Thursday July 26 -- MALVERN, Pa.-- IKON Office Solutions, the world's largest independent channel for document management systems and services, today reported results for the third quarter of fiscal 2007 ended June 30, 2007. For the third quarter, net income was $29 million, or $0.23 per diluted share, representing a 15% increase over the $0.20 in the third quarter of fiscal year 2006, and in line with the Company's previously communicated guidance of $0.22 to $0.24. After adjusting for $0.02 related to the loss on early extinguishment of debt in the third quarter of fiscal year 2006, earnings per diluted share increased 5% year over year.
Total revenue for the third quarter of fiscal year 2007 was $1.0 billion, flat year over year, including a 1% currency benefit. Selling and administrative expenses decreased $18 million year over year and represented 28.1% of revenue in the third quarter, in line with the Company's expense-to-revenue ratio goal of less than 29% for fiscal year 2007. The decrease in selling and administrative expenses was primarily driven by lower administrative expenses, including performance compensation, real estate, and other corporate expenses.
Operating income margin for the third quarter of fiscal year 2007 was $54 million or 5.1% of revenue, compared with $54 million or 5.2% for the third quarter of 2006. Operating income in the third quarter of last year included a $7 million gain related to the sale of the U.S. retained lease portfolio. The Company's effective tax rate for the quarter was 33%. The Company continues to anticipate that the tax rate for fiscal year 2007 will be less than 32%.
"We are encouraged by our earnings performance for the quarter. Our Managed and Professional Services business delivered strong results, Equipment revenue grew 1%, Europe continued its solid performance, and Customer Service revenue is beginning to stabilize," said Matthew J. Espe, IKON's Chairman and Chief Executive Officer.
Third Quarter Fiscal 2007 Financial Details
Equipment revenue of $448 million, which includes the sale of copier/printer multifunction products, increased 1% from the third quarter of fiscal year 2006. The year-over-year increase was driven by revenue growth in both the color office and color production segments and currency, offset by revenue declines in both the black and white office and black and white production segments. Gross margin on equipment decreased to 24.3% from 25.6% in the third quarter of fiscal year 2006 due to lower used equipment revenue, a mix shift to light black and white production devices, and a higher mix of large deals in the quarter.
Customer Service and Supplies revenue of $346 million, which includes revenue from the servicing of copier/printer equipment and direct sales of supplies, decreased 4% year over year, but was flat sequentially as Customer Service revenue begins to stabilize in line with the Company's expectations. Customer Service revenue declined year over year primarily due to lower revenue per page. The Company continues to expect that Customer Service and Supplies revenue in the second half of the fiscal year will decrease 1% to 2% from the first half of fiscal year 2007, driven by a seasonal decline from the third to the fourth quarter. Gross margin on Customer Service and Supplies decreased to 44.2% from 45.6% a year ago due to lower revenue partially offset by lower costs.
Managed and Professional Services revenue of $203 million increased 9% compared to the third quarter of fiscal year 2006. Revenue grew in all three service areas. On-site Managed Services revenue, which represents approximately two-thirds of total Managed and Professional Services, increased 7% year over year, off-site Managed Services increased 8% year over year, and Professional Services grew 22% year over year. Gross margin on Managed and Professional Services increased to 27.8% from 25.1% a year ago due to improvements in on-site Managed Services contract profitability, higher off-site Managed Services revenue on a relatively fixed cost base, and significantly improved profitability in European Professional Services.
Rental and Fees revenue of $32 million declined 6% year over year due to lower rental revenue, and gross margin decreased approximately one point to 74%. Other revenue of $16 million declined 14% compared to the third quarter of fiscal year 2006 primarily due to the loss of a contract in the European technology services business.
Balance Sheet and Liquidity
The Company's cash balance was $287 million as of June 30, 2007, and the Company's debt-to-capital ratio remained stable from the prior quarter at 32%. Cash generated by operations totaled $9 million for the first nine months of fiscal year 2007, compared to a cash usage of $28 million for the first nine months of last year. The cash generated in the first nine months of the year was impacted by a $97 million increase in inventory. The Company expects fiscal year-end 2007 inventory to range from $275 million to $295 million, compared to $315 million at June 30, 2007 and $282 million at June 30, 2006. Capital expenditures on operating rentals and property and equipment, net of proceeds, totaled $33 million for the first nine months, compared to $35 million for the first nine months of fiscal year 2006. Free cash flow was a negative $23 million for the first nine months of the year compared to a negative free cash flow of $63 million in the first nine months last year. The Company expects free cash flow to range between $80 million and $110 million for fiscal year 2007. For the fourth quarter, the Company anticipates working capital improvements to generate between $70 million and $100 million of cash.
For the third quarter, fully diluted weighted average shares were 127 million. At the end of the quarter, actual shares outstanding were 123 million, a reduction of 6% year over year, driven by the Company's ongoing share repurchase program. The Company purchased 3 million shares for $44 million during the third quarter.
Year to date the Company has returned $115 million to its shareholders through $100 million in share repurchases and $15 million in dividend payments, which was funded with cash from the balance sheet. For the fourth quarter, the Company expects to spend $40 to $50 million on share repurchases. Cumulatively through June 30, 2007, the Company has purchased 22% of the shares outstanding as of March 31, 2004. Since the Company initiated its share repurchase program three years ago, it has repurchased a total of 32 million shares for $395 million, and also eliminated its convertible debt, avoiding a potential conversion into 20 million shares of common stock.
IKON's Board of Directors also approved the Company's regular quarterly cash dividend of $0.04 per common share, payable on September 10, 2007 to holders of record at the close of business on August 27, 2007.
Outlook
"In the third quarter, we added over 100 selling resources in the field, including 17 Graphic Arts Specialists who will be focused on selling color production equipment, such as the Canon imagePRESS C1, Canon's portfolio of wide format products, and the Canon imagePRESS C7000VP which we've begun shipping to customers," said Espe. "We remain committed to our action plans to grow revenue, including driving color placements to increase our color page volume mix.
"Looking ahead to the fourth quarter of fiscal 2007, we expect earnings per fully diluted share to be approximately $0.22. Our expectations for fiscal year 2007 are to deliver an operating income margin of approximately 5%, up from the prior year, and earnings per fully diluted share of approximately $0.90."