Financial Highlights
 
02

(in thousands, except per share information)

			May 31,
			2002			2001			2000		1999		1998
Revenues			$	147,864		$	211,176		$	241,793	$	269,739	$	255,505
Costs of revenues and depreciation				81,678			99,724			131,125		139,338		122,080
Selling, administrative and general expenses				50,492			62,625			65,104		77,612		69,099
Interest (income) expense, net				(2,232	)		(708	)		5,465		11,999		9,506
Income before income taxes				17,926			49,535			40,099		40,790		54,820
Income taxes				4,804			18,822			15,237		16,725		22,476
Net income			$	13,122		$	30,713		$	24,862	$	24,065	$	32,344
Earnings per share:
	Basic		$	0.53		$	1.26		$	1.01	$	0.98	$	1.33
	Diluted		$	0.53		$	1.24		$	1.00	$	0.96	$	1.29
Shares used in per share calculation:
		Basic		24,602			24,416			24,571		24,443		24,305
		Diluted		24,837			24,753			24,972		25,004		25,141
Total assets			$	305,390		$	312,468		$	306,435	$	368,708	$	457,896
Bank borrowings			$	—		$	—		$	21,800	$	107,500	$	226,900
Shareholders’ equity			$	264,717		$	250,186		$	221,665	$	196,174	$	172,009
Shareholders’ equity per common share			$	10.68		$	10.21		$	9.00	$	8.01	$	7.04

Electro Rent 2002 Annual Report

Management’s Discussion and Analysis of Financial
Condition and Results of Operations

The following discussion of the Company’s financial condition and results of operations should be read in conjunction with the fiscal 2002 Consolidated Financial Statements and the notes thereto and the other financial and statistical information appearing elsewhere in this annual report.

Overview

The Company generates revenues through the rental, lease and sale of electronic equipment, including test and measurement equipment and data products (personal computers and workstations). In fiscal 2002, 62.6% of rental and lease revenues were derived from test and measurement equipment. This percentage has been increasing over the last four years as a result of a steady erosion of data products revenues related to the weak economy and declines in product purchase prices and rental and lease rates. Short-term rental revenues comprised 73.2% of fiscal 2002 rental and lease revenue, and this percentage also has been increasing over the last four years due to a significant decline in personal computer leasing activity.

The Company’s profitability is primarily a function of the volume and pricing of rental and lease transactions, and utilization of the equipment pool. Significant changes in the purchase or disposal price of equipment or interest rates can also have a significant effect on the Company’s profitability, depending on the ability of the Company to adjust pricing and rental and lease rates for these changes. The Company’s business requires significant expenditures for equipment and, consequently, requires substantial liquidity to finance such expenditures.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management 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, management reviews these estimates including those related to asset lives and depreciation methods, impairment of long-lived assets including intangibles, allowance for doubtful accounts, and contingencies and litigation. These estimates are based on management’s historical experience and on various other assumptions believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Management believes, however, that the estimates, including those for the above-listed items, are reasonable.

Management believes the following critical accounting policies affect the more significant judgments and estimates used in the preparation of the Company’s financial statements:

Asset lives and depreciation methods: The Company’s primary business involves the purchase and subsequent rental and leasing of long-lived electronic equipment. Management has chosen asset lives that it believes correspond to the economic life of the related asset. Management has chosen depreciation methods that it believes matches the benefit to the Company from the asset with the associated costs. These judgments have been made based on management’s expertise in each equipment type that the Company carries. The Company records an impairment when the future undiscounted cash flows are below net book value.

Impairment of long-lived assets: On a regular basis, management reviews the carrying value of its rental and leasing equipment and intangible assets to determine if the carrying value of the assets may not be recoverable due to current and forecasted economic conditions. This requires management to make estimates related to future undiscounted cash flows from the assets and to determine whether any deterioration is temporary or permanent. If these estimates or the related assumptions change in the future, management may be required to record additional impairment charges.

Allowance for doubtful accounts: The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of customers to make rental and leasing payments. These estimates are primarily based on the amount of time that has lapsed since the related payments were due as well as specific knowledge related to the ability of customers to make the required payments. If the financial condition of the Company’s customers were to deteriorate, additional allowances could be required that would reduce income. Conversely, if the financial condition of the customers were to improve or if legal remedies to collect past due amounts were more successful than expected, the allowance for doubtful accounts may need to be reduced and income would be increased.

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Electro Rent 2002 Annual Report

Contingencies and litigation: The Company is subject to legal proceedings and business disputes involving ordinary and routine claims. The ultimate legal and financial liability with respect to such matters 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, the Company may be required to record either more or less litigation expense.

Recent Accounting Pronouncements

In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 141 (“SFAS 141”), “Business Combinations.” SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. SFAS 141 also specifies the types of acquired intangible assets that are required to be recognized and reported separately from goodwill and those that are required to be included in goodwill. The Company adopted SFAS 141 in the first quarter of fiscal year 2002. Adoption of SFAS 141 did not have a significant impact on our financial statements.

In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets.” SFAS 142 requires, among other things, the discontinuance of goodwill amortization and the testing for impairment of goodwill at least annually. The Company adopted SFAS 142 in the first quarter of fiscal year 2002. The impact of SFAS 142 on the Company’s financial position and results of operations was primarily the elimination of annual goodwill amortization of $1.4 million.

In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which is effective for the fiscal years beginning after December 15, 2001. The Company will adopt SFAS No. 144 as required on June 1, 2002. This standard will not have a significant effect on the Company’s consolidated financial statements upon adoption.

Fiscal 2002 Compared with Fiscal 2001

Total revenues for fiscal 2002 decreased 30% to $147.9 million from $211.2 million for the prior year. Rental and leasing revenues decreased 34% to $115.3 million, primarily as a result of continued weakness in the business. Sales of equipment and other revenues decreased 14% to $32.6 million due to lower demand for test and measurement (T&M) and data products (DP) equipment. The T&M and DP businesses were negatively impacted by the weak economy in fiscal 2002. Additionally, rental and lease revenues declined significantly as a result of lower demand in the telecommunications sector for T&M equipment and in the consulting services sector for DP equipment.

In spite of progress in reducing our DP equipment pool and related depreciation, depreciation of equipment increased from 42% of rental and lease revenues in fiscal 2001 to 51% of rental and lease revenues in fiscal 2002. This expense ratio increased because the 19% decline in depreciation expense from the prior year period was exceeded by a 34% decline in rental and lease revenues. These changes also reflect the lower rates of equipment utilization and lower rental and lease yields in the current year, as compared to the prior year.

DP equipment utilization remained near its lowest historical level, while T&M equipment utilization continued a decline which began in the fourth quarter of fiscal 2001 and reached its lowest level since fiscal 1994. As discussed above, the weak economy and certain distressed market sectors reduced demand for rental and lease equipment, which in turn decreased overall equipment utilization. DP equipment utilization actually increased slightly to 60% at the end of fiscal 2002 from 58% at the end of fiscal 2001, while T&M equipment utilization declined to 52% from 59% for the respective dates.

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Electro Rent 2002 Annual Report

Costs of revenues other than depreciation primarily includes the cost of equipment sales, which increased from 69% of equipment sales in fiscal 2001 to 70% of equipment sales in fiscal 2002. This cost ratio increase reflects the liquidation of used equipment which is cumulatively less depreciated in the current year, compared to the prior year.

Selling, general and administrative expenses totaled $50.5 million for fiscal 2002, or 34% of revenues, as compared to $62.6 million, or 30% of revenues, for fiscal 2001. Although SG&A expenses were reduced by 19%, reflecting a reduction in personnel, the closing of certain locations, resolution of the GE Capital Technology Management Services (TMS) arbitration, and the termination of goodwill amortization, total revenues declined at a faster rate of 30%.

As a result of the changes in revenues, operating costs and expenses discussed above, earnings before interest and taxes were $15.7 million or 11% of total revenues in fiscal 2002 compared to $48.8 million or 23% of total revenues in fiscal 2001.

Net interest income increased from $0.7 million in fiscal 2001 to $2.2 million in fiscal 2002. This change is due to the repayment of all bank borrowings during fiscal 2001, and subsequent investment of the Company’s net cash flow in money market instruments.

At fiscal year-end, the Company re-evaluated its accrued liability relating to state, federal, local and foreign income taxes and reduced income tax expense by approximately $2.0 million in the fourth quarter of fiscal 2002. As a result, the effective tax rate was 27% in fiscal 2002, as compared to 38% in fiscal 2001.

Fiscal 2001 Compared with Fiscal 2000

Total revenues for the year ended May 31, 2001 decreased 13% to $211.2 million from $241.8 million, primarily as a result of continuing attrition of the GE Capital Technology Management Services (TMS) business acquired by the Company in November 1997 and a generally weak personal computer market during the last 12 months, partially offset by increased rentals of test and measurement equipment in the Company’s telecommunications product line. Rental and lease revenues decreased 13% to $173.5 million in fiscal 2001, largely for the reasons noted above, and sales of equipment and other revenues decreased 12% to $37.7 million in fiscal 2001.

Depreciation of equipment decreased from 48% of rental and lease revenues in fiscal 2000 to 42% of rental and lease revenues in fiscal 2001. This decrease is primarily due to the fact that a large portion of computers acquired from TMS in fiscal 1998 became fully depreciated in the last half of fiscal 2000. This decrease also reflects the shift in the Company’s equipment portfolio from personal computers, having relatively shorter useful lives, to test and measurement equipment, having relatively longer useful lives.

Costs of revenues other than depreciation primarily includes the cost of equipment sales, which decreased from 82% of equipment sales in fiscal 2000 to 69% of equipment sales in fiscal 2001. This cost ratio decrease primarily results from the sale of equipment that is generally more depreciated than in the prior fiscal year and several non-recurring customer settlements.

Selling, general and administrative expenses totaled $62.6 million in fiscal 2001, or 30% of revenues, as compared to $65.1 million, or 27% of revenues, in fiscal 2000. This expense ratio increase reflects the 13% decline in total revenues, partially offset by a 4% decline in SG&A primarily resulting from a reduction in personnel and the closing of certain facilities.

As a result of the changes in revenues, operating costs and expenses discussed above, earnings before interest and taxes were $48.8 million, or 23% of total revenues in fiscal 2001, compared to $45.6 million, or 19% of total revenues in fiscal 2000.

Net interest income and expense changed from expense of $5.5 million in fiscal 2000 to income of $0.7 million in fiscal 2001. This change results from the Company’s repayment of all of its bank borrowings during the second quarter of fiscal 2001, and the Company’s subsequent investment of its cash in money market instruments.

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Electro Rent 2002 Annual Report

Liquidity and Capital Resources

Electro Rent’s rental and lease equipment portfolio totaled $320.7 million, at acquisition cost, at May 31, 2002, decreasing $68.7 million from last year. During the three years ended May 31, 2002, the Company made payments for equipment purchases totaling $198 million, while recording a net decrease in its equipment portfolio at acquisition cost of $148 million resulting from the liquidation of used equipment. The Company has three principal sources of liquidity: cash flows provided by its operating activities, proceeds from the sale of equipment from its portfolio, and external funds that historically have been provided by bank borrowings.

During the years ended May 31, 2002 and 2001 net cash provided by operating activities was $74.7 million and $97.4 million, respectively. The decrease in fiscal 2002 results primarily from the decline in net income.

During the years ended May 31, 2002 and 2001 net cash used in investing activities was $21.6 million and $13.9 million, respectively. This change is primarily attributable to reduced purchases of rental and lease equipment, net of decreased proceeds from the sale of used equipment. Also contributing to this change is the receipt in the prior year of a $20.8 million purchase price reduction related to the GE TMS acquisition in fiscal 1998.

During fiscal 2002 net cash provided from financing activities was $1.4 million, compared to $24.0 million net cash used in financing activities in fiscal 2001. This change is largely the result of the repayments of all bank borrowings in the prior fiscal year. The total result of the cash flows from operating, investing and financing activities in fiscal 2002 was an increase in cash and cash equivalents of $54.5 million.

As the following table illustrates, cash flows from operating activities and proceeds from the sale of equipment have been more than sufficient to fund the Company’s operations during the last three years.

(in thousands)

										Three Years Ended
	2000			2001			2002			May 31, 2002
Cash flows from operating activities(1)	$	127,771		$	97,434		$	74,660		$	299,865
Proceeds from sale of equipment		37,016			32,745			27,913			97,674
Total cash flows available for equipment purchases		164,787			130,179			102,573			397,539
Payments for equipment purchases		(81,802	)		(66,987	)		(49,408	)		(198,197	)
Net decrease in bank borrowings		(85,700	)		(21,800	)		0			(107,500	)
Net decrease in equipment portfolio at acquisition cost		(23,958	)		(55,048	)		(68,675	)		(147,681	)

⁽¹⁾ For the components of cash flows from operating activities, see the Consolidated Statements of Cash Flows.

As indicated by the table, cash flows from operating activities and proceeds from sale of equipment provided 201% of the funds required for equipment purchased during the three-year period ended May 31, 2002. Rental and lease revenues have been significantly supplemented as a source of cash flow by proceeds from the sale of equipment from Electro Rent’s portfolio. Management believes that cash and cash equivalents, cash flows from operating activities, proceeds from the sale of equipment and its borrowing capacity (see Note 3 of Notes to Consolidated Financial Statements) will be sufficient to fund the Company’s operations.

The market for personal computers and test equipment continued to weaken during fiscal 2002, and as a result, the Company’s expenditures for equipment decreased. The Company repaid its bank borrowings in full during the first half of fiscal 2001. Since then, the Company has invested its growing cash balance in short-term money market funds. The Company’s cash and cash equivalents are likely to continue to grow, unless the Company decides to buy back additional shares, finance an acquisition, or pursue other opportunities.

The Company has a $10.0 million revolving line of credit with a bank, subject to certain restrictions, to meet equipment acquisition needs as well as working capital and general corporate requirements. The Company had no borrowings outstanding at May 31, 2002. The Company has cash commitments under various facility operating leases which are due as follows: $1.5 million in fiscal 2003, $1.9 million in fiscal 2004 to 2006, and $.4 million in fiscal 2007.

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Electro Rent 2002 Annual Report

Inflation generally has favorably influenced the Company’s results of operations by enhancing the sale prices of its used equipment. However, lower inflation rates and the continued availability of newer, less expensive equipment with similar or better specifications could result, over a period of several years, in lower relative sale prices for used electronic equipment. If this should occur, the Company’s margins and earnings will be reduced. Prices of new and used electronic test equipment have not consistently followed the overall inflation rate. Prices of new and used personal computers and workstations have consistently declined for the past three years. Because management is 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 the Company’s margins and earnings.

Qualitative and Quantitative Disclosures About Interest Rates and Currency Rates

The Company’s primary market risk exposure historically has been risks related to interest rate fluctuations, primarily related to its previous borrowings under its unsecured revolving credit facility. However, interest rates do not necessarily impact the Company’s margins or earnings because the effects of higher or lower borrowing costs may be reflected in the financing rates on newly rented and leased assets. The Company may attempt to reduce this risk by utilizing derivative financial instruments, namely interest rate caps and swaps, pursuant to Company policies. The Company does not enter into derivative financial instruments for the purpose of trading. Although the Company has the ability to draw on its revolving credit line, the Company currently has no outstanding borrowings under its credit facility or interest rate protection agreements in place.

The Company is also subject to risks associated with foreign currency rate fluctuations to the extent of financing arrangements for rented and leased equipment denominated in Canadian dollars. The Company has determined that hedging of these assets is not cost effective and instead attempts to minimize its risks due to currency and exchange rate fluctuations through working capital management. The Company does not believe that any foreseeable change in currency rates would materially or adversely affect its financial position or results of operations.

Special Note About Forward-Looking Statements

Except for the historical statements and discussions contained in this Annual Report, statements contained in this Annual Report constitute forward-looking statements within the meaning of section 21E of the Securities Exchange Act of 1934. These forward-looking statements reflect the current views of the Company’s management with respect to future events and financial performance. All plans, projections, and future estimates are forward-looking statements, which in some, but not all, cases, are identified by words such as “anticipate,” “believes,” “expects,” “intends,” “future,” and other similar expressions. Please do not put undue reliance on forward-looking statements. Forward-looking statements are subject to certain risks and uncertainties, not all of which are disclosed in this Annual Report. Although the Company believes its management’s assumptions are reasonable, it is likely that at least some of these assumptions will not come true. Accordingly, the Company’s actual results will probably differ from the outcomes contained in any forward-looking statement, and those differences could be material. Factors that could cause or contribute to these differences include, among others, those risks and uncertainties discussed under the sections contained in this Annual Report entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in “Quantitative and Qualitative Disclosure About Interest Rates and Currency Rates,” as well as in the Company’s Annual Report on Form 10-K for the year ended May 31, 2002, including the “Risk Factors” attached as Exhibit 99 to that document, the Company’s Proxy Statement for its 2002 Annual Meeting of Shareholders and the Company’s other filings with the Securities and Exchange Commission. Should one or more of the risks discussed, or any other risks, materialize, or should one or more of the Company’s underlying assumptions prove incorrect, the Company’s actual results may vary materially from those anticipated, estimated, expected or projected. In light of the risks and uncertainties, there can be no assurance that any forward-looking information will in fact prove to be correct. We do not undertake any obligation to update forward-looking statements.

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Electro Rent 2002 Annual Report

Consolidated Statements of Income

(in thousands, except per share information)

			Year Ended May 31,
			2002			2001			2000
Revenues:
	Rentals and leases		$	115,310		$	173,495		$	199,022
	Sales of equipment and other revenues			32,554			37,681			42,771
		Total revenues		147,864			211,176			241,793
Costs and expenses:
	Depreciation of rental and lease equipment			58,639			72,753			95,769
	Costs of revenues other than depreciation			23,039			26,971			35,356
	Selling, administrative and general expenses			50,492			62,625			65,104
	Interest (income) expense, net			(2,232	)		(708	)		5,465
		Total costs and expenses		129,938			161,641			201,694
Income before income taxes				17,926			49,535			40,099
Income taxes				4,804			18,822			15,237
Net income			$	13,122		$	30,713		$	24,862
Earnings per share:
	Basic		$	0.53		$	1.26		$	1.01
	Diluted		$	0.53		$	1.24		$	1.00
Shares used in per share calculation:
	Basic			24,602			24,416			24,571
	Diluted			24,837			24,753			24,972

The accompanying notes are an integral part of these consolidated financial statements.

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Electro Rent 2002 Annual Report

Consolidated Balance Sheets

(in thousands, except share information)

			As of May 31,
			2002		2001
Assets
	Cash and cash equivalents		$	115,623	$	61,136
	Accounts receivable, net of allowance for doubtful accounts of $2,461 and $1,840			12,023		23,809
	Rental and lease equipment, net of accumulated depreciation of $201,063 and $221,892			119,675		167,521
	Other property, net of accumulated depreciation and amortization of $12,241 and $10,447			16,912		18,841
	Goodwill			35,703		35,703
	Intangibles, net of amortization of $4,942 and $4,816			1,558		1,684
	Other			3,896		3,774
			$	305,390	$	312,468
Liabilities and Shareholders’ Equity
Liabilities:
	Accounts payable			7,185		25,733
	Accrued expenses			17,671		19,606
	Deferred income taxes, net			15,817		16,943
		Total liabilities		40,673		62,282
Commitments and contingencies
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 2002 — 24,774,734; 2001 — 24,502,879			13,246		11,782
	Retained earnings			251,471		238,404
		Total shareholders’ equity		264,717		250,186
			$	305,390	$	312,468

The accompanying notes are an integral part of these consolidated financial statements.

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Electro Rent 2002 Annual Report

Consolidated Statements of Shareholders’ Equity

(in thousands)

		Three years ended May 31, 2002
		Common Stock
		Number						Retained
		of Shares			Amount			Earnings
Balance, May 31, 1999			24,476		$	10,510		$	185,664
	Exercise of stock options, net, including related tax effect		159			629			—
	Net income for the year ended May 31, 2000		—			—			24,862
Balance, May 31, 2000			24,635			11,139			210,526
	Exercise of stock options, net, including related tax effect		186			789			—
	Repurchase of common stock		(318	)		(146	)		(2,835	)
	Net income for the year ended May 31, 2001		—			—			30,713
Balance, May 31, 2001			24,503			11,782			238,404
	Exercise of stock options, net, including related tax effect		276			1,467			—
	Repurchase of common stock		(4	)		(3	)		(55	)
	Net income for the year ended May 31, 2002		—			—			13,122
Balance, May 31, 2002			24,775		$	13,246		$	251,471

The accompanying notes are an integral part of these consolidated financial statements.

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Electro Rent 2002 Annual Report

Consolidated Statements of Cash Flows

(in thousands)

				Year Ended May 31,
				2002			2001			2000
Cash flows from operating activities:
	Net income			$	13,122		$	30,713		$	24,862
	Adjustments to reconcile net income to net cash provided by operating activities:
		Depreciation and amortization			60,781			76,856			100,655
		Provision for losses on accounts receivable			2,930			2,479			1,265
		Gain on sale of rental and lease equipment			(8,294	)		(10,226	)		(6,767	)
		Change in operating assets and liabilities:
			Decrease in accounts receivable		8,856			3,574			14,747
			(Increase) decrease in other assets		(122	)		402			43
			Increase (decrease) in accounts payable		448			(2,578	)		(3,890	)
			Increase (decrease) in accrued expenses		(1,935	)		(5,315	)		(1,804	)
			Increase (decrease) in deferred income taxes		(1,126	)		1,529			(1,340	)
			Net cash provided by operating activities		74,660			97,434			127,771
Cash flows from investing activities:
	Proceeds from sale of rental and lease equipment				27,913			32,745			37,016
	Proceeds from purchase price settlement				—			20,800			—
	Payments for purchase of rental and lease equipment				(49,408	)		(66,987	)		(81,802	)
	Payments for purchase of other property				(87	)		(469	)		(348	)
			Net cash used in investing activities		(21,582	)		(13,911	)		(45,134	)
Cash flows from financing activities:
	Decrease in short-term bank borrowings				—			(21,800	)		(85,700	)
	Proceeds from issuance of common stock				1,467			789			629
	Payment for repurchase of common stock				(58	)		(2,981	)		—
			Net cash provided by (used in) financing activities		1,409			(23,992	)		(85,071	)
Net increase in cash and cash equivalents					54,487			59,531			(2,434	)
Cash and cash equivalents at beginning of year					61,136			1,605			4,039
Cash and cash equivalents at end of year				$	115,623		$	61,136		$	1,605

The accompanying notes are an integral part of these consolidated financial statements.

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Electro Rent 2002 Annual Report

Notes to Consolidated Financial Statements
For the years ended May 31, 2002, 2001 and 2000

(dollar amounts in thousands, except per share amounts)

Note 1  Summary of Significant Accounting Policies

Business and Organization: Electro Rent Corporation primarily engages in the short-term rental and the lease of state-of-the-art electronic equipment. The Company maintains an equipment portfolio composed primarily of general purpose test and measurement instruments, personal computers and workstations purchased from leading manufacturers. Another aspect of the Company’s business is the sale of equipment after its utilization for rental or lease. The Company’s wholly owned subsidiary, Genstar Rental Electronics, Inc., acts as the Company’s agent in Canada for all of these business activities. The Company’s wholly owned subsidiary, Electro Rent de Mexico, S.A. de C.V., was liquidated in fiscal 2002.

The Company’s customers are primarily located in the United States and operate in various industry segments including aerospace and defense, telecommunications, consulting and computer technology. During fiscal 2002, 2001 and 2000 no customer accounted for more than 10% of total revenues.

Basis of Presentation: The consolidated financial statements include Electro Rent Corporation and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.

Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America require management 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. Management’s use of estimates also affects the reported amounts of revenues and expenses during the reporting period. On a regular basis, management reviews these estimates including those related to asset lives and depreciation methods, impairment of long-lived assets including intangibles, allowance for doubtful accounts, and contingencies and litigation. These estimates are based on management’s historical experience and on various other assumptions believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Management believes, however, that the estimates, including those for the above-listed items, are reasonable.

Revenue Recognition: Rental and lease revenues are recognized in the month they are due on the accrual basis of accounting. Other revenues consist of billings to customers for equipment sales, delivery, or repairs, which are recognized in the period in which the respective equipment is shipped and risk of loss is passed to the customer or the services are performed. Interest income on cash equivalents is recognized in the period earned.

Rental and Lease Equipment and Other Property: Assets are generally stated at cost, less accumulated depreciation. Upon retirement or disposal of assets, the cost and the related allowance for depreciation are eliminated from the accounts and any gain or loss is recognized. Depreciation of rental and lease equipment and other property is computed using the straight-line and sum-of-the-years’-digits methods over the estimated useful lives of the respective equipment. New rental and lease equipment is depreciated over three to seven years, and used equipment over two to six years, depending on the type of equipment. Normal maintenance and repairs are expensed as incurred. At May 31, 2002, rental and lease equipment at net book value comprised $99,208 of test and measurement equipment and $20,467 of data products equipment.

Capital Leases: The Company has certain customer leases providing bargain purchase options, which are accounted for as sales-type leases. At May 31, 2002 and 2001 investment in sales-type leases of $1,321 and $1,334 net of deferred interest of $77 and $72, is included in other assets. Interest income is recognized over the life of the lease using the effective interest method.

Fair Value of Financial Instruments: The carrying amount of cash and cash equivalents and accounts receivable approximates fair value due to the short maturity of these instruments. Cash and short term investments with original maturities of 90 days or less are considered to be cash equivalents.

Impairment of Assets: The carrying value of equipment held for rental and lease is assessed quarterly and/or when factors indicating an impairment are present. The Company recognizes impairment losses on equipment held for rental and lease when the expected future undiscounted cash flows are less than the asset’s carrying value, in which case the asset is written down to its estimated fair value.

Goodwill and Intangibles: Until May 31, 2001, goodwill was amortized over a period of 40 years and intangibles were amortized on a straight-line basis over their estimated useful lives, to a residual of zero. On June 1, 2001, the

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Electro Rent 2002 Annual Report

Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 142 “Goodwill and Other Intangible Assets”, which provides that intangible assets with finite useful lives be amortized over that life and that goodwill and intangible assets with indefinite lives not be amortized, but will rather be tested at least annually for impairment.

Concentration of Credit Risk: Financial instruments that potentially subject the Company to concentration of credit risk consist primarily of trade accounts receivable. The Company sells primarily on 30-day terms, performs credit evaluation procedures on each customer’s individual transactions and requires security deposits or personal guarantees from its customers when significant credit risks are identified. Typically, most customers are large, established firms. An allowance for potential credit losses is maintained.

The Company purchases rental and lease equipment from numerous vendors. During fiscal 2002, Agilent Technologies, Inc. was the only vendor that accounted for more than 10% of such purchases.

Derivative Financial Instruments: During 1998, the Financial Accounting Standards Board issued SFAS No. 133, “Accounting for Derivative Instruments and for Hedging Activities,” which establishes new standards for reporting derivative and hedging information. The standard as amended in SFAS 138 is effective for periods beginning after June 15, 2000 and was adopted by the Company in fiscal 2002. The Company did not have any derivative financial instruments as of May 31, 2002 or 2001. The adoption of this standard did not have a significant impact on the consolidated financial statements.

Comprehensive Income: SFAS No. 130, “Reporting Comprehensive Income,” establishes standards to measure all changes in equity that result from transactions and other economic events other than transactions with shareholders. Comprehensive income is the total of net income and all other non-shareholder changes in equity. Other than net income, the Company has no comprehensive income.

Segment Reporting: The Company adopted SFAS No. 131, “Disclosure about Segments of an Enterprise and Related Information,” at May 31, 1999. SFAS No. 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. Under SFAS No. 131, the Company’s operations are treated as one operating segment because discrete financial information is not available for its product groups and the economic characteristics of the product groups are similar.

Net Income Per Common and Common Equivalent Share: Basic earnings per share (“EPS”) is computed as net income divided by the weighted average number of shares of common stock outstanding for the reported year, excluding the dilutive effects of stock options and other potentially dilutive securities. Diluted EPS is computed as net income divided by the weighted average number of shares outstanding of common stock and common stock equivalents for the reported year. Common stock equivalents result from the dilutive stock options computed using the treasury stock method.

Cash Flow: Supplemental disclosures of cash paid during the year for:

	2002		2001		2000
Interest	$	9	$	271	$	4,545
Income taxes		4,666		19,095		17,030

Supplemental disclosure of non-cash investing and financing activities: The Company acquired equipment of $6,626, $25,623, and $19,947, at May 31, 2002, 2001 and 2000, respectively, which was paid for during the subsequent year.

Recent Pronouncements: In August 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which is effective for the fiscal years beginning after December 15, 2001. The Company will adopt SFAS No. 144 as required on June 1, 2002. This standard will not have a significant effect on the Company’s consolidated financial statements upon adoption.

Note 2  Goodwill and Other Intangible Assets

In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 141 (“SFAS 141”), “Business Combinations.” SFAS 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of-interests method. SFAS 141 also

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Electro Rent 2002 Annual Report

specifies the types of acquired intangible assets that are required to be recognized and reported separately from goodwill and those that are required to be included in goodwill. The Company adopted SFAS 141 in the first quarter of fiscal year 2002. Adoption of SFAS 141 did not have a significant impact on the financial statements.

In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 (“SFAS 142”), “Goodwill and Other Intangible Assets.” SFAS 142 requires, among other things, the discontinuance of goodwill amortization and the testing for impairment of goodwill at least annually. The Company adopted SFAS 142 in the first quarter of fiscal year 2002. The impact of SFAS 142 on the Company’s financial position and results of operations was primarily the elimination of annual goodwill amortization of $1.4 million.

In accordance with SFAS 142, the Company discontinued goodwill amortization and tested goodwill for impairment as of June 1, 2001; no such impairment was noted. The Company will continue to test goodwill for impairment at least annually. Other intangible assets, with finite lives, continue to be amortized over their useful life of twenty years.

Goodwill was $35.7 million as of May 31, 2002, and was unchanged for the year. The following sets forth the intangible assets by major asset class as of May 31, 2002:

		Gross
		Carrying		Accumulated
		Amount		Amortization
Asset class
Customer contracts and related relationships		$	4,500	$	(3,920	)
Trade name			2,000		(1,012	)
	Total intangibles	$	6,500	$	(4,942	)

Aggregate amortization expense on intangible assets was approximately $0.13 million for the year ended May 31, 2002. There was no impairment loss recorded during the year. Amortization expense is expected to be approximately $0.13 million in each of the next five fiscal years.

The following table presents net income on a comparable basis, after adjustment for goodwill amortization for the fiscal years ended May 31:

		2002		2001		2000
Reported net income		$	13,122	$	30,713	$	24,862
	Add back: goodwill amortization, net of tax effect		0		857		857
Adjusted net income		$	13,122	$	31,570	$	25,719
Basic earnings per share
	As reported	$	0.53	$	1.26	$	1.01
	As adjusted	$	0.53	$	1.29	$	1.05
Diluted earnings per share
	As reported	$	0.53	$	1.24	$	1.00
	As adjusted	$	0.53	$	1.28	$	1.03

Note 3  Borrowings

On November 29, 2001, the Company renewed its 364-day agreement with a bank to provide a revolving line of credit for a reduced amount of $10.0 million from $25.0 million, subject to certain restrictions, to meet potential equipment acquisition needs as well as working capital and general corporate requirements. The interest rate on the line of credit is based on the prime rate or LIBOR, and the Company had no borrowings outstanding during the fiscal year ended May 31, 2002.

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Electro Rent 2002 Annual Report

Derivative Positions — The Company entered into various interest rate protection agreements, which all expired during fiscal 2001. The Company’s exposure under these agreements was limited to the impact of variable interest rate fluctuations and the periodic settlement of amounts due under these agreements if the other parties failed to perform. There were no derivative financial instruments outstanding as of May 31, 2002 or 2001.

Note 4  Income Taxes

The provision for income taxes consists of the following for the fiscal years ended May 31:

		2002			2001		2000
Current
	Federal	$	4,939		$	15,131	$	14,505
	State		991			2,162		2,072
Deferred
	Federal		(985	)		1,338		(1,172	)
	State		(141	)		191		(168	)
		$	4,804		$	18,822	$	15,237

A reconciliation of the statutory federal income tax rate to the effective tax rate is as follows for the fiscal years ended May 31:

	2002			2001			2000
Statutory federal rate		35.0	%		35.0	%		35.0	%
State taxes, net of federal benefit		5.0			5.0			5.5
Change in tax estimates on existing local, state, federal and foreign tax liabilities		(11.2	)		—			—
Other — net		(2.0	)		(2.0	)		0.5
Effective tax rate		26.8	%		38.0	%		41.0	%

The tax effects of temporary differences that give rise to significant portions of the net deferred tax liabilities at May 31, 2002 and 2001 are as follows:

			2002			2001
Deferred tax assets:
	Allowance for doubtful accounts		$	984		$	736
	Net operating loss carryforwards			646			770
	Deferred compensation and benefits			781			625
	Other			68			1,073
				2,479			3,204
Deferred tax liabilities:
	Accumulated depreciation and amortization			(18,296	)		(16,919	)
	Deferred revenue			0			(2,388	)
	Other			0			(840	)
				(18,296	)		(20,147	)
		Net deferred tax liabilities	$	(15,817	)	$	(16,943	)

Net operating loss carryforwards for federal income tax reporting purposes approximate $1,845 at May 31, 2002 and are available for use against taxable income through 2006. The utilization of operating loss carryforwards is limited to $356 per year for federal income tax reporting purposes.

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Electro Rent 2002 Annual Report

Note 5  Computation of Earnings Per Share

Following is a reconciliation of the denominator used in the computation of basic and diluted EPS:

		2002		2001		2000
Denominator:
	Denominator for basic earnings per share — weighted average common shares outstanding		24,602		24,416		24,571
	Effect of dilutive securities— options		235		337		401
			24,837		24,753		24,972
Net income		$	13,122	$	30,713	$	24,862
Earnings per share:
	Basic	$	.53	$	1.26	$	1.01
	Diluted	$	.53	$	1.24	$	1.00

Certain options to purchase the Company’s common stock were not included in the computation of diluted earnings per share because to do so would have been antidilutive. The quantity of such options is 654,823, 387,661, and 507,137 at May 31, 2002, 2001, and 2000, respectively.

Note 6  Rentals and Leases

The Company rents equipment on a short-term basis and leases equipment for periods greater than 12 months. Such leases provide the lessee with the option of renewing the agreement for periods of up to twelve months or purchasing the equipment at fair market value at the end of the initial or renewal term. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of customers to make rental and lease payments. These estimates are primarily based on the amount of time that has lapsed since the related payments were due as well as specific knowledge related to the ability of customers to make the required payments. If the financial condition of the Company’s customers were to deteriorate, additional allowances could be required that would reduce income. Conversely, if the financial condition of the customers were to improve or if legal remedies to collect past due amounts were more successful than expected, the allowance for doubtful accounts may need to be reduced and income would be increased. A roll-forward of the allowance is as follows at May 31:

	2002
Beginning of year	$	1,840
Provision for doubtful accounts		2,930
Write-offs, net of recoveries		(2,309	)
End of year	$	2,461

The Company’s cost of equipment under operating leases at May 31, 2002, with remaining noncancellable lease terms of more than one year, is $20,078 before accumulated depreciation of $9,093, and the net book value is $10,985.

A schedule of minimum future rentals to be received on noncancellable operating leases with remaining lease terms of more than one year as of May 31, 2002 is as follows:

2003	$	10,051
2004		6,955
2005		1,717
	$	18,723

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Electro Rent 2002 Annual Report

Note 7  Other Property

Other property, at cost, consists of the following at May 31:

	2002			2001
Land	$	6,985		$	6,985
Buildings		13,682			13,682
Furniture and other equipment		6,992			6,957
Leasehold improvements		1,494			1,664
		29,153			29,288
Less — accumulated depreciation and amortization		(12,241	)		(10,447	)
	$	16,912		$	18,841

Note 8  Acquisition Purchase Price Settlement

On December 13, 2000, the Company entered into a settlement agreement to fully resolve its closing balance sheet and purchase price disagreements with GE Capital Technology Management Services (“TMS”), regarding the Company’s acquisition of the TMS computer and test and measurement equipment rental business. The Company received the related settlement payment of $20.8 million on December 14, 2000.

On November 14, 1997, the Company acquired the TMS business for a purchase price of approximately $240 million. The acquisition was accounted for as a purchase and, accordingly, the acquired assets and assumed liabilities were recorded at their estimated fair value at the date of the acquisition. Before the settlement, the purchase price exceeded the fair market value of the tangible net assets acquired resulting in goodwill of approximately $60 million.

The TMS acquisition agreement included provisions for a reduction in the purchase price paid by the Company in the event there were objections to the TMS closing date balance sheet. The Company’s objections were subject to resolution as set forth in the TMS acquisition agreement and were the subject of on-going discussions between the parties. The settlement related to these objections has been used primarily to reduce the TMS goodwill originally recorded.

Note 9  Commitments and Contingencies

The Company leases certain facilities under various operating leases. Most of the lease agreements provide the Company with the option of renewing its lease at the end of the initial lease term, at the fair rental value, for periods of up to five years. In most cases, management expects that in the normal course of business facility leases will be renewed or replaced by other leases.

Minimum payments under these leases, exclusive of property taxes and insurance, are as follows:

2003	$	1,491
2004		924
2005		574
2006		448
2007		388
	$	3,825

Rent expense was $2,698, $2,969, $3,630 in fiscal 2002, 2001, and 2000, respectively.

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Electro Rent 2002 Annual Report

The Company is subject to legal proceedings and business disputes involving ordinary and routine claims. The ultimate legal and financial liability with respect to such matters 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, the Company may be required to record either more or less litigation expense. It is management’s opinion that none of the open matters at May 31, 2002 will have a material adverse effect on the Company’s financial condition or operations.

Note 10  Stock Option Plans

The Company has Stock Option Plans (the “Plans”) which authorize the Board of Directors to grant options for 2,167,500 shares of the Company’s common stock, of which 72,329 were available for future grants at May 31, 2002. The Plans provide for both incentive stock options, which may be granted only to employees, and non-statutory stock options, which may be granted to directors and consultants who are not employees. Pursuant to the Plans, options have been granted 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 ten-year period from the date of grant or a five-year period in the case of an employee who is also a 10 percent stockholder. The Plans provide for a variety of vesting dates with the majority of the options vesting at a rate of 25 percent per year over a period of four years from the date of grant. All outstanding options expire at dates ranging from October 2002 to July 2010. The following table summarizes certain information relative to options for common stock.

		2002					2001					2000
					Weighted					Weighted					Weighted
					Average					Average					Average
		Shares			Exercise Price		Shares			Exercise Price		Shares			Exercise Price
Options outstanding, beginning of year			1,068,794		$	10.35		1,100,847		$	9.19		1,305,771		$	8.54
	Granted		7,574			16.44		172,640			11.60		9,618			12.94
	Exercised		(276,361	)		5.31		(192,693	)		4.52		(167,664	)		2.92
	Forfeited		(16,738	)		12.13		(12,000	)		14.97		(46,878	)		14.47
Options outstanding, end of year			783,269		$	12.15		1,068,794		$	10.35		1,100,847		$	9.19
Options exercisable at end of year			667,429		$	12.25		799,494		$	9.56		866,597		$	7.83
Weighted-average fair value of options granted during year					$	6.81				$	6.62				$	6.44

The following summarizes information regarding stock options outstanding at May 31, 2002:

	Options Outstanding						Options Exercisable
			Weighted
			Average		Weighted				Weighted
			Remaining		Average				Average
	Number		Contractual		Exercise		Number		Exercise
Range of Exercise Prices	Outstanding		Life		Price		Exercisable		Price
$  2.41 — $11.58		200,430		2.8	$	7.42		195,555	$	7.33
$11.59 — $13.86		199,333		7.1		11.73		88,368		11.87
$13.87 — $24.11		383,506		4.4		14.84		383,506		14.84
		783,269		4.7	$	12.15		667,429	$	12.25

Pro Forma Information: The Company applies the intrinsic-value-based method prescribed by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” in accounting for employee stock options. Accordingly, compensation expense is recognized only when options are granted with a discounted exercise price. Any such compensation expense is recognized ratably over the associated service period, which is generally the option vesting term.

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Electro Rent 2002 Annual Report

Pro forma net earnings and earnings per share information, as required by Statement of Financial Accounting Standards No. 123 (SFAS 123), “Accounting for Stock-Based Compensation,” has been determined as if the Company had accounted for employee stock options under SFAS 123’s fair value method. The fair value of these options was estimated at grant date using a Black-Scholes option pricing model with the following weighted-average assumptions for fiscal 2002, 2001, and 2000, respectively: risk-free interest rates of 4.8, 6.2, and 5.8 percent; dividend yield of 0 percent; expected option life of 4.2, 7.2, and 5.0, years; and volatility of 44.1, 44.4, and 47.8 percent.

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the 4-year average vesting period of the options. The Company’s pro forma net earnings for 2002, 2001, and 2000 were $12,581, $29,783, and $23,994, and pro forma net earnings per share were $.51, $1.21, and $.97, respectively, on a diluted earnings per share basis.

Note 11  Savings Plan and Employee Stock Ownership Plan

The Company maintains a Savings Plan (401(k)) and a frozen Employee Stock Ownership Plan (ESOP). Employees become eligible to participate in the 401(k) after one year of employment. The Company has the option to match contributions of participants at a rate management determines each year. For participants with three or more years of service, the Company also may elect to make additional discretionary matching contributions in excess of the rate elected for participants with less than three years of service.

The Board of Directors determines the amount to be contributed annually to the 401(k) in cash, provided that such contributions shall not exceed the amount deductible for federal income tax purposes. Cash contributions to the 401(k) of $441, $670, and $756 were made for 2002, 2001, and 2000, respectively.

The ESOP was established in 1975 and was frozen in 1994, at which time all participants became fully vested. Contributions to the ESOP were invested primarily in stock of the Company. The ESOP held 523,269 shares of the Company’s stock at May 31, 2002.

Note 12  Quarterly Information (Unaudited)

Quarterly information is as follows:

								Earnings per share
		Total		Income		Net
		Revenues		Before Taxes		Income		Basic		Diluted
Fiscal Year 2002
	First Quarter	$	42,956	$	6,441	$	3,994	$	0.16	$	0.16
	Second Quarter		39,081		5,164		3,202		0.13		0.13
	Third Quarter		31,993		2,913		1,807		0.07		0.07
	Fourth Quarter		33,834		3,408		4,119		0.17		0.17
		$	147,864	$	17,926	$	13,122	$	0.53	$	0.53
Fiscal Year 2001
	First Quarter	$	57,333	$	14,339	$	8,890	$	0.36	$	0.36
	Second Quarter		54,517		14,020		8,692		0.36		0.35
	Third Quarter		50,752		12,079		7,490		0.31		0.30
	Fourth Quarter		48,574		9,097		5,641		0.23		0.23
		$	211,176	$	49,535	$	30,713	$	1.26	$	1.24

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Electro Rent 2002 Annual Report

Independent Auditors’ Report

To the Shareholders and Board of Directors of Electro Rent Corporation:

We have audited the accompanying consolidated balance sheet of Electro Rent Corporation (a California Corporation) and subsidiaries (the “Company”) as of May 31, 2002, and the related consolidated statements of income, shareholders’ equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements of the Company as of May 31, 2001 and for the years ended May 31, 2001 and 2000 were audited by other auditors whose report, dated August 6, 2001, expressed an unqualified opinion on those statements.

We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such 2002 financial statements present fairly, in all material respects, the financial position of Electro Rent Corporation and subsidiaries as of May 31, 2002, and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 2 to the financial statements, in the fiscal year ended May 31, 2002, the Company changed its method of accounting for goodwill and other intangibles to conform to Statement of Financial Accounting Standards No. 142, resulting in the discontinuation of amortization of goodwill during the fiscal year ended May 31, 2002.

Los Angeles, California
August 5, 2002

Capital Stock, Shareholders and Cash Dividend Information (Unaudited)

The common stock of the Company is quoted on NASDAQ under the symbol ELRC. There were approximately 464 shareholders of record at August 5, 2002. The Company has not, and does not expect in the future, to pay regular cash or non-cash distributions or dividends to its shareholders. The following table sets forth, for the period shown, the high and low closing sale prices in the NASDAQ National Market System as reported by NASDAQ.

	Fiscal Year 2002				Fiscal Year 2001
	High		Low		High		Low
First Quarter	$	17.39	$	14.15	$	12.75	$	9.50
Second Quarter		15.90		12.40		13.69		11.25
Third Quarter		14.30		12.56		18.00		11.06
Fourth Quarter		14.32		12.50		16.30		13.00

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