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ELRC > SEC Filings for ELRC > Form 10-K on 14-Aug-2013All Recent SEC Filings

Show all filings for ELECTRO RENT CORP

Form 10-K for ELECTRO RENT CORP


14-Aug-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

(in thousands, except per share amounts).

The following discussion of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and the notes thereto and the other financial and statistical information appearing elsewhere in this Form 10-K.


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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 represented only approximately 7%, 7% and 8% of our revenues in fiscal 2013, 2012 and 2011, 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, H/P Compaq, IBM, Toshiba and Apple.

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 March 31, 2010, we completed the acquisition of certain assets (including accounts receivable and rental equipment but excluding certain designated assets) and select liabilities of Telogy for $24.7 million in cash, subject to post-closing adjustments. The purchase price was reduced by $0.3 million in fiscal 2011 reflecting the final determination of assets acquired and other components of the purchase price in accordance with specific provisions of the asset purchase agreement with Telogy. Telogy, headquartered in Union City, California, was a leading provider of electronic T&M equipment in North America.

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 EMT, 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 reflecting the final determination of the post-closing adjustment of the purchase price in accordance with the asset purchase agreement with EMT. (See Note 3 to the consolidated financial statements included in this Form 10-K).

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 2010 through 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 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


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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 fiscal 2013, our revenues were flat compared to fiscal 2012, as 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, were offset by a decline in sales of new equipment. 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 fiscal 2013 as compared to fiscal 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 an 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 2013 in support of our expanded sales opportunities for 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 inventory 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 inventory 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 fiscal 2013 to fiscal 2012, our revenues increased by 0.1% from $248.6 million to $248.7 million, our operating profit increased 1.7% from $36.1 million to $36.7 million and our net income decreased by 11.7% from $25.8 million to $22.8 million. Our net income for fiscal 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 $6.9 million, or 5.3%, from $129.7 million for fiscal 2012 to $136.6 million for fiscal 2013. For fiscal 2013 and 2012, 88% of our rental and lease revenues were derived from T&M equipment. Our T&M rental revenues increased $6.0 million 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. Our rental revenues also include a $1.3 million increase related to the equipment acquired from EMT in late August 2011. Our T&M lease revenues increased approximately $1.3 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 $0.4 million, due to a decrease of $1.4 million relating to lower demand, offsetting an increase of $1.0 million due to higher rental rates. Our DP lease revenues were relatively unchanged.

Our sales of equipment and other revenues decreased $6.7 million, or 5.6%, from $118.8 million for fiscal 2012 to $112.1 million for fiscal 2013. This decrease was primarily due to a decline in new equipment sales of $13.4 million as our customers that traditionally purchase new equipment delayed procurement decisions in response to changes in our U.S. national budgetary policy and uncertainty in the global economy, which more than offset higher used equipment sales of $6.1 million, that reflected a large buyout by a customer in the third fiscal quarter of fiscal 2013 and our increased sales and marketing efforts in this area.


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Some of our key profitability measurements are presented below:

                                                   Fiscal 2013           Fiscal 2012           Fiscal 2011
Net income per diluted common share (EPS)         $        0.94         $        1.07         $        0.99
Net income as a percentage of average assets                7.0 %                 8.1 %                 8.2 %
Net income as a percentage of average equity                9.6 %                10.7 %                10.3 %

Our net income for fiscal 2012 included a bargain purchase gain, net of deferred taxes, of $3.4 million as a result of our acquisition of EMT. For fiscal 2013, our operating profit increased 1.7%, or $0.6 million, compared to fiscal 2012. Our rental and lease business contributed an additional $3.2 million in operating profit, including $1.1 million in connection with the equipment acquired from EMT, resulting from a) a $6.9 million increase in rental and lease revenues, b) an offsetting increase in depreciation expense of $3.1 million, or 5.9%, 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 2.7%. Sales of equipment and other revenues decreased $6.7 million, or 5.6%, but contributed an additional $0.7 million in operating profit, as a decline in our lower margin new equipment sales was offset by an increase in our higher margin used equipment sales, and other revenues slightly increased. Although our higher margin used equipment sales contributed an additional $2.2 million in operating profit, this was offset by a $2.2 million decline in operating profit from sales of our lower margin new equipment. Our selling, general and administrative expenses increased by $3.3 million, or 6.2%, for fiscal 2013 compared to fiscal 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.

We have revenues, expenses, assets and liabilities in foreign currencies, primarily euros, Canadian dollar and Chinese yuan, due to our foreign operations. We enter into forward contracts to hedge against unfavorable currency fluctuations in our monetary assets and liabilities in our European and Canadian operations, and our exposure to fluctuations in the Chinese yuan is not significant. These contracts are designed to minimize the effect of fluctuations in foreign currencies. As a result of these forward contracts, as well as the relative stability of these foreign currencies,the impact on our operating results as a result of foreign currency fluctuations has been insignificant. See "Item 7A-Quantitative and Qualitative Disclosures About Market Risk-Changes in foreign currencies" for additional information about our exposure to foreign currency exchange risk.

The average amount of our equipment on rent, based on acquisition cost, increased to $245.5 million for fiscal 2013, compared to $234.1 million for fiscal 2012 and $212.1 million for fiscal 2011. The average acquisition cost of equipment on lease increased to $35.0 million for fiscal 2013 compared to $31.7 million and $28.7 million for fiscal 2012 and 2011, respectively. The increase in our average equipment on rent and lease is primarily attributable to a growth in our T&M business, which was due, in part, to the acquisition of EMT in fiscal 2012, as well as strengthening demand in our worldwide operations and the expansion of our sales force and integration and cross training of our resale organization and T&M sales force, resulting in increased opportunities.

Average rental rates for our T&M and DP segments decreased by 0.1% for fiscal 2013 compared to fiscal 2012, but increased 1% compared to fiscal 2011. Our average lease rates decreased by 2.6% for fiscal 2013 compared to fiscal 2012, and 5.4% compared to fiscal 2011. Average utilization for our T&M equipment pool, calculated based on average acquisition cost of equipment on rent and lease compared to the average total equipment pool, decreased to 66.9% for fiscal 2013, compared to 67.7% for fiscal 2012 and 70.0% for fiscal 2011. The average utilization of our DP equipment pool, based on the same method of calculation, decreased to 35.6% for fiscal 2013, compared to 38.1% and 41.9% for fiscal 2012 and 2011, respectively. The decline in lease rates is the result of competitive pressures. Our utilization rate fluctuates frequently, and is impacted by new equipment purchases in support of existing and potential business, and sales of used equipment.

As of May 31, 2013 and May 31, 2012, our sales order backlog for T&M equipment relating to our resale channel was $7.6 million and $8.4 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 statement of operations line item captioned "costs of revenues other than depreciation of rental and lease equipment" has been changed to separately present "costs of rentals and leases, excluding depreciation" and "costs of sales of equipment and other revenues" to comply with the applicable income statement disclosure requirements for public companies. Further, in order to more


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closely align activity related to our rental and lease operations, including revenues and the expenses associated with providing those revenues, we have reclassified certain expenses previously included in selling, general and administrative expenses to costs of rentals and leases, excluding depreciation, which resulted in a reduction to previously reported selling, general and administrative expenses of $10.7 million and $10.0 million, respectively, for fiscal 2012 and 2011, respectively. (See Note 1 to our condensed consolidated financial statements included in this Form 10-K for further discussion).

Fiscal 2013 Compared with Fiscal 2012

Total Revenues: Total revenues for fiscal 2013 and 2012 were $248.7 million and $248.6 million, respectively. The 0.1% increase in total revenues was due to a 5.3% increase in rental and lease revenues offset by a 5.6% decrease in sales of equipment and other revenues.

Rental and lease revenues for fiscal 2013 were $136.6 million, compared to $129.7 million for the prior fiscal year. This increase is due to an increase in T&M rental and lease demand, in particular in our 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 decreased to $112.1 million for fiscal 2013 from $118.8 million in the prior year. Sales of used equipment, including finance leases, increased to $31.0 million for fiscal 2013, compared to $24.9 million for fiscal 2012, in part due to a large buyout by a customer in the third quarter of fiscal 2013, while sales of new equipment decreased to $75.0 million for fiscal 2013 compared to $88.4 million for fiscal 2012, as our customers that traditionally purchase new equipment delayed procurement decisions due to changes in the U.S. national budgetary policy and uncertainty in the global economy.

Operating expenses

Depreciation of Rental and Lease Equipment: Depreciation of rental and lease equipment increased in fiscal 2013 to $56.8 million, or 41.6% of rental and lease revenues, from $53.7 million, or 41.4% of rental and lease revenues, in 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, marginally increased due to a moderate decline in utilization rates while rental rates were flat.

Costs of rentals and leases, excluding depreciation: 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 $17.8 million for fiscal 2013 compared to $17.3 million for fiscal 2012, primarily due to higher labor related costs to support growth in our rental and lease business. This expense is not expected to significantly fluctuate from period to period, as only moderate changes are required from time to time to handle changes in rental and lease activity.

Costs of Sales of Equipment and Other Revenues: Costs of sales of equipment and other revenues, which primarily includes the cost of equipment sales, decreased to $80.9 million for fiscal 2013 from $88.2 million in fiscal 2012. Costs of sales of equipment and other revenues decreased as a percentage of sales of equipment and other revenues to 76.3% in fiscal 2013 from 77.8% in 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: Selling, general and administrative expenses increased 6.2% to $56.5 million in fiscal 2013 compared to $53.3 million in fiscal 2012. As a percentage of total revenues, selling, general and administrative expenses increased modestly to 22.7% in fiscal 2013 from 21.4% in 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 fiscal 2012 related to our acquisition of EMT. 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 38.7% for fiscal 2013, compared to 35.6% for fiscal 2012. The increase for fiscal 2013 is due to a bargain purchase gain, net of deferred taxes, of $3.4 million for fiscal 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.

Fiscal 2012 Compared with Fiscal 2011

Total Revenues: Total revenues for fiscal 2012 and 2011 were $248.6 million and $228.7 million, respectively. The 8.7% increase in total revenues was due to a 9.9% increase in rental and lease revenues and a 7.4% increase in sales of equipment and other revenues.

Rental and lease revenues for fiscal 2012 were $129.7 million, compared to $118.1 million for the prior fiscal year. This increase reflects the EMT acquisition in August 2011 and an increase in T&M rental demand and rental rates in our North American and European operations, due to improved market conditions and the integration of our new resale organization and existing T&M sales force, providing additional rental opportunities to an expanding customer base. This increase was offset by a decline in lease revenues in our DP business, due to a decrease in demand.

Sales of equipment and other revenues increased to $118.8 million for fiscal 2012 from $110.7 million in fiscal 2011. Sales of used equipment, including finance leases, decreased to $24.9 million for fiscal 2012, compared to $32.9 million for the prior year period, while sales of new equipment increased to $88.4 million for fiscal 2012 compared to $71.4 million for fiscal 2011 due to an increase in our sales of new T&M equipment through our resale channel, as we continued to grow and expand both our customer base and our sales infrastructure in connection with our Agilent resale agreement

Depreciation of Rental and Lease Equipment: Depreciation of rental and lease equipment increased in fiscal 2012 to $53.7 million, or 41.4% of rental and lease revenues, from $47.9 million, or 40.6% of rental and lease revenues, in fiscal 2011. The increased depreciation expense in fiscal 2012 was due to a higher average rental and lease equipment pool. The depreciation ratio, as a percentage of rental and lease revenues, increased slightly as modest improvements in our average rental rates were more than offset by a decrease in our average utilization rates.

Costs of Rentals and Leases, excluding depreciation: 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 $17.3 million for fiscal 2012 compared to $16.4 million for fiscal 2011, primarily due to higher labor related costs. This expense is not expected to significantly fluctuate from period to period, as only moderate changes are required from time to time to handle changes in rental and lease activity.

Costs of Sales of Equipment and Other Revenues: Costs of sales of equipment and other revenues, which primarily include the cost of equipment sales, increased to $88.2 million for fiscal 2012 from $80.3 million in fiscal 2011. Costs of sales of equipment and other revenues increased as a percentage of sales of equipment and other revenues to 77.8% in fiscal 2012 from 77.0% in fiscal 2011. This increase is due to a decrease in used equipment sales and an increase in sales of new T&M equipment, which generally carry a lower margin than used equipment sales. 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, the global recession, and customer requirements and funding.

Selling, General and Administrative Expenses: Selling, general and administrative expenses increased 12.3% to $53.3 million in fiscal 2012 compared to $47.4 million in fiscal 2011. As a percentage of total revenues, selling, general and administrative expenses increased to 21.4% in fiscal 2012 from 20.7% in fiscal 2011. Our selling, general and administrative expenses increased primarily due to the broadening and strengthening of our sales organization in support of our resale channel and higher rental demand.

Gain on Bargain Purchase: We recorded gain on bargain purchase, net of deferred taxes, of $3.4 million during fiscal 2012 related to our acquisition of EMT and $0.2 million during fiscal 2011 related to our acquisition of Telogy, LLC ("Telogy"), a private company headquartered in Union City, California, and a leading provider of electronic T&M equipment, in March 2010. 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 and Telogy acquisitions, respectively, over the respective purchase prices. A


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majority of the Telogy bargain purchase gain was recorded in fiscal 2010, the year of acquisition. We believe that we were able to negotiate bargain purchase prices as a result of our access to the liquidity necessary to complete the transactions, and the recurring losses and bankruptcy filings of both EMT and Telogy.

Income Tax Provision: Our effective tax rate was 35.6% for fiscal 2012, compared to 36.3% for fiscal 2011. Our effective tax rate for fiscal 2012 includes our bargain purchase gain, net of deferred taxes, of $3.4 million compared to $0.2 million for the prior year period, resulting from of 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. Our effective tax rate for fiscal 2011 includes the benefit . . .

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