Basis of Presentation

The unaudited consolidated financial statements included herein have been prepared by Electro Rent Corporation, pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”). The consolidated financial statements include the accounts of Electro Rent Corporation and its wholly owned subsidiaries, Electro Rent, LLC, ER International, Inc., Electro Rent Europe NV, Electro Rent Asia, Inc. and Electro Rent (Beijing) Test and Measurement Equipment Rental Co., Ltd. (collectively “we”, “us”, or “our”) as well as the elimination of all intercompany transactions.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) have been omitted pursuant to such SEC rules and regulations. These consolidated financial statements reflect all adjustments, consisting of only normal recurring adjustments, and disclosures that are, in our opinion, necessary for a fair presentation of our financial position and results of operations for the interim periods presented. These consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in our latest Annual Report on Form 10-K filed with the SEC on August 11, 2014.

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

Revenue Recognition

We generate revenues primarily through the rental and leasing of test and measurement equipment (“T&M”) and personal computer related data products equipment (“DP”) and through the sale of new and used equipment. Rental revenues comprise short term agreements that can be daily, weekly or monthly. Rental revenues are recognized in the month they are due on the accrual basis of accounting. We lease equipment under both operating and finance lease agreements.

Our operating lease agreements have varying terms, typically one to three years. Upon lease termination, customers have the option to renew the lease term, purchase the equipment at fair market value, or continue to rent on a month-to-month basis. Our operating leases do not provide for contingent rentals. Revenues related to operating leases are recognized on a straight-line basis over the term of the lease. Negotiated lease early-termination charges are recognized upon receipt. Rentals and leases are primarily billed to customers in advance, and unearned billings are recorded as deferred revenue.

Our finance lease agreements contain bargain purchase options and are accounted for as sale-type leases. Revenues from finance leases, which are recorded at the present value of the aggregate future lease payments, are included in sales of equipment and other revenues in our consolidated statements of operations. Unearned interest is recognized over the life of the finance lease term using the effective interest method. Our finance lease terms vary, and are typically one to three years. The net investment in finance leases, which represents the receivables due from lessees, net of unearned interest, is included in other assets in our consolidated balance sheets. Historically, we have not required security deposits based on our assessed credit risk within our customer bases.

Initial direct costs for operating and finance leases are insignificant.

Sales of new equipment through our resale channel are recognized in the period in which the equipment is delivered and risk of loss passes to the customer, while sales of used equipment from our rental and lease equipment pool are recognized in the period in which the equipment is shipped and risk of loss is passed to the customer. In the case of equipment sold to customers that is already on rent or lease to the same party, revenue is recognized at the agreed-upon date when the rent or lease term ends and the risk of loss passes to the customer.

In fiscal 2010, we became a reseller of Agilent Technologies, Inc.’s (now Keysight Technologies, Inc. or "Keysight") new T&M equipment in the U.S. and Canada. In accordance with accounting guidance, we are acting as the principal with respect to sales of new equipment through our resale agreement with Keysight, 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 equipment pool prior to shipment to customers;

(3) We have full discretion in setting pricing terms with our customers and negotiate all such terms ourselves; and

(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.

Other revenues, consisting primarily of billings to customers for delivery, are recognized in the period in which the respective services are performed.

Operating Expenses

Costs of rentals and leases, excluding depreciation, primarily include labor related costs of our operations personnel, supplies, repairs, insurance and warehousing costs associated with our rental and lease revenues.

Costs of sales of equipment and other revenues primarily include the cost of new equipment and the carrying value of used equipment sold.

Selling, general and administrative (“SG&A”) expenses include sales and advertising costs, payroll and related benefit costs, insurance expenses, property taxes on our property and rental and lease equipment, legal and professional fees, and administrative overhead. Advertising costs are expensed as incurred. Total advertising expenses were $250 and $419, respectively, for the three and six months ended November 30, 2014 and $207 and $432, respectively, for the three and six months ended November 30, 2013. SG&A expenses also include shipping and handling costs of $1,085 and $2,121, respectively, for the three and six months ended November 30, 2014 and $1,153 and $2,082 for the three and six months ended November 30, 2013.

Foreign Currency

The U.S. dollar has been determined to be the functional currency of all foreign subsidiaries. The assets and liabilities of our foreign subsidiaries are remeasured from their local currency to U.S. dollars at current or historic exchange rates, as appropriate. Revenues and expenses are remeasured from any foreign currencies to U.S. dollars using historic or average monthly exchange rates, as appropriate, for the month in which the transaction occurred. Remeasurement gains and losses are included in SG&A expenses or income taxes, as appropriate. The assets, liabilities, revenues and expenses of our foreign subsidiaries are individually less than 10% of our respective consolidated amounts. The euro, Canadian dollar and Chinese yuan are our primary foreign currencies. Remeasurement gains and losses have not been significant.

We enter into forward contracts to hedge against unfavorable currency fluctuations in our monetary assets and liabilities in our European and Canadian operations. These contracts are designed to minimize the effect of fluctuations in foreign currencies. To qualify for hedge accounting, contracts must reduce the foreign currency exchange rate and interest rate risk otherwise inherent in the amount and duration of the hedged exposures and comply with established risk management policies. Our derivative instruments are not designated as hedging instruments and, therefore, are recorded at fair value as a current asset or liability, and any changes in fair value are recorded in our consolidated statements of operations. We do not use derivative financial instruments for speculative trading purposes.

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



Derivatives Not Designated as Hedging Instruments	Consolidated Balance Sheet Location	November 30, 2014		May 31, 2014
Foreign exchange forward contracts	Other assets	$	401	$	9

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



Derivatives Not Designated as Hedging Instruments	Location of Gain/(Loss) Recognized in Income on Derivatives	Three Months Ended November 30, 2014		Three Months Ended November 30, 2013
Foreign exchange forward contracts	SG&A expenses	$	508	$	(147	)



Derivatives Not Designated as Hedging Instruments	Location of Gain/(Loss) Recognized in Income on Derivatives	Six Months Ended November 30, 2014		Six Months Ended November 30, 2013
Foreign exchange forward contracts	SG&A expenses	$	381	$	(234	)

Other Assets

We include demonstration equipment used in connection with our resale activity of $10,036 and $6,659 as of November 30, 2014 and May 31, 2014, respectively, in other assets for a period of up to two years. Demonstration equipment is recorded at the lower of cost or estimated market value until the units are sold or transferred to our rental and lease equipment pool. Demonstration equipment transferred to our rental and lease equipment pool is depreciated over its remaining estimated useful life. We also have a Supplemental Executive Retirement Plan (“SERP”) that provides for automatic deferral of contributions in excess of the maximum amount permitted under the 401(k) for our executives who choose to participate. The SERP is a non-qualified deferred compensation program. We have the option to match contributions of participants at a rate we determine each year.

Other assets consisted of the following:



	November 30, 2014		May 31, 2014
Demonstration equipment	$	10,036	$	6,659
Net investment in sales-type leases	5,890		7,264
Prepaid expenses and other	3,738		2,978
SERP	3,394		3,418
Income taxes receivable	—		1,831
	$	23,058	$	22,150

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") and the International Accounting Standards Board ("IASB") issued guidance to establish a new, more robust framework for the recognition of revenue related to the transfer of goods and services to customers. This guidance is effective for reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The impact this guidance will have on the consolidated financial statements has not been determined at this time.

In August 2014, the FASB issued guidance that requires management to evaluate whether there is substantial doubt about the entity's ability to continue as a going concern and, if so, disclose that fact. This guidance is effective for annual periods ending after December 15, 2016, including interim reporting periods thereafter. The new guidance affects disclosures only and is not expected to have a material impact on our consolidated financial position, results of operations or cash flows.

Other Comprehensive Income

Comprehensive income is equivalent to net income for all periods presented.

Out-of-period Adjustment

During the second quarter of fiscal 2015, we identified $1.3 million of previously recognized revenue which the Company was not entitled to recognize. We determined this adjustment to be immaterial to our current and previously filed financial statements. We have recorded this out-of-period adjustment as a reduction to sales of equipment and other revenues and an increase to accrued expenses for the quarter ended November 30, 2014.