ARC DOCUMENT SOLUTIONS, INC., 10-Q filed on 8/9/2011
Quarterly Report
Document and Entity Information (USD $)
6 Months Ended
Jun. 30, 2011
Aug. 2, 2011
Jun. 30, 2010
Document and Entity Information [Abstract]
 
 
 
Entity Registrant Name
American Reprographics CO 
 
 
Entity Central Index Key
0001305168 
 
 
Document Type
10-Q 
 
 
Document Period End Date
Jun. 30, 2011 
 
 
Amendment Flag
FALSE 
 
 
Document Fiscal Year Focus
2011 
 
 
Document Fiscal Period Focus
Q2 
 
 
Current Fiscal Year End Date
--12-31 
 
 
Entity Well-known Seasoned Issuer
No 
 
 
Entity Voluntary Filers
No 
 
 
Entity Current Reporting Status
Yes 
 
 
Entity Filer Category
Accelerated Filer 
 
 
Entity Public Float
 
 
$ 323,997,424 
Entity Common Stock, Shares Outstanding
 
46,245,233 
 
Condensed Consolidated Balance Sheets (Unaudited) (USD $)
In Thousands
Jun. 30, 2011
Dec. 31, 2010
Current assets:
 
 
Cash and cash equivalents
$ 21,907 
$ 26,293 
Accounts receivable, net of allowances for accounts receivable of $3,597 and $4,030
61,045 
52,619 
Inventories, net
11,350 
10,689 
Deferred income taxes
7,157 
Prepaid expenses
4,223 
4,074 
Other current assets
20,775 
6,870 
Total current assets
119,300 
107,702 
Property and equipment, net of accumulated depreciation of $184,497 and $211,875
56,140 
59,036 
Goodwill
271,424 
294,759 
Other intangible assets, net
53,799 
62,643 
Deferred financing costs, net
4,669 
4,995 
Deferred income taxes
1,442 
37,835 
Other assets
2,219 
2,115 
Total assets
508,993 
569,085 
Current liabilities
 
 
Accounts payable
23,167 
23,593 
Accrued payroll and payroll-related expenses
8,040 
7,980 
Accrued expenses
19,497 
30,134 
Current portion of long-term debt and capital leases
32,365 
23,608 
Total current liabilities
83,069 
85,315 
Long-term debt and capital leases
213,288 
216,016 
Deferred income taxes
29,486 
Other long-term liabilities
3,298 
5,072 
Total liabilities
329,141 
306,403 
Commitments and contingencies (Note 6)
 
 
American Reprographics Company stockholders' equity:
 
 
Preferred stock, $0.001 par value, 25,000 shares authorized; 0 and 0 shares issued and outstanding
Common stock, $0.001 par value, 150,000 shares authorized; 46,215 and 46,183 shares issued, and 46,215 and 45,736 shares outstanding
46 
46 
Additional paid-in capital
99,396 
96,251 
Retained earnings
77,477 
173,459 
Accumulated other comprehensive loss
(3,219)
(5,541)
Total Stockholders Equity Before Adjustment of Treasury Stock
173,700 
264,215 
Less cost of common stock in treasury, 0 and 447 shares
7,709 
Total American Reprographics Company stockholders' equity
173,700 
256,506 
Noncontrolling interest
6,152 
6,176 
Total equity
179,852 
262,682 
Total liabilities and equity
$ 508,993 
$ 569,085 
Condensed Consolidated Balance Sheets (Unaudited) (Parenthetical) (USD $)
In Thousands, except Per Share data
Jun. 30, 2011
Dec. 31, 2010
Current assets:
 
 
Allowances for accounts receivable
$ 3,597 
$ 4,030 
Accumulated depreciation on property and equipment
$ 184,497 
$ 211,875 
American Reprographics Company stockholders' equity:
 
 
Preferred stock, par value
$ 0.001 
$ 0.001 
Preferred stock, shares authorized
25,000 
25,000 
Preferred stock, shares issued
Preferred stock, shares outstanding
Common stock, par value
$ 0.001 
$ 0.001 
Common stock, shares authorized
150,000 
150,000 
Common stock, shares issued
46,215 
46,183 
Common stock, shares outstanding
46,215 
45,736 
Treasury stock, shares
447 
Condensed Consolidated Statements of Operations (Unaudited) (USD $)
In Thousands, except Per Share data
3 Months Ended
Jun. 30,
6 Months Ended
Jun. 30,
2011
2010
2011
2010
Net sales
$ 109,590 
$ 115,088 
$ 216,094 
$ 227,249 
Cost of sales
73,895 
75,633 
147,013 
150,943 
Gross profit
35,695 
39,455 
69,081 
76,306 
Selling, general and administrative expenses
26,804 
28,169 
54,636 
55,300 
Amortization of intangible assets
4,721 
2,557 
9,465 
5,193 
Goodwill impairment
23,335 
 
23,335 
 
(Loss) income from operations
(19,165)
8,729 
(18,355)
15,813 
Other income
(35)
(34)
(61)
(77)
Interest expense, net
7,699 
5,754 
15,866 
11,642 
(Loss) income before income tax provision
(26,829)
3,009 
(34,160)
4,248 
Income tax provision
57,913 
1,276 
54,264 
1,806 
Net (loss) income
(84,742)
1,733 
(88,424)
2,442 
Loss (income) attributable to noncontrolling interest
112 
(54)
151 
(46)
Net (loss) income attributable to American Reprographics Company
(84,630)
1,679 
(88,273)
2,396 
(Loss) earnings per share attributable to American Reprographics Company shareholders:
 
 
 
 
Basic
$ (1.87)
$ 0.04 
$ (1.95)
$ 0.05 
Diluted
$ (1.87)
$ 0.04 
$ (1.95)
$ 0.05 
Weighted average common shares outstanding:
 
 
 
 
Basic
45,360 
45,196 
45,341 
45,174 
Diluted
45,360 
45,512 
45,341 
45,422 
Reprographics Services
 
 
 
 
Net sales
70,460 
78,453 
140,482 
154,710 
Facilities Management
 
 
 
 
Net sales
25,596 
22,627 
49,799 
45,030 
Equipment and Supplies Sales
 
 
 
 
Net sales
$ 13,534 
$ 14,008 
$ 25,813 
$ 27,509 
Condensed Consolidated Statements of Equity and Comprehensive Income (Loss) (Unaudited) (USD $)
In Thousands
Total
American Reprographics Company Shareholders Common Stock
American Reprographics Company Shareholders Additional Paid-in Capital
American Reprographics Company Shareholders Retained Earnings
American Reprographics Company Shareholders Accumulated Other Comprehensive Loss
American Reprographics Company Shareholders Common Stock in Treasury
Noncontrolling Interest
Balance at Dec. 31, 2009
$ 282,024 
$ 46 
$ 89,982 
$ 200,961 
$ (7,273)
$ (7,709)
$ 6,017 
Balance, shares at Dec. 31, 2009
 
45,665 
 
 
 
 
 
Stock-based compensation
2,918 
 
2,918 
 
 
 
 
Stock-based compensation, shares
 
29 
 
 
 
 
 
Issuance of common stock under Employee Stock Purchase Plan
36 
 
36 
 
 
 
 
Issuance of common stock under Employee Stock Purchase Plan, shares
 
 
 
 
 
 
Stock options exercised
125 
 
125 
 
 
 
 
Stock options exercised, shares
 
23 
 
 
 
 
 
Tax benefit (deficiency) from stock-based compensation
21 
 
21 
 
 
 
 
Comprehensive income (loss):
 
 
 
 
 
 
 
Net (loss) income
2,442 
 
 
2,396 
 
 
46 
Foreign currency translation adjustments
50 
 
 
 
50 
 
 
Loss on derivative, net of tax effect
(174)
 
 
 
(174)
 
 
Comprehensive income (loss):
2,318 
 
 
 
 
 
 
Balance at Jun. 30, 2010
287,442 
46 
93,082 
203,357 
(7,397)
(7,709)
6,063 
Balance, shares at Jun. 30, 2010
 
45,722 
 
 
 
 
 
Balance at Dec. 31, 2010
262,682 
46 
96,251 
173,459 
(5,541)
(7,709)
6,176 
Balance, shares at Dec. 31, 2010
45,736 
45,736 
 
 
 
 
 
Stock-based compensation
3,258 
 
3,258 
 
 
 
 
Stock-based compensation, shares
 
459 
 
 
 
 
 
Issuance of common stock under Employee Stock Purchase Plan
20 
 
20 
 
 
 
 
Issuance of common stock under Employee Stock Purchase Plan, shares
 
 
 
 
 
 
Stock options exercised
108 
 
108 
 
 
 
 
Stock options exercised, shares
 
17 
 
 
 
 
 
Tax benefit (deficiency) from stock-based compensation
(241)
 
(241)
 
 
 
 
Retirement of 447 treasury shares
 
 
 
(7,709)
 
7,709 
 
Comprehensive income (loss):
 
 
 
 
 
 
 
Net (loss) income
(88,424)
 
 
(88,273)
 
 
(151)
Foreign currency translation adjustments
583 
 
 
 
456 
 
127 
Amortization of derivative, net of tax effect
1,866 
 
 
 
1,866 
 
 
Comprehensive income (loss):
(85,975)
 
 
 
 
 
 
Balance at Jun. 30, 2011
$ 179,852 
$ 46 
$ 99,396 
$ 77,477 
$ (3,219)
$ 0 
$ 6,152 
Balance, shares at Jun. 30, 2011
46,215 
46,215 
 
 
 
 
 
Condensed Consolidated Statements of Equity and Comprehensive Income (Loss) (Unaudited) (Parenthetical)
In Thousands
6 Months Ended
Jun. 30, 2011
American Reprographics Company Shareholders Retained Earnings
 
Treasury shares, retired
447 
American Reprographics Company Shareholders Common Stock in Treasury
 
Treasury shares, retired
447 
Condensed Consolidated Statements of Cash Flows (Unaudited) (USD $)
In Thousands
6 Months Ended
Jun. 30,
2011
2010
Cash flows from operating activities
 
 
Net (loss) income
$ (88,424)
$ 2,442 
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
Allowance for accounts receivable
417 
317 
Depreciation
15,187 
17,571 
Amortization of intangible assets
9,465 
5,193 
Amortization of deferred financing costs
437 
770 
Amortization of bond discount
267 
 
Goodwill impairment
23,335 
 
Stock-based compensation
3,258 
2,918 
Excess tax benefit related to stock-based compensation
(31)
(38)
Deferred income taxes
8,515 
164 
Deferred tax valuation allowance
64,340 
 
Amortization of derivative, net of tax effect
1,866 
 
Other non-cash items, net
(177)
(314)
Changes in operating assets and liabilities, net of effect of business acquisitions:
 
 
Accounts receivable
(8,705)
(5,784)
Inventory
(1,048)
(1,285)
Prepaid expenses and other assets
(14,047)
(1,934)
Accounts payable and accrued expenses
(2,782)
7,726 
Net cash provided by operating activities
11,873 
27,746 
Cash flows from investing activities
 
 
Capital expenditures
(7,622)
(2,777)
Payment for swap transaction
(9,729)
 
Other
647 
845 
Net cash used in investing activities
(16,704)
(1,932)
Cash flows from financing activities
 
 
Proceeds from stock option exercises
108 
125 
Proceeds from issuance of common stock under Employee Stock Purchase Plan
23 
16 
Excess tax benefit related to stock-based compensation
31 
38 
Payments on long-term debt agreements and capital leases
(14,101)
(21,596)
Net borrowings (repayments) under revolving credit facilities
14,620 
(123)
Payment of loan fees
(541)
 
Net cash provided by (used in) financing activities
140 
(21,540)
Effect of foreign currency translation on cash balances
305 
22 
Net change in cash and cash equivalents
(4,386)
4,296 
Cash and cash equivalents at beginning of period
26,293 
29,377 
Cash and cash equivalents at end of period
21,907 
33,673 
Noncash transactions include the following:
 
 
Capital lease obligations incurred
5,453 
4,394 
Accrued liabilities in connection with the acquisition of businesses
 
500 
Loss on derivative, net of tax effect
 
$ (174)
Description of Business and Basis of Presentation
Description of Business and Basis of Presentation
1. Description of Business and Basis of Presentation
American Reprographics Company (“ARC” or the “Company”) is the largest reprographics company in the United States providing business-to-business document management services primarily to the architectural, engineering and construction (“AEC”) industry. ARC also provides these services to companies in non-AEC industries, such as aerospace, technology, financial services, retail, entertainment, and food and hospitality that require sophisticated document management services. The Company conducts its operations through its wholly-owned operating subsidiary, American Reprographics Company, L.L.C., a California limited liability company, and its subsidiaries.
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 United States 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 interim Condensed Consolidated Financial Statements presented herein 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 six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.
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.
The Company reclassified certain amounts in the prior year financial statements to conform to the current presentation. This reclassification had no effect on the Condensed Consolidated Statement of Operations, as previously reported. The Company reclassified $4,074 from prepaid expenses and other current assets at December 31, 2010, as a separate prepaid expenses caption, to conform to the current presentation.
These interim Condensed Consolidated Financial Statements and notes should be read in conjunction with the consolidated financial statements and notes included in the Company’s 2010 Annual Report on Form 10-K.
Recently Adopted Accounting Pronouncements
In December 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2010-29. The amendments in this update affect any public entity as defined by ASC 805, Business Combinations, that enters into business combinations that are material on an individual or aggregate basis. The objective in this update is to address diversity in practice about the interpretation of the pro forma revenue and earnings disclosure requirements for business combinations. ASU 2010-29 is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. The Company adopted provisions of ASU 2010-29 effective January 1, 2011, which did not have a material effect on its Consolidated Financial Statements. The Company has not had any business combinations in 2011.
In December 2010, the FASB issued ASU 2010-28. This update provides amendments to the criteria of ASC 350, Intangibles-Goodwill and Other. The amendments to this update affect all entities that have recognized goodwill and have one or more reporting units whose carrying amount for purposes of performing step one of the goodwill impairment test is zero or negative. ASU 2010-28 is effective for financial statements issued for years beginning after December 15, 2010. Early adoption is not permitted. The Company adopted the provisions of ASU 2010-28 effective January 1, 2011, which did not have a material effect on its Consolidated Financial Statements.
In October 2009, the FASB issued ASU 2009-13. This update provides amendments to the criteria of ASC 605, Revenue Recognition, for separating consideration in multiple-deliverable arrangements. The amendments to this update establish a selling price hierarchy for determining the selling price of a deliverable. ASU 2009-13 is effective for financial statements issued for years beginning on or after June 15, 2010. The Company adopted the provisions of ASU 2010-06 effective January 1, 2011, which did not have a material effect on its Consolidated Financial Statements.
Recent Accounting Pronouncements Not Yet Adopted
In June 2011, the FASB issued ASU 2011-05. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. Instead, an entity will be required to present either a continuous statement of net income and other comprehensive income or in two separate but consecutive statements. The new guidance will be effective for the Company beginning January 1, 2012 and will have presentation changes only.
In May 2011, the FASB issued ASU 2011-04 which amends the accounting and disclosure requirements on fair value measurements. The new guidance limits the highest-and-best-use measure to nonfinancial assets, permits certain financial assets and liabilities with offsetting positions in market or counterparty credit risks to be measured at a net basis, and provides guidance on the applicability of premiums and discounts. Additionally, the new guidance expands the disclosures on Level 3 inputs by requiring quantitative disclosure of the unobservable inputs and assumptions, as well as description of the valuation processes and the sensitivity of the fair value to changes in unobservable inputs. The new guidance will be effective for the Company beginning January 1, 2012. Other than requiring additional disclosures, the Company does not anticipate material impacts to its Consolidated Financial Statements upon adoption.
Segment Reporting
The provisions of ASC 280, Disclosures about Segments of an Enterprise and Related Information, require public companies to report financial and descriptive information about their reportable operating segments. The Company identifies operating segments based on the various business activities that earn revenue and incur expense, whose operating results are reviewed by the chief operating decision maker. Based on the fact that operating segments have similar products and services, classes of customers, production processes and performance objectives, the Company is deemed to operate as a single reportable segment.
Risk and Uncertainties
The Company generates the majority of its revenue from sales of products and services provided to the AEC industry. As a result, the Company’s operating results and financial condition can be significantly affected by economic factors that influence the AEC industry, such as non-residential and residential construction spending, GDP growth, interest rates, unemployment rates, office vacancy rates, and government expenditures. The effects of the recent recession and current economic environment in the United States have resulted in a significant downturn in the non-residential and residential portions of the AEC industry. The AEC industry generally experiences a downturn several months after a downturn in the general economy and there may be a similar delay in the recovery of the AEC industry following a recovery in the general economy. Similar to the AEC industry, the reprographics industry typically lags a recovery in the broader economy. A prolonged downturn in the AEC industry and the reprographics industry would continue to diminish demand for ARC’s products and services, and would therefore negatively impact revenues and have a material adverse impact on its business, operating results and financial condition.
Earnings per Share
Earnings per Share
2. Earnings per Share
The Company accounts for earnings per share in accordance with ASC 260, formerly SFAS No. 128, 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 share is computed similar 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 stock equivalents are excluded from the computation if their effect is anti-dilutive. Stock options for 2.2 million common shares for the three and six months ended June 30, 2011, were excluded from the calculation of diluted net income attributable to ARC per common share because they were anti-dilutive. Stock options for 1.4 million common shares and 1.5 million common shares for the three and six months ended June 30, 2010, respectively, were excluded from the calculation of diluted net income attributable to ARC per common share because they were anti-dilutive.
Basic and diluted earnings per share were calculated using the following common shares for the three and six months ended June 30, 2011 and 2010:
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
(In thousands)   2011     2010     2011     2010  
 
                               
Weighted average common shares outstanding during the period — basic
    45,360       45,196       45,341       45,174  
Effect of dilutive impact on equity based compensation awards
          316             248  
 
                       
Weighted average common shares outstanding during the period — diluted
    45,360       45,512       45,341       45,422  
 
                       
Goodwill and Other Intangibles Resulting from Business Acquisitions
Goodwill and Other Intangibles Resulting from Business Acquisitions
3. Goodwill and Other Intangibles Resulting from Business Acquisitions
Goodwill
In connection with acquisitions, the Company applies the provisions of ASC 805, 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.
The Company assesses goodwill at least annually for impairment as of September 30 or more frequently if events and circumstances indicate that goodwill might be impaired. At June 30, 2011, the Company determined that there were sufficient indicators to trigger an interim goodwill impairment analysis. The indicators included, among other factors: (1) the current economic environment, (2) the performance against plan of reporting units which previously had goodwill impairment, and (3) revised forecasted future earnings. The results of the Company’s analysis indicated that six of its reporting units, all of which are located in the United States, had a goodwill impairment as of June 30, 2011. Accordingly, the Company recorded a pretax, non-cash charge for the three and six months ended June 30, 2011 to reduce the carrying value of goodwill by $23.3 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 acquisition, and all of the activities within a reporting unit, whether acquired or internally generated, are available to support the value of the goodwill.
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 by deducting the fair value of all tangible and intangible assets, excluding goodwill, of the reporting unit from the fair value of the reporting unit as determined in step one. The implied fair value of goodwill determined in this step is compared to the carrying value of goodwill. If the implied fair value of goodwill is less than the carrying value of goodwill, an impairment loss is recognized equal to the difference.
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. The cash flows are discounted by an estimated weighted-average cost of capital, which reflects the overall level of inherent risk of a reporting unit. Determining the fair value of a reporting unit is judgmental in nature and requires the use of significant estimates and assumptions, including revenue growth rates and EBITDA margins, discount rates and future market conditions, among others. The Company considered market information in assessing the reasonableness of the fair value under the income approach outlined above.
Given the current economic environment and the uncertainties regarding the impact on the Company’s business, there can be no assurance that the estimates and assumptions regarding the duration of the lack of significant new construction activity in the AEC industry, or the period or strength of recovery, made for purposes of the Company’s goodwill impairment testing as of June 30, 2011, will prove to be accurate predictions of the future. If the Company’s assumptions regarding forecasted EBITDA margins 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 2011, or following that, if any such change constitutes a triggering event 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, 2010 through June 30, 2011 are summarized as follows:
                         
            Accumulated     Net  
    Gross     Impairment     Carrying  
(In thousands)   Goodwill     Loss     Amount  
 
                       
January 1, 2010
  $ 405,054     $ 72,536     $ 332,518  
Additions
    500             500  
Goodwill impairment
          38,263       (38,263 )
Translation adjustment
    4             4  
 
                 
December 31, 2010
    405,558       110,799       294,759  
Additions
                 
Goodwill impairment
          23,335       (23,335 )
Translation adjustment
                 
 
                 
June 30, 2011
  $ 405,558     $ 134,134     $ 271,424  
 
                 
The additions to goodwill include the excess purchase price over fair value of net assets acquired, purchase price adjustments, and certain earnout payments.
Long-lived 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 divisional 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 not.
The reporting units of the Company have been negatively impacted by the decline in commercial and residential construction. Before assessing the Company’s goodwill for impairment, the Company evaluated, as described above, the long-lived assets in its reporting units for impairment as of June 30, 2011 given the reduced level of expected sales, profits and cash flows. Based on this assessment, there was no impairment as of June 30, 2011.
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.
During the fourth quarter of 2010, the Company decided to consolidate the various brands that previously represented the Company’s market presence around the country. Beginning in January 2011, each of the Company’s operating segments and their respective locations began to adopt ARC, the Company’s overall brand name. Original brand names will be used in conjunction with the new ARC brand name to reinforce the Company’s continuing presence in the business communities it serves, and ongoing relationships with its customers. Accordingly, the remaining estimated useful lives of the trade name intangible assets were revised down to 18 months. This change in estimate is accounted for on a prospective basis, resulting in increased amortization expense over the revised useful life of each trade name. The impact of this change in the three and six months ended June 30, 2011 was an increase in amortization expense of approximately $2.4 million and $4.7 million, respectively. Trade names are amortized using the straight-line method. The latest the Company expects to fully retire original trade names is April 2012.
Non-competition agreements are amortized over their term on a straight-line basis.
The following table sets forth the Company’s other intangible assets resulting from business acquisitions as of June 30, 2011 and December 31, 2010 which continue to be amortized:
                                                 
    June 30, 2011     December 31, 2010  
    Gross             Net     Gross             Net  
    Carrying     Accumulated     Carrying     Carrying     Accumulated     Carrying  
(In thousands)   Amount     Amortization     Amount     Amount     Amortization     Amount  
 
                                               
Amortizable other intangible assets
                                               
Customer relationships
  $ 96,994     $ 52,538     $ 44,456     $ 96,359     $ 48,301     $ 48,058  
Trade names and trademarks
    20,309       10,983       9,326       20,294       5,736       14,558  
Non-competition agreements
    100       83       17       100       73       27  
 
                                   
 
  $ 117,403     $ 63,604     $ 53,799     $ 116,753     $ 54,110     $ 62,643  
 
                                   
Based on current information, estimated future amortization expense of amortizable intangible assets for the remainder of this fiscal year, each of the next four fiscal years and thereafter are as follows:
         
(In thousands)        
 
       
2011
  $ 9,245  
2012
    10,879  
2013
    6,465  
2014
    5,636  
2015
    5,105  
Thereafter
    16,469  
 
     
 
  $ 53,799  
 
     
Income Taxes
Income Taxes
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 rate in conjunction with the recognition of any discrete items within the quarter.
The Company’s effective income tax rate increased to 215.9% and 158.9% for the three and six months ended June 30, 2011 from 42.4% and 42.5% for the same periods in 2010. The increase is primarily due to the establishment of a $64.3 million non-cash valuation allowance against certain of the Company’s deferred tax assets during the three and six months ended June 30, 2011, as discussed below.
During the first quarter of 2011, the audit of the Company’s 2008 federal income tax return by the Internal Revenue Service was finalized and resulted in no adjustments. Due to this final result and other pertinent factors, the Company derecognized its liability for an uncertain tax position of $1.5 million and related accrued interest of $0.1 million.
In accordance with ASC 740-10, Income Taxes, the Company evaluates its deferred tax assets to determine if a valuation allowance is required based on the consideration of all available evidence using a “more likely than not” standard, with significant weight being given to evidence that can be objectively verified. This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability; the length of statutory carryforward periods for operating losses and tax credit carryforwards; and available tax planning alternatives. As of June 30, 2011, the Company determined that cumulative losses for the preceding twelve quarters constituted sufficient objective evidence (as defined by ASC 740-10) that a valuation allowance was needed, and therefore established a $64.3 million valuation allowance against certain of its deferred tax assets.
Based on the Company’s assessment, the remaining net deferred tax assets of $1.4 million as of June 30, 2011 are considered to be more likely than not to be realized. The valuation allowance of $64.3 million may be increased or decreased 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 currently has $74.9 million and $264 thousand of federal taxable income available in 2008 and 2009, respectively, for carry back of federal tax losses generated in 2010 and 2011, respectively. The Company has income tax receivables of $18.2 million as of June 30, 2011 included in other current assets in its consolidated balance sheet primarily relating to 2010 losses that will be carried back to 2008.
Long-Term Debt
Long-Term Debt
5. Long-Term Debt
Long-term debt consists of the following:
                 
    June 30,     December 31,  
(In thousands)   2011     2010  
Borrowings from foreign revolving credit facility; 6.0% interest rate at June 30, 2011
  $ 831     $  
Borrowings from a domestic revolving credit facility; 2.3% interest rate at June 30, 2011
    13,800        
10.5% Senior Notes due 2016, net of bond discount of $4,041 and $4,308
    195,959       195,692  
Various subordinated notes payable; weighted average interest rate of 6.2% and 6.2%; principal and interest payable monthly through November 2013
    3,949       8,635  
Various capital leases; weighted average interest rate of 8.7% and 8.8%; principal and interest payable monthly through August 2016
    31,114       35,297  
 
           
 
    245,653       239,624  
Less current portion
    (32,365 )     (23,608 )
 
           
 
  $ 213,288     $ 216,016  
 
           
10.5% Senior Notes due 2016
On December 1, 2010 (the “Closing Date”), the Company completed a private placement of 10.5% senior unsecured notes due 2016 (the “Notes”).
The Notes have an aggregate principal amount of $200 million. The Notes are general unsecured senior obligations of the Company and are subordinate to all existing and future senior secured debt of the Company to the extent of the assets securing such debt. The Company’s obligations under the Notes are jointly and severally guaranteed by all of the Company’s domestic subsidiaries. The issue price was 97.824% with a yield to maturity of 11.0%. Interest on the Notes accrues at a rate of 10.5% per annum and is payable semiannually in arrears on June 15 and December 15 of each year, commencing on June 15, 2011. The Company will make each interest payment to the holders of record of the Notes on the immediately preceding June 1 and December 1.
The Company received gross proceeds of $195.6 million from the Notes offering. In connection with the issuance of the Notes, the Company entered into an indenture, dated as of the Closing Date (the “Indenture”), among the Company, certain subsidiaries of the Company named therein, as guarantors (the “Guarantors”), and Wells Fargo Bank, National Association, as Trustee; and a Registration Rights Agreement, dated as of the Closing Date (the “Registration Rights Agreement”), among the Company, the Guarantors, and Merrill Lynch, Pierce, Fenner & Smith Incorporated, as representatives of the initial purchasers of the Notes (the “Initial Purchasers”). The Notes were offered only to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”), and outside the United States to non-U.S. persons pursuant to Regulation S under the Securities Act.
Optional Redemption. At any time prior to December 15, 2013, the Company may redeem all or part of the Notes upon not less than 30 nor more than 60 days’ prior notice at a redemption price equal to the sum of (i) 100% of the principal amount thereof, plus (ii) a make-whole premium as of the date of redemption, plus (iii) accrued and unpaid interest, if any, to the date of redemption. In addition, the Company may redeem some or all of the Notes on or after December 15, 2013, at redemption prices set forth in the Indenture, together with accrued and unpaid interest, if any, to the date of redemption. At any time prior to December 15, 2013, the Company may use the proceeds of certain equity offerings to redeem up to 35% of the aggregate principal amount of the Notes, including any permitted additional notes, at a redemption price equal to 110.5% of the principal amount of the Notes redeemed, plus accrued and unpaid interest, if any, to the date of redemption.
Repurchase upon Change of Control. Upon the occurrence of a change in control (as defined in the Indenture), each holder of the Notes may require the Company to repurchase all of the then-outstanding Notes in cash at a price equal to 101% of the aggregate principal amount of the Notes to be repurchased, plus accrued and unpaid interest, if any, to the date of repurchase.
Other Covenants. The Indenture contains covenants that limit, among other things, the Company’s and certain of its subsidiaries’ ability to (1) incur additional debt and issue preferred stock, (2) make certain restricted payments, (3) consummate specified asset sales, (4) enter into certain transactions with affiliates, (5) create liens, (6) declare or pay any dividend or make any other distributions, (7) make certain investments, and (8) merge or consolidate with another person.
Events of Default. The Indenture provides for customary events of default (subject in certain cases to customary grace and cure periods), which include non-payment, breach of covenants in the Indenture, cross default and acceleration of other indebtedness, a failure to pay certain judgments and certain events of bankruptcy and insolvency. Generally, if an event of default occurs, the Trustee or holders of at least 25% in principal amount of the then outstanding Notes may declare the principal of and accrued but unpaid interest on all of the then-outstanding Notes to be due and payable.
Exchange Offer. Pursuant to a registered exchange offer in May 2011, the Company offered to exchange up to $200 million aggregate principal amount of the Notes, for new notes that were registered under the Securities Act of 1933, as amended. The terms of such registered notes are the same as the terms of the Notes, except that they are now registered under the Securities Act and the transfer restrictions, registration rights and additional interest provisions are not applicable to the registered notes. The Company accepted the exchange of $200 million aggregate principal amounts of the Notes that were properly tendered.
2010 Credit Agreement
On the Closing Date, the Company and certain of its subsidiaries also entered into a $50 million credit agreement (the “2010 Credit Agreement”) and paid off in full amounts outstanding under its prior credit agreement.
The 2010 Credit Agreement provides for a $50 million senior secured revolving line of credit, of which up to $20 million is available for the issuance of letters of credit. The line of credit is available on a revolving basis during the period commencing after the Closing Date and ending on December 1, 2015 and is secured by substantially all of the assets of the Company and certain of its subsidiaries. Advances under the revolving line of credit are subject to customary borrowing conditions, including the accuracy of representations and warranties and the absence of events of default. The Company may borrow, partially or wholly repay its outstanding borrowings and reborrow, subject to the terms and conditions contained in the 2010 Credit Agreement.
The Company’s obligations under the 2010 Credit Agreement are guaranteed by its domestic subsidiaries and, subject to certain exceptions, are secured by security interests granted in all of the Company’s and the domestic subsidiaries’ personal and real property.
Advances under the 2010 Credit Agreement bear interest at LIBOR plus the “applicable rate.” The initial applicable rate is 2.00%. The applicable rate is determined based upon the consolidated leverage ratio for the Company with a minimum and maximum applicable rate of 1.50% and 2.00%, respectively. During the continuation of certain events of default, all amounts due under the 2010 Credit Agreement bear interest at 4.0% above the rate otherwise applicable. In addition, the Company is required to pay an unused commitment fee on the average daily unused amount of the line of credit at the applicable rate, calculated and payable quarterly in arrears, as follows: if the consolidated leverage ratio is (i) greater than or equal to 3.00x, the unused commitment fee is 0.20%, (ii) less than or equal to 2.99x but greater than or equal to 2.00x, 0.15%, and (iii) less than 2.00x, 0.10%.
The 2010 Credit Agreement contains the following financial covenants:
   
Maximum consolidated leverage ratio as follows:
   
4.35:1.00 for quarters ending December 31, 2010 through September 30, 2011
 
   
4.25:1.00 for quarters ending December 31, 2011 through September 30, 2012
 
   
4.15:1.00 for quarters ending December 31, 2012 through September 30, 2013
 
   
4.00:1.00 for quarters ending December 31, 2013 through maturity;
   
Maximum consolidated senior secured debt leverage ratio not greater than 1.50:1.00, determined on the last day of each fiscal quarter through maturity;
 
   
Minimum consolidated interest coverage ratio as follows:
   
1.70:1.00 for quarters ending December 31, 2010 through September 30, 2011
 
   
1.75:1.00 for quarters ending December 31, 2011 through maturity;
The 2010 Credit Agreement also contains covenants which, subject to certain exceptions as set forth in the 2010 Credit Agreement, restrict the Company’s ability to incur additional debt, grant liens or guaranty other indebtedness, pay dividends, redeem stock, pay or redeem subordinated indebtedness, make investments or capital expenditures, dispose or acquire assets, dispose of equity interests in subsidiaries, enter into any merger, sale of assets, consolidation or liquidation transaction, or engage in transactions with stockholders and affiliates. Covenants in the 2010 Credit Agreement also require that the Company provide periodic financial reports to the lender, observe certain practices and procedures with respect to the collateral pledged as security, comply with applicable laws and maintain and preserve the Company and its subsidiaries’ properties and maintain insurance.
As of June 30, 2011 the Company was in compliance with the financial incurrence-based covenants under the Notes and financial maintenance-based covenants under the 2010 Credit Agreement. The Company’s trailing twelve months key financial covenant ratios under the 2010 Credit Agreement as of June 30, 2011 were 1.82:1.00 for minimum interest coverage, 3.76:1.00 for maximum total leverage and 0.69:1.00 for maximum senior secured leverage.
The Company expects to be in compliance with the financial covenants in the 2010 Credit Agreement through the term of the agreement. However, it is possible that a default under certain financial covenants may occur in the future, should the minimum required profitability levels not be achieved. If the Company defaults on the covenants under the 2010 Credit Agreement and is unable to obtain waivers from its lenders, the lenders will be able to exercise their rights and remedies under the 2010 Credit Agreement, including a call provision on outstanding debt, which would have a material adverse effect on the Company’s business and financial condition.
As of June 30, 2011, standby letters of credit aggregated to $3.9 million. The standby letters of credit and borrowings under the 2010 Credit Agreement reduced the Company’s borrowing availability under its 2010 Credit Agreement to $32.3 million.
Foreign Credit Facility
In the second quarter of 2011, in conjunction with its Chinese operations, UNIS Document Solutions Co. Ltd. (“UDS”) entered into a one-year revolving credit facility. This facility provides for a maximum credit amount of 8.0 million Chinese Yuan Renminbi. This translates to U.S. $1.2 million as of June 30, 2011. Draws on the facility are limited to 30 day periods and incur a fee of 0.5% of the amount drawn and no additional interest is charged.
Interest Rate Swap Transaction
On December 19, 2007, the Company entered into an interest rate swap transaction (the “Swap Transaction”) in order to hedge the floating interest rate risk on the Company’s long term variable rate debt. Under the terms of the Swap Transaction, the Company was required to make quarterly fixed rate payments to the counterparty calculated based on an initial notional amount of $271.6 million at a fixed rate of 4.1375%, while the counterparty was obligated to make quarterly floating rate payments to the Company based on the three month LIBOR. The notional amount of the Swap Transaction was scheduled to decline over the term of the then existing term loan facility consistent with the scheduled principal payments. The Swap Transaction had an effective date of March 31, 2008 and an original termination date of December 6, 2012.
On October 2, 2009, the Company amended the Swap Transaction (“the Amended Swap Transaction”). The Company entered into the Amended Swap Transaction in order to reduce the notional amount under the initial Swap Transaction from $271.6 million to $210.8 million to hedge the Company’s then-existing variable interest rate debt under the Company’s previous credit agreement.
In connection with the issuance of the Notes, the Amended Swap Transaction no longer qualified as a cash flow hedge and was de-designated.
As of December 31, 2010, the Amended Swap Transaction had a negative fair value of $9.7 million, all of which was recorded in accrued expenses. On January 3, 2011, the Amended Swap Transaction was terminated and settled. For further information, see Note 9 “Derivatives and Hedging Transactions”.
Commitments and Contingencies
Commitments and Contingencies
6. Commitments and Contingencies
Operating Leases. The Company has entered into various non-cancelable operating leases primarily related to facilities, equipment and vehicles used in the ordinary course of business.
Contingent Transaction Consideration. The Company is subject to earnout obligations entered into in connection with prior acquisitions. If the acquired businesses generate sales and/or operating profits in excess of predetermined targets, the Company is obligated to make additional cash payments in accordance with the terms of such earnout obligations. As of June 30, 2011, the Company has potential future earnout obligations for acquisitions consummated before the adoption of ASC 805 in the total amount of approximately $1.5 million through 2014 if predetermined financial targets are met or exceeded. These earnout payments are recorded as additional purchase price (as goodwill) when the contingent payments are earned and become payable.
Legal Proceedings. On October 21, 2010, a former employee, individually and on behalf of a purported class consisting of all non-exempt employees who work or worked for American Reprographics Company, LLC and American Reprographics Company in the State of California at any time from October 21, 2006 through October 21, 2010, filed an action against the Company in the Superior Court of California for the County of Orange. The complaint alleges, among other things, that the Company violated the California Labor Code by failing to (i) provide meal and rest periods, or compensation in lieu thereof, (ii) timely pay wages due at termination, and (iii) that those practices also violate the California Business and Professions Code. The relief sought includes damages, restitution, penalties, interest, costs, and attorneys’ fees and such other relief as the court deems proper. The Company has not included any liability in its Consolidated Financial Statements in connection with this matter. The Company cannot reasonably estimate the amount or range of possible loss, if any, at this time.
In addition to the matter described above, the Company is involved in various additional legal proceedings and other legal matters from time to time in the normal course of business. The Company does not believe that the outcome of any of these matters will have a material adverse effect on its consolidated financial position, results of operations or cash flows.
Comprehensive Loss
Comprehensive Loss
7. Comprehensive Loss
The Company’s comprehensive loss includes foreign currency translation adjustments and the amortized fair value of the Amended Swap Transaction, net of taxes. The Amended Swap Transaction was de-designated on December 1, 2010, as it no longer qualified as a cash flow hedge when the cash proceeds from the issuance of the Notes were used to pay off the Company’s previous credit agreement. At that time, the fair value of the Amended Swap Transaction was computed and the effective portion is stored in other comprehensive income and will be amortized into income, net of tax effect, on the straight-line method, based on the original notional schedule.
The differences between net (loss) income and comprehensive (loss) income attributable to ARC for the three and six months ended June 30, 2011 and 2010 are as follows:
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
(In thousands)   2011     2010     2011     2010  
 
                               
Net (loss) income
  $ (84,742 )   $ 1,733     $ (88,424 )   $ 2,442  
Foreign currency translation adjustments
    294       (66 )     583       50  
Gain (loss) on derivative, net of tax effect
    912       139       1,866       (174 )
 
                       
Comprehensive (loss) income
    (83,536 )     1,806       (85,975 )     2,318  
Comprehensive loss (income) attributable to noncontrolling interest
    17       (54 )     24       (46 )
 
                       
Comprehensive (loss) income attributable to American Reprographics Company
  $ (83,519 )   $ 1,752     $ (85,951 )   $ 2,272  
 
                       
Asset and liability accounts of foreign operations are translated into U.S. dollars, the Company’s functional currency, at current rates. Revenues and expenses are translated at the weighted-average currency rate for the fiscal period.
Stock-Based Compensation
Stock-Based Compensation
8. Stock-Based Compensation
The Company adopted the American Reprographics Company 2005 Stock Plan (the “Stock Plan”) in February 2005. The Stock Plan provides for the grant of incentive and non-statutory stock options, stock appreciation rights, restricted stock purchase awards, restricted stock awards, and restricted stock units to employees, directors and consultants of the Company. The Stock Plan authorizes the Company to issue up to 5,000,000 shares of common stock. This amount automatically increased annually on the first day of the Company’s fiscal year, from 2006 through and including 2010, by the lesser of (i) 1.0% of the Company’s outstanding shares on the date of the increase; (ii) 300,000 shares; or (iii) such smaller number of shares determined by the Company’s board of directors. As of June 30, 2011, 2,309,753 shares remain available for issuance under the Stock Plan.
Stock options granted under the 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 two to five years, 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% (110% in the case of an incentive stock option granted to a 10% stockholder) 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.
In February 2011, the Company granted options to acquire a total of 9,587 shares of the Company’s common stock to certain key employees with an exercise price equal to the fair market value of the Company’s common stock on the date of grant. The stock options granted to those key employees vest at a rate of 33 1/3% on each of the first three anniversaries from the date of grant and expire 10 years after the date of grant.
In March 2011, the Company granted an option to acquire 45,249 shares of the Company’s common stock to its Chief Operating Officer with an exercise price equal to the fair market value of the Company’s common stock on the date of grant. The stock option granted to the Company’s Chief Operating Officer vests at a rate of 25% on each of the first four anniversaries from the date of grant and expires 10 years after the date of grant. The Company also granted 1,444 shares of restricted stock to its President and Chief Executive Officer at a price per share of $8.66, which was the closing price of the Company’s common stock on the New York Stock Exchange (“NYSE”) on the date the restricted stock was granted. The shares of restricted stock will vest at a rate of 25% on each of the first four anniversaries from the date of grant.
In April 2011, the Company granted 15,000 shares of restricted stock to each of the Company’s Chief Accounting Officer and Chief Technology Officer at a price per share of $9.94 and $8.95, respectively, which was the closing price of the Company’s common stock on the NYSE on the date the restricted stock was granted. The shares of restricted stock will vest at a rate of 25% on each of the first four anniversaries of the date of grant. The Company also granted 404,000 shares of restricted stock to certain key employees at a price per share of $8.77, which was the closing price of the Company’s common stock on the NYSE on the date the restricted stock was granted. The shares of restricted stock will vest at a rate of 25% on each of the first four anniversaries from the date of grant. In addition, the Company granted 5,587 shares of restricted stock to each of the Company’s six non-employee members of its Board of Directors at a price per share of $8.95, which was the closing price of the Company’s common stock on the NYSE on the date the restricted stock was granted. The shares of restricted stock will vest on the one year anniversary from the date of grant.
The impact of stock-based compensation on the interim Condensed Consolidated Statements of Operations for the three months ended June 30, 2011 and 2010, before income taxes, was $1.8 million and $1.5 million, respectively.
The impact of stock-based compensation on the interim Condensed Consolidated Statements of Operations for the six months ended June 30, 2011 and 2010, before income taxes, was $3.3 million and $2.9 million, respectively.
As of June 30, 2011, total unrecognized compensation cost related to unvested stock-based payments totaled $5.6 million and is expected to be recognized over a weighted-average period of 3.5 years.
Derivatives and Hedging Transactions
Derivatives and Hedging Transactions
9. Derivatives and Hedging Transactions
As of June 30, 2011, the Company was not party to any derivative or hedging transactions.
As of December 31, 2010, the Company was party to the Amended Swap Transaction, in which the Company exchanged its floating-rate payments for fixed-rate payments. As of December 1, 2010, the Amended Swap Transaction was de-designated upon issuance of the Notes and payoff of the Company’s previous credit agreement. The Amended Swap Transaction no longer qualified as a cash flow hedge under ASC 815, as all the floating-rate debt was extinguished. The Amended Swap Transaction qualified as a cash flow hedge up to November 30, 2010. On January 3, 2011, the Company terminated and settled the Amended Swap Transaction.
As of June 30, 2011, $6.2 million is deferred in Accumulated Other Comprehensive Loss (“AOCL”) and will be recognized in earnings over the remainder of the original term of the Amended Swap Transaction which was scheduled to end in December 2012, but was terminated in January 2011. Over the next 12 months, the Company will amortize $5.0 million from AOCL to interest expense.
The following table summarizes the fair value and classification on the interim Condensed Consolidated Balance Sheets of the Amended Swap Transaction as of December 31, 2010:
                 
            Fair Value  
    Balance Sheet     December 31,  
(In thousands)   Classification     2010  
 
               
Derivative not designated as hedging instrument under ASC 815
               
 
               
Amended Swap Transaction
  Accrued expenses   $ 9,729  
The following table summarizes the loss recognized in AOCL of derivatives, designated and qualifying as cash flow hedges for the three and six months ended June 30, 2010:
                 
    Amount of Gain or (Loss) Recognized in  
    AOCL on Derivative  
    Three Months Ended     Six Months Ended  
(In thousands)   June 30, 2010     June 30, 2010  
 
               
Derivative in ASC 815 cash flow hedging relationship
               
Amended Swap Transaction
  $ 222     $ (326 )
Tax effect
    (83 )     152  
 
           
Amended Swap Transaction, net of tax effect
  $ 139     $ (174 )
 
           
The following table summarizes the effect of the Amended Swap Transaction on the interim Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2011 and 2010:
                                                                 
    Amount of Gain or (Loss) Reclassified from AOCL into Income  
    (effective portion)     (ineffective portion)  
    Three Months Ended     Six Months Ended     Three Months Ended     Six Months Ended  
    June 30,     June 30,     June 30,     June 30,  
(In thousands)   2011     2010     2011     2010     2011     2010     2011     2010  
 
                                                               
Location of Gain or (Loss) Reclassified from AOCL into Income
                                                               
Interest expense
  $ (1,457 )   $ (1,968 )   $ (2,980 )   $ (3,934 )   $     $ (34 )   $     $ (106 )
The following table summarizes the loss recognized in income of derivatives, not designated as hedging instruments under ASC 815 for the three and six months ended June 30, 2011:
                 
    Amount of Loss Recognized in Income on  
    Derivative  
    Three Months Ended     Six Months Ended  
(In thousands)   June 30, 2011     June 30, 2011  
 
               
Derivative not designated as hedging instrument under ASC 815
               
Amended Swap Transaction
  $     $ (120 )
Tax effect
          45  
 
           
Amended Swap Transaction, net of tax effect
  $     $ (75 )
 
           
Fair Value Measurements
Fair Value Measurements
10. Fair Value Measurements
In accordance with ASC 820, 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 sets forth, by level within the fair value hierarchy, the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2010. As required by ASC 820, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels.
         
    Significant Other  
    Observable Inputs  
    Level 2  
(In thousands)   December 31, 2010  
 
       
Recurring Fair Value Measure
       
Amended Swap Transaction
  $ 9,729  
The Company has also included additional required disclosures about the Company’s Amended Swap Transaction in Note 9 “Derivatives and Hedging Transactions.”
The Amended Swap Transaction is valued at fair value with the use of an income approach based on current market interest rates using a discounted cash flow model and an adjustment for counterparty risk. This model reflects the contractual terms of the derivative instrument, including the time to maturity and debt repayment schedule, and market-based parameters such as interest rates and yield curves. This model does not require significant judgment, and the inputs are observable. Thus, the derivative instrument is classified within Level 2 of the valuation hierarchy. The Company terminated and settled the Amended Swap Transaction on January 3, 2011.
The following table summarizes the bases used to measure certain assets and liabilities at fair value on a nonrecurring basis in the consolidated financial statements as of June 30, 2011:
                 
    Significant Other Unobservable Inputs  
    June 30, 2011  
(In thousands)   Level 3     Total Losses  
 
               
Nonrecurring Fair Value Measure
               
Goodwill
  $ 271,424     $ 23,335  
In accordance with the provisions of ASC 350, goodwill was written down to its implied fair value of $271.4 million as of June 30, 2011, resulting in an impairment charge of $23.3 million during the three and six months ended June 30, 2011. See Note 3, “Goodwill and Other Intangibles Resulting from Business Acquisitions” for further information regarding the process of determining the implied fair value of goodwill.
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 Consolidated Balance Sheets were $10.8 million as of June 30, 2011, 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 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 Consolidated Balance Sheet as of June 30, 2011 for its Notes is $200.0 million and $3.9 million for its subordinated notes payable. Using a discounted cash flow technique that incorporates a market interest rate which assumes adjustments for duration, optionality, and risk profile, the Company has determined the fair value of its Notes is $221.8 million as of June 30, 2011 and the fair value and for its subordinated notes payable is $3.8 million as of June 30, 2011.
Interest rate hedge agreements: The fair value of the interest rate swap is based on market interest rates using a discounted cash flow model and an adjustment for counterparty risk.
Condensed Consolidating Financial Statements
Condensed Consolidating Financial Statements
11. Condensed Consolidating Financial Statements
The Notes are fully and unconditionally guaranteed, on a joint and several basis, by all of the Company’s domestic subsidiaries (the “Guarantor Subsidiaries”). The Company’s foreign subsidiaries have not guaranteed the Notes (the “Non-Guarantor Subsidiaries”). Each of the Guarantor Subsidiaries is 100% owned, directly or indirectly, by the Company. There are no significant restrictions on the ability of the Company to obtain funds from any of the Guarantor Subsidiaries by dividends or loan. In lieu of providing separate audited financial statements for the Guarantor Subsidiaries, condensed consolidating financial information is presented below.
Condensed Consolidating Balance Sheet
June 30, 2011
                                         
    American                          
    Reprographics     Guarantor     Non-Guarantor              
(In thousands) (Unaudited)   Company     Subsidiaries     Subsidiaries     Eliminations     Total  
 
                                       
Assets
                                       
 
                                       
Current assets:
                                       
Cash and cash equivalents
  $     $ 9,527     $ 12,380     $     $ 21,907  
Accounts receivable, net
          54,899       6,146             61,045  
Intercompany operations
    295       4,529       (4,824 )            
Inventories, net
          8,072       3,278             11,350  
Deferred income taxes
                             
Prepaid expenses
    33       3,235       955             4,223  
Other current assets
          19,825       950             20,775  
 
                             
Total current assets
    328       100,087       18,885             119,300  
Property and equipment, net
          48,914       7,226             56,140  
Goodwill
          271,424                   271,424  
Investment in subsidiaries
    186,373       12,725             (199,098 )      
Other intangible assets, net
          51,827       1,972             53,799  
Deferred financing costs, net
    4,669                         4,669  
Deferred income taxes
                1,442             1,442  
Other assets
          1,938       281             2,219  
 
                             
Total assets
  $ 191,370     $ 486,915     $ 29,806     $ (199,098 )   $ 508,993  
 
                             
 
                                       
Liabilities and Equity
                                       
 
                                       
Current liabilities:
                                       
Accounts payable
  $ 45     $ 21,135     $ 1,987     $     $ 23,167  
Accrued payroll and payroll-related expenses
          7,752       288             8,040  
Accrued expenses
    875       16,553       2,069             19,497  
Intercompany loans
    (193,009 )     191,487       1,522              
Current portion of long-term debt and capital leases
    13,800       16,841       1,724             32,365  
 
                             
Total current liabilities
    (178,289 )     253,768       7,590             83,069  
Long-term debt and capital leases
    195,959       15,793       1,536             213,288  
Deferred income taxes
          29,486                     29,486  
Other long-term liabilities
          1,495       1,803             3,298  
 
                             
Total liabilities
    17,670       300,542       10,929             329,141  
 
                             
Commitments and contingencies
                                       
Total equity
    173,700       186,373       18,877       (199,098 )     179,852  
 
                             
Total liabilities and equity
  $ 191,370     $ 486,915     $ 29,806     $ (199,098 )   $ 508,993  
 
                             
Condensed Consolidating Balance Sheet
December 31, 2010
                                         
    American                          
    Reprographics     Guarantor     Non-Guarantor              
(In thousands) (Unaudited)   Company     Subsidiaries     Subsidiaries     Eliminations     Total  
 
                                       
Assets
                                       
 
                                       
Current assets:
                                       
Cash and cash equivalents
  $     $ 12,587     $ 13,706     $     $ 26,293  
Accounts receivable, net
          48,283       4,336             52,619  
Intercompany operations
    295       2,717       (3,012 )            
Inventories, net
          8,090       2,599             10,689  
Deferred income taxes
          7,157                   7,157  
Prepaid expenses
    72       2,799       1,203             4,074  
Other current assets
          5,942       928             6,870  
 
                             
Total current assets
    367       87,575       19,760             107,702  
Property and equipment, net
          52,376       6,660             59,036  
Goodwill
          294,759                   294,759  
Investment in subsidiaries
    257,838       16,065             (273,903 )      
Other intangible assets, net
          60,585       2,058             62,643  
Deferred financing costs, net
    4,995                         4,995  
Deferred income taxes
    708       34,453       2,674             37,835  
Other assets
          1,978       137             2,115  
 
                             
Total assets
  $ 263,908     $ 547,791     $ 31,289     $ (273,903 )   $ 569,085  
 
                             
 
                                       
Liabilities and Equity
                                       
 
                                       
Current liabilities:
                                       
Accounts payable
  $     $ 21,137     $ 2,456     $     $ 23,593  
Accrued payroll and payroll-related expenses
          7,643       337             7,980  
Accrued expenses
    2,210       25,563       2,361             30,134  
Intercompany loans
    (190,500 )     190,241       259              
Current portion of long-term debt and capital leases
          22,787       821             23,608  
 
                             
Total current liabilities
    (188,290 )     267,371       6,234             85,315  
Long-term debt and capital leases
    195,692       19,201       1,123             216,016  
Other long-term liabilities
          3,381       1,691             5,072  
 
                             
Total liabilities
    7,402       289,953       9,048             306,403  
 
                             
Commitments and contingencies
                                       
Total equity
    256,506       257,838       22,241       (273,903 )     262,682  
 
                             
Total liabilities and equity
  $ 263,908     $ 547,791     $ 31,289     $ (273,903 )   $ 569,085  
 
                             
Condensed Consolidating Statement of Operations
Three Months Ended
June 30, 2011
                                         
    American                          
    Reprographics     Guarantor     Non-Guarantor              
(In thousands) (Unaudited)   Company     Subsidiaries     Subsidiaries     Eliminations     Total  
Net sales
  $     $ 99,106     $ 10,484     $     $ 109,590  
Cost of sales
          65,315       8,580             73,895  
 
                             
Gross profit
          33,791       1,904             35,695  
Selling, general and administrative expenses
          24,746       2,058             26,804  
Amortization of intangible assets
          4,655       66             4,721  
Goodwill impairment
          23,335                   23,335  
 
                             
Loss from operations
          (18,945 )     (220 )           (19,165 )
Other income
          (35 )                 (35 )
Interest expense (income), net
    5,602       2,114       (17 )           7,699  
 
                             
Loss before equity earnings of subsidiaries and income tax provision
    (5,602 )     (21,024 )     (203 )           (26,829 )
Equity in earnings of subsidiaries
    76,175       1,446             (77,621 )      
Income tax provision
    2,853       53,705       1,355             57,913  
 
                             
Net (loss) income
    (84,630 )     (76,175 )     (1,558 )     77,621       (84,742 )
Loss attributable to noncontrolling interest
                112             112  
 
                             
Net (loss) income attributable to American Reprographics Company
  $ (84,630 )   $ (76,175 )   $ (1,446 )   $ 77,621     $ (84,630 )
 
                             
Consolidating Condensed Statement of Operations
Three Months Ended
June 30, 2010
                                         
    American                          
    Reprographics     Guarantor     Non-Guarantor              
(In thousands) (Unaudited)   Company     Subsidiaries     Subsidiaries     Eliminations     Total  
Net sales
  $     $ 106,504     $ 8,584     $     $ 115,088  
Cost of sales
          69,136       6,497             75,633  
 
                             
Gross profit
          37,368       2,087             39,455  
Selling, general and administrative expenses
          26,404       1,765             28,169  
Amortization of intangible assets
          2,484       73             2,557  
 
                             
Income from operations
          8,480       249             8,729  
Other income, net
          (34 )                 (34 )
Interest expense (income), net
          5,757       (3 )           5,754  
 
                             
Income before equity earnings of subsidiaries and income tax provision
          2,757       252             3,009  
Equity in earnings of subsidiaries
    (1,679 )     (141 )           1,820        
Income tax provision
          1,219       57             1,276  
 
                             
Net income (loss)
    1,679       1,679       195       (1,820 )     1,733  
Income attributable to noncontrolling interest
                (54 )           (54 )
 
                             
Net income (loss) attributable to American Reprographics Company
  $ 1,679     $ 1,679     $ 141     $ (1,820 )   $ 1,679  
 
                             
Consolidating Condensed Statement of Operations
Six Months Ended
June 30, 2011
                                         
    American                          
    Reprographics     Guarantor     Non-Guarantor              
(In thousands) (Unaudited)   Company     Subsidiaries     Subsidiaries     Eliminations     Total  
Net sales
  $     $ 197,096     $ 18,998     $     $ 216,094  
Cost of sales
          131,930       15,083             147,013  
 
                             
Gross profit
          65,166       3,915             69,081  
Selling, general and administrative expenses
          50,573       4,063             54,636  
Amortization of intangible assets
          9,333       132             9,465  
Goodwill impairment
          23,335                   23,335  
 
                             
Loss from operations
          (18,075 )     (280 )           (18,355 )
Other income
          (61 )                 (61 )
Interest expense (income), net
    11,342       4,556       (32 )           15,866  
 
                             
Loss before equity earnings of subsidiaries and income tax provision
    (11,342 )     (22,570 )     (248 )           (34,160 )
Equity in earnings of subsidiaries
    76,225       1,444             (77,669 )      
Income tax provision
    706       52,211       1,347             54,264  
 
                             
Net (loss) income
    (88,273 )     (76,225 )     (1,595 )     77,669       (88,424 )
Loss attributable to noncontrolling interest
                151             151  
 
                             
Net (loss) income attributable to American Reprographics Company
  $ (88,273 )   $ (76,225 )   $ (1,444 )   $ 77,669     $ (88,273 )
 
                             
Consolidating Condensed Statement of Operations
Six Months Ended
June 30, 2010
                                         
    American                          
    Reprographics     Guarantor     Non-Guarantor              
(In thousands) (Unaudited)   Company     Subsidiaries     Subsidiaries     Eliminations     Total  
Net sales
  $     $ 210,593     $ 16,656     $     $ 227,249  
Cost of sales
          138,160       12,783             150,943  
 
                             
Gross profit
          72,433       3,873             76,306  
Selling, general and administrative expenses
          51,831       3,469             55,300  
Amortization of intangible assets
          5,049       144             5,193  
Goodwill impairment
                             
 
                             
Income from operations
          15,553       260             15,813  
Other income, net
          (77 )                 (77 )
Interest expense, net
          11,638       4             11,642  
 
                             
Income before equity earnings of subsidiaries and income tax provision
          3,992       256             4,248  
Equity in earnings of subsidiaries
    (2,396 )     (141 )           2,537        
Income tax provision
          1,737       69             1,806  
 
                             
Net income (loss)
    2,396       2,396       187       (2,537 )     2,442  
Income attributable to noncontrolling interest
                (46 )           (46 )
 
                             
Net income (loss) attributable to American Reprographics Company
  $ 2,396     $ 2,396     $ 141     $ (2,537 )   $ 2,396  
 
                             
Consolidating Condensed Statement of Cash Flows
Six Months Ended
June 30, 2011
                                         
    American                          
    Reprographics     Guarantor     Non-Guarantor              
(In thousands) (Unaudited)   Company     Subsidiaries     Subsidiaries     Eliminations     Total  
 
                                       
Cash flows from operating activities
                                       
Net cash (used in) provided by operating activities
  $ (10,750 )   $ 22,939     $ (316 )   $     $ 11,873  
 
                                       
Cash flows from investing activities
                                       
Capital expenditures
          (6,968 )     (654 )           (7,622 )
Payment for swap transaction
          (9,729 )                 (9,729 )
Other
          803       (156 )           647  
 
                             
Net cash used in investing activities
          (15,894 )     (810 )           (16,704 )
 
                             
 
                                       
Cash flows from financing activities
                                       
Proceeds from stock option exercises
          108                   108  
Proceeds from issuance of common stock under Employee Stock Purchase Plan
          23                   23  
Excess tax benefit related to stock-based compensation
          31                   31  
Payments on long-term debt agreements and capital leases
          (13,325 )     (776 )           (14,101 )
Net borrowings under revolving credit facilities
    13,800             820             14,620  
Payment of deferred loan fees
    (541 )                       (541 )
Advances to/from subsidiaries
    (2,509 )     3,058       (549 )           -  
 
                             
Net cash provided by (used in) financing activities
    10,750       (10,105 )     (505 )           140  
 
                             
Effect of foreign currency translation on cash balances
                305             305  
 
                             
Net change in cash and cash equivalents
          (3,060 )     (1,326 )           (4,386 )
Cash and cash equivalents at beginning of period
          12,587       13,706             26,293  
 
                             
Cash and cash equivalents at end of period
  $     $ 9,527     $ 12,380     $     $ 21,907  
 
                             
Consolidating Condensed Statement of Cash Flows
Six Months Ended
June 30, 2010
                                         
    American                          
    Reprographics     Guarantor     Non-Guarantor              
(In thousands) (Unaudited)   Company     Subsidiaries     Subsidiaries     Eliminations     Total  
 
                                       
Cash flows from operating activities
                                       
Net cash provided by operating activities
  $     $ 27,427     $ 319     $     $ 27,746  
 
                                       
Cash flows from investing activities
                                       
Capital expenditures
          (2,349 )     (428 )           (2,777 )
Payment for swap transaction
                             
Other
          811       34             845  
 
                             
Net cash used in investing activities
          (1,538 )     (394 )           (1,932 )
 
                             
 
                                       
Cash flows from financing activities
                                       
Proceeds from stock option exercises
          125                   125  
Proceeds from issuance of common stock under Employee Stock Purchase Plan
          16                   16  
Excess tax benefit related to stock-based compensation
          38                   38  
Payments on long-term debt agreements and capital leases
          (20,947 )     (649 )           (21,596 )
Net repayments under revolving credit facility
                (123 )           (123 )
Payment of loan fees
                             
Advances to/from subsidiaries
          573       (573 )            
 
                             
Net cash used in financing activities
          (20,195 )     (1,345 )           (21,540 )
 
                             
Effect of foreign currency translation on cash balances
                22             22  
 
                             
Net change in cash and cash equivalents
          5,694       (1,398 )           4,296  
Cash and cash equivalents at beginning of period
          15,319       14,058             29,377  
 
                             
Cash and cash equivalents at end of period
  $     $ 21,013     $ 12,660     $     $ 33,673