Where is IKON Headed?

By Cary Sherburne, Senior Editor

October 10, 2005 -- IKON Office Solutions continues to restructure as it works to bring its costs in line, most recently reducing the size of its marketing department. The company has stated that its goal is to bring its Sales, General & Administrative (SG&A) expenses into alignment with competitors in the marketplace and to position itself for improved earnings and revenue. A closer look at IKON’s performance reveals:

• A steady decline in revenues from a high of $5.6 billion in September 1998 to its 2004 level of $4.6 billion.
• In that same period, IKON has gone from a high of nearly 43,000 employees to approximately 26,000 employees.
• While IKON’s gross profit margin was at 37.6% in 2001, it had declined to 36.9% by the end of its fiscal year in September 2004.
• Both revenues and gross profit margins have continued to decline during the current fiscal year.
• In its third quarter earnings call, the company reported that total revenues were $1.1 billion, down 4% year over year, primarily due to a decrease in net sales and continued transition out of the captive leasing business in North America. The company reported that targeted revenues declined 1%. Gross profit dollars decreased by 8%.

On a positive note, IKON has significantly beefed up its professional services offerings, particularly to serve mid-market customers, many of whom do not have robust IT resources and look to vendors like IKON for turnkey services. Targeted professional services had a strong third quarter, up 15%, with improvements in all key metrics including systems analyst utilization, document strategy assessments, and hardware enablers. Additionally, the company reported record third quarter placements of the IKON CPP 500, the IKON branded version of Konica Minolta’s 50 ppm color printer. This product is now a top revenue-producing color product for the company. In the U.S. office color segment, IKON grew placements by 75%, and across all segments of color, copy volumes were up 47% from the prior year.

IKON reports that it is committed to reducing costs across the organization, and that early 2005 expense actions are now delivering positive results, with SG&A expenses down 7% year over year. At the same time, average equipment sale prices continue to decline due to a combination of new product introductions and lower price points, as well as increased competition.

As part of its cost reduction commitment, in March of this year, IKON exited its Business Document Services (BDS) business unit and most of its operations in Mexico. BDS, at one time a hub-and-spoke print production operation that consisted of 34 sites in North America that was ultimately reduced to some 11 sites, represented a $5 million after-tax loss for IKON. While on the surface, BDS appeared to be a natural companion service to IKON’s on-site facilities management business to accommodate overflow work and complex production, the company had difficulty finding a way to make the business profitable.

In addition, in July of 2005, IKON completed the sale of its French subsidiary to NRG France S.A.S., a subsidiary of NRG Group PLC. Stating that Europe was an important growth area, the company indicated it would continue to serve pan-European customers through an ongoing presence in Paris, as well as its 50 other locations across Europe.

In February of 2005, a BusinessWeek article reported that Steel Partners, a company that has a history of buying big stakes in companies, pushing to maximize their value, and then putting them in play, had acquired a 5.4% interest in IKON. SEC records reflect that that stake was upped to 6.4% in March and now stands at about 10%. The article states, “In its filing with the Securities & Exchange Commission, Steel Partners explained that, with IKON so undervalued, it may seek board seats, buy additional shares, and propose ways to boost earnings.”

What does all of this mean for IKON’s future?

WhatTheyThink interviewed Dan Murphy, Vice President of Investor Relations, and Mike Kohlsdorf, Senior Vice President of IKON Enterprise Services and Information Systems, to get their perspective on IKON’s cost reduction initiatives, as well as prospects for growth. According to Murphy, “We recently had a meeting with Steel Partners and shared with them publicly available information about our progress and plans going forward. As near as we can tell they are a very satisfied investor. They are very supportive of the management team, the strategy and the direction we are taking the company. We are comfortable with the relationship we have with them.”

Staffing Levels and SG&A

When asked about further downsizing, Kohsdorf said, “There is no target number of employees. We have a stated direction relative to SG&A as a percent of revenue, in the context of driving that down. We are not publishing targets, but the direction we are headed, in terms of reducing SG&A, is pretty clear, and will involve both employee and non employee reductions.” Murphy added, “This year, our objective was to reduce the expense-to-revenue ratio by 100 basis points. We see other players in the industry at the 27-28% range, and we are over 30. We want to get down to 30 and be one of the leaders in the industry, if not at the level that our peers are at. If you did a pure financial analysis on our company, you would see we have a higher SG&A than others and there is opportunity to improve. We are looking at our pension plan, real estate, IT, and other best practices. And we are rallying the entire company to manage as effectively as we can to be as competitive as we can.”

Oracle Implementation

IKON has also struggled with its implementation of an enterprise-wide ERP solution based on Oracle. This unifying effort was designed to replace legacy systems left over from the rapid roll-up of over 400 companies in IKON’s heyday. Like many of these types of massive ERP implementation efforts, the results have not met expectations, and the process has turned out to be much more complex than anticipated. On that subject, Kohlsdorf said, “We are still very committed to Oracle as the platform of choice, and we continue to move in that direction. As with any complex, sophisticated IT implementation, there are starts and stops. The most recent assessment we have done suggests that Oracle works the way it is designed to, and while we need to make some changes relative to the design, we are still committed to that platform in the context of moving to a single platform..”

Marketing

Significant reductions in a company’s marketing efforts always raise a red flag, and it has been proven over and over again that reasonable investments in marketing, especially during difficult times, continue to pay dividends into the future. While IKON would not officially comment on the specifics of the most recent reduction, Kohlsdorf said, “As with literally every other function in the company, Marketing is involved in our SG&A objectives. To get into a discussion of the individual functions or departments is not something that we want to do. We feel we have the right level of staffing in marketing for our business right now, especially in the context of driving revenue.” Murphy added, “We have moved some functions around, and some of the affected people are still with the company in different or similar functions. It was not a straight cut; rather, there was some reshuffling to get marketing closer to our customers and to the field.”

Other Restructuring Initiatives

Murphy and Kohlsdorf pointed out that IKON has done a significant amount of restructuring, including the sale of its Mexican and French operations; the elimination or sale of BDS locations, and consolidation of its Legal Document Services locations, once at about 100 locations, and now at about 65. Murphy said, “All of these moves are designed to improve the overall operating income for the company. Our new CFO brings a different view to the company, and it has been a good view. We have a legacy of losing money in BDS and we have lost money there forever. With respect to leasing, when you compare year over year, you will see a decline in revenue as those leases migrate to GE, but our retained portfolio is profitable. A lot of what you see us do is targeted at positioning the company for growth in the future rather than a reaction to the market or to competitive positioning.”

Over the last several years, including under the leadership of former Chairman and CEO Jim Forese, IKON has been working to eliminate what it calls “unprofitable” legacy businesses, including its former Technology Services businesses. In looking at the organization today, it appears that work is mostly completed. When asked about timeframes for revenue and operating income to reverse their downward decline, Murphy stated, “From an operating income standpoint, if you can’t grow revenue immediately, at least you want to make sure you have addressed SG&A. We think we have done both.

Enterprise Services

As Murphy explained, “In May of 2004, we established Enterprise Services under Mike Kohlsdorf’s leadership and by doing so, moved company into the solutions business. Those bets are paying off, and we are seeing dramatic improvements in revenue and operating income in Enterprise Services. We have strong Document Strategy Assessment offerings and a new menu of professional services solutions, complemented by our managed services business, a recasting of LDS back to 65 sites and implementation of our Premium Scan Plus offering in LDS for higher throughput and quality, and our wireless initiatives in Customer Service. We are in a position to continue our progress in Enterprise Services. At some point, these initiatives will contribute to the growth of our hardware business as well.”

Management Team

Murphy was also quick to point out that Matt Espe, IKON’s Chairman and CEO, has assembled a strong management team to develop and execute these strategies.

• Brian Edwards, a 20+ year veteran of IKON, now heads up the company’s sales organization as Senior Vice President of North American Sales. According to Murphy, “He came up through the ranks and knows the business well.”
• Jeff Hickling joined IKON from GE and is running the company’s back office operations, including supply chain and customer care activities as Senior Vice President of Operations.
• Mike Kohlsdorf joined the company after the sale of his previous company to head up Professional Services and now is responsible for all of Enterprise Services and IS as Senior Vice President of Enterprise Services and Information Systems.
• Bob Woods, Senior Vice President and CFO, joined IKON with more than 25 years of experience in financial leadership, most recently serving as Vice President and Controller for IBM,

The management team is rounded out by Beth Sexton, Senior Vice President of Human Resources; Cathy Lewis, Senior Vice President of Marketing; David Mills, Vice President and President of IKON Europe; and Mark Hershey, Senior Vice President and General Counsel.

Summing it Up

On the surface, IKON seems to be making progress, although the numbers are not reflecting it yet. The company is in an extremely competitive market, facing competition not only from big players, including Xerox, Pitney Bowes and its own supplier Canon, but also from a plethora of office products dealers, local outsourcers and value-added resellers. IKON has recognized that the pathway to success is through selling solutions, not boxes, but has a strong box culture in the field to overcome as it executes its plans. 2006 will be a telling year for IKON, whose fiscal year starts October 1. With much of the groundwork completed—the bulk of the Oracle implementation, divestiture of unprofitable businesses, and an SG&A that is headed to the 30% level—the market will clearly expect to see the revenue and operating income lines change for the better.

This report was written by Cary Sherburne. She can be reached via email at cary@sherburneassociates.com, online at www.sherburneassociates.com and by telephone at 603-430-5463.

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