Alta Equipment Group Inc.: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis should be read in conjunction with our interim unaudited condensed consolidated financial statements and related notes included in Item 1 of Part I of this Quarterly Report, and the audited consolidated financial statements and related notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. This discussion contains “forward-looking statements” within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 reflecting Alta’s current expectations, estimates and assumptions concerning events and financial trends that may affect its future operating results or 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 Quarterly Report on Form 10-Q, 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.

Recent Developments

Strategic Acquisitions

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.

Equipment Inventory Availability, Rental Fleet Investment and Product Support

Throughout 2021 and 2022, our industry was unfavorably impacted by equipment supply chain constraints leading to shortages across construction and material handling equipment categories and limiting our ability to meet customer demand and potentially increase our market share. Throughout 2023 equipment supply chain constraints have continued to subside, resulting in an increase in our new equipment inventory relative to prior periods. The increase in new inventory through three quarters of 2023, given the seasonality of our Construction segment, is natural for our business and in line with historic norms. Our ability to take delivery of new equipment from our OEMs throughout 2023 was the primary driver of the $148.8 million increase in new and used equipment sales when compared to the same period last year, as the increase in supply of new equipment meets a strong end-market demand backdrop. The increase in equipment availability in 2023 has also allowed us to replenish and strategically grow our rental fleet in geographies where we intend to grow our market share. Additionally, and notably, supply chain issues have not materially 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. As our customers focus on the “up-time” of their equipment, we continued to see strong demand for our product support capabilities, skilled technicians' labor and replacement parts in 2023, as evidenced by our increased technician headcount and organic product support revenues year over year.

Business Description

The Company owns and operates one of the largest integrated equipment dealership platforms in the U.S. and has a presence in Canada. Through our branch network, we sell, rent, and provide parts and service support for several categories of specialized equipment, including lift trucks, heavy and compact earthmoving equipment, environmental processing equipment, cranes, paving and asphalt equipment, and other material handling and construction equipment. We engage in five principal business activities in these equipment categories:

(i) new equipment sales;

(ii) used equipment sales;

(iii) parts sales;

(iv) repair and maintenance services; and

(v) equipment rentals.

We have operated as an equipment dealership for over 39 years and have developed a branch network that includes over 75 total locations in Michigan, Illinois, Indiana, Ohio, Massachusetts, Maine, Connecticut, New Hampshire, Vermont, Rhode Island, New York, Virginia, Nevada and Florida and the Canadian provinces of Ontario and Quebec. We offer our customers end-to-end solutions for their equipment needs by providing sales, parts, service and rental functions. Additionally, we provide warehouse design and build services, automated equipment installation and system integration solutions within our Material Handling segment.

Within our territories, we are the exclusive distributor of new equipment and replacement parts on behalf of our OEM partners. We and our regional subsidiaries enjoy long-standing relationships with leading material handling and construction equipment OEMs, including Hyster-Yale, Volvo, CNH, JCB and Kubota, among many others. We also now, through the acquisition of Ecoverse, have exclusive master dealer rights throughout North America for environmental processing equipment with leading OEMs including Doppstadt, Backus and Backers, among others. We are consistently recognized by OEMs as a top dealership partner and have been identified as a nationally recognized Hyster-Yale dealer and multi-year recipient of the Volvo Dealer of the Year award. More recently, the Company entered into a dealer agreement with Nikola Corporation to become the authorized dealer to sell and service Nikola medium and long-haul class 8 electric vehicle trucks in New York, New Jersey, eastern Pennsylvania, New England, Florida and Illinois markets.

Business Segments

For detailed description of our business segments, refer to Note 18, Segments.

Financial Statement Overview

Our revenues are primarily derived from 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 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 service 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 OEM’s with which we have exclusive agreements to sell new equipment.

Service revenues. 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 45% of our employees are skilled service technicians.

Rental revenues. 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 $580.7 million as of September 30, 2023. The original acquisition cost of our rental fleet excludes the $9.5 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 service revenues 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 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 consists of the total acquisition costs of the new equipment we purchase from third parties.

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 average 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).

Service revenues. Cost of service revenues primarily represents 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 revenues. 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. Estimated useful lives vary based upon type of equipment. See Note 2, Summary of Significant Accounting Policies, to the audited consolidated financial statements contained in the Company’s 2022 Annual Report on Form 10-K, 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.

Operating 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, such as 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 expense, net. This section of the Condensed Consolidated Statements 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.

Results of Operations

The three and nine months ended September 30, 2023 and 2022

Consolidated Results

28

Non-GAAP Financial Measure: Organic Revenues

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 condensed consolidated statements of operations, balance sheets or statements of cash flows of the company. The non-GAAP financial measure used is organic revenues and growth rates associated with organic revenues. We define organic revenues growth as revenues growth excluding the impact of acquisitions that do not appear fully in both periods in the current and prior years. We believe organic revenues 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.

Pursuant to the requirements of Regulation G, we have provided a reconciliation of organic revenues 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.

Revenues: Consolidated revenues increased by $61.2 million, or 15.1%, to $466.2 million for the three months ended September 30, 2023 as compared to the same period last year. The primary drivers of this period over period increase were the favorable full period impact from acquisitions, the availability of new equipment from OEMs, a favorable business climate for our equipment and services, price increases, and our ability to grow on an organic basis. If excluding the effects of acquisitions by observing the consolidated results on an organic basis, total revenues increased $37.9 million, or 9.5%, to $435.5 million for the three months ended September 30, 2023. Organic new and used equipment sales increased 13.1% over the same period last year as market demand for equipment remains high and the increased availability of new equipment from our suppliers, relative to the same period last year, allowed for throughput of our sales backlogs. Organic parts sales and service revenues increased by 7.8% and 9.1%, respectively, over the same period last year. Similarly, rental revenues exhibited growth on an organic basis of 3.5% period over period as market rental rates in the industry continue to increase in our operating regions. Lastly, rental equipment sales decreased organically by 2.1% from the prior year as we actively retained rental fleet amidst high rental demand, while remaining focused on our field population-based business model and meeting customer demand for used equipment by selling equipment out of our rental fleet.

Consolidated revenues increased by $212.1 million, or 18.6%, to $1,355.3 million for the nine months ended September 30, 2023 as compared to the same period last year. Organic sales growth in the nine months ended September 30, 2023 reached 10.6% compared to the same period last year. Despite headwinds during the year from higher interest rates, inflation and tight labor markets, we have experienced continued demand for our products and services as the fundamentals in many of the markets we serve remain solid. We continue to maintain a strong backlog and, in certain regions, we have taken market share from competitors with our inventory stocking strategies. In the nine months ended September 30, 2023, our customer focus through turbulent market times has led to an organic revenue increase of 15.4% in new and used equipment sales, a 12.6% organic revenue increase in our combined parts and service product support departments and a 5.2% organic increase in rental revenues. Rental equipment sales declined 14.9% for the nine months ended September 30, 2023 as compared to the same period last year due to the growing availability of new equipment throughout the year, combined with our ability to strategically balance the decision to retain fleet to benefit from the elevated rental demand environment but still accommodate sales into our territories to bolster field population for longer-term returns in our product support departments.

Gross profit (GP):

The consolidated gross profit for the three months ended September 30, 2023 was 27.0%, a 60 basis point decrease from the 27.6% for the same period in 2022. Gross margins on new and used equipment sales increased moderately, on higher volumes, when compared to the same period last year as the pricing environment has become more competitive recently, given increased equipment availability, when compared to previous quarters in 2023. Gross margins on service revenues improved by 110 basis points to 56.3% while parts revenue gross margin declined slightly by 50 basis points, but remained in line with expectations and recent historical trends. Gross margins on rental revenues declined in the three months ended September 30, 2023 when compared to the same period in 2022, a result primarily driven by compression of rental margins in the Material Handling segment due to increased rental depreciation expense associated with the acquisition of Yale Industrial Trucks Inc. ("YIT") in the third quarter of 2022 and the increased size of our rental fleet overall.

The consolidated gross profit for the nine months ended September 30, 2023 was 27.6%, a 60 basis point increase from the 27.0% for the same period in 2022. New and used equipment sales margins increased 80 basis points to 17.4%, consistent overall with prior year but reflective of a favorable pricing environment for new and used equipment, particularly in the first half of 2023, and our focus on providing more customized equipment solutions which yield a higher gross margin versus standard products. The favorable pricing market coupled with our flexible rent-to-sell rental model, which allows us to sell previously depreciated rental fleet, led to a 540 basis point increase in rental equipment sales margin when comparing the year-over-year periods despite lower sales volume in the category. The lower sales volume of rental equipment sales is related to loosening supply chain constraints on new equipment, which led to the large increase in new equipment sales, as previously mentioned. Parts sales margins are improved 120 basis points year to date when compared to the same time last year amid a favorable pricing environment and the high gross margins realized on parts in the Master Distribution segment acquired in the fourth quarter of 2022. We realized a 110 basis point decrease in rental revenues gross margin for the nine months ended September 30, 2023, largely a result of replenishing and increasing the size of our rental fleet and the related incremental increase in depreciation expense associated thereto. Service gross margins increased by 30 basis points, remaining consistent year over year and in line with expectations.

Operating expenses: Consolidated operating expenses increased by $14.3 million to $112.2 million for the three months ended September 30, 2023 compared to the same period last year, driven primarily by the full period impact from our 2022 acquisitions, costs associated with organic headcount growth, increases in labor and operating input costs, and certain sales-based expenses.

Consolidated operating expenses increased by $54.5 million to $332.0 million for the nine months ended September 30, 2023 compared to the same period last year. The increase is primarily driven by the full period impact from our 2022 acquisitions and incremental expenses to support our organic growth, such as overall headcount growth, incremental technician service vehicles and marketing expenditures. Additionally, the large increase in equipment sales resulted in higher sales commissions. Further, employment costs such as wages and benefits increased due to inflationary labor market factors.

Other expense, net: Consolidated other expense for the three months ended September 30, 2023 was $13.8 million compared to $8.3 million for the same period in 2022. The increase is primarily due to an increase in interest expense due to higher interest rates and more debt outstanding relative to the same period in 2022.

Consolidated other expense, net for the nine months ended September 30, 2023 was $38.3 million compared to $20.5 million for the same period in 2022. The increase is primarily due to an increase in interest expense due to higher interest rates and more debt outstanding due to recent debt-financed acquisitions and higher inventory and rental fleet levels.

Provision for income taxes: The Company recorded an income tax benefit of $7.3 million and provision of $0.3 million for the three months ended September 30, 2023 and 2022, respectively and $6.9 million benefit and $0.8 million expense for the nine months ended September 30, 2023 and 2022, respectively. The income tax benefit in the current year was due to the full release of the valuation allowance during the third quarter while the prior year expense was primarily due to income that could not be fully offset with net operating losses.

Material Handling Results

31

Revenues: Material Handling segment revenues increased by $13.3 million, or 8.6%, to $168.6 million for the three months ended September 30, 2023 as compared to the same period last year. The primary drivers of this period over period increase were the favorable full period impact from the YIT acquisition in the third quarter of 2022, realization of new equipment sales backlog, general price increases and our ability to grow product support and rental revenues on an organic basis. Organic new and used equipment sales increased by $2.8 million, or 3.4%, over the same period last year as market demand for equipment remains stable amidst a favorable pricing environment when compared to the same period ended September 30, 2022. Our equipment sales backlog remains healthy as of September 30, 2023. Organic parts sales and service revenues increased by 5.3% and 8.2%, respectively, over the same period last year amid a favorable pricing environment and higher technician headcount. Similarly, rental revenues exhibited growth on an organic basis of 1.3% period over period primarily related to higher nominal level of fleet on rent in our operating regions. Although a relatively immaterial component of the overall sales mix in the Material Handling segment, rental equipment sales decreased organically by $0.4 million over the prior year as we actively manage our rental fleet size amid periods of high rental demand, while remaining focused on growing our field population for future product support business by selling used equipment out of our rental fleet.

Material Handling segment revenues increased by $86.1 million to $502.5 million for the nine months ended September 30, 2023 as compared to the same period last year. Organically, the segment revenues increased 11.8% year to date over the same period in the prior year based on a favorable demand backdrop, elevated pricing environment and the ability of our OEMs to deliver more new equipment in 2023 versus 2022 allowing for throughput on our equipment sales backlog. Importantly, on an organic basis product support revenues, made up of the combined parts and service departments, increased 11.4% as volumes and pricing showed improvements. Rental revenues increased 8.2%, on an organic basis for the nine months ended September 30, 2023 as compared to the same period last year on higher rental rates and a higher nominal level of fleet on rent, and rental equipment sales decreased 31.6% on low volume due to our strategic decision to retain fleet to benefit from the elevated rental demand environment but still accommodate sales into our territories to bolster field population for longer-term returns in our product support departments.

Gross profit (GP):

Material Handling gross profit for the three months ended September 30, 2023 increased 90 basis points to 34.7% compared to the same period in 2022. Although the revenue mix was weighted less heavily toward equipment sales, the improved margins in new, used and rental equipment sales improved the overall segment gross profit margin. New and used equipment sales margins increased 160 basis points from the same periods in 2022 but align with expectations. Parts gross profit margins decreased 10 basis points to 38.5% and service gross profit margins increased 120 basis points, both in line with historic norms and expectations. Gross margins on rental revenues were reduced in the three months ended September 30, 2023 when compared to the same period in 2022, a result driven by increased rental depreciation expense associated with the acquisition of YIT in the third quarter of 2022 and the increased size of our rental fleet.

Material Handling gross profit for the nine months ended September 30, 2023 decreased 90 basis points to 34.2% compared to the same period in 2022. New and used equipment gross margins compressed slightly due to product mix variances, and parts and service gross margins have remained relatively consistent year over year. The 20 basis point service margin decline in the Material Handling segment for the nine months ended September 30, 2023 compared to the prior year same period can be partially attributed to the inclusion of our acquired company, YIT, with average service margins lower than the organic locations existing in both periods. Rental revenues gross margins have declined 590 basis points due to replenishing and increasing the size of our rental fleet and the related incremental increase in depreciation expense, and increased rental depreciation expense associated with the acquisition of YIT in the third quarter of 2022. Rental equipment sales margins decreased slightly on low volume of sales.

Operating expenses: Material Handling operating expenses increased by $10.9 million to $56.8 million for the three months ended September 30, 2023 as compared to the same period last year, primarily the result of full period impact from YIT acquisition and sales commissions, labor and operating input costs that support organic revenue growth and changes in intercompany allocation of shared service expenses with offsetting impact in Other income.

Material Handling operating expenses increased by $18.4 million to $146.2 million for the nine months ended September 30, 2023 as compared to the same period last year, mainly due to the full period impact from the YIT acquisition. Sales-related variable costs, such as equipment sales commissions and labor and operating input costs that support organic revenue growth, as described previously, and changes in intercompany allocation of shared service expenses also impacting the year-over-year variance.

Other income (expense), net: Material Handling other income (expense), net increased by $5.1 million to $3.1 million of income for the three months ended September 30, 2023 as compared to the same period last year, primarily due to the aforementioned change in intercompany allocation of expenses for shared service functions between segments.

Material Handling other expense, net increased by $8.2 million to $12.9 million for the nine months ended September 30, 2023 as compared to the same period last year. The increase is mainly related to the increased interest expense associated with an increase in total borrowings used to support a larger rental fleet, higher inventory levels and debt-financed acquisitions combined with a rise in interest rates on our floating-rate debt and the aforementioned change in intercompany expense allocation for shared service functions.

Construction Equipment Results

34

Revenues: Construction Equipment segment revenues increased by $32.3 million to $282.0 million for the three months ended September 30, 2023 as compared to the same period last year. As no acquisitions occurred within the segment over the comparable periods, the entire increase is organic. New and used equipment sales increased 19.3% over the same period last year primarily reflective of inflationary pricing increases and increased supply of equipment from OEMs. Notably, parts and service sales increased 8.6% and 10.5%, respectively, growing at a combined rate of 9.3% when compared to the same period last year, a result of the ability to realize the returns from a growing equipment field population and labor rate increases. Rental revenues have increased 4.9%, primarily on rate increases, when compared to the prior year, and rental equipment sales increased 1.1% as we strategically balance the decision to retain fleet to benefit from the elevated rental rate environment but still accommodate sales into our territories to bolster field population for longer-term returns in our product support departments.

Construction Equipment segment revenues increased by $69.8 million to $796.6 million for the nine months ended September 30, 2023 as compared to the same period last year. Segment revenues increased 9.6% for the nine months ended September 30, 2023 over the same period in the prior year based on a favorable demand backdrop, an elevated pricing environment and our OEMs ability to deliver more new equipment in 2023 versus 2022. New and used equipment sales increased by 15.7% as OEM production shortages in the prior year for new equipment have subsided in the current year, exhibited by the shift in sales mix from rental equipment sales into new equipment sales when comparing the periods. Rental equipment sales decreased for the nine months ended September 30, 2023 due to the aforementioned shift to new equipment sales which allowed for more flexibility in the decision as to whether to strategically sell equipment out of the rental fleet or to retain fleet to benefit from the elevated rental rate environment during the warmer weather rental season. Product support revenues increased 13.4% due to favorable pricing and volumes. Rental revenues increased 3.9% for the nine months ended September 30, 2023 as compared to the same period last year primarily attributable to an increased rental rate environment existing between the comparable periods.

Gross profit (GP):

Construction Equipment gross profit decreased by 140 basis points to 22.3% in the three months ended September 30, 2023 from 23.7% in the same period in 2022. New and used equipment sales margins declined 100 basis points to 12.8% amid a competitive sales backdrop. Notably, nominal gross margin dollars increased when compared to the same period in 2022 on higher equipment sales volumes. Parts sales margins declined 220 basis points but remain in line with recent trends. Service gross profit margins remained consistent and in line with expectations. Gross margin on rental revenues were reduced in the three months ended September 30, 2023 when compared to the same period in 2022, a result primarily driven by increased rental depreciation expense associated with the increased size of our construction rental fleet.

Construction Equipment gross profit increased by 80 basis points to 23.2% in the nine months ended September 30, 2023 from 22.4% in the same period in 2022, with overall margin improvements reflective of the general business climate and demand factors of the industry. Specifically, new and used equipment sales margins increased 30 basis points to 14.2%, primarily related to a strong pricing environment and our ability to provide value-added products to customers, when compared to the same period last year. Notably, with the increased sales volume of new and used equipment coupled with the strong pricing environment, new and used gross profit increased to $58.4 million from $49.6 million in the same period last year. The increased availability of new equipment allowed for a more measured approach on the sale of rental equipment. Despite a lower sales volume of rental equipment, the flexibility afforded by the availability of new equipment in our markets allowed for a more deliberate approach to rental equipment sales which led to a 560 basis point increase in rental equipment sales margin when comparing the year-over-year periods (equating to rental equipment gross profits of $22.5 million compared to $20.5 million from the same period last year). Parts sales margins for the nine months ended September 30, 2023 remained consistent when compared to the same time last year. Service gross margins increased by 110 basis points year over year primarily related to positive trends in road, shop and warranty services when compared to the same period last year. Rental revenues gross margin for the nine months ended September 30, 2023 was consistent with the same period last year.

Operating expenses: Construction Equipment operating expenses increased by $12.0 million to $59.8 million for the three months ended September 30, 2023 as compared to the same period in 2022. The increase can be attributed to incremental variable expenses associated with our organic sales growth and customer relation efforts as well as changes in intercompany allocation of shared service expenses with offsetting impact in Other income.

Construction Equipment operating expenses increased by $21.2 million to $159.6 million for the nine months ended September 30, 2023 as compared to the same period in 2022. The increase is mainly due to inflationary factors, general headcount increases in the segment, rising benefit costs, and incremental expenses associated with our organic growth, such as technician service vehicles as well as changes in allocation of intercompany expenses across segments for shared service functions.

Other expense, net: Construction Equipment other expense decreased by $3.4 million to $2.2 million for the three months ended September 30, 2023 as compared to the same period in 2022 primarily due to the aforementioned change in intercompany allocation of expenses for shared service functions between segments.

Construction Equipment other expense, net increased by $7.2 million to $21.7 million for the nine months ended September 30, 2023 as compared to the same period in 2022. The variance was mainly due to the increase in interest rates on our floating-rate debt and the interest expense related to a larger rental fleet and higher inventory levels partially offset by the aforementioned change in shared service function intercompany segment allocations.

Master Distribution Results

The Company began separately reporting Master Distribution as its own segment in the first quarter of 2023. This business was acquired during the fourth quarter of 2022. As such, all Master Distribution revenue is considered inorganic and the below tables do not include comparable data for the three and nine months ended September 30, 2022.

36

Gross profit (GP):

Overall Summary: Master Distribution segment revenues for the quarter were $18.1 million, made up primarily, 84.0%, of new and used equipment sales and secondarily, 13.8%, of parts sales. It should be noted that Master Distribution’s equipment revenue is seasonal and more heavily weighted towards the first half of the fiscal year, and the first quarter in general, as Master Distribution sells to a network of subdealers who tend to stock inventory early in the year ahead of their customers' buying season. Parts revenues do not have the same level of seasonality. Year-to-date segment revenues were $66.2 million, with 86.6% of sales coming in the form of new and used equipment and 11.9% of sales coming from parts.

Gross profit margin on new and used equipment sales and parts sales was 21.1% and 56.0%, respectively, for the quarter. These gross margin levels are in line with our expectations and pre-acquisition history. Year-to-date gross profit margins on new and used equipment sales and parts sales were 25.5% and 51.9%, respectively.

Operating expenses: Master Distribution segment operating expenses were $4.2 million for the three months ended September 30, 2023 and $11.8 million for the nine months ended September 30, 2023. Personnel costs, such as wages and commissions, and sales-related expenses are the primary operating expense of the Master Distribution segment.

Other expense, net: Master Distribution other expense was $0.3 million for the three months ended September 30, 2023 and $2.1 million for the nine months ended September 30, 2023. Other expenses of the Master Distribution segment include interest expense and foreign currency exchange variances.

Liquidity and Capital Resources

The nine months ended September 30, 2023 and 2022 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 nine months ended September 30, 2023, operating activities resulted in net cash used in operations of $19.4 million. Our reported net income of $10.8 million, when adjusted for non-cash income and expense items, such as depreciation and amortization, inventory obsolescence and bad debt reserves, and stock-based compensation, provided net cash inflows of $91.5 million. Changes in working capital included $247.4 million of inventory purchased (of which $143.0 million has been transferred into our rental fleet for replenishment and growth purposes), and a $32.7 million increase in accounts receivable. Cash flows from operating activities were favorably impacted by $90.7 million due to proceeds from the sale of rental equipment, $97.9 million in net inflows related to manufacturer floor plans and unfavorably impacted by a $6.9 million decrease in accounts payable, accrued expenses, customer deposits, and other current liabilities and by a $12.5 million net change in prepaid expenses and other assets and leases, deferred revenue, and other liabilities.

For the nine months ended September 30, 2022, operating activities resulted in net cash provided by operations of $18.3 million. Our cash flows from operating activities related to net income adjusted for non-cash income and expenses, primarily the gain on sale of rental fleet, depreciation and amortization, inventory obsolescence and bad debt reserves, and stock-based compensation, generated $78.2 million for the nine months ended September 30, 2022. This was partially offset by $59.9 million of net working capital investments. Changes in working capital included $200.8 million of inventory purchased (of which $101.0 million was transferred into our rental fleet for replenishment and growth purposes), and a $24.8 million increase in accounts receivable. Cash flows from operating activities were favorably impacted by $105.1 million due to proceeds from the sale of rental equipment, $37.8 million in net inflows related to manufacturer floor plans and by a $30.5 million increase in accounts payable, accrued expenses, customer deposits, and other current liabilities and unfavorably impacted by a $7.7 million net change in prepaid expenses and other assets and leases, deferred revenue, and other liabilities.

Cash Flow from Investing Activities. For the nine months ended September 30, 2023, our cash used in investing activities was $60.6 million. This was mainly due to $61.4 million purchases of rental equipment, non-rental property and equipment, and equipment contracted under guaranteed purchase obligations as well as acquisition activity partially offset by $0.8 million proceeds from the sale of non-rental property and equipment.

For the nine months ended September 30, 2022, our cash used in investing activities was $85.7 million. This was mainly due to $46.8 million purchases of rental equipment and non-rental property and equipment and $40.4 million use of cash for the YIT acquisition and adjustments to the purchase prices of two of our 2021 acquisitions partially offset by $1.5 million of proceeds from the sale of non-rental assets and equipment contracted under guaranteed purchase obligations .

Cash Flow from Financing Activities. For the nine months ended September 30, 2023, cash provided by financing activities was $78.2 million. The favorable impact was mainly due to $81.5 million of net proceeds under our line of credit, long-term debt, and finance lease obligations, which funded the increase in net working capital and rental fleet as previously noted and net proceeds of $9.8 million related to non-manufacturer floor plans. This was partially offset by payments of $7.9 million for preferred and common stock dividends and $5.2 million related to other financing activities.

For the nine months ended September 30, 2022, cash provided by financing activities was $67.3 million. The favorable impact was mainly due to $57.5 million of net proceeds under our line of credit, primarily related to a draw on the line to fund the YIT acquisition, and net proceeds of $17.5 million related to non-manufacturer floor plans. This was partially offset by $2.5 million payments on finance lease obligations, $4.0 million related to preferred dividend payments and $1.2 million related to other financing activities.

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 $1.4 million in cash for the period ended September 30, 2023. 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 but not limited to new and used equipment inventories, purchases of rental fleet equipment and personal property, payments due under line of credit and floor plans, acquisitions, debt service requirements, and 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 September 30, 2023 was $191.7 million, including $143.0 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 $90.7 million for the period ended September 30, 2023 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.

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 at least the next 12 months and foreseeable future thereafter. As of September 30, 2023, we had $195.2 million of available borrowings under the revolving line of credit and floor plan facilities.

Critical Accounting Policies and Estimates

In the preparation of condensed consolidated financial statements prepared in conformity with U.S. 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. Refer to Part I, Item 1, Note 2 of the notes to our condensed consolidated financial statements for disclosures regarding the use of estimates and assumptions.

Additionally, see Note 2 to the audited consolidated financial statements contained in the Company’s 2022 Annual Report on Form 10-K for a summary of our significant accounting policies.

Our exposure to market risk primarily consists of interest rate risk associated with our variable and fixed rate debt, prices of certain commodities and foreign currency exchange rate risks. We employ financial instruments to manage the Company's exposure to changes in interest rates, diesel and unleaded fuel and foreign currencies. See Note 16, Fair Value of Financial Instruments, for more information.

Interest rate risk: Our earnings may be affected by changes in interest rates on the ABL Facility and Floor Plan Facilities. The interest rates applicable to any loans under the ABL Facility are based, at the option of the borrowers, on (i) a floating rate based on the SOFR (for loans denominated in U.S. dollars) or Canadian Dollar Offered Rate (for loans denominated in Canadian dollars) plus an initial margin of 1.75% or (ii) CBFR (for loans denominated in U.S. dollars) or the Canadian Prime Rate (for loans denominated in Canadian dollars) less an initial margin of 0.75%, in each case, where margin is adjusted under the ABL Facility based on the quarterly average excess availability under the ABL Facility. The interest rates applicable to any loans under various Floor Plan Facilities are based on a wide range of benchmark rates (including SOFR, Prime, Bloomberg Short-Term Bank Yield Index, and the Canadian Bankers' Acceptance Rate) plus an applicable margin. As of September 30, 2023 the lowest Floor Plan Rate was SOFR plus an initial margin of 2.75%, and the highest was SOFR plus an initial margin of 5.00% plus an adjustment of 0.1145% per annum.

At September 30, 2023 and December 31, 2022, we had $305.3 million and $219.5 million, respectively, outstanding borrowings under the ABL Facility. At September 30, 2023 and December 31, 2022, we had $364.8 million and $256.9 million, respectively, outstanding borrowings under the Floor Plan Facilities. As of September 30, 2023, based upon the amount of our variable rate debt outstanding, each one percentage point increase in the interest rates applicable to our variable rate debt when excluding and including the hedge impact of our interest rate cap would reduce our annual pre-tax earnings by $4.8 million and $2.8 million, respectively. The amount of variable rate indebtedness outstanding may fluctuate significantly. See Note 9, Floor Plans, and Note 10, Long-Term Debt, in our condensed consolidated financial statements for additional information concerning the terms of our variable rate debt.

We have fixed rate Notes of $315.0 million which are due in 2026. We did not have exposure to changing interest rates as of September 30, 2023 on the fixed rate Notes. For additional information concerning the terms of our fixed rate debt, see Note 10, Long-Term Debt.

Commodity price risk: The market prices of diesel and unleaded fuels are unpredictable and can fluctuate significantly. Because of the volume of fuel we purchase each year, a significant increase in the price of fuel could adversely affect our business and reduce our operating margins. To manage a portion of this risk, we enter into fixed price swap contracts to purchase gasoline and diesel fuel related to forecasted fuel purchases. For the purchases of unleaded and diesel fuel that we expect to purchase at market prices in the next 12 months, each $0.10 per gallon increase in the price of diesel and unleaded fuel, holding other variables constant, would decrease our pre-tax income during this period by approximately $0.2 million when including the fixed price swap contracts.

Foreign currency exchange rate risk: Due to our international operations, a portion of our revenues, cost of revenues, and operating expenses are subject to foreign currency exchange rate risk. Changes in the exchange rate of the U.S. dollar versus the Canadian dollar and European currencies affect the translated value and relative level of revenues and net income that we report from one period to the next. Based upon balances and exchange rates as of September 30, 2023, holding other variables constant, we believe that a hypothetical 10% increase or decrease in all applicable foreign exchange rates would not have a material impact on our results of operations or cash flows.

Management’s Evaluation of Disclosure Controls and Procedures

Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management utilized the criteria established in the Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) to conduct an assessment of the effectiveness of our internal control over financial reporting as of September 30, 2023

Refer to Item 9A. Controls and Procedures in the 2022 Annual Report on Form 10-K for more information on the material weakness identified leading to the conclusion that our internal control over financial reporting was not effective as of December 31, 2022. As of September 30, 2023, the material weakness has not been fully remediated. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2023. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2023, our disclosure controls and procedures were not effective due to a material weakness in internal control over financial reporting.

Our Chief Executive Officer and Chief Financial Officer have certified that, based on each such officer’s knowledge, the financial statements, and other financial information included in this Quarterly Report on Form 10-Q, fairly present in all material respects our financial condition, results of operations, and cash flows as of, and for, the periods presented in this Quarterly Report on Form 10-Q. We are in the process of executing our remediation plan for the material weakness, which is described below.

Remediation

Management has implemented and continues to implement measures designed to ensure that control deficiencies contributing to the material weakness are remediated, such that these controls are designed, implemented, and operating effectively. The remediation actions include:

For the material weakness over the sales process; (i) we continue to develop and deliver training programs to educate personnel concerning the principles and requirements of each control impacting the sales process; (ii) we have made updates within our business system that will assist with remediation efforts; (iii) we have developed and implemented regular monitoring controls to identify and address deviations from policies in a timely manner, (iv) we are performing testing over the monitoring controls to validate they are being performed as intended.

We believe that these actions will remediate the material weakness. The material weakness will not be considered remediated, however, until the applicable controls operate for a sufficient period of time and management has concluded, through testing, that these controls are operating effectively.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter ended September 30, 2023 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Limitations on Effectiveness of Controls and Procedures

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to apply judgment in evaluating the benefits of possible controls and procedures relative to their costs.

We face a number of uncertainties and risks that are difficult to predict and many of which are outside of our control. For a detailed discussion of the risks that affect our business, please refer to Part I, Item 1A, “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. There have been no material changes from the risk factors included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022.