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ELECTRO RENT CORP - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and the notes thereto and the other financial and statistical information appearing elsewhere in this Annual Report on Form 10-K. OVERVIEW We are one of the largest global organizations devoted to the rental, lease and sale of new and used electronic T&M equipment. We purchase that equipment from leading manufacturers such as Keysight, Anritsu, and Tektronix primarily for use by our customers in the aerospace, defense, telecommunications, electronics, industrial and semiconductor industries. In addition, although it represented only approximately 8%, 7% and 7% of our revenues in fiscal 2014, 2013 and 2012, respectively, we believe our DP division is one of the largest rental businesses in the United States for personal computers and servers from manufacturers including Dell, HP/Compaq, IBM, Toshiba and Apple. In fiscal 2010, we became a reseller for Agilent, the largest T&M equipment manufacturer in North America. On May 29, 2014, we entered into a new agreement with Agilent, pursuant to which we were appointed as a reseller for certain new and premium used T&M products and services in the United States and Canada. This agreement replaced and superseded the previous agreement dated December 1, 2009, which expired according to its terms on May 31, 2014. Agilent has, effective August 1, 2014, assigned our reseller agreement to its wholly-owned subsidiary, Keysight, in connection with the planned spin-off by Agilent of Keysight into a separate publicly traded company, which Agilent has announced it expects to complete by November 14-------------------------------------------------------------------------------- Table of Contents 2014. Our reseller agreement with Keysight provides us with the exclusive right to sell Keysight's more complex T&M equipment to small and medium size customers (who previously purchased directly from Agilent/Keysight). We do not currently have reseller agreements with any other manufacturers for equipment similar to that included in our Keysight reseller agreement. In addition, we sell used equipment from a variety of manufacturers that was previously in our rental and lease pool. We have a focused sales strategy, using a direct sales force to meet our customers' needs in our T&M equipment rental, lease and sales business. We have a large technical sales force that consists primarily of field engineers and applications engineers, each of whom specializes in all the products and services offered by our company. Our sales force is usually assigned to specific territories, and identifies potential customers through coordinated efforts with our marketing organization. Our marketing organization is staffed by professionals with many years of industry-related experience. As our customers have a wide range of requirements for equipment, our sales force is able to leverage our extensive knowledge of the test and measurement equipment environment to determine the right product to rent, lease or sell to the customer to meet the customer's specific needs. Our sales force also specializes in configuring new Keysight equipment to sell to our customers that is tailored to the customer's need. These configurations typically start with a base model, which is frequently upgraded through an extensive list of options in order to perform the customer's specific test or measurement. Once the configuration is determined, it serves as the basis for our orders to Keysight, who builds the product accordingly. We order equipment from Keysight once the customer has placed an order with us. Equipment is typically shipped directly to the customer by Keysight at our request. Occasionally, equipment is shipped to our warehouse prior to delivery to the customer. Inventory held for sale is immaterial and is therefore included in other assets in our consolidated balance sheets. Each order and sales invoice is subject to our standard sales terms and conditions, which include provisions covering equipment delivery delays and warranty services. On August 24, 2011, we completed the acquisition of certain assets (including accounts receivable and rental equipment but excluding certain designated assets) and the assumption of specified post-closing liabilities of EMT, for $10.7 million in cash, of which $0.5 million was deposited into an escrow account for any post-closing adjustments. The purchase price was reduced by $0.3 million reflecting the final determination of the post-closing adjustment of the purchase price in accordance with the asset purchase agreement with EMT. (See Note 3 to the consolidated financial statements included in this Annual Report on Form 10-K). In recent years, our financial results have been impacted by competitive pressure on rental rates due in large part to the recession and subsequent weakness in the U.S. economy and our major international markets. During fiscal 2013, our revenues were flat compared to fiscal 2012 as growth in our rental and leasing business and increased sales of used equipment, in part due to a large buyout of used equipment by a customer in the third fiscal quarter of 2013, was offset by a decline in sales of new equipment. Our operating profit increased modestly for fiscal 2013 as compared to fiscal 2012, as growth in our higher margin rental and lease revenues and used equipment sales offset declines in our sales of new equipment, which typically have lower operating margins. During fiscal 2014, our revenues declined slightly and our operating profit declined moderately as compared to fiscal 2013, primarily due to a decline in our new equipment sales revenue, partially offset by growth in our higher margin rental and lease revenues. Our new equipment sales continue to be affected by delays in our customers' procurement decisions, resulting in decreased demand, particularly in the aerospace and defense sector due to uncertainty regarding U.S. government defense spending. We have also seen a softening in the telecommunications and semiconductor manufacturing sectors. We experienced an increase in our selling, general and administrative expenses as a result of our infrastructure investment which began in fiscal 2011 and continued throughout fiscal 2012, 2013 and 2014 in support of our continued investment in our oversees operations, the strengthening of our IT and financial infrastructure and the expansion of our sales and marketing organization in support of future opportunities. Economic uncertainty continues to impact certain industries that we serve. We will continue to focus on remaining profitable in the current conditions, as well as being prepared for the possibility that recessionary trends may return in future periods. To maximize our overall profit from the rental, leasing, and sales of equipment, we manage our equipment pool on an on-going basis by controlling the timing, pricing and mix of our purchases and sales of equipment. We acquire new and used equipment to meet current technological standards and current and anticipated customer demand, and we sell our used equipment where we believe that is the most lucrative option. We employ a complex equipment management strategy and our proprietary PERFECT software to adjust our equipment pool and pricing on a dynamic basis in order to maximize equipment availability, utilization and profitability. If we do not accurately predict market trends, or if demand for the equipment we supply declines, we can be left with equipment that we are unable to rent or sell for a profit. We assess the carrying value of the equipment pool on an annual basis or more frequently when factors indicating potential impairment are present. 15-------------------------------------------------------------------------------- Table of Contents We have revenues, expenses, assets and liabilities in foreign currencies, primarily the euro, the Canadian dollar and the Chinese yuan, due to our foreign operations. We enter into forward contracts to hedge against unfavorable currency fluctuations in our monetary assets and liabilities in our European and Canadian operations. Our exposure to fluctuations in the Chinese yuan is not significant. These contracts are designed to minimize the effect of fluctuations in foreign currencies. As a result of these forward contracts, as well as the relative stability of these foreign currencies, the impact on our operating results from foreign currency fluctuations has been insignificant. See "Item 7A-Quantitative and Qualitative Disclosures about Market Risk-Changes in Foreign Currencies" for additional information about our exposure to foreign currency exchange risk. Profitability and Key Business Trends Comparing fiscal 2014 to fiscal 2013, our revenues decreased by 3.1% from $248.7 million to $241.1 million, our operating profit decreased 12.5% from $36.7 million to $32.1 million and our net income decreased by 10.3% from $22.8 million to $20.4 million. Our rental and lease revenues increased by 0.6%, from $136.6 million for fiscal 2013 to $137.4 million for fiscal 2014. For fiscal 2014 and 2013, 88% of our rental and lease revenues were derived from T&M equipment. Our T&M rental revenues decreased $0.1 million due to a decrease in demand of $2.2 million offset by an increase in rental rates of $2.1 million. Our T&M lease revenues decreased $0.1 million due to a decrease in lease rates of $0.4 million offset by an increase in demand of $0.3 million. Rental and lease revenues in our DP segment increased $0.6 million and $0.4 million, respectively, due to an increase in rental and lease rates. Our sales of equipment and other revenues decreased 7.5%, from $112.1 million for fiscal 2013 to $103.7 million for fiscal 2014. This decrease was primarily due to a decline in new equipment sales, which continue to be affected by delays in our customers' procurement decisions, resulting in decreased demand, particularly in the aerospace and defense sector due to uncertainty regarding U.S. government defense spending. We have also seen a softening in the telecommunications and semiconductor manufacturing sectors. For fiscal 2014, our operating profit decreased 12.5% compared to fiscal 2013. Our rental and lease business contributed an additional $0.1 million in operating profit resulting from a) a $0.8 million, or 0.6%, increase in rental and lease revenues, b) an offsetting increase in depreciation expense of $0.2 million, or 0.4%, due to a higher average rental equipment pool, and c) an offsetting increase in our costs of rentals and leases, excluding depreciation, of $0.5 million, or 2.8%. Sales of equipment and other revenues decreased $8.4 million, or 7.5%, resulting in a decline of $2.3 million in operating profit. Although our higher margin used equipment sales contributed an additional $1.7 million in revenue, this was offset by a $9.1 million decline in revenue from sales of our lower margin new equipment. The remaining decrease in sales of equipment and other revenues is attributable to a $1.0 million decrease in other revenue. Our selling, general and administrative expenses increased by 4.2% from $56.5 million in fiscal 2013 to $58.9 million in fiscal 2014, primarily due to our continued investment in our oversees operations, the strengthening of our IT and financial infrastructure and the expansion of our sales and marketing organization in support of future opportunities. Our net income for fiscal 2012 included a bargain purchase gain, net of deferred taxes, of $3.4 million as a result of our acquisition of EMT. Some of our key profitability measurements are presented below: Fiscal 2014 Fiscal 2013 Fiscal 2012 Net income per diluted common share (EPS) $ 0.84 $ 0.94 $ 1.07 Net income as a percentage of average assets 6.5 % 7.0 % 8.1 % Net income as a percentage of average equity 8.8 % 9.6 % 10.7 % Our average acquisition cost of equipment for rent and lease in our equipment pool is presented below: Average acquisition cost of Fiscal 2014 vs. Fiscal 2013 Fiscal 2013 vs. Fiscal 2012 equipment (in millions) 2014 2013 Change 2013 2012 Change On rent $ 238.6 $ 245.5 (2.8 )% $ 245.5 $ 234.1 4.9 % On lease $ 37.2 $ 35.0 6.3 % $ 35.0 $ 31.7 10.4 % The decrease in our average equipment on rent is due to a decline in demand in our T&M North American operations, in particular in the aerospace and defense sector, partially offset by increased demand in our T&M foreign operations. Our average equipment on lease increased due to higher demand in North American operations. 16-------------------------------------------------------------------------------- Table of Contents Average rental rates increased by 2.8% in fiscal 2014 as compared to fiscal 2013 and 2.7% as compared to fiscal 2012. Our average lease rates decreased by 0.8% in fiscal 2014 as compared to fiscal 2013, and 3.4% as compared to fiscal 2012. The increase in rental rates is the result of growth in industries where we realize higher rental rates. Average utilization for our T&M equipment pool, calculated based on average acquisition cost of equipment on rent and lease compared to the average total equipment pool, decreased to 64.9% for fiscal 2014, compared to 66.9% for fiscal 2013 and 67.7% for fiscal 2012. The average utilization of our DP equipment pool, based on the same method of calculation, was 35.7% for fiscal 2014, compared to 35.6% for fiscal 2013 and 38.1% for fiscal 2012. Our utilization rate fluctuates frequently, and is impacted by new equipment purchases in support of existing and potential business, and sales of used equipment. As of May 31, 2014, we had a sales order backlog for new T&M equipment of $10.7 million, compared to $7.6 million as of May 31, 2013 and $8.4 million as of May 31, 2012. The increase in backlog is primarily due to longer manufacturing lead times on certain products as well as an increase in demand. RESULTS OF OPERATIONS Fiscal 2014 Compared with Fiscal 2013 Total Revenues: Total revenues for fiscal 2014 and 2013 were $241.1 million and $248.7 million, respectively. The 3.1% decrease in total revenues was due to a 7.5% decrease in sales of equipment and other revenues offset by a 0.6% increase in rental and lease revenues. Rental and lease revenues for fiscal 2014 were $137.4 million, compared to $136.6 million for the prior fiscal year. This increase is due to an increase in rental rates in our T&M and DP segments, due to our growth in industries where we realize higher rental rates, and increased demand in our Chinese and European operations. This increase was offset, in part, by a decrease in demand in our North American operations due to softening in the aerospace and defense and semiconductor industries. Our lease revenues increased primarily due to higher demand for T&M equipment, while our DP lease revenues increased slightly. Sales of equipment and other revenues decreased to $103.7 million for fiscal 2014 from $112.1 million in the prior year. Sales of used equipment, including finance leases, increased to $32.8 million for fiscal 2014, compared to $31.0 million for fiscal 2013 while sales of new equipment decreased to $65.8 million for fiscal 2014 compared to $74.9 million for fiscal 2013. Our new equipment sales continue to be affected by delays in our customers' procurement decisions, resulting in decreased demand, particularly in the aerospace and defense sector due to uncertainty regarding U.S. government defense spending. We have also seen a softening in the telecommunications and semiconductor manufacturing sectors. Operating expenses Depreciation of Rental and Lease Equipment: Depreciation of rental and lease equipment remained relatively consistent at $57.0 million, or 41.5% of rental and lease revenues in fiscal 2014 compared to $56.8 million, or 41.6% of rental and lease revenues in fiscal 2013. The depreciation ratio stayed consistent due to increases in our rental rates of our DP equipment offset by decreases in our lease and utilization rates of our T&M equipment. Costs of Rentals and Leases, Excluding Depreciation: Costs of rentals and leases, excluding depreciation, which primarily includes labor related costs of our operations personnel, supplies, repairs, and insurance and warehousing costs associated with our rental and lease equipment, increased to $18.3 million for fiscal 2014 compared to $17.8 million for fiscal 2013, primarily due to higher labor related costs to support growth in our rental and lease business. This expense is not expected to significantly fluctuate from period to period, as only moderate changes are required from time to time to handle changes in rental and lease activity. Costs of Sales of Equipment and Other Revenues: Costs of sales of equipment and other revenues, which primarily include the costs of equipment sales, decreased to $74.8 million for fiscal 2014 from $80.9 million in fiscal 2013. Costs of sales of equipment and other revenues as a percentage of sales of equipment and other revenues remained flat at 72.1% in fiscal 2014 and fiscal 2013. Our sales margin percentage is expected to fluctuate depending on the mix of used and new equipment sales. Our sales margin is also impacted by competition, economic uncertainty, changes in U.S. governmental policies, and customer requirements and funding. Selling, General and Administrative Expenses: Selling, general and administrative expenses increased 4.2% to $58.9 million in fiscal 2014 compared to $56.5 million in fiscal 2013. As a percentage of total revenues, selling, general and administrative expenses increased modestly to 24.4% in fiscal 2014 from 22.7% in fiscal 2013. The increase in selling, general, and administrative reflects our continued investment in our oversees operations, the strengthening of our IT and financial infrastructure and the expansion of our sales and marketing organization in support of future opportunities. 17-------------------------------------------------------------------------------- Table of Contents Income Tax Provision: Our effective tax rate was 37.3% for fiscal 2014, compared to 38.7% for fiscal 2013. The decrease for fiscal 2014 is due to more income being apportioned to states with lower tax rates resulting in a lower effective state rate as well as the recognition of certain Belgian tax credits which had no impact in fiscal 2013. Fiscal 2013 Compared with Fiscal 2012 Total Revenues: Total revenues for fiscal 2013 and 2012 were $248.7 million and $248.6 million, respectively. The 0.1% increase in total revenues was due to a 5.3% increase in rental and lease revenues offset by a 5.6% decrease in sales of equipment and other revenues. Rental and lease revenues for fiscal 2013 were $136.6 million, compared to $129.7 million for the prior fiscal year. This increase was due to an increase in T&M rental and lease demand, in particular in our North American operations, due in part to the acquisition of EMT, and the integration of our resale organization and T&M sales force, which began in the first quarter of fiscal 2012, providing additional rental opportunities to an expanding customer base, and higher demand from our customers in lieu of new equipment purchases. This increase was partially offset by a decline in rental and lease revenues in our DP business, due to a decrease in demand. Sales of equipment and other revenues decreased to $112.1 million for fiscal 2013 from $118.8 million in the prior year. Sales of used equipment, including finance leases, increased to $31.0 million for fiscal 2013, compared to $24.9 million for fiscal 2012, in part due to a large buyout by a customer in the third quarter of fiscal 2013, while sales of new equipment decreased to $75.0 million for fiscal 2013 compared to $88.4 million for fiscal 2012, as our customers that traditionally purchase new equipment delayed procurement decisions due to changes in the U.S. national budgetary policy and uncertainty in the global economy. Operating expenses Depreciation of Rental and Lease Equipment: Depreciation of rental and lease equipment increased in fiscal 2013 to $56.8 million, or 41.6% of rental and lease revenues, from $53.7 million, or 41.4% of rental and lease revenues, in fiscal 2012. The increased depreciation expense in fiscal 2013 was due to a higher average rental and lease equipment pool. The depreciation ratio, as a percentage of rental and lease revenues, marginally increased due to a moderate decline in utilization rates while rental rates were flat. Costs of Rentals and Leases, Excluding Depreciation: Costs of rentals and leases, excluding depreciation, which primarily include labor related costs of our operations personnel, supplies, repairs, and insurance and warehousing costs associated with our rental and lease equipment, increased to $17.8 million for fiscal 2013 compared to $17.3 million for fiscal 2012, primarily due to higher labor related costs to support growth in our rental and lease business. This expense is not expected to significantly fluctuate from period to period, as only moderate changes are required from time to time to handle changes in rental and lease activity. Costs of Sales of Equipment and Other Revenues: Costs of sales of equipment and other revenues, which primarily include the costs of equipment sales, decreased to $80.9 million for fiscal 2013 from $88.2 million in fiscal 2012. Costs of sales of equipment and other revenues decreased as a percentage of sales of equipment and other revenues to 76.3% in fiscal 2013 from 77.8% in fiscal 2012. This decrease is due to a decline in sales of new T&M equipment, which generally carry a lower margin than used equipment sales, while higher margin used equipment sales increased. Our sales margin percentage is expected to fluctuate depending on the mix of used and new equipment sales. Our sales margin is also impacted by competition, economic uncertainty, changes in U.S. governmental policies, and customer requirements and funding. Selling, General and Administrative Expenses: Selling, general and administrative expenses increased 6.2% to $56.5 million in fiscal 2013 compared to $53.3 million in fiscal 2012. As a percentage of total revenues, selling, general and administrative expenses increased modestly to 22.7% in fiscal 2013 from 21.4% in fiscal 2012. Our selling, general and administrative expenses increased primarily due to the broadening and strengthening of our sales and sales support organizations, as well as our administrative infrastructure, necessary to support our sales and rental demand and to better focus on future growth opportunities. Gain on Bargain Purchase: We recorded a gain on bargain purchase, net of deferred taxes, of $3.4 million during fiscal 2012 related to our acquisition of EMT. The gain on bargain purchase, net of deferred taxes, resulted from the excess of the net fair value of the assets acquired and liabilities assumed in the EMT acquisition, over the respective purchase price. We believe that we were able to negotiate a bargain purchase price as a result of our access to the liquidity necessary to complete the transaction, and the recurring losses and bankruptcy filing of EMT. Income Tax Provision: Our effective tax rate was 38.7% for fiscal 2013, compared to 35.6% for fiscal 2012. The increase for fiscal 2013 is due to a bargain purchase gain, net of deferred taxes, of $3.4 million for fiscal 2012, related to our purchase of 18-------------------------------------------------------------------------------- Table of Contents EMT on August 24, 2011. Bargain purchase gains are recorded net of deferred taxes and are treated as permanent differences, resulting in a lower effective tax rate in the period recorded. Liquidity and Capital Resources We have three principal sources of liquidity: cash flows provided by our operating activities, proceeds from the sale of equipment from our portfolio, and external funds that historically have been provided by bank borrowings. We believe that cash and cash equivalents, cash flows from operating activities, proceeds from the sale of equipment and our borrowing capacity will be sufficient to fund our operations for at least the next twelve months. Cash and Cash Equivalents. The balance of our cash and cash equivalents was $5.9 million at May 31, 2014, a decrease of $4.5 million from May 31, 2013, in part because we chose to borrow less, with bank borrowings declining to $0 as of May 31, 2014 from $10.0 million as of May 31, 2013. Outside of our normal operations and equipment purchases, we use our cash to pay dividends to shareholders and to take advantage of strategic acquisitions and new customer opportunities. We expect that the level of our cash needs may increase if we increase equipment purchases in response to demand, finance an acquisition, or pursue other opportunities. We do not intend to repatriate the funds from our foreign operations as we consider these earnings to be invested indefinitely. Given our growth record achieved since fiscal 2000, and our available line of credit under which we have $25.0 million remaining that we may borrow as of May 31, 2014, we believe that we have ample access to borrowing capacity and that our cash flows from operations and ability to borrow will allow us to continue funding our current and future growth. We may, however, seek to expand our borrowing capacity in order to ensure sufficient resources to quickly respond to strategic growth opportunities. Cash Flows. During fiscal 2014, 2013, and 2012 net cash provided by operating activities was $49.2 million, $68.9 million and $69.9 million, respectively. Operating cash flow for fiscal 2014 decreased as compared to fiscal 2013 primarily due to income taxes paid of $23.8 million in fiscal 2014 as compared to $15.6 million in fiscal 2013, a decline in net income and a decrease in working capital. Operating cash flow for fiscal 2013 was comparable to fiscal 2012 as an improvement in our working capital and an increase in income, after giving effect to non-cash items, was offset by tax payments of $15.6 million for fiscal 2013, compared to a tax refund, net of taxes paid, of $0.5 million for fiscal 2012. During fiscal 2014, 2013 and 2012, net cash used in investing activities was $23.8 million, $34.1 million and $82.9 million, respectively. The decline in cash used in investing activities for fiscal 2014 was due, in part, to a decrease in payments for purchases of rental and lease equipment to $58.7 million from $64.1 million and $96.7 million for fiscal 2013 and 2012, respectively. Payments for purchase of other property also decreased to $0.4 million in fiscal 2014 from $1.1 million in fiscal 2013 and $0.9 million in fiscal 2012. Proceeds from sale of rental and lease equipment were $35.2 million for fiscal 2014 compared to $31.1 million for fiscal 2013 and $25.0 million for fiscal 2012. Fiscal 2012 includes cash paid for the acquisition of EMT of $10.3 million. During fiscal 2014, 2013 and 2012, net cash flows used in financing activities were $29.5 million, $33.6 million and $19.3 million, respectively. These funds used were primarily composed of borrowings and payments under the bank's line of credit of $56.0 million and $66.0 million in fiscal 2014, $63.5 million and $53.5 million in fiscal 2013 and $3.3 million and $3.3 million in fiscal 2012, respectively. We also paid dividends of $19.7 million for fiscal 2014, $43.8 million for fiscal 2013 and $19.4 million for fiscal 2012. As the following table illustrates, aggregate cash flows from operating activities and proceeds from the sale of equipment have provided 127% of the funds required for equipment purchased for the three years ended May 31, 2014, excluding equipment purchased in connection with acquisitions. Fiscal Three Years Ended (in thousands) May 31, 2014 2014 2013 2012 Cash flows from operating activities1 $ 187,991 $ 49,186 $ 68,930 $ 69,875 Proceeds from sale of equipment 91,385 35,224 31,119 25,042 Total 279,376 84,410 100,049 94,917 Payments for equipment purchases (219,475 ) (58,678 ) (64,088 ) (96,709 ) Net increase/(decrease) in equipment portfolio at acquisition cost 72,247 (214 ) 11,972 60,489 1 For the components of cash flows from operating activities see the consolidated statements of cash flows. 19-------------------------------------------------------------------------------- Table of Contents Credit Facilities. We have a $25.0 million revolving bank line of credit, subject to certain restrictions, to meet equipment acquisition needs as well as working capital and general corporate requirements. We borrowed $56.0 million and repaid $66.0 million on our line of credit during fiscal 2014. As of May 31, 2014, we had no borrowings outstanding under the revolving bank line of credit. There are no other bank borrowings outstanding or off balance sheet financing arrangements at May 31, 2014. We are in compliance with all loan covenants at May 31, 2014. Capital Expenditures. Our primary capital requirements have been purchases of rental and lease equipment. We generally purchase equipment throughout the year to replace equipment that has been sold and to maintain adequate levels of rental equipment to meet existing and expected customer demands. To meet T&M rental demand, support areas of potential growth for both T&M and DP equipment and to keep our equipment pool technologically up-to-date, we made payments for purchases of $58.7 million of rental and lease equipment during fiscal 2014, $64.1 million in fiscal 2013 and $96.7 million in fiscal 2012, excluding $15.8 million, at fair value, of rental and lease equipment acquired in connection with our acquisition of EMT in fiscal 2012. The decrease in equipment purchases of 8.6% from fiscal 2013 to fiscal 2014 is due to equipment purchases returning to historical levels after the unusually high payment level of fiscal 2012 which reflected recovery from the preceding economic downturn. Dividends. For fiscal 2014, we paid dividends of $0.80 per common share, compared to $1.80 per common share in fiscal 2013 (including a special dividend of $1.00 per common share) and $0.80 per common share in fiscal 2012 amounting to an aggregate of $19.7 million, $43.8 million and $19.4 million for fiscal 2014, 2013 and 2012, 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. Inflation. Inflation generally has favorably influenced our results of operations by enhancing the sale prices of our used equipment. However, lower inflation rates and the continued availability of newer, less expensive equipment with similar or better specifications over a period of several years could result in lower relative sale prices for used electronic equipment, which could reduce margins and earnings. Prices of new and used electronic test equipment have not consistently followed the overall inflation rate, while prices of new and used personal computers and servers have consistently declined. Because we are unable to predict the advances in technology and the rate of inflation for the next several years, it is not possible to estimate the impact of these factors on our margins and earnings. CONTRACTUAL OBLIGATIONS At May 31, 2014, our material contractual obligations consisted of operating leases for facilities. We lease certain facilities under various operating leases. Most of the lease agreements provide us with the option of renewing the lease at the end of the initial lease term, at the fair rental value, for periods of up to five years. In most cases, we expect that facility leases will be renewed or replaced by other leases in the normal course of business. The table below presents the expected amount of payments due under our contractual obligations, as of May 31, 2014, but does not reflect changes that could arise after that time: Payments due by period Contractual Obligations (in Less than 2-3 3-5 More than thousands) Total 1 year years years 5 years Facility lease payments, not including property taxes and insurance 1,469 773 634 62 - Total $ 1,469 $ 773 $ 634 $ 62 $ - CRITICAL ACCOUNTING POLICIES AND ESTIMATES The preparation of 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, as well as 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 and definite lived intangibles), impairment of goodwill and income taxes. These estimates are based on our historical experience and on various other assumptions we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe the following accounting policies involve the more significant judgments and estimates used in the preparation of our financial statements: Asset Lives and Depreciation Methods: Our primary business involves the purchase and subsequent rental and lease of long-lived electronic equipment. We have chosen asset lives that we believe correspond to the economic lives of the related assets. We have chosen depreciation methods that we believe generally match our benefit from the assets with the associated costs. 20-------------------------------------------------------------------------------- Table of Contents These judgments have been made based on our expertise in each equipment type that we carry. If the asset life and depreciation method chosen do not reduce the book value of the asset to at least our potential future cash flows from the asset, we would be required to record an impairment loss. Depreciation methods and useful lives are periodically reviewed and revised as deemed appropriate. Impairment of Long-Lived Assets: The carrying value of equipment held for rental and lease is assessed quarterly or when circumstances indicate that the carrying amount of equipment may not be recoverable. Recoverability of equipment to be rented and leased is measured by a comparison of the carrying amount to the undiscounted future cash flows expected to be generated by the asset. If the current carrying value exceeds the estimated undiscounted cash flows, an impairment loss is recorded equal to the difference between the asset's current carrying value and its fair value as described in FASB ASC Topic No. 820, Fair Value Measurements and Disclosures. Based upon such periodic assessments, no impairments occurred during fiscal 2014, 2013 and 2012. Goodwill Impairment: We recognized goodwill of $3.1 million on the acquisition of Rush Computer Rentals in January 2006. Goodwill, which represents the excess of purchase price over the fair value of net assets acquired is discussed further in Note 4 to our consolidated financial statements included in this Form 10-K. Pursuant to FASB ASC Topic No. 350, Intangibles - Goodwill and Other ("ASC 350"), goodwill is not amortized but tested annually for impairment, or on an interim basis if an event occurs or circumstances change that would reduce the fair value of a reporting unit below its carrying value. In connection with the annual impairment test for goodwill, we have the option to perform a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If we determine that it was more likely than not that the fair value of the reporting unit is less than its carrying amount, then we perform the impairment test. The impairment test involves a two-step process. The first step involves comparing the fair values of the applicable reporting units with their aggregate carrying values, including goodwill. We generally determine the fair value of our reporting units using the market approach methodology of valuation. If the carrying value of a reporting unit exceeds the reporting unit's fair value, we perform the second step of the test to determine the amount of impairment loss. The second step involves measuring the impairment by comparing the implied fair values of the affected reporting unit's goodwill with the carrying amount of that goodwill. We completed the required impairment review at the end of fiscal 2014, 2013 and 2012 and concluded that there were no impairments. Revenue Recognition-Principal Agent Considerations: In accordance with accounting guidance, we are acting as the principal with respect to sales of new equipment through our resale agreement, based on several factors, including: (1) We act as the primary obligor by working directly with our customers to define their needs, providing them with options to satisfy such needs, contracting directly with the customer, and, to the extent required, providing customers with instruction on the use of the product and additional technical support once the product is received by the customer. The product manufacturer is not a party to our customer sales agreements, nor is it referenced in the agreements, and therefore has no obligation to our customers with the exception of the manufacturer's standard warranty on the product. (2) We bear back-end risk of inventory loss with respect to any product return from the customer as the original manufacturer is not required to accept returns of equipment from us. We also bear front-end risk of inventory loss in those cases where we acquire products for resale into our inventory prior to shipment to customers. (3) We have full discretion in setting pricing terms with our customers and to negotiate all such terms ourselves. (4) We assume all credit risk. Accordingly, sales of new equipment through our resale channel are recorded in Sales of Equipment and Other Revenues and the related equipment costs are recorded in Costs of Sales of Equipment and Other Revenues in our consolidated statements of operations. Income Taxes: We are required to estimate income taxes in each of the jurisdictions in which we operate. Significant judgment is required in determining the provision for income taxes and deferred tax assets and liabilities. This process involves us estimating actual current tax exposure and assessing temporary differences resulting from differing treatment of items, such as depreciation and amortization, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We then assess the likelihood that our deferred tax assets will be recovered. To the extent management believes that recovery is not likely, we establish a valuation allowance. We determined that a valuation allowance was required in fiscal 2014, 2013 and 2012 of $0.3 million, $1.1 million and $0.9 million, respectively, for our deferred tax asset related to certain foreign net operating loss carry forwards and other related timing differences. The guidance for uncertain income tax positions provides that the tax effects of a position be recognized only if it is "more-likely-than-not" to be sustained based solely on its technical merits as of the reporting date. The more-likely-than-not threshold represents a positive assertion by us that our company is entitled to the economic benefits of a tax position. If a tax position is not considered more-likely-than-not to be sustained based solely on its technical merits, no benefits of the position are to be recognized. There were no uncertain tax positions in fiscal 2014, 2013 and 2012. OFF BALANCE SHEET TRANSACTIONS As of May 31, 2014 we did not have any "off-balance-sheet arrangements," as defined in Item 303(a)(4)(ii) of Regulation S-K. Item 7A. Quantitative and Qualitative Disclosures about Market Risk. We could be exposed to market risks related to changes in interest rates and foreign currency exchange rates. Interest Rate and Market Risk. We are exposed to fluctuations in interest rates on our commercial credit agreement with J.P. Morgan Chase Bank, National Association ("JPM") which matures on November 19, 2016. Borrowings under the Credit Agreement bear interest at a rate equal to, at our election, the applicable rate for a "Eurodollar Loan" or a "CB Floating Rate Loan." Eurodollar Loan advances accrue interest at a per annum interest rate equal to (i) the quotient (rounded upwards to the next 1/16th of 1%) of (a) the applicable LIBO Rate, divided by (b) one minus the maximum aggregate reserve requirement (expressed as a decimal) imposed under Federal Reserve Board Regulation D (the "Adjusted LIBO Rate"), plus (ii) 0.75%. CB Floating Rate Loan advances accrue interest at a per annum interest rate equal to (i) the higher of (a) JPM's Prime Rate or (b) the Adjusted LIBO Rate for a one month interest period plus 2.5%, minus (ii) 2.0%. In addition, we pay a commitment fee of 0.10% of the unused amount if the average borrowing under the Credit Agreement is less than or equal to $8.0 million on a quarterly basis. Our borrowings under our commercial credit agreement at May 31, 2014 and 2013 were $0 and $10.0 million, respectively. As our borrowings outstanding have not been significant, and the interest rate is low, a hypothetical increase in interest rates by 10% would not have a material impact on our financial condition or results of operations. Changes in Foreign Currencies. We have wholly owned Chinese and European subsidiaries. In addition, we have revenues, cash and cash equivalents and accounts receivable in other foreign currencies, primarily the Canadian dollar. Our international operations subject us to foreign currency risks (i.e., the possibility that the financial results could be better or worse than planned because of changes in foreign currency exchange rates). During fiscal 2010 we began using forward contracts to hedge our economic exposure with respect to assets and liabilities denominated in foreign currencies. Given the extent of our international operations and our hedging, we would not expect a 10% change in foreign currency rates to have a material impact on our financial condition or results of operations. Item 8. Financial Statements and Supplementary Data. See Consolidated Financial Statements beginning on page F-1 of this Annual Report on Form 10-K. Supplemental Financial Information regarding quarterly results is contained in Note 15-Quarterly Information (unaudited), in the Notes to our Consolidated Financial Statements of this Annual Report on Form 10-K. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. Not applicable. 21-------------------------------------------------------------------------------- Table of Contents |