ARC Document Solutions, Inc. (NYSE:ARC) Q3 2023 Earnings Call Transcript

ARC Document Solutions, Inc. (NYSE:ARC) Q3 2023 Earnings Call Transcript November 4, 2023

Operator: Good day. My name is Jordan, and I’ll be your conference operator today. At this time, I’d like to welcome everyone to the ARC Document Solutions Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a quick question-and-answer session. [Operator Instructions]. Thank you. Vice President of Investor Relations, David Stickney, you may begin the conference.

David Stickney: Thank you, Jordan, 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 third 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 they are only predictions based on information as of today, November 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?

Kumarakulasingam Suriyakumar: Thank you, David, and good afternoon, everyone. Overall sales for the quarter dropped 3% or about $2 million. Adjusted for one working day this year — less this year than we had last year, the drop would have been just 1.3%. This puts us in a very similar situation to the sales we posted in the second quarter, and it is not surprising in the light of the continuing trends we identified in Q2. Sales in digital color and scanning, our strategic areas of growth remain robust, as new customers continue to heavily invest in visual communications and the demand for digitizing files is coming from every industry we serve. Volume in black-and-white printing made up largely of reproducing plans and other construction-based documents fell.

As we projected, it would during our second quarter report in August. This was primarily due to the sustained increase in interest rates, resulting in uncertain and volatile economic conditions in construction. That said, our margins, earnings and cash flows were resilient despite the drop in sales, and they remain more than capable of supporting our commitment to our shareholders value via annual dividend and continuing stock purchases. Using these comments as a framework for further discussion, I will now turn the call over to Dilo and Jorge for a more detailed review of the quarter. Dilo?

Dilantha Wijesuriya: Thank you, Suri. I’m pleased to provide you with an update on ARC’s recent performance and strategic direction for the third quarter. While higher interest rates reduced investment and cautious spending by many customers made for challenging market conditions, our company has demonstrated resilience and adaptability. Despite these challenges, our strategic business lines are improving. Our digital color services and document scanning divisions have delivered continuing growth largely due to our diversification efforts. We have secured large digital color projects in a wide variety of markets, including events, trade shows, schools and sports stadiums. These projects are characterized by the use of multiple graphic products and services across various locations, generating positive customer reviews and strong demand.

Our digital color success extends to smaller venues as well with numerous satisfied customers further validating the demand for our services. Document scanning also experienced high demand from municipalities, cultural institutions and historical archives along with smaller ongoing projects. Midway through the year, we expanded our document scanning capabilities and increased capacity at key locations. This expansion has enhanced our efficiency and throughput for document scanning projects. Our reputation for complex and detailed work continues to attract referrals from previous and existing clients, underpinning our growth in this segment. Our on-site services revenue declined year-over-year as return to office initiatives continue to fluctuate.

However, we have successfully renewed several large on-site service agreements using our certified equipment program, enhancing client satisfaction and improving our margins. Additionally, our service center network has attracted overflow work from customers, further contributing to higher operating margins. In the construction-based plan printing business, we faced challenges due to low construction activity, including commercial and residential construction and fewer office remodels. Despite this, plan printing remains a profitable service line, and we continue to streamline operations and control capital expenditure to keep costs in check. We have cross-trained our employees and leverage our footprint to maintain efficiency. Our efforts in production management have been fruitful, resulting in an improvement in our cost of goods sold this quarter.

We remain vigilant in managing material, labor and production expenses efficiently. Our pipeline, especially in calligraphic and scanning remains robust. Our service centers increased capacity and efficiency position us well to capitalize on these opportunities. Our win-loss ratio for new business is improving, and our marketing efforts are yielding higher quality leads. In summary, our team is highly motivated and actively securing new business to offset declines in the plan printing segment. Our focus remains sharp on the top-line while maintaining the financial discipline that has been a hallmark of ARC bottom line. We are committed to leveraging our experience and expertise over areas we can control, remaining undistracted by external factors beyond our influence.

We look forward to sharing our continuous progress in the coming quarters. Thank you for your trust and continued support. With that, I will turn the call over to Jorge. Jorge?

Jorge Avalos: Thank you, Dilo. While quarterly sales fell 3%, our overall gross margins were up 10 basis points. Our ability to leverage our sales at any level remains a key characteristic of our business model. SG&A was essentially flat despite inflationary pressures. The quarterly earnings felt the impact of lower sales and EPS fell $0.02. Cash flow from operations of $8.7 million for the quarter is suffering from a difficult comparison to prior year. Due to the timing of collections and payables, the first half of 2022 started out extremely slow and momentum built significantly in the second half of the year to make up for it. Given its tendency to fluctuate throughout the year, we have always encouraged an annual perspective when reviewing cash flow from operations.

As a case in point, our year-to-date cash flow remains very healthy at $23 million and fully capable of supporting our annual $0.20 dividend and continuing repurchasing of our shares. Year-to-date comparisons not only better represent our performance in cash generation, but also in operating income, net income, EPS and EBITDA. Year-to-date, operating income for 2023 is slightly higher than 2022. And net income and EPS are essentially flat on a year-to-date basis. EBITDA, while down 10% in the quarter, is down just 5% year-to-date. Obviously, this performance did not reflect the expectations we had in January. But faced with the larger issues affecting the economy and constraining capital spending, we are in a much better position to resume our growth than we would have been prior to the diversification of the business and the reconfiguration of our cost model.

With regards to the balance sheet, we continue to maintain more than $50 million in cash, which we typically use against our revolving debt on an intra-quarter basis to save our interest costs. Net debt at $11.6 million and our leverage remains well under 1x, both very low numbers. We also paid out $2.1 million in quarterly cash dividends, and we used slightly more than $1 million during the quarter to repurchase shares. Via these methods, we expect to return more than 50% of our adjusted free cash flow to shareholders by the end of 2023 and well on our way to exceed $10 million of shareholder returns in 2023. Our top-line may continue to fluctuate for the remainder of the year, but we remain confident that we are focusing on the things that matter most at ARC.

And as a result, we continue to generate opportunities for growth, cash generation and a reliable return of shareholder value in the coming quarters. With that, I’ll turn the call back to Suri. Suri?

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

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Q&A Session

Operator: [Operator Instructions]. And now for our first question is from Greg Burns from Sidoti & Company. Your line is live.

Gregory Burns: Good afternoon. When we look at the 2.5% decline in digital printing this quarter, could you give us the breakdown of what the growth was from color printing and what the decline was from your AEC markets?

Kumarakulasingam Suriyakumar: Yes. Good afternoon. Jorge, would you like to answer?

Jorge Avalos: Sure, sure. So as we’ve always said, roughly 50% of that line item is our legacy plan printing, i.e., blueprinting type of business. The other half is color graphics. In regards to the legacy traditional reprographics, that revenue was down between 6% and 8%. Color was up in that 3% to 5% range.

Gregory Burns: Okay. All right. And then for scanning, it was down a little bit sequentially and grew less than we were expecting. Is that business just project based? I’m just trying to get a better feel for how to think about the growth profile of that business going forward?

Kumarakulasingam Suriyakumar: Dilo?

Dilantha Wijesuriya: Yes. So last year, actually, the scanning revenue, the billing rates are continuing to be the same. It’s continuing to grow. One of the issues that we had was that last year, during the third quarter, we had one significant customer project that we completed and built as a digital service that it was not there this year. So that’s why you see a year-over-year, the growth rate has declined. But if you look at — from the scanning services, otherwise, we are still in that 9% to 10% growth rate.

Jorge Avalos: Yes. So if you really look at it from our day-to-day scanning, the opportunities we go after all the time, we were really growing at that 15-plus percent mark. As Dilo mentioned, that one job that was kind of an odd ball last year, roughly $0.5 million that we booked in third quarter of last year, it’s skewing the year-over-year results, but we feel very confident about that 10%-plus growth in the scanning business.

Gregory Burns: Okay. And then when you look at the opportunities for growth in color and scanning, do you have — maybe it’s difficult now, but do you have line of sight on when you might — when you think you maybe could get back to a little level of growth here or offset the declines, I guess, that you’re seeing in kind of that more traditional plan printing?

Kumarakulasingam Suriyakumar: Dilo?

Dilantha Wijesuriya: Yes, so if you look at our revenue line, as you know, there are four buckets of primary revenue. So when we look at the revenue lines that are currently challenged is primarily the plain paper printing market as well as the equipment sales. That segment of the business is directly connected to the construction industry, right? So as we see the interest, obviously, one of the primary reasons for that challenging situation is the increased interest rate that had totally reduced the opportunities for brand new construction and tenant improvements and so forth. As we see going into the new year, interest rates probably stabilizing, there might — we will see some increased activity in construction. As soon as we see some stabilization in that construction market, we would definitely see some growth within our organization.

So when you take the other — our strategic growth line when it comes to digital color, the market opportunities are continuing to be very strong. Marketing activities are bringing us a lot of new leads. Some of the projects that we execute are very significantly sized project. Many of the top brand organizations are continuing to bring us sizable work, really, they’re focusing on rebranding of their marketing activities. They are doing a lot of trade shows, trade shows, we see quite a lot of activity there as well. And a lot of fair amount of office renovations that takes place revolving around color graphics. So the future opportunities, the pipeline, they are very good and very, very, very strong for our company. Document scanning side is continuing to grow.