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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
[X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the quarterly period ended June 30, 2002 or
[ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the transition period from _____________ to ______________
Commission file number 1-5964
IKON OFFICE SOLUTIONS, INC.
(Exact name of registrant as specified in its charter)
OHIO 23-0334400
(State or other jurisdiction of (I.R.S.Employer Identification No.)
incorporation or organization)
P.O. Box 834, Valley Forge, Pennsylvania 19482
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 296-8000
Former name, former address and former fiscal year,
if changed since last report: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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Applicable only to corporate issuers:
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of August 9, 2002.
Common Stock, no par value 149,309,911 shares
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IKON Office Solutions, Inc.
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Consolidated Balance Sheets--June 30, 2002 (unaudited) and
September 30, 2001
Consolidated Statements of Income--Three and nine months ended
June 30, 2002 and 2001 (unaudited)
Consolidated Statements of Cash Flows--Nine months ended June
30, 2002 and 2001 (unaudited)
Notes to Condensed Consolidated Financial Statements (unaudited)
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
FORWARD-LOOKING INFORMATION
IKON Office Solutions, Inc. (the "Registrant," "IKON" or the "Company") may from
time to time provide information, whether verbally or in writing, including
certain statements included in or incorporated by reference in this Form 10-Q,
which constitute "forward-looking" statements within the meaning of the Private
Securities Litigation Reform Act of 1995 ("Litigation Reform Act"). These
forward-looking statements include, but are not limited to, statements regarding
the following (and certain matters discussed in greater detail herein): growth
opportunities and increasing market share, productivity and infrastructure
initiatives; earnings, revenue, cash flow, margin, and cost-savings projections;
the effect of competitive pressures on equipment sales; expected savings and
lower costs from the restructuring programs and productivity and infrastructure
initiatives; developing and expanding strategic alliances and partnerships; the
impact of e-commerce and e-procurement initiatives; the implementation of the
Oracle e-business suite; anticipated growth rates in the digital and color
equipment and outsourcing industries; the effect of foreign currency exchange
risk; the reorganization of the Company's business segments and the anticipated
benefits of operational synergies related thereto; and the Company's ability to
finance its current operations and its growth initiatives. Although IKON
believes the expectations contained in such forward-looking statements are
reasonable, it can give no assurance that such expectations will prove correct.
The words "anticipate," "believe," "estimate," "expect," "intend," "will," and
similar expressions, as they relate to the Company or the Company's management,
are intended to identify forward-looking statements. Such statements reflect the
current views of the Registrant with respect to future events and are subject to
certain risks, uncertainties and assumptions. Should one or more of these risks
or uncertainties materialize, or should underlying assumptions prove incorrect,
actual results may vary materially from those described herein as anticipated,
believed, estimated, expected or intended. The Registrant does not intend to
update these forward-looking statements.
In accordance with the provisions of the Litigation Reform Act, the Company is
making investors aware that such "forward-looking" statements, because they
relate to future events, are by their very nature subject to many important
factors which could cause actual results to differ materially from those
contained in the "forward-looking" statements. These uncertainties and risks
include, but are not limited to, the following (some of which are explained in
greater detail herein): conducting operations in a competitive environment and a
changing industry (which includes technical services and products that are
relatively new to the industry and to the Company); delays, difficulties,
management transitions and employment issues associated with consolidations
and/or changes in business operations; managing the integration of acquired
businesses; existing and future vendor relationships; risks relating to foreign
currency exchange; economic, legal and political issues associated with
international operations; the Company's ability to access capital and meet its
debt service requirements (including sensitivity to fluctuations in interest
rates); and general economic conditions.
Competition. The Registrant operates in a highly competitive environment. There
are a number of companies worldwide with significant financial resources which
compete with the Registrant to provide similar products and services, such as
Canon, Ricoh, Oce, Xerox and Danka. Competition is based largely upon
technology, performance, pricing, quality, reliability, distribution, customer
service and support. In addition, the financial pressures faced by some of the
Registrant's competitors may cause them to engage in uneconomic pricing
practices, which may cause the prices that the Registrant is able to charge in
the future for its products and services to be less than the Registrant has
historically charged. The Registrant's future success is based in large part
upon its ability to successfully compete in its current markets and expand into
additional products and services offerings. The intense competition inherent in
the Registrant's industry could also result in additional pressure in pricing
and the retention of customers which could negatively affect the Registrant's
results of operations.
Pricing. The Registrant's ability to succeed is dependent upon its ability to
obtain adequate pricing for its products and services. Depending on competitive
market factors, future prices the Registrant can obtain for its products and
services may vary from historical levels.
Transition to Digital. The analog segment of the office equipment market
continues to decline as the office equipment industry transitions to digital
technology. This transition represents a significant technological change in the
Registrant's industry with ramifications that cannot be fully foreseen. Some of
the digital products placed by the Registrant replace or compete with the analog
products placed by the Registrant. If the Company does not adapt successfully to
these changes, our actual results may differ materially from those expected.
Vendor Relationships. The Registrant's access to equipment, parts and supplies
is dependent upon close relationships with its vendors and its ability to
purchase products from these vendors on competitive terms. The cessation or
deterioration in relationships with, or the financial condition of, significant
vendors may cause the Company to be unable to distribute equipment, including
digital products and high-volume or color equipment, parts and supplies, and
would cause actual results to differ materially from those expected.
Financing Business. A significant portion of the Registrant's profits are
derived from the financing of equipment provided to its customers. The
Registrant's ability to provide such financing at competitive rates and realize
profitable margins is highly dependent upon its own costs of borrowing.
Significant changes in credit ratings could reduce the Company's access to
certain credit markets. There is no assurance that these credit ratings can be
maintained and/or the credit markets can be readily accessed.
Productivity Initiatives. The Registrant's ability to improve its profit margins
is largely dependent on its ability to maintain an efficient, cost-effective
operation. The Registrant continues to invest in new market opportunities and to
streamline its infrastructure. These investments are aimed at making the Company
more profitable and competitive in the long-term, and include initiatives such
as centralized credit and purchasing, shared services and the implementation of
the Oracle e-business suite, a comprehensive, multi-year initiative designed to
web-enable our information technology infrastructure. The Registrant's ability
to improve its profit margins through the implementation of these productivity
initiatives is dependent upon certain factors outside the control of the
Registrant and therefore could cause actual results to differ materially from
those anticipated.
International Operations. The Registrant's future revenue, cost and profit
results could be affected by a number of factors, including changes in foreign
currency exchange rates, changes in economic conditions from country to country,
changes in a country's political condition, trade protection measures, licensing
and other legal requirements and local tax issues.
Restructuring. In the fourth quarter of fiscal 2001, the Company announced the
acceleration of certain cost cutting and infrastructure improvements and
recorded a pre-tax restructuring and asset impairment charge of $60,000 and
reserve adjustments related primarily to the exit of the Company's telephony
operations of $5,300. This resulted in a charge of $65,300 ($49,235 after-tax,
or $0.34 per share on a diluted basis). These actions address the exit from the
Company's telephony operations in the United States and Europe, the closing of a
number of non-strategic digital print centers and further downsizing of
operational infrastructures throughout the organization as the Company leverages
and intensifies prior standardization and centralization initiatives. These
actions include the ongoing centralization and consolidation of many selling and
administrative functions, including marketplace consolidation, supply chain,
finance, customer service, sales support and the realignment of sales coverage
against our long-term growth objectives. Additionally, the Company recorded an
asset impairment charge of $3,582 ($3,300 after-tax, or $0.02 per share on a
diluted basis) related to the exit of the Company's technology education
operations. Therefore, the aggregate charge recorded in fiscal 2001 (the "Fiscal
2001 Charge") was $68,882 ($52,535 after-tax, or $0.36 per share on a diluted
basis).
In the first and fourth quarters of fiscal 2000, the Company announced certain
restructuring charges totaling approximately $105,168 (the "Fiscal 2000
Charge"). The restructuring charges are to consolidate or dispose of certain
underperforming and non-core locations and implement productivity enhancements
through consolidation/centralization of activities in inventory management,
purchasing, finance/accounting and other administrative functions and
consolidate or eliminate unproductive real estate facilities. These efforts are
aimed at improving the Company's performance and efficiency.
The failure to execute the actions described above concerning the Fiscal 2001
Charge or Fiscal 2000 Charge would cause actual results to differ materially
from those anticipated.
New Product Offerings. The process of developing and/or distributing new high
technology products and solutions is inherently complex and uncertain. It
requires accurate anticipation of customers' changing needs and emerging
technological trends. The Registrant must make long-term investments and commit
significant resources before knowing whether these investments will eventually
result in products that achieve customer acceptance and generate the revenues
required to provide anticipated returns from these investments.
Integration of Acquired Companies. The Company's success is dependent upon its
ability to integrate acquired companies and their operations which include
companies with technical services and products that are relatively new to the
Company and companies outside the United States that present additional risks
relating to international operations. There can be no assurance the Company will
be successful in managing the integration of acquired companies and their
operations.
IKON Office Solutions, Inc.
Consolidated Balance Sheets
June 30,
2002 September 30,
(in thousands) (unaudited) 2001
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Assets
Cash and cash equivalents $ 90,164 $ 80,351
Restricted cash 135,248 128,365
Accounts receivable, less allowances of: June 30, 2002 - $17,123;
September 30, 2001 - $23,510 597,766 641,059
Finance receivables, less allowances of: June 30, 2002 - $20,492;
September 30, 2001 - $24,424 1,194,211 1,171,004
Inventories 326,783 299,776
Prepaid expenses and other current assets 105,638 95,381
Deferred taxes 98,450 98,701
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Total current assets 2,548,260 2,514,637
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Long-term finance receivables, less allowances of: June 30, 2002 -
$38,056; September 30, 2001 - $45,360 2,217,775 2,176,205
Equipment on operating leases, net 92,077 71,181
Property and equipment, net 209,122 207,812
Goodwill, net 1,244,117 1,258,112
Other assets 60,982 63,045
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Total Assets $ 6,372,333 $ 6,290,992
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Liabilities and Shareholders' Equity
Current portion of long-term debt $ 13,067 $ 17,643
Current portion of long-term debt, finance subsidiaries 1,065,323 1,229,631
Notes payable 7,551 183,688
Trade accounts payable 221,905 222,999
Accrued salaries, wages and commissions 95,190 126,280
Deferred revenues 164,686 185,261
Other accrued expenses 278,444 299,624
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Total current liabilities 1,846,166 2,265,126
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Long-term debt 595,315 599,608
Long-term debt, finance subsidiaries 1,715,008 1,366,108
Deferred taxes 497,871 446,059
Other long-term liabilities 208,541 218,513
Commitments and contingencies
Shareholders' Equity
Common stock, no par value: authorized 300,000 shares; issued: June
30, 2002-149,989 shares; September 30, 2001-150,128 shares;
outstanding: June 30, 2002-143,981 shares; September 30, 2001-
141,776 shares 1,010,567 1,012,302
Series 12 preferred stock, no par value: authorized 480 shares; none
issued or outstanding
Unearned compensation (2,428) (3,745)
Retained earnings 561,843 463,152
Accumulated other comprehensive loss (37,203) (43,484)
Cost of common shares in treasury: June 30, 2002-5,329 shares;
September 30, 2001-7,480 shares (23,347) (32,647)
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Total Shareholders' Equity 1,509,432 1,395,578
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Total Liabilities and Shareholders' Equity $ 6,372,333 $ 6,290,992
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See notes to condensed consolidated financial statements.
IKON Office Solutions, Inc.
Consolidated Statements of Income
(unaudited)
Three Months Ended Nine Months Ended
June 30, June 30,
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(in thousands, except per share amounts) 2002 2001 2002 2001
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Revenues
Net sales $ 598,698 $ 641,858 $ 1,759,136 $ 2,001,648
Services 527,204 577,741 1,610,611 1,721,934
Finance income 92,714 91,558 279,492 266,852
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1,218,616 1,311,157 3,649,239 3,990,434
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Costs and Expenses
Cost of goods sold 390,757 409,861 1,155,784 1,305,473
Services costs 304,755 338,486 955,169 1,030,613
Finance interest expense 39,103 41,783 117,263 132,350
Selling and administrative 401,017 456,249 1,202,562 1,362,578
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1,135,632 1,246,379 3,430,778 3,831,014
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Operating Income 82,984 64,778 218,461 159,420
Interest Expense 12,955 18,345 41,551 54,222
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Income From Continuing Operations
Before Taxes on Income 70,029 46,433 176,910 105,198
Taxes on Income 26,887 20,431 65,899 46,287
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Income From Continuing Operations 43,142 26,002 111,011 58,911
Discontinued Operations,
net of taxes of $942 1,200
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Net Income $ 43,142 $ 26,002 $ 111,011 $ 60,111
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Basic Earnings Per Common Share
Continuing Operations $ 0.30 $ 0.18 $ 0.78 $ 0.41
Discontinued Operations 0.01
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Net Income $ 0.30 $ 0.18 $ 0.78 $ 0.42
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Diluted Earnings Per Common Share
Continuing Operations $ 0.28 $ 0.18 $ 0.74 $ 0.41
Discontinued Operations 0.01
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Net Income $ 0.28 $ 0.18 $ 0.74 $ 0.42
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Cash Dividends Per Common Share $ 0.04 $ 0.04 $ 0.12 $ 0.12
See notes to condensed consolidated financial statements.
IKON Office Solutions, Inc.
Consolidated Statements of Cash Flows
(unaudited)
Nine Months Ended
June 30,
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(in thousands) 2002 2001
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Cash Flows from Operating Activities
Net Income $ 111,011 $ 60,111
Additions (deductions) to reconcile net income to net cash
provided by operating activities of continuing operations:
Depreciation 90,392 88,758
Amortization 10,902 44,128
Provision for losses on accounts receivable 5,090 6,947
Provision for deferred income taxes 52,063 33,174
Provision for lease default reserves 50,557 47,224
Changes in operating assets and liabilities, net of effects from
acquisitions and divestitures:
Decrease in accounts receivable 39,141 40,041
Increase in inventories (11,007) (4,572)
Increase in prepaid expenses and other current assets (15,344) (10,435)
Decrease in accounts payable, deferred revenues and accrued
expenses (75,668) (94,866)
Decrease in accrued restructuring (16,212) (13,902)
Other 8,000 1,628
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Net cash provided by operating activities of continuing operations 248,925 198,236
Gain from discontinued operations (2,142)
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Net cash provided by operating activities 248,925 196,094
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Cash Flows from Investing Activities
Cost of companies acquired, net of cash acquired (2,666)
Expenditures for property and equipment (78,833) (68,737)
Expenditures for equipment on operating leases (63,216) (34,709)
Proceeds from sale of property and equipment 21,627 37,945
Proceeds from sale of equipment on operating leases 10,653 10,209
Finance receivables - additions (1,189,003) (1,381,790)
Finance receivables - collections 1,090,693 1,187,403
Proceeds from sale of finance subsidiaries' lease receivables 15,940
Other (6,521) (317)
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Net cash used in investing activities (214,600) (236,722)
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Cash Flows from Financing Activities
Proceeds from issuance of long-term debt 2,608 36,747
Short-term (repayments) borrowings, net (178,376) 264,907
Long-term debt repayments (11,866) (193,284)
Finance subsidiaries' debt - issuances 1,522,265 2,080,191
Finance subsidiaries' debt - repayments (1,347,815) (2,094,733)
Dividends paid (17,160) (17,022)
Increase in restricted cash (6,883) (53,156)
Proceeds from option exercises and sale of treasury shares 6,203 3,904
Purchase of treasury shares and other (258) (7,876)
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Net cash (used in) provided by financing activities (31,282) 19,678
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Effect of exchange rate changes on cash and cash equivalents 6,770 (7,011)
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Net increase (decrease) in cash and cash equivalents 9,813 (27,961)
Cash and cash equivalents at beginning of year 80,351 78,118
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Cash and cash equivalents at end of period $ 90,164 $ 50,157
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See notes to condensed consolidated financial statements.
IKON Office Solutions, Inc.
Notes to Condensed Consolidated Financial Statements
(in thousands, except per share amounts)
(unaudited)
Note 1: Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of IKON
Office Solutions, Inc. and subsidiaries (the "Company", "we", or "our") have
been prepared in accordance with generally accepted accounting principles for
interim financial information and the instructions to Form 10-Q and Rule 10-01
of Regulation S-X. In the opinion of management, all adjustments (consisting of
normal recurring adjustments) considered necessary for a fair presentation have
been included. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's Annual Report on Form
10-K/A for the year ended September 30, 2001. Certain prior year amounts have
been reclassified to conform with the current year presentation.
Note 2: Adoption of Statement of Financial Accounting Standards ("SFAS") 142,
"Goodwill and Other Intangible Assets"
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS 142.
SFAS 142 supercedes APB 17, Intangible Assets, and primarily addresses
accounting for goodwill and intangible assets subsequent to their acquisition.
The provisions of SFAS 142 are effective for fiscal years beginning after
December 15, 2001, with early adoption permitted. The most significant changes
made by SFAS 142 were: (1) goodwill and indefinite lived intangible assets will
no longer be amortized, (2) goodwill will be tested for impairment at least
annually at the reporting unit level, (3) intangible assets deemed to have an
indefinite life will be tested for impairment at least annually, and (4) the
amortization period of intangible assets with finite lives will no longer be
limited to forty years. Effective October 1, 2001, the Company adopted SFAS 142,
which requires that goodwill not be amortized, but instead tested at least
annually for impairment. An impairment charge will be recognized only when the
implied fair value of a reporting unit, including goodwill, is less than its
carrying amount. The Company calculates fair value using a discounted cash flow
model. As of March 31, 2002, the Company completed its initial impairment review
and determined that no impairment charge was required. The Company has
identified the following reporting units and associated goodwill:
IKON North IKON North
America America Business Sysinct
Copier Outsourcing Imaging (e-business
Business Business IKON Europe Services development) Total
---------------- ---------------- --------------- ---------------- ---------------- ---------------
June 30, 2002
Goodwill $866,434 $70,927 $294,749 $9,011 $2,996 $1,244,117
Changes in the goodwill balance since September 30, 2001 are attributable to
foreign currency translation adjustments.
As of June 30, 2002, there are no intangible assets that are required to be
amortized by SFAS 142.
A reconciliation of reported net income adjusted to reflect the adoption of SFAS
142 is provided below:
Three Months Ended Nine Months Ended
------------------------------- -------------------------------
June 30, June 30, June 30, June 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
Reported net income $43,142 $26,002 $111,011 $60,111
Add-back goodwill amortization, net of
taxes of $236 and $711 10,102 30,468
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Adjusted net income $43,142 $36,104 $111,011 $90,579
============= ============= ============= =============
Reported basic earnings per common share $0.30 $0.18 $0.78 $0.42
Add-back goodwill amortization 0.07 0.21
------------- ------------- ------------- -------------
Adjusted basic earnings per common share $0.30 $0.25 $0.78 $0.63
============= ============= ============= =============
Reported diluted earnings per common share $0.28 $0.18 $0.74 $0.42
Add-back goodwill amortization 0.07 0.21
------------- ------------- ------------- -------------
Adjusted diluted earnings per common share $0.28 $0.25 $0.74 $0.63
============= ============= ============= =============
Note 3: Restructuring and Asset Impairment Charges
In the fourth quarter of fiscal 2001, the Company announced the acceleration of
certain cost cutting and infrastructure improvements and recorded a pre-tax
restructuring and asset impairment charge of $60,000 and reserve adjustments
related primarily to the exit of the Company's telephony operations of $5,300.
These related reserve adjustments were included in cost of goods sold and
selling and administrative expense in the consolidated statement of income. This
resulted in a charge of $65,300 ($49,235 after-tax, or $0.34 per share on a
diluted basis). These actions address the exit from the Company's telephony
operations in the United States and Europe, the closing of a number of
non-strategic digital print centers and further downsizing of operational
infrastructures throughout the organization as the Company leverages and
intensifies prior standardization and centralization initiatives. These actions
include the ongoing centralization and consolidation of many selling and
administrative functions, including marketplace consolidation, supply chain,
finance, customer service, sales support and the realignment of sales coverage
against our long-term growth objectives. Additionally, the Company recorded an
asset impairment charge of $3,582 ($3,300 after-tax, or $0.02 per share on a
diluted basis) related to the exit of the Company's technology education
operations. Therefore, the aggregate charge recorded in fiscal 2001 (the "Fiscal
2001 Charge") was $68,882 ($52,535 after-tax, or $0.36 per share on a diluted
basis). In fiscal 2000, the Company recorded a net restructuring and asset
impairment charge (the "Fiscal 2000 Charge") of $105,168 ($78,940 after-tax, or
$0.53 per share on a diluted basis). All actions related to the Fiscal 2000
Charge are complete.
Severance payments to terminated employees are made in installments. The
remaining balances of the fiscal 2001 and 2000 severance charges are expected to
be paid through fiscal 2003. The charges for contractual commitments relate to
lease commitments where the Company is exiting certain locations and/or
businesses. The remaining balances of the Fiscal 2001 and 2000 Charges for
contractual commitments are expected to be paid over the next several years.
The employees and locations affected by the Fiscal 2001 Charge described above
are as follows:
Remaining
Employees Employee Employees to
Affected Terminations be Terminated
- ---------------------------------------------------------------------------------------------------------------
Terminations 1,600 (1,276) 324
Remaining
Sites Sites Sites to
Affected Closed be Closed
- ---------------------------------------------------------------------------------------------------------------
Closures 24 (21) 3
The following presents a reconciliation of the original restructuring components
of the Fiscal 2001 Charge and Fiscal 2000 Charge from September 30, 2001 to the
balance remaining at June 30, 2002, which is included in other accrued expenses
on the consolidated balance sheet:
Balance Balance
September 30, Payments June 30,
Fiscal 2001 Restructuring Charge 2001 Fiscal 2002 2002
- -------------------------------------------------------------------------------------------
Severance $ 26,500 $ (9,223) $ 17,277
Contractual commitments 8,000 (2,295) 5,705
- -------------------------------------------------------------------------------------------
Total $ 34,500 $ (11,518) $ 22,982
- -------------------------------------------------------------------------------------------
Balance Balance
September 30, Payments June 30,
Fiscal 2000 Restructuring Charge 2001 Fiscal 2002 2002
- ---------------------------------------------------------------------------------------------
Severance $ 2,023 $ (954) $ 1,069
Contractual commitments 10,026 (3,740) 6,286
- ---------------------------------------------------------------------------------------------
Total $ 12,049 $ (4,694) $ 7,355
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Note 4: Unsecured Credit Facility
On May 24, 2002, the Company obtained a new $300,000 unsecured credit facility
(the "New Credit Facility") with a group of lenders. The New Credit Facility
replaces our $600,000 credit facility that was to expire in January 2003 (the
"Old Credit Facility"). Revolving loans are available, with certain sub-limits,
to IOS Capital, LLC, IKON's leasing subsidiary in the United States; IKON
Capital, PLC, IKON's leasing subsidiary in the United Kingdom; and IKON Capital,
Inc., IKON's leasing subsidiary in Canada. The New Credit Facility contractually
matures on May 24, 2005. As of June 30, 2002, the Company has no borrowings
outstanding under the New Credit Facility. The New Credit Facility also provides
support for letters of credit for the Company and its subsidiaries. As of June
30, 2002, letters of credit supported by the New Credit Facility amounted to
$21,418. The remaining amount available under the New Credit Facility for
borrowings or letters of credit is $278,582 as of June 30, 2002.
The New Credit Facility contains affirmative and negative covenants, including
limitations on certain fundamental changes, investments and acquisitions,
mergers, certain transactions with affiliates, creation of liens, asset
transfers, payment of dividends, intercompany loans and certain restricted
payments. The New Credit Facility does not affect our ability to continue to
securitize receivables. In addition, unless the Company achieves certain ratings
on its long and short term senior, unsecured debt (as defined) or has not
redeemed or defeased $250,000 of IOSC's 9.75% Notes due June 15, 2004, all loans
under the New Credit Facility mature on December 15, 2003. Cash dividends may be
paid on common stock subject to certain limitations. The New Credit Facility
also contains certain financial covenants including (i) corporate leverage
ratio; (ii) consolidated interest expense ratio; (iii) consolidated asset test
ratios; and (iv) limitations on capital expenditures. The New Credit Facility
contains defaults customary for facilities of this type. Failure to be in
compliance with any material provision of the New Credit Facility could have a
material adverse effect on our liquidity, financial position and results of
operations.
Note 5: Lease-Backed Notes
In addition to the $1,797,389 of lease-backed notes outstanding on September 30,
2001, on December 28, 2001, IOS Capital, LLC ("IOSC"), IKON's leasing subsidiary
in the United States, and IKON issued $87,011 and repurchased $12,460 of
lease-backed notes (the "Notes") for a net issuance of $74,551. The repurchased
amount was sold on May 24, 2002 for $10,806. The Notes have a stated maturity of
September 15, 2008 and pay an average yield of 5.06%. The Notes are
collateralized by a pool of office equipment leases or contracts, (the "Leases")
and related assets, acquired or originated by the Company (together with the
equipment financing portion of each periodic lease or rental payment due under
the Leases on or after the related transfer date) and all related casualty
payments, retainable deposits and termination payments. Payments on the Notes
are made from payments on the Leases. The Notes have certain credit enhancement
features available to noteholders, including a reserve account and an
overcollateralization account. On May 21, 2002, IKON Receivables Funding, LLC
("Receivables Funding"), a wholly owned subsidiary of IOSC, issued $634,800 of
lease-backed notes (the "2002-1 Notes") pursuant to a shelf registration
statement filed with the Securities and Exchange Commission. The 2002-1 Notes
consist of Class A-1 Notes totaling $171,000 with a stated interest rate of
2.044%, Class A-2 Notes totaling $46,000 with a stated interest rate of 2.91%,
Class A-3 Notes totaling $266,400 with a stated interest rate of 3.90% and Class
A-4 Notes totaling $151,400 with a stated interest rate of 4.68%. The 2002-1
Notes are collateralized by a pool of office equipment leases or contracts and
related assets and the payments on the 2002-1 Notes are made from payments
received on the equipment leases. IOSC repaid $597,279 of lease-backed notes
during the first nine months of fiscal 2002.
Note 6: Asset Securitization Conduit Financing
During the nine months ended June 30, 2002, IOSC pledged or transferred $519,589
in financing lease receivables for $449,911 in cash in connection with its
revolving asset securitization conduit financing agreements. IOSC repaid
$593,411 in connection with its issuance of the Notes described above. As of
June 30, 2002, IOSC had approximately $581,692 available under revolving asset
securitization conduit financing agreements.
Note 7: Convertible Subordinated Notes
On May 13, 2002, IOSC issued $300,000 of convertible subordinated notes (the
"Convertible Notes") with an interest rate of 5.0%, which are due on May 1,
2007. The convertible notes can be converted into shares of IKON common stock at
any time before maturity at a conversion price of $15.03 per share. Interest
will be paid on the convertible notes semi-annually beginning November 1, 2002.
IOSC used the net proceeds to repay loans due to IKON and for general corporate
purposes.
Note 8: Comprehensive Income
Total comprehensive income is as follows:
Three Months Ended Nine Months Ended
June 30, June 30,
------------------------------- ------------------------------------
2002 2001 2002 2001
------------- ------------- ---------------- ----------------
Net income $43,142 $26,002 $111,011 $60,111
Foreign currency translation adjustments 2,371 3,315 (1,865) (3,732)
Cumulative effect of change in accounting
principle for derivative and hedging activities
(SFAS 133), net of tax benefit of $3,778 (5,584)
Net gain (loss) on derivative financial instruments,
net of tax expense (benefit) of: $(1,570) and
$1,065 for the three months ended June 30, 2002
and 2001, respectively; $5,430 and $(7,155) for
the nine months ended June 30, 2002 and 2001,
respectively (2,355) 1,597 8,146 (10,816)
------------- ------------- ---------------- ----------------
Total comprehensive income $43,158 $30,914 $117,292 $39,979
============= ============= ================ ================
Minimum pension liability is adjusted at each fiscal year end; therefore, there
is no impact on total comprehensive income during interim periods. The balances
for foreign currency translation, minimum pension liability and derivative
financial instruments included in accumulated other comprehensive loss in the
consolidated balance sheets were $(14,261), $(714) and $(22,228), respectively,
at June 30, 2002 and $(12,396), $(714) and $(30,374), respectively, at September
30, 2001.
Note 9: Earnings Per Common Share
The following table sets forth the computation of basic and diluted earnings per
common share from continuing operations:
Three Months Ended Nine Months Ended
June 30, June 30,
------------------------------ -------------------------------
2002 2001 2002 2001
------------ ------------- -------------- -------------
Numerator:
Numerator for basic earnings per common share -
income from continuing operations $43,142 $26,002 $111,011 $58,911
------------ ------------- -------------- -------------
Effect of dilutive securities:
Interest expense on Convertible Notes, net of tax 1,264 1,264
------------ ------------- -------------- -------------
Numerator for diluted earnings per common
share - income from continuing operations plus
assumed conversion $44,406 $26,002 $112,275 $58,911
------------ ------------- -------------- -------------
Denominator:
Denominator for basic earnings per common share
- weighted average common shares 143,867 141,546 142,901 142,121
------------ ------------- -------------- -------------
Effect of dilutive securities:
Convertible Notes 10,748 3,583
Employee stock awards 469 402 451 88
Employee stock options 3,511 3,483 3,983 1,773
------------ ------------- -------------- -------------
Dilutive potential common shares 14,728 3,885 8,017 1,861
------------ ------------- -------------- -------------
Denominator for diluted earnings per
common share - adjusted weighted average
common shares and assumed conversions 158,595 145,431 150,918 143,982
------------ ------------- -------------- -------------
Basic earnings per common share from continuing
operations $0.30 $0.18 $0.78 $0.41
============ ============= ============== =============
Diluted earnings per common share from
continuing operations $0.28 $0.18 $0.74 $0.41
============ ============= ============== =============
The Company accounts for the effect of the Convertible Notes in the diluted
earnings per common share calculation using the "if converted" method. Under
that method, the Convertible Notes are assumed to be converted to shares
(weighted for the number of days outstanding in the period) at a conversion
price of $15.03, and interest expense, net of taxes, related to the Convertible
Notes is added back to net income.
Options to purchase 6,497 shares of common stock at $11.45 per share to $46.59
per share were outstanding during the third quarter of fiscal 2002 and options
to purchase 4,982 shares of common stock at $7.50 per share to $56.42 per share
were outstanding during the third quarter of fiscal 2001, but were not included
in the computation of diluted earnings per common share because the options'
prices were greater than the average market price of the common shares;
therefore, the effect would be antidilutive.
Options to purchase 6,497 shares of common stock at $11.45 per share to $46.59
per share were outstanding during the first nine months of fiscal 2002 and
options to purchase 7,508 shares of common stock at $5.39 per share to $56.42
per share were outstanding during the first nine months of fiscal 2001, but were
not included in the computation of diluted earnings per common share because the
options' prices were greater than the average market price of the common shares;
therefore, the effect would be antidilutive.
Note 10: Segment Reporting
The table below presents segment information for the three months ended June 30,
2002 and 2001:
IKON Corporate
North IKON And
America Europe Other Eliminations Total
------------- ------------ ---------- -------------- --------------
Three Months Ended June 30, 2002
Revenues, excluding finance income $ 1,017,183 $ 97,420 $ 11,299 $ 1,125,902
Finance income 87,592 5,122 92,714
Operating income (loss) 129,157 5,689 (785) $ (51,077) 82,984
Interest expense (12,955) (12,955)
Income before taxes 70,029
Three Months Ended June 30, 2001
Revenues, excluding finance income $ 1,065,225 $ 103,231 $ 51,143 $ 1,219,599
Finance income 86,683 4,875 91,558
Operating income (loss) 115,723 7,612 (5,636) $ (52,921) 64,778
Interest expense (18,345) (18,345)
Income before taxes 46,433
The table below presents segment information for the nine months ended June 30,
2002 and 2001:
IKON Corporate
North IKON And
America Europe Other Eliminations Total
------------- ------------ ---------- -------------- --------------
Nine Months Ended June 30, 2002
Revenues, excluding finance income $ 3,010,898 $ 309,811 $ 49,038 $ 3,369,747
Finance income 264,508 14,984 279,492
Operating income (loss) 354,352 16,640 (9,112) $ (143,419) 218,461
Interest expense (41,551) (41,551)
Income before taxes 176,910
Nine Months Ended June 30, 2001
Revenues, excluding finance income $ 3,242,332 $ 324,665 $ 156,585 $ 3,723,582
Finance income 251,617 15,235 266,852
Operating income (loss) 287,394 17,503 (19,819) $ (125,658) 159,420
Interest expense (54,222) (54,222)
Income before taxes 105,198
Note 11: Contingencies
The matter of Whetman, et al. v. IKON Office Solutions, Inc., et al. (the
"Claim") involves a claim brought under the Employee Retirement Income Security
Act of 1974 ("ERISA"). In connection with the Claim, the plaintiffs allege that
the Company and various individuals violated fiduciary duties under ERISA based
on allegedly improper investments in the Company's stock made through the
Company's Retirement Savings Plan (the "Plan"). The court certified a class with
respect to the Claim consisting generally of all those participants in the Plan
after September 30, 1995 and through August 13, 1998, subject to certain
exceptions.
On May 14, 2002, the Company announced that, subject to court approval, it
reached an agreement to settle the Claim. The Company is not making any monetary
payment to the class to settle the lawsuit, and the settlement does not reflect
any admission of liability by the Company. The Company has agreed to make
certain modifications to its Plan in order to allow participants greater
flexibility with respect to investment of the employer match portion of their
individual accounts. Under the settlement, employees who have been with the
Company for at least two years will be permitted to allocate Company matching
funds in investment options other than IKON stock, subject to vesting schedules.
The court has preliminarily approved the settlement. The court held a hearing on
the final approval of the settlement on August 8, 2002, and issued a Memorandum
and Order on August 9, 2002 approving the settlement. Plaintiffs' counsel has
petitioned the court for an award of their fees and costs of litigation. The
court has not yet ruled on the petition. Any fees and costs awarded by the court
will be paid by the Company. Such payment is not expected to have a material
financial impact on the Company.
The Company is involved in a number of environmental remediation actions to
investigate and clean up certain sites related to its discontinued operations in
accordance with applicable federal and state laws. Uncertainties about the
status of laws and regulations, technology and information related to individual
sites, including the magnitude of possible contamination, the timing and extent
of required corrective actions and proportionate liabilities of other
responsible parties, make it difficult to develop a meaningful estimate of
probable future remediation costs. While the actual costs of remediation at
these sites may vary from management's estimates because of these uncertainties,
the Company has established an accrual for known environmental obligations based
on management's best estimate of the aggregate environmental remediation
exposure on these sites. After consideration of the defenses available to the
Company, the accrual for such exposure, insurance coverage and other responsible
parties, management does not believe that its obligations to remediate these
sites would have a material adverse effect on the Company's consolidated
financial statements.
There are other contingent liabilities for taxes, guarantees, other lawsuits and
various other matters occurring in the ordinary course of business. On the basis
of information furnished by counsel and others, and after consideration of the
defenses available to the Company and any related reserves and insurance
coverage, management believes that none of these other contingencies will
materially affect the consolidated financial statements of the Company.
Note 12: Financial Instruments
As of June 30, 2002, all of the Company's derivatives designated as hedges are
interest rate swaps which qualify for evaluation using the "short cut" method
for assessing effectiveness. As such, there is an assumption of no
ineffectiveness. The Company uses interest rate swaps to fix the interest rates
on its variable rate classes of lease-backed notes, which results in a lower
cost of capital than if we had issued fixed rate notes. During the nine months
ended June 30, 2002, an unrealized gain totaling $8,146 after taxes, was
recorded in accumulated other comprehensive loss.
Note 13: Pending Accounting Changes
In June 2001, the FASB approved SFAS 143, "Accounting for Asset Retirement
Obligations." SFAS 143 addresses accounting for legal obligations associated
with the retirement of long-lived assets that result from the acquisition,
construction, development and the normal operation of a long-lived asset, except
for certain obligations of lessees. SFAS 143 requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset and subsequently allocated to expense over the asset's
useful life. SFAS 143 is effective for fiscal years beginning after June 15,
2002. The Company is currently evaluating the impact of the adoption of this
statement, but does not expect a material impact from the adoption of SFAS 143
on our consolidated financial statements.
In August 2001, the FASB approved SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS 144 supercedes SFAS 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of," and APB 30, "Reporting the Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions." SFAS 144 requires an impairment loss to be
recognized only if the carrying amounts of long-lived assets to be held and used
are not recoverable from their expected undiscounted future cash flows. SFAS 144
is effective for fiscal years beginning after December 15, 2001. The Company is
currently evaluating the impact of the adoption of this statement, but does not
expect a material impact from the adoption of SFAS 144 on our consolidated
financial statements.
In May 2002, the FASB approved SFAS 145, "Rescission of SFAS 4, 44, and 64,
Amendment of SFAS 13, and Technical Corrections as of April 2002." SFAS 145
rescinds SFAS 4, "Reporting Gains and Losses from Extinguishment of Debt," and
an amendment of that Statement, SFAS 64, "Extinguishments of Debt Made to
Satisfy Sinking-Fund Requirements." SFAS 145 also rescinds SFAS 44, "Accounting
for Intangible Assets of Motor Carriers." SFAS 145 amends SFAS 13, "Accounting
for Leases," to eliminate an inconsistency between the required accounting for
sale-leaseback transactions and the required accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. SFAS 145 also amends other existing authoritative pronouncements
to make various technical corrections, clarify meanings, or describe their
applicability under changed conditions. The provisions of SFAS 145 related to
the rescission of SFAS 4 shall be applied in fiscal years beginning after May
15, 2002. Any gain or loss on extinguishment of debt that was classified as an
extraordinary item in prior periods presented that does not meet the criteria in
APB 30 for classification as an extraordinary item shall be reclassified. The
provisions in paragraphs 8 and 9(c) of SFAS 145 related to SFAS 13 shall be
effective for transactions occurring after May 15, 2002. All other provisions of
SFAS 145 shall be effective for financial statements issued on or after May 15,
2002. Early application of all provisions is encouraged. The Company is
currently evaluating the impact of the adoption of this statement, but does not
expect a material impact from the adoption of SFAS 145 on our consolidated
financial statements.
In June 2002, the FASB approved SFAS 146, "Accounting for Exit or Disposal
Activities". SFAS 146 addresses accounting for costs to terminate contracts that
are not capital leases, costs to consolidate facilities or relocate employees
and termination benefits. SFAS 146 requires that the fair value of a liability
for penalties for early contract termination be recognized when the entity
effectively terminates the contract. The fair value of a liability for other
contract termination costs should be recognized when an entity ceases using the
rights conveyed by the contract. The liability for one-time termination benefits
should be accrued ratably over the future service period based on when employees
are entitled to receive the benefits and a minimum retention period. SFAS 146
will be effective for disposal activities initiated after December 31, 2002. The
Company is currently evaluating the impact of the adoption of this statement,
but does not expect a material impact from the adoption of SFAS 146 on our
consolidated financial statements.
Item 2: Management's Discussion and Analysis of Financial Condition and Results
of Operations
All dollar and share amounts are in thousands.
IKON Office Solutions, Inc. ("IKON" or "the Company") is one of the world's
leading providers of products and services that help businesses communicate.
IKON provides customers with total business solutions for every office,
production and outsourcing need, including copiers and printers, color
solutions, distributed printing, facilities management, imaging and legal
document solutions, as well as network design and consulting and e-business
development. IKON has locations worldwide, including locations in the United
States, Canada, Mexico and Europe. References herein to "we", "us" or "our"
refer to IKON and its subsidiaries unless the context specifically requires
otherwise.
Critical Accounting Policies
In response to the SEC's Release No. 33-8040, "Cautionary Advice Regarding
Disclosure About Critical Accounting Policies," we have identified below some of
the accounting principles critical to our business and results of operations. We
determined the critical principles by considering accounting policies that
involve the most complex or subjective decisions or assessments. We state these
accounting policies in Management's Discussion and Analysis of Financial
Condition and Results of Operations and in the Notes to the consolidated
financial statements contained in our Annual Report on Form 10-K/A for our
fiscal year ended September 30, 2001, as amended, and at relevant sections in
this discussion and analysis. In addition, we believe our most critical
accounting policies include, but are not limited to, the following:
Revenue Recognition. Revenues are recognized when products are delivered to and
accepted by the customer or services are performed. Revenues from service
contracts and rentals are recognized over the term of the contract. The present
value of payments due under sales-type lease contracts is recorded as revenue
and cost of goods sold is charged with the book value of the equipment when
products are delivered to and accepted by the customer. Finance income is
recognized over the related lease term.
Goodwill. IKON evaluates goodwill in accordance with Statement of Financial
Accounting Standards ("SFAS") 142. SFAS 142 prescribes a two-step method for
determining goodwill impairment. In the first step, we determine the fair value
of the reporting unit using expected future discounted cash flows. If the net
book value of the reporting unit exceeds the fair value, we would then perform
the second step of the impairment test which requires allocation of the
reporting unit's fair value to all of its assets and liabilities in a manner
similar to a purchase price allocation, with any residual fair value being
allocated to goodwill. The fair value of the goodwill is then compared to its
carrying amount to determine impairment. If future discounted cash flows are
less favorable than those anticipated, goodwill may be impaired.
Inventories. Inventories are stated at the lower of cost or market using the
average cost or specific identification methods and consist of finished goods
available for sale. IKON writes down its inventory for estimated obsolescence or
unmarketable inventory equal to the difference between the cost of inventory and
estimated market value based upon assumptions about future demand and market
conditions. If actual market conditions are less favorable than those
anticipated, inventory adjustments may be required.
Allowances for Receivables. IKON maintains allowances for doubtful accounts and
lease defaults for estimated losses resulting from the inability of its
customers to make required payments. If the financial condition of IKON's
customers were to deteriorate, resulting in an impairment of their ability to
make required payments, changes to our allowances may be required.
Income Taxes. Income taxes are determined in accordance with SFAS 109, which
requires recognition of deferred income tax liabilities and assets for the
expected future tax consequences of events that have been included in the
consolidated financial statements or tax returns. Under this method, deferred
income tax liabilities and assets are determined based on the difference between
financial statement and tax basis of liabilities and assets using enacted tax
rates in effect for the year in which the differences are expected to reverse.
SFAS 109 also provides for the recognition of deferred tax assets if it is more
likely than not that the assets will be realized in future years. A valuation
allowance has been established for deferred tax assets for which realization is
not likely. In assessing the valuation allowance, IKON has considered future
taxable income and ongoing prudent and feasible tax planning strategies.
However, in the event that IKON determines the value of a deferred tax asset has
fluctuated from its net recorded amount, an adjustment to the deferred tax asset
would be necessary.
Pension. Certain assumptions are used in the calculation of the actuarial
valuation of our Company-sponsored defined benefit pension plans. These
assumptions include the weighted average discount rate, rates of increase in
compensation levels and expected long-term rates of return on assets. If actual
results are less favorable than those assumed, additional pension expense may be
required.
Residual Values. IKON estimates the residual value of equipment sold under
sales-type leases. Our residuals are based on the dollar value of the equipment.
Residual values generally range between 0% to 25% of retail price, depending on
equipment model and lease term. We evaluate residual values quarterly for
impairment. Changes in market conditions could cause actual residual values to
differ from estimated values, which could accelerate write-down of the value of
the equipment.
Our preparation of this Quarterly Report on Form 10-Q and other financial
statements filed with the SEC requires us to make estimates and assumptions that
affect amounts reported in the consolidated financial statements and notes.
Actual results could differ from those estimates and assumptions.
Results of Operations
This discussion reviews the results of operations of the Company as reported in
the consolidated statements of income.
Three Months Ended June 30, 2002
Compared to the Three Months Ended June 30, 2001
Results of operations for the third quarter of fiscal 2002, compared to the
third quarter of fiscal 2001, were as follows:
Our third quarter revenues decreased by $92,541, or 7.1%, compared to the third
quarter of fiscal 2001. This resulted primarily from the impact of our actions
to exit, sell or downsize certain non-strategic businesses during fiscal 2002.
Excluding the impact of these downsizing actions, revenues for the quarter were
down less than 2%.
Net sales, which includes revenues from the sale of copier/printer equipment,
supplies and technology hardware, decreased by $43,160, or 6.7%, compared to the
third quarter of fiscal 2001. More than half of the decrease was attributable to
a decline in sales of technology-related hardware, down approximately 30% from
the prior year. The Company has been de-emphasizing this low-margin revenue
stream, choosing instead to redirect its technical capabilities to support the
growing service opportunities in document management and digital connectivity.
Excluding the impact of technology-related hardware, net sales were down
approximately 3%. In sales of copier/printer equipment, which were down less
than 2% from the prior year, the Company's performance remained strong in the
high-end, segment 5 & 6 market, with over 30% growth compared to the third
quarter of fiscal 2001, including growth in sales of production monochrome and
color devices. Sales of lower-end copier/printer equipment and supply sales
declined compared to the prior year - a reflection of the strategies the Company
has employed to shift its sales focus to more profitable and strategic
offerings, as well as ongoing economic and competitive pressures.
Services, which primarily includes revenues from the servicing of copier/printer
equipment, outsourcing and other services, decreased by $50,537, or 8.7%,
compared to the third quarter of fiscal 2001. Outsourcing and other service
offerings continued to be impacted by our actions to exit, sell or downsize
certain non-strategic businesses during fiscal 2002, which accounted for
approximately $47,000 of the decline. Excluding the impact of these downsizing
actions, outsourcing and other services were flat for the quarter. The Company's
installed equipment base continues to generate strong revenues from the
servicing of copier/printer equipment, which grew slightly from the prior year
as the base continues to undergo a shift from analog to digital technology, and
the Company's focus on expanding its product mix to higher-end devices.
Finance income increased by $1,156, or 1.3%, compared to the third quarter of
fiscal 2001. Finance income is generated by IKON's wholly-owned leasing
subsidiaries. IOS Capital, LLC ("IOSC"), IKON's leasing subsidiary in the United
States, accounted for approximately 93% of IKON's finance income for the third
quarter of fiscal 2002. Effective as of the third quarter of fiscal 2002, income
generated through IOSC's administrative infrastructure, such as syndication
fees, late fees and other processing-related revenue, will be reported as
Services rather than Finance Income. Costs associated with these income
generating activities have been reclassified from Selling and Administrative
Expenses to Services Costs. There is no impact to operating income, net income
or earnings per share as a result of this change.
The following revenue and expense amounts have been reclassified:
- ------------------------------------------- ---------------------------------------- ----------------------------------------
Revenue* Expense**
-------- ---------
- ------------------------------------------- ---------------------------------------- ----------------------------------------
Quarter ended June 30, 2002 $4,894 $676
- ------------------------------------------- ---------------------------------------- ----------------------------------------
Quarter ended June 30, 2001 $6,079 $631
- ------------------------------------------- ---------------------------------------- ----------------------------------------
*Amounts have been reclassified from Finance Income to Services Revenue.
**Amounts have been reclassified from Selling and Administrative Expenses to
Services Costs.
Overall gross margin was unchanged at 39.7% for the third quarter of fiscal 2002
and 2001. The gross margin on net sales decreased to 34.7% from 36.1% in the
third quarter of fiscal 2001. This was primarily due to the decline in supply
sales gross margins resulting from the decrease in supply sales described above.
The gross margin on services increased to 42.2% from 41.4% in the third quarter
of fiscal 2001. This increase is primarily due to stronger margins on equipment
service, reflecting increased productivity of our service technicians combined
with an increasingly more efficient digital service base. The gross margin on
finance income increased to 57.8% from 54.4% in the third quarter of fiscal
2001, primarily due to the effect of a higher average portfolio yield and lower
average borrowing rates compared to the third quarter of fiscal 2001.
Selling and administrative expense as a percent of revenue was 32.9% in the
third quarter of fiscal 2002 compared to 34.8% in the third quarter of fiscal
2001, representing a decrease of $55,232, or 12.1%. The decrease resulted from
improved productivity, centralization and consolidation initiatives, the
downsizing or elimination of unprofitable businesses, lower selling costs due to
lower sales of equipment, improvements in the sales organization infrastructure,
and the elimination of approximately $10 million of goodwill amortization under
SFAS 142.
Our operating income increased by $18,206 compared to the third quarter of
fiscal 2001. Our operating margin was 6.8% in the third quarter of fiscal 2002
compared to 4.9% (5.7% assuming the impact of not amortizing goodwill) in the
third quarter of fiscal 2001.
Interest expense was $12,955 in the third quarter of fiscal 2002 compared to
$18,345 in the third quarter of fiscal 2001. The decrease was due to lower
average outstanding debt combined with lower average short-term borrowing rates
compared to the third quarter of fiscal 2001.
The effective income tax rate was 38.4% in the third quarter of fiscal 2002
compared to 44.0% in the third quarter of fiscal 2001. The income tax rate
reduction is primarily due to the cessation of goodwill amortization, the
majority of which was non-deductible for tax purposes, as a result of our
adoption of SFAS 142 effective October 1, 2001. The third quarter effective tax
rate reflects a cumulative increase in the tax provision to achieve a year to
date effective tax rate of 37.25%. The effective tax rate was increased from
that used for the first half of fiscal 2002, due to the inability to record tax
benefits on losses incurred in foreign jurisdictions.
Diluted earnings per common share were $0.28 in the third quarter of fiscal 2002
compared to $0.18 in the third quarter of fiscal 2001. The diluted earnings per
common share calculation for the third quarter of fiscal 2002 reflects the
impact of the 5% Convertible Subordinated Notes (the "Convertible Notes") due
2007 issued by IOSC on May 13, 2002. The Company accounts for the effect of the
Convertible Notes in the diluted earnings per common share calculation using the
"if converted" method. Under that method, the Convertible Notes are assumed to
be converted to shares (weighted for the number of days outstanding in the
period) at a conversion price of $15.03, and interest expense, net of taxes,
related to the Convertible Notes is added back to net income. Assuming the
impact of not amortizing goodwill, diluted earnings per common share in the
third quarter of fiscal 2001 would have been $0.25.
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS 142.
SFAS 142 supercedes APB 17, Intangible Assets and primarily addresses accounting
for goodwill and intangible assets subsequent to their acquisition. The
provisions of SFAS 142 are effective for fiscal years beginning after December
15, 2001, with early adoption permitted. The most significant changes made by
SFAS 142 were: (1) goodwill and indefinite lived intangible assets will no
longer be amortized, (2) goodwill will be tested for impairment at least
annually at the reporting unit level, (3) intangible assets deemed to have an
indefinite life will be tested for impairment at least annually, and (4) the
amortization period of intangible assets with finite lives will no longer be
limited to forty years. Effective October 1, 2001, the Company adopted SFAS 142,
which requires that goodwill not be amortized, but instead tested at least
annually for impairment. An impairment charge will be recognized only when the
implied fair value of a reporting unit, including goodwill, is less than its
carrying amount. The Company calculates fair value using a discounted cash flow
model. As of March 31, 2002, the Company completed its initial impairment review
and determined that no impairment charge was required. The Company has
identified the following reporting units and associated goodwill:
IKON North IKON North
America America Business Sysinct
Copier Outsourcing Imaging (e-business
Business Business IKON Europe Services development) Total
---------------- ---------------- --------------- ---------------- ---------------- ----------------
June 30, 2002
Goodwill $866,434 $70,927 $294,749 $9,011 $2,996 $1,244,117
Changes in the goodwill balance since September 30, 2001 are attributable to
foreign currency translation adjustments.
As of June 30, 2002, there are no intangible assets that are required to be
amortized by SFAS 142.
A reconciliation of reported net income adjusted to reflect the adoption of SFAS
142 is provided below:
Three Months Ended
------------------------------
June 30, June 30,
2002 2001
------------- -------------
Reported net income $43,142 $26,002
Add-back goodwill amortization, net of taxes of $236 10,102
------------- -------------
Adjusted net income $43,142 $36,104
============= =============
Reported basic earnings per common share $0.30 $0.18
Add-back goodwill amortization 0.07
------------- -------------
Adjusted basic earnings per common share $0.30 $0.25
============= =============
Reported diluted earnings per common share $0.28 $0.18
Add-back goodwill amortization 0.07
------------- -------------
Adjusted diluted earnings per common share $0.28 $0.25
============= =============
Review of Business Segments
IKON North America
Revenues, excluding finance income, decreased by $48,042, or 4.5%, to $1,017,183
in the third quarter of fiscal 2002 from $1,065,225 in the third quarter of
fiscal 2001. The decrease was primarily due to a decline in sales of
technology-related hardware and lower end copier/printer equipment reflecting
our strategy to de-emphasize certain low margin products as well as ongoing
economic and competitive pressures. This decrease was slightly offset by
increases in revenue from after-market equipment service, facilities management
and the sale of high-end, segment 5 and 6 copier/printer equipment. Finance
income increased by $909, or 1.0%, to $87,592 in the third quarter of fiscal
2002, from $86,683 in the third quarter of fiscal 2001. The increase was
primarily due to growth in the lease receivables portfolio and longer average
lease terms. Operating income increased by $13,434, or 11.6%, to $129,157 in the
third quarter of fiscal 2002 from $115,723 in the third quarter of fiscal 2001.
The increase was due to higher gross margins on services and finance income and
reduced selling and administrative costs as discussed above.
IKON Europe
Revenues, excluding finance income, decreased by $5,811, or 5.6%, to $97,420 in
the third quarter of fiscal 2002 from $103,231 in the third quarter of fiscal
2001. This decrease was due mainly to a decrease in sales of technology-related
hardware and a decline in after-market equipment service revenues. Finance
income increased by $247, or 5.1%, to $5,122 in the third quarter of fiscal 2002
from $4,875 in the third quarter of fiscal 2001. Operating income decreased by
$1,923, or 25.3%, to $5,689 in the third quarter of fiscal 2002 from $7,612 in
the third quarter of fiscal 2001. Excluding a $1,700 gain related to the sale of
certain real estate in the UK in fiscal 2001, operating income decreased by
$223, or 2.9%, due to ongoing economic and competitive pressures, particularly
in France, as well as declines in after-market equipment service.
Other
Other revenues decreased by $39,844, or 77.9%, to $11,299 in the third quarter
of fiscal 2002 from $51,143 in the third quarter of fiscal 2001. The decline is
primarily due to the downsizing, sale, and closure of certain non-strategic
businesses such as telephony and technology education. There was an operating
loss of $785 in the third quarter of fiscal 2002 compared to an operating loss
of $5,636 in the third quarter of fiscal 2001. The decrease in operating loss
reflects the impact of the actions described above concerning the removal of
certain non-strategic businesses to improve operating margin performance.
Nine Months Ended June 30, 2002
Compared to the Nine Months Ended June 30, 2001
Results of operations for the nine months ended June 30, 2002, compared to the
nine months ended June 30, 2001, were as follows:
Our revenues decreased by $341,195, or 8.6%, compared to the nine months ended
June 30, 2001. This resulted primarily from the impact of our actions to exit,
sell or downsize certain non-strategic businesses during fiscal 2002 which
accounted for approximately $200,000 of the decline. Excluding the impact of
these downsizing actions, revenues for the first nine months of fiscal 2002 were
down approximately 3.5%.
Net sales, which includes revenues from the sale of copier/printer equipment,
supplies and technology hardware, decreased by $242,512, or 12.1%, compared to
the nine months ended June 30, 2001. Approximately 4.3% of the decrease was
attributable to a decline in sales of technology-related hardware. The Company
has been de-emphasizing sales of technology-related hardware as part of its
margin improvement strategy, choosing instead to redirect its technical
capabilities to services that support other customer opportunities, including
document management and digital connectivity. Excluding the impact of
technology-related hardware, net sales were down approximately 7.8%. This
decrease was due to a decline in supply sales and sales of copier/printer
equipment resulting from the Company's strategic shift from sales of lower-end,
lower margin equipment to higher-end, higher margin equipment as well as ongoing
economic and competitive pressures. The Company's performance remained strong in
the high-end, segment 5 & 6 market with over 30% growth compared to the first
nine months of fiscal 2001. In addition, the Company continues to focus on
larger regional and national accounts that entail a longer sales cycle. Supply
sales declined due to the customer benefits digital technology provides in terms
of product reliability and efficiency.
Services, which includes revenues from the servicing of copier/printer
equipment, outsourcing and other services, decreased by $111,323, or 6.5%,
compared to the nine months ended June 30, 2001. This was due to a decrease in
outsourcing and other services. Revenues from outsourcing and other services
declined from the prior year due primarily to the downsizing, sale, and closure
of certain non-strategic businesses. Facilities management services, one of the
Company's key outsourcing offerings, continued to grow and offset some of the
decline.
Finance income increased by $12,640, or 4.7%, compared to the nine months ended
June 30, 2001, primarily due to continued growth in the lease receivables
portfolio. Finance income is generated by IKON's wholly-owned leasing
subsidiaries. IOSC accounted for approximately 93% of IKON's finance income for
the nine months ended June 30, 2002. Approximately 79% of IKON North America's
copier and equipment revenues were financed by IOSC during the nine months ended
June 30, 2002 compared to approximately 74% during the nine months ended June
30, 2001. Effective as of the third quarter of fiscal 2002, income generated
through IOSC's administrative infrastructure, such as syndication fees, late
fees and other processing-related revenue, will be reported as Services rather
than within Finance Income. Costs associated with these income generating
activities have been reclassified from Selling and Administrative Expenses to
Services Costs. There is no impact on operating income, net income or earnings
per share as a result of this change.
The following revenue and expense amounts have been reclassified:
- ------------------------------------------- ---------------------------------------- ----------------------------------------
Revenue* Expense**
-------- ---------
- ------------------------------------------- ---------------------------------------- ----------------------------------------
Nine months ended June 30, 2002 $15,933 $1,982
- ------------------------------------------- ---------------------------------------- ----------------------------------------
Nine months ended June 30, 2001 $18,139 $1,813
- ------------------------------------------- ---------------------------------------- ----------------------------------------
*Amounts have been reclassified from Finance Income to Services Revenue.
**Amounts have been reclassified from Selling and Administrative Expenses to
Services Costs.
Overall gross margin was 38.9% compared to 38.1% in the nine months ended June
30, 2001. The gross margin on net sales was 34.3% compared to 34.8% in the nine
months ended June 30, 2001. The gross margin on services increased to 40.7% from
40.1% in the nine months ended June 30, 2001, primarily due to stronger margins
on equipment service which reflects the improved productivity of our service
technicians. The gross margin on finance income increased to 58.0% from 50.4% in
the third quarter of fiscal 2001, primarily due to the effect of a higher
average portfolio yield and lower average borrowing rates compared to the nine
months ended June 30, 2001.
Selling and administrative expense as a percent of revenue was 33.0% in the nine
months ended June 30, 2002 compared to 34.1% in the nine months ended June 30,
2001. The decrease of $160,016, or 11.7%, resulted from improved productivity,
centralization and consolidation initiatives, the downsizing or elimination of
unprofitable businesses, decreased selling costs due to lower sales of
equipment, improvements in the sales organization infrastructure, and the
elimination of goodwill amortization which accounted for approximately $30,000
of the decrease.
Operating income increased by $59,041 compared to the nine months ended June 30,
2001. Our operating margin was 6.0% in the nine months ended June 30, 2002
compared to 4.0% (4.8% assuming the impact of not amortizing goodwill) in the
nine months ended June 30, 2001.
Interest expense was $41,551 in the nine months ended June 30, 2002 compared to
$54,222 in the nine months ended June 30, 2001. The decrease was due to lower
average outstanding debt combined with lower average short-term borrowing rates
compared to the nine months ended June 30, 2001.
The effective income tax rate was 37.3% in the nine months ended June 30, 2002
compared to 44.0% in the nine months ended June 30, 2001. The income tax rate
reduction is primarily due to the cessation of goodwill amortization, the
majority of which was non-deductible for tax purposes, as a result of our
adoption of SFAS 142 effective October 1, 2001.
In the first nine months of fiscal 2001, we recognized a gain of $2,142 ($1,200
after-tax) related to net favorable dispositions of environmental matters at
locations we had previously accounted for as discontinued operations.
Diluted earnings per common share were $0.74 in the nine months ended June 30,
2002 compared to $0.42 ($0.41 excluding the after-tax effect of the gain from
discontinued operations) in the nine months ended June 30, 2001. The diluted
earnings per common share calculation for the first nine months of fiscal 2002
reflects the impact of the Convertible Notes. The Company accounts for the
effect of the Convertible Notes in the diluted earnings per common share
calculation using the "if converted" method. Under that method, the Convertible
Notes are assumed to be converted to shares (weighted for the number of days
outstanding in the period) at a conversion price of $15.03, and interest
expense, net of taxes, related to the Convertible Notes is added back to net
income. Assuming the impact of not amortizing goodwill, diluted earnings per
common share for the nine months ended June 30, 2001 would have been $0.63
($0.62 excluding the after-tax effect of the gain from discontinued operations).
A reconciliation of reported net income adjusted to reflect the adoption of SFAS
142 is provided below:
Nine Months Ended
------------------------------------
June 30, June 30,
2002 2001
---------------- ----------------
Reported net income $111,011 $60,111
Add-back goodwill amortization, net of taxes of $711 30,468
---------------- ----------------
Adjusted net income $111,011 $90,579
================ ================
Reported basic earnings per common share $0.78 $0.42
Add-back goodwill amortization 0.21
---------------- ----------------
Adjusted basic earnings per common share $0.78 $0.63
================ ================
Reported diluted earnings per common share $0.74 $0.42
Add-back goodwill amortization 0.21
---------------- ----------------
Adjusted diluted earnings per common share $0.74 $0.63
================ ================
Review of Business Segments
IKON North America
Revenues, excluding finance income, decreased by $231,434, or 7.1%, to
$3,010,898 for the first nine months of fiscal 2002 from $3,242,332 for the
first nine months of fiscal 2001. The decrease was primarily due to a decline in
sales of technology-related hardware and lower-end copier/printer equipment as a
result of strategic initiatives to de-emphasize sales of certain low margin
products as well as ongoing economic and competitive pressures. This decrease
was slightly offset by increases in revenue from facilities management and the
sale of high-end, segment 5 and 6 copier/printer equipment. Finance income
increased by $12,891, or 5.1%, to $264,508 for the first nine months of fiscal
2002 from $251,617 for the first nine months of fiscal 2001. The increase was
primarily due to growth in the lease receivables portfolio and longer average
lease terms. Operating income increased by $66,958, or 23.3%, to $354,352 for
the first nine months of fiscal 2002 from $287,394 for the first nine months of
fiscal 2001. The increase was due to higher gross margins on services and
finance income and reduced selling and administrative costs as discussed above.
IKON Europe
Revenues, excluding finance income, decreased by $14,854, or 4.6%, to $309,811
for the first nine months of fiscal 2002 from $324,665 for the first nine months
of fiscal 2001. This decrease was due mainly to declines in sales of
technology-related hardware and in the service after-market for copier/printer
equipment, offset by growth in outsourcing. Finance income decreased by $251, or
1.6%, to $14,984 for the first nine months of fiscal 2002 from $15,235 for the
first nine months of fiscal 2001. Operating income decreased by $863, or 4.9%,
to $16,640 for the first nine months of fiscal 2002 from $17,503 for the first
nine months of fiscal 2001. Excluding a $1,700 gain related to the sale of
certain real estate in the UK in fiscal 2001, operating income increased by
$837, or 4.8%, due primarily to ongoing improvements to our operational
infrastructure.
Other
Other revenues decreased by $107,547, or 68.7%, to $49,038 for the first nine
months of fiscal 2002 from $156,585 for the first nine months of fiscal 2001.
The decline is primarily due to the downsizing, sale, and closure of certain
non-strategic businesses such as telephony, technology education and other
technology-related operations. There was an operating loss of $9,112 for the
first nine months of fiscal 2002 compared to an operating loss of $19,819 for
the first nine months of fiscal 2001. The decrease in operating loss reflects
the impact of the actions described above concerning the removal of certain
non-strategic businesses to improve operating margin performance.
Restructuring and Asset Impairment Charges
In the fourth quarter of fiscal 2001, the Company announced the acceleration of
certain cost cutting and infrastructure improvements and recorded a pre-tax
restructuring and asset impairment charge of $60,000 and reserve adjustments
related primarily to the exit of the Company's telephony operations of $5,300.
These related reserve adjustments were included in cost of goods sold and
selling and administrative expense in the consolidated statement of income. This
resulted in a charge of $65,300 ($49,235 after-tax, or $0.34 per share on a
diluted basis). These actions address the exit from the Company's telephony
operations in the United States and Europe, the closing of a number of
non-strategic digital print centers and further downsizing of operational
infrastructures throughout the organization as the Company leverages and
intensifies prior standardization and centralization initiatives. These actions
include the ongoing centralization and consolidation of many selling and
administrative functions, including marketplace consolidation, supply chain,
finance, customer service, sales support and the realignment of sales coverage
against our long-term growth objectives. Additionally, the Company recorded an
asset impairment charge of $3,582 ($3,300 after-tax, or $0.02 per share on a
diluted basis) related to the exit of the Company's technology education
operations. Therefore, the aggregate charge recorded in fiscal 2001 (the "Fiscal
2001 Charge") was $68,882 ($52,535 after-tax, or $0.36 per share on a diluted
basis). In fiscal 2000, the Company recorded a net restructuring and asset
impairment charge (the "Fiscal 2000 Charge") of $105,168 ($78,940 after-tax, or
$0.53 per share on a diluted basis).
All actions related to the Fiscal 2000 Charge are complete. Severance payments
to terminated employees are made in installments. The remaining balances of the
fiscal 2001 and 2000 severance charges are expected to be paid through fiscal
2003. The charges for contractual commitments relate to lease commitments where
the Company is exiting certain locations and/or businesses. The remaining
balances of the fiscal 2001 and 2000 charges for contractual commitments are
expected to be paid over the next several years.
The employees and locations affected by the Fiscal 2001 Charge described above
are as follows:
Remaining
Employees Employee Employees to
Affected Terminations be Terminated
- ---------------------------------------------------------------------------------------------------------------
Terminations 1,600 (1,276) 324
Remaining
Sites Sites Sites to
Affected Closed be Closed
- ---------------------------------------------------------------------------------------------------------------
Closures 24 (21) 3
The following presents a reconciliation of the original restructuring components
of the Fiscal 2001 Charge and Fiscal 2000 Charge from September 30, 2001 to the
balance remaining at June 30,2002, which is included in other accrued expenses
on the consolidated balance sheet:
Balance Balance
September 30, Payments June 30,
Fiscal 2001 Restructuring Charge 2001 Fiscal 2002 2002
- -------------------------------------------------------------------------------------------
Severance $ 26,500 $ (9,223) $ 17,277
Contractual commitments 8,000 (2,295) 5,705
- -------------------------------------------------------------------------------------------
Total $ 34,500 $ (11,518) $ 22,982
- -------------------------------------------------------------------------------------------
Balance Balance
September 30, Payments June 30,
Fiscal 2000 Restructuring Charge 2001 Fiscal 2002 2002
- -------------------------------------------------------------------------------------------
Severance $ 2,023 $ (954) $ 1,069
Contractual commitments 10,026 (3,740) 6,286
- -------------------------------------------------------------------------------------------
Total $ 12,049 $ (4,694) $ 7,355
- -------------------------------------------------------------------------------------------
Financial Condition and Liquidity
Net cash provided by operating activities for the first nine months of fiscal
2002 was $248,925. During the same period, the Company used $214,600 of cash for
investing activities, which included net finance subsidiary use of $98,310,
capital expenditures for property and equipment of $78,833 and capital
expenditures for equipment on operating leases of $63,216. Cash used in
financing activities of $31,282, includes net repayments of $9,258 of
non-finance subsidiaries' long-term debt, net issuances of $174,450 of finance
subsidiaries' debt and net repayments of $178,376 of short-term debt.
Debt, excluding finance subsidiaries, was $615,933 at June 30, 2002, a decrease
of $185,006 from the debt balance of $800,939 at September 30, 2001. Excluding
finance subsidiaries' debt, our debt to capital ratio was 29% at June 30, 2002
compared to 36.5% at September 30, 2001. Finance subsidiaries' debt is excluded
from the calculation because a significant amount of this debt is backed by a
portion of the lease receivables portfolio. Restricted cash on the consolidated
balance sheets primarily represents cash collected on certain finance
receivables, which must be used to repay certain lease-backed notes.
On May 24, 2002, we obtained a new $300,000 unsecured credit facility (the "New
Credit Facility") with a group of lenders. The New Credit Facility replaces our
$600,000 credit facility that was to expire in January 2003 (the "Old Credit
Facility"). Revolving loans are available, with certain sub-limits, to IOS
Capital, LLC, IKON's leasing subsidiary in the United States; IKON Capital, PLC,
IKON's leasing subsidiary in the United Kingdom; and IKON Capital, Inc., IKON's
leasing subsidiary in Canada. The New Credit Facility contractually matures on
May 24, 2005. As of June 30, 2002, the Company has no borrowings
outstanding under the New Credit Facility. The New Credit Facility also provides
support for letters of credit for the Company and its subsidiaries. As of June
30, 2002, letters of credit supported by the New Credit Facility amounted to
$21,418. The remaining amount available under the New Credit Facility for
borrowings or letters of credit is $278,582 as of June 30, 2002.
The New Credit Facility contains affirmative and negative covenants, including
limitations on certain fundamental changes, investments and acquisitions,
mergers, certain transactions with affiliates, creation of liens, asset
transfers, payment of dividends, intercompany loans and certain restricted
payments. The New Credit Facility does not affect our ability to continue to
securitize receivables. In addition, unless the Company achieves certain ratings
on its long and short term senior, unsecured debt (as defined) or has not
redeemed or defeased $250,000 of IOSC's 9.75% Notes due June 15, 2004, all loans
under the New Credit Facility mature on December 15, 2003. Cash dividends may be
paid on common stock subject to certain limitations. The New Credit Facility
also contains certain financial covenants including (i) corporate leverage
ratio; (ii) consolidated interest expense ratio; (iii) consolidated asset test
ratios; and (iv) limitations on capital expenditures. The New Credit Facility
contains defaults customary for facilities of this type. Failure to be in
compliance with any material provision of the New Credit Facility could have a
material adverse effect on our liquidity, financial position and results of
operations.
As of June 30, 2002, finance subsidiaries' debt increased by $184,592 from
September 30, 2001. During the nine months ended June 30, 2002, our finance
subsidiaries repaid $1,347,815 of debt and received $1,522,265 from the issuance
of lease-backed notes and other debt instruments. As of June 30, 2002, IOSC,
IKON Capital, PLC and IKON Capital, Inc. had approximately $655,000,
(pound)20,539 and CN$41,928 available under their revolving asset securitization
conduit financing agreements.
On May 13, 2002, IOSC issued $300,000 of convertible subordinated notes (the
"Convertible Notes") with an interest rate of 5.0%, which are due on May 1,
2007. The Convertible Notes can be converted into shares of IKON common stock at
any time before maturity at a conversion price of $15.03 per share. Interest
will be paid on the convertible notes semi-annually beginning November 1, 2002.
On May 21, 2002, IKON Receivables Funding, LLC (a wholly owned subsidiary of the
Company) issued $634,800 of lease-backed notes (the "2002-1 Notes") pursuant to
a shelf registration statement filed with the Securities and Exchange
Commission. The 2002-1 Notes are comprised of Class A-1 Notes totaling $171,000
with a stated interest rate of 2.044%, Class A-2 Notes totaling $46,000 with a
stated interest rate of 2.91%, Class A-3 Notes totaling $266,400 with a stated
interest rate of 3.90% and Class A-4 Notes totaling $151,400 with a stated
interest rate of 4.68%. The 2002-1 Notes are collateralized by a pool of office
equipment leases or contracts and related assets and the payments on the 2002-1
Notes are made from payments received on the equipment leases.
The Company uses interest rate swaps to fix the interest rates on its variable
rate classes of lease-backed notes, which results in a lower cost of capital
than if we had issued fixed rate notes. During the nine months ended June 30,
2002, unrealized gains totaling $8,146 after taxes, was recorded in accumulated
other comprehensive loss. As of June 30, 2002, all of the Company's derivatives
designated as hedges are interest rate swaps which qualify for evaluation using
the "short cut" method for assessing effectiveness. As such, there is an
assumption of no ineffectiveness.
During the first nine months of fiscal 2002, the Company repurchased 21 shares
of its common stock. From time to time, the Retirement Savings Plan of the
Company may acquire shares of the common stock of the Company in open market
transactions or from treasury shares held by the Company.
The following summarizes IKON's significant contractual obligations and
commitments as of June 30, 2002:
Payments Due by Period
Less Than
Contractual Obligations Total 1 year 1 - 3 years 4 - 5 years After 5 years
- -------------------------------- ----------------- ----------------- ---------------- ----------------- ----------------
Long-Term Debt $608,382 $13,067 $129,302 $55,612 $410,401
Long-Term Debt, Finance
Subsidiaries 2,780,331 1,065,323 1,268,130 446,852 26
Notes Payable 7,551 7,551
Purchase Commitments 26,214 14,058 12,156
Operating Leases 247,318 45,226 94,324 53,550 54,218
Synthetic Leases 41,901 23,901 18,000
- -------------------------------- ----------------- ----------------- ---------------- ----------------- ----------------
Total $3,711,697 $1,169,126 $1,503,912 $574,014 $464,645
Payments on long-term debt, finance subsidiaries generally are made from
collections on our finance receivables. At June 30, 2002, long-term debt,
finance subsidiaries was $2,780,331 and finance receivables were $3,411,986.
Purchase commitments represent future cash payments related to our
implementation of the Oracle e-business suite. Contractual obligations for
future technical support of $15,650 will be expensed over the term of the
contract. The remaining $10,564 is for software and is included in fixed assets
and accrued liabilities as of June 30, 2002.
Synthetic leases are not required to be recorded on the Company's balance sheet.
The payments above represent the contractual obligation due at the end of the
lease period and will be paid from proceeds received from the sale of the
properties related to the synthetic leases. IKON obtains valuations of leased
properties structured as synthetic leases. If market conditions result in a
valuation that is less than the guaranteed residual value of the property, IKON
may be required to record a charge to income. Any current shortfall between the
contractual obligation and the estimated fair value of the leased assets has
been accrued as of June 30, 2002.
The Company has certain commitments available to it in the form of lines of
credit and standby letters of credit. As of June 30, 2002, the Company had
$292,796 available under lines of credit and $27,336 available under standby
letters of credit. All commitments expire within one year.
The Company believes that its operating cash flow together with unused bank
credit facilities and other financing arrangements will be sufficient to finance
current operating requirements for fiscal 2002, including capital expenditures,
dividends and the remaining accrued costs associated with the Company's
restructuring charges.
Pending Accounting Changes
In June 2001, the FASB approved SFAS 143, "Accounting for Asset Retirement
Obligations." SFAS 143 addresses accounting for legal obligations associated
with the retirement of long-lived assets that result from the acquisition,
construction, development and the normal operation of a long-lived asset, except
for certain obligations of lessees. SFAS 143 requires that the fair value of a
liability for an asset retirement obligation be recognized in the period in
which it is incurred if a reasonable estimate of fair value can be made. The
associated asset retirement costs are capitalized as part of the carrying amount
of the long-lived asset and subsequently allocated to expense over the asset's
useful life. SFAS 143 is effective for fiscal years beginning after June 15,
2002. The Company is currently evaluating the impact of the adoption of this
statement, but does not expect a material impact from the adoption of SFAS 143
on our consolidated financial statements.
In August 2001, the FASB approved SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS 144 supercedes SFAS 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of," and APB 30, "Reporting the Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions." SFAS 144 requires an impairment loss to be
recognized only if the carrying amounts of long-lived assets to be held and used
are not recoverable from their expected undiscounted future cash flows. SFAS 144
is effective for fiscal years beginning after December 15, 2001. The Company is
currently evaluating the impact of the adoption of this statement, but does not
expect a material impact from the adoption of SFAS 144 on our consolidated
financial statements.
In May 2002, the FASB approved SFAS 145, "Rescission of SFAS 4, 44, and 64,
Amendment of SFAS 13, and Technical Corrections as of April 2002." SFAS 145
rescinds SFAS 4, "Reporting Gains and Losses from Extinguishment of Debt," and
an amendment of that Statement, SFAS 64, "Extinguishments of Debt Made to
Satisfy Sinking-Fund Requirements." SFAS 145 also rescinds SFAS 44, "Accounting
for Intangible Assets of Motor Carriers." SFAS 145 amends SFAS 13, "Accounting
for Leases," to eliminate an inconsistency between the required accounting for
sale-leaseback transactions and the required accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. SFAS 145 also amends other existing authoritative pronouncements
to make various technical corrections, clarify meanings, or describe their
applicability under changed conditions. The provisions of SFAS 145 related to
the rescission of SFAS 4 shall be applied in fiscal years beginning after May
15, 2002. Any gain or loss on extinguishment of debt that was classified as an
extraordinary item in prior periods presented that does not meet the criteria in
APB 30 for classification as an extraordinary item shall be reclassified. The
provisions in paragraphs 8 and 9(c) of SFAS 145 related to SFAS 13 shall be
effective for transactions occurring after May 15, 2002. All other provisions of
SFAS 145 shall be effective for financial statements issued on or after May 15,
2002. Early application of all provisions is encouraged. The Company is
currently evaluating the impact of the adoption of this statement, but does not
expect a material impact from the adoption of SFAS 145 on our consolidated
financial statements.
In June 2002, the FASB approved SFAS 146, "Accounting for Exit or Disposal
Activities". SFAS 146 addresses accounting for costs to terminate contracts that
are not capital leases, costs to consolidate facilities or relocate employees
and termination benefits. SFAS 146 requires that the fair value of a liability
for penalties for early contract termination be recognized when the entity
effectively terminates the contract. The fair value of a liability for other
contract termination costs should be recognized when an entity ceases using the
rights conveyed by the contract. The liability for one-time termination benefits
should be accrued ratably over the future service period based on when employees
are entitled to receive the benefits and a minimum retention period. SFAS 146
will be effective for disposal activities initiated after December 31, 2002. The
Company is currently evaluating the impact of the adoption of this statement,
but does not expect a material impact from the adoption of SFAS 146 on our
consolidated financial statements.
Item 3: Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk:
Our exposure to market risk for changes in interest rates relates primarily to
our long-term debt. We have no cash flow exposure due to interest rate changes
for long-term debt obligations as the Company uses interest rate swaps to fix
the interest rates on our variable rate classes of lease-backed notes and other
debt obligations. We primarily enter into debt obligations to support general
corporate purposes, including capital expenditures, working capital needs and
acquisitions. Finance subsidiaries' long-term debt is used primarily to fund the
lease receivables portfolio. The carrying amounts for cash and cash equivalents,
accounts receivable and notes payable reported in the consolidated balance
sheets approximate fair value. Additional disclosures regarding interest rate
risk are set forth in the Company's 2001 Annual Report on Form 10-K/A filed with
the Securities and Exchange Commission.
Foreign Exchange Risk:
The Company has various non-U.S. operating locations which expose it to foreign
currency exchange risk. Foreign denominated intercompany debt borrowed in one
currency and repaid in another may be fixed via currency swap agreements.
Additional disclosures regarding foreign exchange risk are set forth in the
Company's 2001 Annual Report on Form 10-K/A filed with the Securities and
Exchange Commission.
PART II. OTHER INFORMATION
Item 1: Legal Proceedings
The matter of Whetman, et al. v. IKON Office Solutions, Inc., et al. (the
"Claim") involves a claim brought under the Employee Retirement Income Security
Act of 1974 ("ERISA"). In connection with the Claim, the plaintiffs allege that
the Company and various individuals violated fiduciary duties under ERISA based
on allegedly improper investments in the Company's stock made through the
Company's Retirement Savings Plan (the "Plan"). The court certified a class with
respect to the Claim consisting generally of all those participants in the Plan
after September 30, 1995 and through August 13, 1998, subject to certain
exceptions.
On May 14, 2002, the Company announced that, subject to court approval, it
reached an agreement to settle the Claim. The Company is not making any monetary
payment to the class to settle the lawsuit, and the settlement does not reflect
any admission of liability by the Company. The Company has agreed to make
certain modifications to its Plan in order to allow participants greater
flexibility with respect to investment of the employer match portion of their
individual accounts. Under the settlement, employees who have been with the
Company for at least two years will be permitted to allocate Company matching
funds in investment options other than IKON stock, subject to vesting schedules.
The court has preliminarily approved the settlement. The court held a hearing on
the final approval of the settlement on August 8, 2002, and issued a Memorandum
and Order on August 9, 2002 approving the settlement. Plaintiffs' counsel has
petitioned the court for an award of their fees and costs of litigation. The
court has not yet ruled on the petition. Any fees and costs awarded by the court
will be paid by the Company. Such payment is not expected to have a material
financial impact on the Company.
Item 2: Changes in Securities and Use of Proceeds
During the quarter ended June 30, 2002, IOSC issued the following securities in
a transaction which was not registered under the Securities Act of 1933, as
amended (the "Act").
(1) 5% Convertible Subordinated Notes due 2007
a) Securities Sold: On May 13, 2002, IOSC issued and sold $300,000 5%
convertible subordinated notes with an interest rate of 5% which are
due May 1, 2007 (the "Convertible Notes").
b) Underwriters and Other Purchasers: The Convertible Notes were sold to
Deutsche Banc Securities, J.P. Morgan Securities Inc., and Bank of
America Securities LLC, as initial purchasers.
c) Consideration: The aggregate offering price was $300,000, reflecting
100% of the aggregate principal amount of the Convertible Notes plus
accrued interest from the issue date. The initial purchasers acquired
the Convertible Notes at a purchase price of 97.5% of the aggregate
principal amount of the Convertible Notes plus accrued interest from
the issue date.
d) Exemption from Registration: Exemption from registration under the Act
was claimed based upon Rule 144A and Regulation S.
e) Terms of Conversion: The Convertible Notes may be converted into
shares of IKON common stock at any time before maturity at a
conversion price of $15.03 per share.
Item 6: Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit 4.1 Indenture dated as of May 13, 2002 between the Company, IOSC and
Deutsche Bank Trust Company Americas, as Trustee.
Exhibit 4.2 Registration Rights Agreement dated May 13, 2002 between the
Company, Deutsche Bank Securities, Inc. Banc of America Securities
LLC and JP Morgan Securities Inc.
Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
b) Reports on Form 8-K
On April 29, 2002, the Company filed a Current Report on Form 8-K to file, under
Item 5 of the Form, information contained in its press release dated April 25,
2002 regarding its results for the second quarter of fiscal 2002.
On May 7, 2002, the Company filed a Current Report on Form 8-K to file, under
Item 9 of the Form, balance sheet and cash flow statements, intended to be
considered in the context of its SEC filings regarding financial statements for
the second quarter of fiscal 2002.
On May 29, 2002, the Company filed a Current Report on Form 8-K to file, under
Item 5 of the Form, information contained in its press release dated May 28,
2002 regarding the completion of a $300 million unsecured revolving credit
facility dated May 24, 2002.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized. This report has also been signed by the
undersigned in his capacity as the chief accounting officer of the Registrant.
IKON OFFICE SOLUTIONS, INC.
Date August 13, 2002 /s/ William S. Urkiel
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William S. Urkiel
Senior Vice President and
Chief Financial Officer