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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, 2003 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 Identification No.)
incorporation or organization)
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
------ -----
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
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 13, 2003:
Common Stock, no par value 144,802,046 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, 2003 (unaudited)
and September 30, 2002
Consolidated Statements of Income--Three and six months ended March 31, 2003
and 2002 (unaudited)
Consolidated Statements of Cash Flows--Six months ended March 31, 2003
and 2002 (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
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
2
FORWARD-LOOKING INFORMATION
IKON Office Solutions, Inc. ("we", "us", "our", "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 our productivity and infrastructure
initiatives; developing and expanding strategic alliances and partnerships; the
impact of e-commerce and e-procurement initiatives; the implementation of
e-IKON; 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. References
herein to "we", "us", "our", "IKON", or the "Company" refer to IKON and its
subsidiaries unless the context specifically requires otherwise.
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 Company 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 Company assumes no
obligations and 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/or to the Company); delays, difficulties,
management transitions and employment issues associated with consolidations
and/or changes in business operations; 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. IKON operates in a highly competitive environment. A number of
companies worldwide with significant financial resources compete with IKON to
provide similar products and services, such as Canon, Ricoh, Danka, Pitney Bowes
and Xerox. Our competitors may be positioned to offer more favorable product and
service terms to the marketplace, resulting in reduced profitability and loss of
market share for IKON. Some of our competitors are also suppliers to IKON of the
products we sell, service and lease. Competition is based largely upon
technology, performance, pricing, quality, reliability, distribution, customer
service and support. In addition, we compete against smaller local independent
office products distributors. Financial pressures faced by our competitors may
cause them to engage in uneconomic pricing practices, which could cause the
prices that IKON is able to charge in the future for its products and services
to be less than it has historically charged. Our future success is based in
large part upon our ability to successfully compete in the markets we currently
serve and to expand into additional products and services offerings. These risks
could lead to a loss of market share for IKON, resulting in a negative impact on
our results of operations.
Pricing. Our ability to succeed is dependent upon our ability to obtain adequate
pricing for the equipment, supplies and services we offer. Depending on
competitive market factors, future prices we can obtain for the equipment,
supplies and services we offer may vary from historical levels.
Vendor Relationships. IKON's access to equipment, parts and supplies depends
upon its relationships with, and its ability to purchase equipment on
competitive terms from its principal vendors, Canon and Ricoh. IKON has not and
does not currently enter into long-term supply contracts with these vendors, and
we have no current plans to do so in the future. These vendors are not required
to use IKON to distribute their equipment and are free to change the prices and
other terms at which they sell to us. In addition, IKON competes with the direct
selling efforts of these vendors. Significant deterioration in relationships
with, or in the financial condition of, these significant vendors could have an
adverse impact on IKON's ability to sell and lease equipment as well as its
ability to provide effective service and technical support. If IKON lost one of
these vendors, or if one of the vendors ceased operations, IKON would be forced
3
to expand its relationship with the other vendor, seek out new relationships
with other vendors or risk a loss in market share due to diminished product
offerings and availability.
Financing Business. A significant portion of our profits are derived from the
financing of equipment provided to our customers. Our ability to provide such
financing at competitive rates and to realize profitable margins is highly
dependent upon our costs of borrowing. If IKON is unable to continue to have
access to its funding sources on terms that allow it to provide leases on
competitive terms, IKON's business could be adversely affected, as IKON's
customers could seek to lease equipment from competitors offering more favorable
leasing terms. For the second quarter ended March 31, 2003, approximately 79% of
equipment sold by IKON in North America was financed through IOS Capital, LLC
("IOSC"), IKON's captive leasing subsidiary. IOSC accesses capital using asset
securitization transactions, including revolving asset securitization conduit
arrangements, public and private offerings of its debt securities, borrowings
from commercial lenders and loans from IKON. IOSC relies primarily on asset
securitization transactions to finance its lease receivables. There is no
assurance that we will continue to have access to our current funding sources,
or that we will be able to obtain additional funding on terms that would allow
us to provide leases on competitive terms. In particular, on May 1, 2003 Moody's
Investor Services lowered the Company's senior unsecured credit rating from Baa2
to Baa3 and maintained our ratings under review for further downgrade. Our
access to certain credit markets is dependent upon our credit ratings. Although
the Company is currently rated investment grade by both Standard and Poor's,
(BBB-, with a stable outlook) and Moody's Investor Services (Baa3, with our
ratings under review), any negative changes to our credit ratings, including any
further downgrades, could reduce and/or foreclose our 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.
Liquidity. During fiscal 2002 we obtained a new $300,000,000 unsecured credit
facility (the "Credit Facility") with a group of lenders. The Credit Facility
contains affirmative and negative covenants, including limitations on certain
fundamental changes, investments and acquisitions, mergers, certain transactions
with affiliates, creation of liens, asset transfers, payment of dividends,
intercompany loans and certain restricted payments. The Credit Facility does not
affect our ability to continue to securitize lease receivables. The Credit
Facility contractually matures on May 24, 2005. Unless the Company achieves
certain ratings on its long and short term senior, unsecured debt (as defined)
or has not redeemed or defeased IOSC's 9.75% Notes due June 15, 2004
($240,500,000 outstanding at March 31, 2003), all loans under the Credit
Facility will mature on December 15, 2003. As a result of any such maturity, the
Company may be required to seek additional sources of financing. The Credit
Facility also contains certain financial covenants, including: (i) corporate
leverage ratio; (ii) consolidated interest expense ratio; (iii) consolidated
asset test ratios; and (iv) limitations on capital expenditures. The Credit
Facility contains defaults customary for facilities of this type. Failure to be
in compliance with any material provision of the Credit Facility, including,
without limitation, the financial covenants described above, could have a
material adverse effect on our liquidity, financial position and results of
operations.
Productivity Initiatives. IKON's ability to improve its profit margins is
largely dependent on the success of its productivity initiatives to streamline
its infrastructure. Such initiatives are aimed at making IKON more profitable
and competitive in the long-term and include initiatives such as centralized
credit and purchasing, shared services and the implementation of e-IKON, a
comprehensive, multi-year initiative designed to web-enable IKON's information
technology infrastructure. IKON's ability to improve its profit margins through
the implementation of these productivity initiatives is dependent upon certain
factors outside the control of IKON. Our failure to successfully implement these
productivity initiatives, or the failure of such initiatives to result in
improved margins, could have a material adverse effect on our liquidity,
financial position and results of operations.
International Operations. IKON operates in 8 countries outside of the United
States. Approximately 14% of our revenues are derived from our international
operations, and approximately 75% of those revenues are derived from Canada and
the United Kingdom. Political or economic instability in Canada or the United
Kingdom could have a material adverse impact on our results of operations.
IKON's future revenues, costs of operations and profits could be affected by a
number of factors related to its international operations, 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. Unanticipated
currency fluctuations in the Canadian Dollar, British Pound or Euro vis-a-vis
the U.S. Dollar could lead to lower reported consolidated results of operations
due to the translation of these currencies.
New Product Offerings. Our business is driven primarily by customers' needs and
demands and by the products developed and manufactured by third parties. Because
IKON distributes products developed and manufactured by third parties, IKON's
business would be adversely affected if its suppliers fail to anticipate which
products or technologies will gain market acceptance or if IKON cannot sell
these products at competitive prices. IKON cannot be certain that its suppliers
will permit IKON to distribute their newly developed products, or that such
products will meet our customers' needs and demands. Additionally, because some
of our principal competitors design and manufacture new technology, those
competitors may have a competitive advantage over IKON. To successfully compete,
IKON must maintain an efficient cost structure, an effective sales and marketing
team and offer additional services that distinguish IKON from its competitors.
Failure to execute these strategies successfully could result in reduced market
share for IKON or could have an adverse impact on its results of operations.
4
PART 1. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
IKON Office Solutions, Inc.
Consolidated Balance Sheets
March 31,
2003 September 30,
(in thousands) (unaudited) 2002
- -------------------------------------------------------------------------------------- -- ------------------ -- -----------------
Assets
Cash and cash equivalents $ 186,990 $ 271,816
Restricted cash 110,899 116,077
Accounts receivable, less allowances of: March 31, 2003 - $14,947;
September 30, 2002 - $14,251 601,148 568,635
Finance receivables, less allowances of: March 31, 2003 - $19,661;
September 30, 2002 - $20,352 1,170,299 1,198,357
Inventories 281,568 318,214
Prepaid expenses and other current assets 92,810 82,880
Deferred taxes 65,422 65,264
- -------------------------------------------------------------------------------------- -- ------------------ -- -----------------
Total current assets 2,509,136 2,621,243
- -------------------------------------------------------------------------------------- -- ------------------ -- -----------------
Long-term finance receivables, less allowances of: March 31, 2003 -
$36,512; September 30, 2002 - $37,796 2,283,673 2,231,490
Equipment on operating leases, net of accumulated depreciation of:
March 31, 2003 - $93,730; September 30, 2002 - $92,741 102,089 99,639
Property and equipment, net of accumulated depreciation of:
March 31, 2003 - $307,241; September 30, 2002 - $306,370 208,141 202,863
Goodwill, net 1,232,894 1,235,418
Other assets 67,416 67,145
- -------------------------------------------------------------------------------------- -- ------------------ -- -----------------
Total Assets $ 6,403,349 $ 6,457,798
====================================================================================== == ================== == =================
Liabilities and Shareholders' Equity
Current portion of long-term debt, excluding finance subsidiaries $ 8,553 $ 11,484
Current portion of long-term debt of finance subsidiaries 1,571,150 1,312,034
Notes payable 1,613 7,162
Trade accounts payable 194,907 232,120
Accrued salaries, wages and commissions 93,656 127,643
Deferred revenues 139,931 161,484
Other accrued expenses 286,793 300,937
- -------------------------------------------------------------------------------------- -- ------------------ -- -----------------
Total current liabilities 2,296,603 2,152,864
- -------------------------------------------------------------------------------------- -- ------------------ -- -----------------
Long-term debt, excluding finance subsidiaries 566,892 594,351
Long-term debt of finance subsidiaries 1,218,477 1,495,827
Deferred taxes 515,353 479,401
Other long-term liabilities 196,827 200,409
Commitments and contingencies
Shareholders' Equity
Common stock, no par value: authorized 300,000 shares; issued: March
31, 2003-149,971 shares; September 30, 2002-150,003 shares;
outstanding: March 31, 2003-144,658 shares; September 30, 2002-
144,024 shares 1,014,163 1,015,177
Series 12 preferred stock, no par value: authorized 480 shares; none
issued or outstanding
Unearned compensation (3,169) (1,981)
Retained earnings 656,133 595,722
Accumulated other comprehensive loss (37,346) (50,805)
Cost of common shares in treasury: March 31, 2003-4,652 shares;
September 30, 2002-5,286 shares (20,584) (23,167)
- -------------------------------------------------------------------------------------- -- ------------------ -- -----------------
Total Shareholders' Equity 1,609,197 1,534,946
- -------------------------------------------------------------------------------------- -- ------------------ -- -----------------
Total Liabilities and Shareholders' Equity $ 6,403,349 $ 6,457,798
====================================================================================== == ================== == =================
See notes to condensed consolidated financial statements.
5
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) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------------
Revenues
Net sales $ 553,308 $ 591,441 $ 1,080,070 $ 1,160,438
Services 504,608 535,077 1,019,911 1,083,407
Finance income 97,008 93,656 191,907 186,778
- ------------------------------------------------------------------------------------------------------------------------
1,154,924 1,220,174 2,291,888 2,430,623
- ------------------------------------------------------------------------------------------------------------------------
Costs and Expenses
Cost of goods sold 368,726 390,680 708,189 765,027
Services costs 301,886 322,177 612,104 650,414
Finance interest expense 36,644 36,995 75,663 78,160
Selling and administrative 377,900 400,660 761,694 801,545
- ------------------------------------------------------------------------------------------------------------------------
1,085,156 1,150,512 2,157,650 2,295,146
- ------------------------------------------------------------------------------------------------------------------------
Operating income 69,768 69,662 134,238 135,477
Interest expense, net 11,259 14,085 23,568 28,596
- ------------------------------------------------------------------------------------------------------------------------
Income before taxes on income 58,509 55,577 110,670 106,881
Taxes on income 22,087 20,286 41,778 39,012
- ------------------------------------------------------------------------------------------------------------------------
Net income $ 36,422 $ 35,291 $ 68,892 $ 67,869
- ------------------------------------------------------------------------------------------------------------------------
Basic earnings per common share $ 0.25 $ 0.25 $ 0.48 $ 0.48
Diluted earnings per common share $ 0.23 $ 0.24 $ 0.44 $ 0.46
Cash dividends per common share $ 0.04 $ 0.04 $ 0.08 $ 0.08
See notes to condensed consolidated financial statements.
6
IKON Office Solutions, Inc.
Consolidated Statements of Cash Flows
(unaudited)
Six Months Ended
March 31,
- --------------------------------------------------------------------------------------------------------------------------------
(in thousands) 2003 2002
- --------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities
Net income $ 68,892 $ 67,869
Additions (deductions) to reconcile net income to net cash
provided by operating activities:
Depreciation 51,037 56,772
Amortization 4,628 7,319
Provision for losses on accounts receivable 4,940 6,344
Provision for deferred income taxes 35,794 21,188
Provision for lease default reserves 36,715 34,312
Changes in operating assets and liabilities, net of effects from
acquisitions and divestitures:
(Increase) decrease in accounts receivable (27,878) 36,746
Decrease (increase) in inventories 28,901 (30,065)
Increase in prepaid expenses and other current assets (5,267) (6,432)
(Decrease) increase in accounts payable, deferred revenues and accrued
expenses (109,433) 2,288
Decrease in accrued restructuring (7,133) (10,504)
Other 23,389 8,306
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 104,585 194,143
- --------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities
Expenditures for property and equipment (49,398) (48,657)
Expenditures for equipment on operating leases (31,634) (39,497)
Proceeds from sale of property and equipment 7,669 18,789
Proceeds from sale of equipment on operating leases 7,062 6,977
Finance receivables - additions (802,617) (764,760)
Finance receivables - collections 758,993 710,305
Other (3,626) (5,488)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (113,551) (122,331)
- --------------------------------------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities
Proceeds from issuance of long-term debt 8,777 2,261
Short-term (repayments) borrowings, net (13,724) 115,584
Long-term debt repayments (40,266) (9,090)
Finance subsidiaries' debt - issuances 578,625 404,021
Finance subsidiaries' debt - repayments (604,672) (557,100)
Dividends paid (11,545) (11,401)
Decrease in restricted cash 5,178 3,127
Proceeds from option exercises and sale of treasury shares 1,400 4,881
Purchase of treasury shares and other (493) (258)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (76,720) (47,975)
- --------------------------------------------------------------------------------------------------------------------------------
Effect of exchange rate changes on cash and cash equivalents 860 506
- --------------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (84,826) 24,343
Cash and cash equivalents at beginning of year 271,816 80,351
- --------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 186,990 $ 104,694
- --------------------------------------------------------------------------------------------------------------------------------
See notes to condensed consolidated financial statements.
7
IKON Office Solutions, Inc.
Notes to Condensed Consolidated Financial Statements
(in thousands, except per share amounts)
(unaudited)
Note 1: Basis of Presentation and Significant Accounting Policies
---------------------------------------------------------
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 accounting principles generally accepted in the
United States 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 for the year ended September 30, 2002.
Certain prior year amounts have been reclassified to conform with the current
year presentation.
Significant Accounting Policies
The following provides additional information regarding our significant
accounting policies contained in note 1 of the Company's Annual Report on Form
10-K for the year ended September 30, 2002:
Accounting for Stock-based Compensation
On December 31, 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 148 "Accounting for Stock-Based
Compensation- Transition and Disclosure - an amendment to SFAS 123" ("SFAS
148"). SFAS 148 requires additional disclosures that are incremental to those
required by SFAS 123 and requires the following disclosures in the Company's
interim financial statements.
As permitted by SFAS 123, "Accounting for Stock-Based Compensation" ("SFAS 123")
we continue to account for our stock options in accordance with Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees".
Employee stock options are granted at or above the market price at dates of
grant which does not require us to recognize any compensation expense. In
general, these options expire in ten years (twenty years for certain
non-employee director options) and vest over three years (five years for grants
issued prior to December 15, 2000). The proceeds from options exercised are
credited to shareholders' equity. A plan for our non-employee directors enables
participants to receive their annual directors' fees in the form of options to
purchase shares of common stock at a discount. The discount is equivalent to the
annual directors' fees and is charged to expense.
If we had elected to recognize compensation expense based on the fair value at
the date of grant for awards in fiscal years 2003 and 2002, consistent with the
provisions of SFAS 123, our net income and earnings per share would have been
reduced to the following pro forma amounts:
Three Months Ended Six Months Ended
March 31, March 31,
------------------------------------------------
2003 2002 2003 2002
---------- ----------- ----------- -----------
Net income as reported $ 36,422 $ 35,291 $ 68,892 $ 67,869
Pro forma effect (1,404) (1,576) (2,849) (2,740)
---------- ----------- ----------- -----------
Net income as adjusted $ 35,018 $ 33,715 $ 66,043 $ 65,129
---------- ----------- ----------- -----------
Basic earnings per common share:
As reported $ 0.25 $ 0.25 $ 0.48 $ 0.48
Pro forma effect (0.01) (0.01) (0.02) (0.02)
---------- ----------- ----------- -----------
As adjusted $ 0.24 $ 0.24 $ 0.46 $ 0.46
---------- ----------- ----------- -----------
Diluted earnings per common share
As reported $ 0.23 $ 0.24 $ 0.44 $ 0.46
Pro forma effect (0.01) (0.01) (0.02) (0.02)
---------- ----------- ----------- -----------
As adjusted $ 0.22 $ 0.23 $ 0.42 $ 0.44
---------- ----------- ----------- -----------
8
Note 2: Goodwill
--------
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
-----------------------------------------------------------------------------------------------------
Goodwill at
March 31, 2003 $854,383 $70,927 $295,577 $9,011 $2,996 $1,232,894
Changes in the goodwill balance since September 30, 2002 are attributable to
foreign currency translation adjustments.
Note 3: Notes Payable, Lease-Backed Notes and Revolving Credit Facility
----------------------------------------------------------------
During the six months ended March 31, 2003, the Company repurchased $17,825 par
value of its 6.75% bonds due in 2004, $9,360 par value of its 6.75% bonds due in
2025, and IOS Capital, LLC ("IOSC") repurchased $9,500 par value of its 9.75%
notes due 2004 for $18,055, $7,440 and $9,598, respectively. As a result of
these repurchases, the Company recognized a net gain, including the write-off of
unamortized costs, of $1,250, which is included in interest expense, net in the
consolidated statement of income.
During the six months ended March 31, 2003, IOSC repaid $474,782 of lease-backed
notes.
At March 31, 2003, the Company had borrowings under its $300,000 unsecured
credit facility of $140,900 and (pound)5,000. As discussed in Note 13, the
Company repaid $140,900 of the borrowings under the unsecured credit facility in
April 2003.
Note 4: Asset Securitization Conduit Financing
---------------------------------------
During the six months ended March 31, 2003, IOSC pledged or transferred $385,140
in financing lease receivables for $326,145 in cash in connection with its
revolving asset securitization conduit financing agreements (the "Conduits"). As
of March 31, 2003, IOSC had approximately $66,355 available under the Conduits.
Note 5: Comprehensive Income
---------------------
Total comprehensive income is as follows:
Three Months Ended Six Months Ended
March 31, March 31,
------------------------------- ------------------------------------
2003 2002 2003 2002
------------- ------------- ---------------- ----------------
Net income $ 36,422 $ 35,291 $ 68,892 $ 67,869
Foreign currency translation adjustments 6,670 (2,226) 6,461 (4,236)
Gain on derivative financial instruments, net of tax
expense of: $2,416 and $4,376 for the three months
ended March 31, 2003 and 2002, respectively;
$4,666 and $7,000 for the six months ended March
31, 2003 and 2002, respectively 3,623 6,564 6,998 10,501
-------- -------- -------- --------
Total comprehensive income $ 46,715 $ 39,629 $ 82,351 $ 74,134
======== ======== ======== ========
The minimum pension liability is adjusted at each fiscal 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 $(17,729), $(2,445) and $(17,172),
9
respectively, at March 31, 2003 and $(24,190), $(2,445) and $(24,170),
respectively, at September 30, 2002.
Note 6: Earnings Per Common Share
- ----------------------------------
The following table sets forth the computation of basic and diluted earnings per
common share:
Three Months Ended Six Months Ended
March 31, March 31,
------------------------------- -------------------------------
2003 2002 2003 2002
------------- ------------- -------------- -------------
Numerator:
Numerator for basic earnings per common share -
Net income $36,422 $35,291 $68,892 $67,869
Effect of dilutive securities: Interest expense
on convertible notes, net of tax 2,302 4,656
------------- ------------- -------------- -------------
Numerator for diluted earnings per common
share - net income plus assumed conversion $38,724 $35,291 $73,548 $67,869
------------- ------------- -------------- -------------
Denominator:
Denominator for basic earnings per common share
- weighted average common shares 144,483 142,965 144,318 142,419
Effect of dilutive securities:
Convertible notes 19,960 19,960
Employee stock awards 251 438 257 442
Employee stock options 2,343 4,374 2,421 4,219
------------- ------------- -------------- -------------
Dilutive potential common shares 22,554 4,812 22,638 4,661
------------- ------------- -------------- -------------
Denominator for diluted earnings per
common share - adjusted weighted average
common shares and assumed conversions 167,037 147,777 166,956 147,080
------------- ------------- -------------- -------------
Basic earnings per common share $0.25 $0.25 $0.48 $0.48
============= ============= ============== =============
Diluted earnings per common share
$0.23 $0.24 $0.44 $0.46
============= ============= ============== =============
The Company accounts for the effect of its convertible notes in the diluted
earnings per common share calculation using the "if converted" method. Under
that method, the convertible notes are assumed to be converted to shares
(weighted for the number of days outstanding in the period) at a conversion
price of $15.03, and interest expense, net of taxes, related to the convertible
notes is added back to net income.
Options to purchase 8,867 shares of common stock at $7.50 per share to $46.59
per share were outstanding during the second quarter of fiscal 2003 and 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, 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.
Options to purchase 8,867 shares of common stock at $7.50 per share to $46.59
per share were outstanding during the first six months of fiscal 2003 and
options to purchase 6,714 shares of common stock at $11.45 per share to $46.59
per share were outstanding during the first six months of fiscal 2002, 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.
10
Note 7: Segment Reporting
------------------
The table below presents segment information for the three months ended March
31, 2003 and 2002:
IKON
North IKON
America Europe Other Corporate Total
------------- ------------ ---------- -------------- --------------
Three Months Ended March 31, 2003
Net sales $ 483,135 $ 70,086 $ 87 $ 553,308
Services 454,424 45,171 5,013 504,608
Finance income 91,264 5,744 97,008
Finance interest expense 34,961 1,683 36,644
Operating income (loss) 141,449 6,172 (753) $ (77,100) 69,768
Interest expense, net (11,259) (11,259)
Income before taxes on income 58,509
Three Months Ended March 31, 2002
Net sales $ 521,189 $ 69,603 $ 649 $ 591,441
Services 486,765 37,336 10,976 535,077
Finance income 88,742 4,914 93,656
Finance interest expense 35,334 1,661 36,995
Operating income (loss) 157,694 5,400 (2,172) $ (91,260) 69,662
Interest expense, net (14,085) (14,085)
Income before taxes on income 55,577
The table below presents segment information for the six months ended March 31, 2003 and 2002:
IKON
North IKON
America Europe Other Corporate Total
------------- ------------ ---------- -------------- --------------
Six Months Ended March 31, 2003
Net sales $ 943,253 $ 136,632 $ 185 $ 1,080,070
Services 918,232 90,908 10,771 1,019,911
Finance income 180,585 11,322 191,907
Finance interest expense 72,173 3,490 75,663
Operating income (loss) 288,670 12,209 (878) $ (165,763) 134,238
Interest expense, net (23,568) (23,568)
Income before taxes on income 110,670
Six Months Ended March 31, 2002
Net sales $ 1,019,402 $ 134,331 $ 6,705 $ 1,160,438
Services 976,953 75,751 30,703 1,083,407
Finance income 176,916 9,862 186,778
Finance interest expense 74,632 3,528 78,160
Operating income (loss) 297,600 10,951 (7,966) $ (165,108) 135,477
Interest expense, net (28,596) (28,596)
Income before taxes on income 106,881
11
During fiscal 2003, the Company made certain changes to its segment reporting to
reflect the way management views IKON's business. Due to the Company's
organizational structure change related to centralization of the supply chain
function and customer care centers announced in October 2002, IKON no longer
allocates these corporate administrative charges to IKON North America. As a
result, these costs are included in Corporate in the table above. In addition, a
unit of our business imaging services operations which had been included in
Other is now included in IKON North America consistent with the way management
now views our segments for making operating decisions. Prior year amounts have
been reclassified to conform with the current year presentation.
Note 8: Restructuring and Asset Impairment Charges
- --------------------------------------------------
In the fourth quarter of fiscal 2001, the Company announced the acceleration of
certain cost cutting and infrastructure improvements (as described below) 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. The related reserve adjustments were included in cost of
goods sold for the write-off of obsolete inventory, and selling and
administrative expense for the write-off of accounts receivable in the
consolidated statement of income. The asset impairments included fixed asset
write-offs totaling $6,078 as follows: $100 from technology services businesses
closures; $897 from digital print center business closures; $338 from digital
print center business sales; and $4,743 relating to IKON infrastructure. The
asset impairments also included goodwill write-offs totaling $19,422 as follows:
$955 from technology services businesses closures; $6,591 from digital print
center business sales; and $11,876 relating to telephony business sales. The
Company developed this plan as part of our continuing effort to streamline
IKON's infrastructure to increase future productivity, and to address economic
changes within specific marketplaces. This resulted in a charge of $65,300
($49,235 after-tax). These actions addressed the sale of the Company's telephony
operations and the closing of twelve nonstrategic digital print centers as the
Company shifts its focus from transactional work toward contract print work and
the support of major accounts. These actions also addressed further downsizing
of operational infrastructures throughout the organization as the Company
leverages and intensifies prior standardization and centralization initiatives.
These actions included 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) related
to the sale of the Company's technology education operations. The asset
impairments included fixed asset write-offs totaling $828. The asset impairments
also included goodwill write-offs totaling $2,754. Therefore, the aggregate
charge recorded in fiscal 2001 (the "Fiscal 2001 Charge") was $68,882 ($52,535
after-tax).
In the first quarter of fiscal 2000, the Company announced plans to improve
performance and efficiency and incurred a total pre-tax restructuring and asset
impairment charge (the "First Quarter 2000 Charge") of $105,340 ($78,479
after-tax). The asset impairments included fixed asset write-offs totaling
$12,668 as follows: $631 from technology services integration and education
business closures; $2,530 from technology services integration and education
business downsizing; $1,269 from digital print center business closures; $588
from digital print center business downsizing; $1,405 from document services
excess equipment; $1,244 from a technology services business sale; and $5,001
relating to IKON infrastructure. The asset impairments included goodwill
write-offs totaling $38,880 as follows: $3,279 from technology services
integration business sales; $10,156 from technology services integration and
education business closures; $9,566 from digital print center business closures;
$14,950 from a technology services business sale; and $929 relating to an IKON
Europe closure. These actions addressed under-performance in certain technology
services operations, business document services, and business information
services locations as well as the Company's desire to strategically position
these businesses for integration and profitable growth. Plans included
consolidating or disposing of certain under-performing and non-core locations;
implementing productivity enhancements through the consolidation and
centralization of activities in inventory management, purchasing,
finance/accounting and other administrative functions; and consolidating real
estate through the co-location of business units as well as the disposition of
unproductive real estate. In the fourth quarter of fiscal 2000, the Company
determined that some first quarter restructuring initiatives would not require
the level of spending that had been originally estimated, and certain other
initiatives would not be implemented due to changing business dynamics.
Previously targeted sites were maintained based on their potential for
improvement as well as their relationship to IKON's overall strategic direction.
As a result of our integration efforts, locations originally identified for sale
or closure were combined with other IKON businesses. As a result, $15,961 was
reversed from the First Quarter 2000 Charge, and the total amount of the First
Quarter 2000 Charge was reduced to $89,379 ($66,587 after-tax). The components
of the reversal were: 538 fewer positions eliminated reduced severance by
$1,784, real estate lease payments reduced by $13,426, and contractual
commitments reduced by $751. The severance reversal resulted from successfully
12
negotiating business sales whereby affected employees assumed positions with the
acquiring companies, higher-than-expected voluntary resignations, and our
decision not to implement certain supply chain and shared service center
consolidation efforts. The real estate lease payment reversal was primarily the
result of our decision not to close certain sites. Also, in the fourth quarter
of fiscal 2000, the Company announced other specific actions designed to address
the changing market conditions impacting technology services, IKON North
America, and outsourcing locations and incurred a total pre-tax restructuring
and asset impairment charge (the "Fourth Quarter 2000 Charge") of $15,789
($12,353 after-tax). The asset impairments consisted of fixed asset write-offs
totaling $2,371 as follows: $1,371 from technology services integration and
education business closures; $721 from digital print center business closures;
and $279 relating to IKON infrastructure. The First Quarter 2000 Charge (as
reduced) and Fourth Quarter 2000 Charge resulted in a net fiscal 2000 charge
(the "Fiscal 2000 Charge") of $105,168 ($78,940 after-tax).
In the fourth quarter of fiscal 2002, the Company reversed $10,497 ($6,823
after-tax) of its restructuring charges described above. The reversed charges
consisted of $7,418 related to severance, $1,667 related to leasehold
termination costs and $1,412 related to contractual commitments. The severance
reversal was the result of the average cost of severance per employee being less
than estimated and 188 fewer positions eliminated than estimated due to
voluntary resignations and our decision not to close a digital print center due
to changing business dynamics. The reversal of leasehold termination costs and
contractual commitments resulted from our decision not to close a digital print
center. Additionally, we were also able to reduce our liability through
successful equipment and real property lease termination negotiations.
The pre-tax components of the restructuring, net, and asset impairment charges
for fiscal 2002, 2001 and 2000 were as follows:
Fiscal Fiscal Fourth Quarter Fiscal First Quarter
2002 2001 Fiscal 2000 2000 Fiscal 2000
Type of Charge Reversal Charge Charge Reversal Charge
- ---------------------------------------------------------------------------------------------------------------------------------
Restructuring Charge:
Severance $ (7,418) $ 26,500 $ 6,092 $ (1,784) $16,389
Leasehold termination costs (1,667) 5,534 6,685 (13,426) 33,691
Contractual commitments (1,412) 2,466 641 (751) 3,712
- ---------------------------------------------------------------------------------------------------------------------------------
Total Restructuring Charge (10,497) 34,500 13,418 (15,961) 53,792
- ---------------------------------------------------------------------------------------------------------------------------------
Asset Impairment Charge:
Fixed assets 6,906 2,371 12,668
Goodwill and intangibles 22,176 38,880
- ---------------------------------------------------------------------------------------------------------------------------------
Total Asset Impairment Charge 29,082 2,371 51,548
- ---------------------------------------------------------------------------------------------------------------------------------
Total $(10,497) $ 63,582 $15,789 $(15,961) $ 105,340
- ---------------------------------------------------------------------------------------------------------------------------------
The Company calculated the asset and goodwill impairments as required by SFAS
121 "Accounting for the Impairment of Long-Lived Assets and Assets to be
Disposed of." The proceeds received for businesses sold were not sufficient to
cover the fixed asset and goodwill balances. As such, those balances were
written-off. Goodwill directly associated with businesses that were closed was
also written-off.
The following presents a rollforward of the restructuring components of the
Fiscal 2001 Charge, Fourth Quarter 2000 Charge and First Quarter 2000 Charge
(collectively the "Charges") from September 30, 2002 to the balance remaining at
March 31, 2003, which is included in other accrued expenses in the consolidated
balance sheets:
Balance Payments Balance
September 30, Fiscal March 31,
Fiscal 2001 Restructuring Charge 2002 2003 2003
-------------------------------------------------------------------------------
Severance $ 7,799 $(3,991) $ 3,808
Leasehold termination costs 2,251 (824) 1,427
Contractual commitments 30 30
-------------------------------------------------------------------------------
Total $ 10,080 $(4,815) $5,265
-------------------------------------------------------------------------------
13
Balance Payments Balance
Fourth Quarter September 30, Fiscal March 31,
Fiscal 2000 Restructuring Charge 2002 2003 2003
-------------------------------------------------------------------------------
Severance $ 112 $ (103) $ 9
Leasehold termination costs 2,948 (1,249) 1,699
-------------------------------------------------------------------------------
Total $3,060 $ (1,352) $1,708
-------------------------------------------------------------------------------
Balance Payments Balance
First Quarter September 30, Fiscal March 31,
Fiscal 2000 Restructuring Charge 2002 2003 2003
-------------------------------------------------------------------------------
Severance $ 355 $(114) $ 241
Leasehold termination costs 1,614 (852) 762
-------------------------------------------------------------------------------
Total $ 1,969 $(966) $1,003
-------------------------------------------------------------------------------
The projected payments of the remaining balances of the Charges are as follows:
Fiscal 2001 Projected Payments FY 2003 FY 2004 FY 2005 FY 2006 Total
- --------------------------------------------------------------------------------------------------------------------
Severance $ 2,510 $1,221 $ 77 $ 3,808
Leasehold termination costs 583 557 244 $ 43 1,427
Contractual commitments 30 30
- --------------------------------------------------------------------------------------------------------------------
Total $3,123 $1,778 $ 321 $ 43 $ 5,265
- --------------------------------------------------------------------------------------------------------------------
Fourth Quarter Fiscal 2000
Projected Payments FY 2003 FY 2004 FY 2005 FY 2006 Beyond Total
- --------------------------------------------------------------------------------------------------------------------
Severance $ 9 $ 9
Leasehold termination costs 50 $825 $429 $239 $156 1,699
- --------------------------------------------------------------------------------------------------------------------
Total $59 $825 $429 $ 239 $156 $ 1,708
- --------------------------------------------------------------------------------------------------------------------
First Quarter Fiscal 2000
Projected Payments FY 2003 FY 2004 FY 2005 Total
- -----------------------------------------------------------------------------------------
Severance $ 241 $ 241
Leasehold termination costs 203 $340 $219 762
- -----------------------------------------------------------------------------------------
Total $444 $340 $219 $ 1,003
- -----------------------------------------------------------------------------------------
The Company determined its probable sub-lease income through the performance of
local commercial real estate market valuations by our external regional real
estate brokers. All lease termination amounts are shown net of projected
sub-lease income. Projected sub-lease income as of March 31, 2003 was $621,
$4,487 and $3,827 for the Fiscal 2001 Charge, Fourth Quarter 2000 Charge and
First Quarter 2000 Charge, respectively.
All actions related to our restructuring are complete. Severance payments to
terminated employees are made in installments. The charges for leasehold
termination costs relate to real estate lease contracts where the Company has
exited certain locations and is required to make payments over the remaining
lease term.
All locations affected by the Charges (23, 5 and 22 locations for the Fiscal
2001 Charge, Fourth Quarter 2000 Charge and First Quarter 2000 Charge,
respectively) have been closed and all employees affected by the Charges (1,412,
386 and 1,394 employees for the Fiscal 2001 Charge, Fourth Quarter 2000 Charge
and First Quarter 2000 Charge, respectively) have been terminated.
Note 9: Synthetic Leases
----------------
On November 21, 2001, IKON entered into a synthetic lease agreement totaling
$18,659 for the purpose of leasing its corporate headquarters in Malvern,
Pennsylvania (the "Corporate Lease"). Under the terms of the Corporate Lease,
IKON is required to occupy the facility for a term of five years from the
agreement date. The Corporate Lease also provides for a residual value guarantee
and includes a purchase option at the lessor's original cost of the property. If
IKON terminates the Corporate Lease prior to the end of the lease term, IKON is
obligated to purchase the leased property at a price equal to the remaining
lease balance. Because IKON is required to only pay the yield due on the
Corporate Lease, IKON's nominal rental rate under the Corporate Lease is
different from what IKON would be required to pay under a market rental rate.
The Corporate Lease contains one financial covenant that requires IKON to meet a
funded debt to total capitalization ratio test. The test requires IKON's total
14
funded debt to not exceed fifty percent of IKON's total capitalization. A
failure to maintain the covenant would constitute a default pursuant to the
Corporate Lease and would permit the lessor to either require IKON to purchase
the leased property for the then-current lease balance, terminate IKON's right
of possession of the leased property, or sell the leased property and apply the
proceeds to the current lease balance. IKON obtains valuations of the property
covered by the Corporate Lease on a regular basis. If market conditions result
in a valuation that is less than the guaranteed residual value of the property,
IKON records a charge to income. As of March 31, 2003 and September 30, 2002,
the accrued shortfall between the contractual obligation and the estimated fair
value of the leased assets under the Corporate Lease equaled $400.
On January 10, 2003, IKON terminated a synthetic lease agreement and paid
$23,901 to acquire three properties under the lease. The Company previously
recorded a reserve of $13,387 for the expected shortfall between the contractual
obligation and the estimated fair value of the leased assets. The properties are
currently for sale.
Note 10: Contingencies
-------------
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 estimate because of these uncertainties,
the Company had accrued balances of $8,170 and $8,314 as of March 31, 2003 and
September 30, 2002, respectively, for its environmental liabilities, and the
accrual is based on management's best estimate of the aggregate environmental
remediation exposure. The measurement of environmental liabilities is based on
an evaluation of currently available facts with respect to each individual site
and considers factors such as existing technology, presently enacted laws and
regulations, prior experience in remediation of contaminated sites and any
studies performed for a site. As assessments and remediation progress at
individual sites, these liabilities are reviewed and adjusted to reflect
additional technical and legal information that becomes available. 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.
The accruals for environmental liabilities are reflected in the consolidated
balance sheet as part of other accrued liabilities. The Company has not recorded
any potential third party recoveries. The Company is indemnified by an
environmental contractor performing remedial work at a site in Bedford Heights,
OH. The contractor has agreed to indemnify the Company from cost overruns
associated with the plan of remediation. Further, the Company has cost sharing
arrangements in place with other potentially responsible parties ("PRP's") at
sites located in Barkhamsted, CT and Rockford, IL. The cost-sharing agreement
for the Barkhamsted, CT site relates to apportionment of expenses associated
with non-time critical removal actions and operation and maintenance work, such
as capping the landfill, maintaining the landfill, fixing erosion rills and
gullies, maintaining site security, maintaining vegetative growth on the
landfill cap and groundwater monitoring. Under the agreement, the Company and
other PRP's agreed to reimburse Rural Refuse Disposal District No. 2, a
Connecticut Municipal Authority, for 50% of these costs. The Company currently
pays a 4.54% share of these costs. The cost-sharing arrangement for the
Rockford, IL site relates to apportioning the costs of a Remedial
Investigation/Feasibility Study and certain operation and maintenance work, such
as fencing the site, removing waste liquids and sludges, capping a former
surface impoundment and demolishing certain buildings. Under this arrangement,
the Company pays 5.12% of these costs.
During the six months ended March 31, 2003 and 2002, the Company did not incur
any expenses for environmental capital projects. During the six months ended
March 31, 2003 and 2002, the Company incurred various expenses in conjunction
with its obligations under consent decrees, orders, voluntary remediation plans,
settlement agreements and to comply with environmental laws and regulations. For
the six months ended March 31, 2003 and 2002, these expenses were $228 and
$2,076, respectively. All expenses were charged against the related
environmental accrual. The Company will continue to incur expenses in order to
comply with its obligations under consent decrees, orders, voluntary remediation
plans, settlement agreements and to comply with environmental laws and
regulations.
The Company has an accrual related to black lung and worker's compensation
liabilities relating to the operations of a former subsidiary, Barnes & Tucker
Company ("B&T"). B&T owned and operated coal mines throughout Pennsylvania. IKON
sold B&T in 1986. In connection with the sale, IKON entered into a financing
agreement with B&T whereby IKON agreed to reimburse B&T for 95% of all costs and
expenses incurred by B&T for black lung and worker's compensation liabilities,
until said liabilities were extinguished. From 1986 through 2000, IKON
reimbursed B&T in accordance with the terms of the financing agreement. In 2000,
B&T filed for bankruptcy protection under Chapter 11. The bankruptcy court
15
approved a plan of reorganization which created a black lung trust and a
worker's compensation trust to handle the administration of all black lung and
worker's compensation claims relating to B&T. IKON now reimburses the trusts for
95% of the costs and expenses incurred by the trusts for black lung and worker's
compensation claims. As of March 31, 2003 and September 30, 2002, the Company's
accrual for black lung and worker's compensation liabilities related to B&T was
$16,023 and $16,734, respectively.
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 11: Financial Instruments
---------------------
As of March 31, 2003, 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, 2003, unrealized gains totaling $6,998 after taxes, were
recorded in accumulated other comprehensive loss.
Note 12: Pending Accounting Changes
--------------------------
In January 2003, the FASB approved FASB Interpretation Number ("FIN 46"),
"Consolidation of Variable Interest Entities, an interpretation of ARB 51". The
primary objectives of FIN 46 are to provide guidance for the identification of
entities for which control is achieved through means other than through voting
rights ("variable interest entities" or "VIEs") and how to determine when and
which business enterprise should consolidate the VIE (the "primary
beneficiary"). This new model for consolidation applies to an entity which
either (1) the equity investors (if any) do not have a controlling financial
interest or (2) the equity investment at risk is insufficient to finance that
entity's activities without receiving additional subordinated financial support
from other parties. In addition, this interpretation requires that both the
primary beneficiary and all other enterprises with a significant variable
interest in a VIE make additional disclosures. Certain disclosure requirements
were effective for financial statements issued after January 31, 2003. The
remaining provisions are effective immediately for all VIE's created after
January 31, 2003 and are effective beginning in the first interim or annual
reporting period beginning after June 15, 2003 for all VIE's created before
February 1, 2003. The Company is currently evaluating the impact of the
application of this interpretation, but does not expect a material impact from
the application of this interpretation on our consolidated financial statements.
In April 2003, the FASB approved SFAS 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". SFAS 149 amends and clarifies
financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in contracts and for hedging activities under
SFAS 133. In particular, SFAS 149 amends SFAS 133 for decisions made as part of
the Derivatives Implementation Group process, other FASB projects dealing with
financial instruments, and implementation issues raised in connection with the
application of the definition of a derivative. SFAS 149 is effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003 with the exception of
implementation issues that have been effective under other pronouncements for
fiscal quarters that began prior to June 15, 2003, which should be applied in
accordance with their respective effective dates. 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 149 on our consolidated financial
statements.
Note 13: Subsequent Events
-----------------
On April 23, 2003, IKON Receivables Funding, LLC (a wholly-owned subsidiary of
IOS Capital) issued Series 2003-1 Lease-Backed Notes (the "2003 Notes") as
described below:
Principal Stated
Issuance Issuance Maturity
Series Notes Date Amount Interest Rate Date
- ----------------------------------------------------------------------------------------------------
2003-1 Class A-1 04/23/03 $253,200 1.30813% May 2004
Class A-2 04/23/03 26,700 1.68% November 2005
Class A-3a 04/23/03 206,400 LIBOR + 0.24% December 2007
Class A-3b 04/23/03 206,400 2.33% December 2007
Class A-4 04/23/03 159,385 3.27% July 2011
- ----------------------------------------------------------------------------------------------------
Total $852,085
- ----------------------------------------------------------------------------------------------------
Proceeds from the issuance of the 2003 Notes were used to make payments on the
Company's Conduits, repay $140,900 of unsecured credit facility borrowings and
increase the Company's cash balance.
In April 2003, the Company entered into a swap transaction to hedge the variable
rate 2003-1 Class A-3a lease-backed note to a fixed rate of 2.095%. This hedge
qualifies for evaluation using the "short cut" method of assessing
effectiveness; accordingly, there is an assumption of no ineffectiveness.
16
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 a leading provider of
products and services that help businesses manage document workflow and increase
efficiency. 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 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, 2002, and at relevant sections in this discussion and
analysis. In addition, we believe our most critical accounting policies include
the following:
Revenue Recognition. We install the majority of the equipment we sell. Revenues
for company-installed copier/printer equipment and technology hardware, included
in net sales, are recognized upon receipt of a signed sales contract and
"delivery and acceptance" certificate. The "delivery and acceptance" certificate
confirms that the product has been delivered, installed, accepted, is in good
condition, and is satisfactory. Revenues for customer installed copier/printer
equipment and technology hardware, included in net sales, are recognized upon
receipt of a sales contract and delivery. Generally, the Company does not offer
any equipment warranties in addition to those which are provided by the
equipment manufacturer. Revenues for sales of supplies are recognized at time of
shipment following the placement of an order from a customer. Revenues for
monthly equipment service and facilities management service are recognized in
the month in which the service is performed. Revenues for other services and
rentals are recognized in the period performed. The present value of payments
due under sales-type lease contracts is recorded as revenue within net sales 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.
Supporting the Company's objective to provide complete solutions to its
customers, the Company generally sells a service agreement when copier/printer
equipment is sold. The typical agreement includes a minimum number of copies for
a base service fee plus an overage charge for any copies in excess of the
minimum. Revenue for each element of a bundled contract is derived from our
national price lists for equipment and service. The national price list for
equipment includes a price range between the manufacturers' suggested retail
price ("MSRP") and the minimum price for which our sales force is permitted to
sell equipment. The price list for equipment is updated monthly to reflect any
vendor-communicated changes in MSRP and any changes in the fair value for which
equipment is being sold to customers. The national price list for service
reflects the price of service charged to customers. The price list for service
is updated quarterly to reflect new service offerings and any changes in the
competitive environment affecting the fair value for which service is being
provided to customers. The national price list, therefore, is representative of
the fair value of each element of a bundled agreement when it is sold
unaccompanied by the other elements.
Revenue for a bundled contract is first allocated to service revenue using the
fair value per our national price list. The remaining revenue is allocated to
equipment revenue and finance income based on a net present value calculation
utilizing an appropriate interest rate that considers the creditworthiness of
the customer, term of the lease, transaction size, and costs of financing. The
equipment revenue is compared to the national price list. If the equipment
revenue falls within the price range per the national price list, no adjustment
is required. If the equipment revenue is not within the price range per the
national price list, service and equipment revenues are proportionately adjusted
while holding the interest rate constant, so that both service and equipment
revenues fall within the price range per the national price list.
Goodwill. IKON evaluates goodwill in accordance with Statement of Financial
Accounting Standards ("SFAS") 142. SFAS 142 prescribes a two-step method for
determining goodwill impairment. In the first step, we determine the fair value
of the reporting unit using expected future discounted cash flows. If the net
book value
17
of the reporting unit exceeds the fair value, we would then perform the second
step of the impairment test which requires allocation of the reporting unit's
fair value to all of its assets and liabilities in a manner similar to a
purchase price allocation, with any residual fair value being allocated to
goodwill. The fair value of the goodwill is then compared to its carrying amount
to determine impairment. 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.
Allowances for Receivables. 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 residual values are based on the dollar value of the
equipment. Residual values generally range between 0% to 22% of MSRP, 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 and other financial
statements filed with the SEC 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, 2003
Compared to the Three Months Ended March 31, 2002
Results of operations for the second quarter of fiscal 2003, compared to the
second quarter of fiscal 2002, were as follows:
Our second quarter revenues decreased by $65,250, or 5.3%, compared to the
second quarter of fiscal 2002. Of this decrease, $37,082 resulted from the
impact of our actions to exit, sell or downsize certain non-strategic businesses
(telephony, education and technology hardware businesses, and certain digital
print centers) during fiscal 2002. Excluding the impact of these actions,
revenues for the quarter were down approximately 2.4%.
18
Net sales, which includes revenues from the sale of copier/printer equipment,
supplies and technology hardware, decreased by $38,133, or 6.4%, compared to the
second quarter of fiscal 2002. Approximately two-thirds of the decrease, or
$24,325, was attributable to a decline in sales of technology-related hardware.
The Company has been de-emphasizing this low-margin revenue stream, choosing
instead to redirect its technical capabilities to support the growing service
opportunities in document management and digital connectivity. Excluding the
impact of technology-related hardware, net sales were down approximately 2.4%.
Revenues from sales of copier/printer equipment decreased by 2.2%, or $9,315,
compared to the second quarter of fiscal 2002 due to a soft economy and delays
in large purchasing decisions by our customers. In addition, we encountered some
changes in sales mix during the second quarter of 2003, with sales of segment
1-4 copiers/printers (equipment with minimum page output of less than 70 pages
per minute) declining less than sales of segment 5 and 6 copiers/printers
(equipment with minimum page output of more than 70 pages per minute). For
example, there was increased demand for lower-priced segment 4 copiers/printers
with new, enhanced features over higher-end segment 5 devices during the
quarter. Services, which includes revenues from the servicing of copier/printer
equipment, outsourcing and other services, decreased by $30,469, or 5.7%,
compared to the second quarter of fiscal 2002. Revenues from the servicing of
copier/printer equipment decreased by approximately 3.4%, or $9,928, compared to
the prior year primarily due to lower average pricing and a slowdown in copy
volumes of segment 1 through 4 devices as a result of continuing economic
uncertainty. These decreases are partially offset by copy volume growth in color
and segment 5 and 6 devices. Revenues from outsourcing and other service
offerings were impacted by our actions to exit, sell or downsize certain
non-strategic businesses during fiscal 2002, which accounted for $12,757 of the
total services revenue decline. Excluding the impact of these actions,
outsourcing and other services decreased approximately 3.4% compared to the
prior year. The decrease in revenue from outsourcing and other services was due
to customers' business downsizing, customers' decisions to in-source and reduced
demand for legal document services, arising from a slowdown in the legal
industry and fewer commercial transactions that utilize such services.
Finance income is generated by IKON's wholly-owned leasing subsidiaries. IOS
Capital, LLC ("IOSC"), IKON's leasing subsidiary in the United States, accounted
for approximately 89% of IKON's finance income for the second quarter of fiscal
2003. Finance income increased by $3,352, or 3.6%, compared to the second
quarter of fiscal 2002, primarily due to growth in the lease portfolio.
Overall gross margin increased to 38.8% for the second quarter of fiscal 2003,
compared to 38.5% for the second quarter of fiscal 2002. The gross margin on net
sales decreased to 33.4% from 33.9% in the second quarter of fiscal 2002,
primarily due to the shift in the sales mix of copier/printer equipment sold
during the period which is partially offset by lower sales of lower-margin
technology hardware. The gross margin on services increased to 40.2% from 39.8%
in the second quarter of fiscal 2002. The gross margin on finance income
increased to 62.2% from 60.5% in the second quarter of fiscal 2002, primarily
due to the effect of lower average borrowing rates compared to the second
quarter of fiscal 2002. The average financing rate on our lease receivables was
approximately 10.9% at March 31, 2003 and 2002. Additionally, our finance
subsidiaries average cost of debt was approximately 5.4% and 6.2% as of March
31, 2003 and 2002, respectively.
Selling and administrative expense as a percentage of revenue was 32.7% in the
second quarter of fiscal 2003 compared to 32.8% in the second quarter of fiscal
2002, representing a decrease of $22,760, or 5.7%. The decrease was primarily
due to approximately $15,700 from improved productivity, centralization and
consolidation initiatives including headcount reductions and approximately
$5,200 from the downsizing or elimination of unprofitable businesses. In
addition, the Company incurred $10,200 of increased pension costs and higher
expenses incurred as part of the Company's e-IKON initiative, which were
partially offset by a $6,100 decline in expenses related to performance
compensation costs. In the second quarter of fiscal 2002, the Company recorded a
charge of $6,000 related to the expected settlement of a legal matter.
Our operating income increased by $106 compared to the second quarter of fiscal
2002. Our operating margin was 6.0% in the second quarter of fiscal 2003
compared to 5.7% in the second quarter of fiscal 2002. Operating margin is
calculated as operating income divided by total revenue.
Interest expense, net was $11,259 in the second quarter of fiscal 2003 compared
to $14,087 in the second quarter of fiscal 2002. The decrease was due to lower
average outstanding debt and net gains, including the write-off of unamortized
costs, of $1,348 recognized as a result of the Company's repurchase of $17,825
par value of 6.75% bonds due in 2004 and $9,360 par value of 6.75% bonds due in
2025 for $18,055 and $7,440, respectively.
The effective income tax rate was 37.75% in the second quarter of fiscal 2003
compared to 36.5% in the second quarter of fiscal 2002. The increase in the
effective tax rate is primarily attributable to an increase in our state tax
rate and our inability to record tax benefits from losses incurred in certain
foreign jurisdictions.
19
Diluted earnings per common share were $0.23 in the second quarter of fiscal
2003 compared to $0.24 in the second quarter of fiscal 2002. The diluted
earnings per common share calculation for the second quarter of fiscal 2003
reflects the impact of the 5% Convertible Subordinated Notes (the "Convertible
Notes") due 2007 issued by IOSC on May 13, 2002. The Company accounts for the
effect of the Convertible Notes in the diluted earnings per common share
calculation using the "if converted" method. Under that method, the Convertible
Notes are assumed to be converted to shares (weighted for the number of days
outstanding in the period) at a conversion price of $15.03, and interest
expense, net of taxes, related to the Convertible Notes is added back to net
income.
Review of Business Segments
- ---------------------------
During fiscal 2003, the Company made certain changes to its segment reporting to
reflect the way management views IKON's business. Due to the Company's
organizational structure change related to centralization of the supply chain
function and customer care centers announced in October 2002, IKON no longer
allocates these corporate administrative charges to IKON North America. As a
result, these costs are included in Corporate. In addition, a unit of our
business imaging services operations which had been included in Other is now
included in IKON North America consistent with the way management now views our
segments for making operating decisions. Prior year amounts have been
reclassified to conform to the current year presentation.
IKON North America
Net sales decreased by $38,054, or 7.3%, to $483,135 in the second quarter of
fiscal 2003 from $521,189 in the second quarter of fiscal 2002. Approximately
$22,400 of the decrease was due to a decline in sales of technology-related
hardware reflecting our strategy to de-emphasize certain low margin products.
The remaining decrease was due to declines in supplies and sales of
copier/printer equipment which have been impacted by a slower economy, delayed
purchasing decisions by our customers and changes in sales mix as a result of
new, lower-priced technologies. Service revenues decreased by $32,341, or 6.6%,
to $454,424 in the second quarter of fiscal 2003 from $486,765 in the second
quarter of fiscal 2002. Approximately $15,500 of the decline resulted from a
decrease in revenue from outsourcing and other service offerings, of which
approximately $6,800 was due to the impact of our actions to exit, sell or
downsize certain non-strategic businesses during fiscal 2002. The remainder of
the decline in revenue from outsourcing and other service offerings was due to
customers' business downsizing, customer's decisions to in-source and reduced
demand for legal document services, arising from a slowdown in the legal
industry and fewer commercial transactions that utilize such services. The
decrease in revenues from the servicing of copier/printer equipment was
primarily due to lower average pricing and a slowdown in copy volumes of segment
1 through 4 devices as a result of continuing economic uncertainty. These
decreases are partially offset by copy volume growth in color and segment 5 and
6 devices. Finance income increased by $2,522, or 2.8%, to $91,264 in the second
quarter of fiscal 2003, from $88,742 in the second quarter of fiscal 2002
primarily due to growth in the lease portfolio compared to the second quarter of
fiscal 2002. Operating income decreased by $16,245, or 10.3%, to $141,449 in the
second quarter of fiscal 2003 from $157,694 in the second quarter of fiscal
2002. The decrease was due to lower gross margins, which were partially offset
by lower selling and administrative costs as discussed above.
IKON Europe
Net sales increased by $483, or 0.7%, to $70,086 in the second quarter of fiscal
2003 from $69,603 in the second quarter of fiscal 2002. This primarily resulted
from a decrease in sales of copier/printer equipment of approximately $8,000 and
a decrease in technology-related hardware of approximately $1,355, offset by an
increase in revenue due to strengthened foreign currencies. Services increased
by $7,835, or 21.0%, to $45,171 in the second quarter of fiscal 2003 from
$37,336 in the second quarter of fiscal 2002. This increase was due to growth in
equipment services and outsourcing and other services of approximately $2,000
combined with an increase due to strengthened foreign currencies. Finance income
increased by $830, or 16.9%, to $5,744 in the second quarter of fiscal 2003 from
$4,914 in the second quarter of fiscal 2002. Operating income increased by $772,
or 14.3%, to $6,172 in the second quarter of fiscal 2003 from $5,400 in the
second quarter of fiscal 2002 due to infrastructure improvements.
Other
Net sales decreased by $562, or 86.7%, to $87 in the second quarter of fiscal
2003 from $649 in the second quarter of fiscal 2002. Services decreased by
$5,963, or 54.3%, to $5,013 in the second quarter of fiscal 2003 from $10,976 in
the second quarter of fiscal 2002. These declines are primarily due to the
downsizing, sale, and closure of certain non-strategic businesses such as
telephony, technology education and other technology-related operations. There
was an operating loss of $753 in the second quarter of fiscal 2003 compared to
an operating loss of $2,172 in the second quarter of fiscal 2002. The decrease
in operating loss reflects the impact of the actions described above concerning
the downsizing, sale or closure of certain non-strategic businesses.
Six Months Ended March 31, 2003
Compared to the Six Months Ended March 31, 2002
Results of operations for the six months ended March 31, 2003, compared to the
six months ended March 31, 2002, were as follows:
Our revenues for the six months ended March 31, 2003 decreased by $138,735, or
5.7%, compared to the six months ended March 31, 2002. Of this decrease, $93,621
resulted from the impact of our actions to exit, sell or downsize certain
non-strategic businesses (telephony, education and technology hardware
businesses, and certain digital print centers) during fiscal 2002. Excluding the
impact of these actions, revenues for the six months ended March 31, 2003, were
down approximately 1.9%.
20
Net sales, which includes revenues from the sale of copier/printer equipment,
supplies and technology hardware, decreased by $80,368, or 6.9%, compared to the
six months ended March 31, 2003. Approximately two-thirds of the decrease, or
$52,462, was attributable to a decline in sales of technology-related hardware.
The Company has been de-emphasizing this low-margin revenue stream, choosing
instead to redirect its technical capabilities to support the growing service
opportunities in document management and digital connectivity. Excluding the
impact of technology-related hardware, net sales were down approximately 2.5%.
Revenues from sales of copier/printer equipment decreased by 2.6%, or $21,376,
due to a soft economy and delayed purchase decisions by our customers.
Services, which includes revenues from the servicing of copier/printer
equipment, outsourcing and other services, decreased by $63,496, or 5.9%,
compared to the six months ended March 31, 2002. Revenues from outsourcing and
other service offerings were impacted by our actions to exit, sell or downsize
certain non-strategic businesses during fiscal 2002, which accounted for $41,159
of the total services revenue decline. Excluding the impact of these actions,
outsourcing and other services decreased approximately 2.1% compared to the
prior year due to customers' business downsizing, customer's decisions to
in-source and reduced demand for legal document services, arising from a
slowdown in the legal business and fewer commercial transactions that utilize
such services. Revenues from the servicing of copier/printer equipment decreased
by approximately 2.5% or $14,938, compared to the prior year primarily due to
lower average pricing and a slowdown in copy volumes in segment 1 through 4
devices as a result of continuing economic uncertainty. These decreases are
partially offset by copy volume growth in color and segment 5 and 6 devices.
Finance income is generated by IKON's wholly-owned leasing subsidiaries. IOSC,
IKON's leasing subsidiary in the United States, accounted for approximately 91%
of IKON's finance income for the six months ended March 31, 2003. Finance income
increased by $5,129, or 2.7%, compared to the six months ended March 31, 2002,
primarily due to growth in the lease portfolio.
Overall gross margin increased to 39.1% for the six months ended March 31, 2003,
compared to 38.6% for the six months ended March 31, 2002. The gross margin on
net sales increased to 34.4% from 34.1% for the six months ended March 31, 2002.
This increase was primarily due to lower sales of lower-margin technology
hardware. The gross margin on services remained consistent at 40.0%. The gross
margin on finance income increased to 60.6% from 58.2% during the six months
ended March 31, 2003, primarily due to the effect of lower average borrowing
rates compared to the six months ended March 31, 2002.
Selling and administrative expense as a percentage of revenue was 33.2% for the
six months ended March 31, 2003 compared to 33.0% for the six months ended March
31, 2002, representing a decrease of $39,851, or 5.0%. The decrease was
primarily due to approximately $29,400 from improved productivity,
centralization and consolidation initiatives including headcount reductions and
approximately $22,700 from the downsizing or elimination of unprofitable
businesses. In addition, the Company incurred $24,300 of increased pension costs
and higher expenses incurred as part of the Company's e-IKON initiative.
Our operating income decreased by $1,239 compared to the six months ended March
31, 2002. Our operating margin was 5.9% for the six months ended March 31, 2003
compared to 5.6% in the six months ended March 31, 2002.
Interest expense, net was $23,568 during the six months ended March 31, 2003
compared to $28,597 during the six months ended March 31, 2002. The decrease was
due to lower average outstanding debt and net gains, including the write-off of
unamortized costs, of $1,250 recognized as a result of the Company's repurchase
of $17,825 par value of 6.75% bonds due in 2004, $9,360 par value of 6.75% bonds
due in 2025 and $9,500 par value of 9.75% notes due 2004 for $18,055, $7,440,
and $9,598, respectively.
The effective income tax rate was 37.75% during the six months ended March 31,
2003 compared to 36.5% during the six months ended March 31, 2002. The increase
in the effective tax rate is primarily attributable to an increase in our state
tax rate and our inability to record tax benefits from losses incurred in
certain foreign jurisdictions.
Diluted earnings per common share were $0.44 for the six months ended March 31,
2003 compared to $0.46 for the six months ended March 31, 2002. The diluted
earnings per common share calculation for the six months ended March 31, 2003
21
reflects the impact of the 5% Convertible Subordinated Notes (the "Convertible
Notes") due 2007 issued by IOSC on May 13, 2002. The Company accounts for the
effect of the Convertible Notes in the diluted earnings per common share
calculation using the "if converted" method. Under that method, the Convertible
Notes are assumed to be converted to shares (weighted for the number of days
outstanding in the period) at a conversion price of $15.03, and interest
expense, net of taxes, related to the Convertible Notes is added back to net
income.
Review of Business Segments
- ---------------------------
IKON North America net sales decreased by $76,149, or 7.5%, to $943,253 during
the six months ended March 31, 2003 from $1,019,402 during the six months ended
March 31, 2002. Approximately $42,000 of the decrease was due to a decline in
sales of technology-related hardware reflecting our strategy to de-emphasize
certain low margin products. The remaining decrease was primarily due to
declines in sales of copier/printer equipment due to a soft economy and delayed
purchase decisions by our customers. Services decreased by $58,721, or 6.0%, to
$918,232 during the six months ended March 31, 2003 from $976,953 during the six
months ended March 31, 2002. Approximately $34,900 of the decline resulted from
a decrease in revenue from outsourcing and other service offerings, of which
approximately $21,200 was due to the impact of our actions to exit, sell or
downsize certain non-strategic businesses during fiscal 2002. The remainder of
the decline in revenue from outsourcing and other service offerings was due to
customers' business downsizing, customers' decisions to in-source and reduced
demand for legal document services, arising from a slowdown in the legal
industry and fewer commercial transactions that utilize such services. The
decrease in revenues from the servicing of copier/printer equipment was
primarily due to lower average pricing and a slowdown in copy volumes of segment
1 through 4 devices as a result of continuing economic uncertainty. These
decreases are partially offset by copy volume growth in color and segment 5 and
6 devices. Finance income increased by $3,669, or 2.1%, to $180,585 during the
six months ended March 31, 2003, from $176,916 during the six months ended March
31, 2002 primarily due to growth in the lease portfolio compared to the six
months ended March 31, 2002. Operating income decreased by $8,930, or 3.0%, to
$288,670 during the six months ended March 31, 2003 from $297,600 during the six
months ended March 31, 2002.
IKON Europe
Net sales increased by $2,301, or 1.7%, to $136,632 during the six months ended
March 31, 2003 from $134,331 during the six months ended March 31, 2002. This
primarily resulted from a decrease in sales of copier/printer equipment of
approximately $9,000 and a decrease in technology-related hardware of
approximately $4,000, offset by an increase in revenue due to strengthened
foreign currencies. Services increased by $15,157, or 20.0%, to $90,908 during
the six months ended March 31, 2003 from $75,751 during the six months ended
March 31, 2002. This increase was due to growth in outsourcing and other
services of approximately $5,000 combined with an increase due to strengthened
foreign currencies. Finance income increased by $1,460, or 14.8%, to $11,322
during the six months ended March 31, 2003 from $9,862 during the six months
ended March 31, 2002. Operating income increased by $1,258, or 11.5%, to $12,209
during the six months ended March 31, 2003 from $10,951 during the six months
ended March 31, 2002 due to infrastructure improvements.
Other
Net sales decreased by $6,520, or 97.2%, to $185 during the six months ended
March 31, 2003 from $6,705 during the six months ended March 31, 2002. Services
decreased by $19,932, or 64.9%, to $10,771 during the six months ended March 31,
2003 from $30,703 during the six months ended March 31, 2002. These declines are
primarily due to the downsizing, sale, and closure of certain non-strategic
businesses such as telephony, technology education and other technology-related
operations. There was an operating loss of $878 during the six months ended
March 31, 2003 compared to an operating loss of $7,966 during the six months
ended March 31, 2002. The decrease in operating loss reflects the impact of the
actions described above concerning the downsizing, sale or closure of certain
non-strategic businesses.
Restructuring and Asset Impairment Charges
- ------------------------------------------
In the fourth quarter of fiscal 2001, the Company announced the acceleration of
certain cost cutting and infrastructure improvements (as described below) 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. The related reserve adjustments were included in cost of
goods sold for the write-off of obsolete inventory, and selling and
administrative expense for the write-off of accounts receivable in the
consolidated statement of income. The asset impairments included fixed asset
write-offs totaling $6,078 as follows: $100 from technology services businesses
closures; $897 from digital print center business closures; $338 from digital
print center business sales; and $4,743 relating to IKON infrastructure. The
asset impairments also included goodwill write-offs totaling $19,422 as follows:
22
$955 from technology services businesses closures; $6,591 from digital print
center business sales; and $11,876 relating to telephony business sales. The
Company developed this plan as part of our continuing effort to streamline
IKON's infrastructure to increase future productivity, and to address economic
changes within specific marketplaces. This resulted in a charge of $65,300
($49,235 after-tax). These actions addressed the sale of the Company's telephony
operations and the closing of twelve nonstrategic digital print centers as the
Company shifts its focus from transactional work toward contract print work and
the support of major accounts. These actions also addressed further downsizing
of operational infrastructures throughout the organization as the Company
leverages and intensifies prior standardization and centralization initiatives.
These actions included 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) related
to the sale of the Company's technology education operations. The asset
impairments included fixed asset write-offs totaling $828. The asset impairments
also included goodwill write-offs totaling $2,754. Therefore, the aggregate
charge recorded in fiscal 2001 (the "Fiscal 2001 Charge") was $68,882 ($52,535
after-tax).
In the first quarter of fiscal 2000, the Company announced plans to improve
performance and efficiency and incurred a total pre-tax restructuring and asset
impairment charge (the "First Quarter 2000 Charge") of $105,340 ($78,479
after-tax). The asset impairments included fixed asset write-offs totaling
$12,668 as follows: $631 from technology services integration and education
business closures; $2,530 from technology services integration and education
business downsizing; $1,269 from digital print center business closures; $588
from digital print center business downsizing; $1,405 from document services
excess equipment; $1,244 from a technology services business sale; and $5,001
relating to IKON infrastructure. The asset impairments included goodwill
write-offs totaling $38,880 as follows: $3,279 from technology services
integration business sales; $10,156 from technology services integration and
education business closures; $9,566 from digital print center business closures;
$14,950 from a technology services business sale; and $929 relating to an IKON
Europe closure. These actions addressed under-performance in certain technology
services operations, business document services, and business information
services locations as well as the Company's desire to strategically position
these businesses for integration and profitable growth. Plans included
consolidating or disposing of certain under-performing and non-core locations;
implementing productivity enhancements through the consolidation and
centralization of activities in inventory management, purchasing,
finance/accounting and other administrative functions; and consolidating real
estate through the co-location of business units as well as the disposition of
unproductive real estate. In the fourth quarter of fiscal 2000, the Company
determined that some first quarter restructuring initiatives would not require
the level of spending that had been originally estimated, and certain other
initiatives would not be implemented due to changing business dynamics.
Previously targeted sites were maintained based on their potential for
improvement as well as their relationship to IKON's overall strategic direction.
As a result of our integration efforts, locations originally identified for sale
or closure were combined with other IKON businesses. As a result, $15,961 was
reversed from the First Quarter 2000 Charge, and the total amount of the First
Quarter 2000 Charge was reduced to $89,379 ($66,587 after-tax). The components
of the reversal were: 538 fewer positions eliminated reduced severance by
$1,784, real estate lease payments reduced by $13,426, and contractual
commitments reduced by $751. The severance reversal resulted from successfully
negotiating business sales whereby affected employees assumed positions with the
acquiring companies, higher-than-expected voluntary resignations, and our
decision not to implement certain supply chain and shared service center
consolidation efforts. The real estate lease payment reversal was primarily the
result of our decision not to close certain sites. Also, in the fourth quarter
of fiscal 2000, the Company announced other specific actions designed to address
the changing market conditions impacting technology services, IKON North
America, and outsourcing locations and incurred a total pre-tax restructuring
and asset impairment charge (the "Fourth Quarter 2000 Charge") of $15,789
($12,353 after-tax). The asset impairments consisted of fixed asset write-offs
totaling $2,371 as follows: $1,371 from technology services integration and
education business closures; $721 from digital print center business closures;
and $279 relating to IKON infrastructure. The First Quarter 2000 Charge (as
reduced) and Fourth Quarter 2000 Charge resulted in a net fiscal 2000 charge
(the "Fiscal 2000 Charge") of $105,168 ($78,940 after-tax).
In the fourth quarter of fiscal 2002, the Company reversed $10,497 ($6,823
after-tax) of its restructuring charges described above. The reversed charges
consisted of $7,418 related to severance, $1,667 related to leasehold
termination costs and $1,412 related to contractual commitments. The severance
reversal was the result of the average cost of severance per employee being less
than estimated and 188 fewer positions eliminated than estimated due to
voluntary resignations and our decision not to close a digital print center due
to changing business dynamics. The reversal of leasehold termination costs and
contractual commitments resulted from our decision not to close a digital print
center. Additionally, we were also able to reduce our liability through
successful equipment and real property lease termination negotiations.
23
The pre-tax components of the restructuring, net, and asset impairment charges
for fiscal 2002, 2001 and 2000 were as follows:
Fiscal Fiscal Fourth Quarter Fiscal First Quarter
2002 2001 Fiscal 2000 2000 Fiscal 2000
Type of Charge Reversal Charge Charge Reversal Charge
- ---------------------------------------------------------------------------------------------------------------------------------
Restructuring Charge:
Severance $ (7,418) $ 26,500 $ 6,092 $ (1,784) $16,389
Leasehold termination costs (1,667) 5,534 6,685 (13,426) 33,691
Contractual commitments (1,412) 2,466 641 (751) 3,712
- ---------------------------------------------------------------------------------------------------------------------------------
Total Restructuring Charge (10,497) 34,500 13,418 (15,961) 53,792
- ---------------------------------------------------------------------------------------------------------------------------------
Asset Impairment Charge:
Fixed assets 6,906 2,371 12,668
Goodwill and intangibles 22,176 38,880
- ---------------------------------------------------------------------------------------------------------------------------------
Total Asset Impairment Charge 29,082 2,371 51,548
- ---------------------------------------------------------------------------------------------------------------------------------
Total $(10,497) $ 63,582 $15,789 $(15,961) $ 105,340
- ---------------------------------------------------------------------------------------------------------------------------------
The Company calculated the asset and goodwill impairments as required by SFAS
121 "Accounting for the Impairment of Long-Lived Assets and Assets to be
Disposed of." The proceeds received for businesses sold were not sufficient to
cover the fixed asset and goodwill balances. As such, those balances were
written-off. Goodwill directly associated with businesses that were closed was
also written-off.
24
The following presents a rollforward of the restructuring components of the
Fiscal 2001 Charge, Fourth Quarter 2000 Charge and First Quarter 2000 Charge
(collectively the "Charges") from September 30, 2002 to the balance remaining at
March 31, 2003, which is included in other accrued expenses in the consolidated
balance sheets:
Balance Payments Balance
September 30, Fiscal March 31,
Fiscal 2001 Restructuring Charge 2002 2003 2003
-------------------------------------------------------------------------------
Severance $ 7,799 $(3,991) $ 3,808
Leasehold termination costs 2,251 (824) 1,427
Contractual commitments 30 30
-------------------------------------------------------------------------------
Total $ 10,080 $(4,815) $5,265
-------------------------------------------------------------------------------
Balance Payments Balance
Fourth Quarter September 30, Fiscal March 31,
Fiscal 2000 Restructuring Charge 2002 2003 2003
-------------------------------------------------------------------------------
Severance $ 112 $ (103) $ 9
Leasehold termination costs 2,948 (1,249) 1,699
-------------------------------------------------------------------------------
Total $3,060 $ (1,352) $1,708
-------------------------------------------------------------------------------
Balance Payments Balance
First Quarter September 30, Fiscal March 31,
Fiscal 2000 Restructuring Charge 2002 2003 2003
-------------------------------------------------------------------------------
Severance $ 355 $(114) $ 241
Leasehold termination costs 1,614 (852) 762
-------------------------------------------------------------------------------
Total $ 1,969 $(966) $1,003
-------------------------------------------------------------------------------
The projected payments of the remaining balances of the Charges are as follows:
Fiscal 2001 Projected Payments FY 2003 FY 2004 FY 2005 FY 2006 Total
- --------------------------------------------------------------------------------------------------------------------
Severance $ 2,510 $1,221 $ 77 $ 3,808
Leasehold termination costs 583 557 244 $ 43 1,427
Contractual commitments 30 30
- --------------------------------------------------------------------------------------------------------------------
Total $3,123 $1,778 $ 321 $ 43 $ 5,265
- --------------------------------------------------------------------------------------------------------------------
Fourth Quarter Fiscal 2000
Projected Payments FY 2003 FY 2004 FY 2005 FY 2006 Beyond Total
- --------------------------------------------------------------------------------------------------------------------
Severance $ 9 $ 9
Leasehold termination costs 50 $825 $429 $239 $156 1,699
- --------------------------------------------------------------------------------------------------------------------
Total $59 $825 $429 $ 239 $156 $ 1,708
- --------------------------------------------------------------------------------------------------------------------
First Quarter Fiscal 2000
Projected Payments FY 2003 FY 2004 FY 2005 Total
- -----------------------------------------------------------------------------------------
Severance $ 241 $ 241
Leasehold termination costs 203 $340 $219 762
- -----------------------------------------------------------------------------------------
Total $444 $340 $219 $ 1,003
- -----------------------------------------------------------------------------------------
25
The Company determined its probable sub-lease income through the performance of
local commercial real estate market valuations by our external regional real
estate brokers. All lease termination amounts are shown net of projected
sub-lease income. Projected sub-lease income as of March 31, 2003 was $621,
$4,487 and $3,827 for the Fiscal 2001 Charge, Fourth Quarter 2000 Charge and
First Quarter 2000 Charge, respectively.
All actions related to our restructuring are complete. Severance payments to
terminated employees are made in installments. The charges for leasehold
termination costs relate to real estate lease contracts where the Company has
exited certain locations and is required to make payments over the remaining
lease term.
All locations affected by the Charges (23, 5 and 22 locations for the Fiscal
2001 Charge, Fourth Quarter 2000 Charge and First Quarter 2000 Charge,
respectively) have been closed and all employees affected by the Charges (1,412,
386 and 1,394 employees for the Fiscal 2001 Charge, Fourth Quarter 2000 Charge
and First Quarter 2000 Charge, respectively) have been terminated.
Financial Condition and Liquidity
- ---------------------------------
Net cash provided by operating activities for the first six months of fiscal
2003 was $104,584. During the same period, the Company used $113,551 of cash for
investing activities, which included net finance subsidiary use of $43,624,
capital expenditures for property and equipment of $49,398 and capital
expenditures for equipment on operating leases of $31,634. Cash used in
financing activities of $76,720, includes net repayments of $31,489 of
non-finance subsidiaries' long-term debt, net repayments of $13,724 of
short-term debt and net repayments of $26,047 of finance subsidiaries' debt.
Debt, excluding finance subsidiaries, was $577,058 at March 31, 2003, a decrease
of $35,939 from the debt balance of $612,997 at September 30, 2002. During the
second quarter of fiscal 2003, the Company repurchased $17,825 par value of
6.75% bonds due in 2004 and $9,360 par value of 6.75% bonds due in 2025 for
$18,055 and $7,440, respectively. Excluding finance subsidiaries' debt, our debt
to capital ratio was 26.4% at March 31, 2003 compared to 28.5% at September 30,
2002. Finance subsidiaries' debt is excluded from the calculation because a
significant amount of this debt is backed by a portion of the lease receivables
portfolio. Including finance subsidiaries' debt, our debt to capital ratio was
67.7% at March 31, 2003 compared to 69.0% at September 30, 2002.
Restricted cash on the consolidated balance sheets primarily represents the cash
that has been collected on the leases that are pledged as collateral for
lease-backed notes. This cash must be segregated within two business days into a
trust account and the cash is used to pay the principal and interest on
lease-backed notes as well as any associated administrative expenses. The level
of restricted cash is impacted from one period to the next by the volume of
leases pledged as collateral on the lease-backed notes and timing of collections
on such leases.
In fiscal 2002, the Company obtained a $300,000 unsecured credit facility (the
"Credit Facility"), which contractually matures on May 24, 2005. Unless the
Company achieves certain ratings on its long and short term senior, unsecured
debt (as defined) or has not redeemed or defeased IOSC's 9.75% Notes due June
15, 2004 ($240,500 outstanding at March 31, 2003), all loans under the Credit
Facility will mature on December 15, 2003. As a result of any such maturity, the
Company may be required to seek additional sources of financing. Revolving loans
are available, with certain sub-limits, to IOSC; IKON Capital, PLC, IKON's
leasing subsidiary in the United Kingdom; and IKON Capital, Inc., IKON's leasing
subsidiary in Canada. As of March 31, 2003, the Company had $140,900 and
(pound)5,000 of borrowings outstanding under the Credit Facility. The Credit
Facility also provides support for letters of credit for the Company and its
subsidiaries. As of March 31, 2003, letters of credit supported by the Credit
Facility amounted to $25,375. The amount available under the Credit Facility is
determined by the level of certain of the Company's unsecured assets and the
open letters of credit for the Company and its subsidiaries. The amount
available under the Credit Facility for borrowings or additional letters of
credit was $125,913 as of March 31, 2003.
The Credit Facility contains affirmative and negative covenants, including
limitations on certain fundamental changes, investments and acquisitions,
mergers, certain transactions with affiliates, creation of liens, asset
transfers, payment of dividends, intercompany loans and certain restricted
payments. The Credit Facility does not affect our ability to continue to
securitize lease receivables. Cash dividends may be paid on common stock subject
to certain limitations. The Credit Facility also contains certain financial
covenants including (i) corporate leverage ratio; (ii) consolidated interest
expense ratio; (iii) consolidated asset test ratios; and (iv) limitations on
capital expenditures. The Credit Facility contains default provisions customary
for facilities of this type. A financial covenant contained in the Credit
Facility was modified in April 2003. Failure to be in compliance with any
material provision of the Credit Facility could have a material adverse effect
on our liquidity, financial position and results of operations.
26
As of March 31, 2003, finance subsidiaries' debt decreased by $18,234 from
September 30, 2002. During the six months ended March 31, 2003, our finance
subsidiaries repaid $604,672 of debt and received $578,625 from the issuance of
debt instruments. During the six months ended March 31, 2003, IOSC repurchased
$9,500 of 9.75% notes due June 15, 2004 for $9,598. As of March 31, 2003, IOSC,
IKON Capital, PLC and IKON Capital, Inc. had approximately $66,355, (pound)6,140
and CN$79,836 available under their revolving asset securitization conduit
financing agreements (the "Conduits").
On May 1, 2003, Moody's Investor Services lowered the Company's senior unsecured
credit rating from Baa2 to Baa3 and maintained our ratings under review for
further downgrade. Our access to certain credit markets is dependent upon our
credit ratings. Although the Company is currently rated investment grade by both
Standard and Poor's, (BBB-, with a stable outlook) and Moody's Investor Services
(Baa3, with our ratings under review), any negative changes to our credit
ratings, including any further downgrades, could reduce and/or foreclose our
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.
On April 23, 2003, IKON Receivables Funding, LLC (a wholly-owned subsidiary of
IOS Capital) issued Series 2003-1 Lease-Backed Notes (the "2003 Notes") as
described below:
Principal Stated
Issuance Issuance Maturity
Series Notes Date Amount Interest Rate Date
- -------------- -------------- ------------ --------------- --------------------- -----------------
2003-1 Class A-1 04/23/03 $253,200 1.30813% May 2004
Class A-2 04/23/03 26,700 1.68% November 2005
Class A-3a 04/23/03 206,400 LIBOR + 0.24% December 2007
Class A-3b 04/23/03 206,400 2.33% December 2007
Class A-4 04/23/03 159,385 3.27% July 2011
- -------------- -------------- ------------ --------------- --------------------- -----------------
Total $852,085
- -------------- -------------- ------------ --------------- --------------------- -----------------
Proceeds from the issuance of the 2003 Notes were used to make payments on the
Company's Conduits, repay $140,900 of Credit Facility borrowings and increase
the Company's cash balance.
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 it had issued fixed rate notes. During the six months ended March 31,
2003, unrealized gains totaling $6,998 after taxes, were recorded in accumulated
other comprehensive loss. As of March 31, 2003, 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.
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. Additionally, from time to time, the Company may
repurchase outstanding debt in open market and private transactions.
The following summarizes IKON's significant contractual obligations and
commitments as of March 31, 2003:
Payments due by
-------------------------------------------------------------------------------------
March 31, March 31, March 31,
Contractual Obligations Total 2004 2006 2008 Thereafter
- ----------------------------------------------------------------------------------------------------------------------------
Long-Term Debt, excluding
Finance Subsidiaries $575,445 $8,553 $165,082 $604 $401,206
Long-Term Debt of Finance
Subsidiaries 2,789,627 1,571,150 905,705 312,719 53
Notes Payable 1,613 1,613
Purchase Commitments 4,528 2,994 1,534
Operating Leases 502,600 137,034 192,644 95,251 77,671
Synthetic Leases 18,484 132 264 18,088
- -------------------------------------- -------------- ----------------- ---------------- -------------------- --------------
Total $3,892,297 $1,721,476 $1,265,229 $426,662 $478,930
-------------- ----------------- ---------------- -------------------- --------------
27
Payments on long-term debt of finance subsidiaries generally are made from
collections on our finance receivables. At March 31, 2003, long-term debt of
finance subsidiaries was $2,789,627 and finance receivables, net of allowances,
were $3,453,972.
Purchase commitments represent future cash payments related to our
implementation of the Oracle e-business suite. Contractual obligations for
software of $3,835 is included in fixed assets and accrued liabilities as of
March 31, 2003. The remaining $693 is for other contractual obligations which
will be either expensed or capitalized in accordance with Statement of Position
98-1 "Accounting for Costs of Computer Software Developed or Obtained for
Internal Use."
On November 21, 2001, IKON entered into a synthetic lease agreement totaling
$18,659 for the purpose of leasing its corporate headquarters in Malvern,
Pennsylvania (the "Corporate Lease"). Under the terms of the Corporate Lease,
IKON is required to occupy the facility for a term of five years from the
agreement date. The Corporate Lease also provides for a residual value guarantee
and includes a purchase option at the lessor's original cost of the property. If
IKON terminates the Corporate Lease prior to the end of the lease term, IKON is
obligated to purchase the leased property at a price equal to the remaining
lease balance. Because IKON is required to only pay the yield due on the
Corporate Lease, IKON's nominal rental rate under the Corporate Lease is
different from what IKON would be required to pay under a market rental rate.
The Corporate Lease contains one financial covenant that requires IKON to meet a
funded debt to total capitalization ratio test. The test requires IKON's total
funded debt to not exceed fifty percent of IKON's total capitalization. A
failure to maintain the covenant would constitute a default pursuant to the
Corporate Lease and would permit the lessor to either require IKON to purchase
the leased property for the then-current lease balance, terminate IKON's right
of possession of the leased property, or sell the leased property and apply the
proceeds to the current lease balance. IKON obtains valuations of the property
covered by the Corporate Lease on a regular basis. If market conditions result
in a valuation that is less than the guaranteed residual value of the property,
IKON records a charge to income. As of March 31, 2003 and September 30, 2002,
the accrued shortfall between the contractual obligation and the estimated fair
value of the leased assets under the Corporate Lease equaled $400.
On January 10, 2003, IKON terminated a synthetic lease agreement and paid
$23,901 to acquire three properties under the lease. The Company previously
recorded a reserve of $13,387 for the expected shortfall between the contractual
obligation and the estimated fair value of the leased assets. The properties are
currently for sale.
The Company has certain commitments available to it in the form of lines of
credit and standby letters of credit. As of March 31, 2003, the Company had
$142,398 available under lines of credit and $25,697 available under standby
letters of credit. All commitments expire within one year.
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 2003, including capital expenditures,
dividends and the remaining accrued costs associated with the Company's
restructuring charges.
Pending Accounting Changes
- --------------------------
In January 2003, the FASB approved FASB Interpretation Number 46, ("FIN 46")
"Consolidation of Variable Interest Entities, an interpretation of ARB 51". The
primary objectives of FIN 46 are to provide guidance for the identification of
entities for which control is achieved through means other than through voting
rights ("variable interest entities" or "VIEs") and how to determine when and
which business enterprise should consolidate the VIE (the "primary
beneficiary"). This new model for consolidation applies to an entity which
either (1) the equity investors (if any) do not have a controlling financial
interest or (2) the equity investment at risk is insufficient to finance that
entity's activities without receiving additional subordinated financial support
from other parties. In addition, this interpretation requires that both the
primary beneficiary and all other enterprises with a significant variable
interest in a VIE make additional disclosures. Certain disclosure requirements
were effective for financial statements issued after January 31, 2003. The
remaining provisions are effective immediately for all VIE's created after
January 31, 2003 and are effective beginning in the first interim or annual
reporting period beginning after June 15, 2003 for all VIE's created before
February 1, 2003. The Company is currently evaluating the impact of the
application of this interpretation, but does not expect a material impact from
the application of this interpretation on our consolidated financial statements.
In April 2003, the FASB approved SFAS 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities". SFAS 149 amends and clarifies
financial accounting and reporting for derivative instruments, including certain
derivative instruments embedded in contracts and for hedging activities under
SFAS 133. In particular, SFAS 149 amends SFAS 133 for decisions made as part of
the Derivatives Implementation Group process, other FASB projects dealing with
financial instruments, and implementation issues raised in connection with the
application of the definition of a derivative. SFAS 149 is effective for
contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003 with the exception of
implementation issues that have been effective under other pronouncements for
fiscal quarters that began prior to June 15, 2003, which should be applied in
accordance with their respective effective dates. 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 149 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
28
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 2002 Annual Report on Form 10-K 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 2002 Annual Report on Form 10-K filed with
the Securities and Exchange Commission.
Item 4: Controls and Procedures
Evaluation of Disclosure Controls and Procedures. The Company's Chief Executive
Officer and Chief Financial Officer have evaluated the effectiveness of the
Company's disclosure controls and procedures (as such term is defined in Rules
13a-14(c) and 15d-14(c) under the Exchange Act) as of an evaluation date within
90 days prior to the filing date of this Quarterly Report on Form 10-Q. Based on
this evaluation, they have concluded that, as of the evaluation date, the
Company's disclosure controls and procedures are reasonably designed to alert
them on a timely basis to material information relating to the Company
(including its consolidated subsidiaries) required to be included in its reports
filed or submitted under the Exchange Act.
Changes in Internal Controls. Since the evaluation date referred to above, there
have not been any significant changes in the Company's internal controls or in
other factors that could significantly affect such controls.
PART II. OTHER INFORMATION
Item 4: Submission of Matters to a Vote of Security Holders
On February 25, 2003, the Company held its annual meeting of shareholders at
which time eight directors were elected to hold office until the election of
their successors. The Company's Non-Employee Director Compensation Plan and
Employee Equity Incentive Plan were also approved.
For Against Withheld
--------------------- -------------------- ---------------------
Judith M. Bell 123,566,963 10,902,464
Philip E. Cushing 122,823,050 11,646,377
Matthew J. Espe 128,478,494 5,990,933
Thomas R. Gibson 122,822,517 11,646,909
Richard A. Jalkut 123,844,415 10,625,011
Arthur E. Johnson 123,917,610 10,551,816
Kurt M. Landgraf 122,846,458 11,622,968
Marilyn M. Ware 123,817,039 10,652,387
Non-Employee Director Compensation Plan 108,384,097 23,570,694 2,514,633
Employee Equity Incentive Plan 107,599,729 24,886,906 1,982,791
Item 6: Exhibits and Reports on Form 8-K
a) Exhibits
4.1 First Amendment, dated as of February 28, 2003, to the Credit Agreement,
dated May 24, 2002, among IKON and various institutional lenders, with JP
Morgan Chase Bank, N.A., as Agent.
4.2 Second Amendment, dated as of April 11, 2003, to the Credit Agreement,
dated May 24, 2002, among IKON and various institutional lenders, with JP
Morgan Chase Bank, N.A., as Agent.
10.1 Amended and Restated Agreement dated as of March 28, 2003, relating to the
Asset Backed Loan Agreement between RochFord, Inc., as Borrower, and IKON
Capital PLC, as Originator and Servicer, and Park Avenue Receivables
Corporation, as Conduit Lender, and Certain APA Banks and JP Morgan Chase
Bank, as Funding Agent.
10.2 Amended and Restated Receivables Transfer Agreement dated as of March 31,
2003 among IKON Funding-3, LLC, as Transferor, IOS Capital, LLC, as
Originator and Collection Agent, Gemini Securitization Corp., as Conduit
Transferee, The Several Financial Institutions party hereto from time to
time, as Alternate Transferees, and Deutsche Bank AG, New York Branch, as
Administrative Agent.
10.3 First Amendment, dated as of May 9, 2003, to the Amended and Restated
Transfer Agreement, dated as of March 31, 2003, among IKON Funding -3, LLC,
as Transferor, IOS Capital, LLC, as Originator and Collection Agent, Gemini
Securitization Corp., as Conduit Transferee, The Several Financial
Institutions party hereto from time to time, as Alternate Transferees, and
Deutsche Bank AB, New York Branch, as Administrative Agent.
99.1 Certification Pursuant to 18 U.S.C. Section 1850, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
b) Reports on Form 8-K
On January 24, 2003, 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 23, 2003 regarding its results for the first quarter of fiscal 2003.
On February 26, 2003, 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
February 25, 2003 regarding the election of Matthew J. Espe, President and CEO,
to the additional position of Chairman of the Board.
29
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, 2003 /s/ William S. Urkiel
------------------- ----------------------
William S. Urkiel
Senior Vice President and
Chief Financial Officer
30
CERTIFICATIONS
I, Matthew J. Espe, Chairman and Chief Executive Officer of IKON Office
Solutions, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of IKON Office
Solutions, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information contained in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors (or persons
performing the equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 15, 2003
/s/ Matthew J. Espe
- ----------------------
Matthew J. Espe
Chairman and Chief Executive Officer
31
I, William S. Urkiel, Senior Vice President and Chief Financial Officer of IKON
Office Solutions, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of IKON Office
Solutions, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information contained in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a. designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing of this
quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of the registrant's board of directors (or persons
performing the equivalent functions):
a. all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b. any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
Date: May 15, 2003
/s/ William S. Urkiel
- --------------------------------
William S. Urkiel
Senior Vice President and Chief Financial Officer
32