ARC Document Solutions, Inc.

Ladies and gentlemen, thank you for standing by. My name is Brent and I will be your conference operator today. At this time, I would like to welcome everyone to the ARC Q4 and fiscal year end 2021 earnings report call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you'd like to ask a question at that time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star 1. Thank you. It's now my pleasure to turn the call over to Mr. David Stickney, Vice President of Investor Relations. Sir, please go ahead.

Thank you, Brent, and welcome, everyone. On the call with me today are Suri Suryakumar, our CEO, our Chief Operating Officer, Dilo Widjasuria, and George Avalos, our Chief Financial Officer. Our fourth quarter and fiscal year results for 2021 were publicized earlier today in a press release. The press release and other company materials are available from our investor relation pages on ARC Document Solutions website at ir.e-arc.com. In today's earnings announcement, ARC offered expanded supplemental disclosures to provide shareholders and analysts with additional information in advance of our quarterly conference call. The disclosures are largely historical and will not be read on today's call. Please note that today's call will contain forward-looking statements that fall within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are only predictions based on information as of today, February 23, 2022, And actual results may differ materially as a result of risks and uncertainties that we highlight in our quarterly and annual SEC filings. This call will also contain references to certain non-GAAP measures, which are reconciled in today's press release and in our Form 8K filing. I'll now turn the call over to our Chairman, President, and CEO, Suri Suryakumar. Suri?

Thank you, David, and welcome, everyone. 2021 was a year of challenges and opportunities. Looking back, I'm pleased to say that we overcame the difficulties in a decisive manner and took advantage of every opportunity for growth that was out there. The year began with business stalled under the cloud of COVID, and our first quarter results reflected those dire circumstances. But in each quarter, Thereafter, the company improved on every front. Our expansion into new markets was remarkable and perhaps surprising to nearly everyone but ourselves. Even our traditional customers in the construction market significantly increased their appetite for our services well beyond digital plan printing. This will allow us to continue to accelerate our revenue streams in growth segments of our business, unlike the pre-pandemic years. Year over year, sales grew in each of the last three quarters, culminating in fourth quarter growth of more than 7%. Of note, every revenue line grew in the fourth quarter, which is typically our softest period of the year. The bottom line was even more impressive as the fourth quarter earnings for the period delivered 158% growth in EPS as compared to the prior year. It was an excellent way to wrap up 2021 any way you look at it, but even more so when we consider how it began. Cash generation in the fourth quarter and the year was as expected, healthy, and consistent with our level of sales. No better evidence of our confidence in continued cash generation was the 150% increase in our dividends announced in December. D'Lo and George will provide more details a little further along in the call. What I'd like to impress upon you most is how well our plans to transform the company have been executed. While the results of the past year have been enormously gratifying in themselves, the power of what we have done will be best demonstrated in the quarters and the years ahead. Our network of service centers is optimized like never before. Our people are heavily cross-trained. We continue to fine-tune our marketing and attract new business And the skill and responsiveness of our sales team is proving to be as versatile and diverse as our new markets are. Not only we can meet the needs of our expanding customer base, but we are focusing our creativity and innovation on creating new services and products that leverage our existing skills and infrastructure. Doing so keeps the cost of developing new offerings low and assign greater value to the experience and talents of our employees. As we continue to reap the benefits of a well-focused strategy and a transformed business model, we are also updating the way we report our results. You will have noticed that the names of two of our primary services, CDIM and AIM, are now referred to as digital printing and scanning and digital imaging. Given our expanding market, we believe it is more powerful to report our services in the language that it describes the way they are produced, rather than by what any given industry might use them for. The methods for financial reporting and revenue recognition in our renamed business lines remain unchanged. The country, our markets, and AHRQ itself are in a very different position today than they were just 12 months ago. Challenges remain, but I think the current situation favors opportunities for 2022, especially for AHRQ. I'll turn the call over to Dilo and George at this point to fill in some important elements of our progress over the past year, and I'm sure you'll see why I remain optimistic about the coming year. Dilo.

Thank you, Suri. As we stated in our comments during our last earnings report, our sales momentum continued into the fourth quarter. As Suri mentioned, we were pleased to see our year-over-year sales grow by nearly 8%. The result of our sales, customer expansion, and product transformation produced good results. The seeds we planted through our sales and marketing campaigns in the previous quarters helped us attract new customers and new projects, and we experienced year-over-year growth in every main revenue category. We continue to position Arc as a key vendor that sits right in the middle of our customers' digital divide. Our ability to produce high-quality prints from digital files, as well as our expertise in converting paper documents into a digital environment, is a value proposition not many companies can offer. By bridging that digital divide, we have earned the trust of our customers, and they are rewarding us with more business. Over the past three years, our teams have been carefully executing a strategy of growing our customer verticals. Several years back, when we were primarily a reprographics company, we served no more than 15 business verticals that were primarily in design and construction. Today, we have successfully grown our customer base and have expanded to serve more than 40 business verticals. Design and construction customers who are our backbone are now consumers of our digital print and scanning and digital imaging services. They are also significant purchasers of management services and equipment and supplies. This has been a key success in our transformation strategy. Each of our service centers, an essential purpose for any business, and our goal is to use them to penetrate all of our new customer verticals. Our continued concentration remains for the following strategic objective. Expand our customer base beyond our traditional market, sell additional growth services to the AC customer base by leveraging the strong relationship we have built over the past 35 years, introduce new growth services that can be performed from the same service center footprint, and protect high margin plan printing revenue. Critical to the achievement of these objectives is the service we provide to our customers. During several of our previous calls, we discussed the need for a higher level of customer service. In tough economic times, many clients moved around due to lack of customer service from their existing providers. As a team, we have diligently strengthened our service levels and communication to deliver superior value to our customers. The evidence of our success can be found in our reviews. We not only have received more than 15,000 online reviews from our customers, but our average rating is in these reviews is 4.97% out of five stars. In terms of economic disruption, supply chain issues were noticeable in our industry at the end of the year. We avoided most supply problems earlier in the year thanks to close inventory management and selling certified used print devices with a full service guarantee from ARC. Printing hardware for management service services incurred delays during the fourth quarter due to our strong vendor relationship. However, we did not experience any delays on the key production materials. Our production management teams were able to maintain good margins and profitability in the fourth quarter despite the issues. As of now, we expect a moderate pushback on the start dates of back to office initiatives as many of our customers are grappling with the effects of the Omicron variant. That said, we expect this to be sorted out within the coming month as restrictions are being lifted. Beyond these challenges, our management teams across the country are looking forward to continuing our progress as we embark on the new year and our mission to be the best digital print company in North America. With that, I'll hand over to George for a financial update. George?

Thank you, Dillo. The year's accomplishments included improvements in nearly every area of our financial performance. Considering that the economy was emerging from the worst of the pandemic at the beginning of the year, common sense suggests we should have struggled throughout the year to get back on track. But that wasn't the case. Sales stabilized and then improved quarter by quarter. Gross margins stayed steady in spite of the reconfiguring of the company to be smaller, more nimble, and more appealing to a wider audience. We compressed our SG&A costs, reduced our need for capital spending and finance leases, and watched while our operating margins responded vigorously. To top it off, net income and EPS grew by more than 45% for the year and by more than 100% in the fourth quarter. Most importantly, however, is the fact that we achieved all of this on the cash we generated during the year, including the $5 million of value we returned to shareholders with an increased quarterly dividend and stock repurchases in the open market. At this point, it might sound odd to suggest that cash flows from operations that declined year over year helped drive our performance. But in reality, that reduction reflects normalized levels of cash generation and collectibles relative to the level of our sales, and just as importantly, a solid foundation to build upon. What's so different is the efficiency of our operations and cost structure after the transformative steps we've taken over the past two years. A perfect example of the efficiency we're achieving is the way we're reducing our capital expenditures and our need for cash at the same time. We have recognized the need for printing equipment and our MPS engagements will be lower in the future due to the permanent adoption of hybrid work models. As such, we're not only acquiring less equipment, but fewer leases for that equipment. On top of it, we're working through existing inventory with our new certified equipment program to reduce capital spending even further and driving more and more work through our service centers where we can leverage production-grade equipment, more capacity, and cross-trained labor. We're tackling other issues in a similar way to address improvements from all angles. The highlights of our financials demonstrate the depth and breadth of this exercise. We grew sales for three consecutive quarters. Our operating margins improved 260 basis points for the quarter and 130 basis points for the year. Cash on the balance sheet was nearly $56 million. At the end of 2021, our debt net of cash was $22.3 million, an annual reduction of $20 million, leaving us with a debt ratio of less than one time. We increased our quarterly dividend from one cent to two cents at the end of 2020, and then raised it to five cents per quarter at the end of 2021. providing an annual yield of more than 5%. Our EBITDA for the year was more than $40 million, with a 15% EBITDA margin, despite the slow start to the year and reduced sales volume. Our EPS for 2021 was 22 cents, a year-over-year increase of 7 cents compared to 2020. It's a long list of accomplishments, and one we're proud of. but it's also an excellent basis for progress and growth in the near future. From a revenue, profitability, and cash flow standpoint, we have created an excellent environment for even more improvements in 2020. I'll now turn the call back to Suri. Suri?

Thank you, George and operator. We are now available to our listeners for their questions.

At this time, I would like to remind everyone In order to ask a question, press star followed by the number one on your telephone keypad. We'll pause for just a moment to compile our Q&A roster. Your first question comes from the line of Robert Shapiro with Singular Research. Your line is open. Hi.

Given the company's transformation that you've been working on, how would this impact the quarterly seasonal trends?

how does it impact the quarterly seasonal trend?

Yeah, you did mention that usually the fourth quarter is the weakest, but maybe because of holiday season, the fourth quarter might be stronger now than some other quarters. Just wondering how that impacts. Let's say, for instance, the first quarter versus the fourth quarter. Would you expect the first quarter to be weaker or stronger than the fourth quarter in terms of seasonal trends?

Yeah, that's a good point. Actually, the fourth quarter is usually the soft quarter, but obviously given our expansion into other verticals and new services, we are finding that's helping to offset some of the softness which we previously experienced in the history of the company. But it's also true that the first quarter last year was largely impacted by the Omicron variant, right? And that was the one thing which put a damper on it. So last year, I mean, it is not a normalized year. So I think as we go forward, we'll start to see a consistent, you know, performance with regard to how sales are reacting and we'll get a better understanding. But last year was obviously tumultuous given the fact that the COVID still had an impact. George, would you like to add to that?

Yeah, and just kind of to add on to Suri's points, I mean, I guess in summary, we don't expect to see such a dramatic difference for the first quarter, the second quarter, the third quarter, the fourth quarter. Are there differences? You know, business is typically a little bit better in the second and third quarter, but as Suri mentioned, not as pronounced as it was in prior years. There will be a more muted difference in between quarters. It wouldn't be industry specific, let's put it that way.

Okay, and you did mention Omicron, the Omicron variant, you did feel like that impacted the fourth quarter, this past quarter?

No, I mean the earlier quarter.

Dilo, would you like to? Yeah, so 2021, yeah, the first quarter was all Delta-related issues. Remember, we had that. But going into the fourth quarter, there was a slight slowdown because many customers were shutting off a lot earlier. before Christmas season due to the variant and so forth. And we noticed that. But again, from the sales point of view, due to the diversification that we've done over the last almost six, seven quarters, and those results are paying true to positive momentum among our customers. So we didn't feel that very much.

Okay, thank you. Again, if you would like to ask a question, press star 1 on your telephone keypad. Your next question comes from Alan Weber with Roboti Advisors. Your line is open.

Oh, hi. Good afternoon. How are you? Very good. Good afternoon. So just a general question. Kind of your legacy business, the architectural, engineering, and like that, roughly what percent of your business is in that legacy industry now? versus say two or three years ago or five years ago?

A high level rule of thumb is you see our digital printing line item. That encompasses our legacy construction related document printing as well as the new color printing. Rough justice, it's about 50, 50% of that line item. I think that's a good rule of thumb. From our perspective, we don't report on it nor do we plan to report on it because there's so much overlap between a lot of that work.

Right. But also, Ellen,

Alan, one other point I must mention is that, you know, although you might see just looking at it 50-50, the kind of services they are buying from us are very different now. For example, there is much less plan printing. There is much less construction plan or specification-related printing because all that has become digital. But what's happening is we are going back to the same customers. We already have relationships. and sending them, I covered that in my, what do you call the script, getting them to buy more digital print and color services, scanning services. So although it seems like it's coming from the industry, it's really a different revenue stream, a new revenue stream, which is much more growth-oriented as against the previous year. So if you go back to the previous years and look at the revenue we generated From even the AEC industry, that was a shrinking revenue. Not anymore. It is actually a growth revenue.

Okay, and then that's great. And then just to follow up, one of you talked about the number of verticals. Can you just talk about kind of what are the fastest growing verticals, just in a general way, over what's changed?

Yes, so verticals. So I spoke about the verticals, how we have expanded the verticals over the last probably two years in the organization. So I wouldn't be able to talk about a specific vertical which is really growing faster than any other vertical. The way we look at it is we look at the vertical, we know what they can buy from digital print and scanning and digital imaging services, and what we are doing is really focusing on understanding what their pain points are and who their buyers and understand their personas and really market to that group of customers so that they know that Arc can provide those services. So that's how we are very tactically going after those verticals and expanding the services that we sell to those customers. So from the vertical standpoint, whether it's higher education, medical, healthcare, government, city and counties, all those verticals are very, very solid for us. Whether it's malls, developers, all those are continuing to stay strong and they have services that they need services that can provide them.

Another way to think about it is, Alan, that instead of thinking about the verticals, think about the product lines. One way to think about it, what are the product lines which are growing fast? So if you think about it, Dilo, wouldn't you agree that digital color and scanning, those are the services which are really growing fast because every vertical requires those kind of services. So what we are doing is by adding verticals, we are continuing to expand the growth of those product lines because we are selling to the same products but to more verticals now. I hope that makes sense.

It does make sense. Just a little unrelated, any thoughts in terms of what, I don't even know if you can talk about this, what you hope to accomplish in terms of buying back stock during 22?

So it will be very opportunistic overall when we look at it. Obviously, we promised over the last 24 months or so, George, we have been talking about focusing on returning shareholder value as the debt levels continue to come down. We focused on retaining shareholder value. And obviously, initially, we were largely focused on share buyback. And then, of course, we shifted to dividends when we started doing it. And we obviously have expanded that aggressively. And share buyback will always be opportunistic, depending on where the market is and how the stocks are trading. George, would you like to add to that?

No. I mean, I think you hit it on there. I mean, we spent $5 million on returning shareholder value in 2021. Now looking at 2022 with the $0.05 dividend, that alone is going to give you $8 million of returning shareholder value in the form of dividends. And as Terry mentioned, we're not abandoning the share repurchase. We're going to be opportunistic and go out there and try to get some more shares.

So the way we are looking at it, balance overall return to shareholder value, we literally doubled it.

Okay, thank you. And my last question is, any thoughts about acquisitions in terms of how much time you spend or is it really... If you can just talk about that.

Very little, because we don't see anybody around who I exactly like, or rather have the similar business models, Alan. But there might be pockets of little acquisitions which might be suitable in certain regional markets. And again, that will be opportunistic. If something knocks on our door and we think it's a fit, we might go after it. But that's not our strategy right now. Right now, it's just basically organic growth. driven by marketing these new services. That's what we're doing right now.

Okay, great. Thank you very much. You're welcome. Thank you, Alan.

Your next question is from the line of Mike Hughes with SGF Capital. Your line is open.

Good afternoon. Thanks for taking my questions. Sure. First high-level question, can you just talk about what pricing will look like for the coming year? And then related to that, I guess, Just talk about the growth potential of the four businesses for this year.

Okay. So from the pricing perspective, we don't see pricing pressures now. Instead, given what's going on around us overall, I think the pricing will be pretty stable. If not, there is opportunity for risk to rise up. And obviously, that depends on suppliers, supply chains, everything that's going around us. but we're very optimistic. So given our buying power, we are able to keep the prices in check while drawing better prices from our customers. That's what's going on. With regard to the four products, you might have just thought of the top four products. Dilal, would you like to comment on that?

Yeah, the top four products, if you look at how we performed in the fourth quarter, I mean, all product lines grew. And we are fairly strong, and we feel fairly strong about each of those product lines as we go through to 2022 as well because the way we are transforming our customer base and the product base, there are more opportunities for us to continue to market and expand into a higher share of wallet within the same customers as well. So we will continue to do that and we feel strongly about growing all four product lines this year.

Okay, just two follow-ups. What does pricing look like over the last four or five years. I assume you've faced pressure. Is that correct? And now it's more stable. Is that right?

No, there's not heavy price pressures like that, the way you identified. There are pockets in the country. Occasionally, we'll see some price pressures due to competition and so forth. But since we went into the pandemic, our customers are clearly wanting services from companies who are reliable, who can get the job done based on the promises that they make. Because with the pandemic, there are so many staff-related disruptions, raw material disruptions that goes on in the industry, quite a bit, quite a bit. And we know the customers are paying a good, fair, competitive price to get the job done right the first time. and from reliable companies like ourselves. So we do not have any meaningful price pressures, and we hope that will continue to stay the same in the future.

So when you talked about, you know, I think just to add to that, you talked about three to five years. If you go back five years, the market was different, without a doubt. And you could say in certain areas there was some amount of price pressure. But like Dilo says, what's happening in the last year or two, especially this year, is companies are willing to pay for high-quality service and reliable service. And we are seeing that. Obviously, that's one of the reasons we focus on high-quality service and get that high level of customer satisfaction. With that kind of thing, we are able to come on better prices.

And our margins prove that out. I mean, our margins have improved and stayed steady.

It's continued to improve, yeah.

Okay, and I understand that the March quarter you have a really easy comparison, so you should be able to put up year-over-year revenue growth, but should that be the case for each of the remaining quarters too? You're looking at revenue growth for all four quarters on a year-over-year basis?

Overall, that's what we are expecting. We obviously want to grow the revenue every quarter. That's the management team's objective. But obviously, you know, as the pandemic settles down and we come back to normalcy, it will be even more clearer. But our expectation is that we'll continue to grow because, you know, organic growth is what we are after and we are driving that hard. And our last three quotes close that out.

Okay, super. One just last question for you. I think in the past you've talked about EBITDA at a level of at least $10 million a quarter. Is that correct? Correct, yes. Okay. Okay. So that would annualize to $40 million. Your interest expense is around two capex of maybe $5 million. And our cash tax is $1 or $2 million. Are all of those decent assumptions?

Cash tax is probably lower. We're well under $500,000. We have historical NOL, so we don't foresee ourselves paying taxes for the foreseeable future. But the rest are generally in line.

Okay. So conservatively, that's $30 million in free cash flow. The dividend consumes $8 to $9 million of that. And then your remainder is about $20 million. And I guess this goes back to the last gentleman's question about the buyback. I guess even if you want to expand it, you're somewhat limited by the restricted payments basket at $15 million. Is that still the case?

That is still the case in our credit agreement.

Okay. Any thoughts on going back to your bankers and having that change so you could do a little bit more aggressive buyback?

Well, we have not gone in there yet. I mean, it remains to be seen. We came out of a very dark era with the banks. You know, they were very nervous when the pandemic hit. And we completely turned that around and got ourselves a very, very favorable deal just very recently. So we are very happy with the deal right now. As it evolves and things become better and become more consistent, we certainly have the opportunity to go back to the bank. And we also want to be mindful of the balance between, you know, dividends and the share buyback. So we'll take it as it comes.

Okay, great. Thank you very much.

You're welcome. If there are no further questions at this time, I will now turn the call back over to Mr. David Stickney.

Thanks, everyone, for your attention this evening. We appreciate your continued interest in AHRQ, and we look forward to talking with you next quarter. Take care and have a good evening.

Ladies and gentlemen, thank you for your participation. This concludes today's conference call. You may now disconnect.