ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition and results of operations together with our financial statements and the related notes appearing under Item 8 of this Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this annual report, including information with respect to our plans and strategy for our business and expected financial results, includes forward-looking statements that involve risks and uncertainties. You should review the "Information Regarding Forward-Looking Statements" in this Item 7 and "Risk Factors" presented under Item 1A for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis in this annual report.
A discussion of changes in our Financial Results and Cash Flow Comparisons from fiscal year 2020 to fiscal year 2021 has been omitted from this Form 10-K, but may be found in Item 7 of Part II of our Annual Report on Form 10-K for the fiscal year ended January 31, 2021, filed with the SEC on March 31, 2021.
BUSINESS DESCRIPTION
We own and operate a network of full service agricultural and construction equipment stores in the United States and Europe. Based upon information provided to us by CNH Industrial N.V. or its U.S. subsidiary CNH Industrial America, LLC, collectively referred to in this Form 10-K as CNH Industrial, we are the largest retail dealer of Case IH Agriculture equipment in the world, one of the largest retail dealers of Case Construction equipment in North America and one of the largest retail dealers of New Holland Agriculture and New Holland Construction equipment in the U.S. We operate our business through three reportable segments: Agriculture, Construction and International. Within each segment, we have four principal sources of revenue: new and used equipment sales, parts sales, service, and equipment rental and other activities.
The agricultural equipment we sell and service includes machinery and attachments for uses ranging from large-scale farming to home and garden use. The construction equipment we sell and service includes heavy construction machinery, light industrial machinery for commercial and residential construction, road and highway construction machinery, energy, and forestry operations equipment. We offer our customers a one-stop solution for their equipment needs through:
•new and used equipment sales;
•parts sales;
•equipment repair and maintenance services; and
•equipment rental and other activities.
The new equipment and parts we sell are supplied primarily by CNH Industrial. According to its public reports, CNH Industrial is a leading manufacturer and supplier of agricultural and construction equipment based on the number of units sold, primarily through the Case IH Agriculture, New Holland Agriculture, Case Construction and New Holland Construction brands. Sales of new CNH Industrial products accounted for approximately 73% of our new equipment revenue in fiscal 2022, with our single largest manufacturer other than CNH Industrial representing approximately 2% of our total new equipment sales in fiscal 2022. We acquire used equipment for resale primarily through trade-ins from our customers and in some cases through selective purchases. We sell parts and provide in-store and on-site repair and maintenance services. We rent equipment and provide other ancillary services such as equipment transportation, GPS signal subscriptions, farm data management systems, precision farming equipment, and finance and insurance products.
Throughout our 41-year operating history, we have built an extensive, geographically contiguous network of 74 stores located in the United States and 35 stores in Europe. We have a history of growth through acquisitions, including over 50 acquisitions in 11 U.S. states and four European countries since January 1, 2003. We believe that there will continue to be opportunities for dealership consolidation in the future, and we expect that acquisitions will continue to be a component of our long-term growth strategy.
Certain External Factors Affecting our Business
We are subject to a number of factors that affect our business including those factors discussed in the sections in this annual report entitled "Risk Factors" and "Information Regarding Forward-Looking Statements." Certain of these external factors include, but are not limited to, the following:
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Russia/Ukraine Geopolitical Conflict
As discussed in Risk Factors and Note 22, to the consolidated Financial Statements, our Ukrainian operations closed for a period of time. While some have reopened others may remain closed indefinitely or perhaps permanently. To the extent the conflict continues, our International revenues and profits will be adversely affected.
Impact of COVID-19 Pandemic on the Company
The outbreak and global spread of COVID-19, which was declared a pandemic by the World Health Organization and a national emergency by the President of the United States in March 2020, continues to have an impact on society, economies, financial markets, and businesses. While the Company's products and services were determined to be an essential business, the pandemic has had an impact on our business operations, existing employees and ability to find new employees, customers, and suppliers. Uncertainty remains regarding the magnitude and duration of the pandemic and the resulting financial effects and will depend on future developments including the efficacy of vaccines, the spread of COVID-19 variants, and the extent of governmental responses, including potential vaccine or testing mandates.
On November 5, 2021, the Department of Labor's Occupational Safety and Health Administration ("OSHA") announced an Emergency Temporary Standard ("ETS") requiring all employers with at least 100 employees to ensure their employees are fully vaccinated or require weekly testing of unvaccinated employees. On January 13, 2022, the US Supreme Court granted emergency relief to stay the implementation of the ETS and on January 26, 2022, OSHA withdrew the standard. Although OSHA withdrew the vaccination and testing ETS as an enforceable emergency temporary standard, the agency is not withdrawing the ETS as a proposed rule. The agency is prioritizing resources and is focusing on finalizing a permanent COVID-19 Healthcare Standard. The ultimate impact of a permanent standard on the Company, if one were to be adopted, is currently unknown and difficult to predict.
The Company has assessed the impacts of the COVID-19 pandemic on its results of operations for the fiscal year ended January 31, 2022, and although there have been challenges, no material adverse impacts were identified. We continue to monitor developments involving our workforce, customers, and suppliers and continue to take steps to mitigate against additional impacts.
Supply Chain Disruptions
In recent months, we have seen increasing supply chain disruptions, including country of origin production and port delays. Additionally, trucker, dockworker, and labor shortages, a surge of consumer demand, and other factors have led to industry-wide delays. In response, we have been, and expect to continue to be, proactive in ordering inventory, parts, and components to ensure our operations can continue without significant delay; however, we have experienced price increases, disruptions and delays on delivery of certain products.
Macroeconomic and Industry Factors
Our Agriculture and International businesses are primarily driven by the demand for agricultural equipment for use in the production of food, fiber, feed grain and renewable energy; home and garden applications; and the maintenance of commercial, residential and government properties. Agriculture industry factors such as changes in agricultural commodity prices and net farm income, have an effect on customer sentiment and their ability to secure financing for equipment purchases. Macroeconomic and industry factors that affect commodity prices and net farm income include changing worldwide demand for agriculture commodities, crop yields and supply disruptions caused by weather patterns and crop diseases, crop stock levels, production costs, and changing U.S. dollar foreign currency exchange rates. Based on U.S. Department of Agriculture ("USDA") publications, the most recent estimate of net farm income for calendar year 2021 increased 25.1% compared to calendar year 2020 due to U.S. crop production and increased commodity exports and partially offset by a reduction in U.S. Federal government's direct farm program payments. Based on its February 2022 report, the USDA projected net farm income for calendar year 2022 to decrease 4.5%, as compared to calendar year 2021.
Our Construction business is primarily impacted by the demand for construction equipment for use in private and government commercial, residential, and infrastructure construction; demolition; maintenance; energy and forestry operations. Industry reports show that demand for construction equipment in our markets is driven by several factors, one of which is public infrastructure spending, including roads and highways, sewer and water. Any growth in federal allocations to public infrastructure spending over the next few years should positively impact our future results of operations. Likewise, any decline in federal allocations to public infrastructure spending over the next few years should negatively impact our future results of operations.
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Seasonality & Weather
The agricultural and construction equipment businesses are highly seasonal, which causes our quarterly results and our available cash flow to fluctuate during the year. Our customers generally purchase and rent equipment in preparation for, or in conjunction with, their busy seasons, which for farmers are the spring planting and fall harvesting seasons; and which for Construction customers is typically the second and third quarters of our fiscal year for much of our Construction footprint. Our parts and service revenues are typically highest during our customers' busy seasons as well, due to the increased use of their equipment during this time, which generates the need for more parts and service work. However, weather conditions impact the timing of our customers' busy times, which may cause greater than expected fluctuations in our quarterly financial results year over year. In addition, the fourth quarter typically is a significant period for equipment sales in the U.S. because of our customers’ year-end tax planning considerations, the timing of dealer incentives and the increase in availability of funds from completed harvests and construction projects.
Seasonal weather trends, particularly severe wet or dry conditions, can have a significant impact on regional agricultural and construction market performance by affecting crop production and the ability to undertake construction projects. Weather conditions that adversely affect the agricultural or construction markets decrease the demand for our products and services.
In addition, numerous external factors such as credit markets, commodity prices, and other circumstances may disrupt normal purchasing practices and buyer sentiment, further contributing to the seasonal fluctuations.
Dependence on our Primary Supplier
The majority of our business involves the distribution and servicing of equipment manufactured by CNH Industrial. In fiscal 2022, CNH Industrial supplied approximately 76% of the new equipment sold in our Agriculture segment, 66% of the new equipment sold in our Construction segment, and 70% of the new equipment sold in our International segment, and represented a significant portion of our parts revenue. Thus, we believe the following factors have a significant impact on our operating results:
•CNH Industrial’s product offerings, reputation and market share;
•CNH Industrial’s product prices and incentive and discount programs;
•CNH Industrial's supply of inventory;
•CNH Industrial's offering of floorplan payable financing for the purchase of a substantial portion of our inventory; and
•CNH Industrial's offering of financing and leasing used by our customers to purchase CNH Industrial equipment from us.
Credit Market Changes
Changes in credit markets can affect our customers' ability and willingness to make capital expenditures, including purchasing our equipment. Tight credit markets, a low level of liquidity in many financial markets, and extreme volatility in fixed income, credit, currency and equity markets have the potential to adversely affect our business. Such disruptions in the overall economy and financial markets and the related reduction in consumer confidence in the economy, slow activity in the capital markets, negatively affect access to credit on commercially acceptable terms, and may adversely impact our customers' access to credit and the terms of any such credit. However, if retail interest rates remain low, our business may be positively affected by customers who find financing purchases of our equipment more attractive due to lower borrowing costs.
Our business is also particularly dependent on our access to credit markets to manage inventory and finance acquisitions. We cannot predict what future changes will occur in credit markets or how these changes will impact our business.
Inflation
Inflationary pressures have led to rising inventory and supply costs as well as increased labor costs. To date, in those instances in which we have experienced cost increases, we have been able to increase selling prices to offset much of the increases and expect to continue to do so in the future.
Significant Items Impacting Our Financial Position and Results of Operations
Jaycox Acquisition
On December 1, 2021, we continued our strategy of acquiring dealerships in desired market areas with our acquisition of Jaycox Implement ("Jaycox"). Jaycox consists of three CaseIH agriculture dealership locations in Worthington and Luverne,
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Minnesota and Lake Park, Iowa. Total cash consideration paid for the business was $28.2 million which was financed through available cash resources. In conjunction with the acquisition, we purchased the real estate for $5.5 million which was financed with available cash and long term debt. The three Jaycox locations are included within our Agriculture segment.
Montana and Wyoming Divestiture
On January 24, 2022, we divested four dealership locations in Billings, Great Falls, and Missoula, Montana and Gillette, Wyoming. The sale of these locations resulted in a $5.7 million gain which is included in fiscal 2022 consolidated operating expenses. The gain on the sale is included in the Construction segment.
HorizonWest Acquisition
On May 4, 2020, the Company acquired certain assets of HorizonWest Inc. This acquired Case IH agriculture dealership complex consisted of three agriculture equipment stores in Scottsbluff and Sidney, Nebraska and Torrington, Wyoming, which expands the Company's agriculture presence in Nebraska and into Wyoming. The total consideration transferred for the acquired business was $6.8 million paid in cash, which the Company financed through available cash resources and capacity under our existing floorplan payable and other credit facilities. The three HorizonWest dealerships are included within our Agriculture segment.
Critical Accounting Policies and Use of Estimates
In the preparation of financial statements prepared in conformity with U.S. generally accepted accounting principles ("GAAP"), we are required to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and the related disclosures. While we believe the estimates and judgments we use in preparing our financial statements are appropriate, they are subject to future events and uncertainties regarding their outcome and therefore actual results may materially differ from these estimates. We describe in Note 1, Business Activity and Significant Accounting Polices, of the Notes to our Consolidated Financial Statements the significant accounting policies used in preparing the consolidated financial statements. We consider the following items in our consolidated financial statements to require significant estimation or judgment.
Revenue Recognition
Equipment revenue transactions include the sale of agricultural and construction equipment and often include both cash and noncash consideration received from our customers, with noncash consideration in the form of used, trade-in, equipment assets. The amount of revenue recognized in the sale transaction is dependent on the value assigned to the trade-in asset. Significant judgment is required to estimate the value of trade-in assets. We assign value based on the estimated selling price for that piece of equipment in the applicable market, less a gross profit amount to be realized at the time the trade-in asset is sold and an estimate of any reconditioning work required to ready the asset for sale. We estimate future selling prices of trade-in assets using various external industry data and relevant internal information, and consider the impact of various factors including model year, hours of use, overall condition, and other equipment specifications. Our estimates of the value of trade-in assets are impacted by changing market values of used equipment and the availability of relevant and reliable third-party data. In instances in which relevant third-party information is not available, the value assigned to trade-in equipment is dependent on internal judgments.
Inventories
New and used equipment inventories are stated at the lower of cost (specific identification) or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The majority of our used equipment inventory is acquired through trade-ins from our customers and is initially measured and recognized based on the estimated future selling price of the equipment, less a gross profit amount to be realized when the trade-in asset is sold and an estimate of any reconditioning work required to ready the asset for sale. Subsequent to the initial recognition, all new and used equipment inventories are subject to lower of cost or net realizable value assessments. We estimate net realizable value using internal information, management judgment and third-party data that considers various factors including age and condition of equipment, hours of use and market conditions. Generally, used equipment prices are more volatile to changes in market conditions than prices for new equipment due to incentive programs that may be offered by manufacturers to assist in the sale of new equipment. We review our equipment inventory values and adjust them whenever the carrying amount exceeds the estimated net realizable value.
Parts inventories are valued at the lower of average cost or net realizable value. We estimate net realizable value of our parts inventories based on various factors including aging and sales history of each type of parts inventory.
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Impairment of Long-Lived Assets
Our long-lived assets consist primarily of property and equipment and operating lease assets. We review these assets for potential impairment whenever events or circumstances indicate that the carrying value may not be recoverable. Recoverability is measured by comparing the estimated future undiscounted cash flows of such assets to their carrying values. If the estimated undiscounted cash flows exceed the carrying value, the carrying value is considered recoverable and no impairment recognition is required. However, if the sum of the undiscounted cash flows is less than the carrying value of the asset, the second step of the impairment analysis must be performed to measure the amount of the impairment, if any. The second step of the impairment analysis compares the estimated fair value of the long-lived asset to its carrying value and any amount by which the carrying value exceeds the fair value is recognized as an impairment charge.
When reviewing long-lived assets for impairment, we group long-lived assets with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Long-lived assets deployed and used by individual store locations are reviewed for impairment at the individual store level. Other long-lived assets shared across stores within a segment or shared across segments are reviewed for impairment on a segment or consolidated level as appropriate.
During our 2022 fiscal year, we determined that events or circumstances were present that may indicate that the carrying amount of certain of our store long-lived assets might not be recoverable. The events or circumstances which indicated that certain of our store long-lived assets might not be recoverable included a current period operating loss combined with historical losses and anticipated future operating losses within certain of our stores, or an expectation that a long-lived asset (or asset group) will be disposed of before the end of its previously estimated useful life. In light of these circumstances, we performed step one of the impairment analysis for these assets, which have a combined carrying value of $25.8 million, to determine if the asset values are recoverable. In certain cases, the analysis indicated that the carrying value is not recoverable. The aggregate carrying value of such assets totaled $5.2 million. Based on this conclusion, we performed step two of the impairment analysis and estimated the fair value of these assets using an income approach that incorporated unobservable inputs including estimated forecasted net cash flows generated from the use and disposition of these assets. Step two of the analysis indicated that an impairment charge in the amount of $0.4 million was necessary, which related to the International segment. In all other cases, in which the aggregate carrying value of such assets totaled $20.6 million, our analyses indicated that the carrying values are recoverable based on our estimates of future undiscounted cash flows under step one of the impairment analysis.
Our impairment analyses require significant judgment, including identification of the grouping of long-lived and other assets and liabilities for impairment testing, estimates of future cash flows arising from these groups of assets and liabilities, and estimates of the remaining useful lives of the long-lived assets being evaluated. Our estimates inherently include a degree of uncertainty and are impacted by macroeconomic and industry conditions, the competitive environment and other factors. Adverse changes in any of these factors in future periods could result in impairment charges in future periods which could materially impact our results of operations and financial position.
Income Taxes
In determining our provision for (benefit from) income taxes, we must make certain judgments and estimates, including an assessment of the realizability of our deferred tax assets. In evaluating our ability to realize the benefit of our deferred tax assets we consider all available positive and negative evidence, including our historical operating results and our expectation of future taxable income, the availability to implement prudent tax-planning strategies, and the carryforward periods over which the assets may be realized. These assumptions require significant judgment and estimation.
In reviewing our deferred tax assets as of January 31, 2022, we concluded that a full valuation allowance continued to be warranted on our Ukrainian subsidiary. It was also concluded that a full valuation allowance was warranted on our German subsidiary which was previously only a partial valuation allowance. We also recorded a full valuation allowance on our Luxembourg holding company. Due to improved performance, a partial release of a valuation allowance for the Company's Bulgarian subsidiary was recorded. In total, valuation allowances of $6.0 million exist for our international entities as of January 31, 2022.
At the end of fiscal year ended January 31, 2021, the Company concluded, a full valuation allowance continued to be warranted in certain jurisdictions. It was also concluded that a full valuation allowance for the Company's Ukrainian subsidiary was warranted and a partial valuation allowance for the Company's German subsidiary was warranted, as such the Company recorded an additional $3.8 million valuation allowance for these two subsidiaries. In total, valuation allowances of $6.1 million existed for certain of our international entities as of January 31, 2021.
The initial recognition of, and any changes in, a deferred tax asset valuation allowance are recorded to the provision for income taxes and impacts our effective tax rate. Our assessment of the need for and magnitude of valuation allowances for
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our deferred tax assets may be impacted by changes in tax laws, our assumptions regarding the ability to generate future taxable income and the availability of tax-planning strategies. Changes in any of these factors could lead to a change in the recognized valuation allowance which may impact our future results of operations and financial position.
New Accounting Pronouncements
Refer to Note 1, Business Activity and Significant Accounting Polices, of the Notes to our Consolidated Financial Statements for a description of new accounting pronouncements recently adopted or not yet adopted and the impact or anticipated impact of such pronouncements to our consolidated financial statements.
Key Financial Metrics
In addition to tracking our sales and expenses to evaluate our operational performance, we also monitor the following key financial metrics. The results of some of these metrics are discussed further throughout the Management's Discussion and Analysis of Financial Condition and Results of Operations section of this Form 10-K.
Inventory Turnover
Inventory turnover measures the rate at which inventory is sold during the year. We calculate it by dividing cost of sales on equipment for the last twelve months by the average of the month-end balances of our equipment and parts inventories for the same twelve-month period. We believe that inventory turnover is an important management metric in evaluating the efficiency at which we are managing and selling our inventories.
Same-Store Results
Same-store results for any period represent results of operations by stores that were part of our Company for the entire comparable period in the preceding fiscal year. We do not distinguish relocated or newly-expanded stores in this same-store analysis. Closed stores are excluded from the same-store analysis.
Absorption
Absorption is an industry term that refers to the percentage of an equipment dealer's operating expense covered by the combined gross profit from parts, service and rental fleet activity. We calculate absorption by dividing our gross profit from sales of parts, service and rental fleet by our operating expenses, less commission expense on equipment sales, plus interest expense on floorplan payables and rental fleet debt. We believe that absorption is an important management metric because during economic down cycles our customers tend to postpone new and used equipment purchases while continuing to run, maintain and repair their existing equipment. Thus, operating at a high absorption rate enables us to operate profitably throughout economic down cycles.
Dollar Utilization
Dollar utilization is a measurement of asset performance and profitability used in the rental industry. We calculate the dollar utilization of our rental fleet equipment by dividing the rental revenue earned on our rental fleet by the average gross carrying value of our rental fleet (comprised of original equipment costs plus additional capitalized costs) for that period. While our rental fleet has variable expenses related to repairs and maintenance, its primary expense for depreciation is fixed. Low dollar utilization of our rental fleet has a negative impact on gross profit margin and gross profit dollars due to the fixed depreciation component. However, high dollar utilization of our rental fleet has a positive impact on gross profit margin and gross profit dollars.
Adjusted EBITDA
EBITDA is a non-GAAP financial measure defined as earnings before finance costs, income taxes, depreciation and amortization and is a metric frequently used to assess and evaluate financial performance. Management uses Adjusted EBITDA as a measure of financial performance, as a supplemental measure to evaluate the Company's overall operating performance and believes it provides a useful metric for comparability between periods and across entities within our industry by excluding differences in capital structure, income taxes, non-cash charges and certain activities that occur outside of the ordinary course of our business. We calculate Adjusted EBITDA as our net income (loss), adjusted for net interest (excluding floorplan interest expense), income taxes, depreciation, amortization, and items included in our non-GAAP reconciliation, for each of the respective periods. Adjusted EBITDA should be evaluated in addition to, and not considered a substitute for, or superior to, any GAAP measure of net income (loss). In addition, other companies may calculate Adjusted EBITDA in a different manner, which may hinder comparability with other companies. Refer to the Non-GAAP Financial Measures section for a reconciliation of Adjusted EBITDA to net income.
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Key Financial Statement Components
Revenue
•Equipment: We derive equipment revenue from the sale of new and used agricultural and construction equipment.
•Parts: We derive parts revenue from the sale of parts for brands of equipment that we sell, other makes of equipment, and other types of equipment and related components. Our parts sales provide us with a relatively stable revenue stream that is less sensitive to the economic cycles that affect our equipment sales.
•Service: We derive service revenue from repair and maintenance services to our customers' equipment. Our repair and maintenance services provide a high-margin, relatively stable source of revenue through changing economic cycles.
•Rental and other: We derive other revenue from equipment rentals and ancillary equipment support activities such as equipment transportation, GPS signal subscriptions and reselling financial and insurance products.
Cost of Revenue
•Equipment: Cost of equipment revenue is the lower of the acquired cost or the net realizable value of the specific piece of equipment sold.
•Parts: Cost of parts revenue is the lower of the acquired cost or the market value of the parts sold, based on average costing.
•Service: Cost of service revenue represents costs attributable to services provided for the maintenance and repair of customer-owned equipment and equipment then on-rent by customers.
•Rental and other: Costs of other revenue represent costs associated with equipment rental, such as depreciation, maintenance and repairs, as well as costs associated providing transportation, hauling, parts freight, GPS subscriptions and damage waivers, including, among other items, drivers' wages, truck depreciation, fuel costs, shipping costs and our costs related to damage waiver policies.
Operating Expenses
Our operating expenses include sales and marketing expenses, sales commissions (which generally are based upon equipment gross profit margins), payroll and related benefit costs, insurance expenses, professional fees, property rental and related costs, property and other taxes, administrative overhead, and depreciation associated with property and equipment (other than rental and trucking equipment).
Floorplan Interest
The cost of financing inventory is an important factor affecting our results of operations. Floorplan payable financing from CNH Industrial Capital, the Bank Syndicate Agreement, DLL Finance and various credit facilities related to our foreign subsidiaries represent the primary sources of financing for equipment inventories. CNH Industrial regularly offers interest-free periods as well as additional incentives and special offers. As of January 31, 2022, 78.8% of our floorplan payable financing was non-interest bearing.
Other Interest Expense
Interest expense represents the interest on our debt instruments, other than floorplan payable financing facilities. This includes long-term debt used to finance the purchase of real estate and vehicles.
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Results of Operations
Comparative financial data for each of our four sources of revenue for fiscal 2022 and 2021 are presented below. The results include the acquisitions made during these periods. The year-to-year comparison included below is not necessarily indicative of future results. Information regarding segment revenue and income (loss) before income taxes is presented for each fiscal year following our discussion of the consolidated results of operations. Additional information regarding our segments is included in Note 21 of our consolidated financial statements.
Year Ended January 31,
(dollars in thousands)
Equipment
Gross profit margin 12.5 % 10.3 %
Parts
Gross profit margin 30.2 % 29.8 %
Service
Gross profit margin 66.5 % 65.8 %
Rental and other
Gross profit margin 36.6 % 30.3 %
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The following table sets forth our statements of operations data expressed as a percentage of revenue for the fiscal years indicated.
Year Ended January 31,
Revenue
Rental and other 2.2 % 3.1 %
Total Cost of Revenue 80.6 % 81.5 %
Gross Profit Margin 19.4 % 18.5 %
Operating Expenses 14.1 % 15.6 %
Impairment of Goodwill — % 0.1 %
Impairment of Intangible and Long-Lived Assets 0.1 % 0.1 %
Income from Operations 5.3 % 2.7 %
Other Income (Expense) (0.2) % (0.5) %
Income Before Income Taxes 5.1 % 2.2 %
Provision for Income Taxes 1.2 % 0.8 %
Net Income 3.9 % 1.4 %
Fiscal Year Ended January 31, 2022 Compared to Fiscal Year Ended January 31, 2021
Consolidated Results
Revenue
Year Ended January 31, Increase/ Percent
(dollars in thousands)
The increase in total revenue for fiscal 2022, as compared to fiscal 2021, was primarily the result of Company-wide same-store sales increase of 23.5% over the prior fiscal year and our acquisitions of HorizonWest and Jaycox, completed in May 2020 and December 2021, respectively. The strong same store sales increase was primarily driven by strong agriculture equipment sales due to higher commodity prices, higher net farm income, and good growing conditions in our international footprint.
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Gross Profit
Year Ended January 31, Increase/ Percent
(dollars in thousands)
Gross Profit
Gross Profit Margin
Total Gross Profit Margin 19.4 % 18.5 % 0.9 % 4.9 %
Gross Profit Mix
Gross profit increased 27.3% or $71.4 million from fiscal 2021 to fiscal 2022, primarily due to higher revenue and gross profit from our equipment, parts, and service business. Gross profit margin increased from 18.5% in fiscal 2021 to 19.4% in fiscal 2022. The increase in overall gross profit margin was primarily due to stronger equipment margins, which were positively impacted by favorable end market conditions, healthy inventory, and a $6.4 million increase in the amount earned under manufacturer incentive programs.
Our company-wide absorption rate improved to 84.6% for fiscal 2022 as compared to 77.7% during fiscal 2021 as the increase in gross profit from parts and service combined with lower floorplan interest expenses more than offset the increase in operating expenses compared to that of fiscal 2021. The overall absorption rate in fiscal 2022 was positively impacted by a one-time gain of $5.7 million on the fourth quarter divestiture of three Montana and one Wyoming stores in our Construction segment.
Operating Expenses
Year Ended January 31, Increase/ Percent
(dollars in thousands)
Operating Expenses as a Percentage of Revenue 14.1 % 15.6 % (1.5) % (9.6) %
Operating expenses for fiscal 2022 increased $20.3 million, as compared to fiscal 2021. The increase in operating expenses was primarily due to variable expenses associated with increased sales, which was partially offset by a one-time gain of $5.7 million on the fourth quarter fiscal 2022 divestiture of three Montana and one Wyoming stores in our Construction segment. In fiscal 2022, operating expenses as a percentage of revenue decreased to 14.1% from 15.6% in fiscal 2021. The decrease in operating expenses as a percentage of total revenue was due to the increase in total revenue in fiscal 2022 compared to fiscal 2021, which positively affected our ability to leverage our fixed operating costs.
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Impairment
Year Ended January 31, Percent
(dollars in thousands)
Impairment of Goodwill $ — $ 1,453 $ (1,453) n/m
Impairment of Intangible and Long-Lived Assets 1,498 1,727 (229) (13.3) %
During fiscal 2022, the Company did not recognize any goodwill impairment charges and recognized a total of $1.5 million of impairment charges related to certain intangible and long-lived assets. In fiscal 2021, the Company recognized $1.5 million of impairment charges related to goodwill and $1.7 million of impairment charges related to other intangible and long lived assets. The fiscal 2022 and 2021 impairment expenses were primarily related to the impairment of goodwill and certain other intangible assets in our International segment.
Other Income (Expense)
Year Ended January 31, Increase/ Percent
(dollars in thousands)
Interest and other income (expense) $ 2,431 $ 527 $ 1,904 n/m
The increase in Interest and other income (expense) compared to fiscal 2021 is primarily the result of fluctuations in foreign currency exchange rates, primarily the Ukrainian currency. The decrease in floorplan interest expense for fiscal 2022, as compared to fiscal 2021, was due to an overall lower interest rate environment as well as lower borrowings. The increase in other interest expense in fiscal 2022 is the result of an increased amount of long term debt resulting from real estate purchased in fiscal 2022.
Provision for Income Taxes
Year Ended January 31, Percent
(dollars in thousands)
Our effective tax rate decreased from 37.1% in fiscal 2021 to 24.0% in fiscal 2022. The Company's effective tax rate decreased due to changes in valuation allowances recognized for deferred tax assets. In fiscal 2021, the Company added a full valuation allowance for the Company's Ukrainian subsidiary as well as a partial valuation allowance for the Company's German subsidiary. In fiscal 2022, the Company released a portion of the valuation allowance on its Bulgarian subsidiary's deferred tax assets, which was offset by a valuation allowance on its Luxembourg holding company.
See Note 14 to our consolidated financial statements for further details on our effective tax rate.
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Segment Results
Year Ended January 31, Increase/ Percent
(dollars in thousands)
Revenue
Income (Loss) Before Income Taxes
Agriculture
Agriculture segment revenue for fiscal 2022 increased 21.5% or $190.3 million compared to the same period last year. Agriculture same-store sales increased 19.3% for fiscal 2022, as compared to fiscal 2021. Equipment sales were driven by increased equipment demand due to higher commodity prices and higher net farm income. The HorizonWest and Jaycox acquisitions, which were completed in May 2020 and December 2021, respectively, also contributed to the total sales growth for the segment.
Agriculture segment income before income taxes for fiscal 2022 improved by $26.1 million or 76.0% compared to fiscal 2021. The improvement in segment results was the result of stronger equipment margins which were positively impacted by favorable end market conditions, healthy inventory, and a $5.1 million increase in the amount earned under manufacturer incentive programs. Decreased inventory levels resulted in lower floorplan interest expense which also contributed to the improvement in segment results.
Construction
Construction segment revenue for fiscal 2022 increased 3.7% or $11.4 million compared to fiscal 2021 due to a same-store sales increase of 14.8% which more than offset our divestiture of the Phoenix and Tucson stores in the fourth quarter of fiscal 2021. Higher equipment sales were driven by increased construction activity throughout the footprint.
The Construction segment income before income taxes was $15.5 million for fiscal 2022 compared to income of $0.2 million for the prior year. The improvement in segment results was the result of improved equipment margins and lower floorplan and other interest expense. The segment also benefited from a $5.7 million gain on the divestiture of our Billings, Great Falls, and Missoula, Montana and Gillette, Wyoming locations.
International
International segment revenue for fiscal 2022 increased 45.2% or $99.0 million compared to fiscal 2021. Higher segment revenue is being driven by higher commodity prices as well as favorable growing conditions for much of our farming footprint, which had a positive impact on all sources of sales, but primarily equipment sales.
Our International segment income before income taxes was $12.6 million for fiscal 2022, compared to loss before income taxes of $6.0 million for fiscal 2021. The higher segment results were primarily the result of increased equipment sales and equipment gross profit margin including a $1.3 million increase in manufacturer incentive programs. Impairment charges of $1.5 million were recognized in fiscal 2022, compared to impairment charges of $2.3 million in fiscal 2021.
Shared Resources/Eliminations
We incur centralized expenses/income at our general corporate level, which we refer to as “Shared Resources,” and then allocate most of these net expenses to our segments. Since these allocations are set early in the year, and a portion is
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planned to be unallocated, unallocated balances may occur. Shared Resource loss before income taxes was $1.8 million for fiscal 2022 compared to income before income taxes of $2.2 million for fiscal 2021.
Non-GAAP Financial Measures
To supplement our net income and diluted earnings per share ("diluted EPS"), both GAAP measures, we present and our management utilizes adjusted net income, adjusted diluted EPS, and adjusted EBITDA, all non-GAAP financial measures. Generally, these non-GAAP financial measures include adjustments for items such as ERP transition costs for fiscal year 2021, impairment charges, and foreign currency remeasurement gains/losses in Ukraine. Furthermore, we calculate adjusted EBITDA as our net income (loss), adjusted for net interest (excluding floorplan interest expense), income taxes, depreciation, amortization, and the adjustments included in our non-GAAP reconciliation as described above, for each of the respective periods. We believe that the presentation of adjusted net income, adjusted diluted EPS and adjusted EBITDA is relevant and useful to our management and investors because they each provide a measurement of earnings on activities that we consider to occur in the ordinary course of our business. In addition, our management uses adjusted EBITDA, as a supplemental measure of financial performance, to evaluate the Company's overall operating performance and believes it provides a useful metric for comparability between periods and across entities within our industry by excluding differences in capital structure, income taxes, non-cash charges and certain activities that occur outside of the ordinary course of our business. Adjusted net income, adjusted diluted EPS, and adjusted EBITDA should be evaluated in addition to, and not considered a substitute for, or superior to, the most comparable GAAP financial measure. In addition, other companies may calculate these non-GAAP financial measures in a different manner, which may hinder comparability of our results with those of other companies.
Changes in Presentation of Non-GAAP Financial Measures
Beginning in the third quarter of fiscal 2022, the Company discontinued the use of the adjusted cash-flow measure and revised its presentation of two non-GAAP financials measures, Adjusted Net Income and Adjusted Diluted EPS, to better align with SEC guidance. The adjustment for income tax valuation allowance, a non-cash tax expense related to the use of deferred tax assets in certain jurisdictions, will no longer be an adjustment included in these two non-GAAP financial measures. For comparability, references to prior periods' non-GAAP financial measures have also been updated to show the effect of omitting the valuation allowance from Adjusted Net Income and Adjusted Diluted EPS - see tables below.
The following tables reconcile net income and diluted EPS, GAAP financial measures, to adjusted net income, adjusted diluted EPS, and adjusted EBITDA, all non-GAAP financial measures.
Year Ended January 31,
(dollars in thousands, except per share data)
Adjusted Net Income
Adjustments
ERP transition costs — 2,990
Ukraine remeasurement (gain) / loss (263) 1,174
Tax Effect of Adjustments (1) — 2,227
Adjusted Diluted EPS
Adjustments (2)
ERP transition costs — 0.13
Ukraine remeasurement (gain) / loss (0.01) 0.05
Total Pre-Tax Adjustments 0.06 0.32
Tax Effect of Adjustments (1) — 0.09
Adjusted Diluted EPS $ 2.98 $ 1.09
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Year Ended January 31,
(dollars in thousands, except per share data)
Adjusted EBITDA
Adjustments
Interest expense, net of interest income 4,208 3,574
Adjustments
ERP transition costs — 2,990
Ukraine remeasurement (gain) / loss (263) 1,174
(1)The tax effect of U.S. related adjustments was calculated using a 26% tax rate, determined based on a 21% federal statutory rate and a 5% blended state income tax rate. The tax effect of the Germany related adjustments was calculated using a 29% tax rate. Included in the tax effect of the adjustments is the tax impact of foreign currency changes in Ukraine of $1.2 million for fiscal 2021.
(2)Adjustments are net of the impact of amounts allocated to participating securities where applicable
Liquidity and Capital Resources
Sources of Liquidity
Our primary sources of liquidity are cash reserves, cash generated from operations, and borrowings under our floorplan payable and other credit facilities. We expect these sources of liquidity to be sufficient to fund our working capital requirements, acquisitions, capital expenditures and other investments in our business, service our debt, pay our tax and lease obligations and other commitments and contingencies, and meet any seasonal operating requirements for the foreseeable future, provided, however, that our borrowing capacity under our credit agreements is dependent on compliance with various financial covenants as further described in Note 8 to our consolidated financial statements included in this Form 10-K. We have worked in the past, and will continue to work in the future if necessary, with our lenders to implement satisfactory modifications to these financial covenants when appropriate for the business conditions confronted by us.
Equipment Inventory and Floorplan Payable Credit Facilities
Floorplan payable balances reflect the amount owed for new equipment inventory purchased from a manufacturer and used equipment inventory, which is primarily purchased through trade-in on equipment sales, net of unamortized debt issuance costs incurred for floorplan credit facilities. Certain of the manufacturers from which we purchase new equipment inventory offer financing on these purchases, either offered directly from the manufacturer or through the manufacturers’ captive finance affiliate. CNH Industrial's captive finance subsidiary, CNH Industrial Capital, also provides financing of used equipment inventory. We also have floorplan payable balances with non-manufacturer lenders for new and used equipment inventory. Borrowings and repayments on manufacturer floorplan facilities are reported as operating cash flows, while borrowings and repayments on non-manufacturer floorplan facilities are reported as financing cash flows in our consolidated statements of cash flows.
As of January 31, 2022, we had floorplan payable lines of credit for equipment purchases totaling $752.0 million, which includes a $450.0 million credit facility with CNH Industrial Capital, a $185.0 million floorplan payable line under the Bank Syndicate Agreement, a $50.0 million credit facility with DLL Finance, and additional credit facilities related to our foreign subsidiaries. Available borrowing capacity under these lines of credit are reduced by amounts outstanding under such facilities, borrowing base calculations and amount of standby letters of credit outstanding with respect to the Bank Syndicate Agreement, and certain acquisition-related financing arrangements with respect to the CNH Industrial Capital credit facility. As of January 31, 2022, the Company was in compliance with the financial covenants under its credit agreements. Additional
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details on each of these credit facilities are disclosed in Note 8 to our consolidated financial statements included in this annual report.
As of January 31, 2022, the Company was not subject to the fixed charge ratio covenant under the Bank Syndicate Agreement as our adjusted excess availability plus eligible cash collateral (as defined in the Bank Syndicate Agreement) was not less than 15% of the total amount of the credit facility. Please refer to Note 8 to our consolidated financial statement included in Item 8 for further information regarding the Company's line of credit.
Our equipment inventory turnover increased to 3.4 times for fiscal 2022 compared to 2.0 times for fiscal 2021. Our equipment inventories amount decreased 4.2% from January 31, 2021 to January 31, 2022. The improvement in equipment turnover was due to the combination of the increase in equipment sales volume in fiscal 2022 as compared to fiscal 2021 and a decrease in our average equipment inventory over these time periods. Our equity in equipment inventory, which reflects the portion of our equipment inventory balance that is not financed by floorplan payables, increased to 58.2% as of January 31, 2022, from 52.1% as of January 31, 2021. The increase in our equity in equipment inventory is primarily due to a high level of cash generation in fiscal 2022, which was applied against interest bearing floorplan payables.
Long-Term Debt Facilities
As of January 31, 2021, we had a $65.0 million working capital line of credit under the Bank Syndicate Agreement (the "Revolver Loan"). The Revolver Loan is used to finance our working capital requirements and fund certain capital expenditures, as needed. As of January 31, 2022, the Company did not have a need to utilize any of the Revolver Loan, as such the outstanding balance was zero. The Company works with various lenders to finance the purchase of real estate we currently lease or are acquiring through an acquisition. The Company may also decide in the future to finance a portion of our rental fleet as well as our capital expenditures using long-term debt from various lenders.
Adequacy of Capital Resources
Our primary uses of cash have been to fund our operating activities, including the purchase of inventories and providing for other working capital needs; meeting our debt service requirements; making payments due under our various leasing arrangements; and funding capital expenditures, including the purchase of rental fleet assets. The primary factor affecting our ability to generate cash and to meet cash requirements, is our operating performance as impacted by (i) industry factors, (ii) competition, (iii) general economic conditions, (iv) the timing and extent of acquisitions, and (v) business and other factors including those identified in Item 1A "Risk Factors" and discussed in this Form 10-K.
Our ability to service our debt will depend upon our ability to generate necessary cash. This will in turn depend on our future acquisition activity, operating performance, general economic conditions, and financial, competitive, business and other factors, some of which are beyond our immediate control. Based on our current operational performance, we believe our cash flow from operations, available cash, and available borrowings under our existing credit facilities will be adequate to meet our liquidity needs for, at a minimum, the next 12 months.
In fiscal 2022, we used $14.6 million in cash for rental fleet purchases and $23.0 million in cash for property and equipment purchases and financed $14.6 million in property and equipment purchases with long-term debt and finance leases. The property and equipment purchases in fiscal 2022 primarily related to improvements to, or purchases of, real estate assets and the purchase of vehicles. In fiscal 2021, we used $7.1 million in cash for rental fleet purchases, $13.0 million in cash for property and equipment purchases, and financed $19.5 million in property and equipment purchases with long-term debt. The property and equipment purchases in fiscal 2022 primarily related to the purchase of vehicles, trucks and real estate. We expect our cash expenditures for property and equipment, exclusive of rental fleet purchases, for fiscal 2023 to be approximately $25.0 million and expect cash expenditures for our rental fleet for fiscal 2023 to be approximately $10.0 million. The actual amount of our fiscal 2023 capital expenditures will depend upon factors such as general economic conditions, growth prospects for our industry and our decisions regarding financing and leasing options. We currently expect to finance property and equipment purchases with borrowings under our existing credit facilities, financing with long-term debt, with available cash or with cash flow from operations. We may need to incur additional debt if we pursue any future acquisitions.
There can be no assurances, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available under the credit facilities with the Bank Syndicate, CNH Industrial Capital and DLL Finance in amounts sufficient to allow us to service our indebtedness and to meet our other commitments. If we are unable to generate sufficient cash flow from operations or to obtain sufficient future borrowings, we may be required to seek one or more alternatives such as refinancing or restructuring our indebtedness, selling material assets or operations or seeking to raise additional debt or equity capital. There can be no assurances that we will be able to succeed with one of these alternatives on commercially reasonable terms, if at all. In addition, if we pursue strategic acquisitions, we may require additional equity or debt financing to consummate the transactions, and we cannot assure you that we will succeed in obtaining this financing on favorable terms or at all. If we incur additional indebtedness to finance any of these transactions, this may place increased
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demands on our cash flow from operations to service the resulting increased debt. Our existing debt agreements contain restrictive covenants that may restrict our ability to adopt any of these alternatives. Any non-compliance by us under the terms of our debt agreements could result in an event of default which, if not cured, could result in the acceleration of our debt. We have met all financial covenants under these credit agreements as of January 31, 2022. If anticipated operating results create the likelihood of a future covenant violation, we would seek to work with our lenders on an appropriate modification or amendment to our financing arrangements.
Cash Flow
Cash Flow Provided By Operating Activities
Net cash provided by operating activities in fiscal 2022 was $158.9 million compared to $173.0 million in fiscal 2021. The decrease in net cash provided by operating activities of $14.1 million from fiscal 2021 to fiscal 2022 is primarily the result of a consistent inventory balance and manufacturer floorplan payable balance during fiscal 2022 compared to a reduction in inventories in fiscal 2021, this was partially offset by an increase in receivables and prepaid expenses for fiscal 2022.
Cash Flow Used For Investing Activities
Net cash used for investing activities is primarily comprised of cash used for property and equipment purchases, including rental fleet purchases, and for business acquisitions.
Net cash used for investing activities was $55.2 million in fiscal 2022, compared to $20.3 million in fiscal 2021. In fiscal 2022, the Company used $37.6 million of cash, compared to use of $20.1 million in fiscal 2021, for additional investment in our rental fleet, vehicles, capital improvements, and purchases of real estate. In addition, the Company utilized $33.6 million of cash in fiscal 2022, compared to use of $6.8 million in the prior fiscal year, for acquisitions.
Cash Flow Provided By (Used For) Financing Activities
Net cash used for financing activities was $35.3 million in fiscal 2022, compared to net cash used for financing activities of $117.9 million in fiscal 2021. In fiscal 2022, net cash used for financing activities was the result of decreased non-manufacturer floorplan payables, which was reduced due to use of cash provided by operating activities.
Future Cash Requirements
We enter into contractual obligations in the ordinary course of business that may require future cash payments. Such obligations include, but are not limited to, debt arrangements, leasing arrangements, and costs related to Information Technology ("IT"), including ERP expenses. The Notes to the Consolidated Financial Statements provide additional information in regard to Long Term Debt (Note 10) and Leases (Note 13). Other purchase obligations consist primarily of ERP related expenses with estimated cash payments of $4.4 million for fiscal 2023, $9.1 million combined for fiscal years 2024, 2025, and 2026.
Information Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. We include "forward-looking" information in this Form 10-K, including this Item 7, as well as in other materials filed or to be filed by us with the SEC (as well as information included in oral statements or other written statements made or to be made by us).
This Form 10-K contains forward-looking statements that involve risks and uncertainties. In some cases, you can identify forward-looking statements by the following words: "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," "ongoing," "plan," "potential," "predict," "project," "should," "will," "would," or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. These statements involve known and unknown risks, uncertainties and other factors that may cause our or our industry's actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. Forward-looking statements are only predictions and are not guarantees of performance. These statements are based on our management's beliefs and assumptions, which in turn are based on currently available information. Our forward-looking statements in this Form 10-K generally relate to the following:
•our beliefs and intentions with respect to our growth strategies, including growth through strategic acquisitions, the types of acquisition targets we intend to pursue, the availability of suitable acquisition targets, the industry climate for dealer consolidation, and our ability to implement our growth strategies;
•our beliefs with respect to factors that will affect demand and seasonality of purchasing in the agricultural and construction industries;
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•our beliefs with respect to our primary supplier (CNH Industrial) of equipment and parts inventory;
•our beliefs with respect to the equipment market, our competitors and our competitive advantages;
•our beliefs with respect to the impact of U.S federal government policies on the agriculture economy;
•our beliefs with respect to the impact of commodity prices for the fossil fuels and other commodities on our operating results;
•our beliefs with respect to the impact of government regulations;
•our beliefs with respect to our business strengths and the diversity of our customer base;
•our plans and beliefs with respect to real property used in our business;
•our plans and beliefs regarding future sales, sales mix, and marketing activities;
•our beliefs and assumptions regarding the payment of dividends;
•our beliefs and assumptions regarding valuation reserves, equipment inventory balances, fixed operating expenses, and absorption rate;
•our beliefs and expectations regarding the impact of the Russia-Ukraine military conflict on our Ukrainian operations;
•our beliefs and assumptions with respect to our rental equipment operations;
•our beliefs with respect to our employee relations;
•our assumptions, beliefs and expectations with respect to past and future market conditions, including interest rates, and public infrastructure spending, new environmental standards, and the impact these conditions will have on our operating results;
•our beliefs with respect to the impact of our credit agreements, including future interest expense, limits on corporate transactions, financial covenant compliance, and ability to negotiate amendments or waivers, if needed;
•our beliefs with respect to the impact of increase or decrease in applicable foreign exchange rates;
•our plans and assumptions for future capital expenditures and rental fleet purchases;
•our cash needs, sources of liquidity, and the adequacy of our working capital.
Forward-looking statements are only predictions and are not guarantees of performance. These statements are based on our management's beliefs and assumptions, which in turn are based on currently available information. Important assumptions relating to the forward-looking statements include, among others, assumptions regarding demand for our products, the expansion of product offerings geographically, the timing and cost of planned capital expenditures, competitive conditions and general economic conditions. These assumptions could prove inaccurate. Forward-looking statements also involve known and unknown risks and uncertainties, which could cause actual results that differ materially from those contained in any forward-looking statement. Many of these factors are beyond our ability to control or predict. Such factors include, but are not limited to, the following:
•the impact of the Russian-Ukraine military conflict on our operations in Ukraine;
•assumptions regarding our cash needs and the amount of inventory we need on hand;
•general economic conditions and construction activity in the markets where we operate;
•our dependence on CNH Industrial, our primary supplier of equipment and parts inventory, and our relationships with other equipment suppliers;
•the terms of the CNH dealer agreements that subject us to restrictions that may adversely impact our business and growth;
•the risks associated with our international operations;
•risks resulting from the implementation or design of our new ERP system;
•risks resulting from the impact of the enactment of "right to repair" legislation;
•the impact of security breaches and other disruptions to our information system;
•our level of indebtedness and ability to comply with the terms of agreements governing our indebtedness;
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•the risks associated with the expansion of our business;
•the risks resulting from outbreaks or other public health crises, including COVID-19;
•the potential inability to integrate any businesses we acquire;
•competitive pressures;
•significant fluctuations in the price of our common stock;
•risks related to our dependence on our information technology systems and the impact of potential breaches and other disruptions;
•compliance with laws and regulations; and
•other factors discussed under "Risk Factors" or elsewhere in this Form 10-K.
You should read the risk factors and the other cautionary statements made in this Form 10-K as being applicable to all related forward-looking statements wherever they appear in this Form 10-K. We cannot assure you that the forward-looking statements in this Form 10-K will prove to be accurate. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified timeframe, if at all. Other than as required by law, we undertake no obligation to update these forward-looking statements, even though our situation may change in the future.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to various market risks, including changes in interest rates and foreign currency exchange rates. Market risk is the potential loss arising from adverse changes in market rates and prices such as interest rates and foreign currency exchange rates.
Interest Rate Risk
Exposure to changes in interest rates results from borrowing activities used to fund operations. For fixed rate debt, interest rate changes affect the fair value of financial instruments but do not impact earnings or cash flows. Conversely, for floating rate debt, interest rate changes generally do not affect the fair market value but do impact future earnings and cash flows, assuming other factors are held constant. We have both fixed and floating rate financing. Some of our floating rate credit facilities contain minimum rates of interest to be charged. Based upon our interest-bearing balances and interest rates as of January 31, 2022, holding other variables constant, a one percentage point increase in interest rates for the next 12-month period would decrease pre-tax earnings and cash flow by approximately $0.3 million. Conversely, a one percentage point decrease in interest rates for the next 12-month period would result in an increase to pre-tax earnings and cash flow of approximately $0.3 million. At January 31, 2022, we had total floorplan payables outstanding of $135.4 million, of which $28.6 million was interest-bearing at variable interest rates and $106.8 million was non-interest bearing. In addition, at January 31, 2022, we had total long-term debt outstanding and finance lease liabilities of $89.6 million, primarily all of which is fixed rate debt.
Foreign Currency Exchange Rate Risk
Our foreign currency exposures arise as the result of our foreign operations. We are exposed to transactional foreign currency exchange rate risk through our foreign entities holding assets and liabilities denominated in currencies other than their functional currency. In addition, the Company is exposed to foreign currency transaction risk as a result of certain intercompany financing transactions. The Company attempts to manage its transactional foreign currency exchange rate risk through the use of derivative financial instruments, primarily foreign exchange forward contracts, or through natural hedging instruments. Based upon balances and exchange rates as of January 31, 2022, holding other variables constant, we believe that a hypothetical 10% increase or decrease in all applicable foreign exchange rates would not have a material impact on our results of operations or cash flows. As of January 31, 2022, our Ukrainian subsidiary had $1.7 million of net monetary assets denominated in Ukrainian hryvnia (UAH). We have attempted to minimize our net monetary asset position through reducing overall asset levels in Ukraine and through borrowing in UAH which serves as a natural hedging instrument offsetting our net UAH denominated assets. With the Russia/Ukraine conflict significantly intensifying in February 2022, currency and payment controls imposed by the National Bank of Ukraine limit our ability to manage our net monetary asset position. However in late March 2022, Ukraine's government classified agriculture as a critical industry. This has allowed us to convert hryvnia to pay for certain parts and equipment invoices. Continuation of political tensions in the Russian/Ukraine conflict could lead to more significant UAH devaluations. The inability to fully manage our net monetary asset position and continued UAH devaluations for an extended period of time, could have a material impact on our results of operations and cash flows.
In addition to transactional foreign currency exchange rate risk, we are also exposed to translational foreign currency exchange rate risk as we translate the results of operations and assets and liabilities of our foreign operations from their functional currency to the U.S. dollar. As a result, our results of operations, cash flows and net investment in our foreign operations may be adversely impacted by fluctuating foreign currency exchange rates. We believe that a hypothetical 10% increase or decrease in all applicable foreign exchange rates, holding all other variables constant, would not have a material impact on our results of operations or cash flows.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Balance Sheets of the Company as of January 31, 2022 and 2021, and the related Consolidated Statements of Operations, Comprehensive Income, Stockholders' Equity, and Cash Flows for the years ended January 31, 2022, 2021 and 2020, and the notes thereto, have been audited by Deloitte & Touche LLP, an independent registered public accounting firm.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Titan Machinery Inc.—Financial Statements
Audited Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm (PCAOB ID No. 34) 44
Report of Independent Registered Public Accounting Firm 46
Consolidated Balance Sheets as of January 31, 2022 and 2021 47
Notes to Consolidated Financial Statements 51
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the stockholders and the Board of Directors of Titan Machinery Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Titan Machinery Inc. and subsidiaries (the "Company") as of January 31, 2022 and 2021, the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows, for each of the three years in the period ended January 31, 2022, and the related notes and the schedule listed in the Index at Part IV, Item 15 (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of January 31, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended January 31, 2022, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of January 31, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 31, 2022, expressed an unqualified opinion on the Company's internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current-period audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Inventories – Valuation of Used Equipment Inventories — Refer to Notes 1 and 5 to the financial statements
Critical Audit Matter Description
The majority of the Company’s used equipment inventories are acquired through trade-ins from customers. Equipment that is traded-in is recorded at fair value less a normal gross profit margin. The Company determines fair value for the traded-in equipment through internal and third-party data that considers various factors including the age and condition of the equipment, hours of use, and market conditions. The Company’s used equipment inventories are stated at the lower of cost (specific identification) or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The Company periodically subjects used equipment inventories to lower of cost or net realizable value assessments and adjusts carrying values when such values exceed estimated net realizable value. The Company estimates net realizable value using internal and third-party data that considers various factors including the age and condition of the equipment, hours of use, and market conditions. The used equipment inventories balance as of January 31, 2022 was $128.0 million.
Given the significant judgments made by management to determine the initial fair value and subsequent net realizable value of used equipment inventories, performing audit procedures to evaluate these judgments to determine the valuation of used equipment inventories required a high degree of auditor judgment and an increased extent of effort.
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How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to management’s judgments regarding the valuation of used equipment inventories included the following, among others:
•We tested the effectiveness of controls over the valuation of used equipment inventories, including the reasonableness of various factors including the age and condition of the equipment, hours of use, and market conditions, used to determine the net realizable value of the equipment.
•We tested the effectiveness of controls over the internal and external data used to determine the valuation of used equipment inventories.
•We evaluated the reasonableness of management’s judgments utilized to determine the net realizable value of the used equipment inventories by:
◦Evaluating the reasonableness and consistency of the methodology and assumptions used by management to determine net realizable value.
◦Testing the underlying determination of the net realizable value by obtaining sales documentation containing the age of the equipment and hours of use and comparing it to comparable internal and external data.
◦Performing a retrospective lookback analysis of management’s process by comparing the actual selling prices of used equipment inventories units sold in the current year to the selling prices estimated by management for those units in the prior year.
/s/ DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
March 31, 2022
We have served as the Company's auditor since 2013.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the stockholders and the Board of Directors of Titan Machinery Inc.
Opinion on Internal Control over Financial Reporting
We have audited the internal control over financial reporting of Titan Machinery Inc. and subsidiaries (the “Company”) as of January 31, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 31, 2022, based on criteria established in Internal Control — Integrated Framework (2013) issued by COSO.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated financial statements as of and for the year ended January 31, 2022, of the Company and our report dated March 31, 2022, expressed an unqualified opinion on those financial statements.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ DELOITTE & TOUCHE LLP
Minneapolis, Minnesota
March 31, 2022
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TITAN MACHINERY INC.
CONSOLIDATED BALANCE SHEETS
AS OF JANUARY 31, 2022 AND 2021
(in thousands, except per share data)
Assets
Current Assets
Receivables, net of allowance for expected credit losses 94,287 69,109
Noncurrent Assets
Property and equipment, net of accumulated depreciation 178,243 147,165
Intangible assets, net of accumulated amortization 10,624 7,785
Liabilities and Stockholders' Equity
Current Liabilities
Current maturities of long-term debt 5,876 4,591
Current maturities of operating leases 9,601 11,772
Long-Term Liabilities
Long-term debt, less current maturities 74,772 44,906
Deferred income taxes 2,006 —
Commitments and Contingencies (Note 12)
Stockholders' Equity
Accumulated other comprehensive income (loss) (2,172) 1,499
Total Liabilities and Stockholders' Equity $ 946,667 $ 815,789
See Notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED JANUARY 31, 2022, 2021 AND 2020
(in thousands, except per share data)
Revenue
Cost of Revenue
Impairment of Goodwill — 1,453 —
Impairment of Intangible and Long-Lived Assets 1,498 1,727 3,764
Other Income (Expense)
Earnings per Share:
Weighted Average Common Shares:
See Notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
YEARS ENDED JANUARY 31, 2022, 2021 AND 2020
(in thousands)
Other Comprehensive Income (Loss)
Foreign currency translation adjustments (3,671) 4,719 (880)
See Notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED JANUARY 31, 2022, 2021 AND 2020
(in thousands)
Shares Outstanding Amount
Stock-based compensation expense — — 2,693 — — 2,693
Cumulative-effect adjustment of adopting ASC 842, Leases — — — (5,464) — (5,464)
Other comprehensive loss — — — — (880) (880)
Stock-based compensation expense — — 2,515 — — 2,515
Other comprehensive loss — — — — 4,719 4,719
Stock-based compensation expense — — 2,554 — — 2,554
Other comprehensive income — — — — (3,671) (3,671)
See Notes to Consolidated Financial Statements
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CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED JANUARY 31, 2022, 2021 AND 2020
(in thousands)
Operating Activities
Adjustments to reconcile net income to net cash provided by operating activities
Gain on sale of property & equipment (4,525) (863) (875)
Changes in assets and liabilities
Receivables, prepaid expenses and other assets (37,037) 4,469 6,217
Investing Activities
Acquisition consideration, net of cash acquired (33,643) (6,790) (13,887)
Financing Activities
Principal payments on senior convertible notes — — (45,644)
Principal payments on long-term debt and finance leases (9,212) (15,942) (4,490)
Effect of Exchange Rate Changes on Cash (1,224) 509 (379)
Supplemental Disclosures of Cash Flow Information
Cash paid during the period
Supplemental Disclosures of Noncash Investing and Financing Activities
Long-term debt to acquire finance leases $ 11,000 $ — $ —
See Notes to Consolidated Financial Statements
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BUSINESS ACTIVITY AND SIGNIFICANT ACCOUNTING POLICIES
Nature of Business
Titan Machinery Inc. and its subsidiaries (collectively, the "Company") are engaged in the retail sale, service and rental of agricultural and construction machinery through its stores in the United States and Europe. The Company's North American stores are located in Colorado, Iowa, Minnesota, Nebraska, North Dakota, South Dakota, Wisconsin and Wyoming, and its European stores are located in Bulgaria, Germany, Romania, and Ukraine.
Russia/Ukraine Geopolitical Conflict
On February 24, 2022, the ongoing Russia/Ukraine conflict significantly intensified. Titan Machinery Ukraine, LLC. ("Titan Machinery Ukraine"), the Company's wholly owned Ukrainian subsidiary, has ten locations in Ukraine, each of which were temporarily closed for a period of time, some locations have remained closed, as the well-being of the employees is the Company's primary concern. The Company is actively monitoring the quickly evolving geopolitical situation but due to the unknown nature of this conflict, the duration of the closures are unknown and may vary across different areas of Ukraine.
For the fiscal year ended January 31, 2022, the Company had total assets of $32.7 million in Ukraine. The physical assets (e.g. inventory and fixed assets) are almost exclusively located in central and western areas of the country. The Company has been monitoring Titan Machinery Ukraine's net monetary asset position, but the currency and payment controls imposed by the National Bank of Ukraine have limited our ability to fully manage our net monetary asset position.
The Russia/Ukraine conflict did not have a significant impact on our results of operations for the fiscal year ended January 31, 2022, but depending on the extent and duration of the conflict may have a material adverse effect on Titan Machinery Ukraine's operations going forward.
Impact of the COVID-19 Pandemic
The outbreak and global spread of COVID-19, which was declared a pandemic by the World Health Organization and a national emergency by the President of the United States in March 2020, continues to have an impact on society, economies, financial markets, and businesses. While the Company's products and services were determined to be an essential business, the pandemic has had an impact on the Company's business operations, existing employees and ability to find new employees, customers, and suppliers. Uncertainty remains regarding the magnitude and duration of the pandemic and the resulting financial effects and will depend on future developments including the efficacy of vaccines, the spread of COVID-19 variants, and the extent of governmental responses, including potential vaccine or testing mandates.
On November 5, 2021, the Department of Labor's Occupational Safety and Health Administration ("OSHA") announced an Emergency Temporary Standard ("ETS") requiring all employers with at least 100 employees to ensure their employees are fully vaccinated or require weekly testing of unvaccinated employees. On January 13, 2022, the US Supreme Court granted emergency relief to stay the implementation of the ETS and on January 26, 2022, OSHA withdrew the standard. Although OSHA withdrew the vaccination and testing ETS as an enforceable emergency temporary standard, the agency is not withdrawing the ETS as a proposed rule. The agency is prioritizing resources and is focusing on finalizing a permanent COVID-19 Healthcare Standard. The ultimate impact of a permanent standard on the Company, if one were to be adopted, is currently unknown and difficult to predict.
The Company has assessed the impacts of the COVID-19 pandemic on its results of operations for the fiscal year ended January 31, 2022, and although there have been challenges, no material adverse impacts were identified. We continue to monitor developments involving our workforce, customers, and suppliers and continue to take steps to mitigate against additional impacts.
Seasonality
The agricultural and construction equipment businesses are highly seasonal, which causes the Company's quarterly results and cash flows to fluctuate during the year. The Company's customers generally purchase and rent equipment in preparation for, or in conjunction with, their busy seasons, which for farmers are the spring planting and fall harvesting seasons, and for construction customers is dependent on weather seasons in their respective regions, which is typically the second and third quarters of the Company's fiscal year for much of its Construction footprint. The Company's parts and service revenues are also typically highest during its customers' busy seasons, due to the increased use of their equipment during this time, which generates the need for more parts and service work. However, weather conditions impact the timing of our customers' busy times, which may cause the Company's quarterly financial results to differ between fiscal years. In addition, the fourth quarter
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
typically is a significant period for equipment sales in the United States because of our customers’ year-end tax planning considerations, the timing of dealer incentives and the increase in availability of funds from completed harvests and construction projects.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant accounts, transactions and profits between the consolidated companies have been eliminated in consolidation.
The Company's foreign subsidiaries have fiscal years ending on December 31 of each year, consistent with statutory reporting requirements in each of the respective countries. The accounts of the Company's foreign subsidiaries are consolidated as of December 31 of each year. No events or transactions occurred related to these subsidiaries in January 2022 that would have materially affected the consolidated financial position, results of operations or cash flows.
Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates, particularly related to realization of inventory, impairment of long-lived assets, goodwill, indefinite-lived intangible assets, collectability of receivables, and income taxes.
Concentrations of Credit Risk
The Company's sales are to agricultural and construction equipment customers principally in the states in which it has stores as well as in the European countries in which its stores are located. The Company extends credit to its customers in the ordinary course of business and monitors its customers' financial condition to minimize its risks associated with trade receivables; however, the Company does not generally require collateral on trade receivables.
The Company's cash balances are maintained in bank deposit accounts, which, generally, are in excess of federally insured limits.
Concentrations in Operations
The Company currently purchases new equipment, rental equipment and the related parts from a limited number of manufacturers. Although no change in suppliers is anticipated, the occurrence of such a change could cause a possible loss of sales and adversely affect operating results. The Company is the holder of authorized dealerships granted by CNH Industrial America, LLC and CNHI International SA (collectively referred to "CNH Industrial") whereby it has the right to act as an authorized dealer for the entity's equipment at specified locations. The dealership authorizations and floorplan payable facilities can be canceled by the respective entity if the Company does not observe certain established guidelines and covenants.
In addition, the Company believes that the following factors related to concentrations in suppliers, and in particular CNH Industrial, have a significant impact on its operating results:
•CNH Industrial's product offerings, reputation and market share
•CNH Industrial's product prices and incentive and discount programs
•Supply of inventory from CNH Industrial
•CNH Industrial provides floorplan payable financing for the purchase of a substantial portion of the Company's inventory
•CNH Industrial provides a significant percentage of the financing and lease financing used by the Company's customers to purchase CNH Industrial equipment from the Company
Revenue Recognition
Revenues are recognized when control of the promised goods or services is transferred to the customer, in an amount that reflects the consideration the Company expects to collect in exchange for those goods or services. Shipping and handling costs are recorded as cost of revenue. Sales, value added and other taxes collected from the Company's customers concurrent with the Company's revenue activities are excluded from revenue.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Equipment Revenue. Equipment revenue transactions include the sale of new and used agricultural and construction equipment. The Company satisfies its performance obligations and recognizes revenue at a point in time, primarily upon the delivery of the product. Once a product is delivered, the customer has physical possession of the asset, can direct the use of the asset, and has the significant risks and rewards of ownership of the asset. Equipment transactions often include both cash and non-cash consideration. Cash consideration is paid directly by the Company's customers or by third-party financial institutions financing the Company's customer transactions. Non-cash consideration is in the form of trade-in equipment assets. The Company assigns a value to trade-in assets by estimating a future selling price, which the Company estimates based on relevant internal and third-party data, less a gross profit amount to be realized at the time the trade-in asset is sold and an estimate of any reconditioning work required to ready the asset for sale. Both cash and non-cash consideration may be received prior to or after the Company's performance obligation is satisfied. Any consideration received prior to the satisfaction of the Company's performance obligation is recognized as deferred revenue. Receivables recognized for amounts not paid at the time our performance obligation is satisfied, including amounts due from third-party financial institutions, generally do not have established payment terms but are collected in relatively short time periods.
Parts Revenue. We sell a broad range of maintenance and replacement parts for both equipment that we sell and other types of equipment. The Company satisfies its performance obligation and recognizes revenue at a point in time, upon delivery of the product to the customer. Once a product is delivered, the Company has a present right to payment, the customer has physical possession of the asset, can direct the use of the asset, and has the significant risks and rewards of ownership of the asset. In many cases, customers tender payment at the time of delivery. Balances not paid at the time of delivery are typically due in full within 30 days. Most parts are sold with a thirty-day right of return or exchange. Historically, parts returns have not been material.
Parts revenue also includes the retail value of parts inventories consumed during the course of customer repair and maintenance services and services provided under manufacturer warranties. As further described below, we recognize revenue from these activities over time.
Service Revenue. We provide repair and maintenance services, including repairs performed under manufacturer warranties, for our customer’s equipment. We recognize service and associated parts revenue of our repair and maintenance services over time as we transfer control of these goods and services over time. The Company recognizes revenue over time in the amount to which we have the right to invoice the customer, as such an amount corresponds to the value of our performance completed to date. Generally, the Company has the right to invoice the customer for labor hours incurred and parts inventories consumed during the performance of the service arrangement. Customer invoicing most often occurs at the conclusion of our repair and maintenance services. Accordingly, we recognize unbilled receivables for the amount of unbilled labor hours incurred and parts inventories consumed under our repair and maintenance arrangements. Upon customer invoicing, unbilled receivables are reclassified to receivables. In many cases, customers tender payment at the completion of our work and the creation of the invoice. Balances not paid at the time of invoicing are typically due in full within 30 days.
Rental and Other Revenue. We rent equipment to our customers on a short-term basis for periods ranging from a few days to a few months. Rental revenue is recognized on a straight-line basis over the period of the related rental agreement. Revenue from rental equipment delivery and pick-up services is recognized when the service is performed. Other revenues primarily consist of fees charged in connection with short-haul equipment delivery and pick-up services, in which revenue is recognized at a point in time when the service is completed, and Global Positioning System ("GPS") signal subscriptions, in which revenue is recognized on a straight-line basis over the subscription period.
Manufacturer Incentives and Discounts
The Company receives various manufacturer incentives and discounts, which are based on a variety of factors. Discounts and incentives related to the purchase of inventory are recognized as a reduction of inventory prices and recognized as a reduction of cost of revenue when the related inventory is sold. Other incentives, reflecting reimbursement of qualifying expenses, are recognized as a reduction of the related expense when earned.
Receivables and Credit Policy
Trade accounts receivable due from customers are uncollateralized customer obligations due under normal trade terms requiring payment within 30 to 90 days from the invoice date. Balances unpaid after the due date based on trade terms are considered past due and begin to accrue interest. Payments of trade receivables are allocated to the specific invoices identified on the customer's remittance advice or, if unspecified, are applied to the earliest unpaid invoices. Trade accounts receivable due from manufacturers relate to discount programs and incentive programs. Trade accounts receivable due from finance companies primarily consist of contracts in transit with finance companies and balances due from credit card companies. These receivables
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do not generally have established payment terms but are collected in relatively short time periods. Unbilled receivables primarily represent unbilled labor hours incurred and parts inventories consumed during the performance of service arrangements for our customers at the Company's retail rates.
The carrying amount of trade receivables is reduced by a valuation allowance that reflects management's best estimate of the amounts that will not be collected. Management reviews aged receivable balances and estimates the portion, if any, of the balance that will not be collected. Account balances are charged off after all appropriate means of collection have been exhausted and the potential for recovery is considered remote.
Inventories
New and used equipment are stated at the lower of cost (specific identification) or net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. All new and used equipment inventories, including that which has been rented, are subject to periodic lower of cost or net realizable value evaluations that consider various factors including aging and condition of the equipment and market conditions. Equipment inventory values are adjusted whenever the carrying amount exceeds the net realizable value. Parts inventories are valued at the lower of average cost or net realizable value. The Company estimates its lower of average cost or net realizable value adjustments on its parts inventories based on various factors including aging and sales of each type of parts inventory. Work in process represents costs incurred in the reconditioning and preparation for sale of our equipment inventories.
Property and Equipment
Property and equipment is carried at cost less accumulated depreciation and amortization. Depreciation and amortization are computed on a straight-line basis over the estimated useful life of each asset, as summarized below:
Buildings and leasehold improvements Lesser of 10 - 40 years or lease term
Machinery and equipment 3 - 10 years
Furniture and fixtures 3 - 10 years
Vehicles 5 - 10 years
Rental fleet 3 - 10 years
Depreciation for income tax reporting purposes is computed using accelerated methods.
Goodwill
Goodwill is recognized and initially measured as any excess of the acquisition-date consideration transferred in a business combination over the acquisition-date amounts recognized for the net identifiable assets acquired. Goodwill is not amortized but is tested for impairment annually, or more frequently if an event occurs or circumstances change that would more likely than not result in an impairment of goodwill. Impairment testing is performed at the reporting unit level. A reporting unit is defined as an operating segment or one level below an operating segment, referred to as a component. A component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of that component. The goodwill impairment analysis is a single-step quantitative assessment that identifies both the existence of impairment and the amount of impairment loss by comparing the estimated fair value of a reporting unit to its carrying value, with any excess carrying value over the fair value being recognized as an impairment loss, limited to the total amount of goodwill allocated to that reporting unit. The Company performs its annual goodwill impairment test as of December 31st of each year. See Note 7 for details and results of the Company's impairment testing.
Intangible Assets
Intangible assets with a finite life consist of customer relationships and covenants not to compete, and are carried at cost less accumulated amortization. The Company amortizes the cost of identified intangible assets on a straight-line basis over the expected period of benefit, which is generally five years for customer relationships and the contractual term for covenants not to compete, which range from three to 5 years.
Intangible assets with an indefinite life consist of distribution rights with manufacturers. Distribution rights are classified as an indefinite-lived intangible asset because the Company's distribution agreements continue indefinitely by their terms, or are routinely awarded or renewed without substantial cost or material modifications to the underlying agreements.
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Accordingly, the Company believes that its distribution rights intangible assets will contribute to its cash flows for an indefinite period, therefore the carrying amount of distribution rights is not amortized, but is tested for impairment annually, or more frequently upon the occurrence of certain events or when circumstances indicate that impairment may be present. The impairment test is a single-step assessment that identifies both the existence of impairment and the amount of impairment loss by comparing the estimated fair value of the asset to its carrying value, with any excess carrying value over the fair value being recognized as an impairment loss. The Company performs its annual impairment test as of December 31st of each year. See Note 7 for details and results of the Company's impairment testing.
Impairment of Long-Lived Assets
The Company's long-lived assets consist of its property and equipment. These assets are reviewed for potential impairment when events or circumstances indicate that the carrying value may not be recoverable. Recoverability is measured by comparing the estimated future undiscounted cash flows of such assets to their carrying values. If the estimated undiscounted cash flows exceed the carrying value, the carrying value is considered recoverable and no impairment recognition is required. However, if the sum of the undiscounted cash flows is less than the carrying value of the asset, the estimated fair value of the long-lived asset is compared to its carrying value and any amount by which the carrying value exceeds the fair value is recognized as an impairment charge.
When reviewing long-lived assets for impairment, we group long-lived assets with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. Long-lived assets deployed and used by individual store locations are reviewed for impairment at the individual store level. Other long-lived assets shared across stores within a segment or shared across segments are reviewed for impairment on a segment or consolidated level as appropriate.
During the year ended January 31, 2022, the Company determined that certain events or circumstances, including a current period operating loss combined with historical losses and anticipated future operating losses, within certain of its stores was an indication that the long-lived assets of these stores may not be recoverable. The aggregate carrying value of such assets totaled $5.2 million. In light of these circumstances, the Company performed a long-lived asset impairment analysis for these assets and concluded that the carrying value was not recoverable. Accordingly, the Company estimated the fair value of the assets using an income approach. The Company recognized total impairment charges of $0.4 million, which relates to the International segment.
We performed similar impairment analyses at the end of fiscal 2021 and 2020. The Company recognized impairment charges totaling $0.9 million on long-lived assets during the year ended January 31, 2021, of which $0.3 million related to the Agriculture segment and $0.6 million related to the Construction segment. The Company recognized impairment charges totaling $3.1 million on long-lived assets during the year ended January 31, 2020, of which $2.3 million related to the Agriculture segment and $0.8 million related to the Construction segment. All impairment charges recognized are included in the Impairment of Intangible and Long-Lived Assets line item in the consolidated statements of operations.
Construction of Leased Assets and Sale-Leaseback Accounting
The Company, from time to time, performs construction projects on its store locations, which are recorded as property and equipment in the consolidated balance sheet during the construction period. Upon completion, these assets are either placed in service, at which point the depreciation of the asset commences, or are part of a sale-leaseback transaction with a third-party buyer/lessor. In certain other situations, the Company enters into build-to-suit construction projects with third-party lessors. Under the applicable lease accounting rules, certain forms of lessee involvement in the construction of the leased asset deem the Company to be the owner of the leased asset during the construction period and requires capitalization of the lessor's total project costs on the consolidated balance sheet with the recognition of a corresponding financing obligation. Upon completion of a project for which the constructed assets are sold to a buyer/lessor or the completion of a capitalized build-to suit construction project, the Company performs a sale-leaseback analysis to determine if the asset and related financing obligation can be derecognized from the consolidated balance sheet. Certain provisions in a number of our lease agreements, primarily provisions regarding repurchase options, are deemed to be continuing involvement in the sold asset which precludes sale recognition. In such cases, the asset remains on the consolidated balance sheet under property and equipment and the proceeds received in the sale-leaseback transaction are recognized as a financing obligation within long-term debt in the consolidated balance sheet. Both the asset and the financing obligation are amortized over the lease term. In instances in which the Company has no continuing involvement in the sold asset, the criteria for sale recognition are met and the asset and any related financing obligation are derecognized from the consolidated balance sheet, and the lease is analyzed for proper accounting treatment as either an operating or finance lease.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Derivative Instruments
In the normal course of business, the Company is subject to risk from adverse fluctuations in foreign currency exchange rates. The Company may manage its market risk exposures through a program that includes the use of derivative instruments, primarily foreign exchange forward contracts. The Company's objective in managing its exposure to market risk is to minimize the impact on earnings, cash flows and the consolidated balance sheet. The Company does not use derivative instruments for trading or speculative purposes.
All outstanding derivative instruments are recognized in the consolidated balance sheet at fair value. The effect on earnings from recognizing the fair value of the derivative instrument depends on its intended use, the hedge designation, and the effectiveness in offsetting the exposure of the underlying hedged item. Changes in fair values of instruments designated to reduce or eliminate fluctuations in the fair values of recognized assets and liabilities and unrecognized firm commitments are reported currently in earnings along with the change in the fair value of the hedged items. Changes in the fair value of derivative instruments that are not designated as hedging instruments or do not qualify for hedge accounting treatment are reported currently in earnings.
Income Taxes
The Company uses the asset and liability method to account for income taxes. Under this method, deferred tax assets and liabilities are recognized for the expected future tax consequences of differences between the carrying amounts of assets and liabilities and their respective tax bases. Deferred tax assets are reduced by a valuation allowance when it is more likely than not that a portion or all of the deferred tax assets will not be realized. Changes in valuation allowances are included in its provision for income taxes in the period of the change. Deferred tax assets and liabilities are netted by taxing jurisdiction and presented as either a net asset or liability position, as applicable, on the consolidated balance sheets.
The Company recognizes the financial statement benefit of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured as the largest amount that has a greater than 50% likelihood of being realized. Changes in the recognition or measurement of such positions are reflected in its provision for income taxes in the period of the change. The Company's policy is to recognize interest and penalties related to income tax matters within its provision for income taxes.
Advertising Costs
Costs incurred for producing and distributing advertising are expensed as incurred. Advertising expense amounted to $2.5 million, $2.2 million and $2.2 million for the years ended January 31, 2022, 2021 and 2020, respectively.
Stock-Based Compensation
The Company accounts for stock-based compensation at the fair value of the related equity instrument over the applicable service or performance period.
Comprehensive Income and Foreign Currency Matters
For the Company, comprehensive income (loss) represents net income adjusted for foreign currency translation adjustments. For the Company's foreign subsidiaries in which their local currency is their functional currency, assets and liabilities are translated into U.S. dollars at the balance sheet date exchange rate. Income and expenses are translated at average exchange rates for the year. Foreign currency translation adjustments are recorded directly as other comprehensive income (loss), a component of stockholders' equity. For the Company's foreign subsidiaries in which the local currency is not the functional currency, prior to translation into U.S. dollars, amounts must first be remeasured from the local currency into the functional currency. Nonmonetary assets and liabilities are remeasured at historical exchange rates and monetary assets and liabilities are remeasured at the balance sheet date exchange rate. Income and expenses are remeasured at average exchange rates for the year. Foreign currency remeasurement adjustments are included in the statement of operations.
The Company recognized, in interest and other income in its consolidated statements of operations, a net foreign currency transaction loss of $0.1 million and $2.8 million for the years ended January 31, 2022 and 2021, respectively, and a net foreign currency transaction gain of $0.4 million for the year ended January 31, 2020.
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Business Combinations
The Company accounts for business combinations by allocating the purchase price amongst the assets acquired, including identifiable intangible assets, and liabilities assumed based on the fair values of the acquired assets and assumed liabilities. The acquisition accounting is finalized during the measurement period, which may not exceed one year from the date of acquisition. During the measurement period the Company's accounting for the business combination transaction may be based on estimates due to various unknown factors present at the date of acquisition.
Fair Value Measurements
Fair value is defined as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. Three levels of inputs may be used to measure fair value:
Level 1—Values derived from unadjusted quoted prices in active markets for identical assets and liabilities.
Level 2—Values derived from observable inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets in markets that are not active.
Level 3—Values derived from unobservable inputs for which there is little or no market data available, thereby requiring the reporting entity to develop its own assumptions.
In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety.
Segment Reporting
The Company operates its business in three reportable segments, the Agriculture, Construction and International segments.
Recent Accounting Guidance
Accounting guidance not yet adopted
In March 2020, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting (“ASU No. 2020-04”), which provides temporary optional expedients and exceptions to accounting guidance on contract modifications and hedge accounting to ease entities’ financial reporting burdens as the market transitions from the London Interbank Offered Rate (“LIBOR”) and other interbank offered rates to alternative reference rates. ASU 2020-04 is effective upon issuance and can be applied through December 31, 2022. The Company is currently evaluating its contracts that reference LIBOR and is working with our creditors on updating credit agreements as necessary to include language regarding the successor or alternate rate to LIBOR. The Company does not expect the guidance to have a material impact on its results of operations, financial position, cash flows or disclosures.
NOTE 2 - EARNINGS PER SHARE
Earnings Per Share ("EPS")
The Company uses the two-class method to calculate basic and diluted EPS. Unvested restricted stock awards are considered participating securities because they entitle holders to non-forfeitable rights to dividends during the vesting term. Under the two-class method, earnings of the Company are allocated between common stockholders and these participating securities based on the weighted-average number of shares of common stock and participating securities outstanding during the relevant period.
Basic EPS is computed by dividing net income attributable to Titan Machinery Inc. common stockholders by the weighted-average number of shares of common stock outstanding during the relevant period. Diluted EPS is computed by dividing net income attributable to Titan Machinery Inc. common stockholders by the weighted-average number of shares of common stock outstanding after adjusting for potential dilution related to the conversion of all dilutive securities into common stock. All potentially dilutive securities were included in the computation of diluted EPS for years with net income. All anti-dilutive securities were excluded from the computation of diluted EPS.
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The following table sets forth the calculation of basic and diluted EPS:
Year Ended January 31,
(in thousands, except per share data)
Numerator
Allocation to participating securities (977) (325) (221)
Denominator
Plus: incremental shares from assumed vesting of restricted stock units 10 4 7
Earnings per Share:
NOTE 3 - REVENUE
The following tables present our revenue disaggregated by revenue source and segment for the years ended January 31, 2022, 2021 and 2020:
Agriculture Construction International Total