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, 1998 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 0-20405 IOS CAPITAL, INC. (Exact name of registrant as specified in its charter) DELAWARE 23-2493042 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 1738 Bass Road, Macon, Georgia 31210 (Address of principal executive offices) (Zip Code) (912) 471-2300 (Registrant's telephone number, including area code) NONE (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ____ * Applicable only to issuers involved in bankruptcy proceedings during the preceding five years: Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ____ No ____ * Applicable only to corporate issuers: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of April 30, 1998. Common Stock, $.01 par value per share 1,000 shares Registered Debt Outstanding as of April 30, 1998 $1,710,750,000 The registrant, an indirect wholly owned subsidiary of IKON Office Solutions, Inc. ("IKON"), meets the conditions set forth in General Instruction H(1)(a) and (b) of Form 10-Q and is, therefore, filing with the reduced disclosure format contemplated thereby. INDEX IOS CAPITAL, INC. PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Balance Sheets--March 31, 1998 and September 30, 1997 Statements of Income--Three and six months ended March 31, 1998 and March 31, 1997 Statements of Cash Flows--Six months ended March 31, 1998 and March 31, 1997 Notes to Financial Statements--March 31, 1998 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K SIGNATURES PART I . FINANCIAL INFORMATION Item 1: Financial Statements (unaudited) IOS Capital, Inc. BALANCE SHEETS (in thousands, except share and per share amounts) March 31, September 30, 1998 1997 Assets Investment in leases: Direct financing leases $1,848,712 $1,640,559 Less: Unearned income (320,102) (286,769) ------------------ ----------------- 1,528,610 1,353,790 Funded leases, net 555,952 485,658 ------------------ ----------------- 2,084,562 1,839,448 Cash 805 Accounts receivable 57,502 55,589 Due from IKON Office Solutions 4,463 Prepaid expenses and other assets 12,641 13,436 Leased equipment-operating rentals at cost less accumulated depreciation of: 3/98 - $37,222; 9/97 - $ 33,598 63,742 50,945 Property and equipment at cost, less accumulated depreciation of: 3/98 - $4,632; 9/97 - $ 3,771 11,439 12,330 ================== ================= Total assets $2,230,691 $1,976,211 ================== ================= Liabilities and shareholder's equity Liabilities: Accounts payable and accrued expenses $48,979 $51,018 Accrued interest 33,832 27,785 Due to IKON Office Solutions 1,891 Notes payable to banks 25,000 25,000 Medium term notes 1,735,750 1,542,250 Deferred income taxes 84,965 64,177 ------------------ ----------------- Total liabilities 1,930,417 1,710,230 Shareholder's equity: Common Stock - $.01 par value, 1,000 shares authorized, issued, and outstanding Contributed capital 149,415 144,415 Retained earnings 150,859 121,566 ------------------ ----------------- Total shareholder's equity 300,274 265,981 ================== ================= Total liabilities and shareholder's equity $2,230,691 $1,976,211 ================== ================= See notes to financial statements. IOS Capital, Inc. STATEMENTS OF INCOME (in thousands) Three Months Ended Six Months Ended March 31 March 31 -------------------------------- -------------------------------- 1998 1997 1998 1997 -------------- ------------ ------------- ------------- Revenues: Lease finance income $54,787 $40,657 $106,266 $77,557 Rental income 9,098 5,136 18,149 9,928 Interest on IKON tax deferrals 3,844 2,888 7,505 5,624 Other income 3,130 2,097 5,365 3,831 -------------- ------------ ------------- ------------ 70,859 50,778 137,285 96,940 Expenses: Interest 27,208 19,602 53,073 37,228 General and administrative 17,972 15,113 35,743 28,072 -------------- ------------ ------------- ------------ 45,180 34,715 88,816 65,300 Gain on sale of lease receivables 617 664 1,181 1,277 -------------- ------------ ------------- ------------ Income before income taxes 26,296 16,727 49,650 32,917 Provision for income taxes 10,782 6,858 20,357 13,496 -------------- ------------ ------------- ------------ Net income $15,514 $9,869 $29,293 $19,421 ============== ============ ============= ============ See notes to financial statements. IOS Capital, Inc. STATEMENTS OF CASH FLOWS (in thousands) Six Months Ended March 31, ------------------------------ 1998 1997 ------------- ------------- Operating activities: Net income $29,293 $19,421 Adjustments to reconcile net income to net cash provided by operating activities Depreciation and amortization 16,221 7,872 Provision for deferred taxes 20,788 13,900 Gain on sale of lease receivables (1,181) (1,277) Changes in operating assets and liabilities: Accounts receivable (1,913) (4,842) Prepaid expenses and other assets 1,976 4,586 Accounts payable and accrued expenses (2,039) (640) Accrued interest 6,047 2,338 ------------- ------------- Net cash provided 69,192 41,358 ------------- ------------- Investing activities: Purchases of leased equipment, net (28,142) (16,447) Purchases of property and equipment, net 15 (3,082) Direct financing leases: Additions (631,051) (619,015) Cancellations 123,443 87,839 Collections 280,517 225,802 Proceeds from sale 52,271 51,407 Funded leases: Additions (210,120) (187,360) Cancellations 41,103 26,587 Collections 98,723 78,111 ------------- ------------- Net cash used (273,241) (356,158) ------------- ------------- Financing activities: Payments on bank borrowings 0 (33,000) Proceeds from issuance of medium term notes 348,500 385,500 Payments on medium term notes (155,000) (43,000) Capital contributed by IKON 5,000 19,000 ------------- ------------- Net cash provided 198,500 328,500 ------------- ------------- (Increase) decrease in cash and amounts due to IKON (5,549) 13,700 Due from (to) IKON at beginning of year 4,463 (24,330) ============= ============= Cash and due to IKON at end of period ($1,086) ($10,630) ============= ============= See notes to financial statements. IOS Capital, Inc. Notes to Financial Statements March 31, 1998 Note 1: Basis of Presentation The accompanying unaudited condensed financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. For further information, refer to the financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended September 30, 1997. Note 2: Medium Term Note Program During the six months ended March 31, 1998, IOS Capital issued $348.5 million under its medium term note program. At March 31, 1998, $1,735.8 million of medium term notes were outstanding with a weighted average interest rate of 6.5%. The remaining amount available under this registration statement is $1,298.2 million. Note 3: Asset Securitization IOS Capital has asset securitization agreements for $275 million of eligible direct financing receivables that expire September 1998 ($150 million) and March 1999 ($125 million). Both of these agreements are expected to be renewed. Under these agreements, the Company sold $52.3 million in direct financing leases during the first six months of fiscal 1998, replacing leases which had been liquidated during the period and recognized a pretax gain of approximately $1.2 million. Under the terms of the sales agreements, the Company will continue to service the lease portfolio. Note 4: Name Change On January 22, 1998, the Company changed its name from IKON Capital, Inc. to IOS Capital, Inc. Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations Pursuant to General Instruction H(2) (a) of Form 10-Q, the following analysis of the results of operations is presented in lieu of Management's Discussion and Analysis of Financial Condition and Results of Operations. Three Months Ended March 31, 1998 Compared with the Three Months Ended March 31, 1997 Comparative summarized results of operations for the three months ended March 31, 1998 and 1997 are set forth in the table below. This table also shows the increase in the dollar amounts of major revenue and expense items between periods, as well as the related percentage increase. Three Months (dollars in thousands) Ended March 31 Increase 1998 1997 Amount Percent Revenues: Lease finance income $54,787 $40,657 $14,130 34.8% Rental income 9,098 5,136 3,962 77.1% Interest on IKON tax deferrals 3,844 2,888 956 33.1% Other income 3,130 2,097 1,033 49.3% ---------- ---------- ---------- 70,859 50,778 20,081 39.5% Expenses: Interest 27,208 19,602 7,606 38.8% General and administrative 17,972 15,113 2,859 18.9% ---------- ---------- ---------- 45,180 34,715 10,465 30.1% Gain on sale of lease receivables 617 664 (47) (7.1)% ---------- ---------- ---------- Income before income taxes 26,296 16,727 9,569 57.2% Provision for income taxes 10,782 6,858 3,924 57.2% ---------- ---------- ---------- Net income $ 15,514 $ 9,869 $ 5,645 57.2% ========== ========== ========== Revenues Total revenues increased $20.1 million or 39.5% in the second quarter of fiscal 1998 compared to the second quarter of fiscal 1997. Approximately 70.4% or $14.1 million of this increase in revenues was a result of increased lease finance income due to continued growth in the portfolio of direct financing and funded leases. The lease portfolio, net of lease receivables that were sold in asset securitization transactions, increased 31.3 % from March 31, 1997 to March 31, 1998. Office equipment placed on rental by the IKON marketplaces to customers, with cancelable terms, may be purchased by the Company. During the second quarters of fiscal 1998 and 1997, IOS Capital purchased operating lease equipment of $9.4 million and $9.6 million, respectively. Operating leases contributed $9.1 million in rental income during the second quarter of fiscal 1998, compared to $5.1 million in the second quarter of fiscal 1997. The Company earns interest income on the deferred tax liabilities of the IKON marketplaces associated with leases funded through the Company at a rate consistent with the Company's weighted average outside borrowing rate of interest. The Company's average rate was 6.5% for the second quarter of fiscal 1998 and 6.8% for the second quarter of fiscal 1997. In addition, the deferred tax base upon which these payments are calculated increased 31.7% to $244.3 million at March 31, 1998 from $185.5 million at March 31, 1997. Primarily as a result of the increased deferred tax liabilities, interest income on deferred taxes rose $956,000 or 33.1% when comparing the three months ended March 31, 1998 to the three months ended March 31, 1997. Other income consists primarily of late payment charges and various billing fees. The structure of these fees has remained basically unchanged from fiscal 1997. The growth in other income from fees is primarily due to the increased size of the lease portfolio upon which these fees are based. Overall, fee income from these sources grew by $1.0 million or 49.3%, when comparing the second quarter of fiscal 1998 to the same period of fiscal 1997. Expenses Average borrowings to finance the lease portfolio in the form of loans from banks and the issuance of medium term notes in the public market increased by 31.7% from March 31, 1997, to $1,760.8 million outstanding at March 31, 1998. The Company paid a weighted average interest rate on all borrowings of 6.5% for the second quarter of fiscal 1998 and 6.8% for the second quarter of fiscal 1997. Primarily as a result of the increased borrowings, interest expense grew by $7.6 million or 38.8%, when comparing the second quarter of fiscal 1998 to the second quarter of fiscal 1997. At March 31, 1998, the Company's debt to equity ratio, including intercompany amounts due to IKON was 5.9 to 1. Total general and administrative expenses for the quarter ended March 31, 1998 increased by $2.9 million or 18.9%, over the quarter ended March 31, 1997. The general and administrative expense category in the second quarter of fiscal 1998 includes depreciation expense on leased equipment totaling $7.7 million, compared to $3.7 million for the second quarter of fiscal 1997. In addition, the general and administrative expense category includes lease bonus subsidy payments to either IKON or directly to the IKON marketplaces, based on the level of dealer participation in the Company's leasing programs or for the funding of targeted new lease volume. During the second quarter of fiscal 1998, lease bonus subsidy payments totaled $3.8 million compared to $3.5 million during the second quarter of fiscal 1997. Excluding the effects of increased depreciation expense on operating leases and lease bonus subsidy payments, remaining general and administrative expenses decreased by $1.5 million or 18.5% compared to general and administrative expenses in the second quarter of fiscal 1997. This decrease is due to recent cost controls initiated within the Company. Gain on Sale of Lease Receivables The Company has asset securitization agreements for $275 million of eligible direct financing lease receivables that expire September 1998 ($150 million) and March 1999 ($125 million). Both of these agreements are expected to be renewed. As collections reduce previously sold interests, new leases can be sold up to the agreement amount. During the three months ended March 31, 1998, collections reduced previously sold interests by approximately $26.5 million on these two agreements. The Company sold an additional $26.5 million in net eligible direct financing leases during the three months of fiscal 1998 and recognized pretax gains of $617,000. Income Before Income Taxes Income before income taxes for the second quarter of fiscal 1998 increased by $9.6 million or 57.2% over the second quarter of fiscal 1997. This increase in income before income taxes was essentially the effect of higher earnings due to a larger lease portfolio base, net of increased general and administrative expenses, partially offset by higher borrowing costs resulting from increased debt to fund the lease portfolio. Provision for Income Taxes Income taxes for the second quarter of fiscal 1998 increased by $3.9 million or 57.2% over the second quarter of fiscal 1997. This increase in income taxes is directly attributable to the increase in income before taxes in the second quarter of fiscal 1998 compared to the second quarter of fiscal 1997. The effective tax rate was 41% for both the second quarter of fiscal 1998 and 1997. Six Months Ended March 31, 1998 Compared with the Six Months Ended March 31, 1997 Comparative summarized results of operations for the six months ended March 31, 1998 and 1997 are set forth in the table below. This table also shows the increase in the dollar amounts of major revenue and expense items between periods, as well as the related percentage increase. Six Months (dollars in thousands) Ended March 31 Increase 1998 1997 Amount Percent Revenues: Lease finance income $106,266 $77,557 $28,709 37.0% Rental income 18,149 9,928 8,221 82.8% Interest on IKON tax deferrals 7,505 5,624 1,881 33.4% Other income 5,365 3,831 1,534 40.0% ---------- -------- --------- 137,285 96,940 40,345 41.6% Expenses: Interest 53,073 37,228 15,845 42.6% General and administrative 35,743 28,072 7,671 27.3% ---------- -------- --------- 88,816 65,300 23,516 36.0% Gain on sale of lease receivables 1,181 1,277 (96) (7.5)% ---------- -------- --------- Income before income taxes 49,650 32,917 16,733 50.8% Provision for income taxes 20,357 13,496 6,861 50.8% ---------- -------- --------- Net income $ 29,293 $ 19,421 $ 9,872 50.8% ========== ======== ========= Revenues Total revenues increased $40.3 million or 41.6% in the first six months of fiscal 1998 compared to the first six months of fiscal 1997. Approximately 71.2% or $28.7 million of this increase in revenues was a result of increased lease finance income due to continued growth in the portfolio of direct financing and funded leases. The lease portfolio, net of lease receivables that were sold in asset securitization transactions, increased 31.3 % from March 31, 1997 to March 31, 1998. Office equipment placed on rental by the IKON marketplaces to customers, with cancelable terms, may be purchased by the Company. During the first six months of fiscal 1998 and 1997, IOS Capital purchased operating lease equipment of $28.1 million and $16.4 million, respectively. Operating leases contributed $18.1 million in rental income during the first six months of fiscal 1998, compared to $9.9 million in the first six months of fiscal 1997. The Company earns interest income on the deferred tax liabilities of the IKON marketplaces associated with leases funded through the Company at a rate consistent with the Company's weighted average outside borrowing rate of interest. The Company's average rate was 6.6% for the first six months of fiscal 1998 and 6.8% for the first six months fiscal 1997. In addition, the deferred tax base upon which these payments are calculated increased 31.7% to $244.3 million at March 31, 1998 from $185.5 million at March 31, 1997. Primarily as a result of the increased deferred tax liabilities, interest income on deferred taxes rose $1.9 or 33.4% when comparing the first six months ended March 31, 1998 to the first six months ended March 31, 1997. Other income consists primarily of late payment charges and various billing fees. The structure of these fees has remained basically unchanged from fiscal 1997. The growth in other income from fees is primarily due to the increased size of the lease portfolio upon which these fees are based. Overall, fee income from these sources grew by $1.5 million or 40%, when comparing the first six months of fiscal 1998 to the same period of fiscal 1997. Expenses Average borrowings to finance the lease portfolio in the form of loans from banks and the issuance of medium term notes in the public market increased by 31.7%, to $1,760.8 million outstanding at March 31, 1998 from March 31, 1997. The Company paid a weighted average interest rate on all borrowings of 6.6% for the first six months of fiscal 1998 and 6.8% for the first six months of fiscal 1997. Primarily as a result of the increased borrowings, interest expense grew by $15.8 million or 42.6%, when comparing the first half of fiscal 1998 to the first half of fiscal 1997. At March 31, 1998, the Company's debt to equity ratio, including intercompany amounts due to IKON was 5.9 to 1. Total general and administrative expenses for the first six months ended March 31, 1998 increased by $7.7 million or 27.3%, over the first six months ended March 31, 1997. The general and administrative expense category in the first six months of fiscal 1998 includes depreciation expense on leased equipment totaling $15.3 million, compared to $7.9 million for the first six months of fiscal 1997. In addition, the general and administrative expense category includes lease bonus subsidy payments to either IKON or directly to the IKON marketplaces, based on the level of dealer participation in the Company's leasing programs or for the funding of targeted new lease volume. During the first six months of fiscal 1998, lease bonus subsidy payments totaled $7.6 million compared to $5.6 million during the first six months of fiscal 1997. Excluding the effects of increased depreciation expense on operating leases and lease bonus subsidy payments, remaining general and administrative expenses decreased by $1.8 million or 12.4% compared to general and administrative expenses in the first six months of fiscal 1997. This decrease is due to recent cost controls initiated within the Company. Gain on Sale of Lease Receivables The Company has asset securitization agreements for $275 million of eligible direct financing lease receivables that expire September 1998 ($150 million) and March 1999 ($125 million). Both of these agreements are expected to be renewed. As collections reduce previously sold interests, new leases can be sold up to the agreement amount. During the six months ended March 31, 1998, collections reduced previously sold interests by approximately $52.3 million on these two agreements. The Company sold an additional $52.3 million in net eligible direct financing leases during the first six months of fiscal 1998 and recognized pretax gains of $1.2 million. Income Before Income Taxes Income before income taxes for the first six months of fiscal 1998 increased by $16.7 million or 50.8% over the first six months of fiscal 1997. This increase in income before income taxes was essentially the effect of higher earnings due to a larger lease portfolio base, net of increased general and administrative expenses, partially offset by higher borrowing costs resulting from the increased debt to fund the lease portfolio. Provision for Income Taxes Income taxes for the first six months of fiscal 1998 increased by $6.9 million or 50.8% over the first six months of fiscal 1997. This increase in income taxes is directly attributable to the increase in income before taxes in the first half of fiscal 1998 compared to the first half of fiscal 1997. The effective tax rate was 41% for both the first half of fiscal 1998 and 1997. FORWARD-LOOKING INFORMATION This document contains disclosures which are forward-looking statements relating to the Company or its parent, IKON, within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the 1934 Act. Such forward-looking statements address, among other things, strategic initiatives (including plans for enhancing the Company's or IKON's business through new acquisitions, information technology systems, sales strategies, market growth plans, margin enhancement initiatives, capital expenditure requirements and financing sources). Such forward-looking information is based upon management's current plans or expectations and is subject to a number of uncertainties and risks that could significantly affect the Company's and/or IKON's current plans, anticipated actions and future financial condition and results. These uncertainties and risks include, but are not limited to, those relating to IKON's successful management of an aggressive program to acquire and integrate new companies, including companies with technical services and products that are relatively new to IKON, and also including companies outside the United States, which present additional risks relating to international operations; risks and uncertainties (applicable to both the Company and IKON) relating to conducting operations in a competitive environment; delays, difficulties, technological changes and employment issues (applicable to both the Company and IKON) associated in a large-scale transformation project; debt service requirements (applicable to both the Company and IKON) including sensitivity to fluctuation in interest rates; and general economic conditions. As a consequence, current plans, anticipated actions and future financial condition and results may differ from those expressed in any forward-looking statements made by or on behalf of the Company or IKON. PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) The following Exhibits are furnished pursuant to Item 601 of Regulation S-K: Exhibit No. (27) Financial Data Schedule (b) Reports on Form 8-K On April 27, 1998, the registrant filed a Current Report on Form 8-K to file, under Item 5 of the form, the press release dated April 22, 1998 of its parent, IKON, which reported IKON's earnings for the fiscal quarter ended March 31, 1998, provided earnings estimates for the remainder of IKON's 1998 fiscal year and provided additional information regarding IKON's business, acquisitions and transformation process. 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. IOS CAPITAL, INC. Date May 14, 1998 /s/ Harry G. Kozee Harry G. Kozee Vice President - Finance (Chief Accounting Officer) Index to Exhibits Exhibit Number (27) Financial Data Schedule