10-Q/A 1 d10qa.htm IKON OFFICE SOLUTIONS INC--FORM 10-Q/A Ikon Office Solutions Inc--Form 10-Q/A
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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q/A

 


 

(Mark One)

x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the three months ended December 31, 2004 or

 

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from              to             .

 

Commission file number 1-5964

 


 

IKON OFFICE SOLUTIONS, INC.

(Exact name of registrant as specified in its charter)

 


 

OHIO   23-0334400

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

70 Valley Stream Parkway, Malvern, Pennsylvania   19355
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (610) 296-8000

 


 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class


 

Name of each exchange

on which registered


Common Stock, no par value   New York Stock Exchange
(with Preferred Share Purchase Rights)    

 

Securities registered pursuant to Section 12(g) of the Act: 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  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).    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 February 4, 2005:

 

Common Stock, no par value    140,633,100 shares

 



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EXPLANATORY NOTE

 

This Amendment to the Registrant’s (the “Company”) Quarterly Report on Form 10-Q for the three months ended December 31, 2004 (the “Amendment”) is being filed (i) to restate certain amounts to correct our financial statements as explained further below (see also “Item 1. Financial Statements—Note 2. Restatement of Previously Issued Financial Statements,” for discussion of significant changes), (ii) to revise disclosures of the Company’s Condensed Consolidated Financial Statements for the three months ending December 31, 2004, (iii) to amend “Item 4. Controls and Procedures,” to disclose certain matters identified in connection with the Company’s evaluation, under the supervision and with the participation of the Company’s management, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to the U.S. Securities and Exchange Commission (“SEC”) Rules 13a-15 and 15d-15 under the Exchange Act and (iv) to amend Items 1, 2, and 4 in Part I and the “Forward-Looking Information” section. The Company has also made conforming updates to the index and signature page. Items not being amended and restated are presented for the convenience of the reader only. This Amendment continues to describe conditions as of the date of the original filing of the Quarterly Report on Form 10-Q for the three months ending December 31, 2004 and the Company has not updated the disclosures contained therein to reflect events that occurred at a later date, except for items relating specifically to the restatement, and items relating specifically to disclosure controls and procedures. Therefore, this Amendment should be read together with other documents that the Company has filed with the SEC subsequent to the filing of the original Quarterly Report on Form 10-Q for the three months ending December 31, 2004. Information in such reports and documents updates and supercedes certain information contained in this Amendment.

 

During an analysis of aged trade accounts receivable conducted during fiscal 2005, and in connection with performing self-assessment and testing of the Company’s internal controls over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002, the Company identified deficiencies in the processes and timeliness by which it issues and adjusts certain invoices. The identified deficiencies result principally from the centralization of billing centers and the migration to a new billing platform and relate to certain of the Company’s U.S. trade accounts receivable, and do not affect receivables arising under the Company’s Mexican operations, receivables owing from General Electric Capital Corporation (“GE”) under the Company’s leasing relationship with GE, or receivables arising under the Company’s Legal Document Service and Business Document Service businesses. In connection with these developments, the Company’s management executed a comprehensive review (the “Review”) to determine the extent of such accounts receivable and billing errors. Based on the results of the Review, the Company’s management and the Audit Committee of the Company’s Board of Directors concluded that the errors had a cumulative effect over multiple periods and that prior period financial statements required restatement. On April 28, 2005, the Company reported on Form 8-K that it would restate its previously issued financial statements included in the Company’s Form 10-K for fiscal 2004 and Form 10-Q for the three months ending December 31, 2004, due to the impact of the identified deficiencies. Accordingly, in this Amendment the Company is restating its consolidated balance sheets (unaudited) at December 31, 2004 and September 30, 2004, and consolidated statements of income (unaudited) and cash flows (unaudited) for the three months ending December 31, 2004 and 2003 (the “Restatement”) for the impact of billing errors and other identified adjustments as a result of the Review. As a result of the Review the Company has restated:

 

    revenues, accounts receivable and deferred revenues for all periods presented to reflect the impact of billing errors;

 

    the allowance for doubtful accounts and bad debt expense for all periods presented to reflect only the impact on accounts receivable of credit losses due to the inability of customers to pay;

 

    revenues and selling and administrative expense for all periods presented for the reclassification of billing error corrections which were incorrectly recorded as selling and administrative expense rather than as a reduction of revenue;

 

    income and deferred income taxes for all periods presented for the tax impact of the above items;

 

    the Company’s balance sheets for all periods presented to reclassify certain accounts receivable which were previously recorded as a reduction of deferred revenues; and


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    the Company’s balance sheet at September 30, 2004, to record accounts receivable from the Company’s customers and a corresponding liability to GE for invoices billed and collected by GE on the Company’s behalf and advanced by GE to the Company prior to payment by the Company’s customers.

 

These adjustments resulted in an increase in previously reported net income and earnings per share for the three months ending December 31, 2004 and 2003 of $4.6 million, or $0.02 per diluted share and $1.1 million, or $0.00 per diluted share, respectively.

 

The Restatement affected periods prior to fiscal 2004 and the impact of the Restatement on such prior periods of $(30,032) was reflected as an adjustment to retained earnings as of October 1, 2003.

 

The following table sets forth the increase (decrease) to certain income statement line items in various periods impacted by the Restatement (amounts in thousands, except per share data).

 

Period    Revenue

    Selling and
Administrative Expense


    Operating Income

    Net Income

    Diluted Earnings
per Share


 

1st Quarter Fiscal 2005

   $ 1,320     $ (6,305 )   $ 7,625     $ 4,613     $ 0.02  

Fiscal 2004

     (36,269 )     (23,277 )     (12,992 )     (7,860 )     (0.05 )

Fiscal 2003

     2,248       (9,470 )     11,718       7,090       0.04  

Fiscal 2002

     (5,016 )     (1,233 )     (3,783 )     (2,288 )     (0.01 )

Fiscal 2001

     1,360       1,227       133       80       —    

Fiscal 2000

     (11,922 )     (9,302 )     (2,620 )     (1,585 )     (0.01 )

Prior to Fiscal 2000

     (76,746 )     (21,892 )     (54,854 )     (33,328 )     N/A  
    


 


 


 


       

Cumulative Impact

   $ (125,025 )   $ (70,252 )   $ (54,773 )   $ (33,278 )     N/A  
    


 


 


 


       

 

The following table sets forth the increase (decrease) to certain balance sheet line items in various periods impacted by the Restatement (amounts in thousands).

 

Period    Accounts
Receivable


    Deferred Tax
Asset


   Deferred Revenues

    Accounts Payable

   Retained Earnings

 

December 31, 2004

   $ (31,956 )   $ 21,495    $ (2,300 )   $ 25,118    $ (33,279 )

September 30, 2004

     (44,001 )     24,507      (3,169 )     21,567      (37,892 )

September 30, 2003

     (58,275 )     19,375      (8,868 )     —        (30,032 )

September 30, 2002

     (84,483 )     24,003      (23,358 )     —        (37,122 )

September 30, 2001

     (58,696 )     22,509      (1,353 )     —        (34,834 )

September 30, 2000

     (60,047 )     22,561      (2,572 )     —        (34,914 )

October 1, 1999

     (59,050 )     21,526      (4,196 )     —        (33,328 )

 

The majority of the changes reflected in this Amendment are set forth on pages 1, 3-7, 10-17, 27, 29 and 39-41, however, readers are strongly encouraged to read this Amendment in its entirety.


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IKON OFFICE SOLUTIONS, INC.

 

INDEX

 

PART I—FINANCIAL INFORMATION     
ITEM 1.   Financial Statements     
    Consolidated Balance Sheets—December 31, 2004 and September 30, 2004 (unaudited)    5
    Consolidated Statements of Income—Three months ended December 31, 2004 and 2003 (unaudited)    6
    Consolidated Statements of Cash Flows—Three months ended December 31, 2004 and 2003 (unaudited)    7
    Notes to Condensed Consolidated Financial Statements (unaudited)    8
ITEM 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations    26
ITEM 3.   Quantitative and Qualitative Disclosures About Market Risk    39
ITEM 4.   Controls and Procedures    39
PART II—OTHER INFORMATION     
ITEM 2.   Unregistered Sales of Equity Securities and Use of Proceeds    42
ITEM 6.   Exhibits    42
SIGNATURES     

 


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FORWARD-LOOKING INFORMATION

 

IKON Office Solutions, Inc. (“we,” “us,” “our,” “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/A, which constitutes “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995 (the “Litigation Reform Act”). These forward-looking statements include, but are not limited to, statements regarding the following: the expected impact and use of proceeds from our transactions with General Electric Capital Corporation (“GE”) and its affiliates involving the sale of certain assets and liabilities of our leasing operations in the U.S. and Canada; earnings, revenue, cash flow, margin, and cost-savings projections; core business growth opportunities and increasing market share; infrastructure and operational leverage and efficiency initiatives; our ability to repay debt; the run-off of our retained U.S. lease portfolio; the expensing of our stock options; the effect of competitive pressures on equipment sales; conducting operations in a competitive environment and a changing industry; developing and expanding strategic alliances and partnerships; the implementation, timing, and cost of our ongoing conversion to a common enterprise resource planning (“ERP”) system, which is primarily based on the Oracle E-Business Suite (the “ERP Conversion”); anticipated growth rates in the digital monochrome and color equipment and outsourcing areas; the effect of foreign currency exchange risks; the reorganization of our business segments and the anticipated benefits of operational synergies related thereto; our ability to finance our current operations and growth initiatives; our ability to remediate control deficiencies identified in our billing and trade accounts receivable processes; our ability to have effective internal controls over financial reporting at September 30, 2005; and existing or future vendor relationships. Although we believe the expectations contained in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove correct. References herein to “we,” “us,” “our,” “IKON,” or the “Company” refer to IKON and its subsidiaries unless the context specifically requires or implies otherwise.

 

The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “will,” “should,” “may,” “plan,” and similar expressions, as they relate to us or our management, are intended to identify forward-looking statements. Such statements reflect our current views of the Company 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, intended, or planned. We assume no obligations related to, nor do we intend to update, these forward-looking statements.

 

In accordance with the provisions of the Litigation Reform Act, we are 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 these forward-looking statements. These factors include, but are not limited to, the following (some of which are explained in greater detail in this Form 10-Q/A): our ability to successfully integrate our equipment distribution business with a third-party finance vendor program, which involves the integration and transition of complex systems and processes; operating in a competitive environment and a changing industry, which includes technological services and products that are relatively new to the industry; delays, difficulties, management transitions, and employment issues associated with consolidations and/or changes in business operations, including our ERP Conversion; existing and future vendor relationships; risks relating to foreign currency exchange; economic, legal, and political issues associated with international operations; our ability to access capital and meet our debt service requirements (including sensitivity to fluctuations in interest rates); and general economic conditions.

 

Billing and Trade Accounts Receivable. Our ability to timely issue accurate invoices is critical to ensuring accurate recording of our revenue and trade accounts receivable. We identified deficiencies in the processes and timeliness by which we issue and adjust certain invoices (See “Item 1. Financial Statements—Note 2. Restatement of Previously Issued Financial Statements”) and have implemented processes designed to fairly present our financial statements. Our inability to continue to remediate these deficiencies could result in a material adverse impact on our financial position and results of operations.

 

Competition. We operate in a highly competitive environment. Competition is based largely upon technology, performance, pricing, quality, reliability, distribution, and customer support. A number of companies

 

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worldwide with significant financial resources or customer relationships compete with us to provide similar products and services, such as Xerox, Pitney Bowes, and Danka. Our competitors may be positioned to offer more favorable product and service terms to the marketplace, resulting in reduced profitability and loss of market share for us. Some of our competitors, such as Canon, Ricoh, Konica Minolta, and HP, also supply us with the products we sell, service, and lease. In addition, we compete against smaller local independent office equipment distributors. Financial pressures faced by our competitors may cause them to engage in uneconomic pricing practices, which could cause the prices that we are able to charge in the future for our products and services to be less than we have historically charged. Our future success is based in large part upon our ability to successfully compete in the markets we currently serve and to expand into additional product and service offerings. Our failure to do so could lead to a loss of market share for us, resulting in a material adverse effect on our results of operations.

 

Pricing. Our success is dependent upon our ability to charge adequate prices for the equipment, parts, supplies, and services we offer. Depending on competitive market factors, future prices we can charge for the equipment, parts, supplies, and services we offer may vary from historical levels and may impact our profitability.

 

Third-party Finance Vendor Relationships. If we are unable to continue to successfully integrate our equipment distribution business with third-party finance vendors under our program agreement (the “U.S. Program Agreement”) with GE and our rider to the U.S. Program Agreement with GE in Canada (the “Canadian Rider;” together with the U.S. Program Agreement, the “Program Agreements”), which involves the integration and transition of complex systems and processes, our liquidity, financial position, and results of operations may be adversely affected. Prior to our entry into the Program Agreements, significant portions of our profits were derived from our leasing operations in the U.S. and Canada. Currently, we are entitled to receive certain fees under the Program Agreements for future leases funded by GE. We intend to use these fees as well as the proceeds from the sale of our North American leasing operations to implement certain strategies, including, among other things, to enhance our core business of document management solutions, reduce our debt, and repurchase shares of our common stock. Our failure to successfully implement these strategies could have a material adverse effect on our liquidity, financial position, and results of operations.

 

Our ability to generate ongoing revenue from the Program Agreements is dependent upon our ability to identify and secure opportunities for lease-financing transactions with our customers under the Program Agreements. Our failure to secure such opportunities for funding by GE could result in a material adverse effect on our liquidity, financial position, and results of operations.

 

Vendor Relationships. Our access to equipment, parts, supplies, and services depends upon our relationships with, and our ability to purchase these items on competitive terms from, our principal vendors, Canon, Ricoh, Konica Minolta, EFI, and HP. We do not enter into long-term supply contracts with these vendors and we have no current plans to do so in the future. These vendors are not required to use us to distribute their equipment and are free to change the prices and other terms at which they sell to us. In addition, we compete with the direct selling efforts of some of these vendors. Significant deterioration in relationships with, or in the financial condition of, these significant vendors could have an adverse impact on our ability to sell and lease equipment as well as our ability to provide effective service and technical support. If one of these vendors terminated or significantly curtailed its relationship with us, or if one of these vendors ceased operations, we would be forced to expand our relationship with other vendors, seek new relationships with other vendors, or risk a loss in market share due to diminished product offerings and availability. In addition, as we continue to seek expansion of our products and services portfolio, we are developing relationships with certain software vendors. As our relationships with software vendors become more integral to our development and growth, the termination or significant curtailment of these relationships may force us to seek new relationships with other software vendors, or pose a risk of loss in market share due to diminished software offerings.

 

New Product Offerings. Our business is driven primarily by customers’ needs and demands and by the products developed and manufactured by third parties. Because we distribute products developed and

 

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manufactured by third parties, our business would be adversely affected if our suppliers fail to anticipate which products or technologies will gain market acceptance or if we cannot sell these products at competitive prices. We cannot be certain that our suppliers will permit us to distribute their newly developed products or that such products will meet our customers’ needs and demands. Additionally, because some of our principal competitors design and manufacture their own products rather than rely on third parties to supply them, those competitors may have a competitive advantage over us. To successfully compete, we must maintain an efficient cost structure, an effective sales and marketing team, and offer additional services that distinguish us from our competitors. Failure to execute these strategies successfully could result in reduced market share for us or could have a material adverse effect on our liquidity, financial position, and results of operations.

 

Liquidity. We maintain a $200 million secured credit facility (the “Credit Facility”) with a group of lenders. The Credit Facility provides the availability of revolving loans, with certain sub-limits, and provides support for letters of credit. The amount of credit available under the Credit Facility is reduced by open letters of credit. The amount available under the Credit Facility for borrowings or additional letters of credit was $165.6 million at December 31, 2004. The Credit Facility is secured by our accounts receivable and inventory, the stock of our first-tier domestic subsidiaries, 65% of the stock of our first-tier foreign subsidiaries, and all of our intangible assets. All security interests pledged under the Credit Facility are shared with the holders of our 7.25% notes payable due 2008.

 

The Credit Facility contains affirmative and negative covenants, including limitations on certain fundamental core business changes, investments and acquisitions, mergers, certain transactions with affiliates, creations of liens, asset transfers, payments of dividends, intercompany loans, and certain restricted payments. The Credit Facility does not, however, limit our ability to continue to securitize lease receivables. The Credit Facility matures on March 1, 2008, but is subject to certain early maturity events in November 2006, January 2007, and April 2007 if our 5% convertible subordinated notes due May 2007 (the “Convertible Notes”) have not been converted to equity or refinanced and minimum liquidity is not met as of such dates. Minimum liquidity is defined as having sufficient cash, including any unused capacity under the Credit Facility, to repay the balance of the Convertible Notes plus an additional $100 million. The Credit Facility contains certain financial covenants relating to: (i) our corporate leverage ratios; (ii) our consolidated interest coverage ratio; (iii) our consolidated asset coverage ratio; (iv) our consolidated net worth ratios; (v) limitations on our capital expenditures; and (vi) limitations on additional indebtedness and liens. Under the terms of the Credit Facility, share repurchases are permitted in an aggregate amount not to exceed $250 million during the period of July 28, 2004 through March 1, 2008. From July 28, 2004 through September 30, 2005, share repurchases are permitted in an aggregate amount not to exceed $150 million. Beginning on October 1, 2005, we are permitted to repurchase (a) shares and pay dividends in an aggregate annual amount not to exceed 50% of our annual net income, plus (b) that portion of the $150 million allowance that we did not utilize prior to October 1, 2005. As of December 31, 2004, $72.7 million of the $150 million allowance was utilized. Additionally, the Credit Facility contains default provisions customary for facilities of this type. Failure to comply with any material provision of the Credit Facility could have a material adverse effect on our liquidity, financial position, and results of operations. During the third quarter of fiscal 2005, we entered into a consent (the “Consent”) to our Credit Facility to provide us with an extension to the deadline by which we must deliver to the lenders certain items required under the Credit Facility, including our financial statements for the second quarter of fiscal year 2005, in order to allow us to complete the review of our billing controls and reserve practices for our trade accounts receivable (see Note 2 to the Condensed Consolidated Financial Statements).

 

Operational Efficiencies. Our ability to improve our profit margins is largely dependent on the success of our initiatives to streamline our infrastructure and drive operational efficiencies across our company. Such initiatives, which include consolidation and process redesign and the ERP Conversion, and process enhancement through Six Sigma, are focused on strategic priorities such as process redesign and improvement, organizational development, and asset management. Six Sigma is a disciplined business methodology designed to assist companies in increasing profitability by streamlining operations, improving quality, and eliminating possible defects in processes. Six Sigma is intended to provide specific methods to re-create a particular process, starting

 

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from the customer’s vantage point, so that defects in the process are eliminated and any potential defects are prevented. Our failure to successfully implement these initiatives, or the failure of such initiatives to result in improved profit margins, could have a material adverse effect on our liquidity, financial position, and results of operations.

 

International Operations. We have international operations in Canada, Mexico, and Western Europe. Approximately 18% of our revenues are derived from our international operations, and approximately 74% of those revenues are derived from Canada and the United Kingdom. Our future revenues, costs of operations, and profits could be affected by a number of factors related to our international operations, 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. For example, unanticipated currency fluctuations in the Canadian Dollar, British Pound, or Euro versus the U.S. Dollar could lead to lower reported consolidated results of operations due to the translation of these currencies.

 

Internal Controls. Effective internal controls are necessary for us to provide reasonable assurance with respect to our financial reports and to effectively prevent fraud. If we cannot provide reasonable assurance with respect to our financial reports and effectively prevent fraud, our brand and operating results could be harmed. Pursuant to the Sarbanes-Oxley Act of 2002, we are required to furnish a report by management on internal controls over financial reporting, including management’s assessment of the effectiveness of such controls. Internal controls over financial reporting may not prevent or detect misstatements because of their inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Therefore, even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. In addition, projections of any evaluation of effectiveness of internal controls over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. If we fail to maintain the adequacy of our internal controls, including any failure to implement required new or improved controls, or if we experience difficulties in their implementation, our business and operating results could be harmed, we could fail to meet our reporting obligations, and there could be a material adverse effect on our stock price.

 

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PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

IKON OFFICE SOLUTIONS, INC.

 

CONSOLIDATED BALANCE SHEETS

(unaudited)

(in thousands)

 

    Restated
December 31, 2004


    Restated
September 30, 2004


 

Assets

               

Cash and cash equivalents

  $ 292,241     $ 472,951  

Restricted cash

    26,721       27,032  

Accounts receivable, less allowances of: December 31, 2004 - $6,789; September 30, 2004—$7,224

    754,570       728,634  

Finance receivables, less allowances of: December 31, 2004 - $2,870; September 30, 2004—$2,514

    444,154       457,615  

Inventories

    289,510       233,345  

Prepaid expenses and other current assets

    72,122       81,188  

Deferred taxes

    61,469       64,481  
   


 


Total current assets

    1,940,787       2,065,246  
   


 


Long-term finance receivables, less allowances of: December 31, 2004—$3,963; September 30, 2004—$3,932

    672,847       753,146  

Equipment on operating leases, net of accumulated depreciation of: December 31, 2004—$80,356; September 30, 2004—$76,456

    88,191       78,673  

Property and equipment, net of accumulated depreciation of: December 31, 2004—$328,886; September 30, 2004—$321,789

    159,421       164,132  

Goodwill

    1,316,704       1,286,564  

Unsold residual value (Note 3)

    58,370       45,548  

Other assets

    121,366       125,104  
   


 


Total Assets

  $ 4,357,686     $ 4,518,413  
   


 


Liabilities and Shareholders’ Equity

               

Current portion of corporate debt

  $ 5,265     $ 62,085  

Current portion of debt supporting finance contracts and unsold residual value

    402,834       439,941  

Notes payable

    864       938  

Trade accounts payable

    269,451       307,170  

Accrued salaries, wages, and commissions

    80,641       124,808  

Deferred revenues

    113,923       116,682  

Taxes payable

    105,943       52,976  

Other accrued expenses

    150,845       170,741  
   


 


Total current liabilities

    1,129,766       1,275,341  
   


 


Long-term corporate debt

    742,036       741,857  

Long-term debt supporting finance contracts and unsold residual value

    384,430       422,868  

Deferred taxes

    150,864       187,091  

Other long-term liabilities

    218,774       203,538  

Commitments and contingencies (Note 10)

               

Shareholders’ Equity

               

Common stock, no par value: authorized 300,000 shares issued: December 31, 2004—150,196 shares; September 30, 2004—149,955 shares, shares outstanding: December 31, 2004—140,381 shares; September 30, 2004—142,133 shares

    1,025,746       1,022,842  

Series 12 preferred stock, no par value: authorized 480 shares; none issued or outstanding

               

Deferred compensation

    210       209  

Unearned compensation

    (5,557 )     (2,448 )

Retained earnings

    738,226       723,847  

Accumulated other comprehensive income

    69,687       20,195  

Cost of common shares in treasury: December 31, 2004—8,909 shares; September 30, 2004—7,196 shares

    (96,496 )     (76,927 )
   


 


Total Shareholders’ Equity

    1,731,816       1,687,718  
   


 


Total Liabilities and Shareholders’ Equity

  $ 4,357,686     $ 4,518,413  
   


 


 

See notes to condensed consolidated financial statements.

 

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IKON OFFICE SOLUTIONS, INC.

 

CONSOLIDATED STATEMENTS OF INCOME

(unaudited)

(in thousands, except per share data)

 

     Three Months Ended December 31

     Restated
      2004      


     Restated
      2003      


Revenues

               

Net sales

   $ 464,711      $ 450,804

Services

     601,454        586,422

Finance income

     30,806        99,011
    

    

       1,096,971        1,136,237
    

    

Costs and Expenses

               

Cost of goods sold

     330,885        318,249

Services costs

     361,672        352,226

Finance interest expense

     7,888        34,938

Selling and administrative

     351,450        374,385
    

    

       1,051,895        1,079,798
    

    

Operating income

     45,076        56,439

Loss from early extinguishment of debt

              73

Interest expense, net

     12,803        10,085
    

    

Income before taxes on income

     32,273        46,281

Taxes on income

     11,033        17,503
    

    

Net income

   $ 21,240      $ 28,778
    

    

Basic Earnings Per Common Share

               

Net income

   $ 0.15      $ 0.20
    

    

Diluted Earnings Per Common Share

               

Net income

   $ 0.14      $ 0.18
    

    

Cash dividends per common share

   $ 0.04      $ 0.04
    

    

 

 

See notes to condensed consolidated financial statements.

 

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IKON OFFICE SOLUTIONS, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

 

     Three Months Ended December 31

 
     Restated
      2004      


    Restated
      2003      


 
        

Cash Flows from Operating Activities

                

Net income

   $ 21,240     $ 28,778  

Additions (deductions) to reconcile net income to net cash used in operating activities:

                

Depreciation

     19,325       22,360  

Amortization

     1,202       3,159  

Provisions for losses on accounts receivable

     3,297       5,602  

Deferred income taxes

     (33,216 )     13,216  

Provision for lease default reserves

     288       14,124  

Pension expense

     10,938       13,779  

Non-cash interest expense on debt supporting unsold residual value

     500          

Loss from early extinguishment of debt

             73  

Changes in operating assets and liabilities

                

Increase in accounts receivable

     (21,369 )     (9,987 )

Increase in inventories

     (52,925 )     (23,132 )

Decrease (increase) in prepaid expenses and other current assets

     8,711       (5,007 )

Decrease in accounts payable, deferred revenues and accrued expenses

     (51,616 )     (183,342 )

Other

     1,492       (1,326 )
    


 


Net cash used in operating activities

     (92,133 )     (121,703 )
    


 


Cash Flows from Investing Activities

                

Expenditures for property and equipment

     (4,848 )     (4,471 )

Expenditures for equipment on operating leases

     (13,856 )     (12,297 )

Proceeds from sale of property and equipment

     643       808  

Proceeds from sale of equipment on operating leases

     975       2,883  

Proceeds from the sale of finance receivables

     61,428          

Finance receivables—additions

     (88,159 )     (380,802 )

Finance receivables—collections

     136,106       382,148  

Other

     (3,804 )     (2,557 )
    


 


Net cash provided by (used in) investing activities

     88,485       (14,288 )
    


 


Cash Flows from Financing Activities

                

Proceeds from issuance of long-term corporate debt

     230       3,045  

Short-term corporate debt repayments, net

     (91 )     (2,505 )

Repayment of other borrowings

     (1,981 )        

Long-term corporate debt repayments

     (57,496 )     (4,795 )

Debt supporting finance contracts—issuances

     5,926       196,049  

Debt supporting finance contracts—repayments

     (103,905 )     (210,175 )

Dividends paid

     (5,667 )     (5,860 )

Decrease (increase) in restricted cash

     311       (17,895 )

Proceeds from option exercises and sale of treasury shares

     712       1,805  

Purchase of treasury shares

     (21,916 )     (181 )
    


 


Net cash used in financing activities

     (183,877 )     (40,512 )
    


 


Effect of exchange rate changes on cash and cash equivalents

     6,815       (806 )
    


 


Net decrease in cash and cash equivalents

     (180,710 )     (177,309 )

Cash and cash equivalents at beginning of year

     472,951       360,030  
    


 


Cash and cash equivalents at end of period

   $ 292,241     $ 182,721  
    


 


 

See notes to condensed consolidated financial statements.

 

7


Table of Contents

IKON OFFICE SOLUTIONS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

IKON Office Solutions, Inc. (“IKON” or the “Company”) delivers integrated document management solutions and systems, enabling customers to improve document workflow and increase efficiency. We are the world’s largest independent channel for copier, printer and multifunction product (“MFP”) technologies, integrating best-in-class systems from leading manufacturers, such as Canon, Ricoh, Konica Minolta, EFI, and HP, and document management software from companies such as Captaris, EMC (Documentum), Kofax, and others, to deliver tailored, high-value solutions implemented and supported by our services organization-Enterprise Services. We offer financing in North America through a program agreement (the “U.S. Program Agreement”) with IKON Financial Services, a wholly owned subsidiary of General Electric Capital Corporation (“GE”), and a rider to the U.S Program Agreement (the “Canadian Rider”) with GE in Canada. We entered into the U.S. Program Agreement and Canadian Rider as part of the sale of certain assets and liabilities of our U.S. leasing business to GE (the “U.S. Transaction”) and our Canadian lease portfolio (the “Canadian Transaction,” and together with the U.S. Program Agreement, the Canadian Rider and the U.S. Transaction, the “Transactions”), respectively. We represent one of the industry’s broadest portfolios of document management services, including professional services, a unique blend of on-site and off-site Managed Services, customized workflow solutions, and comprehensive support through our service force of 16,600 employees, including our team of 7,000 customer service technicians and support resources worldwide. We have approximately 500 locations throughout North America and Western Europe. References herein to “we,” “us,” or “our” refer to IKON and its subsidiaries unless the context specifically requires otherwise. All dollar and share amounts are in thousands, except per share data.

 

Throughout these notes to the condensed consolidated financial statements, certain prior period comparisons reflect the balances and amounts on a restated basis. For information on the restatement, see Note 2.

 

1. SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q/A and Rule 10-01 of Regulation S-X. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. For further information, refer to the consolidated financial statements and footnotes thereto included in our annual report on Form 10-K/A for the year ended September 30, 2004.

 

Use of Estimates

 

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management 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.

 

Book Overdrafts

 

We had $28,988 and $92,968 of book overdrafts (outstanding checks on zero balance bank accounts which are funded from an investment account with another financial institution upon presentation for payment) included within our accounts payable balance at December 31, 2004 and September 30, 2004, respectively. The changes in these book overdrafts are included as a component of cash flows from operations in our consolidated statements of cash flows.

 

Accounting for Stock-Based Compensation

 

We have stock-based employee compensation plans. As permitted by Statement of Financial Accounting Standards (“SFAS”) 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), we continue to account for our stock options in accordance with APB 25, “Accounting for Stock Issued to Employees.” Employee stock

 

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IKON OFFICE SOLUTIONS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

options are granted at or above the market price at dates of grant, which does not require us to recognize any compensation expense. In general, these options expire in ten years (twenty years for certain non-employee director options) and vest over three years (five years for grants issued prior to December 15, 2000). The proceeds from options exercised are credited to shareholders’ equity. A plan for our non-employee directors enables participants to receive their annual directors’ fees in the form of options to purchase shares of common stock at a discount. The discount is equivalent to the annual directors’ fees and is charged to expense.

 

If we had elected to recognize compensation expense based on the fair value at the date of grant for awards in the first quarter of fiscal years 2005 and 2004, consistent with the provisions of SFAS 123, our net income and earnings per share would have been reduced to the following unaudited pro forma amounts:

 

     Three Months Ended December 31

 
     Restated
    2004    


    Restated
    2003    


 

Net income as reported

   $ 21,240     $ 28,778  

Pro forma effect of expensing stock based compensation plans using fair value method not included in net income as reported

     (1,493 )     (1,644 )
    


 


Net income, as adjusted

   $ 19,747     $ 27,134  
    


 


Basic earnings per common share:

                

Net income as reported

   $ 0.15     $ 0.20  

Pro forma effect of expensing stock based compensation plans using fair value method not included in net income as reported

     (0.01 )     (0.01 )
    


 


Basic earnings per common share, as adjusted

   $ 0.14     $ 0.19  
    


 


Diluted earnings per common share:

                

Net income as reported

   $ 0.14     $ 0.19  

Pro forma effect of expensing stock based compensation plans using fair value method not included in net income as reported

     (0.01 )     (0.01 )
    


 


Diluted earnings per common share, as adjusted

   $ 0.13     $ 0.18  
    


 


 

Pending Accounting Changes

 

In October 2004, the American Jobs Creation Act (the “AJCA”) was signed into law. The AJCA includes a deduction of 85% of certain foreign earnings that are repatriated, as defined by the AJCA. We may elect to apply this provision to qualifying earnings repatriations in either the balance of fiscal 2005 or in fiscal 2006. We have begun an evaluation of the effects of the repatriation provision; however, we do not expect to be able to complete this evaluation until after Congress or the Treasury Department provides additional clarifying language on key elements of the provision. We expect to complete our evaluation of the effects of the repatriation provision within a reasonable period of time following the publication of the additional clarifying language. The range of possible amounts that we are considering for repatriation under this provision is between $0 and $130,000. The related potential range of income tax is between $0 and $7,000.

 

In December 2004, the Financial Accounting Standards Board (the “FASB”) issued its final standard on accounting for share-based payments, SFAS 123R (Revised 2004), “Share-Based Payments” (“SFAS 123R”). SFAS 123R requires companies to expense the fair value of employee stock options and other similar awards, effective for interim and annual periods beginning on or after June 15, 2005. When measuring the fair value of these awards, companies can choose from two different pricing models that appropriately reflect their specific circumstances and the economics of their transactions. In addition, we are in the process of selecting between one of three transition methods available to us under SFAS 123R. Accordingly, we have not yet determined the

 

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IKON OFFICE SOLUTIONS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

impact on our consolidated financial statements of adopting SFAS 123R. Additional information regarding the pro forma impact of expensing stock options is presented above.

 

Also in December 2004, the FASB issued its final standard on accounting for exchanges of non-monetary assets, SFAS 153, “Exchanges of Non-monetary Assets an amendment of APB Opinion No. 29” (“SFAS 153”). SFAS 153 requires that exchanges of non-monetary assets be measured based on the fair value of assets exchanged for annual periods beginning after June 15, 2005. We are currently evaluating the impact of SFAS 153, but we do not expect a material impact from the adoption of SFAS 153 on our consolidated financial statements.

 

2. RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS

 

During an analysis of aged trade accounts receivable conducted during fiscal 2005, and in connection with performing self-assessment and testing of our internal controls over financial reporting under Section 404 of the Sarbanes-Oxley Act of 2002, we identified deficiencies in the processes and timeliness by which we issue and adjust certain invoices. The identified deficiencies result primarily from the centralization of billing centers and the migration to a new billing platform and relate to certain of our U.S. trade accounts receivable, and do not affect receivables arising under our Mexican operations, receivables owing from GE under our leasing relationship with GE, or receivables arising under our Legal Document Service and Business Document Service businesses. In connection with these developments, the Company’s management executed a comprehensive review (the “Review”) to determine the extent of such accounts receivable and billing errors. Based on the results of the Review, the Company’s management and the Audit Committee of the Company’s Board of Directors concluded that the errors had a cumulative effect over multiple periods and that prior period financial statements required restatement. Accordingly, we have restated our consolidated balance sheets at December 31, 2004 (unaudited) and September 30, 2004, and consolidated statements of income (unaudited) and cash flows (unaudited) for the three months ended December 31, 2004 and 2003 (the “Restatement”) for the impact of billing errors and other identified adjustments (described further below) as a result of the Review. The Restatement affected periods prior to fiscal 2004 and the impact of the Restatement on such prior periods of $(30,032) was reflected as an adjustment to retained earnings as of October 1, 2003. Set forth below are the Restatement adjustments, each of which is an “error” within the meaning of Accounting Principles Board Opinion No. 20, Accounting Changes.

 

Allowance for Doubtful Accounts, Billing Quality and Deferred Revenues

 

Historically, the allowance for doubtful accounts was our best estimate of the amount of probable credit losses in our existing accounts receivable balance based on our historical experience, and was calculated based on the aging of the accounts receivable portfolio. In addition, an allowance was established for any credit matters we were aware of with specific customers. These allowances were recorded as a reduction of accounts receivable and changes to allowance requirements were recorded within selling and administrative expense. As a result of the Review, we determined that trade accounts receivable included billing errors that should have been recorded as a reduction of revenue and accounts receivable in the period in which the revenue was recognized. Because of the length of time between invoice issuance and invoice correction, allowances for accounts receivable with unknown billing errors were incorrectly recorded as a bad debt expense when the accounts receivable reached a certain age. As a result, previously reported revenues and previously reported bad debt expense (included within selling and administrative expense) were misstated.

 

In addition, we determined that due to the identified billing errors included within our accounts receivable, deferred revenues required restatement. Deferred revenues represent revenues to be earned in future periods that

 

10


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IKON OFFICE SOLUTIONS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

have been billed to customers. To the extent that accounts receivable related to deferred revenues included billing errors, the deferred revenues balance was overstated.

 

As a result of the above, we have restated:

 

    revenues, accounts receivable and deferred revenues for all periods presented to reflect the impact of billing errors;

 

    the allowance for doubtful accounts and bad debt expense for all periods presented to reflect only the impact on accounts receivable of credit losses due to the inability of customers to pay;

 

    revenues and selling and administrative expense for all periods presented for the reclassification of billing error corrections which were incorrectly recorded as selling and administrative expense rather than a reduction of revenue; and

 

    income and deferred income taxes for the tax impact of the above items.

 

In addition, we determined that amounts owed by customers for services provided by us but which were not yet invoiced were improperly recorded as a reduction of deferred revenues. As a result, we have reclassified these amounts from deferred revenue to accounts receivable for all periods presented. This adjustment did not have an impact on net income or earnings per share.

 

Advances from GE

 

As a result of the U.S. Transaction, GE bills and collects certain trade accounts receivable on the Company’s behalf. Upon billing, GE advances the Company for the customer receivable prior to collections. Historically, we did not recognize accounts receivable from our customers and a corresponding liability to GE for these types of transactions. In addition to the billing error described above and as a result of the Review, we have determined that an accounts receivable from the customer and a corresponding liability to GE should be recognized for cash received from GE which has not yet been collected from our customers. Accordingly, we have restated the consolidated balance sheets, as of December 31, 2004 and September 30, 2004, to increase accounts receivable and accounts payable to appropriately reflect amounts due from customers and amounts payable to GE. This adjustment did not have an impact on net income or earnings per share.

 

11


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IKON OFFICE SOLUTIONS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Financial Statement Impact

 

The following table presents the impact of the Restatement adjustments on our previously reported results as of December 31, 2004 and September 30, 2004, and for the three months ended December 31, 2004 and 2003:

 

Statements of Income:

 

     Three Months Ended December 31, 2004

 
    

As

Previously

Reported


   As
Restated


   Change

 

Revenues:

                      

Net sales

   $ 461,897    $ 464,711    $ 2,814 (a)

Services

     602,948      601,454      (1,494 )(b)

Finance income

     30,806      30,806         
    

  

  


       1,095,651      1,096,971      1,320  
    

  

  


Costs and Expenses:

                      

Cost of goods sold

     330,885      330,885         

Services costs

     361,672      361,672         

Finance interest expense

     7,888      7,888         

Selling and administrative

     357,755      351,450      (6,305 )(c)
    

  

  


       1,058,200      1,051,895      (6,305 )
    

  

  


Operating income

     37,451      45,076      7,625  

Interest expense, net

     12,803      12,803         
    

  

  


Income before taxes on income

     24,648      32,273      7,625  

Taxes on income

     8,021      11,033      3,012 (d)
    

  

  


Net income

   $ 16,627    $ 21,240    $ 4,613  
    

  

  


Basic Earnings Per Common Share

                      

Net income

   $ 0.12    $ 0.15    $ 0.03  
    

  

  


Diluted Earnings Per Common Share

                      

Net income

   $ 0.12    $ 0.14    $ 0.02  
    

  

  


 

Statement of Income components increased (decreased) as a result of the following:

 

(a)

 

Net Sales

        
   

Adjustment for the impact of billing errors

   $ 3,271  
   

Adjustment for the impact of billing errors incorrectly recorded within selling and administrative expense rather than a reduction of revenue

     (457 )
        


   

Net increase

   $ 2,814  
        


(b)

 

Services

        
   

Adjustment for the impact of billing errors

   $ 36  
   

Adjustment for the impact of billing errors incorrectly recorded within selling and administrative expense rather than a reduction of revenue

     (1,530 )
        


   

Net decrease

   $ (1,494 )
        


(c)

 

Selling and Administrative Expense

        
   

Adjustment for the impact of billing errors incorrectly recorded within selling and administrative expense rather than a reduction of revenue

   $ (1,987 )
   

Adjustment for the impact of overstated bad debt expense and allowance for doubtful accounts

     (4,318 )
        


   

Net decrease

   $ (6,305 )
        


(d)

 

Taxes on Income

        
   

Net increase to taxes on income due to above adjustments

   $ 3,012  
        


 

12


Table of Contents

IKON OFFICE SOLUTIONS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

     Three Months Ended December 31, 2003

 
    

As

Previously

Reported


   As
Restated


   Change

 

Revenues:

                      

Net sales

   $ 451,698    $ 450,804    $ (894 )(a)

Services

     585,770      586,422      652 (b)

Finance income

     99,011      99,011         
    

  

  


       1,136,479      1,136,237      (242 )
    

  

  


Costs and Expenses:

                      

Cost of goods sold

     318,249      318,249         

Services costs

     352,226      352,226         

Finance interest expense

     34,938      34,938         

Selling and administrative

     376,468      374,385      (2,083 )(c)
    

  

  


       1,081,881      1,079,798      (2,083 )
    

  

  


Operating income

     54,598      56,439      1,841  

Loss from early extinguishment of debt

     73      73         

Interest expense, net

     10,085      10,085         
    

  

  


Income before taxes on income

     44,440      46,281      1,841  

Taxes on income

     16,776      17,503      727 (d)
    

  

  


Net income

   $ 27,664    $ 28,778    $ 1,114  
    

  

  


Basic Earnings Per Common Share

                      

Net income

   $ 0.19    $ 0.20    $ 0.01  
    

  

  


Diluted Earnings Per Common Share

                      

Net income

   $ 0.18    $ 0.18    $ 0.00  
    

  

  


 

Statement of Income components increased (decreased) as a result of the following:

 

(a)

  

Net Sales

        
    

Adjustment for the impact of billing errors

   $ (648 )
    

Adjustment for the impact of billing errors incorrectly recorded within selling and administrative expense rather than a reduction of revenue

     (246 )
         


    

Net decrease

   $ (894 )
         


(b)

  

Services

        
    

Adjustment for the impact of billing errors

   $ 1,476  
    

Adjustment for the impact of billing errors incorrectly recorded within selling and administrative expense rather than a reduction of revenue

     (824 )
         


    

Net increase

   $ 652  
         


(c)

  

Selling and Administrative Expense

        
    

Adjustment for the impact of billing errors incorrectly recorded within selling and administrative expense rather than a reduction of revenue

   $ (1,070 )
    

Adjustment for the impact of overstated bad debt expense and allowance for doubtful accounts

     (1,013 )
         


    

Net decrease

   $ (2,083 )
         


(d)

  

Taxes on Income

        
    

Net increase to taxes on income due to above adjustments

   $ 727  
         


 

13


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IKON OFFICE SOLUTIONS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Balance Sheets:

 

     December 31, 2004

 
     Amount
Previously
Reported


    As Restated

    Change

 

ASSETS

                        

Cash and cash equivalents

   $ 292,241     $ 292,241          

Restricted cash

     26,721       26,721          

Accounts receivable, less allowances of $22,177 (as reported) and $6,789 (as restated)

     786,526       754,570     $ (31,956 )(a)

Finance receivables, net

     444,154       444,154          

Inventories

     289,510       289,510          

Prepaid expenses and other current assets

     72,122       72,122          

Deferred taxes

     39,974       61,469       21,495 (b)
    


 


 


Total current assets

     1,951,248       1,940,787       (10,461 )
    


 


 


Long-term finance receivables, net

     672,847       672,847          

Equipment on operating leases, net

     88,191       88,191          

Property and equipment, net

     159,421       159,421          

Goodwill

     1,316,704       1,316,704          

Unsold residual value

     58,370       58,370          

Other assets

     121,366       121,366          
    


 


 


Total Assets

   $ 4,368,147     $ 4,357,686     $ (10,461 )
    


 


 


LIABILITIES AND SHAREHOLDERS’ EQUITY

                        

Current portion of corporate debt

   $ 5,265     $ 5,265          

Current portion of debt supporting finance contracts and unsold residual value

     402,834       402,834          

Notes payable

     864       864          

Trade accounts payable

     244,333       269,451     $ 25,118 (c)

Accrued salaries, wages and commissions

     80,641       80,641          

Deferred revenues

     116,223       113,923       (2,300 )(d)

Taxes payable

     105,943       105,943          

Other accrued expenses

     150,845       150,845          
    


 


 


Total current liabilities

     1,106,948       1,129,766       22,818  
    


 


 


Long-term corporate debt

     742,036       742,036          

Long-term debt supporting finance contracts and unsold residual value

     384,430       384,430          

Deferred taxes

     150,864       150,864          

Other long-term liabilities

     218,774       218,774          

SHAREHOLDERS’ EQUITY

                        

Common stock, no par value

     1,025,746       1,025,746          

Series 12 preferred stock, no par value

                        

Deferred compensation

     210       210          

Unearned compensation

     (5,557 )     (5,557 )        

Retained earnings

     771,505       738,226       (33,279 )(e)

Accumulated other comprehensive income

     69,687       69,687          

Cost of common shares in treasury

     (96,496 )     (96,496 )        
    


 


 


Total Shareholders’ Equity

     1,765,095       1,731,816       (33,279 )
    


 


 


Total Liabilities and Shareholders’ Equity

   $ 4,368,147     $ 4,357,686     $ (10,461 )
    


 


 


 

14


Table of Contents

IKON OFFICE SOLUTIONS, INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Balance sheet components increased (decreased) due to the following:

 

(a)

  

Accounts Receivable, net

        
    

Adjustment for the impact of billing errors

   $ (98,388 )
    

Adjustment for the overstatement of the allowance for doubtful accounts

     24,045  
    

Adjustment for the accounting for advances from GE

     25,118  
    

Adjustment for accounts receivable incorrectly recorded as a reduction of deferred revenues

     17,269  
         


    

Net decrease

   $ (31,956 )
         


(b)

  

Deferred Taxes

        
    

Net increase for deferred tax impact related to the Restatement

   $ 21,495  
         


(c)

  

Trade Accounts Payable

        
    

Adjustment for the accounting for advances from GE

   $ 25,118  
         


(d)

  

Deferred Revenue

        
    

Adjustment for the impact of billing errors

   $ (19,569 )
    

Adjustment for accounts receivable incorrectly recorded as a reduction of deferred revenues

     17,269  
         


    

Net decrease

   $ (2,300 )
         


(e)

  

Retained Earnings

        
    

Net increase to retained earnings for Restatement adjustments (net of taxes) in fiscal 2005

   $ 4,613  
    

Net decrease to retained earnings for Restatement adjustments (net of taxes) for fiscal years prior to October 1, 2004

     (37,892 )
         


    

Net decrease

   $ (33,279 )
         


 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Balance Sheets:

 

     September 30, 2004

 
     Amount
Previously
Reported


    As Restated

    Change

 

ASSETS

                        

Cash and cash equivalents

   $ 472,951     $ 472,951          

Restricted cash

     27,032       27,032          

Accounts receivable, less allowances of $20,112 (as reported) and $7,224 (as restated)

     772,635       728,634     $ (44,001 )(a)

Finance receivables, net

     457,615       457,615          

Inventories

     233,345       233,345          

Prepaid expenses and other current assets

     81,188       81,188          

Deferred taxes

     39,974       64,481       24,507 (b)
    


 


 


Total current assets

     2,084,740       2,065,246       (19,494 )
    


 


 


Long-term finance receivables, net

     753,146       753,146          

Equipment on operating leases, net

     78,673       78,673          

Property and equipment, net

     164,132       164,132          

Goodwill

     1,286,564       1,286,564          

Unsold residual value

     45,548       45,548          

Other assets

     125,104       125,104          
    


 


 


Total Assets

   $ 4,537,907     $ 4,518,413     $ (19,494 )
    


 


 


LIABILITIES AND SHAREHOLDERS’ EQUITY

                        

Current portion of corporate debt

   $ 62,085     $ 62,085          

Current portion of debt supporting finance contracts and unsold residual value

     439,941       439,941          

Notes payable

     938       938          

Trade accounts payable

     285,603       307,170     $ 21,567 (c)

Accrued salaries, wages and commissions

     124,808       124,808          

Deferred revenues

     119,851       116,682       (3,169 )(d)

Taxes payable

     52,976       52,976          

Other accrued expenses

     170,741       170,741          
    


 


 


Total current liabilities

     1,256,943       1,275,341       18,398  
    


 


 


Long-term corporate debt

     741,857       741,857          

Long-term debt supporting finance contracts and unsold residual value

     422,868       422,868          

Deferred taxes

     187,091       187,091          

Other long-term liabilities

     203,538       203,538          

SHAREHOLDERS’ EQUITY

                        

Common stock, no par value

     1,022,842       1,022,842          

Series 12 preferred stock, no par value

                        

Deferred compensation

     209       209          

Unearned compensation

     (2,448 )     (2,448 )        

Retained earnings

     761,739       723,847       (37,892 )(e)

Accumulated other comprehensive income

     20,195       20,195          

Cost of common shares in treasury:

     (76,927 )     (76,927 )        
    


 


 


Total Shareholders’ Equity

     1,725,610       1,687,718       (37,892 )
    


 


 


Total Liabilities and Shareholders’ Equity

   $ 4,537,907     $ 4,518,413     $ (19,494 )
    


 


 


 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Balance sheet components increased (decreased) due to the following:

 

(a)

  

Accounts Receivable, net

        
    

Adjustment for the impact of billing errors

   $ (105,490 )
    

Adjustment for the overstatement of the allowance for doubtful accounts

     22,653  
    

Adjustment for the accounting for advances from GE

     21,567  
    

Adjustment for accounts receivable incorrectly recorded as a reduction of deferred revenues

     17,269  
         


    

Net decrease

   $ (44,001 )
         


(b)

  

Deferred Taxes

        
    

Net increase for deferred tax impact related to the Restatement

   $ 24,507  
         


(c)

  

Trade Accounts Payable

        
    

Adjustment for the accounting for advances from GE

   $ 21,567  
         


(d)

  

Deferred Revenue

        
    

Adjustment for the impact of billing errors

   $ (20,438 )
    

Adjustment for accounts receivable incorrectly recorded as a reduction of deferred revenues

     17,269  
         


    

Net decrease

   $ (3,169 )
         


(e)

  

Retained Earnings

        
    

Net decrease to retained earnings for Restatement adjustments (net of taxes) in fiscal 2004

   $ (7,860 )
    

Net decrease to retained earnings for Restatement adjustments (net of taxes) for fiscal years prior to October 1, 2003

     (30,032 )
         


    

Net decrease

   $ (37,892 )
         


 

3. NOTES PAYABLE AND LONG-TERM DEBT

 

Long-term corporate debt and notes payable consisted of:

 

    

December 31,

2004


  

September 30,

2004


Bond issues

   $ 354,784    $ 411,423

Convertible subordinated notes

     290,000      290,000

Notes payable

     94,835      94,835

Miscellaneous notes, bonds, mortgages, and capital lease obligations

     8,546      8,622
    

  

       748,165      804,880

Less: current maturities

     6,129      63,023
    

  

     $ 742,036    $ 741,857
    

  

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Long-term debt supporting finance contracts and unsold residual value (“Non-Corporate Debt”) consisted of:

 

    

December 31,

2004


  

September 30,

2004


Lease-backed notes

   $ 585,462    $ 683,086

Asset securitization conduit financing

     135,783      129,668

Notes payable to banks

     6,508      3,868

Debt supporting unsold residual value

     59,511      46,187
    

  

       787,264      862,809

Less: current maturities

     402,834      439,941
    

  

     $ 384,430    $ 422,868
    

  

 

Our 6.75% notes due 2004 were paid upon maturity in November 2004. The balance of these notes at September 30, 2004 was $56,659.

 

During the first quarter of fiscal 2005, we repaid $97,624 of lease-backed notes.

 

Asset Securitization Conduit Financing Agreements

 

As of December 31, 2004, IKON Capital, PLC, our leasing subsidiary in the United Kingdom, had approximately $29,175 available under its asset securitization conduit financing agreement (the “Conduit”). During the three months ended December 31, 2004, IKON Capital, PLC repaid $3,453 in connection with the Conduit. No additional borrowings were made in connection with the Conduit during the first quarter of fiscal 2005. During the third quarter of fiscal 2005, we received a waiver to the Conduit to provide us with an extension to the deadline by which we must deliver to the lender certain items required under the Conduit, including our financial statements for the second quarter of fiscal year 2005, in order to allow us to complete the review of our billing controls and reserve practices for our trade accounts receivable (see Note 2).

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Debt Supporting Unsold Residual Value

 

Due mainly to certain provisions within our agreements with GE and other lease syndicators, which do not allow us to recognize the sale of the residual value on leases in which we are the equipment lessor (primarily state and local government contracts), we must keep the present value of the residual value of those leases on our balance sheet. A corresponding amount of debt is recorded representing the cash received from GE and the other lease syndicators for the residual value. This debt will not be repaid unless required under the applicable agreement in the event that an IKON service performance failure is determined to relieve the lessee of its lease payment obligations. Over the last three years, total repurchases of lease receivables related to our service performance failures have amounted to approximately $500 on a cumulative basis. The net book value of the combined lease portfolio as of December 31, 2004 was approximately $3,100,000.

 

In addition, we transferred lease receivables to GE for which we have retained all of the risks of ownership. A corresponding amount of debt was recorded representing the cash received from GE for these receivables.

 

As of December 31, 2004, we had $59,511 of debt related to $58,370 of unsold residual value and the present value of the remaining lease receivables that remained on our balance sheet. During the first quarter of fiscal 2005, we imputed interest at our average borrowing rate of 3.73% and recorded $500 of interest expense related to this debt. Upon the end of the lease term or repurchase of the lease, whichever comes first, we will reverse the unsold residual value and related debt as the underlying leases mature and any differential will be recorded as a gain on the extinguishment of debt. As of December 31, 2004, this differential was $1,141.

 

Credit Facility

 

We maintain a $200,000 secured credit facility (the “Credit Facility”) with a group of lenders. The Credit Facility provides the availability of revolving loans, with certain sub-limits, and provides support for letters of credit. The amount of credit available under the Credit Facility is reduced by open letters of credit. The amount available under the Credit Facility for borrowings or additional letters of credit was $165,579 at December 31, 2004. The Credit Facility is secured by our accounts receivable and inventory, the stock of our first-tier domestic subsidiaries, 65% of the stock of our first-tier foreign subsidiaries, and all of our intangible assets. All security interests pledged under the Credit Facility are shared with the holders of our 7.25% notes payable due 2008.

 

The Credit Facility contains affirmative and negative covenants, including limitations on certain fundamental core business changes, investments and acquisitions, mergers, certain transactions with affiliates, creations of liens, asset transfers, payments of dividends, intercompany loans, and certain restricted payments. The Credit Facility does not, however, limit our ability to continue to securitize lease receivables. The Credit Facility matures on March 1, 2008, but is subject to certain early maturity events in November 2006, January 2007, and April 2007 if our 5% convertible subordinated notes due May 2007 (the “Convertible Notes”) have not been converted to equity or refinanced and minimum liquidity is not met as of such dates. Minimum liquidity is defined as having sufficient cash, including any unused capacity under the Credit Facility, to repay the balance of the Convertible Notes plus an additional $100,000. The Credit Facility contains certain financial covenants relating to: (i) our corporate leverage ratios; (ii) our consolidated interest coverage ratio; (iii) our consolidated asset coverage ratio; (iv) our consolidated net worth ratios; (v) limitations on our capital expenditures; and (vi) limitations on additional indebtedness and liens. Under the terms of the Credit Facility, share repurchases are permitted in an aggregate amount not to exceed $250,000 during the period of July 28, 2004 through March 1, 2008. From July 28, 2004 through September 30, 2005, share repurchases are permitted in an aggregate amount not to exceed $150,000. Beginning on October 1, 2005, we are permitted to repurchase (a) shares and pay dividends in an aggregate annual amount not to exceed 50% of our annual net income, plus (b) that portion of the $150,000 allowance that we did not utilize prior to October 1, 2005. As of December 31, 2004, $72,742 of the $150,000 allowance was utilized. Additionally, the Credit Facility contains default provisions customary for facilities of this type. During the third quarter of fiscal 2005, we entered into a consent (the “Consent”) to our

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

Credit Facility to provide us with an extension to the deadline by which we must deliver to the lenders certain items required under the Credit Facility, including our financial statements for the second quarter of fiscal year 2005, in order to allow us to complete the review of our billing controls and reserve practices for our trade accounts receivable (see Note 2).

 

Letters of Credit

 

We have certain commitments available to us in the form of lines of credit and standby letters of credit. As of December 31, 2004, we had $179,164 available under lines of credit, including the $165,579 available under the Credit Facility and had open standby letters of credit totaling $34,421. These letters of credit are primarily supported by the Credit Facility. All letters of credit expire within one year.

 

4. SALE OF LEASE RECEIVABLES

 

Under the U.S. Program Agreement, the Canadian Rider, and agreements with other syndicators, from time-to-time we may sell customer lease receivables. We do not expect to retain interests in these assets. Gains or losses on the sale of these lease receivables depend in part on the previous carrying amount of the financial assets involved in the transfer. We estimate fair value based on the present value of future expected cash flows. As these same assumptions are used in recording the lease receivables, and sale of the lease receivables occurs shortly thereafter, management anticipates that in most instances, book value is expected to approximate fair value.

 

During the first quarter of 2005, we sold lease receivables totaling $61,428 for cash proceeds in transactions to GE and other syndicators. In those transactions, we will not retain any interest in the assets. No material gain or loss resulted from these transactions.

 

5. GOODWILL

 

Goodwill associated with our reporting segments was:

 

    

IKON North

America


  

IKON

Europe


   Total

Goodwill at September 30, 2004

   $ 949,138    $ 337,426    $ 1,286,564

Translation adjustment

     5,085      25,055      30,140
    

  

  

Goodwill at December 31, 2004

   $ 954,223    $ 362,481    $ 1,316,704
    

  

  

 

Changes in the goodwill balance since September 30, 2004 are attributable to foreign currency translation adjustments.

 

As of December 31, 2004, we had no intangible assets other than goodwill except those related to our defined benefit plans.

 

6. SHARE REPURCHASES

 

In March 2004, our Board of Directors authorized the repurchase of up to $250,000 of our outstanding shares of common stock (the “2004 Plan”). From time-to-time, our Retirement Savings Plan may acquire shares of our common stock in open market transactions or from our treasury shares. During the first quarter of fiscal 2005, we repurchased 1,957 shares of our outstanding common stock for $21,797, leaving $150,629 remaining for share repurchases under the 2004 Plan. Under the terms of the Credit Facility, share repurchases are permitted up to $150,000 until September 2005. Beginning on October 1, 2005, we are permitted to repurchase (a) shares and pay dividends in an aggregate annual amount not to exceed 50% of our annual net income, plus (b) that portion of the $150,000 allowance that we did not utilize prior to October 1, 2005. As of December 31, 2004, $72,742 of the $150,000 allowance was utilized.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

7. COMPREHENSIVE INCOME

 

Total comprehensive income is as follows:

 

    

Three Months Ended

December 31


    

Restated

2004


  

Restated

2003


Net income

   $ 21,240    $ 28,778

Foreign currency translation adjustments

     49,227      39,373

Gain on derivative financial instruments, net of tax expense of: $170 and $2,186 for the three months ended December 31, 2004 and 2003, respectively

     265      3,885
    

  

Total comprehensive income

   $ 70,732    $ 72,036
    

  

 

The 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 income in the consolidated balance sheets were $115,645, $(46,400) and $442, respectively, at December 31, 2004 and $66,418, $(46,400) and $177, respectively, at September 30, 2004.

 

8. EARNINGS PER COMMON SHARE

 

The following table sets forth the computation of basic and diluted earnings per common share:

 

     Three Months Ended December 31

    

Restated

      2004      


  

Restated

      2003      


Numerator:

             

Numerator for basic earnings per common share—net income

   $ 21,240    $ 28,778

Effect of dilutive securities:

             

Interest expense on Convertible Notes, net of taxes

     2,248      2,354
    

  

Numerator for diluted earnings per common share—net income

   $ 23,488    $ 31,132
    

  

Denominator:

             

Denominator for basic earnings per common share—weighted average common shares

     141,477      146,503

Effect of dilutive securities:

             

Convertible Notes

     19,295      19,960

Employee stock options

     420      328

Employee stock awards

     2,054      2,376
    

  

Dilutive potential common shares

     21,769      22,664

Denominator for diluted earnings per common share—adjusted weighted average common shares and assumed conversions

     163,246      169,167
    

  

Basic earnings per common share

   $ 0.15    $ 0.20
    

  

Diluted earnings per common share

   $ 0.14    $ 0.18
    

  

 

We account 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

 

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(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 4,854 shares of common stock at $11.22 to $46.59 per share were outstanding during the first quarter of fiscal 2005 and options to purchase 8,091 shares of common stock at $9.05 to $46.59 per share were outstanding during the first quarter of fiscal 2004, but were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares; therefore, the effect would be antidilutive.

 

9. SEGMENT REPORTING

 

The table below presents segment information for the three months ended December 31, 2004 and 2003:

 

    

IKON North

America


  

IKON

Europe


  

Corporate

and

Eliminations


    Total

 

Three Months Ended December 31, 2004 (as restated)

                              

Net sales

   $ 388,298    $ 76,413            $ 464,711  

Services

     540,323      61,131              601,454  

Finance income

     24,051      6,755              30,806  

Finance interest expense

     6,158      1,730              7,888  

Operating income (loss)

     114,137      6,915    $ (75,976 )     45,076  

Interest expense, net

                   (12,803 )     (12,803 )

Income before taxes

                           32,273  

Three Months Ended December 31, 2003 (as restated)

                              

Net sales

   $ 383,857    $ 66,947            $ 450,804  

Services

     531,957      54,465              586,422  

Finance income

     92,919      6,092              99,011  

Finance interest expense

     33,290      1,648              34,938  

Operating income (loss)

     125,561      5,092    $ (74,214 )     56,439  

Interest expense, net

                   (10,085 )     (10,085 )

Income before taxes

                           46,281  

 

We report information about our operating segments according to the “management approach.” The management approach is based on the way management organizes the segments within the enterprise for making operating decisions and assessing performance. Our reportable segments are IKON North America (“INA”) and IKON Europe (“IE”). The INA and IE segments provide copiers, printers, color solutions, and a variety of document management service capabilities through Enterprise Services. These segments also include our captive finance subsidiaries in North America (including those now divested) and Europe, respectively.

 

Corporate and Eliminations, which is not treated as a business segment, includes certain selling and administrative functions such as finance, supply chain, and customer support.

 

10. CONTINGENCIES

 

We are involved in a number of environmental remediation actions to investigate and clean up certain sites related to our 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

 

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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 estimate because of these uncertainties, we had accrued balances, included in other long-term liabilities in our consolidated balance sheets, of $7,840 and $7,928 as of December 31, 2004 and September 30, 2004, respectively, for our environmental liabilities, and the accrual is based on management’s best estimate of the aggregate environmental exposure. The measurement of environmental liabilities is based on an evaluation of currently available facts with respect to each individual site and considers factors such as existing technology, presently enacted laws and regulations, prior experience in remediation of contaminated sites, and any studies performed for a site. As assessments and remediation progress at individual sites, these liabilities are reviewed and adjusted to reflect additional technical and legal information that becomes available. After consideration of the defenses available to us, 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 our consolidated financial statements.

 

The accruals for such environmental liabilities are reflected in the consolidated balance sheets as part of other accrued liabilities. We have not recorded any potential third party recoveries. We are indemnified by an environmental contractor performing remedial work at a site in Bedford Heights, Ohio. The contractor has agreed to indemnify us from cost overruns associated with the plan of remediation. Further, we have cost-sharing arrangements in place with other potentially responsible parties at sites located in Barkhamsted, Connecticut and Rockford, Illinois. The cost-sharing agreement for the Barkhamsted, Connecticut site relates to apportionment of expenses associated with non-time critical removal actions and operation and maintenance work, such as capping the landfill, maintaining the landfill, fixing erosion rills and gullies, maintaining site security, maintaining vegetative growth on the landfill cap, and groundwater monitoring. Under the agreement, we and other potentially responsible parties agreed to reimburse Rural Refuse Disposal District No. 2, a Connecticut Municipal Authority, for 50% of these costs. We currently pay a 4.54% share of these costs. The cost-sharing arrangement for the Rockford, Illinois site relates to apportioning the costs of a Remedial Investigation/Feasibility Study and certain operation and maintenance work, such as fencing the site, removing waste liquids and sludges, capping a former surface impoundment and demolishing certain buildings. Under this arrangement, we pay 5.12% of these costs.

 

During fiscal 2005 and 2004, we did not incur any costs for environmental capital projects, but incurred various costs in conjunction with our obligations under consent decrees, orders, voluntary remediation plans, settlement agreements, and other actions to comply with environmental laws and regulations. For the three months ended December 31, 2004 and December 31, 2003, these costs were $101 and $132, respectively. All costs were charged against the related environmental accrual. We will continue to incur expenses in order to comply with our obligations under consent decrees, orders, voluntary remediation plans, settlement agreements, and other actions to comply with environmental laws and regulations.

 

We have an accrual related to black lung and workers’ compensation liabilities relating to the operations of a former subsidiary, Barnes & Tucker Company (“B&T”). B&T owned and operated coalmines throughout Pennsylvania. We sold B&T in 1986. In connection with the sale, we entered into a financing agreement with B&T whereby we agreed to reimburse B&T for 95% of all costs and expenses incurred by B&T for black lung and workers’ compensation liabilities, until such liabilities were extinguished. From 1986 through 2000, we reimbursed B&T in accordance with the terms of the financing agreement. In 2000, B&T filed for bankruptcy protection under Chapter 11. The bankruptcy court approved a plan of reorganization that created a black lung trust and a workers’ compensation trust to handle the administration of all black lung and workers’ compensation claims relating to B&T. We now reimburse the trusts for 95% of the costs and expenses incurred by the trusts for

 

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black lung and workers’ compensation claims. As of December 31, 2004 and September 30, 2004, our accrual for black lung and workers’ compensation liabilities related to B&T was $12,252 and $12,384, respectively, and was reflected in the consolidated balance sheets as part of other long-term liabilities.

 

We received notice of possible additional taxes due related to international matters. We believe they will not materially affect our consolidated financial statements.

 

We recognize certain guarantees in accordance with FASB Interpretation No. 45. Accordingly, we recognize a liability related to guarantees for the fair value, or market value, of the obligation we assume.

 

As a result of the U.S. Transaction, we agreed to indemnify GE with respect to certain liabilities that may arise in connection with business activities that occurred prior to the completion of the U.S. Transaction or that may arise in connection with leases sold to GE under the U.S. Program Agreement. If GE were to incur a liability or have a liability increase as a result of a successful claim, pursuant to the terms of the indemnification, we would be required to reimburse GE for the full amount of GE’s damages; provided, that for certain successful claims, we would only be required to reimburse GE for damages in excess of $20,000, but not to exceed, in the aggregate, $2,000,000. These indemnification obligations generally relate to recourse on different types of lease receivables sold to GE that could potentially become uncollectible. In the event that all lease receivables for which we have indemnified GE become uncollectible, the maximum potential loss we could incur as a result of these indemnifications at December 31, 2004 was $273,462. Based on our analysis of historical losses for these types of leases, we had recorded reserves totaling approximately $464 at December 31, 2004. The equipment leased to the customers related to the above indemnifications represents collateral which we would be entitled to recover and could be remarketed by us. No specific recourse provisions exist with other parties related to assets sold under the U.S. Program Agreement.

 

We guarantee an industrial revenue bond in Covington, Tennessee relating to The Delfield Company (“Delfield”), a former subsidiary of Alco Standard (our predecessor company). This bond matures in full on September 1, 2006. We have not accrued any liability with respect to this guarantee based on our analysis of Delfield’s ability and intent to make payment or refinance the bond. In the event Delfield defaults on the bond, we would be required under the agreement to make payment to the lender. As of December 31, 2004, the maximum amount that we would be required to pay the lender is $3,150.

 

There are other contingent liabilities for taxes, guarantees, 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 us and any related reserves and insurance coverage, management believes that none of these other contingencies will materially affect our consolidated financial statements.

 

11. PENSION PLANS

 

We sponsor defined benefit pension plans for the majority of our employees (all U.S. employees hired on or after July 1, 2004 are not eligible to participate in the U.S. defined benefit pension plan). The benefits generally are based on years of service and compensation. We fund at least the minimum amount required by government regulations.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(Continued)

 

The components of net periodic pension cost for the company-sponsored defined benefit pension plans are:

 

     Three Months Ended December 31

 
     2004

    2003

 
    

U.S.

Plans


   

Non-U.S.

Plans


   

U.S.

Plans


   

Non-U.S.

Plans


 

Service cost

   $ 7,033     $ 1,067     $ 7,714     $ 1,010  

Interest cost on projected benefit obligation

     8,107       966       7,666       765  

Expected return on assets

     (7,502 )     (940 )     (5,666 )     (703 )

Amortization of net obligation

             9               9  

Amortization of prior service cost

     142       2       142       1  

Recognized net actuarial loss

     1,892       162       2,628       213  
    


 


 


 


Net periodic pension cost

   $ 9,672     $ 1,266     $ 12,484     $ 1,295  
    


 


 


 


 

As of December 31, 2004, $8,871 of contributions had been made. We expect to contribute an additional $3,350 to the plans during the remainder of fiscal 2005.

 

12. FINANCIAL INSTRUMENTS

 

As of December 31, 2004, all of our 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 that the interest rate swaps are fully effective. We use interest rate swaps to fix the interest rates on our 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 three months ended December 31, 2004, unrealized gains totaling $265, after taxes, were recorded in accumulated other comprehensive income.

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following information has been amended to reflect the restatement made to the Condensed Consolidated Condensed Financial Statements as further discussed in “Item 1. Financial Statements—Note 2. Restatement of Previously Issued Financial Statements.” This information should be read in conjunction with the information contained in the Condensed Consolidated Financial Statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q/A.

 

OVERVIEW

 

IKON Office Solutions, Inc. (“IKON” or the “Company”) delivers integrated document management solutions and systems, enabling customers to improve document workflow and increase efficiency. We are the world’s largest independent channel for copier, printer and multifunction product (“MFP”) technologies, integrating best-in-class systems from leading manufacturers, such as Canon, Ricoh, Konica Minolta, EFI, and HP, and document management software from companies such as Captaris, EMC (Documentum), Kofax, and others, to deliver tailored, high-value solutions implemented and supported by our services organization-Enterprise Services. We offer financing in North America through a program agreement (the “U.S. Program Agreement”) with IKON Financial Services, a wholly owned subsidiary of General Electric Capital Corporation (“GE”), and a rider to the U.S Program Agreement (the “Canadian Rider”) with GE in Canada. We entered into the U.S. Program Agreement and Canadian Rider as part of the sale of certain assets and liabilities of our U.S. leasing business to GE (the “U.S. Transaction”) and our Canadian lease portfolio (the “Canadian Transaction,” and together with the U.S. Program Agreement, the Canadian Rider and the U.S. Transaction, the “Transactions”), respectively. We represent one of the industry’s broadest portfolios of document management services, including professional services, a unique blend of on-site and off-site Managed Services, customized workflow solutions, and comprehensive support through our service force of 16,600 employees, including our team of 7,000 customer service technicians and support resources worldwide. We have approximately 500 locations throughout North America and Western Europe.

 

For fiscal 2005, we have outlined the following objectives for our business:

 

    improving operational leverage;

 

    core growth; and

 

    related expansion.

 

These objectives assume continued growth and profitability improvements in our ongoing revenue streams, while we continue to transition out of our captive leasing business in North America.

 

Operating leverage requires that we continue to lower our overall cost-to-serve and improve both sales and administrative productivity through centralization, process, and system enhancements. In particular, we are focused on reducing our selling and administrative expenses to more competitive levels, and have established a fiscal 2005 target for selling and administrative expense as a percentage of revenues of one percentage point below fiscal year 2004 levels. In the first quarter of fiscal 2005, selling and administrative expense as a percentage of revenue was 32.0% compared to 32.9% a year ago. We had a headcount decline of over 350 employees in the first quarter of fiscal 2005, driven by our centralization and productivity initiatives. In addition, improved visibility in our supply chain function is yielding new opportunities through real estate benefits and additional headcount reductions. We continued to consolidate our supply chain during the quarter, reducing our equipment configuration centers to 24 from 28 at September 30, 2004.

 

Core growth has three points of focus: improvement of sales effectiveness in all market segments; gain of market share in underrepresented markets; and the targeting of product segments in which demand is growing the fastest. A top priority for us in fiscal 2005 is our implementation of the integrated selling model, which is designed to provide sales coverage on a lower-cost-to-serve basis through the use of professional phone based sales representatives working in concert with our field-based representatives. We believe this model will also

 

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improve our retention of small to medium-sized customers while at the same time provide us with added sales capacity for higher-end selling solutions. In the first quarter of fiscal 2005, the integrated selling model went live in 17 of our U.S. and Canadian marketplaces, bringing over 50% of our marketplaces onto this new model at the end of the first quarter of fiscal 2005. Also during the first quarter of fiscal 2005, we continued to strengthen our share of the market encompassing Fortune 500 and large global and private companies (through our “National Account Program”) as we added 13 new contracts and added sales resources to this focus area. To ensure that we capture the fastest growing product technologies, we continue to strengthen our color equipment portfolio with a diversified mixture of products. Color equipment revenues grew 17% in the first quarter of fiscal 2005 compared to the same period of fiscal 2004, fueling double-digit growth in Customer Service color copy volumes.

 

We are expanding into adjacent markets such as Europe and new service opportunities within Enterprise Services that differentiate and build solidly on our core business, which involves equipment sales and the ongoing volume in services and supplies that those sales generate. In Europe, our City Strategy focuses on expansion to key cities throughout Europe. Under this strategy, we commenced operations in two additional cities, Milan and Barcelona, in the first quarter of 2005. Within Enterprise Services, Professional Services is a key growth opportunity for us, and we experienced an increase in revenues of 22% in the first quarter of fiscal 2005 compared to the first quarter of fiscal 2004. Activity in this area during the first quarter of fiscal 2005 included training on our new, integrated solutions model and changes to coverage and incentive structures to ensure that we continue to support the increasing demand for this area of our business.

 

For the first quarter of fiscal 2005, we had revenues of $1.1 billion, representing a 3.5% decline from the first quarter of fiscal 2004. This decline was due in large measure to the impact of lower North American equipment revenues; lower Managed Services revenues; and our transition out of the North American leasing operations in fiscal 2004 and the decrease in high-margin revenues previously recognized from that business. Diluted earnings per share for the first quarter of fiscal 2005 were $0.14. Refer to “Restated Results of Operations” for further discussion of our quarterly financial statements.

 

OUTLOOK

 

In our Quarterly Report on Form 10-Q for the three months ended December 31, 2004, filed on February 8, 2005 (the “Initial 10-Q”), we provided an outlook of earnings for the second quarter and full year fiscal 2005. We have not updated this outlook to reflect the effect of the Restatement and other events which have occurred since the filing of the Initial 10-Q. Accordingly, such disclosure should not be viewed as indicative of our current outlook.

 

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RESTATED RESULTS OF OPERATIONS

 

This discussion reviews the results of our operations as reported in the consolidated statements of income. All dollar and share amounts are in thousands, except per share data. Unless otherwise noted, references to 2005 and 2004 refer to the three months ended December 31, 2004 and 2003, respectively.

 

Three Months Ended December 31, 2004

Compared to the Three Months Ended December 31, 2003

 

Revenues

 

     Restated
2005


   Restated
2004


   Change

 

Net sales

   $ 464,711    $ 450,804    3.1 %

Services

     601,454      586,422    2.6  

Finance income

     30,806      99,011    (68.9 )
    

  

  

     $ 1,096,971    $ 1,136,237    (3.5 )%
    

  

  

 

The decrease in revenues of 3.5% compared to the first quarter of fiscal 2004, which includes a currency benefit of 1.5% (revenues denominated in foreign currencies impacted favorably when converted to U.S. dollars for reporting purposes), is a result of an overall decrease in finance income as a result of the sale of our North American leasing business, lower equipment revenues in North America, and lower Managed Services revenues, partially offset by an increase in net sales and services as a result of benefits realized from fees received under the U.S. Program Agreement and the Canadian Rider and revenues generated from our National Account Program.

 

Net sales includes revenues from the sale of copier/printer multifunction equipment, direct supplies, and technology hardware. The increase in net sales includes a currency benefit of 1.8%. Equipment revenue, which comprises approximately 90% of our net sales mix, increased by approximately 4.3%, or $17,502, compared to the same period in fiscal 2004 due mainly to the net impact of the relationship with GE and continued growth from the sale of color equipment. Origination fees from, and sales of residual value to, GE (not recognized as revenue when we had captive finance subsidiaries in North America) contributed $38,283 of equipment revenue during the first quarter of fiscal 2005. As a result, equipment revenue would have decreased by approximately 4.8% excluding the impact of the origination fees and sales of residual value. While European equipment sales were stronger compared to the first quarter of fiscal 2004, North American equipment sales declined due to competitive pressure, and lower sales productivity. North America was impacted by changes in sales coverage, selling processes and incentives, as we launched important long-term initiatives in Professional Services and the new integrated selling model. Revenues generated from the sale of color devices increased by 17% compared to the first quarter of fiscal 2004 due to higher demand for these products, particularly higher-end color production equipment, as new products continued to be introduced at more affordable prices. As a percentage of equipment revenue, color devices increased from approximately 20% in the first quarter of fiscal 2004 to approximately 25% in the first quarter of fiscal 2005. Revenues from the sale of segment 5 and 6 black and white production equipment (devices with page outputs greater than 70 pages per minute) decreased approximately 18% compared to the first quarter of fiscal 2004 due to continued pricing pressure, a shift to lower-end products within this segment and new alternate products available in segment 4. However, during the first quarter of fiscal 2005, we experienced strong performance in the high-end of segment 6 equipment sales. Sales of segment 1 – 4 black and white office equipment (devices with page outputs less than 70 pages per minute, fax and other equipment) declined approximately 6% compared to the first quarter of fiscal 2004. This decrease was attributable to lower demand for these products compared to the same period in the prior year, due in part to the shift of sales focus to color devices and lower average selling prices for these products. As of December 31, 2004, sales of black and white office equipment represented 59% of equipment revenue, compared to 60% at December 31, 2003. Direct supply sales decreased by approximately 10%, or $3,403, compared to the first quarter of fiscal 2004, due to lower demand for fax and lower-end copier supplies.

 

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Services is comprised of Enterprise Services and Other Services. Enterprise Services consists of Managed Services, which provides on- and off-site outsourcing services and other expertise; Customer Services (equipment service); and Professional Services, which focuses on integrating hardware and software technologies that capture, manage, control, and store output for customers’ document lifecycles. Other Services includes rental income on operating leases, income from the sharing of gains on certain lease-end activities with GE in the U.S., and fees received from GE for providing preferred services for lease generation in the U.S. (the “Preferred Fees”). Services increased by 2.6% including a currency benefit of approximately $7,143. Excluding the impact of currency translation, services increased by approximately 1.3%. Managed Services revenues, which includes both on-site Managed Services and off-site digital print and legal document services, decreased by $10,763, or 5.7%, due mainly to the recognition of a large commercial imaging contract during the first quarter of fiscal 2004 which benefited first quarter fiscal 2004 revenues by $10,119. Off-site Managed Services, a short-cycle and increasingly competitive transactional business, declined by approximately $17,430 compared to the first quarter of fiscal 2004 due to pricing pressure, lower copy volumes and the impact of the large commercial imaging contract discussed above. On-site Managed Services revenues grew from the prior year, due to an increase in new contracts and an improved retention rate. Customer Services revenues (which are significantly impacted by the amount and mix of copy volumes) increased by $4,497, or 1.3%, compared to the first quarter of fiscal 2004, attributable mainly to an increase in copy volumes of approximately 4% partially offset by a decrease in average revenue per copy. Professional Services increased 22%, or by $3,943, compared to the first quarter of fiscal 2004 as a result of continued focus on providing customers with digital technologies to reduce their costs and improve workflow. We believe that our new solutions portfolio, expanded sales coverage, and incentives built into our commission structure will continue to fuel growth into this important area during the remainder of fiscal 2005. A significant contribution to the services increase was the impact of fees received as a result of the GE relationship, including Preferred Fees of $12,677 during the first quarter of fiscal 2005 partially offset by the impact of lease-end activities of approximately $7,244. We expect to earn approximately $50,000 of Preferred Fees annually until the initial term of the U.S. Program Agreement terminates on March 31, 2009. Rental revenue decreased by $3,171, or 14.2%, compared to the first quarter of fiscal 2004, due primarily from the sale of $38,900 of rental assets to GE on March 31, 2004. We expect rental revenue to continue to decline through the second quarter of fiscal 2005 when compared to the same period of fiscal 2004.

 

Finance income is generated by our leasing subsidiaries, as well as by certain lease receivables not sold to GE as part of the U.S. Transaction. The decrease in finance income was due primarily to the impact of the sale of $2,027,832 of lease receivables to GE during fiscal 2004 as part of the Transactions. Accordingly, lease receivables sold as part of the Transactions did not generate finance income for us during the first quarter of fiscal 2005. This decrease was partially offset by a currency benefit of 1.9%. Although we will continue to receive finance income under certain leases that will be financed directly by us, our total finance income will continue to decrease in future periods as a result of the Transactions. In fiscal 2005, we expect finance income to decline approximately 60% compared to fiscal 2004 as a result of the Transactions and the continued run-off of the retained U.S. lease portfolio.

 

Gross Margin

 

     Restated
2005


    Restated
2004


 

Gross margin, net sales

   28.8 %   29.4 %

Gross margin, services

   40.0     39.9  

Gross margin, finance income

   74.4     64.7  

Gross margin, total

   36.1     37.9  

 

The decrease in the gross margin percentage on net sales was due to a less favorable mix of equipment, growth in lower-margin National Account Program revenues, and continued market competitiveness. In addition, the net impact of origination fees and sales of equipment residual values to GE negatively impacted the net sales gross margin by approximately 30 basis points. We expect the net impact of origination fees and sales of equipment residual values to GE to continue to negatively impact the net sales gross margin percentage during fiscal 2005 compared to fiscal 2004.

 

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The gross margin percentage on services remained relatively flat compared to the first quarter of fiscal 2004. However, the services gross margin percentage during the first quarter of fiscal 2004 was negatively impacted by 70 basis points from the completion of a multi-year commercial imaging contract in which no profit was earned. Off-site Managed Services margins declined compared to the first quarter of fiscal 2004 due to the impact of lower revenues. The off-site Managed Services cost structure is less variable than our other lines of business; therefore, gross margin percentages are more heavily influenced by changes in revenue. We will be taking aggressive actions to improve the variability of the cost structure of off-site Managed Services during the remainder of fiscal 2005. Professional Services margins declined as a result of our increase in staffing in advance of our expected increase in demand. These decreases were offset by an increase in Customer Services gross margin percentage of approximately 27 basis points and the net impact of the GE relationship (income from the sharing of gains on certain lease-end activities with GE as well as the Preferred Fees), which positively impacted the services gross margin percentage by approximately 41 basis points. We expect the services gross margin percentage to improve during the remainder of fiscal 2005 as we take actions to reduce the overhead of off-site Managed Services, continue to grow Professional Services revenues and complete Six Sigma projects which will benefit many services offerings.

 

The gross margin percentage on finance income increased from 64.7% in the first quarter of fiscal 2004 to 74.4% in the first quarter of fiscal 2005 due to European leasing revenues becoming a larger part of the finance income mix in fiscal 2005 compared to fiscal 2004. Because European leases are leveraged with a lower amount of debt, European leases generate higher profit margins than our sold North American leases. In addition, there was a lower leverage ratio on the U.S. lease receivable portfolio after the U.S. Transaction during the first quarter of fiscal 2005 compared to the first quarter of fiscal 2004. Part of this lower leverage was due to the fact that $5,980 of interest expense recorded in “Interest expense, net” during fiscal 2005 related to debt that was reclassified from debt supporting finance contracts and unsold residual value (“Non-Corporate Debt”) to corporate debt beginning on April 1, 2004. Prior to April 1, 2004, interest costs of the Non-Corporate Debt were recorded in finance interest expense. As a result, the gross margin on finance income was positively impacted by this change in classification. In fiscal 2005, we expect finance income to decline approximately 60% compared to fiscal 2004 as a result of the Transactions and the continued run-off of the retained U.S. lease portfolio. By September 30, 2005, we believe that approximately 83% of the gross profit we estimated would be generated by the retained U.S. lease portfolio as of the consummation of the U.S. Transaction will have been earned.

 

Selling and Administrative Expenses

 

     Restated
2005


    Restated
2004


    Change

 

Selling and administrative expenses

   $ 351,450     $ 374,385     (6.1 )%

S&A as a % of revenue

     32.0 %     32.9 %      

 

Selling and administrative expense, which was unfavorably impacted by $4,135 due to foreign currency translation compared to the prior year, decreased by $22,935, or 6.1%, during the first quarter fiscal 2005 compared to the first quarter of fiscal 2004, and decreased from 32.9% to 32.0% as a percentage of revenue.

 

The net impact of the Transactions of $22,486 was a significant factor of the decrease in selling and administrative expense compared to fiscal 2004. Approximately $11,295 of this decrease was due to no lease default expense being required for either retained or sold IOS Capital LLC, our former leasing subsidiary in the U.S. (“IOSC”), lease receivables during the first quarter of fiscal 2005. Under the terms of the U.S. Program Agreement, GE assumed substantially all risks related to lease defaults for both the retained and sold lease receivables of IOSC. The remaining decrease in selling and administrative expense as a result of the Transactions was due to the transfer of over 300 employees to GE. In addition, during the first quarter of fiscal 2005 we received a refund from GE of approximately $3,400 related to administrative fees paid to GE for servicing our retained U.S. lease portfolio during fiscal 2004. Partially offsetting these decreases were increases in corporate costs to support the Transactions, including headcount and certain infrastructure enhancements.

 

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Pension costs decreased by $1,506 compared to the first quarter of fiscal 2004, due mainly to the impact of changes in actuarial assumptions compared to fiscal 2004. Pension expense is allocated between selling and administrative expense and cost of revenues based on the number of employees related to those areas. We expect that our total fiscal 2005 pension expense will decrease compared to fiscal 2004.

 

The positive impact of headcount reduction efforts made during fiscal 2004 as a result of our continued efforts to consolidate and centralize administrative functions was offset by higher employee salary levels in fiscal 2005.

 

Compared to the fourth quarter of fiscal 2004, selling and administrative expense declined by $20,821 due to a decline in variable selling costs as a result of lower equipment sales in the first quarter of fiscal 2005, administrative headcount reductions during the fourth quarter of fiscal 2004 and first quarter of fiscal 2005, as well as lower facilities expense, information technology spending and consulting compared to the fourth quarter of fiscal 2004.

 

For the remainder of fiscal 2005, we will be taking aggressive actions to reduce selling and administrative expense to achieve our goal of reducing selling and administrative expense as a percentage of revenue for the 2005 fiscal year by one percentage point compared to fiscal year 2004. We expect to accomplish this goal through a combination of possible headcount reductions, real estate and discretionary expense reductions, and we will review the profitability of certain business lines to streamline our selling and administrative structure. In addition, we expect to continue to realize benefits of lower selling and administrative expense in the second quarter of fiscal 2005 as a result of the Transactions. These decreases will be partially offset by the impact of an increase in consulting and audit fees related to our Sarbanes-Oxley internal control certification efforts (see also Item 4. “Controls and Procedures”).

 

Other

 

     Restated
2005


   Restated
2004


   Change

 

Operating income

   $ 45,076    $ 56,439    (20.1 )%

Loss from early extinguishment of debt

            73    (100.0 )

Interest expense, net

     12,803      10,085    27.0  

Taxes on income

     11,033      17,503    (37.0 )

Net income

     21,240      28,778    (26.2 )

Diluted earnings per common share

     0.14      0.18    (22.2 )

 

Operating income decreased in fiscal 2005 by 20.1% compared to fiscal 2004, as a result of the factors discussed above.

 

During the first quarter of fiscal 2004, we recorded a loss from the early extinguishment of debt of $73, as a result of the repurchase of $2,000 of the 9.75% notes due 2004 (the “2004 Notes”).

 

The increase in interest expense, net was primarily due to our assumption of IOSC’s public debt (the 2004 Notes, 5% convertible notes due May 2007 (the “Convertible Notes”), and the 7.25% notes payable due 2008 (the “2008 Notes”); collectively, the “Additional Corporate Debt”) as part of the U.S. Transaction. Interest on this debt, which was reported in “Finance interest expense” prior to April 1, 2004, is now reported as “Interest expense, net.” This change resulted in approximately $5,980 of additional interest expense being recorded in “Interest expense, net” compared to fiscal 2004. We expect to continue to experience a modest increase in

 

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“Interest expense, net,” as the Additional Corporate Debt will be included on this income statement line for the entire 2005 fiscal year, partially offset by the benefit of lower average outstanding balances of other debt during fiscal 2005.

 

The effective income tax rate was 34.19% and 37.82% for the first quarter of fiscal 2005 and 2004, respectively. This decrease is primarily due to the deferral of depreciation expense for tax purposes in Ireland as a result of tax planning strategies. In particular, we have previously expensed depreciable asset purchases in accordance with Irish tax law provisions. We are currently taxed at 10% of income; however, effective January 1, 2006, we will be taxed at 12.5% of income. During the first quarter of fiscal 2005, we determined that we would not deduct depreciable asset purchases in fiscal 2004 and fiscal 2005. As a result, we will receive a tax benefit of 12.5% rather than 10% from the depreciation of these assets. The first quarter of fiscal 2005 results reflect the benefit of the change in tax planning with respect to depreciable assets in fiscal 2004 of $1,345. The fiscal 2005 expected benefit of $822 has been considered in the determination of the expected effective tax rate for fiscal 2005. The effective income tax rate for the remaining quarters of fiscal 2005 is expected to be 38.0%, resulting in a full year effective tax rate of 37.1%.

 

Diluted earnings per common share were $0.14 for the first quarter of fiscal 2005, compared to $0.18 for the first quarter of fiscal 2004. The decline in diluted earnings per share is mainly attributable to the negative impact of the Transactions, lower profit generated by legal document services and the impact of lower equipment sales partially offset by the impact of a non-recurring tax adjustment, the effect of lower outstanding shares and other operational changes compared to the first quarter of fiscal 2004.

 

Review of Business Segments

 

Our reportable business segments are IKON North America (“INA”) and IKON Europe (“IE”). INA and IE provide copiers, printers, color solutions, and a variety of document management service capabilities through Enterprise Services. These segments also include our captive finance subsidiaries in North America (including those now divested) and Europe.

 

IKON North America

 

     Restated
2005


   Restated
2004


   Change

 

Net sales

   $ 388,298    $ 383,857    1.2 %

Services

     540,323      531,957    1.6  

Finance income

     24,051      92,919    (74.1 )

Finance interest expense

     6,158      33,290    (81.5 )

Operating income

     114,137      125,561    (9.1 )

 

Approximately 87% of our revenues are generated by INA; accordingly, many of the items discussed above regarding our consolidated results are applicable to INA.

 

Net sales increased by 1.2% due to an increase in equipment sales of 2.2% due mainly to the net impact of the relationship with GE and continued growth from the sale of color equipment. Origination fees and sales of residual value to GE (not recognized as revenue when we had captive finance subsidiaries in North America) contributed to $38,283 of equipment revenue during fiscal 2005. As a result, equipment revenue would have decreased approximately 8.1% excluding the impact of the origination fees and sales of residual value. This decline was due to competitive pressure and lower sales productivity as a result of several long-term strategic priorities launched during the first quarter of fiscal 2005. Revenues generated from the sale of color devices increased compared to the first quarter of fiscal 2004 due to higher demand for these products, particularly higher-end color production equipment, as new products continued to be introduced at more affordable prices.

 

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These increases were offset by a large decrease in the sale of segment 5 and 6 black and white production equipment compared to the first quarter of fiscal 2004 due to continued pricing pressure, a shift to lower-end products within this segment and new alternate products available in segment 4. However, during the first quarter of fiscal 2005, we experienced strong performance in the high-end of segment 6 equipment sales. Sales of segment 1 – 4 black and white office equipment declined compared to the first quarter of fiscal 2004. This decrease was attributable to lower demand for these products compared to the same period in the prior year, due in part, to the shift of sales focus to color devices and lower average selling prices for these products. Direct supply sales decreased by approximately 11.5% compared to the first quarter of fiscal 2004, due to lower demand for fax and lower-end equipment supplies.

 

Services increased by 1.6% due primarily to the fees received as a result of the GE relationship. Professional Services grew by $2,544, or 22%, compared to the first quarter of fiscal 2004 as a result of continued focus on providing customers with digital technologies to reduce their costs and improve workflow. Customer Services remained relatively consistent, decreasing by $301 compared to fiscal 2004. These changes were partially offset by decreases in Managed Services of $11,260, or 6.4%, due mainly to the recognition of a large commercial imaging contract during the first quarter of fiscal 2004, which benefited the first quarter of fiscal 2004 revenue by $10,119. On-site Managed Services grew from the prior year, due to an increase in new contracts and an improved retention rate. Off-site Managed Services, declined by approximately $17,430 due to pricing pressure, lower copy volumes and the impact of the large commercial imaging contract discussed above. Rental revenue decreased by $3,142, or 15.1%, due primarily to the sale of $38,900 of rental assets to GE on March 31, 2004.

 

Finance income and finance interest expense decreased as a result of the Transactions. Accordingly, lease receivables sold as part of the Transactions did not generate finance income for us during the first quarter of fiscal 2005.

 

Operating income decreased primarily due to a decline in finance income, lower equipment revenues and a decline in off-site Managed Services revenues compared to the first quarter of fiscal 2004, partially offset by the impact of the reclassification of the Additional Corporate Debt of $5,980.

 

IKON Europe

 

     2005

   2004

   Change

 

Net sales

   $ 76,413    $ 66,947    14.1 %

Services

     61,131      54,465    12.2  

Finance income

     6,755      6,092    10.9  

Finance interest expense

     1,730      1,648    5.0  

Operating income

     6,915      5,092    35.8  

 

Net sales includes a currency benefit of approximately $6,663. Excluding the impact of currency translation, net sales increased by 4.2% primarily driven by an increase in equipment sales of 17.7%, compared to fiscal 2004, due to several large contracts during the first quarter of fiscal 2005 as a result of our ongoing emphasis on national and global accounts. The increases in equipment sales were partially offset by decreases in direct supplies sales and technology hardware revenues of 1.1% and 4.7%, respectively. Services increased as a result of currency benefits of approximately $5,169. Excluding the impact of currency translation, services increased by 2.7% due to an increase in customer services revenues of 14.1% as a result of an increase in copy volumes across Europe. Finance income increased primarily as a result of strengthened foreign currencies, which resulted in a benefit of $574. Operating income in fiscal 2005 increased due to the operational performance discussed above and the favorable impact of currency.

 

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Corporate and Eliminations

 

Corporate and Eliminations, which is not treated as a business segment, is comprised of certain selling and administrative functions including finance, supply chain, and customer service. INA and IE are not presented on a comparative basis because certain administrative costs of INA are included in Corporate and Eliminations, and excluded from the presentation of results of INA, but are included in the presentation of results of IE. Operating losses in Corporate and Eliminations, were $75,976 and $74,214 in the first quarter of fiscal 2005 and the first quarter of fiscal 2004, respectively.

 

Financial Condition and Liquidity

 

Cash Flows and Liquidity

 

The following summarizes cash flows for the three months ended December 31, 2004 as reported in our consolidated statements of cash flows:

 

     2005

 

Cash used in operating activities

   $ (92,133 )

Cash provided by investing activities

     88,485  

Cash used in financing activities

     (183,877 )

Effect of exchange rates

     6,815  
    


Decrease in cash

     (180,710 )

Cash and cash equivalents at beginning of the year

     472,951  
    


Cash and cash equivalents at end of period

   $ 292,241  
    


 

Operating Cash Flows

 

We used $92,133 of cash for operating activities during the first quarter of fiscal 2005. Our most significant use of cash was due to the decrease in accounts payable, deferred revenue, and accrued expenses of $51,616 from September 30, 2004, due mainly to a decrease in accounts payable of $37,719 as a result of less favorable terms with some of our vendors compared to September 30, 2004, partially offset by the impact on accounts payable for late fourth quarter inventory purchases as discussed below. Accrued salaries, wages and commissions decreased as a result of the timing of the payroll cycle and the payment of fiscal 2004 performance compensation during the first quarter of fiscal 2005. In addition, interest payable decreased by $13,523 as a result of a semi-annual interest payment that was made during fiscal 2005. We used $52,925 of cash to replenish inventories that were depleted due to our sales initiatives late in the fourth quarter of fiscal 2004, including a large purchase of inventory made late in the first quarter of fiscal 2005. As a result, our inventory turns decreased to 9.2 from 9.6 turns at September 30, 2004. An increase in accounts receivable negatively impacted cash flow from operations by $21,369 as a result of higher days sales outstanding compared to September 30, 2004. Partially offsetting these uses of cash was a decrease in prepaid expenses and other current assets of $8,711 due mainly to receipt of a tax refund during the first quarter of fiscal 2005. Net income was $21,240 during the first quarter of fiscal 2005 and non-cash operating expenses were $2,334, which includes depreciation, amortization, provision for losses on accounts and lease receivables, deferred income taxes, pension expense, and non-cash interest expense on debt supporting unsold residual value.

 

Investing Cash Flows

 

During the first quarter of fiscal 2005, we generated $88,485 of cash from investing activities, mainly attributable to the sale and collection of $61,428 and $136,106, respectively, of our finance receivables partially offset by $88,159 of finance receivable additions during the first quarter of fiscal 2005. As a result of the Transactions, collections received from our U.S. retained lease portfolio will continue to significantly outpace finance receivable additions. During the first quarter of fiscal 2005, we had capital expenditures for property and equipment of $4,848 and capital expenditures for equipment on operating leases of $13,856. Capital expenditures for equipment on operating leases represent purchases of equipment that are placed on rental with our customers.

 

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Proceeds from the sale of property and equipment during fiscal 2005 were $643. Proceeds from the sale of equipment on operating leases during fiscal 2005 were $975.

 

Financing Cash Flows

 

During the first quarter of fiscal 2005, we used $183,877 of cash for financing activities. As discussed in further detail below under “Debt Structure” during fiscal 2005 we used $163,473 for debt payments. These payments include the maturity of $56,659 of the 6.75% notes due 2004 (the “November 2004 Notes”) that were paid in November 2004 and $103,905 of lease related debt. In March 2004, the Board of Directors authorized the repurchase of up to $250,000 of our outstanding shares of common stock (the “2004 Plan”), superceding the fiscal 2000 share repurchase authorization. During the first quarter of fiscal 2005, we repurchased 1.9 million shares of our outstanding common stock for $21,916 (including payment of related fees), leaving $150,629 remaining for share repurchases under the 2004 Plan. During the remainder of fiscal 2005, we plan to continue share repurchases.

 

During the first quarter of fiscal 2005, we paid $5,667 of dividends, representing $0.04 per common share to shareholders of record.

 

Debt Structure

 

Long-term corporate debt and notes payable consisted of:

 

    

December 31,

2004


  

September 30,

2004


Bond issues

   $ 354,784    $ 411,423

Convertible subordinated notes

     290,000      290,000

Notes payable

     94,835      94,835

Miscellaneous notes, bonds, mortgages, and capital lease obligations

     8,546      8,622
    

  

       748,165      804,880

Less: current maturities

     6,129      63,023
    

  

     $ 742,036    $ 741,857
    

  

 

Long-term debt supporting finance contracts and unsold residual value (“Non-Corporate Debt”) consisted of:

 

    

December 31,

2004


  

September 30,

2004


Lease-backed notes

   $ 585,462    $ 683,086

Asset securitization conduit financing

     135,783      129,668

Notes payable to banks

     6,508      3,868

Debt supporting unsold residual value

     59,511      46,187
    

  

       787,264      862,809

Less: current maturities

     402,834      439,941
    

  

     $ 384,430    $ 422,868
    

  

 

Our November 2004 Notes were paid upon maturity in November 2004. The balance of these notes at September 30, 2004 was $56,659.

 

During the first quarter of fiscal 2005, we repaid $97,624 of lease-backed notes.

 

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Asset Securitization Conduit Financing Agreements

 

As of December 31, 2004, IKON Capital, PLC, our leasing subsidiary in the United Kingdom, had approximately $29,175 available under its asset securitization conduit financing agreement (the “Conduit”). During the first quarter of fiscal 2005, IKON Capital, PLC repaid $3,453 in connection with the Conduit. No additional borrowings were made in connection with the Conduit during the first quarter of fiscal 2005. During the third quarter of fiscal 2005, we received a waiver to the Conduit to provide us with an extension to the deadline by which we must deliver to the lender certain items required under the Conduit, including our financial statements for the second quarter of fiscal year 2005, in order to allow us to complete the review of our billing controls and reserve practices for our trade accounts receivable (see Note 2 to the Condensed Consolidated Financial Statements).

 

Debt Supporting Unsold Residual Value

 

Due mainly to certain provisions within our agreements with GE and other lease syndicators, which do not allow us to recognize the sale of the residual value on leases in which we are the equipment lessor (primarily state and local government contracts), we must keep the present value of the residual value of those leases on our balance sheet. A corresponding amount of debt is recorded representing the cash received from GE and the other lease syndicators for the residual value. This debt will not be repaid unless required under the applicable agreement in the event that an IKON service performance failure is determined to relieve the lessee of its lease payment obligations. Over the last three years, total repurchases of lease receivables related to our service performance failures have amounted to approximately $500 on a cumulative basis. The net book value of the combined lease portfolio as of December 31, 2004 was approximately $3,100,000.

 

In addition, we transferred lease receivables to GE for which we have retained all of the risks of ownership. A corresponding amount of debt was recorded representing the cash received from GE for these receivables.

 

As of December 31, 2004, we had $59,511 of debt related to $58,370 of unsold residual value and the present value of the remaining lease receivables that remained on our balance sheet. During the first quarter of fiscal 2005, we imputed interest at our average borrowing rate of 3.73% and recorded $500 of interest expense related to this debt. Upon the end of the lease term or repurchase of the lease, whichever comes first, we will reverse the unsold residual value and related debt as the underlying leases mature and any differential will be recorded as a gain on the extinguishment of debt. As of December 31, 2004, this differential was $1,141.

 

Credit Facility

 

We maintain a $200,000 secured credit facility (the “Credit Facility”) with a group of lenders. The Credit Facility provides the availability of revolving loans, with certain sub-limits, and provides support for letters of credit. The amount of credit available under the Credit Facility is reduced by open letters of credit. The amount available under the Credit Facility for borrowings or additional letters of credit was $165,579 at December 31, 2004. The Credit Facility is secured by our accounts receivable and inventory, the stock of our first-tier domestic subsidiaries, 65% of the stock of our first-tier foreign subsidiaries, and all of our intangible assets. All security interests pledged under the Credit Facility are shared with the holders of our 7.25% notes payable due 2008.

 

The Credit Facility contains affirmative and negative covenants, including limitations on certain fundamental core business changes, investments and acquisitions, mergers, certain transactions with affiliates, creations of liens, asset transfers, payments of dividends, intercompany loans, and certain restricted payments. The Credit Facility does not, however, limit our ability to continue to securitize lease receivables. The Credit Facility matures on March 1, 2008, but is subject to certain early maturity events in November 2006, January 2007, and April 2007 if our Convertible Notes have not been converted to equity or refinanced and minimum liquidity is not met as of such dates. Minimum liquidity is defined as having sufficient cash, including any unused capacity under the Credit Facility, to repay the balance of the Convertible Notes plus an additional $100,000. The Credit Facility contains certain financial covenants relating to: (i) our corporate leverage ratios; (ii) our consolidated interest coverage ratio; (iii) our consolidated asset coverage ratio; (iv) our consolidated net worth ratios; (v) limitations on our capital expenditures; and (vi) limitations on additional indebtedness and liens.

 

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Under the terms of the Credit Facility, share repurchases are permitted in an aggregate amount not to exceed $250,000 during the period of July 28, 2004 through March 1, 2008. From July 28, 2004 through September 30, 2005, share repurchases are permitted in an aggregate amount not to exceed $150,000. Beginning on October 1, 2005, we are permitted to repurchase (a) shares and pay dividends in an aggregate annual amount not to exceed 50% of our annual net income, plus (b) that portion of the $150,000 allowance that we did not utilize prior to October 1, 2005. As of December 31, 2004, $72,742 of the $150,000 allowance was utilized. Additionally, the Credit Facility contains default provisions customary for facilities of this type. During the third quarter of fiscal 2005, we entered into a consent (the “Consent”) to our Credit Facility to provide us with an extension to the deadline by which we must deliver to the lenders certain items required under the Credit Facility, including our financial statements for the second quarter of fiscal year 2005, in order to allow us to complete the review of our billing controls and reserve practices for our trade accounts receivable (see Note 2 to the Condensed Consolidated Financial Statements).

 

Letters of Credit

 

We have certain commitments available to us in the form of lines of credit and standby letters of credit. As of December 31, 2004, we had $179,164 available under lines of credit, including the $165,579 available under the Credit Facility and had open standby letters of credit totaling $34,421. These letters of credit are primarily supported by the Credit Facility. All letters of credit expire within one year.

 

Credit Ratings

 

As of December 31, 2004, the credit ratings on our senior unsecured debt were designated Ba2 with stable outlook by Moody’s Investor Services and BB with stable outlook by Standard and Poor’s.

 

Liquidity Outlook

 

The following summarizes our significant contractual obligations and commitments as of December 31, 2004:

 

     Payments due

Contractual Obligations


   Total

   Less Than 1
Year


   1-3 Years

   3-5 Years

   Thereafter

Corporate debt

   $ 1,340,255    $ 51,402    $ 380,717    $ 149,443    $ 758,693

Non-Corporate Debt

     754,706      421,258      333,448              

Notes payable

     987      91      896              

Purchase commitments

     732      732                     

Other long-term liabilities

     201,140      7,680      57,374      50,758      85,328

Operating leases

     379,014      110,007      143,366      64,049      61,592
    

  

  

  

  

Total

   $ 2,676,834    $ 591,170    $ 915,801    $ 264,250    $ 905,613
    

  

  

  

  

 

Non-Corporate Debt excludes the maturity of debt supporting unsold residual value of $59,511. This debt will not be repaid unless required under the applicable agreement in the event that an IKON service performance failure is determined to relieve the lessee of its lease payment obligations. Over the last three years, total repurchases of lease receivables related to our service performance have amounted to approximately $500 on a cumulative basis. The net book value of the combined lease portfolio as of December 31, 2004 was approximately $3,100,000. Maturities of debt include estimated interest payments. Maturities of lease-backed notes are based on the contractual maturities of leases. Payments on Non-Corporate Debt are generally made from collections of our finance receivables. At December 31, 2004, Non-Corporate Debt (excluding debt supporting unsold residual value) was $727,753 and finance receivables, net of allowances, were $1,117,001.

 

Other long-term liabilities exclude $8,634 of accrued contingencies due to the inability to predict the timing of payments due to the uncertainty of their outcome. Planned contributions to our defined benefit plans have been included in the estimated period of payment. All other liabilities related to pension are included in “Thereafter”

 

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($48,121), as required payments are based on actuarial data that has not yet been determined. Payment requirements may change significantly based on the outcome or changes of various actuarial assumptions.

 

Purchase commitments represent future cash payments related to an agreement with an outside consultant to be rendered prior to March 31, 2005.

 

From time-to-time, our Retirement Savings Plan may acquire shares of our common stock in open market transactions or from our treasury shares. Additionally, from time-to-time we may repurchase available outstanding indebtedness in open market and private transactions. During the first quarter of fiscal 2005, we repurchased 1,957 shares of our outstanding common stock for $21,797, leaving $150,629 remaining for share repurchases under the 2004 Plan. Under the terms of the Credit Facility, share repurchases are permitted up to $150,000 until September 2005. Beginning on October 1, 2005, we are permitted to repurchase (a) shares and pay dividends in an aggregate annual amount not to exceed 50% of our annual net income, plus (b) that portion of the $150,000 allowance that we did not utilize prior to October 1, 2005. As of December 31, 2004, $72,742 of the $150,000 allowance was utilized.

 

For fiscal 2005, we expect to generate (use) $25,000 to $(25,000) in cash from operations. These expected results are primarily due to the payment of tax obligations related to the retained U.S. leasing portfolio in which we will continue to pay over the next several years as the underlying leases run-off. We expect to make tax payments of approximately $150,000 to $170,000 during fiscal 2005. We expect net lease receivable collections, reported under “Cash from Investing Activities,” to more than offset the future tax liabilities related to leases during the transition period, as well as the obligations for the underlying debt supporting the lease receivables. Capital expenditures, net of proceeds from the sale of fixed assets, are expected to be approximately $90,000 for fiscal 2005.

 

We believe that our operating cash flow together with our current cash position and other financing arrangements will be sufficient to finance current operating requirements for fiscal 2005, including capital expenditures, and payment of dividends.

 

PENDING ACCOUNTING CHANGES

 

In October 2004, the American Jobs Creation Act (the “AJCA”) was signed into law. The AJCA includes a deduction of 85% of certain foreign earnings that are repatriated, as defined by the AJCA. We may elect to apply this provision to qualifying earnings repatriations in either the balance of fiscal 2005 or in fiscal 2006. We have begun an evaluation of the effects of the repatriation provision; however, we do not expect to be able to complete this evaluation until after Congress or the Treasury Department provides additional clarifying language on key elements of the provision. We expect to complete our evaluation of the effects of the repatriation provision within a reasonable period of time following the publication of the additional clarifying language. The range of possible amounts that we are considering for repatriation under this provision is between $0 and $130,000. The related potential range of income tax is between $0 and $7,000.

 

In December 2004, the Financial Accounting Standards Board (the “FASB”) issued its final standard on accounting for share-based payments, SFAS 123R (Revised 2004), “Share-Based Payments” (“SFAS 123R”). SFAS 123R requires companies to expense the fair value of employee stock options and other similar awards, effective for interim and annual periods beginning on or after June 15, 2005. When measuring the fair value of these awards, companies can choose from two different pricing models that appropriately reflect their specific circumstances and the economics of their transactions. In addition, we are in the process of selecting one of three transition methods available to us under SFAS 123R. Accordingly, we have not yet determined the impact on our consolidated financial statements of adopting SFAS 123R. Additional information regarding the pro forma impact of expensing stock options is presented in Note 1 to the Notes to Condensed Consolidated Financial Statements (Unaudited).

 

Also in December 2004, the FASB issued its final standard on accounting for exchanges of non-monetary assets, SFAS 153, “Exchanges of Non-monetary Assets an amendment of APB Opinion No. 29” (“SFAS 153”). SFAS 153 requires that exchanges of non-monetary assets be measured based on the fair value of assets

 

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exchanged for annual periods beginning after June 15, 2005. We are currently evaluating the impact of SFAS 153, but we do not expect a material impact from the adoption of SFAS 153 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 we use 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. Debt supporting finance contracts 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 our 2004 annual report on Form 10-K/A filed with the Securities and Exchange Commission (the “SEC”).

 

Foreign Exchange Risk. We have various non-U.S. operating locations which expose us to foreign currency exchange risk. Foreign denominated intercompany debt borrowed in one currency and repaid in another may be fixed via currency swap agreements.

 

Item 4. Controls and Procedures

 

Restatement

 

During an analysis of aged trade accounts receivable conducted during fiscal 2005, and in connection with our documentation, evaluation and testing of internal controls of our significant processes over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act (“SOX 404”) in order to allow our management to report on our internal controls over financial reporting, we identified deficiencies in the processes and timeliness by which we issue certain invoices. These deficiencies primarily impact revenue and accounts receivable and have a corresponding impact on deferred revenues and income taxes. These deficiencies do not affect receivables arising from our Mexican operations, receivables owing from General Electric Capital Corporation (“GE”) under our leasing relationship with GE, or receivables arising under our Legal Document Service and Business Document Service businesses.

 

In connection with these developments, we conducted an evaluation and comprehensive review (the “Review”) to determine the extent of such accounts receivable and billing errors (collectively, the “Billing Matter”). Based on the results of the Review, our management, together with the Audit Committee of our Board of Directors, concluded that the errors related principally to revenue, accounts receivable, deferred revenues and income taxes, and that the errors had a cumulative effect over multiple periods and, therefore, we have restated our consolidated balance sheets (unaudited) at December 31, 2004 and September 30, 2004, and consolidated statements of income (unaudited) and cash flows (unaudited) for the three months ending December 31, 2004 and 2003 (the “Restatement”). The Restatement affected periods prior to 2004 and the impact of the Restatement on such prior periods was reflected as an adjustment to retained earnings as of October 1, 2003. As described in “Item 1. Financial Statements—Note 2. Restatement of Previously Issued Financial Statements”, each of the Restatement adjustments for the three months ended December 31, 2004 and 2003 constitutes an “error” within the meaning of Accounting Principles Board Opinion No. 20, Accounting Changes.

 

Evaluation of Disclosure Controls and Procedures

 

In our Quarterly Report on Form 10-Q for the quarter ended December 31, 2004, filed on February 8, 2004 (the “Initial Form 10-Q”) our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rule 13a-15(e) promulgated under the Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by the Initial Form 10-Q. Based on that evaluation, our management initially concluded that our disclosure controls and procedures were effective in reaching a reasonable level of assurance that information required to be included in our reports filed or submitted under the Exchange Act as of such time was recorded, processed, summarized, and reported within the time period specified in the U.S Securities and Exchange Commission’s (the “Commission”) rules and forms.

 

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In connection with the Restatement, our management, including our Chief Executive Officer and Chief Financial Officer, reevaluated the effectiveness of our disclosure controls and procedures as of December 31, 2004 pursuant to SEC Rules 13a-15(b) under the Exchange Act. As a result of such reevaluation, management has determined that the Billing Matter constituted a material weakness in our internal controls over financial reporting as of such date, which has caused us to amend our Initial Form 10-Q for the quarter ended December 31, 2004, in order to restate our Condensed Consolidated Financial Statements as described above.

 

As a result of the Billing Matter, our management has revised its earlier assessment and has now concluded that our disclosure controls and procedures were not effective as of December 31, 2004 in reaching a reasonable level of assurance that information required to be in our reports filed or submitted under the Exchange Act was properly processed, summarized, and reported within the time periods specified in the Commission’s rules and forms.

 

Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act are properly recorded, processed, summarized and reported within the time periods required by the Commission’s rules and forms. Management necessarily applied its judgment in assessing the costs and benefits of such controls and procedures that, by their nature, can provide only reasonable assurance regarding management’s control objectives. Management does not expect that its disclosure controls and procedures will prevent all errors and fraud. A control system, irrespective of how well it is designed and operated, can only provide reasonable assurance, and cannot guarantee that it will succeed in its stated objectives.

 

Changes in Internal Controls over Financial Reporting

 

Our management discussed the Billing Matter with our Audit Committee and Independent Registered Public Accounting Firm and advised them that management believes it constitutes a material weakness in our internal controls over financial reporting. As a result, we have implemented processes designed to fairly present our financial statement including:

 

    applying an error rate to the appropriate U.S. accounts receivable;

 

    reclassifying billing errors from selling and administrative expense to a reduction of revenue;

 

    properly stating bad debt expense and the related allowance for doubtful accounts;

 

    correcting the treatment of advances we receive from GE for customer receivables as an accounts payable; and

 

    recording the impact of billing errors on deferred revenues.

 

We have a complex billing process that is performed in several locations using multiple billing platforms. The process requires the proper initiation of a customer master record and contract to ensure consistent billing of monthly charges. Additionally, our collection of accurate meter readings from equipment is critical in order to ensure the generation of a proper bill to our customers. We are undertaking several efforts to remediate our billing errors, including:

 

    redesigning and simplifying our billing process;

 

    improving our meter reading collection process and reducing reliance on meter estimates; and

 

    standardizing training for contract set-up and execution.

 

We can give no assurances that these remediation efforts will be adequate to fully remediate the Billing Matter, or that the efforts will be completed on or prior to September 30, 2005. Currently, management does not expect that the remediation will be completed on or prior to September 30, 2005. If the Billing Matter is not remedied on or prior to September 30, 2005, it would constitute a material weakness as defined by the Public Company Accounting Oversight Board and we would disclose it as such in Management’s Report on Internal Controls over Financial Reporting in Item 9A of our Annual Report on Form 10-K for the fiscal year ending September 30, 2005.

 

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As reported in our Initial Form 10-Q, during the quarter ended December 31, 2004, GE acted as servicer for the portion of the U.S. lease asset portfolio retained by IKON under the U.S. Transaction and provided periodic reporting with respect to both the serviced and originated lease portfolios. Both the U.S. Program Agreement and the Canadian Rider contain audit right provisions that require, upon our request, GE’s external auditors to perform certain audit procedures and issue annual and quarterly reports relating to GE’s servicing of such portfolios (“Servicing Controls”), including a Type II Statement on Auditing Standards (“SAS”) 70 Report relating to the Servicing Controls. The audit rights and Type II SAS 70 Report are designed to inform us of any identified weakness relating to the Servicing Controls and to provide us with an opportunity to review and understand such findings in advance of our fiscal year reporting requirements. We believe that such audit rights and the Type II SAS 70 Report are reasonably designed to confirm that the objectives of the Servicing Controls are met.

 

The Type II SAS 70 Report obtained from GE identified certain control deficiencies relating to the Servicing Controls. In response, GE performed an analysis of the related controls and then initiated and completed certain remedial measures designed to address the identified control deficiencies. Based on our own analysis and the remediation efforts completed to date, we do not believe that the identified control deficiencies had, or are likely to have, a material impact on our internal controls over financial reporting.

 

In addition to the Billing Matter, we have identified other deficiencies that we have remediated or are in the process of implementing remediation plans. We are continuing to document, review and evaluate the design effectiveness of our internal controls over financial reporting and are executing our testing plan of such controls as required under SOX 404. Consequently, we may identify additional areas where disclosure and corrective measures are advisable or required. We have assigned the highest priority to the short and long-term correction of the internal control deficiencies that have been identified and are taking the steps necessary to strengthen our internal controls and to address the identified control deficiencies.

 

Other than the internal control issues and corresponding corrective actions discussed above, our Chief Executive Officer and Chief Financial Officer have each confirmed that there have been no changes in internal controls over financial reporting that occurred during the period covered by this Amended Report on Form 10-Q/A that have materially affected, or are reasonably likely to affect materially, our internal control over financial reporting.

 

In light of the material weakness in our internal controls described above, we performed additional analysis and other post-closing procedures to ensure our condensed consolidated financial statements are prepared in accordance with generally accepted accounting principles. Accordingly, we believe that the condensed consolidated financial statements included in this report fairly present in all material respects our financial position, results of operations and cash flows for the periods presented.

 

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PART II—OTHER INFORMATION

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

The following table provides information relating to our purchases of our common stock during the quarter ended December 31, 2004:

 

Period


  

Total Number

of Shares

Purchased (1)


  

Average

Price Paid

per Share


  

Total Number

of Shares

Purchased

as Part of Publicly

Announced

Program


  

Approximate

Dollar Value

of Shares That

May Yet Be

Purchased Under

the Program (2)


October 1, 2004 – October 31, 2004

   244,500    $ 11.32    244,500    $ 169,658,060

November 1, 2004 – November 30, 2004

   704,000      10.99    704,000      161,920,865

December 1, 2004 – December 31, 2004

   1,008,500      11.20    1,008,500      150,629,112
    
         
  

     1,957,000    $ 11.14    1,957,000    $ 150,629,112
    
         
  


(1) As of December 31, 2004, we repurchased a total of 8,697,500 shares of our common stock pursuant to the repurchase program (the “Program”) that we publicly announced in our quarterly report on Form 10-Q filed with the SEC on May 14, 2004.
(2) Our Board of Directors authorized us to repurchase up to $250,000,000 of our outstanding common stock under the Program. The Program will remain in effect until the $250,000,000 repurchase limit is reached; however, our Board of Directors may discontinue the Program at any time. As of December 31, 2004, we had utilized $99,370,888 under the Program (see page 36 for information concerning our share repurchase activity and how it relates to our Credit Facility).

 

Item 6. Exhibits

 

a) Exhibits

 

31.1   Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934
31.2   Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934
32.1   Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350
32.2   Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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: July 8, 2005
By:  

/s/    ROBERT F. WOODS      


   

(Robert F. Woods)

Senior Vice President and Chief Financial Officer

(Principal Financial Officer)

 

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