IKON Office Solutions F1Q08 (Qtr End 12/31/07) Earnings Call Transcript

IKON Office Solutions, Inc. (IKN)

F1Q08 Earnings Call

January 24, 2008 9:00 am ET

Executives

Henry M. Miller Jr. - Vice President, Corporate Finance

Matthew J. Espe - Chairman of the Board, President, Chief Executive Officer

Robert F. Woods - Chief Financial Officer, Senior Vice President

Analysts

Matt Troy - Citigroup

Carol Sabbagha - Lehman Brothers

Woo Jin Ho - Merrill Lynch

Ananda Baruah - Banc of America

Shannon Cross - Cross Research

Presentation

Operator

Greetings, ladies and gentlemen and welcome to IKON’s first quarter fiscal 2008 earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Mr. Henry Miller, Vice President of Corporate Finance for IKON Office Solutions. Thank you, Mr. Miller. You may begin.

Henry M. Miller Jr.

Thank you and good morning. Before we begin, we would like to caution you that the call we are about to conduct contains forward-looking statements with the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. References made during the call are based on management’s current expectations or beliefs and are subject to a number of factors and uncertainties that could cause the actual results to differ materially from those described in the forward-looking statements. The company does not intend to update any forward-looking statements made during this call.

As a reminder, today’s call is being recorded at the request of IKON. This call may not be rebroadcast or replayed without the express prior written approval of IKON.

Third-party transcriptions of the conference call have not been approved by IKON and we take no responsibility for their accuracy.

The call today will be hosted by Matt Espe, IKON's Chairman and CEO. Bob Woods, Senior Vice President and Chief Financial Officer, will also be participating on the call.

At this point, I am going to turn the call over Matt Espe, who will begin today’s presentation on slide three.

Matthew J. Espe

Thanks, Henry. Good morning, everyone and welcome to the IKON Office Solutions first quarter 2008 earnings release conference call. Today we reported earnings per diluted share for the first quarter of fiscal 2008 of $0.17, excluding a restructuring charge of $0.04. This result was within our revised outlook we’ve provided you on January the 10th.

As reported, earnings per diluted share were $0.13. The $0.04 charge relates to actions we are taking right now to improve our fiscal year 2008 financial results. Bob will discuss the actions we are taking in more detail during his remarks a little later.

Total revenue for the quarter was $998 million, a 1% decrease year over year, including a currency benefit of two points. Our revenue performance reflects lower-than-expected equipment sales in North America, which were partially offset by revenue growth in customer service and supplies, strong growth in managed and professional service, and continued solid performance by our team in Europe.

Needless to say, our financial performance this quarter was disappointing. As mentioned earlier, the primary driver was lower-than-expected equipment revenue in North America. Our earnings were also impacted by a higher-than-expected tax rate due to a recent change in Canadian tax law. This was a one-time, non-cash event and the guidance for our full year tax rate remains unchanged.

Now to be clear, we believe our first quarter performance includes IKON-specific issues that have been and will be corrected.

We’ve taken several actions to improve equipment revenue. We’ve worked with vendors, we’ve adjusted our go-to-market strategy and we are implementing steps to improve the productivity of our sales force.

We are also taking immediate steps, which are expected to reduce our cost and expense structure by $25 million this fiscal year. Now, before I discuss equipment revenue in more detail, I would like to highlight three key points I want you to take away from our call this morning.

First, we remain committed to growing revenue. We’ll continue our sprint to color strategy by increasing placements of color machines and working with our vendors to enhance the depth and breadth of our color portfolio. We’ll optimize customer coverage and sales force effectiveness. We’ll continue to stabilize our after-market annuity stream. We’ll continue to grow managed and professional services and continue to expand geographically in Europe.

Second, we remain committed to delivering an expense-to-revenue ratio of about 28% in 2008, which together with improved top line performance will drive an operating income margin of approximately 5% and earnings per diluted share to range from $0.92 to $0.98, excluding the restructuring charge.

Lastly, we plan to complete our purchase of $500 million of common stock we announced in November of 2007. The balance of the repurchase plan and the rate and pace of any share repurchases remain, of course, subject to financing and market conditions, as well as applicable regulations.

Now please turn to slide four and I’ll review equipment revenue for the quarter.

In the first quarter, equipment revenue was $393 million, down 6% year over year. When looking at equipment revenue drivers from a customer segment perspective, national and strategic accounts results were lower than expected due to fewer large transactions closing in the quarter, primarily as a result of customers delaying their buying decisions.

However, our large deal pipeline is strong for the second fiscal quarter. In the first quarter, national accounts renewed five accounts with existing customers and added six new customers, including Hanes Brands and a major automotive manufacturer.

Strategic and mid-market accounts were impacted by three factors that reduced our sales force productivity. First, the substantial reduction of the terms of a longstanding vendor promotional program made our B-to-C products less competitive. Second, B-to-C was also impacted by a change in IKON pricing strategy. Let me be clear -- both of these issues have been fixed.

Third, we conducted several new development and training programs in the first quarter, which resulted in a higher-than-normal level of training activity. These programs were implemented to train new sales reps, to help expand our business with state and local governments, and to improve the sales force’s ability to sell our value-added services.

These training programs negatively impacted our first quarter results by reducing the number of sales professionals out selling. We expect their improved skills and increased time in the field for the balance of the year to increase productivity going forward.

Equipment revenue in all customer segments was also negatively impacted by an IT systems outage on December 29th. This outage disrupted our primary operating system for a day and slightly longer for some ancillary systems.

This disruption was our first major systems outage in eight years and was caused by a failure in storage systems on lease from a major IT vendor. The failure, coming on such a critical weekend at our quarter end adversely affected both revenue and cash flow. Our vendor promptly replaced the system and has provided backup storage capacity to help us avoid a recurrence.

Now please turn to slide five and I’ll discuss our equipment revenue performance by product segment.

Looking at the key product segments of the U.S. equipment market, we experienced year-over-year revenue decline in black-and-white segments and office color segment, partially offset by an increase in color production.

Color equipment revenue increased 9% with placements up 5%. Our color revenue mix in the first quarter increased to 38% from 32% in the first quarter last year. Color office declined 2% with placements up 4%.

As I mentioned, these results were primarily driven by a vendor’s reduction of a longstanding promotional program and a change in our pricing strategy.

Color production revenue increased 39% and placements increased 11%, primarily driven by strong placements of the Canon C7000. We placed 40 units of this machine in the quarter, a significant increase from 23 in our fourth quarter of ’07.

The continued success of the IKON CPP 650 and the successful launch of the CPP 550 also contributed to our strong results.

Black-and-white office revenue declined 14% with placements down 10%. These results were due to the continued commoditization and convergence of segments one to three, competition and pricing pressures, and lower-than-expected sales productivity.

In addition, the market migration of lower priced A4MSPs drove strong placements of the Canon IR1023 and Ricoh MP161 but negatively impacted revenue.

We are currently repositioning our product portfolio to better address the market shift. Black-and-white production revenue declined 16% with placements down 8%. The revenue decline was primarily due to continued mix shift, a light production, and previously mentioned change in a vendor program.

In summary, our North American equipment revenue was lower than we expected this quarter but we believe the internal factors contributing to our performance have been addressed.

In Europe, equipment revenue was up 4% year over year at constant currency as a result of strong performance in the U.K. and Germany in our pan-European accounts. As reported, Europe’s equipment revenue grew 14%.

Customer service supplies revenue was $350 million in the quarter, up 1% year over year on strong performance in Europe and a currency benefit of two points. Sequentially, customer service and supplies revenue reflects continued stabilization in North America.

For the year, we now expect customer service and supplies revenue to be essentially flat year over year.

In North America, our customer service revenue continued to be affected by lower total page volume. Within total page volume, declining pages from analog devices and black-and-white office products were partially offset by strong page growth from our color devices. Pages made on color devices represent 9% of total, about half of which are billed at a color rate.

As we execute on our strategies to drive color placement growth, particularly in the color production segment, we continue to expect our mix of color pages year over year to increase.

As expected, the higher mix of color pages is more than offsetting lower revenue per page in black-and-white and resulting in more stable revenue per total page. Now, we simply need to grow total page volume in North America and our sprint to color strategy of course is our key driver.

In Europe, customer service and supplies revenue grew 5% year over year at constant currency, driven by an increase in color page volume and strong color placement growth. As reported, Europe’s customer service and supplies revenue grew 14%.

Now please turn to slide seven.

Total managed and professional services revenue was $206 million, a 7% increase year over year. On-site managed services revenue, which represents about two-thirds of total managed and professional services, increased a strong 10% year over year. Revenue growth was primarily driven by our ability to expand existing accounts and by the cumulative effect of net new site additions in the current and prior periods.

Off-site managed services revenue decreased 3% year over year driven by a lower volume of activity. We remain focused on addressing this issue.

Professional services revenue increased 9% in the first quarter, driven by strong growth in Europe.

Now please turn to slide eight and I’ll discuss the actions we are taking to improve our financial performance.

We’ve taken three actions to drive revenue growth. First, we’ve worked with a vendor to reinstate the program previously in place. This is expected to positively impact our equipment revenue and placements going forward.

Second, we’ve adjusted the pricing strategy that made us uncompetitive in the first quarter. This action will enhance our ability to compete for color office machines.

And third, we’re modifying our sales management structure to improve the productivity of our mid-market account executives. This action enhances our sales force capability to focus on specific customers and prospective accounts.

In addition to these revenue actions, we’ve put in place a restructuring plan which is expected to reduce spending by $25 million in 2008.

Please turn to slide nine and Bob will review our financial results for the quarter, as well as our restructuring plan.

Robert F. Woods

Thank you, Matt and good morning, everyone. For the first quarter of fiscal 2008, earnings per diluted share were $0.13, including a $0.04 restructuring charge. Excluding this charge, earnings per diluted share were $0.17. As Matt mentioned, this $0.04 charge relates to actions we were taking to improve our financial results.

Gross margin for the quarter was 34.1%, an increase of 70 basis points from 33.4% in the first quarter last year. I’ll review gross margins in more detail on slide 11.

Selling and administrative expenses were $295 million, up $7 million year over year, primarily due to currency and, to a lesser extent, our investment in selling resources in the latter part of fiscal 2007.

For the quarter, our S&A expense-to-revenue ratio was 29.6% versus 28.6% in the first quarter last year. As Matt mentioned, we still expect our expense-to-revenue ratio to be approximately 28% for the full fiscal year 2008.

In addition, we continue to advance our migration to one platform in the U.S. by successfully completing our fifth migration in the first quarter. As a result, we are on track to complete the last remaining migration in the third quarter of fiscal 2008.

Operating income for the quarter was $38 million, or 3.8% of revenue as reported, compared to $49 million, or 4.9% of revenue in the first quarter last year. Operating income this quarter includes a $7 million charge related to the actions we are taking to reduce cost and expense, drive margin expansion, and full-year earnings per share growth.

Our effective tax rate for the first quarter was 44% due to a recent change in the corporate tax rate in Canada, which resulted in a $2.4 million one-time, non-cash revaluation of our Canadian deferred tax asset. We continue to expect our tax rate for fiscal year 2008 to be less than 33% and we also anticipate that the second quarter tax rate will range between 34% and 36%.

At the end of the quarter, actual shares outstanding were 93 million shares, a reduction of 26% year over year, driven by our share repurchase program, which included our equity tender.

Our fully diluted weighted average shares were 115 million shares for the quarter. Based on our capital structure and shares outstanding as of December 31, 2007, we believe fully diluted weighted average shares will average about 96 million shares over the remaining three quarters of fiscal 2008, bringing fully diluted weighted average shares for the full year of fiscal 2008 to approximately 101 million shares.

Since the company initiated its share repurchase program in the second half of fiscal 2004, it has repurchased a total of 62 million shares for $785 million, representing 42% of the shares outstanding as of March 31, 2004. During this time, the company also eliminated its convertible debt, avoiding a potential conversion into 20 million shares of common stock.

Now please turn to slide 10 and I’ll provide more details on our restructuring plan.

The $7 million pretax charge, or $0.04 per diluted share we incurred this quarter, is a result of actions we are taking to lower cost and expense, which when combined with other actions, will reduce headcount by approximately 350 people. The majority of these reductions will affect non-sales related functions.

In addition, we are also taking the following actions: we are reducing executive bonuses to reflect management’s disappointment with the first quarter results; and we are accelerating our ongoing efforts to reduce spending company wide in purchasing, real estate, IT, travel, and other corporate expenses. We expect these actions to yield approximately $25 million in savings in fiscal 2008 and to improve our operating income rate, particularly in the second half of the fiscal year.

Now please turn to slide 11 and I’ll discuss our gross profit.

Gross profit margin in the first quarter increased to 34.1% from 33.4% a year ago, primarily driven by improvements in equipment margin and managed and professional services margin. The equipment margin benefited by 150 basis points from a significant vendor rebate in the quarter as a result of a large equipment purchase, partially offset by pricing pressures. Excluding the vendor rebate, the equipment gross margins still improved sequentially from the fourth quarter.

Customer service and supplies margin decreased on slightly higher cost. The managed and professional services margin increased, primarily due to improved contract profitability in on-site managed services and improved professional services margin.

Now please turn to slide 12 and I’ll review cash flow.

For the first quarter of fiscal 2008, we used $16 million of cash from operations compared to a usage of $8 million in the first quarter last year. We generally use cash in the first quarter due to the payment of annual bonuses.

As I previously mentioned, we executed a large inventory purchase in the quarter which had no impact on cash flow because of a corresponding increase in accounts payable. We expect to substantially sell through this incremental inventory in our second fiscal quarter.

For fiscal year 2008, we expect free cash flow to range between $80 million and $110 million.

Now please turn to slide 13 and I’ll cover our tender offer results and our fiscal year 2008 share repurchase plan.

In November 2007, we announced our plan to repurchase $500 million of common stock. As part of that plan, we successfully completed a $295 million modified Dutch auction tender in December, purchasing 22.69 million shares. The repurchased shares represented 19.6% of our shares outstanding as of November 27, 2007. The tender was financed with cash from the balance sheet and $150 million of new notes. In addition, we repurchased $20 million of stock in the open market in the first quarter, bringing total repurchases during the quarter to $315 million.

We currently have little remaining repurchase capacity under the terms of our 2015 and 2012 notes and we have $315 million remaining under our board authorization. We plan to complete the balance of the $500 million share repurchase program announced in November 2007. However, the plan, the rate, and timing of any share repurchases remains subject to financing and market conditions, as well as any applicable regulations.

Execution of the balance of the share repurchase plan is expected to result in a one-time cash and pretax charge of $60 million to $70 million to refinance the 2015 and 2012 notes and complete other related transactions.

Now please turn to slide 14 and I’ll cover our balance sheet.

Cash on the balance sheet was lower by $207 million, corporate debt increased by $153 million, and equity decreased by $315 million from September 30, 2007, primarily due to the $315 million of share repurchases in the quarter.

Inventory increased to $357 million, up $69 million from September 30, 2007, substantially due to the large equipment purchase. As I mentioned, we expect to sell through the vast majority of this incremental inventory in our second quarter.

Now please turn to slide 15 and I’ll turn the call back to Matt.

Matthew J. Espe

Thanks, Bob. For fiscal 2008, we expect revenue to be flat year over year. This expectation reflects an improving year-over-year equipment trend, essentially flat customer services and supplies, and continued growth in managed and professional services.

We expect an expense-to-revenue ratio of about 28% and an operating income margin of about 5%. We also anticipate fully diluted earnings per share to range from $0.92 to $0.98, excluding the restructuring charge we took in the first quarter. Including this charge, we expect fully diluted EPS to range from $0.88 to $0.94. For our second quarter, we expect earnings per diluted share to range from $0.16 to $0.19.

As you can see from this guidance, we expect significantly higher earnings in the second half of fiscal 2008 compared to our first half. But two primary drivers will contribute to stronger financial results in the second half of the year. First, the principal benefits of the cost and expense reductions we’ve talked about and second, the tax rate will be substantially lower.

Please note that these expectations are based on our capital structure and shares outstanding as of December 31st and exclude the impact of any additional actions we may take to improve our business.

Lastly, given the reduction in our share count year over year, one penny of earnings per share is now equivalent to less than $1 million of net income. Given this greater sensitivity, we’ve widened the range of our EPS guidance.

Before I close and take your questions, I want to mention that last evening, we announced the creation of a new organization, IKON U.S. This action combines our U.S. sales and operations teams and completes the evolution of our corporate structure into three operating business units, U.S., Canada, and Europe, enabling us to operate more efficiently.

In connection with the new organization, I am pleased to announced that Jeff Hickling, Senior Vice President of Operations, will assume the role of President IKON U.S. As a result of this organization, Brian Edwards, Senior Vice President of U.S. Sales and Services, has decided to leave IKON. On behalf of everyone here, I want to personally thank Brian for his many years of dedicated service and leadership and we all wish him the very best.

In closing, we’ve already taken actions to improve revenue growth, lower selling and administrative expenses, and improve our operating income margin. These actions reflect our view that the economic environment, while challenging, doesn’t worsen. However, if these actions don’t yield the expected results or we see a further deterioration in the operating environment, we’ll take further actions.

While we are and I am disappointed with our first quarter results, aside from North American equipment revenue I am pleased that the rest of the business is healthy and performing as expected.

Thanks for listening and now we’ll be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Matt Troy with Citigroup.

Matt Troy - Citigroup

I had a question on the equipment sales weakness. You cited three things. I think fewer large transactions, vendors substantially reducing terms, and a change in pricing strategy. And then third, just the IT systems outage. I was wondering if you could directionally quantify in terms of the magnitude of the shortfall, which contributed what?

Matthew J. Espe

I think the way to think about it is the vendor program combined with our own B-to-C pricing strategy shift was probably worth 15 to 20, and the IT outage was worth about 5.

Matt Troy - Citigroup

Okay, now are you -- you’re talking about percentage?

Matthew J. Espe

No, I’m talking about million of dollars of equipment revenue, I’m sorry.

Matt Troy - Citigroup

Even better, thank you. In terms of -- I just want to be clear. The vendor, can you clarify -- when you talk about the longstanding promotional program, it sounds like it was reduced. You talked to the vendor, it was put back in place. I’m trying to reconcile that with your commentary about having higher inventory. It feels as if you are being bullied somewhat by our OEMs.

Can you just help us sort through what happened there? Why this is not indicative of a new level of relationship going forward or why this is now a one-time item and behind us?

Matthew J. Espe

Sure. I guess to try to answer the question firstly, there was no correlation between the vendor program and the inventory play. Different vendors, different dynamics. I believe we had -- we’ve had a very good run with the vendor program that we’ve been talking about. And I believe that the vendor in question decided to test the elasticity of demand. So while that program was eliminated, it was replaced with a less competitive program.

We were pretty vocal early in the quarter about our views around the program, embraced the new program, and try to run like hell with that. The results speak for themselves. The vendor immediately reversed their position and is right back in line and in place.

So I wouldn’t categorize it as a change in the dynamics. Let’s call it a testing of the waters. And frankly, Matt, we did the same thing on our own pricing. I mean, we looked at our performance in B-to-C, which has been outstanding the last several quarters, and started to test price elasticity and we obviously discovered that that’s not elastic. So the vendor and we reversed our programs.

The inventory -- we always make large inventory buys and we take advantage of competitive offerings from our vendors. I would suggest that instead of increasing the leverage on us, this is us taking advantage of our leverage on the vendors. Those are always positive.

I think Bob mentioned we expect to sell through most of the incremental inventory. I would also tell you that the alignment with the vendors has never been better, on both the promotional activity and the inventory buy. We had a lot of help profiling the inventory and we like what we bought and we think we’re at a significant competitive advantage as a result of it.

Matt Troy - Citigroup

On the first issue, the fewer larger transactions closing, I mean, everyone says it’s easy to cite the economy but what is your sense of the driver there? Are we seeing any specific end-market vertical, was it more broad-based, your customers delaying the buying decision?

Matthew J. Espe

Let me try to characterize it this way and let me just start with this comment -- our work in the last several weeks as we’ve tried to understand the quarter has been biased entirely towards our own execution issues, so we came at this specifically looking at what IKON or IKON and our vendors could have done better or differently to improve our performance in the quarter.

We’re not throwing the economy flag, per se. However, having said that, it’s clear that the operating environment has gotten more challenging, not just dramatically in our first quarter but as we’ve all seen over the last few quarters.

I think the way I would characterize the economy impacting us versus the vendor program and our own pricing strategies, I would categorize it in the following way -- we saw the large deal pipeline push obviously more in our national accounts in major and strategic accounts. To the extent that that timing and those cycles expanded more than usual, we could certainly say hey, the economy and a tougher, more challenging operating environment contributed to that.

I think that the vendor programs probably affected us more in the mid-market. I would also point out that the timing of the big deals occurred very late in the quarter, so as we went through the quarter the order patterns and our relative performance was very close to normal or average. What we experienced in terms of the big deals being pushed happened extremely late, unusually late in the quarter. And that I think you could point to the economy on some of that.

Matt Troy - Citigroup

Your sense is that is demand that will be recovered near term or is your sense that there are broader market issues? Because we’ve certainly heard from EFI and some of the independents out there that market conditions are tougher, have not really seen a bounce. I was wondering if you had any thoughts there.

Matthew J. Espe

We actually tend to do really we, as everybody knows, in the major strategic and national accounts, so we like our close rate, we like the size of the big deal pipeline. I think what’s happened is -- what we are looking at now is less of an erosion in the pipeline and more of an extension of the sales cycle.

So a big deal that we used to be able to close in 60 to 90 days may go to 120 days, so it’s that dynamic more than the deals have dried up. We may get -- we may cycle through a buying decision one or two more times than usual. That’s kind of where we see that dynamic, Matt.

The mid-market, because of the corrections we’ve made with and without the vendor, we expect to come back a little bit more rigorously. But we’re a business that has been heavily loaded on the bigger deals and so when the bigger deals push, this is what happens.

Matt Troy - Citigroup

Thank you.

Operator

Our next question comes from the line of Carol Sabbagha with Lehman Brothers.

Carol Sabbagha - Lehman Brothers

I had a question on the $60 million to $70 million you highlighted to refinance the two bond deals, et cetera. I just want to make sure I understand, that that’s expected to be a cash out?

Robert F. Woods

Carol, yeah, there is -- the $60 million to $70 million will be both a pretax earnings charge and will be a cash charge. They are not exactly the same charges because what you are doing is when you are taking off old stuff off your books, you are writing off any costs that were incurred that haven’t been amortized related to those items. And then you are incurring new costs and you are putting them on your books and that’s the cash charge.

But coincidentally when you look at it, it’s both a pretax charge and a cash charge in the range of $60 million to $70 million.

Carol Sabbagha - Lehman Brothers

And what do you think the components of the cash charge will be? Is it just calling the bonds early and refinancing? What makes up that $60 million to $70 million?

Robert F. Woods

If you look at it, the biggest item is we don’t have the ability to call any of the bonds and the bonds are blockers to the share buy-back. So in order for us -- you’ll recall we did a consent solicitation about a year ago to give us more share repurchase capacity, which we in fact just used in the tender.

So when you look at it, the biggest item is -- the way you have to take out those bonds is through a tender and a tender offer is very expensive. That is far and away the biggest piece of the $60 million to $70 million.

And then you have deferred charge write-offs and you also have obviously transaction fees for anything new that you are going to do.

Carol Sabbagha - Lehman Brothers

Okay, and then what sort of was the thought process behind being aggressive, taking the hit on tendering in terms of cash out and doing a $200 million incremental sooner rather than later, versus stretching it out over a longer period of time, a couple of years, doing the exact same amount but over a long period of time and not incurring the $60 million to $70 million incremental hit?

Robert F. Woods

In order not to incur the $60 million to $70 million incremental hit, we don’t have the ability to tender for the 2015s until 2010, so they would have been, or at the moment an inhibitor to any share buy-back beyond the 295 that we did.

Our thought process in going out first with the tender was if you are going to do $295 million and you are bullish on the company, which we are, we thought it was a good opportunity to take out a large chunk of stock and then to come back with a 205, as we’ve said, when we think the timing is right for that.

Carol Sabbagha - Lehman Brothers

Okay. Thank you very much.

Operator

Our next question comes from the line of Woo Jin Ho with Merrill Lynch.

Woo Jin Ho - Merrill Lynch

Thanks. Matt, a question on Europe; Europe has been strong for the past several quarters, double-digit growth for IKON in 2007, another double-digit quarter. Could you discuss some of the expectations out of the European business for ’08 and what are some of the underlying internal and external assumptions that you have to achieve those expectations?

Matthew J. Espe

Well, we expect Europe to continue to perform through the balance of the year like they performed the first half, or the first quarter, rather, and through 2007. We have a very solid, stable leadership team. I think one of the enablers to their execution, and we certainly saw it I think in Canada, Bob, last year as well was combining the structure and the European context, running it as a self-contained P&L, we made the same change in Canada last year where we appointed Sean Smith President of IKON Canada. We had much crisper execution across the Canadian business in 2007 as a result of that combination. That’s one of the drivers and one of the factors that went into the decision to create IKON U.S.

What we are learning is an integrated P&L allows us to move more quickly to simply all of our business processes, to offer a lot more clarity to our sales professionals, our customers, and to actually help us integrate even more effectively with our suppliers.

So back to Europe, we see Europe continuing to perform at or above market. We will continue to invest in Europe. We’re looking for opportunities to expand geographically and it’s a result of a very solid, experienced leadership team with the right structure.

Woo Jin Ho - Merrill Lynch

Okay, just turning to the 7000 real quickly, you indicated 40 placements in the quarter, 23 placements in the fourth quarter. According to the data, it seems as if it is below half of the U.S. -- Canon U.S.A.’s placements for the U.S. Are you in fact accounting for the majority share of Canon U.S. shipments or are you lagging your targets that you placed at the analyst day?

Matthew J. Espe

We can’t comment on anything that Canon has expressed. I think we’ve seen real momentum in the 7000s. I mean, 23 to 40. The investments we’ve made in the graphic arts space with the graphic arts representatives have built a very impressive pipeline. We like the direction we’re going. We have a very strong pipeline of commercial print, print for pay, as well as in-plant. The primary source of our success so far has been in-plant, so we’ve been able to convert and share shift fairly successfully there. [Regardless], have built a very impressive pipeline in commercial print and print for pay, so we see it as real upside, so we like our performance.

I can’t really comment on the Canon comparison. Canon’s business units, CBS and others, are coming from a very different dynamic than we are in terms of conversion of other technology, et cetera. So it’s -- you know, I’d say let’s let this thing play out another year or so before we start making those kinds of comparisons.

Woo Jin Ho - Merrill Lynch

Sure. And one more on the customer services and supplies, 1.4% growth in the first quarter. However, you are still forecasting flat year over year for customer services and supplies, you’re guiding to that for FY08. So that implies that the next three quarters is going to decline. How should I think of the customer services and supplies for the next three quarters?

Matthew J. Espe

I’ll take a whack at it and let Bob take it from there but you are going to have a reversal of currency benefits as we go into the second half of the year. The underlying constant currency improvement in customer service and supplies will continue, and it’s offset a little bit late in the year with currency going the other way. Bob, I’ll let you --

Robert F. Woods

If you go back to what we said, the first quarter was up one but it include a two-point currency benefit, so think of it ex-currency as being down one. And then what we went on to say is we expect to be essentially flat year over year and that’s with a currency environment that’s going to turn as the year progresses. So like we said last year and this year, we continue to stabilize and improve the business, but it was down one ex-currency first quarter.

Woo Jin Ho - Merrill Lynch

Great. Thank you.

Operator

Our next question comes from the line of Ananda Baruah with Banc of America.

Ananda Baruah - Banc of America

Just a quick question on the inventory, loud and clear that you feel you’re going to burn off the incremental build in the March quarter, but if I’m correct, your inventory has kind of built up over the last couple of quarters relative to what sales growth has been. Just interested to hear what the driver of that has been and if you’re including any of that in the incremental burn that you are talking about. I guess that’s the first thing.

The second thing is it sounds like, and this is more of a clarification than anything, but it sounds like your comments around your mid-market business imply that you’ve not yet seen what you would consider to be I guess weakening economic impact on that business. Some of the broader IT distributors over the last few weeks have begun to comment on incremental slowing growth in sort of the small and medium business, so just interested in getting your comments about how you feel the mid-market may be shaping up from a broader market perspective as you move into the year here?

Matthew J. Espe

Let me take a whack at the answer and I’ll ask Bob to fill in. The inventory pressure we’ve experienced the last few quarters has been a function of kind of two things -- number one, our [Kiaserameda] value brand inventory, we built that up to help drive that program based on the supply chain connection back to the factory in Asia. We continue to burn that down and sell it off.

The other thing that we worked on is a conversion in Konica Minolta from the CPP 500 to the 650 and the 550, so as we work to convert that technology, you sort of double down your inventory, again directionally. That’s behaving like we expected it, as we said we had very strong revenue of the 650 and the 550 in our quarter.

So clearly our inventory has increased a little bit in the last few months. Net of the buy we made at the end of the quarter, you would have seen that inventory go down.

We always make, as I said, or we tend to make large inventory buys at the end of our vendors fiscal year to take advantage of -- you know, leverage our size, take advantage of additional promotional and margin opportunities there.

We were very thoughtful in the profiling of the inventory that we bought and it’s that profiling that gives us confidence that we’ll be able to burn that inventory down largely in the first quarter.

Robert F. Woods

On the inventory, it’s important when you look at December and you see inventory up, your first reaction is oh, that must be economic. It’s very important to stress what Matt said -- our inventory, the largest driver to the inventory increase is the buy we did to take advantage of some very attractive pricing.

Now, what we said in our September or I guess October earnings call was we expected inventory to be down $30 million this year. We continue to expect inventory to be down $30 million this year, so last year we closed the year at around $288 million. We told you in October we expected that to be down 30. I will tell you again we expect that to be down 30. So I wouldn’t read in the inventory increase anything of concern. I would read into it we took advantage of a great opportunity and we continue to believe, based on everything that we have going on, that our inventory will be lower year over year.

Matthew J. Espe

Your comment or the question regarding the mid-market, again I would say that our performance in the mid-market this quarter was affected more by our pricing strategies than by the economy, but I also want to stress that the profile of our orders and our revenue flow throughout the quarter, until very, very late in the quarter, looked very normal. Underlying that profile was the reliance on the larger deals to help us close a quarter and of course, as I’ve said a couple of times, those deals pushed.

So our position on the mid-market is it’s an opportunity for us. We believe that we have made the changes necessary to become more competitive there. We are making I would say modest but important management structural changes in the field, and by that I mean we are aligning the mid-market teams with mid-market sales managers to provide more support for our mid-market account execs, product programs, et cetera, to help really line up and allow our selling professionals in the mid-market to do what they do best, which is go write deals and take care of customers.

So simplifying all of that I think helps. Clearly the economy isn’t helping. Based on our customer profile, we would feel the economy more in the major and strategic accounts than we would the mid-market, and clearly as I said that’s affecting the deal cycles in national and major accounts. It provides a little headwind in the mid-market. We believe we’ve corrected the program issues we had in the first quarter and by simplifying the sales structure and providing additional tools the mid-market account execs, by returning training back to normal levels, et cetera, we’ll be back in the hunt in the mid-market in the second quarter.

As I said though, if the environment deteriorates rapidly, if the economic environment worsens, we’re prepared to take additional actions, as you might expect us to.

Ananda Baruah - Banc of America

That’s helpful. I guess just to clarify, it sounds like at this point you are not seeing -- you sort of feel comfortable with -- I mean, issues, company-specific issues this quarter notwithstanding, it feels -- it sounds like you are saying that the pure end market demand environment from the mid-market level hasn’t changed substantively from the last couple of quarters.

Matthew J. Espe

Well, it’s a -- let me try to answer it this way. It’s clearly a challenging environment. Our industry is challenged even in a robust environment. Our current outlook assumes no significant deterioration in the challenging environment, and if that outlook holds then we believe the actions we have in place will get us home.

If we see a sudden or continued deterioration in the environment, we’re prepared to take additional steps.

Ananda Baruah - Banc of America

Got it. Thank you.

Operator

Our next question comes from the line of Shannon Cross with Cross Research.

Shannon Cross - Cross Research

Just a couple of questions; the first one, just with regard to the incremental share repurchase that you outlined, at least historically, I’m curious as to what your thoughts are on that. I believe you are still committed. And secondly, how will that be funded as you go through the year?

Robert F. Woods

We are committed to the remaining $205 million share buy-back. The way it will be funded is certain debt that is on our books will need to be removed and then some form of new financing will need to be put in place, probably a combination of some kind of asset-backed loan and also a notes offering.

As we said though, the timing, rate, and pace of that is also going to be dependent on the market.

Shannon Cross - Cross Research

Okay, and then just one question for Matt -- with regard to the push-back in the deals, and I think you’ve covered it but I just want to -- what’s your comfort level in all of those deals closing such that this current quarter comes in line? How far along are they? Anything you can give us to provide some comfort level that those will close?

Matthew J. Espe

I think it’s a combination of two things. I think it’s a combination of the total pipeline as we look at the second quarter, the mix of the deals in that total pipeline looks more normal to us. And so what I mean is if you look at our pipeline of closable deals in the second quarter, the mix of large and medium deals appears to be more normal. As we look back in the first quarter, as I said we became more heavily dependent on mid-market deals and the big deals pushed.

So I’ll start with the make-up of our pipeline as we enter the second quarter looks more normal.

We are -- obviously we are tracking every single deal and while the cycles are lengthening, our ability to close them has not diminished.

Shannon Cross - Cross Research

Okay, great and then just one last question with regard to the pricing environment, any changes, anything we should be aware of, either in Europe or the U.S. in terms of shifts in pricing?

Matthew J. Espe

No major shifts, Shannon. I mean, it continues to be tough. We see competitive pricing across the board. The dynamics, the relative dynamics haven’t changed much. I mean, it’s tough in black-and-white office. New products entered into the marketplace by our vendors and our competition offer new technology and new functionality at lower price points in B-to-C. Our aggressive moves into office production seem to be pricing out at kind of where we expected them to be.

So it continues to be real tough in office black-and-white, just sort of across the board; new products kind of drive some of the price pressure in B-to-C; and pricing seems to be holding up reasonably well in color production.

Shannon Cross - Cross Research

Okay, great. Thank you.

Operator

Ladies and gentlemen, this does conclude the question-and-answer session. Thank you for your participation. You may disconnect your lines at this time. Thank you for listening to today’s conference.