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

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Form 10-Q for ELECTRO RENT CORP


8-Oct-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 August 31, 2013 and May 31, 2013 the results of our operations for the three months ended August 31, 2013 and 2012, respectively, and cash flows for the three month periods ended August 31, 2013 and 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, 2013, 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 test and measurement ("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%, 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, HP/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.

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 2013, our revenues were flat compared to fiscal 2012, as rental and lease growth and increased sales of used equipment were offset by a decline in sales of new equipment. Our increased sales of used equipment during fiscal 2013 was in part due to a large buyout of used equipment by a customer in the third fiscal quarter of 2013.

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.

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During the three months ended August 31, 2013, our revenues increased compared to the three months ended August 31, 2012, as we continue to experience strong rental growth offset, in part, by a decline in our sales revenue, primarily due to 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 increased for the three months ended August 31, 2013, as compared to the three months ended August 31, 2012, as growth in our higher margin rental and lease revenues offset increases in our selling, general and administrative expenses, which were a result of continued infrastructure investment as we continue to explore opportunities to expand 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 three months of fiscal 2014 to the first three months of fiscal 2013, our revenues increased by 2.8% from $58.5 million to $60.2 million, our operating profit increased 6.6% from $8.2 million to $8.8 million and our net income increased by 12.0% from $5.1 million to $5.7 million.

Our rental and lease revenues increased $2.0 million, or 5.9%, from $33.7 million for the first three months of fiscal 2013 to $35.7 million for the first three months of fiscal 2014. During the first quarter of fiscal 2014, 86% of our rental and lease revenues were derived from T&M equipment compared to 88% for the same period in the prior fiscal year. Our T&M rental revenues increased $0.9 million, including $0.8 million due to an increase in rental rates and $0.1 million due to an increase in demand, in particular in our North American and European operations. Our T&M lease revenues increased approximately $0.3 million, which was primarily attributed to an increase in demand. Rental revenues in our DP segment increased $0.7 million, including $0.4 million due to an increase in rental rates and $0.3 million due to higher demand.
Alternatively, our DP lease revenues remained unchanged during the first quarter of fiscal 2014 compared to the first quarter of fiscal 2013.

Our sales of equipment and other revenues decreased $0.3 million, or 1.3%, from $24.8 million for the first three months of fiscal 2013 to $24.5 million for the first three months of fiscal 2014. This decrease was primarily due to a decline in new equipment sales 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.

For the three months ended August 31, 2013, our operating profit increased 6.6%, or $0.5 million, compared to the three months ended August 31, 2012. Our rental and lease business contributed $1.3 million in operating profit, resulting from
a) a $2.0 million increase in rental and lease revenues, b) an offsetting increase in depreciation expense of $0.3 million, or 2.2%, due to a higher average rental equipment pool, and c) an offsetting increase in our costs of rentals and leases, excluding depreciation, of $0.4 million, or 10.1%. Although our sales of equipment and other revenues decreased, our operating profit increased $0.2 million due to a slight increase in other revenues.

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Our selling, general and administrative expenses increased by $0.9 million, or 6.5%, for the first three months of fiscal 2014 compared to the first three months of fiscal 2013, primarily due to the broadening and strengthening of our sales organization as we continued to explore opportunities to expand our new and used equipment sales, and support higher rental demand and future growth opportunities.

Some of our key profitability measurements are presented below for the three months ended August 31, 2013 and 2012:

                                                        Fiscal       Fiscal
                                                         2014         2013
         Net income per diluted common share (EPS)      $  0.23      $  0.21
         Net income as a percentage of average assets       7.1 %        6.2 %
         Net income as a percentage of average equity       9.8 %        8.3 %

We have revenues, expenses, assets and liabilities in foreign currencies, primarily euro, 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.

The average amount of our equipment on rent, based on acquisition cost, increased to $244.1 million for the first three months of fiscal 2014 compared to $242.3 million for the first three months of fiscal 2013. The average acquisition cost of equipment on lease increased to $36.7 million for the first three months of fiscal 2014 from $33.3 million for the first three months of fiscal 2013. The increase in our average equipment on rent and lease is primarily attributable to a growth in our T&M business, in particular in the industrial and telecommunications industries, due in part to an expansion of our sales force, resulting in increased opportunities. In addition, our DP business grew primarily due to increased rental opportunities from our existing customers.

Average rental rates for our T&M and DP segments increased by 4.1% from August 31, 2012 to August 31, 2013. Our average lease rates for the same period increased by 1.0%. 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 65.4% at August 31, 2013 from 66.4% at August 31, 2012. The average utilization of our DP equipment pool, based on the same method of calculation, increased to 39.9% from 36.8% over the same period. The increase in rental and lease rates is the result of growth in industries where we realize higher rental rates. 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 August 31, 2013 and 2012, our sales order backlog for T&M equipment relating to our resale channel was $6.9 million and $7.8 million, respectively.

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 $2.8 million from selling, general and administrative expenses to costs of rentals and leases, excluding depreciation, for the three months ended August 31, 2012 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.

Comparison of Three Months Ended August 31, 2013 and August 31, 2012

Revenues

Total revenues for the three months ended August 31, 2013 and 2012 were $60.2 million and $58.5 million, respectively. The 2.8% increase in total revenues was due to a 5.9% increase in rental and lease revenues offset by a 1.3% decrease in sales of equipment and other revenues.

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Rental and lease revenues for the three months ended August 31, 2013 were $35.7 million, compared to $33.7 million for the same period of the prior fiscal year. This increase is due to an increase in rental rates and a higher demand for both T&M and DP equipment, in particular in North American operations, which have benefited from the integration of our resale organization and T&M sales force, providing additional rental opportunities to an expanding customer base, and higher demand from our customers in lieu of new equipment purchases. Our lease revenues increased primarily due to higher demand for T&M equipment, while our DP lease revenues were essentially unchanged.

Sales of equipment and other revenues decreased to $24.5 million for the first quarter of fiscal 2014 from $24.8 million in the prior year quarter. Sales of used equipment, including finance leases, decreased slightly to $6.1 million for the three months ended August 31, 2013, compared to $6.2 million for the prior year period, while sales of new equipment decreased to $16.8 million for the three months ended August 31, 2013 compared to $17.1 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 first quarter of fiscal 2014 to $14.4 million, or 40.3% of rental and lease revenues, from $14.1 million, or 41.8% of rental and lease revenues, in the first quarter of fiscal 2013. The increased depreciation expense in fiscal 2014 was due to a higher average rental and lease equipment pool. The depreciation ratio, as a percentage of rental and lease revenues, decreased due to increases in our rental and lease rates and increased utilization for our DP equipment, offset by moderate declines in utilization of our T&M equipment.

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 $4.8 million for the three months ended August 31, 2013 compared to $4.4 million for the three months ended August 31, 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, decreased to $17.5 million in the first quarter of fiscal 2014 from $18.0 million in the same period of fiscal 2013. Costs of sales and other revenues decreased as a percentage of sales of equipment and other revenues to 76.6% in the first quarter of fiscal 2014 from 77.3% in the first quarter of fiscal 2013. This decrease is primarily due to a decline in sales of new T&M equipment, which generally carry a lower margin than used equipment sales, which were essentially flat. 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 6.5% to $14.7 million in the first quarter of fiscal 2014 compared to $13.8 million in the first quarter of fiscal 2013. As a percentage of total revenues, selling, general and administrative expenses increased to 24.4% in the first quarter of fiscal 2014 from 23.6% in the first quarter of fiscal 2013. 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 current sales and rental demand and to better focus on future growth opportunities.

Income Tax Provision

Our effective tax rate was 35.8% in the first quarter of fiscal 2014, compared to 39.4% in the first quarter of fiscal 2013. The decrease during the three months ended August 31, 2013 was due to changes in state tax apportionment, resulting in a lower overall rate.

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 $16.7 million of rental and lease equipment during the first three months of fiscal 2014 compared to $19.8 million during the first three months of fiscal 2013, a decline of 15.9%.

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Dividends Paid

During the first three months of fiscal 2014 and 2013, we paid dividends of $0.20 per common share, amounting to an aggregate of $5.0 million and $4.9 million, respectively. We expect to continue paying a quarterly dividend in future quarters, although the amount and timing of dividends, if any, will be made at the discretion of our board of directors in each quarter, subject to compliance with applicable law.

Cash and Cash Equivalents

The balance of our cash and cash equivalents was $5.5 million at August 31, 2013, a decrease of $4.9 million from May 31, 2013. Outside our normal operations and equipment purchases, we use our cash to pay dividends to shareholders and to take advantage of strategic acquisitions and new customer opportunities. Since the beginning of fiscal 2011 we have returned $77.6 million in cash to our shareholders, increasing our annual dividend rate from $0.60 per common share to $0.80 per common share in fiscal 2012. On December 19, 2012, we used $6.1 million of our cash and borrowed $23.0 million against our credit facility with Union Bank to pay the quarterly dividend of $0.20 per common share and a special dividend of $1.00 per common share on December 21, 2012. Since fiscal 2010, we have also made payments of $34.7 million in connection with two acquisitions and invested heavily in new equipment to take advantage of key new customer opportunities.

We expect that the level of our cash needs may increase as we pay dividends in future quarters, or if we decide to buy back our common stock, increase equipment purchases in response to demand, finance another acquisition, or pursue other opportunities.

Given our growth record achieved since fiscal 2000, and our available line of credit under which we have $45 million remaining that we may borrow as of August 31, 2013, we believe that we have ample access to borrowing capacity and that our cash flow from operations and ability to borrow will allow us to continue funding our current and future growth. We may, however, seek to expand our borrowing capacity in order to ensure sufficient resources to quickly respond to strategic growth opportunities.

Cash Flows and Credit Facility

During the first three months of fiscal 2014 and 2013, net cash provided by operating activities was $14.0 million and $21.0 million, respectively. The decrease in operating cash flow for the first three months of fiscal 2014 was primarily attributable to decreases in our working capital.

During the first three months of fiscal 2014 and 2013, net cash used in investing activities was $8.8 million and $13.6 million, respectively. The decline in cash used in investing activities for the first three months of fiscal 2014 was due, in part, to a decrease in payments for purchases of rental and lease equipment to $16.7 million for the three months ended August 31, 2013 compared to $19.8 million for the three months ended August 31, 2012, and an increase in the proceeds from sale of rental and lease equipment to $8.0 million for the first three months of fiscal 2014 compared to $6.3 million for the first three months of fiscal 2013.

Net cash flows used in financing activities were $9.9 million and $4.8 million for the first three months of fiscal 2014 and 2013, respectively. This decrease was the result of net pay down of our line of credit by $5.0 million for the three months ended August 31, 2013, compared to $0 for the three months ended August 31, 2012.

We have a $50.0 million revolving bank line of credit, of which $5.0 million was outstanding as of August 31, 2013, subject to certain restrictions, to meet equipment acquisition needs as well as working capital and general corporate requirements. We borrowed $9.0 million and repaid $14.0 million on our line of credit during the first three months of fiscal 2014. There are no other bank borrowings outstanding or off balance sheet financing arrangements at August 31, 2013.

We believe that cash and cash equivalents, cash flows from operating activities, proceeds from the sale of equipment and our borrowing capacity will be sufficient to fund our operations for at least the next twelve months.

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Contractual Obligations

Our contractual obligations have not changed materially from those included in our Annual Report on Form 10-K for the fiscal year ended May 31, 2013.

Critical Accounting Policies and Estimates

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America ("generally accepted accounting principles") requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On a regular basis, we review these estimates, including those related to asset lives and depreciation methods, impairment of long-lived assets including rental and lease equipment, goodwill and definite lived intangible assets, allowance for doubtful accounts and income taxes, and adjust them as appropriate. These estimates are based on our historical experience and on various other assumptions we believe to be reasonable under the circumstances.

These determinations, even though inherently subjective and subject to change, affect the reported amounts of our assets, liabilities and expenses. While we believe that our estimates are based on reasonable assumptions and judgments at the time they are made, some of our assumptions, estimates and judgments will inevitably prove to be incorrect. As a result, actual outcomes will likely differ from our accruals, and those differences-positive or negative-could be material.

We identified certain critical accounting policies that affect certain of our more significant estimates and assumptions used in preparing our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended May 31, 2013. We have not made any material changes to these policies as previously disclosed.

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