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Danka Business Systems 10-Q 2005

Documents found in this filing:

  1. 10-Q
  2. Ex-31.1
  3. Ex-31.2
  4. Ex-32.1
  5. Ex-32.1
For The Quarterly Period Ended December 31, 2004
Table of Contents

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 


 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2004

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM              TO             

 

Commission file number: 0-20828

 


 

DANKA BUSINESS SYSTEMS PLC

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 


 

ENGLAND & WALES   98-0052869

(STATE OR OTHER JURISDICTION OF

INCORPORATION OR ORGANIZATION)

 

(I.R.S. EMPLOYER

IDENTIFICATION NO.)

 

11101 ROOSEVELT   AND   MASTERS HOUSE 107

BOULEVARD

ST. PETERSBURG, FLORIDA 33716

     

HAMMERSMITH ROAD LONDON

W14 0QH ENGLAND

(ADDRESSES OF PRINCIPAL EXECUTIVE OFFICES)

 

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE:

727-622-2100 in the United States

011-44-207-605-0150 in the United Kingdom

 

NOT APPLICABLE

(FORMER NAME OR FORMER ADDRESS, IF CHANGED SINCE LAST REPORT)

 


 

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  ¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes  x    No  ¨

 

Applicable only to corporate issues:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of February 1, 2005. The registrant had 254,028,656 ordinary shares outstanding, including 50,647,183 represented by American Depositary Shares (“ADS”). Each ADS represents four ordinary shares.

 



Table of Contents

INDEX

 

         Page

RISK FACTORS

   4

PART I – FINANCIAL INFORMATION

   11

ITEM 1.

  CONSOLIDATED FINANCIAL STATEMENTS    11
   

Consolidated Statements of Operations for the Three and Nine Months Ended
December 31, 2004 and 2003

   11
   

Consolidated Balance Sheets as of December 31, 2004 and March 31, 2004

   12
   

Consolidated Statements of Cash Flows for the Nine Months Ended
December 31, 2004 and 2003

   13
   

Consolidated Statements of Shareholders’ Equity (Deficit) for the Nine Months Ended
December 31, 2004 and 2003

   14
   

Notes to Consolidated Financial Statements

   15

ITEM 2.

  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS    33

ITEM 3.

  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK    52

ITEM 4.

  CONTROLS AND PROCEDURES    52

PART II – OTHER INFORMATION

   56

ITEM 1.

  LEGAL PROCEEDINGS    56

ITEM 2.

  CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES    56

ITEM 3.

  DEFAULTS UPON SENIOR SECURITIES    56

ITEM 4.

  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS    56

ITEM 5.

  OTHER INFORMATION    57

ITEM 6.

  EXHIBITS    57

SIGNATURE

   58

 

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Table of Contents

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

 

Certain statements contained herein, or otherwise made by our officers, including statements related to our future performance and our outlook for our businesses and respective markets, projections, statements of our plans or objectives, forecasts of market trends and other matters, are forward-looking statements, and contain information relating to us that is based on our beliefs as well as assumptions, made by, and information currently available to us. The words “goal”, “anticipate”, “expect”, “believe”, “could”, “should”, “intend” and similar expressions as they relate to us are intended to identify forward-looking statements, although not all forward looking statements contain such identifying words. No assurance can be given that the results in any forward-looking statement will be achieved. For the forward-looking statements, we claim the protection of the safe harbor for forward-looking statements provided for in the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, or the Exchange Act. Such statements reflect our current views with respect to future events and are subject to certain risks, uncertainties and assumptions that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that might cause such actual results to differ materially from those reflected in any forward-looking statements include, but are not limited to, the following: (i) any inability to successfully implement our strategy; (ii) any inability to successfully implement our cost restructuring plans to achieve and maintain cost savings; (iii) any inability to comply with the Sarbanes-Oxley Act of 2002; (iv) any material adverse change in financial markets, the economy or in our financial position; (v) increased competition in our industry and the discounting of products by our competitors; (vi) new competition as the result of evolving technology; (vii) any inability by us to procure, or any inability by us to continue to gain access to and successfully distribute new products, including digital products, color products, multi-function products and high-volume copiers, or to continue to bring current products to the marketplace at competitive costs and prices; (viii) any inability to arrange financing for our customers’ purchases of equipment from us; (ix) any inability to successfully enhance, unify and effectively utilize our management information systems; (x) any inability to record and process key data due to ineffective implementation of business processes and policies; (xi) any negative impact from the loss of a key vendor or customer; (xii) any negative impact from the loss of any of our senior or key management personnel; (xiii) any change in economic conditions in markets where we operate or have material investments which may affect demand for our products or services; (xiv) any negative impact from the international scope of our operations; (xv) fluctuations in foreign currencies; (xvi) any incurrence of tax liabilities or tax payments beyond our current expectations, which could adversely affect our liquidity and profitability; (xvii) any inability to comply with the financial or other covenants in our debt instruments; (xviii) any delayed or lost sales or other impacts related to the commercial and economic disruption caused by natural disasters; (xix) any delayed or lost sales and other impacts related to the commercial and economic disruption caused by terrorist attacks, the related war on terrorism, and the fear of additional terrorist attacks; and (xx) other risks including those risks identified in any of our filings with the Securities and Exchange Commission, or the SEC. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect our analysis only as of the date they are made. Except as required by applicable law, we undertake no obligation, and do not intend, to update these forward-looking statements to reflect events or circumstances that arise after the date they are made. Furthermore, as a matter of policy, we do not generally make any specific projections as to future earnings, nor do we endorse any projections regarding future performance, which may be made by others outside our company.

 

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RISK FACTORS

 

Business Strategy—Danka Business Systems PLC (also referred to herein as “Danka” or the “Company”) believes that in order to stay competitive and generate positive earnings and cash flow, we must successfully implement our strategies.

 

In connection with the implementation of our strategies, we have launched, and expect to continue to launch, several operational and strategic initiatives. However, the success of any of these initiatives may not be achieved if:

 

    they are not accepted by our customers;

 

    they do not result in revenue growth, generate cash flow, reduce operating costs or reduce our working capital investments; or

 

    we are unable to provide the hardware, software, solutions or services necessary to successfully implement these initiatives.

 

Failure to implement one or more of our strategies and related initiatives could materially and adversely affect our business, financial condition or results of operations.

 

Operating Earnings—Although we generated operating earnings for the first nine months of fiscal year 2005, we generated an operating loss for the quarter due to decreasing revenues and higher operating costs. If we are not able to stabilize our revenues or reduce our operating costs, these operating losses may continue in the future. The operating losses for the nine months ended December 31, 2003 and for fiscal year 2004 included $20.0 million and $50.0 million in restructuring charges, respectively, and as we continue to evaluate our business and strategies, we could incur future restructuring charges which may materially and adversely affect our operations, financial position or results of operations. If we incur operating losses or do not generate sufficient profitability in the future, our growth potential and our ability to execute our business strategy may be limited. In addition, our ability to service our indebtedness may be impaired because we may not generate sufficient cash flow from operations to pay principal or interest when due.

 

Restructuring of Operations—We have implemented plans to reduce costs in order to become more competitive within our industry. These cost reduction plans involve, among other things, significant headcount reductions, the exit of certain non-strategic facility locations and the consolidation of many back-office functions into more centralized locations and business process changes. If we fail to successfully implement our cost restructuring plans, including the timely sublease of vacant facilities, and fail to achieve our other long-term cost reduction goals, we may not reduce costs quickly enough to become competitive within our industry. Additionally, we may lose valuable institutional knowledge, bear the risk of additional costs and expenses and incur a breakdown in our business and operational functions, including certain critical back-office operations, any of which could result in negative consequences to our customer service, our current internal control environment and operating results.

 

Economic Uncertainty—The profitability of our business is susceptible to uncertainties in the global economy. Overall demand for our products and services and their profit margins may decline as a direct result of an economic recession, inflation, interest rates or governmental fiscal policy. As a result, our customers may reduce or delay expenditures for our products and services.

 

Competition—The industry in which we operate is highly competitive. We have competitors in all markets in which we operate, and our competitors include a number of companies worldwide with significant technological, distribution and financial resources. Competition in our industry is based upon technology, performance, pricing, quality, reliability, distribution, market coverage, customer service and support and lease and rental financing. In addition, our equipment suppliers have established themselves as direct competitors in many of the areas in which we do business.

 

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As our suppliers develop new products, there is no guarantee that they will permit us to distribute such products or that such products will meet our customers’ needs and demands. Furthermore, some of our principal competitors design and manufacture new technology, which may give them a competitive advantage over us.

 

Besides competition from within the office imaging industry, we are also experiencing competition from other sources as a result of evolving technology, including the development of alternative means of document processing, retention, storage and printing. Our retail equipment operations are in direct competition with local and regional equipment suppliers and dealers, manufacturers, mass merchandisers and wholesale clubs. We have suffered, and may continue to suffer, a reduction of our market share because of the high level of competition in our industry. The intense competition in our industry may result in pressure on the prices and margins that we can obtain for our products and may affect our ability to retain customers, both of which could materially and adversely affect our business, financial condition or results of operations.

 

Furthermore, there is a trend arising within the industry to offer on-demand pricing where the customer does not buy or lease the equipment. Rather, the customer is only charged for the number of images produced by the equipment. This trend could require us to increase our rental equipment investments in order to remain competitive.

 

Additionally, the competitive environment hinders employee retention, especially in the sales and service areas, which leads to higher turnover of employees and increased compensation expense.

 

Technological Changes—The industry in which we operate is characterized by rapidly changing technology. Technological changes have contributed to declines in our revenues in the past and may continue to do so in the future. For example, the office imaging industry has changed from analog to digital copiers, multi-function peripherals (“MFPs”) and printers. Most of our digital products replace analog products, which have historically been a significant percentage of our machines in field (“MIF”). Digital copiers and MFPs are more reliable than analog copiers and require less maintenance. Moreover, color printing and copying represents an important and growing part of our industry. We must improve our execution of color sales and meet the demand for color products if we are to maintain and improve our operating performance and our ability to compete.

 

Another industry change that has been fueled by technological changes is the migration of copy volume from traditional stand-alone copiers to network printers. This change allows end users to print distributed documents on printers linked directly to their personal computers as opposed to receiving copies of such documents that were copied on a traditional stand-alone copier. We will need to increasingly provide comprehensive solutions to our customers, such as offering digital copiers, MFPs, software solutions and printers that are directly linked to their networks, in order to remain competitive. Finally, the speed of technological changes may cause us in the future to write down our inventory, including, but not limited to showroom, rental and other equipment and related supplies and parts, including parts and supplies for our TechSource initiative, as a result of obsolescence. In order to remain competitive, we must quickly and effectively respond to changing technology. Otherwise, such developments of technologies in our industry may impair our business, financial condition, results of operations or competitive position.

 

Third Party Financing Arrangements—A large majority of our retail equipment and related sales are financed by third party finance or leasing companies. We have an agreement with General Electric Capital Corporation (or “GECC”), under which GECC has agreed to provide financing to our qualified United States customers to purchase equipment from us. Although we have other financing arrangements in place, GECC finances a significant part of our United States business. GECC has current and prospective lease financing agreements with our competitors. If these agreements result in more favorable terms to our competitors than our current agreement with GECC, we may be placed at a competitive disadvantage within the industry in arranging third party financing to our customers, which could negatively affect our operating results. With respect to our customers outside the United States, we have country by country arrangements with various third party finance and leasing companies.

 

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If we were to breach the covenants or other restrictions in our agreements with one or more of our financing sources, including GECC, such sources might refuse to provide financing to our customers. If one or more of our financing sources were to fail to provide financing to our customers, those customers might be unable to purchase equipment from us if we were unable to arrange alternative financing arrangements on similar terms or provide financing ourselves. In addition, if we were unable to arrange financing, we would lose sales, which could negatively affect our operating results. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Other Financing Arrangements—General Electric Capital Corporation”.

 

Information Systems—Our Europe/Australia and Non-U.S. Americas operations run on numerous disparate legacy IT systems that are outdated and incompatible. The operation and coordination of these management information systems and billings systems is labor intensive and expensive. As such, we have evaluated what information system investments we should make. We have determined that we need to upgrade our information systems in Italy, Germany, the United Kingdom, France, Austria, the Netherlands and other countries and expect to spend $3 million to $6 million over the next 24 months for such upgrades. The failure to successfully upgrade our management information systems, including our customer billing systems in our Europe/Australia and Non-U.S. Americas operations or any disruption in our business processes when we upgrade our IT systems could materially and adversely affect our operations, internal controls, financial position or results of operations.

 

Disaster Recovery—Our systems in the United States are designed for security and reliability. We regularly back up our information systems and subject them to a virus scan. These efforts are intended to buttress the integrity and security of our information systems and the data stored in them, and to minimize the potential for loss in the event of a disaster, including but not limited to natural disasters or terrorist attacks. Our facilities have reserve power generating systems to prevent the loss of product and minimize downtime in the event of shortages.

 

Due to the delayed investment in our information systems in Europe/Australia and Non-U.S. Americas operations, we have not properly invested in world-wide disaster recovery systems. In the event that one or more of our business systems in Europe/Australia and Non-U.S. Americas operations were to fail, we would be at risk of losing valuable business knowledge in the locations where the failure occurred. We are developing a comprehensive disaster recovery plan but until it is implemented, a disaster could materially and adversely affect our business, financial condition, results of operations or competitive position.

 

Business Processes and Policies—Our past rapid expansion through acquisitions, past financial difficulties and a historical lack of focus on, and investment in, our information systems have impeded our ability to develop and implement internal controls and business processes consistently and enforce policies effectively. We have identified instances where we do not have adequate processes in place or our business processes and policies have not been properly implemented or followed in the past, which have resulted in, among other things, poor billing and credit practices, weak customer contract management, excessive and undisciplined issuances of customer credits, inaccurate customer data, inconsistent customer contract terms and conditions, inadequate document retention and inconsistent lease classification. While we believe that some of these issues that relate to the United States have been addressed with the implementation of new manual internal control procedures and the implementation of our Oracle ERP system, which is configured with better system internal controls, there is no assurance that all of these issues will be completely corrected by such changes.

 

Vendor Relationships—We primarily have relationships with Canon, Ricoh, Toshiba, Nexpress, Kodak and Konica-Minolta. These companies manufacture equipment, parts, supplies and software for resale by us in the markets in which we operate. We also rely on our equipment suppliers for related parts and supplies and for financial support in certain competitive transactions and markets which may include vendor rebates and market development funds. Any inability to obtain equipment, parts, supplies or software in the volumes required and at competitive prices from our major vendors, or the loss of any major vendor, or the lack of vendor support may seriously harm our business because we may not be able to supply those vendors’ products to our customers on a timely basis in sufficient quantities or at all. In addition, we rely on our vendors to effectively respond to

 

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changing technology and manufacture new products to meet the demands of evolving customer needs. There is no guarantee that these vendors or any of our other vendors will effectively respond to changing technology, continue to sell their products and services to us, or that they will do so at competitive prices. Other factors, including reduced access to credit by our vendors resulting from economic conditions, may impair our vendors’ ability to effectively respond to changing technology or provide products in a timely manner or at competitive prices.

 

International Scope of Operations—We are incorporated under the laws of England and Wales, and we conduct a significant portion of our business outside of the United States. We generated 54% of our revenue outside the United States during the first nine months of fiscal year 2005. We market office imaging equipment, document solutions and related services and supplies directly to customers in over 20 countries. The international scope of our operations may lead to volatile financial results and difficulties in managing our operations because of, but not limited to, the following:

 

    difficulties and costs of staffing, social responsibility and managing international operations;

 

    currency restrictions and exchange rate fluctuations;

 

    unexpected changes in regulatory requirements;

 

    potentially adverse tax and tariff consequences;

 

    the burden of complying with multiple and potentially conflicting laws;

 

    the impact of business cycles, including potentially longer payment cycles, in any particular region;

 

    the geographic, time zone, language and cultural differences between personnel in different areas of the world;

 

    greater difficulty in collecting accounts receivables in and moving cash out of certain countries;

 

    the need for a significant amount of available cash to fund operations in a number of geographic and economically diverse locations; and

 

    political, social and economic instability in any particular region, including Central America and South America.

 

With respect to our international operations that are experiencing difficulties as described above, we continue to evaluate the viability and future prospects of these businesses. Based on these evaluations, during the quarter ended December 31, 2004, we implemented plans to exit our operations in Portugal and Russia. Should we decide to downsize or exit any other of these businesses, we could incur costs relating to severance, closure of facilities and write-off of goodwill, and we may also be required to recognize cumulative translation losses and minimum pension liabilities that would reduce our earnings.

 

Any of these factors could materially and adversely affect our business, financial condition or results of operations.

 

Currency Fluctuations—As a multinational company, changes in currency exchange rates affect our revenues, cost of sales and operating expenses. In addition, fluctuations in exchange rates between the United States dollar and the currencies in each of the countries in which we operate affect the results of our operations and the value of the net assets of our non-United States operations when reported in United States dollars in our United States financial statements. These fluctuations may negatively impact our results of operations or financial condition or, in some circumstances, may positively impact our results of operations disproportionately to underlying levels of actual growth or improvement in our businesses.

 

The majority of our revenues outside the United States are denominated in either the euro or the British pound sterling. During the quarter ended December 31, 2004, the euro strengthened 2.29% against the United States dollar and the British pound sterling strengthened 1.0% against the United States dollar which positively impacted our reported revenue and net earnings on a sequential basis.

 

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Further, our intercompany loans are subject to fluctuations in exchange rates between the United States dollar and the currencies in each of the countries in which we operate, primarily the euro and the British pound sterling. Based on the outstanding balance of our intercompany loans at December 31, 2004, an increase of 1% in the exchange rate for the euro and British pound sterling would cause a foreign exchange loss of approximately $0.3 million, while a decrease of 1% in the exchange rate of the euro and the British pound sterling would cause a foreign exchange gain of approximately $0.3 million.

 

Moreover, we pay for some inventory in euro countries in United States dollars, but we generally invoice our customers in such countries in euros. If the euro weakens against the United States dollar, our operating margins and cash flow may be negatively impacted when we receive payment in euros but we pay our suppliers in United States dollars.

 

We do not currently hedge our exposure to changes in foreign currency.

 

Tax Payments—We are either currently under audit or may be audited in the key jurisdictions in which we operate. While we believe we are adequately reserved for such liabilities, should revenue agencies impose assessments or require payments in excess of those we currently expect to pay, we could be required to record additional liabilities or our liquidity could be further affected based upon the size and timing of such payments.

 

Indebtedness—At December 31, 2004, we had consolidated long-term indebtedness, including current maturities of long-term debt and notes payable, of $244.0 million which included $64.5 million in principal amount of 10% subordinated notes due April 1, 2008 and $175.0 million in principal amount of 11% senior notes due June 15, 2010, less unamortized discount of $3.5 million. The subordinated notes accrue interest which is paid every six months on April 1 and October 1 while the senior notes have interest payable every six months on June 15 and December 15.

 

The amount of our indebtedness could have important consequences to us, including the following:

 

    use of a portion of our cash flow to pay interest on our indebtedness will reduce the availability of our cash flow to fund working capital, capital expenditures, strategic initiatives and other business activities, including keeping pace with the technological, competitive and other changes currently affecting our industry;

 

    increase our vulnerability to general adverse economic and industry conditions;

 

    limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

 

    limit our ability in making strategic acquisitions or exploiting business opportunities; and

 

    limit our operational flexibility, including our ability to borrow additional funds or dispose of assets.

 

Debt and Credit Facilities—The indenture governing our senior notes, our $50 million senior secured revolving credit facility with Fleet Capital Corporation (or “Fleet Credit Facility”) and our euro 11.8 million letter of credit facility with ABN AMRO contains covenants that, among other things, limit our ability to: (1) incur additional indebtedness or, in the case of our restricted subsidiaries, issue preferred stock; (2) create liens; (3) pay dividends or make other restricted payments; (4) make certain investments; (5) sell or make certain dispositions of assets or engage in sale and leaseback transactions; (6) engage in transactions with affiliates; (7) engage in certain business activities; and (8) engage in mergers or consolidations. They also restrict the ability of our restricted subsidiaries to pay dividends, or make other payments to us. In addition, the indenture governing the senior notes may require us to use a portion of our excess cash flow (as defined in the indenture) to repay other senior indebtedness or offer to repurchase the senior notes.

 

Disclosure Controls and Procedures and Internal Controls—We maintain disclosure controls and procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act is recorded, processed, summarized and reported within the time periods

 

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specified in the SEC’s rules and forms and that such information is accumulated and communicated to our Audit Committee and management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. We also maintain internal controls that are designed with the objective of providing reasonable assurance that (1) our transactions are properly authorized; (2) our assets are safeguarded against unauthorized or improper use; and (3) our transactions are properly recorded and reported, in order to permit the preparation of our financial statements in conformity with generally accepted accounting principles and to comply with Sections 302, 906 and 404 of the Sarbanes-Oxley Act.

 

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of one or more individuals, by collusion of two or more individuals, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Further, because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

Compliance with Sarbanes-Oxley Act of 2002—We are in the process of documenting and testing our internal control procedures in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act, which, beginning at the end of this fiscal year, requires annual management assessments of the design and effectiveness of our internal control over financial reporting and a report by our Independent Registered Certified Public Accounting Firm addressing these assessments. Compliance with this legislation will continue to divert management’s attention and resources and will cause us to incur significant expense during this period and in the foreseeable future. There can be no guarantees that management will conclude the work necessary to complete its assessment of internal control over financial reporting in time to comply with the requirements of Section 404 of the Sarbanes-Oxley Act.

 

In addition, if we fail to achieve and maintain the adequacy of our internal controls, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal controls over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act. If this were to occur, we may be unable to assert that the internal control over financial reporting is effective, or our Independent Registered Certified Public Accounting Firm may not be able to render the required attestation concerning our assessment and the effectiveness of the internal controls over financial reporting, which could adversely impact our business.

 

Share Price—The market price of our ordinary shares and American Depository Shares (or “ADSs”) could be subject to significant fluctuations as a result of many factors. In addition, global stock markets have from time to time experienced significant price and volume fluctuations. These fluctuations may lead to a drop in the market price of our ordinary shares and ADSs. Factors which may add to the volatility of the price of our ordinary shares and ADSs include many of the factors set out above, and may also include changes in liquidity in the market for our ordinary shares and ADSs, sales of our ordinary shares and ADSs, investor sentiment towards the business sector in which we operate and conditions in the capital markets generally. Many of these factors are beyond our control. These factors may change the market price of our ordinary shares and ADSs, regardless of our operating performance.

 

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Dividends on Ordinary Shares—We have not paid any cash or other dividends on our ordinary shares since 1998 and we do not expect to do so for the foreseeable future. We are an English company and, under English law, we are allowed to pay dividends to shareholders only if, as determined by reference to our financial statements prepared in accordance with UK GAAP:

 

    we have accumulated, realized profits that have not been previously distributed or capitalized, in excess of our accumulated, realized losses that have not previously been written off in a reduction or reorganization of capital; and

 

    our net assets are not less than the aggregate of our share capital and our non-distributable reserves, either before or as a result of the dividend.

 

As of the date of filing of this quarterly report, we have insufficient accumulated, realized profits to pay dividends on our ordinary shares. In addition, our Fleet Credit Facility prohibits us from paying dividends on our ordinary shares without our lenders’ consent, and the indenture governing the senior notes restricts our ability to pay such dividends. Also, we may only pay dividends on our ordinary shares if we have paid all dividends due on our 6.50% senior convertible participating shares.

 

ADDITIONAL INFORMATION AVAILABLE ON COMPANY WEB-SITE

 

Our most recent Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports may be viewed or downloaded electronically from our website: http://www.danka.com as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our recent press releases are also available to be viewed or downloaded electronically at http://www.danka.com. We will also provide electronic or paper copies of our SEC filings free of charge on request. Any information on or linked from our website is not incorporated by reference into this Quarterly Report on Form 10-Q.

 

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PART I – FINANCIAL INFORMATION

 

Item 1. Consolidated Financial Statements

 

Danka Business Systems PLC

Consolidated Statements of Operations for the Three and Nine Months Ended

December 31, 2004 and 2003

(In thousands, except per American Depositary Share (“ADS”) amounts)

(Unaudited)

 

     For the Three Months Ended

    For the Nine Months Ended

 
    

December 31,

2004


   

December 31,

2003


   

December 31,

2004


   

December 31,

2003


 

Revenue:

                                

Retail equipment and related sales

   $ 111,831     $ 114,607     $ 326,109     $ 342,608  

Retail service

     151,451       156,493       455,161       477,717  

Retail supplies and rentals

     25,147       35,012       81,472       97,176  

Wholesale

     25,354       24,969       70,020       70,328  
    


 


 


 


Total revenue

     313,783       331,081       932,762       987,829  
    


 


 


 


Costs of sales:

                                

Retail equipment and related sales costs

     72,024       74,373       211,913       226,260  

Retail service costs

     92,716       95,940       270,137       284,344  

Retail supplies and rental costs

     14,305       20,614       48,293       57,622  

Wholesale costs

     21,448       20,132       57,877       56,832  
    


 


 


 


Total cost of sales

     200,493       211,059       588,220       625,058  
    


 


 


 


Gross profit

     113,290       120,022       344,542       362,771  

Operating expenses:

                                

Selling, general and administrative expenses

     116,392       108,720       335,322       346,322  

Restructuring charges (credits)

     (390 )     20,046       (2,459 )     19,452  

Other expense (income), net

     1,519       1,861       2,048       1,651  
    


 


 


 


Total operating expenses

     117,521       130,627       334,911       367,425  
    


 


 


 


Operating earnings (loss)

     (4,231 )     (10,605 )     9,631       (4,654 )

Interest expense

     (8,154 )     (7,931 )     (23,263 )     (25,753 )

Interest income

     206       429       814       978  

Write-off of debt issuance costs

     —         —         —         (20,562 )
    


 


 


 


Earnings (loss) before income taxes

     (12,179 )     (18,107 )     (12,818 )     (49,991 )

Provision (benefit) for income taxes

     (16,635 )     (1,166 )     (15,855 )     (14,995 )
    


 


 


 


Net earnings (loss)

   $ 4,456     $ (16,941 )   $ 3,037     $ (34,996 )
    


 


 


 


Calculation of earnings (loss) per ADS

                                

Earnings (loss)

   $ 4,456     $ (16,941 )   $ 3,037     $ (34,996 )

Dividends and accretion on participating shares

     (5,111 )     (4,811 )     (15,108 )     (14,216 )
    


 


 


 


Income (loss) available to common shareholders

   $ (655 )   $ (21,752 )   $ (12,071 )   $ (49,212 )
    


 


 


 


Basic and diluted earnings (loss) available to common shareholders per ADS:

                                

Net earnings (loss) per ADS

   $ (0.01 )   $ (0.35 )   $ (0.19 )   $ (0.79 )
    


 


 


 


Weighted average ADSs

     63,185       62,531       62,938       62,474  

 

See accompanying notes to the consolidated financial statements

 

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Danka Business Systems PLC

Consolidated Balance Sheets as of December 31, 2004 and March 31, 2004

(In thousands)

 

    

December 31,

2004


    March 31,
2004


 
     (Unaudited)        

Assets

                

Current assets:

                

Cash and cash equivalents

   $ 89,254     $ 112,790  

Accounts receivable, net

     251,594       246,996  

Inventories

     118,722       93,295  

Prepaid expenses, deferred income taxes and other current assets

     18,345       16,862  
    


 


Total current assets

     477,915       469,943  

Equipment on operating leases, net

     24,202       29,478  

Property and equipment, net

     54,821       65,888  

Goodwill, net

     302,821       282,430  

Other intangible assets, net

     2,472       2,340  

Deferred income taxes

     7,981       7,688  

Other assets

     25,215       25,801  
    


 


Total assets

   $ 895,427     $ 883,568  
    


 


Liabilities and shareholders’ equity (deficit)

                

Current liabilities:

                

Current maturities of long-term debt and notes payable

   $ 4,185     $ 3,212  

Accounts payable

     168,464       135,460  

Accrued expenses and other current liabilities

     94,080       128,963  

Taxes payable

     36,134       47,200  

Deferred revenue

     44,082       45,090  
    


 


Total current liabilities:

     346,945       359,925  

Long-term debt and notes payable, less current maturities

     239,848       240,761  

Deferred income taxes and other long-term liabilities

     65,201       68,029  
    


 


Total liabilities

     651,994       668,715  
    


 


6.5% senior convertible participating shares

     294,716       279,608  

Shareholders’ equity (deficit):

                

Ordinary shares, 1.25 pence stated value

     5,268       5,194  

Additional paid-in capital

     328,876       328,070  

Accumulated deficit

     (354,657 )     (342,586 )

Accumulated other comprehensive loss

     (30,770 )     (55,433 )
    


 


Total shareholders’ equity (deficit)

     (51,283 )     (64,755 )
    


 


Total liabilities and shareholders’ equity (deficit)

   $ 895,427     $ 883,568  
    


 


 

See accompanying notes to the consolidated financial statements

 

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Danka Business Systems PLC

Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2004 and 2003

(In thousands)

(Unaudited)

 

     For the Nine Months Ended

 
     December 31,
2004


    December 31,
2003


 

Operating activities:

                

Net earnings (loss)

   $ 3,037     $ (34,996 )

Adjustments to reconcile net earnings (loss) to net cash provided by (used in) operating activities:

                

Depreciation and amortization

     29,532       39,274  

Deferred income taxes

     837       (14,352 )

Amortization of debt issuance costs

     1,487       4,993  

Write-off of debt issuance costs

     —         20,562  

(Gain) loss on sale of property and equipment and equipment on operating leases

     (1,395 )     1,959  

Proceeds from sale of equipment on operating leases

     3,220       2,790  

Restructuring charges (credits)

     (2,459 )     19,452  

Changes in net assets and liabilities:

                

Accounts receivable, net

     (4,052 )     16,440  

Inventories

     (25,161 )     4,900  

Prepaid expenses and other current assets

     (1,464 )     3,345  

Other non-current assets

     5,061       2,412  

Accounts payable

     32,589       (19,696 )

Accrued expenses and other current liabilities

     (43,691 )     1,230  

Deferred revenue

     (1,099 )     2,706  

Other long-term liabilities

     (3,422 )     1,254  
    


 


Net cash provided by (used in) operating activities

     (6,980 )     52,273  
    


 


Investing activities:

                

Capital expenditures

     (16,292 )     (35,872 )

Purchase of subsidiary, net of cash acquired

     (2,110 )     —    

Proceeds from sale of subsidiary

     209       —    

Proceeds from the sale of property and equipment

     313       706  
    


 


Net cash used in investing activities

     (17,880 )     (35,166 )
    


 


Financing activities:

                

Net borrowings (payments) under line of credit agreements

     506       (112,960 )

Net borrowings (payments) under capital lease arrangements

     (1,794 )     2,436  

Principal payments of debt

     —         (48,867 )

Proceeds from debt issuance

     —         170,905  

Payment of debt issue costs

     —         (10,767 )

Proceeds from stock options exercised

     880       —    
    


 


Net cash provided by (used in) financing activities

     (408 )     747  
    


 


Effect of exchange rates

     1,732       5,708  
    


 


Net increase (decrease) in cash and cash equivalents

     (23,536 )     23,562  

Cash and cash equivalents, beginning of period

     112,790       81,493  
    


 


Cash and cash equivalents, end of period

   $ 89,254     $ 105,055  
    


 


 

See accompanying notes to the consolidated financial statements

 

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Danka Business Systems PLC

Consolidated Statements of Shareholders’ Equity (Deficit)

For the Nine Months Ended December 31, 2004 and 2003

(In thousands)

(Unaudited)

 

    

Number of
Ordinary

Shares

(4 Ordinary
Shares Equal

1 ADS)


   Ordinary
Shares


   Additional
Paid-In
Capital


   Accumulated
Deficit


    Accumulated
Other
Comprehensive
Income/(Loss)


    Total

 

Balances at March 31, 2004

   250,812    $ 5,194    $ 328,070    $ (342,586 )   $ (55,433 )   $ (64,755 )
                                       


Net earnings (loss)

   —        —        —        3,037       —         3,037  

Currency translation adjustment

   —        —        —        —         24,663       24,663  
                                       


Comprehensive income

                                        27,700  

Dividends and accretion on participating shares

   —        —        —        (15,108 )     —         (15,108 )

Shares issued under employee stock plans, net of tax

   3,191      74      806      —         —         880  
    
  

  

  


 


 


Balances at December 31, 2004

   254,003    $ 5,268    $ 328,876    $ (354,657 )   $ (30,770 )   $ (51,283 )
    
  

  

  


 


 


Balances at March 31, 2003

   249,532    $ 5,167    $ 327,173    $ (189,995 )   $ (76,636 )   $ 65,709  
                                       


Net earnings (loss)

   —        —        —        (34,996 )     —         (34,996 )

Minimum pension liability adjustment

   —        —        —        —         (2,260 )     (2,260 )

Currency translation adjustment

   —        —        —        —         28,518       28,518  
                                       


Comprehensive loss

                                        (8,738 )

Dividends and accretion on participating shares

   —        —        —        (14,113 )     —         (14,113 )

Shares issued under employee stock plans, net of tax

   772      15      595      —         —         610  
    
  

  

  


 


 


Balances at December 31, 2003

   250,304    $ 5,182    $ 327,768    $ (239,104 )   $ (50,378 )   $ 43,468  
    
  

  

  


 


 


 

 

See accompanying notes to the consolidated financial statements

 

 

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Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands, except per American Depositary Share (“ADS”) amounts)

(Unaudited)

 

Note 1. Basis of Presentation

 

The accompanying financial statements of Danka Business Systems PLC (the “Company”) are unaudited for the three and nine month periods ended December 31, 2004 and 2003. In the opinion of management, all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of the results of operations for the interim periods presented have been reflected herein. The consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended March 31, 2004.

 

The Company’s operations have historically experienced lower revenue during the second quarter of its fiscal year, which is the three month period ended September 30. This is primarily due to increased vacation time by European and Canadian residents during July and August and lower levels of retail service revenue from U.S. governmental agencies. This has historically resulted in reduced sales activity and reduced usage of photocopiers, facsimiles and other office imaging equipment during the second quarter. Accordingly, the results of operations for the interim periods are not necessarily indicative of the results which may be expected for the entire fiscal year.

 

The financial statements contained herein for the three and nine months ended December 31, 2004 do not comprise statutory accounts within the meaning of Section 240 of the United Kingdom Companies Act 1985. Statutory accounts for the year ended March 31, 2004 were delivered to the Registrar of Companies for England and Wales on December 15, 2004 following the Company’s 2004 annual general meeting. The independent auditors’ report on those statutory accounts was unqualified and did not contain a statement under Section 237(2) or 237(3) of the United Kingdom Companies Act 1985.

 

The Company’s cash balance includes restricted cash of $11.8 million.

 

Certain prior year amounts have been reclassified to conform to current year presentation.

 

Note 2. Interim Period Stock Compensation Disclosures

 

As permitted by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), the Company accounts for its stock option plans under the intrinsic value recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. As the exercise prices of all options granted under these plans were equal to the market price of the underlying American Depository Shares (“ADS”) on the grant date, no stock-based employee compensation cost was recognized in net earnings (loss). In general, these options expire in ten years and vest over three years. The proceeds from options exercised are credited to shareholders’ equity (deficit).

 

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Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands, except per American Depositary Share (“ADS”) amounts)—(Continued)

(Unaudited)

 

The following table illustrates the effect on basic and diluted net earnings (loss) available and earnings (loss) available per ADS shareholder if the Company had applied the fair value recognition provisions of SFAS 123 (using the Black-Scholes option pricing model) to employee stock benefits, including ADS shares issued under the stock option plans. For purposes of this pro-forma disclosure, the estimated fair value of the options is assumed to be amortized to expense over the options’ vesting periods.

 

    

For the Three Months Ended

December 31,


   

For the Nine Months Ended

December 31,


 
     2004

    2003

    2004

    2003

 

Net earnings (loss), as reported

   $ 4,456     $ (16,941 )   $ 3,037     $ (34,996 )

Less: total stock-based employee compensation expense determined under the fair value provisions of SFAS 123 for all awards, net of tax

     (913 )     (1,035 )     (2,797 )     (2,869 )
    


 


 


 


Pro forma net earnings (loss)

     3,543       (17,976 )     240       (37,865 )

Participating share dividend

     (5,111 )     (4,811 )     (15,108 )     (14,216 )
    


 


 


 


Pro forma income (loss) available to common shareholders

   $ (1,568 )   $ (22,787 )   $ (14,868 )   $ (52,081 )
    


 


 


 


Basic and diluted earnings (loss) available to common shareholders per ADS

                                

As reported

   $ (0.01 )   $ (0.35 )   $ (0.19 )   $ (0.79 )

Pro forma

     (0.02 )     (0.36 )     (0.24 )     (0.83 )

Weighted average ADSs

     63,185       62,531       62,938       62,474  

 

Note 3. Recent Accounting Pronouncements

 

In December 2003, the Financial Accounting Standards Board (the “FASB”) revised FASB Statement No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits (“SFAS 132”).” The revised standard mandates additional required disclosures for pensions and other postretirement benefit plans and is designed to improve disclosure transparency within financial statements and requires certain disclosures to be made on a quarterly basis. The revised standard replaces existing pension disclosure requirements. Compliance with SFAS 132 was generally effective for fiscal periods beginning after December 15, 2003. However, since all of the required disclosures relate to the Company’s international plans, the implementation rules are effective for the Company’s year ending March 31, 2005 and as such, no interim period disclosures have been made in this quarterly report on Form 10-Q. The Company does not anticipate the adoption of SFAS 132 to have a material impact on its consolidated financial statements.

 

In March 2004, the Emerging Issues Task Force reached a consensus on Issue 03-6, “Participating Securities and the Two-Class Method under FAS 128, Earnings per Share” (“EITF 03-6”). EITF 03-6 requires the use of the two-class method in calculating basic earnings per share by issuers with participating convertible securities. Companies were required to retroactively apply EITF 03-6 to participating securities in the quarter beginning April 1, 2004. The Company adopted EITF 03-6 in the quarter beginning April 1, 2004. Due to the Company’s capital structure and insufficient income, the adoption had no impact on its consolidated financial statements or earnings available per share presented herein.

 

In December 2004, the FASB issued FASB Statement No. 123R, “Share-Based Payment (“SFAS 123R”),” which revises FASB Statement No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”, and its related implementation

 

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Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands, except per American Depositary Share (“ADS”) amounts)—(Continued)

(Unaudited)

 

guidance. SFAS 123R requires public entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award in the statement of operations. Pro forma disclosure is no longer allowable under the new standard. The cost will be recognized over the period during which an employee is required to provide service in exchange for the reward - the requisite service period, usually the vesting period. Adoption of SFAS 123R is required as of the beginning of the first interim reporting period that begins after June 15, 2005. As of December 31, 2004, the Company had not yet assessed the impact the adoption of SFAS 123R will have on its consolidated financial statements.

 

Note 4. Restructuring Charges (Credits)

 

Fiscal Year 2005 Charge: In fiscal year 2005, the Company formulated plans to continue to reduce its selling, general and administrative costs by reducing headcount in Europe/Australia. As part of these plans, the Company recorded a $0.9 million restructuring charge in the first nine months of fiscal year 2005. Cash outlays for the employee severance during the nine months ended December 31, 2004 were $0.8 million. The remaining liability of the 2005 restructuring charge, totaling $0.1 million is categorized within “Accrued expenses and other current liabilities”.

 

The following table summarizes the fiscal year 2005 restructuring charge:

 

2005 Restructuring Charge:

 

     Fiscal 2005
Expense


   Cash
Outlays


    Other
Non-Cash
Changes


  

Reserve at
December 31,

2004


Severance

   $ 855    $ (733 )     11    $ 133

Future lease obligations on facility closures

     29      (29 )     —        —  
    

  


 

  

Total

   $ 884    $ (762 )   $ 11    $ 133
    

  


 

  

 

Fiscal Year 2004 Charge: In fiscal year 2004, the Company formulated plans to significantly reduce its selling, general and administrative costs by consolidating its back-office functions in the United States, exiting non-strategic real estate facilities and reducing headcount in the Americas and Europe/Australia. As part of these plans, the Company recorded a $50.6 million restructuring charge in fiscal year 2004 that included $26.9 million related to severance for employees and $23.7 million related to future lease obligations for facilities that were vacated by March 31, 2004. These charges were accounted for under the provisions of Statement of Financial Accounting Standards No. 112, “Employers’ Accounting for Postemployment Benefits” (“SFAS 112”) and Statement of Financial Accounting Standards No. 146, “Accounting for Cost Associated with Exit or Disposal Activities” (“SFAS 146”). Cash outlays for the employee severance during the nine months ended December 31, 2004 were $10.1 million. Cash outlays for the remaining terms of the facility leases during the nine months ending December 31, 2004 were $6.4 million. If these leases are not terminated, the Company’s payments will continue through their respective terms unless otherwise disposed of. The Company reversed $2.5 million and $0.8 million of fiscal year 2004 severance and facility charges during the second and third quarters of fiscal year 2005, respectively, as a result of employee attrition in its Americas and Europe/Australia segments, a change in restructuring plans in the Europe/Australia segment partially offset by a higher estimate of facility charges in the Americas. The remaining non-cash changes of $0.6 million relate to foreign currency movements. The remaining liability of the 2004 restructuring charge of $10.8 million and $11.2 million is categorized within “Accrued expenses and other current liabilities” and “Deferred income taxes and other long-term liabilities, respectively.”

 

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Table of Contents

Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands, except per American Depositary Share (“ADS”) amounts)—(Continued)

(Unaudited)

 

The following table summarizes the fiscal year 2004 restructuring charge:

 

2004 Restructuring Charge:

 

     Fiscal 2004
Expense


  

Reserve at

March 31,

2004


   Cash
Outlays


    Other
Non-Cash
Changes


   

Reserve at
December 31,

2004


Severance

   $ 26,910    $ 21,524    $ (10,079 )   $ (4,385 )   $ 7,060

Future lease obligations on facility closures

     23,684      20,842      (6,385 )     434       14,891
    

  

  


 


 

Total

   $ 50,594    $ 42,366    $ (16,464 )   $ (3,951 )   $ 21,951
    

  

  


 


 

 

2004 Restructuring Severance Charge by Operating Segment:

 

     Fiscal 2004
Expense


  

Reserve at

March 31,

2004


   Cash
Outlays


    Other
Non-Cash
Changes


   

Reserve at
December 31,

2004


Americas

   $ 8,768    $ 5,946    $ (4,356 )   $ (916 )   $ 674

Europe/Australia

     17,957      15,393      (5,675 )     (3,332 )     6,386

Other

     185      185      (48 )     (137 )     —  
    

  

  


 


 

Total

   $ 26,910    $ 21,524    $ (10,079 )   $ (4,385 )   $ 7,060
    

  

  


 


 

 

2004 Restructuring Facility Charge by Operating Segment:

 

     Fiscal 2004
Expense


  

Reserve at

March 31,

2004


   Cash
Outlays


    Other
Non-Cash
Changes


   

Reserve at
December 31,

2004


Americas

   $ 13,552    $ 10,840    $ (4,667 )   $ 261     $ 6,434

Europe/Australia

     6,126      6,354      (570 )     (266 )     5,518

Other

     4,006      3,648      (1,148 )     439       2,939
    

  

  


 


 

Total

   $ 23,684    $ 20,842    $ (6,385 )   $ 434     $ 14,891
    

  

  


 


 

 

Fiscal Year 2002 Charge: The Company’s fiscal year 2002 restructuring charge included $4.9 million related to severance for 355 employees in the Americas and Europe/Australia. The restructuring charge also included $6.1 million for future lease obligations on 39 facilities that were vacated by March 31, 2002. Cash outlays for the reductions during the nine months ended December 31, 2004 were $0.2 million. Due to a change in estimate, the Company reversed $0.5 million of fiscal year 2002 severance and facility charges during the first quarter of fiscal year 2004. The remaining liability of the 2002 restructuring charge is categorized within “Accrued expenses and other current liabilities.”

 

The following table summarizes the fiscal year 2002 restructuring charge:

 

2002 Restructuring Charge:

 

     Fiscal 2002
Expense


  

Reserve at

March 31,

2004


   Cash
Outlays


    Other
Non-Cash
Changes


  

Reserve at
December 31,

2004


Severance

   $ 4,967    $ 132    $ (7 )   $ 21    $ 146

Future lease obligations on facility closures

     6,074      215      (229 )     14      —  
    

  

  


 

  

Total

   $ 11,041    $ 347    $ (236 )   $ 35    $ 146
    

  

  


 

  

 

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Table of Contents

Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands, except per American Depositary Share (“ADS”) amounts)—(Continued)

(Unaudited)

 

The remaining balance of the 2002 Restructuring Charge is for the Company’s Europe/Australia operating segment.

 

Note 5. Income Taxes

 

The Company recorded an income tax benefit of $15.9 million in the first nine months of fiscal year 2005 compared to a benefit of $15.0 million in the prior year period. The tax benefit for the current period is attributable to adjustments to tax liabilities and valuation allowance for prior periods of $19.0 million less tax expense attributable to current year results of $3.1 million. The adjustments primarily related to favorable settlements of tax audits in the Company’s European operations partially offset by increases in tax liabilities in the U.S. The Company recognized a tax expense on the current year operating loss due to the inability to recognize a tax benefit on the losses incurred in most jurisdictions. In the prior year period, the Company recognized an operating loss which generated an income tax benefit of $11.8 million. In addition, the Company reversed $3.2 million in foreign tax accruals in the prior year period.

 

The tax rate for the first nine months of fiscal year 2005 was 124% compared to a rate of 30% in the prior year period. The net increase in the tax rate is comprised of two counter active factors. The rate decreased due to the inability to recognize a tax benefit on losses incurred in most jurisdictions. The rate increased due to the adjustment of accrued tax liabilities relating primarily to favorable tax audit settlements.

 

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences which give rise to the deferred tax asset become deductible. The Company’s past financial performance is a significant factor which contributes to its inability, pursuant to Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS 109”), to use projections of future taxable income in assessing the realizability of deferred tax assets. Management therefore is limited to considering the scheduled reversal of deferred tax liabilities and tax planning strategies in making this assessment. Due to the inability to use projections of future taxable income in making its assessment, management concluded that it is not “more likely than not” that the Company will realize the benefits of certain deferred tax assets at December 31, 2004. The Company has a valuation allowance against deferred tax assets in most jurisdictions at December 31, 2004.

 

Note 6. Earnings (Loss) Per Share

 

The effect of the Company’s 6.5% senior convertible participating shares, which represent the ADSs shown in the table below are not included in the computation of diluted earnings per share for the three and nine months ended December 31, 2004 and 2003 because they are anti-dilutive as the Company incurred losses available to common shareholders. Stock options representing the ADSs shown in the table below, presented using the treasury stock method, are not included in the computation of diluted earnings per share for the three and nine months ended December 31, 2004 and 2003 because they are anti-dilutive as the Company is in a loss position. The total number of outstanding shares related to stock options (all of which are anti-dilutive) was 8,036 and 8,566 at December 31, 2004 and 2003, respectively.

 

Potential ADSs issuance from:

 

    

Three Months Ended

December 31,


  

Nine Months Ended

December 31,


     2004

   2003

   2004

   2003

6.5% senior convertible participating shares

   23,861    22,372    23,486    22,020

Stock options

   1,701    1,513    2,109    1,717

 

19


Table of Contents

Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands, except per American Depositary Share (“ADS”) amounts)—(Continued)

(Unaudited)

 

Note 7. Segment Reporting

 

Historically, the Company had been organized into three reporting segments: United States, Europe and International. The International segment included the Company’s operations in Canada, Central America, South America and Australia. As of April 1, 2004, the Company changed its operating organization into two reporting segments, the Americas and Europe/Australia. The geographical areas covered by the Americas segment include the United States, Canada, Central America and South America while the Europe/Australia segment includes operations in Europe and Australia. Consequently, the Company’s primary areas of management and decision-making are now the Americas and Europe/Australia. Danka’s Americas and Europe/Australia segments provide office imaging equipment, document solutions and related services and supplies on a direct basis to retail customers. The Company’s Europe/Australia segment also provides office imaging equipment and supplies on a wholesale basis to independent dealers. The Company’s management relies on an internal management reporting process that provides segment revenue and operating earnings. Management believes that this is an appropriate measure of evaluating the operating performance of our segments. The following tables present information about the Company’s segments. Fiscal year 2004 amounts have been restated to reflect the Company’s new operating organization.

 

     For the Three Months Ended

    For the Nine Months Ended

 
    

December 31,

2004


   

December 31,

2003


   

December 31,

2004


   

December 31,

2003


 

Revenues

                                

Americas

   $ 155,129     $ 180,328     $ 481,331     $ 539,797  

Europe/Australia

     158,654       150,753       451,431       447,998  

Other (1)

     —         —         —         34  
    


 


 


 


Total Revenues

   $ 313,783     $ 331,081     $ 932,762     $ 987,829  
    


 


 


 


Gross Profit

                                

Americas

   $ 63,568     $ 70,662     $ 197,252     $ 216,092  

Europe/Australia

     49,722       48,845       147,290       146,142  

Other (1)

     —         515       —         537  
    


 


 


 


Total Gross Profit

   $ 113,290     $ 120,022     $ 344,542     $ 362,771  
    


 


 


 


Operating Earnings (Loss)

                                

Americas

   $ 4,586     $ 10,107     $ 22,063     $ 15,056  

Europe/Australia

     1,832       4,911       13,163       16,418  

Other (1)

     (10,649 )     (25,623 )     (25,595 )     (36,128 )
    


 


 


 


Total Operating Earnings (Loss)

   $ (4,231 )   $ (10,605 )   $ 9,631     $ (4,654 )
    


 


 


 


Capital Expenditures

                                

Americas

   $ 3,551     $ 2,635     $ 7,145     $ 23,087  

Europe/Australia

     2,317       4,698       8,527       10,021  

Other (2)

     65       (2,548 )     620       2,764  
    


 


 


 


Total Capital Expenditures

   $ 5,933     $ 4,785     $ 16,292     $ 35,872  
    


 


 


 


Depreciation and Amortization

                                

Americas

   $ 6,633     $ 9,528     $ 20,071     $ 27,888  

Europe/Australia

     2,663       4,593       7,806       10,239  

Other (1)

     643       457       1,655       1,147  
    


 


 


 


Total Depreciation and Amortization

   $ 9,939     $ 14,578     $ 29,532     $ 39,274  
    


 


 


 


 

20


Table of Contents

Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands, except per American Depositary Share (“ADS”) amounts)—(Continued)

(Unaudited)

 

     December 31,
2004


   March 31,
2004


Assets

             

Americas

   $ 310,051    $ 312,224

Europe/Australia

     533,374      471,535

Other (3)

     52,002      99,809
    

  

Total Assets

   $ 895,427    $ 883,568
    

  

Long-lived Assets

             

Americas

   $ 122,186    $ 137,139

Europe/Australia

     279,868      260,000

Other (3)

     15,458      16,486
    

  

Total Long-lived Assets

   $ 417,512    $ 413,625
    

  


(1) Other primarily includes corporate expenses and foreign exchange gains/losses.
(2) Other includes corporate assets.
(3) Other primarily includes corporate assets and deferred tax assets.

 

Note 8. Debt

 

Debt consisted of the following at December 31, 2004 and March 31, 2004:

 

     December 31,
2004


    March 31,
2004


 

10.0% subordinated notes due April 2008

   $ 64,520     $ 64,520  

11.0% senior notes due June 2010

     175,000       175,000  

Capital lease obligations

     5,300       6,411  

Various notes payable bearing interest from prime to 12.0% maturing principally over the next 5 years

     2,675       1,834  
    


 


Total long-term debt and notes payable

     247,495       247,765  

Less unamortized discount on senior notes

     (3,462 )     (3,792 )
    


 


Total long-term debt and notes payable less unamortized discount

     244,033       243,973  

Less current maturities of long-term debt and notes payable

     (4,185 )     (3,212 )
    


 


Long-term debt and notes payable, less current maturities

   $ 239,848     $ 240,761  
    


 


 

The 10.0% subordinated notes due April 1, 2008 have interest payments of $3.2 million every six months on April 1 and October 1.

 

The 11.0% senior notes due June 15, 2010 have a fixed annual interest rate of 11.0% and have interest payments of $9.6 million that will be paid every six months on June 15 and December 15. The senior notes are fully and unconditionally guaranteed on a joint and several basis by all of the Company’s Australian and Canadian subsidiaries, a Luxembourg subsidiary, two UK subsidiaries, one of which is the Company’s primary UK operating subsidiary, and all of its United States subsidiaries other than certain dormant entities, all of which are 100% owned by the Company.

 

If, for any fiscal year commencing with the fiscal year ended March 31, 2004, there is excess cash flow, as such term is defined in the indenture governing the senior notes, in an amount in excess of $5.0 million, the

 

21


Table of Contents

Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands, except per American Depositary Share (“ADS”) amounts)—(Continued)

(Unaudited)

 

Company will be required to make an offer in cash to holders of the senior notes to use 50% of such excess cash flow to purchase their senior notes at 101% of the aggregate principal amount of the senior notes to be repurchased plus accrued and unpaid interest and additional amounts, if any. No such payment has been made to date.

 

The Company incurred $7.2 million in debt issuance costs relating to the senior notes and is amortizing these costs over the term of the senior notes. The balance of these costs as of December 31, 2004 was $5.6 million. The $4.1 million discount related to the senior notes is being accreted to interest expense using the effective interest method over the life of the related debt. The balance of the discount as of December 31, 2004 was $3.5 million.

 

The Company has a credit facility which expires on January 4, 2008 with Fleet Capital Corporation (the “Fleet Credit Facility”) to provide a $50.0 million, senior secured revolving credit facility, which includes a $30.0 million sub-limit for standby and documentary letters of credit. Under the terms of the Fleet Credit Facility, as amended, extensions of credit to the borrowers are further limited to the lesser of the commitment and the borrowing base. In addition, the Fleet Credit Facility requires the Company to keep $5.0 million of cash in an operating account. As of December 31, 2004, the borrowing base for the credit facility was $46.5 million and the Company had no borrowings under the Fleet Credit Facility.

 

The Company incurred $1.7 million in debt issuance costs relating to the origination and amendment of the Fleet Credit Facility and is amortizing these costs over the remaining term of the credit facility. The balance of these costs as of December 31, 2004 was $0.8 million.

 

On December 31, 2003, the Company entered into a one year letter of credit facility with ABN AMRO. On November 2, 2004, the agreement was amended to provide the Company a letter of credit facility for Euro 11.8 million (U.S. $16.0 million) and an open term credit facility of Euro 1.0 million (U.S. $1.4 million) available for general working capital purposes, including overdrafts. This facility is secured by certain of its Netherlands and Belgium subsidiaries’ assets. The availability of this credit facility is subject to a borrowing base and complying with certain requirements, including maintaining certain levels of tangible net worth requirements as defined by the lender. The borrowing base totaled approximately Euro 6.9 million (U.S. $9.3 million) as of December 31, 2004 and the Company had no borrowings under the facility. Based on calculations as of December 31, 2004, the Company was in compliance with the terms of the amended agreement. In addition, the amendment requires the Company to cash collateralize the letter of credit facility by Euro 5.0 million (U.S. $6.8 million). The letter of credit facility bears a commission of 1%, while the general credit facility bears interest at ABN’s Euro base rate plus 1.5%. ABN’s Euro base rate as of December 31, 2004, was 1.67%.

 

Note 9. Contingencies

 

In June 2003, Danka was served with a putative class action complaint titled Stephen L. Edwards, et al., Plaintiffs vs. Danka Industries, Inc., et al., including American Business Credit Corporation, Defendants, alleging claims of breach of contract, fraud/intentional misrepresentation, unjust enrichment, violation of the Florida Deception and Unfair Trade Protection Act and injunctive relief. The claim was filed in the state court in Tennessee, and the Company has removed the claim to the United States District Court for Middle District of Tennessee for further proceedings. The plaintiffs have filed a motion to certify the class, which the Company has opposed. The Company has filed a motion for summary judgment, which plaintiffs have opposed. While the amount sought in this complaint is in excess of $75,000, the Company can not, at this time, estimate its potential exposure. The Company will continue to vigorously defend the claims alleged by the plaintiff in this action.

 

22


Table of Contents

Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands, except per American Depositary Share (“ADS”) amounts)—(Continued)

(Unaudited)

 

The Company is also subject to legal proceedings and claims which arise in the ordinary course of its business. The Company does not expect these legal proceedings to have a material effect upon its financial position, results of operations or liquidity.

 

Note 10. Supplemental Consolidating Financial Data for Subsidiary Guarantors of 11.0% Senior Notes

 

On July 1, 2003, the Company issued its 11.0% senior notes. The senior notes are fully and unconditionally guaranteed on a joint and several basis by all of the Company’s Australian and Canadian subsidiaries, a Luxembourg subsidiary, two UK subsidiaries, one of which is the primary UK operating subsidiary, and all of its United States subsidiaries other than certain dormant entities (collectively, the “Subsidiary Guarantors”). All subsidiaries are 100% owned by the Company. The Subsidiary Guarantors generated [58.5% and 60.6%] of the Company’s total revenue during the three and nine months ended December 31, 2004, respectively. Certain prior year amounts have been reclassified to conform to the current year classification.

 

The Company reported its subsidiary non-guarantors’ equity (income) loss and net earnings (loss) for the three months ended June 30, 2004 as $16.1 million and ($21.9 million), respectively; those amounts should have been ($15.5 million) and $9.7 million, respectively. Additionally, the Company reported its subsidiary non-guarantors’ equity (income) loss and net earnings (loss) for the three months ended September 30, 2004 as $10.9 million and ($22.7 million), respectively; those amounts should have been ($10.4 million) and $67.9 million, respectively. The changes had no impact on the parent company’s, the subsidiary guarantors’ or the consolidated results of operations for those periods previously reported.

 

The Company reported its subsidiary non-guarantors’ equity (income) loss and net earnings (loss) for the three months ended September 30, 2003 was $31.0 million and ($46.5 million), respectively; those amounts should have been ($10.1 million) and ($5.4 million), respectively. The changes had no impact on the parent company’s, the subsidiary guarantors’ or the consolidated results of operations for the period previously reported.

 

 

23


Table of Contents

Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands)

(Unaudited)

 

    

Supplemental Consolidating Statement of Operations

For the Three Months Ended

December 31, 2004


 
     Parent
Company
(1)


    Subsidiary
Guarantors
(2)


   

Subsidiary

Non -

Guarantors
(3)


    Eliminations

    Consolidated
Total


 

Revenue:

                                        

Retail equipment and related sales

   $ —       $ 69,420     $ 42,411     $ —       $ 111,831  

Retail service

     —         96,512       54,939       —         151,451  

Retail supplies and rentals

     —         17,628       7,519       —         25,147  

Wholesale

     —         —         25,354       —         25,354  
    


 


 


 


 


Total revenue

     —         183,560       130,223       —         313,783  
    


 


 


 


 


Costs of sales:

                                        

Retail equipment and related sales costs

     —         43,901       28,123       —         72,024  

Retail service costs

     —         57,399       35,317       —         92,716  

Retail supplies and rental costs

     —         10,504       3,801       —         14,305  

Wholesale costs

     —         —         21,448       —         21,448  
    


 


 


 


 


Total cost of sales

     —         111,804       88,689       —         200,493  
    


 


 


 


 


Gross profit

     —         71,756       41,534       —         113,290  

Operating expenses:

                                        

Selling, general and administrative expenses

     1,349       75,209       39,834       —         116,392  

Restructuring charges (credits)

     —         354       (744 )     —         (390 )

Equity (income) loss

     (18,193 )     (10,931 )     (16,217 )     45,341       —    

Other (income) expense, net

     7,053       (2,675 )     (1,119 )     (1,740 )     1,519  
    


 


 


 


 


Total operating expenses

     (9,791 )     61,957       21,754       43,601       117,521  
    


 


 


 


 


Operating earnings (loss)

     9,791       9,799       19,780       (43,601 )     (4,231 )

Interest expense

     (6,740 )     (1,520 )     (2,394 )     2,500       (8,154 )

Interest income

     1,383       1,793       (413 )     (2,557 )     206  
    


 


 


 


 


Earnings (loss) before income taxes

     4,434       10,072       16,973       (43,658 )     (12,179 )

Provision (benefit) for income taxes

     (22 )     4,585       (21,198 )     —         (16,635 )
    


 


 


 


 


Net earnings (loss)

   $ 4,456     $ 5,487     $ 38,171     $ (43,658 )   $ 4,456  
    


 


 


 


 


 

 

24


Table of Contents

Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands)

(Unaudited)

 

    

Supplemental Consolidating Statement of Operations

For the Three Months Ended

December 31, 2003


 
    

Parent
Company

(1)


    Subsidiary
Guarantors
(2)


   

Subsidiary

Non -

Guarantors
(3)


    Eliminations

    Consolidated
Total


 

Revenue:

                                        

Retail equipment and related sales

   $ —       $ 81,092     $ 33,515     $ —       $ 114,607  

Retail service

     —         101,283       55,210       —         156,493  

Retail supplies and rentals

     —         25,195       9,817       —         35,012  

Wholesale

     —         —         24,969       —         24,969  
    


 


 


 


 


Total revenue

     —         207,570       123,511       —         331,081  
    


 


 


 


 


Costs of sales:

                                        

Retail equipment and related sales costs

     —         52,628       21,745       —         74,373  

Retail service costs

     —         59,893       36,047       —         95,940  

Retail supplies and rental costs

     —         15,178       5,436       —         20,614  

Wholesale costs

     —         —         20,132       —         20,132  
    


 


 


 


 


Total cost of sales

     —         127,699       83,360       —         211,059  
    


 


 


 


 


Gross profit

     —         79,871       40,151       —         120,022  

Operating expenses:

                                        

Selling, general and administrative expenses

     1,218       71,701       35,801       —         108,720  

Restructuring charges (credits)

     —         11,914       8,132       —         20,046  

Equity (income) loss

     29,242       12,783       3,148       (45,173 )     —    

Other (income) expense, net

     (12,202 )     2,642       11,421       —         1,861  
    


 


 


 


 


Total operating expenses

     18,258       99,040       58,502       (45,173 )     130,627  
    


 


 


 


 


Operating earnings (loss)

     (18,258 )     (19,169 )     (18,351 )     45,173       (10,605 )

Interest expense

     (6,626 )     (671 )     (16,830 )     16,196       (7,931 )

Interest income

     16,195       559       (129 )     (16,196 )     429  
    


 


 


 


 


Earnings (loss) before income taxes

     (8,689 )     (19,281 )     (35,310 )     45,173       (18,107 )

Provision (benefit) for income taxes

     8,252       (1,204 )     (8,214 )     —         (1,166 )
    


 


 


 


 


Net earnings (loss)

   $ (16,941 )   $ (18,077 )   $ (27,096 )   $ 45,173     $ (16,941 )
    


 


 


 


 


 

 

25


Table of Contents

Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands)

(Unaudited)

 

    

Supplemental Consolidating Statement of Operations

For the Nine Months Ended

December 31, 2004


 
     Parent
Company
(1)


    Subsidiary
Guarantors
(2)


   

Subsidiary

Non-

Guarantors
(3)


    Eliminations

    Consolidated
Total


 

Revenue:

                                        

Retail equipment and related sales

   $ —       $ 211,802     $ 114,307     $ —       $ 326,109  

Retail service

     —         294,028       161,133       —         455,161  

Retail supplies and rentals

     —         59,468       22,004       —         81,472  

Wholesale

     —         —         70,020       —         70,020  
    


 


 


 


 


Total revenue

     —         565,298       367,464       —         932,762  
    


 


 


 


 


Costs of sales:

                                        

Retail equipment and related sales costs

     —         135,601       76,312       —         211,913  

Retail service costs

     —         171,032       99,105       —         270,137  

Retail supplies and rental costs

     —         36,036       12,257       —         48,293  

Wholesale costs

     —         —         57,877       —         57,877  
    


 


 


 


 


Total cost of sales

     —         342,669       245,551       —         588,220  
    


 


 


 


 


Gross profit

     —         222,629       121,913       —         344,542  

Operating expenses:

                                        

Selling, general and administrative expenses

     3,987       222,536       108,799       —         335,322  

Restructuring charges (credits)

     —         1,483       (3,942 )     —         (2,459 )

Equity (income) loss

     (27,761 )     (20,561 )     (42,149 )     90,471       —    

Other (income) expense, net

     4,559       (14,775 )     (41,344 )     53,608       2,048  
    


 


 


 


 


Total operating expenses

     (19,215 )     188,683       21,364       144,079       334,911  
    


 


 


 


 


Operating earnings (loss)

     19,215       33,946       100,549       (144,079 )     9,631  

Interest expense

     (20,201 )     (2,975 )     (8,233 )     8,146       (23,263 )

Interest income

     4,023       2,147       2,790       (8,146 )     814  
    


 


 


 


 


Earnings (loss) before income taxes

     3,037       33,118       95,106       (144,079 )     (12,818 )

Provision (benefit) for income taxes

     —         4,820       (20,675 )     —         (15,855 )
    


 


 


 


 


Net earnings (loss)

   $ 3,037     $ 28,298     $ 115,781     $ (144,079 )   $ 3,037  
    


 


 


 


 


 

 

26


Table of Contents

Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands)

(Unaudited)

 

    

Supplemental Consolidating Statement of Operations

For the Nine Months Ended

December 31, 2003


 
    

Parent
Company

(1)


    Subsidiary
Guarantors
(2)


   

Subsidiary

Non -

Guarantors
(3)


    Eliminations

    Consolidated
Total


 

Revenue:

                                        

Retail equipment and related sales

   $ —       $ 241,345     $ 101,263     $ —       $ 342,608  

Retail service

     —         316,500       161,217       —         477,717  

Retail supplies and rentals

     —         72,137       25,039       —         97,176  

Wholesale

     —         —         70,328       —         70,328  
    


 


 


 


 


Total revenue

     —         629,982       357,847       —         987,829  
    


 


 


 


 


Costs of sales:

                                        

Retail equipment and related sales costs

     —         160,533       65,727       —         226,260  

Retail service costs

     —         181,871       102,473       —         284,344  

Retail supplies and rental costs

     —         43,005       14,617       —         57,622  

Wholesale costs

     —         —         56,832       —         56,832  
    


 


 


 


 


Total cost of sales

     —         385,409       239,649       —         625,058  
    


 


 


 


 


Gross profit

     —         244,573       118,198       —         362,771  

Operating expenses:

                                        

Selling, general and administrative expenses

     3,284       239,274       103,764       —         346,322  

Restructuring charges (credits)

     —         11,914       7,538       —         19,452  

Equity (income) loss

     47,975       10,816       (17,410 )     (41,381 )     —    

Other (income) expense, net

     (22,879 )     528       24,002       —         1,651  
    


 


 


 


 


Total operating expenses

     28,380       262,532       117,894       (41,381 )     367,425  
    


 


 


 


 


Operating earnings (loss)

     (28,380 )     (17,959 )     304       41,381       (4,654 )

Interest expense

     (22,332 )     (1,821 )     (48,412 )     46,812       (25,753 )

Interest income

     46,811       874       105       (46,812 )     978  

Write-off of debt issuance costs

     (20,562 )     —         —         —         (20,562 )
    


 


 


 


 


Earnings (loss) before income taxes

     (24,463 )     (18,906 )     (48,003 )     41,381       (49,991 )

Provision (benefit) for income taxes

     10,533       (11,512 )     (14,016 )     —         (14,995 )
    


 


 


 


 


Net earnings (loss)

   $ (34,996 )   $ (7,394 )   $ (33,987 )   $ 41,381     $ (34,996 )
    


 


 


 


 


 

 

27


Table of Contents

Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands)

(Unaudited)

 

   

Supplemental Consolidating Balance Sheet Information

December 31, 2004


 
    Parent
Company (1)


    Subsidiary
Guarantors (2)


   

Non -

Guarantors (3)


    Eliminations

    Consolidated
Total


 

Assets

                                       

Current assets:

                                       

Cash and cash equivalents

  $ 6,619     $ 31,088     $ 51,547     $ —       $ 89,254  

Accounts receivable, net

    —         136,246       115,348       —         251,594  

Inventories

    —         60,482       58,240       —         118,722  

Due (to)/from affiliate

    (580,948 )     430,274       146,629       4,045       —    

Prepaid expenses, deferred income taxes and other current assets

    1,036       6,526       10,783       —         18,345  
   


 


 


 


 


Total current assets

    (573,293 )     664,616       382,547       4,045       477,915  

Equipment on operating leases, net

    —         14,042       10,160       —         24,202  

Property and equipment, net

    31       47,511       7,279       —         54,821  

Goodwill, net

    —         145,980       156,841       —         302,821  

Other intangible assets, net

    —         2,300       172       —         2,472  

Investment in subsidiaries

    1,052,263       149,834       1,054,996       (2,257,093 )     —    

Deferred income taxes

    —         3,461       4,520       —         7,981  

Other assets

    4,651       14,743       5,821       —         25,215  
   


 


 


 


 


Total assets

  $ 483,652     $ 1,042,487     $ 1,622,336     $ (2,253,048 )   $ 895,427  
   


 


 


 


 


Liabilities and shareholders’ equity (deficit)

                                       

Current liabilities:

                                       

Current maturities of long-term debt and notes payable

  $ —       $ 1,428     $ 2,757     $ —       $ 4,185  

Accounts payable

    81       92,808       75,575       —         168,464  

Accrued expenses and other current liabilities

    4,041       52,675       37,364       —         94,080  

Taxes payable

    40       (7,372 )     43,466       —         36,134  

Deferred revenue

    —         25,140       18,942       —         44,082  
   


 


 


 


 


Total current liabilities:

    4,162       164,679       178,104       —         346,945  

Long-term debt and notes payables, less current maturities

    236,057       2,980       811       —         239,848  

Deferred income taxes and other long-term liabilities

    —         43,242       21,959       —         65,201  
   


 


 


 


 


Total liabilities

    240,219       210,901       200,874       —         651,994  
   


 


 


 


 


6.5% convertible participating shares

    294,716       —         —         —         294,716  
   


 


 


 


 


Shareholders’ equity (deficit)

                                       

Ordinary shares

    5,268       1,188,957       236,949       (1,425,906 )     5,268  

Additional paid-in capital

    328,876       26,729       441,594       (468,323 )     328,876  

Retained earnings (accumulated deficit)

    (354,657 )     (465,613 )     899,393       (433,780 )     (354,657 )

Accumulated other comprehensive (loss) income

    (30,770 )     81,513       (156,474 )     74,961       (30,770 )
   


 


 


 


 


Total shareholders’ equity (deficit)

    (51,283 )     831,586       1,421,462       (2,253,048 )     (51,283 )
   


 


 


 


 


Total liabilities & shareholders’ equity (deficit)

  $ 483,652     $ 1,042,487     $ 1,622,336     $ (2,253,048 )   $ 895,427  
   


 


 


 


 


 

 

28


Table of Contents

Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands)

(Unaudited)

 

   

Supplemental Consolidating Balance Sheet Information

March 31, 2004


 
    Parent
Company (1)


    Subsidiary
Guarantors (2)


   

Non

Guarantors (3)


    Eliminations

    Consolidated
Total


 

Assets

                                       

Current assets:

                                       

Cash and cash equivalents

  $ 68,389     $ 22,092     $ 22,309     $ —       $ 112,790  

Accounts receivable, net

    —         131,432       115,564       —         246,996  

Inventories

    —         48,239       45,056       —         93,295  

Due (to)/from affiliate

    (607,012 )     483,128       119,839       4,045       —    

Prepaid expenses, deferred income taxes and other current assets

    932       6,580       9,350       —         16,862  
   


 


 


 


 


Total current assets

    (537,691 )     691,471       312,118       4,045       469,943  

Equipment on operating leases, net

    —         18,130       11,348       —         29,478  

Property and equipment, net

    27       58,736       7,125       —         65,888  

Goodwill, net

    —         144,144       138,286       —         282,430  

Other intangible assets, net

    —         2,168       172       —         2,340  

Investment in subsidiaries

    993,301       114,351       854,497       (1,962,149 )     —    

Deferred income taxes

    —         7,688       —         —         7,688  

Other assets

    5,428       14,673       5,700       —         25,801  
   


 


 


 


 


Total assets

  $ 461,065     $ 1,051,361     $ 1,329,246     $ (1,958,104 )   $ 883,568  
   


 


 


 


 


Liabilities and shareholders’ equity (deficit)

                                       

Current liabilities:

                                       

Current maturities of long-term debt and notes payable

  $ —       $ 1,315     $ 1,897     $ —       $ 3,212  

Accounts payable

    95       83,219       52,146       —         135,460  

Accrued expenses and other current liabilities

    10,559       73,368       45,036       —         128,963  

Taxes payable

    (169 )     59,753       (12,384 )     —         47,200  

Deferred revenue

    —         24,941       20,149       —         45,090  
   


 


 


 


 


Total current liabilities:

    10,485       242,596       106,844       —         359,925  

Long-term debt and notes payables, less current maturities

    235,727       3,814       1,220       —         240,761  

Deferred income taxes and other long-term liabilities

    —         52,801       15,228       —         68,029  
   


 


 


 


 


Total liabilities

    246,212       299,211       123,292       —         668,715  
   


 


 


 


 


6.5% convertible participating shares

    279,608       —         —         —         279,608  
   


 


 


 


 


Shareholders’ equity (deficit)

                                       

Ordinary shares

    5,194       1,188,947       237,022       (1,425,969 )     5,194  

Additional paid-in capital

    328,070       26,743       442,065       (468,808 )     328,070  

Retained earnings (accumulated deficit)

    (342,586 )     (491,934 )     822,105       (330,171 )     (342,586 )

Accumulated other comprehensive (loss) income

    (55,433 )     28,394       (295,238 )     266,844       (55,433 )
   


 


 


 


 


Total shareholders’ equity (deficit)

    (64,755 )     752,150       1,205,954       (1,958,104 )     (64,755 )
   


 


 


 


 


Total liabilities & shareholders’ equity (deficit)

  $ 461,065     $ 1,051,361     $ 1,329,246     $ (1,958,104 )   $ 883,568  
   


 


 


 


 


 

 

29


Table of Contents

Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands)

(Unaudited)

 

    

Supplemental Condensed Consolidating Statement of Cash Flows

For the Nine Months Ended

December 31, 2004


 
     Parent
Company
(1)


    Subsidiary
Guarantors
(2)


   

Subsidiary
Non -

Guarantors
(3)


    Eliminations

   Consolidated
Total


 

Net cash provided by (used in) operating activities

   $ (62,650 )   $ 19,071     $ 35,799     $ —      $ (6,980 )

Investing activities

                                       

Capital expenditures

     —         (7,938 )     (8,354 )     —        (16,292 )

Purchase of subsidiary, net of cash acquired

     —         (2,110 )     —         —        (2,110 )

Proceeds from sale of subsidiary

     —         62       147       —        209  

Proceeds from the sale of property and equipment

     —         84       229       —        313  
    


 


 


 

  


Net cash used in investing activities

     —         (9,902 )     (7,978 )     —        (17,880 )
    


 


 


 

  


Financing activities

                                       

Net borrowings (payments) of debt

     —         (1,180 )     (108 )     —        (1,288 )

Proceeds from stock options exercised

     880       —         —         —        880  
    


 


 


 

  


Net cash provided by (used in) financing activities

     880       (1,180 )     (108 )     —        (408 )
    


 


 


 

  


Effect of exchange rates

     —         207       1,525       —        1,732  
    


 


 


 

  


Net increase (decrease) in cash and cash equivalents

     (61,770 )     8,996       29,238       —        (23,536 )

Cash and cash equivalents, beginning of period

     68,389       22,092       22,309       —        112,790  
    


 


 


 

  


Cash and cash equivalents, end of period

   $ 6,619     $ 31,088     $ 51,547     $ —      $ 89,254  
    


 


 


 

  


 

 

30


Table of Contents

Danka Business Systems PLC

Notes to Consolidated Financial Statements

(in thousands)

(Unaudited)

 

    

Supplemental Condensed Consolidating Statement of Cash Flows

For the Nine Months Ended

December 31, 2003


 
     Parent
Company
(1)


    Subsidiary
Guarantors
(2)


   

Subsidiary

Non - 

Guarantors
(3)


    Eliminations

   Consolidated
Total


 

Net cash provided by (used in) operating activities

   $ (16,350 )   $ 37,746     $ 30,877     $ —      $ 52,273  

Investing activities

                                       

Capital expenditures

     —         (26,226 )     (9,646 )     —        (35,872 )

Proceeds from the sale of property and equipment

     —         403       303       —        706  
    


 


 


 

  


Net cash used in investing activities

     —         (25,823 )     (9,343 )     —        (35,166 )
    


 


 


 

  


Financing activities

                                       

Net borrowings (payments) of debt

     10,715       2,070       (1,271 )     —        11,514  

Payment of debt issue costs

     (10,767 )     —         —         —        (10,767 )
    


 


 


 

  


Net cash provided by (used in) financing activities

     (52 )     2,070       (1,271 )     —        747  
    


 


 


 

  


Effect of exchange rates

     —         1,117       4,591       —        5,708  
    


 


 


 

  


Net increase (decrease) in cash and cash equivalents

     (16,402 )     15,110       24,854       —        23,562  

Cash and cash equivalents, beginning of period

     42,709       13,898       24,886       —        81,493  
    


 


 


 

  


Cash and cash equivalents, end of period

   $ 26,307     $ 29,008     $ 49,740     $ —      $ 105,055  
    


 


 


 

  



(1) Danka Business Systems PLC
(2) Subsidiary Guarantors include the following subsidiaries:

 

    Danka Australasia Pty Limited, Danka Australia Pty Limited, Danka Tower Pty Ltd, Danka Distributors Pty Ltd, Danka Datakey Pty Ltd, Datakey Alcatel Pty. Ltd. and Danka Systems Pty Limited, representing all of the Company’s Australian Subsidiaries;

 

    Danka Business Finance Ltd., Danka Canada Inc. and Kalmara Inc., representing all of our Canadian subsidiaries;

 

    Dankalux S.à r.L., a Luxembourg subsidiary;

 

    Danka UK Plc, the Company’s primary UK operating subsidiary, and Danka Services International Ltd., a UK subsidiary; and

 

    Danka Holding Company, American Business Credit Corporation, Danka Management II Company, Inc., Herman Enterprises, Inc. of South Florida, D.I. Investment Management, Inc., Quality Business, Inc., Danka Management Company, Inc., Corporate Consulting Group, Inc., Danka Imaging Distribution, Inc. and Danka Office Imaging Company, which represent all of the Company’s United States Subsidiaries other than certain dormant entities.

 

(3) Subsidiaries of Danka Business Systems PLC other than Subsidiary Guarantors

 

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Table of Contents

Note 11. Subsequent Events

 

On February 4, 2005, the Company announced plans to eliminate inefficiencies in its field operations, and to reduce its selling, general and administrative costs by eliminating and consolidating back office functions and exiting certain facilities. The Company plans to take a charge to earnings of $20 million to $30 million over the next several quarters, with severance costs of between $17 million to $25 million, and facilities costs of between $3 million to $5 million.

 

32


Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Danka’s mission is to deliver value to clients worldwide by using our expert sales, technical and professional services to implement effective document information solutions and services. Our product portfolio is designed to enable choice, convenience, custom cost management and continuity. Our vision is to empower our customers to benefit fully from the convergence of image and document technologies in a connected environment. This approach will strengthen our client relationships and expand Danka’s strategic value.

 

Our strategy to accomplish our mission is to:

 

    enhance customer relationships;

 

    grow revenues by providing value-added and cost-driven solutions and services;

 

    re-engineer processes and systems;

 

    maximize free cash flow generation and reduce net debt; and

 

    develop an efficient and productive organization.

 

Based on revenue, we are one of the largest independent providers of office imaging equipment, document solutions and related services and supplies in the United States and Europe. We offer a wide range of state of the art office imaging products, peripherals and solutions that primarily include digital and color copiers, digital and color multi-function peripherals (“MFPs”), facsimile machines and software. We also provide a wide range of contract services, including professional and consulting services, maintenance, supplies, leasing arrangements, technical support and training on the installed base of equipment created primarily by our retail equipment and related sales and have increased our contract services to include multi-vendor equipment and comprehensive solutions to companies’ printing needs.

 

We currently operate in over 20 countries. Our reportable segments are the Americas and Europe/Australia, both of which include operations that are experiencing political, social and/or economic difficulty. We continue to evaluate the viability and future prospects of the operations in certain countries in light of uncertain conditions. Based on these evaluations, during the quarter ended December 31, 2004, we implemented plans to exit operations in Portugal and Russia. The impact of these exit plans is immaterial to our business, financial condition, results of operations and our competitive position. Should we decide to downsize or exit any of our other operations in the future, we could incur costs in respect of severance and closure of facilities and we may also be required to realize cumulative translation losses and minimum pension liabilities that would reduce our earnings, all or any of which may have a material impact on our operating results.

 

Critical Accounting Policies and Estimates

 

Allowance for Doubtful Accounts—We provide an allowance on our accounts receivable for estimated losses. Our estimates are based upon the aging of our accounts receivable and expected credits to our customers due to billing disputes and inaccuracies and bad debts. If the financial condition of any of our customers were to deteriorate and result in the impairment of their ability to make payments to us or if actual credits exceed estimated credits, an additional allowance may be required.

 

The following table summarizes our net accounts receivable:

 

    

December 31,

2004


   

March 31,

2004


 

Accounts receivable, gross

   $ 294,263     $ 294,249  

Allowance for doubtful accounts

     (42,669 )     (47,253 )
    


 


Accounts receivable, net

   $ 251,594     $ 246,996  
    


 


Allowance for doubtful accounts as a % of gross accounts receivable

     14.5 %     16.1 %

 

33


Table of Contents

Inventories—We acquire inventory based on our projections of future demand and market conditions. Any unexpected decline in demand and/or rapid product improvements or technological changes may cause us to have excess and/or obsolete inventories. We have provided appropriate reserves against these inventory items in current and prior periods. On an ongoing basis, we review for estimated obsolete or unmarketable inventories and write-down our inventories to their estimated net realizable value based upon our forecasts of future demand and market conditions using historical trends and analysis. If actual market conditions are less favorable than our forecasts due, in part, to a greater acceleration within the industry to digital office imaging equipment, additional inventory write-downs may be required. Our estimates are influenced by a number of considerations including, but not limited to, the following: decline in demand due to economic downturns, rapid product improvements and technological changes, and our ability to return to vendors a certain percentage of our purchases.

 

Revenue Recognition—Wholesale and retail equipment and related sales are recognized upon acceptance of delivery by the customer. In the case of equipment sales financed by third party finance/leasing companies, retail equipment and related sales are recognized upon acceptance of delivery by the customer and credit acceptance by the finance/leasing company, if later. In addition, for the sale of certain digital equipment that requires a comprehensive setup by us before it can be used by a customer, such as a Heidelberg 9110/9150 or equivalent type of equipment, revenue is recognized upon acceptance of delivery and installation by the customer and written confirmation of installation by a company representative. Supply sales to customers are recognized at the time of shipment unless supply sales are included in a service contract, in which case supply sales are recognized upon equipment usage by the customer.

 

Rental operating lease income is recognized straight-line over the lease term. Retail service revenues, which include TechSource service contract revenues, are generally recognized ratably over the term of the underlying maintenance contracts. Under the terms of the retail service contract, the customer is billed a flat periodic charge and/or a usage-based fee. We record revenue for the flat periodic charge each period and for actual or estimated usage every period.

 

Deferred Income Taxes—As part of the process of preparing our consolidated financial statements, we have to estimate our income and corporation taxes in each of the taxing jurisdictions in which we operate. This process involves estimating our actual current tax expense and loss carryforwards together with assessing any temporary differences resulting from the different treatment of certain items, such as the timing for recognizing revenues and expenses for tax and accounting purposes. These differences and loss carryforwards may result in deferred tax assets and liabilities, which are included in our consolidated balance sheet.

 

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Our past financial performance is a significant factor which contributes to our inability, pursuant to Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS 109”), to use projections of future taxable income in assessing the realizability of deferred tax assets. Management therefore is limited to considering the scheduled reversal of deferred tax liabilities and tax planning strategies in making this assessment. Due to the inability to use projections of future taxable income in making its assessment, management concluded that it is not “more likely than not” we will realize the benefits of the deferred tax assets at December 31, 2004. We have a valuation allowance against net deferred tax assets in most jurisdictions at December 31, 2004.

 

In addition, we operate within multiple taxing jurisdictions and are subject to audit in these jurisdictions. These audits can involve complex issues, which may require an extended period of time to resolve. In management’s opinion, adequate provisions for income and corporation taxes have been made for all years.

 

Goodwill—We review our goodwill and indefinite-lived intangible assets annually for possible impairment, or more frequently if impairment indicators arise. Separable intangible assets that have finite lives are amortized over their estimated useful lives.

 

34


Table of Contents

We had goodwill of $302.8 million as of December 31, 2004. If it is determined under Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), that our goodwill is impaired, we will be required to write-down the value of such goodwill in amounts that could have a material impact on our operations.

 

We performed our annual impairment test during the fourth quarter of our fiscal year 2004, under the requirements of SFAS 142. Based on the results of that impairment test, no adjustments for impairment were necessary.

 

Accounting for Stock Based Compensation—As permitted by Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), we account for our stock option plans under the intrinsic value recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. As the exercise prices of all options granted under these plans were equal to the market price of the underlying American Depository Shares (“ADS”) on the grant date, no stock-based employee compensation expense was recognized in net earnings. In general, these options expire in ten years and vest over three years. The proceeds from options exercised are credited to shareholders’ equity (deficit), net of related tax benefits.

 

For disclosure purposes we compute the impact to earnings (loss) of stock-based compensation using the Black-Scholes option pricing model. SFAS 123 allows the use of option pricing models that were not developed for use in valuing employee stock options. The Black-Scholes option pricing model was developed for use in estimating the fair value of short-lived exchange traded options that have no vesting restrictions and are fully transferable. In addition, option pricing models require the input of highly subjective assumptions, including the option’s expected life and price volatility of the underlying stock. Because our stock options have characteristics significantly different from those traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in the opinion of management, the existing model does not necessarily provide a reliable single measure of the fair value of employee stock options.

 

In December 2004, the FASB issued FASB Statement No. 132B, “Share-Based Payment” (“SFAS 132R”), which revises SFAS 123 and supersedes APB 25, and its related guidance. SFAS 132R requires public entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award in the statement of operations. Pro forma disclosure is no longer allowable under the new standard. Adoption of SFAS 123R is required as of the beginning of the first interim reporting period that begins after June 15, 2005. We have not yet assessed the impact the adoption of SFAS 123R will have on our consolidated financial statements.

 

Restructuring Charges—We recognized restructuring charges for the consolidation of back office functions, exiting non-strategic real estate facilities and reducing headcount. These charges were recorded pursuant to formal plans developed and approved by management. The recognition of restructuring charges requires that we make certain judgments and estimates regarding the nature, timing and amount of costs associated with these plans. The estimates of future liabilities may change, requiring additional restructuring charges or the reduction of liabilities already recorded. At the end of each reporting period, we evaluate the remaining accrued balances to ensure that no excess accruals are retained and the utilization of the provisions are for their intended purpose in accordance with the restructuring programs. For further discussion of our restructuring programs, refer to Note 4—“Restructuring Charges (Credits)” to the Consolidated Financial Statements and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.”

 

35


Table of Contents

All tables presented herein are in thousands unless otherwise noted.

 

Financial Condition

 

    

December 31,

2004


   

March 31,

2004


 

Total assets

   $ 895,427     $ 883,568  

Total liabilities

   $ 651,994     $ 668,715  

Working capital

   $ 130,970     $ 110,018  

Liabilities to liabilities and capital

     73 %     76 %

Inventory turnover ratio

     4 x     5 x