UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
AMENDMENT NO. 1 TO 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 21 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/A
Amendment No. 1 to Form 10-Q
September 30, 2001
Explanation of amendment:
Amended filing to correct amounts reported in change in estimates table on
page 7 for provisions for obsolete and excess inventory.
Table of Contents
Page
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition
Results of Operations 6
Capital Resources and Liquidity 14
Risk Management 19
Signatures 21
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.
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) (177) (109)
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 million 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 million. 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
million 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.
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 15, 2001 By Gary R. Kabureck
Assistant Controller and
Chief Accounting Officer
(Principal Accounting Officer)