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 ended
Business Summary
•digital printing of general and specialized business documents such as those found in marketing and advertising, engineering and construction and other industries, as well as producing highly-customized display graphics of all types and sizes; •acquiring, placing and managing ARC-certified office printing equipment with proprietary device tracking and print management software at our customers' offices and job sites; •scanning documents, indexing them and adding digital search features for use in digital document management, document archives and facilities management, as well as providing other digital imaging services; and, •reselling digital printing equipment and supplies.
Each of these services frequently include additional logistics services in the form of distributing and delivering finished documents, installing display graphics, or the digital storage of graphic files.
We have categorized our service and product offerings to report distinct sales recognized from:
Digital Printing: We print documents of any size in color and black and white on a variety of materials including plain paper, vinyl, fabric, metal, wood and other three-dimensional substrates. While we can and do print high-page count work such as manuals or catalogs, the documents we typically produce are usually characterized by their high-quality production, low-volume and quick turnaround, and are produced using highly-sophisticated digital printing equipment. Managed Print Services: We acquire and manage digital printing equipment and place it in our customers' facilities for their use, based on a service level agreement. We lease or own the equipment ourselves, while our customers pay for what they use. Per-use minimum charges are often part of our service agreements. We operate more than 10,500 managed print services, or MPS locations, ranging in size from one or two pieces of equipment in a single office, to hundreds of pieces of equipment in offices around the world. We also provide proprietary software to our customers to control their print expenses and connect their remote employees with their offices and ARC print centers nationwide. This software is developed and integrated by ARC. Scanning and Digital Imaging: We scan hard-copy small format or large format documents in color or black and white, typically providing them to our customers as searchable PDF files. We also use our patented optical character recognition technology to make documents searchable, and we host them on proprietary applications for use as part of our ARC Facilities solutions. The types of documents that we scan include office files, construction plans and other small or large documents. We also process, distribute and print-on-demand images we capture for our customers. Our large, centralized Scanning and Digital Imaging centers are compliant with the Health Insurability Portability and Accountability Act of 1996, or HIPAA, so we can convert documents that include protected health information. Our unique software creates efficient search tags on scanned data for easy search and retrieval. We offer Cloud-based document management software and other digital hosting services to our customers or make files available for our customers to host themselves.
Equipment and Supplies Sales: We sell equipment and supplies to a small segment of our customer base. We also provide ancillary services such as equipment service and maintenance, often as a way to generate recurring revenue in addition to a one-time sale. In addition, we offer certified used equipment available for sale or for use in our MPS offering.
The majority of our products and services are available from each of our service
centers. Our primary operational objective is to optimize our business
performance by driving as much customer work through our service center network
as is practical, and leveraging our production infrastructure, workforce, and
production-grade equipment. All our production centers are digitally connected
and we operate standard software and systems to support seamless movement of
customers digital data and print anywhere within the ARC system.
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In addition, we can provide many of our services in our customers' offices. Our
geographic presence is concentrated in the U.S. , with additional service centers
in Canada , the United Arab Emirates (UAE ), China , India , and the United Kingdom .
Our origin as a company was in California , and the initial expansion of our
business was concentrated there. We derive approximately 31% of our total
revenue from the products and services delivered in California .
All of our production facilities are connected via a Software-Defined Wide Area
Network (SD-WAN). Our cloud offerings are hosted by Amazon Web Services . We
employ a combination of proprietary and industry-leading technologies to provide
redundancy, backup and security of all data in our systems. All of our
technology operations are designed to meet ISO 29001 standards for data
security, and several of our service centers are HIPAA-compliant allowing us to
manage document conversions and other scanning tasks involving protected health
information, or PHI.
Costs and Expenses
Our cost of sales consists primarily of materials (paper, toner and other
consumables), labor, and "indirect costs." Indirect costs consist primarily of
equipment expenses related to our MPS locations (typically our customers'
offices and job sites) and our service centers. Facilities and equipment
expenses include maintenance, repairs, rents, insurance, and depreciation. Paper
is the largest component of our material cost; however, the impact of paper
pricing on our operating margins is mitigated, and in some cases eliminated, as
it is often passed on to our customers. We closely monitor material cost as a
percentage of net sales to measure volume and waste, and we maintain low levels
of inventory. We also track labor utilization, or net sales per employee, to
measure productivity and determine staffing levels.
The effects of the 2022 global supply chain disruptions have eased in 2023. The
supply chain disruptions for us were primarily confined to price increases. As
noted above, price increases are often passed on to our customers. Labor costs
have increased moderately to retain valuable employees or to compete for new
hires. While these increases had an effect, we believe our cost optimization
program will continue to make them manageable in the future.
Historically, our capital expenditure requirements have varied based on our need
for printing equipment in our MPS locations and service centers. Over the past
two years, the pandemic has reduced the number of employees in our customers'
locations, which has, in turn, reduced the need for equipment. We believe this
equipment trend is likely to become permanent and, as a result, we think the
past two years are more indicative of future capital needs than historical
trends.
Because our relationships with credit providers allows us to obtain attractive
lease rates, we have historically chosen to lease rather than purchase most of
our equipment over the past two years. With the rising cost of capital, in 2023
we have decided to adjust our historical strategy and use more of our available
cash to acquire equipment and minimize the impact of interest expense on our
results of operations.
Research and development costs consist mainly of the salaries, leased building
space, and computer equipment related to 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 COVID-19 pandemic adversely impacted our financial performance during 2020 to 2022, but we expect that its acute impact is mostly behind us. We believe, however, that the reduced office presence of employees brought on by the COVID-19 pandemic will be permanent. As a result, our MPS business remains under pressure as most employers have left work-from-home policies in place. We expect that remote work and hybrid work arrangements will remain the norm for many of our customers, but print volumes may increase marginally as they did in the first quarter of 2023 as some employers bring their employees back into the office at higher rates than we saw in 2022. We believe work-from-home and hybrid work practices benefit our scanning business as employees need access to documents, regardless of where they are working, and document scanning is the first step in making them accessible in the cloud. Uncertainty around the potential disruption to our business related to the COVID-19 pandemic and its effect on theU.S. economy and our clients' ongoing business operations has largely been mitigated, but we remain watchful and prepared to alter our business operations to protect employees and customers. The following discussions are subject to the future effects of the COVID-19 pandemic on our ongoing business operations. 22 --------------------------------------------------------------------------------
Results of Operations
Three Months Ended March 31, Increase (decrease)
(In millions, except percentages) 2023(1) 2022(1) $ %
Digital Printing $ 41.4 $ 41.9 $ (0.6) (1.4) %
MPS 19.0 18.7 0.4 1.9 %
Scanning and Digital Imaging 4.6 4.2 0.4 10.2 %
Equipment and supplies sales 3.9 4.7 (0.8) (16.7) %
Total net sales $ 68.9 $ 69.5 $ (0.6) (0.8) %
Gross profit $ 22.9 $ 22.4 $ 0.5 2.1 %
Selling, general and administrative expenses $ 19.5 $ 19.4 $ 0.1 0.7 %
Amortization of intangible assets $ - $ - $ - (68.6) %
Interest expense, net $ 0.5 $ 0.4 $ - 6.0 %
Income tax provision $ 1.2 $ 0.8 $ 0.4 45.4 %
Net income attributable to ARC $ 1.9 $ 2.0 $ - (1.6) %
Non-GAAP (2)
Adjusted net income attributable to ARC (2) $ 2.2 $ 2.0 $ 0.2 9.9 %
EBITDA (2) $ 8.2 $ 8.6 $ (0.4) (4.8) %
Adjusted EBITDA (2) $ 8.7 $ 9.1 $ (0.4) (4.0) %
1.Column does not foot due to rounding. 2.See "Non-GAAP Financial Measures" following "Results of Operations" for definitions, reconciliations and more information related to our Non-GAAP disclosures.
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
Three Months Ended March 31,
2023 (1) 2022 (1)
Net sales 100.0 % 100.0 %
Cost of sales 66.7 67.7
Gross profit 33.3 32.3
Selling, general and administrative expenses 28.3 27.9
Amortization of intangible assets - 0.1
Income from operations 5.0 4.4
Interest expense, net 0.7 0.6
Income before income tax provision 4.3 3.8
Income tax provision 1.7 1.1
Net income 2.7 2.7
Loss attributable to the noncontrolling interest 0.2 0.2
Net income attributable to ARC 2.8 % 2.8 %
Non-GAAP (2)
EBITDA (2) 11.9 % 12.4 %
Adjusted EBITDA (2) 12.6 % 13.1 %
(1)Column does not foot due to rounding. (2)See "Non-GAAP Financial Measures" following "Results of Operations" for definitions, reconciliations and more information related to our Non-GAAP disclosures.
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Three Months Ended
Net sales for the three months endedMarch 31, 2023 , decreased 0.8% compared to the same period in 2022. The decrease in net sales for the first quarter 2023 was primarily driven by a decrease in our lower margin Equipment & Supplies sales and a decrease in our Digital Printing services, partially offset by the year-over-year increase in sales from MPS and Scanning and Digital Imaging services. Digital Printing. Year-over-year sales of Digital Printing services decreased$0.6 million , or 1.4%, for the three months endedMarch 31, 2023 . Year-over-year sales increased in digital color graphic printing from new and existing customers and we experienced continuing demand for digital color graphic printing across most of our customer base. This growth was offset by the decrease in digital plan printing sales which we attribute to less activity and lower spending on new construction projects due to increased costs of capital. Digital Printing services represented 60% of total net sales for the three months endedMarch 31, 2023 andMarch 31, 2022 . MPS. Year-over-year sales of MPS services for the three months endedMarch 31, 2023 , increased$0.4 million , or 1.9%. Growth in MPS sales reflects an increase of on-site printing volume as moderation of work-from-home directives encouraged more employees to return to offices during the period.
MPS sales represented approximately 28% of total net sales for the three months
ended
The number of MPS locations has remained relatively flat year-over-year at
approximately 10,700 as of
Scanning and Digital Imaging. Year-over-year sales of Scanning and Digital Imaging services increased$0.4 million , or 10.2% for the three months endedMarch 31, 2023 . The increase in sales of our Scanning and Digital Imaging services was primarily attributable to growing demand for paper-to-digital document conversions used in day-to-day business operations, and the creation of digital archives to replace long-term warehoused paper document storage. We continue to drive an expansion of our addressable market for Scanning and Digital Imaging services with increased marketing activity, as well as 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 the markets and industries we serve and the desire of our existing customers to have digital access to documents, our Scanning and Digital Imaging services will continue to grow in the future. Equipment and Supplies Sales. Year-over-year sales of Equipment and Supplies decreased$0.8 million , or 16.7%, for the three months endedMarch 31, 2023 driven mostly by a year-over-year sales drop of$0.5 million from our Chinese joint venture as the Chinese economy continues to be challenged.
Gross Profit
During the three months endedMarch 31, 2023 , gross profit increased to$22.9 million , or 33.3%, compared to$22.4 million , or 32.3% during the three months endedMarch 31, 2022 , primarily driven by the efficiency in our cost structure and the reduction in depreciation expense of$0.7 million . Gross margin improvement was largely driven by our efforts to drive more work through our service centers which allows us to leverage our infrastructure (facilities & equipment), cross-trained workforce, and production-grade equipment, as well as improved production efficiencies in 2023. The improvements were partially offset by an increase in labor resulting from the inflationary pressures experienced during the last twelve months.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by$0.1 million , or 0.7%, to$19.5 million for the three months endedMarch 31, 2023 compared to the three months endedMarch 31, 2022 , which is consistent compared to the same period in 2022 despite the increase in labor costs.
Amortization of Intangibles
Amortization of intangibles decreased to less than
24
--------------------------------------------------------------------------------Interest Expense, Net
Net interest expense of$0.5 million for the three months endedMarch 31, 2023 , increased$0.1 million , compared to$0.4 million for the three months endedMarch 31, 2022 . The slight increase is due to the increase in interest rates partially offset by the continued pay down of our long-term debt. Our 2021 Credit Agreement (as defined below) features a flexible payment schedule which allows us to pay down or draw on it at any time. As such, we intend to use available cash throughout the year to pay down the revolving loan to manage our interest expense. Income Taxes We recorded an income tax provision of$1.2 million in relation to pretax income of$3.0 million for the three months endedMarch 31, 2023 , which resulted in an effective income tax rate of 38.8%. Our effective income tax rate for the three months endedMarch 31, 2023 , was primarily impacted by state taxes, non-deductible compensation, certain stock-based compensation and other non-deductible expenses. Excluding the impact of certain stock-based compensation, an increase in certain valuation allowances, and other discrete items, our effective income tax rate for the consolidated company would have been 30.4% and our effective income tax rate attributable toARC Document Solutions, Inc. would have been 29.9% for the three months endedMarch 31, 2023 . By comparison, we recorded an income tax provision of$0.8 million in relation to pretax income of$2.7 million for the three months endedMarch 31, 2022 , which resulted in an effective income tax rate of 30.1%. Our effective income tax rate for the three months endedMarch 31, 2022 , was primarily impacted by state taxes, certain stock-based compensation, change in valuation allowances against certain deferred tax assets and non-deductible expenses. Excluding the impact of the change in valuation allowances and certain stock-based compensation, our effective income tax rate for the consolidated company would have been 28.8% and our effective income tax rate attributable toARC Document Solutions, Inc. would have been 28.6% for the three months endedMarch 31, 2022 .
We have a
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 decreased to$1.9 million during the three months endedMarch 31, 2023 , as compared to$2.0 million during the three months endedMarch 31, 2022 . The decrease in net income attributable to ARC was primarily driven by the increase in income tax provision as noted above in the first quarter of 2023.
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 11.9% for the three months endedMarch 31, 2023 , from 12.4% for the same period in 2022. Excluding the effect of stock-based compensation, adjusted EBITDA margin decreased to 12.6% during the three months endedMarch 31, 2023 , as compared to 13.1% for the same period in 2022. The decrease for the three months endedMarch 31, 2023 , is largely attributable to lower sales. 25 --------------------------------------------------------------------------------
Impact of Inflation
Rising costs for raw materials, such as paper, and fuel charges are largely being passed on to customers via price increases during the ordinary course of business. These price increases have moderated the impact of inflation on our financial results in 2023. As these inflationary pressures continue, however, the increased cost of labor, materials and other indirect costs require close and active management to avoid material impacts to our cost structure.
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, net income margin 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 divisions. Our operating divisions' financial performance includes all of the operating activities except debt and taxation which are managed at the corporate level forU.S. operating divisions. We use EBITDA to compare the performance of our operating divisions 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 months endedMarch 31, 2023 and 2022 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 months endedMarch 31, 2023 and 2022. We believe these changes were the result of items which are not indicative of our actual operating performance. 26 -------------------------------------------------------------------------------- We have presented adjusted EBITDA for the three months endedMarch 31, 2023 and 2022 to exclude stock-based compensation expense. Adjusted EBITDA margin is a non-GAAP measure calculated by dividing adjusted EBITDA by net sales. 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 March 31, (In thousands) 2023 2022 Cash flows provided by operating activities$ 3,824 $ 2,931 Changes in operating assets and liabilities 4,204 5,585 Non-cash expenses, including depreciation and amortization (6,201) (6,660) Income tax provision 1,160 798 Interest expense, net 456 430 Loss attributable to the noncontrolling interest 113 116 Depreciation and amortization 4,663 5,429 EBITDA$ 8,219 $ 8,629
The following is a reconciliation of net income attributable to
Three Months Ended
March 31,
(In thousands) 2023 2022
Net income attributable to
$ 1,972 Interest expense, net 456 430 Income tax provision 1,160 798 Depreciation and amortization 4,663 5,429 EBITDA 8,219 8,629 Stock-based compensation 494 451 Adjusted EBITDA$ 8,713 $ 9,080
The following is a reconciliation of net income margin attributable to
Three Months Ended
March 31,
2023 (1) 2022 (1)
Net income margin attributable to ARC Document Solutions, Inc. 2.8 % 2.8 %
Interest expense, net 0.7 0.6
Income tax provision 1.7 1.1
Depreciation and amortization 6.8 7.8
EBITDA margin 11.9 12.4
Stock-based compensation 0.7 0.6
Adjusted EBITDA margin 12.6 % 13.1 %
(1)Column does not foot due to rounding.
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The following is a reconciliation of net income attributable to
Three Months Ended
March 31,
(In thousands, except per share amounts) 2023 2022
Net income attributable to ARC Document Solutions, Inc. $ 1,940 $ 1,972
Deferred tax valuation allowance and other discrete tax items 234 6
Adjusted net income attributable to
$ 1,978
Actual:
Earnings per share attributable toARC Document Solutions, Inc. shareholders: Basic$ 0.05 $ 0.05 Diluted$ 0.04 $ 0.05 Weighted average common shares outstanding: Basic 42,552 42,064 Diluted 43,764 43,739 Adjusted: Earnings per share attributable toARC Document Solutions, Inc. shareholders: Basic$ 0.05 $ 0.05 Diluted$ 0.05 $ 0.05 Weighted average common shares outstanding: Basic 42,552 42,064 Diluted 43,764 43,739
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 and stock repurchases.
Total cash and cash equivalents as ofMarch 31, 2023 was$49.8 million . Of this amount,$4.3 million was held in foreign countries, with$2.7 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. 28 --------------------------------------------------------------------------------
Supplemental information pertaining to our historical sources and uses of cash
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