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UNITED STATES

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 November 30, 2011

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 of incorporation or organization)		(I.R.S. Employer Identification No.)
6060 Sepulveda Boulevard, Van Nuys, California		91411-2501
(Address of principal executive offices)		(Zip Code)

(818) 787-2100

(Issuer’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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer		¨		Accelerated filer		x
Non-accelerated filer		¨		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares outstanding of the registrant’s common stock as of December 16, 2011 was 23,980,581.

 

 

 

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Electro Rent Corporation

Quarterly Report on Form 10-Q

For the Quarterly Period Ended November 30, 2011

TABLE OF CONTENTS

 

				Page
EXPLANATORY NOTE					3
SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS					3
PART I—FINANCIAL INFORMATION					4
Item 1.		Financial Statements.			4
		Condensed Consolidated Statements of Operations for the Three and Six Months Ended November  30, 2011 and 2010 (Unaudited)			4
		Condensed Consolidated Balance Sheets at November 30, 2011 and May 31, 2011 (Unaudited)			5
		Condensed Consolidated Statements of Cash Flows for the Six Months Ended November  30, 2011 and 2010 (Unaudited)			6
		Notes to Condensed Consolidated Financial Statements (Unaudited)			7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations.			19
Item 3.		Quantitative and Qualitative Disclosures About Market Risk.			24
Item 4.		Controls and Procedures.			24
PART II—OTHER INFORMATION					25
Item 1.		Legal Proceedings.			25
Item 1A.		Risk Factors.			25
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds.			25
Item 3.		Defaults Upon Senior Securities.			25
Item 4.		(Removed and Reserved).			25
Item 5.		Other Information.			25
Item 6.		Exhibits.			25
SIGNATURES					26

 

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EXPLANATORY NOTE

In this report, unless the context indicates otherwise, the terms “Electro Rent,” “Company,” “we,” “us” and “our” refer to Electro Rent Corporation, a California corporation, and its subsidiaries.

SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). You can find many (but not all) of these statements by looking for words such as “approximates,” “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “would,” “may” or other similar expressions in this report. We claim the protection of the safe harbor contained in the Private Securities Litigation Reform Act of 1995. We caution investors that any forward-looking statements presented in this report, or that we may make orally or in writing from time to time, are based on the beliefs of, assumptions made by, and information currently available to, us. Such statements are based on assumptions, and the actual outcome will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control. Although we believe that our assumptions are reasonable, they are not guarantees of future performance, and some will inevitably prove to be incorrect. As a result, our actual future results may differ from our expectations, and those differences may be material. We are not undertaking any obligation to update any forward-looking statements. Accordingly, investors should use caution in relying on past forward-looking statements, which are based on known results and trends at the time they are made, to anticipate future results or trends.

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,” “Part I, Item 3. Quantitative and Qualitative Disclosures About Market Risk,” and “Part II, Item 1A. Risk Factors” as well as in our Annual Report on Form 10-K for the fiscal year ended May 31, 2011 (including the “Risk Factors” discussed in Item 1A in that document), and our other filings with the Securities and Exchange Commission. The risks included in those documents are not exhaustive, and additional factors could adversely affect our business and financial performance. We operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time, and it is not possible for us to predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

 

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Part I. FINANCIAL INFORMATION

Item 1. Financial Statements

ELECTRO RENT CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited) (in thousands, except per share data)

 

		Three Months Ended November 30,								Six Months Ended November 30,
		2011				2010				2011				2010
Revenues:
Rentals and leases		$	32,912			$	29,673			$	64,221			$	58,460
Sales of equipment and other revenues			28,731				23,604				56,072				45,642
Total revenues			61,643				53,277				120,293				104,102
Operating expenses:
Depreciation of rental and lease equipment			13,374				11,919				25,901				23,575
Costs of revenues other than depreciation of rental and lease equipment			22,901				18,087				44,511				35,309
Selling, general and administrative expenses			15,929				13,714				31,822				27,282
Total operating expenses			52,204				43,720				102,234				86,166
Operating profit			9,439				9,557				18,059				17,936
Gain on bargain purchase, net of deferred taxes			188				49				3,382				202
Interest income, net			108				101				207				219
Income before income taxes			9,735				9,707				21,648				18,357
Income tax provision			3,716				2,588				7,124				6,017
Net income		$	6,019			$	7,119			$	14,524			$	12,340
Earnings per share:
Basic		$	0.25			$	0.30			$	0.61			$	0.51
Diluted		$	0.25			$	0.30			$	0.60			$	0.51
Shares used in per share calculation:
Basic			23,981				23,976				23,981				23,970
Diluted			24,149				24,075				24,139				24,049

See accompanying notes to condensed consolidated financial statements (unaudited).

 

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ELECTRO RENT CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited) (in thousands, except share numbers)

 

		November  30, 2011				May  31, 2011
ASSETS
Cash and cash equivalents		$	12,530			$	41,441
Accounts receivable, net of allowance for doubtful accounts of $542 and $602			34,662				30,616
Rental and lease equipment, net of accumulated depreciation of $194,420 and $191,160			233,649				195,632
Other property, net of accumulated depreciation and amortization of $17,315 and $16,825			14,032				14,127
Goodwill			3,109				3,109
Intangibles, net of amortization of $1,221 and $1,151			1,284				1,214
Other assets			19,574				19,788
		$	318,840			$	305,927
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Accounts payable		$	7,080			$	8,237
Accrued expenses			10,540				10,437
Deferred revenue			6,975				5,874
Deferred tax liability			48,296				41,004
Total liabilities			72,891				65,552
Commitments and contingencies (Note 12)
Shareholders’ equity:
Preferred stock, $1 par - shares authorized 1,000,000, none issued or outstanding
Common stock, no par - shares authorized 40,000,000; issued and outstanding November 30, 2011- 23,980,581; May 31, 2011- 23,980,581			35,445				34,742
Retained earnings			210,504				205,633
Total shareholders’ equity			245,949				240,375
		$	318,840			$	305,927

See accompanying notes to condensed consolidated financial statements (unaudited).

 

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ELECTRO RENT CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited) (in thousands)

 

		Six Months Ended November 30,
		2011				2010
Cash flows from operating activities:
Net income		$	14,524			$	12,340
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			26,542				24,176
Put option loss			—				952
Realized gain on redemption of trading securities			—				(952	)
Remeasurement loss (gain) on foreign currency			75				(3	)
Provision for losses on accounts receivable			132				169
Gain on sale of rental and lease equipment			(4,948	)			(5,064	)
Gain on bargain purchase, net of deferred taxes			(3,382	)			(202	)
Stock compensation expense			710				436
Excess tax benefit from share based compensation			(50	)			(25	)
Deferred income taxes			5,200				6,995
Changes in operating assets and liabilities:
Accounts receivable			(3,958	)			(2,789	)
Other assets			205				(3,225	)
Accounts payable			(1,556	)			20
Accrued expenses			156				(4,809	)
Deferred revenue			654				45
Net cash provided by operating activities			34,304				28,064
Cash flows from investing activities:
Proceeds from sale of rental and lease equipment			11,152				12,993
Cash paid for acquisition			(10,625	)			—
Proceeds from acquisition purchase price adjustment			—				202
Payments for purchase of rental and lease equipment			(53,773	)			(49,701	)
Redemptions of investments, trading			—				14,275
Payments for purchase of other property			(475	)			(535	)
Net cash used in investing activities			(53,721	)			(22,766	)
Cash flows from financing activities:
Proceeds from issuance of common stock			—				197
Excess tax benefit from share based compensation			50				25
Payment of dividends			(9,653	)			(7,237	)
Net cash used in financing activities			(9,603	)			(7,015	)
Net decrease in cash and cash equivalents			(29,020	)			(1,717	)
Effect of exchange rate changes on cash			109				(122	)
Cash and cash equivalents at beginning of period			41,441				32,906
Cash and cash equivalents at end of period		$	12,530			$	31,067

See accompanying notes to condensed consolidated financial statements (unaudited).

 

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ELECTRO RENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(in thousands, except per share amounts)

Note 1: Basis of Presentation

The unaudited condensed consolidated financial statements included herein have been prepared by Electro Rent Corporation, pursuant to the rules and regulations of the United States 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., Electro Rent, LLC, ER International, Inc., Electro Rent Europe NV, Electro Rent Asia, Inc., Electro Rent (Beijing) Test and Measurement Equipment Rental Co., Ltd., and Electro Rent (Tianjin) Rental Co., Ltd. (collectively “we”, “us”, or “our”) as well as 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 (“GAAP”) have been condensed or omitted pursuant to such SEC rules and regulations. These condensed consolidated financial statements reflect all adjustments and disclosures that are, in our opinion, necessary for a fair presentation of our financial position and results of operations for the interim periods presented. These condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in our latest Annual Report on Form 10-K filed with the SEC on August 8, 2011.

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as the disclosures of contingent assets and liabilities as of the date of these financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, and results of operations for interim periods are not necessarily indicative of results for the full year.

Foreign Currency

The U.S. dollar has been determined to be our functional currency. The assets and liabilities of our foreign subsidiaries are remeasured from their functional currency to U.S. dollars at current or historic exchange rates, as appropriate. Revenues and expenses are remeasured from any foreign currencies to U.S. dollars using historic or average monthly exchange rates, as appropriate, for the month in which the transaction occurred. Remeasurement gains and losses are included in selling, general and administrative expenses or income taxes, as appropriate. The assets, liabilities, revenues and expenses of our foreign subsidiaries are individually less than 10% of our respective consolidated amounts. The euro, Canadian dollar and Chinese yuan are our primary foreign currencies.

We enter into forward contracts to hedge against unfavorable fluctuations in our monetary assets and liabilities in our European and Canadian operations. These contracts are designed to minimize the effect of fluctuations in foreign currencies. Such derivative instruments are not designated as hedging instruments and, therefore, are recorded at fair value as a current asset or liability, and any changes in fair value are recorded in our condensed consolidated statements of operations.

The fair value of our foreign exchange forward contracts in the consolidated balance sheets is shown in the table below:

 

Derivatives Not Designated as Hedging Instruments		Consolidated Balance Sheet Location		November 30, 2011				May 31, 2011
Foreign exchange forward contracts		Other assets		$	90			$	15

 

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ELECTRO RENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(in thousands, except per share amounts)

 

The table below provides data about the amount of gains and losses recognized in income for derivative instruments not designated as hedging instruments:

 

Derivatives Not Designated as Hedging Instruments		Location of Gain/(Loss) Recognized in Income on Derivatives		Three Months Ended November  30, 2011				Three Months Ended November  30, 2010
Foreign exchange forward contracts		Selling, general and administrative expenses		$	247			$	(32	)
Derivatives Not Designated as Hedging Instruments		Location of Gain/(Loss) Recognized in Income on Derivatives		Six Months Ended November 30, 2011				Six Months Ended November 30, 2010
Foreign exchange forward contracts		Selling, general and administrative expenses		$	241			$	(170	)

Other Assets

We include demonstration equipment used in connection with our resale activity of $4,789 and $3,894 as of November 30, 2011 and May 31, 2011, respectively, in other assets for a period of up to two years. Demonstration equipment is recorded at the lower of cost or estimated market value until the units are sold or transferred to our rental and lease equipment pool. Demonstration equipment transferred to our rental and lease equipment pool is depreciated over its remaining estimated useful life.

Other assets consisted of the following:

 

		November 30, 2011				May 31, 2011
Net investment in sales-type leases		$	8,678			$	7,478
Demonstration equipment			4,789				3,894
Supplemental executive retirement plan assets			2,426				2,671
Income taxes receivable			601				3,066
Prepaid expenses and other			3,080				2,679
		$	19,574			$	19,788

Recent Accounting Pronouncements

In December 2010, the FASB issued an update to its existing guidance for goodwill and other intangible assets. This guidance modifies testing for reporting units with zero or negative carrying amounts. For those reporting units, in addition to evaluating whether the carrying amount of a reporting unit exceeds fair value, an entity must assess whether it is more likely than not that a goodwill impairment exists. To make that determination, an entity must consider whether there are any adverse qualitative factors indicating potential impairment. The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. We do not anticipate that the adoption of this guidance will have a material impact on our financial condition, results of operations or cash flows.

In May 2011, the FASB issued guidance to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. generally accepted accounting principles and International Financial Reporting Standards. The guidance also changes certain fair value measurement principles and enhances the disclosure requirements particularly for Level 3 fair value measurements. This guidance is effective for reporting periods beginning on or after December 15, 2011, with early adoption prohibited. We will be required to adopt this guidance beginning with our fourth quarter of fiscal 2012. We do not anticipate that the adoption of this guidance will have a material impact on our financial condition, results of operations or cash flows.

 

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ELECTRO RENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(in thousands, except per share amounts)

 

In June 2011, the FASB issued guidance on presentation of comprehensive income. The new guidance eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. Instead, an entity will be required to present either a continuous statement of net income and other comprehensive income or in two separate but consecutive statements. This guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption of the new guidance is permitted and full retrospective application is required. We will be required to adopt this guidance beginning with our first quarter of fiscal 2013. We do not anticipate that the adoption of this guidance will have a material impact on our financial condition, results of operations or cash flows.

In September 2011, the FASB issued guidance to simplify how an entity tests goodwill for impairment. The amendments in the update provide for an option to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. An entity will no longer be required to calculate the fair value of a reporting unit (Step 1) unless the entity determines, based on a qualitative assessment, that it is more likely than not that the fair value of the reporting unit is less than its carrying amount. This guidance is effective for fiscal years beginning after December 15, 2011. We will have the option to adopt the qualitative process beginning with our first quarter of fiscal 2013. We do not anticipate that the adoption of this guidance will have a material impact on our financial condition, results of operations or cash flows.

Reclassifications

We have reclassified our gain on bargain purchase, net of deferred taxes of $49 and $202 for the three and six months ended November 30, 2010, respectively, from operating expenses to a component of income before income taxes to conform to the current year presentation. As a result, our operating expenses increased, and our operating profit decreased, by $49 and $202 for the three and six months ended November 30, 2010, respectively.

Note 2: Cash and Cash Equivalents

We consider highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Cash equivalents consisted primarily of AAA-rated money market funds in all periods presented.

Note 3: Fair Value Measurements

We measure certain financial assets and liabilities at fair value on a recurring basis, including cash equivalents, supplemental executive retirement plan assets and liabilities, and foreign currency derivatives. The fair value of these financial assets and liabilities was determined based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value, as follows:

Level 1 – Observable inputs, such as quoted prices in active markets for identical assets or liabilities;

Level 2 – Inputs, other than the quoted prices in active markets, that are observable either directly or through corroboration with observable market data; and

Level 3 – Unobservable inputs, for which there is little or no market data for the assets or liabilities, such as internally-developed valuation models.

 

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ELECTRO RENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(in thousands, except per share amounts)

 

Assets and liabilities measured at fair value on a recurring basis were as follows:

 

		At November 30, 2011
		Quoted Prices in Active Markets for Identical Instruments (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Total Balance
Assets
Money market funds		$	3,657			$	—			$	—			$	3,657
Supplemental executive retirement plan			2,426				—				—				2,426
Foreign exchange forward contracts			—				90				—				90
Total assets measured at fair value		$	6,083			$	90			$	—			$	6,173
Liabilities
Supplemental executive retirement plan		$	2,426			$	—			$	—			$	2,426
Total liabilities measured at fair value		$	2,426			$	—			$	—			$	2,426
		At May 31, 2011
		Quoted Prices in Active Markets for Identical Instruments (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Total Balance
Assets
Money market funds		$	32,868			$	—			$	—			$	32,868
Supplemental executive retirement plan			2,671				—				—				2,671
Foreign exchange forward contracts			—				15				—				15
Total assets measured at fair value		$	35,539			$	15			$	—			$	35,554
Liabilities
Supplemental executive retirement plan		$	2,671			$	—			$	—			$	2,671
Total liabilities measured at fair value		$	2,671			$	—			$	—			$	2,671

The fair value measures for our money market funds and supplemental executive retirement plan asset and liability were derived from quoted market prices in active markets and are included in Level 1 inputs. Foreign currency forward contracts were valued based on observable market spot and forward rates as of our reporting date and are included in Level 2 inputs.

The following table presents a reconciliation of all assets and liabilities measured at fair value on a recurring basis, excluding accrued interest components, using significant unobservable inputs (Level 3):

 

		Six Months Ended November 30, 2010
		Put Option				Auction Rate Securities
Fair value at beginning of period		$	952			$	13,323
Settlements (at par)			—				(14,275	)
Realized gains (losses) included in interest income, net			(952	)			952
Fair value at end of period		$	—			$	—

 

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ELECTRO RENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(in thousands, except per share amounts)

 

During the first quarter of fiscal 2011, we sold our remaining Auction Rate Securities (“ARS”) to UBS AG (“UBS”) at par plus accrued interest, for $14,275 in cash when we exercised our put right (the “Put Option”) under a November 2008 settlement agreement (“Agreement”) with UBS. As a result, we included in earnings a realized gain of $952 attributable to the sale and a realized loss of $952 attributable to the Put Option. The ARS were long-term debt instruments backed by student loans, a substantial portion of which was guaranteed by the United States government. The ARS and Put Option were valued from quotes received from our broker, UBS, which were derived from UBS’s internally developed model. In accordance with accounting guidance, which permits an entity to elect the fair value option for financial assets and liabilities, we elected to measure the Put Option at fair value in order to match the changes in the fair value of the ARS.

Note 4: Acquisitions

Equipment Management Technology, Inc.

On August 24, 2011, pursuant to an asset purchase agreement, we completed the purchase of certain assets and the assumption of specified post-closing liabilities of Equipment Management Technology, Inc., a Nevada Corporation (“EMT”), for cash consideration of $10,673. EMT, headquartered in Las Vegas, Nevada, was a provider of electronic T&M equipment. We acquired EMT in order to facilitate growth in our test and measurement (“T&M”) business. EMT had previously filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the District of Nevada. The sale was approved by the Bankruptcy Court on August 11, 2011, and the related sale order was issued on August 12, 2011. At closing, $500 was deposited into an escrow account for any post-closing adjustments that reduce the purchase price. We have accounted for the acquisition of EMT as a business combination in accordance with accounting guidance.

At August 31, 2011, we completed our estimates of the fair value of rental and lease equipment and deferred revenue. Due to the timing of the acquisition, we completed our evaluation of intangible assets and accounts receivable in our second quarter ending November 30, 2011. We acquired gross accounts receivable of $972, of which an estimated $430 is not expected to be collected, resulting in a fair value of $542. Under accounting guidance, a bargain purchase gain results if the fair value of the purchase consideration is less than the net fair value of the assets acquired and liabilities assumed. We recorded a bargain purchase gain of $3,194, net of deferred taxes, related to our acquisition of EMT at August 31, 2011. We believe that we were able to negotiate a bargain purchase price as a result of our access to the liquidity necessary to complete the transaction and EMT’s recurring losses and recent bankruptcy filing.

The following table provides the estimated fair values of the assets acquired and liabilities assumed as of the date of acquisition.

 

Total cash consideration		$	10,673
Preliminary purchase price allocation:
Accounts receivable			542
Rental and lease equipment			15,896
Deferred tax liability			(2,092	)
Deferred revenue			(479	)
Net assets acquired			13,867
Bargain purchase gain, net of deferred taxes of $2,092		$	(3,194	)

The bargain purchase gain is classified separately in our condensed consolidated statements of operations.

Acquisition-related transaction costs of $55 were accounted for as expenses in the periods in which the costs were incurred and are included in our selling, general and administrative expenses.

The acquisition of EMT was an asset purchase, and EMT’s operations were integrated with ours immediately after the acquisition date. Revenues and income before income taxes of $1,907 and $911, respectively, from the acquired customers were included in our consolidated statements of operations for the six months ended November 30, 2011.

 

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ELECTRO RENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(in thousands, except per share amounts)

 

During the three ended November 30, 2011, we increased the bargain purchase gain by $308 ($188, net of tax) consisting of (i) $140 representing the estimated fair value of customer relationships acquired, (ii) $72 of purchase price adjustments, and (iii) $148 of post closing adjustments in accordance with the Asset Purchase Agreement (“APA”) (thereby reducing the remaining escrow balance to $352), offset by (iv) $52 representing a change in the fair value of certain assets acquired.

Supplemental pro forma information reflecting the acquisition of EMT as if it occurred on June 1, 2010 is not practicable because we are not able to obtain reliable historical financial information for 2010 and 2011, primarily due to a deterioration of the organization and controls leading up to and following the February 2011 bankruptcy filing.

Telogy, LLC

We recorded additional bargain purchase gain associated with our March 31, 2010 acquisition of Telogy LLC (“Telogy”) of $342 ($202, net of deferred tax) during the six months ended November 30, 2010. The increase in the bargain purchase gain consisted of (i) $260 representing the final determination of assets acquired and other components of the purchase price in accordance with specific provisions of the APA, and (ii) $82 resulting from a final determination of fair value of certain assets and liabilities acquired from Telogy.

Note 5: Equity Incentive Plan

Our 2005 Equity Incentive Plan (the “Equity Incentive Plan”) authorizes our Board of Directors to grant incentive and non-statutory stock option grants, stock appreciation rights, restricted stock awards, restricted stock units, performance unit awards and performance share awards covering a maximum of 1,000 shares of our common stock. The Equity Incentive Plan replaced our prior stock option plans, under which there are no outstanding options. Pursuant to the Equity Incentive Plan, we have granted incentive and non-statutory options to directors, officers and key employees at prices not less than 100% of the fair market value on the day of grant. In addition, we have granted restricted stock and restricted stock units to directors, officers and key employees. The Equity Incentive Plan provides for a variety of vesting dates. All outstanding options expired in October 2011.

Stock Options

The following table summarizes certain information relative to options for common stock:

 

		Options				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term (in years)
Outstanding at May 31, 2011			36			$	17.69
Granted			—				—
Exercised			—				—
Forfeited/canceled			(36	)		$	17.69
Outstanding at November 30, 2011			—			$	—				—

There were no stock options granted or vested during the three or six months ended November 30, 2011 and 2010. The aggregate intrinsic value of options exercised is calculated as the difference between the exercise price of the underlying awards and the closing price of our common stock on the Nasdaq Stock Market on the date of measurement. The aggregate intrinsic value of options exercised during both the three and six months ended November 30, 2011 was $0, and during the three and six months ended November 30, 2010 was $7 and $13, respectively. Shares of newly issued common stock were issued upon any exercise of stock options.

 

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ELECTRO RENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(in thousands, except per share amounts)

 

Restricted Stock Units

A restricted stock unit represents the right to receive one share of our common stock, provided that the vesting conditions are satisfied. The following table represents restricted stock unit activity for the six months ended November 30, 2011:

 

		Restricted Stock Units				Weighted – Average Grant Date Fair Value
Nonvested at May 31, 2011			204			$	11.36
Granted			101				16.47
Vested			(88	)			11.30
Forfeited/canceled			—				—
Nonvested at November 30, 2011			217			$	13.78

We granted 16 and 101 restricted stock units during the three and six months ended November 30, 2011, respectively, and 10 and 106 restricted stock units during the three and six months ended November 30, 2010, respectively. As of November 30, 2011, we have unrecognized share-based compensation cost of approximately $2,423 associated with restricted stock unit awards. This cost is expected to be recognized over a weighted-average period of approximately 1.9 years.

Accounting for Share Based Payments

Accounting guidance requires all share-based payments to employees, including grants of employee stock options, restricted stock and restricted stock units, to be recognized as compensation expense in the consolidated financial statements based on their fair values. Compensation expense is recognized over the period that an employee provides service in exchange for the award.

We use the Black-Scholes option pricing model to calculate the fair value of any option grant. Our computation of expected volatility is based on historical volatility. Our computation of expected term is determined based on historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. The expected term represents the period that our option awards are expected to be outstanding and is determined based on historical experience of similar awards. The risk-free interest rate is based on U.S. Treasury zero-coupon issues with a term equal to the expected term of the option at the date of grant. Forfeitures are estimated at the date of grant based on historical experience. We use the market price of our common stock on the date of grant to calculate the fair value of each grant of restricted stock and restricted stock units.

We recorded $384 and $710 of stock-based compensation as part of selling, general and administrative expenses for the three and six months ended November 30, 2011, respectively, compared to $241 and $436 for the three and six months ended November 30, 2010, respectively.

We receive a tax deduction for certain stock option exercises during the period the options are exercised, generally for the excess of the fair value of our common stock at the date of exercise over the exercise price of the options, and dividends paid on vested restricted stock units. Excess tax benefits are realized tax benefits from tax deductions for exercised options in excess of the deferred tax asset attributable to stock compensation costs for such options. The total tax benefit realized from stock option exercises, shares issued and dividend payments for vested restricted stock units for the six months ended November 30, 2011 and 2010 was $50 and $25, respectively. Cash received from stock option exercises was $0 and $197 for the six months ended November 30, 2011 and 2010, respectively.

Note 6: Goodwill and Intangibles

Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in a business combination. Intangible assets resulting from the acquisitions of entities accounted for using the purchase method of accounting are recorded at the estimated fair value of the assets acquired. Identifiable intangible assets consist of purchased customer relationships and trade names.

 

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ELECTRO RENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(in thousands, except per share amounts)

 

Our goodwill and intangibles at November 30, 2011 are the result of our acquisition of EMT on August 24, 2011, Telogy on March 31, 2010 and of Rush Computer Rentals, Inc. on January 31, 2006.

The changes in carrying amount of goodwill and other intangible assets for the six months ended November 30, 2011 were as follows:

 

		Balance as of June 1, 2011 (net of amortization)				Additions				Amortization				Balance as of November 30, 2011
Goodwill		$	3,109			$	—			$	—			$	3,109
Trade name			411				—				—				411
Customer relationships			803				140				(70	)			873
		$	4,323			$	140			$	(70	)		$	4,393

Goodwill is not deductible for tax purposes.

We evaluate the recoverability of goodwill and indefinite-lived intangible assets annually as of May 31, and whenever events or changes in circumstances indicate to us that carrying amount may not be recoverable. There were no conditions that indicated any impairment of goodwill or identifiable intangible assets as of May 31, 2011.

Intangible assets with finite useful lives are amortized over their respective estimated useful lives. The following table provides a summary of our intangible assets:

 

		November 30, 2011
		Estimated Useful Life				Gross Carrying Amount				Accumulated Amortization				Net Carrying Amount
Trade name			indefinite			$	411			$	—			$	411
Customer relationships			3-4 years				2,094				(1,221	)			873
						$	2,505			$	(1,221	)		$	1,284
		May 31, 2011
		Estimated Useful Life				Gross Carrying Amount				Accumulated Amortization				Net Carrying Amount
Trade name			indefinite			$	411			$	—			$	411
Customer relationships			3-4 years				1,954				(1,151	)			803
						$	2,365			$	(1,151	)		$	1,214

Amortization expense related to intangible assets was $41 and $70 for the three and six months ended November 30, 2011, respectively, compared to $55 and $109 for the three and six months ended November 30, 2010, respectively.

 

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ELECTRO RENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(in thousands, except per share amounts)

 

Amortization expense for customer relationships and non-compete agreements is included in selling, general and administrative expenses. The following table provides estimated future amortization expense related to intangible assets as of November 30, 2011:

 

Year ending May 31,		Future Amortization
2012 (remaining)		$	82
2013			164
2014			164
2015			129
2016			118
Thereafter			216
		$	873

Note 7: Noncash Investing and Financing Activities

We had accounts payable and other accruals related to acquired rental and lease equipment totaling $5,313 and $4,860 as of November 30, 2011 and May 31, 2011, respectively, and $4,800 and $6,167 as of November 30, 2010 and May 31, 2010, respectively, all of which amounts were subsequently paid. During the six months ended November 30, 2011 and the fiscal year ended May 31, 2011, we transferred $460 and $520, respectively, of demonstration equipment, included in other assets, to rental and lease equipment. There were no similar activities for the six months ended November 30, 2010 or the fiscal year ended May 31, 2010.

Note 8: Sales-Type Leases

We have 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 initial acceptance of customer finance arrangements is based on an in-depth review of each customer’s credit profile, including review of third party credit reports, customer financial statements and bank verifications. We monitor the credit quality of our sales-type lease portfolio based on payment activity that drives the finance lease receivable aging. This credit quality is assessed on a monthly basis. There were no balances due for sales-type receivables beyond 90 days as of November 30, 2011. Our historical losses on finance lease receivables are insignificant, and therefore we do not have a specific allowance for credit losses.

The minimum lease payments receivable and the net investment included in other assets for such leases were as follows:

 

		November 30, 2011				May 31, 2011
Gross minimum lease payments receivable		$	9,077			$	7,834
Less – unearned interest			(399	)			(356	)
Net investment in sales-type lease receivables		$	8,678			$	7,478

The following table provides estimated future minimum lease payments receivable related to sales-type leases:

 

Year ending May 31,
2012 (remaining)		$	5,837
2013			2,566
2014			673
2015			1
		$	9,077

 

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ELECTRO RENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(in thousands, except per share amounts)

 

Note 9: Segment Reporting and Related Disclosures

Accounting guidance establishes reporting standards for an enterprise’s operating segments and related disclosures about its products, services, geographic areas and major customers. Operating segments are defined as components of an enterprise for which separate financial information is available that is regularly evaluated by the chief operating decision maker in deciding how to allocate resources and in assessing performance. In order to determine our operating segments, we considered the following: an operating segment is a component of an enterprise (i) that engages in business activities from which it may earn revenues and incur expenses, (ii) whose operating results are regularly reviewed by the enterprise’s chief operating decision maker to make decisions about resources to be allocated to the segment and assess its performance, and (iii) for which discrete financial information is available. In accordance with this guidance, we have identified two operating segments: the rental, lease and sale of T&M equipment and the rental, lease and sale of data products (“DP”) equipment.

Although we have separate operating segments for T&M and DP equipment, these two segments are aggregated into a single reportable segment because they have similar economic characteristics and qualitative factors. The T&M and DP segments have similar long-term average gross margins, and both rent, lease and sell electronic equipment to large corporations, purchase directly from major manufacturers, configure and calibrate the equipment, and ship directly to customers.

Our equipment pool, based on acquisition cost, consisted of $387,775 of T&M equipment and $40,294 of DP equipment at November 30, 2011 and $347,138 of T&M equipment and $39,654 of DP equipment at May 31, 2011.

Revenues for these product groups were as follows for the three months ended November 30, 2011 and 2010:

 

		T&M				DP				Total
2011
Rentals and leases		$	28,651			$	4,261			$	32,912
Sales of equipment and other revenues			28,113				618				28,731
		$	56,764			$	4,879			$	61,643
2010
Rentals and leases		$	25,186			$	4,487			$	29,673
Sales of equipment and other revenues			23,093				511				23,604
		$	48,279			$	4,998			$	53,277

Revenues for these product groups were as follows for the six months ended November 30, 2011 and 2010:

 

		T&M				DP				Total
2011
Rentals and leases		$	55,253			$	8,968			$	64,221
Sales of equipment and other revenues			54,829				1,243				56,072
		$	110,082			$	10,211			$	120,293
2010
Rentals and leases		$	49,223			$	9,237			$	58,460
Sales of equipment and other revenues			44,463				1,179				45,642
		$	93,686			$	10,416			$	104,102

No single customer accounted for more than 10% of total revenues during the three and six months ended November 30, 2011 and 2010.

 

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ELECTRO RENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(in thousands, except per share amounts)

 

Selected country information is presented below:

 

		Three Months Ended November 30,								Six Months Ended November 30,
		2011				2010				2011				2010
Revenues: (1)
U.S.		$	53,490			$	46,875			$	103,577			$	91,999
Other (2)			8,153				6,402				16,716				12,103
Total		$	61,643			$	53,277			$	120,293			$	104,102

 

		As of
		November 30, 2011				May 31, 2011
Net Long-Lived Assets: (3)
U.S.		$	204,924			$	180,591
Other (2)			47,150				33,491
Total		$	252,074			$	214,082

 

(1)	Revenues by country are based on the location of shipping destination, and not whether the order originates in the United States parent or a foreign subsidiary.

(2)	Other consists of foreign countries that each individually account for less than 10% of the total revenues or assets.

(3)	Net long-lived assets include rental and lease equipment, other property, goodwill and intangibles, net of accumulated depreciation and amortization.

Note 10: Computation of Earnings Per Share

The following is a reconciliation of the denominator used in the computation of basic and diluted earnings per share for the three and six months ended November 30, 2011 and 2010:

 

		Three Months Ended November 30,								Six Months Ended November 30,
		2011				2010				2011				2010
Denominator:
Denominator for basic earnings per share - weighted average common shares outstanding			23,981				23,976				23,981				23,970
Effect of dilutive options and restricted stock			168				99				158				79
Diluted shares used in per share calculation			24,149				24,075				24,139				24,049
Net income		$	6,019			$	7,119			$	14,524			$	12,340
Earnings per share:
Basic		$	0.25			$	0.30			$	0.61			$	0.51
Diluted		$	0.25			$	0.30			$	0.60			$	0.51

Note 11: Income Taxes

We recognize a liability or asset for the deferred tax consequences of temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements. These temporary differences will result in taxable or deductible amounts in future years when reported amounts of the assets or liabilities are recovered or settled. The deferred tax assets are periodically reviewed for recoverability.

 

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ELECTRO RENT CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(in thousands, except per share amounts)

 

On June 1, 2007, we adopted new accounting guidance which establishes a single model to address the accounting for uncertain tax positions. Specifically, it prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues.

We recognize the tax impact from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax impact recognized in the financial statements from such a position is measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. We recognize interest, penalties and foreign currency gains and losses with respect to uncertain tax positions as components of our income tax provision. Accrued interest and penalties are included within accrued expenses in the consolidated balance sheet. Significant judgment is required in the identification of uncertain tax positions and in the estimation of penalties and interest on uncertain tax positions. During the second quarter of fiscal 2011 we effectively settled our remaining uncertain tax positions, and derecognized $4,515 of previously recognized uncertain tax positions, and the related deferred tax asset, and $1,396 for interest and penalties previously recognized. This derecognition decreased our effective tax rate from 41.0% to 26.7% for the three months ended November 30, 2010, and from 40.4% to 32.8% for the six months ended November 30, 2010.

We are subject to taxation in the U.S., as well as various states and foreign jurisdictions. We have substantially settled all income tax matters for the United States federal jurisdiction for years through fiscal 2009. Major state jurisdictions have been examined through fiscal years 2004 and 2005, and foreign jurisdictions have not been examined for their respective maximum statutory periods.

There were no unrecognized tax benefits for the six months ended November 30, 2011.

Note 12: Commitments and Contingencies

We purchase substantial amounts of rental equipment from numerous vendors. As a result, we have occasionally been included as a member of the plaintiff class in class action lawsuits related to product warranties or price adjustments. Settlements of such claims can result in distributions of cash or product coupons that can be redeemed, sold or used to purchase new equipment. We recognize any benefits from such settlements when all contingencies have expired, to the extent either cash has been received and/or realization of value from any coupon is assured.

We are subject to legal proceedings and business disputes involving ordinary routine legal proceedings and claims incidental to our business. The ultimate legal and financial liability with respect to such matters generally 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, we may be required to record either more or less litigation expense. We are not involved in any pending or threatened legal proceedings, other than ordinary routine legal proceedings and claims incidental to our business, that we believe could reasonably be expected to have a material adverse effect on our financial condition, results of operations or cash flows.

Note 13: Subsequent Events

On December 1, 2011 we signed an extension of our resale agreement with Agilent through January 31, 2012. We continue to negotiate with Agilent regarding a longer term extension.

 

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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, 2011 and May 31, 2011, the results of our operations for the three and six months ended November 30, 2011 and 2010, respectively, and cash flows for the six month periods ended November 30, 2011 and 2010. 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, 2011, 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 primarily for use by our customers in the aerospace, defense, telecommunications, electronics, industrial and semiconductor industries. Although it represented only approximately 8% of our revenues in fiscal 2011 and for the six months ended November 30, 2011, respectively, we believe our data products (“DP”) equipment division is one of the largest rental businesses in the United States for personal computers and servers from manufacturers including Dell, HP/Compaq, IBM and Toshiba. Our resale agreement with Agilent, which commenced in fiscal 2010, gives us 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. Since entering into the resale agreement with Agilent, we have expanded our sales force to support our sales of Agilent’s T&M equipment and have cross trained our new resale organization and existing T&M sales force to provide both new and existing customers a complete product offering, including rental, lease and sales of new and used equipment.

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

On August 24, 2011, we completed the purchase of certain assets (including accounts receivable and rental equipment but excluding certain designated assets) and the assumption of specified post-closing liabilities of Equipment Management Technology, Inc., a Nevada Corporation (“EMT”), for $10.7 million in cash, of which $0.5 million was deposited into an escrow account for any post-closing adjustments. (See Note 4 to the condensed consolidated financial statements (unaudited) included in this Form 10-Q.)

In recent years, our financial results were impacted by competitive pressure on rental rates due in large part to the recession in the U.S. and our major international markets. During fiscal 2011 and the first six months of fiscal 2012, we experienced a modest improvement in our T&M and DP rental rates and a significant increase in our equipment on rent, in part due to our recent acquisitions, while maintaining a high utilization rate, in particular in our North American and European operations. In addition, our rental revenues have benefited from our expanded sales force and integration and cross training of our new resale organization and existing T&M sales force. As a result of these continued improvements, and sales of T&M equipment in connection with our Agilent resale agreement, we experienced strong growth in revenues for fiscal 2011 and the first six months of fiscal 2012. For the six months ended November 30, 2011, compared to the six months ended November 30, 2010, our operating profit modestly improved reflecting our significant investment in broadening and strengthening our sales organization in support of increased sales and rental demand and to better focus on future growth opportunities. Despite our growth, our customers and competitors continue to be affected by the recent recession and ongoing uncertainty in the U.S. and global economy, resulting in more stringent credit requirements and reduced access to capital. We will continue to focus on remaining profitable in the current conditions, as well as being prepared for the possibility that recessionary trends may continue in future periods.

For the six months ended November 30, 2011, 86% of our rental and lease revenues were derived from T&M equipment, compared to 84% for the first six months of fiscal 2012. We have experienced growth in our T&M rental revenues, due to increased rental activity, that is attributable in part to our acquisition of EMT, a modest increase in rates, and the integration of our new resale organization and existing T&M sales force, while our DP lease revenues modestly declined.

 

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For the first six months of fiscal 2012, rental revenues were 91% of our rental and lease revenues, compared to 89% for the first six months of fiscal 2011. The increase is the result of an increase in our T&M and DP rental activity, while our lease revenues modestly declined, reflecting a slight increase in T&M lease revenues as a result of the EMT acquisition that was more than offset by a decline in our DP segment.

To maximize our overall profit from the rental, leasing, and sales of equipment, we manage our equipment pool on an on-going basis by controlling the timing, pricing and mix of our purchases and sales of equipment. We acquire new and used equipment to meet current technological standards and current and anticipated customer demand, and we sell our used equipment where we believe that is the most lucrative option. We employ a complex equipment management strategy and our proprietary PERFECT™ software to adjust our inventory and pricing on a dynamic basis in order to maximize equipment availability, utilization and profitability. We manage each specific equipment class based on a separate assessment of that equipment’s historical and projected life cycle and numerous other factors, including the U.S. and global economy, interest rates and new product launches. If we do not accurately predict market trends, or if demand for the equipment we supply declines, we can be left with inventory that we are unable to rent or sell for a profit. We assess the carrying value of the equipment pool on a quarterly basis or more frequently when factors indicating potential impairment are present.

Profitability and Key Business Trends

Comparing the first six months of fiscal 2012 to the first six months of fiscal 2011, our revenues increased by 15.6% from $104.1 million to $120.3 million, our operating profit increased 0.7% from $17.9 million to $18.1 million and our net income increased by 17.7% from $12.3 million to $14.5 million.

Our rental and lease revenues increased 9.9% from $58.5 million for the first half of fiscal 2011 to $64.2 million for the first half of fiscal 2012, while our T&M sales activity increased 23.3% from $44.5 million to $54.8 million during those same periods. Our rental revenues have grown as a result of the EMT acquisition in August 2011, increased rental activity and rental rates in our North American and European operations, as well as the integration of our new resale organization and existing T&M sales force. Our sales revenues have increased due to continued growth in new equipment sales in connection with our Agilent resale agreement and an increase in our finance leases.

Some of our key profitability measurements are presented below for the six months ended November 30, 2011 and 2010:

 

		Fiscal 2012				Fiscal 2011
Net income per diluted common share (EPS)		$	0.60			$	0.51
Net income as a percentage of average assets			9.3	%			8.8	%
Net income as a percentage of average equity			12.2	%			10.8	%

Our net income includes bargain purchase gains, net of deferred taxes, of $3.4 million and $0.2 million for the six months ended November 30, 2011 and 2010, respectively, as a result of our acquisitions of EMT and Telogy, respectively. Our operating profit modestly improved, as growth in our rental revenues and sales of new equipment were offset by an increase in depreciation expense of $2.3 million, or 9.9%, as we have invested in additional rental equipment to support our growth, and an increase in selling, general and administrative expenses of $4.5 million, or 16.6%, primarily related to the broadening and strengthening of our sales organization in support of our Agilent resale agreement, higher rental demand, and future growth opportunities.

The average amount of our equipment on rent, based on acquisition cost, increased 10.9% to $230.2 million for the first half of fiscal 2012 from $207.7 million for the first half of fiscal 2011. The average acquisition cost of equipment on lease increased 5.1% to $30.9 million for the first half of fiscal 2012 from $29.4 million for the first half of fiscal 2011. The increase in our average equipment on rent and lease was due, in part, to the acquisition of EMT during the six months ended November 30, 2011.

Average rental rates for our T&M and DP segments increased by 2.1% from November 30, 2010 to November 30, 2011, while average lease rates declined by 5.5% for the same period. Average utilization for our T&M equipment pool, based on average acquisition cost of equipment on rent and lease compared to the total average equipment pool, decreased slightly to 69.0% at November 30, 2011 from 70.5% at November 30, 2010. The average utilization of our DP equipment pool, based on the same method of calculation, decreased to 40.8% from 45.7% over the same period.

 

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As of November 30, 2011 and 2010, our unfilled orders for T&M equipment relating to our Agilent resale agreement were $16.2 million and $16.7 million, respectively.

Results of Operations

Comparison of Three Months Ended November 30, 2011 and November 30, 2010

Revenues

Total revenues for the three months ended November 30, 2011 and 2010 were $61.6 million and $53.3 million, respectively. The 15.7% increase in total revenues was due to a 10.9% increase in rental and lease revenues and a 21.7% increase in sales of equipment and other revenues.

Rental and lease revenues for the three months ended November 30, 2011 were $32.9 million, compared to $29.7 million for the same period of the prior fiscal year. This increase reflects the EMT acquisition in August 2011 and an increase in our T&M rental activity and rental rates in our North American and European operations, due to improved market conditions and the integration of our new resale organization and existing T&M sales force, providing additional rental opportunities to an expanding customer base. This increase was offset by a decline in lease revenues in our DP business, due to a decrease in demand.

Sales of equipment and other revenues increased to $28.7 million for the second quarter of fiscal 2012 from $23.6 million in the prior year quarter. The increase is due to an increase in our sales of new T&M equipment through our Agilent resale agreement and increased finance lease activity, partially offset by a decline in the sales of used equipment.

Operating Expenses

Depreciation of rental and lease equipment increased in the second quarter of fiscal 2012 to $13.4 million, or 40.6% of rental and lease revenues, from $11.9 million, or 40.2% of rental and lease revenues, in the second quarter of fiscal 2011. The increased depreciation expense in fiscal 2012 was due to a higher average rental and lease equipment pool. The depreciation ratio, as a percentage of rental and lease revenues, was relatively unchanged as modest improvements in our average rental rates were offset by a slight decrease in our average utilization rates.

Costs of revenues other than depreciation increased 26.6% to $22.9 million in the second quarter of fiscal 2012 from $18.1 million in the same period of fiscal 2011. Costs of revenues other than depreciation primarily includes the cost of equipment sales, which increased as a percentage of equipment sales to 77.8% in the second quarter of fiscal 2012 from 76.2% in the second quarter of fiscal 2011. This increase is due to a decrease in used equipment sales and an increase in sales of new T&M equipment through our Agilent resale agreement, which generally carry a lower margin than used equipment sales. Our sales margin percentage is expected to continue to decline as a result of anticipated growth in connection with our Agilent resale agreement. Our sales margin is also impacted by competition, the global recession, and customer requirements and funding.

Selling, general and administrative expenses increased 16.2% to $15.9 million in the second quarter of fiscal 2012 compared to $13.7 million in the second quarter of fiscal 2011. As a percentage of total revenues, selling, general and administrative expenses increased modestly to 25.8% in the second quarter of fiscal 2012 from 25.7% in the second quarter of fiscal 2011. Our selling, general and administrative expenses increased primarily due to the broadening and strengthening of our sales organization in support of our Agilent resale agreement, higher rental demand, and future growth opportunities.

Income Tax Provision

Our effective tax rate was 38.2% in the second quarter of fiscal 2012, compared to 26.7% in the second quarter of fiscal 2011. The increase is due primarily to the benefit from derecognition of $1.4 million of interest and penalties resulting from the effective settlement of our uncertain tax positions during the six months ended November 30, 2010. (See Note 11 to our condensed consolidated financial statements for further discussion.)

 

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Comparison of Six Months Ended November 30, 2011 and November 30, 2010

Revenues

Total revenues for the six months ended November 30, 2011 and 2010 were $120.3 million and $104.1 million, respectively. The 15.6% increase in total revenues was due to a 9.9% increase in rental and lease revenues and a 22.9% increase in sales of equipment and other revenues.

Rental and lease revenues for the six months ended November 30, 2011 were $64.2 million, compared to $58.5 million for the same period of the prior fiscal year. This increase reflects the EMT acquisition in August 2011 and an increase in our T&M rental activity and rental rates in our North American and European operations, due to improved market conditions and the integration of our new resale organization and existing T&M sales force, providing additional rental opportunities to an expanding customer base. This increase was offset by a decline in lease revenues in our DP business, due to a decrease in demand.

Sales of equipment and other revenues increased to $56.1 million for the first six months of fiscal 2012 from $45.6 million in the same period of the prior fiscal year. The increase is due to an increase in our sales of new T&M equipment through our Agilent resale agreement and increased finance lease activity, partially offset by a decline in the sales of used equipment.

Operating Expenses

Depreciation of rental and lease equipment increased in the first six months of fiscal 2012 to $25.9 million, or 40.3% of rental and lease revenues, from $23.6 million, or 40.3% of rental and lease revenues, in the first six months of fiscal 2011. The increased depreciation expense in fiscal 2012 was due to a higher average rental and lease equipment pool. The depreciation ratio, as a percentage of rental and lease revenues, was unchanged as modest improvements in our average rental rates were offset by a slight decrease in our average utilization rates.

Costs of revenues other than depreciation increased 26.1% to $44.5 million in the first six months of fiscal 2012 from $35.3 million in the same period of fiscal 2011. Costs of revenues other than depreciation primarily includes the cost of equipment sales, which increased as a percentage of equipment sales to 77.7% in the first six months of fiscal 2012 from 76.5% in the first six months of fiscal 2011. This increase is due to a decrease in used equipment sales and an increase in sales of new T&M equipment through our Agilent resale agreement, which generally carry a lower margin than used equipment sales. Our sales margin percentage is expected to continue to decline as a result of anticipated growth in connection with our Agilent resale agreement. Our sales margin is also impacted by competition, the global recession, and customer requirements and funding.

Selling, general and administrative expenses increased 16.6% to $31.8 million in the first six months of fiscal 2012 compared to $27.3 million in the first six months of fiscal 2011. As a percentage of total revenues, selling, general and administrative expenses increased to 26.5% in the first six months of fiscal 2012 from 26.2% in the first six months of fiscal 2011. Our selling, general and administrative expenses increased primarily due to the broadening and strengthening of our sales organization in support of our Agilent resale agreement, higher rental demand, and future growth opportunities.

Gain on Bargain Purchase

We recorded gain on bargain purchase, net of deferred tax, of $3.4 million during the first six months of fiscal 2012 related to our acquisition of EMT and $0.2 million during the same prior year period related to our acquisition of Telogy. The gain on bargain purchase, net of deferred tax, resulted from the excess of the net fair value of the assets acquired and liabilities assumed in the EMT and Telogy acquisitions, respectively, over the respective purchase prices. A majority of the Telogy bargain purchase gain was recorded in fiscal 2010, the year of acquisition. We believe that we were able to negotiate bargain purchase prices as a result of our access to the liquidity necessary to complete the transactions, and the recurring losses and recent bankruptcy filings of both EMT and Telogy.

Income Tax Provision

Our effective tax rate was 32.9% in the first six months of fiscal 2012, compared to 32.8% in the first six months of fiscal 2011. Our effective tax rate for the six months ended November 30, 2011 includes our bargain purchase gain, net of deferred taxes, of $3.4 million for the six months ended November 30, 2011 compared to $0.2 for the prior year

 

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period, resulting from of our purchase of EMT on August 24, 2011. Bargain purchase gains are recorded net of deferred taxes, and are treated as permanent differences, resulting in a lower effective tax rate in the period recorded. Our effective tax rate for the six months ended November 30, 2010 includes the benefit from derecognition of $1.4 million of interest and penalties resulting from the effective settlement of our uncertain tax positions during the six months ended November 30, 2010. (See Note 11 to our condensed consolidated financial statements for further discussion.)

Liquidity and Capital Resources

Capital Expenditures

Our primary capital requirements have been purchases of rental and lease equipment. We generally purchase equipment throughout the year to replace equipment that has been sold and to maintain adequate levels of rental equipment to meet existing and expected customer demands. To meet T&M rental demand, support areas of potential growth for both T&M and DP equipment and to keep our equipment pool technologically up-to-date, we made payments for purchases of $53.8 million of rental and lease equipment during the first six months of fiscal 2012 compared to $49.7 million during the first six months of fiscal 2011.

Dividends

During the first six months of fiscal 2012, we paid dividends of $0.40 per common share or $0.80 per annum, amounting to an aggregate of $9.6 million. In the first six months of fiscal 2011, we paid dividends of $0.30 per common share or $0.60 per annum, amounting to an aggregate of $7.2 million. 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 $12.5 million at November 30, 2011, or a decline of $28.9 million from May 31, 2011. This reflects our use of cash to pay increased dividends to shareholders as well as cash used to take advantage of strategic acquisition and new customer opportunities in recent years. For example, since the beginning of fiscal 2009 we have returned $76.6 million in cash to our shareholders and in fiscal 2011 increased our annual dividend rate from $0.60 per common share to $0.80 per common share, as described above. We have also paid cash of $35.4 million in connection with the recent acquisitions of Telogy and EMT 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, and therefore we may need to draw upon our $10 million unused line of credit with a bank. We may also need to expand our borrowing capacity in order to ensure sufficient resources to quickly respond to strategic growth opportunities. Given our growth record achieved with no debt, 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.

Cash Flows and Credit Facilities

During the first six months of fiscal 2012 and fiscal 2011, net cash provided by operating activities was $34.4 million and $28.1 million, respectively. The increase in operating cash flow for fiscal 2012 was primarily attributable to a tax refund of approximately $2.5 million as well as an improvement in working capital for the first six months of fiscal 2012 compared to fiscal 2011.

During the first six months of fiscal 2012 and 2011, net cash used in investing activities was $53.7 million and $22.8 million, respectively. The increase in cash used in investing activities for the first six months of fiscal 2012 was due, in part, to the cash paid for the acquisition of EMT of $10.7 million, and a decrease in the proceeds from sale of rental and lease equipment to $11.2 million for fiscal 2012 compared to $13.0 million for the first six months of fiscal 2011. There were no redemptions of investments, trading, during the first six months of fiscal 2012 compared to $14.3 million for the same period of fiscal 2011. Payments for purchase of rental and lease equipment were $53.8 million for the six months ended November 30, 2011 compared to $49.7 million for the six months ended November 30, 2010.

 

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Net cash flows used in financing activities were $9.6 million and $7.0 million for the first six months of fiscal 2012 and 2011, respectively. These funds used were primarily composed of payments for dividends of $9.6 million and $7.2 million for the first six months of fiscal 2012 and 2011, respectively.

We have 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. We had no bank borrowings outstanding or off balance sheet financing arrangements at November 30, 2011.

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

Contractual Obligations

Our contractual obligations have not changed materially from those included in our Annual Report on Form 10-K for the fiscal year ended May 31, 2011.

Critical Accounting Policies and Estimates

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

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

We identified certain critical accounting policies that affect certain of our more significant estimates and assumptions used in preparing our consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended May 31, 2011. We have not made any material changes to these policies as previously disclosed.

 

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

During the first six months of fiscal 2012, there were no material changes in the information regarding market risk contained in our Annual Report on Form 10-K for the fiscal year ended May 31, 2011.

 

Item 4.

Controls and Procedures.

As of November 30, 2011, the end of the period covered by this report, our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on that evaluation, our 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 were effective.

There was no change in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected.

 

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PART II—OTHER INFORMATION

 

Item 1.

Legal Proceedings.

From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business, including claims of alleged infringement, misuse or misappropriation of intellectual property rights of third parties. As of the date of this report, we are not a party to any litigation which we believe would have a material adverse effect on our business operations or financial condition.

 

Item 1A.

Risk Factors.

In addition to the other information set forth in this report, you should carefully consider the discussion of various risks and uncertainties contained in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended May 31, 2011. We believe those risk factors are the most relevant to our business and could cause our results to differ materially from the forward-looking statements made by us. However, those are not the only risk factors that we face. Additional risks that we do not consider material, or of which we are not currently aware, may also have an adverse impact on us. Our business, financial condition, and results of operations could be seriously harmed if any of these risks or uncertainties actually occurs or materializes. In that event, the market price for our common stock could decline, and our shareholders may lose all or part of their investment.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

None.

 

Item 3.

Defaults Upon Senior Securities.

None.

 

Item 4.

(Removed and Reserved).

 

Item 5.

Other Information.

None.

 

Item 6.

Exhibits.

 

Exhibit No.		Document Description		Incorporation by Reference
10.22		Fourth amendment to Commercial Credit Agreement dated as of September 28, 2011 between the Company and Union Bank of California, N.A.		Incorporated by reference from Registrant’s Current Report on Form 8-K filed September 30, 2011.
31.1		Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer		Filed herewith.
31.2		Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer		Filed herewith.
32.1		Section 1350 Certification by Chief Executive Officer		Filed herewith.
32.2		Section 1350 Certification by Chief Financial Officer		Filed herewith.
101.INS*		XBRL Instance Document.
101.SCH*		XBRL Taxonomy Extension Schema Document.
101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document.
101.LAB*		XBRL Taxonomy Extension Label Linkbase Document.
101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document.

 

(*	furnished herewith and not “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended)

 

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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
Date: December 22, 2011		/s/ Craig R. Jones
		Craig R. Jones Vice President and Chief Financial Officer (Principal Financial and Accounting Officer and duly authorized to sign this report on behalf of the company)

 

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