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IOS Capital, Inc.
FORM 10-K
September 30, 1999
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As filed with the Securities and Exchange Commission on December 28, 1999
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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(Mark One)
[X] Annual report pursuant to section 13 or 15(d) of the Securities Exchange
Act of 1934 for the fiscal year ended September 30, 1999 or
[_] Transition report pursuant to section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to
FORM 10-K
Commission file number 0-20405
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IOS CAPITAL, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 23-2493042
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1738 Bass Road, Macon, Georgia 31210
(Address of principal executive offices) (Zip Code)
(912) 471-2300
(Registrant's telephone number, including area code)
----------------------
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
The number of shares of common stock, par value $.01 per share, outstanding as
of December 28, 1999 was 1,000, all of which were owned by IKON Office
Solutions, Inc.
Registered debt outstanding as of December 28, 1999 was $1,022,850,000.
Documents incorporated by reference:
None
The registrant meets the conditions set forth in General Instruction (I)(1)(a)
and (b) of Form 10-K and is therefore filing with the reduced disclosure format
contemplated thereby.
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TABLE OF CONTENTS
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Page No.
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PART I
ITEM 1. BUSINESS........................................................................ 1
ITEM 2. PROPERTIES...................................................................... 6
ITEM 3. LEGAL PROCEEDINGS............................................................... 6
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................. 6
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS.......................................................... 7
ITEM 6. SELECTED FINANCIAL DATA......................................................... 7
ITEM 7. FINANCIAL INFORMATION........................................................... 7
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK...................... 12
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA..................................... 12
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.......................................... 13
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS................................................ 13
ITEM 11. EXECUTIVE COMPENSATION.......................................................... 13
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT................................................................... 13
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.................................. 13
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
FORM 8-K..................................................................... 13
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PART I
ITEM 1. BUSINESS
General
IOS Capital, Inc. ("IOS Capital" or the "Company"), formerly known as IKON
Capital, 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 and is the
largest independent distribution network of office equipment in North America.
IKON has over 1,000 locations in the United States, Canada, the United Kingdom,
Germany, France, Denmark, Ireland and Mexico. IKON provides products and
services to meet business communication needs, including copiers and printers,
color solutions, distributed printing, outsourcing services, imaging and legal
oursourcing solutions, as well as network design and consulting, application
development and technology training. IKON's fiscal 1999 revenues were $5.5
billion.
The Company is engaged in the business of arranging lease financing
exclusively for office equipment marketed by IKON's marketplaces ("IKON
marketplaces"), which sell and service copier equipment, facsimile machines and
other equipment. The ability to offer lease financing on this equipment through
IOS Capital is considered a competitive marketing advantage which more closely
ties IKON to its customer base. During the 1999 fiscal year, 67% 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, Ricoh and Oce.
Currently 62% of the equipment financed by the Company represents copiers, 17%
fax machines, and 21% other equipment.
The Company provides IKON with standard lease rates for use in customer
quotes. However, IKON marketplaces may charge the customer more or less than IOS
Capital's standard rates, and the IKON marketplace would absorb any difference
resulting from any such variances from IOS 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 7.5%
of the Company's total lease portfolio. The typical new lease financed by the
Company averages $17,739 and 47 months in duration. Although 94% 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").
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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 19% of the Company's leases as of
September 30, 1999. 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, 1999. 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, 1999,
the average equipment residual value for all leases in the Company's portfolio
was 8.2%. 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 current operating guidelines, 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 a 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.
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Support 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.
2. The 1994 Support Agreement
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 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.
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 1999, 1998 and 1997 and earned interest income of approximately $6.0
million, $5.3 million and $5.4 million, respectively.
Management Fee
Included in general and administrative expenses are corporate overhead
expenses charged by IKON of $552,000 in fiscal years 1999, 1998 and 1997. These
corporate charges represent management's estimate of costs incurred by IKON on
behalf of IOS Capital.
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 $260 million at the end of fiscal 1999. IKON pays the Company
interest on these tax deferrals which arise from tax deferrals on intercompany
sales. In fiscal years 1999, 1998 and 1997, 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
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Company earned interest at an average rate of 6.6% in fiscal 1999 totaling
$16.8 million, 6.5% in fiscal 1998 totaling $15.7 million and 6.6% in fiscal
1997 totaling $12.1 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. The
focus of the bonus subsidy program was to reimburse IKON for third party lease
payoffs incurred when buying out the equipment leases of a competitor. During
fiscal 1999, 1998 and 1997, bonus payments made to IKON marketplaces or IKON
totaled $12.0 million, $16.4 million and $9.8 million, respectively. Effective
October 1, 1999, the Company and IKON agreed to terminate this program.
Credit Policies and Loss Experience
Prior to October 1, 1998, each IKON marketplace was 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 were consistent with IKON's overall policies for leasing and credit
approval. On October 1, 1998, the Company began the implementation of a national
credit review process for all lease transactions submitted to the Company for
funding. Under the new process, which was implemented in April 1999, the Company
approves the credit for all the lease transactions prior to funding the IKON
marketplaces.
Prior to October 1, 1999, the Company had full recourse to the IKON
marketplace for any lease which became past due by 120 days or more. Excluding
the effect of recoveries, the gross value of leases charged back to IKON
marketplaces was $79.2 million in fiscal 1999, $98.8 million in fiscal 1998 and
$51.6 million in fiscal 1997. For fiscal 1999, 1998 and 1997, the gross
chargebacks represented 3.0%, 3.9% and 2.7%, respectively, of the average
portfolio balances during the year. Effective October 1, 1999, the Company began
a shared recourse arrangement with the IKON marketplaces. This arrangement
provides for net losses resulting from lease defaults to be shared equally
between the Company and the IKON marketplaces. As of the date of this policy
change, related lease default reserves were transferred from the IKON
Marketplaces to the Company.
Prior to October 1, 1999, reserves for credit losses were maintained by the
IKON marketplaces and IKON. On a monthly basis, the Company reported the
respective net investment value of the lease portfolio to each IKON marketplace
so the IKON marketplace could properly accrue the credit loss reserve balance.
In accordance with IKON policy, each IKON marketplace maintained reserves based
on its loss experience (including $275 million of net leases sold under an asset
securitization agreement being serviced by the Company). Reserves maintained for
fiscal 1999 and 1998, as a percentage of the leasing portfolio at fiscal year
end, were 2.8% and 3.4% respectively. Effective October 1, 1999, reserves for
credit losses will be maintained by the Company consistent with the policy
change noted above.
During fiscal 1999 and 1998, accounts classified as current (less than 30 days
past due) ranged from 89% to 92% of the total portfolio balance on a monthly
basis. The aging of the Company's lease portfolio receivables at September 30,
1999 (excluding $275 million of net lease receivables sold under an asset
securitization agreement being serviced by the Company) was as follows:
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(dollars in millions)
<S> <C> <C>
Current........................................................................... $2,554.0 89.6%
Over 30 days...................................................................... 168.2 5.9%
Over 60 days...................................................................... 79.8 2.8%
Over 90 days...................................................................... 48.5 1.7%
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$2,850.5 100.0%
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Less:
Unearned interest.............................................................. (448.9)
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$2,401.6
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Funding
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, 1999, $1,242.9 million of medium term notes were outstanding with
a weighted average interest rate of 6.5%.
In December 1998, the Company entered into an asset securitization transaction
whereby it sold $366.6 million in direct financing lease receivables for $250
million in cash and a retained interest in the remainder. The agreement is for
an initial three year term with certain renewal provisions and is structured as
a revolving asset securitization so that as collections reduce previously sold
interests in this new pool of leases, additional leases can be sold up to $250
million. The terms of the agreement require that the Company continue to
service the lease portfolio. The Company recognized a pretax gain of $14.3
million during the first quarter of fiscal 1999 on this agreement. On May 25,
1999, the Company repurchased the leases sold in this transaction with the
proceeds from the lease-backed notes described below.
The Company had additional asset securitization agreements for $275 million of
eligible direct financing receivables. These agreements were also structured as
revolving securitizations, whereby additional leases can be sold as collections
reduce the previously sold interests. During fiscal 1999, collections reduced
previously sold interests on these two agreements and the $250 million
transaction, described above, by $152.1 million. The Company sold an additional
$152.1 million in net eligible direct financing leases and recognized pretax
gains of $12.2 million for fiscal year 1999. On October 7, 1999, these leases
were repurchased with a portion of the proceeds received from the issuance of
$700 million of leased-backed notes.
On May 19, 1999, IKON Receivables, LLC (an affiliate of the Company) publicly
issued approximately $752 million of lease backed notes (the "Notes") under a
$1.825 billion shelf registration statement. Class A-1 Notes totaling $305
million have a stated interest rate of 5.11%, Class A-2 Notes totaling $62
million have a stated interest rate of 5.60%, Class A-3 Notes totaling $304
million have a stated interest rate of 5.99% and Class A-4 Notes totaling $81
million have a stated interest rate of 6.23%. The transaction was structured
using two special purpose limited liability companies: IKON Receivables-1, LLC,
of which the Company is the sole member, and IKON Receivables, LLC, of which
IKON Receivables-1, LLC is the sole member. The Company contributed to IKON
Receivables-1, LLC a pool of office equipment leases or contracts and related
assets (the "1999-1 Asset Pool"), and IKON Receivables-1, LLC transferred
them (other than equipment) to IKON Receivables, LLC, which is the issuer of the
Notes. The Notes are secured by the Asset Pool and the payments on the Notes are
made from payments on the leases. The Company received approximately $749
million in net proceeds from the sale of the Notes and used $250 million of that
amount to repurchase previously sold assets in connection with the asset
securitization transaction completed in December 1998. The repurchased assets
were contributed to IKON Receivables-1, LLC as part of the 1999-1 Asset Pool.
Restricted cash on the balance sheet represents cash that has been collected on
the lease receivables in the Asset Pool, which must be used to repay the Notes.
On October 7, 1999, IKON Receivables, LLC (an affiliate of the Company)
publicly issued approximately $700 million of lease backed notes (the "1999-2
Notes") under the $1.825 billion shelf registration statement noted above. Class
A-1 Notes totaling $236 million have a stated interest rate of 6.14125%, Class
A-2 Notes totaling $51 million have a stated interest rate of 6.31%, Class A-3a
Notes totaling $100 million have a stated interest rate of 6.59%, Class A-3b
Notes totaling $241 million have a variable interest rate and Class A-4 Notes
totaling $72 million have a stated interest rate of 6.88%. The Class A-3b Notes
pay interest at a rate of LIBOR plus 0.36% (which we have fixed at 6.58% through
an interest rate swap). The transaction was structured the same as the 1999-1
Notes described above. The Notes are secured by a pool of office equipment
leases or contracts and related assets ("the 1999-2 Asset Pool") and the
payments on the Notes are made from payments on the leases. The Company received
approximately $697 million in net proceeds from the sale of the 1999-2 Notes and
used $275 million of that amount to repurchase previously sold leases. The
repurchased leases were contributed as part of the 1999-2 Asset Pool.
Employees
At September 30, 1999, the Company had approximately 302 employees. Employee
relations are considered to be good.
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Proprietary Matters
Other than the "IOS 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.
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 independent
distribution network of office equipment in North America. IKON marketplaces
compete on the basis of quality of service and ability to provide value added
document services.
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 I(2)(d).
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. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No response to this item is required.
6
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PART II
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. The company paid IKON a $30 million dividend in fiscal 1999. No
dividends were paid in fiscal 1998 or 1997. 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. SELECTED FINANCIAL DATA
The information called for by this item has been omitted pursuant to General
Instruction I(2)(a).
ITEM 7. FINANCIAL INFORMATION
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Pursuant to General Instruction I(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.
Impact of Year 2000
State of Readiness. The Year 2000 issue is the result of computer programs
being written using two digits rather than four to define the applicable year.
Any of the Company's computer programs or hardware that have date-sensitive
software or embedded technology (non-IT systems) may recognize a date using "00"
as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities. The potential for a problem exists
with all computer hardware and software, as well as in products with embedded
technology; copiers and fax machines; security and HVAC systems; voice/telephony
systems; elevators, etc.
IKON has appointed a Year 2000 Corporate Compliance Team, which has prepared a
compliance program for all business units, including the Company, and is
responsible for coordination and inspecting compliance activities in all
business units. The compliance program requires all business units and locations
in every country to inventory potentially affected systems and products, assess
risk, take any required corrective actions, test and certify compliance. IKON's
Year 2000 Testing and Certification Guidelines delineate the Year 2000
compliance process, testing and quality assurance guidelines, certification and
reporting processes and contingency planning. An independent consulting company
has reviewed the compliance program.
Costs. The Company has used both internal and external resources to reprogram
or replace, test and implement its IT and non-IT systems for Year 2000
modifications. The Company does not separately track the internal costs
incurred on the Year 2000 project. Such costs are principally payroll and
related costs for internal IT personnel. The Company's total cost of the Year
2000 project, excluding these internal costs, is approximately $1.2 million and
is being funded through operating cash flows. Of the total estimated project
cost, approximately $0.2 million is attributable to the purchase of new software
and hardware and has been capitalized. Through October 31, 1999, IOS Capital
has incurred approximately $1.1 million ($0.9 million expensed and $0.2 million
capitalized), related to its Year 2000 project. Remaining amounts are to be
incurred early in the first quarter of fiscal 2000.
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Risks. Management believes, based on the information currently available
to it, that the most reasonably likely worst case scenario that could be caused
by technology failures relating to Year 2000 could pose a significant threat not
only to the Company, IKON, its customers and suppliers, but to all businesses.
Risks include :
. Legal risks, including customer, supplier, employee or shareholder
lawsuits over failure to deliver contracted services, product failure,
or health and safety issues.
. Loss of revenues due to failure to meet customer quality expectations.
. Increased operational costs due to manual processing, data corruption
or disaster recovery.
. Inability to bill or invoice.
The cost of the project and the date on which IKON and the Company believe
it will complete the Year 2000 modifications are based on management's best
estimates, which were derived using numerous assumptions of future events,
including the continued availability of certain resources and other factors.
However, there can be no guarantee that these estimates will be achieved and
actual results could differ materially from those anticipated. Specific factors
that might cause such material differences include, but are not limited to, the
availability and costs of personnel trained in this area, the ability to locate
and correct all relevant computer codes, and similar uncertainties.
Contingency Plans. IKON's Guidelines require that contingency plans be
developed and validated in the event that any critical system cannot be
corrected and certified before the system's failure date. Contingency plans are
currently being developed and completed.
Fiscal 1999 Compared with Fiscal 1998
Comparative summarized results of operations for the fiscal years ended
September 30, 1999 and 1998 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.
<TABLE>
<CAPTION>
Fiscal Year
Ended September 30 Increase (Decrease)
------------------------ ------------------------
1999 1998 Amount Percent
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
(dollars in thousands)
Revenues:
Lease finance income................................................... $225,647 $223,131 $ 2,516 1.1%
Rental income.......................................................... 39,483 38,749 734 1.9%
Interest on IKON income tax deferral................................... 16,764 15,734 1,030 6.5%
Other income........................................................... 17,076 11,653 5,423 46.5%
-------- -------- -------
298,970 289,267 9,703 3.4%
Expenses:
Interest............................................................... 114,961 109,737 5,224 4.8%
General and administrative............................................. 67,226 72,938 (5,712) (7.8)%
-------- -------- -------
182,187 182,675 (488) (.3)%
Gain on sale of lease receivables........................................ 26,454 2,724 23,730 871.1%
-------- -------- -------
Income before taxes...................................................... 143,237 109,316 33,921 31.0%
Provision for income taxes............................................... 54,910 46,194 8,716 18.9%
-------- -------- -------
Net income............................................................... $ 88,327 $ 63,122 $25,205 39.9%
======== ======== =======
</TABLE>
Revenues
Total revenues increased $9.7 million or 3.4% in fiscal 1999 from fiscal
1998. Approximately $2.5 million of this increase in revenues was a result of
increased lease finance income due to continued growth in the portfolio of
direct financing and funded leases, adjusted for the effects of the asset
securitizations. The lease portfolio, net of lease receivables that were sold in
asset securitization transactions, increased 6.7% from September 30, 1998 to
September 30, 1999.
8
<PAGE>
Office equipment placed on rental by the IKON marketplaces to customers
with cancelable terms may be purchased by the Company. During fiscal 1999 and
1998, IOS Capital purchased operating lease equipment of $23.8 million and $64.0
million, respectively. Operating leases contributed $39.5 million in rental
income to total revenues during fiscal 1999 compared to $38.7 million in fiscal
1998.
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 1999 and 6.5% for
fiscal 1998. The deferred tax base upon which these payments are calculated
decreased 4.1% to $260 million at September 30, 1999 from $271 million at
September 30, 1998. Due to an increase in the average rate and an increase in
the average deferred tax liability balance, interest income on deferred taxes
rose $1.0 million or 6.5% when comparing fiscal 1999 to fiscal 1998.
Other income consists primarily of late payment charges and various billing
fees. The structure of these fees has remained basically unchanged from fiscal
1998. 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 $5.4 million or 46.5%, when comparing fiscal 1999 to
fiscal 1998. Effective October 1, 1999 the Company has discontinued its policy
of charging billing fees to the IKON marketplaces.
Expenses
Average borrowings to finance the lease portfolio in the form of loans from
banks and the issuance of medium term notes and lease-backed notes in the public
market increased by 6.4%, with $1,865.8 million outstanding at September 30,
1999. The Company paid a weighted average interest rate on all borrowings for
fiscal 1999 of 6.6% compared to 6.5% for fiscal 1998. Primarily as a result of
the increased average borrowings, interest expense grew by $5.2 million or 4.8%,
when comparing fiscal 1999 to fiscal 1998. At September 30, 1999, the Company's
debt to equity ratio including amounts due to IKON was 5.0 to 1.
The Company has a medium term note program which 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, 1999, approximately $1.2 billion of medium
term notes were outstanding under these programs with a weighted average
interest rate of 6.5%, while approximately $1.1 billion remains available under
this program.
At September 30, 1999, the Company had no outstanding notes payable to
banks, compared to $100 million at September 30, 1998 with a weighted average
interest rate of 6.0%.
The Company has filed a $1.825 billion shelf registration statement for
lease backed notes. The Company, through its affiliate IKON Receivables LLC,
issued lease-backed notes under this shelf of approximately $752 million on May
19, 1999 at an average interest rate of 5.7%. On October 7, 1999, an additional
$700 million of lease-backed notes were issued leaving approximately $373
million currently available under the noted shelf registration statement. (See
"Business - Funding")
Total general and administrative expenses decreased by $5.7 million or
7.8%, when comparing fiscal 1999 to fiscal 1998. The general and administrative
expense category for fiscal 1999 includes depreciation expense on leased
equipment totaling $33.6 million compared to $32.7 million in fiscal 1998. In
addition, lease bonus subsidy payments included in the general and
administrative expense categories were approximately $4.4 million less in fiscal
1999 than in fiscal 1998. Excluding the effects of increased depreciation
expense on operating leases and lease bonus subsidy payments, remaining general
and administrative expenses decreased approximately $2.2 million or 9.2%, when
comparing fiscal 1999 to fiscal 1998.
Gain on Sale of Lease Receivables
In December 1998, the Company entered into an asset securitization
transaction whereby it sold $366.6 million in direct financing lease receivables
for $250 million in cash and a retained interest in the remainder. The agreement
is for an initial three-year term with certain renewal provisions and was
structured as a revolving asset securitization so that as collections reduce
previously sold interests in the pool of leases, additional leases can be sold
up to $250 million.
9
<PAGE>
The terms of the agreement require that the Company will continue to service the
lease portfolio. The Company recognized a pretax gain of $14.3 million during
the first quarter of fiscal 1999 on this agreement. On May 25, 1999, the Company
repurchased leases sold under this agreement with the proceeds from the lease-
backed notes. As a result of the repurchase, the $250 million commitment remains
available.
The Company had additional asset securitization agreements for $275 million
of eligible direct financing receivables. These agreements were also structured
as revolving securitizations, whereby additional leases can be sold as
collections reduce the previously sold interests. During fiscal 1999,
collections reduced previously sold interests on these two agreements and the
$250 million transaction, described above, by $152.1 million. The Company sold
an additional $152.1 million in net eligible direct financing leases and
recognized pretax gains of $12.2 million for fiscal year 1999.
Income Before Taxes
Income before taxes increased by $33.9 million or 31.0%, when comparing
pretax earnings for fiscal 1999 to fiscal 1998. This increase in income before
taxes was essentially the effect of higher earnings on a larger portfolio base,
gains from asset securitization transactions and decreased general and
administrative expenses, partially offset by higher borrowing costs due to the
increase in average debt to fund the lease portfolio.
Provision for Income Taxes
Income taxes for fiscal 1999 increased by $8.7 million or 18.9% over fiscal
1998. The increase in income taxes is directly attributable to the increase in
income before taxes in fiscal 1999 as compared to fiscal 1998 and a drop in the
effective tax rate. During fiscal 1999, the Company's effective income tax rate
was 38.3%, as compared to 42.3% in fiscal 1998, due to the use of state net
operating loss carryforwards in fiscal 1999.
Fiscal 1998 Compared with Fiscal 1997
Comparative summarized results of operations for the fiscal years ended
September 30, 1998 and 1997 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.
<TABLE>
<CAPTION>
Fiscal Year
Ended September 30 Increase (Decrease)
------------------------ -----------------------
1998 1997 Amount Percent
----------- ----------- ---------- -----------
(dollars in thousands)
<S> <C> <C> <C> <C>
Revenues:
Lease finance income................................................... $223,131 $170,505 $ 52,626 30.9%
Rental income.......................................................... 38,749 24,012 14,737 61.4%
Interest on IKON income tax deferral................................... 15,734 12,134 3,600 29.7%
Other income........................................................... 11,653 7,638 4,015 52.6%
-------- -------- --------
289,267 214,289 74, 978 35.0%
Expenses:
Interest............................................................... 109,737 83,536 26,201 31.4%
General and administrative............................................. 72,938 61,790 11,148 18.0%
-------- -------- --------
182,675 145,326 37,349 25.7%
Gain on sale of lease receivables........................................ 2,724 2,602 122 4.7%
-------- -------- --------
Income before taxes...................................................... 109,316 71,565 37,751 52.8%
Provision for income taxes............................................... 46,194 28,984 17,210 59.4%
-------- -------- --------
Net income............................................................... $ 63,122 $ 42,581 $ 20,541 48.2%
======== ======== ========
</TABLE>
10
<PAGE>
Revenues
Total revenues increased $75.0 million or 35.0% in fiscal 1998 from fiscal
1997. Approximately 70.2% or $52.6 million of this increase in revenues was a
result of increased lease finance income due to continued 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
22.4% from September 30, 1997 to September 30, 1998.
Office equipment placed on rental by the IKON marketplaces to customers
with cancelable terms may be purchased by the Company. During fiscal 1998 and
1997, IOS Capital purchased operating lease equipment of $64.0 million and $48.5
million, respectively. Operating leases contributed $38.7 million in rental
income to total revenues during fiscal 1998 compared to $24.0 million in fiscal
1997.
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 6.5% for fiscal 1998 compared to 6.6%
for fiscal 1997. In addition, the deferred tax base upon which these payments
are calculated increased 23.7% to $271 million at September 30, 1998 from $219
million at September 30, 1997. Primarily as a result of the increased deferred
tax liabilities, interest income on deferred taxes rose $3.6 million or 29.7%
when comparing fiscal 1998 to fiscal 1997.
Other income consists primarily of late payment charges and various billing
fees. The structure of these fees has remained basically unchanged from fiscal
1997. 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 $4.0 million or 52.6%, when comparing fiscal 1998 to
fiscal 1997.
Expenses
Average borrowings to finance the lease portfolio in the form of loans from
banks and the issuance of medium term notes in the public market increased by
24.4%, with $1,949.8 million outstanding at September 30, 1998. The Company paid
a weighted average interest rate on all borrowings for fiscal 1998 of 6.5%
compared to 6.6% for fiscal 1997. Primarily as a result of the increased
borrowings, interest expense grew by $26.2 million or 31.4%, when comparing
fiscal 1998 to fiscal 1997. At September 30, 1998, the Company's debt to equity
ratio was 5.8 to 1. On August 14, 1998, Standard and Poor's lowered its credit
rating one level on the Company and IKON to "BBB+" from "A-" and Moody's
Investor Service lowered its credit ratings one level on the Company and IKON to
"Baal" from "A3".
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, 1998, approximately
$1.8 billion of medium term notes were outstanding under these programs with a
weighted average interest rate of 6.5%, while approximately $1.1 billion remains
available under this program.
At September 30, 1998, the Company had outstanding notes payable to banks
of $100 million, with a weighted average interest rate of 6.0%, compared to $25
million at September 30, 1997 at 6.5%.
Total general and administrative expenses increased by $11.1 million or
18.0%, when comparing fiscal 1998 to fiscal 1997. The general and administrative
expense category for fiscal 1998 includes depreciation expense on leased
equipment totaling $32.7 million compared to $19.8 million in fiscal 1997. In
addition, lease bonus subsidy payments included in the general and
administrative expense categories were approximately $6.6 million more in fiscal
1998 than in fiscal 1997. Excluding the effects of increased depreciation
expense on operating leases and lease bonus subsidy payments, remaining general
and administrative expenses decreased approximately $8.3 million or 25.9%, when
comparing fiscal 1998 to fiscal 1997. This decrease is due to cost controls
initiated within the company.
11
<PAGE>
Gain on Sale of Lease Receivables
The company has asset securitization agreements for $275 million of
eligible direct financing lease receivables. As collections reduce previously
sold interests, new leases can be sold up to the agreement amount. During fiscal
1998, collections reduced previously sold interests by approximately $106.1
million on these two agreements. The Company sold an additional $106.1 million
in net eligible direct financing leases during fiscal 1998 and recognized a
pretax gain of $2.7 million.
Income Before Taxes
Income before taxes increased by $37.8 million or 52.8%, when comparing
pretax earnings for fiscal 1998 to fiscal 1997. This increase in income before
taxes was essentially the effect of higher earnings on a larger portfolio base
increased general and administrative expenses, partially offset by higher
borrowing costs due to the increase in debt to fund the lease portfolio.
Provision for Income Taxes
Income taxes for fiscal 1998 increased by $17.2 million or 59.4% over
fiscal 1997. The increase in income taxes is directly attributable to the
increase in income before taxes in fiscal 1998 as compared to fiscal 1997.
During fiscal 1998, the Company's effective income tax rate was 42.3%, as
compared to 40.5% in fiscal 1997.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(No response to this item is required.)
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements of IOS Capital, Inc. are submitted herewith on
Pages F-1 through F-11 of this report.
Quarterly Data
The following table shows comparative summarized unaudited quarterly
results for fiscal 1999 and 1998.
<TABLE>
<CAPTION>
First Quarter Second Quarter Third Quarter Fourth Quarter Total
------------- ---------------- --------------- --------------- ------------
(in thousands)
<S> <C> <C> <C> <C> <C>
1999
Lease finance income.......................... $60,527 $51,323 $54,513 $59,284 $225,647
Interest expense.............................. 29,202 26,607 28,339 30,813 114,961
Income before income taxes.................... 48,484 30,818 32,751 31,184 143,237
Net income.................................... 28,121 17,874 21,444 20,888 88,327
First Quarter Second Quarter Third Quarter Fourth Quarter Total
------------- ---------------- --------------- --------------- ------------
(in thousands)
1998
Lease finance income.......................... $51,479 $54,787 $56,904 $59,961 $223,131
Interest expense.............................. 25,865 27,208 27,382 29,282 109,737
Income before income taxes.................... 23,354 26,296 29,691 29,975 109,316
Net income.................................... 13,779 15,514 17,220 16,609 63,122
</TABLE>
Any additional information required by this item has been omitted pursuant
to General Instruction I(2)(a) of Form 10-K.
12
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The directors and executive officers of the Company are as follows:
Russell Slack, age 41, has been President of IOS Capital since 1999. He
joined the company in 1996 as Vice President of Portfolio Quality. His
experience includes over 15 years in equipment leasing.
Harry G. Kozee, age 44, has been Vice President--Finance of the Company
since 1993. He joined the Company in 1991 and was promoted to Controller in
1992.
William S. Urkiel, age 54, sole director, has been Chief Financial Officer
and Senior Vice-President of IKON since 1999. Prior to joining IKON, he was
Corporate Vice President and Chief Financial Officer, AMP, Inc. (1997-1998);
Corporate Controller, AMP Inc. (1995-1996); Senior Managing Director and Chief
Financial Officer, IBM Japan (1994). He was named a Director of the Company on
May 10, 1999.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by this item has been omitted pursuant to
General Instruction I(2)(c) of Form 10-K.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by this item has been omitted pursuant to
General Instruction I(2)(c) of Form 10-K.
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 I(2)(c) of Form 10-K.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Financial Statements
<TABLE>
<CAPTION>
Page
------
<S> <C>
Report of Ernst & Young LLP, Independent Auditors.................................................. F-1
Balance Sheets at September 30, 1999 and 1998...................................................... F-2
Statements of Income for Fiscal Years Ended September 30, 1999, 1998 and 1997...................... F-3
Statements of Changes in Shareholder's Equity for Fiscal Years Ended September 30,
1999, 1998 and 1997.............................................................................. F-4
Statements of Cash Flows for Fiscal Years Ended September 30, 1999, 1998 and
1997............................................................................................. F-5
Notes to Financial Statements...................................................................... F-6
</TABLE>
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.
13
<PAGE>
(b) Exhibits
<TABLE>
<S> <C>
3.1 Articles of Incorporation of the Company, filed on May 4, 1994 as Exhibit 3.1 to the Company's
Registration Statement on Form 10, are incorporated herein by reference.
3.2 Bylaws of the Company, filed on May 4, 1994 as Exhibit 3.2 to the Company's Registration Statement
on Form 10, are incorporated herein by reference.
4.1 Form of Fixed Rate Note and Floating Rate Note with respect to the Company's Medium Term Note
Program, filed as Exhibit 4 to the Company's Form 10-Q for the fiscal quarter ended June 30, 1994, is
Incorporated herein by reference.
4.2 Pursuant to Regulation S-K item 601 (b)(4)(iii), the Company agrees to furnish to the Commission,
Upon request, a copy of instruments defining the rights of holders of long term debt of the Company.
10.1 Support Agreement, dated as of October 22, 1996, between the Company and Alco Standard
Corporation, filed as Exhibit 10.4 to the Company's Form 8-K dated November 12, 1996, is
incorporated herein by reference.
10.2 Amended and Restated Receivables Transfer Agreement dated as of March 31, 1997, among IKON
Funding, Inc., IKON Capital, Inc., Twin Towers, Inc. and Deutsche Bank AG, New York Branch, filed
as Exhibit 10.10 to IKON's 10-K for the fiscal year ended September 30, 1997, is incorporated herein
by reference.
10.3 First Tier Transfer Agreement dated as of March 31, 1997 between IKON Capital and IKON Funding,
Inc., filed as Exhibit 10.11 to IKON's Form 10-K for the fiscal year ended September 30, 1997 is
incorporated herein by reference.
10.4 Receivables Transfer Agreement dated as of September 30, 1996 among IKON Funding, Inc., IKON
Capital, Inc., Old Line Funding Corp. and Royal Bank of Canada, filed as Exhibit 4.1 to IKON's Form
10-K for the fiscal year ended September 30, 1996, is incorporated herein by reference. Amendment 1
to Receivables Transfer Agreement, dated as of October 7, 1997, filed as Exhibit 10.7 to IKON's Form
10-K for the fiscal year ended September 30, 1997, is incorporated herein by reference.
10.5 Transfer Agreement dated as of September 30, 1996, filed as Exhibit 4.3 to IKON's Form 10-K for the
fiscal year ended September 30, 1996, is incorporated herein by reference.
10.6 Indenture dated as of July 1, 1995 between the Company and Chase Manhattan Bank, N.A. (formerly
Chemical Bank, N.A.), as Trustee, filed as Exhibit 10.8 to IKON's Form 10-K for the fiscal year ended
September 30, 1996, is incorporated herein by reference.
10.7 Indenture dated as of July 1, 1994 between the Company and Nations Bank, N.A., as Trustee, filed as
Exhibit 4 to the Company's Registration Statement No. 33-53779 on Form S-3, is incorporated herein
by reference.
10.8 Distribution Agreement dated as of June 4, 1997, between the Company and various distribution
agents, filed as Exhibit 10.13 to IKON's Form 10-K for the fiscal year ended September 30, 1997, is
incorporated herein by reference.
10.9 Distribution Agreement dated as of June 30, 1995 between the Company and various distribution
agents, filed as Exhibit 10.21 to IKON's 10-K for the fiscal year ended September 30, 1995, is
incorporated herein by reference.
10.10 Distribution Agreement dated July 1, 1994, filed as Exhibit 1 to the Company's Form 10-Q for the
fiscal quarter ended June 30, 1994 is incorporated herein by reference.
10.11 Federal Income Tax Allocation Agreement, filed on May 4, 1994 as Exhibit 10.1 to the Company's
Registration Statement on Form 10, is incorporated herein by reference.
12 Ratio of Earnings to Fixed Charges
</TABLE>
14
<PAGE>
<TABLE>
<S> <C>
21 Subsidiaries of the Registrant
23 Auditors' Consent
24 Powers of Attorney; certified resolution re: Powers of Attorney
27 Financial Data Schedule
</TABLE>
(c) Reports on Form 8-K.
On July 28, 1999, the registrant filed a Current Report on Form 8-K to
file, under Item 5 of the form, information contained in a press release of
its parent, IKON, dated July 28, 1999 concerning IKON's earnings for the
fiscal quarter and nine-month period ended June 30, 1999.
Forward Looking Information
This Report includes or incorporates by reference information which may
constitute forward-looking statements within the meaning of the federal
securities laws. Although the Company believes the expectations contained in
such forward-looking statements are reasonable, it can give no assurances that
such expectations will prove correct. Such forward-looking information is based
on management's current plans or expectations and is subject to a number of
risks and uncertainties that could significantly affect current plans,
anticipated actions and the Company's and/or IKON's future financial condition
and results. These uncertainties and risks which apply to both the Company and
IKON, include, but are not limited to; risks and uncertainties relating to
conducting operations in a competitive environment; delays, difficulties,
management transitions and employment issues associated with consolidation of,
and/or changes in business operations managing the integration of existing and
acquired companies risks and uncertainties associated with existing or future
vendor relationships; and general economic conditions. As a consequence of these
and other risks and uncertainties, 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 Company.
15
<PAGE>
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
Board of Directors
IKON Office Solutions, Inc.
We have audited the accompanying consolidated balance sheets of IOS Capital,
Inc. (a wholly-owned subsidiary of IKON Office Solutions, Inc.) as of September
30, 1999 and 1998, and the related consolidated statements of income, changes in
shareholder's equity, and cash flows for each of the three years in the period
ended September 30, 1999. 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 consolidated financial position of IOS Capital, Inc.
at September 30, 1999 and 1998, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended September 30,
1999, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
----------------------------------
Ernst & Young LLP
Philadelphia, Pennsylvania
October 25, 1999, execpt for the fourth paragraph of note 4, as to which the
date is December 9, 1999
F-1
<PAGE>
IOS CAPITAL, INC.
BALANCE SHEETS
(in thousands except share and per share amounts)
<TABLE>
<CAPTION>
September 30
--------------------------------
1999 1998
--------------- ---------------
<S> <C> <C>
Assets
Investments in leases (notes 3 and 4):
Direct financing leases................................................................ $2,310,663 $2,002,012
Less: Unearned income.................................................................. (374,279) (343,211)
---------- ----------
1,936,384 1,658,801
Funded leases, net..................................................................... 465,188 592,827
---------- ----------
2,401,572 2,251,628
Cash..................................................................................... 1,335 2,621
Restricted Cash.......................................................................... 29,625
Accounts receivable...................................................................... 76,805 63,066
Due from IKON Office Solutions, Inc. (note 3)............................................ 52,060
Prepaid expenses and other assets........................................................ 10,018 14,224
Leased equipment--operating rentals at cost, less accumulated depreciation of:
1999--$51,055; 1998--$43,411............................................................ 59,681 76,551
Property and equipment at cost, less accumulated depreciation of:
1999--$7,384; 1998--$5,596 (note 2).................................................... 10,395 11,491
---------- ----------
Total assets........................................................................ $2,589,431 $2,471,641
========== ==========
Liabilities and Shareholder's equity
Liabilities:
Accounts payable and accrued expenses.................................................. $ 65,204 $ 59,206
Accrued interest....................................................................... 23,481 33,467
Due to IKON Office Solutions........................................................... 112,649
Notes payable to banks (note 5)........................................................ 100,000
Medium term notes (note 5)............................................................. 1,242,850 1,849,750
Lease-backed notes (note 5)............................................................ 622,948
Deferred income taxes (note 7)......................................................... 129,869 95,115
---------- ----------
Total liabilities................................................................... 2,197,001 2,137,538
Shareholder's equity:
Common stock--$.01 par value, 1,000 shares authorized, issued, and
outstanding
Contributed capital.................................................................... 149,415 149,415
Retained earnings...................................................................... 243,015 184,688
---------- ----------
Total shareholder's equity.......................................................... 392,430 334,103
---------- ----------
Total liabilities and shareholder's equity.......................................... $2,589,431 $2,471,641
========== ==========
</TABLE>
See accompanying notes.
F-2
<PAGE>
IOS CAPITAL, INC.
STATEMENTS OF INCOME
(in thousands)
<TABLE>
<CAPTION>
Fiscal Year Ended
September 30
-------------------------------------------
1999 1998 1997
------------- ------------- -------------
<S> <C> <C> <C>
Revenues:
Lease finance income (note 2)............................................... $225,647 $223,131 $170,505
Rental income............................................................... 39,483 38,749 24,012
Interest on IKON income tax deferrals (note 3).............................. 16,764 15,734 12,134
Other income................................................................ 17,076 11,653 7,638
-------- -------- --------
298,970 289,267 214,289
Expenses:
Interest (note 3)........................................................... 114,961 109,737 83,536
General and administrative.................................................. 67,226 72,938 61,790
-------- -------- --------
182,187 182,675 145,326
Gain on sale of lease receivables (note 4).................................... 26,454 2,724 2,602
-------- -------- --------
Income before income taxes.................................................... 143,237 109,316 71,565
Provision for income taxes (note 7)........................................... 54,910 46,194 28,984
-------- -------- --------
Net income............................................................... $ 88,327 $ 63,122 $ 42,581
======== ======== ========
</TABLE>
See accompanying notes.
F-3
<PAGE>
IOS CAPITAL, INC.
STATEMENTS OF CHANGES IN SHAREHOLDER'S EQUITY
(in thousands)
<TABLE>
<CAPTION>
Common Contributed Retained
Stock Capital Earnings Total
----------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Balance at October 1, 1996................................... * 112,415 78,985 191,400
Net income................................................... 42,581 42,581
Capital contributions from IKON.............................. 32,000 32,000
-------- -------- --------
Balance at September 30, 1997................................ * 144,415 121,566 265,981
Net Income................................................... 63,122 63,122
Capital contributions from IKON.............................. 5,000 5,000
-------- -------- --------
Balance at September 30, 1998................................ * 149,415 184,688 334,103
Net Income................................................... 88,327 88,327
Dividend to IKON............................................. (30,000) (30,000)
-------- -------- --------
Balance at September 30, 1999................................ $ * $149,415 $243,015 $392,430
================= ======== ======== ========
</TABLE>
______________
* Amount is less than one thousand dollars.
See accompanying notes.
F-4
<PAGE>
IOS CAPITAL, INC.
STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
Fiscal Year Ended
September 30
--------------------------------------------------
1999 1998 1997
--------------- --------------- --------------
<S> <C> <C> <C>
Operating activities
Net income..................................................................... $ 88,327 $ 63,122 $ 42,581
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization................................................ 35,390 34,579 17,209
Provision for deferred taxes................................................. 34,754 30,938 20,209
Gain on sale of lease receivables............................................ (26,454) (2,724) (2,602)
Changes in operating assets and liabilities:
Accounts receivable....................................................... (13,739) (7,477) (7,255)
Prepaid expenses and other assets......................................... 23,299 1,936 4,748
Accounts payable and accrued expenses..................................... 4,275 8,188 6,697
Accrued interest.......................................................... (9,986) 5,682 6,915
--------------- --------------- --------------
Net cash provided by operating activities...................................... 135,866 134,244 88,502
--------------- --------------- --------------
Investing activities
Purchases of equipment for rental, net....................................... (16,732) (58,308) (35,577)
Purchases of property and equipment, net..................................... (691) (1,038) (6,676)
Investment in leases:
Additions.................................................................... (1,535,165) (1,676,712) (1,618,984)
Cancellations................................................................ 349,732 362,725 275,751
Collections.................................................................. 894,785 795,663 473,157
Proceeds from sale........................................................... 402,098 106,144 281,270
Repurchase of leases sold.................................................... (250,000)
--------------- --------------- --------------
Net cash used by investing activities.......................................... (155,973) (471,526) (631,059)
--------------- --------------- --------------
Financing activities
Proceeds from bank borrowings................................................ 300,000
Payments on bank borrowings.................................................. (100,000) (225,000) (33,000)
Proceeds from issuance of medium term notes.................................. 523,500 853,350
Payments on medium term notes................................................ (606,900) (216,000) (281,000)
Proceeds from issuance of lease-backed notes................................. 749,331
Payments on lease-backed notes............................................... (128,694)
Deposit to restricted cash................................................... (29,625)
Capital contributed by IKON.................................................. 5,000 32,000
Dividend to IKON............................................................. (30,000)
--------------- --------------- --------------
Net cash (used in) provided by financing activities............................ (145,888) 387,500 571,350
--------------- --------------- --------------
(Decrease) increase in cash and amounts due to IKON............................ (166,955) 50,218 28,793
Cash and Due from (to) IKON at beginning of period............................. 54,681 4,463 (24,330)
--------------- --------------- --------------
Cash and Due (to) from IKON at end of period................................... $ (111,314) $ 54,681 $ 4,463
=============== =============== ==============
</TABLE>
See accompanying notes.
F-5
<PAGE>
IOS CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS
1. Business
IOS 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's marketplaces
("IKON marketplaces"), which sell and service copier equipment, facsimile
machines and other equipment. 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, Ricoh and Oce. Currently 62% of the equipment financed by the
Company represents copiers, 17% fax machines, and 21% other equipment. The
Company changed its name from IKON Capital, Inc. to IOS Capital, Inc. on January
22, 1998.
2. Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements of IOS Capital, Inc. include the
accounts of the Company and its wholly-owned subsidiaries, after elimination of
all intercompany transactions, accounts and profits.
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.
Restricted Cash
Restricted cash on the balance sheet represents cash which has been
collected on the lease receivables in the Asset Pool, which must be used to
repay the Notes.
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.
F-6
<PAGE>
Pending Accounting Change
In June 1998, the FASB issued Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133), which establishes accounting and
reporting standards for derivative instruments and hedging activities. It
F-7
<PAGE>
IOS CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
will require us to recognize all derivatives as either assets or liabilities and
measure the instruments at fair value. The statement is effective for all
fiscal quarters of fiscal years beginning after June 15, 2000. We intend to
adopt the standard on October 1, 2000. We do not believe the effect of adoption
will be material.
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 ($725,000) and ($3,782,000) in
fiscal 1999 and 1998, respectively, based on termination of the agreements.
3. Agreements between IOS 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 1999, 1998 and 1997 and earned interest income
of $5,956,000, $5,290,000 and $5,404,000 respectively (included in interest
expense). The Company considers its account with IKON to represent a cash
balance. Accordingly, the accompanying Statements of Cash Flows includes the
changes in Cash and "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 1999, 1998 and 1997. These
corporate charges represent management's estimate of costs incurred by IKON on
behalf of IOS 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
1999 and 1997 and 6.5% in 1998.
Lease Defaults
Prior to October 1, 1999, the Company and IKON followed an operating
arrangement that required, in the event of default, the IKON marketplace to
repurchase the equipment at the net investment value of the lease on the default
date. Default is defined as any receivable becoming 120 days past due or
otherwise being reasonably declared uncollectible by the Company. At September
30, 1999, 1998 and 1997, 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 agreement, the Company made no provision in the
accompanying financial statements for uncollectible receivables. Effective
October 1, 1999, the
F-8
<PAGE>
IOS CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Company began a shared recourse arrangement with the IKON marketplaces. This
arrangement provides for net losses resulting from lease defaults to be shared
equally. Lease default reserves will be transferred from the IKON marketplaces
to the Company effective October 1, 1999 and will be maintained at the Company.
Provisions for lease defaults will be shared between the Company and the IKON
marketplaces.
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.
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, 1999, 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):
<TABLE>
<CAPTION>
Direct
Financing Funded
Leases Leases
--------------- -------------
<S> <C> <C>
2000 $ 832,481 $194,491
2001 682,810 159,524
2002 469,005 109,573
2003 245,867 57,441
2004 80,500 18,807
--------------- -------------
2,310,663 539,836
Less unearned interest...................................... (374,279) (74,648)
--------------- -------------
$1,936,384 $465,188
=============== =============
</TABLE>
In December 1998, the Company entered into an asset securitization
transaction whereby it sold $366.6 million in direct financing lease receivables
for $250 million in cash and a retained interest in the remainder. The agreement
is for an initial three-year term with certain renewal provisions and was
structured as a revolving asset securitization so that as collections reduce
previously sold interests in the pool of leases, additional leases can be sold
up to $250 million. The terms of the agreement require that the Company will
continue to service the lease portfolio. The Company recognized a pretax gain of
$14.3 million during the first quarter of fiscal 1999 on this agreement. On May
25, 1999, the Company repurchased leases sold under this agreement with the
proceeds from the lease-backed notes. As a result of the repurchase, the $250
million commitment remains available.
On December 9, 1999, the Company transferred an additional $311,381,604 in
financing lease receivables for $247,600,000 in cash in connection with this
revolving asset securitization.
The Company had entered into asset securitization agreements for
$275,000,000 of eligible direct financing lease receivables. These agreements
were also structured as revolving securitizations, whereby additional leases can
be sold as collections reduce the previously sold interests. During fiscal 1999,
collections reduced previously sold interests on these two agreements and the
$250,000,000 transaction, described above, by $152,098,000. The Company sold an
additional $152,098,000 in net eligible direct financing leases and recognized
pretax gains of $12.2 million for fiscal year 1999. On October 7, 1999, these
leases were repurchased with a portion of proceeds received from the issuance of
$700,000,000 of leased-backed notes.
F-9
<PAGE>
IOS CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The changes in the servicing liabilities relating to the asset
securitization agreements for the fiscal years ended September 30, 1999 and 1998
are as follows (in thousands):
1999 1998
---- ----
Beginning of period..........................$ 8,243 $ 8,248
Additions................................... 2,459 3,454
Less: Amortization.......................... .(3,789) (3,459)
------- -------
Balance at September 30..................... $ 6,913 $ 8,243
======= =======
5. Notes Payable to Banks, Medium Term Notes and Leased-Backed Notes
There are no outstanding notes payable to banks at September 30, 1999.
On May 19, 1999, IKON Receivables, LLC (an affiliate of the Company)
publicly issued approximately $752 million of lease backed notes (the "Notes")
under a $1.825 billion shelf registration statement. Class A-1 Notes totaling
$304,474,000 have a stated interest rate of 5.11%, Class A-2 Notes totaling
$61,579,000 have a stated interest rate of 5.60%, Class A-3 Notes totaling
$304,127,000 have a stated interest rate of 5.99% and Class A-4 Notes totaling
$81,462,000 have a stated interest rate of 6.23%. The transaction was structured
using two special purpose limited liability companies: IKON Receivables- 1, LLC,
of which the Company is the sole member, and IKON Receivables, LLC, of which
IKON Receivables- 1, LLC is the sole member. The Company contributed (other
than equipment) to IKON Receivables-1, LLC a pool of office equipment leases or
contracts and related assets (the "Asset Pool"), and IKON Receivables-1, LLC
transferred them to IKON Receivables, LLC, which is the issuer of the Notes. The
Notes are secured by the Asset Pool and the payments on the Notes are made from
payments on the leases. The Company received approximately $749 million in net
proceeds from the sale of the Notes and used $250 million of that amount to
repurchase previously sold assets in connection with the asset securitization
transaction completed in December 1998. The repurchased assets were contributed
as part of the Asset Pool. Restricted cash on the balance sheet represents cash
that has been collected on the lease receivables in the Asset Pool, which must
be used to repay the Notes.
On May 21, 1997, the Company increased the amount available to be offered
under its medium term notes program 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, 1999, $1,242,850,000 of medium term notes are outstanding with a
weighted average interest rate of 6.5% and $1,123,250,000 remains available
under the program.
The Company must comply with certain restrictive covenants under the terms
of its loan agreements. 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 $124,947,000, $104,055,000 and $76,621,000 for
the fiscal years ended September 30, 1999, 1998 and 1997, respectively.
At September 30, 1999 and 1998, the fair value of the Company's notes
payable to banks, medium term notes and lease-backed notes is estimated to be
$1,805,722,000 and $1,937,762,000, respectively, using a discounted cash flow
analysis.
F-10
<PAGE>
IOS CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Future maturities of all medium term notes and lease-backed notes
outstanding at September 30, 1999 are as follows (in thousands):
Fiscal 2000...................................... $ 945,163
2001............................................. 672,018
2002............................................. 203,813
2003............................................. 44,804
----------
$1,865,798
==========
On October 7, 1999, IKON Receivables, LLC (an affiliate of the Company)
publicly issued approximately $700 million of lease backed notes (the"1999-2
Notes") under a $1.825 billion shelf registration statement. Class A-1 Notes
totaling $235,326,000 have a stated interest rate of 6.14125%, Class A-2 Notes
totaling $51,100,000 have a stated interest rate of 6.31%, Class A-3a Notes
totaling $100,000,000 have a stated interest rate of 6.59%, Class A-3b Notes
totaling $240,891,000 have a variable interest rate and Class A-4 Notes totaling
$72,278,000 have a stated interest rate of 6.88%. The Class A-3b Notes pay
interest at a rate of LIBOR plus 0.36% (which we have fixed at 6.58% through an
interest rate swap). The transaction was structured using two special purpose
limited liability companies: IKON Receivables- 1, LLC, of which the Company is
the sole member, and IKON Receivables, LLC, of which IKON Receivables- 1, LLC is
the sole member. The Company contributed to IKON Receivables-1, LLC a pool of
office equipment leases or contracts and related assets (the "1999-2 Asset
Pool"), and IKON Receivables- 1, LLC transferred them (other than equipment) to
IKON Receivables, LLC, which is the issuer of the Notes. The Notes are secured
by the 1999-2 Asset Pool and the payments on the Notes are made from payments on
the leases. The Company received approximately $697 million in net proceeds from
the sale of the 1999-2 Notes and used $275 million of that amount to repurchase
previously sold leases. The repurchased leases were contributed as part of the
1999-2 Asset Pool. Future maturities, based on contractual maturity of leases,
of the 1999-2 Notes are $252,700,000, $193,944,770, $143,174,200, $88,815,390,
and $20,960,620 in fiscal 2000, 2001, 2002, 2003 and 2004, respectively.
6. Lease Commitments
Total rent expense under all operating leases aggregated $1,842,000 in
1999, $2,018,000 in 1998 and $1,857,000 in 1997. At September 30, 1999, future
minimum payments under noncancelable operating leases with initial or remaining
terms of more than one year were: 2000--$567,000; 2001--$567,000; 2002--
$240,000.
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:
<TABLE>
<CAPTION>
Fiscal Year Ended September 30
---------------------------------------------------------------------------
1999 1998 1997
------------------------ ------------------------ -----------------------
<S> <C> <C> <C> <C> <C> <C>
(in thousands)
Current Deferred Current Deferred Current Deferred
------- ------- ------- ------- ------- --------
Federal................... $19,389 $30,324 $15,221 $22,542 $8,230 $16,418
State..................... 767 4,430 35 8,396 545 3,791
------- ------- ------- ------- ------ -------
Income Taxes.............. $20,156 $34,754 $15,256 $30,938 $8,775 $20,209
======= ======= ======= ======= ====== =======
</TABLE>
The components of deferred income tax assets and liabilities were as
follows:
<TABLE>
<CAPTION>
September 30
--------------------------------
1999 1998
----------------- -------------
<S> <C> <C>
(in thousands)
Deferred tax assets:
Accrued liabilities.................................................................. $ 0 $ 498
Net operating loss and alternative minimum tax credit
carryforwards...................................................................... 94,357 94,115
--------- ---------
Total deferred tax assets......................................................... 94,357 94,613
Valuation allowance.................................................................. 3,661 5,063
--------- ---------
Net deferred tax assets........................................................... 90,696 89,550
Deferred tax liabilities:
Other, net........................................................................... (163) 0
Depreciation......................................................................... (2,394) (2,154)
Lease income recognition............................................................. (218,008) (182,511)
--------- ---------
Total deferred tax liabilities.................................................... (220,565) (184,665)
--------- ---------
</TABLE>
F-11
<PAGE>
<TABLE>
<S> <C> <C>
Net deferred tax liabilities...................................................... $(129,869) $ (95,115)
========= =========
</TABLE>
IOS CAPITAL, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Net operating loss carryforwards consist primarily of federal carryforwards
of approximately $39,720,000 which will expire in 2018. Credit carryforwards
consist principally of federal and state alternative minimum tax credits of
approximately $76,793,000 (with no expiration date).
The components of the effective income tax rate were as follows:
<TABLE>
<CAPTION>
Fiscal Year Ended
September 30
----------------------------------
1999 1998 1997
----------- --------- ----------
<S> <C> <C> <C>
Taxes at federal statutory rate..................................................... 35.0% 35.0% 35.0%
State taxes, net of federal benefit................................................. 3.6 7.7 5.8
Other............................................................................... (0.3) (0.4) (0.3)
---- ---- ----
Effective income tax rate........................................................... 38.3% 42.3% 40.5%
==== ==== ====
</TABLE>
The Company made net income tax payments, including amounts paid to IKON,
of $16,976,000, $5,446,000 and $1,427,000 in fiscal years 1999, 1998 and 1997,
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 1999, 1998 and 1997 was $197,000, $131,000
and $121,000, respectively.
The majority of the Company's employees were eligible to participate in
IKON's 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 plans amounted to $186,000, $377,000 and $362,000 in
1999, 1998 and 1997, respectively.
F-12
<PAGE>
F-13
<PAGE>
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, 1999 to be signed on its behalf by the undersigned, thereunto duly
authorized.
IOS Capital, Inc.
Date: December 28, 1999
By /s/ Harry G. Kozee
-----------------------
(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 28, 1999 by the following persons on
behalf of the registrant and in the capacities indicated.
Signatures Title
---------- -----
/s/ RUSSELL SLACK President (Principal Executive Officer)
-----------------
(Russell Slack)
/s/ HARRY G. KOZEE Vice President--Finance (Principal
------------------
(Harry G. Kozee) Financial Officer and Principal
Accounting Officer)
/s/ WILLIAM S. URKIEL Director
---------------------
William S. Urkiel
<PAGE>
IOS CAPITAL, INC.
INDEX TO EXHIBITS
Exhibit
No. Title
- --- -----
12 Ratio of Earnings to Fixed Charges
21 Subsidiaries of Registrant
23 Auditors' Consent
27 Financial Data Schedule
<PAGE>
Exhibit 12
IOS CAPITAL, INC.
RATIO OF EARNINGS TO FIXED CHARGES
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER 10
----------------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
EARNINGS
Income from continuing operations... $ 88,327 $ 63,122 $ 42,581 $ 31,512 $ 17,860
Add:
Provision for income taxes........ 54,910 46,194 28,984 23,150 14,476
Fixed charges..................... 121,531 115,699 89,560 63,538 38,263
-------- -------- -------- -------- --------
Earnings, as adjusted(A)............ $264,768 $225,015 $161,125 $118,200 $ 70,599
======== ======== ======== ======== ========
FIXED CHARGES
Other interest expense, including
interest on capital leases......... $120,917 $115,026 $ 88,941 $ 63,125 $ 37,945
Estimated interest component of
rental expense..................... 614 673 619 413 318
-------- -------- -------- -------- --------
Total fixed charges(B)............ $121,531 $115,699 $ 89,560 $ 63,538 $ 38,263
======== ======== ======== ======== ========
RATIO OF EARNINGS TO FIXED CHARGES
(A) divided by (B).................. 2.2 1.9 1.8 1.9 1.8
-------- -------- -------- -------- --------
</TABLE>
<PAGE>
EXHIBIT 21
SUBSIDIARIES OF REGISTRANT
The registrant is IOS Capital, Inc., a Delaware corporation, whose parent
is IKON Office Solutions, Inc. The following sets forth information with respect
to IOS Capital, Inc.'s subsidiaries as of December 28, 1999.
<TABLE>
<CAPTION>
STATE OR OTHER
JURISDICTION OF
% VOTING SECURITIES INCORPORATION OR
SUBSIDIARY OWNED (BY WHOM) ORGANIZATION
- ---------- ----------------- ----------------
<S> <C> <C>
IKON Funding, Inc....................... 100% IOS Capital Delaware
IKON Funding, LLC....................... 100% IOS Capital Delaware
IKON Funding-1, LLC..................... 100% IOS Capital Delaware
IKON Receivables-1, LLC................. 100% IOS Capital Delaware
IKON Receivables Funding, Inc........... 100% IOS Capital Delaware
</TABLE>
<PAGE>
Exhibit 23
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statement (Form
S-3 No. 333-27141) of IOS Capital, Inc. and in the related Prospectus of our
report dated October 25, 1999, (except for the fourth paragraph of note 4, as to
which the date is December 9, 1999) with respect to the financial statements of
IOS Capital, Inc. included in this Annual Report (Form 10-K) for the year ended
September 30, 1999.
/s/ Ernst & Young LLP
Philadelphia, Pennsylvania
December 28, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF IOS CAPITAL, INC. AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> SEP-30-1999
<PERIOD-END> SEP-30-1999
<CASH> 1,335
<SECURITIES> 0
<RECEIVABLES> 2,478,377<F1>
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 0
<PP&E> 128,515,000<F2>
<DEPRECIATION> 58,439,000<F2>
<TOTAL-ASSETS> 2,589,431,000
<CURRENT-LIABILITIES> 0
<BONDS> 1,865,798,000
0
0
<COMMON> 0<F3>
<OTHER-SE> 392,430,000
<TOTAL-LIABILITY-AND-EQUITY> 2,589,431,000
<SALES> 0
<TOTAL-REVENUES> 298,970,000
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 67,226,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 114,961,000
<INCOME-PRETAX> 143,237,000
<INCOME-TAX> 54,910,000
<INCOME-CONTINUING> 88,327,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 88,327,000
<EPS-BASIC> 0<F4>
<EPS-DILUTED> 0<F4>
<FN>
<F1>INCLUDE NET INVESTMENTS IN LEASES OF $2,401,572,000 AND OTHER ACCOUNTS
RECEIVABLE.
<F2>INCLUDES LEASED EQUIPMENT OF COST - $110,735,790; ACCUMULATED DEPRECIATION -
$51,055,000.
<F3>COMMON STOCK, $.01 PAR VALUE, 1,000 SHARES OUTSTANDING. SINCE TOTAL IS LESS
THAN $1,000, ZERO IS REPORTED.
<F4>NOT REQUIRED AS THE REGISTRANT IS A WHOLLY-OWNED SUBSIDIARY.
</FN>
</TABLE>
