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 June 30, 1999 or [ ] Transition
report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934
for the transition period from _____ to _____
Commission file number 1-5964
IKON OFFICE SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
OHIO 23-0334400
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
P.O. Box 834, Valley Forge, Pennsylvania 19482
(Address of principal executive offices)
(Zip Code)
(610) 296-8000
(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 July 31, 1999.
Common Stock, no par value 149,124,413 shares
INDEX
IKON OFFICE SOLUTIONS, INC.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets--June 30, 1999
and September 30, 1998
Consolidated Statements of Operations--Three and Nine
Months ended June 30, 1999 and June 30, 1998
Consolidated Statements of Cash Flows--Nine Months
ended June 30, 1999 and June 30, 1998
Notes to Consolidated Financial Statements--
June 30, 1999
Item 2. Management's Discussion and Analysis of Results
of Operations and Financial Condition and Liquidity
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
PART I. FINANCIAL INFORMATION
Item 1: Financial Statements (unaudited)
IKON OFFICE SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
June 30 September 30
ASSETS 1999 1998
Current Assets
Cash and cash equivalents $ 118,641 $ 963
Restricted cash 33,433
Accounts receivable, net 752,495 793,934
Finance receivables, net 876,132 827,363
Inventories 381,976 431,837
Prepaid expenses and other current assets 110,113 97,534
Deferred taxes 111,986 112,609
----------- -----------
Total current assets 2,384,776 2,264,240
----------- -----------
Investments and Long-Term Receivables 21,502 25,109
Long-Term Finance Receivables, net 1,661,711 1,565,674
Equipment on Operating Rental, net 95,741 110,891
Property and Equipment, at cost 521,430 499,546
Less accumulated depreciation 266,874 239,440
----------- -----------
254,556 260,106
----------- -----------
Goodwill 1,391,156 1,387,390
Miscellaneous 136,968 149,400
----------- -----------
$ 5,946,410 $ 5,762,810
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Current portion of long-term debt $ 87,388 $ 56,358
Current portion of long-term debt,
finance subsidiaries 994,786 726,159
Notes payable 10,066 87,180
Trade accounts payable 185,837 245,520
Accrued salaries, wages and commissions 115,496 115,101
Deferred revenues 197,358 211,824
Other accrued expenses 321,415 326,725
----------- -----------
Total current liabilities 1,912,346 1,768,867
----------- -----------
Long-Term Debt 717,122 712,384
Long-Term Debt, Finance Subsidiaries 1,299,112 1,374,478
Deferred Taxes 351,563 325,488
Other Long-Term Liabilities 156,966 154,305
Shareholders' Equity
Series BB conversion preferred stock, no par value,
9/98 - 3,877 depositary shares issued and outstanding 290,170
Common stock, no par value:
Authorized - 300,000 shares
Issued 6/99 - 149,193 shares;
9/98 - 137,139 shares 1,007,547 689,195
Unearned compensation (6,610)
Retained earnings 512,583 452,051
Accumulated other comprehensive income (1,800) (473)
Cost of common shares in treasury: 6/99 - 79 shares;
9/98 - 124 shares (2,419) (3,655)
----------- -----------
1,509,301 1,427,288
----------- -----------
$ 5,946,410 $ 5,762,810
=========== ===========
See notes to consolidated financial statements.
IKON OFFICE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Three Months Ended Nine Months Ended
June 30 June 30
------------------------------ ------------------------------
1999 1998 1999 1998
-------------- ------------- -------------- -------------
Revenues
Net sales $ 719,047 $ 721,044 $ 2,146,828 $ 2,236,092
Service and rentals 586,850 594,806 1,754,734 1,740,694
Finance income 79,570 78,878 252,972 223,788
-------------- ------------- -------------- -------------
1,385,467 1,394,728 4,154,534 4,200,574
-------------- ------------- -------------- -------------
Costs and Expenses
Cost of goods sold 500,614 520,442 1,464,723 1,490,189
Service and rental costs 331,240 351,701 1,007,930 1,028,514
Finance interest expense 30,553 33,171 92,539 96,876
Selling and administrative 455,043 543,703 1,393,917 1,450,307
Loss from asset impairment 20,000 20,000
Transformation costs 16,539 54,250
-------------- ------------- -------------- -------------
1,317,450 1,485,556 3,959,109 4,140,136
-------------- ------------- -------------- -------------
Operating income (loss) 68,017 (90,828) 195,425 60,438
Interest expense 17,031 17,684 55,573 50,956
-------------- ------------- -------------- -------------
Income (loss) before taxes 50,986 (108,512) 139,852 9,482
Income taxes (benefit) 23,708 (19,867) 61,031 30,852
-------------- ------------- -------------- -------------
Net Income (loss) 27,278 (88,645) 78,821 (21,370)
Less: Preferred Dividends 4,885 14,655
-------------- ------------- -------------- -------------
Available to Common Shareholders $ 27,278 $ (93,530) $ 78,821 $ (36,025)
============== ============= ============== =============
Basic and Diluted Earnings (Loss) Per Share $ 0.18 $ (0.69) $ 0.53 $ (0.27)
============== ============= ============== =============
Cash Dividends Per Share of Common Stock $ 0.04 $ 0.04 $ 0.12 $ 0.12
============== ============= ============== =============
See notes to consolidated financial statements.
IKON OFFICE SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Nine Months Ended
June 30
-------------------------------------
1999 1998
-------------------------------------
Operating Activities
Net income $ 78,821 $ (21,370)
Additions (deductions) to reconcile net income to net cash
provided by operating activities
Depreciation 103,040 101,219
Amortization 45,543 50,152
Provisions for losses on accounts receivable 25,743 46,421
Provision for deferred taxes 32,000 14,000
Gain on asset securitizations (25,360) (3,145)
Loss from asset impairment 20,000
Changes in operating assets and liabilities, net of effects from
acquisitions:
Decrease (increase) in accounts receivable 21,904 (27,364)
Decrease (increase) in inventories 51,332 (26,802)
Decrease (increase) in prepaid expenses and other current assets 8,909 (10,445)
(Decrease) increase in accounts payable, deferred
revenues and accrued expenses (85,625) 19,473
Miscellaneous 9,779 (10,013)
------------- --------------
Net cash provided by operating activities 266,086 152,126
Investing activities
Proceeds from the sale of property and equipment 14,644 11,658
Cost of companies acquired, net of cash acquired (24,419) (41,186)
Expenditures for property and equipment (72,617) (91,228)
Expenditures for equipment on operating rental, net (28,270) (56,540)
Purchase of miscellaneous assets (2,934) (9,042)
Finance receivables - additions (953,475) (1,156,662)
Finance receivables - collections 668,678 626,042
Proceeds from sale of finance subsidiaries' lease receivables 399,446 162,095
Repurchase of finance subsidiary's lease receivables (250,000)
------------- --------------
Net cash used in investing activities (248,947) (554,863)
Financing activities
Short-term borrowing repayments, net (77,114) (172,398)
Proceeds from issuance of long-term debt 56,387 259,356
Proceeds from option exercises and sale of treasury shares 4,803 17,566
Long-term debt repayments (23,143) (17,704)
Finance subsidiaries' debt - issuance 750,941 601,892
Finance subsidiaries' debt - repayments (559,991) (267,890)
Dividends paid (17,743) (30,830)
Deposit to restricted cash (33,433)
Purchase of treasury shares (168) (3,963)
------------- --------------
Net cash provided by financing activities 100,539 386,029
Net increase (decrease) in cash and cash equivalents 117,678 (16,708)
Cash at beginning of year 963 21,341
------------- --------------
Cash and cash equivalents at end of period $ 118,641 $ 4,633
============= ==============
See notes to consolidated financial statements.
IKON OFFICE SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 1999
Note 1: Basis of Presentation
The accompanying unaudited condensed consolidated 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
consolidated financial statements and footnotes thereto included in the
Company's annual report on Form 10-K/A for the year ended September 30, 1998.
Certain prior year amounts have been reclassified to conform to the current year
presentation.
Note 2: Asset Securitization
In addition to the $410 million of asset securitizations in place at
the end of fiscal 1998 in the U.S. and Canada, in December 1998, the Company's
U.S. finance subsidiary entered into an asset securitization transaction whereby
it sold $366.6 million in direct financing lease receivables for $250 million in
cash and a retained interest in the remainder. The agreement is for an initial
three-year term with certain renewal provisions and was structured as a
revolving asset securitization so that as collections reduce previously sold
interests in the pool of leases, additional leases can be sold up to $250
million. The terms of the agreement provide that the Company will continue to
service the lease portfolio for the securitization provider. The Company
recognized a pretax gain of $14.3 million during the first quarter of fiscal
1999 on this agreement and additional gains on the revolving portion of all
agreements of $11.1 million, for total a total gain of $25.4 million for the
nine months ended June 30, 1999. On May 25, 1999, the Company's U.S. finance
subsidiary repurchased the leases sold in this transaction with the proceeds
from the lease-backed notes described below.
Note 3: Leased-backed Notes
On May 19, 1999, IKON Receivables, LLC (an affiliate of the U.S.
finance subsidiary) publicly issued approximately $752 million of lease-backed
notes (the "Notes") under a $1.825 billion shelf registration statement. Class
A-1 Notes totaling $304,474,000 have a stated interest rate of 5.11%, Class A-2
Notes totaling $61,579,000 have a stated interest rate of 5.60%, Class A-3 Notes
totaling $304,127,000 have a stated interest rate of 5.99% and Class A-4 Notes
totaling $81,462,000 have a stated interest rate of 6.23%. The transaction was
structured using two special purpose limited liability companies: IKON
Receivables-1, LLC, of which the Company's U.S. finance subsidiary is the sole
member, and IKON Receivables, LLC, of which IKON Receivables-1, LLC is the sole
member. The Company's U.S. finance subsidiary contributed to IKON Receivables-1,
LLC a pool of office equipment leases or contracts and related assets (the
"Asset Pool"), and IKON Receivables-1, LLC transferred them to IKON Receivables,
LLC, which is the issuer of the Notes. The Notes are secured by the Asset Pool
and the payments on the Notes are made from payments on the leases. The
Company's U.S. finance subsidiary received approximately $749 million in net
proceeds from the sale of the Notes and used $250 million of that amount to
repurchase previously sold leases. The repurchased leases were contributed as
part of the Asset Pool. Restricted cash on the balance sheet represents cash
that has been collected on the lease receivables in the Asset Pool, which must
be used to repay the Notes.
Note 4: Conversion of Series BB Preferred Stock
On October 1, 1998, each of the outstanding depositary shares of the
Series BB Preferred Stock automatically converted to 2.4972 shares of common
stock per depositary share, resulting in the issuance of 9,682,143 common
shares. The common stock account increased by $290.2 million to reflect the
conversion. There was no change to total shareholders' equity.
IKON OFFICE SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
JUNE 30, 1999
Note 5: Transformation Costs
In September 1995, the Company announced its transformation program to
change its organization into a more cohesive and efficient network by building a
uniform information technology system and implementing best practices for
critically important management functions throughout the IKON companies. The
Company substantially completed the transformation program as of September 30,
1998. The transformation involved a variety of activities, including
consolidating purchasing, inventory control, logistics and other activities into
thirteen customer service centers in the U.S., establishing a single financial
processing center, building a common information technology system, adopting a
common name and common benefit programs. Transformation costs in the first nine
months of fiscal 1998 of $54.3 million relate principally to severance and other
employee-related costs, including temporary labor ($36.7 million), facility
consolidation costs, including lease buyouts and write-offs of leasehold
improvements ($12.2 million), and technology conversion costs ($5.4 million).
Cash of $9.9 million was expended during the first nine months of fiscal 1999,
reducing the September 30, 1998 severance and lease buyout accruals to $4.0
million and $6.2 million, respectively, at June 30, 1999.
Note 6: Comprehensive Income
As of October 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). SFAS
130 establishes rules for the reporting and presentation of comprehensive income
and its components. SFAS 130 requires foreign currency translation adjustments,
equity adjustments related to pension liabilities and mark to market adjustments
on retained interests in lease receivables to be included in other comprehensive
income. Equity accounts as of September 30, 1998 have been reclassified to
conform to the requirements of SFAS 130. The adoption of SFAS 130 did not impact
the Company's net income or total shareholders' equity.
Total comprehensive income is as follows (in thousands):
Three Months Ended Nine Months Ended
June 30 June 30
1999 1998 1999 1998
-------- -------- -------- --------
Net income $ 27,278 ($88,645) $ 78,821 ($21,370)
Foreign currency translation adjustments (1,562) (191) (1,327) (470)
Mark to market adjustment, net of tax (1,128) 0
-------- -------- -------- --------
Total comprehensive income $ 24,588 ($88,836) $ 77,494 ($21,840)
======== ======== ======== ========
Note 7: Income Tax Benefit
During the second quarter of fiscal 1999, the Company recorded a
one-time tax benefit of $4.0 million related to restructuring the European
leasing operations. Excluding the one-time benefit, diluted earnings per share
for the nine months ended June 30, 1999 would have been $.50.
IKON OFFICE SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
JUNE 30, 1999
Note 8: Earnings Per Share
The following table sets forth the computation of basic and diluted
earnings per share (in thousands):
For the fiscal quarter ended 6/30/99 6/30/98
------------------------------------------------------------------------------
Numerator:
Net income $ 27,278 $ (88,645)
Preferred stock dividends 4,885
--------- ---------
Numerator for basic and diluted earnings
per share - income available to
common shareholders $ 27,278 $ (93,530)
========= =========
Denominator:
Weighted average shares 148,422 135,465
Contingently issuable shares 365 116
--------- ---------
Denominator for basic earnings per
share - weighted average shares 148,787 135,581
Effect of dilutive securities:
Additional contingently issuable shares 157
Employee stock options 171
---------
Dilutive potential common shares 328
Denominator for diluted earnings per
share - adjusted weighted average
shares and assumed conversions 149,115 135,581
========= =========
Basic earnings (loss) per share $ 0.18 ($ 0.69)
========= =========
Diluted earnings (loss) per share $ 0.18 ($ 0.69)
========= =========
For the nine months ended 6/30/99 6/30/98
------------------------------------------------------------------------------
Numerator:
Net income $ 78,821 $ (21,370)
Preferred stock dividends 14,655
--------- ---------
Numerator for basic and diluted earnings
per share - income available to
common shareholders $ 78,821 $ (36,025)
========= =========
Denominator:
Weighted average shares 147,748 134,681
Contingently issuable shares 828 118
--------- ---------
Denominator for basic earnings per
share - weighted average shares 148,576 134,799
IKON OFFICE SOLUTIONS, INC
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT.)
JUNE 30, 1999
Note 8: Earnings Per Share (continued)
Effect of dilutive securities:
Additional contingently issuable shares 253
Employee stock options 132
---------
Dilutive potential common shares 385
Denominator for diluted earnings per
share - adjusted weighted average
shares and assumed conversions 148,961 134,799
========= =========
Basic earnings (loss) per share $ 0.53 ($ 0.27)
========= =========
Diluted earnings (loss) per share $ 0.53 ($ 0.27)
========= =========
Options to purchase 6,319,528 shares of common stock at $14.00 per
share to $56.42 per share were outstanding during the third quarter of fiscal
1999 and options to purchase 3,496,536 shares of common stock at $26.53 per
share to $62.93 per share were outstanding during the third quarter of fiscal
1998 but were not included in the computation of diluted earnings per share
because the options' exercise prices were greater than the average market price
of the common shares and, therefore, the effect would be antidilutive.
The Company's Series BB conversion preferred stock is excluded from the
diluted calculation for the quarter and nine months ended June 30, 1998 because
the effect of adding 9,682,143 shares and deleting the preferred dividends to
reflect assumed conversion would be antidilutive.
Note 9: Shareholder Lawsuit
The Company and certain current and former principal officers and
employee directors were named as defendants in a series of purported class
action complaints which were purportedly filed on behalf of purchasers of the
Company's common stock. The complaints were filed in the United States District
Court for the Eastern District of Pennsylvania following the issuance of the
Company's August 14, 1998 earnings release. By court order dated November 30,
1998 the Court appointed co-lead counsel. By court order dated December 3, 1998,
all the complaints were consolidated. The consolidated complaint was filed on
December 18, 1998 and alleges that the defendants publicly disseminated a series
of false and misleading statements, including filings with the Securities and
Exchange Commission, concerning the Company's revenue, profitability and
financial condition, in violation of the federal securities law. The plaintiffs
seek to represent a class of persons who purchased or acquired the Company's
equity securities between January 24, 1996 and August 13, 1998. In an amended
consolidated complaint filed on June 28, 1999, Ernst & Young LLP (the Company's
independent auditors) was added as a defendant. The complaint seeks unspecified
compensatory and punitive damages, prejudgment interest, attorneys' fees and
costs. The Company has responded to the complaint and believes that the
allegations contained therein are without merit and that the outcome of the
proceedings will not have a material adverse effect on the financial position or
overall trends in the results of operations of the Company. However, due to the
inherent uncertainties of litigation, the Company cannot predict the ultimate
outcome of these proceedings or the probability of any liability or losses
relating thereto, and, accordingly, no provision has been made for any liability
or loss that may result from the adjudication or settlement of these proceedings
in the financial statements for the first nine months of fiscal 1999. An
unfavorable outcome of these proceedings could have a material adverse impact on
the Company's financial condition and results of operations.
Item 2: Management's Discussion and Analysis of Results of Operations and
Financial Condition and Liquidity
The Company sells, rents and leases photocopiers, digital printers and
other automated office equipment for use in both traditional and integrated
office environments. The Company also provides outsourcing and imaging services
and offers consulting, design, computer networking and technology training for
the networked office environment.
Results of Operations
The discussion of the results of operations reviews the operations of
the Company as reported in the Consolidated Statements of Operations.
Three and Nine Months Ended June 30, 1999
Compared with the Three and Nine Months Ended June 30, 1998
Results of operations for the third quarter and year-to-date of fiscal
1999 compared to the third quarter and year-to-date of fiscal 1998 were as
follows:
Three Months Ended Nine Months Ended
June 30 % June 30 %
1999 1998 Change 1999 1998 Change
(in millions)
REVENUES $1,385 $1,395 (0.7)% $4,155 $4,201 (1.1)%
====== ======= ====== ======
INCOME BEFORE TAXES:
Operating income, excluding
transformation costs $68.0 $(74.3) $195.4 $114.7 70.4%
Transformation costs (16.5) (54.3)
------ -------- ------ ------
Operating income 68.0 (90.8) 195.4 60.4 223.5%
Interest expense (17.0) (17.7) (55.5) (50.9)
------ ------- ------ ------
$51.0 $(108.5) $139.9 $9.5 1,372.6%
====== ======== ====== ======
THIRD QUARTER:
The Company's third quarter revenues decreased by $10 million or .7%
from the third quarter of fiscal 1998. Revenues increased from the second
quarter of fiscal 1999, but were down compared to the same period in the prior
fiscal year due primarily to reductions in and realignment of the sales force,
as well as the closure or consolidation of 22 document services branches and two
technology services branches during fiscal 1999. These actions were taken to
strengthen productivity, tighten marketing disciplines and build a solid
cost-competitive infrastructure. Net sales, which includes equipment revenue,
decreased by $2 million or .3% in the third quarter of fiscal 1999, compared to
the third quarter of fiscal 1998. Net sales were down slightly ($1 million) from
the second quarter of fiscal 1999. Service and rental revenue decreased by $8
million or 1.3% compared to the third quarter fiscal 1998, but increased by $10
million from the second quarter of fiscal 1999. Finance income increased by $.7
million or .9% compared to the third quarter of fiscal 1998, due to the growth
in the lease portfolio.
Revenues from the Company's operations outside the U.S. were $198
million for the third quarter of fiscal 1999 compared to $181 million for the
same period of the prior fiscal year. European operations increased by $28
million, due primarily to acquisitions, while Canadian revenues decreased by $10
million and other foreign operations revenue decreased by $1 million in the
third quarter of fiscal 1999 compared to the third quarter of fiscal 1998. There
were no acquisitions in the third quarter of fiscal 1999.
The Company's operating income increased by $158.8 million compared to
the prior year's quarter. Excluding transformation costs in fiscal 1998,
operating income increased by $142.3 million to $68.0 million for the third
quarter of fiscal 1999 compared to a loss of $74.3 million in the third quarter
of fiscal 1998. During August 1998, the Company completed an in-depth review of
its operations and recorded charges against earnings totaling $94 million
related to the third quarter of fiscal 1998 and $16 million related to the
second quarter of fiscal 1998. Excluding the third quarter charges,
pre-transformation operating income would have been $19.8 million in the third
quarter of fiscal 1998, compared to $68.0 million in the third quarter of fiscal
1999, an increase of $48.2 million. Gross margins in the third quarter of fiscal
1999 were 37.8%, compared to 35.1% in the same period of the prior fiscal year
(37.2% excluding the third quarter charges) and 37.6% in the second quarter of
fiscal 1999. This increase is primarily the result of increased service margins.
The increase in service margins reflects the growing discipline and productivity
from the national sales model, which includes a focus on protecting and growing
aftermarket. Improved service margins are partially offset by a decline in
equipment margins due to continued price pressure in analog sales and to the
closing of a portion of the Company's remanufacturing operations in June 1999.
Selling and administrative expense as a percent of revenue was 32.9% in the
third quarter of fiscal 1999 compared to 39.0% in the third quarter of fiscal
1998 (35.9% excluding the third quarter charges). Selling and administrative
expense as a percent of revenue decreased in the third quarter of fiscal 1999
from the 33.6% in the second quarter of fiscal 1999 as a result of the ongoing
expense reduction programs launched in the second half of fiscal 1998.
Costs associated with the Company's transformation program were $16.5
million in the third quarter of fiscal 1998. Severance and other employee costs
were $10.0 million, facility consolidation costs were $5.4 million and
technology conversion costs were $1.1 million. The transformation is essentially
complete, and there are no significant transformation expenses in fiscal 1999.
Operating income from foreign operations was $5.4 million for the third
quarter of fiscal 1999, down $2.5 million from $7.9 million (excluding
transformation costs) for the third quarter of fiscal 1998 and down slightly
($.3 million) from the second quarter of fiscal 1999. Canadian operating income
increased by $.4 million compared to the third quarter of fiscal 1998, while
European operating income decreased by $1.8 million and other foreign operations
decreased by $1.1 million. Europe has been experiencing price discounting of
both analog and digital products as a result of direct competition from the
manufacturers. There was no material effect of foreign currency exchange rate
fluctuations on the results of operations in the third quarter of fiscal 1999
compared to the third quarter of fiscal 1998.
NINE MONTHS:
The Company's revenues for the first nine months of fiscal 1999
decreased by $46 million or 1.1% compared to the first nine months of fiscal
1998. The first quarter of fiscal 1999 included a $14.3 million gain from an
asset securitization. Excluding the securitization gain, overall revenue
decreased by $60 million compared to the first nine months of fiscal 1998. Net
sales, which includes equipment revenue, decreased by $89 million or 4.0%
compared to the first nine months of fiscal 1998. Service and rental revenue
increased by $14 million or .8%. Finance income increased $15 million, or 6.6%,
excluding the gain, due to the growth in the lease portfolio.
Revenues from the Company's operations outside the U.S. were $605
million for the first nine months of fiscal 1999 compared to $548 million for
the same period of the prior fiscal year. European operations increased by $90
million, due primarily to acquisitions, while Canadian revenues decreased by $31
million and other foreign operations revenue decreased by $2 million in the
first nine months of fiscal 1999 compared to the first nine months of fiscal
1998. In the first quarter of fiscal 1999, the Company completed five
acquisitions, all in Europe.
The Company's operating income increased by $135.0 million in the first
nine months of fiscal 1999 compared to the first nine months of fiscal 1998.
Excluding transformation costs in fiscal 1998 and the gain from the asset
securitization in fiscal 1999, operating income increased by $66.4 million to
$181.1 million for the first nine months of fiscal 1999 compared to $114.7
million for the first nine months of the prior fiscal year. Year to date
operating income for fiscal 1998 was impacted by the $110 million of charges
noted above.
Costs associated with the Company's transformation program were $54.3
million in the first nine months of fiscal 1998. Severance and other employee
costs were $36.7 million, facility consolidation costs were $12.2 million and
technology conversion costs were $5.4 million. The transformation is essentially
complete and there are no significant transformation expenses in fiscal 1999.
Operating income from foreign operations was $14.6 million for the
first nine months of fiscal 1999, down $16.7 million from $31.3 million
(excluding transformation costs) for the first nine months of fiscal 1998.
European operations decreased by $6.6 million compared to the same period in the
prior fiscal year, while Canadian operating income decreased by $8.0 million and
other foreign operations decreased by $2.1 million. There was no material effect
of foreign currency exchange rate fluctuations on the results of operations in
the first nine months of fiscal 1999 compared to the first nine months of fiscal
1998.
Other
Interest expense decreased by $.7 million in the third quarter of
fiscal 1999 compared to the third quarter of fiscal 1998 but increased by $4.6
million in the first nine months of fiscal 1999 compared to the first nine
months of fiscal 1998. The increased expense year-to-date is due primarily to
higher debt levels in the first half of fiscal 1999.
Income before taxes increased by $159.5 million in the third quarter of
fiscal 1999 and $130.4 million in the first nine months of fiscal 1999 compared
to the comparable periods in the prior fiscal year, primarily as a result of the
$110 million of charges in fiscal 1998 and the transformation costs in fiscal
1998. The effective income tax rate for the first nine months of fiscal 1999 is
43.6% compared to 325.3% for the same period in fiscal 1998. Income tax expense
in fiscal 1999 includes a one-time tax benefit related to restructuring the
European leasing operations in the second quarter. Excluding this one-time
benefit, the year-to-date effective tax rate would have been 46.5%. The unusual
effective tax rate of 325.3% in the first nine months of fiscal 1998 is the
result of the impact of non-tax deductible items (primarily goodwill
amortization and loss from asset impairment) in relation to lower income before
taxes.
Diluted earnings per common share increased from $(.69) per share for
the third quarter of fiscal 1998 to $.18 per share for the third quarter of
fiscal 1999. Excluding transformation costs and special charges, diluted
earnings per common share were $(.11) per share in the third quarter of fiscal
1998. Diluted earnings per common share increased from $(.27) per share for the
first nine months of fiscal 1998 to $.53 per share for the first nine months of
fiscal 1999. Excluding the after-tax gain on the asset securitization that was
completed in December 1998, diluted earnings per common share were $.47 in the
first nine months of fiscal 1999. Diluted weighted average shares increased by
14.2 million for the nine months ended June 30, 1999 primarily as a result of
the conversion of the Series BB preferred stock on October 1, 1998 (9.7 million
weighted shares) and the full period impact of 1998 common share issuances
related to acquisitions (3.7 million weighted shares).
Impact of Year 2000
State of Readiness. The Year 2000 issue arises from computer programs
being written using two digits rather than four to define the applicable year.
Any of the Company's computer programs or hardware that have date-sensitive
software or embedded technology (non-IT systems) may recognize a date using "00"
as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities. The potential for a problem exists
with all computer hardware and software, as well as in products with embedded
technology: copiers and fax machines; security and HVAC systems; voice/telephony
systems; elevators, etc.
The Company has appointed a Year 2000 Corporate Compliance Team, which
has prepared an international compliance program for the Company and is
responsible for coordinating and inspecting compliance activities in all
business units. The compliance program requires all business units and locations
in every country to inventory potentially affected systems and products, assess
risk, take any required corrective actions, test and certify compliance. The
Company's Year 2000 Testing and Certification Guidelines delineate the Year 2000
compliance process, testing and quality assurance guidelines, certification and
reporting processes and contingency planning. An independent consulting company
has reviewed the compliance program.
The Company's Year 2000 compliance program has five phases: 1)
inventory of internal IT and non-IT systems; 2) risk assessment of the Year 2000
compliance issues associated with such internal IT and non-IT systems; 3)
remediation of non-compliant systems; 4) testing and validation of remediated
systems; and 5) implementation of remediated systems throughout the Company. The
progress to date of each of these phases is as follows: 1) internal IT and
non-IT systems have been inventoried; 2) appropriate risk assessments have been
completed; 3) remediation of critical systems has been substantially completed
and remediation of non-critical systems is progressing; 4) testing and
validation of critical systems has been substantially completed; and 5) Year
2000 compliant versions are in the process of being implemented in field
operations. The Company anticipates completing the Year 2000 project no later
than October 31, 1999, which is prior to any anticipated material impact on its
operating systems.
Product warranties and certifications are being sought from vendors and
suppliers. The Company has obtained "Year 2000 Statements" from critical
national equipment vendors including Canon, Oce, Ricoh and Sharp.
Costs. The Company will use both internal and external resources to
reprogram or replace, test and implement its IT and non-IT systems for Year 2000
modifications. The Company does not separately track the internal costs incurred
on the Year 2000 project. Such costs are principally payroll and related costs
for its internal IT personnel. The total cost of the Year 2000 project,
excluding these internal costs, is estimated at $11.4 million and is being
funded through operating cash flows. Of the total estimated project cost,
approximately $3.2 million is attributable to the purchase of new software and
hardware which will be capitalized. The remaining $8.2 million will be expensed
as incurred. Through June 30, 1999, the Company has incurred approximately $3.5
million ($3.1 million expensed and $0.4 million capitalized) related to its Year
2000 project.
Risks. Management believes, based on the information currently
available to it, that the most reasonably likely worse case scenario that could
be caused by technology failures relating to the Year 2000 could pose a
significant threat not only to the Company, its customers and suppliers, but to
all businesses. Risks include, but are not limited to:
o Legal risks, including customer, supplier, employee or shareholder lawsuits
over failure to deliver contracted services, product failure, or health and
safety issues.
o Loss of sales due to failure to meet customer quality expectations or
inability to ship products.
o Increased operational costs due to manual processing, data corruption or
disaster recovery.
o Inability to bill or invoice.
The Company has taken steps to limit the scope of product and service
warranties to customers to either the replacement of noncompliant products or to
reimbursement of the cost of the product or service provided. With respect to
products sold by the Company prior to the inclusion of such limited warranties,
differing interpretations of the warranties included with such products will
likely result in litigation against the Company. The Company is not able to
assess the impact of such potential litigation at this time.
The Company is engaged in the provision of certain Year 2000 services
to customers, whereby the Company evaluates the Year 2000 compliance of
customers' software and hardware, and works with customers to find solutions to
Year 2000 problems. The Company has taken steps to limit its warranties with
respect to the Company's provision of such services.
The cost of the project and the date on which the Company believes it
will complete the Year 2000 modifications are based on management's best
estimates, which were derived using numerous assumptions of future events,
including the continued availability of certain resources and other factors.
However, there can be no guarantee that these estimates will be achieved and
actual results could differ materially from those anticipated. Specific factors
that might cause such material differences include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to locate
and correct all relevant computer codes, and other uncertainties.
Contingency Plans. The Company's Guidelines require that contingency
plans be developed and validated in the event that any critical system cannot be
corrected and certified before the system's failure date. Contingency plans are
currently being developed and are expected to be in place by October 31, 1999.
In addition, the Company is forming a rapid response team as part of its IT
group that will respond to any operational problems during the Year 2000 date
change period.
Financial Condition and Liquidity
Net cash provided by operating activities for the first nine months of
fiscal 1999 was $266 million. During the same period, the Company used $249
million in cash for investing activities, which included net finance subsidiary
activity of $135 million, acquisition activity at a cash cost of $24 million,
capital expenditures for property and equipment of $73 million and net capital
expenditures for equipment on operating rental of $28 million. Cash provided by
financing activities includes $44 million net decrease in corporate debt,
excluding the effects of acquisitions, and $191 million net funding from finance
subsidiaries debt. Debt, excluding finance subsidiaries, was $815 million at
June 30, 1999, a decrease of $41 million from the debt balance at September 30,
1998 of $856 million. Debt levels, excluding finance subsidiaries, were down and
the Company has additional cash and cash equivalents on the balance sheet at
June 30, 1999 as a result of prefunding for the U.S. finance subsidiary. The
debt to capital ratio, excluding finance subsidiaries, was 35.1% at June 30,
1999 (36.2% adjusted for the prefunding) compared to 37.5% at September 30,
1998.
As of June 30, 1999, the Company had no short-term borrowings under its
$600 million credit agreement, however, the Company has a $25 million letter of
credit supported by the facility. The Company also has $700 million available
for either stock or debt offerings under its shelf registration statement.
Finance subsidiaries debt increased by $193 million from September 30,
1998. During the nine months ended June 30, 1999, the U.S. finance subsidiary
repaid $386 million of its medium term notes and $100 million of bank debt and
no new notes were issued. At June 30, 1999, $1.5 billion of medium term notes
were outstanding with a weighted interest rate of 6.5%, while $1.1 billion
remains available under this program. In December 1998, the U.S. finance
subsidiary entered into a new asset securitization agreement under which it
received cash of $250 million in December 1998. Under its previously existing
$275 million asset securitization programs and the securitization closed in
December 1998, the U.S. finance subsidiary sold an additional $125 million in
direct financing leases during the first nine months of fiscal 1999, replacing
those leases liquidated and leaving the amount of contracts sold unchanged.
CN$37 million ($24 million) of additional leases were sold under the Canadian
CN$175 million asset securitization agreement during the first nine months of
fiscal 1999, replacing leases liquidated. The balance of Canadian securitized
receivables at June 30, 1999 is CN$138 million.
On May 19, 1999, IKON Receivables, LLC (an affiliate of the U.S.
finance subsidiary) publicly issued approximately $752 million of lease-backed
notes (the "Notes") under a $1.825 billion shelf registration statement. Class
A-1 Notes totaling $304,474,000 have a stated interest rate of 5.11%, Class A-2
Notes totaling $61,579,000 have a stated interest rate of 5.60%, Class A-3 Notes
totaling $304,127,000 have a stated interest rate of 5.99% and Class A-4 Notes
totaling $81,462,000 have a stated interest rate of 6.23%. The Notes are secured
by a pool of leases and the payments on the Notes are made from payments on the
leases. The Company's finance subsidiary received approximately $749 million in
net proceeds from the sale of the Notes and used $250 million of that amount to
repurchase assets previously sold in connection with the asset securitization
transaction completed in December 1998. As a result of the repurchase, the $250
million securitization commitment remains available.
The Company filed a shelf registration for 10 million shares of common
stock in April 1997. Shares issued under the registration statement are reserved
for use in acquisition transactions. Approximately 3.4 million shares have been
issued under this shelf registration through June 30, 1999, leaving 6.6 million
shares available for issuance.
On April 17, 1997, the Company announced that it may repurchase from
time to time as much as five percent of the outstanding IKON common stock in
open market transactions. Through fiscal 1998, the Company repurchased 4.6
million common shares for $113 million under this program.
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, including capital expenditures,
acquisitions, dividends, stock repurchases and the remaining accrued costs
associated with the Company's transformation program.
Forward-Looking Information
This Report includes or incorporates by reference information which may
constitute forward-looking statements within the meaning of the federal
securities laws. Although the Company believes the expectations contained in
such forward-looking statements are reasonable, it can give no assurances that
such expectations will prove correct. Such forward-looking information is based
upon management's current plans or expectations and is subject to a number of
risks and uncertainties that could significantly affect current plans,
anticipated actions and the Company's future financial condition and results.
These risks and uncertainties include, but are not limited to, risks and
uncertainties relating to conducting operations in a competitive environment;
delays, difficulties, management transitions and employment issues associated
with consolidation of, and/or changes in business operations; managing the
integration of existing and acquired companies; risks and uncertainties
associated with existing or future vendor relationships; and general economic
conditions. Certain additional risks and uncertainties are set forth in the
Company's 1998 Annual Report on Form 10-K/A filed with the Securities and
Exchange Commission. As a consequence of these and other risks and
uncertainties, current plans, anticipated actions and future financial condition
and results may differ materially from those expressed in any forward-looking
statements made by or on behalf of the Company.
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 May 5, 1999, the Company filed a Current Report on Form 8-K to
file, under Item 5 of the form, information contained in 1) its
press release dated April 22, 1999 regarding the appointment of
William S. Urkiel as the Company's Chief Financial Officer and
Senior Vice President, and 2) the press release dated April 28,
1999 regarding the Company's financial results for the period ended
March 31, 1999, including unaudited consolidated statements of
income for the three months ended March 31, 1999 and the six months
ended March 31, 1999.
On May 19, 1999, 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 May 17, 1999 regarding certain organizational
changes.
On July 30, 1999, the Company filed a Current Report on Form 8-K to
file, under Item 5 of the form, its press release dated July 28,
1999 regarding the Company's financial results for the period ended
June 30, 1999, including unaudited consolidated statements of
operations for the three months ended June 30, 1999 and the nine
months ended June 30, 1999.
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 August 13, 1999 /s/ William S. Urkiel
--------------- ---------------------
William S. Urkiel
Senior Vice President and
Chief Financial Officer
(Chief Accounting Officer)
INDEX TO EXHIBITS
Exhibit Number
(27) Financial Data Schedule