If you'll recall from our prior slide, when we talked about the owning and operating period of a rental fleet, the number one expense item was depreciation. So I'd like to take a few minutes to really help you understand depreciation and net book value and the choices that we make as a company in selecting what kind of depreciation schedule we're going to choose according to the type of equipment and how long we anticipate holding that piece of equipment before we roll it out. And then also how that affects the profitability associated with that particular machine. So we're going to start with a graph here that shows you market value. If you notice the legend in the bottom, the blue line is market value. So what this assumption is telling you is that we have a brand new machine that on day one, if we were to sell that to someone, we would be selling it for about $165,000. You'll also notice that at the end of the first year, the value of that machine in terms of market value, we're making an assumption that it has dropped dramatically, probably in excess of 20%. Now obviously this is an assumption and maybe in your market used equipment values are going up, but I want to illustrate the difference between net book value and market value and what typically happens. So the curve that you're looking at is very typical. That the first year depreciation on a machine would probably go down at least 20%. It might even go more than that. You'll start to see that the inflection of that line at the end of the second year is not quite as steep because our assumption is that at the second year period, the value of that machine may drop somewhere in the neighborhood of 18%. And so probably by the end of two years, that machine has probably dropped in market value between 35% and 40%. So then it starts to get on a more regular curve and our assumption in this particular exercise is that it goes down approximately 15% per year thereafter. So if you'll follow that curve line, you'll see that at the end of four years, it's crossing the $80,000 threshold. So our assumption here is that at the end of four years, the market value for this machine is about half of what it started at. And then if you look out somewhere in the neighborhood of seven years, you see it crossing the line at approximately $60,000 value that it started at $165,000. So the blue line represents market value. Now we're going to overlay this with net book value. That's what NBV stands for, net book value. This is the valuation that we have on this piece of equipment during its holding period. So when we buy that machine brand new, we're not paying $165,000 for it. That's what we were going to retail it for. So we're probably going to pay somewhere between $145,000 and $150,000 for that machine. And we are going to put it on our books for that price. And over the next five years, we're going to depreciate that machine about 20% per year. Okay? That's what's called straight-line depreciation. And this is a pretty widely accepted, very conservative approach to valuation. Because we know this machine, let's just pick a wheel loader, or you might even do a motor grader or dozer, you know for sure that this thing probably has at least a seven- to ten-year lifespan before it could go into a secondary market. So five-year depreciation, taking it to zero. And that's what five-year straight-line is, is you'll see that the red line ends up on the value of zero. So what that means at the end of five years, we'd have it on the books for zero. And if you'll go up the fifth-year column, you'll see that we would probably be able to sell that for between $65,000, $70,000, maybe even a little bit more. And so what that means is we have developed equity for that particular machine until which time we decide to sell it. So now let's look at margins. So we paid, again, for illustration purposes, approximately $150,000. We're going to sell it for $165,000. That's the gross profit margin right up there, day one, if I was retailing it. The AED averages over the last about 24 months has been somewhere between 11% and 12% gross profit margin on the sale of a new machine. So let's take a look at what happens at the end of the first year. If I'm bringing that machine down on my books for 20%, but the market value for that used machine at the end of one year went down 22%, I'd actually be losing 2% gross profit margin if I sold it at the end of one year. As you can see, the lines run parallel or actually start to get a little tighter at the end of the first year period. At the end of the second year period, on the books, I've taken it down 40% on my books because 20% each year. What this model is illustrating is that the market price has come down approximately 40% as well. But it didn't come down 20% and 20%. We're going to suggest that the first year it came down maybe 22%, and then maybe 18% the second year. And so we've got a net of 40% versus a net of 40%. So at the end of the second year, if I was to sell that machine, I would end up making the same exact gross profit margin that I did on day one. The only difference is I would have the rental revenue that I would have accrued during the 24-month period. Let's look and see what happens if we keep it longer. So at the three-year period, you can see the lines start to separate. And at the end of the four-year period, now I've got a machine on my books for $30,000, and I've got a street value of about $80,000. I've got $50,000 in margin to be made there whenever I decide to pull the trigger, versus up at the very beginning, I might have $15,000 or $18,000 available for me in gross profit margin. So the reason that I am trying to describe this in such detail is that most dealers today are not letting the machines stay in rental long enough. They're reaching in, and they're pulling the machines out somewhere between that 18- and 24-month period, and they're really not helping themselves because they are not really keeping the units that busy, and they end up with the same gross profit margin. So one of the byproducts of having an effective rental fleet is not only earning profit during the holding period while it's active in the fleet, but we should be improving gross profit margins on used machines as well.

depreciation

net book value

rental fleets

depreciation schedule

gross profit margin