ITEM 1. BUSINESS
GENERAL
IKON Capital, Inc. ("IKON Capital" or the "Company") formerly known as Alco Capital Resource, Inc., was formed in 1987 to provide lease financing to customers of IKON Office Solutions, Inc. ("IKON"). The Company's offices are located at 1738 Bass Road, Macon, Georgia, 31210 (telephone number 912-471- 2300). The Company is a wholly-owned subsidiary of IKON.
IKON is a public company headquartered in Malvern, Pennsylvania. On June 19, 1996, IKON announced that it would split its two operating units into independent companies by spinning off its paper products and supply systems distribution group, Unisource Worldwide Inc., as a separate publicly owned company effective December 31, 1996. Continuing operations of IKON consist of the largest network of independent copier and office equipment marketplaces in North America and the United Kingdom, with locations in 50 states, eight Canadian provinces, in Europe and in Mexico. IKON also provides equipment services and supplies, outsourcing and imaging services, such as mailroom and copy center management, specialized document copying services and electronic imaging and file conversion. IKON also offers network consulting and design, hardware and software product interfaces, computer networking, technology training and software solutions for the networked office environment. IKON's fiscal 1997 revenues from continuing operations were $5.1 billion.
The Company is engaged in the business of arranging lease financing exclusively for office equipment marketed by IKON's office equipment marketplaces ("IKON marketplaces"), which sell and service copier equipment and facsimile machines. The ability to offer lease financing on this equipment through IKON Capital is considered a competitive marketing advantage which more closely ties IKON to its customer base. During the 1997 fiscal year, 69% of new equipment sold by IKON marketplaces was financed through the Company. The Company and IKON will seek to increase this percentage in the future, as leasing enhances the overall profit margin on equipment and is considered an important customer retention strategy.
The equipment financed by the Company consists of copiers, facsimile machines, and related accessories and peripheral equipment, the majority of which are produced by major office equipment manufacturers including Canon, Oce, Ricoh, and Sharp. Currently 74% of the equipment financed by the Company represents copiers, 17% fax machines, and 9% other equipment. Although equipment models vary, IKON is increasingly focusing its marketing efforts on the sale of higher segment equipment, such as copiers which produce 50 or more impressions per minute.
The Company provides IKON with standard lease rates for use in customer quotes. However, IKON marketplaces may charge the customer more or less than IKON Capital's standard rates, and the IKON marketplace would absorb any difference resulting from any such variances from IKON Capital's standard rates.
The Company's customer base (which consists of the end users of the equipment) is widely dispersed, with the ten largest customers representing less than 2% of the Company's total lease portfolio. The typical new lease financed by the Company averages $17,000 in amount and 45 months in duration. Although 97% of the leases are scheduled for regular monthly payments, customers are also offered quarterly, semi-annual, and other customized payment terms. In connection with its leasing activities, the Company performs billing, collection, property and sales tax filings, and provides quotes on equipment upgrades and lease-end notification. The Company also provides certain financial reporting services to the IKON marketplaces, such as a monthly report of marketplace increases in leasing activity and related statistics.
IKON and the Company were previously parties to the 1994 Support Agreement, pursuant to which IKON agreed to make payments to the Company, if necessary, to enable the Company to maintain (i) a ratio of income before interest expense and taxes to interest expense of 1.25 times and (ii) a minimum consolidated tangible net worth of $1.00 at all times. On October 22, 1996, IKON and the Company replaced the 1994 Support Agreement
with a new support agreement (the "1996 Support Agreement"). The 1996 Support Agreement is identical to the 1994 Support Agreement except that the 1996 Support Agreement requires 100% ownership of the Company by IKON, limits the leverage of debt to equity to a maximum of 6 to 1, and requires that IKON obtain the consent of two-thirds of the debtholders as a condition to assignment (see "Relationship with IKON Office Solutions"). In addition, the Company and IKON are currently parties to a maintenance agreement dated August 15, 1991 (the "1991 Maintenance Agreement") and an operating agreement dated August 15, 1991 (the "1991 Operating Agreement"), (collectively, the "1991 Maintenance and Operating Agreements") which require IKON to make payments to the Company, if necessary, to meet a specified minimum fixed charge coverage ratio and a maximum debt-to-equity ratio. In addition, the 1991 Operating Agreement requires the IKON marketplaces to repurchase all defaulted lease contracts.
The Company has agreed not to amend the 1991 Maintenance and Operating Agreements without the consent of certain lenders under loan agreements scheduled to expire no later than August 1998. In September 1998, the Company and IKON intend to terminate the 1991 Maintenance and Operating Agreements. Although the IKON marketplaces are not subject to a repurchase obligation under the terms of the 1996 Support Agreement (as they are under the 1991 Operating Agreement), IKON and the Company presently intend to continue such repurchase practice. (See "Relationship with IKON Office Solutions" below).
TYPES OF LEASES
The lease portfolio of the Company includes direct financing leases and funded leases. Direct financing leases are contractual obligations between the Company and the IKON customer and represent the majority of the Company's lease portfolio. Funded leases are contractual obligations between the IKON marketplace and the IKON customer which have been financed by the Company.
Funded leases represented approximately 26% of the Company's leases as of September 30, 1997. The IKON marketplaces have assigned to the Company, with full recourse, their rights under the underlying contracts including the right to receive lease and rental payments as well as a security interest in the related equipment.
Direct financing leases and funded leases are structured as either tax leases (from the Company's perspective) or conditional sales contracts, depending on the customer's (or, for funded leases, the IKON marketplace's) needs. The customer (or the IKON marketplace for funded leases) decides which of the two structures is desired. Under either structure, the total cost of the equipment to the customer (or to the IKON marketplace) is substantially the same (assuming the exercise of the purchase option).
Tax Leases
Tax leases represented 96% of the Company's total lease portfolio as of September 30, 1997. The Company or the IKON marketplace is considered to be the owner of the equipment for tax purposes during the life of these leases and receives the tax benefit associated with equipment depreciation. Tax leases are structured with a fair market value purchase option. Generally, the customer may return the equipment, continue to rent the equipment or purchase the equipment for its fair market value at the end of the lease.
Each tax lease has a stated equipment residual value generally ranging from 0% to 25% of retail price, depending on model and term. As of September 30, 1997, the average equipment residual value for all leases in the Company's portfolio was 6.8%. Upon early termination of the lease or at the normal end of the lease term, the Company charges the IKON marketplace for the stated residual position, if any, and the equipment is returned to the IKON marketplace. Any gain or loss on the equipment's residual value is realized by the IKON marketplace.
Conditional Sales Contracts
Conditional sales contracts account for the remaining 4% of the total leases in the Company's portfolio. Under these arrangements, the customer is considered to be the owner of the equipment for tax purposes and
would receive any tax benefit associated with equipment depreciation. Each conditional sales contract has a stated residual value of 0%. Conditional sales contracts are customarily structured with higher monthly lease payments than the tax leases and have a $1 purchase option for the equipment at lease- end. Thus, because of the higher monthly payments, the after-tax cost of the equipment to the customer (or, for funded leases, to the IKON marketplace) under a conditional sales contract is substantially the same as under a tax lease (assuming the exercise of the purchase option). Although the customer has the option of returning or continuing to rent the equipment at lease-end, the customer almost always exercises the $1 purchase option at the end of the lease term.
Leased Equipment
The Company also offers from time to time financing of the cost of office equipment that the IKON marketplaces maintain in inventory for short-term rental to customers. This category of leased equipment also includes equipment currently rented to customers where the rental agreements are considered to be cancelable by the customer, based on the terms and conditions of the rental contracts in effect. Under operating guidelines in effect, any equipment not physically on rental to customers for a period exceeding 120 continuous days must be repurchased by the IKON marketplaces at its current book value.
RELATIONSHIP WITH IKON OFFICE SOLUTIONS, INC.
The Company, as the captive finance subsidiary of IKON, derives its customer base from the business sourced by its affiliates within IKON. There are several agreements and programs between the Company and IKON, which are described below.
Support Agreements
The Company and IKON are parties to an agreement (the "1996 Support Agreement") dated as of October 22, 1996. The Company's agreements with noteholders and other lenders generally include covenants that it will not amend the 1996 Support Agreement except under certain circumstances. (See "1996 Support Agreement", below).
The Company and IKON were previously parties to the 1994 Support Agreement, dated as of June 1, 1994, which contained terms identical to those contained in the 1996 Support Agreement, except that the 1994 Support Agreement did not contain the requirement that IKON maintain 100% of ownership of the Company, did not limit the leverage of debt to equity to a maximum of 6 to 1, and did not contain the requirement that IKON obtain the consent of two-thirds of the debtholders as a condition to assignment. Except for these three new requirements, which are included in the 1996 Support Agreement, all of the other provisions of the 1996 Support Agreement, described below, are identical to those previously included in the 1994 Support Agreement. The 1994 Support Agreement was replaced by the 1996 Support Agreement after the Company obtained in writing from Moody's Investors Services and Standard & Poor's Rating Group confirmation that the Company's debt rating would not be downgraded as a result of the foregoing new requirements.
The Company and IKON are also parties to a Maintenance Agreement dated August 15, 1991 and an Operating Agreement dated August 15, 1991 (the "1991 Maintenance and Operating Agreements"), which are further described below. The Company has generally agreed with its lenders pursuant to loan agreements entered into before June 1, 1994 that it will not amend the 1991 Maintenance and Operating Agreements without each such lender's consent. The remaining loan agreement will mature in August 1998, at which time the Company and IKON intend to terminate the 1991 Maintenance and Operating Agreements.
1. THE 1996 SUPPORT AGREEMENT
The 1996 Support Agreement between the Company and IKON provides that IKON will make a cash payment to the Company (or an investment in the form of equity or subordinated notes) as needed to comply with two requirements: i) that the Company will maintain a pre-tax interest coverage ratio (income before interest
expense and taxes divided by interest expense) so that the Company's pre-tax income plus interest expense will not be less than 1.25 times interest expense, and ii) that the Company will maintain a minimum tangible net worth of $1.00. The agreement also provides that IKON will maintain 100% direct or indirect ownership of the Company.
Pursuant to the indentures and other documentation governing debt incurred after June 1, 1994, the Company is not permitted to amend or terminate the 1996 Support Agreement unless: (a) all of the outstanding debt of the Company is repaid, or (b) approval of two-thirds of the debtholders (not including IKON, the Company, or their affiliates) for all amounts outstanding covered by the 1996 Support Agreement (generally, all debt entered into after June 1, 1994) is obtained.
Unlike the 1991 Operating Agreement, which is further described below, the 1996 Support Agreement does not contain a requirement that the IKON marketplaces repurchase all defaulted lease contracts. The 1996 Support Agreement does not include the repurchase requirement because the Company and IKON wish to preserve the flexibility, on a prospective basis, to allow the credit risk for defaulted contracts to remain with the Company. In such event, the credit decision and reserves for defaulted contracts would become the responsibility of the Company. If the Company were responsible for the credit risk and costs associated with defaulted contracts, the Company would increase its current lease rates in order to offset these increased costs. Consequently, the Company believes that the impact of any future shift of the credit risk from the IKON marketplaces to the Company would not be material to the Company's future results of operations. The Company's (and IKON's) present intention, however, is to continue the repurchase arrangement with the IKON marketplaces as currently in effect.
2. THE 1991 MAINTENANCE AND OPERATING AGREEMENTS
The 1991 Maintenance Agreement provides that IKON will make a cash payment to the Company (or an investment in the form of equity or subordinated notes) as needed in amounts sufficient to meet a specified minimum fixed charge coverage ratio and a maximum debt-to-equity ratio. Earnings before fixed charges (primarily interest) must be at least 1.3 times fixed charges. The Company has satisfied this requirement independently without requiring payment or an investment from IKON. The Company's debt-to-equity ratio is limited to 6 to 1 according to the terms of the Maintenance Agreement. The Company must also maintain minimum tangible net worth of not less than $1.00.
Pursuant to the terms of the 1991 Maintenance Agreement, the Company received capital contributions from IKON of $32 million in 1997, $30 million in 1996 and $29 million in 1995.
The 1991 Operating Agreement requires the IKON marketplaces to repurchase all defaulted lease contracts. A default is defined in the 1991 Operating Agreement as any receivable which is past due for 120 days or is otherwise reasonably declared uncollectible by the Company. The repurchase amount is identified as the net book value of a lease on the default date.
The 1991 Maintenance and Operating Agreements provide for modification or amendment with both parties' consent and provide for cancellation by either party upon 90 days written notice. The Company has generally agreed with its lenders in loan agreements entered into prior to June 1, 1994, however, that it will not amend the 1991 Maintenance and Operating Agreements without each such lender's consent. The remaining loan agreement will mature in August 1998, at which time the Company and IKON intend to terminate the 1991 Maintenance and Operating Agreements.
Cash Management Program
The Company participates in IKON's domestic Cash Management program. Under this program, the Company has an account with IKON through which cash in excess of current operating requirements is temporarily placed on deposit. Similarly, amounts are periodically borrowed from IKON. Interest is paid (or
charged) by IKON on these amounts. The Company was in a net average deposit condition with IKON during 1997, 1996 and 1995 and earned interest income of approximately $5.4 million, $2.9 million and $1.5 million, respectively.
Management Fee
The Company is charged a management fee by IKON to cover certain corporate overhead expenses. These charges are included as general and administrative expenses in the Company's financial statements and amounted to $552,000 in each of fiscal years 1997, 1996 and 1995.
Federal Income Tax Allocation Agreement
IKON and the Company participate in a Federal Income Tax Allocation Agreement dated June 30, 1989, in which the Company consents to the filing of consolidated federal income tax returns with IKON. IKON agrees to collect from or pay to the Company its allocated share of any consolidated federal income tax liability or refund applicable to any period for which the Company is included in IKON's consolidated federal income tax return.
Interest on Income Tax Deferrals
The Company provides substantial tax benefits to IKON through the use of the installment sales method on equipment financed through the Company. Taxes deferred by IKON due to this tax treatment totaled a cumulative amount of approximately $349 million at the end of fiscal 1997. IKON pays the Company interest on the portion of these tax deferrals (approximately $219 million at the end of fiscal 1997) which arise from tax deferrals on intercompany sales. In fiscal years 1997, 1996 and 1995, interest was earned by the Company at a rate consistent with the Company's weighted average outside borrowing rate of interest. Under this method, the Company earned interest at an average rate of 6.6% in fiscal 1997 totaling $12.1 million, 6.8% in fiscal 1996 totaling $8.7 million and 6.7% in fiscal 1995 totaling $5.9 million.
Lease Bonus Program
The Company sponsored a lease bonus subsidy program which provided incentives to IKON marketplaces when IKON customers lease equipment from the Company. Effective October 1, 1996, the Company changed the focus of the bonus subsidy program to reimburse IKON for third party lease payoffs incurred when buying out the equipment leases of a competitor. Payments under this program can be reduced or eliminated at any time by joint agreement of the Company and IKON. During fiscal 1997, 1996 and 1995, bonus payments made to IKON marketplaces or IKON totaled $9.8 million, $6.9 million and $7.3 million, respectively.
Credit Policies and Loss Experience
Each IKON marketplace is responsible for developing and maintaining a formal credit policy that governs credit practices and procedures. In addition, the credit practices of the individual IKON marketplaces must be consistent with IKON's overall policies for leasing and credit approval.
The Company presently has full recourse to the IKON marketplace for any lease which becomes past due by 120 days or more. Excluding the effect of recoveries, the gross value of leases charged back to IKON marketplaces was $51.6 million in fiscal 1997, $29.9 million in fiscal 1996 and $20.9 million in fiscal 1995. For fiscal 1997, 1996 and 1995, the gross chargebacks represented 2.7%, 2.3% and 2.4%, respectively, of the average portfolio balances during the year.
Reserves for credit losses are maintained by the IKON marketplaces and IKON. On a monthly basis, the Company reports the respective net investment value of the lease portfolio to each IKON marketplace so the IKON marketplace can properly accrue the credit loss reserve balance. In accordance with IKON policy, each IKON marketplace must maintain aggregate reserves of at least 3% of the IKON marketplace's total portfolio
(including $275 million of net leases sold under an asset securitization agreement being serviced by the Company). Reserves maintained for fiscal 1997 and 1996, as a percentage of the leasing portfolio at fiscal year end, were 3.4% and 3.8%, respectively.
Delinquencies remained at a consistent level for fiscal 1997 and 1996. During this two-year period, accounts classified as current (less than 30 days past due) ranged from 85% to 89% of the total portfolio balance on a monthly basis. The aging of the Company's lease portfolio receivables at September 30, 1997 (excluding $275 million of net lease receivables sold under an asset securitization agreement being serviced by the Company) was as follows:
FUNDING
Prior to July 1994, the majority of the Company's debt funding was through privately placed term notes with banks and an insurance company. The Company follows a policy of matching the maturities of borrowed funds to the average life of the leases being financed in order to minimize the impact of interest rate changes on its operations. All notes carry terms of one to three years and are either at fixed interest rates or have had the interest rate fixed through interest rate swap contracts. (See Note 5 to the Company's Financial Statements on page hereof). Covenants in the note agreements entered into before July 1994 include a minimum fixed charge coverage requirement of 1.3 times fixed charges and a maximum debt-to-equity ratio of 6 to 1. Also, there is a covenant in each such note agreement which requires each lender's consent to any amendment to the 1991 Maintenance and Operating Agreements (see page 6 hereof for a description of the 1991 Maintenance and Operating Agreements). As of September 30, 1997, the amounts outstanding under these note agreements totaled $25 million.
Prior to July 1994, the only other funding sources for the Company were capital contributions and advances received from IKON. As of September 30, 1997, the Company's total shareholder's equity was $266.0 million, of which $144.4 million consisted of contributed capital.
Effective July 1, 1994, the Company commenced a medium term note program of $500 million which was fully subscribed as of July 1995. On June 30, 1995, the Company increased the amount available to be offered under this medium term note program by $1 billion and on May 21, 1997, the Company further increased the amount available by $2 billion. The program allows the Company to offer to the public from time to time medium term notes having an aggregate initial offering price not exceeding the total program amount. These notes are offered at varying maturities of nine months or more from their dates of issue and may be subject to redemption at the option of the Company, in whole or in part, prior to the maturity date in conjunction with meeting specified provisions. Interest rates are determined based on market conditions at the time of issuance. As of September 30, 1997, $1,542.3 million of medium term notes were outstanding with a weighted average interest rate of 6.6%.
The Company has entered into asset securitization agreements for $275 million of eligible direct financing lease receivables that expire in March 1998 ($125 million) and September 1998 ($150 million). The agreements contain limited recourse provisions which require the Company to assign an additional undivided interest in
leases to cover any potential losses to the purchaser due to uncollectible leases. As collections reduce previously sold interests, new leases can be sold up to the agreement amount. In fiscal 1997, the Company sold an additional $103.4 million in leases, replacing leases paid/collected during the year and recognized pretax gains of $2.6 million. Under the terms of the sales agreements, the Company will continue to service the lease portfolios sold.
EMPLOYEES
At September 30, 1997, the Company had approximately 261 employees. Employee relations are considered to be good.
PROPRIETARY MATTERS
Other than the "IKON Capital" trade name and service mark, the Company has no names, trademarks, trade names, or service marks which are used in the conduct of its business. The Company has been sued by a third party who has alledged that the Company's use of the name "IKON Capital" infringes on its proprietary rights. The parties are presently in settlement discussions and the Company believes that the lawsuit may be resolved shortly. The Company does not believe that the outcome of such settlement discussions (or a judicial determination adverse to the Company in a court of law) would have a material adverse effect on the Company's operations taken as a whole.
COMPETITION AND GOVERNMENT REGULATION
The finance business in which the Company is engaged is highly competitive. Competitors include leasing companies, commercial finance companies, commercial banks and other financial institutions.
The Company competes primarily on the basis of financing rates, customer convenience and quality customer service. IKON marketplaces offer financing by the Company at the time equipment is leased or sold to the customer, reducing the likelihood that the customer will contact outside funding sources. There is a communications network between the Company and the IKON marketplaces to allow prompt transmittal of customer and product information. Contract documentation is straightforward and clearly written, so that financings are completed quickly and to the customer's satisfaction. Finally, both the Company and the IKON marketplaces are firmly committed to providing excellent customer service over the duration of the contract.
Certain states have enacted retail installment sales or installment loan statutes relating to consumer credit, the terms of which vary from state to state. The Company does not generally extend consumer credit as defined in those statutes.
The financing activities of the Company are dependent upon sales or leases of office equipment by the IKON marketplaces, who are subject to substantial competition by both independent office equipment dealers and the direct sales forces of office equipment manufacturers. IKON is the largest network of independent copier and office equipment dealers in North America and in the United Kingdom. IKON marketplaces compete on the basis of price, quality of service and product performance.
ITEM 2.
ITEM 2. PROPERTIES
The Company's operations are located in Macon, Georgia and occupy approximately 70,000 square feet. In addition, IKON utilizes approximately 27,000 square feet in adjacent facilities owned by the Company for a corporate-wide data center and financial processing center. The Company uses its facility for normal operating activities such as lease processing, customer service, billing and collections. Certain specialized services (such as legal, accounting, treasury, tax and audit services) are also performed for the Company at IKON's corporate headquarters located in Malvern, Pennsylvania. The Company's facilities are deemed adequate by management to conduct the Company's business.
Any additional information called for by this item has been omitted pursuant to General Instruction J(2)(d).
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
A number of ordinary course legal proceedings are pending against the Company. However, there are no material pending legal proceedings to which the Company is a party (or to which any of its property is subject). To the Company's knowledge, no material legal proceedings are contemplated by governmental authorities against the Company or any of its properties.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No response to this item is required.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
All outstanding shares of the Company's common stock are currently owned by IKON Office Solutions, Inc. Therefore, there is no market for the Company's common stock. No dividends were paid in fiscal 1997, 1996 or 1995. The Company and IKON will, from time to time, determine the appropriate capitalization for the Company, which will, in part, affect any future payment of dividends to IKON or capital contributions to the Company.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The information called for by this item has been omitted pursuant to General Instruction J(2)(a).
ITEM 7.
ITEM 7. FINANCIAL INFORMATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Pursuant to General Instruction J(2)(a) of Form 10-K, the following analysis of the results of operations is presented in lieu of Management's Discussion and Analysis of Financial Condition and Results of Operations.
YEAR 2000 COSTS
In July 1996, the Emerging Issues Task Force of the Financial Accounting Standards Board reached a consensus on Issue 96-14, Accounting for the Costs Associated with Modifying Computer Software for the Year 2000, which provides that costs associated with modifying computer software for the year 2000 be expensed as incurred. The Company is assessing the extent of the necessary modifications to its computer software.
FISCAL 1997 COMPARED WITH FISCAL 1996
Comparative summarized results of operations for the fiscal years ended September 30, 1997 and 1996 are set forth in the table below. This table also shows the increase in the dollar amounts of major revenue and expense items between periods, as well as the related percentage change.
Revenues
Total revenues increased $63.2 million or 41.8% in fiscal 1997 from fiscal 1996. Approximately 78.1% or $49.4 million of this increase in revenues was a result of increased lease finance income due to growth in the portfolio of direct financing and funded leases. The lease portfolio, net of lease receivables that were sold in asset securitization transactions, increased 47.1% from September 30, 1996 to September 30, 1997.
Office equipment placed on rental by the IKON marketplaces to customers with cancelable terms may be purchased by the Company. During fiscal 1997 and 1996, IKON Capital purchased operating lease equipment of $48.5 million and $27.3 million, respectively. Operating leases contributed $24.0 million in rental income to total revenues during fiscal 1997 compared to $14.6 million in fiscal 1996.
The Company earns interest income on the deferred tax liabilities of the IKON marketplaces associated with leases funded through the Company at a rate consistent with the Company's weighted average outside borrowing rate of interest. The Company's average rate was 6.6% for fiscal 1997 compared to 6.8% for fiscal 1996. In addition, the deferred tax base upon which these payments are calculated increased 39.5% to $219 million at September 30, 1997 from $157 million at September 30, 1996. As a result of the increased deferred tax balances, net of the decrease in interest rates, interest income on deferred taxes rose $3.5 million or 39.8% when comparing fiscal 1997 to fiscal 1996.
Other income consists primarily of late payment charges and various billing fees. The structure of these fees has remained basically unchanged from fiscal 1996. The growth in other income from fees is primarily due to the increased size of the lease portfolio upon which these fees are based. Overall, fee income from these sources grew by $946,000 or 14.1%, when comparing fiscal 1997 to fiscal 1996.
Expenses
Average borrowings to finance the lease portfolio increased by 52.5%, to $1,416.9 million. The Company paid a weighted average interest rate on all borrowings for fiscal 1997 of 6.6% compared to 6.8% for fiscal 1996. As a result of increased borrowings and a decrease in the Company's overall weighted average interest rate, interest expense grew by $23.3 million or 38.6%, when comparing fiscal 1997 to fiscal 1996. At September 30, 1997, the Company's debt to equity ratio was 5.9 to 1.
During May 1997, the Company completed the filing of a medium term note registration in the amount of $2 billion, designed to meet the Company's anticipated portfolio funding needs into fiscal 1999. This new note program was structured similar to the original $500 million medium term note program that was filed in June 1994 and the $1 billion medium term note program that was filed in June 1995 which was used to meet the Company's portfolio funding needs during the period July 1994 to June 1997. The medium term note program allows for the issuance of medium term notes in the public markets with varying maturities of nine months or more from their dates of issuance, through four nationally recognized investment firms. At September 30, 1997, approximately $1.5 billion of medium term notes were outstanding under these programs with a weighted average interest rate of 6.6%, while approximately $1.6 billion remains available under this program.
At September 30, 1997, the Company had outstanding notes payable to banks of $25 million, with a weighted average rate of 6.6%, compared to $58 million at September 30, 1996.
Total general and administrative expenses grew by $19.9 million or 47.4%, when comparing fiscal 1997 to fiscal 1996. However, the general and administrative expense category for fiscal 1997 includes depreciation expense on leased equipment totaling $19.8 million compared to $13.4 million in fiscal 1996. In addition, lease bonus subsidy payments were approximately $2.9 million more in fiscal 1997 than in fiscal 1996. Excluding the effects of increased depreciation expense on operating leases and lease bonus subsidy payments, remaining general and administrative expenses grew approximately $10.5 million or 48.4%, when comparing fiscal 1997 to fiscal 1996. This increase is attributable to the growth in the lease portfolio.
Gain on Sale of Lease Receivables
The Company has asset securitization agreements for $275 million of eligible direct financing lease receivables that expire in March 1998 ($125 million) and September 1998 ($150 million). As collections reduce previously sold interests, new leases can be sold up to the agreement amount. During fiscal 1997, collections reduced previously sold interests by approximately $103.4 million on these two agreements. The Company sold an additional $103.4 million in net eligible direct financing leases during fiscal 1997 and recognized a pretax gain of $2.6 million.
Income Before Taxes
Income before taxes grew by $16.9 million or 30.9%, when comparing pretax earnings for fiscal 1997 to fiscal 1996. This increase in income before taxes was essentially the effect of higher earnings on a larger portfolio base, net of increased general and administrative expenses, partially offset by higher borrowing costs due to the increase in debt to fund the lease portfolio.
At the end of fiscal 1996, the Company entered into an additional $150 million asset securitization program and recognized a pretax gain on sale of approximately $4.5 million during fiscal 1996 in addition to the $1.2 million of 1996 pretax securitization gains related to the 1994 agreement. As mentioned above, securitization gains in fiscal 1997 were approximately $2.6 million on a pretax basis. Excluding the effect of the securitization gains from pretax income for both fiscal years 1997 and 1996, pretax income grew by $20.0 million or 40.9% in fiscal 1997 from fiscal 1996.
Provision for Income Taxes
Income taxes for fiscal 1997 increased by $5.8 million or 25.2% over fiscal 1996. The increase in income taxes is directly attributable to the increase in income before taxes in fiscal 1997 as compared to fiscal 1996. During fiscal 1997, the Company's effective income tax rate was 40.5%, as compared to 42.4% in fiscal 1996.
FISCAL 1996 COMPARED WITH FISCAL 1995
Comparative summarized results of operations for the fiscal years ended September 30, 1996 and 1995 are set forth in the table below. This table also shows the increase in the dollar amounts of major revenue and expense items between periods, as well as the related percentage change.
Revenues
Total revenues increased $57.0 million or 60.6% in fiscal 1996 from fiscal 1995. Approximately 78.3% or $44.6 million of this increase in revenues was a result of increased lease finance income due to growth in the portfolio of direct financing and funded leases. During the twelve-month period from September 30, 1995 to September 30, 1996, the portfolio grew at a 43.5% rate, net of lease receivables that were sold in asset securitization transactions.
In October 1994, the Company began offering an operating lease product to the IKON marketplaces whereby office equipment placed on rental to customers with cancelable terms may be purchased by the Company. In preceding years, this equipment was financed by the respective IKON marketplace instead of the leasing Company. During fiscal 1996 and 1995, the Company purchased operating lease equipment of $27.3 million and $33.6 million, respectively. Operating leases contributed $14.6 million in rental income during fiscal 1996 compared to $7.0 million in 1995. The increase in revenue is attributable to 1996 representing a full year of income on the rental assets.
In both fiscal 1996 and 1995, the Company earned interest income on the deferred taxes on the IKON marketplaces books resulting from leases funded through the Company at a rate consistent with the Company's weighted average outside borrowing rate of interest. The Company's average rate was 6.8% for fiscal 1996 compared to 6.7% for fiscal 1995. In addition, the deferred tax base upon which these payments are calculated increased 40.3% to $157 million at September 30, 1996 from $112 million at September 30, 1995. As a result of the increased deferred tax balances, interest income on deferred taxes rose $2.7 million or 46.2% when comparing fiscal 1996 to fiscal 1995.
Other income consists primarily of late payment charges and various billing fees. The structure of these fees has remained basically unchanged in fiscal 1996 from fiscal 1995. The growth in other income from fees is primarily due to the increased size of the lease portfolio upon which these fees are based. Overall, fee income from these sources grew by $2.1 million or 44.9%, when comparing fiscal 1996 to fiscal 1995.
Expenses
During fiscal 1996, average borrowings to finance the lease portfolio increased by 55.9%, to $929.1 million. The Company paid a weighted average interest rate on all borrowings for fiscal 1996 of 6.8% compared to 6.7% for fiscal 1995. Due to the combined effect of increased borrowings and an increase in the Company's overall weighted average interest rate, interest expense grew by $23.9 million or 65.5%, when comparing fiscal 1996 to fiscal 1995. At September 30, 1996, the Company's debt to equity ratio, including intercompany amounts owed to IKON, was 5.5 to 1.
During June 1995, the Company completed the filing of a medium term note registration in the amount of $1 billion, designed to meet the Company's anticipated portfolio funding needs into fiscal 1997. This new note program was structured similar to the original $500 million medium term note program that was filed in June 1994 which was used to meet the Company's portfolio funding needs during the period July 1994 to June 1995. The medium term note program allows for the issuance of medium term notes in the public markets with varying maturities of nine months or more from their dates of issuance, through four nationally recognized investment firms. At September 30, 1996, $969.9 million of medium term notes were outstanding under these two programs with a weighted average interest rate of 6.8%.
At September 30, 1996, the Company had outstanding notes payable to banks of $58 million, with a weighted average rate of 6.0%, compared to $173 million at September 30, 1995.
Total general and administrative expenses grew by $15.4 million or 57.8%, when comparing fiscal 1996 to fiscal 1995. However, the general and administrative expense category for fiscal 1996 includes depreciation expense on leased equipment totaling $13.4 million compared to $5.9 million in fiscal 1995. In addition, lease bonus subsidy payments to IKON marketplaces were approximately $425,000 less in fiscal 1996 than in fiscal 1995, due to a reduction in the bonus subsidy payout percentage.
Excluding the effects of the addition of approximately $7.5 million of depreciation expense on operating leases in fiscal 1996 over fiscal 1995 and the reduction of approximately $425,000 in lease bonus payments in fiscal 1996 from fiscal 1995, remaining general and administrative expenses grew approximately $8.3 million or 62.5%, when comparing fiscal 1996 to fiscal 1995. This increase includes $1.9 million in expenses related to new leasing software implemented in May 1996. Additionally, the Company developed a lease marketing network with costs of $1.0 million. After excluding these expenses, general and administrative expenses grew $5.4 million or 40.4%.
Gain on Sale of Lease Receivables
In September 1996, the Company entered into an asset securitization transaction whereby the Company sold an undivided ownership interest in an additional $150 million in eligible direct financing lease receivables. This agreement was structured as a revolving securitization so that as collections reduce previously sold interests in this new pool of leases, additional leases can be sold up to $150 million. The Company recognized a pretax gain of $4.5 million in fiscal 1996 on this agreement.
Under the asset securitization program entered into in September 1994, the Company sold an undivided ownership interest in $125 million of eligible direct financing lease receivables. This agreement was also structured as a revolving securitization. Under this program, new leases can be sold up to $125 million. During fiscal 1996, collections reduced previously sold interests by approximately $52.7 million. The Company sold an additional $52.7 million in net eligible direct financing leases and recognized a pretax gain of $1.2 million.
Income Before Taxes
Income before taxes grew by $22.3 million or 69.0%, when comparing pretax earnings for fiscal 1996 to fiscal 1995. This increase in income before taxes was essentially the effect of higher earnings on a larger portfolio base, supplemented by strong growth in interest income on deferred taxes and in other income.
At the end of fiscal 1996, the Company entered into an additional $150 million asset securitization program and recognized a pretax gain on sale of approximately $4.5 million during fiscal 1996 in addition to the $1.2 million of 1996 pretax securitization gains related to the 1994 agreement. As mentioned above, securitization gains in fiscal 1995 were approximately $1.2 million on a pretax basis. Excluding the effect of the securitization gains from pretax income for both fiscal years 1996 and 1995, pretax income grew by $17.8 million or 57.2% in fiscal 1996 from fiscal 1995.
Provision for Income Taxes
The approximate $8.7 million or 59.9% increase in income taxes in fiscal 1996 from fiscal 1995 is directly attributable to the higher net income before taxes in fiscal 1996 as compared to fiscal 1995. During fiscal 1996, the Company's effective income tax rate was 42.4%, as compared to 44.8% in fiscal 1995. Excluding the valuation adjustment recorded in fiscal 1995 relating to certain stated deferred tax items, the 1995 effective tax rate would have been 42.8%.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(No response to this item is required.)
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of IKON Capital, Inc. are submitted herewith on Pages through of this report.
QUARTERLY DATA
The following table shows comparative summarized quarterly results for fiscal 1997 and 1996.
- - -------- (1) Includes $4.5 million gain on additional sale of lease receivables of $150 million.
Any additional information required by this item has been omitted pursuant to General Instruction J(2)(a) of Form 10-K.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company are as follows:
RICHARD P. MAIER, age 46, has been President of the Company since 1989. He joined IKON (the Company's parent) in 1981 as Controller of the Alco Automotive Group and was promoted to Division Controller of IKON Office Solutions (which includes all of the IKON marketplaces) in 1983. He served as Vice President of Acme Business Products (an IKON company) from 1984 to 1988 and became Vice President of IKON Capital in 1988.
HARRY G. KOZEE, age 42, has been Vice President--Finance of the Company since 1993. He joined the Company in 1991 and was promoted to Controller in 1992.
KURT E. DINKELACKER, age 44, was appointed the sole director of the Company in 1995. He has served as Executive Vice President and Chief Financial Officer of IKON from 1997 to the present and from 1993 to 1995. He served as President and Chief Operating Officer of IKON from 1995 to 1997.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this item has been omitted pursuant to General Instruction J(2)(c) of Form 10-K.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this item has been omitted pursuant to General Instruction J(2)(c) of Form 10-K.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
See Item 1 hereof for information concerning the relationship between the Company, IKON and the IKON marketplaces.
Any additional information required by this item has been omitted pursuant to General Instruction J(2)(c) of Form 10-K.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements
Financial Statements and Schedules other than those listed above are omitted because the required information is included in the financial statements or the notes thereto or because they are inapplicable.
(b) Exhibits
(c) Reports on Form 8-K.
On July 17, 1997, the Company filed a Current Report on Form 8-K to file, under Item 5 of the form, information contained in a press release issued by its parent, IKON Office Solutions, Inc. ("IKON") concerning IKON's earnings for the fiscal quarter ended June 30, 1997.
On October 22, 1997, the Company filed a Current Report on Form 8-K to file, under Item 5 of the form, information contained in a press release issued by its parent, IKON, concerning IKON's earnings for the fiscal quarter and fiscal year ended September 30, 1997.
FORWARD LOOKING INFORMATION
This Report includes or incorporates by reference information which may constitute forward-looking statements about the Registrant or IKON made pursuant to the safe harbor provisions of the federal securities laws. Although the Registrant believes the expectations contained in such forward- looking statements are reasonable, no assurances can be given that such expectations will prove correct. Such forward-looking information is based on the Registrant's or IKON's current plans or expectations, and is subject to risks and uncertainties that could significantly affect the Registrant's and/or IKON's current plans, anticipated actions and future financial condition and results. These uncertainties and risks include, but are not limited to, those relating to IKON's successful management of an aggressive program to acquire and integrate new companies, including companies with technical services and products that are relatively new to IKON, and also including companies outside the United States, which present additional risks relating to international operations; risks and uncertainites (applicable to both the Registrant and IKON) relating to conducting operations in a competitive environment; delays, difficulties, technological changes, management transitions and employment issues (applicable to both the Registrant and IKON) associated with a large-scale transformation project; debt service requirements (applicable to both the Registrant and IKON), including sensitivity to fluctuation in interest rates; and general economic conditions. As a consequence, current plans, anticipated actions and future financial condition and results may differ materially from those expressed in any forward-looking statements made by or on behalf of the Registrant or IKON.
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors IKON Office Solutions, Inc.
We have audited the accompanying balance sheets of IKON Capital, Inc. (a wholly-owned subsidiary of IKON Office Solutions, Inc.) as of September 30, 1997 and 1996, and the related statements of income, changes in shareholder's equity, and cash flows for each of the three years in the period ended September 30, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of IKON Capital, Inc. at September 30, 1997 and 1996, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 1997, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP _____________________________________ Ernst & Young LLP
Philadelphia, Pennsylvania October 15, 1997
IKON CAPITAL, INC.
BALANCE SHEETS (IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
See accompanying notes.
IKON CAPITAL, INC.
STATEMENTS OF INCOME (IN THOUSANDS)
See accompanying notes.
IKON CAPITAL, INC.
STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY (IN THOUSANDS)
- - -------- * Amount is less than one thousand dollars.
See accompanying notes.
IKON CAPITAL, INC.
STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See accompanying notes.
IKON CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS
1. BUSINESS
IKON Capital, Inc. (the "Company"), a wholly-owned subsidiary of IKON Office Solutions, Inc. ("IKON"), is engaged in the business of arranging lease financing exclusively for office equipment marketed by IKON marketplaces, which sell and service copier equipment and facsimile machines.
2. SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect amounts reported in the financial statements and notes. Actual results could differ from those estimates and assumptions.
Revenue Recognition
Unearned lease finance income is amortized into revenue using the effective interest method over the term of the lease agreements.
Property and Equipment
Property and equipment, including leased equipment, is carried on the basis of cost. Depreciation is principally computed using the straight-line method over the estimated useful lives of the assets.
Income Taxes
The Company's deferred tax expense and the related liability are primarily the result of the difference between the financial statement and income tax treatment of direct financing leases.
Fair Value Disclosures
FASB Statement No. 107, "Disclosures about Fair Value of Financial Instruments" (SFAS 107), requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the Company has computed and disclosed the fair value of its notes payable (Note 5) and interest rate swaps.
Reclassifications
Certain prior year amounts have been reclassified to conform with the current year presentation.
Accounting Change
FASB Statement No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS 125), was adopted effective January 1, 1997. As a result, the Company has modified its agreements to meet the new requirements to enable it to continue recognizing transfers of certain receivables to special-purpose entities as sales, therefore, SFAS 125 did not have a material effect on the Company's financial statements.
IKON CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
Interest Rate Swap Agreements
The Company uses interest rate swap agreements for purposes other than trading and they are treated as off-balance sheet items. Interest rate swap agreements are used by the Company to modify variable rate obligations to fixed rate obligations, thereby reducing the exposure to market rate fluctuations. The interest rate swap agreements are designated as hedges, and effectiveness is determined by matching the principal balance and terms with that specific obligation. Such an agreement involves the exchange of amounts based on fixed interest rates for amounts based on variable interest rates over the life of the agreement without an exchange of the notional amount upon which payments are based. The differential to be paid or received as interest rates change is accounted for on the accrual method of accounting. Gains and losses on terminations of interest rate swap agreements are deferred and amortized over the remaining term of the original contract life of the terminated swap agreement. In the event of early extinguishment of the obligation, any realized or unrealized gain or loss from the swap would be recognized in income at the time of extinguishment. Fair values for the Company's interest rate swaps (off-balance sheet instruments) are estimated to be ($400,000) and ($768,000) in fiscal 1997 and 1996, respectively, based on termination of the agreements.
3. AGREEMENTS BETWEEN IKON CAPITAL AND IKON
Cash Management Program
The Company participates in IKON's domestic cash management program. Under this program, the Company has an account with IKON wherein cash temporarily in excess of current operating requirements earns interest at rates established by IKON. Similarly, amounts are periodically borrowed from IKON, with interest charged at market rates on borrowed funds. The Company was in a net average deposit position with IKON during 1997, 1996 and 1995 and earned interest income of $5,404,000, $2,870,000 and $1,545,000 respectively (included in interest expense). The Company considers its account with IKON to represent its cash balance. Accordingly, the accompanying Statements of Cash Flows present the changes in the caption "Due from (to) IKON".
Management Fee
Included in general and administrative expenses are corporate overhead expenses charged by IKON of $552,000 in fiscal years 1997, 1996 and 1995. These corporate charges represent management's estimate of costs incurred by IKON on behalf of IKON Capital.
Interest on IKON Income Tax Deferrals
The Company charges IKON interest on IKON's income tax deferrals associated with the Company's leasing transactions. Such charges were calculated at 6.6% in 1997, 6.8% in 1996 and 6.7% in 1995.
The 1991 Maintenance and Operating Agreements
The Maintenance Agreement between the Company and IKON provides that IKON will pay fees and make capital contributions to the Company in amounts sufficient to meet the restrictive financial covenants included in the Company's loan agreements (Note 5).
In the event of default of any lease on equipment purchased by the Company from IKON marketplaces, the Operating Agreement requires the IKON marketplace to repurchase the equipment at the net investment value of the lease on the default date. Default is defined by the Operating Agreement as any receivable becoming 120 days past due or otherwise being reasonably declared uncollectible by the Company. At September 30, 1997,
IKON CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED) 1996 and 1995, all of the Company's accounts receivable and direct financing leases, including residual values, were subject to such repurchase terms. In view of the foregoing terms of the Operating Agreement, the Company has made no provision in the accompanying financial statements for uncollectible receivables.
The 1996 Support Agreement
The 1996 Support Agreement between the Company and IKON provides that IKON will make a cash payment to the Company (or an investment in the form of equity or subordinated notes) as needed to comply with certain requirements. This agreement does not contain a requirement that the IKON marketplaces repurchase all defaulted lease contracts. In such event, the credit decision and reserves for defaulted contracts would become the responsibility of the Company. The present intent of the Company and IKON, however, is to continue the repurchase arrangement with the IKON marketplaces as currently in effect.
4. INVESTMENTS IN LEASES
The Company's funded leases include certain internal lease portfolios and non-cancelable rental contracts for IKON marketplaces, which have been financed by the Company. Under the terms of these financing arrangements, the IKON marketplace maintains the contractual relationship with the third-party customer. The IKON marketplaces have assigned to the Company, with full recourse, their rights under the underlying contracts including the right to receive lease and rental payments and a security interest in the related equipment.
At September 30, 1997, aggregate future minimum payments to be received, including guaranteed residual values, for each of the succeeding fiscal years under direct financing and funded leases are as follows (in thousands):
The Company has entered into asset securitization agreements for $275,000,000 of eligible direct financing lease receivables that expire in March 1998 ($125,000,000) and September 1998 ($150,000,000). The agreements contain limited recourse provisions which require the Company to assign an additional amount of undivided interest in leases as a reserve to cover any potential losses to the purchaser due to uncollectible leases. As collections reduce previously sold interests, new leases can be sold up to the agreement amount. In fiscal year 1997, the Company sold an additional $103,401,000 in leases, replacing leases paid/collected during the year. Under the terms of the sales agreements, the Company will continue to service the lease portfolio.
IKON CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The changes in the servicing liabilities relating to the asset securitization agreements for the fiscal years ended September 30, 1997 and 1996 are as follows (in thousands):
The estimated fair value of the servicing liabilities aggregated $7,485,000 at September 30, 1997 and $7,587,000 at September 30, 1996.
5. NOTES PAYABLE TO BANKS AND MEDIUM TERM NOTES
The note payable at September 30, 1997 bears interest at a fixed rate of 6.56% and matures on August 21, 1998. Notes payable outstanding at September 30, 1996 of $58,000,000 had a weighted average interest rate of 6.0%.
On May 21, 1997, the Company increased the amount available to be offered under its medium term notes program by $2,000,000,000 to $3,500,000,000 or the equivalent thereof in foreign currency. The program allows the Company to offer to the public from time to time medium term notes having an aggregate initial offering price not exceeding the total program amount. These notes are offered at varying maturities of nine months or more from their dates of issue and may be subject to redemption at the option of the Company, in whole or in part, prior to the maturity date in conjunction with meeting specified provisions. Interest rates are determined based on market conditions at the time of issuance. As of September 30, 1997, $1,542,250,000 of medium term notes are outstanding with a weighted average interest rate of 6.63% and $1,646,750,000 remains available under the program.
The Company must comply with certain restrictive covenants under the terms of its loan agreements. For loan agreements entered into before July 1, 1994, the Company agrees to maintain earnings before fixed charges (primarily interest) of not less than 1.3 times fixed charges, a ratio of debt to tangible net worth not exceeding 6 to 1 and tangible net worth not less than $1. For loan agreements (and medium term notes) entered into after July 1, 1994, the Company agrees to maintain earnings before fixed charges of not less than 1.25 times fixed charges and a tangible net worth of not less than $1.
Interest paid amounted to $76,621,000, $51,934,000 and $29,193,000 for the fiscal years ended September 30, 1997, 1996 and 1995, respectively.
At September 30, 1997 and 1996, the fair value of the Company's notes payable to banks and medium term notes is estimated to be $1,575,535,000 and $1,027,028,000, respectively, using a discounted cash flow analysis.
Future maturities of all notes payable and medium term notes outstanding at September 30, 1997 are as follows (in thousands):
IKON CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
6. LEASE COMMITMENTS
Total rent expense under all operating leases aggregated $1,857,000 in 1997, $1,239,000 in 1996 and $955,000 in 1995. At September 30, 1997, future minimum payments under noncancelable operating leases with initial or remaining terms of more than one year were: 1998-$1,979,000; 1999-$1,637,000; 2000-$809,000.
7. INCOME TAXES
Taxable income of the Company is included in the consolidated federal income tax return of IKON and all estimated tax payments and refunds, if any, are made through IKON. The provision for income taxes was determined as if the Company was a separate taxpayer.
Provision for income taxes:
FISCAL YEAR ENDED SEPTEMBER 30 (IN THOUSANDS)
The components of deferred income tax assets and liabilities were as follows:
SEPTEMBER 30 (IN THOUSANDS)
Net operating loss carryforwards consist primarily of federal carryforwards of approximately $61,712,000 which will expire in 2012. Credit carryforwards consist principally of federal and state alternative minimum tax credits of approximately $43,428,000 (with no expiration date).
IKON CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
The components of the effective income tax rate were as follows:
FISCAL YEAR ENDED SEPTEMBER 30
The Company made net income tax payments (refunds), including amounts paid (received) to/from IKON, of $1,427,000, ($15,639,000) and $1,862,000 in fiscal years 1997, 1996 and 1995, respectively.
8. PENSION AND STOCK PURCHASE PLAN
The Company participates in IKON's defined benefit pension plan covering the majority of its employees. The Company's policy is to fund pension costs as accrued. Pension expense recorded in 1997, 1996 and 1995 was $121,000, $62,000 and $43,000, respectively.
The majority of the Company's employees were eligible to participate in IKON's Stock Participation Plan under which they were permitted to invest 2% to 6% of regular compensation before taxes. The Company contributed an amount equal to two-thirds of the employees' investments and all amounts were invested in IKON's common shares. Effective October 2, 1995, the Stock Participation Plan was replaced by a Retirement Savings Plan (RSP). The RSP allows employees to invest 1% to 16% of regular compensation before taxes in six different investment funds. The Company contributes an amount equal to two-thirds of the employees' investments, up to 6% of regular compensation, for a maximum company match of 4%. All Company contributions are invested in IKON's common shares. Employees vest in a percentage of the Company's contribution after two years of service, with full vesting at the completion of five years of service. IKON also charges the Company for costs related to a similar plan for eligible management employees. The Company's cost of the stock participation plans amounted to $362,000, $240,000 and $195,000 in 1997, 1996 and 1995, respectively.
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS FORM 10-K FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 1997 TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
IKON Capital, Inc.
Date: December 24, 1997 /s/ Harry G. Kozee By___________________________________ (HARRY G. KOZEE) VICE PRESIDENT-- FINANCE
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS FORM 10-K HAS BEEN SIGNED BELOW ON DECEMBER 24, 1997 BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES INDICATED.
SIGNATURES TITLE
*Richard P. Maier President (Principal Executive - - ------------------------------------- Officer) (RICHARD P. MAIER)
/s/ Harry G. Kozee Vice President--Finance (Principal - - ------------------------------------- Financial Officer and Principal (HARRY G. KOZEE) Accounting Officer)
*Kurt E. Dinkelacker Director - - ------------------------------------- (KURT E. DINKELACKER)
*By his signature set forth below, Harry G. Kozee, pursuant to duly executed Powers of Attorney duly filed with the Securities and Exchange Commission, has signed this Form 10-K on behalf of the persons whose signatures are printed above, in the capacities set forth opposite their respective names.
/s/ Harry G. Kozee December 24, 1997 - - ------------------------------------- (HARRY G. KOZEE)
IKON CAPITAL, INC.
INDEX TO EXHIBITS