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Danka Posts Loss in Q1; Operating Earnings Down $10 Million

Press release from the issuing company

ST. PETERSBURG, Fla.--Aug. 5, 2003-- Danka Business Systems PLC today announced results for the first quarter of fiscal year 2004 ended June 30, 2003. First Quarter Results Danka reported operating earnings of $5.0 million in the first quarter of fiscal year 2004 compared to operating earnings of $15.0 million in the comparable year-ago quarter. The company's net loss for the first quarter was $0.8 million, compared to net earnings of $5.8 million in the year-ago quarter. After allowing for the dilutive effect of dividends and accretion on participating shares, Danka posted a loss in the first quarter of $.09 per basic and diluted American Depositary Share (ADS) compared to earnings of $.02 per basic and diluted ADS in the year-ago quarter. Total revenues were $333.8 million in the first quarter of fiscal year 2004, a decline of $13.3 million or 3.8% from the $347.1 million posted in the year-ago quarter. The decline in total revenues during the quarter was partially offset by a $26.5 million foreign currency benefit. Excluding the impact of foreign currency gains, total revenues would have been $307.3 million, an 11.4% decrease from the year-ago quarter. Revenues continue to be affected by increasingly competitive economic and market conditions, especially in the United States, technology convergence and the global slowdown in capital spending. Retail equipment and related revenues were $112.8 million in the first quarter, a 2.4% increase from the year-ago quarter. This increase was primarily due to increased revenues in the European business, which was the result of foreign currency gains of $7.1 million in the first quarter. Retail service revenues were down 7.4% from the year-ago quarter to $165.9 million. This decline was due to the continuing industry-wide conversion from analog-to-digital equipment which was offset, in part, by a $12.0 million foreign currency gain. Retail supply and rental revenues were $31.8 million during the first quarter, a 14.1% decrease from the year-ago quarter, primarily due to the downsizing of the U.S. rental business. Wholesale revenues were $23.2 million during the first quarter, a 12.1% increase from the year-ago quarter, primarily due to a $4.5 million foreign currency gain. Total gross margins decreased to 36.7% in the first quarter from 38.6% in the year-ago quarter. Total United States gross margins declined to 40.3%, from 44.1% in the year-ago quarter while European gross margins were relatively flat at 32.3% and International gross margins increased to 37.5% from 30.7% in the year-ago quarter. The retail equipment and related sales margin decreased to 30.7% in the first quarter from 35.4% in the year-ago quarter primarily due to lower margins in the U.S. business. The first quarter retail equipment and related sales revenue gross margin was negatively impacted by a $3.5 million decrease in lease and residual payments from a diminishing external lease funding program which contributed $4.5 million to gross margin in the year-ago quarter. Gross margins for service decreased slightly to 41.9% from 42.0%. The European wholesale gross margins increased to 20.0% from 18.3%. "We saw continued progress in mitigating the decline in our revenues in certain key aspects of our business; however, we experienced a decline in our gross margins, almost exclusively in the U.S. equipment and related sales area," said Lang Lowrey, Danka's Chairman and Chief Executive Officer. "Some of this decline can be attributed to a larger than expected shift in the mix of our sales toward lower margin, large enterprise accounts. Additionally, toward the end of the quarter, we were affected by changing market conditions in our industry, which appear to now be dictating lower average sales prices in certain segments of our equipment portfolio. "On the positive side, we did see stabilizing trends in the performance in our retail equipment and related business, continued positive trends in our service annuity business and a turnaround in our International business, which contributed measurable, positive results for the first time in several quarters." Overall, SG&A expenses in the first quarter decreased by $1.0 million or 0.9% to $118.5 million from $119.5 million in the year-ago quarter. This decrease was offset, in part, by a positive foreign currency movement of $7.2 million. During the quarter, the Company incurred approximately $3.2 million in Vision 21 and ancillary expenses as well as almost $650,000 in expenditures related to the new corporate headquarters building. As a percentage of revenue, SG&A costs increased to 35.5% from 34.4%. "We continue to be challenged with a cost structure which is too high," stated Lowrey. "Our ability to reduce SG&A costs will be instrumental to our achieving acceptable financial results for the balance of this year. Realization of a large measure of cost savings requires us to continue making significant expenditures on our Vision 21, Oracle 11i ERP system and its related, ancillary cost which we do not expect to continue in the second half of the year. We currently expect that we can complete our implementation during our third fiscal quarter, which will allow us to continue the transition away from the expensive manual operation of our outdated legacy systems and processes. The efficiencies we expect to achieve from a single, integrated ERP system, coupled with the anticipated decline in ancillary expenses, should provide a significant SG&A opportunity, particularly in the second half of the fiscal year." Net cash provided by operating activities during the quarter was approximately $0.9 million compared to $34.2 million in the prior year. Free cash flow (defined as net cash provided by operating activities, less capital expenditures, plus proceeds from the sale of property and equipment) was ($13.7) million during the year compared to $25.7 million in the prior year. (See reconciliation to GAAP at page 9). Total capital expenditures in the first quarter were $14.8 million compared to $8.6 million in the prior year. Total capital expenditures during the quarter related to the Vision 21 project and the new corporate headquarters building were $6.5 million and $1.1 million, respectively. In addition, inventories increased by $2.9 million and the Company reduced accounts payable by $17 million during the quarter. "We expect to improve our working capital performance during the second quarter," stated Mark Wolfinger, Danka's Chief Financial Officer. "Cash generation and management of working capital has been the cornerstone of our balance sheet improvements over the past two years. During the quarter we incurred significant, necessary capital expenditures on Vision 21 and on the consolidation out of our expensive, inefficient corporate campus buildings into our new corporate headquarters building. We are very focused on the investments in working capital that occurred this quarter and expect improvement in this area during the second quarter, which is our slowest quarter seasonally, and during which we will continue to have significant expenses on Vision 21 and our corporate campus consolidation." On July 1, 2003, the Company closed the offering of $175 million in new 11% senior unsecured notes due 2010 and a $50 million senior secured revolving credit facility. The company used a portion of the net proceeds from the new senior notes to repay the remaining $107.1 million of outstanding indebtedness under its existing bank credit facility. The Company will also use a portion of such net proceeds to redeem its $47.6 million of zero coupon senior subordinated notes due April 1, 2004. The Company has issued notice to holders of its zero coupon notes that it will redeem the notes at their par value on or about August 18, 2003. "The refinancing was clearly a bright spot for the quarter, and is the culmination of years of management effort to provide long term financing for the Company," said Wolfinger. "In the process, we have lowered our overall cost of capital and significantly extended the maturities of a large portion of our capital structure. We believe this refinancing has solidified the financial position of the Company and will allow our management team to focus on executing our business and process improvement plans. For the past several years we have been operating under a credit facility which was extremely expensive, and contained very onerous financial covenants, which often hampered our ability to exploit new opportunities," concluded Wolfinger. The senior notes have a fixed annual interest rate of 11%, and an 11.5% yield to maturity. The new senior credit facility will bear interest at a range of between 1.75% and 2.5% over LIBOR, depending on the amount of borrowings outstanding. Because the refinancing closed on July 1, 2003, unamortized debt issuance costs, anniversary fees and amendment fees of $20.6 million relating to the prior credit facility at June 30, 2003 will be charged to pre-tax earnings in the quarter ending September 30, 2003. The Company resumed the rollout of its Oracle 11i, ERP system to the remainder of its U.S. business on August 1, 2003. The Company had halted further geographical rollouts over the past six months to focus on adding needed system functionality and to adequately address certain issues such as systems performance and data conversion, and to focus on key areas of needed improvement. The Company had previously implemented the system to approximately one-third of its U.S. business. The August 1 rollout will convert an additional 15% of the Company's U.S. business, bringing the total conversion to approximately fifty percent. The Company currently expects to complete the final two phases of the rollout by Fall of this year, on budget, as previously announced. Danka's Chief Information Officer, Gene Hatcher, commented: "I am pleased that we have met the necessary requirements to continue with the rollout. We learned a great deal from the problems encountered in the first one-third of our rollout and have improved the integration and communication between our corporate IT and U.S. business units. As a result, we have been able to develop functionality to support our improved business processes. We believe these efforts have set the stage for the substantial completion of our U.S. implementation by this fall." "While we are disappointed with our first quarter financial results, we saw progress in the mitigation of our past revenue declines in certain aspects of our business, encouraging signs in our service business and progress with our Oracle implementation," stated Lowrey. "Toward the end of the quarter, however, we encountered increasingly competitive market conditions which placed downward pressure on sales and margins, particularly in the U.S. field sales force. Our ability to successfully respond and improve sales and margin performance in light of these industry conditions, better manage our working capital, timely complete our Oracle rollout, realize capital spending reductions and cost savings from the new IT system and move to our new headquarters building remain the most significant factors to achieving our financial forecast for the fiscal year," concluded Lowrey.