ARC DOCUMENT SOLUTIONS, INC. 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 Annual Report on Form 10-K for the year endedDecember 31, 2020 and this Quarterly Report on Form 10-Q for the quarter endedJune 30, 2021 . Business SummaryARC 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 to manage and distribute documents and information related to construction projects and related project-based businesses outside of the architectural, engineering and construction (AEC) industry. Our reconfiguration of the Company's sales and marketing functions in late-2019, as well as customer needs driven by the COVID-19 pandemic, have led to the significant expansion of the non-AEC segment of our CDIM business, primarily through the provision of color graphics and signage. CDIM sales also 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. Managed Print Services (MPS), which 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 sales represent 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. Because the recent pandemic has forced a large number of our clients to direct their employees to work from home, MPS volume and sales have declined over the past year. Archiving and Information Management (AIM), which consists of 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 application 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. A growing portion of our sales are being driven by our ability to handle protected health information (PHI) as our regional scanning centers are HIPAA-compliant. AIM sales are driven by the need to leverage past intellectual property 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. Remote access to digital documents driven by work-from-home conditions created by the recent pandemic have also contributed to recent sales in this area of our business.
Equipment and Supplies, which consists of reselling printing, imaging, and related equipment to customers primarily to 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, AIM and
CDIM, as 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, and
away from its historical emphasis on large-format construction drawings produced
"offsite" in our service centers.
19
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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 67% of our net sales for the six
months ended June 30, 2021 , with the remaining 33% consisting of sales to
businesses outside of 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, rental payments,
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 have 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.
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COVID-19 Pandemic
The global spread of the novel coronavirus (COVID-19) 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 prolonged uncertainty in the global economy and has
negatively affected our business, employees, suppliers, and customers. While our
sales during the second quarter of 2021 increased as the negative effects of the
recent pandemic began to subside with increasing economic activity compared to
the same period in 2020, there is still uncertainty regarding COVID-19 variants,
including but not limited to the Delta variant. 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 "Part I - Item 1A. Risk Factors" of
our Annual Report on Form 10-K for the year ended December 31, 2020 .
To adapt to the uncertainty and shifting demands brought on by the COVID-19
pandemic, we transformed our business during the second quarter of 2020 into a
smaller but stronger company, 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 have repositioned the Company based on 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 continues to persist, 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 ongoing economic uncertainty resulting from the COVID-19 pandemic, we
have taken actions to improve our current liquidity position, including reducing
working capital, postponing capital expenditures, reducing operating costs,
initiating workforce 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 considered an essential business.
We also serve the housing, healthcare, and technology industries, and have been
able to keep almost all of our service centers open during the pandemic, 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 on 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 2021 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.
21
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Results of Operations
Six Months Ended
Three Months Ended June 30 , Increase (decrease) June 30 , Increase (decrease)
(In millions, except percentages) 2021(1) 2020(1) $ % 2021(1) 2020(1) $ %
CDIM $ 43.1 $ 41.1 $ 2.0 4.9 % $ 80.5 $ 90.2 $ (9.7) (10.8) %
MPS 18.0 16.2 1.8 10.9 % 35.3 43.5 (8.2) (18.8) %
AIM 3.3 2.7 0.6 23.9 % 6.3 6.3 0.1 0.9 %
Equipment and supplies sales 4.4 4.4 0.1 1.3 % 8.4 12.7 (4.4) (34.3) %
Total net sales $ 68.8 $ 64.3 $ 4.5 7.0 % $ 130.5 $ 152.7 $ (22.2) (14.5) %
Gross profit $ 22.8 $ 20.4 $ 2.3 11.5 % $ 41.6 $ 48.0 $ (6.5) (13.5) %
Selling, general and administrative
$ 1.3 7.3 %$ 35.5 $ 41.6 $ (6.1) (14.6) %
expenses
Amortization of intangible assets
$ (0.4) (88.1) %$ 0.1 $ 1.1 $ (0.9) (87.7) % Interest expense, net$ 0.6 $ 1.1 $ (0.6) (49.1) %$ 1.2 $ 2.2 $ (1.0) (46.6) % Income tax provision$ 1.2 $ 0.1 $ 1.0 680.4 %$ 1.7 $ 1.3 $ 0.4 31.6 % Net income attributable to ARC$ 2.6 $ 1.5 $ 1.1 76.2 %$ 3.4 $ 2.1 $ 1.2 56.9 % Non-GAAP (2) Adjusted net income attributable to ARC$ 2.6 $ 1.2 $ 1.4 116.4 %$ 3.6 $ 2.4 $ 1.2 48.2 % (2) EBITDA (2)$ 10.7 $ 10.3 $ 0.4 4.0 %$ 19.1 $ 21.2 $ (2.1) (9.7) % Adjusted EBITDA (2)$ 11.1 $ 10.7 $ 0.4 3.7 %$ 19.9 $ 22.1 $ (2.2) (10.1) % (1)Column does not foot due to rounding. (2)See "Non-GAAP Financial Measures" on pg. 25 for additional information. 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 Three Months Ended June 30, Six Months Ended June 30, 2021 (1) 2020 2021 (1) 2020(1) Net sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 66.9 68.2 68.1 68.5 Gross profit 33.1 31.8 31.9 31.5 Selling, general and administrative expenses 27.0 26.9 27.2 27.3 Amortization of intangible assets 0.1 0.7 0.1 0.7 Income from operations 6.1 4.2 4.5 3.5 Interest expense, net 0.8 1.8 0.9 1.5 Income before income tax provision 5.3 2.4 3.6 2.1 Income tax provision 1.7 0.2 1.3 0.8 Net income 3.6 2.2 2.4 1.2 Loss attributable to the noncontrolling interest 0.2 0.1 0.2 0.2 Net income attributable to ARC 3.7 % 2.3 % 2.6 % 1.4 % Non-GAAP (2) EBITDA (2) 15.5 % 16.0 % 14.6 % 13.9 % Adjusted EBITDA (2) 16.1 % 16.6 % 15.2 % 14.5 % (1)Column does not foot due to rounding. (2)See "Non-GAAP Financial Measures" on pg. 25 for additional information. 22 -------------------------------------------------------------------------------- Three and Six Months EndedJune 30, 2021 Compared to Three and Six Months EndedJune 30, 2020 Net Sales Net sales for the three months endedJune 30, 2021 increased 7.0% compared to the same period in 2020. The increase in net sales in the second quarter of 2021 is primarily due to increasing year-over-year economic activity as the negative effects of the COVID-19 pandemic began to subside. Sales in the second quarter also benefited from targeted marketing of services to address the changing graphic printing and scanning needs of customers. Net sales for the six months endedJune 30, 2021 decreased 14.5% compared to the same period in 2020. The decrease in net sales is primarily due to stronger pre-pandemic results during the three months endedMarch 31, 2020 , which are included in the comparative period. CDIM. Year-over-year sales of CDIM services increased$2.0 million , or 4.9% for the three months endedJune 30, 2021 compared to the same period in 2020. Year-over-year sales of CDIM services decreased$9.7 million or 10.8% for the six months endedJune 30, 2021 compared to the same period in 2020. CDIM services represented 63% and 62% of total net sales for the three and six months endedJune 30, 2021 , respectively, compared to 64% and 59% for the three and six months endedJune 30, 2020 , respectively. The impact of the COVID-19 pandemic on sales from CDIM was not as pronounced as it was on other parts of our business due to the changes we made in 2019 and 2020 to expand our products and services beyond the construction vertical ("Expanded Offerrings") and to reconfigure our sales and marketing functions. During the second quarter of 2021, sales increases were due to increased sales of our Expanded Offerings, as well as increased demand from businesses re-openings, and the increase in general economic activity for the period. MPS. Year-over-year sales of MPS services for the three months endedJune 30, 2021 increased$1.8 million , or 10.9%. MPS sales increased as work from home directives ended for some of our customers, which in turn, lead to increased demand for our services performed on site. Year-over year sales of MPS services for the six months endedJune 30, 2021 decreased$8.2 million or 18.8%. The decline during the six months endedJune 30, 2021 , was primarily caused by employer work-from-home directives issued in 2020 that significantly reduced the volume of printing done in our customers' offices. MPS engagements on construction job sites continued to operate, and many customers have required minimums that helped mitigate the drop in print volumes. MPS sales represented approximately 26% and 27% of total net sales for the three and six months endedJune 30, 2021 , respectively, compared to 25% and 29% for the three and six months endedJune 30, 2020 . The number of MPS locations have declined slightly year over year to approximately 10,780 as ofJune 30, 2021 , representing a net decrease of approximately 165 locations compared toJune 30, 2020 . AIM. Year-over-year sales of AIM services increased$0.6 million , or 23.9%, and$0.1 million or 0.9% for the three and six months endedJune 30, 2021 , respectively. The increase in sales of our AIM services was primarily attributable to the end of work from home directives for some of our customers resulting in greater demand for scanning services. We continue to drive an expansion of our addressable market for AIM services by targeting building owners and facility managers that require on-demand access to their legacy documents to operate their assets efficiently. We believe that, with the expansion of our addressable market and the desire of our customers to have digital access to documents, our AIM services will grow in the future. Equipment and Supplies Sales. Year-over-year sales of Equipment and Supplies increased$0.1 million , or 1.3% for the three months endedJune 30, 2021 compared to the same period in 2020. The increase is a reflection of the more favorable economic conditions in 2021 when compared to the second quarter of 2020, especially in theU.S. Year-over-year sales of Equipment and Supplies decreased$4.4 million or 34.3%, for the six months endedJune 30, 2021 . The decline in Equipment and Supplies sales for the six months endedJune 30, 2021 was primarily driven by the economic slowdown inChina related to the COVID-19 pandemic, which decreased sales fromUNIS Document Solutions Co. Ltd ("UDS"), our Chinese joint venture. Equipment and Supplies sales at UDS were$0.8 million and$1.6 million for the three and six months endedJune 30, 2021 , respectively, compared to$1.4 million and$4.8 million for the three and six months endedJune 30, 2020 . We generally do not anticipate growth in Equipment and Supplies sales as we continue to place more focus on growing MPS sales and converting sales contracts to MPS agreements. 23 -------------------------------------------------------------------------------- Gross Profit During the three months endedJune 30, 2021 , gross profit and gross margin increased to$22.8 million , or 33.1%, compared to$20.4 million , or 31.8% during the three months endedJune 30, 2020 , on a sales increase of$4.5 million . During the six months endedJune 30, 2021 , gross profit decreased to$41.6 million and gross margin increased to 31.9%, compared to$48.0 million , or 31.5% during the six months endedJune 30, 2020 , on a sales decline of$22.2 million . During the three months endedJun 30, 2020 , we began to reconfigure our operating structure and costs to serve new customer needs and to reflect the reduction in our revenues as a result of the COVID-19 pandemic. The leverage provided by the new cost structure drove a year-over-year gross margin increase of 130 basis points on higher sales for the three months endedJune 30, 2021 . The benefits of the new cost structure also increased year-over-year gross margin in the first six-months of 2021 by 40 basis points, despite lower sales compared to the same period in 2020. Selling, General and Administrative Expenses Selling, general and administrative expenses increased$1.3 million , or 7.3%, for the three months endedJune 30, 2021 , compared to the three months endedJune 30, 2020 , primarily driven by an increase in commissions and bonus payments as a result of improved sales and profitability for the period. Additionally, in 2021 we eliminated the temporary wage reductions for most employees that were put in place at the beginning of the pandemic. Selling, general and administrative expenses decreased$6.1 million , or 14.6% for the six months endedJune 30, 2021 , compared to the six months endedJune 30, 2020 . The reduction was due to cost savings initiated in response to the current COVID-19 pandemic that included headcount reductions, suspension of business travel, reduced consulting expenses, reduced bonuses and commissions, and the elimination of discretionary spending. Amortization of Intangibles Amortization of intangibles of$0.1 million for the three and six months endedJune 30, 2021 , decreased by$0.4 million and$0.9 million compared to the three and six months endedJune 30, 2020 , respectively, due to the completed amortization of certain customer relationship intangibles related to historical acquisitions. Interest Expense,Net Net interest expense of$0.6 million and$1.2 million for the three and six months endedJune 30, 2021 , respectively, decreased by$0.6 million and$1.0 million compared to the three and six months endedJune 30, 2020 , respectively, due to the continued pay-down of our long-term debt, decrease in LIBOR, and a decrease in the bank debt interest spread due to an improvement in our leverage ratio. Income Taxes We recorded an income tax provision of$1.2 million and$1.7 million and in relation to pretax income of$3.6 million and$4.7 million for the three and six months endedJune 30, 2021 , respectively, which resulted in an effective income tax rate of 31.9% and 34.9%. Our effective income tax rate for the three and six months endedJune 30, 2021 , was primarily affected by certain stock-based compensation, a change in valuation allowances against certain deferred tax assets, and non-deductible expenses. Excluding the impact of the change in valuation allowances, certain nondeductible stock-based compensation, and other discrete tax items, our effective income tax rate would have been 29.9% and 29.7%, respectively, for the three and six months endedJune 30, 2021 . By comparison, we 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 endedJune 30, 2020 , respectively, which resulted in an effective income tax rate of 9.4% and 40.0%. The increase in our effective income tax rate for the three and six months endedJune 30, 2020 , was primarily affected by certain stock-based compensation, a change in valuation allowances against certain deferred tax assets, and non-deductible expenses. Excluding the impact of the change in valuation allowances, certain nondeductible stock-based compensation, and other discrete tax items, our effective income tax rate would have been 24.9% and 29.1% for the three and six months endedJune 30, 2020 . We have a$2.2 million valuation allowance against certain deferred tax assets as ofJune 30, 2021 . 24 -------------------------------------------------------------------------------- Noncontrolling Interest Net loss attributable to noncontrolling interest represents 35% of the income/loss of UDS and its subsidiaries, which together comprise our Chinese joint venture operations. Net Income Attributable to ARC Net income attributable to ARC increased to$2.6 million and$3.4 million during the three and six months endedJune 30, 2021 , respectively. The increase in net income attributable to ARC compared to the prior year period for the three and six months endingJune 30, 2020 was driven primarily by improved gross margin, reduction in amortization expense, and significantly lower net interest expense as a result of debt pay-downs and a decrease in LIBOR. EBITDA EBITDA margin and Adjusted EBITDA margin is not a recognized measure under GAAP. When analyzing our operating performance, investors should use EBITDA margin and Adjusted EBITDA in addition to, and not as an alternative for, operating income or any other performance measure presented in accordance with GAAP. It is a measure we use to measure our performance and liquidity. We believe EBITDA margin and Adjusted EBITDA reflect an additional way of viewing aspects of our operations that, when viewed with our GAAP results, provides a more complete understanding of factors and trends affecting our business. We believe the measure is used by investors and is a useful indicator to measure our performance. Because not all companies use identical calculations, our presentation of EBITDA margin and Adjusted EBITDA may not be comparable to similarly titled measures of other companies. See Non-GAAP Financial Measures below for additional discussion. EBITDA margin decreased to 15.5% for the three months endedJune 30, 2021 , from 16.0% for the same period in 2020. Excluding the effect of stock-based compensation, adjusted EBITDA margin decreased to 16.1% during the three months endedJune 30, 2021 , as compared to 16.6% for the same period in 2020. The decrease in adjusted EBITDA margin for the three months endedJune 30, 2021 , was primarily due to the increase in selling, general and administrative expenses, as noted above. EBITDA margin increased to 14.6% for the six months endedJune 30, 2021 , from 13.9% for the same period in 2020. Excluding the effect of stock-based compensation, adjusted EBITDA margin increased to 15.2% during the six months endedJune 30, 2021 , as compared to 14.5% for the same period in 2020. The increase in adjusted EBITDA margin for the six months endedJune 30, 2021 , was primarily due to the increase in gross margins, as noted above. Impact of Inflation 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. Non-GAAP Financial Measures 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 inthe 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 forU.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 25 -------------------------------------------------------------------------------- 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 endedJune 30, 2021 and 2020 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 endedJune 30, 2021 and 2020. We believe these charges were the result of items which are not indicative of our actual operating performance. We have presented adjusted EBITDA for the three and six months endedJune 30, 2021 and 2020 to exclude stock-based compensation expense. The adjustment to exclude stock-based compensation expense to EBITDA is consistent with the definition of adjusted EBITDA in our 2021 Credit Agreement; therefore, we believe this information is useful to investors in assessing our financial performance. The following is a reconciliation of cash flows provided by operating activities to EBITDA: Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2021 2020 2021 2020 Cash flows provided by operating activities$ 11,514 $ 23,481 $ 16,889 $ 26,255 Changes in operating assets and liabilities (1,165) (13,689) 1,329 (6,188) Non-cash expenses, including depreciation and amortization (7,881) (8,372) (15,138) (18,185) Income tax provision 1,155 148 1,651 1,255 Interest expense, net 576 1,131 1,196 2,240 Loss attributable to the noncontrolling interest 106 41 283 262 Depreciation and amortization 6,375 7,528 12,899 15,532 EBITDA$ 10,680 $ 10,268 $ 19,109 $ 21,171 26
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The following is a reconciliation of net income attributable to
Three Months Ended Six Months Ended
June 30, June 30,
(In thousands) 2021 2020 2021 2020
Net income attributable to ARC Document Solutions,
Inc. $ 2,574 $ 1,461 $ 3,363 $ 2,144
Interest expense, net 576 1,131 1,196 2,240
Income tax provision 1,155 148 1,651 1,255
Depreciation and amortization 6,375 7,528 12,899 15,532
EBITDA 10,680 10,268 19,109 21,171
Stock-based compensation 404 416 743 920
Adjusted EBITDA $ 11,084 $ 10,684 $ 19,852 $ 22,091 The following is a reconciliation of net income margin attributable to
Three Months Ended Six Months Ended
June 30, June 30,
2021 2020 2021(1) 2020
Net income margin attributable to ARC Document
Solutions, Inc. 3.7 % 2.3 % 2.6 % 1.4 %
Interest expense, net 0.8 1.8 0.9 1.5
Income tax provision 1.7 0.2 1.3 0.8
Depreciation and amortization 9.3 11.7 9.9 10.2
EBITDA margin 15.5 16.0 14.6 13.9
Stock-based compensation 0.6 0.6 0.6 0.6
Adjusted EBITDA margin 16.1 % 16.6 % 15.2 % 14.5 %
(1)Column does not foot due to rounding.
27
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The following is a reconciliation of net income attributable to ARC Document
Solutions, Inc. to adjusted net income attributable to ARC Document Solutions,
Inc. :
Three Months Ended Six Months Ended
June 30, June 30,
(In thousands, except per share amounts) 2021 2020 2021 2020
Net income attributable to
$ 2,574 $ 1,461 $ 3,363 $ 2,144
Deferred tax valuation allowance and other discrete tax items
68 (240) 199 259
Adjusted net income attributable to ARC Document
Solutions, Inc. $ 2,642 $ 1,221 $ 3,562 $ 2,403 Actual:
Earnings per share attributable toARC Document Solutions, Inc. shareholders: Basic$ 0.06 $ 0.03 $ 0.08 $ 0.05 Diluted$ 0.06 $ 0.03 $ 0.08 $ 0.05 Weighted average common shares outstanding: Basic 42,304 42,672 42,284 43,154 Diluted 42,597 42,767 42,613 43,277 Adjusted: Earnings per share attributable toARC Document Solutions, Inc. shareholders: Basic$ 0.06 $ 0.03 $ 0.08 $ 0.06 Diluted$ 0.06 $ 0.03 $ 0.08 $ 0.06 Weighted average common shares outstanding: Basic 42,304 42,672 42,284 43,154 Diluted 42,597 42,767 42,613 43,277 Liquidity and Capital Resources Our principal sources of cash have been cash flows from operations and borrowings under our debt and lease agreements. Our recent historical uses of cash have been for ongoing operations, payment of principal and interest on outstanding debt obligations, capital expenditures, dividends and stock repurchases. Total cash and cash equivalents as ofJune 30, 2021 was$52.4 million . Of this amount,$16.0 million was held in foreign countries, with$14.6 million held inChina . Repatriation of some of our cash and cash equivalents in foreign countries could be subject to delay for local country approvals and could have potential adverse tax consequences. As a result of holding cash and cash equivalents outside of theU.S. , our financial flexibility may be reduced. Supplemental information pertaining to our historical sources and uses of cash is presented as follows and should be read in conjunction with our interim Condensed Consolidated Statements of Cash Flows and notes thereto included elsewhere in this report. Three Months Ended Six Months Ended June 30, June 30, (In thousands) 2021 2020 2021 2020 Net cash provided by operating activities$ 11,514 $ 23,481 $ 16,889 $ 26,255 Net cash used in investing activities$ (897) $ (1,453) $ (1,334) $ (2,501) Net cash (used in) provided by financing activities$ (7,983) $ (2,105) $ (18,364) $ 5,438 28
-------------------------------------------------------------------------------- Operating Activities Cash flows from operations are primarily driven by sales and net profit generated from these sales, excluding non-cash charges. The decrease in cash flows from operations during the three and six months endedJune 30, 2021 , compared to the same period in 2020, reflect normalized levels of cash generation and collectibles for the period, compared to the same period in 2020 when aggressive measures were implemented to manage working capital and preserve cash in response to the COVID-19 pandemic. Days sales outstanding ("DSO") was 50 days as ofJune 30, 2021 and 59 as ofJune 30, 2020 . We are closely managing cash collections which have remained relatively consistent since the outbreak of the COVID-19 pandemic. Investing Activities Net cash used in investing activities was primarily related to capital expenditures. We incurred capital expenditures totaling$1.6 million and$2.6 million for the six months endedJune 30, 2021 and 2020, respectively. The decrease in capital expenditures is driven primarily by a concerted effort to reduce and closely manage capital expenditures during the COVID-19 pandemic. As we continue to foster our relationships with credit providers and obtain attractive lease rates, we have increasingly chosen to lease rather than purchase equipment. Financing Activities Net cash of$18.4 million used in financing activities during the six months endedJune 30, 2021 , primarily relates to payments on our revolver debt agreement, finance leases, dividends and share repurchases. Our cash position, working capital, and debt obligations as ofJune 30, 2021 andDecember 31, 2020 are shown below and should be read in conjunction with our interim Condensed Consolidated Balance Sheets and related notes contained elsewhere in this report. (In thousands) June 30, 2021 December 31, 2020 Cash and cash equivalents$ 52,372 $ 54,950 Working capital$ 32,779 $ 32,500
Borrowings from revolving credit facility
55,000 Other debt obligations 34,896 42,236 Total debt obligations$ 83,646 $ 97,236 The increase of$0.3 million in working capital was primarily driven by the increase in accounts receivable and decrease in the current portion of operating and finance lease liabilities, as we entered into fewer leases since the beginning of the COVID-19 pandemic. To manage our working capital, we chiefly focus on our DSO and monitor the aging of our accounts receivable, as receivables are the most significant element of our working capital. We believe that our current cash and cash equivalents balance of$52.4 million , combined with availability under our revolving credit facility, availability under our equipment lease lines, and cash flows provided by operations should be sufficient to cover the next twelve months working capital needs, leasing requirements consisting of scheduled principal and interest payments, and planned capital expenditures, to the extent such items are known or are reasonably determinable based on current business and market conditions. However, as the impact of the COVID-19 pandemic on the economy and our operations evolves, we will continue to assess our liquidity needs. The COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains and created significant volatility and disruption of financial markets. An extended period of global supply chain and economic disruption could materially affect our business, results of operations, ability to meet debt covenants, access to sources of liquidity and financial condition. Given the economic uncertainty as a result of the COVID-19 pandemic, we have taken actions to improve our current liquidity position by reducing working capital, reducing capital expenditures, reducing operating costs, initiating workforce reductions, and substantially reducing discretionary spending. See "Debt Obligations" section for further information related to our revolving credit facility. We generate the majority of our revenue from sales of services and products to the AEC/O industry. As a result, our operating results and financial condition can be significantly affected by economic factors that influence the AEC/O industry, including the COVID-19 pandemic which has already reduced non-residential and residential construction spending. Additionally, a 29 -------------------------------------------------------------------------------- general economic downturn may adversely affect the ability of our customers and suppliers to obtain financing for significant operations and purchases, and to perform their obligations under their agreements with us. We believe that credit constraints in the financial markets could result in a decrease in, or cancellation of, existing business, could limit new business, and could negatively affect our ability to collect our accounts receivable on a timely basis. We have not been actively seeking growth through acquisition, nor do we intend to in the near future. Debt Obligations Credit Agreement OnApril 22, 2021 , we entered into a Credit Agreement withU.S. Bank National Association , as administrative agent and the lender party thereto (the "2021 Credit Agreement"). The 2021 Credit Agreement provides for the extension of revolving loans in an aggregate principal amount not to exceed$70 million and replaces the 2014 Credit Agreement dated as ofNovember 20, 2014 , as amended (the "2014 Credit Agreement"). The 2021 Credit Agreement features terms similar to the 2014 Credit Agreement, including the ability to use excess cash of up to$15 million per year for restricted payments such as share repurchases and dividends. The obligation under the 2021 Credit Agreement matures onApril 22, 2026 . The 2021 Credit Agreement also includes certain tests we are 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 2021 Credit Agreement, the amount of all such payments will be limited to$15 million during any twelve-month period. When calculating the fixed charge coverage ratio, we may exclude up to$10 million of such restricted payments that would otherwise constitute fixed charges in any twelve-month period. As ofJune 30, 2021 , our borrowing availability under the revolving loan commitment was$19.1 million , after deducting outstanding letters of credit of$2.2 million and outstanding revolving loans of$48.8 million . Loans borrowed under the 2021 Credit Agreement bear interest, in the case of LIBOR loans, at a per annum rate equal to the applicable LIBOR (which rate shall not be less than zero), plus a margin ranging from 1.25% to 1.75%, based on our Total Leverage Ratio (as defined in the 2021 Credit Agreement). Loans borrowed under the 2021 Credit Agreement that are not LIBOR loans bear interest at a per annum rate (which rate shall not be less than zero) equal to (i) the greatest of (A) the Federal Funds Rate plus 0.50%, (B) the one month LIBOR plus 1.00% per annum, and (C) the rate of interest announced, from time to time, byU.S. Bank National Association as its "prime rate," plus (ii) a margin ranging from 0.25% to 0.75%, based on our Total Leverage Ratio. We pay certain recurring fees with respect to the 2021 Credit Agreement, including administration fees to the administrative agent. Subject to certain exceptions, including, in certain circumstances, reinvestment rights, the loans extended under the 2021 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 2021 Credit Agreement); the net proceeds from certain issuances of equity securities; and net proceeds of certain insurance recoveries and condemnation events. The 2021 Credit Agreement contains customary representations and warranties, subject to limitations and exceptions, and customary covenants restricting the ability (subject to various exceptions) of us and our 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 us or our subsidiaries; change the nature of their business; prepay or amend certain indebtedness; engage in certain transactions with affiliates; amend our organizational documents; or enter into certain restrictive agreements. In addition, the 2021 Credit Agreement contains financial covenants which requires us to maintain (i) at all times, a Total Leverage Ratio in an amount not to exceed 2.75 to 1.00; and (ii) a Fixed Charge Coverage Ratio (as defined in the 2021 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 ofJune 30, 2021 . After considering a variety of potential effects the COVID-19 pandemic could have on our consolidated sales, as well as the actions we have already taken and other options available to us, we currently believe we will be in compliance with our covenants for the remainder of the term of the 2021 Credit Agreement. The impact of the COVID-19 pandemic, however, and the speed of economic recovery in the markets we serve is highly uncertain. If conditions change in the future due to the ongoing COVID-19 pandemic or for other reasons and we expect to be out of compliance as a result, we will likely seek waivers from the lenders prior to any covenant violation. Any covenant waiver may lead to increased costs, increased interest rates, additional restrictive covenants and other available lender protections that would be applicable. There can be no assurance that we would be able to obtain any such waivers in a timely manner, or on acceptable terms, or at all. If we were not able to obtain covenant violation waivers or repay our debt facilities, this would lead to an event of default and potential acceleration of 30 -------------------------------------------------------------------------------- amounts due under all of our outstanding debt. As a result, the failure to obtain covenant violation waivers or repay our debt obligations when they become due would have a material adverse effect on us. Refer to "Part I - Item 1A. Risk Factors" of our Annual Report on Form 10-K for the year endedDecember 31, 2020 , for more information. The 2021 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 our subsidiary that is the borrower under the 2021 Credit Agreement are guaranteed by us and each of our otherUnited States domestic subsidiaries. The 2021 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 our and each guarantor's assets (subject to certain exceptions). Finance Leases As ofJune 30, 2021 , we had$34.9 million of finance lease obligations outstanding, with a weighted average interest rate of 4.9% and maturities between 2021 and 2026. Refer to Note 7, Leasing, as previously disclosed on our Annual Form 10-K for the fiscal year ended forDecember 31, 2020 for the schedule on maturities of finance lease liabilities, as there have been no material changes to report as ofJune 30, 2021 . Off-Balance Sheet Arrangements As ofJune 30, 2021 , we did not have any off-balance-sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K. Contractual Obligations and Other Commitments Operating Leases. We have entered into various non-cancelable operating leases primarily related to facilities, equipment and vehicles used in the ordinary course of business. Refer to Note 7, Leasing, as previously disclosed in our Annual Report on Form 10-K for the fiscal year ended forDecember 31, 2020 for the schedule on maturities of operating lease liabilities as there were no material changes as ofJune 30, 2021 . Legal Proceedings. We are involved, and will continue to be involved, in legal proceedings arising out of the conduct of our business, including commercial and employment-related lawsuits. Some of these lawsuits purport or may be determined to be class actions and seek substantial damages, and some may remain unresolved for several years. We establish accruals for specific legal proceedings when it is considered probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Our evaluation of whether a loss is reasonably probable is based on our assessment and consultation with legal counsel regarding the ultimate outcome of the matter. As ofJune 30, 2021 we have accrued for the potential impact of loss contingencies that are probable and reasonably estimable. We do not currently believe that the ultimate resolution of any of these matters will have a material adverse effect on our results of operations, financial condition, or cash flows. However, the results of these matters cannot be predicted with certainty, and an unfavorable resolution of one or more of these matters could have a material adverse effect on our results of operations, financial condition, or cash flows. 31 -------------------------------------------------------------------------------- Critical Accounting Policies Critical accounting policies are those accounting policies that we believe are important to the portrayal of our financial condition and results and require our most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. Our Annual Report on Form 10-K for the year endedDecember 31, 2020 includes a description of certain critical accounting policies, including those with respect to goodwill, revenue recognition, and income taxes. There have been no material changes to our critical accounting policies described in our Annual Report on Form 10-K for the year endedDecember 31, 2020 . Goodwill Impairment In accordance with ASC 350, Intangibles -Goodwill and Other, we assess goodwill for impairment annually as ofSeptember 30 , and more frequently if events and circumstances indicate that goodwill might be impaired. AtSeptember 30, 2020 , the Company performed its assessment and determined that goodwill was not impaired.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. In 2017, we elected to early-adopt ASU 2017-04 which simplifies subsequent goodwill measurement by eliminating step two from the goodwill impairment test. We determine the fair value of our reporting units using an income approach. Under the income approach, we 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. We have evaluated numerous factors disrupting our business and made significant assumptions which include the severity and duration of our business disruption, the timing and degree of economic recovery and ultimately, the combined effect of these assumptions on our future operating results and cash flows. The results of the annual goodwill impairment test, as ofSeptember 30, 2020 , were as follows: Number of Reporting Representing (Dollars in thousands) Units Goodwill of No goodwill balance 6 $ - Fair value of reporting units exceeds their carrying values by more than 50% 2 121,051 8$ 121,051 Based upon a sensitivity analysis, a reduction of approximately 50-basis points of projected EBITDA in 2020 and beyond, assuming all other assumptions remain constant, would result in no impairment of goodwill. Based upon a separate sensitivity analysis, a 50-basis point increase to the weighted average cost of capital would result in no further impairment of goodwill. Given the uncertainty regarding the ultimate financial impact of the COVID-19 pandemic and the proceeding economic recovery, and the changing document and printing needs of our customers and the uncertainties regarding the effect on our business, there can be no assurance that the estimates and assumptions made for purposes of our goodwill impairment testing in 2020 will prove to be accurate predictions of the future. If our assumptions, including forecasted EBITDA of certain reporting units, are not achieved, or our assumptions change regarding disruptions caused by the pandemic, and the impact on the recovery from COVID-19 change, then we may be required to record goodwill impairment charges in future periods, whether in connection with our next annual impairment testing in the third quarter of 2021, 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 we regularly perform our 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. Income Taxes Deferred tax assets and liabilities reflect temporary differences between the amount of assets and liabilities for financial and tax reporting purposes. Such amounts are adjusted, as appropriate, to reflect changes in tax rates expected to be in effect when the temporary differences reverse. A valuation allowance is recorded to reduce our deferred tax assets to the amount that is more 32 -------------------------------------------------------------------------------- likely than not to be realized. Changes in tax laws or accounting standards and methods may affect recorded deferred taxes in future periods. When establishing a valuation allowance, we consider future sources of taxable income such as future reversals of existing taxable temporary differences, future taxable income exclusive of reversing temporary differences and carryforwards and tax planning strategies. A tax planning strategy is an action that: is prudent and feasible; an enterprise ordinarily might not take, but would take to prevent an operating loss or tax credit carryforward from expiring unused; and would result in realization of deferred tax assets. In the event we determine that our deferred tax assets, more likely than not, will not be realized in the future, the valuation adjustment to the deferred tax assets will be charged to earnings in the period in which we make such a determination. We have a$2.2 million valuation allowance against certain deferred tax assets as ofJune 30, 2021 . In future quarters we will continue to evaluate our historical results for the preceding twelve quarters and our future projections to determine whether we will generate sufficient taxable income to utilize our deferred tax assets, and whether a valuation allowance is required. We calculate our current and deferred tax provision based on estimates and assumptions that could differ from the actual results reflected in income tax returns filed in subsequent years. Adjustments based on filed returns are recorded when identified. Income taxes have not been provided on certain undistributed earnings of foreign subsidiaries because such earnings are considered to be permanently reinvested. The amount of taxable income or loss we report to the various tax jurisdictions is subject to ongoing audits by federal, state and foreign tax authorities. We estimate of the potential outcome of any uncertain tax issue is subject to management's assessment of relevant risks, facts, and circumstances existing at that time. We use a more-likely-than-not threshold for financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. We record a liability for the difference between the benefit recognized and measured and tax position taken or expected to be taken on its tax return. To the extent that our assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made. We report tax-related interest and penalties as a component of income tax expense. Recent Accounting Pronouncements See Note 1, "Description of Business and Basis of Presentation" to our interim Condensed Consolidated Financial Statements for disclosure on recent accounting pronouncements not yet adopted. Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
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