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IKON Q1 Results; Performance was disappointing

Friday, January 25, 2008

Press release from the issuing company

January 24, 2008 -- MALVERN, Pa. -- IKON Office Solutions, the world’s largest independent channel for document management systems and services, today reported results for the first quarter of fiscal 2008, which ended December 31, 2007. Earnings per diluted share were $0.17, excluding a $7 million pre-tax restructuring charge, or $0.04 per diluted share. Excluding the charge, earnings per diluted share were within the Company’s revised outlook of $0.15 to $0.17 provided on January 10, 2008. As reported, net income was $15 million, or $0.13 per diluted share for the first quarter of fiscal 2008. For the first quarter of fiscal 2007, the Company’s net income was $27 million, or $0.21 per diluted share.

Total revenue for the first quarter of fiscal 2008 was $998 million, representing a 1 percent decline year over year, including 2 points of currency benefit. Selling and administrative expenses increased $7 million year over year to $295 million, primarily due to currency and, to a lesser extent, the Company’s investment in selling resources in the latter part of fiscal 2007. Selling and administrative expenses were 29.6 percent of revenue in the first quarter of fiscal 2008 versus 28.6 percent in the first quarter last fiscal year. In addition, the Company continued to advance its migration to One Platform in the U.S. by successfully completing its fifth migration. As a result, the Company is on track to complete the last remaining migration in the third quarter of fiscal 2008.

Operating income for the first quarter of fiscal 2008 was $38 million, or 3.8 percent of revenue, including the $7 million restructuring charge. In the first quarter of fiscal 2007, operating income was $49 million, or 4.9 percent of revenue. The Company’s effective tax rate for the quarter was 44 percent, which was negatively impacted by a change in the corporate tax rate in Canada that resulted in a $2.4 million one-time, non-cash revaluation of the Company’s Canadian deferred tax asset.

“Our first quarter financial performance was disappointing,” said IKON Chairman and Chief Executive Officer Matthew J. Espe. “Two key factors drove our results. The primary driver was lower-than-expected Equipment revenue in North America, but our earnings were also impacted by a higher-than-anticipated tax rate.

“We believe our first quarter performance included IKON-specific issues that have been and will be corrected. As a result, we have taken several steps to improve Equipment revenue. In addition, we are taking immediate actions that are expected to reduce our cost and expense structure by $25 million this fiscal year.”

First Quarter Fiscal 2008 Financial Details

Equipment revenue of $393 million, which includes the sale of copier/printer multifunction products, declined 6 percent from the first quarter of fiscal 2007. This performance reflects fewer large transactions as a result of customers delaying their buying decisions, as well as lower-than-expected sales productivity and a quarter-end IT systems outage. The equipment results were driven primarily by lower revenues in the black and white office and production segments of 14 and 16 percent, respectively, and, to a lesser extent, the color office segment, partially offset by a 39 percent increase in the color production segment and currency. Gross margin on Equipment increased to 25.9 percent from 25.0 percent, reflecting a 150 basis point benefit from a significant vendor rebate on a large equipment purchase in the quarter, partially offset by pricing pressures.

Customer Service and Supplies revenue of $350 million, which includes revenue from the servicing of copier/printer equipment and direct sales of supplies, grew 1 percent year over year, reflecting strong performance in Europe and a currency benefit of 2 points. Sequentially, Customer Service and Supplies revenues reflect continued stabilization in North America. For the year, the Company now expects Customer Service and Supplies revenue to be essentially flat year over year. In North America, Customer Service revenue continued to be driven by lower total page volume. Within total page volume, declining pages from analog and black and white devices were partially offset by strong page growth from color devices. Gross margin on Customer Service and Supplies was 43.4 percent in the first quarter of fiscal 2008 compared with 43.9 percent in the first quarter of fiscal 2007, reflecting slightly higher costs.

Managed and Professional Services revenue of $206 million increased 7 percent year over year. On-site Managed Services revenue, which represents approximately two-thirds of total Managed and Professional Services, increased 10 percent; Professional Services grew 9 percent; and Off-site Managed Services declined 3 percent. Gross margin on Managed and Professional Services increased to 27.6 percent from 26.0 percent a year ago primarily due to improved contract profitability in On-site Managed Services and improved Professional Services margin.

Rental and Fees revenue of $31 million declined 13 percent year over year, reflecting lower fees received from GE due to the change in the GE lease program agreement last year and the impact of lower Equipment revenue. Gross margin improved to 75.1 percent from 72.0 percent in the prior year. Other revenue of $18 million grew 2 percent and gross margin was 33.1 percent.

Cost and Expense Reduction Plan

In the first quarter, the Company incurred a $7 million pre-tax restructuring charge, or $0.04 per diluted share, as a result of actions the Company is taking to reduce cost and expense, which when combined with other actions will reduce headcount by approximately 350. The majority of the reductions will affect non-sales related functions. In addition, the Company is reducing executive bonuses to reflect management’s disappointment with the first quarter results and accelerating its ongoing efforts to reduce spending. The Company expects these actions to yield approximately $25 million in savings in fiscal 2008 and to improve the operating income run rate, particularly in the second half of the fiscal year.

Tender Offer Results and Share Repurchase Plan

In November 2007, the Company announced its intention to repurchase $500 million of its common stock. As part of that plan, the Company completed a $295 million modified Dutch auction self-tender offer in December, purchasing 22.69 million shares. The repurchased shares represented 19.6 percent of shares outstanding as of November 27, 2007. The tender offer was financed with cash and $150 million of new notes.

In addition, the Company repurchased $20 million of its common stock in the open market, bringing total repurchases to $315 million in the first quarter.

The Company plans to complete the balance of the $500 million share repurchase plan announced in November 2007. The plan, rate and timing of any share repurchases remain subject to financing and market conditions, as well as applicable regulations. The Company currently has little remaining share repurchase capacity under the terms of its 2015 and 2012 Notes, and $315 million remaining under its Board authorization. Execution of the balance of the share repurchase plan is expected to result in a one-time cash and pre-tax charge of $60 to $70 million to refinance the 2015 and 2012 Notes and complete other related transactions.

Balance Sheet and Liquidity

During the first quarter, the Company’s cash balance declined to $142 million, corporate debt increased to $746 million and shareholders’ equity declined to $1.4 billion, primarily due to the $315 million of share repurchases in the quarter. The Company’s inventory was $357 million at December 31, 2007, up from $288 million at September 30, 2007, substantially due to a large equipment purchase to take advantage of certain vendor rebates in the quarter. The Company anticipates it will sell the vast majority of this incremental inventory in the second quarter.

In the first quarter, the Company used $16 million of cash from operations, compared to an $8 million usage in the first quarter of fiscal 2007. The Company typically uses cash in its first fiscal quarter due to annual bonus payments. Capital expenditures on operating rentals and property and equipment, net of proceeds, totaled $10 million in the first quarter of fiscal 2008, compared with $9 million in the prior-year quarter. As a result, free cash flow was a usage of $26 million in the quarter, versus a usage of $18 million in the prior-year quarter.

For the first quarter of fiscal 2008, fully diluted weighted average shares were 115 million. At December 31, 2007, actual shares outstanding were 93 million, a reduction of 26 percent year over year, driven by the Company’s share repurchase program.

In the first quarter, the Company paid $5 million in dividends to shareholders. In January, IKON’s Board of Directors approved the Company’s regular quarterly cash dividend of $0.04 per common share, payable on March 10, 2008 to holders of record at the close of business on February 19, 2008.

Outlook

For fiscal 2008, the Company expects revenue to be flat year over year. This expectation reflects an improving year-over-year Equipment trend, essentially flat Customer Service & Supplies, and continued growth in Managed & Professional Services. The Company expects its expense-to-revenue ratio and operating income margin to be approximately 28 and 5 percent, respectively, and its tax rate to be less than 33 percent. The Company expects fully diluted weighted average shares will average 96 million over the remaining three quarters of fiscal 2008. For the full fiscal year 2008, the Company anticipates fully diluted weighted average shares will be about 101 million.

For fiscal 2008, the Company expects earnings per diluted share to range from $0.92 to $0.98, excluding the restructuring charge taken in the first quarter. As reported, the Company expects diluted earnings per share to range from $0.88 to $0.94. In addition, free cash flow is expected to range from $80 to $110 million.

For the second quarter of fiscal 2008, the Company expects earnings per diluted share to range from $0.16 to $0.19 and its tax rate to range from 34 to 36 percent. The significantly higher earnings projection in the second half of fiscal 2008 is primarily due to the benefits of the Company's cost and expense reductions, and a substantially lower tax rate in the second half of the fiscal year.

“We have already taken several actions to improve revenue growth, lower selling and administrative expenses and improve our operating income margin,” said Espe. “While we are disappointed with our first quarter North American Equipment revenue performance, I am pleased that the rest of our business is healthy and performing as expected.”

The aforementioned outlook is based on the Company’s capital structure as of December 31, 2007, and excludes the impact of any additional actions it may take to improve results.

 

 

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