10-Q 1 ikonoffice10q.txt ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q (Mark One) [X] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2002 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from _____________ to ______________ Commission file number 1-5964 IKON OFFICE SOLUTIONS, INC. (Exact name of registrant as specified in its charter) OHIO 23-0334400 (State or other jurisdiction of (I.R.S.Employer Identification No.) incorporation or organization) P.O. Box 834, Valley Forge, Pennsylvania 19482 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (610) 296-8000 Former name, former address and former fiscal year, if changed since last report: None Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------- ------- Applicable only to corporate issuers: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of August 9, 2002. Common Stock, no par value 149,309,911 shares ================================================================================ IKON Office Solutions, Inc. INDEX PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements Consolidated Balance Sheets--June 30, 2002 (unaudited) and September 30, 2001 Consolidated Statements of Income--Three and nine months ended June 30, 2002 and 2001 (unaudited) Consolidated Statements of Cash Flows--Nine months ended June 30, 2002 and 2001 (unaudited) Notes to Condensed Consolidated Financial Statements (unaudited) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk PART II. OTHER INFORMATION Item 1. Legal Proceedings Item 2. Changes in Securities and Use of Proceeds Item 6. Exhibits and Reports on Form 8-K SIGNATURES FORWARD-LOOKING INFORMATION IKON Office Solutions, Inc. (the "Registrant," "IKON" or the "Company") may from time to time provide information, whether verbally or in writing, including certain statements included in or incorporated by reference in this Form 10-Q, which constitute "forward-looking" statements within the meaning of the Private Securities Litigation Reform Act of 1995 ("Litigation Reform Act"). These forward-looking statements include, but are not limited to, statements regarding the following (and certain matters discussed in greater detail herein): growth opportunities and increasing market share, productivity and infrastructure initiatives; earnings, revenue, cash flow, margin, and cost-savings projections; the effect of competitive pressures on equipment sales; expected savings and lower costs from the restructuring programs and productivity and infrastructure initiatives; developing and expanding strategic alliances and partnerships; the impact of e-commerce and e-procurement initiatives; the implementation of the Oracle e-business suite; anticipated growth rates in the digital and color equipment and outsourcing industries; the effect of foreign currency exchange risk; the reorganization of the Company's business segments and the anticipated benefits of operational synergies related thereto; and the Company's ability to finance its current operations and its growth initiatives. Although IKON believes the expectations contained in such forward-looking statements are reasonable, it can give no assurance that such expectations will prove correct. The words "anticipate," "believe," "estimate," "expect," "intend," "will," and similar expressions, as they relate to the Company or the Company's management, are intended to identify forward-looking statements. Such statements reflect the current views of the Registrant with respect to future events and are subject to certain risks, uncertainties and assumptions. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected or intended. The Registrant does not intend to update these forward-looking statements. In accordance with the provisions of the Litigation Reform Act, the Company is making investors aware that such "forward-looking" statements, because they relate to future events, are by their very nature subject to many important factors which could cause actual results to differ materially from those contained in the "forward-looking" statements. These uncertainties and risks include, but are not limited to, the following (some of which are explained in greater detail herein): conducting operations in a competitive environment and a changing industry (which includes technical services and products that are relatively new to the industry and to the Company); delays, difficulties, management transitions and employment issues associated with consolidations and/or changes in business operations; managing the integration of acquired businesses; existing and future vendor relationships; risks relating to foreign currency exchange; economic, legal and political issues associated with international operations; the Company's ability to access capital and meet its debt service requirements (including sensitivity to fluctuations in interest rates); and general economic conditions. Competition. The Registrant operates in a highly competitive environment. There are a number of companies worldwide with significant financial resources which compete with the Registrant to provide similar products and services, such as Canon, Ricoh, Oce, Xerox and Danka. Competition is based largely upon technology, performance, pricing, quality, reliability, distribution, customer service and support. In addition, the financial pressures faced by some of the Registrant's competitors may cause them to engage in uneconomic pricing practices, which may cause the prices that the Registrant is able to charge in the future for its products and services to be less than the Registrant has historically charged. The Registrant's future success is based in large part upon its ability to successfully compete in its current markets and expand into additional products and services offerings. The intense competition inherent in the Registrant's industry could also result in additional pressure in pricing and the retention of customers which could negatively affect the Registrant's results of operations. Pricing. The Registrant's ability to succeed is dependent upon its ability to obtain adequate pricing for its products and services. Depending on competitive market factors, future prices the Registrant can obtain for its products and services may vary from historical levels. Transition to Digital. The analog segment of the office equipment market continues to decline as the office equipment industry transitions to digital technology. This transition represents a significant technological change in the Registrant's industry with ramifications that cannot be fully foreseen. Some of the digital products placed by the Registrant replace or compete with the analog products placed by the Registrant. If the Company does not adapt successfully to these changes, our actual results may differ materially from those expected. Vendor Relationships. The Registrant's access to equipment, parts and supplies is dependent upon close relationships with its vendors and its ability to purchase products from these vendors on competitive terms. The cessation or deterioration in relationships with, or the financial condition of, significant vendors may cause the Company to be unable to distribute equipment, including digital products and high-volume or color equipment, parts and supplies, and would cause actual results to differ materially from those expected. Financing Business. A significant portion of the Registrant's profits are derived from the financing of equipment provided to its customers. The Registrant's ability to provide such financing at competitive rates and realize profitable margins is highly dependent upon its own costs of borrowing. Significant changes in credit ratings could reduce the Company's access to certain credit markets. There is no assurance that these credit ratings can be maintained and/or the credit markets can be readily accessed. Productivity Initiatives. The Registrant's ability to improve its profit margins is largely dependent on its ability to maintain an efficient, cost-effective operation. The Registrant continues to invest in new market opportunities and to streamline its infrastructure. These investments are aimed at making the Company more profitable and competitive in the long-term, and include initiatives such as centralized credit and purchasing, shared services and the implementation of the Oracle e-business suite, a comprehensive, multi-year initiative designed to web-enable our information technology infrastructure. The Registrant's ability to improve its profit margins through the implementation of these productivity initiatives is dependent upon certain factors outside the control of the Registrant and therefore could cause actual results to differ materially from those anticipated. International Operations. The Registrant's future revenue, cost and profit results could be affected by a number of factors, including changes in foreign currency exchange rates, changes in economic conditions from country to country, changes in a country's political condition, trade protection measures, licensing and other legal requirements and local tax issues. Restructuring. In the fourth quarter of fiscal 2001, the Company announced the acceleration of certain cost cutting and infrastructure improvements and recorded a pre-tax restructuring and asset impairment charge of $60,000 and reserve adjustments related primarily to the exit of the Company's telephony operations of $5,300. This resulted in a charge of $65,300 ($49,235 after-tax, or $0.34 per share on a diluted basis). These actions address the exit from the Company's telephony operations in the United States and Europe, the closing of a number of non-strategic digital print centers and further downsizing of operational infrastructures throughout the organization as the Company leverages and intensifies prior standardization and centralization initiatives. These actions include the ongoing centralization and consolidation of many selling and administrative functions, including marketplace consolidation, supply chain, finance, customer service, sales support and the realignment of sales coverage against our long-term growth objectives. Additionally, the Company recorded an asset impairment charge of $3,582 ($3,300 after-tax, or $0.02 per share on a diluted basis) related to the exit of the Company's technology education operations. Therefore, the aggregate charge recorded in fiscal 2001 (the "Fiscal 2001 Charge") was $68,882 ($52,535 after-tax, or $0.36 per share on a diluted basis). In the first and fourth quarters of fiscal 2000, the Company announced certain restructuring charges totaling approximately $105,168 (the "Fiscal 2000 Charge"). The restructuring charges are to consolidate or dispose of certain underperforming and non-core locations and implement productivity enhancements through consolidation/centralization of activities in inventory management, purchasing, finance/accounting and other administrative functions and consolidate or eliminate unproductive real estate facilities. These efforts are aimed at improving the Company's performance and efficiency. The failure to execute the actions described above concerning the Fiscal 2001 Charge or Fiscal 2000 Charge would cause actual results to differ materially from those anticipated. New Product Offerings. The process of developing and/or distributing new high technology products and solutions is inherently complex and uncertain. It requires accurate anticipation of customers' changing needs and emerging technological trends. The Registrant must make long-term investments and commit significant resources before knowing whether these investments will eventually result in products that achieve customer acceptance and generate the revenues required to provide anticipated returns from these investments. Integration of Acquired Companies. The Company's success is dependent upon its ability to integrate acquired companies and their operations which include companies with technical services and products that are relatively new to the Company and companies outside the United States that present additional risks relating to international operations. There can be no assurance the Company will be successful in managing the integration of acquired companies and their operations. IKON Office Solutions, Inc. Consolidated Balance Sheets
June 30, 2002 September 30, (in thousands) (unaudited) 2001 --------------------------------------------------------------------------------------------------------------------------------- Assets Cash and cash equivalents $ 90,164 $ 80,351 Restricted cash 135,248 128,365 Accounts receivable, less allowances of: June 30, 2002 - $17,123; September 30, 2001 - $23,510 597,766 641,059 Finance receivables, less allowances of: June 30, 2002 - $20,492; September 30, 2001 - $24,424 1,194,211 1,171,004 Inventories 326,783 299,776 Prepaid expenses and other current assets 105,638 95,381 Deferred taxes 98,450 98,701 --------------------------------------------------------------------------------------------------------------------------------- Total current assets 2,548,260 2,514,637 --------------------------------------------------------------------------------------------------------------------------------- Long-term finance receivables, less allowances of: June 30, 2002 - $38,056; September 30, 2001 - $45,360 2,217,775 2,176,205 Equipment on operating leases, net 92,077 71,181 Property and equipment, net 209,122 207,812 Goodwill, net 1,244,117 1,258,112 Other assets 60,982 63,045 --------------------------------------------------------------------------------------------------------------------------------- Total Assets $ 6,372,333 $ 6,290,992 --------------------------------------------------------------------------------------------------------------------------------- Liabilities and Shareholders' Equity Current portion of long-term debt $ 13,067 $ 17,643 Current portion of long-term debt, finance subsidiaries 1,065,323 1,229,631 Notes payable 7,551 183,688 Trade accounts payable 221,905 222,999 Accrued salaries, wages and commissions 95,190 126,280 Deferred revenues 164,686 185,261 Other accrued expenses 278,444 299,624 --------------------------------------------------------------------------------------------------------------------------------- Total current liabilities 1,846,166 2,265,126 --------------------------------------------------------------------------------------------------------------------------------- Long-term debt 595,315 599,608 Long-term debt, finance subsidiaries 1,715,008 1,366,108 Deferred taxes 497,871 446,059 Other long-term liabilities 208,541 218,513 Commitments and contingencies Shareholders' Equity Common stock, no par value: authorized 300,000 shares; issued: June 30, 2002-149,989 shares; September 30, 2001-150,128 shares; outstanding: June 30, 2002-143,981 shares; September 30, 2001- 141,776 shares 1,010,567 1,012,302 Series 12 preferred stock, no par value: authorized 480 shares; none issued or outstanding Unearned compensation (2,428) (3,745) Retained earnings 561,843 463,152 Accumulated other comprehensive loss (37,203) (43,484) Cost of common shares in treasury: June 30, 2002-5,329 shares; September 30, 2001-7,480 shares (23,347) (32,647) --------------------------------------------------------------------------------------------------------------------------------- Total Shareholders' Equity 1,509,432 1,395,578 --------------------------------------------------------------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $ 6,372,333 $ 6,290,992 ---------------------------------------------------------------------------------------------------------------------------------
See notes to condensed consolidated financial statements. IKON Office Solutions, Inc. Consolidated Statements of Income (unaudited)
Three Months Ended Nine Months Ended June 30, June 30, ------------------------------------------------------------------------------------------------------------------------ (in thousands, except per share amounts) 2002 2001 2002 2001 ------------------------------------------------------------------------------------------------------------------------ Revenues Net sales $ 598,698 $ 641,858 $ 1,759,136 $ 2,001,648 Services 527,204 577,741 1,610,611 1,721,934 Finance income 92,714 91,558 279,492 266,852 ------------------------------------------------------------------------------------------------------------------------ 1,218,616 1,311,157 3,649,239 3,990,434 ------------------------------------------------------------------------------------------------------------------------ Costs and Expenses Cost of goods sold 390,757 409,861 1,155,784 1,305,473 Services costs 304,755 338,486 955,169 1,030,613 Finance interest expense 39,103 41,783 117,263 132,350 Selling and administrative 401,017 456,249 1,202,562 1,362,578 ------------------------------------------------------------------------------------------------------------------------ 1,135,632 1,246,379 3,430,778 3,831,014 ------------------------------------------------------------------------------------------------------------------------ Operating Income 82,984 64,778 218,461 159,420 Interest Expense 12,955 18,345 41,551 54,222 ------------------------------------------------------------------------------------------------------------------------ Income From Continuing Operations Before Taxes on Income 70,029 46,433 176,910 105,198 Taxes on Income 26,887 20,431 65,899 46,287 ------------------------------------------------------------------------------------------------------------------------ Income From Continuing Operations 43,142 26,002 111,011 58,911 Discontinued Operations, net of taxes of $942 1,200 ------------------------------------------------------------------------------------------------------------------------ Net Income $ 43,142 $ 26,002 $ 111,011 $ 60,111 ------------------------------------------------------------------------------------------------------------------------ Basic Earnings Per Common Share Continuing Operations $ 0.30 $ 0.18 $ 0.78 $ 0.41 Discontinued Operations 0.01 ------------------------------------------------------------------------------------------------------------------------ Net Income $ 0.30 $ 0.18 $ 0.78 $ 0.42 ------------------------------------------------------------------------------------------------------------------------ Diluted Earnings Per Common Share Continuing Operations $ 0.28 $ 0.18 $ 0.74 $ 0.41 Discontinued Operations 0.01 ------------------------------------------------------------------------------------------------------------------------ Net Income $ 0.28 $ 0.18 $ 0.74 $ 0.42 ------------------------------------------------------------------------------------------------------------------------ Cash Dividends Per Common Share $ 0.04 $ 0.04 $ 0.12 $ 0.12
See notes to condensed consolidated financial statements.
IKON Office Solutions, Inc. Consolidated Statements of Cash Flows (unaudited) Nine Months Ended June 30, ---------------------------------------------------------------------------------------------------------------------------------- (in thousands) 2002 2001 ---------------------------------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities Net Income $ 111,011 $ 60,111 Additions (deductions) to reconcile net income to net cash provided by operating activities of continuing operations: Depreciation 90,392 88,758 Amortization 10,902 44,128 Provision for losses on accounts receivable 5,090 6,947 Provision for deferred income taxes 52,063 33,174 Provision for lease default reserves 50,557 47,224 Changes in operating assets and liabilities, net of effects from acquisitions and divestitures: Decrease in accounts receivable 39,141 40,041 Increase in inventories (11,007) (4,572) Increase in prepaid expenses and other current assets (15,344) (10,435) Decrease in accounts payable, deferred revenues and accrued expenses (75,668) (94,866) Decrease in accrued restructuring (16,212) (13,902) Other 8,000 1,628 ---------------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities of continuing operations 248,925 198,236 Gain from discontinued operations (2,142) ---------------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 248,925 196,094 ---------------------------------------------------------------------------------------------------------------------------------- Cash Flows from Investing Activities Cost of companies acquired, net of cash acquired (2,666) Expenditures for property and equipment (78,833) (68,737) Expenditures for equipment on operating leases (63,216) (34,709) Proceeds from sale of property and equipment 21,627 37,945 Proceeds from sale of equipment on operating leases 10,653 10,209 Finance receivables - additions (1,189,003) (1,381,790) Finance receivables - collections 1,090,693 1,187,403 Proceeds from sale of finance subsidiaries' lease receivables 15,940 Other (6,521) (317) ---------------------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (214,600) (236,722) ---------------------------------------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities Proceeds from issuance of long-term debt 2,608 36,747 Short-term (repayments) borrowings, net (178,376) 264,907 Long-term debt repayments (11,866) (193,284) Finance subsidiaries' debt - issuances 1,522,265 2,080,191 Finance subsidiaries' debt - repayments (1,347,815) (2,094,733) Dividends paid (17,160) (17,022) Increase in restricted cash (6,883) (53,156) Proceeds from option exercises and sale of treasury shares 6,203 3,904 Purchase of treasury shares and other (258) (7,876) ---------------------------------------------------------------------------------------------------------------------------------- Net cash (used in) provided by financing activities (31,282) 19,678 ---------------------------------------------------------------------------------------------------------------------------------- Effect of exchange rate changes on cash and cash equivalents 6,770 (7,011) ---------------------------------------------------------------------------------------------------------------------------------- Net increase (decrease) in cash and cash equivalents 9,813 (27,961) Cash and cash equivalents at beginning of year 80,351 78,118 ---------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of period $ 90,164 $ 50,157 ----------------------------------------------------------------------------------------------------------------------------------
See notes to condensed consolidated financial statements. IKON Office Solutions, Inc. Notes to Condensed Consolidated Financial Statements (in thousands, except per share amounts) (unaudited) Note 1: Basis of Presentation The accompanying unaudited condensed consolidated financial statements of IKON Office Solutions, Inc. and subsidiaries (the "Company", "we", or "our") have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K/A for the year ended September 30, 2001. Certain prior year amounts have been reclassified to conform with the current year presentation. Note 2: Adoption of Statement of Financial Accounting Standards ("SFAS") 142, "Goodwill and Other Intangible Assets" In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS 142. SFAS 142 supercedes APB 17, Intangible Assets, and primarily addresses accounting for goodwill and intangible assets subsequent to their acquisition. The provisions of SFAS 142 are effective for fiscal years beginning after December 15, 2001, with early adoption permitted. The most significant changes made by SFAS 142 were: (1) goodwill and indefinite lived intangible assets will no longer be amortized, (2) goodwill will be tested for impairment at least annually at the reporting unit level, (3) intangible assets deemed to have an indefinite life will be tested for impairment at least annually, and (4) the amortization period of intangible assets with finite lives will no longer be limited to forty years. Effective October 1, 2001, the Company adopted SFAS 142, which requires that goodwill not be amortized, but instead tested at least annually for impairment. An impairment charge will be recognized only when the implied fair value of a reporting unit, including goodwill, is less than its carrying amount. The Company calculates fair value using a discounted cash flow model. As of March 31, 2002, the Company completed its initial impairment review and determined that no impairment charge was required. The Company has identified the following reporting units and associated goodwill:
IKON North IKON North America America Business Sysinct Copier Outsourcing Imaging (e-business Business Business IKON Europe Services development) Total ---------------- ---------------- --------------- ---------------- ---------------- --------------- June 30, 2002 Goodwill $866,434 $70,927 $294,749 $9,011 $2,996 $1,244,117
Changes in the goodwill balance since September 30, 2001 are attributable to foreign currency translation adjustments. As of June 30, 2002, there are no intangible assets that are required to be amortized by SFAS 142. A reconciliation of reported net income adjusted to reflect the adoption of SFAS 142 is provided below:
Three Months Ended Nine Months Ended ------------------------------- ------------------------------- June 30, June 30, June 30, June 30, 2002 2001 2002 2001 ------------- ------------- ------------- ------------- Reported net income $43,142 $26,002 $111,011 $60,111 Add-back goodwill amortization, net of taxes of $236 and $711 10,102 30,468 ------------- ------------- ------------- ------------- Adjusted net income $43,142 $36,104 $111,011 $90,579 ============= ============= ============= ============= Reported basic earnings per common share $0.30 $0.18 $0.78 $0.42 Add-back goodwill amortization 0.07 0.21 ------------- ------------- ------------- ------------- Adjusted basic earnings per common share $0.30 $0.25 $0.78 $0.63 ============= ============= ============= ============= Reported diluted earnings per common share $0.28 $0.18 $0.74 $0.42 Add-back goodwill amortization 0.07 0.21 ------------- ------------- ------------- ------------- Adjusted diluted earnings per common share $0.28 $0.25 $0.74 $0.63 ============= ============= ============= =============
Note 3: Restructuring and Asset Impairment Charges In the fourth quarter of fiscal 2001, the Company announced the acceleration of certain cost cutting and infrastructure improvements and recorded a pre-tax restructuring and asset impairment charge of $60,000 and reserve adjustments related primarily to the exit of the Company's telephony operations of $5,300. These related reserve adjustments were included in cost of goods sold and selling and administrative expense in the consolidated statement of income. This resulted in a charge of $65,300 ($49,235 after-tax, or $0.34 per share on a diluted basis). These actions address the exit from the Company's telephony operations in the United States and Europe, the closing of a number of non-strategic digital print centers and further downsizing of operational infrastructures throughout the organization as the Company leverages and intensifies prior standardization and centralization initiatives. These actions include the ongoing centralization and consolidation of many selling and administrative functions, including marketplace consolidation, supply chain, finance, customer service, sales support and the realignment of sales coverage against our long-term growth objectives. Additionally, the Company recorded an asset impairment charge of $3,582 ($3,300 after-tax, or $0.02 per share on a diluted basis) related to the exit of the Company's technology education operations. Therefore, the aggregate charge recorded in fiscal 2001 (the "Fiscal 2001 Charge") was $68,882 ($52,535 after-tax, or $0.36 per share on a diluted basis). In fiscal 2000, the Company recorded a net restructuring and asset impairment charge (the "Fiscal 2000 Charge") of $105,168 ($78,940 after-tax, or $0.53 per share on a diluted basis). All actions related to the Fiscal 2000 Charge are complete. Severance payments to terminated employees are made in installments. The remaining balances of the fiscal 2001 and 2000 severance charges are expected to be paid through fiscal 2003. The charges for contractual commitments relate to lease commitments where the Company is exiting certain locations and/or businesses. The remaining balances of the Fiscal 2001 and 2000 Charges for contractual commitments are expected to be paid over the next several years. The employees and locations affected by the Fiscal 2001 Charge described above are as follows:
Remaining Employees Employee Employees to Affected Terminations be Terminated --------------------------------------------------------------------------------------------------------------- Terminations 1,600 (1,276) 324 Remaining Sites Sites Sites to Affected Closed be Closed --------------------------------------------------------------------------------------------------------------- Closures 24 (21) 3
The following presents a reconciliation of the original restructuring components of the Fiscal 2001 Charge and Fiscal 2000 Charge from September 30, 2001 to the balance remaining at June 30, 2002, which is included in other accrued expenses on the consolidated balance sheet:
Balance Balance September 30, Payments June 30, Fiscal 2001 Restructuring Charge 2001 Fiscal 2002 2002 ------------------------------------------------------------------------------------------- Severance $ 26,500 $ (9,223) $ 17,277 Contractual commitments 8,000 (2,295) 5,705 ------------------------------------------------------------------------------------------- Total $ 34,500 $ (11,518) $ 22,982 ------------------------------------------------------------------------------------------- Balance Balance September 30, Payments June 30, Fiscal 2000 Restructuring Charge 2001 Fiscal 2002 2002 --------------------------------------------------------------------------------------------- Severance $ 2,023 $ (954) $ 1,069 Contractual commitments 10,026 (3,740) 6,286 --------------------------------------------------------------------------------------------- Total $ 12,049 $ (4,694) $ 7,355 ---------------------------------------------------------------------------------------------
Note 4: Unsecured Credit Facility On May 24, 2002, the Company obtained a new $300,000 unsecured credit facility (the "New Credit Facility") with a group of lenders. The New Credit Facility replaces our $600,000 credit facility that was to expire in January 2003 (the "Old Credit Facility"). Revolving loans are available, with certain sub-limits, to IOS Capital, LLC, IKON's leasing subsidiary in the United States; IKON Capital, PLC, IKON's leasing subsidiary in the United Kingdom; and IKON Capital, Inc., IKON's leasing subsidiary in Canada. The New Credit Facility contractually matures on May 24, 2005. As of June 30, 2002, the Company has no borrowings outstanding under the New Credit Facility. The New Credit Facility also provides support for letters of credit for the Company and its subsidiaries. As of June 30, 2002, letters of credit supported by the New Credit Facility amounted to $21,418. The remaining amount available under the New Credit Facility for borrowings or letters of credit is $278,582 as of June 30, 2002. The New Credit Facility contains affirmative and negative covenants, including limitations on certain fundamental changes, investments and acquisitions, mergers, certain transactions with affiliates, creation of liens, asset transfers, payment of dividends, intercompany loans and certain restricted payments. The New Credit Facility does not affect our ability to continue to securitize receivables. In addition, unless the Company achieves certain ratings on its long and short term senior, unsecured debt (as defined) or has not redeemed or defeased $250,000 of IOSC's 9.75% Notes due June 15, 2004, all loans under the New Credit Facility mature on December 15, 2003. Cash dividends may be paid on common stock subject to certain limitations. The New Credit Facility also contains certain financial covenants including (i) corporate leverage ratio; (ii) consolidated interest expense ratio; (iii) consolidated asset test ratios; and (iv) limitations on capital expenditures. The New Credit Facility contains defaults customary for facilities of this type. Failure to be in compliance with any material provision of the New Credit Facility could have a material adverse effect on our liquidity, financial position and results of operations. Note 5: Lease-Backed Notes In addition to the $1,797,389 of lease-backed notes outstanding on September 30, 2001, on December 28, 2001, IOS Capital, LLC ("IOSC"), IKON's leasing subsidiary in the United States, and IKON issued $87,011 and repurchased $12,460 of lease-backed notes (the "Notes") for a net issuance of $74,551. The repurchased amount was sold on May 24, 2002 for $10,806. The Notes have a stated maturity of September 15, 2008 and pay an average yield of 5.06%. The Notes are collateralized by a pool of office equipment leases or contracts, (the "Leases") and related assets, acquired or originated by the Company (together with the equipment financing portion of each periodic lease or rental payment due under the Leases on or after the related transfer date) and all related casualty payments, retainable deposits and termination payments. Payments on the Notes are made from payments on the Leases. The Notes have certain credit enhancement features available to noteholders, including a reserve account and an overcollateralization account. On May 21, 2002, IKON Receivables Funding, LLC ("Receivables Funding"), a wholly owned subsidiary of IOSC, issued $634,800 of lease-backed notes (the "2002-1 Notes") pursuant to a shelf registration statement filed with the Securities and Exchange Commission. The 2002-1 Notes consist of Class A-1 Notes totaling $171,000 with a stated interest rate of 2.044%, Class A-2 Notes totaling $46,000 with a stated interest rate of 2.91%, Class A-3 Notes totaling $266,400 with a stated interest rate of 3.90% and Class A-4 Notes totaling $151,400 with a stated interest rate of 4.68%. The 2002-1 Notes are collateralized by a pool of office equipment leases or contracts and related assets and the payments on the 2002-1 Notes are made from payments received on the equipment leases. IOSC repaid $597,279 of lease-backed notes during the first nine months of fiscal 2002. Note 6: Asset Securitization Conduit Financing During the nine months ended June 30, 2002, IOSC pledged or transferred $519,589 in financing lease receivables for $449,911 in cash in connection with its revolving asset securitization conduit financing agreements. IOSC repaid $593,411 in connection with its issuance of the Notes described above. As of June 30, 2002, IOSC had approximately $581,692 available under revolving asset securitization conduit financing agreements. Note 7: Convertible Subordinated Notes On May 13, 2002, IOSC issued $300,000 of convertible subordinated notes (the "Convertible Notes") with an interest rate of 5.0%, which are due on May 1, 2007. The convertible notes can be converted into shares of IKON common stock at any time before maturity at a conversion price of $15.03 per share. Interest will be paid on the convertible notes semi-annually beginning November 1, 2002. IOSC used the net proceeds to repay loans due to IKON and for general corporate purposes. Note 8: Comprehensive Income Total comprehensive income is as follows:
Three Months Ended Nine Months Ended June 30, June 30, ------------------------------- ------------------------------------ 2002 2001 2002 2001 ------------- ------------- ---------------- ---------------- Net income $43,142 $26,002 $111,011 $60,111 Foreign currency translation adjustments 2,371 3,315 (1,865) (3,732) Cumulative effect of change in accounting principle for derivative and hedging activities (SFAS 133), net of tax benefit of $3,778 (5,584) Net gain (loss) on derivative financial instruments, net of tax expense (benefit) of: $(1,570) and $1,065 for the three months ended June 30, 2002 and 2001, respectively; $5,430 and $(7,155) for the nine months ended June 30, 2002 and 2001, respectively (2,355) 1,597 8,146 (10,816) ------------- ------------- ---------------- ---------------- Total comprehensive income $43,158 $30,914 $117,292 $39,979 ============= ============= ================ ================
Minimum pension liability is adjusted at each fiscal year end; therefore, there is no impact on total comprehensive income during interim periods. The balances for foreign currency translation, minimum pension liability and derivative financial instruments included in accumulated other comprehensive loss in the consolidated balance sheets were $(14,261), $(714) and $(22,228), respectively, at June 30, 2002 and $(12,396), $(714) and $(30,374), respectively, at September 30, 2001. Note 9: Earnings Per Common Share The following table sets forth the computation of basic and diluted earnings per common share from continuing operations:
Three Months Ended Nine Months Ended June 30, June 30, ------------------------------ ------------------------------- 2002 2001 2002 2001 ------------ ------------- -------------- ------------- Numerator: Numerator for basic earnings per common share - income from continuing operations $43,142 $26,002 $111,011 $58,911 ------------ ------------- -------------- ------------- Effect of dilutive securities: Interest expense on Convertible Notes, net of tax 1,264 1,264 ------------ ------------- -------------- ------------- Numerator for diluted earnings per common share - income from continuing operations plus assumed conversion $44,406 $26,002 $112,275 $58,911 ------------ ------------- -------------- ------------- Denominator: Denominator for basic earnings per common share - weighted average common shares 143,867 141,546 142,901 142,121 ------------ ------------- -------------- ------------- Effect of dilutive securities: Convertible Notes 10,748 3,583 Employee stock awards 469 402 451 88 Employee stock options 3,511 3,483 3,983 1,773 ------------ ------------- -------------- ------------- Dilutive potential common shares 14,728 3,885 8,017 1,861 ------------ ------------- -------------- ------------- Denominator for diluted earnings per common share - adjusted weighted average common shares and assumed conversions 158,595 145,431 150,918 143,982 ------------ ------------- -------------- ------------- Basic earnings per common share from continuing operations $0.30 $0.18 $0.78 $0.41 ============ ============= ============== ============= Diluted earnings per common share from continuing operations $0.28 $0.18 $0.74 $0.41 ============ ============= ============== =============
The Company accounts for the effect of the Convertible Notes in the diluted earnings per common share calculation using the "if converted" method. Under that method, the Convertible Notes are assumed to be converted to shares (weighted for the number of days outstanding in the period) at a conversion price of $15.03, and interest expense, net of taxes, related to the Convertible Notes is added back to net income. Options to purchase 6,497 shares of common stock at $11.45 per share to $46.59 per share were outstanding during the third quarter of fiscal 2002 and options to purchase 4,982 shares of common stock at $7.50 per share to $56.42 per share were outstanding during the third quarter of fiscal 2001, but were not included in the computation of diluted earnings per common share because the options' prices were greater than the average market price of the common shares; therefore, the effect would be antidilutive. Options to purchase 6,497 shares of common stock at $11.45 per share to $46.59 per share were outstanding during the first nine months of fiscal 2002 and options to purchase 7,508 shares of common stock at $5.39 per share to $56.42 per share were outstanding during the first nine months of fiscal 2001, but were not included in the computation of diluted earnings per common share because the options' prices were greater than the average market price of the common shares; therefore, the effect would be antidilutive. Note 10: Segment Reporting The table below presents segment information for the three months ended June 30, 2002 and 2001:
IKON Corporate North IKON And America Europe Other Eliminations Total ------------- ------------ ---------- -------------- -------------- Three Months Ended June 30, 2002 Revenues, excluding finance income $ 1,017,183 $ 97,420 $ 11,299 $ 1,125,902 Finance income 87,592 5,122 92,714 Operating income (loss) 129,157 5,689 (785) $ (51,077) 82,984 Interest expense (12,955) (12,955) Income before taxes 70,029 Three Months Ended June 30, 2001 Revenues, excluding finance income $ 1,065,225 $ 103,231 $ 51,143 $ 1,219,599 Finance income 86,683 4,875 91,558 Operating income (loss) 115,723 7,612 (5,636) $ (52,921) 64,778 Interest expense (18,345) (18,345) Income before taxes 46,433
The table below presents segment information for the nine months ended June 30, 2002 and 2001:
IKON Corporate North IKON And America Europe Other Eliminations Total ------------- ------------ ---------- -------------- -------------- Nine Months Ended June 30, 2002 Revenues, excluding finance income $ 3,010,898 $ 309,811 $ 49,038 $ 3,369,747 Finance income 264,508 14,984 279,492 Operating income (loss) 354,352 16,640 (9,112) $ (143,419) 218,461 Interest expense (41,551) (41,551) Income before taxes 176,910 Nine Months Ended June 30, 2001 Revenues, excluding finance income $ 3,242,332 $ 324,665 $ 156,585 $ 3,723,582 Finance income 251,617 15,235 266,852 Operating income (loss) 287,394 17,503 (19,819) $ (125,658) 159,420 Interest expense (54,222) (54,222) Income before taxes 105,198
Note 11: Contingencies The matter of Whetman, et al. v. IKON Office Solutions, Inc., et al. (the "Claim") involves a claim brought under the Employee Retirement Income Security Act of 1974 ("ERISA"). In connection with the Claim, the plaintiffs allege that the Company and various individuals violated fiduciary duties under ERISA based on allegedly improper investments in the Company's stock made through the Company's Retirement Savings Plan (the "Plan"). The court certified a class with respect to the Claim consisting generally of all those participants in the Plan after September 30, 1995 and through August 13, 1998, subject to certain exceptions. On May 14, 2002, the Company announced that, subject to court approval, it reached an agreement to settle the Claim. The Company is not making any monetary payment to the class to settle the lawsuit, and the settlement does not reflect any admission of liability by the Company. The Company has agreed to make certain modifications to its Plan in order to allow participants greater flexibility with respect to investment of the employer match portion of their individual accounts. Under the settlement, employees who have been with the Company for at least two years will be permitted to allocate Company matching funds in investment options other than IKON stock, subject to vesting schedules. The court has preliminarily approved the settlement. The court held a hearing on the final approval of the settlement on August 8, 2002, and issued a Memorandum and Order on August 9, 2002 approving the settlement. Plaintiffs' counsel has petitioned the court for an award of their fees and costs of litigation. The court has not yet ruled on the petition. Any fees and costs awarded by the court will be paid by the Company. Such payment is not expected to have a material financial impact on the Company. The Company is involved in a number of environmental remediation actions to investigate and clean up certain sites related to its discontinued operations in accordance with applicable federal and state laws. Uncertainties about the status of laws and regulations, technology and information related to individual sites, including the magnitude of possible contamination, the timing and extent of required corrective actions and proportionate liabilities of other responsible parties, make it difficult to develop a meaningful estimate of probable future remediation costs. While the actual costs of remediation at these sites may vary from management's estimates because of these uncertainties, the Company has established an accrual for known environmental obligations based on management's best estimate of the aggregate environmental remediation exposure on these sites. After consideration of the defenses available to the Company, the accrual for such exposure, insurance coverage and other responsible parties, management does not believe that its obligations to remediate these sites would have a material adverse effect on the Company's consolidated financial statements. There are other contingent liabilities for taxes, guarantees, other lawsuits and various other matters occurring in the ordinary course of business. On the basis of information furnished by counsel and others, and after consideration of the defenses available to the Company and any related reserves and insurance coverage, management believes that none of these other contingencies will materially affect the consolidated financial statements of the Company. Note 12: Financial Instruments As of June 30, 2002, all of the Company's derivatives designated as hedges are interest rate swaps which qualify for evaluation using the "short cut" method for assessing effectiveness. As such, there is an assumption of no ineffectiveness. The Company uses interest rate swaps to fix the interest rates on its variable rate classes of lease-backed notes, which results in a lower cost of capital than if we had issued fixed rate notes. During the nine months ended June 30, 2002, an unrealized gain totaling $8,146 after taxes, was recorded in accumulated other comprehensive loss. Note 13: Pending Accounting Changes In June 2001, the FASB approved SFAS 143, "Accounting for Asset Retirement Obligations." SFAS 143 addresses accounting for legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and the normal operation of a long-lived asset, except for certain obligations of lessees. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and subsequently allocated to expense over the asset's useful life. SFAS 143 is effective for fiscal years beginning after June 15, 2002. The Company is currently evaluating the impact of the adoption of this statement, but does not expect a material impact from the adoption of SFAS 143 on our consolidated financial statements. In August 2001, the FASB approved SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS 144 supercedes SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and APB 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." SFAS 144 requires an impairment loss to be recognized only if the carrying amounts of long-lived assets to be held and used are not recoverable from their expected undiscounted future cash flows. SFAS 144 is effective for fiscal years beginning after December 15, 2001. The Company is currently evaluating the impact of the adoption of this statement, but does not expect a material impact from the adoption of SFAS 144 on our consolidated financial statements. In May 2002, the FASB approved SFAS 145, "Rescission of SFAS 4, 44, and 64, Amendment of SFAS 13, and Technical Corrections as of April 2002." SFAS 145 rescinds SFAS 4, "Reporting Gains and Losses from Extinguishment of Debt," and an amendment of that Statement, SFAS 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." SFAS 145 also rescinds SFAS 44, "Accounting for Intangible Assets of Motor Carriers." SFAS 145 amends SFAS 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provisions of SFAS 145 related to the rescission of SFAS 4 shall be applied in fiscal years beginning after May 15, 2002. Any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in APB 30 for classification as an extraordinary item shall be reclassified. The provisions in paragraphs 8 and 9(c) of SFAS 145 related to SFAS 13 shall be effective for transactions occurring after May 15, 2002. All other provisions of SFAS 145 shall be effective for financial statements issued on or after May 15, 2002. Early application of all provisions is encouraged. The Company is currently evaluating the impact of the adoption of this statement, but does not expect a material impact from the adoption of SFAS 145 on our consolidated financial statements. In June 2002, the FASB approved SFAS 146, "Accounting for Exit or Disposal Activities". SFAS 146 addresses accounting for costs to terminate contracts that are not capital leases, costs to consolidate facilities or relocate employees and termination benefits. SFAS 146 requires that the fair value of a liability for penalties for early contract termination be recognized when the entity effectively terminates the contract. The fair value of a liability for other contract termination costs should be recognized when an entity ceases using the rights conveyed by the contract. The liability for one-time termination benefits should be accrued ratably over the future service period based on when employees are entitled to receive the benefits and a minimum retention period. SFAS 146 will be effective for disposal activities initiated after December 31, 2002. The Company is currently evaluating the impact of the adoption of this statement, but does not expect a material impact from the adoption of SFAS 146 on our consolidated financial statements. Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations All dollar and share amounts are in thousands. IKON Office Solutions, Inc. ("IKON" or "the Company") is one of the world's leading providers of products and services that help businesses communicate. IKON provides customers with total business solutions for every office, production and outsourcing need, including copiers and printers, color solutions, distributed printing, facilities management, imaging and legal document solutions, as well as network design and consulting and e-business development. IKON has locations worldwide, including locations in the United States, Canada, Mexico and Europe. References herein to "we", "us" or "our" refer to IKON and its subsidiaries unless the context specifically requires otherwise. Critical Accounting Policies In response to the SEC's Release No. 33-8040, "Cautionary Advice Regarding Disclosure About Critical Accounting Policies," we have identified below some of the accounting principles critical to our business and results of operations. We determined the critical principles by considering accounting policies that involve the most complex or subjective decisions or assessments. We state these accounting policies in Management's Discussion and Analysis of Financial Condition and Results of Operations and in the Notes to the consolidated financial statements contained in our Annual Report on Form 10-K/A for our fiscal year ended September 30, 2001, as amended, and at relevant sections in this discussion and analysis. In addition, we believe our most critical accounting policies include, but are not limited to, the following: Revenue Recognition. Revenues are recognized when products are delivered to and accepted by the customer or services are performed. Revenues from service contracts and rentals are recognized over the term of the contract. The present value of payments due under sales-type lease contracts is recorded as revenue and cost of goods sold is charged with the book value of the equipment when products are delivered to and accepted by the customer. Finance income is recognized over the related lease term. Goodwill. IKON evaluates goodwill in accordance with Statement of Financial Accounting Standards ("SFAS") 142. SFAS 142 prescribes a two-step method for determining goodwill impairment. In the first step, we determine the fair value of the reporting unit using expected future discounted cash flows. If the net book value of the reporting unit exceeds the fair value, we would then perform the second step of the impairment test which requires allocation of the reporting unit's fair value to all of its assets and liabilities in a manner similar to a purchase price allocation, with any residual fair value being allocated to goodwill. The fair value of the goodwill is then compared to its carrying amount to determine impairment. If future discounted cash flows are less favorable than those anticipated, goodwill may be impaired. Inventories. Inventories are stated at the lower of cost or market using the average cost or specific identification methods and consist of finished goods available for sale. IKON writes down its inventory for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those anticipated, inventory adjustments may be required. Allowances for Receivables. IKON maintains allowances for doubtful accounts and lease defaults for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of IKON's customers were to deteriorate, resulting in an impairment of their ability to make required payments, changes to our allowances may be required. Income Taxes. Income taxes are determined in accordance with SFAS 109, which requires recognition of deferred income tax liabilities and assets for the expected future tax consequences of events that have been included in the consolidated financial statements or tax returns. Under this method, deferred income tax liabilities and assets are determined based on the difference between financial statement and tax basis of liabilities and assets using enacted tax rates in effect for the year in which the differences are expected to reverse. SFAS 109 also provides for the recognition of deferred tax assets if it is more likely than not that the assets will be realized in future years. A valuation allowance has been established for deferred tax assets for which realization is not likely. In assessing the valuation allowance, IKON has considered future taxable income and ongoing prudent and feasible tax planning strategies. However, in the event that IKON determines the value of a deferred tax asset has fluctuated from its net recorded amount, an adjustment to the deferred tax asset would be necessary. Pension. Certain assumptions are used in the calculation of the actuarial valuation of our Company-sponsored defined benefit pension plans. These assumptions include the weighted average discount rate, rates of increase in compensation levels and expected long-term rates of return on assets. If actual results are less favorable than those assumed, additional pension expense may be required. Residual Values. IKON estimates the residual value of equipment sold under sales-type leases. Our residuals are based on the dollar value of the equipment. Residual values generally range between 0% to 25% of retail price, depending on equipment model and lease term. We evaluate residual values quarterly for impairment. Changes in market conditions could cause actual residual values to differ from estimated values, which could accelerate write-down of the value of the equipment. Our preparation of this Quarterly Report on Form 10-Q and other financial statements filed with the SEC requires us to make estimates and assumptions that affect amounts reported in the consolidated financial statements and notes. Actual results could differ from those estimates and assumptions. Results of Operations This discussion reviews the results of operations of the Company as reported in the consolidated statements of income. Three Months Ended June 30, 2002 Compared to the Three Months Ended June 30, 2001 Results of operations for the third quarter of fiscal 2002, compared to the third quarter of fiscal 2001, were as follows: Our third quarter revenues decreased by $92,541, or 7.1%, compared to the third quarter of fiscal 2001. This resulted primarily from the impact of our actions to exit, sell or downsize certain non-strategic businesses during fiscal 2002. Excluding the impact of these downsizing actions, revenues for the quarter were down less than 2%. Net sales, which includes revenues from the sale of copier/printer equipment, supplies and technology hardware, decreased by $43,160, or 6.7%, compared to the third quarter of fiscal 2001. More than half of the decrease was attributable to a decline in sales of technology-related hardware, down approximately 30% from the prior year. The Company has been de-emphasizing this low-margin revenue stream, choosing instead to redirect its technical capabilities to support the growing service opportunities in document management and digital connectivity. Excluding the impact of technology-related hardware, net sales were down approximately 3%. In sales of copier/printer equipment, which were down less than 2% from the prior year, the Company's performance remained strong in the high-end, segment 5 & 6 market, with over 30% growth compared to the third quarter of fiscal 2001, including growth in sales of production monochrome and color devices. Sales of lower-end copier/printer equipment and supply sales declined compared to the prior year - a reflection of the strategies the Company has employed to shift its sales focus to more profitable and strategic offerings, as well as ongoing economic and competitive pressures. Services, which primarily includes revenues from the servicing of copier/printer equipment, outsourcing and other services, decreased by $50,537, or 8.7%, compared to the third quarter of fiscal 2001. Outsourcing and other service offerings continued to be impacted by our actions to exit, sell or downsize certain non-strategic businesses during fiscal 2002, which accounted for approximately $47,000 of the decline. Excluding the impact of these downsizing actions, outsourcing and other services were flat for the quarter. The Company's installed equipment base continues to generate strong revenues from the servicing of copier/printer equipment, which grew slightly from the prior year as the base continues to undergo a shift from analog to digital technology, and the Company's focus on expanding its product mix to higher-end devices. Finance income increased by $1,156, or 1.3%, compared to the third quarter of fiscal 2001. Finance income is generated by IKON's wholly-owned leasing subsidiaries. IOS Capital, LLC ("IOSC"), IKON's leasing subsidiary in the United States, accounted for approximately 93% of IKON's finance income for the third quarter of fiscal 2002. Effective as of the third quarter of fiscal 2002, income generated through IOSC's administrative infrastructure, such as syndication fees, late fees and other processing-related revenue, will be reported as Services rather than Finance Income. Costs associated with these income generating activities have been reclassified from Selling and Administrative Expenses to Services Costs. There is no impact to operating income, net income or earnings per share as a result of this change. The following revenue and expense amounts have been reclassified:
------------------------------------------- ---------------------------------------- ---------------------------------------- Revenue* Expense** -------- --------- ------------------------------------------- ---------------------------------------- ---------------------------------------- Quarter ended June 30, 2002 $4,894 $676 ------------------------------------------- ---------------------------------------- ---------------------------------------- Quarter ended June 30, 2001 $6,079 $631 ------------------------------------------- ---------------------------------------- ----------------------------------------
*Amounts have been reclassified from Finance Income to Services Revenue. **Amounts have been reclassified from Selling and Administrative Expenses to Services Costs. Overall gross margin was unchanged at 39.7% for the third quarter of fiscal 2002 and 2001. The gross margin on net sales decreased to 34.7% from 36.1% in the third quarter of fiscal 2001. This was primarily due to the decline in supply sales gross margins resulting from the decrease in supply sales described above. The gross margin on services increased to 42.2% from 41.4% in the third quarter of fiscal 2001. This increase is primarily due to stronger margins on equipment service, reflecting increased productivity of our service technicians combined with an increasingly more efficient digital service base. The gross margin on finance income increased to 57.8% from 54.4% in the third quarter of fiscal 2001, primarily due to the effect of a higher average portfolio yield and lower average borrowing rates compared to the third quarter of fiscal 2001. Selling and administrative expense as a percent of revenue was 32.9% in the third quarter of fiscal 2002 compared to 34.8% in the third quarter of fiscal 2001, representing a decrease of $55,232, or 12.1%. The decrease resulted from improved productivity, centralization and consolidation initiatives, the downsizing or elimination of unprofitable businesses, lower selling costs due to lower sales of equipment, improvements in the sales organization infrastructure, and the elimination of approximately $10 million of goodwill amortization under SFAS 142. Our operating income increased by $18,206 compared to the third quarter of fiscal 2001. Our operating margin was 6.8% in the third quarter of fiscal 2002 compared to 4.9% (5.7% assuming the impact of not amortizing goodwill) in the third quarter of fiscal 2001. Interest expense was $12,955 in the third quarter of fiscal 2002 compared to $18,345 in the third quarter of fiscal 2001. The decrease was due to lower average outstanding debt combined with lower average short-term borrowing rates compared to the third quarter of fiscal 2001. The effective income tax rate was 38.4% in the third quarter of fiscal 2002 compared to 44.0% in the third quarter of fiscal 2001. The income tax rate reduction is primarily due to the cessation of goodwill amortization, the majority of which was non-deductible for tax purposes, as a result of our adoption of SFAS 142 effective October 1, 2001. The third quarter effective tax rate reflects a cumulative increase in the tax provision to achieve a year to date effective tax rate of 37.25%. The effective tax rate was increased from that used for the first half of fiscal 2002, due to the inability to record tax benefits on losses incurred in foreign jurisdictions. Diluted earnings per common share were $0.28 in the third quarter of fiscal 2002 compared to $0.18 in the third quarter of fiscal 2001. The diluted earnings per common share calculation for the third quarter of fiscal 2002 reflects the impact of the 5% Convertible Subordinated Notes (the "Convertible Notes") due 2007 issued by IOSC on May 13, 2002. The Company accounts for the effect of the Convertible Notes in the diluted earnings per common share calculation using the "if converted" method. Under that method, the Convertible Notes are assumed to be converted to shares (weighted for the number of days outstanding in the period) at a conversion price of $15.03, and interest expense, net of taxes, related to the Convertible Notes is added back to net income. Assuming the impact of not amortizing goodwill, diluted earnings per common share in the third quarter of fiscal 2001 would have been $0.25. In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS 142. SFAS 142 supercedes APB 17, Intangible Assets and primarily addresses accounting for goodwill and intangible assets subsequent to their acquisition. The provisions of SFAS 142 are effective for fiscal years beginning after December 15, 2001, with early adoption permitted. The most significant changes made by SFAS 142 were: (1) goodwill and indefinite lived intangible assets will no longer be amortized, (2) goodwill will be tested for impairment at least annually at the reporting unit level, (3) intangible assets deemed to have an indefinite life will be tested for impairment at least annually, and (4) the amortization period of intangible assets with finite lives will no longer be limited to forty years. Effective October 1, 2001, the Company adopted SFAS 142, which requires that goodwill not be amortized, but instead tested at least annually for impairment. An impairment charge will be recognized only when the implied fair value of a reporting unit, including goodwill, is less than its carrying amount. The Company calculates fair value using a discounted cash flow model. As of March 31, 2002, the Company completed its initial impairment review and determined that no impairment charge was required. The Company has identified the following reporting units and associated goodwill:
IKON North IKON North America America Business Sysinct Copier Outsourcing Imaging (e-business Business Business IKON Europe Services development) Total ---------------- ---------------- --------------- ---------------- ---------------- ---------------- June 30, 2002 Goodwill $866,434 $70,927 $294,749 $9,011 $2,996 $1,244,117
Changes in the goodwill balance since September 30, 2001 are attributable to foreign currency translation adjustments. As of June 30, 2002, there are no intangible assets that are required to be amortized by SFAS 142. A reconciliation of reported net income adjusted to reflect the adoption of SFAS 142 is provided below:
Three Months Ended ------------------------------ June 30, June 30, 2002 2001 ------------- ------------- Reported net income $43,142 $26,002 Add-back goodwill amortization, net of taxes of $236 10,102 ------------- ------------- Adjusted net income $43,142 $36,104 ============= ============= Reported basic earnings per common share $0.30 $0.18 Add-back goodwill amortization 0.07 ------------- ------------- Adjusted basic earnings per common share $0.30 $0.25 ============= ============= Reported diluted earnings per common share $0.28 $0.18 Add-back goodwill amortization 0.07 ------------- ------------- Adjusted diluted earnings per common share $0.28 $0.25 ============= =============
Review of Business Segments IKON North America Revenues, excluding finance income, decreased by $48,042, or 4.5%, to $1,017,183 in the third quarter of fiscal 2002 from $1,065,225 in the third quarter of fiscal 2001. The decrease was primarily due to a decline in sales of technology-related hardware and lower end copier/printer equipment reflecting our strategy to de-emphasize certain low margin products as well as ongoing economic and competitive pressures. This decrease was slightly offset by increases in revenue from after-market equipment service, facilities management and the sale of high-end, segment 5 and 6 copier/printer equipment. Finance income increased by $909, or 1.0%, to $87,592 in the third quarter of fiscal 2002, from $86,683 in the third quarter of fiscal 2001. The increase was primarily due to growth in the lease receivables portfolio and longer average lease terms. Operating income increased by $13,434, or 11.6%, to $129,157 in the third quarter of fiscal 2002 from $115,723 in the third quarter of fiscal 2001. The increase was due to higher gross margins on services and finance income and reduced selling and administrative costs as discussed above. IKON Europe Revenues, excluding finance income, decreased by $5,811, or 5.6%, to $97,420 in the third quarter of fiscal 2002 from $103,231 in the third quarter of fiscal 2001. This decrease was due mainly to a decrease in sales of technology-related hardware and a decline in after-market equipment service revenues. Finance income increased by $247, or 5.1%, to $5,122 in the third quarter of fiscal 2002 from $4,875 in the third quarter of fiscal 2001. Operating income decreased by $1,923, or 25.3%, to $5,689 in the third quarter of fiscal 2002 from $7,612 in the third quarter of fiscal 2001. Excluding a $1,700 gain related to the sale of certain real estate in the UK in fiscal 2001, operating income decreased by $223, or 2.9%, due to ongoing economic and competitive pressures, particularly in France, as well as declines in after-market equipment service. Other Other revenues decreased by $39,844, or 77.9%, to $11,299 in the third quarter of fiscal 2002 from $51,143 in the third quarter of fiscal 2001. The decline is primarily due to the downsizing, sale, and closure of certain non-strategic businesses such as telephony and technology education. There was an operating loss of $785 in the third quarter of fiscal 2002 compared to an operating loss of $5,636 in the third quarter of fiscal 2001. The decrease in operating loss reflects the impact of the actions described above concerning the removal of certain non-strategic businesses to improve operating margin performance. Nine Months Ended June 30, 2002 Compared to the Nine Months Ended June 30, 2001 Results of operations for the nine months ended June 30, 2002, compared to the nine months ended June 30, 2001, were as follows: Our revenues decreased by $341,195, or 8.6%, compared to the nine months ended June 30, 2001. This resulted primarily from the impact of our actions to exit, sell or downsize certain non-strategic businesses during fiscal 2002 which accounted for approximately $200,000 of the decline. Excluding the impact of these downsizing actions, revenues for the first nine months of fiscal 2002 were down approximately 3.5%. Net sales, which includes revenues from the sale of copier/printer equipment, supplies and technology hardware, decreased by $242,512, or 12.1%, compared to the nine months ended June 30, 2001. Approximately 4.3% of the decrease was attributable to a decline in sales of technology-related hardware. The Company has been de-emphasizing sales of technology-related hardware as part of its margin improvement strategy, choosing instead to redirect its technical capabilities to services that support other customer opportunities, including document management and digital connectivity. Excluding the impact of technology-related hardware, net sales were down approximately 7.8%. This decrease was due to a decline in supply sales and sales of copier/printer equipment resulting from the Company's strategic shift from sales of lower-end, lower margin equipment to higher-end, higher margin equipment as well as ongoing economic and competitive pressures. The Company's performance remained strong in the high-end, segment 5 & 6 market with over 30% growth compared to the first nine months of fiscal 2001. In addition, the Company continues to focus on larger regional and national accounts that entail a longer sales cycle. Supply sales declined due to the customer benefits digital technology provides in terms of product reliability and efficiency. Services, which includes revenues from the servicing of copier/printer equipment, outsourcing and other services, decreased by $111,323, or 6.5%, compared to the nine months ended June 30, 2001. This was due to a decrease in outsourcing and other services. Revenues from outsourcing and other services declined from the prior year due primarily to the downsizing, sale, and closure of certain non-strategic businesses. Facilities management services, one of the Company's key outsourcing offerings, continued to grow and offset some of the decline. Finance income increased by $12,640, or 4.7%, compared to the nine months ended June 30, 2001, primarily due to continued growth in the lease receivables portfolio. Finance income is generated by IKON's wholly-owned leasing subsidiaries. IOSC accounted for approximately 93% of IKON's finance income for the nine months ended June 30, 2002. Approximately 79% of IKON North America's copier and equipment revenues were financed by IOSC during the nine months ended June 30, 2002 compared to approximately 74% during the nine months ended June 30, 2001. Effective as of the third quarter of fiscal 2002, income generated through IOSC's administrative infrastructure, such as syndication fees, late fees and other processing-related revenue, will be reported as Services rather than within Finance Income. Costs associated with these income generating activities have been reclassified from Selling and Administrative Expenses to Services Costs. There is no impact on operating income, net income or earnings per share as a result of this change. The following revenue and expense amounts have been reclassified:
------------------------------------------- ---------------------------------------- ---------------------------------------- Revenue* Expense** -------- --------- ------------------------------------------- ---------------------------------------- ---------------------------------------- Nine months ended June 30, 2002 $15,933 $1,982 ------------------------------------------- ---------------------------------------- ---------------------------------------- Nine months ended June 30, 2001 $18,139 $1,813 ------------------------------------------- ---------------------------------------- ----------------------------------------
*Amounts have been reclassified from Finance Income to Services Revenue. **Amounts have been reclassified from Selling and Administrative Expenses to Services Costs. Overall gross margin was 38.9% compared to 38.1% in the nine months ended June 30, 2001. The gross margin on net sales was 34.3% compared to 34.8% in the nine months ended June 30, 2001. The gross margin on services increased to 40.7% from 40.1% in the nine months ended June 30, 2001, primarily due to stronger margins on equipment service which reflects the improved productivity of our service technicians. The gross margin on finance income increased to 58.0% from 50.4% in the third quarter of fiscal 2001, primarily due to the effect of a higher average portfolio yield and lower average borrowing rates compared to the nine months ended June 30, 2001. Selling and administrative expense as a percent of revenue was 33.0% in the nine months ended June 30, 2002 compared to 34.1% in the nine months ended June 30, 2001. The decrease of $160,016, or 11.7%, resulted from improved productivity, centralization and consolidation initiatives, the downsizing or elimination of unprofitable businesses, decreased selling costs due to lower sales of equipment, improvements in the sales organization infrastructure, and the elimination of goodwill amortization which accounted for approximately $30,000 of the decrease. Operating income increased by $59,041 compared to the nine months ended June 30, 2001. Our operating margin was 6.0% in the nine months ended June 30, 2002 compared to 4.0% (4.8% assuming the impact of not amortizing goodwill) in the nine months ended June 30, 2001. Interest expense was $41,551 in the nine months ended June 30, 2002 compared to $54,222 in the nine months ended June 30, 2001. The decrease was due to lower average outstanding debt combined with lower average short-term borrowing rates compared to the nine months ended June 30, 2001. The effective income tax rate was 37.3% in the nine months ended June 30, 2002 compared to 44.0% in the nine months ended June 30, 2001. The income tax rate reduction is primarily due to the cessation of goodwill amortization, the majority of which was non-deductible for tax purposes, as a result of our adoption of SFAS 142 effective October 1, 2001. In the first nine months of fiscal 2001, we recognized a gain of $2,142 ($1,200 after-tax) related to net favorable dispositions of environmental matters at locations we had previously accounted for as discontinued operations. Diluted earnings per common share were $0.74 in the nine months ended June 30, 2002 compared to $0.42 ($0.41 excluding the after-tax effect of the gain from discontinued operations) in the nine months ended June 30, 2001. The diluted earnings per common share calculation for the first nine months of fiscal 2002 reflects the impact of the Convertible Notes. The Company accounts for the effect of the Convertible Notes in the diluted earnings per common share calculation using the "if converted" method. Under that method, the Convertible Notes are assumed to be converted to shares (weighted for the number of days outstanding in the period) at a conversion price of $15.03, and interest expense, net of taxes, related to the Convertible Notes is added back to net income. Assuming the impact of not amortizing goodwill, diluted earnings per common share for the nine months ended June 30, 2001 would have been $0.63 ($0.62 excluding the after-tax effect of the gain from discontinued operations). A reconciliation of reported net income adjusted to reflect the adoption of SFAS 142 is provided below:
Nine Months Ended ------------------------------------ June 30, June 30, 2002 2001 ---------------- ---------------- Reported net income $111,011 $60,111 Add-back goodwill amortization, net of taxes of $711 30,468 ---------------- ---------------- Adjusted net income $111,011 $90,579 ================ ================ Reported basic earnings per common share $0.78 $0.42 Add-back goodwill amortization 0.21 ---------------- ---------------- Adjusted basic earnings per common share $0.78 $0.63 ================ ================ Reported diluted earnings per common share $0.74 $0.42 Add-back goodwill amortization 0.21 ---------------- ---------------- Adjusted diluted earnings per common share $0.74 $0.63 ================ ================
Review of Business Segments IKON North America Revenues, excluding finance income, decreased by $231,434, or 7.1%, to $3,010,898 for the first nine months of fiscal 2002 from $3,242,332 for the first nine months of fiscal 2001. The decrease was primarily due to a decline in sales of technology-related hardware and lower-end copier/printer equipment as a result of strategic initiatives to de-emphasize sales of certain low margin products as well as ongoing economic and competitive pressures. This decrease was slightly offset by increases in revenue from facilities management and the sale of high-end, segment 5 and 6 copier/printer equipment. Finance income increased by $12,891, or 5.1%, to $264,508 for the first nine months of fiscal 2002 from $251,617 for the first nine months of fiscal 2001. The increase was primarily due to growth in the lease receivables portfolio and longer average lease terms. Operating income increased by $66,958, or 23.3%, to $354,352 for the first nine months of fiscal 2002 from $287,394 for the first nine months of fiscal 2001. The increase was due to higher gross margins on services and finance income and reduced selling and administrative costs as discussed above. IKON Europe Revenues, excluding finance income, decreased by $14,854, or 4.6%, to $309,811 for the first nine months of fiscal 2002 from $324,665 for the first nine months of fiscal 2001. This decrease was due mainly to declines in sales of technology-related hardware and in the service after-market for copier/printer equipment, offset by growth in outsourcing. Finance income decreased by $251, or 1.6%, to $14,984 for the first nine months of fiscal 2002 from $15,235 for the first nine months of fiscal 2001. Operating income decreased by $863, or 4.9%, to $16,640 for the first nine months of fiscal 2002 from $17,503 for the first nine months of fiscal 2001. Excluding a $1,700 gain related to the sale of certain real estate in the UK in fiscal 2001, operating income increased by $837, or 4.8%, due primarily to ongoing improvements to our operational infrastructure. Other Other revenues decreased by $107,547, or 68.7%, to $49,038 for the first nine months of fiscal 2002 from $156,585 for the first nine months of fiscal 2001. The decline is primarily due to the downsizing, sale, and closure of certain non-strategic businesses such as telephony, technology education and other technology-related operations. There was an operating loss of $9,112 for the first nine months of fiscal 2002 compared to an operating loss of $19,819 for the first nine months of fiscal 2001. The decrease in operating loss reflects the impact of the actions described above concerning the removal of certain non-strategic businesses to improve operating margin performance. Restructuring and Asset Impairment Charges In the fourth quarter of fiscal 2001, the Company announced the acceleration of certain cost cutting and infrastructure improvements and recorded a pre-tax restructuring and asset impairment charge of $60,000 and reserve adjustments related primarily to the exit of the Company's telephony operations of $5,300. These related reserve adjustments were included in cost of goods sold and selling and administrative expense in the consolidated statement of income. This resulted in a charge of $65,300 ($49,235 after-tax, or $0.34 per share on a diluted basis). These actions address the exit from the Company's telephony operations in the United States and Europe, the closing of a number of non-strategic digital print centers and further downsizing of operational infrastructures throughout the organization as the Company leverages and intensifies prior standardization and centralization initiatives. These actions include the ongoing centralization and consolidation of many selling and administrative functions, including marketplace consolidation, supply chain, finance, customer service, sales support and the realignment of sales coverage against our long-term growth objectives. Additionally, the Company recorded an asset impairment charge of $3,582 ($3,300 after-tax, or $0.02 per share on a diluted basis) related to the exit of the Company's technology education operations. Therefore, the aggregate charge recorded in fiscal 2001 (the "Fiscal 2001 Charge") was $68,882 ($52,535 after-tax, or $0.36 per share on a diluted basis). In fiscal 2000, the Company recorded a net restructuring and asset impairment charge (the "Fiscal 2000 Charge") of $105,168 ($78,940 after-tax, or $0.53 per share on a diluted basis). All actions related to the Fiscal 2000 Charge are complete. Severance payments to terminated employees are made in installments. The remaining balances of the fiscal 2001 and 2000 severance charges are expected to be paid through fiscal 2003. The charges for contractual commitments relate to lease commitments where the Company is exiting certain locations and/or businesses. The remaining balances of the fiscal 2001 and 2000 charges for contractual commitments are expected to be paid over the next several years. The employees and locations affected by the Fiscal 2001 Charge described above are as follows:
Remaining Employees Employee Employees to Affected Terminations be Terminated --------------------------------------------------------------------------------------------------------------- Terminations 1,600 (1,276) 324 Remaining Sites Sites Sites to Affected Closed be Closed --------------------------------------------------------------------------------------------------------------- Closures 24 (21) 3
The following presents a reconciliation of the original restructuring components of the Fiscal 2001 Charge and Fiscal 2000 Charge from September 30, 2001 to the balance remaining at June 30,2002, which is included in other accrued expenses on the consolidated balance sheet:
Balance Balance September 30, Payments June 30, Fiscal 2001 Restructuring Charge 2001 Fiscal 2002 2002 ------------------------------------------------------------------------------------------- Severance $ 26,500 $ (9,223) $ 17,277 Contractual commitments 8,000 (2,295) 5,705 ------------------------------------------------------------------------------------------- Total $ 34,500 $ (11,518) $ 22,982 ------------------------------------------------------------------------------------------- Balance Balance September 30, Payments June 30, Fiscal 2000 Restructuring Charge 2001 Fiscal 2002 2002 ------------------------------------------------------------------------------------------- Severance $ 2,023 $ (954) $ 1,069 Contractual commitments 10,026 (3,740) 6,286 ------------------------------------------------------------------------------------------- Total $ 12,049 $ (4,694) $ 7,355 -------------------------------------------------------------------------------------------
Financial Condition and Liquidity Net cash provided by operating activities for the first nine months of fiscal 2002 was $248,925. During the same period, the Company used $214,600 of cash for investing activities, which included net finance subsidiary use of $98,310, capital expenditures for property and equipment of $78,833 and capital expenditures for equipment on operating leases of $63,216. Cash used in financing activities of $31,282, includes net repayments of $9,258 of non-finance subsidiaries' long-term debt, net issuances of $174,450 of finance subsidiaries' debt and net repayments of $178,376 of short-term debt. Debt, excluding finance subsidiaries, was $615,933 at June 30, 2002, a decrease of $185,006 from the debt balance of $800,939 at September 30, 2001. Excluding finance subsidiaries' debt, our debt to capital ratio was 29% at June 30, 2002 compared to 36.5% at September 30, 2001. Finance subsidiaries' debt is excluded from the calculation because a significant amount of this debt is backed by a portion of the lease receivables portfolio. Restricted cash on the consolidated balance sheets primarily represents cash collected on certain finance receivables, which must be used to repay certain lease-backed notes. On May 24, 2002, we obtained a new $300,000 unsecured credit facility (the "New Credit Facility") with a group of lenders. The New Credit Facility replaces our $600,000 credit facility that was to expire in January 2003 (the "Old Credit Facility"). Revolving loans are available, with certain sub-limits, to IOS Capital, LLC, IKON's leasing subsidiary in the United States; IKON Capital, PLC, IKON's leasing subsidiary in the United Kingdom; and IKON Capital, Inc., IKON's leasing subsidiary in Canada. The New Credit Facility contractually matures on May 24, 2005. As of June 30, 2002, the Company has no borrowings outstanding under the New Credit Facility. The New Credit Facility also provides support for letters of credit for the Company and its subsidiaries. As of June 30, 2002, letters of credit supported by the New Credit Facility amounted to $21,418. The remaining amount available under the New Credit Facility for borrowings or letters of credit is $278,582 as of June 30, 2002. The New Credit Facility contains affirmative and negative covenants, including limitations on certain fundamental changes, investments and acquisitions, mergers, certain transactions with affiliates, creation of liens, asset transfers, payment of dividends, intercompany loans and certain restricted payments. The New Credit Facility does not affect our ability to continue to securitize receivables. In addition, unless the Company achieves certain ratings on its long and short term senior, unsecured debt (as defined) or has not redeemed or defeased $250,000 of IOSC's 9.75% Notes due June 15, 2004, all loans under the New Credit Facility mature on December 15, 2003. Cash dividends may be paid on common stock subject to certain limitations. The New Credit Facility also contains certain financial covenants including (i) corporate leverage ratio; (ii) consolidated interest expense ratio; (iii) consolidated asset test ratios; and (iv) limitations on capital expenditures. The New Credit Facility contains defaults customary for facilities of this type. Failure to be in compliance with any material provision of the New Credit Facility could have a material adverse effect on our liquidity, financial position and results of operations. As of June 30, 2002, finance subsidiaries' debt increased by $184,592 from September 30, 2001. During the nine months ended June 30, 2002, our finance subsidiaries repaid $1,347,815 of debt and received $1,522,265 from the issuance of lease-backed notes and other debt instruments. As of June 30, 2002, IOSC, IKON Capital, PLC and IKON Capital, Inc. had approximately $655,000, (pound)20,539 and CN$41,928 available under their revolving asset securitization conduit financing agreements. On May 13, 2002, IOSC issued $300,000 of convertible subordinated notes (the "Convertible Notes") with an interest rate of 5.0%, which are due on May 1, 2007. The Convertible Notes can be converted into shares of IKON common stock at any time before maturity at a conversion price of $15.03 per share. Interest will be paid on the convertible notes semi-annually beginning November 1, 2002. On May 21, 2002, IKON Receivables Funding, LLC (a wholly owned subsidiary of the Company) issued $634,800 of lease-backed notes (the "2002-1 Notes") pursuant to a shelf registration statement filed with the Securities and Exchange Commission. The 2002-1 Notes are comprised of Class A-1 Notes totaling $171,000 with a stated interest rate of 2.044%, Class A-2 Notes totaling $46,000 with a stated interest rate of 2.91%, Class A-3 Notes totaling $266,400 with a stated interest rate of 3.90% and Class A-4 Notes totaling $151,400 with a stated interest rate of 4.68%. The 2002-1 Notes are collateralized by a pool of office equipment leases or contracts and related assets and the payments on the 2002-1 Notes are made from payments received on the equipment leases. The Company uses interest rate swaps to fix the interest rates on its variable rate classes of lease-backed notes, which results in a lower cost of capital than if we had issued fixed rate notes. During the nine months ended June 30, 2002, unrealized gains totaling $8,146 after taxes, was recorded in accumulated other comprehensive loss. As of June 30, 2002, all of the Company's derivatives designated as hedges are interest rate swaps which qualify for evaluation using the "short cut" method for assessing effectiveness. As such, there is an assumption of no ineffectiveness. During the first nine months of fiscal 2002, the Company repurchased 21 shares of its common stock. From time to time, the Retirement Savings Plan of the Company may acquire shares of the common stock of the Company in open market transactions or from treasury shares held by the Company. The following summarizes IKON's significant contractual obligations and commitments as of June 30, 2002:
Payments Due by Period Less Than Contractual Obligations Total 1 year 1 - 3 years 4 - 5 years After 5 years -------------------------------- ----------------- ----------------- ---------------- ----------------- ---------------- Long-Term Debt $608,382 $13,067 $129,302 $55,612 $410,401 Long-Term Debt, Finance Subsidiaries 2,780,331 1,065,323 1,268,130 446,852 26 Notes Payable 7,551 7,551 Purchase Commitments 26,214 14,058 12,156 Operating Leases 247,318 45,226 94,324 53,550 54,218 Synthetic Leases 41,901 23,901 18,000 -------------------------------- ----------------- ----------------- ---------------- ----------------- ---------------- Total $3,711,697 $1,169,126 $1,503,912 $574,014 $464,645
Payments on long-term debt, finance subsidiaries generally are made from collections on our finance receivables. At June 30, 2002, long-term debt, finance subsidiaries was $2,780,331 and finance receivables were $3,411,986. Purchase commitments represent future cash payments related to our implementation of the Oracle e-business suite. Contractual obligations for future technical support of $15,650 will be expensed over the term of the contract. The remaining $10,564 is for software and is included in fixed assets and accrued liabilities as of June 30, 2002. Synthetic leases are not required to be recorded on the Company's balance sheet. The payments above represent the contractual obligation due at the end of the lease period and will be paid from proceeds received from the sale of the properties related to the synthetic leases. IKON obtains valuations of leased properties structured as synthetic leases. If market conditions result in a valuation that is less than the guaranteed residual value of the property, IKON may be required to record a charge to income. Any current shortfall between the contractual obligation and the estimated fair value of the leased assets has been accrued as of June 30, 2002. The Company has certain commitments available to it in the form of lines of credit and standby letters of credit. As of June 30, 2002, the Company had $292,796 available under lines of credit and $27,336 available under standby letters of credit. All commitments expire within one year. The Company believes that its operating cash flow together with unused bank credit facilities and other financing arrangements will be sufficient to finance current operating requirements for fiscal 2002, including capital expenditures, dividends and the remaining accrued costs associated with the Company's restructuring charges. Pending Accounting Changes In June 2001, the FASB approved SFAS 143, "Accounting for Asset Retirement Obligations." SFAS 143 addresses accounting for legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and the normal operation of a long-lived asset, except for certain obligations of lessees. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and subsequently allocated to expense over the asset's useful life. SFAS 143 is effective for fiscal years beginning after June 15, 2002. The Company is currently evaluating the impact of the adoption of this statement, but does not expect a material impact from the adoption of SFAS 143 on our consolidated financial statements. In August 2001, the FASB approved SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS 144 supercedes SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and APB 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions." SFAS 144 requires an impairment loss to be recognized only if the carrying amounts of long-lived assets to be held and used are not recoverable from their expected undiscounted future cash flows. SFAS 144 is effective for fiscal years beginning after December 15, 2001. The Company is currently evaluating the impact of the adoption of this statement, but does not expect a material impact from the adoption of SFAS 144 on our consolidated financial statements. In May 2002, the FASB approved SFAS 145, "Rescission of SFAS 4, 44, and 64, Amendment of SFAS 13, and Technical Corrections as of April 2002." SFAS 145 rescinds SFAS 4, "Reporting Gains and Losses from Extinguishment of Debt," and an amendment of that Statement, SFAS 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." SFAS 145 also rescinds SFAS 44, "Accounting for Intangible Assets of Motor Carriers." SFAS 145 amends SFAS 13, "Accounting for Leases," to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. SFAS 145 also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provisions of SFAS 145 related to the rescission of SFAS 4 shall be applied in fiscal years beginning after May 15, 2002. Any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in APB 30 for classification as an extraordinary item shall be reclassified. The provisions in paragraphs 8 and 9(c) of SFAS 145 related to SFAS 13 shall be effective for transactions occurring after May 15, 2002. All other provisions of SFAS 145 shall be effective for financial statements issued on or after May 15, 2002. Early application of all provisions is encouraged. The Company is currently evaluating the impact of the adoption of this statement, but does not expect a material impact from the adoption of SFAS 145 on our consolidated financial statements. In June 2002, the FASB approved SFAS 146, "Accounting for Exit or Disposal Activities". SFAS 146 addresses accounting for costs to terminate contracts that are not capital leases, costs to consolidate facilities or relocate employees and termination benefits. SFAS 146 requires that the fair value of a liability for penalties for early contract termination be recognized when the entity effectively terminates the contract. The fair value of a liability for other contract termination costs should be recognized when an entity ceases using the rights conveyed by the contract. The liability for one-time termination benefits should be accrued ratably over the future service period based on when employees are entitled to receive the benefits and a minimum retention period. SFAS 146 will be effective for disposal activities initiated after December 31, 2002. The Company is currently evaluating the impact of the adoption of this statement, but does not expect a material impact from the adoption of SFAS 146 on our consolidated financial statements. Item 3: Quantitative and Qualitative Disclosures About Market Risk Interest Rate Risk: Our exposure to market risk for changes in interest rates relates primarily to our long-term debt. We have no cash flow exposure due to interest rate changes for long-term debt obligations as the Company uses interest rate swaps to fix the interest rates on our variable rate classes of lease-backed notes and other debt obligations. We primarily enter into debt obligations to support general corporate purposes, including capital expenditures, working capital needs and acquisitions. Finance subsidiaries' long-term debt is used primarily to fund the lease receivables portfolio. The carrying amounts for cash and cash equivalents, accounts receivable and notes payable reported in the consolidated balance sheets approximate fair value. Additional disclosures regarding interest rate risk are set forth in the Company's 2001 Annual Report on Form 10-K/A filed with the Securities and Exchange Commission. Foreign Exchange Risk: The Company has various non-U.S. operating locations which expose it to foreign currency exchange risk. Foreign denominated intercompany debt borrowed in one currency and repaid in another may be fixed via currency swap agreements. Additional disclosures regarding foreign exchange risk are set forth in the Company's 2001 Annual Report on Form 10-K/A filed with the Securities and Exchange Commission. PART II. OTHER INFORMATION Item 1: Legal Proceedings The matter of Whetman, et al. v. IKON Office Solutions, Inc., et al. (the "Claim") involves a claim brought under the Employee Retirement Income Security Act of 1974 ("ERISA"). In connection with the Claim, the plaintiffs allege that the Company and various individuals violated fiduciary duties under ERISA based on allegedly improper investments in the Company's stock made through the Company's Retirement Savings Plan (the "Plan"). The court certified a class with respect to the Claim consisting generally of all those participants in the Plan after September 30, 1995 and through August 13, 1998, subject to certain exceptions. On May 14, 2002, the Company announced that, subject to court approval, it reached an agreement to settle the Claim. The Company is not making any monetary payment to the class to settle the lawsuit, and the settlement does not reflect any admission of liability by the Company. The Company has agreed to make certain modifications to its Plan in order to allow participants greater flexibility with respect to investment of the employer match portion of their individual accounts. Under the settlement, employees who have been with the Company for at least two years will be permitted to allocate Company matching funds in investment options other than IKON stock, subject to vesting schedules. The court has preliminarily approved the settlement. The court held a hearing on the final approval of the settlement on August 8, 2002, and issued a Memorandum and Order on August 9, 2002 approving the settlement. Plaintiffs' counsel has petitioned the court for an award of their fees and costs of litigation. The court has not yet ruled on the petition. Any fees and costs awarded by the court will be paid by the Company. Such payment is not expected to have a material financial impact on the Company. Item 2: Changes in Securities and Use of Proceeds During the quarter ended June 30, 2002, IOSC issued the following securities in a transaction which was not registered under the Securities Act of 1933, as amended (the "Act"). (1) 5% Convertible Subordinated Notes due 2007 a) Securities Sold: On May 13, 2002, IOSC issued and sold $300,000 5% convertible subordinated notes with an interest rate of 5% which are due May 1, 2007 (the "Convertible Notes"). b) Underwriters and Other Purchasers: The Convertible Notes were sold to Deutsche Banc Securities, J.P. Morgan Securities Inc., and Bank of America Securities LLC, as initial purchasers. c) Consideration: The aggregate offering price was $300,000, reflecting 100% of the aggregate principal amount of the Convertible Notes plus accrued interest from the issue date. The initial purchasers acquired the Convertible Notes at a purchase price of 97.5% of the aggregate principal amount of the Convertible Notes plus accrued interest from the issue date. d) Exemption from Registration: Exemption from registration under the Act was claimed based upon Rule 144A and Regulation S. e) Terms of Conversion: The Convertible Notes may be converted into shares of IKON common stock at any time before maturity at a conversion price of $15.03 per share. Item 6: Exhibits and Reports on Form 8-K a) Exhibits Exhibit 4.1 Indenture dated as of May 13, 2002 between the Company, IOSC and Deutsche Bank Trust Company Americas, as Trustee. Exhibit 4.2 Registration Rights Agreement dated May 13, 2002 between the Company, Deutsche Bank Securities, Inc. Banc of America Securities LLC and JP Morgan Securities Inc. Exhibit 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. b) Reports on Form 8-K On April 29, 2002, the Company filed a Current Report on Form 8-K to file, under Item 5 of the Form, information contained in its press release dated April 25, 2002 regarding its results for the second quarter of fiscal 2002. On May 7, 2002, the Company filed a Current Report on Form 8-K to file, under Item 9 of the Form, balance sheet and cash flow statements, intended to be considered in the context of its SEC filings regarding financial statements for the second quarter of fiscal 2002. On May 29, 2002, the Company filed a Current Report on Form 8-K to file, under Item 5 of the Form, information contained in its press release dated May 28, 2002 regarding the completion of a $300 million unsecured revolving credit facility dated May 24, 2002. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. This report has also been signed by the undersigned in his capacity as the chief accounting officer of the Registrant. IKON OFFICE SOLUTIONS, INC. Date August 13, 2002 /s/ William S. Urkiel ------------------- --------------------------- William S. Urkiel Senior Vice President and Chief Financial Officer