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 DECEMBER 31, 2004
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
FOR THE TRANSITION PERIOD FROM TO
Commission file number: 0-20828
DANKA BUSINESS SYSTEMS PLC
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
ENGLAND & WALES | 98-0052869 | |
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) |
(I.R.S. EMPLOYER IDENTIFICATION NO.) |
11101 ROOSEVELT | AND | MASTERS HOUSE 107 | ||
BOULEVARD ST. PETERSBURG, FLORIDA 33716 |
HAMMERSMITH ROAD LONDON W14 0QH ENGLAND |
(ADDRESSES OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANTS TELEPHONE NUMBER, INCLUDING AREA CODE:
727-622-2100 in the United States
011-44-207-605-0150 in the United Kingdom
NOT APPLICABLE
(FORMER NAME OR FORMER ADDRESS, IF CHANGED SINCE LAST REPORT)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No ¨
Applicable only to corporate issues:
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of February 1, 2005. The registrant had 254,028,656 ordinary shares outstanding, including 50,647,183 represented by American Depositary Shares (ADS). Each ADS represents four ordinary shares.
Page | ||||
4 | ||||
11 | ||||
ITEM 1. |
CONSOLIDATED FINANCIAL STATEMENTS | 11 | ||
Consolidated Statements of Operations for the Three and Nine Months Ended |
11 | |||
Consolidated Balance Sheets as of December 31, 2004 and March 31, 2004 |
12 | |||
Consolidated Statements of Cash Flows for the Nine Months Ended |
13 | |||
Consolidated Statements of Shareholders Equity (Deficit) for the Nine Months Ended |
14 | |||
Notes to Consolidated Financial Statements |
15 | |||
ITEM 2. |
MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 33 | ||
ITEM 3. |
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 52 | ||
ITEM 4. |
CONTROLS AND PROCEDURES | 52 | ||
56 | ||||
ITEM 1. |
LEGAL PROCEEDINGS | 56 | ||
ITEM 2. |
CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES | 56 | ||
ITEM 3. |
DEFAULTS UPON SENIOR SECURITIES | 56 | ||
ITEM 4. |
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS | 56 | ||
ITEM 5. |
OTHER INFORMATION | 57 | ||
ITEM 6. |
EXHIBITS | 57 | ||
58 |
2
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
Certain statements contained herein, or otherwise made by our officers, including statements related to our future performance and our outlook for our businesses and respective markets, projections, statements of our plans or objectives, forecasts of market trends and other matters, are forward-looking statements, and contain information relating to us that is based on our beliefs as well as assumptions, made by, and information currently available to us. The words goal, anticipate, expect, believe, could, should, intend and similar expressions as they relate to us are intended to identify forward-looking statements, although not all forward looking statements contain such identifying words. No assurance can be given that the results in any forward-looking statement will be achieved. For the forward-looking statements, we claim the protection of the safe harbor for forward-looking statements provided for in the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, or the Exchange Act. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that might cause such actual results to differ materially from those reflected in any forward-looking statements include, but are not limited to, the following: (i) any inability to successfully implement our strategy; (ii) any inability to successfully implement our cost restructuring plans to achieve and maintain cost savings; (iii) any inability to comply with the Sarbanes-Oxley Act of 2002; (iv) any material adverse change in financial markets, the economy or in our financial position; (v) increased competition in our industry and the discounting of products by our competitors; (vi) new competition as the result of evolving technology; (vii) any inability by us to procure, or any inability by us to continue to gain access to and successfully distribute new products, including digital products, color products, multi-function products and high-volume copiers, or to continue to bring current products to the marketplace at competitive costs and prices; (viii) any inability to arrange financing for our customers purchases of equipment from us; (ix) any inability to successfully enhance, unify and effectively utilize our management information systems; (x) any inability to record and process key data due to ineffective implementation of business processes and policies; (xi) any negative impact from the loss of a key vendor or customer; (xii) any negative impact from the loss of any of our senior or key management personnel; (xiii) any change in economic conditions in markets where we operate or have material investments which may affect demand for our products or services; (xiv) any negative impact from the international scope of our operations; (xv) fluctuations in foreign currencies; (xvi) any incurrence of tax liabilities or tax payments beyond our current expectations, which could adversely affect our liquidity and profitability; (xvii) any inability to comply with the financial or other covenants in our debt instruments; (xviii) any delayed or lost sales or other impacts related to the commercial and economic disruption caused by natural disasters; (xix) any delayed or lost sales and other impacts related to the commercial and economic disruption caused by terrorist attacks, the related war on terrorism, and the fear of additional terrorist attacks; and (xx) other risks including those risks identified in any of our filings with the Securities and Exchange Commission, or the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our analysis only as of the date they are made. Except as required by applicable law, we undertake no obligation, and do not intend, to update these forward-looking statements to reflect events or circumstances that arise after the date they are made. Furthermore, as a matter of policy, we do not generally make any specific projections as to future earnings, nor do we endorse any projections regarding future performance, which may be made by others outside our company.
3
Business StrategyDanka Business Systems PLC (also referred to herein as Danka or the Company) believes that in order to stay competitive and generate positive earnings and cash flow, we must successfully implement our strategies.
In connection with the implementation of our strategies, we have launched, and expect to continue to launch, several operational and strategic initiatives. However, the success of any of these initiatives may not be achieved if:
| they are not accepted by our customers; |
| they do not result in revenue growth, generate cash flow, reduce operating costs or reduce our working capital investments; or |
| we are unable to provide the hardware, software, solutions or services necessary to successfully implement these initiatives. |
Failure to implement one or more of our strategies and related initiatives could materially and adversely affect our business, financial condition or results of operations.
Operating EarningsAlthough we generated operating earnings for the first nine months of fiscal year 2005, we generated an operating loss for the quarter due to decreasing revenues and higher operating costs. If we are not able to stabilize our revenues or reduce our operating costs, these operating losses may continue in the future. The operating losses for the nine months ended December 31, 2003 and for fiscal year 2004 included $20.0 million and $50.0 million in restructuring charges, respectively, and as we continue to evaluate our business and strategies, we could incur future restructuring charges which may materially and adversely affect our operations, financial position or results of operations. If we incur operating losses or do not generate sufficient profitability in the future, our growth potential and our ability to execute our business strategy may be limited. In addition, our ability to service our indebtedness may be impaired because we may not generate sufficient cash flow from operations to pay principal or interest when due.
Restructuring of OperationsWe have implemented plans to reduce costs in order to become more competitive within our industry. These cost reduction plans involve, among other things, significant headcount reductions, the exit of certain non-strategic facility locations and the consolidation of many back-office functions into more centralized locations and business process changes. If we fail to successfully implement our cost restructuring plans, including the timely sublease of vacant facilities, and fail to achieve our other long-term cost reduction goals, we may not reduce costs quickly enough to become competitive within our industry. Additionally, we may lose valuable institutional knowledge, bear the risk of additional costs and expenses and incur a breakdown in our business and operational functions, including certain critical back-office operations, any of which could result in negative consequences to our customer service, our current internal control environment and operating results.
Economic UncertaintyThe profitability of our business is susceptible to uncertainties in the global economy. Overall demand for our products and services and their profit margins may decline as a direct result of an economic recession, inflation, interest rates or governmental fiscal policy. As a result, our customers may reduce or delay expenditures for our products and services.
CompetitionThe industry in which we operate is highly competitive. We have competitors in all markets in which we operate, and our competitors include a number of companies worldwide with significant technological, distribution and financial resources. Competition in our industry is based upon technology, performance, pricing, quality, reliability, distribution, market coverage, customer service and support and lease and rental financing. In addition, our equipment suppliers have established themselves as direct competitors in many of the areas in which we do business.
4
As our suppliers develop new products, there is no guarantee that they will permit us to distribute such products or that such products will meet our customers needs and demands. Furthermore, some of our principal competitors design and manufacture new technology, which may give them a competitive advantage over us.
Besides competition from within the office imaging industry, we are also experiencing competition from other sources as a result of evolving technology, including the development of alternative means of document processing, retention, storage and printing. Our retail equipment operations are in direct competition with local and regional equipment suppliers and dealers, manufacturers, mass merchandisers and wholesale clubs. We have suffered, and may continue to suffer, a reduction of our market share because of the high level of competition in our industry. The intense competition in our industry may result in pressure on the prices and margins that we can obtain for our products and may affect our ability to retain customers, both of which could materially and adversely affect our business, financial condition or results of operations.
Furthermore, there is a trend arising within the industry to offer on-demand pricing where the customer does not buy or lease the equipment. Rather, the customer is only charged for the number of images produced by the equipment. This trend could require us to increase our rental equipment investments in order to remain competitive.
Additionally, the competitive environment hinders employee retention, especially in the sales and service areas, which leads to higher turnover of employees and increased compensation expense.
Technological ChangesThe industry in which we operate is characterized by rapidly changing technology. Technological changes have contributed to declines in our revenues in the past and may continue to do so in the future. For example, the office imaging industry has changed from analog to digital copiers, multi-function peripherals (MFPs) and printers. Most of our digital products replace analog products, which have historically been a significant percentage of our machines in field (MIF). Digital copiers and MFPs are more reliable than analog copiers and require less maintenance. Moreover, color printing and copying represents an important and growing part of our industry. We must improve our execution of color sales and meet the demand for color products if we are to maintain and improve our operating performance and our ability to compete.
Another industry change that has been fueled by technological changes is the migration of copy volume from traditional stand-alone copiers to network printers. This change allows end users to print distributed documents on printers linked directly to their personal computers as opposed to receiving copies of such documents that were copied on a traditional stand-alone copier. We will need to increasingly provide comprehensive solutions to our customers, such as offering digital copiers, MFPs, software solutions and printers that are directly linked to their networks, in order to remain competitive. Finally, the speed of technological changes may cause us in the future to write down our inventory, including, but not limited to showroom, rental and other equipment and related supplies and parts, including parts and supplies for our TechSource initiative, as a result of obsolescence. In order to remain competitive, we must quickly and effectively respond to changing technology. Otherwise, such developments of technologies in our industry may impair our business, financial condition, results of operations or competitive position.
Third Party Financing ArrangementsA large majority of our retail equipment and related sales are financed by third party finance or leasing companies. We have an agreement with General Electric Capital Corporation (or GECC), under which GECC has agreed to provide financing to our qualified United States customers to purchase equipment from us. Although we have other financing arrangements in place, GECC finances a significant part of our United States business. GECC has current and prospective lease financing agreements with our competitors. If these agreements result in more favorable terms to our competitors than our current agreement with GECC, we may be placed at a competitive disadvantage within the industry in arranging third party financing to our customers, which could negatively affect our operating results. With respect to our customers outside the United States, we have country by country arrangements with various third party finance and leasing companies.
5
If we were to breach the covenants or other restrictions in our agreements with one or more of our financing sources, including GECC, such sources might refuse to provide financing to our customers. If one or more of our financing sources were to fail to provide financing to our customers, those customers might be unable to purchase equipment from us if we were unable to arrange alternative financing arrangements on similar terms or provide financing ourselves. In addition, if we were unable to arrange financing, we would lose sales, which could negatively affect our operating results. See Managements Discussion and Analysis of Financial Condition and Results of OperationsOther Financing ArrangementsGeneral Electric Capital Corporation.
Information SystemsOur Europe/Australia and Non-U.S. Americas operations run on numerous disparate legacy IT systems that are outdated and incompatible. The operation and coordination of these management information systems and billings systems is labor intensive and expensive. As such, we have evaluated what information system investments we should make. We have determined that we need to upgrade our information systems in Italy, Germany, the United Kingdom, France, Austria, the Netherlands and other countries and expect to spend $3 million to $6 million over the next 24 months for such upgrades. The failure to successfully upgrade our management information systems, including our customer billing systems in our Europe/Australia and Non-U.S. Americas operations or any disruption in our business processes when we upgrade our IT systems could materially and adversely affect our operations, internal controls, financial position or results of operations.
Disaster RecoveryOur systems in the United States are designed for security and reliability. We regularly back up our information systems and subject them to a virus scan. These efforts are intended to buttress the integrity and security of our information systems and the data stored in them, and to minimize the potential for loss in the event of a disaster, including but not limited to natural disasters or terrorist attacks. Our facilities have reserve power generating systems to prevent the loss of product and minimize downtime in the event of shortages.
Due to the delayed investment in our information systems in Europe/Australia and Non-U.S. Americas operations, we have not properly invested in world-wide disaster recovery systems. In the event that one or more of our business systems in Europe/Australia and Non-U.S. Americas operations were to fail, we would be at risk of losing valuable business knowledge in the locations where the failure occurred. We are developing a comprehensive disaster recovery plan but until it is implemented, a disaster could materially and adversely affect our business, financial condition, results of operations or competitive position.
Business Processes and PoliciesOur past rapid expansion through acquisitions, past financial difficulties and a historical lack of focus on, and investment in, our information systems have impeded our ability to develop and implement internal controls and business processes consistently and enforce policies effectively. We have identified instances where we do not have adequate processes in place or our business processes and policies have not been properly implemented or followed in the past, which have resulted in, among other things, poor billing and credit practices, weak customer contract management, excessive and undisciplined issuances of customer credits, inaccurate customer data, inconsistent customer contract terms and conditions, inadequate document retention and inconsistent lease classification. While we believe that some of these issues that relate to the United States have been addressed with the implementation of new manual internal control procedures and the implementation of our Oracle ERP system, which is configured with better system internal controls, there is no assurance that all of these issues will be completely corrected by such changes.
Vendor RelationshipsWe primarily have relationships with Canon, Ricoh, Toshiba, Nexpress, Kodak and Konica-Minolta. These companies manufacture equipment, parts, supplies and software for resale by us in the markets in which we operate. We also rely on our equipment suppliers for related parts and supplies and for financial support in certain competitive transactions and markets which may include vendor rebates and market development funds. Any inability to obtain equipment, parts, supplies or software in the volumes required and at competitive prices from our major vendors, or the loss of any major vendor, or the lack of vendor support may seriously harm our business because we may not be able to supply those vendors products to our customers on a timely basis in sufficient quantities or at all. In addition, we rely on our vendors to effectively respond to
6
changing technology and manufacture new products to meet the demands of evolving customer needs. There is no guarantee that these vendors or any of our other vendors will effectively respond to changing technology, continue to sell their products and services to us, or that they will do so at competitive prices. Other factors, including reduced access to credit by our vendors resulting from economic conditions, may impair our vendors ability to effectively respond to changing technology or provide products in a timely manner or at competitive prices.
International Scope of OperationsWe are incorporated under the laws of England and Wales, and we conduct a significant portion of our business outside of the United States. We generated 54% of our revenue outside the United States during the first nine months of fiscal year 2005. We market office imaging equipment, document solutions and related services and supplies directly to customers in over 20 countries. The international scope of our operations may lead to volatile financial results and difficulties in managing our operations because of, but not limited to, the following:
| difficulties and costs of staffing, social responsibility and managing international operations; |
| currency restrictions and exchange rate fluctuations; |
| unexpected changes in regulatory requirements; |
| potentially adverse tax and tariff consequences; |
| the burden of complying with multiple and potentially conflicting laws; |
| the impact of business cycles, including potentially longer payment cycles, in any particular region; |
| the geographic, time zone, language and cultural differences between personnel in different areas of the world; |
| greater difficulty in collecting accounts receivables in and moving cash out of certain countries; |
| the need for a significant amount of available cash to fund operations in a number of geographic and economically diverse locations; and |
| political, social and economic instability in any particular region, including Central America and South America. |
With respect to our international operations that are experiencing difficulties as described above, we continue to evaluate the viability and future prospects of these businesses. Based on these evaluations, during the quarter ended December 31, 2004, we implemented plans to exit our operations in Portugal and Russia. Should we decide to downsize or exit any other of these businesses, we could incur costs relating to severance, closure of facilities and write-off of goodwill, and we may also be required to recognize cumulative translation losses and minimum pension liabilities that would reduce our earnings.
Any of these factors could materially and adversely affect our business, financial condition or results of operations.
Currency FluctuationsAs a multinational company, changes in currency exchange rates affect our revenues, cost of sales and operating expenses. In addition, fluctuations in exchange rates between the United States dollar and the currencies in each of the countries in which we operate affect the results of our operations and the value of the net assets of our non-United States operations when reported in United States dollars in our United States financial statements. These fluctuations may negatively impact our results of operations or financial condition or, in some circumstances, may positively impact our results of operations disproportionately to underlying levels of actual growth or improvement in our businesses.
The majority of our revenues outside the United States are denominated in either the euro or the British pound sterling. During the quarter ended December 31, 2004, the euro strengthened 2.29% against the United States dollar and the British pound sterling strengthened 1.0% against the United States dollar which positively impacted our reported revenue and net earnings on a sequential basis.
7
Further, our intercompany loans are subject to fluctuations in exchange rates between the United States dollar and the currencies in each of the countries in which we operate, primarily the euro and the British pound sterling. Based on the outstanding balance of our intercompany loans at December 31, 2004, an increase of 1% in the exchange rate for the euro and British pound sterling would cause a foreign exchange loss of approximately $0.3 million, while a decrease of 1% in the exchange rate of the euro and the British pound sterling would cause a foreign exchange gain of approximately $0.3 million.
Moreover, we pay for some inventory in euro countries in United States dollars, but we generally invoice our customers in such countries in euros. If the euro weakens against the United States dollar, our operating margins and cash flow may be negatively impacted when we receive payment in euros but we pay our suppliers in United States dollars.
We do not currently hedge our exposure to changes in foreign currency.
Tax PaymentsWe are either currently under audit or may be audited in the key jurisdictions in which we operate. While we believe we are adequately reserved for such liabilities, should revenue agencies impose assessments or require payments in excess of those we currently expect to pay, we could be required to record additional liabilities or our liquidity could be further affected based upon the size and timing of such payments.
IndebtednessAt December 31, 2004, we had consolidated long-term indebtedness, including current maturities of long-term debt and notes payable, of $244.0 million which included $64.5 million in principal amount of 10% subordinated notes due April 1, 2008 and $175.0 million in principal amount of 11% senior notes due June 15, 2010, less unamortized discount of $3.5 million. The subordinated notes accrue interest which is paid every six months on April 1 and October 1 while the senior notes have interest payable every six months on June 15 and December 15.
The amount of our indebtedness could have important consequences to us, including the following:
| use of a portion of our cash flow to pay interest on our indebtedness will reduce the availability of our cash flow to fund working capital, capital expenditures, strategic initiatives and other business activities, including keeping pace with the technological, competitive and other changes currently affecting our industry; |
| increase our vulnerability to general adverse economic and industry conditions; |
| limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; |
| limit our ability in making strategic acquisitions or exploiting business opportunities; and |
| limit our operational flexibility, including our ability to borrow additional funds or dispose of assets. |
Debt and Credit FacilitiesThe indenture governing our senior notes, our $50 million senior secured revolving credit facility with Fleet Capital Corporation (or Fleet Credit Facility) and our euro 11.8 million letter of credit facility with ABN AMRO contains covenants that, among other things, limit our ability to: (1) incur additional indebtedness or, in the case of our restricted subsidiaries, issue preferred stock; (2) create liens; (3) pay dividends or make other restricted payments; (4) make certain investments; (5) sell or make certain dispositions of assets or engage in sale and leaseback transactions; (6) engage in transactions with affiliates; (7) engage in certain business activities; and (8) engage in mergers or consolidations. They also restrict the ability of our restricted subsidiaries to pay dividends, or make other payments to us. In addition, the indenture governing the senior notes may require us to use a portion of our excess cash flow (as defined in the indenture) to repay other senior indebtedness or offer to repurchase the senior notes.
Disclosure Controls and Procedures and Internal ControlsWe maintain disclosure controls and procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods
8
specified in the SECs rules and forms and that such information is accumulated and communicated to our Audit Committee and management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. We also maintain internal controls that are designed with the objective of providing reasonable assurance that (1) our transactions are properly authorized; (2) our assets are safeguarded against unauthorized or improper use; and (3) our transactions are properly recorded and reported, in order to permit the preparation of our financial statements in conformity with generally accepted accounting principles and to comply with Sections 302, 906 and 404 of the Sarbanes-Oxley Act.
A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of one or more individuals, by collusion of two or more individuals, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Further, because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Compliance with Sarbanes-Oxley Act of 2002We are in the process of documenting and testing our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which, beginning at the end of this fiscal year, requires annual management assessments of the design and effectiveness of our internal control over financial reporting and a report by our Independent Registered Certified Public Accounting Firm addressing these assessments. Compliance with this legislation will continue to divert managements attention and resources and will cause us to incur significant expense during this period and in the foreseeable future. There can be no guarantees that management will conclude the work necessary to complete its assessment of internal control over financial reporting in time to comply with the requirements of Section 404 of the Sarbanes-Oxley Act.
In addition, if we fail to achieve and maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. If this were to occur, we may be unable to assert that the internal control over financial reporting is effective, or our Independent Registered Certified Public Accounting Firm may not be able to render the required attestation concerning our assessment and the effectiveness of the internal controls over financial reporting, which could adversely impact our business.
Share PriceThe market price of our ordinary shares and American Depository Shares (or ADSs) could be subject to significant fluctuations as a result of many factors. In addition, global stock markets have from time to time experienced significant price and volume fluctuations. These fluctuations may lead to a drop in the market price of our ordinary shares and ADSs. Factors which may add to the volatility of the price of our ordinary shares and ADSs include many of the factors set out above, and may also include changes in liquidity in the market for our ordinary shares and ADSs, sales of our ordinary shares and ADSs, investor sentiment towards the business sector in which we operate and conditions in the capital markets generally. Many of these factors are beyond our control. These factors may change the market price of our ordinary shares and ADSs, regardless of our operating performance.
9
Dividends on Ordinary SharesWe have not paid any cash or other dividends on our ordinary shares since 1998 and we do not expect to do so for the foreseeable future. We are an English company and, under English law, we are allowed to pay dividends to shareholders only if, as determined by reference to our financial statements prepared in accordance with UK GAAP:
| we have accumulated, realized profits that have not been previously distributed or capitalized, in excess of our accumulated, realized losses that have not previously been written off in a reduction or reorganization of capital; and |
| our net assets are not less than the aggregate of our share capital and our non-distributable reserves, either before or as a result of the dividend. |
As of the date of filing of this quarterly report, we have insufficient accumulated, realized profits to pay dividends on our ordinary shares. In addition, our Fleet Credit Facility prohibits us from paying dividends on our ordinary shares without our lenders consent, and the indenture governing the senior notes restricts our ability to pay such dividends. Also, we may only pay dividends on our ordinary shares if we have paid all dividends due on our 6.50% senior convertible participating shares.
ADDITIONAL INFORMATION AVAILABLE ON COMPANY WEB-SITE
Our most recent Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports may be viewed or downloaded electronically from our website: http://www.danka.com as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our recent press releases are also available to be viewed or downloaded electronically at http://www.danka.com. We will also provide electronic or paper copies of our SEC filings free of charge on request. Any information on or linked from our website is not incorporated by reference into this Quarterly Report on Form 10-Q.
10
PART I FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements
Consolidated Statements of Operations for the Three and Nine Months Ended
December 31, 2004 and 2003
(In thousands, except per American Depositary Share (ADS) amounts)
(Unaudited)
For the Three Months Ended |
For the Nine Months Ended |
|||||||||||||||
December 31, 2004 |
December 31, 2003 |
December 31, 2004 |
December 31, 2003 |
|||||||||||||
Revenue: |
||||||||||||||||
Retail equipment and related sales |
$ | 111,831 | $ | 114,607 | $ | 326,109 | $ | 342,608 | ||||||||
Retail service |
151,451 | 156,493 | 455,161 | 477,717 | ||||||||||||
Retail supplies and rentals |
25,147 | 35,012 | 81,472 | 97,176 | ||||||||||||
Wholesale |
25,354 | 24,969 | 70,020 | 70,328 | ||||||||||||
Total revenue |
313,783 | 331,081 | 932,762 | 987,829 | ||||||||||||
Costs of sales: |
||||||||||||||||
Retail equipment and related sales costs |
72,024 | 74,373 | 211,913 | 226,260 | ||||||||||||
Retail service costs |
92,716 | 95,940 | 270,137 | 284,344 | ||||||||||||
Retail supplies and rental costs |
14,305 | 20,614 | 48,293 | 57,622 | ||||||||||||
Wholesale costs |
21,448 | 20,132 | 57,877 | 56,832 | ||||||||||||
Total cost of sales |
200,493 | 211,059 | 588,220 | 625,058 | ||||||||||||
Gross profit |
113,290 | 120,022 | 344,542 | 362,771 | ||||||||||||
Operating expenses: |
||||||||||||||||
Selling, general and administrative expenses |
116,392 | 108,720 | 335,322 | 346,322 | ||||||||||||
Restructuring charges (credits) |
(390 | ) | 20,046 | (2,459 | ) | 19,452 | ||||||||||
Other expense (income), net |
1,519 | 1,861 | 2,048 | 1,651 | ||||||||||||
Total operating expenses |
117,521 | 130,627 | 334,911 | 367,425 | ||||||||||||
Operating earnings (loss) |
(4,231 | ) | (10,605 | ) | 9,631 | (4,654 | ) | |||||||||
Interest expense |
(8,154 | ) | (7,931 | ) | (23,263 | ) | (25,753 | ) | ||||||||
Interest income |
206 | 429 | 814 | 978 | ||||||||||||
Write-off of debt issuance costs |
| | | (20,562 | ) | |||||||||||
Earnings (loss) before income taxes |
(12,179 | ) | (18,107 | ) | (12,818 | ) | (49,991 | ) | ||||||||
Provision (benefit) for income taxes |
(16,635 | ) | (1,166 | ) | (15,855 | ) | (14,995 | ) | ||||||||
Net earnings (loss) |
$ | 4,456 | $ | (16,941 | ) | $ | 3,037 | $ | (34,996 | ) | ||||||
Calculation of earnings (loss) per ADS |
||||||||||||||||
Earnings (loss) |
$ | 4,456 | $ | (16,941 | ) | $ | 3,037 | $ | (34,996 | ) | ||||||
Dividends and accretion on participating shares |
(5,111 | ) | (4,811 | ) | (15,108 | ) | (14,216 | ) | ||||||||
Income (loss) available to common shareholders |
$ | (655 | ) | $ | (21,752 | ) | $ | (12,071 | ) | $ | (49,212 | ) | ||||
Basic and diluted earnings (loss) available to common shareholders per ADS: |
||||||||||||||||
Net earnings (loss) per ADS |
$ | (0.01 | ) | $ | (0.35 | ) | $ | (0.19 | ) | $ | (0.79 | ) | ||||
Weighted average ADSs |
63,185 | 62,531 | 62,938 | 62,474 |
See accompanying notes to the consolidated financial statements
11
Consolidated Balance Sheets as of December 31, 2004 and March 31, 2004
(In thousands)
December 31, 2004 |
March 31, 2004 |
|||||||
(Unaudited) | ||||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 89,254 | $ | 112,790 | ||||
Accounts receivable, net |
251,594 | 246,996 | ||||||
Inventories |
118,722 | 93,295 | ||||||
Prepaid expenses, deferred income taxes and other current assets |
18,345 | 16,862 | ||||||
Total current assets |
477,915 | 469,943 | ||||||
Equipment on operating leases, net |
24,202 | 29,478 | ||||||
Property and equipment, net |
54,821 | 65,888 | ||||||
Goodwill, net |
302,821 | 282,430 | ||||||
Other intangible assets, net |
2,472 | 2,340 | ||||||
Deferred income taxes |
7,981 | 7,688 | ||||||
Other assets |
25,215 | 25,801 | ||||||
Total assets |
$ | 895,427 | $ | 883,568 | ||||
Liabilities and shareholders equity (deficit) |
||||||||
Current liabilities: |
||||||||
Current maturities of long-term debt and notes payable |
$ | 4,185 | $ | 3,212 | ||||
Accounts payable |
168,464 | 135,460 | ||||||
Accrued expenses and other current liabilities |
94,080 | 128,963 | ||||||
Taxes payable |
36,134 | 47,200 | ||||||
Deferred revenue |
44,082 | 45,090 | ||||||
Total current liabilities: |
346,945 | 359,925 | ||||||
Long-term debt and notes payable, less current maturities |
239,848 | 240,761 | ||||||
Deferred income taxes and other long-term liabilities |
65,201 | 68,029 | ||||||
Total liabilities |
651,994 | 668,715 | ||||||
6.5% senior convertible participating shares |
294,716 | 279,608 | ||||||
Shareholders equity (deficit): |
||||||||
Ordinary shares, 1.25 pence stated value |
5,268 | 5,194 | ||||||
Additional paid-in capital |
328,876 | 328,070 | ||||||
Accumulated deficit |
(354,657 | ) | (342,586 | ) | ||||
Accumulated other comprehensive loss |
(30,770 | ) | (55,433 | ) | ||||
Total shareholders equity (deficit) |
(51,283 | ) | (64,755 | ) | ||||
Total liabilities and shareholders equity (deficit) |
$ | 895,427 | $ | 883,568 | ||||
See accompanying notes to the consolidated financial statements
12
Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2004 and 2003
(In thousands)
(Unaudited)
For the Nine Months Ended |
||||||||
December 31, 2004 |
December 31, 2003 |
|||||||
Operating activities: |
||||||||
Net earnings (loss) |
$ | 3,037 | $ | (34,996 | ) | |||
Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities: |
||||||||
Depreciation and amortization |
29,532 | 39,274 | ||||||
Deferred income taxes |
837 | (14,352 | ) | |||||
Amortization of debt issuance costs |
1,487 | 4,993 | ||||||
Write-off of debt issuance costs |
| 20,562 | ||||||
(Gain) loss on sale of property and equipment and equipment on operating leases |
(1,395 | ) | 1,959 | |||||
Proceeds from sale of equipment on operating leases |
3,220 | 2,790 | ||||||
Restructuring charges (credits) |
(2,459 | ) | 19,452 | |||||
Changes in net assets and liabilities: |
||||||||
Accounts receivable, net |
(4,052 | ) | 16,440 | |||||
Inventories |
(25,161 | ) | 4,900 | |||||
Prepaid expenses and other current assets |
(1,464 | ) | 3,345 | |||||
Other non-current assets |
5,061 | 2,412 | ||||||
Accounts payable |
32,589 | (19,696 | ) | |||||
Accrued expenses and other current liabilities |
(43,691 | ) | 1,230 | |||||
Deferred revenue |
(1,099 | ) | 2,706 | |||||
Other long-term liabilities |
(3,422 | ) | 1,254 | |||||
Net cash provided by (used in) operating activities |
(6,980 | ) | 52,273 | |||||
Investing activities: |
||||||||
Capital expenditures |
(16,292 | ) | (35,872 | ) | ||||
Purchase of subsidiary, net of cash acquired |
(2,110 | ) | | |||||
Proceeds from sale of subsidiary |
209 | | ||||||
Proceeds from the sale of property and equipment |
313 | 706 | ||||||
Net cash used in investing activities |
(17,880 | ) | (35,166 | ) | ||||
Financing activities: |
||||||||
Net borrowings (payments) under line of credit agreements |
506 | (112,960 | ) | |||||
Net borrowings (payments) under capital lease arrangements |
(1,794 | ) | 2,436 | |||||
Principal payments of debt |
| (48,867 | ) | |||||
Proceeds from debt issuance |
| 170,905 | ||||||
Payment of debt issue costs |
| (10,767 | ) | |||||
Proceeds from stock options exercised |
880 | | ||||||
Net cash provided by (used in) financing activities |
(408 | ) | 747 | |||||
Effect of exchange rates |
1,732 | 5,708 | ||||||
Net increase (decrease) in cash and cash equivalents |
(23,536 | ) | 23,562 | |||||
Cash and cash equivalents, beginning of period |
112,790 | 81,493 | ||||||
Cash and cash equivalents, end of period |
$ | 89,254 | $ | 105,055 | ||||
See accompanying notes to the consolidated financial statements
13
Consolidated Statements of Shareholders Equity (Deficit)
For the Nine Months Ended December 31, 2004 and 2003
(In thousands)
(Unaudited)
Number of Shares (4 Ordinary 1 ADS) |
Ordinary Shares |
Additional Paid-In Capital |
Accumulated Deficit |
Accumulated Other Comprehensive Income/(Loss) |
Total |
|||||||||||||||
Balances at March 31, 2004 |
250,812 | $ | 5,194 | $ | 328,070 | $ | (342,586 | ) | $ | (55,433 | ) | $ | (64,755 | ) | ||||||
Net earnings (loss) |
| | | 3,037 | | 3,037 | ||||||||||||||
Currency translation adjustment |
| | | | 24,663 | 24,663 | ||||||||||||||
Comprehensive income |
27,700 | |||||||||||||||||||
Dividends and accretion on participating shares |
| | | (15,108 | ) | | (15,108 | ) | ||||||||||||
Shares issued under employee stock plans, net of tax |
3,191 | 74 | 806 | | | 880 | ||||||||||||||
Balances at December 31, 2004 |
254,003 | $ | 5,268 | $ | 328,876 | $ | (354,657 | ) | $ | (30,770 | ) | $ | (51,283 | ) | ||||||
Balances at March 31, 2003 |
249,532 | $ | 5,167 | $ | 327,173 | $ | (189,995 | ) | $ | (76,636 | ) | $ | 65,709 | |||||||
Net earnings (loss) |
| | | (34,996 | ) | | (34,996 | ) | ||||||||||||
Minimum pension liability adjustment |
| | | | (2,260 | ) | (2,260 | ) | ||||||||||||
Currency translation adjustment |
| | | | 28,518 | 28,518 | ||||||||||||||
Comprehensive loss |
(8,738 | ) | ||||||||||||||||||
Dividends and accretion on participating shares |
| | | (14,113 | ) | | (14,113 | ) | ||||||||||||
Shares issued under employee stock plans, net of tax |
772 | 15 | 595 | | | 610 | ||||||||||||||
Balances at December 31, 2003 |
250,304 | $ | 5,182 | $ | 327,768 | $ | (239,104 | ) | $ | (50,378 | ) | $ | 43,468 | |||||||
See accompanying notes to the consolidated financial statements
14
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands, except per American Depositary Share (ADS) amounts)
(Unaudited)
Note 1. Basis of Presentation
The accompanying financial statements of Danka Business Systems PLC (the Company) are unaudited for the three and nine month periods ended December 31, 2004 and 2003. In the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the results of operations for the interim periods presented have been reflected herein. The consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Companys Annual Report on Form 10-K for the year ended March 31, 2004.
The Companys operations have historically experienced lower revenue during the second quarter of its fiscal year, which is the three month period ended September 30. This is primarily due to increased vacation time by European and Canadian residents during July and August and lower levels of retail service revenue from U.S. governmental agencies. This has historically resulted in reduced sales activity and reduced usage of photocopiers, facsimiles and other office imaging equipment during the second quarter. Accordingly, the results of operations for the interim periods are not necessarily indicative of the results which may be expected for the entire fiscal year.
The financial statements contained herein for the three and nine months ended December 31, 2004 do not comprise statutory accounts within the meaning of Section 240 of the United Kingdom Companies Act 1985. Statutory accounts for the year ended March 31, 2004 were delivered to the Registrar of Companies for England and Wales on December 15, 2004 following the Companys 2004 annual general meeting. The independent auditors report on those statutory accounts was unqualified and did not contain a statement under Section 237(2) or 237(3) of the United Kingdom Companies Act 1985.
The Companys cash balance includes restricted cash of $11.8 million.
Certain prior year amounts have been reclassified to conform to current year presentation.
Note 2. Interim Period Stock Compensation Disclosures
As permitted by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), the Company accounts for its stock option plans under the intrinsic value recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As the exercise prices of all options granted under these plans were equal to the market price of the underlying American Depository Shares (ADS) on the grant date, no stock-based employee compensation cost was recognized in net earnings (loss). In general, these options expire in ten years and vest over three years. The proceeds from options exercised are credited to shareholders equity (deficit).
15
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands, except per American Depositary Share (ADS) amounts)(Continued)
(Unaudited)
The following table illustrates the effect on basic and diluted net earnings (loss) available and earnings (loss) available per ADS shareholder if the Company had applied the fair value recognition provisions of SFAS 123 (using the Black-Scholes option pricing model) to employee stock benefits, including ADS shares issued under the stock option plans. For purposes of this pro-forma disclosure, the estimated fair value of the options is assumed to be amortized to expense over the options vesting periods.
For the Three Months Ended December 31, |
For the Nine Months Ended December 31, |
|||||||||||||||
2004 |
2003 |
2004 |
2003 |
|||||||||||||
Net earnings (loss), as reported |
$ | 4,456 | $ | (16,941 | ) | $ | 3,037 | $ | (34,996 | ) | ||||||
Less: total stock-based employee compensation expense determined under the fair value provisions of SFAS 123 for all awards, net of tax |
(913 | ) | (1,035 | ) | (2,797 | ) | (2,869 | ) | ||||||||
Pro forma net earnings (loss) |
3,543 | (17,976 | ) | 240 | (37,865 | ) | ||||||||||
Participating share dividend |
(5,111 | ) | (4,811 | ) | (15,108 | ) | (14,216 | ) | ||||||||
Pro forma income (loss) available to common shareholders |
$ | (1,568 | ) | $ | (22,787 | ) | $ | (14,868 | ) | $ | (52,081 | ) | ||||
Basic and diluted earnings (loss) available to common shareholders per ADS |
||||||||||||||||
As reported |
$ | (0.01 | ) | $ | (0.35 | ) | $ | (0.19 | ) | $ | (0.79 | ) | ||||
Pro forma |
(0.02 | ) | (0.36 | ) | (0.24 | ) | (0.83 | ) | ||||||||
Weighted average ADSs |
63,185 | 62,531 | 62,938 | 62,474 |
Note 3. Recent Accounting Pronouncements
In December 2003, the Financial Accounting Standards Board (the FASB) revised FASB Statement No. 132, Employers Disclosures about Pensions and Other Postretirement Benefits (SFAS 132). The revised standard mandates additional required disclosures for pensions and other postretirement benefit plans and is designed to improve disclosure transparency within financial statements and requires certain disclosures to be made on a quarterly basis. The revised standard replaces existing pension disclosure requirements. Compliance with SFAS 132 was generally effective for fiscal periods beginning after December 15, 2003. However, since all of the required disclosures relate to the Companys international plans, the implementation rules are effective for the Companys year ending March 31, 2005 and as such, no interim period disclosures have been made in this quarterly report on Form 10-Q. The Company does not anticipate the adoption of SFAS 132 to have a material impact on its consolidated financial statements.
In March 2004, the Emerging Issues Task Force reached a consensus on Issue 03-6, Participating Securities and the Two-Class Method under FAS 128, Earnings per Share (EITF 03-6). EITF 03-6 requires the use of the two-class method in calculating basic earnings per share by issuers with participating convertible securities. Companies were required to retroactively apply EITF 03-6 to participating securities in the quarter beginning April 1, 2004. The Company adopted EITF 03-6 in the quarter beginning April 1, 2004. Due to the Companys capital structure and insufficient income, the adoption had no impact on its consolidated financial statements or earnings available per share presented herein.
In December 2004, the FASB issued FASB Statement No. 123R, Share-Based Payment (SFAS 123R), which revises FASB Statement No. 123 (SFAS 123), Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation
16
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands, except per American Depositary Share (ADS) amounts)(Continued)
(Unaudited)
guidance. SFAS 123R requires public entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award in the statement of operations. Pro forma disclosure is no longer allowable under the new standard. The cost will be recognized over the period during which an employee is required to provide service in exchange for the reward - the requisite service period, usually the vesting period. Adoption of SFAS 123R is required as of the beginning of the first interim reporting period that begins after June 15, 2005. As of December 31, 2004, the Company had not yet assessed the impact the adoption of SFAS 123R will have on its consolidated financial statements.
Note 4. Restructuring Charges (Credits)
Fiscal Year 2005 Charge: In fiscal year 2005, the Company formulated plans to continue to reduce its selling, general and administrative costs by reducing headcount in Europe/Australia. As part of these plans, the Company recorded a $0.9 million restructuring charge in the first nine months of fiscal year 2005. Cash outlays for the employee severance during the nine months ended December 31, 2004 were $0.8 million. The remaining liability of the 2005 restructuring charge, totaling $0.1 million is categorized within Accrued expenses and other current liabilities.
The following table summarizes the fiscal year 2005 restructuring charge:
2005 Restructuring Charge:
Fiscal 2005 Expense |
Cash Outlays |
Other Non-Cash Changes |
Reserve at 2004 | ||||||||||
Severance |
$ | 855 | $ | (733 | ) | 11 | $ | 133 | |||||
Future lease obligations on facility closures |
29 | (29 | ) | | | ||||||||
Total |
$ | 884 | $ | (762 | ) | $ | 11 | $ | 133 | ||||
Fiscal Year 2004 Charge: In fiscal year 2004, the Company formulated plans to significantly reduce its selling, general and administrative costs by consolidating its back-office functions in the United States, exiting non-strategic real estate facilities and reducing headcount in the Americas and Europe/Australia. As part of these plans, the Company recorded a $50.6 million restructuring charge in fiscal year 2004 that included $26.9 million related to severance for employees and $23.7 million related to future lease obligations for facilities that were vacated by March 31, 2004. These charges were accounted for under the provisions of Statement of Financial Accounting Standards No. 112, Employers Accounting for Postemployment Benefits (SFAS 112) and Statement of Financial Accounting Standards No. 146, Accounting for Cost Associated with Exit or Disposal Activities (SFAS 146). Cash outlays for the employee severance during the nine months ended December 31, 2004 were $10.1 million. Cash outlays for the remaining terms of the facility leases during the nine months ending December 31, 2004 were $6.4 million. If these leases are not terminated, the Companys payments will continue through their respective terms unless otherwise disposed of. The Company reversed $2.5 million and $0.8 million of fiscal year 2004 severance and facility charges during the second and third quarters of fiscal year 2005, respectively, as a result of employee attrition in its Americas and Europe/Australia segments, a change in restructuring plans in the Europe/Australia segment partially offset by a higher estimate of facility charges in the Americas. The remaining non-cash changes of $0.6 million relate to foreign currency movements. The remaining liability of the 2004 restructuring charge of $10.8 million and $11.2 million is categorized within Accrued expenses and other current liabilities and Deferred income taxes and other long-term liabilities, respectively.
17
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands, except per American Depositary Share (ADS) amounts)(Continued)
(Unaudited)
The following table summarizes the fiscal year 2004 restructuring charge:
2004 Restructuring Charge:
Fiscal 2004 Expense |
Reserve at March 31, 2004 |
Cash Outlays |
Other Non-Cash Changes |
Reserve at 2004 | |||||||||||||
Severance |
$ | 26,910 | $ | 21,524 | $ | (10,079 | ) | $ | (4,385 | ) | $ | 7,060 | |||||
Future lease obligations on facility closures |
23,684 | 20,842 | (6,385 | ) | 434 | 14,891 | |||||||||||
Total |
$ | 50,594 | $ | 42,366 | $ | (16,464 | ) | $ | (3,951 | ) | $ | 21,951 | |||||
2004 Restructuring Severance Charge by Operating Segment:
Fiscal 2004 Expense |
Reserve at March 31, 2004 |
Cash Outlays |
Other Non-Cash Changes |
Reserve at 2004 | |||||||||||||
Americas |
$ | 8,768 | $ | 5,946 | $ | (4,356 | ) | $ | (916 | ) | $ | 674 | |||||
Europe/Australia |
17,957 | 15,393 | (5,675 | ) | (3,332 | ) | 6,386 | ||||||||||
Other |
185 | 185 | (48 | ) | (137 | ) | | ||||||||||
Total |
$ | 26,910 | $ | 21,524 | $ | (10,079 | ) | $ | (4,385 | ) | $ | 7,060 | |||||
2004 Restructuring Facility Charge by Operating Segment:
Fiscal 2004 Expense |
Reserve at March 31, 2004 |
Cash Outlays |
Other Non-Cash Changes |
Reserve at 2004 | |||||||||||||
Americas |
$ | 13,552 | $ | 10,840 | $ | (4,667 | ) | $ | 261 | $ | 6,434 | ||||||
Europe/Australia |
6,126 | 6,354 | (570 | ) | (266 | ) | 5,518 | ||||||||||
Other |
4,006 | 3,648 | (1,148 | ) | 439 | 2,939 | |||||||||||
Total |
$ | 23,684 | $ | 20,842 | $ | (6,385 | ) | $ | 434 | $ | 14,891 | ||||||
Fiscal Year 2002 Charge: The Companys fiscal year 2002 restructuring charge included $4.9 million related to severance for 355 employees in the Americas and Europe/Australia. The restructuring charge also included $6.1 million for future lease obligations on 39 facilities that were vacated by March 31, 2002. Cash outlays for the reductions during the nine months ended December 31, 2004 were $0.2 million. Due to a change in estimate, the Company reversed $0.5 million of fiscal year 2002 severance and facility charges during the first quarter of fiscal year 2004. The remaining liability of the 2002 restructuring charge is categorized within Accrued expenses and other current liabilities.
The following table summarizes the fiscal year 2002 restructuring charge:
2002 Restructuring Charge:
Fiscal 2002 Expense |
Reserve at March 31, 2004 |
Cash Outlays |
Other Non-Cash Changes |
Reserve at 2004 | ||||||||||||
Severance |
$ | 4,967 | $ | 132 | $ | (7 | ) | $ | 21 | $ | 146 | |||||
Future lease obligations on facility closures |
6,074 | 215 | (229 | ) | 14 | | ||||||||||
Total |
$ | 11,041 | $ | 347 | $ | (236 | ) | $ | 35 | $ | 146 | |||||
18
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands, except per American Depositary Share (ADS) amounts)(Continued)
(Unaudited)
The remaining balance of the 2002 Restructuring Charge is for the Companys Europe/Australia operating segment.
Note 5. Income Taxes
The Company recorded an income tax benefit of $15.9 million in the first nine months of fiscal year 2005 compared to a benefit of $15.0 million in the prior year period. The tax benefit for the current period is attributable to adjustments to tax liabilities and valuation allowance for prior periods of $19.0 million less tax expense attributable to current year results of $3.1 million. The adjustments primarily related to favorable settlements of tax audits in the Companys European operations partially offset by increases in tax liabilities in the U.S. The Company recognized a tax expense on the current year operating loss due to the inability to recognize a tax benefit on the losses incurred in most jurisdictions. In the prior year period, the Company recognized an operating loss which generated an income tax benefit of $11.8 million. In addition, the Company reversed $3.2 million in foreign tax accruals in the prior year period.
The tax rate for the first nine months of fiscal year 2005 was 124% compared to a rate of 30% in the prior year period. The net increase in the tax rate is comprised of two counter active factors. The rate decreased due to the inability to recognize a tax benefit on losses incurred in most jurisdictions. The rate increased due to the adjustment of accrued tax liabilities relating primarily to favorable tax audit settlements.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences which give rise to the deferred tax asset become deductible. The Companys past financial performance is a significant factor which contributes to its inability, pursuant to Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109), to use projections of future taxable income in assessing the realizability of deferred tax assets. Management therefore is limited to considering the scheduled reversal of deferred tax liabilities and tax planning strategies in making this assessment. Due to the inability to use projections of future taxable income in making its assessment, management concluded that it is not more likely than not that the Company will realize the benefits of certain deferred tax assets at December 31, 2004. The Company has a valuation allowance against deferred tax assets in most jurisdictions at December 31, 2004.
Note 6. Earnings (Loss) Per Share
The effect of the Companys 6.5% senior convertible participating shares, which represent the ADSs shown in the table below are not included in the computation of diluted earnings per share for the three and nine months ended December 31, 2004 and 2003 because they are anti-dilutive as the Company incurred losses available to common shareholders. Stock options representing the ADSs shown in the table below, presented using the treasury stock method, are not included in the computation of diluted earnings per share for the three and nine months ended December 31, 2004 and 2003 because they are anti-dilutive as the Company is in a loss position. The total number of outstanding shares related to stock options (all of which are anti-dilutive) was 8,036 and 8,566 at December 31, 2004 and 2003, respectively.
Potential ADSs issuance from:
Three Months Ended December 31, |
Nine Months Ended December 31, | |||||||
2004 |
2003 |
2004 |
2003 | |||||
6.5% senior convertible participating shares |
23,861 | 22,372 | 23,486 | 22,020 | ||||
Stock options |
1,701 | 1,513 | 2,109 | 1,717 |
19
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands, except per American Depositary Share (ADS) amounts)(Continued)
(Unaudited)
Note 7. Segment Reporting
Historically, the Company had been organized into three reporting segments: United States, Europe and International. The International segment included the Companys operations in Canada, Central America, South America and Australia. As of April 1, 2004, the Company changed its operating organization into two reporting segments, the Americas and Europe/Australia. The geographical areas covered by the Americas segment include the United States, Canada, Central America and South America while the Europe/Australia segment includes operations in Europe and Australia. Consequently, the Companys primary areas of management and decision-making are now the Americas and Europe/Australia. Dankas Americas and Europe/Australia segments provide office imaging equipment, document solutions and related services and supplies on a direct basis to retail customers. The Companys Europe/Australia segment also provides office imaging equipment and supplies on a wholesale basis to independent dealers. The Companys management relies on an internal management reporting process that provides segment revenue and operating earnings. Management believes that this is an appropriate measure of evaluating the operating performance of our segments. The following tables present information about the Companys segments. Fiscal year 2004 amounts have been restated to reflect the Companys new operating organization.
For the Three Months Ended |
For the Nine Months Ended |
|||||||||||||||
December 31, 2004 |
December 31, 2003 |
December 31, 2004 |
December 31, 2003 |
|||||||||||||
Revenues |
||||||||||||||||
Americas |
$ | 155,129 | $ | 180,328 | $ | 481,331 | $ | 539,797 | ||||||||
Europe/Australia |
158,654 | 150,753 | 451,431 | 447,998 | ||||||||||||
Other (1) |
| | | 34 | ||||||||||||
Total Revenues |
$ | 313,783 | $ | 331,081 | $ | 932,762 | $ | 987,829 | ||||||||
Gross Profit |
||||||||||||||||
Americas |
$ | 63,568 | $ | 70,662 | $ | 197,252 | $ | 216,092 | ||||||||
Europe/Australia |
49,722 | 48,845 | 147,290 | 146,142 | ||||||||||||
Other (1) |
| 515 | | 537 | ||||||||||||
Total Gross Profit |
$ | 113,290 | $ | 120,022 | $ | 344,542 | $ | 362,771 | ||||||||
Operating Earnings (Loss) |
||||||||||||||||
Americas |
$ | 4,586 | $ | 10,107 | $ | 22,063 | $ | 15,056 | ||||||||
Europe/Australia |
1,832 | 4,911 | 13,163 | 16,418 | ||||||||||||
Other (1) |
(10,649 | ) | (25,623 | ) | (25,595 | ) | (36,128 | ) | ||||||||
Total Operating Earnings (Loss) |
$ | (4,231 | ) | $ | (10,605 | ) | $ | 9,631 | $ | (4,654 | ) | |||||
Capital Expenditures |
||||||||||||||||
Americas |
$ | 3,551 | $ | 2,635 | $ | 7,145 | $ | 23,087 | ||||||||
Europe/Australia |
2,317 | 4,698 | 8,527 | 10,021 | ||||||||||||
Other (2) |
65 | (2,548 | ) | 620 | 2,764 | |||||||||||
Total Capital Expenditures |
$ | 5,933 | $ | 4,785 | $ | 16,292 | $ | 35,872 | ||||||||
Depreciation and Amortization |
||||||||||||||||
Americas |
$ | 6,633 | $ | 9,528 | $ | 20,071 | $ | 27,888 | ||||||||
Europe/Australia |
2,663 | 4,593 | 7,806 | 10,239 | ||||||||||||
Other (1) |
643 | 457 | 1,655 | 1,147 | ||||||||||||
Total Depreciation and Amortization |
$ | 9,939 | $ | 14,578 | $ | 29,532 | $ | 39,274 | ||||||||
20
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands, except per American Depositary Share (ADS) amounts)(Continued)
(Unaudited)
December 31, 2004 |
March 31, 2004 | |||||
Assets |
||||||
Americas |
$ | 310,051 | $ | 312,224 | ||
Europe/Australia |
533,374 | 471,535 | ||||
Other (3) |
52,002 | 99,809 | ||||
Total Assets |
$ | 895,427 | $ | 883,568 | ||
Long-lived Assets |
||||||
Americas |
$ | 122,186 | $ | 137,139 | ||
Europe/Australia |
279,868 | 260,000 | ||||
Other (3) |
15,458 | 16,486 | ||||
Total Long-lived Assets |
$ | 417,512 | $ | 413,625 | ||
(1) | Other primarily includes corporate expenses and foreign exchange gains/losses. |
(2) | Other includes corporate assets. |
(3) | Other primarily includes corporate assets and deferred tax assets. |
Note 8. Debt
Debt consisted of the following at December 31, 2004 and March 31, 2004:
December 31, 2004 |
March 31, 2004 |
|||||||
10.0% subordinated notes due April 2008 |
$ | 64,520 | $ | 64,520 | ||||
11.0% senior notes due June 2010 |
175,000 | 175,000 | ||||||
Capital lease obligations |
5,300 | 6,411 | ||||||
Various notes payable bearing interest from prime to 12.0% maturing principally over the next 5 years |
2,675 | 1,834 | ||||||
Total long-term debt and notes payable |
247,495 | 247,765 | ||||||
Less unamortized discount on senior notes |
(3,462 | ) | (3,792 | ) | ||||
Total long-term debt and notes payable less unamortized discount |
244,033 | 243,973 | ||||||
Less current maturities of long-term debt and notes payable |
(4,185 | ) | (3,212 | ) | ||||
Long-term debt and notes payable, less current maturities |
$ | 239,848 | $ | 240,761 | ||||
The 10.0% subordinated notes due April 1, 2008 have interest payments of $3.2 million every six months on April 1 and October 1.
The 11.0% senior notes due June 15, 2010 have a fixed annual interest rate of 11.0% and have interest payments of $9.6 million that will be paid every six months on June 15 and December 15. The senior notes are fully and unconditionally guaranteed on a joint and several basis by all of the Companys Australian and Canadian subsidiaries, a Luxembourg subsidiary, two UK subsidiaries, one of which is the Companys primary UK operating subsidiary, and all of its United States subsidiaries other than certain dormant entities, all of which are 100% owned by the Company.
If, for any fiscal year commencing with the fiscal year ended March 31, 2004, there is excess cash flow, as such term is defined in the indenture governing the senior notes, in an amount in excess of $5.0 million, the
21
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands, except per American Depositary Share (ADS) amounts)(Continued)
(Unaudited)
Company will be required to make an offer in cash to holders of the senior notes to use 50% of such excess cash flow to purchase their senior notes at 101% of the aggregate principal amount of the senior notes to be repurchased plus accrued and unpaid interest and additional amounts, if any. No such payment has been made to date.
The Company incurred $7.2 million in debt issuance costs relating to the senior notes and is amortizing these costs over the term of the senior notes. The balance of these costs as of December 31, 2004 was $5.6 million. The $4.1 million discount related to the senior notes is being accreted to interest expense using the effective interest method over the life of the related debt. The balance of the discount as of December 31, 2004 was $3.5 million.
The Company has a credit facility which expires on January 4, 2008 with Fleet Capital Corporation (the Fleet Credit Facility) to provide a $50.0 million, senior secured revolving credit facility, which includes a $30.0 million sub-limit for standby and documentary letters of credit. Under the terms of the Fleet Credit Facility, as amended, extensions of credit to the borrowers are further limited to the lesser of the commitment and the borrowing base. In addition, the Fleet Credit Facility requires the Company to keep $5.0 million of cash in an operating account. As of December 31, 2004, the borrowing base for the credit facility was $46.5 million and the Company had no borrowings under the Fleet Credit Facility.
The Company incurred $1.7 million in debt issuance costs relating to the origination and amendment of the Fleet Credit Facility and is amortizing these costs over the remaining term of the credit facility. The balance of these costs as of December 31, 2004 was $0.8 million.
On December 31, 2003, the Company entered into a one year letter of credit facility with ABN AMRO. On November 2, 2004, the agreement was amended to provide the Company a letter of credit facility for Euro 11.8 million (U.S. $16.0 million) and an open term credit facility of Euro 1.0 million (U.S. $1.4 million) available for general working capital purposes, including overdrafts. This facility is secured by certain of its Netherlands and Belgium subsidiaries assets. The availability of this credit facility is subject to a borrowing base and complying with certain requirements, including maintaining certain levels of tangible net worth requirements as defined by the lender. The borrowing base totaled approximately Euro 6.9 million (U.S. $9.3 million) as of December 31, 2004 and the Company had no borrowings under the facility. Based on calculations as of December 31, 2004, the Company was in compliance with the terms of the amended agreement. In addition, the amendment requires the Company to cash collateralize the letter of credit facility by Euro 5.0 million (U.S. $6.8 million). The letter of credit facility bears a commission of 1%, while the general credit facility bears interest at ABNs Euro base rate plus 1.5%. ABNs Euro base rate as of December 31, 2004, was 1.67%.
Note 9. Contingencies
In June 2003, Danka was served with a putative class action complaint titled Stephen L. Edwards, et al., Plaintiffs vs. Danka Industries, Inc., et al., including American Business Credit Corporation, Defendants, alleging claims of breach of contract, fraud/intentional misrepresentation, unjust enrichment, violation of the Florida Deception and Unfair Trade Protection Act and injunctive relief. The claim was filed in the state court in Tennessee, and the Company has removed the claim to the United States District Court for Middle District of Tennessee for further proceedings. The plaintiffs have filed a motion to certify the class, which the Company has opposed. The Company has filed a motion for summary judgment, which plaintiffs have opposed. While the amount sought in this complaint is in excess of $75,000, the Company can not, at this time, estimate its potential exposure. The Company will continue to vigorously defend the claims alleged by the plaintiff in this action.
22
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands, except per American Depositary Share (ADS) amounts)(Continued)
(Unaudited)
The Company is also subject to legal proceedings and claims which arise in the ordinary course of its business. The Company does not expect these legal proceedings to have a material effect upon its financial position, results of operations or liquidity.
Note 10. Supplemental Consolidating Financial Data for Subsidiary Guarantors of 11.0% Senior Notes
On July 1, 2003, the Company issued its 11.0% senior notes. The senior notes are fully and unconditionally guaranteed on a joint and several basis by all of the Companys Australian and Canadian subsidiaries, a Luxembourg subsidiary, two UK subsidiaries, one of which is the primary UK operating subsidiary, and all of its United States subsidiaries other than certain dormant entities (collectively, the Subsidiary Guarantors). All subsidiaries are 100% owned by the Company. The Subsidiary Guarantors generated [58.5% and 60.6%] of the Companys total revenue during the three and nine months ended December 31, 2004, respectively. Certain prior year amounts have been reclassified to conform to the current year classification.
The Company reported its subsidiary non-guarantors equity (income) loss and net earnings (loss) for the three months ended June 30, 2004 as $16.1 million and ($21.9 million), respectively; those amounts should have been ($15.5 million) and $9.7 million, respectively. Additionally, the Company reported its subsidiary non-guarantors equity (income) loss and net earnings (loss) for the three months ended September 30, 2004 as $10.9 million and ($22.7 million), respectively; those amounts should have been ($10.4 million) and $67.9 million, respectively. The changes had no impact on the parent companys, the subsidiary guarantors or the consolidated results of operations for those periods previously reported.
The Company reported its subsidiary non-guarantors equity (income) loss and net earnings (loss) for the three months ended September 30, 2003 was $31.0 million and ($46.5 million), respectively; those amounts should have been ($10.1 million) and ($5.4 million), respectively. The changes had no impact on the parent companys, the subsidiary guarantors or the consolidated results of operations for the period previously reported.
23
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands)
(Unaudited)
Supplemental Consolidating Statement of Operations For the Three Months Ended December 31, 2004 |
||||||||||||||||||||
Parent Company (1) |
Subsidiary Guarantors (2) |
Subsidiary Non - Guarantors |
Eliminations |
Consolidated Total |
||||||||||||||||
Revenue: |
||||||||||||||||||||
Retail equipment and related sales |
$ | | $ | 69,420 | $ | 42,411 | $ | | $ | 111,831 | ||||||||||
Retail service |
| 96,512 | 54,939 | | 151,451 | |||||||||||||||
Retail supplies and rentals |
| 17,628 | 7,519 | | 25,147 | |||||||||||||||
Wholesale |
| | 25,354 | | 25,354 | |||||||||||||||
Total revenue |
| 183,560 | 130,223 | | 313,783 | |||||||||||||||
Costs of sales: |
||||||||||||||||||||
Retail equipment and related sales costs |
| 43,901 | 28,123 | | 72,024 | |||||||||||||||
Retail service costs |
| 57,399 | 35,317 | | 92,716 | |||||||||||||||
Retail supplies and rental costs |
| 10,504 | 3,801 | | 14,305 | |||||||||||||||
Wholesale costs |
| | 21,448 | | 21,448 | |||||||||||||||
Total cost of sales |
| 111,804 | 88,689 | | 200,493 | |||||||||||||||
Gross profit |
| 71,756 | 41,534 | | 113,290 | |||||||||||||||
Operating expenses: |
||||||||||||||||||||
Selling, general and administrative expenses |
1,349 | 75,209 | 39,834 | | 116,392 | |||||||||||||||
Restructuring charges (credits) |
| 354 | (744 | ) | | (390 | ) | |||||||||||||
Equity (income) loss |
(18,193 | ) | (10,931 | ) | (16,217 | ) | 45,341 | | ||||||||||||
Other (income) expense, net |
7,053 | (2,675 | ) | (1,119 | ) | (1,740 | ) | 1,519 | ||||||||||||
Total operating expenses |
(9,791 | ) | 61,957 | 21,754 | 43,601 | 117,521 | ||||||||||||||
Operating earnings (loss) |
9,791 | 9,799 | 19,780 | (43,601 | ) | (4,231 | ) | |||||||||||||
Interest expense |
(6,740 | ) | (1,520 | ) | (2,394 | ) | 2,500 | (8,154 | ) | |||||||||||
Interest income |
1,383 | 1,793 | (413 | ) | (2,557 | ) | 206 | |||||||||||||
Earnings (loss) before income taxes |
4,434 | 10,072 | 16,973 | (43,658 | ) | (12,179 | ) | |||||||||||||
Provision (benefit) for income taxes |
(22 | ) | 4,585 | (21,198 | ) | | (16,635 | ) | ||||||||||||
Net earnings (loss) |
$ | 4,456 | $ | 5,487 | $ | 38,171 | $ | (43,658 | ) | $ | 4,456 | |||||||||
24
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands)
(Unaudited)
Supplemental Consolidating Statement of Operations For the Three Months Ended December 31, 2003 |
||||||||||||||||||||
Parent (1) |
Subsidiary Guarantors (2) |
Subsidiary Non - Guarantors |
Eliminations |
Consolidated Total |
||||||||||||||||
Revenue: |
||||||||||||||||||||
Retail equipment and related sales |
$ | | $ | 81,092 | $ | 33,515 | $ | | $ | 114,607 | ||||||||||
Retail service |
| 101,283 | 55,210 | | 156,493 | |||||||||||||||
Retail supplies and rentals |
| 25,195 | 9,817 | | 35,012 | |||||||||||||||
Wholesale |
| | 24,969 | | 24,969 | |||||||||||||||
Total revenue |
| 207,570 | 123,511 | | 331,081 | |||||||||||||||
Costs of sales: |
||||||||||||||||||||
Retail equipment and related sales costs |
| 52,628 | 21,745 | | 74,373 | |||||||||||||||
Retail service costs |
| 59,893 | 36,047 | | 95,940 | |||||||||||||||
Retail supplies and rental costs |
| 15,178 | 5,436 | | 20,614 | |||||||||||||||
Wholesale costs |
| | 20,132 | | 20,132 | |||||||||||||||
Total cost of sales |
| 127,699 | 83,360 | | 211,059 | |||||||||||||||
Gross profit |
| 79,871 | 40,151 | | 120,022 | |||||||||||||||
Operating expenses: |
||||||||||||||||||||
Selling, general and administrative expenses |
1,218 | 71,701 | 35,801 | | 108,720 | |||||||||||||||
Restructuring charges (credits) |
| 11,914 | 8,132 | | 20,046 | |||||||||||||||
Equity (income) loss |
29,242 | 12,783 | 3,148 | (45,173 | ) | | ||||||||||||||
Other (income) expense, net |
(12,202 | ) | 2,642 | 11,421 | | 1,861 | ||||||||||||||
Total operating expenses |
18,258 | 99,040 | 58,502 | (45,173 | ) | 130,627 | ||||||||||||||
Operating earnings (loss) |
(18,258 | ) | (19,169 | ) | (18,351 | ) | 45,173 | (10,605 | ) | |||||||||||
Interest expense |
(6,626 | ) | (671 | ) | (16,830 | ) | 16,196 | (7,931 | ) | |||||||||||
Interest income |
16,195 | 559 | (129 | ) | (16,196 | ) | 429 | |||||||||||||
Earnings (loss) before income taxes |
(8,689 | ) | (19,281 | ) | (35,310 | ) | 45,173 | (18,107 | ) | |||||||||||
Provision (benefit) for income taxes |
8,252 | (1,204 | ) | (8,214 | ) | | (1,166 | ) | ||||||||||||
Net earnings (loss) |
$ | (16,941 | ) | $ | (18,077 | ) | $ | (27,096 | ) | $ | 45,173 | $ | (16,941 | ) | ||||||
25
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands)
(Unaudited)
Supplemental Consolidating Statement of Operations For the Nine Months Ended December 31, 2004 |
||||||||||||||||||||
Parent Company (1) |
Subsidiary Guarantors (2) |
Subsidiary Non- Guarantors |
Eliminations |
Consolidated Total |
||||||||||||||||
Revenue: |
||||||||||||||||||||
Retail equipment and related sales |
$ | | $ | 211,802 | $ | 114,307 | $ | | $ | 326,109 | ||||||||||
Retail service |
| 294,028 | 161,133 | | 455,161 | |||||||||||||||
Retail supplies and rentals |
| 59,468 | 22,004 | | 81,472 | |||||||||||||||
Wholesale |
| | 70,020 | | 70,020 | |||||||||||||||
Total revenue |
| 565,298 | 367,464 | | 932,762 | |||||||||||||||
Costs of sales: |
||||||||||||||||||||
Retail equipment and related sales costs |
| 135,601 | 76,312 | | 211,913 | |||||||||||||||
Retail service costs |
| 171,032 | 99,105 | | 270,137 | |||||||||||||||
Retail supplies and rental costs |
| 36,036 | 12,257 | | 48,293 | |||||||||||||||
Wholesale costs |
| | 57,877 | | 57,877 | |||||||||||||||
Total cost of sales |
| 342,669 | 245,551 | | 588,220 | |||||||||||||||
Gross profit |
| 222,629 | 121,913 | | 344,542 | |||||||||||||||
Operating expenses: |
||||||||||||||||||||
Selling, general and administrative expenses |
3,987 | 222,536 | 108,799 | | 335,322 | |||||||||||||||
Restructuring charges (credits) |
| 1,483 | (3,942 | ) | | (2,459 | ) | |||||||||||||
Equity (income) loss |
(27,761 | ) | (20,561 | ) | (42,149 | ) | 90,471 | | ||||||||||||
Other (income) expense, net |
4,559 | (14,775 | ) | (41,344 | ) | 53,608 | 2,048 | |||||||||||||
Total operating expenses |
(19,215 | ) | 188,683 | 21,364 | 144,079 | 334,911 | ||||||||||||||
Operating earnings (loss) |
19,215 | 33,946 | 100,549 | (144,079 | ) | 9,631 | ||||||||||||||
Interest expense |
(20,201 | ) | (2,975 | ) | (8,233 | ) | 8,146 | (23,263 | ) | |||||||||||
Interest income |
4,023 | 2,147 | 2,790 | (8,146 | ) | 814 | ||||||||||||||
Earnings (loss) before income taxes |
3,037 | 33,118 | 95,106 | (144,079 | ) | (12,818 | ) | |||||||||||||
Provision (benefit) for income taxes |
| 4,820 | (20,675 | ) | | (15,855 | ) | |||||||||||||
Net earnings (loss) |
$ | 3,037 | $ | 28,298 | $ | 115,781 | $ | (144,079 | ) | $ | 3,037 | |||||||||
26
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands)
(Unaudited)
Supplemental Consolidating Statement of Operations For the Nine Months Ended December 31, 2003 |
||||||||||||||||||||
Parent (1) |
Subsidiary Guarantors (2) |
Subsidiary Non - Guarantors |
Eliminations |
Consolidated Total |
||||||||||||||||
Revenue: |
||||||||||||||||||||
Retail equipment and related sales |
$ | | $ | 241,345 | $ | 101,263 | $ | | $ | 342,608 | ||||||||||
Retail service |
| 316,500 | 161,217 | | 477,717 | |||||||||||||||
Retail supplies and rentals |
| 72,137 | 25,039 | | 97,176 | |||||||||||||||
Wholesale |
| | 70,328 | | 70,328 | |||||||||||||||
Total revenue |
| 629,982 | 357,847 | | 987,829 | |||||||||||||||
Costs of sales: |
||||||||||||||||||||
Retail equipment and related sales costs |
| 160,533 | 65,727 | | 226,260 | |||||||||||||||
Retail service costs |
| 181,871 | 102,473 | | 284,344 | |||||||||||||||
Retail supplies and rental costs |
| 43,005 | 14,617 | | 57,622 | |||||||||||||||
Wholesale costs |
| | 56,832 | | 56,832 | |||||||||||||||
Total cost of sales |
| 385,409 | 239,649 | | 625,058 | |||||||||||||||
Gross profit |
| 244,573 | 118,198 | | 362,771 | |||||||||||||||
Operating expenses: |
||||||||||||||||||||
Selling, general and administrative expenses |
3,284 | 239,274 | 103,764 | | 346,322 | |||||||||||||||
Restructuring charges (credits) |
| 11,914 | 7,538 | | 19,452 | |||||||||||||||
Equity (income) loss |
47,975 | 10,816 | (17,410 | ) | (41,381 | ) | | |||||||||||||
Other (income) expense, net |
(22,879 | ) | 528 | 24,002 | | 1,651 | ||||||||||||||
Total operating expenses |
28,380 | 262,532 | 117,894 | (41,381 | ) | 367,425 | ||||||||||||||
Operating earnings (loss) |
(28,380 | ) | (17,959 | ) | 304 | 41,381 | (4,654 | ) | ||||||||||||
Interest expense |
(22,332 | ) | (1,821 | ) | (48,412 | ) | 46,812 | (25,753 | ) | |||||||||||
Interest income |
46,811 | 874 | 105 | (46,812 | ) | 978 | ||||||||||||||
Write-off of debt issuance costs |
(20,562 | ) | | | | (20,562 | ) | |||||||||||||
Earnings (loss) before income taxes |
(24,463 | ) | (18,906 | ) | (48,003 | ) | 41,381 | (49,991 | ) | |||||||||||
Provision (benefit) for income taxes |
10,533 | (11,512 | ) | (14,016 | ) | | (14,995 | ) | ||||||||||||
Net earnings (loss) |
$ | (34,996 | ) | $ | (7,394 | ) | $ | (33,987 | ) | $ | 41,381 | $ | (34,996 | ) | ||||||
27
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands)
(Unaudited)
Supplemental Consolidating Balance Sheet Information December 31, 2004 |
||||||||||||||||||||
Parent Company (1) |
Subsidiary Guarantors (2) |
Non - Guarantors (3) |
Eliminations |
Consolidated Total |
||||||||||||||||
Assets |
||||||||||||||||||||
Current assets: |
||||||||||||||||||||
Cash and cash equivalents |
$ | 6,619 | $ | 31,088 | $ | 51,547 | $ | | $ | 89,254 | ||||||||||
Accounts receivable, net |
| 136,246 | 115,348 | | 251,594 | |||||||||||||||
Inventories |
| 60,482 | 58,240 | | 118,722 | |||||||||||||||
Due (to)/from affiliate |
(580,948 | ) | 430,274 | 146,629 | 4,045 | | ||||||||||||||
Prepaid expenses, deferred income taxes and other current assets |
1,036 | 6,526 | 10,783 | | 18,345 | |||||||||||||||
Total current assets |
(573,293 | ) | 664,616 | 382,547 | 4,045 | 477,915 | ||||||||||||||
Equipment on operating leases, net |
| 14,042 | 10,160 | | 24,202 | |||||||||||||||
Property and equipment, net |
31 | 47,511 | 7,279 | | 54,821 | |||||||||||||||
Goodwill, net |
| 145,980 | 156,841 | | 302,821 | |||||||||||||||
Other intangible assets, net |
| 2,300 | 172 | | 2,472 | |||||||||||||||
Investment in subsidiaries |
1,052,263 | 149,834 | 1,054,996 | (2,257,093 | ) | | ||||||||||||||
Deferred income taxes |
| 3,461 | 4,520 | | 7,981 | |||||||||||||||
Other assets |
4,651 | 14,743 | 5,821 | | 25,215 | |||||||||||||||
Total assets |
$ | 483,652 | $ | 1,042,487 | $ | 1,622,336 | $ | (2,253,048 | ) | $ | 895,427 | |||||||||
Liabilities and shareholders equity (deficit) |
||||||||||||||||||||
Current liabilities: |
||||||||||||||||||||
Current maturities of long-term debt and notes payable |
$ | | $ | 1,428 | $ | 2,757 | $ | | $ | 4,185 | ||||||||||
Accounts payable |
81 | 92,808 | 75,575 | | 168,464 | |||||||||||||||
Accrued expenses and other current liabilities |
4,041 | 52,675 | 37,364 | | 94,080 | |||||||||||||||
Taxes payable |
40 | (7,372 | ) | 43,466 | | 36,134 | ||||||||||||||
Deferred revenue |
| 25,140 | 18,942 | | 44,082 | |||||||||||||||
Total current liabilities: |
4,162 | 164,679 | 178,104 | | 346,945 | |||||||||||||||
Long-term debt and notes payables, less current maturities |
236,057 | 2,980 | 811 | | 239,848 | |||||||||||||||
Deferred income taxes and other long-term liabilities |
| 43,242 | 21,959 | | 65,201 | |||||||||||||||
Total liabilities |
240,219 | 210,901 | 200,874 | | 651,994 | |||||||||||||||
6.5% convertible participating shares |
294,716 | | | | 294,716 | |||||||||||||||
Shareholders equity (deficit) |
||||||||||||||||||||
Ordinary shares |
5,268 | 1,188,957 | 236,949 | (1,425,906 | ) | 5,268 | ||||||||||||||
Additional paid-in capital |
328,876 | 26,729 | 441,594 | (468,323 | ) | 328,876 | ||||||||||||||
Retained earnings (accumulated deficit) |
(354,657 | ) | (465,613 | ) | 899,393 | (433,780 | ) | (354,657 | ) | |||||||||||
Accumulated other comprehensive (loss) income |
(30,770 | ) | 81,513 | (156,474 | ) | 74,961 | (30,770 | ) | ||||||||||||
Total shareholders equity (deficit) |
(51,283 | ) | 831,586 | 1,421,462 | (2,253,048 | ) | (51,283 | ) | ||||||||||||
Total liabilities & shareholders equity (deficit) |
$ | 483,652 | $ | 1,042,487 | $ | 1,622,336 | $ | (2,253,048 | ) | $ | 895,427 | |||||||||
28
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands)
(Unaudited)
Supplemental Consolidating Balance Sheet Information March 31, 2004 |
||||||||||||||||||||
Parent Company (1) |
Subsidiary Guarantors (2) |
Non Guarantors (3) |
Eliminations |
Consolidated Total |
||||||||||||||||
Assets |
||||||||||||||||||||
Current assets: |
||||||||||||||||||||
Cash and cash equivalents |
$ | 68,389 | $ | 22,092 | $ | 22,309 | $ | | $ | 112,790 | ||||||||||
Accounts receivable, net |
| 131,432 | 115,564 | | 246,996 | |||||||||||||||
Inventories |
| 48,239 | 45,056 | | 93,295 | |||||||||||||||
Due (to)/from affiliate |
(607,012 | ) | 483,128 | 119,839 | 4,045 | | ||||||||||||||
Prepaid expenses, deferred income taxes and other current assets |
932 | 6,580 | 9,350 | | 16,862 | |||||||||||||||
Total current assets |
(537,691 | ) | 691,471 | 312,118 | 4,045 | 469,943 | ||||||||||||||
Equipment on operating leases, net |
| 18,130 | 11,348 | | 29,478 | |||||||||||||||
Property and equipment, net |
27 | 58,736 | 7,125 | | 65,888 | |||||||||||||||
Goodwill, net |
| 144,144 | 138,286 | | 282,430 | |||||||||||||||
Other intangible assets, net |
| 2,168 | 172 | | 2,340 | |||||||||||||||
Investment in subsidiaries |
993,301 | 114,351 | 854,497 | (1,962,149 | ) | | ||||||||||||||
Deferred income taxes |
| 7,688 | | | 7,688 | |||||||||||||||
Other assets |
5,428 | 14,673 | 5,700 | | 25,801 | |||||||||||||||
Total assets |
$ | 461,065 | $ | 1,051,361 | $ | 1,329,246 | $ | (1,958,104 | ) | $ | 883,568 | |||||||||
Liabilities and shareholders equity (deficit) |
||||||||||||||||||||
Current liabilities: |
||||||||||||||||||||
Current maturities of long-term debt and notes payable |
$ | | $ | 1,315 | $ | 1,897 | $ | | $ | 3,212 | ||||||||||
Accounts payable |
95 | 83,219 | 52,146 | | 135,460 | |||||||||||||||
Accrued expenses and other current liabilities |
10,559 | 73,368 | 45,036 | | 128,963 | |||||||||||||||
Taxes payable |
(169 | ) | 59,753 | (12,384 | ) | | 47,200 | |||||||||||||
Deferred revenue |
| 24,941 | 20,149 | | 45,090 | |||||||||||||||
Total current liabilities: |
10,485 | 242,596 | 106,844 | | 359,925 | |||||||||||||||
Long-term debt and notes payables, less current maturities |
235,727 | 3,814 | 1,220 | | 240,761 | |||||||||||||||
Deferred income taxes and other long-term liabilities |
| 52,801 | 15,228 | | 68,029 | |||||||||||||||
Total liabilities |
246,212 | 299,211 | 123,292 | | 668,715 | |||||||||||||||
6.5% convertible participating shares |
279,608 | | | | 279,608 | |||||||||||||||
Shareholders equity (deficit) |
||||||||||||||||||||
Ordinary shares |
5,194 | 1,188,947 | 237,022 | (1,425,969 | ) | 5,194 | ||||||||||||||
Additional paid-in capital |
328,070 | 26,743 | 442,065 | (468,808 | ) | 328,070 | ||||||||||||||
Retained earnings (accumulated deficit) |
(342,586 | ) | (491,934 | ) | 822,105 | (330,171 | ) | (342,586 | ) | |||||||||||
Accumulated other comprehensive (loss) income |
(55,433 | ) | 28,394 | (295,238 | ) | 266,844 | (55,433 | ) | ||||||||||||
Total shareholders equity (deficit) |
(64,755 | ) | 752,150 | 1,205,954 | (1,958,104 | ) | (64,755 | ) | ||||||||||||
Total liabilities & shareholders equity (deficit) |
$ | 461,065 | $ | 1,051,361 | $ | 1,329,246 | $ | (1,958,104 | ) | $ | 883,568 | |||||||||
29
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands)
(Unaudited)
Supplemental Condensed Consolidating Statement of Cash Flows For the Nine Months Ended December 31, 2004 |
|||||||||||||||||||
Parent Company (1) |
Subsidiary Guarantors (2) |
Subsidiary Guarantors |
Eliminations |
Consolidated Total |
|||||||||||||||
Net cash provided by (used in) operating activities |
$ | (62,650 | ) | $ | 19,071 | $ | 35,799 | $ | | $ | (6,980 | ) | |||||||
Investing activities |
|||||||||||||||||||
Capital expenditures |
| (7,938 | ) | (8,354 | ) | | (16,292 | ) | |||||||||||
Purchase of subsidiary, net of cash acquired |
| (2,110 | ) | | | (2,110 | ) | ||||||||||||
Proceeds from sale of subsidiary |
| 62 | 147 | | 209 | ||||||||||||||
Proceeds from the sale of property and equipment |
| 84 | 229 | | 313 | ||||||||||||||
Net cash used in investing activities |
| (9,902 | ) | (7,978 | ) | | (17,880 | ) | |||||||||||
Financing activities |
|||||||||||||||||||
Net borrowings (payments) of debt |
| (1,180 | ) | (108 | ) | | (1,288 | ) | |||||||||||
Proceeds from stock options exercised |
880 | | | | 880 | ||||||||||||||
Net cash provided by (used in) financing activities |
880 | (1,180 | ) | (108 | ) | | (408 | ) | |||||||||||
Effect of exchange rates |
| 207 | 1,525 | | 1,732 | ||||||||||||||
Net increase (decrease) in cash and cash equivalents |
(61,770 | ) | 8,996 | 29,238 | | (23,536 | ) | ||||||||||||
Cash and cash equivalents, beginning of period |
68,389 | 22,092 | 22,309 | | 112,790 | ||||||||||||||
Cash and cash equivalents, end of period |
$ | 6,619 | $ | 31,088 | $ | 51,547 | $ | | $ | 89,254 | |||||||||
30
Danka Business Systems PLC
Notes to Consolidated Financial Statements
(in thousands)
(Unaudited)
Supplemental Condensed Consolidating Statement of Cash Flows For the Nine Months Ended December 31, 2003 |
|||||||||||||||||||
Parent Company (1) |
Subsidiary Guarantors (2) |
Subsidiary Non - Guarantors |
Eliminations |
Consolidated Total |
|||||||||||||||
Net cash provided by (used in) operating activities |
$ | (16,350 | ) | $ | 37,746 | $ | 30,877 | $ | | $ | 52,273 | ||||||||
Investing activities |
|||||||||||||||||||
Capital expenditures |
| (26,226 | ) | (9,646 | ) | | (35,872 | ) | |||||||||||
Proceeds from the sale of property and equipment |
| 403 | 303 | | 706 | ||||||||||||||
Net cash used in investing activities |
| (25,823 | ) | (9,343 | ) | | (35,166 | ) | |||||||||||
Financing activities |
|||||||||||||||||||
Net borrowings (payments) of debt |
10,715 | 2,070 | (1,271 | ) | | 11,514 | |||||||||||||
Payment of debt issue costs |
(10,767 | ) | | | | (10,767 | ) | ||||||||||||
Net cash provided by (used in) financing activities |
(52 | ) | 2,070 | (1,271 | ) | | 747 | ||||||||||||
Effect of exchange rates |
| 1,117 | 4,591 | | 5,708 | ||||||||||||||
Net increase (decrease) in cash and cash equivalents |
(16,402 | ) | 15,110 | 24,854 | | 23,562 | |||||||||||||
Cash and cash equivalents, beginning of period |
42,709 | 13,898 | 24,886 | | 81,493 | ||||||||||||||
Cash and cash equivalents, end of period |
$ | 26,307 | $ | 29,008 | $ | 49,740 | $ | | $ | 105,055 | |||||||||
(1) | Danka Business Systems PLC |
(2) | Subsidiary Guarantors include the following subsidiaries: |
| Danka Australasia Pty Limited, Danka Australia Pty Limited, Danka Tower Pty Ltd, Danka Distributors Pty Ltd, Danka Datakey Pty Ltd, Datakey Alcatel Pty. Ltd. and Danka Systems Pty Limited, representing all of the Companys Australian Subsidiaries; |
| Danka Business Finance Ltd., Danka Canada Inc. and Kalmara Inc., representing all of our Canadian subsidiaries; |
| Dankalux S.à r.L., a Luxembourg subsidiary; |
| Danka UK Plc, the Companys primary UK operating subsidiary, and Danka Services International Ltd., a UK subsidiary; and |
| Danka Holding Company, American Business Credit Corporation, Danka Management II Company, Inc., Herman Enterprises, Inc. of South Florida, D.I. Investment Management, Inc., Quality Business, Inc., Danka Management Company, Inc., Corporate Consulting Group, Inc., Danka Imaging Distribution, Inc. and Danka Office Imaging Company, which represent all of the Companys United States Subsidiaries other than certain dormant entities. |
(3) | Subsidiaries of Danka Business Systems PLC other than Subsidiary Guarantors |
31
Note 11. Subsequent Events
On February 4, 2005, the Company announced plans to eliminate inefficiencies in its field operations, and to reduce its selling, general and administrative costs by eliminating and consolidating back office functions and exiting certain facilities. The Company plans to take a charge to earnings of $20 million to $30 million over the next several quarters, with severance costs of between $17 million to $25 million, and facilities costs of between $3 million to $5 million.
32
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
Dankas mission is to deliver value to clients worldwide by using our expert sales, technical and professional services to implement effective document information solutions and services. Our product portfolio is designed to enable choice, convenience, custom cost management and continuity. Our vision is to empower our customers to benefit fully from the convergence of image and document technologies in a connected environment. This approach will strengthen our client relationships and expand Dankas strategic value.
Our strategy to accomplish our mission is to:
| enhance customer relationships; |
| grow revenues by providing value-added and cost-driven solutions and services; |
| re-engineer processes and systems; |
| maximize free cash flow generation and reduce net debt; and |
| develop an efficient and productive organization. |
Based on revenue, we are one of the largest independent providers of office imaging equipment, document solutions and related services and supplies in the United States and Europe. We offer a wide range of state of the art office imaging products, peripherals and solutions that primarily include digital and color copiers, digital and color multi-function peripherals (MFPs), facsimile machines and software. We also provide a wide range of contract services, including professional and consulting services, maintenance, supplies, leasing arrangements, technical support and training on the installed base of equipment created primarily by our retail equipment and related sales and have increased our contract services to include multi-vendor equipment and comprehensive solutions to companies printing needs.
We currently operate in over 20 countries. Our reportable segments are the Americas and Europe/Australia, both of which include operations that are experiencing political, social and/or economic difficulty. We continue to evaluate the viability and future prospects of the operations in certain countries in light of uncertain conditions. Based on these evaluations, during the quarter ended December 31, 2004, we implemented plans to exit operations in Portugal and Russia. The impact of these exit plans is immaterial to our business, financial condition, results of operations and our competitive position. Should we decide to downsize or exit any of our other operations in the future, we could incur costs in respect of severance and closure of facilities and we may also be required to realize cumulative translation losses and minimum pension liabilities that would reduce our earnings, all or any of which may have a material impact on our operating results.
Critical Accounting Policies and Estimates
Allowance for Doubtful AccountsWe provide an allowance on our accounts receivable for estimated losses. Our estimates are based upon the aging of our accounts receivable and expected credits to our customers due to billing disputes and inaccuracies and bad debts. If the financial condition of any of our customers were to deteriorate and result in the impairment of their ability to make payments to us or if actual credits exceed estimated credits, an additional allowance may be required.
The following table summarizes our net accounts receivable:
December 31, 2004 |
March 31, 2004 |
|||||||
Accounts receivable, gross |
$ | 294,263 | $ | 294,249 | ||||
Allowance for doubtful accounts |
(42,669 | ) | (47,253 | ) | ||||
Accounts receivable, net |
$ | 251,594 | $ | 246,996 | ||||
Allowance for doubtful accounts as a % of gross accounts receivable |
14.5 | % | 16.1 | % |
33
InventoriesWe acquire inventory based on our projections of future demand and market conditions. Any unexpected decline in demand and/or rapid product improvements or technological changes may cause us to have excess and/or obsolete inventories. We have provided appropriate reserves against these inventory items in current and prior periods. On an ongoing basis, we review for estimated obsolete or unmarketable inventories and write-down our inventories to their estimated net realizable value based upon our forecasts of future demand and market conditions using historical trends and analysis. If actual market conditions are less favorable than our forecasts due, in part, to a greater acceleration within the industry to digital office imaging equipment, additional inventory write-downs may be required. Our estimates are influenced by a number of considerations including, but not limited to, the following: decline in demand due to economic downturns, rapid product improvements and technological changes, and our ability to return to vendors a certain percentage of our purchases.
Revenue RecognitionWholesale and retail equipment and related sales are recognized upon acceptance of delivery by the customer. In the case of equipment sales financed by third party finance/leasing companies, retail equipment and related sales are recognized upon acceptance of delivery by the customer and credit acceptance by the finance/leasing company, if later. In addition, for the sale of certain digital equipment that requires a comprehensive setup by us before it can be used by a customer, such as a Heidelberg 9110/9150 or equivalent type of equipment, revenue is recognized upon acceptance of delivery and installation by the customer and written confirmation of installation by a company representative. Supply sales to customers are recognized at the time of shipment unless supply sales are included in a service contract, in which case supply sales are recognized upon equipment usage by the customer.
Rental operating lease income is recognized straight-line over the lease term. Retail service revenues, which include TechSource service contract revenues, are generally recognized ratably over the term of the underlying maintenance contracts. Under the terms of the retail service contract, the customer is billed a flat periodic charge and/or a usage-based fee. We record revenue for the flat periodic charge each period and for actual or estimated usage every period.
Deferred Income TaxesAs part of the process of preparing our consolidated financial statements, we have to estimate our income and corporation taxes in each of the taxing jurisdictions in which we operate. This process involves estimating our actual current tax expense and loss carryforwards together with assessing any temporary differences resulting from the different treatment of certain items, such as the timing for recognizing revenues and expenses for tax and accounting purposes. These differences and loss carryforwards may result in deferred tax assets and liabilities, which are included in our consolidated balance sheet.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Our past financial performance is a significant factor which contributes to our inability, pursuant to Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109), to use projections of future taxable income in assessing the realizability of deferred tax assets. Management therefore is limited to considering the scheduled reversal of deferred tax liabilities and tax planning strategies in making this assessment. Due to the inability to use projections of future taxable income in making its assessment, management concluded that it is not more likely than not we will realize the benefits of the deferred tax assets at December 31, 2004. We have a valuation allowance against net deferred tax assets in most jurisdictions at December 31, 2004.
In addition, we operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions. These audits can involve complex issues, which may require an extended period of time to resolve. In managements opinion, adequate provisions for income and corporation taxes have been made for all years.
GoodwillWe review our goodwill and indefinite-lived intangible assets annually for possible impairment, or more frequently if impairment indicators arise. Separable intangible assets that have finite lives are amortized over their estimated useful lives.
34
We had goodwill of $302.8 million as of December 31, 2004. If it is determined under Statement of Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets (SFAS 142), that our goodwill is impaired, we will be required to write-down the value of such goodwill in amounts that could have a material impact on our operations.
We performed our annual impairment test during the fourth quarter of our fiscal year 2004, under the requirements of SFAS 142. Based on the results of that impairment test, no adjustments for impairment were necessary.
Accounting for Stock Based CompensationAs permitted by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), we account for our stock option plans under the intrinsic value recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As the exercise prices of all options granted under these plans were equal to the market price of the underlying American Depository Shares (ADS) on the grant date, no stock-based employee compensation expense was recognized in net earnings. In general, these options expire in ten years and vest over three years. The proceeds from options exercised are credited to shareholders equity (deficit), net of related tax benefits.
For disclosure purposes we compute the impact to earnings (loss) of stock-based compensation using the Black-Scholes option pricing model. SFAS 123 allows the use of option pricing models that were not developed for use in valuing employee stock options. The Black-Scholes option pricing model was developed for use in estimating the fair value of short-lived exchange traded options that have no vesting restrictions and are fully transferable. In addition, option pricing models require the input of highly subjective assumptions, including the options expected life and price volatility of the underlying stock. Because our stock options have characteristics significantly different from those traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in the opinion of management, the existing model does not necessarily provide a reliable single measure of the fair value of employee stock options.
In December 2004, the FASB issued FASB Statement No. 132B, Share-Based Payment (SFAS 132R), which revises SFAS 123 and supersedes APB 25, and its related guidance. SFAS 132R requires public entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award in the statement of operations. Pro forma disclosure is no longer allowable under the new standard. Adoption of SFAS 123R is required as of the beginning of the first interim reporting period that begins after June 15, 2005. We have not yet assessed the impact the adoption of SFAS 123R will have on our consolidated financial statements.
Restructuring ChargesWe recognized restructuring charges for the consolidation of back office functions, exiting non-strategic real estate facilities and reducing headcount. These charges were recorded pursuant to formal plans developed and approved by management. The recognition of restructuring charges requires that we make certain judgments and estimates regarding the nature, timing and amount of costs associated with these plans. The estimates of future liabilities may change, requiring additional restructuring charges or the reduction of liabilities already recorded. At the end of each reporting period, we evaluate the remaining accrued balances to ensure that no excess accruals are retained and the utilization of the provisions are for their intended purpose in accordance with the restructuring programs. For further discussion of our restructuring programs, refer to Note 4Restructuring Charges (Credits) to the Consolidated Financial Statements and Managements Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital Resources.
35
All tables presented herein are in thousands unless otherwise noted.
Financial Condition
December 31, 2004 |
March 31, 2004 |
|||||||
Total assets |
$ | 895,427 | $ | 883,568 | ||||
Total liabilities |
$ | 651,994 | $ | 668,715 | ||||
Working capital |
$ | 130,970 | $ | 110,018 | ||||
Liabilities to liabilities and capital |
73 | % | 76 | % | ||||
Inventory turnover ratio |
4 | x | 5 | x |
Total assets as of December 31, 2004 increased $11.9 million or 1.3%, from March 31, 2004. This increase was primarily from increases in inventory of $25.4 million due to an extension in our line of credit with vendors which allowed us to increase our inventory levels to meet customer demands in our European countries and goodwill of $20.4 million due to foreign currency movements offset by a decrease in property and equipment of $11.1 million due to the continuing depreciation of the assets and the decrease in capital spending during the year and a decrease in cash of $23.5 million to fund operations, including the acquisition of a regional print service provider.
Total liabilities decreased $16.7 million, or 2.5% primarily due to the payout of severance and facility lease obligations related to our 2004 Restructuring Plan and taxes payable offset by an increase in accounts payable due to the increase of inventory through the extension of our line of credit with vendors.
Working capital, defined as current assets less current liabilities, increased $21.0 million from March 31, 2004 primarily resulting from the increase in inventories and accounts receivable during the nine months ending December 31, 2004.
Liabilities to liabilities and capital decreased slightly at December 31, 2004 compared to March 31, 2004.
For the period ending December 31, 2004, our annualized inventory turnover ratio decreased to 4x compared from 5x at March 31, 2004. The decrease is due to an increase in inventory in Europe to meet customer demand. Inventory turnover ratio is calculated by dividing non-retail service cost of sales by ending inventory for the period.
Results of Operations
Certain prior year amounts have been reclassified to conform to current year presentation.
The following table sets forth, for the periods indicated, the percentage of total revenue represented by certain items in our Consolidated Statements of Operations:
For the Three Months Ended December 31, |
For the Nine Months Ended December 31, |
|||||||||||
2004 |
2003 |
2004 |
2003 |
|||||||||
Revenue: |
||||||||||||
Retail equipment and related sales |
35.6 | % | 34.6 | % | 35.0 | % | 34.7 | % | ||||
Retail service |
48.3 | 47.3 | 48.8 | 48.4 | ||||||||
Retail supplies and rentals |
8.0 | 10.6 | 8.7 | 9.8 | ||||||||
Wholesale |
8.1 | 7.5 | 7.5 | 7.1 | ||||||||
Total revenue |
100.0 | 100.0 | 100.0 | 100.0 | ||||||||
Cost of sales |
63.9 | 63.7 | 63.1 | 63.3 | ||||||||
Gross profit |
36.1 | 36.3 | 36.9 | 36.7 | ||||||||
Selling, general and administrative expenses |
37.1 | 32.8 | 35.9 | 35.1 | ||||||||
Restructuring charges (credits) |
(0.1 | ) | 6.1 | (0.2 | ) | 2.0 | ||||||
Other (income) expense |
0.5 | 0.6 | 0.2 | | ||||||||
36
For the Three Months Ended December 31, |
For the Nine Months Ended December 31, |
|||||||||||
2004 |
2003 |
2004 |
2003 |
|||||||||
Operating earnings (loss) |
(1.4 | ) | (3.2 | ) | 1.0 | (0.4 | ) | |||||
Interest expense |
(2.6 | ) | (2.4 | ) | (2.5 | ) | (2.6 | ) | ||||
Interest income |
0.1 | 0.1 | 0.1 | 0.1 | ||||||||
Write-off of debt issuance costs |
| | | (2.1 | ) | |||||||
Earnings (loss) before income taxes |
(3.9 | ) | (5.5 | ) | (1.4 | ) | (5.0 | ) | ||||
Provision (benefit) for income taxes |
(5.3 | ) | (0.4 | ) | (1.7 | ) | (1.5 | ) | ||||
Net earnings (loss) |
1.4 | % | (5.1 | )% | 0.3 | % | (3.5 | )% | ||||
The following table sets forth for the periods indicated the percentage of revenue change from the year-ago period:
For the Three Months Ended December 31, |
For the Nine Months Ended December 31, |
|||||||||||
2004 |
2003 |
2004 |
2003 |
|||||||||
Retail equipment and related sales |
(2.4 | )% | (5.9 | )% | (4.8 | )% | (2.1 | )% | ||||
Retail service |
(3.2 | ) | (10.1 | ) | (4.7 | ) | (9.2 | ) | ||||
Retail supplies and rentals |
(28.2 | ) | (0.3 | ) | (16.2 | ) | (8.9 | ) | ||||
Wholesale |
1.5 | 12.8 | (0.4 | ) | 14.5 | |||||||
Total revenue |
(5.2 | )% | (6.2 | )% | (5.6 | )% | (5.4 | )% | ||||
The following table sets forth for the periods indicated the gross profit margin percentage for each of our revenue classifications:
For the Three Months Ended December 31, |
For the Nine Months Ended December 31, |
|||||||||||
2004 |
2003 |
2004 |
2003 |
|||||||||
Retail equipment and related sales |
35.6 | % | 35.1 | % | 35.0 | % | 34.0 | % | ||||
Retail service |
38.8 | 38.7 | 40.7 | 40.5 | ||||||||
Retail supplies and rentals |
43.1 | 41.1 | 40.7 | 40.7 | ||||||||
Wholesale |
15.4 | 19.4 | 17.3 | 19.2 | ||||||||
Total gross profit margin |
36.1 | % | 36.3 | % | 36.9 | % | 36.7 | % | ||||
The following tables set forth for the periods indicated the revenue, gross profit, operating earnings (loss), capital expenditures and depreciation and amortization for each of our operating segments:
For the Three Months Ended |
For the Nine Months Ended | |||||||||||
December 31, 2004 |
December 31, 2003 |
December 31, 2004 |
December 31, 2003 | |||||||||
Revenues |
||||||||||||
Americas |
$ | 155,129 | $ | 180,328 | $ | 481,331 | $ | 539,797 | ||||
Europe/Australia |
158,654 | 150,753 | 451,431 | 447,998 | ||||||||
Other (1) |
| | | 34 | ||||||||
Total Revenues |
$ | 313,783 | $ | 331,081 | $ | 932,762 | $ | 987,829 | ||||
Gross Profit |
||||||||||||
Americas |
$ | 63,568 | $ | 70,662 | $ | 197,252 | $ | 216,092 | ||||
Europe/Australia |
49,722 | 48,845 | 147,290 | 146,142 | ||||||||
Other (1) |
| 515 | | 537 | ||||||||
Total Gross Profit |
$ | 113,290 | $ | 120,022 | $ | 344,542 | $ | 362,771 | ||||
37
For the Three Months Ended |
For the Nine Months Ended |
|||||||||||||||
December 31, 2004 |
December 31, 2003 |
December 31, 2004 |
December 31, 2003 |
|||||||||||||
Operating Earnings (Loss) |
||||||||||||||||
Americas |
$ | 4,586 | $ | 10,107 | $ | 22,063 | $ | 15,056 | ||||||||
Europe/Australia |
1,832 | 4,911 | 13,163 | 16,418 | ||||||||||||
Other (1) |
(10,649 | ) | (25,623 | ) | (25,595 | ) | (36,128 | ) | ||||||||
Total Operating Earnings (Loss) |
$ | (4,231 | ) | $ | (10,605 | ) | $ | 9,631 | $ | (4,654 | ) | |||||
Capital Expenditures |
||||||||||||||||
Americas |
$ | 3,551 | $ | 2,635 | $ | 7,145 | $ | 23,087 | ||||||||
Europe/Australia |
2,317 | 4,698 | 8,527 | 10,021 | ||||||||||||
Other (2) |
65 | (2,548 | ) | 620 | 2,764 | |||||||||||
Total Capital Expenditures |
$ | 5,933 | $ | 4,785 | $ | 16,292 | $ | 35,872 | ||||||||
For the Three Months Ended |
For the Nine Months Ended | |||||||||||
December 31, 2004 |
December 31, 2003 |
December 31, 2004 |
December 31, 2003 | |||||||||
Depreciation and Amortization |
||||||||||||
Americas |
$ | 6,633 | $ | 9,528 | $ | 20,071 | $ | 27,888 | ||||
Europe/Australia |
2,663 | 4,593 | 7,806 | 10,239 | ||||||||
Other (1) |
643 | 457 | 1,655 | 1,147 | ||||||||
Total Depreciation and Amortization |
$ | 9,939 | $ | 14,578 | $ | 29,532 | $ | 39,274 | ||||
(1) | Other primarily includes corporate expenses and foreign exchange gains/losses. |
(2) | Other includes corporate assets. |
The following table sets forth for the periods indicated the percentage of revenue change from the year-ago period for each of our operating segments:
For the Three Months Ended |
For the Nine Months Ended |
|||||||||||
December 31, 2004 |
December 31, 2003 |
December 31, 2004 |
December 31, 2003 |
|||||||||
Americas |
(14.0 | )% | (11.9 | )% | (10.8 | )% | (13.0 | )% | ||||
Europe/Australia |
5.2 | 1.6 | 0.8 | 5.8 |
The following tables set forth for the periods indicated the gross profit margin percentage and operating earnings margin percentages for each of our operating segments:
For the Three Months Ended |
For the Nine Months Ended |
|||||||||||
December 31, 2004 |
December 31, 2003 |
December 31, 2004 |
December 31, 2003 |
|||||||||
Gross profit margin |
||||||||||||
Americas |
41.0 | % | 39.2 | % | 41.0 | % | 40.0 | % | ||||
Europe/Australia |
31.3 | 32.4 | 32.6 | 32.6 | ||||||||
Operating earnings margin |
||||||||||||
Americas |
3.0 | % | 5.6 | % | 4.6 | % | 2.8 | % | ||||
Europe/Australia |
1.2 | 3.3 | 2.9 | 3.7 |
Three Months Ended December 31, 2004 compared to the Three Months Ended December 31, 2003
Revenue
Revenue includes customer purchases of office peripherals; professional, consulting and maintenance services; supplies; software and related support products; and leasing arrangements. Total revenue for the third
38
quarter of fiscal year 2005 declined by $17.3 million or 5.2% to $313.8 million compared to the year-ago quarter with the Americas segment down 14.0% and the Europe/Australia segment up 5.2%. This decrease was the result of a decline in retail service revenue due to a decline in machines in field (MIF) because of the continuing industry-wide conversion from analog-to-digital equipment and a decline in overall sales coverage in our Americas operations due to restructuring efforts aimed at reducing our cost structure and a decline in retail equipment and related sales revenue from our Americas Enterprise and National Accounts. Our total revenue in the current year third quarter was impacted by a $13.6 million positive foreign currency movement compared to the year-ago quarter, all of which was attributable to Europe/Australia. During the third quarter of fiscal year 2005, 49.4% of our revenue was generated by our Americas segment and 50.6% by our Europe/Australia segment.
Retail equipment and related sales revenue declined by $2.8 million or 2.4% to $111.8 million. The Americas segment was down $13.7 million or 18.9%. This decrease in the Americas segment is the result of our declining revenue streams from our Enterprise and National Accounts sales channels. This decline is primarily due to the maturation of existing accounts and increased competition in these channels. Our intentions are to make up for the shortfall by increasing sales coverage in certain of our Americas sales channels. We have had difficulty hiring and retaining qualified sales personnel. This may continue to hinder our progress in growing retail equipment and related sales revenue in the Americas segment.
Retail equipment and related sales revenue in the Europe/Australia segment was up $10.9 million or 25.7%. This increase in the Europe/Australia segment is attributed to positive foreign currency movement of $4.2 million or 10.1% during the current quarter. We are experiencing turn-over in our UK sales force which is impacting revenue in the segment. We have had difficulty hiring and retaining qualified sales personnel. This may continue to hinder our progress in growing retail equipment and related sales revenue in the Europe/Australia segment.
In line with the decrease in retail equipment and related sales revenue and the trend toward lower MIF, retail service revenue declined by $5.0 million or 3.2% to $151.5 million. The Americas segment was down $3.5 million or 3.9%. This decrease in the Americas segment is a direct result of the continued decline in our MIF and a decline in our average monthly per machine copy volumes. During fiscal year 2004, we strategically reduced the number of service personnel in the field which is causing some declines in our MIF and the revenue therefrom.
Retail service revenue in the Europe/Australia segment was down $1.6 million or 2.3%. This decline is primarily due to ongoing service declines in the UK, Germany and France as a result of reduced MIF due to a sales coverage decline and a de-emphasis on rental investments. This decrease was partially offset by a positive foreign currency movement of $5.5 million or 8.1%.
Retail supplies and rental revenue declined by $9.9 million or 28.2% to $25.1 million. The Americas segment was down $8.1 million or 40.9%. Supplies decreased $5.9 million in the Americas segment primarily due to the decline in our Kodak analog base. The Kodak base uses a proprietary supply product and that page volume is rapidly moving to digital, a natural but negative consequence of digital transition. Rental revenue for the quarter decreased $2.2 million due to strategic initiatives to de-emphasize investment in rental equipment as leases expire. This initiative reduces cash outlays for such equipment.
Retail supplies and rental revenue in the Europe/Australia segment was down $1.8 million or 11.7%. This decrease in total retail supplies and rental revenue for the Europe/Australia segment was primarily due to our strategic initiatives to de-emphasize investment in rental equipment as mentioned above. This decrease was partially offset by a positive foreign currency movement of $2.1 million or 6.9%.
Wholesale revenue for the third quarter of fiscal year 2005 increased slightly during the quarter ended December 31, 2004 compared to the year-ago quarter.
39
Gross Profit Margin
Our total gross profit margin, after costs of goods sold which primarily includes inventory, service labor and overhead, management costs and depreciation of equipment, remained relatively constant at 36.1% in the third quarter ended December 31, 2004 compared to 36.3% in the year-ago quarter. The gross profit margin for the Americas segment increased to 41.0% from 39.2% and the Europe/Australia segment decreased to 31.3% from 32.4%.
The retail equipment and related sales margin increased to 35.6% in the third quarter from 35.1% in the year-ago quarter. The smaller percentage of business coming from our Americas Enterprise and National Accounts, which generally are lower margin deals, contributed to our higher margins this quarter. However, we are experiencing increasing competition which is putting pressure on our margins.
Retail service margins remained stable at 38.8% in the third quarter versus 38.7% in the year-ago quarter.
Retail supplies and rental margins increased to 43.1% in the third quarter from 41.1% in the year-ago quarter. This increased primarily related to the de-emphasis on investment in rental equipment which resulted in lower depreciation costs for the quarter. The increase was partially offset by a decrease in supplies margins in the Americas segment due to the decline in our Kodak analog base which generally has higher margins.
Wholesale margins decreased to 15.4% in the third quarter from 19.4% in the year-ago quarter due to a shift toward lower margin business in an effort to win back customer loyalty resulting from poor execution on deliveries to customers due to back office constraints. Our conversion to the Oracle system in certain European locations will help to alleviate these constraints, even though we experienced some difficulties this quarter due to the implementation of the system.
Selling, General and Administrative Expenses
Selling, general and administrative expenses (SG&A) in the third quarter of fiscal year 2005 increased by $7.7 million or 7.1% from the year-ago quarter to $116.4 million. SG&A primarily consists of compensation and commissions, professional and consulting fees, selling and marketing expenses, facility rentals, depreciation on fixed assets and information systems related to general management functions. The current quarter included $3.1 million for outside resources relating to Sarbanes-Oxley compliance and $1.0 million for other consulting services. The year-ago quarter included a one-time favorable pension adjustment of $2.3 million. The foreign currency movement increased SG&A for the current quarter by 3.9% or $4.2 million. As a percentage of total revenue, SG&A expenses increased to 37.1% from 32.8%.
Restructuring Charges (Credits)
During the third quarter of fiscal 2004, we recorded a $20.0 million restructuring charge for severance related to our 2004 restructuring plan aimed at cost reductions.
Other (Income) Expense
Other expense was $1.5 million for the third quarter of fiscal year 2005 compared to other expense of $1.9 million in the year-ago quarter. Other expense consisted of a foreign currency loss of $0.4 million in the Europe/Australia segment in the current quarter and a loss of $1.1 million associated with our exit plans of our subsidiaries in Portugal and Russia. The prior year quarter included a $1.9 million write-off of trademark costs associated with the Kodak acquisition.
Operating Earnings (Loss)
For the third quarter of fiscal year 2005, the operating loss was $4.2 million compared to a loss of $10.6 million in the year-ago quarter. The prior year quarter included the restructuring charge of $20.0 million discussed above. The loss for the current quarter is attributable to lower revenues and higher SG&A costs.
40
Interest Expense
Interest expense increased by $0.2 million to $8.1 million for the third quarter of fiscal year 2005.
Income Taxes
We recorded an income tax benefit of $16.6 million in the third quarter of fiscal year 2005 compared to a benefit of $1.2 million in the prior year period. The tax benefit for the current quarter is primarily attributable to adjustments to tax liabilities and valuation allowance for prior periods of $19.8 million less tax expense attributable to current year results of $3.2 million. The adjustments primarily related to favorable settlements of tax audits in the Companys European operations, partially offset by increases in tax liabilities in the U.S. The Company recognized a tax expense on the current year operating loss due to the inability to recognize a tax benefit on the losses incurred in most jurisdictions.
Net Earnings (Loss)
For the third quarter of fiscal year 2005, we generated net income of $4.5 million compared to a net loss of $16.9 million in the year-ago quarter. The current quarter income includes the tax benefit attributable to the favorable tax settlements in foreign jurisdictions as discussed above. The net loss for the prior year quarter includes the restructuring charge of $20.0 million also discussed above.
After allowing for the dilutive effect of dividends on our participating shares, we generated a net loss available to common shareholders of $0.01 per ADS in the third quarter of fiscal year 2005 compared to a net loss available to common shareholders of $0.35 per ADS in the year-ago quarter.
Exchange Rates
Fluctuations in the exchange rates between the British pound sterling and the United States dollar affect the British pound sterling market price of our ordinary shares on the London Stock Exchange and the dollar market price of our American Depository Shares.
We operate in over 20 countries worldwide. Fluctuations in exchange rates between the United States dollar and the currencies in each of the countries in which we operate affect:
| the results of our international operations reported in United States dollars; and |
| the value of the net assets of our international operations reported in United States dollars. |
The results of operations are affected by the relative strength of currencies in the countries where our products are sold. During the third quarter of fiscal year 2005, 56.0% of our revenue was generated outside the United States with 50.6% of our revenues generated in Europe/Australia and 5.4% in the foreign locations of our Americas segment We generated 51.6% of our revenue for the third quarter of fiscal year 2004 outside the United States with 45.5% generated in Europe/Australia and 6.1% in the foreign locations of our Americas segment.
In comparing the average exchange rates between the third quarter of fiscal year 2005 and the year-ago period, the euro currency and the British pound sterling strengthened against the dollar by approximately 9.1% and 9.6%, respectively. The change in exchange rates positively impacted revenue by approximately $13.6 million and negatively impacted gross margins and SG&A expenses by $4.2 million in each category.
Our inter-company loans are subject to fluctuations in exchange rates between the United States dollar and the currencies in each of the countries in which we operate, primarily the euro and the British pound sterling. Based on the outstanding balance of our inter-company loans at December 31, 2004, an increase of 1% in the exchange rate for the euro and British pound sterling would cause a foreign exchange loss of approximately $0.3 million, while a decrease of 1% in the exchange rate of the euro and the British pound sterling would cause a foreign exchange gain of approximately $0.3 million.
Our results of operations and financial condition have been, and in the future may be, adversely affected by the fluctuations in foreign currencies and by translation of the financial statements of our non-United States
41
subsidiaries from local currencies to the United States dollar. Currently, we do not hedge our exposure to changes in foreign currency. Gains and losses included in the consolidated statements of operations from foreign currency transactions included a $0.4 million loss in the third quarter of fiscal year 2005. Gains and losses included in the consolidated statements of operations from foreign currency transactions included a $0.1 million gain in the third quarter of fiscal year 2004.
Nine Months Ended December 31, 2004 compared to the Nine Months Ended December 31, 2003
Revenue
Total revenue for the first nine months of fiscal year 2005 declined by $55.1 million or 5.6% to $932.8 million compared to the year-ago period with the Americas segment down 10.8% and the Europe/Australia segment up 0.8%. Our total revenue in the current year was impacted by a $36.4 million positive foreign currency movement compared to the year-ago period, all of which was attributable to Europe/Australia. During the first nine months of fiscal year 2005, 51.6% of our revenue was generated by our Americas segment and 48.4% by our Europe/Australia segment.
Retail equipment and related sales revenue declined by $16.5 million or 4.8% to $326.1 million. The Americas segment was down $22.1 million or 10.9%. This decrease in the Americas segment is the result of our declining revenue streams from our Americas Enterprise and National Accounts sales channels. This decline is primarily due to the maturation of existing accounts and increased competition in these channels. Our intentions are to make up for the shortfall by increasing sales coverage in certain of our Americas sales channels. We have had difficulty hiring and retaining qualified sales personnel. This may continue to hinder our progress in growing retail equipment and related sales revenue in the Americas segment.
Retail equipment and related sales revenue in the Europe/Australia segment was up $5.6 million or 4.1%. This increase in the Europe/Australia segment is attributed to a positive foreign currency movement of $11.4 million or 8.2% during the current period. Revenue in the current year was impacted by a change in vendor suppliers in Australia which caused a delay in shipments during the second quarter. We are experiencing turn-over in our UK sales force which is impacting revenue in the segment. We have had difficulty hiring and retaining qualified sales personnel. This may continue to hinder our progress in growing retail equipment and related sales revenue in the Europe/Australia segment.
In line with the decrease in retail equipment and related sales revenue, retail service revenue declined by $22.5 million or 4.7% to $455.2 million. The Americas segment was down 7.5%. This decrease in the Americas segment is a direct result of the continued decline in our MIF and a decline in our average monthly per machine copy volumes. During fiscal year 2004, we strategically reduced the number of service personnel in the field which is causing some declines in our MIF and the revenue therefrom.
Retail service revenue in the Europe/Australia segment was comparable to the prior year period after a positive foreign currency movement of $15.6 million or 7.9%. The positive currency movement was offset by ongoing service declines in the UK, Germany and France as a result of reduced MIF due to a sales coverage decline and a de-emphasis on rental investments.
Retail supplies and rental revenue declined by $15.7 million or 16.2% to $81.5 million. The Americas segment was down 27.1%. Supplies decreased $10.0 million in the Americas segment primarily due to the decline in our Kodak analog base. The Kodak base uses a proprietary supply product and that page volume is rapidly moving to digital, a natural but negative consequence of digital transition. Rental revenue for the period decreased $5.5 million due to strategic initiatives to de-emphasize investment in rental equipment as leases expire. This initiative reduces cash outlays for such equipment.
Retail supplies and rental revenue in the Europe/Australia segment was comparable to the prior period after a positive foreign currency movement of $3.5 million or 8.6% for Europe/Australia. The positive currency
42
movement was offset primarily by our strategic initiatives to de-emphasize investment rental equipment as mentioned above.
Wholesale revenue decreased by $0.3 million or 0.4% to $70.0 million.
Gross Profit Margin
Our total gross profit margin increased slightly to 36.9% for the nine months ended December 31, 2004 from 36.7% in the year-ago period. The increase in our gross profit margin is primarily due to the increase in margins during the first quarter of fiscal year 2005. The gross profit margin for the Americas segment increased to 41.0% from 40.0% and the Europe/Australia segment remained stable at 32.6%.
The retail equipment and related sales margin increased to 35.0% from 34.0% in the year-ago period primarily due to the shift in the mix of our sales toward higher margin equipment sales in all segments. The smaller percentage of business coming from our Americas Enterprise and National accounts, which generally are lower margin deals, contributed to our higher margins during the period. However, we are experiencing increasing competition which is putting pressure on our margins.
Retail service margins increased to 40.7% from 40.5% in the year-ago period primarily due to lower parts and labor costs.
Retail supplies and rental margins remained stable at 40.7%. Margins increased primarily related to the de-emphasis on investment in rental equipment which resulted in lower depreciation costs for the quarter. The increase was partially offset by a decrease in supplies margins in the Americas segment due to the decline in our Kodak analog base which generally has higher margins.
Wholesale margins decreased to 17.3% from 19.2% in the year-ago period due to a shift toward lower margin business in an effort to win back customer loyalty resulting from poor execution on deliveries to customers due to back office constraints. Our conversion to our Oracle system will help to alleviate these constraints, even though we experienced some difficulties due to the implementation of the system.
Selling, General and Administrative Expenses
Selling, general and administrative expenses (SG&A) decreased by $11.0 million or 3.2% from the year-ago period to $335.3 million due to ongoing cost reduction efforts and the progress in the implementation of our worldwide cost reduction program. The cost reduction program allowed us to reduce our compensation expense, lower our professional fees and lower our facility costs. The cost reduction efforts were partially offset by Sarbanes-Oxley compliance costs of $4.8 million for the period, $3.0 million relating to other consulting services and a foreign currency movement which increased SG&A by 3.2% or $11.3 million. As a percentage of total revenue, SG&A expenses increased to 35.9% from 35.1% due to lower revenues for the first nine months of fiscal year 2005.
Restructuring Charges (Credits)
In the first nine months of fiscal year 2004, we recorded a restructuring charge of $20.0 million aimed at cost reductions offset by a reduction in prior years restructuring plans of $0.6 million for severance due to employee attrition and a lower estimate of facility charges. In the first nine months of fiscal year 2005, we reversed $3.3 million of restructuring charges for severance due to employee attrition and a change in estimate relating to restructuring plans in our Europe/Australia segment partially offset by a higher estimate of facility charges in the U.S. In addition, during the first nine months of fiscal year 2005, we recorded a $0.9 million restructuring charge related to our 2005 restructuring plan aimed at further cost reductions.
Other (Income) Expense
Other expense was $2.0 million compared to other expense of $1.7 million in the year-ago period. Other expense consisted primarily of a foreign currency loss of $0.8 million and a loss associated with our exit plans of our subsidiaries in Portugal and Russia of $1.1 million. Other expense for the prior year period included a $1.9 million write-off of trademark costs associated with the Kodak acquisition offset by a foreign currency gain of $0.4 million.
43
Operating Earnings (Loss)
For the first nine months of fiscal year 2005, operating earnings were $9.6 million compared to a loss of $4.7 million in the year-ago period. This improvement was largely due to lower SG&A as discussed above offset by lower revenues for the period.
Interest Expense
Interest expense decreased by $2.5 million to $23.3 million. The decrease was due to a lower effective interest rate on our indebtedness in part because of the refinancing of our debt in July 2003.
Income Taxes
We recorded an income tax benefit of $15.9 million in the first nine months of fiscal year 2005 compared to a benefit of $15.0 million in the prior year period. The tax benefit for the current period is attributable to adjustments to tax liabilities and valuation allowance for prior periods of $19.0 million less tax expense attributable to current year results of $3.1 million. The adjustments primarily related to favorable settlements of tax audits in our European operations partially offset by increases in tax liabilities in the U.S. We recognized a tax expense on the current year operating loss due to the liability to recognize a tax benefit on the losses incurred in most jurisdictions. In the prior year period, we recognized an operating loss which generated an income tax benefit of $11.8 million. In addition, we reversed $3.2 million in foreign tax accruals in the prior year period.
Net Earnings (Loss)
For the first nine months of fiscal year 2005, we generated net income of $3.0 million compared to a net loss of $35.0 million in the year-ago period. During the year-ago period, we wrote off $20.6 million in debt issuance costs relating to the early repayment of our credit facility and incurred restructuring charges of $19.4 million.
After allowing for the dilutive effect of dividends on our participating shares, we generated a net loss available to common shareholders of $0.19 per ADS for the first nine months of fiscal year 2005 compared to a net loss available to common shareholders of $0.79 per ADS in the year-ago period.
Exchange Rates
Fluctuations in the exchange rates between the British pound sterling and the United States dollar affect the British pound sterling market price of our ordinary shares on the London Stock Exchange and the dollar market price of our American Depository Shares.
We operate in over 20 countries worldwide. Fluctuations in exchange rates between the United States dollar and the currencies in each of the countries in which we operate affect:
| the results of our international operations reported in United States dollars; and |
| the value of the net assets of our international operations reported in United States dollars. |
The results of operations are affected by the relative strength of currencies in the countries where our products are sold. During the first nine months of fiscal year 2005, 53.8% of our revenue was generated outside the United States with 48.4% of our revenues generated in Europe/Australia and 5.4% in the foreign locations of our Americas segment. We generated 51.1% of our revenue for the first nine months of fiscal year 2004 outside the United States with 45.4% generated in Europe/Australia and 5.7% in the foreign locations of our Americas segment.
In comparing the average exchange rates between the first nine months of fiscal year 2005 and the year-ago period, the euro currency and the British pound sterling strengthened against the dollar by approximately 8.0% and 11.4%, respectively. The change in exchange rates positively impacted revenue by $36.4 million and negatively impacted gross margins and SG&A expenses by $11.8 million and $11.3 million, respectively.
Our results of operations and financial condition have been, and in the future may be, adversely affected by the fluctuations in foreign currencies and by translation of the financial statements of our non-United States
44
subsidiaries from local currencies to the United States dollar. Currently, we do not hedge our exposure to changes in foreign currency. Gains and losses included in the consolidated statements of operations from foreign currency transactions included a $0.8 million loss in the first nine months of fiscal year 2005. Gains and losses included in the consolidated statements of operations from foreign currency transactions included a $0.4 million gain in the first nine months of fiscal year 2004.
Liquidity and Capital Resources
Our generation and use of cash is cyclical within a quarter. We generate a significant portion of our cash toward the end of each quarter while our use of cash is more evenly spread over the quarter with a greater use of cash toward the beginning of the quarter. In the first and third quarter of every fiscal year, we make interest payments of $12.9 million for the 10.0% subordinated notes and the 11.0% senior notes.
Cash provided by operations and cash on the balance sheet continue to be our primary source of funds to finance operating needs and capital expenditures. Our net cash flow used in operating activities was $7.0 million for the first nine months of fiscal year 2005 compared to cash flow provided by operating activities of $52.3 million for the first nine months of fiscal year 2004. The $59.3 million decrease in fiscal year 2005 operating cash flow was primarily due to restructuring cash payments of $17.5 million, the build up of inventory during the period and lower equipment and related sales revenues, lower collections on accounts receivable as a result of lower revenues and the application of credits to customers accounts of $6.1 million related to the project to validate customer accounts, partially offset by an increase in accounts payable due to the increase in inventory purchases.
Net cash flow used in investing activities was $17.9 million and $35.2 million for the first nine months of fiscal year 2005 and 2004, respectively. The decrease in fiscal year 2005 cash outlays for investing activities was primarily due to decreased spending for property and equipment related, in part, to the Vision 21 project and the new United States headquarters that were completed in fiscal year 2004, offset by the payment of $2.1 million for the acquisition of Image One, a regional print service provider.
Net cash flow used in financing activities was $0.4 million for the first nine months of fiscal year 2005 compared to net cash flow provided by financing activities of $0.7 million for the first nine months of fiscal year 2004. In fiscal year 2004, we refinanced our bank debt.
The Oracle ERP implementation has allowed us to issue customer statements in the United States and more readily reconcile customer accounts. The reconciliation of our United States customer accounts has resulted in the issuance of customer credits and refunds during the first nine months of the fiscal year. During the nine months ended December 31, 2004, we applied $5.0 million of credits to active accounts and refunded $1.1 million to customers.
Restructuring Charges (Credits)
Fiscal Year 2005 Charge: In fiscal year 2005, we formulated plans to continue to reduce our selling, general and administrative costs by reducing headcount in Europe/Australia. As part of these plans, we recorded a $0.9 million restructuring charge in fiscal year 2005. Cash outlays for the employee severance during the nine months ended December 31, 2004 were $0.8 million. The remaining liability of the 2005 restructuring charge, totaling $0.1 million is categorized within Accrued expenses and other current liabilities.
45
The following table summarizes the fiscal year 2005 restructuring charge:
2005 Restructuring Charge:
Fiscal 2005 Expense |
Cash Outlays |
Other Non-Cash Changes |
Reserve at December 31, 2004 | ||||||||||
Severance |
$ | 855 | $ | (733 | ) | 11 | $ | 133 | |||||
Future lease obligations on facility closures |
29 | (29 | ) | | | ||||||||
Total |
$ | 884 | $ | (762 | ) | $ | 11 | $ | 133 | ||||
On February 4, 2005, we announced plans to eliminate inefficiencies in our field operations, and to reduce our selling, general and administrative costs by eliminating and consolidating back office functions and exiting certain facilities. We estimate that this program will reduce operating expenses by $44 million to $51 million and cost of goods sold by $16 million to $22 million per year when fully implemented, and will result in a 12% decrease in the worldwide workforce. The actions needed to achieve these savings will be taken in steps over the next two to three quarters and are expected to require up to $37 million of cash. The payback on the cash usage is expected to be less than 12 months. We plan to take a charge to earnings of $20 million to $30 million over the next several quarters, with severance costs of between $17 million to $25 million, and facilities costs of between $3 million to $5 million.
Fiscal Year 2004 Charge: In fiscal year 2004, we formulated plans to significantly reduce our selling, general and administrative costs by consolidating its back-office functions in the United States, exiting non-strategic real estate facilities and reducing headcount in the Americas and Europe/Australia. As part of these plans, we recorded a $50.6 million restructuring charge in fiscal year 2004 that included $26.9 million related to severance for employees and $23.7 million related to future lease obligations for facilities that were vacated by March 31, 2004. These charges were accounted for under the provisions of Statement of Financial Accounting Standards No. 112, Employers Accounting for Postemployment Benefit (SFAS 112) and Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS 146). Cash outlays for the employee severance during the nine months ended December 31, 2004 were $10.1 million. Cash outlays for the remaining terms of the facility leases during the nine months ending December 31, 2004 were $6.4 million. If these leases are not terminated, our payments will continue through their respective terms unless otherwise disposed of. We reversed $2.5 million and $0.8 million of fiscal year 2004 severance and facility charges during the second and third quarter of fiscal year 2005, respectively as a result of employee attrition in its Americas and Europe/Australia segments, a change in restructuring plans in the Europe/Australia segment partially offset by a higher estimate of facility charges in the Americas. The remaining non-cash changes of $0.6 million relate to foreign currency movements. The remaining liability of the 2004 restructuring charge of $10.8 million and $11.2 million is categorized within Accrued expenses and other current liabilities and Deferred income taxes and other long-term liabilities, respectively.
The following table summarizes the fiscal year 2004 restructuring charge:
2004 Restructuring Charge:
Fiscal 2004 Expense |
Reserve at March 31, |
Cash Outlays |
Other Non-Cash Changes |
Reserve at December 31, 2004 | |||||||||||||
Severance |
$ | 26,910 | $ | 21,524 | $ | (10,079 | ) | $ | (4,385 | ) | $ | 7,060 | |||||
Future lease obligations on facility closures |
23,684 | 20,842 | (6,385 | ) | 434 | 14,891 | |||||||||||
Total |
$ | 50,594 | $ | 42,366 | $ | (16,464 | ) | $ | (3,951 | ) | $ | 21,951 | |||||
46
2004 Restructuring Severance Charge by Operating Segment:
Fiscal 2004 Expense |
Reserve at March 31, 2004 |
Cash Outlays |
Other Non-Cash Changes |
Reserve at December 31, 2004 | |||||||||||||
Americas |
$ | 8,768 | $ | 5,946 | $ | (4,356 | ) | $ | (916 | ) | $ | 674 | |||||
Europe/Australia |
17,957 | 15,393 | (5,675 | ) | (3,332 | ) | 6,386 | ||||||||||
Other |
185 | 185 | (48 | ) | (137 | ) | | ||||||||||
Total |
$ | 26,910 | $ | 21,524 | $ | (10,079 | ) | $ | (4,385 | ) | $ | 7,060 | |||||
2004 Restructuring Facility Charge by Operating Segment:
Fiscal 2004 Expense |
Reserve at March 31, 2004 |
Cash Outlays |
Other Non-Cash Changes |
Reserve at December 31, 2004 | |||||||||||||
Americas |
$ | 13,552 | $ | 10,840 | $ | (4,667 | ) | $ | 261 | $ | 6,434 | ||||||
Europe/Australia |
6,126 | 6,354 | (570 | ) | (266 | ) | 5,518 | ||||||||||
Other |
4,006 | 3,648 | (1,148 | ) | 439 | 2,939 | |||||||||||
Total |
$ | 23,684 | $ | 20,842 | $ | (6,385 | ) | $ | 434 | $ | 14,891 | ||||||
Fiscal Year 2002 Charge: Our fiscal year 2002 restructuring charge included $4.9 million related to severance for 355 employees in the Americas and Europe/Australia. Cash outlays for the reductions during the nine months ended December 31, 2004 were $0.2 million. The restructuring charge also included $6.1 million for future lease obligations on 39 facilities that were vacated by March 31, 2002. Due to a change in estimate, we reversed $0.5 million of fiscal year 2002 severance and facility charges during the first quarter of fiscal year 2004. The remaining liability of the 2002 restructuring charge is categorized within Accrued expenses and other current liabilities.
The following table summarizes the fiscal year 2002 restructuring charge:
2002 Restructuring Charge:
Fiscal 2002 Expense |
Reserve at March 31, 2004 |
Cash Outlays |
Other Non-Cash Changes |
Reserve at December 31, 2004 | ||||||||||||
Severance |
$ | 4,967 | $ | 132 | $ | (7 | ) | $ | 21 | $ | 146 | |||||
Future lease obligations on facility closures |
6,074 | 215 | (229 | ) | 14 | | ||||||||||
Total |
$ | 11,041 | $ | 347 | $ | (236 | ) | $ | 35 | $ | 146 | |||||
The remaining balance of the 2002 Restructuring Charge is for the Companys Europe/Australia operating segment.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements as defined under Item 303(a)(4) of Regulation S-K.
47
Contractual Obligations and Commitments
The following table summarizes our significant contractual obligations at December 31, 2004, and the effect such obligations are expected to have on our liquidity and cash flows in future periods.
Amount of contractual obligations per period | |||||||||||||||
Total |
Less than 1 year |
1 3 years |
4 5 years |
After 5 years | |||||||||||
Long-term debt 11.0% Notes |
$ | 175,000 | $ | | $ | | $ | | $ | 175,000 | |||||
Long-term debt 10.0% Notes |
64,520 | | | 64,520 | | ||||||||||
Capital lease obligations |
5,300 | 2,053 | 2,608 | 639 | | ||||||||||
Other long-term obligations |
2,675 | 2,132 | 264 | 67 | 212 | ||||||||||
Operating lease obligations |
56,089 | 16,890 | 24,517 | 8,831 | 5,851 | ||||||||||
Purchase obligations |
73,397 | 67,583 | 5,814 | | | ||||||||||
Pension obligations |
17,189 | 908 | 3,618 | 3,618 | 9,045 | ||||||||||
Total contractual obligations |
$ | 394,170 | $ | 89,566 | $ | 36,821 | $ | 77,675 | $ | 190,108 | |||||
The 10.0% subordinated notes due April 1, 2008 have interest payable of $3.6 million every six months on April 1 and October 1.
The senior notes have a fixed annual interest rate of 11.0% and interest payments of $9.6 million for the senior notes will be paid every six months on June 15 and December 15. The senior notes mature on June 15, 2010. The senior notes are fully and unconditionally guaranteed on a joint and several basis by all of our Australian and Canadian subsidiaries, a Luxembourg subsidiary, two UK subsidiaries, one of which is our primary UK operating subsidiary, and all of our United States subsidiaries other than certain dormant entities.
If, for any fiscal year commencing with the fiscal year ending March 31, 2004, there is excess cash flow, as such term is defined in the indenture governing the senior notes, in an amount in excess of $5.0 million, we will be required to make an offer in cash to holders of the senior notes to use 50% of such excess cash flow to purchase their senior notes at 101% of the aggregate principal amount of the senior notes to be repurchased plus accrued and unpaid interest and additional amounts, if any.
We incurred $7.2 million in debt issuance costs relating to the senior notes and are amortizing these costs over the term of the senior notes. The balance of these costs as of December 31, 2004 was $5.6 million. The $4.1 million discount related to the senior notes is being accreted to interest expense using the effective interest method over the life of the related debt. The balance of the discount as of December 31, 2004 was $3.5 million.
We have a credit facility which expires on January 4, 2008, with Fleet Capital Corporation (the Fleet Credit Facility) to provide a $50.0 million, senior secured revolving credit facility, which includes a $30.0 million sub-limit for standby and documentary letters of credit. Under the terms of the Fleet Credit Facility, as amended, extensions of credit to the borrowers are further limited to the lesser of the commitment and the borrowing base. In addition, the Fleet Credit Facility requires us to keep $5.0 million of cash in an operating account. As of December 31, 2004, the borrowing base for the credit facility was $46.5 million and we had no borrowings under the Fleet Credit Facility.
We incurred $1.7 million in debt issuance costs relating to the origination and amendment of the Fleet Credit Facility and are amortizing these costs over the remaining term of the credit facility. The balance of these costs as of December 31, 2004 was $0.8 million.
On December 31, 2003, we entered into a one year letter of credit facility with ABN. On November 2, 2004, the agreement was amended to provide us a letter of credit facility for Euro 11.8 million (U.S. $16.0 million) and an open term credit facility of Euro 1.0 million (U.S. $1.4 million) available for general working capital
48
purposes, including overdrafts. This facility is secured by certain of our Netherlands and Belgium subsidiaries assets. The availability of this credit facility is subject to a borrowing base and complying with certain requirements, including maintaining certain levels of tangible net worth requirements as defined by the lender. The borrowing base totaled approximately Euro 6.9 million (U.S. $9.3 million) as of December 31, 2004 and we had no borrowings under the facility. Based on calculations as of December 31, 2004, we were in compliance with the terms of the amended agreement. In addition, the amendment requires us to cash collateralize the letter of credit facility by Euro 5.0 million (U.S. $6.8 million). The letter of credit facility bears a commission of 1%, while the general credit facility bears interest at ABNs Euro base rate plus 1.5%. ABNs Euro base rate as of December 31, 2004, was 1.67%.
Other Financing Arrangements
Senior Convertible Participating SharesOn December 17, 1999, we issued 218,000 6.50% senior convertible participating shares for $218.0 million. The participating shares are entitled to dividends equal to the greater of 6.50% per annum or ordinary share dividends on an as converted basis. Dividends are cumulative and are paid in the form of additional participating shares through December 2004. At that time, we will be obliged to pay the participating share dividends in cash. However, the terms of the participating shares permit us to continue to pay payment-in-kind dividends following December 17, 2004 if our then existing principal indebtedness, which would include our new credit facility and debt securities issued in an aggregate principal amount in excess of $50.0 million which were issued in a bona fide underwritten public or private offering, prohibits us from paying cash dividends. Further, if we are not permitted by the terms of the participating shares to pay payment-in-kind dividends following December 17, 2004 and we have insufficient distributable reserves under English law to pay cash dividends, the amount of any unpaid dividend will be added to the liquidation return of each participating share.
The participating shares are currently convertible into ordinary shares at a conversion price of $3.11 per ordinary share (equal to $12.44 per ADS), subject to adjustment in certain circumstances to avoid dilution of the interests of participating shareholders. As of December 31, 2004, the participating shares have voting rights, on an as converted basis, currently corresponding to approximately 27.6% of the total voting power of our capital stock which includes an additional 81,271 participating shares in respect of payment-in-kind dividends.
If, by December 17, 2010, we have not converted or otherwise redeemed the participating shares, we are required, subject to compliance with applicable laws and the instruments governing our indebtedness, to redeem the participating shares for cash at the greater of (a) the then liquidation value or (b) the then market value of the ordinary shares into which the participating shares are convertible, in each case plus accumulated and unpaid dividends from the most recent dividend payment date. If the price set out in (b) above is applicable, we are permitted to convert the participating shares into the number of ordinary shares into which they are convertible instead of making the cash payment.
In the event of liquidation of Danka, participating shareholders will be entitled to receive a distribution equal to the greater of (a) the liquidation return per share (initially $1,000 and subject to upward adjustment on certain default events by us) plus any accumulated and unpaid dividends accumulating from the most recent dividend date or (b) the amount that would have been payable on each participating share if it had been converted into ordinary shares if the market value of those shares exceed the liquidation value of the participating shares.
We are not permitted to pay dividends, other than payment-in-kind dividends on our participating shares, under our new credit facility or the senior notes and we do not anticipate the payment of a dividend on our ordinary shares in the foreseeable future.
We are an English company and, under English law, we are allowed to pay cash dividends to shareholders only if as determined by reference to our financial statements prepared in accordance with UK GAAP:
| we have accumulated, realized profits that have not been previously distributed or capitalized, in excess of our accumulated, realized losses that have not previously been written off in a reduction or reorganization of capital; and |
49
| our net assets are not less than the aggregate of our share capital and our non-distributable reserves, either before, or as a result of, dividends or other distributions. |
At this time, we have insufficient, accumulated realized profits to pay dividends to shareholders. Since December 2000, we have satisfied our obligation to make payment-in-kind dividends on our participating shares by capitalizing part of our share premium account, which is a reserve required by English company law and which consists of premiums paid to us on the issuance of our shares.
General Electric Capital CorporationWe have an agreement with General Electric Capital Corporation (GECC) under which GECC agrees to provide financing to our qualified United States customers to purchase equipment. The agreement expires March 31, 2009. In connection with this agreement, we are obligated to provide a minimum level of customer leases to GECC. The minimum level of customer leases is equal to a specified percentage of United States retail equipment and related sales revenues. If we fail to provide a minimum level of customer leases under the agreement, we are obligated to pay penalty payments to GECC. We were not required to make any penalty payments for the years ended March 31, 2003 and 2004. We have not accrued any penalty payments for the nine months ended December 31, 2004.
Tax Payments
We have not paid substantial amounts of income tax in the prior three years because of our net operating losses. However, we are subject to audits by multiple tax authorities with respect to prior years and certain of these audits are in the latter stages. Where we disagree with any of these positions adopted by the tax authorities, we may formally protest them. We may be required to pay between $12 million and $18 million to certain European tax authorities within the next two quarters as a result of audits nearing settlement and recurring operations. In addition, we could be required to pay amounts, which could be material, during the next 12 months, as a result of other tax audits and settlements.
Market Risk Management
Our market risk is primarily limited to fluctuations in interest rates as it pertains to our borrowings under our credit facilities while the 11% senior notes and the 10% subordinated notes bear a fixed rate.
Interest Rate RiskWe are exposed to interest rate risk primarily on our Fleet Credit Facility. We have fixed interest rates on our senior and subordinated notes. We estimate that a 1% change in interest rates would not have a material impact on our results of operations for 2005 since we have not made any borrowings under this facility. The Fleet Credit Facility, as amended on October 21, 2004, bears interest at an annual rate equal to, at our option, (a) the rate of interest publicly announced from time to time by Fleet National Bank as its prime or the sum of the base rate of interest plus the applicable margin thereon or (b) the sum of LIBOR for interest periods at our option of one, two, three or six months plus the applicable margin thereon.
The applicable interest rate margin on loans for which interest is calculated by reference to the base or prime rate, or base rate loans, will range from 0.25% to 1.00% per annum, and the applicable interest rate margin on loans for which interest is calculated by reference to the LIBOR rate, or LIBOR rate loans, will range from 2.25% to 3.00% per annum, in each case based on average adjusted availability, or availability under the Fleet Credit Facility plus cash.
Foreign Currency Exchange RiskOperating in international markets involves exposure to the possibility of volatile movements in foreign exchange rates. These exposures may impact future earnings and/or cash flows. Revenue from foreign locations represented approximately 54% of our consolidated revenue during the first nine months of fiscal year 2005. The economic impact of foreign exchange rate movements is complex because such changes are often linked to variability in real growth, inflation, interest rates, governmental actions and other factors. These changes, if material, could cause us to adjust our financing and operating strategies. Therefore, to
50
solely isolate the effect of changes in currency does not accurately portray the effect of these other important economic factors. As foreign exchange rates change, translation of the income statements of our international subsidiaries into U.S. dollars affects year-over-year comparability of operating results. While we may hedge specific transaction risks, we currently do not hedge translation risks because we believe there is no long-term economic benefit in doing so.
At December 31, 2004, we had no outstanding forward contracts or option contracts to buy or sell foreign currency. For the nine month period ended December 31, 2004, there were no gains or losses included in our consolidated statements of operations on forward contracts and option contracts.
Assets and liabilities are matched in the local currency, which reduces the need for dollar conversion. Any foreign currency impact on translating assets and liabilities into dollars is included as a component of shareholders equity. Our revenue results for the first nine months of fiscal year 2005, as compared to the prior year-ago period, were positively impacted by a $36.4 million foreign currency movement, primarily due to the strengthening of the euro and the British pound sterling against the dollar.
Changes in foreign exchange rates that had the largest impact on translating our international operating profits for the nine months ended December 31, 2004 related to the euro and the British pound sterling versus the U.S. dollar.
Seasonality
Our operations have historically experienced lower revenue during the second quarter of our fiscal year, which is the three month period ended September 30. This is primarily due to increased vacation time by European and Canadian residents during July and August and lower levels of retail service revenue from U.S. governmental agencies. This has historically resulted in reduced sales activity and reduced usage of photocopiers, facsimiles and other office imaging equipment during the second quarter. Accordingly, the results of operations for the interim periods are not necessarily indicative of the results which may be expected for the entire fiscal year.
New Accounting Pronouncements
In December 2003, the Financial Accounting Standards Board (the FASB) revised FASB Statement No. 132, Employers Disclosures about Pensions and Other Postretirement Benefits (SFAS 132). The revised standard mandates additional required disclosures for pensions and other postretirement benefit plans and is designed to improve disclosure transparency within financial statements and requires certain disclosures to be made on a quarterly basis. The revised standard replaces existing pension disclosure requirements. Compliance with SFAS 132 was generally effective for fiscal periods beginning after December 15, 2003. However, since all of the required disclosures relate to the Companys international plans, the implementation rules are effective for the Companys year ending March 31, 2005 and as such, no interim period disclosures have been made in this quarterly report on Form 10-Q. The Company does not anticipate the adoption of SFAS 132 to have a material impact on its consolidated financial statements.
In March 2004, the Emerging Issues Task Force reached a consensus on Issue 03-6, Participating Securities and the Two-Class Method under FAS 128, Earnings per Share (EITF 03-6). EITF 03-6 requires the use of the two-class method in calculating basic earnings per share by issuers with participating convertible securities. Companies were required to retroactively apply EITF 03-6 to participating securities in the quarter beginning April 1, 2004. The Company adopted EITF 03-6 in the quarter beginning April 1, 2004. Due to the Companys capital structure and insufficient income, the adoption had no impact on its consolidated financial statements or earning available per share presented herein.
In December 2004, the FASB issued FASB Statement No. 123R, Share-Based Payment (SFAS 123R), which revises FASB Statement No. 123 (SFAS 123), Accounting for Stock-Based Compensation and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation
51
guidance. SFAS 123R requires public entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award in the statement of operations. Pro forma disclosure is no longer allowable under the new standard. The cost will be recognized over the period during which an employee is required to provide service in exchange for the reward - the requisite service period, usually the vesting period. Adoption of SFAS 123R is required as of the beginning of the first interim reporting period that begins after June 15, 2005. As of December 31, 2004, the Company had not yet assessed the impact the adoption of SFAS 123R will have on its consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our market risk is primarily limited to fluctuations in interest rates as it pertains to our borrowings under our credit facility, while the 11% senior notes and the 10% subordinated notes bear a fixed rate. Other than as described below, there have been no material changes to the information under Item 7A of our Annual Report on Form 10-K for the fiscal year ended March 31, 2004.
We have outstanding $64.5 million of subordinated notes that have a fixed annual interest rate of 10% and interest payments of $3.2 million for the subordinated notes will be paid every six month on April 1 and October 1. The subordinated notes mature on April 1, 2008.
We have outstanding $175 million aggregate principal amount of senior notes that have a fixed annual interest rate of 11.0% and interest payments of $9.6 million for the senior notes will be paid every six months on June 15 and December 15. The senior notes mature on June 15, 2010.
We also have a credit facility with Fleet Capital Corporation that expires on January 4, 2008, to provide a $50.0 million, senior secured revolving credit facility, which includes a $30.0 million sublimit for standby and documentary letters of credit. The Fleet Credit Facility will bear interest at an annual rate equal to, at our option (a) the sum of the rate of interest publicly announced from time to time by Fleet National Bank as its prime or base rate of interest plus the applicable margin thereon or (b) the sum of LIBOR for interest periods at our option of one, two, three or six months plus the applicable margin thereon.
On December 31, 2003, we entered into a one year letter of credit facility with ABN. On November 2, 2004, the agreement was amended to provide us a letter of credit facility for Euro 11.8 million (U.S. $16.0 million) and an open term credit facility of Euro 1.0 million (U.S. $1.4 million) available for general working capital purposes, including overdrafts. This facility is secured by certain of our Netherlands and Belgium subsidiaries assets. The availability of this credit facility is subject to a borrowing base and complying with certain requirements, including maintaining certain levels of tangible net worth requirements (as defined) by the lender. The borrowing base totaled approximately Euro 6.9 million (U.S. $9.3 million) as of December 31, 2004 and we had no borrowings under the facility. Based on calculations as of December 31, 2004, we were in compliance with the terms of the amended agreement. In addition, the amendment requires us to cash collateralize the letter of credit facility by Euro 5.0 million (U.S. $6.8 million). The letter of credit facility bears a commission of 1%, while the general credit facility bears interest at ABNs Euro base rate plus 1.5%. ABNs Euro base rate as of December 31, 2004, was 1.67%.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that the information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported on a timely basis, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer (together our Certifying Officers), as appropriate, to allow timely decisions regarding required disclosure.
The Companys management, with the participation of the Certifying Officers, has evaluated the effectiveness of the Companys disclosure controls and procedures (as such term is defined in Rules 13a-15(e) or
52
15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on such evaluation, the Certifying Officers have concluded that, as of the end of such period, the Companys disclosure controls and procedures are effective in providing reasonable assurance that information required to be disclosed by the Company in the reports that it files or furnishes under the Exchange Act is recorded, processed, summarized and reported on a timely basis.
Limitations on the Effectiveness of Controls
We maintain a system of internal control over financial reporting to provide reasonable assurance that assets are safeguarded and that transactions are executed in accordance with managements authorization and recorded properly to permit the preparation of financial statements in accordance with accounting principles generally accepted in the United States. However, our management, including the Certifying Officers, does not expect that our disclosure controls or internal control over financial reporting will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.
Changes in Internal Control Over Financial Reporting
There have not been any changes in our internal control over financial reporting (as such term is defined in rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the period covered by this report, that have materially affected, or are reasonably likely to materially affect, the Companys internal control over financial reporting.
Section 404 of the Sarbanes-Oxley Act
We are in the process of documenting and testing our internal control over financial reporting in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act and the related SEC rules, which require annual management assessments of the effectiveness of our internal control over financial reporting and a report by our Independent Registered Certified Public Accounting Firm addressing managements assessments. We consider the implementation of Sarbanes-Oxley Section 404 to be part of our plan to improve controls and are well into implementation. We anticipate expenditures on outside resources of approximately $7 million to $8 million in fiscal year 2005. We are using outside resources combined with internal resources to implement Section 404. The steps we have taken to date and the steps we are still in the process of implementing are subject to continuing management review and testing by our internal and external auditors. We will use our best efforts to evaluate our internal control over financial reporting and remediate any deficiencies by the end of our fiscal year; however, given the effort needed, we may not be able to take all actions required by March 31, 2005 and, therefore, management could conclude that we have one or more material weaknesses in our internal control over financial reporting.
During the course of our testing, we have identified certain matters relating to the design and operational effectiveness of our internal control over financial reporting which need to be remediated, and which could form the basis of one or more material weaknesses ,
53
These matters include the following:
| Establish more robust documentation standards to validate compliance with internal policies; |
| Improve the adequacy of general IT controls outside of the U.S.; and |
| Improve internal controls for the following functions: |
| billing and receivables; |
| payroll; and |
| purchasing and disbursements. |
We believe that we have in place certain detective controls that compensate for the operational control issues noted above, including, but not limited to:
| Conduct regularly-scheduled meetings between senior management and the business segment leaders to discuss operational matters and results of operations; |
| Perform analyses of actual results against budgets and prior periods; |
| Perform revenue cut-off tests; |
| Perform accrual revenue tests; |
| Send out periodic account statements to U.S. customers; |
| Obtain quarterly representation letters from financial and operational personnel in management positions, which include representations regarding (1) conformity with approved policies and procedures, (2) acknowledgement of responsibility for correct reporting of their operating results, and (3) responsibilities regarding fraud; |
| Established a disclosure committee, which conducts regularly-scheduled meetings to discuss appropriateness of disclosures in the Companys periodic financial statements; |
| Perform reconciliations of key accounts; |
| Perform analytical review procedures on results of operations, financial position and cash flows; |
| Maintain an approved Finance Manual and distribute it to employees on a quarterly basis; and |
| Perform monthly management reviews of account balances. |
APPROVAL OF NON-AUDIT SERVICES
The audit committee approved Ernst & Young LLP and its affiliates to perform services regarding certain tax matters during the nine months ended December 31, 2004.
SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS
Certain statements contained herein, or otherwise made by our officers, including statements related to our future performance and our outlook for our businesses and respective markets, projections, statements of our plans or objectives, forecasts of market trends and other matters, are forward-looking statements, and contain information relating to us that is based on our beliefs as well as assumptions, made by, and information currently available to us. The words goal, anticipate, expect, believe, could, should, intend and similar expressions as they relate to us are intended to identify forward-looking statements, although not all forward looking statements contain such identifying words. No assurance can be given that the results in any forward-looking statement will be achieved. For the forward-looking statements, we claim the protection of the safe
54
harbor for forward-looking statements provided for in the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, or the Exchange Act. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that might cause such actual results to differ materially from those reflected in any forward-looking statements include, but are not limited to, the following: (i) any inability to successfully implement our strategy; (ii) any inability to successfully implement our cost restructuring plans to achieve and maintain cost savings; (iii) any inability to comply with the Sarbanes-Oxley Act of 2002; (iv) any material adverse change in financial markets, the economy or in our financial position; (v) increased competition in our industry and the discounting of products by our competitors; (vi) new competition as the result of evolving technology; (vii) any inability by us to procure, or any inability by us to continue to gain access to and successfully distribute new products, including digital products, color products, multi-function products and high-volume copiers, or to continue to bring current products to the marketplace at competitive costs and prices; (viii) any inability to arrange financing for our customers purchases of equipment from us; (ix) any inability to successfully enhance, unify and effectively utilize our management information systems; (x) any inability to record and process key data due to ineffective implementation of business processes and policies; (xi) any negative impact from the loss of a key vendor or customer; (xii) any negative impact from the loss of any of our senior or key management personnel; (xiii) any change in economic conditions in markets where we operate or have material investments which may affect demand for our products or services; (xiv) any negative impact from the international scope of our operations; (xv) fluctuations in foreign currencies; (xvi) any incurrence of tax liabilities or tax payments beyond our current expectations, which could adversely affect our liquidity and profitability; (xvii) any inability to comply with the financial or other covenants in our debt instruments; (xviii) any delayed or lost sales or other impacts related to the commercial and economic disruption caused by natural disasters; (xix) any delayed or lost sales and other impacts related to the commercial and economic disruption caused by terrorist attacks, the related war on terrorism, and the fear of additional terrorist attacks; and (xx) other risks including those risks identified in any of our filings with the Securities and Exchange Commission, or the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our analysis only as of the date they are made. Except as required by applicable law, we undertake no obligation, and do not intend, to update these forward-looking statements to reflect events or circumstances that arise after the date they are made. Furthermore, as a matter of policy, we do not generally make any specific projections as to future earnings, nor do we endorse any projections regarding future performance, which may be made by others outside our company.
55
Item 1. | Legal Proceedings |
In June 2003, Danka was served with a putative class action complaint titled Stephen L. Edwards, et al., Plaintiffs vs. Danka Industries, Inc., et al., including American Business Credit Corporation, Defendants, alleging claims of breach of contract, fraud/intentional misrepresentation, unjust enrichment, violation of the Florida Deception and Unfair Trade Protection Act and injunctive relief. The claim was filed in the state court in Tennessee, and we have removed the claim to the United States District Court for Middle District of Tennessee for further proceedings. The plaintiffs have filed a motion to certify the class, which we have opposed. We filed a motion for summary judgment, which plaintiffs have opposed. While the amount sought in this complaint is in excess of $75,000, we can not, at this time, estimate our potential exposure. We will continue to vigorously defend the claims alleged by the plaintiff in this action.
We are also subject to legal proceedings and claims which arise in the ordinary course of our business. We do not expect these legal proceedings to have a material effect upon our financial position, results of operations or liquidity.
Item 2. | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities |
Not applicable.
Item 3. | Defaults Upon Senior Securities |
Not applicable.
Item 4. | Submission of Matters to a Vote of Security Holders |
The annual general meeting of the shareholders of Danka Business Systems PLC was held on December 7, 2004. At the meeting, the following actions were taken by the shareholders:
1. Todd L. Mavis was elected as Director of the Company. The voting on resolution was as follows:
FOR |
195,229,088 | |
AGAINST |
5,175,435 | |
ABSTAIN |
0 |
2. Erik Vonk was elected as Director of the Company. The voting on resolution was as follows:
FOR |
198,668.908 | |
AGAINST |
2,317,737 | |
ABSTAIN |
0 |
3. P. Lang Lowrey, III was re-elected as Director of the Company. The voting on resolution was as follows:
FOR |
185,450,959 | |
AGAINST |
15,101,024 | |
ABSTAIN |
0 |
4. Michael B. Gifford was re-elected as Director of the Company. The voting on resolution was as follows:
FOR |
198,630,582 | |
AGAINST |
2,357,063 | |
ABSTAIN |
0 |
56
The following directors continued their terms of office after the meeting: Kevin C. Daly, Jamie W. Ellertson, Christopher B. Harned, W. Andrew McKenna, J. Ernst Riddle, and James L. Singleton. Richard M. Haddrill retired from the Board of Directors effective December 7, 2004.
5. Ernst & Young LLP was re-appointed as our auditor for fiscal year 2005, and the Board of Directors, or duly appointed Committee thereof, was authorized to fix the auditors remuneration. The voting on resolution was as follows:
FOR |
197,815,899 | |
AGAINST |
2,736,084 | |
ABSTAIN |
0 |
6. The Board of Directors was granted the authority to allot securities up to an aggregate nominal amount of £1,048,759. The voting on resolution was as follows:
FOR |
196,278,138 | |
AGAINST |
4,709,507 | |
ABSTAIN |
0 |
7. The Board of Directors was granted the authority to allot equity securities, subject to certain limitations, without providing certain pre-emptive rights. The voting was as follows:
FOR |
170,487,207 | |
AGAINST |
29,987,778 | |
ABSTAIN |
0 |
8. The Board of Directors was granted the authority to allot securities relating to our convertible participating shares up to an aggregate nominal amount of £1,625,000. The voting on resolution was as follows:
FOR |
188,253,051 | |
AGAINST |
11,910,732 | |
ABSTAIN |
0 |
9. The Board of Directors was granted the authority to allot equity securities relating to our convertible participating shares, subject to certain limitations, without providing certain pre-emptive rights. The voting on resolution was as follows:
FOR |
187,263,075 | |
AGAINST |
12,923,708 | |
ABSTAIN |
0 |
10. The Directors Remuneration report for fiscal year 2004 was approved. The voting on resolution was as follows:
FOR |
161,122,145 | |
AGAINST |
39,503,900 | |
ABSTAIN |
0 |
Item 5. | Other Information |
Not applicable.
Item 6. | Exhibits |
(a) | Exhibits. |
31.1 | Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certification of CEO and CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
57
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.
Danka Business Systems PLC | ||
(Registrant) | ||
Date: February 9, 2005 | /S/ F. MARK WOLFINGER | |
F. Mark Wolfinger | ||
Executive Vice-President and Chief Financial Officer | ||
(Principal Financial Officer and Chief | ||
Accounting Officer) |
58