Item 1. BUSINESS
Our Company
We are a leading regional equipment rental company in the United States, focused on the fast-growing Sunbelt states. We offer a broad array of equipment rental solutions for our diverse customer base, including infrastructure, non-residential construction, oil and gas and residential construction customers. Our broad fleet of equipment includes earthmoving, material handling, aerial and other rental equipment, which we package together to meet the specific needs of our customers.
Our Branch Network and Fleet
As of
December 31, 2016
, we operated
69
branches organized into operating clusters in
five
regions in the United States: Florida, Atlantic, Central, Southeastern and Western. We are strategically located in markets that we believe feature high levels of population growth as well as high levels of construction activity over the near term. We believe that our clustering approach enables us to establish a strong local presence in targeted markets and meet the needs of our customers that have multiple projects within a specific region.
Revenues by Region
for the year ended December 31, 2016
Our Five Regions
As of
December 31, 2016
, our rental fleet consisted of approximately
15,000
major units of equipment with an original equipment cost, or OEC, of approximately
$824.7 million
and an average age of approximately
48
months. Our earthmoving fleet represented approximately
54%
of OEC and had an average age of approximately
42
months. We believe that our focus on earthmoving equipment positions us to take advantage of future growth opportunities in our key end-markets.
Rental Fleet by Equipment Category as a Percentage of OEC as of
December 31, 2016
Segment Reporting
We have one reportable segment. For financial information regarding our reportable segments, refer to our financial statements and notes thereto included in Item 8 of this annual report on Form 10-K and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in this annual report on Form 10-K.
Our Business Strengths
End-Market Growth.
For the year ended
December 31, 2016
, approximately
85%
of our rental revenues were derived from five key end-markets: infrastructure, non-residential construction, oil and gas, municipal and residential construction. We believe that our current business is well aligned with these end-markets, and that we will continue to benefit from macroeconomic growth.
Our Rental Revenues by End-Market for the Year Ended
December 31, 2016
Prominent Position in Fast-Growing Sunbelt States.
64
of our
69
branches are located in the Sunbelt states of Virginia, North Carolina, South Carolina, Florida, Georgia, Alabama, Tennessee, Louisiana, Texas, Arizona, Nevada and California. Our Sunbelt state locations benefit from favorable climate conditions that facilitate year-round construction activity and reduce seasonality in our business. According to the American Rental Association, construction and industrial equipment rental revenue in the states where we have branch locations is expected to grow approximately
5%
annually from 2016 to 2020, compared to an average growth rate of approximately
4%
for all other states. By clustering our operations and concentrating our branches in these strategic regional markets, we have established a strong local presence and developed significant brand recognition in those markets.
High-Quality Fleet Focused on Earthmoving Equipment.
We offer our customers a broad array of rental equipment with a focus on the earthmoving category. We believe that we are well positioned to benefit from additional penetration in the earthmoving equipment category, which had a penetration rate of approximately
51%
in 2016, compared to approximately
92%
for the aerial and
84%
for the material handling categories, respectively. As of
December 31, 2016
, we had approximately
5,800
units of earthmoving equipment, accounting for
54%
of the OEC of our rental fleet.
Disciplined Sales Culture Drives Strong Customer Relationships.
We have a diverse base of customers who we believe value our knowledge and expertise. Our customer base includes large and mid-sized construction firms, municipalities, utilities and industrial users. We serve approximately
15,400
customers annually.
For the year ended December 31, 2016
, no single customer accounted for more than 1% of our total rental revenues and our ten largest customers accounted for approximately
6%
of our total rental revenues, collectively. Our culture is built around the disciplined use of our customer relationship management system, or "CRM system," at every level of our organization, which we believe provides our employees with the tools and information to efficiently provide customized solutions to our existing and potential customers. In addition, our CRM system automatically notifies our sales force of new construction projects within their territories and provides them with the names and contact information of key contractors.
Strong Operating Trends.
We have experienced substantial earnings momentum since 2011, driven by the rebound in our end-markets and supported by significant investment in our fleet, which has resulted in an increase in OEC from $471.1 million at December 31, 2011 to
$824.7 million
at
December 31, 2016
. In addition, our time utilization, which we define as the daily
average OEC of equipment on rent, divided by the OEC of all equipment in the rental fleet during the relevant period, has increased from 65.0% for the year ended December 31, 2011 to
67.1%
for the year ended December 31, 2016
. We believe that the combination of favorable industry dynamics, significant investments in our fleet and our focus on operating leverage (which has seen our Adjusted EBITDA margin increase from 35.4% for the year ended December 31, 2011 to
48.8%
for the year ended December 31, 2016
) have driven our Adjusted EBITDA from $86.7 million to
$193.8 million
over this period. For additional discussion on Adjusted EBITDA and Adjusted EBITDA margin see Management's Discussion and Analysis of Financial Conditions and Results of Operations.
Experienced Management Team.
Our senior management team has significant operating experience in the equipment rental industry and has worked together at our company for over a decade. Graham Hood, our Chief Executive Officer, has
39
years of rental industry experience and Mark Irion, our Chief Financial Officer, has
18
years of rental industry experience. Our regional Vice Presidents, with an average of
20
years with our company and
33
years of industry experience, provide us with a stable base of operating management with long-term, local relationships and deep equipment rental industry expertise. This industry expertise, combined with our disciplined sales culture and CRM system, enables our regional management team to respond quickly to changing market conditions.
Our Business Strategy
Focus on Premium Customer Service to Create Strong Customer Relationships.
We are committed to providing our customers with premium service. We believe that our customers value our strong regional presence, well established local relationships and full-service branches, which offer 24/7 customer support. Our regional presence is supplemented by a national account focus that allows us to differentiate our brand and product offering to our larger customer accounts. We intend to continue to leverage our national accounts program, our customer service capabilities and our advanced CRM system to retain our existing customers and further penetrate our target customer base.
Emphasis on Active Asset Management.
We have invested significantly in both customized technologies and the development of our personnel to ensure that we manage our fleet efficiently. Our equipment clustering strategy allows us to share and deploy equipment among our branches as demand for equipment shifts throughout our branch network. Over time, we have demonstrated our ability to both increase and decrease the age of our fleet in response to changing market conditions. We actively monitor the market environment to determine where investment in fleet assets should be made or when fleet asset divestitures should occur. Our emphasis on active asset management, combined with our rigorous repair and maintenance program, allows us to increase time utilization, extend the useful life of our fleet and also results in higher resale values for our equipment.
Focus on Growing Markets.
We believe that our focus on the infrastructure, non-residential construction and residential construction end-markets positions us to benefit from favorable industry and macroeconomic trends. We believe that all of these end-markets are currently experiencing significant growth and will continue to benefit from investment spending driven by the economic recovery in the United States. FMI Construction Outlook predicts that from 2016 through 2020, U.S. infrastructure spending will grow approximately
4.6%
annually, U.S. non-residential construction spending will grow
4.7%
annually, and U.S. residential construction will grow
3.5%
annually. We believe that our focus on these end-markets will position us to achieve significant growth in revenues.
Capitalize on Operating Leverage.
We have a highly scalable business model constructed around our network of
69
full-service branch locations. We believe that our current network can support significant additions to our rental fleet without substantial additional investment in infrastructure, personnel or information technology. We intend to capitalize on anticipated growth opportunities primarily by increasing our fleet size within our existing branch network, using our active asset management capabilities to increase time utilization and improve pricing levels and serving customers who value our equipment mix and service capabilities. We regularly evaluate new branch opportunities based on stringent investment return criteria to identify promising new branch locations and will continue to monitor opportunities to expand our strategic branch network.
History and Structure
Neff Corporation was formed as a Delaware corporation on August 18, 2014 by Wayzata Opportunities Fund II, L.P. and Wayzata Opportunities Fund Offshore II, L.P., private investment funds (the "Wayzata Funds") managed by Wayzata Investment Partners LLC (and together with the Wayzata Funds, "Wayzata"). On November 26, 2014, Neff Corporation completed an Initial Public Offering (the "IPO") of 10,476,190 shares of Class A common stock in exchange for net proceeds of approximately $146.1 million. A portion of the net proceeds received by Neff Corporation from the IPO were used to purchase 10,476,190 common units in Neff Holdings, which was wholly owned by Wayzata Funds prior to the IPO.
Neff Corporation is the sole managing member of Neff Holdings and as of
December 31, 2016
, subsequent to common unit repurchases and other equity transactions, owns
8,859,662
common units of Neff Holdings representing approximately
37.2%
of the combined voting power of all of Neff Corporation's common stock and through Neff Corporation's ownership of Neff
Holdings' common units, indirectly holds approximately
37.2%
of the economic interest in the business of Neff Holdings and its subsidiaries. As the sole managing member of Neff Holdings, we control its business and affairs and therefore, we consolidate its financial results within ours. Neff Holdings is a holding company that conducts no operations and, as of the consummation of the IPO, its only material asset is the equity interests of its direct and indirect subsidiaries.
As of
December 31, 2016
, Wayzata Funds through its ownership of Neff Corporation's Class B common stock, owns
14,951,625
common units of Neff Holdings representing a collective
62.8%
of the combined voting power of all of Neff Corporation's common stock and through its ownership of Neff Holdings' common units, holds approximately
62.8%
of the economic interest in the business of Neff Holdings and its subsidiaries. Each common unit held by Wayzata Funds or acquired by individuals upon exercise of existing options granted by Neff Holdings will be redeemable, at the election of such member, for, at Neff Corporation's option, newly-issued shares of Class A common stock on a one-for-one basis or a cash payment equal to a volume-weighted average market price of one share of Class A common stock for each common unit redeemed (subject to customary adjustments, including for stock splits, stock dividends and reclassifications) in accordance with the terms of the Neff Holdings LLC Agreement; provided that, at Neff Corporation's election, Neff Corporation may effect a direct exchange of such Class A common stock or such cash for such common units.
The following diagram sets forth our ownership structure and percentages of voting power and common unit ownership, as of
December 31, 2016
:
Operations
Through our
69
branches, located primarily in the Sunbelt states of Virginia, North Carolina, South Carolina, Florida, Georgia, Alabama, Tennessee, Louisiana, Texas, Arizona, Nevada and California, we generate revenues primarily through the rental of a broad array of construction and industrial equipment, the sale of used and new equipment and the sale of parts, supplies and related merchandise.
Rental Fleet.
Our broad fleet of equipment includes earthmoving, material handling, aerial and other rental equipment. As of
December 31, 2016
, we had over
5,800
units of earthmoving equipment, accounting for
54%
of the OEC of our rental fleet. We generate revenue under leases for our rental equipment as well as from fees we charge for the pickup and delivery of equipment, damage waivers and other surcharges.
We purchase our equipment from vendors who we believe have reputations for good product quality and support. We identify original equipment manufacturers, or "OEMs" who can supply quality, reliable products and provide value added support services.
As of
December 31, 2016
, our rental fleet is comprised of the following equipment categories and respective primary OEM suppliers:
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Equipment
Category
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Primary Fleet Equipment
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Primary OEM
Suppliers
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Percentage
of OEC
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Earthmoving
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Excavators, backhoes, loaders, bulldozers, mini-excavators, trenchers, sweepers and tractors, track loaders and skid steers
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Komatsu, John Deere, Kobelco, IHI, Doosan, Bobcat, Link-Belt, Case, Kubota and Takeuchi
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54
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%
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Material Handling
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Reach forklifts, industrial forklifts and straight-mast forklifts
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JLG, Gehl, Genie, JCB, Caterpillar, Case, Doosan, Komatsu, Skytrak and Heli
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17
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%
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Aerial
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Personnel lifts, electric scissor lifts, dual fuel scissor lifts, articulating boom lifts and straight boom lifts
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JLG, Genie and Skyjack
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11
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%
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Other Rental Equipment
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Compaction and concrete, trucks and trailers, sweepers, air equipment, generators, welders, lighting, pumps and other small equipment and tools
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Hamm, International, Wacker, Ford, Bomag, Magnum, EPI, Freightliner, Atlas Copco and Doosan
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18
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%
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Rental Revenues.
We offer our equipment for rent on a daily, weekly and monthly basis and our customers typically execute written rental agreements, which we account for as leases under generally accepted accounting principles in the United States ("US GAAP"). The majority of our written rental agreements are short-term and do not include specific provisions for early termination. We determine rental rates for each type of equipment based on the cost and expected time utilization of the equipment and adjust rental rates at each location based on demand, length of rental, volume of equipment rented and other competitive considerations.
Equipment Sales.
We maintain a regular program of selling used equipment in order to adjust the size and composition of our rental fleet to changing market conditions and to maintain the quality and average age of our rental fleet. We attempt to balance the objective of obtaining acceptable prices from used equipment sales against the recurring revenues obtainable from equipment rentals. Our proactive management of our rental fleet allows us to adjust the rate and timing of new equipment purchases and used equipment sales to improve time utilization rates, take advantage of attractive disposition opportunities and respond to changing economic conditions.
To a much lesser extent, we also generate revenue through the sale of ancillary new equipment.
Parts and Service.
We sell complementary parts, supplies, fuel and merchandise to our customers in conjunction with our equipment rental and sales businesses. We maintain an inventory of fuel, maintenance and replacement parts and related products, which are important for timely parts and service support and helps reduce downtime for both our customers and us.
For additional financial information regarding revenues for our rental fleet, equipment sales and parts and service as well as our consolidated net income and total assets, please refer to our financial statements and the notes to the financial statements.
Fleet Management
Our branches are often within close geographic proximity to each other and are all connected through a centralized system which allows any other branch to view rental equipment availability throughout our entire branch network. As a result, we can respond quickly to the needs of our customers and increase the time utilization rates of our equipment, thereby improving profitability and reducing capital expenditures.
We actively monitor fleet purchases to maintain appropriate inventory levels and to manage capital expenditures. At times, we may selectively increase or decrease the age of our fleet in response to changing market conditions. We actively monitor the market environment to determine where investment in fleet assets should be made or when fleet asset divestitures should be made.
We provide transportation of our rental equipment to and from the customer's location and our payroll expenses reflect the cost of providing such transportation. Once our drivers have delivered rental equipment to the customer, the customer takes
complete control of operating the equipment. All customers are expected to provide insurance coverage of the rental equipment under their control during the period of utilization of such rental equipment.
Customers
Our large customer base, which included approximately
15,400
customers
for the year ended December 31, 2016
, is diversified among various industries, including infrastructure, non-residential construction, oil and gas, municipal and residential construction. In particular within these industries, we serve industrial and civil construction, manufacturing, public utilities, offshore oil exploration and drilling, refineries and petrochemical facilities, municipalities, golf course construction, shipping and the military. We target mid-sized, regional and local construction companies that value customer service. Our customer base includes both large Fortune 500 companies who have elected to outsource some of their equipment needs and small construction contractors, subcontractors and machine operators whose equipment needs are job-based. Our top ten customers accounted for approximately
6%
of our total rental revenues
for the year ended December 31, 2016
collectively, and no single customer accounted for more than
1%
of our total rental revenues
for the year ended December 31, 2016
.
We largely conduct our business on account with customers who are screened through a credit application process. Credit account customers are our core customers, accounting for approximately
98%
of our total revenues
for the year ended December 31, 2016
.
Sales and Marketing
We maintain a strong sales and marketing orientation throughout our organization, which we believe helps us to increase our customer base and better understand and serve our customers. Managers develop relationships with local customers and assist them in planning their equipment rental requirements. They are also responsible for managing the mix of equipment at their locations, keeping current on local construction activity and monitoring competitors in their respective markets. To stay informed about their local markets, salespeople track rental opportunities and construction projects in the area through Equipment Data Reports, F.W. Dodge Reports, PEC (Planning, Engineering and Construction) Reports and local contacts.
Our national accounts are serviced by a core team of dedicated managers to provide continuity and customized solutions to our national account customers.
Our sales training program emphasizes customer service and focuses on sales generation.
Management Information Systems
In addition to our CRM system, we have developed customized management information systems, capable of monitoring our branch operations and sales force productivity on a real-time basis, which management believes can support our current and future needs. These systems link all of our rental locations and allow management to track customer and sales information, as well as the location, rental status and maintenance history of every major piece of equipment in the rental fleet. By using these systems, branch managers can search our entire rental fleet for needed equipment, quickly determine the closest location of such equipment and arrange for delivery of equipment to the customer's work site.
Employees
As of
December 31, 2016
, we had approximately
1,160
full-time employees. None of our employees are represented by a union or covered by a collective bargaining agreement. We believe we have satisfactory relations with our employees.
Our sales force is divided into salaried sales coordinators and field sales professionals. Our sales professionals receive monthly sales commissions based on rental revenue and a percentage of the gross profit from the sale of used and new equipment.
Seasonality and Cyclicality
Our Sunbelt locations benefit from favorable climate conditions that facilitate year round construction activity and reduce seasonality in our business. Our operating results are subject to annual and seasonal fluctuations resulting from a variety of factors, including:
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the seasonality of rental activity by our customers, with lower activity levels during the winter;
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the cyclicality of the construction industry;
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the number of our significant competitors and the competitive supply of rental equipment;
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general economic conditions; and
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the price of oil and other commodities and other general economic trends impacting the industries in which our customers and end users operate.
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In addition, our operating results may be affected by severe weather events and seismic conditions (such as hurricanes, tornadoes, flooding and earthquakes) in the regions we serve. Severe weather events can result in short-term reductions in construction activity levels, but after these periods of reduced construction activity, repair and reconstruction efforts have historically resulted in periods of increased demand for rental equipment.
Competition
The equipment industry is highly fragmented and we believe that competition tends to be based on geographic proximity and availability of products. While the competitive landscape also includes small, independent businesses with only a few rental locations, we believe that we mostly compete against regional competitors which operate in one or more states, public companies and equipment vendors and dealers who both sell and rent equipment directly to customers. Some of these competitors include United Rentals, Herc Rentals, Ahern Rentals, H&E Equipment Services, CAT Rental, Sunstate Equipment and Sunbelt Rentals.
We believe that, in general, large companies may enjoy competitive advantages compared to smaller operators, including greater purchasing power, a lower cost of capital, the ability to provide customers with a broader range of equipment and services, and greater flexibility to transfer equipment among locations in response to customer demand. See "Risk Factors—Risks Relating to Our Business—The equipment rental industry is highly competitive, and competitive pressures could lead to a decrease in our market share or in rental rates and our ability to sell equipment at favorable prices."
Environmental and Safety Regulations
We and our facilities and operations are subject to comprehensive and frequently changing federal, state and local environmental and safety and health requirements, including those relating to discharges of substances to the air, water and land, the handling, storage, transport, use and disposal of hazardous materials and wastes and the cleanup of properties affected by pollutants. In connection with our vehicle and equipment fueling and maintenance, repair and washing operations, we use regulated substances such as petroleum products and solvents and we generate small quantities of regulated waste such as used oil, radiator fluid and spent solvents. All of our properties currently have above ground and/or underground storage tanks and oil-water separators (or equivalent wastewater collection/treatment systems). Although we have made, and will continue to make capital expenditures to comply with environmental requirements, we do not anticipate that compliance with such requirements will have a material adverse effect on our business or financial condition or competitive position. However, in the future, new or more stringent laws or regulations could be adopted. Accordingly, we cannot assure you that we will not have to make significant capital or other expenditures in the future in order to comply with applicable laws and regulations or that we will be able to remain in compliance at all times.
Most, but not all, of our current properties have been the subject of an environmental site assessment conducted with the goal of identifying conditions that may cause us to incur costs under applicable environmental laws. In addition, all but one of our properties are leased and certain of our lease agreements provide that the site owner has responsibility for the preexisting environmental contamination at the property and that we are liable for contamination caused by us or that occurs during the term of the lease. However, given the nature of our operations and the historical operations conducted at these properties, and inherent limits on the information from the environmental site assessments mentioned above, we cannot be sure that all potential instances of contamination have been identified, that our operations have not caused contamination or that our landlords will be able or willing to hold us harmless for preexisting contamination at the relevant sites. Future events, such as changes in laws or policies, the discovery of previously unknown contamination, or the failure of another party to honor an obligation it may have to indemnify us for remediation costs or liabilities, may give rise to remediation costs which may be material. See "Risk Factors—Risks Relating to Our Business—We are subject to numerous environmental and health and safety laws and regulations that may result in our incurring liabilities, which could have a material adverse effect on our operating performance."
Other Information
We maintain a website with the address
www.neffrental.com
. We are not including the information contained in our website as part of, or incorporating it by reference into, this annual report on Form 10-K. We make available, free of charge through our website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports as soon as reasonably practicable after we electronically file these materials with, or otherwise furnish them to, the Securities and Exchange Commission (the “SEC”).
Item 1A. RISK FACTORS
Neff Corporation and its consolidated subsidiaries, including Neff Holdings and Neff Holdings' subsidiaries, Neff LLC and Neff Rental LLC, (collectively, the "Company," "we," "our" or "us") face significant risks and uncertainties. Certain important factors may have a material adverse effect on our business, financial condition, results of operations or cash flows. Accordingly, in evaluating our business, you should carefully consider the following discussion of risk factors in addition to other information contained in or incorporated by reference into this annual report on Form 10-K and our other public filings with the SEC.
Risks Relating to Our Business
The equipment rental industry is highly cyclical. Decreases in construction or industrial activities could materially adversely affect our revenues and operating results by decreasing the demand for our equipment or the rental rates or prices we can charge.
The equipment rental industry is highly cyclical and its revenues are closely tied to general economic conditions and to conditions in the non-residential construction industry in particular. Our products and services are used primarily in non-residential construction and oil and gas end-markets and, to a lesser extent, in industrial activity and residential construction end-markets. These are cyclical businesses that are sensitive to changes in general economic conditions. Weakness in our end-markets, such as a decline in non-residential construction, oil and gas end-markets or industrial activity, have led, and may in the future lead, to a decrease in the demand for our equipment or the rental rates or prices we can charge. For example, in 2009 and 2010, there were significant decreases in non-residential construction activity compared to prior periods, which materially adversely affected our results for those periods. Recently, we have observed a significant slowdown in activity in the oil and gas industry, which has materially adversely affected our rentals to participants in this industry. Factors that may cause weakness in our end-markets include:
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weakness in the economy, decreases in the market value of real estate or the onset of a new recession;
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slowdowns in residential construction and/or non-residential construction in the geographic regions in which we operate;
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continued decline and/or volatility in oil and gas prices as well as slowdowns in the oil and gas industry in the geographic regions in which we operate;
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reductions in spending levels by customers;
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unfavorable credit markets affecting end-user access to capital;
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adverse changes in the federal and local government infrastructure spending;
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an increase in the cost of construction materials;
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adverse weather conditions which may affect a particular region;
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oversupply of available commercial real estate in the markets we serve;
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increases in interest rates; and
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terrorism or hostilities involving the United States.
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Future declines in non-residential construction and industrial activity could materially adversely affect our operating results by decreasing our revenues and gross profit margins. Because of our focus on the earthmoving equipment category, which represented approximately
54%
of our OEC as of
December 31, 2016
, any such declines may affect us more than our competitors.
In addition, the cyclicality of our industry makes it more difficult for us to forecast trends. Uncertainty regarding future product demand could cause us to maintain excess equipment inventory and increase our equipment inventory costs. Alternatively, during periods of increased demand, we may not have enough rental equipment to satisfy demand, which could result in a loss of market share.
Our substantial indebtedness could materially adversely affect our business, financial condition, results of operations and cash flows.
We have a significant amount of indebtedness. As of
December 31, 2016
, we had total indebtedness of approximately
$702.1 million
(of which
$475.7 million
consisted of borrowings under our second lien credit agreement (the "Second Lien Loan")
and
$226.4 million
consisted of borrowings under our Revolving Credit Facility (as defined below)). As of
December 31, 2016
, we had borrowing capacity under our senior secured revolving credit facility (the "Revolving Credit Facility"), net of approximately
$4.1 million
in outstanding letters of credit, of
$223.0 million
, subject to certain conditions. In addition, subject to certain conditions, our Second Lien Loan can be increased by an additional $75.0 million under an uncommitted incremental facility. Under the terms of the agreements governing our indebtedness, we may be able to incur substantial indebtedness in the future.
Our substantial indebtedness could have important consequences to you. For example, it could:
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make it more difficult for us to satisfy our obligations with respect to our indebtedness or refinance our indebtedness as they become due;
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increase our vulnerability to general adverse economic and industry conditions;
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require us to dedicate a substantial portion of our cash flow from operations to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures, strategic growth efforts and other general corporate purposes;
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decrease our profitability or cash flow;
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limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
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limit our ability to attract acquisition candidates or to complete future acquisitions;
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place us at a competitive disadvantage compared to our competitors who have less indebtedness; and
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limit our ability to obtain additional financing for working capital, capital expenditures, acquisitions or general corporate purposes.
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In addition, the agreements governing our indebtedness contain restrictive covenants that limit our ability to engage in activities that may be in our long-term best interests. Our failure to comply with those covenants could result in an event of default which, if not cured or waived, could result in the acceleration of all of our indebtedness. In the past, we have had to seek waivers and amendments to certain covenants from our lenders which we obtained. There can be no assurance that we will not be required to seek waivers and amendments in the future or that, if sought, our lenders would grant such waivers or amendments.
To service our indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control and any failure to meet our debt service obligations could harm our business, financial condition and results of operations.
As a result of our significant indebtedness, we have substantial debt service requirements. Our ability to satisfy our debt service requirements and to meet our other capital and liquidity needs will depend on our ability to generate sufficient cash flow. Our ability to generate sufficient cash flow to satisfy our debt service requirements is subject to numerous factors, many of which are beyond our control, such as general economic conditions and changes in our industry. Also, we are dependent on the ability of our subsidiaries to distribute their operating cash flow to the borrower under our indebtedness to satisfy our debt service requirements. If our subsidiaries are restricted from distributing cash, whether by reason of contractual limitations, legal restrictions or otherwise, we may not be able to cause such cash to be distributed.
We cannot assure you that our business will generate sufficient cash flow from operations or that future borrowings will be available to us under our Revolving Credit Facility in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs. We may need to refinance all or a portion of our indebtedness on or before maturity. Our ability to refinance our indebtedness will depend on the capital markets and our financial condition at such time. Any refinancing of our indebtedness could be at high interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. We cannot assure you that we will be able to refinance any of our indebtedness, including our Revolving Credit Facility and the Second Lien Loan, on commercially reasonable terms or at all. Our inability to refinance our indebtedness or to do so upon attractive terms could materially and adversely affect our business, results of operations, financial condition, cash flows and make us vulnerable to adverse industry and general economic conditions.
Without a refinancing, we could be forced to implement alternative actions, including to reduce or delay capital expenditures, limit our growth, seek additional capital, or sell assets to make up for any shortfall in our payment obligations under unfavorable circumstances. The Revolving Credit Facility and the documentation governing the Second Lien Loan limit our ability to sell assets and also restrict the use of proceeds from such a sale. Moreover, the Revolving Credit Facility is secured on a first-priority basis by substantially all of our assets and the Second Lien Loan and the guarantees are secured on a second-priority basis
by substantially the same assets. We may not be able to sell assets quickly enough or for sufficient amounts to enable us to meet our obligations.
Variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.
Borrowings under our Revolving Credit Facility and the Second Lien Loan are at variable rates of interest and expose us to interest rate risk. While we have generally not entered into hedging arrangements in the ordinary course of our business, in March 2015, we did enter into an interest rate swap in the notional amount of $200.0 million to hedge the variable rate on a portion of the Revolving Credit Facility for the period between April 8, 2015 and April 8, 2020. Since our hedging arrangements only cover a portion of our indebtedness, our results of operations are still sensitive to movements in interest rates. There are many economic factors outside our control that have in the past and may, in the future, impact rates of interest including publicly announced indices that underlie the interest obligations related to a certain portion of our debt. Factors that impact interest rates include governmental monetary policies, inflation, recession, changes in unemployment, the money supply, international disorder and instability in domestic and foreign financial markets. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same.
The terms of our Revolving Credit Facility and the Second Lien Loan may restrict our current and future operations, particularly our ability to respond to changes in our business or to take certain actions.
Our Revolving Credit Facility and the documentation governing the Second Lien Loan contain, and the terms of any future indebtedness of ours would likely contain, a number of restrictive covenants that will impose significant operating and other restrictions on us. These restrictions will affect, and in many respects will limit or prohibit, among other things, our ability to:
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incur additional indebtedness;
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pay dividends and make distributions;
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issue stock of subsidiaries;
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make certain investments, acquisitions or capital expenditures;
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enter into affiliate transactions;
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enter into sale-leaseback transactions;
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merge or consolidate; and
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transfer and sell assets.
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In addition, our Revolving Credit Facility includes other more restrictive covenants and limits us from prepaying our other indebtedness, including the Second Lien Loan, while borrowings under the Revolving Credit Facility are outstanding.
The operating and financial restrictions and covenants in our existing debt agreements and any future financing agreements may adversely affect our ability to finance future operations or capital needs or to engage in other business activities. In addition, a failure to comply with the covenants contained in the credit agreements governing our Revolving Credit Facility or the Second Lien Loan could result in an event of default under the applicable facility which, if not cured or waived, could have a material adverse effect on our business, financial condition and results of operations. If we default under our Revolving Credit Facility or the Second Lien Loan, the lenders thereunder:
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will not be required to lend any additional amounts to us;
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could elect to declare all of our outstanding borrowings, together with accrued and unpaid interest and fees, to be immediately due and payable; and
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could effectively require us to apply all of our available cash to repay these borrowings even if they do not accelerate the borrowings.
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Any of these actions under one of our credit facilities could result in an event of default under the other facility or a future debt facility.
If the indebtedness under our Revolving Credit Facility or the Second Lien Loan were to be accelerated, there can be no assurance that our assets would be sufficient to repay such indebtedness in full and we could be forced into bankruptcy or liquidation.
If we are unable to obtain additional capital as required, we may be unable to fund the capital outlays required for the success of our business, including those relating to purchasing equipment, opening new rental locations, making acquisitions and refinancing existing indebtedness.
Our business has significant capital requirements. Our ability to remain competitive, sustain our growth and expand our operations through start-up locations and acquisitions largely depends on our access to capital. If the cash that we generate from our business, together with cash on hand and borrowings under our Revolving Credit Facility, to the extent available, is not sufficient to meet our capital needs and implement our growth strategy, we will require additional financing. However, we may not succeed in obtaining additional financing on terms that are satisfactory to us or at all. In addition, our ability to obtain additional financing will be restricted by the terms of our Revolving Credit Facility and by the terms of the Second Lien Loan. If we are unable to obtain sufficient additional capital in the future, we may be unable to fund the capital outlays required for the success and growth of our business, including those relating to purchasing equipment, opening new rental locations and completing acquisitions. Any additional indebtedness that we do incur will make us more vulnerable to economic downturns and may limit our ability to withstand competitive pressures.
Past economic downturns have had, and future economic downturns could have, a material adverse impact on our business.
Economic downturns in the areas we do business adversely affect us as our end-markets are in the highly cyclical construction area. A slowdown in the economic recovery or worsening of economic conditions, in particular with respect to U.S. construction and industrial activities, could have a material adverse effect on our overall business, results of operations and financial condition in a number of ways, including the following:
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a decrease in expected levels of infrastructure spending, including lower than expected government funding for economic stimulus projects;
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a decrease in expected levels of capital projects;
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a lack of availability of credit or an increase in interest rates due to deterioration or volatility of the banking system or financial markets;
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a delay or inability to pay for equipment rentals or fulfill other terms of rental agreements by customers;
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a delay or decrease in equipment rentals by existing or potential customers; and
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an increase in our equipment inventory costs.
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Our revenues and operating results will fluctuate, which could affect the volatility of the trading of our Class A common stock.
Our revenues and operating results fluctuate from quarter to quarter due to various factors, including:
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changes in rental rates or changes in demand for our equipment due to economic conditions, competition, weather or other factors;
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seasonal rental and purchasing patterns of our customers, with rental and purchasing activity tending to be lower in the winter due to weather and the holiday season;
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the cyclical nature of the businesses of our construction customers;
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the timing of capital expenditures for rental fleet expansion;
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changes in the cost and availability of equipment we purchase, including changes in manufacturer incentive programs;
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changes in corporate spending for plants and facilities or changes in government spending for infrastructure projects;
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severe weather and seismic conditions temporarily affecting the regions we serve (such as hurricanes, tornadoes, flooding and earthquakes) or the suppliers that supply us with equipment;
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cost fluctuations, including fuel costs and other raw material costs (such as the price of steel);
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other cost fluctuations, such as costs for employee related compensation and healthcare benefits;
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potential enactment of new legislation affecting our operations, rental equipment or labor relations;
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the timing and cost of opening new rental or customer repair center locations or acquiring new locations; and
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our effectiveness in integrating new or acquired rental or customer repair center locations and branch locations, in integrating acquisitions with existing operations, or in achieving the anticipated benefits of such integrations, expansions and acquisitions.
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Any of these factors could increase the volatility, or materially adversely affect, the trading price of our Class A common stock.
The equipment rental industry is highly competitive, and competitive pressures could lead to a decrease in our market share or in rental rates and our ability to sell equipment at favorable prices.
The equipment rental industry is highly fragmented and very competitive. Our competitors include:
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a few large national companies, including public companies and divisions of public companies;
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several regional competitors that operate in multiple states;
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thousands of small, independent businesses with only one or a few rental locations; and
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hundreds of equipment manufacturers and dealers that both sell and rent equipment directly to customers.
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Some of our competitors are significantly larger than we are and have greater financial and marketing resources than we have. In addition, some of our competitors have a more diversified offering than us. Some of our competitors also have greater technical resources, longer operating histories, lower cost structures and better relationships with equipment manufacturers than we have. In addition, certain of our competitors are more geographically diverse than we are and have greater name recognition among customers than we do. As a result, our competitors that have the advantages identified above may be able to provide their products and services at lower costs or may be able to capture a greater market share. We may in the future encounter increased competition in the equipment rental market, equipment sales market or in the equipment repair and services market from existing competitors or from new market entrants.
We believe that rental rates, fleet size and quality are the primary competitive factors in the equipment rental industry. From time to time, we or our competitors may attempt to compete aggressively by lowering rental rates or prices. Competitive pressures could materially adversely affect our revenues and operating results by decreasing our market share or depressing the rental rates. To the extent we lower rental rates or increase our fleet in order to retain or increase market share, our operating margins would be adversely impacted. In addition, we may not be able to match a larger competitor's price reductions or fleet investment because of its greater financial resources, all of which could adversely impact our operating results through a combination of a decrease in our market share and revenues.
We are exposed to various risks relating to legal proceedings or claims that could materially adversely affect our operating results. The nature of our business exposes us to various liability claims which may exceed the level of our insurance coverage and thereby not fully protect us, or not be covered by our insurance at all, and this could have a material adverse effect on our operating performance.
We are a party to lawsuits in the normal course of our business. Litigation in general can be expensive, lengthy and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. Responding to lawsuits brought against us, or legal actions that we may initiate, can often be expensive and time consuming. Unfavorable outcomes from these claims and/or lawsuits could materially adversely affect our business, results of operations and financial condition, and we could incur substantial monetary liability and/or be required to change our business practices.
Our business exposes us to claims for personal injury, death or property damage resulting from the use of the equipment we rent, sell, service or repair and from injuries caused in motor vehicle accidents in which our personnel are involved and other employee related matters. Additionally, we could be subject to potential litigation associated with compliance with various laws and governmental regulations at the federal, state or local levels, such as those relating to the protection of persons with disabilities, employment, health, safety, security and other regulations under which we operate.
We carry comprehensive insurance, subject to deductibles, at levels we believe are sufficient to cover existing and future claims made during the respective policy periods. However, we may be exposed to multiple claims, including workers compensation claims, that do not exceed our deductibles, and, as a result, we could incur significant out-of-pocket costs that could materially adversely affect our business, financial condition and results of operations. In addition, the cost of such insurance policies may increase significantly upon renewal of those policies as a result of general rate increases for the type of insurance we carry as well as our historical experience and experience in our industry. Our existing or future claims may exceed the coverage level of our insurance, and such insurance may not continue to be available on economically reasonable terms, or at all. If we are required to pay significantly higher premiums for insurance, are not able to maintain insurance coverage at affordable rates or if we must pay amounts in excess of claims covered by our insurance, we could experience higher costs that could materially adversely affect our business, financial condition, results of operations and cash flows. In addition, we may be subject to various legal proceedings and claims, such as claims for punitive damages or damages arising from intentional misconduct, either asserted or unasserted, that may not be covered by our insurance. Any such claims, whether with or without merit, could be time consuming and expensive to defend and could divert management's attention and resources.
We depend on key personnel whom we may not be able to retain.
Our operations are managed by a small number of key executive officers, and our future performance depends on the continued contributions of those management personnel. A loss of one or more of these key people could harm our business and prevent us from implementing our business strategy. We do not maintain "key man" life insurance on the lives of any members of our senior management. We have existing employment agreements with certain key executives. However, each of the employment agreements is of limited duration. We cannot assure you that these executives will remain employed with us for the full term of their agreements or that the term of their agreements will be extended beyond the current term.
The success of our operations also depends in part on our ability to attract, hire, train and retain qualified managerial, sales and marketing personnel. Competition for these types of personnel is high. We may be unsuccessful in attracting and retaining the personnel we require to conduct our operations successfully and, in such an event, our business could be materially adversely affected.
We may recognize significantly higher maintenance costs in connection with increases in the weighted average age of our rental fleet.
As our fleet of rental equipment ages, the cost of maintaining such equipment, if not replaced, will likely increase. We manage the average age of different types of equipment according to the expected wear and tear that a specific type of equipment is expected to experience over its useful life. As of
December 31, 2016
, the average age of our rental equipment fleet was approximately
48
months. As of
December 31, 2016
, approximately
54%
(based on OEC) of our rental fleet consisted of earthmoving equipment, which generally has higher maintenance costs than similar-sized aerial or material handling equipment. It is possible that we may allow the average age of our rental equipment fleet to increase, which would require an increase in the amounts we invest in maintenance, parts and repair. We cannot assure you that costs of maintenance, parts or repair will not materially increase in the future. Any material increase in such costs could have a material adverse effect on our business, financial condition and results of operations.
We are subject to numerous environmental and health and safety laws and regulations that may result in our incurring liabilities, which could have a material adverse effect on our operating performance.
Our facilities and operations are subject to comprehensive and frequently changing federal, state and local laws and regulations relating to environmental protection and health and safety. These laws and regulations govern, among other things, the discharge of substances into the air, water and land, the handling, storage, transport, use and disposal of hazardous materials and wastes and the cleanup of properties affected by pollutants. If we violate environmental laws or regulations, we may be required to implement corrective actions and could be subject to civil or criminal fines or penalties or other sanctions. Although expenses related to environmental compliance have not been material to date, we cannot assure you that we will not have to make significant capital or operating expenditures in the future in order to comply with applicable laws and regulations or that we will comply with applicable environmental laws at all times. Such violations or liability could have a material adverse effect on our business, financial condition and results of operations.
Environmental laws also impose obligations and liability for the investigation and cleanup of properties affected by hazardous substance spills or releases. These liabilities are often joint and several (which could result in an entity paying for more than its fair share), and may be imposed on the parties generating or disposing of such substances or on the owner or operator of affected property, often without regard to whether the owner or operator knew of, or was responsible for, the presence of hazardous substances. We may also have liability for past contamination as successors-in-interest for companies which were acquired or where there was a merger. Accordingly, we may become liable, either contractually or by operation of law, for investigation, remediation, monitoring and other costs even if the contaminated property is not presently owned or operated by us, or if the
contamination was caused by third parties during or prior to our ownership or operation of the property. Contamination and exposure to hazardous substances can also result in claims for damages, including personal injury, property damage, and natural resources damage claims.
All of our properties currently have above ground and/or underground storage tanks and oil-water separators (or equivalent wastewater collection/treatment systems). Given the nature of our operations (which involve the use of diesel and other petroleum products, solvents and other hazardous substances) for fueling, washing and maintaining our rental equipment and vehicles, and the historical operations at some of our properties, we may incur material costs associated with soil or groundwater contamination. Future events, such as changes in existing laws or policies or their enforcement, or the discovery of currently unknown contamination, may give rise to remediation liabilities or other claims or costs that may be material.
Various U.S. and international authorities continue to consider legislation and regulations related to greenhouse gas emissions. Should legislation or regulations be adopted imposing significant limitations on greenhouse gas emissions or costs on entities deemed to be responsible for such emissions, demand for our services could be affected, our costs could increase, and our business, financial condition and results of operations could be materially adversely affected.
We are dependent on our relationships with our key equipment manufacturers and the termination of one or more of our relationships with any of these key equipment manufacturers or their inability to fulfill the terms of their agreements with us could have a material adverse effect on our business.
We purchase most of our rental and sales equipment from a limited number of OEMs. For example, as of
December 31, 2016
, equipment from JLG Industries, Komatsu, John Deere and Kobelco represented approximately
14.4%
,
10.9%
,
8.1%
and
7.9%
, respectively, of our total OEC. Termination of one or more of our relationships with any of these or other major suppliers or insolvency, financial difficulties or other factors may result in our equipment manufacturers not being able to fulfill the terms of their agreement with us or may force our suppliers to seek to renegotiate existing contracts with us. Although we believe we have alternative sources of supply for the equipment we need, termination of our relationship with any of our key suppliers could have a material adverse effect on our business, financial condition and results of operations if we were unable to obtain adequate equipment for rental and sale from other sources in a timely manner, on favorable terms or at all. Because our major suppliers also sell equipment to our competitors, our relationships with our suppliers do not provide us any particular competitive advantage.
Our rental fleet is subject to residual value risk upon disposition.
The market value of any given piece of rental equipment could be less than its depreciated value at the time it is sold. The market value of used rental equipment depends on several factors, including:
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the market price for new equipment of a like kind;
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wear and tear on the equipment relative to its age;
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the age of the equipment at the time it is sold;
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the time of year that it is sold (generally prices are higher during the peak construction season for any given area);
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worldwide and domestic supply of and demand for used equipment;
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inventory levels at OEMs; and
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general economic conditions.
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We include in income from operations the difference between the sales price and the depreciated value of an item of equipment sold. Changes in our assumptions regarding depreciation could change our depreciation expense, as well as the gain or loss realized upon disposal of equipment. If prices we are able to obtain for our used rental equipment decline or fall below our projections or if we sell our equipment in lesser quantities as a result of the above or other factors, our operating results may be materially adversely affected.
The cost of new equipment we use in our rental fleet may increase, which may cause us to spend significantly more for replacement equipment, and in some cases we may not be able to procure equipment at all due to supplier constraints.
We operate in a capital intensive business. Price increases could materially adversely affect our business, financial condition and results of operations.
While we can manage the size and aging of our fleet generally over time, eventually we must retire older equipment and either allow our fleet to shrink or replace the older equipment in our fleet with newer models. We anticipate that we will need to
purchase additional equipment in 2017 in order to supplement our current fleet. We may be at a competitive disadvantage if the average age of our fleet increases compared to the age of our competitors' fleets.
In some cases, we may not be able to procure replacement equipment on a timely basis to the extent that manufacturers for the equipment we need are not able to produce sufficient inventory on schedules that meet our timing demands. If demand for new equipment increases significantly, manufacturers may not be able to meet customer orders on a timely basis. As a result, we at times may experience long lead times for certain types of new equipment and we cannot assure you that we will be able to acquire the types or sufficient numbers of the equipment we need to replace older equipment as quickly as we would like. Consequently, we may have to age our fleet longer than we would consider optimal or shrink our fleet, either of which could restrict our ability to grow our business.
Trends in oil and gas prices could adversely affect the level of exploration, development and production activity of certain of our customers and the demand for our services and products.
Demand for our services and products is sensitive to the level of exploration, development and production activity of, and the corresponding capital spending by, oil and gas companies, including national oil companies, regional exploration and production providers, and related service providers. The level of exploration, development and production activity is directly affected by trends in oil and gas prices, which historically have been volatile and are likely to continue to be volatile.
Prices for oil and gas are subject to large fluctuations in response to relatively minor changes in the supply of and demand for oil and gas, market uncertainty, and a variety of other economic factors that are beyond our control. Factors affecting the prices of oil and gas include:
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the level of supply and demand for oil and gas;
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governmental regulations, including the policies of governments regarding the exploration for, and production and development of, oil and gas reserves;
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weather conditions and natural disasters;
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worldwide political, military and economic conditions;
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the level of oil production by non-Organization of the Petroleum Exporting Countries ("OPEC") countries and the available excess production capacity within OPEC;
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oil refining capacity and shifts in customer preferences toward fuel efficiency and the use of gas;
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the cost of producing and delivering oil and gas; and
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potential acceleration of the development of alternative fuels.
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Any prolonged reduction in oil and gas prices will depress the immediate levels of exploration, development and production activity, which could have an adverse effect on our business, results of operations and financial condition. Even the perception of longer-term lower oil and gas prices by oil and gas companies and related service providers can similarly reduce or defer major expenditures by these companies and service providers given the long-term nature of many large scale development projects.
Disruptions in or threats to the security of our information technology and customer relationship management systems could materially adversely affect our operating results by limiting our capacity to effectively monitor and control our operations.
Our information technology systems facilitate our ability to monitor and control our operations to adjust to changing market conditions, including management of our rental fleet. Our CRM system allows our sales force to access comprehensive information about customer activity relating to specific accounts to assist their sales efforts. The effectiveness of our sales force depends upon the continuous availability and reliability of our CRM system. Consequently, any disruptions in our information technology or customer relationship management systems or the failure of these systems, including our redundant systems, to operate as expected could, depending on the magnitude of the problem, impair our ability to effectively monitor and control our existing operations and improve our future sales efforts, and thereby materially adversely affect our operating results.
Additionally, we collect and store data in the ordinary course of our business that is sensitive to our company and our customers. Operating our information technology systems and networks in a manner that maintains this data in a secure manner is critical to our business. Potential security threats, including cybersecurity attacks to gain unauthorized access to our systems, networks and data are increasing in frequency and sophistication and have impacted a number of companies, including companies much larger than us. While we actively manage information technology security risks within our control, we cannot assure you that such actions will be sufficient to prevent or mitigate all potential risks to our systems, networks and data. If we were to
experience a material cybersecurity attack, such attack may materially adversely affect our operating results, and may result in reputational damage, litigation with third parties, and increased cybersecurity protection and remediation costs.
Potential acquisitions and expansions into new markets may result in significant transaction expenses and expose us to risks associated with entering new markets and integrating new or acquired operations.
We may encounter risks associated with entering new markets in which we have limited or no experience. Startup rental locations, in particular, require significant capital expenditures and may initially have a negative impact on our short-term cash flow, net income and results of operations. New startup locations may not become profitable when projected or ever. Acquisitions may impose significant strains on our management, operating systems and financial resources and could experience unanticipated integration issues. The pursuit and integration of acquisitions will require substantial attention from our senior management, which will limit the amount of time they have available to devote to our existing operations. Our ability to realize the expected benefits from any future acquisitions depends in large part on our ability to integrate and consolidate the new operations with our existing operations in a timely and effective manner. Future acquisitions also could result in the incurrence of substantial amounts of indebtedness and contingent liabilities (including potentially environmental, employee benefits and safety and health liabilities), accumulation of goodwill that may become impaired, and an increase in amortization expenses related to intangible assets. Any significant diversion of management's attention from our existing operations, the loss of key employees or customers of any acquired business, any major difficulties encountered in the opening of startup locations or the integration of acquired operations or any associated increases in indebtedness, liabilities or expenses could have a material adverse effect on our business, financial condition and results of operations, which could decrease our cash flows and make it more difficult for us to make payments on our indebtedness.
We have operations throughout the United States, which exposes us to multiple state and local regulations. Changes in applicable law, regulations or requirements, or our material failure to comply with any of them, can increase our costs and have other negative impacts on our business.
Our
69
branch locations are located in
14
states and we must comply with many different state and local regulations. These laws and requirements address multiple aspects of our operations, such as worker safety, consumer rights, privacy, employee benefits and more, and can often have different requirements in different jurisdictions. Changes in these requirements, or any material failure by our branches to comply with them, can increase our costs, affect our reputation, limit our business, consume management time and attention and otherwise impact our operations in adverse ways.
If we determine that our goodwill has become impaired, we may incur impairment charges, which would negatively impact our operating results
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At
December 31, 2016
, we had
$60.6 million
of goodwill on our consolidated balance sheet. Goodwill represents the excess of cost over the fair value of identifiable net assets of businesses acquired. We assess potential impairment of our goodwill at least annually. Impairment may result from significant changes in the manner of use of the acquired assets, negative industry or economic trends and/or significant underperformance relative to historic or projected operating results. A material impairment charge may occur in a future period. Such a charge could materially adversely affect our financial condition and results of operations.
Labor disputes could disrupt our ability to serve our customers and/or lead to higher labor costs.
Although none of our employees are currently represented by unions or covered by collective bargaining agreements, union organizing activity may take place in the future. Union organizing efforts or collective bargaining negotiations could potentially lead to work stoppages and/or slowdowns or strikes by certain of our employees, which could materially adversely affect our ability to serve our customers. Further, settlement of actual or threatened labor disputes or an increase in the number of our employees covered by collective bargaining agreements can have unknown effects on our labor costs, productivity and flexibility.
Risks Relating to Our Organizational Structure
The Wayzata Funds have substantial control over us including over decisions that require the approval of stockholders, and its interest in our business may conflict with yours.
As of
December 31, 2016
, the Wayzata Funds held a majority of the combined voting power of our common stock through its ownership of 100% of our outstanding Class B common stock.
Accordingly, the Wayzata Funds, acting alone, have the ability to approve or disapprove substantially all transactions and other matters submitted to a vote of our stockholders, such as a merger, consolidation, dissolution or sale of all or substantially all of our assets, the issuance or redemption of certain additional equity interests, and the election of directors. These voting and class approval rights may enable the Wayzata Funds to consummate transactions that may not be in the best interests of holders
of our Class A common stock or, conversely, prevent the consummation of transactions that may be in the best interests of holders of our Class A common stock. In addition, although the Wayzata Funds have voting control of us, the Wayzata Funds' entire economic interest in us is in the form of its direct interest in Neff Holdings through the ownership of Neff Holdings' common units, the payments it may receive from us under the tax receivable agreement (the "Tax Receivable Agreement") and the proceeds it may receive upon any redemption of its common units in Neff Holdings, including issuance of shares of our Class A common stock upon any such redemption and any subsequent sale of such Class A common stock. As a result, the Wayzata Funds' interests may conflict with the interests of our Class A common stockholders. For example, the Wayzata Funds may have different tax positions from us which could influence their decisions regarding whether and when to dispose of assets, whether and when to incur new or refinance existing indebtedness, especially in light of the existence of a Tax Receivable Agreement that we entered into in connection with our initial public offering, and whether and when we should terminate the Tax Receivable Agreement and accelerate our obligations thereunder. In addition, the structuring of future transactions may take into consideration tax or other considerations of the Wayzata Funds or other certain members of management of Neff Holdings and certain non-executive members of its board of managers (collectively, the "Prior LLC Owners") even in situations where no similar considerations are relevant to us.
In addition, Wayzata is in the business of making or advising on investments in companies and may hold, and may from time to time in the future acquire interests in or provide advice to businesses that directly or indirectly compete with certain portions of our business or are suppliers or customers of ours. Our amended and restated certificate of incorporation provides that, to the fullest extent permitted by law, none of Wayzata or any director who is not employed by us or his or her affiliates will have any duty to refrain from engaging in a corporate opportunity in the same or similar lines of business as us. Wayzata may also pursue acquisitions that may be complementary to our business, and, as a result, those acquisition opportunities may not be available to us.
Our only asset is our interest in Neff Holdings, and accordingly we depend on distributions from Neff Holdings to pay taxes and expenses, including payments under the Tax Receivable Agreement. Neff Holdings' ability to make such distributions may be subject to various limitations and restrictions.
We are a holding company and have no material assets other than our ownership of common units of Neff Holdings. We have no independent means of generating revenue or cash flow, and our ability to pay dividends in the future, if any, is dependent upon the financial results and cash flows of Neff Holdings and its subsidiaries and distributions we receive from Neff Holdings. There can be no assurance that our subsidiaries will generate sufficient cash flow to pay dividends or distribute funds to us or that applicable state law and contractual restrictions, including negative covenants in our debt instruments, will permit such dividends or distributions.
Neff Holdings is treated as a partnership for U.S. federal income tax purposes and, as such, is not subject to any entity-level U.S. federal income tax. Instead, taxable income is allocated to holders of its common units, including us. As a result, we incur income taxes on our allocable share of any net taxable income of Neff Holdings. Under the terms of Neff Holdings' second amended and restated limited liability company agreement (the "Neff Holdings LLC Agreement"), Neff Holdings is obligated to make tax distributions to holders of its common units, including us. In addition to tax expenses, we also incur expenses related to our operations, including expenses under the Tax Receivable Agreement, which could be significant. We intend, as its managing member, to cause Neff Holdings to make distributions in an amount sufficient to allow us to pay our taxes and operating expenses, including any payments due under the Tax Receivable Agreement. However, Neff Holdings' ability to make such distributions is subject to various limitations and restrictions including, but not limited to, restrictions on distributions that would either violate any contract or agreement to which Neff Holdings LLC is then a party, including debt agreements, or any applicable law, or that would have the effect of rendering Neff Holdings insolvent. If Neff Holdings does not have sufficient funds to pay tax or other liabilities to fund our operations, we may have to borrow funds, which could materially adversely affect our liquidity and financial condition and subject us to various restrictions imposed by any such lenders. To the extent that we are unable to make payments under the Tax Receivable Agreement for any reason, such payments will be deferred and will accrue interest until paid. If Neff Holdings does not have sufficient funds to make distributions, our ability to declare and pay cash dividends in the future may also be restricted or impaired.
Our Tax Receivable Agreement with our Prior LLC Owners requires us to make cash payments to them in respect of certain tax benefits to which we may become entitled, and the amounts that we may be required to pay could be significant.
Pursuant to the Tax Receivable Agreement, we will be required to make cash payments to our Prior LLC Owners equal to 85% of the tax benefits, if any, that we actually realize, or in some circumstances are deemed to realize as a result of (i) increases in tax basis resulting from any redemptions or exchanges of common units, (ii) certain allocations in connection with our initial public offering and as a result of the application of the principles of Section 704(c) of the Internal Revenue Code to take into account the difference between the fair market value and the adjusted tax basis of certain assets of Neff Holdings on the date that we purchased Neff Holdings common units directly from Neff Holdings with a portion of the proceeds from our initial public
offering and (iii) certain other tax benefits related to our entering into the Tax Receivable Agreement, including tax benefits attributable to payments under the Tax Receivable Agreement.
The amount of the cash payments that we may be required to make under the Tax Receivable Agreement could be significant. Payments under the Tax Receivable Agreement will be based on the tax reporting positions that we determine, which tax reporting positions will be based on the advice of our tax advisors. Any payments made by us to our Prior LLC Owners under the Tax Receivable Agreement will generally reduce the amount of overall cash flow that might have otherwise been available to us. To the extent that we are unable to make timely payments under the Tax Receivable Agreement for any reason, the unpaid amounts will be deferred and will accrue interest until paid by us. Furthermore, our future obligation to make payments under the Tax Receivable Agreement could make us a less attractive target for an acquisition, particularly in the case of an acquirer that cannot use some or all of the tax benefits that may be deemed realized under the Tax Receivable Agreement. The payments under the Tax Receivable Agreement are also not conditioned upon our Prior LLC Owners maintaining a continued ownership interest in either Neff Holdings or us.
We expect that the payments we will be required to make under the Tax Receivable Agreement will be substantial. Assuming that the holders of the common units of Neff Holdings would have sold all of their common units to us as of December 30, 2016, there are no material changes in the relevant tax law, Neff Holdings is able to fully depreciate or amortize its assets, we earn sufficient taxable income to realize full tax benefit of the increased depreciation and amortization of our assets, and the market value of one share of Class A common stock is equal to the price per share on December 30, 2016, we expect that the payments under the Tax Receivable Agreement associated with (i) the purchase of common units from Neff Holdings with proceeds from our IPO on November 26, 2014 and (ii) future redemptions or exchanges of common units as described above could aggregate approximately
$310.0 million
and range from approximately
$11.0 million
to
$45.0 million
per year, over a 15 year period.
The amounts that we may be required to pay to our Prior LLC Owners under the Tax Receivable Agreement may be accelerated in certain circumstances and may also significantly exceed the actual tax benefits that we ultimately realize.
The Tax Receivable Agreement provides that if certain mergers, asset sales, other forms of business combination, or other changes of control were to occur, or that if, at any time, we elect an early termination of the Tax Receivable Agreement, then the Tax Receivable Agreement will terminate and our obligations, or our successor's obligations, to make payments under the Tax Receivable Agreement would accelerate and become immediately due and payable. The amount due and payable in that circumstance is determined based on certain assumptions, including an assumption that we would have sufficient taxable income to fully utilize all potential future tax benefits that are subject to the Tax Receivable Agreement.
As a result of a change in control or our election to terminate the Tax Receivable Agreement early, (i) we could be required to make cash payments to our Prior LLC Owners that are greater than the specified percentage of the actual benefits we ultimately realize in respect of the tax benefits that are subject to the Tax Receivable Agreement and (ii) we would be required to make an immediate cash payment equal to the present value of the anticipated future tax benefits that are the subject of the Tax Receivable Agreement, which payment may be made significantly in advance of the actual realization, if any, of such future tax benefits. In these situations, our obligations under the Tax Receivable Agreement could have a substantial negative impact on our liquidity and could have the effect of delaying, deferring or preventing certain mergers, asset sales, other forms of business combination, or other changes of control. There can be no assurance that we will be able to finance our obligations under the Tax Receivable Agreement.
We will not be reimbursed for any payments made to our existing investors under the Tax Receivable Agreement in the event that any tax benefits are disallowed.
We will not be reimbursed for any cash payments previously made to our Prior LLC Owners pursuant to the Tax Receivable Agreement if any tax benefits initially claimed by us are subsequently challenged by a taxing authority and are ultimately disallowed. Instead, any excess cash payments made by us to a Prior LLC Owner will be netted against any future cash payments that we might otherwise be required to make under the terms of the Tax Receivable Agreement. However, we might not determine that we have effectively made an excess cash payment to our Prior LLC Owners for a number of years following the initial time of such payment. As a result, it is possible that we could make cash payments under the Tax Receivable Agreement that are substantially greater than our actual cash tax savings.
Unanticipated changes in effective tax rates or adverse outcomes resulting from examination of our income or other tax returns could adversely affect our operating results and financial condition.
We are subject to income taxes in the United States, and our domestic tax liabilities will be subject to the allocation of expenses in differing jurisdictions. Our future effective tax rates could be subject to volatility or adversely affected by a number of factors, including:
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changes in the valuation of our deferred tax assets and liabilities;
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expected timing and amount of the release of any tax valuation allowances;
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changes in the Tax Receivable Agreement liability;
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tax effects of stock-based compensation;
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costs related to intercompany restructurings; or
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changes in tax laws, regulations or interpretations thereof.
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In addition, we may be subject to audits of our income, sales and other transaction taxes by U.S. federal and state authorities. Outcomes from these audits could have an adverse effect on our operating results and financial condition.
If we were deemed to be an investment company under the Investment Company Act of 1940, as amended (the "1940 Act"), as a result of our ownership of Neff Holdings, applicable restrictions could make it impractical for us to continue our business as contemplated and could have a material adverse effect on our business.
Under Sections 3(a)(1)(A) and (C) of the 1940 Act, a company generally will be deemed to be an "investment company" for purposes of the 1940 Act if (i) it is, or holds itself out as being, engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in securities or (ii) it engages, or proposes to engage, in the business of investing, reinvesting, owning, holding or trading in securities and it owns or proposes to acquire investment securities having a value exceeding 40% of the value of its total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis. We do not believe that we are an "investment company," as such term is defined in either of those sections of the 1940 Act.
As the sole managing member of Neff Holdings, we will control and operate Neff Holdings. On that basis, we believe that our interest in Neff Holdings is not an "investment security" as that term is used in the 1940 Act. However, if we were to cease participation in the management of Neff Holdings, our interest in Neff Holdings could be deemed an "investment security" for purposes of the 1940 Act.
We and Neff Holdings intend to conduct our operations so that we will not be deemed an investment company. However, if we were to be deemed an investment company, restrictions imposed by the 1940 Act, including limitations on our capital structure and our ability to transact with affiliates, could make it impractical for us to continue our business as contemplated and could have a material adverse effect on our business.
Risks Relating to Ownership of Our Class A Common Stock
The Wayzata Funds directly (through Class B common stock) and indirectly (through ownership of Neff Holdings common units) own interests in us, and the Wayzata Funds have the right to redeem such interests pursuant to the terms of the Neff Holdings LLC Agreement.
As of
December 31, 2016
, we had an aggregate of
91,140,338
shares of Class A common stock authorized but unissued, including approximately
15,709,560
shares of Class A common stock issuable, at our election, in Class A common stock or a cash payment equal to the volume - weighted average market price of the Class A common stock upon redemption of Neff Holdings common units held by the Wayzata Funds and the Prior LLC Owners upon the exercise of options in Neff Holdings. Neff Holdings has entered into the Neff Holdings LLC Agreement and, subject to certain restrictions set forth therein and as described elsewhere in this annual report on Form 10-K, the Wayzata Funds and Prior LLC Owners are entitled thereunder to redeem its common units for an aggregate of up to
15,709,560
shares of our Class A common stock, subject to customary adjustments.
We have also entered into a registration rights agreement (the "Registration Rights Agreement") with the Wayzata Funds and the Prior LLC Owners pursuant to which the shares of Class A common stock issued upon such redemption will be eligible for resale, subject to certain limitations set forth therein. Any sales in connection with the Registration Rights Agreement, or the prospect of any such sales, could materially impact the market price of our Class A common stock and could impair our ability to raise capital through future sales of equity securities.
We cannot predict whether future issuances of our Class A common stock or the availability of shares of our Class A common stock for resale in the open market will affect the market price of our Class A common stock. The issuance of substantial numbers of shares of our Class A common stock in the public market, or upon exchange of common units redeemed by the selling stockholders, or the perception that such issuances might occur, could adversely affect the per share trading price of our Class A common stock. Sales of substantial amounts of our Class A common stock in the public market, or upon exchange of the common
units owned by the selling stockholders or others, or speculation that such sales might occur, could adversely affect the liquidity of the market of our Class A common stock or the prevailing market price of our Class A common stock.
You may be diluted by future issuances of additional Class A common stock in connection with any redemption of the common units, our incentive plans, acquisitions or otherwise; future sales of such shares in the public market, or the expectations that such sales may occur, could lower our stock price.
Our amended and restated certificate of incorporation, which we refer to as the "Certificate of Incorporation" authorizes us to issue shares of Class A common stock and options, rights, warrants and appreciation rights relating to Class A common stock for the consideration and on the terms and conditions established by our board of directors in its sole discretion, whether in connection with acquisitions or otherwise. In addition, we and the Wayzata Funds are party to the Neff Holdings LLC Agreement under which the members of Neff Holdings (or certain permitted transferees thereof) have the right (subject to the terms of the Neff Holdings LLC Agreement) to have their common units redeemed by Neff Holdings in exchange for, at Neff Corporation's election, shares of our Class A common stock on a one-for-one basis or a cash payment equal to the volume-weighted average market price of one share of our Class A common stock for each common unit (subject to customary adjustments, including for stock splits, stock dividends and reclassifications); provided that, at Neff Corporation's election, Neff Corporation may effect a direct exchange of such Class A common stock or such cash for such common units. The market price of shares of our Class A common stock could decline as a result of these redemptions or the perception that a redemption could occur. These redemptions, or the possibility that these redemptions may occur, also might make it more difficult for holders of our Class A common stock to sell such stock in the future at a time and at a price that they deem appropriate.
We have reserved shares for issuance under the Neff Corporation 2014 Incentive Award Plan (the “2014 Incentive Award Plan") in an amount equal to
1,500,000
shares of Class A common stock, and we granted options and restricted stock units under the 2014 Incentive Award Plan covering a total of
355,504
shares of Class A common stock concurrently with the consummation of our initial public offering and we granted options and restricted stock units under the 2014 Incentive Award Plan covering a total of
822,534
shares of Class A common stock subsequent to our initial public offering. Any Class A common stock that we issue, including under our 2014 Incentive Award Plan or other equity incentive plans that we may adopt in the future, would dilute the percentage ownership of holders of our Class A common stock. In addition, each common unit received upon the exercise by the Prior LLC Owners of outstanding options to acquire membership units in Neff Holdings will be redeemable for, at Neff Corporation's option, newly-issued shares of Class A common stock on a one-for-one basis or a cash payment equal to the market price of one share of Class A common stock (subject to customary adjustments, including for stock splits, stock dividends and reclassifications) in accordance with the terms of the Neff Holdings LLC Agreement; provided that, at Neff Corporation's election, Neff Corporation may effect a direct exchange of such Class A common stock or such cash for such common units. In addition, we may issue equity in future offerings to fund acquisitions and other expenditures, which may further decrease the value for our stockholders' investment in us.
Since May 20, 2015, we and our officers and directors and Prior LLC Owners are no longer subject to lock-up agreements entered into with Morgan Stanley & Co. LLC and Jefferies LLC which had previously limited the ability of these parties to (i) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, lend or otherwise transfer or dispose of, directly or indirectly, any shares of Class A common stock or any securities convertible into or exercisable or exchangeable for shares of Class A common stock; (ii) file any registration statement with the SEC relating to the offering of any shares of Class A common stock or any securities convertible into or exercisable or exchangeable for Class A common stock; or (iii) enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of Class A common stock.
The market price of our Class A common stock has declined subsequent to the restrictions in resale by our existing stockholders lapsing and may continue to decline as a result of sales of our Class A common stock or the expectation that such sales may occur. A decline in the price of our Class A common stock might impede our ability to raise capital through the issuance of additional shares of Class A common stock or other equity securities.
Our Class A common stock price may be volatile or may decline regardless of our operating performance and you may not be able to resell your shares at or above the price you paid for them.
Prior to our initial public offering, there was no public market for our Class A common stock. As a public company, the market price for our Class A common stock is likely to be volatile, in part because our shares were not previously traded publicly. Volatility in the market price of our Class A common stock may prevent you from being able to sell your shares at or above the price you paid for them. Many factors, which are outside our control, may cause the market price of our Class A common stock to fluctuate significantly, including those described elsewhere in this "Risk Factors" section and this annual report on Form 10-K, as well as the following:
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issuances, exchanges or sales, or expected issuances, exchanges or sales of our capital stock;
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our operating and financial performance and prospects;
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our quarterly or annual earnings or those of other companies in our industry compared to market expectations;
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conditions that impact demand for our services;
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future announcements concerning our business or our competitors' businesses;
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the public's reaction to our press releases, other public announcements and filings with the SEC;
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the size of our public float;
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changes in market valuations of similar companies;
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coverage by or changes in financial estimates by securities analysts or failure to meet their expectations;
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market and industry perception of our success, or lack thereof, in pursuing our growth strategy;
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strategic actions by us or our competitors, such as acquisitions or restructurings;
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adverse market reaction to any increased indebtedness we incur in the future;
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changes in laws or regulations which adversely affect our industry or us;
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changes in accounting standards, policies, guidance, interpretations or principles;
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changes in senior management or key personnel;
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changes in our dividend policy;
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adverse resolution of new or pending litigation against us; and
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changes in general market, economic and political conditions in the United States and global economies or financial markets, including those resulting from natural disasters, terrorist attacks, acts of war and responses to such events.
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As a result, volatility in the market price of our Class A common stock may prevent our stockholders from being able to sell their Class A common stock at or above the price paid for them or at all. These broad market and industry factors may materially reduce the market price of our Class A common stock, regardless of our operating performance. In addition, price volatility may be greater if the public float and trading volume of our Class A common stock is low. As a result, you may suffer a loss on your investment.
We do not intend to pay dividends on our Class A common stock for the foreseeable future.
We currently have no intention to pay dividends on our Class A common stock at any time in the foreseeable future. Any decision to declare and pay dividends in the future will be made at the discretion of our board of directors and will depend on, among other things, our results of operations, financial conditions, cash requirements, contractual restrictions and other factors that our board of directors may deem relevant. Certain of our debt instruments contain covenants that restrict the ability of our subsidiaries to pay dividends to us. In addition, we are permitted under the terms of our debt instruments to incur additional indebtedness, which may restrict or prevent us from paying dividends on our Class A common stock. Furthermore, our ability to declare and pay dividends may be limited by instruments governing future outstanding indebtedness we may incur.
We may issue shares of preferred stock in the future, which could make it difficult for another company to acquire us or could otherwise adversely affect holders of our Class A common stock, which could depress the price of our Class A common stock.
Our Certificate of Incorporation authorizes us to issue one or more series of preferred stock. Our board of directors has the authority to determine the preferences, limitations and relative rights of the shares of preferred stock and to fix the number of shares constituting any series and the designation of such series, without any further vote or action by our stockholders. Our preferred stock could be issued with voting, liquidation, dividend and other rights superior to the rights of our Class A common stock. The potential issuance of preferred stock may delay or prevent a change in control of us, discouraging bids for our Class A
common stock at a premium to the market price, and materially and adversely affect the market price and the voting and other rights of the holders of our Class A common stock.
If securities analysts do not publish research or reports about our company, or if they issue unfavorable commentary about us or our industry or downgrade our Class A common stock, the price of our Class A common stock could decline.
The trading market for our Class A common stock depends in part on the research and reports that third-party securities analysts publish about our company and our industry. We may be unable or slow to attract research coverage and if one or more analysts cease coverage of our company, we could lose visibility in the market. In addition, one or more of these analysts could downgrade our Class A common stock or issue other negative commentary about our company or our industry. As a result of one or more of these factors, the trading price of our Class A common stock could decline.
We cannot assure our stockholders that our share repurchase program will enhance long-term stockholder value. Share repurchases, if any, could increase the volatility of the price of our Class A common stock and could increase our debt.
In November 2015, our board of directors authorized a share repurchase program. Under the program, we are authorized to repurchase shares of our Class A common stock in open market or privately negotiated transactions for an aggregate purchase price not to exceed $25 million. As of
December 31, 2016
, approximately
$13.2 million
remains available for repurchases under the current repurchase program. Although the board of directors has authorized a share repurchase program, the share repurchase program does not obligate the Company to repurchase any specific dollar amount or to acquire any specific number of shares. The existence of a share repurchase program could cause our stock price to be higher than it would be in the absence of such a program and could potentially reduce the market liquidity for our stock. The timing and actual number of shares repurchased, if any, will depend on a variety of factors including market and business conditions, the trading price of the Company's Class A common stock, the nature of other investment or strategic opportunities, the rate of dilution of our equity compensation program, the availability of adequate funds, and other factors.
Any repurchases of our Class A common stock pursuant to our share repurchase program could affect our stock price and increase its volatility. Additionally, repurchases under our share repurchase program may increase our debt, which could impact our ability to pursue possible future strategic opportunities and acquisitions and could result in lower overall returns on our cash balances. There can be no assurance that any share repurchases will enhance stockholder value because the market price of our Class A common stock may decline below the levels at which we repurchased shares of stock. Although our share repurchase program is intended to enhance long-term stockholder value, short-term stock price fluctuations could reduce the program’s effectiveness. The repurchase program may in the future be limited, suspended or discontinued at any time without prior notice and any such limitation, suspension or discontinuation could cause the market price of our Class A common stock to decline. There can be no assurance that we will repurchase shares of our Class A common stock under our share repurchase program or that any future repurchases will have a positive impact on the trading price of our Class A common stock or earnings per share.
Delaware law and certain provisions in our Certificate of Incorporation may prevent efforts by our stockholders to change the direction or management of our Company.
We are a Delaware corporation, and the anti-takeover provisions of Delaware law impose various impediments to the ability of a third party to acquire control of us, even if a change of control would be beneficial to our existing stockholders. In addition, our Amended and Restated Certificate of Incorporation and our Amended and Restated By-laws contain provisions that may make the acquisition of our company more difficult without the approval of our board of directors, including, but not limited to, the following:
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our board of directors is classified into three classes, each of which serves for a staggered three year term;
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only our board of directors may call special meetings of our stockholders;
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we have authorized undesignated preferred stock, the terms of which may be established and shares of which may be issued as authorized by our board of directors without stockholder approval;
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our stockholders have only limited rights to amend our by-laws; and
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we require advance notice and duration of ownership requirements for stockholder proposals.
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These provisions could discourage, delay or prevent a transaction involving a change in control of our company. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and cause us to take other corporate actions you desire. In addition, because our board of directors is responsible
for appointing the members of our management team, these provisions could in turn affect any attempt by our stockholders to replace current members of our management team.
For as long as we are an emerging growth company, we will not be required to comply with certain reporting requirements, including those relating to accounting standards and disclosure about our executive compensation, that apply to other public companies.
We are an "emerging growth company," as defined in Section 2(a) of the Securities Act of 1933, as amended ("Securities Act"), as modified by the Jumpstart our Business Startups Act of 2012 (the "JOBS Act"). As such, we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not "emerging growth companies," including, but not limited to, (i) not being required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act"), (ii) reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and (iii) exemptions from the requirements of holding a non-binding advisory vote on executive compensation and of stockholder approval of any golden parachute payments not previously approved. We have elected to adopt these reduced disclosure requirements. We cannot predict if investors will find our Class A common stock less attractive as a result of our taking advantage of these exemptions and as a result, there may be a less active trading market for our Class A common stock and our stock price may be more volatile.
In addition, Section 107 of the JOBS Act also provides that an "emerging growth company" can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an "emerging growth company" can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We intend to take advantage of the benefits of this extended transition period. As a result, our financial statements may not be comparable to companies that comply with public company effective dates.
We could remain an "emerging growth company" through December 31, 2019 or until the earliest of (a) the last day of the first fiscal year in which our annual gross revenues exceed $1 billion, (b) the date that we become a "large accelerated filer" as defined in Rule 12b-2 under the Exchange Act, which would occur if the market value of our common stock that is held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter and (c) the date on which we have issued more than $1 billion in non-convertible debt securities during the preceding three-year period.
The obligations associated with being a public company require significant resources and management attention, which may divert from our business operations.
We are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended ("Exchange Act") and the Sarbanes-Oxley Act. The Exchange Act requires that we file annual, quarterly and current reports with respect to our business and financial condition. The Sarbanes-Oxley Act requires, among other things, that we establish and maintain effective internal controls and procedures for financial reporting. As a result, we incur significant legal, accounting and other expenses that we did not previously incur as a private company.
In addition, the need to maintain the corporate infrastructure demanded of a public company may divert management's attention from implementing our business strategy, which could prevent us from improving our business, results of operations and financial condition. We have made, and will continue to make, changes to our internal controls, including information technology controls, and procedures for financial reporting and accounting systems to meet our reporting obligations as a public company. However, the measures we take may not be sufficient to satisfy our obligations as a public company. If we do not continue to develop and implement the right processes and tools to manage our changing enterprise and maintain our culture, our ability to compete successfully and achieve our business objectives could be impaired, which could negatively impact our business, financial condition and results of operations. We anticipate that these costs will materially increase our general and administrative expenses.
Furthermore, as a public company, we incur additional legal, accounting and other expenses that have not been reflected in our predecessor's historical financial statements. In addition, rules implemented by the SEC and the NYSE have imposed various requirements on public companies, including establishment and maintenance of effective disclosure and financial controls and certain corporate governance practices. Our management and other personnel have devoted, and will continue to devote a substantial amount of time to these compliance initiatives. These rules and regulations result in our incurring legal and financial compliance costs and will make some activities more time-consuming and costly. As a result, it may be more difficult for us to attract and retain qualified people to serve on our board of directors, our board committees or as executive officers.
Our failure to achieve and maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act as a public company could have a material adverse effect on our business and share price.
Prior to our initial public offering, we had not operated as a public company and were not required to independently comply with Section 404(a) of the Sarbanes-Oxley Act. Section 404(a) of the Sarbanes-Oxley Act requires annual management
assessments of the effectiveness of our internal control over financial reporting, starting with the second annual report that we file with the SEC. We were required to meet these standards in the course of preparing our financial statements as of and for the year ended December 31, 2015, and our management was required to report on the effectiveness of our internal control over financial reporting for such year. Additionally, once we are no longer an emerging growth company, as defined by the JOBS Act, our independent registered public accounting firm will be required pursuant to Section 404(b) of the Sarbanes-Oxley Act to attest to the effectiveness of our internal control over financial reporting on an annual basis. The rules governing the standards that must be met for our management to assess our internal control over financial reporting are complex and require significant documentation, testing and possible remediation.
Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with US GAAP. We are currently in the process of reviewing, documenting and testing our internal control over financial reporting. We may encounter problems or delays in implementing any changes necessary to make a favorable assessment of our internal control over financial reporting. In addition, we may encounter problems or delays in completing the implementation of any requested improvements and receiving a favorable attestation in connection with the attestation to be provided by our independent registered public accounting firm after we cease to be an emerging growth company. If we cannot favorably assess the effectiveness of our internal control over financial reporting, or if our independent registered public accounting firm is unable to provide an unqualified attestation report on our internal controls after we cease to be an emerging growth company, investors could lose confidence in our financial information and the price of our Class A common stock could decline.
Additionally, the existence of any material weakness or significant deficiency may require management to devote significant time and incur significant expense to remediate any such material weaknesses or significant deficiencies and management may not be able to remediate any such material weaknesses or significant deficiencies in a timely manner. The existence of any material weakness in our internal control over financial reporting could also result in errors in our financial statements that could require us to restate our financial statements, cause us to fail to meet our reporting obligations and cause stockholders to lose confidence in our reported financial information, all of which could materially and adversely affect our business and share price.