ALTA EQUIPMENT GROUP INC. (ALTG) FY 2022 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis should be read in conjunction with the financial statements and related notes included elsewhere in this annual report. This discussion contains “forward-looking statements” reflecting Alta’s current expectations, estimates, and assumptions concerning events and financial trends that may affect its future operating results and financial position. Actual results and the timing of events may differ materially from those contained in these forward-looking statements due to a number of factors. Factors that could cause or contribute to such differences include, but are not limited to, economic and competitive conditions, regulatory changes and other uncertainties, as well as those factors discussed below and elsewhere in this annual report, particularly in “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements,” all of which are difficult to predict. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed may not occur. Alta assumes no obligation to update any of these forward-looking statements.

Strategic Acquisitions in 2022

Our growth strategy is predicated on making strategic acquisitions that expand our geographic reach, broaden our capabilities and service offerings and diversify our customer and supplier bases. We believe these acquisitions, both immediately and over the long-term will be accretive to our financial performance. In Q3 and Q4 of 2022, we acquired Yale Industrial Trucks Inc. ("YIT") and Ecoverse, respectively. The YIT acquisition expands our Material Handling segment internationally into the major metropolitan markets of Toronto and Montreal. The Ecoverse acquisition represents our entrance into the master dealer distribution business as we now have master dealer rights in the United States and Canada for several best-in-class environmental processing equipment OEMs.

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Supply Chain Disruptions

Our industry continues to be unfavorably impacted by equipment supply chain constraints leading to shortages across construction and material handling equipment categories and limiting our collective ability to meet customer demand and potentially increase our market share. We continued to experience supply chain disruptions related to our ability to take delivery of new equipment from our OEMs during 2022 however, the supply chain constraints began to abate during the second half of 2022, resulting in an increase in our new equipment inventory relative to prior periods. Importantly, the broader supply chains issues that have impacted new equipment availability has not negatively impacted our ability to source replacement parts for our service operation, as our OEMs have prioritized the production and delivery of replacement parts to dealers. Should the new equipment supply chain issues continue for an extended period of time or worsen, the impact on our distribution could have an adverse effect on our results of operations, financial condition, and cash flows. Management continues to monitor and evaluate all of these factors and the related impacts on our business and operations, and we are diligently working to minimize the equipment supply chain impacts to our business and to our customers.

Business Description and Segments

For detailed description of our business and segments, refer to Part I, Item 1, Business, and Note 19, Segments, respectively.

Financial Statement Overview

Our revenues are primarily derived from the sale or rental of equipment and product support (e.g., parts and service) related activities, and consist of:

New Equipment Sales. We sell new heavy construction, material handling and environmental processing equipment and are a leading regional distributor for many nationally recognized equipment manufacturers. Our new equipment sales operation is a primary source of new customers for the rental, parts and services business. The majority of our new equipment sales is predicated on exclusive distribution agreements we have with best-in-class OEMs. The sale of new equipment to customers, while profitable from a gross margin perspective, acts as a means of generating equipment field population and activity for our higher-margin aftermarket revenue streams, specifically service and parts. We also sell tangential products and services related to our material handling equipment offerings which include, but are not limited to, automated equipment and related installation, warehouse systems integration solutions and related controls software.

Used Equipment Sales. We sell used equipment which is typically equipment that has been taken in on trade from a customer that is purchasing new equipment, equipment coming off a third-party lease arrangement where we purchase the equipment from the finance company, or used equipment that is sourced for our customers in the open market by our used equipment specialists. Used equipment sales in our territories, like new equipment sales, generate parts and services business for the Company.

Parts Sales. We sell replacement parts to customers and supply parts to our own rental fleet. Our in-house parts inventory is extensive such that we are able to provide timely service support to our customers. The majority of our parts inventory is made up of OEM replacement parts for those OEMs with which we have exclusive dealership agreements to sell new equipment.

Service Support. We provide maintenance and repair services for customer-owned equipment and we maintain our own rental fleet. In addition to repair and maintenance on an as needed or scheduled basis, we provide ongoing preventative maintenance services and warranty repairs for our customers. We have committed substantial resources to training our technical service employees and have a full-scale service infrastructure that we believe differentiates us from our competitors. Approximately 40% of our employees are skilled service technicians.

Equipment Rentals. We rent heavy construction, compact, aerial, material handling and a variety of other types of equipment to our customers on a daily, weekly and monthly basis. Our rental fleet, which is well-maintained, has an original acquisition cost (which we define as the cost originally paid to manufacturers plus any capitalized costs) of $504.6 million as of December 31, 2022. The original acquisition cost of our rental fleet excludes the $11.8 million of assets associated with our guaranteed purchase obligations, which are assets that are not in our day-to-day operational control. In addition to being a core business, our rental business also creates cross-selling opportunities for us in our sales and product support activities.

Rental Equipment Sales. We also sell rental equipment from our rental fleet. Customers often have options to purchase equipment after or before rental agreements have matured. Rental equipment sales, like new and used equipment sales, generate customer-based equipment field population within our territories and ultimately yield high-margin parts and services revenue for us.

Principal Costs and Expenses

Our cost of revenues are primarily related to the costs associated with the sale or rental of equipment and product support activities, which includes direct labor costs for our skilled technicians. Our operating expenses consist principally of selling, general and administrative expenses, which primarily includes personnel costs associated with our sales and administrative staff and expenses

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associated with the deployment of our service vehicle fleet and occupancy expenses. In addition, we have interest expense related to our floorplan payables, finance leases, line of credit, and secured second lien notes. These principal costs and expenses are described further below:

New Equipment Sales. Cost of new equipment sold primarily consists of the equipment cost of the new equipment that is sold, net of any amount of credit given to the customer from trade-ins of used equipment.

Used Equipment Sales. Cost of used equipment sold consists of the net book value, or cost, of used equipment we purchase from third parties or the trade-in value of used equipment that we obtain from customers in new equipment sales transactions.

Parts Sales. Cost of parts sales represents the net book value, or cost, of parts used in the maintenance and repair of customer-owned equipment we service or parts sold directly to customers for their owned equipment (e.g., over-the-counter parts).

Services Revenue. Cost of services revenues represents, primarily, the labor costs attributable to services provided for the maintenance and repair of customer-owned equipment. Training, paid time off, and other non-billable costs of maintaining our expert technicians flow through this department in addition to the direct customer-billable labor.

Rental Revenue. Rental expense represents the costs associated with rental equipment, including, among other things, the cost of repairing and maintaining our rental equipment and other miscellaneous costs of owning rental equipment. Other rental expenses consist primarily of equipment support activities that we provide our customers in connection with renting equipment, such as freight services and damage waiver policies.

Rental Depreciation. Depreciation of rental equipment represents the depreciation costs attributable to rental equipment. See Note 2, Summary of Significant Accounting Policies, for information on our rental equipment depreciation methods.

Rental Equipment Sales. Cost of previously rented equipment sold consists of the net book value (i.e., net of accumulated depreciation) of rental equipment sold from our rental fleet.

General and Administrative Expenses. These costs are comprised of three main components: personnel, operational and occupancy costs. Personnel costs are comprised of hourly and salaried wages for administrative employees, including incentive compensation, and employee benefits, including medical benefits. Operational costs include marketing activities, costs associated with deploying and leasing our service vehicle fleet, insurance, IT, office and shop supplies, general corporate costs, depreciation on non-sales and rental related assets and intangible amortization. Occupancy costs are comprised of all expenses related to our facility infrastructure, including rent, utilities, property taxes and building insurance.

Other Income (Expense). This section of the Consolidated Statement of Operations is mostly comprised of interest expense and other miscellaneous items that result in income or expense. Interest expense is mostly driven by our OEM floorplan financing arrangements, a working capital line of credit, our second lien secured notes and our finance lease arrangements. Also included in this section of the financials are non-recurring costs, in particular expenses associated with the extinguishment of debt in 2021 and 2020.

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Results of Operations

Years ended December 31, 2022 and 2021

Consolidated Results

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Non-GAAP Financial Measure: Organic Revenue Growth

The above table contains a non-GAAP financial measure. A “non-GAAP financial measure” is defined as a numerical measure of a company’s financial performance that excludes or includes amounts so as to be different than the most directly comparable measure calculated and presented in accordance with GAAP in the consolidated statements of income, balance sheets or statements of cash flows of the company. The non-GAAP financial measure used is organic revenue and growth rates associated with organic revenue. Pursuant to the requirements of Regulation G, we have provided a reconciliation of organic revenue to the most directly comparable GAAP financial measure in the table above and in subsequent tables in management's discussion and analysis of our individual business segments. This measure is supplemental to, and should be used in conjunction with, the most comparable GAAP measure. Management uses this non-GAAP financial measure to monitor and evaluate financial results and trends.

We define organic revenue growth as revenue growth excluding the impact of acquisitions that do not appear fully in both periods in the current and prior years. We believe organic revenue growth is a meaningful metric to investors as it provides a more consistent comparison of our revenues to prior periods as well as to industry peers.

Revenues: Consolidated revenues increased by $359.0 million, or 29.6%, to $1,571.8 million for the year ended December 31, 2022 as compared to the same period last year. Organic revenue growth in the year ended December 31, 2022 increased 16.1% compared to the same period last year. In summary, we have experienced a high level of market demand for our products and services in a supply and labor constrained environment and in certain regions we have taken market share from our competitors. These conditions and our market performance have led to a year-to-date organic revenue increase of 26.3% in new and used equipment sales, a 13.6% organic revenue increase in our combined parts and service product support departments, and a 10.3% organic increase in rental revenue, which is a result of a larger fleet in 2022 and both higher physical utilization and rental rates when compared to 2021. Rental equipment sales declined for the year ended December 31, 2022 as compared to the same period last year as we strategically balance the decision to retain fleet, given OEM new equipment supply chain challenges, to benefit from the elevated utilization and rental rate environment but still accommodate sales into our territories to bolster field population for longer-term returns in our product support departments. On a consolidated basis, we realized an organic increase of $193.9 million for the year ended December 31, 2022, as compared to the same period last year.

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Gross profit (GP):

Consolidated gross profit increased by 80 basis points from 25.9% in the year ended December 31, 2021 to 26.7% over the same period in 2022. New and used equipment sales margins increased 40 basis points to 16.4%, reflecting our focus on providing more customized equipment solutions which yield a higher gross margin versus commodity products, and a favorable equipment pricing environment when compared to the same period last year. The favorable pricing environment also contributed to a 770 basis points increase in rental equipment sales margin when comparing the year over year periods. Parts sales margins modestly improved year over year amid high demand for equipment replacement parts on an aging field population. We realized a 260 basis points increase in rental revenue gross margin for the year ended December 31, 2022 largely as a result of improved physical utilization of the rental fleet and a rising rental rate environment when compared to the same period last year. Additionally, service gross margins decreased 270 basis points year over year primarily related to an increase in non-billable costs of our technicians which include training, paid time off, unreimbursed travel time to customers, and a reduction of OEM reimbursement rates on warranty and fleet repairs which has led to incremental warranty write-offs. Additionally, service margins were partially impacted due to a year-over-year labor cost allocation change in our Material Handling segment, which impacted reporting for a portion of 2021. This allocation change is described further in the Material Handling Results section below.

General and administrative expenses: Consolidated general and administrative (“G&A”) expenses increased by 27.8% to $378.8 million for the year ended December 31, 2022 compared to the same period last year, driven by the full period impact from our 2021 acquisitions, incremental costs from our 2022 acquisitions, as well as increases in operating input costs such as vehicles, fuel, and technician supplies, and an increase in certain sales-based expenses such as sales commissions and marketing expenditures which supported the large increase in equipment sales year over year. Further, employment costs such as wages and benefits increased due to the overall growth of our employee headcount compounded by inflationary labor market factors.

Other (expense) income: Consolidated other expense for the year ended December 31, 2022 was $30.2 million compared to $35.2 million for the year ended December 31, 2021. The decrease is primarily due to the loss on debt extinguishment in the second quarter of 2021 of $11.9 million that did not recur in 2022 partially offset by an increase in interest expense due to higher rates on our variable rate debt and more debt outstanding due to acquisitions and increasing inventory levels.

Provision (benefit) for income taxes: The Company recorded an income tax provision of $1.3 million and $3.6 million for the years ended December 31, 2022 and 2021, respectively, primarily due to income in the current year that cannot be fully offset with net operating losses and establishing a full valuation allowance against our deferred tax asset in 2021.

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Material Handling Results

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Revenues: Material Handling segment revenues increased by $103.2 million to $570.7 million for the year ended December 31, 2022 as compared to the same period last year. Organically, the segment revenues increased 16.5% for the year ended December 31, 2022 over the same period in the prior year based on strong customer demand, a favorable pricing environment and our OEMs ability to produce and deliver more new equipment in 2022 versus 2021. Importantly, product support revenues increased 15.8%, and rental revenue increased 21.3%, on an organic basis, for the year ended December 31, 2022 as compared to the same period last year. The organic increase in rental revenues year over year is primarily attributable to a larger rental fleet and increases in both physical fleet utilization and rental rates. Additionally, the year ended December 31, 2022 included five months of operating activity for our YIT acquisition, which closed on July 29, 2022, driving further variance between the comparable periods on an inorganic basis.

Gross profit (GP):

Material Handling gross profit for the year ended December 31, 2022 decreased 10 basis points to 34.4% compared to the same period in 2021, remaining relatively consistent overall. While new and used equipment gross margins have remained relatively consistent year over year, we have gained 240 basis points in parts gross margin during 2022 when compared to the same period last year amid a favorable pricing environment for equipment replacement parts. The 460 basis points service margin declines for the year ended December 31, 2022, can be primarily attributed to the historic allocation of technician labor cost in our New York City-based business to general and administrative expense versus cost of labor while they operated on their legacy accounting system. On June 1, 2021, the business unit was fully integrated into our ERP platform and cost of technician labor has since been allocated to costs of sales. Secondarily, as it relates to service gross margin for the year ended December 31, 2022, we have also experienced a reduction of OEM reimbursement rates on warranty and fleet repairs which has led to incremental warranty write-offs and compression in gross margin. Lastly, for the year ended December 31, 2022, we experienced an increase in non-billable costs of our technicians which include training, paid time off, and unreimbursed travel time to customers as a percentage of service revenue when compared to the year ended December 31, 2021.

General and administrative expenses: General and administrative expenses increased by $26.3 million to $172.1 million for the year ended December 31, 2022 as compared to the same period last year mainly due to the full period impact from the 2021 acquisitions of ScottTech and Baron, and the 2022 YIT acquisition. Sales related variable costs, such as sales commissions and bonuses as well as an increase in operating input costs, as described previously, are also impacting the variance year over year.

Other (expense) income: Other expense increased by $2.1 million to $7.3 million for the year ended December 31, 2022 as compared to the same period last year. The increase is mainly related to the increase in total borrowings used to support acquisitions combined with a rise in interest rates on our variable rate debt.

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Construction Equipment Results

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Revenues: Construction equipment segment revenues increased by 33.6% to $995.8 million for the year ended December 31, 2022 as compared to the same period last year. Organically, the segment revenues increased 16.0% year over year based on strong customer demand, a favorable pricing environment and our OEMs ability to produce and deliver more new equipment in 2022 versus 2021. Importantly, product support revenues increased 11.8%, and rental revenue increased 5.3%, on an organic basis, for the year ended December 31, 2022 as compared to the same period last year. While we effectively held the gross book value of the rental fleet in the construction segment constant in 2022 when compared to 2021, we were able to organically increase rental revenues for the year ended December 31, 2022 primarily due to increases in rental rates year over year. Rental equipment sales declined for the year ended December 31, 2022 as compared to the same period last year as we strategically balance the decision to retain fleet, given OEM new equipment supply chain challenges, to benefit from the elevated utilization and rental rate environment but still accommodate sales into our territories to bolster field population for longer-term returns in our product support departments.

Gross profit (GP):

Construction equipment gross profit increased by 170 basis points to 22.3% for the year ended December 31, 2022, from 20.6% compared to the same period in 2021, with overall margin improvements reflective of the general business climate and demand factors of the industry. Specifically, new and used equipment sales margins increased 200 basis points to 14.1%, primarily related to a favorable equipment pricing environment and revenue mix being more weighted to higher margin equipment types when compared to the same period last year. These factors also led to a 690 basis points increase in rental equipment sales margin when comparing the periods year over year. Parts sales margins are modestly improved year over year amid a favorable pricing environment for equipment replacement parts. Rental revenue gross margin for the year ended December 31, 2022 was moderately improved from the same period last year due to higher rental rates. Service gross margins reduced slightly year over year primarily related to an increase in non-billable costs of our technicians which include training, paid time off and unreimbursed travel time to customers and a reduction of OEM reimbursement rates on warranty and fleet repairs which has led to excess warranty write-offs.

General and administrative expenses: General and administrative expenses increased by 33.9% to $187.5 million for the year ended December 31, 2022 as compared to the same period in 2021, mainly due to the influence of our acquired companies’ impact on the current period and increases in operating input costs, such as vehicles, fuel and technician shop supplies, and an increase in certain sales-related expenses such as sales commissions and marketing expenditures, which supported the large increase in new and used equipment sales for the year. Additionally, we realized increases in personnel costs such as wages, bonuses, and employer-sponsored benefits, a result of inflationary factors and general headcount increases in the segment.

Other (expense) income: Other expense increased by $4.5 million to $20.6 million for the year ended December 31, 2022 as compared to the same period in 2021 primarily due to the increase in interest rates on our variable rate debt and the interest expense related to the financing of our 2021 acquisitions, as the acquisitions were financed through our line of credit and floorplan financing facilities.

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Liquidity and Capital Resources

Year ended December 31, 2022, 2021 Cash Flows

Cash Flow from Operating Activities. Cash flows from operating activities include net income adjusted for non-cash items and the effects of changes in working capital. For the year ended December 31, 2022, operating activities resulted in net cash provided by operations of $26.0 million. Our cash flows from operating activities related to net income adjusted for non-cash income and expenses, primarily gain on sale of rental fleet and depreciation and amortization, generated $101.0 million for the year ended December 31, 2022. This metric increased $23.7 million for the year end December 31, 2022 when compared to the same period last year, primarily due to the increase in income from operations year over year. This was partially offset by $75.0 million of net working capital investments.

For the year ended December 31, 2021, operating activities resulted in net cash provided by operations of $30.7 million. Our cash flows from operating activities related to net loss adjusted for non-cash income and expenses, primarily gain on sale of rental fleet and depreciation and amortization, generated $77.3 million for the year ended December 31, 2022. This was partially offset by $46.6 million of net working capital investments.

Cash Flow from Investing Activities. For the year ended December 31, 2022, our cash used in investing activities was $162.6 million. This was mainly due to $75.9 million in purchases of rental equipment, non-rental property and equipment, and equipment contracted under guaranteed purchase obligations, offset by proceeds from the sale of non-rental assets, and $86.7 million cash for the 2022 acquisitions and adjustments to the purchase prices of our 2021 acquisitions.

For the year ended December 31, 2021, our cash used in investing activities was $113.4 million. This was mainly due to $63.4 million cash used as a result of the 2021 acquisitions and $50.0 million in purchases of rental equipment, non-rental property and equipment, and equipment contracted under guaranteed purchase obligations offset by proceeds from the sale of non-rental assets.

Cash Flow from Financing Activities. For the year ended December 31, 2022, cash provided by financing activities was $136.9 million. The impact was mainly due to $118.5 million of net proceeds under our line of credit, primarily related to a draw on the line to fund the YIT and Ecoverse acquisitions, and net proceeds of $28.0 million related to floor plans with an unaffiliated source (i.e., a non-OEM vendor) to increase new equipment inventory levels and $0.7 million related to other financing activities. Inflows were partially offset by $3.6 million of payments on finance lease obligations and $6.7 million related to preferred and common stock dividend payments.

For the year ended December 31, 2021, cash provided by financing activities was $83.8 million. Net proceeds under our lines of credit and floor plans with an unaffiliated source (i.e. a non-vendor) were $59.4 million and $4.8 million, respectively. Net proceeds from issuance of notes amounted to $310.2 million. This was partially offset by payments related to the extinguishment of former debt which totaled $153.1 million, expenditures of debt issuance costs of $1.7 million, $3.8 million of payments on long term debt and finance lease obligations and promissory note and dividend payments totaling $3.6 million.

Sources of Liquidity

Our principal sources of liquidity have been from cash provided by our service, parts and rental related operations and the sales of new, used, and rental fleet equipment, proceeds from the issuance of debt, and borrowings available under our line of credit and floor plans. The Company reported $2.7 million in cash as of December 31, 2022. For more information on our available borrowings under the revolving line of credit, senior secured second lien notes, and floor plans, please refer to Note 9, Floor Plans and Note 10, Long-term Debt. We consider the undistributed earnings of our foreign subsidiaries to be indefinitely reinvested as we do not anticipate the need to repatriate funds to the U.S. to satisfy domestic liquidity needs.

Cash Requirements Related to Operations

Our principal uses of cash have been to fund operating activities and working capital (including new and used equipment inventories), purchases of rental fleet equipment and property and equipment, fund payments due under line of credit and floor plans payable, fund acquisitions, meet debt service requirements and funding the preferred stock and common stock dividends. In the future, we may pursue additional strategic acquisitions and seek to open new start-up locations. We anticipate that the uses described above encompass the principal demands on our cash and availability under our line of credit and floor plans in the future.

The amount of our future capital expenditures will depend on a number of factors including general economic conditions and growth prospects. Our gross rental fleet capital expenditures for the period ended December 31, 2022 were approximately $186.9 million, including $122.9 million of transfers from new and used inventory to rental fleet. This gross rental fleet capital expenditure was offset by sales proceeds of rental equipment of approximately $133.1 million for the period ended December 31, 2022 as our business model is to sell lightly used inventory to customers from our rental fleet to increase field population in our geographies. In response to changing economic conditions, we have the flexibility to modify our capital expenditures, especially as it relates to rental fleet.

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To service our debt, we will require a significant amount of cash. Our ability to pay interest and principal on our indebtedness, will depend upon our future operating performance and the availability of borrowings under the line of credit and/or other debt and equity financing alternatives available to us, which will be affected by prevailing economic conditions and conditions in the global credit and capital markets, as well as financial, business and other factors, some of which are beyond our control. Based on our current level of operations and given the current state of the capital markets, we believe our cash flow from operations, available cash, and available borrowings under the line of credit will be adequate to meet our future liquidity needs for the foreseeable future. As of December 31, 2022, we had $264.3 million of available borrowings under the revolving line of credit and floor plans.

Critical Accounting Policies and Estimates

In the preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”), we are required to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures. Our management reviews these estimates and assumptions on an ongoing basis. While we believe the estimates and judgments we use in preparing our consolidated financial statements are reasonable and appropriate, they are subject to future events and uncertainties regarding their outcome; therefore, actual results may materially differ from these estimates. If actual amounts are ultimately different from our estimates, the revisions are included in our results of operations for the period in which the actual amounts first become known. We consider the following items in the consolidated financial statements to require significant estimation or judgment. See Note 2 to our consolidated financial statements for a summary of our significant accounting policies.

Useful Lives of Property and Equipment

We depreciate rental equipment and property and equipment over their estimated useful lives. The useful life of rental equipment is determined based on our estimate of the period the asset will generate revenues. The principal methods of depreciation used are straight-line basis over the estimated useful lives or percentage of rental revenue based on the unit of activity method. We periodically review the assumptions used in calculating rates of depreciation. We may be required to change these estimates based on changes in our industry or changes in other circumstances. If these estimates change in the future, we may be required to recognize increased or decreased depreciation expense for these assets. The amount of depreciation expense we record is highly dependent upon the estimated useful lives assigned to each category of equipment and the utilization of equipment where the unit of activity method is applied.

Generally, we assign the following useful lives to the below categories of Property and Equipment:

The useful lives and methods of depreciation are reviewed at each financial year-end and adjusted prospectively, if appropriate.

Acquisition Accounting

We have made significant acquisitions in the past and we intend to make additional acquisitions in the future that meet our selection criteria with an objective of increasing our revenues, improving our profitability, diversifying our end market and geographic exposure and strengthening our competitive position. The assets acquired and liabilities assumed (including contingent purchase consideration) are recorded based on their respective fair values at the date of acquisition. Such fair market value assessments require judgments and estimates that can be affected by various factors over time, which may cause final amounts to differ materially from original estimates. The significant judgments include the estimation of future cash flows, which are dependent on forecasts; the estimation of a long-term rate of growth; the estimation of the useful life over which cash flows will occur; and the determination of a risk-adjusted weighted average cost of capital. When appropriate, our estimates of the fair values of assets and liabilities acquired include assistance from independent third-party appraisal firms. The judgments made in determining the estimated fair value assigned to the assets acquired, as well as the estimated life of the assets, can materially impact net income in periods subsequent to the acquisition through depreciation and amortization, and in certain instances through impairment charges, if the asset becomes impaired in the future. As discussed below, we regularly review for impairments.

New and used equipment inventories, long-lived assets (primarily rental equipment), goodwill, and other intangible assets generally represent the largest component of our acquisitions. Inventories acquired in the transaction are valued at fair value, which approximates a market participant’s estimated selling price adjusted for (1) costs to sell and (2) a reasonable profit allowance. In addition to long-lived assets, we also acquire other assets and assume liabilities. These other assets and liabilities typically include, but are not limited to, parts inventory, accounts receivable, accounts payable, floor plans payable and other working capital items.

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Because of their short-term nature, the fair values of these assets and liabilities generally approximate the carrying values reflected on the acquired entities balance sheets. However, when appropriate, we adjust these carrying values for factors such as collectability, existence, and consistency with Company accounting policies.

Pursuant to accounting standard Topic 350 - Intangibles - Goodwill and Other, we record as goodwill the excess of the consideration transferred over the fair values of the identifiable net assets acquired. The intangible assets that we have acquired consist of tradenames, non-compete agreements, supplier relationships, and customer relationships. A tradename has a fair value equal to the present value of the royalty income attributable to it. The royalty income attributable to a tradename represents the hypothetical cost savings that are derived from owning the tradename instead of paying royalties to license the tradename from another owner. The fair value of non-compete agreements is estimated based on an income approach since their values are representative of the current and future revenue and profit erosion protection they provide. Customer and supplier relationships are generally valued based on an excess earnings or income approach with consideration to projected cash flows.

Impairment of Goodwill and Long-lived Assets

Refer to Note 2, Summary of Significant Accounting Policies, herein for more information.

Revenue Recognition

Refer to Note 2, Summary of Significant Accounting Policies, and Note 3, Revenue Recognition, herein for more information.

Income Taxes

The Company operates in a number of geographic locations and is subject to foreign, U.S. federal, state, and local taxes applicable in each of the respective jurisdictions. These tax laws are complex and involve uncertainties in the application of our facts and circumstances that may be subject to interpretation. We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, we determine deferred tax assets and liabilities on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

As a part of our income tax provision, we must also evaluate the likelihood that we will be able to realize our deferred tax assets which is dependent on our ability to generate sufficient taxable income in future years. Our deferred tax calculation requires management to make certain estimates about future operations. We recognize deferred tax assets to the extent that we believe that these assets are more likely than not (a likelihood of greater than 50%) to be realized. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. These estimates involve judgment. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. If we determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amount, we would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes. There has been no change to the assumption methodology during the current or prior period.

Allowance for Doubtful Accounts

The Company records trade accounts receivables at invoice amount less an allowance for doubtful accounts. The allowance for doubtful accounts is evaluated periodically and includes specific reserves for certain customer accounts identified as known collection problems due to insolvency, disputes or other collection issues and estimates by management based on the following assumptions and variables: the customer’s financial position, age of the customer’s receivables, and changes in payment schedules. In addition to the specific reserves, management establishes a non-specific allowance for doubtful accounts by applying specific percentages to the different receivable aging categories (excluding the specifically reserved accounts) based on the history of past write-offs and collections and current customer credit conditions. Changes in the economy or in the credit conditions of individual customers or other circumstances could require increases or decreases in our allowances. The percentage applied against the past due categories increases as the accounts become further past due. A receivable is considered past due if payments have not been received by the Company based on established customer payment terms. Generally, the Company does not accrue interest on past due receivables. Certain accounts are turned over to collection agencies, while the Company places liens and pursues a variety of other collection strategies on others. The allowance for doubtful accounts is charged with the write-off when deemed uncollectible by management. Write-offs of such receivables require management approval based on specified dollar thresholds.

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