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: June 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 July 31, 2001
Common Stock 716,989,392 shares
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.
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.
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. In the near-term
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.
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 are required to offset labor
cost inflation and potential materials cost changes and competitive price
pressures.
International Operations - 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 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 Growth - the Registrant's ability to attain a consistent trend of
revenue growth over the intermediate to longer term is largely dependent upon
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 to provide industry-oriented global solutions for major customers
and expansion of our distribution 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 and logistics operations, reductions in operational expenses and
the successful implementation of process and systems changes.
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 and various financing strategies
including securitizations. Should the Registrant not be able to successfully
complete the turnaround program, including positive cash generation on a timely
or satisfactory basis, the Registrant will need to obtain additional sources of
funds through other operating improvements, financing from third parties, or a
combination thereof.
Xerox Corporation
Form 10-Q
June 30, 2001
Table of Contents
Page
Part I - Financial Information
Item 1. Financial Statements
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 22
Capital Resources and Liquidity 29
Risk Management 33
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 34
Part II - Other Information
Item 1. Legal Proceedings 34
Item 2. Changes in Securities 34
Item 5. Other Information 36
Item 6. Exhibits and Reports on Form 8-K 36
Signatures 38
Exhibit Index
By-Laws of Registrant, as amended through August 1, 2001 39
Registrant's 1991 Long-Term Incentive Plan, as amended 52
through October 9, 2000
Form of Salary Continuance Agreement 60
Computation of Net Income (Loss) per Common Share 66
Computation of Ratio of Earnings to Fixed Charges 67
For additional information about The Document Company Xerox, please visit our
World-Wide Web site at www.xerox.com/investor
PART I - FINANCIAL INFORMATION
Item 1 Xerox Corporation
Consolidated Statements of Operations (Unaudited)
Three months ended Six months ended
June 30, June 30,
(In millions, except per-share data) 2001 2000* 2001 2000*
Revenues
Sales $ 1,981 $ 2,569 $ 4,036 $ 4,920
Service, outsourcing, financing
and rentals 2,156 2,209 4,303 4,398
Total Revenues 4,137 4,778 8,339 9,318
Costs and Expenses
Cost of sales 1,354 1,535 2,787 2,878
Cost of service, outsourcing, financing
and rentals 1,278 1,313 2,633 2,642
Inventory charges 24 - 24 90
Research and development expenses 249 254 495 506
Selling, administrative and general expenses
expenses 1,263 1,377 2,415 2,647
Restructuring charge and asset impairments 291 (2) 391 504
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 161 54 251 159
Total Costs and Expenses 4,620 4,531 8,227 9,432
Income (Loss) before Income Taxes (Benefits), (483) 247 112 (114)
Equity Income and Minorities' Interests
Income taxes (benefits) (160) 79 243 (40)
Income (loss) after Income Taxes (Benefits)
before Equity income and Minorities' Interests (323) 168 (131) (74)
Equity in net income of unconsolidated
affiliates 30 46 32 50
Minorities' interests in earnings of
subsidiaries 6 12 13 23
Net income (loss) before extraordinary gain
and cumulative effect of change in accounting
principle (299) 202 (112) (47)
Extraordinary gain on early extinguishment of
debt (less income taxes of $12 and $23,
respectively) 18 - 35 -
Cumulative effect of change in accounting
principle (less income tax benefit of $1) - - (2) -
Net Income (Loss) $ (281) $ 202 $ (79) $ (47)
Basic earnings (loss) per share:
Income (loss) before extraordinary gain and
cumulative effect of change in accounting
principle $ (0.43) $ 0.29 $ (0.18) $ (0.10)
Extraordinary gain, net 0.03 - 0.05 -
Cumulative effect of change in accounting
principle, net - - (0.00) -
Basic Earnings (Loss) per Share $ (0.40) $ 0.29 $ (0.13) $ (0.10)
Diluted earnings (loss) per share:
Income (loss) before extraordinary gain and
cumulative effect of change in accounting
principle $ (0.43) $ 0.27 $ (0.18) $ (0.10)
Extraordinary gain, net 0.03 - 0.05 -
Cumulative effect of change in accounting
principle, net - - (0.00) -
Diluted Earnings (Loss) per Share $ (0.40) $ 0.27 $ (0.13) $ (0.10)
See accompanying notes
* As restated, see Note 2
Xerox Corporation
Consolidated Balance Sheets
June 30, December 31,
(In millions, except share data in thousands) 2001 2000
Assets (Unaudited)
Cash and cash equivalents $ 2,177 $ 1,741
Accounts receivable, net 2,006 2,281
Finance receivables, net 4,837 5,097
Inventories, net 1,566 1,932
Equipment on operating leases, net 621 724
Deferred taxes and other current assets 1,221 1,247
Total Current Assets 12,428 13,022
Finance receivables due after one year, net 7,130 7,957
Land, buildings and equipment, net 2,160 2,495
Investments in affiliates, at equity 641 1,362
Intangible and other assets, net 3,462 3,061
Goodwill, net 1,477 1,578
Total Assets $ 27,298 $ 29,475
Liabilities and Equity
Short-term debt and current portion of
long-term debt $ 2,754 $ 2,693
Accounts payable 824 1,033
Accrued compensation and benefit costs 654 662
Unearned income 259 250
Other current liabilities 1,779 1,630
Total Current Liabilities 6,270 6,268
Long-term debt 13,512 15,404
Postretirement medical benefits 1,216 1,197
Deferred taxes and other liabilities 1,839 1,876
Deferred ESOP benefits (221) (221)
Minorities' interests in equity of subsidiaries 116 141
Obligation for equity put options - 32
Company-obligated, mandatorily redeemable
preferred securities of subsidiary trust
holding solely subordinated debentures of
the Company 639 638
Preferred stock 620 647
Common shareholders' equity 3,307 3,493
Total Liabilities and Equity $ 27,298 $ 29,475
Shares of common stock issued and outstanding 715,374 668,576
See accompanying notes.
Xerox Corporation
Consolidated Statements of Cash Flows (Unaudited)
Six months ended June 30 (In millions) 2001 2000*
Cash Flows from Operating Activities
Net Loss $ (79) $ (47)
Adjustments required to reconcile net income (loss) to
cash flows from operating activities, net of
effects of acquisitions:
Depreciation and amortization 462 453
Provisions for doubtful accounts 215 245
Restructuring and other charges 407 621
Gains on sales of businesses and assets (747) (84)
Gain on early extinguishment of debt (58) -
Cumulative effect of change in accounting principle 3 -
Cash payments for restructurings (265) (131)
Minorities' interests in earnings of subsidiaries 13 23
Undistributed equity in income of
affiliated companies (1) (11)
Decrease (increase) in inventories 255 (245)
Increase in on-lease equipment (123) (246)
Decrease (increase) in finance receivables 219 (509)
Decrease (increase) in accounts receivable 97 (362)
Decrease in accounts payable and accrued
compensation and benefit costs (197) (216)
Net change in current and deferred income taxes 338 (365)
Change in other current and non-current
liabilities (111) (277)
Other, net 43 (327)
Net cash provided by (used in) operating activities 471 (1,478)
Cash Flows from Investing Activities
Cost of additions to land, buildings and equipment (121) (240)
Proceeds from sales of land, buildings and equipment 47 55
Acquisitions, net of cash acquired - (856)
Proceeds from divestitures 1,635 50
Other, net - (17)
Net cash provided by (used in) investing activities 1,561 (1,008)
Cash Flows from Financing Activities
Net change in debt (1,195) 2,759
Cash paid to fund Ridge Re Trust (255) -
Dividends on common and preferred stock (93) (294)
Proceeds from sales of common stock 28 18
Settlements of equity put options, net (28) -
Dividends to minority shareholders (2) (3)
Net cash (used in) provided by financing activities (1,545) 2,480
Effect of Exchange Rate Changes on Cash
and Cash Equivalents (51) -
Increase (Decrease) in Cash and Cash Equivalents 436 (6)
Cash and Cash Equivalents at Beginning of Period 1,741 126
Cash and Cash Equivalents at End of Period $ 2,177 $ 120
See accompanying notes.
* As restated, see Note
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 (consisting only of 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", and SFAS No.
138 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 income.
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 and Minorities' Interests".
References herein to "we" or "our" refer to Xerox and consolidated subsidiaries
unless the context specifically requires otherwise.
2. Restatement:
We have restated our Consolidated Financial Statements for the three and six
month periods ended June 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 six months ended June 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 the imprudent and improper business
practices in Mexico, the acquisition contingencies associated with our
acquisition of the remaining ownership interest in Xerox Limited from the Rank
Group Plc, the 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)(in millions):
Three months Six months
ended June 30, ended June 30,
2001 2000 2001 2000
Increase (decrease) to pre-tax
income (loss):
Mexico $ - $ 82 $ - $ 48
Lease issues, net 15 23 28 50
Other, net - (17) 58 (22)
Total $ 15 $ 88 $ 86 $ 76
The following tables present the impact of the adjustments and restatements on
a condensed basis (in millions):
Previously As
Reported Restated
Statement of Operations:
Three months ended June 30, 2000
Revenues $ 4,688 $ 4,778
Costs and expenses 4,529 4,531
Net income (loss) before extraordinary gain
and cumulative effect of change in
accounting principle 145 202
Basic earnings per share $ 0.21 $ 0.29
Diluted earnings per share $ 0.19 $ 0.27
Previously As
Reported Restated
Statement of Operations:
Six months ended June 30, 2000
Revenues $ 9,119 $ 9,318
Costs and expenses 9,309 9,432
Net income (loss) before extraordinary gain
and cumulative effect of change in
accounting principle (98) (47)
Basic loss per share $ (0.17) $ (0.10)
Diluted loss per share $ (0.17) $ (0.10)
3. Inventories:
Inventories consist of the following (in millions):
June 30, December 31,
2001 2000
Finished products $ 1,051 $ 1,439
Work in process 141 147
Raw materials and supplies 374 346
Total $ 1,566 $ 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 to be
eliminated are in the U.S., 20 percent are in Europe, and the remainder are
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 ($47 after taxes), 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 quarter 2001 we recorded a net reversal to the March 2000
restructuring reserve of $7 ($6 after taxes). This included the reversal of
$43 of previously recorded charges and additional charges of $36. These
amounts relate to the adjustment of the originally recorded reserves based on
management's most recent estimate of the costs to complete previously announced
actions. There were no reversals recorded in the second quarter of 2001.
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 include: 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 in a manner that
does not involve the Xerox balance sheet, and over time will 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).
We are engaged in other activities that will enhance our liquidity. These
activities include asset sales, strategic alliances, securitizations, and the
sale or outsourcing of certain manufacturing operations.
Regarding the cost reductions, we have implemented actions that account for
more than 75 percent of our goal to reduce costs by at least $1.0 billion
annually. During the second quarter of 2001, and in connection with the
Turnaround Program, we recorded an additional pre-tax restructuring provision
totaling $41 ($35 after taxes), in connection with finalized initiatives under
the Turnaround Program. This charge consists of estimated costs for severance
associated with work force reductions related to the elimination of
approximately 700 positions worldwide. The severance costs relate to continued
streamlining of existing work processes, elimination of redundant resources and
the consolidation of existing activities into other existing operations.
The following table summarizes the status of the March 2000 Restructuring
Reserve and the Turnaround Program (in millions):
Charges
Original Net New Against 6/30/01
Reserve Reversals Actions(2) Reserve Balance
March 2000 restructuring:
Cash charges
Severance and
related costs $ 384 $ (66) - $ (279)(1) $ 39
Lease cancellation
and other costs 51 (12) - (37)(1) 2
Subtotal 435 (78) - (316) 41
Non-cash charges
Asset impairment 71 - - (71) -
Inventory charges 90 - - (90) -
Subtotal 161 - - (161) -
Subtotal March 2000 596 (78) - (477) 41
Turnaround Program:
Severance and related 71 - 138 (94)(1) 115
costs
Asset impairment 34 - 11 (45) -
Subtotal Turnaround 105 - 149 (139) 115
Grand Total $ 701 $ (78) 149 $ (616) $ 156
(1) Including the impact of currency translation adjustments.
(2) Year to date values for 2001.
At June 30, 2001, the ending reserve balance for the March 2000 restructuring
program is $41 and for the Turnaround Program is $115, resulting in a total
reserve balance of $156 as of June 30, 2001. The remaining reserve
relates to cash expenditures to be incurred primarily during 2001 and is
included in Other current liabilities.
In June 2001, the Ad Hoc Committee of the Board of Directors 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 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. The charges associated
with this action include approximately $37 in employee termination costs, $146
of asset impairments including facilities and equipment, $24 in inventory
charges, $25 in purchase commitments, $25 in decommitment costs, and $17 in
other miscellaneous charges. The SOHO disengagement reserve balance at
June 30, 2001 was $103.
5. Common Shareholders' Equity:
Common shareholders' equity consists of (in millions):
June 30, December 31,
2001 2000
Common & class B stock $ 717 $ 670
Additional paid-in-capital 1,842 1,556
Retained earnings 3,316 3,441
Accumulated other comprehensive
loss (1) (2,568) (2,174)
Total $ 3,307 $ 3,493
(1) Accumulated other comprehensive loss at June 30, 2001 is composed of
cumulative translation of $(2,506), minimum pension liability of
$(27),unrealized losses on marketable securities of $(16), and mark to market
losses on cash flow hedges of $(19).
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 income (loss) for the three months and six months ended June 30,
2001 and 2000 is as follows (in millions):
Three months ended Six months ended
June 30, June 30, June 30, June 30,
2001 2000 2001 2000
Net income (loss) $ (281) $ 202 $ (79) $ (47)
Translation adjustments (100) (169) (366) (134)
Unrealized gains (losses)on
marketable securities (11) - (9) 14
Cash flow hedge adjustments 5 - (19) -
Comprehensive income (loss) $ (387) $ 33 $ (473) $ (167)
6. Interest expense and income:
Interest expense totaled $264 and $247 for the three months ended June 30, 2001
and 2000, respectively, and $551 and $474 for the six months ended June 30,
2001 and 2000, respectively. Interest income totaled $235 and $239 for the
three months ended June 30, 2001 and 2000, respectively, and $477 and $475 for
the six months ended June 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 Ad Hoc Committee of the Board of
Directors 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 June 30,
2001 and 2000 is as follows (in millions):
Developing
Production Office SOHO Markets Other Total
2001
Revenues from external
customers $ 1,453 $ 1,709 $ 95 $ 435 $ 445 $ 4,137
Intercompany revenues - 5 - - (5) -
Total segment revenues $ 1,453 $ 1,714 $ 95 $ 435 $ 440 $ 4,137
Segment profit/
(loss) $ 147 $ 159 $ (79)$ (131)$ (234) $ (138)
2000
Revenues from external
customers $ 1,621 $ 1,829 $ 139 $ 644 $ 545 $ 4,778
Intercompany revenues - 5 - - (5) -
Total segment revenues $ 1,621 $ 1,834 $ 139 $ 644 $ 540 $ 4,778
Segment profit/
(loss) $ 246 $ 65 $ (57)$ 52 $ (15) $ 291
Operating segment profit/(loss) information for the six months ended June 30,
2001 and 2000 is as follows (in millions):
Developing
Production Office SOHO Markets Other Total
2001
Revenues from external
customers $ 2,897 $ 3,414 $ 215 $ 894 $ 919 $ 8,339
Intercompany revenues - 8 2 - (10) -
Total segment revenues $ 2,897 $ 3,422 $ 217 $ 894 $ 909 $ 8,339
Segment profit/
(loss)(1) $ 278 $ 224 $ (157)$ (204) $ (351) $ (210)
2000
Revenues from external
customers $ 3,133 $ 3,527 $ 300 $ 1,240 $ 1,118 $ 9,318
Intercompany revenues - 7 - - (7) -
Total segment revenues $ 3,133 $ 3,534 $ 300 $ 1,240 $ 1,111 $ 9,318
Segment profit/
(loss)(1) $ 483 $ 175 $ (106)$ 78 $ (73) $ 557
(1) The following is a reconciliation of segment profit/(loss) to total Company
Income (Loss) before Income Taxes (Benefits), Equity Income and Minorities'
Interest:
Three months Six months
ended June 30, ended June 30,
2001 2000 2001 2000
Total segment profit (loss) $ (138) $ 291 $ (210) $ 557
Restructuring:
Inventory charges (24) - (24) (90)
Restructuring charge and asset
impairments (291) 2 (391) (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 (30) (46) (32) (50)
Income (Loss) before Income Taxes
(Benefits),Equity Income and
Minorities' Interests $ (483) $ 247 $ 112 $ (114)
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 June 30, 2001 the balance of receivables transferred was $635
and is included in Finance receivables, net in the Consolidated Balance
Sheets. The remaining secured borrowing balance of $243 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.
Refer to Note 11 - Divestitures for a discussion of the sale of certain of our
European leasing businesses and Note 14 - Subsequent Events for a discussion of
the sale of certain finance receivables subsequent to June 30, 2001.
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) and SFAS 138 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 half:
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 result in our inability to obtain hedge accounting
treatment in accordance with SFAS No. 133. This will result in mark-to-market
valuation of these derivatives directly through earnings, which will lead to
increased volatility in our earnings.
During the second quarter and first half, the net effect from the mark-to-
market valuation of our interest rate derivatives recorded in earnings was not
material. However, the mark-to-market valuation of certain cross
currency interest rate swap agreements did result in a net gain/(loss) during
the second quarter and first half of $(12) and $12, respectively, which is net
of the remeasurement of the underlying foreign currency debt and is included in
Other, net.
As of May 2001, we designated certain cross currency interest rate swaps
associated with 65 billion in Yen borrowings as fair value type hedges and
accounted for them accordingly 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 earnings during the second quarter, was immaterial.
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 second
quarter and first half, 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 second quarter and first half,
$(9) and $17, 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:
In the first quarter 2001, we retired $122 of long-term debt through
the exchange of 15.5 million shares of common stock valued at $94. In
the second quarter 2001, we retired an additional $205 of debt
through the exchange of 20.7 million shares of common stock valued at $179.
The second quarter retirements resulted in a pre-tax extraordinary
gain of $30 ($18 after taxes) for a net equity increase of
approximately $197. For the six months, the retirements resulted in a
pre-tax extraordinary gain of $58 ($35 after taxes) for a net
equity increase of $308.
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 a 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 is appealing to the Court of Appeals for the Federal
Circuit. Accuscan is appealing the new trial grant which reduced the verdict
from $40 and seeking a reversal of the jury's finding of no willful
infringement. On May 31, 2001 the U.S. Court of Appeals for the federal circuit
ruled that the Company did not infringe the patent and reversed this judgment
for Accuscan. On June 11, 2001 Accuscan filed a petition for a rehearing.
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. The defendants' motion for dismissal of the complaint is
pending. 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. Two separate actions have been filed in that court on
behalf of the Company against all current members of the Board of Directors
(with the exception of Anne M. Mulcahy) and G. Richard Thoman (in one of the
actions) and the Company, as a nominal defendant. Another, now dismissed,
putative shareholder derivative action was pending in the United States
District Court for the District of Connecticut. Plaintiffs claim breach of
fiduciary duties and/or gross mismanagement related to certain of the alleged
accounting practices of the Company's operations in Mexico. The complaints in
all three actions alleged that the individual named defendants breached their
fiduciary duties and/or mismanaged the Company by, among other things,
permitting wrongful business/accounting practices to occur and in-adequately
supervising and failing to instruct employees and managers of the Company. In
one of the New York actions it is claimed that the individual defendants
disseminated or permitted the dissemination of misleading information. In the
other New York action it is also alleged that the individual defendants failed
to vigorously investigate potential and known problems relating to accounting,
auditing and financial functions and to take affirmative steps in good faith to
remediate the alleged problems. In the federal action in Connecticut it was
also alleged that the individual defendants failed to take steps to institute
appropriate legal action against those responsible for unspecified wrongful
conduct. Plaintiffs claim that the Company has suffered unspecified damages.
Among other things, the existing complaints in the (now consolidated) New York
actions seek unspecified monetary damages, removal and replacement of the
individuals as directors of the Company and/or institution and enforcement of
appropriate procedural safeguards to prevent the alleged wrongdoing.
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. Plaintiffs have indicated that they
intend to file and serve a consolidated amended complaint. On August 2, 2001
the Commonwealth Court of Pennsylvania issued an order which, among other
things, purports 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 action. With respect to suits filed outside the
Commonwealth of Pennsylvania and in the federal courts, the order purports to
request comity to effectuate the stay in the court where the matter is pending.
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, purports 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. With respect to suits filed
outside the Commonwealth of Pennsylvania and in the federal courts, the order
purports to request comity to effectuate the stay in the court where the matter
is pending. 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 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 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 Securities and Exchange Commission
(SEC) had entered an order of a formal, non-public investigation into our
accounting and financial reporting practices in Mexico and other areas. We are
cooperating fully with the SEC. The Company cannot predict when the SEC will
conclude its investigation or its outcome.
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 denies any
wrongdoing and intends to vigorously defend the action.
Note 13 - New Accounting Pronouncement
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. The
Company recognized $15 of goodwill amortization expense in the second quarter
of 2001 and $30 in the first half 2001. The statement also requires an
evaluation of existing acquired goodwill and other intangible assets for proper
classification under the new requirements. The Company is currently evaluating
the impacts of this new standard on our financial statements. The Company will
adopt this standard, as required, in 2002.
Note 14 - Subsequent Events:
In July 2001, we completed the offering of $513 of floating rate asset
backed notes and received cash proceeds of $483 million. 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 $628 of domestic finance receivables to a qualified
special purpose entity in which we have a retained interest of approximately
$148, including the cash proceeds held in reserve. The transaction will be
accounted for as a sale of finance receivables.
In July 2001, the Board of Directors decided to eliminate the payment of
dividends on the Company's common stock. Additionally the Board of Directors
chose not to declare the dividend on the Employee Stock Ownership Program
(ESOP) preferred stock. Instead we will make an additional contribution to the
ESOP trust.
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 June 30, 2000. All dollar and per share amounts
and financial ratios have been revised, as appropriate, for the effects of the
restatement.
Total second quarter 2001 revenues of $4.1 billion declined 13 percent (12
percent pre-currency) from $4.8 billion in the 2000 second quarter. 2001
second quarter year over year pre-currency revenue declines of 4 percent in
North America and 7 percent in Europe reflected in part, a weakened economic
environment that impacted equipment sales. Developing Markets Operations second
quarter 2001 revenues were 33 percent below the 2000 second quarter as we
reconfigure our Latin American Operations to a new business approach
prioritizing cash and profitable revenue.
Total revenues in the first half 2001 of $8.3 billion declined 11 percent (9
percent pre-currency) from $9.3 billion in the first half 2000. 2001 year to
date pre-currency revenue declines of 1 percent in North America and 5 percent
in Europe were the result of a weak economic environment partly offset by
stabilization of the U.S. direct sales force.
Including a $196 million after-tax charge associated with the company's
disengagement from the small office/home office (SOHO) business, an additional
net after-tax restructuring provision of $35 million associated with the
company's previously announced Turnaround Program and an $18 million after tax
gain on early retirement of debt, the second quarter 2001 net loss was $281
million. Excluding all these special items, the second quarter 2001 loss was
$68 million including a loss of $56 million in our worldwide SOHO operations
from which we have recently announced our disengagement. Second quarter 2000
net income was $202 million. The 2001 second quarter loss reflected the
revenue decline as well as a gross margin decline partially offset by lower
selling, administrative and general expenses (SAG) reflecting the continuing
benefits from our Turnaround Program.
The 2001 first half net loss was $79 million compared to a net loss of $47
million in the first half 2000. 2001 special items included the following
after-tax charges - $196 million associated with the company's disengagement
from the SOHO business, $96 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 $35
million associated with the early retirement of debt. 2000 special items
include a $423 million after tax restructuring provision and a $19 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 first half 2001 net loss was
$120 million compared with net income of $394 million in the 2000 first half.
Including the $0.28 SOHO disengagement charge, $0.05 restructuring provision
and the $0.03 gain from the early retirement of debt, our loss per share was
$0.40 in the 2001 second quarter. Excluding these items the second quarter
2001 loss per share was $0.10 compared with $0.27 earnings per share in the
2000 second quarter.
Including the $0.28 SOHO disengagement charge, $0.14 restructuring provision,
$0.43 gain on the sale of Fuji Xerox, and $0.05 gain from the early retirement
of debt, the first half 2001 loss per share was $0.13. The first half 2000
loss per share was $0.10 including charges of $0.66 for restructuring and
acquired CPID in-process R&D. Excluding all special items, the 2001 first half
loss per share was $0.19 compared with $0.56 earnings per share in the 2000
first half.
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 Six months
ended June 30, ended June 30,
2001 2000 2001 2000
Impact on pre-tax
income (loss):
Provisions for doubtful accounts $(123) $(134) $(215) $(245)
Provisions for obsolete and excess
inventory (63) (34) (121) (62)
Revenue allocations (16) 22 (17) 33
Finance discount rates ( 9) 5 (18) 22
The 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 6
percent stronger in the 2001 second quarter than in the 2000 second quarter.
As a result, currency translation had an unfavorable impact of approximately
two percentage points on revenue growth.
Segment Analysis
Revenues and year-over-year revenue growth rates by segment are as follows
(Dollars are in billions):
Q2 2001
Post Currency
2000 Pre-Currency Revenue Growth
Full
Year 2000 2001
Revenues Q1 Q2 Q3 Q4 FY Q1 Q2 Revenues Growth
Total Revenues $18.7 8% -% (2)% (9)% (1)% (5)% (12)% $4.1 (13)%
Production 6.3 1 (2) (8) (12) (6) (2) (8) 1.5 (10)
Office 7.1 4 5 4 (3) 2 3 (5) 1.7 (6)
SOHO 0.6 35 (3) (2) 1 6 (24) (30) 0.1 (31)
DMO 2.5 36 4 (3) (21) - (21) (31) 0.4 (33)
Other 2.2 7 (9) (1) (4) (2) (16) (17) 0.4 (19)
Memo: Color 2.9 64 60 74 54 62 17 1 0.7 (1)
YTD 2001
Revenue Growth
Pre Post
Revenues Currency Currency
Total Revenues $8.3 (9) % (11)%
Production 2.9 (5) (7)
Office 3.4 (1) (3)
SOHO 0.2 (27) (28)
DMO 0.9 (27) (28)
Other 0.9 (17) (19)
Memo: Color 1.4 8 5
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. Second quarter 2001 revenues declined 10 percent (8 percent pre-
currency). Monochrome production revenues declined reflecting the weaker
economic environment and continued movement to distributed printing and
electronic substitutes. Post equipment install revenues continue to be
adversely affected by reduced equipment placements in earlier quarters.
Production color revenues grew modestly reflecting continued strong sales of
the successful DocuColor 2000 series which began shipments in June, 2000,
partially offset by DocuColor 30/40 and mid-range color revenue declines.
Production revenues represented 35 percent of second quarter 2001 revenues
compared with 34 percent in the 2000 second quarter. Second quarter 2001 gross
margin for the production segment declined from the 2000 second quarter
primarily as a result of the greater proportion of our gross profits from lower
margin color equipment sales.
Production revenues declined 7 percent (5 percent pre-currency) in the first
half 2001 from the first half 2000 due to a weaker economic environment and
continued movement to distributed printing and electronic substitutes. Strong
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, 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. Second quarter 2001 revenues declined 6 percent (5 percent pre-
currency) from the second quarter 2000. Black and white copying revenues
declined as strong Document Centre installations, including the Document Centre
480 which prints and copies at 75 pages per minute, was more than offset by
increased pricing pressures, continued 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 marketshare to
profitable revenue. Shipments of the recently announced Document Centre 490,
the fastest in its class at 90 pages-per-minute will begin in September.
Excellent 2001 second quarter monochrome laser printing revenue growth
reflected excellent equipment sales and supplies revenue growth. Good office
color revenue growth was driven by continued excellent placements and strong
Document Centre ColorSeries 50 recurring revenue growth. The Document Centre
ColorSeries 50 is the industry's first color-enabled digital multi-function
product. Office revenues represented 41 percent of second quarter 2001 revenues
compared with 38 percent in the 2000 second quarter. Second quarter 2001
gross margin for the office segment improved from the 2000 second quarter
primarily as a result of stabilizing Document Centre margins, facilitated by
strong Document Centre 480 placements, and improvements in laser and solid ink
printers.
Office revenues decreased 3 percent (one percent pre-currency) in the first
half 2001 from the first half 2000 as modest black and white copying revenue
declines were only partially offset by strong office color revenue growth.
Small Office/Home Office (SOHO) revenues include inkjet printers and personal
copiers sold through indirect channels in North America and Europe. On June 14
we announced our disengagement from the worldwide SOHO business. Second quarter
2001 SOHO revenues declined 31 percent (30 percent pre-currency) from the 2000
second quarter and declined 28 percent (27 percent pre-currency) in the first
half 2001 from the first half 2000. Gross margin declined significantly in a
very difficult market environment. SOHO revenues represented 2 percent of
second quarter 2001 revenues and 3 percent of the first half 2001 revenues
compared with 3 percent in the 2000 second quarter and 3 percent in the first
half 2000.
Developing Markets Operations (DMO) includes operations in Latin America,
Russia, India, the Middle East and Africa. Second quarter 2001 revenue declined
significantly in Brazil from the 2000 second quarter reflecting reduced
equipment placements and lower prices as the company focused on reducing
inventory and transitioning its business model to maximize cash rather than
market share, compounded by a 21 percent devaluation in the Real. Second
quarter and first half 2000 revenues in Brazil included structured
transactions, as discussed below, of $35 million and $81 million, respectively;
there were no similar arrangements in the 2001 second quarter and first half.
Revenue declined throughout the other Latin American countries due to weaker
economies and our decision to focus on cash and profitable revenue generation
rather than market share. The Middle East and Africa had good revenue growth in
the 2001 second quarter and Russia had excellent revenue growth. DMO incurred
a substantial pre-tax loss in the second quarter 2001. Gross margin declined
in DMO as a result of lower equipment and service margins primarily due to an
increased competitive environment, currency devaluation not offset by price
increases, lower selling prices as we focused on reducing inventory, weak mix,
and the absence of any structured transaction in Brazil.
DMO revenues decreased 28 percent (27 percent pre-currency) in the first half
2001 from the first half 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 20
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 no sales of equipment
subject to operating leases in North America in either the first half 2001 or
2000. The reduction of operating lease revenues as a result of prior year
sales of equipment on operating leases was $9 million and $18 million in the
second quarter of 2001 and 2000, respectively and $21 million and $36 million
in the first half 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 Six months
Ended June 30, Ended June 30,
2001 2000 2001 2000
Sales of equipment $ - $ 35 $ - $ 81
Reduced Operating Lease Revenue (30) (31) (62) (57)
Net revenue impact $ (30) $ 4 $ (62) $ 24
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.
Key Ratios and Expenses
The trend in key ratios was as follows:
2000 2001
Q1 Q2 Q3 Q4 FY Q1 Q2 YTD
Gross Margin 39.1%* 40.4% 35.0% 35.1% 37.4%* 33.6% 35.8%** 34.7%**
SAG % Revenue 28.0 28.8 31.7 32.2 30.2 27.4 30.6 29.0
*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 and
35.0 percent for the first half 2001.
Including inventory charges associated with the SOHO disengagement, the second
quarter 2001 gross margin declined by 4.6 percentage points from the 2000
second quarter. Excluding these charges, the second quarter 2001 gross margin
of 36.4 percent declined by 4.0 percentage points from the 2000 second quarter.
Approximately 2 percentage points of the year over year decline were due to
weak performance in Developing Markets Operations. Increased SOHO price
pressures and unfavorable mix resulted in one percentage point of the decline.
Cost savings and productivity improvements resulting from our Turnaround
Program offset increased pricing pressures. Improved asset management
practices, lower activity levels and unfavorable mix adversely impacted gross
margin. Excluding the gross margin in the SOHO operations, the gross margin in
the 2001 second quarter was 38.1 percent.
Including inventory charges associated with the SOHO disengagement, the gross
margin was 34.7 percent for the first half 2001, a decline of 5.1 percentage
points from the first half 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 first half
2001 gross margin was 35.0 percent compared to 40.8 percent in the first half
2000. Approximately 2 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. The first half 2000 gross margin benefited by
approximately 0.5 percentage points from increased licensing and stand-alone
software revenues associated with the licensing of a number of patents from our
intellectual property portfolio.
Selling, administrative and general expenses (SAG) declined 8 percent (7
percent pre-currency) in the 2001 second quarter from the second quarter 2000.
2001 first half SAG declined 9 percent (7 percent pre-currency) from the 2000
first half. SAG declines in both the second quarter and first half reflect
continued benefits from our Turnaround Program including significantly lower
labor costs and advertising and marketing communications spending. These
reductions were partially offset by second quarter 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. Second quarter
and first half 2001 bad debt provisions of $123 million and $215 million,
respectively, were $12 million and $30 million lower than the 2000 second
quarter and first half. In the 2001 second quarter, SAG represented 30.6
percent of revenue compared with 28.8 percent of revenue in the 2000 second
quarter. First half 2001 SAG represented 29.0 percent of revenue compared with
28.4 percent of revenue in the 2000 first half.
Research and development (R&D) expense was $5 million lower in the 2001 second
quarter and $11 million lower in the 2001 first half compared to the 2000
second quarter and first half. The decrease in R&D is due to lower inkjet
spending in our SOHO operations reflecting our disengagement from this
business. R&D spending was 6 percent of revenue in both the 2001 second quarter
and first half 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 6,600 in the 2001 second quarter and
first half respectively to 85,600 primarily as a result of employees leaving
the company under our restructuring programs. Excluding divestitures,
worldwide employment has declined by 8,600 since implementation of our
Turnaround Program in October, 2000.
Other, net was $161 million in the 2001 second quarter compared to $54 million
in the second quarter 2000. Second quarter 2000 results benefited from gains
of $75 million associated with the sale of the North American commodity paper
business and sales of other assets. In the second quarter 2001 we incurred $14
million of net currency losses resulting from the remeasurement of unhedged
foreign currency-denominated assets and liabilities and $6 million of mark-to-
market losses recorded as a result of the new accounting required under FAS
133. Due to the inherent volatility in the foreign currency markets, the
company is unable to predict the amount of any such mark-to-market gains or
losses in future periods. Second quarter 2001 net non-financing interest
expense of $90 million was $3 million lower than the 2000 second quarter.
The 2001 first half increase in Other, net of $92 million was primarily due to
an increase of $32 million in net non-financing interest expense, a $39 million
increase in Brazilian indirect taxes and gains in the first half 2000 of $75
million associated with the sale of the North American commodity paper business
and sales of other assets partially offset by $27 million of net currency gains
resulting from the remeasurement of unhedged foreign currency-denominated
assets and liabilities, $16 million of mark-to-market gains recorded as a
result of the new accounting required under FAS 133 and an $8 million credit to
adjust the remaining 1998 restructuring reserves.
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
second quarter of 2001 we provided an incremental $41 million to complete our
open initiatives under the Turnaround plan. For the first half, we have
provided a total of $141 million under this plan. We expect additional
provisions will be required in 2001 as additional plans are finalized. The
restructuring reserve balance at June 30, 2001 for both the Turnaround Program
and the March 2000 program amounted to $156 million.
In June 2001, the Ad Hoc Committee of the Board of Directors approved the
disengagement from our SOHO business. In connection with this disengagement,
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. The charges associated
with this action include approximately $37 million in employee termination
costs, $146 million of asset impairments, $24 million in inventory charges, $25
million in purchase commitments, $25 million in decommitment costs, and $17
million in other miscellaneous charges. The SOHO disengagement reserve balance
at June 30, 2001 was $103 million.
Over the remainder of the year 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
Pre-tax income (loss) was $(483) million in the 2001 second quarter including
the SOHO disengagement and Turnaround restructuring provisions. Excluding these
items, the pre-tax loss was $(169) million in the 2001 second quarter. The 2000
second quarter pre-tax income of $247 million included a $2 million
restructuring credit.
Including the effect of special items, pre-tax income was $112 million in the
2001 first half compared to a $(114) million loss for the first half 2000.
Excluding special items, the pre-tax loss was $(250) million for the first half
2001 compared to pre-tax income of $507 million for the first half 2000.
2001 special items included a charge of $274 million related to the SOHO
disengagement, a $133 million net charge in connection with our existing
restructuring programs and a gain of $769 million related to the sale of our 25
percent ownership in Fuji Xerox. In the 2000 first half, 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 tax benefit related to the SOHO
disengagement provision and the additional restructuring provision, was 33.2
percent in the 2001 second quarter. Excluding special items and other tax
adjustments, the underlying 2001 second quarter and first half tax rates were
42.0 percent compared to 32.0 percent in the 2000 second quarter. The increase
in the underlying effective tax rate from 32.0 percent to 42.0 percent in 2001
is due primarily to continued losses in a low-tax rate jurisdiction.
Equity in net income of unconsolidated affiliates is principally our 25 percent
share of Fuji Xerox income. Total equity in net income declined by $16 million
and $18 million in the 2001 second quarter and first half, respectively, due to
our reduced ownership in Fuji Xerox. Our share of total Fuji Xerox net income
of $29 million and $34 million in the 2001 second quarter and first half,
respectively, decreased by $19 million and $20 million from the 2000 periods.
In the first quarter 2001, we retired $122 million of long-term debt through
the exchange of 15.5 million shares of common stock valued at $94 million. In
the second quarter 2001, we retired an additional $205 million of debt through
the exchange of 20.7 million shares of common stock valued at $179 million.
The second quarter retirements resulted in a pre-tax extraordinary gain of $30
million ($18 million after taxes) for a net equity increase of approximately
$197 million. For the six months, the retirements resulted in a pre-tax
extraordinary gain of $58 million ($35 million after taxes) for a net equity
increase of $308 million.
We adopted Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities" (SFAS No. 133), and SFAS No.
138, as of January 1, 2001. Upon adoption of SFAS 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 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 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.
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 June 30, 2001, cash on hand was $2,177 million versus $1,741 million at
December 31, 2000, and total debt was $16,266 million versus $18,097 million at
December 31, 2000. Total debt, net of cash on hand (Net Debt), decreased by
$2,267 million in the first six months of 2001 versus an increase of $2,551
million in the first six months of 2000. As of June 30, 2001, Net Debt has
decreased by $2,954 million since our Turnaround Program was initiated on
September 30, 2000.
The consolidated ratio of total debt to common and preferred equity was 4.1:1
as of June 30, 2001 compared to 4.4:1 at 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 June 30,
2001 and December 31, 2000 been reduced to historical levels by paying off
debt, the debt to equity ratio would have been approximately 3.6:1 and 4.0:1,
respectively.
We historically managed the capital structures of our non-financing operations
and our captive financing operations separately. We have announced our intent
to exit customer equipment financing as part of our global Turnaround Program,
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
six months ended June 30, 2001 and 2000:
2001 2000
Loss from continuing operations $ (79) $ (47)
Income tax provision (benefit) 265 (40)
Depreciation and amortization 462 453
Restructuring charges 407 594
Interest expense 551 474
Gains on sales of businesses (754) (63)
Other items (4) 53
EBITDA 848 1,424
Less financing and interest income (477) (475)
Adjusted EBITDA 371 949
Working capital and other changes 437 (1,456)
On-Lease inventory spending (123) (246)
Capital spending (121) (240)
Restructuring payments (265) (131)
Financing cash flow, net of interest 90 (507)
Operating Cash Flow (Usage)* 389 (1,631)
Dividends (93) (294)
Proceeds from sales of businesses 1,635 50
Acquisitions - (856)
Other non-operating items (300) (34)
Debt borrowings (repayments), net (1,195) 2,759
Net Change in Cash $ 436 $ (6)
*The primary variation from cash flow from operations as reported on the
Consolidated Statement of Cash Flows is the inclusion above of capital
spending as an operational use of cash.
Operating cash flow improved by approximately $2.0 billion, to $389 million in
the first six months of 2001 versus $(1,631) million usage in the prior year
period. A major portion of the improvement was driven by significant reductions
in working capital. Lower EBITDA, reflecting weaker operating results, and
higher restructuring payments were offset by improvements in financing cash
flow and lower investments in on-lease equipment and capital spending. The
working capital improvements stem largely from reductions in accounts
receivable, inventories, and tax payments in the first six months of 2001
compared to the same period in 2000. The inventory reduction reflects
management actions to improve inventory turns, and changes in the supply/demand
and logistics processes. We expect to continue to reduce inventory levels in
2001. The accounts receivable decrease reflects progress in our efforts to
reduce average days' sales outstanding, which effort has been hampered by the
persisting effects of changes we made in 1998 to the U.S. customer
administration centers. The significant 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 2001 capital spending to be
approximately 30 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 2001. The increase in financing cash flow, net in 2001
reflects the lower equipment sales in the first six months of 2001 versus the
year ago period, which resulted in a lower level of finance receivable
originations. This improvement was partially offset by an increase in interest
costs in 2001.
Cash restructuring payments of $265 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.
Other non-operating cash usage in the first six months of 2001 totaled $300
million, including a premium payment of $45 million to Ridge Reinsurance. The
remaining $255 million of non-operating cash usage related to our replacement
of Ridge Reinsurance letters of credit. In April 2001, letters of credit
totaling $660 million, which supported Ridge Reinsurance ceded reinsurance
obligations, were replaced with trusts collateralized by the Ridge Reinsurance
investment portfolio of approximately $405 million plus cash of $255 million.
The Ridge Reinsurance investment portfolio is included in Intangible and Other
Assets in our Consolidated Balance Sheets.
In the first six months of 2001, we generated approximately $1.7 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. Net of
amounts paid to Ridge Reinsurance, these asset sales, together with the
previously announced dividend reductions, the significant improvement in
operating cash flow, and the non-cash exchange of $328 million of debt for
equity described below, enabled us to reduce Net Debt by $2,267 million. In the
comparable 2000 period, the significant operating cash usage, together with the
acquisition of the Color Printing and Imaging Division of Tektronix, Inc.,
resulted in an increase in Net Debt of $2,551 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 2000, the agencies that assign ratings to our debt downgraded the
Company's senior and short-term debt several times. As of August 7, 2001,
debt ratings by Moody's are Ba1 and Not Prime, respectively, and the ratings
outlook is negative; debt ratings by Fitch are BB and B, respectively, and the
ratings outlook is stable; and debt ratings by Standard and Poors (S&P) are
BBB- and A-3, respectively, and the ratings outlook is negative. 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 and our
affiliates. We expect this to result in higher borrowing costs going forward.
This may also result in our having to increase our level of intercompany
lending to affiliates.
Consequently, 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 June 30, 2001, our CTNW was $489
million in excess of the minimum requirement, a decrease of $111 million from
the December 31, 2000 level. Further operating losses, restructuring costs and
adverse currency translation adjustments would erode this excess, while
operating income, gains on asset sales, additional exchanges of debt for
equity, and favorable currency translation would improve this excess.
As of June 30, 2001, we had approximately $1.4 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 $0.4 0.1
Fourth Quarter 1.0 7.6*
Full Year $1.4 $9.0
* Includes $7.0 billion maturity under the Revolver
In the first six months of 2001, we retired $328 million of long-term debt
through the exchange of 36.1 million shares of common stock of the Company,
which increased CTNW by approximately $308 million.
We do not have any other material obligations scheduled to mature in 2001
unless our debt ratings are further downgraded as discussed below.
We are implementing a global Turnaround Program which includes initiatives to
reduce costs on an annualized basis by at least $1 billion by the end of 2001,
improve operations, and sell certain assets. We believe these actions will
positively affect our capital resources and liquidity position when completed.
In connection with these initiatives, we announced and completed the sale of
our China operations to Fuji Xerox Co., Ltd. ("Fuji Xerox") in the fourth
quarter of 2000, which generated $550 million of cash and transferred debt of
$118 million 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.
We have initiated discussions to implement third-party vendor financing
programs which, when implemented, 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 portfolio, 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.
As of June 30, 2001, the remaining balance of this secured borrowing was $243
million. 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 certain
retained interests. 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, Xerox Corporation sold $513 million of asset-backed
securities, supported by domestic finance receivables, for cash proceeds
of $483 million and certain retained interests.
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. Should we be unable to
successfully complete these initiatives on a timely or satisfactory basis, we
will need to obtain additional sources of funds through other operating
improvements, financing from third parties, additional asset sales, 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 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.
To minimize the resulting exposures, we also voluntarily terminated other
derivative agreements. At June 30, 2001, the remaining derivative portfolio had
a net positive value to us of $33 million. Should our debt ratings be
downgraded by Standard and Poors to below investment grade, we may be required
to repurchase certain of the out-of-the-money derivative agreements currently
in place, in the approximate aggregate amount as of June 30, 2001 of $124
million. However, it is also possible that some counterparties may require, or
agree to, the repurchase of certain of the in-the-money derivatives currently
in place, which could reduce or eliminate this cash requirement.
There is no assurance that our credit ratings will be maintained, or that the
various counterparties to derivative agreements would not require us to
repurchase the obligations in cases where the agreements permit such
termination.
In December 2000, as a result of the debt downgrade discussed above, Xerox
Corporation renegotiated a $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 debt is downgraded to or below BB
by S&P and Ba2 by Moody's, at which time we would seek to renegotiate the terms
of the facility.
As of December 31, 2000, 0.8 million equity put options were outstanding, at a
strike price of approximately $41 per share. In January 2001, we paid $28
million to settle these put options, which we funded by issuing 5.9 million
unregistered common shares.
On May 10, 2001, a European affiliate of Xerox Corporation convened a meeting
of holders of its GBP 125 million 8-3/4 percent Guaranteed Bonds, issued in
1993 and maturing in 2003 (the "Bonds"), which are guaranteed by Xerox Limited,
in order to consider a proposal to repay the Bonds early at par plus accrued
interest. Repaying the Bonds early would reduce outstanding indebtedness and
interest costs, and would eliminate 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. At the May 10 meeting, the Bondholders rejected the
proposal to repay the Bonds early. Therefore, the Bonds remain outstanding. We
are maintaining cash of $194 million in a trust, which represents the par value
plus one year's interest on the Bonds. We can withdraw this cash upon 21 days'
written notice to the trustee.
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 ability to employ that strategy effectively has been severely
limited. Any future downgrades of our debt could further limit our ability to
execute this risk management strategy effectively.
Currency derivatives are primarily arranged in conjunction with underlying
transactions that give rise to foreign currency-denominated payables and
receivables. For example, we would purchase an option to buy foreign currency
to settle the importation of goods from foreign suppliers denominated in that
same currency, or a forward exchange contract to fix the dollar value of a
foreign currency-denominated loan.
Our primary foreign currency market exposures include the Japanese Yen, Euro,
Brazilian Real, British Pound Sterling and Canadian Dollar. In order to manage
the risk of foreign currency exchange rate fluctuations, we have historically
hedged a significant portion of all cross-border cash transactions denominated
in a currency other than the functional currency applicable to each of our
legal entities. From time to time (when cost-effective) foreign-currency debt
and foreign-currency derivatives are used to hedge international equity
investments. Consistent with the nature of economic hedges of such foreign
currency exchange contracts, associated unrealized gains or losses would be
offset by corresponding changes in the value of the underlying asset or
liability being hedged.
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.
We refer to the effect of these conservative practices as "match funding"
customer financing assets. This practice effectively eliminates the risk of a
major decline in interest margins during a period of rising interest rates.
Conversely, this practice effectively eliminates the opportunity to materially
increase margins when interest rates are declining.
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. The potential risk attendant
to this strategy is the non-performance of the swap counterparty. We address
this risk by arranging swaps with a diverse group of strong-credit
counterparties, regularly monitoring their credit ratings and determining the
replacement cost, if any, of existing transactions.
Many of the financial instruments we use are sensitive to changes in interest
rates. Hypothetically, interest rate changes result in gains or losses related
to the market value of our term debt and interest rate swaps due to differences
between current market interest rates and the stated interest rates within the
instrument.
Our currency and interest rate hedging are typically unaffected by changes in
market conditions as forward contracts, options and swaps are normally held to
maturity consistent with our objective to lock in currency rates and interest
rate spreads on the underlying transactions.
As described above, the downgrades of our debt during 2000 significantly
reduced our access to capital markets. Furthermore, the specific downgrade of
our debt on December 1, 2000 triggered the repurchase of a number of derivative
contracts which were in place at that time, and further downgrades could
require us to repurchase additional outstanding contracts. Therefore, our
ability to continue to effectively manage the risks associated with interest
rate and foreign currency fluctuations, including our ability to continue
effectively employing our match funding strategy, is severely constrained, 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 33-34 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 June 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 April 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 $94,875), based upon the
market value on the date of issuance, in payment of the
quarterly Directors' fees pursuant to Registrant's
Restricted Stock Plan for Directors.
(4) Exemption from registration under the Act was claimed based
upon Section 4(2) as a sale by an issuer not involving a
public offering.
(b) In addition, during the quarter ended June 30, 2001, Registrant issued an
aggregate of 20,658,067 shares of Common Stock in the following transactions,
all of which were not registered under the Act by reason of the exemption from
registration under the Act provided by Section 3(a)(9) of the Act:
Date issued ... May 23 May 29 June 12 June 14 June 14 June 15
Aggregate amount
of consider-
ation received
by Registrant ..$ 6,000,000 $ 7,790,000 $21,930,000 $12,000,000 $11,225,000 $12,280,000
Aggregate number
of shares
of Common
Stock
issued by
Registrant .. 485,459 679,236 1,885,549 1,101,904 1,044,393 1,110,204
Aggregate value
of Common
Stock
delivered by
Registrant ..$ 5,230,000 $ 7,011,000 $19,413,050 $10,545,000 $ 9,990,250 $9,660,000
Names of the
principal
underwriters ... None None None None None None
Date issued ... June 21 June 18 June 21 June 19 June 26 June 27
Aggregate amount
of consider-
ation received
by Registrant ..$10,000,000 $12,900,000 $18,420,000 $11,842,000 $33,500,000 $11,535,000
Aggregate number
of shares
of Common
Stock
issued by
Registrant . .1,038,933 1,317,679 1,736,993 1,221,773 3,637,520 ,322,173
Aggregate value
of Common
Stock
delivered by
Registrant ..$ 8,787,500 $11,545,500 $14,700,000 $10,545,000 $29,150,000 10,275,000
Names of the
principal
underwriters ... None None None None None None
Date issued ... June 29 June 29 June 29
Aggregate amount
of consider-
ation received
by Registrant ...$12,000,000 $12,000,000 $12,000,000
Aggregate number
of shares
of Common
Stock
issued by
Registrant ... 1,340,218 1,361,386 1,374,647
Aggregate value
of Common
Stock
delivered by
Registrant ...$10,395,000 $10,560,000 $10,470,000
Names of the
principal
underwriters ... None None 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 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
August 1, 2001.
Exhibit 10 (b) Registrant's 1991 Long-Term Incentive Plan, as amended
through October 9, 2000.
Exhibit 10 (t) Form of Salary Continuance Agreement entered into with
certain executive officers.
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 April 2, 2001, April 4, 2001, April 19,
2001, May 8, 2001, May 30, 2001 and June 14, 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/ Gregory B. Tayler
_____________________________
Date: August 13, 2001 By Gregory B. Tayler
Vice President and Controller
(Principal Accounting Officer)