ARC Document Solutions, Inc. (NYSE:ARC) Q4 2023 Earnings Call Transcript

ARC Document Solutions, Inc. (NYSE:ARC) Q4 2023 Earnings Call Transcript March 2, 2024

ARC isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, everyone. Welcome to the ARC Document Solutions to report 2023 Fourth Quarter and Year End Results Conference Call. At this time, I would like to hand things over to David Stickney, Vice President of Investor Relations. Please go ahead, sir.

David Stickney: Thank you, Lisa, 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 fourth quarter and full year 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, February 28, 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. If there was a year that validated our efforts to transform the company, 2023 might have been it. The challenges were easy to see, but so were the opportunities that balance them. Watching the progress we made in offsetting declines in our older business lines with our more contemporary services, namely color and document scanning, was extremely gratifying. I can see a time in the not-too-distant future when our strategic business lines will come to dominate our revenue mix. Business conditions were fairly predictable for us after the first quarter of 2023. Capital spending was constrained due to interest rate hikes, market activity was strong but focused on short term, return-to-office initiatives lost much of their momentum, and while the country and the general business environment seemed like it was improving, sentiment was muted.

As much as we prefer bigger long-term projects, seasonal and event-driven marketing work helped us build growth in our color services throughout the year. The trend for converting paper documents to digital information that began with the pandemic continued to gain momentum throughout the year and dramatically increased demand for scanning historical documents from the office and from warehouse storage. While the short-term growth of this service is gratifying, the volume of such information and the compelling need for it to be converted are both enormous and likely to last for decades. While you’ve seen declines in our on-site services as employees continue to work from home, sales in 2023 began to stabilize, and we had significant success in the fourth quarter.

You will hear more about that from Dilo later on this call. In this economic environment, construction projects were much more difficult to justify as for the purchases of large equipment. So it wasn’t much of a surprise when construction plan printing got off to a sluggish start, and the equipment and supply sales followed suit. But our ability to adapt to changing market conditions drove an increase in the fourth quarter revenue, limited declines in annual revenue to less than 2%, and our skill and experience in managing costs held gross margin steady for the year. We had higher hopes, of course, but the continuing progress we made in identifying new markets, launching new and exciting products and finding new partners and making the necessary investments to take promising services to the next level positioned us well for 2024 and beyond.

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Q&A Session

To help explain some of the details about our efforts throughout the last quarter and to help with the entire year end perspective, I’ll turn the call over to Dilo and Jorge for their comments. Dilo?

Dilantha Wijesuriya: Thank you, Suri. In the fourth quarter, we achieved encouraging results, particularly in our strategic revenue lines, as Suri mentioned. Despite facing a decline in plan printing revenue, we successfully offset this loss by growing our document scanning and digital color revenue streams. Notably, our sales in document scanning services were 34% higher than they were in 2022, and our digital color services saw a surge in demand, driven by significant projects supporting year-end promotional activities across various business verticals. Beyond the holidays, our consistent focus on expanding retail, trade show and small and more operations, coupled with increased tourism activity in the hotel vertical, contributed much of the business that led to our growth in digital color printing.

Leveraging our premier digital print services brand, Riot, we continued to attract major brands across North America, positioning ourselves as a leading provider of on-demand, high-quality color printing solutions in all major markets in the U.S. In North America, a few companies offer anything close. Achieving this level of service demands meticulous planning and a cohesive, dedicated production team, qualities that define our operations. Over the past three decades, we honed these capabilities with plan printing, resulting in a dominant market presence in construction. Now we are applying the same expertise and core competencies to our digital wide-format color services, ensuring consistent quality and efficiency to our clients. The demand for document scanning remains robust as businesses prioritize moving their critical content to digital platforms.

Hybrid work models and the growing trend of office space reduction further propel the adoption of document digitization projects among our clientele. Our teams conduct thorough site audits and collaborate closely with clients to tailor solutions to their specific requirements. Our Scan by the Box program caters to smaller clients seeking efficient and cost-effective scanning solutions for a file cabinet or two. And our success in securing enterprise-level scanning contract in the past few months, with several contracts exceeding six figures, has significantly improved our production backlog. Through targeted marketing campaigns, we are actively educating clients on the advantages of digitizing documents, and our performance is solidifying ARC’s reputation as a trusted nationwide provider of document scanning services.

Additionally, our continuous enhancement of technology tools enables us to streamline project management, elevate quality standard, manage labor costs and provide improved accessibility via cloud-based solutions for our valued customers. By contrast, we have yet to observe any significant improvement in plan printing from new construction projects. Our assessment indicates that positive momentum in this revenue stream hinges on a substantial decline in interest rates, which we have yet to witness. Nonetheless, we remain proactive in showcasing and promoting other services offered by ARC to diversify our revenue streams. Our long-standing relationship with construction clients serve as a valuable foundation for introducing and expanding our new services within their accounts.

As office customer behaviors evolve, we’ve also noted a decline in on-site print services, along with equipment sales. However, over the past year, we have made a constant — concerted effort in renewing our on-site service contracts with our key clients. I’m pleased to report that we’ve achieved successful renewals for multiple years with several major MPS customers. Their continued satisfaction with our service and confidence in our comprehensive on-site service solution bode well for maintaining revenue in the service line. Moving forward, our revenue performance in the fourth quarter serves as a clear indication of the positive direction our company is headed. Our emphasis on scanning and digital color printing is driving overall company expansion, and our management team is — every market is 100% on board.

Our strategic investments, ongoing staff training initiatives and targeted marketing and selling strategies are all directed towards advancing this primary objective. Key areas of focus for our management teams include production management, customer service, margin optimization and planning capacity. We are also doubling down on our online and social media marketing efforts to generate new customer leads while maintaining a steady sales representative headcount. I encourage our investor community to follow us on LinkedIn and other social media platforms. Creating and sustaining a fun and secure workplace environment for employees remains a top priority for management. We consistently implement initiatives to support our team members, including various employee assistance programs and a profit-sharing bonus plan.

As we further establish ourselves as a prominent presence in digital color printing, document conversion and more, fostering a dedicated and inspired team is crucial to our success. I look forward to sharing our first quarter results. So at this point, I’ll hand over to Jorge for more on the financials. Jorge?

Jorge Avalos: Thank you, Dilo. While sales of equipment and supplies, on-site services and construction plan printing were soft during the first three quarters, we saw signs of stabilization in the fourth quarter, combined with strong sales in color and scanning that led to incremental sales during the period. As Suri and Dilo noted, our work in 2023 has created a favorable environment for new sales opportunities. With rates forecasted to come down, a limited chance of recession and confidence building and the resilience of the economy, we’re in a good position to capitalize on them in 2024. Gross margin held steady for the year but fell in the fourth quarter as a result of our fourth quarter mix of business. High-margin plan printing decreased as it normally does during the fourth quarter.

But unlike last year, we did not have a drop in the low-margin equipment sales. Throughout the year, we kept a tight leash on cost in light of softer sales, reap the benefits of lower depreciation costs that reduced our equipment purchases on on-site services. And even higher labor costs associated with increase in scanning and revenue and inflationary pressures were not enough to put a dent on our gross margin. SG&A for the year was down, benefiting from a lower level of sales commissions and bonuses, which left us with net income and earnings per share relatively stable year-over-year. The decrease in adjusted EBITDA for the year was attributed to our lower sales and an increase in labor costs. While cash flow from operations was affected by the same things, the decrease was mitigated by strong cash collection efforts in the second half of the year.

Our DSO dropped a full four days, which helped keep 2023 cash flow from operations in line with prior year and drove the $2.9 million increase in the fourth quarter. We are happy to report that for the full year, we returned $12 million to shareholders in the form of dividend and share buyback. This was the most we have ever done in the history of the company, and we plan to do it again in 2024. Our liquidity and capital structure continues to improve, even after the $12 million spent on shareholder returns. Our cash balance decreased by $3.5 million. Our net debt was only $6 million, representing a $7.7 million decrease. Our leverage ratio stands at only 0.3 adjusted EBITDA. Finally, before we end our remarks, we need to address the obvious outlier on our P&L for the year, the site remediation expense.

The expense stems from an acquisition we made in California during the 1990s that include a property that have been used for a gas station before we purchased it. The gas station had long been demolished and its storage tax removed well before our involvement. Several years ago, ground monitoring detected petroleum on the property, and we were asked to create a remediation plan for this site. We did so, and the plan was approved. But further monitoring in the fourth quarter of 2023 turned up additional risk and now required a much more extensive plan. Three points are worth emphasizing about this expense. First, none of this has to do with our operations. Second, this is the only service center property we own. And third, and most importantly, this expense will extend over a long period of time, but accounting rules require us to establish reliability now.

We don’t expect it to hamper our operations or our cash flows in a meaningful way in any given year of the project. Turning our attention to 2024. We are seeing encouraging growth in our strategic services, and our pipeline of opportunities and backlog is robust. The economy is benefiting from anticipated declines in interest rates, and the variety of industries and customers we serve continues to grow. We’ve also made prudent investments in people, marketing and equipment to drive future growth. With that in mind, we look forward to what lies ahead in 2024 and sharing our progress with you in the coming quarters. At this point, I’ll turn the call back to Suri. Suri?

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

Operator: Thank you. [Operator Instructions] We’ll go to Greg Burns, Sidoti & Company.

Gregory Burns: Good afternoon. In the construction plan printing market, I guess, you noted you saw some signs of stabilization in the fourth quarter. As you look into ’24, I know interest rates going down would be a potential catalyst to get that part of the business higher. But do you — barring interest rates going down, do you feel like that business has stabilized at a lower level? How should we think about the potential for further declines in that side of the business?

Kumarakulasingam Suriyakumar: Yeah. Like you said, Greg, if actually the interest rates go down, it’s definitely going to kickstart some of the construction business, and it will be helpful for the plan printing segment of our revenues. However, if the interest rates don’t move, which I think is unlikely, probably it’s going to be stable, and it’s going to just be muted. I don’t think it’s going to do any different. Dilo, would you agree?

Dilantha Wijesuriya: No, I agree, Suri. And I’m thinking the other thing to do is, even if the interest rates go down in the second quarter, it’s going to depend always at a six to nine month lag to see new designs, new construction put into place. So I just wanted to keep that timing in mind as well.

Operator: And we will move to our next question.

Dilantha Wijesuriya: Hang on. Greg, did you have another question?

Gregory Burns: Yeah. Sure. Just one more around your capital allocation priorities. I guess, if the cash flow remains strong this year, you’ll probably be in a net cash position. What are your thoughts on maybe increasing the dividend or accelerating buybacks? How do you think about the capitalization and share return for the business?

Kumarakulasingam Suriyakumar: Yeah. Both of those opportunities, Greg. I mean, obviously, based on everything that we did last year, which was an amazing year from a shareholder returns point of view, I mean, I was talking to Jorge, 33% of our cash flow from operations went back to the shareholders. How good is that? So I mean — so that — it’s already pretty good. And if it continues to improve, then of course, depending on the market conditions, we will decide what to do as to whether we should buy back more shares or how we deploy that cash. Cost of operating the business is also going up. So it’s something that we want to bear in mind. We might choose to make some investments in the business. Jorge, would you like to add to that?

Jorge Avalos: Yes. But I mean, we don’t see us reducing the level we did at ’23. I mean, we think cash flows we generate, obviously, stay pretty stable and will allow us to do that and more. Like I mentioned on my script, I mean, even with everything we did and returning to shareholder value, we still grew cash by almost $4 million after all that. So future is bright for us. We have options, which is a good thing.

Gregory Burns: Okay. Thank you.

Operator: And we’ll go to our next question, which comes from David Marsh, Singular Research.

David Marsh: Hey, guys. Thanks for taking the questions and congrats on the year. So it looks like you used a little over $600,000 to repurchase equity in the fourth quarter. Can you just give us an update on where that puts you with regard to your share repurchase program? And can you give us a sense of kind of what the average…

Kumarakulasingam Suriyakumar: Sorry, could you repeat that question? It is not very clear.

Jorge Avalos: I think it’s about share repurchase. And if I don’t answer the question right, just clarify. But I think you were saying the repurchases we did, we did $3.5 million worth of share repurchases. We still have another $9 million-ish available under the Board-approved plan. Every quarter is a little different. Sometimes there’s more opportunity to buy more in the third quarter versus another one. Think about the first quarter. open window doesn’t open until March. So we have two, three weeks to buy shares, very truncated period of time. But overall, for the year, we expect to be in that $3.5 million range for 2024, barring other opportunities that Suri mentioned earlier. Did that answer your question?

David Marsh: Yeah. Just to ask you, the other part of it was, could you just give us a sense for what the average price per share was at repurchase?

Jorge Avalos: The repurchase, it was under $3, and it was in that $2.80 to $2.90 range. Don’t quote me exactly, but it’s pretty close to that.

Kumarakulasingam Suriyakumar: Yeah.

David Marsh: Got it. Yeah. That’s helpful. And then just turning to more kind of the business fundamental side. Are there particular industry verticals that have started to show incremental strengths here in the back half of ’23, early ’24 that maybe you didn’t have as strong of a performance from during the earlier part of ’23? And are there any other particular verticals that — away from the construction side, which, obviously, we know hinges a little bit on interest rate movements. But are there any other verticals that you could talk about that you have kind of particularly strong expectations for in the coming year?

Kumarakulasingam Suriyakumar: Yeah. So I mean, obviously, based on the market sentiments right now, it sure looks like we’re going to have a positive impact on the market going forward. Nothing shows that the market is going to deteriorate. It’s going to — it sure seems like it’s stabilizing. And if that is the case, obviously, the other segments of the business is going to be much more active. And we are thinking that, that will be a positive. Dilo, what’s your perspective on that?

Dilantha Wijesuriya: Yes. I think if you’re looking at the business segments of the company, there was one or two specific business segment that really helped us in Q4 because different seasons, different customer types get busy, obviously, towards the holiday season, retail, retail mall, mall operations. Those of our customers are very, very strong in the fourth quarter. But overall, when we track all our verticals, as you know, we track about 53 verticals in the organization. We see a bump in almost all categories. Because one of the things that we see is that every company is marketing. They are marketing, they are trying to grab back extra market share. A lot of trade show work is continuing to bump up. So I think that’s the positive sign that we see pretty much in all business verticals because everybody is looking for that new business. So that’s where our digital marketing and digital color graphics services bode well with those customer verticals.

David Marsh: That’s very helpful. And then just last one for me, just another kind of housekeeping type item. Jorge, just looking at the liability side here, balance sheet, it looks like — it kind of looks like the operating leases bumped up a bit and the debt and finance leases kind of bumped up a little bit long term. Can you just talk about what’s going on there and what your expectation is for the next 12 months?

Jorge Avalos: Yes. I’ll start off with the easy one. In regards to the finance leases, that actually went down. 2022, end of the year, we were at $26 million. We ended the year at $22 million. So I foresee that kind of staying either in that range or potentially dropping a little bit more. So not a big shift there from a balance sheet perspective. In regards to the operating leases, this is just a product facility renewals. Our annual rent expense is going to stay pretty stable. But the new accounting rules say, okay, if I’m in a building, say, it’s one of my bigger buildings and I renew it in December, now I have a seven-year lease for the next seven years. That all shows up as a liability on my books, but my annual rent stays the same. So it’s kind of just like a balance sheet gross up on your financials there. Nothing that I would be worried about from a — this is going to have an impact on my P&L. Does that make sense?

David Marsh: Yes, makes a lot of sense.

Jorge Avalos: No problem.

David Marsh: Thanks very much. I appreciate the time.

Jorge Avalos: No problem.

Operator: [Operator Instructions] And we’ll go back to Greg Burns.

Gregory Burns: I just wanted to follow up with your outlook for 2024. If construction plan printing is stable, do you foresee the strategic growth areas driving net growth next year for the business?

Kumarakulasingam Suriyakumar: Well, yeah, we definitely feel so, especially given the activity we have been having with the customers. I think it will be going in the — it will definitely improve. Dilo, would you like to add to that?

Dilantha Wijesuriya: Yeah. I mean if you take a look at Q4 as a proxy, our strategic business line growth overtook the drop in plan printing. So if the plan printing stabilizes in 2024, definitely, we’ll see that growth. But we are fully focused on building our strategy, building our push behind those specific growth initiatives. And that, as I said in the call, all our management teams are fully behind that. Over the last two years, we’ve been putting certain things in place, and now we are enjoying the benefits of that.

Gregory Burns: Okay. Great. Thank you.

Operator: And at this time, there are no further questions. I’ll hand things back to Mr. David Stickney for any additional or closing remarks.

David Stickney: Thanks, Lisa, and thank you, everyone, for your attention tonight. We appreciate your continuing interest in ARC and encourage you to reach out with us — to us with any questions about our progress. In the meantime, we look forward to talking with you soon on our first quarter call in early May. Thanks, and have a good evening.

Operator: And once again, that does conclude this conference. Thank you all for your participation. You may now disconnect.