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IKON Announces Q3 Results: Facilities Management Grows 3.7%

Friday, July 25, 2003

Press release from the issuing company

VALLEY FORGE, Pa.--July 24, 2003-- IKON Office Solutions, the world's largest independent distributor of document management products and services with operations throughout North America and Europe, today reported results for the Company's third fiscal quarter ended June 30, 2003. Net income for the third quarter was $14.7 million, or $.10 per diluted share, including a loss of $.10 per diluted share from the early extinguishment of debt, on revenues of $1.15 billion. On June 3, 2003 the Company announced a series of financing actions to improve financial liquidity, which included the repurchase of $83.5 million of corporate (non-finance subsidiary) debt and a tender offer for the June 2004 9.75% notes of IOS Capital, IKON's leasing subsidiary for the U.S. Together, these actions resulted in a pretax loss from the early extinguishment of debt of $27.5 million. Excluding these charges, earnings for the third quarter of Fiscal 2003 were $.20 per diluted share. Revenues for the third quarter of Fiscal 2003 were $1.15 billion, compared to revenues of $1.22 billion for the third quarter of Fiscal 2002, a decline of 5.6%. Approximately 60%, or $41 million, of the revenue decline related to the Company's downsizing and exit strategies commenced during the first quarter of Fiscal 2002, including the de-emphasis of non-core technology hardware such as computers, routers and servers. Core revenues, defined as all remaining revenues including the sale of copiers/printers from leading vendors such as Canon and Ricoh, supplies, and the Company's wide array of services, declined 2.3% from the third quarter a year ago. Core revenues were negatively impacted by a decline in copier/printer equipment revenues, which were partially offset by the Company's stream of services and supply revenues which comprise over 65% of the Company's core revenue mix. Equipment revenues were impacted by an increase in vendor backorders of $14 million above the two year quarterly average, continued delays in customer purchasing decisions, and lower average selling prices due to mix shift in some segments of the market, primarily color. Operating Income of $63.8 million for the third quarter of Fiscal 2003 declined from $83.0 million for the same period a year ago. Lower equipment revenues and the resulting impact on gross profit, coupled with additional expenses that were reflected in equipment costs and Selling and Administrative expense for the quarter, were the primary reasons for the decline in operational performance. Commenting on the quarter's results, Matthew J. Espe, IKON's Chairman and Chief Executive Officer stated, "Our results this quarter do not reflect the potential I believe this Company can deliver, and point to the need for better execution and even greater responsiveness to changing market conditions. The document management industry will continue to experience fundamental shifts as digital and color technology evolves, and services play an increasingly larger and more critical role in winning new business. These changes underscore the importance of our objectives for Fiscal 2003: setting new foundations for growth to capitalize on the Company's global capabilities, service differentiation, and breadth of products; and, executing e-IKON to drive future earnings growth through highly efficient customer support and delivery mechanisms." During the quarter, the Company made progress on these strategic priorities by: Increasing placements of copiers/printers by approximately 6%, which will continue to fuel equipment service, supplies, and other services offered by IKON; Enhancing its product portfolio with Production MICR check printing technology with the introduction of the Canon iR110M, and launching new color offerings from Canon and Ricoh, the iRC3200 and the CL7000, respectively; Growing facilities management, the Company's largest outsourcing offering, by more than 3.7%; Delivering the highest level of national account wins in the quarter since the Company more aggressively targeted this customer set in 2000; and, Launching e-IKON - the Company's enterprise-wide systems and process redesign incorporating the Oracle E-Business Suite - in the second wave of marketplaces in the U.S. and the second of the Company's three mega Customer Care Centers. In addition, during the third quarter, the Company took a number of actions to improve its financial liquidity, including the repurchase of non-finance subsidiary debt. As of June 30, 2003, the Company's total debt to capital ratio, including finance subsidiary debt, was 67.7%. Excluding finance subsidiary debt, the Company's corporate debt to capital ratio as of June 30, 2003 was 22.8% compared to 29% a year ago. Financial Analysis Year-to-year comparisons of both Net Sales and Services were impacted unfavorably by actions the Company has taken to strengthen the business model and facilitate long-term profitability objectives. During the first quarter of Fiscal 2002, the Company exited its telephony business, sold its technology education business, and began the process of closing or selling a number of digital print centers and technology services locations. The Company also began to de-emphasize the distribution of low-margin technology hardware - an undertaking expected to continue throughout Fiscal 2003. Net Sales of $536.5 million, which include the sale of copier/printer equipment, supplies and technology hardware, declined by 10.4% from the third quarter of Fiscal 2002. This comparison was affected by the de-emphasis on technology hardware, which declined by approximately $31 million, for a Net Sales decline without technology hardware of 5.7%. Supplies declined 4% from the prior year and copier/printer equipment revenues declined by 6.2% from the same period a year ago. Equipment revenues were impacted by an increase in vendor backorders of approximately $14 million over the two year quarterly average, continued delays in customer purchasing decisions, and lower average selling prices. Lower average selling prices stem from new technologies launched during the quarter at lower price points than former alternatives as well as the mix of products sold during the quarter when compared to the prior year. These pricing shifts were partially offset by increased placements in the third quarter, which the Company believes will serve as a facilitator for future equipment service, outsourcing, supplies, and financing revenue opportunities. Gross profit margin on Net Sales declined to 32.6% for the third quarter of Fiscal 2003 from 34.7% in the prior year, largely due to additional adjustments to costs of $2.5 million and lower margins on copier/printer equipment sales as a result of pricing dynamics. Services, which include revenues from the servicing of copier/printer equipment, and outsourcing and other services, declined by 1.9% to $517.1 million from the third quarter of Fiscal 2002. The impact of businesses exited or downsized in Fiscal 2002 contributed to approximately $10 million of the decline, resulting in slight growth in Services excluding these actions. Approximately 55% of Services stem from revenues associated with the servicing of the Company's installed base of copier/printer equipment by more than 7,000 technicians throughout North America and Europe. Revenues from equipment service are closely linked to the number of copies IKON's customers generate on their copier/printer devices during a quarter, and for the third quarter copy volumes grew approximately 2% over the prior year, resulting in a moderate increase in equipment service revenues compared to the third quarter a year ago. Outsourcing and other services declined by 4% from the prior year, negatively impacted by the $10 million related to IKON's Fiscal 2002 downsizing and exit strategies. Excluding the $10 million decrease, outsourcing and other services revenues for the third quarter were essentially flat compared to the third quarter of the prior year. Gross profit margin on Services of 42.1% was consistent with the prior year of 42.2%, due to the benefits of the prior year's downsizing efforts and the ongoing productivity gains of the Company's equipment service operations. Finance Income grew 4.9% to $97.2 million from the third quarter of Fiscal 2002 due to continued growth in the lease portfolio in the U.S., Canada, and Europe as customers continue to utilize IKON's ability to offer captive lease financing. In the third quarter, approximately 80% of IKON's equipment revenues in the U.S. were financed through IOS Capital, IKON's largest leasing subsidiary. Portfolio quality at IOS Capital remains stable, with charge-offs and collections remaining at consistent levels. Gross profit margin from finance subsidiaries in the third quarter of Fiscal 2003 increased to 62.5% from 57.8% for the third quarter of the prior year, reflecting lower average borrowing costs as a result of market rate reductions and the Company's chosen mix of capital resources - primarily lease-backed notes - to support lease financing. Selling and Administrative expenses declined by 2.8% or $11.3 million from the third quarter of the prior year as the Company absorbed higher pension, health care, and e-IKON implementation expenses in Fiscal 2003. Softer market conditions for equipment sales in Fiscal 2003 have warranted a continued sequential reduction in Selling and Administrative expenses, which the Company achieved in its first two fiscal quarters. However, this rate of decline slowed this quarter due to a higher level of fixed selling expenses, severance costs and higher expenses associated with the e-IKON pilot. Balance Sheet and Liquidity During the quarter, IOS Capital continued to raise capital for its leasing operations. After completion of the following transactions in the quarter, IOS Capital's average cost of financing remains under 6% and minimum return on equity targets remain at 17%. On April 23, 2003, IKON Receivables Funding, LLC, a wholly owned subsidiary of IOS Capital, issued $852 million of equipment leased-backed notes with a weighted average interest rate of 2.58%. The notes are rated Aaa/AAA by Moody's and Standard and Poor's, respectively, and are insured by AMBAC Assurance Corporation. IOS Capital acts as servicer on the notes. On June 3, 2003, the Company commenced a tender offer for $240.5 million of IOS Capital's 9.75% notes due June 2004. Approximately 85.5%, or $205.6 million, of the notes were tendered and delivered to the trustee prior to June 30, 2003. Subsequently, funds were irrevocably deposited into an account with an escrow agent to cover the principal and interest due through maturity on the remaining $34.9 million of the 9.75% notes. These actions satisfied the early maturity provision contained in IKON's $300 million credit facility. As of June 30, 2003, there were no borrowings against the credit facility. On June 16, 2003, IOS Capital issued $350 million of 7.25% unsecured notes due 2008. The proceeds of this offering, which was raised from an initial amount of $250 million to $350 million, were used primarily to finance the above tender offer. In addition, during the third quarter IKON continued to improve its financial flexibility by repurchasing $83.5 million of non-finance subsidiary debt in the open market. As of June 30, 2003, the remaining non-finance subsidiary debt was $492 million, more than 80% of which matures in 2025 and beyond. The tender offer for IOS Capital's 9.75% notes, in addition to the repurchase of non-finance subsidiary debt during the quarter, resulted in a loss from the early extinguishment of debt of $27.5 million, or $.10 per diluted share, in the quarter. As of June 30, 2003, the Company had approximately $207 million in non-restricted cash on its balance sheet. Cash from operations for the first nine months of the fiscal year was approximately $125 million. For the full fiscal year, the Company expects Cash from Operations to be in the range of $310 million to $335 million, compared to the expected range of $365 million to $390 million previously communicated. Capital expenditures, consisting of operating rentals and property and equipment expenditures, net of proceeds, are expected to be approximately $85 million for Fiscal 2003 compared to prior expectations of $115 million. Fourth Quarter Earnings Outlook Fourth quarter earnings are expected to be in the range of $.15 to $.17 per diluted share on a revenue decline in the range of 4% to 5%. This range assumes similar trends in terms of pricing and demand for copier/printer equipment as experienced in the third quarter, and the historically sequential decline in equipment service as a result of the summer months. These expectations exclude any additional potential loss from the early extinguishment of debt that the Company may incur should the Company continue to repurchase non-finance subsidiary debt in the fourth quarter. Adjusted Financial Information Net income and earnings per diluted share in this earnings release are presented on an adjusted basis to exclude the impact of the loss from the early extinguishment of debt. Revenues are also presented on an adjusted basis to exclude the impact of downsizing and exit strategies commenced during the first quarter of Fiscal 2002. In addition, the Company's debt to capital ratio is presented excluding finance subsidiary debt. Management believes these presentations provide a reasonable basis on which to present adjusted financial information and ratios that provide investors with a useful indication of the performance of the Company's ongoing operations and financial strength. This adjusted financial information should not be construed as an alternative to our reported results determined in accordance with generally accepted accounting principles (GAAP). Further, our definition of this adjusted financial information may differ from similarly titled measures used by other companies.




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