ARC Document Solutions, Inc. (NYSE:ARC) Q2 2024 Earnings Call Transcript

ARC Document Solutions, Inc. (NYSE:ARC) Q2 2024 Earnings Call Transcript August 7, 2024

Operator: Thank you for standing by. My name is John, and I’ll be your conference operator for today. At this time, I’d like to welcome everyone to the ARC Document Solutions Second Quarter 2024 Earnings Report. All lines have been mute to prevent any background noise. [Operator Instructions] Thank you. I’d now like to turn the call over to David Stickney, Vice President of Investor Relations. Please go ahead.

David Stickney: Thank you, John, and welcome, everyone. On the call with me today are 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 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, August 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?

Suri Suriyakumar: Thank you, David.

David Stickney: Before reviewing our second quarter results, we should note that the company has disclosed its receipt of a non-binding proposal outlining a going private transaction at a purchase price of $3.25 per share in cash. The proposal was submitted by an acquisition group consisting of our C-suite and a private investor. In response to the proposal, a special committee of our Board of Directors, consisting entirely of independent disinterested directors was formed to review and evaluate the proposed transaction and continues to carefully consider it with the assistance of its independent financial and legal advisers. No assurances can be given regarding the terms and details of any transaction that any proposal made by the acquisition group regarding a transaction will be accepted by the special committee, that definitive documentation relating to any such transaction will be executed or that a transaction will be consummated in accordance with that documentation, if at all.

For further information, we direct you to the 8-K Form 13D and the press release available on ARC’s Investor Relations website at ir.e-arc.com. No additional information has been released nor will be on this call. We will now continue with our customary remarks. And at this point, I’ll turn the call over to our Chairman and CEO, Suri Suriyakumar. Suri?

Suri Suriyakumar: Thank you, David, and good afternoon, everyone. Net sales continued to grow in the second quarter as did our gross margin and adjusted earnings per share. The execution of our strategic objectives were once again responsible for our success despite uncertain business conditions caused by the high interest rates and the weakness in commercial construction due to excess supply. Our strategic sales focus drove top line growth with digital color printing making an outsized contribution to our overall success despite the decrease in digital plan printing. Scanning and archiving continued to grow at a healthy pace as expected. On-site Services sales fell slightly, but we continue to believe it will provide a steady base of sales with upside potential in the future.

While we saw an incremental uptick in equipment and supplies, we believe that buying habits have stabilized as customers have adjusted to a new high interest rate environment. With an increase in sales and our ability to leverage our workforce and our 2008 costs, we exceeded our own expectations in gross margins growing by 30 basis points year-over-year. Throughout the past several quarters, we also made several investments in our sales force and in new marketing programs. While these quarterly SG&A costs were not inconsequential, putting new initiatives on trial to boost sales must be part of our growth efforts, and we were generally pleased with the results. Our performance in the first half of the year has been gratifying, and it is a testament to our strategic decisions and the company’s execution.

While we expect difficult market conditions to continue in the second half of the year, we remain focused on our long-term objectives. For more details about our activities in the second quarter, I’ll now ask Dilo and Jorge for their comments. Dilo?

Dilo Wijesuriya: Thank you, Suri. The momentum we built in the first quarter has continued demonstrating solid sales growth in the second quarter achieving nearly 4% growth under the current volatile economic condition is commendable. I want to extend my appreciation to our staff who remain committed to our company’s transformation and the execution of our business plan for the year. While interest rates and uncertain political climates have pressured some of our customers, I believe that companies with good strategies and a relentless focus on quality and customer service will continue to secure new market share and growth. ARC remains steadfast in executing our fundamental strategies to keep the company healthy and growing.

Our color digital printing services were the key driver of our sales improvement and easily offset the decline in Black & White plan printing. Both regular and new customers leveraged our services for brand promotion, new product launches, trade shows and entertainment events. Our efforts to diversify customer verticals continue to yield impressive results and those following us on social media we’ll see how we bring custom ideas to life with wider and graphics. The market for digital color is becoming increasingly competitive with many traditional print companies transitioning to digital printing. However, ARC stands out with our extensive footprint, comprehensive service offerings and a seasoned management team characterized by a can do mindset.

Our construction plant printing segment continues to face challenges due to the higher interest rates, which have led to cancellations and delays in new construction projects. Our strategy is to maintain our current customer base, and we prepare to take on new projects as the economy improves and interest rates decline. While plant printing is important, we are not reliant on this recovery. The transformation initiatives we implemented several years ago are proving successful as evidenced by our results. Our document scanning services have provided a notable boost in revenue. We are building our reputation by delivering projects on time with high digital accuracy. Our dual sales approach, targeting enterprise customers and offering low volume scanned by the box services continues to be effective.

Our strong online presence, supported by positive reviews and the ease with which our customers can find us is helping to organically grow our reputation as one of the best scanning providers in the country. While NPS sales have slighted during the quarter, it has stabilized over the past two years. Meanwhile, the Equipment and Supply segment experienced nominal growth. We anticipate further positive results as the general economy shows signs of recovery. Our international division including Canada, the UK and India have also delivered strong growth by adopting similar strategies to expand customer verticals and implement services that we have introduced in the US. We are optimistic about delivering continued strong sales results in the coming quarters.

While we experienced gross margin pressure in the first quarter, we reversed the decline with a 13 basis point improvement in the second quarter. Our ability to manage labor and operational cost efficiently combined with subdued inflationary pressures drove the gains. Our operational and sales headcount remained stable, providing us with adequate capacity to deliver excellent value to our customers. Our marketing efforts are ongoing, supported by effective demand generation programs. We use social media, Google and e-mail marketing strategies to attract more visitors to our website and capture warm leads. As always, our focus remains on strong business fundamentals. Our seasoned management team is unmatched, and we are united in our direction.

Regardless of economic conditions, we are confident in our winning solutions that prioritize delivering value and making it easy and enjoyable for our customers to do business with us. I’ll now ask Jorge to give you an update of our financial results. Jorge?

Jorge Avalos: Thank you, Dilo. As our financial results show, we continue to drive progress on the top line with strategic business sales, while taking advantage of opportunities to improve our margins. In the second quarter, our revenue increases came primarily from color and scanning as we’ve pointed out. But with inflationary pressures easy, we were better able to leverage our labor and our overhead costs and our gross margins improved by 30 basis points. SG&A costs rose due to our continuing investments in sales and marketing and also included $900,000 related to the previously disclosed take private proposal. Lower cash flows from operations year-over-year was the outlier for the quarter, but it was due to the timing of sales collections.

We won and completed a number of large projects in late May and June of this year, while this benefited sales, collections for those projects extended into July and hence muted the increase in operating cash we normally see in the second quarter. We are confident that cash flows from operations will continue to improve in the third and fourth quarters, just as it did last year. Of note, we achieved more than 60% of our 2023 cash flows in the second half of the year, and we anticipate a similar performance in 2024. Our strong capital structure remains intact, as does our commitment to return shareholder value. As such, our plan to issue a $0.05 quarterly dividend remains unchanged. We were pleased to build on the progress we made in the first quarter, and we believe we can continue to build on this success for the balance of the year.

With that as a summary of our financial results, I’ll turn the call back to Suri. Suri?

Suri Suriyakumar: Thank you, Jorge. Operator, we are now ready to take questions from our listeners.

Q&A Session

Operator: Thank you. We will now begin our question-and-answer session. [Operator Instructions] Thank you. Your first question comes from the line of Greg Burns of Sidoti. Please go ahead.

Greg Burns: Good afternoon. When you look at demand, the demand you’re seeing in color printing, have you seen any changes in terms of buying decisions, willingness to spend? Like what is the outlook for that market look like for the balance of the year, given a more uncertain macro environment that we’re seeing now? And then, when we think about the growth opportunity for you there, obviously, you’re still a relatively smaller part of the overall market. So do you still feel like you can grow even if maybe the overall market spend rates decline? Thank you.

Suri Suriyakumar: Dilo, do you like to take that?

Dilo Wijesuriya: Yeah. So we haven’t seen any — first question is you want to know whether there is any slowdown in your spending opportunities from customers and so forth. No, we haven’t seen very much as of this point. Because as you said, we are relatively a smaller organization and a growing organization in this big digital Print market. So therefore, we are actually canvassing to different types of customers. As we are canvassing to medium regional types of customers because of our footprint capabilities and our ability to do projects anywhere in the U.S. with more project management services and so forth. So we haven’t seen any significant slowdown or drop in spending by many of the marketing customers, but obviously, some of these big macro market news that we hear in the last, what, three, four weeks have been maybe alluding to that, but we haven’t seen that.

With regard to the growth opportunities, we are certainly positive about our color growth. Again, as I mentioned, that we are not one of those companies who has one or two massive locations that do thousands and millions of prints. We are not that. We are that on-demand, short run, high-quality print company that has a sizable footprint all across where we provide that high-touch service. So we are continuing to focus our sales reps to continue to focus on the — our core competencies where we know there is a significant mark-to-market out there. There is a significant demand from customers out there for companies like us. So we feel still strong about our future growth.

Greg Burns: Okay. And then in terms of your more traditional Plan Printing, the decline slow there at all? What is the — where is that market at? And I guess, obviously, interest rates will help it out, but can you just maybe give us a little bit more insight into where that business currently is at and what trajectory is on?

Dilo Wijesuriya: Yeah. So the plan paper printing is continuing to be the same, right? I haven’t seen a much change in the last three, four quarters. I mean, the same trend has been there. We’ve seen a couple of projects slowing down or getting delayed. But with regard to the plan paper usage, there is still a lull in that market. And I attribute that quite a bit to the higher interest rates that we’re currently experiencing — someday down the line a couple of quarters down the line that when we see some easement in interest rates some of that work is going to come back, right? The homebuilding, home construction, some of the tenant improvement work. They have all come back to some level. But some of the secular changes that we see in the plan paper printing, I don’t think it’s going to come back.

Those things will continue to be moving to digital workflows. So, while the business is somewhat now getting stabilized, but I think the same headwinds will be there for a while.

Greg Burns: Okay. And then in terms of margins, obviously, very, very nice improvement in the margins this quarter. How should we think about that going forward relative to you balancing, continuing to invest for growth against maybe driving some operating leverage in the model? Is this maybe — it was just a strong quarter and maybe we see a step back in the coming quarters? How should we think about margin progression from here?

Jorge Avalos: I mean the way — I’ll break it up into two points. From a gross margin perspective, with the easing of inflationary pressures, coupled with the increase in revenue, then we’re better able to leverage our labor and our overhead. So, we feel good about our prospects as we move later in the year. I mean would we be able to repeat 35% gross margins, maybe not in regards to pending as you know, we have seasonality in sales, for example, fourth quarters are typically lower. But when we look at it from a year-over-year perspective, we have — we feel we have a good chance of been in that range. Now, the second part of your question in regards to the investments and the impact on our margins, those investments are coming in sales and marketing, which flow through your SG&A.

And the levels that you see in the second quarter is a good gauge to use as a predictor moving forward, absent the $900,000 in transaction fees related to the proposed go-private transaction. Does that make sense?

Greg Burns: Yes. No, no, that’s helpful. All right. I’ll pass it along. Thank you.

Jorge Avalos: Yes. No problem.

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

David Marsh: Hey guys. Thank you very much for taking the questions.

Suri Suriyakumar: Sure.

David Marsh: So yes, if I could start, it doesn’t — it looks like the share count actually ticked up a bit. Just wondered — I know repurchasing shares had been a priority if the market opportunity was there. Wondering if this go-private transaction kind of supersedes your ability to repurchase any shares.

Jorge Avalos: The quick answer is, yes, it does.

David Marsh: Okay. And so it looks like you took some cash and maybe paid down a little bit of debt in the quarter. Am I reading that right? And then what would be the kind of priority uses of cash going forward as you evaluate this transaction?

Jorge Avalos: In regards to — we’re looking at the business just as a go-forward basis as running business as usual. So, same thing we did last year, we used more of our cash to purchase equipment versus using capital leases. As you can see from our financials, we did that in 2023 because interest rates were high, and I don’t want to pay 9% interest to acquire equipment, and we’ve continued that strategy moving in here into 2024. So, no change in our strategies that we’ve had over the last couple of years.

David Marsh: Okay. So this proposal, obviously, management is an involved party or some portion of the management teams involved party in the proposal. But — again, going back to your comment, looking at the business more as just kind of a continuing operation as a public company, are you seeing any opportunities for acquisitions that would either get you into a new business line or a new geography that you’re not already in that might be compelling here as we’re starting to see some kind of disruption in the overall financial markets?

Suri Suriyakumar: So I’ll take that one. So in terms of acquisitions, we’ve not had anything in pipeline. We’ve always said that we’ll be opportunistic about it. Something pops up, it pops up, but we never had anything in the pipeline or neither did we — we’re in consideration to do anything. With regard to the Go Private transaction, it’s now completely assigned to the special committee appointed by the Board. They are independent directors. They’ll do whatever they have to do from a legal and SEC perspective. We just run the business as usual, business as usual here. And then nothing — no acquisitions or any other thoughts, we just come across our table, if that comes. And if it merits a review, we will do so.

David Marsh: Okay. That’s pretty helpful. Just — I’m sorry. I’m probably repeating the previous caller’s question. I apologize if I do. Jorge, I think you said $900,000 in expense related to the evaluation of the Go Private transaction in the quarter. Is that right? Are they right? — SG&A line?

Jorge Avalos: That is correct on both points.

David Marsh: Okay. So as we go forward, that essentially the demonstrably lower presumably. Is that a fair assessment?

Jorge Avalos: We just don’t know, and it’s something we can’t comment on.

Suri Suriyakumar: That’s completely up to the special committee. They have white powers to do whatever they have to do to evaluate the proposal. They’ll do whatever they are supposed to do as an independent committee, full of independent directors. We have no control over that.

David Marsh: Roger that. Okay, guys. Thanks very much for taking the questions. I’ll pass it along.

Suri Suriyakumar: You’re welcome.

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

Glenn Primack: Hi. Good afternoon everyone. Digging a little deeper on the increased marketing expense, is that going towards a specific program, like the scanning — or is that — can you just touch on like what’s specific programs you’re really going after with the extra dollars there?

Suri Suriyakumar: Yes. So there’s no — I can attribute it to a very specific program, Glenn. It’s the extra spend that we’ve seen year-over-year for the second quarter, there’s a component for that goes into head count. We’ve added a couple of sales — new sales consultants specially experienced consultants who are good in digital color, white format color printing. So we’ve added them in specific geographical markets, very strategic locations for. So some amount is in head count. And the rest of it is — we just launched a new website. I hope you’ve got a chance to see that. The new ARC website is on — we launched a new red color [ph] website a couple of months ago. And we are just focusing on some really strong SEO programs, driving traffic into the website, using keywords and so forth.

A little bit of spending on Google advertising as well, not a heap or lot, no big investments compared to last year. But we’ve been very focused on organic driven marketing programs. E-mail marketing programs are going as well. So the spend is primarily the headcount. And obviously, our sales have grown, especially on the color side. So there is an increased payment of commissions. But the rest of it is on the marketing programs.

Glenn Primack: All right. Great. So on the sales side, you probably got some payback off of that — experienced people that you’re putting in these different locations versus a newbie. Is that safe to assume?

Suri Suriyakumar: Yes. So usually, it takes a couple of months or even for experienced people to get comfortable with the company and get used to the systems and start soliciting. So yes, definitely, they are early stages of delivering. Some takes a little bit more extra time. So there are different stages. While the goal is to make them all successful very quickly.

Glenn Primack: Yes. And it’s no doubt that you and Jorge will measure everything anyways.

Jorge Avalos: Every time, Glenn, every time.

Glenn Primack: I love that. That’s it for me. I can’t wait to go check out the new website and the red [ph] relatively new website.

Suri Suriyakumar: Thank you.

Operator: And that does conclude the question-and-answer session. I would like to turn the call back over to Mr. David Stickney for closing remarks.

David Stickney: As usual, we appreciate your continuing interest in ARC, and we encourage you to reach out with any questions about our progress. You can always check our Investor Relations website at ir.e-arc.com. For more information, we look forward to talking with you soon. Take care. Bye-bye.

Operator: Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.