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, 2008 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)
818 787-2100
(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 a large accelerated filer, an “accelerated filer”, a “non-accelerated filer” or a “smaller reporting company”. See definition 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 18, 2008 was 24,575,804.
ELECTRO RENT CORPORATION
FORM 10-Q
November 30, 2008
TABLE OF CONTENTS | | Page |
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Part I: FINANCIAL INFORMATION | | 3 |
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Item 1. Financial Statements | | 3 |
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Condensed Consolidated Statements of Operations for the Three and Six Months Ended November 30, 2008 and 2007 (Unaudited) | | 3 |
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Condensed Consolidated Balance Sheets at November 30, 2008 and May 31, 2008 (Unaudited) | | 4 |
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Condensed Consolidated Statements of Cash Flows for the Six Months Ended November 30, 2008 and 2007 (Unaudited) | | 5 |
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Notes to Condensed Consolidated Financial Statements (Unaudited) | | 6 |
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations | | 17 |
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Item 3. Quantitative and Qualitative Disclosures About Market Risk | | 24 |
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Item 4. Controls and Procedures | | 24 |
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Part II: OTHER INFORMATION | | 24 |
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Item 1. Legal Proceedings | | 24 |
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Item 1A. Risk Factors | | 25 |
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds | | 25 |
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Item 3. Defaults Upon Senior Securities | | 25 |
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Item 4. Submission of Matters to a Vote of Security Holders | | 25 |
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Item 5. Other Information | | 25 |
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Item 6. Exhibits | | 26 |
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SIGNATURES | | 27 |
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
ELECTRO RENT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) (000's omitted, except per share data)
| | Three Months Ended | | | Six Months Ended | |
| | November 30, | | | November 30, | |
| | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| | | | | | | | | | | | |
Revenues: | | | | | | | | | | | | |
Rentals and leases | | $ | 26,155 | | | $ | 27,425 | | | $ | 53,389 | | | $ | 54,869 | |
Sales of equipment and other revenues | | | 9,278 | | | | 7,938 | | | | 17,030 | | | | 15,103 | |
| | | | | | | | | | | | | | | | |
Total revenues | | | 35,433 | | | | 35,363 | | | | 70,419 | | | | 69,972 | |
| | | | | | | | | | | | | | | | |
Operating expenses: | | | | | | | | | | | | | | | | |
Depreciation of rental and lease equipment | | | 11,555 | | | | 11,211 | | | | 23,139 | | | | 22,204 | |
Costs of revenues other than deprecation of | | | | | | | | | | | | | | | | |
rental and lease equipment | | | 6,985 | | | | 5,189 | | | | 12,351 | | | | 10,052 | |
Selling, general and administrative expenses | | | 12,054 | | | | 10,726 | | | | 24,104 | | | | 21,623 | |
| | | | | | | | | | | | | | | | |
Total operating expenses | | | 30,594 | | | | 27,126 | | | | 59,594 | | | | 53,879 | |
| | | | | | | | | | | | | | | | |
Operating profit | | | 4,839 | | | | 8,237 | | | | 10,825 | | | | 16,093 | |
| | | | | | | | | | | | | | | | |
Interest income, net | | | 632 | | | | 901 | | | | 1,223 | | | | 1,773 | |
| | | | | | | | | | | | | | | | |
Income before income taxes | | | 5,471 | | | | 9,138 | | | | 12,048 | | | | 17,866 | |
| | | | | | | | | | | | | | | | |
Income tax provision | | | 1,977 | | | | 3,402 | | | | 4,183 | | | | 6,816 | |
| | | | | | | | | | | | | | | | |
Net income | | $ | 3,494 | | | $ | 5,736 | | | $ | 7,865 | | | $ | 11,050 | |
| | | | | | | | | | | | | | | | |
Earnings per share: | | | | | | | | | | | | | | | | |
Basic | | $ | 0.14 | | | $ | 0.22 | | | $ | 0.31 | | | $ | 0.43 | |
Diluted | | $ | 0.14 | | | $ | 0.22 | | | $ | 0.31 | | | $ | 0.42 | |
| | | | | | | | | | | | | | | | |
Shares used in per share calculation: | | | | | | | | | | | | | | | | |
Basic | | | 25,420 | | | | 25,919 | | | | 25,646 | | | | 25,879 | |
Diluted | | | 25,511 | | | | 26,089 | | | | 25,756 | | | | 26,061 | |
See accompanying notes to condensed consolidated financial statements (unaudited).
ELECTRO RENT CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited) (000's omitted, except share data)
| | November 30, | | | May 31, | |
| | 2008 | | | 2008 | |
ASSETS | | | | | | |
| | | | | | |
Cash and cash equivalents | | $ | 42,474 | | | $ | 50,964 | |
Investments, trading, at fair value (cost of $22,800) | | | 19,769 | | | | - | |
Investments available-for-sale, at fair value (cost of $23,600) | | | - | | | | 22,601 | |
Put option | | | 3,031 | | | | - | |
Accounts receivable, net of allowance for doubtful accounts of $327 and $359 | | | 21,026 | | | | 23,128 | |
Rental and lease equipment, net of accumulated depreciation of $174,579 and $161,187 | | | 172,061 | | | | 172,468 | |
Other property, net of accumulated depreciation and amortization of $14,810 and $14,427 | | | 14,109 | | | | 14,341 | |
Goodwill | | | 3,109 | | | | 3,109 | |
Intangibles, net of amortization of $1,573 and $1,406 | | | 902 | | | | 1,069 | |
Other | | | 6,132 | | | | 5,402 | |
| | $ | 282,613 | | | $ | 293,082 | |
| | | | | | | | |
LIABILITIES AND SHAREHOLDERS' EQUITY | | | | | | | | |
| | | | | | | | |
Liabilities: | | | | | | | | |
Accounts payable | | $ | 6,612 | | | $ | 4,562 | |
Accrued expenses | | | 12,714 | | | | 12,565 | |
Deferred revenue | | | 4,790 | | | | 4,943 | |
Deferred tax liability | | | 17,257 | | | | 14,904 | |
Total liabilities | | | 41,373 | | | | 36,974 | |
| | | | | | | | |
Commitments and contingencies (Note 11) | | | | | | | | |
| | | | | | | | |
Shareholders' equity: | | | | | | | | |
Preferred stock, $1 par - shares authorized 1,000,000; none issued | | | | | | | | |
Common stock, no par - shares authorized 40,000,000; | | | | | | | | |
issued and outstanding November 30, 2008 - 24,572,641; | | | | | | | | |
May 31, 2008 - 25,945,283 | | | 32,790 | | | | 33,938 | |
Accumulated other comprehensive loss, net of tax | | | - | | | | (619 | ) |
Retained earnings | | | 208,450 | | | | 222,789 | |
Total shareholders' equity | | | 241,240 | | | | 256,108 | |
| | $ | 282,613 | | | $ | 293,082 | |
See accompanying notes to condensed consolidated financial statements (unaudited).
ELECTRO RENT CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (000's omitted)
| | Six Months Ended | |
| | November 30 | |
| | 2008 | | | 2007 | |
| | | | | | |
Cash flows from operating activities: | | | | | | |
Net income | | $ | 7,865 | | | $ | 11,050 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | |
Depreciation and amortization | | | 23,725 | | | | 23,032 | |
Put option gain | | | (3,031 | ) | | | - | |
Mark to market, trading | | | 3,031 | | | | - | |
Remeasurement loss (gain) | | | 483 | | | | (203 | ) |
Gain on sale of rental and lease equipment | | | (4,454 | ) | | | (4,872 | ) |
Deferred tax liability | | | 1,976 | | | | 701 | |
Stock compensation expense | | | 90 | | | | 152 | |
Provision for losses on accounts receivable | | | 184 | | | | 176 | |
Excess tax benefit for stock based compensation | | | (44 | ) | | | (128 | ) |
Changes in operating assets and liabilities: | | | | | | | | |
Accounts receivable | | | 1,332 | | | | (2,946 | ) |
Other assets | | | (727 | ) | | | (93 | ) |
Accounts payable | | | 664 | | | | 206 | |
Accrued expenses | | | 275 | | | | 1,798 | |
Deferred revenue | | | (115 | ) | | | 68 | |
Net cash provided by operating activities | | | 31,254 | | | | 28,941 | |
| | | | | | | | |
Cash flows from investing activities: | | | | | | | | |
Proceeds from sale of rental and lease equipment | | | 14,389 | | | | 12,681 | |
Payments for purchase of rental and lease equipment | | | (31,213 | ) | | | (37,228 | ) |
Purchases of investments | | | - | | | | (1,800 | ) |
Redemptions of investments | | | 800 | | | | 1,250 | |
Payments for purchase of other property | | | (186 | ) | | | (255 | ) |
Net cash used in investing activities | | | (16,210 | ) | | | (25,352 | ) |
| | | | | | | | |
Cash flows from financing activities: | | | | | | | | |
Proceeds from the exercise of common stock options | | | 652 | | | | 1,064 | |
Excess tax benefit for stock based compensation | | | 44 | | | | 128 | |
Payment for repurchase of common stock | | | (16,376 | ) | | | (19 | ) |
Payment of dividends | | | (7,762 | ) | | | (5,175 | ) |
Net cash used in financing activities | | | (23,442 | ) | | | (4,002 | ) |
| | | | | | | | |
Net decrease in cash and cash equivalents | | | (8,400 | ) | | | (413 | ) |
Effect of exchange rate changes on cash | | | (90 | ) | | | 125 | |
Cash and cash equivalents at beginning of period | | | 50,964 | | | | 57,172 | |
Cash and cash equivalents at end of period | | $ | 42,474 | | | $ | 56,884 | |
See accompanying notes to condensed consolidated financial statements (unaudited).
ELECTRO RENT CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(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 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., ER International, Inc., Electro Rent Europe NV, Electro Rent Asia, Inc., and Electro Rent (Tianjin) Rental Co., Ltd. (collectively "we", "us", or "our" hereafter) 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. These condensed consolidated financial statements reflect all adjustments and disclosures, which 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.
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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.
Revenue recognition: In accordance with EITF 00-10, Accounting for Shipping and Handling Fees and Costs, delivery and handling revenues are recorded as other revenues and the related expenses are recorded in selling, general and administrative expenses. An amount of $507 and $922 for the three and six months ended November 30, 2007, respectively, has been corrected to properly state sales of equipment and other revenues and selling, general and administrative expenses in accordance with this policy. Management believes the correction to be immaterial to the consolidated statements of operations.
Foreign Currency
The assets and liabilities of our foreign subsidiaries are remeasured from their foreign currency to U.S. dollars at current or historic exchange rates, as appropriate. The U.S. dollar has been determined to be our functional currency. Revenues and expenses are remeasured from any foreign currencies to U.S. dollars using historic rates or an average monthly rate, as appropriate, for the month in which the transaction occurred. Our foreign subsidiaries individually have assets, liabilities, revenues and expenses under 10% of our respective consolidated amounts. The euro, Canadian dollar and Chinese yuan are our primary foreign currencies.
We may enter into forward contracts designated as hedges against unfavorable fluctuations in our monetary assets and liabilities, primarily in our European and Canadian operations. These contracts are designed to minimize the effect of fluctuations in foreign currencies. Such contracts do not qualify to be accounted for under hedge accounting in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 133, Accounting for Derivative Instruments and Hedging Activities, (“SFAS 133”) and are recorded at fair value as a current asset or liability and any changes in fair value are recorded in selling, general and administrative expenses in the consolidated statements of operations.
Adopted Accounting Pronouncements
Effective June 1, 2008, we adopted SFAS No. 157, Fair Value Measurements (“SFAS 157”) as amended by Financial Accounting Standards Board (“FASB”) Staff Position SFAS 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13 (“FSP SFAS 157-1”) and FASB Staff Position SFAS 157-2, Effective Date of FASB Statement No. 157 (“FSP SFAS 157-2”). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and provides for expanded disclosure about fair value measurements. SFAS 157 applies prospectively to all other accounting pronouncements that require or permit fair value measurements. FSP SFAS 157-1 amends SFAS 157 to exclude from the scope of SFAS 157 certain leasing transactions accounted for under SFAS No. 13, Accounting for Leases. FSP SFAS 157-2 amends SFAS 157 to defer the effective date of SFAS 157 for all non-financial assets and non-financial liabilities except those that are recognized or disclosed at fair value in the financial statements on a recurring basis to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. We will adopt FSP SFAS 157-2 with our first quarter of fiscal 2010.
The adoption of SFAS 157 did not have a material impact on our financial condition, results of operations, or cash flows. While we continue to evaluate the impact that SFAS 157 will have on our non-financial assets and non-financial liabilities, we do not anticipate that the impact will be material to our financial condition, results of operations, or cash flows. The assets and liabilities typically recorded at fair value on a non-recurring basis to which we have not yet applied SFAS 157 due to the deferral of SFAS 157 for such items include:
| • | | Non-financial assets and liabilities initially measured at fair value in an acquisition or business combination, and |
| • | | Long-lived assets measured at fair value due to an impairment assessment under SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. |
Effective October 10, 2008 we adopted FASB Staff Position 157-3, Determining Fair Values of a Financial Asset When the Market for That Asset Is Not Active (“FSP FAS 157-3”). FSP FAS 157-3 clarifies the application of SFAS 157 to financial instruments in an inactive market. The adoption of FSP FAS 157-3 did not have a material impact on our financial condition, results of operations, or cash flows.
Effective June 1, 2008, we adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of the guidance is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The adoption of SFAS 159 did not have a material impact on our financial condition, results of operations, or cash flows since we did not elect to apply the fair value option for any of our eligible financial instruments or other items on the June 1, 2008 effective date. See Note 2 for discussion of the fair value election of our put option asset.
New Accounting Pronouncements
In June 2008, the FASB issued FSP Emerging Issues Task Force (“EITF”) Issue No. 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“FSP EITF 03-6-1”). FSP EITF 03-6-1 addresses whether instruments granted by an entity in share-based payment transactions should be considered as participating securities prior to vesting and, therefore, should be included in the earnings allocation in computing earnings per share under the two-class method described in paragraphs 60 and 61 of FASB Statement No. 128, Earnings per Share. FSP EITF 03-6-1 clarifies that instruments granted in share-based payment transactions can be participating securities prior to vesting (that is, awards for which the requisite service had not yet been rendered). Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. FSP EITF 03-6-1 requires us to retrospectively adjust our earnings per share data (including any amounts related to interim periods, summaries of earnings and selected financial data) to conform to the provisions of FSP EITF 03-6-1. FSP EITF 03-6-1 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. Early adoption is prohibited. We will adopt FSP EITF 03-6-1 beginning with our first quarter of fiscal 2010. We do not anticipate that the adoption of FSP EITF 03-6-1 will have a material impact on our financial condition, results of operations, or cash flows.
In April 2008, the FASB issued FSP SFAS No. 142-3, Determination of the Useful Life of Intangible Assets (“FSP SFAS 142-3”). FSP SFAS 142-3 is intended to improve the consistency between the useful life of recognized intangible assets under SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), and the period of expected cash flows used to measure the fair value of the assets under SFAS No. 141(R), Business Combinations (“SFAS 141R”). FSP SFAS 142-3 amends the factors an entity should consider in developing renewal or extension assumptions in determining the useful life of recognized intangible assets. FSP SFAS 142-3 requires an entity to consider its own historical experience in renewing or extending similar arrangements, or to consider market participant assumptions consistent with the highest and best use of the assets if relevant historical experience does not exist. In addition to the required disclosures under SFAS 142, FSP SFAS 142-3 requires disclosure of the entity’s accounting policy regarding costs incurred to renew or extend the term of recognized intangible assets, the weighted average period to the next renewal or extension, and the total amount of capitalized costs incurred to renew or extend the term of recognized intangible assets. FSP SFAS 142-3 is effective for financial statements issued for fiscal years and interim periods beginning after December 15, 2008. While the standard for determining the useful life of recognized intangible assets is to be applied prospectively only to intangible assets acquired after the effective date, the disclosure requirements shall be applied prospectively to all recognized intangible assets as of, and subsequent to, the effective date. Early adoption is prohibited. We will adopt FSP SFAS 142-3 beginning with our first quarter of fiscal 2010. We do not anticipate that the adoption of FSP SFAS 142-3 will have a material impact on our financial condition, results of operations, or cash flows.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133 (“SFAS 161”). SFAS 161 requires entities to provide enhanced disclosures about (a) how and why an entity uses derivative instruments and that the objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation, (b) how derivative instruments and related hedged items are accounted for under SFAS 133, Accounting for Derivative Instruments and Hedging Activities and its related interpretations, including a tabular format disclosure of the fair values of derivative instruments and their gains and losses and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. SFAS 161 encourages, but does not require, comparative disclosures for earlier periods at initial adoption. We will be required to adopt the provisions of SFAS 161 beginning with our first quarter of fiscal 2010. We do not anticipate that the adoption of SFAS No. 161 will have a material effect on our financial condition, results of operations, or cash flows.
In December 2007, the FASB issued SFAS No. 141R, Business Combinations (“SFAS 141R”). SFAS 141R replaces SFAS No. 141, Business Combinations, to provide greater consistency in the accounting and financial reporting of business combinations. SFAS 141R requires that the acquiring entity in a business combination recognize all assets acquired and liabilities assumed in the transaction, establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed, establishes principles and requirements for how an acquirer recognizes and measures any non-controlling interest in the acquiree and the goodwill acquired, and requires the acquirer to disclose the nature and financial effect of the business combination. Among other changes, this statement also requires that “negative goodwill” be recognized in earnings as a gain attributable to the acquisition, that acquisition-related costs are to be recognized separately from the acquisition and expensed as incurred and that any deferred tax benefits resulting from a business combination be recognized in income from continuing operations in the period of the combination or directly in contributed capital, depending on the circumstances. SFAS 141R is effective for fiscal years beginning on or after December 15, 2008. We will be required to adopt the provisions of SFAS 141R beginning with our first quarter of fiscal 2010. We do not anticipate that the adoption of SFAS 141R will have a material effect on our financial condition, results of operations, or cash flows.
In December 2007, the FASB issued SFAS No. 160, Non-controlling Interests in Consolidated Financial Statements (“SFAS 160”). SFAS 160 amends Accounting Research Bulletin 51, Consolidated Financial Statements, to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. It also clarifies that a non-controlling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements. SFAS 160 also changes the way the consolidated income statement is presented by requiring consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. It also requires disclosure, on the face of the consolidated statement of income, of the amounts of consolidated net income attributable to the parent and to the non-controlling interest. SFAS 160 requires that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated and requires expanded disclosures in the consolidated financial statements that clearly identify and distinguish between the interests of the parent owners and the interests of the non-controlling owners of a subsidiary. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. We will be required to adopt the provisions of SFAS 160 beginning with our first quarter of fiscal 2010. We do not anticipate that the adoption of SFAS 160 will have a material effect on our financial condition, results of operations, or cash flows.
Note 2: Cash and cash equivalents and investments
We consider highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Cash equivalents consist primarily of AAA-rated money market funds in all periods presented. Investments consist of Auction Rate Securities (“ARS”) that we carry at fair value and classify as trading securities at November 30, 2008. Previously, our ARS were classified as investments available-for-sale. Except for direct obligations of the United States government, securities issued by agencies of the United States government, and money market or cash management funds, we diversify our investments by limiting our holdings with any individual issuer.
When made, our investments are intended to establish a high-quality portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations and delivers an appropriate yield in relationship to our investment guidelines and market conditions.
At November 30, 2008, we held $22.8 million, at cost, in ARS. During the six months ended November 30, 2008, we sold $800 of our ARS at par value. Our ARS are long-term debt instruments backed by student loans, a substantial portion of which are guaranteed by the United States government. All of our ARS have credit ratings of AAA or AA, and none are mortgage-backed debt obligations. Historically, our ARS were highly liquid, using a Dutch auction process that resets the applicable interest rate at predetermined intervals, typically every 35 days, to provide liquidity at par. However, as a result of liquidity issues in the global credit and capital markets, the auctions for all of our ARS failed beginning in February 2008 when sell orders exceeded buy orders. The failures of these auctions do not affect the value of the collateral underlying the ARS, and we continue to earn and receive interest on our ARS at a pre-determined formula with spreads tied to particular interest rate indexes. We value the ARS from quotes received from our broker which are derived from their internally developed model. In determining a discount factor for each ARS, the model weights various factors, including assessments of credit quality, duration, insurance wraps, portfolio composition, discount rates, overall capital market liquidity and comparable securities, if any.
On November 6, 2008, we accepted an offer from UBS AG (“UBS”), providing us with rights related to our ARS (the “Rights”). The Rights permit us to require UBS to purchase our ARS at par value, which is defined as the price equal to the liquidation preference of the ARS plus accrued but unpaid dividends or interest, at any time during the period of June 30, 2010 through July 2, 2012. Conversely, UBS has the right, in its discretion, to purchase or sell our ARS at any time until July 2, 2012, so long as we receive payment at par value upon any sale or disposition. We expect to sell our ARS under the Rights. However, if the Rights are not exercised before July 2, 2012 they will expire and UBS will have no further rights or obligation to buy our ARS. So long as we hold our ARS, they will continue to accrue interest as determined by the auction process or the terms of the ARS if the auction process fails.
UBS’s obligations under the Rights are not secured by its assets and do not require UBS to obtain any financing to support its performance obligations under the Rights. UBS has disclaimed any assurance that it will have sufficient financial resources to satisfy its obligations under the Rights.
The Rights represent a firm agreement in accordance with SFAS 133, which defines a firm agreement as an agreement with an unrelated party, binding on both parties and usually legally enforceable, with the following characteristics: a) the agreement specifies all significant terms, including the quantity to be exchanged, the fixed price, and the timing of the transaction, and b) the agreement includes a disincentive for nonperformance that is sufficiently large to make performance probable. The enforceability of the Rights results in a put option and should be recognized as a free standing asset separate from the ARS. Upon acceptance of the offer from UBS, we recorded $1.9 million as the fair value of the put option asset with a corresponding credit to interest income, net. We subsequently recorded a $1.1 million increase in the fair value of the put option, for a total fair value of $3.0 million as of November 30, 2008, with a corresponding credit to interest income, net, in the condensed consolidated statements of operations for the six months ended November 30, 2008. The put option does not meet the definition of a derivative instrument under SFAS 133. Therefore, we have elected to measure the put option at fair value under SFAS 159, which permits an entity to elect the fair value option for recognized financial assets, in order to match the changes in the fair value of the ARS. As a result, unrealized gains and losses will be included in earnings in future periods. We expect that future changes in the fair value of the put option will approximate fair value movements in the related ARS.
Prior to accepting the UBS offer, we recorded our ARS as investments available-for-sale. We recorded unrealized gains and losses on our available-for-sale debt securities, net of a tax benefit, in accumulated other comprehensive income in the shareholders’ equity section of our balance sheets. Such an unrealized loss did not reduce net income for the applicable accounting period.
In connection with our acceptance of the UBS offer in November 2008, resulting in our right to require UBS to purchase our ARS at par value beginning on June 30, 2010, we transferred our ARS from investments available-for-sale to trading securities in accordance with SFAS 115. The transfer to trading securities reflects management’s intent to exercise its put option during the period June 30, 2010 to July 3, 2012. Prior to our agreement with UBS, our intent was to hold the ARS until the market recovered. At the time of transfer, the unrealized loss on our ARS was $1.9 million, an increase of $900 from May 31, 2008. This unrealized loss was included in other comprehensive income. Upon transfer to trading securities, we immediately recognized a loss of $1.9 million, included in interest income, net, for the amount of the unrealized loss not previously recognized in earnings. Subsequently, we recognized an additional decline in fair value of $1.1 million for a total unrealized loss of $3.0 million, included in interest income, net, in the condensed consolidated statements of operations for the six months ended November 30, 2008.
The following is a summary of available-for-sale securities as of May 31, 2008:
| | May 31, 2008 | |
| | Available-for-sale Securities | |
| | | | | Gross | | | Gross | | | | |
| | | | | Unrealized | | | Unrealized | | | Estimated | |
| | Cost | | | Gains | | | Losses | | | Fair Value | |
Auction rate securities | | $ | 23,600 | | | $ | - | | | $ | (999 | ) | | $ | 22,601 | |
| | $ | 23,600 | | | $ | - | | | $ | (999 | ) | | $ | 22,601 | |
We continue to monitor the market for ARS and consider its impact (if any) on the fair market value of our investments. If the market conditions deteriorate further, we may be required to record additional unrealized losses in earnings, offset by corresponding increases in the put option. We believe that, based on our current cash and cash equivalents balance, the current lack of liquidity in the credit and capital markets will not have a material impact on our liquidity, cash flows or ability to fund our operations.
Note 3: Fair Value Measurements
As described in Note 1, we adopted SFAS 157 on June 1, 2008. SFAS 157, among other things, defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. SFAS 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, SFAS 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring 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.
Assets and liabilities measured at fair value on a recurring basis at November 30, 2008 are as follows:
| | Quoted Prices in Active Markets for Identical Instruments (Level 1) | | | Significant Other Observable Inputs (Level 2) | | | Significant Unobservable Inputs (Level 3) | | | Total Balance | |
Money market funds | | $ | 36,974 | | | $ | - | | | $ | - | | | $ | 36,974 | |
Auction rate securities | | | - | | | | - | | | | 19,769 | | | | 19,769 | |
Put option | | | | | | | | | | | 3,031 | | | | 3,031 | |
Foreign currency forward contract | | | | | | | 23 | | | | | | | | 23 | |
Total assets measured at fair value | | $ | 36,974 | | | $ | 23 | | | $ | 22,800 | | | $ | 59,797 | |
We value the ARS from quotes received from our broker which are derived from their internally developed model. In determining a discount factor for each ARS, the model weights various factors, including assessments of credit quality, duration, insurance wraps, portfolio composition, discount rates, overall capital market liquidity and comparable securities, if any. The put option is a free standing asset separate from the ARS, and represents our contractual right to require our broker, UBS, to purchase our ARS at par value during the period of June 30, 2010 through July 2, 2012. In order to value the put option, we considered the intrinsic value, time value of money, and our assessment of the credit worthiness of UBS.
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) for the three and six months ended November 30, 2008:
| | Three Months Ended November 30, 2008 | |
| | Put Option | | | Auction Rate Securities | |
Fair value at August 31, 2008 | | $ | - | | | $ | 22,644 | |
Settlements (at par) | | | - | | | | (800 | ) |
Issuance of put | | | 1,891 | | | | - | |
Unrealized gains included in earnings | | | 1,140 | | | | - | |
Unrealized losses included in earnings (1) | | | - | | | | (2,075 | ) |
Fair value at November 30, 2008 | | $ | 3,031 | | | $ | 19,769 | |
| | Six Months Ended November 30, 2008 | |
| | Put Option | | | Auction Rate Securities | |
Fair value at June 1, 2008 | | $ | - | | | $ | 22,601 | |
Settlements (at par) | | | - | | | | (800 | ) |
Issuance of put | | | 1,891 | | | | - | |
Unrealized gains included in earnings | | | 1,140 | | | | - | |
Unrealized losses included in earnings (1) | | | - | | | | (2,032 | ) |
Fair value at November 30, 2008 | | $ | 3,031 | | | $ | 19,769 | |
(1) Total unrealized losses for the three and six months ended November 30, 2008 were $3.0 million, including $946 and $1.0 million transferred from other comprehensive income for unrealized losses as of August 31, 2008 and May 31, 2008, respectively. (See Note 2 for further discussion).
Note 4: Stock Options and Equity Incentive Plan
We have an Equity Incentive Plan that authorizes the Board of Directors to grant incentive and non-statutory stock option grants, stock appreciation rights, restricted stock awards and performance unit per share awards covering a maximum of 1,000 shares of our common stock. The Equity Incentive Plan replaced our Stock Option Plans (those Stock Option Plans, together with the Equity Incentive Plan, the “Plans”) in October 2005, although 383 options to purchase our common stock for previously granted incentive stock options and non-statutory stock options granted to directors, officers and consultants under our Stock Option Plans remain in effect according to their terms. Pursuant to the Plans, 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. Options are exercisable at various dates over a five-year or ten-year period from the date of grant. The Plans provide for a variety of vesting dates with the majority of the options vesting at a rate of one-third per year over a period of three years or one-fourth per year over a period of four years from the date of grant.
The following table represents stock option activity for the six months ended November 30, 2008:
| | Shares | | | Weighted Average Exercise Price | | | Weighted Average Remaining Contractual Term (in years) | | | Aggregate Intrinsic Value | |
Outstanding at June 1, 2008 | | | 512 | | | $ | 10.02 | | | | | | | |
Granted | | | - | | | | - | | | | | | | |
Exercised | | | (70 | ) | | | 9.14 | | | | | | | |
Forfeited/canceled | | | (3 | ) | | | 12.21 | | | | | | | |
Outstanding at November 30, 2008 | | | 439 | | | $ | 10.14 | | | | 0.97 | | | $ | 668 | |
Vested and expected to vest at November 30, 2008 | | | 437 | | | $ | 10.09 | | | | 0.96 | | | $ | 668 | |
Exercisable at November 30, 2008 | | | 431 | | | $ | 9.99 | | | | 0.93 | | | $ | 668 | |
We did not grant any stock options during the three and six months ended November 30, 2008 and 2007. The total fair value of options vested was $99 during the three and six months ended November 30, 2008, compared to $139 and $765 during the three and six months ended November 30, 2007, respectively. The aggregate intrinsic value of options exercised is calculated as the difference between the exercise price of the underlying awards and the quoted price of our common stock, and was $59 and $233 during the three and six months ended November 30, 2008, respectively, and $138 and $539 during the three and six months ended November 30, 2007, respectively. As of November 30, 2008 there was approximately $41 of total unrecognized compensation cost related to unvested share-based arrangements granted under our Plans. The cost is expected to be recognized over a weighted-average period of 0.9 years. Shares of newly issued common stock will be issued upon exercise of stock options.
Stock-Based Compensation
We account for stock-based compensation in accordance with SFAS No. 123R, Share-Based Payment, (“SFAS 123R”) which requires all share-based payments to employees, including grants of employee stock options, 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 each 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 stock-based awards are expected to be outstanding and was 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 recorded $40 and $90 of stock-based compensation for employee stock options and restricted stock, as part of selling, general and administrative expenses for the three and six months ended November 30, 2008, respectively, compared to $28 and $152 for the three and six months ended November 30, 2007, respectively. This compensation cost caused net income to decrease by $25 and $57 for the three and six months ended November 30, 2008, respectively, compared to $18 and $112 for the three and six months ended November 30, 2007, respectively, and did not have a material impact on basic or diluted earnings per share.
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 stock at the date of exercise over the exercise price of the options. 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 for the six months ended November 30, 2008 and 2007 was $44 and $128, respectively. Cash received from stock option exercises was $652 and $1.1 million for the six months ended November 30, 2008 and 2007, respectively.
Restricted Stock
Compensation expense resulting from restricted stock awards is measured at fair value on the date of grant and is recognized in selling, general and administrative expenses over a one-year vesting period. We recognized approximately $22 and $48 of related compensation expense in the three and six months ended November 30, 2008, respectively, related to restricted stock awards. There were no restricted stock award grants for the three and six months ended November 30, 2007. As of November 30, 2008, we have unrecognized share-based compensation cost of approximately $45 associated with these awards. This cost is expected to be recognized over the next six months.
Restricted stock activity for the six months ended November 30, is set forth below:
| | Shares | | | Weighted – Average Grant Date Fair Value | |
Nonvested at June 1, 2008 | | | - | | | $ | - | |
Granted | | | 7 | | | | 14.12 | |
Vested | | | (3 | ) | | | (14.12 | ) |
Canceled | | | (1 | ) | | | (14.12 | ) |
Nonvested at November 30, 2008 | | | 3 | | | $ | 14.12 | |
Note 5: 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 comprise purchased customer relationships, trademarks and trade names, developed technologies and other intangible assets.
Our goodwill and intangibles at November 30, 2008 are the result of the acquisition 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, 2008 are as follows:
| | Balance as of June 1, 2008 (net of amortization) | | | Adjustments | | | Amortization | | | Balance as of November 30, 2008 | |
Goodwill | | $ | 3,109 | | | $ | - | | | $ | - | | | $ | 3,109 | |
Trade Name | | | 411 | | | | - | | | | - | | | | 411 | |
Non-compete agreements | | | 266 | | | | - | | | | (50 | ) | | | 216 | |
Customer relationships | | | 392 | | | | - | | | | (117 | ) | | | 275 | |
| | $ | 4,178 | | | $ | - | | | $ | (167 | ) | | $ | 4,011 | |
The goodwill and intangibles have been assigned to our computer-related data products (“DP”) operating segment. Goodwill is not deductible for tax purposes.
We were aware of no conditions that indicated any impairment of goodwill or identifiable intangible assets as of November 30, 2008 or May 31, 2008. The annual impairment review date for goodwill and intangible assets is May 31.
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, 2008 | |
| | Estimated Useful Life | | | Gross Carrying Amount | | | Accumulated Amortization | | | Net Carrying Amount | |
Trade name | | | - | | | $ | 411 | | | $ | - | | | $ | 411 | |
Non-compete agreements | | 2-5 years | | | | 1,050 | | | | (834 | ) | | | 216 | |
Customer relationships | | 3-4 years | | | | 1,014 | | | | (739 | ) | | | 275 | |
| | | | | | $ | 2,475 | | | $ | (1,573 | ) | | $ | 902 | |
| | May 31, 2008 | |
| | Estimated Useful Life | | | Gross Carrying Amount | | | Accumulated Amortization | | | Net Carrying Amount | |
Trade name | | | - | | | $ | 411 | | | $ | - | | | $ | 411 | |
Non-compete agreements | | 2-5 years | | | | 1,050 | | | | (784 | ) | | | 266 | |
Customer relationships | | 3-4 years | | | | 1,014 | | | | (622 | ) | | | 392 | |
| | | | | | $ | 2,475 | | | $ | (1,406 | ) | | $ | 1,069 | |
Amortization expense was $83 and $167 for the three and six months ended November 30, 2008, respectively, compared to $147 and $293 for the three and six months ended November 30, 2007, respectively.
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:
Year ending May 31, | | Future Amortization | |
2009 | | $ | 168 | |
2010 | | | 257 | |
2011 | | | 66 | |
2012 | | | 0 | |
2013 | | | 0 | |
| | $ | 491 | |
Note 6: Noncash Investing and Financing Activities
We had accounts payable and other accruals related to acquired equipment totaling $5,477 and $3,824 as of November 30, 2008 and May 31, 2008, respectively, and $4,551 and $8,844 as of November 30, 2007 and May 31, 2007, respectively, which amounts were paid in following periods. During the six months ended November 30, 2008 we transferred $20.9 million at fair value from investments available-for-sale to investments, trading.
Note 7: 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 minimum lease payments receivable and the net investment included in other assets for such leases are as follows:
| | November 30, 2008 | | | May 31, 2008 | |
Gross minimum lease payments receivable | | $ | 2,609 | | | $ | 1,392 | |
Less – unearned interest | | | (174 | ) | | | (112 | ) |
Net investment in sales-type lease receivables | | $ | 2,434 | | | $ | 1,280 | |
Note 8: Segment Reporting and Related Disclosures
SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information (“SFAS 131”), establishes annual and interim reporting standards for an enterprise’s operating segments and related disclosures about its products, services, geographic areas and major customers. According to SFAS 131, operating segments are defined as components of an enterprise for which separate financial information is available that is evaluated regularly 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 guidance in accordance with SFAS 131: 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 and DP equipment.
Although we have separate operating segments for T&M and DP equipment under SFAS 131, 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 they 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, comprised $301,169 of T&M equipment and $45,472 of DP equipment at November 30, 2008 and $289,061 of T&M equipment and $44,594 of DP equipment at May 31, 2008.
Revenues for these product groups were as follows for the three months ended November 30, 2008 and 2007:
| | T&M | | | DP | | | Total | |
2008 | | | | | | | | | |
Rentals and leases | | $ | 20,441 | | | $ | 5,714 | | | $ | 26,155 | |
Sales of equipment and other revenues | | | 8,430 | | | | 848 | | | | 9,278 | |
| | $ | 28,871 | | | $ | 6,562 | | | $ | 35,433 | |
| | | | | | | | | | | | |
2007 | | | | | | | | | | | | |
Rentals and leases | | $ | 21,435 | | | $ | 5,990 | | | $ | 27,425 | |
Sales of equipment and other revenues | | | 7,145 | | | | 793 | | | | 7,938 | |
| | $ | 28,580 | | | $ | 6,783 | | | $ | 35,363 | |
Revenues for these product groups were as follows for the six months ended November 30, 2008 and 2007:
| | T&M | | | DP | | | Total | |
2008 | | | | | | | | | |
Rentals and leases | | $ | 41,110 | | | $ | 12,279 | | | $ | 53,389 | |
Sales of equipment and other revenues | | | 15,256 | | | | 1,774 | | | | 17,030 | |
| | $ | 56,366 | | | $ | 14,053 | | | $ | 70,419 | |
| | | | | | | | | | | | |
2007 | | | | | | | | | | | | |
Rentals and leases | | $ | 42,766 | | | $ | 12,103 | | | $ | 54,869 | |
Sales of equipment and other revenues | | | 13,568 | | | | 1,535 | | | | 15,103 | |
| | $ | 56,334 | | | $ | 13,638 | | | $ | 69,972 | |
No single customer accounted for more than 10% of total revenues during the three and six months ended November 30, 2008 and 2007.
Selected country information is presented below:
| | Three Months Ended November 30, | | | Six Months Ended November 30, | |
| | 2008 | | | 2007 | | | 2008 | | | 2007 | |
Revenues: (1) | | | | | | | | | | | | |
U.S. | | $ | 30,466 | | | $ | 28,750 | | | $ | 60,299 | | | $ | 57,961 | |
Other (2) | | | 4,967 | | | | 6,613 | | | | 10,120 | | | | 12,011 | |
Total | | $ | 35,433 | | | $ | 35,363 | | | $ | 70,419 | | | $ | 69,972 | |
| | November 30, 2008 | | | May 31, 2008 | |
Net Long-Lived Assets: (3) | | | | | | |
U.S. | | $ | 159,198 | | | $ | 165,984 | |
Other (2) | | | 30,983 | | | | 25,003 | |
Total | | $ | 190,181 | | | $ | 190,987 | |
(1) | Revenues by country are based on the location of shipping destination, and not whether the order originates in the U.S. parent or a foreign subsidiary. |
(2) | Other consists of other 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 9: Computation of Earnings Per Share
The following is a reconciliation of the denominator used in the computation of basic and diluted EPS for the three and six months ended November 30, 2008 and 2007:
| | Three Months Ended November 30, | | | Six Months Ended November 30, | |
| | 2008 | | | 2007 | | | 2008 | | | 2007 | |
| | | | | | | | | | | | |
Denominator: | | | | | | | | | | | | |
Denominator for basic earnings per share - weighted average common shares outstanding | | | 25,420 | | | | 25,919 | | | | 25,646 | | | | 25,879 | |
Effect of dilutive securities-options (1) | | | 91 | | | | 170 | | | | 110 | | | | 182 | |
| | | 25,511 | | | | 26,089 | | | | 25,756 | | | | 26,061 | |
| | | | | | | | | | | | | | | | |
Net income | | $ | 3,494 | | | $ | 5,736 | | | $ | 7,865 | | | $ | 11,050 | |
Earnings per share: | | | | | | | | | | | | | | | | |
Basic | | $ | 0.14 | | | $ | 0.22 | | | $ | 0.31 | | | $ | 0.43 | |
Diluted | | $ | 0.14 | | | $ | 0.22 | | | $ | 0.31 | | | $ | 0.42 | |
(1) Excludes 38 and 37 options outstanding during the three and six months ended November 30, 2008, respectively, and 41 during the three and six months ended November 30 2007, respectively, for which the exercise price exceeded the average market price of our stock during that period.
Note 10: Income Taxes
At May 31, 2008, we had unrecognized tax benefits of $3,693. Unrecognized tax benefits decreased by $342 in the six months ended November 30, 2008. The decrease in the unrecognized tax benefits is the result of a decline in the Canadian dollar for the six months ended November 30, 2008.
The unrecognized tax benefit at November 30, 2008, if recognized, would have no impact on the effective tax rate. However, the derecognition of $1,018 related to the associated interest and penalties at November 30, 2008 would decrease the effective tax rate.
We recognize interest and penalties accrued with respect to uncertain tax positions as components of our income tax provision. We had approximately $1,506 for the payment of interest and penalties as of November 30, 2008.
We are subject to taxation in the U.S., various states and foreign jurisdictions. We have substantially settled all income tax matters for the United States federal jurisdiction for years through fiscal 2006. 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 additional unrecognized tax benefits for the six months ended November 30, 2008. We anticipate no significant increase or decrease in the total amounts of unrecognized tax benefits within 12 months of the date of this report.
Note 11: 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 and routine claims. 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 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.
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, 2008 and May 31, 2008 and the results of our operations for the three and six months ended November 30, 2008 and 2007, respectively, and cash flows for the six month periods ended November 30, 2008 and 2007. This discussion should be read in conjunction with the Management's Discussion and Analysis section included on pages 10-18 and the Risk Factors discussed in Item 1A, of our 2008 Annual Report on From 10-K to which the reader is directed for additional information.
Overview
We generate revenues through the rental, lease and sale of electronic equipment, primarily test and measurement ("T&M") and personal computer-related data products ("DP") equipment.
For the first six months of fiscal 2009, 77% of our rental and lease revenues were derived from T&M equipment. This percentage has decreased slightly from the prior year period due to an increase in our DP revenues, while T&M revenues have declined, primarily due to a decline in lease revenues. While we have experienced increased rental activity for our T&M equipment, it has been offset by a decline in rental rates, reflecting competitive pressures.
For the first six months of fiscal 2009, rental revenues comprised 86% of our rental and lease revenue. That percentage has increased over the last two years due to an increase in T&M and DP rental activity in our U.S. and European operation, while lease revenues have declined.
A significant part of our T&M equipment portfolio is rented or leased to large companies in the aerospace and defense, telecommunications, semiconductor and electronics industries. We believe that a large part of our T&M equipment is used in research and development activities. We also rent equipment to companies of various sizes representing a cross-section of industry. Our business is relatively non-seasonal except for the third quarter months of December, January and February, when rental activity declines due to extended holiday closings by a number of customers. In addition, rental billing is reduced during February because it is a short month.
We sell used equipment in the normal course of business based on customer requirements. Our sale of used equipment allows us to maintain our inventory with equipment that meets current technological standards. In fiscal 2007, we entered into distribution agreements with three leading manufacturers to sell basic T&M equipment to current and prospective customers through our new distribution channel.
The profitability of our business depends in 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 for the purpose of deriving a profit from a combination of renting and/or selling such equipment. The sale of equipment, either after acquisition or after it has been rented, can comprise a significant portion of our revenues and operating profit. To maximize our 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 projected performance and 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 generally based on the following fundamentals:
| · | 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 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 when factors indicating impairment are present.
During the early part of this decade, our business significantly contracted due to a slow-down in the U.S. economy. When the U.S. and global economy began to rebound in fiscal 2004, we saw increased demand for our equipment, and were able to sell equipment that was older and more fully depreciated. Due in part to these events, we experienced greater than normal gross margin on equipment sales of 47% for our 2007 fiscal year. As we anticipated, our gross margin on sales in fiscal 2008 declined to 35%, reflecting increases in lower margin sales under our arrangements to act as a distributor of new T&M equipment for certain manufacturers and a large buyout of used equipment at lower than normal margins. Based on our current equipment management strategy, we anticipate that future gross margin on sales will trend downward as lower margin finance leases and distribution sales continue to grow, although the gross margin percentage will fluctuate on a quarterly basis. Our gross margin on sales for the three and six months ended November 30, 2008 was 28% and 31%, respectively, compared to 37% and 38% for the three and six months ended November 30, 2007, respectively.
The economy in the United States and, to a certain degree the other markets in which we operate, has been slowing, which has impacted our current profitability, and may impact our prospects for growth and profitability in future periods.
We generally 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 (annualized); and |
| · | Net income as a percentage of average tangible equity (annualized). |
STRATEGIC GROWTH PLANS
We believe that our resources and financial infrastructure remain capable of handling a significantly greater volume of business activity without a proportionate increase in expenses. Based on this belief, we have been seeking ways to increase revenues to leverage that infrastructure. These strategies include:
INTERNAL GROWTH STRATEGIES: We intend to foster internal growth by building upon our vendor and customer relationships and expanding the types of services and equipment we provide. Thus, for example,
| · | We created a new distribution channel by entering into distribution agreements with three leading manufacturers for a range of basic T&M equipment. |
| · | We have re-focused our DP marketing approach to emphasize short-term, event-oriented rentals in addition to our traditional markets. |
| · | We are developing vendor leasing programs that provide customers with flexible financing alternatives. |
ACQUISITION GROWTH STRATEGIES: We are also seeking to grow through acquisitions. Acquisitions can permit us to rapidly add revenues, as well as to expand into new geographical areas and/or markets.
GEOGRAPHIC EXPANSION STRATEGIES: Prior to fiscal 2006, our activity was largely limited to North America, except for some limited rentals to North American companies operating in other geographical areas. We have been expanding our rental and leasing services globally. As part of that strategy, in fiscal 2006 we entered two of the largest world markets: Europe and China.
| · | Our wholly owned subsidiary in Tianjin, China, commenced operations in June 2005 after we received what we believe to be one of the first licenses for a wholly foreign-owned equipment rental business in China. |
| · | In September 2005, we acquired a small T&M equipment rental company based in Belgium, from which we service the European market. |
The financial results of our European operation improved during the first six months of fiscal 2009, compared to the same period in fiscal 2008, while our other foreign operations declined.
Although our strategic initiatives have contributed to our revenue growth, our operating results declined for the six months ended November 30, 2008, compared to the six months ended November 30, 2007. Each of our strategic initiatives entails risks that could impact our continuing business results over the long term. In addition to the risks associated with our core operations, there are special risks associated with international operations and with acquisitions, as well as with growth in general. Recent uncertainty in the U.S. and global economy as a result of more stringent credit requirements and access to capital may adversely affect our customers. While our results improved from 2004 through 2007, and were flat in fiscal 2008, our financial results for the first six months of fiscal 2009 were impacted by competitive pressure on rental rates and lower utilization rates due in part to the economic slow-down in the U.S. and our major international markets. Furthermore, as our foreign operations continue to grow, fluctuations in currency exchange rates will result in additional gains and losses which are difficult to predict. As noted above, our rental and lease utilization rates, operating results and net income could continue to be adversely affected by recent economic trends. For a more detailed summary of some of the risks associated with these and other factors, please see the Risk Factors discussed in Item 1A of our 2008 Annual Report on Form 10-K.
PROFITABILITY AND KEY BUSINESS TRENDS
For the first six months of fiscal 2009, compared to the same period in fiscal 2008, our revenues rose by 0.6 % to $70.4 million, our operating profit decreased by 32.9% to $10.8 million and our net income decreased by 28.1% to $7.9 million. Our revenue growth included growth in our DP business, European operation and distribution channel. Our T&M rental activity increased for the six months ended November 30, 2008 compared to the six months ended November 30, 2007. However, T&M revenues slightly declined, due primarily to competitive pressure on rental rates and a decline in lease revenues. Our profitability measurements are presented in the table below for the six months ended November 30, 2008 and 2007:
| | 2008 | | | 2007 | |
Net income per diluted common share (EPS) | | $ | 0.31 | | | $ | 0.42 | |
Net income as a percentage of average assets (annualized) | | | 5.5 | % | | | 7.7 | % |
Net income as a percentage of average tangible equity (annualized) | | | 6.5 | % | | | 9.1 | % |
The decrease in our operating profit primarily reflects competitive pressures on rental rates and lower equipment utilization rates. In addition, our selling, general and administrative expenses have increased due to higher personnel and benefit costs to support our current operations and develop our strategic initiatives, and foreign currency losses of $837 for the six months ended November 30, 2008, compared to a foreign currency gain of $203 for the prior year period, as a result of a strengthening of the U.S. dollar against key currencies.
The amount of our equipment on rent, based on acquisition cost, increased 4.4% to $155.4 million at November 30, 2008 from $148.8 million at November 30, 2007. Acquisition cost of equipment on lease decreased 18.4% to $31.6 million at November 30, 2008 from $38.7 million at November 30, 2007. Utilization for our T&M equipment pool, based on acquisition cost of equipment on rent and lease compared to the total pool, was 57.9% at November 30, 2008 compared to 63.7% at November 30, 2007. Over the same period, utilization of our DP equipment pool decreased to 46.3% from 57.2%.
The following table shows the revenue and operating profit trends over the last five quarters (in thousands):
| | Three Months Ended | |
| | Nov 30, 2008 | | | Aug 31, 2008 | | | May 31, 2008 | | | Feb 29, 2008 | | | Nov 30, 2007 | |
Rentals and leases | | $ | 26,155 | | | $ | 27,234 | | | $ | 27,648 | | | $ | 26,244 | | | $ | 27,425 | |
Sales of equipment and other revenues | | | 9,278 | | | | 7,752 | | | | 11,253 | | | | 9,419 | | | | 7,938 | |
Operating profit | | | 4,839 | | | | 5,986 | | | | 7,673 | | | | 6,929 | | | | 8,237 | |
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, 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 believed 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 which 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 year ended May 31, 2008. We have not made any material changes to these policies as previously disclosed.
Results of Operations
Comparison of Three Months Ended November 30, 2008 and November 30, 2007
Revenues
Total revenues for the three months ended November 30, 2008 and 2007 were flat at $35.4 million. Sales of equipment and other revenue increased 16.9%, offset by a decline in rental and lease revenues of 4.6%.
Rental and lease revenues in the second quarter of fiscal 2009 were $26.2 million, compared to $27.4 million in the prior year period. This reflects a decline in our T&M lease revenues, while our T&M rental revenues remained flat, with an increase in T&M rental activity offset by a decline in rental rates due to competitive pressure. In addition, demand for our DP equipment declined for the three months ended November 30, 2008 compared to the prior year period.
Sales of equipment and other revenues increased to $9.3 million for the three months ended November 30, 2008 compared to $7.9 million in the prior year period. In part, this increase reflects the results of our strategic initiatives outlined above relating to distribution sales and increased finance lease activity. Gross margin on sales decreased to $2.2 million in the second quarter of fiscal 2009 as compared to $2.5 million a year ago, while the gross margin percentage decreased to 27.8% for the second quarter of fiscal 2009 compared to 36.7% for the second quarter of fiscal 2008. As noted above, our gross margin percentage decreased primarily due to an increase in our lower margin finance leases and distribution sales.
Operating Expenses
Depreciation of rental and lease equipment increased to $11.6 million, or 44.2% of rental and lease revenues, in the second quarter of fiscal 2009, from $11.2 million, or 40.9% of rental and lease revenues, in the second quarter of fiscal 2008. The increased depreciation expense in fiscal 2009 was due to a higher average rental and lease equipment pool, while the increased depreciation ratio, as a percentage of rental and lease revenues, was due primarily to lower rental and utilization rates.
Costs of revenues other than depreciation increased 34.6% to $7.0 million in the second quarter of fiscal 2009 from $5.2 million in the prior year period. Costs of revenues other than depreciation primarily includes the cost of equipment sales, which increased as a percentage of equipment sales to 72.2% in the second quarter of fiscal 2009 from 63.3% in the second quarter of fiscal 2008, reflecting increased finance leases and distribution sales which carry a lower margin. Our cost of revenues other than depreciation increased primarily due to an increase in our finance leases and distribution sales. As noted above in the “overview section”, we expect that this number will fluctuate quarter-to-quarter, depending primarily on customer requirements and funding and growth in our distribution channel.
Selling, general and administrative expenses were $12.1 million in the second quarter of fiscal 2009, as compared to $10.7 million in the second quarter of fiscal 2008. Selling, general and administrative expenses as a percentage of total revenues increased to 34.0% in the second quarter of fiscal 2009 from 30.3% in the second quarter of fiscal 2008. Our selling, general and administrative expenses increased due to higher personnel and benefit costs to support our current operations and develop our strategic initiatives, and a foreign currency loss of $361 for the three months ended November 30, 2008, compared to a foreign currency gain of $187 for the three months ended November 30, 2007, as a result of a strengthening of the U.S. dollar against key currencies.
Interest Income, Net
Net interest income was $0.6 million for the second quarter of fiscal 2009 compared to $0.9 million in the prior year period. The decrease reflects decreases in prevailing money-market interest rates and a lower cash balance. Interest income, net, includes $3.0 million of unrealized gain on our put option. In addition, interest income, net, includes $3.0 million of unrealized losses on our investments, trading.
Income Tax Provision
Our effective tax rate was 36.1% in the second quarter of fiscal 2009, compared to 37.2% for the same period in fiscal 2008. The decrease is due primarily to changes in estimated tax exposures.
Comparison of Six Months Ended November 30, 2008 and November 30, 2007
Revenues
Total revenues for the six months ended November 30, 2008 rose $0.4 million, or 0.6%, to $70.4 million, compared to $70.0 million in the same period in the prior year. The increase in total revenues was due to a 12.8% increase in sales of equipment and other revenues, offset by a decline in rental and lease revenues of 2.7%.
Rental and lease revenues in the first six months of fiscal 2009 were $53.4 million, compared to $54.9 million in the prior year period. This reflects a decline in our T&M lease revenues, while our T&M rental revenues remained flat, with an increase in T&M rental activity offset by a decline in rental rates due to competitive pressure. The decline was offset in part by higher demand for our DP equipment.
Sales of equipment and other revenues increased to $17.0 million for the six months ended November 30, 2008 compared to $15.1 million in the prior year period. In part, this increase reflects the results of our strategic initiatives outlined above relating to distribution sales and increased finance lease activity. Gross margin on sales decreased to $4.5 million in the first six months of fiscal 2009 as compared to $4.9 million a year ago, while the gross margin percentage decreased to 31.0% for the first six months of fiscal 2009 compared to 38.4% for the first six months of fiscal 2008. As noted above, our gross margin percentage decreased primarily due to an increase in our lower margin finance leases and distribution sales.
Operating Expenses
Depreciation of rental and lease equipment increased to $23.1 million, or 43.3% of rental and lease revenues, in the first six months of fiscal 2009, from $22.2 million, or 40.5% of rental and lease revenues, in the first six months of fiscal 2008. The increased depreciation expense in fiscal 2009 was due to a higher average rental and lease equipment pool, while the increased depreciation ratio, as a percentage of rental and lease revenues, was due primarily to lower rental and utilization rates.
Costs of revenues other than depreciation increased 22.9% to $12.4 million in the first six months of fiscal 2009 from $10.1 million in the prior year period. Costs of revenues other than depreciation primarily includes the cost of equipment sales, which increased to 69.0% of equipment sales in the first six months of fiscal 2009 from 61.6% in the first six months of fiscal 2008, reflecting increased finance leases and distribution sales which carry a lower margin. Our cost of revenues other than depreciation increased primarily due to an increase in our finance leases and distribution sales. As noted above in the “overview section”, we expect that this number will fluctuate quarter-to-quarter, depending primarily on customer requirements and funding and growth in our distribution channel.
Selling, general and administrative expenses were $24.1 million in the first six months of fiscal 2009, as compared to $21.6 million in the first six months of fiscal 2008. Selling, general and administrative expenses as a percentage of total revenues increased to 34.2% in the first six months of fiscal 2009 from 30.9% in the first six months of fiscal 2008. Our selling, general and administrative expenses increased due to higher personnel and benefit costs to support our current operations and develop our strategic initiatives, and a foreign currency loss of $837 for the six months ended November 30, 2008, compared to a foreign currency gain of $203 for the six months ended November 30, 2007, as a result of a strengthening of the U.S. dollar against key currencies.
Interest Income, Net
Net interest income was $1.2 million for the first six months of fiscal 2009 compared to $1.8 million in the prior year period. The decrease reflects decreases in prevailing money-market interest rates and a lower cash balance. Interest income, net, includes $3.0 million of unrealized gain on our put option. In addition, interest income, net, includes $3.0 million of unrealized losses on our investments, trading.
Income Tax Provision
Our effective tax rate was 34.7% in the first six months of fiscal 2009, compared to 38.2% for the same period in fiscal 2008. The decrease is due primarily to changes in estimated tax exposures.
Liquidity and Capital Resources
Our primary capital requirements are purchases of rental and lease equipment. We generally purchase 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. To meet T&M rental demand, support areas of potential growth for both T&M and DP equipment and to keep our equipment pool technologically up-to-date, we made payments for the purchase of $31.2 million of rental and lease equipment during the first six months of fiscal 2009. This amount was 16% lower than the $37.2 million in the same period for fiscal 2008.
In addition to increasing our rental equipment pool, we periodically repurchase shares of our common stock under an authorization from our board of directors. Shares we repurchase are retired and returned to the status of authorized but unissued stock. During the six months ended November 30, 2008, we purchased 1,445,660 shares of our common stock for $16.4 million, at an average price of $11.33 per share. We may make purchases of common stock in the future through open market transactions or otherwise, but we have no commitments to do so.
In April 2007, our board of directors authorized a regular quarterly cash dividend of $0.10 per common share, or $0.40 per annum. We commenced payment of our quarterly cash dividend in July 2007. In January 2008, our board of directors approved an increase to $0.15 per common share, or $0.60 per annum. For the six months ended November 30, 2008 and 2007, we paid dividends of $7.8 million and $5.2 million, respectively.
We expect to continue paying a quarterly dividend in future quarters, although the amount and timing of dividends, if any, will be made at the discretion of our board of directors in each quarter, subject to compliance with applicable law.
At November 30, 2008, we held $22.8 million, at cost, in auction rate securities (“ARS”), which we classify as investments, trading. The fair value of our ARS at November 30, 2008 was $19.8 million. Our ARS are long-term debt instruments backed by student loans, a substantial portion of which are guaranteed by the United States government. All of our ARS have credit ratings of AAA or AA, and none are mortgage-backed debt obligations. Historically, our ARS have been highly liquid, using a Dutch auction process that resets the applicable interest rate at predetermined intervals, typically every 35 days, to provide liquidity at par. However, as a result of liquidity issues in the global credit and capital markets, the auctions for all of our ARS failed beginning in February 2008 when sell orders exceeded buy orders. The failures of these auctions do not affect the value of the collateral underlying the ARS, and we continue to earn and receive interest on our ARS at a predetermined formula with spreads tied to particular interest rate indexes. We value the ARS from quotes received from our broker which are derived from their internally developed model. In determining a discount factor for each ARS, the model weights various factors, including assessments of credit quality, duration, insurance wraps, portfolio composition, discount rates, overall capital market liquidity and comparable securities, if any.
On November 6, 2008, we accepted an offer from UBS AG (“UBS”), providing us with rights related to our ARS (the “Rights”). The Rights permit us to require UBS to purchase our ARS at par value, which is defined as the price equal to the liquidation preference of the ARS plus accrued but unpaid dividends or interest, at any time during the period of June 30, 2010 through July 2, 2012. Conversely, UBS has the right, in its discretion, to purchase or sell our ARS at any time until July 2, 2012, so long as we receive a payment at par value upon any sale or disposition. We expect to sell our ARS under the Rights. However, if the Rights are not exercised before July 2, 2012 they will expire and UBS will have no further rights or obligation to buy our ARS. So long as we hold our ARS, they will continue to accrue interest as determined by the auction process or the term of the ARS if the auction process fails. In addition, if we request, prior to June 30, 2010, UBS Bank USA or an affiliate will establish a credit line for us in an amount up to 75% of the market value of the ARS that we pledge as collateral.
In any case, given the approximately $42.5 million we hold in cash and cash equivalents, primarily U.S. Treasury money market funds, and our lack of bank debt, we expect to continue to finance our operations even if our ARS were to be illiquid for an extended period of time.
During the first six months of fiscal 2009 and fiscal 2008, net cash provided by operating activities was $31.3 million and $28.9 million, respectively. The increase in operating cash flow was due primarily to a $1.3 million decrease in accounts receivable for the six months ended November 30, 2008 compared to an increase of $2.9 in the prior year period, and a remeasurement loss of $483 for the six months ended November 30, 2008, compared to a gain of $203 in the prior year period. This increase was offset by a decline in net income of $3.1 million for the six months ended November 30, 2008 compared to the six months ended November 30, 2007.
During the six months ended November 30, 2008 net cash used in investing activities was $16.2 million, compared to $25.4 million in the same period of fiscal 2008. The decline in net cash used in investing activities is due to a decrease in payments for the purchase of rental and lease equipment to $31.2 million for the six months ended November 30, 2008 compared to $37.2 million for the six months ended November 30, 2007. In addition, proceeds from sale of rental and lease equipment increased to $14.4 million for the six months ended November 30, 2008 from $12.7 million in the prior year period.
Net cash used in financing activities increased to $23.4 million from $4.0 million for the six months ended November 30, 2008 and 2007, respectively, due to an increase in payments for the repurchase of common stock to $16.4 million for the current fiscal period compared to $19 for the prior year period, and an increase in dividends paid to $7.8 million for the six months ended November 30, 2008 compared to $5.2 million for the six months ended November 30, 2007.
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, 2008.
We believe that based on our current cash and cash equivalents balance of $42.5 million at November 30, 2008 and expected operating cash flows, the current lack of liquidity in the global credit and capital markets will not have a material impact on our liquidity, cash flows, or financial flexibility or our ability to fund our operations, including the dividend.
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, 2008. The exact timing of reversal or settlement of our FIN 48 liabilities of $4.9 million could not be reasonably estimated at the end of the current fiscal quarter.
SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. 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 which 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," and in “Part II. Item 1A. Risk Factors” and in "Quantitative and Qualitative Disclosure About Market Risk Related to Interest Rates and Currency Rates," as well as in our Annual Report on Form 10-K for the year ended May 31, 2008 (including the "Risk Factors" discussed in Item 1A to 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
During the first six months of fiscal 2009, 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, 2008.
Item 4. Controls and Procedures
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 Exchange Act of 1934) as of the end of the period covered by this report. 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 in ensuring that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms.
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.
Part II. OTHER INFORMATION
Item 1. Legal Proceedings
In the normal course of our business, we are involved in various claims and legal proceedings. We are not involved in any pending or threatened legal proceedings, other than 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.
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 fiscal 2008 Annual Report on Form 10-K. 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 facing us. 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. During the first six months of fiscal 2009, we do not believe there were any material changes in the information regarding risk factors contained in our Annual Report on Form 10-K for the fiscal year ended May 31, 2008. However, economic and credit conditions in recent months have significantly deteriorated.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders
a) On October 16, 2008, we held our 2008 Annual Meeting of Shareholders. We solicited proxies in connection with the meeting pursuant to Regulation 14A. 24,431,495 shares were present in person or by proxy out of a total of 26,008,563 shares issued and outstanding and eligible to vote on the record date.
(b) At the meeting the following directors were elected by the number of affirmative votes set opposite their respective names:
Name | | Number of Shares For | | | Number of Shares Withheld | |
Gerald D. Barrone | | | 24,184,190 | | | | 247,305 | |
Nancy Y. Bekavac | | | 24,184,190 | | | | 247,305 | |
Karen J. Curtin | | | 24,364,417 | | | | 67,078 | |
Daniel Greenberg | | | 24,184,207 | | | | 247,288 | |
Joseph J. Kearns | | | 24,184,190 | | | | 247,305 | |
James S. Pignatelli | | | 24,235,426 | | | | 196,069 | |
(c) Other matters submitted to a vote of security holders:
The shareholders ratified the appointment of Deloitte & Touche LLP as the registrant's independent public accountants for the current year. 24,418,081 shares were voted for, 5,579 shares were voted against, and 7,895 shares abstained from voting.
Item 5. Other Information
There have been no material changes to the procedures by which security holders may recommend nominees to our board of directors since we last provided disclosure in response to the requirements of Item 407(c)(2)(iv) or Item 401(c)(3) of Regulation S-K.
Item 6. Exhibits
Exhibit# | | Description |
| | |
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 |
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: December 23, 2008
/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) |