ARC Document Solutions, Inc. (NYSE:ARC) Q2 2023 Earnings Call Transcript

ARC Document Solutions, Inc. (NYSE:ARC) Q2 2023 Earnings Call Transcript August 2, 2023

ARC Document Solutions, Inc. misses on earnings expectations. Reported EPS is $0.08 EPS, expectations were $0.09.

Operator: Good afternoon. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the ARC Document Solutions 2023 Second Quarter Earnings report conference call. [Operator Instructions]. Mr. David Stickney, Vice President of Investor Relations, you may begin your conference.

David Stickney: Thanks, Abby, 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 second quarter results for 2023 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, August 2, 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 Form 8-K filing. I’ll turn the call over to our Chairman and CEO, Suri Suriyakumar. Suri?

Suri Suriyakumar: Thank you, David. Good afternoon, and thank you for joining us. Today, I’m happy to report a strong quarter in terms of net earnings despite the softening of overall sales driven by the current market conditions. Our business model continues to prove its effectiveness in leveraging sales, generating cash and creating opportunities for future growth. During the second quarter, we experienced healthy demand in digital color printing and growth of more than 20% in scanning. These 2 service lines continue to show healthy demand as retail markets make a comeback, customers in this segment are investing more in color to aggressively compete for their share of the business. While the corporate clients, including state and federal institutions are increasingly using visual communications to articulate their values to both customers and employees.

Scanning continues to show high demand as customers continue converting their legacy information to create digital access. Construction-related printing, on the other hand, [indiscernible] the volatile conditions in construction due to interest rate hikes, and we have seen — interest rate hikes we have seen to date and there are no obvious catalysts to change these conditions in the months ahead. This is where our diversification into new and growing industry segments has allowed us to become less dependent on planned printing revenues. At this point, we think it’s likely that the plan printing will suffer the same effects of slowing construction activity through the end of the year. While the timing of this trend will make it harder to drive overall sales in the last half of the year, we feel strongly that we can maintain strong profitability and cash flows in 2023 and drive sales growth in 2024 with the support of a strong pipeline with some large projects scheduled to ramp up later this year.

As always, cash flows remained healthy, supporting our commitment to return shareholder value via an annual dividend and continuing stock purchases. With that as a background for the quarter, I’ll now turn over the call to Dilo and Jorge for a more detailed review. Dilo?

Dilantha Wijesuriya: Thank you, Suri. We understand that the business conditions ahead might be challenging. But I want to assure you that we at ARC are well prepared and focused on maintaining our strong fundamentals to do well in the coming quarters. During the second quarter, we prioritized key business fundamentals that have proven successful for us. We executed our sales opportunities well, and we took pride in delighting our customers with exceptional work we delivered. Making it easy and enjoyable for our customers to do business with us has always been at the core of our execution plans. Despite tough market conditions, we are pleased to report that several of our key business lines showed year-over-year growth. Notably, our digital color traffic services continue to perform well.

We witnessed rising demand as our customers recognize the importance of elevating their brand presence and accelerating their marketing efforts. By assisting them beyond graphics printing, we create immersive environments that captivate audiences ultimately expanding their brand presence. The big growth story for the quarter however, is in document scanning and archiving. We saw an impressive double-digit increase, reflecting the confidence our customers have in our services and technology. With the recent completion of our Phase 2 expansion of equipment and facilities in our scanning centers, we are now better equipped to deliver services more rapidly for our customers and has already helped us in addressing a healthy backlog of work. On-site printing services remained relatively steady and equipment supply sales are down significantly as capital constraints and lending rates remain high.

As a technology-driven print and document scanning company, staying ahead of customer trends is crucial for us. Adopting the latest technology-driven printers allows us to deliver high-quality print output, sets us apart from the competition and ensures our customers receive the best possible service. We have been refreshing portions of our digital color equipment in a disciplined way to ensure we have competitive advantages in our market as our market evolves. These upgrades have been factored into our CapEx and cash flow projections for the year. With regard to our sales pipeline, we have made good progress during the first half of the year. We have improved our win loss ratio and the overall value of new projects we have borne is higher than last year’s.

As Suri mentioned, we have some good projects in the pipeline that will start to ramp up later this year. The size of our sales force remains the same as we double down on our marketing efforts. Our divisional management teams have shown commendable results by improving gross profit year-over-year. Our focus on operational fundamentals such as good material and labor management as well as cost-efficient processes has contributed to a 60 basis point improvement in gross margins. Our demand gen and online marketing activities are ongoing, yielding good customer leads via our website and social channels. By showcasing our completed projects capabilities, we are successfully attracting new customers. At ARC, we believe that our success lies not only in our business strategies, but also in the dedication and motivation of our staff.

We recently implemented the program to support our employees who engage in community volunteer programs. This initiative reflects our commitment to making a positive impact in society and fostering a motivated and inspired workforce. All of these efforts are in support of our strategy to transform our addressable market, meet it needs and delight our customers with outstanding service. We are confident that this strategy remains the most direct path for the company’s growth as we head to the end of 2023 and approach 2024. Jorge?

Jorge Avalos: Thank you, Dilo. As we’ve heard, overall sales dropped 3%, but grew in our most important strategic areas. Despite the overall sales drop of $2.2 million, gross profit was down just $360,000 and gross margins improved by 60 basis points. The margin expansion was achieved due to our efficient and flexible cost structure. We exerted our usual discipline over SG&A controlling variable costs, which helped drive a $360,000 increase in adjusted net income. EPS also increased, up at penny year-over-year at $0.09. Adjusted EBITDA for the quarter was essentially flat. By contrast, cash flow from operations was up more than $2.5 million year-to-date and was assisted by strong performance in our accounts receivable collections.

As many of our investors know, our strong cash flows allow us to acquire or upgrade equipment for 3 primary reasons: To improve operational efficiencies, to maintain a competitive advantage or it should increase capacity to serve a new market or an expand in existing ones. Our overall equipment budget for 2023 remains unchanged for the remainder of the year at approximately $3 million to $4 million per quarter. But with high interest rates, we are choosing to use more cash as compared to finance leases. As a result, lease payments will continue to drop and overall interest expense of approximately $450,000 per quarter will remain unchanged. As we’ve stated repeatedly, the primary use of excess cash is to return shareholder value. And in the second quarter, we paid out $2.1 million in quarterly cash dividends, and we used $1.7 million during the quarter to repurchase shares.

If we maintain this trend and at this time, it appears we will, we will have returned more than 50% of our adjusted free cash flow to shareholders by the end of 2023. In summary, we are optimistic about our growth prospects based on our pipeline. While sales may lag a bit behind the improvements to our bottom line, the solid EPS and cash flows we expect for the balance of the year will position us well for 2024. 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: [Operator Instructions]. Your first question comes from the line of Greg Burns from Sidoti.

Gregory Burns: When we look at the digital printing, what is the split in revenue between digital color graphics and construction-related printing. And what are the relative growth rates of those 2 segments. I’m just trying to get a sense of kind of maybe when the secular growth of the digital printing might be enough to offset some of the cyclical headwinds you’re seeing on the construction side of the business?

Dilantha Wijesuriya: Yes. So Greg, on the digital printing side, 50% of the revenue is from digital color graphic services and the other 50% is coming from traditional plan printing services. So currently, on the — when you take the digital color segment. That segment is definitely a growth segment, and we continue to grow in that market in the services and the customers are continuing to get busier, and that will continue to grow, as we’ve seen in the last couple of quarters. Plan printing services are definitely under some stress with the current market conditions, what we see out there. And that segment has been, as you know, that we dropped last quarter. Even this quarter, we had a drop. And I think that will continue for the next couple of quarters until we see some kind of stabilization in the interest rates and so forth.

But when it comes to the growth areas, primarily on the digital printing side, we continue to see good market conditions, good customer interactions with us. Budgets are still fairly good. And we continue to — we will see that uptick in the coming quarters.

Gregory Burns: Okay. Great. And then to that point about the digital print market. Can you just talk about maybe the verticals where you’re seeing the most growth or if you’re seeing weakness in any specific verticals? And then maybe if you could share any other metrics around lead gen, the number of leads you’re generating, conversion or any other kind of pipeline metrics that might give us a sense of the demand environment.

Dilantha Wijesuriya: The digital — on the digital graphics color, many of the customer verticals are continuing to grow. There’s not a single segment of the business that is not growing because most of the customers are continuing to market, continue to take part in trade shows. They are renovating their offices to accommodate the new staff coming in. So some of the significant wins that we had during the second quarter came from different verticals. We got a significant large win from a bank completely renovating their office space. We got a large hotel chain renovating their vacation type of hotels significantly. Lots of school districts are continuing to revamp their internal graphics of schools. We saw — we’ve seen many malls, many retail malls upgrading their locations to attract new tenants and also protect the tenants that they have as well.

So when it comes to digital color graphics, the types of customers that are engaged with us, type of customers who are spending money are continuing to be — we have a very good customer base continuing to do well with us. One segment that is continuing to be a little sluggish is the technology companies, the larger technology companies coming out of their bad times, some of their expenditure has been curtailed. Budgets have reduced a bit. So I think in the next couple of quarters when conditions improve in the market, we should see the technology companies coming back again. But otherwise, the rest of the markets that we are marketing to are continuing to do well, and we are happy about — happy with the results we see from our marketing activity.

I think your second question was about our digital marketing campaigns. We — as I said, look, we are really doubling down on the sales and marketing activities among those customers. And we see a growth in our inbound lead program as well. I mean just rough numbers year-over-year, we just had that meetings last week. We’ve seen about a 40% growth in our leads year-over-year as well. So we continue to perform well in the inbound leads, and it is really helping our sales organization to be out there to take in the leads and converting them into an actual court and then to a final win. So overall, happy with the marketing program as well.

Gregory Burns: Okay. Great. And then just lastly, I know you were kind of in the market buying back stock this past quarter. What’s your — I guess, what are your plans going forward in terms of capital allocation between the dividend and stock and maybe any other priorities you might have?

Jorge Avalos: Yes. When we look at the dividend, we’ve been pretty consistent, $0.05 a quarter, $2 million a quarter, roughly $8 million a year. So we don’t anticipate changing that. What we did do this year is get more aggressive with the stock buyback as we communicated today, we used about $1.7 million for stock buyback. So when you crunch the numbers there, roughly 50% plus of our excess free cash flows are being used to return shareholder value. And as I just mentioned, we know the number for dividend, the delta would be on the stock.

Operator: Your next question comes from the line of David Marsh from Singular Research.

David Marsh: Just first one to follow up on the question about leads and your comment, Dilo, about kind of 40% growth in leads year-over-year. Can you just talk about conversion, what the typical cycle is for conversion and what percentage of those leads that you have been successful in converting into new business in the last couple of quarters?

Dilantha Wijesuriya: Yes. So as I said in my earlier commentary, we are continuing really doubling down on our digital marketing activity. And the leads that we see year-over-year has picked up as well. And since we offer about almost 22, 23 types of services, we get a variety of leads from each different type of services. So our marketing programs really cater, go after the specific segment of buyers with a certain service. That’s how we market. We don’t just do one e-mail or one market for all prospects, we try and segment and go after it. So the leads that we receive are very diversified pool of leads that we get. The close rate for different services and the time it takes to close for different services are very different.

For example, we get quite a bit of document scanning leads, and those leads can close within a couple of weeks because once we inspect, we have standard pricing. We get that converted real quickly. A small digital format type of work for marketing purposes and so forth, we closed them quickly because those are ready to go basically. Some of the larger projects like enterprise type of scanning opportunities where some public institute or a big company has HIPAA-related documents, those type of leads require a little bit more conversation, back and forth inspections and so forth. So they may take maybe a couple of months for us to make that close, part of it, some of the larger color opportunities that require a complete rehaul of their office will take a couple of weeks to a month, 1.5 months for us to close.

And some of the leads that are not — that we don’t win, right? There’s — some of it is getting pushed back due to the budgetary requirements. Once the customer understands what it truly cost, they might punt it down for a couple of quarters and say, okay, let’s pick back up in the new year, right? So some of the deals that we don’t win are — sometimes it’s below our margins, and we don’t want to perform at that type of work. Some of the local competition probably might go at a number that we are not comfortable. But overall, our leads that we receive, the quality of the leads are good. Our sales engagement of those leads are good. The speed to get in front of a lead is also good. So overall, there are — always we look for ways of improving.

Right now, we are currently focusing on improving our win rate. We want to challenge ourselves to improve our win rates. So that’s a third quarter challenge that we have taken upon ourselves among our senior leadership in the sales side. How do we win more? But overall, things are going well on the marketing side.

David Marsh: That’s really very helpful. Jorge, I want to turn to the balance sheet for a minute. I mean, obviously, you guys did a great job on the working capital front. Inventory levels are down at pretty historically low levels for the last couple of years. I mean, is this sustainable like inventory level going forward? I mean — or do you think that you’re going to have to commit perhaps a little bit of capital going forward to grow inventories if some of the — particularly if some of the construction work comes back?

Jorge Avalos: The quick answer is, this is our new level and it’s sustainable. I mean it might vary a little bit up or down between quarters, but not dramatically.

David Marsh: That’s certainly very good news from a working capital management perspective. And then just touching again on the leases. How much exactly do you expect would roll off on the finance leases this year?

Jorge Avalos: Roughly, we’ll pay down roughly $12 million worth of leases, we will probably add somewhere in the $6 million to $8 million range. So if you just do the math there, in that $4 million range. Does that make sense?

David Marsh: Yes, it does. And I guess when you mentioned in your remarks, I guess, the interest rate being higher, you just — your interest expense is going to remain kind of steady.

Jorge Avalos: Yes. If you’re modeling now, use the same interest rate, I know that’s the beauty about our company, right? You hear all this rising interest rates, they’re doubling but we essentially don’t have any bank debt because I use my excess cash to pay down the revolver. So we really just have those capital leases, as you just mentioned, are dropping. So our interest expense will be around $450,000 a quarter, about $1.6 million a year. I think very few companies could say that in this environment, that their interest expense is going to stay flat year-over-year, and we anticipate that will be this year and next year.

David Marsh: Right. No, that’s definitely a very strong point for the company, I would concur. And just lastly, I just wanted to talk about the share count a little bit. The basic share count ticked up a little bit sequentially, diluted ticked down a little bit with the share repurchase activity. Could you just give us a little bit of guidance in terms of how to think about that going forward? Will those 2 numbers sort of continue to kind of merge closer to one another? Is that the way we should think about that? Or is there something else there?

Jorge Avalos: It’s really hard to answer that question because the product of how close they are, it’s really dependent on what the stock price is. Depending on what the stock price is will dictate if outstanding options and restricted starts are dilutive or not dilutive. When they’re dilutive, while then they get out of the equation and your basic and your diluted shares are closer together. So like I said, it’s — from my perspective, I want the stock price to keep going up and up and that delta to be greater. But what I could tell you is that we’re committing to continuing our buyback of shares in the open market. We bought back over $0.5 million here in the second quarter. We’re going to keep attacking that number in third quarter, fourth quarter and into next year. I can’t commit on a specific number, but what I could commit to you is that we’re committed as an organization to drive that number down.

David Marsh: And what can — are you able to disclose the average per share repurchase price during the quarter?

Jorge Avalos: Yes, it was $3 — a little under $3.

Operator: [Operator Instructions]. Your next question comes from the line of Glenn Primack from Lisa Investment Group.

Glenn Primack: I have a couple of quick ones. I really like that no increase in interest expense, by the way, Jorge. First, on the Bipartisan Infrastructure Bill. Do you think you’ll see any projects starting to flow in your inbound in the next 12 months?

Dilantha Wijesuriya: Yes, definitely. We’ve seen the infrastructure funding come back to certain states for certain projects. And I’ll just give you one good example is that there’s a brand-new chip plant being built in Boise, Idaho. So we have a piece of that. So similarly, we’ve also seen some of our larger customers like AECOM, who are taking part or have been awarded significant sized projects in airport renovations, new infrastructure spending as well. So I think this is just the beginning. Things are just trying to roll down from [indiscernible] back to the states and — for certain projects. So I think in the next year, 2 years, there will be a lot more work coming down to those large contractors.

Glenn Primack: That’s great. Second quick one. I don’t know if you track trade shows as a market segment. And so, is it typically stronger in the first half of the year or the back half of the year?

Dilantha Wijesuriya: Usually, the first quarter is a big first quarter, second quarter is a big trade show period, then again, September through end of October is another period. But those are for the major national shows that takes place in Vegas, Florida or the larger organizations. But one of the things that we’ve noticed since the pandemic is that regional trade shows are very popular, right? So there are smaller shows, very condensed. It’s market-driven. And there are more shows regionally than at a national level, while the national levels are picking up. So when it comes to trade shows, we don’t typically — right now, think about, okay, if there is a trade show season for us, trade show season is every month because every city, every region, every big hotel, every big convention center, there’s something going on every month, every week per se.

So that’s where we see good opportunities. We just had to hunt for that business. But unlike in the past, there’s more activity happening at the trade show market.

Glenn Primack: Okay. And then do you think you’re at an advantage in that market just because you have the national presence to print for some segment of the economy that’s having a big show, let’s say, in Vegas and then like some follow-up thing in Atlanta, and you want all the printing of the boards and everything else to be consistent?

Dilantha Wijesuriya: We believe that we have a leg up, but that doesn’t mean there’s no competition. There’s fierce competition when it comes to trade show work because there are well-established companies around the country who has done this work for a long time. But when it comes to quick turnaround, high quality and to get the work done locally in the mines, there’s nobody — no better person — company better than ours. So we market to that specific types of features and benefits that we can provide. And we feel that we have a good chance.

Glenn Primack: All right. And then the last one, which I don’t know, maybe answer or not, but does the — scanning product line, does that have a higher gross margin than the reported gross margin?

Dilantha Wijesuriya: Since we performed the scanning work within our same service center, we don’t report the gross margin separated by product line. But overall, all of our product lines have a very similar gross margin line. So we have — so that’s how we would — I would like you to think about the margins.

Operator: There are no further questions at this time. Mr. David Stickney, I turn the call back over to you.

David Stickney: Thanks, Abby, and thanks, everyone, for your interest this evening. We very much appreciate your continued interest in the company and in stock, and we look forward to talking with you next quarter about it and to tell you about our progress. Thanks so much. Take care. Have a good night. Bye-bye.

Operator: This concludes today’s conference call. You may now disconnect.