Notes to Consolidated Financial Statements
Note 1: Business and Organization
Organization
Custom Truck One Source, Inc., formerly Nesco Holdings, Inc., a Delaware corporation, and its wholly owned subsidiaries are engaged in the business of providing a range of products and services to customers through rentals and sales of specialty equipment, rentals and sales of aftermarket parts and services related to the specialty equipment, and repair, maintenance and customization services related to that equipment. Immediately following the acquisition by Nesco Holdings II, Inc. of Custom Truck One Source, L.P. (“Custom Truck LP”) as discussed in Note 3: Business Combinations, on April 1, 2021 (the “Acquisition”), Nesco Holdings, Inc. (“Nesco Holdings”) changed its name to “Custom Truck One Source, Inc.” and changed The New York Stock Exchange ticker for its shares of common stock (“Common Stock”) from “NSCO” to “CTOS,” and the ticker of its redeemable warrants from “NSCO.WS” to “CTOS.WS.” Terms such as, “we,” “our,” “us,” or “the Company” refer to Nesco Holdings prior to the Acquisition, and to the combined company after the Acquisition. Unless the context otherwise requires, the term “Nesco” or “Nesco Holdings” as used in these financial statements means Nesco Holdings and its consolidated subsidiaries prior to the Acquisition, and the term “Custom Truck LP” means Custom Truck LP and its consolidated subsidiaries prior to and on the date of the Acquisition.
We are a specialty equipment provider to the electric utility transmission and distribution, telecommunications, rail, forestry, waste management and other infrastructure-related industries in North America. Our core business relates to our new equipment inventory and rental fleet of specialty equipment that is utilized by service providers in infrastructure development and improvement work. We offer our specialized equipment to a diverse customer base, including utilities and contractors, for the maintenance, repair, upgrade, and installation of critical infrastructure assets, including distribution and transmission electric lines, telecommunications networks and rail systems, as well as for lighting and signage. We rent, produce, sell and service a broad range of new and used equipment, including bucket trucks, digger derricks, dump trucks, cranes, service trucks, and heavy-haul trailers. We manage the business in three reporting segments: Equipment Rental Solutions (“ERS”), Truck and Equipment Sales (“TES”) and Aftermarket Parts and Services (“APS”). Segment information provided within this Annual Report on Form 10-K, is included in Note 21: Segments.
Equipment Rental Solutions (“ERS”) Segment
We own a broad range of new and used specialty equipment, including truck-mounted aerial lifts, cranes, service trucks, dump trucks, trailers, digger derricks and other machinery and equipment. As of December 31, 2022, this equipment (the “rental fleet”) is comprised of more than 10,000 units. The majority of our rental fleet can be used across a variety of end-markets, which coincides with the needs of many of our customers who operate in multiple end-markets. As is customary for equipment rental companies, we sell used equipment out of our rental fleet to end user customers. These sales are often made in response to specific customer requests. These sales offer customers an opportunity to buy well-maintained equipment with long remaining useful lives and enable us to effectively manage the age and mix of our rental fleet to match current market demand. We also employ rental purchase options on a select basis, which provide a buyout option with an established purchase price that decreases over time as rental revenue is collected. Customers are given credit against such purchase price for a portion of the amounts paid over the life of the rental, allowing customers the flexibility of a rental with the option to purchase at any time at a known price. Activities in our ERS segment consist of the rental and sale from the rental fleet, of the foregoing products.
Truck and Equipment Sales (“TES”) Segment
We offer a broad variety of new equipment for sale to be used across our end-markets, which can be modified to meet our customers’ specific needs. We believe that our integrated production capabilities and extensive knowledge gained over a long history of selling equipment have established us as a trusted partner for customers seeking tailored solutions with short lead times. In support of these activities, we primarily employ a direct-to-customer sales model, leveraging our dedicated sales force of industry and product managers, who are focused on driving national and local sales. We also opportunistically engage in the sale of used equipment purchased from third parties or received via trade-ins from new equipment sales customers. In all of these cases, we will sell used equipment directly to customers, rather than relying on auctions. Activities in our TES segment consist of the production and sale of new and used specialty equipment and vocational trucks, which includes equipment from leading original equipment manufacturers (“OEMs”) across our end-markets, as well as our Load KingTM brand.
Aftermarket Parts and Services (“APS”) Segment
The APS segment includes the sale of specialized aftermarket parts, including captive parts related to our Load KingTM brand, used in the maintenance and repair of the equipment we sell and rent. Specialized tools, including stringing blocks, insulated hot stick, and rigging equipment, are sold or rented to our customers on an individual basis or in packaged specialty kits. We also provide truck and equipment maintenance and repair services, which are executed throughout our nationwide branch network and fleet of mobile technicians supported by our 24/7 call center based in Kansas City, Missouri.
Supply Chain
The Company purchases raw materials, component parts and finished goods to be used in the manufacturing, sale and rental of its products. Uncertainty remains regarding supply chain disruptions, inflationary pressures, public health crises, and geopolitical risks that have led to issues, broadly, in the supply chain. Changes in the Company’s relationships with suppliers, shortages in availability of materials, production delays, regulatory restrictions, public health crises, or other supply chain disruptions, whether due to suppliers or customers, could have a material adverse effect on the Company’s ability to timely manufacture and market products. Increases in the costs of shipping and transportation, purchased raw materials, component parts or finished goods could result in manufacturing interruptions, delays, inefficiencies or the Company’s inability to market products. The unprecedented nature of the supply chain disruptions continues to make it difficult to predict the Company’s future business and financial performance. The Company continues to monitor the impact on its supply chain, including, but not limited to, the commercial vehicle manufacturers that provide the chassis used in the Company’s production and manufacturing processes and the ongoing semiconductor shortage, which could potentially limit the ability of these manufacturers to meet demand in future periods.
Note 2: Summary of Significant Accounting Policies
Basis of Presentation
Our accompanying consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) and the accounting policies described below. Our consolidated financial statements include the accounts of all wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. The preparation of financial statements in accordance with GAAP requires that these Consolidated Financial Statements and most of the disclosures in these Notes be presented on a historical basis, as of or for the current annual period or prior annual periods. The consolidated financial position and results of operations and cash flows (including segment information) presented herein include those of Custom Truck One Source, Inc. as of December 31, 2022 and since the date of the Acquisition. Financial information presented for periods prior to the Acquisition represent those of Nesco Holdings and its subsidiaries.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Recently Issued Accounting Pronouncements
Accounting for Contract Assets and Contract Liabilities from Contracts with Customers
In October 2021, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2021-08, Accounting for Contract Assets and Contract Liabilities from Contracts with Customers (“ASU 2021-08”). This ASU improves the comparability for both the recognition and measurement of acquired revenue contracts with customers at the date of and after a business combination and requires that an entity (acquirer) recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606. The amended guidance specifies for all acquired revenue contracts regardless of their timing of payment (1) the circumstances in which the acquirer should recognize contract assets and contract liabilities that are acquired in a business combination and (2) how to measure those contract assets and contract liabilities, thereby providing consistent recognition and measurement guidance for revenue contracts with customers acquired in a business combination and revenue contracts with customers not acquired in a business combination. The ASU is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption of the amendments is permitted. The Company will apply the guidance in ASU 2021-08 prospectively to any future business combinations occurring on or after the effective date of January 1, 2023.
In March 2022, the FASB issued ASU No. 2022-02, Financial Instruments—Credit Losses (Topic 326) (“ASU 2022-04”), which requires an entity to disclose current period gross write-offs by year of origination for financing receivables and net investment in leases. Gross write-off information must be included in the vintage disclosures, which requires that an entity disclose the amortized cost basis of financing receivables by credit-quality indicator and class of financing receivable by year of origination. The disclosure requirements in ASU 2022-02 are effective for fiscal years beginning after December 15, 2022. Early adoption is permitted. The Company will adopt the disclosure requirements in the first quarter of 2023.
Revenue Recognition
We recognize revenue in accordance with two different accounting standards: (1) Topic 606, Revenue from contracts with customers (“Topic 606”), and Topic 842, Leases (“Topic 842”), for periods after January 1, 2021, and (2) Topic 606 and Topic 840, Leases, for periods prior to January 1, 2021.
Under Topic 606, revenue from contracts with customers is measured based on the consideration specified in the contract with the customer, and excludes any sales incentives and amounts collected on behalf of third parties. A “performance obligation” is a promise in a contract to transfer a distinct good or service to a customer, and is the unit of account under Topic 606. We recognize revenue when we satisfy a performance obligation by transferring control over a product or service to a customer. The amount of revenue recognized reflects the consideration we expect to be entitled to in exchange for such products or services. Our contracts with customers generally do not include multiple performance obligations.
Rental Revenue – Rental revenue is primarily comprised of revenues from rental agreements and freight charges billed to customers. We also charge customers for damaged equipment, which is assessed and billed at the time a rental asset is returned to the Company and recorded within Parts Sales and Services revenue. In connection with our adoption of Topic 842, beginning January 1, 2021, we record changes in the estimated collectability of operating lease trade receivables against rental revenue. Such amounts were previously classified as selling, general and administrative expenses. Our rental contracts are for various equipment, aftermarket parts and services under 28-day or monthly agreements which include automatic renewal provisions. The majority of our rental payments are due upon receipt, with a majority billed at the end of each 28-day or monthly period. Revenue is recognized ratably over the rental agreement period and in accordance with Topic 842, and, for periods prior to January 1, 2021, Topic 840. Unearned revenue is reported in deferred revenue and customer deposits in our consolidated balance sheets. We require our rental customers to maintain liability and property insurance covering the units during the rental term and to indemnify us from losses caused by the negligence of the customer, their employees or contractors.
We also provide rental customers the opportunity to enter into contracts containing a rental purchase option (“RPO”). The RPO allows the customer to earn credit towards the purchase price of the leased equipment. The earned credit is based on rental payments made. Certain leases containing these purchase options are classified as sales-type leases because the RPO purchase price related to the leased equipment is considered to be a “bargain purchase option” in the lease. Revenue on these lease contracts is recognized at the point in time when the customer’s net purchase price for the equipment meets or falls below the fair value of the equipment. Revenue from these leases is recorded as equipment sales in the Consolidated Statements of Operations and Comprehensive Income (Loss).
Equipment Sales – We sell both new and used equipment. There are no rights of return or warranties offered on equipment sales. The contractual sales price for each individual equipment represents the standalone selling price. Our used equipment is of a sufficiently unique nature, based on specific characteristics such as its age and usage, that it does not have an observable standalone selling price. Equipment sales revenue is recognized upon the transfer of control of equipment. Except for equipment sold under bill-and-hold arrangements, control is transferred when title and physical possession of the equipment has transferred to the customer, which is at the point in time of customer pickup or when the equipment is delivered to a specified destination and the Company has a present right to payment. Payment is usually due within 30 days subsequent to transfer of control of the equipment.
We have bill and hold arrangements with a small number of customers who request to complete the purchase of equipment prior to their ability to take physical possession. In these cases, customers request that we retain physical possession of the equipment until customer pickup or delivery at a later date. Under these arrangements, control is transferred to the customer when the equipment is ready for transfer to the customer, the customer has taken legal title, and the Company has a present right to payment. Under the bill and hold arrangements, which are rare, we recognize sales only when all of the following criteria are met: 1) the customer’s reason for the bill-and-hold arrangement is substantive, 2) the equipment is separately identified as belonging to the customer, 3) the equipment is ready for transfer to the customer and 4) we do not have the ability to use the equipment or direct it to another customer.
Parts Sales and Services – We sell aftermarket parts and services. We derive our services revenue primarily from maintenance, repair and upfit services on heavy-duty trucks and cranes. Revenue from these services includes parts sales needed to complete the service work. We recognize services revenue as the service work is completed. We record revenue on a point in time basis as parts are delivered. The amount of consideration we receive for parts is based upon a list price net of discounts and incentives, and the impact
of such variable consideration is factored into the amount of revenue we recognize at any point in time. The amount of consideration received for services is based upon labor hours expended and parts utilized to perform and complete the necessary services for our customers. There are no rights of return or warranties offered on parts sales. Payment is usually due and collected within 30 days subsequent to delivery of parts or performance of service.
We record sales tax billed to customers and remitted to governmental authorities on a net basis and, consequently, these amounts are excluded from revenues and expenses. Sales taxes are recorded as accrued expenses when billed.
Shipping and Handling Costs – We classify shipping and handling fees billed to customers related to the placement of rental units as rental revenue in our Consolidated Statements of Operations and Comprehensive Income (Loss). We include the related shipping and handling costs in cost of rental revenue, excluding depreciation, in our Consolidated Statements of Operations and Comprehensive Income (Loss). Shipping and handling fees billed to customers related to the sale of equipment and parts are recorded as equipment sales or parts sales and services revenue, respectively. The related shipping and handling costs are recorded in cost of equipment sales or cost of parts sales and services, respectively.
Cash and Cash Equivalents
Cash and cash equivalents consists of cash and short-term investments with remaining maturities of three months or less when acquired. The carrying amount of cash and cash equivalents approximates its fair value. The Company maintains deposits at financial institutions in excess of federally insured limits.
Trade Receivables and Allowance for Credit Losses
We are exposed to credit losses from trade receivables generated through our leasing, sales and service businesses. We assess each customer’s ability to pay for the products and services by conducting a credit review. The credit review considers expected billing exposure and timing for payment and the customer’s established credit rating. We perform a credit review of new customers at inception of the customer relationship and, for existing customers, when the customer transacts new leases or product orders after a period of dormancy. We also consider contract terms and conditions, country risk and business strategy in the evaluation.
We monitor ongoing credit exposure through an active review of customer balances against contract terms and due dates. We may employ collection agencies and legal counsel to pursue recovery of defaulted receivables. The allowances for credit losses reflect the estimate of the amount of receivables that management assesses will be unable to be collected based on historical write-off experience and, as applicable, current conditions and reasonable and supportable forecasts that affect collectability. This estimate could require change based on changing circumstances, including changes in the economy or in the particular circumstances of individual customers. Accordingly, we may be required to increase or decrease the allowances. We review the adequacy of the allowance on a quarterly basis. The allowance for doubtful accounts is included in accounts receivable, net on our Consolidated Balance Sheets.
Accounts receivable, net consisted of the following:
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| (in $000s) | December 31, 2022 | | December 31, 2021 |
| Accounts receivables | $ | 212,347 | | | $ | 179,214 | |
| Less: allowance for doubtful accounts | (19,241) | | | (10,820) | |
| Accounts receivable, net | $ | 193,106 | | | $ | 168,394 | |
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The relationship between provision for losses on accounts receivable and allowance for doubtful accounts is presented below:
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| Year Ended December 31, |
| (in $000s) | 2022 | | 2021 | | 2020 |
| Allowance - beginning of period | $ | 10,820 | | | $ | 6,372 | | | $ | 4,654 | |
| Provision for losses on accounts receivable | 12,650 | | | 11,103 | | | 3,765 | |
| Accounts written off during period, net of recoveries | (4,229) | | | (6,655) | | | (2,047) | |
| Allowance - end of period | $ | 19,241 | | | $ | 10,820 | | | $ | 6,372 | |
In accordance with the adoption of Topic 842, effective January 1, 2021, specifically identifiable lease revenue receivables not deemed probable of collection are recorded as a reduction of rental revenue. The remaining provision for credit losses, which relates to product sales and services, is recorded in selling, general and administrative expense. For periods prior to January 1, 2021, the entire provision for credit losses was recorded in selling, general and administrative expense.
Inventory
Inventory is carried at the lower of cost or net realizable value. The Company periodically reviews inventories on hand and maintains reserves for slow-moving, excess, or obsolete inventories.
Whole goods inventory is comprised of chassis, attachments (i.e., boom cranes, aerial lifts, digger derricks, dump bodies, etc.), and the in-process costs incurred in the final assembly of those units. As part of our business model, we sell unassembled individual whole goods and whole goods with varying levels of customization direct to consumers or dealers. Whole goods inventory also includes new equipment purchased specifically for resale to customers, which purchases are recorded directly to inventory when received. Cost is determined by specific identification for whole goods inventory. Aftermarket parts and services inventories are recorded at weighted average cost.
Rental Equipment and Property and Equipment
Rental Equipment
Rental equipment is primarily comprised of the cost of truck-mounted aerial lifts, cranes, trucks, trailers, digger derricks, line equipment, cranes, pressure diggers, underground and other machinery and equipment. The rental equipment we purchase is recorded at cost and depreciated over the estimated rentable life of the equipment using the straight-line method over useful lives, depending on product categories, ranging from 5 to 7 years, to an estimated residual value, depending on product categories, ranging from 15% to 35% of cost. Depreciation of rental equipment commences when a rental unit is placed into the rental fleet and becomes available to rent and the cost is depreciated whether or not the equipment is on rent. We reevaluate the estimated rentable life as rental equipment is purchased, estimating the period that the asset will be held, considering factors such as historical rental activity and expectations of future rental activity. We also reevaluate the estimated residual values of the applicable rental equipment. The residual value of equipment is affected by factors that include equipment age, amount of usage and market conditions. Market conditions for used equipment sales can also be affected by external factors such as the economy, natural disasters, fuel prices, supply of similar used equipment, the market price for similar new equipment, and incentives offered by manufacturers of new equipment. These factors are considered when estimating future residual values and depreciation periods.
Expenditures for repair and maintenance that extend the useful life of the equipment and are necessary to keep an equipment unit in rentable condition are capitalized and depreciated over the estimated remaining useful life of the equipment, which is the period the repair and maintenance is expected to provide future economic benefit. When making repairs, we dispose of damaged and replaced components at their net carrying values. The cost of routine and recurring maintenance activities related to the rental fleet are charged to expense as incurred.
Property and Equipment
Property and equipment is primarily comprised of land, buildings and improvements, machinery and equipment, and vehicles, and is carried at cost, net of accumulated depreciation. Depreciation is provided using the straight-line method based on useful lives ranging from four to 39.5 years. Expenditures for major renewals and betterments that extend the useful lives of property and equipment are capitalized. Expenditures for maintenance and repairs are charged to expense as incurred. Leasehold improvements are depreciated over the lesser of the improvement’s useful life or the remaining lease term.
Leases as Lessee
We determine if an arrangement is a lease at inception of an arrangement. Operating and finance lease assets and liabilities are recognized at the commencement date of the lease based on the present value of lease payments over the lease term. Lease assets represent the Company’s right to use an underlying asset for the lease term, while lease liabilities represent the Company’s obligation to make lease payments arising from the lease. As most leases do not provide an implicit interest rate, we use our incremental borrowing rate based on the information available at the lease commencement date, in determining the present value of lease payments. The length of a lease term includes options to extend or terminate the lease when it is reasonably certain that we will exercise those options. The Company made an accounting policy election to not recognize lease assets or liabilities for leases with a term of 12 months or less. Additionally, we elected the practical expedient to not separate lease and non-lease components and also elected the short-term practical expedient for all leases that qualify. As a result, we will not recognize right-of-use assets or liabilities for short-term leases that qualify for the short-term practical expedient, but instead will recognize the lease payments as lease cost on a straight-line basis over the lease term. Finally, we apply a portfolio approach to determine the discount rate for leases with similar characteristics.
For our leases classified as operating, the ROU asset is measured throughout the lease term at the carrying amount of the lease liability, plus unamortized initial direct costs, plus/(minus) any unamortized prepaid/(accrued) lease payments, less the unamortized balance of lease incentives received. Lease expense for lease payments is recognized on a straight-line basis over the lease term.
For our leases classified as finance leases, the ROU asset is amortized using the straight-line method from the lease commencement date to the earlier of the end of its useful life or the end of the lease term unless the lease transfers ownership of the underlying asset to the Company, or the Company is reasonably certain to exercise an option to purchase the underlying asset. In those cases, the ROU asset is amortized over the useful life of the underlying asset. We expect to exercise our options to purchase the rental equipment assets we lease under finance leases. Accordingly, the assets leased under the finance leases are included in rental equipment and property and equipment, and depreciation thereon is recognized in depreciation of rental equipment, cost of revenue and non-rental depreciation expense in the Consolidated Statements of Operations and Comprehensive Income (Loss). When we make our contractually required payments under finance leases, we allocate a portion to reduce the finance lease obligation and a portion is recognized as interest expense.
Goodwill and Other Intangible Assets
We recognize goodwill when the purchase price of an acquired business exceeds the fair value of net assets acquired. Goodwill is not amortized for financial reporting purposes. Goodwill is impaired when its carrying value exceeds its implied fair value. We perform our goodwill impairment analysis annually on October 1 or more frequently if an event or circumstance (such as a significant adverse change in the business climate, operating performance metrics, or legal factors) indicates that an impairment may have occurred. If the fair value of the reporting unit exceeds its carrying value, goodwill of the reporting unit is not considered impaired. If the carrying value of the reporting unit exceeds its fair value, then there is an indication impairment may exist.
Recognized goodwill is assigned to our reporting units using an income approach based on the present value of estimated future cash flows. We estimate the fair value of our reporting units using both an income approach based on the present value of estimated future cash flows and a market approach based on traded values of selected companies. We believe this combined approach yields the most appropriate evidence of fair value. Determining the fair value of our reporting units is judgmental and involves the use of significant estimates and assumptions. We based our fair value estimates on assumptions that we believe are reasonable. Changes in these estimates and assumptions could materially affect the determination of fair value and goodwill impairment for our reporting units.
The Company performed a Step 1 quantitative impairment test on October 1, 2022 to evaluate whether it was more likely than not that the fair value of its three reporting units was less than their respective carrying amounts as of its annual assessment date. Goodwill was tested for impairment at the reporting unit level, which the Company has determined to be the same as its reportable segments (ERS, TES, and APS). The Company estimated the fair value of these reporting units by weighting the results from the income approach and the market approach. The market value approach compared current and projected financial results to entities of similar size and industry to determine market value. The income approach utilized assumptions regarding estimated future cash flows and other factors to determine the fair value of the respective assets. The estimates of future cash flow required the Company to establish expectations about customer demand, investments in maintaining or expanding infrastructure for the markets each reporting unit serves, and the supply and capacity of equipment in the rental market, among others. The related cash flows were discounted using rates ranging from 10.00% to 10.50% for the Company’s reporting units. The Company used a long-term growth rate of 2.50%. Significant management judgment was involved in estimating these factors, and they include inherent uncertainties, which fall under Level 3 within the fair value measurement hierarchy.
The Company performed a qualitative impairment test as of December 31, 2022 and concluded that it was not more likely than not that the fair value of either of the Company’s three reporting units had been reduced below their respective carrying amounts. As a result, the Company concluded that there were no triggering events as of December 31, 2022. There were no intangible asset impairment charges incurred during the years ended December 31, 2022 and December 31, 2021.
See Note 11: Goodwill and Intangible Assets for additional information.
Impairment of Long-Lived Assets, including Intangible Assets
We evaluate the carrying value of long-lived assets held for use, including rental equipment and definite-lived intangible assets, for impairment whenever an event or circumstance has occurred (such as a significant adverse change in the business climate, operating performance metrics, or legal factors) which suggests that the carrying value may not be recoverable. Impairment of a long-lived asset held for use (or relative asset group, if applicable) is measured when the anticipated separately identifiable undiscounted cash flows from the asset are less than the carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair value. Fair value is determined primarily using anticipated cash flows discounted at a rate commensurate with the risk involved.
Other intangible assets consist of customer relationships, non-compete agreements and trade names. We amortize intangible assets with finite lives over the period the economic benefits are estimated to be consumed. Definite lived intangibles are amortized using the straight-line method over their useful life, as we believe this method best matches the pattern of economic benefit. See Note 11: Goodwill and Intangible Assets for additional information.
Fair Value Measurements
Fair value is defined as an exit price representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date in the principal or most advantageous market. Fair value is a market-based measurement that is determined based on inputs, which refer broadly to assumptions that market participants use in pricing assets and liabilities. These inputs can be readily observable, market corroborated, or generally unobservable.
Fair Value Hierarchy - In measuring fair value, we use observable market data when available and minimize the use of unobservable inputs. Unobservable inputs may be required to value certain financial instruments due to complexities in contract terms. Inputs used in fair value measurements are categorized into three fair value hierarchy levels for disclosure purposes. The entire fair value measurement is categorized based on the lowest level of input that is significant to the fair value measurement. The three levels of the fair value hierarchy are:
Level 1 - Inputs that reflect unadjusted quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur with both sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2 - Inputs that reflect quoted prices for similar assets and liabilities are available in active markets, and inputs other than quoted prices that are observable for the assets or liabilities, either directly or indirectly, for substantially the full term of the financial instruments.
Level 3 - Inputs that are generally less observable or from unobservable sources in which there is little or no market data. These inputs may be used with internally developed methodologies that result in our best estimate of fair value.
Valuation Techniques - Assets and liabilities measured at fair value are based on one or more of the following three valuation techniques:
Market approach - Technique that uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
Income approach - Technique that converts future amounts to a single present amount based upon market expectations (including present value techniques, option-pricing, and excess earnings models).
Cost approach - Technique that estimates the amount that would be required to replace the service capacity of an asset (i.e., replacement cost).
Assets and Liabilities with Recurring Fair Value Measurements - Certain assets and liabilities may be measured at fair value on an ongoing basis. We did not elect to apply the fair value option for recording financial assets and financial liabilities. Other than the warrants liability and an interest rate collar (which was settled in February 2022), we do not have any assets or liabilities which we measure at fair value on a recurring basis.
Assets and Liabilities with Nonrecurring Fair Value Measurements - Certain assets and liabilities are not measured at fair value on an ongoing basis. These assets and liabilities, which include long-lived assets, goodwill, and intangible assets, are subject to fair value adjustment in certain circumstances. From time to time, the fair value is determined on these assets as part of related impairment tests. For certain assets and liabilities acquired in business combinations, we record the fair value as of the acquisition date. Refer to Note 3: Business Combinations, for the fair values of assets acquired and liabilities assumed in connection with our business combinations. Other than acquisition adjustments, no adjustments to fair value or fair value measurements were required for non-financial assets and liabilities for all periods presented. See Note 11: Goodwill and Intangible Assets and Note 15: Fair Value Measurements for additional information.
Deferred Financing Costs
Direct costs incurred in connection with the issuance, and amendments thereto, of our debt are capitalized and amortized over the terms of the respective agreements using the effective interest method, or the straight-line method when not materially different than the effective interest method. The net carrying value of deferred financing costs are classified as a reduction to long-term debt in the
Consolidated Balance Sheets (see Note 9: Long-Term Debt). The amortization is included in interest expense on our Consolidated Statements of Operations and Comprehensive Income (Loss).
Accrued Expenses
Accrued expenses consisted of the following:
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| (in $000s) | December 31, 2022 | | December 31, 2021 |
| Accrued interest | $ | 14,097 | | | $ | 11,773 | |
| Accrued salaries, wages and benefits | 39,653 | | | 36,535 | |
| Accrued sales taxes | 8,533 | | | 5,755 | |
| Other | 6,501 | | | 6,274 | |
| Total accrued expenses | $ | 68,784 | | | $ | 60,337 | |
Cloud Computing Arrangement Implementation Costs
The Company has entered into certain cloud-based hosting agreements that are accounted for as service contracts. For internal-use software obtained through a hosting arrangement that is a service contract, the Company capitalizes certain implementation costs, such as costs incurred to integrate, configure, and customize internal-use software, which are consistent with costs incurred during the application development stage for on-premise software. These capitalized development costs are recorded in other assets on our Consolidated Balance Sheets. Capitalized implementation costs are amortized straight-line over the term of the hosting arrangement plus any reasonably certain renewal periods, which range from three years to 10 years.
Cloud computing arrangements, net included in other assets in the Consolidated Balance Sheets consisted of the following:
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| (in $000s) | December 31, 2022 | | December 31, 2021 | | |
| Cloud computing arrangements | $ | 34,587 | | | $ | 28,094 | | | |
| Less: accumulated amortization | (9,703) | | | (4,865) | | | |
| Cloud computing arrangements, net | $ | 24,884 | | | $ | 23,229 | | | |
Amortization expense for these assets is included in selling, general, and administrative expenses in the Consolidated Statements of Operations and Comprehensive Income (Loss). For the years ended December 31, 2022 and December 31, 2021, amortization expense was $4.3 million and $2.5 million, respectively. For the year ended December 31, 2020, amortization of these costs was not material.
Advertising Costs
We promote our business through various industries media channels, and expense advertising costs as incurred to selling, general, and administrative expenses. For the years ended December 31, 2022 and December 31, 2021, advertising costs were approximately $3.1 million and $4.8 million respectively. Amounts were immaterial for the year ended December 31, 2020.
Share-Based Compensation
The fair value of equity-classified awards is determined at the grant date using techniques appropriate for the awards, which we use to determine compensation expense over the service period. We recognize compensation expense for our share-based payments over the requisite service period for the entire award and forfeitures are recognized as they occur. See Note 14: Share-Based Compensation for additional information.
Income Taxes
We utilize the asset and liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the differences between financial accounting and tax bases of assets and liabilities and are measured using the tax rates and laws that are expected to be in effect when the differences are expected to reverse. Recognition of deferred tax assets is limited to amounts considered by management to be more-likely-than-not to be realized in future periods. A valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized. The effect on net deferred tax assets and liabilities resulting from a change in tax rates is recognized as income or expense in the period that the change in tax rates is enacted.
We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments are applied in the calculation of the deferred income tax expense or benefit associated with certain deferred tax assets and liabilities. Significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period.
Our income tax returns are subject to examination by federal, state and foreign tax authorities. There may be differing interpretations of tax laws and regulations, and as a result, disputes may arise with these tax authorities involving the timing and amount of deductions and allocation of income. With the exception of net operating loss carryforwards, we are generally no longer subject to federal, state, local, and foreign income tax examinations by tax authorities for years ending on or prior to December 31, 2018.
We recognize uncertain income tax positions if it is more-likely-than-not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more-likely-than-not means a likelihood of more than 50%. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. Our determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management’s judgment. Unrecognized tax benefits are tax benefits claimed in our tax returns that do not meet recognition and measurement standards. Our policy is to record interest and penalties related to unrecognized tax benefits in income tax expense (benefit) on our Consolidated Statements of Operations and Comprehensive Income (Loss). As of December 31, 2022 and 2021, our uncertain income tax positions, unrecognized tax benefits, and accrued interest were not material.
Acquisition Accounting
We have made acquisitions in the past and may continue to make acquisitions in the future. The assets acquired and liabilities assumed are recorded based on their respective fair values at the date of acquisition. Long-lived assets (principally rental equipment), goodwill and other intangible assets generally represent the largest components of our acquisitions. Rental equipment is valued utilizing either a cost, market or income approach, or a combination of certain of these methods, depending on the asset being valued and the availability of market or income data. The intangible assets that we have acquired are non-compete agreements, customer relationships and trade names and associated trademarks. The estimated fair values of these intangible assets reflect various assumptions about discount rates, revenue growth rates, operating margins, royalty rates, customer attrition rates, terminal values, useful lives and other prospective financial information. Goodwill is calculated as the excess of the cost of the acquired entity over the net of the fair value of the assets acquired and the liabilities assumed. Non-compete agreements, customer relationships and trade names and associated trademarks are valued based on an excess earnings or income approach based on projected cash flows.
Determining the fair value of the assets and liabilities acquired is judgmental in nature and can involve the use of significant estimates and assumptions. 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 (loss) in periods subsequent to the acquisition because of depreciation and amortization, and in certain instances through impairment charges if the asset becomes impaired in the future. As discussed above, we regularly review long-lived assets for impairments.
When we make an acquisition, 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 and other working capital items. Because of their short-term nature, the fair values of these other assets and liabilities generally approximate the carrying values on the acquired entities’ balance sheets.
Note 3: Business Combinations
Acquisition of Custom Truck One Source, L.P.
On December 3, 2020, Nesco Holdings and Nesco Holdings II, Inc., a subsidiary of Nesco Holdings (the “Buyer” or the “Issuer”), entered into a Purchase and Sale Agreement (as amended, the “Purchase Agreement”) with certain affiliates of The Blackstone Group (“Blackstone”) and other direct and indirect equity holders (collectively, “Sellers”) of Custom Truck One Source, L.P., Blackstone Capital Partners VI-NQ L.P., and PE One Source Holdings, LLC, an affiliate of Platinum Equity, LLC (“Platinum”), pursuant to which Buyer agreed to acquire 100% of the partnership interests of Custom Truck LP. In connection with the Acquisition, Nesco Holdings and certain Sellers entered into Rollover and Contribution Agreements (the “Rollover Agreements”), pursuant to which such Sellers agreed to contribute a portion of their equity interests in Custom Truck LP (the “Rollovers”) with an aggregate value of $100.5 million in exchange for shares of Common Stock, valued at $5.00 per share. We believe the Acquisition creates a leading, one-stop shop for specialty equipment, serving highly attractive and growing infrastructure end-markets, including transmission and distribution, telecom, rail and other national infrastructure initiatives.
Also on December 3, 2020, Nesco Holdings entered into a Common Stock Purchase Agreement (the “Investment Agreement”) with Platinum, relating to, among other things, the issuance and sale to Platinum (the “Subscription”) of shares of Common Stock, for an aggregate purchase price in the range of $700 million to $763 million, with the specific amount calculated in accordance with the
Investment Agreement based upon the total equity funding required to fund the consideration paid pursuant to the terms of the Purchase Agreement. The shares of Common Stock issued and sold to Platinum had a purchase price of $5.00 per share. In accordance with the Investment Agreement, on December 21, 2020, Nesco Holdings entered into Subscription Agreements (the “Subscription Agreements”) with certain investors (the “PIPE Investors”) to finance, in part, the Acquisition. Pursuant to the Subscription Agreements, concurrently with the closing of the transactions contemplated by the Investment Agreement, the PIPE Investors agreed to purchase an aggregate of 28,000,000 shares of Common Stock at $5.00 per share for an aggregate purchase price of $140 million (the “Supplemental Equity Financing”).
On April 1, 2021 (the “Closing Date”), in connection with (i) the Rollovers, the Company issued, in the aggregate, 20,100,000 shares of Common Stock to the parties to the Rollover Agreements, (ii) the Subscription, the Company issued 148,600,000 shares of Common Stock to Platinum, and (iii) the Supplemental Equity Financing, the Company issued, in the aggregate, 28,000,000 shares of Common Stock to the PIPE Investors.
Purchase Price
The Company issued 20,100,000 shares of Common Stock to Custom Truck LP equity interest holders, as well as paid cash and repaid debt obligations as consideration for the Acquisition. The trading price of the Common Stock was $9.35 per share on the Closing Date. The purchase price has been determined to be as follows:
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| (in $000s, except share and per share data) | |
| Common stock issued | 20,100,000 | |
| Common stock per share price as of April 1, 2021 | $ | 9.35 | |
| Fair value of common stock issued | $ | 187,935 | |
| Cash consideration paid to equity interest holders | 790,324 | |
| Repayment of debt obligations | 552,600 | |
| Total purchase price | $ | 1,530,859 | |
During the year ended December 31, 2021, the Company transferred an additional $3.4 million of cash consideration to the Sellers related to certain customary closing adjustments set forth in the Purchase Agreement.
Opening Balance Sheet
The acquisition of Custom Truck LP has been accounted for using the acquisition method of accounting, and the Company is considered the accounting acquirer. Under the acquisition method of accounting, we are required to assign the purchase price to tangible and identifiable intangible assets acquired and liabilities assumed based on their fair values as of the Closing Date. The excess of the purchase price over those fair values is recorded as goodwill. The total purchase price has been assigned to the underlying assets acquired and liabilities assumed based upon their fair values as of the Closing Date, and the estimated fair values have been recorded based on independent valuations, discounted cash flow analysis, quoted market prices, contributory asset charges, and estimates made by management, which estimates fall under “Level 3” of the fair value hierarchy (as defined in Note 15: Fair Value Measurements).
The following table summarizes the April 1, 2021 fair values of the assets acquired and liabilities assumed. Since the Closing Date, the Company identified and recorded certain measurement period adjustments to the preliminary purchase price allocation, which are reflected in the table below. These adjustments were not significant and related primarily to rental equipment and current liabilities. The measurement period adjustments, coupled with the additional cash consideration discussed above, increased goodwill by approximately $15.6 million during the year ended December 31, 2021. The final assessment of the fair value of the Custom Truck LP assets acquired and liabilities assumed was complete as of March 31, 2022.
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| (in $000s) | |
| Accounts and financing receivables (a) | $ | 115,325 | |
| Inventory | 431,648 | |
| Other current assets | 13,201 | |
| Property and equipment (b) | 104,721 | |
| Rental equipment | 556,569 | |
| Intangible assets (c) | 301,018 | |
| Operating lease assets | 23,793 | |
| Other assets | 18,223 | |
| Total identifiable assets acquired | 1,564,498 | |
| Current liabilities | (410,276) | |
| Long-term debt | (28,607) | |
| Operating lease liabilities-noncurrent | (21,308) | |
| Deferred tax and other liabilities | (31,261) | |
| Total identifiable liabilities assumed | (491,452) | |
| Total net assets | 1,073,046 | |
| Goodwill (d) | 457,813 | |
| Net assets acquired (purchase price) | $ | 1,530,859 | |
a.The estimated fair value of accounts and financing receivables is $115.3 million, with the gross contractual amount being $122.4 million. The Company estimates approximately $7.0 million to be uncollectible.
b.Acquired property and equipment is primarily comprised of land, buildings and improvements with an estimated fair value of $67.9 million, and machinery, equipment and vehicles, with an estimated fair value of $31.1 million, as well as other property with an estimated fair value of $5.7 million.
c.The acquired identified intangible assets are comprised of trade names, with an estimated fair value of $151.0 million, and customer relationships, with an estimated fair value of $150.0 million. The weighted average useful lives of the trade names and the customer relationships are estimated to be 15 years and 12 years, respectively.
d.The goodwill recognized is attributable primarily to synergies and economies of scale provided by the acquired rental and new equipment sales businesses, as well as the assembled workforce of Custom Truck LP. Approximately $265.4 million of the goodwill is expected to be deductible for income tax purposes.
Goodwill attributable to the Acquisition was assigned to the Company’s segments as follows:
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| (in $000s) | |
| ERS | $ | 261,607 | |
| TES | 167,307 | |
| APS | 28,899 | |
Custom Truck LP generated $923.8 million of revenue and $28.2 million of pre-tax loss since the Closing Date for the year ended December 31, 2021, which was included in the Consolidated Statements of Operations and Comprehensive Income (Loss) for the year ended December 31, 2021.
Financing Transactions
On the Closing Date, the Issuer issued $920 million in aggregate principal amount of 5.50% senior secured second lien notes due 2029 (the “2029 Secured Notes”). The 2029 Secured Notes were issued pursuant to an indenture, dated as of April 1, 2021, by and among the Issuer, Wilmington Trust, National Association, as trustee, and the guarantors party thereto (the “Indenture”). The Issuer will pay interest on the Notes semi-annually in arrears on April 15 and October 15 of each year, which commenced on October 15, 2021. Unless earlier redeemed, the 2029 Secured Notes will mature on April 15, 2029. The notes were offered pursuant to a private placement exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”), to qualified institutional buyers pursuant to Rule 144A under the Securities Act and to certain non-U.S. persons outside of the United States in reliance on Regulation S under the Securities Act. The proceeds from the issuance and sale of the 2029 Secured Notes were used to consummate the Acquisition and to repay the Senior Secured Notes due 2024 previously issued by Nesco Holdings, repay certain indebtedness of Custom Truck LP and pay certain fees and expenses related to the Acquisition and financing transactions.
Also on the Closing Date, the Buyer, its direct parent, and certain of its direct and indirect subsidiaries entered into a senior secured asset-based revolving credit agreement (the “ABL Credit Agreement”) with Bank of America, N.A., as administrative agent and collateral agent, and certain other lenders party thereto, consisting of a $750.0 million first lien senior secured asset-based revolving credit facility with a maturity of five years (the “ABL Facility”), which includes borrowing capacity for revolving loans (with a swingline sub-facility) and the issuance of letters of credit. Proceeds from the ABL Facility were used to finance the repayment of
certain indebtedness of (i) Custom Truck LP under that certain Credit Agreement, dated as of April 18, 2017 (the “Custom Truck LP Credit Facility”), by and among Custom Truck LP, the other entities party thereto and Morgan Stanley Senior Funding, Inc., as administrative agent, and (ii) Buyer under that certain Credit Agreement, dated as of July 31, 2019 (the “2019 Credit Facility”), by and among Capitol Investment Merger Sub 2, LLC, the other entities party thereto and JPMorgan Chase Bank, N.A., as administrative agent, as well as to pay fees and expenses related to the Acquisition and the financing transactions.
Pro Forma Information
The below pro forma information is presented for the years ended December 31, 2021 and December 31, 2020 and uses the estimated fair value of assets and liabilities on the Closing Date, and makes the following assumptions: (1) removes acquisition-related costs and charges that were recognized in the Company's consolidated financial statements in the year ended December 31, 2021 and applies these costs and charges to the year ended December 31, 2020, as if the Acquisition and related financing transactions had occurred on January 1, 2020; (2) removes the loss on the extinguishment of debt that was recognized in the Company's consolidated financial statements in the year ended December 31, 2021 and applies the charge to the year ended December 31, 2020, as if the debt extinguishment giving rise to the loss had occurred on January 1, 2020; (3) adjusts for the impacts of purchase accounting in the years ended December 31, 2021 and December 31, 2020; (4) adjusts interest expense, including amortization of debt issuance costs, to reflect borrowings on the ABL Facility and issuance of the 2029 Secured Notes, as if the funds had been borrowed and the notes had been issued on January 1, 2020 and used to repay Nesco’s 2019 Credit Facility, Nesco’s Senior Secured Notes due 2024 (both as defined in Note 9: Long-Term Debt) and the Custom Truck LP Credit Facility and term loan; and (5) adjusts for the income tax effect using a tax rate of 25%. The pro forma information is not necessarily indicative of the Company’s results of operations had the Acquisition been completed on January 1, 2020, nor is it necessarily indicative of the Company’s future results. The pro forma information does not reflect any cost savings from operating efficiencies, synergies, or revenue opportunities that could result from the Acquisition.
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| | | Year Ended December 31, |
| (in $000s) | | | | | 2021 | | 2020 |
| Revenue | | | | | $ | 1,483,625 | | | $ | 1,356,481 | |
| Net income (loss) | | | | | $ | (90,521) | | | $ | (96,415) | |
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The following presents a summary of the pro forma adjustments that are directly attributable to the business combination:
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| | | | Year Ended December 31, |
| (in $000s) | | | | | | 2021 | | 2020 |
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| Increase (decrease) net income/loss: | | | | | | | | |
| Impact of fair value mark-ups on inventory | a | | | | | $ | 19,186 | | | $ | (14,775) | |
| Impact of fair value mark-ups on rental fleet depreciation | b | | | | | (3,817) | | | (8,643) | |
| Intangible asset amortization and other depreciation expense | c | | | | | (3,376) | | | (12,964) | |
| Transaction expenses | d | | | | | 40,277 | | | (40,277) | |
| Interest expense and amortization of debt issuance costs | e | | | | | 3,919 | | | 26,232 | |
| Loss on extinguishment of debt refinanced | f | | | | | 61,695 | | | (61,695) | |
| Income tax (benefit) expense | g | | | | | (29,471) | | | 28,031 | |
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a.Represents adjustments to cost of revenue for the run-off of the mark-up in fair value of inventory acquired and applied to the year ended December 31, 2020.
b.Represents the adjustment for depreciation of rental fleet relating to the estimated increase in the value of the rental fleet to its fair value.
c.Represents the differential in amortization and depreciation of non-rental equipment related to the respective fair values of the assets.
d.Represents adjustments for transaction expenses that are applied to the year ended December 31, 2020.
e.Reflects the differential in interest expense, inclusive of amortization of capitalized debt issuance costs, related to our debt structure after the Acquisition as though the following had occurred on January 1, 2020: (i) borrowings under the ABL Facility; (ii) repayment of the 2019 Credit Facility; (iii) repayment of the Senior Secured Notes due 2024; (iv) repayment of the Custom Truck LP’s borrowings under its revolving credit and term loan facility ; and (v) the issuance of the 2029 Secured Notes.
f.Represents the adjustment of the loss on extinguishment of debt applied to the year ended December 31, 2020 as though the repayment of the 2019 Credit Facility and Senior Secured Notes due 2024 had occurred on January 1, 2020.
g.Reflects the adjustment to recognize the tax impacts of the pro forma adjustments for which a tax expense is recognized using a statutory tax rate of 25%. This rate may vary from the actual effective rate of the historical and combined businesses.
Transaction Costs
The Company expensed approximately $51.8 million in transaction and post-acquisition integration costs related to the Acquisition within transaction expenses and other in the year ended December 31, 2021.
Acquisition of HiRail
On January 14, 2022, a subsidiary of the Company, CTOS Canada, Ltd., closed a Share Purchase Agreement with certain affiliates of Ontario Limited (d/b/a HiRail Leasing), Ontario Inc. (d/b/a Heavy Equipment Repairs), and Ontario Limited (d/b/a Northshore Rail Contracting) (collectively “HiRail”) to acquire 100% of the equity interests of HiRail. The acquisition of HiRail expands our presence in our strategic markets and deepens our relationships with key customers. HiRail, including the assignment of purchase accounting goodwill (see below), is included in the Company’s ERS segment.
Purchase Price
The Company paid $51.0 million, net of working capital adjustments, to HiRail equity interest holders and to repay debt obligations as consideration for the HiRail acquisition.
Opening Balance Sheet
The acquisition of HiRail has been accounted for using the acquisition method of accounting. Under the acquisition method of accounting, the Company was required to assign the purchase price to tangible and identifiable intangible assets acquired and liabilities assumed based on their fair values as of January 14, 2022. The excess of the purchase price over those fair values was recorded as goodwill and was attributable to expanded access to markets for the Company’s product and service offering, synergies, and broader product offerings to existing customers of HiRail. The total purchase price has been assigned to the underlying assets acquired and liabilities assumed based upon their fair values as of January 14, 2022, and the estimated fair values have been recorded based on independent valuations, discounted cash flow analysis, quoted market prices, contributory asset charges, and estimates made by management, which estimates fall under “Level 3” of the fair value hierarchy (as defined in Note 15: Fair Value Measurements).
The following table summarizes the January 14, 2022 fair values of the assets acquired and liabilities assumed. The final assessment of the fair value of the HiRail assets acquired and liabilities assumed was complete as of December 31, 2022.
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| (in $000s) | January 14, 2022 | | Changes | | December 31, 2022 |
| Current assets | $ | 2,891 | | | $ | 956 | | | $ | 3,847 | |
| Property, equipment and other assets | 819 | | | — | | | 819 | |
| Rental equipment | 34,224 | | | — | | | 34,224 | |
| Total identifiable assets acquired | 37,934 | | | 956 | | | 38,890 | |
| Total identifiable liabilities assumed | (6,011) | | | (1,596) | | | (7,607) | |
| Total net assets | 31,923 | | | (640) | | | 31,283 | |
| Goodwill | 8,685 | | | (41) | | | 8,644 | |
| Intangible assets | 11,027 | | | — | | | 11,027 | |
| Net assets acquired (purchase price) | 51,635 | | | (681) | | | 50,954 | |
| Less: cash acquired | (1,122) | | | — | | | (1,122) | |
| Net cash paid | $ | 50,513 | | | $ | (681) | | | $ | 49,832 | |
Since January 14, 2022, HiRail has generated $16.9 million of revenue and $2.6 million of pre-tax income, which are included in the Consolidated Statements of Operations and Comprehensive Income (Loss) for the year ended December 31, 2022. Costs and expenses related to the acquisition were expensed as incurred and were not material. Additionally, pro forma information as if the acquisition of HiRail had occurred on January 1, 2021 is not being presented as the information is not considered material to our consolidated financial statements.
Note 4: Revenue
Revenue Disaggregation
Geographic Areas
The Company had total revenue in the following geographic areas:
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| | | Year Ended December 31, |
| (in $000s) | | | | | 2022 | | 2021 | | 2020 |
| United States | | | | | $ | 1,529,165 | | | $ | 1,148,683 | | | $ | 295,125 | |
| Canada | | | | | 43,921 | | | 18,471 | | | 5,827 | |
| Mexico | | | | | — | | | — | | | 1,787 | |
| Total revenue | | | | | $ | 1,573,086 | | | $ | 1,167,154 | | | $ | 302,739 | |
Major Product Lines and Services
Equipment leasing and equipment sales are the core businesses of the Company, with leasing complemented by the sale of rental units from the rental fleet. The Company’s revenue by major product and service line are presented in the tables below.
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| Year Ended December 31, | | Year Ended December 31, | | Year Ended December 31, |
| 2022 | | 2021 | | 2020 |
| (in $000s) | Topic 842 | | Topic 606 | | Total | | Topic 842 | | Topic 606 | | Total | | Topic 840 | | Topic 606 | | Total |
| Rental: | | | | | | | | | | | | | | | | | |
| Rental | $ | 444,155 | | | $ | — | | | $ | 444,155 | | | $ | 355,658 | | | $ | — | | | $ | 355,658 | | | $ | 187,522 | | | $ | — | | | $ | 187,522 | |
| Shipping and handling | — | | | 19,884 | | | 19,884 | | | — | | | 14,409 | | | 14,409 | | | — | | | 7,968 | | | 7,968 | |
| Total rental revenue | 444,155 | | | 19,884 | | | 464,039 | | | 355,658 | | | 14,409 | | | 370,067 | | | 187,522 | | | 7,968 | | | 195,490 | |
| Sales and services: | | | | | | | | | | | | | | | | | |
| Equipment sales | 30,547 | | | 951,794 | | | 982,341 | | | 16,274 | | | 679,060 | | | 695,334 | | | — | | | 56,632 | | | 56,632 | |
| Parts and services | 13,402 | | | 113,304 | | | 126,706 | | | 6,726 | | | 95,027 | | | 101,753 | | | — | | | 50,617 | | | 50,617 | |
| Total sales and services | 43,949 | | | 1,065,098 | | | 1,109,047 | | | 23,000 | | | 774,087 | | | 797,087 | | | — | | | 107,249 | | | 107,249 | |
| Total revenue | $ | 488,104 | | | $ | 1,084,982 | | | $ | 1,573,086 | | | $ | 378,658 | | | $ | 788,496 | | | $ | 1,167,154 | | | $ | 187,522 | | | $ | 115,217 | | | $ | 302,739 | |
Rental revenue is primarily comprised of revenues from rental agreements and freight charges billed to customers. Equipment sales recognized pursuant to sales-type leases are recorded within equipment sales revenue. Charges to customers for damaged rental equipment are recorded within parts and services revenue. Parts and services revenue includes $26.1 million and $21.5 million related to services provided to customers for the years ended December 31, 2022 and December 31, 2021, respectively. Services revenue in the year ended December 31, 2020 was not material.
Receivables, Contract Assets and Liabilities
As of December 31, 2022 and December 31, 2021, the Company had receivables related to contracts with customers of $98.0 million and $69.7 million, respectively. As of December 31, 2022 and December 31, 2021, the Company had receivables related to rental contracts and other of $95.1 million and $98.7 million, respectively.
The Company manages credit risk associated with its accounts receivable at the customer level. Because the same customers generate the revenues that are accounted for under both Topic 606 and Topic 842 (or Topic 840 for periods prior to January 1, 2021), the discussions below on credit risk and the Company's allowance for credit losses address the Company's total revenues. Concentration of credit risk with respect to the Company's receivables is limited because of a large number of geographically diverse customers who operate in a variety of end user markets. The Company manages credit risk through credit approvals, credit limits, and other monitoring procedures.
The Company’s allowance for credit losses reflects its estimate of the amount of receivables that it will be unable to collect. The estimated losses are based upon a review of outstanding receivables, the related aging, including specific accounts if deemed necessary, and on the Company’s historical collection experience. The estimated losses are calculated using the loss rate method based upon a review of outstanding receivables, related aging, and historical collection experience. The Company's estimates reflect changing circumstances, including changes in the economy or in the particular circumstances of individual customers, and, as a result,
the Company may be required to increase or decrease its allowance. See Note 2: Summary of Significant Accounting Policies for further information regarding allowance for credit losses.
When customers are billed for rentals in advance of the rental period, the Company defers recognition of revenue. As of both December 31, 2022 and December 31, 2021, the Company had approximately $3.0 million of deferred rental revenue. Additionally, the Company collects deposits from customers for orders placed for equipment and rentals. The Company had approximately $29.6 million and $32.9 million in deposits as of December 31, 2022 and December 31, 2021, respectively. Of the $32.9 million deposit liability balance as of December 31, 2021, $32.2 million was recorded as revenue during the year ended December 31, 2022 due to performance obligations being satisfied. The Company’s remaining performance obligations on its equipment deposit liabilities have original expected durations of one year or less.
The Company does not have material contract assets, and it did not recognize any material impairments of any contract assets.
The primary costs to obtain contracts for new and rental unit sales with the Company's customers are commissions. The Company pays its sales force commissions related to the sale and rental of new and used units. For new unit and rental unit sales, the period benefited by each commission is less than one year. As a result, the Company has applied the practical expedient for incremental costs of obtaining a sales contract and expenses commissions as incurred.
Note 5: Sales-Type Leases
Revenue from rental agreements qualifying as sales-type leases was as follows:
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| (in $000s) | | | | | 2022 | | 2021 | | |
| Equipment sales | | | | | $ | 41,525 | | | $ | 16,274 | | | |
| Cost of equipment sales | | | | | 37,582 | | | 16,532 | | | |
| Gross profit (loss) | | | | | $ | 3,943 | | | $ | (258) | | | |
As these transactions remained under rental contracts, $21.3 million and $12.7 million for the years ended December 31, 2022 and December 31, 2021, respectively, were billed under the contracts as rentals. Interest income from financing receivables was $12.1 million and $5.9 million for the years ended December 31, 2022 and December 31, 2021, respectively.
The Company’s financing receivables are related to sales-type leases and are collateralized by a security interest in the underlying equipment. As of December 31, 2022 and December 31, 2021 financing receivables, net of unearned income of $0.7 million and $0.4 million, were $38.3 million and $28.6 million, respectively.
Note 6: Inventory
Inventory consisted of the following:
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| (in $000s) | December 31, 2022 | | December 31, 2021 |
| Whole goods | $ | 468,557 | | | $ | 326,641 | |
| Aftermarket parts and services inventory | 128,167 | | | 83,901 | |
| Inventory | $ | 596,724 | | | $ | 410,542 | |
Note 7: Floor Plan Financing
Floor plan payables represent financing arrangements to facilitate the Company’s purchase of new and used trucks, cranes, and construction equipment inventory. All floor plan payables are collateralized by the inventory financed. These payables become due and payable upon the sale, transfer, or reclassification of each unit of inventory. Certain floor plan arrangements require the Company to satisfy various financial ratios consistent with those under the ABL Facility. See Note 9: Long-Term Debt. As of December 31, 2022, the Company was in compliance with these covenants.
The amounts owed under floor plan payables are summarized as follows:
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| (in $000s) | December 31, 2022 | | December 31, 2021 | | |
| Trade: | | | | | |
| Daimler Truck Financial | $ | 105,447 | | | $ | 46,012 | | | |
| PACCAR Financial Services | 31,187 | | | 26,702 | | | |
| Trade floor plan payables | $ | 136,634 | | | $ | 72,714 | | | |
| Non-trade: | | | | | |
| PNC Equipment Finance, LLC | $ | 293,536 | | | $ | 165,239 | | | |
| Non-trade floor plan payables | $ | 293,536 | | | $ | 165,239 | | | |
Interest on outstanding floor plan payable balances is due and payable monthly. Floor plan interest expense was $12.6 million and $5.2 million for the years ended December 31, 2022 and December 31, 2021, respectively.
Trade Floor Plan Financing:
Daimler Truck Financial
The Company is party to the Wholesale Financing Agreement with Daimler Truck Financial (the “Daimler Facility”) which bears interest at a rate of the Prime plus 0.80% after an initial interest free period of up to 150 days. The total borrowing capacity under the Daimler Facility is $175.0 million. The Daimler agreement is evergreen and is subject to termination by either party through written notice.
PACCAR
The Company has an Inventory Financing Agreement with PACCAR Financial Corp that provides the Company with a line of credit of $75.0 million to finance inventory purchases of new Peterbilt and/or Kenworth trucks, tractors, and chassis. Amounts borrowed against this line of credit incur interest at a rate of the London Interbank Offered Rate (“LIBOR”) plus 2.4%. Effective during the first quarter of 2023, the interest rate will be U.S. Prime Rate minus 0.6%. The PACCAR agreement extends automatically each April and is subject to termination by either party through written notice.
References to the prime rate in the foregoing agreements represent the rate as published in The Wall Street Journal.
Non-Trade Floor Plan Financing:
PNC Equipment Finance, LLC
The Company has an Inventory Loan, Guaranty and Security Agreement (the “Loan Agreement”) with PNC Equipment Finance, LLC. As of December 31, 2022, the Loan Agreement provided the Company with a $315.0 million revolving credit facility, which matures on August 25, 2023. The Loan Agreement interest rate at December 31, 2022 and December 31, 2021 was a three-month term secured overnight financing rate (“SOFR”) plus 3.25% and a LIBOR plus 3.05%, respectively.
Note 8: Rental Equipment and Property and Equipment
Rental equipment, net consisted of the following:
| | | | | | | | | | | |
| (in $000s) | December 31, 2022 | | December 31, 2021 |
| Rental equipment | $ | 1,360,205 | | | $ | 1,247,375 | |
| Less: accumulated depreciation | (476,531) | | | (413,050) | |
| Rental equipment, net | $ | 883,674 | | | $ | 834,325 | |
Property and equipment, net consisted of the following:
| | | | | | | | | | | |
| (in $000s) | December 31, 2022 | | December 31, 2021 |
| Buildings and leasehold improvements | $ | 65,660 | | | $ | 52,418 | |
| Vehicles | 29,184 | | | 17,656 | |
| Land and improvements | 25,773 | | | 20,290 | |
| Machinery and equipment | 22,224 | | | 31,578 | |
| Furniture and fixtures | 6,321 | | | 5,502 | |
| Construction in progress | 2,981 | | | 2,016 | |
| Total property and equipment | 152,143 | | | 129,460 | |
| Accumulated depreciation | (30,187) | | | (20,848) | |
| Property and equipment, net | $ | 121,956 | | | $ | 108,612 | |
Note 9: Long-Term Debt
Debt obligations and associated interest rates consisted of the following:
| | | | | | | | | | | | | | | | | | | | | | | |
| (in $000s) | December 31, 2022 | | December 31, 2021 | | December 31, 2022 | | December 31, 2021 |
| ABL Facility | $ | 437,731 | | | $ | 394,945 | | | 6.1% | | 1.8% |
| 2029 Secured Notes | 920,000 | | | 920,000 | | | 5.5% | | 5.5% |
| Notes payable | 31,661 | | | 32,619 | | | 3.1%-5.0% | | 3.0%-5.0% |
| Total debt outstanding | 1,389,392 | | | 1,347,564 | | | | | |
| Deferred financing fees | (27,686) | | | (32,945) | | | | | |
| Total debt excluding deferred financing fees | 1,361,706 | | | 1,314,619 | | | | | |
| Less: current maturities | (6,940) | | | (6,354) | | | | | |
| Long-term debt | $ | 1,354,766 | | | $ | 1,308,265 | | | | | |
In connection with the Acquisition and related financing transactions, on April 1, 2021, the Company entered into the ABL Facility and repaid the Custom Truck LP Credit Facility and Nesco’s 2019 Credit Facility as described in Note 3: Business Combinations. Additionally, on April 1, 2021, the Company redeemed all of Nesco’s Senior Secured Notes due 2024 and paid a make-whole premium. The terms of the ABL Facility and 2029 Secured Notes are described below. The financing transactions related to the Acquisition resulted in the recognition of a loss on the extinguishment of debt in the year ended December 31, 2021, comprised of (i) the elimination of unamortized deferred financing fees related to the 2019 Credit Facility and the Senior Secured Notes due 2024 of $8.2 million and, (ii) the payment of the make-whole premium to holders of the Senior Secured Notes due 2024 of $38.5 million. Additionally, prior to the consummation of the Acquisition, on December 3, 2020, the Company entered into a bridge financing commitment that was available to be used to provide a portion of the financing necessary to fund the consideration to be paid pursuant to the terms of the Acquisition. Because the Company entered into the ABL Facility and issued the 2029 Secured Notes, financing under the bridge facility was not used; however, on the Closing Date, the Company paid $15.0 million in fees to the bridge financing parties, which fees are included in loss on extinguishment of debt, in the Consolidated Statements of Operations and Comprehensive Income (Loss) for the year ended December 31, 2021.
ABL Facility
In connection with the Acquisition, Buyer, as borrower, and the ABL Guarantors (as defined in the ABL Credit Agreement) entered into the ABL Credit Agreement. The ABL Facility provides for revolving loans, in an amount equal to the lesser of the then-current borrowing base (described below) and the committed maximum borrowing capacity of $750.0 million, with a $75.0 million swingline sublimit, and letters of credit in an amount equal to the lesser of (a) $50.0 million and (b) the aggregate unused amount of commitments under the ABL Facility then in effect. The ABL Facility permits the Buyer to incur additional capacity under the ABL Facility in an aggregate amount equal to the greater of (x) $200.0 million and (y) 60.0% of Consolidated EBITDA (as defined in the ABL Credit Agreement) in additional commitments. As of the Closing Date, Buyer had no commitments from any lender to provide incremental commitments.
Borrowings under the ABL Facility are limited by a borrowing base calculation based on the sum of, without duplication:
(a) 90.0% of book value of eligible accounts of Buyer and certain ABL Guarantors; plus
(b) the lesser of (i) 75.0% of book value of eligible parts inventory of Buyer and certain ABL Guarantors (subject to certain exceptions) and (ii) 90.0% of the net orderly liquidation value of eligible parts inventory of Buyer and certain ABL Guarantors; plus
(c) the sum of (i) 95.0% of the net book value of the eligible fleet inventory of Buyer and certain ABL Guarantors that has not been appraised and (ii) 85.0% of the net orderly liquidation value of the eligible fleet inventory of Buyer and certain ABL Guarantors that has been appraised; plus
(d) 100.0% of eligible cash of Buyer and certain ABL Guarantors; minus
(e) any reserves established by the administrative agent from time to time.
As of December 31, 2022, borrowing availability under the ABL Facility was $309.4 million, and outstanding standby letters of credit were $2.9 million. Borrowings under the ABL Facility bears interest at a floating rate, which, at Buyer’s election, could be (a) in the case of U.S. dollar denominated loans, either (i) LIBOR plus an applicable margin or (ii) the base rate plus an applicable margin; or (b) in the case of Canadian dollar denominated loans, the CDOR rate plus an applicable margin. The applicable margin varies based on Average Availability (as defined in the ABL Credit Agreement) from (a) with respect to base rate loans, 0.50% to 1.00% and (b) with respect to LIBOR loans and CDOR rate loans, 1.50% to 2.00%. The ability to draw under the ABL Facility or issue letters of credit thereunder is conditioned upon, among other things, delivery of prior written notice of a borrowing or issuance, as applicable, the ability to reaffirm the representations and warranties contained in the ABL Credit Agreement and the absence of any default or event of default under the ABL Facility.
Buyer is required to pay a commitment fee to the lenders under the ABL Facility in respect of the unutilized commitments thereunder at a rate equal to 0.375% per annum, which may be reduced following the first full fiscal quarter to 0.250% per annum based on average daily usage. Buyer must also pay customary letter of credit and agency fees.
The balance outstanding under the ABL Facility will be due and payable on April 1, 2026. Buyer may, at any time and from time to time, prepay, without premium or penalty, any borrowing under the ABL Facility and terminate, or from time to time reduce, the commitments under the ABL Facility.
The obligations under the ABL Facility are guaranteed by Capitol Investment Merger Sub 2, LLC, Buyer and each of Buyer’s existing and future direct and indirect wholly owned domestic restricted subsidiaries, subject to certain exceptions, as well as certain of Buyer’s material Canadian subsidiaries (the “ABL Guarantors”). The obligations under the ABL Facility and the guarantees of those obligations are secured by (subject to certain exceptions): (i) a first priority pledge by each ABL Guarantor of all of the equity interests of restricted subsidiaries directly owned by such ABL Guarantors (limited to 65% of voting capital stock in the case of foreign subsidiaries owned directly by a U.S. subsidiary and subject to certain other exceptions in the case of non-wholly owned subsidiaries) and (ii) a first priority security interest in substantially all of the ABL Guarantors’ present and after-acquired assets (subject to certain exceptions).
The ABL Facility contains customary negative covenants for transactions of this type, including covenants that, among other things, limit Buyer’s and its restricted subsidiaries’ ability to: incur additional indebtedness; pay dividends, redeem stock, or make other distributions; repurchase, prepay, or redeem subordinated indebtedness; make investments; create restrictions on the ability of Buyer’s restricted subsidiaries to pay dividends to Buyer; create liens; transfer or sell assets; consolidate, merge, sell, or otherwise dispose of all or substantially all of Buyer’s assets; enter into certain transactions with Buyer’s affiliates; and designate subsidiaries as unrestricted subsidiaries, in each case subject to certain exceptions, as well as a restrictive covenant applicable to each Specified Floor Plan Company (as defined in the ABL Credit Agreement) limiting its ability to own certain assets and engage in certain lines of business. In addition, the ABL Facility contains a springing financial covenant that requires Buyer and its restricted subsidiaries to maintain a Consolidated Fixed Charge Coverage Ratio (as defined in the ABL Credit Agreement) of at least 1.00 to 1.00; provided that the financial covenant shall only be tested when Specified Excess Availability (as defined in the ABL Credit Agreement) under the ABL Facility is less than the greater of (i) 10.0% of the Line Cap (as defined in the ABL Credit Agreement) and (ii) $60.0 million (the “FCCR Test Amount”), in which case it shall be tested at the end of each succeeding fiscal quarter thereafter until the date on which Specified Excess Availability has exceeded the FCCR Test Amount for 30 consecutive calendar days.
The ABL Facility provides for a number of customary events of default, including, among others, and in each case subject to an applicable grace period: payment defaults to the lenders; covenant defaults; material inaccuracies of representations and warranties; failure to pay certain other indebtedness after final maturity or acceleration of other indebtedness exceeding a specified amount; voluntary and involuntary bankruptcy proceedings; material judgments for payment of money exceeding a specified amount; and certain change of control events. The occurrence of an event of default could result in the acceleration of obligations and the termination of revolving commitments under the ABL Facility.
2029 Secured Notes
On the Closing Date, the Issuer issued $920.0 million in aggregate principal amount of 5.50% senior secured second lien notes due 2029. The 2029 Secured Notes were issued pursuant to an Indenture, dated as of April 1, 2021, between the Issuer, Wilmington Trust, National Association, as trustee and the guarantors party thereto. The Issuer pays interest on the 2029 Secured Notes semi-annually in arrears on April 15 and October 15 of each year, commencing on October 15, 2021. Unless earlier redeemed, the 2029 Secured Notes will mature on April 15, 2029.
Ranking and Security
The 2029 Secured Notes are jointly and severally guaranteed on a senior secured basis by Capitol Investment Merger Sub 2, LLC and, subject to certain exceptions, each of the Issuer’s existing and future wholly owned domestic restricted subsidiaries that is an obligor under the ABL Credit Agreement or certain other capital markets indebtedness. Under the terms of the Indenture, the 2029 Secured Notes and the related guarantees rank senior in right of payment to all of the Issuer’s and the guarantors’ subordinated indebtedness and are effectively senior to all of the Issuer’s and the guarantors’ unsecured indebtedness, and indebtedness secured by liens junior to the liens securing the 2029 Secured Notes, in each case, to the extent of the value of the collateral securing the 2029 Secured Notes. The 2029 Secured Notes and the related guarantees rank equally in right of payment with all of the Issuer’s and the guarantors’ senior indebtedness, without giving effect to collateral arrangements, and effectively equal to all of the Issuer’s and the guarantors’ senior indebtedness secured on the same priority basis as the 2029 Secured Notes. The 2029 Secured Notes and the related guarantees are effectively subordinated to any of the Issuer’s and the guarantors’ indebtedness that is secured by assets that do not constitute collateral for the 2029 Secured Notes to the extent of the value of the assets securing such indebtedness, and indebtedness that is secured by a senior-priority lien, including the ABL Credit Agreement to the extent of the value of the collateral securing such indebtedness, and are structurally subordinated to the liabilities of the Issuer’s non-guarantor subsidiaries.
Optional Redemption Provisions and Repurchase Rights
At any time, upon not less than 10 nor more than 60 days’ notice, the 2029 Secured Notes are redeemable at the Issuer’s option, in whole or in part, at a price equal to 100% of the principal amount of the 2029 Secured Notes redeemed, plus a make-whole premium as set forth in the Indenture, plus accrued and unpaid interest, if any, to, but not including, the applicable redemption date. Beginning April 15, 2024, the Issuer may redeem the 2029 Secured Notes, at its option, in whole or in part, at any time, subject to the payment of a redemption price together with accrued and unpaid interest, if any, to, but not including, the applicable redemption date. The redemption price includes a call premium that varies (from 2.750% to 0.000%) depending on the year of redemption.
In addition, at any time prior to April 15, 2024, the Issuer may redeem up to 40% of the aggregate principal amount of the 2029 Secured Notes, at a redemption price equal to 105.5% of the principal amount thereof, together with accrued and unpaid interest, if any, to, but not including, the applicable redemption date, with the net cash proceeds of sales of one or more equity offerings by the Issuer or any direct or indirect parent of the Issuer, subject to certain exceptions.
In addition, at any time prior to April 15, 2024, the Issuer may redeem during each calendar year up to 10% of the aggregate principal amount of the 2029 Secured Notes at a redemption price equal to 103% of the aggregate principal amount of the 2029 Secured Notes to be redeemed, together with accrued and unpaid interest, if any, to, but not including, the applicable redemption date; provided that, in any given calendar year, any amount not previously utilized in any calendar year may be carried forward to subsequent calendar years.
Subject to certain exceptions, the holders of the 2029 Secured Notes also have the right to require the Issuer to repurchase their 2029 Secured Notes upon the occurrence of a change in control, as defined in the Indenture, at an offer price equal to 101% of the principal amount of the 2029 Secured Notes plus accrued and unpaid interest, if any, to, but not including, the date of repurchase.
In addition, if the Issuer or any of its restricted subsidiaries sells assets, under certain circumstances, the Issuer is required to use the net proceeds to make an offer to purchase the 2029 Secured Notes at an offer price in cash equal to 100% of the principal amount of the 2029 Secured Notes plus accrued and unpaid interest to, but not including, the repurchase date.
In connection with any offer to purchase all or any of the 2029 Secured Notes (including a change of control offer and any tender offer), if holders of no less than 90% of the aggregate principal amount of the 2029 Secured Notes validly tender their 2029 Secured Notes, the Issuer or a third party is entitled to redeem any remaining 2029 Secured Notes at the price offered to each holder.
Restrictive Covenants
The Indenture contains covenants that limit the Issuer’s (and certain of its subsidiaries’) ability to, among other things: (i) incur additional debt or issue certain preferred stock; (ii) pay dividends, redeem stock, or make other distributions; (iii) make other restricted payments or investments; (iv) create liens on assets; (v) transfer or sell assets; (vi) create restrictions on payment of dividends or other
amounts by the Issuer to the Issuer’s restricted subsidiaries; (vii) engage in mergers or consolidations; (viii) engage in certain transactions with affiliates; or (ix) designate the Issuer’s subsidiaries as unrestricted subsidiaries.
Events of Default
The Indenture provides for customary events of default, including non-payment, failure to comply with covenants or other agreements in the Indenture, and certain events of bankruptcy or insolvency. If an event of default occurs and continues with respect to the 2029 Secured Notes, the trustee or the holders of at least 30% in aggregate principal amount of the outstanding 2029 Secured Notes of such series may declare the entire principal amount of all the 2029 Secured Notes to be due and payable immediately (except that if such event of default is caused by certain events of bankruptcy or insolvency, the entire principal of the 2029 Secured Notes will become due and payable immediately without further action or notice).
Notes Payable
Our notes payable require the Company to pay monthly and quarterly interest payments and have maturities through 2026. Notes payable include (i) debt assumed from the Acquisition related to borrowings for facilities renovations and to support general business activities, (ii) notes payable related to past businesses acquired, and (iii) term loans. Subsequent to the Acquisition, the Company consolidated certain notes payable assumed from the Acquisition into a $23.9 million loan agreement with Security Bank of Kansas City (“SBKC”) that bears interest at a rate of 3.125% per annum, and a $3.5 million loan agreement with SBKC that bears interest at a rate of 3.5% per annum.
Debt Maturities
As of December 31, 2022, the principal payments of debt outstanding over the next five years and thereafter were as follows:
| | | | | | | | | | | |
| (in $000s) | Notes Payable | | Long-Term Debt |
| 2023 | $ | 6,940 | | | $ | — | |
| 2024 | 1,080 | | | — | |
| 2025 | 1,117 | | | — | |
| 2026 | 22,524 | | | 437,731 | |
| 2027 | — | | | — | |
| Thereafter | — | | | 920,000 | |
| Total | $ | 31,661 | | | $ | 1,357,731 | |
| Less unamortized discount and issuance costs | — | | | (27,686) | |
| $ | 31,661 | | | $ | 1,330,045 | |
2023 Credit Facility
On January 13, 2023, the Company entered into a new credit agreement allowing for borrowings of up to $18.0 million (the “2023 Credit Facility”). Proceeds from the credit agreement were used to finance a portion of the Company’s acquisition of real property from a related party in December 2022, see Note 20: Related Parties for further information. A portion of the loan proceeds will be used to finance improvements to the property. In connection with entering into the agreement, the Company received proceeds of $13.7 million with the ability to draw an additional $4.2 million upon completion of certain construction milestones. Borrowings bear interest at a fixed rate of 5.75% per annum and are required to be repaid monthly in an amount of approximately $0.1 million with a balloon payment due on the maturity date of January 13, 2028. Borrowings are secured by the real property and improvements.
Note 10: Leases as Lessee
The Company adopted Topic 842 on January 1, 2021, using the modified retrospective transition method; and therefore, the comparative information has not been adjusted for the year ended December 31, 2020 and continues to be reported under the accounting standards in effect for that year (e.g., under Topic 840).
The Company’s operating lease agreements primarily consist of real estate property, such as warehouses and office buildings, in addition to personal property, such as vehicles and equipment. The majority of the Company’s lease arrangements are comprised of fixed payments and a limited number of these arrangements include a variable payment component based on certain index fluctuations. The Company also leases certain rental equipment under master lease agreements, which are classified as finance leases. The master lease agreements are typically for a five-year period, at the end of which the Company is entitled to return or purchase the equipment, or extend the life of the lease.
Components of Lease Expense
The components of lease expense are as follows:
| | | | | | | | | | | |
| Year Ended December 31, |
| (in $000s) | 2022 | | 2021 |
| Operating lease cost | $ | 7,659 | | | $ | 6,969 | |
| Finance lease cost: | | | |
| Amortization of lease assets | 1,820 | | | 2,973 | |
| Interest on lease liabilities | 1,189 | | | 1,431 | |
| Short-term lease cost | 1,472 | | | 3,690 | |
| | | |
| Sublease income | (1,730) | | | (5,383) | |
| Total lease cost | $ | 10,410 | | | $ | 9,680 | |
Supplemental Cash Flow Information
Supplemental cash flow information related to leases is as follows:
| | | | | | | | | | | |
| Year Ended December 31, |
| (in $000s) | 2022 | | 2021 |
| Cash paid for amounts included in the measurement of lease liabilities: | | | |
| Operating cash outflows - payments on operating leases | $ | 7,855 | | | $ | 6,969 | |
| Operating cash outflows - interest payments on finance leases | $ | 1,189 | | | $ | 1,431 | |
| Finance cash outflows - payments on finance lease obligations | $ | 3,955 | | | $ | 5,223 | |
| Supplemental disclosure of noncash leasing activities: | | | |
| Right-of-use assets obtained in exchange for new operating lease liabilities (1) | $ | 3,761 | | | $ | 1,809 | |
(1) Includes lease extension and option exercises.
Supplemental Balance Sheet Information
Supplemental balance sheet information related to leases is as follows:
| | | | | | | | | | | |
| (in $000s) | December 31, 2022 | | December 31, 2021 |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| Finance leases | | | |
| Property and equipment | $ | 4,362 | | | $ | 3,535 | |
| Accumulated depreciation | (1,089) | | | (95) | |
| Property and equipment, net | $ | 3,273 | | | $ | 3,440 | |
| | | |
| Rental equipment | $ | 11,370 | | | $ | 18,715 | |
| Accumulated depreciation | (6,610) | | | (8,056) | |
| Rental equipment, net | $ | 4,760 | | | $ | 10,659 | |
Future Maturities and Payment Information
Maturities of lease liabilities as of December 31, 2022 are as follows:
| | | | | | | | | | | |
| (in $000s) | Operating Leases | | Finance Leases |
| 2023 | $ | 6,898 | | | $ | 2,047 | |
| 2024 | 5,939 | | | 3,744 | |
| 2025 | 4,796 | | | — | |
| 2026 | 3,918 | | | — | |
| 2027 | 3,121 | | | — | |
| Thereafter | 13,981 | | | — | |
| Total lease payments | 38,653 | | | 5,791 | |
| Less: imputed interest | (8,573) | | | (789) | |
| Total present value of lease liabilities | $ | 30,080 | | | $ | 5,002 | |
The weighted average discount rate under operating and finance leases was 6.0% and 11.6%, respectively, as of December 31, 2022. The weighted average remaining lease term under operating and finance leases was 7.9 years and 1.4 years, respectively, as of December 31, 2022.
Note 11: Goodwill and Intangible Assets
Goodwill
The following table summarizes the changes in goodwill by reporting unit:
| | | | | | | | | | | | | | | | | | | | | | | |
| (in $000s) | ERS | | TES | | APS | | Total |
| Balance, December 31, 2020 | $ | 229,055 | | | $ | — | | | $ | 8,997 | | | $ | 238,052 | |
| Acquisition of Custom Truck One Source, L.P. (1) | 261,607 | | | 167,307 | | | 28,899 | | | 457,813 | |
| Balance, December 31, 2021 | 490,662 | | | 167,307 | | | 37,896 | | | 695,865 | |
| Acquisition of HiRail (1) | 8,644 | | | — | | | — | | | 8,644 | |
| Currency translation adjustment | (682) | | | — | | | — | | | (682) | |
| Balance, December 31, 2022 | $ | 498,624 | | | $ | 167,307 | | | $ | 37,896 | | | $ | 703,827 | |
(1) See Note 3: Business Combinations, for additional information.
Intangible Assets
Intangible assets consisted of the following:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2022 | | December 31, 2021 |
| (in $000s) | Weighted Average Remaining Life (Years) | | Gross Carrying Amount | | Accumulated Amortization | | Gross Carrying Amount | | Accumulated Amortization |
| Definite-lived intangible assets: | | | | | | | | | |
| Trade names | 13.2 | | $ | 180,780 | | | $ | (46,513) | | | $ | 180,780 | | | $ | (28,978) | |
| Customer relationships | 11.8 | | 212,351 | | | (42,502) | | | 202,170 | | | (26,173) | |
| Non-compete agreements and other | 1.2 | | 535 | | | (519) | | | 538 | | | (497) | |
| Total | | | $ | 393,666 | | | $ | (89,534) | | | $ | 383,488 | | | $ | (55,648) | |
Amortization expense associated with the intangible assets noted above was $33.9 million, $40.8 million, and $3.2 million for the years ended December 31, 2022, December 31, 2021, and December 31, 2020, respectively.
Amortization Expense
As of December 31, 2022, estimated amortization expense for intangible assets for each of the next five years and thereafter is estimated to be as follows:
| | | | | |
| (in $000s) | Amortization |
| 2023 | $ | 26,760 | |
| 2024 | 26,380 | |
| 2025 | 26,378 | |
| 2026 | 26,377 | |
| 2027 | 26,377 | |
| Thereafter | 171,860 | |
| Total estimated future amortization expense | $ | 304,132 | |
NESCO Trade Name
In connection with the Acquisition and the combination of the businesses of Nesco Holdings and Custom Truck LP, the Company’s products and services will no longer be marketed under the “NESCO” brand. Accordingly, management began the process of discontinuing the brand, which includes the use of trade names such as, “NESCO Specialty” and “NESCO Sales and Rentals.” Prior to the Acquisition, the trade name intangible asset was carried as an indefinite-lived intangible asset. As a result of the decommissioning of the brand, the Company determined that the trade name intangible asset should be reclassified to a definite-lived asset. Accordingly, the intangible asset was amortized over a 12-month period, which was the estimated remaining period of economic benefit to the Company. As of December 31, 2022, the trade name was fully amortized.
Note 12: Earnings (Loss) Per Share
Basic earnings (loss) per share is computed by dividing net earnings (loss) by the weighted-average number of shares of Common Stock outstanding. Diluted net earnings (loss) per share includes the effects of potentially dilutive shares of Common Stock, if dilutive. Potentially dilutive effects include the exercise of warrants, contingently issuable shares, and share-based compensation. Our potentially dilutive shares aggregated 26.7 million, 24.4 million, and 27.7 million for years ended December 31, 2022, December 31, 2021, and December 31, 2020, respectively, were not included in the computation of diluted earnings (loss) per share because they would not be issuable if the end of the reporting period were the end of the contingency period or they would be anti-dilutive.
The following tables set forth the computation of basic and dilutive earnings (loss) per share:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, 2022 | | Year Ended December 31, 2021 | | Year Ended December 31, 2020 |
| (in $000s, except per share data) | | Net Income (Loss) | | Weighted Average Shares | | Per Share Amount | | Net Income (Loss) | | Weighted Average Shares | | Per Share Amount | | Net Income (Loss) | | Weighted Average Shares | | Per Share Amount |
| Basic earnings (loss) per share | | $ | 38,905 | | | 247,152 | | | $ | 0.16 | | | $ | (181,501) | | | 241,370 | | | $ | (0.75) | | | $ | (21,277) | | | 49,065 | | | $ | (0.43) | |
| Dilutive common share equivalents | | — | | | 553 | | | | | — | | | — | | | | — | | | — | | |
| Diluted earnings (loss) per share | | $ | 38,905 | | | 247,705 | | | $ | 0.16 | | | $ | (181,501) | | | 241,370 | | | $ | (0.75) | | | $ | (21,277) | | | 49,065 | | | $ | (0.43) | |
Note 13: Equity
Preferred Stock
As of both December 31, 2022 and December 31, 2021, we were authorized to issue 10,000,000 shares of preferred stock with a par value of $0.0001 per share, with such designation, rights and preferences as may be determined from time to time by our board of directors. As of both December 31, 2022 and December 31, 2021, there were no shares of preferred stock issued or outstanding.
Common Stock
As of December 31, 2022 and December 31, 2021, we were authorized to issue 500,000,000 shares of common stock with a par value of $0.0001 per share.
On August 2, 2022, the Company’s Board of Directors authorized a stock repurchase program, allowing for the repurchase of up to $30 million of the Company’s ordinary common shares. During the year ended December 31, 2022, the Company repurchased approximately 1.7 million shares of its common stock, which are held in treasury, for a total of $10.5 million, including an accrual of $0.2 million and also commission fees for the repurchase of its common stock.
Contingently Issuable Shares
NESCO Holdings, LP is a Delaware limited partnership holding shares of our common stock. NESCO Holdings, LP is owned and controlled by Energy Capital Partners, and has the right to receive: (1) up to an additional 1,800,000 shares of common stock through July 31, 2024, in increments of 900,000 shares, if (x) the trading price of the common stock exceeds $13.00 per share or $16.00 per share for any 20 trading days during a 30 consecutive trading day period or (y) a sale transaction of the Company occurs in which the consideration paid per share to holders of common stock of the Company exceeds $13.00 per share or $16.00 per share, and (2) an additional 1,651,798 shares of common stock if during the seven-year period ending July 31, 2026, the trading price of common stock exceeds $19.00 per share for any 20 trading days during a 30 consecutive trading day period or if a sale transaction of the Company occurs in which the consideration paid per share to holders of common stock exceeds $19.00 per share.
Note 14: Share-Based Compensation
On July 8, 2021, the Company's stockholders approved the Amended and Restated 2019 Omnibus Incentive Plan, which increased the total authorized shares of Common Stock to 14,650,000 (the “Plan”). The purpose of the Plan is to provide the Company and its subsidiaries’ officers, directors, employees and consultants who, by their position, ability and diligence, are able to make important contributions to the Company’s growth and profitability, with an incentive to assist the Company in achieving its long-term corporate objectives, to attract and retain executive officers and other employees and to provide such persons with an opportunity to acquire an equity interest in the Company. To accomplish these objectives, the Plan provides for awards of equity-based incentives through granting of restricted stock units, stock options, stock appreciation rights and other stock or cash-based awards. The Plan provides for share recycling whereby shares underlying expired, lapsed or terminated awards, as well as shares surrendered, repurchased, redeemed, or canceled without having been fully exercised or forfeited in a manner that results in the Company acquiring shares covered by the award, are available for award grants under the Plan. At December 31, 2022, there were approximately 1.4 million shares in the share reserve still available for issuance.
The Company records share-based compensation awards using a fair value method and recognizes compensation expense for an amount equal to the fair value of the share-based payment issued in its financial statements. The Company’s share-based compensation plans include programs for stock options, restricted stock units (“RSUs”), performance share units (“PSUs”) and deferred compensation. Compensation expense for equity awards recognized in selling, general and administrative expenses in the Consolidated Statements of Operations and Comprehensive Income (Loss) was $12.3 million, $17.3 million and $2.4 million for the years ended December 31, 2022, December 31, 2021, and December 31, 2020, respectively.
Restricted Stock Units and Performance Stock Units
Restricted and performance stock awards vest over a period of one to four years. Performance stock awards may be based on the achievement of specific financial performance metrics and market conditions. Awards based strictly on time-based vesting are valued at the market price on the date of grant. The fair values of the awards that contain market conditions are estimated using a Monte Carlo simulation approach in a risk-neutral framework to model future stock price movements based upon historical volatility (based on the weighted-average combination of the Company’s historic volatility and of the implied volatility of a group of the Company’s peers), risk-free rates of return, and correlation matrix. Restricted and performance stock awards are generally forfeitable in the event of terminated employment prior to vesting.
The following table summarizes the Company’s RSU and PSU award activity:
| | | | | | | | | | | |
| Number of Shares | | Weighted Average Grant Date Fair Value |
| Outstanding, December 31, 2019 | 656,666 | | | $ | 6.98 | |
| Granted | 867,838 | | | $ | 2.76 | |
| Forfeited/cancelled/expired | (219,412) | | | $ | 6.37 | |
| Vested | (127,500) | | | $ | 6.98 | |
| Outstanding, December 31, 2020 | 1,177,592 | | | $ | 4.05 | |
| Granted | 4,362,692 | | | $ | 7.70 | |
| Forfeited/cancelled/expired | (24,919) | | | $ | 2.19 | |
| Vested | (998,898) | | | $ | 4.39 | |
| Outstanding, December 31, 2021 | 4,516,467 | | | $ | 7.51 | |
| Granted | 4,334,217 | | | $ | 5.53 | |
| Forfeited/cancelled/expired | (449,189) | | | $ | 7.81 | |
| Vested | (897,877) | | | $ | 7.54 | |
| Outstanding, December 31, 2022 | 7,503,618 | | | $ | 6.34 | |
At December 31, 2022, unrecognized compensation expense related to these awards was $33.5 million and is expected to be recognized over a remaining period of approximately 4.0 years.
Stock Options
The following table summarizes the Company’s stock option activity:
| | | | | | | | | | | |
| Number of Options | | Weighted Average Exercise Price |
| Outstanding stock options, December 31, 2019 | 1,513,334 | | | $ | 9.60 | |
| Granted | 1,297,076 | | | $ | 3.70 | |
| Exercised | — | | | $ | — | |
| Forfeited/cancelled/expired | (418,494) | | | $ | 9.45 | |
| Outstanding stock options, December 31, 2020 | 2,391,916 | | | $ | 6.43 | |
| Granted | — | | | $ | — | |
| Exercised | (502,761) | | | $ | 4.99 | |
| Forfeited/cancelled/expired | (7,956) | | | $ | 3.85 | |
| Outstanding stock options, December 31, 2021 | 1,881,199 | | | $ | 6.82 | |
| Granted | — | | | $ | — | |
| Exercised | (48,815) | | | $ | 4.00 | |
| Forfeited/cancelled/expired | (11,692) | | | $ | 4.15 | |
| Outstanding stock options, December 31, 2022 | 1,820,692 | | | $ | 6.92 | |
At December 31, 2022, unrecognized compensation expense related to stock options was not material and the Company made no grants of options in the years ended December 31, 2022 and 2021. As of December 31, 2022, the total intrinsic value of stock options outstanding and currently exercisable was $2.4 million.
The following table presents the options outstanding and options exercisable by exercise price with the weighted-average remaining contractual life for the options outstanding and the weighted-average exercise price at December 31, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Options Outstanding | | Options Exercisable |
| Exercise Price | | Options Outstanding at December 31, 2022 | | Weighted Average Remaining Contractual Life (In Years) | | Weighted Average Grant Date Fair Value | | Options Exercisable at December 31, 2022 | | Weighted Average Grant Date Fair Value |
$3.49 - $10.00 | | 1,820,692 | | | 3.03 | | $ | 2.36 | | | 1,787,361 | | | $ | 2.39 | |
| | | | | | | | | | |
| | | | | | | | | | |
Note 15: Fair Value Measurements
FASB accounting standards provide a comprehensive framework for measuring fair value and sets forth a definition of fair value and establishes a hierarchy prioritizing the inputs to valuation techniques, giving the highest priority to quoted prices in active markets for identical assets and liabilities and the lowest priority to unobservable value inputs.
The following table sets forth the carrying values (exclusive of deferred financing fees) and fair values of our financial liabilities:
| | | | | | | | | | | | | | | | | | | | | | | |
| Carrying Value | | Fair Value |
| (in $000s) | | | Level 1 | | Level 2 | | Level 3 |
| December 31, 2022 | | | | | | | |
| ABL Facility | $ | 437,731 | | | $ | — | | | $ | 437,731 | | | $ | — | |
| 2029 Secured Notes | 920,000 | | | — | | | 814,200 | | | — | |
| Other notes payable | 31,661 | | | — | | | 31,661 | | | — | |
| Derivative and warrant liabilities | 3,012 | | | — | | | — | | | 3,012 | |
| | | | | | | |
| December 31, 2021 | | | | | | | |
| ABL Facility | $ | 394,945 | | | $ | — | | | $ | 394,945 | | | $ | — | |
| 2029 Secured Notes | 920,000 | | | — | | | 949,900 | | | — | |
| Other notes payable | 32,619 | | | — | | | 32,619 | | | — | |
| Derivative and warrant liabilities | 24,164 | | | — | | | 2,388 | | | 21,776 | |
The carrying amounts of the ABL Facility and other notes payable approximated fair value as of December 31, 2022 and December 31, 2021 based upon terms and conditions available to the Company at those dates in comparison to the terms and conditions of its outstanding debt. The estimated fair value of the 2029 Secured Notes is calculated using Level 2 inputs, based on bid prices obtained from brokers. The Level 3 fair value presented above consists of the fair value of the Non-Public Warrants (as defined in Note 16: Financial Instruments). The Company estimated the fair value using the Black-Scholes option-pricing model based on the market value of the underlying Common Stock, the remaining contractual term of the warrants, risk-free interest rates and expected dividends, and expected volatility of the price of the underlying Common Stock. The changes in the fair value of the derivative and warrant liabilities are recorded in Financing and other expense (income) in the Consolidated Statements of Operations and Comprehensive Income (Loss) and cash flow from operating activities in the Consolidated Statements of Cash Flows.
Note 16: Financial Instruments
In the normal course of business and from time to time, the Company may use various financial instruments, including derivative instruments, to manage the risks associated with interest rate exposure. The Company does not intend to use any of these financial instruments for trading or speculative purposes.
Warrants
During the years ended December 31, 2022 and December 31, 2021, the Company recorded a change in fair value of Non-Public Warrants of approximately $(18.6) million and $10.8 million, respectively, in Financing and other expense (income) in its Consolidated Statements of Operations and Comprehensive Income (Loss) related to the change in fair value Non-Public Warrants.
The Company’s predecessor, Capitol Investment Corp. IV, an entity formed on May 1, 2017, as a special purpose acquisition company (“Capitol” or the “SPAC”), issued warrants for the purchase of approximately 7.5 million shares of the Company’s Common Stock pursuant to a private placement agreement (the “Non-Public Warrants”). In connection with the SPAC’s initial public offering, warrants for the purchase of approximately 13.4 million shares of the Company’s Common Stock were issued to public investors (the “Public Warrants”). The Public Warrants together with the Non-Public Warrants may hereafter be referred to collectively as the “Warrants.”
The Warrants provide for the purchase of approximately 20.9 million shares of the Company’s Common Stock. Each Warrant entitles the holder to purchase one share of Common Stock at a price of $11.50 per share, subject to certain adjustments. The Warrants are currently exercisable and terminate on the earlier to occur of (i) July 31, 2024, and (ii) the redemption date. The Company may redeem the Public Warrants at a price of $0.01 per Public Warrant upon providing 30-days’ notice, only in the event that the last sale price of the Common Stock is at least $18.00 per share for any 20 trading days within a 30-trading day period ending on the third business day prior to the date on which notice of redemption is given. If the Company elects to redeem the Public Warrants as described above, the Public Warrant may be exercised on a “cashless basis.” The redemption rights do not apply to the Non-Public Warrants if, at the time
of the redemption, such Non-Public Warrants continue to be held by the initial holders as of July 31, 2019, or their affiliates or permitted transferees; however, once such Non-Public Warrants are transferred (other than to an affiliate or permitted transferee), the Company may redeem those Non-Public Warrants that have been transferred in a manner similar to any Public Warrants.
The Public Warrants are accounted for as freestanding equity-classified instruments because the Company has the ability to settle with holders of the Public Warrants either by net-share or physical settlement. Because the Non-Public Warrants do not meet the “indexed to the entity’s stock” condition, the Non-Public Warrants are accounted for as a derivative liability and remeasured at their estimated fair value each period. The change in fair value each period is reported in the Company’s Consolidated Statements of Operations and Comprehensive Income (Loss).
Note 17: Income Taxes
We are subject to taxation in all jurisdictions in which we operate within the United States and Canada. Substantially all of our income before income taxes for all periods presented is U.S. sourced. The provision for income tax expense (benefit), including the amount of domestic and foreign loss before taxes, is as follows:
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| (in $000s) | 2022 | | 2021 | | 2020 |
| Components of income (loss) before tax: | | | | | |
| Domestic | $ | 44,214 | | | $ | (180,669) | | | $ | (49,096) | |
| Foreign | 2,518 | | | 3,593 | | | (2,255) | |
| Total income (loss) before tax | 46,732 | | | (177,076) | | | (51,351) | |
| Current tax expense (benefit): | | | | | |
| Federal | — | | | — | | | (1,393) | |
| Foreign | 161 | | | 320 | | | 61 | |
| State | 772 | | | 242 | | | 66 | |
| Total current tax expense (benefit) | 933 | | | 562 | | | (1,266) | |
| Deferred tax expense (benefit): | | | | | |
| Federal | 6,262 | | | (33,415) | | | (9,179) | |
| Foreign | (1,829) | | | 826 | | | — | |
| State | 4,963 | | | (9,507) | | | (1,786) | |
| Total deferred tax expense (benefit) | 9,396 | | | (42,096) | | | (10,965) | |
| Expense (benefit) from change in valuation allowance | (2,502) | | | 45,959 | | | (17,843) | |
| Total tax expense (benefit) | $ | 7,827 | | | $ | 4,425 | | | $ | (30,074) | |
A reconciliation between the federal statutory income tax rate and our actual effective income tax rate is as follows:
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2022 | | 2021 | | 2020 |
| Expected federal statutory income tax rate | 21.0% | | 21.0% | | 21.0% |
| Tax effect of differences: | | | | | |
| | | | | |
| Foreign operations | (3.3)% | | (0.3)% | | (0.1)% |
| Share-based payments | (1.0)% | | 1.0% | | (0.2)% |
| Effect of state income taxes, net of federal income tax benefit | 9.8% | | 5.2% | | 2.6% |
| Nondeductible acquisition costs | —% | | (0.7)% | | —% |
| Nontaxable income on Warrants (see Note 16) | (8.4)% | | (1.3)% | | —% |
| Change in valuation allowance | (3.3)% | | (25.8)% | | 34.7% |
| Other | 1.9% | | (1.6)% | | 0.6% |
| Effective income tax rate | 16.7% | | (2.5)% | | 58.6% |
The Company's effective tax rate differs from the U.S. federal statutory tax rate of 21% and is affected by a number of factors, such as the relative amounts of income we earn in differing tax jurisdictions, tax law changes, certain non-deductible expenses (non-taxable income), such as compensation disallowance and mark-to-market adjustments on derivative financial instruments, and changes in the valuation allowance we establish against deferred tax assets. The rate is also affected by discrete items that may occur in any given year, such as legislative enactments and changes in our corporate structure that may occur.
The components of the deferred tax assets and liabilities are as follows:
| | | | | | | | | | | |
| (in $000s) | December 31, 2022 | | December 31, 2021 |
| Deferred tax assets | | | |
| Accounts receivable | $ | 4,744 | | | $ | 2,703 | |
| Inventory | 5,602 | | | 6,435 | |
| Transaction and debt issuance costs | 3,964 | | | 4,946 | |
| Compensation and benefits | 6,511 | | | 6,067 | |
| Net operating loss carryforwards | 252,804 | | | 241,663 | |
| Section 163j interest disallowance carryforwards | 39,344 | | | 21,283 | |
| Operating lease liabilities | 7,548 | | | 8,731 | |
| Foreign tax credits, accrued expenses, and other | 1,547 | | | 455 | |
| Total deferred tax assets | 322,064 | | | 292,283 | |
| Less: valuation allowance | (78,600) | | | (84,577) | |
| Total deferred tax assets, net | 243,464 | | | 207,706 | |
| | | |
| Deferred tax liabilities | | | |
| Financing receivable | (9,415) | | | (3,466) | |
| Rental equipment and other property and equipment | (208,108) | | | (173,522) | |
| Goodwill and other intangibles | (46,394) | | | (36,825) | |
| Operating lease assets | (7,388) | | | (8,647) | |
| Prepaid expenses and other items | (1,245) | | | (867) | |
| Total deferred tax liabilities | (272,550) | | | (223,327) | |
| Net deferred tax asset (liability) | $ | (29,086) | | | $ | (15,621) | |
As a result of the Acquisition, the Company expects to be able to amortize for U.S. tax purposes, a portion of the goodwill recognized from the Acquisition. For U.S. income taxes, the Acquisition was partly a taxable acquisition and partly a non-taxable acquisition. Accordingly, the taxable component is expected to give rise to increases in the tax bases for a portion of the net assets acquired, while the non-taxable component will result in a carryforward of pre-acquisition tax bases (referred as, “carryover basis”) for a portion of the net assets acquired. The differential between the fair values of the assets acquired and the carryover basis has been recognized as a net deferred tax liability as of the Closing Date (see Note 3: Business Combinations). Additionally, certain federal and state net operating loss and interest expense carryforwards were acquired in the Acquisition and the utilization of these is subject to limitations prescribed by U.S. Internal Revenue Code Section 382 (“Section 382”). The aforementioned net deferred tax liabilities recognized in connection with the assignment of the purchase price from the Acquisition include deferred tax assets from the tax deduction carryforwards, and were reduced by a valuation allowance as of the Closing Date. The acquisition of HiRail did not give rise to any increase in the tax bases acquired in the acquisition and the Company has reflected the carryover tax bases of the net assets acquired. There is no tax basis in amortizable goodwill related to the HiRail acquisition.
We record a valuation allowance against deferred tax assets when we determine that it is more likely than not that all or a portion of a deferred tax asset will not be realized. The valuation allowance primarily relates to federal and state net operating loss carryforwards, as well as disallowed interest expense deduction carryforwards. While the Acquisition resulted in a significant increase in deferred tax liabilities, these tax liabilities, which give rise to future taxable income against which tax carryforwards may be applied, are subject to limitations. Federal and state income tax limitation rules are expected to limit the application of our carryforwards and, accordingly, we record a valuation allowance to reduce our deferred tax assets to amounts expected to be realized.
The following presents changes in the valuation allowance:
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| (in $000s) | 2022 | | 2021 | | 2020 |
| Valuation allowance - beginning of year | $ | (84,577) | | | $ | (16,542) | | | $ | (34,385) | |
| Assigned in purchase accounting (see Note 3) | 3,475 | | | (22,076) | | | — | |
Charged to benefit (expense)(a) | 2,502 | | | (45,959) | | | 17,843 | |
| Valuation allowance - end of year | $ | (78,600) | | | $ | (84,577) | | | $ | (16,542) | |
(a) Charged to benefit (expense) during the year ended December 31, 2021 includes a reduction to the allowance of approximately $9.1 million related to federal and state disallowed interest expense deduction carryforwards, offset by additional valuation allowance related to tax losses generated in the year, resulting in net income tax expense of $4.4 million.
As discussed above, the Company acquired certain federal and state net operating loss and interest expense carryforwards in connection with the Acquisition, the utilization of which is subject to limitations prescribed by Section 382. Accordingly, a portion of the carryforwards is expected to expire prior to being utilized. As of December 31, 2022, we had net operating loss carryforwards of approximately $1,067.0 million for U.S. federal income tax purposes and $513.4 million for state income tax purposes. As of December 31, 2021, we had net operating loss carryforwards of approximately $1,035.6 million for U.S. federal income tax purposes and $447.1 million for state income tax purposes. The net operating loss carryforwards expire at various dates commencing during 2031 through 2037 for U.S. federal income tax purposes and 2023 through 2042 for state income tax purposes.
Note 18: Concentration Risks
Concentration of Credit Risks
Financial instruments that potentially subject us to significant concentrations of credit risk include cash and cash equivalents and accounts receivable. We maintain cash and cash equivalents with federally insured financial institutions and may maintain deposits in excess of financial insured limits. However, we believe that we are not exposed to significant credit risks due to the financial position of the depository institutions in which our deposits are held. No customer accounted for more than 10% of consolidated revenues during the years ended December 31, 2022, December 31, 2021, and December 31, 2020. Five customers, collectively, accounted for 11.7% of consolidated revenue in 2022. No customer accounted for more than 3% of consolidated revenue in 2021 and three customers, collectively, accounted for 11.1% of consolidated revenue in 2020.
Vendor Concentrations
In 2022, one vendor accounted for approximately 16% of purchases, primarily related to booms, lifts and parts, and the top five vendors accounted for approximately 41% of purchases. In both 2021 and 2020, no vendor accounted for more than 10.0% of purchases and in 2020 three vendors, collectively, accounted for more than 10.0% of purchases.
Note 19: Commitments and Contingencies
We record a liability when we believe that it is both probable that a liability has been incurred and the amount can be reasonably estimated. Significant judgment is required to determine both probability and the estimated amount. We review these provisions at least quarterly and adjust these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information.
Legal Matters
In the normal course of business, there are various claims in process, matters in litigation, and other contingencies. At this time, no claims of these types, certain of which are covered by insurance policies, have had a material effect on the Company. Certain jurisdictions in which the Company operates do not provide insurance recoveries related to punitive damages. For matters pertaining to the pre-Acquisition activities of Custom Truck LP, Sellers have agreed to indemnify Nesco and Buyer for losses arising out of the breach of Sellers’ pre-closing covenants in the Purchase Agreement and certain indemnified tax matters, with recourse limited to a $10 million and $8.5 million escrow account, respectively.
From time to time, the Company is audited by state and local taxing authorities. These audits typically focus on the Company’s withholding of state-specific sales tax and rental-related taxes.
Custom Truck LP’s withholdings of federal excise taxes for each of the four quarterly periods during 2015 are currently under audit by the Internal Revenue Service (the “IRS”). The IRS issued an assessment on October 28, 2020 in an aggregate amount of $2.4 million for the 2015 periods, alleging that certain types of sold equipment are not eligible for the Mobile Machinery Exemption set forth in the Internal Revenue Code (the “Code”). An appeal was filed on January 28, 2021. Based on management’s understanding of the facts and circumstances, including the relevant provisions of the Code, and historical precedent, including previous successful appeals of similar assessments in prior years, management does not believe the likelihood of a loss resulting from the IRS assessment to be probable at this time.
While it is not possible to predict the outcome of the foregoing matters with certainty, it is the opinion of management that the final outcome of these matters will not have a material effect on the Company’s consolidated financial condition, results of operations and cash flows.
Purchase Commitments
We enter into purchase agreements with manufacturers and suppliers of equipment for our rental fleet and inventory. All of these agreements are cancellable within a specified notification period to the supplier.
Note 20: Related Parties
The Company has transactions with related parties as summarized below.
Rentals and Sales — The Company rents and sells equipment and provides services to R&M Equipment Rental, a business partially owned by members of the Company’s management. The Company also rents equipment and purchases inventory from R&M Equipment Rental. During the year ended December 31, 2021, the Company purchased approximately $19.4 million in rental equipment from R&M Equipment Rental.
Prior to August 1, 2022, Energy Capital Partners (“ECP”), a stockholder of the Company, and their affiliates had ownership interests in PLH Group, Inc., which was a customer of the Company.
The PIPE Investors, as described in Note 3: Business Combinations, included certain members of management and directors of the Company, which persons purchased approximately 1.4 million shares of the Company’s common stock at a price of $5.00 per share, during the year ended December 31, 2021.
Facilities Leases and Other — The Company has leased certain facilities, as well as purchased aircraft charter services, from entities owned by members of the Company’s management and their immediate families. Lease and charter services payments related to these transactions are immaterial. Rent and air travel expenses are recorded in selling, general, and administrative expenses. In December 2022, the Company terminated the lease agreements and purchased the facilities and land from these related parties for a purchase price of approximately $15.4 million.
Management Fees — The Company entered into the Corporate Advisory Services Agreement with Platinum effective as of the Closing Date, under which management fees are payable to Platinum quarterly. The management fees are recorded in transaction expenses and other in the Company’s Consolidated Statements of Operations and Comprehensive Income (Loss).
A summary of the transactions with the foregoing related parties included in the Consolidated Statements of Operations and Comprehensive Income (Loss) is as follows:
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, |
| (in $000s) | | | | | 2022 | | 2021 | | 2020 |
| Total revenues from transactions with related parties | | | | | $ | 33,816 | | | $ | 23,251 | | | $ | 9,181 | |
| Expenses incurred from transactions with related parties included in cost of revenue | | | | | $ | 2,318 | | | $ | 1,687 | | | $ | — | |
| Expenses incurred from transactions with related parties included in operating expenses | | | | | $ | 6,103 | | | $ | 4,283 | | | $ | — | |
Amounts receivable from/payable to related parties included in the Consolidated Balance Sheets are as follows:
| | | | | | | | | | | |
| (in $000s) | December 31, 2022 | | December 31, 2021 |
| Accounts receivable from related parties | $ | 5,053 | | | $ | 5,145 | |
| Accounts payable to related parties | $ | 36 | | | $ | 26 | |
Note 21: Segments
Our operations are primarily organized and managed by operating segment. Operating segment performance and resource allocations are primarily based on gross profit. The accounting policies of the reportable segments are consistent with those described in Note 2: Summary of Significant Accounting Policies to the financial statements. Intersegment sales and any related profits are eliminated in consolidation. We manage the business in three reporting segments: Equipment Rental Solutions (“ERS”), Truck and Equipment Sales (“TES”) and Aftermarket Parts and Services (“APS”). The segment operations are described in Note 1: Business and Organization to these financial statements. The revenue by geography is disclosed in Note 4: Revenue. Segment information is presented below.
The Company’s segment results are presented in the tables below:
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2022 |
| (in $000s) | ERS | | TES | | APS | | Total |
| Revenue: | | | | | | | |
| Rental | $ | 449,108 | | | $ | — | | | $ | 14,931 | | | $ | 464,039 | |
| Equipment sales | 212,146 | | | 770,195 | | | — | | | 982,341 | |
| Parts and services | — | | | — | | | 126,706 | | | 126,706 | |
| Total revenue | 661,254 | | | 770,195 | | | 141,637 | | | $ | 1,573,086 | |
| Cost of revenue: | | | | | | | |
| Rentals/parts and services | 106,598 | | | — | | | 105,185 | | | 211,783 | |
| Equipment sales | 158,167 | | | 647,685 | | | — | | | 805,852 | |
| Depreciation of rental equipment | 167,962 | | | — | | | 3,741 | | | 171,703 | |
| Total cost of revenue | 432,727 | | | 647,685 | | | 108,926 | | | 1,189,338 | |
| Gross profit | $ | 228,527 | | | $ | 122,510 | | | $ | 32,711 | | | $ | 383,748 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2021 |
| (in $000s) | ERS | | TES | | APS | | Total |
| Revenue: | | | | | | | |
| Rental | $ | 354,557 | | | $ | — | | | $ | 15,510 | | | $ | 370,067 | |
| Equipment sales | 105,435 | | | 589,899 | | | — | | | 695,334 | |
| Parts and services | — | | | — | | | 101,753 | | | 101,753 | |
| Total revenue | 459,992 | | | 589,899 | | | 117,263 | | | 1,167,154 | |
| Cost of revenue: | | | | | | | |
| Rentals/parts and services | 94,644 | | | — | | | 86,943 | | | 181,587 | |
| Equipment sales | 90,420 | | | 528,024 | | | — | | | 618,444 | |
| Depreciation of rental equipment | 151,954 | | | — | | | 5,156 | | | 157,110 | |
| Total cost of revenue | 337,018 | | | 528,024 | | | 92,099 | | | 957,141 | |
| Gross profit | $ | 122,974 | | | $ | 61,875 | | | $ | 25,164 | | | $ | 210,013 | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2020 |
| (in $000s) | ERS | | TES | | APS | | Total |
| Revenue: | | | | | | | |
| Rental | $ | 179,933 | | | $ | — | | | $ | 15,557 | | | $ | 195,490 | |
| Equipment sales | 31,533 | | | 25,099 | | | — | | | 56,632 | |
| Parts and services | — | | | — | | | 50,617 | | | 50,617 | |
| Total revenue | 211,466 | | | 25,099 | | | 66,174 | | | 302,739 | |
| Cost of revenue: | | | | | | | |
| Rentals/parts and services | 56,140 | | | — | | | 44,217 | | | 100,357 | |
| Equipment sales | 25,615 | | | 21,792 | | | — | | | 47,407 | |
| Depreciation of rental equipment | 74,376 | | | — | | | 4,156 | | | 78,532 | |
| Total cost of revenue | 156,131 | | | 21,792 | | | 48,373 | | | 226,296 | |
| Gross profit | $ | 55,335 | | | $ | 3,307 | | | $ | 17,801 | | | $ | 76,443 | |
Total assets by operating segment are not disclosed herein because asset by operating segment data is not reviewed by the chief operating decision-maker (“CODM”) to assess performance and allocate resources.
Gross profit is the primary operating result whereby our segments are evaluated for performance and resource allocation. The following table presents a reconciliation of consolidated gross profit to consolidated loss before income taxes:
| | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, |
| (in $000s) | | | | | 2022 | | 2021 | | 2020 |
| Gross Profit | | | | | $ | 383,748 | | | $ | 210,013 | | | $ | 76,443 | |
| Selling, general and administrative expenses | | | | | 210,868 | | | 155,783 | | | 46,409 | |
| Amortization | | | | | 33,940 | | | 40,754 | | | 3,153 | |
| Non-rental depreciation | | | | | 9,414 | | | 3,613 | | | 95 | |
| Transaction expenses and other | | | | | 26,218 | | | 51,830 | | | 9,538 | |
| | | | | | | | | |
| Loss on extinguishment of debt | | | | | — | | | 61,695 | | | — | |
| Interest expense, net | | | | | 88,906 | | | 72,843 | | | 63,200 | |
| Financing and other expense (income) | | | | | (32,330) | | | 571 | | | 5,399 | |
| Income (Loss) Before Income Taxes | | | | | $ | 46,732 | | | $ | (177,076) | | | $ | (51,351) | |
The following table presents total assets by country:
| | | | | | | | | | | |
| (in $000s) | December 31, 2022 | | December 31, 2021 |
| Assets: | | | |
| United States | $ | 2,830,958 | | | $ | 2,653,058 | |
| Canada | 107,254 | | | 30,708 | |
| $ | 2,938,212 | | | $ | 2,683,766 | |