Management Commentary

"In a year where interest rates constrained capital spending and sentiment was mixed on the health of the economy, our ability to adapt and manage costs drove an increase in fourth quarter revenue, limited declines in annual revenue to less than two percent, and held gross margins steady for the year," said Suri Suriyakumar, CEO of ARC Document Solutions. "Importantly, the changes we've made over the past several years to refine our strategic focus served us well in 2023 and positioned us well for ongoing success in 2024."

"We grew our strategic business segments in each quarter of the year, with document scanning leading the way with year-over-year sales growth of 34% in the fourth quarter and 17% for the year. We also entered new markets for color services-significantly offsetting softness in construction plan printing-and maintained profitability in 2023," said Dilo Wijesuriya, President and Chief Operating Officer. "Moving forward, our revenue performance in the fourth quarter serves as a clear indication of the positive direction our company is headed. Our emphasis on scanning and digital color printing is driving overall company expansion, and our management team in every market is 100 percent focused on achieving superior results in the coming year."

"In 2023, we continued to optimize our costs while balancing our investment in our people and infrastructure, and we generated healthy cash flows from operations in the fourth quarter and the year," said Jorge Avalos, Chief Financial Officer. "Shareholder returns reached an all-time high for the second year in a row as we used more than $12 million dollars to issue dividends and repurchase shares. We have every intention of repeating that performance in 2024. As for the site remediation issue, we don't expect it to hamper our operations or our cash flows in a meaningful way in any given year of the project's execution."

Fourth Quarter Overview

Demand for digital color printing across our customer base was robust for the first three quarters of the year and continued in the fourth quarter with year-end and holiday marketing promotions. Strength in this business line continued to offset weakness in black and white construction plan printing volume due to a lack of construction activity. With no significant letup in interest rates, capital spending constraints left our equipment and supply sales essentially flat year-over-year. Onsite print volumes moderated slightly in the fourth quarter, but we saw signs of stabilization as we successfully completed a number of multi-year contract renewals with large, enterprise-level customers. Demand for document scanning grew 34% year-over-year in the fourth quarter and helped ARC achieve 17% sales growth in this strategic sales category for the year. Economic inflation in the U.S., Canada, and abroad had a material effect on our business over the past year, primarily in the form of higher labor and material costs. Price increases in materials continue to be passed on to our customers. Supply chain disruptions, other than price increases, were largely resolved in 2023, and we remain reasonably protected from them due to the wide variety of suppliers we have developed over our history.

2023 Fourth Quarter Supplemental Information:

• Cash and cash equivalents on the consolidated balance sheet in the fourth quarter 2023 were $56.1 million.
• ARC's next quarterly cash dividend of $0.05 will be paid on February 29, 2024 with a record date of January 31, 2024.
• Days sales outstanding were 47 days as of fourth quarter 2023, a decline of four days over the same period in the prior year.
• The number of MPS locations at the end of the fourth quarter was approximately 10,440.

Net Revenue

In the fourth quarter 2023, net revenue increased by $0.1 million compared to the fourth quarter of 2022. Net revenue for full-year 2023 decreased 1.7% or $4.8 million compared to the full year of 2022, primarily driven by the decrease in sales from digital construction plan printing and Equipment and Supplies, partially offset by the year-over-year increase in sales from Scanning and digital color printing.

Revenue by Business Line

For the fourth quarter 2023, Digital Printing sales decreased 2.5% compared to prior year, and for the full-year 2023 decreased 2.7% year-over-year. Year-over-year sales for the fourth quarter and full year 2023 increased in digital color graphic printing from new and existing customers, and we experienced continuing demand for digital color graphic printing across most of our customer base. This growth was offset by the decrease of sales in digital plan printing for construction, which we attribute to less activity and lower spending on new building projects due to increased costs of capital.

For the fourth quarter 2023, Managed Print Services (MPS) sales decreased 1.4% compared to prior year, and sales for full-year 2023 decreased 1.3% as compared to 2022. Fewer employees returning to the workplace after the pandemic has generally constrained onsite print volumes.

For the fourth quarter 2023, Scanning and Digital Imaging sales increased 33.7% compared to prior year, and sales for the full-year 2023 increased 17.0% as compared to the full year of 2022. The increase in sales was primarily attributable to growing demand for paper-to-digital document conversions used in day-to-day business operations, and the creation of digital archives to replace long-term warehoused paper document storage.

For the fourth quarter 2023, Equipment and Supplies sales decreased 0.7% compared to prior year, and sales for the full-year 2023 declined 11.5% as compared to the full year of 2022. The decrease was a result of reduced sales from our Chinese joint venture as the Chinese economy continues to be challenged. Equipment and Supplies sales continue to decline in the U.S. as well. We attribute the decrease in sales to our customers' reluctance to acquire equipment while interest rates remain high.

Gross Profit

Fourth quarter gross profit decreased by $1.0 million or 150 basis points as a result of the decline in high-margin digital plan printing sales. Despite a sales decrease of $4.8 million for the full-year 2023 as compared to the same period in 2022, gross profit decreased by just $1.6 million. Gross margin for the full-year 2023 remained flat at 33.6%, as compared to 2022. Gross margin stability during 2023 was driven by improved efficiency in our cost structure and a reduction in depreciation expense.

Selling, General and Administrative Expenses

Selling, general and administrative expenses in the fourth quarter 2023 decreased in absolute dollars year-over-year by $0.6 million or 3.1%, and decreased $1.2 million or 1.6% for the full year 2023, as compared to 2022. The decrease was primarily driven by lower commission and bonus accruals due to the decline in net sales and net income attributable to ARC.

Site Remediation Expense

We are currently involved in a site remediation obligation due to a former gas station that had been situated on a property we obtained as part of a business acquisition in the late 1990s. In 2020, the local County's Department of Environmental Health (CDEH), approved our remedial clean-up plan, hence a liability on an undiscounted basis for $0.6 million for costs attributable to our clean-up plan was established. Additional review conducted in the fourth quarter of 2023 identified certain potential risks arising out of a structure on a neighboring property. As a result, in December of 2023, the CDEH requested that an alternative remedial plan be developed and submitted by March 12, 2024, to address the structural aspects of the site. We are in the process of finalizing an alternative plan with the guidance and expertise of an environmental consulting firm engaged expressly for this purpose. The additional concerns identified in December 2023 require more complex remediation measures for a longer duration than those contained in the plan approved by the CDEH in 2020. In light of the expected increase in expenses associated with remediating the site we have increased the reserve by approximately $4.0 million, reflecting a total reserve on an undiscounted basis of $4.5 million as of December 31, 2023. We have accrued probable and reasonably estimable costs for the resolution of the obligation based upon types of remediation efforts currently anticipated, the volume of contaminants in the impacted areas, regulatory oversight, and other costs.

Net Income and Earnings Per Share

Year-over-year, net income attributable to ARC and earnings per share in the fourth quarter of 2023 and for the full year 2023 as compared to 2022 decreased primarily due to the site remediation expense. Year-over year, adjusted net income attributable to ARC and adjusted earnings per share for the full year 2023 as compared to 2022, remained relatively flat despite the $4.8 million decline in net sales, primarily driven by lower selling, general and administrative expenses as noted above.

The increase in cash flows from operations during the fourth quarter of 2023 as compared to the same period in 2022, was primarily due to improvement in collections. The decrease in cash flows from operations for the full-year 2023, compared to the same period in 2022, was primarily due to the decrease in net income, partially offset by the improvement in our collection of accounts receivable.

Decrease in EBITDA in the fourth quarter of 2023 as compared to the same period in 2022, is primarily due to the site remediation expense. The decrease in Adjusted EBITDA for the full year 2023 as compared to the same period in 2022, is largely attributable to lower sales in 2023.