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

Show all filings for ELECTRO RENT CORP

Form 10-Q for ELECTRO RENT CORP


8-Apr-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 February 28, 2014 and May 31, 2013, the results of our operations for the three and nine months ended February 28, 2014 and 2013, respectively, and cash flows for the nine month periods ended February 28, 2014 and 2013, 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, pursuant to the terms of an Authorized Technology Partner Program Agreement. That agreement, which runs through May 31, 2014 under the current amendment, 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. 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. Our direct sales force includes highly technical engineers who specialize in 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.
We also specialize 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.
During the first nine months of fiscal 2014, our revenues and operating profit decreased compared to the first nine months of fiscal 2013 primarily due to a decline in our new equipment sales revenue, partially offset by growth in our higher margin rental and lease revenues. Our new equipment sales continue to be affected by uncertainty in U.S. government defense spending, causing delays in our customers' procurement decisions and resulting in decreased demand, particularly in the aerospace and defense sector. We have also seen a softening in the telecommunications and semiconductor manufacturing sectors. As of February 28, 2014, our sales order backlog for T&M equipment relating to our resale channel was $9.8 million, an increase of 104.0% over the $4.8 million at February 28, 2013. The increase in backlog for fiscal 2014 is primarily due to longer manufacturing lead time.
Global 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,

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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 an annual basis or more frequently when factors indicating potential impairment are present.
Profitability and Key Business Trends
Comparing the first nine months of fiscal 2014 to the first nine months of fiscal 2013, our revenues decreased by 4.4% to $180.1 million from $188.4 million, our operating profit decreased 7.6% to $24.9 million from $26.9 million, and our net income decreased 3.3% to $15.8 million from $16.4 million. Our rental and lease revenues increased $2.2 million, or 2.2%, from $101.1 million for the first nine months of fiscal 2013 to $103.3 million for the first nine months of fiscal 2014. During the first nine months of fiscal 2014, 88% of our rental and lease revenues were derived from T&M equipment compared to 89% for the same period in the prior fiscal year. Our T&M rental revenues increased $0.6 million due to an increase in rental rates of $1.9 million offset by a decrease in demand of $1.3 million. Our T&M lease revenues increased approximately $0.6 million due to an increase in demand of $0.8 million offset by a decrease in lease rates of $0.2 million. Rental and lease revenues in our DP segment increased $1.1 million due to an increase in rental and lease rates. Our sales of equipment and other revenues decreased $10.6 million, or 12.1%, from $87.3 million for the first nine months of fiscal 2013 to $76.7 million for the first nine months of fiscal 2014. This decrease was primarily due to a decline in new equipment sales, in particular in the aerospace and defense, telecommunications manufacturing and semiconductor manufacturing industries, as our customers that traditionally purchase new equipment delayed procurement decisions in response to uncertainty around U.S. government defense spending and general uncertainty in the global economy.
Our operating profit decreased 7.6%, or $2.0 million, from $26.9 million for the first nine months of fiscal 2013 compared to $24.9 million for the first nine months of fiscal 2014. Our rental and lease business contributed $1.3 million in increased operating profit, resulting from (a) a $2.3 million increase in rental and lease revenues, (b) an offsetting increase in depreciation expense of $0.5 million, or 1.2%, and (c) an offsetting increase in our costs of rentals and leases, excluding depreciation, of $0.5 million, or 3.3%. Operating profit from our sales of equipment and other revenues decreased $1.7 million, primarily due to the decline in our new equipment sales. Our selling, general and administrative expenses increased $1.7 million, primarily due to higher personnel and benefit costs.
Some of our key profitability measurements are presented below for the nine months ended February 28, 2014 and 2013:

                                              Fiscal 2014     Fiscal 2013
Net income per diluted common share (EPS)    $      0.65     $      0.68
Net income as a percentage of average assets         6.8 %           6.9 %
Net income as a percentage of average equity         9.3 %           9.8 %

Due to our foreign operations, we have revenues, expenses, assets and liabilities in foreign currencies, primarily the euro, Canadian dollar and Chinese yuan. While our exposure to fluctuations in the Chinese yuan is not significant, 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 from foreign currency fluctuations has been insignificant.

Average acquisition cost of      Three Months Ended February 28,           Nine Months Ended February 28,
equipment (in thousands)         2014           2013        Change         2014           2013        Change
on rent                      $     230.9     $  242.4        (4.7 )%   $     239.9     $  244.3        (1.8 )%
on lease                     $      36.1     $   34.7         3.8  %   $      36.5     $   34.0         7.4  %

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 T&M foreign operations. Our average equipment on lease increased due to higher demand in North American operations.
Average rental rates increased by 2.3% and 3.5% for the three and nine months ended February 28, 2014, respectively, compared to the three and nine months ended February 28, 2013. Our average lease rates increased by 0.5% and 0.6% for the

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three and nine months ended February 28, 2014, respectively, compared to the three and nine months ended February 28, 2013. The increase in rental and lease rates is the result of growth industries where we realize higher rental rates. Average utilization for our equipment pool, calculated based on average acquisition cost of equipment on rent and lease compared to the average total equipment pool, decreased from 64.8% to 60.7% for the three months ended February 28, 2013 and 2014, respectively, while average utilization decreased from 64.2% to 62.6% for the nine months ended February 28, 2013 and 2014, respectively. 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 February 28, 2014 and February 28, 2013 Revenues
Total revenues for the three months ended February 28, 2014 and 2013 were $62.0 million and $64.7 million, respectively. The 4.1% decrease in total revenues was due to a 1.1% decrease in rental and lease revenues and a 7.2% decrease in sales of equipment and other revenues.
Rental and lease revenues for the three months ended February 28, 2014 were $32.5 million, compared to $32.8 million for the same period of the prior fiscal year. This decrease is primarily due to a decline in rental demand in our North American operations due to softening in the aerospace and defense and semiconductor industries offset by an increase in lease demand.
Sales of equipment and other revenues decreased to $29.5 million for the third quarter of fiscal 2014 from $31.8 million in the prior year quarter. Sales of used equipment, including finance leases, increased to $11.0 million for the three months ended February 28, 2014, compared to $9.5 million for the prior year period, while sales of new equipment decreased to $17.6 million for the three months ended February 28, 2014 compared to $21.0 million for the three months ended February 28, 2013. Our new equipment sales continue to be affected by uncertainty in U.S. government defense spending, 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 manufacturing sectors as a result of general uncertainty in the global economy. Operating Expenses
Depreciation of rental and lease equipment increased in the third quarter of fiscal 2014 to $14.4 million, or 44.2% of rental and lease revenues, from $14.3 million, or 43.6% of rental and lease revenues, in the third quarter of fiscal 2013. While the depreciation expense was essentially flat, the depreciation ratio, as a percentage of rental and lease revenues, increased as the increase in our rental and lease rates were offset by declines in utilization rates. Costs of rentals and leases, excluding depreciation, which primarily include labor related costs of our operations personnel, supplies, repairs, equipment subrentals and insurance and warehousing costs associated with our rental and lease equipment, decreased to $4.5 million for the three months ended February 28, 2014 compared to $4.7 million for the three months ended February 28, 2013. 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 $21.6 million in the third quarter of fiscal 2014 from $23.5 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 73.1% in the third quarter of fiscal 2014 from 73.7% in the third 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 increased to $14.4 million in the third quarter of fiscal 2014 from $13.8 million in the same period of fiscal 2013, due to an increase in personnel and benefit costs. As a percentage of total revenues, selling, general and administrative expenses increased to 23.2% in the third quarter of fiscal 2014 from 21.3% in the third quarter of fiscal 2013. The increase in selling, general, and administrative expenses as a percentage of revenues was attributable to both an increase in the dollar amount of expenses, as well as a decline in overall revenues. Income Tax Provision
Our effective tax rate was 37.8% in the third quarter of fiscal 2014, compared to 40.3% in the third quarter of fiscal 2013. The decrease during the three months ended February 28, 2014 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.

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Comparison of Nine Months Ended February 28, 2014 and February 28, 2013 Revenues
Total revenues for the nine months ended February 28, 2014 and 2013 were $180.1 million and $188.4 million, respectively. The 4.4% decrease in total revenues was due to a 12.1% decrease in sales of equipment and other revenues offset by a 2.2% increase in rental and lease revenues.
Rental and lease revenues for the nine months ended February 28, 2014 were $103.3 million, compared to $101.1 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. 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 $76.7 million for the first nine months of fiscal 2014 from $87.3 million in the same period of the prior fiscal year. Sales of used equipment, including finance leases, increased to $24.2 million for the nine months ended February 28, 2014, compared to $23.6 million for the first nine months of fiscal 2013, while sales of new equipment decreased to $48.4 million for the nine months ended February 28, 2014 compared to $59.2 million for the first nine months of fiscal 2013. Our new equipment sales continue to be affected by uncertainty in U.S. government defense spending, causing delays in our customers' procurement decisions and resulting in decreased demand in the aerospace and defense sector. We have also seen softening in the telecommunications and semiconductor manufacturing sectors as a result of general uncertainty in the global economy. Operating Expenses
Depreciation of rental and lease equipment increased in the first nine months of fiscal 2014 to $43.0 million, or 41.6% of rental and lease revenues, from $42.5 million, or 42.0% of rental and lease revenues, in the first nine 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 $14.1 million for the nine months ended February 28, 2014 compared to $13.7 million for the nine months ended February 28, 2013. This increase is the result of higher equipment subrental expense of $0.5 million for the nine months ended February 28, 2014, compared to the nine months ended February 28, 2013. 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 include the cost of equipment sales, decreased to $54.8 million in the first nine months of fiscal 2014 from $63.7 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 71.4% in the first nine months of fiscal 2014 from 73.0% in the first nine 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 4.0% to $43.3 million in the first nine months of fiscal 2014 compared to $41.6 million in the first nine months of fiscal 2013 due to an increase in personnel and benefit costs. As a percentage of total revenues, selling, general and administrative expenses increased to 24.0% in the first nine months of fiscal 2014 from 22.1% in the first nine months of fiscal 2013. The increase in selling, general, and administrative expenses as a percentage of revenues was attributable to both an increase in the dollar amount of expenses, as well as a decline in overall revenues.
Income Tax Provision
Our effective tax rate was 37.1% in the first nine months of fiscal 2014, compared to 40.0% in the first nine months of fiscal 2013. The decrease during the nine months ended February 28, 2014 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.

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Liquidity and Capital Resources
Capital Expenditures
Our primary capital expenditures 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 purchased $44.7 million of rental and lease equipment during the first nine months of fiscal 2014 compared to $48.8 million during the first nine months of fiscal 2013, a decline of 8.3%. Dividends Paid
We paid dividends of $0.60 per common share during the first nine months of fiscal 2014, compared to $1.60 per common share, including a special dividend of $1.00 per common share, during the first nine months of fiscal 2013. During the first nine months of fiscal 2014 and 2013, the dividends paid amount to an aggregate of $14.8 million and $39.0 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 $5.2 million at February 28, 2014, a decrease of $5.2 million from May 31, 2013, in part because we chose to borrow less, with bank borrowings declining to $2.0 million as of February 28, 2014 from $10.0 million as of 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 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 if we 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 $23.0 million remaining that we may borrow as of February 28, 2014, 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 nine months of fiscal 2014 and 2013, net cash provided by operating activities was $38.3 million and $48.0 million, respectively. The decrease in net cash provided by operating activities for the first nine months of fiscal 2014 was primarily attributable to moderate decreases in net income, changes in operating assets and liabilities, as well as a reduction in our deferred tax liability. Our income tax payments have increased approximately $6.4 million for the first nine months of fiscal 2014 compared to the first nine months of fiscal 2013.
During the first nine months of fiscal 2014 and 2013, net cash used in investing activities was $20.6 million and $27.9 million, respectively. The decline in cash used in investing activities for the first nine months of fiscal 2014 was due, in part, to a decrease in purchases of rental and lease equipment to $44.7 million for the nine months ended February 28, 2014 compared to $48.8 million for the nine months ended February 28, 2013, and an increase in the proceeds from sale of rental and lease equipment to $24.5 million for the first nine months of fiscal 2014 compared to $21.7 million for the first nine months of fiscal 2013.
Net cash used in financing activities were $22.6 million and $22.3 million for the first nine months of fiscal 2014 and 2013, respectively. Borrowings under our bank lines of credit were $43.8 million for the nine months ended February 28, 2014 compared to $31.5 million for the nine months ended February 28, 2013. Payments under our bank lines of credit were $51.7 million for the nine months ended February 28, 2014 compared to $15.0 million for the nine months ended February 28, 2013. Payments of dividends were $14.8 million for the nine months ended February 28, 2014, compared to $39.0 million for the nine months ended February 28, 2013.

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On November 19, 2013, we entered into a new credit agreement (the "Credit Agreement") with J.P. Morgan Chase Bank, National Association ("JPM"), as administrative agent, J.P. Morgan Securities LLC, as sole bookrunner and sole lead arranger, and a syndicate of lenders. The Credit Agreement provides for a $25 million revolving credit facility including swingline loans and letters of credit, and has a term of three years, of which $2.0 million was outstanding as of February 28, 2014. We have an option to increase the commitments under the Credit Agreement by up to $25 million, subject to certain approvals and conditions as set forth in the Credit Agreement. Borrowings under the Credit Agreement bear interest at a rate equal to, at our election, the applicable rate for a "Eurodollar Loan" or a "CB Floating Rate Loan." Eurodollar Loan advances accrue interest at a per annum interest rate equal to (i) the quotient (rounded upwards to the next 1/16th of 1%) of (a) the applicable LIBO Rate, divided by
(b) one minus the maximum aggregate reserve requirement (expressed as a decimal) imposed under Federal Reserve Board Regulation D (the "Adjusted LIBO Rate"), plus (ii) 0.75%. CB Floating Rate Loan advances accrue interest at a per annum interest rate equal to (i) the higher of (a) JPM's Prime Rate or (b) the Adjusted LIBO Rate for a one month interest period plus 2.5%, minus (ii) 2.0%. . . .

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