Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Business Summary
ARC Document Solutions Inc. is a digital printing company. We provide digital printing and document-related services to customers in a growing variety of industries. Our primary services are:
• 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.
For a more complete description of our business, and product and service offerings, see Part I, Item 1 - "Business" - of this Annual Report on Form 10-K.
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 on our business 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. Our labor costs have increased moderately as we sought to retain valuable employees and competed for new hires in 2023. While these increases had an effect on our results of operations, we believe our cost optimization initiatives allowed us to mitigate their impact and will allow us to continue to manage them in future periods.
Historically, our capital expenditure requirements have varied based on our need for printing equipment in our MPS locations and service centers. Over the past several 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 has become permanent and, as a result, we think our past two years of capital expenditures are more indicative of our future capital needs than our longer-term history suggests.
Because our relationships with credit providers allow us to obtain attractive lease rates, we have historically chosen to lease rather than purchase most of our equipment. Due in part to the rising cost of capital in 2023, we have adjusted our historical equipment acquisition strategy and used more of our available cash to purchase equipment during the prior year to reduce the impact of interest expense on our operating results.
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.
COVID-19 Pandemic
The COVID-19 pandemic adversely impacted our financial performance from 2020 to 2022, but we expect that its acute impact is behind us. We believe, however, that the reduced in office presence of employees brought on by the COVID-19 pandemic are permanent. As a result, our MPS business has been and remains under pressure as most employers have left work-from-home policies in place and less equipment is needed to support them in typical office spaces. By contrast, we believe work-from-home and hybrid work practices benefit our scanning business because 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 the U.S. economy and our clients’ ongoing business operations has diminished, but we remain watchful and prepared to alter our business operations to protect employees and customers.
Market Review
We believe the expanding list of industries we serve are generally growing and offer ongoing sales opportunities for our services.
Demand for digital printing appears high across our customer base, and includes environmental graphics, marketing and promotional work. We believe that the desire to communicate visually—and especially in color—is growing in all areas of commerce, in office environments, in educational venues, and in public spaces of all kinds. While office capacity has fluctuated in recent years due to work-from-home and hybrid work policies, we have experienced minimal desire among our customers to completely abandon in office work, and we have many customers who have expressed a desire to make work spaces more inviting and engaging for the people who occupy them.
While the demand for MPS has declined from its peak, we believe it remains sought after by many clients, due to our flexible print network capacity, use of certified used equipment to reduce hardware costs, and ability to create efficiencies in the printing environment through our software and services. Unlike MPS, work-from-home and other remote document access requirements increase demand for scanning and digital imaging services.
In 2023, construction activity was constrained by higher interest rates and continuing labor shortages. The volume of construction plan printing fell alongside the reduction in construction activity. While we expect building activity to increase as interest rates ease, we do not expect the use of construction plan printing to be commensurate with it.
Economic inflation in the U.S., Canada and abroad has materially affected our business over the past year, primarily in the form of higher labor and raw material costs. Price increases in materials continue to be passed on to our customers, as well as some of the labor cost increases. Supply chain disruptions, other than price increases, have largely resolved in 2023, and we believe we remain reasonably protected from them due to the wide variety of suppliers we have developed relationships with over our history.
Results of Operations
2023 Versus 2022
Year Ended December 31,
Increase (decrease)
(In millions, except percentages)
Digital Printing
MPS
Scanning and Digital Imaging
Total services sales
Equipment and Supplies sales
Total net sales
Gross profit
Selling, general and administrative expenses
Amortization of intangibles
Site remediation expense
Interest expense, net
Income tax provision
Net income attributable to ARC
Adjusted net income attributable to ARC (2)
Cash flows provided by operating activities
EBITDA (2)
Adjusted EBITDA (2)
(1) Column does not foot due to rounding.
(2) Non-GAAP financial measure. 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
Year Ended December 31,
Net Sales
Cost of sales
Gross profit
Selling, general and administrative expenses
Amortization of intangibles
Site remediation expense
Income from operations
Interest expense, net
Income before income tax provision
Income tax provision
Net income
Loss attributable to the noncontrolling interest
Net income attributable to ARC
EBITDA (2)
Adjusted EBITDA (2)
(1) Column does not foot due to rounding.
(2) Non-GAAP financial measure. See "Non-GAAP Financial Measures" following "Results of Operations" for definitions, reconciliations and more information related to our Non-GAAP disclosures.
Fiscal Year Ended December 31, 2023 Compared to Fiscal Year Ended December 31, 2022
Net Sales
Net sales in 2023 decreased 1.7%, compared to 2022. The decrease in net sales was primarily driven by the decrease in sales from Digital Printing and Equipment & Supplies, partially offset by the year-over-year increase in sales from Scanning and Digital Imaging services.
Digital Printing . Sales of Digital Printing services in 2023 decreased by $4.7 million, or 2.7%, compared to 2022. 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 of sales in digital plan printing for construction, which we attribute to less activity and lower spending on new building projects due to higher interest rates and increased costs of capital. Digital Printing services represented 60% and 61% of total net sales for 2023 and 2022, respectively.
MPS . Sales of MPS services in 2023 decreased by $1.0 million, or 1.3%, compared to 2022. Fewer employees returning to the workplace after the pandemic has generally constrained onsite print volumes. Revenues from MPS sales represented approximately 27% of total net sales for both 2023 and 2022.
The number of MPS locations has decreased to approximately 10,440 locations as of December 31, 2023 from 10,720 as of December 31, 2022.
Scanning and Digital Imaging . Year-over-year sales of Scanning and Digital Imaging services increased by $3.0 million, or 17.0%, in 2023, compared to 2022. 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 are expanding operational capacity in this service line, and plan to continue to drive an expansion of our addressable market for Scanning and Digital Imaging services with increased marketing activity, as well as 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 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 . Equipment and Supplies sales decreased by $2.1 million, or 11.5%, in 2023, compared to 2022. The decrease was primarily driven by the ongoing economic slowdown in China, which decreased sales from UNIS Document Solutions Co. Ltd, or UDS, our Chinese joint venture. Equipment and Supplies sales continue to decline in the U.S. as well. We attribute the decrease in sales to our customers' reluctance to acquire equipment while interest rates remain high and, in certain markets including China, economic activity remains depressed. Equipment and Supplies sales derived from UDS, were $1.7 million in 2023, as compared to $2.5 million in 2022. Equipment and Supplies sales represented approximately 6% of total net sales for 2023 for 2022, respectively.
Gross Profit
Gross profit decreased to $94.4 million in 2023, compared to $96.0 million in 2022. Despite a sales decrease of $4.8 million in 2023, gross profit decreased by just $1.6 million. Gross margin remained flat at 33.6% in 2023, compared to 2022. Gross margin stability was driven by improved efficiency in our cost structure and a reduction in depreciation expense of $2.6 million. Offsetting these cost reductions were increased labor expenses related to the growth in Scanning and Digital Imaging Services, as well as wage inflation pressures across our workforce during 2023.
Selling, General and Administrative Expenses
Selling, general and administrative expenses decreased by $1.2 million, or 1.6%, in 2023 compared to 2022. The decrease was primarily driven by lower commission and bonus accruals due to the decline in net sales and net income attributable to us.
Amortization of Intangibles
Amortization of intangibles decreased to less than $0.1 million in 2023 as compared to $0.1 million in 2022, primarily due to the completed amortization of certain customer relationships related to historical acquisitions.
Site Remediation Expense
We are currently involved in a site remediation obligation due to a former gas station that had been situated on a property we obtained as part of a business acquisition in the late 1990s. In 2020, the local County's Department of Environmental Health, or CDEH, approved our remedial clean-up plan, hence a liability on an undiscounted basis for $0.6 million for costs attributable to our clean-up plan was established. Additional review conducted in the fourth quarter of 2023 identified certain additional potential risks arising out of a structure on a neighboring property. As a result, in December of 2023, the CDEH requested that an alternative remedial plan be developed and submitted by March 12, 2024, to address the structural aspects of the site. We are in the process of finalizing an alternative plan with the guidance and expertise of an environmental consulting firm engaged expressly for this purpose. The additional concerns identified in December 2023 require more complex remediation measures for a longer duration than those contained in the plan approved by the CDEH in 2020. In light of the expected increase in expenses associated with remediating the site we have increased the reserve by approximately $4.0 million, reflecting a total reserve on an undiscounted basis of $4.5 million as of December 31, 2023. We have accrued probable and reasonably estimable costs for the resolution of the obligation based upon types of remediation efforts currently anticipated, the volume of contaminants in the impacted areas, regulatory oversight and other costs. The history of this site remediation obligation is summarized in Note 6, Commitments and Contingencies - Site Remediation Obligation within Part IV, Item 15 - "Exhibits and Financial Statement Schedule” of this Annual Report on Form 10-K.
Interest Expense, Net
Net interest expense totaled $1.6 million in 2023, compared to $1.8 million in 2022. The decrease in 2023 compared to 2022 was due to the continuing reduction of our overall debt, partially offset by increases in interest rates.
Income Taxes
We recorded an income tax provision of $4.4 million in relation to pretax income of $12.5 million for 2023, which resulted in an effective income tax rate of 35.2%. In addition to recurring state and foreign taxes and certain nondeductible expenses, our effective income tax rate for 2023 was impacted by an expiration of tax credits which were offset by a change in valuation allowances against those and other certain deferred tax assets and stock based compensation forfeitures. Excluding the impact of those expirations and valuation allowances, stock based compensation forfeitures and other discrete items, our effective income tax rate for the consolidated company would have been 29.2% and our effective income tax rate attributable to ARC Document Solutions, Inc. would have been 29.1%.
We recorded an income tax provision of $5.8 million in relation to pretax income of $16.6 million for 2022, which resulted in an effective income tax rate of 35.1%. In addition to recurring state and foreign taxes and certain nondeductible expenses, our effective income tax rate for 2022 was primarily impacted by a change in valuation allowances against certain deferred tax assets and stock-based compensation forfeitures. Excluding the impact of valuation allowances, stock based compensation forfeitures and other discrete items, our effective income tax rate for the consolidated company would have been 29.4% and our effective income attributable to ARC Document Solutions, Inc. would have been 29.1%.
Noncontrolling Interest
Net income attributable to noncontrolling interest represents 35% of the income of our Chinese joint venture with UDS and its subsidiaries, which together comprise our Chinese joint-venture operations.
Impact of Inflation
Rising costs for raw materials, such as paper, inks and toners were largely passed on to customers through price increases during 2022 and 2023, moderating the impact of inflation on our financial results. 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.
Net Income Attributable to ARC
Net income attributable to us was $8.2 million in 2023, as compared to $11.1 million in 2022. The decrease in net income attributable to us in 2023 was primarily driven by the increase in the site remediation reserve, net of taxes, noted above.
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 11.3% in 2023 from 13.7% in 2022. Excluding the effect of the site remediation expense and stock-based compensation, adjusted EBITDA margin decreased slightly to 13.6% in 2023 from 14.3% in 2022. The decrease is largely attributable to lower sales and an increase in labor costs.
Non-GAAP Financial Measures
EBITDA, EBITDA margin, Adjusted EBITDA, Adjusted EBITDA margin, adjusted net income and adjusted earnings per share 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 or GAAP. These measures are not measurements of our financial performance under GAAP and should not be considered as alternatives to net income, net income margin, income from operations, diluted earnings per share or any other performance measures presented in accordance with GAAP or as an alternative to cash flows from operating, investing or financing activities as a measure of our liquidity. We have presented these measures 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.
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 use EBITDA and EBITDA margin 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 for U.S. operating divisions. We use EBITDA and EBITDA margin to compare the performance of our operating divisions and to measure performance for determining consolidated-level compensation. In addition, we use EBITDA and EBITDA margin to evaluate potential acquisitions and potential capital expenditures.
EBITDA and EBITDA margin 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 EBITDA margin only as supplements.
Our presentation of adjusted net income and adjusted EBITDA 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 stockholders for 2023 and 2022 to reflect the exclusion of the site remediation expense and 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 2023 and 2022. We believe these changes were the result of items which are not indicative of our actual operating performance.
We have presented adjusted EBITDA for 2023 and 2022 to exclude the site remediation expense as it is not indicative of our ongoing operations. We have presented adjusted EBITDA for 2023 and 2022 to also exclude stock-based compensation expense, as it is consistent with the definition of adjusted EBITDA in our Credit Agreement; therefore, we believe this information is useful to investors assessing our financial performance. We calculate adjusted EBITDA margin by dividing adjusted EBITDA by net sales.
The following is a reconciliation of cash flows provided by operating activities to EBITDA:
Year Ended December 31,
(In thousands)
Cash flows provided by operating activities
Changes in operating assets and liabilities
Non-cash expenses
Income tax provision
Interest expense, net
Loss attributable to the noncontrolling interest
EBITDA
The following is a reconciliation of net income attributable to ARC Document Solutions, Inc. stockholders to EBITDA and adjusted EBITDA:
Year Ended December 31,
(In thousands)
Net income attributable to ARC Document Solutions, Inc. stockholders
Interest expense, net
Income tax provision
Depreciation and amortization
EBITDA
Site remediation expense
Stock-based compensation
Adjusted EBITDA
The following is a reconciliation of net income margin attributable to ARC Document Solutions, Inc. stockholders to EBITDA margin and adjusted EBITDA margin:
Year Ended December 31,
Net income margin attributable to ARC Document Solutions, Inc. stockholders
Interest expense, net
Income tax provision
Depreciation and amortization
EBITDA margin
Site remediation expense
Stock-based compensation
Adjusted EBITDA margin
(1) Column does not foot due to rounding.
The following is a reconciliation of net income attributable to ARC Document Solutions, Inc. stockholders to adjusted net income and adjusted earnings per share attributable to ARC Document Solutions, Inc. stockholders:
Year Ended December 31,
(In thousands, except per share data)
Net income attributable to ARC Document Solutions, Inc. stockholders
Site remediation expense
Income tax benefit related to above item
Deferred tax valuation allowance and other discrete tax items
Adjusted net income attributable to ARC Document Solutions, Inc. stockholders
Actual:
Earnings per share attributable to ARC Document Solutions, Inc. stockholders:
Basic
Diluted
Weighted average common shares outstanding:
Basic
Diluted
Adjusted:
Earnings per share attributable to ARC Document Solutions, Inc. stockholders:
Basic
Diluted
Weighted average common shares outstanding:
Basic
Diluted
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.
We continually assess our capital allocation strategy, including decisions relating to dividends, repurchase shares of our common stock, capital expenditures, and debt pay-downs. The timing, declaration and payment of future dividends, however, falls within the discretion of our Board of Directors and will depend upon many factors, including our financial condition and earnings, the capital requirements of our business, restrictions imposed by applicable law and the terms of any of our debt agreements and any other factors the Board of Directors deems relevant from time to time.
In February 2023, our Board of Directors approved a stock repurchase program that authorized us to purchase up to $20.0 million of our outstanding common stock through March 31, 2026. Purchases may be made from time to time in the open market at prevailing market prices or in privately negotiated transactions. During the year ended December 31, 2023 we repurchased 1.0 million shares of our common stock for a total purchase price of $3.2 million. During the year ended December 31, 2022 we repurchased 0.6 million shares of our common stock for a total purchase price of $1.7 million.
Total cash and cash equivalents as of December 31, 2023 was $56.1 million. Of this amount, $5.7 million was held in foreign countries, with $2.6 million held in China. 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 the U.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 Consolidated Statements of Cash Flows and notes thereto included elsewhere in this report.
Year Ended December 31,
(In thousands)
Net cash provided by operating activities
Net cash used in investing activities
Net cash used in financing activities
Operating Activities
Cash flows from operations are primarily driven by sales and the net profit generated from these sales, excluding non-cash charges.
The decrease in cash flows from operations in 2023 was primarily due to the decrease in net income partially offset by the improvement in our collection of accounts receivables.
Days sales outstanding, or DSO was 47 days as of December 31, 2023 as compared to 51 days as of December 31, 2022. We are closely managing cash collections.
DSO is calculated by taking the respective years December 31 st , accounts receivable balance divided by the net sales during the fourth quarter of that year multiplied by the number of total days in a quarter.
We have presented DSO because we consider it an important metric as it is a valuable indicator of the efficiency of the business and quality of our cash flows. We believe investors may also find this metric meaningful given the importance of cash flows from operations and management's ability to efficiently manage our working capital.
Investing Activities
Net cash used in investing activities was primarily related to capital expenditures. We incurred capital expenditures totaling $10.8 million and $5.9 million, in 2023 and 2022, respectively. The year-over-year increase in capital expenditures is driven primarily by our decision to enter into fewer leases and acquire more equipment outright in 2023 due to increasing interest rates.
Financing Activities
Net cash of $22.6 million used in financing activities in 2023 primarily relates to payments on our finance leases, dividends, and repurchases of shares of our common stock, partially offset by proceeds from stock option exercises. Our need for printing equipment has significantly decreased over the past several years, resulting in a decrease of $4.2 million in our finance lease liability as of December 31, 2023 compared to the balance in the prior year. This reduction in the finance lease liability will also drive a further reduction in 2024 payments for financed leases.
Our cash position, working capital, and debt obligations as of December 31, 2023 and 2022 are shown below and should be read in conjunction with our Consolidated Balance Sheets and notes thereto contained elsewhere in this report.
December 31,
(In Thousands)
Cash and cash equivalents
Working capital
Borrowings from revolving credit facility
Various finance leases
Total debt obligations
The increase of $2.6 million in working capital in 2023 was primarily driven by the increase in cash of $3.5 million and $2.7 million decrease in the current portion of our finance lease liability, partially offset by a $3.0 million decrease in accounts receivable and an increase in accounts payable over 2022. 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 $56.1 million, the availability under our 2021 Credit Agreement, the availability under our equipment lease lines, and cash flows provided by operations should be adequate to cover the next twelve months and beyond of working capital needs, debt 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. See “ Debt Obligations ” section for further information related to our 2021 Credit Agreement.
A significant portion of our revenue across all of our product and services is generated from customers in 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 disruptions in the capital markets, economic sanctions and economic slowdowns or
recessions, rising inflation, public health crises, like the COVID-19 pandemic, and interest rates fluctuations. Additionally, a 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 since 2009, but will consider acquisitions that we feel add value to the overall company.
Debt Obligations
Credit Agreement
On June 15, 2023, we entered into an amendment, or the Amendment, to our Credit Agreement dated as of April 22, 2021, or the 2021 Credit Agreement, with U.S. Bank National Association, as administrative agent and the lenders part thereto. The Amendment, among other things, modifies certain terms of the 2021 Credit Agreement to replace the relevant benchmark provisions from the London Interbank Offered Rate to the forward-looking term rate based on the Secured Overnight Financing Rate, or SOFR. The Amendment also modifies certain terms of the 2021 Credit Agreement relating to the payment of dividends and stock repurchases made by us and the related component calculations included in the fixed charge coverage ratio that we are required to maintain. After giving effect to the Amendment, we are permitted to repurchase up to $10.0 million of shares of our common stock in any twelve-month period and all such permitted stock repurchases will be excluded from the calculation of the fixed charge coverage ratio. In addition, we are permitted to make other restricted payments that are not stock repurchases, such as the payment of dividends, of up to $12.0 million during any twelve-month period which will also be excluded from the calculation of the fixed charge coverage ratio. The making of stock repurchases and the payment of dividends and other restricted payments is subject, in each case, to pro forma compliance with the financial covenants and other customary conditions set forth in 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 Credit Agreement dated as of November 20, 2014, as amended, or the 2014 Credit Agreement. The obligation under the 2021 Credit Agreement matures on April 22, 2026.
As of December 31, 2023, our borrowing availability under the Revolving Loan commitment was $27.8 million, after deducting outstanding letters of credit of $2.2 million and an outstanding Revolving Loan balance of $40.0 million.
Loans borrowed under the 2021 Credit Agreement bear interest, in the case of Term SOFR loans, at a per annum rate equal to the applicable Term SOFR (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 Term SOFR loans bear interest at a per annum rate equal to the Alternate Base Rate (as such terms is defined in the 2021 Credit Agreement) plus a margin ranging from 0.25% to 0.75%, based on our Total Leverage Ratio. As of December 31, 2023, one month Term SOFR loans borrowed under the 2021 Credit Agreement accrued interest at 6.8%. 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) we 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 we 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 of December 31, 2023.
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 other United 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).
Credit Agreement
The following table sets forth the outstanding balance, borrowing capacity and applicable interest rate under Credit Agreement.
December 31, 2023
Balance
Available
Borrowing
Capacity
Interest
Rate
(Dollars in thousands)
Revolving Loans (1)
(1) Revolving Loan available borrowing capacity, net of $2.2 million of outstanding standby letters of credit as of December 31, 2023.
Finance Leases
As of December 31, 2023, we had $22.2 million of finance lease obligations outstanding, with a weighted average interest rate of 5.5% and maturities between 2024 and 2029.
Commitments and Contingencies
Operating Leases. We lease machinery, equipment, and office and operational facilities under non-cancelable operating lease agreements. Certain lease agreements for our facilities generally contain renewal options and provide for annual increases in rent based on the local Consumer Price Index. Refer to Note 7, Leasing, for the schedule of our future minimum operating lease payments as of December 31, 2023.
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. We evaluate whether a loss is reasonably probable based on our assessment and consultation with legal counsel regarding the ultimate outcome of the matter. As of December 31, 2023, 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.
Site Remediation Obligation. As part of a business acquisition in the 1990’s, we purchased a site located in California where a former commercial gas station had operated from 1939 until approximately 1986. Prior to our acquisition, the gas station was demolished and its underground storage tanks were removed.
Environmental monitoring of the property was conducted from 1987 through 2017 under the oversight of the local County's Department of Environmental Health (CDEH) and it eventually revealed petroleum products in the soil, groundwater, and the air in between soil particles. As a result, a Corrective Action Implementation Plan (CAIP) detailing remedial clean-up methods at the site was required to be submitted in 2020. Accordingly, we recorded a liability on an undiscounted basis of $0.6 million in 2020, the estimated cost, to remediate the site.
The 2020 CAIP was approved by the CDEH, but based on additional site data, the department requested a submission of addenda to the CAIP to address other site conditions. The additional review conducted in the fourth quarter of 2023 identified certain potential risks arising out of a structure on a neighboring property. As a result, in December of 2023, the CDEH requested that an alternative remedial plan be developed and submitted by March 12, 2024, to address the structural aspects of the site. We are in the process of finalizing an alternative plan with the guidance and expertise of an environmental consulting firm engaged expressly for this purpose. The additional concerns identified in 2023 require that the new plan be designed in a
way that is significantly more expensive than the original plan, is more complicated, and will result in a longer duration to remediate the site.
The Consolidated Balance Sheets include a liability on an undiscounted basis for the site remediation of $4.5 million as of December 31, 2023, of which $2.2 million is classified as a current liability, and $0.6 million as of December 31, 2022. As of December 31, 2023, the liability represents our estimate of the probable cleanup, investigation, and remediation costs based on available information. We anticipate that most of this liability will be paid out over seven years, but some costs maybe be paid out over a longer period.
The estimate of our final remediation expenses may change over time because of the varying costs of currently available cleanup techniques, unpredictable contaminant reduction rates associated with available cleanup techniques, and the difficulty of determining in advance the nature and full extent of contamination. However, evolving statutory and regulatory standards, their interpretation, more vigorous enforcement policies of regulatory agencies, or stricter or different interpretations of existing statutory and regulatory standards, may require additional expenditures, which may be material. Accordingly, there can be no assurance that we will not incur significant additional environmental compliance costs in the future.
Critical Accounting Policies and Significant Judgments and Estimates
Our management prepares financial statements in conformity with GAAP. When we prepare these consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates and judgments, including those related to accounts receivable, inventories, deferred tax assets, goodwill and intangible assets, long-lived assets and leases. We base our estimates and judgments on historical experience and on various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management's judgments and estimates.
Goodwill Impairment
In accordance with ASC 350, Intangibles - Goodwill and Other , we assess goodwill for impairment annually as of September 30, and more frequently if events and circumstances indicate that goodwill might be impaired. At September 30, 2023, the Company performed its annual 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 judgement and estimation is inherently higher in these uncertain economic times.
The results of the latest annual goodwill impairment test, as of September 30, 2023, were as follows:
(Dollars in thousands)
Number of
Reporting
Units
Representing
Goodwill of
No goodwill balance
Fair value of reporting units exceeds their carrying values by more than 15%
Based upon a sensitivity analysis, a reduction of approximately 50 basis points of projected EBITDA in 2023 and beyond, assuming all other assumptions remain constant, would result in no further 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 uncertain economic times 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 2023 will prove to be accurate predictions of the future. If our assumptions, including forecasted EBITDA of certain reporting units, are not achieved, 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 2024, 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.
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 that we are expected to be entitled to in exchange for those goods or services. We applied practical expedients related to unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which the Company recognizes revenue at the amount to which it has the right to invoice for services performed.
Digital Printing 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, or Ordered Prints and (ii) specialized graphic color printing. Substantially, all the Company’s revenue from Digital Printing 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 re-produced 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 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 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”. MPS sales are driven by the ongoing print needs of the Company’s customers at their facilities. Upon the issuance of 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. The pattern of revenue recognition for the Company's MPS revenue has remained substantially unchanged following the adoption of ASC 842. See Note 7, Leasing, for additional information.
Scanning and Digital Imaging combines software and professional services to facilitate the capture, management, access and retrieval of documents and information that have been produced in the past. Scanning and Digital Imaging may include our hosted SKYSITE software and facilities solution 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, or Scanned Documents, and their cloud-based storage and maintenance. Sales of Scanning and Digital Imaging professional services, which represent substantially all revenue for this business line, 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, our facilities solution or through other 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, or 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. We have experienced minimal customer returns or refunds and does not offer a warranty on equipment that it is reselling.
Leases
We recognize lease assets and corresponding lease liabilities for all operating and finance leases on our Consolidated Balance Sheets, excluding short-term leases (leases with terms of 12 months or less) as described under ASU No. 2016-02, Leases (Topic 842 ). Some of our long-term operating lease agreements include options to extend, which are also factored into the recognition of their respective assets and liabilities when appropriate based on management’s assessment of the probability that the options will be exercised. Lease payments are discounted using the rate implicit in the lease, or, if not readily determinable, a third-party secured incremental borrowing rate based on information available at lease commencement. Additionally, certain of our lease agreements include escalating rents over the lease terms which, under Topic 842, results in rent being expensed on a straight-line basis over the life of the lease that commences on the date we have the right to control the property. 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. For additional information about the impact of the adoption of ASC 842, see Note 7, Leasing .
Site Remediation Obligation
We are currently involved in a site remediation obligation due to a former gas station that had been situated on a property we obtained as part of a business acquisition in the late 1990s. We have accrued estimates of the probable and reasonably estimable costs for the resolution of the obligation based upon types of remediation efforts currently anticipated, the volume of contaminants in the impacted areas, regulatory oversight and other costs.
Our current estimates of future environmental cleanup and remediation liabilities related to the site may change over time due to various factors, including but not limited to, the nature and extent of required future cleanup and removal activities, and the extent and duration of regulatory oversight, among other things. The final outcome of any regulatory inquiries and requirements cannot be predicted with certainty, and unfavorable or unexpected outcomes could result in additional costs that could be material to our results of operations during any particular year of the remediation process. See Note 6, Commitments and Contingencies - Site Remediation Obligation within Part IV, Item 15 - "Exhibits and Financial Statement Schedule” of this Annual Report on Form 10-K , for further discussion on environmental matters.
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 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 its 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 $1.3 million valuation allowance against certain deferred tax assets as of December 31, 2023.
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 2, Summary of Significant Accounting Policies to our Consolidated Financial Statements for disclosure on recently adopted accounting pronouncements and those not yet adopted.
