ARC Document Solutions, Inc.

Thank you for standing by. My name is John, and I'll be your conference operator for today. At this time, I would like to welcome everyone to the ArcDocument Solutions second quarter 2024 earnings report. All lights 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 would like to ask a question during this time, simply press star, followed by the number one on your telephone keypad. If you would like to withdraw a question, simply press star one again. Thank you. I would now like to turn the call over to David Stickney, Vice President, Investor Relations.

Please go ahead. Thank you, John, and welcome, everyone. On the call with me today are Suri Suryakumar, our CEO and Chairman, our President and Chief Operating Officer, Dilo Ujusuriya, and George 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 our 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 in our Form 8K filing. 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 ARC's 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 independent financial and legal advisors. 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 form 13 and a press release available on AHRQ'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 Suryakumar. Suri?

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 continue to grow at a healthy pace as expected. On-site services sales fell slightly, but we continue to believe it'll 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 overhead cost, we exceeded our own expectations in gross margins, growing it 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 ourselves. 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 George for their comments. Dilo? 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 conditions 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 climate 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 grow. 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 and 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 will see how we bring custom ideas to life with vibrant graphics. The market for digital color is becoming increasingly competitive with many traditional print companies transitioning to digital printing. However, AHRQ 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 be prepared to take on new projects as the economy improves and interest rates decline. While plan 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 revenues. 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 scan 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 MPS sales fell slightly 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 divisions, 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 U.S. We are optimistic about delivering continued strong sales results in the coming quarters. While we experienced gross margin pressures in the first quarter, we reversed the decline with a 30 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 email 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 George to give you an update of our financial results. George?

Thank you, Dalal. 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 easing, 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 five-cent 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 result, I'll turn the call back to Suri. Suri? Thank you, George.

Operator, we are now ready to take questions from our listeners.

Thank you. We will now begin our question and answer session. If you have dialed in and would like to ask a question, please press star followed by the number one on your touchstone phone. If you would like to withdraw your question, simply press star one again. If you are called upon to ask your question and are listening via loudspeaker on your device, Please pick up your handset and ensure that your phone is not on mute when asking your question. Thank you. Your first question comes from the line of Greg Burns from Sidoti. Please go ahead.

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? 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, you know, 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, you know, maybe the overall market spend rates decline? Thank you.

You know, would you like to add that?

Yeah. So, you know, we haven't seen any First question is, you know, you want to know whether there were any slowdown in 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, you know, we are actually canvassing to different types of customers. 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 three, four weeks have been have been, you know, 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, you know, we are not one of those companies who has one or two massive locations that do, you know, 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. We are continuing to focus, our sales reps are continuing to focus on our core competencies where we know there is a significant market out there. There is a significant demand from customers out there for companies like us. We feel still strong about our future growth.

Okay. And then in terms of your more traditional plan printing, did the decline slow there at all? 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 it's on?

Yeah. So the plain 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 trends have been there. You know, we've seen a couple of projects slowing down or, you know, getting delayed. But with regard to the plain paper usage, there is still a lull in that market, you know, and I attribute that quite a bit to the higher interest rates that we're currently experiencing. You know, someday down the line, couple of quarters down the line, that When we see some easement in interest rates, some of that work is going to come back. The home building, home construction, some of the tenant improvement work, they'll all come back to some level. But some of the secular changes that we've seen, the plain 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.

Okay. In terms of margins, obviously 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... You know, it's just a strong quarter and maybe we see a step back in the coming quarters. How should we think about margin progression from here?

I mean, I'll break it up into two points. From a gross margin perspective, you know, 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 prospect as we move forward. later in the year. I mean, would we be able to repeat 35% gross margins? Maybe not if in regards, depending, as you guys, 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 feel we have a good chance of being in that range. Now, the second part of your question in regards to the investments and the impact on their 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?

Yep. No, that's helpful. All right. I'll pass it along. Thank you.

Yeah, no problem. Your next question comes from the line of David Marsh from Singular Research. Please go ahead.

Hey, guys. Thank you very much for taking the questions. Sure. So, yeah, if I could start. It looks like the share count actually ticked up a bit. Just wondered, you know, I know, you know, repurchasing shares had been a priority if the market opportunity was there. I'm wondering if this go private transaction kind of supersedes your ability to repurchase any shares.

The quick answer is yes, it does. Okay.

And so it looks like you took some cash and maybe paid down a little bit of debt in a quarter. Am I reading that right? And then

know what would be the kind of uh priority uses of cash going forward as you evaluate this transaction um in regards to we're 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 could see from our financials, we did that in 2023 because interest rates were high and I didn'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.

Okay. So, you know, this is, you know, this proposal, obviously management is an involved party or some portion of the management team is an involved party in the proposal. But, you know, going back to your comment, looking at business more as a, you know, just kind of a continuing operation as a public company, you know, are you seeing any opportunities for acquisitions that would, you know, 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?

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 were we in consideration to do anything. With regard to the 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

review we will do so okay uh that's pretty helpful uh just i'm sorry yeah i'm probably repeating uh the previous caller's question i apologize if i do uh george i think you said nine hundred thousand dollars in expense related to the evaluation of the go private transaction in the quarter is that right today you're right and did that hit the sgna line

That is correct on both points.

Okay, so as we go forward, that extent should be demonstrably lower, presumably. Is that a fair assessment?

We just don't know, and it's something we can't comment on.

That's completely up to the special committee. They have right 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.

Roger that. Okay, guys. Thanks very much for taking the questions. I'll pass it along.

You're welcome. Your next question comes from the line of Glenn Primack from Luce Investment Group. Please go ahead.

Good afternoon. Good afternoon. Digging a little deeper on the... increased marketing expense is that going towards a specific program like the uh the scanning or is that um can you just uh touch on like what uh what specific programs you're really going after with the extra dollars there yeah so i there's no i can attribute it to a very specific program glenn you know it's uh the extra spend that we've seen year over year for the second quarter

There's a component that goes into headcount. We've added a couple of new sales consultants, especially experienced consultants who are good in digital color, white format color printing. So we've added them in specific geographical markets, very strategic locations. So some amount is in headcount. And the rest of it is, you know, we just launched a new website. You know, I hope you got a chance to see that the new Arc website is on. We launched a new Riot Color 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. You know, a little bit of Spending on Google advertising as well, but not a heck of a lot. No big investments compared to last year. But we've been very focused on organic driven marketing programs. Email 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.

All right, great. So on the sales side, you've probably got some payback off of that if it's experienced people that you're putting in these different locations versus a newbie. Is that safe to assume?

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

Yeah, and it's no doubt that you and George will measure everything anyways.

Every time, Glenn, every time.

I love that. That's it for me. I can't wait to go check out the new website and the RIOT, you know, relatively new website.

Thank you. Great. And that does conclude the question and answer session. I would like to turn the floor back over to Mr. David Spicke for closing remarks.

As usual, we appreciate your continuing interest in AHRQ. 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.

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