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ELRC > SEC Filings for ELRC > Form 10-Q on 8-Jan-2014All Recent SEC Filings

Show all filings for ELECTRO RENT CORP

Form 10-Q for ELECTRO RENT CORP


8-Jan-2014

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 November 30, 2013 and May 31, 2013, the results of our operations for the three and six months ended November 30, 2013 and 2012, respectively, and cash flows for the six month periods ended November 30, 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 and 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.

We are 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 under a contract whose latest expiration date is currently 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.

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During the first six months of fiscal 2014, our revenues and operating profit decreased compared to the first six months of fiscal 2013 primarily due to a decline in our new equipment sales revenue, offsetting growth in our higher margin rental and lease revenues. Our new equipment sales continue to be affected by changes in the U.S. national budgetary policy and uncertainty in the global economy, causing delays in our customers' procurement decisions and resulting in decreased demand in the aerospace and defense sector. We have also seen a softening in the telecommunications and semiconductor sectors. In the second quarter of fiscal 2014, our new equipment sales revenues were also impacted by delayed shipments by the manufacturers, as well as the Thanksgiving holiday, which fell during the last week of our second quarter causing the delay in delivery of equipment to some of our customers into the third quarter. As of November 30, 2013, our sales order backlog for T&M equipment relating to our resale channel was $11.2 million, an increase of 56% over the $7.2 million at November 30, 2012.

Economic uncertainty continues to impact our customers and competitors. 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 six months of fiscal 2014 to the first six months of fiscal 2013, our revenues decreased by 4.6% from $123.7 million to $118.0 million, our operating profit decreased 4.7% from $18.6 million to $17.7 million, while our net income remained unchanged at $11.3 million.

Our rental and lease revenues increased $2.7 million, or 3.8%, from $68.2 million for the first six months of fiscal 2013 to $70.9 million for the first six months of fiscal 2014. During the first six months of fiscal 2014, 87% 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 $1.3 million, primarily due to an increase in rental rates, in particular in our North American and European operations and increased demand in our Chinese operations. Our T&M lease revenues increased approximately $0.5 million, which was primarily attributed to an increase in demand. Rental and lease revenues in our DP segment increased $0.8 million due to an increase in rental and lease rates.

Our sales of equipment and other revenues decreased $8.3 million, or 14.9%, from $55.5 million for the first six months of fiscal 2013 compared to $47.2 million for the first six months of fiscal 2014. This decrease was primarily due to a decline in new equipment sales, in particular in the aerospace and defense, telecommunications and semiconductor industries, 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 six months ended November 30, 2013, our operating profit decreased 4.7%, or $0.9 million, compared to the six months ended November 30, 2012. Our rental and lease business contributed $1.5 million in increased operating profit, resulting from a) a $2.7 million increase in rental and lease revenues, b) an offsetting increase in depreciation expense of $0.5 million, or 1.7%, due to a higher average rental equipment pool, and c) an offsetting increase in our costs of rentals and leases, excluding depreciation, of $0.7 million, or 7.6%. Operating profit from our sales of equipment and other revenues decreased $1.3 million, primarily due to the decline in our new equipment sales. Our selling, general and administrative expenses increased $1.1 million, primarily due to higher salaries and related costs.

Some of our key profitability measurements are presented below for the six months ended November 30, 2013 and 2012:

                                                        Fiscal       Fiscal
                                                         2014         2013
         Net income per diluted common share (EPS)      $  0.46      $  0.47
         Net income as a percentage of average assets       7.0 %        6.9 %
         Net income as a percentage of average equity       9.6 %        9.8 %

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

                                                             Three months ended                    Six months ended
                                                                November 30,                         November 30,
Average acquisition cost of equipment (in thousands)    2013        2012       Change        2013        2012       Change

on rent $ 245.7 $ 248.2 -1.0 % $ 244.9 $ 245.2 -0.2 % on lease $ 35.9 $ 33.9 5.8 % $ 36.3 $ 33.6 8.2 %

The decrease in our average equipment on rent is due to a decline in demand in our T&M North American operations, in particular in the aerospace and defense sector, partially offset by increased demand in our Chinese operations. Our average equipment on lease increased due to higher demand in North American operations.

Average rental rates for our T&M and DP segments increased by 2.8% and 3.5% for the three and six months ending November 30, 2013, respectively, compared to the three and six months ended November 30, 2012. Our average lease rates increased by 1.2% and 1.1% for the three and six months ended November 30, 2013, respectively, compared to the three and six months ended November 30, 2012. 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 from 67.2% to 65.6% for the three months ended November 30, 2012 and 2013, respectively, while average utilization declined from 66.8% to 65.5% for the six months ended November 30, 2012 and 2013, respectively. The average utilization of our DP equipment pool, based on the same method of calculation, decreased from 37.3% to 34.8% for the three months ended November 30, 2012 and 2013, respectively, while average utilization increased from 37.0% to 37.3% for the six months ended November 30, 2012 and 2013, respectively. 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.

Comparison of Three Months Ended November 30, 2013 and November 30, 2012

Revenues

Total revenues for the three months ended November 30, 2013 and 2012 were $57.9 million and $65.2 million, respectively. The 11.2% decrease in total revenues was due to a 1.8% increase in rental and lease revenues offset by a 26.0% decrease in sales of equipment and other revenues.

Rental and lease revenues for the three months ended November 30, 2013 were $35.2 million, compared to $34.6 million for the same period of the prior fiscal year. This increase is due to an increase in rental rates in our T&M and DP segments, due to growth in industries where we realize higher rental rates, and increased demand in our Chinese operations. This increase was offset, in part, by a decrease in demand in our North American operations due to softening in the aerospace and defense and semiconductor industries. 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 $22.7 million for the second quarter of fiscal 2014 from $30.6 million in the prior year quarter. Sales of used equipment, including finance leases, modestly decreased to $7.2 million for the three months ended November 30, 2013, compared to $7.8 million for the prior year period. Our new equipment sales continue to be affected by changes in the U.S. national budgetary policy and uncertainty in the global economy, causing delays in our customers' procurement decisions and resulting in decreased demand in the aerospace and defense sector. We have also seen a softening in the telecommunications and semiconductor sectors. In the second quarter of fiscal 2014, our new equipment sales revenues were also impacted by delayed shipments by the manufacturers, as well as the Thanksgiving holiday, which fell during the last week of our second quarter causing the delay in delivery of equipment to some of our customers into the third quarter.

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Operating Expenses

Depreciation of rental and lease equipment increased in the second quarter of fiscal 2014 to $14.2 million, or 40.5% of rental and lease revenues, from $14.1 million, or 40.7% of rental and lease revenues, in the second 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, was essentially flat as increases in our rental and lease rates were offset by moderate declines in utilization rates.

Costs of rentals and leases, excluding depreciation, which primarily includes labor related costs of our operations personnel, supplies, repairs, equipment subrentals and insurance and warehousing costs associated with our rental and lease equipment, increased to $4.8 million for the three months ended November 30, 2013 compared to $4.6 million for the three months ended November 30, 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 $15.7 million in the second quarter of fiscal 2014 from $22.2 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 74.3% in the second quarter of fiscal 2014 from 76.7% in the second quarter of fiscal 2013. This decrease is primarily due to the decline 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, economic uncertainty, changes in U.S. governmental policies, and customer requirements and funding.

Selling, general and administrative expenses remained relatively unchanged at $14.2 million and $14.1 million in the second quarter of fiscal 2014 and fiscal 2013, respectively. As a percentage of total revenues, selling, general and administrative expenses increased to 24.6% in the second quarter of fiscal 2014 from 21.6% in the second quarter of fiscal 2013, due to a decline in our sales of new equipment without a commensurate decrease in selling, general and administrative expenses.

Income Tax Provision

Our effective tax rate was 38.0% in the second quarter of fiscal 2014, compared to 40.3% in the second quarter of fiscal 2013. The decrease during the three months ended November 30, 2013 was due to a decrease in foreign losses where we have a valuation allowance and therefore do not recognize a tax benefit, resulting in a lower overall rate.

Comparison of Six Months Ended November 30, 2013 and November 30, 2012

Revenues

Total revenues for the six months ended November 30, 2013 and 2012 were $118.0 million and $123.7 million, respectively. The 4.6% decrease in total revenues was due to a 3.8% increase in rental and lease revenues offset by a 14.9% decrease in sales of equipment and other revenues.

Rental and lease revenues for the six months ended November 30, 2013 were $70.9 million, compared to $68.2 million for the same period of the prior fiscal year. This increase is due to an increase in rental rates in our T&M and DP segments, due to growth industries where we realize higher rental rates, and increased demand in our Chinese and European operations. This increase was offset, in part, by a decrease in demand in our North American operations due to softening in the aerospace and defense and semiconductor industries in our North American operations. 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 $47.2 million for the first six months of fiscal 2014 from $55.5 million in the same period of the prior fiscal year. Sales of used equipment, including finance leases, decreased slightly to $13.2 million for the six months ended November 30, 2013, compared to $14.1 million for the first six months of fiscal 2013, while sales of new equipment decreased to $30.7 million for the six months ended November 30, 2013 compared to $38.2 million for the first six months of fiscal 2013. Our new equipment sales continue to be affected by changes in the U.S. national budgetary policy and uncertainty in the global economy, causing delays in our

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customers' procurement decisions and resulting in decreased demand in the aerospace and defense sector. We have also seen a softening in the telecommunications and semiconductor sectors. In the second quarter of fiscal 2014, our new equipment sales revenues were also impacted by delayed shipments by the manufacturers, as well as the Thanksgiving holiday, which fell during the last week of our second quarter causing the delay in delivery of equipment to some of our customers into the third quarter.

Operating Expenses

Depreciation of rental and lease equipment increased in the first six months of fiscal 2014 to $28.6 million, or 40.4% of rental and lease revenues, from $28.1 million, or 41.2% of rental and lease revenues, in the first six months 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, equipment subrentals and insurance and warehousing costs associated with our rental and lease equipment, increased to $9.6 million for the six months ended November 30, 2013 compared to $8.9 million for the six months ended November 30, 2012. This increase is the result of higher equipment subrental expense of $0.5 million for the three months ended November 30, 2013, compared to the three months ended November 30, 2012. We subrent equipment from time to time to supplement our rental equipment pool with equipment we choose not to own. In general, our costs of rentals and leases, excluding depreciation expense is 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 $33.2 million in the first six months of fiscal 2014 from $40.2 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 75.5% in the first six months of fiscal 2014 from 76.9% in the first six months of fiscal 2013. This decrease is primarily due to a significant decline 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, economic uncertainty, changes in U.S. governmental policies, and customer requirements and funding.

Selling, general and administrative expenses increased 3.8% to $28.9 million in the first six months of fiscal 2014 compared to $27.8 million in the first six months of fiscal 2013. As a percentage of total revenues, selling, general and administrative expenses increased to 24.3% in the first six months of fiscal 2014 from 22.5% in the first six months 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 36.9% in the first six months of fiscal 2014, compared to 39.9% in the first six months of fiscal 2013. The decrease during the six months ended November 30, 2013 was due to changes in state tax apportionment, and a decrease in our foreign losses where we have a valuation allowance and therefore do not recognize a tax benefit, 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. Our equipment purchases will fluctuate based on changes in our utilization, used equipment sales activity and technology trends. To meet current 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 $31.8 million of rental and lease equipment during the first six months of fiscal 2014 compared to $36.0 million during the first six months of fiscal 2013, a decline of 11.6%.

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Dividends Paid

During the first six months of fiscal 2014 and 2013, we paid dividends of $0.40 per common share, amounting to an aggregate of $9.9 million and $9.7 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 $8.2 million at November 30, 2013, a decrease of $2.2 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. In fiscal 2012, we increased our annual dividend rate from $0.60 per common share to $0.80 per common share. 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 regular quarterly dividend of $0.20 per common share, and the 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 $16.5 million remaining that we may borrow as of November 30, 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 six months of fiscal 2014 and 2013, net cash provided by operating activities was $26.3 million and $33.0 million, respectively. The decrease in operating cash flow for the first six months of fiscal 2014 was primarily attributable to decreases in our working capital, as well as a reduction in our deferred tax liability. Our income tax payments have increased approximately $4.2 million for the first six months of fiscal 2014 compared to the first six months of fiscal 2013

During the first six months of fiscal 2014 and 2013, net cash used in investing activities was $17.0 million and $22.3 million, respectively. The decline in cash used in investing activities for the first six months of fiscal 2014 was due, in part, to a decrease in payments for purchases of rental and lease equipment to $31.8 million for the six months ended November 30, 2013 compared to $36.0 million for the six months ended November 30, 2012, and an increase in the proceeds from sale of rental and lease equipment to $15.1 million for the first six months of fiscal 2014 compared to $14.2 million for the first six months of fiscal 2013.

Net cash flows used in financing activities were $11.3 million and $9.7 million for the first six months of fiscal 2014 and 2013, respectively. This increase was the result of net payments on our line of credit by $1.5 million for the six . . .

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