Management's Responsibility for Financial Reporting
The management of IKON Office Solutions, Inc. is responsible for the preparation
and presentation of the financial statements and related financial information
included in this annual report. The financial statements include amounts that
are based on management's best estimates and judgments. These statements have
been prepared in conformity with generally accepted accounting principles
consistently applied and have been audited by Ernst & Young LLP, independent
auditors.
Management is also responsible for maintaining systems of internal accounting
controls that are designed to provide reasonable assurance as to the integrity
of the financial records and the protection of corporate assets. IKON Office
Solutions, Inc. supports and manages an active program of auditing to monitor
the proper functioning of its systems. The reports issued under this program, as
well as comment letters from Ernst & Young LLP, are reviewed regularly by the
Audit Committee of the Board of Directors, which is composed of four directors
who are not employees of the Company. The Audit Committee meets periodically
with Ernst & Young LLP and management to review audit scope, timing and results.
/s/ John E. Stuart
John E. Stuart
Chairman and Chief Executive Officer
/s/ Kurt E. Dinkelacker
Kurt E. Dinkelacker
Executive Vice President and Chief Financial Officer
Report of Ernst & Young LLP, Independent Auditors
To the Board of Directors and Shareholders, IKON Office Solutions, Inc.
We have audited the accompanying consolidated balance sheets of IKON Office
Solutions, Inc. and subsidiaries as of September 30, 1997 and 1996, and the
related consolidated statements of income, changes in shareholders' equity, and
cash flows for each of the three years in the period ended September 30, 1997.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of IKON
Office Solutions, Inc. and subsidiaries at September 30, 1997 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended September 30, 1997, in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
Philadelphia, Pennsylvania
October 15, 1997,
except for note 8,
as to which the date is
October 27, 1997
Consolidated Statements of Income
- --------------------------------------------------------------------------------
IKON Office Solutions, Inc. and Subsidiaries
----------------------------------------------
Fiscal Year Ended September 30 (in thousands, except per share data) 1997 1996 1995
======================================================================================================================
Revenues
Net sales $2,841,561 $2,381,151 $1,807,408
Service and rentals 2,063,186 1,560,915 1,191,175
Finance income 223,686 157,707 93,019
- ----------------------------------------------------------------------------------------------------------------------
5,128,433 4,099,773 3,091,602
- ----------------------------------------------------------------------------------------------------------------------
Costs and Expenses
Cost of goods sold 1,828,883 1,552,183 1,189,533
Service and rental costs 1,007,060 743,110 565,131
Finance interest expense 98,664 68,043 40,216
Selling and administrative 1,806,352 1,404,958 1,084,538
Transformation costs 126,908 21,423
- ----------------------------------------------------------------------------------------------------------------------
4,867,867 3,789,717 2,879,418
- ----------------------------------------------------------------------------------------------------------------------
Operating Income 260,566 310,056 212,184
Interest Expense 47,453 37,179 21,672
- ----------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations Before Taxes and Extraordinary Loss 213,113 272,877 190,512
Taxes on Income 90,751 107,984 75,501
- ----------------------------------------------------------------------------------------------------------------------
Income from Continuing Operations Before Extraordinary Loss 122,362 164,893 115,011
Discontinued Operations 20,151 45,848 88,661
- ----------------------------------------------------------------------------------------------------------------------
Income Before Extraordinary Loss 142,513 210,741 203,672
Extraordinary Loss from Early Extinguishment of Debt, net of tax benefit (12,156)
- ----------------------------------------------------------------------------------------------------------------------
Net Income 130,357 210,741 203,672
Less Preferred Dividends 19,540 22,319 15,209
- ----------------------------------------------------------------------------------------------------------------------
Net Income Available to Common Shareholders $ 110,817 $ 188,422 $ 188,463
======================================================================================================================
Earnings Per Share
Continuing operations $ .77 $ 1.12 $ .86
Discontinued operations .15 .36 .76
Extraordinary loss (.09)
- ----------------------------------------------------------------------------------------------------------------------
$ .83 $ 1.48 $ 1.62
======================================================================================================================
Cash Dividends Per Share of Common Stock $ .26 $ .56 $ .52
See notes to consolidated financial statements.
19
Consolidated Balance Sheets
- --------------------------------------------------------------------------------
IKON Office Solutions, Inc. and Subsidiaries
------------------------------------------------
September 30 (dollars in thousands) 1997 1996
=================================================================================================
Assets
Current Assets
Cash $ 21,341 $ 46,056
Accounts receivable, less allowances of: 1997-$54,192; 1996-$35,308 765,660 513,378
Finance receivables, net 670,784 435,434
Inventories 442,207 350,774
Prepaid expenses 101,294 80,352
Deferred taxes 124,520 83,161
- -------------------------------------------------------------------------------------------------
Total current assets 2,125,806 1,509,155
- -------------------------------------------------------------------------------------------------
Investments and Long-Term Receivables 17,508 48,165
Long-Term Finance Receivables, net 1,331,372 878,324
Equipment on Operating Leases, net of accumulated
depreciation of: 1997-$167,464; 1996-$153,909 101,900 95,043
Property and Equipment, net 239,545 188,818
Goodwill 1,348,133 1,087,210
Other Assets 159,622 88,679
Net Assets of Discontinued Operations 1,489,201
- -------------------------------------------------------------------------------------------------
$ 5,323,886 $ 5,384,595
=================================================================================================
Liabilities and Shareholders' Equity
Current Liabilities
Current portion of long-term debt $ 60,794 $ 62,697
Current portion of long-term debt, finance subsidiaries 251,711 314,000
Notes payable 266,979 186,462
Trade accounts payable 206,547 123,571
Accrued salaries, wages and commissions 110,628 101,632
Deferred revenues 208,612 200,225
Other accrued expenses 268,511 269,400
- -------------------------------------------------------------------------------------------------
Total current liabilities 1,373,782 1,257,987
- -------------------------------------------------------------------------------------------------
Long-Term Debt 490,235 721,923
Long-Term Debt, Finance Subsidiaries 1,494,043 813,026
Deferred Taxes 330,996 191,272
Other Long-Term Liabilities 153,182 144,883
Shareholders' Equity
Series BB conversion preferred stock, no par value:
3,877,200 depositary shares issued and outstanding 290,170 290,170
Common stock, no par value: authorized 300,000,000 shares;
issued 1997-135,705,000 shares; 1996-131,930,000 shares 677,681 1,305,413
Retained earnings 574,646 701,771
Foreign currency translation adjustment (728) (25,187)
Cost of common shares in treasury: 1997-2,401,000 shares;
1996-374,000 shares (60,121) (16,663)
- -------------------------------------------------------------------------------------------------
1,481,648 2,255,504
- -------------------------------------------------------------------------------------------------
$ 5,323,886 $ 5,384,595
=================================================================================================
See notes to consolidated financial statements.
20
Consolidated Statements of Changes in Shareholders' Equity
---------------------------------------------------------------------------
IKON Office Solutions, Inc. and Subsidiaries
-------------------------------------------------
Fiscal Year Ended September 30 (in thousands,
except per share data) 1997 1996 1995
----------------------------------------------------------------------------------------------------------------------------
Shares Amounts Shares Amounts Shares Amounts
----------------------------------------------------------------------------------------------------------------------------
Series AA Convertible Preferred Stock
Balance, beginning of year 4,025 $201,924 4,025 $ 199,912
Dividend accretion 503 2,012
Preferred stock conversion (4,025) (202,427)
----------------------------------------------------------------------------------------------------------------------------
Balance, end of year 4,025 $ 201,924
============================================================================================================================
Series BB Conversion Preferred Stock
Balance, beginning of year 3,877 $ 290,170 3,877 $290,170
Issued in public offering 3,877 $ 290,170
----------------------------------------------------------------------------------------------------------------------------
Balance, end of year 3,877 $ 290,170 3,877 $290,170 3,877 $ 290,170
============================================================================================================================
Common Stock
Balance, beginning of year 131,930 $1,305,413 116,136 $643,998 112,998 $ 551,711
Series AA preferred stock conversion 8,198 368,382
Mergers, acquisitions and other 3,775 145,265 7,596 285,836 3,138 87,566
Unisource spin-off (779,770)
Tax benefit relating to stock plans 6,773 7,197 4,721
----------------------------------------------------------------------------------------------------------------------------
Balance, end of year 135,705 $ 677,681 131,930 $1,305,413 116,136 $ 643,998
============================================================================================================================
Retained Earnings
Balance, beginning of year $ 701,771 $781,536 $ 659,526
Net income 130,357 210,741 203,672
Cash dividends declared:
Series AA preferred stock, per share:
1996 - $.719; 1995 - $2.875 (2,779) (11,572)
Series BB preferred stock, per share:
1997 and 1996 - $5.04; 1995 - $.938 (19,540) (19,540) (3,637)
Common stock, per share: 1997- $.26;
1996 - $.56; 1995 - $.52 (34,640) (70,010) (57,267)
Pooled companies, prior to merger (177) (2,159)
Series AA preferred stock conversion (199,108)
Unisource spin-off (210,071)
Credits (charges) from issuance of
treasury shares and other 6,769 1,108 (7,027)
----------------------------------------------------------------------------------------------------------------------------
Balance, end of year $ 574,646 $701,771 $ 781,536
============================================================================================================================
Foreign Currency Translation Adjustment
Balance, beginning of year $ (25,187) $(21,540) $ (22,609)
Translation adjustment (4,659) (3,647) 1,069
Unisource spin-off 29,118
----------------------------------------------------------------------------------------------------------------------------
Balance, end of year $ (728) $(25,187) $ (21,540)
============================================================================================================================
Cost of Common Shares in Treasury
Balance, beginning of year 374 $ (16,663) 118 $ (4,726) 148 $ (4,067)
Purchases 4,486 (112,192) 2,004 (86,084) 2,783 (91,430)
Reissued for:
Exercise of options (50) 1,471 (395) 17,287 (544) 16,652
Sales to employee stock plans (501) 16,438 (534) 23,710 (2,267) 74,067
Mergers, acquisitions and other (1,908) 50,825 (2) 52
Series AA preferred stock conversion (819) 33,150
----------------------------------------------------------------------------------------------------------------------------
Balance, end of year 2,401 $ (60,121) 374 $(16,663) 118 $ (4,726)
============================================================================================================================
See notes to consolidated financial statements.
21
Consolidated Statements of Cash Flows
- --------------------------------------------------------------------------------------------------------------------------------
IKON Office Solutions, Inc. and Subsidiaries
------------------------------------------------
Fiscal Year Ended September 30 (in thousands) 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------------------------
Operating Activities
Income from continuing operations $ 122,362 $ 164,893 $ 115,011
Additions (deductions) to reconcile income from continuing operations to
net cash provided by operating activities of continuing operations:
Depreciation 108,037 84,447 62,064
Amortization 48,555 34,107 25,309
Provisions for losses on accounts receivable 25,724 18,296 10,051
Provision for deferred income taxes 92,063 62,174 42,106
Write-off of abandoned software and other assets due to transformation 25,342
Changes in operating assets and liabilities, net of effects from
acquisitions and divestitures:
Increase in accounts receivable (202,790) (83,783) (66,184)
Increase in inventories (70,189) (41,445) (41,698)
Increase in prepaid expenses (21,699) (52,733) (18,508)
Increase in accounts payable, deferred revenues
and accrued expenses 37,125 77,430 88,173
Miscellaneous 8,986 4,475 5,166
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities of continuing operations 173,516 267,861 221,490
Net cash provided by (used in) operating activities of
discontinued operations 24,176 205,914 (66,618)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 197,692 473,775 154,872
- --------------------------------------------------------------------------------------------------------------------------------
Investing Activities
Cost of companies acquired, net of cash acquired (155,907) (171,804) (260,975)
Expenditures for property and equipment (193,238) (146,634) (91,112)
Proceeds from sale of property and equipment 35,980 34,482 18,427
Purchase of miscellaneous assets (10,678) (19,054) (8,729)
Finance receivables - additions (1,459,102) (1,005,270) (665,058)
Finance receivables - collections 651,025 389,384 241,886
- --------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities of continuing operations (1,131,920) (918,896) (765,561)
Net cash used in investing activities of discontinued operations (38,058) (201,356) (146,249)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (1,169,978) (1,120,252) (911,810)
- --------------------------------------------------------------------------------------------------------------------------------
Financing Activities
Proceeds from:
Issuance of long-term debt 35,605 439,149 33,377
Issuance of Series BB conversion preferred stock, net 290,170
Option exercises and sale of treasury shares 43,807 55,084 91,848
Sale of finance subsidiaries' lease receivables 103,401 202,713 66,677
Proceeds from (payments to) discontinued operations 551,834 (53,370) (217,573)
Issuance (repayment) of short-term borrowings, net 75,388 (69,883) 158,569
Long-term debt repayments (328,702) (74,546) (40,394)
Finance subsidiaries' debt - issuance 932,728 515,673 534,717
Finance subsidiaries' debt - repayments (314,000) (206,232) (182,014)
Dividends paid (54,180) (91,826) (70,464)
Purchase of treasury shares (112,192) (86,084) (91,430)
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities of continuing operations 933,689 630,678 573,483
Net cash provided by (used in) financing activities of
discontinued operations 13,882 (4,558) 212,867
- --------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 947,571 626,120 786,350
- --------------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash (24,715) (20,357) 29,412
Cash at beginning of year 46,056 66,413 37,001
- --------------------------------------------------------------------------------------------------------------------------------
Cash at end of year $ 21,341 $ 46,056 $ 66,413
================================================================================================================================
See notes to consolidated financial statements.
22
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
IKON Office Solutions, Inc. and Subsidiaries
--------------------------------------------
IKON Office Solutions, Inc. (IKON or the Company) is a leading office technology
company, providing customers with total office solutions, including copier and
printing systems, computer networking, print-on-demand services, copy center
management, hardware and software product interfaces and electronic file
conversion. IKON has locations throughout the United States and Canada and in
Europe (primarily in the United Kingdom), which comprise the largest network of
independent copier and office equipment dealers in North America and in the
United Kingdom. The Company's name was changed from Alco Standard Corporation
(Alco) to IKON Office Solutions, Inc. effective January 23, 1997.
1. Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of the Company and
its subsidiaries, all of which are wholly owned. Significant intercompany
accounts and transactions have been eliminated in consolidation. The spin off of
Unisource Worldwide, Inc. (Unisource), the Company's paper products and supply
systems distribution business, was completed on December 31, 1996, as discussed
in note 5. All of the following notes, unless otherwise stated, reflect data on
a continuing operations basis.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect amounts reported in the financial statements and notes. Actual results
could differ from those estimates and assumptions.
Revenue Recognition
Revenues are recorded at the time of shipment of products or performance of
services. Revenues from service contracts are recognized over the term of the
contract. The present value of payments due under sales-type lease contracts is
recorded as revenues and cost of goods sold is charged with the book value of
the equipment at the time of shipment. Finance income is recognized over the
related lease term.
Inventories
Inventories are stated at the lower of cost or market using the first-in,
first-out method and consist of finished goods available for sale.
Goodwill
Substantially all goodwill (excess of purchase price over net assets acquired)
is amortized over periods ranging from 25 to 40 years using the straight-line
method. The recoverability of goodwill is evaluated at the operating unit level
by an analysis of operating results and consideration of other significant
events or changes in the business environment. If an operating unit has current
operating losses and based upon projections there is a likelihood that such
operating losses will continue, the Company will evaluate whether impairment
exists on the basis of undiscounted expected future cash flows from operations
before interest for the remaining amortization period. If impairment exists, the
carrying amount of the goodwill is reduced by the estimated shortfall of cash
flows. Accumulated amortization at September 30, 1997 and 1996 was $103,000,000
and $70,000,000, respectively.
Depreciation
Properties and equipment are depreciated over their useful lives by the
straight-line method.
Earnings Per Share
Earnings per share are based on 134,373,000 weighted average shares in 1997,
127,649,000 shares in 1996 and 116,474,000 shares in 1995, and include the
dilutive effect of common stock equivalents, principally stock options. Common
shares and per share amounts give retroactive effect to a two-for-one stock
split in November 1995.
Foreign Currency Translation
Assets and liabilities of all material foreign subsidiaries are translated into
U.S. dollars at fiscal year-end exchange rates. Income and expense items are
translated at average exchange rates prevailing during the fiscal year. The
resulting translation adjustments are recorded as a component of shareholders'
equity.
Accounting Changes
The Company adopted FASB Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed of" (SFAS 121), in
the first quarter of fiscal 1997. The adoption of SFAS 121 did not have a
material impact on the Company's financial statements.
FASB Statement No. 123, "Accounting for Stock-Based Compensation" (SFAS
123), requires companies to measure employee stock compensation plans based on
the fair value method of accounting or to continue to apply APB No. 25,
"Accounting for Stock Issued to Employees," and provide pro forma footnote
disclosures under the fair value method in SFAS 123. The Company will continue
to apply the principles of APB No. 25 and has provided pro forma fair value
disclosures in note 9.
FASB Statement No. 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities" (SFAS 125), was adopted
effective January 1, 1997. As a result, the Company has modified its agreements
to meet the new requirements to enable it to continue recognizing transfers of
certain receivables to special-purpose entities as sales, therefore, SFAS 125
did not have a material effect on the Company's financial statements.
Pending Accounting Changes
In February 1997, the FASB issued Statement No. 128, "Earnings Per Share" (SFAS
128), which simplifies the standards for computing earnings per share (EPS).
SFAS 128 is effective for financial statements issued for periods ending after
December 15, 1997. Earlier application is not permitted. Accordingly, the
Company will replace the presentation of primary EPS with a dual presentation of
basic and diluted EPS. The effect of adoption will not be material on EPS
previously presented.
23
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
IKON Office Solutions, Inc. and Subsidiaries
--------------------------------------------
In June 1997, the FASB issued Statements No. 130, "Reporting Comprehensive
Income" (SFAS 130), and No. 131, "Disclosures about Segments of an Enterprise
and Related Information" (SFAS 131). SFAS 130 establishes standards for
reporting and display of comprehensive income and its components (revenues,
expenses, gains and losses) in the financial statements. SFAS 131 establishes
standards for reporting information about operating segments and supersedes SFAS
14, "Financial Reporting for Segments of a Business Enterprise." Both SFAS 130
and 131 will be adopted in fiscal 1999.
Interest Rate and Currency Swap Agreements
The Company uses interest rate and currency swap agreements for purposes other
than trading and they are treated as off-balance sheet items. Interest rate swap
agreements are used by the Company to modify variable rate obligations to fixed
rate obligations, thereby reducing the exposure to market rate fluctuations. The
interest rate swap agreements are designated as hedges, and effectiveness is
determined by matching the principal balance and terms with that specific
obligation. Such an agreement involves the exchange of amounts based on fixed
interest rates for amounts based on variable interest rates over the life of the
agreement without an exchange of the notional amount upon which payments are
based. The differential to be paid or received as interest rates change is
accounted for on the accrual method of accounting. The related amount payable to
or receivable from counterparties is included as an adjustment to accrued
interest in other accrued expenses. Currency swap agreements are used to manage
exposure relating to certain intercompany debt denominated in one foreign
currency that will be repaid in another foreign currency. Currency swap
agreements are designated as hedges of firm commitments to pay interest and
principal on debt, which would otherwise expose the Company to foreign currency
risk. Current translation gains and losses on the principal swapped are offset
by corresponding translation gains and losses on the related foreign denominated
assets. Gains and losses on terminations of interest rate and currency swap
agreements are deferred as an adjustment to the carrying amount of the
outstanding obligation and amortized as an adjustment to interest expense
related to the obligation over the remaining term of the original contract life
of the terminated swap agreement. In the event of early extinguishment of the
obligation, any realized or unrealized gain or loss from the swap would be
recognized in income at the time of extinguishment.
Business Segment Information
As a result of the spin-off of Unisource, the Company operates in a single
industry segment. The Company provides its customers with integrated solutions
for copier, office equipment, outsourcing and networking needs.
Reclassifications
Certain prior-year amounts have been reclassified to conform with the
current-year presentation.
2. Transformation Costs
At the end of fiscal 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. In
March 1997, the Company announced that it was accelerating the transformation
program. As a result, the Company began to separately disclose these costs as a
component of operating expenses on the Statements of Income. The Company expects
to substantially complete the transformation program by the end of fiscal 1998.
The transformation involves a variety of activities that the Company believes
will significantly lower administrative costs and improve margins. These
activities include 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 creating marketplace-focused field
operations with greater attention to customer sales and services.
Costs charged to transformation expense in fiscal 1997 of $126,908,000
relate principally to the write-off of costs related to the abandoned SAP
computer pilot program and technology conversion costs ($37,297,000), severance
and other employee related costs, including temporary labor and costs related to
consultants assisting with the transformation ($53,866,000), facility
consolidation costs, including lease buyouts and write-offs of leasehold
improvements ($24,738,000), and costs incurred in connection with the adoption
of the IKON name worldwide ($11,007,000). Transformation costs of $21,423,000
for fiscal 1996 consist primarily of severance and other employee related costs,
including costs related to consultants assisting with the transformation
($18,702,000), technology conversion costs ($1,428,000) and facility
consolidation costs ($1,293,000). The Company estimates the total remaining
costs of its transformation program, excluding capital costs, to be from
$50,000,000 to $70,000,000, all of which is expected to be expended in fiscal
1998.
3. Mergers
During the second quarter of fiscal 1996, the Company completed two mergers
accounted for as poolings-of-interests by issuing common stock for all of the
shares of Legal Copies International, Inc. and JMM Enterprises, Inc. Total
common shares issued in connection with these mergers were 3,953,990.
24
Components of the operating results from continuing operations for periods prior
to the merger were:
Three Months Ended
December 31, 1995 Fiscal Year Ended
(in thousands) (unaudited) September 30, 1995
- -------------------------------------------------------------------------------
Revenues
IKON Office Solutions, Inc. $852,396 $2,911,626
Pooled companies 48,183 179,976
- -------------------------------------------------------------------------------
$900,579 $3,091,602
===============================================================================
Income from continuing operations
IKON Office Solutions, Inc. $ 35,186 $ 114,071
Pooled companies 1,751 940
- -------------------------------------------------------------------------------
$ 36,937 $ 115,011
===============================================================================
The mergers reduced fiscal 1995 earnings per share by $.02.
4. Acquisitions
In fiscal 1997, the Company made 89 acquisitions for an aggregate purchase price
of $317,864,000 in cash and stock. Total assets related to these 89 acquisitions
were $438,954,000, including goodwill of $277,209,000. In addition, $9,608,000
was paid and capitalized in fiscal 1997 relating to prior years' acquisitions.
In addition to the mergers described in note 3, 97 acquisitions were made
in fiscal 1996 for an aggregate purchase price of $358,568,000 in cash, notes
and stock. Total assets related to these 97 acquisitions were $499,729,000,
including goodwill of $313,495,000. The Company also issued 486,304 common
shares for an acquisition accounted for as a pooling-of-interests whose results
of operations were included from the beginning of the fiscal year. An additional
$4,086,000 was paid and capitalized in fiscal 1996 relating to prior years'
acquisitions.
In June 1995, the Company purchased all of the outstanding shares of
Southern Business Group PLC for approximately $133,800,000. This business sells,
leases, services and remanufactures copiers and other office equipment in
southern England. Total assets acquired were $163,359,000, which includes
goodwill of $119,556,000. In addition, 99 other acquisitions were made in fiscal
1995 for an aggregate purchase price of $228,258,000 in cash, notes and stock.
Total assets related to these 99 acquisitions were $313,966,000, including
goodwill of $218,549,000. The Company also issued 675,106 common shares for two
acquisitions accounted for as poolings-of-interests and their results of
operations were included from the beginning of the fiscal year. In fiscal 1995,
$4,648,000 of additional cash was paid and capitalized relating to prior years'
acquisitions.
All acquisitions, unless otherwise noted, are included in results of
operations from their dates of acquisition.
Had the purchase acquisitions been made at the beginning of the fiscal year
prior to their acquisition, unaudited pro forma results from continuing
operations would have been:
Fiscal Year Ended September 30 (in thousands except per share data)
(unaudited) 1997 1996 1995
- -------------------------------------------------------------------------------
Revenues $5,383,303 $4,961,482 $3,847,045
Income from continuing operations 132,078 180,934 146,589
Earnings per share from
continuing operations .83 1.19 .95
- -------------------------------------------------------------------------------
5. Discontinued Operations
On June 19, 1996, the Company announced that it would separate Unisource, its
paper products and supply systems distribution business from IKON, its office
solutions business, with each business operating as a stand-alone, publicly
traded company. In order to effect the separation of these businesses, the
Company declared a dividend payable to holders of record of Alco common stock at
the close of business on December 13, 1996 (the Record Date) of one share of
common stock, $.001 par value, of Unisource common stock, for every two shares
of Alco stock owned on the Record Date. The distribution resulted in 100% of the
outstanding shares of Unisource common stock being distributed to Alco
shareholders on December 31, 1996. The Internal Revenue Service issued a ruling
letter which provided that, except for any cash received in lieu of fractional
shares, the spin-off of Unisource was tax-free to Alco and to Alco's U.S.
shareholders.
In conjunction with the separation of their businesses, Unisource and the
Company entered into various agreements that address the allocation of assets
and liabilities between them and define their relationship after the separation,
including a Distribution Agreement (Distribution Agreement), a Benefits
Agreement (Benefits Agreement) and a Tax Sharing and Indemnification Agreement
(Tax Sharing Agreement). The Distribution Agreement provides for, among other
things, the principal transactions required to effect the Distribution, the
conditions to the Distribution, the allocation between the Company and Unisource
of certain assets and liabilities and cooperation by the Company and Unisource
in the provision of information and certain facilities necessary to perform the
administrative functions incident to their respective businesses. The
Distribution Agreement includes cross-indemnification provisions pursuant to
which Unisource and the Company indemnify each other for damages that may arise
out of a breach of their respective obligations under the agreement. Under the
Benefits Agreement, Unisource's obligation to provide benefits includes all
obligations with respect to Unisource employees under pension plans, savings
plans and multiemployer plans, welfare plans (retiree medical plans),
supplemental benefit plans, certain deferred compensation plans, incentive
plans, stock-based plans and other plans covering Unisource employees and
includes liabilities that arose while the individuals were employed by Alco. The
Benefits Agreement requires the Company to reimburse Unisource for a portion of
any payments made by Unisource to former Unisource employees under Alco's 1985,
1991 and 1994 deferred compensation plans. Unisource assumed certain Alco
pension plans cover-
25
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
IKON Office Solutions, Inc. and Subsidiaries
--------------------------------------------
ing Unisource employees, and assets and liabilities attributable to Unisource
employees under Alco's participating companies pension plan and Alco's 401(k)
plan have been transferred to new Unisource pension and 401(k) plans,
respectively. Under the Tax Sharing Agreement, Unisource will bear its
respective share of (i) the Company's federal consolidated income tax liability
(or benefit), (ii) any unitary state income tax liability, and (iii) the
Company's consolidated personal property tax liability for all tax periods that
end before or that include the Distribution Date. Unisource is responsible for
paying any tax liabilities arising for any tax return that it files separately.
If any tax year ending before or including the Distribution Date is subsequently
examined by the IRS, and an adjustment results from such examination, then
Unisource's share of the Company's additional federal consolidated income tax
liability (or benefit for that tax year) will be computed and agreed to by the
parties. The Tax Sharing Agreement generally provides that in the event either
the Company or Unisource takes any action inconsistent with, or fails to take
any action required by, or in accordance with the qualification of the
Distribution as tax-free, then the Company or Unisource, as the case may be,
will be liable for and indemnify and hold the other harmless from any tax
liability resulting from such action.
The Company has accounted for Unisource as a discontinued operation for all
periods presented in these financial statements. Prior-year amounts for
Unisource have been restated to reflect interest and other expenses allocated by
the Company. Unisource has been charged corporate interest expense based on the
relationship of its net assets to total Company net assets, excluding corporate
debt, in amounts of $7,203,000 in the first quarter of fiscal 1997, $29,572,000
in fiscal 1996 and $26,586,000 in fiscal 1995. The Company recorded a charge
against earnings of $50,000,000 in the third quarter of fiscal 1996 for new
restructuring activities at Unisource. The charge includes facility closures
costs of $33,000,000 and severance costs for approximately 900 employees of
$17,000,000 associated with the announced regional realignment from ten to five
regions in the United States and facilities mergers in the U.S. and Canada. An
$18,000,000 charge against earnings was recorded in the third quarter of fiscal
1996 for costs associated with the spin-off of Unisource consisting primarily of
investment banking fees, legal and accounting fees, filing fees and employee
termination costs directly related to the spin-off.
The Company has owned several manufacturing and industrial businesses, all
of which have been sold. There are currently environmental remediation claims
pending for manufacturing or landfill sites in the United States that relate to
these discontinued operations. As a result of several environmental remediation
claims, and increased estimated costs associated with existing environmental
remediation sites, primarily related to discontinued manufacturing operations
divested by the Company in 1991 and prior, the Company took a fourth quarter
charge in fiscal 1995 to increase its liabilities for environmental remediation.
The discontinued operations charge was $23,630,000 ($16,541,000 net of tax or
$.14 per share).
During 1995, the Company agreed to pay $10,000,000 to settle a claim by a
former subsidiary, which had asserted that the Company was liable for certain
employee liabilities. This amount was primarily charged against existing
reserves for discontinued operations. The Company paid $5,000,000 during 1995,
$2,000,000 in 1996 and $1,500,000 in 1997 with the remaining $1,500,000 to be
paid over the next two years.
The results of discontinued operations were:
Fiscal Year
Ended September 30
Three Months Ended ------------------------------
(in thousands) December 31, 1996 1996 1995
- ---------------------------------------------------------------------------------------------
Revenues (Unisource) $ 1,728,533 $ 7,022,808 $ 6,987,274
=============================================================================================
Income (loss) before taxes
Unisource (including $50,000
restructuring charge in 1996) $ 34,743 $ 103,003 $ 172,745
Spin-off costs (18,000)
Environmental charge (23,630)
- ---------------------------------------------------------------------------------------------
34,743 85,003 149,115
Tax expense (benefit)
Unisource 14,592 43,005 67,543
Spin-off costs (3,850)
Environmental charge (7,089)
- ---------------------------------------------------------------------------------------------
14,592 39,155 60,454
Net income (loss)
Unisource 20,151 59,998 105,202
Spin-off costs (14,150)
Environmental charge (16,541)
- ---------------------------------------------------------------------------------------------
$ 20,151 $ 45,848 $ 88,661
=============================================================================================
The net assets of discontinued operations at September 30, 1996 consist of:
(in thousands)
- ------------------------------------------------------------------------------
Working capital $ 750,792
Net property and equipment 224,168
Other assets 637,062
Long-term debt and other liabilities (122,821)
- ------------------------------------------------------------------------------
Unisource equity and intercompany debt $1,489,201
==============================================================================
In December 1996, Unisource repaid $553,500,000 of intercompany debt outstanding
with the Company and the Unisource common stock was distributed to Alco
shareholders. Equity of the Company was reduced by $960,723,000, which was the
equity of Unisource at December 31, 1996, adjusted for post-closing tax and
pension adjustments.
26
6. Finance Receivables
The Company's wholly owned finance subsidiaries are engaged in purchasing office
equipment from Company dealers and leasing the equipment to customers under
direct financing leases.
Components of finance receivables, net, are as follows:
September 30 (in thousands) 1997 1996
- --------------------------------------------------------------------------------
Gross receivables $ 2,491,817 $ 1,538,183
Unearned income (607,533) (272,279)
Unguaranteed residuals 194,639 108,338
Allowance for doubtful accounts (76,767) (60,484)
- --------------------------------------------------------------------------------
Lease receivables 2,002,156 1,313,758
Less: Current portion 670,784 435,434
- --------------------------------------------------------------------------------
Long-term lease receivables $ 1,331,372 $ 878,324
================================================================================
At September 30, 1997, future minimum lease payments to be received under direct
financing leases were: 1998 - $850,079,000; 1999 - $717,633,000; 2000 -
$512,561,000; 2001 - $292,177,000; 2002 - $117,662,000; thereafter - $1,705,000;
while future minimum lease payments to be received under operating leases were:
1998 - $42,066,000; 1999 - $29,857,000; 2000 - $20,845,000; 2001 - $11,863,000;
2002 - $5,461,000; thereafter - $15,000.
IKON's U.S. finance subsidiary has entered into asset securitization
agreements for $275,000,000 of eligible direct financing lease receivables that
expire in March 1998 ($125,000,000) and September 1998 ($150,000,000). The
agreements contain limited recourse provisions that require the finance
subsidiary to assign an additional amount of undivided interest in leases as a
reserve to cover any potential losses to the purchaser due to uncollectible
leases. As collections reduce previously sold interests, new leases can be sold
up to the agreement amount. In fiscal year 1997, the finance subsidiary sold an
additional $103,401,000 in leases, replacing leases liquidated during the year,
under the agreements.
The changes in the finance subsidiary servicing liabilities relating to the
asset securitization agreements for the fiscal years ended September 30, 1997
and 1996, are as follows:
(in thousands) 1997 1996
- --------------------------------------------------------------------------------
Beginning of period $ 8,467 $ 4,187
Additions 3,170 6,050
Less: Amortization (3,389) (1,770)
- --------------------------------------------------------------------------------
Balance at September 30 $ 8,248 $ 8,467
================================================================================
The estimated fair value of the servicing liabilities aggregated $7,485,000 at
September 30, 1997 and $7,587,000 at September 30, 1996.
7. Property and Equipment
Property and equipment, at cost, consisted of:
September 30 (in thousands) 1997 1996
- --------------------------------------------------------------------------------
Land $ 6,797 $ 9,412
Buildings and improvements 101,773 72,709
Furniture and equipment 353,790 276,113
- --------------------------------------------------------------------------------
462,360 358,234
Less: accumulated depreciation 222,815 169,416
- --------------------------------------------------------------------------------
$239,545 $188,818
================================================================================
8. Notes Payable and Long-Term Debt
Notes payable consisted of:
September 30 (in thousands) 1997 1996
- --------------------------------------------------------------------------------
Notes payable to banks at average interest rate:
1997 - 6.1%; 1996 - 6.0% $259,464 $184,358
Other notes payable at average interest rate:
1997 - 8.8%; 1996 - 8.2% 7,515 2,104
- --------------------------------------------------------------------------------
$266,979 $186,462
================================================================================
Long-term debt consisted of:
September 30 (in thousands) 1997 1996
- --------------------------------------------------------------------------------
Bond issue at stated interest rate of 6.75%, net of
discount (1997- $4,467;1996 - $4,519), due 2025,
effective interest of rate 6.87% $295,533 $295,481
Bond issue at interest rate of 8 7/8% due 2001 43,819 150,000
Private placement debt at average interest rate:
1997 - 7.2%; 1996 - 7.7%, due 2005 55,000 105,000
Bank debt at average interest rate: 1997 - 7.7%;
1996 - 7.6%, due 2000 71,641 72,721
Notes payable to insurance company at average
interest rate of 9.7% 60,000
Sundry notes, bonds and mortgages at average
interest rate: 1997 - 7.7%; 1996 - 6.9%, due
1998 - 2003 52,876 74,929
Present value of capital lease obligations
(gross amount: 1997 - $36,494; 1996 - $30,201) 32,160 26,489
- --------------------------------------------------------------------------------
551,029 784,620
Less current maturities 60,794 62,697
- --------------------------------------------------------------------------------
$490,235 $721,923
================================================================================
After giving effect to interest rate swaps, the average effective interest rate
on the Company's long-term bank debt was 7.7% and 7.6% at September 30, 1997 and
September 30, 1996, respectively, compared to average rates of 3.5% and 4.8% as
the stated variable rate at September 30, 1997 and September 30, 1996,
respectively.
27
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
IKON Office Solutions, Inc. and Subsidiaries
--------------------------------------------
Long-term debt, finance subsidiaries consisted of:
September 30 (in thousands) 1997 1996
- ------------------------------------------------------------------------------------
Medium term notes at average interest rate:
1997 - 6.6%; 1996 - 6.8% $1,542,250 $ 969,900
Notes payable to banks at average interest rate:
1997 and 1996 - 6.4% 203,504 157,126
- ------------------------------------------------------------------------------------
1,745,754 1,127,026
Less current maturities 251,711 314,000
- ------------------------------------------------------------------------------------
$1,494,043 $ 813,026
====================================================================================
Long-term debt and long-term debt, finance subsidiaries mature as follows:
Long-Term Debt,
Finance
(in thousands) Long-Term Debt Subsidiaries
- ---------------------------------------------------------------
(fiscal year)
1998 $ 60,794 $251,711
1999 11,724 629,828
2000 6,555 346,257
2001 75,372 428,673
2002 45,120 80,964
2003 - 2025 351,464 8,321
- ---------------------------------------------------------------
On December 2, 1996, Unisource borrowed under its new credit facility to repay
$553,500,000 of intercompany debt with the Company. The Company prepaid debt in
the amount of $514,000,000 from these funds. Early repayment of this debt
resulted in certain prepayment penalties. Total prepayment penalties of
$18,701,000 and related tax benefits of $6,545,000 are reflected as an
extraordinary loss on early extinguishment of debt on the Statement of Income
for fiscal 1997.
On December 16, 1996, the Company entered into a credit agreement with
several banks under which it may borrow up to $400,000,000. This multicurrency
facility replaced a $500,000,000 credit facility that was due to expire December
1, 1999 and a $100,000,000 credit facility that was canceled on December 2,
1996. The reduced credit commitment reflects the spin-off of the Unisource
business that was effective December 31, 1996 (see note 5). The new agreement,
that expires December 15, 2001, includes a facility fee that could range from
6.5 to 9.0 basis points per annum on the commitment, based upon the Company's
current long-term debt rating (8 basis points per annum at September 30, 1997).
The agreement provides that loans may be made under either domestic or
Eurocurrency notes at rates computed under a selection of rate formulas
including prime or Eurocurrency rates. At September 30, 1997, short-term
borrowings supported by the credit agreement totaled $248,100,000 leaving
$151,900,000 unused and available.
On October 27, 1997, the Company completed a $250,000,000 underwritten
public debt offering consisting of $125,000,000 6.75% notes due November 1, 2004
and $125,000,000 7.3% notes due November 1, 2027. The 6.75% notes were sold at a
discount to yield 6.794% and carry a make-whole call provision with a five
basis-points premium. The 7.3% notes were also sold at a discount to yield
7.344% and carry a make-whole call provision with a 15 basis-points premium. The
proceeds of the offering were used to repay short-term borrowings.
The wholly owned U.S. finance subsidiary of the Company may offer notes to
the public from time to time under its medium term notes program. These notes
are offered at varying maturities of nine months or more from their dates of
issue and may be subject to redemption at the option of the finance subsidiary,
in whole or in part, prior to the maturity date in conjunction with meeting
specified provisions. Interest rates are determined based on market conditions
at the time of issuance. At September 30, 1997, $1,646,750,000 is available for
issuance under this program.
The Company is in compliance with all covenants, including financial, for
all loan agreements. Capital lease obligations and mortgages are secured by
property and equipment that had a net book value of $18,444,000 at September 30,
1997.
Interest paid, including finance subsidiaries and corporate interest
allocated to discontinued operations, approximated $151,000,000, $119,000,000
and $84,000,000 for fiscal years 1997, 1996 and 1995, respectively.
9. Shareholders' Equity
During the first quarter of fiscal 1996, 432,130 common shares were issued for
Series AA Preferred Stock conversions by holders. On February 9, 1996, the
Company redeemed the balance of its Series AA Preferred Stock for common stock
at the conversion rate of 2.2402 shares of common stock for each depositary
share. Common shares totaling 8,585,423 were issued in connection with this
redemption.
On July 25, 1995, the Company sold 3,877,200 depositary shares, each
representing 1/100th of a share of Series BB conversion preferred stock, for
$77.375 per depositary share totaling $299,998,350, and used the net proceeds to
reduce debt. Dividends are cumulative at $5.04 per year per depositary share.
The Series BB Preferred Stock has one vote per share (equivalent to 1/100th vote
per depositary share) and has a liquidation preference of $77.375 per depositary
share plus an amount equal to accrued and unpaid dividends. Prior to October 1,
1998, each depositary share is convertible at the option of the holder into
2.0468 shares of common stock of the Company. On October 1, 1998, unless
previously converted at the option of the holder, each of the outstanding
depositary shares will automatically convert into a number of shares of common
stock of the Company equal to (a) 2.0468 shares of common stock per depositary
share if the current
28
market price of the Company's common stock is greater than or equal to $37.80
per share, (b) the number of shares of common stock (per depositary share)
having a value (determined at the current market price) equivalent to $77.375,
if the current market price is less than $37.80, but greater than $30.98 and (c)
2.4972 shares of common stock per depositary share if the current market price
of the Company's common stock is at or below $30.98 per share. The current
market price to be used in the conversion calculation will be the average
closing price per share of common stock of the Company on the twenty trading
days immediately prior to, but not including, October 1, 1998. At September 30,
1997, 7,935,853 shares of common stock were reserved for conversion of the
Series BB conversion preferred stock.
Employee stock options are granted at the market price at dates of grant
which does not require the Company to recognize any compensation expense. These
options expire in ten years and generally vest over five years. The proceeds of
options exercised are credited to shareholders' equity. As permitted by SFAS
123, the Company continues to account for its stock options in accordance with
APB 25. A plan for the Company's 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.
Changes in common shares under option were:
Weighted
Average
Shares Price
- ----------------------------------------------------------------
September 30, 1994 4,664,586 $17.35
Granted 822,236 30.07
Exercised (854,250) 14.67
Cancelled (46,214) 23.44
- ----------------------------------------------------------------
September 30, 1995 4,586,358 20.07
Granted 1,582,767 43.17
Exercised (813,408) 15.77
Cancelled (72,077) 35.25
- ----------------------------------------------------------------
September 30, 1996 5,283,640 27.45
Unisource Spin-off Adjustment 952,043 23.53
Granted 1,395,757 38.96
Exercised (894,601) 16.85
Cancelled
Unisource Spin-off (943,103) 32.34
Other (219,045) 26.39
- ----------------------------------------------------------------
September 30, 1997 5,574,691 $26.53
================================================================
Available for Grant 4,654,902
- ----------------------------------------------------------------
In connection with the separation of Unisource from Alco, stock options
that were not exercised prior to the effective date of the Distribution were
adjusted. Optionholders who remain employees of IKON retained their options to
purchase IKON shares. The number of shares subject to, and the exercise price
of, each IKON option was adjusted based upon a formula that preserved the
inherent intrinsic value and vesting and term provisions of such options.
Optionholders who became employees of Unisource after the Distribution were
given the opportunity to receive options to purchase shares of Unisource Common
Stock in lieu of their Alco options or had their options cancelled.
The following is provided to comply with the disclosure requirements of
SFAS 123. If the Company had elected to recognize compensation costs based on
the fair value at the date of grant for awards in fiscal years 1997 and 1996,
consistent with the provisions of SFAS 123, the Company's net income and
earnings per share would have been reduced to the following pro forma amounts:
Fiscal year ended September 30 (in thousands, except per share data)
1997 1996
- -------------------------------------------------------------------------------------------------
Income from continuing operations before extraordinary loss $ 117,615 $ 162,932
Income from discontinued operations 19,871 45,116
Income before extraordinary loss 137,486 208,048
Earnings per share
Continuing operations $ .73 $ 1.10
Discontinued operations .15 .35
Extraordinary loss (.09)
- -------------------------------------------------------------------------------------------------
Net Income $ .79 $ 1.45
=================================================================================================
The pro forma effect on net income for fiscal 1997 and 1996 may not be
representative of the pro forma effect on net income of future years because the
SFAS 123 method of accounting for pro forma compensation expense has not been
applied to options granted prior to October 1, 1995.
The weighted-average fair values at date of grant for options granted
during fiscal years 1997 and 1996 were $15.49 and $14.75, respectively, and were
estimated using the Black-Scholes option-pricing model. The following
assumptions were applied for periods before the Unisource spin-off and
subsequent to the Unisource spin-off, respectively: (i) expected dividend yields
of 1.4% and .6%, (ii) expected volatility rates of 29.1% and 31.8%, and (iii)
expected lives
The following table summarizes information about stock options outstanding
at September 30, 1997:
Options Outstanding Options Exercisable
- ------------------------------------------------------------------------------------------------------------------------------------
Number Weighted-Average Weighted-Average Number Weighted-Average
Range of Outstanding Remaining Exercise Exercisable Exercise
Exercise Prices at 9/30/97 Contractual Life Price at 9/30/97 Price
$ 7.85 - $13.01 972,984 3.2 years $12.07 972,984 $ 12.07
14.18 - 19.90 1,199,454 5.8 18.11 783,571 17.67
22.84 - 29.18 1,169,981 8.1 25.16 337,799 24.27
30.03 - 38.79 1,676,810 8.4 35.71 254,024 35.27
44.63 - 59.99 555,462 9.2 45.17 43,566 50.96
29
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
IKON Office Solutions, Inc. and Subsidiaries
--------------------------------------------
of 5.4 years and 5.7 years. The risk-free interest rates applied for fiscal 1997
and 1996 were 5.9% and 6.4%, respectively.
In fiscal 1995, with Board of Director and shareholder approvals, the
Company amended and restated its Long-Term Incentive Compensation Plan (LTIP).
The plan is intended to motivate, recognize and reward key management employees
for long-term performance. Under the plan, key management employees are granted
stock or cash awards, which are earned upon achieving predetermined performance
objectives during three-year intervals. The value of these awards is charged to
expense over the related plan period. In fiscal 1995, the Company granted
198,706 stock awards under the plan. At December 31, 1996, 85,302 awards were
transferred to Unisource. The remaining 113,404 stock awards were adjusted to
139,963 as a result of the spin-off, of which 80,660 awards were earned and
59,303 awards were cancelled. In 1996, the Company changed the form of the LTIP
award granted from a stock award to a fixed cash award. In fiscal 1997 and 1996,
cash awards totaling $4,819,500 and $3,910,419, respectively, were granted to
LTIP participants. In connection with these plans, the Company expensed
$3,111,000 in fiscal 1997, $7,500,000 in fiscal 1996 and $6,596,000 in fiscal
1995.
IKON amended its Rights Agreement (Rights Plan) as of June 18, 1997. The
Rights Plan, which was scheduled to expire in accordance with its terms on
February 10, 1998, was extended as amended for an additional ten-year term
expiring June 18, 2007.
The Rights Plan established a new exercise price of $204.00 per preferred
stock purchase right (individually, a "Right," and collectively, the "Rights").
A Right entitles holders thereof to buy 1/100th of a share of Series 12
Preferred Stock of the Company (the "Preferred Shares").
The Rights Plan provides that the Rights will be exercisable and will trade
separately from shares of the Company's common stock only if a person or group
(an "Acquiring Person") acquires beneficial ownership of 15% or more of the
shares of the Company's common stock or commences a tender or exchange offer
that would result in such a person or group owning 15% or more of the shares of
the Company's common stock (a "Flip-in Event"). Only when one or more of these
events occur will shareholders receive certificates for the Rights.
If any person actually acquires 15% or more of the shares of common stock,
other than through a tender or exchange offer for all shares of common stock
that provides a fair price and other terms for such shares, or if a 15%-or-more
shareholder engages in certain "self-dealing" transactions or engages in a
merger or other business combination in which the Company survives and shares of
its common stock remain outstanding, the other shareholders will be able to
exercise the Rights and buy shares of common stock of the Company having twice
the value of the exercise price of the Rights. A provision has been added to the
Rights Plan that allows shareholders, upon action by a majority of the
Continuing Directors (Continuing Directors are, in general, directors who were
members of the Board of Directors prior to a Flip-in Event), to exercise their
Rights for 50% of the shares of common stock otherwise purchasable upon
surrender to the Company of the Rights so exercised and without other payment of
exercise price.
The Rights Plan has also reduced the price at which the Board of Directors
can redeem the Rights to $.01.
The Rights, in general, may be redeemed at any time prior to the tenth day
following public announcement that a person has acquired a 15% ownership
position in shares of common stock of the Company.
10. Taxes on Income
Provision for income taxes:
Fiscal Year Ended September 30 (in thousands) 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------
Current Deferred Current Deferred Current Deferred
- ---------------------------------------------------------------------------------------------------------------------
Federal $(2,983) $78,770 $21,144 $58,540 $8,832 $41,723
Foreign (361) 8,353 13,496 528 8,923 1,653
State 2,032 4,940 11,170 3,106 15,640 (1,270)
- ---------------------------------------------------------------------------------------------------------------------
Taxes on income $(1,312) $92,063 $45,810 $62,174 $33,395 $42,106
=====================================================================================================================
The components of deferred income tax assets and liabilities, including finance
subsidiaries, were as follows:
September 30 (in thousands) 1997 1996
- ---------------------------------------------------------------
Deferred tax liabilities:
Depreciation and amortization $45,891 $32,284
Lease income recognition 344,553 227,003
- ---------------------------------------------------------------
Total deferred tax liabilities 390,444 259,287
Deferred tax assets:
Accrued liabilities 144,324 137,982
Net operating loss carryforwards 28,766 17,939
AMT credit carryforwards 38,792 7,600
Other-net 15,341 14,302
- ---------------------------------------------------------------
Total deferred tax assets 227,223 177,823
Valuation allowance 43,255 26,647
- ---------------------------------------------------------------
Net deferred tax assets 183,968 151,176
- ---------------------------------------------------------------
Net deferred tax liabilities $206,476 $108,111
===============================================================
Net operating loss carryforwards consist primarily of state carryforwards of
$457,000,000 principally expiring in years 1998 through 2012. A full valuation
allowance has been established against this amount. Credit carryforwards consist
principally of federal and state alternative minimum tax (AMT) credits of
approximately $38,792,000 (with no expiration date) and affordable housing
credits of approximately $1,017,000 (expiring in 2012).
Components of the effective income tax rate:
Fiscal Year Ended September 30 1997 1996 1995
- -------------------------------------------------------------------------------
Federal 35.0% 35.0% 35.0%
State 3.8 3.4 4.9
Goodwill 5.0 2.1 2.5
Foreign including credits (.6) (.3) 1.2
Other (.6) (.6) (4.0)
- -------------------------------------------------------------------------------
Effective income tax rate 42.6% 39.6% 39.6%
===============================================================================
Net income tax payments (refunds) for all operations, including discontinued,
amounted to $(22,081,000) in 1997, $46,231,000 in 1996 and $30,436,000 in 1995.
Undistributed earnings of the Company's foreign subsidiaries were
approximately $65,110,000 at September 30, 1997. Those earnings are considered
to be indefinitely reinvested and, therefore, no provision has been recorded for
U.S. federal and state income taxes.
11. Leases
Equipment acquired under capital leases is included in property and equipment in
the amount of $44,465,000 in 1997 and $33,141,000 in 1996 and the related
amounts of accumulated amortization are $26,021,000 in 1997 and $11,491,000 in
1996. Related obligations are in long-term debt and related amortization is
included in depreciation.
At September 30, 1997, future minimum lease payments under noncancelable
operating leases with initial or remaining terms of more than one year were:
1998 - $79,979,000; 1999 - $62,493,000; 2000 - $46,857,000; 2001 - $35,434,000;
2002 - $27,628,000; thereafter - $34,181,000.
Total rental expense was $81,608,000 in 1997, $67,006,000 in 1996 and
$61,398,000 in 1995.
12. Contingencies
There are contingent liabilities for taxes, guarantees, lawsuits, environmental
remediation claims relating to discontinued operations (see note 5) and various
other matters occurring in the ordinary course of business. On the basis of
information furnished by counsel and others, management believes that none of
these contingencies will materially affect the Company.
13. Pension and Stock Purchase Plans
The Company sponsors defined benefit pension plans for the majority of its
employees. The benefits generally are based on years of service and
compensation. The Company funds at least the minimum amount required by
government regulations. The cost of these plans, together with contributions to
multiemployer and defined contribution pension plans ($861,000 in 1997,
$1,338,000 in 1996 and $1,346,000 in 1995) charged to continuing operations
amounted to $17,623,000 for 1997, $20,215,000 for 1996 and $12,846,000 for 1995.
The components of net periodic pension cost for the Company-sponsored defined
benefit pension plans were:
Fiscal Year Ended September 30 (in thousands) 1997 1996 1995
- -----------------------------------------------------------------------------------------------
Service cost $ 19,208 $ 15,734 $ 10,610
Interest cost on projected benefit obligation 18,373 7,448 7,429
Actual return on plan assets (30,949) (15,663) (18,409)
Net amortization and deferral 10,130 11,358 11,870
- -----------------------------------------------------------------------------------------------
Net pension cost $ 16,762 $ 18,877 $ 11,500
===============================================================================================
31
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
IKON Office Solutions, Inc. and Subsidiaries
--------------------------------------------
Assumptions used in accounting for the Company-sponsored defined benefit pension
plans were:
1997 1996 1995
- -----------------------------------------------------------------------------
Weighted average discount rates 7.75% 7.75% 7.50%
Rates of increase in compensation levels 6.25% 6.25% 6.00%
Expected long-term rate of return on assets 10.00% 10.00% 10.00%
The funded status and amounts recognized in the Consolidated Balance Sheets for
the Company-sponsored defined benefit pension plans were:
September 30 (in thousands) 1997 1996
- -------------------------------------------------------------------------------------
Actuarial present value of benefit obligations
Vested $ 212,332 $ 198,061
=====================================================================================
Accumulated $ 218,585 $ 204,457
=====================================================================================
Projected $ 260,959 $ 237,043
Plan assets at fair value 259,243 224,265
- -------------------------------------------------------------------------------------
Plan assets less than projected benefits (1,716) (12,778)
Items not yet recognized
Net gain (42,864) (34,231)
Prior service cost 12,705 12,526
Net asset existing at transition date (7,494) (8,742)
Adjustment required to recognize minimum liability (4,535) (4,603)
- -------------------------------------------------------------------------------------
Net pension liability $ (43,904) $ (47,828)
=====================================================================================
Under the Benefits Agreement with Unisource, the Company assumed certain benefit
obligations and related assets for retirees and terminated vested employees of
Unisource which totaled approximately $105,000,000.
Substantially all of the plan assets at September 30, 1997 are invested in
listed stocks, including common stock of the Company having a fair value of
$30,675,600.
The majority of the Company's employees were eligible to participate in the
Company's Stock Participation Plan through fiscal 1995, under which they were
permitted to invest 2% to 6% of regular compensation before taxes. The Company
contributed an amount equal to two-thirds of the employees' investments and all
amounts were invested in the Company's common shares. Effective October 2, 1995,
the Stock Participation Plan was replaced by a Retirement Savings Plan (RSP).
The RSP allows employees to invest 1% to 16% of regular compensation before
taxes in six different investment funds. The Company contributes an amount equal
to two-thirds of the employees' investments, up to 6% of regular compensation,
for a maximum company match of 4%. All Company contributions are invested in the
Company's common shares. Employees vest in a percentage of the Company's
contribution after two years of service, with full vesting at the completion of
five years of service. There is a similar plan for eligible management
employees. The cost of the plans charged to continuing operations amounted to
$31,026,000 in 1997, $23,596,000 in 1996 and $16,983,000 in 1995.
14. Geographic Information
Revenues, income before taxes and identifiable assets by geographic area from
continuing operations for the fiscal years ended September 30 were as follows:
(in millions) 1997 1996 1995
- ----------------------------------------------------------------
Revenues
Domestic $4,467.6 $3,559.7 $2,802.2
Europe 375.8 360.6 178.4
Canada 270.7 177.7 111.0
Other 14.3 1.8
- ----------------------------------------------------------------
Total $5,128.4 $4,099.8 $3,091.6
================================================================
Income Before Taxes
Domestic $ 233.4 $ 251.1 $ 186.7
Europe 10.0 38.3 9.0
Canada 17.5 20.6 16.5
Other (.3) .1
- ----------------------------------------------------------------
Operating 260.6 310.1 212.2
Interest expense (47.5) (37.2) (21.7)
- ----------------------------------------------------------------
Total $ 213.1 $ 272.9 $ 190.5
================================================================
Assets
Domestic $4,340.4 $3,096.2 $2,313.4
Europe 566.3 560.2 300.5
Canada 405.1 227.5 161.5
Other 12.1 11.5
- ----------------------------------------------------------------
Total $5,323.9 $3,895.4 $2,775.4
================================================================
15. Financial Instruments
The Company uses financial instruments in the normal course of its business,
including derivative financial instruments, for purposes other than trading.
These financial instruments include debt, commitments to extend credit and
interest rate and currency swap agreements. The notional or contractual amounts
of these commitments and other financial instruments are discussed below.
Concentration of Credit Risk
The Company is subject to credit risk through trade receivables, lease
receivables and short-term cash investments. Credit risk with respect to trade
receivables is minimized because of a large customer base and its geographic
dispersion. Short-term cash investments are placed with high-credit quality
financial institutions and in short duration corporate and government debt
securities funds. By policy, the Company limits the amount of credit exposure in
any one type of investment instrument.
Interest Rate and Currency Swap Agreements
The Company has interest rate swap agreements relating to finance subsidiaries'
financial instruments having a total principal/notional amount of $105,000,000
with fixed rates from 5.77% to 7.08%. The Company also has Canadian dollar
denominated interest rate swap agreements having a total principal/notional
amount of $71,092,000 (CN$98,248,000) with fixed rates from 7.43% to 7.74%. The
Company is required to make payments to the
32
counterparties at the fixed rate stated in the agreements and in return the
Company receives payments at variable rates.
The Company has also entered into cross-currency swap agreements to
exchange Canadian dollars (CN$98,248,000) for pounds sterling
((Pounds)46,500,000). The Company is required to make pounds sterling payments
at fixed rates from 9.53% to 9.90% in exchange for Canadian dollar payments at
fixed rates from 9.02% to 9.38%.
The Company is exposed to credit loss in the event of nonperformance by the
counterparties to the swap agreements. However, the Company does not anticipate
nonperformance by the counterparties.
The following methods and assumptions were used by the Company in
estimating fair value disclosures for financial instruments.
Cash, Notes Payable and Long-Term Receivables
The carrying amounts reported in the consolidated balance sheets approximate
fair value.
Long-Term Debt
The fair value of long-term debt instruments is estimated using a discounted
cash flow analysis. For more information on these instruments, refer to note 8.
Off-Balance-Sheet Instruments
Fair values for the Company's off-balance-sheet instruments (interest rate and
currency swaps) are based on the termination of the agreements.
The carrying amounts and fair values of the Company's financial instruments were
as follows:
1997 1996
September 30 (in thousands) Carrying Amount Fair Value Carrying Amount Fair Value
- ----------------------------------------------------------------------------------------------------------------
Long-term debt:
Bond issues $ 339,352 $ 327,869 $ 445,481 $ 423,667
Private placement debt 55,000 55,791 105,000 103,538
Bank debt 71,641 74,269 72,721 73,406
Notes payable to insurance company 60,000 61,813
Sundry notes, bonds and mortgages 52,876 54,581 74,929 75,900
Finance subsidiaries' debt 1,745,754 1,750,298 1,127,026 1,124,395
Interest rate and currency swaps (7,183) (5,074)
Financial Review
- --------------------------------------------------------------------------------
IKON Office Solutions, Inc. and Subsidiaries
--------------------------------------------
On June 19, 1996, the Company announced that it would split its two operating
units into independent companies by spinning off Unisource, its paper products
and supply systems distribution group, as a separate publicly owned company. The
Company accomplished the transaction through a U.S. tax-free distribution of
Unisource stock to Company shareholders on December 31, 1996. As a result of the
spin-off of Unisource, the Company has accounted for Unisource as a discontinued
operation. Continuing operations of the Company consist of IKON, which sells,
rents and leases photocopiers, digital printers and other automated office
equipment for use in both traditional and integrated office environments. IKON
also provides outsourcing and imaging services and offers consulting, design,
computer networking and technology training for the networked office
environment.
Results of Operations
Revenues and income before taxes for continuing operations for fiscal years
ended September 30, 1997, 1996 and 1995 and the percentage change for 1997
versus 1996 and 1996 versus 1995 were:
(in millions) 1997 1996 % Change 1996 1995 % Change
- ---------------------------------------------------------------------------------------------------------------------------
Revenues $5,128 $4,100 25.1% $4,100 $3,092 32.6%
===========================================================================================================================
Income before taxes:
Operating income, excluding transformation costs $387.5 $331.5 16.9% $331.5 $212.2 56.2%
Transformation costs (126.9) (21.4) (21.4)
- ---------------------------------------------------------------------------------------------------------------------------
Operating income 260.6 310.1 (16.0%) 310.1 212.2 46.1%
Interest expense (47.5) (37.2) (37.2) (21.7)
- ---------------------------------------------------------------------------------------------------------------------------
$213.1 $272.9 (21.9%) $272.9 $190.5 43.3%
===========================================================================================================================
33
Financial Review
- --------------------------------------------------------------------------------
IKON Office Solutions, Inc. and Subsidiaries
--------------------------------------------
Fiscal 1997 Compared to Fiscal 1996
The Company's revenues increased approximately $1.0 billion, or 25.1% in fiscal
1997 compared to fiscal 1996, of which $554 million relates to current and
prior-year acquisitions and $474 million to base companies' internal growth.
Revenues from the Company's operations outside the U.S. were $660 million in
fiscal 1997 compared to $540 million in fiscal 1996. The Company's European
operations accounted for $15 million of the increase, while Canadian revenues
increased $93 million as a result of acquisitions and internal growth in base
companies. Other foreign companies added $12 million of revenue in fiscal 1997.
The Company's worldwide internal revenue growth was 12% in fiscal 1997 compared
to 14% in fiscal 1996. The internal revenue growth has been negatively impacted
by short-term issues related to the acceleration of the Company's transformation
initiative and its impact on operations both in the U.S. and U.K. In fiscal
1997, IKON completed 89 acquisitions with annualized trailing revenues of $528
million. Of the companies acquired, 27 were outsourcing and imaging companies,
28 were technology services companies and 34 were traditional copier companies.
This year, as part of its total solutions strategy, IKON has emphasized the
acquisition of technology services and outsourcing companies to build its
capabilities in these areas.
The Company's operating income decreased by $49.5 million compared to the
prior year. However, excluding transformation costs, operating income increased
$56.0 million, or 16.9% over the prior year. Operating income from foreign
operations was $27.1 million for fiscal 1997 compared to $59.0 million in the
prior year. European operations posted a $28.3 million decline in operating
income in fiscal 1997, relating primarily to revenue declines in the U.K. and
transformation costs. Canadian operating income decreased $3.2 million and other
foreign operations decreased $.4 million. These declines are also primarily the
result of transformation costs. There was no material effect of foreign currency
exchange rate fluctuations on the results of operations in fiscal 1997 compared
to fiscal 1996. Finance subsidiaries contributed 23.5% of IKON's operating
income in fiscal 1997 compared to 15.1% in fiscal 1996. The Company's operating
margins were 5.1% in fiscal 1997 compared to 7.6% in fiscal 1996. Excluding
transformation costs, the Company's operating margins were 7.6% in fiscal 1997,
compared to 8.1% in fiscal 1996. Costs associated with the Company's
transformation program increased $105 million in fiscal 1997 compared to fiscal
1996, primarily relating to the write-off of costs associated with the SAP
computer platform that was abandoned during the second quarter and technology
conversion costs ($36 million), severance and other employee related costs,
including temporary labor and costs related to consultants assisting with the
transformation ($35 million), facility consolidations costs, including lease
buyouts and write-offs of leasehold improvements ($23 million) and costs
incurred in connection with the adoption of the IKON name worldwide ($11
million).
Interest expense increased $10.3 million in fiscal 1997, primarily the
result of increased borrowing levels when adjusted for the Unisource
intercompany debt repayment made in December 1996. Income from continuing
operations before taxes decreased by $59.8 million from the prior year,
primarily reflecting the combined result of internal growth from base companies
along with earnings contributed by acquisitions, net of increased transformation
and interest costs. The effective income tax rate is 42.6% in fiscal 1997
compared to 39.6% in fiscal 1996. The Company used the proceeds of a December 2,
1996 $553.5 million intercompany debt repayment from its discontinued operation,
Unisource, to prepay $514 million of corporate debt. The Company recorded an
extraordinary charge of $12.2 million after tax ($18.7 million pretax) in the
first quarter of fiscal 1997 primarily for prepayment penalties relating to its
early extinguishment of certain corporate debt. Earnings per share from
continuing operations, excluding the extraordinary charge, decreased from $1.12
per share in fiscal 1996 to $.77 per share in fiscal 1997. Excluding
transformation costs, earnings per share from continuing operations would have
increased 12.2% from $1.23 per share in fiscal 1996 to $1.38 per share in fiscal
1997. Including the loss per share of $.09 on the extraordinary charge and the
earnings per share of $.15 on discontinued operations, earnings per share of the
Company were $.83 for fiscal 1997 compared to $1.48 (which includes $.36 for
discontinued operations) for fiscal 1996. Weighted average shares of 134.4
million in fiscal 1997 were 6.8 million shares greater than the 127.6 million
weighted average shares in fiscal 1996, primarily the result of stock issued for
acquisitions (5.8 million weighted shares) and conversion of the Series AA
Preferred Stock effective February 9, 1996 (2.4 million weighted shares), net
of treasury share repurchases (2.4 million weighted shares).
Fiscal 1996 Compared to Fiscal 1995
The Company's revenues increased $1 billion, or 32.6% in fiscal 1996 compared to
fiscal 1995, of which $675 million relates to current and prior-year
acquisitions and $333 million is internal growth. In fiscal 1996, IKON completed
100 acquisitions with annualized trailing revenues of $714 million. Revenues
from the Company's operations outside the U.S. were $540 million in fiscal 1996
compared to $289 million in fiscal 1995. The Company's European operations
accounted for $182 million of the increase, primarily the result of the
acquisitions in the latter half of fiscal 1995, while Canadian revenues
increased $67 million as a result of acquisitions and internal growth.
Operating income increased by $97.9 million, or 46.1% over the prior year.
Current and prior-year acquisitions accounted for $55.8 million, while the
remaining $42.1 million was the result of internal growth, net of transformation
costs. Excluding transformation costs, fiscal 1996 operating income increased
$119.3 million, or 56.2% over fiscal 1995. Finance subsidiaries contributed
15.1% of operating income in fiscal 1996 compared to 12.3% in fiscal 1995.
IKON's operating margins were 7.6% in fiscal 1996 compared to
34
6.9% in fiscal 1995. Excluding transformation costs, fiscal 1996 operating
margins were 8.1%. Operating income from foreign operations was $59 million in
fiscal 1996, up $33.5 million from the prior year of which $29.3 million is
attributable to European operations and $4.1 million is attributable to Canadian
operations. Costs associated with the Company's transformation program related
primarily to severance and other employee related costs, including temporary
labor and costs related to consultants assisting with the transformation ($19
million).
Interest expense, net of corporate interest allocated to discontinued
operations, increased $15.5 million in fiscal 1996, primarily the result of
increased borrowing levels. Income from continuing operations before taxes
increased by $82.4 million, or 43.3% over the prior year, primarily reflecting
the combined result of internal growth along with earnings contributed by
acquisitions, net of increased interest costs. The effective income tax rate is
39.6% in both fiscal 1996 and fiscal 1995. Earnings per share from continuing
operations increased 30.2% from $.86 per share in fiscal 1995 to $1.12 per share
in fiscal 1996. Weighted average shares of 127.6 million in fiscal 1996 were
11.1 million shares greater than the 116.5 million weighted average shares in
fiscal 1995, primarily the result of stock issued for acquisitions (4.7 million
weighted shares) and conversion of the Series AA Preferred Stock effective
February 9, 1996 (6.6 million weighted shares).
Discontinued Operations
The Company spun-off Unisource, its paper products and supply systems
distribution group, at the end of the first quarter of fiscal 1997. Revenues of
Unisource increased $13 million or .7% in the first quarter of fiscal 1997
compared to the first quarter of fiscal 1996. This change was due to increases
associated with current and prior-year acquisitions of $152 million, which were
offset by revenue declines of $139 million in base operations. The decline in
base operations was principally due to an estimated decrease in average paper
prices of 17% compared to the same period in fiscal 1996. The price deflation
was partially offset by volume gains in the base operations. Income before
income taxes decreased $8.5 million to $34.7 million for the first quarter of
fiscal 1997 compared to $43.3 million in the first quarter of fiscal 1996. This
decrease is primarily related to price decreases, net of volume increases in
base operations and operating income contributed by acquisitions, plus
additional interest expense of $3.5 million in the first quarter of fiscal 1997
compared to the first quarter of fiscal 1996.
Revenues of Unisource were flat at $7 billion in both fiscal 1996 and 1995
as a result of price and volume declines, net of $528 million contributed by
acquisitions. Income before income taxes decreased $69.7 million to $103 million
in fiscal 1996 compared to $172.7 million in fiscal 1995. This decrease consists
of a $50 million restructuring charge recorded in the third quarter of fiscal
1996 and an operating income decrease of $21.8 million, primarily related to the
price and volume decreases experienced during the year, net of operating income
contributed by acquisitions, while a reduction in interest expense of $2.1
million in fiscal 1996 slightly offset the operating income decline.
An $18 million charge against earnings was recorded in the third quarter of
fiscal 1996 for costs associated with the spin-off of Unisource consisting
primarily of investment banking fees, legal and accounting fees, filing fees and
employee termination costs directly related to the spin-off.
Year 2000 Costs
In July 1996, the Emerging Issues Task Force of the Financial Accounting
Standards Board reached a consensus on Issue 96-14, Accounting for the Costs
Associated with Modifying Computer Software for the Year 2000, which provides
that costs associated with modifying computer software for the year 2000 be
expensed as incurred. The Company is assessing the extent of the necessary
modifications to its computer software.
Financial Condition and Liquidity
Net cash provided by operating activities of continuing operations for fiscal
1997 was $174 million, primarily the result of net income from continuing
operations before the extraordinary loss, plus noncash charges to income, offset
by increases in working capital. During the same period, the Company used $1.1
billion in cash for investing activities, which included finance subsidiary
activity of $808 million, acquisition activity at a cash cost of $156 million
and capital expenditures of $193 million. Investing activities were funded
primarily through financing activities. Cash provided by financing activities
included $552 million of intercompany debt repayments by Unisource that was used
primarily to prepay corporate debt of the Company and $619 million of additional
net funding for finance subsidiaries. Financing activities also included $112
million use of cash for the purchase of treasury shares.
Debt, excluding finance subsidiaries, was $818 million at September 30,
1997, a decrease of $153 million from the continuing operations debt balance at
September 30, 1996 of $971 million. At September 30, 1997, debt as a percentage
of capitalization, excluding finance subsidiaries, was 35.6%, compared to 31.4%
in the prior year, while the current ratio was 1.5 to 1. The increased debt to
capital ratio reflects the effects of higher working capital, which the Company
is currently managing to lower levels as the transformation proceeds, and the
effects of the share repurchase program. At the end of fiscal 1997, the
Company's commitments for capital expenditures were approximately $27 million,
most of which are expected to be expended during fiscal 1998 and relate to IT
initiatives.
On December 16, 1996, the Company entered into a credit agreement with
several banks under which it may borrow up to $400 million. This credit facility
replaces a $500 million credit facility that was due to expire December 1999 and
a $100 million credit facility that was canceled on December 2, 1996. The
reduced credit commitment reflects
35
the spin-off of the Unisource business that was effective December 31, 1996. As
of September 30, 1997, short-term borrowings totaled $248 million, leaving $152
million available under the $400 million credit facility. In October 1997, the
Company completed a $250 million two tranche underwritten public offering
consisting of $125 million 6.75% notes due November 1, 2004 and $125 million
7.3% notes due November 1, 2027. The 6.75% notes were sold at a discount to
yield 6.794% and carry a make-whole call provision with a five basis-points
premium. The 7.3% notes were also sold at a discount to yield 7.344% and carry a
make-whole call provision with a 15 basis-points premium. The proceeds of the
offering were used to repay short-term borrowings. The Company also has $200
million available for either stock or debt offerings under its shelf
registration statement filed November 1995.
Finance subsidiaries' debt grew by $618.7 million from September 30, 1996,
a result of increased leasing activity. During fiscal 1997, the U.S. finance
subsidiary issued an additional $853.4 million under its $3.5 billion medium
term notes program that began in July 1994 (including the shelf registration
filed in May 1997 for $2 billion of medium term notes). At September 30, 1997,
$1.5 billion of medium term notes were outstanding with a weighted average
interest rate of 6.6%, while $1.6 billion remains available under this program.
Under its $275 million asset securitization programs, the U.S. finance
subsidiary sold $103.4 million in direct financing leases during fiscal 1997,
replacing those leases liquidated and leaving the amount of contracts sold
unchanged.
The Company filed shelf registrations for 10 million shares of common stock
in April 1997 and 5 million shares of common stock in March 1996. Shares issued
under these registration statements are being used for acquisitions.
Approximately 4 million shares have been issued under these shelf registrations
through September 30, 1997, leaving 11 million shares available for issuance.
On April 17, 1997, the Company announced that it may repurchase from time
to time as much as 5% of the outstanding IKON common stock in open market
transactions. Through September 30, 1997, the Company repurchased 4.4 million
common shares for $109.7 million. Approximately 2.3 million shares may still be
acquired by the Company in open market transactions 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 costs associated with the Company's
transformation program. The Company estimates the total remaining costs of its
transformation program to be from $50 million to $70 million, excluding capital
costs. Quarterly transformation costs are expected to be in the range of $5
million to $20 million for the next four quarters.
Market Risk
Interest Rate Risk. The Company's exposure to market risk for changes in
interest rates relates primarily to the Company's long-term debt. The Company
has no cash flow exposure due to interest rate changes for long-term debt
obligations. The Company primarily enters into debt obligations to support
general corporate purposes, including acquisitions, capital expenditures and
working capital needs. Finance subsidiaries' long-term debt is used to fund the
lease receivables portfolio. For interest rate swaps, the table presents
notional amounts and weighted average interest rates by contractual maturity
dates using September 30, 1997 variable rates. The carrying amounts for cash,
accounts receivable, long-term receivables and notes payable reported in the
consolidated balance sheets approximate fair value.
The table below presents principal amounts and related average interest
rates by year of maturity for the Company's long-term debt obligations:
(in thousands) 1998 1999 2000 2001 2002 Thereafter
- ------------------------------------------------------------------------------------------------------------------------------------
Long-term debt
Fixed rate $60,794 $11,724 $6,555 $3,731 $45,120 $351,464
Average interest rate 7.8% 8.4% 8.6% 8.6% 8.9% 6.8%
Variable rate $71,641
Average interest rate 3.5%
- ------------------------------------------------------------------------------------------------------------------------------------
Long-term debt, finance subsidiaries
Fixed rate $251,711 $629,828 $346,257 $428,673 $80,964 $8,321
Average interest rate 7.1% 6.3% 6.7% 6.7% 6.2% 5.3%
- ------------------------------------------------------------------------------------------------------------------------------------
Interest Rate Derivative Financial Instruments Related to Debt
Interest rate swaps:
Pay fixed/receive variable $71,092
Average pay rate 7.7%
Average receive rate 3.5%
====================================================================================================================================
Foreign Exchange Risk. The Company does not have significant foreign exchange
risk. Foreign denominated intercompany debt borrowed in one currency and repaid
in another is fixed via currency swap agreements. Gains and losses resulting
from the remeasurement of foreign financial statements into U.S. dollars did not
have a significant effect on the results of operations for fiscal years 1997,
1996 or 1995.
36
Quarterly Financial Summary
- --------------------------------------------------------------------------------
IKON Office Solutions, Inc. and Subsidiaries
------------------------------------------------
First Second Third Fourth
(unaudited, in millions except per share data) Quarter Quarter Quarter Quarter Total
- ------------------------------------------------------------------------------------------------------------------------------------
1997
Revenues $1,140.4 $1,277.9 $1,316.3 $1,393.8 $5,128.4
Gross profit 499.3 544.6 561.4 588.5 2,193.8
Transformation costs 14.3 61.2 23.0 28.4 126.9
Income before taxes 73.2 30.1 52.6 57.2 213.1
Income (loss)
Continuing operations 44.7 14.6 30.1 33.0 122.4
Discontinued operations 20.2 20.2
Extraordinary loss (12.2) (12.2)
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $52.7 $14.6 $30.1 $33.0 $130.4
====================================================================================================================================
Earnings (loss) per share
Continuing operations $.30 $.07 $.19 $.21 $.77
Discontinued operations .15 .15
Extraordinary loss (.09) (.09)
- ------------------------------------------------------------------------------------------------------------------------------------
$.36 $.07 $.19 $.21 $.83
====================================================================================================================================
Dividends per share $.14 $.04 $.04 $.04 $.26
Common stock price
High/Low 52 1/4 - 44 3/8 46 5/8 - 32 1/2 34 7/8 - 20 5/8 29 5/8 - 21 1/2 52 1/4 - 20 5/8
- ------------------------------------------------------------------------------------------------------------------------------------
1996
Revenues $900.6 $1,015.4 $1,059.1 $1,124.7 $4,099.8
Gross profit 383.2 417.1 460.0 476.1 1,736.4
Transformation costs .7 5.6 5.6 9.5 21.4
Income before taxes 61.3 66.3 72.8 72.5 272.9
Income (loss)
Continuing operations 36.9 40.5 43.7 43.8 164.9
Discontinued operations 26.3 28.6 (20.2) (a) 11.1 45.8 (a)
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $63.2 $69.1 $23.5 $54.9 $210.7
====================================================================================================================================
Earnings (loss) per share
Continuing operations $.25 $.28 $.30 $.30 $1.12
Discontinued operations .22 .22 (.16) (a) .08 .36 (a)
$.47 $.50 $.14 $.38 $1.48
====================================================================================================================================
Dividends per share $.14 $.14 $.14 $.14 $.56
Common stock price
High/Low 46 3/8 - 42 54 5/8 - 37 3/8 66 - 44 5/8 49 7/8 - 38 66 - 37 3/8
(a) Discontinued operations in the third quarter and year-to-date fiscal 1996
includes a pretax charge of $50,000,000 ($32,500,000 net of taxes or $.25
per share) for restructuring activities of Unisource and a pretax charge of
$18,000,000 ($14,150,000 net of taxes or $.11 per share) for expenses
related to the spin-off of Unisource.
37
Corporate Financial Summary
- --------------------------------------------------------------------------------
IKON Office Solutions, Inc. and Subsidiaries
------------------------------------------------
Ten-Year
(in millions, except per share data, Compound
shareholders of record, employees) Growth 1997 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------------------
Continuing Operations
Revenues 18.8% $5,128.4 $4,099.8 $3,091.6 $2,391.1
Gross profit 23.9 2,193.8 1,736.5 1,296.7 1,030.2
% of revenues 42.8 42.4 41.9 43.1
Selling and administrative 22.6 1,806.4 1,405.0 1,084.5 853.6
% of gross profit 82.3 80.9 83.6 82.9
Operating income 20.5 260.6 310.1 212.2 59.4
% of revenues 5.1 7.6 6.9 2.5
Income before taxes 23.4 213.1 272.9 190.5 43.3
% of revenues 4.2 6.7 6.2 1.8
Effective income tax rate (%) 42.6 39.6 39.6 95.4
Income 23.4 122.4 164.9 115.0 2.0
% of revenues 2.4 4.0 3.7 0.1
Earnings (loss) per share
Primary .77 1.12 0.86 (0.09)
Fully diluted (e) (e) (e) (e)
Capital expenditures 20.8 193.2 146.6 91.1 79.0
Depreciation and amortization 19.2 156.6 118.6 87.4 67.4
- --------------------------------------------------------------------------------------------------------------------------------
Discontinued Operations and Extraordinary Items
Income (loss) $8.0 $45.8 $88.7 $74.5
Earnings (loss) per share
Primary .06 .36 0.76 0.67
Fully diluted (e) (e) (e) (e)
- --------------------------------------------------------------------------------------------------------------------------------
Total Operations and Extraordinary Items
Net income 4.7% $130.4 $210.7 $203.7 $76.5
Earnings (loss) per share
Primary .83 1.48 1.62 0.58
Fully diluted (e) (e) (e) (e)
- --------------------------------------------------------------------------------------------------------------------------------
Share Activity
Dividends per share (2.1)% $0.26 $0.56 $0.52 $0.50
Per share book value 3.8 8.94 14.94 12.06 10.50
Return on shareholders' equity 7.8 13.8 15.8 15.1
Average common and common equivalent shares 134.4 127.6 116.5 111.4
Shareholders of record 15,089 15,033 15,099 14,348
- --------------------------------------------------------------------------------------------------------------------------------
Supplementary Information
Days sales outstanding (g) 44.5 34.2 33.6 30.2
Inventory turns (g) 6.3 5.7 6.3 5.7
Current ratio 1.5 1.2 1.1 1.3
Pretax return on capital employed 8.5 14.8 17.1 15.9 (b)
Pretax return on capital employed, excluding
finance subsidiaries 10.0 19.0 21.1 18.6 (b)
Working capital 10.2% $752.0 $251.2 $144.7 $171.5
Total assets 17.1 5,323.9 5,384.6 4,110.3 2,897.7
Total debt 26.9 2,563.8 2,158.4 1,499.3 949.2
% of capitalization 63.4 48.9 44.2 40.7
Total debt, excluding finance subsidiaries 14.4 818.0 1,031.4 681.7 484.3
% of capitalization 35.6 31.4 26.5 25.9
Serial preferred stock
Employees (h) 40,900 43,100 39,200 33,100
- --------------------------------------------------------------------------------------------------------------------------------
(a) Continuing operations include unrelated businesses sold in 1988.
(b) Excludes the effect of the sale of IMMOS in fiscal 1994 and Unisource
restructuring costs in fiscal 1993.
(c) Includes the sale of an automobile leasing subsidiary that resulted in a
pretax gain of $17,637,000.
(d) Includes unusual pretax charges relating to the Hillman Companies of
$10,323,000.
(e) Dilution is immaterial after 1987; therefore, no disclosure.
(f) Excludes gain on sale of Alco Health Services Corporation of pretax -
$96,800,000; net income - $61,900,000.
(g) Continuing operations only.
(h) Includes discontinued operations.
Note: Unless otherwise noted, ratios and operating results include the
effect of: fiscal 1994 - loss on sale of investment in IMMOS, pretax income
($115,265,000), net income ($95,086,000), earnings per share ($.85); fiscal
1993 - Unisource restructuring costs, operating income ($175,000,000), net
income ($112,875,000), earnings per share ($1.14); fiscal 1997 -
transformation costs, operating income ($126,908,000), net income
($82,490,000), earnings per share ($.61).
38
(in millions, except per share data,
shareholders of record, employees) 1993 1992 1991 1990
- ---------------------------------------------------------------------------------------------------------------
Continuing Operations
Revenues $1,723.1 $1,354.2 $1,127.4 $1,018.6
Gross profit 755.2 613.2 497.8 451.8
% of revenues 43.8 45.3 44.2 44.4
Selling and administrative 635.9 523.4 440.0 418.3
% of gross profit 84.2 85.4 88.4 92.6
Operating income 116.8 96.5 57.8 28.8
% of revenues 6.8 7.1 5.1 2.8
Income before taxes 101.4 85.1 40.4 8.3 (d)
% of revenues 5.9 6.3 3.6 0.8
Effective income tax rate (%) 39.6 39.4 39.0 40.7
Income 61.3 51.6 24.6 4.9 (d)
% of revenues 3.6 3.8 2.2 0.5
Earnings (loss) per share
Primary 0.52 0.53 0.26 0.06 (d)
Fully diluted (e) (e) (e) (e)
Capital expenditures 64.3 36.9 33.4 40.5
Depreciation and amortization 51.3 42.3 43.1 38.0
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Discontinued Operations and Extraordinary Items
Income (loss) ($58.6) $47.5 $94.1 $88.6
Earnings (loss) per share
Primary (0.59) 0.49 1.00 0.95
Fully diluted (e) (e) (e) (e)
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Total Operations and Extraordinary Items
Net income $2.6 $99.1 $118.7 $93.5 (d)
Earnings (loss) per share
Primary (0.07) 1.01 1.26 1.01
Fully diluted (e) (e) (e) (e)
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Share Activity
Dividends per share $0.48 $0.46 $0.44 $0.42
Per share book value 8.55 9.11 8.91 8.20
Return on shareholders' equity 11.6 11.6 15.0 13.4
Average common and common equivalent shares 98.7 97.7 94.1 93.1
Shareholders of record 13,999 13,726 14,096 14,152
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Supplementary Information
Days sales outstanding (g) 32.9 32.3 33.8 34.8
Inventory turns (g) 5.1 5.2 4.8 4.7
Current ratio 1.1 1.3 1.9 1.7
Pretax return on capital employed 13.5 (b) 15.1 15.3 18.5
Pretax return on capital employed, excluding
finance subsidiaries 15.8 (b) 17.5 17.6 20.9
Working capital $87.2 $140.4 $299.9 $216.9
Total assets 2,734.2 1,944.0 1,703.0 1,544.0
Total debt 1,240.0 805.4 548.1 469.2
% of capitalization 54.5 48.0 39.8 38.3
Total debt, excluding finance subsidiaries 825.7 504.9 327.4 309.6
% of capitalization 44.4 36.6 28.3 29.0
Serial preferred stock 0.3 1.6 2.9 4.9
Employees (h) 30,200 24,800 19,800 21,700
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(in millions, except per share data,
shareholders of record, employees) 1989 1988 1987
- ----------------------------------------------------------------------------------------------
Continuing Operations
Revenues $789.3 $667.0 (a) $917.9 (a)
Gross profit 342.6 255.6 (a) 257.2 (a)
% of revenues 43.4 38.3 28.0
Selling and administrative 318.7 241.0 (a) 234.5 (a)
% of gross profit 93.0 94.3 91.2
Operating income 23.9 22.5 (a) 40.3 (a)
% of revenues 3.0 3.4 4.4
Income before taxes 9.1 10.7 (a) 26.0 (a)(c)
% of revenues 1.2 1.6 2.8
Effective income tax rate (%) 20.0 25.5 42.5
Income 7.3 8.0 (a) 14.9 (a)(c)
% of revenues 0.9 1.2 1.6
Earnings (loss) per share
Primary 0.08 0.08 (a) 0.16 (a)(c)
Fully diluted (e) (e) 0.16 (a)(c)
Capital expenditures 35.1 26.3 (a) 29.1 (a)
Depreciation and amortization 32.1 25.3 (a) 27.0 (a)
- ----------------------------------------------------------------------------------------------
Discontinued Operations and Extraordinary Items
Income (loss) $160.2 $103.4 $67.4
Earnings (loss) per share
Primary 1.70 1.04 0.73
Fully diluted (e) (e) 0.68
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Total Operations and Extraordinary Items
Net income $167.5 $111.4 $82.3 (c)
Earnings (loss) per share
Primary 1.78 1.12 0.89 (c)
Fully diluted (e) (e) 0.84 (c)
- ----------------------------------------------------------------------------------------------
Share Activity
Dividends per share $0.38 $0.34 $0.32
Per share book value 7.25 6.98 6.15
Return on shareholders' equity 16.6 (f) 17.1 16.2
Average common and common equivalent shares 94.3 99.5 92.3
Shareholders of record 13,410 14,103 12,875
- ----------------------------------------------------------------------------------------------
Supplementary Information
Days sales outstanding (g) 37.6 37.9 45.0
Inventory turns (g) 4.3 4.1 3.6
Current ratio 1.5 2.2 2.4
Pretax return on capital employed 19.4 (f) 19.2 21.6
Pretax return on capital employed, excluding
finance subsidiaries 21.1 (f) 20.0 22.2
Working capital $161.9 $209.8 $284.5
Total assets 1,295.8 1,182.1 1,099.8
Total debt 391.2 261.5 237.1
% of capitalization 37.8 27.4 27.9
Total debt, excluding finance subsidiaries 296.7 209.3 213.4
% of capitalization 31.5 23.2 25.9
Serial preferred stock 7.4 9.9 11.4
Employees (h) 20,500 17,900 17,800
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39
IKON Office Solutions
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Board of Directors
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John E. Stuart/3/
Age 53, is Chairman and Chief Executive Officer of IKON Office Solutions. Mr.
Stuart was elected a director in 1993. He also serves on the board of directors
of Foster Wheeler Corporation.
James R. Birle/1,2,3/
Age 61, is Founder and Chairman of Resolute Partners, Inc. He is a director of
Massachusetts Mutual Life Insurance Company, Drexel Industries, Inc., The
Connecticut Health and Education Facilities Authority and Transparency
International. Mr. Birle was elected a director in 1996.
Philip E. Cushing
Age 47, is Group Chief Executive of Inchcape plc. Mr. Cushing has also served as
non-executive director of Bunzl plc since March 1994. He was elected to the
board in 1997.
Kurt E. Dinkelacker/3/
Age 44, is Executive Vice President and Chief Financial Officer of IKON Office
Solutions. He is a member of the Finance Committee of Crozer-Keystone Health
System in Media, Pennsylvania. Mr. Dinkelacker was elected to the board in 1996.
William F. Drake, Jr./3/
Age 65, is Vice Chairman and General Counsel of IKON Office Solutions. Mr. Drake
serves as a director of Nocopi Technologies and is Of Counsel to Montgomery,
McCracken, Walker & Rhoads. He has been a director since 1969.
Frederick S. Hammer/1,2,3/
Age 61, has been a director since 1986. His other directorships include United
Student Aid Group, Inc., Tri-Arc Financial Services, Inc., Partner in Inter-
Atlantic Capital Partners, Inc., and National Media Corporation.
Barbara Barnes Hauptfuhrer/1,2,3/
Age 69, has been a director since 1988 and was elected Chairman of the
Independent Directors in 1995. Her other directorships include The Great
Atlantic and Pacific Tea Co., Inc., Massachusetts Mutual Life Insurance Co.,
Raytheon Company and The Vanguard Group of Investment Companies.
Richard A. Jalkut/1,2,3/
Age 53, is President and Chief Executive Officer of PathNet. Mr. Jalkut serves
on the Board of Directors of the Marine Midland Bank. Mr. Jalkut was named a
director in 1996.
1 Audit Committee
2 Human Resources Committee
3 Investment Committee
Corporate Officers
- --------------------------------------------------------------------------------
John E. Stuart
Chairman and Chief Executive Officer
Kurt E. Dinkelacker
Executive Vice President and Chief Financial Officer
William F. Drake, Jr.
Vice Chairman and General Counsel
James J. Forese
Executive Vice President and President of International Operations
David M. Gadra
Senior Vice President and Chief Information Officer
William A. Brady
Vice President, Law and Assistant Secretary
O. Gordon Brewer, Jr.
Vice President, Finance
Michael J. Dillon
Vice President and Controller
Michael H. Dudek
Vice President, Acquisitions
Karin M. Kinney
Corporate Counsel and Secretary
J.F. Quinn
Treasurer
Beth B. Sexton
Vice President, Human Resources
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, no assurances can be given
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 uncertainties and risks that could significantly affect current
plans, anticipated actions and the Company's future financial condition and
results. These uncertainties and risks include, but are not limited to, those
relating to successfully managing an aggressive program to acquire and
integrate new companies, including companies with technical services and
products that are relatively new to the Company, and also including companies
outside the United States, which present additional risks relating to
international operations; risks and uncertainties relating to conducting
operations in a competitive environment; delays, difficulties, technological
changes, management transitions and employment issues associated with a large-
scale transformation project; debt service requirements (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 materially from those expressed in any forward-looking
statements made by or on behalf of the Company.
40