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”). All intercompany balances and transactions have been eliminated in consolidation.

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 unaudited 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 unaudited 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 13, 2015.

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.

We enter into finance leases as lessor for some of our equipment. 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, net of unearned interest, 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 base.

Initial direct costs for operating and finance leases are insignificant.

Sales of new equipment 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 passes to the customer. In the case of equipment sold to customers that is already on rent or on 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.

The amount of revenue recognized for sales of new equipment depends on whether we sell as principal or as agent for the original equipment manufacturer. Prior to May 31, 2015, our sales of new equipment were derived primarily from the reseller agreement with Keysight Technologies, Inc. In fiscal 2016, we were able to enter into reseller agreements with other T&M equipment manufacturers, including Anritsu, Inc. ("Anritsu") and Rohde & Schwarz Gmbh & Co. KG ("Rohde & Schwarz"). Under the terms of the agreements we act as the principal with respect to sales of new equipment, 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 original equipment 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 equipment manufacturer is not required to accept returns of equipment from us. Under the reseller agreement with Keysight, we also bore front-end risk of inventory loss in those cases where we acquired 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.

In situations where we act as principal, the gross sales of new equipment are recorded in sales of equipment and other revenues, while the related equipment costs, including the purchase price from the original equipment manufacturer, are recorded in costs of sales of equipment and other revenues in our consolidated statements of operations.

We are currently establishing new resale relationships, where we may act as an agent for the original equipment manufacturer. Under those arrangements, we recognize revenue only on the commissions that we receive, which are recorded in other revenue within the sales of equipment and other revenues in our consolidated statement of operations.

Other revenues, which primarily include billings to customers for delivery and repairs, 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 equipment, relating to our rental and lease revenues. Costs of rentals and leases included impairment charges of $0 and $443 related to our T&M rental and lease equipment during the three and six months ended November 30, 2015. No impairments occurred for the three and six months ended November 30, 2014.

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 $373 and $590 for the three and six months ended November 30, 2015 and $250 and $419 for the three and six months ended November 30, 2014. SG&A expenses also included shipping and handling costs of $929 and $1,873 for the three and six months ended November 30, 2015 and $1,085 and $2,121 for the three and six months ended November 30, 2014.

Foreign Currency

The U.S. dollar has been determined to be the functional currency of all foreign subsidiaries. The euro, Canadian dollar and Chinese yuan are our primary foreign currencies. 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 operations that are susceptible to foreign currency fluctuations are individually less than 10% of our respective consolidated amounts. Net 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, Chinese 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 an 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 values of our foreign exchange forward contracts in the consolidated balance sheets are shown in the table below:



Derivatives Not Designated as Hedging Instruments	Consolidated Balance Sheet Location	November 30, 2015		May 31, 2015
Foreign exchange forward contracts	Other assets	$	12	$	(16	)

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, 2015		Three Months Ended November 30, 2014
Foreign exchange forward contracts	SG&A expenses	$	149	$	508



Derivatives Not Designated as Hedging Instruments	Location of Gain/(Loss) Recognized in Income on Derivatives	Six Months Ended November 30, 2015		Six Months Ended November 30, 2014
Foreign exchange forward contracts	SG&A expenses	$	177	$	381

Other Assets

We include demonstration equipment used in connection with our resale activity 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, 2015		May 31, 2015
Demonstration equipment	$	4,937	$	81
Net investment in sales-type leases	4,737		5,876
Prepaid expenses and other	3,677		4,265
SERP	3,274		3,521
Income taxes receivable	2,631		—
	$	19,256	$	13,743

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board and the International Accounting Standards Board 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, 2017, including interim reporting periods within that reporting period. The impact this guidance will have on the consolidated financial statements cannot be determined at this time.

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.