ARC DOCUMENT SOLUTIONS, INC.
The accompanying notes are an integral part of these condensed consolidated financial statements.
The accompanying notes are an integral part of these condensed consolidated financial statements.
ARC DOCUMENT SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data or where otherwise noted)
(Unaudited)
1. Description of Business and Basis of Presentation
ARC Document Solutions, Inc. (“ARC Document Solutions,” “ARC” or the “Company”) is a leading document solutions provider to architectural, engineering, construction, and facilities management professionals, while also providing document solutions to businesses of all types. ARC offers a variety of services including: Construction Document Information Management ("CDIM"), Managed Print Services ("MPS"), and Archive and Information Management ("AIM"). In addition, ARC also sells Equipment and Supplies. The Company conducts its operations through its wholly-owned operating subsidiary, ARC Document Solutions, LLC, a Texas limited liability company, and its affiliates.
Basis of Presentation
The accompanying interim Condensed Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in conformity with the requirements of the U.S. Securities and Exchange Commission ("SEC"). As permitted under those rules, certain footnotes or other financial information required by GAAP for complete financial statements have been condensed or omitted. In management’s opinion, the accompanying interim Condensed Consolidated Financial Statements presented reflect all adjustments of a normal and recurring nature that are necessary to fairly present the interim Condensed Consolidated Financial Statements. All intercompany accounts and transactions have been eliminated in consolidation. The operating results for the three and six months ended June 30, 20192020 are not necessarily indicative of the results that may be expected for the year ending December 31, 20192020.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the interim Condensed Consolidated Financial Statements and accompanying notes. The Company evaluates its estimates and assumptions on an ongoing basis and relies on historical experience and various other factors that it believes to be reasonable under the circumstances to determine such estimates. Actual results could differ from those estimates and such differences may be material to the interim Condensed Consolidated Financial Statements.
These interim Condensed Consolidated Financial Statements and accompanying notes should be read in conjunction with the consolidated financial statements and notes included in the Company’s 20182019 Form 10-K.
Revenue Recognition
Revenue is recognized when control of the promised goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Net sales of the Company’s principal services and products were as follows:
|
| | | | | | | | | | | | | | | | |
| | Three Months Ended
June 30, | | | Six Months Ended
June 30, |
| | 2020 | | 2019 | | | 2020 | | 2019 |
| CDIM | $ | 41,070 |
| | $ | 54,394 |
| | | $ | 90,230 |
| | $ | 105,199 |
|
MPS(1) | 16,233 |
| | 31,578 |
| | | 43,541 |
| | 62,485 |
|
| AIM | 2,653 |
| | 3,601 |
| | | 6,253 |
| | 6,863 |
|
| Equipment and supplies sales | 4,363 |
| | 9,300 |
| | | 12,720 |
| | 21,448 |
|
| Net sales | $ | 64,319 |
| | $ | 98,873 |
| | | $ | 152,744 |
| | $ | 195,995 |
|
|
| | | | | | | | | | | | | | | | |
| | Three Months Ended
June 30, | | | Six Months Ended
June 30, |
| | 2019 | | 2018 | | | 2019 | | 2018 |
| CDIM | $ | 54,394 |
| | $ | 55,531 |
| | | $ | 105,199 |
| | $ | 107,851 |
|
MPS(1) | 31,578 |
| | 33,330 |
| | | 62,485 |
| | 64,797 |
|
| AIM | 3,601 |
| | 3,170 |
| | | 6,863 |
| | 6,093 |
|
| Equipment and supplies sales | 9,300 |
| | 12,159 |
| | | 21,448 |
| | 23,157 |
|
| Net sales | $ | 98,873 |
| | $ | 104,190 |
| | | $ | 195,995 |
| | $ | 201,898 |
|
(1) MPS includes $14.7 million of rental income and $1.5 million of service income for the three months ended June 30, 2020 and $40.1 million of rental income and $3.4 million of service income for the six months ended June 30, 2020. MPS includes $29.4 million of rental income and $2.2 million of service income for the three months ended June 30, 2019 and $58.0 million of rental income and $4.4 million of service income for the six months ended June 30, 2019.
CDIM consists of professional services and software services to (i) reproduce and distribute large-format and small-format documents in either black and white or color (“Ordered Prints”) and (ii) specialized graphic color printing. Substantially all of the Company’s revenue from CDIM comes from professional services to reproduce Ordered Prints. Sales of Ordered Prints are initiated through a customer order or quote and are governed by established terms and conditions agreed upon at the onset of the customer relationship. Revenue is recognized when the performance obligation under the terms of a contract with a customer are satisfied; generally, this occurs with the transfer of control of the reproduced Ordered Prints. Transfer of control occurs at a specific point in time, when the Ordered Prints are delivered to the customer’s site or handed to the customer for walk inwalk-in orders. Revenue is
measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services. Taxes collected concurrent with revenue-producing activities are excluded from revenue.
MPS consists of placement, management, and optimization of print and imaging equipment in the customers' offices, job sites, and other facilities. MPS relieves the Company’s customers of the burden of purchasing print equipment and related supplies and maintaining print devices and print networks, and it shifts their costs to a “per-use” basis. MPS is supported by our hosted proprietary technology, Abacus®, which allows our customers to capture, control, manage, print, and account for their documents. Under its MPS contracts, the Company is paid a fixed rate per unit for each print produced (per-use), often referred to as a “click charge.”charge”. MPS sales are driven by the ongoing print needs of the Company’s customers at their facilities. Upon the issuance of Accounting Standards Codification ("ASC") 842, Leases, the Company concluded that certain of its MPS arrangements, which had previously been accounted for as service revenue under ASC 606, Revenue from Contracts with Customers, are accounted for as operating leases under ASC 842. See Note 6, Leasing, for additional information.
AIM combines software and professional services to facilitate the capture, management, access and retrieval of documents and information that have been produced in the past. AIM includes our hosted SKYSITE® software to organize, search and retrieve documents, as well as the provision of services that include the capture and conversion of hardcopy and electronic documents into digital files (“Scanned Documents”), and their cloud-based storage and maintenance. Sales of AIM professional services, which represents the majority of AIM revenue, are initiated through a customer order or proposal and are governed by established terms and conditions agreed upon at the onset of the customer relationship. Revenue is recognized when the performance obligation under the terms of a contract with a customer are satisfied; generally, this occurs with the transfer of control of the digital files. Transfer of control occurs at a specific point in time, when the Scanned Documents are delivered to the customer either through SKYSITE or on electronic media. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services. Taxes collected concurrent with revenue-producing activities are excluded from revenue.
Equipment and Supplies sales consist of reselling printing, imaging, and related equipment (“Goods”) to customers primarily in architectural, engineering and construction firms. Sales of equipment and supplies are initiated through a customer order and are governed by established terms and conditions agreed upon at the onset of the customer relationship. Revenue is recognized when the performance obligations under the terms of a contract with a customer are satisfied; generally, this occurs with the transfer of control of the Goods. Transfer of control occurs at a specific point in time, when the Goods are delivered to the customer’s site. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods or providing services. Taxes collected concurrent with revenue-producing activities are excluded from revenue. The Company has experienced minimal customer returns or refunds and does not offer a warranty on equipment that it is reselling.
Recently Adopted Accounting Pronouncements
In December 2019, the FASB issued Accounting Standards Update No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes (“ASU 2019-12”), which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. ASU 2019-12 will be effective for interim and annual periods beginning after December 15, 2020. Early adoption is permitted. The Company elected to early adopt ASU 2019-12 on January 1, 2020. The adoption of ASU 2019-12 did not have a material impact on the Company's consolidated financial statements.
Recent Accounting Pronouncements Not Yet Adopted
In FebruaryJune 2016, the FASB issued ASC 842, Leases.Accounting Standards Update No. 2016-13, Financial Instruments - Credit Loss (Topic 326) (“ASU 2016-13”), which updates the guidance on recognition and measurement of credit losses for financial assets. The new guidance replacedrequirements, known as the existing guidance in ASC 840, Leases. ASC 842 requirescurrent expected credit loss model ("CECL") will require entities to adopt an impairment model based on expected losses rather than incurred losses. ASU 2016-13 must be adopted on a dual approachmodified-retrospective approach. This update was effective for lessee accounting under which a lessee accounts for leases as finance leases or operating leases. Both finance leases and operating leases result in the lessee recognizing a right-of-use ("ROU") asset and a corresponding lease liability. For finance leases, the lessee recognizes interest expense and amortization of the ROU asset and for operating leases the lessee will recognize a straight-line total lease expense. The Company adopted ASC 842 on January 1, 2019.fiscal years beginning after December 15, 2020 including interim periods within those fiscal years. In July 2018,October 2019, the FASB issued ASU 2018-11, Leases(Topic 842): Targeted Improvements, which provided entities the optionapproved an extension for all non-SEC filers including small reporting companies (SRC) to useextend the effective date asto fiscal years beginning after December 15, 2022 including interim periods within those fiscal years. Therefore, the effective date of initial application on transition to the new guidance.for this update will be January 1, 2023. The Company elected this transition method, and as a result,is currently evaluating the Company did not adjust comparative information for prior periods. For additional information about thepotential impact of the adoption of ASC 842, see Note 6, Leasing.the new standard on its consolidated statements of financial condition and results of operations.
Segment Reporting
The provisions of ASC 280, Segment Reporting, require public companies to report financial and descriptive information about their reportable operating segments. The Company identifies operating segments based on the various business activities that earn revenue and incur expense and whose operating results are reviewed by the Company's Chief Executive Officer, who is the Company's chief operating decision maker. Because its operating segments have similar products and services, classes of customers, production processes, distribution methods and economic characteristics, the Company operates as a single reportable segment.
Risk and Uncertainties
The Company generates the majority of its revenue from sales of services and products to customers in the architectural, engineering, construction and building owner/operator ("AEC/O") industry. As a result, the Company’s operating results and financial condition can be significantly affected by economic factors that influence the AEC/O industry, such as non-residential construction spending, GDP growth, interest rates, unemployment rates, and office vacancy rates.rates, all of which have been amplified due to the COVID-19 pandemic. Reduced activity (relative to historic levels) in the AEC/
O industry would diminish demand for some of ARC’s services and products, and it would therefore negatively affect revenues and have a material adverse effect on itsARC's business, operating results and financial condition.
As part of the Company’s growth strategy, ARC intends to continue to offer and grow a variety of service offerings, some of which are relatively new to the Company. The success of the Company’s efforts will be affected by its ability to acquire new customers for the Company’s new service offerings, as well as to sell the new service offerings to existing customers. The Company’s inability to successfully market and execute these relatively new service offerings could significantly affect its business and reduce its longlong- term revenue, resulting in an adverse effect on its results of operations and financial condition.
2. Earnings per Share
The Company accounts for earnings per share in accordance with ASC 260, Earnings Per Share. Basic earnings per share is computed by dividing net income attributable to ARC by the weighted-average number of common shares outstanding for the period. Diluted earnings per common share is computed similarly to basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if common shares subject to outstanding options and acquisition rights had been issued and if the additional common shares were dilutive. Common share equivalents are excluded from the computation if their effect is anti-dilutive. For the three and six months ended June 30, 2019, 5.5 million and 5.62020, 5.2 million common shares were excluded from the calculation of diluted net income attributable to ARC per common share, respectively, because they were anti-dilutive. For the three and six months ended June 30, 20182019, 5.45.5 million and 5.25.6 million common shares were excluded from the calculation of diluted net loss attributable to ARC per common share, respectively, because they were anti-dilutive. The Company's common share equivalents consist of stock options issued under the Company's stock plan.
Basic and diluted weighted average common shares outstanding were calculated as follows for the three and six months ended June 30, 20192020 and 20182019:
|
| | | | | | | | | | | | |
| | Three Months Ended
June 30, | | | Six Months Ended
June 30, |
| | 2020 | | 2019 | | | 2020 | | 2019 |
| Weighted average common shares outstanding during the period—basic | 42,672 |
| | 45,225 |
| | | 43,154 |
| | 45,172 |
|
| Effect of dilutive stock awards | 95 |
| | 73 |
| | | 123 |
| | 156 |
|
| Weighted average common shares outstanding during the period—diluted | 42,767 |
| | 45,298 |
| | | 43,277 |
| | 45,328 |
|
|
| | | | | | | | | | | | |
| | Three Months Ended
June 30, | | | Six Months Ended
June 30, |
| | 2019 | | 2018 | | | 2019 | | 2018 |
| Weighted average common shares outstanding during the period—basic | 45,225 |
| | 44,936 |
| | | 45,172 |
| | 44,839 |
|
| Effect of dilutive stock options | 73 |
| | 43 |
| | | 156 |
| | 85 |
|
| Weighted average common shares outstanding during the period—diluted | 45,298 |
| | 44,979 |
| | | 45,328 |
| | 44,924 |
|
3. Goodwill and Other Intangibles
Goodwill
In accordance with ASC 350, Intangibles - Goodwill and Other, the Company assesses goodwill for impairment annually as of September 30, and more frequently if events and circumstances indicate that goodwill might be impaired.
At September 30, 2018,March 31, 2020, the Company performed its assessment and determined that there were sufficient indicators to trigger an interim goodwill impairment analysis based on a combination of factors, all of which relate to the COVID-19 Pandemic. The indicators included (1) the current global economic environment, (2) a revision of the Company's forecasted future earnings, and (3) a decline in the Company's market capitalization in 2020. As a result of this analysis, the Company concluded that the fair value of each reporting unit exceeds its carrying value, and goodwill was not impaired.0t impaired as of March 31, 2020. Although, the COVID-19 pandemic continues to cause
uncertainty in the global economic environment, the Company significantly outperformed its revised forecasted earnings and had an increase in its market capitalization in excess of 20% between March 31, 2020 and June 30, 2020. As a result, the Company concluded that 0 goodwill impairment triggering events have occurred during the second quarter of 2020 that would require an additional impairment test.
Goodwill impairment testing is performed at the reporting unit level. Goodwill is assigned to reporting units at the date the goodwill is initially recorded. Once goodwill has been assigned to reporting units, it no longer retains its association with a particular acquisition, and all of the activities within a reporting unit, whether acquired or internally generated, are available to support the value of the goodwill. For its annual goodwill impairment test as of September 30,In 2017, the Company elected to early-adopt ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies subsequent goodwill measurement by eliminating step two from the goodwill impairment test.
The Company determines the fair value of its reporting units using an income approach. Under the income approach, the Company determined fair value based on estimated discounted future cash flows of each reporting unit. Determining the fair value of a reporting unit is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates and EBITDA margins, discount rates and future market conditions, among others.The level of judgment and estimation is inherently higher in the current environment considering the uncertainty created by the COVID-19 pandemic. The Company has evaluated numerous factors disrupting its business and made significant assumptions which include the severity and duration of the business disruption, the timing and degree of economic recovery and the combined effect of these assumptions on the Company's future operating results and cash flows.
Given the changing document and printing needsuncertainty regarding the ultimate financial impact of the Company’s customers,COVID-19 pandemic and the uncertainties regarding the effect on the Company’s business,ensuing economic recovery, there can be no assurance that the estimates and assumptions made for purposes of the Company’s goodwill impairment testanalysis in 20182020 will prove to be accurate predictions of the future. If the Company’s assumptions, including forecasted EBITDA of certain reporting units, are not achieved, or its assumptions regarding disruptions caused by the pandemic, and its impact on the recovery from COVID-19 change, then the Company may be required to record additional goodwill impairment
charges in future periods, whether in connection with the Company’s next annual impairment testing in the third quarter of 2019,2020, or on an interim basis, if any such change constitutes a triggering event (as defined under ASC 350, Intangibles-Goodwill and Other) outside of the quarter when the Company regularly performs its annual goodwill impairment test. It is not possible at this time to determine if any such future impairment charge would result or, if it does, whether such charge would be material. There was no0 change in the carrying amount of goodwill from January 1, 20182019 through June 30, 2019.2020.
See “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations for further information regarding the process and assumptions used in the goodwill impairment analysis.
Long-lived and Other Intangible Assets
The Company periodically assesses potential impairments of its long-lived assets in accordance with the provisions of ASC 360, Accounting for the Impairment or Disposal of Long-lived Assets. An impairment review is performed whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. The Company groups its assets at the lowest level for which identifiable cash flows are largely independent of the cash flows of the other assets and liabilities. The Company has determined that the lowest level for which identifiable cash flows are available is the regional level, which is the operating segment level.
Factors considered by the Company include, but are not limited to, significant underperformance relative to historical or projected operating results; significant changes in the manner of use of the acquired assets or the strategy for the overall business; and significant negative industry or economic trends. When the carrying value of a long-lived asset may not be recoverable based upon the existence of one or more of the above indicators of impairment, the Company estimates the future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future undiscounted cash flows and eventual disposition is less than the carrying amount of the asset, the Company recognizes an impairment loss. An impairment loss is reflected as the amount by which the carrying amount of the asset exceeds the fair value of the asset, based on the fair value if available, or discounted cash flows, if fair value is not available.
As a result of the effect of the COVID-19 pandemic on the Company's expected future operating cash flows, we determined certain impairment triggers had occurred. The Company assessed its long-lived assets for possible impairment as of March 31, 2020 and concluded that its long-lived assets were not impaired. For the three months ended June 30, 2020, the Company determined that there was 0 indication of impairment of the intangible assets.
Other intangible assets that have finite lives are amortized over their useful lives. Customer relationships are amortized using the accelerated method, based on customer attrition rates, over their estimated useful lives of 13 (weighted average) years.
The following table sets forth the Company’s other intangible assets resulting from business acquisitions as of June 30, 20192020 and December 31, 20182019 which continue to be amortized:
|
| | | | | | | | | | | | | | | | | | | | | | | |
| | June 30, 2020 | | December 31, 2019 |
| | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount |
| Amortizable other intangible assets | | | | | | | | | | | |
| Customer relationships | $ | 99,064 |
| | $ | 98,440 |
| | $ | 624 |
| | $ | 99,127 |
| | $ | 97,430 |
| | $ | 1,697 |
|
| Trade names and trademarks | 20,269 |
| | 19,991 |
| | 278 |
| | 20,279 |
| | 19,980 |
| | 299 |
|
| | $ | 119,333 |
| | $ | 118,431 |
| | $ | 902 |
| | $ | 119,406 |
| | $ | 117,410 |
| | $ | 1,996 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | |
| | June 30, 2019 | | December 31, 2018 |
| | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount |
| Amortizable other intangible assets | | | | | | | | | | | |
| Customer relationships | $ | 99,237 |
| | $ | 96,179 |
| | $ | 3,058 |
| | $ | 99,136 |
| | $ | 94,345 |
| | $ | 4,791 |
|
| Trade names and trademarks | 20,289 |
| | 19,969 |
| | 320 |
| | 20,259 |
| | 19,924 |
| | 335 |
|
| | $ | 119,526 |
| | $ | 116,148 |
| | $ | 3,378 |
| | $ | 119,395 |
| | $ | 114,269 |
| | $ | 5,126 |
|
Estimated future amortization expense of other intangible assets for the remainder of the 20192020 fiscal year, and each of the subsequent four fiscal years and thereafter are as follows:
|
| | | |
| 2020 (excluding the six months ended June 30, 2020) | $ | 430 |
|
| 2021 | 167 |
|
| 2022 | 96 |
|
| 2023 | 41 |
|
| 2024 | 39 |
|
| Thereafter | 129 |
|
| | $ | 902 |
|
|
| | | |
| 2019 (excluding the six months ended June 30, 2019) | $ | 1,374 |
|
| 2020 | 1,525 |
|
| 2021 | 172 |
|
| 2022 | 99 |
|
| 2023 | 42 |
|
| Thereafter | 166 |
|
| | $ | 3,378 |
|
4. Income Taxes
On a quarterly basis, the Company estimates its effective tax rate for the full fiscal year and records a quarterly income tax provision based on the anticipated annual effective rate and the recognition of any discrete items within the quarter.
The Company recorded an income tax provision of $0.1 million and $1.3 million in relation to pretax income of $1.6 million and $3.1 million for the three and six months ended June 30, 2020, respectively, which resulted in an effective income tax rate of 9.4% and 40.0%, respectively. The Company recorded an income tax provision of $3.9 million and $4.2 million in relation to pretax income of $4.4 million and $5.1 million for the three and six months ended June 30, 2019, respectively, which resulted in an effective income tax rate of 88.4% and 81.3%, respectively. The Company recorded an income tax provision of $1.8 million and $1.9 million and in relation to pretax income of $5.8 million and $6.4 million for the three and six months ended June 30, 2018, respectively, which resulted in an effective income tax rate of 31.5% and 29.5%, respectively. The increase in the Company's effective income tax rate for the three and six months ended June 30, 20192020 was due to deferred tax expense related toprimarily impacted by certain stock-based compensation, that expiredchange in the second quarter of 2019.valuation allowances against certain deferred tax assets and non-deductible expenses.
In accordance with ASC 740-10, Income Taxes, the Company evaluates the need for deferred tax asset valuation allowances based on a more likely than not standard. The ability to realize deferred tax assets depends on the ability to generate sufficient taxable income within the carryback or carryforward periods provided for in the tax law for each applicable tax jurisdiction. The Company considers the following possible sources of taxable income when assessing the realization of deferred tax assets:
Future reversals of existing taxable temporary differences;
Future taxable income exclusive of reversing temporary differences and carryforwards;
Taxable income in prior carryback years; and
Tax-planning strategies.
The assessment regarding whether a valuation allowance is required or should be adjusted also considers all available positive and negative evidence factors, including but not limited to:
Nature, frequency, and severity of recent losses;
Duration of statutory carryforward periods;
Historical experience with tax attributes expiring unused; and
Near- and medium-term financial outlook.
The Company utilizes a rolling three years of actual and current year anticipated results as the primary measure of cumulative income/losses in recent years, as adjusted for permanent differences. The evaluation of deferred tax assets requires judgment in
assessing the likely future tax consequences of events that have been recognized in the Company's financial statements or tax returns and future profitability. The Company's accounting for deferred tax consequences represents its best estimate of those future events. Changes in the Company's current estimates, due to unanticipated events, such as the ultimate financial impact of and recovery from the COVID-19 pandemic or otherwise, could have a material effect on its financial condition and results of operations. The Company has a $2.2 million valuation allowance against certain deferred tax assets as of June 30, 2019.2020.
Based on the Company’s current assessment, the remaining net deferred tax assets as of June 30, 20192020 are considered more likely than not to be realized. The valuation allowance of $2.2 million may be increased or reduced as conditions change or if the Company is unable to implement certain available tax planning strategies. The realization of the Company’s net deferred tax assets ultimately dependdepends on future taxable income, reversals of existing taxable temporary differences or through a loss carry back. The Company has income tax receivables of $0.1$0.4 million as of June 30, 20192020 included in other current assets in its interim Condensed Consolidated Balance Sheet primarily related to income tax refunds for prior years.
5. Long-Term Debt
Long-term debt consists of the following:
|
| | | | | | | | |
| | | June 30, 2020 | | December 31, 2019 |
Revolving Loans; 2.79% and 3.63% interest rate at June 30, 2020 and December 31, 2019 | | 75,000 |
| | 60,000 |
|
Various finance leases; weighted average interest rate of 4.8% and 4.9% at June 30, 2020 and December 31, 2019; principal and interest payable monthly through November 2025 | | 47,791 |
| | 46,157 |
|
| | | 122,791 |
| | 106,157 |
|
| Less current portion | | (16,885 | ) | | (17,075 | ) |
| | | $ | 105,906 |
| | $ | 89,082 |
|
|
| | | | | | | | |
| | | June 30, 2019 | | December 31, 2018 |
Term Loan maturing 2022, net of deferred financing fees of $462 and $556; 4.17% and 4.11% interest rate at June 30, 2019 and December 31, 2018 | | $ | 50,538 |
| | $ | 52,694 |
|
Revolving Loans; 4.71% and 4.74% interest rate at June 30, 2019 and December 31, 2018 | | 19,000 |
| | 26,750 |
|
Various finance leases; weighted average interest rate of 4.9% and 4.8% at June 30, 2019 and December 31, 2018; principal and interest payable monthly through June 2024 | | 47,439 |
| | 47,737 |
|
Various other notes payable with a weighted average interest rate of 10.7% at June 30, 2019 and December 31, 2018; principal and interest payable monthly through November 2019 | | 9 |
| | 11 |
|
| | | 116,986 |
| | 127,192 |
|
| Less current portion | | (22,916 | ) | | (22,132 | ) |
| | | $ | 94,070 |
| | $ | 105,060 |
|
Credit Agreement
On July 14, 2017,December 17, 2019, the Company amended its Credit Agreement which was originally entered into on November 20, 2014 with Wells Fargo Bank, National Association, as administrative agent and the lenders party thereto.
Prior to being amended, the Credit Agreement provided for the extension of term loans (“Term Loans”) in an aggregate principal amount of $175.0 million. In addition, prior to being amended, the Credit Agreement provided for the extension of revolving loans (“Revolving Loans”) in an aggregate principal amount not to exceed $30.0 million.
The amendment increased the maximum aggregate principal amount of Revolving Loansrevolving loans under the agreement from $30.0 million to $80.0 million and reduced the outstanding principal amount of the Term Loan under the agreement to $60.0 million. Upon the execution of the amendment to the Credit Agreement from $65 million to $80 million. Proceeds of a portion of the total principal amountrevolving loans available to be drawn under the Credit Agreement were used to fully repay the $49.5 million term loan that was outstanding under the agreement remained unchanged at $110.0 million. As a result of the amendment to the Credit Agreement, the principal of the Term Loan amortizes at an annual rate of 7.5% during the first and second years following the date of the amendment and at an annual rate of 10% during the third, fourth and fifth years following the date of the amendment, with any remaining balance payable upon the maturity date. The amendment also extended the maturity date for both the Revolving Loans and the Term Loans until July 14, 2022. In November 2018, the Company reduced the $80.0 million Revolving Loan commitment by $15.0 million.Agreement.
As of June 30, 2019,2020, the Company's borrowing availability of Revolving Loans under the Revolving Loan commitment was $43.8$2.8 million, after deducting outstanding letters of credit of $2.2 million and outstanding Revolving Loans of $19.0$75.0 million.
Loans borrowed under the Credit Agreement bear interest, in the case of LIBOR rate loans, at a per annum rate equal to the applicable LIBOR rate, plus a margin ranging from 1.25% to 2.25%1.75%, based on the Company’s Total Leverage Ratio (as defined in the Credit Agreement). Loans borrowed under the Credit Agreement that are not LIBOR rate loans bear interest at a per annum rate equal to (i) the greatest of (A) the Federal Funds Rate plus 0.50%, (B) the one month LIBOR rate plus 1.00%, per annum, and (C) the rate of interest announced, from time to time, by Wells Fargo Bank, National Association as its “prime rate,” plus (ii) a margin ranging from 0.25% to 1.25%0.75%, based on the Company’s Total Leverage Ratio. The amendment reduced the rate of interest payable on the loans borrowed under the Credit Agreement by 0.25%.
The Company pays certain recurring fees with respect to the credit facility, including administration fees to the administrative agent.
Subject to certain exceptions, including, in certain circumstances, reinvestment rights, the loans extended under the Credit Agreement are subject to customary mandatory prepayment provisions with respect to: the net proceeds from certain asset sales; the net proceeds from certain issuances or incurrences of debt (other than debt permitted to be incurred under the terms of the Credit Agreement); the net proceeds from certain issuances of equity securities; and net proceeds of certain insurance recoveries and condemnation events of the Company.
The Credit Agreement contains customary representations and warranties, subject to limitations and exceptions, and customary covenants restricting the ability (subject to various exceptions) of the Company and its subsidiaries to: incur additional indebtedness (including guarantee obligations); incur liens; sell certain property or assets; engage in mergers or other fundamental changes;
consummate acquisitions; make investments; pay dividends, other distributions or repurchase equity interest of the Company or its subsidiaries; change the nature of their business; prepay or amend certain indebtedness; engage in certain transactions with affiliates; amend their organizational documents; or enter into certain restrictive agreements. In addition, the Credit Agreement contains financial covenants which requires the Company to maintain (i) at all times, a Total Leverage Ratio in an amount not to exceed 3.252.75 to 1.00; and (ii) a Fixed Charge Coverage Ratio (as defined in the Credit Agreement), as of the last day of each fiscal quarter, an amount not less than 1.15 to 1.00. We were in compliance with our covenants as of June 30, 2020.
The amendment also modified certain tests the Company is required to meet in order to pay dividends, repurchase stock and make other restricted payments. In order to make such payments which are permitted subject to certain customary conditions set forth in the Credit Agreement, the amount of all such payments will be limited to $15 million during any twelve-month period. Pursuant to the amendment, when calculating the fixed charge coverage ratio, the Company may exclude up to $10 million of such restricted payments that would otherwise constitute fixed charges in any twelve month period.
The amendment allows for payment of dividends. In February 2020, the Company's board of directors declared a quarterly cash dividend of $0.01 per share that was paid on May 29, 2020 to shareholders of record as of April 30, 2020.
The Credit Agreement contains customary events of default, including with respect to: nonpayment of principal, interest, fees or other amounts; failure to perform or observe covenants; material inaccuracy of a representation or warranty when made; cross-default to other material indebtedness; bankruptcy, insolvency and dissolution events; inability to pay debts; monetary judgment defaults; actual or asserted invalidity or impairment of any definitive loan documentation, repudiation of guaranties or subordination terms; certain ERISA related events; or a change of control.
The obligations of the Company’s subsidiary that is the borrower under the Credit Agreement are guaranteed by the Company and each of its other United States domestic subsidiary of the Company.subsidiaries. The Credit Agreement and any interest rate protection and other hedging arrangements provided by any lender party to the credit facility or any affiliate of such a lender are secured on a first priority basis by a perfected security interest in substantially all of the borrower’s, the Company’s and each guarantor’s assets (subject to certain exceptions).
6. Leasing
Adoption of ASC Topic 842, Leases
In February 2016, the FASB issued ASC 842, Leases. The new guidance replaces the existing guidance in ASC 840, Leases. ASC 842 requires a dual approach for lessee accounting under which a lessee accounts for leases as finance leases or operating leases. Both finance leases and operating leases result in the lessee recognizing a right-of-use ("ROU") asset and a corresponding lease liability. For finance leases the lessee recognizes interest expense and amortization of the ROU asset, and for operating leases the lessee will recognize a straight-line total lease expense. In addition, ASC 842 changes the definition of a lease, which resulted in changes to the classification of certain service contracts with customers to lease arrangements. The Company adopted ASC 842 on January 1, 2019.
In July 2018, the FASB issued ASU 2018-11, Leases(Topic 842): Targeted Improvements, which provided entities the option to use the effective date as the date of initial application on transition to the new guidance. The Company elected this transition method, and as a result, the Company did not adjust comparative information for prior periods. The Company elected certain additional practical expedients permitted by the new guidance allowing the Company to carry forward historical accounting related to lease identification and classification for existing leases upon adoption. The Company elected, for its equipment asset classes, the practical expedient that allows lessees to treat the lease and non-lease components of leases as a single lease component. Leases with an initial term of 12 months or less are not recorded on the Company's consolidated balance sheet.
As part of the transition, the Company completed a comprehensive review of its lease portfolio, including significant leases by geography and by asset type that were impacted by the new guidance, and enhanced its controls around leasing. The adoption of ASC 842 resulted in an increase to total assets and liabilities due to the recording of operating lease ROU assets of approximately $46.9 million and operating lease liabilities of approximately $53.7 million, as of January 1, 2019. Finance leases were not impacted by the adoption of ASC 842, as finance lease liabilities and the corresponding ROU assets were already recorded in the balance sheet under the previous guidance, ASC 840. The adoption did not materially impact the Company’s Consolidated Statements of Operations or Cash Flows.
Lessee Accounting
The Company determines whether an arrangement is a lease contract at inception. The Company's material lease contracts are generally for real estate or print equipment, and the determination of whether such contracts contain leases generally does not require significant estimates or judgments. The Company’s leases that are classified as operating leases primarily consist of real estate leases. The Company’s real estate leases contain both lease and non-lease components, which are accounted for separately. The Company’s leases that are classified as finance leases primarily consist of print equipment. Certain print equipment leases have lease and non-lease components, which are accounted for as a single lease component as discussed above. Other than the election to treat the Company's fixed lease payment as a single lease component, the accounting for finance leases will remain unchanged under ASC 842.
Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most of the Company's operating leases do not provide an implicit rate, the Company uses its incremental
borrowing rate based on the information available at commencement date in determining the present value of lease payments. The operating lease ROU assets also include any lease payments made and are reduced by any lease incentives received. The lease terms primarily range from one to ten years, with renewal terms that can extend the lease term from 1 to 5 years. A portion of the Company’s real estate leases are generally subject to annual changes in the Consumer Price Index (CPI), which are treated as variable lease payments and recognized in the period in which the obligation for those payments was incurred. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.
The tables below present financial information associated with the Company's leases. This information is only presented as of, and for the three and six months ended, June 30, 2019 because, as noted above, the Company adopted ASC 842 using a transition method that does not require application to periods prior to adoption.
|
| | | | |
| | Classification | June 30, 2019 |
| Assets | | |
| Operating lease assets | Right-of-use assets from operating leases | $ | 42,845 |
|
| Finance lease assets | Property and equipment | 83,761 |
|
| | Less accumulated depreciation | (39,217 | ) |
| | Property and equipment, net | 44,544 |
|
| Total lease assets | | $ | 87,389 |
|
| | | |
| Liabilities | | |
| Current | | |
| Operating | Current operating lease liabilities | $ | 11,372 |
|
| Finance | Current portion of long-term debt and finance leases | 16,906 |
|
| Long-term | | |
| Operating | Long-term operating lease liabilities | 38,550 |
|
| Finance | Long-term debt and finance leases | 30,533 |
|
| Total lease liabilities | | $ | 97,361 |
|
|
| | | | | | | | |
| | Classification | Three Months Ended June 30, 2019 | | Six Months Ended June 30, 2019 |
| Operating lease cost | Cost of sales | $ | 4,415 |
| | $ | 8,785 |
|
| | Selling, general and administrative expenses | 923 |
| | 1,740 |
|
Total operating lease cost (1) | | $ | 5,338 |
| | $ | 10,525 |
|
| | | | | |
| Finance lease cost | | | | |
| Amortization of leased assets | Cost of sales | $ | 4,746 |
| | $ | 9,300 |
|
| | Selling, general and administrative expenses | 62 |
| | 127 |
|
| Interest on lease liabilities | Interest expense, net | 536 |
| | 1,117 |
|
| Total finance lease cost | | 5,344 |
| | 10,544 |
|
| Total lease cost | | $ | 10,682 |
| | $ | 21,069 |
|
(1) Includes variable lease costs and short-term lease costs of $768 and $194, respectively for the three months ended June 30, 2019, and variable lease costs and short-term lease costs of $1,487 and $264, respectively for the six months ended June 30, 2019
|
| | | | | | | | |
| Maturity of lease liabilities (as of June 30, 2019) | Operating leases(1) | | Finance leases(2) |
| 2019 | | $ | 7,288 |
| | $ | 9,754 |
|
| 2020 | | 12,335 |
| | 17,208 |
|
| 2021 | | 9,832 |
| | 13,113 |
|
| 2022 | | 8,209 |
| | 7,728 |
|
| 2023 | | 6,939 |
| | 3,482 |
|
| 2024 | | 5,254 |
| | 652 |
|
| Thereafter | | 10,688 |
| | — |
|
| Total | | 60,545 |
| | 51,937 |
|
| Less amount representing interest | | 10,623 |
| | 4,498 |
|
| Present value of lease liability | | $ | 49,922 |
| | $ | 47,439 |
|
(1) Reflects payments for non-cancelable operating leases with initial terms of one year or more as of June 30, 2019. The table above does not include any legally binding minimum lease payments for leases signed but not yet commenced, and such leases are not material in the aggregate.
(2) The table above does not include any legally binding minimum lease payments for leases signed but not yet commenced, and such leases are not material in the aggregate.
As previously disclosed in the Company's 2018 Annual Report on Form 10-K and under the previous lease accounting standard, future minimum lease payments for operating leases and capital lease obligation as of December 31, 2018 were as follows: |
| | | | | | | | |
| Maturity of lease liabilities (as of December 31, 2018) | Operating leases | | Capital leases |
| 2019 | | $ | 16,355 |
| | $ | 16,872 |
|
| 2020 | | 12,956 |
| | 13,817 |
|
| 2021 | | 10,130 |
| | 10,141 |
|
| 2022 | | 8,510 |
| | 5,274 |
|
| 2023 | | 7,054 |
| | 1,633 |
|
| Thereafter | | 16,650 |
| | — |
|
| Total | | $ | 71,655 |
| | $ | 47,737 |
|
|
| | | |
| June 30, 2019 |
Weighted average remaining lease term (years) | |
Operating leases | | 5.7 |
|
Finance leases | | 3.2 |
|
| | |
Weighted average discount rate | |
Operating leases | | 5.9 | % |
Finance leases | | 4.9 | % |
|
| | | | |
| Other information | Six Months Ended June 30, 2019 |
| Cash paid for amounts included in the measurement of lease liabilities | |
| Operating cash flows from operating leases | $ | 6,017 |
|
| Operating cash flows from finance leases | $ | 1,138 |
|
| Financing cash flows from finance leases | $ | 9,196 |
|
Lessor Accounting
The Company concluded that certain of its contracts with customers contain leases under the new leasing standard and accordingly should be accounted for as operating leases upon adoption of ASC 842. Specifically, certain of the Company's MPS arrangements, which had previously been accounted for as service revenue under ASC 606, Revenue from Contracts with Customers, are now accounted for as operating leases under ASC 842.
The Company's MPS arrangements consists of the placement, management, and optimization of print and imaging equipment in customers' offices, job sites, and other facilities under which the Company is paid a fixed rate per unit for each print produced (per-use), often referred to as a “click charge.” Accordingly, the fixed rate per unit charged to the customer covers the use of the equipment (i.e., the lease component), as well as the additional services performed by the Company as described above (i.e., the non-lease component). Certain of the Company's MPS contracts provide the customer the option to renew or terminate the agreement, which are considered when assessing the lease term. The Company elected the practical expedient to not separate certain lease and non-lease components related to its MPS arrangements, and accounts for the combined component under ASC 842. The pattern of revenue recognition for the Company's MPS revenue has remained substantially unchanged following the adoption of ASC 842.
MPS revenue includes $29.4 million of rental income and $2.2 million of service income for the three months ended June 30, 2019, and $58.0 million of rental income and $4.4 million of service income for the six months ended June 30, 2019. The Company's property and equipment, net of accumulated depreciation, includes approximately $40 million of equipment subject to leases with customers under the Company's MPS arrangements. Following the termination of an MPS arrangement, the Company will place existing equipment at an alternate customer site pursuant to an MPS arrangement, at one of the Company's service centers, or dispose of the equipment.
7. Commitments and Contingencies
Operating Leases. The Company leases machinery, equipment, and office and operational facilities under non-cancelable operating lease agreements used in the ordinary course of business. Certain lease agreements for the Company's facilities generally contain renewal options and provide for annual increases in rent based on the local Consumer Price Index. Refer to Note 8, Leasing, on our Annual Form 10-K, for a schedule of the Company's future minimum operating lease payments.
Indemnification Agreements. The Company has entered into indemnification agreements with each director and named executive officer which provide indemnification under certain circumstances for acts and omissions which may not be covered by any directors’ and officers’ liability insurance. The indemnification agreements may require the Company, among other things, to indemnify its officers and directors against certain liabilities that may arise by reason of their status or service as officers and directors (other than liabilities arising from willful misconduct of a culpable nature), to advance their expenses incurred as a result of any proceeding against them as to which they could be indemnified, and to obtain officers’ and directors’ insurance if available on reasonable terms. There have been no events to date which would require the Company to indemnify its officers or directors.
Legal Proceedings. We are involved in various legal proceedings and other legal matters from time to time in the normal course of business. We do not believe that the outcome of any of those matters will have a material effect on our consolidated financial position, results of operations or cash flows.
8.7. Stock-Based Compensation
The Company's stock plan provides for the grant of incentive and non-statutory stock options, stock appreciation rights, restricted stock, restricted stock units, stock bonuses and other forms of awards granted or denominated in the Company's common stock or units of the Company's common stock, as well as cash bonus awards, to employees, directors and consultants of the Company. On April 26, 2018, the Company's shareholders approved an amendment to the Company's stock plan to increase the aggregate number of shares authorized for issuance under such plan by 3.5 million shares. The Company's stock plan, as amended, currently authorizes the Company to issue up to 7.0 million shares of common stock. As of June 30, 2019, 1.92020, 1.0 million shares remained available for issuance under the stock plan.
Stock options granted under the Company's stock plan generally expire no later than ten years from the date of grant. Options generally vest and become fully exercisable over a period of three to four years from date of award, except that options granted to non-employee directors may vest over a shorter time period. The exercise price of options is equal to at least 100% of the fair
market value of the Company’s common stock on the date of grant. The Company allows for cashless exercises of vested outstanding options.
During the six months ended June 30, 20192020, the Company granted options to acquire a total of 0.70.5 million shares of the Company's common stock to certain key employees with an exercise price equal to the fair market value of the Company’s common stock on the date of grant. During the six months ended June 30, 2019,2020, the Company granted 0.50.3 million shares of restricted stock awards to certain key employees with a deemed issuance price per share equal to the closing price of the Company's common stock on the date the restricted stock was granted. These stock options and restricted stock awards vest annually over three years from the grant date. In addition, the Company granted approximately 2686 thousand shares of restricted stock awards to each of the Company's six4 non-employee members of its board of directors with a deemed issuance price per share equal to the closing price of the Company's common stock on the date the restricted stock was granted.
Stock-based compensation expense was $0.6$0.4 million and $1.2$0.9 million for the three and six months ended June 30, 2019,2020, respectively compared to stock-based compensation expense of $0.6 million and $1.2 million for the three and six months ended June 30, 2018.2019, respectively.
As of June 30, 2019,2020, total unrecognized compensation cost related to unvested stock-based payments totaled $3.7$2.3 million and is expected to be recognized over a weighted-average period of approximately 2.01.7 years.
9.8. Fair Value Measurements
In accordance with ASC 820, Fair Value Measurement, the Company has categorized its assets and liabilities that are measured at fair value into a three-level fair value hierarchy. If the inputs used to measure fair value fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement. The three levels of the hierarchy are defined as follows:
Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 inputs to the valuation methodology are unobservable and significant to the fair value measurement.
As of June 30, 2019,2020, the Company's assets and liabilities that are measured at fair value were not material.
Fair Values of Financial Instruments.The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments for disclosure purposes:
Cash equivalents: Cash equivalents are time deposits with maturity of three months or less when purchased, which are highly liquid and readily convertible to cash. Cash equivalents reported in the Company’s interim Condensed Consolidated Balance Sheet were $7.3$11.9 million as of June 30, 20192020 and $9.3 million as of December 31, 20182019, and are carried at cost and approximate fair value due to the relatively short period to maturity of these instruments.
Short and long-term debt: The carrying amount of the Company’s finance leases reported in the interim Condensed Consolidated Balance Sheets approximates fair value based on the Company’s current incremental borrowing rate for similar types of borrowing arrangements. The carrying amount reported in the Company’s interim Condensed Consolidated Balance Sheet as of June 30, 20192020 for borrowings under its Credit Agreement is $70.0 million, excluding unamortized deferred financing fees.$75.0 million. The Company
has determined, utilizing observable market quotes, that the fair value of borrowings under its Credit Agreement is $70.0$75.0 million as of June 30, 20192020.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our interim Condensed Consolidated Financial Statements and the related notes and other financial information appearing elsewhere in this report as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 20182019 Form 10-K and this Quarterly Report on Form 10-Q for the quarter ended June 30, 2019.2020.
Business Summary
ARC Document Solutions, Inc. (“ARC Document Solutions,” “ARC,” “we,” “us,” or “our”) is a leading document solutions provider to design, engineering, construction, and facilities management professionals, while also providing document solutions to businesses of all types.
Our customers need us to manage the scale, complexity and workflow of their documents. We help them reduce their costs and increase their efficiency by improving their access and control over documents, and we offer a wide variety of ways to access, distribute, collaborate on, and store documents.
Each of our service offerings is enabled through a suite of supporting proprietary technology and a wide variety of value-added services. We have categorized our service and product offerings to report distinct sales recognized from:
Construction Document and Information Management (CDIM), which consists of professional services and software services to manage and distribute documents and information primarily related to construction projects.information. CDIM sales include software services such as SKYSITE®, our cloud-based project communication application, as well as providing document and information management services that are often technology-enabled. The bulk of our current revenue from CDIM comes from large-format and small-format printing services we provide in both black and white and in color.
The sale of services addresses a variety of customer needs including the provision of project communication tools, project information management, building information modeling, digital document distribution services, printing services, and others.
Managed Print Services (MPS), consists of placement, management, and optimization of print and imaging equipment in our customers' offices, job sites, and other facilities. MPS relieves our customers of the burden of owning and managing print devices and print networks, and shifts their costs to a “per-use” basis. MPS is supported by our proprietary technology, Abacus®, which allows our customers to capture, control, manage, print, and account for their documents. MPS revenue is derived from two sources: 1) an engagement with the customer to place primarily large-format equipment, that we own or lease, at a construction site or in our customers’ offices, and 2) an arrangement by which our customers outsource their printing function to us, including all office printing, copying, and reprographics printing. In both cases this is recurring, contracted revenue in which we are paid a single cost per unit of material used, often referred to as a “click charge.” MPS sales are driven by the ongoing print needs of our customers at their facilities.
Archiving and Information Management (AIM), combines software and professional services to facilitate the capture, management, access and retrieval of documents and information that have been produced in the past. AIM includes our SKYSITE software to organize, search and retrieve documents, as well as the provision of services that include the capture and conversion of hardcopy and electronic documents, and their cloud-based storage and maintenance. AIM sales are driven by the need to leverage past intellectual propertylegacy information and documents for present or future use, facilitate cost savings and efficiency improvements over current hardcopy and digital storage methods, as well as comply with regulatory and records retention requirements.
Equipment and Supplies, which consists of reselling printing, imaging, and related equipment to customers primarily toin architectural, engineering and construction firms.
We have expanded our business beyond the services we traditionally provided to the architectural, engineering, construction, and building owner/operator (AEC/O) industry in the past and are currently focused on growing MPS, AIMhave diversified our offerings ranging beyond the construction vertical and CDIM, as wehistorical print segments. We believe the mix of services demanded by the AEC/O industry continues to shift toward document management at customer locations and in the cloud,color graphics and away from its historical emphasis on large-format construction drawings produced “offsite” in our service centers.
We deliver our services via the cloud, through a nationwide network of service centers, regionally-based technical specialists, locally-based sales executives, and a national/regional sales force known as Global Solutions.
Based on our analysis of our operating results, we estimate that sales to the AEC/O industry accounted for approximately 79%72% of our net sales for the six months ended June 30, 2019,2020, with the remaining 21%28% consisting of sales to businesses outside of construction.the AEC/O industry.
Costs and Expenses
Our cost of sales consists primarily of materials (paper, toner, and other consumables), labor, and “indirect costs” which consist primarily of equipment expenses related to our MPS contracts and our service center facilities. Facilities and equipment expenses include maintenance, repairs, rents, insurance, and depreciation. Paper is the largest component of our material cost; however, paper pricing typically does not significantly affect our operating margins due, in part, to our efforts to pass increased costs on to our customers. We closely monitor material cost as a percentage of net sales to measure volume and waste. We also track labor utilization, or net sales per employee, to measure productivity and determine staffing levels.
We maintain low levels of inventory. Historically, our capital expenditure requirements have varied due to the cost and availability of finance lease lines of credit. Our relationships with credit providers hashave provided attractive lease rates over the recent years, and as a result, we chose to lease rather than purchase equipment in a significant portion of our engagements.
Research and development costs consist mainly of the salaries, leased building space, and computer equipment that comprises our data storage and development centers in San Ramon, California and Kolkata, India. Such costs are primarily recorded to cost of sales.
COVID-19 Pandemic
The global spread of the novel coronavirus (COVID-19) in recent months has negatively impacted the global economy, disrupted global supply chains and created significant volatility and disruption of financial markets. The impact of this pandemic has created significant uncertainty in the global economy and has negatively affected our business, employees, suppliers, and customers. Despite a strong start to the year, the decline in demand for our products and services that began in late-March 2020, as a result of the COVID-19 pandemic, negatively impacted our sales and profitability during the first half of 2020. The duration of these trends and the magnitude of such impacts cannot be precisely estimated at this time, as they are affected by a number of factors, many of which are outside management’s control, including those presented in Item 1A. Risk Factors of this Quarterly Report. Although, there is uncertainty as the COVID-19 pandemic continues to unfold, we saw this as an opportunity to transform our business into a smaller but stronger company during the second quarter of 2020, offering a range of products beyond the construction vertical and our historical print segments, and reconfiguring our operations and cost structure to fit the needs of our customers in the current market. We've repositioned the Company with the belief that there is potential for new growth and similar, if not better margins, barring any unforeseen changes that may arise due to the COVID-19 pandemic or otherwise.
Sustained adverse impacts to us, as well as to certain of our suppliers, dealers or customers may also affect our future valuation of certain assets and therefore may increase the likelihood of an impairment charge, write-off, or reserve associated with such assets, including goodwill, intangible assets, property and equipment, inventories, accounts receivable, tax assets, and other assets.
We believe that we have taken appropriate measures to mitigate the impacts of the COVID-19 pandemic as it relates to the health and safety of our employees and customers. As the situation evolves into what could be a prolonged pandemic, we will continue to analyze additional mitigation measures that may be needed to preserve the health and safety of our workforce and our customers, and the ongoing continuity of our business operations. Those measures might include temporarily suspending operations at select service centers, modifying workspaces, continuing social distancing protocols, incorporating additional personal protective equipment and/or incorporating health screening policies at our facilities, or such other industry best practices needed to comply with applicable government orders and to continue to maintain a healthy and safe environment for our employees during the COVID-19 pandemic.
Given the economic uncertainty resulting from the COVID-19 pandemic, we have taken actions to improve our current liquidity position, including drawing on our revolving credit facility within the first quarter of 2020, reducing working capital, suspending share repurchases and future dividends, postponing capital expenditures, reducing operating costs, initiating workforce reductions and salary reductions, and substantially reducing discretionary spending.
We are the largest document services provider to industries that build and maintain our country's infrastructure and thus were considered an essential business and permitted to remain open in most markets during the first half of 2020. We also serve the housing, healthcare, and technology industries, and we were able to keep almost all of our 170 service centers open, though at reduced volumes, in order to fulfill our customers' needs. However, there is uncertainty around the extent and duration of interruptions to our business related to the COVID-19 pandemic, as well as the pandemic's overall impact on the U.S. economy, on our clients' ongoing business operations, and our results of operations and financial condition. While our management team is actively monitoring the impacts of the COVID-19 pandemic and may take further actions altering our business operations that we determine are in the best interests of our employees and clients or as required by federal, state, or local authorities, the full impact of the COVID-19 pandemic on the results of our operations, financial condition, or liquidity for the remainder of fiscal year 2020 and beyond cannot be estimated at this point. The following discussions are subject to the future effects of the COVID-19 pandemic on our ongoing business operations.
Results of Operations
| | | | Three Months Ended June 30, | | Increase (decrease) | | Six Months Ended
June 30, | | Increase (decrease) | Three Months Ended June 30, | | Increase (decrease) | | Six Months Ended
June 30, | | Increase (decrease) |
| (In millions, except percentages) | 2019 | | 2018 | | $ | | % | | 2019 | | 2018 (2) | | $ | | % | 2020(2) | | 2019(2) | | $ | | % | | 2020(2) | | 2019(2) | | $ | | % |
| CDIM | $ | 54.4 |
| | $ | 55.5 |
| | $ | (1.1 | ) | | (2.0 | )% | | $ | 105.2 |
| | $ | 107.9 |
| | $ | (2.7 | ) | | (2.5 | )% | $ | 41.1 |
| | $ | 54.4 |
| | $ | (13.3 | ) | | (24.5 | )% | | $ | 90.2 |
| | $ | 105.2 |
| | $ | (15.0 | ) | | (14.2 | )% |
| MPS | 31.6 |
| | 33.3 |
| | (1.8 | ) | | (5.3 | )% | | 62.5 |
| | 64.8 |
| | (2.3 | ) | | (3.6 | )% | 16.2 |
| | 31.6 |
| | (15.3 | ) | | (48.6 | )% | | 43.5 |
| | 62.5 |
| | (18.9 | ) | | (30.3 | )% |
| AIM | 3.6 |
| | 3.2 |
| | 0.4 |
| | 13.6 | % | | 6.9 |
| | 6.1 |
| | 0.8 |
| | 12.6 | % | 2.7 |
| | 3.6 |
| | (0.9 | ) | | (26.3 | )% | | 6.3 |
| | 6.9 |
| | (0.6 | ) | | (8.9 | )% |
| Equipment and supplies sales | 9.3 |
| | 12.2 |
| | (2.9 | ) | | (23.5 | )% | | 21.4 |
| | 23.2 |
| | (1.7 | ) | | (7.4 | )% | 4.4 |
| | 9.3 |
| | (4.9 | ) | | (53.1 | )% | | 12.7 |
| | 21.4 |
| | (8.7 | ) | | (40.7 | )% |
| Total net sales | $ | 98.9 |
| | $ | 104.2 |
| | $ | (5.3 | ) | | (5.1 | )% | | $ | 196.0 |
| | $ | 201.9 |
| | $ | (5.9 | ) | | (2.9 | )% | $ | 64.3 |
| | $ | 98.9 |
| | $ | (34.6 | ) | | (34.9 | )% | | $ | 152.7 |
| | $ | 196.0 |
| | $ | (43.3 | ) | | (22.1 | )% |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Gross profit | $ | 33.8 |
| | $ | 35.8 |
| | $ | (2.0 | ) | | (5.5 | )% | | $ | 64.5 |
| | $ | 66.0 |
| | $ | (1.5 | ) | | (2.3 | )% | $ | 20.4 |
| | $ | 33.8 |
| | $ | (13.4 | ) | | (39.6 | )% | | $ | 48.0 |
| | $ | 64.5 |
| | $ | (16.5 | ) | | (25.5 | )% |
| Selling, general and administrative expenses | $ | 27.2 |
| | $ | 27.5 |
| | $ | (0.3 | ) | | (1.0 | )% | | $ | 54.9 |
| | $ | 54.8 |
| | $ | — |
| | 0.1 | % | $ | 17.3 |
| | $ | 27.2 |
| | $ | (9.9 | ) | | (36.5 | )% | | $ | 41.6 |
| | $ | 54.9 |
| | $ | (13.2 | ) | | (24.1 | )% |
| Amortization of intangibles | $ | 0.9 |
| | $ | 1.0 |
| | $ | (0.1 | ) | | (12.0 | )% | | $ | 1.8 |
| | $ | 2.0 |
| | $ | (0.2 | ) | | (11.6 | )% | |
| Amortization of intangible assets | | $ | 0.5 |
| | $ | 0.9 |
| | $ | (0.4 | ) | | (45.7 | )% | | $ | 1.1 |
| | $ | 1.8 |
| | $ | (0.7 | ) | | (39.4 | )% |
| Interest expense, net | $ | 1.4 |
| | $ | 1.5 |
| | $ | (0.1 | ) | | (9.5 | )% | | $ | 2.8 |
| | $ | 3.0 |
| | $ | (0.2 | ) | | (5.3 | )% | $ | 1.1 |
| | $ | 1.4 |
| | $ | (0.2 | ) | | (17.6 | )% | | $ | 2.2 |
| | $ | 2.8 |
| | $ | (0.6 | ) | | (20.1 | )% |
| Income tax provision | $ | 3.9 |
| | $ | 1.8 |
| | $ | 2.1 |
| | 111.7 | % | | $ | 4.2 |
| | $ | 1.9 |
| | $ | 2.3 |
| | 122.5 | % | $ | 0.1 |
| | $ | 3.9 |
| | $ | (3.7 | ) | | (96.2 | )% | | $ | 1.3 |
| | $ | 4.2 |
| | $ | (2.9 | ) | | (70.0 | )% |
| Net income attributable to ARC | $ | 0.5 |
| | $ | 4.1 |
| | $ | (3.6 | ) | | (87.1 | )% | | $ | 1.1 |
| | $ | 4.7 |
| | $ | (3.6 | ) | | (76.3 | )% | $ | 1.5 |
| | $ | 0.5 |
| | $ | 0.9 |
| | 178.8 | % | | $ | 2.1 |
| | $ | 1.1 |
| | $ | 1.0 |
| | 92.1 | % |
Non-GAAP (1) | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Adjusted net income attributable to ARC (1) | $ | 3.1 |
| | $ | 4.1 |
| | $ | (1.0 | ) | | (24.8 | )% | | $ | 3.7 |
| | $ | 4.6 |
| | $ | (0.9 | ) | | (19.3 | )% | $ | 1.2 |
| | $ | 3.1 |
| | $ | (1.9 | ) | | (60.8 | )% | | $ | 2.4 |
| | $ | 3.7 |
| | $ | (1.3 | ) | | (35.6 | )% |
EBITDA (1) | $ | 13.8 |
| | $ | 15.6 |
| | $ | (1.8 | ) | | (11.5 | )% | | $ | 24.4 |
| | $ | 25.9 |
| | $ | (1.4 | ) | | (5.5 | )% | $ | 10.3 |
| | $ | 13.8 |
| | $ | (3.5 | ) | | (25.6 | )% | | $ | 21.2 |
| | $ | 24.4 |
| | $ | (3.3 | ) | | (13.3 | )% |
Adjusted EBITDA (1) | $ | 14.4 |
| | $ | 16.2 |
| | $ | (1.7 | ) | | (10.8 | )% | | $ | 25.7 |
| | $ | 27.1 |
| | $ | (1.4 | ) | | (5.2 | )% | $ | 10.7 |
| | $ | 14.4 |
| | $ | (3.7 | ) | | (26.0 | )% | | $ | 22.1 |
| | $ | 25.7 |
| | $ | (3.6 | ) | | (13.9 | )% |
| |
| (1) | See "Non-GAAP Financial Measures" on pg. 2624 for additional information. |
| |
| (2) | Column does not foot due to rounding. |
The following table provides information on the percentages of certain items of selected financial data as a percentage of net sales for the periods indicated:
| | | | As Percentage of Net Sales | | As Percentage of Net Sales | As Percentage of Net Sales | | As Percentage of Net Sales |
| | Three Months Ended June 30, | | Six Months Ended June 30, | Three Months Ended June 30, | | Six Months Ended June 30, |
| | 2019 (1) | | 2018 (1) | | 2019 | | 2018 (1) | 2020 (1) | | 2019 (1) | | 2020 (1) | | 2019 |
| Net Sales | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % | 100.0 | % | | 100.0 | % | | 100.0 | % | | 100.0 | % |
| Cost of sales | 65.8 |
| | 65.6 |
| | 67.1 |
| | 67.3 |
| 68.2 |
| | 65.8 |
| | 68.5 |
| | 67.1 |
|
| Gross profit | 34.2 |
| | 34.4 |
| | 32.9 |
| | 32.7 |
| 31.8 |
| | 34.2 |
| | 31.5 |
| | 32.9 |
|
| Selling, general and administrative expenses | 27.5 |
| | 26.4 |
| | 28.0 |
| | 27.1 |
| 26.9 |
| | 27.5 |
| | 27.3 |
| | 28.0 |
|
| Amortization of intangibles | 0.9 |
| | 0.9 |
| | 0.9 |
| | 1.0 |
| |
| Amortization of intangible assets | | 0.7 |
| | 0.9 |
| | 0.7 |
| | 0.9 |
|
| Income from operations | 5.8 |
| | 7.0 |
| | 4.0 |
| | 4.6 |
| 4.2 |
| | 5.8 |
| | 3.5 |
| | 4.0 |
|
| Interest expense, net | 1.4 |
| | 1.5 |
| | 1.4 |
| | 1.5 |
| 1.8 |
| | 1.4 |
| | 1.5 |
| | 1.4 |
|
| Income before income tax provision | 4.5 |
| | 5.6 |
| | 2.6 |
| | 3.2 |
| 2.4 |
| | 4.5 |
| | 2.1 |
| | 2.6 |
|
| Income tax provision | 3.9 |
| | 1.8 |
| | 2.1 |
| | 0.9 |
| 0.2 |
| | 3.9 |
| | 0.8 |
| | 2.1 |
|
| Net income | 0.5 |
| | 3.8 |
| | 0.5 |
| | 2.2 |
| 2.2 |
| | 0.5 |
| | 1.2 |
| | 0.5 |
|
| Loss attributable to the noncontrolling interest | — |
| | 0.1 |
| | 0.1 |
| | 0.1 |
| 0.1 |
| | — |
| | 0.2 |
| | 0.1 |
|
| Net income attributable to ARC | 0.5 | % | | 3.9 | % | | 0.6 | % | | 2.3 | % | 2.3 | % | | 0.5 | % | | 1.4 | % | | 0.6 | % |
Non-GAAP (2) | | | | | | | | | | | | | | |
EBITDA (2) | 14.0 | % | | 15.0 | % | | 12.5 | % | | 12.8 | % | 16.0 | % | | 14.0 | % | | 13.9 | % | | 12.5 | % |
Adjusted EBITDA (2) | 14.6 | % | | 15.5 | % | | 13.1 | % | | 13.4 | % | 16.6 | % | | 14.6 | % | | 14.5 | % | | 13.1 | % |
We have a $2.2 million valuation allowance against certain deferred tax assets as of June 30, 2019.2020.
Net loss attributable to noncontrolling interest represents 35% of the income of UDS and its subsidiaries, which together comprise our Chinese joint venture operations.
We do not believe inflation has had a significant effect on our operations. Price increases for raw materials, such as paper and fuel charges, typically have been, and we expect will continue to be, passed on to customers in the ordinary course of business.
EBITDA and related ratios presented in this report are supplemental measures of our performance that are not required by or presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These measures are not measurements of our financial performance under GAAP and should not be considered as alternatives to net income, income from operations, or any other performance measures derived in accordance with GAAP or as an alternative to cash flows from operating, investing or financing activities as a measure of our liquidity.
EBITDA represents net income before interest, taxes, depreciation and amortization. EBITDA margin is a non-GAAP measure calculated by dividing EBITDA by net sales.
We have presented EBITDA and related ratios because we consider them important supplemental measures of our performance and liquidity. We believe investors may also find these measures meaningful, given how our management makes use of them. The following is a discussion of our use of these measures.
We use EBITDA to measure and compare the performance of our operating segments. Our operating segments’ financial performance includes all of the operating activities except debt and taxation which are managed at the corporate level for U.S. operating segments. We use EBITDA to compare the performance of our operating segments and to measure performance for
determining consolidated-level compensation. In addition, we use EBITDA to evaluate potential acquisitions and potential capital expenditures.
EBITDA and related ratios have limitations as analytical tools, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are as follows:
They do not reflect our cash expenditures, or future requirements for capital expenditures and contractual commitments;
They do not reflect changes in, or cash requirements for, our working capital needs;
They do not reflect the significant interest expense, or the cash requirements necessary, to service interest or principal payments on our debt;
Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA does not reflect any cash requirements for such replacements; and
Other companies, including companies in our industry, may calculate these measures differently than we do, limiting their usefulness as comparative measures.
Because of these limitations, EBITDA and related ratios should not be considered as measures of discretionary cash available to us to invest in business growth or to reduce our indebtedness. We compensate for these limitations by relying primarily on our GAAP results and using EBITDA and related ratios only as supplements.
Our presentation of adjusted net income and adjusted EBITDA over certain periods is an attempt to provide meaningful comparisons to our historical performance for our existing and future investors. The unprecedented changes in our end markets over the past several years have required us to take measures that are unique in our history and specific to individual circumstances. Comparisons inclusive of these actions make normal financial and other performance patterns difficult to discern under a strict GAAP presentation. Each non-GAAP presentation, however, is explained in detail in the reconciliation tables below.
Specifically, we have presented adjusted net income attributable to ARC and adjusted earnings per share attributable to ARC shareholders for the three and six months ended June 30, 20192020 and 20182019 to reflect the exclusion of changes in the valuation allowances related to certain deferred tax assets and other discrete tax items. This presentation facilitates a meaningful comparison of our operating results for the three and six months ended June 30, 20192020 and 2018.2019. We believe these charges were the result of items which are not indicative of our actual operating performance.
The following is a reconciliation of cash flows provided by operating activities to EBITDA:
The following is a reconciliation of net income attributable to ARC Document Solutions, Inc. to EBITDA and adjusted EBITDA: