UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________ 
Form 10-Q
  _______________________________________ 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-32407
_______________________________________ 
ARC DOCUMENT SOLUTIONS, INC.
(Exact name of Registrant as specified in its Charter)
_______________________________________ 
Delaware
20-1700361
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
1981 N. Broadway, Suite 385
Walnut Creek, California 94596
(925) 949-5100
(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)
_______________________________________ 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   ý     No   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   ý     No   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,”and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):  
Large accelerated filer
¨
Accelerated filer
ý
 
 
 
 
Non-accelerated filer
¨   (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
 
 
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨  
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes   ¨     No   ý
As of October 27, 2017 , there were 46,457,281 shares of the issuer’s common stock outstanding.



ARC DOCUMENT SOLUTIONS, INC.
Form 10-Q
For the Quarter Ended September 30, 2017
Table of Contents
 
PART I—FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2017 and December 31, 2016 (Unaudited)
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2017 and 2016 (Unaudited)
Condensed Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2017 and 2016 (Unaudited)
Condensed Consolidated Statements of Equity for the nine months ended September 30, 2017 and 2016 (Unaudited)
Condensed Consolidated Statements of Cash Flows for the three and nine months ended September 30, 2017 and 2016 (Unaudited)
Notes to Condensed Consolidated Financial Statements (Unaudited)
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II—OTHER INFORMATION
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits
Signatures
Exhibit Index
Exhibit 31.1
 
Exhibit 31.2
 
Exhibit 32.1
 
Exhibit 32.2
 
 
 
 
 
 
 
 
 
 
 

2


FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains statements that are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. When used in this Form 10-Q, the words “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “project,” “target,” “likely,” “will,” “would,” “could,” and variations of such words and similar expressions as they relate to our management or to ARC Document Solutions, Inc. (the “Company”) are intended to identify forward-looking statements. These forward-looking statements involve risks and uncertainties that could cause actual results to differ materially from those contemplated herein. We have described in Part II, Item 1A-“Risk Factors” a number of factors that could cause our actual results to differ from our projections or estimates. These factors and other risk factors described in this Form 10-Q are not necessarily all of the important factors that could cause actual results to differ materially from those expressed in any of our forward-looking statements. Other unknown or unpredictable factors also could harm our results. Consequently, there can be no assurance that the actual results or developments anticipated by us will be realized or, even if substantially realized, that they will have the expected consequences to, or effects on, us. Given these uncertainties, you are cautioned not to place undue reliance on such forward-looking statements.
Except where otherwise indicated, the statements made in this Form 10-Q are made as of the date we filed this report with the Securities and Exchange Commission and should not be relied upon as of any subsequent date. All future written and verbal forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We undertake no obligation, and specifically disclaim any obligation, to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. You should, however, consult further disclosures we make in future filings of our Forms 10-K, Forms 10-Q, and Forms 8-K, and any amendments thereto, as well as our proxy statements.


3


PART I—FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
ARC DOCUMENT SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
 
September 30,
 
December 31,
(In thousands, except per share data)
2017
 
2016
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
26,363

 
$
25,239

Accounts receivable, net of allowances for accounts receivable of $2,495  and $2,060
59,006

 
59,735

Inventories, net
19,095

 
18,184

Prepaid expenses
5,008

 
3,861

Other current assets
5,034

 
4,785

Total current assets
114,506

 
111,804

Property and equipment, net of accumulated depreciation of $205,435  and $201,192
65,645

 
60,735

Goodwill
121,051

 
138,688

Other intangible assets, net
10,087

 
13,202

Deferred income taxes
41,364

 
42,667

Other assets
2,590

 
2,185

Total assets
$
355,243

 
$
369,281

Liabilities and Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
25,027

 
$
24,782

Accrued payroll and payroll-related expenses
10,908

 
12,219

Accrued expenses
15,041

 
16,138

Current portion of long-term debt and capital leases
20,268

 
13,773

Total current liabilities
71,244

 
66,912

Long-term debt and capital leases
128,917

 
143,400

Other long-term liabilities
3,329

 
2,148

Total liabilities
203,490

 
212,460

Commitments and contingencies (Note 6)

 

Stockholders’ equity:
 
 
 
ARC Document Solutions, Inc. stockholders’ equity:
 
 
 
Preferred stock, $0.001 par value, 25,000 shares authorized;  0 shares issued and outstanding
—

 
—

Common stock, $0.001 par value, 150,000 shares authorized; 47,891  and 47,428 shares issued and 46,451  and 45,988 shares outstanding
48

 
47

Additional paid-in capital
120,204

 
117,749

Retained earnings
32,681

 
41,822

Accumulated other comprehensive loss
(2,545
)
 
(3,793
)
 
150,388

 
155,825

Less cost of common stock in treasury, 1,440  shares
5,909

 
5,909

Total ARC Document Solutions, Inc. stockholders’ equity
144,479

 
149,916

Noncontrolling interest
7,274

 
6,905

Total equity
151,753

 
156,821

Total liabilities and equity
$
355,243

 
$
369,281

The accompanying notes are an integral part of these condensed consolidated financial statements.

4




ARC DOCUMENT SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
(In thousands, except per share data)
2017
 
2016
 
2017
 
2016
Service sales
$
85,625

 
$
89,178

 
$
262,459

 
$
272,394

Equipment and supplies sales
10,833

 
11,265

 
35,010

 
35,369

Total net sales
96,458

 
100,443

 
297,469

 
307,763

Cost of sales
67,231

 
67,713

 
202,918

 
204,904

Gross profit
29,227

 
32,730

 
94,551

 
102,859

Selling, general and administrative expenses
25,843

 
24,893

 
76,540

 
76,752

Amortization of intangible assets
1,053

 
1,160

 
3,250

 
3,705

Goodwill impairment
17,637

 
—

 
17,637

 
73,920

Restructuring expense
—

 
—

 
—

 
7

(Loss) income from operations
(15,306
)
 
6,677

 
(2,876
)
 
(51,525
)
Other income, net
(19
)
 
(16
)
 
(60
)
 
(54
)
Loss on extinguishment and modification of debt
124

 
66

 
230

 
156

Interest expense, net
1,530

 
1,563

 
4,679

 
4,535

(Loss) income before income tax (benefit) provision
(16,941
)
 
5,064

 
(7,725
)
 
(56,162
)
Income tax (benefit) provision
(2,174
)
 
2,162

 
1,574

 
(5,884
)
Net (loss) income
(14,767
)
 
2,902

 
(9,299
)
 
(50,278
)
Income attributable to the noncontrolling interest
(7
)
 
(61
)
 
(55
)
 
(211
)
Net (loss) income attributable to ARC Document Solutions, Inc. shareholders
$
(14,774
)
 
$
2,841

 
$
(9,354
)
 
$
(50,489
)
(Loss) earnings per share attributable to ARC Document Solutions, Inc. shareholders:
 
 
 
 
 
 
 
Basic
$
(0.32
)
 
$
0.06

 
$
(0.20
)
 
$
(1.10
)
Diluted
$
(0.32
)
 
$
0.06

 
$
(0.20
)
 
$
(1.10
)
Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
45,834

 
45,599

 
45,756

 
46,055

Diluted
45,834

 
46,189

 
45,756

 
46,055

The accompanying notes are an integral part of these condensed consolidated financial statements.


5


ARC DOCUMENT SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
(In thousands)
2017
 
2016
 
2017
 
2016
Net (loss) income
$
(14,767
)
 
$
2,902

 
$
(9,299
)
 
$
(50,278
)
Other comprehensive income (loss), net of tax
 
 
 
 
 
 
 
Foreign currency translation adjustments, net of tax
681

 
(250
)
 
1,421

 
(873
)
Fair value adjustment of derivatives, net of tax
55

 
47

 
141

 
(50
)
Other comprehensive income (loss), net of tax
736

 
(203
)
 
1,562

 
(923
)
Comprehensive (loss) income
(14,031
)
 
2,699

 
(7,737
)
 
(51,201
)
Comprehensive income attributable to noncontrolling interest
149

 
36

 
369

 
22

Comprehensive (loss) income attributable to ARC Document Solutions, Inc. shareholders
$
(14,180
)
 
$
2,663

 
$
(8,106
)
 
$
(51,223
)
The accompanying notes are an integral part of these condensed consolidated financial statements.


6


ARC DOCUMENT SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(Unaudited)  

 
ARC Document Solutions, Inc. Shareholders
 
 
 
 
 
Common Stock
 
 
 
 
 
Accumulated
 
 
 
 
 
 
(In thousands, except per share data)
Shares
 
Par
Value
 
Additional Paid-in
Capital
 
Retained Earnings
 
Other Comprehensive
Loss
 
Common Stock in
Treasury
 
Noncontrolling
Interest
 
Total
Balance at December 31, 2015
47,130

 
$
47

 
$
115,089

 
$
89,687

 
$
(2,097
)
 
$
(612
)
 
$
7,020

 
$
209,134

Stock-based compensation
229

 
—

 
2,073

 
—

 
—

 
—

 
—

 
2,073

Issuance of common stock under Employee Stock Purchase Plan
28

 
—

 
96

 
—

 
—

 
—

 
—

 
96

Stock options exercised
28

 
—

 
76

 
—

 
—

 
—

 
—

 
76

Tax deficiency from stock-based compensation


 


 
(70
)
 


 


 


 


 
(70
)
Treasury shares
—

 
—

 
—

 
—

 
—

 
(5,297
)
 
—

 
(5,297
)
Comprehensive loss:
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Net (loss) income
—

 
—

 
—

 
(50,489
)
 
—

 
—

 
211

 
(50,278
)
Foreign currency translation adjustments, net of tax
—

 
—

 
—

 
—

 
(684
)
 
—

 
(189
)
 
(873
)
Fair value adjustment of derivatives, net of tax
—

 
—

 
—

 
—

 
(50
)
 
—

 
—

 
(50
)
Comprehensive loss
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(51,201
)
Balance at September 30, 2016
47,415

 
$
47

 
$
117,264

 
$
39,198

 
$
(2,831
)
 
$
(5,909
)
 
$
7,042

 
$
154,811

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
ARC Document Solutions, Inc. Shareholders
 
 
 
 
 
Common Stock
 
 
 
 
 
Accumulated
 
 
 
 
 
 
(In thousands, except per share data)
Shares
 
Par
Value
 
Additional Paid-in
Capital
 
Retained
Earnings
 
Other Comprehensive
Loss
 
Common Stock in
Treasury
 
Noncontrolling
Interest
 
Total
Balance at December 31, 2016
47,428

 
$
47

 
$
117,749

 
$
41,822

 
$
(3,793
)
 
$
(5,909
)
 
$
6,905

 
$
156,821

Stock-based compensation
403

 
1

 
2,250

 
—

 
—

 
—

 
—

 
2,251

ASU 2016-09 adoption adjustment

—

 
—

 
29

 
213

 
—

 
—

 
—

 
242

Issuance of common stock under Employee Stock Purchase Plan
33

 
—

 
103

 
—

 
—

 
—

 
—

 
103

Stock options exercised
27

 
—

 
73

 
—

 
—

 
—

 
—

 
73

Comprehensive loss:
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Net (loss) income
—

 
—

 
—

 
(9,354
)
 
—

 
—

 
55

 
(9,299
)
Foreign currency translation adjustments, net of tax
—

 
—

 
—

 
—

 
1,107

 
—

 
314

 
1,421

Fair value adjustment of derivatives, net of tax
—

 
—

 
—

 
—

 
141

 
—

 
—

 
141

Comprehensive loss
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(7,737
)
Balance at September 30, 2017
47,891

 
$
48

 
$
120,204

 
$
32,681

 
$
(2,545
)
 
$
(5,909
)
 
$
7,274

 
$
151,753

The accompanying notes are an integral part of these condensed consolidated financial statements.

7


ARC DOCUMENT SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
(In thousands)
2017
 
2016
 
2017
 
2016
Cash flows from operating activities
 
 
 
 
 
 
 
Net (loss) income
$
(14,767
)
 
$
2,902

 
$
(9,299
)
 
$
(50,278
)
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
 
 
 
 
 
 
 
Allowance for accounts receivable
306

 
324

 
867

 
644

Depreciation
7,377

 
6,697

 
21,787

 
20,032

Amortization of intangible assets
1,053

 
1,160

 
3,250

 
3,705

Amortization of deferred financing costs
69

 
111

 
246

 
344

Goodwill impairment
17,637

 
—

 
17,637

 
73,920

Stock-based compensation
699

 
650

 
2,251

 
2,073

Deferred income taxes
(2,380
)
 
2,299

 
1,045

 
(6,018
)
Deferred tax valuation allowance
454

 
(1
)
 
488

 
(16
)
Loss on extinguishment and modification of debt
124

 
66

 
230

 
156

Other non-cash items, net
(205
)
 
(87
)
 
(340
)
 
(540
)
Changes in operating assets and liabilities:
 
 
 
 
 
 
 
Accounts receivable
554

 
(897
)
 
406

 
(2,285
)
Inventory
(142
)
 
(429
)
 
(650
)
 
(3,196
)
Prepaid expenses and other assets
1,029

 
1,179

 
(1,129
)
 
513

Accounts payable and accrued expenses
(482
)
 
(1,811
)
 
(33
)
 
(5,008
)
Net cash provided by operating activities
11,326

 
12,163

 
36,756

 
34,046

Cash flows from investing activities
 
 
 
 
 
 
 
Capital expenditures
(2,335
)
 
(2,430
)
 
(7,246
)
 
(7,580
)
Other
72

 
135

 
466

 
842

Net cash used in investing activities
(2,263
)
 
(2,295
)
 
(6,780
)
 
(6,738
)
Cash flows from financing activities
 
 
 
 
 
 
 
Proceeds from stock option exercises
2

 
46

 
73

 
76

Proceeds from issuance of common stock under Employee Stock Purchase Plan
37

 
26

 
103

 
96

Share repurchases
—

 
(200
)
 
—

 
(5,297
)
Contingent consideration on prior acquisitions
(63
)
 
(86
)
 
(214
)
 
(453
)
Early extinguishment of long-term debt
—

 
(7,000
)
 
(14,150
)
 
(16,000
)
Payments on long-term debt agreements and capital leases
(52,146
)
 
(3,310
)
 
(60,060
)
 
(9,651
)
Borrowings under revolving credit facilities
52,350

 
—

 
54,850

 
—

Payments under revolving credit facilities
(9,375
)
 
—

 
(9,675
)
 
—

Payment of deferred financing costs
(270
)
 
(76
)
 
(270
)
 
(106
)
Net cash used in financing activities
(9,465
)
 
(10,600
)
 
(29,343
)
 
(31,335
)
Effect of foreign currency translation on cash balances
161

 
(80
)
 
491

 
(296
)
Net change in cash and cash equivalents
(241
)
 
(812
)
 
1,124

 
(4,323
)
Cash and cash equivalents at beginning of period
26,604

 
20,452

 
25,239

 
23,963

Cash and cash equivalents at end of period
$
26,363

 
$
19,640

 
$
26,363

 
$
19,640

Supplemental disclosure of cash flow information
 
 
 
 
 
 
 
Noncash investing and financing activities
 
 
 
 
 
 
 
Capital lease obligations incurred
$
6,404

 
$
3,738

 
$
20,714

 
$
12,345

Contingent liabilities in connection with acquisition of businesses
$
—

 
$
—

 
$
27

 
$
85

The accompanying notes are an integral part of these condensed consolidated financial statements.

8


ARC DOCUMENT SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except per share data or where otherwise noted)
(Unaudited)
1. Description of Business and Basis of Presentation
ARC Document Solutions, Inc. (“ARC Document Solutions,” “ARC” or the “Company”) is a leading document solutions provider to architectural, engineering, construction, and facilities management professionals, while also providing document solutions to businesses of all types. ARC offers a variety of services including: Construction Document Information Management ("CDIM"), Managed Print Services ("MPS"), and Archive and Information Management ("AIM"). In addition, ARC also sells Equipment and Supplies. The Company conducts its operations through its wholly-owned operating subsidiary, ARC Document Solutions, LLC, a Texas limited liability company, and its affiliates.
Basis of Presentation
The accompanying interim Condensed Consolidated Financial Statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and in conformity with the requirements of the Securities and Exchange Commission (SEC). As permitted under those rules, certain footnotes or other financial information required by GAAP for complete financial statements have been condensed or omitted. In management’s opinion, the accompanying interim Condensed Consolidated Financial Statements presented reflect all adjustments of a normal and recurring nature that are necessary to fairly present the interim Condensed Consolidated Financial Statements. All material intercompany accounts and transactions have been eliminated in consolidation. The operating results for the three and nine months ended September 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017 .
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the interim Condensed Consolidated Financial Statements and accompanying notes. The Company evaluates its estimates and assumptions on an ongoing basis and relies on historical experience and various other factors that it believes to be reasonable under the circumstances to determine such estimates. Actual results could differ from those estimates, and such differences may be material to the interim Condensed Consolidated Financial Statements.
These interim Condensed Consolidated Financial Statements and accompanying notes should be read in conjunction with the consolidated financial statements and notes included in the Company’s 2016 Form 10-K.
Correction to 2016 Financial Statements
Subsequent to the issuance of the Company's 2016 Consolidated Financial Statements, management identified an immaterial error in the balance sheet presentation of the Company's deferred tax assets and liabilities as of December 31, 2016. In its 2016 Consolidated Financial Statements, the Company presented its deferred taxes on a gross basis; however, such deferred taxes should have been presented on a net basis by taxing jurisdiction in accordance with Accounting Standards Codification (ASC) 740, Income Taxes . As a result of the error, the Company has corrected the deferred tax assets and deferred tax liabilities balances as of December 31, 2016 in the accompanying Condensed Consolidated Balance Sheets. The correction resulted in a decrease to the Company's deferred tax liabilities balance of $30.3 million with a corresponding decrease of the same amount to the Company's deferred tax assets balance as of December 31, 2016. This correction had no impact to the Company's previously reported Consolidated Statements of Operations, Consolidated Statements of Comprehensive Income (Loss), Consolidated Statements of Equity, Consolidated Statements of Cash Flows, or Notes to the Consolidated Financial Statements. The Company has concluded that the error correction was not material to the Consolidated Financial Statements.
Recent Accounting Pronouncements

In January 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2017-04, Intangibles-Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment . The new guidance simplifies subsequent goodwill measurement by eliminating step two from the goodwill impairment test. Accordingly, the Company is required to perform its annual, or interim, goodwill impairment tests by comparing the fair value of a reporting unit with its respective carrying value, and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The new standard is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2019 with early adoption permitted for interim or annual goodwill impairment tests performed after January 1, 2017. The Company elected to early-adopt ASU 2017-04 for its annual goodwill impairment test as of September 30, 2017. See Note 3, “Goodwill and Other Intangibles” for further information regarding the process of assessing goodwill impairment and the results of the Company's 2017 annual goodwill impairment test.

9



In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments. The new guidance addresses diversity in practice for classification of certain transactions in the statement of cash flows including, but not limited to: debt prepayment or debt extinguishment costs, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, and distributions received from equity method investees. ASU 2016-15 is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. Early adoption is permitted. The Company is currently in the process of evaluating the impact of the adoption of ASU 2016-15 on its Condensed Consolidated Financial Statements.

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. The new guidance requires excess tax benefits and tax deficiencies to be recorded in the statement of operations when share-based awards vest or are settled. In addition, cash flows related to excess tax benefits will no longer be separately classified as a financing activity apart from other income tax cash flows. The standard also allows the Company to repurchase more of an employee’s shares for tax withholding purposes without triggering liability accounting, clarifies that all cash payments made on an employee’s behalf for withheld shares should be presented as a financing activity on the Company's statement of cash flows, and provides an accounting policy election to account for forfeitures as they occur. The Company adopted ASU 2016-09 on January 1, 2017, which resulted in a cumulative adjustment to equity of $0.2 million . In conjunction with the adoption of ASU 2016-09, the Company elected to account for forfeitures of share-based awards when they occur.

In February 2016, the FASB issued Accounting Standards Codification (“ASC”) 842 (“ASC 842”), Leases. ASC 842 requires a dual approach for lessee accounting under which a lessee would account for leases as finance leases or operating leases. Both finance leases and operating leases will result in the lessee recognizing a right-of-use (ROU) asset and a corresponding lease liability. For finance leases the lessee would recognize interest expense and amortization of the ROU asset and for operating leases the lessee would recognize a straight-line total lease expense. ASC 842 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption is permitted. While the Company is continuing to assess the potential impacts that ASC 842 will have on its condensed consolidated financial statements, the Company believes that the most significant impact relates to its accounting for facility leases related to its service centers and office space, which are currently classified as operating leases. The resulting impact of the adoption of ASC 842 will be an increase to assets and a corresponding increase to liabilities for the same amount on the Company's consolidated balance sheet. The Company expects the accounting for capital leases related to its machinery and equipment will remain substantially unchanged under the new standard.
In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory. The new guidance requires that inventory be measured at the lower of cost or net realizable value and amends existing guidance which requires inventory be measured at the lower of cost or market. Replacing the concept of market with the single measurement of net realizable value is intended to create efficiencies for financial statement preparers. ASU 2015-11 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. The Company adopted ASU 2015-11 on January 1, 2017. The adoption of ASU 2015-11 did not have a material impact on its Condensed Consolidated Financial Statements.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) . The new guidance requires entities to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received in exchange for those goods or services. In addition, ASU 2014-09 provides guidance on the recognition of costs related to obtaining and fulfilling customer contracts. The new guidance is effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period.
T he Company will adopt the new standard on January 1, 2018 under the modified retrospective method and expects the cumulative effect adjustment in retained earnings as of adoption date to be minimal. While the Company is continuing to finalize its ASU 2014-09 assessment and the resulting impact the adoption will have on its consolidated financial statements, the Company does not expect the adoption will have a material impact to its consolidated financial statements.
The Company has performed an analysis of each of its service revenue categories (CDIM, MPS and AIM) to identify any differences in the recognition, measurement, or presentation of revenue recognition and related costs. In addition, the Company is analyzing its product revenue category (equipment and supplies sales). Based on its preliminary analyses, the Company expects the pattern of revenue recognition and the costs to acquire customer contracts to remain consistent with the Company's current revenue recognition policy. The Company is also analyzing detailed disclosure requirements as well as any changes to the Company’s systems and internal controls to support adoption of the new standard.
Segment Reporting
The provisions of ASC 280, Segment Reporting , require public companies to report financial and descriptive information about their reportable operating segments. The Company identifies operating segments based on the various business activities that earn

10


revenue and incur expense and whose operating results are reviewed by the Company's Chief Executive Officer, who is the Company's chief operating decision maker. Because its operating segments have similar products and services, classes of customers, production processes, distribution methods and economic characteristics, the Company operates as a single reportable segment.
Net sales of the Company’s principal services and products were as follows:
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2017
 
2016
 
2017
 
2016
Service Sales
 
 
 
 
 
 
 
CDIM
$
50,089

 
$
53,228

 
$
155,031

 
$
161,753

MPS
32,153

 
32,796

 
97,697

 
100,082

AIM
3,383

 
3,154

 
9,731

 
10,559

Total service sales
85,625

 
89,178

 
262,459

 
272,394

Equipment and supplies sales
10,833

 
11,265

 
35,010

 
35,369

Total net sales
$
96,458

 
$
100,443

 
$
297,469

 
$
307,763

Risk and Uncertainties
The Company generates the majority of its revenue from sales of services and products to customers in the architectural, engineering, construction and building owner/operator (AEC/O) industry. As a result, the Company’s operating results and financial condition can be significantly affected by economic factors that influence the AEC/O industry, such as non-residential construction spending, GDP growth, interest rates, unemployment rates, and office vacancy rates. Reduced activity (relative to historic levels) in the AEC/O industry would diminish demand for some of ARC’s services and products, and would therefore negatively affect revenues and have a material adverse effect on its business, operating results and financial condition.
As part of the Company’s growth strategy, ARC intends to continue to offer and grow a variety of service offerings, some of which are relatively new to the Company. The success of the Company’s efforts will be affected by its ability to acquire new customers for the Company’s new service offerings, as well as to sell the new service offerings to existing customers. The Company’s inability to successfully market and execute these relatively new service offerings could significantly affect its business and reduce its long term revenue, resulting in an adverse effect on its results of operations and financial condition.
2. Earnings per Share
The Company accounts for earnings per share in accordance with ASC 260, Earnings Per Share. Basic earnings per share is computed by dividing net income attributable to ARC by the weighted-average number of common shares outstanding for the period. Diluted earnings per common share is computed similarly to basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if common shares subject to outstanding options and acquisition rights had been issued and if the additional common shares were dilutive. Common share equivalents are excluded from the computation if their effect is anti-dilutive. For the three and nine months ended September 30, 2017 , 5.3 million common shares were excluded from the calculation of diluted net income attributable to ARC per common share, because they were anti-dilutive. For the three and nine months ended September 30, 2016 , 3.0 million and 4.4 million common shares were excluded from the calculation of diluted net loss attributable to ARC per common share, respectively, because they were anti-dilutive. The Company's common share equivalents consist of stock options issued under the Company's stock plan.
Basic and diluted weighted average common shares outstanding were calculated as follows for the three and nine months ended September 30, 2017 and 2016 :
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2017
 
2016
 
2017
 
2016
Weighted average common shares outstanding during the period—basic
45,834

 
45,599

 
45,756

 
46,055

Effect of dilutive stock options
—

 
590

 
—

 
—

Weighted average common shares outstanding during the period—diluted
45,834

 
46,189

 
45,756

 
46,055



11


Stock Repurchase Program
On February 8, 2016, the Company announced that the Company's Board of Directors had approved a stock repurchase program that authorizes the Company to purchase up to $15.0 million of the Company's outstanding common stock through December 31, 2017. Under the repurchase program, purchases of shares of common stock may be made from time to time in the open market, or in privately negotiated transactions, in compliance with applicable state and federal securities laws. The stock repurchase program does not obligate the company to acquire any specific number of shares in any period, and may be expanded, extended, modified or discontinued at any time without prior notice. See Part II, Item 2., “Unregistered Sales of Equity Securities and Use of Proceeds” of this report for additional information on the stock repurchase program.
3. Goodwill and Other Intangibles
Goodwill
In connection with acquisitions, the Company applies the provisions of ASC 805, Business Combinations , using the acquisition method of accounting. The excess purchase price over the fair value of net tangible assets and identifiable intangible assets acquired is recorded as goodwill.
In accordance with ASC 350, Intangibles - Goodwill and Other , the Company assesses goodwill for impairment annually as of September 30, and more frequently if events and circumstances indicate that goodwill might be impaired.
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.
Traditionally, goodwill impairment testing is a two-step process. Step one involves comparing the fair value of the reporting units to its carrying amount. If the carrying amount of a reporting unit is greater than zero and its fair value is greater than its carrying amount, there is no impairment. If the reporting unit’s carrying amount is greater than the fair value, the second step must be completed to measure the amount of impairment, if any. Step two involves calculating an implied fair value of goodwill.
For its annual goodwill impairment test as of September 30, 2017, the Company elected to early-adopt ASU 2017-04 which simplifies subsequent goodwill measurement by eliminating step two from the goodwill impairment test. As a result, the Company compared the fair value of a reporting unit with its respective carrying value, and recognized an impairment charge for the amount by which the carrying amount exceeded the reporting unit’s fair value.
The Company determines the fair value of its reporting units using an income approach. Under the income approach, the Company determined fair value based on estimated discounted future cash flows of each reporting unit. Determining the fair value of a reporting unit is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates and EBITDA margins, discount rates and future market conditions, among others.
At September 30, 2017, the Company's goodwill impairment analysis showed one reporting unit with goodwill attributed to it had a carrying amount which exceeded its fair value. The underperformance of the Company relative to its forecast in the third quarter of 2017, and more specifically, the underperformance against forecast of one of the Company's reporting units which previously had goodwill impairment in 2016 drove the decline in the fair value of the reporting unit. As a result, the Company recorded a pretax, non-cash charge for the three and nine months ended September 30, 2017 to reduce the carrying value of goodwill by $17.6 million .
At June 30, 2016, the Company determined that there were sufficient indicators to trigger an interim goodwill impairment analysis. The indicators included, among other factors: (1) the underperformance against plan of the Company's reporting units, (2) a revision of the Company's forecasted future earnings, and (3) a decline in the Company's market capitalization in 2016. The Company's interim goodwill impairment analysis as of June 30, 2016 indicated that five of its eight reporting units, four in the United States and one in Canada, failed step one of the impairment analysis. Accordingly, the Company recorded a pretax, non-cash charge for the three and six months ended June 30, 2016 to reduce the carrying value of goodwill by $73.9 million .
Given the changing document and printing needs of the Company’s customers, and the uncertainties regarding the effect on the Company’s business, there can be no assurance that the estimates and assumptions made for purposes of the Company’s goodwill impairment test in 2017 will prove to be accurate predictions of the future. If the Company’s assumptions, including forecasted EBITDA of certain reporting units, are not achieved, the Company may be required to record additional goodwill impairment charges in future periods, whether in connection with the Company’s next annual impairment testing in the third quarter of 2018, or on an interim basis, if any such change constitutes a triggering event (as defined under ASC 350, Intangibles-Goodwill and

12


Other ) outside of the quarter when the Company regularly performs its annual goodwill impairment test. It is not possible at this time to determine if any such future impairment charge would result or, if it does, whether such charge would be material.
The changes in the carrying amount of goodwill from January 1, 2016 through September 30, 2017 are summarized as follows:
 
 
Gross
Goodwill
 
Accumulated
Impairment
Loss
 
Net
Carrying
Amount
 
 
 
 
 
 
January 1, 2016
$
405,558

 
$
192,950

 
$
212,608

Additions
—

 
—

 
—

Goodwill impairment
—

 
73,920

 
(73,920
)
December 31, 2016
405,558

 
266,870

 
138,688

Additions
—

 
—

 
—

Goodwill impairment
—

 
17,637

 
(17,637
)
September 30, 2017
$
405,558

 
$
284,507

 
$
121,051

See “Critical Accounting Policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations for further information regarding the process and assumptions used in the goodwill impairment analysis.
Long-lived and Other Intangible Assets
The Company periodically assesses potential impairments of its long-lived assets in accordance with the provisions of ASC 360, Accounting for the Impairment or Disposal of Long-lived Assets . An impairment review is performed whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. The Company groups its assets at the lowest level for which identifiable cash flows are largely independent of the cash flows of the other assets and liabilities. The Company has determined that the lowest level for which identifiable cash flows are available is the regional level, which is the operating segment level.
Factors considered by the Company include, but are not limited to, significant underperformance relative to historical or projected operating results; significant changes in the manner of use of the acquired assets or the strategy for the overall business; and significant negative industry or economic trends. When the carrying value of a long-lived asset may not be recoverable based upon the existence of one or more of the above indicators of impairment, the Company estimates the future undiscounted cash flows expected to result from the use of the asset and its eventual disposition. If the sum of the expected future undiscounted cash flows and eventual disposition is less than the carrying amount of the asset, the Company recognizes an impairment loss. An impairment loss is reflected as the amount by which the carrying amount of the asset exceeds the fair value of the asset, based on the fair value if available, or discounted cash flows, if fair value is not available. The Company assessed potential impairments of its long lived assets as of September 30, 2017 and concluded that there was no impairment.
Other intangible assets that have finite lives are amortized over their useful lives. Customer relationships are amortized using the accelerated method, based on customer attrition rates, over their estimated useful lives of 13 (weighted average) years.
The following table sets forth the Company’s other intangible assets resulting from business acquisitions as of September 30, 2017 and December 31, 2016 which continue to be amortized:
 
 
September 30, 2017
 
December 31, 2016
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Amortizable other intangible assets
 
 
 
 
 
 
 
 
 
 
 
Customer relationships
$
99,484

 
$
89,789

 
$
9,695

 
$
99,104

 
$
86,305

 
$
12,799

Trade names and trademarks
20,283

 
19,891

 
392

 
20,281

 
19,878

 
403

 
$
119,767

 
$
109,680

 
$
10,087

 
$
119,385

 
$
106,183

 
$
13,202

Estimated future amortization expense of other intangible assets for the remainder of the 2017 fiscal year, each of the subsequent four fiscal years and thereafter are as follows:
 

13


2017 (excluding the nine months ended September 30, 2017)
$
1,027

2018
3,875

2019
3,151

2020
1,539

2021
178

Thereafter
317

 
$
10,087

4. Income Taxes
On a quarterly basis, the Company estimates its effective tax rate for the full fiscal year and records a quarterly income tax provision based on the anticipated annual effective rate and the recognition of any discrete items within the quarter.
The Company recorded an income tax benefit of $2.2 million and an income tax provision of $1.6 million in relation to pretax losses of $16.9 million and $7.7 million for the three and nine months ended September 30, 2017 , respectively, which resulted in an effective income tax rate of 12.8% and (20.4)% , for the three and nine months ended September 30, 2017 , respectively. The Company recorded an income tax provision of $2.2 million in relation to pretax income of $5.1 million for the three months ended September 30, 2016, and an income tax benefit of $5.9 million in relation to pretax losses of $56.2 million for the nine months ended September 30, 2016 , which resulted in an effective income tax rate of 15.2% and 13.1% , for the three and nine months ended September 30, 2016 , respectively. The Company's low effective income tax rate was primarily due to the portion of its goodwill impairments related to historical stock acquisitions which cannot be deducted for income tax purposes until the related stock is disposed of ( $10.0 million and $41.4 million recognized in 2017 and 2016, respectively).

In accordance with ASC 740-10, Income Taxes , the Company evaluates the need for deferred tax asset valuation allowances based on a more likely than not standard. The ability to realize deferred tax assets depends on the ability to generate sufficient taxable income within the carryback or carryforward periods provided for in the tax law for each applicable tax jurisdiction. The Company considers the following possible sources of taxable income when assessing the realization of deferred tax assets:

•
Future reversals of existing taxable temporary differences;
•
Future taxable income exclusive of reversing temporary differences and carryforwards;
•
Taxable income in prior carryback years; and
•
Tax-planning strategies.

The assessment regarding whether a valuation allowance is required or should be adjusted also considers all available positive and negative evidence factors, including but not limited to:

•
Nature, frequency, and severity of recent losses;
•
Duration of statutory carryforward periods;
•
Historical experience with tax attributes expiring unused; and
•
Near- and medium-term financial outlook.

The Company utilizes a rolling three years of actual and current year anticipated results as the primary measure of cumulative income/losses in recent years, as adjusted for permanent differences. The evaluation of deferred tax assets requires judgment in assessing the likely future tax consequences of events that have been recognized in the Company's financial statements or tax returns and future profitability. The Company's accounting for deferred tax consequences represents its best estimate of those future events. Changes in the Company's current estimates, due to unanticipated events or otherwise, could have a material effect on its financial condition and results of operations. The Company has a $1.8 million valuation allowance against certain deferred tax assets as of September 30, 2017 .

Based on the Company’s current assessment, the remaining net deferred tax assets as of September 30, 2017 are considered more likely than not to be realized. The valuation allowance of $1.8 million may be increased or reduced as conditions change or if the Company is unable to implement certain available tax planning strategies. The realization of the Company’s net deferred tax assets ultimately depend on future taxable income, reversals of existing taxable temporary differences or through a loss carry back. The Company has income tax receivables of $0.2 million as of September 30, 2017 included in prepaid expenses in its Condensed Consolidated Balance Sheet primarily related to income tax refunds for prior years.


14


5. Long-Term Debt
Long-term debt consists of the following:
 
 
 
September 30, 2017
 
December 31, 2016
Term A loan facility maturing 2022 net of deferred financing fees of $811  and $1,039; 3.07%   and 2.86% interest rate at September 30, 2017 and December 31, 2016
 
$
58,064

 
$
119,961

Borrowings from revolving loan facility under the Term A Credit Agreement; 3.23%  and 2.64% interest rate at September 30, 2017 and December 31, 2016
 
46,125

 
950

Various capital leases; weighted average interest rate of 4.6%   and 5.6% at September 30, 2017 and December 31, 2016; principal and interest payable monthly through September 2022
 
44,975

 
36,231

Various other notes payable with a weighted average interest rate of 10.8%  and 10.7% at September 30, 2017 and December 31, 2016; principal and interest payable monthly through November 2019
 
21

 
31

 
 
149,185

 
157,173

Less current portion
 
(20,268
)
 
(13,773
)
 
 
$
128,917

 
$
143,400



Amended Term A Loan Facility
On July 14, 2017, the Company amended its Credit Agreement (the “Term A Credit Agreement”) which was originally entered into on November 20, 2014 with Wells Fargo Bank, National Association, as administrative agent and the lenders party thereto.
The original Term A Credit Agreement provided for the extension of term loans (“Term Loans”) in an aggregate principal amount of $175.0 million , the entirety of which was disbursed on the Closing Date in order to pay outstanding obligations under the Company’s then effective Term Loan Credit Agreement. The original Credit Agreement also provided for the extension of revolving loans (“Revolving Loans”) in an aggregate principal amount not to exceed $30.0 million . The amendment increases the maximum aggregate principal amount of Revolving Loans under the agreement from $30 million to $80 million and resizes the outstanding principal amount of the Term Loan under the agreement at $60 million . Upon the execution of the amendment to the Term A Credit Agreement, the total principal amount outstanding under the agreement remained unchanged at $110.0 million . As amended, the principal of the resized Term Loan balance will amortize at an annual rate of 7.5% during the first and second years following the date of the amendment and at an annual rate of 10% during the third, fourth and fifth years following the date of the amendment, with any remaining balance payable upon the maturity date. The amendment also extended the maturity date for both the Revolving Loans and the Term Loans until July 14, 2022.
As of September 30, 2017 , the Company's borrowing availability under the amended Term A Credit Agreement was $32.1 million , which was the maximum borrowing limit of $80.0 million reduced by outstanding letters of credit of $1.8 million and revolver credit facility balance of $46.1 million .

Loans borrowed under the amended Term A Credit Agreement bear interest, in the case of LIBOR rate loans, at a per annum rate equal to the applicable LIBOR rate, plus a margin ranging from 1.25% to 2.25% , based on the Company’s Total Leverage Ratio (as defined in the amended Term A Credit Agreement). Loans borrowed under the amended Term A Credit Agreement that are not LIBOR rate loans bear interest at a per annum rate equal to (i) the greatest of (A) the Federal Funds Rate plus 0.50% , (B) the one month LIBOR rate plus 1.00% , per annum, and (C) the rate of interest announced, from time to time, by Wells Fargo Bank, National Association as its “prime rate,” plus (ii) a margin ranging from 0.25% to 1.25% , based on the Company’s Total Leverage Ratio. The amendment reduced the rate of interest payable on the loans borrowed under the amended Term A Credit Agreement by 0.25% .

The Company pays certain recurring fees with respect to the credit facility, including administration fees to the administrative agent.

Subject to certain exceptions, including in certain circumstances, reinvestment rights, the loans extended under the amended Term A 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

15


of the amended Term A Credit Agreement); the net proceeds from certain issuances of equity securities; and net proceeds of certain insurance recoveries and condemnation events of the Company.

The amended Term A Credit Agreement contains customary representations and warranties, subject to limitations and exceptions, and customary covenants restricting the ability (subject to various exceptions) of the Company and its subsidiaries to: incur additional indebtedness (including guarantee obligations); incur liens; sell certain property or assets; engage in mergers or other fundamental changes; consummate acquisitions; make investments; pay dividends, other distributions or repurchase equity interest of the Company or its subsidiaries; change the nature of their business; prepay or amend certain indebtedness; engage in certain transactions with affiliates; amend their organizational documents; or enter into certain restrictive agreements. In addition, the amended Term A Credit Agreement contains financial covenants which requires the Company to maintain (i) at all times, a Total Leverage Ratio in an amount not to exceed 3.25 to 1.00; and (ii) a Fixed Charge Coverage Ratio (as defined in the amended Term A Credit Agreement), as of the last day of each fiscal quarter, an amount not less than 1.15 to 1.00.

The amended Term A Credit Agreement contains customary events of default, including with respect to: nonpayment of principal, interest, fees or other amounts; failure to perform or observe covenants; material inaccuracy of a representation or warranty when made; cross-default to other material indebtedness; bankruptcy, insolvency and dissolution events; inability to pay debts; monetary judgment defaults; actual or asserted invalidity or impairment of any definitive loan documentation, repudiation of guaranties or subordination terms; certain ERISA related events; or a change of control.

The obligations of the Company’s subsidiary that is the borrower under the amended Term A Credit Agreement are guaranteed by the Company and each other United States domestic subsidiary of the Company. The amended Term A Credit Agreement and any interest rate protection and other hedging arrangements provided by any lender party to the Credit Facility or any affiliate of such a lender are secured on a first priority basis by a perfected security interest in substantially all of the borrower’s, the Company’s and each guarantor’s assets (subject to certain exceptions).
Prior to entering into the amended Term A Credit Agreement, the Company had paid $68.2 million in aggregate principal on its original $175.0 million Term Loan Credit Agreement. Principal payments on the Term Loan Credit Agreement of $14.2 million in 2017 resulted in a loss on extinguishment and modification of debt of $0.1 million and $0.2 million for the three and nine months ended September 30, 2017 .

6. Commitments and Contingencies
Operating Leases. The Company leases machinery, equipment, and office and operational facilities under non-cancelable operating lease agreements used in the ordinary course of business.

Legal Proceedings. We are involved in various legal proceedings and other legal matters from time to time in the normal course of business. We do not believe that the outcome of any of these matters will have a material effect on our consolidated financial position, results of operations or cash flows.
7. Stock-Based Compensation
At the Company's annual meeting of stockholders held on May 1, 2014, the Company's stockholders approved the Company's 2014 Stock Plan (the “2014 Stock Plan”) as adopted by the Company's board of directors. The 2014 Stock Plan replaces the American Reprographics Company 2005 Stock Plan (the "2005 Plan"). The 2014 Stock Plan provides for the grant of incentive and non-statutory stock options, stock appreciation rights, restricted stock, restricted stock units, stock bonuses and other forms of awards granted or denominated in the Company's common stock or units of the Company's common stock, as well as cash bonus awards to employees, directors and consultants of the Company. The 2014 Stock Plan authorizes the Company to issue up to 3.5 million shares of common stock. As of September 30, 2017 , 0.7 million shares remain available for issuance under the Stock Plan.
Stock options granted under the 2014 Stock Plan generally expire no later than ten years from the date of grant. Options generally vest and become fully exercisable over a period of three to four years from date of award, except that options granted to non-employee directors may vest over a shorter time period. The exercise price of options must be equal to at least 100% of the fair market value of the Company’s common stock on the date of grant. The Company allows for cashless exercises of vested outstanding options.
During the nine months ended September 30, 2017 , the Company granted options to acquire a total of 0.5 million shares of the Company's common stock to certain key employees with an exercise price equal to the fair market value of the Company’s common

16


stock on the date of grant. During the nine months ended September 30, 2017 , the Company granted 0.4 million shares of restricted stock to certain key employees at a price per share equal to the closing price of the Company's common stock on the date the restricted stock was granted. The granted stock options and restricted stock vest annually over a period of three to four years from the grant date.
Stock-based compensation was $0.7 million for the three months ended September 30, 2017 and 2016 . Stock-based compensation was $2.3 million and $2.1 million for the nine months ended September 30, 2017 and 2016 , respectively.
As of September 30, 2017 , total unrecognized compensation cost related to unvested stock-based payments totaled $3.7 million and is expected to be recognized over a weighted-average period of approximately 1.9 years.
8. Derivatives and Hedging Transactions

The Company uses derivative financial instruments to hedge its exposure to interest rate volatility related to its Term A Loan Facility. The Company does not use derivative financial instruments for speculative or trading purposes. Such derivatives are designated as cash flow hedges and accounted for under ASC 815, Derivatives and Hedging . Derivative instruments are recorded at fair value as either assets or liabilities in the interim condensed consolidated balance sheets. Changes in fair value of cash flow hedges that are designated as effective hedging instruments are deferred in equity as a component of accumulated other comprehensive loss ("AOCL"). Any ineffectiveness in such cash flow hedges is immediately recognized in earnings. Changes in the fair value of hedges that are not designated as effective hedging instruments are immediately recognized in earnings. Cash flows from the Company’s derivative instruments are classified in the condensed consolidated statements of cash flows in the same category as the items being hedged.

In January 2015, the Company entered into three one -year interest rate cap contracts to hedge against its exposure to interest rate volatility: (1) $80.0 million notional interest rate cap effective in 2015, (2) $65.0 million notional forward interest rate cap effective in 2016, and (3) $50.0 million notional forward interest rate cap effective in 2017. Over the next twelve months, the Company expects to reclassify $0.1 million from AOCL to interest expense.

The following table summarizes the fair value and classification on the Condensed Consolidated Balance Sheets of the Company's derivatives as of September 30, 2017 and December 31, 2016 :
 
 
 
Fair Value
 
Balance Sheet Classification
 
September 30, 2017
 
December 31, 2016
Derivative designated as hedging instrument under ASC 815
 
 
 
 
 
Interest rate cap contracts - current portion
Other current assets
 
$
10

 
$
39

Interest rate cap contracts - long-term portion
Other assets
 
—

 
—

Total derivatives designated as hedging instruments
 
 
$
10

 
$
39



The following table summarizes the income (loss) recognized in AOCL of derivatives, designated and qualifying as cash flow hedges for the three and nine months ended September 30, 2017 and 2016 :

 
 
Amount of Income (Loss) Recognized in AOCL on Derivatives
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2017
 
2016
 
2017
 
2016
Derivative in ASC 815 Cash Flow Hedging Relationship
 
 
 
 
 
 
 
 
Interest rate cap contracts, net of tax
 
$
55

 
$
47

 
$
141

 
$
(50
)

The following table summarizes the effect of the interest rate cap on the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2017 and 2016 :


17


 
 
Amount of Loss Reclassified from AOCL into Income
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
 
2017

2016
 
2017
 
2016
 
 
Effective Portion
 
Ineffective Portion
 
Effective Portion
 
Ineffective Portion
 
Effective Portion
 
Ineffective Portion
 
Effective Portion
 
Ineffective Portion
Location of Loss Reclassified from AOCL into Income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense
 
$
103

 
$
—

 
$
68

 
$
—

 
$
261

 
$
—

 
$
132

 
$
—


9. Fair Value Measurements
In accordance with ASC 820, Fair Value Measurement , the Company has categorized its assets and liabilities that are measured at fair value into a three-level fair value hierarchy as set forth below. If the inputs used to measure fair value fall within different levels of the hierarchy, the categorization is based on the lowest level input that is significant to the fair value measurement. The three levels of the hierarchy are defined as follows:
Level 1-inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2-inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3-inputs to the valuation methodology are unobservable and significant to the fair value measurement.

The following table summarizes the bases used to measure certain assets and liabilities at fair value on a nonrecurring basis as of and for the nine months ended September 30, 2017 and 2016:

 
Significant Other Unobservable Inputs
 
September 30, 2017
 
September 30, 2016
 
Level 3
 
Total Losses
 
Level 3
 
Total Losses
Nonrecurring Fair Value Measure
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Goodwill
$
121,051

 
$
17,637

 
$
138,688

 
$
73,920

 
 
 
 
 
 
 
 
In accordance with ASC 350, goodwill was written down to its implied fair value of $121.1 million as of September 30, 2017 and $138.7 million as of June 30, 2016, resulting in impairment charges of $17.6 million during the three and nine months ended September 30, 2017 and $73.9 million during the nine months ended September 30, 2016 . See Note 3, “Goodwill and Other Intangibles” for further information regarding the process of determining the implied fair value of goodwill and change in goodwill.

The following table summarizes the bases used to measure certain assets and liabilities at fair value on a recurring basis as of and for the nine months ended September 30, 2017 and as of and for the year ended December 31 2016 :

 
 
 
Significant Other Unobservable Inputs
 
 
 
September 30, 2017
 
December 31, 2016
 
 
 
Level 2
 
Level 3
 
Total Losses
 
Level 2
 
Level 3
 
Total Losses
Recurring Fair Value Measure
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate cap contracts
 
$
10

 
$
—

 
$
—

 
$
39

 
$
—

 
$
—

 
Contingent purchase price consideration for acquired businesses
 
$
—

 
$
258

 
$
—

 
$
—

 
$
402

 
$
—


The Company determines the fair value of its interest rate cap contracts based on observable interest rate yield curves and represent the expected discounted cash flows underlying the financial instruments.

18


The Company recognizes liabilities for future earnout obligations on business acquisitions, or contingent purchase price consideration for acquired businesses, at their fair value based on discounted projected payments on such obligations. The inputs to the valuation, which are level 3 inputs within the fair value hierarchy, are projected sales to be provided by the acquired businesses based on historical sales trends for which earnout amounts are contractually based. Based on the Company's assessment as of September 30, 2017 , the estimated contractually required earnout amounts would be achieved.
The following table presents the change in the Level 3 contingent purchase price consideration liability for the three and nine months ended September 30, 2017 and 2016 :
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2017
 
2016
 
2017
 
2016
Beginning balance
$
318

 
$
604

 
$
402

 
$
1,059

     Additions related to acquisitions
—

 
—

 
34

 
104

     Payments
(70
)
 
(86
)
 
(221
)
 
(453
)
     Adjustments included in earnings
3

 
15

 
26

 
(180
)
     Foreign currency translation adjustments
7

 
8

 
17

 
11

Ending balance
$
258

 
$
541

 
$
258

 
$
541

Fair Values of Financial Instruments. The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments for disclosure purposes:
Cash equivalents: Cash equivalents are time deposits with maturity of three months or less when purchased, which are highly liquid and readily convertible to cash. Cash equivalents reported in the Company’s Condensed Consolidated Balance Sheet were $6.4 million and $3.9 million as of September 30, 2017 and December 31, 2016 , respectively, and are carried at cost and approximate fair value due to the relatively short period to maturity of these instruments.
Short and long-term debt: The carrying amount of the Company’s capital leases reported in the Condensed Consolidated Balance Sheets approximates fair value based on the Company’s current incremental borrowing rate for similar types of borrowing arrangements. The carrying amount reported in the Company’s Condensed Consolidated Balance Sheet as of September 30, 2017 for borrowings under its Term Loan Credit Agreement is $105.0 million , excluding unamortized deferred financing fees. The Company has determined, utilizing observable market quotes, that the fair value of borrowings under its Term Loan Credit Agreement is $105.0 million as of September 30, 2017 .


19


Item 2 . Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our interim Condensed Consolidated Financial Statements and the related notes and other financial information appearing elsewhere in this report as well as Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our 2016 Form 10-K and this Quarterly Report on Form 10-Q for the quarter ended September 30, 2017 .
Business Summary
ARC Document Solutions, Inc. (“ARC Document Solutions,” “ARC,” “we,” “us,” or “our”) is a leading document solutions provider to design, engineering , construction, and facilities management professionals, while also providing document solutions to businesses of all types.
Our customers need us to manage the scale, complexity and workflow of their documents. We help them reduce their costs and increase their efficiency by improving their access and control over documents, and we offer a wide variety of ways to access, distribute, collaborate on, and store documents.
Each of our service offerings is enabled through a suite of supporting proprietary technology and a wide variety of value-added services. We have categorized our service and product offerings to report distinct sales recognized from:

Construction Document and Information Management (CDIM), which consists of software services and professional services to manage and distribute documents and information primarily related to construction projects. CDIM sales include software services such as SKYSITE®, our cloud-based project communication application, as well as providing document and information management services that are often technology-enabled. The bulk of our current revenue from CDIM comes from large-format and small-format printing services we provide in both black and white and in color. Sales from traditional printing have been in steady decline since the last recession due in large measure to the adoption of technology, but we believe there is market share still to be captured.
Software services are a smaller part of overall CDIM sales which we anticipate to continue to grow with the adoption of technology. The sale of services addresses a variety of customer needs including the provision of project communication tools, project information management, building information modeling, digital document distribution services, printing services, and others.
Managed Print Services (MPS), consists of placement, management, and optimization of print and imaging equipment in our customers' offices, job sites, and other facilities. MPS relieves our customers of the burden of owning and managing print devices and print networks, and shifts their costs to a “per-use” basis. MPS is supported by our proprietary technology, Abacus™, which allows our customers to capture, control, manage, print, and account for their documents. MPS Services revenue is derived from two sources: 1) an engagement with the customer to place primarily large-format equipment, that we own or lease, at a construction site or in our customers’ offices, and 2) an arrangement by which our customers outsource their printing function to us, including all office printing, copying, and reprographics printing. In both cases this is recurring, contracted revenue with most contracts ranging from 3 to 5 years and we are paid a single cost per unit of material used, often referred to as a “click charge.” MPS sales are driven by the ongoing print needs of our customers at their facilities.
Archiving and Information Management (AIM), combines software and professional services to facilitate the capture, management, access and retrieval of documents and information that have been produced in the past. AIM includes our SKYSITE software to organize, search and retrieve documents, as well as the provision of services that include the capture and conversion of hardcopy and electronic documents, and their cloud-based storage and maintenance. AIM sales are driven by the need to leverage past intellectual 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.
Equipment and Supplies, which consists of reselling printing, imaging, and related equipment to customers primarily to architectural, engineering and construction firms.
We focus on growing MPS, AIM and CDIM, as we believe the mix of services demanded by the architectural, engineering, construction, and building owner/operator (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.
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.

20


Acquisition activity during the last three years has been minimal and did not materially affect our overall business.
We believe we offer a distinct portfolio of services within the AEC/O industry, though clients outside of our core market continue to show significant interest in our offerings. Based on our analysis of our operating results, we estimate that sales to the AEC/O industry accounted for approximately 78% of our net sales for the nine months ended September 30, 2017 , with the remaining 22% consisting of sales to businesses outside of construction.
We identify operating segments based on the various business activities that earn revenue and incur expense. Our operating results are reviewed by the Company's Chief Executive Officer, who is our Company's chief operating decision maker. Since our operating segments have similar products and services, classes of customers, production processes, distribution methods and economic characteristics, we have a single reportable segment. See Note 1 “Description of Business and Basis of Presentation” for further information.
Costs and Expenses
Our cost of sales consists primarily of materials (paper, toner and other consumables), labor, and “indirect costs” which consist primarily of equipment expenses related to our MPS contracts and our service center facilities. Facilities and equipment expenses include maintenance, repairs, rents, insurance, and depreciation. Paper is the largest component of our material cost; however, paper pricing typically does not significantly affect our operating margins due, in part, to our efforts to pass increased costs on to our customers. We closely monitor material cost as a percentage of net sales to measure volume and waste. We also track labor utilization, or net sales per employee, to measure productivity and determine staffing levels.
We maintain low levels of inventory. Historically, our capital expenditure requirements have varied due to the cost and availability of capital lease lines of credit. Our relationships with credit providers has provided attractive lease rates over the past two 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 Fremont, California and Kolkata, India. Such costs are primarily recorded to cost of sales.
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 in the United States of America (“GAAP”). These measures are not measurements of our financial performance under GAAP and should not be considered as alternatives to net income, income from operations, or any other performance measures derived in accordance with GAAP or as an alternative to cash flows from operating, investing or financing activities as a measure of our liquidity.
EBITDA represents net income before interest, taxes, depreciation and amortization. EBITDA margin is a non-GAAP measure calculated by dividing EBITDA by net sales.
We have presented EBITDA and related ratios because we consider them important supplemental measures of our performance and liquidity. We believe investors may also find these measures meaningful, given how our management makes use of them. The following is a discussion of our use of these measures.
We use EBITDA to measure and compare the performance of our operating segments. Our operating segments’ financial performance includes all of the operating activities except debt and taxation which are managed at the corporate level for U.S. operating segments. We use EBITDA to compare the performance of our operating segments and to measure performance for determining consolidated-level compensation. In addition, we use EBITDA to evaluate potential acquisitions and potential capital expenditures.
EBITDA and related ratios have limitations as analytical tools, and should not be considered in isolation, or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are as follows:
•
They do not reflect our cash expenditures, or future requirements for capital expenditures and contractual commitments;
•
They do not reflect changes in, or cash requirements for, our working capital needs;
•
They do not reflect the significant interest expense, or the cash requirements necessary, to service interest or principal payments on our debt;

21


•
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 nine months ended September 30, 2017 and 2016 to reflect the exclusion of loss on extinguishment and modification of debt, goodwill impairment, restructuring 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 the three and nine months ended September 30, 2017 and 2016 . We believe these charges were the result of our capital restructuring, or other items which are not indicative of our actual operating performance.
We have presented adjusted EBITDA for the three and nine months ended September 30, 2017 and 2016 to exclude loss on extinguishment and modification of debt, goodwill impairment, restructuring expense and stock-based compensation expense. The adjustment of EBITDA for these items is consistent with the definition of adjusted EBITDA in our 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 
 September 30,
 
Nine Months Ended 
 September 30,
(In thousands)
2017
 
2016
 
2017
 
2016
Cash flows provided by operating activities
$
11,326

 
$
12,163

 
$
36,756

 
$
34,046

Changes in operating assets and liabilities, net of effect of business acquisitions
(959
)
 
1,958

 
1,406

 
9,976

Non-cash expenses, including depreciation, amortization and goodwill impairment
(25,134
)
 
(11,219
)
 
(47,461
)
 
(94,300
)
Income tax (benefit) provision
(2,174
)
 
2,162

 
1,574

 
(5,884
)
Interest expense, net
1,530

 
1,563

 
4,679

 
4,535

Income attributable to the noncontrolling interest
(7
)
 
(61
)
 
(55
)
 
(211
)
Depreciation and amortization
8,430

 
7,857

 
25,037

 
23,737

EBITDA
$
(6,988
)
 
$
14,423

 
$
21,936

 
$
(28,101
)

22


The following is a reconciliation of net (loss) income attributable to ARC Document Solutions, Inc. to EBITDA and adjusted EBITDA:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
(In thousands)
2017
 
2016
 
2017
 
2016
Net (loss) income attributable to ARC Document Solutions, Inc.
$
(14,774
)
 
$
2,841

 
$
(9,354
)
 
$
(50,489
)
Interest expense, net
1,530

 
1,563

 
4,679

 
4,535

Income tax (benefit) provision
(2,174
)
 
2,162

 
1,574

 
(5,884
)
Depreciation and amortization
8,430

 
7,857

 
25,037

 
23,737

EBITDA
(6,988
)
 
14,423

 
21,936

 
(28,101
)
Loss on extinguishment and modification of debt
124

 
66

 
230

 
156

Goodwill impairment
17,637

 
—

 
17,637

 
73,920

Restructuring expense
—

 
—

 
—

 
7

Stock-based compensation
699

 
650

 
2,251

 
2,073

Adjusted EBITDA
$
11,472

 
$
15,139

 
$
42,054

 
$
48,055


The following is a reconciliation of net (loss) income margin attributable to ARC Document Solutions, Inc. to EBITDA margin and adjusted EBITDA margin:

 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2017 (1)
 
2016
 
2017 (1)
 
2016 (1)
Net (loss) income margin attributable to ARC Document Solutions, Inc.
(15.3
)%
 
2.8
%
 
(3.1
)%
 
(16.4
)%
Interest expense, net
1.6

 
1.6

 
1.6

 
1.5

Income tax (benefit) provision
(2.3
)
 
2.2

 
0.5

 
(1.9
)
Depreciation and amortization
8.7

 
7.8

 
8.4

 
7.7

EBITDA margin
(7.2
)
 
14.4

 
7.4

 
(9.1
)
Loss on extinguishment and modification of debt
0.1

 
0.1

 
0.1

 
0.1

Goodwill impairment
18.3

 
—

 
5.9

 
24.0

Restructuring expense
—

 
—

 
—

 
—

Stock-based compensation
0.7

 
0.6

 
0.8

 
0.7

Adjusted EBITDA margin
11.9
 %
 
15.1
%
 
14.1
 %
 
15.6
 %
 
(1)
Column does not foot due to rounding


23


The following is a reconciliation of net (loss) income attributable to ARC Document Solutions, Inc. to adjusted net income attributable to ARC Document Solutions, Inc.:
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
(In thousands, except per share amounts)
2017
 
2016
 
2017
 
2016
Net (loss) income attributable to ARC Document Solutions, Inc.
$
(14,774
)
 
$
2,841

 
$
(9,354
)
 
$
(50,489
)
Loss on extinguishment and modification of debt
124

 
66

 
230

 
156

Goodwill impairment
17,637

 
—

 
17,637

 
73,920

Restructuring expense
—

 
—

 
—

 
7

Income tax benefit related to above items
(3,144
)
 
(26
)
 
(3,186
)
 
(13,395
)
Deferred tax valuation allowance and other discrete tax items
515

 
138

 
594

 
341

Adjusted net income attributable to ARC Document Solutions, Inc.
$
358

 
$
3,019

 
$
5,921

 
$
10,540

 
 
 
 
 
 
 
 
Actual:
 
 
 
 
 
 
 
(Loss) earnings per share attributable to ARC Document Solutions, Inc. shareholders:
 
 
 
 
 
 
 
Basic
$
(0.32
)
 
$
0.06

 
$
(0.20
)
 
$
(1.10
)
Diluted
$
(0.32
)
 
$
0.06

 
$
(0.20
)
 
$
(1.10
)
Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
45,834

 
45,599

 
45,756

 
46,055

Diluted
45,834

 
46,189

 
45,756

 
46,055

Adjusted:
 
 
 
 
 
 
 
Earnings per share attributable to ARC Document Solutions, Inc. shareholders:
 
 
 
 
 
 
 
Basic
$
0.01

 
$
0.07

 
$
0.13

 
$
0.23

Diluted
$
0.01

 
$
0.07

 
$
0.13

 
$
0.23

Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
45,834

 
45,599

 
45,756

 
46,055

Diluted
46,342

 
46,189

 
46,335

 
46,655





24


Results of Operations
 
 
Three Months Ended September 30,
 
Increase (decrease)
 
Nine Months Ended 
 September 30,
 
Increase (decrease)
(In millions, except percentages)
2017 (1)
 
2016 (1)
 
$
 
%
 
2017 (1)
 
2016 (1)
 
$
 
%
CDIM
$
50.1

 
$
53.2

 
$
(3.1
)
 
(5.9
)%
 
$
155.0

 
$
161.8

 
$
(6.7
)
 
(4.2
)%
MPS
32.2

 
32.8

 
(0.6
)
 
(2.0
)%
 
97.7

 
100.1

 
(2.4
)
 
(2.4
)%
AIM
3.4

 
3.2

 
0.2

 
7.3
 %
 
9.7

 
10.6

 
(0.8
)
 
(7.8
)%
Total service sales
85.6

 
89.2

 
(3.6
)
 
(4.0
)%
 
262.5

 
272.4

 
(9.9
)
 
(3.6
)%
Equipment and supplies sales
10.8

 
11.3

 
(0.4
)
 
(3.8
)%
 
35.0

 
35.4

 
(0.4
)
 
(1.0
)%
Total net sales
$
96.5

 
$
100.4

 
$
(4.0
)
 
(4.0
)%
 
$
297.5

 
$
307.8

 
$
(10.3
)
 
(3.3
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
$
29.2

 
$
32.7

 
$
(3.5
)
 
(10.7
)%
 
$
94.6

 
$
102.9

 
$
(8.3
)
 
(8.1
)%
Selling, general and administrative expenses
$
25.8

 
$
24.9

 
$
1.0

 
3.8
 %
 
$
76.5

 
$
76.8

 
$
(0.2
)
 
(0.3
)%
Amortization of intangibles
$
1.1

 
$
1.2

 
$
(0.1
)
 
(9.2
)%
 
$
3.3

 
$
3.7

 
$
(0.5
)
 
(12.3
)%
Goodwill impairment
$
17.6

 
$
—

 
$
17.6

 
—
 %
 
$
17.6

 
$
73.9

 
$
(56.3
)
 
(76.1
)%
Loss on extinguishment and modification of debt
$
0.1

 
$
0.1

 
$
0.1

 
87.9
 %
 
$
0.2

 
$
0.2

 
$
0.1

 
47.4
 %
Interest expense, net
$
1.5

 
$
1.6

 
$
—

 
(2.1
)%
 
$
4.7

 
$
4.5

 
$
0.1

 
3.2
 %
Income tax (benefit) provision
$
(2.2
)
 
$
2.2

 
$
(4.3
)
 
(200.6
)%
 
$
1.6

 
$
(5.9
)
 
$
7.5

 
(126.8
)%
Net (loss) income attributable to ARC
$
(14.8
)
 
$
2.8

 
$
(17.6
)
 
(620.0
)%
 
$
(9.4
)
 
$
(50.5
)
 
$
41.1

 
(81.5
)%
Non-GAAP (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net income attributable to ARC (2)
$
0.4

 
$
3.0

 
$
(2.7
)
 
(88.1
)%
 
$
5.9

 
$
10.5

 
$
(4.6
)
 
(43.8
)%
EBITDA (2)
$
(7.0
)
 
$
14.4

 
$
(21.4
)
 
(148.5
)%
 
$
21.9

 
$
(28.1
)
 
$
50.0

 
(178.1
)%
Adjusted EBITDA (2)
$
11.5

 
$
15.1

 
$
(3.7
)
 
(24.2
)%
 
$
42.1

 
$
48.1

 
$
(6.0
)
 
(12.5
)%
 
(1)
Column does not foot due to rounding
(2)
See "Non-GAAP Financial Measures" on pg. 24 for additional information.


25


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 September 30,
 
Nine Months Ended September 30,
 
2017 (1)
 
2016 (1)
 
2017 (1)
 
2016 (1)
Net Sales
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Cost of sales
69.7

 
67.4

 
68.2

 
66.6

Gross profit
30.3

 
32.6

 
31.8

 
33.4

Selling, general and administrative expenses
26.8

 
24.8

 
25.7

 
24.9

Amortization of intangibles
1.1

 
1.2

 
1.1

 
1.2

Goodwill impairment
18.3

 
—

 
5.9

 
24.0

(Loss) income from operations
(15.9
)
 
6.6

 
(1.0
)
 
(16.7
)
Loss on extinguishment and modification of debt
0.1

 
0.1

 
0.1

 
0.1

Interest expense, net
1.6

 
1.6

 
1.6

 
1.5

(Loss) income before income tax provision (benefit)
(17.6
)
 
5.0

 
(2.6
)
 
(18.2
)
Income tax (benefit) provision
(2.3
)
 
2.2

 
0.5

 
(1.9
)
Net (loss) income
(15.3
)
 
2.9

 
(3.1
)
 
(16.3
)
Income attributable to the noncontrolling interest
—

 
(0.1
)
 
—

 
(0.1
)
Net (loss) income attributable to ARC
(15.3
)%
 
2.8
 %
 
(3.1
)%
 
(16.4
)%
Non-GAAP (2)
 
 
 
 
 
 
 
EBITDA (2)
(7.2
)%
 
14.4
 %
 
7.4
 %
 
(9.1
)%
Adjusted EBITDA (2)
11.9
 %
 
15.1
 %
 
14.1
 %
 
15.6
 %
 
(1)
Column does not foot due to rounding
(2)
See "Non-GAAP Financial Measures" on pg. 24 for additional information.
Three and Nine Months Ended September 30, 2017 Compared to Three and Nine Months Ended September 30, 2016
Net Sales
Net sales for the three and nine months ended September 30, 2017 decrease d by 4.0% , and 3.3% compared to the same periods in 2016 due primarily to declines in our print-based service offerings. Overall declines in our print-based revenues were also affected by inclement weather in the Southeastern U.S. during the third quarter. We estimate that the closure of our service centers and our customers' locations driven by the hurricanes in the Southeastern U.S. contributed approximately $1.0 million to the year-over-year sales declines. Also contributing to the overall sales decline for the three and nine months ended September 30, 2017 is the fact that we had one less business day during these time periods as compared to the same periods in 2016 resulting in a decline in revenue of approximately $1.5 million.
CDIM . Year-over-year sales of CDIM services decrease d $3.1 million , or 5.9% , and $6.7 million , or 4.2% , for the three and nine months ended September 30, 2017 , respectively. The decrease in sales of CDIM services was primarily due to the continued but moderating reduction in demand for printed construction drawings and related services driven by the ongoing adoption of technology replacing traditional print-based service offerings, and softness in our color imaging sales for the period. Also contributing to the decline in sales of CDIM for the period was the extended closure of our service centers in the Southeastern U.S. which were impacted by hurricanes during the third quarter of 2017. CDIM services represented 52% of total net sales for the three and nine months ended September 30, 2017 compared to 53% during the same periods in 2016 .
MPS . Year-over-year sales of MPS services for the three and nine months ended September 30, 2017 decrease d $0.6 million , or 2.0% , and $2.4 million , or 2.4% , respectively, due to the decline in print volumes from existing customers. The decline in print volumes was driven in part by the continued optimization of our customers' in-house print environment partially offset by new customer acquisitions. Also contributing to the decline in sales of MPS for the period was the closure of certain of our customers' offices in the Southeastern U.S. which were impacted by hurricanes during the third quarter of 2017. Our MPS offering delivers value to its customers by optimizing their print infrastructure, which in turn, will lower their print volume over time. Sales reductions associated with a decline in print volume are typically offset by new customer acquisitions and expansion of MPS services within

26


existing customers. Revenues from MPS Services sales represented approximately 33% of total net sales for both the three and nine months ended September 30, 2017 and 2016 .
The number of MPS locations has grown to approximately 10,000 as of September 30, 2017 , an increase of approximately 630 locations compared to September 30, 2016 . While MPS is subject to temporary performance fluctuations based on the loss or acquisition of large clients, we believe there is an opportunity for MPS sales growth in the future due to the value that we bring to our customers and the desire to reduce costs in the AEC/O industry.
We intend to continue the expansion of our MPS offering through our regional sales force and through our national accounts group "Global Solutions." Our Global Solutions sales force has established long-term contract relationships with 25 of the largest 100 AEC/O firms. MPS services are driven in large part by the number of customer employees at an office as that drives office printing and copying.
AIM . Year-over-year sales of AIM Services increased $0.2 million , or 7.3% , and declined $0.8 million , or 7.8% , for the three and nine months ended September 30, 2017 , respectively. The increase during the three months ended September 30, 2017 was driven by the completion of larger projects compared to the prior year. The sales decline for the nine months ended September 30, 2017 was primarily driven by a reorganization in our sales staff which we believe caused a temporary decline in AIM sales during the first half of 2017. We are driving an expansion of our addressable market for AIM by targeting building owners and facilities managers that require on-demand legacy documents to operate their assets efficiently. We believe we have developed a valuable solution that will drive growth in the future.
Equipment and Supplies Sales . Year-over-year sales of Equipment and Supplies decrease d $0.4 million , or 3.8% , and $0.4 million , or 1.0% , for the three and nine months ended September 30, 2017 , respectively. Quarterly changes in Equipment and Supplies Sales are largely driven by the timing of replacements of aging equipment fleets for customers who prefer to own their equipment. Equipment and Supplies Sales derived from UNIS Document Solutions Co. Ltd (“UDS”), our Chinese business venture, increased during the period, and were $5.4 million and $17.2 million for the three and nine months ended September 30, 2017 , as compared to $ 4.9 million and $14.5 million for the three and nine months ended September 30, 2016 , respectively. These increases were offset by declines in Equipment and Supplies sales in the U.S. We do not anticipate sustained growth in Equipment and Supplies Sales as we are placing more focus on growing MPS sales and converting sales contracts to MPS agreements; however, we intend to be opportunistic about sales opportunities as they arise in North America and abroad.
Gross Profit
During the three months ended September 30, 2017 , gross profit and gross margin decreased to $29.2 million , and 30.3% compared to $32.7 million and 32.6% , during the same period in 2016 , on a sales decline of $4.0 million .
During the nine months ended September 30, 2017 , gross profit and gross margin decreased to $94.6 million , and 31.8% compared to $102.9 million and 33.4% , during the same period in 2016 , on a sales decline of $10.3 million .
The decline in our gross margins for the three and nine months ended September 30, 2017 , was primarily driven by 1) the impact of lower revenue for the period reducing our ability to leverage the fixed portion of our overhead and labor costs, and 2) the increase in low-margin equipment sales in China.
Selling, General and Administrative Expenses
Selling, marketing, general and administrative expenses increased $1.0 million and decreased $0.2 million for the three and nine months ended September 30, 2017 , respectively, compared to the same periods in 2016 .
General and administrative expenses decreased $0.3 million or 2.2% , and $1.6 million or 3.4% for the three and nine months ended September 30, 2017 , compared to the same periods in 2016 . The reduction in expenses was primarily due to cost reduction initiatives undertaken in response to the drop in revenue.
Year-over-year sales and marketing expenses increased $1.3 million and $1.4 million , for the three and nine months ended September 30, 2017 , compared to the same periods in 2016 . The increase for the three and nine months ended September 30, 2017 , was primarily due to investments in sales and marketing staff, training and marketing initiatives to support our new technology-enabled offerings.

27


Amortization of Intangibles
Amortization of intangibles of $1.1 million and $3.3 million for the three and nine months ended September 30, 2017 , decreased slightly compared to the same periods in 2016 , primarily due to the completed amortization of certain customer relationship intangibles related to historical acquisitions.
Goodwill Impairment
At September 30, 2017 and June 30, 2016, the Company recorded a pretax, non-cash charges to reduce the carrying value of goodwill by $17.6 million and $73.9 million, respectively. See Note 3, “Goodwill and Other Intangibles” for further information regarding the process of assessing goodwill impairment.
Loss on Extinguishment and Modification of Debt
We made additional principal payments of $14.2 million on our original $175.0 million Term Loan Credit Agreement, which was amended in the third quarter of 2017, above our required principal payments. The additional principal payments and modification resulted in a loss on the extinguishment and modification of debt of $0.1 million and $0.2 million for the three and nine months ended September 30, 2017 .
Interest Expense, Net
Net interest expense totaled $1.5 million and $4.7 million for the three and nine months ended September 30, 2017 , compared to $1.6 million and $4.5 million for the same periods in 2016 . The slight increase for the nine months ended September 30, 2017 compared to 2016 was primarily a result of the increase in LIBOR which impacts our Term A loan interest rate, partially offset by the early extinguishment of our long-term debt as described above. This slight increase was offset for the three months ended September 30, 2017 compared to 2016 due to the amendment of our Term Loan Credit Agreement, which reduced the rate of interest payable on the loans borrowed by 0.25%.
Income Taxes

We recorded an income tax benefit of $2.2 million and an income tax provision of $1.6 million in relation to pretax losses of $16.9 million and $7.7 million for the three and nine months ended September 30, 2017 , respectively, which resulted in an effective income tax rate of 12.8% and (20.4)% , for the three and nine months ended September 30, 2017 , respectively.

For the three and nine months ended September 30, 2017 , our effective income tax rate would have been 41.1%, excluding the impact of the goodwill impairment, an additional valuation allowance, certain stock-based compensation not deductible for income tax purposes and other discrete items. We have a $1.8 million valuation allowance against certain deferred tax assets as of September 30, 2017 .

Our gross deferred tax assets remain available to us for use in future years until they fully expire, which based on forecasted continuing profitability, we estimate that it is more likely than not that future earnings will be sufficient to realize certain of our deferred tax assets. As of December 31, 2016, we had approximately $79.9 million of consolidated federal, $96.6 million of state and $2.6 million of foreign net operating loss and charitable contribution carryforwards available to offset future taxable income, respectively, available for use in 2017 and future years. The federal net operating loss carryforward began in 2011 and will begin to expire in varying amounts between 2031 and 2034. The charitable contribution carryforward began in 2009 and will begin to expire in varying amounts between 2017 and 2021. The state net operating loss carryforwards expire in varying amounts between 2017 and 2034. The foreign net operating loss carryforwards begun to expire in varying amounts beginning in 2017.
Noncontrolling Interest
Net income attributable to noncontrolling interest represents 35% of the income of UDS and its subsidiaries, which together comprise our Chinese joint-venture operations.
Net (Loss) Income Attributable to ARC
Net loss attributable to ARC was $14.8 million and $9.4 million , during the three and nine months ended September 30, 2017 , as compared to net income (loss) attributable to ARC of $2.8 million and $(50.5) million in the same periods in 2016 . The changes in net income attributable to ARC for three and nine months ended September 30, 2017 versus the prior year periods is primarily due to the goodwill impairment charges taken in the third quarter of 2017 and in the second quarter of 2016, as noted above.


28


EBITDA
EBITDA margin decreased to (7.2)% for the three months ended September 30, 2017 from 14.4% for the same period in 2016. EBITDA margin increased to 7.4% for the nine months ended September 30, 2017 from (9.1)% for the same period in 2016. Excluding the effect of the loss on extinguishment of debt, goodwill impairment, restructuring expense and stock-based compensation, adjusted EBITDA margin decreased to 11.9% and 14.1% during the three and nine months ended September 30, 2017 , as compared to 15.1% and 15.6% for the same periods in 2016 . The decrease in adjusted EBITDA margin was due to the declines in revenue and gross margins described 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.
Liquidity and Capital Resources
Our principal sources of cash have been 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 of September 30, 2017 , was $26.4 million . Of this amount, $14.8 million was held in foreign countries, with $12.7 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 interim Condensed Consolidated Statements of Cash Flows and notes thereto included elsewhere in this report.
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
(In thousands)
2017
 
2016
 
2017
 
2016
Net cash provided by operating activities
$
11,326

 
$
12,163

 
$
36,756

 
$
34,046

Net cash used in investing activities
$
(2,263
)
 
$
(2,295
)
 
$
(6,780
)
 
$
(6,738
)
Net cash used in financing activities
$
(9,465
)
 
$
(10,600
)
 
$
(29,343
)
 
$
(31,335
)

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 months ended September 30, 2017 compared to the same period in 2016 was primarily due to the decline in profitability offset, in part, by the timing of payables and accounts receivable collections. The increase in cash flows from operations during the nine months ended September 30, 2017 compared to the same period in 2016 was primarily due to the timing of payables, including the payment of a legal settlement in the second quarter of 2016, changes in inventory, and accounts receivable collections offset, in part, by the decline in profitability in 2017. Days sales outstanding (“DSO”) was 55  days as of September 30, 2017 and September 30, 2016 . We continue our focus on the timely collection of our accounts receivable.
Investing Activities
Net cash used in investing activities was primarily related to capital expenditures. We incurred capital expenditures totaling $7.2 million and $7.6 million for the nine months ended September 30, 2017 and 2016 , respectively. The change in capital expenditures is driven by the timing of equipment purchases, and whether such equipment is leased or purchased with available cash. 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 $29.3 million used in financing activities during the nine months ended September 30, 2017 primarily relates to payments on our debt agreements and capital leases. The Company amended its Term Loan Credit Agreement in the third quarter of 2017 resulting in a decrease in required quarterly principal payments on its term loan debt. In addition, the amendment increased

29


the maximum aggregate principal amount of revolving loans from $30.0 million to $80.0 million, and resized the outstanding principal amount of the term loan under the agreement at $60.0 million, although the total principal amount outstanding remained unchanged at $110.0 million on the date of the amendment. Prior to the amendment, the Company paid down the principal of its term loan debt by making required quarterly payments in advance. Principal payments made in 2017 were $14.2 million greater than the minimum principal payments required by the agreement.
Our cash position, working capital, and debt obligations as of September 30, 2017 and December 31, 2016 are shown below and should be read in conjunction with our Condensed Consolidated Balance Sheets and notes thereto contained elsewhere in this report.
 
(In thousands)
September 30, 2017
 
December 31, 2016
Cash and cash equivalents
$
26,363

 
$
25,239

Working capital
$
43,262

 
$
44,892

 
 
 
 
Borrowings from term loan facility (1) (2)
$
104,189

 
$
120,911

Other debt obligations
44,996

 
36,262

Total debt obligations
$
149,185

 
$
157,173

 
(1) Net of deferred financing fees of $811 and $1,039 at September 30, 2017 and December 31, 2016 , respectively.
(2) Includes $46.1 million and $1.0 million of revolving loans outstanding under Term A Loan Facility at September 30, 2017 and December 31, 2016 , respectively.
The decrease of $1.6 million in working capital in 2017 was primarily due to an increase in the current portion of long-term debt driven by the amendment to our credit agreement in the third quarter of 2017. 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 $26.4 million , availability under our revolving credit facility, availability under our equipment lease lines, and cash flows provided by operations should be adequate to cover the next twelve months of working capital needs, debt service 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 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, such as non-residential and residential construction spending. 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.
While we have not been actively seeking growth through acquisition, the executive team continues to selectively evaluate potential acquisitions.
Debt Obligations

Amended Term A Loan Facility
On July 14, 2017, we amended our Credit Agreement (the “Term A Credit Agreement”) which was originally entered into on November 20, 2014 with Wells Fargo Bank, National Association, as administrative agent and the lenders party thereto.
The original Term A Credit Agreement provided for the extension of term loans (“Term Loans”) in an aggregate principal amount of $175.0 million , the entirety of which was disbursed on the Closing Date in order to pay outstanding obligations under our then effective Term Loan Credit Agreement. The original Credit Agreement also provided for the extension of revolving loans (“Revolving Loans”) in an aggregate principal amount not to exceed $30.0 million . The amendment increases the maximum aggregate principal amount of Revolving Loans under the agreement from $30 million to $80 million and resizes the outstanding principal amount of the Term Loan under the agreement at $60 million. Upon the execution of the amendment to the Term A Credit Agreement, the total principal amount outstanding under the agreement remained unchanged at $110.0 million. As amended, the

30


principal of the resized Term Loan balance will amortize at an annual rate of 7.5% during the first and second years following the date of the amendment and at an annual rate of 10% during the third, fourth and fifth years following the date of the amendment, with any remaining balance payable upon the maturity date. The amendment also extended the maturity date for both the Revolving Loans and the Term Loans until July 14, 2022.
As of September 30, 2017 , our borrowing availability under the amended Term A Credit Agreement was $32.1 million , which was the maximum borrowing limit of $80.0 million reduced by outstanding letters of credit of $1.8 million and revolver credit facility balance of $46.1 million .

Loans borrowed under the amended Term A Credit Agreement bear interest, in the case of LIBOR rate loans, at a per annum rate equal to the applicable LIBOR rate, plus a margin ranging from 1.25% to 2.25% , based on our Total Leverage Ratio (as defined in the amended Term A Credit Agreement). Loans borrowed under the amended Term A Credit Agreement that are not LIBOR rate loans bear interest at a per annum rate equal to (i) the greatest of (A) the Federal Funds Rate plus 0.50% , (B) the one month LIBOR rate plus 1.00% , per annum, and (C) the rate of interest announced, from time to time, by Wells Fargo Bank, National Association as its “prime rate,” plus (ii) a margin ranging from 0.25% to 1.25% , based on the Company’s Total Leverage Ratio. The amendment reduced the rate of interest payable on the loans borrowed under the amended Term A Credit Agreement by 0.25% .

Subject to certain exceptions, including in certain circumstances, reinvestment rights, the loans extended under the amended Term A 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 amended Term A Credit Agreement); the net proceeds from certain issuances of equity securities; and net proceeds of certain insurance recoveries and condemnation events of us.

The amended Term A 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 amended Term A Credit Agreement contains financial covenants which requires us to maintain (i) at all times, a Total Leverage Ratio in an amount not to exceed 3.25 to 1.00; and (ii) a Fixed Charge Coverage Ratio (as defined in the amended Term A 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 September 30, 2017 and forecasted to remain in compliance with our covenants for the remainder of the term of the agreement.

The amended Term A 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 amended Term A Credit Agreement are guaranteed by us and each of our other United States domestic subsidiaries. The amended Term A 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).
Prior to entering into the amended Term A Credit Agreement, we had paid $68.2 million in aggregate principal on our original $175.0 million Term Loan Credit Agreement. Principal payments on the Term Loan Credit Agreement of $14.2 million in 2017 resulted in a loss on extinguishment and modification of debt of $0.1 million and $0.2 million for the three and nine months ended September 30, 2017 .
Capital Leases
As of September 30, 2017 , we had $45.0 million of capital lease obligations outstanding, with a weighted average interest rate of 4.6% and maturities between 2017 and 2022.
Off-Balance Sheet Arrangements
As of September 30, 2017 , we did not have any off-balance-sheet arrangements as defined in Item 303(a)(4)(ii) of Regulation S-K.

31


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.

Contingent Transaction Consideration. We have entered into earnout obligations in connection with business acquisitions. If the acquired businesses generate sales and/or operating profits in excess of predetermined targets, we are obligated to make additional cash payments in accordance with the terms of such earnout obligations. As of September 30, 2017 , we recorded liabilities related to future earnout payments consummated subsequent to the adoption of ASC 805, Business Combinations, of $0.3 million . Liabilities related to future earnout payments are carried at fair value, and any changes in fair value at each reporting period, are recognized in our condensed consolidated statement of operations.

Legal Proceedings. We are involved in various legal proceedings and other legal matters from time to time in the normal course of business. We do not believe that the outcome of any of these matters will have a material effect on our consolidated financial position, results of operations or cash flows.
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 2016 Annual Report on Form 10-K 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 2016 Annual Report on Form 10-K, except for the adoption of ASU 2017-04 described below.
Goodwill Impairment
In connection with acquisitions, we apply the provisions of ASC 805, Business Combinations , using the acquisition method of accounting. The excess purchase price over the fair value of net tangible assets and identifiable intangible assets acquired is recorded as goodwill.
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, 2017, our goodwill impairment analysis showed one reporting unit with goodwill attributed to it had a carrying amount which exceeded its fair value. Our underperformance relative to our forecast in the third quarter of 2017, and more specifically, the underperformance against forecast of one of our reporting units which previously had goodwill impairment in 2016 drove the decline in the fair value of the reporting unit. As a result, we recorded a pretax, non-cash charge for the three and nine months ended September 30, 2017 to reduce the carrying value of goodwill by $17.6 million .
During 2016, we performed an interim goodwill impairment analysis as of June 30, 2016 in addition to our annual goodwill impairment analysis as of September 30, 2016.
At June 30, 2016, we determined that there were sufficient indicators to trigger an interim goodwill impairment analysis. The indicators included, among other factors: (1) the underperformance against plan of our reporting units, (2) a revision of our forecasted future earnings, and (3) a decline in the Company's market capitalization in 2016. The underperformance against plan of our reporting units and the resulting revision of our forecasted future earnings was driven by: (a) a larger than expected decline in our print-related sales which began during the second quarter of 2016 due to an acceleration in the adoption of new technology replacing printed documents in our industry, (b) the lack of new national customer acquisitions, which had been expected based on historical customer acquisition rates, and (c) lower than expected growth derived from our cloud-based digital document management solutions. Based on currently available information, we do not believe that the trend we have identified to replace traditional print-based document reproduction and management with digital document solutions is temporary, and we anticipate that such declines will continue to impact the Company’s net sales in the foreseeable future.
Our interim goodwill impairment analysis indicated that five of our eight reporting units, four in the United States and one in Canada, failed step one of the impairment analysis. Accordingly, we recorded a pretax, non-cash charge for the three and six months ended June 30, 2016 to reduce the carrying value of goodwill by $73.9 million .
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

32


acquisition, and all of the activities within a reporting unit, whether acquired or internally generated, are available to support the value of the goodwill. During the second quarter of 2016, in connection with an operationally focused reorganization of certain of our reporting units, one additional reporting unit was added. As such, the goodwill of the former reporting units affected was reassigned to the new reporting unit based on their relative fair values and represented less than one percent of the Company's goodwill balance at the time.

Traditionally, goodwill impairment testing is a two-step process. Step one involves comparing the fair value of the reporting units to its carrying amount. If the carrying amount of a reporting unit is greater than zero and its fair value is greater than its carrying amount, there is no impairment. If the reporting unit’s carrying amount is greater than the fair value, the second step must be completed to measure the amount of impairment, if any. Step two involves calculating the implied fair value of goodwill. For our annual goodwill impairment test as of September 30, 2017, we elected to early-adopt ASU 2017-04 which simplifies subsequent goodwill measurement by eliminating Step 2 from the goodwill impairment test. As a result, we compared the fair value of a reporting unit with its respective carrying value, and recognized an impairment charge for the amount by which the carrying amount exceeded the reporting unit’s fair value.
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.
Our projections are driven, in part, by industry data gathered from third parties, including projected growth rates of the AEC/O industry by segment (i.e. residential and non-residential) and anticipated GDP growth rates, as well as company-specific data such as estimated composition of our customer base (i.e. non-AEC/O vs. AEC/O, residential vs. non- residential), historical revenue trends, and EBITDA margin performance of our reporting units. Our revenue projections for each of ARC’s reporting units include the estimated respective customer composition for each reporting unit, year-to-date revenue at the time of the goodwill impairment analysis, and projected growth rates for the related customer types. Although we rely on a variety of internal and external sources in projecting revenue, our relative reliance on each source or trend changes from year to year. In 2012 and into 2013, we noted a continued divergence between our historic revenue growth rates and AEC/O non-residential construction growth rates, as well as the “dilution” of traditional reprographics as the Company’s dominant business line. Therefore, we increased our reliance upon internal sources for our short-term and long-term revenue forecasts. Once the forecasted revenue was established for each of the reporting units based on the process noted above, using the current year EBITDA margin as a base line, we forecasted future EBITDA margins. In general, our EBITDA margins are significantly affected by (1) revenue trends and (2) cost management initiatives. Revenue trends impact our EBITDA margins because a significant portion of our cost of sales are considered relatively fixed therefore an increase in forecasted revenue (particularly when combined with any cost management or productivity enhancement initiatives) would result in meaningful gross margin expansion. Similarly, a significant portion of our selling, general, and administrative expenses are considered fixed. Hence, in forecasting EBITDA margins, significant reliance was placed on the historical impact of revenue trends on EBITDA margin.
As of September 30, 2017, the estimated fair values of our reporting units were based upon their respective projected EBITDA margins, which were anticipated to vary from annual declines to increases up to 100 basis points for the periods analyzed. These cash flows were discounted using a weighted average cost of capital ranging from 10% to 12%, depending upon the size and risk profile of the reporting unit. We considered market information in assessing the reasonableness of the fair value under the income approach described above.
The results of the goodwill impairment test, as of September 30, 2017, were as follows:

(Dollars in thousands)
Number of
Reporting
Units
 
Representing
Goodwill of
No goodwill balance
6

 
$
—

Fair value of reporting units exceeds their carrying values by more than 100%
2

 
121,051

 
8

 
$
121,051

The goodwill balances reflected above are net of the $17.6 million goodwill impairment recognized in the third quarter of 2017.
Based upon a sensitivity analysis, a reduction of approximately 50 basis points of projected EBITDA in 2017 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

33


further impairment of goodwill.
Given 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 2017 will prove to be accurate predictions of the future. If our assumptions, including forecasted EBITDA of certain reporting units, are not achieved, we may be required to record additional goodwill impairment charges in future periods, whether in connection with our next annual impairment testing in the third quarter of 2018, 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 likely than not to be realized. Changes in tax laws or accounting standards and methods may affect recorded deferred taxes in future periods.

In accordance with ASC 740-10, Income Taxes , we evaluate the need for deferred tax asset valuation allowances based on a more likely than not standard. The ability to realize deferred tax assets depends on the ability to generate sufficient taxable income within the carryback or carryforward periods provided for in the tax law for each applicable tax jurisdiction. We consider the following possible sources of taxable income when assessing the realization of deferred tax assets:

•
Future reversals of existing taxable temporary differences;
•
Future taxable income exclusive of reversing temporary differences and carryforwards;
•
Taxable income in prior carryback years; and
•
Tax-planning strategies.

The assessment regarding whether a valuation allowance is required or should be adjusted also considers all available positive and negative evidence factors, including but not limited to:

•
Nature, frequency, and severity of recent losses;
•
Duration of statutory carryforward periods;
•
Historical experience with tax attributes expiring unused; and
•
Near- and medium-term financial outlook.

It is difficult to conclude a valuation allowance is not required when there is significant objective and verifiable negative evidence, such as cumulative losses in recent years. We utilize a rolling three years of actual and current year anticipated results as the primary measure of cumulative income/losses in recent years, as adjusted for permanent differences. The evaluation of deferred tax assets requires judgment in assessing the likely future tax consequences of events that have been recognized in our financial statements or tax returns and future profitability.

Our accounting for deferred tax consequences represents our best estimate of those future events. Changes in our current estimates, due to unanticipated events or otherwise, could have a material effect on our financial condition and results of operations. At September 30, 2015 as a result of sustained profitability in the U.S. evidenced by three years of earnings and forecasted continuing profitability, we determined it was more likely than not future earnings will be sufficient to realize deferred tax assets in the U.S. We had a $1.8 million valuation allowance against certain deferred tax assets as of September 30, 2017 .
Our gross deferred tax assets remain available to us for use in future years until they fully expire, which based on forecasted continuing profitability, we estimate that it is more likely than not that future earnings will be sufficient to realize certain of our deferred tax assets. 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 partial or full 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.

34


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. Our 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 our 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 had no unrecognized tax benefits as of September 30, 2017 . We report tax-related interest and penalties as a component of income tax expense.
For further information regarding the accounting policies that we believe to be critical accounting policies and that affect our more significant judgments and estimates used in preparing our interim condensed consolidated financial statements see our 2016 Annual Report on Form 10-K.
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.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our primary exposure to market risk is interest rate risk associated with our debt instruments. We use both fixed and variable rate debt as sources of financing. In 2014, we entered into a $175.0 million Term A Credit Agreement, which was later amended in 2017. Borrowings under the amended Term A Credit Agreement bear interest at a rate equal to an applicable margin plus a variable rate. As such, our amended Term A Credit Agreement exposes us to market risk for changes in interest rates. To manage our exposure to interest rate volatility associated with borrowings under our Term A Credit Agreement, we entered into interest rate cap agreements in the first quarter of 2015. We have not, and do not plan to, enter into any derivative financial instruments for trading or speculative purposes.

As of September 30, 2017 , we had $150.0 million of total debt and capital lease obligations, of which approximately 30% was at a fixed rate, with the remainder at variable rates. Given our outstanding indebtedness at September 30, 2017 , the effect of a 100 basis point increase in LIBOR on our interest expense would be approximately $0.9 million annually.

Although we have international operating entities, our exposure to foreign currency rate fluctuations is not significant to our financial condition or results of operations.


35


Item 4. Controls and Procedures
Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Exchange Act are recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2017 . Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that as of September 30, 2017 , our disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
There were no changes to internal control over financial reporting during the three months ended September 30, 2017 , that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


36


PART II—OTHER INFORMATION
Item 1. Legal Proceedings
This information is included under the caption “Legal Proceedings” in Note 6 to our Condensed Consolidated Financial Statements in Part 1, Item 1 of this Quarterly Report on Form 10-Q.
Item 1A. Risk Factors
Information concerning certain risks and uncertainties appears in Part I, Item 1A “Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 . You should carefully consider those risks and uncertainties, which could materially affect our business, financial condition and results of operations. There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016 .

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities

(In thousands, except for price per share)
 
(a) Total Number of
Shares Purchased (1)
 
(b) Average Price Paid per Share ($)
 
(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
(d) Approximate Dollar Value of Shares That May Yet Be Purchased Under The Plans or Programs (1)
Period
 
 
 
 
 
 
 
 
July 1, 2017—July 31, 2017
 
—

 
$
—

 
—

 
$
9,621

August 1, 2017—August 31, 2017
 
—

 
$
3.85

 
—

 
$
9,620

September 1, 2017—September 30, 2017
 
2

 
$
3.48

 
2

 
$
9,614

Total
 
2

 


 
2

 
 

(1)
On February 8, 2016, we announced that the Company's Board of Directors approved a stock repurchase program that authorizes the Company to purchase up to $15.0 million of the Company's outstanding common stock through December 31, 2017.


37


Item 6. Exhibits
 
Exhibit
Number
 
Description
 
 
 
10.1
 
 
 
31.1
 
 
 
31.2
 
 
 
32.1
 
 
 
32.2
 
 
 
101.INS
 
XBRL Instance Document *
 
 
101.SCH
 
XBRL Taxonomy Extension Schema *
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase *
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase *
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase *
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase *
*
Filed herewith

38


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: November 2, 2017
 
ARC DOCUMENT SOLUTIONS, INC.
 
/s/ KUMARAKULASINGAM SURIYAKUMAR
Kumarakulasingam Suriyakumar
Chairman, President and Chief Executive Officer
 
/s/ JORGE AVALOS
Jorge Avalos
Chief Financial Officer


39


EXHIBIT INDEX
 
Exhibit
Number
 
Description
 
 
10.1
 
 
 
 
31.1
 
 
 
31.2
 
 
 
32.1
 
 
 
32.2
 
 
 
101.INS
 
XBRL Instance Document *
 
 
101.SCH
 
XBRL Taxonomy Extension Schema *
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase *
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase *
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase *
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase *
 
*
Filed herewith


40
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