The following discussion of our financial condition and results of operations should be read together with the consolidated financial statements and the accompanying notes included elsewhere in this Annual Report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in those forward-looking statements as a result of certain factors, including, but not limited to, those described under "Item 1A. "Risk Factors."
With an improving economy, our leasing revenue increased approximately 7.7% from 2012. We continued to keep our business right-sized, allowing us to maintain a strong adjusted EBITDA margin of 38.7% during 2013. We generated
$109.4 millionof free cash flow in 2013 and have been cash flow positive for 24 consecutive quarters. We used this positive cash flow in 2013 to pay down debt of approximately $123.8 million. Our level of business improved on a year over year basis beginning with signs of moderate economic recovery in 2011. Our leasing revenues and total revenues improved quarter over quarter in 2011, 2012 and 2013, compared to the same period in the prior year. We continue to enact price increases, focusing on both new and existing customers that had units out on rent for an extended period of time. We continue to optimize our hybrid sales model, incorporating a local, as well as centralized component, with both groups incentivized on the basis of performance. The sales personnel at our field locations primarily focus on construction customers who tend to be large multi-unit customers that benefit from local service, while those in our NSC in Tempe, Arizonatarget the balance of our customers, which includes single-unit customers. We also have a similar model in the U.K.We monitor our business activity levels through a variety of metrics that we use to determine the optimal efficiencies for our drivers, dispatchers, managers, salespeople and corporate staff needed while continuing our focus on customer service and sales activity levels. In the past few years, as our operations began to stabilize from the economic downturn and with growth returning to our business, we began entering a few new markets and completed some small acquisitions. We redeployed existing fleet to these new locations and have been repositioning available assets to high demand markets to optimize utilization. At December 31, 2013, we operated in 136 locations throughout North Americaand the U.K.and believe we can expand to more than 50 new markets in North America. We believe these continued growth efforts, together with managing working capital and controls over capital expenditures, will allow us to generate free cash flow in 2014. In 2013, we reduced our debt by $123.8 millionand had $573.3 millionof unused borrowing capacity under our Credit Agreement as of December 31, 2013.
Our focus is on revenue growth at both our existing and new locations as we continue our sophisticated sales campaign strategies at our NSC and field locations. We intend to accomplish this in part through increasing sales personnel accountability through our disciplined sales processes, which we believe gives us a significant competitive advantage.
December 2013, we entered into a share sale and purchase agreement to sell Mobile Mini Holding B.V., comprising our Netherlandsoperation. In connection with this transaction, we recorded a $1.2 millionafter-tax loss on the sale in the fourth quarter 2013. This transaction closed on December 31, 2013and the loss on the transaction as well as 2013 and prior period results for The Netherlandsare reflected in discontinued operation in the consolidated financial statements.
We are the world's leading provider of portable storage solutions, through a total lease fleet of approximately 212,900 units at
December 31, 2013. We operate in 136 locations throughout North Americaand in the U.K., maintaining a strong leadership position in virtually all markets served. We offer a wide range of portable storage products in varying lengths and widths with an assortment of differentiated features such as our patented locking systems, premium doors, electrical wiring and shelving. Our portable storage units provide secure, accessible temporary storage for a diversified client base of over 84,000 customers across various industries, including construction, consumer services and retail, industrial, commercial and governmental. Our customers use our products for a wide variety of storage applications, including retail and manufacturing supplies, inventory and maintenance supplies, temporary offices, construction materials and equipment, documents and records and household goods. We derive most of our revenues from leasing our portable storage containers, security office units and mobile office units. We also sell new and used portable storage containers, security office units and mobile office units and provide delivery, installation and other ancillary products and services to our customers. Our sales revenues represented 9.9% and 9.4% of total revenues in 2012 and 2013, respectively. 27
Table of Contents
December 31, 2013, we operated 115 locations in the U.S., four in Canadaand 17 in the U.K.Traditionally, we have entered new markets through the acquisition of smaller local competitors and then implement our business model, which is typically more focused on customer service and marketing than the acquired business or other market competitors. We also enter new markets by migrating available fleet to new locations and high utilization markets. When we enter a new market, we incur certain costs in developing new infrastructure. For example, advertising and marketing costs are incurred and certain minimum levels of staffing and delivery equipment are put in place regardless of the new market's revenue base. Once we have achieved revenues that are sufficient to cover our fixed expenses, we are able to generate relatively high margins on incremental lease revenues. Therefore, each additional unit rented in excess of the break-even level contributes significantly to increase our profitability and operating leverage. When we refer to our operating leverage in this discussion, we are describing the impact on margins once we either cover our fixed costs or if we incur additional fixed costs in a market. With a new location, we must first fund and absorb the start-up costs for setting up the new location, hiring and developing the management and sales team and developing our marketing and advertising programs. A new location will have lower adjusted EBITDA margins in its early years until the location increases the number of units it has on rent. Because this operating leverage creates higher operating margins on incremental lease revenue, which we realize on a location-by-location basis when the location achieves leasing revenues sufficient to cover the location's fixed costs, leasing revenues in excess of the break-even amount produce large increases in profitability. Conversely, absent growth in leasing revenues, the adjusted EBITDA margin at a location is expected to remain relatively flat on a period-by-period comparative basis if expenses remained the same or would decrease if fixed costs increased. We approach the market through a hybrid sales model, consisting of a dedicated sales staff at our field locations as well as at NSC. The NSC handles inbound calls and digital leads from new customers and leads outbound sales campaigns to new and existing customers not serviced by sales personnel at our field locations. Our sales staff at the NSC work with our local field managers, dispatchers and sales personnel to ensure customers receive integrated first class service from initial call to delivery. Our field location sales staff, NSC and sales management team at our headquarters conduct sales and marketing on a full-time basis. We believe that offering local salesperson presence for customers along with the efficiencies of a centralized sales operation for customers not needing a local sales contact will continue to allow us to provide high levels of customer service and serve all of our customers in a dedicated efficient manner. The level of non-residential construction activity is an important external factor that we examine to access market trends and determine the direction of our business. Because of the degree of our operating leverage, increases or decreases in non-residential construction activity can have a significant effect on our operating margins and net income. Customers in the construction industry represented approximately 36% and 33% of our leased units at December 31, 2013and 2012, respectively. In managing our business, we focus on growing leasing revenues, particularly in existing markets where we can take advantage of the operating leverage inherent in our business model. Our goal is to increase operating margins as we continue to grow leasing revenues. We are a capital-intensive business. Therefore, in addition to focusing on earnings per share ("EPS"), we focus on adjusted EBITDA to measure our operating results. We calculate this number by first calculating EBITDA, which we define as net income before discontinued operation, net of taxes, interest expense, income taxes, depreciation and amortization and debt restructuring or extinguishment expense, including any write-off of deferred financing costs. This measure eliminates the effect of financing transactions that we enter into and it provides us with a means to track internally generated cash from which we can fund our interest expense and our lease fleet growth. In comparing EBITDA from year to year, we further adjust EBITDA to exclude non-cash share-based compensation expense and the effect of what we consider transactions or events not related to our core business operations to arrive at what we define as adjusted EBITDA. In managing our business, we measure our adjusted EBITDA margins from year to year based on the size of the location. We define this margin as adjusted EBITDA divided by our total revenues, expressed as a percentage. We use this comparison, for example, to study internally the effect that increased costs have on our margins. As capital is invested in our established locations, we achieve higher adjusted EBITDA margins on that capital than we achieve on capital invested to establish a new field location, because our fixed costs are already in place in connection with the established locations. The fixed costs are those associated with yard and delivery equipment, as well as advertising, sales, marketing and office expenses. Because EBITDA, adjusted EBITDA, EBITDA margin and adjusted EBITDA margin are non-GAAP financial measures, as defined by the SEC, we include in this Annual Report reconciliations of EBITDA to the most directly comparable financial measures calculated and presented in accordance with GAAP. These reconciliations are included in "Item 6. Selected Financial Data." 28
Table of Contents
Accounting and Operating Overview
Our leasing revenues include all rent and ancillary revenues we receive for our portable storage containers and combination storage/office and mobile office units. Our sales revenues include sales of these units to customers. Our other revenues consist principally of charges for the delivery of the units we sell. Our principal operating expenses are: (i) cost of sales; (ii) leasing, selling and general expenses and (iii) depreciation and amortization, primarily depreciation of the portable storage units and mobile offices in our lease fleet. Cost of sales is the cost of the units that we sold during the reported period and includes both our cost to buy, transport, remanufacture and modify used ocean-going containers and our cost to manufacture portable storage units and other structures. Leasing, selling and general expenses include, among other expenses, payroll and payroll related costs, advertising and other marketing expenses, real property lease expenses, commissions, repair and maintenance costs of our lease fleet and transportation equipment, stock-based compensation expense and corporate expenses for both our leasing and sales activities. Annual repair and maintenance expenses on our leased units over the last three years have averaged approximately 4.1% of lease revenues and are included in leasing, selling and general expenses. These expenses tend to increase during periods when utilization is increasing. We expense our normal repair and maintenance costs as incurred (including the cost of periodically repainting units). Our principal asset is our container lease fleet, which has historically maintained an appraised value close to its original cost. Our lease fleet primarily consists of remanufactured and modified steel portable storage containers, steel security offices, steel combination offices and wood mobile offices that are leased to customers under short-term operating lease agreements with varying terms. Depreciation is calculated using the straight-line method over the estimated useful life of our units, after the date that we put the unit in service, and are depreciated down to their estimated residual values. Our steel units are depreciated over 30 years with an estimated residual value of 55%. The depreciation policy is supported by our historical lease fleet data, which shows that we have been able to obtain comparable rental rates and sales prices irrespective of the age of our container lease fleet. Wood office units are depreciated over 20 years with an estimated residual value of 50%. Van trailers, which are a small part of our fleet, are depreciated over seven years to an estimated residual value of 20%. Van trailers, which are only added to the fleet as a result of acquisitions of portable storage businesses, are of much lower quality than storage containers and consequently depreciate more rapidly. We have other non-core products that have various other measures of useful lives and residual values. During the last five fiscal years, our annual utilization levels averaged 59.0% and ranged from a low of 53.4% in 2010 to a high of 65.8% in 2013. Average lease fleet utilization in 2013 increased 5.8 percentage points to 65.8% from 60.0% in 2012, primarily due to a 3.5% increase in units on rent. Historically, our average utilization has been somewhat seasonal with the low normally being realized in the first quarter and the high realized in the fourth quarter of each year. 29
Table of Contents
Results of Operations
The following table shows the percentage of total revenues represented by the key items that make up our statements of income:
Year Ended December 31, 2009 2010 2011 2012 2013 Revenues: Leasing 89.5 % 89.4 % 87.6 % 89.5 % 90.1 % Sales 9.9 9.8 11.6 9.9 9.4 Other 0.6 0.8 0.8 0.6 0.5 Total revenues 100.0 100.0 100.0 100.0 100.0 Costs and expenses: Cost of sales 6.5 6.5 7.3 6.1 6.3 Leasing, selling and general expenses 51.3 54.2 56.0 57.6 58.4 Merger and restructuring expenses 3.0 1.2 0.3 1.9 0.6 Asset impairment charge, net - - - - 9.5 Depreciation and amortization 10.3 10.8 9.9 9.5 8.7 Total costs and expenses 71.1 72.7 73.5 75.1 83.5 Income from operations 28.9 27.3 26.5 24.9 16.5 Other income (expense): Interest income - - - - - Interest expense (15.7 ) (17.1 ) (12.8 ) (9.8 ) (7.2 ) Debt extinguishment/restructuring expense - (3.4 ) (0.4 ) (0.7 ) - Deferred financing costs write-off - (0.2 ) - (0.5 ) - Foreign currency exchange - - - - - Income from continuing operations before provision for income taxes 13.2 6.6 13.3 13.9 9.3 Provision for income taxes 5.1 2.6 4.6 4.9 3.0 Income from continuing operations 8.1 4.0 8.7 9.0 6.3 Loss from discontinued operation, net of taxes (0.1 ) (0.1 ) (0.2 ) (0.1 ) (0.3 ) Net income 8.0 % 3.9 % 8.5 % 8.9 % 6.0 %
Twelve Months Ended
Total revenues in 2013 increased
$26.6 million, or 7.0%, to $406.5 millionfrom $379.9 millionin 2012. Leasing, our primary revenue focus, accounted for approximately 90.1% of total revenues during 2013. Leasing revenues in 2013 increased $26.3 million, or 7.7%, to $366.3 millionfrom $340.0 millionin 2012. This increase in leasing revenues was driven by an increase in the number of units on rent, increased rental rates and higher trucking and ancillary revenues. Yield (leasing revenues divided by average units on rent) increased 4.1% and includes a rental rate increase of 2.9% over 2012. Our sales of portable storage and office units increased $0.3 millionto $38.1 millionin 2013 from $37.8 millionin 2012. Other revenues are primarily related to transportation charges for the delivery of units sold and the sale of ancillary products and represented 0.5% and 0.6% of total revenues in 2013 and 2012, respectively. Cost of sales is the cost related to our sales revenue only. Cost of sales was 66.8% and 61.4% of sales revenue in 2013 and 2012, respectively. The increase in cost of sales was primarily related to the U.K.military sale in the first quarter of 2013, which was at a lower than average selling margin. Leasing, selling and general expenses increased $18.9 million, or 8.6%, to $237.6 millionin 2013 from $218.7 millionin 2012. Leasing, selling and general expenses, as a percentage of total revenues, were 58.4% and 57.6% in 2013 and 2012, respectively. Our consumer initiative program that was terminated in August 2012accounted for $4.5 millionin 2012. Excluding the consumer initiative program, leasing, selling and general expenses would have increased $23.4 million, or 10.9%, compared to 2012. This increase is primarily due to variable costs associated with an increased level of business activity. Excluding the consumer initiative program, the major increases in leasing, selling and general expenses for 2013 were: (i) payroll related costs (including stock compensation expense of $6.8 million) increased $12.9 millionas a result of hiring additional yard drivers and administrative personnel to support increased leasing activity and annual merit increases, (ii) investments in repairs and maintenance of our lease fleet and delivery equipment increased $6.3 million, and (iii) transportation costs increased $3.0 million, as a result of our fleet repositioning to high utilization markets and incremental costs as a result of our increased delivery activity. 30
Table of Contents
Merger and restructuring expenses for 2013 were
$2.4 million, compared to $7.1 millionin 2012. In 2012, these costs included the consumer initiative program that was terminated in August 2012(approximately $0.7 million) and the transition of our former President and Chief Executive Officer in December 2012(approximately $5.1 million). Other costs in 2013 and 2012 primarily represented costs associated with reductions in our workforce, lease abandonment costs and continuing MSG merger expenses. Asset impairment charge, net for 2013 was $38.7 millionand relates to the write-down of certain assets to fair value and classified as held for sale in the second quarter of 2013, less subsequent recovery of assets sold in excess of the fair values. See Note 17 to the Consolidated Financial Statements for a further discussion on asset impairment. Net income from continuing operations in 2013 decreased 26.7% to $25.2 million, compared to $34.4 millionin 2012. Net income in 2013 was negatively impacted by $38.7 million(approximately $25.0 millionafter tax) related to the asset impairment charge discussed above. Net income includes a reduction in the U.K.corporate tax rates of $1.9 millionand $1.2 millionin 2013 and 2012, respectively. Net income in 2012 was also negatively impacted by $4.7 million(approximately $2.9 millionafter tax), respectively, related to debt restructuring expense and deferred financing costs write-off discussed below. Net income results also include merger and restructuring expenses of $2.4 millionand $7.1 million(approximately $1.5 millionand $4.4 millionafter tax) for 2013 and 2012, respectively. Adjusted EBITDA increased $12.0 million, or 8.3%, to $157.5 million, compared to $145.4 millionin 2012. Adjusted EBITDA margins were 38.7% and 38.3% of total revenues for 2013 and 2012, respectively. Expenses prior to terminating our consumer initiative program adversely impacted adjusted EBITDA in 2012 by approximately $4.2 million. Excluding this charge, adjusted EBITDA in 2012 would be approximately $149.6 million. Depreciation and amortization expenses remained relatively the same at $35.4 millionin 2013 and $36.0 millionin 2012. Our depreciation expense relates to property, plant and equipment, primarily trucks, forklifts and trailers to support the lease fleet, the customized ERP, CRM and other systems to enhance our reporting environment together with our lease fleet depreciation expense. Interest expense decreased $7.8 million, or 20.9%, to 29.5 million in 2013 from $37.3 millionin 2012. The decrease in interest expense is attributable to a decrease in our lower average debt outstanding in 2013 compared to 2012, principally due to the use of operating cash flow to reduce our debt over the past year as well as a lower weighted average interest rate. In August 2012, we redeemed $150.0 millionaggregate principal balance outstanding of our 6.875% senior notes due 2015 (the "2015 Notes") by drawing down funds under our lower variable interest rate Credit Agreement. Our average annual debt outstanding decreased $92.6 million, or 13.6%, compared to the same period last year. The annual weighted average interest rate on our debt was 4.5% for 2013, compared to 5.0% for 2012, excluding the amortizations of debt issuance and other costs. Taking into account the amortizations of debt issuance and other costs, the annual weighted average interest rate was 5.0% in 2013 and 5.5% in 2012.
Debt restructuring expense in 2012 was
Deferred financing costs write-off in 2012 of
$1.9 millionrepresents the unamortized deferred financing costs associated with the redemption of the 2015 Notes in August 2012and a portion of the deferred financing costs associated with our prior $850.0 millioncredit agreement, which was replaced in February 2012with our $900.0 millionCredit Agreement. Our annual effective tax rate was 32.7% for 2013, compared to 35.0% for 2012. In July 2013and 2012, the U.K'sgovernment authorized reductions in the corporate income tax rates. This change reduced our deferred tax liability in the U.K.by approximately $1.9 millionand $1.2 millionin 2013 and 2012, respectively. Our 2013 consolidated tax provision includes the enacted tax rates for our operations in the U.S., Canadaand the U.K.See Note 8 to the Consolidated Financial Statements for a further discussion on income taxes. At December 31, 2013, we had a federal net operating loss carryforward of approximately $264.1 million, which expires, if unused, from 2022 to 2031. In addition, we had net operating loss carryforwards in the various states in which we operate. We believe, based on internal projections, that we will generate sufficient taxable income needed to realize the corresponding federal and state deferred tax assets to the extent they are recorded as deferred tax assets in our balance sheet. Loss from discontinued operation, net of tax, was $1.3 millionin 2013, of which $1.2 millionresulted from the sale, and $0.2 millionin 2012 and represents our Netherlandsoperation that was sold in December 2013. See Note 18 to the Consolidated Financial Statements. 31
Table of Contents
Twelve Months Ended
Total revenues in 2012 increased
$20.8 million, or 5.8%, to $379.9 millionfrom $359.1 millionin 2011. Leasing, our primary revenue focus, accounted for approximately 89.5% of total revenues during 2012. Leasing revenues in 2012 increased $25.3 million, or 8.0%, to $340.0 millionfrom $314.7 millionin 2011. This increase in leasing revenues was driven by an increase in the number of units on rent, increased rental rates and higher trucking and ancillary revenues. Yield (leasing revenues divided by average units on rent) increased 4.5% and includes a rental rate increase of 1.5% over 2011. In 2012, leasing revenues increased primarily as the result of an improving economic environment. Revenues from the sale of portable storage and office units decreased $3.9 million, or 9.4%, to $37.8 millionin 2012 from $41.7 millionin 2011 and reflects a lower volume of units sold, driven by market demand. Other revenues are primarily related to transportation charges for the delivery of units sold and the sale of ancillary products and represented 0.6% and 0.8% of total revenues in 2012 and 2011, respectively. Cost of sales is the cost related to our sales revenue only. Cost of sales was 61.4% and 62.7% of sales revenue in 2012 and 2011, respectively. Although we sold fewer units, the units we sold were at a higher average selling margin, compared to 2011. Leasing, selling and general expenses increased $17.5 million, or 8.7%, to $218.7 millionin 2012 from $201.2 millionin 2011. Leasing, selling and general expenses, as a percentage of total revenues, were 57.6% and 56.0% in 2012 and 2011, respectively. Our consumer initiative program that was terminated in August 2012accounted for $4.5 millionof these additional expenses. Excluding the consumer initiative program, leasing, selling and general expenses would have increased $13.0 million, to $214.2 million, or 6.4% compared to 2011. This increase is primarily due to variable costs associated with an increased level of business activity. Excluding the consumer initiative program, the major increases in leasing, selling and general expenses for 2012 were: (i) payroll and related payroll costs increased by $3.9 millionas a result of increased leasing activity, annual merit increases and a higher level of performance compensation achieved, (ii) delivery and freight costs increased $2.5 milliondue to an increase in delivery activity of units and the deployment of units to our four new locations in 2012, (iii) repairs and maintenance expenses of our lease fleet and delivery equipment increased $2.0 millionas a result of an increase in delivery activity in both our core business and holiday rental business, and (iv) insurance costs increased $1.9 millionprimarily related to higher claims. Fixed costs for building and land leases for our locations, including real property taxes, increased $1.1 millionprimarily due to contractual rate increases, new market locations and property tax increases and advertising expense decreased $0.9 million. Merger and restructuring expenses for 2012 was $7.1 million, compared to $1.1 millionin 2011. In 2012, these costs included the consumer initiative program (approximately $0.7 million) that was terminated in August 2012and a transition of leadership (approximately $5.1 millionpursuant to an employment agreement and a separation agreement), whereby our former President and Chief Executive Officer stepped down from such positions and as a member of our Board of Directors effective December 23, 2012. Other costs in 2012 and 2011 primarily represented costs associated with reductions in our workforce. Net income from continuing operations in 2012 increased 10.5% to $34.4 million, compared to $31.2 millionin 2011. Net income includes $1.2 millionand $1.1 millionin 2012 and 2011, respectively, due to the U.K.'sreduction in the corporate tax rates discussed below. Net income in 2012 and 2011 was also negatively impacted by $4.7 millionand $1.3 million(approximately $2.9 millionand $0.8 millionafter tax), respectively, related to debt restructuring expense and deferred financing costs write-off discussed below. Net income results also include merger and restructuring expenses of $7.1 millionand $1.1 million(approximately $4.4 millionand $0.7 millionafter tax) for 2012 and 2011, respectively. Adjusted EBITDA increased $5.3 million, or 3.8%, to $145.4 million, compared to $140.1 millionin 2011. Adjusted EBITDA margins were 38.3% and 39.0% of total revenues for 2012 and 2011, respectively. Expenses prior to terminating our consumer initiative program adversely impacted adjusted EBITDA in 2012 by approximately $4.2 million. Excluding this charge, adjusted EBITDA would have increased $9.5 millionto $149.6 million, compared to 2011, and adjusted EBITDA margin would have been approximately 39.4%. Depreciation and amortization expenses remained relatively the same at $36.0 millionin 2012 and $35.4 millionin 2011. Our depreciation expense relates to property, plant and equipment, primarily trucks, forklifts and trailers to support the lease fleet, the customized ERP, CRM and other systems to enhance our reporting environment together with our lease fleet depreciation expense. Depreciation expense for 2012 increased $1.3 millionand was partially offset by a decrease in amortization of intangible assets by $0.7 million. Interest expense decreased $8.8 million, or 19.2%, to $37.3 millionin 2012 from $46.1 millionin 2011. The decrease in interest expense is attributable to a decrease in our lower average debt outstanding in 2012, compared to 2011, principally due to the use of operating cash flow to reduce our debt over the past year as well as a lower weighted average interest rate. In August 2012, we redeemed $150.0 millionaggregate principal balance outstanding of our 2015 Notes by drawing down funds under our lower variable interest rate Credit Agreement. The redemption of these notes was estimated to produce in excess of $6.6 millionin annualized interest savings based on our then current Credit Agreement borrowing rate and debt level. Our average annual debt outstanding decreased $53.9 million, or 7.3%, compared to the same period last year. The annual weighted average interest rate on our debt was 5.0% for 2012, compared to 5.7% for 2011, excluding the amortizations of debt issuance and other costs. Taking into account the amortizations of debt issuance and other costs, the annual weighted average interest rate was 5.5% in 2012 and 6.3% in 2011. 32
Table of Contents
Debt restructuring expense in 2012 was
$2.8 millionand related to the redemption of the 2015 Notes, representing the redemption premiums and the write-off of the unamortized original issuance discount related to such redeemed notes. Debt restructuring expense in 2011 was $1.3 million, which related to the redemption of $22.3 millionaggregate principal balance outstanding of our 9.75% senior notes due 2014 and represents the redemption premiums and the write-off of the unamortized acquisition date discount related to such redeemed notes. Deferred financing costs write-off in 2012 of $1.9 millionrepresents the unamortized deferred financing costs associated with the redemption of the 2015 Notes in August 2012and a portion of the deferred financing costs associated with our prior $850.0 millioncredit agreement, which was replaced in February 2012with our $900.0 millionCredit Agreement. Our annual effective tax rate was 35.0% for 2012, compared to 34.7% for 2011. In July 2012and 2011, the U.K'sgovernment authorized reductions in the corporate income tax rates. This change reduced our deferred tax liability in the U.K.by approximately $1.2 millionand $1.0 millionin 2012 and 2011, respectively. Our 2012 consolidated tax provision includes the enacted tax rates for our operations in the U.S. Canadaand the U.K.See Note 8 to the Consolidated Financial Statements for a further discussion on income taxes. Loss from discontinued operation, net of tax, was $0.2 millionand $0.6 millionin 2012 and 2011, respectively. Amounts represent our Netherlandsoperation sold in December 2013with amounts recast and reflected as a discontinued operation. See Note 18 to the Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Leasing is a capital-intensive business that requires us to acquire assets before they generate revenues, cash flow and earnings. The assets that we lease have very long useful lives and require relatively little maintenance expenditures. Most of the capital we have deployed in our leasing business historically has been used to expand our operations geographically, to increase the number of units available for lease at our existing locations, and to add to the mix of products we offer. During recent years, our operations have generated annual cash flow that exceeds our pre-tax earnings, particularly due to cash flow from operations and the deferral of income taxes caused by accelerated depreciation of our fixed assets in our tax return filings. Our cash flow from operations has been positive even after capital expenditures for the past five years. During the past five years, our capital expenditures and acquisitions have been funded by our cash flow from operations and in 2013, we generated free cash flow of
$109.4 million. We define free cash flow as net cash provided by operating activities, minus or plus, net cash used in or provided by investing activities, excluding acquisitions and certain transactions. Free cash flow is a non-GAAP financial measure and is not intended to replace net cash provided by operating activities, the most directly comparable financial measure prepared in accordance with GAAP. We present free cash flow because we believe it provides useful information regarding our liquidity and ability to meet our short-term obligations. In particular, free cash flow indicates the amount of cash available after capital expenditures for, among other things, investments in our existing businesses, debt service obligations, pay authorized quarterly dividends and strategic acquisitions. (See Item 6, "Free Cash Flow", for the reconciliation of cash provided by operating activities to free cash flow). We expect this trend to continue in 2014. As our utilization and demand for certain product types increases, we may spend more to meet those demands, as was the case in the U.K.during 2012 and 2013. In addition to free cash flow, our principal current source of liquidity is our Credit Agreement described below. Revolving Credit Facility. On February 22, 2012, we entered into our $900.0 millionCredit Agreement with Deutsche Bank AG New York Branch and other lenders party thereto. The Credit Agreement provides for a five-year, revolving credit facility and matures on February 22, 2017. The obligations of us and our subsidiary guarantors under the Credit Agreement are secured by a blanket lien on substantially all of our assets. At December 31, 2013, we had $319.3 millionof borrowings outstanding and $573.3 millionof additional borrowing availability under the Credit Agreement, based upon borrowing base calculations as of such date. We were in compliance with the terms of the Credit Agreement as of December 31, 2013and were above the minimum borrowing availability threshold and therefore not subject to any financial maintenance covenants. Amounts borrowed under the Credit Agreement and repaid or prepaid during the term may be reborrowed. Outstanding amounts under the Credit Agreement bear interest at our option at either: (i) LIBORplus a defined margin, or (ii) the Agent bank's prime rate plus a margin. The applicable margin for each type of loan is based on an availability-based pricing grid and ranges from 1.75% to 2.25% for LIBORloans and 0.75% to 1.25% for base rate loans at each measurement date. Based on the pricing grid at December 31, 2013, the applicable margins are 2.00% for LIBORloans and 1.00% for base rate loans and will be remeasured at the end of the next measurement date, which is within 10 days following the end of each fiscal quarter. Availability of borrowings under the Credit Agreement is subject to a borrowing base calculation based upon a valuation of our eligible accounts receivable, eligible container fleet (including containers held for sale, work-in-process and raw materials) and machinery and equipment, each multiplied by an applicable advance rate or limit. The lease fleet is appraised at least once annually by a third-party appraisal firm and up to 90% of the net orderly liquidation value, as defined in the Credit Agreement, is included in the borrowing base to determine how much we may borrow under the Credit Agreement. 33
Table of Contents
The Credit Agreement provides for
U.K.borrowings, which are, at our option, denominated in either Pounds Sterling or Euros, by our U.K.subsidiary based upon a U.K.borrowing base; Canadian borrowings, which are denominated in Canadian dollars, by our Canadian subsidiary based upon a Canadian borrowing base; and U.S. borrowings, which are denominated in U.S. dollars, based upon a U.S. borrowing base along with any Canadian assets not included in the Canadian subsidiary. The Credit Agreement also contains customary negative covenants, including covenants that restrict our ability to, among other things: (i) allow certain liens to attach to the Company or its subsidiary assets; (ii) repurchase or pay dividends or make certain other restricted payments on capital stock and certain other securities, prepay certain indebtedness or make acquisitions or other investments subject to Payment Conditions (as defined in the Credit Agreement); and (iii) incur additional indebtedness or engage in certain other types of financing transactions. Payment Conditions allow restricted payments and acquisitions to occur without financial covenants as long as we have $225.0 millionof pro forma excess borrowing availability under the Credit Agreement. We must also comply with specified financial maintenance covenants and affirmative covenants only if we fall below $90.0 millionof borrowing availability levels. We believe our cash provided by operating activities will provide for our normal capital needs for the next twelve months. If not, we have sufficient borrowings available under our Credit Agreement to meet any additional funding requirements. We monitor the financial strength of our lenders on an ongoing basis using publicly-available information. Based upon that information, we do not presently believe that there is a likelihood that any of our lenders will be unable to honor their respective commitments under the Credit Agreement. Senior Notes. At December 31, 2013, we had outstanding $200.0 millionaggregate principal amount of 7.875% senior notes due 2020 (the "2020 Notes" or the "Senior Notes"). Interest on the 2020 Notes is payable semiannually in arrears on June 1and December 1of each year. The $150.0 millionoutstanding principal balance of the 2015 Notes was fully redeemed on August 2, 2012. We drew upon our Credit Agreement to fund the redemption. Operating Activities. Net cash provided by operating activities was $116.1 million, compared to $90.9 millionin 2012 and $85.0 millionin 2011. The $25.2 millionincrease in cash provided by operating activities in 2013 compared to 2012 was primarily attributable to an increase in net income after giving effect to non-cash items, partially offset by an increase in working capital. The $5.9 millionincrease in cash provided by operating activities in 2012 compared to 2011 was primarily attributable to an increase in net income after giving effect to non-cash items, partially offset by an increase in working capital. In 2012, working capital was primarily affected by a decrease in accounts payable caused by the timing of scheduled payments compared to the prior year. Cash provided by operating activities is enhanced by the deferral of most income taxes due to the rapid tax depreciation rate of our assets and our federal and state net operating loss carryforwards. At December 31, 2013, we had a federal net operating loss carryforward of approximately $264.1 millionand a net deferred tax liability of $209.6 million. Investing Activities. Net cash used in investing activities was $6.0 millionin 2013, compared to $29.4 millionin 2012 and $12.8 millionin 2011. In 2013, we did not enter into any acquisitions as compared to payments for acquisitions of $3.6 millionand $7.8 millionin 2012 and 2011, respectively. Cash proceeds from sale of lease fleet units, net of expenditures for our lease fleet was $7.1 millionin 2013, compared to net capital expenditures of $14.6 millionin 2012, and compared to net cash proceeds of $6.4 millionin 2011. Lease fleet capital expenditures in 2013 included modifying and remanufacturing units for higher utilization markets in North Americaand for units acquired for the U.K.with an increase in demand. Lease fleet capital expenditures decreased in 2013 from 2012 levels as we alternatively invested in our existing fleet through normal repairs and maintenance, which is expensed as incurred. Our capital expenditures for our lease fleet increased in 2012 from 2011 levels as we added lease fleet to higher utilization markets, primarily in the U.K.Proceeds from sale of lease fleet units in 2013 increased 22.5%, compared to 2012 and decreased 18.9% in 2012, compared to 2011. The $36.0 millionin proceeds from sale of lease fleet units in 2013 includes a bulk sale to the U.K.military of approximately $4.3 millionand approximately $7.8 millionfrom the impaired assets held for sale. Additions to the lease fleet primarily include remanufacturing of prior acquisition units and manufactured steel offices and other steel units for higher utilization markets. During the past several years, we have continued the customization of our fleet, enabling us to differentiate our products from our competitors' products, and we have complimented our lease fleet by adding steel security offices. Capital expenditures for property, plant and equipment, net of proceeds from any sale of property, plant and equipment, were $13.8 millionin 2013, $11.2 millionin 2012 and $11.4 millionin 2011. The expenditures for property, plant and equipment in 2013 and 2012 were primarily for replacement of our transportation equipment and upgrades to technology equipment. The expenditures for property, plant and equipment in 2011 were primarily for delivery equipment, technology and communication improvements and improvements to our field locations. The amount of cash that we use during any period in investing activities is almost entirely within management's discretion. We anticipate our near term investing activities will be primarily focused on investments in transportation and technology equipment as well as some remanufacturing of lease fleet units and adding lease fleet in higher utilization markets. We have no contracts or other arrangements pursuant to which we are required to purchase a fixed or minimum amount of goods or services in connection with any portion of our business. Maintenance capital expenditures is the cost to replace old forklifts, trucks and trailers that we use to move and deliver our products to our customers, and for replacements to enhance our computer information and communication systems. Our maintenance capital replacements were approximately $8.3 millionin 2013, $5.5 millionin 2012 and $3.5 millionin 2011. In addition, we financed equipment through capital lease obligations of $8.5 millionand $0.3 millionin 2013 and 2012, respectively. 34
Table of Contents
Financing Activities. Net cash used in financing activities was
$110.3 millionin 2013, compared to $60.7 millionin 2012 and $71.1 millionin 2011. In 2013, reductions in our net borrowings under our Credit Agreement were $123.1 million. In 2012, reductions in our net borrowings under our Credit Agreement was $52.8 million, before giving effect to redeeming $150.0 millionaggregate principal amount of the 2015 Notes. In connection with the redemption of the 2015 Notes in 2012, we incurred approximately $2.6 millionin redemption premiums and incurred financing costs of approximately $8.1 millionfor the Credit Agreement entered into on February 22, 2012. In 2011, we reduced our net borrowings under our prior credit agreement by $51.7 millionin addition to redeeming $22.3 millionprincipal amount of our 9.75% senior notes due 2014. In connection with the redemption of these notes, we incurred approximately $1.1 millionin tender premiums. We received $13.8 million, $3.6 millionand $5.3 millionfrom the exercises of employee stock options and the related tax benefits in 2013, 2012 and 2011, respectively, and acquired $0.4 millionin outstanding common stock. As of December 31, 2013, we had $319.3 millionof borrowings outstanding under our Credit Agreement and approximately $573.3 millionof additional borrowings were available to us under such agreement. Hedging Activities. Interest rate swap agreements are the only instruments that we have used to manage our interest rate fluctuations affecting our variable rate debt. We historically have entered into interest rate swap agreements that effectively fixed the interest rate so that the rate is payable based upon a spread from fixed rates, rather than a spread from the LIBORrate. At December 31, 2013and December 31, 2012, we did not have any interest rate swap agreements.
Contractual Obligations and Commitments
Our contractual obligations primarily consist of our outstanding balance under the Credit Agreement,
$200.0 millionaggregate principal amount of the 2020 Notes and obligations under capital leases. We also have operating lease commitments for: (i) real estate properties for the majority of our locations with remaining lease terms typically ranging from one to five years; (ii) delivery, transportation and yard equipment, typically under a five-year lease with purchase options at the end of the lease term at a stated or fair market value price and (iii) office related equipment. At December 31, 2013, primarily in connection with securing of our insurance policies, we provided certain insurance carriers and others with approximately $7.4 millionin letters of credit. We currently do not have any obligations under purchase agreements or commitments.
The table below provides a summary of our contractual commitments as of
Payments Due by Period Less Than More Than Total 1 Year 1-3 Years 3-5 Years 5 Years (In thousands) Revolving credit facility
$ 319,314$ - $ - $ 319,314$ - Scheduled interest payment obligations under our revolving credit facility(1) 34,880 6,976 13,952 13,952 - Senior Notes 200,000 - - - 200,000 Scheduled interest payment obligations under our Senior Notes(2) 102,375 15,750 31,500 31,500 23,625 Obligations under capital leases 8,781 1,298 2,147 1,976 3,360 Scheduled interest payment obligations under our capital leases(3) 731 178 271 183 99 Operating leases(4) 45,471 16,840 19,631 8,214 786 Total contractual obligations $ 711,552 $ 41,042 $ 67,501 $ 375,139 $ 227,870
(1) Scheduled interest rate obligations under our revolving credit facility,
which is subject to a variable rate of interest, were calculated using our
weighted average rate 2.19% at
(2) Scheduled interest rate obligations under our Senior Notes were calculated
using the stated rate of 7.875%.
(3) Scheduled interest rate obligations under capital leases were calculated
using imputed rates ranging from 1.8% to 8.1%.
(4) Operating lease obligations include operating commitments and restructuring
related commitments and are net of sub-lease income. For further discussion
see Note 12 to our Consolidated Financial Statements.
Off-Balance Sheet Transactions
We do not maintain any off-balance sheet transactions, arrangements, obligations or other relationships with unconsolidated entities or others that are reasonably likely to have a material current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. 35
Table of Contents
Demand from some of our customers is somewhat seasonal. Demand for leases of our portable storage units by large retailers is stronger from September through December because these retailers need to store more inventories for the holiday season. These retailers usually return these leased units to us in December and early in the following year. This seasonality has historically caused lower utilization rates for our lease fleet during the first quarter of each year.
Critical Accounting Policies, Estimates and Judgments
Our significant accounting policies are disclosed in Note 1 to our Consolidated Financial Statements. The following discussion addresses our most critical accounting policies, some of which require significant judgment.
Our consolidated financial statements have been prepared in accordance with GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses during the reporting period. These estimates and assumptions are based upon our evaluation of historical results and anticipated future events, and these estimates may change as additional information becomes available. The
SECdefines critical accounting policies as those that are, in management's view, most important to our financial condition and results of operations and those that require significant judgments and estimates. Management believes that our most critical accounting policies relate to: Revenue Recognition. We recognize revenue, including multiple element arrangements, in accordance with the provisions of applicable accounting guidance. We generate revenue from the leasing of portable storage containers and office units, as well as other services such as pickup and delivery. In most instances, we provide some of the above services under the terms of a single customer lease agreement. We also generate revenue from the sale of containers and office units. Our lease arrangements typically include lease deliverables such as the lease of container or office unit and ancillary charges related to the leased container or office unit during the lease term. Arrangement consideration is allocated between lease deliverables and non-lease deliverables based on the relative estimated selling (leasing) price of each deliverable. Estimated selling (leasing) price of the lease deliverables is based on the price of those deliverables when sold separately (vendor-specific objective evidence). Because delivery and pick-up services are not sold separately by us, the estimated selling price of those deliverables is based on prices charged for similar services provided by other vendors (third party evidence of fair value). The arrangement consideration allocated to lease deliverables is accounted for pursuant to accounting guidance on leases. Such revenues from leases are billed in advance and recognized as earned, on a straight line basis over the lease period specified in the associated lease agreement. Lease agreement terms typically span several months or longer. Because the term of the agreements can extend across financial reporting periods, when leases are billed in advance, we defer recognition of revenue and record unearned leasing revenue at the end of reporting period so that rental revenue is included in the appropriate period. Transportation revenue from container and mobile office delivery service is recognized on the delivery date and is recognized for pick-up service when the container or office unit is picked-up. We recognize revenues from sales of containers and office units upon delivery when the risk of loss passes, the price is fixed and determinable and collectability is reasonably assured. We sell our products pursuant to sales contracts stating the fixed sales price with our customers. Share-Based Compensation. We account for share-based compensation using the modified-prospective-transition method and recognize the fair-value of share-based compensation transactions in the consolidated statements of income. The fair value of our share-based awards is estimated at the date of grant using the Black-Scholes option pricing model. The Black-Scholes valuation calculation requires us to estimate key assumptions such as future stock price volatility, expected terms, risk-free rates and dividend yield. Expected stock price volatility is based on the historical volatility of our stock. We use historical data to estimate option exercises and employee terminations within the valuation model. The expected term of options granted is derived from an analysis of historical exercises and remaining contractual life of stock options, and represents the period of time that options granted are expected to be outstanding. The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of grant. We historically had not paid cash dividends and therefore have assumed a 0% dividend rate in 2012. If our actual experience differs significantly from the assumptions used to compute our share-based compensation cost, or if different assumptions had been used, we may have recorded too much or too little share-based compensation cost. In the past, we have issued stock options and restricted stock, which we also refer to as nonvested share-awards. For stock options and nonvested share-awards subject solely to service conditions, we recognize expense using the straight-line method. For nonvested share-awards subject to service and performance conditions, we are required to assess the probability that such performance conditions will be met. If the likelihood of the performance condition being met is deemed probable, we will recognize the expense using the accelerated attribution method. In addition, for both stock options and nonvested share-awards, we are required to estimate the expected forfeiture rate of our stock grants and only recognize the expense for those shares expected to vest. If the actual forfeiture rate is materially different from our estimate, our share-based compensation expense could be materially different. We had approximately $15.2 millionof total unrecognized compensation costs related to stock options at December 31, 2013that are expected to be recognized over a weighted average period of 1.7 years and $9.7 millionof total unrecognized compensation costs related to nonvested share-awards at December 31, 2013that are expected to be recognized over a weighted average period 2.6 years. See Note 10 to the Consolidated Financial Statements for a further discussion of share-based compensation. 36
Table of Contents
Allowance for Doubtful Accounts. We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We establish and maintain reserves against estimated losses based upon historical loss experience and evaluation of past due accounts receivables. Management reviews the level of the allowances for doubtful accounts on a regular basis and adjusts the level of the allowances as needed. If we were to increase the factors used for our reserve estimates by 25%, it would have the following approximate effect on our net income and diluted EPS as follows: Years Ended December 31, 2012 2013 (In thousands except per share data) Continuing Operations: As reported: Net income
$ 34,423 $ 25,224Diluted EPS $ 0.76 $ 0.55As adjusted for change in estimates: Net income $ 34,010 $ 24,818Diluted EPS $ 0.75 $ 0.54
If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
Impairment of Goodwill. We assess the impairment of goodwill and other identifiable intangibles on an annual basis or whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Some factors we consider important which could trigger an impairment review include the following:
• significant under-performance relative to historical, expected or
projected future operating results;
• significant changes in the manner of our use of the acquired assets or the
strategy for our overall business; • our market capitalization relative to net book value; and • significant negative industry or general economic trends. We operate in two reportable segments,
North Americaand the U.K.All of our goodwill was allocated between these two reporting units. At December 31, 2013, North Americaand the U.K.have goodwill subject to impairment testing. We perform an annual impairment test on goodwill at December 31, 2013. In addition, we perform impairment tests during any reporting period in which events or changes in circumstances indicate that an impairment may have incurred. In assessing the fair value of the reporting units, we consider both the market approach and the income approach. Under the market approach, the fair value of the reporting unit is based on quoted market prices of companies comparable to the reporting unit being valued. Under the income approach, the fair value of the reporting unit is based on the present value of estimated cash flows. The income approach is dependent on a number of significant management assumptions, including estimated future revenue growth rates, gross margins on sales, operating margins, capital expenditures, tax payments and discount rates. Each approach is given equal weight in arriving at the fair value of the reporting unit. As of December 31, 2013, management assessed qualitative factors and determined it is more likely than not each of our two reporting units assigned goodwill had estimated fair values greater than the respective reporting unit's individual net asset carrying values; therefore, the two step impairment test was not required. Impairment of Long-Lived Assets. Our lease fleet, property, plant and equipment and intangibles with finite lives (those assets resulting from acquisitions) are reviewed for impairment when events or circumstances indicate these assets might be impaired. We test impairment using historical cash flows and other relevant facts and circumstances as the primary basis for our estimates of future cash flows. This process requires the use of estimates and assumptions, which are subject to a high degree of judgment. If these assumptions change in the future, whether due to new information or other factors, we may be required to record impairment charges for these assets. Management evaluated its long-lived assets for impairment during the third quarter of 2013 and determined there is no impairment on a held-for-use basis. However, in the second quarter of 2013, with a strategic focus on increasing return on capital and a move toward a rent-ready business model, we conducted an assessment of our lease fleet and rolling stock equipment. Management determined that certain of these units were either non-core to our leasing strategy or were uneconomic to repair. In connection with this evaluation, management determined to place the assets for sale, resulting in a non-cash asset impairment charge on long-lived assets in the second quarter of 2013. See Note 17 to the accompanying Consolidated Financial Statement for a further discussion on the asset impairment. There were no indicators of impairment at December 31, 2013. 37
Table of Contents
Depreciation Policy. Our depreciation policy for our lease fleet uses the straight-line method over the estimated useful life of our units, after the date that we put the unit in service. Our steel units are depreciated over 30 years with an estimated residual value of 55%. Wood offices units are depreciated over 20 years with an estimated residual value of 50%. Van trailers, which are a small part of our fleet, are depreciated over seven years to an estimated 20% residual value. We have other non-core products that have various other measures of useful lives and residual values. Van trailers and other non-core products are typically only added to the fleet as a result of acquisitions of portable storage businesses. We periodically review our depreciation policy against various factors, including the results of our lenders' independent appraisal of our lease fleet, practices of the competitors in our industry, profit margins we achieve on sales of depreciated units and lease rates we obtain on older units. At the end of the second quarter of 2013, in conjunction with our analysis of certain assets, we re-evaluated our depreciation policies and modified the useful life and residual values on our forklifts and non-core aluminum containers, which became effective on
July 1, 2013. If we were to change our depreciation policy on our steel units from a 55% residual value and a 30-year life to a lower or higher residual value and a shorter or longer useful life, such change could have a positive, negative or neutral effect on our earnings, with the actual effect determined by the change. For example, a change in our estimates used in our residual values and useful life would have the following approximate effect on our net income and diluted EPS as reflected in the table below. Useful Residual Life in Value Years 2012 2013 (In thousands except per share data) Continuing Operations: As Reported: 55 % 30 Net income $ 34,423 $ 25,224Diluted EPS $ 0.76 $ 0.55As adjusted for change in estimates: 70 % 20 Net income $
Diluted EPS $
As adjusted for change in estimates: 62.5 % 25 Net income $
Diluted EPS $
As adjusted for change in estimates: 50 % 20 Net income $
Diluted EPS $
As adjusted for change in estimates: 47.5 % 35 Net income $
Diluted EPS $
As adjusted for change in estimates: 40 % 40 Net income $
Diluted EPS $
As adjusted for change in estimates: 30 % 25 Net income $
Diluted EPS $
As adjusted for change in estimates: 25 % 25 Net income
$ 25,222 $ 15,702Diluted EPS $ 0.56 $ 0.34Insurance Reserves. Our worker's compensation, auto and general liability insurance are purchased under large deductible programs. Our current per incident deductibles are: worker's compensation $250,000, auto $500,000and general liability $100,000. We provide for the estimated expense relating to the deductible portion of the individual claims. However, we generally do not know the full amount of our exposure to a deductible in connection with any particular claim during the fiscal period in which the claim is incurred and for which we must make an accrual for the deductible expense. We make these accruals based on a combination of the claims development experience of our staff and our insurance companies. At year end, the accrual is reviewed and adjusted, in part, based on an independent actuarial review of historical loss data and using certain actuarial assumptions followed in the insurance industry. A high degree of judgment is required in developing these estimates of amounts to be accrued, as well as in connection with the underlying assumptions. In addition, our assumptions will change as our loss experience is developed. All of these factors have the potential for significantly impacting the amounts we have previously reserved in respect of anticipated deductible expenses, and we may be required in the future to increase or decrease amounts previously accrued. 38
Table of Contents
North Americahealth benefits programs are considered to be self-insured products; however, we buy excess insurance coverage that limits our medical liability exposure on a per individual insured basis. Additionally, our medical program has a limitation on our total aggregate claim exposure and we accrue and reserve to the total projected losses. Our Canadian and U.K.employees are primarily provided medical coverage through their governmental national insurance programs. Contingencies. We are a party to various claims and litigation in the normal course of business. Management's current estimated range of liability related to various claims and pending litigation is based on claims for which our management can determine that it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. Because of the uncertainties related to both the probability of incurred and possible range of loss on pending claims and litigation, management must use considerable judgment in making reasonable determination of the liability that could result from an unfavorable outcome. As additional information becomes available, we will assess the potential liability related to our pending litigation and revise our estimates. Such revisions in our estimates of the potential liability could materially impact our results of operation. We do not anticipate the resolution of such matters known at this time will have a material adverse effect on our business or consolidated financial position. Deferred Taxes. In preparing our consolidated financial statements, we recognize income taxes in each of the jurisdictions in which we operate. For each jurisdiction, we estimate the actual amount of taxes currently payable or receivable as well as deferred tax assets and liabilities attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided for those deferred tax assets for which it is more likely than not that the related benefits will not be realized. In determining the amount of the valuation allowance, we consider estimated future taxable income as well as feasible tax planning strategies in each jurisdiction. If we determine that we will not realize all or a portion of our deferred tax assets, we will increase our valuation allowance with a charge to income tax expense. Conversely, if we determine that we will ultimately be able to realize all or a portion of the related benefits for which a valuation allowance has been provided, all or a portion of the related valuation allowance will be reduced with a credit to income tax expense. At December 31, 2013, we had a $1.1 millionvaluation allowance and $112.4 millionof gross deferred tax assets included within the net deferred tax liability on our balance sheet. The majority of the deferred tax asset relates to federal net operating loss carryforwards that have future expiration dates. Management currently believes that adequate future taxable income will be generated through future operations, or through available tax planning strategies to recover these assets. However, given that these federal net operating loss carryforwards that give rise to the deferred tax asset expire over 10 years beginning in 2022, there could be changes in management's judgment in future periods with respect to the recoverability of these assets. As of December 31, 2013, management believes that it is more likely than not that the unreserved portion of these deferred tax assets will be recovered. Purchase Accounting. We account for acquisitions under the acquisition method. Under the acquisition method of accounting, the price paid by us, is allocated to the assets acquired and liabilities assumed based upon the estimated fair values at the closing date. Goodwill is measured as the excess of the fair value of the consideration transferred over the fair value of the identifiable net assets. Earnings Per Share. Basic net income per share is calculated by dividing income allocable to common stockholders by the weighted-average number of common shares outstanding, net of shares subject to repurchase by us during the period. Income allocable to common stockholders is net income less the earnings allocable to preferred stockholders, if applicable. Diluted net income per share is calculated under the if-converted method unless the conversion of the preferred stock is anti-dilutive to basic net income per share. To the extent the inclusion of preferred stock is anti-dilutive, we calculate diluted net income per share under the two-class method. Potential common shares include restricted common stock and incremental shares of common stock issuable upon the exercise of stock options and vesting of nonvested share-awards and upon conversion of convertible preferred stock using the treasury stock method.
Recent Accounting Pronouncements
Comprehensive Income. In
June 2011, the Financial Accounting Standards Board("FASB") issued an amendment to the existing guidance on the presentation of comprehensive income. Under the amended guidance, an entity is required to present the effect of reclassification adjustments out of accumulated other comprehensive income in both net income and other comprehensive income in the financial statements. In February 2013, the FASB issued an amendment to this provision which is effective on a prospective basis for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of this amendment did not have a material impact on our consolidated financial statements and related disclosures. Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. In July 2013, the FASB issued this accounting guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists. The guidance is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013, with an option for early adoption. We intend to adopt this guidance at the beginning of our first quarter of fiscal year 2014, and do not anticipate any material impact on our consolidated financial statements and disclosures. 39
Table of Contents