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ELRC > SEC Filings for ELRC > Form 10-Q on 8-Apr-2013All Recent SEC Filings

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Form 10-Q for ELECTRO RENT CORP


8-Apr-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion addresses our financial condition as of February 28, 2013 and May 31, 2012, the results of our operations for the three and nine months ended February 28, 2013 and February 29, 2012, respectively, and cash flows for the nine month periods ended February 28, 2013 and February 29, 2012, respectively. This discussion should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and the Risk Factors in Item 1A of our Annual Report on Form 10-K for the fiscal year ended May 31, 2012, to which you are directed for additional information.

Overview

We are one of the largest global organizations devoted to the rental, lease and sale of new and used electronic T&M equipment. We purchase that equipment from leading manufacturers such as Agilent Technologies, Inc. ("Agilent") and Tektronix Inc. primarily for use by our customers in the aerospace, defense, telecommunications, electronics, industrial and semiconductor industries.

In addition, although it represents only approximately 7%, 8% and 13% of our revenues in fiscal 2012, 2011 and 2010, respectively, we believe our data products ("DP") division is one of the largest rental businesses in the United States for personal computers and servers from manufacturers including Dell, Hewlett Packard and Toshiba.

In fiscal 2010, we became a reseller for Agilent, the largest T&M equipment manufacturer in North America, which provides us with the exclusive right to sell Agilent's more complex T&M equipment to small and medium size customers (who previously purchased directly from Agilent) in the United States and Canada through January 31, 2014. We do not currently have reseller agreements with any other manufacturers for equipment similar to that included in our Agilent reseller agreement. In addition, we sell used equipment from a variety of manufacturers that was previously in our rental and lease pool.

We have a focused sales strategy, using a direct sales force to meet our customers' needs in our T&M equipment rental, lease and sales business. We have a large technical sales force that consists primarily of field engineers and applications engineers, each of whom specializes in all the products and services offered by our company. Our sales force is usually assigned to specific territories, and identifies potential customers through coordinated efforts with our marketing organization. Our marketing organization is staffed by professionals with many years of industry-related experience. As our customers have a wide range of requirements for equipment, our sales force is able to leverage our extensive knowledge of the test and measurement equipment environment to determine the right product to rent, lease or sell to the customer to meet the customer's specific needs.

Our sales force also specializes in configuring new Agilent equipment to sell to our customers that is tailored to the customer's need. These configurations typically start with a base model, which is frequently upgraded through an extensive list of options in order to perform the customer's specific test or measurement. Once the configuration is determined, it serves as the basis for our orders to Agilent, who builds the product accordingly. We order equipment from Agilent once the customer has placed an order with us. Equipment is typically shipped directly to the customer by Agilent at our request. Occasionally, equipment is shipped to our warehouse prior to delivery to the customer. Inventory held for sale is immaterial and is therefore included in other assets in our consolidated balance sheets. Each order and sales invoice is subject to our standard sales terms and conditions, which include provisions covering equipment delivery delays and warranty services.

On August 24, 2011, we completed the acquisition of certain assets (including accounts receivable and rental equipment but excluding certain designated assets) and the assumption of specified post-closing liabilities of Equipment Management Technology, Inc., for $10.7 million in cash, of which $0.5 million was deposited into an escrow account for any post-closing adjustments. The purchase price was reduced by $0.3 million in fiscal 2012 reflecting the final determination of the post-closing adjustment of the purchase price in accordance with the asset purchase agreement with EMT. (See Note 4 to the condensed consolidated financial statements (unaudited) included in this Form 10-Q.)

In recent years, our financial results were impacted by competitive pressure on rental rates due in large part to the recession in the U.S. and our major international markets. During fiscal 2012, we experienced a modest improvement in our T&M and DP rental rates and a significant increase in our equipment on rent, in part due to our acquisition of EMT at the end of the first quarter of fiscal 2012, while maintaining a high utilization rate, in particular in our North American and European operations. In addition, our rental revenues have benefited from our expanded sales force and

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integration and cross training of our resale organization and T&M sales force. As a result of these continued improvements, and sales of T&M equipment in connection with our resale channel, we experienced strong growth in revenues for fiscal 2012. During fiscal 2012, our operating profit modestly declined reflecting our significant investment in broadening and strengthening our sales and sales support organizations, as well as our administrative infrastructure, necessary to support our increased sales and rental demand and to better focus on future growth opportunities. During the nine months ended February 28, 2013, our revenues increased compared to the nine months ended February 29, 2012, as we continued to experience rental and lease growth and increased sales of used equipment, in part due to a large buyout of used equipment by a customer in the third fiscal quarter of 2013, while our sales of new equipment declined. Our new equipment sales were affected by changes in the U.S. national budgetary policy and continuing uncertainty in the economy, including the telecommunications and national defense sectors, causing delays in our customers' procurement decisions. As a result, many customers have chosen to rent equipment or delay all significant procurement decisions as they contemplate how to operate going forward. Our operating profit modestly increased for the nine months ended February 28, 2013, as compared to the nine months ended February 29, 2012, as growth in our higher margin rental and lease revenues and used equipment sales offset declines in our sales of new equipment, which have lower operating margins. We experienced a moderate increase in our selling, general and administrative expenses as a result of our infrastructure investment which began in fiscal 2011 and continued throughout fiscal 2012 and the first nine months of fiscal 2013 in support of expected growth in our sales of new and used equipment, as well as growth in our rental and lease business.

Economic uncertainty continues to impact our customers and competitors, resulting in more stringent credit requirements and reduced access to capital. We will continue to focus on remaining profitable in the current conditions, as well as being prepared for the possibility that recessionary trends may return in future periods.

To maximize our overall profit from the rental, leasing, and sales of equipment, we manage our equipment pool on an on-going basis by controlling the timing, pricing and mix of our purchases and sales of equipment. We acquire new and used equipment to meet current technological standards and current and anticipated customer demand, and we sell our used equipment where we believe that is the most lucrative option. We employ a complex equipment management strategy and our proprietary PERFECT™ software to adjust our equipment pool and pricing on a dynamic basis in order to maximize equipment availability, utilization and profitability. We manage each specific equipment class based on a separate assessment of that equipment's historical and projected life cycle and numerous other factors, including the U.S. and global economy, interest rates and new product launches. If we do not accurately predict market trends, or if demand for the equipment we supply declines, we can be left with equipment that we are unable to rent or sell for a profit. We assess the carrying value of the equipment pool on a quarterly basis or more frequently when factors indicating potential impairment are present.

Profitability and Key Business Trends

Comparing the first nine months of fiscal 2013 to the first nine months of fiscal 2012, our revenues increased by 4.4% from $180.4 million to $188.4 million, our operating profit increased 4.0% from $25.9 million to $26.9 million and our net income decreased by 16.2% from $19.5 million to $16.4 million. Our net income for the nine months ended February 29, 2012 included a bargain purchase gain, net of deferred taxes, of $3.4 million, as a result of our acquisition of EMT.

Our rental and lease revenues increased $5.2 million, or 5.4%, from $95.9 million for the first nine months of fiscal 2012 to $101.1 million for the first nine months of fiscal 2013. For the nine months ended February 28, 2013, 89% of our rental and lease revenues were derived from T&M equipment, compared to 87% for the prior year period. Our T&M rental revenues increased approximately $5.0 million, of which $3.7 million was due to an increase in rental demand, in particular in our North American and European operations, and the integration of our resale organization and T&M sales force, and a $1.3 million increase related to the equipment acquired from EMT in late August 2011. Our T&M lease revenues increased approximately $1.1 million, which was primarily attributed to an increase in demand for equipment leases. The impact of the changes in T&M rental and lease rates on rental and lease revenues was insignificant. Rental revenues in our DP segment declined $0.7 million, due to a decrease of $1.2 million relating to lower demand, offsetting an increase of $0.5 million due to higher rental rates. Our DP lease revenues were relatively flat.

Our sales of equipment and other revenues increased $2.8 million, or 3.4%, from $84.4 million for the first nine months of fiscal 2012 to $87.3 million for the first nine months of fiscal 2013. Our sales of equipment and other revenues increased primarily due to higher used equipment sales of $6.5 million, due in part to a large buyout by a customer in the third fiscal quarter of fiscal 2013 and our increased sales and marketing efforts in this area. This increase was partially offset by a decline in new equipment sales of $4.0 million as our customers that traditionally purchase new equipment delayed procurement decisions due to changes in our U.S. national budgetary policy and uncertainty in the global economy.

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Some of our key profitability measurements are presented below for the nine months ended February 28, 2013 and February 29, 2012:

                                                        Fiscal       Fiscal
                                                         2013         2012
         Net income per diluted common share (EPS)      $  0.68      $  0.81
         Net income as a percentage of average assets       6.7 %        8.3 %
         Net income as a percentage of average equity       9.4 %       10.9 %

Our net income includes a bargain purchase gain, net of deferred taxes, of $3.4 million for the nine months ended February 29, 2012, as a result of our acquisition of EMT. For the nine months ended February 28, 2013, our operating profit increased 4.0%, or $1.0 million, compared to the nine months ended February 29, 2012. Our rental and lease business contributed an additional $1.8 million in operating profit, including $1.0 million in connection with the equipment acquired from EMT, resulting from a) a $5.2 million increase in rental and lease revenues, b) an offsetting increase in depreciation expense of $2.9 million, or 7.3%, due to a higher average rental equipment pool, and c) an offsetting increase in our costs of rentals and leases, excluding depreciation, of $0.5 million, or 3.4%. Sales of equipment and other revenues increased by $2.8 million, or 3.4%, and contributed an additional $1.5 million in operating profit, as a $2.1 million increase in our higher margin used equipment sales more than offset a $0.9 million decline in sales of our lower margin new equipment. Our selling, general and administrative expenses increased by $2.3 million, or 5.9%, for the nine months ended February 28, 2013 compared to the nine months ended February 29, 2012, primarily due to the broadening and strengthening of our sales organization in support of our new and used equipment sales, higher rental demand, and future growth opportunities. Finally, a decline in our foreign currency rates reduced our operating profit by $0.5 million.

The average amount of our equipment on rent, based on acquisition cost, increased to $242.4 million and $244.3 million for the three and nine months ended February 28, 2013, respectively, compared to $233.4 million and $231.3 million, respectively, for the same periods last year, an increase of 3.9% and 5.6%, respectively. The average acquisition cost of equipment on lease increased to $34.7 million and $34.0 million for the three and nine months ending February 28, 2013, respectively, compared to $32.5 million and $31.4 million, respectively, for the same periods last year, an increase of 6.9% and 8.1%, respectively. The increase in our average equipment on rent and lease was due, in part, to the acquisition of EMT during the nine months ended February 29, 2012 as well as strengthening demand in our worldwide operations.

Average rental rates for our T&M and DP segments combined increased by 1.3% for the three months ending February 28, 2013 compared to February 29, 2012, while average rental rates decreased 0.7% for the nine months ending February 28, 2013 compared to the prior year period. Average utilization for our T&M equipment pool, based on average acquisition cost of equipment on rent and lease compared to the average total equipment pool, increased marginally from 66.2% to 66.3% for the three months ended February 29, 2012 and February 28, 2013, respectively, while average utilization decreased from 68.0% to 66.6% for the nine months ended February 29, 2012 and February 28, 2013, respectively. The average utilization of our DP equipment pool, based on the same method of calculation, decreased from 34.5% to 31.1% for the three months ended February 29, 2012 and February 28, 2013, respectively, while average utilization decreased from 38.8% to 35.1% for the nine months ending February 29, 2012 and February 28, 2013, respectively.

As of February 28, 2013 and February 29, 2012, our unfilled orders for T&M equipment relating to our resale channel were $4.8 million and $11.8 million, respectively. The decline in backlog for fiscal 2013 is primarily due to shorter manufacturing lead time and a reduction in new sales orders, reflecting lower demand.

Results of Operations

Reclassification

The previously reported "costs of revenues other than depreciation of rental and lease equipment" have been changed to separately present "costs of rentals and leases, excluding depreciation" and "costs of sales of equipment and other revenues". In addition, we have reclassified $2.7 million and $8.2 million from selling, general and administrative expenses to costs of rentals and leases, excluding depreciation, for the three and nine months ended February 29, 2012, respectively, to conform to the current year presentation. (See Note 1 to our condensed consolidated financial statements included in this Form 10-Q for further discussion).

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Comparison of Three Months Ended February 28, 2013 and February 29, 2012

Revenues

Total revenues for the three months ended February 28, 2013 and February 29, 2012 were $64.7 million and $60.1 million, respectively. The 7.6% increase in total revenues was due to a 3.6% increase in rental and lease revenues and a 12.2% increase in sales of equipment and other revenues.

Rental and lease revenues for the three months ended February 28, 2013 were $32.8 million, compared to $31.7 million for the same period of the prior fiscal year. This increase is due to an increase in T&M rental and lease demand, in particular in North American operations, due in part to the acquisition of EMT, and the integration of our resale organization and T&M sales force, which began in the first quarter of fiscal 2012, providing additional rental opportunities to an expanding customer base, and higher demand from our customers in lieu of new equipment purchases. This increase was partially offset by a decline in rental and lease revenues in our DP business, due to a decrease in demand.

Sales of equipment and other revenues increased to $31.8 million for the third quarter of fiscal 2013 from $28.4 million in the prior year quarter. Sales of used equipment, including finance leases, increased to $9.5 million for the three months ended February 28, 2013, compared to $5.9 million for the prior year period, in part due to a large buyout by a customer in the third quarter of fiscal 2013, while sales of new equipment decreased to $21.0 million for the three months ended February 28, 2013 compared to $21.2 million for the prior year period, as our customers that traditionally purchase new equipment delayed procurement decisions due to changes in our U.S. national budgetary policy and uncertainty in the global economy.

Operating Expenses

Depreciation of rental and lease equipment increased in the third quarter of fiscal 2013 to $14.3 million, or 43.6% of rental and lease revenues, from $13.7 million, or 43.1% of rental and lease revenues, in the third quarter of fiscal 2012. The increased depreciation expense in fiscal 2013 was due to a higher average rental and lease equipment pool. The depreciation ratio, as a percentage of rental and lease revenues, increased due to moderate declines in rental and utilization rates, offset, in part, by increased demand for leases.

Costs of rentals and leases, excluding depreciation, which primarily includes labor related costs of our operations personnel, supplies, repairs, and insurance and warehousing costs associated with our rental and lease equipment, increased slightly to $4.7 million for the three months ended February 28, 2013 compared to $4.4 million for the three months ended February 29, 2012. This expense remains relatively stable as our rental and lease business does not significantly fluctuate from period to period, and our existing infrastructure is capable of handling moderate changes in rental and lease activity.

Costs of sales of equipment and other revenues, which primarily includes the cost of equipment sales, increased to $23.5 million in the third quarter of fiscal 2013 from $21.1 million in the same period of fiscal 2012. Related to equipment sales, costs of sales and other revenues decreased as a percentage of sales of equipment and other revenues to 77.0% in the third quarter of fiscal 2013 from 77.9% in the third quarter of fiscal 2012. This decrease is due to a decline in sales of new T&M equipment, which generally carry a lower margin than used equipment sales, while higher margin used equipment sales increased. Our sales margin percentage is expected to fluctuate depending on the mix of used and new equipment sales. Our sales margin is also impacted by competition, economic uncertainty, changes in U.S. governmental policies, and customer requirements and funding.

Selling, general and administrative expenses increased 5.8% to $13.8 million in the third quarter of fiscal 2013 compared to $13.0 million in the third quarter of fiscal 2012. As a percentage of total revenues, selling, general and administrative expenses decreased to 21.3% in the third quarter of fiscal 2013 from 21.7% in the third quarter of fiscal 2012. Our selling, general and administrative expenses increased primarily due to the broadening and strengthening of our sales and sales support organizations, as well as our administrative infrastructure, necessary to support our sales and rental demand and to better focus on future growth opportunities.

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Income Tax Provision

Our effective tax rate was 40.3% in the third quarter of fiscal 2013, compared to 37.7% in the third quarter of fiscal 2012. The increase during the three months ended February 28, 2013 was due to a refund of foreign taxes in the prior year.

Comparison of Nine Months Ended February 28, 2013 and February 29, 2012

Revenues

Total revenues for the nine months ended February 28, 2013 and February 29, 2012 were $188.4 million and $180.4 million, respectively. The 4.4% increase in total revenues was due to a 5.4% increase in rental and lease revenues and a 3.4% increase in sales of equipment and other revenues.

Rental and lease revenues for the nine months ended February 28, 2013 were $101.1 million, compared to $95.9 million for the same period of the prior fiscal year. This increase is due to an increase in T&M rental and lease demand, in particular in North American operations, due in part to the acquisition of EMT, and the integration of our resale organization and T&M sales force, which began in the first quarter of fiscal 2012, providing additional rental opportunities to an expanding customer base, and higher demand from our customers in lieu of new equipment purchases. This increase was partially offset by a decline in rental and lease revenues in our DP business, due to a decrease in demand.

Sales of equipment and other revenues increased to $87.3 million for the first nine months of fiscal 2013 from $84.4 million in the same period of the prior fiscal year. Sales of used equipment, including finance leases, increased to $23.6 million for the nine months ended February 28, 2013, compared to $17.0 million for the prior year period, in part due to a large buyout by a customer in the third quarter of fiscal 2013 while sales of new equipment decreased to $59.2 million for the nine months ended February 28, 2013 compared to $63.2 million for the same prior year period as our customers that traditionally purchase new equipment delayed procurement decisions due to changes in our U.S. national budgetary policy and uncertainty in the global economy.

Operating Expenses

Depreciation of rental and lease equipment increased in the first nine months of fiscal 2013 to $42.5 million, or 42.0% of rental and lease revenues, from $39.6 million, or 41.3% of rental and lease revenues, in the first nine months of fiscal 2012. The increased depreciation expense in fiscal 2013 was due to a higher average rental and lease equipment pool. The depreciation ratio, as a percentage of rental and lease revenues, increased due to moderate declines in rental and utilization rates, offset, in part, by increased demand for leases.

Costs of rentals and leases, excluding depreciation, which primarily includes labor related costs of our operations personnel, supplies, repairs, and insurance and warehousing costs associated with our rental and lease equipment, increased to $13.7 million for the nine months ended February 28, 2013 compared to $13.2 million for the nine months ended February 29, 2012. This expense remains relatively stable as our rental and lease business does not significantly fluctuate from period to period, and our existing infrastructure is capable of handling moderate changes in rental and lease activity.

Costs of sales of equipment and other revenues, which primarily include the cost of equipment sales, increased to $63.7 million in the first nine months of fiscal 2013 from $62.4 million in the same period of fiscal 2012. Related to equipment sales, costs of sales and other revenues decreased as a percentage of sales of equipment and other revenues to 77.0% in the first nine months of fiscal 2013 from 77.7% in the first nine months of fiscal 2012. This decrease is due to a decline in sales of new T&M equipment, which generally carry a lower margin than used equipment sales, while the higher margin used equipment sales increased. Our sales margin percentage is expected to fluctuate depending on the mix of used and new equipment sales. Our sales margin is also impacted by competition, economic uncertainty, changes in U.S. national budgetary policies, and customer requirements and funding.

Selling, general and administrative expenses increased 5.9% to $41.6 million in the first nine months of fiscal 2013 compared to $39.3 million in the first nine months of fiscal 2012. As a percentage of total revenues, selling, general and administrative expenses increased to 22.1% in the first nine months of fiscal 2013 from 21.8% in the nine months of fiscal 2012. Our selling, general and administrative expenses increased primarily due to the broadening and strengthening of our sales and sales support organizations, as well as our administrative infrastructure, necessary to support our sales and rental demand and to better focus on future growth opportunities.

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Gain on Bargain Purchase

We recorded a gain on bargain purchase, net of deferred taxes, of $3.4 million during the nine months ended February 29, 2012 compared to $0 for the nine months ended February 28, 2013, related to our acquisition of EMT in August 2011. The gain on bargain purchase, net of deferred taxes, resulted from the excess of the net fair value of the assets acquired and liabilities assumed in the EMT acquisition over the respective purchase price. We believe that we were able to negotiate a bargain purchase price as a result of our access to the liquidity necessary to complete the transaction, and the recurring losses and bankruptcy filing of EMT.

Income Tax Provision

Our effective tax rate was 40.0% in the first nine months of fiscal 2013, compared to 34.2% in the first nine months of fiscal 2012. The increase during the nine months ended February 28, 2013 is due to an increase in certain foreign losses for which we have a valuation allowance and therefore we do not receive a tax benefit, and a bargain purchase gain, net of deferred taxes, of $3.4 million for the nine months ended February 29, 2012, related to our purchase of EMT on August 24, 2011. Bargain purchase gains are recorded net of deferred taxes and are treated as permanent differences, resulting in a lower effective tax rate in the period recorded.

Liquidity and Capital Resources

Capital Expenditures

Our primary capital requirements have been purchases of rental and lease equipment. We generally purchase equipment throughout the year to replace equipment that has been sold and to maintain adequate levels of rental equipment to meet existing and expected customer demands. To meet T&M rental demand, support areas of potential growth for both T&M and DP equipment and to keep our equipment pool technologically up-to-date, we made payments for the purchase of $48.8 million of rental and lease equipment during the first nine months of fiscal 2013 compared to $78.7 million during the first nine months of fiscal 2012, a decline of 38.0% from the unusually high payment level of the prior year which reflected continued recovery from the economic downturn.

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