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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] Quarterly Report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended August 31, 2004 or
[ ] Transition report pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from _____ to _____
Commission File Number: 0-9061
ELECTRO RENT CORPORATION
Exact name of registrant as specified in its charter
CALIFORNIA 95-2412961
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification No.)
6060 SEPULVEDA BOULEVARD
VAN NUYS, CALIFORNIA 91411-2501
(Address of Principal Executive Offices and Zip Code)
818 786-2525
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
Indicate by check mark whether the registrant is an accelerated
filer (as defined in Rule 12b-2 of the Exchange Act).
Yes X No
The number of shares outstanding of the registrant's common stock
as of September 3, 2004 was 24,905,959.
Page 1
ELECTRO RENT CORPORATION
FORM 10-Q
AUGUST 31, 2004
TABLE OF CONTENTS Page
Part I: FINANCIAL INFORMATION 3
Item 1. Financial Statements 3
Condensed Consolidated Statements of Income for the Three 3
Months Ended August 31, 2004 and 2003 (Unaudited)
Condensed Consolidated Balance Sheets at 4
August 31, 2004 and May 31, 2004 (Unaudited)
Condensed Consolidated Statements of Cash Flows for the 5
Three Months Ended August 31, 2004 and 2003 (Unaudited)
Notes to Condensed Consolidated Financial Statements 6
(Unaudited)
Item 2. Management's Discussion and Analysis of 12
Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures 20
About Market Risk
Item 4. Controls and Procedures 20
Part II: OTHER INFORMATION 21
SIGNATURES 22
Page 2
Part I. FINANCIAL INFORMATION
- --------------------------------
Item 1. Financial Statements
ELECTRO RENT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) (000's omitted except per share data)
Three Months Ended
August 31,
2004 2003
---------- ----------
Revenues:
Rentals and leases $ 19,608 $ 16,681
Sales of equipment
and other revenues 6,011 6,016
---------- ----------
Total revenues 25,619 22,697
---------- ----------
Operating expenses:
Depreciation of rental
and lease equipment 8,025 8,061
Costs of revenues other
than depreciation of
rental and lease equipment 3,160 3,765
Selling, general and
administrative expenses 7,385 7,824
---------- ----------
Total operating expenses 18,570 19,650
---------- ----------
Operating profit 7,049 3,047
Interest and investment
income, net 258 421
Income from litigation
settlement 1,758 0
---------- ----------
Income before income taxes 9,065 3,468
Income taxes 3,438 1,342
---------- ----------
Net income $ 5,627 $ 2,126
========== ==========
Earnings per share:
Basic $0.23 $0.09
Diluted $0.22 $0.09
Shares used in per
share calculation:
Basic 24,900 24,823
Diluted 25,102 24,864
See accompanying notes to
condensed consolidated financial statements.
Page 3
ELECTRO RENT CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)(000's omitted)
ASSETS
August 31, May 31,
2004 2004
---------- ----------
Cash and cash equivalents $ 17,526 $ 29,692
Marketable securities 58,550 52,475
Accounts receivable, net of allowance for
doubtful accounts of $1,124 and $1,157 9,950 8,095
Rental and lease equipment, net of accumulated
depreciation of $141,712 and $143,403 107,033 96,346
Other property, net of accumulated depreciation and
amortization of $11,756 and $11,547 15,884 16,084
Other 3,624 3,675
---------- ----------
$ 212,567 $ 206,367
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Accounts payable $ 16,107 $ 16,560
Accrued expenses 11,674 11,000
Deferred revenue 2,685 2,197
Deferred tax liability 7,822 7,994
---------- ----------
Total liabilities 38,288 37,751
---------- ----------
Shareholders' equity:
Common stock 19,538 19,502
Retained earnings 154,741 149,114
---------- ----------
Total shareholders' equity 174,279 168,616
---------- ----------
$ 212,567 $ 206,367
========== ==========
See accompanying notes to
condensed consolidated financial statements.
Page 4
ELECTRO RENT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (000's omitted)
Three Months Ended
August 31,
2004 2003
---------- ----------
Cash flows from operating activities:
Net income $ 5,627 $ 2,126
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 8,246 8,316
Provision for losses on accounts receivable 3 199
Gain on sale of rental and lease equipment (2,455) (2,167)
Deferred tax liability (172) (67)
Change in operating assets and liabilities:
Accounts receivable (1,858) (490)
Other assets 39 877
Accounts payable (858) (50)
Accrued expenses 674 453
Deferred revenue 488 161
---------- ----------
Net cash provided by operating activities 9,734 9,358
---------- ----------
Cash flows from investing activities:
Proceeds from sale of rental and lease equipment 4,968 5,392
Payments for purchase of rental and lease equipment (20,818) (7,775)
Purchases of marketable securities (6,075) (10,000)
Payments for purchase of other property (11) (72)
---------- ----------
Net cash used in investing activities (21,936) (12,455)
---------- ----------
Cash flows from financing activities:
Proceeds from issuance of common stock 36 33
---------- ----------
Net cash provided by financing
activities 36 33
---------- ----------
Net decrease in cash and cash equivalents (12,166) (3,064)
Cash and cash equivalents at beginning of period 29,692 151,448
---------- ----------
Cash and cash equivalents at end of period $ 17,526 $ 148,384
========== ==========
See accompanying notes to
condensed consolidated financial statements.
Page 5
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(U.S. dollar amounts and shares in thousands,
except per share amounts)
Note 1: Basis of Presentation
The condensed consolidated financial statements included herein
have been prepared by Electro Rent Corporation without audit,
pursuant to the rules and regulations of the Securities and
Exchange Commission (the "SEC"). The condensed consolidated
financial statements include the accounts of Electro Rent
Corporation and its wholly owned subsidiaries, Genstar Rental
Electronics, Inc., and ER International, Inc. (collectively, the
"Company") as consolidated with the elimination of all
intercompany transactions. Certain information and footnote
disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the
United States of America have been condensed or omitted pursuant
to such SEC rules and regulations. Nevertheless, the Company
believes that the disclosures are adequate to make the
information presented not misleading. These condensed
consolidated financial statements should be read in conjunction
with the audited financial statements and notes thereto included
in the Company's latest Annual Report as found on Form 10-K. In
the opinion of management, all adjustments, including normal
recurring adjustments necessary to present fairly the financial
position of the Company with respect to the condensed
consolidated financial statements and the results of its
operations for the interim period ended August 31, 2004, have
been included. Certain reclassifications have been made to prior
year amounts to conform to the 2004 presentation. The results of
operations for interim periods are not necessarily indicative of
results for the full year.
The preparation of financial statements in conformity with
generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts
of assets and liabilities and 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. Actual results could differ from those estimates.
Note 2: Stock-Based Compensation
At August 31, 2004, the Company had four stock option plans,
which are described more fully in Note 11 in the Company's 2004
Annual Report on Form 10-K. The Company accounts for stock
options using the intrinsic value method under the provisions of
Accounting Principles Board ("APB") Opinion No. 25 and provides
proforma net income and proforma earnings per share disclosures
for employee stock option grants as if the fair-value-based
method, defined in Statement of Financial Accounting Standards
("SFAS") No. 123 (as amended by SFAS No. 148), "Accounting for
Stock-Based Compensation", had been applied. Had the Company
determined compensation cost based on the fair value at the grant
date for its stock options under SFAS No. 123, the Company's net
income would have been reduced to the pro forma amounts indicated
below for the three month periods presented:
Page 6
Three Months Ended
----------------
Aug. 31, Aug. 31,
2004 2003
------- -------
Net income, as reported $5,627 $2,126
Deduct: Total stock-based employee
compensation expense determined
under the fair value based method
for all awards, net of related tax
effects (280) (247)
------- -------
Proforma net income $5,347 $1,879
======= =======
Earnings per share:
Basic, as reported $0.23 $0.09
Basic - pro forma $0.21 $0.08
Diluted, as reported $0.22 $0.09
Diluted - pro forma $0.21 $0.08
The fair value of these options was estimated at grant date using
a Black-Scholes option pricing model with the following weighted-
average assumptions:
Three Months Ended
----------------
Aug. 31, Aug. 31,
2004 2003
------- -------
Average risk-free interest rate 3.7% 2.3%
Expected dividend yield 0 0
Expected volatility 52.7 45.9
Expected life 4.9 5.0
As described in Note 10 of this Quarterly Report on Form 10-Q, on
January 14, 2004 the Company paid a $99.5 million special
distribution to shareholders. As a result, the Board approved an
adjustment to the exercise price of all of our outstanding
options to take effect on the close of business on January 14,
2004. Consequently, 964,315 stock options with an average
exercise price of $11.95 were adjusted to 1,327,237 stock options
with an average exercise price of $8.48. In accordance with FIN
44, "Accounting for Certain Transactions involving Stock
Compensation an interpretation of APB Opinion No. 25," there was
no accounting consequence due to the changes made to the exercise
price or the number of shares other than future potential
dilution to shareholders because the aggregate intrinsic value of
each award immediately after the change was not greater than the
aggregate intrinsic value of the award immediately before the
change and the ratio of the exercise price per share to the
market value per share was not reduced.
Page 7
Note 3: Impairment of Assets
The carrying value of equipment held for rental and lease is
assessed when factors indicating an impairment are present. The
Company recognizes impairment losses on equipment held for rental
and lease when the expected future undiscounted cash flows are
less than the asset's carrying value, in which case the asset is
written down to its estimated fair value. There were no
impairment losses recorded during the three months ended August
31, 2004 and 2003.
Note 4: Noncash Investing and Financing Activities
The Company had accounts payable and other accruals related to
acquired equipment totaling $14,298 and $14,703 as of August 31,
2004 and May 31, 2004, respectively, and $8,760 and $6,243 as of
August 31, 2003 and May 31, 2003, respectively, which will be
paid in the following period.
Note 5: Capital Leases
The Company has certain customer leases providing bargain
purchase options, which are accounted for as sales-type leases.
Interest income is recognized over the life of the lease using
the effective interest method. The minimum lease payments
receivable and the net investment included in other assets for
such leases are as follows at:
August May
31, 31,
2004 2004
------ ------
Gross minimum lease payments receivable $ 748 $ 894
Less - unearned interest (39) (53)
------ ------
Net investment in sales-type lease $ 709 $ 841
receivables ------ ------
Note 6: Restructuring Charge
Due to the prolonged downturn in our industry, in May 2003 the
Company restructured its business as part of its continuing
program to create efficiencies within its operations. In the
quarter ended May 31, 2003, the Company recorded restructuring
charges of $821 in selling, general and administrative expenses,
which included the following:
Reducing the Company's workforce by approximately 27
employees, mainly in the Duluth, Georgia, warehouse and
sales office, resulting in a severance charge of
approximately $220. Approximately $113 was paid in May
2003, and the remainder was paid in the first quarter of
fiscal 2004.
Page 8
Closing of the Duluth, Georgia, warehouse. Property and
equipment that was disposed of or removed from operations
resulted in a charge of $31 and consisted primarily of
leasehold improvements, equipment and furniture and
fixtures. In addition, we incurred a charge of $570
associated with the lease related to the closed facility,
which represents the fair value of the liability determined
based on the remaining lease rentals, reduced by estimated
sublease rentals. Amounts accrued (net of estimated sublease
proceeds) related to the facility closure will be paid over
the remaining lease term through May 2005.
Remaining Cash Remaining
Liability Payments Liability
Balances Balances
as of as of
May 31, August 31,
2004 2004
-------- -------- --------
Lease commitments 261 (65) 196
-------- -------- --------
$261 $(65) $196
======== ======== ========
Page 9
Note 7: Segment Reporting
SFAS No. 131, "Disclosure about Segments of an Enterprise and
Related Information," establishes annual and interim reporting
standards for an enterprise's operating segments and related
disclosures about its products, services, geographic areas and
major customers. Under SFAS No. 131, the Company's operations
are treated as one operating segment.
Although the Company has only one reportable segment, it has two
groups of similar products: test and measurement (T&M) and data
products (DP) equipment. The Company's equipment pool, based on
acquisition cost, comprised $201,285 of T&M equipment and $47,460
of DP equipment at August 31, 2004, and $193,029 of T&M equipment
and $46,720 of DP equipment at May 31, 2004.
Revenues for these product groups were as follows for the first
quarter of fiscal:
T&M DP Total
2004
Rentals and leases $14,762 $4,846 $19,608
Sales of equipment and other
Revenues 5,714 297 6,011
-------- -------- --------
$20,476 $5,143 $25,619
======== ======== ========
2003
Rentals and leases $11,618 $5,063 $16,681
Sales of equipment and other
Revenues 5,284 732 6,016
-------- -------- --------
$16,902 $5,795 $22,697
======== ======== ========
No single customer accounted for more than 10% of total revenues
during the first three months of fiscal 2004 and 2003. In
addition, total foreign country customers and operations
accounted for no more than 10% of the Company's revenues and long-
lived assets for the same periods.
Note 8: Computation of Earnings Per Share
Following is a reconciliation of the denominator used in the
computation of basic and diluted EPS for the three months ended
August 31, 2004 and 2003:
2004 2003
------ ------
Denominator:
Denominator for basic earnings
per share-weighted average
common shares outstanding 24,900 24,823
Effect of dilutive securities-
options 202 41
------ ------
25,102 24,864
====== ======
Net income $5,627 $2,126
Earnings per share:
Basic $0.23 $0.09
Diluted $0.22 $0.09
Note 9: Commitments and Contingencies
The Company leases certain facilities under various operating
leases. Most of the lease agreements provide the Company with the
option of renewing its lease at the end of the initial lease
term, at the fair rental value, for periods of up to five years.
In most cases, management expects that in the normal course of
business facility leases will be renewed or replaced by other
leases.
The Company is subject to legal proceedings and business disputes
involving ordinary and routine claims. The ultimate legal and
financial liability with respect to such matters cannot be
estimated with certainty and requires the use of estimates in
recording liabilities for potential litigation settlements.
Estimates for losses from litigation are made after consultation
with outside counsel. If estimates of potential losses increase
or the related facts and circumstances change in the future, the
Company may be required to record either more or less litigation
expense. It is management's opinion that none of the open matters
at August 31, 2004 will have a material adverse effect on the
Company's financial condition or results of operations.
Page 10
Note 10: Extraordinary Distribution
On January 14, 2004, the Company paid an extraordinary
distribution of $4.00 per outstanding common share, which totaled
$99.5 million. The record date for the extraordinary
distribution was December 16, 2003, and the ex-dividend date was
January 15, 2004.
Note 11: Income From Litigation Settlement
On June 12, 2004, when all contingencies expired, the Company
recognized as other income $1,758 related to funds received from
a class action lawsuit. The Company, as a purchaser of certain
products under warranty, participated as a member of the
plaintiff class.
Page 11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
The following discussion addresses the financial condition of the
Company as of August 31, 2004 and the results of operations for
the three month period ended August 31, 2004. This discussion
should be read in conjunction with the Management's Discussion
and Analysis section included in the Company's 2004 Annual Report
on Form 10-K (pages 5-11) to which the reader is directed for
additional information.
General
The Company generates revenues through the rental, lease and sale
of electronic equipment, primarily test and measurement (T&M) and
personal computer-related (DP) equipment. In the first quarter
of fiscal 2005, 75.3% of rental and lease revenues was derived
from T&M equipment. This percentage has been increasing over the
last four years as a result of a steady erosion of DP rental and
lease revenues related to declines in product purchase prices and
unit volume. Rental revenues comprised 77.2% of rental and lease
revenue, which percentage has been increasing over the last four
years due to a significant decline in personal computer leasing
activity.
A large part of our test and measurement equipment portfolio is
rented or leased to Fortune 500 companies in the aerospace,
defense, electronics and telecommunications industries. We
believe that a large part of our test and measurement equipment
is used in research and development activities and that a
significant amount of this equipment is used in connection with
government-generated projects. We also rent equipment to
companies of various sizes representing a cross-section of
American industry.
The profitability of our business also depends in significant
part on controlling the timing, pricing and mix of purchases and
sales of equipment. We seek to acquire new and used equipment at
attractive prices that we feel we can make a profit from a
combination of renting and/or selling them. At times, we may
acquire equipment that we do not intend to rent, because we think
it can be more profitably sold. The sale of equipment, either
after acquisition or after it has been rented, can comprise a
significant portion of revenues and operating profit. To maximize
overall profit from the rental, leasing, and sales of equipment,
we manage our equipment pool on an on-going basis by analyzing
our product strategy for each specific equipment class in light
of that equipment's historical and projected life cycle. In doing
so, we must compare our estimate of potential profit from rental
with the potential profit from the product's immediate sale and
replacement with new or other equipment. In our analysis, we
assume depreciation and impairment of equipment based on
historical levels, although historical trends are not necessarily
indicative of future trends. Our overall equipment management is
complex and our product strategy can change during a product's
lifetime based upon numerous factors, including the U.S. and
global economy, interest rates and new product launches. Our
strategic equipment decisions are based on the following
fundamentals:
Page 12
The acquisition cost for Electro Rent;
Our estimates of current and future market demand for
rentals;
Our estimates of current and future supply of product;
The book value of the product after depreciation and other
impairment;
Our estimates of the effect of interest rates on rental and
leasing fees as well as capital financing; and
Our estimates of the potential current and future sale
prices.
If we are unable to accurately predict market trends, or if
demand for the equipment we supply declines, we can be left with
large lots of inventory that we are unable to rent or sell for a
profit. The Company assesses the carrying value of the equipment
pool on a quarterly basis or when factors indicating impairment
are present. When the U.S. and global economy began to rebound in
fiscal 2004, we saw increased demand for our equipment, and the
Company was able to sell equipment that we had previously written
down or that was older and more fully depreciated. Due in part to
these events, the Company experienced greater than normal gross
margins on equipment sales in fiscal 2004 and 2005. We intend to
maintain our equipment management strategy, and, accordingly, we
expect that gross margins on sales will return to normal
historical levels as older and previously impaired equipment
constitute a smaller percentage of sales.
We measure our overall level of profitability with the following
metrics:
Net income per diluted common share (EPS);
Net income as a percentage of average assets; and
Net income as a percentage of average equity.
PROFITIABLITY AND KEY BUSINESS TRENDS
In fiscal 2004 and 2005, we improved profitability with each
successive quarter. Lower depreciation and selling, general and
administrative expenses, improved gross profit on equipment
sales, and higher asset levels on rent led to this improvement.
During fiscal 2004, we began to focus on core T&M and DP markets.
Organic growth has been modest, consistent with the economic
environment. As a result, we have supplemented growth with the
March 2004 acquisition of a small disaster recovery business that
integrates well with our existing DP business. Focused, prudent
growth continues to be a primary goal for fiscal 2005.
Page 13
Our profitability measurements are presented in the table below
for the quarters ended August 31:
2004 2003
---- ----
Net income per diluted share $0.22 $0.09
Net income as a percentage of average
assets 10.7% 3.0%
Return on average equity 13.1% 3.4%
After several years of declines, T&M rental and lease activity
steadily increased during fiscal 2004 and 2005, reflecting the
strengthening global economy. Although DP rental and lease demand
and rates continued to be soft in fiscal 2004, we are beginning
to see some improvement in fiscal 2005.
The amount of equipment on rent, based on acquisition cost,
increased from $94.8 million at August 31, 2003, to $114.3
million at August 31, 2004. Acquisition cost of equipment on
lease increased from $37.7 million at August 31, 2003, to $40.0
million at August 31, 2004. Overall utilization for the
Company's equipment pool, again based on acquisition cost,
increased from 56.9% at August 31, 2003, to 65.5% at August 31,
2004, which reflects increasing customer demand and the Company's
continued liquidation and write-off of under-performing assets.
During the same period, monthly rental rates increased by 4.6%
and monthly lease rates increased by 2.3%. There were no
impairment losses recorded during the three months ended August
31, 2004 and 2003.
We believe that demand for rental electronic equipment should
further improve if the U.S. economy continues to recover. Also,
increased defense spending on advanced weapons and intelligence
systems should benefit the Company. Until demand improves
further, the Company will strive to operate the business
efficiently at the current activity level.
The following table shows the revenue and income trends over the
last five quarters:
Three Months Ended
-------------------
Aug. May Feb. Nov. Aug.
31, 31, 29, 30, 31,
2004 2004 2004 2003 2003
(1) (2)
------ ------ ------ ------ ------
Rentals and leases $19,608 $18,016 $16,943 $18,628 $16,681
Sales of equipment and
other revenues 6,011 5,670 6,623 5,533 6,016
Net income (loss) 5,627 3,916 3,281 2,662 2,126
(1) For the three months ended August 31, 2004, net income
included $1.8 million (pre-tax) related to funds received from a
class action lawsuit.
Page 14
(2) For the three months ended November 30, 2003, rentals and
leases included $1,200 from the reversal of various customer
credits; selling, general and administrative expenses included a
$2,300 accrual related to the retirement of the Company's
president; and income taxes were reduced by $400 due to a change
in estimated liability.
Critical Accounting Policies and Estimates
The preparation of condensed consolidated financial statements in
conformity with generally accepted accounting principles requires
management 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, management
reviews these estimates including those related to asset lives
and depreciation methods, impairment of long-lived assets
including rental and lease equipment and allowance for doubtful
accounts. These estimates are based on management's historical
experience and on various other assumptions believed to be
reasonable under the circumstances. Actual results may differ
from these estimates under different assumptions or conditions.
Management believes, however, that the estimates, including those
for the above-listed items, are reasonable.
Management believes the following critical accounting policies
affect the more significant judgments and estimates used in the
preparation of the Company's financial statements:
Asset lives and depreciation methods: The Company's primary
business involves the purchase and subsequent rental and leasing
of long-lived electronic equipment. Management has chosen asset
lives that it believes correspond to the economic life of the
related asset. Management has chosen depreciation methods that it
believes matches the benefit to the Company from the asset with
the associated costs. These judgments have been made based on
management's expertise in each equipment type that the Company
carries. If the asset life and depreciation method chosen do not
reduce the book value of the asset to at least the estimated
future cash flows from the asset to the Company, the Company
would be required to record a loss on revaluation. Depreciation
methods and useful lives are periodically reviewed and revised as
deemed appropriate.
Impairment of long-lived assets: When factors indicate an
impairment is present, management reviews the carrying value of
its rental and leasing equipment to determine if the carrying
value of the assets may not be recoverable due to current and
forecasted economic conditions. This requires management to make
estimates related to future cash flows from the assets and to
determine whether any deterioration is temporary or permanent.
If these estimates or the related assumptions change in the
future, management may be required to record additional
impairment charges.
Page 15
Allowance for doubtful accounts: The Company maintains
allowances for doubtful accounts for estimated losses resulting
from the inability of customers to make rental and lease
payments. These estimates are primarily based on the amount of
time that has lapsed since payments were due, as well as specific
knowledge related to the ability of customers to make the
required payments. If the financial condition of the Company's
customers were to deteriorate, additional allowances could be
required that would reduce income. Conversely, if the financial
condition of the customers were to improve or if legal remedies
to collect past due amounts are more successful than expected,
the allowance for doubtful accounts may need to be reduced and
income would be increased.
Results of Operations
Comparison of Three Months Ended August 31, 2004 and August 31,
2003
Revenues
Total revenues for the three months ended August 31, 2005 rose
$2.9 million, or 12.9%, to $25.6 million, compared to $22.7
million in the same period in the prior year. The increase in
total revenues was due to an increase in rental and lease
revenues of 17.5% while sales of equipment remained comparatively
constant.
Rental and lease revenues in the first quarter of fiscal 2005
were $19.6 million, a 17.5% increase from the same period in the
prior year. This increase reflects higher demand for test and
measurement equipment in the Company's major market segments,
relating to the general economic recovery.
Sales of equipment and other revenues were $6.0 million in the
first quarter of fiscal 2005, which is comparable to the first
quarter of fiscal 2004. This reflects rising demand for T&M
equipment, offset by a declining pool of DP equipment available
for sale. Sales continue to occur routinely as a normal part of
the Company's rental business; however, these sales can fluctuate
from quarter to quarter and year to year depending on equipment
availability and customer requirements and funding. Gross margin
on sales increased from $2.2 million, or 40.2%, in the first
quarter of fiscal 2004 to $2.5 million, or 49.4%, in the first
quarter of fiscal 2005, due to improvement in equipment market
values and increases in sales of equipment that had been
previously written down or that was older and more fully
depreciated. The Company expects that gross margin on sales will
return to more normal levels over the next two years as older and
previously impaired equipment become a smaller part of sales.
Operating Expenses
Depreciation of rental and lease equipment decreased from $8.1
million, or 48.3% of rental and lease revenues, in the first
quarter of fiscal 2004, to $8.0 million, or 40.9% of rental and
lease revenues, in the first quarter of fiscal 2005. These
declines reflect the Company's previous write-downs and continued
liquidation of under-performing assets. The acquisition cost of
rental and lease equipment was $248.7 million and $249.6 million
at August 31, 2004 and 2003, respectively.
Page 16
Costs of revenues other than depreciation decreased 16.1% from
$3.8 million in the first quarter of fiscal 2004 to $3.2 million
in the first quarter of fiscal 2005. Costs of revenues other
than depreciation primarily includes the cost of equipment sales,
which decreased from 59.8% of equipment sales in the first
quarter of fiscal 2004 to 50.6% of equipment sales in the first
quarter of fiscal 2005. The decrease in this percentage is
largely due to the fact that the equipment sold in the first
quarter of fiscal 2005 was more fully depreciated or had been
previously written down.
Selling, general and administrative expenses decreased $0.4
million, or 5.6%, to $7.4 million in the first quarter of fiscal
2005 as compared to $7.8 million in the first quarter of fiscal
2004. These expenses as a percentage of total revenues decreased
from 34.5% in the first quarter of fiscal 2004 to 28.8% in the
first quarter of fiscal 2005. The decline in SG&A expenses is
largely the result of reductions in personnel, facility and
freight costs. The Company's employees currently total 256, a
12.9% decline from the end of the first quarter of fiscal 2004.
Interest and Investment Income
Net interest and investment income of $.3 million for the first
quarter of fiscal 2005 was 38.7% lower than $.4 million recorded
in the first quarter of the prior year, mainly as a result of
decreased investments due to the $99.5 million special
distribution paid to common shareholders on January 14, 2004.
Income from Litigation Settlement
On June 12, 2004, when all contingencies expired, the Company
recognized as other income $1.8 million related to funds received
from a class action lawsuit (see Note 11). There was no
comparable income in the prior year period.
Income Taxes
The effective tax rate decreased slightly to 37.9% in the first
quarter of fiscal 2005, as compared to 38.7% for the same period
in the prior year, which primarily reflects the effect of tax-
advantaged investments.
Liquidity and Capital Resources
Historically, the Company's primary capital requirements have
been purchases of rental and lease equipment and debt service.
The Company generally purchases equipment throughout each year to
replace equipment that has been sold, and to maintain adequate
levels of rental equipment to meet existing and new customer
demands. However, the rental and leasing market for personal
computers and T&M equipment has declined over the last four
years, and, accordingly, the Company's equipment purchases also
had declined. During the last twelve months the Company
experienced a modest increase in overall rental activity,
including a slight increase in rental rates. To support some
areas of potential growth for both T&M and DP equipment, and to
keep the Company's equipment pool technologically up-to-date the
Company increased purchases of equipment in the first three
months of fiscal 2005 over the prior year comparable period. The
Company has had no bank borrowings since the first quarter of
fiscal 2001.
Page 17
On January 14, 2004, the Company paid a special cash distribution
of $4 per share, or approximately $99.5 million to its
shareholders of record on December 16, 2003. Following this
distribution, cash and cash equivalents have declined due to the
higher level of equipment purchases, and further declines could
result if current equipment purchase levels are sustained, the
Company decides to buy back additional shares of its common stock
under the Company's stock repurchase program, pay another special
dividend, pay regular dividends, finance another acquisition, or pursue
other opportunities. The Company has invested its cash balance
in U.S. government money market funds and other instruments with
maturities of less than 90 days.
During the first three months of fiscal 2005 and 2004 net cash
provided by operating activities was $9.7 million and $9.4
million, respectively. The increase in fiscal 2005 is generally
the result of increased net income, partially offset by higher
accounts receivable.
During the three months ended August 31, 2004 net cash used in
investing activities was $21.9 million, compared to $12.5 million
in the same period of the prior year. This increase is mostly
attributable to the purchase of rental and lease equipment
partially offset by decreased payments for the purchase of
marketable securities.
During the first three months of fiscal 2005 and 2004 net cash
flows from financing activities were not significant.
The Company has a $10.0 million revolving line of credit with an
institutional lender, subject to certain restrictions, to meet
equipment acquisition needs as well as working capital and
general corporate requirements. The Company had no borrowings
outstanding at August 31, 2004.
Page 18
SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS
Except for the historical statements and discussions, statements
contained in this Form 10-Q constitute forward-looking statements
within the meaning of section 21E of the Securities Exchange Act
of 1934. These forward-looking statements reflect the current
views of the Company's management with respect to future events
and financial performance; however, you should not put undue
reliance on these statements. The Company undertakes no
obligation to update or revise any forward-looking statements
that are or may be affected by developments, which the Company's
management does not deem material. When used in this Form 10-Q,
the words "anticipate," "believes," "expects," "intends,"
"future," and other similar expressions identify forward-looking
statements. These forward-looking statements are subject to
certain risks and uncertainties, not all of which are disclosed
in this Form 10-Q. Although the Company believes its
management's assumptions are reasonable, nonetheless, it is
likely that at least some of these assumptions will not come
true. Accordingly, the Company's actual results will probably
differ from the outcomes contained in any forward-looking
statement, and those differences could be material. Factors that
could cause or contribute to these differences include, among
others, those risks and uncertainties discussed under the
sections contained in this Form 10-Q entitled "Management's
Discussion and Analysis of Financial Condition and Results of
Operations," and in "Quantitative and Qualitative Disclosure
About Market Risk Related to Interest Rates and Currency Rates,"
as well as in the Company's Annual Report on Form 10-K for the
year ended May 31, 2004 including the "Risk Factors" attached as
Exhibit 99 to that document, the Company's Proxy Statement for
its 2004 Annual Meeting of Shareholders and the Company's other
filings with the Securities and Exchange Commission. Should one
or more of the risks discussed, or any other risks, materialize,
or should one or more of the Company's underlying assumptions
prove incorrect, the Company's actual results may vary materially
from those anticipated, estimated, expected or projected.
Page 19
Item 3. Quantitative and Qualitative Disclosures About Interest
Rates and Currency Rates
The Company is exposed to market risks related to changes in
interest rates and foreign currency exchange rates, however, the
Company does not believes those risks to be material in relation
to its operations. The Company does not have any derivative
financial instruments.
As of August 31, 2004 and May 31, 2004, cash and cash equivalents
included money market securities and the Company had investments
in marketable securities. Due to the short-term duration of our
investment portfolio, an immediate 10% change in interest rates
would not have a material effect on the fair market value of our
portfolio, therefore, the Company would not expect our operating
results or cash flows to be affected to any significant degree by
the effect of a sudden change in market interest rates on our
securities portfolio.
The Company is also subject to risks associated with foreign
currency rate fluctuations to the extent of financing
arrangements for rented and leased equipment denominated in
Canadian dollars or Euros. The Company has determined that
hedging of these assets is not cost effective and instead
attempts to minimize its risks due to currency and exchange rate
fluctuations through working capital management. The Company does
not believe that any foreseeable change in currency rates would
materially or adversely affect its financial position or results
of operations.
Item 4: Controls and Procedures
(a) Evaluation of disclosure controls and procedures
The Company's management, with the participation of the Company's
Chief Executive Officer and Chief Financial Officer, evaluated
the effectiveness the Company's disclosure controls and
procedures as of the end of the period covered by this report.
Based on that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and
procedures as of the end of the period covered by this report are
functioning effectively to provide reasonable assurance that the
information required to be disclosed by the Company in reports
filed under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods
specified in the SEC's rules and forms. A controls system, no
matter how well designed and operated, cannot provide absolute
assurance that the objectives of the controls system are met, and
no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, within a company
have been detected.
(b) Change in Internal Control over Financial Reporting
No change in the Company's internal control over financial
reporting occurred during the Company's most recent fiscal
quarter that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial
reporting.
Page 20
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 6. Exhibits
(a)
Exhibit # Description
- --------- -----------
3 Articles of Incorporation (Restated) and bylaws are
incorporated by reference to Exhibits 1.2 and 6.1,
respectively, of Registration Statement (Form S-14),
File No. 2-63532. A copy of the Restated Articles of
Incorporation and the Certificate of Amendment of
Restated Articles of Incorporation filed October 24,
1988 are incorporated by reference to Exhibit (3) to
the Annual Report (Form 10-K) for the fiscal year
ended May 31, 1989. A copy of the Certificate of
Amendment of Restated Articles of Incorporation filed
October 15, 1997 is filed as Exhibit (3) to the
Annual Report (Form 10-K) for the fiscal year ended
May 31, 1999. A copy of the amendment to the bylaws
adopted October 6, 1994 is incorporated by reference
to the Annual Report (Form 10-K) for the fiscal year
ended May 31, 1995. A copy of the amendment to the
bylaws adopted November 15, 1996 is incorporated by
reference to Exhibit (3) of the Annual Report (Form
10-K) for the fiscal year ended May 31, 1997
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief
Executive Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief
Financial Officer
32.1 Section 1350 Certification by Principal Executive
Officer
32.2 Section 1350 Certification by Chief Financial Officer
Page 21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereto duly authorized.
ELECTRO RENT CORPORATION
DATED: September 15, 2004
/s/ Craig R. Jones
Craig R. Jones
Vice President and Chief Financial Officer
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