UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
For the quarterly period ended March 31, 2004
For the transition period from to
Commission File No. 1-14387
United Rentals, Inc.
Commission File No. 1-13663
United Rentals (North America), Inc.
(Exact names of registrants as specified in their charters)
Five Greenwich Office Park,
Greenwich, Connecticut
(203) 622-3131
(Registrants’ telephone number, including area code)
Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. x Yes ¨ No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). x Yes ¨ No
As of May 6, 2004, there were 77,143,306 shares of the United Rentals, Inc. common stock, $.01 par value, outstanding. There is no market for the common stock of United Rentals (North America), Inc., all outstanding shares of which are owned by United Rentals, Inc.
This combined Form 10-Q is separately filed by (i) United Rentals, Inc. and (ii) United Rentals (North America), Inc. (which is a wholly owned subsidiary of United Rentals, Inc.). United Rentals (North America), Inc. meets the conditions set forth in general instruction H(1) (a) and (b) of Form 10-Q and is therefore filing this form with the reduced disclosure format permitted by such instruction.
UNITED RENTALS, INC.
UNITED RENTALS (NORTH AMERICA), INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
INDEX
PART I
Item 1
United Rentals, Inc. Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003 (unaudited)
United Rentals, Inc. Consolidated Statements of Operations for the Three Months Ended March 31, 2004 and 2003 (unaudited)
United Rentals, Inc. Consolidated Statement of Stockholders’ Equity for the Three Months Ended March 31, 2004 (unaudited)
United Rentals, Inc. Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003 (unaudited)
United Rentals (North America), Inc. Consolidated Balance Sheets as of March 31, 2004 and December 31, 2003 (unaudited)
United Rentals (North America), Inc. Consolidated Statements of Operations for the Three Months Ended March 31, 2004 and 2003 (unaudited)
United Rentals (North America), Inc. Consolidated Statement of Stockholder’s Equity for the Three Months Ended March 31, 2004 (unaudited)
United Rentals (North America), Inc. Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003 (unaudited)
Notes to Unaudited Consolidated Financial Statements
Item 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3
Quantitative and Qualitative Disclosures about Market Risk
Item 4
Controls and Procedures
Legal Proceedings
Item 6
Exhibits and Reports on Form 8-K
Signatures
Certain statements contained in this Report are forward-looking in nature. Such statements can be identified by the use of forward-looking terminology such as “believe,” “expect,” “may,” “will,” “should,” “seek,” “on-track,” “plan,” “intend” or “anticipate,” or the negative thereof or comparable terminology, or by discussions of strategy. You are cautioned that our business and operations are subject to a variety of risks and uncertainties and, consequently, our actual results may materially differ from those projected by any forward-looking statements. Certain of these factors are discussed in Item 2 of Part I of this Report under the caption “—Factors that May Influence Future Results and Results Anticipated by Forward-Looking Statements.” We make no commitment to revise or update any forward-looking statements in order to reflect events or circumstances after the date any such statement is made.
We make available on our internet website free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to such reports as soon as practicable after we electronically file such reports with the SEC. Our website address is www.unitedrentals.com. The information contained in our website is not incorporated by reference in this Report.
UNITED RENTALS
United Rentals is the largest equipment rental company in North America. We offer for rent over 600 types of equipment—everything from heavy machines to hand tools—through our network of more than 730 rental locations in the United States, Canada and Mexico. We currently serve approximately 1.9 million customers including construction and industrial companies, manufacturers, utilities, municipalities, homeowners and others.
Our fleet of rental equipment, the largest in the world, includes over 500,000 units having an original purchase price of approximately $3.7 billion. The fleet includes:
In addition to renting equipment, we sell used rental equipment, act as a dealer for new equipment and sell related merchandise, parts and service.
Industry Background
Based on industry sources, we estimate that the U.S. equipment rental industry has grown from approximately $6.6 billion in annual rental revenues in 1990 to about $23.5 billion in 2003. This represents a compound annual growth rate of approximately 10.3%, although in the past two years industry rental revenues decreased by about $1.3 billion. The recent downturn in industry revenues is a reflection of the significant slowdown in private non-residential construction activity. This activity declined 2% in the first quarter of 2004 from the same quarter last year, 5.2% in 2003 and 13.2% in 2002 according to Department of Commerce data. Our industry is particularly sensitive to changes in non-residential construction activity because to date the principal end market for rental equipment has been non-residential construction. When non-residential construction activity eventually rebounds, we would expect to see our industry resume its long-term growth trend.
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We believe that long-term industry growth, in addition to reflecting general economic expansion, is being driven by an end-user market that increasingly recognizes the many advantages of renting equipment rather than owning. Customers recognize that by renting they can:
While the construction industry has to date been the principal user of rental equipment, industrial companies, utilities and others are increasingly using rental equipment for plant maintenance, plant turnarounds and other operations requiring the periodic use of equipment. We believe that over the long term, increasing rentals by the industrial sector could become a more significant factor in driving our industry’s growth.
Competitive Advantages
We believe that we benefit from the following competitive advantages:
Large and Diverse Rental Fleet. Our rental fleet is the largest and most comprehensive in the industry, which allows us to:
Significant Purchasing Power. We purchase large amounts of equipment, merchandise and other items, which enables us to negotiate favorable pricing, warranty and other terms with our vendors.
Operating Efficiencies. We benefit from the following operating efficiencies:
Equipment Sharing Among Branches. We generally group our branches into clusters of 10 to 30 locations that are in the same geographic area. Each branch within a cluster can access all available equipment in the cluster area. This increases equipment utilization because equipment that is idle at one branch can be marketed and rented through other branches. In the first quarter of 2004, the sharing of equipment among branches accounted for approximately 10.4%, or $49 million, of our total rental revenue.
Ability to Transfer Equipment Among Branches. The size of our branch network gives us the ability to take advantage of strength at a particular branch or in a particular region by permanently transferring underutilized equipment from weaker to stronger areas.
Consolidation of Common Functions. We reduce costs through the consolidation of functions that are common to our more than 730 branches, such as payroll, accounts payable, benefits and risk management, information technology and credit and collection.
State-of-the-Art Information Technology Systems. We have state-of-the-art information technology systems that facilitate our ability to make rapid and informed decisions, respond quickly to changing market conditions, and share equipment among branches. We have an in-house team of information technology specialists that supports our systems.
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Strong Brand Recognition. We have strong brand recognition, which helps us to attract new customers and build customer loyalty.
Geographic and Customer Diversity. We have more than 730 branches in 47 states, seven Canadian provinces and Mexico and serve customers that range from Fortune 500 companies to small companies and homeowners. In 2003, we served more than 1.9 million customers and our top ten customers accounted for less than 3% of our revenues. We believe that our geographic and customer diversity provide us with many advantages including: (1) enabling us to better serve National Account customers with multiple locations, (2) helping us achieve favorable resale prices by allowing us to access used equipment resale markets across the country, (3) reducing our dependence on any particular customer and (4) reducing the impact that fluctuations in regional economic conditions have on our overall financial performance.
National Account Program. Our National Account sales force is dedicated to establishing and expanding relationships with large companies, particularly those with a national or multi-regional presence. We offer our National Account customers the benefits of a consistent level of service across North America, a wide selection of equipment and a single point of contact for all their equipment needs. We currently serve more than 1,700 National Account customers.
Strong and Motivated Branch Management. Each of our branches has a full-time branch manager who is supervised by a district manager from one of our 58 districts and a vice president from one of our nine regions. We believe that our managers are among the most knowledgeable and experienced in the industry, and we empower them—within budgetary guidelines—to make day-to-day decisions concerning branch matters. Senior management closely tracks branch, district and regional performance with extensive systems and controls, including performance benchmarks and detailed monthly operating reviews. The compensation of branch managers and certain other branch personnel is linked to their branch’s financial performance and return on assets. This incentivizes branch personnel to control costs, optimize pricing, share equipment with other branches and manage their fleet efficiently.
Risk Management and Safety Programs. We believe that we have one of the most comprehensive risk management and safety programs in the industry. Our risk management department is staffed by experienced professionals and is responsible for implementing our safety programs and procedures, developing our employee and customer training programs and managing any claims against us.
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CONSOLIDATED BALANCE SHEETS
(Unaudited)
Cash and cash equivalents
Accounts receivable, net of allowance for doubtful accounts of $48,930 in 2004 and $47,439 in 2003
Inventory
Prepaid expenses and other assets
Rental equipment, net
Property and equipment, net
Goodwill, net
Other intangible assets, net
Liabilities:
Accounts payable
Debt
Subordinated convertible debentures
Deferred taxes
Accrued expenses and other liabilities
Total liabilities
Commitments and contingencies
Stockholders’ equity:
Preferred stock—$.01 par value, 5,000,000 shares authorized:
Series C perpetual convertible preferred stock—$300,000 liquidation preference, 300,000 shares issued and outstanding
Series D perpetual convertible preferred stock—$150,000 liquidation preference, 150,000 shares issued and outstanding
Common stock—$.01 par value, 500,000,000 shares authorized, 77,349,461 shares issued and outstanding in 2004 and 77,150,277 in 2003
Additional paid-in capital
Deferred compensation
Accumulated deficit
Accumulated other comprehensive income
Total stockholders’ equity
See accompanying notes.
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CONSOLIDATED STATEMENTS OF OPERATIONS
Revenues:
Equipment rentals
Sales of rental equipment
Sales of equipment and contractor supplies and other revenues
Total revenues
Cost of revenues:
Cost of equipment rentals, excluding depreciation
Depreciation of rental equipment
Cost of rental equipment sales
Cost of equipment and contractor supplies sales and other operating costs
Total cost of revenues
Gross profit
Selling, general and administrative expenses
Non-rental depreciation and amortization
Operating income
Interest expense
Interest expense—subordinated convertible debentures
Preferred dividends of a subsidiary trust
Other (income) expense, net
Loss before benefit for income taxes
Benefit for income taxes
Net loss
Loss per share:
Basic and diluted
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CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Balance, December 31, 2003
Comprehensive income (loss):
Other comprehensive income (loss):
Foreign currency translation adjustments
Comprehensive loss:
Exercise of common stock options and warrants
Amortization of deferred compensation
Balance March 31, 2004
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Cash Flows From Operating Activities:
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization
Gain on sales of rental equipment
Repurchase premiums for debt refinancing
Changes in operating assets and liabilities:
Accounts receivable
Net cash provided by operating activities
Cash Flows From Investing Activities:
Purchases of rental equipment
Purchases of property and equipment
Proceeds from sales of rental equipment
Deposits on rental equipment purchases
Purchases of other companies
Net cash used in investing activities
Cash Flows From Financing Activities:
Proceeds from debt
Payments of debt
Payments of financing costs
Proceeds from the exercise of common stock options and warrants
Net cash provided by financing activities
Effect of foreign exchange rates
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental disclosure of cash flow information:
Cash paid for interest
Cash paid for income taxes, net of refunds
Supplemental disclosure of non-cash investing and financing activities:
The Company acquired the net assets and assumed certain liabilities of other companies as follows:
Assets, net of cash acquired
Liabilities assumed
Due to seller and other payments
Net cash paid
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(In thousands,
except share data)
ASSETS
LIABILITIES AND STOCKHOLDER’S EQUITY
Stockholder’s equity:
Common stock—$.01 par value, 3,000 shares authorized, 1,000 shares issued and outstanding
Total stockholder’s equity
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Cost of equipment and contractor supplies and other operating costs
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CONSOLIDATED STATEMENT OF STOCKHOLDER’S EQUITY
Comprehensive loss
Contributed capital from parent
Dividend distributions to parent
Balance, March 31, 2004
10
Three Months Ended
March 31
Capital contributions by parent
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
1. Basis of Presentation
General
United Rentals, Inc., (“Holdings” or the “Company”) is principally a holding company and conducts its operations primarily through its wholly owned subsidiary United Rentals (North America), Inc. (“URI”) and subsidiaries of URI. Separate footnote information is not presented for the financial statements of URI and subsidiaries as that information is substantially equivalent to that presented below. Earnings per share data is not provided for the operating results of URI and its subsidiaries as they are wholly owned subsidiaries of Holdings.
The Consolidated Financial Statements of the Company included herein are unaudited and, in the opinion of management, such financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the results of the interim periods presented. Interim financial statements do not require all disclosures normally presented in year-end financial statements, and, accordingly, certain disclosures have been omitted. Results of operations for the three month period ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. The Consolidated Financial Statements included herein should be read in conjunction with the Company’s Consolidated Financial Statements and related Notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
Stock-Based Compensation
The Company accounts for its stock-based compensation arrangements using the intrinsic value method under the provisions of Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”. At March 31, 2004, the Company had six stock-based compensation plans. Since stock options are granted by the Company with exercise prices at or greater than the fair value of the shares at the date of grant, no compensation expense is recognized. Restricted stock awards granted by the Company are recognized as deferred compensation. The Company recognizes compensation expense related to these restricted stock awards over their vesting periods. The following table provides additional information related to the Company’s stock-based compensation arrangements for the three months ended March 31, 2004 and 2003 (in thousands, except per share data):
Net loss, as reported
Plus: Stock-based compensation expense included in reported net loss, net of tax
Less: Stock-based compensation expense determined using the fair value method, net of tax
Pro forma net loss
Basic loss per share:
As reported
Pro forma
Diluted loss per share:
The weighted average fair value of options granted was $7.77 and $4.36 during the three months ended March 31, 2004 and 2003, respectively. The fair value is estimated on the date of grant using the Black-Scholes option pricing model which uses subjective assumptions which can materially affect fair value estimates and, therefore, does not necessarily provide a single measure of fair value of options. The Company used a risk-free
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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
interest rate average of 1.99% and 1.93% in 2004 and 2003, respectively, a volatility factor for the market price of the Company’s common stock of 62% and 65% in 2004 and 2003, respectively, and a weighted-average expected life of options of approximately three years in 2004 and 2003. For purposes of these pro forma disclosures, the estimated fair value of options is amortized over the options’ vesting period. Since the number of options granted and their fair value may vary significantly from year to year, the pro forma compensation expense in future years may be materially different.
Impact of Recently Issued Accounting Standards
In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”, revised December 2003), “Consolidation of Variable Interest Entities,” which addresses consolidation of variable interest entities (“VIEs”). FIN 46 requires a VIE to be consolidated by a parent company if that company is subject to the majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. A VIE is a corporation, partnership, trust or any other legal structure used for business purposes that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities. The consolidation requirements of FIN 46 apply immediately to VIEs created after January 31, 2003. For entities created prior to February 1, 2003 the effective date of these requirements, which originally was July 1, 2003, was deferred so as not to apply until the first period ending after December 15, 2003. Upon adoption of this standard, as of December 31, 2003, the Company deconsolidated a subsidiary trust that had issued trust preferred securities. As a result of such deconsolidation (i) the trust preferred securities issued by the Company’s subsidiary trust, which had previously been reflected on the Company’s consolidated balance sheets, were removed from its consolidated balance sheets at December 31, 2003, (ii) the subordinated convertible debentures that the Company issued to the subsidiary trust, which previously had been eliminated in the Company’s consolidated balance sheets, were no longer eliminated in its consolidated balance sheets as of December 31, 2003 and (iii) commencing January 1, 2004, the interest on the subordinated convertible debentures is reflected as an expense on our consolidated statement of operations instead of the dividends on the trust preferred securities. The carrying amount of the trust preferred securities removed from the consolidated balance sheets was the same as the carrying amount of the subordinated convertible debentures added to the consolidated balance sheets. However, the subordinated convertible debentures are reflected as a component of liabilities on the consolidated balance sheets at December 31, 2003, whereas the trust preferred securities were reflected as a separate category prior to December 31, 2003. The adoption of this standard did not otherwise have a material effect on the Company’s statements of financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”. This standard amends and clarifies financial accounting and reporting for derivative instruments and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. This standard is effective for contracts entered into or modified after June 30, 2003, except as stated below and for hedging relationships designated after June 30, 2003. The provisions of this standard that relate to SFAS No. 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. The adoption of this standard regarding the provisions effective after June 30, 2003 did not have a material effect on the Company’s statements of financial position or operations.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This standard requires that financial instruments falling within the scope of this standard be classified as liabilities. This standard is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective with the first interim period beginning after June 15, 2003. The adoption of this standard did not have a material effect on the Company’s statements of financial position or results of operations.
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2. Acquisitions
During each of the three months ended March 31, 2004 and the year ended December 31, 2003, the Company completed one acquisition that was accounted for as a purchase. The results of operations of the businesses acquired in these acquisitions have been included in the Company’s results of operations from their respective acquisition dates.
In February 2004, the Company acquired 843504 Alberta Ltd. (formerly known as Skyreach Equipment, Ltd.) with annual revenues of approximately $40 million for approximately $60 million.
The purchase prices for acquisitions accounted for as purchases have been allocated to the assets acquired and liabilities assumed based on their respective fair values at their respective acquisition dates. Purchase price allocations are subject to change when additional information concerning asset and liability valuations are completed. The preliminary purchase price allocations that are subject to change primarily consist of rental and non-rental equipment valuations. These allocations are finalized within 12 months of the acquisition date and are not expected to result in significant differences between the preliminary and final allocations.
The following table summarizes, on an unaudited pro forma basis, the results of operations of the Company for the three months ended March 31, 2004 and 2003 as though each acquisition which was consummated during the period January 1, 2003 to March 31, 2004 as mentioned above and in Note 3 to the Notes to Consolidated Financial Statements included in the Company’s 2003 Annual Report on Form 10-K was made on January 1, 2003 (in thousands, except per share data):
Revenues
Basic loss per share
Diluted loss per share
The unaudited pro forma results are based upon certain assumptions and estimates which are subject to change. These results are not necessarily indicative of the actual results of operations that might have occurred, nor are they necessarily indicative of expected results in the future.
3. Goodwill and Other Intangible Assets
Changes in the Company’s carrying amount of goodwill for the first three months of 2004 are as follows (in thousands):
Balance at December 31, 2003
Goodwill related to acquisitions
Foreign currency translation and other adjustments
Balance at March 31, 2004
In accordance with SFAS No. 142, goodwill, which was previously amortized over 40 years, is no longer amortized. The Company’s approximately $2.6 million of other intangible assets will continue to be amortized over their estimated useful lives. The Company is required to periodically review its goodwill for impairment. In general this means that the Company must determine whether the fair value of the goodwill, calculated in accordance with applicable accounting standards, is at least equal to the recorded value shown on its balance sheet. If the fair value of the goodwill is less than the recorded value, the Company is required to write off the excess goodwill as expense.
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The Company is generally required to review its goodwill for impairment annually. However, if events or circumstances suggest that its goodwill could be impaired, impairment testing may be required before the scheduled annual impairment test. The next scheduled annual impairment test will be as of October 1, 2004.
The Company assesses impairment solely on the basis of recent historical performance and without reference to expected future performance. This means that, if the historical data for a reporting unit indicates impairment, a goodwill write-off is required even when the Company believes that reporting unit’s future performance will be significantly better. The fact that the Company tests for impairment using only historical financial data increases the likelihood that the Company will be required to take additional non-cash goodwill write-offs in the future, although it cannot quantify at this time the magnitude of any future write-offs.
Other intangible assets consist of non-compete agreements and are amortized over periods ranging from three to eight years. The cost of other intangible assets and the related accumulated amortization as of March 31, 2004 were $18.4 million and $15.8 million, respectively. Amortization expense of other intangible assets was $1.2 million for the first three months of 2004 and $0.9 million for the first three months of 2003.
As of March 31, 2004, estimated amortization expense of other intangible assets for the remainder of 2004 and for each of the next five years is as follows (in thousands):
Remainder of 2004
2005
2006
2007
2008
2009
4. Restructuring Charges
The Company adopted a restructuring plan in 2001 and a second restructuring plan in 2002 as described below. In connection with these plans, the Company recorded restructuring charges of $28.9 million in 2001 (including a non-cash component of approximately $10.9 million) and $28.3 million in the fourth quarter of 2002 (including a non-cash component of approximately $2.5 million).
The 2001 plan involved the following principal elements: (i) 31 underperforming branches were closed or consolidated with other locations, (ii) five administrative offices were closed or consolidated with other locations; (iii) the reduction of the Company’s workforce by 489 through the termination of branch and administrative personnel and (iv) certain information technology hardware and software was no longer used.
The 2002 plan involved the following key elements: (i) 40 underperforming branches and five administrative offices were closed or consolidated with other locations; (ii) reduction of the Company’s workforce by 412 through the termination of branch and administrative personnel, and (iii) a certain information technology project was abandoned.
The costs to vacate facilities primarily represent the payment of obligations under leases offset by estimated sublease opportunities, the write-off of capital improvements made to such facilities and the write-off of related
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goodwill (only in 2001). The workforce reduction costs primarily represent severance. The information technology costs represent the payment of obligations under equipment leases relating to the abandonment of certain information technology projects.
The aggregate balance of the 2001 and 2002 charges was $15.9 million as of March 31, 2004 consisting of $0.7 million for the 2001 charge and $15.2 million for the 2002 charge. The Company estimates that approximately $5.4 million of the aggregate amount will be incurred by December 31, 2004 and approximately $10.5 million will be paid in future periods.
Components of the restructuring charges are as follows (in thousands):
BalanceDecember 31,
2003
BalanceMarch 31,
2004
Costs to vacate facilities
Workforce reduction costs
Information technology costs
5. Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):
Numerator:
Loss
Denominator:
Denominator for basic and diluted earnings per share-weighted-average shares
Loss per share—basic
Loss per share—diluted
The diluted share base for the first three months of 2004 and 2003, where the numerator represents a loss, excludes incremental weighted shares for the effect of dilutive securities due to their antidilutive effect.
6. Comprehensive Income
The following table sets forth the Company’s comprehensive income (loss) (in thousands):
Foreign currency translation adjustment
Derivatives qualifying as hedges, net of tax
Comprehensive income (loss)
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7. Segment Information
Beginning in the first quarter of 2004, the Company has two operating segments: general rentals and traffic control. The general rentals segment includes the rental of construction, aerial, industrial and homeowner equipment and related services and activities. The general rentals segment’s customers include construction and industrial companies, manufacturers, utilities, municipalities and homeowners. The general rentals segment operates throughout the United States, Canada and Mexico. The traffic control segment includes the rental of equipment for controlling traffic and related services and activities. The traffic control segment’s customers include construction companies involved in infrastructure projects and municipalities. The traffic control segment operates in the United States. In the tables below, the Company has restated its segment information for prior periods to reflect the change in operating segments. The new segments align the Company’s external segment reporting to how management evaluates and allocates resources and provide more transparent disclosure to the Company’s investors. The Company evaluates segment performance based on segment operating income. The change in segments was attributable to a change in the role of the chief operating decision maker as defined in accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”.
The accounting policies of the Company’s segments are the same as those described in the summary of significant accounting policies in note 2 to the Company’s 2003 Annual Report on Form 10-K. Certain corporate costs, including those related to selling, finance, legal, risk management, human resources, corporate management and information technology systems, are deemed to be of an operating nature and are allocated to each of the operating segments.
The following table sets forth financial information by operating segment (in thousands):
Total Revenues
General rentals
Traffic control
Total Depreciation and Amortization Expense
Total depreciation and amortization expense
Segment Operating Income (Loss)
Segment operating income
Total Capital Expenditures
Total capital expenditures
Total Assets
Total assets
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The following table sets forth a reconciliation between segment operating income and loss before income taxes (in thousands):
Vesting of restricted shares granted in 2001 (included in selling, general and administrative expenses)
8. Financing Transactions
Debt consists of the following:
Credit Facility, interest payable at a weighted average rate of 4.6% at March 31,2004 and 5.3% at December 31, 2003
Term Loan, interest payable at 3.4% and at 4.2% at March 31,2004 and December 31, 2003, respectively
6½% Senior Notes, interest payable semi-annually
7% Senior Subordinated Notes, interest payable semi-annually
9¼% Senior Subordinated Notes, interest payable semi-annually
9% Senior Subordinated Notes, interest payable semi-annually
7¾% Senior Subordinated Notes, interest payable semi-annually
10¾% Senior Notes, interest payable semi-annually
1 7/8% Convertible Senior Subordinated Notes, interest payable semi-annually
Other debt, including capital leases, due through 2009
The Company refinanced approximately $2.1 billion of its debt in 2004. As part of this refinancing, the Company:
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The refinancing described above was completed during the first quarter of 2004, except that (i) the redemption of the 9% Notes was completed on April 1, 2004 and (ii) a portion of the term loan that is part of the new senior secured credit facility was drawn on April 1, 2004.
In connection with the refinancings in the first quarter of 2004, the Company incurred aggregate pre-tax charges of approximately $161 million in the first quarter and expects to incur additional charges of approximately $11 million in the second quarter. These charges are attributable primarily to (i) the redemption and tender premiums for notes redeemed or repurchased as part of the refinancing and (ii) the write-off of previously capitalized costs relating to the debt refinanced. These charges were recorded in other (income) expense, net.
7% Senior Subordinated Notes. In January 2004, as part of the refinancing in 2004 described above, URI issued $375 million aggregate principal amount of 7% Senior Subordinated Notes (the “7% Notes”) which are due February 15, 2014. The net proceeds from the sale of the 7% Notes were approximately $369 million (after deducting the initial purchasers’ discount and offering expenses). The 7% Notes are unsecured and are guaranteed by Holdings and, subject to limited exceptions, URI’s domestic subsidiaries. The 7% Notes mature on February 15, 2014 and may be redeemed by URI on or after February 15, 2009, at specified redemption prices that range from 103.5% in 2009 to 100.0% in 2012 and thereafter. In addition, on or prior to February 15, 2007, URI may, at its option, use the proceeds of a public equity offering to redeem up to 35% of the outstanding 7% Notes at a redemption price of 107.0%. The indenture governing the 7% Notes contains certain restrictive covenants, including limitations on (i) additional indebtedness, (ii) restricted payments, (iii) liens, (iv) dividends and other payments, (v) preferred stock of certain subsidiaries, (vi) transactions with affiliates, (vii) the disposition of proceeds of asset sales and (viii) the Company’s ability to consolidate, merge or sell all or substantially all of its assets.
6 1/2% Senior Notes. In February 2004, as part of the refinancing in 2004 described above, URI issued $1 billion aggregate principal amount of 6 1/2% Senior Notes (the “6 1/2% Notes”) which are due February 15, 2012. The net proceeds from the sale of the 6 1/2% Notes were approximately $984 million (after deducting the initial purchasers’ discount and offering expenses). The 6 1/2% Notes are unsecured and are guaranteed by Holdings and, subject to limited exceptions, URI’s domestic subsidiaries. The 6 1/2% Notes mature on February 15, 2012 and may be redeemed by URI on or after February 15, 2008, at specified redemption prices that range from 103.25% in 2008 to 100.0% in 2010 and thereafter. In addition, on or prior to February 15, 2007, URI may, at its option, use the proceeds of a public equity offering to redeem up to 35% of the outstanding 6 1/2% Notes at a redemption price of 106.5%. The indenture governing the 6 1/2% Notes contains certain restrictive covenants, including limitations on (i) additional indebtedness, (ii) restricted payments, (iii) liens, (iv) dividends and other payments, (v) preferred stock of certain subsidiaries, (vi) transactions with affiliates, (vii) the disposition of proceeds of asset sales, (viii) the Company’s ability to consolidate, merge or sell all or substantially all of its assets and (ix) sale-leaseback transactions.
New Credit Facility. In the first quarter of 2004, as part of the refinancing in 2004 described above, the Company obtained a new senior secured credit facility. The new facility includes (i) a $650 million revolving credit facility, (ii) a $150 million institutional letter of credit facility and (iii) a $750 million term loan. The revolving credit facility, institutional letter of credit facility and term loan are governed by the same credit agreement. Set forth below is certain additional information concerning the revolving credit facility, institutional letter of credit facility and term loan.
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Revolving Credit Facility. The revolving credit facility enables URI to borrow up to $650 million on a revolving basis and enables certain of the Company’s Canadian subsidiaries to borrow up to $150 million (provided that the aggregate borrowings of URI and the Canadian subsidiaries may not exceed $650 million). A portion of the revolving credit facility, up to $250 million, is available in the form of letters of credit. The revolving credit facility is scheduled to mature and terminate in February 2009. As of March 31, 2004, the outstanding borrowings under this facility was approximately $94 million and the face amount of undrawn letters of credit obtained under this facility was approximately $44 million.
Institutional Letter of Credit Facility (“ILCF”). The ILCF provides for up to $150 million in letters of credit. The ILCF is in addition to the letter of credit capacity under the revolving credit facility. The total combined letter of credit capacity under the revolving credit facility and the ILCF is $400 million. Subject to certain conditions, all or part of the ILCF may be converted into term loans. The ILCF is scheduled to terminate in February 2011.
Term Loan. The term loan was obtained in two draws. An initial draw of $550 million was obtained upon the closing of the credit facility in February 2004 and an additional $200 million was obtained on April 1, 2004. Amounts repaid in respect of the term loan may not be reborrowed.
The term loan must be repaid in installments as follows: (i) during the period from and including June 30, 2004 to and including March 31, 2010, URI must repay on each March 31, June 30, September 30 and December 31 of each year an amount equal to one-fourth of 1% of the original aggregate principal amount of the term loan and (ii) URI must repay on each of June 30, 2010, September 30, 2010, December 31, 2010, and February 14, 2011 an amount equal to 23.5% of the original aggregate principal amount of the term loan.
Interest. Borrowings by URI under the revolving credit facility accrue interest, at URI’s option, at either (A) the ABR rate (which is equal to the greater of (i) the Federal Funds Rate plus 0.5% and (ii) JPMorgan Chase Bank’s prime rate) plus a margin of 1.25%, or (B) an adjusted LIBOR rate plus a margin of 2.25%. The above interest rate margins are adjusted quarterly based on the Company’s Funded Debt to Cash Flow Ratio, up to the maximum margins described in the preceding sentence and down to minimum margins of 0.75% and 1.75% for revolving loans based on the ABR rate and the adjusted LIBOR rate, respectively.
Canadian dollar borrowings under the revolving credit facility accrue interest, at the borrower’s option, at either (A) the Canadian prime rate (which is equal to the greater of (i) the CDOR rate plus 1% and (ii) JPMorgan Chase Bank, Toronto Branch’s prime rate) plus a margin of 1.25%, or (B) the B/A rate (which is equal to JPMorgan Chase Bank, Toronto Branch’s B/A rate) plus a margin of 2.25%. These above interest rate margins are adjusted quarterly based on the Company’s Funded Debt to Cash Flow Ratio, up to the maximum margins described in the preceding sentence and down to minimum margins of 0.75% and 1.75% for revolving loans based on the Canadian prime rate and the B/A rate, respectively.
URI is also required to pay the lenders a commitment fee equal to 0.5% per annum in respect of undrawn commitments under the revolving credit facility.
Borrowings under the term loan accrue interest, at URI’s option, at either (a) the ABR rate (which is equal to the greater of (i) the Federal Funds Rate plus 0.5% and (ii) JPMorgan Chase Bank’s prime rate) plus a margin of 1.25%, or (b) an adjusted LIBOR rate plus a margin of 2.25% (which margins may be reduced to 1.00% and 2.00%, respectively, for certain periods based on our Funded Debt to Cash Flow Ratio).
If at any time an event of default under the credit agreement exists, the interest rate applicable to each revolving loan and term loan will be based on the highest margins described above plus 2%. URI is required to
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pay a fee which accrues at the rate of 0.10% per annum on the amount of the ILCF. In addition, URI is required to pay participation fees and fronting fees in respect of letters of credit. For letters of credit obtained under the ILCF, these fees accrue at the rate of 2.25% and 0.25% per annum, respectively.
Covenants. Under the agreement governing the Company’s senior secured credit facility, the Company is required to, among other things, satisfy certain financial tests relating to: (a) interest coverage ratio, (b) the ratio of funded debt to cash flow, (c) the ratio of senior secured debt to tangible assets and (d) the ratio of senior secured debt to cash flow. If the Company is unable to satisfy any of these covenants, the lenders could elect to terminate the credit facility and require the Company to repay the outstanding borrowings under the credit facility. The Company is also subject to various other covenants under the agreements governing its credit facility and other indebtedness. These covenants limit or prohibit, among other things, the Company’s ability to incur indebtedness, make prepayments of certain indebtedness, pay dividends, make investments, create liens, make acquisitions, sell assets and engage in mergers and acquisitions.
Interest Rate Swap Agreements. As of March 31, 2004, the Company had swap agreements with an aggregate notional amount of $1,345 million. The effect of these agreements was to convert $1,345 million of the Company’s fixed rate notes to floating rate instruments. The fixed rate notes converted consist of: (i) $445 million of our 6 1/2% senior notes through 2012, (ii) $525 million of our 7 3/4% senior subordinated notes through 2013 and (iii) $375 million of our 7% senior subordinated notes through 2014. The Company’s swap agreements that convert its fixed rate notes to floating rate instruments are designated as fair value hedges. Changes in the fair values of the Company’s fair value hedges, as well as the offsetting fair value changes in the hedged items, are recorded on the statement of operations. There was no ineffectiveness related to the Company’s hedges.
9. Restricted Stock and Operating Leases
Restricted Stock
The Company has granted to employees other than executive officers and directors approximately 900,000 shares of restricted stock that contain the following provisions. The shares vest in 2005, 2006 or 2007 or earlier upon a change in control of the Company, death, disability, retirement or certain terminations of employment, and are subject to forfeiture prior to vesting on certain other terminations of employment, the violation of non-compete provisions and certain other events. If a holder of restricted stock sells his stock and receives sales proceeds that are less than a specified guaranteed amount set forth in the grant instrument, the Company has agreed to pay the holder the shortfall between the amount received and such specified amount. However, the foregoing only applies to sales that are made within five trading days of the vesting date. The specified guaranteed amount is (i) $27.26 per share with respect to approximately 300,000 shares scheduled to vest in 2005, (ii) $9.18 per share with respect to approximately 400,000 shares scheduled to vest in 2006 and (iii) $17.20 per share with respect to approximately 200,000 shares scheduled to vest in 2007.
Operating Leases
As part of certain of its equipment operating leases, the Company guarantees that the value of the equipment at the end of the lease term will not be less than a specified projected residual value. The use of these guarantees helps to lower the Company’s monthly operating lease payments. The Company does not know at this time the extent to which the actual residual values may be less than the guaranteed residual values and, accordingly, cannot quantify the amount that it will be required to pay, if any, under these guarantees. If the actual residual value for all equipment subject to such guarantees were to be zero, then the Company’s maximum potential liability under these guarantees would be approximately $39.2 million. In accordance with FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” this potential liability was not reflected on the Company’s balance sheet as of March 31, 2004, or any prior date because the leases associated with such guarantees were entered into prior to January 1, 2003.
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10. Condensed Consolidating Financial Information of Guarantor Subsidiaries
URI, a wholly owned subsidiary of Holdings (the “Parent”), has outstanding (i) certain indebtedness that is guaranteed by the Parent and (ii) certain indebtedness that is guaranteed by both Parent and substantially all of URI’s United States subsidiaries (the “guarantor subsidiaries”). However, this indebtedness is not guaranteed by URI’s foreign subsidiaries (the “non-guarantor subsidiaries”) and certain of its United States subsidiaries. The guarantor subsidiaries are all 100%-owned and the guarantees are made on a joint and several basis and are full and unconditional (subject to subordination provisions and subject to a standard limitation which provides that the maximum amount guaranteed by each guarantor will not exceed the maximum amount that can be guaranteed without making the guarantee void under fraudulent conveyance laws). Separate consolidated financial statements of the guarantor subsidiaries have not been presented because management believes that such information would not be material to investors. However, condensed consolidating financial information as of March 31, 2004 and December 31, 2003, and for each of the three month periods ended March 31, 2004 and 2003, are presented. The condensed consolidating financial information of the Company and its subsidiaries are as follows:
CONDENSED CONSOLIDATING BALANCE SHEET
March 31, 2004
Accounts receivable, net
Intercompany receivable (payable)
Investment in subsidiaries
Intangible assets, net
Preferred stock
Common stock
(Accumulated deficit) retained earnings
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December 31, 2003
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CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Cost of equipment and contractor suppliessales and other operating costs
Operating income (loss)
Income (loss) before benefit for income taxes
Income (loss) before equity in net loss of subsidiaries
Equity in net loss of subsidiaries
Net income (loss)
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Income (loss) before provision (benefit) for income taxes
Provision (benefit) for income taxes
Income (loss) before equity in net earnings of subsidiaries
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CONDENSED CONSOLIDATING CASH FLOW INFORMATION
Net cash provided by (used in) operating activities
Cash flows from investing activities:
Capital contributed to subsidiary
Cash flows from financing activities:
Proceeds from dividends from subsidiary
Net cash provided by (used in) financing activities
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion reviews our operations for the three months ended March 31, 2004 and 2003 and should be read in conjunction with the unaudited consolidated financial statements and related notes included herein and the consolidated financial statements and related notes included in our 2003 Annual Report on Form 10-K.
United Rentals is the largest equipment rental company in North America. Our revenues are divided into three categories:
Our cost of operations consists primarily of: (i) depreciation costs relating to the rental equipment that we own and lease payments for the rental equipment that we hold under operating leases, (ii) the cost of repairing and maintaining rental equipment, (iii) the cost of the items that we sell including new and used equipment and related parts, merchandise and supplies and (iv) personnel costs, occupancy costs and supply costs.
We record rental equipment expenditures at cost and depreciate equipment using the straight-line method over the estimated useful life (which ranges from two to ten years), after giving effect to an estimated salvage value of 0% to 10% of cost.
Selling, general and administrative expenses primarily include sales commissions and salaries, bad debt expense, advertising and marketing expenses, management salaries, and clerical and administrative overhead.
Non-rental depreciation and amortization includes (i) depreciation expense associated with equipment that is not offered for rent (such as vehicles, computers and office equipment) and amortization expense associated with leasehold improvements, (ii) the amortization of deferred financing costs and (iii) the amortization of other intangible assets. Our other intangible assets consist of non-compete agreements.
We completed acquisitions in each of 2004 and 2003. See note 2 to our notes to unaudited consolidated financial statements included elsewhere in this Report. In view of the fact that our operating results for these years were affected by acquisitions, we believe that our results for these periods are not directly comparable.
Goodwill and Other Intangible Assets
Pursuant to an accounting standard adopted in 2002, we no longer amortize goodwill. Instead, we are required to periodically review our goodwill for impairment. In general, this means that we must determine whether the fair value of the goodwill, calculated in accordance with applicable accounting standards, is at least equal to the recorded value shown on our balance sheet. If the fair value of the goodwill is less than the recorded value, we are required to write off the excess goodwill as an expense. Our other intangible assets continue to be amortized over their estimated useful lives.
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We are generally required to review our goodwill for impairment annually. However, if events or circumstances suggest that our goodwill could be impaired, then impairment testing may be required before the scheduled annual impairment test. Our next scheduled annual impairment test will be as of October 1, 2004. Over the past two years we have recorded significant goodwill write-offs, and we may require additional write-offs in the future. If we continue to see weakness in our end markets, the likelihood of possible additional write-offs would increase. Future goodwill write-offs, if required, may have a material adverse effect on our results.
Restructuring Plans in 2001 and 2002
We adopted a restructuring plan in April 2001 and a second restructuring plan in October 2002 as described below. In connection with these plans, we recorded a restructuring charge of $28.9 million in 2001 and $28.3 million in the fourth quarter of 2002.
The 2001 plan involved the following principal elements: (i) 31 underperforming branches and five administrative offices were closed or consolidated with other locations, (ii) the reduction of our workforce by 489 through the termination of branch and administrative personnel, and (iii) certain information technology hardware and software was no longer used.
The 2002 plan involved the following principal elements: (i) 40 underperforming branches and five administrative offices were closed or consolidated with other locations; (ii) the reduction of our workforce by 412 through the termination of branch and administrative personnel, and (iii) a certain information technology project was abandoned.
2003(1)
2004(3)
Costs to vacate facilities(4)
Workforce reduction costs(5)
Information technology costs(6)
As indicated in the table above, the aggregate balance of the 2001 and 2002 charges was $15.9 million as of March 31, 2004 consisting of $0.7 million for the 2001 charge and $15.2 million for the 2002 charge. We estimate that approximately $5.4 million of the remaining 2001 and 2002 charges will be paid by December 31, 2004 and approximately $10.5 million in future periods. These payments will not affect our future earnings because the charges associated with these payments have already been recorded in our 2001 or 2002 results. We expect to make these payments with cash from our operations.
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Charges Related to Debt Refinancings and Vesting of Restricted Stock
During 2004, we refinanced approximately $2.1 billion of our debt. See “—Liquidity and Capital Resources—Recent Financing Transactions.” In connection with the foregoing, we recorded aggregate pre-tax charges in the first quarter of $161.1 million ($95.2 million, net of tax) attributable primarily to (i) the redemption and tender premiums for notes redeemed and tendered as part of the refinancing and (ii) the write-off of previously capitalized costs relating to the debt refinanced. These charges were recorded in other (income) expense, net. We expect to incur additional charges of approximately $11.0 million during the second quarter in connection with the refinancing.
We incurred a pre-tax non-cash charge of $7.0 million ($5.5 million, net of tax) in the first quarter of 2004 due to the vesting of restricted shares granted to senior executives in 2001. This charge represents the remaining unamortized portion of the deferred compensation charge associated with the award of such shares.
Information Concerning Segments
We currently have two business segments: general rentals and traffic control. The general rentals segment includes all aspects of our business, other than the rental of traffic control equipment and related services and activities. That portion of our business forms the separate traffic control segment. Commencing with this Report on Form 10-Q, we will provide certain operating and other data concerning our segments. Data for periods prior to the first quarter of 2004 have been reclassified to conform to the current organization of our segments.
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The following table shows certain results of our segments for the three months ended March 31, 2004 and 2003 (in millions):
General Rentals Segment
Cost of revenues
Cost of equipment and contractor supplies sales and other operating expenses
Traffic Control Segment
Consolidated Results
General rentals segment operating income
Traffic control segment operating income (loss)
Vesting of restricted shares granted to executives in 2001(1)
Columns may not add due to rounding
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Discussion of Results
Generally Accepted Accounting Principles (“GAAP”) Results and Adjusted Results
Our results for the first three months of 2004 were impacted by (i) $161.1 million of charges ($95.2 million, net of tax) relating to a debt refinancing that we completed in the first quarter of 2004 and (ii) a $7.0 million charge ($5.5 million, net of tax) for the vesting of restricted stock granted to executives in 2001. Our operating income was also impacted by the charge related to the accelerated vesting of restricted stock. See “—Charges Related to Debt Refinancings and Vesting of Restricted Stock.”
The table below shows (i) our operating income and results in accordance with GAAP and (ii) our operating income and results adjusted to exclude the foregoing charges. We provide this adjusted data because we believe that this data may be useful to investors in analyzing the period-to-period changes in our results that are due to changes in business conditions.
Three MonthsEnded
Operating income (GAAP)
Vesting of restricted shares granted to executives in 2001
Operating income, as adjusted
Net loss (GAAP)
Refinancing costs, net of tax
Vesting of restricted shares granted to executives in 2001, net of tax
Net loss, as adjusted
Overview of Adjusted Results
Our revenues in the first three months of 2004 increased 8.9% to $644.7 million from $591.9 million in the first three months of 2003. This increase in revenues, partially offset by higher cost of revenues, caused gross profit in the first three months of 2004 to increase 6.6% to $164.1 million from $154.0 million in the first three months of 2003. These increases were entirely attributable to our general rentals segment. At our traffic control segment, both revenues and gross profit declined partially offsetting the increases at the general rentals segment.
The increase in revenues at our general rentals segment reflected the following:
Segment operating income at the general rentals segment increased to $53.7 million in the first three months of 2004 from $48.7 million in the first three months of 2003. This increase reflected the higher revenues and gross profit at this segment partially offset by higher selling, general and administrative expenses (“SG&A”). The increase in operating income at the general rentals segment was entirely offset by a widening of the loss at the traffic control segment due to lower revenues and, to a lesser extent, higher SG&A expense. The net effect was that total adjusted operating income in the first three months of 2004 was substantially the same as in the first three months of 2003—$39.9 million in the 2004 period versus $40.2 million in the 2003 period.
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Our total adjusted operating income excludes a charge described above relating to the vesting of restricted stock. After giving effect to this charge, we recorded operating income in accordance with GAAP of $32.9 million in the first three months of 2004 compared with $40.2 million in the first three months of 2003.
Our total interest expense decreased to $49.6 million in the first three months of 2004 from total interest expense and preferred dividends of a subsidiary trust of $54.7 million in the first three months of 2003. This decrease primarily reflected lower interest rates on our debt.
Our adjusted net loss for the first three months of 2004 was $5.9 million compared with a net loss of $8.7 million in the first three months of 2003. The decrease in the adjusted net loss in the 2004 period primarily reflected the lower interest expense.
The adjusted net loss excludes certain charges described above relating to debt refinancing and the vesting of restricted stock. After giving effect to these charges, we recorded a net loss in accordance with GAAP of $106.6 million in the first three months of 2004 compared with $8.7 million in the first three months of 2003.
Additional Information Concerning Results
Three Months Ended March 31, 2004 and 2003
1. General Rentals Segment Revenues. Our general rentals segment had total revenues of $599.3 million in the first three months of 2004, an increase of 11.2% compared with $538.8 million in the first three months of 2003. The revenues from this segment accounted for 93.0% of our total revenues in the first three months of 2004 and 91.0% during the first three months of 2003. The components of this segment’s revenues are discussed below.
A. Equipment Rentals. Revenues from equipment rentals at the general rentals segment were $427.5 million in the first three months of 2004, an increase of 7.6% compared with revenues of $397.4 million in the first three months of 2003. These revenues accounted for 71.3% of the segment’s total revenues in the first three months of 2004 compared with 73.8% in the same period last year. Rental rates for this segment increased 6.5% during the first three months of 2004 compared with the same period last year.
The increase in rental revenues at this segment during the first three months of 2004 principally reflected the following:
B. Sales of Rental Equipment. Revenues from the sale of rental equipment at the general rentals segment were $54.7 million in the first three months of 2004, representing a 55.8% increase from $35.1
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million in the first three months of 2003. These revenues accounted for 9.1% of the segment’s total revenues in the first three months of 2004 compared with 6.5% in the same period last year. The increase in these revenues in 2004 primarily reflected an increase in the volume of equipment sold. Used equipment prices were up slightly.
C. Sales of Equipment and Contractor Supplies and Other Revenues. Revenues from “sales of equipment and contractor supplies and other revenues” at the general rentals segment were $117.2 million in the first three months of 2004, representing a 10.3% increase from $106.3 million in the first three months of 2003. These revenues accounted for 19.6% of the segment’s total revenues in the first three months of 2004 compared with 19.7% in the same period last year. The increase in these revenues in 2004 principally reflected a 34% increase in contractor supplies sales.
2. Traffic Control Segment Revenues. Our traffic control segment had total revenues of $45.4 million in the first three months of 2004, representing a decrease of 14.5% from $53.1 million in the first three months of 2003. The revenues from this segment accounted for 7.0% of our total revenues in the first three months of 2004 and 9.0% during the first three months of 2003. The components of this segment’s revenues are discussed below.
A. Equipment Rentals. Revenues from equipment rentals at the traffic control segment were $39.8 million in the first three months of 2004, representing a decrease of 14.0% from $46.3 million in the first three months of 2003. These revenues accounted for 87.7% of the segment’s total revenues in the first three months of 2004 and 87.2% in the same period last year. The decrease in rental revenues at this segment principally reflected an 11.7% decrease in same store revenues and, to a lesser extent, the closing of branches.
B. Sales of Rental Equipment. Revenues from the sale of rental equipment at the traffic control segment were $0.7 million in the first three months of 2004 and $0 in the first three months of 2003. These revenues accounted for 1.5% of the segment’s total revenues in the first three months of 2004 compared with 0% in the same period last year.
C. Sales of Equipment and Contractor Supplies and Other Revenues. Revenues from “sales of equipment and contractor supplies and other revenues” at the traffic control segment were $4.9 million in the first three months of 2004, representing a 29.0% decrease from $6.9 million in the first three months of 2003. These revenues accounted for 10.8% of the segment’s total revenues in the first three months of 2004 and 13.0% in the same period last year. The decrease in these revenues in 2004 principally reflected a decrease in the traffic control segment’s sales of contractor supplies.
3. Total Consolidated Revenues. We had total revenues of $644.7 million in the first three months of 2004, an increase of 8.9% compared with total revenues of $591.9 million in the first three months of 2003. The increase reflected the higher revenues at our general rentals segment partially offset by the lower revenues at our traffic control segment. Dollar equipment utilization for the first quarter of 2004 was 49.6%, an increase of 3.0 percentage points from the first quarter of 2003.
Gross Profit
1. General Rentals Segment Gross Profit. Our general rentals segment had total gross profit of $165.9 million in the first three months of 2004, an increase of 9.6% compared with $151.4 million in the first three months of 2003. This increase reflected the increase in revenues described above partially offset by the decrease in gross profit margin described below from equipment rental and sales of rental equipment. Information concerning gross profit margin of the general rentals segment by source of revenue is set forth below:
A. Equipment Rentals. The gross profit margin from equipment rental revenues was 27.1% in the first three months of 2004 and 27.9% in the first three months of 2003. The decrease in 2004 principally reflected cost increases which partially offset the increase in rental rates. The cost increases impacted several areas including repairs and maintenance, employee benefits and insurance.
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B. Sales of Rental Equipment. The gross profit margin from the sale of rental equipment was 32.3% in the first three months of 2004 and 33.7% in the first three months of 2003. The decrease in 2004 primarily reflected a shift in mix to the sale of more under-utilized and relatively older equipment in the 2004 period.
C. Sales of Equipment and Contractor Supplies and Other Revenues. The gross profit margin from “sales of equipment and contractor supplies and other revenues” was 27.7% in the first three months of 2004 and 27.1% in the first three months of 2003. The increase in gross profit margin in 2004 primarily reflected increased margins from the sale of contractor supplies.
2. Traffic Control Segment Gross Profit (Loss). Our traffic control segment had a gross loss of $1.9 million in the first three months of 2004 compared with a gross profit $2.6 million in the first three months of 2003. The gross loss in the first three months of 2004 primarily reflected the decrease in revenues from equipment rentals during the 2004 period. Although costs also decreased during the period, the decrease in costs was less than the decrease in revenues.
3. Total Consolidated Gross Profit. We had total gross profit of $164.1 million in the first three months of 2004, representing an increase of 6.6% from $154.0 million in the first three months of 2003. The increase reflected the higher gross profit at our general rentals segment partially offset by the gross loss at our traffic control segment.
Selling, General and Administrative Expense
1. General Rentals Segment SG&A. SG&A at our general rentals segment was $96.1 million, or 16.0% of total segment revenues, during the first three months of 2004 and $86.2 million, or 16.0% of total revenues, during the first three months of 2003. The increase in the dollar amount of SG&A in the 2004 period primarily reflected higher costs related to selling commissions.
2. Traffic Control Segment SG&A. SG&A at our traffic control segment was $11.6 million, or 25.6% of total segment revenues, during the first three months of 2004 and $10.6 million, or 20.0% of total revenues, during the first three months of 2003. The increase in the dollar amount of SG&A in the 2004 period primarily reflected higher bad debt expense. The increase in SG&A as a percentage of revenues during the 2004 period primarily reflected the foregoing and the reduction in revenues described above.
3. Total Consolidated SG&A. Total SG&A expense was $114.8 million, or 17.8% of total revenues, during the first three months of 2004 and $96.8 million, or 16.4% of total revenues, during the first three months of 2003. The increase in SG&A as a percentage of revenues in the first three months of 2004 was primarily attributable to a $7.0 million charge for the vesting of restricted stock granted to executives in 2001. This charge has not been allocated to either of our segments.
Excluding the aforementioned charge, SG&A would have been $107.8 million, or 16.7% of total revenues, in the first three months of 2004 compared with $96.8 million, or 16.4% of total revenues, during the first three months of 2003. The increase in the dollar amount of SG&A, excluding the aforementioned charge, in the 2004 period reflected higher SG&A expenses at both of our segments as described above. The increase in SG&A, excluding the aforementioned charge, as a percentage of revenues during the 2004 period primarily reflected the decrease in revenues at our traffic control segment as described above.
Non-rental Depreciation and Amortization
1. General Rentals Segment Non-rental Depreciation and Amortization. Non-rental depreciation and amortization for the general rentals segment was $16.2 million, or 2.7% of total segment revenues, in the first three months of 2004 and $16.6 million, or 3.1% of total segment revenues, in the first three months of 2003. The decrease in such expense as percentage of revenues primarily reflected the increase in revenues described above.
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2. Traffic Control Segment Non-rental Depreciation and Amortization. Non-rental depreciation and amortization for the traffic control segment was $0.3 million in the first three months of 2004 and $0.4 million in the first three months of 2003.
3. Total Consolidated Non-rental Depreciation and Amortization. Total non-rental depreciation and amortization was $16.4 million, or 2.5% of total revenues, in the first three months of 2004 and $17.0 million, or 2.9% of total revenues, in the first three months of 2003. The decrease in such expense as percentage of revenues primarily reflected the increase in revenues described above.
Interest Expense
Interest expense was $45.9 million in the first three months of 2004 and $51.0 million in the first three months of 2003. The decrease in interest expense was attributable to lower interest rates on our debt.
Interest Expense—Subordinated Convertible Debentures and Preferred Dividends of a Subsidiary Trust
In August 1998, a subsidiary trust of United Rentals, Inc. (“Holdings”) sold certain trust preferred securities and used the proceeds from such sale to purchase certain convertible subordinated debentures from Holdings. See “—Certain Information Concerning Trust Preferred Securities.” The subsidiary trust that issued the trust preferred securities was consolidated with Holdings until December 31, 2003, when it was deconsolidated following the adoption of a new accounting principle. See “—Impact of Recently Issued Accounting Standards.”
For periods prior to the deconsolidation, the dividends on the trust preferred securities was reflected as an expense on our consolidated statement of operations and the interest on the subordinated convertible debentures was eliminated in consolidation and thus was not reflected as an expense on our consolidated statement of operations. For periods after the deconsolidation, the dividends on the trust preferred securities is no longer reflected as an expense on our consolidated statement of operations and the interest on the subordinated convertible debentures is no longer eliminated in consolidation and thus is now reflected as an expense on our consolidated statement of operations. Because the interest on the subordinated convertible debentures corresponds to the dividends on the trust preferred securities, this change does not alter the total amount of expense required to be recorded.
The expense recorded in connection with the foregoing securities was $3.6 million in the first three months of 2004 and $3.7 million in the first three months of 2004. The expense in the 2004 period is recorded on the statement of operations as “Interest Expense—Subordinated Convertible Debentures” and the expense in the 2003 period is recorded as “Preferred Dividends of a Subsidiary Trust.” The decrease in the first three months of 2004 was attributable to the repurchase of a portion of the trust preferred securities after the first three months of 2003.
Other (Income) Expense
Other expense was $160.9 million in the first three months of 2004 compared with other income of $0.1 million in the first three months of 2003. The other expense in the first three months of 2004 was primarily attributable to the charges related to debt refinancings described under “—Charges Related to Debt Refinancings and Vesting of Restricted Stock.” Excluding these charges, we would have had other income of $0.2 million.
Benefit for Income Taxes
Income taxes were a benefit of $71.0 million, or an effective rate of 40%, in the first three months of 2004 and a benefit of $5.6 million, or an effective rate of 39%, in the first three months of 2003. Excluding the effects on our 2004 results of (i) the vesting of restricted stock granted to executives in 2001 and (ii) the refinancing charges, discussed above, we would have had an effective rate of 38.3% in the first three months of 2004.
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Liquidity and Capital Resources
Recent Financing Transactions
We recently refinanced approximately $2.1 billion of our debt. This refinancing was completed in the first quarter of 2004, except as described below. The purpose of this refinancing was to reduce our interest expense and extend the maturities on a substantial amount of our debt. As part of this refinancing, we:
The refinancing described above was completed during the first quarter of 2004, except that (i) the redemption of the 9% Senior Subordinated Notes Due 2009 was completed on April 1, 2004 and (ii) a portion of the term loan that is part of the new senior secured credit facility was drawn on April 1, 2004.
The table below shows our debt at March 31, 2004, as adjusted to give effect to those elements of the refinancing that were completed on April 1, 2004.
Revolving credit facility
Term loan
Receivables securitization
6 1/2% Senior notes
7% Senior subordinated notes
7 3/4% Senior subordinated notes
1 7/8% Convertible senior subordinated notes
10 3/4% Senior notes
Other debt
Total debt
For further information concerning our debt see note 8 to our notes to unaudited consolidated financial statements included elsewhere herein and note 9 to our notes to consolidated financial statements included in our 2003 Annual Report on Form 10-K.
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Sources and Uses of Cash
During the first three months of 2004, we (i) generated cash from operations of $202.5 million, (ii) generated cash from the sale of rental equipment of $55.4 million and (iii) obtained cash from borrowings, net of repayments, of approximately $51.5 million. We used cash during this period principally to (i) pay consideration for acquisitions of $60.7 million, (ii) purchase rental equipment of $152.5 million, (iii) purchase other property and equipment of $18.7 million and (iv) pay financing costs of $33.7 million. Our overall cash increased during the first three months of 2004 by approximately $47.7 million.
Cash Requirements Related to Operations
Our principal existing sources of cash are cash generated from operations and from the sale of rental equipment and borrowings available under our revolving credit facility and receivables securitization facility. As of April 29, 2004, we had $514.0 million of borrowing capacity available under our $650 million revolving credit facility (reflecting outstanding loans of approximately $93.8 million and outstanding letters of credit in the amount of approximately $42.2 million). We believe that our existing sources of cash will be sufficient to support our existing operations over the next twelve months.
We expect that our principal needs for cash relating to our existing operations over the next twelve months will be to fund (i) operating activities and working capital, (ii) the purchase of rental equipment and inventory items offered for sale, (iii) payments due under operating leases, (iv) debt service, and (v) costs relating to our restructuring plans. We plan to fund such cash requirements relating to our existing operations from our existing sources of cash described above. In addition, we may seek additional financing through the securitization of some of our equipment or through the use of additional operating leases. For information on the scheduled principal payments coming due on our outstanding debt and on the payments coming due under our existing operating leases, see “—Certain Information Concerning Contractual Obligations.”
Our capital expenditures for the first quarter of 2004 amounted to $171 million. These expenditures are comprised of (i) approximately $152 million of expenditures for the purchase of rental equipment and (ii) $19 million of expenditures for the purchase of property and equipment. Our capital expenditures in future periods will depend on a number of factors, including general economic conditions and growth prospects. Based on current conditions, we estimate that capital expenditures for the balance of 2004 will be approximately $405 million to $530 million for our existing operations. These expenditures are comprised of approximately: (i) $375 million to $500 million of expenditures for the purchase of rental equipment and (ii) $30 million of expenditures for the purchase of property and equipment. We expect that we will fund such expenditures from proceeds from the sale of used equipment, cash generated from operations and, if required, borrowings available under our revolving credit facility and receivables securitization facility.
While emphasizing internal growth, we may also continue to expand through a disciplined acquisition program. We will consider potential transactions of varying sizes and may, on a selective basis, pursue acquisition or consolidation opportunities involving other public companies or large privately-held companies. We expect to pay for future acquisitions using cash, capital stock, notes and/or assumption of indebtedness. To the extent that our existing sources of cash described above are not sufficient to fund such future acquisitions, we will require additional debt or equity financing and, consequently, our indebtedness may increase or the ownership of existing stockholders may be diluted as we implement our growth strategy.
Certain Information Concerning Contractual Obligations
The table below provides certain information concerning the payments coming due under certain categories of our existing contractual obligations. The information is as of March 31, 2004, as adjusted to give effect to certain transactions relating to our recent refinancing that were completed on April 1, 2004 as described under “—Liquidity and Capital Resources—Recent Financing Transactions.”
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Debt excluding capital leases(1)
Capital leases (1)
Operating leases(1):
Real estate
Rental equipment
Other equipment
Purchase obligations
Other long-term liabilities reflected on balance sheet in accordance with GAAP(2)
Total
Certain Information Concerning Related Party
We have from time to time purchased equipment from Terex Corporation (“Terex”) and expect to do so in the future. The chief executive officer and a director of Terex is also a director of our company. We purchased equipment from Terex of approximately $17 million during the first three months of 2004.
Certain Information Concerning Off-Balance Sheet Arrangements
Restricted Stock. We have granted to employees other than executive officers and directors approximately 900,000 shares of restricted stock that contain the following provisions. The shares vest in 2005, 2006 or 2007 or earlier upon a change in control of the Company, death, disability, retirement or certain terminations of employment, and are subject to forfeiture prior to vesting on certain other terminations of employment, the violation of non-compete provisions and certain other events. If a holder of restricted stock sells his stock and receives sales proceeds that are less than a specified guaranteed amount set forth in the grant instrument, we have agreed to pay the holder the shortfall between the amount received and such specified amount. However, the foregoing only applies to sales that are made within five trading days of the vesting date. The specified guaranteed amount is (i) $27.26 per share with respect to approximately 300,000 shares scheduled to vest in 2005, (ii) $9.18 per share with respect to approximately 400,000 shares scheduled to vest in 2006, and (iii) $17.20 per share with respect to approximately 200,000 shares scheduled to vest in 2007.
Operating Leases. We lease real estate, rental equipment and non-rental equipment under operating leases as a regular business activity. As part of many of our equipment operating leases, we guarantee that the value of the equipment at the end of the term will not be less than a specified projected residual value. The use of these guarantees helps to lower our monthly operating lease payments. We do not know at this time the extent to which the actual residual values may be less than the guaranteed residual values and, accordingly, cannot quantify the amount that we ultimately will be required to pay, if any, under these guarantees. However, under current circumstances we do not anticipate paying significant amounts under these guarantees in the future. If the actual residual value for all equipment subject to such guarantees were to be zero, then our maximum potential liability under these guarantees would be approximately $39.2 million. In accordance with FIN 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” this potential liability was not reflected on our balance sheet as of March 31, 2004 or any prior date because the leases associated with such guarantees were entered into prior to January 1, 2003. For additional information concerning lease payment obligations under our operating leases, see “—Certain Information Concerning Contractual Obligations” above.
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Certain Information Concerning Trust Preferred Securities
In August 1998, a subsidiary trust of United Rentals, Inc. (“Holdings”) sold six million shares of 6 1/2% Convertible Quarterly Income Preferred Securities (“trust preferred securities”) for aggregate consideration of $300 million. The trust used the proceeds from the sale of these securities to purchase 6 1/2% subordinated convertible debentures due 2028 from Holdings which resulted in Holdings receiving all of the net proceeds of the sale. The subsidiary trust that issued the trust preferred securities was consolidated with Holdings until December 31, 2003, when it was deconsolidated following the adoption of a new accounting principle. See “—Impact of Recently Issued Accounting Standards.”
Relationship Between Holdings and URI
Holdings is principally a holding company and primarily conducts its operations through its wholly owned subsidiary United Rentals (North America), Inc. (“URI”) and subsidiaries of URI. Holdings provides certain services to URI in connection with its operations. These services principally include: (i) senior management services, (ii) finance and tax related services and support, (iii) information technology systems and support, (iv) acquisition related services, (v) legal services, and (vi) human resource support. In addition, Holdings leases certain equipment and real property that are made available for use by URI and its subsidiaries. URI has made, and expects to continue to make, certain payments to Holdings in respect of the services provided by Holdings to URI. The expenses relating to URI’s payments to Holdings are reflected on URI’s financial statements as selling, general and administrative expenses. In addition, although not legally obligated to do so, URI has in the past made, and expects that it will in the future make, distributions to Holdings to, among other things, enable Holdings to pay interest on the convertible debentures that were issued to a subsidiary trust of Holdings as described above.
As discussed above, our consolidated financial statements reflect (i) for periods prior to January 1, 2004, expenses related to dividends on certain trust preferred securities issued by a subsidiary trust of Holdings and (ii) for periods after January 1, 2004, expenses related to certain subordinated convertible debentures issued by Holdings to such subsidiary trust. However, the foregoing expenses are not reflected on the consolidated financial statements of URI because URI is not obligated with respect to the foregoing securities. This is the principal reason for the difference in the historical net income (loss) reported on the consolidated financial statements of URI and the net income (loss) reported on the consolidated financial statements of Holdings.
Seasonality
Our business is seasonal with demand for our rental equipment tending to be lower in the winter months. The seasonality of our business is heightened because we offer for rent traffic control equipment. Branches that rent a significant amount of this type of equipment tend to generate most of their revenues and profits in the second and third quarters of the year, slow down during the fourth quarter and operate at a loss during the first quarter.
Inflation
Although we cannot accurately anticipate the effect of inflation on our operations, we believe that inflation, has not had, and is not likely in the foreseeable future to have, a material impact on our results of operations. However, as described above, cost increases have, from time to time, impacted our results.
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In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”, revised December 2003), “Consolidation of Variable Interest Entities,” which addresses consolidation of variable interest entities (“VIEs”). FIN 46 requires a VIE to be consolidated by a parent company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both. A VIE is a corporation, partnership, trust or any other legal structure used for business purposes that either does not have equity investors with voting rights or has equity investors that do not provide sufficient financial resources for the entity to support its activities. The consolidation requirements of FIN 46 apply immediately to VIEs created after January 31, 2003. For entities created prior to February 1, 2003, the effective date of these requirements, which originally was July 1, 2003, was deferred so as not to apply until the first period ending after December 15, 2003. Upon adoption of this standard, as of December 31, 2003, we deconsolidated a subsidiary trust that had issued trust preferred securities as described above. As a result of such deconsolidation, (i) the trust preferred securities issued by our subsidiary trust, which had previously been reflected on our consolidated balance sheets, were removed from our consolidated balance sheets at December 31, 2003, (ii) the subordinated convertible debentures that we issued to the subsidiary trust, which previously had been eliminated in our consolidated balance sheets, were no longer eliminated in our consolidated balance sheets at December 31, 2003 and (iii) commencing January 1, 2004, the interest on the subordinated convertible debentures is reflected as an expense on our consolidated statement of operations instead of the dividends on the trust preferred securities. The carrying amount of the trust preferred securities removed from the consolidated balance sheets was the same as the carrying amount of the subordinated convertible debentures added to the consolidated balance sheets. However, the subordinated convertible debentures are reflected as a component of liabilities on the consolidated balance sheets at December 31, 2003, whereas the trust preferred securities were reflected as a separate category prior to December 31, 2003. The adoption of this standard did not otherwise have a material effect on our statements of financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”. This standard amends and clarifies financial accounting and reporting for derivative instruments and for hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”. This standard is effective for contracts entered into or modified after June 30, 2003, except as stated below, and for hedging relationships designated after June 30, 2003. The provisions of this standard that relate to SFAS No. 133 Implementation Issues that have been effective for fiscal quarters that began prior to June 15, 2003, should continue to be applied in accordance with their respective effective dates. The adoption of this standard regarding the provisions effective after June 30, 2003 did not have a material effect on our statements of financial position or operations.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. This standard requires that financial instruments falling within the scope of this standard be classified as liabilities. This standard is effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective with the first interim period beginning after June 15, 2003. The adoption of this standard did not have a material effect on our statements of financial position or results of operations.
Factors that May Influence Future Results and Accuracy of Forward-Looking Statements
Sensitivity to Changes in Construction and Industrial Activities
Our general rental equipment is principally used in connection with construction and industrial activities and our traffic control equipment is principally used in connection with the construction or repair of roads and bridges and similar infrastructure projects. Weakness in our end markets, such as a decline in construction or industrial activity or a reduction in infrastructure projects, may lead to a decrease in the demand for our equipment or the prices that we can charge. Any such decrease could adversely affect our operating results by
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decreasing revenues and gross profit margins. For example, there have been significant declines in non-residential construction activity in 2002 and 2003 and reductions in government spending on infrastructure projects in several key states. This weakness in our end markets adversely affected our results in 2002, 2003 and in the first quarter of 2004.
We have identified below certain factors that may cause further weakness in our end markets, either temporarily or long-term:
Fluctuations of Operating Results
We expect that our revenues and operating results may fluctuate from quarter to quarter or over the longer term due to a number of factors. These factors include:
Substantial Goodwill
At March 31, 2004, we had on our balance sheet net goodwill in the amount of $1,465 million, which represented approximately 30% of our total assets at such date. This goodwill is an intangible asset and represents the excess of the purchase price that we paid for acquired businesses over the estimated fair value of the net assets of those businesses. We are required to test our goodwill for impairment at least annually. In general, this means that we must determine whether the fair value of the goodwill, calculated in accordance with applicable accounting standards, is at least equal to the recorded value shown on our balance sheet. If the fair value of the goodwill is less than the recorded value, we are required to write off the excess goodwill as an expense. Any write-off would reduce our total assets and shareholders’ equity and be a charge against income.
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We assess impairment solely on the basis of recent historical performance and without reference to expected future performance. This means that, if the historical data for a reporting unit indicates impairment, a goodwill write-off is required even when we believe that reporting unit’s future performance will be significantly better. The fact that we test for impairment using only historical financial data increases the likelihood that we will be required to take additional non-cash goodwill write-offs in the future.
Substantial Indebtedness
At March 31, 2004, our total indebtedness was approximately $3,227.8 million, which includes $221.6 million in subordinated convertible debentures. Our substantial indebtedness has the potential to affect us adversely in a number of ways. For example, it will or could:
Furthermore, if we are unable to service our indebtedness and fund our business, we will be forced to adopt an alternative strategy that may include:
Even if we adopt an alternative strategy, the strategy may not be successful and we may continue to be unable to service our indebtedness and fund our business.
A portion of our indebtedness bears interest at variable rates that are linked to changing market interest rates. As a result, an increase in market interest rates would increase our interest expense and our debt service obligations. At March 31, 2004, as adjusted to give effect to the completion of our approximately $2.1 billion debt refinancing as described under “—Liquidity and Capital Resources—Recent Financing Transactions,” and taking into account our interest rate swap agreements, we had $2,188.9 million of variable rate indebtedness.
Need to Satisfy Financial and Other Covenants in Debt Agreements
Under the agreement governing our senior secured credit facility, we are required to, among other things, satisfy certain financial tests relating to: (a) the interest coverage ratio, (b) the ratio of funded debt to cash flow, (c) the ratio of senior secured debt to tangible assets and (d) the ratio of senior secured debt to cash flow. If we are unable to satisfy any of these covenants, the lenders could elect to terminate the credit facility and require us to repay the outstanding borrowings under the credit facility. In such event, unless we are able to refinance the indebtedness coming due and replace the credit facility, we would likely not have sufficient liquidity for our business needs and be forced to adopt an alternative strategy as described above. Even if we adopt an alternative strategy, the strategy may not be successful and we may not have sufficient liquidity for our business.
We are also subject to various other covenants under the agreements governing our credit facility and other indebtedness. These covenants limit or prohibit, among other things, our ability to incur indebtedness, make prepayments of certain indebtedness, pay dividends, make investments, create liens, make acquisitions, sell assets and engage in mergers and acquisitions. These covenants could adversely affect our operating results by significantly limiting our operating and financial flexibility.
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Dependence on Additional Capital
If the cash that we generate from our business, together with cash that we may borrow under our credit facility, is not sufficient to fund our capital requirements, we will require additional debt and/or equity financing. However, we may not succeed in obtaining the requisite additional financing on terms that are satisfactory to us or at all. 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 of our business, including those relating to purchasing equipment, making acquisitions, opening new rental locations and refinancing existing indebtedness.
Certain Risks Relating to Acquisitions
We have grown in part through acquisitions and may continue to do so. We will consider potential acquisitions of varying sizes and may, on a selective basis, pursue acquisitions or consolidation opportunities involving other public companies or large privately-held companies. We expect to pay for future acquisitions using cash, capital stock, notes and/or assumption of indebtedness. To the extent that our existing sources of cash are not sufficient to fund future acquisitions, we will require additional debt or equity financing and, consequently, our indebtedness may increase as we implement our growth strategy. The making of acquisitions entails certain risks, including:
It is possible that we will not realize the expected benefits from our acquisitions or that our existing operations will be harmed as a result of acquisitions.
Dependence on Management
Our success is highly dependent on the experience and skills of our senior management team. If we lose the services of any member of this team and are unable to find a suitable replacement, we may not have the depth of senior management resources required to efficiently manage our business and execute our strategy. We do not maintain “key man” life insurance on the lives of members of senior management.
Competition
The equipment rental industry is highly fragmented and competitive. Our competitors primarily include small, independent businesses with one or two rental locations, regional competitors which operate in one or more states, public companies or divisions of public companies, and equipment vendors and dealers who both sell and rent equipment directly to customers. We may in the future encounter increased competition from our existing competitors or from new companies. Competitive pressures could adversely affect our revenues and operating results by decreasing our rental volumes or depressing the prices that we can charge.
Dependence on Information Technology Systems
Our information technology systems facilitate our ability to monitor and control our operations and adjust to changing market conditions. Any disruptions in these systems or the failure of these systems to operate as expected could, depending on the magnitude of the problem, adversely affect our operating results by limiting our capacity to effectively monitor and control our operations and adjust to changing market conditions.
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Liability and Insurance
We are exposed to various possible claims relating to our business. These possible claims include those relating to (1) personal injury or death caused by equipment rented or sold by us, (2) motor vehicle accidents involving our delivery and service personnel and (3) employment related claims. We carry a broad range of insurance for the protection of our assets and operations. However, such insurance may not fully protect us for a number of reasons, including:
If we are found liable for any significant claims that are not covered by insurance, our operating results could be adversely affected because our expenses related to claims would increase. It is possible that some or all of the insurance that is currently available to us will not be available in the future on economically reasonable terms or at all.
Environmental and Safety Regulations
Our operations are subject to numerous laws governing environmental protection and occupational health and safety matters. These laws regulate such issues as wastewater, stormwater, solid and hazardous wastes and materials, and air quality. Under these laws, we may be liable for, among other things, (1) the costs of investigating and remediating contamination at our sites as well as sites to which we sent hazardous wastes for disposal or treatment regardless of fault and (2) fines and penalties for non-compliance. Our operations generally do not raise significant environmental risks, but we use hazardous materials to clean and maintain equipment, and dispose of solid and hazardous waste and wastewater from equipment washing, and store and dispense petroleum products from underground and above-ground storage tanks located at certain of our locations.
Based on the conditions currently known to us, we do not believe that any pending or likely remediation and compliance costs will have a material adverse effect on our business. We cannot be certain, however, as to the potential financial impact on our business if new adverse environmental conditions are discovered or environmental and safety requirements become more stringent. If we are required to incur environmental compliance or remediation costs that are not currently anticipated by us, our operating results could be adversely affected depending on the magnitude of the cost.
Labor Matters
We have approximately 1,200 employees that are represented by unions and covered by collective bargaining agreements. If we should experience a prolonged labor dispute involving a significant number of our employees, our ability to serve our customers could be adversely affected. In addition, our labor costs could increase as a result of the settlement of actual or threatened labor disputes. Furthermore, union organizing efforts or related actions could negatively affect our relationships with employees or customers.
Operations Outside the United States
Our operations in Canada and Mexico are subject to the risks normally associated with international operations. These include (1) the need to convert currencies, which could result in a gain or loss depending on fluctuations in exchange rates, (2) the need to comply with foreign laws and (3) the possibility of political or economic instability in foreign countries.
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Item 3. Quantitative and Qualitative Disclosures about Market Risk
We periodically utilize interest rate swap agreements to manage our interest costs and exposure to changes in interest rates. At March 31, 2004, we had swap agreements with an aggregate notional amount of $1,345 million. The effect of these agreements was to convert $1,345 million of our fixed rate notes to floating rate instruments. The fixed rate notes being converted consisted of: (i) $445 million of our 6 1/2% senior notes through 2012, (ii) $375 million of our 7% senior subordinated notes through 2014, and (iii) $525 million of our 7 3/4% senior subordinated notes through 2013.
As of March 31, 2004, after giving effect to our interest rate swap agreements, we had an aggregate of $2,189 million of indebtedness that bears interest at variable rates. This debt includes, in addition to the $1,345 million of debt subject to the swap agreements described above, (i) all borrowings under our $650 million revolving credit facility ($94 million outstanding) and (ii) our term loan ($750 million outstanding). The weighted average interest rates applicable to our variable rate debt on March 31, 2004 were (i) 4.6% for the revolving credit facility (represents the Canadian rate since the amount outstanding was Canadian borrowings), (ii) 3.4% for the term loan and (iii) 3.9% for the debt subject to our swap agreements. As of March 31, 2004, based upon the amount of our variable rate debt outstanding, after giving effect to our interest rate swap agreements, our annual earnings would decrease by approximately $13.5 million for each one percentage point increase in the interest rates applicable to our variable rate debt. The amount of our variable rate indebtedness may fluctuate significantly as a result of changes in the amount of indebtedness outstanding under our revolving credit facility and receivables securitization facility from time to time. For additional information concerning the terms of our variable rate debt, see note 9 to our notes to consolidated financial statements included in our 2003 Annual Report on Form 10-K.
Market risk relating to changes in foreign currency exchanges rates were reported in Item 7A of our Annual Report on Form 10-K for the year ended December 31, 2003. There has been no material change in this market risk since the end of the fiscal year 2003.
Item 4. Controls and Procedures
An evaluation has been carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and the operation of our “disclosure controls and procedures” (as such term is defined in Rules 13a-14(c) under the Securities Exchange Act of 1934) as of March 31, 2004. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of March 31, 2004, the disclosure controls and procedures were reasonably designed and effective at the reasonable assurance level to ensure that (i) information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
In connection with the preparation and audit of our consolidated financial statements included in our 2003 Annual Report on Form 10-K, we became aware of certain weaknesses in our internal controls. We believe that these weaknesses did not affect the accuracy of our financial statements included in our Annual Report on Form 10-K. However, they represented a significant deficiency in our internal controls as of December 31, 2003. In order to correct this deficiency, we took the following actions: (i) reinforced compliance with existing processes and procedures relating to the financial statement close process and implemented additional processes and procedures relating thereto and (ii) expanded and enhanced the periodic review process by our company’s financial and accounting personnel. We believe that the foregoing actions fully corrected the deficiency.
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PART II OTHER INFORMATION
Item 1. Legal Proceedings
We and our subsidiaries are parties to various litigation matters involving ordinary and routine claims incidental to our business. Our ultimate legal and financial liability with respect to such pending litigation cannot be estimated with certainty but we believe, based on our examination of such matters, that such ultimate liability will not have a material adverse effect on our consolidated financial position or results of operations.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Description of Exhibit
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(b) Reports on Form 8-K:
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
John N. Milne
President and Chief Financial Officer
(Principal Financial Officer)
Joseph B. Sherk
Vice President, Corporate Controller
(Principal Accounting Officer)
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