UNITED STATES
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: September 30, 2001
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 1-4471
XEROX CORPORATION
(Exact Name of Registrant as
specified in its charter)
New York 16-0468020
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
P.O. Box 1600
Stamford, Connecticut 06904-1600
(Address of principal executive offices) (Zip Code)
(203) 968-3000
(Registrant's telephone number, including area code)
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 ______ No X
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Class Outstanding at October 31, 2001
Common Stock 719,988,021 shares
This document consists of 55 pages.
Forward-Looking Statements
From time to time Xerox Corporation (the Registrant or the Company) and its
representatives may provide information, whether orally or in writing,
including certain statements in this Form 10-Q, which are deemed to be
"forward-looking" within the meaning of the Private Securities Litigation
Reform Act of 1995 ("Litigation Reform Act"). These forward-looking statements
and other information relating to the Company are based on the beliefs of
management as well as assumptions made by and information currently available
to management.
The words "anticipate", "believe", "estimate", "expect", "intend", "will", and
similar expressions, as they relate to the Company or the Company's management,
are intended to identify forward-looking statements. Such statements reflect
the current views of the Registrant with respect to future events and are
subject to certain risks, uncertainties and assumptions. Should one or more of
these risks or uncertainties materialize, or should underlying assumptions
prove incorrect, actual results may vary materially from those described herein
as anticipated, believed, estimated or expected. The Registrant does not intend
to update these forward-looking statements.
In accordance with the provisions of the Litigation Reform Act we are making
investors aware that such "forward-looking" statements, because they relate to
future events, are by their very nature subject to many important factors which
could cause actual results to differ materially from those contained in the
"forward-looking" statements. Such factors include but are not limited to the
following:
Competition - the Registrant operates in an environment of significant
competition, driven by rapid technological advances and the demands of
customers to become more efficient. There are a number of companies worldwide
with significant financial resources which compete with the Registrant to
provide document processing products and services in each of the markets served
by the Registrant, some of whom operate on a global basis. The Registrant's
success in its future performance is largely dependent upon its ability to
compete successfully in its currently-served markets and to expand into
additional market segments. If we are unable to compete successfully it could
adversely affect our results of operations and financial condition.
Transition to Digital - presently black and white light-lens copiers represent
approximately 25% of the Registrant's revenues. This segment of the market is
mature with anticipated declining industry revenues as the market transitions
to digital technology. Some of the Registrant's new digital products replace or
compete with the Registrant's current light-lens equipment. Changes in the mix
of products from light-lens to digital, and the pace of that change as well as
competitive developments could cause actual results to vary from those
expected.
Expansion of Color - color printing and copying represents an important and
growing segment of the market. Printing from computers has both facilitated
and increased the demand for color. A significant part of the Registrant's
strategy and ultimate success in this changing market is its ability to develop
and market machines that produce color prints and copies quickly and at reduced
cost. The Registrant's continuing success in this strategy depends on its
ability to make the investments and commit the necessary resources in this
highly competitive market. If we are unable to develop and market alternative
offerings in digital and color technologies, we may lose market share which
could have a material adverse effect on our operating results.
Pricing - the Registrant's ability to succeed is dependent upon its ability to
obtain adequate pricing for its products and services which provide a
reasonable return to shareholders. Depending on competitive market factors,
future prices the Registrant can obtain for its products and services may vary
from historical levels. In addition, pricing actions to offset currency
devaluations may not prove sufficient to offset further devaluations or may not
hold in the face of customer resistance and/or competition.
Customer Financing Activities - On average, 75 - 80 percent of the Registrant's
equipment sales are financed through the Registrant. To fund these
arrangements, the Registrant must access the credit markets and the long-term
viability and profitability of its customer financing activities is dependent
on its ability to borrow and its cost of borrowing in these markets. This
ability and cost, in turn, is dependent on the Registrant's credit ratings.
Currently the Registrant's credit ratings effectively preclude its ready access
to capital markets and the Registrant is currently funding its customer
financing activity from available sources of liquidity including cash on hand.
There is no assurance that the Registrant will be able to continue to fund its
customer financing activity at present levels. The Registrant is actively
seeking third parties to provide financing to its customers and recently
announced a "framework agreement" for GE Capital's Vendor Financial Services to
become the primary equipment financing for Xerox customers in the United
States. This Agreement has not yet been completed and remains subject to the
negotiation of definitive agreements and satisfaction of closing conditions,
including completion of due diligence. We are in various stages of
negotiations with third party vendors to offer financing to our customers in
Canada and all of the major countries in Europe. There is no assurance if or
when we will be able to successfully complete these negotiations. The
Registrant's ability to continue to offer customer financing and be successful
in the placement of its equipment with customers is largely dependent upon
obtaining such third party financing. In addition, the Company does not expect
to be able to access the capital markets in registered public offerings pending
resolution of the review of the Company's accounting practices by the
Securities and Exchange Commission referred to in Note 12 to the Consolidated
Financial Statements. The Company cannot predict when the Securities and
Exchange commission will conclude either its investigation or its review or the
outcome or impact of either.
Manufacturing Outsourcing - In October 2001, the Registrant announced a
manufacturing agreement with Flextronics, a $12 billion global electronics
manufacturing services company. The agreement includes a five-year supply
contract for Flextronics to manufacture certain office equipment and components
and the payment of approximately $220 million to Registrant for inventory,
property and equipment at a modest premium over book value, and the assumption
of certain liabilities. The actual cash proceeds will vary, based upon the
actual net asset levels at the time of the closings. As a result of these
actions, Registrant expects to incur restructuring charges in the fourth
quarter of 2001. Approximately 50 percent of Registrant's manufacturing
capacity has been sold to Flextronics. Registrant's ability to ensure
continued product availability and achieve improved asset utilization, supply
chain flexibilities and cost savings is dependent upon successfully completing
the transition to Flextronics. The Registrant's future success in the market
for office equipment will be significantly effected by the successful
conclusion, implementation and operation of this manufacturing agreement.
Productivity - the Registrant's ability to sustain and improve its profit
margins is largely dependent on its ability to maintain an efficient, cost-
effective operation. Productivity improvements through process reengineering,
design efficiency and supplier cost improvements, including manufacturing
outsourcing discussed above, are required to offset labor cost inflation and
potential materials cost changes and competitive price pressures. Registrant's
productivity in the market for office equipment will be significantly effected
by the successful conclusion, implementation and operation of the manufacturing
agreement with Flextronics described above.
International Operations - Following the events of September 11, 2001, economic
outlook in the United States and the other areas of the world has further
weakened. The Registrant derives approximately half its revenue from operations
outside of the United States. In addition, the Registrant manufactures or
acquires many of its products and/or their components outside the United
States. The Registrant's future revenue, cost and profit results could be
affected by a number of factors, including global economic conditions, changes
in foreign currency exchange rates, changes in economic conditions from country
to country, changes in a country's political conditions, trade protection
measures, licensing requirements and local tax issues. Our ability to enter
into new foreign exchange contracts to manage foreign exchange risk is
currently severely limited and, therefore, we anticipate increased volatility
in our results of operations due to changes in foreign exchange rates.
New Products/Research and Development - the process of developing new high
technology products and solutions is inherently complex and uncertain. It
requires accurate anticipation of customers' changing needs and emerging
technological trends. The Registrant must then make long-term investments and
commit significant resources before knowing whether these investments will
eventually result in products that achieve customer acceptance and generate the
revenues required to provide anticipated returns from these investments.
Revenue - the Registrant's ability to attain a consistent trend of
revenue over the intermediate to longer term is largely dependent upon
stabilization and subsequent expansion of its equipment sales worldwide and
usage growth (i.e., an increase in the number of images produced by customers).
The ability to achieve equipment sales growth is subject to the successful
implementation of our initiatives, including our vendor financing programs, to
ensure the stability and increasing tenure of our direct sales force while
continuing to expand indirect sales channels in the face of global competition
and pricing pressures. The ability to grow usage may be adversely impacted by
the movement towards distributed printing and electronic substitutes. Our
inability to attain a consistent trend of revenue growth could materially
affect the trend of our actual results.
Turnaround Program - In October 2000, the Registrant announced a turnaround
program which includes a wide-ranging plan to generate cash, return to
profitability and pay down debt. The success of the turnaround program is
dependent upon successful and timely sales of assets, restructuring the cost
base, placement of greater operational focus on the core business and the
transfer of the financing of customer equipment purchases to third parties.
Cost base restructuring is dependent upon effective and timely elimination of
employees, closing and consolidation of facilities, outsourcing of certain
manufacturing operations, reductions in operational expenses and the successful
implementation of process and systems changes. See "Customer Financing
Activities" and "Manufacturing Outsourcing" above for a description of two of
the Turnaround initiatives.
Liquidity - the Registrant's liquidity is dependent on the timely
implementation and execution of the various turnaround program initiatives as
well as its ability to generate positive cash flow from operations, possible
asset sales, and various financing strategies including securitizations and its
ability to successfully refinance a portion of its $7 billion Revolving Credit
Agreement and extend its maturity beyond October, 2002. Should the Registrant
not be able to successfully complete the turnaround program, generate cash and
refinance and extend the maturity of the Revolving Credit Agreement on a timely
or satisfactory basis, the Registrant will need to obtain additional sources of
funds through other operating improvements, financing from third parties, asset
sales, or a combination thereof. There can be no assurance that we can obtain
these additional sources of funds. We have initiated discussions with the
agent banks under our $7 billion revolving credit agreement in order to
refinance a portion and extend its maturity beyond October, 2002. This
agreement contains a consolidated tangible net worth ("CTNW") covenant and at
September 30, 2001 we had a $182 million cushion over the minimum amount
required under the covenant. Operating losses, restructuring costs and adverse
currency translation adjustments would erode the cushion. Failure to
successfully refinance and extend the maturity of the agreement or a breach of
the CTNW covenant could have a serious adverse impact on our liquidity.
Xerox Corporation
Form 10-Q
September 30, 2001
Table of Contents
Page
Part I - Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Statements of Operations 6
Consolidated Balance Sheets 7
Consolidated Statements of Cash Flows 8
Notes to Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition
Results of Operations 23
Capital Resources and Liquidity 31
Risk Management 36
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 37
Part II - Other Information
Item 1. Legal Proceedings 37
Item 2. Changes in Securities 37
Item 4. Submission of Matters to a Vote of Security
Holders 38
Item 5. Other Information 39
Item 6. Exhibits and Reports on Form 8-K 39
Signatures 40
Exhibit Index
By-Laws of Registrant, as amended through October 8, 2001 41
Computation of Net Income (Loss) per Common Share 54
Computation of Ratio of Earnings to Fixed Charges 55
For additional information about The Document Company Xerox, please visit our
World-Wide Web site at www.xerox.com/investor. Any information on or linked
from the website is not incorporated by reference into the Form 10-Q.
PART I - FINANCIAL INFORMATION
Item 1 Xerox Corporation
Consolidated Statements of Operations (Unaudited)
Three months ended Nine months ended
September 30, September 30,
(In millions, except per-share data) 2001 2000* 2001 2000*
Revenues
Sales $1,842 $2,420 $5,878 $7,341
Service, outsourcing, financing
and rentals 2,060 2,083 6,363 6,479
---------------------------------
Total Revenues 3,902 4,503 12,241 13,820
---------------------------------
Costs and Expenses
Cost of sales 1,262 1,582 4,049 4,460
Cost of service, outsourcing, financing
and rentals 1,226 1,344 3,860 3,986
Inventory charges 5 - 29 90
Research and development expenses 284 269 779 774
Selling, administrative and general expenses 1,215 1,428 3,629 4,074
Restructuring charge and asset impairments 39 - 431 504
Gain on sale of half of interest in Fuji Xerox - - (769) -
Gain on affiliate's sale of stock - - - (21)
Purchased in-process research and development - - - 27
Other, net 119 115 370 274
---------------------------------
Total Costs and Expenses 4,150 4,738 12,378 14,168
---------------------------------
Loss before Income Taxes (Benefits),
Equity Income (Loss), Minorities' Interests,
Extraordinary Gain, and Cumulative Effect of
Change in Accounting Principle (248) (235) (137) (348)
Income taxes (benefits) (56) (44) 187 (84)
---------------------------------
Loss after Income Taxes (Benefits)
before Equity income and Minorities' Interests(192) (191) (324) (264)
Equity in net income (loss) of unconsolidated
affiliates (1) 10 32 60
Minorities' interests in earnings of
subsidiaries 19 10 31 33
---------------------------------
Loss before extraordinary gain
and cumulative effect of change in accounting
principle (212) (191) (323) (237)
Extraordinary gain on early extinguishment of
debt (less income taxes of $1 and $23,
respectively) 1 - 36 -
Cumulative effect of change in accounting
principle (less income tax benefit of $1) - - (2) -
---------------------------------
Net Loss $ (211) $ (191) $ (289) $ (237)
=================================
Basic loss per share:
Loss before extraordinary gain and
cumulative effect of change in accounting
principle $(0.29) $(0.30) $(0.48) $(0.39)
Extraordinary gain, net - - 0.05 -
Cumulative effect of change in accounting
principle, net - - - -
---------------------------------
Basic Loss per Share $(0.29) $(0.30) $(0.43) $(0.39)
=================================
Diluted loss per share:
Loss before extraordinary gain and
cumulative effect of change in accounting
principle $(0.29) $(0.30) $(0.48) $(0.39)
Extraordinary gain, net - - 0.05 -
Cumulative effect of change in accounting
principle, net - - - -
---------------------------------
Diluted Loss per Share $(0.29) $(0.30) $(0.43) $(0.39)
=================================
See accompanying notes
* As restated, see Note 2
Xerox Corporation
Consolidated Balance Sheets
September 30, December 31,
(In millions, except share data in thousands) 2001 2000
Assets (Unaudited)
Cash and cash equivalents $ 2,427 $ 1,741
Accounts receivable, net 1,994 2,281
Finance receivables, net 4,828 5,097
Inventories, net 1,541 1,932
Equipment on operating leases, net 573 724
Deferred taxes and other current assets 1,409 1,247
-------------------------
Total Current Assets 12,772 13,022
Finance receivables due after one year, net 6,498 7,957
Land, buildings and equipment, net 2,099 2,495
Investments in affiliates, at equity 659 1,362
Intangible and other assets, net 3,478 3,061
Goodwill, net 1,525 1,578
-------------------------
Total Assets $ 27,031 $ 29,475
=========================
Liabilities and Equity
Short-term debt and current portion of
long-term debt $ 2,696 $ 2,693
Accounts payable 710 1,033
Accrued compensation and benefit costs 720 662
Unearned income 269 250
Other current liabilities 1,982 1,630
-------------------------
Total Current Liabilities 6,377 6,268
Long-term debt 13,380 15,404
Postretirement medical benefits 1,224 1,197
Deferred taxes and other liabilities 1,822 1,876
Deferred ESOP benefits (221) (221)
Minorities' interests in equity of subsidiaries 76 95
Obligation for equity put options - 32
Company-obligated, mandatorily redeemable
preferred securities of subsidiary trusts
holding solely subordinated debentures of
the Company 686 684
Preferred stock 613 647
Common shareholders' equity 3,074 3,493
-------------------------
Total Liabilities and Equity $ 27,031 $ 29,475
=========================
Shares of common stock issued and outstanding 717,518 668,576
See accompanying notes.
Xerox Corporation
Consolidated Statements of Cash Flows (Unaudited)
Nine Months ended September 30 (In millions) 2001 2000*
Cash Flows from Operating Activities
Net Loss $ (289) $ (237)
Adjustments required to reconcile net loss to
cash flows from operating activities, net of
effects of acquisitions:
Depreciation and amortization 794 794
Provisions for doubtful accounts 401 417
Restructuring and other charges 452 621
Gains on sales of businesses and assets (745) (84)
Gain on early extinguishment of debt (59) -
Cash payments for restructurings (368) (222)
Minorities' interests in earnings of subsidiaries 31 33
Undistributed equity in income of
affiliated companies - (20)
Decrease (increase) in inventories 279 (158)
Increase in on-lease equipment (176) (350)
Decrease (increase) in finance receivables 400 (776)
Securitization of finance receivables 480 -
Decrease (increase) in accounts receivable 66 (188)
Securitization of accounts receivable - 315
Decrease in accounts payable and accrued
compensation and benefit costs (237) (126)
Net change in current and deferred income taxes 256 (481)
Change in other current and non-current
liabilities (131) (219)
Other, net (136) (482)
-------------------
Net cash provided by (used in) operating activities 1,018 (1,163)
-------------------
Cash Flows from Investing Activities
Additions to land, buildings and equipment (159) (324)
Proceeds from sales of land, buildings and equipment 64 80
Acquisitions, net of cash acquired - (856)
Proceeds from divestitures 1,635 90
Cash paid to fund Ridge Re Trust (255) -
Other, net - (17)
-------------------
Net cash provided by (used in) investing activities 1,285 (1,027)
-------------------
Cash Flows from Financing Activities
Net change in debt (1,530) 2,619
Dividends on common and preferred stock (93) (441)
Proceeds from sales of common stock 28 22
(Settlements of) proceeds from equity put options, net (28) 24
Dividends to minority shareholders (2) (5)
------------------
Net cash (used in) provided by financing activities (1,625) 2,219
------------------
Effect of Exchange Rate Changes on Cash
and Cash Equivalents 8 (1)
------------------
Increase in Cash and Cash Equivalents 686 28
Cash and Cash Equivalents at Beginning of Period 1,741 126
------------------
Cash and Cash Equivalents at End of Period $ 2,427 $ 154
==================
See accompanying notes.
* As restated, see Note
Xerox Corporation
Notes to Consolidated Financial Statements (Unaudited)
($ in millions except per share data)
1. Basis of Presentation:
The unaudited consolidated interim financial statements presented herein have
been prepared by Xerox Corporation (the Company) in accordance with the
accounting policies described in its 2000 Annual Report to Shareholders and
should be read in conjunction with the notes thereto.
In the opinion of management, all adjustments (including normal recurring
adjustments) which are necessary for a fair statement of operating results for
the interim periods presented have been made.
We adopted Statement of Financial Accounting Standards (SFAS) No. 133,
"Accounting for Derivative Instruments and Hedging Activities" as of January 1,
2001. See Note 9 for additional details.
Prior years' financial statements have been reclassified to reflect certain
reclassifications to conform with the 2001 presentation. The impact of these
changes is not material and did not affect net loss.
The term "pre-tax income (loss)" as used herein refers to the Consolidated
Statement of Operations line item "Income (Loss) before Income Taxes
(Benefits), Equity Income (Loss), Minorities' Interests, Extraordinary Gain and
Cumulative Effect of Change in Accounting Principle".
References herein to "we" or "our" refer to Xerox Corporation and consolidated
subsidiaries unless the context specifically requires otherwise.
2. Restatement:
We have restated our Consolidated Financial Statements for the three and nine
month periods ended September 30, 2000 as a result of two separate
investigations conducted by the Audit Committee of the Board of Directors.
These investigations involved previously disclosed issues in our Mexico
operations and a review of our accounting policies and procedures and the
application thereof. This filing should be read in conjunction with Amendment
No. 1 to our Annual Report on Form 10-K for the fiscal year ended December 31,
2000. The adjustments made to the Consolidated Financial Statements for the
three months and nine months ended September 30, 2000 reflect the changes
discussed in such amendment. All amounts included herein have been restated to
reflect the changes as discussed in that report.
These adjustments relate primarily to imprudent and improper business practices
in Mexico, acquisition contingencies associated with our acquisition of the
remaining ownership interest in Xerox Limited from the Rank Group Plc,
misapplications of GAAP under SFAS No. 13 "Accounting for Leases" and certain
other items.
The following table presents the effects of the adjustments on pre-tax income
(loss):
Three months ended Nine months ended
September 30, 2000 September 30, 2000
Mexico $ 21 $ 69
Lease issues, net 22 72
Other, net (82) (104)
--------------------------------
Total $(39) $ 37
================================
The following tables present the impact of the adjustments and restatements on
a condensed basis:
Previously As
Reported Restated
Statement of Operations:
Three months ended September 30, 2000
Revenues $ 4,462 $ 4,503
Costs and expenses $ 4,658 $ 4,738
Net loss before extraordinary gain
and cumulative effect of change in
accounting principle $ (167) $ (191)
Basic loss per share $ (0.26) $ (0.30)
Diluted loss per share $ (0.26) $ (0.30)
Previously As
Reported Restated
Statement of Operations:
Nine months ended September 30, 2000
Revenues $ 13,581 $ 13,820
Costs and expenses $ 13,966 $ 14,168
Net loss before extraordinary gain
and cumulative effect of change in
accounting principle $ (265) $ (237)
Basic loss per share $ (0.44) $ (0.39)
Diluted loss per share $ (0.44) $ (0.39)
3. Inventories:
Inventories consist of the following:
September 30, December 31,
2001 2000
Finished products $ 1,038 $ 1,439
Work in process 112 147
Raw materials and supplies 391 346
-------------------------
Total $ 1,541 $ 1,932
=========================
4. Restructurings and Turnaround Program:
March 2000 Restructuring. In March 2000, we announced details of a
worldwide restructuring program. In connection with this program, we recorded a
pre-tax provision of $596 ($423 after taxes, including our $18 share of a
restructuring provision recorded by Fuji Xerox, an unconsolidated affiliate).
The $596 pre-tax charge included severance costs related to the elimination of
5,200 positions worldwide. Approximately 65 percent of the positions
eliminated were in the U.S., 20 percent were in Europe, and the remainder were
predominantly in Latin America. The employment reductions primarily affected
employees in manufacturing, logistics, customer service and back office support
functions. For facility fixed assets classified as assets to be disposed of,
the impairment loss recognized is based on the fair value less cost to sell,
with fair value based on estimates of existing market prices for similar
assets. The inventory charges relate primarily to the consolidation of
distribution centers and warehouses and the exit from certain product lines.
Included in the original provision were reserves related to liabilities due to
various third parties and several asset impairment charges. Liabilities
recorded for lease cancellation and other costs originally aggregated $51 and
included $32 for various contractual commitments, other than facility occupancy
leases, that will be terminated early as a result of the restructuring. The
commitments include cancellation of supply contracts and outsourced vendor
contracts. Included in the asset impairment charge of $71 was: $44 for
machinery and tooling for products that were discontinued or will be
alternatively sourced; $7 for leasehold improvements at facilities that will be
closed; and $20 of sundry surplus assets, individually insignificant, from
various parts of our business. These impaired assets were primarily located in
the U.S. and the related product lines generated an immaterial amount of
revenue. Approximately $71 of the $90 of inventory charges related to excess
inventory in many product lines created by the consolidation of distribution
centers and warehouses. The remainder was primarily related to the transition
to inkjet technology in our wide format printing business.
Weakening business conditions and operating results during 2000 required a re-
evaluation of the initiatives announced in March 2000. Accordingly, during the
fourth quarter of 2000, and in connection with the Turnaround Program discussed
below, $71 of the original $596 provision was reversed, $59 related to
severance costs for 1,000 positions and $12 related to lease cancellation and
other costs. The reversals primarily relate to delays in the consolidation and
outsourcing of certain of our warehousing and logistics operations and the
cancellation of certain European initiatives no longer necessary as a result
of higher than expected attrition.
During the first nine months of 2001 we recorded a net reversal to the March
2000 restructuring reserve of $14. This included the reversal of
approximately $53 of previously recorded charges and additional charges of
approximately $39. These reversals relate to adjustments to the originally
recorded reserves based on management's most recent estimate of the costs to
fund previously announced actions. Cash charges against the reserve for
the first nine months were $161. Other reductions to the reserve, including
currency, were $19. The cash charges were primarily for severance and related
costs. The March 2000 restructuring reserve balance at September 30, 2001 is
$15. The remaining reserve is primarily related to committed severance costs
for actions that are substantially complete.
During the third quarter of 2001, we also reversed $8 related to our
April 1998 restructuring program based on management's most recent estimate of
the costs to fund previously announced actions. Cash charges against the
reserve for the first nine months were $49. Other reductions to the reserve,
including currency, were $18. The April 1998 restructuring reserve balance at
September 30, 2001 is $24. The remaining balance will be utilized as severance
and remaining lease payments are made.
Turnaround Program. During 2000, the significant business challenges that we
began to experience in the second half of 1999 continued to adversely affect
our financial performance. These challenges included: the ineffective execution
of a major sales force realignment, the ineffective consolidation of our U.S.
customer administrative centers, increased competition and adverse economic
conditions.
These operational challenges, exacerbated by significant technology and
acquisition investments, led to a net loss in 2000, credit rating agency
downgrades, limited access to capital markets and marketplace concerns
regarding our liquidity. In response to these challenges, in October 2000, we
announced a Turnaround Program that includes a wide-ranging plan to sell
assets, cut costs and strengthen core operations. Additionally, we are
in substantive negotiations to provide financing for customers using third
parties.
In December 2000, we sold our operations in China to Fuji Xerox for $550 and
in March 2001 we sold half of our ownership interest in Fuji Xerox Co., Ltd.
(Fuji Xerox) to Fuji Photo Film Co, Ltd. (Fujifilm) for $1,283. In April 2001,
we sold our leasing business in four Nordic countries to Resonia Leasing AB
for cash proceeds of $352 (See Note 11). In July we completed the offering of
floating rate asset backed notes supported by U.S. finance receivables for
proceeds of $480 net of $3 paid in expenses and fees. As part of our plan to
transition customer equipment financing to third parties, in September we
announced a framework agreement with GE Capital under which, GE Capital's
Vendor Financial Services Group will become the primary equipment financing
provider for Xerox customers in the United States. We also agreed to the
principal terms of a financing agreement under which we will receive
approximately $1 billion from GE Capital, secured by portions of Xerox's U.S.
finance receivables. Both agreements are subject to the completion of
definitive agreements and the satisfactory completion of due diligence. (Refer
to Note 14 - Subsequent Events for a discussion of our agreement with
Flextronics.)
In 2000, we provided $105 for the Turnaround Program, $71 for severance and
related costs and $34 for asset impairments associated with the disposition of
a non-core business. During the first nine months of 2001 we provided an
additional $220, $192 for severance and related costs and $28 for asset
impairments. The severance and related costs are related to the elimination of
approximately 3,400 positions worldwide reflecting continued streamlining of
existing work processes, elimination of redundant resources and the
consolidation of activities into other existing operations. The asset
impairments related primarily to manufacturing operations. Cash charges
against the reserve for the first nine months were $126. Other reductions to
the reserve, including currency, were $1. The cash charges were primarily for
severance and related costs. The reserve balance at September 30, 2001 was
$127.
SOHO Disengagement. In June 2001, the Company approved the disengagement from
our worldwide SOHO business. In connection with exiting this business, we
recorded a second-quarter pretax charge of $274 ($196 after taxes). The charge
included provisions for the elimination of approximately 1,200 jobs worldwide
by the end of 2001, the closing of facilities and the write-down of certain
assets to net realizable value. In the 2001 third quarter we reduced the
original $274 provision by a net $12 as a result of changes in estimates for
employee termination and de-commitment costs. This included the reversal of
approximately $19 of previously recorded charges and additional charges of
approximately $7. The year to date $262 pretax charge for the SOHO
disengagement consists of $30 in employee termination costs, $144 of asset
impairments, $29 in inventory charges, $24 in purchase commitments, $16 in
decommitment costs and $19 in other miscellaneous charges. Charges against the
SOHO disengagement reserve were $180 for asset impairments and $32 for
severance and related costs. The reserve balance at September 30, 2001 was
$49.
5. Common Shareholders' Equity:
Common shareholders' equity consists of:
September 30, December 31,
2001 2000
Common stock $ 719 $ 670
Additional paid-in-capital 1,861 1,556
Retained earnings 3,105 3,441
Accumulated other comprehensive
loss (1) (2,611) (2,174)
-------------------------
Total $ 3,074 $ 3,493
=========================
(1) Accumulated other comprehensive loss at September 30, 2001 is comprised of
cumulative translation of $2,550, minimum pension liability of $28, unrealized
losses on marketable securities of $15, and mark to market losses on cash flow
hedges of $18.
In January 2001, 0.8 million put options with a strike price of $40.56 per
share were net cash settled for $28. Funds for this net cash settlement were
obtained by selling 5.9 million unregistered shares of our common stock for
proceeds of $28.
Comprehensive loss for the three months and nine months ended September 30,
2001 and 2000 is as follows:
Three months ended Nine months ended
September 30, September 30,
2001 2000 2001 2000
Net loss $ (211) $ (191) $ (289) $ (237)
Translation adjustments (45) (108) (411) (242)
Unrealized gains (losses)on
marketable securities - - (9) 14
Cash flow hedge adjustments 1 - (18) -
------------------------------------------
Comprehensive loss $ (255) $ (299) $ (727) $ (465)
==========================================
6. Interest expense and income:
Interest expense totaled $131 and $265 for the three months ended September 30,
2001 and 2000, respectively, and $683 and $739 for the nine months ended
September 30, 2001 and 2000, respectively. Interest income totaled $211 and
$236 for the three months ended September 30, 2001 and 2000, respectively, and
$688 and $711 for the nine months ended September 30, 2001 and 2000,
respectively.
7. Segment Reporting:
In the first quarter of 2001, we completed the realignment of our operations in
order to more closely align our reportable segments with the markets that we
serve. As a result of this realignment our reportable segments have been
revised accordingly and are as follows: Production, Office, Small Office/Home
Office, and Developing Markets Operations.
The Production segment includes DocuTech, production printing, color products
for the production and graphic arts markets and light-lens copiers over 90
pages per minute sold to Fortune 1000, graphic arts and government, education
and other public sector customers predominantly through direct sales channels
in North America and Europe.
The Office segment includes our family of Document Centre digital multi-
function products, light-lens copiers under 90 pages per minute, color
laser, solid ink and monochrome laser desktop printers, digital copiers and
facsimile products sold through direct and indirect sales channels in North
America and Europe. The Office market is comprised of global, national and mid-
size commercial customers as well as government, education and other public
sector customers.
The Small Office/Home Office (SOHO) segment includes inkjet printers and
personal copiers sold through indirect channels in North America and Europe to
small offices, home offices and personal users (consumers). As more fully
discussed in Note 4, in June 2001 the Company approved the disengagement from
the worldwide SOHO business.
The Developing Markets Operations segment (DMO) includes Latin America, Russia,
India, the Middle East and Africa.
Other includes several units, none of which met the thresholds for separate
segment reporting. This group primarily includes Xerox Engineering Systems and
Xerox Supplies Group (predominantly paper). Other segment profit/(loss)
includes certain corporate items such as non-financing interest expense which
have not been allocated to the operating segments.
Operating segment profit/(loss) information for the three months ended
September 30, 2001 and 2000 is as follows:
Developing
Production Office SOHO Markets Other Total
2001
Revenues from external
customers $ 1,377 $ 1,626 $ 109 $ 417 $ 373 $ 3,902
Intercompany revenues - (8) - - 8 -
-------------------------------------------------------
Total segment revenues $ 1,377 $ 1,618 $ 109 $ 417 $ 381 $ 3,902
=======================================================
Segment profit/
(loss) $ 45 $ 124 $ (49) $ (76) $ (249) $ (205)
=======================================================
2000
Revenues from external
customers $ 1,494 $ 1,713 $ 140 $ 635 $ 521 $ 4,503
Intercompany revenues - (4) 1 - 3 -
-------------------------------------------------------
Total segment revenues $ 1,494 $ 1,709 $ 141 $ 635 $ 524 $ 4,503
=======================================================
Segment profit/
(loss) $ 29 $ (1)$ (79) $ (37) $ (137) $ (225)
=======================================================
Operating segment profit/(loss) information for the nine months ended September
30, 2001 and 2000 is as follows:
Developing
Production Office SOHO Markets Other Total
2001
Revenues from external
customers $ 4,277 $ 5,051 $ 326 $ 1,314 $ 1,273 $12,241
Intercompany revenues - (15) (2) - 17 -
-------------------------------------------------------
Total segment revenues $ 4,277 $ 5,036 $ 324 $ 1,314 $ 1,290 $12,241
=======================================================
Segment profit/
(loss)(1) $ 309 $ 354 $ (208) $ (279) $ (590) $ (414)
=======================================================
2000
Revenues from external
customers $ 4,622 $ 5,244 $ 439 $ 1,877 $ 1,638 $13,820
Intercompany revenues - (11) 1 - 10 -
-------------------------------------------------------
Total segment revenues $ 4,622 $ 5,233 $ 440 $ 1,877 $ 1,648 $13,820
=======================================================
Segment profit/
(loss)(1) $ 525 $ 183 $ (183) $ 42 $ (216) $ 351
=======================================================
(1) The following is a reconciliation of segment profit/(loss) to total Company
Income (Loss) before Income Taxes (Benefits), Equity Income (Loss),
Minorities' Interest, Extraordinary Gain and Cumulative Effect of Change in
Accounting Principle:
Three months Nine months
ended September 30, ended September 30,
2001 2000 2001 2000
Total segment profit (loss) $ (205) $ (225) $ (414) $ 351
Restructuring:
Inventory charges (5) - (29) (90)
Restructuring charge and asset
impairments (39) - (431) (504)
Gain on sale of half of ownership
interest in Fuji Xerox - - 769 -
Purchased in-process R&D - - - (27)
Equity in net income of unconsolidated
affiliates 1 (10) (32) (78)*
----------------------------------
Income (Loss) before Income Taxes
(Benefits),Equity Income (Loss),
Minorities' Interests, Extraordinary
Gain and Cumulative Effect of
Change in Accounting Principle $ (248) $ (235) $ (137) $ (348)
===================================
* Excludes $18 associated with our share of Fuji Xerox after-tax
restructuring expenses.
8. Receivables - Financing transactions:
In January 2001, we transferred $898 of finance receivables to a special
purpose entity for cash proceeds of $435, received from an affiliate of General
Electric Capital Corporation (GE Capital), and a retained interest of $463. The
proceeds were accounted for as a secured borrowing. At September 30, 2001 the
balance of receivables transferred was $624 and is included in Finance
receivables, net in the Consolidated Balance Sheets. The remaining secured
borrowing balance of $168 is included in Debt. The total proceeds of $435 are
included in the Net Change in debt in the Consolidated Statements of Cash
Flows. The borrowing will be repaid over 18 months and bears interest at the
rate of 8.98 percent.
In July 2001, we completed the offering of $513 of floating rate asset
backed notes and received cash proceeds of $480 million net of $3 million paid
in expenses and fees. The remaining cash proceeds of approximately $30 will be
held in reserve over the term of the asset backed notes. As part of the
transaction we sold approximately $639 of domestic finance receivables to a
qualified special purpose entity in which we have a retained interest of
approximately $159, including the cash proceeds held in reserve. The
transaction was accounted for as a sale of finance receivables at approximately
book value.
In September 2001 Xerox and GE Capital announced a framework agreement for GE
Capital's Vendor Financial Services Unit to become the primary equipment
financing provider for Xerox customers in the United States. The two companies
also agreed to the principal terms of a financing arrangement under which
Xerox will receive from GE Capital approximately $1 billion secured by
portions of Xerox's finance receivables in the United States. As part of this
transaction, Xerox will transition nearly all of its U.S. customer
administration operations into a co-managed joint venture with GE Capital
Vendor Financial Services. It is anticipated that Xerox employees who work in
Xerox customer financing and administration offices will join the new joint
venture on January 2, 2002. Their work, which includes order processing,
credit approval, financing programs, billing and collections, is expected to
continue in the current locations. The arrangements are subject to the
negotiation of definitive agreements and satisfaction of closing conditions,
including completion of due diligence.
Refer to Note 11 - Divestitures for a discussion of the sale of certain of our
European leasing businesses.
9. Accounting Changes - Accounting for Derivative Instruments:
We adopted Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities", (SFAS No. 133) as of
January 1, 2001. SFAS No. 133 requires companies to recognize all derivatives
as assets or liabilities measured at their fair value. Gains or losses
resulting from changes in the fair value of derivatives would be recorded each
period in current earnings or other comprehensive income, depending on whether
a derivative is designated as part of a hedge transaction and, if it is,
depending on the type of hedge transaction.
Upon adoption of SFAS No. 133, we recorded a net cumulative after-tax
loss of $2 in the first quarter statement of operations and a net cumulative
after-tax loss of $19 in Accumulated Other Comprehensive Income. Further, as a
result of recognizing all derivatives at fair value, including the differences
between the carrying values and fair values of related hedged assets,
liabilities and firm commitments, we recognized a $403 increase in Total Assets
and a $424 increase in Total Liabilities. Approximately $4 of the
after-tax loss of $19 recorded in Accumulated Other Comprehensive
Income at transition has been reclassified to year to date earnings.
The adoption of SFAS 133 is expected to increase the future volatility of
reported earnings and other comprehensive income. In general, the amount of
volatility will vary with the level of derivative and hedging activities and
the market volatility during any period. However, as more fully described in
management's discussion of capital resources and liquidity, our ability to
enter into new derivative contracts is severely constrained. The following is
a summary of our FAS 133 activity during the first nine months of 2001:
Interest Rate/Cross Currency Swaps. We enter into several types of derivative
agreements primarily to manage interest rate and currency exposures related to
our indebtedness and to "match fund" our customer financing assets. We attempt
to manage our exposures in total on an economic basis, considering our total
portfolio of indebtedness, which includes fixed rate, variable rate and
foreign currency borrowings with varying terms. Accordingly, while all of our
derivative instruments are intended to economically hedge currency and
interest rate risk, differences between the contract terms of our derivatives
and the underlying related debt preclude hedge accounting in accordance with
SFAS No. 133. This results in mark-to-market valuation of these derivatives
directly through earnings which leads to increased earnings volatility.
During the third quarter we recorded a net gain of $46 from the mark-to-market
valuation of our interest rate derivatives primarily as a result of lower
interest rates during the period. Previous quarter mark-to-market valuations
were not material, however, the mark-to-market valuation of certain cross
currency interest rate swap agreements did result in a net gain of $14. This
gain is net of the remeasurement of the underlying foreign currency debt and
is included in Other, net.
Since May 2001, we designated certain cross currency interest rate swaps
associated with 65 billion in Yen borrowings as fair value type hedges and
accordingly accounted for them on a prospective basis. These borrowings have
an underlying Yen fixed interest rate, which the swaps convert to a US dollar
variable based rate. The net ineffective portion of these fair value hedges
recorded in third quarter and year to date earnings was not material.
Currency Derivatives. We utilize forward exchange contracts and option
contracts to hedge against the potentially adverse impacts of foreign currency
fluctuations on foreign currency denominated assets and liabilities. Changes
in the value of these currency derivatives are recorded in earnings together
with the offsetting foreign exchange gains and losses on the underlying assets
and liabilities.
We also utilize currency derivatives to hedge anticipated transactions,
primarily forecasted purchases of foreign-sourced inventory and lease payments.
These contracts are accounted for as cash flow hedges, and changes in their
value are deferred in Accumulated Other Comprehensive Income (AOCI) until the
anticipated transaction is recognized through earnings. During the third
quarter and first nine months of 2001, the impacts of our cash flow hedges
recorded through AOCI were not material.
Net Investment Hedges. We also utilize currency derivatives to hedge against
the potentially adverse impacts of foreign currency fluctuations on certain of
our investments in foreign entities. During the third quarter and first nine
months of 2001, $(5) and $12, respectively, of net after-tax gains/(losses)
related to hedges of our net investments in Xerox Brazil, Xerox Limited and
Fuji Xerox were included in the cumulative translation adjustments account.
10. Debt for Equity Exchanges:
We retired $340 of long-term debt through the exchange of 37.4 million shares
of common stock valued at $283 in the first nine months of 2001. These
retirements resulted in a pre-tax extraordinary gain of $59 ($36 after taxes)
for a net equity increase of $319.
11. Divestitures:
In March 2001, we completed the sale of half of our ownership interest in Fuji
Xerox to Fujifilm for $1,283 in cash. The sale resulted in a pre-tax gain of
$769 ($300 after taxes). Under the agreement, Fujifilm's ownership interest in
Fuji Xerox increased from 50 percent to 75 percent. While Xerox's ownership
interest decreased to 25 percent, we retain significant rights as a minority
shareholder. All product and technology agreements between us and Fuji Xerox
will continue, ensuring that the two companies retain uninterrupted access to
each other's portfolio of patents.
In the second quarter of 2001, we sold our leasing businesses in four Nordic
countries to Resonia Leasing AB for $352 in cash and retained interests in
certain finance receivables for total proceeds of approximately $370. The
carrying value of the assets transferred was approximately $385. These sales
are part of an agreement under which Resonia will provide on-going, exclusive
equipment financing to our customers in those countries.
12. Litigation:
On April 11, 1996, an action was commenced by Accuscan Corp. (Accuscan), in the
United States District Court for the Southern District of New York, against the
Company seeking unspecified damages for infringement of a patent of Accuscan
which expired in 1993. The suit, as amended, was directed to facsimile and
certain other products containing scanning functions and sought damages for
sales between 1990 and 1993. On April 1, 1998, the jury entered verdict in
favor of Accuscan for $40. However, on September 14, 1998, the court granted
the Company's motion for a new trial on damages. The trial ended on October 25,
1999 with a jury verdict of $10. The Company's motion to set aside the verdict
or, in the alternative, to grant a new trial was denied by the court. The
Company appealed to the Court of Appeals for the Federal Circuit which found
the patent not infringed, thereby terminating the lawsuit subject to an appeal
which has been filed by Accuscan to the U.S. Supreme Court. The Company will
file its opposition to the appeal.
On June 24, 1999, the Company was served with a summons and complaint filed in
the Superior Court of the State of California for the County of Los Angeles.
The complaint was filed on behalf of 681 individual plaintiffs claiming damages
as a result of the Company's alleged disposal and/or release of hazardous
substances into the soil, air and groundwater. On July 22, 1999, April 12,
2000, November 30, 2000, March 31, 2001 and May 24, 2001, respectively, five
additional complaints were filed in the same court on behalf of an additional
79, 141, 76, 51, and 29 plaintiffs, respectively, with the same claims for
damages as the June 1999 action. Four of the five additional cases have been
served on the Company.
Plaintiffs in all six cases further allege that they have been exposed to such
hazardous substances by inhalation, ingestion and dermal contact, including but
not limited to hazardous substances contained within the municipal drinking
water supplied by the City of Pomona and the Southern California Water Company.
Plaintiffs' claims against Registrant include personal injury, wrongful death,
property damage, negligence, trespass, nuisance, fraudulent concealment,
absolute liability for ultra-hazardous activities, civil conspiracy, battery
and violation of the California Unfair Trade Practices Act. Damages are
unspecified.
The Company denies any liability for the plaintiffs' alleged damages and
intends to vigorously defend these actions. The Company has not answered or
appeared in any of the cases because of an agreement among the parties and the
court to stay these cases pending resolution of several similar cases currently
pending before the California Supreme Court. However, the court recently
directed that the six cases against the Company be coordinated with a number of
other unrelated groundwater cases pending in Southern California.
A consolidated securities law action entitled In re Xerox Corporation
Securities Litigation is pending in the United States District Court for the
District of Connecticut. Defendants are Registrant, Barry Romeril, Paul
Allaire and G. Richard Thoman, former Chief Executive Officer, and purports to
be a class action on behalf of the named plaintiffs and all other purchasers of
Common Stock of the Company during the period between October 22, 1998 through
October 7, 1999 (Class Period). The amended consolidated complaint in the
action alleges that in violation of Section 10(b) and/or 20(a) of the
Securities Exchange Act of 1934, as amended (34 Act), and Securities and
Exchange Commission Rule 10b-5 thereunder, each of the defendants is liable as
a participant in a fraudulent scheme and course of business that operated as a
fraud or deceit on purchasers of the Company's Common Stock during the Class
Period by disseminating materially false and misleading statements and/or
concealing material facts. The amended complaint further alleges that the
alleged scheme: (i) deceived the investing public regarding the economic
capabilities, sales proficiencies, growth, operations and the intrinsic value
of the Company's Common Stock; (ii) allowed several corporate insiders, such as
the named individual defendants, to sell shares of privately held Common Stock
of the Company while in possession of materially adverse, non-public
information; and (iii) caused the individual plaintiffs and the other members
of the purported class to purchase Common Stock of the Company at inflated
prices. The amended consolidated complaint seeks unspecified compensatory
damages in favor of the plaintiffs and the other members of the purported class
against all defendants, jointly and severally, for all damages sustained as a
result of defendants' alleged wrongdoing, including interest thereon, together
with reasonable costs and expenses incurred in the action, including counsel
fees and expert fees. On September 28, 2001, the court denied the defendants'
motion for dismissal of the complaint. On November 5, 2001, the defendants
answered the complaint. The named individual defendants and the Company deny
any wrongdoing and intend to vigorously defend the action.
A consolidated putative shareholder derivative action entitled In re Xerox
Derivative Actions is pending in the Supreme Court of the State of New York,
County of New York against several current and former members of the Board of
Directors including William F. Buehler, B.R. Inman, Antonia Ax:son Johnson,
Vernon E. Jordan, Jr., Yotaro Kobayashi, Hilmar Kopper, Ralph Larsen, George J.
Mitchell, N.J. Nicholas, Jr., John E. Pepper, Patricia Russo, Martha Seger,
Thomas C. Theobald, Paul Allaire, G. Richard Thoman, Anne Mulcahy and Barry
Romeril, as well as the Company, as a nominal defendant. Previously, two
separate derivative actions had been filed in that court and another had been
pending in the United States District Court for the District of Connecticut.
Defendants filed a motion to dismiss in one of the New York actions.
Subsequently, the parties to the federal action in Connecticut agreed to
dismiss that action without prejudice in favor of the earlier-filed New York
action. The parties also agreed, subject to court approval, to seek
consolidation of the New York actions and a withdrawal, without prejudice, of
the motion to dismiss. On May 10, 2001 the court entered an order which, among
other things, approved that agreement. On or about October 16, 2001 the
plaintiffs in the two prior New York actions and the federal action in
Connecticut, along with one additional plaintiff filed an amended consolidated
complaint. The amended complaint alleges that each of the individual
defendants breached their fiduciary duties to the Company and its shareholders
by, among other things, ignoring indications of a lack of oversight at the
Company and the existence of flawed business and accounting practices within
the Company's Mexican and other operations which allegedly caused serious harm
to the Company; failing to have in place sufficient controls and procedures to
monitor the Company's accounting practices; knowingly and recklessly
disseminating and permitting to be disseminated, misleading information to
shareholders and the investing public; and permitting the Company to engage in
improper accounting practices. The amended complaint further alleges that each
of the individual defendants breached their duties of due care and diligence in
the management and administration of the Company's affairs and grossly
mismanaged or aided and abetted the gross mismanagement of the Company and its
assets. Further, the plaintiffs allege that the defendant members of the Audit
Committee failed to adequately inform themselves about the Company's accounting
practices and breached their fiduciary duties. On behalf of the Company, the
plaintiffs seek a judgment that the individual defendants violated and/or aided
and abetted the breach of their fiduciary duties to the Company and its
shareholders, unspecified compensatory damages against the individual
defendants, punitive damages, costs, and reasonable attorneys' and experts'
fees. On August 2, 2001 the Commonwealth Court of Pennsylvania issued an order
which, among other things, purported to stay, for a period of 180 days from
August 2, 2001, certain actions pending against insured parties of Reliance
Insurance Company, including this derivative litigation. On October 3, 2001
that court issued an order which, among other things, purports to supersede its
previous order and stays, for a period of 90 days from October 3, 2001, all
proceedings in which Reliance is obligated to defend a party. This litigation
does not fall within that category. The individual defendants deny the
wrongdoing alleged and intend to vigorously defend the litigation.
Twelve purported class actions had been pending in the United States District
Court for the District of Connecticut against Registrant, KPMG LLP (KPMG), and
Paul A. Allaire, G. Richard Thoman, Anne M. Mulcahy and Barry D. Romeril. A
court order consolidated these twelve actions and established a procedure for
consolidating any subsequently filed related actions. The consolidated action
purports to be a class action on behalf of the named plaintiffs and all
purchasers of securities of, and bonds issued by, Registrant during the period
between February 15, 1998 through February 6, 2001 (Class). Among other things,
the consolidated complaint generally alleges that each of the Company, KPMG,
the individuals and additional defendants Philip Fishbach and Gregory Tayler
violated Sections 10(b) and/or 20(a) of the 34 Act and Securities and Exchange
Commission Rule 10b-5 thereunder, by participating in a fraudulent scheme that
operated as a fraud and deceit on purchasers of the Company's Common Stock by
disseminating materially false and misleading statements and/or concealing
material adverse facts relating to the Company's Mexican operations and other
matters relating to the Company's financial condition beyond the Company's
Mexican operations. The amended complaint generally alleges that this scheme
deceived the investing public regarding the true state of the Company's
financial condition and caused the named plaintiff and other members of the
alleged Class to purchase the Company's Common Stock and Bonds at artificially
inflated prices. The amended complaint seeks unspecified compensatory damages
in favor of the named plaintiff and the other members of the alleged Class
against the Company, KPMG and the individual defendants, jointly and severally,
including interest thereon, together with reasonable costs and expenses,
including counsel fees and expert fees. Following the entry of the order of
consolidation, several (nine) additional related class action complaints were
filed in the same Court. In each of these cases, the plaintiffs defined a class
consisting of persons who purchased the Common Stock of the Company during the
period February 15, 1998 through and including February 6, 2001. Some of these
plaintiffs filed objections to the consolidation order, challenging the
appointment of lead plaintiffs and lead and liaison counsel and have separately
moved for the appointment of lead plaintiff and lead counsel. The court has not
rendered a decision with regard to the objections or motion. On August 2, 2001
the Commonwealth Court of Pennsylvania issued an order which, among other
things, purported to stay, for a period of 180 days from August 2, 2001,
certain actions pending against insured parties of Reliance Insurance Company,
including this consolidated securities law action. On October 3, 2001 that
court issued an order which, among other things, purports to supersede its
previous order and stays, for a period of 90 days from October 3, 2001, all
proceedings in which Reliance is obligated to defend a party. This litigation
does not fall within that category. The individual defendants and the Company
deny any wrongdoing alleged in the complaints and intend to vigorously defend
the actions.
A lawsuit has been instituted in the Superior Court, Judicial District of
Stamford/Norwalk, Connecticut, by James F. Bingham, a former employee of the
Company, against the Company, Barry D. Romeril, Eunice M. Filter and Paul
Allaire. The complaint alleges that the plaintiff was wrongfully terminated in
violation of public policy because he attempted to disclose to senior
management and to remedy alleged accounting fraud and reporting irregularities.
The plaintiff further claims that the Company and the individual defendants
violated the Company's policies/commitments to refrain from retaliating against
employees who report ethics issues. The plaintiff also asserts claims of
defamation and tortious interference with a contract. He seeks: (a) unspecified
compensatory damages in excess of $15 thousand, (b) punitive damages, and (c)
the cost of bringing the action and other relief as deemed appropriate by the
court. The individuals and the Company deny any wrongdoing and intend to
vigorously defend the action.
A putative shareholder derivative action is pending in the Supreme Court of the
State of New York, Monroe County against certain current and former members of
the Board of Directors, namely G. Richard Thoman, Paul A. Allaire, B. R. Inman,
Antonia Ax:son Johnson, Vernon E. Jordan Jr., Yotaro Kobayashi, Ralph S.
Larsen, Hilmar Kopper, John D. Macomber, George J. Mitchell, N. J. Nicholas,
Jr., John E. Pepper, Patricia L. Russo, Martha R. Seger and Thomas C. Theobald
(collectively, the "Individual Defendants"), and the Company, as a nominal
defendant. Plaintiff claims the Individual Defendants breached their fiduciary
duties of care and loyalty to the Company and engaged in gross mismanagement by
allegedly awarding former CEO, G. Richard Thoman, compensation including
elements that were unrelated in any reasonable way to his tenure with the
Company, his job performance, or the Company's financial performance. The
complaint further specifically alleges that the Individual Defendants failed to
exercise business judgment in granting Thoman lifetime compensation, a special
bonus award, termination payments, early vesting of stock compensation, and
certain transportation perquisites, all of which allegedly constituted gross,
wanton and reckless waste of corporate assets of the Company and its
shareholders. Plaintiff claims that the Company has suffered damages and seeks
judgment against the Individual Defendants in an amount equal to the sum of the
special bonus, the present value of the $800 thousand per year lifetime
compensation, the valuation of all options unexercised upon termination, the
cost of transportation to and from France, and/or an amount equal to costs
already incurred under the various compensation programs, cancellation of
unpaid balances of these obligations, and/or cancellation of unexercised
options and other deferred compensation at the time of his resignation, plus
the cost and expenses of the litigation, including reasonable attorneys',
accountants' and experts' fees and other costs and disbursements. On May 31,
2001 defendants filed a motion to dismiss the complaint. The motion is
pending. The Individual Defendants deny the wrongdoing alleged in the complaint
and intend to vigorously defend the action.
A class was certified in an action originally filed in the United States
District Court for the Southern District of Illinois last August against the
Company's Retirement Income Guarantee Plan ("RIGP"). Plaintiffs bring this
action on behalf of themselves and an alleged class of over 25,000 persons who
received lump sum distributions from RIGP after January 1, 1990. Plaintiffs
assert violations of the Employee Retirement Income Security Act ("ERISA"),
claiming that the lump sum distributions were improperly calculated. The
damages sought are not specified. On July 3, 2001 the court granted the
Plaintiffs' motion for summary judgment, finding that the lump sum calculations
violated ERISA. RIGP denies any wrongdoing and intends to appeal the
District Court's ruling.
In 2000, the Company was advised that the Division of Enforcement of the
Securities and Exchange Commission (SEC) had entered an order of a formal, non-
public investigation into our accounting and financial reporting practices.
The investigation initially focused on accounting and financial reporting
practices in Mexico. Subsequent SEC inquiries have included certain of our
accounting policies and procedures and the application thereof referred to in
Note 2. We are cooperating fully with the SEC. Among ongoing SEC matters, the
Company is also engaged in a review with the SEC's Division of Corporation
Finance and its Office of the Chief Accountant concerning the Company's method
of accounting for sales-type leases under the Financial Accounting Standard
Board's Statement of Financial Accounting Standards No. 13 ("SFAS No. 13").
The review concerns whether the Company's method of applying SFAS No. 13
results in an appropriate allocation of revenue among the various elements of
its sales-type leases; equipment, financing, service and supplies. The Company
believes both the methodology and the financial results it reports are in
accordance with SFAS No. 13 and GAAP. The Company cannot predict when the SEC
will conclude either its investigation or its review or the outcome or impact
of either.
On June 19, 2001, an action was commenced by Pitney Bowes in the United States
District Court for the District of Connecticut against the Company seeking
unspecified damages for infringement of a patent of Pitney Bowes which expired
on May 31, 2000. Plaintiff claims that two printers containing image
enhancement functions infringe the patent and seeks damages in an unspecified
amount for sales between June 1995 and May 2000. The Company filed their answer
and counter claims on October 1, 2001. The Company denies any wrongdoing and
intends to vigorously defend the action.
At this time we do not expect these matters to have a material adverse effect
on our current financial position. However, these matters could have a
material adverse effect on our future results of operations and cash flows.
13. New Accounting Pronouncements:
In June of 2001, the Financial Accounting Standards Board issued Statement No.
141, "Business Combinations" (SFAS No. 141). SFAS No. 141 requires the use of
the purchase method of accounting for business combinations and prohibits the
use of the pooling of interests method. The Company has not historically
engaged in transactions that qualify for using the pooling of interest method
and therefore, this aspect of the new rules will not have an impact on the
Company's financial results. SFAS No. 141 also changes the definition of
intangible assets acquired in a purchase business combination. As a result, the
purchase price allocation of future business combinations may be different than
the allocation that would have resulted under the old rules. Business
combinations must be accounted for using SFAS No. 141 starting on July 1, 2001.
In June of 2001, the Financial Accounting Standards Board issued Statement No.
142 "Goodwill and Other Intangible Assets" (SFAS No. 142). The statement
addresses financial accounting and reporting for acquired goodwill and other
intangible assets. This statement recognizes that goodwill has an indefinite
useful life and will no longer be subject to periodic amortization. However,
goodwill will be tested at least annually for impairment in lieu of
amortization. The Company recognized goodwill amortization expense of $14 and
$44 in the third quarter and first nine months of 2001, respectively. The
statement also requires the Company to perform transitional impairment tests on
existing acquired goodwill and other intangible assets and evaluate those
assets for proper classification. The Company is currently evaluating the
impacts of this new standard on our financial statements. The Company will
adopt this standard, as required, on January 1, 2002.
In June of 2001, The Financial Accounting Standards Board issued SFAS No. 143,
"Accounting for Asset Retirement Obligations". The Statement addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets that result from the acquisition,
construction, development and (or) the normal operation of a long-lived asset,
except for certain obligations of lessees. In August 2001, The Financial
Accounting Standards Board issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets". The Statement primarily supercedes FASB
Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed of. This Statement addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
Management believes that adoption of both Statements will not have a material
effect on the financial position or results of operations of the Company.
The Company will adopt the Statements, as required on January 1, 2003 and
January 1, 2002, respectively.
14. Subsequent Events:
In October 2001, we announced a manufacturing agreement with Flextronics, a $12
billion global electronics manufacturing services company. The agreement
includes a five-year supply contract for Flextronics to manufacture certain
office equipment and components, payment of approximately $220 million to Xerox
for inventory, property and equipment at a modest premium over book value, and
the assumption of certain liabilities. The premium will be amortized over the
life of the five-year supply contract. The actual cash proceeds will vary,
based upon the actual net asset levels at the time of the closings. As a
result of these actions, we expect to incur restructuring charges in the
fourth quarter of 2001. Additional information on the agreement with
Flextronics is included in the accompanying Management's Discussion and
Analysis on pages 30-31.
In October 2001, S&P reduced its rating of our senior debt to below investment
grade. Additional information related to the downgrade is included in the
accompanying Management's Discussion and Analysis on page 35.
As more fully discussed on page 36 in the accompanying Management's Discussion
and Analysis, a European affiliate of Xerox Corporation repaid its 125 million
GBP 8-3/4 percent Guaranteed Bonds on October 4, 2001 at 103% of par including
accrued interest.
Item 2 Xerox Corporation
Management's Discussion and Analysis of
Results of Operations and Financial Condition
Results of Operations
Summary
As discussed in Note 2 to the Consolidated Financial Statements, we have
restated our 1999 and 1998 financial statements. This restatement has also
impacted the quarterly and year to date financial information previously
presented for the period ended September 30, 2000. All dollar and per share
amounts and financial ratios have been revised, as appropriate, for the effects
of the restatement.
Total third quarter 2001 revenues of $3.9 billion declined 13 percent (12
percent pre-currency) from $4.5 billion in the 2000 third quarter. This decline
was driven by increased competitive pressure and continued weakness in the
economy exacerbated by the events of September 11. While revenue in North
America and Europe declined, both regions showed significant year-over-year
profitability improvements led by North America. Developing Markets Operations
third quarter 2001 revenues were 34 percent below the 2000 third quarter as we
reconfigure our Latin American Operations to a new business approach
prioritizing liquidity and profitable revenue rather than market share.
Total revenues in the first nine months of 2001 of $12.2 billion declined 11
percent (10 percent pre-currency) from $13.8 billion in the first nine months
of 2000. Year to date pre-currency revenue declines of 2 percent in North
America and 5 percent in Europe were the result of a weak economic environment
and competition partly offset by stabilization of the U.S. direct sales force.
Including additional net after-tax restructuring provisions of $37 million
associated with the company's previously announced Turnaround Program and
disengagement from our worldwide small office / home office (SOHO) business and
a $1 million after tax gain on early retirement of debt, the third quarter 2001
net loss was $211 million. Excluding these items, the third quarter 2001 after
tax loss was $175 million. In the 2001 third quarter, we incurred a $37
million loss in our worldwide SOHO operations. The 2001 third quarter loss
reflected the revenue decline, but our operating margin stabilized together
with an improvement in the gross margin.
The 2001 year to date net loss was $289 million compared to a net loss of $237
million in the first nine months 2000. 2001 special items included the
following after-tax charges - $190 million associated with the Company's
disengagement from the SOHO business, $139 million related to the Company's
previously announced Turnaround Program, and a $2 million loss from the
implementation of SFAS 133. Special items also included the following after-
tax gains - $300 million related to the March 2001 sale of half of our
investment in Fuji Xerox Co., Ltd. (Fuji Xerox) to Fuji Photo Film Co. Ltd.
(Fujifilm), and $36 million associated with the early retirement of debt. 2000
special items include a $423 million after tax restructuring provision and a
$16 million after tax in-process research and development charge associated
with the January 1, 2000 acquisition of the Tektronix, Inc. Color Printing and
Imaging Division (CPID).
Excluding all special items, the year to date 2001 net loss was $294 million
compared with net income of $202 million in the first nine months of 2000.
Our loss per share was $0.29 in the 2001 third quarter. Excluding the $0.05
restructuring provision, the third quarter 2001 loss per share was $0.24
compared with $0.30 loss per share in the 2000 third quarter.
Including the $0.27 SOHO disengagement charge, $0.20 restructuring provision,
$0.43 gain on the sale of Fuji Xerox, and $0.05 gain from the early retirement
of debt, the year to date 2001 loss per share was $0.43. The year to date 2000
loss per share was $0.39 including charges of $0.66 for restructuring
and acquired CPID in-process R&D. Excluding all special items, the 2001 year
to date loss per share was $0.44 compared with $0.27 earnings per share in
the first nine months of 2000.
In the ordinary course of business, management makes many estimates in the
accounting for items that affect our reported results of operations and
financial position. The following table summarizes the more significant of
these estimates, and the changes therein, and their impacts on pre-tax income
(loss):
Three months Nine months
ended September 30, ended September 30,
2001 2000 2001 2000
Impact on pre-tax
income (loss):
Provisions for doubtful accounts $(186) $(172) $(401) $(417)
Provisions for obsolete and excess
inventory (46) (36) (108) (70)
Revenue allocations (21) 18 (37) 50
Finance discount rates (8) - (25) 22
The significant preceding items are analyzed as appropriate in succeeding
sections of this Management's Discussion and Analysis of Operations and
Financial Condition and/or the accompanying Notes to Consolidated Financial
Statements.
Pre-Currency Growth
To understand the trends in the business, we believe that it is helpful to
adjust revenue and expense growth (except for ratios) to exclude the impact of
changes in the translation of European and Canadian currencies into U.S.
dollars. We refer to this adjusted growth as "pre-currency growth." Latin
American currencies are shown at actual exchange rates for both pre-currency
and post-currency reporting, since these countries generally have volatile
currency and inflationary environments.
A substantial portion of our consolidated revenues is derived from operations
outside of the United States where the U.S. dollar is not the functional
currency. When compared with the average of the major European and Canadian
currencies on a revenue-weighted basis, the U.S. dollar was approximately 2
percent stronger in the 2001 third quarter than in the 2000 third quarter.
As a result, currency translation had an unfavorable impact of approximately
one percentage point on revenue growth.
Segment Analysis
Revenues and year-over-year revenue growth rates by segment are as follows
(Dollars are in billions):
Q3 2001
Post Currency
2000 Pre-Currency Revenue Growth
Full
Year 2000 2001
Revenues Q1 Q2 Q3 Q4 FY Q1 Q2 Q3 Revenues Growth
Total Revenues $18.7 8% -% (2)% (9)% (1)% (5)%(12)%(12)% $3.9 (13)%
Production 6.3 1 (2) (8) (12) (6) (2) (8) (7) 1.4 (8)
Office 7.1 4 5 4 (3) 2 3 (5) (4) 1.6 (5)
SOHO 0.6 35 (3) (2) 1 6 (24) (30) (22) 0.1 (23)
DMO 2.5 36 4 (3) (21) - (21) (31) (33) 0.4 (34)
Other 2.2 7 (9) (1) (4) (2) (16) (17) (26) 0.4 (27)
Memo: Color 2.9 64 60 74 54 62 17 1 (4) 0.7 (6)
YTD 2001
Revenue Growth
Pre Post
Revenues Currency Currency
Total Revenues $12.2 (10)% (11)%
Production 4.3 (6) (8)
Office 5.0 (2) (4)
SOHO 0.3 (25) (26)
DMO 1.3 (29) (30)
Other 1.3 (20) (22)
Memo: Color 2.1 4 2
2000 pre-currency revenue growth includes the beneficial impact of the January
1, 2000 acquisition of the Tektronix, Inc. Color Printing and Imaging Division.
Production revenues include DocuTech, Production Printing, color products for
the production and graphic arts markets and light-lens copiers over 90 pages
per minute sold predominantly through direct sales channels in North America
and Europe. Third quarter 2001 revenues declined 8 percent (7 percent pre-
currency). Third quarter 2001 pre-currency revenues declined 3 percent in North
America and 7 percent in Europe from the 2000 third quarter. Monochrome
production revenue declines reflect the downturn in the economy, competitive
product introductions and continued movement to distributed printing and
electronic substitutes. In addition, revenue was adversely impacted by reduced
DocuTech sales to Fuji Xerox and unfavorable product mix reflecting
installations of the recently introduced DocuTech 75 and DocuPrint 75. Post
equipment install revenues continue to be adversely affected by reduced
equipment placements in earlier quarters and lower print volumes. Production
color revenues declined as the weaker economic environment impacted sales of
color equipment and competitive product introductions continued. Revenues from
the successful DocuColor 2000 series, which began shipments in June 2000,
continued to grow reflecting increased equipment sales and recurring revenues.
Reduced DocuColor 30/40 and mid-range installs combined with more aggressive
pricing resulted in revenue declines. Production revenues represented 35
percent of third quarter 2001 revenues compared with 33 percent in the 2000
third quarter. Third quarter 2001 gross margin for the production segment
improved from the 2000 third quarter as significant improvement in document
outsourcing margins and improved service productivity were only partially
offset by unfavorable mix.
Production revenues declined 8 percent (6 percent pre-currency) in the first
nine months of 2001 from the first nine months of 2000 due to a weaker
economic environment and continued movement to distributed printing and
electronic substitutes. Good growth in production color revenues are not yet
sufficient to offset monochrome declines.
Office revenues include our family of Document Centre digital multi-function
products; light-lens copiers under 90 pages per minute; and our color laser,
solid ink and monochrome laser desktop printers, digital copiers and facsimile
products sold through direct and indirect sales channels in North America and
Europe. Third quarter 2001 revenues declined 5 percent (4 percent pre-currency)
from the third quarter 2000. Black and white revenues declined as equipment
sales were impacted by the weaker economy, continued competitive pressures and
light lens declines and our decision in Europe to reduce our participation in
very aggressively priced competitive customer bids and tenders as we reorient
our focus from market share to profitable revenue. Shipments of the Document
Centre 490, the fastest in its class at 90 pages-per-minute began in North
America in September. European launch is scheduled for the first quarter 2002.
Strong office color revenue growth was driven by continued growth in the
Document Centre ColorSeries 50 partially offset by office color printer
equipment sales declines. The Document Centre ColorSeries 50 is the industry's
first color-enabled digital multi-function product. Office revenues represented
41 percent of third quarter 2001 revenues compared with 38 percent in the 2000
third quarter. Third quarter 2001 gross margin for the office segment improved
significantly from the 2000 third quarter primarily as a result of our reduced
participation in very aggressively priced competitive bids and tenders,
improving Document Centre margins facilitated by strong Document Centre 480
placements and initial Document Centre 490 placements, improved manufacturing
and service productivity, favorable currency and significantly improved
document outsourcing margins.
Office revenues declined 4 percent (2 percent pre-currency) in the first
nine months of 2001 from the first nine months of 2000 as strong office color
revenue growth was insufficient to offset black and white declines.
Small Office/Home Office (SOHO) revenues include inkjet printers and personal
copiers sold through indirect channels in North America and Europe. On June
14, 2001 we announced our disengagement from the SOHO business. Third quarter
and year to date 2001 SOHO revenues declined 23 percent (22 percent pre-
currency) and 26 percent (25 percent pre-currency), respectively, from the 2000
periods and gross margin declined as we exit this business and reduce equipment
inventory in a very difficult market environment. SOHO revenues represented 3
percent of third quarter and year to date revenues in both 2001 and 2000.
Developing Markets Operations (DMO) includes operations in Latin America,
Russia, India, the Middle East and Africa. Third quarter 2001 revenue declined
significantly in Brazil from the 2000 third quarter reflecting reduced
equipment placements and the transition of its business model to maximize
liquidity and profitable revenue rather than market share, compounded by an
average 29 percent devaluation in the Brazilian Real. During the third quarter
and first nine months of 2000 revenues in Brazil included structured
transactions, as discussed below, of $30 million and $111 million,
respectively; there were no similar arrangements in the 2001 third quarter and
first nine months.
Revenue declined throughout the other Latin American countries due to weaker
economies and our decision to focus on liquidity and profitable revenue rather
than market share. DMO revenues represented 11 percent of third quarter 2001
revenues compared with 14 percent in the 2000 third quarter. DMO incurred a
substantial pre-tax loss in the third quarter 2001. Gross margin declined in
DMO as a result of lower equipment and service margins, currency devaluation
not offset by price increases, weak mix and the absence of any structured
transactions in Brazil.
DMO revenues decreased 30 percent (29 percent pre-currency) in the first nine
months of 2001 from the first nine months of 2000 reflecting reduced equipment
placements, an increased competitive environment, the lack of structured
transactions in 2001, and lower prices as we focused on reducing inventory,
compounded by a 21 percent devaluation in the Real.
Since 1985 the company, primarily in North America, has sold pools of equipment
subject to operating leases to third party finance companies (the counter-
party) and recorded these transactions as sales at the time the equipment is
accepted by the counter-party. The various programs provided us with additional
funding sources and/or enhanced credit positions. The counter-party accepts the
risks of ownership of the equipment. Remanufacturing and remarketing of off-
lease equipment belonging to the counter-party is performed by the company on a
nondiscriminatory basis for a fee. North American transactions are structured
to provide cash proceeds up front from the counter-party versus collection over
time from the underlying customer lessees. There were $22 of sales of equipment
subject to operating leases in North America in the third quarter and first
nine months of 2000, none in the first nine months of 2001. The reduction of
operating lease revenues as a result of prior year sales of equipment on
operating leases was $9 million and $15 million in the third quarter of 2001
and 2000, respectively, and $30 million and $52 million in the first nine
months of 2001 and 2000, respectively.
Beginning in 1999 several Latin American affiliates entered into certain
structured transactions involving contractual arrangements which transferred
the risks of ownership of equipment subject to operating leases to third party
financial companies who are obligated to pay the Company a fixed amount each
month. The Company accounts for these transactions similar to its sales-type
leases. The counter-party assumes the risks associated with the payments from
the underlying customer lessees thus mitigating risk and variability from the
cash flow stream. The following shows the effects of such sales of equipment
under structured finance arrangements offset by the associated reductions of
operating lease revenues from current and prior year transactions:
Three months Nine months
Ended September 30, Ended September 30,
2001 2000 2001 2000
Sales of equipment $ - $ 30 $ - $ 111
Reduced Operating Lease Revenue (27) (34) (89) (92)
-----------------------------------
Net revenue impact $ (27) $ (4) $ (89) $ 19
===================================
Over time the number and value of the contracts will vary depending on the
number of operating leases entered into in any given period, the willingness of
third party financing institutions to accept the risks of ownership, and our
consideration as to the desirability of entering into such arrangements. At
this time, the Company does not expect to enter into any structured
transactions for the remainder of 2001.
Key Ratios and Expenses
The trend in key ratios was as follows:
2000 2001
Q1 Q2 Q3 Q4 FY Q1 Q2 Q3 YTD
Gross Margin 39.1%* 40.4% 35.0% 35.1% 37.4%* 33.6% 35.8%** 36.1%** 35.2%**
SAG % Revenue 28.0 28.8 31.7 32.2 30.2 27.4 30.6 31.1 29.6
*Includes inventory charges associated with the 2000 restructuring. If
excluded the gross margin would have been 41.1 percent and 37.9 percent,
respectively.
**Includes inventory charges associated with the SOHO disengagement. If
excluded the gross margin would have been 36.4 percent for second quarter, 36.2
percent for the third quarter and 35.4 percent for the first nine months of
2001.
The third quarter 2001 gross margin improved by 1.2 percentage points from the
2000 third quarter as improved manufacturing and service productivity and
favorable currency were only partially offset by unfavorable mix. Weak
performance in DMO reduced the gross margin by 0.7 percentage points.
Excluding SOHO operations, the 2001 third quarter gross margin was 37.7
percent.
Including inventory charges associated with the SOHO disengagement, the gross
margin was 35.2 percent for the first nine months of 2001, a decline of 3.0
percentage points from the first nine months of 2000 gross margin which
includes inventory charges associated with the 2000 restructuring program.
Excluding the 2001 SOHO inventory charges and the 2000 restructuring inventory
charges, the gross margin for the first nine months of 2001 was 35.4 percent
compared to 38.9 percent in the first nine months of 2000. Approximately two
percentage points of the decline was due to weak activity in Developing
Markets, primarily in Brazil, as well as lower lease residual values being
recognized in 2001 versus the prior year, and the absence of the previously
described structured transactions. In addition, improved asset management
practices, lower activity levels and unfavorable mix adversely impacted gross
margin.
Selling, administrative and general expenses (SAG) declined 15 percent (14
percent pre-currency) in the 2001 third quarter from the third quarter 2000.
SAG declined 11 percent (10 percent pre-currency) in the first nine months of
2001 from the first nine months of 2000. SAG declines in both the third
quarter and first nine months reflect continued benefits from our Turnaround
Program including significantly lower labor costs and advertising and marketing
communications spending. These reductions were partially offset by increased
professional costs related to our regulatory filings and related
matters and higher costs incurred by Developing Markets Operations in the
renegotiation of customer contracts associated with implementation of their new
business approach. Third quarter 2001 bad debt provisions of $186 million were
$14 million higher than the 2000 third quarter despite an improvement in
Mexico. Increased provisions in North America primarily associated with
higher risk smaller customers in this weakened economic environment more than
offset the significant 2000 third quarter provisions in Mexico. Bad debt
provisions were $401 million and $417 million for the first nine months of 2001
and 2000, respectively. In the 2001 third quarter, SAG represented 31.1
percent of revenue compared with 31.7 percent of revenue in the 2000 third
quarter. SAG represented 29.6 percent of revenue in the first nine months of
2001 compared with 29.5 percent of revenue in the first nine months of 2000.
Research and development (R&D) expense was $15 million and $5 million higher
in the 2001 third quarter and first nine months, respectively, compared to the
2000 third quarter and first nine months due to increased iGen3 expenses. R&D
spending was 7 percent and 6 percent of revenue in the 2001 third quarter and
first nine months, respectively, as we continue to invest in technological
development, particularly color, to maintain our position in the rapidly
changing document processing market. Xerox R&D remains technologically
competitive and is strategically coordinated with Fuji Xerox.
Worldwide employment declined by 2,300 and 8,900 in the 2001 third quarter and
first nine months, respectively, to 83,300 primarily as a result of employees
leaving the company under our restructuring programs. Excluding divestitures,
worldwide employment has declined by 10,900 since implementation of our
Turnaround Program in October 2000.
Other, net was $119 million in the 2001 third quarter compared to $115 million
in the third quarter 2000. In the third quarter 2001 we incurred $54 million of
net currency losses resulting from the remeasurement of unhedged foreign
currency-denominated assets and liabilities. These currency exposures are
unhedged in 2001 largely due to our restricted access to the derivatives
markets. Also included in Other, net in the 2001 third quarter is $10 million
of property losses related to the September 11 incident. In addition, the 2000
third quarter included approximately $30 million of non-recurring interest
income related to an income tax refund receivable. Lower third quarter 2001
net non-financing interest expense of $94 million primarily reflects lower
interest rates and lower debt levels as compared to the prior year, including
net gains of $46 million from the mark-to-market of our remaining interest rate
swaps required to be recorded as a result of applying SFAS 133 accounting
rules. This was primarily driven by sharply lower variable rates in the
quarter. Differences between the contract terms of our interest rate swaps and
the underlying related debt preclude hedge accounting treatment in accordance
with SFAS 133 which requires us to record the mark-to-market valuation of these
derivatives directly through earnings. Due to the inherent volatility in the
interest and foreign currency markets, the company is unable to predict the
amount of the above-noted remeasurement and mark-to-market gains or losses in
future periods.
The year to date 2001 increase in Other, net of $96 million was primarily due
to a $48 million increase in Brazilian indirect taxes, approximately $30
million of non-recurring interest income in 2000 related to an income tax
refund receivable and gains in 2000 of $75 million associated with the sale of
the North American commodity paper business and sales of other assets. These
unfavorable items were offset by a decrease of $64 million in net non financing
interest expense reflecting our lower net debt levels and lower interest rates.
During the fourth quarter of 2000 we announced a Turnaround Program in which we
outlined a wide-ranging plan to sell assets, cut costs and strengthen our
strategic core. We announced plans that were designed to reduce costs by at
least $1.0 billion annually, the majority of which will affect 2001. As part of
the cost cutting program, we continue to take additional charges for finalized
initiatives under the Turnaround Program. As a result of these actions, in the
third quarter of 2001 we provided an incremental $56 million to complete our
open initiatives under the Turnaround plan. For the first nine months of 2001,
we have provided a total of $220 million under this plan. We expect additional
provisions will be required in 2001 as additional plans are finalized. The
restructuring reserve balance at September 30, 2001 for both the Turnaround
Program and the March 2000 program amounted to $142 million.
In connection with the disengagement from our SOHO business, we recorded a
second-quarter pretax charge of $274 million ($196 million after taxes). The
charge includes provisions for the elimination of approximately 1,200 jobs
worldwide by the end of 2001, the closing of facilities and the write-down of
certain assets to net realizable value. In the 2001 third quarter, changes in
estimates for employee termination and decommitment costs reduced the original
reserve by approximately $12 million. The year to date $262 million pretax
charge for the SOHO disengagement consists of approximately $30 million in
employee termination costs, $144 million of asset impairments, $29 million in
inventory charges, $24 million in purchase commitments, $16 million in
decommitment costs, and $19 million in other miscellaneous charges. The SOHO
disengagement reserve balance at September 30, 2001 was $49 million.
Over the remainder of the fourth quarter we will discontinue our line of
personal inkjet and xerographic printers, copiers, facsimile machines and
multi-function devices which are sold primarily through retail channels to
small offices, home offices and personal users (consumers). We intend to sell
the remaining inventory through current channels. We will continue to provide
service, support and supplies, including the manufacturing of such supplies,
for customers who currently own SOHO products during a phase-down period to
meet customer commitments.
Income Taxes, Equity in Net Income of Unconsolidated Affiliates and Minorities'
Interests in Earnings of Subsidiaries
Our pre-tax loss was $(248) million in the 2001 third quarter including
the restructuring provisions. Excluding these items, the pre-tax loss was
$(204) million in the 2001 third quarter compared to a loss of $(235) million
in the 2000 third quarter.
Including the effect of special items, pre-tax loss was $(137) million in the
first nine months of 2001 compared to a $(348) million loss for the first nine
months of 2000. Excluding special items, the pre-tax loss was $(455) million
for the first nine months 2001 compared to pre-tax income of $273 million for
the first nine months 2000. 2001 special items included a net charge of $262
million related to the SOHO disengagement, a $190 million net charge in
connection with our existing restructuring programs and a gain of $769 million
related to the sale of half our ownership in Fuji Xerox. In the first
nine months of 2000, special items included a $594 million charge related to
the 2000 restructuring program and a $27 million charge for acquired in-process
research and development associated with the CPID acquisition.
The effective tax rate, including the net tax benefit related to additional
restructuring provisions and an adjustment to the underlying tax rate on the
2001 first half loss was 22.6 percent in the 2001 third quarter. Excluding
these items, the 2001 third quarter and year to date tax rates were
33.7 percent compared to 34.9 percent in the 2000 third quarter. This reduction
in the tax rate is due primarily to continued losses in low-tax rate
jurisdictions where losses could not be tax effected, offset by a favorable tax
audit.
The third quarter change in the tax rate from 42.0 percent to 33.7 percent
required a catch up adjustment to the previously recorded first half tax
benefits. This catch-up adjustment reduced the tax benefit and increased the
third quarter 2001 net loss by $21 million. A similar 2000 third quarter
adjustment reduced that tax benefit and increased the 2000 net loss by $41
million.
Equity in net income of unconsolidated affiliates is principally our 25 percent
share of Fuji Xerox income. Total equity in net income declined by $11 million
and $29 million in the 2001 third quarter and first nine months, respectively,
due primarily to our reduced ownership in Fuji Xerox. Our share of total Fuji
Xerox net income of $4 million and $27 million in the 2001 third quarter and
first nine months, respectively, decreased by $11 million and $39 million from
the 2000 periods.
In the first nine months of 2001, we retired $340 million of debt
through the exchange of 37.4 million shares of common stock valued at $283
million, resulting in pre-tax extraordinary gains of $59 million ($36 million
after taxes) for a net equity increase of approximately $319 million.
In the 2001 second quarter, we sold our leasing businesses in four European
countries to Resonia Leasing AB for proceeds of approximately $370 million.
These sales are part of an agreement under which Resonia will provide
on-going, exclusive equipment financing to our customers in those countries.
In July 2001, we completed the offering of $513 million of floating rate asset
backed notes. In conjunction with this offering, we received cash proceeds
of $480 million net of $3 million paid in expenses and fees. The remaining
cash proceeds of approximately $30 million will be held in reserve over the
term of the asset backed notes. As part of the transaction we sold
approximately $639 million of domestic finance receivables to a qualified
special purpose entity in which we have a retained interest of approximately
$159 million, including the cash proceeds held in reserve. The transaction was
accounted for as a sale of finance receivables at approximately book value.
In September 2001 Xerox and GE Capital announced a framework agreement for GE
Capital's Vendor Financial Services Unit to become the primary equipment
financing provider for Xerox customers in the United States. The two companies
also agreed to the principal terms of a financing arrangement under which
Xerox will receive from GE Capital approximately $1 billion secured by
portions of Xerox's finance receivables in the United States.
As part of this transaction, Xerox will transition nearly all of its U.S.
customer administration operations into a co-managed joint venture with
GE Capital Vendor Financial Services. It is anticipated that Xerox employees
who work in Xerox customer financing and administration offices will join the
new joint venture on January 2, 2002. Their work, which includes order
processing, credit approval, financing programs, billing and collections, is
expected to continue in the current locations, ensuring further continuity for
Xerox customers and employees. The arrangements are expected to close in the
fourth quarter subject to the negotiation of definitive agreements and
satisfaction of closing conditions, including completion of due diligence.
In October 2001, we announced a manufacturing agreement with Flextronics, a
$12 billion global electronics manufacturing services company. The
agreement includes a five-year supply contract for Flextronics to manufacture
certain office equipment and components, payment of approximately $220 million
to Xerox for inventory, property and equipment at a modest premium over book
value, and the assumption of certain liabilities. The premium will be
amortized over the life of the five-year supply contract. As a result of these
actions, we expect to incur restructuring charges in the fourth quarter of
2001.
Flextronics will purchase four Xerox office products manufacturing operations
including selected manufacturing assets and inventory. The approximately 3,650
current Xerox employees in these operations are expected to transfer to
Flextronics. We will also stop production by the end of the second quarter
2002 at our printed circuit board factory in El Segundo, California, and our
customer replaceable unit plant in Utica, New York. Flextronics will build
this work into its global network of manufacturing plants. In addition, we
have begun consultations with European works councils regarding the sale of our
office manufacturing operations in Venray, The Netherlands, and the transfer to
Flextronics of some production work currently performed at our site in
Mitcheldean, England. In total, the agreement with Flextronics represents
approximately 50 percent of our overall manufacturing operations. The first
sales are expected to close in the fourth quarter, beginning a one-year
transition period for Flextronics to assume manufacturing of Xerox-designed
office products and related components. The actual cash proceeds will vary,
based upon the actual net asset levels at the time of the closings.
We adopted Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities" (SFAS No. 133), as of
January 1, 2001. Upon adoption of SFAS No. 133 we recorded a net cumulative
after-tax loss of $2 million in the first quarter Income Statement and a net
cumulative after-tax loss of $19 million in Accumulated Other Comprehensive
Income. The adoption of SFAS No. 133 is expected to increase the future
volatility of reported earnings and other comprehensive income. In general, the
amount of volatility will vary with the level of derivative and hedging
activities and the market volatility during any period.
Additional details regarding the effects of SFAS No. 133 on the quarter and
year-to-date results are included in Note 9 of the "Notes to Consolidated
Financial Statements".
The $21 million gain on affiliate's sale of stock in the first quarter 2000
reflected our proportionate share of the increase in equity of Scansoft Inc.
(NASDAQ:SSFT) resulting from Scansoft's issuance of stock in connection with an
acquisition. This gain was partially offset by a $5 million charge reflecting
our share of Scansoft's write-off of in-process research and development
associated with this acquisition, which is included in Equity in net income of
unconsolidated affiliates.
See footnote No. 13 in the Notes to Consolidated Financial Statements for a
discussion of the impact of recently issued accounting standards.
Capital Resources and Liquidity
Xerox and its material subsidiaries and affiliates have cash management systems
and internal policies and procedures for managing the availability of worldwide
cash, cash equivalents and liquidity resources. They are subject to (i)
statutes, regulations and practices of the local jurisdictions in which the
companies operate, (ii) legal requirements of the agreements to which the
companies are parties and (iii) the policies and continuing cooperation of the
financial institutions utilized by the companies to maintain such cash
management systems.
At September 30, 2001, cash on hand was $2,427 million versus $1,741 million at
December 31, 2000, and total debt was $16,076 million versus $18,097 million at
December 31, 2000. Total debt net of cash on hand (Net Debt) decreased by
$2,707 million in the first nine months of 2001 versus an increase of $2,168
million in the first nine months of 2000. As of September 30, 2001, Net Debt
has decreased by $3,394 million since our Turnaround Program was initiated on
September 30, 2000. The consolidated ratio of total debt to common and
preferred equity was 4.4:1 as of both September 30, 2001 and December 31, 2000.
This ratio reflects our decision, beginning in the fourth quarter of 2000, to
accumulate cash to maintain financial flexibility, rather than continue our
historical practice of using available excess cash to pay down debt. Had our
cash balance at September 30, 2001 and December 31, 2000 been reduced to
historical levels by paying off debt, the debt to equity ratio would have been
approximately 3.7:1 and 4.0:1, respectively.
We historically managed the capital structures of our non-financing operations
and our captive financing operations separately. We are in the process of
exiting the customer equipment financing business, and we are no longer
managing our liquidity on a financing / non-financing basis. Accordingly, we
believe that a review of operating cash flow and earnings before interest,
income taxes, depreciation, amortization and special items (EBITDA) provides
the most meaningful understanding of our changes in cash and debt balances.
The following is a summary of EBITDA, operating and other cash flows for the
nine months ended September 30, 2001 and 2000:
2001 2000
Net Loss $ (289) $ (237)
Income tax provision (benefit) 209 (84)
Depreciation and amortization 794 794
Restructuring charges 452 594
Interest expense 683 739
Gains on sales of businesses (754) (63)
Other items 26 (26)
----------------
EBITDA 1,121 1,717
Less financing and interest income (689) (711)
----------------
Adjusted EBITDA 432 1,006
Working capital and other changes 496 (669)
On-Lease equipment spending (176) (350)
Capital spending (159) (324)
Restructuring payments (368) (222)
Interest Payments (819) (739)
----------------
Operating Cash Flow (Usage)* (594) (1,298)
Financing Cash Flow 1,568 (65)
Debt borrowings (repayments), net (1,530) 2,619
Dividends and other non-operating items (393) (462)
Proceeds from sales of businesses 1,635 90
Acquisitions - (856)
-----------------
Net Change in Cash $ 686 $ 28
=================
* The primary difference between this amount and the Cash Flows from Operations
reported in our Statements of Cash Flows, is the inclusion of Capital Spending
in, and the exclusion of Financing Cash Flow from, the amount shown above.
Operating cash usage in the first nine months of 2001 decreased by
approximately $700 million, to $(594) million, versus $(1,298) million usage in
the prior year period. Excluding the effect of a $315 million accounts
receivable securitization in the third quarter of 2000, operating cash flow
improved by over $1 billion. The improvement was driven by significant
reductions in working capital. Lower investments in on-lease equipment and
capital spending only partially offset higher restructuring payments and the
negative cash flow impacts of weak operating results on EBITDA. The working
capital improvements stem largely from a significant reduction in inventories
and lower tax payments in the first nine months of 2001 compared to the same
period in 2000. The significant inventory reduction reflects management actions
to improve inventory turns, and changes in the supply/demand and logistics
processes. The decline in 2001 capital spending versus 2000 is due primarily to
substantial completion of our Ireland projects as well as significant spending
constraints. We expect full-year 2001 capital spending to be approximately 50
percent below 2000 levels. Investments in on-lease equipment reflect the growth
in our document outsourcing business, which we expect will continue to grow in
the remainder of 2001.
Cash restructuring payments of $368 million reflect continued progress with
respect to our Turnaround Program. The status of the restructuring reserves is
discussed in Note 4 to the Consolidated Financial Statements.
The increase in financing cash flow in 2001 includes the sale of asset-backed
securities in July 2001 for net proceeds of $480 million. The remaining cash
flow improvement reflects the lower equipment sales in the first nine months of
2001 versus the year-ago period, which resulted in a lower level of finance
receivable originations.
Dividends and other non-operating items in the first nine months of 2001
totaled $(393) million, including a premium payment of $45 million to Ridge
Reinsurance, a payment of $255 million related to our funding of trusts to
replace Ridge Reinsurance letters of credit, and dividends of $93 million. The
2000 amount of $(462) million includes dividends of $441. The improvement in
2001 versus 2000 is due to our elimination of dividends which we announced in
July 2001, offset by the Ridge Reinsurance trust funding requirement.
In the first nine months of 2001, we generated approximately $1.6 billion of
cash from the sale of half our interest in Fuji Xerox and the sale of our
leasing businesses in four European countries as discussed below. These asset
sales, together with the significant improvements in operating and financing
cash flows and the absence in 2001 of acquisitions, which used cash of $856 in
the first nine months of 2000, funded debt repayments of $1.5 billion in 2001,
versus incremental borrowings of $2.6 billion in 2000, and generated a net cash
increase of $658 million.
Liquidity and Funding Plans for 2001
Historically, our primary sources of funding have been cash flows from
operations, borrowings under our commercial paper and term funding programs,
and securitizations of finance and trade receivables. Our overall funding
requirements have been to finance customers' purchases of our equipment, to
fund working capital and capital expenditure requirements, and to finance
acquisitions.
During 2001 and 2000, the agencies that assign ratings to our debt downgraded
the Company's debt several times. As of October 31, 2001, senior and short-term
debt ratings by Moody's are Ba1 and Not Prime, respectively, and the outlook is
negative; ratings by Fitch are BB and B, respectively, and the outlook is
stable; and ratings by Standard and Poors (S&P) are BB and B, respectively, and
the outlook is stable. Since October 2000, uncommitted bank lines of credit and
the unsecured capital markets have been, and are expected to continue to be,
largely unavailable to us. We expect this to result in higher borrowing costs
going forward, and this may also result in Xerox Corporation having to increase
its level of intercompany lending to affiliates. In addition, the Company does
not expect to be able to access the capital markets in registered public
offerings pending resolution of the review of the Company's accounting
practices by the Securities and Exchange Commission referred to in Note 12 to
the Consolidated Financial Statements.
As a result of the debt downgrades described above, in the fourth quarter 2000
we drew down the entire $7.0 billion available to us under our Revolving Credit
Agreement (the "Revolver"), primarily to maintain financial flexibility and pay
down debt obligations as they came due. We are in compliance with the
covenants, terms and conditions in the Revolver, which matures on October 22,
2002. The only financial covenant in the Revolver requires us to maintain a
minimum of $3.2 billion of Consolidated Tangible Net Worth, as defined
("CTNW").
At September 30, 2001, our CTNW was $182 million in excess of the minimum
requirement, a decrease of approximately $330 million from the December 31,
2000 level. The decrease is due to operating and restructuring losses and
unfavorable foreign currency translation during that period of time, offset
partially by the favorable impacts of gains on asset sales and debt-for-equity
exchanges described below. Further operating losses, restructuring costs and
adverse currency translation adjustments would erode this excess, while
operating income, gains on asset sales, favorable currency translation, and
exchanges of debt for equity would increase this excess. We expect to be in
continued compliance with the covenant.
The Company has recently initiated discussions with its agent banks to
refinance a portion of the Revolver and extend its maturity beyond October
2002. Failure to successfully refinance and extend the maturity of the
Revolver or a breach of the CTNW covenant could have a serious adverse effect
on our liquidity.
In the first nine months of 2001, we retired $340 million of long-term debt
through the exchange of 37.4 million shares of common stock of the Company,
which increased CTNW by approximately $319 million. Since September 30, 2001 we
have retired an additional $35 million of debt through the exchange of 3.8
million additional shares, which increased our CTNW by an estimated $32
million.
As of September 30, 2001, we had approximately $1.3 billion of debt obligations
expected to be repaid during the remainder of 2001, and $9.0 billion maturing
in 2002, as summarized below (in billions):
2001 2002
First Quarter $0.3
Second Quarter 1.0
Third Quarter 0.1
Fourth Quarter $1.3 7.6*
----------------
Full Year $1.3 $9.0
================
* Includes $7.0 billion maturity under the Revolver
In 2000 we announced a global Turnaround Program which includes initiatives to
sell certain assets, improve operations and liquidity, and reduce annual costs
by at least $1 billion. As of September 30, 2001 we had made significant
progress toward these objectives, which we believe will positively affect our
capital resources and liquidity position when completed.
With respect to asset sale initiatives, in the fourth quarter of 2000 we sold
our China operations to Fuji Xerox Co., Ltd. ("Fuji Xerox"), generating $550
million of cash and transferring $118 million of debt to Fuji Xerox. In March
2001, we sold half of our interest in Fuji Xerox to Fuji Photo Film Co., Ltd.
for $1,283 million in cash. On October 2, 2001, we announced an agreement under
which Flextronics, a Singapore company, will purchase certain assets and assume
certain liabilities related to our office-segment manufacturing facilities in
several locations around the world. We expect to receive cash proceeds of
approximately $220 million in phases over the next year, including a
significant portion in the fourth quarter 2001, as each of the applicable
locations is sold. Under this agreement, Flextronics will manufacture certain
of our office-segment equipment and components for a period of five years.
We have initiated discussions to implement third-party vendor financing
programs which will significantly reduce our debt and finance receivables
levels going forward. In addition, we are in discussions to consider selling
portions of our existing finance receivables portfolios, and we continue to
actively pursue alternative forms of financing including securitizations and
secured borrowings. In connection with these initiatives, in January 2001, we
received $435 million in financing from an affiliate of GE Capital, secured by
our portfolio of lease receivables in the United Kingdom. In the second quarter
of 2001, we sold our leasing businesses in four Nordic countries to Resonia
Leasing AB for $352 million in cash plus retained interests in certain finance
receivables for total proceeds of approximately $370 million. These sales are
part of an agreement under which Resonia will provide on-going, exclusive
equipment financing to our customers in those countries. In July 2001, we sold
$513 million of floating-rate asset-backed notes for cash proceeds of $480
million net of $3 million of expenses and fees. An additional $30 million of
proceeds will be held in reserve until the notes are repaid, which we currently
estimate will occur in August 2003. As part of the transaction, we sold
approximately $639 million of domestic finance receivables to a qualified
special-purpose entity in which we have a retained interest of $159 million,
which includes the $30 million cash reserve. The transaction was accounted for
as a sale of finance receivables.
On September 11, 2001, we announced a Framework Agreement with GE Capital's
Vendor Financial Services group, under which GE Capital will become the primary
equipment-financing provider for our U.S. customers. We also announced an
agreement under which we will receive a loan of approximately $1 billion from
GE Capital, secured by certain of our lease receivables in the United States.
We expect both of these agreements to be completed in the fourth quarter
2001.
On June 5, 2001, we had announced our receipt of a commitment letter from
Bankers Trust Company, a subsidiary of Deutsche Bank, for a fully underwritten
secured revolving borrowing facility of $500 million. As a result of the
commencement of discussions to refinance the Revolver, as well as the progress
we have made to-date on the global initiatives discussed above, we have allowed
the Bankers Trust loan commitment to expire unutilized.
With $2.4 billion of cash on hand at September 30, 2001, we believe our
liquidity is presently sufficient to meet current and anticipated needs going
forward, subject to timely implementation and execution of the various global
initiatives discussed above and our ability to successfully refinance a portion
of the Revolver and extend its maturity beyond October, 2002. Should we be
unable to successfully complete these initiatives or refinance and extend the
maturity of the Revolver on a timely or satisfactory basis, we will need to
obtain additional sources of funds through further operating improvements,
financing from third parties, additional asset sales including sales or
securitizations of our receivables portfolios, or a combination thereof. The
adequacy of our continuing liquidity depends on our ability to successfully
generate positive cash flow from an appropriate combination of these sources.
On December 1, 2000, Moody's reduced its rating of our senior debt to below
investment grade, significantly constraining our ability to enter into new
foreign-currency and interest rate derivative agreements, and requiring us to
immediately repurchase certain of our then-outstanding derivative agreements.
On October 23, 2001, S&P reduced its rating of our senior debt to below
investment grade, further constraining our ability to enter into new derivative
agreements, and requiring us to immediately repurchase certain of our then-
outstanding out-of-the-money interest-rate and cross-currency interest-rate
derivative agreements for a total of $148 million. To minimize the resulting
interest and currency exposures, we replaced two of the terminated derivatives
with a derivative contract involving a new counterparty. That contract will
require us to collateralize any out-of-the-money positions going forward. Our
remaining consolidated derivative portfolio at October 31, 2001, included $15
million of out-of-the-money contracts which are contractually subject to
termination by the related counterparties. The fair market values of all of our
derivative contracts change with fluctuations in interest rates and currency
rates where applicable, as discussed in the Risk Management section below.
In the third quarter 2000, Xerox Credit Corporation (XCC) securitized certain
finance receivables in the United States, generating gross proceeds of $411
million. This facility was accounted for as a secured borrowing. In the third
quarter 2000, Xerox Corporation securitized certain accounts receivable in the
United States, generating gross proceeds of $315 million. This revolving
facility was accounted for as a sale of receivables. In December 2000, as a
result of the senior debt downgrade by Moody's discussed above, Xerox
Corporation renegotiated the $315 million accounts receivable securitization
facility, reducing the facility size to $290 million. The facility size will
remain at $290 million unless and until our senior debt is downgraded to or
below a Ba2 rating by Moody's, at which time we would seek to renegotiate the
terms of the facility.
In January 2001, we paid $28 million to settle 0.8 million outstanding equity
put options at their strike price of approximately $41 per share, which we
funded by issuing 5.9 million unregistered common shares.
On October 4, 2001, a European affiliate of Xerox Corporation convened a second
meeting of holders of its 125 million GBP 8-3/4 percent Guaranteed Bonds,
issued in 1993 and maturing in 2003 (the "Bonds"), in order to consider a
proposal to repay the Bonds early at 103% of par plus accrued interest. At the
meeting, Bondholders holding approximately 79% of the outstanding amount voted
in favor of the proposal. On October 11, 2001, the Bonds were repaid for 129
million GBP (approximately $184 million) plus accrued interest. Repaying the
Bonds early has reduced outstanding indebtedness and eliminated certain
restrictive covenants in the Bonds and related documents, thereby providing
additional flexibility to Xerox and its subsidiaries and affiliates in
connection with their cash management systems and practices. Repaying the bonds
will also reduce future interest costs.
Risk Management
We are typical of multinational corporations because we are exposed to market
risk from changes in foreign currency exchange rates and interest rates that
could affect our results of operations and financial condition.
We have historically entered into certain derivative contracts, including
interest rate swap agreements, forward exchange contracts and foreign currency
swap agreements, to manage interest rate and foreign currency exposures. These
instruments are held solely to hedge economic exposures; we do not enter into
derivative instrument transactions for trading purposes, and we employ long-
standing policies prescribing that derivative instruments are only to be used
to achieve a set of very limited objectives. As described above, our ability to
currently enter into new derivative contracts is severely constrained.
Therefore, while the following paragraphs describe our overall risk management
strategy, our current ability to employ that strategy effectively has been
severely limited.
Currency derivatives are primarily arranged to manage the risk of exchange rate
fluctuations associated with assets and liabilities that are denominated in
foreign currencies. Our primary foreign currency market exposures include the
Japanese Yen, Euro, Brazilian Real, British Pound Sterling and Canadian Dollar.
For each of our legal entities, we have historically hedged a significant
portion of all foreign-currency-denominated cash transactions. From time to
time (when cost-effective) foreign-currency-denominated debt and foreign-
currency derivatives have been used to hedge international equity investments.
Virtually all customer-financing assets earn fixed rates of interest.
Therefore, we have historically sought to "lock in" an interest rate spread by
arranging fixed-rate liabilities with similar maturities as the underlying
assets, and we have funded the assets with liabilities in the same currency. As
part of this overall strategy, pay-fixed-rate/receive-variable-rate interest
rate swaps are often used in place of more expensive fixed-rate debt.
Additionally, pay-variable-rate/receive-fixed-rate interest rate swaps are used
from time to time to transform longer-term fixed-rate debt into variable-rate
obligations. The transactions performed within each of these categories enable
more cost-effective management of interest rate exposures by eliminating the
risk of a major change in interest rates. We refer to the effect of these
conservative practices as "match funding" customer financing assets.
Consistent with the nature of economic hedges, unrealized gains or losses from
interest rate and foreign currency derivative contracts are designed to offset
any corresponding changes in the value of the underlying assets, liabilities or
debt. As described above, the downgrades of our debt during 2000 and 2001 and
the ongoing SEC investigation have significantly reduced our access to capital
markets. Furthermore, the specific downgrades of our debt on December 1, 2000,
and October 23, 2001, required us to repurchase a number of derivative
contracts which were then outstanding, and we could contractually be required
to repurchase additional contracts which are currently outstanding. Therefore,
we are largely precluded from utilizing derivative agreements to manage the
risks associated with interest rate and foreign currency fluctuations,
including our ability to continue effectively employing our match funding
strategy, and we anticipate increased volatility in our results of operations
due to market changes in interest rates and foreign currency rates.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
The information set forth under the caption "Risk Management" on pages 36-37 of
this Quarterly Report on Form 10-Q is hereby incorporated by reference in
answer to this Item.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The information set forth under Note 12 contained in the "Notes to Consolidated
Financial Statements" on pages 17-21 of this Quarterly Report on Form 10-Q is
incorporated by reference in answer to this item.
Item 2. Changes in Securities
(a) During the quarter ended September 30, 2001, registrant issued the
following securities in transactions which were not registered under the
Securities Act of 1933, as amended (the Act):
(1) Securities Sold: on July 1, 2001, Registrant issued
9,925 shares of Common stock, par value $1 per share.
(2) No underwriters participated. The shares were issued to
each of the non-employee Directors of Registrant: B.R.
Inman, A.A.Johnson, V.E. Jordan, Jr., Y. Kobayashi,
H. Kopper, R.S. Larsen, G.J. Mitchell, N.J. Nicholas, Jr.,
J.E. Pepper, M.R. Seger and T.C.Theobald.
(3) The shares were issued at a deemed purchase price of
$9.57 per share (aggregate price $94,875), based upon the
market value on the date of issuance, in payment of the
quarterly Directors' fees pursuant to Registrant's
Restricted Stock Plan for Directors.
(4) Exemption from registration under the Act was claimed based
upon Section 4(2) as a sale by an issuer not involving a
public offering.
(b) In addition, during the quarter ended September 30, 2001, Registrant
issued an aggregate of 1,225,019 shares of Common Stock in the following
transactions, all of which were not registered under the Act by reason of the
exemption from registration under the Act provided by Section 3(a)(9) of the
Act:
Date issued ... July 27
Aggregate amount
of consider-
ation received
by Registrant ...$12,000,000
Aggregate number
of shares
of Common
Stock
issued by
Registrant ...1,225,019
Aggregate value
of Common
Stock
delivered by
Registrant ...$10,245,000
Names of the
principal
underwriters ... None
The "Aggregate amount of consideration received by Registrant" in Item
2(b) above represents the aggregate principal amount (or the aggregate accreted
value, in the case of original issue discount securities) of the outstanding
publicly-issued debt securities of Registrant which the holders of such debt
securities exchanged for the number of shares of Common Stock specified in
"Aggregate number of shares of Common Stock issued by Registrant" in Item 2(b)
above.
The "Aggregate value of Common Stock delivered by Registrant" in Item 2(b)
above represents the multiple of the "Aggregate number of shares of Common
Stock issued by Registrant", times either a fixed price per share of Common
Stock or the average of the closing price, or the volume weighted average
price, per share of Common Stock on the New York Stock Exchange over a certain
number of days.
In each of the transactions described in Item 2(b) above, Registrant
issued shares of Common Stock pursuant to the exemption from registration under
the Act provided by Section 3(a)(9) of the Act. Registrant's reliance upon the
Section 3(a)(9) exemption from registration is premised upon the facts that the
shares of Common Stock were issued by Registrant to the then holders of
outstanding publicly-issued debt securities of Registrant solely in exchange
for such debt securities, that each of the exchanges was effected pursuant to
an unsolicited offer from such holder of debt securities, and that no
commission or remuneration was paid or given directly or indirectly in
connection with any such exchange.
Item 4. Submission of Matters to a Vote of Security Holders
The Annual Meeting of Shareholders of Xerox Corporation was duly
called and held on August 28, 2001 at Sheraton Stamford, 2701 Summer Street,
Stamford, Connecticut.
Proxies for the meeting were solicited on behalf of the Board of Directors of
the Registrant pursuant to Regulation 14A of the General Rules and Regulations
of the Commission. There was no solicitation in opposition to the Board of
Directors' nominees for election as directors as listed in the Proxy
Statement, and all nominees were elected.
At the meeting, votes were cast upon the election of directors as described in
the Proxy Statement for the meeting (filed with the Commission pursuant to
Regulation 14A and incorporated herein by reference)as follows:
Name For Withheld Vote
Paul A. Allaire 314,123,843 9,137,191
Antonia Ax:son Johnson 314,255,064 9,005,971
Vernon E. Jordan, Jr. 313,752,971 9,508,064
Yotaro Kobayashi 314,254,376 9,006,659
Hilmar Kopper 314,264,433 8,996,602
Ralph S. Larsen 314,252,811 9,008,223
Anne M. Mulcahy 314,254,119 9,006,915
George J. Mitchell 314,110,372 9,150,663
N. J. Nicholas, Jr. 314,270,426 8,990,608
John E. Pepper 314,268,329 8,992,705
Barry D. Romeril 314,141,449 9,119,586
Martha R. Seger 314,213,894 9,047,141
Thomas C. Theobald 314,225,849 9,035,186
Item 5. Other Information
None.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit 3(a)(1) Restated Certificate of Incorporation of
Registrant filed by the Department of State of the State of
New York on October 29, 1996. Incorporated by reference to
Exhibit 3(a)(1) to Registrant's Quarterly Report on Form
10-Q for the Quarter Ended September 30, 1996.
Exhibit 3 (b) By-Laws of Registrant, as amended through
October 8, 2001.
Exhibit 11 Computation of Net Income (Loss) per Common Share.
Exhibit 12 Computation of Ratio of Earnings to Fixed Charges.
(b) Current reports on Form 8-K dated July 9, 2001, July 26, 2001 and
September 11, 2001 reporting Item 5 "Other Events" were filed
during the quarter for which this Quarterly Report is filed.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
XEROX CORPORATION
(Registrant)
/s/ Gary R. Kabureck
_____________________________
Date: November 13, 2001 By Gary R. Kabureck
Assistant Controller and
Chief Accounting Officer
(Principal Accounting Officer)