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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended March 31, 2002 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from to
Commission file number 1-5964
IKON OFFICE SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
OHIO 23-0334400
(State or other jurisdiction of (I.R.S.Employer
incorporation or organization) Identification No.)
P.O. Box 834, Valley Forge, Pennsylvania 19482
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 296-8000
Former name, former address and former fiscal year,
if changed since last report: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
Applicable only to corporate issuers:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of May 10, 2002.
Common Stock, no par value 143,954,610 shares
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IKON Office Solutions, Inc.
INDEX
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Condensed Consolidated Financial Statements
Consolidated Balance Sheets--March 31, 2002 (unaudited) and
September 30, 2001
Consolidated Statements of Income--Three and six months ended
March 31, 2002 and 2001 (unaudited)
Consolidated Statements of Cash Flows--Six months ended March
31, 2002 and 2001 (unaudited)
Notes to Condensed Consolidated Financial Statements (unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
PART II. OTHER INFORMATION
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Item 1. Legal Proceedings
Item 4. Submission of Matters to a Vote of Security Holders
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
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FORWARD-LOOKING INFORMATION
---------------------------
IKON Office Solutions, Inc. (the "Registrant," "IKON" or the "Company") may from
time to time provide information, whether verbally or in writing, including
certain statements included in or incorporated by reference in this Form 10-Q,
which constitute "forward-looking" statements within the meaning of the Private
Securities Litigation Reform Act of 1995 ("Litigation Reform Act"). These
forward-looking statements include, but are not limited to, statements regarding
the following (and certain matters discussed in greater detail herein): growth
opportunities and increasing market share, productivity and infrastructure
initiatives; earnings, revenue, cash flow, margin, and cost-savings projections;
the effect of competitive pressures on equipment sales; expected savings and
lower costs from the restructuring programs and productivity and infrastructure
initiatives; developing and expanding strategic alliances and partnerships; the
impact of e-commerce and e-procurement initiatives; the implementation of the
Oracle e-business suite; anticipated growth rates in the digital and color
equipment and outsourcing industries; the effect of foreign currency exchange
risk; the reorganization of the Company's business segments and the anticipated
benefits of operational synergies related thereto; and the Company's ability to
finance its current operations and its growth initiatives. Although IKON
believes the expectations contained in such forward-looking statements are
reasonable, it can give no assurance that such expectations will prove correct.
The words "anticipate," "believe," "estimate," "expect," "intend," "will," and
similar expressions, as they relate to the Company or the Company's management,
are intended to identify forward-looking statements. Such statements reflect the
current views of the Registrant with respect to future events and are subject to
certain risks, uncertainties and assumptions. Should one or more of these risks
or uncertainties materialize, or should underlying assumptions prove incorrect,
actual results may vary materially from those described herein as anticipated,
believed, estimated, expected or intended. The Registrant does not intend to
update these forward-looking statements.
In accordance with the provisions of the Litigation Reform Act, the Company is
making investors aware that such "forward-looking" statements, because they
relate to future events, are by their very nature subject to many important
factors which could cause actual results to differ materially from those
contained in the "forward-looking" statements. These uncertainties and risks
include, but are not limited to, the following (some of which are explained in
greater detail herein): conducting operations in a competitive environment and a
changing industry (which includes technical services and products that are
relatively new to the industry and to the Company); delays, difficulties,
management transitions and employment issues associated with consolidations
and/or changes in business operations; managing the integration of acquired
businesses; existing and future vendor relationships; risks relating to foreign
currency exchange; economic, legal and political issues associated with
international operations; the Company's ability to access capital and meet its
debt service requirements (including sensitivity to fluctuations in interest
rates); and general economic conditions.
Competition. The Registrant operates in a highly competitive environment. There
are a number of companies worldwide with significant financial resources which
compete with the Registrant to provide similar products and services, such as
Canon, Ricoh, Oce, Xerox and Danka. Competition is based largely upon
technology, performance, pricing, quality, reliability, distribution, customer
service and support. In addition, the financial pressures faced by some of the
Registrant's competitors may cause them to engage in uneconomic pricing
practices, which may cause the prices that the Registrant is able to charge in
the future for its products and services to be less than the Registrant has
historically charged. The Registrant's future success is based in large part
upon its ability to successfully compete in its current markets and expand into
additional products and services offerings. The intense competition inherent in
the Registrant's industry could also result in additional pressure in pricing
and the retention of customers which could negatively affect the Registrant's
results of operations.
Pricing. The Registrant's ability to succeed is dependent upon its ability to
obtain adequate pricing for its products and services. Depending on competitive
market factors, future prices the Registrant can obtain for its products and
services may vary from historical levels.
Transition to Digital. The analog segment of the office equipment market
continues to decline as the office equipment industry transitions to digital
technology. This transition represents a significant technological change in the
Registrant's industry with ramifications that cannot be fully foreseen. Some of
the digital products placed by the Registrant replace or compete with the analog
products placed by the Registrant. If the Company does not adapt successfully to
these changes, our actual results may differ materially from those expected.
Vendor Relationships. The Registrant's access to equipment, parts and supplies
is dependent upon close relationships with its vendors and its ability to
purchase products from these vendors on competitive terms. The cessation or
deterioration in relationships with, or the financial condition of, significant
vendors may cause the Company to be unable to distribute equipment, including
digital products and high-volume or color equipment, parts and supplies, and
would cause actual results to differ materially from those expected.
Financing Business. A significant portion of the Registrant's profits are
derived from the financing of equipment provided to its customers. The
Registrant's ability to provide such financing at competitive rates and realize
profitable margins is highly dependent upon its own costs of borrowing.
Significant changes in credit ratings could reduce the Company's access to
certain credit markets. There is no assurance that these credit ratings can be
maintained and/or the credit markets can be readily accessed.
Productivity Initiatives. The Registrant's ability to improve its profit margins
is largely dependent on its ability to maintain an efficient, cost-effective
operation. The Registrant continues to invest in new market opportunities and to
streamline its infrastructure. These investments are aimed at making the Company
more profitable and competitive in the long-term, and include initiatives such
as centralized credit and purchasing, shared services and the implementation of
the Oracle e-business suite, a comprehensive, multi-year initiative designed to
web-enable our information technology infrastructure. The Registrant's ability
to improve its profit margins through the implementation of these productivity
initiatives is dependent upon certain factors outside the control of the
Registrant and therefore could cause actual results to differ materially from
those anticipated.
International Operations. The Registrant's future revenue, cost and profit
results could be affected by a number of factors, including changes in foreign
currency exchange rates, changes in economic conditions from country to country,
changes in a country's political condition, trade protection measures, licensing
and other legal requirements and local tax issues.
Restructuring. In the fourth quarter of fiscal 2001, the Company announced the
acceleration of certain cost cutting and infrastructure improvements and
recorded a pre-tax restructuring and asset impairment charge of $60,000 and
reserve adjustments related primarily to the exit of the Company's telephony
operations of $5,300. This resulted in a charge of $65,300 ($49,235 after-tax,
or $0.34 per share on a diluted basis). These actions address the exit from the
Company's telephony operations in the United States and Europe, the closing of a
number of non-strategic digital print centers and further downsizing of
operational infrastructures throughout the organization as the Company leverages
and intensifies prior standardization and centralization initiatives. These
actions include the ongoing centralization and consolidation of many selling and
administrative functions, including marketplace consolidation, supply chain,
finance, customer service, sales support and the realignment of sales coverage
against our long-term growth objectives. Additionally, the Company recorded an
asset impairment charge of $3,582 ($3,300 after-tax, or $0.02 per share on a
diluted basis) related to the exit of the Company's technology education
operations. Therefore, the aggregate charge recorded in fiscal 2001 (the "Fiscal
2001 Charge") was $68,882 ($52,535 after-tax, or $0.36 per share on a diluted
basis).
In the first and fourth quarters of fiscal 2000, the Company announced certain
restructuring charges totaling approximately $105,168 (the "Fiscal 2000
Charge"). The restructuring charges are to consolidate or dispose of certain
underperforming and non-core locations and implement productivity enhancements
through consolidation/centralization of activities in inventory management,
purchasing, finance/accounting and other administrative functions and
consolidate or eliminate unproductive real estate facilities. These efforts are
aimed at improving the Company's performance and efficiency.
The failure to execute the actions described above concerning the Fiscal 2001
Charge or Fiscal 2000 Charge would cause actual results to differ materially
from those anticipated.
New Product Offerings. The process of developing new high technology products
and solutions is inherently complex and uncertain. It requires accurate
anticipation of customers' changing needs and emerging technological trends. The
Registrant must make long-term investments and commit significant resources
before knowing whether these investments will eventually result in products that
achieve customer acceptance and generate the revenues required to provide
anticipated returns from these investments.
Integration of Acquired Companies. The Company's success is dependent upon its
ability to integrate acquired companies and their operations which include
companies with technical services and products that are relatively new to the
Company and companies outside the United States that present additional risks
relating to international operations. There can be no assurance the Company will
be successful in managing the integration of acquired companies and their
operations.
IKON Office Solutions, Inc.
Consolidated Balance Sheets
March 31,
2002 September 30,
(in thousands) (unaudited) 2001
- ----------------------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 104,694 $ 80,351
Restricted cash 125,238 128,365
Accounts receivable, less allowances of: March 31, 2002 - $19,709;
September 30, 2001 - $23,510 592,153 641,059
Finance receivables, less allowances of: March 31, 2002 - $21,410;
September 30, 2001 - $24,424 1,175,748 1,171,004
Inventories 327,565 299,776
Prepaid expenses and other current assets 97,867 95,381
Deferred taxes 98,450 98,701
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Total current assets 2,521,715 2,514,637
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Long-term finance receivables, less allowances of: March 31, 2002 -
$39,762; September 30, 2001 - $45,360 2,183,182 2,176,205
Equipment on operating leases, net 80,980 71,181
Property and equipment, net 217,495 207,812
Goodwill, net 1,255,081 1,258,112
Other assets 59,540 63,045
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Total Assets $ 6,317,993 $ 6,290,992
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Liabilities and Shareholders' Equity
Current portion of long-term debt $ 13,473 $ 17,643
Current portion of long-term debt, finance subsidiaries 1,292,784 1,229,631
Notes payable 298,853 183,688
Trade accounts payable 226,691 222,999
Accrued salaries, wages and commissions 104,573 126,280
Deferred revenues 167,189 185,261
Other accrued expenses 327,754 299,624
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Total current liabilities 2,431,317 2,265,126
- ----------------------------------------------------------------------------------------------------------------
Long-term debt 595,923 599,608
Long-term debt, finance subsidiaries 1,144,131 1,366,108
Deferred taxes 466,996 446,059
Other long-term liabilities 216,090 218,513
Commitments and contingencies
Shareholders' Equity
Common stock, no par value: authorized 300,000 shares; issued: March
31, 2002-150,009 shares; September 30, 2001-150,128 shares;
outstanding: March 31, 2002-143,276 shares; September 30, 2001-
141,776 shares 1,010,831 1,012,302
Series 12 preferred stock, no par value: authorized 480 shares; none
issued or outstanding
Unearned compensation (3,000) (3,745)
Retained earnings 519,400 463,152
Accumulated other comprehensive loss (37,219) (43,484)
Cost of common shares in treasury: March 31, 2002-6,034 shares;
September 30, 2001-7,480 shares (26,476) (32,647)
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Total Shareholders' Equity 1,463,536 1,395,578
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Total Liabilities and Shareholders' Equity $ 6,317,993 $ 6,290,992
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See notes to condensed consolidated financial statements.
IKON Office Solutions, Inc.
Consolidated Statements of Income
(unaudited)
Three Months Ended Six Months Ended
March 31, March 31,
- -------------------------------------------------------------------------------------------------------------------------
(in thousands, except per share amounts) 2002 2001 2002 2001
- -------------------------------------------------------------------------------------------------------------------------
Revenues
Net sales $ 591,441 $ 704,719 $1,160,438 $1,359,790
Service and rentals 529,445 562,520 1,072,368 1,132,133
Finance income 99,288 93,987 197,817 187,354
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1,220,174 1,361,226 2,430,623 2,679,277
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Costs and Expenses
Cost of goods sold 390,680 460,619 765,027 895,612
Service and rental costs 321,570 348,891 649,108 690,945
Finance interest expense 36,995 44,363 78,160 90,567
Selling and administrative 401,267 458,356 802,851 907,511
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1,150,512 1,312,229 2,295,146 2,584,635
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Operating Income 69,662 48,997 135,477 94,642
Interest Expense 14,085 19,123 28,596 35,877
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Income From Continuing Operations
Before Taxes on Income 55,577 29,874 106,881 58,765
Taxes on Income 20,286 13,144 39,012 25,856
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Income From Continuing Operations 35,291 16,730 67,869 32,909
Discontinued Operations,
net of taxes of $942 1,200
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Net Income $ 35,291 $ 16,730 $ 67,869 $ 34,109
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Basic Earnings Per Common Share
Continuing Operations $ 0.25 $ 0.12 $ 0.48 $ 0.23
Discontinued Operations 0.01
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Net Income $ 0.25 $ 0.12 $ 0.48 $ 0.24
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Diluted Earnings Per Common Share
Continuing Operations $ 0.24 $ 0.12 $ 0.46 $ 0.23
Discontinued Operations 0.01
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Net Income $ 0.24 $ 0.12 $ 0.46 $ 0.24
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Cash Dividends Per Common Share $ 0.04 $ 0.04 $ 0.08 $ 0.08
See notes to condensed consolidated financial statements.
IKON Office Solutions, Inc.
Consolidated Statements of Cash Flows
(unaudited)
Six Months Ended
March 31,
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(in thousands) 2002 2001
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Cash Flows from Operating Activities
Net Income $ 67,869 $ 34,109
Additions (deductions) to reconcile net income to net cash
provided by operating activities of continuing operations:
Depreciation 56,772 58,333
Amortization 7,319 30,039
Provision for losses on accounts receivable 6,344 8,015
Provision for deferred income taxes 21,188 16,780
Provision for lease default reserves 34,312 31,693
Changes in operating assets and liabilities, net of effects from
acquisitions and divestitures:
Decrease in accounts receivable 36,746 17,023
Increase in inventories (30,065) (14,290)
Increase in prepaid expenses and other current assets (6,432) (16,804)
Increase (decrease) in accounts payable, deferred revenues and accrued
expenses 2,288 (69,934)
Decrease in accrued restructuring (10,504) (10,271)
Other 8,306 (1,437)
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Net cash provided by operating activities of continuing operations 194,143 83,256
Gain from discontinued operations (2,142)
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Net cash provided by operating activities 194,143 81,114
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Cash Flows from Investing Activities
Cost of companies acquired, net of cash acquired (2,666)
Expenditures for property and equipment (48,657) (50,506)
Expenditures for equipment on operating leases (39,497) (24,833)
Proceeds from sale of property and equipment 18,789 18,628
Proceeds from sale of equipment on operating leases 6,977 6,334
Finance receivables - additions (764,760) (922,855)
Finance receivables - collections 710,305 785,212
Proceeds from sale of finance subsidiaries' lease receivables 15,548
Other (5,488) 3,786
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Net cash used in investing activities (122,331) (171,352)
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Cash Flows from Financing Activities
Proceeds from issuance of long-term debt 2,261 34,980
Short-term borrowings, net 115,584 489,578
Long-term debt repayments (9,090) (146,119)
Finance subsidiaries' debt - issuances 404,021 1,067,479
Finance subsidiaries' debt - repayments (557,100) (1,247,100)
Dividends paid (11,401) (11,367)
Decrease (increase) in restricted cash 3,127 (38,640)
Proceeds from option exercises and sale of treasury shares 4,881 157
Purchase of treasury shares and other (258) (7,654)
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Net cash (used in) provided by financing activities (47,975) 141,314
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Effect of exchange rate changes on cash and cash equivalents 506 (12,095)
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Net increase in cash and cash equivalents 24,343 38,981
Cash and cash equivalents at beginning of year 80,351 78,118
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Cash and cash equivalents at end of period $ 104,694 $ 117,099
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See notes to condensed consolidated financial statements.
IKON Office Solutions, Inc.
Notes to Condensed Consolidated Financial Statements
(in thousands, except per share amounts)
(unaudited)
Note 1: Basis of Presentation
---------------------
The accompanying unaudited condensed consolidated financial statements of IKON
Office Solutions, Inc. and subsidiaries (the "Company", "we", or "our") have
been prepared in accordance with generally accepted accounting principles for
interim financial information and the instructions to Form 10-Q and Rule 10-01
of Regulation S-X. In the opinion of management, all adjustments (consisting of
normal recurring adjustments) considered necessary for a fair presentation have
been included. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's Annual Report on Form
10-K/A for the year ended September 30, 2001. Certain prior year amounts have
been reclassified to conform with the current year presentation.
Note 2: Adoption of Statement of Financial Accounting Standards ("SFAS") 142,
"Goodwill and Other Intangible Assets"
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In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS 142.
SFAS 142 supercedes APB 17, Intangible Assets and primarily addresses accounting
for goodwill and intangible assets subsequent to their acquisition. The
provisions of SFAS 142 are effective for fiscal years beginning after December
15, 2001, with early adoption permitted. The most significant changes made by
SFAS 142 were: (1) goodwill and indefinite lived intangible assets will no
longer be amortized, (2) goodwill will be tested for impairment at least
annually at the reporting unit level, (3) intangible assets deemed to have an
indefinite life will be tested for impairment at least annually, and (4) the
amortization period of intangible assets with finite lives will no longer be
limited to forty years. Effective October 1, 2001, the Company adopted SFAS 142,
which requires that goodwill not be amortized, but instead tested at least
annually for impairment. An impairment charge will be recognized only when the
implied fair value of a reporting unit, including goodwill, is less than its
carrying amount. The Company calculates fair value using a discounted cash flow
model. As of March 31, 2002, the Company completed its initial impairment review
and determined that no impairment charge was required. The Company has
identified the following reporting units and associated goodwill:
IKON North IKON North
America America Business Sysinct
Copier Outsourcing Imaging (e-business
Business Business IKON Europe Services development) Total
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March 31, 2002
Goodwill $866,514 $70,927 $305,633 $9,011 $2,996 $1,255,081
Changes in the goodwill balance since September 30, 2001 are attributable to
foreign currency translation adjustments.
As required by SFAS 142, intangibles with finite lives continue to be amortized.
The Company has non-compete agreements with a net book value of $811 at March
31, 2002, which will be fully amortized during fiscal 2002.
A reconciliation of reported net income adjusted to reflect the adoption of SFAS
142 is provided below:
Three Months Ended Six Months Ended
March 31, March 31, March 31, March 31,
2002 2001 2002 2001
------------- ------------- ------------- -------------
Reported net income $35,291 $16,730 $67,869 $34,109
Add-back goodwill amortization, net of
taxes of $242 and $475 10,365 20,366
------------- ------------- ------------- -------------
Adjusted net income $35,291 $27,095 $67,869 $54,475
============= ============= ============= =============
Reported basic earnings per common share $0.25 $0.12 $0.48 $0.24
Add-back goodwill amortization 0.07 0.14
------------- ------------- ------------- -------------
Adjusted basic earnings per common share $0.25 $0.19 $0.48 $0.38
============= ============= ============= =============
Reported diluted earnings per common share $0.24 $0.12 $0.46 $0.24
Add-back goodwill amortization 0.07 0.14
------------- ------------- ------------- -------------
Adjusted diluted earnings per common share $0.24 $0.19 $0.46 $0.38
============= ============= ============= =============
Note 3: Restructuring and Asset Impairment Charges
------------------------------------------
In the fourth quarter of fiscal 2001, the Company announced the acceleration of
certain cost cutting and infrastructure improvements and recorded a pre-tax
restructuring and asset impairment charge of $60,000 and reserve adjustments
related primarily to the exit of the Company's telephony operations of $5,300.
These related reserve adjustments were included in cost of goods sold and
selling and administrative expense in the consolidated statement of income. This
resulted in a charge of $65,300 ($49,235 after-tax, or $0.34 per share on a
diluted basis). These actions address the exit from the Company's telephony
operations in the United States and Europe, the closing of a number of
non-strategic digital print centers and further downsizing of operational
infrastructures throughout the organization as the Company leverages and
intensifies prior standardization and centralization initiatives. These actions
include the ongoing centralization and consolidation of many selling and
administrative functions, including marketplace consolidation, supply chain,
finance, customer service, sales support and the realignment of sales coverage
against our long-term growth objectives. Additionally, the Company recorded an
asset impairment charge of $3,582 ($3,300 after-tax, or $0.02 per share on a
diluted basis) related to the exit of the Company's technology education
operations. Therefore, the aggregate charge recorded in fiscal 2001 (the "Fiscal
2001 Charge") was $68,882 ($52,535 after-tax, or $0.36 per share on a diluted
basis). In fiscal 2000, the Company recorded a net restructuring and asset
impairment charge (the "Fiscal 2000 Charge") of $105,168 ($78,940 after-tax, or
$0.53 per share on a diluted basis).
All actions related to the Fiscal 2000 Charge are complete. Severance payments
to terminated employees are made in installments. The remaining balances of the
fiscal 2001 and 2000 severance charges are expected to be paid through fiscal
2003. The charges for contractual commitments relate to lease commitments where
the Company is exiting certain locations and/or businesses. The remaining
balances of the fiscal 2001 and 2000 charges for contractual commitments are
expected to be paid over the next several years.
The employees and locations affected by the Fiscal 2001 Charge described above
are as follows:
Remaining
Employees Employee Employees to
Affected Terminations be Terminated
- --------------------------------------------------------------------------------------------
Terminations 1,600 (943) 657
Remaining
Sites Sites Sites to
Affected Closed be Closed
- --------------------------------------------------------------------------------------------
Closures 24 (16) 8
The following presents a reconciliation of the original restructuring components
of the Fiscal 2001 Charge and Fiscal 2000 Charge from September 30, 2001 to the
balance remaining at March 31, 2002, which is included in other accrued expenses
on the consolidated balance sheet:
Balance Balance
September 30, Payments March 31,
Fiscal 2001 Restructuring Charge 2001 Fiscal 2002 2002
- -------------------------------------------------------------------------------------------
Severance $ 26,500 $ (5,317) $ 21,183
Contractual commitments 8,000 (1,788) 6,212
- -------------------------------------------------------------------------------------------
Total $ 34,500 $ (7,105) $ 27,395
- -------------------------------------------------------------------------------------------
Balance Balance
September 30, Payments March 31,
Fiscal 2000 Restructuring Charge 2001 Fiscal 2002 2002
- -------------------------------------------------------------------------------------------
Severance $ 2,023 $ (723) $ 1,300
Contractual commitments 10,026 (2,676) 7,350
- -------------------------------------------------------------------------------------------
Total $ 12,049 $ (3,399) $ 8,650
- -------------------------------------------------------------------------------------------
Note 4: Lease-Backed Notes
------------------
In addition to the $1,797,389 of lease-backed notes outstanding on September 30,
2001, on December 28, 2001, the Company issued $87,011 and re-purchased $12,460
of lease-backed notes (the "Notes") for a net issuance of $74,551. The Notes
have a stated maturity of September 15, 2008 and pay an average yield of 5.06%.
The Notes are collateralized by a pool of office equipment leases or contracts,
(the "Leases") and related assets, acquired or originated by the Company
(together with the equipment financing portion of each periodic lease or rental
payment due under the Leases on or after the related transfer date) and all
related casualty payments, retainable deposits and termination payments.
Payments on the Notes are made from payments on the Leases. The Notes have
certain credit enhancement features available to noteholders, including a
reserve account and an overcollateralization account.
Note 5: Asset Securitization Conduit Financing
--------------------------------------
During the six months ended March 31, 2002, the Company pledged or transferred
$362,216 in financing lease receivables for $242,336 in cash in connection with
its revolving asset securitization conduit financing agreements. On December 28,
2001, the Company repaid $70,000 in connection with its issuance of the Notes
described above. As of March 31, 2002, the Company had approximately $264,664
available under its revolving asset securitization conduit financing agreements.
Note 6: Comprehensive Income
--------------------
Total comprehensive income is as follows:
Three Months Ended Six Months Ended
March 31, March 31,
------------------------------- ------------------------------------
2002 2001 2002 2001
------------- ------------- ---------------- ----------------
Net income $35,291 $16,730 $67,869 $34,109
Foreign currency translation adjustments (2,226) (5,278) (4,236) (7,047)
Cumulative effect of change in accounting
principle for derivative and hedging activities
(SFAS 133), net of tax benefit of $3,778 (5,584)
Net gain (loss) on derivative financial instruments,
net of tax expense (benefit) of:
$4,376 and $(5,116) for the three
months ended March 31, 2002 and 2001,
respectively; $7,000 and $(8,220) for the six
months ended March 31, 2002 and 2001,
respectively 6,564 (7,675) 10,501 (12,413)
------------- ------------- ---------------- ----------------
Total comprehensive income $39,629 $3,777 $74,134 $9,065
============= ============= ================ ================
Minimum pension liability is adjusted at each year end; therefore, there is no
impact on total comprehensive income during interim periods. The balances for
foreign currency translation, minimum pension liability and derivative financial
instruments included in accumulated other comprehensive loss in the consolidated
balance sheets were $(13,783), $(714) and $(19,873), respectively, at March 31,
2002 and $(14,406), $(714) and $(26,437), respectively, at September 30, 2001.
Note 7: Earnings Per Common Share
-------------------------
The following table sets forth the computation of basic and diluted earnings per
common share from continuing operations:
Three Months Ended Six Months Ended
March 31, March 31,
------------------------------- -------------------------------
2002 2001 2002 2001
------------- ------------- -------------- -------------
Numerator:
Income from continuing operations $35,291 $16,730 $67,869 $32,909
============= ============= ============== =============
Denominator:
Denominator for basic earnings per common share
- weighted average common shares 142,965 141,402 142,419 142,087
------------- ------------- -------------- -------------
Effect of dilutive securities:
Employee stock awards 438 119 442
Employee stock options 4,374 1,741 4,219 918
------------- ------------- -------------- -------------
Dilutive potential common shares 4,812 1,860 4,661 918
------------- ------------- -------------- -------------
Denominator for diluted earnings per
common share - adjusted weighted average
common shares and assumed conversions 147,777 143,262 147,080 143,005
------------- ------------- -------------- -------------
Basic earnings per common share from continuing
operations $0.25 $0.12 $0.48 $0.23
============= ============= ============== =============
Diluted earnings per common share from
continuing operations $0.24 $0.12 $0.46 $0.23
============= ============= ============== =============
Options to purchase 3,449 shares of common stock at $12.76 per share to $46.59
per share were outstanding during the second quarter of fiscal 2002 and options
to purchase 8,171 shares of common stock at $4.30 per share to $56.42 per share
were outstanding during the second quarter of fiscal 2001, but were not included
in the computation of diluted earnings per common share because the options'
prices were greater than the average market price of the common shares;
therefore, the effect would be antidilutive.
Note 8: Segment Reporting
-----------------
The table below presents segment information for the three months ended March
31, 2002 and 2001:
IKON Corporate
North IKON And
America Europe Other Eliminations Total
------------- ------------ ---------- -------------- --------------
Three Months Ended March 31, 2002
Revenues, excluding finance income $ 1,001,140 $ 109,248 $ 10,498 $ 1,120,886
Finance income 94,374 4,914 99,288
Operating income (loss) 119,068 5,400 (2,225) $ (52,581) 69,662
Interest expense (14,085) (14,085)
Income before taxes 55,577
Three Months Ended March 31, 2001
Revenues, excluding finance income $ 1,105,010 $ 112,141 $ 50,088 $ 1,267,239
Finance income 88,760 5,227 93,987
Operating income (loss) 95,821 4,990 (7,865) $ (43,949) 48,997
Interest expense (19,123) (19,123)
Income before taxes 29,874
The table below presents segment information for the six months ended March 31,
2002 and 2001:
IKON Corporate
North IKON And
America Europe Other Eliminations Total
------------- ------------ ---------- -------------- --------------
Six Months Ended March 31, 2002
Revenues, excluding finance income $ 1,982,676 $ 212,391 $ 37,739 $ 2,232,806
Finance income 187,955 9,862 197,817
Operating income (loss) 225,195 10,951 (8,327) $ (92,342) 135,477
Interest expense (28,596) (28,596)
Income before taxes 106,881
Six Months Ended March 31, 2001
Revenues, excluding finance income $ 2,165,047 $ 221,434 $ 105,442 $ 2,491,923
Finance income 176,994 10,360 187,354
Operating income (loss) 182,214 9,891 (14,183) $ (83,280) 94,642
Interest expense (35,877) (35,877)
Income before taxes 58,765
Note 9: Contingencies
-------------
The matter of Whetman, et al. v. IKON Office Solutions, Inc., et al. (the
"Claim") involves a claim brought under the Employee Retirement Income Security
Act of 1974 ("ERISA"). In connection with that Claim, the plaintiffs allege that
the Company and various individuals violated fiduciary duties under ERISA based
on allegedly improper investments in the Company's stock made through the
Company's Retirement Savings Plan (the "Plan"). The court certified a class with
respect to this claim consisting generally of all those participants in the Plan
after September 30, 1995 and through August 13, 1998, subject to certain
exceptions.
On May 14, 2002, the Company announced that, subject to court approval, it has
reached an agreement to settle the Claim. The Company is not making any monetary
payment to the class to settle the lawsuit, and the settlement does not reflect
any admission of liability by the Company. The Company has agreed to make
certain modifications to its Plan in order to allow participants greater
flexibility with respect to investment of the employer match portion of their
individual accounts. Under the settlement, employees who have been with the
Company for at least two years will be permitted to allocate Company matching
funds in investment options other than IKON stock, subject to vesting schedules.
The court has preliminarily approved the settlement. The court will hold a
hearing on the final approval of the settlement on August 8, 2002. It is
expected that plaintiffs' counsel will petition the court for an award of their
fees and costs of litigation, which, if awarded, will be paid by the Company.
Such payment is not expected to have a material financial impact on the Company.
The Company is involved in a number of environmental remediation actions to
investigate and clean up certain sites related to its discontinued operations in
accordance with applicable federal and state laws. Uncertainties about the
status of laws and regulations, technology and information related to individual
sites, including the magnitude of possible contamination, the timing and extent
of required corrective actions and proportionate liabilities of other
responsible parties, make it difficult to develop a meaningful estimate of
probable future remediation costs. While the actual costs of remediation at
these sites may vary from management's estimates because of these uncertainties,
the Company has established an accrual for known environmental obligations based
on management's best estimate of the aggregate environmental remediation
exposure on these sites. After consideration of the defenses available to the
Company, the accrual for such exposure, insurance coverage and other responsible
parties, management does not believe that its obligations to remediate these
sites would have a material adverse effect on the Company's consolidated
financial statements.
There are other contingent liabilities for taxes, guarantees, other lawsuits and
various other matters occurring in the ordinary course of business. On the basis
of information furnished by counsel and others, and after consideration of the
defenses available to the Company and any related reserves and insurance
coverage, management believes that none of these other contingencies will
materially affect the consolidated financial statements of the Company.
Note 10: Financial Instruments
---------------------
As of March 31, 2002, all of the Company's derivatives designated as hedges are
interest rate swaps which qualify for evaluation using the "short cut" method
for assessing effectiveness. As such, there is an assumption of no
ineffectiveness. The Company uses interest rate swaps to fix the interest rates
on its variable rate classes of lease-backed notes, which results in a lower
cost of capital than if we had issued fixed rate notes. During the six months
ended March 31, 2002, an unrealized gain totaling $10,501 after taxes, was
recorded in accumulated other comprehensive loss.
Note 11: Pending Accounting Changes
--------------------------
In June 2001, the FASB approved SFAS 143, "Accounting for Asset Retirement
Obligations." SFAS 143 addresses accounting for legal obligations associated
with the retirement of long-lived assets that result from the acquisition,
construction, development and the normal operation of a long-lived asset, except
for certain obligations of lessees. SFAS 143 requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset and subsequently allocated to expense over the asset's
useful life. SFAS 143 is effective for fiscal years beginning after June 15,
2002. The Company is currently evaluating the impact of the adoption of this
statement, but does not expect a material impact from the adoption of SFAS 143
on our consolidated financial statements.
In August 2001, the FASB approved SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS 144 supercedes SFAS 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of," and APB 30, "Reporting the Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions." SFAS 144 requires an impairment loss to be
recognized only if the carrying amounts of long-lived assets to be held and used
are not recoverable from their expected undiscounted future cash flows. SFAS 144
is effective for fiscal years beginning after December 15, 2001. The Company is
currently evaluating the impact of the adoption of this statement, but does not
expect a material impact from the adoption of SFAS 144 on our consolidated
financial statements.
Note 12: Subsequent Event
----------------
On May 13, 2002, IOSC issued $300,000 of convertible subordinated notes (the
"convertible notes") with an interest rate of 5.0%, which are due on May 1,
2007. The convertible notes can be converted into shares of IKON common stock at
any time before maturity at a conversion price of $15.03 per share. Interest
will be paid on the convertible notes semi-annually beginning November 1, 2002.
IOSC has also granted an option to purchase $50,000 aggregate principal amount
of additional convertible notes. IOSC intends to use the net proceeds to repay
loans due to IKON and for general corporate purposes.
Item 2: Management's Discussion and Analysis of Financial Condition and
Results of Operations
All dollar and share amounts are in thousands.
IKON Office Solutions, Inc. ("IKON" or "the Company") is one of the world's
leading providers of products and services that help businesses communicate.
IKON provides customers with total business solutions for every office,
production and outsourcing need, including copiers and printers, color
solutions, distributed printing, facilities management, imaging and legal
document solutions, as well as network design and consulting and e-business
development. IKON has locations worldwide, including locations in the United
States, Canada, Mexico and Europe. References herein to "we", "us" or "our"
refer to IKON and its subsidiaries unless the context specifically requires
otherwise.
Critical Accounting Policies
- ----------------------------
In response to the SEC's Release No. 33-8040, "Cautionary Advice Regarding
Disclosure About Critical Accounting Policies," we have identified below some of
the accounting principles critical to our business and results of operations. We
determined the critical principles by considering accounting policies that
involve the most complex or subjective decisions or assessments. We state these
accounting policies in Management's Discussion and Analysis of Financial
Condition and Results of Operations and in the Notes to the consolidated
financial statements contained in our Annual Report on Form 10-K for our fiscal
year ended September 30, 2001, as amended, and at relevant sections in this
discussion and analysis. In addition, we believe our most critical accounting
policies include, but are not limited to, the following:
Revenue Recognition. Revenues are recognized when products are delivered to and
accepted by the customer or services are performed. Revenues from service
contracts and rentals are recognized over the term of the contract. The present
value of payments due under sales-type lease contracts is recorded as revenue
and cost of goods sold is charged with the book value of the equipment when
products are delivered to and accepted by the customer. Finance income is
recognized over the related lease term.
Goodwill. IKON evaluates goodwill in accordance with Statement of Financial
Accounting Standards ("SFAS") 142, by comparing expected future discounted cash
flows to the carrying amount of the goodwill. If future discounted cash flows
are less favorable than those anticipated, goodwill may be impaired.
Inventories. Inventories are stated at the lower of cost or market using the
average cost or specific identification methods and consist of finished goods
available for sale. IKON writes down its inventory for estimated obsolescence or
unmarketable inventory equal to the difference between the cost of inventory and
estimated market value based upon assumptions about future demand and market
conditions. If actual market conditions are less favorable than those
anticipated, inventory adjustments may be required.
Reserves. IKON maintains allowances for doubtful accounts and lease defaults for
estimated losses resulting from the inability of its customers to make required
payments. If the financial condition of IKON's customers were to deteriorate,
resulting in an impairment of their ability to make required payments, changes
to our allowances may be required.
Income Taxes. Income taxes are determined in accordance with SFAS 109, which
requires recognition of deferred income tax liabilities and assets for the
expected future tax consequences of events that have been included in the
consolidated financial statements or tax returns. Under this method, deferred
income tax liabilities and assets are determined based on the difference between
financial statement and tax basis of liabilities and assets using enacted tax
rates in effect for the year in which the differences are expected to reverse.
SFAS 109 also provides for the recognition of deferred tax assets if it is more
likely than not that the assets will be realized in future years. A valuation
allowance has been established for deferred tax assets for which realization is
not likely. In assessing the valuation allowance, IKON has considered future
taxable income and ongoing prudent and feasible tax planning strategies.
However, in the event that IKON determines the value of a deferred tax asset has
fluctuated from its net recorded amount, an adjustment to the deferred tax asset
would be necessary.
Pension. Certain assumptions are used in the calculation of the actuarial
valuation of our Company-sponsored defined benefit pension plans. These
assumptions include the weighted average discount rate, rates of increase in
compensation levels and expected long-term rates of return on assets. If actual
results are less favorable than those assumed, additional pension expense may be
required.
Residual Values. IKON estimates the residual value of equipment sold under
sales-type leases. Our residuals are based on the dollar value of the equipment.
Residual values generally range between 0% to 25% of retail price, depending on
equipment model and lease term. We evaluate residual values quarterly for
impairment. Changes in market conditions could cause actual residual values to
differ from estimated values, which could accelerate write-down of the value of
the equipment.
Our preparation of this Quarterly Report on Form 10-Q requires us to make
estimates and assumptions that affect amounts reported in the consolidated
financial statements and notes. Actual results could differ from those estimates
and assumptions.
Results of Operations
- ---------------------
This discussion reviews the results of operations of the Company as reported in
the consolidated statements of income.
Three Months Ended March 31, 2002
Compared to the Three Months Ended March 31, 2001
Results of operations for the second quarter of fiscal 2002, compared to the
second quarter of fiscal 2001, were as follows:
Our second quarter revenues decreased by $141,052, or 10.4%, compared to the
second quarter of fiscal 2001. This resulted primarily from decreases in net
sales and service and rentals revenues.
Net sales, which includes revenues from the sale of copier/printer equipment,
supplies and technology hardware, decreased by $113,278, or 16.1%, compared to
the second quarter of fiscal 2001. The decrease was primarily attributable to a
decline in sales of technology hardware, copier/printer equipment and supplies.
The Company has been de-emphasizing sales of technology hardware as part of its
margin improvement strategy as it shifts technology resources within the Company
from hardware sales to support customer opportunities involving connectivity and
document management consulting. Sales of copier/printer equipment declined due
to ongoing economic and competitive pressures. In addition, these results also
reflect the decline in the sale of lower-end devices as the Company continues to
realign its product mix to enhance margins and improve overall profitability.
Sales of higher-end, segment 5 and 6 equipment and production color equipment,
continued to demonstrate strong growth compared to the prior year.
Service and rentals, which includes revenues from the servicing of
copier/printer equipment, outsourcing and other services, decreased by $33,075,
or 5.9%, compared to the second quarter of fiscal 2001. Copier/printer service
revenues increased slightly from the prior year due to product mix strategies
focused on improving aftermarket revenue streams, including strategies to
promote higher-end products and digital connectivity to increase copy volumes.
Outsourcing and other services declined from the prior year primarily due to the
downsizing, sale, and closure of certain non-strategic businesses. Facilities
management, the Company's largest outsourcing offering, continued to grow in the
quarter, despite a slight slowdown in customer activity due to general economic
conditions.
Finance income increased by $5,301, or 5.6%, compared to the second quarter of
fiscal 2001, primarily due to continued growth in the lease receivables
portfolio and longer average lease terms. During the second quarter of fiscal
2002, approximately 78% of IKON North America's copier and equipment revenues
were financed by our captive finance subsidiary, IOS Capital, LLC ("IOSC"),
compared to approximately 71% during the second quarter of fiscal 2001.
Overall gross margin was 38.6% compared to 37.3% in the second quarter of fiscal
2001. The gross margin on net sales decreased to 33.9% from 34.6% in the second
quarter of fiscal 2001. This was primarily due to the decline in supply sales
margins. The gross margin on service and rentals increased to 39.3% from 38.0%
in the second quarter of fiscal 2001, primarily due to stronger margins on
equipment service which reflects the improved productivity of our service
technicians. The gross margin on finance income increased to 62.7% from 52.8% in
the second quarter of fiscal 2001, primarily due to the effect of a higher
average portfolio yield and lower average borrowing rates compared to the second
quarter of fiscal 2001.
Selling and administrative expense as a percent of revenue was 32.9% in the
second quarter of fiscal 2002 compared to 33.7% in the second quarter of fiscal
2001 representing a decrease of $57,089. The elimination of goodwill
amortization under SFAS 142 accounted for approximately $10,000 of the decrease.
The remaining decrease is the result of downsizing, sale and closure of certain
non-strategic businesses, operational infrastructure improvements, continued
centralization of business processes, reduced selling costs due to lower
revenues, improvements in the structure of the sales organization and ongoing
expense control measures.
Our operating income increased by $20,665 compared to the second quarter of
fiscal 2001. Our operating margin was 5.7% in the second quarter of fiscal 2002
compared to 3.6% (4.4% excluding the impact of goodwill amortization) in the
second quarter of fiscal 2001.
Interest expense was $14,085 in the second quarter of fiscal 2002 compared to
$19,123 in the second quarter of fiscal 2001. The decrease was due to lower
average outstanding debt combined with lower average short-term borrowing rates
compared to the second quarter of fiscal 2001.
The effective income tax rate was 36.5% in the second quarter of fiscal 2002
compared to 44% in the second quarter of fiscal 2001. The income tax rate
reduction is primarily due to the cessation of goodwill amortization, the
majority of which was non-deductible for tax purposes, as a result of our
adoption of SFAS 142 effective October 1, 2001. The completion of certain tax
planning initiatives during the first quarter of fiscal 2002 also contributed to
the reduced tax rate.
Diluted earnings per common share were $0.24 in the second quarter of fiscal
2002 compared to $0.12 in the second quarter of fiscal 2001. Excluding the
impact of goodwill amortization, diluted earnings per common share in the second
quarter of fiscal 2001 would have been $0.19.
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS 142.
SFAS 142 supercedes APB 17, Intangible Assets and primarily addresses accounting
for goodwill and intangible assets subsequent to their acquisition. The
provisions of SFAS 142 are effective for fiscal years beginning after December
15, 2001, with early adoption permitted. The most significant changes made by
SFAS 142 were: (1) goodwill and indefinite lived intangible assets will no
longer be amortized, (2) goodwill will be tested for impairment at least
annually at the reporting unit level, (3) intangible assets deemed to have an
indefinite life will be tested for impairment at least annually, and (4) the
amortization period of intangible assets with finite lives will no longer be
limited to forty years. Effective October 1, 2001, the Company adopted SFAS 142,
which requires that goodwill not be amortized, but instead tested at least
annually for impairment. An impairment charge will be recognized only when the
implied fair value of a reporting unit, including goodwill, is less than its
carrying amount. The Company calculates fair value using a discounted cash flow
model. As of March 31, 2002, the Company completed its initial impairment review
and determined that no impairment charge was required. The Company has
identified the following reporting units and associated goodwill:
IKON North
IKON North America Business Sysinct
America Copier Outsourcing Imaging (e-business
Business Business IKON Europe Services development) Total
----------------------------------------------------------------------------------------------------
March 31, 2002
Goodwill $866,514 $70,927 $305,633 $9,011 $2,996 $1,255,081
Changes in the goodwill balance since September 30, 2001 are attributable to
foreign currency translation adjustments.
As required by SFAS 142, intangibles with finite lives continue to be amortized.
The Company has non-compete agreements with a net book value of $811 at March
31, 2002, which will be fully amortized during fiscal 2002.
A reconciliation of reported net income adjusted to reflect the adoption of SFAS
142 is provided below:
Three Months Ended
March 31, March 31,
2002 2001
------------- -------------
Reported net income $35,291 $16,730
Add-back goodwill amortization, net of taxes of $242 10,365
------------- -------------
Adjusted net income $35,291 $27,095
============= =============
Reported basic earnings per common share $0.25 $0.12
Add-back goodwill amortization 0.07
------------- -------------
Adjusted basic earnings per common share $0.25 $0.19
============= =============
Reported diluted earnings per common share $0.24 $0.12
Add-back goodwill amortization 0.07
------------- -------------
Adjusted diluted earnings per common share $0.24 $0.19
============= =============
Review of Business Segments
- ---------------------------
IKON North America
Revenues, excluding finance income, decreased by $103,870, or 9.4%, to
$1,001,140 in the second quarter of fiscal 2002 from $1,105,010 in the second
quarter of fiscal 2001. The decrease was primarily due to a decline in revenue
from sales of technology hardware and copier/printer equipment as a result of
strategic initiatives to de-emphasize certain low margin products as well as
ongoing economic and competitive pressures. This decrease was slightly offset by
increases in revenue from facilities management and the sale of high-end,
segment 5 and 6 copier/printer equipment as well as production color equipment.
Finance income increased by $5,614, or 6.3%, to $94,374 in the second quarter of
fiscal 2002, from $88,760 in the second quarter of fiscal 2001. The increase was
primarily due to growth in the lease receivables portfolio and longer average
lease terms. Operating income increased by $23,247, or 24.3%, to $119,068 in the
second quarter of fiscal 2002 from $95,821 in the second quarter of fiscal 2001.
The increase was due to higher gross margins on service and rentals and finance
income and reduced selling and administrative costs as discussed above.
IKON Europe
Revenues, excluding finance income, decreased by $2,893, or 2.6%, to $109,248 in
the second quarter of fiscal 2002 from $112,141 in the second quarter of fiscal
2001. This decrease was due mainly to a decrease in revenues from sales of
technology hardware and copier/printer equipment, offset by growth in
outsourcing. Finance income decreased by $313, or 6.0%, to $4,914 in the second
quarter of fiscal 2002 from $5,227 in the second quarter of fiscal 2001.
Operating income increased by $410, or 8.2%, to $5,400 in the second quarter of
fiscal 2002 from $4,990 in the second quarter of fiscal 2001, due primarily to
ongoing improvements to our operational infrastructure.
Other
Other revenues decreased by $39,590, or 79.0%, to $10,498 in the second quarter
of fiscal 2002 from $50,088 in the second quarter of fiscal 2001. The decline is
primarily due to the downsizing, sale, and closure of certain non-strategic
businesses such as telephony and technology education. There was an operating
loss of $2,225 in the second quarter of fiscal 2002 compared to an operating
loss of $7,865 in the second quarter of fiscal 2001. The decrease in operating
loss reflects the impact of the actions described above concerning certain
non-strategic businesses from our operations.
Six Months Ended March 31, 2002
Compared to the Six Months Ended March 31, 2001
Results of operations for the six months ended March 31, 2002, compared to the
six months ended March 31, 2001, were as follows:
Our revenues decreased by $248,654, or 9.3%, compared to the six months ended
March 31, 2001. This resulted primarily from decreases in net sales and service
and rentals revenues.
Net sales, which includes revenues from the sale of copier/printer equipment,
supplies and technology hardware, decreased by $199,352, or 14.7%, compared to
the six months ended March 31, 2001. The decrease was primarily due to a decline
in sales of technology hardware and copier/printer equipment. The Company has
been de-emphasizing sales of technology hardware as part of its margin
improvement strategy as it shifts technology resources within the Company from
hardware sales to support other customer opportunities. Sales of copier/printer
equipment declined due to ongoing economic and competitive pressures as well as
the Company's strategic focus on moving from sales of low-end, lower margin
products to high-end, higher margin products, in addition to a focus on larger
regional and national accounts which entail a longer sales cycle.
Service and rentals, which includes revenues from the servicing of
copier/printer equipment, outsourcing and other services, decreased by $59,765,
or 5.3%, compared to the six months ended March 31, 2001. This was due to a
decrease in outsourcing and other services, partially offset by growth in
equipment service. Revenues from outsourcing and other services declined from
the prior year due primarily to the downsizing, sale, and closure of certain
non-strategic businesses. Revenues from facilities management, which is included
in outsourcing, continued to grow and offset some of the decline.
Finance income increased by $10,463, or 5.6%, compared to the six months ended
March 31, 2001, primarily due to continued growth in the lease receivables
portfolio and longer average lease terms. During the six months ended March 31,
2002, approximately 78% of IKON North America's copier and equipment revenues
were financed by our captive finance subsidiary, IOS Capital, LLC ("IOSC")
compared to approximately 72% during the six months ended March 31, 2001.
Overall gross margin was 38.6% compared to 37.4% in the six months ended March
31, 2001. The gross margin on net sales was 34.1% for the six months ended March
31, 2002 and 2001. The gross margin on service and rentals increased to 39.5%
from 39.0% in the six months ended March 31, 2001, primarily due to stronger
margins on equipment service which reflects the improved productivity of our
service technicians. The gross margin on finance income increased to 62.7% from
52.8% in the second quarter of fiscal 2001, primarily due to the effect of a
higher average portfolio yield and lower average borrowing rates compared to the
six months ended March 31, 2001.
Selling and administrative expense as a percent of revenue was 33.0% in the six
months ended March 31, 2002 compared to 33.9% in the six months ended March 31,
2001. The elimination of goodwill amortization under SFAS 142 accounted for
approximately $20,000 of the decrease. The remaining decrease is the result of
downsizing, sale, and closure of certain non-strategic businesses; operational
infrastructure improvements and continued centralization of business processes;
reduced selling costs due to lower revenues and improvements in the structure of
the sales organization; and ongoing expense control measures.
Our operating income increased by $40,835 compared to the six months ended March
31, 2001. Our operating margin was 5.6% in the six months ended March 31, 2002
compared to 3.5% (4.3% excluding the impact of goodwill amortization) in the six
months ended March 31, 2001.
Interest expense was $28,596 in the six months ended March 31, 2002 compared to
$35,877 in the six months ended March 31, 2001. The decrease was due to lower
average outstanding debt combined with lower average short-term borrowing rates
compared to the six months ended March 31, 2001.
The effective income tax rate was 36.5% in the six months ended March 31, 2002
compared to 44% in the six months ended March 31, 2001. The income tax rate
reduction is primarily due to the cessation of goodwill amortization, the
majority of which was non-deductible for tax purposes, as a result of our
adoption of SFAS 142 effective October 1, 2001. The completion of certain tax
planning initiatives during the first quarter of fiscal 2002 also contributed to
the reduced tax rate.
In the first six months of fiscal 2001, we recognized a gain of $2,142 ($1,200
after-tax) related to net favorable dispositions of environmental matters at
locations we had previously accounted for as discontinued operations.
Diluted earnings per common share were $0.46 in the six months ended March 31,
2002 compared to $0.24 ($0.23 excluding the after-tax effect of the gain from
discontinued operations) in the six months ended March 31, 2001. Excluding the
impact of goodwill amortization, diluted earnings per common share for the six
months ended March 31, 2001 would have been $0.38 ($0.37 excluding the after-tax
effect of the gain from discontinued operations).
A reconciliation of reported net income adjusted to reflect the adoption of SFAS
142 is provided below:
Six Months Ended
March 31, March 31,
2002 2001
---------------- ----------------
Reported net income $67,869 $34,109
Add-back goodwill amortization, net of taxes of $475 20,366
---------------- ----------------
Adjusted net income $67,869 $54,475
================ ================
Reported basic earnings per common share $0.48 $0.24
Add-back goodwill amortization 0.14
---------------- ----------------
Adjusted basic earnings per common share $0.48 $0.38
================ ================
Reported diluted earnings per common share $0.46 $0.24
Add-back goodwill amortization 0.14
---------------- ----------------
Adjusted diluted earnings per common share $0.46 $0.38
================ ================
Review of Business Segments
- ---------------------------
IKON North America
Revenues, excluding finance income, decreased by $182,371, or 8.4%, to
$1,982,676 for the first six months of fiscal 2002 from $2,165,047 for the first
six months of fiscal 2001. The decrease was primarily due to a decline in
revenue from sales of technology hardware and copier/printer equipment as a
result of strategic initiatives to de-emphasize certain low margin products as
well as ongoing economic and competitive pressures. This decrease was slightly
offset by increases in revenue from facilities management and the sale of
high-end, segment 5 and 6 copier/printer equipment as well as production color.
Finance income increased by $10,961, or 6.2%, to $187,955 for the first six
months of fiscal 2002, from $176,994 for the first six months of fiscal 2001.
The increase was primarily due to growth in the lease receivables portfolio and
longer average lease terms. Operating income increased by $42,981, or 23.6%, to
$225,195 for the first six months of fiscal 2002 from $182,214 for the first six
months of fiscal 2001. The increase was due to higher gross margins on service
and rentals and finance income and reduced selling and administrative costs as
discussed above.
IKON Europe
Revenues, excluding finance income, decreased by $9,043, or 4.1%, to $212,391
for the first six months of fiscal 2002 from $221,434 for the first six months
of fiscal 2001. This decrease was due mainly to a decline in revenues from sales
of technology hardware and copier/printer equipment, offset by growth in
outsourcing. Finance income decreased by $498, or 4.8%, to $9,862 for the first
six months of fiscal 2002 from $10,360 for the first six months of fiscal 2001.
Operating income increased by $1,060, or 10.7%, to $10,951 for the first six
months of fiscal 2002 from $9,891 for the first six months of fiscal 2001, due
primarily to the ongoing improvements to our operational infrastructure.
Other
Other revenues decreased by $67,703, or 64.2%, to $37,739 for the first six
months of fiscal 2002 from $105,442 for the first six months of fiscal 2001. The
decline is primarily due to the downsizing, sale, and closure of certain
non-strategic businesses such as telephony and technology education. There was
an operating loss of $8,327 for the first six months of fiscal 2002 compared to
an operating loss of $14,183 for the first six months of fiscal 2001. The
decrease in operating loss reflects the impact of the actions described above
concerning certain non-strategic businesses from our operations.
Restructuring and Asset Impairment Charges
- ------------------------------------------
In the fourth quarter of fiscal 2001, the Company announced the acceleration of
certain cost cutting and infrastructure improvements and recorded a pre-tax
restructuring and asset impairment charge of $60,000 and reserve adjustments
related primarily to the exit of the Company's telephony operations of $5,300.
These related reserve adjustments were included in cost of goods sold and
selling and administrative expense in the consolidated statement of income. This
resulted in a charge of $65,300 ($49,235 after-tax, or $0.34 per share on a
diluted basis). These actions address the exit from the Company's telephony
operations in the United States and Europe, the closing of a number of
non-strategic digital print centers and further downsizing of operational
infrastructures throughout the organization as the Company leverages and
intensifies prior standardization and centralization initiatives. These actions
include the ongoing centralization and consolidation of many selling and
administrative functions, including marketplace consolidation, supply chain,
finance, customer service, sales support and the realignment of sales coverage
against our long-term growth objectives. Additionally, the Company recorded an
asset impairment charge of $3,582 ($3,300 after-tax, or $0.02 per share on a
diluted basis) related to the exit of the Company's technology education
operations. Therefore, the aggregate charge recorded in fiscal 2001 (the "Fiscal
2001 Charge") was $68,882 ($52,535 after-tax, or $0.36 per share on a diluted
basis). In fiscal 2000, the Company recorded a net restructuring and asset
impairment charge (the "Fiscal 2000 Charge") of $105,168 ($78,940 after-tax, or
$0.53 per share on a diluted basis).
All actions related to the Fiscal 2000 Charge are complete. Severance payments
to terminated employees are made in installments. The remaining balances of the
fiscal 2001 and 2000 severance charges are expected to be paid through fiscal
2003. The charges for contractual commitments relate to lease commitments where
the Company is exiting certain locations and/or businesses. The remaining
balances of the fiscal 2001 and 2000 charges for contractual commitments are
expected to be paid over the next several years.
The employees and locations affected by the Fiscal 2001 Charge described above
are as follows:
Remaining
Employees Employee Employees to
Affected Terminations be Terminated
- ---------------------------------------------------------------------------------------------
Terminations 1,600 (943) 657
Remaining
Sites Sites Sites to
Affected Closed be Closed
- ---------------------------------------------------------------------------------------------
Closures 24 (16) 8
The following presents a reconciliation of the original restructuring components
of the Fiscal 2001 Charge and Fiscal 2000 Charge from September 30, 2001 to the
balance remaining at March 31,2002, which is included in other accrued expenses
on the consolidated balance sheet:
Balance Balance
September 30, Payments March 31,
Fiscal 2001 Restructuring Charge 2001 Fiscal 2002 2002
- -------------------------------------------------------------------------------------------
Severance $ 26,500 $ (5,317) $ 21,183
Contractual commitments 8,000 (1,788)
6,212
- -------------------------------------------------------------------------------------------
Total $ 34,500 $ (7,105) $ 27,395
- -------------------------------------------------------------------------------------------
Balance Balance
September 30, Payments March 31,
Fiscal 2000 Restructuring Charge 2001 Fiscal 2002 2002
- -------------------------------------------------------------------------------------------
Severance $ 2,023 $ (723) $ 1,300
Contractual commitments 10,026 (2,676) 7,350
- -------------------------------------------------------------------------------------------
Total $ 12,049 $ (3,399) $ 8,650
- -------------------------------------------------------------------------------------------
Financial Condition and Liquidity
- ---------------------------------
Net cash provided by operating activities for the first six months of fiscal
2002 was $194,143. During the same period, the Company used $122,331 of cash for
investing activities, which included net finance subsidiary use of $54,455,
capital expenditures for property and equipment of $48,657 and capital
expenditures for equipment on operating leases of $39,497. Cash used in
financing activities of $47,975, includes repayments of $9,090 of non-finance
subsidiaries' long-term debt and net repayments of $153,079 of finance
subsidiaries' debt. Debt, excluding finance subsidiaries, was $908,249 at March
31, 2002, an increase of $107,310 from the debt balance of $800,939 at September
30, 2001. Excluding finance subsidiaries' debt and the impact of short-term
loans to and from our finance subsidiaries, our debt to capital ratio was 28% at
March 31, 2002 compared to 31% at September 30, 2001. Finance subsidiaries' debt
is excluded from the calculation because substantially all of this debt is
backed by a portion of the lease receivables portfolio. Restricted cash on the
consolidated balance sheets primarily represents cash collected on certain
finance receivables, which must be used to repay certain lease-backed notes.
As of March 31, 2002, short-term borrowings under a $600,000 credit agreement
totaled $282,168. The Company also has $700,000 available for either stock or
debt offerings under a shelf registration statement filed with the Securities
and Exchange Commission.
As of March 31, 2002, finance subsidiaries' debt decreased by $158,824 from
September 30, 2001. During the six months ended March 31, 2002, our finance
subsidiaries repaid $557,100 of debt and received $404,021 from the issuance of
lease-backed notes and other debt instruments. As of March 31, 2002, IOSC, our
Canadian finance subsidiary and our United Kingdom finance subsidiary had
approximately $264,664, CN$48,447 and (pound)23,094 available under their
revolving asset securitization financing agreements. IOSC has $873,350 available
under a shelf registration statement filed with the Securities and Exchange
Commission. IKON Receivables Funding, LLC, has $2,500,000 available under a
shelf registration statement filed with the Securities and Exchange Commission.
The Company uses interest rate swaps to fix the interest rates on its variable
rate classes of lease-backed notes, which results in a lower cost of capital
than if we had issued fixed rate notes. During the six months ended March 31,
2002, unrealized gains totaling $10,501 after taxes, was recorded in accumulated
other comprehensive loss. As of March 31, 2002, all of the Company's derivatives
designated as hedges are interest rate swaps which qualify for evaluation using
the "short cut" method for assessing effectiveness. As such, there is an
assumption of no ineffectiveness.
The Company has also filed several shelf registration statements with the
Securities and Exchange Commission to register the sale of 25,000 shares of
common stock. Shares issued under the registration statements may be used for
acquisitions. Approximately 18,970 shares have been issued under these shelf
registrations through March 31, 2002, leaving approximately 6,030 shares
available for issuance.
During the first six months of fiscal 2002, the Company repurchased 21 shares of
its common stock. From time to time, the Retirement Savings Plan of the Company
may acquire shares of the common stock of the Company in open market
transactions or from treasury shares held by the Company.
The following summarizes IKON's significant contractual obligations and
commitments as of March 31, 2002:
Payments Due by Period
Less Than
Contractual Obligations Total 1 year 1 - 3 years 4 - 5 years After 5 years
- ----------------------------------------------------------------------------------------------------------------------
Long-Term Debt $609,396 $13,473 $130,081 $55,709 $410,133
Long-Term Debt, Finance
Subsidiaries 2,436,915 1,292,784 1,052,788 88,124 3,219
Notes Payable 298,853 298,853
Purchase Commitments 33,497 16,017 17,480
Operating Leases 177,139 33,081 63,434 36,441 44,183
Synthetic Leases 41,901 23,901 18,000
- ----------------------------------------------------------------------------------------------------------------------
Total $3,597,701 $1,678,109 $1,263,783 $198,274 $457,535
Payments on long-term debt, finance subsidiaries are made from collections on
our finance receivables. At March 31, 2002, long-term debt, finance subsidiaries
was $2,436,915 and finance receivables were $3,358,930.
Purchase commitments represent future cash payments related to our
implementation of the Oracle e-business suite. Contractual obligations for
future technical support of $18,015 will be expensed over the term of the
contract. The remaining $15,482 is for software and is included in fixed assets
and accrued liabilities as of March 31, 2002.
Synthetic leases are not required to be recorded on the Company's balance sheet.
The payments above represent the contractual obligation due at the end of the
lease period and will be paid from proceeds received from the sale of the
properties related to the synthetic leases. IKON obtains valuations of leased
properties structured as synthetic leases. If market conditions result in a
valuation that is less than the guaranteed residual value of the property, IKON
may be required to record a charge to income. Any current shortfall between the
contractual obligation and the estimated fair value of the leased assets has
been accrued as of December 31, 2001.
Amount of Commitment Expiration Per Period
Less Than
Contractual Obligations Total 1 year 1 - 3 years 4 - 5 years After 5 years
- ------------------------------------------------------------------------------------------------------------------------
Lines of Credit $633,923 $633,923
Standby Letters of Credit 28,313 28,313
- ------------------------------------------------------------------------------------------------------------------------
Total $662,236 $662,236
The Company believes that its operating cash flow together with unused bank
credit facilities and other financing arrangements will be sufficient to finance
current operating requirements for fiscal 2002, including capital expenditures,
dividends and the remaining accrued costs associated with the Company's
restructuring charges.
Subsequent Event
- ----------------
On May 13, 2002, IOSC issued $300,000 of convertible subordinated notes (the
"convertible notes") with an interest rate of 5.0%, which are due on May 1,
2007. The convertible notes can be converted into shares of IKON common stock at
any time before maturity at a conversion price of $15.03 per share. Interest
will be paid on the convertible notes semi-annually beginning November 1, 2002.
IOSC has also granted an option to purchase $50,000 aggregate principal amount
of additional convertible notes. IOSC intends to use the net proceeds to repay
loans due to IKON and for general corporate purposes.
Pending Accounting Changes
- --------------------------
In June 2001, the FASB approved SFAS 143, "Accounting for Asset Retirement
Obligations." SFAS 143 addresses accounting for legal obligations associated
with the retirement of long-lived assets that result from the acquisition,
construction, development and the normal operation of a long-lived asset, except
for certain obligations of lessees. SFAS 143 requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset and subsequently allocated to expense over the asset's
useful life. SFAS 143 is effective for fiscal years beginning after June 15,
2002. The Company is currently evaluating the impact of the adoption of this
statement, but does not expect a material impact from the adoption of SFAS 143
on our consolidated financial statements.
In August 2001, the FASB approved SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS 144 supercedes SFAS 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of," and APB 30, "Reporting the Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions." SFAS 144 requires an impairment loss to be
recognized only if the carrying amounts of long-lived assets to be held and used
are not recoverable from their expected undiscounted future cash flows. SFAS 144
is effective for fiscal years beginning after December 15, 2001. The Company is
currently evaluating the impact of the adoption of this statement, but does not
expect a material impact from the adoption of SFAS 144 on our consolidated
financial statements.
Item 3: Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk:
Our exposure to market risk for changes in interest rates relates primarily to
our long-term debt. We have no cash flow exposure due to interest rate changes
for long-term debt obligations as the Company uses interest rate swaps to fix
the interest rates on our variable rate classes of lease-backed notes and other
debt obligations. We primarily enter into debt obligations to support general
corporate purposes, including capital expenditures, working capital needs and
acquisitions. Finance subsidiaries' long-term debt is used primarily to fund the
lease receivables portfolio. The carrying amounts for cash and cash equivalents,
accounts receivable and notes payable reported in the consolidated balance
sheets approximate fair value. Additional disclosures regarding interest rate
risk are set forth in the Company's 2001 Annual Report on Form 10-K/A filed with
the Securities and Exchange Commission.
Foreign Exchange Risk:
The Company has various non-U.S. operating locations which expose it to foreign
currency exchange risk. Foreign denominated intercompany debt borrowed in one
currency and repaid in another may be fixed via currency swap agreements.
Additional disclosures regarding foreign exchange risk are set forth in the
Company's 2001 Annual Report on Form 10-K/A filed with the Securities and
Exchange Commission.
PART II. OTHER INFORMATION
- ---------------------------
Item 1: Legal Proceedings
The matter of Whetman, et al. v. IKON Office Solutions, Inc., et al. (the
"Claim") involves a claim brought under the Employee Retirement Income Security
Act of 1974 ("ERISA"). In connection with that Claim, the plaintiffs allege that
the Company and various individuals violated fiduciary duties under ERISA based
on allegedly improper investments in the Company's stock made through the
Company's Retirement Savings Plan (the "Plan"). The court certified a class with
respect to this claim consisting generally of all those participants in the Plan
after September 30, 1995 and through August 13, 1998, subject to certain
exceptions.
On May 14, 2002, the Company announced that, subject to court approval, it has
reached an agreement to settle the Claim. The Company is not making any monetary
payment to the class to settle the lawsuit, and the settlement does not reflect
any admission of liability by the Company. The Company has agreed to make
certain modifications to its Plan in order to allow participants greater
flexibility with respect to investment of the employer match portion of their
individual accounts. Under the settlement, employees who have been with the
Company for at least two years will be permitted to allocate Company matching
funds in investment options other than IKON stock, subject to vesting schedules.
The court has preliminarily approved the settlement. The Court will hold a
hearing on the final approval of the settlement on August 8, 2002. It is
expected that plaintiffs' counsel will petition the court for an award of their
fees and costs of litigation, which, if awarded, will be paid by the Company.
Such payment is not expected to have a material financial impact on the Company.
Item 4: Submission of Matters to a Vote of Security Holders
On February 26, 2002, the Company held its annual meeting of shareholders at
which time eight directors were elected to hold office until the election of
their successors.
For Withheld
------------- -------------
Judith M. Bell 122,709 10,063
Philip E. Cushing 128,137 4,635
James J. Forese 127,735 5,037
Thomas R. Gibson 128,115 4,657
Richard A. Jalkut 128,079 4,693
Arthur E. Johnson 128,024 4,748
Kurt M. Landgraf 128,035 4,737
Marilyn M. Ware 122,992 9,780
Item 6: Exhibits and Reports on Form 8-K
a) Exhibits
10.1 Executive Employment Contract for Dennis P. LeStrange.
10.2 Executive Employment Contract for Cathy L. Lewis.
10.3 Executive Employment Contract for Don H. Liu.
10.4 Executive Employment Contract for Beth Sexton.
10.5 Executive Employment Contract for William S. Urkiel.
10.6 Executive Employment Contract for David M. Gadra.
b) Reports on Form 8-K
On January 30, 2002, the Company filed a Current Report on Form 8-K to file,
under Item 5 of the Form, information contained in its press release dated
January 25, 2002 regarding its results for the first quarter of fiscal 2002.
On March 15, 2002, the Company filed a Current Report on Form 8-K to file, under
Item 5 of the Form, information contained in its press release dated March 13,
2002 regarding the initiation of a transition plan to new leadership.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized. This report has also been signed by the
undersigned in his capacity as the chief accounting officer of the Registrant.
IKON OFFICE SOLUTIONS, INC.
Date May 15, 2002 /s/ William S. Urkiel
---------------- ----------------------------
William S. Urkiel
Senior Vice President and
Chief Financial Officer