for Dave. Dave Marsh couldn’t join us today. The functionality here is, now I think I have it. So congrats on the solid quarter. It looks like you beat the estimates on the street. I know that’s not the game short-term, but it looks like a pretty good ramp. So congratulations to the team?

Kumarakulasingam Suriyakumar: Thank you.

Robert Maltbie: First question I have is, I mean, gross margins were flat sequentially and down year-over-year. Can you explain why? And what can you do to expand them going forward?

Jorge Avalos: Yes, I mean, from a year-over-year perspective, I mean, you know, we talked a lot about the investments we did in the second half of the year to bolster not only our operating capabilities, but our expertise and also adding new sales personnel into the organization. Some of these paid quick dividends, those that were more in the production area. Some of these investments are more long-term. We’re just trying to gain more expertise, getting more efficient over a period of time as we become more proficient, more knowledgeable in doing scanning, and doing the color graphics. That coupled with inflationary pressures on material and labor costs drove our costs up. We were able to leverage our overhead with the increase in revenues, but ultimately resulted in a decline year-over-year in margins.

Now, first quarter is usually our softest quarter and we start out the year slower with our margins. So we fully expect on a sequential basis for our margins to increase. Additionally, we’re doing other things to try to improve efficiencies internally, looking at various vendors to reduce material costs, looking at some other overhead costs. So just to name a few, there are some initiatives we have in place to. Hopefully mitigate the increase of inflationary pressures and see a year-over-year return in our margins. With that said, do we expect to match last year’s gross margins when we look in the balance of 2024 year-over-year? Probably not, but we also expect for them to moderate. We do not expect them to be 100 basis points below prior year as we progress through the year.

Hopefully that answers your question.

Robert Maltbie: Yes, thank you. And do you think the positive sales momentum realized in Q1 will continue throughout the year?

Kumarakulasingam Suriyakumar: Yes, we hope to continue that. Obviously our legacy plan printing segment will always be challenged. It’s very hard to predict during the year, but however, our strategic services that we’ve embarked on several years ago, as you’ve seen in the last quarter, will continue to do well for us, for our company.

Robert Maltbie: Yes, great. And could you perhaps remind us a little bit about your, I guess, calculus on share repurchases as a cost of capital versus other opportunities? When would you choose to repurchase shares?

Jorge Avalos: I mean, we’re opportunistic and we buy them on the open market. Well, we’ve kind of said since last year, we’re holding the same. We spent about $12 million last year on returning shareholder value. $8 million of that roughly was coming from dividends and the other balance, roughly $4 million, was stock repurchase, or repurchasing our own stock in the open market. And by and large, we plan to stick to that mantra coming into this year, 2024. If you look at that as a percentage of our adjusted free cash flows, we spent over 75% of our adjusted free cash flows and returning shareholder values in ’23. And we will be in that similar range as we look at ’24 for the full year. As I mentioned earlier, slow start to the year just because timing-wise, we really didn’t have an opportunity to repurchase shares when you look at the timing of when we filed the K and when our window closes.

Robert Maltbie: Thank you. And finally, Paul has talked about AI and the benefits therein from various perspectives. In terms of your operations, are you utilizing any AI or plan to, and are realizing any strategic benefits?

Dilantha Wijesuriya: So like I said in the previous person who asked me the question about AI, where we use AI largely, is basically in the scanning business where we not only scan these documents in many of the customers, when they want to extract information from these drawings, then we are able to do that using AI and really AI-driven optical character recognition, that’s what we do. So for our facilities customers, we do that quite a bit in order to really extract, building information from drawings, and then be able to deliver it to them. But that’s all in the scanning and facilities-related business. Obviously in the printing business, we don’t utilize a whole lot of AI.

Kumarakulasingam Suriyakumar: But you know, AI is part of the back office in trying to improve stuff. We use it in some of our marketing and so on. I’m exploring some ways to use it in the finance and accounting. So I guess a quick answer is yes, we are using AI and just like everybody else, we’re exploring or we’re analyzing it on a monthly, quarterly basis and see where we could utilize it to make ourselves more efficient.

Robert Maltbie: Terrific, I’ll go back. Thank you gentlemen for taking my questions and I’ll go back into queue.

Operator: There are no more questions. I will now turn the conference back over to David for closing remarks.

David Stickney: Thank you Pam and thank you everyone for joining us this evening. We appreciate your continued interest in ARC and encourage you to reach out with any questions, or requests for information. We look forward to speaking with you here next quarter, and any time in between. Thanks so much, have a great evening, good night.

Operator: Ladies and gentlemen, that concludes today’s call. Thank you all for joining, you may now disconnect.