In Fiscal 2004, IKON competed effectively in the face of market conditions that continued to prove challenging. In an environment of intense competition, we executed with discipline on a sound and consistent strategy to become the channel of choice linking manufacturers and customers in the world of document services. We positioned IKON to target well-defined areas of opportunity in the marketplace. We continued the hard work of building operational excellence. And, as we transitioned out of our North American captive leasing business, we made tremendous progress toward one of our most important goals: financial flexibility. We also sharpened our focus on the services side of our business, creating a unified strategy under Enterprise Services and launching an integrated solutions portfolio to complement our best-in-class equipment lineup.
Financial Overview
In the year ended September 30, 2004, IKON recorded net income of $92 million on revenue of $4.65 billion, down 1.3 percent, or $61 million, from 2003 revenues. Net income per diluted share declined to $.60 from $.75 in 2003. This decline was due in large measure to the initial impact of IKON’s transition out of North American leasing operations and the decrease in high-margin revenues from that business. Targeted revenues, which exclude our North American finance revenues and de-emphasized technology hardware, increased by 2 percent.
The leasing transition, accomplished through a strategic alliance with GE Commercial Finance (GE) announced in December 2003, greatly strengthened IKON’s risk profile and capital structure, enabling the repayment or repurchase of $1.8 billion in corporate and lease financing debt, resulting in a 19 percentage point reduction in our total debt-to-capital ratio. Over the course of the year, IKON also made $78 million in share repurchases.
Progress in 2004
A year ago I outlined three strategic priorities for IKON: strengthening our growth platforms, driving efficiency into our operation, and improving our financial flexibility. These priorities guided our work over the course of 2004, and we can report real progress.
Our biggest news, of course, concerns the objective of financial flexibility. IKON’s alliance with GE, through which we are exiting our North American leasing business, streamlines our capital structure, puts new opportunities within reach, and brings new focus to our business—all of which have been reflected in a positive impact on the company’s stock price. It is important, however, that we also recognize the challenges that come with this transition. In the years ahead, we will need to replace North American leasing income through revenue growth and improved margins in our remaining business.
During Fiscal 2004, IKON also made progress in strengthening our growth platforms. We focused on improving our business mix, and saw results confirming that opportunities for growth in targeted areas are real. Focusing on our supplier partnerships, we reached a record $1 billion milestone in the purchase of Canon products; we realized success in the Ricoh channel through a new dedicated support team; we launched a co-branding venture with Konica Minolta—a clear win for IKON and our customers; and we greatly expanded our portfolio of document management software solutions through strategic alliances with industry leading partners.
Our progress on operational efficiency was real, but not up to our expectations. We focused much of our attention on process improvements at our newly centralized customer care centers, and we made strides in deploying resources that will deliver on productivity improvements in 2005. Continued progress will come through our Six Sigma initiative, which is well underway and delivering benefits.
Strategic Priorities
Building on the achievements of 2004, three strategic priorities are guiding our work going forward. These are, first, to create operational leverage by improving efficiency and effectiveness in our business processes; second, to drive growth in our core distribution business; and third, to expand into related markets of opportunity.
These three priorities create a pathway to IKON’s long-term financial goals, which calls for an improved mix of profitable revenue growth and a 200 basis point improvement in operating margins from a 4 percent baseline that accounts for the full transition out of North American leasing over time. We will also continue to work toward a stronger cash profile that allows for greater flexibility in cash allocation than in the past.
Outlined below are some of the actions we are taking in support of each of these strategic priorities. In addition, we have provided greater detail on six areas of particular focus later in this report.
Creating Operational Leverage For IKON, creating operational leverage means moving beyond the last legacy of our origins as a holding company—removing complexity and residual inefficiency in our business processes. To do so, we are vigorously pursuing a set of initiatives already well underway last year.
The most important of these is Six Sigma, the methodology we have chosen to drive process improvement. I have been involved in Six Sigma for 10 years, and I know that it works. It is the perfect fit for a company that has gone through the magnitude of operational consolidation that IKON has undertaken. At fiscal year-end, IKON had 126 Six Sigma Black Belts and 202 projects underway, each with a minimum expected benefit of approximately $250,000.
Underlying Six Sigma is our ongoing Enterprise Resource Planning (ERP) implementation, which is proceeding in carefully structured components. When complete, this implementation will support our centralization efforts and enhanced business processes with a single, scalable IT infrastructure, adding even more visibility into our business.
Driving Core Business Growth When we speak of IKON’s core business, we are referring to equipment sales and the ongoing volume in services and supplies those sales generate. Our drive toward growth in the core has three points of focus: first, to improve our sales effectiveness in all market segments through an enhanced coverage model; second, to gain market share in key customer segments where we have been underrepresented; and third, to target select product segments where demand is growing the fastest.
Successfully piloted in 2004, the launch of our new Integrated Selling Model in the U.S. and Canada is now underway. This cost-effective coverage model utilizes teleweb resources to create a team-based approach to selling for lower-end solutions, allowing our sales professionals to increase capacity and pursue higher-value, solutions-based selling opportunities. In pilot markets, we have experienced a double-digit improvement in sales productivity, and we expect similar results across the U.S. and Canada by 2006.
Through our Metro Markets Strategy, we are increasing our penetration of accounts in 12 of the largest North American cities. In two years, we have increased our share in these markets by 230 basis points. Through IKON’s National Account Program, we are investing the resources needed to build multidimensional partnerships with targeted accounts, primarily the Fortune 500 and large global and private companies. IKON has decisive advantages to offer this market, including breadth of portfolio, geographic reach, and document management expertise. In 2004, we implemented a six-fold increase in the number of sales executives dedicated to these accounts and saw dramatic results: national account revenues increased by 87 percent.
As we’ve targeted key growth segments on the product side, we have seen similarly positive results, such as a 40 percent increase in revenues from 2003 to 2004 from the placement of color devices. Color growth and steady penetration of the higher-volume black and white equipment segment, evidenced by a 15 percent increase in placements of Canon imageRUNNER 110s and 150s, contributed to double-digit increases in copy volumes for those areas in 2004, which helped us offset the industry-wide decline in fax and lower-end copy volumes that has pressured our Customer Services revenues.
Expanding into Related Markets To complement growth in IKON’s core business, we are also moving rapidly to expand into adjacent markets of two kinds: geographic regions where we will be well-advantaged, and markets for new products and services that build solidly on our core.
A promising region for IKON is Europe, where we are one of the largest independent distributors in a highly fragmented market, which provides us with a great opportunity to build on our strengths and grow our share of the market. Our approach in Europe consists of a City Strategy, through which we are targeting European cities with the greatest customer opportunity to build a broad footprint, and a Pan European Strategy, through which we are selling our multinational presence to large organizations with diverse locations to support.
At the center of our plans for new product and service expansion is Enterprise Services, which at present accounts for roughly $2.2 billion in revenues. Formed in mid-2004, Enterprise Services brings together a complete portfolio of software and enablers, products and services, as well as the expertise we need to deliver integrated document solutions. Our unique approach begins with a strategic assessment of document workflow and then applies best-in-class hardware and software technologies, providing tailored solutions to our customers’ requirements. This approach allows us to deliver on our value proposition of document efficiency. In 2004, we enhanced this capability with an integrated solutions portfolio, expanding our channel partners through relationships with technology suppliers such as Captaris, EMC (Documentum), Kofax, and others. These solutions, coupled with our ability to deliver integrated services from assessment to post-sale support, position IKON to grow share in this expanding market.
The Right Model
As IKON moves into the market for integrated document solutions, we are aligned with our customers’ evolving needs and, as a result, are powerfully positioned to win. As a sales and service channel rather than an equipment manufacturer, IKON has always enjoyed access to best-in-class products, and today that portfolio is more complete than ever with a set of solutions on the software side as robust as our lineup of hardware. And, in an environment in which we are now selling strategic insights as well as devices, we have an added edge over manufacturers—objectivity. Our customers know they can trust IKON to identify the best solutions to meet their needs, not just the best ones available in a particular brand.
As I look at IKON today, I see an organization defined by
transformation—the transformation from holding company to operating company, which is well underway, and the transformation from hardware provider to solutions provider, which is off to a great start.
I also see a company with the solid governance structure that both investors and customers recognize as critical, and with a dedicated and capable senior management team in place. The newest addition to this team is Bob Woods, who has succeeded Bill Urkiel as Senior Vice President and CFO. I welcome Bob, who brings outstanding experience to the job, and also extend my deepest thanks to Bill, who has played an invaluable part in leading IKON through times of important change.
I am extremely confident about 2005 and beyond. Our company holds great potential, and the path to realizing that potential is clear. Throughout our organization, our people are deeply committed to achieving our shared vision, to seizing every opportunity the market presents, and to returning the resulting value to our investors.
Sincerely,
Matthew J. Espe
Chairman and Chief Executive Officer
